Optimal Trading System
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Hi, In today’s video, we discuss how you can grow your trading account rapidly through swing trading. If you are new to swing trading, this introduction could be for you.
In swing trading, the trader aims to capture short-to-mid-term moves in a financial instrument. These moves last for a few days to several weeks and traders generally use technical analysis to enter and exit their positions.
Different traders have different ways of swing trading. Some are trend followers and trade the continuation of a trend. These traders try to capture a small part of a large move on either side, long or short. The other category of trader is a reversal or range trader, who either profit from range-bound prices or buy when the price approaches a support zone and sell when it enters a resistance zone.
As with all things in the market, all swing trades can’t be profitable. In fact, for the best of traders, less than half of their trades are profitable. However, the winners tend to be bigger than the losers, creating a favorable risk-reward outcome over a large sample of trades, and that’s the foundation of profitability.
There are four main aspects that must be considered when compounding your capital through swing trading.
The trading system must have positive expectancy. You should have clear position sizing rules, stop loss, and profit taking rules. And equally as important, you must maintain discipline.
Let’s elaborate on these aspects, starting with a trading system with positive expectancy.
A profitable trading system is built on two key parameters.
1. Success rate or strike rate
and
2. Average reward-to-risk
There can be numerous permutations and combinations of these two parameters for profitable trading. For example, if you take 5 positions in a trading system that has an 80% success rate, and a reward-to-risk ratio of 1, you can achieve a return of over 70% on your account when you eventually make 50 trades, even if you lose 10% on a losing trade and win the same 10% on the winning trade.
If however, you drop the success rate to 50% and maintain other metrics, you will break even but lose when trading costs are considered. With a success rate of 40%, the returns will drop to negative 20%.
On the flip side, with a success rate of 40%, if you can maintain a reward-to-risk of 2.5 to 1, equal to gaining 25% on winning trades and losing 10% on losing trades, you can achieve a return of over 40% over a series of 50 trades. With a 5% strike rate increasing to 45%, the return would go to over 70%.
Therefore, the key to compounding your capital with swing trading is to adopt a trading system that either has a high success rate, or a high reward-to-risk ratio, a combination of both would of course be even better.
To help you visualize how equity could grow through a system of positive expectancy, you can see my stats over the last eight years. You can see that currently I have just under a 50% success rate but with a reward-to-risk ratio of almost 4 to 1.
Such stats resulted in this equity curve. Remember however, the hidden factor is having the discipline to follow the rules during periods of lackluster performance.
The ability to stay disciplined is ultimately dependent on your personality. If you like to take quick profits, you must have a high success rate. Or, if you are patient and can wait for bigger gains, you can be profitable with a lower success rate.
For example, legendary trader KRISTJAN KULLAMÄGI whom we covered in a previous video, maintains a low success rate of near 25%, but the winners far outpace the losers, therefore helping him create 3-digit percentage returns on overall capital.
On the other hand, another legendary trader Mark Minervini, who also produces huge returns, works with a better success rate of near 45%, but the average reward to risk is much smaller than KULLAMÄGI’s. Both traders have different trading systems, but similar returns through trading.
The bottom line is you need to be clear on the game you are playing, quick profits and a high success rate or large profits and a low success rate. Whichever system you choose, you must give it enough time for the positive expectancy to materialize, therefore your discipline must be on point.
Another point to consider here is that the success rate will also fluctuate based on the overall condition of the market. Long positions will have a better chance of success in a bull market and shorts will have a better chance of success in bear markets. Therefore, you should adapt your approach to the changing market environment.
Let’s get to the next important aspect of swing trading, which is position sizing.
In any form of trading, you must find a balance between being too concentrated and too diversified. If you concentrate too much, you risk losing a large part of your capital if you hit a few stop losses in a row. On the other hand, if you diversify too much, you might not gain much on the few highly profitable trades.
The optimum number of trading positions at a time could perhaps be between 4 and 8 trades. You could however take this number up to 16 if you have enough capital and experience to manage higher volume.
There is often simple math behind position sizing philosophy.
A 10% return on a 5% position size delivers a 0.5% return at the portfolio level, while the same return on a 25% position size delivers a 2.5% return on overall capital. To double your account with 5% position sizing through compounding, you would need 145 trades, while you would only need 29 trades to double your account with 25% position sizing. That’s the impact of position sizing despite the same 10% return on an individual trade.
The third important aspect of swing trading (or trading in general) is stop loss and profit taking rules.
In swing trading, you should set your stop loss based on the technical structure in a price chart, and only take trades that give you a low-risk entry point.
For example, one of our group's recent trades was this consolidation breakout. Here the entry point would have been $94, whilst the stop loss was placed near $84. The risk would be close to 11%, which is a solid low-risk trade. Had the low of the range been near $78, the risk would have increased to near 18%, therefore the risk taken would have been far less favourable.
The key point here is that you must look for low-risk entry points and follow a risk-first approach. When faced with a choice between two or more trades, all other aspects being equal, go with the trade that has the lowest risk.
It is also important to have set exit rules that help you to lock in profits and not allow profitable trades to breakeven, or even worse, turn into losing trades. There is however a balance, you don’t want to cut the reward element of the trade too early either, you need a mechanism where you feel the trade is starting to lose its momentum and have the discipline to exit when that happens.
All forms of trading require discipline, and swing trading is no different. Once you have a set of rules for your trading, you can’t break them, unless you are ultra-experienced always follow the rules.
To stay disciplined It’s always best to have a strategy that is as mechanical as possible. Being emotional at the wrong time or frequently flouting your trading rules will always be an impediment to your trading success.
For those interested, we have a highly engaged group that uses our bespoke breakout scanner to find some of the best trades, offering low-risk high reward potential. Feel free to use the links below, and as always thanks for watching.
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