Step 2: Test your methodology for positive results
(A) This step is probably what most traders really consider to be the most important part of trading: a system that introduces and executes trades that are only profitable. No losses – never. Such a system, if there was one, would make a trader richer than he ever dreamed of. But the truth is that such a system does not exist. There are good and better methods and even very average methods to make money. The performance of a trading system is more about the trader than about the system. A good driver can reach his destination with virtually any vehicle, but an untrained driver probably won’t make it, no matter how fast the car is. (Sometimes the best system is a mixture of different methods. To learn more, see Blending Technical And Fundamental Analysis).
(B) According to the above, it is necessary to select a method and implement it many times in different timeframes and markets to measure its success rate. Often, a system is only a successful predictor of the market direction in 55-60% of cases, but with adequate risk management, the trader can still make a lot of money with such a system.
(C) Personally, I like to use a system where risk is most rewarded, which means that I tend to look for turning points at the level of support and resistance because these are the points where the risk is most easily identified and quantified. Support is not always strong enough to stop a falling market, and resistance is not always strong enough to reverse a price rise. However, a system can be built around the concept of support and resistance to give a trader the advantage he needs to be profitable.
(D) Once you have designed your system, it is important to measure its expectation or reliability under different conditions and timeframes. If it has a positive expectation (it produces more profitable deals than lost deals), it can be used as a means of timing to control entry and exit into the markets.
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