Technical or Fundamental
When creating a new trading strategy their are two distinct approaches. The first and more popular when individuals develop strategies is Technical analysis which uses past indicators as a tool analyze previous and expected price movements. The other option is fundamental analysis which looks at the fundamentals behind a company or instrument to determine what will be the likely effect of future price changes. The majority of Strategies use technical indicators though it is possible to use fundamental analysis.
Picking Your Indicators
There is a wealth of different indicators that can be used when you decide to build a trading strategy, here we are going to run through some of the most common indicators used by those who build trading systems.
- ADX, is generally used to determine whether a particular instrument is trending or not. Quite often used in conjunction with Directional Movement which can make it possible to work out whether the instrument is trending up or down.
- Stochastic’s, a controversial indicator which many contend has no predictive power. Attempts to work out whether an instrument is overbought or oversold, doesn’t work well when prices are trending and suffers from not being able to determine the point at which the instrument is at the end of the period of being overbought or oversold.
- Moving Averages, there are various ways Moving Averages can be worked out with the most popular being exponential and simple Moving Averages being the most popular.
- ATR, a indicator used measure the volatility of price action.
- MACD, a very popular indicator can also be used as an independent trading strategy or can be used for analyzing divergence and convergence.
- Pivot Points, a popular indicator primarily used for instruments with high levels of liquidity such as forex or Indices.
What do you want from a strategy?
When you start developing a system for trading it should be in the forefront of your mind what exactly do you want the system to do. Things you might want to consider include how often you desire to have trading signal generated and the risk level that is acceptable to you. Choosing the correct time frame is particularly important, if your looking for constant action then strategy that produces signals often will be best for you but if you have other commitments you may want a daily indicator. Then there is the possibility of creating a fully automated system. These questions should be answered before you begin creating a system.
Part II at Trading System’s Strategy Development II- Trade Entry
Part III at Trading System’s Strategy Development III- Trade Exit