Critical Steps to Developing a Day Trading Strategy

Many seasoned day traders have discovered the remarkable benefits that having a sound, objective and profitable trading system can have on their bottom line.

Furthermore, having an objective trade plan that incorporates good risk management principles can keep a day trader from blowing out their account by running losses excessively that can often be due to either carelessness or an uncontrolled emotional reaction to losing money.

Of course, you will need to develop enough trust in using your day trading plan to maintain the discipline necessary to carry it out successfully. The following sections cover how to go about testing a day trading system to the point where it is reasonable to place your faith in it.

An initial step to take involves back testing the trading plan over historical price data for the market that you are interested in trading.

Although the historical trading results of a day trading system do not necessarily predict its future results, it still makes sense to perform historical testing to get an initial sense of how a trade plan may possibly operate in the future.

During this testing phase you will want to review such parameters as the system’s overall profitability, its maximum drawdown, its highest run of consecutive losing trades and its ratio of winning trades to losing trades. Each parameter should also be assessed over a variety of historical time frames and various market trading conditions.

Paper or Demo Trading

If the system still looks good after reviewing its back testing results, then you can move to paper or demo trading the system to get the hang of using it.

Paper trading means that you are recording your system’s trades on paper, while demo trading means that you are using a dealing platform along with a demonstration account to enter and record your trades.

This stage is also a good time to start to develop the all important discipline that you will need to cultivate with respect to sticking to your day trading plan without deviation.

Micro Trading

The next testing step for a day trading system that has passed the previous two testing steps involves starting to operate the system it in its first actual live trading environment.

Nevertheless, rather than starting out with full lot sizes, it instead makes better sense to start test trading the system on small dealing sizes or micro lots to see if the system still performs as well in a live trading environment.

Numerous systems have passed the first and second steps only to fail on the third, so the importance of taking the time to implement this initial micro trading phase cannot be overestimated.

Full Live Trading

If everything still looks good because the system seems to be performing profitably in micro trading and you have developed the discipline to operate and keep to the system, you could now consider starting to day trade it properly on a live account using larger dealing sizes.

One final warning is that you should only operate your new day trading system with dealing amounts that are suitable for your portfolio size and risk tolerance since market conditions can change and make formerly profitable systems obsolete in the process.