How to Create a Trading Strategy

Many stock traders dive into trading without having a strategy. This approach can be very costly in terms of money, time and stress. A trading strategy is defined based on a mathematical formula that calculates a projected gross gain out of the following parameters:

  • C: The initial trading capital.
  • T: The cost of a buy or a sell transaction.
  • G: The average percent gain of a profitable trade.
  • L: The average percent loss of a loosing trade. L can be equal the stop loss percentage set by the trader.
  • P: The trader’s performance in percent of profitable trades out of the total number of trades N.

Assuming that the cost of the trades does not come out from the traded capital C. The Gross gain formula is then:

Gross Gain Formula

Gross Gain Formula

This formula has in it all the parameters that will affect the trader’s performance and for that reason they should be taken into consideration in the trading strategy. In real life these parameters depend on the traders resources and choices:

  • The number of transactions N depends on the time allocated for trading, the type of trading account, etc.
  • The performance P depends on the trader’s training, tools, etc. The trader can approximate P by calculating the performance during a paper trading period of a few months.
  • The average gain G and loss L depend on the stock’s volatility, the chosen stop loss, etc. These two parameters can also be approximated using the average gain and loss during a paper trading period of a few months.

Below is a trade strategy simulator based on the gross gain formula, you can plug your numbers and experiment by tweaking them to see the effect of each parameter on your projected gains.

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