A Step by Step Process for Developing a Consistently Profitable Trading Strategy

Your current trading strategy blows; it’s time to search for a new one. That’s what a lot of traders think when they are not seeing consistently profitable results. What you probably don’t realize is that you have all the tools; it’s just a matter of fine tuning.

In this article I will share with you a step by step approach for creating and fine tuning a custom trading strategy fit to your personality. If you have developed a plan or are currently working on one, this process can help you uncover the specific areas that need fine tuning.  Let’s get started!

The Pieces of a Winning Trading Plan

Your trading strategy should fit with your trading plan like a baseball fits in a catcher’s glove, comfortably. You might be wondering what the difference between a trading plan and a trading strategy is in the first place. Your trading plan is your business plan and your trading strategy is a piece of your trading plan. I break down the trading plan into two parts.

Section 1: Market Ideology

Included in this plan should be your specific goals, perhaps a motivating quote which acts as your inspiration, and your ideology towards the markets. This section of your plan is important because it gives your direction and guidance, which is especially helpful through the hard times (as there will be some).

Section 2: Trading Strategy

This is the section we will be addressing today. If you haven’t completed section 1 you can read about developing trading goals and their importance in my Getting Started post.

A winning trading strategy should be incredibly detailed. Every possible outcome must be thought out and accounted for in order to succeed. Often times, once a trader places a trade their plan and objectivity go out the window. As the saying goes, luck favors the prepared. So take the time to develop your strategy before making that first live trade.

Outline of a Winning Trading Strategy

A trading plan may contain multiple strategies, but I recommend first going through the process of fully developing and fine tuning one strategy before moving on to a second. Once you have your first strategy to the point where you can visualize the setups in your sleep and enter your trades without hesitation you are ready to build additional strategies.

Set your risk limits at the time you open your trading account:

  • Max Daily Loss: How much are you willing to lose in a day before you stop trading?

(Rule of Thumb: No more than 5% of your trading capital)

  • Max Loss per Trade: How much are you comfortable risking on each trade?

(Rule of Thumb: 1% of your total trading capital)

Specify the markets and times of the day you will trade:

  • Pick a Market: What market and trading vehicle fits your goals and personality?

While there is always a market open somewhere, the best traders focus on a select few and specific times to trade them. There are other vehicles out there besides the common Stocks, Options, Futures, and Forex. What works for one trader may not work for you and vice versa.

  • Pick a Time: What does your schedule allow for trading time?

Integrating trading into your already hectic schedule probably means incorporating work, family, and recreation. When first starting out I recommend sticking to the larger time frame of a daily chart rather than jumping into day trading. This is because the moves take longer to develop. You can build a strategy and your patience at the same time. Remember, speed does not necessarily equate to more profits. In most cases it’s the larger time frames that pay the biggest rewards.

Choose a Methodology

Your methodology is only a small piece of a winning trading system. Success results from perfect execution. When searching through various indicators, technical analysis studies and fundamental analysis criteria remember to K.I.S.S – keep it simple stupid.

  • Picking an Indicator: Begin with price and volume

Open up your trading platform and remove all the indicators from your screen. In fact, remove everything except a candlestick or bar chart of the market in which you have selected to trade. Watch the price action and study the volume patterns for two weeks.

Print out daily charts and identify the inflection points. That is, points when the market starts moving. Go back and look for trends in volume and similar candlestick or bar formations that happen repeatedly. Once you’ve identified a number of similar patterns you can then introduce and indicator to help filter out the false moves and help pinpoint the best entries.

My Own Trading Strategy

Fibonacci retracements, market internals, and candlestick charts are the three tools that make up the basis of my own methodology.

If you’re interest, you can check out my Trading Rules for the ES & 6E Futures.

Develop a Structure of Trading Rules

Here are some examples of general trading rules that I use:

1. Plan your trade and trade your plan.
2. Keep things simple.
3. Only place trades when you are in a calm, cool, and collected state. Do NOT trade if not in this state of mind.
4. Be selective with your trades!
5. Don’t chase trades.
6. Don’t buy highs, don’t sell lows.
7. Never let a big winner turn into a loser.
8. If the market doesn’t act as initially anticipated, get out.
9. Never add to a losing position.
10. Understanding the psychology of human behavior is more important than understanding economics.
11. You alone are held accountable for every trade.
12. Attitude influences behavior so keep a positive attitude.
13. Hold opinions loosely.
14. Don’t dwell on past trades.
15. Be prepared to adapt as market conditions vary.

Establish Your Position Size

If trading contract markets such as options and futures, begin with one contract. However, once you develop a feel for the markets it will be more beneficial to move to two. This is because you now have the ability to scale out which can dramatically improve your returns.

If trading stock, use the following equation to determine how many shares to buy.

  • Stock Position Calculation: $ risk per trade / $ stop

For example if your risk per trade is set to $100, and you plan to place a $5 stop on the trade you are allowed to purchase 20 shares ($100 / $5 = 20).

Things to account for before you place EVERY trade:

  • Defined Entry
  • Defined Stop
  • Defined Profit Target(s)

Hands down this is the most important part of your strategy, defining your entry, stop, and target before you place the trade will keep you objective and thinking clearly as the trade starts to unfold.

Calculations to Help Fine Tune Your Trading Strategy

Once you’ve placed some trades with your strategy you can begin to analyze the data. A paper trade account is a great way to tweak and fine tune, but switching to a live trading account WILL change your results (this could be good or bad).

The more data the better, as a rule of thumb place at least 100 trades with your specific setup before analyzing the data.

Use these calculations to help analyze your data:

Winning and Losing %: # of Winners / Total # of Trades

Losing % = 100 – Winning %

Avg. W/L $ Amount: Sum of Profitable Trades/Total # of Winning Trades

Sum of Losing Trades/Total # of Losing Trades

Avg. W/L Hold Time: How long do you stay in a winner versus a loser, find the sweet spot.

Reward/Risk Ratio: Avg. W / Avg. L

(How much your winners are beating your losers)

Expectancy: [(W % x Avg. W) – (L % x Avg. L)] – round turn commission

(The average $ amount you can expect to win (or loose) per trade.

Record Keeping Tips:

Keep track of your profit loss, commission, daily winners and losers, weekly profits, and individual trade setups. This will help you spot trends in your trading and fine tune even more. In my post Ideas for Building Your Personal Trading Journal I outline some more ways to make this process easier.

Tools to Fine Tune Your Trading Strategy

To become successful you must focus on trading effectively and not on the profit/loss. Do your research, and then act. Use this step by step approach and the tools above to guide you in developing a strategy that is consistently profitable over time.

By Tim Racette



Trading involves substantial risk of loss and is not suitable for all individuals. Past Performance is not indicative of future results.