What do traders love most? Strategies, strategies, strategies. Just one great idea, one well-functioning algo and we are in heaven. We always think that strategies are the path to trader nirvana. But let’s admit it - all strategies suck. In fact there are really only three types of trading strategies in existence.
- Breakout strategies which are based on price momentum and velocity and depend on continuation for their success.
- Mean reversion strategies which are based on fundamental value or temporary extremes in price conditions and depend on price reversal for their success.
- And finally what I call cheating strategies that depend on technical, regulatory, or capital arbitrage opportunities that take advantage of certain market peculiarities available only to a few privileged players.
Once you understand this fact you realize that no strategy is bullet proof. Momo strategies fail miserably in choppy markets. Mean reversion strategies get decimated in strongly trending environments, and cheating strategies eventually become obsolete as more and more players attempt to exploit the particular loopholes in the market.
Don’t get me wrong. Strategies are very important. They provide the framework for everything you do. But the longer I trade the more I realize that it is not the specific strategies that matter but the general rules of trade you employ every day.
What leverage do you use?
- Do you double down on your positions?
- Do you ignore your own setup rules in the heat of the battle?
- Do you pull your stops when the market trades against you?
These are much more important questions to consider than whether to use a simple or an exponential moving average when evaluating a trade. All strategies suck and all strategies are great depending on the market environment. What distinguishes success from failure is much more a function of your own behavior rather than the clever little algo you just created.
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