Trading Strategy

A trading strategy is a set of rules that traders use when making trading decisions. When properly researched and executed a trading strategy helps traders in achieving high returns. When the strategy execution is fully automated, it is called an algorithmic trading strategy.

Algorithmic trading strategies typically follow the following steps:

1. Hypothesis Formation / Strategy formation - Hypothesis formation is basically an educated guess (based on confidence intervals) about what you think market behaviour is. For example, if you believe market is going up you would want to go long, if you think market is trending bearish you would want to go short and back this with your statistical analysis.

2. Coding Strategy - Once you have decided your strategy, you code the logic which includes trade entry and exit points, decide on take profit and stop loss condition and other factors including trade size, etc.

3. Backtesting and Optimization - Backtesting is an essential tool to analyze the strategy based on historical data. If the results meet the necessary criteria, the strategy can be implemented with some degree of confidence in live market. If the results are less favorable, the strategy can be modified, adjusted and optimized to achieve a more desirable result.

4. Simulator Testing - Before going live with the strategy, it is advised to test your strategy on the simulated (virtual trading) environment. This will give you a clear picture of how your strategy performs in the live market and identify any bugs or edge conditions that might be present in the strategy code.

5. Live Trading - Once you are confident about the back-test results and virtual trading, it is show-time for live trading. Following is the list of parameters that are to be estimated generally when you execute live trading.

• CAGR (Compounded Annual Growth Rate)

• Success ratio - Ratio of number of profitable trades over number of loss making trades

• Average profit or loss per trade

• Maximum drawdown

• Sharpe ratio, Sortino Ratio