I had an opportunity a month ago to hear a sharing from an experienced senior that made me feel enlightened, and my trading mindset was directly elevated to another level! Indeed, for people at our level, if we are fortunate enough to see a certain sentence in a book or even a phrase from a senior, it can be enough to help us break through ourselves.
Fundamental understanding of trading
I don't know how many friends still care about the result of a single trade, or still think luck is very important in trading? I understand that many people are superstitious about various things; I respect religion, I believe in God and revere God, but in trading, I have no thoughts of relying on God. Because I know that as I continue to make more trades over time, the impact of luck will gradually diminish. As long as a trading system can persist, it has its own probability and expected value. In statistics, as long as the sample size is large enough, the statistical result's experimental probability will get infinitely close to the theoretical probability.
For example, if we were to flip a coin, the probability of heads and tails is theoretically 50:50. However, if I only flip once and guess it will be heads, I might lose. If I can earn $2 when guessing heads correctly and only $1 when guessing tails correctly, even though I might lose $1 afterward, I can continue playing, and in the long run, I will definitely profit. This is the basic understanding of expected value and risk-reward ratio.
Back to trading, if we can find a trading rule that wins more when it wins than loses when it loses, even if we do not know the future development of the market, theoretically, we can achieve long-term profits.
There is one very important point that many people overlook: trading advantage comes from expected value advantage, not necessarily from probability advantage; the hit rate does not need to be very high, but the expected value must be positive.
Trading logic
Actually, this is a process that teaches you to establish a trading system. It can be simple enough for elementary school students to understand, or it can be complex enough to require a professional team to operate. From a professional trading perspective, a sustainable and profitable trading model should look like this:
1. Trial-and-error inevitable pattern
This is a trial-and-error mentality, indicating that one will not fully invest in buying all at once, as one does not know whether the market will move in the desired direction, so it is just trial and error. The inevitable pattern refers to the features that our trading framework should be based on when a unidirectional trend is occurring, such as when an upward trend is about to occur or is already in progress, the stock price must be above the moving average (forming the moving average strategy), or it has already broken through the previous high (breakout strategy). This component will give traders confidence in their trading system to continue. Then, it is crucial to enter decisively; when the trend presents an entry opportunity that aligns with one's trading system, one must enter decisively and not hesitate to miss the trading opportunity. If the market can develop in the desired direction, one can continue to hold; conversely, if it is the wrong position, one should immediately cut losses.
2. Decisive stop loss
This point is easy to understand; if you do not stop loss in time, any wrong trade can lead a trader into an irreversible situation. At the same time, the profit of a single trade is determined by the market; what we can do is only control how much maximum risk this single trade can bear, which is the setting of the stop loss order.
3. Let profits run
I think many people say that trading means making ten trades where maybe eight are small wins or losses, and only one or two are big profits, but not many can explain it clearly. The specific meaning is that when our trade is in a floating profit state, we proactively take on a considerable level of pullback in exchange for further trend development to create further profit opportunities.
In the early stages of learning, often those books and some seniors would teach us that each trade should have a risk-reward ratio of at least 2:1. If the trading plan is set to fully take profit after meeting the 2:1 risk-reward ratio target, it cannot achieve letting profits run, because the profit potential is capped by the 2:1 risk-reward ratio, and there is no active assumption of a considerable level of pullback in exchange for further trend development.
If you want to actively take on a considerable level of pullback in exchange for further development of the trend, you can only continuously raise the take profit/stop loss price along with the trend, such as moving take profit and adjusting based on price action; or you can partially take profit after meeting the 2:1 risk-reward ratio target, letting the remaining position run for profits.
4. Appropriate time frame
If the time frame we trade is designed to be too short, the transaction costs generated by each trade will severely erode trading profits. On the other hand, if the trading time frame is too long, the trading efficiency of this trading system will be very low, as the time interval between each trade will be very long, and it will not be able to achieve the short-term snowball effect advantage of short-term trading.
However, there is no standard answer in the trading world; everyone's suitable time frame is different. For example, if we only have one position in the $Micro Nasdaq 100 Index Main Contract (2506) (MNQmain.US)$ and trade on a one-minute chart, while only capturing a few minutes of market movement, we might earn an average of 10-20 points per trade. However, based on the broker's fees, the cost for a single trade back and forth is about $4-5. If we only earn 10 points, that would mean only $20 profit, but we need to pay the broker $4-5 as trading cost, resulting in an overall performance reduced by 25%. However, if we trade the $Micro Nasdaq 100 Index Main Contract (2506) (MNQmain.US)$ on a one-minute chart and the trading system can capture a small intraday wave, we could potentially earn 50 points or even more, making that trading system not too bad after deducting costs.
5. Appropriate filtering
There is no one who can accurately predict future market trends, nor is there a trading strategy that can profit every time. If there were, all the money in the market would be earned by that person. If there is an appropriate filter when designing a trading system, it will allow traders to focus on trading opportunities that meet their required conditions and avoid random trades. For traders, filtering conditions are one of the most important aspects of trading rules, determining what constitutes their trading opportunities, ensuring that each trade is a quality trade.
Capital management
If a trading strategy can achieve the above 5 points, it has basically formed a trading strategy with long-term profitability. However, in risk management, besides stop loss, there is also capital management. Because no matter how good a strategy is, there is always a chance of consecutive losses. If too much capital is used for each entry, even using all funds, consecutive stop losses of 3-4 times can be unbearable. Even if only 5% stop loss is used per order, losing 3 times would exceed 15%, and to recover, one would need to earn more than 17% to break even.
However, if the capital used is too small, it is also not conducive to doing good trades, because the floating fluctuations of profits and losses are too small, and without a sense of it, there is a chance to trade randomly, which does not help train trading discipline. Unless you are the kind of person who can follow the rules even when making profits or losses of just a few dollars every day, I think when I trained myself back then, I would use a few thousand as trading capital for over a year. Many predecessors say that everyone has blown their accounts a few times before the trading path becomes smoother.
In fact, since I entered the cryptocurrency market and stock market as a beginner, I have really never blown an account. The most was when I used 9x leverage to enter, and the target price retraced 1%, immediately receiving a margin call prompt, after which I would usually hit the stop loss order to exit. Of course, I am not that person who casually used ten thousand or a few thousand to open leverage anymore. Small traders have an advantage in futures trading with smaller amounts; leverage/position size is usually a bit larger, and when profitable, the percentage can be very high. However, profits and losses are two sides of the same coin; while the percentage can be high when earning, it can also be high when losing, so I no longer play those large leverages. Even if I trade futures, I usually do not use the entire account's margin to buy futures.
It sounds complicated, but it's actually very simple.
Next, I want to use a simple example that even elementary school students can understand, but definitely not many people can outperform.
In my understanding, common trading methods include breakout strategies, trend-following pullback buying strategies, and moving average strategies. I believe a good trading strategy should be simple enough to be explained in a few sentences, simple enough for elementary school students to learn, which is the moving average strategy. The moving average strategy can also be single moving average and double moving average strategies, and I will directly show you the results from historical backtesting on TradingView.
If my strategy is as follows:
1. Use the second candle after the breakout as the entry signal,
2. When the $S&P 500 ETF-SPDR (SPY.US)$ breaks above the 200 Tesla line, go long;
3. When the $S&P 500 ETF-SPDR (SPY.US)$ breaks below the 200 Tesla line, go short,
Using the moving average as a signal already meets the first two points when breaking through for buying; and as long as the trend has not changed, the moving average will not reverse, satisfying the third point; given the long bull characteristics of U.S. stocks, plus many people will choose to hold long-term, using the 200 moving average can also satisfy these two needs, and the time frame will not be too short to incur too many trading costs, with each trade possibly spaced a few months apart, and later examples will have shorter-term applications. As for using the second candle as the entry signal to avoid too many false signals that could lead to unnecessary losses, after all, moving averages are support and resistance levels.
The result given is as follows:
As for the effect of using QQQ, it is as follows:
Of course, the application of different moving averages will yield different results. If you're interested, you can also do backtesting yourself, using the daily level 200 moving average as a representation of a relatively long holding period. And since QQQ and SPY have been introduced for some time, the data behind it is based on decades of backtesting, which is very valuable for reference. Of course, based on the characteristics of the long bull market in U.S. stocks, we can further filter: do not short or go long after breaking below the 200 Tesla line, only remain in cash.
If you want to engage in shorter-term trades, resolving in as short as a day or no more than a week or two, you can observe the performance of the 200 moving average on the 15-minute chart for the $Micro Nasdaq 100 Index Main Contract (2506) (MNQmain.US)$:
Because futures settle every three months, this result only utilized data from July 2024 to the present.
I actually tried running a double moving average strategy (buy on golden cross, sell on death cross); for some targets, it improved, but for others, it was not as good as the single moving average strategy. The length of this article is too long, so I won't discuss this direction further, as many people who understand programming have likely tested moving average strategies. There are many videos online, and it has already brought out the key points I want to make.
Trading has always been about simplicity being beautiful; complicating it might not necessarily lead to profits.
Therefore, as long as you have your own trading system, you only need to pay attention to whether there are entry points within your system; others' opinions are just noise. Moreover, signals that exist in others' systems do not necessarily equate to signals in your system. Whether it is a moving average strategy or a breakout strategy, these are trend-following strategies characterized by low win rates in exchange for high risk-reward ratios and strong explosive power (profitability). For example, in the above test, the win rate can be as low as 17%, and at most only around 30%, yet it can still be profitable in the long run. This illustrates the problem of many retail investors blindly following others: you can only follow that person for a single or half a position, but you won't be able to leverage their system's advantages. Unless you can follow them every time they place an order, but there is another problem: how can they inform you in time, and since they can keep making profits, why would they need to bring you along?