To be successful as a trader, you need to understand how the market works. This starts with a foundation of market knowledge. To help students understand this, I use the Trading Pyramid™, which shows the levels of information a trader uses.
One of the least understood aspects of the Trading Pyramid™ is the level called Trading Systems. Without a thorough understanding of Trading Systems and which strategies were designed for each kind of trading system, you will yield disappointing results in your trading efforts. Trading Systems are the third level of the TechniTrader® Trading Pyramid™.
No matter how you trade the market, you are using a trading system. A trading system is not a strategy, a software program, or an entry signal. It is a set of rules and parameters that were developed around a formula of indicators and price action for a specific type of market condition.
Often a trader will complain that a strategy doesn’t work. They struggle with meager results that entice them to continue trying but seldom pay the bills. These traders go from seminar to seminar hoping to find that ‘perfect’ strategy. But it’s not the strategy. It’s the market condition under which the strategy is being applied that is not right. Strategies work best when applied to the proper market conditions for which they were designed. But before you can choose a strategy for the current market conditions, you must thoroughly understand what a trading system is and which system works under what market condition.
The Trading Pyramid™ starts with the base of knowledge all traders need to succeed in the market. The next level is trading styles, and the third level is trading systems. Trading systems have been around for more than a century in many versions and variations. But all trading systems used today fall under 6 categories. Since the sixth is fundamental systems, it will not be discussed here.
For technical analysis traders, there are 5 primary types of trading systems. These systems are:
Trading systems have developed as market conditions continually changed over the past century and they will continue to evolve as the market and participants change. By understanding how they work, why they were written, and when to use each system, you will be able to choose which one to use to optimize your profits in current market conditions.