How to Design a Stock Market Trading Strategy

Stock market trading with or without a strategy can be a frightening. Some might be drawn to follow rumor, analyst recommendations, or investment news services on the TV and Internet. Why might this be dangerous?

First there is the fear of being scammed. The Internet is flooded with get rich quick systems that often only put money in the author’s pocket.

Second is the issue of applicability. One system might be suitable for high risk investors that enjoy day trading against the trend while another is for momentum traders that play the news. Still another is for long term buy and hold traders looking for some stable income as they enter retirement.

How can you protect yourself? The answer lies in creating a customized system to fit your personal needs.

Begin With Macro Trends

Most advertised systems will show screen-shots of how amazingly their indicators forecast a upwards or downwards move. Usually these moves were the result of some event that could not have been foreknown such as a buyout, or large EPS surprise (hence the word surprise), or the stock was merely mirroring the overall market trend.

When the market is in a bull stage, the majority of stocks move up; when the market is in a bear phase the majority of stocks fall. This means that you could blindly pick stocks and still have a winning system as long as you properly understand market cycle timing.

In this regard there are two sources that I endorse for understanding market timing, and the two are closely related.

1. William J. O’Neil, famous author and creator of the high growth strategy called CAN SLIM, has a decent method for determining market sentiment. In a nutshell, you can determine when the market is about to crash or when the market is about to rise in a new bull trend based on the volume of a leading index. Too many high volume sell-off days in a row indicate that the institutions are liquidating. His book, How to Make Money in Stocks, is a good starter for growth stock screening and basic market timing.

2. Kiev Nadir is another uprising author who has built on this approach in his work titled, How to Become a Market Timing Guru. A worthy read for $3.99 with the Kindle format.

Basically follow the rule of only investing long in bull markets and liquidating or short sell in bear markets and you will likely propel yourself to the upper echelon of investors in no time at all.

Individual Stock Trends

The next step is to analyze individual stock trends. It is assumed you already have a basket of stocks to trade. If not, read about value investing, dividend stocks, and growth stocks to see which appeals to you the most. Some love the wild rides up and down while others like steady sailing with lower payouts.

With your stock, analyze the long term trend. You can do this by using weekly bar charts combined with ADX or other trend indicators. Also pay careful attention to the 350, 200, and 50 day moving averages. These averages will tell you volumes about institutional buying and selling, as well as the current strength of the stock. Long term investors will often buy and sell based on market sentiment and long term trends alone.

Short Term Entry and Exits

Entry and exit signals are usually the focus of most systems. I have seen a lot of different systems and they are usually variations of the same thing: pivot point reversals, MACD crossovers, positive or negative divergence, oversold or overbought conditions, candlestick formations, some unreliable chart pattern, or trendline analysis. For the most part, systems are just churning out the same material in different formats.

You can learn many strategies for free or how to use indicators by heading over the Stockcharts.com or Investopedia.com. John Murphy is a technical analyst genius in his own right.

Exiting is where most systems lose their money. Some systems do not even have the ability to generate an exit signal which is very scary. For beginners that buy and hold for weeks to months use these simple rules: set your initial stop loss to 7 or 8 percent below your buy price. Also have a trailing stop-loss about 5 to 7 percent as a profit-taking method.

Creating a System and Testing It

Of course, there is much more to a system than just this. You have to consider money management amongst other items, but you should at least have an idea of where to begin.

Probably the biggest help that I can offer is to sign up with a site like Portfolio123 (using link will give you 45 free days on any membership level. They even have a free membership). Here they have dozens of stragies so you can screen, backtest, and trade stock market investing strategies that mirror the greats like Peter Lynch, Warren Buffett, Benjamin Graham, William J. O'Neil and more. It is an extremely high-grade platform that usually costs institutions hundreds or even into the thousands per month - but you can freely use it to generate and test out famous strategies or your very own based on over 550 different fundamental and technical criteria. I'd say this is the first place you should go - and signing up with the American Association for Independent Investors is another good site for strategy testing and education.

So how do you develop a stock market trading strategy? First you learn a little. Then you analyze what type of trading suits you best. Next you learn a little more specialized knowledge. Never forget to look at the market from the broadest view down to the narrowest point necessary, regardless of whether you are a day trader or prefer to buy and hold.