Trading strategies are absolutely essential for successful trading. A trading strategy can be simply defined as a set of rules specifically designed to trade profitably.

In the trading world the word, “strategies” is often interchanged with the word, “systems”. While the words are often used interchangeably the word “system” is more often used to describe a single set of trading rules. A strategy, on the other hand may contain one or many trading systems each with their own set of rules.

Let’s take a look at an example of a simple trading strategy:

It is important to note that these are oversimplified examples provided strictly for the purposes of illustration. In these examples you see a very basic structure that is found in a wide variety of trading methods. That structure is that of the, “if – then” statement.

In example number 1 above we are instructed to buy XYZ stock only if a certain condition is met. The condition that must be met is, “today’s high must be higher than yesterday’s high”. If that condition is met then we will have purchased 100 shares of XYZ stock at a price above the previous day’s high.

In example number 2 above we are instructed to sell short XYZ stock only if today’s low is lower than yesterday’s low. If that condition is met then we will have sold short 100 shares of XYZ stock at a price below the previous day’s low.

The same basic principal applies for all financial instruments be they stock, futures, Forex, etc. Creating strategies in the, “if – then” format is very powerful. Why? Because we can a build as set of trading rules to be as selective as we want.
You see, our objective is to wait for those opportunities which our strategy has shown to have the greatest probability of producing winning trades.

Another huge advantage of trading using a strategy is that a strategy has been tested and proven trade effectively in a variety of market conditions. This testing is usually done on a computer running specialized trading system development software or on a trading platform that has such capabilities already built into to it. The test can be run on years of past data to see how the strategy would have performed. This process of tesing a strategy using historical data is known as “backtesting”. You have probaly heard the phrase, “Past perfomance is no gurantee of future results”. While this is true, proper backtesting can give us insight into which type of strategy parameters may be likely to perform well in the future.