A trading system generates "Long" or "Short" signals only. It is a trader's choice to interpret these signals as "Buy" or "Sell" signals, to decide which trading vehicle to use and what percent of the portfolio to invest. Trading system development is only half of the preparation required before trading begins. As important as it is to develop a reliable trading system, it is just as important to develop a trading strategy to use with the system. Without a correctly developed strategy, even a profitable trading system can fail.
For example, a simple choice that depends on the current trader's position must be made when a trading system generates a "Long" signal. A trader must decide whether he/she wishes to close a short position (if he/she is short) and then must decide whether to stay in "Cash" or open a "Long" position. The same is true when a "Short" signal is generated. The trader must make two trading decisions. One is to close the "Long" position (if he/she is currently in "Long") and the second is whether to stay in "Cash" or open a "Short" position.
As you see, from the moment when the system first generates a signal, the trader has decisions to make. The famous quote "to be or not to be" can be changed to "to buy or not to buy" or to "to sell or not to sell". The need to make a trading decision on the basis of the generated signals is a part of the trading strategy that must be developed by each trader. It is essential to have this strategy developed and to follow the strategy's rules in order to exclude emotion from the trading decisions.
It is a common mistake to think that the trading system must be developed to exclude emotion. As we mentioned above, the trading system generates "Long" and "Short" signals only and the signals based on technical indicators are always unemotional. Emotions arise when a trader must make a decision based on these signals. The trading strategy that defines how to react to a signal generated by the system helps to exclude emotion. The more detailed your trading strategy is, the less likely it is that emotions will be involved in your trading decisions.
In general, a trading strategy tells you what to do when a signal is generated by the trading system. The trading system depends on technical indicators, market research and various analyses. The trading strategy depends on one's personal trading style and risk tolerance, portfolio size and, of course, on the market's behavior.
Personal Trading Style - Depending on one's personal preferences and what trading vehicle a trader is most familiar with and feels most comfortable with, a trader may decide to trade stocks or options or futures, etc. Depending on the trading vehicle selected, the trading strategy will differ.
Personal Risk Tolerance - Depending on the degree of risk a trader is willing to accept, a trader may decide to trade on margin or to invest only a small part of the portfolio. In addition, he may choose to trade risky futures or only conservative stocks. Depending on the risk tolerance, different stop-loss rules can be selected to protect the portfolio.
Portfolio Size - Depending on the size of the portfolio, a trader could be limited by margin requirements to certain types of trading. It's unlikely that a trader with a small portfolio would be able to invest in uncovered options. At the same time, a trader with a small portfolio is often willing to invest an entire portfolio in a single trade, while a trader with a large portfolio usually invests only a small percentage of his portfolio in a trade.
Market Behavior - A trader can select a different strategy to use with the signals generated by the system, depending on the market's behavior. For instance, if a trader believes that the market is in a long-term uptrend, he/she may decide to trade only shorter-term "Long" signals. Alternatively, a trader who believes in a long-term recession may decide to trade only shorter-term "Short" signals. At the same time, in a volatile market, a trader may choose to trade options, but chose to trade uncovered options in a non-volatile market.
The first three parameters that affect a chosen trading strategy are more personal while the fourth one depends less on personal preferences, but helps to avoid unnecessary trading risk in certain markets. In the following articles below, we delve deeper into how to define different market conditions and what trading strategy to chose.
A trading strategy to make Buy/Sell trading decision - this article explain how signals generated by trading system can be used in different markets.
A trading strategy to decide how much to invest - this article gives examples to illustrate the importance of defining how much to invest in a trade.
A trading strategy to decide what to buy and what to sell - this article explain the possibility of using different strategies in different markets.
Naked options trading is very risky - many people lose money trading them. It is recommended contacting your broker or investment professional to find out about trading risk and margin requirements before getting involved into trading uncovered options.