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Strategy Development: Understanding the Process
TradeStation Technologies

When developing trading strategies, there are certain procedural steps, or guidelines, that should be followed. The following article will provide a walk-through of these basic steps.

Select Market Activity
The very first step in developing a strategy is to decide on the type of market activity you want to trade. Obviously, this includes selecting a symbol to trade, or to develop a strategy for, and choosing a time frame to trade (minute charts, daily charts, etc.). This is an important decision because it determines the type of strategy you will be developing. This section will help you to understand some of the conditions that can occur during different types of market activity, and the types of strategies that complement those markets. Once a familiarity with the basic market types has been established and a symbol and timeframe to trade have been selected, a strategy type may be chosen. Please note: It is extremely unlikely that any one strategy will work well across all market types. The key is to develop a strategy that works well during one type of market activity, while at the same time limits losses during other types of market action. This is a basic but extremely important concept.

Let’s take a look at the strategies that are appropriate to each type of market.

Trending Market

Trending markets are characterized by a large and sustained increases or decreases in price, over an extended period of time.

Momentum Strategies

Momentum strategies are designed for trending markets and attempt to take advantage of all the big trending moves that may occur. In creating a momentum strategy, the number one priority should be that the strategy never misses a big move. The easiest way to accomplish this is to always be in the market, that is, to always be either short or long. If you always have a position, you will always be there when the big move takes place.

The other method is to always have a “stop” order in the market, resting either above or below the current price (this is the same order as a stop loss, but it is used to enter the market rather than exit). Using a stop to enter the market will protect you because if the market moves quickly in either direction you will be stopped in before the big move begins.

Keep in mind that momentum strategies tend to lose money in choppy or directionless phases of the market. They have a small percentage of winning trades; that is, they make their money in a few big trades. This means that if you miss a big move, you may not have enough capital to hold out through the draw-down as you wait for the next big move.

Another design characteristic should be to limit your losses during the market’s sideways mode. Remember, no strategy will make money in every market condition. If the strategy is designed to make money in a trending market, it will lose money in the choppy phase. Your priority should be to minimize the losses in the directionless market.

Many momentum strategies make their money in one or two months of the year and break even or lose money for the rest. The most common indicators used in momentum or "trend following" strategies are moving averages, most often two—a short moving average and a longer moving average.

Momentum strategies have the following characteristics:


They make 80% of their profits on 20% of their trades. This is the difficult part of trend trading—a low percentage of winning trades. You need a lot of positive self-esteem and confidence in your abilities to trade a strategy that loses money on 60 or 65% of its trades. You should also be able to sit through significant draw-downs as the market drifts through a directionless period.


Many researchers have estimated that any market is in the trend mode 15% of the time and is directionless 85% of the time. A momentum strategy then, by definition, has a low percentage of profitable trades. In addition it is most likely the most psychologically difficult to trade, but if you think you can successfully trade without constant positive feedback, it can prove to be very profitable.


They attempt to limit losses during the market’s sideways mode; no strategy will make money in every market condition, but a good strategy will limit losses in market conditions for which it was not designed.


Momentum-based strategies are the most popular type of strategy. With a high percentage of losing trades, you might be wondering why it is so popular. Very simply, trend-following strategies can be very profitable overall, and this is why people attempt to trade them. Another reason is that people like to follow (and make money on) the big trends. It is human nature to want to cash in on the big moves in the market. It is innately satisfying to get in early on a trend and watch your profits soar.

Directionless Market
A directionless market is characterized by smaller and frequent up and down movements in price, with the general movement sideways, or within some defined trading range.

Countertrend Strategies

The main focus of a countertrend strategy is to profit from the pricengs that occur in directionless markets. Countertrend strategies start with the premise that markets are directionless 85% of the time. The strategy attempts to take advantage of this price movement and catch the smallngs that take place in sideways or choppy markets. This type of strategy has a higher number of winning trades, with small profits on each winning trade. It misses the full trend because it exits early in the trend as the market becomes quickly overbought or oversold.

A countertrend strategy is built on the premise of buying low and selling high. As you are buying when prices are low and selling when prices go up, you are actually trading against the trend. Essentially, you are picking tops and bottoms.

Although a countertrend strategy is easier to trade emotionally, many traders don’t trade this type of strategy because they fear missing the big move. Although countertrend strategies generally have a higher percentage of winning trades than momentum strategies, profit amount per trade are smaller as a result of the smaller and more frequent price movements of varying direction. A major drawback for this type of strategy is the potential to result in substantial losses during large trends.

In addition to momentum and countertrend strategies, there are other strategy types designed to take advantage of event-based market opportunities such as cycles, chart patterns or other definable market occurrences. These other strategy types are not necessarily associated with specific market types.

Time Frame to Trade

As you look at a chart and are evaluating market action type, it is important to consider the time frame of your chart. In fact, choosing which time frame is appropriate for you is almost as important as the type of market action and strategy you want to trade. You can take the same chart and time period, and when you change the time frame, say from 5-minute to daily, the market action type may be completely different. We’ll discuss three basic types of charts: intraday, daily, and weekly.

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