Writing down a strategy
A strategy only counts as one if a stranger could carry it out without a single question. Everything else is a collection of good intentions.
Learning objective: After this lesson you can judge whether a strategy is written down precisely enough for someone else to carry it out.
The test is simple. Give your strategy to someone who knows nothing about it. If they can apply it without a single question, it's defined. If not, it isn't.
Six questions
A complete strategy answers six questions. What do I trade? When do I get in? How big is the position? Where do I get out with a loss? Where with a profit? And when don't I trade at all?
The most important question
Almost everyone forgets the last question, and it's the most important. A strategy also has to say when it doesn't apply, or at some point you'll apply it to everything.
Writing down the reason
Also write down why you believe it works. If you can't give the reason in two sentences, you only have a rule without foundations, and you'll break it at the first headwind. You'll find an overview of common kinds of strategies and what research says about them under Strategy types overview.
For a strategy to be testable, it has to fix exactly which assets qualify, what a signal is, how big the position will be, when you get out, at what times you trade and what costs you assume. Every gap gives you leeway later when evaluating. And that leeway is almost always used to make the result look nicer. That makes any test worthless.
A reason you can name
The reasoning should name a cause you can point to: a risk premium, a constraint that forces many investors into certain behavior, or a well documented thinking error. Without such a reason, a rule that looks good in old data can't be told apart from a lucky hit. Then nobody can say why it should keep working.
When to pause
Also decide beforehand when you'll suspend the strategy: from what drawdown, at what deviation from the expected figures or after how many months without confirmation. If you don't, you'll make that decision in the middle of a loss, and that's the worst moment for it.
Summary
- Six questions: what, when in, how big, where out with a loss, where with a profit, when not at all.
- Without a reason you can name, a rule can't be told apart from chance.
- Decide when you'll stop before the first trade, not in the middle of a loss.
Did you get it?
When is a strategy fully defined?
When a stranger could carry it out without asking anything.
Which question is most often forgotten?
When the strategy doesn't apply and you don't trade at all.
Why does a rule need a reason?
Because without a cause you can name, a rule that looks good in old data can't be told apart from a lucky hit.
Check your understanding
Your task
Write a strategy or an idea on one page and answer the six questions from the lesson. Hand the page to someone who knows nothing about markets and count how many questions they ask. Each question is a gap you need to close.
Related
- Win rate and expected valueStage 3
- Capital preservation before profitStage 3
- Loss aversionStage 3
- Matching questions for this stageQuestions