In finance, a trading strategy is a fixed plan that is designed to achieve a profitable return by going long or short in markets. The main reasons that a properly researched trading strategy helps are its verifiability, quantifiability, consistency, and objectivity.
A statistical evaluation of a trading strategy has two main goals. The first is to find out the optimal account capitalization required to achieve the maximum rate of sustainable return. The second is to find out whether the risk-adjusted reward is equal to, inferior to, or superior to other competing strategies. Without a statistically reliable measurement of the risk-adjusted reward, it is impossible to assess whether future performance is in line with historical performance. The cost of trading a strategy is primarily defined by risk, and without a statistically reliable measure of risk, portfolio management is impossible.
When developing a trading strategy, many things must be considered: return, risk, volatility, time frame, style, correlation with the markets, methods, etc. After developing a strategy, it can be back tested using computer programs. Although backtesting is no guarantee of future performance, it gives the trader confidence that the strategy has worked in the past. If the strategy is not over-optimized, data-mined, or based on random coincidences, it might have a good chance of working in the future.
A trading strategy can be executed by a trader (manually) or automated (by computer). Manual trading requires a great deal of skill and discipline. It is tempting for the trader to deviate from the strategy, which usually reduces its performance.
An automated trading strategy wraps trading formulas into automated order and execution systems. Advanced computer modeling techniques, combined with electronic access to world market data and information, enable traders using a trading strategy to have a unique market vantage point. A trading strategy can automate all or part of your investment portfolio. Computer trading models can be adjusted for either conservative or aggressive trading styles.
- Pardo, R. The Evaluation and Optimization of Trading Strategies. J. Wiley & Sons, 2008, page 18. ISBN 978-0-470-12801-5