Morgan Litgate — Trading research

Part 2 of 3: Turning ideas into a repeatable process

A trading system should not begin with an indicator, a chart pattern or a promise of high returns. It should begin with a practical question:

How will I make decisions consistently when the market is uncertain and I am under pressure?

In Part 1, we looked at why traders need a system. Markets can move quickly, remain directionless for long periods and produce losing streaks even when the underlying method is sound. Without clearly defined rules, traders are likely to change their behaviour in response to fear, frustration, boredom or overconfidence.

Creating a trading system means converting a general idea into a written process. It should explain what you trade, when you trade, how much you risk, how you manage the position and when you stop.

The aim is not to predict every market movement. The aim is to build a method that can be tested, followed and improved.

Start with your circumstances

Before deciding on an entry strategy, consider whether the system will fit your life.

Different approaches demand different amounts of time and attention. Short-term trading may require frequent monitoring and rapid decisions. A longer-term approach may allow more time between entries, but positions could remain exposed for days or weeks.

A system that requires you to watch the market continuously is unlikely to be suitable if you have only a few minutes available each day. Similarly, a slower approach may be difficult to follow if you prefer frequent decision-making and become impatient while waiting.

Consider:

How much time can you realistically devote to trading?
Which market sessions can you monitor?
Are you comfortable holding positions overnight?
Can you respond quickly if the market moves against you?
How will trading fit around your work, family and other responsibilities?
Are you more comfortable with frequent small decisions or fewer larger ones?

There is no universally correct trading style. The best system is one you can follow consistently.

Choose one market and a clear area of focus

New traders often move between currencies, indices, shares, commodities and cryptocurrencies in search of the best opportunity. This can create a large amount of information without producing a deeper understanding of any particular market.

Starting with one market—or a small group of closely related markets—can make the learning process more manageable. You can observe how that market behaves during different sessions, how it reacts to news, how its spread changes and how often your preferred setups occur.

This does not mean that you must trade only one instrument forever. It means that you should develop a meaningful understanding of your chosen market before adding unnecessary complexity.

Your system should specify:

The instruments you are permitted to trade
The trading hours or sessions you will use
The timeframes you will analyse
Whether positions may remain open overnight or over weekends
Which market conditions are unsuitable for your strategy

A system becomes more difficult to evaluate when its results combine several unrelated markets, timeframes and approaches.

Define the market conditions you want to trade

A trading system should describe the environment in which it is designed to operate.

For example, a strategy may be intended for:

Strong directional trends
Breakouts from established ranges
Pullbacks within a trend
Reversals at significant levels
Short-term movements during specific market sessions
Volatile markets following a defined event
Quiet markets with clearly defined support and resistance

It is equally important to identify conditions in which the strategy should not be used.

A trend-following method may struggle when the market is moving sideways. A breakout strategy may produce repeated false signals in a narrow range. A short-term approach may be affected by wide spreads during illiquid periods.

Ask:

Is the market trending or ranging?
Is volatility suitable for the strategy?
Is liquidity sufficient?
Are major announcements approaching?
Has the market already made an unusually large move?
Are several instruments showing the same exposure?

The decision to remain out of the market is part of the system. There is no requirement to trade simply because the market is open.

Define the entry conditions

An entry rule should be specific enough that you can identify whether it has been met.

“Buy when the market looks strong” is an opinion, not a complete rule. A more useful rule might require a combination of conditions, such as:

A defined trend on a higher timeframe
A pullback to a predetermined area
A particular price pattern
Confirmation that momentum has returned
A minimum reward-to-risk relationship
No immediate high-impact event that could invalidate the setup

The exact method is up to the trader. The important point is that the conditions should be written down.

A complete entry plan should answer:

What must happen before a trade becomes possible?
What confirms that the setup is valid?
At what price or condition will the entry occur?
What cancels the setup?
How long is the setup valid?
What happens if the market moves away before the order is filled?

The last question is important. Traders often create a plan for the ideal entry and then chase the market when that entry is missed. Your system should state whether you are allowed to enter late, wait for a new setup or stand aside.

Missing a trade is not the same as losing money. A trader does not need to participate in every move.

Replace the formula section with this:

Decide where the trade is invalidated

Every trade should have a clear point at which the original idea is no longer acceptable. This is the logical location for the stop-loss.

The stop should not be chosen simply because it represents a convenient monetary amount. It should relate to the market structure and the reason for entering the trade.

For example, a stop may belong:

Beyond a recent swing high or low
Outside a defined range
Beyond a level that invalidates the pattern
At a distance that allows normal market movement without immediately stopping the trade

Once the stop location is known, position size can be calculated.

The basic calculation is:

Position size = Maximum acceptable loss / Risk per unit

For example:

Maximum planned loss: $100
Entry price: $25.00
Stop-loss: $24.75
Risk per unit: $0.25

$100 / $0.25 = 400 units

A position of 400 units would create a planned loss of approximately $100 if the stop were reached, before commissions, spread differences and slippage.

This process should run in the correct order:

Decide where the trade is invalidated.
Decide how much money you are willing to lose.
Calculate the risk per unit.
Calculate the position size.
Reduce the position if the market is unusually volatile or execution risk is elevated.

Do not begin with the maximum position your broker or platform allows. Begin with the amount you can afford to lose.

Treat the stop-loss as a risk-control tool, not a guarantee

A stop-loss is essential for many trading systems, but it does not guarantee that the position will be closed at the exact price displayed on the platform.

In a rapidly moving market, the stop may become a market order and be filled at the next available price. Gaps, thin liquidity, spread widening and major news events can all produce slippage.

This means that a stop at a particular level defines an intended exit, but not always the maximum possible loss.

Your system should therefore consider:

Whether the market is liquid enough
How spreads behave during volatile periods
Whether major announcements are approaching
Whether the position will remain open overnight or over a weekend
Whether the trade is large enough to be affected significantly by slippage
Whether a smaller position would make the potential loss more manageable

If the market moves quickly and your entry changes, recalculate the risk. A trade planned at $25.00 with a stop at $24.75 has a different risk profile from a trade entered at $25.10 with the same stop.

If there is not enough time to recalculate, reduce the position or skip the trade. An opportunity is not automatically suitable simply because it was suitable a few seconds earlier.

The article “Stoplosses: They ain't what they used be?” looks at slippage, gaps, stop-limit orders and the practical limitations of stop-losses in greater detail.

Establish your risk rules

Risk management should be part of the trading system from the beginning. It should not be added after the entry strategy has been designed.

Your rules should define:

The maximum risk per trade
The maximum daily loss
The maximum weekly loss
The maximum number of trades in a session
The maximum total exposure
The maximum exposure to correlated instruments
What happens after a losing streak
When trading must stop for the day

Many traders begin with a rule such as risking 1% per trade. This can be a useful reference, but it should not be followed mechanically in every circumstance.

A system may require lower risk when:

Volatility is unusually high
The setup is less reliable
Several open positions are exposed to the same market
A major announcement is approaching
The strategy is being tested in live conditions
The trader is operating under strict daily or total-loss limits

The maximum allowed risk is not the same as the amount that must be risked. A trader permitted to risk 1% does not need to risk 1% on every trade.

The purpose of risk management is to keep the trader in the game long enough for the system’s results to matter. A profitable strategy can still experience losing streaks. Position sizing must allow the account to survive them.

The related article “Risk Management: The Foundation of Consistent Trading” explains how stop-loss distance, position size, maximum-loss rules and gradual increases in exposure can work together.

Consider account size and financial pressure

A system cannot be separated entirely from the account on which it is traded.

If an account is too small for the chosen market, the minimum available position may create more risk than the trader can reasonably accept. The trader may then feel pressure to increase risk simply because sensible returns appear too small.

For example, risking 1% of a $100 account means risking $1. That may be entirely appropriate for learning, but it is unlikely to produce meaningful income. If the trader expects large returns from that account, they may begin increasing position size, using excessive leverage or taking trades that do not meet the system’s criteria.

The problem is not necessarily that the strategy is too slow. The account or financial objective may be unrealistic.

An account should be large enough—or the position size small enough—to allow:

Logical stop placement
Appropriate position sizing
Survival through normal losing periods
Realistic expectations about returns
Sufficient room for transaction costs and slippage

If the minimum position size risks too much, the responsible alternatives are to trade a smaller instrument, use fractional units where available, practise in a simulator or wait until more capital is available.

Do not use money needed for rent, debt repayments, emergencies or essential living expenses. Trading capital should be money that can be lost without damaging your financial stability.

The article “Account size: How much money do I need to trade?” explores the relationship between account size, risk, realistic returns and psychological pressure.

Decide how to manage an open trade

A trading system should explain what happens after entry. Many traders spend considerable time planning the entry but have no clear process once the position is live.

Define in advance:

Whether the stop-loss can be moved
Whether profits will be taken partially
Whether the stop will move to break-even
Whether the position will have a fixed target
Whether the trade will be managed using a trailing stop
What happens if the market reaches a key level
How long the trade may remain open
When the trade will be closed before a market session ends

A particularly important rule concerns moving the stop-loss.

If the market moves against the position, moving the stop further away only to avoid taking the planned loss changes the original risk. It may turn a controlled trade into an uncontrolled one.

There may be valid systems that adjust stops as new information develops, but the adjustment must be part of the original method. It should not be an emotional reaction to discomfort.

Likewise, taking profits early may feel reassuring, but doing so inconsistently can change the system’s expected reward-to-risk relationship. If a trader repeatedly accepts small profits while allowing occasional large losses, the overall result may be poor even if many trades are profitable.

Define when not to trade

A strong system includes no-trade conditions.

These may include:

Major economic announcements
Low-liquidity periods
Excessively wide spreads
Unusually large price gaps
A market that is moving outside the strategy’s tested conditions
A daily loss limit that has already been reached
Fatigue, illness or emotional distress
A desire to recover a previous loss
A need to make money quickly

The final two conditions are especially important. Trading because you need a particular financial outcome is likely to create pressure and poor decision-making.

Sometimes the correct response to a stressful session is to stop trading. A daily loss limit is not a target. It is a boundary.

The article “Should you trade: Do you have what it takes?” discusses the importance of patience, realistic expectations, time commitment and the willingness to follow a process rather than chase quick results.

Decide how position size will change

Position size should not automatically increase after a single winning trade.

One profitable trade may be the result of a good decision, favourable market conditions or simple randomness. Increasing exposure immediately can make the account more vulnerable before the strategy has demonstrated consistent performance.

A system can use a fixed position size, a fixed percentage of equity or a gradual method that increases exposure only after a defined amount of closed profit has been accumulated.

For example, a trader might create position tiers:

Accumulated closed profit	Maximum position
Below $1,000	400 units
$1,000 or more	800 units
$3,000 or more	1,200 units
$6,000 or more	1,600 units

This type of gradual progression prevents position size from growing too quickly. If profits fall back below a defined threshold, exposure can be reduced again.

The maximum tier is never a requirement. The actual position must still be limited by the stop-loss distance, the maximum trade risk and the overall exposure of the account.

Use the smaller of:

The maximum position permitted by your sizing plan
The maximum position permitted by your risk limit

The smaller number is the correct position.

Funded and evaluation accounts still require a system

Some traders use evaluation-based funding programmes because a small personal account may limit the financial value of conservative trading. These programmes can provide access to a larger notional account, but they do not remove the need for a system.

In many cases, the trader must operate within specific daily-loss, total-loss and trading-condition rules. A strategy that is profitable but occasionally produces a large drawdown may not be suitable for those limits.

A larger nominal account also does not mean that the trader should use the entire available risk budget. The account may be large, but the loss limits are still real.

Before considering an evaluation, a trader should be able to:

Follow a documented system
Calculate position size correctly
Respect daily and total-loss limits
Handle losing streaks without changing the rules
Understand the effects of slippage and gaps
Trade without chasing a profit target
Accept that the evaluation fee can be lost

The article “Other people's money: How to trade with it?” discusses the difference between notional capital and personal cash, along with the risks of changing a strategy simply because the account appears larger.

Write the system as a checklist

A trading system should be usable during a real trading session. If the rules are buried in several pages of theory, they may be difficult to apply when the market is moving quickly.

A practical checklist might look like this:

Before the session

Which markets am I allowed to trade?
Which sessions will I monitor?
Is there important news or event risk?
What are the market conditions?
What is my maximum daily loss?
What is my maximum number of trades?
Am I rested and able to make decisions?

Before entering

Is this a valid setup?
Does it meet every entry condition?
Where is the trade invalidated?
Where is the stop-loss?
What is the monetary risk per unit?
What position size is permitted?
Is the potential reward sufficient?
Are there correlated positions already open?
Has the entry moved too far?
Is execution risk acceptable?

After entering

Is the stop-loss in place?
What will cause me to exit?
Am I following the plan or reacting emotionally?
Has market information changed in a way that invalidates the trade?
Am I allowed to adjust the stop or target?
Has the maximum daily exposure changed?

After closing

Did I follow the rules?
Was the trade valid, regardless of the result?
Did I enter too early or too late?
Did I alter the risk?
Did emotions influence the decision?
What should be repeated or avoided?

A checklist does not need to be complicated. Its purpose is to prevent important decisions from being made impulsively.

Test the system before trusting it

A system is only an idea until it has been tested.

Testing can involve:

Historical chart review
Manual backtesting
Bar replay
Demo trading
Simulated execution
Very small live positions

The testing process should use clearly defined rules. If the trader changes the entry, stop or exit after every losing example, the results will not provide a reliable assessment of the method.

Record enough information to evaluate the system properly:

Date and time
Instrument
Market conditions
Entry reason
Entry price
Stop-loss level
Position size
Exit reason
Planned risk
Actual result
Slippage and costs where relevant
Whether the rules were followed
Emotional state

Testing should also include realistic trading costs and execution problems. A strategy that only works when every order is filled perfectly may not be robust enough for live conditions.

Consider modelling:

Spread costs
Commission
Adverse slippage
Wider spreads during volatile periods
Gaps where relevant
Delayed execution
Partial fills, depending on the market

The objective is not to produce a perfect historical equity curve. It is to understand how the system behaves across different conditions.

Evaluate the process, not only the profit

A profitable result does not automatically mean that the system was followed correctly. A trade may make money despite breaking several rules.

Likewise, a losing trade does not automatically mean that the system failed. If the setup was valid, the risk was controlled and the exit followed the plan, it may simply have been a normal losing trade.

Review:

Win rate
Average win
Average loss
Reward-to-risk ratio
Maximum drawdown
Longest losing streak
Number of trades
Results in different market conditions
Frequency of rule violations
Impact of costs and slippage

Also separate system performance from trader performance.

For example:

A valid trade that loses may be a normal system outcome.
An invalid trade that wins may reinforce a dangerous habit.
A large loss caused by moving the stop is a process failure.
A missed trade may be less damaging than an impulsive trade taken outside the plan.

The goal of journalling is not to create a record of wins and losses only. It is to identify patterns in decision-making.

Do not optimise the system into uselessness

Once traders begin testing, there is a temptation to add more rules to eliminate every losing trade from the historical sample.

This can create overfitting. A system may look excellent on the data used to design it but perform poorly when market conditions change.

Avoid changing the method because of one trade or one short losing streak. A strategy needs a meaningful sample before conclusions can be drawn.

When making an adjustment:

Identify the specific problem.
Explain why the change may address it.
Test the revised rule separately.
Compare the new results with the original system.
Use out-of-sample or forward testing where possible.
Change one important variable at a time.

A system should evolve through evidence, not through frustration.

The completed system

A basic trading system should now answer the following questions:

What do I trade?
When do I trade?
What market conditions do I want?
What exactly qualifies as an entry?
What invalidates the trade?
Where is the stop-loss?
How much can I lose?
How is position size calculated?
How are open trades managed?
When are profits taken?
When must I stop trading?
How will I deal with slippage, gaps and event risk?
How will I increase or reduce exposure?
How will I record and review results?
How many trades are needed before evaluating performance?

If these questions cannot be answered, the system is probably still an idea rather than a complete process.

A good system may appear restrictive. That is intentional. It should protect the trader from acting on every impulse the market creates.

The purpose is not to remove all uncertainty. It is to define what you will do when uncertainty appears.

Conclusion

Creating a trading system is the process of turning intention into rules.

It begins with choosing a market and style that fit your circumstances. It continues with clear entry conditions, logical stop placement, position sizing, risk limits and rules for managing open trades. It also includes the discipline to remain out of the market when conditions are unsuitable.

The most important part of the process is not finding a system that wins every trade. That system does not exist. The objective is to create a method with a reasonable chance of producing favourable results over a large enough sample while keeping losses and emotional decisions under control.

A system should help you trade less impulsively, not make you feel more certain than the market justifies.

In Part 3, I will explain my own trading strategy and show how these principles are combined into a practical system, including the conditions I look for, how I manage risk and when I decide not to trade.

Trading involves substantial risk. No trading system can guarantee profits or prevent losses. Stop-losses may be affected by slippage, gaps and market conditions. Never trade money needed for essential expenses, and test any strategy carefully in a simulator or with very small size before applying it to a live account.

Trading systems: What are they - how can they help you with trading?