A stock trading system is essentially a set of rules used by a trader to determine which stock to buy, how much to buy, when to buy and when to sell. The box below displays the basics of a trading system that a swing or position trader may use.
Visually, the stock chart below shows how the above trade would have been carried out by the trader. The trader would have entered the trade at just above $8.00 with an initial stop loss at $7.74. The stock would have been sold a few days later as the price closed below the last major move.
For the purposes of this site, stock traders generally use one of four stock trading systems:
No system - These people buy and sell stocks randomly. They have really no idea on what they are buying, why they are buying and have no idea on when to sell. There is a good chance they do not know if the stock is in a bearish or bullish cycle. They learn nothing from each transaction and tend to continually repeat their mistakes. This obviously is not a good system to use.
Black Box Systems - If you look around in the trading world (magazines, Internet, and conferences) eventually you will see ads like this:
245 trades with only 2 losses
2398 % in 3 years
Doubled my money in a month
These headlines are meant to pull you in. Many of these stock trading systems have been optimized on historical data. There is a good chance the ad is true, but you will likely never repeat the success. By our definition, a black box is a system someone else has perfected. These systems generally tell you what and when to buy and when to sell. They do not teach you how to trade better. The good ones are expensive. If you are heading in this direction, do a lot of research before you buy.
Taught systems - You have probably seen ads in your local newspaper like this:
Come to a free two-hour seminar and
we will show you how to make money trading stocks
These people are also selling you a stock trading system, their system! There is an advantage, generally in the free introductory lecture you get a feel for what you will learn in their more expensive one to two day workshop. These workshops generally cost between $ 500 to 5,000. For this you normally get training, a binder of information, generally a website or software stock-searching system, hands-on training, one on one coaching after the workshop and other offers. In many cases, the monthly maintenance costs are waived for a few months after the course. After this period, there is generally a few hundred dollars required to maintain your subscription level. If their system is well thought out this can be a valuable learning experience and potentially can start you down the road to being a better trader.
Teaching yourself - there are hundreds of books and websites on trading. If you can identify some of the better ones you should be able to use the information in them to improve your trading skills. Ultimately, you should be able to develop your own stock trading system. A number of useful books have been reviewed on this site.
To find articles on building a stock trading system see the review of systems which is published every year in the magazine Technical Analysis of Stocks and Commodities - Bonus Issue.