How to Evaluate a Day Trading Strategy?

Most day traders evaluate day trading strategies by their win rate and potential profit. While these are important metrics to look out for. The most important part of the evaluation is to understand the concept of the day trading strategy.

A day trading strategy is not merely a set of rules. It is a concept of how the market works and how traders react to price movements. This concept is the basis of the trading rules. Without understanding the concept underlying the day trading strategy, you cannot judge if the rules makes sense. You are also unable to improve on the rules and differentiate the better trade setups from the worse.

Let’s take the popular Holy Grail trading setup by Linda Raschke as an example. The concept behind this trading strategy is that in very strong trends, pullbacks tend to fail. The strategy then uses the Average Directional Index (ADX) indicator to find strong trends. If the market is trending upwards, once prices pull back to the moving average, we will buy, and hopefully the trend will resume.

Indicators are not perfect. However, with the concept of this strategy in mind, regardless of what the ADX shows, you should look at the chart and ask yourself if the chart shows a strong trend. If it does not, regardless of the value of the ADX, you should skip the trade.

After understanding the concept of the strategy and why it works, you should classify the strategy. There are four types of basic trade setups: reversal, retracement, range-bound, and breakout. The win rate and reward-to-risk ratio depends on the type of trade setup. The Holy Grail strategy is a retracement type strategy with high win rate and lower reward-to-risk ratio.

Before accepting the strategy into your day trading arsenal, you should also take note of the indicators needed and if you have access to these indicators. Some indicators might be proprietary and you may need to fork out a hefty sum to get them. Even if the indicators are freely available, you should also check if your trading platform provides them. This is an important step as having the right indicator is crucial to employing any day trading strategy.

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