Professional Trading Strategies (Rules, Setup, Backtest, Example Analysis) - Quantified Strategies (2024)

Professional traders have their unique ways of trading, but one thing that is common among them is that they do not follow the crowd. They follow their specific trading plans and use their own strategies. But what are professional trading strategies?

Professional traders use the normal indicators, price action patterns, and strategies that are available to most traders. The only difference is that professional traders know the ones that work and how to use them well. Unlike retail traders who dabble with different strategies they never know work or not, professional traders only employ strategies they have confirmed through backtesting to have an edge in the market and then execute them in the right way and at the right time. Professional traders know what they do and why.

In this post, we take a look at professional trading strategies. At the end of the article, we make some backtests.

Related reading: – Looking for examples of free trading systems? (We have hundreds)

What strategies do professional traders use?

Although retail traders often think that professional traders use complex strategies to trade the markets profitably, that is not the case at all. Professional traders use the normal indicators, price action patterns, and strategies that are available to most traders. The only difference is that professional traders know the ones that work and how to use them well,and they are looking for simplicity:

• 2 Reasons Why Less Is More In Trading (Keep Trading And Investing Simple)
• Simple Vs Complex Trading Strategies: The Simpler The Better

Professional traders only employ strategies they have confirmed to have an edge in the market they are trading and execute them in the right way and at the right time. This is unlike retail traders who dabble with different strategies without first knowing whether they work or not.

Whether a strategy is based on a simple indicator like the RSI or a complex price action pattern, the essence of any strategy that would make money is its edge. This is why professional traders take a lot of time and effort searching for an edge. If there is any unique thing professional traders do that makes them money, it is their use of only strategies with an edge.

But how do they find that edge? The obvious answer is through research and testing. They research the market to find inefficiencies, which they convert to trading ideas. Some of the tools they use for their research are academic publications in financial journals, studying the price charts for repetitive patterns, and tweaking existing indicators or strategies.

When they find a useful idea, they formulate different trading rules for it and backtest them on past price data. If the strategy performs well on historical price data, they go ahead and forward-test it on current market data to see if works as well in current market conditions. It is only when they have confirmed that the strategy can make money that they use it to trade on their real account.

With the knowledge that their strategy has an edge, a professional trader has the confidence to execute the strategy even when they are experiencing a drawdown, knowing that in the long run, the strategy would make money. Trading, then, becomes a game of odds. The trader knows that there is no way of knowing which particular trade would be a winner or a loser but after a series of many trades, the odds play out and there would be more winners than losses or more money made on winners than the money lost on users.

Thus, with a verified edge in the market and understanding that trading is all about the odds playing out over a series of trades, the professional trader’s game becomes about risk management — using the right position size and maintaining a certain account risk that offer them the best chance for their odds to play out. For instance, risking 10% per trade would wipe them out in 10 losing trades, but risking only 1% per trade, they still have over 90% of their capital to play with even after 10 consecutive losses.

Recommended Reading: Imbalance Trading Strategy

How many strategies do professional traders use?

Another thing about professional traders is that they employ many strategies at the same time, and they trade both long and short, regardless of the market they are trading in — stocks, futures, forex, bonds, or cryptocurrencies. By doing that, they sort of hedge their risk and also achieve diversification. Short-selling may be difficult in some markets, such as stocks, because of inflation and earnings growth, but it is still part of professionals’ trading plans, as it can provide valuable diversification.

While there are many methods out there, the common strategies professional traders employ include momentum, mean-reversion, and trend-following strategies.

Momentum strategies

These are strategies that attempt to trade along with price momentum. That is, signals are generated when the price is gaining momentum in one direction. An example is the breakout strategy. There is usually a rise in price momentum when a breakout occurs, probably from a narrow range.

• London Breakout Strategy – Rules And Performance (Backtest)
• Opening Range Breakout Strategy – 5 minute ORB Trading System (Day trading, Backtest)
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• Breakout Trading Strategies (Including Backtest and Examples with Channel System)

Another example is trading only impulse swings in a trending market. Impulse swings follow pullbacks and are usually large and with higher velocity. Those who know how to capture them, either with price action or indicators like the RSI, enjoy the high momentum that goes with them.

Mean-reversion strategies

These strategies harness the price’s tendency to revert to its mean after drifting significantly away from it. This is a sort of contrarian strategy and works best in a range-bound market. Professionals can use both price action and indicators to trade mean reversion.

An example of a price action method that exploits mean reversion is the Spring and Upthrust strategy in a range-bound market. Those who trade the strategy with an indicator may use the Bollinger Bands or RSI which show overbought and oversold levels.

• Bollinger Band + RSI trading strategy

Trend-following strategies

These strategies try to ride the trend to its conclusion and milk all the profits it has to offer. Many of these strategies use moving averages or other trend-following indicators. It is common for a trend-following signal to come from a breakout from an accumulation phase of the market.

• Combining A Trend Following And Mean Reversion Strategy

Professional traders’ Holy Grail

The real thing that makes professional traders successful is that they understand the game. They play their odds, knowing that they will make money eventually, but most importantly, they use diversification to manage risk. Diversification is their trading Holy Grail in trading! Here’s how they do it:

• Diversification with strategies: Professional traders often have a diversified portfolio of strategies. They use a combination of trend-following, mean-reversion, and momentum strategies to get the best out of any market they are trading. If the market condition is not favorable to one strategy, the favored strategy would be making money to offset any losses from the one in an offseason.
• Diversification across asset classes: Professional traders also trade different assets at the same time. The idea is that if their strategies are not doing well in one asset, the gains from the ones that are performing well would offset the losses.
• Diversification across timeframes: Professional traders also diversify across timeframes. They have strategies to trade on the daily timeframe and ones to trade on lower timeframes, thereby employing scalping, day trading, swing trading, and position trading styles at the same time. This diversified approach helps them to manage risks.

Professional trader requirements

There are different career paths for a trader:

• Trading one’s own account from home
• Trading for a hedge fund or large investment bank
• Opening an asset management firm and trading other investors’ money

Of course, you can trade stocks, currencies, or any other financial instrument for your own account as you please and can also trade for a prop firm. You don’t need a finance degree or MBA for that, even though that may be helpful.

But while you don’t need any licenses to trade for your own account, if you want to trade other investors’ money, you will have to meet the requirements of the Financial Industry Regulatory Authority in the US.

There are many types of FINRA registrations available to traders, but most likely you’ll have to meet the requirements for a General Securities Registered Representative which requires you to pass the Series 7 exam. There are also other, more limited types of FINRA registrations that allow you to only trade options, futures, or government bonds.

Here is a list of common FINRA securities examinations in the table below:

If you want to check the complete list, take a look at FINRA’s website.

It may be necessary to pursue a technical analysis license to help a professional trading career. The CMT Association offers the well-known Chartered Market Technical Program and follows a strict learning curriculum to master the art of technical analysis.

In Europe, to qualify as a professional trader, you may have to meet criteria set by ESMA (the European Securities and Marketing Authority), which are:

• You currently work or have worked in the financial sector in a professional position for at least a year, requiring knowledge of derivatives trading
• You averaged ten significantly sized transactions per quarter, during the past year
• You have a financial instrument portfolio, including cash deposits, exceeding €500,000

Common rules used by professional traders

Becoming a successful professional trader is not just about qualifications and licenses. There are some rules they adhere to that make them stay ahead of the market. These are some of them:

• Ignoring the wisdom of the crowd: The wisdom of the crowd does not work in the financial market. Professional traders have an independent mindset — they design and execute their strategies as they deem fit, not depending on tips or the opinion of others.
• Finding the edge first: The key to making money from trading is having a strategy with an edge in the market. This is why professional traders first try to find that edge and verify it through backtesting and forward-testing before putting their hard-earned money on the line.
• Having a robust risk management strategy: Without a proper risk management plan, it is not possible to stay in the game long enough to be profitable. Position sizing must be in such a way as to maintain a small account risk per trade.
• Always learning from the market: Professional traders are always eager to learn something new from the market. When they are not busy executing their trades, they are analyzing their parameters or researching new ideas and creating new strategies. There is always something to learn from the market.
• Playing all setups that match their strategy: For a strategy to be profitable, it has to play out across all matching setups. It is not good to miss or cherry-pick the setups to trade, as the missed ones may be the ones that would work. This is why many now code their strategies into trading algos to execute their trades at all times without missing any setups.
• Accepting losses as part of the game: No matter how good a strategy is, it must have some losing trades. Losses are part of the trading game. They are the cost of doing business in trading. What matters is being profitable in the long run.
• Thinking in probabilities: Professional traders know how to think in probabilities. This implies knowing that the outcome of any specific trade does not matter as long as their strategy has an edge in the market. Over a series of trades, their odds would play out and they would be profitable.
• Controlling trading emotions: Trading emotions, such as fear, greed, hope, and excitement, are the bane of discretionary trading. They make trade execution difficult, turning a winning strategy into a losing one. This is why professional traders convert their strategies to trading algos. Many traders lose because of trading biases.
• Knowing when to stay out: A trader needs to know when to stay away from the market. If a strategy is built to exploit range-bound markets, it makes no sense trying to trade it in a trending market.
• Being disciplined: Professional traders know how to stick to their trading plan. They already know they have an edge, so they have confidence in their system and trade it until they complete their planned sample size.
• Being in the right mental state: Your mental state matters in trading. It is easy to carry over whatever is wrong in your life to your trading performance. Try to separate your trading needs from your personal needs.
• Keeping things simple: Trading is a lot easier when things are kept simple. Simple strategies are easier to implement than complex ones and well-implemented strategies are more likely to make money.

Professional trading account – how do professional traders trade?

Most professional traders trade proprietary. We at Quantified Strategies traded prop for almost 20 years, and we can recommend it, even though proprietary trading firms have changed a lot over the years. The biggest change is that US traders are at a disadvantage in terms of regulation, but this is out of scope for this article.

• Proprietary Trading – A Personal Experience – Prop Trading Strategies

There are many reasons for trading prop:

• You trade amongst professionals – not retail traders
• You get to learn how to trade
• You trade the firm’s capital – not yours

If you’re in a good proprietary firm, we believe you’re in good hands. The fact is that almost all retail traders end up losing money.

Professional trading strategies – backtest

Professional trading is about making money – not about making complex strategies. With this in mind, we make a strategy with the following trading rules and settings:

1. The close must be above the 200-day average.
2. The 5-day RSI indicator of the 5-day Rate of Change indicator must be below 20.
3. We sell when the 5-day RSI is above 50.

This simple trading strategy doesn’t trade often, but it might be useful as one of many strategies. It’s a bull market trading strategy because we have a trend filter – the 200-day moving average trend filter.

How does the professional trading strategy perform? Pretty good on the S&P 500 (SPY):

The 100 000 invested in 1993 grows to 269 000, something that is 3.3% annually. That might not look very impressive, but the strategy is invested only 5% of the time. If we adjust for that and calculate the risk-adjusted return, it is a more impressive 61%. This means you have resources to add complementary trading strategies.

The performance and trading metrics look like this:

Other professional trading strategies

We have been publishing trading strategies since 2012 and have hundreds of free trading systems, although we charge a fee for the best ones. Please click here for an example of a free and profitable trading strategy.

You can find all our paid products in the Quantified Strategies Shop – including many relevant courses.

How do you become a professional trader?

To become a professional trader, follow these steps:

1. Learn and Research: Gain knowledge through academic publications, price chart studies, and financial journals.
2. Develop and Backtest Strategies: Create trading strategies and backtest them on historical data.
3. Risk Management: Implement robust risk management techniques and diversify your portfolio.
4. Continuous Learning: Keep analyzing the market and refining your strategies.
5. Licenses and Regulations: Obtain necessary licenses like Series 7 for trading, or meet criteria set by authorities like ESMA in Europe.

FAQ:

What are professional trading strategies?

Professional trading strategies are methods employed by seasoned traders who rely on confirmed, backtested approaches with an edge in the market. Unlike retail traders who experiment with various strategies, professionals focus on a few proven ones, executing them with precision and timing.

How do professional traders determine which strategies to use?

Professional traders meticulously research and test strategies to identify inefficiencies in the market. They rely on tools such as academic publications, price chart analysis, and adjustments to existing indicators. Backtesting on historical data is crucial; only strategies that prove profitable in backtests undergo further validation in current market conditions.

What are momentum, mean-reversion, and trend-following strategies?

Professional traders commonly utilize momentum, mean-reversion, and trend-following strategies. Momentum strategies capitalize on price momentum, mean-reversion strategies rely on price reverting to its mean after significant drifts, and trend-following strategies aim to ride a trend to its conclusion. These strategies are adaptable to different market conditions.