What Traders Get Wrong About Trading Strategies

Having an appropriate trading strategy is undeniably one of the most important factors for succeeding at trading.

But it’s also one of the main things people get wrong.

I don’t just mean slightly wrong.

I mean almost everyone in the industry is taught to do the exact opposite of what they should be doing. The same misconception is repeated everywhere you look.

So what is everyone getting wrong?

They misunderstand two fundamental things:

1. Where strategy fits in the trading process
2. What a strategy is actually meant to do

Think about how “strategy” is usually explained.

It’s a set of pre-defined rules and criteria, a bit like a recipe or a checklist that dictates how to find trades, when to enter, how to manage the position, and where to exit.

You’re told to figure out a ‘profitable strategy’ and backtest it. Then take that set formula and apply it in the markets over and over again. (Just make sure you develop the discipline to stick with it!)

But this approach is completely backwards. 

You’re coming up with a solution before you understand the problem. 
You’re giving an answer before you know the question.
You’re trying to win a game before you’ve even figured out what you’re playing.

The truth is this:

Your strategy shouldn’t come before your analysis. It should be the outcome of it.

You don’t bring a strategy to the market, you create one in response to what the market is showing you.

This isn’t unique to trading. It’s how real strategy works in any serious field, including business, politics, and the military. But the trading industry often acts like it exists in a vacuum, reinventing the wheel with approaches that don’t make sense anywhere else.

To correct this, let’s turn to one of the world’s leading strategy experts: Richard Rumelt.

This is how he defines strategy:

“The core of strategy work is always the same: discovering the critical factors in a situation and designing a way of coordinating and focusing actions to deal with those factors… A good strategy recognizes the nature of the challenge and offers a way of surmounting it.”

He explains that at the heart of any good strategy is the Strategy Kernel. A model made up of three connected components:

1. Diagnosis
2. Guiding Policy
3. Coherent Actions.

This model applies perfectly to the trading process, and should become the foundation of how you approach your trades. 

1. Diagnosis

This is your market analysis, but deeper and more purposeful than most traders realise.

In most cases, what traders call “analysis” is simply identifying and labelling things: marking up price structures, plotting levels, identifying patterns, checking indicators. Then they derive some pre-conceived meaning from it all.

That’s not analysis. 

True analysis means interpreting the information and drawing conclusions from it. Not just identifying elements, but understanding the meaning and implications of them. What’s really going on in the market? What may have caused it? What’s the narrative?

Once you’ve identified the context, you need to reach a conclusion.

Based on the information you’ve gathered and the interpretation you have of it, what outcomes may happen next?

Notice that’s ‘outcomes’, plural.

We know a range of possible outcomes could happen, and it’s important to recognise all of them.

If we think about other fields, it’s common for strategic analysis to identify the opportunities and threats in a situation. In trading, we also have opportunities and threats. Outcomes that would lead to a loss are threats, whereas the ones that would lead to profits are opportunities.

We need to understand all of them, and the probability of them occurring, if we want to come up with the right strategy.

You need to:

• Understand the past market context
• Use that to interpret the current context
• Use that to anticipate a range of potential outcomes
• Estimate the probabilities of those outcomes

2. Guiding Policy

Once you’ve diagnosed the situation, you need to filter your options through your guiding policy.

If you think about this for a business, they might have brand principles, market positioning, or company values. These dictate the sort of actions they can or can’t take.

You should have the same with your trading too. These will usually come from two places:

1. Your trading approach: For example, at Duomo we follow the Duomo Method, rooted in Duomo Market Theory. This gives clear principles for actions and decisions that are optimal, logical, and precise in the markets.
   
   
2. Your personal constraints: You’ll have your own strengths, weaknesses, preferences, risk appetite, skill and knowledge gaps, and experience. These shape what you’re most capable and comfortable doing.

For example, a situation might call for a very aggressive strategy. But if you know you’re highly risk-averse or lack the experience to manage that scenario confidently, you’d make appropriate adjustments to your approach based on your guiding policy.

3. Coherent Actions

Once you've diagnosed the situation and filtered it through your guiding policy, you're ready to develop your actual strategy. The coherent actions.

These actions must be:

• Clear (Not vague or open to interpretation in the heat of the moment)
• Practical (Something you can actually execute, not wishful thinking)
• Directly linked (Every action must reflect the diagnosis and stay within your guiding policy)

When you break it down, there are only a handful of actions available to you as a trader.

With the initial entry we can choose an entry method (i.e. market order, limit order etc.), a position size, and our next decision points (including automated decisions through a stop loss or take profit order). In advanced cases you might also use hedging or other means of protection and diversification.

Once the position is open we can move our stop loss (or other exit approach), scale in, scale out, or exit the trade.

And nearly all of these actions come down to risk management. That’s why at Duomo, rather than referring to “trade management” we think of it as Strategic Risk Management.

Even with a relatively small toolkit, there are many nuanced ways we can combine these tools in different scenarios. This is the beauty of trade strategy and what makes it so interesting. 

It’s like a problem solving exercise: given our diagnosis of the situation, how and when should we use these tools? What’s the most optimal way of dealing with the full range of potential outcomes? What will trigger different actions being taken?

Then, once the trade is in play, you should continue diagnosing the situation through active analysis and update your strategy when needed.

Just like analysis, trade strategy is a skill that takes time and effort to develop. You might start off with basic strategies, but as you gain more experience and skill you can come up with more advanced ways to deal with a situation and enhance the expectancy of your opportunities.

You don’t need a rigid “strategy” that you apply to every market like a paint-by-numbers routine.

You need to diagnose the situation, run it through your guiding policy, and execute coherent actions based on that. Every trade is its own problem-solving exercise.

This is the step you need to take to go from just being an analyst who takes trades, to a fully-fledged trader who understands the opportunity.