You may decide to develop your own trading system or you
may prefer to purchase one that has already been developed
for use and has a proven track record.
In this article we will look at the basics of developing
your own trading system.
In essence a trading system is any set of rules that must
be conformed to when trading, so you could for example
detail the following rules.
If a 5 period exponential moving average (EMA) crosses up
over a 13 period exponential moving average(EMA), enter a
long trade.
If a 5 period exponential moving average (EMA) crosses down
over a 13 period exponential moving average (EMA), enter a
short trade.
You have now created the basis of your trading system.
Of course this would not be nearly enough to produce a
successful trading system, so now you need to enter some
safeguards.
If the 5 period EMA crosses up over the 13 period EMA
enter a long trade and immediately place a stop loss order
at 50 pips below the entry value.
If the 5 period EMA crosses down over the 13 period EMA
enter a short trade and immediately place a stop loss
order at 50 pips above the entry value.
So far you have only one criterea for trade entry and this
could lead to many false signals. To help prevent this you
might well add one or more technical indicators as a
filter, but keep in mind that the more filters, the less
trades will be signalled and although this can be a good
thing, it is important to maintain a balance.
Continuing with the system building process, you might
choose to add MACD as a filter.
If the 5 period EMA crosses up over the 13 period EMA AND
MACD is rising above the signal line, enter a long trade
and immediately place a stop loss order at 50 pips below
the entry value.
If the 5 period EMA crosses down over the 13 period EMA AND
MACD is falling below the signal line, enter a short trade
and immediately place a stop loss order at 50 pips above
the entry value.
It will be necessary to back test your trading system with
various time frames to establish the optimum time frame(s)
for the system.
Back testing can be carried out by using a backtesting
program or by visually looking back at the charts and
identifying the points at which "your trading system"
conformed to the trade entry rules. Then look forward to
see if the trade would have been successful.
Make sure that you make precise notes regarding each
theoretical trade.
Next you will need to develop a rule or set of rules for
exiting the trade. There are many ways to do this.
Developing a reliable exit method is in many ways more
important than developing a reliable trade entry system.
One popular method is to use a trailing stop and to
continue to trail price until the trade is eventually
"stopped out" in profit.
A trading system, no matter how good, will not produce a
winning trade for every trade entry.
Your goal is to establish a system that is successful more
than 50% of the time. The higher the percentage the better
the system will be.
If your system checks out favourably during back testing
you should proceed to trade it in REAL-TIME but using a
DEMO ACCOUNT only.
It is most important at this stage not to put any real
money at risk, because back testing is not reliable enough
to prove a trading system's worth.
If after a month or two of REAL-TIME testing the system
shows a consistent winning average of above 50% then you
can consider making further adjustments to improve the
average.
Each time that you make an adjustment, it is most important
to go through the whole testing process again from the
begining, to ensure that the adjustment has made a
favourable difference.
There is no reliable short cut to this process.
Make sure to only make changes one at a time and carry out
the whole testing process for each change. If you make more
than one change at a time, you will never be certain which
of the changes were beneficial and which were not.
Finally, after all of your testing has been carried out and
you are ready to fund a live account, it is essential to
apply a system of money management.
This needs to be a rigid set of rules that might for
example include - Never trade using more than 2-3% of your
trading account on any one trade - and so on.
Good luck and happy trading.
----------------------------------------------------
Martin Bottomley is a full time professional forex trader,
forex tutor, acknowledged author and co-developer of forex
trading software including The Amazing Stealth Forex
Trading system. You will find more information at:
http://www.stealthforex.com
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