System Basics

System Basics Forex Trading

Before you buy a currency trading system or devise your own you need to ask yourself some questions, to enable you get the right trading system. By the right system we mean one that’s suits your personality and your pocket.

Let’s look at the basic questions you need to answer and first let’s look at buying a ready made system.

1. Does the Trading System Have a Real Time Track Record?

You will see numerous forex trading robots for sale, offering extraordinary profits and they look to good to be true but are they? You won’t be surprised to learn that they are. The track records are simply made up, by simulating the track record over past data in hindsight. See a track record on most automatic forex trading systems and you will also see this warning:

“CFTC RULE 4.41 – Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under-or-over compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown”.

If you see the above warning, be very wary of buying the trading system.

Getting perfect market timing with your trading signals in hindsight is easy, as the system is simply bent to fit the data. You are better off in most instances; go with one which has been proven in real time trading.

2. If you are Happy with the Performance What about Peak to Valley Drawdown?

The track record may look good over 2 or 3 years – but what about the drawdowns in between? Don’t just look at the average draw down but the worst peak to valley drawdown. This means you assume that you join at the worst possible time. Look at the decline in equity and ask yourself – could you live with that and the time it takes to make a new peak in equity? Always assume your worst drawdown is ahead and be prepared to stick with your system through these periods of losses.

3. Do You Understand The Logic and Do You Have Confidence In It?

Never buy a black box currency trading system. This is a trading software package where the logic upon which the software calculates the trades is not revealed. The system may be successful – but if you don’t know the logic, you are unlikely to have confidence in it. Without confidence, it’s hard to keep executing trading signals through periods of losses. Always try and buy a system where the logic is revealed and learn how and why it works.

4. What Do You Know About The Vendor and The Systems History?

It’s always good to know something about the vendor. For example, has the trader traded how long what support does he give? etc. Feel free to ask as many questions as you want, as a good vendor will be pleased to answer and it also allows you to test the support you will get in advance of buying the program.

If you want to buy a totally mechanical forex trading system which has a real time track record don’t expect to get it for a few hundred dollars. Expect to pay anywhere between $1,000 and $20,000, as a minimum. Be very careful of buying the huge amount of automatic trading software for sale with a simulated track record – these have never been proven to work, so avoid them.

If you are devising a system for yourself:

You need to decide exactly what type of system you want and make sure it suits your personality. Here are some tips on building your own currency trading system.

1. What Type Of Trader Are You?

Are you a patient trader or do you like more action? Are you highly disciplined or know you lack discipline? Well when you answer these two questions you have a choice of two methods of trading which are outlined below.

2. Do You Want To Swing Trade or Trend Follow?

Your real choice is between forex swing trading and long term trend following – forget day trading or scalping, these methods don’t work. Swing trading suits the impatient trader, who lack discipline and is perfect for a novice forex trading strategy. You get plenty of trades and both profits and losses, tend to be banked quickly. Long term trading suits the patient trader and can be very lucrative however, you must have the discipline to take short term drawdowns in open positions ( which is hard) and keep your eye on the bigger prize.

3. Do You Want a Totally Objective Rule Based System?

Many traders simply like to execute trading signals but some (us included) like to have a manual override on the forex trading signals. We like to be able to adjust the money management parameters and weight the trades. If you are disciplined and have knowledge of forex trading, then this option works well. Keep in mind a human has a brain and can think, this gives the disciplined trader an advantage a computer doesn’t have.

Both options can work and work well – the choice is simply a matter of personal preference.

Once you have answered the above questions, you then need to construct your currency trading system. You should keep the following points firmly in mind when doing so:

1. Keep it Simple

Simple systems work best, as they are more robust and complicated ones which have more elements to break. Furthermore, the more complicated you make a trading system, the more likely you are to fall victim to curve fitting.

2. Understand Support & Resistance

All systems are based around support and resistance and you can define this in a number of ways. Which ever way you do, consider incorporating breakout trading in your system. Some of the best moves (particularly big trends) start from new market highs or lows.

3. Understand You Need To Confirm

Whatever system you use, make sure you confirm each and every move based upon price momentum. Use momentum indicators to prove that the momentum is accelerating or declining, at an important resistance or support point to get the odds on your side. There are many to choose from but good ones are – the stochastic and the Relative Strength Index (RSI).

4. Money Management

If you want to win long term in forex trading, you need a good forex money management system. This involves not just placing a stop – but a weighting of risk based upon the odds. To make long term profits, you need to play great defense first just like a good football team, your offense will get the opportunities and turn them into profits for you.

You can have far more losers than winners ( particularly in long term trend following) if your winners are big and you stay with them.

5. Stop Losses and Profit Taking

When trend following, you will tend to work with a trailing stop loss and with swing trading, it’s always best to work with a profit taking target.

In trend following you need to run your stop loss behind normal volatility and have an understanding of standard deviation of price. If you don’t know what it is, make part of your forex education now. The real problem is not setting a stop loss – but trailing it and knowing when to take profits.

Trail your stop to close and you will get bumped out of the trend early, you need to give the market room to breathe. You will miss a bit of profit when the trend turns – but as you cant predict that anyway, so don’t try. Keep in mind if you caught just 50% of every big trade, you would make huge profits.

In swing trading you are aiming for a lot of profits that are small so have a target and take your profit early – before everyone else. By doing this you will keep the odds on your side. Try and trail a stop loss and chances are you will see your profits disappear quickly.

The above are the basics you need to consider when buying a currency trading system or building your own. If you follow the above tips, you can find or build a system which will lead you to currency trading success.

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