The main objective of this article is to guide you through the process of developing your own forex trading system.
Although devising a system may not take too long, it can take a long time to prove its effectiveness. So, you must be patient, because in the long run a good trading system can make you a lot of money.
Step 1: Time frame
The first thing you need to decide when creating your trading system is to know what kind of trader you want to be. Do you want to be a 1 day or 1 hour trader? Would you like to see charts every day, every week, every month or even every year?
How long would you like to keep your positions open?
Answering these questions will help you determine which time frame to use in your trades. Although you will also be able to analyze charts with different time periods, this will be your main time frame, which you will use when looking for signals to open or close positions.
Step 2: Choose indicators to help you identify a new trend
Since one of our objectives is to identify trends as early as possible, we should use technical analysis indicators that can achieve this. For example, moving averages are one of the most popular indicators that traders use to identify trends. Two moving averages are usually used (one slow and one fast) and one waits for the fast to cross to the slow above or below. This is the basis for what is known as a system based on the crossing of moving averages.
Of course, there are many other ways to find trends, but moving average crossovers are one of the easiest to achieve.
Step 3: Find indicators that confirm the trend
The second objective for our Forex trading system is that it has the ability to avoid false signals and thus avoid falling into false trends. The way to do this is to make sure that when we see a signal of a new trend, we can confirm it using other indicators.
There are many indicators that confirm trends, such as MACD, Stochastic and RSI.
As you become more familiar with the indicators, you will find some that you will prefer over others and that you can incorporate into your system.
Step 4: Define the level of risk
When developing the system it is very important that you define how much you are willing to lose in each operation. Very few people like to talk about losing, but in reality, a good operator first thinks about what he can eventually lose before thinking about how much he can gain.
The amount of money you are willing to lose is very different from trader to trader. You have to decide how much space is enough to allow your trades to breathe, but at the same time, not to risk too much in one trade. In the following lessons we will explain more details about money management. Money management plays a big role in terms of the risk you must give to each operation.
Step 5: Define Inputs and Outputs
Once you’ve defined how much you’re willing to lose on a trade, the next step is to figure out where to place the close of a trade to get the maximum profit possible.
Some people like to enter as fast as they can into a trend when their indicators give a good signal, even when the candle is not closed. Others like to wait until the candle closes.
In my experience I think it is best to wait for the candle to close before making an entry. I have been in many situations where I am in the middle of the candle and all of my indicators fit together, only to discover that at the close of the candle, the operation turned against me.
But you may have a different opinion when you have some experience. It’s really just a trading style. Some people are more aggressive than others and you have to slowly figure out what kind of trader you are.
For closures or market exits, there are different options. One way to make a close is to place a stop loss, this means that if the price moves for your favor in “X” amount, you move the stop loss by that “X” amount.
Another way is to determine a level, and exit when the price reaches that level. How you calculate that level is up to you. Some people choose support and resistance levels for it. Others only choose the same amount of pips in each trade. However, calculating the target level is up to you, just make sure it’s the optimum for you and stick to it. No matter what happens, never go out before.
Another way to get out is to have a criterion that gives you a signal that allows you to get out. For example, you can create a rule in which, when your indicators are set to a certain level, you leave the operation.
Step 6: Write the system rules and PLAY THEM!
This is the most important step in creating your forex trading system. You must write down the rules of your system and follow them at all times. Discipline is the most important feature a Forex trader should have, so always stay true to your system! Only then will you be able to detect possible errors and improvements but step by step, try, re-test, draw conclusions and make small changes without going crazy. If you are continually changing the system without giving it a certain margin it is impossible for you to know what works and what doesn’t work. No system will work for you if you don’t follow its rules, so remember to be disciplined!
How to test your system?
The fastest way to test the effectiveness of your trading system is to open a demo account with an online broker. You will be able to access the trading platform and charts where you can go back in time and move the chart forward little by little to see if your system would have worked well. The ideal would be to be able to advance sail by sail. When you move the candlestick chart you can follow the rules of your trading system and analyze what would be the result of your trades accordingly. You can write down your trading history and be honest with yourself.
Save profits, losses, average profits and losses. If you are happy with the results try your system on the demo account for a reasonable period of time. At least two months is recommended. This will give you an idea of how you can operate your system when the market moves. You must believe me that there is a big difference when you trade live, than when you just test.
After a couple of months of trading in demo, you will be able to see if your system is reliable for the market and switch to using your system in a live trading account. At this point, you must be confident and comfortable with your system to open trades without hesitation.