The main objective of this article is to guide you through the process of developing your own trading system to trade in Forex.
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 term a good Forex trading system can generate you a lot of money. Therefore, it is worth investing the necessary time to create, evaluate and implement a winning strategy, since a losing system can cause us a lot of losses in terms of time and money.
For this purpose, the following tips can help you in this process of development and evaluation.
Step 1: Time frame
The first thing you need to decide when creating your Forex trading system is to know what kind of trader you want to be. Do you want to be a daytrader or a position trader? Would you like to observe price 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 what timeframe to use in your trades. Although you can also analyze charts with different timeframes, this will be your main time frame, which you will use when looking for trading signals to open or close positions.
Step 2: Choose indicators that help you identify a new trend
Since one of our objectives is the identification of trends as soon as possible, we must use technical analysis indicators that can achieve it. For example, moving averages are one of the most popular indicators that traders in many markets use to identify trends. Two moving averages are usually used (one slow and one fast) and it is expected that the fast-moving average crosses the slow-moving average above or below. This is the basis for what is known as a moving average crossing system.
Of course, there are many other ways to find trends, but the moving average crosses 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 in order to avoid false market 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.
As you feel 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 risk level of your Forex trading system
When developing the system, it is very important that you define how much you are willing to lose in each transaction. No trader likes to lose, but in reality, a good trader thinks first of what he can eventually can lose before thinking about how much he can earn.
The amount of money a person is willing to lose in trading is very different from one trader to another. You have to decide how much space is enough to allow your positions to breathe, but at the same time, without risking too much money with respect to the equity of the account. In subsequent lessons we will explain more details about money management. Money management plays a big role in the risk we assume in each trade.
Step 5: Define entries and exits
Once you have defined how much you are willing to lose in any trade, the next step is to discover where to place the entries and exits of your positions to obtain the maximum possible benefits.
Some people like to enter as fast as they can in a trend when their indicators give a good signal, even when the candle has not closed. Others like to wait until the candle closes.
According to my experience I think it is better to wait until the candle closes before opening a position. I have been in many situations where I am in the middle of the candle and all my indicators fit indicating a good trade, only to discover that when the candlestick closes, the market turned against me.
But you can have a different opinion when you have some experience. In the end it all comes down to the trader’s trading style. Certain people are more aggressive than others and each person must determine over time what kind of trader he is.
For closures or exits from the market, there are different options. One way to close your trade is to place a stop loss, an order that allows to protect the position and the trading account equity if the market moves against us a certain amount of pips. If the price moves in our favor, we can move the stop loss in favor of the position an amount of “X” pips. This is known as a trailing stop. To choose an appropriate trailing stop we can use the ATR indicator.
Another way is to determine a take profit level, and exit when the price reaches that price level. The way to determine that level depends on each trader. Some people choose support and resistance levels as take profits. Others, only choose the same number of pips in each trade. Anyway, calculating the target level is up to you, just make sure it’s the optimal one for you and your trading system hold on to it.
Another way to close your trades is through a technical criterion, such as a signal from a technical indicator, that tells us when it is the right time to exit the market. For example, you can create a rule in which, when your indicators are marked at a certain level, you exit the trade.
Step 6: Write the rules of your trading system and comply with them
This is the most important step when creating your Forex trading system. You must write the rules of your system and follow them always. Discipline is the most important feature that a Forex trader should have, so always stay true to your system! Only then you can detect possible errors and improvements, test your system, test again, draw conclusions and make small changes without going crazy. If you are continuously changing the system without giving it a certain margin, it is impossible for you to know what works and what does not. No system will work for you if you do not 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 can access the trading platform and the 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 candle to candle. When you move the chart candle to candle you can follow the rules of your trading system and analyze what would be the result of your trades according to it. You can write down the history of your operations and be honest with yourself.
Save the data of profits, losses, average gains and losses. If you are happy with the results, test your system in the demo account for a reasonable period of time. A period of at least two months is recommended. This will give you an idea of how you can trade with your system when the market moves. You must believe that there is a big difference when you trade live, that when you only do tests in a demo account.
After a couple of months of demo trading, you will be able to find out if your system is reliable for the market and move on to using your system in a real trading account. At this point, you must have confidence and feel comfortable with your system to open operations without hesitation.