During previous tutorials, we learned how to make trades, studied methods of technical analysis, and elaborated on the main indices of fundamental analysis. Every trader has to be aware of these basic principles in order to analyze and understand any financial market. However, in many cases, it is not enough. It is common that different investors with similar backgrounds implement the same systems and indicators, watch and read the same information, but some quit trading in a few months while others stay in the market and become successful. So, what exactly helps traders make money? What do they spot on charts and why do they make progress? There is no secret at all. Every trader just develops his own trading system.
It is the trading systems that we are going to deal with in this tutorial.
” A trading system is the result of a trader’s experience, hard work, and knowledge. “
Designing a proper trading system comes at a high price. It involves days and nights spent at a computer, critical analysis of past mistakes, and the heart you put into it. However, the result is an individual trading system which is a secret formula for success. Two identical systems do not exist. Every trader has certain tools and techniques. He can share them with other traders but will be unable to explain all the details and intricacies of his own view on the market. That is why it is necessary to design a system of your own from the very beginning, from your first steps in trading. If you decided to become a professional trader and trade in the market steadily, efficiently, and for a long time, you need to create an individual trading system. Today there are a lot of books where famous traders reveal their secrets and give examples of trading systems which helped them achieve success in their careers. You may find it very useful to learn from their experience and follow their advice. But keep in mind that it will not have the desired effect if you follow those systems blindly. You need to dig up the core idea which will help you design a unique trading system.
” A trading system is a blend of several important components. “
It can be compared to a mechanism. Even if a single cog in the machine is removed, the machine will malfunction or stop working. The same applies to a trading system. If you add up a wrong component, all your work would be for nothing. A system has to be adjusted carefully and customized. Besides, a trading system is not permanent, you must constantly monitor and streamline it. At the same time, a system must minimize risks and ensure maximum accuracy of forecasts. A trading system is a precise calculation, a balance point between several unknown and constantly changing factors. It is extremely important to get the priorities straight, diversify risks, calculate entry and exit points, and choose analytical tools.
” A trading system is a set of strict rules that determine price levels, time, and conditions for entering and exiting the market. “
A trader with an elaborated trading system is always ready for any development on the market. Every minute the trader can tell what exactly he is going to do or avoid doing with a certain currency in the market. If he cannot tell for sure, he did not learn to understand the signals provided by the trading system, which is unacceptable. Steady profits are the only measure of the system’s efficiency. As we have already mentioned, a trading system is a set of rules, which stipulate the steps you should take after some important factors have influenced financial markets. More specifically, the system reflects the overall results of fundamental and technical analysis, risk management, and capital allocation. An application of a trading system is called a trading plan.
Before adopting a trading system, you have to consider some basics. We refer to portfolio management, risk management, and trading strategies in the first place. In other words, the trader should take into account
- Initial deposit (the size of the account required by the company) or choose a leverage by yourself;
- Minimum required level of margin to keep positions open (maintenance margin);
- A lot size, overall maximum level of loss;
- Maximum loss on one position, possibility of hedging;
- Maximum number of open positions;
- The average gain included in the trading plan, an approximate value of one pip for a particular currency.
Then you need to choose trading instruments. The four most traded currency pairs are EUR/USD, USD/JPY, GBP/USD, USD/CHF. You can also use other currency pairs that do not involve the US dollar or cross rates.
Anyways, you must know the exchange rates of different currencies and a pip value in the US dollars. Now you can pass on to technical analysis. You need to prepare a set of technical tools that you are going to use in trading. These tools include trend lines and/or levels of resistance and support, trends, automated technical indicators, chart patterns, Elliott waves, Japanese candlesticks, Fibonacci levels, and so on. The choice of instruments is quite rich. That is why, in order to decide on the necessary instruments, you should have a closer look at them. The most difficult part is selecting appropriate automated technical indicators. Even though there is a great variety of indicators, we recommend using just several simple tools. Your assortment of tools should definitely include both trend indicators and oscillators. The choice of a certain indicator largely depends on the time frame of trading, whether it is intraday trading or mid-term positions. At the same time, the adjustment of the same technical indicators is limited to the technical characteristics of the system itself.
Finally, the last step is to work out a sample of a trading plan which you have to fill in every day, one sample for each currency pair or cross rate. Apart from columns comprising technical tools and automated technical indicators, a sample can have a separate column on без fundamental analysis, which includes upcoming economic events, forecasts, and the time when they are slated for release. You can also put down market expectations here. This information is available on our website (www. instaforex.com) in sections devoted to forex trading. In addition, a trading plan should include columns titled Conclusions and Review. In the first one, you write down your thoughts about whether or not you should enter the market. If yes, at what price and under which circumstances, where you have to place a stop-loss and a take profit order, etc. The next day, you fill in the Review column to summarize the results of the previous trading day. For example, you indicate whether the trading plan was successful, as well as causes and mistakes if it failed. Don’t forget to put down the balance of your account following the trades you’ve made (or assumed trades at first).
As soon as you designed your own trading plan and the methodology of technical analysis, each time it will be easier for you to make the same everyday job. Discipline is the main thing in such work. A trading plan is the first step to your own trading system. Carefully designed method of your routine work will form the pillar of your own trading system.
” The choice of technical tools and instruments is crucial because they signal possible price movements. “
The main point is to distinguish between major and minor signals.
It is important to know why you need a particular instrument. This is the time when you work out the basics of your own trading strategy.
Technical tools are used to:
- determine an ongoing trend (uptrend, downtrend, sideways movement);
- calculate key and local entry and exit points (levels).
You may find it very useful to employ trend lines, support and resistance levels, continuation and reversal chart patterns, Fibonacci levels in various positions (pullbacks, rebounds, extensions, fans, arcs, etc.), Elliott waves, and Japanese candlesticks.
Automated technical indicators are most widely used to:
- get confirmation of entry points;
- determine the probability of the price movement to change its direction.
Before studying signals provided by automated technical indicators, you should examine the market with the use of traditional technical analysis. Every trader has to understand that those indicators are nothing else but price derivatives, even though some of them represent leading indicators.
Using the tools of classic technical analysis, you should answer the following questions:
What trend is dominating the market? (uptrend, downtrend, sideways trend).
Which trend is major and which one is minor?
Are there any chart patterns and what do they mean?
Is it necessary to use Fibonacci numbers (after a sharp price movement or in order to identify the future movement)?
Which price levels represent key support and resistance levels and which of them are minor?
As soon as you’ve got an idea of how the market works, you can proceed to automated technical analysis. As we have already mentioned, automated technical analysis is a derivative of the price movement and, therefore, of classic technical analysis.
” Automated technical indicators either confirm or deny signals provided by technical tools. “
Remember that there is no versatile indicator. Any indicator helps to make predictions with relative accuracy. Here is some advice on how to compile your own set of tools, so that you understand where to start.
The tool kit must consist of both trend-following indicators and oscillators. The choice of a particular indicator depends on the type of trades you plan to make. For example, if you are involved in intraday trading, oscillators must prevail in your set of tools. If you prefer medium-term trading, you should equally use trend-following indicators and oscillators. With long-term positions, you should mainly employ trend-following indicators.
Besides dividing those indicators into two large groups, you have to know what they are used for, the meaning and importance of their signals. For example, among trend-following indicators, the Average Directional Index (ADX) is considered the best tool to evaluate the beginning of a trend. Meanwhile, Moving average convergence divergence (MACD) is mostly used for identifying the end of the current trend.
It is recommended that you have at least one indicator in your inventory which helps to evaluate the prevailing trend as well the sideways movement, like MACD.
In your set of tools, you need indicators based on different principles. This will help to avoid overlapping of signals. It is good to employ slow stochastics, Relative Strength Index (RSI), Price Rate Of Change (ROC), moving averages, and Bollinger Bands. Similar indicators usually provide overlapping signals. Meanwhile, indicators based on different principles ensure fewer entry and exit signals with higher accuracy.