Forex System Trading

By: Martin Bottomley
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 criteria 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.

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