THE FOREX TRADING SYSTEM
The forex trading system outlines a structure, usually in the form of a set of rules, for trading. It
specifies when to get into a trade, either long or short, and when to close a trade, either at a profit or a loss. Developing
a trading system and then following that system is the key to trading forex responsibly.
A forex trading system can be discretionary or computer based. Discretionary forex trading systems rely on subjective analyses or
even just the "gut feeling“ of the trader.
For a variety of reasons, most traders have moved away from relying on discretion. Principal among these are the lack of consistency and
reliability of trading performance associated with discretionary trading. As well, there is no way to back-test the trader's skill using
historical data.
Computer-based forex trading systems mechanically
quantify the conditions or criteria under which a trade is made with the intent
of eliminating the discretionary element from the trading decision.
Every trading system should be first tested under
simulated but real-life
conditions prior to risking actual dollars. This will enable the
forex trader to develop some skill in implementing the system and, more importantly, generate valuable feedback. Feedback provides
insights into improving the trading system's performance.
CRITERIA FOR ESTABLISHING A TRADE
The forex trading system must have clear rules that specify when to establish and/or add to a
new position. This
signal may depend upon technical considerations, fundamental considerations or some combination of both. Because of the short-term
nature of most forex trading systems,
technical analysis tends to
be more predominant and, indeed, retail forex trading platforms
typically provide a wide range of technical tools, many of which can be customized by the trader.
CRITERIA FOR CLOSING A TRADE
The forex trading system must also specify when to close an outstanding position that is losing money. The stop order is a useful risk management
tool to limit the loss on a trade, but determining the
amount to risk before
a position is closed is not easy. For example, a stop order should accommodate a minor price reaction so as to not close a potentially
trade prematurely, which will depend upon the volatility of the currency pair being traded, yet it should not keep the trader too long
in a losing position. Deciding when to close a trade with a profit is also not simple. Should a price target be set or should the stop
order be trailed? Each of these will require firm guiding rules.
THE OVERALL OBJECTIVE
All of these rules of the trading system are interdependent and they must work together so that overall, trading
is profitable. Finding this set of rules is the task that every serious forex trader sets out to accomplish.
It will likely be the case that a wide variety of trading rules will need to be created and back-tested with the intent
of finding a winning formula. Consequently, patience and dedication are required. In many cases, the feedback provided
from back-testing can provide insight to a clear and methodical thinker into how to modify the trading rules in order to
improve overall performance.
There are no guarantees of profitability in the world of forex trading,
but the discipline of a trading system goes a long way toward improving your chance of success.
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Your Forex Trading System. Trading systems are individualistic, based on such factors as personal experience,
available risk capital and tolerance toward risk. Consequently, trading systems
usually differ from one trader to another. You must develop a system that works
best for you. Among other things, this requires patience, rigid adherence to
the rules of the system, meticulous record keeping of trading performance
(which is valuable feedback) and an open mind to try new methods.
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Fitting the Pieces. The production profile of a trading system reflects these four interdependent factors.
Changing one will lead to a change or trade-off in others. For example, a trading system that risks very little on each
trade will likely generate high trading volume with many of those being losing trades, but the fluctuation in trading
account equity will be low. A system that risks more on every trade may generate fewer trades and have a better win-to-loss ratio,
but will likely see the account equity fluctuate more.
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A Work in Progress. Trading systems are dynamic and always subject to modification in order to better
respond to the current market climate. A trading system that worked well in the past may need modification in light of
changing market conditions.
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