How to build a trading system

How to Build A Trading System Practical example of how to design your Forex trading system from scratch by Gonçalo Moreira | September 2012 Material extracted from FXstreet.com Learning Center

INTRODUCTION DEFINITION: A Trading system is a set of rules that formulates buy and sell signals without any ambiguity or any subjective elements. PRIMARY AIM: Manage risk and increase profitability in any market environment. Optimal levels of risk and reward are accomplished by modifying the different parameters within each rule of the system. PRINCIPAL BENEFIT of trading with a system: Removal of emotion from trading Systematical trader will, for instance, not place an excessively high risk trade due to frustration from a prior losing trade. - Read the article “The Pleasure and Pain Game” by Sam Evans on how emotions affect your trading 2 - Listen to Steve Wards podcast on “Emotions, Decisions and Discipline”Extract of FXstreet.com Learning Center

INTRODUCTION No system is better than any other But a good system is one that is adapted to: ✔ your goals ✔ your time window ✔ your start capital ✔ your personality 3 Read Jody Samuels on how to “Define Your Goals”Extract of FXstreet.com Learning Center

STEPS Steps to build a trading system from scratch: 1. Observation 2. Hypothesis 3. Measuring the Hypothesis 4. Selecting the Time Frame 5. Developing the Strategy 6. Entry Rules 7. Exit Rules 8. Position Size and Risk Management 4Extract of FXstreet.com Learning Center

LETS GO! We will build together a simple system going through these steps. Its a real system that has been backtested. It is particularly appropriate for Beginners and Intermediate traders and to be traded with mini lots or lower. 5 On our Brokers comparative table, you will find which regulated brokers let you trade with small lot sizesExtract of FXstreet.com Learning Center

1. OBSERVATION If you intend to capitalize on the market behavior, you need a BELIEF SYSTEM on how the markets operate. Series of ideas you have gathered after observing the market for a while. Market observations are thus the building blocks of every system and trading method. Extremely important aspect most novice traders neglect!!! 6 Read the article “Beliefs: What You Hold as True Will Drive What You Do” by Dr Woody JohnsonExtract of FXstreet.com Learning Center

1. OBSERVATION Look at different currency pairs and charts and see what ideas pop up to our mind. Lets OBSERVE this chart This daily chart shows that most of the daily candles have different lengths in terms of pips. We also notice that they break the high or low price from the previous daily candle most of the time. The magnitude of the breakouts differs from candle to candle, but in many cases the distance the exchange rate shoots off the previous daily extremes is large enough to be considered a profit potential. 7 Breakout: DefinitionExtract of FXstreet.com Learning Center

2. HYPOTHESIS Once you have enough evidence that the recurring action- reaction event takes place on a regular basis, then you can formulate the hypothesis. This strategy aims to capture part of a breakout movement, starting from the high or low level of the previous day. The MARKET CONDITIONS to meet in order to capture this event are: ✔ An increased momentum and volatility in the market. ✔ A major underlying trend in the direction of the breakout. - Momentum: Definition 8 - Check the currency pairs momentum in the Heat Map tool.Extract of FXstreet.com Learning Center

3. MEASURING THE HYPOTHESIS Take a sample of past price data and take some rough measures accordingly to your hypothesis. Collect enough data to sustain your initial hypothesis. A number of 100 occurrences of the event under observation will provide a good statistical foundation. In order to measure the potential of the breakout, we will take the GBP/USD pair For its characteristics as a fast moving currency pair, WHY this pair? able to break support and resistance levels when it gains in speed and momentum. Other majors would also be suitable for this strategy... we just had to choose one! In our “Volatility Watch” widget you can observe the volatility 9 measures of the pairs: BBW (Bollinger Bands Width), STD (Standard Deviation) and ATR ( Average True Range)Extract of FXstreet.com Learning Center

3. MEASURING THE HYPOTHESIS Now you need to take a sample of past price data and take some rough measures accordingly to one of the above hypothesis. Lets take the one based on the breakout of the previous day high and low. The results could look like this: during 2005, the average magnitude of the breakout was 65 pips in the GBP/USD. Of those breakouts, 92% were more than 10 pips, 38% more than 65 pips, 19% more than 100 pips. As for the frequency, the pair broke out 88% of the days that year. 10Extract of FXstreet.com Learning Center

4. SELECTING THE TIME FRAME Experiment the system with different time intervals. A hypothesis may work better in a small time frame than in a longer one or vice versaAlthough the event of the breakout is visible on the daily charts, we will choose the 1H timeframe to start evaluating the strategy with the help of technical indicators. The 4H time interval seems too high to WHY 1H? visualize the smaller breakouts + Any time frame below 1H may generate unnecessary signals. The TIMEZONE used for testing will be GMT, the standardized timezone for the FX market. 11 - Check the Market Timeline to check the trading sessions timesExtract of FXstreet.com Learning Center - Volatility Distribution by hour for the GBP/USD

5. DEVELOPING THE STRATEGY: THE TOOLS Describe your system. Fully articulate the initial idea. This includes an explanation about the tools to be used and what events provide the conditions to get into and out of positions. The TOOLS of our strategy: 1. A price box to mark off the high and low prices of the previous day will be displayed on the 1H chart. Each 24-hour period will be marked with a vertical line to distinguish the start/end of the day. 12Extract of FXstreet.com Learning Center

5. DEVELOPING THE STRATEGY: THE TOOLS 2. A combination of two moving averages will help to get the direction of the underlying trend. Those will be the 21 and the 89 Simple Moving Averages, two numbers taken from the Fibonacci sequence which are not contiguous (...,8, 13, 21, 34, 55, 89, 144,...). 13 - Simple Moving Averages: Definition - Read “A Practical Guide To Moving Averages” by S.A GhafariExtract of FXstreet.com Learning Center

5. DEVELOPING THE STRATEGY: THE TOOLS 3. Bollinger Bands applied to the 21 SMA will be used as an indicator for volatility. The higher the standard deviation used in the settings, the more closing prices are contained within the bands. As the breakout movement needs to be aligned with the main trend, we need a parameter that gives some room for price to develop. Therefore the deviation will be initially set to 3. 3 standard deviations contain 99.7% of the closing prices. This indicator will help us avoid trading breakouts if the previous daily range has been very tiny and the market lacks volatility. 14 Book: “Bollinger on Bollinger Bands” by John A. Bollinger, the creator of this technical indicatorExtract of FXstreet.com Learning Center

5. DEVELOPING THE STRATEGY: THE TOOLS 4. Pivot Points will be used as a tool to manage the positions and to take profits.The classical Pivot Points and theircorresponding Support and Resistance levels -S1, S2, R1, and R2 - are needed for thissystem.This indicator will help us to filter some of theless probable breakouts .It will also help us moving the stop to breakeven, if any of the Pivot Point levels has beencleared on a close. 15 Check the Classic Pivot Points levels for GBP/USDExtract of FXstreet.com Learning Center

6. ENTRY RULESThe parameters to enter positions are related to the type of systemyou use.The strategy has to be designed in a way that does not require youto make any subjective decisions whether the signal is valid or not. The trade entry must be described in detail, including concrete definitions of:  The proper market conditions for entry  The optimal trade set-up  The final confirmation signal, also known as the “trigger”. 16Extract of FXstreet.com Learning Center

6. ENTRY RULESThe ENTRY RULES of our system: In order to start testing the strategy only one trade per day will be taken. Market Conditions as for the direction of the breakout: 1. The faster 21-period Simple Moving Average is above the slower 89-period Simple Moving Average. The direction will remain unchanged until the faster 21-period Simple Moving Average crosses below the slower 89-period Simple Moving Average. 17Extract of FXstreet.com Learning Center

6. ENTRY RULES If a certain day doesnt break a previous day price extreme, the direction of the breakout remains as it was before. 3. If a certain day breaks the previous day high AND low price extremes, the direction of the breakout will be determined by the position of the Moving Averages as explained in Rule 1. 18Extract of FXstreet.com Learning Center

6. ENTRY RULES LONG ENTRY conditions: The 21 SMA is above 89 SMA. The upper Bollinger Band is notcontracting to the downside inthe last candle before thebreakout. The 161,8% Fibonacciextension is equal or closer than15% of yesterdays tradingrange. 19 Range: DefinitionExtract of FXstreet.com Learning Center

6. ENTRY RULES LONG ENTRY trigger:  The exchange rate breaks above the high of the previous day.  Adjust the entry level to the previous day high adding one pip and the spread to the upside. For example, if yesterdays high was 1.6350 and your spread for the GBP/USD is 3 pip, then the entry level is 1.6354. 20Extract of FXstreet.com Learning Center

6. ENTRY RULES SHORT ENTRY conditions:  The previous day low was lower than the day before (as explained above).  The 21 SMA is under 89 SMA.  The lower Bollinger Band is not contracting to the upside in the last candle before the breakout.  The 161,8% Fibonacci extension is equal or closer than 15% of yesterdays trading range. SHORT ENTRY trigger:  The exchange rate breaks below the low of the previous day. Adjust the entry level to one pip less than the previous day low 21 to the downside.Extract of FXstreet.com Learning Center

6. ENTRY RULES PRACTICE your entry rules by MEASURING the price moves after the signals across several time frames and considering if multiple entries or re-entries would enhance your edge. Once you are able to spot your exact entry points, then you have to work on the exit plan. 22Extract of FXstreet.com Learning Center

7. EXIT RULES Exit rules are part of the decision to take a position. There are two types of exits:  A stop loss to get out of a bad trade.  A profit target to realize profits when the market moves in your favor. 23 - Types of Orders, in the Learning CenterExtract of FXstreet.com Learning Center

7. EXIT RULES The EXIT RULES of our system Target: Fibonacci extension 161.8%. The exact take profit order will be placed a few pips before the 161.8% level. If there is a round number closer than 10 pips to the 161.8% level, take the round number as a target. Also make sure to add the spread to the target level on short trades. For example, if the 161.8% extension level on a short USD/JPY is 90.00 then the target would be placed at 90.04 if the spread is 4 pips. 24 - Fibonacci Extensions: Definition - Read the article “Fixed Spreads Vs Variable Spreads” by CMSExtract of FXstreet.com Learning Center

7. EXIT RULES 25 Watch “The ABCs of Fibonacci” webinar by Andrei KnightExtract of FXstreet.com Learning Center

7. EXIT RULES C. EXIT RULES Stop Loss Long Trade: placed below the 21 SMA or the 68.1% Fibonacci level, which ever is closer to the entry price. Conversely, the stop loss on a short trade is placed above the 21 SMA or the 61.8% Fibonacci level, the one that is closer to the entry price. This way, the worst initial win/loss ratio on every trade is a Phi ratio (61,8 / 38,2 = 1,617801047...). 26 Read “Stop Market Orders: Ideas on Utilization” by Gabe VelázquezExtract of FXstreet.com Learning Center

7. EXIT RULES 27 Watch “Developing a Profitable Trading Strategy (Part 1)”, a webinar by Markus HeitkoetterExtract of FXstreet.com Learning Center

8. POSITION SIZE AND RISK MANAGEMENT Money management principles serve to determine your position size and risk management, the proportion of your trading account that is risked per trade. For testing purposes, Each position will be entered with one mini-lot + we will limit the risk to 2% of the account balance. - Read Andrei Knights advice about Money Management 28 - Read “Portfolio Management - Position Sizing and Stop Losses”Extract of FXstreet.com Learning Center by LearningMarkets.com

CONCLUSION For now, just concentrate on following the previous steps and follow the rules mechanically. Systematically following a set of trading rules will help you grow as a trader (consistency, self-confidence, execution, mind training...) 29 Read Jody Samuels advice about the importance of Following a System.Extract of FXstreet.com Learning Center

CONCLUSION You may start with this system as a guide to develop a different one, you may even start by copying this system. develop your But with time, your goal will be to own unique trading approach = a system that serves as a logical frame work for any trading decision you make Another essential step in building a trading method is to backtest and forwardtest your system before committing real money. 30 - Read more about Back- and Forwardtesting in the Learning Center - Watch “Backtesting a System or Strategy” by Valeria BednarikExtract of FXstreet.com Learning Center

BACKTESTING Backtesting Results of the system 31 Forex Tester is a powerful software that you can use for your backtestingExtract of FXstreet.com Learning Center

BACKTESTING Backtesting Results of the system EQUITY CURVE $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 11 16 21 36 41 46 61 66 71 91 96 1 6 26 31 51 56 76 81 86 10 1 10 6 11 1 1 16 1 21 12 6 13 1 13 6 1 41 1 46 15 6 16 1 1 66 1 71 18 1 18 6 1 91 1 96 20 6 21 1 2 16 2 21 23 1 23 6 2 41 2 46 25 6 26 1 2 66 2 71 28 1 28 6 2 91 151 176 201 226 251 276 TRADES 32 Forex Tester is a powerful software that you can use for your backtestingExtract of FXstreet.com Learning Center

WEBINAR This system was presented in a webinar that you can watch whenever you want! 33Extract of FXstreet.com Learning Center

How To Build A Trading System by Gonçalo Moreira | September 2012 Material extracted from FXstreet.com Learning Center 34

http://www.fxstreet.com	1641
http://www.forexstreet.net	432
http://backoffice.fxstreet.com	170
http://www.facebook.com	40
https://www.facebook.com	22
http://tradingformyfreedom.wordpress.com	16
http://t.co	10
http://m.facebook.com	4
https://si0.twimg.com	3
https://twitter.com	3
https://twimg0-a.akamaihd.net	2
http://localhost	1
http://feeds.feedburner.com	1
https://fr.twitter.com	1
http://www.yoono.com&_=1346324667068 HTTP	1
http://webcache.googleusercontent.com	1

How to build a trading system

by FXstreet.com on Aug 30, 2012

Accessibility

Categories

Upload Details

Usage Rights

16 Embeds 2,348

Statistics

How to build a trading system Presentation Transcript