Forex Trading System And Strategies
A forex trading system or strategy is what actually gives you the edge in the forex market.
It is the edge that will determine if you make money or not in the forex market.
It is said that most people who approach the forex market do so without a forex trading system, and therefore lose money in the long term. That is, many traders are just going with a hunch, or were trading for excitement.
However, it's a good idea to treat forex trading as a “systematic activity, where you make money consistently”.
A more subtle version of trading without a system, is traders using a system where they don’t know if it’s profitable or not, because it has never been backtested or measured!
Here are some of the more popular forex systems and automated forex systems at the moment:
With a good trading system is a system that you can trade with, which has an edge over the market, you'll be following a system and its results rather than trying it out on your own with no experience or knowledge of forex trading.
With any trading system, there are going to be wins and losses.
A profitable system may have a win-loss ratio (the proportion of winning trades to losing trades) of say 0.7 (70%), with some being around 0.8. And the profit-loss ratio (the size of the average win to the size of the average loss) may be say 2-3 to 1. You can quickly work out, that it is the combination of the win-loss and profit-loss ratios, called the profitability ratio, that tells you if the system is profitable. When multiplied, the profitability ratio should add up to greater than one, ideally much greater than one.
You may be quite surprised at these figures.
For those of you who have traded stocks or CFDs before, you may have dealt with systems that typically had a 40-50% win-loss ratio, but where the system was still profitable as the profit loss ratio was high enough, say 2.5 or 3 to 1.
A system with a high win-loss ratio is "psychologically" easier to trade, though as mentioned above, it is ultimately the combination of this and the profit loss ratio that really matters. If a system has both of these parameters are high, then that’s a bonus.
More and more people are realising now that there are many good forex systems around. And there's also a growing acceptance that one should trade with a forex system, to be successful in the market.
Forex Currency Trading Systems: What You Need To Know
Let’s now have a look at these three questions related to forex systems in more detail:
1. What exactly is a trading system?
2. How can you tell which system is a really good one?
3. And how can you tell which system suits my lifestyle?
Many people, especially if they’re new to forex trading, aren’t sure of how to assess forex systems and strategies, or even know what one really is. Once you’re familiar with the information here, it will be a lot easier to evaluate a forex system that’s in front of you.
What exactly is a forex system or strategy?
A forex system or strategy is a specific set of rules designed by a person or persons, that tells you how to trade the forex market. And it should be teachable.
Specifically, forex trading systems will have rules for:
1. What currency pairs are traded by the system.
2. When to enter of a trade, that is, a) what times of the day are traded, b) the precise rules for entering based on price action and indicators.
3. How to determine the exit of a trade, such as a) initial stops, b) trailing stops, c) breakeven stops, and d) target profit stops.
4. How to apply risk management rules to the system.
5. How fundamental events, such as announcements, affect whether you trade, or whether you exit a trade, during those times.
6. Other rules, depending on the system.
Now you may ask whether rules in trading systems are mechanical, or are mostly mechanical with some open to discretion? This depends on the system of course, though most systems will not leave a huge amount open to interpretation, if at all.
If you don’t understand a rule used in the system, because it’s not explained well by the course, then you’ll need to get this sorted out by getting the author to explain more, such as by email or in a forum.
Let’s say we understand the system rules. In this case, what we mean by rules being mechanical, is that an indicator either passes the rule or it doesn’t, such as MACD has closed below zero, or above zero on a specific chart. This is a mechanical forex trading rule. Now, there may be systems where the rules are clear and teachable, but may not be necessarily result in “purely” mechanical trading. For example, with support and resistance lines, there will be clear guidelines as how to do it, but you may draw a line that’s a few pips above or below someone else’s.
Having said this, there are systems where such lines is in fact mechanical, because there’s a precise way of drawing it in the system. System trading is getting more mechanical over time, and thus we can all get good results with the same system. This is one of the best features about the newer trading systems.
What you should do after you’ve learnt a system, is to trade the system on a demo account to ensure that:
1. You know how to trade the system correctly, and
2. That it is profitable, before going onto a real float.
It takes some time and effort, but the rewards are certainly there.
How can you tell which forex system or strategy is a really good one?
Firstly let's consider the profitability of a system.
A system’s profits may be expressed in pips, or dollar amounts based on a float. Profits expressed in pips is probably the most commonly used indicator of a system’s performance, and most forex traders talk about number of pips made per month. Besides, everyone is trading a different sized float, so pips per month is one way of comparing systems. If you know the pip amount per month, the actual dollar profits of course depends on how much face value you are trading, and thus depends on your float size and your risk management rules.
The alternative way is to quote the dollar returns based on a hypothetical float. If you have 2 systems that quote this way, and had the same float, then you could do a comparison.
While pips are important, you should also consider other parameters of a system, which are just as important. Let’s list the factors here:
1. What are the historical profits, either as pips per month, or as a dollar amount based on a float. For dollar amounts quoted, you can express it as a percentage of the cash float. For example, if your cash float is $10 000, and the return per year is $50 000, then the system is returning 500% per annum.
2. What is the maximum historical drawdown of the system, as pips or as a percentage of the cash float used. For example, if the maximum historical drawdown was $2000 based on a $10 000 float, then the drawdown is 20%. The maximum historical drawdown is the largest decrease in equity that has occurred in the past during backtesting or trading.
3. What is the win–loss ratio. That is, the percentage of trades that are winners, compared to those that are losers.
4. What is the profit-loss ratio. That is, the size of the average winning trade divided by the size of the average losing trade.
5. How consistent is the system? Are there consistently winning months, with only a few that have low returns or losses.
As mentioned, some systems that have only a moderately high hit rate, are still profitable because their win-loss ratio is very good.
For example, if the win-loss ratio is only 1:1 (that is a 50% "hit rate"), but the win-loss ratio is 5, then the profitability ratio for the system is 1 x 5, which is 5. As long as this number is greater than 1, the system is profitable. Ideally, the higher the number the better.
Sone systems have both a high win-loss ratio as well as a high profit-loss ratio. The high win–loss ratio as makes the system psychologically easier to trade, and the high profit–loss ratio makes the trade results rewarding as you’re not making money just to give it back to the market. That is, your winning trades are much larger than the losing trades.
How can you tell which forex system suits my lifestyle?
Here’s an area where most traders new to forex are not aware of, or forget to take into consideration. What I mean by a system suiting your lifestyle is:
1. What is the amount of time needed to analyse the market per day?
2. What are the times of the day that you can apply the systems, and does this suit your time zone?
3. Does the system hold positions overnight or are all exited intraday? Some people prefer systems that exit intraday so they can see what is going on with the chart frequently and with no breaks, whereas for others they don’t mind as long as their stop loss is in place.
So once you’re familiar with these concepts here, you’ll much more easily be able to focus on understanding a good forex system or strategy that’s placed in front of you, understand how good an edge it has on the market, and whether the forex system fits in with your lifestyle as well.
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