An Intern Learns - Developing A Trading System, Part 1
Welcome to another ‘Intern Learns’, hope you have all had some success with your latest trading. In recent blogs I’ve discussed negative emotions and some ways in which you can overcome these in order to trade successfully. In this blog I will be developing this further by investigating how to develop a trading system. This is really helpful and once you have a system in place it’s really important to stick to this to see if it really works for you and how you can tweak it to make improvements. Part of making this system is also deciding what kind of trader you are and I will discuss this too. Remember this discussion on trading techniques is a basic guideline; it can be no guarantee on success. If you are still new to forex like I am, there’s no harm is trying all these techniques on a demo account just as I am doing. The MahiFX demo account is an exact replica of the live account, including the price movement. This is a great way to develop your skills and fine-tune your trading system before you go for the real thing.
There are a number of steps to take to developing a trading system and the first is deciding which time frame you are going to use. Your time frame depends on what kind of trading style you prefer. MahiFX has quite a handy Infographic that details the trading strategies of some of the world’s most famous traders over the years and how each one specialized in a different style. Perhaps you can find some inspiration in ‘What forex trading style suits you?’
I’ve already described the practice of scalping as a trading strategy in a previous blog post, but there are other trading styles to consider such as day trading and swing trading.
Not quite as quick and high action as scalping, day trading is exactly as its name suggests – you trade for the day and don’t leave your positions open overnight. This style of trading doesn’t suit everyone as it has a strong impact on your daily timetable. Day trading is for you if you have the time to analyse the charts throughout the day and like to know if you’ve had a winning or losing trade before you go to bed! If you have a day job or are still at school/university day trading might be too time consuming for you. Remember, unlike scalping, fundamentals in the market have an impact on a day trader’s charts, so keep an ear to the economic news!
Within day trading there are three types of analysis that you can undertake: trend, counter trend and breakout analysis. A trend trade is also as its name suggests – establish what the dominating trend is at a longer time frame such as a 1hr or 4hr and then use a shorter time frame to get a good entry point. You can use SMAs or EMAs to help make an assessment of which way the general trend is going. The ADX indicator also works really well for seeing if there is a strong trend or if the market is only ranging. Counter-trending is the opposite of trend trading in that once you have established a dominant trend, you watch out for possible reversals. The good thing about this is that by getting in on a reversal early you can really take advantage of the new trend right from the beginning and get some great pips. However this technique can be quite risky as the reversal could just be a retracement and you could end up with a loss on your hands, use cautiously!
The last type of day trading analysis is breakout trading. This is a type of trading takes advantage of ranging markets. Remember a ranging market is one that has no clear trend direction but is rather sticking in a horizontal pattern, normally between a resistance and support level. The way to take advantage of this is to place market orders above and below the current range, and then whichever way the trend swings will activate your order once it hits the specified price. This works best when the range is quite ‘tight’, i.e. it sticks within a narrow price band, as this is likely to precede a breakout.
If day trading is not quite your thing and you want to go for the longer haul style trading and you’re totally into fundamentals then swing trading is probably for you. Swing trading will really suit someone who doesn’t have the time to monitor their charts all day, but can afford a couple hours at the end of the day to make sure things are still going on track. In this style of trading you will want to set your stop loss and take profits a little further than you normally would, as they need to weather changes in price. By setting them further apart you will be able to go through retracements and stay in for longer periods.
If you are new to swing trades perhaps try pairs that are less volatile and make sure you stay calm if things don’t go your way. You must stick to your plan! Bear in mind that there may be times when things could go quite wrong - counter to what you predicted and you may want to consider stopping the trade. Ultimately if you’ve done your homework you should be able to make a call on whether you should stick to your guns or look to get out of there. Take the time to analyse the price movement and the market fundamentals so that when you enter the market you have a clear as possible idea of where the market is likely to go.
Lastly, the ultimate marathon of trading is the position trader. This is the longest trading time frame and can last anything from months to even years! You will need super levels of patience to do this kind of trade and its great for those that don’t have even a couple hours a day to check the price movement. Based on some research I’ve done, it is generally accepted that this is for more experienced traders who have an excellent knowledge of market fundamentals. This kind of trading also requires that you have sufficient capital resources, as you don’t want to get a margin call. As these trades are held for such long periods, it is likely that the market will go against you at times and you need to be able to handle this pressure and be confident that you’ve made the right decision.
In the next blog I will finish discussing the steps to developing your own trading system. This first step was quite laborious but the rest are somewhat more succinct! I will also discuss how to best evaluate your trading system so that over time you can make it truly awesome. Good luck!