There is a lot of information available about how to use trading systems to make intelligent forex trades, and there’s even more information available about buying someone else’s trading system. But what about if you want to build your own trading system? There’s not a lot of information about how to do that.
This article will cover the basic principles of building a reliable automated trading system that has the goal of generating trades with positive expectancy. This means that on average you will make money.
Think of a system with positive expectancy as being like a casino’s house advantage. Gamblers may win money from the house, but overall the casino has an advantage that allows it to make money over time. You need the same advantage in your trading system.
Types of trading systems
These are the four basic types of trading system in use by most FX traders:
- Breakout trading system: Breakout systems monitor the price of currency pairs and generate a trade signal in the direction of the trend if the price breaks through a certain level.
- Reversal trading system: Reversal systems look for a trend that is near completion and then generates a trade signal in the direction of the reversal.
- Indicator trading system: An indicator system is designed up to monitor the trader’s preferred technical indicators and then generates a trade signal when one of those indicators is met.
- Trend-based trading system: A trend-based system determines when a trend exists as well as the direction of the trend. It then executes a trade signal in the direction of the trend. This includes volatility based systems.
In this tutorial, we will focus on breakout and trend based trading systems.
Trading system objectives
The purpose behind having and using a trading system is to receive consistent answers to these critical questions:
- Trend identification: Selecting a currency pair that is trending and suitable for trading
- Position sizing: The quantity to trade
- Entry signals: When to execute a trade
- Stop loss signals: When to exit a losing trade
- Exit signals: When to exit a winning trade
A trading system doesn’t guarantee that you will never have a losing trade (although you should be able to make money over time if you have a positive expectancy). It simply guarantees that all of your trades will be consistent and that your trading decisions will not be influenced by anything other than the rules of the system.