To build a trading system really only requires three ingredients.

1. An entry point – A rule set to get you in the market.
2. A stop point – A rule set to get you out of the market when the market is not doing what you anticipated.
3. A exit point – A point at which you exit the market with profits

This is really pretty straight forward and should be easy to do one would think.  In my honest opinion a strict rule set for all three is absolutely necessary, without this you are doomed to failure.  There is still discretion involved but the market needs to meet a set requirement for you to act.  So lets look at each ingredient and some examples that would fit each ones needs.

ENTRY

• First lets look at the big picture, what is the currency pair doing on the daily time-frame, is it trending or is it in a range. These things alone you need rules for.  Trending could be defined by a moving average or making higher highs and higher lows or, with the use of an indicator like the MACD for example. This only you can decide but will increase your odds of success if you have a rule set in place.
  I cant state this enough and intend to comment on it regularly as it is of the utmost importance and that is back-testing.  You must back-test your theories and prove that they have an  edge before putting any of your hard earned money into the market.  Believe me it is just too easy to loose, I know as I have lost plenty by not adhering to these rules in the past.
  I  currently use a product called Forex Tester which allows me to back-test all my ideas with ease, I will do a separate review on this soon as it is an excellent tool and would be the best investment anyone could make to improve their odds of success.
• Secondly a set of rules that are conditional for taking a position. This could be for an example the daily trend is up so we are looking to go long.  We need a break of a downward sloping trend-line on a four hour chart with a thrusting price bar showing high demand.

So we now have a place and a reason to take a position, we now need to look for a logical place to position our stop and then we can calculate our position size.

STOPS

• When placing a stop you have to consider a logical place to position your order. there are a number of things to consider here because if it is to close to the action you are more likely to have your stop hit and if to far away from the action then this can limit the size of the position you can take. The things that I generally consider are.
  1. Where is the nearest major support or resistance levels.
  2. Where are the closest round number levels as these can also be considered major support and resistance levels.
  3. If as in the entry example we used previously with the trend line break we would need to consider a retest of the trend-line so this would also be a consideration.
  4. Where are the most recent swing highs or swing lows.
  5. Where are the closest Pivot points and consider both the daily and weekly pivot points.  If you need a good source for pivot points try Action Forex.

Once you have taken all these things into consideration you can then define where you will place your stop. Now this can be a mental stop or a stop order placed in the market, this depends entirely on whether you intend to babysit your position or just set and forget or,  a combination of the two.  Again this is personal and only you can decide.

Click on image to see larger view.      note: will open in another window.

This example of the eur/jpy is an ideal scenario and went straight into profit and didn’t look back.  Not all trades go this way but when they do these are the ones that add to your bottom line and managed correctly will see you in the black rather than the red so to speak.

EXITS

Exits in my honest opinion are the key to successful trading, if not managed correctly a winning trade can quite easily become a loser. There is definitely an art to exits and determining an exit strategy requires a great deal of effort and some serious, you got it…back-testing.  Once you have determined an entry method you need to do a lot of ground work to ascertain the best exit method. This requires many hours of trawling through charts and history over and over and applying different exit strategies until you determine the most viable exit method.

It is a fine line between being to aggressive with your adjustment of stop positions and letting a position ride.  There are a number of things to consider when determining your exits so lets explore these now.

• Firstly you  need to be realistic with profit targets in relation to the time-frame you are trading. For example if you are trading the one hour chart it is not  realistic to expect to catch a 2000 pip move.  The currency pair is going to have a retrace at some time and unless you have picked the exact bottom of the move and are prepared to watch a very large portion of your profits evaporate or even all your profits if say it is forming a double bottom for example.
• Trailing stops can be utilized effectively again if back-testing is carried out to ascertain the right size to trail your stop in relation to that particular currency pair.
  
• A  system of moving stops up as new lows are formed and confirmed can be effective.
  
• Another method that works quite well is through the use of a moving average, you just trail your stop under the moving average and when price closes below the moving average the position is liquidated.
• Scaling out of positions is a great way to assure profits are banked, this way one can reduce risk and still target larger parts of the move.
• A common target when swing trading and entering on retracements is the most recent swing high,  you will regularly see price test recent swing highs at a minimum, this is a high probability target and a very realistic goal.
  

The style of trading that suits your personality will determine a lot of these things.  First you need to identify if you are going to be a trend follower or swing trader.  How many hours a day you plan to trade or have available as this will dictate which time frames you trade.  Once these things are decided then you can choose which style is best for you.

Perry

Related Posts:

• The Count Back
• Support and Resistance Trading
• ForexTester
  

Popularity: 5% [?]