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What is a Trading System?

Forex Chart

Forex chart – Click to Enlarge

A trading system is a set of rules and formulas that determine entry and exit of the markets based on predefined rules.

This is the very short end of it, now to the long part….

Why trading system to begin with?

There are a few major advantages to trading system and a few disadvantages. On the plus side, trading systems take out the emotion and human element. A trading system will not try to double down on a trade that went wrong or get into a trade right after a losing trade because of frustration…(unless coded to do so).

A proper trading system can also be executed automatically, which can save time and eliminate the possibility of you being busy as a trader and “missing” on a trade.

On the flip side the main drawdown to trading system in my opinion is the optimization and back testing which in many cases will produce a “great looking” trading system on paper but one that does not perform very well in live, real trading and I will touch on that a bit more below.

Another issue worth noting is that once a system is set to trade automatically, one needs to be technologically savvy in order to set up a good mechanism of execution, back up, reliable internet data and much more.

There are many types of different trading systems. Some will go in and out very quickly, often staying in the market for seconds ( HFT= high frequency trading), some will look to enter with the trend and stay in the market for days if not weeks and there is quite a bit in between.

Most common are: trend following, counter trend, mean aversion and time/day specific trading strategies.

Some systems are black boxes, some are gray and the color refers to how much the end user knows about what is the logic behind the buy and the sell.

There are a few common factors to most trade systems:

  • Rules for entering a position (buy or sell). Many times these rules are designed based on different technical indicators, oscillators, and moving averages and such. Once a signal been identified the system needs to specify method of entry? Limit order? Market order? etc.
  • Once in a position the following is typical of many trade systems. Initial stop loss? Initial target?
  • If the system reaches a certain level of profit, does the stop loss starts trailing? Perhaps a break even stop?
  • Targets can be based on price levels / dollar targets but can also be based on technical indicators such as Bollinger bands.

So if you have an interest in Forex trading systems it can be one of the two different angles. The first is that you would like to invest money and have this money traded according to a certain trade system. If that is the case, I recommend talking to an experienced broker who can look at the statistics of the system, draw downs, avg. number of trades, worst loser and many other factors to try and help you evaluate different trading systems.

The other angle is you have a concept in mind of different trade set ups and would like to program the set ups into actual trading system that will then trade automatically. If that is the case, you will need to choose the right trading software, evaluate your own programming skills, create a system, back test it and then hopefully trade live. Learning curve, mistakes to watch for and much more. We can help you save time and money by simply sharing our knowledge.

One important advice if you plan to create a trading system:

Create the system and back test it for a certain time frame in the past, example is apply, back test and optimize for the time between June 2011 and June 2012. If you like what you see, take it and apply to the time frame of June 2012- June 2013. If the results are 70% as good of the period you optimized the data for you may have a system that is worth testing first in simulated environment and then based on your risk capital with real trading.

With the advances of technology, the world of trading systems can be very exciting.

Be careful of over optimization and from trying to find the “perfect system” (in my opinion – no such thing).

Good trading!

About the author: Ilan Levy-Mayer is the VP of Cannon Trading Co, Inc. and CEO of LEVEX Capital Management. He has developed many different systems and has the experience from the design stage, execution stage, technology aspects; assisting clients evaluate systems and much more.

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