Creating Your Own Trading System

Creating Your Own Trading System

Posted on 26. Aug, 2010 by in Forex

You’re better off flying without any cockpit instruments than trading without a system.  There may be lots of people who are willing to sell you their system, but it’s even better to be able to build your own.  This article will give you an overview of key parts of investment systems so that you have the tools to begin making your own.

Seven Vital Components

A trading system consists of these seven vital components that answer the following questions:

  1. Suitability check – Is this system suitable for the market and conditions?
  2. Selection criteria – Which of the many investments should you put your money into?
  3. Entry signal – What will be the triggering event that causes you to put money into that investment?
  4. Bail-out point – How bad can things get before you need to get your money out and cut your losses?
  5. Re-entry plan – Has the situation changed so that I could make money by reinvesting in this?
  6. Exit plan – What is my signal that things are turning around and I need to cash out now?
  7. Risk management – How can I keep from losing so much money that I cannot recover?  How much of my total available money should I risk in this investment?  (Experts recommend about 1%)

A Quick Example

Let’s put all this together in an example.  I have 10,000 X (some fictional unit of currency) and I want to make a Forex investment.  My system appears adequate (Step 1), and after analysis it appears that Y will be the best currency to invest in (Step 2).  I see the exchange rate is 0.45 nem = 1 mellev.  and decide my entry signal (Step 3) will be an exchange rate of .5 to 1.  If the rate drops to .3 to 1, I’ll bail-out to cut my losses (Step 4).  When the entry signal comes I spend 250 X to buy 500 Y (Step 7 dictates this:  selling at my bail-out point leads to a loss of 100 X (1% of my 10,000)).  I will exit as soon as I see a .10 drop from the highest rate (Step 6).  Fortunately, my bail-out point is never reached and the exchange rate climbs to 1.1 X per Y then it drops back down to 1.0.  When I convert my Y into X currency, I have 500 X instead of the 250 X I invested in the beginning.  So, I have a profit of 250 X currency.  Although  actual currencies are traded in pairs, this is generally how you profit in trading.

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