All potential
traders examine these fundamentals which are necessary for starting analyzing
and understanding any financial market. However, as experience has shown it is
not enough.
It can be often observed that that almost one and the same people
work in dealing centres in front of one and the same computers, using one and
the same systems and indicators, seeing and reading one and the same.
However
some of them leave in 1 -2 months,
some of them continue working. What is a recipe for the success of some traders? What
allows them to “win”? What do they see on the screen, that allows them stably,
exactly stably, blossom? In reality, nothing special, each successful trader
has his/her own trading system.
We are going to talk about exactly trading system
in this lesson.
The trading system is a concentration of experience,
efforts and knowledge of trader. The cost of such a successful trading system is
really high – days and nights spent in front of computers, careful and
sometimes agonizing analysis of mistakes, nerves, nerves and nerves.
However, as As a result of all this, the trader himself, like it or not, create his/her own,
individual trading system. It is his professional secret and not because he/she
does not want to share it but because it cannot be passed on.
It cannot be two
similar systems; each trader has his own methods and skills which he/she can
share. However, he cannot explain all nuances and niceties of his/her market
understanding, adjustment, tests, control, further development of his/her
trading system with the best will in the world.
It should be created by yourself
- from the very beginning, from the first step. And if someone decided to
become a real trader – i.e. work stably and effectively (read, with profit) at
the market for a long time – then he/she must create his/her own trading
system.
There is extended literature where famous traders share their secrets and
give examples of their trading systems which helped them to achieve success. It
is very useful to familiarize yourself with these systems; however, their
copying will not give you desirable result and professionals’ experience should
be used only as an example.
The example shows how to use technical instruments,
how to combine the methods of analysis, what can be considered a wake-up
call and what to retreat. It will help to find a rational kernel that will help
you to create your own unique trading systems.
A trading system is a rather complicated mechanism
which consists of several components each having its own key value.
It is similar to the details of one mechanism, if
one little screw is not inappropriate to place, the whole mechanism will not work
or will work badly. The same is with the trading system: if some component will not
be adjusted, the whole work will come to nothing. Moreover, since one and the
same factors in different conditions can lead to the opposite market reaction,
the system should be rather flexible.
Also, the system is never static, it should be
constantly checked and updated. For all that it should provide minimal risks
with maximal accuracy of forecasts made (exactly in such sequence). The system is
an accurate calculation, the balance point between several unknown quantities and
constantly changing factors. It is a correct question and correct answer. Specifically, it is gaining a trader’s profit.
That is
why it is very important to highlight the key points, spread the risks,
calculate the point of entering and exit the market and choose the analytical
instruments. The trading system is a system of hard rules defining the points
(prices), time and conditions for entering and exit the market.
Experienced, or
in other words, by having a trading system, the trader is always ready for any turn of
events on market. He/she can give a detailed account of his/her future actions
with any currency. He/she should be able to explain it distinctly.
If he/she cannot explain this, then he/she cannot
understand it but this is an inadmissible luxury that can turn to a great loss. The only
criterion confirming the effectiveness or inefficiency of any system is the practical
results of work.
As it was said above, the trading system is a system of
rules detecting the consequences of several major factors that influence financial markets. Saying specifically, it is combined results of fundamental analysis, technical analysis, risk management and allocation of capital. The concrete “embodiment” of a trading system is the trading plan.
The first step of trading system creation consists
of the trader’s decision on some principle questions. They are questions concerning the allocation of capital, trading strategy and risk management. In other words,
he/she should clearly know:
1) the volume of initial funds (i.e. account size);
providing by the company (or choosing by yourself) leverage;
2) margin call level (minimal margin for opened
position keeping);
3) lot sizes, the general level of maximal losses;
4) level of losses by one position, the possibility of
hedging (for instance, work not only on Forex but also at the currency futures
market, if account size allows);
5) maximal number of opened positions;
6) the average amount of profit built in the trading plan,
approximate cost of one point in some currency, etc.
Then future trader should decide what exactly tools
he/she will use. Traditionally one start trading with four major currencies,
quoted against the US Dollar: Euro, Swiss Franc, Japanese Yen, British pound.
Moreover, a trader can work with other instruments: Canadian or Australian
dollar, ruble, hryvnia or cross-courses. However, a trader should know where the relative value of currencies against each other and the cost of one point.
After
that technical analysis turn comes: trader should create some range of means of
technical analysis which he/she will use. They include resistance and support
levels and/or lines, trends, indicators, graphical patterns, Elliot waves,
analysis of Candlestick charts, Fibonacci relations and others.
The choice is
rather wide, and to make a choice it is necessary to get acquainted with all of
them. The process of indicators selection is more complicated. In spite of a huge
number of them, we advise limiting them to the several simplest ones. Indicators
from the trend group as well as from the oscillators group should be presented in
your set.
Choosing of indicators mostly depends on traders’ work type – intraday
trading or medium-term positions. Meanwhile, the possibility of one and the same
indicators’ variation is limited only by the technical capabilities of the
system.
In the end, the last step is the development of a trading
plan ready form which the trader will fill in daily in several copies – one for
every chosen currency or cross-course. Besides the necessary column with an enumeration of technical analysis means and set of indicators, the trading platform
should include a separate line for fundamental analysis with an enumeration of
further events, probable date and time of publication.
One more obligatory “supplement” of the trading plan is
column “Results” and “Check”. Result of trader’s reflection: enter the market
or not, if enter then what price and what conditions at (for example, after
data publication), where to place stop-loss, were to close profit position,
etc. In other words, concrete trading plan for the current day.
Thereafter, column
“Check” is filled the next day taking into consideration the results of the previous
day: if the trading plan was drawn accurately, if not – indicate reasons and/or
mistakes (if possible). It is obligatory to indicate the status of the account by the
results of executed operations – “executed conventionally” for the short-haul.
Developed the scheme of a trading plan and methodology of market analysis, the trader
is quickly used to the chore, which will be becoming easier and habitual every
day. The main thing in this chore is discipline. Making up of trading plan is
the first step of trading system development. Created technology of daily work
will become that basis upon which your own system of work at financial markets will
be based upon.
Selection of means and instruments of technical
analysis is very important; on basis of these criteria, a trader should forecast
the market movements. The main question is defining what really important and
what useful addition is.
What is primary and what is secondary. And the most
important why and what for some instruments are necessary. At this stage of
selection and analysis, the trader starts working directly on the thing which will
become his/her trading system in future.
Technical analysis tools are used for:
a) reveal of existing trend (ascending, descending or side);
b) calculate the points (levels) of entering and exit
from the position – major and local.
Usage of such instruments as trendlines, support
and resistance levels, graphical patterns (reversal and continuation), Fibonacci
lines in a different application (retracements, fan, arc, etc), Elliot wave theory and analysis by the candlesticks will bring invaluable benefit.
Indicators are mostly used for:
a) receiving confirmation of entering points;
b) determine the possibility of trendline reversal.
Before analyzing indicators, traders should make
analysis using so-called instruments of “classical” technical analysis. Every
trader should understand that indicators are derivations from the prices. Even
besides the fact that some of them make advanced signals.
With the help of classical technical analysis
instruments, a trader should get answers to the following questions:
1. What trend is leading at the market (ascending,
descending, sideward), which trend is a major one, which one is local (for
example, small ascending correction while the long-term trend).
2. Patterns and their meanings.
3. The necessity of using some Fibonacci numbers (after
the abrupt price movement or for projection of future movement).
4. What price levels are major points of
support/resistance, which one is local.
Having an idea of the market and what is going on there, a trader can proceed to the computer analysis. As it was said, computer analysis
is secondary against the price movement and, consequently, against the classic
technical analysis.
Signals and reading of indicators should be
considered as confirmatory – or contradictory – to the conclusion made on the basis
of usage of classic technical analysis instruments.
A universal indicator does not exist. Any indicator
gives only an approximate forecast. To answer the question of what to start and what
to finish with, we bring to your attention some pieces of advice about the
making up of your own instruments:
1. Trend indicators and oscillators must be in the
set. Naturally, preference to one indicator or another will be shown according
to the character of operations which will be executed by the trader. In other
words, if a trader is going to work intraday, then oscillators should prevail in
his/her instruments.
If preference is given to the medium-term trading, the
trend indicators and oscillators should be presented in the instruments
half-and-half. If inclination to the long-term trading exists, then among using
instruments trend indicators will prevail.
2. Besides the belonging indicators to some group, a trader should know what each indicator intend for, what signals it gives and
what their meanings are. For example, it is supposed that ADX is the best
indicator for trend beginning determination, and MACD (divergence at MACD)
shows its finishing.
3. It is better to have an indicator that can work at the trend and non-trend market. For instance, MACD – histogram.
4. Indicators calculated by different principals must
be in the set of instruments. It helps to avoid duplication (for example, slow
stochastics, relative strength index (RSI), and the Rate of Change indicator,
moving average and Bollinger bands, etc.).
Doubling indicators will often make
similar signals, meanwhile, the coincidence of indicators calculated by different
principles give rare signals of entering/exit with a more accurate forecast.
The set of
indicators should not be too wide because you will have to analyze
their data in the different time period – from week to hour. Even from three-four
indicators receiving of discrepant signals is probable.
OPTIMIZATION AND TESTING
After the selection of one-two computer indicators, it
is necessary to test them. Testing is usually made in two steps – by history
and on a real-time basis. The testing process helps trader notice some nuances
which rarely mentioned in educational literature.
During testing, the trader learns
how to recognize signals: in past, everything looks simple, but in real-time, some
skills are needed. Then trader makes his/her own list of entering/exit signals and
ascertains that these signals do not always correspond to described ones in
the literature during the real work.
At the first step of testing, the trader decides how
chosen indicator suits future work. In this case, the testing process consists of a simple count
of a number of correct signals on basis of available data. If the trader decides that
indicator worth working with it, then the second part of the first step
(optimization) starts.
In other words, the trader will try to achieve an increase
in the number of correct signals. The most common way of optimization is a change of
entering variable, with the help of which this indicator is calculated. Methods
of mathematic optimization with the help of different is also possible formulas
– for example, computation of exponential formula and etc.
But it suits those
who know mathematics or the market very well. It is not necessary to use one and
the same variable for work during different time charts. It can be supposed
that at daily charts moving mean with the period 1 0
will make more correct signals, and an intraday charts an optimal number of
periods for moving averages will be 5 or 7. The main thing is to find optimal
conditions for the indicator to make more correct signals; it is the aim of
optimization.
The second step of testing is based upon the work
of an already optimized indicator. It is the “highest instance” already – the indicator must make correct signals in real-time. A trader should learn how to
recognize these signals – also in real-time mode. It can appear to be
another number of correct signals that is why a trader will need to make
optimization again.
The third step is the coupling of signals from all
chosen indicators and methods of classic technical analysis to a signal which
will determine the moment of entering the market (buying and selling) and exit
from the position.
For instance, the signal of entering the short position
can be appearance the following situation:
Uptrend is at the market, the last event allowed to
determine reversal pattern “Engulfing” (candlestick analysis), at the moment of
this pattern formation histograms MACD (computer analysis) did not show new
maximum relative to the previous maximum, it means that opportunity of
divergence appeared.
Followed reduction confirmed that supposition, breakdown
of uptrend line (trend analysis) became additional confirmation of previous
signals about probable trend reverse, stochastics chart left overbought area
and downward direction complete the list of necessary components of the signal
which was accepted by the trader for a short position opening.
Optimized up to 90% of successful trading systems are
rare. So please do not attempt impossibilities: a ratio of 70% to 30% can be
considered sufficient for successful trading on the market.
Let us now try to create our own trading system. I
offer to pay attention to the logic concept which must be used during the trading
system building and based upon the theoretical knowledge and observation
practice.
So let us first clarify that we are newbies and
will follow the main rule – TRADE TO THE DIRECTION OF TREND, so our trading
system should be developed as a system of trend following. From the beginning, we should determine with an instrument which the trading will be built upon.
Then
choose the time period off the chart. It depends on what type of trading we
prefer. If it is intraday trading then the time period should be short – 5 – 30 min
charts, if trading will continue longer, then the chart should be of longer level.
I would advise you to start from the time interval which seems for you the most
informative, afterwards, while the correction and optimization of the trading
system optimum alternative will be found. Let us start the selection of instruments
that will be the basis of a trading system (TS).
From the theory and observations, it is known that trend formation is accompanied by the consequent formation of
maximums and minimums. These cardinal points are the completion of continuation
patterns formation (flag, pennon, triangle, that is why the first object for
our selection is these patterns, precisely the moment connected with the completion
of their formation.
Besides, to be sure that trend is continuing it is better
to choose a trend indicator. I advise including to the set of instruments the
following: simple moving average (MA), better two MA with different periods,
let it be 21 and 34 (Fibonacci
numbers).
And, of course, one oscillator because the formation of mentioned above
patterns occurs in range, and oscillators work the best exactly in wide-band
consolidation of price, probably slow stochastic will be a not that bad choice.
The overall picture of the chart with the applied set of instruments of technical
analysis will look as follows (see pic. 1 ).
 |
| Pic. |
After strategy and instruments of technical analysis are determined, let us start the chart’s analysis and signals’ determination. As it was underlined above, we should start with the history (see pic. 2).
 |
| Pic. 2. Adjustment pattern was forming at the market (2), the previous price
movement and consequently MA ( |
Now let us make a line of signals as available:
- The stochastic outcome from the oversold area and formed divergence;
- Breakthrough of MA from the downward by the price
- Breakthrough of the trend line which clamps the pennon from the upwards
- Test by the price of broken trend line concerning support
From these observations, the conclusion can be made
that we should buy after the signal 4 appearance. Now we should establish where
the order limiting the losses, i.e. stop-loss, must be put. The ideal variant
is to place it below MA closer to point of a breakthrough by the price of the
moving averages (at the pic. 2 points (4)), less attractive and more a money-losing variant is below the trend line which clams the “pennon” from the
downward.
Then price target will be the bound of order execution and
signal which will lead to close the position before the planned exit must be
determined. As it was said at the lectures about continuation patterns, the price
target for position retention after the continuation model can be the level
equal to the market movement preceding the model formation. We will measure the
vertical distance from the previous model to the formed one and plot it
upwards, so we will find the target point.
Concerning the signal of premature
exit, apparently, such signal can be: breakthrough of MA lined from above,
breakthrough from above of MA of the short period by MA of the longer period,
etc. You can see in picture 3 that the signal for premature
exit appeared earlier. Price broke through MA (7), which became a basis for the execution of reversing trade.
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| Pic. 3. Signal for premature exit appeared earlier before we hit the target. In point 7 price crossed both MA and gave solid grounds for supposing about probable trend reverse. |
You should not extend by analysis of one case, observation of the history should be made until all the variants of possible patterns (flag, triangle) will not be considered and the most peculiarities connected with price behaviour in the process of models’ formation would not be determined.
After that, you can start designation of these signals
at charts on a real-time basis. During this step more concrete remarks and
conclusions about the significance of some tools of technical analysis and more
liable for real trading points of entering a position. The next step is
optimization.
Variants for changing the data of used tools should be considered –
change of stochastic and MA settings (change of simple moving averages to
scientific ones is possible), work view of TS at other time periods of the
chart, etc. After receiving the optimal results you should start testing your
trading system on DEMO accounts.
The more tests for TS the better; 70% of
positive enters and 30% of negative ones is an acceptable result. However, as the practice has shown, it is not enough, the last and the most important test will
be the trial on the live account. The thing is that only on live trading
account important factor appears – psychological or emotional factor, i.e.
trader checks how his trading system corresponds with psychological
individuality and also receives the opportunity to train the discipline which
is very important in trading.
Of course, this step is better to hold on to accounts with a small deposit which would not be so big a loss. Probably, someone
can say that a small deposit will not give you a full vision of the psychological
pressure and I agree. But you can make some deception, you can consider the deposit
of 500 USD as a deposit of 50 000 USD, opened position with 1 000 USD as a position with 1 00 000
USD, i.e. bring the situation to the amount which is planned for future
trading.
Lessons: