Answer these 5 questions and you have the core components of a trading system.
You are on the way to having your edge:
- Which currency pair and at what time frame(Asian/UK/US) to trade?
- Your Position Sizing and how much risk per trade?
- How does the system determines when to buy or sell?
- When to get out of a losing trade?
- When to get out of a winning trade?
1. Which currency pair to trade and at which time-frame?
One of the first decisions any trader makes is what to trade. It will depend on your personality and preference.
Majors (with USD) Trend more than ranging conditions
Commodity Pairs If you want to participate in trading gold and oil, you can participate in market movements by trading on AUD/USD or USD/CAD. The Aussie has a positive correlation with gold and the loonie has a positive correlation with Oil.
Cross Pair (Does not involve USD) -Ranged bound more than trending
Trading the above currency pairs provide you with high liquidity and instant execution. You will be able to sell or buy at your determined price.
2. Your position size and how much risk per trade?
Position sizing is also called money management. It is the critical component to trading success as Gibbon Burke of MarketHistory.com Observes:
“Money management is like sex: Everyone does it, one way or another, but not many like to talk about it and some do it better than the others.”
The essence of managing your risk is making a decision about how much to buy or sell whenever a trading signal is generated. If you are using metatrader 4, this is the figures you enter into the volume contract.
1.00 (1 standard contract ie 100 000 of base currency, 1 pip = $10 USD) 0.10 ( 1 mini contract ie 10 000 of base currency, 1 pip = $1 USD) 0.01 ( 1 micro contract ie 1 000 of base currency, 1pip = $0.10 USD)
FXEaReview believes that for beginning traders, 2% risk per trade is the maximum risk the trader should undertake in any of his trades. A maximum of 6% risk per month should also applies. How do you calculate how much to buy/sell?
total amount equity X %risk per trade / No of pips from entry price to stop loss / 10 = You will get the volume (formula only applies for majority of MT4 brokers)
Using this formula, you ensure that you are risking 2% in any of the trades.
3. When do you buy or sell?
You buy or sell when certain conditions are met. It depends on how you trade in the market. A trader can use fundamental analysis or technical analysis to trade the market. The common method between the 2 analysis is that the trader will establish his personal trading philosophy. Based on the philosophy, he defined the conditions he wants to trade. When all the conditions are met, a buy or sell signal will be generated.
4. When do you get out of a losing trade?
The time to think most clearly about why and when to exit is before getting in. In any trading system, the most important thing is to preserve your capital.
Before you ever start trading, you already know you will have losses. You also know that small losses do not go on forever with a profitable system. Favourable conditions will eventually emerge at the time you are about ready to throw in the towel. Ways of exiting a losing trade includes:
Time Stop – Trade exited if it did not move in the favourable direction after x number of days ( period can be hrs )
Equity Stop – Trade exited if it reached X% of your account equity
Volatility Stop – Trade exited if price move X times of the Average True Range (10)
5. When do you get out of a winning trade?
Exiting a winning trade can be a challenge since you have to be comfortable letting the profits run as far as it can and then begin to decline before considering an exit with profits. Different systems will use different ways to exit a winning trades. For scalping and ranging systems, they will usually employed a fixed take profit level. Trend following systems will use a trailing stop. That will mean trailing the price by moving average or the 2 bar high/low.
If you answered the 5 questions above, you have mechanised a system for your personal use. These rules will serve you very well when you are in the heat of the trading battle, your rules must be clear, precise and established in advanced. It also helps to be n the defensive:
“We approach markets backwards. The first thing we ask is not what can we make, but how much can we lose. We play a defensive game.” – Larry Hite