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Introduction There are numerous trading systems out there, some may work for you and the rest don t, even if they are making great results with their systems. That s simply because we are all different from each other and the way we perceive the market may also differ. Following another person s system blindly is not the best approach to trading. You have to know how the system works and why it works. If you have chosen a trading system, make it your own so that it works for you. There comes a time in the life of a trader that he would rather develop his own trading system. A method that suits his own time, to trade the timeframes and currency pairs he likes, during days he is available to trade. It sounds like a great idea, but before you get carried away, let me take you back to reality. Warning! This path is not as straight as many would imagine it to be. Many traders do find themselves crisscrossing, moving back and forth, and going in circles. Developing a system is not nuclear science, but it does involve the same objectivity required in the scientific method. If you want to spend the least amount of time and effort in developing a strategy, then you need to have an objective approach. This report is designed to help you as you go into system development. I will explain the important aspects of a trading system, and show you how to make the choices that are right for you as a trader. Basically, a trading system is a procedure that describes in detail how you enter and exit your trades. It answers the WH questions: What, Where, When, Why and How. We will talk about the following: What are the tools involved in the trading system? Where should I trade? When do I trade? Why should I? How do I trade? If your system answers all of these questions, then you have a good working system. www.russhorn.com 3
Components of a System Before we begin with the steps to making a trading strategy, let s first talk about the different components that make up a trading system. 1. Indicators and tools Technical analysis involves the use of indicators and other charting tools for analyzing the market. In previous reports, you have seen the different types of indicators and how they are used in trading; feel free to review them as you start looking for indicators to use. Although there are a few traders out there who choose not to use these technical analysis tools, most successful traders do, with good reason. Indicators are used for: - Identifying the trend - Measuring the momentum of the trend - Pointing out entry signals - Filtering out false or bad trading signals Different indicators have various functions and having a combination of indicators, each performing one or more of the functions listed above is a good starting point. Just make sure that all the functions are covered. All the standard indicators are found in the navigator window of the platform. Here s a list of the commonly used indicators: Average Directional Movement Index (ADX) Average True Range (ATR) Bollinger Bands Commodity Channel Index (CCI) Fractals Ichimoku Kinko Hyo MACD Moving Averages Parabolic SAR Relative Strength Index (RSI) Stochastic Oscillator Williams Percent Range There are also many custom indicators available out there that were designed for specific reasons. Some of them are to perform new tasks, some to improve already existing indicators, while others are a combination of existing indicators. www.russhorn.com 4
You can readily find charting tools on the toolbar at the top of the chart. But to see the complete list, you may click on the Insert tab at the top menu. (See image to the right.) Test some indicators and tools you like and select the best. The simplest way to test them is by applying them on your charts and going back into the history. Then see which signals it made failed and which ones worked. Select the best indicator/setting and study it further in terms of how its false signals can be filtered out by adding a tool or another indicator. To the right is an image of a chart with moving averages that have different period settings. Before you begin, make sure that the Chart Shift button is disabled. Once done, just drag the chart to the right to see historical data. If you re more familiar about the platform, another way to test your indicators is by using the Strategy Tester. www.russhorn.com 5
2. Currency pairs to trade Knowing which pairs you want to trade is essential. Below is a list of commonly traded currency pairs. Majors: EUR/USD - (Euro Dollar) GBP/USD - (Pound Dollar) AUD/USD - (Aussie Dollar) NZD/USD - (Kiwi Dollar) USD/CAD - (Dollar Loonie) USD/CHF - (Dollar Swissy) USD/JPY - (Dollar Yen) Cross Currencies: AUD/CHF CAD/CHF EUR/GBP EUR/CHF EUR/JPY GBP/AUD GBP/CAD GBP/CHF GBP/JPY NZD/JPY As you select the currency pair, take the following points into consideration. a. Which sessions are open during the time of the day you re available to trade. If you are able to trade during the London session, then the pairs you should be trading are the EUR, GBP and CHF pairs. But if you can trade during the US session, then pairs with the USD currency are more suitable. During the Asian session, the pairs with AUD and JPY have more movement and can be traded at that time. b. Make sure that the spread of the currency pair is low. Each trade you take will involve a spread; this is how brokers make their money. Each currency pair has a different spread and it pays to check these in your selection. Ideal pairs have a spread of about 2 pips or less. This means you can start making profit once the trades have gone in your favor beyond 2 pips. If you are trading on a pair that has a spread of 5 pips, then you ll need to cover 5 pips into the trade before you can start making money. www.russhorn.com 6
3. Timeframe It s also important to consider the timeframe you are trading. This depends on your availability to trade. If you are only able to trade a few hours in a day, you may want to use lower timeframes to scalp the market. You will have small frequent trades but you need to be in front of your computer to monitor them. For those who are able to check their trades every hour, then the 1 hour timeframe can be used. Others are only available every 4 hours, while others can only trade once a day. We need to think about these things because we do not want to be stuck in a trade when we need to be away. Checking for signals and placing the trades shouldn t take long, and for the higher timeframes, you don t need to watch the chart as it moves. You can use your valuable time for other activities until the next candle opens. That s the only time you need to check the progress of your trade. So take note, smaller timeframes (1, 5, 15 Minute) may need constant monitoring, but higher than that (1 or 4 Hour, and Daily) just need to be checked at the open of every candle. www.russhorn.com 7
4. Entry Criteria The most important aspect of a trading system is the trading rules, which consists of the entries and exit criteria. The entry criteria are the first part of the rules in a trading system. It is a list of signals you are looking for on the chart that indicates if you have a trade. Your entry criteria needs to be detailed. It should follow a chronological order and include the following information: - Indicator/Charting tool - Timeframe - Exact signal Here s an example: EMA System Buy Trade Rules 1. On the 1 hour chart, check that the 100 EMA is sloping upward and below the price and the other EMAs. 2. Wait for the 5 EMA to cross above the 15 EMA. 3. At the close of the candle above the 5 EMA, place a buy trade order. www.russhorn.com 8
4. Exit Criteria Knowing when to enter a trade is not enough. We also need to exit the trade, and preferably, in profit. There are three common ways that a trade is closed: - Stop Loss - Take Profit - Manual Closing Stop Losses Stop losses and take profits are vital to every trading system. In fact, a system is incomplete without them. Every trade comes with a risk. The main purpose for a stop loss is to set a limit to the potential loss of a trade. In selecting the ideal stop loss for your trade, you have to identify the level that price has reversed. To use a fixed value is debatable. It is only good if you have tested certain stop loss levels for each currency pair or timeframe, to be truly precise. Here are some approximations of the stop loss levels that can be used on the different timeframes. 1 Minute = 1 pip 5 Minute = 1 to 2 pips 15 Minute = 2 to 5 pips 30 Minute = 3 to 7 pips 1 hour = 5 to 10 pips 4 hour = 10 to 20 pips Daily = 20 to 50 pips Weekly = 50 to 100 pips Monthly = 100 to 250 pips The safest way to identify a stop loss level is to consider each situation involved in each particular trade. I m talking about identifying support and resistance levels. You may use swing highs or lows, and even indicators such as moving averages, fractals, or tools like trendlines or Fibonacci. Whichever you choose, make sure that the stop loss is beyond that support/resistance line to give a little bit of room for price to bounce back into your favor. I will show you an example on the next page. www.russhorn.com 9
EMA System Buy Trade Rules 3. At the close of the candle above the 5 EMA, place a buy trade order. 4. Set the stop loss a few pips under the previous swing low, or under the 100 EMA, whichever is closer. Take Profit Take profits are the opposite of stop losses. Traders set a take profit to bag their profits at a specified level. Some traders who do not use a take profit level find their profits go higher than expected, but more often than not, they end up watching their profits go back down and end in the negative. We don t want that to happen. We just want to go in a trade and get out with our profit. The take profit to use would depend on a few factors: - Risk to reward ratio (Money Management) - Timeframe - Market volatility Many traders argue about the risk to reward ratio. Some say 1:3 (1Risk:3Rward) is the best! Yes, that s great if it s only feasible. With the current economic situation, those types of trades are not common. Price is more volatile and it could turn in a blink of an eye. If you choose this type of take profit, it would be wise to add another exit rule that allows you to exit the trade manually if the price has reversed. www.russhorn.com 10
There are systems out there that use a risk to reward of 1:1 that also works. Testing is the key. If you have a high win rate, then a 1:1 ratio is fine. You will still come out profitable. If you want to use a fixed take profit, you ll have to take the timeframe into consideration. Smaller timeframes will give you smaller trades, while higher timeframes will yield higher gains. Manual Closing If there s no take profit in place, an additional exit criterion can also be used. Its purpose should mainly be to identify reversals and get out of the trade early. Here s an example: EMA System Buy Trade Rules 4. Set the stop loss a few pips under the previous swing low, or under the 100 EMA, whichever is closer. 5. Set the take profit at 1:1 risk to reward ratio. 6. Move the stop loss to breakeven as the profit reaches half of the desired amount. This will allow you to cut off all the risk involved in the trade. This will allow you to cut off all the risk involved in the trade. 7. Close the buy trade if the 5 EMA crosses back under the 15 EMA or if a sell signal appears. www.russhorn.com 11
Testing When developing a trading system, you ll need to do a lot of testing either back-testing or forward testing. Back-testing means using historical data to test the trading strategy. You may do it manually or using the Strategy Tester on the platform. As you do this, remember the following pointers: 1. Test one variable at a time while keeping the rest constant. This means that you should only tweak one indicator or setting at a time and run another test to see if the result has changed. This will allow you to see the exact change in the results and will help you identify whether or not the adjustment you had made was effective. 2. Make sure you have enough data to test. Test at least 3 or more months of historical data. If the result gives you only 20 trades, then you have to consider increasing the amount of data to be tested. 20 trades is not enough to prove the worth of a system. 3. As you are running each test, stay true to the rules of your system. It has to be done as mechanical as possible. Forward testing is using present and future data. Once you have gathered enough back-testing evidence that your system works, that s the only time that you should do forward-testing. That s because this type of testing a strategy is time consuming. You ll need a demo account and paper trade the system there. The results will take months to complete. After you have gained enough evidence on a demo account that your system works without a shadow of doubt, then and only then should you test it on a live account. Trading on a live account can be tricky and needs some getting used to. Just to get your feet wet, open a small account that you are willing to lose. You can open an account with as low as $50 or $100. Trade small and build up the small account. Only add funds when you have doubled or tripled the small account. By then, you would have enough practice trading live and confidence in your trading system. www.russhorn.com 12
Summary Designing your own trading system does take time and effort, but it will not go to waste. The rewards of having your own personalized method are far greater than the cost. Forex Trading is not a get rich quick thing; it is much like a profession. Successful traders spent a lot of time studying and testing before they actually became successful. It s the leg work that brought them there, and more often than not, part of it is developing their own trading system. It is our sincere hope that this report can help you in your trading journey! Sincerely, www.russhorn.com 13