How to develop a successful trading system

Introduction

In order to manage risk and increase profit, every trader needs to have a trading system. A trading system is a fixed  systematic process used to identify a trading opportunity, execute it and close it. A trading strategy, on the other hand, is a set of rules that help identify high probability setups.

Table of contents

• The difference between a trading system and a trading strategy
• Bulding a trading system
• Importance of consistency
• Building a trading strategy
• Developing a successful trading plan

The difference between a trading system and a trading strategy

A trading system involves steps that are fixed and do not change nomatter the type of trade you are entering. The system maps the steps to follow towards achieving your trading goal and the strategy may differ in every step taken towards achieving your main goal.

Bulding a trading system

To build your trading system you will need to:

• Determine the time frame that you are going to use to execute your trades. 

This depends on the type of trader that you are and the amount of time that you are dedicating to analysing the markets. For example, if you are a day trader, you may look at the 15 minute chart to determine the direction of the market in the long term, the 5 minute chart as a guide in the direction of the market in the medium term and the 2 minute chart as the time frame that you use to look for the best levels to enter trades. When these time frames confirm that price is moving in the same direction, then a trader seeks the best opportunities to enter a trade.

• Identify the position of the market.

 This is the direction in which the market moves. The primary trend (also known as the long term trend) can move in an uptrend, sideways or downtrend. If, for example, the market is moving in an uptrend, then you look for opportunities to enter into buy positions, similarly, if the general direction of the market is in a downtrend, then you look for opportunities to enter sell positions. Trend analysis is covered in depth in this article. 

• Find the levels of support and resistance

Support and resistance levels, are the levels that price reach over time. These levels can be identified by analysing the levels were price changes direction. As traders, it is important to avoid trading near those support and resistance levels.

• Determine your entry and exit levels

These are the rules for executing trades. Whether you are using price action or indicators to determine entry levels, you should be consistent with those rules. For example, if you are using crossover of moving averages to determine entry levels, then be disciplined enough to patiently watch the market until you see the crossover. Do not assume that the moving averages will crossover. Another mistake that traders make is they manage to identify the entry level, but once the trade starts moving in the opposite direction, they panic and close the trade. When you are entering into a trade look at the level that you are entering the trade, where your stop loss will be, and also how much profit you can make from the trade. Your risk:reward ratio should always come into play when determining your entry and exit levels. For example, you cannot risk $10 for $5 profit. The risk should be less. A risk:reward ratio of 1:3 is reasonable. 

• Assess your mental state

This is simple. Stay away from the market if you are not in an emotional state to trade. Trading with emotions is not good for your account.

• The type of market that you will trade

You need to know which market you will trade, whether you want to invest in stocks, forex or synthetic indices such as volatility indices, crash and boom. Once you have determined that, you need to determine the type of assets that you will trade. I recommend that you start by trading one asset, then as you get familiar with the market you can increase the number of assets. In forex trading, you can start by trading currency pairs that are stable, such as the Cable (GBP/USD) or the EUR/USD currency pair among others and for synthetic indices, volatility 75 index is beginner friendly and its minimum lot size is 0.001. 

• How much capital will you invest

The amount of capital can help you set the amount that you are willing to risk in a trade and the lot size that you are going to use in each trade. As you make more profit and your account size starts increasing then you may consider increasing the number of positions or the lot size for each trade. Remember the risk:reward ratio should ideally be 1:3. Do not risk all of your capital in a trade.

Importance of consistency

The aim of a trader is not to make profits, or consistent profits but to be consistent with their trading system.

If you are a consistent trader but you are constantly making losses, it helps in identifying the parts of your trading system that need improvement. If you are consistent and profitable, you just need to repeat what you are doing indefinitely and you can also work on improving your consistent approach in order to make more profits. 

Building a trading strategy

This process is important for the success of your trading plan.  A trading strategy is a set of rules to follow in order to execute a trade. After developing your trading system, you need a strategy that will work for your trading system. At this level, you should be able to identify the type of trader that you are, whether you are a day trader, swing trader or long term trader. You should also decide the time frames that you are going to be using in your trading system so that you can develop a strategy that will work well with your system. The important things to consider when developing a trading strategy are the tools that you will use to identify the trend and volume.

You are looking at how you will be analysing the charts, whether you will be using price action strategy to analyse the candlesticks chart, or whether you will be using indicators. For example, some traders use moving averages to determine the direction of price movement, when the moving average is moving horizontally for a long period of time then they know that the market is ranging. Some use two or more moving averages and the crossover of these moving averages would signal a buy or sell signal. Some use a combination of moving averages and oscillators.  You will need to back-test different strategies and find the one that works for you.

I have found the Ichimoku cloud to be the perfect indicator for my day trading system because this indicator does all the work for me, all I need to do is patiently wait for the best entry signals. The indicator shows the direction of the trend, trading volume and also shows support and resistance levels. If you would like to know how to use this indicator, read 'How to use the Ichimoku Cloud in Forex Trading'.

Developing a successful trading plan

What are your goals?

The first thing to consider are your trading goals which will help you to stay motivated. You can have a long term goal which may be monetary goals or educational goals, for example you may be working towards becoming a full time trader. You will also need to have short term goals which will help you towards achieving the long term goal.

Risk management rules

This should include the percentage of money in your account that you are willing to risk on a certain trade and the total amount that you can lose in a day before you stop trading. Such rules protect you from blowing your account due to the emotions involved in losing trades.

Get a trading journal

Keeping a journal with the detailed records of your daily trades is important so that when a trading session is not successful you can reflect back to it, and find ways to improve on your next trading session. It helps you to recognise errors and improve your trading system. A trading journal may also help to track your progress towards achieving your goal. 

This article on 'The Importance of Having a Forex Trading Journal' will give you a guide on developing your own trading journal.

Summary

Treat trading as a business. All businesses involve risk. To get consistent profits, you need discipline. Your main goal of trading and clearly outlined steps to take towards achieving that goal will help you become a successful trader.