Steps to Creating a Forex Trading System Based on Rules

Trading the financial markets can be a difficult journey, especially if you continuously feel tired of mental energy and have trouble focusing on the markets.

A trading system consists of more than just a rule or set of rules for when to enter and leave a deal. It’s a thorough plan that considers six key aspects, the most significant of which is your own personality. In this article, we’ll go through how to create a rule-based trading system in general.

1st Step: Examine Your Perspective

Be aware of who you are: When trading the markets, examine your skills and limitations, then consider how you would behave if presented with an opportunity or if your position were endangered.

Match your trading style to your personality: Make sure you’re comfortable with the kind of trading situations you’ll encounter throughout various time frames.  For example, when designing your strategy, the first thing you must decide is what type of forex trader you are.

Do you like to day trade or swing trade?

Do you enjoy looking at charts on a daily, weekly, monthly, or even annual basis? How long do you intend to stay in your current positions?

This will assist you to figure out who you are. Even though you will still look at numerous time frames when looking for a trade signal, this will be the primary time frame you will use.

Prepare yourself: Winning traders examine and review their trading results on a regular basis. They recognize that trading is a talent that can only be acquired with consistent practice over time. Plan your deal so you can execute it. Preparation is a mental run-through of your possible trades, similar to a dress rehearsal. You are establishing the ground rules as well as your restrictions by preparing your trade ahead of time. You can be impartial and step back from the fear/greed cycle if you know what you’re looking for and how you plan to react if the market does what you expect. 

Maintain objectivity: Don’t get emotionally invested in your trade. It makes no difference whether you are correct or incorrect. Trading is not about ego, however, it might be unnerving for most of us when we design a move, apply all of our logical prowess, and then discover that the market disagrees. It’s a matter of conditioning yourself to realize that not every trade will be profitable, and that you’ll have to accept modest losses gracefully and move on to the next opportunity.

Be self-disciplined: Trading success requires self-discipline. Unfortunately, self-discipline is sometimes the most difficult discipline to master. Most of us are better at following rules forced on us from outside sources than we are at following rules we make for ourselves. This is not a mindset that will help you succeed in trading.

Regardless of how current market movement affects their account balance, they are disciplined in their trading and can assess the market objectively. This includes knowing when to buy and sell. Stick to your pre-planned strategy when making decisions. You may cut out of a position only to discover that it reverses and would have been profitable if you had stayed in it. However, this is the foundation of a really bad habit. You can always get back into a position if you don’t neglect your stop losses. Cutting your losses and accepting a little loss is more reassuring than hoping that your substantial loss would be recouped when the market recovers. This is more akin to trading your ego than it is to trading the stock market.

Be patient: Patience is a virtue when it comes to trading. Learn to wait until the market reaches the point where you’ve drawn your line in the sand. What have you lost if it doesn’t make it to your entry point? There will always be another day when you can earn a profit.

Have reasonable expectations: This implies you won’t lose sight of reality and expect to transform $1,000 into $1 million in ten deals. What constitutes a reasonable expectation? One of the reasons why traders lose so often is that many of the attitudes and concepts that serve us well in life do not work well in the world of trading. Most traders are unaware of this and have only a rudimentary understanding of what trading is all about. We are encouraged to avoid unsafe circumstances in our everyday lives. However, trading is all about taking chances.

2nd Step: Define Your Mission And Objectives

Winning traders understand the difference between a “poor trade” and a “losing trade.” This is an important aspect to grasp. Simply because you lose money on a trade does not mean it was a terrible trade; it simply means it was a losing trade. It is not whether a transaction wins or loses that determines if it is a good deal; it is a good trade if it offers greater potential return than risk, and the odds or probabilities of success are in your favor, regardless of how it comes out. Even if you get stopped out for a loss, if you take a trade for sound reasons and handle it well while you’re in it, it’s a good trade. (On the other hand, even if a transaction makes money, if it wasn’t started for the right reasons and with a positive risk/reward ratio, it’s still a bad trade.)

Winning traders believe that if they continue to make “excellent transactions,” as defined above, they will be lucrative in the long run. Losing traders mistakenly label any deal that loses money as a “bad trade” and any trade that wins money as a “good trade,” regardless of whether the trade had a solid foundation – and this leads to bad, losing trading over time. When you evaluate trades only on the basis of whether they win or lose, you’re essentially looking at random rewards, similar to when you’re playing a slot machine.

Any path will get you where you want to go in life if you don’t know where you’re going. In terms of investment, this means sitting down with your calculator to figure out what kind of returns you’ll need to meet your financial objectives.

The next step is to figure out how much you need to make in a deal and how often you’ll have to trade to meet your objectives. Don’t forget to account for trades that didn’t work out. This may lead you to realize that your trading strategy is at odds with your objectives. As a result, it’s vital to match your methods to your objectives. If you trade in conventional 100,000 lot sizes, a pip is worth roughly $10 on average. So, how many pips do you think you’ll make per trade? Calculate your winnings by adding up the winners and losers from your last 20 trades. This can be used to forecast the profitability of your existing methodology. You can determine whether you can attain your objectives and whether you are being realistic after you have this knowledge.

3rd Step: Make Certain You Have Enough Cash

When they see a genuine profit opportunity based on their market analysis and trading plan, winning traders are not afraid to take a risk. They do not, however, take risks with their money. They undertake careful risk management by establishing small limitations on their losses, always conscious of the chance of being incorrect.

Cash is the fuel that allows you to begin trading, and if you don’t have enough, your trade will suffer from a lack of liquidity. Cash, on the other hand, is a safety net against lost trades. You won’t be able to resist a temporary loss or give your position enough breathing room while the market swings back and forth with fresh trends if you don’t have a cushion.

Cash cannot be obtained from sources that are required for other key events in your life, such as your college savings plan for your children. Money in a trading account is considered “risk” money. This money, also known as risk capital, is an amount you can afford to lose without negatively impacting your lifestyle. Consider exchanging money in the same way you’d save for a vacation. You understand that the money will be wasted once the vacation is done, and you are fine with it. Trading entails a significant amount of risk. Treating your trading capital as vacation money does not imply that you are not concerned about protecting it; rather, it means psychologically releasing yourself from the fear of losing so that you can make the trades necessary to develop your capital. Perform a personal SWOT analysis once again to ensure that the required trading positions do not conflict with your personality profile.

4th Step: Find A Market That Trades Consistently

Winning traders understand and accept that the market is ultimately unpredictable and that there is no foolproof market analysis technique or strategy that can predict price changes with certainty. Because they are well aware of this, they keep a close eye out for signals that their analysis is flawed, and if they see them, they swiftly change their trading position. Losing traders, on the other hand, tend to only seek market movement that confirms that they are correct, and to minimize or rationalize away any market action that appears to contradict their analysis once they have entered a trade. As a result, they frequently stay in losing trades for much too long and suffer excessively significant losses.

Choose a currency pair and experiment with it over various time intervals. Begin with weekly charts and work your way down to daily, four-hour, two-hour, one-hour, 30-minute, 10-minute, and five-minute charts. Determine whether the market turns at strategic points, such as Fibonacci levels, trendlines, or moving averages, the majority of the time. This will give you an idea of how the currency trades over various time ranges.

To observe if any of these levels cluster together, set up support and resistance levels in different time frames. The price at a 127 Fibonacci extension on a weekly time frame, for example, could be the same as the price at a 1.618 extension on a daily time period. The support or resistance at that price point would be strengthened by such a cluster.

Rep with different currencies until you discover the one that you believe is the most predictable for your process.

Remember that trading requires passion. You must enjoy what you are doing in order to test your setups repeatedly. You can learn to effectively judge the market if you have enough passion.

Once you’ve found a currency pair you like, start reading about it in the news and in the comments section. Try to figure out if the fundamentals back up what you think the chart is saying. For example, since gold is a commodity that is often positively connected with the Australian currency, if gold rises, it will likely benefit the Australian dollar. If you believe gold will fall, wait for the appropriate period on the chart to short the Australian dollar. Before you make the deal, look for a line of resistance to be the right line in the sand to gain timing confirmation. 

5th Step: Check For Positive Results Using Your Methodology

This phase is arguably what most traders consider to be the most crucial aspect of trading: a system that only enters and exits lucrative trades. There will never be any losses. If such a method existed, a trader would be wealthy beyond their wildest dreams. But the truth is that such a system does not exist. There are good, better, and even below-average methodologies that can all be employed to produce money. The trader is more important than the system when it comes to a trading system’s performance. A good driver can get to their location in almost any vehicle, while an untrained driver will almost certainly not make it, regardless of how nice or quick the vehicle is.

Having stated that, it is vital to select a methodology and test it numerous times in various time frames and markets in order to determine its success rate. A system may only be a successful predictor of market direction 55%–60% of the time, but with proper risk management, a trader can still make a lot of money using such a method.

Personally, I prefer to adopt a technique that maximizes return while minimizing risk, which means that I prefer to look for turning points at support and resistance levels because these are the easiest to identify and measure risk. Support isn’t always strong enough to stop a market from falling, and resistance isn’t always strong enough to reverse a price increase. However, a method based on the principle of support and resistance may be developed to provide a trader with the necessary edge to be profitable.

It’s critical to test your system’s expectancy or reliability in a variety of settings and time frames after you’ve created it. It can be used to time entrance and exit in the markets if it has a positive expectation (it produces more successful trades than losing ones).

Losing traders make the mistake of thinking that mastering the market is the key to success. They refuse to acknowledge that the market cannot be dominated. The market is beyond your control. You have control over yourself and what you do in response to market movements. Winning traders understand this and devote more time and energy to perfecting themselves and their trading activities than they do to learning market analysis. It’s not that market research isn’t valuable. It’s only that the amount of data to evaluate, as well as the number of various technical and fundamental indicators, is practically limitless. Furthermore, what is significant at one point in time may be completely irrelevant at another.

It’s simply too much data to filter through, and it’s difficult to do it perfectly. A trader’s time is best spent honing their trading skills and perfecting themselves.

6th Step: Calculate Your Risk-To-Reward Ratios And Limits

People with poor risk tolerance and an inability to tolerate losing transactions are not cut out to be successful traders, as losing trades are an inevitable part of the game. Winning traders are emotionally capable of accepting the inherent risk of trading. Trading is not the same as putting your money in a guaranteed-return savings account.

The first line to draw in the sand is where you would quit your position if the market went against you. This is where your stop loss will be placed.

Determine how many pips your stop is from your entry point. If you trade a regular lot and your stop is 20 pips distant from the entry point, each pip is worth about $10. (if the U.S. dollar is your quote currency). If you’re dealing with cross currencies, a pip calculator can help you figure out how much a pip is worth.

Calculate the proportion of your trading capital that your stop loss would be. For example, if your trading account has $1,000 in it, 2% equals $20. Make sure your stop-loss isn’t more than $20 from where you started. If 20 pips equal $200, you’re using too much leverage for your trading capital. To get around this, you’ll need to downsize your trading from a conventional lot to a mini-lot. A single pip in a mini-lot is worth about $1. To keep your risk-to-capital ratio at 2%, your maximum loss should be $20, which means you should only trade one mini-lot.

Now, on your chart, add a line where you wish to take profit. Make sure it’s at least 40 pips away from your entrance. This will result in a profit-to-loss ratio of 2:1. Because you can’t predict whether the market will reach this level, slide your stop to break even as soon as the market moves past your entry point. At worst, you’ll scratch your transaction and keep your entire investment.

Don’t give up if you’re knocked out on your first try. It’s common for your second entry to be correct. “The second mouse gets the cheese,” as the saying goes. If you’re buying, the market will often bounce off your support, and if you’re selling, the market will retreat from your resistance, and you’ll enter the trade to see if the market will trade back to your support or resistance. Then you’ll be able to profit the second time around.

Synopsis

You’ll have the tools to choose an optimal currency pair by combining psychology, fundamentals, a trading approach, and risk management. All that’s left is to practice trading until the strategy becomes second nature to you. You can become a successful trader if you have enthusiasm and determination.

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