How to Build a Trading System that Suits You
“If you’re going to make it, then you have to start today to do those things that are compatible with what someone who is
performing at that level is doing.” – Ari Kiev
In my Coaching experience, most clients end up with a style similar to my own. It’s not a bad thing but it’s not necessarily the optimal solution. Getting exposure to various approaches of professionals who have worked in the industry and share what works for them, is sometimes more functional. You see various styles and can pick out the elements that best fit your personality, time availability and risk tolerance.
This is what our Forex System Development Workshop was created for: to give traders a knowledge base that encompasses the diverse experience and trading models of various professionals, and then offers a structure from which to build a trading model from the ground up.
In this post we’ll shed some light on the System Development process, and why there’s much more to trading than just pin-bars, support/resistance plotting or moving average crossovers.
What is a Trading System?
Most would think it’s just a set of rules. Look for a pin-bar at a key level…buy when there’s a volatility expansion beyond the bollinger bands, etc. Traders concentrate on the wrong things: the entries. Instead, that’s the tip of the iceberg. There is a whole structure and processes you need to create, if you want to achieve your trading goals.
Like every profession, there are basics that need to be mastered before one can excel. Most trades start out with technical school and apprenticeship programs, while most whitecollar jobs begin with a university degree.
Trading is different in that there is no school (except perhaps the school of hard knocks). In the past, aspiring traders would try to get a job at a bank and learn from peers, on the job. But that pathway is closed. Nowadays most traders are self-taught. However, learning the foundations of trading is essential to success.
What can be taught are functional principles, entry strategies, exit strategies and money management guidelines. There is no single strategy that guarantees perfect entry and exit levels, but there are strategies that work better in different markets. If you can devise a series of strategies for different market types, and then recognise the type of market you are dealing in, you will
be a long way towards becoming a great trader.
The System Development Workshop is designed to kickstart this educational process at your own pace. Get to know yourself and what makes you tick, and build systems that reflect the type of person you are.
Beyond Setups: The Ingredients of a Functional Trading System
“Expecting the same system to work in all market types is the definition of insanity.” – Van K. Tharp
We have all done it. Embarked on the quest to find the Holy Grail – a system that produces consistent results with a limited drawdown and a nice upward-sloping equity curve. But there is a problem with the Holy Grail approach to system development that means the search leaves us more frustrated than enlightened. If you can understand the problem, then you will have one of the keys to a winning Forex trading system firmly within your grasp.
Developing a system that works for you is more than just recognizing (insert your favorite setup here) . Understanding this is already part of the solution. Here are the main components of a trading system that helps you reach your objetives.
- Understanding how Beliefs shape your trading: trading is an unlimited environment. There are no real cold hard rules that dictate how you should go about trading the markets. So how do you end up making decisions? It’s all based on your beliefs. You may think it’s a piece of news or the price action on a chart, but it’s not. It’s your belief about what the news or the chart means that is causing you to take action.
What are your beliefs about the markets? Take out a pen and paper and see if you can list 10. Are they rather limiting beliefs or are they functional beliefs?
- Market Types: if all you have is a hammer, everything looks like a nail. You need to know how to identify the best market type for your trading strategy. If you are in a sideways volatile market, should you be buying dips as if there were a trend? How many traders get blown out of the water trying to pick bottoms in a strong bear market?
Various market type shifts in GBPCAD
We’ve discussed market types already in various blog posts. Click here to view the best ones.
- Good Setups: setups enchant new traders, because ex-post on their price charts everything looks crystal clear and easy. The reality is different. Each setup is based around a certain market behaviour, and each behaviour is best exploited within a certain market type. But broadly speaking, there are 5 types of setups:
1. Technical set-ups
2. News-based set-ups
3. Big picture fundamental set-ups
4. Sentiment set-ups
5. Expert set-ups
We encourage traders to select one or two setups and become specialists. Understand that the setup is different than the entry. For example, a setup could be a volatility contraction.
A volatility contraction setup, and the subsequent breakout on the Italian 10YR Bond
In order to exploit a setup, ask yourself the following questions:
- What are 2–4 options of that can come out of this set-up?
- Where are my potential entry points?
- Where are my potential profit targets?
- What could happen after I enter my trade?
- Where can I re-enter if I get stopped out?
- Where can I scale into the trade?
- Simple Entries: this is where most traders spend most of their time, when in reality the entry shouldn’t account for more than 10% of your entire trading strategy. If you spend too much of your focus searching for the Holy Grail entry, then you will experience a major time-suck…or worse, end up with a half-baked system that costs you not only time but also money.
Any single trade is like a spin on the wheel of fortune. A trader’s edge appears over a series of trades, but each trade has a much more random nature to it than we’d like to believe. So in reality, the entry has a very specific function: to get you in the market with as tight a risk placement as possible, given your setup.
Compare these potential entries. Observe how the risk placement can vary significantly and offer much higher risk-reward opportunities.
In the chart above, we have classic bearish engulfings from key levels, in the direction of the current trend. The entry would happen at the end of the day, near the lows of the candle or as a breakout of the candle lows. The logical stop loss would be above the highs of those candles.
There’s nothing wrong about operating this way…but the stop loss is rather wide (130 pips more or less). If you have the time to check your screens at various times of the day, perhaps you could study alternative entries into the same bear market?
In the chart above, we have highlighted the pullbacks to the key levels. They happen on the same day that price closes with the bearish engulfings, but by using the same price-action techniques at the zone of interest, a much tighter stop loss is possible – and the trade can deliver much more signficant returns.
These are just 2 variations on the same theme: trading pullbacks in a bear market. They are simple but logical and efficient, as all entries should be.
- Exit Strategy: exits are simple in nature, but we need a strategy in order to react to the various scenarios that can manifest themselves after you enter the trade.
Our Free Advanced Forex Course for Smart Traders confronts this topic in depth, and we also have some blog posts on the subject here, here and here.
- Position Sizing Basics: a well-designed position-sizing model gives you the ability not only to manage risk but also
to meet your trading objectives, unlike any other aspect of your Forex trading system.
To make this crystal clear, let’s go through an exercize that Van Tharp puts aspiring traders through. It starts with a bag of marbles.
- Each marble pulled from the bag represents the return (in R-multiples) of a single trade. You may lose 1R, win 1R, win 5R, lose 3R, etc.
- Everyone has the same amount of starting capital and each trader decides the risk (the position size) to allocate to each trade before it’s extracted from the bag.
- There is real money on the table, for each participant can decide how much he wants to risk. (when Sam took Van Tharp’s course, there was $1200 on the table at one point). This makes the simulation realistic because there is skin in the game.
- Everyone gets the same trade results, so any differences in returns depend on the trader’s position sizing decisions.
- The bag of marbles contains a positive-expectancy, which means that by extracting all the marbles form the bag, the trading system makes money. But the results are random and there is no guarantee on the sequence of wins/losses.
The only control participants have in this game, is on the size of their positions. Yet at the end of the game, inevitably some traders are bankrupt whereas some have millions of dollars in profit.
We’ve covered this topic here, here and here.
Why The Workshop Works
As you can see, there’s a lot to think about when structuring a proper trading system. We try to facilitate traders by holding their hand through the process and offering feedback constantly, along the way.
- The workshop is a carefully structured process, and you are guided by an experienced trainer who provides you with direct feedback.
- You get to see how a variety of FX professionals (hedge fund managers, bank traders, and other industry professionals) go about their business and approach the markets.
- The focus is on YOU.
Over To You
Hopefully you have a better idea of the kind of input that goes into building a proper trading system, and the relative weight of the inputs (the entry is almost the least important part). While there is no Holy Grail to be found, we believe that you can gain significant insight by seeing how other professional confront the market and what their beliefs are.
Then, with a much better awareness of market dynamics and with a structure to follow, you can go about creating a proper trading system that meets your objectives.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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