Creating a Forex Trading System: Indicator Based Forex System
A Forex System refers to a set of rules that you follow to manage your trades. These rules will determine when you open a trade and when you will exit. A trade system is created by combining two or more technical indicators.
For example, the Stochastic Oscillator can be combined with other indicators to form a trading system. For this example stochastics can be combined with the indicators below to come up with the following system.
- Moving Averages
Creating a Forex System - Forex System Trading Example
So the question is how can one come up with a Forex trading systems that work like the one above and how does one write it's rules? follow the steps below.
Seven steps to creating an indicator-based Forex system
To come up with these set of rules we use the following seven steps.
1. Choose your Time Frame
This first step depends on how many hours you want to dedicate to currency trading. Whether you prefer sitting in front of the computer constantly for several hours analyzing short time frames OR you prefer setting up your charts using bigger time-frames once or twice a day. Choosing a time-frame will mainly depend on what type of trader you are.
Chart Time Frames on MetaTrader 4 Forex Trading Software
While testing your new Forex system you may want to find out about its performance on different chart time frames and then choose the most accurate and profitable chart time-frame for you.
2. Choose indicators to identify a new trend
The goal of a currency trader is to get into the trade as early as possible and take maximum advantage of price moves.
One of the common ways to spot a new Forex trend as fast as possible is to use Moving Averages Indicator. A simple strategy is to use a moving average crossover system that will identify a new trading opportunity at its earliest stage.
Moving Average Crossover Method
Sell signal and Buy signal Generated by Moving Average Crossover Method
3. Choose additional indicators to confirm the trend
To confirm the signals we use RSI and Stochastic Oscillator.
RSI and Stochastic Oscillator Indicator Forex System
4. Finding entry and exit points
Once indicators are chosen so that one indicator gives the signal and another confirms the signal, it is time to enter a trade.
A Forex trader should enter as soon as a signal is generated and confirmed after a candlestick closes.
Aggressive traders enter a transaction immediately without waiting for the current price bar to close.
Others wait until the current price bar is closed and then enter the transaction if the trade setup has not changed and the signal remains valid. This method is more considerate and prevents additional false entries and whipsaws.
Generating Forex Signals.
Generating Forex Trade Signals
For exits, one can either set an amount he wants to earn per trade or use technical tools that help to set profit goals like Fibonacci expansion or set a protective stop loss depending on the market volatility at any given time. Alternatively one can exit when the indicators give an opposite signal.
When opening a new transaction it is always important to calculate in advance how much you are willing to lose if the transaction goes against you. Although the goal is to create the best Forex trading system in the world, losses are inevitable and therefore being ready to tell where you will give up and cut your losses before starting a transaction is very important.
5. Calculate risks in each setup
In Forex you must calculate your risk for each trade. Serious currency traders will only enter look to open an order it the risk to reward ratio is 2:1 or more.
If you use a high risk to reward ratio like 2:1, you significantly increase your chances of becoming profitable in the long run.
The Reward to Risk Chart below shows you how:
Money Management Reward Risk Chart
In the first example of Risk to Reward Ratio, you can see that even if your currency trading system only won 50% of your trades, you would still make a profit of $10,000. Read more on this topic: Here Money Management Rules and Money Management Methods.
Before opening a new trade, one should define the point at which he will close the trade if it turns to be a losing one. Some people use Fibonacci levels and support and resistance levels. Others just use a pre-determined stop loss to set stop loss order once they have opened a trade transaction.
6. Write down the systems trading rules and follow them
A Forex Trade System refers to a set of rules that you follow to manage your trades.
The keyword is A SET OF TRADING RULES which you must follow. If you don't follow the rules then you don't even have a trading system in the first place.
The next Forex trading systems lesson shows you an example of how to use the above steps to come up with your own Forex online trading system:
7. Practice on a Demo Account
Without enough trades, you will not be able to realize the true profitability of your Forex system.
Open a free demo practice account and trade your system to see how well it will respond.
It is strongly recommended to start with a demo account and practice for at least for 1 or 2 months so as to gain some practice and experience how the currency market works.
Once you start making some decent profit on your demo account you can then try opening a live Forex trading account and start trading with real money.