| Your trading should be
governed by a system of rules to ensure that your participation in the
markets is objective and not based on your emotions.
What should a forex trading system
comprise?
A complete forex trading system should
encompass all eventualities you may be faced with so that nothing needs to
be decided during the trade. Therefore, a forex trading system should
comprise rules governing:
- What currencies to trade
- Entry point
- Exit point
- Initial stop loss
- Trailing stop loss
- Take profit point
- How many contracts to trade with
Contrary to popular belief, the entry
criteria is probably the least most important parameter of a forex trading
system. It is the money management
component that is the most important aspect of any system.
Any forex trading system should be
thoroughly tested using historical price data. There are a number of
different software packages available which allow users to program in
their particular system and backtest it automatically. This testing can
then be used to optimise your trading system's parameters. This process
assumes that the markets future behaviour will be similar to its past
behaviour. While this may not necessarily be true as all markets are in a
constant state of flux, we believe that changes will occur slowly over
time, and by backtesting your forex trading system on a regular basis, you
will be able to adapt your parameters to the changing market environment.
Trend vs Range Forex Trading Systems
A forex trading system may be developed for
either trending or ranging markets. It is not easy to develop a system
which works well in both environments.
Markets range more often than they trend.
Therefore, a forex trading system optimised for use in a ranging market
may seem ideal. However, with range trading your profit is limited to the
size of the range, but when trading trending markets your profits are
essentially uncapped. Therefore, trend trading is more lucrative although
you probably have to endure more losses before you hit a bonanza run.
Which method makes more money - Scalping 10
pips or letting profits ride?
A forex trading system designed to scalp 10
to 20 pips may seem easier than one in which you are aiming to make a
profit of around 100 pips or more. However, the spread and the risk-reward
ratio are two factors which make scalping much less favourable.
The effect of spread is best demonstrated
using an example. If you place an order to buy EUR/USD at 1.3050 (Ask
price) with a take profit of 10 pips (i.e. Bid price = 1.3060), the market
actually needs to move 15 pips to 1.3060 (Bid)/ 1.3065 (Ask), with a
typical spread of 5 pips, before you make 10 pips profit. However, if you
have a stop loss of 10 pips (i.e. Bid price = 1.3040), the market only has
to move 10 pips to 1.3040 (Bid)/ 1.3045 (Ask) in order to sell you out.
Therefore, even though you think your risk/ reward ratio is 1:1, you will
generally lose more often than you will gain as the market needs to move
only 10 pips against you before you lose your trade while a move of 15
pips in your favour is required before you take profit. This effect of the
spread becomes more pronounced when your profit is small, i.e. comparable
to the size of the spread.
When you allow your profits to run,
risk-reward ratios of 1:2 or better can be achieved and the effect of the
spread is not so pronounced. |
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