WHAT IS A TRADING SYSTEM?
A trading system is the main component of a trading plan. A trading plan cannot work without a trading system, hence a good trading system is an essential part of a good trading plan
Mechanical trading systems are built with two very important goals in mind to achieve. They are:
The system should be able to identify trends as early as possible
The system should be able to prevent you from going into an unprofitable trade by determining a true trend that is a genuine trade signal, from a fake trend which is a fake trade signal.
When designing a trade system, you should know that creating a system takes no time at all, but what takes time is testing it over several trades to make sure its foolproof, as error proof as possible, and perfectly meeting the goals of creating it. A good trading system which has been well tested over time, is a guaranteed money maker for every trader.
Creating A Mechanical Trading System
Step 1: determine your time frame
Your time frame is determined by the type of trader you have identified yourself to be. Before going into the trade, you need to determine how long you want to hold your positions for. Even though you will also study your charts in different timeframes, your trading style will determine which timeframe will be used for generating trading signals
Step 2: find the right tool for identifying a new trend
There are various tools or indicators used for identifying new trends. Here is one of the most popularly used one:
Moving averages - It uses a slow moving average and a fast moving average. A new trend is identified when the fast MA crosses over or under the slow MA. This is called a moving average crossover system, and its the fastest and easiest way to identify and spot new trends
Step 3: find the right tool to confirm the trend
To avoid being caught in a false trend, you need to find the right tool to confirm if a newly identified trend is a real one or a fake one. This is done by using one or more additional indicators such as the MACD (moving average convergence divergence), or RSI (relative strength index), or stochastic
Step 4: define your level of risk
It is important to figure out way ahead of making your trade, how much you are willing to lose on the trade if it doesnt go as planned. A good trader always considers this, even before considering how much he stands to gain too if the trade goes as planned
Step 5: define your entry and exit points
It is now necessary to identify at which point you will enter into a trade and exit the trade in order to get the most profit.
• For entries: once both indicators have identified and confirmed a trend, it is always good to enter into the trade at the close of the candlestick, that is at the close of the current timeframe in which you are studying the chart
• For exits: it is entirely up to you to figure out when to exit a trade. Exiting a trade, depends on how much profit or loss you are comfortable or okay with. Usually traders just fix their exit point at a particular price, and when price reaches that point, then they exit the trade, irrespective of whether the price is still climbing higher or not. Most traders usually use support and resistance lines to set their target price for exiting trades.
Step 6: write out the rules of your system and stick to it no matter what
This step is as simple as it is written; when you have identified and confirmed a trend, ascertained how much you are willing to risk, defined your entry and exit points, then write it all down in your trading journal, and FOLLOW IT TO THE LETTER !
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