Guidelines to creating own Forex trading system (Part 2)
Submitted by Edward Revy on April 22, 2007 - 11:03.
Finding entry and exit points
Once indicators are chosen so that one gives and another confirms the signal, it is time to jump in and see how far you may go and how much earn.
A trader can enter as soon as signal is confirmed or in order to find the best entry point he can switch to a smaller time frame and enter at the most advantageous point.
There are two major styles for entry. First is for aggressive traders – immediate entry without waiting for the current price bar to close.
Second method is to wait until the current price bar is closed and then enter the trade with the next bar if conditions have not changed and the signal remains valid. This method is more considerate and prevents additional “false” entries.
For exits Trader can either set an amount he wants to earn per trade (for example, 25 pips per each trade), OR use trading tools that help to set profit goals (Fibonacci tool, Pivot Points studying), OR use trailing stop (usually after some profits have been achieved, instead of closing a current position Trader can wait longer to achieve possibly greater results. To secure already made gains traders use trailing stop — so when the price again makes another positive progress this stop will move same amount of times up, securing additionally gained profits. If price reverts against the open position, trailing stop won’t move and thus if hit will close the trade in profit anyway).
Another logical way to set protective stops is placing a stop depending on the market volatility at any given time. For this purpose traders use Bollinger Band tool which generates so called “corridors” around the price actions. The wider the corridor the higher is the activity on the market and vice versa. Measuring the width of the corridor (in pips) at the moment of entering the trade, Trader can easily set up protective stop out of the range of market fluctuation and thus protect himself from so called market “noise”.
When opening a new trade it is also important to calculate in advance how much you are willing to lose if the trade goes against you. Although everybody’s goal is to create the best working system, losses are inevitable and therefore being ready to tell where you will give up your trade and cut your losses is as important as starting any trading in Forex at all.
Calculating risks in each trade
It is a gold rule in Forex to know what are your risks and rewards in each trade. A serious trader will enter the trade only if risks are at least twice lower than potential rewards. E.g. risk/reward ratio required is 1:2. Some traders will only consider 1:3 risk to reward ratio to be worth trading.
Therefore, before pushing the button to open a new trading position, Trader should define level/point at which he will close the trade if it turns to be a losing one. Again, some trading tools like Fibonacci tool or Pivot Point studying can give an absolute clue where the profits could be taken and where to be prepared to close the trade. Having such information on the chart helps to calculate risks versus rewards prior to entering the trade.
If indicators you choose are simple and do not give such hints, simply know how much you can afford to lose and don’t forget to set stop loss order once in the trade.
Demo Trading own system to see if it works
After this long journey and fruitful research it is time to see if the system has a right to live.
Test, improve and finally write down the steps, settings and rules that will be used for trading. Once you have your system written, it is time for the big test.
Open a Demo account with any Forex broker that offers such accounts and Demo trade your system to see how well it will respond.
It is strongly recommended to do the demo trading for at least for 3 to 4 months. Among numerous reasons for that is that Forex market naturally has several periods during which its behavior may change dramatically.
For example, the market was trending well for several months while you were testing your system, then you make a decision to open a real account but the market decides to convert to its next stage and starts ranging, going sideways for indefinite period of time... You have not tested your system under such conditions and it would be very disappointing to discover that your system does not perform as well as it was doing during the trending market or is unable to bring profits at all... There are other reasons like experience and intensive practice that should motivate new traders to stick to Demo trading for a longer (sometimes up to several years) period of time.
Try next: set a goal of how much money you want to make trading Forex. Then try on your Demo account with honest trading and realistic account size achieve that goal. Once the task is accomplished, it might be the right time to think about trading with real money.
Good luck in creating your best Forex trading system!
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