Creating a Robust Forex Trading System - Part 1

01/29/2014 9:00 am EST

Focus: FOREX

Trading systems are vital for traders in the forex markets because they allow unemotional trading, free from the psychological perils of overtrading, loss-chasing, and self-sabotage, writes the staff at FXTM.

It’s true that there are lots of trading systems already floating around the forex markets but there is still room for more. For one thing, many trading systems are built around popular indicators that everyone knows, such as moving averages and Bollinger Bands. It’s, therefore, a much better idea to come up with your own unique indicators and patterns. That will make your system different from the rest and therefore, hard to beat.

1. Search the Data
The first step in creating a robust trading system is to look over past trading data. Scan price charts over different time horizons and conditions. Check different markets and try to look for patterns that you think you might be able to take advantage of. Try out different indicators and see whether they are able to predict market turns or trends as well.

For example, you may have noticed a pattern in your trading that one of your markets e.g. EUR/USD, always advances during the last hour of trading. Look through the charts and see if this is the case and then start thinking of ways you can get that pattern programmed into mathematical code. Once it is on paper as code you’ll be able to test it objectively on past data.

2. Create an Indicator
Once you’ve found a pattern you think will make money, turn the idea into mathematical code in the form of an indicator. At this point there’s no need to give the indicator a fancy name and it doesn’t matter how simple it is. If your pattern is based on a traditional indicator, then you can just as easily use that too.

3. Optimize
Now you have your indicator, you can start testing it on historical data. You need to start with some very crude and rough tests so that you can see if the indicator is of any worth. Most of the time, the indicator or pattern you’ve designed will look good during some time periods and fail over other periods. Nevertheless it’s important to test very roughly at first in order to come up with a system that is robust enough to cope with changing conditions.

Plot the indicator on your price charts and run some backtests. Next, try optimizing different parameters and see how they perform. For example, see how different moving average lengths affect the performance. Keep focusing in on the parameters until you find an area where the system works best, i.e. it produces the most profit for least risk. Tomorrow, we’ll talk about the next three steps.

By the Staff at FXTM

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