The formal definition of a trading systems should be something
like: "A set of rules by which buying and selling of securities should
be carried out for the purpose of profit. The rules govern the behavior
of buying, selling, and possibly also trade management." The simplest
example of a trading system is: "Buy on the open and sell on the close"
you won't be making too much money with that one but your broker would
sure be happy.
Why are trading systems important? Well, if we just trade based on our gut instinct or don't have a sound strategy for exiting the market, we may fall prey to our emotions of fear and greed and make a possibly financially disastrous decision. Also, there is no way to empirically improve your trading if you don't have rules that can be modified to see if they yield better results over time. Other than that, if you would like to automate your trading so that a computer does all your trading for you and is watching the market when you cannot, it is necessary to first build a trading system. Finally, if you would like steady trading income, a system of some type is necessary.
Trading systems, by nature, have to consist of highly specific rules, which encompass most, if not all, possibilities. A more complex trading system could be "Buy when the 20 day simple moving average crosses up above the 50 day moving average and set a trailing stop loss of 40 pips. If three consecutive trades are exited with a loss, paper trade until a profit of >= 50 pips is made, then resume normal trading." It may seem to be quite complicated, but taken one rule at a time, it is possible to understand the system.
The first rule is to buy when the 20 day simple moving average crosses above the 50 day moving average. A moving average cross is one of the most popular trading systems. Its popular for a reason: It Makes Money. Also, you can build and test a moving average cross system easily in Excel without any programming. A moving average is the average of the previous n days. So, a 20 day simple moving average (SMA) is the average closing price of the previous 20 days and a 50 day simple moving average (SMA) is the closing price of the previous 50 days. Each SMA is calculated after the close, if the 20 SMA was previously less than the 50 SMA and after today's close it is now equal to or higher than the 50 SMA then a buy signal is generated. If the system is automated then the program enters the trade, if it is a manual system then the trader, upon seeing the signal will manually enter the trade at the open of the next day.
So, that is the entry, the exit is a simple trailing stop loss of 40 pips. A trailing stop loss automatically adjusts the stop loss (which is a trigger to exit a trade, commonly placed with the broker) so that it is x pips less than the highest level the security has reached during the current trade. So, for example if while trading you enter the market at 100 with a 20 pip trailing stop loss (stop loss when you enter is at 80) and the market rises to 110 (stop loss now at 90) and then falls back to 100 (stop loss still at 90) and then rises again to 130 (stop loss now at 110) and then falls to 115 (stop loss still at 110)... are you getting the picture? Trailing stop losses tend to be an aggressive exit strategy which means that using them often means giving up possible gains, but they are a good, simple strategy nonetheless.
The third rule is a bit more complicated and if you have not traded much with moving averages its purpose may not be immediately apparent. A moving average cross strategy tends to be the most profitable when the market is trending in one direction rather than trading in a small range. Therefore, if the market is range-bound between two levels and those levels happen to be near the point where the 20 SMA and 50 SMA cross, our system will produce a lot of false signals causing small losses (called "whipsawing").
Hence, the third rule, the purpose of which is to keep us out of the market should the market start to whipsaw. The third rule says that if three consecutive trades end in losses, which would occur when we enter and the market does not rise but falls and we exit at the stop loss, to stop trading in the market and essentially "watch" the market. If a buy signal is generated then you would watch the trade, if it ends up profitably by 50 pips or more then resume trading normally, else stay out of the market.
Trading systems are necessary to take your trading to the next level. A level where you can adjust and improve your trading success. It is through trading systems that you will also be able to establish steady trading income which may be just a little on the side or, with time, it may become your primary income.
Good luck.
Why are trading systems important? Well, if we just trade based on our gut instinct or don't have a sound strategy for exiting the market, we may fall prey to our emotions of fear and greed and make a possibly financially disastrous decision. Also, there is no way to empirically improve your trading if you don't have rules that can be modified to see if they yield better results over time. Other than that, if you would like to automate your trading so that a computer does all your trading for you and is watching the market when you cannot, it is necessary to first build a trading system. Finally, if you would like steady trading income, a system of some type is necessary.
Trading systems, by nature, have to consist of highly specific rules, which encompass most, if not all, possibilities. A more complex trading system could be "Buy when the 20 day simple moving average crosses up above the 50 day moving average and set a trailing stop loss of 40 pips. If three consecutive trades are exited with a loss, paper trade until a profit of >= 50 pips is made, then resume normal trading." It may seem to be quite complicated, but taken one rule at a time, it is possible to understand the system.
The first rule is to buy when the 20 day simple moving average crosses above the 50 day moving average. A moving average cross is one of the most popular trading systems. Its popular for a reason: It Makes Money. Also, you can build and test a moving average cross system easily in Excel without any programming. A moving average is the average of the previous n days. So, a 20 day simple moving average (SMA) is the average closing price of the previous 20 days and a 50 day simple moving average (SMA) is the closing price of the previous 50 days. Each SMA is calculated after the close, if the 20 SMA was previously less than the 50 SMA and after today's close it is now equal to or higher than the 50 SMA then a buy signal is generated. If the system is automated then the program enters the trade, if it is a manual system then the trader, upon seeing the signal will manually enter the trade at the open of the next day.
So, that is the entry, the exit is a simple trailing stop loss of 40 pips. A trailing stop loss automatically adjusts the stop loss (which is a trigger to exit a trade, commonly placed with the broker) so that it is x pips less than the highest level the security has reached during the current trade. So, for example if while trading you enter the market at 100 with a 20 pip trailing stop loss (stop loss when you enter is at 80) and the market rises to 110 (stop loss now at 90) and then falls back to 100 (stop loss still at 90) and then rises again to 130 (stop loss now at 110) and then falls to 115 (stop loss still at 110)... are you getting the picture? Trailing stop losses tend to be an aggressive exit strategy which means that using them often means giving up possible gains, but they are a good, simple strategy nonetheless.
The third rule is a bit more complicated and if you have not traded much with moving averages its purpose may not be immediately apparent. A moving average cross strategy tends to be the most profitable when the market is trending in one direction rather than trading in a small range. Therefore, if the market is range-bound between two levels and those levels happen to be near the point where the 20 SMA and 50 SMA cross, our system will produce a lot of false signals causing small losses (called "whipsawing").
Hence, the third rule, the purpose of which is to keep us out of the market should the market start to whipsaw. The third rule says that if three consecutive trades end in losses, which would occur when we enter and the market does not rise but falls and we exit at the stop loss, to stop trading in the market and essentially "watch" the market. If a buy signal is generated then you would watch the trade, if it ends up profitably by 50 pips or more then resume trading normally, else stay out of the market.
Trading systems are necessary to take your trading to the next level. A level where you can adjust and improve your trading success. It is through trading systems that you will also be able to establish steady trading income which may be just a little on the side or, with time, it may become your primary income.
Good luck.
Learn how to gain financial freedom through automated trading:
get my free report, The 5-Step Formula to Trading Like a Pro here
[http://powerupyourprofit.com/5-step_formula.html].
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