Given the importance of trading systems in Forex, let‘s cover what
trading systems actually are and what the benefits of defining a trading
system as a part of a comprehensive trading plan are. In addition,
we’ll show you a simple Forex trading system that works, based on
high-probability price action setups on higher timeframes. Lets get
started.
What is a Forex trading system?
A Forex trading system is a set of rules which define how youre
trading the market. It should include all important points which could
potentially affect your trading performance, such as a complete set of
rules for identifying trade setups, risk and money management
guidelines, types of analysis in changing market conditions, and a way
of managing your open positions.
A well-defined trading system is like a road map for the financial
market. Without a map, you would likely be lost in the wilderness of
erratic price movements and place trades based on emotion, rather than
your ratio. Since trading is a highly analytical discipline, hitting the
market without a map doesnt seem like a wise decision.
Benefits of having a trading system
Besides the set of rules which define all actions taken on the market,
having a trading system also has some additional advantages which
cannot be neglected. First and foremost, trading on strict and detailed
rules as a part of a trading system prevents you from placing emotional
trades and increases your discipline.
Emotions, such as greed and fear, are well-known enemies of rational
trading which often attack beginners – mostly those who dont have a
detailed trading plan. As a result, greed and fear interfere with your
trading decisions and cause you to chase the market for trading
opportunities, even if no setups exist. Your mind will try to convince
you to take a trade in the hopes of obtaining potential profits, without
taking into account the risks associated with the trade. Fear, on the
other hand, often leads to closing a profitable position too early and
letting your losers run, in the hopes that the price will reverse to
break even. When using a trading system with strict rules, these
mistakes can be easily avoided.
Trend-following trading system on higher TFs
One of the best Forex currency trading systems are trend-following
systems which aim to take trades only in the direction of the underlying
trend. This way, riskier counter-trend trades based on price
corrections can be avoided, and price corrections are only used to enter
with a market order when prices are relatively oversold during
uptrends, or relatively overbought during downtrends.
This system uses higher timeframes, such as the 4-hour, daily, and
weekly timeframes, and utilises a multi-timeframe analysis to identify
the overall market trend.
Chart patterns are also an important part of the system, since these
patterns are often used to find tops and bottoms of trends and to
identify potential trend continuations.
To enter with a long position, all three timeframes (weekly, daily,
and four-hour) need to align and to show an uptrend. This might require
some experience, as some of the timeframes may contradict each other,
even though the overall trend is still intact.
1) The weekly timeframe needs to form higher highs and higher lows
during uptrends, and lower lows and lower highs during downtrends. The
weekly timeframe is only used to identify the overall trend in a
currency pair, not to spot entry and exit points. 2) The daily
timeframe needs to show a tradeable setup, based on price action tools
such as channels, trend lines and chart patterns. All of the tools
should confirm a trade in the direction of the overall trend, as shown
on the weekly timeframe. Fibonacci retracement tools also play an
important role in this system, as we want to buy low and sell high.
Multi-timeframe analysis is extremely important, as an uptrend on higher
timeframes may look like a downtrend on shorter timeframes.
If the daily chart is in a downtrend, but the weekly shows an uptrend,
make sure to draw a Fibonacci retracement tool to identify the potential
levels where the correction might end on the daily timeframe.
Everything between the 38.2% and 61.8% Fib retracement levels can be a
good point to enter in the direction of the overall trend.
3)Finally, zoom-in to the 4-hour chart to find potential entry and exit
levels for the trade, as well as stop loss levels. Recent swing highs
and swing lows, horizontal support, and resistance levels, channels, and
trend lines (from the daily timeframe) can all point to levels to enter
into the trade. Since a complete trading system also factors in risk
and money management, make sure that your trade setup returns a
satisfying reward-to-risk ratio of at least 1 or preferably higher.
