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SERIES OF Q&A ABOUT TRADING SYSTEM
What is a Trading System ?
A trading system (TS) is a set of instructions which advise opening or closing trading positions based on the results of technical analysis. A trading system allows to exclude randomness in the trading process. Strict adherence to the system permits to rule out the emotional factor in the trade. For this reason, one must follow all recommendations of the system strictly even if for all that a potentially profitable position will not be opened.
The first thing you need to do when creating a trading system is to select time periods, or working timeframes, you will work with. A lot of restrictions in this respect come from the starting deposit and principles of capital management. Long-term periods are accompanied by lesser "financial noise" than shorter periods. Technical analysis performed for long term periods is more accurate and provides a lesser number of false incitements. Long-term periods are preferable in terms of successful working, but, however, they require a larger starting deposit. Shorter timeframes are characterized by greater noise, but, hence, the technical analysis is less accurate and gives out more false signals.
In cases of a modest starting deposit, it is not recommended to direct one’s attention in trading to long timeframes, it is better to try medium and short ones first. On longer time periods price fluctuations are not as evident, but, in fact, these fluctuations may be significant enough so as to "eat up" the entire starting deposit. Thus, the first restriction for the trading system is the starting deposit that determines the choice of the working timeframe. Please bear in mind that the settings of analytical instruments for each of the periods are to be selected individually. Besides, if performing analysis for short timeframes, the requirements to the analytical instruments have to be as exacting as possible.
The second task of the trading system is to define the entry point with the help of technical analysis. In any TS, irrespective of analytical instruments, the analysis must be started from a large timeframe and pass gradually to shorter ones. The first thing to be defined is the current market conditions as a whole.
For instance, if our trade is guided by the trend, we first determine the global trend. Even if a signal to buy comes at the time of a downward trend, a position should not be opened in such a trading system.
After that, the market conditions for periods of lesser order are analyzed. Eventually, the working timeframe is analyzed. If there appears a signal confirmed on long timeframes, one can open position immediately. However, to define the optimal entry point one can perform additional analysis on shorter timeframes.
The most important task of TS’s is to determine the exit point. Any system must provide not only the signal to open a position, but estimated levels of profit, as well. Order Take Profit should be placed next to this level. It is also necessary to identify the level of stop loss for the case when the market starts to move in an opposite direction. Place the Stop Loss order at this level. In other words, the TS must define exactly, up till which level the position should be held open in order to receive maximal profit, and define mechanisms for loss stopping in case of an unfavorable development of the market.
TO BE CONTINUED-------
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