Forex Trading Systems Types of Trading Systems

There are basically two types of Forex trading systems, mechanical and discretionary systems. The trading signals that come out of mechanical systems are mainly based on technical analysis applied in a systematic way (technical indicators, chart patterns, etc).

On the other hand, discretionary systems use experience, intuition or judgment on entries and exits.

Which type produces better results? Or more importantly, which one better fits your trading style?

In this section, we will try to answer the question above. We will first analyze the pros and cons of each system approach.

Mechanical Systems

Advantages

• This kind of system can be automated and backtested efficiently.
• They have very rigid rules. Either, there is a trade or there isn’t.
• Mechanical traders are less susceptible to emotions than discretionary traders.

Disadvantages

• Most traders backtest Forex trading systems incorrectly. In order to produce accurate results you need tick data.
• The Forex market is always changing. The Forex market (and all markets) has a random component. The market conditions may look similar, but they are never the same.
• A system that worked successfully in the past doesn’t necessary mean it will work in the future.

Discretionary Systems

Advantages

• Discretionary systems are easily adaptable to new market conditions.
• Trading decisions are based on experience. Traders learn to see which trading signals have a higher probability of success.

Disadvantages

• They cannot be backtested or automated, since there is always a decision to be made based on judgment.
• It takes time to develop the experience required to trade successfully and track trades in a discretionary way. In the early stages this can be dangerous.

Now, which approach is better for Forex traders?

It is advisable to always start trading a mechanical system, as you gain experience, you will realize which signals produce better results but this requires time and experience, so start first with a mechanical system. Another point you should take in consideration is if you are a trader that finds it hard to follow your trading signals, then you are better off using a mechanical system, where your judgment won’t play an important role in your system. You only take the trades that your system signals.

If the psychological barriers that affect every trader (fear, greed, anger, etc.) puts you in unwanted scenarios, you are also better off trading mechanical systems, because you only need to follow what your system is telling you, go short, go long, close a trade. No other decision has to be made.

On the other hand, if you are a disciplined and experienced trader, then you are better off using a discretionary system, because discretionary systems adapt to the market conditions and you are able to change your trading conditions as the market changes. For instance, you have a target of 60 pips on a long trade, the market goes up quickly reaching 50 pips in your favor in a few minutes, allowing you to change the target level to 100 pips. These kinds of decisions are nice to adapt once you have enough experience, however it could be dangerous at early stages.

Does it mean that trading a discretionary system has no rules? This is absolutely incorrect. Trading discretionary systems means that once a trader finds his/her setup, the trader then decides what to do. But every trader still needs certain rules that need to be followed, such as the size of the position, conditions that have to be met before thinking to get into the market, and so on.

Whether you choose to be a discretionary or a mechanical trader there are some important points you should take in consideration:

1. You need to make sure the Forex trading system you are using totally fits your personality. Otherwise you will find yourself outguessing your system (develop it yourself).
2. You also need to clearly define your rules and most importantly have the discipline to follow them.
3. Take your time to build the perfect system for you. It is not easy and requires time and hard work, but in the end, if done correctly, it will give you consistent profitable results.

Forex Trading,Some Points to Take in Consideration

Here are some important points you need to take in consideration while creating your trading system.

1. Always be skeptical about your own ideas, focus only on results. Sometimes is easy to track trading opportunities, what is hard is to capitalize on them and make money from them. The performance of any trading system should be measured with actual trading (either demo or an account with limited funds).

2. Sometimes you lose even when you have followed your system to the rules. Losses are part of the game, there is no possible way to avoid them, and we need to learn to lose. So if you have followed your system 100% and took a loss, celebrate it! The only way to stay ahead of the game is by rigorously following your system.

3. Sometimes while trading large positions you can lose control of your emotions. Don't be overly aggressive with the market and follow a well planned money management technique. It should tell you what you are going to risk on your next trade.

4. Try to understand why your system works, this way you will develop the required confidence in yourself and your system.

5. There will always be some “indicator” that could have kept you out of a losing trade. But remember your system is not designed to win all your trades, but to win most of them.

6. When you finally created your system, describe it in simple and logical terms. If a 15 year old kid is not able to understand it, then something is wrong with it.

7. Use only 2-3 indicators: one indicator to identify the trend and one or two indicators or variables for entries and exits. The more indicators you use, the more complicated your system becomes. Most of the time “the simpler the system the better performance it will have”. Also use non-correlated indicators, do not choose two indicators that are supposed to measure the same market condition.

8. Test your system over large data samples (over 50 trades) and in various market conditions, this way you can see under what conditions your system works better.

9. If you decide to trade several currency pairs, try non-correlated pairs. For instance, if you trade long the Euro and long The Pound, your are likely to get the same result on both of them, elevating your risk if the market goes against you.

10. News trading? Determine whether you are going to keep your trades open during important news announcements. If you are trading for the short term you are likely to keep tight stops, and an important news announcement might hit your stop loss level.

11. While you are in a trade, open your mind to every possibility, sometimes you don't see or ignore evidence against your trade.