What is a Forex Trading System and Why You Need One?

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Just like in any business, you must have a forex trading system to trade the forex markets. Without planning daily activities, such as writing down your grocery list or planning your gym session, you’ll have no idea of what to do next which leads to lower results than expected.

The same applies to trading. If you’re serious about improving your trading results and being successful in the long run, you’ll need a written plan which contains the main rules you need to follow in trading. This is called a trading strategy, and is part of a forex trading system which also includes anything from your trading style, money and risk management to keeping a trading journal. You can also include something else that you think deserves its place in your forex trading system, in order to be more successful in your trading.

1.Psychological Factors in Trading

It is worth emphasizing that the most important part of development your forex trading system is Psychological Factors,it makes up at least 60% of your overall trading system,then money management it taken 30%,the last 10% is your own trading strategies(last,but not least).

First of all, you must be responsible for your trade,the market doesn’t owe you anything. One of the largest mistakes new forex traders make is to chase the market after a loosing trade, in order to bring the lost money back. Unfortunately, trading doesn’t work that way, and many of those traders will end up losing even more or blowing their entire account.

Having a well-rounded forex trading system will avoid making trading mistakes like this.Your forex trading system contains all rules you need to respect when taking a trade, such as your position size, stop-loss level, trading strategy, and money management guidelines. In the end, you’re always responsible for your trade, and remember that the market is neither moral nor unmoral – it’s amoral. Don’t chase your trades, because there are many trading opportunities on various currency pairs throughout the week.

2.Why Trading Discipline is Important for Success

New traders to the forex market get a feel of joy with a few profitable trades in a row, and think that having a strict trading strategy is not necessary for success. The truth is that discipline is key to be successful in the long run, and a trading strategy helps you achieve exactly that – discipline in trading. Have you ever seen a professional athlete preparing for the Olympic Games, without a training plan that they rigorously follow? Traders need a strict trading strategy if they’re serious about trading.

You may have a few profitable trades without a strategy, but your money and risk management, entry and exit rules are likely to suffer, and without keeping a trading journal you’ll not know what you do correct and where you need to improve.

All the rules in your trading strategy are there to avoid emotional trading. Emotions such as greed or fear are the biggest enemies of traders, and I’ve seen too many of them blowing their account because they didn’t have strict rules set in their trading strategy. A profitable trade triggers a dopamine rush in your body, and most newbie traders feel invincible if they get a few profitable trades in a row. Unfortunately, most of them will significantly increase their risk per trade afterwards, and lose all their gains with a single losing trade. In order to avoid all the mentioned mistakes, let’s see the main points you need to have in your forex trading system.

  • Know Your Trading Style

Your trading style will be defined to a large degree by your trading system. There are three major trading styles in the forex market: scalping, day trading and position trading. Day traders are further divided into swing traders and breakout traders. All mentioned trading styles differ in some way one from another, and the trading style you choose should reflect your psychology in trading, time you have to invest in managing your trades, number of trades you take during a certain period etc.

Scalping is fastest trading style, and is based on trading many trades which are held from a few seconds to a few minutes. Scalpers need to spend a lot of time in front of their computer to look out for trading opportunities and manage their trades.

Day traders hold their trades from intra-day to a few days, and usually close all their positions with the end of the trading week at Friday. Many forex traders are day traders, as it combines the benefits of taking a reasonable number of trades without the need to spend many hours in front of the screen.

Position traders hold their trades for a long period of time, usually for a few months to even years. These trades are based on fundamentals of the currency they trade, but require only a small amount of time to manage their trade.

Various factors will determine which trading style suits you best, such as your amount of time, trading goals and risk profile, and the main points of your trading style should become a part of your overall forex trading system.

  • How to Choose the Right Trading Strategy?

Your trading strategy is the cornerstone of your forex trading system. A trading strategy defines how you analyze the market, when to enter a trade, and where to put your stop-loss and take-profit levels. One of the mistakes that beginners make in trading, is jumping from one strategy to another in hope to find the “holy grail” in trading. Unfortunately, these traders will never find a trading strategy that suits them, as they have unreasonable expectations from the market.

Begin with choosing one strategy that suits your trading style, and spend a certain period of time trading with it. You’ll need to embrace all its strengths, and try to improve its weaknesses over time by correcting or adjusting the exit rules(enter rules not as important as you think,but you must know when cut off a failing or end a profitable deal) and the size of the position. A trading journal can help you a lot with this endeavor, as will be discussed later in this article. One of the most important rules of a trading strategy is determining the stop-loss and take-profit levels of your trades.

  • Where Should You Exit Your Trades

The stop-loss level of a trade is where you will exit the market in case the price turns against you. It’s mandatory to always have a stop-loss level in place! There are a few types of stop-losses, such as

  1.  percentage stops,
  2. volatility stops,
  3. chart stops
  4. time stops.

A percentage stop is a stop-loss which is set at a predetermined percentage level of your account, such as 1% of your account size. Volatility stops take into account the average volatility of the currency pair you trade, and time stops are set to exit the trade based on a period of time, such as after the London session closes, or after the finish of the trading week. We separated these types of stops from chart stops with a reason, because these stops don’t take into account the market environment and should generally be avoided.

A chart stop, on the other hand, takes into account the market environment and price-action of the currency pair, and is usually set at major support & resistance lines, trendlines, at recent swing highs and swing lows etc. These types of stops will generate the best results in the long run, and should be well-defined in your forex trading system.

Similar to your stop-loss, the take-profit should also be based on price-action and the characteristics of your trading strategy. You can place your take-profits at support and resistance zones, swing highs and lows, taking into account chart patterns or other price-action levels.

  • What Position Size You Should Take

The position size you take determines your overall risk and potential profit of your trade, making it a very important aspect of your trading strategy and overall forex trading system.

Fortunately, there is a simple rule that helps you to determine the perfect position size for your trade in a few steps.

Step 1: Calculate your risk level. Let’s say you don’t want to risk more than 1% of your trading account on a single trade. If your account size is $10,000, this means that you will not risk more than $100 on one trade.

Step 2: Determine your stop-loss level. By using a chart stop, you found a good price level where you could place your stop-loss order. This level is just below a support line, as you intend to enter a long position on the currency pair. Your stop-loss level is 50 pips away from your entry price, and this will be the main information used to determine your position size.

Step 3: Calculate your position size. Now that you know that your stop-loss order is 50 pips, you can easily calculate your position size. Remember that you aim to risk no more than 1% percent of your account, which equals $100. By dividing your money at risk with the stop-loss level in pips, you will get the pip-value of the position size you should take. $100 / 50 pips = 2$ per pips, or 0.2 lots. Your position size should be 0.2 lots.

The way you calculate your position size should be a part of your trading system, in order to have written rules to which you stick all the time.

  • The Importance of Reward-to-Risk Ratios in Trading

Your forex trading system should also define the reward-to-risk ratio of your trades. A reward-to-risk, or R/R ratio, is the ratio between your risk and potential profit. Taking the example above, if your trade has a 50-pips stop loss, and you put your take-profit 50 pips away from your entry price, your trade will have a 1:1 reward-to-risk ratio. Putting your take-profit level 150 pips away from your entry price, will increase your reward-to-risk ratio to 3:1.

 

The reward-to-risk ratio is an important concept in trading, as it defines how much losing trades and winning trades you can have to stay at the breakeven point – that is, neither losing nor winning money. If you take trades with a R/R ratio of 1:1, you can have 50% losing trades and 50% winning trades to be breakeven. But if your trades have a 3:1 R/R ratio, you can loose 3 trades and have just one winning trade to be breakeven. As you can see, trades with higher R/R ratios are a better choice than trades with lower R/R ratios, but have in mind that the price will need more time to hit your take-profit if it’s put too far away, or not hit it at all in the worst case. A reasonable R/R ratio you should aim in trading is 2:1 or 3:1 at most.

3.The Benefits of Keeping a Trading Journal

Now that you have included all the main points mentioned above in your forex trading system and developed your trading strategy, it’s time to keep track of your performance and spot your weaknesses over time in order to improve them. This can be done with the usage of a trading journal.

A trading journal contains all the trades you make over time. A journal entry should contain at lease the entry price of your trade, its stop-loss and take-profit level, the entry trigger (based on your trading strategy), the date and time you took the trade, the position size and the outcome of the trade.

It’s important to occasionally make a retrospective of your finished trades. This way, you’ll be able to identify what worked and what didn’t, where the weaknesses of your trading strategy are and what you can do to improve your trading results. Remember, traders need to keep a trading journal to improve their performance over time.

Conclusion

In this article, we provided you with a detailed overview of what a forex trading system is, what it should contain and how you can improve your trading with the help of a forex trading system. A forex trading system should be concise and comprehensive, providing you with well-defined rules to base your trading decisions on. This way, traders can avoid that emotions interfere with their trading decisions, as all entry and exit rules (and more) are already contained in their forex trading system. Of course, just having a forex trading system will not do much for your trading performance if you don’t follow it rigorously. In addition, keeping a trading journal will tremendously help you to identify where you need to improve your trading, and which trading decisions have led to the most profitable trades.

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