Building A Winning Trading System Howard Friend C.M.T
What should the trading system do?
- Provide a clear set of rules which dictate market entry and exit
- Income from winning trades will be much greater than losses from losing trades (net P & L)
- Losses should be kept to a minimum (small dips in equity curve)
- System should be compatible with the trader’s personality/psychology
- Must be 100% executable, fitting in with the trader’s time schedule
Profitable Trading Opportunities (PTOs)
What kind of movement should the system capture?
- 10 pips, 50 pips or over 100 pips on each trade?
How long should a position be held for?
- a few seconds, minutes, hours or several days/weeks?
The larger the required price move the longer the time taken (usually)
Full time or part-time trader?
- Can the trader devote all of the trading day to trading?
- ALL system trades must be taken (e.g. orders placed, cancelled, amended etc.).
- Cannot pick and choose which trades to take; nobody knows which ones will win/lose!
- Trading during the day is very time consuming and requires sharp focus and discipline
- If a system trader cannot take all system’s trades, may need a lower frequency system (end of day)
Swing trader
Buy or sell holding for 2 to 5 days
Almost unlimited number of trading setups to test:
- Wait for a pullback against the trend before entering in direction of trend
- Determine an overbought/oversold market before entering
- Enter on an expansion in volatility as this may determine start of trend
- Pattern recognition, e.g. candlestick/bar chart combinations
- Seasonal tendencies, e.g. day of week or month of year bias
The ideal price move
Make notes on specifics of an ideal move;
What did happen, what didn’t happen. E.g. could take note of the following:
- Distance from swing low to swing high in pips or percent
- How many consecutive closes in both directions?
- How many consecutive highs/lows in both directions?
Summarize the ideal price move and identify several on the charts
Identifying PTOs
Go through examples of ideal price swing and make notes on price patterns/indicator readings/seasonal
tendencies just before inception
- Was market overbought/oversold?
- Was market in a bull/bear trend?
- Did yesterday close up or down?
- Did yesterday close in the upper/lower half of the last n day range?
- Was yesterday an inside day, outside day, large range, small range?
- System should be based on a sound methodology – let’s consider SWING TRADING
Some definitions
- Swing high (H): the end of a move from a market low to a market high
- Swing Low (L): the end of a move from a market high to a market low
- An uptrend is defined as a series of higher swing highs and swing lows
- A downtrend is defined as a series of lower swing highs and swing lows
Objective of the swing trader
- To buy a) as close to a swing low as possible or b) to buy on the break of a swing high
- Once long, to exit as close to the swing high as possible
- To sell short a) as close to a swing high as possible or b) on the break of a swing low
- Once short, to exit as close to the swing low as possible
- We will build a swing high break/swing low break system (b)
Classification of swing highs/lows - The minimum number of bars to the left and right of the swing high is called its ‘strength’
- The more bars to the left and the right of a swing high/low, the more significant the level
- The higher the strength of a swing high/low, the larger swing one can expect to follow a break
Build a EUR/USD daily swing high/low system
- Let’s try going for the large multiday swings lasting 10-20 days
- Looking at the chart, buying/selling 8/8 strength swing highs/lows looks good
- Put down some initial trading rules
System building – first steps
EUR/USD 1 lot 8/8 swing high/low system, no stop, 10 bar exit.
LONG entry rule
“Buy 1 pip above the last swing high (8/8 strength)”.
LONG exit rules
“Hold the long position for 10 bars then exit on the close”
SHORT entry rule
“Sell short 1 pip below the last swing low (8/8 strength)”.
SHORT exit rules
“Hold the short position for 10 bars then exit on the close”
Having defined some good exit rules, let’s re-test the entry - Optimisation of swing high/low strength variables from 2 to 20
Howard Friend C.M.T.
E-MAIL: [email protected]
WEBSITE: http://www.hf-systems.com
TWITTER: @Break_Retrace3