FOREX SYSTEMS. WHAT ARE THEY?
Trading system is a method of forex trading that is based on forex indicators or
forex analyze to determine whether to buy or sell a currency. Forex systems can be
manual or automated.
Strategy or system – what’s the difference?
The words strategy, system, methodology most often are used interchangeably
and their respective meanings are whatever the individual trader ascribes to them.
However, in general, ‘strategy’ tends to refer to a discretionary approach to trading,
whereas ‘system’ tends to refer to a mechanical approach to trading.
In more details, a strategy involves the trader making all trading decisions
themselves, whereas a system involves deferring some or all trading decisions to
some kind of filter, often coded computer software. In some instances, the whole
trading process is completely automated.
Today let me speak about manual systems (and strategies).
There are basically 3 main time frames which one deals with holding currency in
forex trading. These are long term, medium term, and short term. Each has its
distinct advantages and disadvantages.
I would like to start with this classification:
Short-term forex systems (forex scalping forex systems),
Medium-term forex systems,
and Long-term forex systems.
Short-term forex systems
A short-term trader capitalizes on very small variations in rates that they expect
every day. The study of daily indicators, charts, and even time of day are a base of
the forex system for the short-term trader.
Forex scalping
Forex Scalping can also be called a quick trading.
It is a method where traders allow their positions to
last only for a matter of seconds, to a full minute and
rarely longer than that. (As a rule if a trader holds to a
position for more than a minute or two it is considered
no longer a scalping, but rather a regular trading.)
The purpose of scalping is making small profits
while exposing a trading account to a very limited risk, which is due to a quick
open/close trading mode.
Benefits for short-term forex system:
Quick realization of profits or losses due to the rapid-fire nature of this type of
trading.
Shortcomings for short-term forex system:
These forex systems very sensitive for spread, execution and dialer intervention.
Large capital and/or risk requirements due to the large amount of leverage needed
to profit from such small movements.
Medium-term forex systems
The most part of traders in forex trading are the medium-term traders. They need
less capital than the other types and have less risk, but their trading opportunities are
limited. Essentially this is exactly the same as a short-term position, but for a longer
period of time. With a medium-term position you do need to consider what both your
short-term and long-term positions are. Normally medium-term positions are seen as
being investments you have for one to two months.
Trading
A trader typically looking to hold positions for one
or more days, often taking advantage of opportunistic
technical situations.
The timeframes for this style of trading can be
different.
Benefits for medium-term forex system:
No sensitive for spread, execution and dialer intervention.
Low capital requirements as leverage is necessary only to boost profits.
Shortcomings for medium-term forex system:
Fewer opportunities because these types of trades are more difficult to find and
execute.
Long-term forex systems
A long-term trader demands large amounts of capital to cover daily fluctuations.
The forex system of a long-term trader will focus on fundamental (long-term) factors.
The investment period is usually for more than 12-months.
Trading
Open and hold positions for months or several
months.
Benefits for long-term forex system:
More reliable long-run profits because this depends
on reliable fundamental factors.
Shortcomings for long-term forex system:
Large deposit is required to cover volatile movements
against any open position.
In conclusion:
The long term trader will hold on to his currency for months or even years. The
short term position holder, sometimes known as a scalper, will be making quick fire
trades often exchanging currencies back and forth within a single day. The medium
term trader normally holds his positions for a few days or a week. The outstanding
value of the medium term option is that it requires the least amount of capital to
realize the most profit. Leverage is only needed to boost that profit, whereas in both
long and short term trading, it is needed to both guarantee the chance of profit and
protect the investment. For this reason the medium term option is normally
recommended for beginner traders. However, it is best to fully assess your financial
position and goals before deciding on your trading term and creating your forex
trading system.
And now few words about trend trading as the most popular with traders style of
trading.
Trend trading
Trend following is perhaps the most popular long-term
strategy in all financial markets. It is exceedingly effective and
profitable when the conditions are favorable, is quite
straightforward in its methodology, and there are many
individuals, past and present, famous or obscure, who have
used this strategy to success and riches. We should note that
the technical aspect of trend following is in fact quite simple,
but also that it requires, before everything else, discipline,
sound money management, and patience from the trader.
Trend following is not a short-term method, and patience and determination are as
important as correct analysis as a result. Sometimes trend trading is used for
medium-term trading.
Trends are created by powerful underlying economic factors which may not be
all that clear to those who are not very familiar with fundamental analysis. But the
simple patterns created by the price action in response to the economic events
can often be identified through methods that are easy to learn and apply. Thus, the
retail trader has as much potential of success as the most experienced analyst if he
can control his emotions and behave logically.
To apply this strategy we must first be aware of the existence of a trend. Without
identifying a trend we would be gambling, and that’s not the purpose of trading forex.
Both fundamental and technical analysis can be employed for identifying a trend,
and both of them have their advantages and drawbacks.
Fundamental analysis
*Fundamentals – The underlying elements affecting
the economy of the subject is studied by Forex
fundamental analysis. According to this method, the
analysis of economic indicators, social factors and
government policy of a business cycle can forecast price
movement and trends of the market.
It considers how political and economical events influence currency market.
Usually many factors are extremely important – economic indicators, social factors,
government policy and macroeconomic factors as growth rates, interest rates,
inflation, unemployment level and others.
Fundamental elements of the economy are:
• The Business Cycle
• Inflation
• Deflation
• Gross National Product (GNP)
• Indicators of the Business Cycle
• The business cycle's effect in Forex
• Monetary Policy
• The activity of the Federal Reserve System (FRS)
The fundamentals of any country, multinational industry, or trading bloc lie in the
combination of factors like social, political, and economic influences. However, it is
rather hard to stay aside from all these variable factors. Therefore, the sphere of
complicated and subtle market fundamental lets the explorer know and understand
more details of a dynamic global market during the analyzing.
Technical analysis
A method of evaluating securities by
analyzing statistics generated by market
activity, such as past prices and volume.
Technical analysts do not attempt to measure
a security's intrinsic value, but instead use
charts and other tools to identify patterns that
can suggest future activity.
Technical analysts believe that the
historical performance of stocks and markets
are indications of future performance.
Technical analysts make a few key assumptions:
• All market fundamentals are reflected in price data. Moods, differing opinions,
and other market fundamentals need not be studied.
• History repeats itself in regular, fairly predictable patterns. These patterns,
generated by price movements, are called signals. A technical analyst's goal is
to uncover a current market's signals by examining past market signals.
• Prices move in trends. Technical analysts believe price fluctuations are not
random and unpredictable. Once an up, down or sideways trend has been
established, it usually will continue for a period.
It is in general a good idea to use a combination of fundamental and technical analysis
for deciding on the trend’s character, and deciding on entry and exit points.
Trend reversals while trend following trading
It is a fact that if you make a sizable commitment in either direction and the
market fails to act in the anticipated manner, the losses could be sizable. But while it
is true that timing the markets in the short-term can be dangerous and
counterproductive with respect to the acquisition of prudent and conservative trading
techniques, it is possible to take advantage of certain events in such a way that a
reversal in a long-term trend can be recognized in time to allow the prevention of
losses, and maximization of profits.
The exact beginning or end of a trend may not be evident, but it is still possible to
time it for optimal results. What should the trader consider?
1. Interest Rate:
Forex trends follow the dynamics of interest rate gaps. It
is generally understood that directions of forex trends
coincide with the direction of interest rate policies of the
central banks involved.
Two considerations must dominate the validity of interest
rate reversals before traders determine if the change is tradeable or not.
First, is the central bank following its own wisdom and analysis in changing the
course of policy, or is it obeying the dictates of the market.
Second, if the central bank follows the prevailing trend in its group, or is it taking
an isolated course for whatever reason. If the central bank is being forced to change
policy direction by market events, or other factors, the trend reversal generally
possesses a lower degree of trading ability, because such decisions can often prove to
be counter-productive in the longer run. The bank may also be responding to internal
conditions that are isolated, at least for the short term, from external developments,
which could justify the independent course of monetary policy. But it is equally
possible that a policy error is being made, which could signal a false trend change.
2. Interventions:
Interventions fall into the two categories of coordinated,
and isolated. If a central bank is intervening in the currency
market, for whatever reason, there is a good chance that the
behavior will lead to a trend reversal, at least for a period of a
few months. The criterion that will help to isolate false signals from reliable ones is the
relationship between external trends, and the policy direction of the central bank.
An example of central bank intervention that goes against the overall trend is the
2010 Euro purchasing program of the SNB, which failed to reverse the appreciation
trend of the CHF since it was initiated in isolation and went against general market
consensus. An example of a successful central bank intervention is that of the
RBNZ(Reserve Bank of New Zealand) in 2007, which in fact precisely marked the
reversal point in the NZDUSD pair. In that case, the RBNZ policy was in positive
alignment with general USD appreciation and risk aversion trends soon to emerge,
and proved to be highly successful.
3. Bubbles:
Bubbles are harder to identify, but offer the greatest
short-term potential among these categories. They are
easiest to trade when they burst, but because of the high
volatility that follows the breakdown, it is difficult to be sure
that the bubble is really finished.
The rule of thumb in exploiting bubbles for identifying trend reversals is keeping in
mind that the longer they last, the faster and the more violent they crash. The
greatest advantage in trading them is the fact that they almost always come with
warning signs, since bubbles easily outlast the end of the fundamental conditions that
created them in the first place.
Let me also provide you with the FAQ in order to explain
the principles of TREND TRADING. It is shown as a dialogue
between the Trader and the Beginner
B: I have heard about trend following method. How should I trade?
T: You must first choose whether you want to employ technical or fundamental
analysis for your method, or a combination of both.
B: Is there a difference between these methods?
T: Yes. Fundamental analysis can provide you with information which can predict
the strength and length of a trend, while technical analysis can show you how it
develops. Fundamental analysis is more reliable than technical analysis in defining a
trend that has long term potential, but without technical analysis it would be
extremely difficult to decide when or how to trade. Technical analysis can suggest the
beginning of a trend, but it’s unlikely to tell much about the length or strength of the
same. Thus, I suggest that you use both technical and fundamental methods for
your trend following strategy, with fundamental factors eliminating the false signals of
technical analysis, and technical tools providing you with a time-price frame for
deciding on entry points.
B: How do I decide on the existence of a trend?
T: There are many technical tools that can signal, but there are an equal number
of false signals generated by them. Remember that there are only three kinds of
trends that can exist at any time: flat, up or down, and it is possible to speak of
trends between any two points on a price chart. Simply take two random points on a
chart, draw a moving average on it, and the pattern that arises can be analyzed as a
trend. Thus it is always necessary to have at least a basic of understanding of the
economic factors that can create trends, before deciding on the validity of a chart
pattern.
B: What kind of price pattern would create a trend?
T: The trend for trading is different from random fluctuations, range patterns and
similar price movements in that the price itself, in the absence of any technical
indicator, can still be recognized as showing a trend. Depending on the type of the
trend (that is, an up- or downtrend), successive highs and lows should constitute a
rising or falling pattern, with relatively few irregularities. So, you should be able to see
the “general” direction. But such a case is often a rarity, and the trader will have to
back his technical patterns with conviction that can perhaps only be gained through
fundamental analysis.
B: If the trend can be identified visually, why use technical tools?
T: Even though we can notice the existence of a trend, we still need technical tools
to trade it, and time it. Market timing never works when one is trying to predict
reversal points on a technical basis. However market timing in the context of a trend,
with the purpose of picking the counter-trend extremes, and using them to enter a
trade, is necessary and profitable.
And there lies the main principle of a trend following strategy:
Recognize the trend, identify counter-trend moves, and use them to enter
a trade in the direction of the trend.
B: How long should the trend follower hold his position?
T: As long as the fundamental reasons that back the trend are dominant. If the
trader cannot identify those reasons, if he’s unwilling to do so, or if he doesn’t believe,
for some unfathomable reason, that they are useful, he can use technical patterns to
time his exit point. Even if the trader is aware of the fundamental factors, and is able
to evaluate them correctly, technical analysis can still provide him with a very useful
early warning system. If the price action is suggesting strongly that there’s some
error in the trader’s fundamental outlook, he can use the technical signals as an
occasion to reevaluate and reexamine his fundamental picture.
B: How do I time my trade with technical analysis?
T: The best tools for trend following are supplied by moving averages and
simple price charts. Bar charts, candlesticks and many others can be equally useful
if employed with moving averages. It is also possible to use moving average
crossovers, and myriad other methods, but whichever you choose to use, you should
ensure that you do not complicate the main aspect of your strategy, which is trend
following.
B: Which time frame do you recommend for the moving average?
T: If you want to trade on a weekly or daily basis, the 100-day MA will probably
be able to capture most of the important trends. Anything with a longer period is
likely to be meaningless because of too much data discarded, and any time frame that
is too much below the 100-day period may be too sensitive to price action. But as
usual, one can use other timeframes below 100, provided that he doesn’t clutter his
screen with lots of indicators, charts, tools.
B: When trend following, where should I place my stop-loss and take
profit?
T: This partly depends on the term and nature of your trend following method. A
stop-loss order can be placed a short distance above or below the trend line,
whether it is provided by the moving average, or a simple line drawn on the chart.
Though, there is an opinion that the trend follower should not take his profits until
he has a good reason to do so. The purpose of this strategy is to focus on underlying
price dynamics by stripping out volatility and short term movements, and there is
little logic to realizing profits in response to fluctuations which are irrelevant to the
main action of the trend.
B: But I still have to take profit at some point. When?
T: Go as far as the trend goes, then stop. You can use the MAs to decide on that,
but it’s far better to identify the fundamental causes behind a trend, and then to exit
the trade once those reasons are eliminated.
In conclusion
To sum it up, I would like to remind you that trend
following is the easiest and most straightforward way of
making money in the forex market. As traders say The trend
is your friend.
But successful trading requires the foresight provided by
analysis and the patience that only comes with confidence.
If you are a novice trader you are probably aware that you would need to find your
own trading system to suit your trading style. And this involves a lot of hard work as
you need to find and learn the information about the rules and principles of Forex
Trading, to search and try many different trading strategies in order to understand
how they work.
Only then you would definitely feel what is trading for you, what are your
preferences. You would be able to choose the “right” system among hundreds or even
create your own strategy to reflect your trading style and to meet your special
demands.
The more systems you analyze the more experienced trader you became. The
more strategies you learn the more profitable your trading is. A wise man is strong,
a man of knowledge increaseth strength.
Forex can be learnt. It just takes time.
Please do not be afraid to spend you time learning it. It is essential to understand
and forecast the events, to “read” the economic news in terms of Forex, to be a bit
“intuitive”. To sum up, the perfect combination for the trader is to have analytical
skills along with some intuition and confidence.
by : Rita Lasker
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