How to choose a trading system: sort the wheat from the chaff
Prices for financial instruments are moving in a completely unpredictable path. A trend doesn’t guarantee that the quotes won’t reverse at the next session, or that the price will reach a certain level.
The situation, when you can predict with a high probability the price rise or its drop for a certain instrument, is called a trading tactic. It is forecast, based on analyzing the fundamental events, when you know the market reaction to them in advance. For example, projections for macroeconomic indicators, when it is known in advance that the interest rate will be up, or the presidential elections, emerging some insider information.
A properly structured trading tactic includes:
- Entry/exit point. For example, buying an asset after the news release (or before);
- Direction of your trade (buy/sell);
- The rule of limiting losses – the price level where the position will be closed;
- The rule of profit-fixing or the way to follow your profit (moving take profit, to fix a part of it when the price rolls back in the opposite direction).
Friend or Foe
In the twenty-first century, a trader is challenged by a huge amount of information. Each broker, business publisher, blogger suggests millions of trading ideas, justified and unjustified predictions and offers.
The science of trading teaches traders to think for themselves instead of following someone else's tips. Experienced traders agree with it, as they don’t need to peep into other people’s minds. But what should a novice, not that experienced, be based on? When a trader lacks skills, they miss entry points, news releases; they don’t understand the levels and can’t yet make more or less accurate projections.
From the very start, a trader should find out a reliable source of trading ideas and tactics, like complete recommendations (entry/exit points, stop losses). It is better to look for recommendations, suggesting some training, which reveal and explain the facts that the analysts are based on to suggest a certain trading scenario.
If a trading system is properly described, it includes some educational elements, removes beginner’s responsibility for a trade, easing psychological tension, and so, helps understand new assets.
However, you shouldn’t blindly follow the tips, offered by an analyst or a company, right away. You must check the earlier analytics by historical data; analyze the efficiency of their recommendations. You should not take anything on trust, as the matter involves real investments. If you can’t check the accuracy of some forecasts, you can always find another “advisor”, as there are plenty of them in the world of financial markets.
“Fundamentals proved by Technicals”
Fundamental and technical analyses are often separated as two different sciences, though they are two halves of same thing. Nobody will study geometry separately from the mathematics; but traders often bet on either technical or fundamental analysis alone.
Both parties to the dispute about the advantages of one type analysis over the other provide some evidence of correct forecasts, based on just fundamental or technical analysis alone. In 90% of cases, ahead the important fundamental events, the price charts reach the technical key levels, and “important patterns” emerge.
One is impossible without the other. You should use this rule to test a trading idea. If it is based on fundamental analysis, the technical one will indicate the entry point; if – on technical analysis, the fundamental one will suggest the right time to enter a trade. If a trading idea is not double-proved (by both technical and fundamental factors) it is highly likely to be false.
Choosing from a variety of trading ideas
The term “trading idea” is applied to long-term and middle-term trading. The flaw of such strategies is little number of trades, and, accordingly, ideas.
To avoid sessions without any trading ideas, traders “increase the load”, extending the list of the instruments they analyze.
It results in multiple trading ideas at the beginning of the session, which can’t be all implemented within a certain deposit (not enough money) and so, they have to choose, which trades to enter and which ones to give up.
A simple criterion for choice is how well you know a certain instrument. Each trader has an asset, which they started trading with, tested different strategies and remember almost by heart its price moves in the quotes history. This knowledge will help you objectively assess what a trading idea is promising. So, your choice should be based on how well you know and understand an instrument.
Yearly highs and lows – market analysts and the financial press always note when some certain assets reach these “historical levels”.
As a rule, at such moments, quotes are likely to rebound; the price never reaches multi-year highs right away. These moments are rather rare. If your trading idea is associated with them, you’d better prefer it to other trades.
There are tactics for similar assets, corresponding to the same industry or type. For example, they can be major currency pairs, metals or energy resources (oil).
Traders should choose these tactics if:
- there is an arbitrage situation for closely correlated assets that suggests differently directed trades (sale of one and purchase of the other) after their price charts diverged (there was no correlation, the instrument prices were moving in the opposite directions before the positron is opened);
- trading idea suggests positions in the same direction for correlated assets. For example, when EUR/USD, AUD/USD, GBP/USD currency pairs are “sending buy signals”. The global link between the markets and the U.S. global economic influence can make the pairs that include the U.S. dollar reach the important levels simultaneously. This coinciding will be a kind of filter, proving the trade to be safe;
- trading idea emerged for an asset that is behind the leading one and suggests the “narrowing the gap”.
In any industry or type, there is a leader – a liquid instrument with a larger money turnover, compared to its “fellow assets” that follow its trend and direction.
For metals, it is gold, for currency pairs, it is EURUSD. A good example of how the idea about narrowing the gap works is the GBPUSD rate, which dropped deeper than other major currency pairs after the referendum on Brexit.
Trading tactic, based on insider information, which can substantially affect the market and has been learned by a trader before its official release, promises 100% advantage over the other.
Insider dealing is illegal and is thought to be a criminal offence in the entire financial world. However, a trader can learn this information legally, by means of analysis.
A real trading example is scalping on the central bank’s interventions. Having studied economic indicators of a certain country, assuming the intervention and the direction, a trader needs to wait with a “high volume in the market depth” for a signal to go ahead. While other traders will be wondering why the volume is high, that trader will make “deep” profits; the interventions are very quick, for a central bank usually aims at moving “the rate” as far as possible during a short period of time.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.