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)

Trend trader or swing trader?

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

A good methodology: swing trading

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

Example of swing highs/lows with strength 3

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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”

What about exiting after several Thrust patterns?

Thrust patterns as part of a trend

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: howardmarcfriend@gmail.com

WEBSITE: http://www.hf-systems.com

TWITTER: @Break_Retrace3