Getting Started with Trading Systems

What Is a Trading System?

A trading system is a defined set of rules and conditions designed to generate buy and sell signals without requiring human intervention. These systems follow a consistent and objective process to make decisions based on historical data, technical indicators, or market patterns.

As technology continues to advance, the trading industry evolves in parallel. Since the early 2000s, automated trading has experienced exponential growth. What was once exclusive to hedge funds and financial institutions is now accessible to retail traders worldwide.

With just a personal computer and an internet connection, modern traders can access hundreds of global financial markets — and even build their own automated trading systems with relative ease and minimal cost.

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Introduction to Trading Systems -The Two Approaches

 

While there are many ways to categorize trading systems, two primary approaches stand out:

1. Model-Based Systems

These systems are built on predefined rules and assumptions about how markets behave. For example, they might include:

• Technical indicators (e.g., Moving Averages, RSI, MACD)

• Price action patterns (e.g., breakouts, reversals)

• Trend-following logic

Model-based systems are relatively easy to implement and are often used by both beginners and experienced traders.

2. Data-Driven Strategies

These strategies rely on large datasets and machine learning models to identify patterns that may not be visible to the human eye. They often require:

• Access to historical and real-time data

• Strong programming skills

• Computational resources (e.g., Python, R, cloud computing)

While data-driven approaches are powerful and often used by quant funds or algorithmic trading firms, they are generally more complex and resource-intensive than model-based systems.

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Why Focusing on Model-Based Systems?

For most retail traders, model-based systems provide a practical and efficient way to begin automating their strategies. They are:

• Easier to understand and build

• Faster to test and deploy

• More affordable in terms of tools and resources

Whether you're coding your own Expert Advisor (EA) in MetaTrader or using drag-and-drop platforms like EA Builder, model-based systems offer a gateway to consistent, rule-based trading.

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The Key Questions to Ask When Building any Trading System

 

A robust trading system should be more than just a set of rules — it must serve as a decision-making framework that answers the following seven questions. These questions help ensure that the system is adaptable, risk-aware, and strategically sound.

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1. What Assets or Markets Should I Trade?

The first decision involves identifying which markets or financial instruments to include in your strategy — Forex, stocks, indices, commodities, or cryptocurrencies. This choice affects volatility, liquidity, trading hours, and risk profile.

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2. What Direction Should I Trade (Bullish or Bearish)?

Your system must determine trade bias:

• Long (buy) in bullish trends

• Short (sell) in bearish trends

• Neutral or flat during sideways or uncertain market conditions

This is often dictated by trend-following or mean-reversion logic.

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3. When Should I Enter a Trade?

Timing is crucial. This includes:

• The price level at which to enter (e.g., breakout levels, retracements)

• The specific time of day (e.g., opening hours, overlap sessions)

Efficient entry timing can improve risk-reward ratios and execution reliability.

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4. What Are the Trading Costs?

Every system should account for transaction costs, including:

• Broker commissions and spreads

• Slippage

• Overnight or swap fees (especially in Forex)

Ignoring these can lead to overestimating profitability.

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5. Are There Hidden Risks Involved?

All strategies carry non-obvious risks:

• Low liquidity or high spread during volatile times

• Correlation risk (e.g., trading EUR/USD and GBP/USD simultaneously)

• Platform or data feed issues

A good system includes risk management logic that anticipates and mitigates these threats.

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6. How Much to Trade (Position Sizing)?

Position sizing defines how much capital is allocated per trade. Key methods include:

• Fixed lot sizing

• Risk-based sizing (e.g., risking 1–2% of account equity)

• Volatility-adjusted sizing

This is a critical factor in long-term performance and drawdown control.

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7. What Type of Orders Should Be Used?

Selecting the right order types is essential:

• Market orders (instant execution)

• Pending/limit orders (execute at predefined levels)

• Stop-loss and take-profit orders (for risk and reward control)

Your system must use these smartly to balance precision and execution speed.

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8. When or Where to Exit the Trade?

Know your exit plan:

• Fixed targets (e.g., 1.5x or 2x risk)

• Trailing stops

• Time-based exits

• Technical levels (e.g., support/resistance)

Exit rules often determine profitability more than entry rules.

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Walk-Through: Optimization Process

After defining your system’s logic, the next step is optimization — refining parameters (indicators, filters, thresholds) through backtesting and forward testing. However, over-optimization (curve fitting) should be avoided. A well-optimized system strikes a balance between historical performance and future robustness.

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Identifying Market Trends

 

Understanding market trends is foundational for any strategy. Accurately identifying a trend — especially in Forex — can significantly enhance trade profitability.

There are two core types of market trends:

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I. Primary Trend

The Primary Trend reflects the long-term movement of a market and may last:

• Weeks, months, or even years

• Often includes several secondary trends within it

According to Dow Theory, the primary trend shapes the broader market direction and overshadows minor fluctuations.

Key factors influencing primary trends include:

• Central bank policies

• Macroeconomic cycles

• Especially actions and signals from the U.S. Federal Reserve (FED)

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II. Secondary Trend

A Secondary Trend is a short- to medium-term movement that runs counter to the primary trend or forms part of a correction or consolidation.

It may last:

• Hours, days, or weeks

• And typically occurs within the broader context of the primary trend

Identifying and trading within the direction of the dominant (primary) trend increases your probability of success.

»  Identifying the Forex Trend at FxPros.net

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Trading Strategies and Categories

 

In modern financial markets, there are dozens of trading strategies. Traders often combine multiple methods to build multi-strategy systems that enhance reliability and adaptability. Below are five core categories of trading strategies used by both manual and algorithmic traders.

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1. Trend-Following Strategies

Trend-following strategies aim to capitalize on sustained market direction. Trends are typically classified as:

• Short-term

• Intermediate-term

• Long-term

Common tools used in trend-following (via technical analysis) include:

• Historical support and resistance levels

• Key trendlines

• Price channels

These tools help identify the direction and strength of the prevailing market trend, enabling traders to align with it rather than trade against it.

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2. Mean-Reversion Strategies

The mean-reversion hypothesis suggests that price will revert to its average (mean) level approximately 80% of the time. This means that markets mostly range, and extremes often signal buy or sell opportunities.

Key characteristics:

• Historical price data is used to calculate a mean price or range.

• When price deviates significantly, a reversion trade is triggered.

Examples include:

• Bollinger Bands

• RSI-based range strategies

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3. Volatility-Expansion Strategies

These strategies focus on sudden volatility changes and short-term price momentum. Volatility expansion setups aim to detect breakouts after periods of price compression or low volatility.

Strategy features:

• Combine volatility metrics (e.g., ATR, Bollinger Band Width) with price action.

• Trades often have a high win rate, but relatively small profits per trade.

Used effectively in scalping and day trading.

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4. Market Sentiment Strategies

These strategies aim to quantify the emotional bias of market participants, often serving as contrarian indicators or trend confirmations.

Data sources include:

• Put/Call Ratio (Options market sentiment)

• Commitment of Traders (COT) Report (from the CFTC)

• Social Media & News Sentiment (via data mining and AI)

Market sentiment helps assess fear vs greed, crowd positioning, and potential reversals.

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5. News-Event Strategies

News-event strategies seek to trade the volatility generated by economic news releases, earnings reports, and unexpected events.

Core principles:

• Monitor scheduled/unplanned events (e.g., NFP, CPI, central bank decisions)

• Quantify the deviation between actual data and consensus

• Execute trades automatically based on predefined criteria

Risk controls are vital to avoid slippage, spikes, and stop-hunting tactics by market makers.

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Technical Analysis: Overlays and Indicators

 

Technical Analysis is a core toolset used by traders to:

• Identify market trends

• Detect overbought/oversold conditions

• Forecast potential entry and exit points

Three Main Categories of Technical Tools

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A. Overlays

These are indicators plotted directly on price charts:

• Moving Averages (SMA, EMA)

• Bollinger Bands

• Ichimoku Cloud

• Parabolic SAR

They help identify trend direction, momentum, and volatility.

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B. Price-Based Indicators

These indicators are based solely on price movements:

• Relative Strength Index (RSI)

• MACD (Moving Average Convergence Divergence)

• Stochastic Oscillator

• Average True Range (ATR)

These tools measure momentum, trend strength, and potential reversals.

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C. Volume-Based Indicators

Volume confirms the strength of price movements:

• On-Balance Volume (OBV)

• Volume Weighted Average Price (VWAP)

• Accumulation/Distribution Line

Used for confirming breakouts, trends, and identifying divergence.

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D. Market Breadth Indicators

These assess overall market strength:

• Advance-Decline Line

• New Highs vs New Lows

• Market Volume Ratios

Useful in assessing whether broader participation supports a trend.

»  Technical Analysis Overlays and Indicators

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