How to Use Your Forex Trading System

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IS THE FOREX TRADING SYSTEM I BOUGHT ... USELESS?

This is a long topic, so I separated it into two posts for ease of reading and understanding.

 

PART ONE … Comparing Hindsight with Reality

 

Every day we see on the Internet, new and interesting forex trading systems. The sales pitch that goes with these trading systems is so well written, that many currency traders become convinced that “at last – a breakthrough” has occurred that will turn their losing trading efforts into profits. The story promises to give ordinary traders an advantage they never had before.

 

The retail forex market is truly in the trading and investing spotlight today, and an amazing amount of recycled and old information is packaged and sold as “a breakthrough.” How many hundreds of forex vendors have sprung up on the Internet to “share with the public for the very first time, the trading secret that made them a millionaire”? … blah … blah … blah!

 

Forex charts, videos and equity curves are even produced, and guarantees are given that promise to refund your money “no questions asked” if not satisfied. Some of these system marketers do honour their guarantees, and some will blame the trader for “not following the rules.”

 

There is a grain of truth in some of these counter-claims, but generally, a response like that from a vendor clearly points to problems … “money-back-no-questions-asked” should be honoured as stated.

 

I have bought four or five strategies/systems myself, so I know some of them DO actually work and function well. Some do not. Most forex system vendors DO honour their guarantees. Some do not.

 

Forex trading strategies have several things in common – you need to actually understand and master them, and apply the strategy and the principles to your trading. Another thing they have in common is: they do not work ALL the time. Nothing does.

 

All trading systems WILL take a draw-down at some stage during their operation. There is a reason for that. Markets trend. Then they consolidate within a range. Systems are designed to take advantage of trending markets or ranging markets – few strategies can handle both ranging AND trending markets.

 

Ok – so let’s get back to the topic: if some of the forex trading systems on the market are NOT failures, then where does that leave the trader? What is the deal here?

 

Clearly the issue comes down to how the trader applies that system to what he is seeing on his charts. Traders are inventive and entrepreneurial people. They are never contented with the opportunity to trade a strategy faithfully that has been proven to work well. Some traders will always try to apply a different indicator, a different setting, or they will want it to work on other TF or other currency pairs than it was designed for.

 

In fact, you could bet the house that traders will feel some need to change something, somewhere about the strategy.

 

But could there be more to this problem than just the application of the strategy?

 

There certainly could be … and there is a LOT more. To expect a trading system to work “out of the box” … meaning as soon as you receive it and apply it to your charts – could be a bit too much to expect. Salespeople do not care whether you are an experienced trader from Tennessee, or a newbie from Newport!

 

So to solve this dilemma, let’s assume the trader has enough experience to know his way around a trading platform, and has traded demo mode for a few months. In other words, the trader has some experience, and knows what he is looking at. And we’ll also assume that the system happens to be a reasonable trading strategy that genuinely does make pips … a positive expectation.

 

To simplify the issue, let’s take the system that we created a few days ago, (see April blog entries) and see if we can show how to use it, from a section of the chart that I admit I did “cherry pick” for the illustration.

 

The system I am using here is similar to one found on a popular Internet forex trading forum. I have applied slightly different values to the indicators. But the principles of most systems that involve using a three Moving Averages cross-over, are generally the same: when the fast MA cross the medium MA, there is an alert. When the fast MA then crosses the slower MA too, then you have the signal to buy or sell.

 

The strategy of using three (or even four) time frames to assess trend, is an effective approach, but still there can be no guarantee that any trend will continue. Trends end, and price can become range-bound … consolidating. If traders keep this in the front of their minds at all times, then the dangers associated with attempting to find trend-trades when there are none, will be lessened.

 

Check the 4H chart attached below, with our three moving averages coming together in a nice area of confluence. I can assure you that the DAILY chart is in a strong down-trend, so we are only interested in trades that we can enter in the short direction.

 

The price trend on the 4H charts is UP. We treat this as a pull-back, and look for short entries.

 

The MACD is clearly also showing UPWARD MOMENTUM. We can not trade against this upward momentum.

 

The RSI is ABOVE 50, so the expectation is that the upward trend “should” continue.

 

I refrain from using such terms as “will” because as traders it is NOT our role to be telling the market what it “will” do. Instead, our role is to follow exactly what the market IS doing – we REACT to activity – we do not dictate activity.

 

So … while our first thoughts are that price might continue to rise, there are clues that this is NOT necessarily the case. There is something else developing. Take a closer look at RSI … clearly it is still above the 50 level – yes - but it is turning down fairly steeply, even though price is in a nice uptrend. Further evidence that there might be an imminent change in trend direction, is seen by the confluence of the three EMA’s – exactly on that last 4H candle.

 

Now we can not know what is going on until the current candle has completed, and the new one begins … or can we? Well the answer to that question, is: look at the next lower TF … the 1H.

 

Notice where we are looking as we apply this system. We are not looking at the activity 10 or even 7 candles back … we are looking at the CURRENT candle, because when you are trading, THIS is the candle, and THIS is the price that you will be dealing with. What your indicators are doing RIGHT NOW is what will be fuelling your emotions, intellect, intuition and interpretation of what you are seeing.

 

The decisions you make will be based partly on what has gone before – yes – but the actual buy/sell trigger will be pulled depending on what is happening in the present moment – not 4 or 40 hours ago. This is what the Forex System vendors will be showing you – where you “could” have entered, and where their “system” generates the profits. But they are unable to show you H-O-W to actually detect and execute a trade, so that you DO get the expected profits.

 

Getting back to our 1H chart we can see that the fastest EMA – the 5 – has crossed the medium EMA – the 13 – at the same point of confluence we saw on the 4H chart earlier. The fast 5EMA has not yet crossed the slow 34EMA.

 

But notice that the MACD histogram has crossed UNDER its signal line, and is falling. This tells us MOMENTUM is slowing … nothing else. Next, the RSI is still ABOVE 50, and parallel to the 50 line. No conclusions to be drawn there either. We need to wait another hour, to see what price is going to do. There is no other conclusion we can draw right now.

 

In PART TWO of this exercise (next blog post) we will continue with this setup. And I will show you how to actually locate the signals and place the trades, according to real rules; and I’ll show you how to locate the legitimate exits that lead to real trading profits.

 

Continued and concluded with next Blog post …….

 

Posted in my Blog: http://forexapplepie.com/