The financial trading system is a system which allocates resources for buying and selling securities. It may sound simple, but this investment system requires a specific and efficient trading strategy because the trading market is a complex world. But as traders vary in their trading strategies and approaches, a trader can develop his own financial trading system. The following are some steps on how to set up a personally developed financial trading system.
- The trader must first understand the basic assumptions and hypotheses behind the system and try to find out its restrictions. Indicators provide tools for building a system. Like in cooking, we need tools to do the work. However, we still need a good recipe to make a good dish. A good trading system is a good recipe. Without it, no profit can be made.
- The system should be tested on theoretical data. To test the system on theoretical data means to simulate the market price data by setting up a model. By definition, a model is a simplification of reality. The model must have assumptions and approximations because in reality business is very complicated and crucial. However, a good model must have simplicity, objectivity, conformity, applicability, agreement with experimental (theoretical) data, and non-arbitrariness.
- After testing the system on theoretical data (and making sure that it is profitable), the trader should test the system on some past financial data. Yet, there is still no guarantee that by comparing past real data the system will be profitable for future financial data. This is because real financial data is difficult to model and forecast. Real financial data is often unpredictable. All a trader can hope for is to work out a system that will give him a better edge of profiting.
- After testing, traders can now create financial trading systems in a cycle mode. A cycle mode is when the prices at the market move up and down. When the market is in cycle mode within a specific timeframe, the strategy would be simple. The trader must only identify the market tops and bottoms.
- To compare, traders can also create the financial trading system in a trending mode. When the market is in a trending mode, two timeframes should be used by traders: long term and short term. The long term timeframe is employed to ensure that the market is trending. On the other hand, a short term timeframe is used to look for entry points when the market retraces. To link the long term and short term timeframes, a “factor of five” is the most common. For example, traders use daily and weekly charts because there are five trading days in a week.
Remember, a good financial trading system, coupled with wise money and time management, risk analysis, and sound business decisions, can increase the probability of a trader’s profitability.