A Step-by-Step Guide to Creating Your Own System – Part 1

Filed under: Learn Forex Trading |

Today, I want to run you through the process of creating your very own working forex trading system. There is most definitely a process to these things, and although system creation is not easy, I can tell you that systems can be made that give you an edge and a long-term profitability factor.

 

To begin with, you need to come up with a hypothesis. We need to take a very scientific approach when creating systems – otherwise, we may be subject to researcher bias, or making the data fit a preconceived idea. We should not backfit data to fit our hypothesis – but rather, we should rigorously test our hypothesis and try to disprove it. If we cannot disprove it, then the system has a level of significance that we can work with.

 

Let’s use an example to go through the process. One of the most common and well-known assumptions is that long term trend trading is profitable. We can test this hypothesis by using moving averages. Let’s make our hypothesis that when a 100-day exponential moving average crosses above a 350-day exponential moving average, we initiate a long trade, and when a 100-day exponential moving average crosses below a 350-day exponential moving average, we exit the long trade and take a short trade. Also, when the 100-day exponential moving average crosses above the 350-day exponential moving average again, we exit the short trade and go long. And we do this ad infinitum.

 

Now that we have got our hypothesis, we can go about testing this theory. But how and in what markets? Well, in forex, the obvious markets to begin the testing phase are on the most liquid markets – which are the forex majors of AUD/USD, GBP/USD, USD/JPY, EUR/USD, and the USD/CHF pairs. I’ll talk about how to conducts these tests in part 2.

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