5 Principles of Forex Trading Systems

Forex trading is a complicated affair. The complication largely arises because of the innumerable factors that are at play in the Forex market. However, this is further exacerbated by human emotions of greed and fear. Let’s see how forex trading systems can help simplify Forex trading for the average Joe.

What is a Forex Trading System?

A Forex trading system is a set of rules that must be followed by traders. Markets are fuelled by greed and fear. In the heat of the moment, emotions might take over the psychology of the trader and drive a perfectly rational trader to make irrational decisions.

In such scenarios, Forex trading systems come in handy. They provide traders with a set of rules that best suit their trading style and financial situation. Traders must trade themselves to ensure that they adhere to these rules in the heat of the moment. There is no one size fits all Forex trading system. Each trader, through trial and error, must build their own trading system i.e. a set of rules, their guiding philosophy.

All these Forex trading system are guided by the same principles. If your philosophy is against one of these principles, it is not necessarily wrong. However, it would be advisable for you to verify its effectiveness. These principles have been time tested in the Forex markets and philosophies which oppose them seldom make money.

The common principles that lie beneath most successful Forex trading system are as follows:

Principle #1: Be Realistic

This point cannot be stressed enough. It feels really sad to see advertisements guaranteeing 1000% returns per annum or making such other absurd commitments. It is very important to get into the market with a realistic mindset. Otherwise even a success will seem like a failure to you and you will get demotivated. You may possibly quit half way even though you are making good progress.

Please be aware that trading is a risky business by definition and profits made are rewards for bearing risk intelligently. Also, please understand that the word guarantee is almost certainly a misrepresentation in the Forex market. Nothing can ever be guaranteed here!

So before you build your system, know that your returns are going to be in the 25%-50% range per annum. They are not less by any means. Consistency is the key here. At this rate, your capital would double every two to three years. You can accelerate the speed by using borrowed capital i.e. leverage. However, that is a strategy which must only be used once a certain level of proficiency has been reached. The maxim “slow and steady wins the race” applies here.

Principle #2: Keep It Simple

A lot of Forex trading coaches guide their students by offering them increasingly complex strategies. They seem great on paper. However, all of them seem to fail in the market. For a retail investor, the strategy must be really simple. Difficult strategies are complicated and cannot be easily executed.

As a result, slippage occurs and people lose money. Just like everything else in the Forex market, the complexity of the strategy must be gradually increased. In the initial stages, say no to complicated strategies like straddle and reverse straddle. Focus on simple trading and take it up one notch at a time. Soon you will become comfortable with complexity. An alternate approach would be to keep trading on the demo account and move on to the real account only after a certain amount of proficiency has been reached.

Principle #3: Benchmark

Financial markets move up and down in a random manner and Forex markets are no exception. Therefore, there will be times when everyone will be making a handsome return and other times when everyone will be losing money. They are often referred to as the business cycle.

Because of this phenomena of the business cycle, it makes no sense to judge your performance by an absolute return. When the going is good a 25% return is also considered to be below average. However, when bad times strike, even a 5% return can be commendable. To correctly judge your performance you need to benchmark it against other traders. Think of it as a classroom full of traders and try to hold in rank in your class. Forex markets are relative. The returns obtained need to be evaluated in the context of the markets. Feedback is an essential component of any Forex trading system. Unless you know how well or bad you are performing, how will you modify your strategies? How will you possibly know which strategies are working and which aren’t.

Principle #4: Drip-Feed Model

While creating your Forex trading system ensure that you do not put your money in one single trade. Follow the drip and feed model. This means that you can open multiple different trades in the beginning. You then take some time to figure out which trades are making money and which of them are losing money. The objective is to get rid of the losers as soon as possible and use the money freed up to increase your winning bets.

Principle #5: Do Not Argue With the Trend

Lastly, Forex markets are driven by trends. In the short run these trends are virtually unstoppable. Also, given the leverage that is involved in the forex market, no one really holds a position for very long. It would therefore not be advisable to argue with the trend. On the other hand, being conversant with technical analysis tools that help you gauge the prevalent trend can be very valuable.