Building a Trading System

Building a trading system is easier than you think. Without a system, you are almost certain to fail in your quest to be a successful trader.

As we learned last week, our trading brain is actually composed of two different parts that dramatically effect our trading. There is the old primitive brain our ancestors lived (or died) by and the new age brain that provides the sophistication necessary to survive in today's world.

Using Our Logical Brain

Our logical or "new age" brain can think logically, analyze situations and make good decisions. The problem is that once we are trading, our primitive brain takes over and runs the show.

The trick to keeping your primitive brain out of your trading is to develop a trading system that is "rules-based" using your logical brain. With a system, once certain rules are satisfied, you trade according to your plan. This is the way you keep your "brains" from messing up your trading.

Let's build a short-term system (a few hours to a couple of days) that we will use to guide our trades...

Getting Started

So, where do we start? We start by establishing the rules.

For example... since the safest direction is to trade with a trend, we need to determine the current trend. The problem with that is what time period do we use? The 5 minute is up, the 15 minute is sideways, the 30 minute is down, the hourly is flat and the daily is pointing at the moon!

Can you imagine the war going on between your two brains? This is why we build the rules ahead of time. In our case, let's set a rule that says the 15 minute, 1 hour and 4 hour chart are all moving in the same direction when we check their 21 period exponential moving averages.

I use the 21 period because it is a Fibonacci number that a lot of short-term traders follow and the exponential MA is more "in tune" with the current action than a simple MA.

Something you will learn along the way is certain indicators are followed by a large number of traders and knowing how other traders are likely to react when the indicators give their "signal" will help you anticipate the probable reaction to prices hitting a certain level.

Next week we'll continue building a trading system by adding more rules to our check list.

Wishing you trading success,
David Stevenson.