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Module 4
Trading Systems
1. Let’s look at creating your own trading system.
If you do a simple search on Google for “Trading systems” you'll find many
people out there who claim to have the “Holy Grail” system that you can
purchase form them. These systems supposedly make thousands percent a
week and never or hardly ever lose. They will show you supposed “results” of
their perfect system where you might be tempted to think your financial
worries are over. Besides, if this system is making thousands percent a week
or a month, you’ll be able to make your money back in no time.”
There are some things you should know before you give them your credit card
number and make that impulse buy.
The truth is that many of these systems DO in fact work. Maybe not as
spectacular as implied, but never the less, they do work. The problem is that
traders lack the discipline to follow the rules that go along with the system.
The second truth is that instead of paying thousands to buy a system, you can
spend your time developing your own system. This will allow you to develop a
trading system that suits your personality.
The third truth is that creating systems is not that difficult. What is difficult is
following the rules that you set when you do develop your system.
There are many companies and people that sell trading packages or systems,
but we haven’t seen any that teach you how to create your own system. This
lesson will guide you through the steps you need to take to develop a system
that is right for you.

2. Goals of your trading system

What are your goals? Many people say, my goal of my trading system is to
make a fortune. While that is a wonderful goal, it’s not exactly the kind of goal
that will make you a successful trader.
When developing your system, there are two important goals that you would
like to achieve:
• Your system should be able to identify trends as early as possible.
• Your system should be able to protect you from whipsaws and false
breakouts.
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If you can accomplish these two things with your trading system, you will be
successful. The difficult part about those goals is that they contradict each
other. If you have a system for which its sole purpose is to catch trends early,
then you will probably get false signals many times.
On the other hand, if you have a system for which its sole purpose is to avoid
whipsaws, then you will be late on many trades and will also probably miss out
on a lot of trades.
Your task, when developing your system, is to find a compromise between the
two goals. Find a way to identify trends early, but also find ways that will help
you distinguish the fake signals from the real ones.
Always remember these two goals when you create your system. They have
the potential to make you a lot of money.

2.1 Six Steps to Setting Up Your System

The main focus of this part of the training is to guide you through the process
of developing your own trading system. While it doesn’t take long to come up
with a system, it does take some time to extensively test it. So be patient; in
the long run, a good system can potentially make you a lot of money.

• Step 1: Time Frame

The first thing you need to decide when creating your system is what kind of
trader you are. Are you a day trader or a swing trader? Do you like looking at
charts every day, every week, every month, or even every year? How long do
you want to hold on to your positions?
This will help determine which time frame you will use to trade. Even though
you will still look at multiple time frames (see the chapter above on time
frames), this will be the main time frame you will use when looking for a trade
signal.

• Step 2: Find indicators that help IDENTIFY a new trend.

Since one of our goals is to identify trends as early as possible, we should use
indicators that can accomplish this. Moving averages are one of the most
popular indicators that traders use to help them identify a trend. Specifically,
they will use 2 moving averages (one slow and one fast) and wait until the fast
one crosses over or under the slow one. This is the basis for what’s known as
a “moving average crossover” system.
In its simplest form, moving average crossovers are the fastest ways to
identify new trendis. It is also the easiest way to spot a new trend.
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Of course there are many other ways traders spot trends, but moving
averages are one of the easiest to use.

• Step 3: Find indicators that help CONFIRM the trend.

Our second goal for our system is to have the ability to avoid whipsaws,
meaning that we don’t want to be caught in a “false” trend. The way we do
this is by making sure that when we see a signal for a new trend, we can
confirm it by using other indicators.
There are many good indicators for confirming trends, some of the more
popular are the ones that we have already covered, the MACD, Stochastics,
and the RSI. As you become more familiar with various indicators, you will
find ones that you prefer over others, and can incorporate those into your
system.

• Step 4: Define Your Risk

When developing your system, it is very important that you define how much
you are willing to lose on each trade. Not many people like to talk about
losing, but in reality traders think about what they could potentially lose
BEFORE thinking about how much they can make.
The amount you are willing to lose will be different than everyone else. You
have to decide how much room is enough to give your trade some breathing
space, but at the same time, not risk too much on one trade. You’ll learn more
about money management in a later lesson. Money management plays a
very important role in how much you should risk in a single trade.

• Step 5: Define Entries & Exits

Once you define how much you are willing to lose on a trade, your next step is
to find out where you will enter and exit a trade in order to get the most profit.
Some people like to enter as soon as all of their indicators match up and give
a good signal, even if the candle hasn’t closed. Others like to wait until the
close of the candle. It all depends on your strategy.
From experience, many traders believe that it is best to wait until a candle
closes before entering. Many times traders get into a situation where the price
of an instrument will be in the middle of a candle and all the indicators match
up, only to find that by the close of the candle, the trade has totally reversed.
It’s all really just a matter of trading style. Some people are more aggressive
than others and you will eventually find out what kind of trader you are.
For exits, you have a few different options. One way is to trail your stop,
meaning that if the price moves in your favour by ‘X’ amount, your stop moves
by ‘X’ amount.

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Another way to exit is to have a set target, and exit when the price hits that
target. How you calculate your target is up to you. Some people choose
support and resistance levels as their targets. Others just choose to go for the
same amount of points (pips) on every trade. However, you decide to
calculate your target, just make sure you stick with it. Never exit too early.
Stick to your system. There is no hard and fast rule to this it depends on you.
One more way you can exit is to have a set of criteria that, when met, would
signal you to exit. For example, you could make it a rule that if your indicators
happen to reverse to a certain level, you would then exit out of the trade.
Remember it’s your money; don’t trade yourself out of the market.

• Step 6: Write down your system rules and FOLLOW IT!

This is the most important step of creating your trading system. You MUST
write your trading system rules down and ALWAYS follow them. Discipline is
one of the most important characteristics a trader must have, so you must
always remember to stick to your system! No system will ever work for you if
you don’t stick to the rules, so remember to be disciplined.

2.2 What should your trading system look like?

In this section we will give you an idea of what a trading system should look
like. This should give you an idea of what you should be looking for when you
develop your system.

Trading Setup i.e.

• Trade on daily chart (swing trading)
• 5 EMA applied to the close
• 10 EMA applied to the close
• Stochastic (10,3,3)
• RSI (14)
Trading Rules
Stop Loss = 20 points
Entry Rules
• Enter long if:
• The 5 EMA crosses above the 10 EMA and both stochastic lines
are heading up (do not enter if the stochastic lines are already in
the overbought territory)
• RSI is greater than 50
• Enter short if:
 • The 5 EMA crosses below the 10 EMA and both stochastic lines
are heading down AND (do not enter if the stochastic lines are
already in oversold territory)
• RSI is less than 50
Exit Rules
• Exit when the 5 EMA crosses the 10 EMA in the opposite direction of
your trade OR if RSI crosses back below 50

6.3 A simple Trading System

As you can see, we have all the components of a good trading system. First,
we’ve decided that this is a swing trading system, and that we will trade on a
daily chart. Next, we use moving averages to help us identify a new trend as
early as possible.
The Stochastic help us determine if it’s still ok for us to enter a trade after a
moving average crossover, and it also helps us avoid oversold and
overbought areas. The RSI is an extra confirmation tool that helps us
determine the strength of our trend.
After figuring out our trade setup, we then determined our risk for each trade.
For this system (as an example), we are willing to risk 30 points on each
trade. Usually, the higher the time frame, the more points you should be
willing to risk because your gains will typically be larger than if you were to
trade on a smaller time frame.
Next, we clearly defined our entry and exit rules. At this point, we would begin
the testing phase by starting with manual back tests.
Here are a couple of examples:
If we went back in time and looked at this chart, we would see that according
to our system rules, this would be a good time to go long. To back test, write
down at what price you would’ve entered, your stop loss, and your exit
strategy. Then you would move the chart one candle at a time to see how the
trade unfolds.
In this particular case, you would’ve made a massive point gain. You can see
that when the moving averages cross in the opposite direction, it was a good
time for us to exit. Of course, not all your trades will look like this, but you
should always remember to stay disciplined and stick to your trading system
rules.
In this example, we can see that our criteria are met and at this point we
would enter short. Now we would record our entry price, our stop loss and exit
strategy, and then move the chart forward one candle at a time to see what
happens.
You can see that we would’ve stayed in this trade until the moving averages
crossed again and RSI went back to 50.
The most important thing is discipline. We can’t stress it enough.
YOU MUST ALWAYS STICK TO YOUR TRADING SYSTEM RULES!
If you have tested your system thoroughly through back testing and by trading
it live on a demo account, then you should feel confident enough to know that
as long as you follow your rules, you will end up profitable in the long run.
2.4 How to Test Your System
The fastest way to test your system is to find a charting software package
where you can go back in time and move the chart forward one candle at a
time. When you move your chart forward one candle at a time, you can follow
your trading system rules and take your trades accordingly. Record your
trading record, and be honest with yourself. Record your wins, losses,
average win, and average loss. If you are happy with your results, then you
can go on to the next stage of testing: trading live (small trades) or on a demo
account.
Trade your new system live on a demo account until you are confident that it
works. This will give you a feel for how you can trade your system when the
market is moving.
Once you have traded your system on a demo account and feel confident
about the results, then you can choose to trade your
system live on a REAL account. At this point, you should
feel very confident with your system and feel comfortable taking trades with no
hesitation

Module 5
1. Money Management
This section is one of the most important sections you will ever read about
trading.
Why is it important? Well, we are in the business of making money, and in
order to make money we have to learn how to manage it. Ironically, this is one
of the most overlooked areas in trading. Many traders are just anxious to get
right into trading with no regards to their total account size. They simply
determine how much they can stomach to lose in a single trade and hit the
“trade” button. There’s a term for this type of trading….it’s called GAMBLING!
When you trade without money management rules, you are in fact gambling.
You are not looking at the long term return on your investment. Instead you
are only looking for that “jackpot”. Money management rules will not only
protect us, but they will make you very profitable in the long run. If you think
that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes to win a
big jackpot, and in fact, many people do win. So how in the world, are casino’s
still making money if many individuals are winning jackpots? The answer is
that while even though people win jackpots, in the long run, Casinos are still
profitable because they rake in more money from the people that don’t win.
That is where the term “the house always wins” comes from.

2. Drawdown and Maximum Drawdown?

Money management will make us money in the long run, but now let’s look at the
other side of things. What would happen if you didn’t use money management
rules?
Consider this example:
Let’s say you have a $100,000 and you lose $50,000. What percentage of
your account have you lost? The answer is 50%. Now, what percentage of
that $50,000 do you have to make in order to get back to your original
$100,000? You would have to make back 100% of the $50,000 you are left
with to get back to your original $100,000.
3. Losing Streak
Here is a little illustration that will show you the difference between risking a
small percentage of your capital compared to risking a higher percentage.

You can see that there is a big difference between risking 2% of your account
compared to risking 10% of your account on a single trade. If you happened to
go through a losing streak and lost only 19 trades in a row, you would’ve went
from starting with $20,000 to having only $3,002 left if you risked 10% on each
trade. You would’ve lost over 85% of your account! If you risked only 2% you
would’ve still had $13,903 which is only a 30% loss of your total account.
Of course, the last thing we want to do is lose 19 trades in a row, but even if
you only lost 5 trades in a row, look at the difference between risking 2% and
10%. If you risked 2% you would still have $18,447. If you risked 10% you
would only have $13,122. That’s less than what you would’ve had even if you
lost all 19 trades and risked only 2% of your account!
The point of this illustration is that you want to setup your money management
rules so that when you do have a drawdown period (losing streak) you will still
have enough capital to stay in the game. Can you imagine if you lost 85% of
your account? You would have to make 566% on what you are left with in
order to get back to break even. You do NOT want to be in
that position. In fact, here is a chart that will illustrate what
percentage you would have to make to breakeven if you were to lose a certain
percentage of your account.

You can see that the more you lose, the harder it is to make it back to your
original account size. This is all the more reason that you should do everything
you can to protect your account.

• Risk to Reward
Another way you can increase your chances of profitability is to trade when
you have the potential to make 3 times more than you are risking. If you give
yourself a 3:1 reward/risk ratio, you have a significantly greater chance of
ending up profitable in the long run. Take a look at this chart as an example:

In this example, you can see that even if you only won 50% of your trades,
you would still make a profit of $10,000. Just remember that whenever you
trade with a good risk to reward ratio, your chances of being profitable are
much greater even if you have a lower win percentage.
Money Management and Calculating Volume
Below is a formula and example for calculating your volume, an important part of money
management, as it helps you calculate how much of your total account balance you are
risking on any one trade. Many traders have lost most and even ALL of their money owing to
incorrect volume and risk management calculations. This calculation needs to be done
correctly for every single trade you take.

Balance = $500
Pip value = Risk / Stop Loss
$5 / 40 pips
$0.125
Volume = Pip value / 10
$0.125 / 10
$0.0125
Price = 1.00470 (buying)
Stop loss = 1.00470 - 40 pips
Take Profit = 1.00470 + Risk/Reward Ratio (1:1, 1:2, 1:3)

If you start off with a balance of $500, you would ideally want to only risk 1% of your
balance, which is $5. You would then need to determine, in pips (points) how big/ small you
want your stop loss to be (a small/tight stop loss puts you at a greater risk of the market
closing you out with a loss because of a small movement in the opposite direction to your
trade, so a bigger stop loss is recommended so you give your trade room to breathe).

Divide your risk (1%) by the amount (in pips) of your stop loss, and that will give you your
pip value, which is the amount in dollars (or your own country’s currency equivalent) that
each pip/point movement is worth. To calculate your volume, just simply divide your pip
value by 10 (ten) and that will be the value you insert on your platform for volume.
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