A Stock, Futures And Forex Trading System That Gets Back To The Basics
All professions whether it be sport, business, or trading have what are called the basics and if youíre starting out in a new profession, the basics form the foundation or the core. However if youíve been practicing your profession for quite some time and feel youíve gone off track or are not hitting your goals, usually the best thing to do is just get back to the basics: and trading is no different.
This is not an article based on emotional discipline or psychology, it is based on the basics of a trading plan, and it really doesnít matter if youíre long term or short term, the basics apply to most market participants. Some may have trading plans that are quite different to the basics however for the majority who are relatively new to trading or are struggling, the basics are by far the best approach to adopt.
The basics are split into three and are:
1. Determine the trend2. Wait for a pullback3. Enter on an event or pattern
1. Determining the trend can be a discretionary or mechanical decision. For example, a lot of traders can pull up a chart and instantly determine itís going up, down, or itís sideways and choppy, and if itís the latter it is best left alone; this is a discretionary approach.
For otherís they need some tools to make that decision for them such as moving averages, MACD or trend lines to name a few. All have their pluses and minuses and it usually helps to use a couple of tools or to add some discretion.
Iíll give you an example of a completely mechanical approach to determining a trend.
Set up a 200 day simple moving average (200 SMA) on your chart. Also add the indicator ATR (average true range) and set it to 100. If you take the current 200 SMA reading and the reading from 50 days ago, the difference needs to be greater than 4 times the current ATR(100) reading.
For example, if the current 200 SMA reading is 60 and the reading from 50 days ago is 50, thatís a difference of 10. If the current ATR(100) reading is 2, multiplying it by 4 gives you 8, and as such means you are in a mechanical uptrend. The opposite applies to downtrends or bear markets.
2. Waiting for a pullback simply allows you to get on board a trend at a cheaper price. It can become somewhat of an issue for many as itís hard to time when the pullback has ended or to determine if indeed the trend will continue. It could end up being that the trend has ended.
Keeping it simple is the best policy. Oscillating indicators are great tools for this very purpose, such as Stochastic or RSI to name a couple. Oscillators such as these have what are called over-bought and over-sold zones which you should become familiar with. When in an uptrend, a pullback in price coupled with an over-sold reading on your indicator is telling you it may be time to look for a possible trade to go long.
Using an RSI (14) is a popular method for determining if a pullback is over-sold when it reaches or goes below the 30 level.
Many will want more than just one indicator and will prefer a confluence of events to occur. Other tools will include trend lines, Bollinger bands, old support and resistance levels, volume, Fibonacci levels and so on. My suggestion is to just pull up some charts and look at what pullbacks cause your indicators to do regularly. It doesnít have to be all the time, but if it does it enough, you have your tools for measuring a pullback.
3. Entering your trade should probably be the most mechanical of the three basics. The reason is because it is the point where emotions can run high and traders can get twitchy. Itís also a time when someone will start to question whether they have the first two basics right.
If you have determined that the trend is up, and a pullback has occurred youíll need a way to get in and this is best done by waiting for some event or pattern.
Events can be that price has exceeded a certain number of price bars, or it crosses over a short moving average. If the pullback made lower highs and lower lows, you could wait for a higher low to be made which could signal that the pullback is over and enter after a break of the most recent high.
Once again, by looking at a few charts you can get a feel for what could work and what wouldnít.
A simple and popular method is to wait for price to close higher than the previous 3 bars. In other words, the closing price of the current price bar must be higher than the 3 previous bars highs.
So there you have what I call the three basics of a trading plan or system however it is not the complete picture. Itís ok to get into the market but how do you get out? And it is this part of trading that I believe goes beyond the basics because everyone is different. Different goals, different risk profile and tolerance levels, different resources such as time and capital and so on. Because of this, an exit strategy needs to center around the trader themselves.
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ABOUT THE AUTHOR
Dean Whittingham created A Traders Universe - Trading System Development in 2005 as a resource site for traders of all levels, with education, courses, brokers, tips, free videos, newsletters, trading systems, simulations and a free 7 step process for building a profitable stock, futures or forex trading system.