DEVELOPING A MECHANICAL
TRADING SYSTEM
As a trader, having a good trading system is very important, because it allows a
trader to save time on a daily basis when trading. It also allows a trader to be only
make decisions based on a platform that has been backtested using various
parameters.
Broadly, there are two main types of trading systems:
A manual system where one uses excel analysis
An automated or mechanical system
A simple Google search will produce thousands of trading systems which have been
developed by traders. Some are good while some are not appropriate at all.
In this article, We will write on how you can develop your own trading system. When
developing a mechanical trading system, your aim should never to make a
billion dollars. The two most important goals you should aim to achieve are to
identify a trend as early as possible and to avoid whipsaws.
On paper, these are simple strategies which you can come up with. In reality, it is
more complicated than this because the strategies contradict one another.
→What you need to know about Trading System
Page Contents
Set the timeframe
Select indicators
Find indicators to confirm the trend
Risk assessment
Entry and exit points
SET THE TIMEFRAME
Every trader has specific timeframes that they trade with. Some are perfect trading
with hourly charts while others are perfect when trading 30 minutes charts. To select
the timeframe, you need to assess yourself to understand the type of trader you
are.
If you are a day trader, we suggest you use hourly and 30 minutes charts. Instead, if
you are a swing trader, you should use daily charts.
→3 key Differences between day trading and swing trading
SELECT INDICATORS
After setting the timeframe, the next step is to select the indicators to use. As a day
trader, to accomplish the first goal mentioned above, we suggest that you
use moving averages. You should use two moving averages, one fast and another
one slow and wait until the fast one crosses the slow one.
This is a concept known as moving average crossover.
FIND INDICATORS TO CONFIRM THE TREND
In this stage, you simply want to fulfil the second goal we mentioned above (avoid
whipsaws). You want to avoid being in a false trend, thus the need to confirm the
trend. To achieve this goal, We suggest that you use MACD, Relative Strength
Index, and Stochastic.
→ Best Technical Indicators for Day Trading
RISK ASSESSMENT
No system is accurate. Therefore, it is important to define the risk that you intend to
use. Some trades will go against the system. It is thus important to define the
amount of risk you are willing to take on every trade you enter.
ENTRY AND EXIT POINTS
After following the above steps, the final step is to define the entry and exit points.
There are many theories on how to make this happen, however most people believe
in entering the trades when all the indicators match up even before the candle
closes. Other people, instead, prefer seeing all the traders match up and wait until
the candle closes up.
In our experience, we believe in waiting for the candle to close. This is because at
times the indicators might match and change before the candle closes.
Once you are in a trade, the next challenge is on when to exit. The best way to do
this is to trail your stop. This means that if your trade turns positive by X, you move
your stop by X. You can also set the stop loss by using the support and resistance
levels.
Here a practical example.
Entry Positions – Place a buy position if: the 5 day moving average is above the 10
day simple moving average and when the stochastic lines are moving up. Finally,
enter when the RSI is greater than 50.
Exit Positions – Place a sell order when the 5 day simple moving average moves
below the 10 day simple moving average. The stochastic lines should be moving
down. This will prevent you from entering when the stochastic lines are in
overbought sections. The relative strength index should be less than 50.
Rules of exits – The trade should exit when the 5 day simple moving average
crosses the 10 day simple moving average in the opposite direction. Also, the RSI
should cross back to zero. Finally, you should exit when the trade hits the stop loss
of 100 pips.
The charts below shows some examples of this system in action.
A short trade
A long
trade
EXTERNAL RESOURCES FOR MECHANICAL TRADING SYSTEM
Mechanical trading systems save you from yourself! – Tradingsystemlife
Emotions And Mechanical Trading Systems – Netpicks
