Forex trading system is the subsystem of the forex trading plan which controls when and at which price you open and close your trades. A trading system operates on the signals generated by technical analysis and/or fundamental analysis. The signals are processed to determine if the trader should buy or sell a particular currency pair or should close the existing positions. Any currency trading system prevents information overload by filtering the universe of technical and/or fundamental signals in such a way that only the most reliable (successful in the past) signals or signal combinations are acted upon.
There are two types of forex trading systems – the discretionary and the mechanical. Discretionary trading systems require the trader to use his or her own judgment to determine the importance of each of the technical or fundamental signals (whose number is potentially unlimited) that he or she receives. Mechanical trading systems operate on a fixed number of technical or fundamental signals without the participation of the trader. Discretionary trading systems require the constant application of creativity (flexibility of approach) from the forex trader in the interpretation of the changing market conditions. Mechanical trading systems require the creativity from the trader only in the forex system development phase.
Discretionary forex trading systems are best used by professional forex traders with a lot of experience (internalized practical market knowledge) against which they can determine the validity of any signal that they receive. These traders typically remember a large number of different signal patterns from the past (just like the master chessmen) that they can compare to the current market conditions, to make their analysis more objective. In essence, they use themselves (i.e. their brain) as their forex trading system – often very successfully – because human mind has the greatest pattern recognition power on the planet.
Beginning currency traders are advised to start by following professionally created mechanical forex trading systems. Most of these systems are sold in the form of the forex signals that are usually developed by seasoned traders who have found a way to systematize their knowledge of the markets into a working strategy. At the same time, the beginning traders can work on building their own knowledge base of the forex market through the quality forex books, educational courses, bank reports and newswires on this subject -so that they can too, with time, create mechanical forex trading systems from their own insights and intuitions (using the forex charting packages which allow to do this).
Starting without a proven mechanical forex trading system (that has positive mathematical expectation) drastically reduces the chances of preserving the capital. This is because any intuition or a hunch that the traders experience as a result of some newly gained knowledge of the forex market is likely to be overridden by one of the two emotional derivatives of their life-long programming towards the money – the greed and the fear. In other words, without strict adherence to an existing mechanical trading system the beginning trader will eventually succumb to his or her emotions. As a matter of fact, the only way the traders can learn discipline in the early phases of their trading careers is by closely following the signals generated by a proven mechanical forex trading system.
Note: Neural Network Packages (e.g. NeuroShell) emulate the process of human learning and can be used to accumulate the knowledge of the past technical and/or fundamental signal patterns (just like the mind of professional forex traders does) for the purpose of the future currency price forecasting.
Quote: “A mechanical approach to the markets can be successful and this is backed up by the fact that approximately 80% of the $30 billion in the managed futures industry is traded by exact systematic methods”, from the “The Ultimate Trading Guide” by John R. Hill, George Pruitt, and Lundy Hill