6 Steps to Designing a Trading System (and an Example)

Trading can be a great way to earn income through profits, but it’s important to remember that it’s a risky business. That’s why it’s important to design your system and test it before you start trading with real money. In this blog post, we will walk you through the six steps for designing a trading system.

We’ll also give you an example so you can see how it works.

So let’s get started!

DESIGNING A TRADING SYSTEM: 6 STEPS

Step 1: Establish the time frame.

The time frame you choose will depend on your trading objectives and preferences. You may want to trade short-term or long-term, day trading or swing trading, etc. You must find the right time frame for you before proceeding with designing a trading system.

Step 2: Find indicators that assist in identifying new trends.

A good way to find these is to look at what other successful traders are using. You should also try out different indicators and study how they work to get comfortable with them. Moving averages are popular for spotting trends. Simply look for moving average crossovers to spot a trend (among other indicators).

Step 3: Use indicators that CONFIRM the trend.

Once you have identified a potential new trend, you will want to make sure it is confirmed by other indicators before entering into any trades.

You can use indicators such as MACD, Stochastic, Relative Strength Index (RSI), Bollinger Bands, or Parabolic SAR to help you make sure the trend is real.

Step 4: Define your risk.

Before entering any trade, it’s important to know how much risk you are willing to take and set a stop-loss accordingly. You should also consider setting a limit on the amount of money you are willing to lose in each trade.

Step 5: Define entries and exits.

This is an important step because it will help you determine when and where to enter and exit a trade. You should take into consideration factors such as support and resistance levels, pivot points, etc.

Entries: Some traders wait until their indicators line up and some like to wait until the close of a candle to enter a trade. It’s a matter of preference.

Exits: There are several ways to define your exits.

Among them are:

• Trailing stops:

If the price moves in your favour by X amount, you move your stop by X amount. Many platforms offer an automatic trailing stop.

• Take profit target:

When your position hits that target, you close the position.

• Fixed risk:

Pursuing the same amount of profit units on every trade.

• Criteria-based:

When your position meets a set of criteria determined by certain technical indicators, you exit.

Step 6: Write down your system rules and follow them strictly.

Writing down your system rules and following them is essential for successful trading. This will help you stay disciplined and consistent, which are two important factors for profitable trading.

By following these six steps, you can easily design your trading system that matches your objectives. Remember to always test your system before trading with real money, and be sure to follow your system rules religiously.

Testing Your Trading System

The best way to test is to get some charting software that allows you to back test — meaning go back in time and move forward a candle at a time, taking trades where your system dictates and analyzing the results.

Be honest with yourself and let the numbers speak for themselves as you record your trades.

Record wins, losses, average win, and average loss.

Once you’re happy with the results, test in a demo environment for at least two months. If you are still getting good results, it may be time to move to a live, real money account.

An Example Trading System: Moving Average Crossover System

We’ll lay out a very simple example for designing a trading system with a moving average crossover strategy. The moving average crossovers will determine if we go long or short.

But first, we must:

1. Define a time frame

2. Determine entry trigger(s)

3. Determine exit trigger(s)

Trading Setup

• Trade on the hourly chart (day trading)
• 5 simple moving average (SMA) applied to the close
• 10 SMA applied to the close
• Stochastic (14,3,3)
• RSI (9)

Trading Rules

Entry Rules

Go LONG if:

• The 5 SMA crosses above the 10 SMA and both Stochastic lines are moving up
• No entry if Stochastic lines are in the overbought zone
• RSI is greater than 50

Go SHORT if:

• The 5 SMA crosses below the 10 SMA and both Stochastic lines are heading down
• No entry if the Stochastic lines are in an oversold zone
• RSI is less than 50 Exit Rules
• Exit when the 5 SMA crosses the 10 SMA in the opposite direction of your trade OR if the RSI crosses back to 50
• Exit when a trade hits stop-loss of 20 pips

While this is a simple system, it demonstrated how to construct rules that determine your trades, entries, and exits.