Simple Manual Trading System Part 1 - Moving Average and Pivots
This article is the first part in a series of lessons aimed at beginners who have an interest in creating their own strategy.
What are signals and which signals should you use.
If you are a beginner and have taken a look at the popular forums, you probably have no idea where to start. Some beginners read books and some register on forums while others try to trade randomly, often losing money quickly and then closing the account. At some point each beginner who survives some time on the market discovers that traders need some set of rules for their trades. They need a system.
What is system then? Basically speaking a system is a set of rules under which you perform your transactions. These rules are called signals whenever certain conditions are met. Ideally, signals should tell you when and where you can enter a trade that will eventually be profitable. Of course not every signal and not every system will be profitable. It's very important to connect some different signals into a well-oiled mechanism while identifying other signals that should probably be ignored.
We can find signals among price patterns (candle setups and swing formations) or we can use more advanced tools - indicators. The most common and basic indicators are oscillators or trend indicators and among them for instance: RSI, Stochastic, Envelopes, Bollinger Bands, Moving averages, etc. Regarding price patterns we can find Candle setups like: Pinbar, Engulf, etc. and swing patterns like Double Top/Bottom or Head and Shoulders. All these indicators are somehow bases on price and just use it in different ways. The most basic example is moving average indicator that takes the average price value (i.e. close) from last n periods. There are also wide range of custom indicators that traders can make, download or buy on their own. Here, in this just few sections we've touched a very interesting case. Some people may be familiar with it and some may be new. For those who are new I will provide a better explanation in further parts of this series. I would also encourage you to look for your own information to compliment this article.
To get started we need some trend indicator. Basically all systems can be divided into range and trend systems. For now we will only cover trend systems. It's very important, because the nature of these two market states is so different that an inappropriate system will provide wrong signals or no signals at all. Let us start by using a Moving average indicator to show us the market state and direction of our trades.
To place Moving Average on our chart we use "Add indicator" button and then we have to find SMA in list. SMA is common acronym for Simple Moving Average.
Then we just need to set it properly. It is often advised to experiment with various Moving Average periods to pick one that is sound for the market. For example period value 12 on m5 chart will give us averaged values for 60 minutes backwards.
Then we could use some price levels for entry - levels that will tell us where to buy or sell, where to stop our loss and take desired profit. Here, we could use Pivot Points. Pivot points are synthetic levels derived from previous day price movement - high, low, close. Of course, if you are able to assign your own Support/Resistance levels, it's good for you. But probably most people struggling with making their own trading system could use some additional help. Pivot Points could be very helpful here. The basic assumption when trading Pivot points is that buy orders are allowed only above pivot point, and sell orders are allowed only below Pivot Point.
Therefore ideally our system should work with descending moving average below Pivot Point or with an ascending moving average above Pivot Point. The advantage of such a system is that its signal indicators base on price showing its dynamics - moving average and pivot points base on price movement during certain time. Moreover here we are trying to sell a really bearish market, and not just one that is in range or corrective move.
As we see on screen above, sometimes it's useful to be familiar with price action, so we could interpret price behavior over certain levels.
Some indicators are already available in Platform while others need to be imported. You can upload your own indicators into Protrader 3 platform using import option:
When we have our signals prepared, setups visualized, trades back tested and custom indicators imported and performance is good, we may step to live tests.
After a short while of looking right pair we found USD/JPY in a clearly bearish day. We may now identify if and where our signals confirm a good setup for entry. If most people lose most of the time then it's logical that same amount of the time market is hard to trade profitably. Therefore we should stick to pending orders than market orders. Please notice how long our decent entry signal lasted, just few minutes - a single wick of 5 minute candle. During the whole day only few minutes were providing us a decent entry opportunity. Therefore our next signal will be extracted using a pending limit order.
And here we go - our resistance line from yesterday became Pivot line and price dropped nicely bringing us a very good profit that we can book for now.
Always watch out for temptation. It’s common to have profits in the beginning and start imagining - "What if I made 10 trades like that per day? Or if I make them with 10 lots?.” This is the first step to loosen your entry regime because greed tells you to look for more trades. Always stick to your rules, do not let yourself to misbehave on markets. What you think is not that markets will do. In example below you might see further drop, so what's the point in waiting for breaking support level? It seems better to place short NOW, when market is still several pips above.
Actually there is great chance that market will go upwards from actual support area and our Stop Loss would be challenged badly. On the other hand buying here would go against today's sentiment, so it has significant risk of failure.
As you can see, not every place is good for trades and it's not good to listen your greed. You'll probably need to train your self-control a lot.
Here was just brief introduction to making system. But you should keep few points in mind before you start earning money. It's trader who earns money and not the system. System is just a tool that helps you to be profitable, but you need skills and experience as well. The main factor in earning system is the trader. Moreover not only system decide whether trader is profitable or not. Very important is trader's psychology that needs lot of attention and training. Also, system is not the complete tool for trading. System should be part of a complex strategy. In further episodes I will try to describe closer further aspects of manual trading and potentially good indicators for a system.