Technical & Fundamental Trading Systems
A trading system is a set of parameters that predicts the price movement of a currency. Most experienced traders will use a trading system because it helps to determine when to enter a trade, how long to hold it, and when to sell and take a profit or accept a loss. These are decisions that traders make every day in every trade. Using a good trading system will not protect against a losing trade. However, it will help to keep losses to a minimum. It can also maximize the profits on each trade. In short, a trading system takes much of the guesswork out of trading.
Many beginning traders reject using a trading system because they believe that trading systems are too restrictive or that they will miss out on good trades because they didn’t fit into the parameters of the system. But experienced traders know that trading systems will discover good quality trades. Of course, no trading system will find every profitable price movement. But it will make the most of their trading funds.
Choosing a trading system is not an easy task. When selecting a system, the basic question to determine is what kind of trader you are. Are you a technical trader or a fundamental trader? Do you rely on charts and technical indicators or do you rely on economic data and reports? The answers to these questions are critical because it will help you to determine what type of trading system to adopt.
Two Types of Trading Systems
Like traders, there are basically two types of trading systems: Technical and Fundamental. There is another group emerging called the Intermarket trading system, but this type is not yet fully developed or employed by any definable group of traders. Back to the basics, the two types of trading systems are technical systems and fundamental systems. Let’s briefly review each type.
- Technical Trading Systems
Technical trading systems rely on technical indicators and charting techniques. The parameters for the system are determined solely by certain price movements on charts and the data from technical indicators. For example, a technical trading system could employ a parameter that the currency price must be within five percent of the 20-period moving average line. Another example is that a trading system looking for a strong trending currency could require that the ADX level is above 40.
Technical trading systems often combine technical indicators to determine the parameters. For example, a trading system could require that the currency is moving within the Bollinger Bands and that the ADX is above 40. Alternatively, a trading system looking for an explosive price movement could require that the Bollinger Bands are squeezing the currency pair and that the ADX is below ten.
Technical trading systems are used by both range traders and trend traders. There is so much technical data available that the indicators can be used for a wide variety of price movements.
Advantages and Disadvantages
There are advantages and disadvantages to using technical trading systems. The advantages are that technical trading systems are inexpensive, easy to use, and very reliable. They can be as basic or as detailed as the trader can manage. Also, they quite precise by clearly showing the entry and exit points for a trade.
The limitations of technical trading systems are similar to the limitations of technical analysis in general. These are basically the unpredictability of certain events (such as terrorist attacks, wars, natural disasters, etc.) that cause technical analysis to fail.
- Fundamental Trading Systems
A fundamental trading system relies on the release of economic reports and the data found in those reports as parameters for entering a trade. This type of system is much more dependent on demand factors than technical trading systems. The parameters are the economic reports and their ability to affect the demand for a currency.
A fundamental trading system can have the parameters such as the release of the nonfarm payrolls with the expectation that the payrolls figure will be high, which would create more demand for the USD. Another parameter could be the release of the FOMC minutes in which the Fed makes a decision on interest rates. Any economic report can affect the demand for a currency and fundamental trading systems predict how and when this will happen.
Fundamental trading systems do not usually combine more than one report at one time, but will use only report and its analysts’ expectations to determine if demand will be increased or decreased. Charts are not considered or used by fundamental trading systems.
Advantages and Disadvantages
The advantages of using a fundamental trading system are very similar to the advantages of using fundamental analysis. Fundamental trading systems can be quite useful because they look at the real moving force behind a currency price movement, namely the demand for a currency. Their predictive power is quite accurate, particularly when they adopt an Intermarket approach.
The main disadvantage of using a fundamental trading system is that the economic reports can surprise everyone, including the experts. When that happens, the parameters will not be met or will fail, leading to losses. Another disadvantage is that the price change is often factored into the currency price by the time the economic data is released. So, even if the report is consistent with the analysts’ expectations, the price might not move or any price movement will not be strong or reliable.
An Important Decision
Trading systems are very useful, but they must also be consistent with your trading style. Choosing a trading system is one of the most important decisions that you will make as a trader. Take it seriously and it can improve your trades and reduce your trading stress.
