Manual Trading Systems

Chapter progress:

A manual trading system is one where the trading decision may be devised and delivered to you based on a computerized trading system, but you have to execute the trade yourself with your own hands. You can build your own manual system, or you can buy one or sometime acquire one free online. Purchased systems can take the form of software that you run yourself, or they can be in the form of a report that the advisor emails to you or makes available on a website.

Because you are required to input each trade, you also have the choice of declining to accept every trade the system recommends. It goes without saying that if you cherry-pick the trades and decline to take all of them, your performance track record will differ from the hypothetical track record of the trading system. Since we use indicators and mechanical trading systems to liberate us from impulse and emotion, it can take superhuman self-control to execute some trades the system dictates but that we think must be losers.

Second-guessing the system can be wise or foolish, depending on the environment and how slow or lagging the trading system may be. When a big event comes along that will cause an outright reversal, for example, the indicators in a particular system may not catch the reversal in the same period and you may have to wait for the next period to enter/exit. By then, a big opportunity has been lost. This is a case when overriding the system makes sense, but you need to be sure you really do have knowledge that rises to the standard of being worthy, and is not just chatter possibly maliciously designed to lure you into thinking something that is not actually true.

Many traders choose ready-made manual trading systems to avoid the lengthy and sometimes tedious preparation work of become truly expert in the Forex market, including being able to meld technical and fundamental factors. If you are a beginner or relative beginner, you should be careful when overriding a mechanical system on fundamental variables. After all, the price has already developed to its current state based on the trading actions of authentic experts, who know about the fundamentals, too. The classic statement that “the market price incorporates all known knowledge” is not fully accurate in Forex — some important knowledge is not widely known, like the positioning of big players (since we do not get accurate volume data in Forex). But some traders at the big banks and brokerages do have this knowledge and trade for their own account using it, with a heavy influence on the price. What makes you think you know better than they do? You may, but it pays to have high confidence in what you think you know if you are going to use it to override a trading system.

The essence of every trading system is specification of the buy/sell price levels together with defined exit levels, preferably both a stop-loss and a profit target. The chief advantage of a manual trading system — aside from being able to opt out of any particular trade — is that you are in full control of the indicator-based buy/sell rules (trading strategy) and also the pre-set stop and target criteria (money management tactics). A good manual trading system has flexible entry and exit rules and can also be visualized via charts for a better understanding.

If you decide to buy a trading system from someone, be careful. Some vendors will hype their indicators as the “most reliable” or “most profitable,” and if you see those words, run away and seek another system. Any indicator can be the best on some currency in some timeframe with some risk preference profile, but when it comes to trading systems, there is no “one size fits all.” The value of a manual trading systems depends not on the indicators themselves, but on the indicators being combined in such a way that they deliver more gains than losses. For a system to be profitable, the trade's expected payoff should be positive. This can be achieved even when the system delivers fewer winning than losing trades, as long as the average profit is sufficiently higher than the average loss.

This is why you want to see the track record of the system over a long period, to verify it is “robust,” meaning it continues to deliver a good gain/loss ratio over varying market conditions. A year or two is not enough — you want at least five years of continuous performance data. Moreover, it does not matter if the trades are actually executed by the system vendor, as long as the buy/sell signals are issued enough ahead of time for a reasonable trader to have been able to follow them, and the subsequent accounting of gains and losses matches up to the signals previously issued.

Another factor to consider in judging a manual trading system is its money management rules. We can easily agree that any number of equally valid indicator sets will come up with good entries, but for calculating profit and loss, it is when you exit that counts. A rule of thumb, and an excellent one, is that profit targets should always be bigger than stops. When this is the case, you can have 50% winning and 50% losing trades and still have a profitable system. Of course, it may be psychologically damaging to have half your trades be losers. To see if you can tolerate the gain/loss ratio, look at the track record. You should verify that the system really does apply a consistent stop/target rule and that it is suitable to your risk profile and capital stake. You should be able easily to understand the money management rules embedded in the system and you should be able to verify that what the vendors claims is what the vendor is delivering. For example, a standard approach to stops and targets is to make them a function of average true range, which of course varies quite considerably. If the stop/target is always a fixed number of points, then by definition the system does not use ATR to set stops. This is not to say ATR is the only or the best way to set stops/targets, but it is to say the money management rules should be disclosed and they should be verifiable.

Stops and targets are the bare minimum you should expect by way of money management. If you get additional tactics, like advice on scaling in and out or conditional trades, it is icing on the cake.

To summarize: there are a lot of disreputable system vendors and scam artists out there. Some system vendors use a single indicator over a few months and claim spectacular results. Needless to say, that indicator may never deliver again for a decade.

To avoid being cheated, you should be able to understand each of the indicators generating buy/sell signals and whether the manual trading system vendor uses “discretion” to override his own indicators. If you do not understand a signal reversal and after hard examination of the charts, still cannot see how the indicators could have generated a reversal, you should be able to question the vendor. You should understand the money management principles in use and verify that they are not just decorative lettuce on the promotion, but actually applied. And you should read the fine print. For example, one manual trading system may require a starting capital stake of $50,000 or $100,000. This is almost certainly because given the leverage and indicators in this system, drawdowns can be substantial and could take many months to recover. It would be fool-hardy to buy into a $50,000 system with $2,000 in starting capital.

Finally, take note that many expert traders who have developed their own trading systems continue to buy manual trading systems because another system can serve as a sanity check. Let’s say the traders’ own system always trades a pullback — fading the trend — and so does the outside system when the pullback is strong enough. The trader gets a sell signal but the other system does not. This gives the trader pause for a second consideration of the countertrend trade, and possibly saves him from a bad trade.

Quiz:

1. A manual trading system requires fancy software in addition to your broker/platform trading software.

2. You should never, ever override the system’s buy/sell and exit advice.

3. Manual trading systems should deliver indicator-based buy/sell signals but do not need to include money management rules likes stops and targets, scaling in and out, etc.

Done