How do I Choose the Best Forex Trading System?

Choosing the best forex trading system depends in large part on the trader’s bankroll and disposition. Forex trading is an around the clock Monday through Friday operation, and so provides day-trading opportunities in any time zone, even for the part time trader. A position trader, one who watches the market before taking a position and then stays in the position for days and weeks, also can find or create a forex trading system suitable for his time frame. Positions systems require significantly more capital than day trading systems.

Forex trading systems divide into two types. One is entirely or nearly entirely computerized, while the other relies on the trader’s judgment and pattern recognition skills. The latter are called “discretionary systems.” Wholly computerized systems can be purchased or built if the trader has computer skills. Discretionary systems require a lot of training time for the trader.

Learning to trade a discretionary system takes time and practice. Discretionary systems often have higher winning percentages, at least on paper. Under the stress of trading, a trader is much more likely to make a poor trading decision than is a computer. The success of a discretionary system is directly related to a trader's experience, risk tolerance, and knowledge of forex trading markets and trends.

Computerized systems’ greatest weakness is a lack of adaptability to changing market environments. They will usually have periods of good performance interspersed with periods of poor performance. The great strength of a computerized forex trading system is that it relies nearly exclusively on quantitative analysis. Two popular approaches to computerized systems are price breakout and volatility breakout entries, combined with any number of exit paradigms.

Actual evaluation of forex trading systems requires that the trader generate some trading data and do some simple arithmetic. The data the trader needs to generate include the percentage of win, the average win, the average loss, and the largest loss. Trader’s “edge” equals the win percentage multiplied by the average win, minus 1 minus the win percentage multiplied by the average loss. This is called “mathematical expectation.”

If the trader’s edge is negative, he will go broke using this forex trading system. The size of the edge matters, and it is very hard to make money if your edge is $1 per trade, unless your are trading many times an hour. Even then, you could give back all your winnings in one unexpected loss.