All profitable forex traders use a set of rules, a system to guide their decisions. Trading in the forex market without a well-defined system is the equivalent of gambling. It's vital to your success as a forex trader to find a profitable system and trade it.
Whether you're a fundamental analyst, checking the trends in interest rates, labor markets, and GDP or a purely technical trader, using Fibonacci retracements, pivot points, and technical indicators, you must have a set of rules that define your actions. Most importantly, you need to define the following five essential elements: entry point, exit point, stop loss, pairs to trade, and position size.
The entry point component of a system is probably the one that is paid the most attention. Finding a consistent approach to entering a trade is critical. You want to focus on consistency and objectivity and define a rule that is repeatable. You want to avoid a rule that relationships on historical observations or too heavily on interpretation.
The exit point rule is one that gives a lot of traders much trouble. You want to try to maximize profits as much possible but at the same time take a good profit when you've got one. There are basically two approaches to defining an exit point. The first is to use a pre-defined target or a specific number of pips. The second approach is to use a market-generated exit point, which can help to keep you in long-repeating trends and to maximize your profit.
The stop loss is an absolute must when trading forex. Fortunately, due to the 24 hour nature of forex, receiving good fills on stop losses is possible; there's very little risk of a gap beyond your stop price. Like the exit point rule, the stop loss rule has two solutions. You can use either a fixed stop loss or a stop loss that is based on your position size and the unique characteristics of the individual currency.
The fourth element of a successful forex system is deciding which pairs you're going to trade. This is a step that is often over-looked by new forex traders. Many beginners do not realize that a long in the EUR / USD and GBP / USD, for example, is a very similar trade; in fact, this combination may actually increase your risk. You need to define a rule that prevails you from over-leveraging a single currency or trading too many closely correlated pairs.
The fifth and final element of a successful forex trading system is determining the position size. This is probably the most-overlooked aspect of trading. Many beginners never even think about how much to invest in a single trade. Unfortunately, the lack of understanding of position size is the ruin of most new forex traders. The way around this risk is to divide your account into equal parts, and to spread your money out across multiple trades.
All good forex trading systems incorporate these five fundamental elements. If they do not, they are bound to fail. Make sure that you are refining entry and exit points, stop losses, pairs, and position size in your forex trading.