The aim of this article is to aid in the development of a profitable forex system through currency trading education. The most important factors in relation to developing a trading system is risk management. It may be boring but, I kid you not, executed properly the results are exhilarating. In my own experiences in system development some of the most effective factors are positive expectancy, draw-down percentage, and kelly ratio. There are definitely others but for now I will concentrate on these three.
In terms of developing a profitable forex system, and currency trading education as well, positive expectancy is the most important factor. It is, in essence, a calculation that determines whether or not a system will return a profit. It calculates how much we can expect, on average, to make (or lose) per trade. Take a look and you can see that, for example, a system with a low win rate can be a winner and one with a high win rate can be a loser.
formula:
Expectancy = (Wins% x Avg. win size) – (Losses% x Avg. loss size)
example 1:
Expectancy = (30% x $300) – (70% x $100) = $20
example 2:
Expectancy = (90% x $50) – (10% x $500) = -$5
So we can see from the above examples that for the first system each trade will return an average of $20. This is positive expectancy. The second system, however, shows an average loss of $5 per trade: a negative expectancy.
Obviously it is essential to have a positive expectancy to make a profit in forex trading. Therefore it would be folly not to factor it into developing a forex system, and your currency trading education in general. I use this calculation and I strongly urge you to do so also.
Draw-down percentage is the next thing to look at in relation to developing a profitable forex system and currency trading education. This factor is the highest amount, in percentage terms, that your system will lose before continuing above the previous high.
Example:
Your trading account makes a high of $11000 before a string of losing trades resulting in a low of $9000. Then there is a winning period which takes the balance up to $12000.
Draw-down therefore is:
$11000 – $9000 = $2000
We then express this as a percentage of capital it previous high:
$2000 / $11000 = 18.2%
The purpose of this calculation is to find the largest “peak to trough” draw-down in percentage terms. From this we can decide whether this is an acceptable amount of capital to lose when testing and, if so, prepare for such an occurrence in the future. What I do with my own systems is to allow for a slightly larger draw-down than in testing. I can then make a “line in the sand” whereby if the maximum allowable draw-down is reached then the system is back to the drawing board.
Your development of a forex system, and currency trading education would be incomplete without utilizing draw-down percentage. It is another factor that I would not trade a system without knowing in advance. I do like the smell of cash you know.
The “Kelly Formula” is another useful tool in developing a profitable forex system, and your currency trading education as well. It calculates how much risk a system can absorb and is particularly useful when comparing systems. Essentially the higher the kelly% the less risky its is. Here are the results of two real life systems with the exact same positive expectancy of $23 per trade.
Formula:
Kelly % = Win% – [(1-Win%)/(Avg. win/Avg. loss]
Example 1:
Win rate= 60%Avg. win= 105Avg. loss= 100
Kelly= 0.6- [(1-0.6)/(105/100)] = 0.6- [0.4/1.05] = 0.6- 0.38 = 22%
Example 2:
Win rate= 30%Avg. win= 310Avg. loss= 100
Kelly= 0.3- [(1-0.3)/(310/100)] = 0.3- [0.7/3.1] = 0.3- 0.23 = 7%
As you can see, the first system is a far better trading candidate. It offers the opportunity to use more leverage and will almost certainly incur less draw-down. This formula has served me well as I am sure it will you too.
I hope you have found this article helpful in developing a profitable forex system, and your currency trading education as well. I know that without these things to aid me I would be lucky to turn a profit at all. By using them yourself you are on the right track to forex trading profit.
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