It will be no surprise to hear that the best forex trading systems are the ones that make money! The problem is simply how to identify which ones those are, and in particular, how to decide which system will be best for an individual trader, i.e. you.
First let’s rule out some systems that never make money for anybody, at least not in the long term. These are the kind of systems that gamblers sometimes call loss recovery systems. They involve varying the risk according to whether the last trade won or lost.
The idea is that if your last trade lost, then your next is more likely to win, so you take a bigger position. However this idea is completely wrong. Statistics disprove it every time. Gamblers lose their shirts on these systems and it would be crazy for a forex trader to use a system like that.
So with that rant out of the way, let’s look at how to identify a profitable system. To do that we will introduce the concept of edge.
Edge is the measure of a system’s returns over a period of time. It is a simple calculation but you do need a reasonable number of results to measure it from. Back testing is a good way to get those results.
Demo testing is even better because it is closer to the real situation, but it can take a long time to collect enough results from demo testing so most people use back tests which are quicker.
Edge is simply the probability of a win multiplied by the average profit on a winning trade, minus the probability of a loss multiplied by the average loss on a losing trade. Results are calculated after subtracting the spread and any other per trade costs.
So if we take a scalping system that makes an average of 20 pips on a profitable trade and loses an average 30 pips on a losing trade, with 80% of its trades being profitable and only 20% losses, this is the edge for this system:
Edge = (80% x 20 pips) – (20% x 30 pips) = 10 pips
That would be a profitable system and a good one to use if you were interested in becoming a scalper. However, you might find a very different type of system that had results that were just as good.
For example, you might come across a system that worked the opposite way, with a lot of small losses, say 60% losses of 10 pips each time, and then some bigger gains, making say 40 pips average profit on successful trades. For this system,
Edge = (40% x 40) – (60% x 10) = 10 pips
So these two very different systems have exactly the same results, and the decision on which was the best forex trading system for you would be entirely dependent on your trading style.
A good way to test this out would be to operate both systems in a demo account, say for one month each. At the end of the month you could analyze the theoretical results from a back test over the month to see how your own results varied from the back tests.
This would give you an idea of how successful you would be operating that system for real. Comparing with back test results for the same period would prevent you from throwing out a system just because it happened to have a bad month. This could be a useful comparison when selecting the best forex trading system from a number of systems that are profitable in theory.
