4 Basic Ways to Create Trading Filters
Forex trading systems are not a new thing. In fact, they have been around for at least 40 years and since there is great wealth to be made from trading, plenty of resources have been spent looking for winning formulas.
Because of this, many of the simple technical strategies that were once used on financial markets no longer work.
Money can still be made, however, and trading systems need to evolve in order to make this a real possibility.
One way traders can improve their trading systems is to create filters. By doing so, they can set their systems to only trade when the perfect conditions lineup.
Filter 1: The overall market
One way to filter your trades is to watch what’s going on in the overall market. If you trade GBPUSD and you get a signal to go long, that signal will likely be more successful if the overall trend for GBPUSD is up too.
You can therefore set up a filter to only trade when the longer term trend is up. As an example, you could limit your system to only trade when the 50 EMA is above the 200 EMA. This can be applied just as easily for short positions too.
Filter 2: Previous trade
One filter that was successfully used by the Turtle Traders (led by Richard Dennis) was to only take a trade if the previous signal would also have made a profit. The Turtle Traders found that limiting their trades in this way allowed a higher percentage of winners, probably because it made it easier to find better trending markets.
Filter 3: Volatility
Another way to filter trades is to use volatility. Sometimes, a system will get a signal to go long during quiet markets. During quiet markets, volatility is low and signals are generally not as strong. By limiting the system to only trade when a signal occurs and volatility is reasonable helps the system take real higher probability trades.
Similarly, too much volatility can be bad because it can lead to irrational markets and whipsaws. In this instance it’s possible to limit trades where the volatility is too high.
Filter 4: Strength and other indicators
Other indicators such as RSI or MACD can also be used to provide extra confidence to a trade, this is especially true when you get a signal but your intuition tells you it could be a bad trade.
Consider a situation where you get a signal to go long on GBPUSD but the market has already made excessive new highs. The market may even be looking parabolic in nature. In this situation you can use a filter to only take the first or second breakout or long signal. This would stop the system from taking trades right at the top.