How to develop your own trading strategy
Hello. Sooner or later, every beginner forex trader comes to the understanding that he needs his own trading system. You can, of course, use ready-made Forex strategies, but they should also be tailored to suit your own trading style. In this lesson we will talk about the essential components of a trading strategy, why a trader needs it and what questions should be asked when developing a system that suits you.
What is a trading strategy?
A trading strategy is a set of rules that allow you to systematize trade, give a trader a clear idea of when to enter a transaction, when it is time to exit it, and when it is better to refrain from trading at all. The system also provides at what time and on which timeframe to trade, which currency pairs to use and with what lot to enter into transactions. TS helps to turn off emotions and protect themselves from their negative impact on trading.
Trading system advantages
There are several obvious advantages of trading by strategy:
- Statistical advantage. A trader knows that, if the TS rules are followed, there will be more profitable trades than unprofitable ones, and as a result, he will be in positive territory (if this was confirmed by preliminary testing on history). Even if a series of losing trades has occurred, the trader knows that the situation is likely to improve;
- Every time a trader does not need to guess whether or not to open a deal. It only follows the signals of the vehicle;
- The trader is easier psychologically. Greed, fear and the desire to recoup by increasing the lot, it is easier to control when there are clear rules that make the trader more a performer than a decision maker.
We can say that the strategy turns Forex trading from an exciting activity into a routine, but most traders come to the market to earn money rather than play, and the TS helps them achieve their main goal.
Why create your own vehicle?
There are many ready-made trading systems on the market, both simple and rather complex and understandable only to professionals. Beginners, as a rule, start trading using a finished vehicle, and not the most difficult one. However, over time, almost every one of them understands that trading truly effectively is possible only with a strategy developed personally, based on their own experience and preferences.
Not always TS is developed from scratch. Often (especially if this is the first experience of a trader in creating a strategy), a ready-made system is taken, and some changes are made to it: indicators are added, parameters of already installed tools are changed, etc.
Regardless of whether a trader creates a strategy from scratch or modifies a finished one, it is necessary that it be suitable for him in character: scalping is hardly suitable for a thoughtful and prudent person, just as long-term trading may not suit another.
Mandatory components of a trading strategy
Each strategy should include certain points, which together will ensure the stability of trade:
- Rationale. This is the main idea on which the trading strategy is based. It is the foundation on which all other components are based;
- Currency pairs for trading;
- Timeframe and trading time (trading session);
- Entry rules (signals for opening a position);
- Exit rules. How are stop loss and take profit set;
- Trading lot volume and risk limitation.
If all these parameters are taken into account, you can start testing the strategy on the history or demo account.
An example of developing a trading strategy structure
In order to better understand the mechanism of creating a trading system, we will analyze its structure using a specific example.
First of all, you need to decide on the main idea of the strategy. This may be some specific dependence or pattern in the behavior of the price, on the basis of which it can be predicted its further movement.
For example, we noticed that the market, even being in a trend, never moves smoothly and smoothly: there are always some corrections and price fluctuations that are opposite to the main movement. We will build our trading system on this idea: by entering the market after correction, you can get more profit and increase the chances that the price will, in principle, go in the right direction.
Based on the general concept, entry rules are immediately determined - at the moment of price reversal in the direction of the global trend. To determine these points, tools are selected, a timeframe and a currency pair are selected, etc.
Another example: we noticed that the EURUSD and USDCHF currency pairs often move in a mirror relative to each other and when one of the pairs starts moving up, the second will soon start moving down, and vice versa. Therefore, having noticed that a new trend has begun on one of the assets, you can open a deal for another currency pair in the opposite direction, having every reason to count on speedy movement.
In this case, the issue of assets for trading is immediately resolved, since there are no more correlating currency pairs on the market.
The choice of time frame depends on how much time the trader is ready to devote to trading. If on the daily charts the formation of a candle takes a whole day, respectively, to assess the situation and make a decision, it will take only a few minutes a day, then on M1 everything changes every minute, and the trader will need to constantly be present at the trading terminal. The smaller the timeframe, the more signals will come, respectively, the greater the potential profit. However, not everyone has the opportunity to devote all day to trading, and for working people a daily schedule would be the best option.
It is also believed that technical analysis works better on daily charts than on hourly charts, and especially on minute charts, so D1 will be the best choice for beginners. Most often, traders work on D1-M15, five-minute and minute charts are too unpredictable, and only highly specialized professionals can earn stable money on them.
In most cases, it is optimal to choose EURUSD or another currency pair major as the trading asset. In the MetaTrader 4 trading terminal, you can choose to display only the necessary assets by right-clicking on the "Market Watch" field and selecting "Character Set" - "Forex".
In the case when the idea itself is tailored for a specific asset (for example, gold or the S&P 500 index), the choice is completely obvious.
Selection of tools for analysis
After the trading idea becomes clear, the timeframe and currency pairs for trading are selected, you need to decide on the tools for analyzing and determining entry and exit points. The main rule in this matter is not to overdo it. As a rule, simple systems show themselves most effectively in real trading. In the same TS, which are oversaturated with indicators, various constructions and other signals, these tools often contradict each other, only confusing the trader and provoking him to mistakes.
If the strategy is indicator, then, as a rule, it should have from 2 to 5 instruments. The required minimum is one trend indicator that determines the direction of opening a transaction, and one overbought / oversold indicator (oscillator), which helps to avoid false entries.
If the strategy is focused on candlestick analysis, then the trader needs to be well-versed in Price Action patterns. If you plan to use graphical analysis, you need good knowledge of the figures (triangles, flags and pennants, double peaks, etc.).
It is also necessary to decide whether news and important economic events will be taken into account (if the vehicle itself is based on a technical analysis). If the system is based on fundamental analysis, you need to decide which news to trade. News can be tracked using the economic calendar and special indicators.
Entry and Exit Rules
First of all, it is necessary to decide what type of orders will be used to enter the market: pending or market ones. Pending orders, on the one hand, help to avoid false entrances, but on the other hand, they take part of the profit due to the fact that the price travels a certain distance until the moment the order is activated.
It is also necessary to decide in advance by what principle take profit and stop loss will be set. In some vehicles, setting a take is optional (for example, when using a trailing stop), however, stop loss should always be set. Stop loss is primarily a risk limiter, and protects the trader’s capital from force majeure, for example, from disconnecting the Internet or electricity.
After all the rules are defined, they must be fixed on paper or in a separate file - i.e. checklist required. Then you can start testing the vehicle.
Testing on history and demo account
First of all, the strategy needs to be tested on history. This will give statistics and a primary understanding of its profitability. However, historical data lose relevance over time, so the behavior of the strategy in the real market will provide more useful information.
Before entering the real account, the TS must be tested on a demo. Testing time depends on the timeframe: when trading on H1-H4 or, especially, D1, it will take at least several months to determine profitability, while the effectiveness of a scalping strategy can be determined in a week.
Each trader should have a trading system. Sometimes it seems to newcomers that they will be able to trade exclusively by intuition, especially if this error is confirmed by a couple of successful transactions. In addition, there are cases when experienced traders opened transactions by intuition or contrary to the rules of the system and earned a lot of money.
However, experience is a key factor in this exception. A professional trader is able to understand when you can turn on intuition, and when you should work clearly on the system. As a rule, intuition is used very rarely, and rather in order not to enter the market on a signal, rather than then, to open a deal not according to the rules and get a loss.
In any case, only professionals with years or even tens of years of experience can afford such actions without serious risk to capital. For beginners, determined to learn how to make money on Forex, there is only one right way - the way of system trading.
In addition, there is one point that very experienced traders often miss in their trading. it Rationale trading strategy. This is very important, so even if you already have a lot of practice working on Forex, watch at least a part of the video that talks about what each system should have Main ideaon which it is built.