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Building a trading strategy: how to develop your own Forex strategy | FxPro

Building a trading strategy: how to develop your own Forex strategy | FxPro

Table of Contents

In this article, we will focus on finding day trading strategies, particularly using technical analysis indicators. You will learn how to develop a trading strategy, find confident rationales for its signals, and start applying your new rules for making trades on a real account.

Most novice traders do not follow any strategy at all. They rely solely on their own visual assessment of the current price chart and are happy when they find even the professional term "Price Action Trading" for their activity (actually, PA is more than just looking at charts, but that's not the point now).

However, everyone who is mature enough to trade Forex competently is recommended to use auxiliary tools to confirm their trading hypothesis. Forex indicators are usually one of such tools.

What is a trading strategy?

A trading strategy is a sequence of actions, as well as a set of signals from various indicators, which together determine the conditions for opening and closing trades. In general, they are instructions on how to trade effectively based on your previous experience. Implicit in this definition of trading is the idea that strategies need to be tested.

Such a strategy should consist of a detailed investment plan, as well as a trading algorithm that specifies what is acceptable to you

  • risks on a per-transaction basis,
  • time horizon (the length of time your position will be in the market),
  • investment objectives (potential profit and possible losses),
  • as well as technical characteristics (conditions for opening and closing the deal).

Trading strategies can be created on the basis of information obtained on the Internet for trading either manually or with the participation of trading robots (mechanical trading systems with a built-in algorithm). One of the most difficult methods is visual development of your strategy, i.e. trying to trade according to the same Price Action, only with the need to identify Japanese candlestick patterns on the charts. The risk of making a mistake and seeing a pattern not where it is actually forming is very high.

As a result, you may end up with a trading strategy that can automate all or part of your trading process. If you are going to use automated algorithms, you can modify them for both aggressive and conservative trading styles.

How to develop your own trading strategy?

Intraday trading

For intraday trading, start by selecting one stock, currency pair or futures contract that you will trade, making trades exclusively intraday, not carrying them through the night. Typically, a trader opens and closes 3-10 orders per day with an average profitability of 20-50 pips. Once you identify a strategy that works with one asset, you can probably adapt it to other markets as well. Typically, traders start with the most popular currency pairs EURUSD or GBPUSD. If you want to begin your journey in the futures market, you can start with the S&P500 Emini (ES).

Trading on fluctuations

These are usually news trading and scalping with different trade durations. If you trade CFDs on stocks, make it a rule to identify the assets with the greatest potential for you every week. There are more than 2000 of them on the FxPro platform. Stock market analytics, as well as communication in traders' chats will help you choose the trading instrument that will be in the center of attention in the near future.

For example, there is a week of quarterly reports from US companies ahead. Watch which ones will publish their data this week and get ready to trade on these assets. Your task is to observe the chart and understand how you can use a similar event for your trading in the future. Typically, increased volatility on the chart of a stock and currency pair begins a few hours before a report is released and plays out in the first few minutes after the release. Be sure to keep in mind that price movements can be extremely sharp and unpredictable. If you want to trade on currency pairs, pay attention to the indicators that are published in the Economic Calendar on the FxPro website. Currency quotes can react strongly both before and immediately after the publication of the data.

Once you have decided on the asset and trading style, start watching the market. And it is best to watch not just one, but several charts at once. It is not recommended to open trades at this time of development, because you do not have a strategy as such yet! It is better to look at changes in the behavior of the price chart on different timeframes: from 5 minutes to months. After all, choosing the period for trading is also an important part of the plan.

Next, we will talk about how to justify a trading strategy, i.e. to select specific criteria for your algorithm.

Logical rationale for trading

So, a close look at the charts of currency pairs or stocks begins by looking for areas and moments where profits could be made. Usually, one starts by looking at larger price movements on historical data. Then draw your own conclusion as to what was happening on the chart that could suggest to the trader a good time to open a trade.

Next, it makes sense to look at charts of other timeframes and other assets (if we are developing day trading strategies) and try to find similar movements, i.e. market reactions to similar events (e.g. NFP news publication), but at a different time (a month or two ago). This will help us find a rationale for the terms of our trading strategy.

In this way, you will be able to see patterns and as a result you will have a strategy hypothesis. For example, you will notice that volatility on pairs with the dollar usually increases 3 hours before the publication of Nonfarm Payrolls, and in the last two months reacts to the publication with negativity, as if all positive expectations of traders have already been put into the price earlier.

However, remember that conclusions should be your own. If you are basing your conclusions on the reasoning of an analyst from the Internet, be sure to test his hypotheses on a demo account before opening real trades. Also remember that previous price movements do not guarantee that an asset will react the same way in the future. However, the chances that the action will repeat itself if it has occurred several times in the past do increase.

Strategy testing

Once you have a working idea for a trading strategy, for which you also have a rationale based on historical data, you can start to elaborate in more detail. To do this, see if your new strategy works on recent price movements: choose several charts of currencies (for example, with the dollar) and look at them for different periods. Now your task is to find 10 or more "trading signals", i.e. justified good moments to open a trade. Remember that the justification for each of them must be the same, otherwise it is not a signal at all.

Let's say you decide that with every positive Nonfarm Payrolls report you will open a buy trade on USDJPY, and with every negative report you will place a sell position on the pair.

Rewind the chart back a few months. At the same time, open the Economic Calendar for previous periods. See when NFP was better than expected and imagine that you opened a buy trade at that moment. Go back to the chart: would you have made money that way? Or did the market behave illogically and the price of the pair began to fall? Most likely, you will come to the conclusion that your hypothesis does not give profit in 100% of cases, and this is normal.

The main thing is to test the trading strategy for success by adding up all the trades with a minus and trades with a plus. What result did you get for six months? Has your account turned out to be in the plus? Did you come up with a working hypothesis for the trading strategy? It can easily turn out that it is not. It may even happen that you have no ideas for a strategy based on fundamental analysis. Then a more stable variant comes to your aid - strategies based on signals from technical indicators.

If significant economic news or company reports are not published very often, technical indicators analyze price behavior from morning to evening, allowing you to keep trading even at night. However, for this purpose you will have to put the chosen algorithm into the basis of the robot and install it to trade non-stop on a dedicated personal VPS server. FxPro managers will tell you more about it.

Stages of technical trading strategy

So, how to successfully develop a trading strategy based on technical indicators? A technical strategy usually includes several stages, each of which should be recorded in the Trader's Diary (Journal), which we will discuss below.

1. Determine the type of market and type of transaction

If you want to develop a technical trading strategy, you need to write down at once what market you are trading on (currencies, stocks, metals, etc.), on what asset, what timeframe and duration of the transaction you prefer, as well as what will be the duration of each transaction (at least approximately). For example, if we are talking about a two or three month long trade, there is no point in worrying about price changes within one hour - the market will change a million times before your position is closed.

At the same time, if the trade is for a short period of time (say, a few hours or even days), you may want to study the charts for longer periods to get an idea of the bigger picture and the overall trend. Here's what this is for: if the price suddenly goes against you in the short term, but you know that the trend of the month is upward, so chances are high that the quotes will still return to the medium-term path that you have laid down on the scale of a few weeks.

2. Select technical indicators

It is impossible to build a trading strategy without determining the technical indicators that will form its basis.

Based on the criteria discussed in the previous paragraph, you should select the appropriate filters for the chart under study. You should have a good understanding of at least the basic built-in indicators and understand when it is appropriate to use them. In this case, you will interpret their signals more accurately and be able to open trades more often.

Thus, if the market is trending, there is no point in using RSI, which will show itself well during chart reversals. At the same time, if the market is characterized by wide uncertain fluctuations, moving averages (SMA) are unlikely to be of much use. If the underlying currency pair is highly cyclical (for example, if the currency is issued by a commodity-exporting country), the Commodity Channel Index (CCI) may be an appropriate choice. Also, if the chart is highly volatile, smoothing out the fluctuations with moving average crossovers may be just right.

Let's summarize:

  • Since different instruments experience different phases of price fluctuations, you should have 3-5 trading strategies in your arsenal for market situations of trend, reversal, flat, news trading, etc. You can use them either one by one, based on the specific market phase and situation, or you can define for yourself only the only conditions under which you will enter the market.
  • It is extremely risky to base a robot on one algorithm, run it and forget about it, believing that this instruction will become a universal magic wand for any market situation. Accordingly, even mechanical trading systems must be corrected by hand or a new one must be started, pausing the previous one.

3. Specify periods and other input data

Having chosen technical tools for their trading strategies, the trader must logically select the periods and ranges whose values should be transmitted to the software (your Expert Advisor).

For example, you must answer the question for yourself: for a trading strategy based on RSI, do you choose a period of 14, 10 or 7? Or what will be the periods of the moving averages that make up the MACD indicator?

Don't worry if you don't know the right answers right away. They will come only with experience, which is gained on a practice demo account.

4. Start looking for signals

Once the technical tools for trading strategies are set up, you need to learn how to properly search for signals based on your indicators. They should show you current trading opportunities to open trades, acting as a financial advisor.

For example, you look at the moving averages and wait for the moment of their crossing, or wait for the appearance of divergence between the movement of the MACD oscillator and the asset chart. The main purpose of such observation is to confirm your hypotheses embedded in the combination of indicators and learn how to profit from the received signals.

What are trading signals in simple words? Let's look at examples:

  • the price moves in the channel, pushing from one or the other border. The moment of reversal will be the signal to open a deal;
  • crossings of indicator lines (for example, SMAs with different periods);
  • divergence (divergence) between the price movement and the oscillator;
  • breakthroughs of channel boundaries or support and resistance lines;
  • appearance of additional Japanese candlestick figures, etc.

5. Analyze

After making a decision to open a deal based on the trading strategy signals, we will analyze it, determining the working entry points, as well as the rules and algorithm for exiting the market. The last point, by the way, is very important: traders lose a significant part of their profits precisely because of ill-considered moments of closing positions. In addition, it is necessary to calculate effective volumes of transactions, taking into account fundamental and technical analysis of the market and using the principles of money management.

When analyzing data, a trader should focus on trading signals related to the period and plan we have chosen. Opening a trade should be a clear and informed action.

6. Compare the results and make the transaction

After studying the various scenarios presented on the charts and determining which one is valid, the trader will compare them in terms of reliability and potential profit. For example, how consistent the indicator values are with the signals, and what profit or loss will be realized if the Take Profit or Stop Loss protective orders are triggered. Once this is done, the trader will choose the trade that offers the highest return with the lowest risk based on the most controversial technical scenario.

It follows from the above that if a trader uses a trend strategy, he will wait for a correction, entering trades against the current movement based on the indications of the main trend. Or, when a speculator uses channel tactics, his main task will be to watch for the price approaching the range boundaries to open positions for breakout or rebound.

When to move to a real account?

Demo accounts are used by beginners, and as strange as it may sound, but also by professional traders, at various stages of work on trading strategies. You should always first of all check how certain algorithm changes work on a demo account, and only then on a real one.

If your strategy shows successful results on the demo, you can move to a real account. However, each trader determines this moment for himself, and no specific recommendations should be given. The simplest answer is: when you and your strategy are ready for it.

Why do you need a transaction diary?

Forex trading journal is on the one hand a chronological record of your actions on the account, and on the other hand, answers to questions about the work of the trading strategy. In the journal, traders record various characteristics of completed trades - from indicator readings to their own emotions. At first it seems that this process may take too much time, but then you begin to understand what exactly you need for future analysis, and reduce the list to the minimum you need.

But you can start by asking general questions before you start trading:

  • What is the best time for me to enter the market? (Morning, afternoon, evening, specific hours, lunch break, etc.)
  • How much time and when do I have to analyze the market and events?
  • What assets do I prefer for trading? (Forex, stocks, CFDs, futures, etc.)
  • How long do I plan to keep the trade active?
  • At what times will I not open a trade even if there is a signal? (Holidays, before a news release, etc.)

Choosing the moment to enter a deal

  • What specific event would tell me that now is the time to open a position?
  • Which way do I prefer to enter a trade: market order, limit order, stop order, stop limit order? Which type is best for what I am trying to accomplish?
  • Which of the actions I took earlier will help me enter the deal more effectively now?
  • Is there a suitable signal to enter a position now? What is my prediction of the movement potential?
  • Are all the rules of my strategy for entering a trade fully implemented?

Choice of the moment of exit from the deal

  • Entering the market correctly is half of the possible profit. But it is equally important to understand when the trade will be closed. Do I understand now when the trade will be closed with a profit or loss?
  • What trading signals do I use to close a trade?
  • How do I know the trend is over and there will be a trend reversal?
  • How far can the price go against the trend before it rolls back? Do I want to close the trade before the first major pullback or will I sit it out?
  • If my entry criteria for a trade disappears, can I use that as an exit signal?
  • How long can I stay in a trend trade to capture most of it, but not lose too much profit when it reverses?
  • Not every trade you enter will be successful. So think about where to place your stop loss so that your risk is limited.
  • Would a trailing stop allow me to make a bigger profit? If yes, what should it be?
  • Will Take Profit work with my trading strategy algorithm?

Money Management

  • Developing a trading strategy also involves money management. It helps us determine whether a trade is worth taking, how much risk are we willing to take, and does the potential reward justify taking the risk in the first place?
  • What is the risk in dollars based on entry point and stop loss based on position size? The amount lost if the price reaches the stop loss should not exceed 5% of the total account balance, and ideally 2-3%
  • What is the potential profit from the transaction? What can be the maximum loss in pips and monetary units?
  • Based on the two answers above, should I make the trade? If the risk is too great or I start acting too late, I need to adjust. If I lose too much profit when prices reverse, I need to adjust.
  • For day trading, the profit should be 1.5 times the risk. For swing trading, the profit should be twice the risk. It is worth looking not at each trade, but at the average value for the whole trade.

If you lost a lot of money implementing the strategy, it would tell you something worthwhile: perhaps if you do the opposite of the actions that caused the loss, they will have a positive result. Think about it, if the strategy is making you losses, it means that someone else is making them. Try to understand what this group of traders is doing!

In short, it pays to analyze the financial charts looking for profit opportunities. Explore these opportunities and consider how you can turn them into real money without exposing yourself to excessive risk.

Conclusion

Technical trading strategies are created by combining indicator signals and patterns. It is a good idea to combine them with price patterns to get more reliable indications of a potential trade. For example, a MACD crossover after a major counter-trend move can be much more reliable as a trading signal than a MACD value at another point in time, however extreme it may be.

In short, instead of absolute values, the technical analyst will prefer to focus on the rarer phenomena we have just discussed. In the following chapters of this section, we will discuss technical strategies in more detail.

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