Developing a forex trading strategy guarantees better results
Forex traders regardless of their experience or skill eventually forget that while a big move in the market can help reach their goals much faster, if they are proven wrong, it can set them back or completely wipe out their entire investment.
This is why sticking to a trading strategy or at least an overarching trading plan with clear entry and exit rules is so important to your survival as a trader. Spotting a big opportunity on the fly and realizing a big profit is great when it happens, but the main objective here should be to formulate a strategy that provides you with consistent results regardless of isolated intraday movements.
What comprises a forex trading strategy?
While trading strategies can differ both in scope and complexity, their main purpose is the same. To help determine if an asset or currency pair, in this case, is favorable to trade and if you should buy or sell.
Doing your research or market analysis can help identify the best possible time to enter a trade in order to realize the highest profit. Timing is an important factor in trading because forex is a fast-moving market and huge price movements can be completed in seconds. Therefore, if you fail to identify and open a position in time, you can easily miss an extremely profitable opportunity. In short, the faster you manage to enter a trade before a big move, the higher the potential profit.
Market analysis is the first step in every successful trading strategy, and this can be broken down to fundamental and technical analysis. Fundamental analysis refers to trading based on fundamental indicators or key news and announcements that have a tendency to affect the financial markets while technical analysis involves looking at the charts and historical price patterns to determine where the market will move next.
Arguably, traders can base their forex strategy on both of these forms of market analysis and still be successful. In fact, it’s ideal that you are fluent in market developments around the globe and also proficient in utilizing some basic technical indicators such as the Moving Average and Support and Resistance levels.
In order for a trading strategy to be effective, however, the trader must also have the discipline to follow the rules consistently. Otherwise, any potential profit may be eliminated in just a couple of trades – especially if these are placed without a planned entry or exit strategy.
How to create a trading strategy
There’s a number of proven forex trading strategies that you can make use of and these are varied enough to suit the style and goals of any retail trader. Sometimes, however, it’s best to invest the time to developing a strategy from scratch in order to ensure that you understand how everything works.
- Decide on the timeframe. The price chart can be adjusted according to the timeframe you prefer trading with. In general, the more aggressive strategies that focus on short-term results are traded on the lower timeframes like the M15, M30, H1 which represent the movements of the price in increments of 15 minutes, 30 minutes and of 1 hour. If you want to see the bigger picture, it’s best to move to higher frames like the H4, D1, W1 or even the monthly chart. Regardless of your main timeframe, however, you can switch it up in order to confirm an entry signal.
- Discover which tools can help you determine when the market will start a new trend. This is where the technical indicators come in and the Moving Average (MA) indicator we mentioned before is a perfect example of an indicator that can help identify a trend.
- Confirm your findings. Technical indicators aren’t always reliable and there is a chance they will provide you with a false positive. If you want to ensure that your results are correct, you need to employ another indicator like the Moving Average Convergence Divergence (MACD). This indicator may used to determine if the market is moving upwards or downwards and when used in conjunction with the MA, it can help you confirm that there is a new trend forming as well as the direction of said trend.
- Set a risk limit and employ risk management with every trade. Forex trading is a volatile investment and traders bear the risk of loss of their invested capital. Therefore, the first rule of risk management is to not invest money that you can’t afford to risk in the first place. The next rule would be to decide how much money you are willing to risk in every trade and it’s commonly accepted that you shouldn’t risk more than 2-3% of your total account in a single trade. As the market is quite volatile, you should make sure that you have enough equity available to sustain potential losses and this rule guarantees that your account will survive even the harshest of losing streaks.
The only thing that all traders can agree on is that nobody succeeded in the markets by trading blind without a clearly defined trading plan in place. There are short-term traders who open hundreds of trades in a single day and there are traders who keep a couple positions open for weeks or even months and both groups can be successful as long there is an underlying strategy that needs to be followed and keep them accountable.
If the strategy you have chosen or created doesn’t seem to provide the results you were aiming for, you can always switch to a different one, but trading merely on whim or trading based on rumors from forums isn’t going to get you any better results in the long-term.
Thankfully, you can test out your trading strategy on a demo account without risking real money. Trading on demo is highly advised for beginner traders or traders who are trying a different strategy with indicators they aren’t familiar with yet.