How to Develop Your Own Forex Strategy
In this article, we will focus on finding day trading strategies, specifically using technical analysis indicators. You will learn how to develop a trading strategy, find solid grounds for its signals, and start applying your new live trading rules.
Most beginner 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 even find the professional term “Price Action Trading” for their occupation (actually, PA is not just looking at charts, but this is not about that now).
Nevertheless, everyone who has already matured to trade Forex competently is recommended to use auxiliary tools to confirm their trading hypothesis. One of these tools is usually Forex indicators.
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 transactions.
In general, these are instructions for conducting effective trading based on your previous experience.
In this definition of trading lies the idea that strategies need to be tested.
Such a strategy should consist of a detailed investment plan, as well as a trading algorithm, which indicates the acceptable
- risks per trade,
- time horizon (the period during which your position will be in the market),
- investment objectives (potential profit and possible losses),
- as well as technical characteristics (conditions for opening and closing a transaction).
Trading strategies can be created on the basis of information obtained on the Internet for trading both manually and with the participation of trading robots (mechanical trading systems with a built-in algorithm). One of the most difficult methods is the visual development of your strategy, i.e. an attempt to trade on 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 figure not where it is actually formed is very high.
As a result, you can get 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 both for an aggressive trading style and for a conservative one.
How to develop your own trading strategy?
For intraday trading, start by choosing one stock, currency pair, or futures contract that you will trade exclusively intraday, not overnight. Usually a trader opens and closes 3-10 orders per day with an average profit of 20-50 pips.
Once you have a strategy that works for one asset, you can probably adapt it to other markets as well. Typically, traders start with the most popular EURUSD or GBPUSD currency pairs. If you want to start your journey in the futures market, you can start with the S&P500 Emini (ES).
Usually this is news trading and scalping with different duration of transactions. If you are a stock CFD trader, make it a point to identify the assets with the highest potential every week. There are more than 2,000 of them on the FxPro platform. Stock market analytics, as well as communication in traders' chats, will help you choose a trading instrument that will be in the spotlight in the near future.
For example, ahead of a week of quarterly reports of American companies. See which of them 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. Usually, increased volatility on the chart of a stock and a currency pair begins a few hours before the publication of the report and wins back in the first minutes after publication. 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 in the period before and immediately after the publication of the data.
Once you have decided on an asset and trading style, start watching the market. And best of all, not behind one, but immediately behind several charts. At this time of development, it is highly not recommended to open deals, 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 a period for trading is also an important part of the plan.
Next, we will talk about how to justify a trading strategy, i.e. select specific criteria for the algorithm you have outlined.
Rationale for trading
So, a close examination of the charts of currency pairs or stocks begins with the search for areas and moments in which one could make a profit. One usually starts by looking at larger historical price movements. Then they make their own conclusion about what happened on the chart, which could tell the trader a good moment to open a deal.
Next, it makes sense to look at the 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 (for example, the publication of NFP news), but at a different time (a month or two ago). This will help us find the rationale for the terms of our trading strategy.
Thus, you will be able to see the patterns and as a result you will have a strategy hypothesis. For example, you will notice that the volatility on pairs with the dollar usually increases 3 hours before the publication of Nonfarm Payrolls, and in the last two months it reacts to the publication with a negative, as if all the positive expectations of traders were already included in the price earlier.
However, remember that the conclusions should be your own. If you are based 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 in the same way in the future. However, the chances that this action will be repeated, if it has happened several times in the past, do increase.
Once you have a working idea for a trading strategy, for which you also find the rationale based on historical data, you can begin to work out in more detail. To do this, see if your new strategy works on recent price movements: select several currency charts (for example, with the dollar) and view them for different periods. Now your task is to find 10 or more “trading signals”, i.e. reasonable good times to open a trade. Remember that the rationale for each of them must be the same, otherwise it is not a signal at all.
Let's say you decide that with each positive Nonfarm Payrolls report, you will open a buy trade on USDJPY, and with each negative report, you will place a position to sell the pair.
Rewind the chart a few months ago. In parallel, open the Economic calendar for previous periods. See when NFP was better than expected, and imagine that at that moment you opened a buy trade. Return to the chart: could you make money this 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 work 100% of the time, and this is normal.
The main thing is to check the trading strategy for success by adding up all trades with a minus and trades with a plus. What was your result in six months? Did you get a positive account? Have you put forward a working hypothesis for a trading strategy? It could easily turn out not to be. It may even be that you no longer have ideas for a strategy based on fundamental analysis. Then a more stable option comes to the rescue - strategies based on signals from technical indicators.
If significant economic news or company reports are not published very often, then technical indicators analyze price behavior from morning to evening, allowing you not to stop trading even at night. However, for this purpose, you will have to put the selected 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 a 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 must be recorded in the trader's diary (journal), which we will discuss later.
1. Determine the market type and trade type
If you want to develop a technical trading strategy, you must immediately write down which market you are trading (currencies, stocks, metals, etc.), which asset, which timeframe and duration of the transaction you prefer, and also what will be the duration of each transaction (at least about). For example, if we are talking about a deal that is two or three months long, there is no point in worrying about price changes within one hour - before the moment you close your position, the market will change a million times more.
At the same time, if the trade is for a short period of time (say, a few hours or even days), you may be interested in studying charts for longer periods in order to get an idea of ??the bigger picture and the overall trend. Here's what it's for: if suddenly the price goes against you in the short term, but you know that the trend of the month is up, so there are high chances that quotes will still return to the medium-term path that was laid down on a scale of several weeks.
2. Choose technical indicators
Building a trading strategy is impossible without determining the technical indicators that will form its basis.
Based on the criteria discussed in the previous paragraph, you must select the appropriate filters for the graph 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, as well as be able to open trades more often.
So, if the market is trending, it makes no sense to use RSI, which will perform 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 choice of Commodity Channel Index (CCI) indicator may be quite appropriate. Also, if the chart is extremely volatile, smoothing out fluctuations with moving average crossovers can be just right.
- Since different instruments go through different stages of price fluctuations, you should have 3-5 trading strategies in your arsenal for market situations of a trend, reversal, flat, news trading, etc. You can use them either in turn, based on a specific market phase and situation, or determine for yourself only the only conditions under which you will enter the market.
- It is extremely risky to lay one algorithm as the basis of the robot, run it and forget, believing that this instruction will become a universal magic wand for any market situation. Accordingly, even mechanical trading systems must be manually corrected or a new one launched, pausing the previous one.
3. Refine periods and other inputs
Having chosen technical instruments for their trading strategies, a trader should logically choose periods and ranges, the values of which should be transmitted to the software (your Expert Advisor).
For example, you must answer the question for yourself: for a trading strategy based on the 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 correct answers right away. They will come only with the experience that is gained on a practice demo account.
4. Start looking for signals
After the technical tools for trading strategies are set up, you need to learn how to properly search for signals on your own based on the readings of 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 intersection, or you expect a divergence between the movement of the MACD oscillator and the asset chart. The main goal of such an observation is to confirm your hypotheses embedded in the combination of indicators and learn how to profit from the signals you receive.
What are trading signals in simple terms? Let's look at examples:
- the price moves in the channel, starting from one or the other border. The moment of reversal will be a signal to open a deal;
- intersection of indicator lines (for example, SMA with different periods);
- divergences (divergences) between the price movement and the oscillator;
- breakouts of channel boundaries or support and resistance lines;
- the appearance of additional figures of Japanese candlesticks, etc.
After making a decision to open a deal based on the signals of the trading strategy, we will analyze it by 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-conceived moments of closing positions. In addition, it is required to calculate the effective volumes of transactions, taking into account the 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 deal should be a clear and conscious action.
6. Compare Results and Make a Trade
After examining the various scenarios presented on the charts and determining which one is viable, the trader will compare them in terms of reliability and profit potential. For example, to what extent the indicator values are consistent with the signals, what profit or loss will be received in the event of the triggering of protective Take Profit or Stop Loss orders. 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 trending strategy, he will wait for a correction, entering trades against the current movement, based on the indications of the main trend. Or, when the speculator uses channel tactics, his main task will be to monitor the approach of the price to the borders of the range in order to open positions for breakout or rebound.
When to switch to a real account?
A demo account is also used by beginners, and no matter how strange it may sound, but also by professional traders, at various stages of working 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 switch to a real account. However, each trader determines this moment for himself, and no specific recommendations should be given in this regard. The simplest answer is when you and your strategy are ready for it.
Why do you need a trade diary?
The 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 operation of the trading strategy. In the journal, traders record various characteristics of completed transactions - from indicator readings to their own emotions. At first it seems that this process can 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 with general questions before 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 to trade? (Forex, stocks, CFDs, futures, etc.)
- How long do I plan to keep the deal active?
- At what moments will I not open a trade, even if there is a signal? (Holidays, before news releases, etc.)
Choosing the moment to enter a trade
- What specific event would tell me that now is the time to open a position?
- How do I prefer to enter a trade: market order, limit order, stop order, stop limit order? Which view is best for what I'm trying to accomplish?
- Which of the things I did earlier will help me enter a trade more effectively now?
- Is there a suitable signal to enter the position now? What forecast do I make regarding the potential for movement?
- Are all the rules of my strategy for entering a trade fully implemented?
Choosing the moment to exit the trade
- Entering the market correctly is half the possible profit. But it is equally important to understand when the deal will be closed. Do I now understand when the trade will be closed with profit or loss?
- What trading signals do I use to close a trade?
- How do I understand that the trend is over and there will be a trend reversal?
- How far can price go against the trend before pulling back? Do I want to close the trade before the first major pullback or will I sit it out?
- If my trade entry criteria disappears, can I use that as an exit signal?
- How long can I stay in a trend trade to capture most of it, but still not lose too much profit when it reverses?
- Not all trades you enter will be successful. Therefore, think about where to place your stop loss so that the risk is limited.
- Would a trailing stop allow me to make more profit? If yes, what should it be?
- Will Teke Profit work with my trading strategy algorithm?
- The development of a trading strategy also includes money management. It helps us determine if a trade is worth taking, how much we are willing to risk, and does the potential reward justify taking the risk in the first place?
- What is the dollar risk based on entry and stop loss based on position size? The amount of loss, 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 deal? What can be the maximum loss in points and monetary units?
- Based on the two answers above, should you 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 correct.
- For day trading, the profit must exceed the risk by 1.5 times. For swing trading, the profit must be twice the risk. When calculating, it is worth looking not at each transaction, but at the average value for the entire trade.
If you were to lose a lot of money implementing a strategy, this will tell you something worthwhile: perhaps if you take actions opposite to those that brought a loss, they will give a positive result. Consider if a strategy is making you a loss, then someone else is making money. Try to understand what this group of traders is doing!
In short, it is worth analyzing financial charts for profit opportunities. Explore these opportunities and consider how you can turn them into real money without exposing yourself to excessive risk.
Technical trading strategies are created by a combination of indicator signals and patterns. It's 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 countertrend move can be a much more reliable trading signal than the 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 that we have just discussed. In the following chapters of this section, we will discuss technical strategies in more detail.
Guide to develop your own forex trading strategy using technical analysis indicator