Trading Strategy Basics

How to Develop a Winning Trading Strategy?

  Reason for trading:

When you open a position, you must have a clear reason of why buy or sell. If you enter a position just for the excitement and thrills, the chance of losing your money becomes greater. You should always buy or sell currency based on a clear reason.

  What currency pair to trade?

When starting out on Forex trading, you may be overwhelmed by a sheer number of currency pairs available for trading. It is advisable to focus on just a few of the major pairs, such as EUR/USD, GBP/USD and USD/JPY.

  Types of Trade and Trading Styles:

• When and How often do you want to trade?
• During Day or Night?
• Over a period of a Week or Longer?
• Should you trade as a Day trader, Swing trader or Position trader?
• Make sure your work schedule and other responsibilities can accommodate your trading preferences.
• You need to decide which Trading Style and what Time you want to trade.

  What is your Trading Objective?

It is important to set your Goals and decide what your Take profit target and your Stop loss limit are. Place your take profit and stop loss orders before entering the trade. If something significant happens during the trade, you can always change that.

Many newbie traders perform mistakes by taking profits very quickly and/or exiting the losing trades too late. Good experienced traders know when to take a loss and they minimize the damages by exiting the trade early. They admit when they make mistakes and learn from the experience. If you have a hard time accepting that you are wrong, you may hang on to a losing trade too long and could lose more money than you should have.

It is essential to define your take profit target and stop loss limit prior to entering the trade. Do not set out unrealistic goals. Making huge profits right from the start is rather unrealistic. It takes some time to learn the Forex trading. A 20-30% of return on the initial investment during the first 6 months should be considered as great target for novice traders.

  Money Management:

Money management is another important aspect of trading, and your mindset or attitude toward trading is a crucial part of sound money management. Even the most successful traders do not have a 100% winning ratio; good traders know when to take losses. They admit their mistakes and exit the trade early to minimize the losses.

It is very important as a Forex trader that you admit when you are wrong before your mistake becomes too big to bear. To do this, you have to know clearly how much equity you can afford to fund your account. You also have to determine how much risk you are willing to take on each trade. For example: many successful traders risk 4% or less of their total account capital on each trade. If you take a similar approach, it would definitely help you avoid big losses and keep you in the market while gaining necessary experience to learn the trade.

It is also important to have a positive average profit compared to the average loss ratio. For example: if your average profit is twice as much as your average loss, then you only need to make 5 winning trades to compensate for 10 losing trades.

  Records and Documentations:

Each trader must learn from his own mistakes and successes. It would therefore be essential to keep track of your trading results for further analysis.

Trading Entry Techniques

Many new traders think they have done all their homework by learning all about candlestick charting, learning a few key technical analysis tools and studying fundamental analysis. They have even developed a trading plan. Then when they see a live chart they simply jump into a trade just because the market looks like it is going to go up or its going to go down. Either they have ignored their entry exit rules or they simply have failed to create them. By jumping straight into the market without any entry plan is just plain suicide and a recipe for bad trades. If the trade is successful then it’s pure beginners luck.

  What Are The Different Types Of Trading Entry Techniques ?

• In the Pullback Entry the buyer would buy when the price retraces back to a known support area. If the trader is a seller then he would be looking to sell when the price retraces to a resistance area. This particular technique can be used in ranging or trending markets.
  
  
• In the Breakout method the buyer is looking to buy when the price is making new highs because the trader will view this as a signal of strength and the price will increase. However, a seller would be looking at the opposite situation. A seller will be looking to sell as the market makes new lows as he would take this price action as a sign of weakness in the market and the price will fall lower.

  A note of caution should be voiced here because if a market is consolidating and ranging these techniques could be extremely risky.

Trading Entry Example :

Let’s look at a chart now and see how these entry points might be accomplished. We can use any time frame for these entry strategies and any currency pair for the important point is that we trade in the same way whatever the asset.

  The GBP/USD 15 minute Chart Example :

The chart below shows that the price action has hit a known resistance level at 1.22036 (blue arrow). We know that there is a support level at 1.21704, so we have two possibilities:

• The price could retrace to this support level (1.21704).
• Or, the market is gaining strength and will break new highs in the future to reach the next resistance level (1,22231).

  We can therefore, depending on what other indicators suggest:

• Go short at the resistance point at the 1.22036 price.
• Go long at the resistant point with a view to it breaking to a new high.

  Supposing that our favorite indicators suggest that the price will retrace so we open a short position:

• Our take profit will at the first known support: 1.21704.
• Our stop loss for the sell position should have been placed just above the last significant top which was 1.22086.

  Outcome : The price retraced to the support area (to the 1.21704 price) and we made a profit of 33 Pips.

• Profit: 1,22036 - 1,21704 = ‭0,00332‬ ⇔ +33,2 Pips.
• Risk: 1,22036 - 1.22086 = ‭-0,0005‬ ⇔ -5 Pips.
• We risked only 5 pips to gain 33 pips which was a nice risk/reward ratio of 1:6.

  However, if we had taken a long position at the resistance point of 1.22036 we would still have had a successful trade as long as:

• We had kept in the trade until it had rebounded from the support level (1,21704) and moved up to 1.22231 where the take profit should be placed .
• Our stop loss for a buy trade should have been placed 3 Pips below this support level (1.21704 + 0,0003 = 1,21674).

  For the Long position the Outcome will be:

• Profit: 1.22231 - 1.22036 = 0,00195 ⇔ +19,5 Pips.
• Risk: 1,21674 - 1.22036 = -0,00362 ⇔ -36,2 Pips.
• The riskier trade was the Buy because we risked 36 pips to gain 19 pips (2:1 risk/reward ratio) and that is a bad ratio.