How to create a trading strategy

Author: Martin Moni
Martin Moni
All publications of the author

The only way to succeed in Forex trading is to have a proper working strategy, and this is one of the most important steps successful traders have learnt. It would be easier for me to lay out my own trading strategy which has been working profitably, but I don’t like easy; and besides, it might not work for everyone. You see, a trader’s strategy is like a custom-tailored suit for that particular trader – another person can wear the suit, but it might not be as comfortable or good-looking.

In light of this, I’m not going to share my trading strategy, or copy another trader’s strategy, but I’ve got the next best thing. They say, give a hungry man a fish and they won’t be hungry that day, but teach them how to fish, and they will never be hungry again – something like that. So, I’m going to show you how you can create your own trading strategy and make it just as profitable as anyone else’s.

What you need for your strategy

First, there are some key things you need to decide upon before you can start trading. These will be the foundation of your trading plan, then we’ll look at the execution.

Decide on your preferred method of analysis

As we have already seen in a previous post, you can either be a technical or fundamental analyst. The former depends on studying the Forex charts online, determine the direction of the markets using pivot points, instruments, candlestick patterns, etc. and make trades based on this analysis. The latter, fundamental analysis, involves watching the economic calendar Forex to anticipate how the markets will respond to financial news announcements.

After going through that previous post which can be viewed when comparing between technical and fundamental analysis, you will see that there are benefits and downsides to either of those strategies. You will also see that I advise traders to use a combination of the two analyses, but you will need to select the one that best suits your personality and master in that. The other strategy should only be complimentary to your primary analysis strategy.

Once you decide on your primary form of market analysis, you establish what leads you to make trades, which is a very important step.

Figure out which financial instrument suits you best

There are stocks, binary options, futures and Forex, all of which can be traded to make profits, but you can’t be a master of them all. Again, each of these instruments has its own peculiarities and intricacies which it different from the others, so choose which you like most. For the purpose of creating a trading strategy, this is what you should consider about each of these instruments:

Stocks

Stocks are great if you have a substantial capital – they’re well regulated and easily predictable because high net-worth investors like private equity firms and hedge funds respond to financial announcements about companies. Just look at what the news about Volkswagen did to the company’s share price – this makes stocks favourable to fundamental analysts. However, it is not a 24-hour market and may be unfavourable to some traders, for example, a stock trader in Australia may have to stay up all night if they intend to trade US stocks.

Forex

The Forex market is kind of a free-for-all because it is the biggest market in the world with $5.1 trillion being traded every day to provide enough volatility. It is also a 24-hour market which anyone can get in on at any time of day, unlike the stock market. These and many more advantages make the Forex market open to anyone, so it’s always available as part of your trading strategy.

Binary options

Also known as all-or-nothing options are quite different from the other markets, and you can find out more about them in the history of binary options. They are great because they are very simple, you simply need to ‘bet’ whether a certain instrument is going to be more or less valuable than it is at the time of the trade. If this already seems tempting, then check out some of the binary options brokers we know. However, you should know that if you’re wrong, you may lose your entire investment.

Futures

These are a bit different from the other forms of financial instruments, primarily because payment is made or received after the expiration date. If you’re not familiar with futures, you can learn all you need to know about futures from this post. Futures can be very profitable because futures brokers offer high leverages, and the capital requirements don’t have to be very substantial. On the other hand, they can be risky if you don’t have a reliable broker, but you can compare CFD brokers to find the right one.

Commodities

These are physical assets like gold, silver, wheat, etc., but this doesn’t mean you have to handle physical assets. Just like stocks, they are also predictable and regulated, but you need a substantial capital.

 

Even after you select your preferred market, you will still need to narrow down your concentration area. For example, in the Forex market, focus on a few currency pairs which you understand very well, or the stocks you can easily get information about, not some obscure company’s stocks news channels don’t talk about. Your choice of financial instrument will also affect your choice of a broker since there is no broker who can offer all the instruments available to a single account.

Self-awareness

It might sound silly, claiming this, but you are the most important factor whenever you are trading, and you won’t succeed unless you know yourself. This includes knowing beforehand:

  • what your ultimate goals are: are you looking to trade as a form of long-term investment, or to provide income for monthly expenses?
  • how much you know: do you have an economic background and knowledge about the financial world? Knowledge is power, and you will need to learn everything you can about the financial markets if you don’t have a background in an economics program
  • how much are you willing to risk: Forex trading is risky and you will always be warned not to risk more than you’re willing to lose, so, how much are you willing to risk?

Knowing who you are will shape your trading strategy immensely, and this is part of the reason you should not copy someone else’s strategy no matter how profitable it is. We all have different motivations and goals, and unless you fulfil those, your trading career will quickly become stressful and unsatisfying.

Execution of trades

By this stage, you have most things figured out, and here is when you

Determine your frequency of trading

Your trading patterns should also be favourable to your lifestyle. If time is not an issue, you can make lots of trades every day just like how scalpers make money, which would keep you glued to your computer screen. Some traders don’t have this much time, though, and prefer to place only a few trades in a day – it all comes down to what you’re most comfortable with.

Besides the number of trades, how long you are going to hold on to trades is an important factor. Holding on to a trade for a few days ensures you get the most out of your trade by giving it time to grow as the markets move in your favour, but you also incur swaps. Swaps, or swap rates, are a commission charged for holding onto a position overnight, and they are incurred every day a trade position is held open. Usually, these swap rates are minimal, but they vary depending on your broker Forex. Major currency pairs have small swap rates, but if you trade with exotic pairs, then the swap is going to be higher, and may affect how long you can hold on to a trade.

On the other hand, short-term trading is ideal for someone who wants to make a profit and move on. Within a short time, the profits may not be as much as those you would get if you kept holding your position, but it frees you to move on to the next thing without any strings attached.

Choose a favourable lot size and leverage

Risk management is what sets apart successful traders from the rest who lose money or struggle to break even. Leverage and the lot size dictate your position size and determines how much risk you’re willing to take.

Leverage allows you to trade large quantities of a commodity, and the higher it is, the more you can trade and subsequently, the higher the profits. Brokers may offer leverage as high as 1:100 or up to 1:500, which enables you to make large trades. It can be tempting to go with the highest leverage available, but remember this can be deadly just as it can be helpful because if your trade goes bad and you start losing, the higher leverage may work against you. This still doesn’t mean that you should go for the lowest leverage possible, but rather that you should choose the leverage that best suits your appetite for risk.

On the matter of risk, choosing a lot size is critical because this determines how much of your capital you invest in a single trade. Just like leverage, the higher the lot size, the higher the profits and risk, so it is also dependent on your appetite for risk. The universally recommended lot size is one which doesn’t risk more than 2% of your capital, but you can still be safe if you risk up to 5%.

Basically, these two factors should be determined by the amount of capital you have in your trading account. If you have, say, $10,000, then using a higher leverage and lot size may still be safer compared to using similar proportions on an account with $1,000. Too much risk leads to margin calls, and before you know it you may be stopped out and your account wiped out. So, think about the leverage and lot size that provides you with just enough risk without placing your entire capital in danger.

What is your profit target?

There is usually a temptation to place a trade after studying the markets and waiting to see how it goes, but this is not the best strategy. We all want to make the maximum possible profits, yes, but you should never enter a trade blindly. Before clicking on the buy or sell button, you should know how much profit you would like to earn, and if it doesn’t go well, how much of a loss you’re willing to incur. This is going to involve a bit of arithmetic, and you might need to do some quick calculations before placing your take profit (TP) and stop loss (SL) targets.

Some Forex trading platforms like cTrader have a simplified interface that does these calculations for you so you know your exact profit and loss targets, and even the option to place 3 TP and SL targets. The other temptation occurs once you place your trade, and you begin moving the SL and TP lines away from the candlestick. If you do this on a winning trade, fine, but the better option would be to remove the TP line once your profit target is reached and replace it with a SL line, then keep moving the SL in the direction of the market. When automated, this process is known as a trailing stop, and can be used to maximize profits. However, if the trade doesn’t go your way, do not move the SL line, accept the loss and move on – a lot of traders have been burned because of doing this, including myself.

Go for it

With all this done, you now have your very own trading strategy, and you need to be really disciplined if you want to be successful. When you have all the steps figured out, try it out first with a demo account before putting it in practice. It might not work the first time, but the more you keep refining your strategy according to the above steps, the more profitable it becomes. Also do not be afraid to try new things, like trading various instruments you have never traded with before – you might find they are just as profitable. Afterwards, stick to your trading plan and only make trades when it fits into your trading strategy.

Creating a trading strategy is going to be the most important step you take, but it’s not going to be easy or quick. It might take you weeks or even months before you find a strategy that works for you, but it will be worth the effort once the profits start rolling in.

 

Now, I know I said I wouldn't teach you any specific strategy, but these 7 strategies are basically what you will likely end up with after following the instructions:


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