When trading at random, without using a proven algorithm of actions, losses are inevitable. And if you want to have a stable profit, then you need to find your own trading strategy (TS) or use ready-made tactics from experienced traders. You can combine several options to work with different instruments and in different market situations.
What is a trading strategy?
This is a set of rules according to which traders trade in the financial market. The main task of such an algorithm is to increase the efficiency of working with assets and cut off emotions that negatively affect the results.
A trading strategy includes the following blocks of rules:
- signals for opening an order;
- holding a position;
- signals for closing an order;
- money management.
For instruments with noticeable differences, you can create separate trading strategies.
Before choosing a strategy, it should be thoroughly tested. And if the strategy has shown a good level of effectiveness, then it is necessary to strictly follow the rules drawn up. That is, you should give up any improvisations based on emotional impulses.
If you want, you can automate a proven strategy that gives good results by turning it into an algorithm for a trading robot.
Advantages of a trading strategy
The movement of the foreign exchange market has its own patterns. Well-designed conditions for opening and closing a transaction allow you to use a particular pattern to make a profit. Experienced traders note that following a trading strategy is the execution of monotonous actions. And this approach to trading ultimately provides a tangible profit on a stable basis.
Having a steady income in trading without adhering to a proven algorithm of actions is an almost impossible task. Sooner or later, the deposit will be drained. Only the right trading strategy gives a positive mathematical expectation on a constant basis. That is, it provides you with a profit from month to month. One of the conditions for obtaining such success is the correct ratio of stop loss and take profit. But if your strategy does not produce stable results, you need to change it or choose another one.
Thanks to a well-organized work with the market, even if there are unprofitable trades within each trading period, you will still have a profit. Using a working vehicle on a regular basis, you get used to acting according to a clear algorithm, ignoring your own emotions. This is a professional approach to trading. It is the ability to follow the established rules that distinguishes a successful player from a beginner.
It also leaves aside the need to constantly think about which direction to open a trade in. The strategy already contains signals for entering the market. If there are no such signals, then you simply do not need to open a trade. This format of trading allows you to reduce the workload on the mind. At the same time, having a ready-made algorithm of actions, you will react to market changes quickly and correctly. As a result, you will reduce the number of mistakes due to fatigue or emotional decisions.
Experienced traders say that you need to pay attention to the most effective trading time. This refers to hours in a day or days of the week, within which good results are consistently obtained.
You can identify these periods with the help of statistics – a detailed record of all information about transactions in a special journal:
- currency pair;
- selected timeframe;
- price and time of opening;
- stop loss and take profit;
- price and time of closing;
- why the position was opened and closed (description of the logic of actions);
- what are the results of the exit from the market?
When the journal accumulates such information for a month or quarter, it should be studied in order to identify patterns.
Analyzing the statistics of their trading, traders often notice that at certain hours/days they often record a profit. Problematic time intervals are also identified in the same way. Given this information, you can bring your trading to a new level of efficiency. That is why many traders make keeping detailed statistics part of their trading algorithm.
Statistical data is also good because it allows you to identify the weaknesses and strengths of the strategy. The collected information will allow you to determine which logic of opening trades led to a stable profit, and which provided losses.
What does a trading strategy consist of?
Any trading strategy has the same basic structure. The differences may be within a separate section of the trading algorithm.
Signal for entering market
These are the conditions for opening a buy or sell transaction when working with a separate currency pair. Signals can include fundamental or technical factors, or combine both of these groups of features.
The signal function can be performed by:
- breakout, the rebound of the instrument from the price level on a certain timeframe;
- reversal or emergence of a trend;
- fundamental news;
- indicator/Expert Advisor data;
- the exit of the asset from the overbought or oversold state;
- any other calculations concerning the patterns of the foreign exchange market.
It is convenient to enter the market with the help of pending orders. They allow you not to constantly monitor the schedule and open deals only at the right price. Correct signals are market characteristics that provide a statistical advantage in the trading process.
Holding a position
To get more profit in the foreign exchange market, you need to try to take the maximum movement of the asset. This is why the position is held for several hours, days, weeks, and even months. And the signals for such a hold are also written in the trading strategy.
There are several ways to keep your position open while controlling your risks:
- Classic stop loss. It is set at the desired distance from the opening point of the transaction. The usual setting of the stop is according to the calculations made or to the selected ratio (1/3).
- Transfer of the stop loss to breakeven. When the price goes in the direction of profit, you can move the Stop Loss to the point where the trade was opened. If the asset abruptly goes in the opposite direction, the transaction will close at zero or with a small plus.
- Trailing stop loss. When the tool goes in a favorable direction, Stop Loss can be moved behind it, maintaining the initially set distance. For example, 10 points. The asset has gone up by 100 points, and the stop moves by the same amount after it. With a sharp reversal of the instrument, you will get a profit minus the stop size.
- Hold based on the indicator data. If the chart shows signals indicating the continuation of the movement, the trade is left open. The goal is to take more profit. At the same time, you can use a trailing stop loss.
One of the principles of successful trading is not to exit a trade too early. Yes, it is virtually impossible take 100% of the movement of the asset. But if you leave too early, you will lose a significant part of the profit that you could have earned. For this reason, the trade must be held until the signals to close it are received.
The retention period can also be determined by the trading style:
- Scalping. A large number of transactions within a day. The order is held for a few minutes (rarely more than an hour).
- Intraday. Trading within a day with holding a position for a few hours.
- Swing trading. The position is held for one or more days.
- Medium-term trading. With this trading style, the position is held several weeks or months.
- Long-term trading. This is the investment level. Trades are opened for a period of up to 1 year or longer.
If the task is to make money without a long wait, it is better to choose options 2 or 3. Scalping greatly overloads the mind with a huge number of transactions. And long-term trading requires large funds and gives a slow result.
Closing a position
In this part of the strategy, a group of signals is prescribed that indicate the need to perform one of two actions:
- Close the order to fix the profit. You can do it manually or by using take profit. For example, when rebounding from the price level
- Close the current trade and open a new one in the other direction. It is performed when the trend reverses.
You can exit the market using the reverse signal of the indicators.
Sometimes you can see the potential movement of an asset, but doubt the accuracy of your analysis. In this situation, you can exit the position gradually. That is, close part of the trade volume – 50%, 30%, 20% , etc. With a partial exit, the total profit can either decrease or increase.
Money management in trading can be reduced to a few points:
- Selecting the correct part of the deposit to open a trade. For example, no more than 5% of the total amount. If the deposit is $1000, then the trade volume should be $50. After getting the desired number, you need to determine which part of the lot it corresponds to. The lot consists of 100,000 units of the base currency in the selected pair. If you select 0.05 lots, a deal of 5000 units will open. It can be a euro, a dollar, or another asset.
- Calculation of Stop Loss and Take Profit. If you correctly determine these values, you can have a stable profit in the presence of unprofitable transactions. The most common ratios are 1/2, 1/3, and 1/4. If you choose a ratio in which the take profit is 3 times more than the stop, then closing 34% of the trades in plus and 66% in minus, you will go to zero. With the better ratio, you will get a profit.
Stop loss and take profit are set in points, the value of which will change depending on the exchange rate of the base currency in the pair selected for the transaction.
To stay in trading for a long time, you need to learn how to correctly use loss limitation and profit-taking. When trading without Stop Loss, the risk of total loss of the deposit increases to the maximum. There are cases when one unexpected impulse on the daily chart nullifies the trader's account.
You also need to carefully choose the transaction volume-part of the lot when opening an order. This is especially important when using leverage. If you chose 0.05 lots, set a stop of 100 points, and lost $100 when closing the position in the negative – this is normal. When losses are expressed in larger amounts, it is necessary to lower part of the lot.
How to treat losses and profits
Often novice traders painfully perceive the fact of closing a trade in the negative. Every loss for them is a defeat. In fact, losing trades are an integral part of trading. They will always be there. You need to learn to treat them as performance indicators.
It is necessary to focus on the final result within a separate period – week, month, quarter. If you used the ratio of Stop Loss and Take Profit 1/3, then getting 60% of losing trades per month, you will still come out in the green. This is because one profitable position brings in 3 times more money than you lose on losing trades. For this reason, you need to focus on the percentage of positions closed in the negative and in the positive. If the trading strategy contains the correct opening and closing signals, then each losing trade brings you closer to making a profit.
Here you can give a simple example: in a black bag there are 10 rectangular pieces of paper, 4 of which are bills of $1000. And if you put your hand in there and just take out a piece of paper, you give 50 dollars.
There is a chance that even with the first 5 attempts, you will not be able to pull out the money. But if on the 5th time you manage to get $1000 out of the package, then you will cover all your losses ($250 for 5 pieces of paper) and make a profit. In addition, five failed attempts will mean that the chances of taking a cash bill in the package are now extremely high.
This principle begins to work in trading when choosing a ratio of 1/3 or more. That is, when the Take Profit is 3 times greater than the Stop Loss. But it is important that the entry and exit signals are working, otherwise you can get 80% of unprofitable trades and go into negative territory.
The chances of getting a profit will increase if you work with not one, but with mutliple instruments. When you trade only one currency pair, you periodically encounter such a problem as an unexpected change in volatility. The market can go into a sideways movement with minimal price changes. It is difficult to get a tangible profit under such conditions.
Working with multiple pairs, you can switch to another asset with a pronounced price movement. However, you should not open positions on a large number of charts – such trading requires a lot of money and time. Another way to increase the level of profit is to use multiple working strategies. That is, you need to be flexible.
How to test a trading strategy
To check the effectiveness of the strategy, it is better to open a demo account. In this case, it will be possible to record the results with zero risk of losing funds.
In this type of testing, you need to follow a few rules:
- It is necessary to open an account with the amount of the deposit that will be used in real trading. If you plan to start with $ 000, then you need to set the same amount for demo trading.
- You need to trade for 2-4 weeks. With lesser amount of time spent, it will be difficult to assess the effectiveness of the strategy.
- In the process of trading, you need to accurately follow all the rules of the strategy. If you deviate from the algorithm of actions, the results will be incorrect.
- It is necessary to test the strategy in all market situations. It is important to gain trading experience during the price drop, its growth and sideways movement (flat).
If you have met all these conditions and received positive trading statistics, you can switch to a cent account. When trading on live money, you need to open small trades, fully adhering to the trading strategy. This practice makes it possible to feel emotions that appear only when working with a real account.
So you begin to feel:
- fear of losing money;
- the desire to recoup after unsuccessful trades;
- euphoria at the first success.
The task is to feel these emotions and learn to abstract from them, precisely following the trading algorithm. 2 to 4 weeks should be allocated to this. If you get a stable profit when working with real money, you can increase the volume of transactions by switching to standard accounts.
How to calculate the effectiveness of a trading strategy
The main task here is to calculate the mathematical expectation. That is, you need to get the figure of the profitability of the strategy - Profit Factor.
The basic calculation is simple: the number of points of profit for the entire period is divided by the number of points of loss for the same time. The resulting figure is the mathematical expectation for the strategy.
If this indicator is at level 2 or higher, then the chosen trading strategy can be considered effective.
This is another indicator that determines the effectiveness of the vehicle. To calculate the net profit as a percentage, you need to divide the resulting profit by the figure of the initial deposit and then multiply by 100%. If you take the indicators for 12 months, you can determine the annual income.
Maximum drawdown (MDD)
This is the level of reduction of the deposit amount from the point of its maximum value (peak value) to the point of the minimum (lowest value). That is, it is an indicator of the maximum losses that you have suffered for a month, quarter, six months, etc.
The calculation is made as follows:
- For example, you started with a deposit of $100,000. After a while, thanks to successful trading, your deposit increased to $120,000.
- Then you made mistakes, and the deposit amount dropped to $70,000.
- After that, you repeatedly received a profit, and the amount on the account again reached the mark of $ 40,000.
All this could happen in one or several months.
With such inputs, the maximum drawdown is calculated using the formula:
MDD = (120 000$–70 000$) / 120 000$ = 41,67%
The resulting figure is the maximum loss from the maximum deposit. You must decide whether you can continue to follow the strategy clearly with such a drawdown. If not, the strategy needs to be adjusted.
The higher this indicator, the more effective the strategy is. The Recovery Factor is calculated as follows.
Recovery Factor = Profit (in %) / MDD (in %)
This indicator is well suited for comparing the effectiveness of different trading strategies.
Now you know what a forex trading strategy is, and how to use it correctly. We also recommend that you visit our trading strategies section. There are ready-made trading methods with training, manuals, and video lessons, and you can test them on training accounts.