Trading strategy

  • Oct 18 2022
  • by
  • Analyst AZA
Trading strategy

How to construct a trading strategy

Before initiating the construction of a trading strategy, a trader must first think about what trading style is suitable for them. Would you prefer to sit in front of the PC for most of the day executing trades in a 5-minute time frame, or will trading on a bigger timeframe be suitable for you? My recommendation for traders is simple. The bigger the timeframe, the better. It is much easier to trade on bigger timeframes, and it will make you money in the long run. I advise beginners not to initiate their trading careers with day trading, but rather to gain experience before jumping on the day-trading scene. Trading using smaller timeframes has a lot of risk due to unpredictable random erratic movements. Trading on smaller timeframes can present a trader with heavy losses, especially during economic news events that are released almost every day.

After gaining more experience, traders can now move to trade smaller time frames like the one-hour and the two-hour charts. I advised traders not to solely rely on day trading, but to consider it as a backup to the higher time-frames strategy. With the above in mind, the next task is to decide what will be included in your trading strategy. To help you to be profitable at this stage, the trader needs to decide which technical tools to use as part of their strategy. From my time in trading the markets, the technical tools have proven to produce a great success rate due to their repeating nature. The tools include candlesticks patterns, support and resistance zones, Fibonacci ratios, price patterns, and price trends. These are some of the technical tools that beginner traders can use in constructing their trading system.

Price trends always get repeated on the charts and they are a core principle of the FX market. Price trends should always be included in the construction of a trading strategy because trading will be easier when you are trading in the direction of the trend. Whenever prices are printing higher highs and higher lows, we can conclude that the price is trending upwards, and when prices are printing lower lows and lower highs, we can say that the market is on a downtrend. Understanding the top-down analysis will be advantageous to a trader that is trading price trends. For example, the market can be down-trending on a smaller time frame, but up-trending on a higher timeframe. Therefore, a trader who analysed the higher time frame would have a bigger picture of the direction of the market.

Support and resistance levels are key components of technical analysis, and most traders integrate them into their strategies. Beginner traders should incorporate them into their strategies to generate maximum returns. Fibonacci tools are one of the most used technical tools, especially Fibonacci replacements. Fibonacci replacements can act as significant support or resistance for price action. The most respected Fibonacci levels are the 50% and 1.161% retirement zones. Price patterns and candlestick patterns are very popular with the majority of forex traders, and they offer the highest success rates. Price patterns can provide signals that show when the market is in preparation for a move in a particular direction, and candlestick patterns will be used in conjunction for confirmation.

Before executing a trade, it's up to a trader to decide whether to include all of the tools that were discussed in their trading strategies or just use some of them. Technical indicators should not be used in trading because they are worthless and will be a hindrance to your profitability in the long run. A trader can generate profits today using technical indicators, but in the longer term, they will surely average losing trades. Technical indicators such as the RSI, Stochastic, MAC, or the Williams percentage are all lagging indicators because they are designed to follow past price action. Do not be fooled when you are back-testing them, and you realise that the indicator is going to generate substantial profits. In real-time, you will be wasting both your time and your money. Traders should always keep in mind that price action is the best indicator of future price movements.

The simpler the trading strategy, the better, and using technicals and indicators will complicate your strategy. From my trading experience, the only indicator that's very useful is the 200-exponential moving average. Most traders incorporate it into their trading systems, and that explains why the price tends to bounce or reverse whenever it touches the moving average. However, it should not be regarded as a primary indicator to make executions, but as a confirmation tool. For example, if the strategy is signalling a buying opportunity, one can use the 200 EMA to gain extra confidence in the trade by monitoring whether the price is above or below the moving average. A robust trading system consists of solid money management. Traders who are good at managing their money will be in the trading game for the long haul.

Good money management allows a trader who is only correct on 50%, 40%, or even 30% of his trades to remain profitable. The first rule of management is position sizing. A good trading strategy should highlight the maximum amount of money that can be lost before opening the position. For a trader to set this amount, they will have to consider their balance and their risk tolerance. I advised traders not to risk more than 3% of their trading balance on a single trade. Your trading strategy should clearly outline the levels where the trade will be entered, the stop loss, and the profit target. For example, a trader who has a $2000 trading account and decides to only risk 1% of his balance on each trade. This means if the trade moves against the trader by 50 pips, they will lose $20. Next week he will be willing to lose $20. If a trader wants to know the dollar value of a pip move, they can divide $20 by $50, which would be $0,4. This means $0.4 will be lost for every that moves against them.

This calculation should be done on every trade regardless of how promising the reward is. The profit target should always be three times or higher than the amount risked. Having a trading strategy with good money management techniques is only 50% of the requirement to be profitable. The other half is the psychology side of trading, which consists of mastering emotions, cutting external influences, and having patience. Patience is a key component in trading, and without it, the chances of success are very slim. Traders need to keep in mind that sometimes they will need to wait for an extended amount of time for their trade setup to emerge as outlined by their strategy. The trick here is to follow the strategy. This will help you with mastering your emotions. Another point is to refrain from taking advice from traders who try to sell signals that are supposedly hundred per cent profitable.

Remember if it sounds too good to be true, it usually is.

After gaining more experience, traders can now move to trade smaller time frames like the one-hour and the two-hour charts.


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