In forex, undisciplined, hit-or-miss and seat-of-your-pants trading will only get you so far. Eventually the law of averages takes over and you start finding yourself upside down too many times. What you need is a trading system. The difference between winning and losing traders is that winners have a tested system that defines entry and exit points, and how much to risk on each trade.
Forex Currency Trading Strategy
You can either buy a trading system from one of the “experts”, or you can develop one that exactly matches your needs, budget and trading personality.
While the term “trading system” can sound technical, it’s really no more than a formalized set of rules that dictate when you will buy and when you will sell.
If you buy a trading system then you are also buying into the author’s ideas of what buy and sell signals look like. If you develop your own then you make the rules.
A trading system’s objective is to keep your trades in the money as much as possible and to help limit your losses. It’s designed to remove fear, greed and pride from the trading equation. If you decide to develop your own system, be sure that it addresses these points:
1. The Foreign Currency Trading System must define and supports realistic trading goals
If you set your daily income levels too high then you will force yourself to take more risks to achieve them. Low goals are relatively easy to reach. Raise them as your skills and bankroll grows.
In addition, a trading system should be able to work with your available capital. It is not much use having a system that has heavy drawdowns, requiring a $100,000 account if your account is $10,000.
2. The Forex Trading system must define the rules for entering and exiting a trade
What does a “buy signal” and “sell signal” look like to you? It could be something as simple as “buy when the target currency’s exchange rate is above the moving average and sell when it falls below”. These signals need to be clear and unambiguous.
3. The FX Strategy define the rules for limiting your risk and exposure
Remember that the concept of stop loss is different in the Forex market because of the principles of leverage. If you take a position at 100:1 then it makes very little sense to place a stop loss at 2% of your entry point. On the other hand, you don’t want to walk the FX tightwire without a safety net. What will yours be?
4. It must limit the number of open trades allowed
Too many open trades are not only hard to track, but they put too much of your money at risk. Ensure that your system does not place trades in correlated markets without you understanding the risk involved.
5. It must reflect your trading methodology or personality
Using a system that conflicts with your trading personality will mean that you will be uncertain about some of the signals, and lack confidence in the system. In addition, the trading style may not fit your risk tolerance. This is why it is generally best to develop your own system rather than purchase one from someone else – a system you develop will reflect your own view of the markets and appetite for risk.
6. The fx trading strategy must have a positive expectancy
Expectancy is the average amount you expect to make for every trade placed, winning or losing. A system that wins 80% of the time but loses 10 times as much for a losing trade as it wins will eventually wipe out your trading account. You should never trade a system with negative expectancy. It is important to backtest your system before committing money to trading with it.
Think of trading like a casino. The casino may lose individual bets, but in the long term it always wins. Why? It has a house advantage. This means that it has a positive expectancy. The casino doesn’t gamble, that is for the gamblers. On average, it gains for every bet placed. That is what pays for the grand buildings. You need to build in a positive expectancy if you want to win.
7. The online forex trading system must perform well in both backtesting and in real time testing
Backtesting is the process of checking your system against historical data. You should use at least 1,000 periods of data to ensure that you are not “curve fitting” your system. This is when the trader optimises the system to a particular time period so that it performs well during that time period. Inevitably this curve fitting results in a model that does not trade well in real life. Using a lot of data for testing eliminates the tendency to over optimise your system.
In addition, you should test your system in real time. Most brokers offer trial accounts where you can place trades without risking your real money. You can see how the system performs in the real market, rather than just against historical data, and iron out any problems that come up. A Good forex trading system will do well both historical and in the future.
8. Don’t be afraid to use the work of others
Even if you are developing your own trading system, there’s no law saying you can’t borrow heavily from other systems that you like. You’re not trying to reinvent the wheel, you’re just looking for a safe and profitable set of trading rules that can make you more money than you lose.