Thinking of building an ideal trading strategy in forex? If yes then we will guide you in this article.
Strategy means a plan of action or policy designed to achieve a major or overall aim. In real life, everything we do requires a plan or a strategy that guides us toward our goals in life.
In business, especially when you are trading, you must have a proper trading plan that directs you to the right path to success in the long run of your trading career. Moreover, an ideal trading strategy in forex can make your trading life much easier, more progressive, and more fun.
What is Forex Trading Strategy?
A forex trading strategy represents a comprehensive investing and trading plan on the basis of predefined rules used to make trading decisions.
There are many traders, especially beginners who think trading strategy means just a bunch of indicators thrown at the same chart with the belief of more indicators mean better confirmation of the trading signals – which is not always right.
Besides indicators, there are some other factors like specific trading goals, the risk-to-reward ratio, trading discipline, and understanding the market sentiments are considered must-have factors to be included in the process of creating an ideal trading strategy.
How to build Trading Strategy in Forex?
Building a profitable strategy and choosing an ideal one for trading are not the same. In other words, a profitable strategy doesn’t necessarily mean it’ll suit everybody.
The compatibility between the user and the strategy depends on different goals, personalities, and trading approaches.
In this article, we’ll discuss all the necessary elements you need to set up to build an ideal trading strategy. So, let’s get started!
1. Set your trading goals & plans
The trading goal means targeting a specific destination that you want to reach within a realistic period of time. A trading strategy without a goal is like a ship without a radar.
In real life, everything you do requires a plan to get it done with success within your budgeted time span.
In the forex business, a proper plan will help you to project where you want to be within the next 3 to 5 years. Therefore, you can easily set your daily, weekly, and monthly targets to reach your ultimate goal.
2. Choosing the right time frame charts
It all depends on your trading styles. Scapers or short-term traders usually look for 1-minute to 15-minute charts. Whereas Intraday traders keep sharp eye on 1-hour to 4-hour or daily charts.
On the other hand, long-term traders rely more on daily, weekly, and even monthly time frame charts.
Picking the right time frame chart also depends on your trade frequency. For example, If you’re aiming to execute more than 10 trades a day, you may want to look for shorter time frame charts that produce frequent trade signals.
But traders who aim to make 1 or 2 entries a day are comfortable with longer time frames which produce less but carry better strength of the trade signals.
This is a 5-minute GBP/USD chart of 18th June 2019. As you can see, there are lots of ups and downs within a short range of movements but in the end, the price was actually heading nowhere.
Trading and making profits in such scenarios are hard and cause confusion in decision makings.
Now if we look at the same chart in a 1-hour time frame, we can see the price was not in a trend during 18 June and was coiling in a short range.
Such sidelined situation of market trends usually offers breakout trading opportunities. Therefore, a longer time frame chart gives you the bigger picture and helps you to be prepared for the upcoming price actions.
On the other hand, shorter time frames produce numerous trade signals and put you at risk of being a victim of false signals.
However, smaller time frame charts magnify the current scenario of the price movements and show the exact point of market turn arounds.
3. Manage the risk-to-reward ratio
The risk-to-reward ratio means the amount you’re risking in order to achieve the amount of your targeted profit. For example, you’re making double profits compared to your budgeted loss which means your risk-to-reward ratio is 1:2.
Within this ratio, if you lose 5 trades of 100 pips each, your total loss is 500 pips.
But, if you win 5 trades making double of your budgeted loss, you earn 1000 pips (200 x 5). That means losing 5 trades out of 10, you’re still in 500 pips profit.
Therefore, managing a proper risk-to-reward ratio helps you to make your trading strategy in forex profitable in the long run.
One best way to maintain the risk-to-reward ratio is to set the stop loss and take the profit limit instantly with every trade execution. Besides, experts recommend not leaving any trade without setting a stop loss.
For example, if your usual stop loss budget is 100 pips and if you lose 200/300 pips instead for not setting up a stop-loss limit, it’ll definitely affect your confidence and gut feeling about the market.
4. Keep trading journals
A trading journal means the log of all your trading activities. It is the best way to track and evaluate your past trading performance. In your trading journal, you write all the information about the trades you have executed so far.
This includes the reason behind activating the trade, plans, and results. If the trade is successful find and writes how much risk to reward ratio it has earned so far.
If it is a failed trade then write the reasons behind the failure which will help you to minimize the mistakes in the future.
A trading journal also helps traders to find if there is any fault in their trading strategy or plan and allows them to fix it.
Maintaining a trading journal is the best way to avoid doing the same trading mistakes and tune up the trading strategies according to your needs.
5. Adjusting the trading volumes
According to market professionals, your daily risk amount should not exceed more than 1% of your total capital.
That means you’ll have to lose in 100 consecutive days to completely blow out your account which undoubtedly makes better room for you to fix your trading mistakes and move forward for perfection.
There is a myth, that ‘more than 90% of forex traders end losing all the money of their first trading account’. Now, the question is “why this happens?” One common answer to this question is “greed”.
After making 1 or 2 profitable trades, traders become so confident that they start to think ‘If I’d doubled the volume the profit would be doubled as well.
But thinking like that you’re just ignoring the dark side of the moon! Doubling the trade volume means doubling the risks as well.
Besides, a bigger or abnormal amount of loss will make you frustrated, demotivated, and quite emotional which is enough to lead you through the path of the ultimate destruction of your trading account.
Therefore, it is ideal to set your trading volume according to the size, budgeted loss, and trading goals so that you never lose track while chasing your dreams.
6. Over-analysis causes paralysis – keep your strategy simple
A trading strategy with more than 5 to 10 indicators doesn’t help you much in making trade decisions.
Different indicators use different parameters and demonstrate different types of signals at the same time, which is enough to make you confused over deciding whether to go or not to go for a particular trade.
Both of the images represent the GBP/USD 4-hourly chart and were snapped during the same period of time. It shows you the difference between applying too many indicators vs limited indicators on a chart.
If you look at the first image, I can bet you’ll barely be able to spot any trade opportunities.
Besides, it brings a lot of confusion too! Now look at the second chart, it is clean, relaxing, and looks much easier to make a trading decision using only a 21-day Exponential Moving Average (EMA).
Another important thing is, that you must know when you should analyze your trade and when you should not. Analyzing the chart, looking for trade opportunities, and then entering a trade is a normal process of trading.
But there are traders who keep analyzing the chart even after making an entry. This is not an ideal trading approach.
Analyzing the trade right after making a decision may influence you to modify/override the trade which often results in early exits, late exits, and unexpected trading results.
This is why we recommend you to stand by your decision and once you made one, let the trade run in its own way and let the market decide whether it is going to hit your stop loss or the take profit level.
7. Build a confluent trading strategy in forex
As a trader, you cannot depend on a single technical factor to make trade decisions. You need to focus on multiple factors to add a better probability of success to your trading strategies.
For example, you cannot simply go for a long entry just because your indicator says the trend is bullish. You also need to be aware of the important market levels like support/resistance. Why? Here is an example:
This is a 1-hour GBP/USD chart. We’ve applied a 50-day Exponential Moving Average (EMA) in order to define the market trend.
Price closes above the 50 EMA mean the trend is bullish. So, once the price closed as a bullish bar above the EMA level, we decided to go long at the break of the respective bullish bar’s high by the following price candle.
The buy was triggered and another bullish bar was plotted. But that was the last bullish candle before the price started to dive downwards and hitting your stop loss level right below the 50 EMA area. So, what went wrong?
Here is the answer:
This is the same chart but here we’ve spotted a resistance level right at 1.3995. This means we’ve made the buy entry right below the resistance.
It was a wrong decision because support and resistance levels are commonly considered as the potential swing areas of the market.
After triggering the buy entry, the price had tested the resistance, failed to break above, and returned back downwards hitting your stop loss level.
So, if you were aware of the resistance, possibly you wouldn’t go for the long entry.
After defining the trend and important levels of the market, we still need a final confirmation that tells us exactly when we’re supposed to pull the trigger which is called the “signal”.
There are a lot of indicators, EAs, and trading systems used in the market for generating trade signals.
However, for newbie traders, the best possible option is to start with the price-action signals. You’ll find numerous articles, tutorials, learning videos, and courses on price-action around the web.
Finally, we’d like to show you what happens when you add price-action signals in line with trends and horizontal support/resistance:
This is an hourly EUR/USD chart showing a selling opportunity defined by a confluent trading strategy. We’ve applied a 50-day Simple Moving Average (SMA) in order to identify the market trend.
We’ve also added horizontal support and resistance levels to define the possible swing levels of the market.
Moreover, we’ve also managed to spot price action signals as confirmation for the sell-entry. Here is a summary of our findings:
- The price had failed to move above the resistance at 1.1738. Instead, it plotted a bearish pin bar that closed right below the respective resistance level.
- After a while, the price moved below the 50 SMA confirming the bearish trend of the market.
- Finally, we’ve spotted another bearish candle showing a rejection of price from the 50 SMA and pushed to the downwards.
After considering the above facts, a sell-entry could be triggered at the break of the current low of the market. For the sell entries, it is ideal to put a stop-loss limit above the 50 SMA.
For profit-taking, wait until the price hits the nearest support level.
Alternatively, you can exit manually when the trade achieves your desired risk-to-reward ratio.
The best forex trading strategy brings a better probability of success in your trading plans. It keeps you focused, disciplined, and practical about your trading activities.
If you are looking forward to being a consistent winner in the market, we recommend you build your own trading strategy or follow the one that suits you best.
There are many brokers in the market offering free demo trading accounts. So, you can easily test your strategies there without risking a single penny.