Creating your Forex Trading Strategy (1)

Ordinarily, most new traders do not have a trading strategy.  However, a Forex Trading Strategy is a set of rules to be met for trade entries, exits, order types, money management, time frames etc. When studied and properly applied, it can provide a statistical expectation for the specified rules, and help traders and investors determine if a trading idea is profitable. Forex Strategies can be based on technical analysis charting tools, fundamental and news-based events. Usually, they are available for free, for a fee or developed by the traders themselves.

Since Forex trading offers a lot of attractive features like 24 hours, trade both short and long, leverage, etc, most of the new traders entering the market get carried away believing that they can become very profitable and make a fortune in a short term.  They tend to acquire a bad psychology, which ends up hastening a losing pattern. This is in contrast with the successful trader known for his humility and discipline. These qualities ultimately are acquired through experience and accepting some simple realities of the Forex market.

The first step towards becoming a successful and profitable trader is to devise a trading strategy or plan, which is very important.

However, you must address the following to create a successful trading strategy:

• Reason of the trade: Am I to buy or Sell? Which pair?
• Time of the trade: Now? Before economic news release or after? Day or night?
• Trading Objective: Take profit target and stop loss limit
• Money Management
• Documentation and analysis of the results

Note that there must be a good reason for taking a buy or sell position, which could be fundamental or technical or both.

Determine the Currency Pairs to Trade

There are three categories of currency pairs; Majors, Crosses and Exotics. From experience, it is recommended to start with some of the major pairs like EURUSD, GBPUSD and USDJPY.  The EURUSD is one of the most widely traded pairs and it carries with it a lot of volume and liquidity. Also, you can find a lot of analysis on this currency pair in a lot of websites as well as other Majors.

You also have to resolve when you will trade and how often you will trade. For instance, are you going to be a day trader or hold positions for a longer period of time? Your schedule and responsibilities may have some impact on that.

Should you trade before economic releases or after? Should you trade heavily on nights, during UK open and close etc?

 It is important to define these basic ideas to begin to form some consistency and discipline.

Define your Trading Objectives

In defining your trading objectives, you determine your end goal, your take profit targets and stop loss limits. It is good to place your take profit and stop loss before entering the trade since you can always modify that if something important happens in the market on the interim. A common mistake lots of traders make is to take their profits early and allow their losses to run. This is simply because the inexperienced trader’s mindset is very difficult to accept that he/she is wrong.

 Placing your stop loss at the time you open a trade helps create discipline and lets you know that sometimes you will be wrong. Furthermore, most new traders have completely unrealistic goals. Making big returns in the first year of trading is possible but highly doubtful. These unrealistic expectations wipe out a lot of traders before they even had the chance to learn the market. Breaking even in the first year is splendid goal; many traders do not do that. If a trader makes 20-30% on their initial investment in their first year, I consider this to be really good.

Money Management

This is perhaps the most important aspect of trading.  First you have to recognize that in trading nobody can have a 100% winning ratio and everybody (even the most experienced traders) are sometimes wrong. Accepting that sometimes you might be wrong is again of paramount importance. The key here is accepting you are wrong before your mistake becomes too big. To do that you need to agree on how much equity you have to fund you account. Then you must determine how much risk you are willing to take on each trade. Most experienced traders risk 1-4 % of their account balance on each trade. This may look too low to the new Forex traders, but will definitely help you avoid big losses, create the necessary discipline and keep you in the market in order to get the necessary experience. Also very important is to have a positive percentage of winning trades compared to losing trades and a positive average profit compared to the average loss ratio. If your average loss is two times your average profit that means you need to make 10 profitable trades to cover 5 losing trades. Keep this in mind.

Along with money management, it is vital to keep track of your past trading and results in order to recognize past mistakes and avoid them in the future.

This is just a crucial start to having a successful trading strategy in the long run but will definitely help new traders get the discipline required to be profitable in the very exciting Forex market.

For those of you in Ibadan, Nigeria, we hold a forex trader's forum regularly.  
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