A forex trading strategy in its simplest form is a set of rules that should be followed when trading. Usually based on either technical analysis, fundamental analysis or a combination of both, a trading strategy can be applied manually or in some cases turned into an automated trading system.
Technical analysis covers a variety of techniques that use historical price data to interpret and try to forecast future price movement. Fundamental analysis is the process of using political, economic and social factors to interpret the potential impacts these may have on the value of a country’s currency.
A manual strategy will require the investor to interact with their brokers trading platform in identifying market entry and exit points, then proceeding accordingly. Trades can be opened and managed in the trading platform through the use of market and pending orders.
Some trading strategies can be automated by programming, the outcome is a software or piece of code (also called script) commonly known as an Expert Advisor (EA) or trading robot. EAs are used to either display Buy, Sell or close signals etc. or to take these actions automatically without manual intervention from the investor.
With a mountain of trading strategies available on the Internet, there’s no single trading strategy which works in all market conditions. That’s why it’s important to understand the main aspects shared across many of the trading strategies available out there when considering this area.
A clear set of rules governing the criteria of the entry and exit signals is just one of the elements that a trading strategy will usually have to meet prior to a trade being executed. Commonly used are technical indicators, particular support/resistance levels, candlestick/chart patterns or combinations of these.
Whilst only trading and investing with an amount of money that the trader is prepared to potentially lose, it can also be good practice for a trading strategy to clearly address the potential risk to reward ratio of any potential transaction prior to the trade being opened. A minimum risk to reward ratio may in turn be one of the criteria that the trading strategy would need to have to provide a trading signal of any type.
Based on the risk factors of the strategy, the lot size of the position being opened on a financial instrument should be carefully considered prior to the trade being opened. Many trading robots include a preset lot size or the option to select a desired position value. The size of the investment (the volume) will directly influence the impact of each price change (expressed in pips), resulting in larger or smaller profits or losses. To learn more about a pip and its value please click here.
Take Profit, Stop Loss and Trailing Stops
The use of a Stop Loss, Take Profit order and Trailing Stop are risk management tools that can be utilised to help limit losses whilst locking in potential profits from open trades. Stop Loss, Take Profit and Trailing Stop orders can be based on your daily trading targets, a maximum drawdown or trade levels which can be programmed into an Expert Advisor.
Some traders may wish to lock in profits once they gained a couple of pips per trade or limit losses to a maximum drawdown percentage of their total capital. Other traders may consider price indicators such as moving averages, Fibonacci retracements or pivot points (support or resistance). Regardless of the trigger, utilising a Take Profit, Stop Loss or Trailing Stop can make the difference between sound and careless trading. Please click here to learn more about these order types.
No matter your knowledge or trading experience, all trading strategies should be tested and understood first in a risk-free Demo environment prior to being traded with real money. You can register a Demo account today by simply clicking here.