How to Setup a Forex Trading Strategy
- Wednesday, 30 March 2011 02:07
Trading the forex can be a difficult and dangerous task. Every trader should have a well thought out strategy keep thing under control and not to loose money. Here are a five guidelines to help you create a successful strategy.
1- Determine your schedule
The forex is a 24 hour market which makes it quite flexible. If you only have a few hours a week to dedicate then a longer term trading strategy would suit you best. If on the other hand you plan on making trading a full time job, then you may consider a day trading strategy. However, keep in mind that certain markets in the forex are only open during a few hours day. The London and the New York trading hours are the times when the forex is the most active. Below is a breakdown of the trading hours of the major forex makets:
As you can see, between 13:00 and 16:00 GMT, the London and the New York sessions overlap. That’s when the trading volume is the highest. On another hand, there is very little activity when the New York session closes until the opening of the Tokyo session.
2- Determine your time frame
Finding the right time frame to trade can be very tricky especially if you are relying heavily on technical analysis. Indicators often give different signals on different time frames. That is when experimenting comes into hand. Try trading on different time frames until you become comfortable with one or many of them. The smaller time frames (one hour and less) are best suited for very active traders. The one hour, four hour, and daily time frames are used mostly for swing traders. Longer time frame can be used to gauge the overall trend of the market or to make trading decisions for the long term.
One important thing to consider when choosing a time frame is the stop loss and position size. You are more likely to use a smaller stop loss on smaller time frames. Using smaller stop loss allows you to increase your position size for a same VAR (value at risk).
3- Determine your entry and exit
Your entry signal is what triggers a trade. In the forex, many traders rely on technical analysis for their entry signals. At this point, it is strongly of advisable to have a set of basic rules before that determine at what point you should or should not take a trade. For instance, you might want to prevent any trade during news events or during specific times. You might want to only trade breakouts, or reversal patterns. Even more important than the entry signal is the exit signal, because it is the moment at which you exit a trade that will determine your profit or loss.
4- Manage Risk
This is perhaps the most important notion in trading. A good way to manage your risk is to determine your value at risk (VAR). The value at risk is the maximum amount that you can lose in a trade. By setting a stop loss and a position size, you can calculate your value at risk. For instance, if you buy 1 lot of the EURUSD, every pip is worth 10$ and setting up a stop loss of 20 pips will give you a VAR of 200$ (pip value x stop loss). Your VAR should not exceed a certain percentage of your balance — the lower the better (some advice not risking more than 2% of your balance on any trade). By limiting your VAR you also control your leverage which is a good thing.
5- Test your strategy
Testing out your strategy on a demo account is very important and it should be done over an extended period of time (many weeks to many months). Keep track of every trade and monitor your progress as you go. Try to analyse why some of your trades where profitable while others were not. Pay a particular attention to your emotions as well. Being a successful trader has a lot to do with controlling emotions.
