In order to create a viable trading system for forex some basic principles need to be followed. Of course, there are some exotic forex strategies breaking all the rules and thinking outside the box. And we love those strategies very much. However, those same rules can be applied and connected with aggressive, or any other approach of strategy creation and bring you improved results..
This way, you can benefit and take advantages from both worlds. We have created, reviewed or published close to a thousand forex strategies. Thousand hours of getting familiar with the rules, looking for the flaws and often time finding exceptional trading systems. However, after all the years I still tick with my old routine. Why ? Because even when I find exceptional forex strategy, the one that I use – I know it like a palm of my hand. It also suits my character. It would take years to master the new forex strategy and acquire trust in its rules, which is absolutely crucial if you want to stay calm and confident in difficult situation.
For the best results, trade with professional ECN/STP broker with MT4. If you can't trade with profit. Automatically copy the traders that are already profitable.
There are a few rules you need to follow to create your perfect-fit system that would suit your character and would be enjoyable to trade.
How to create your profitable forex strategy
Pick a timeframe
Actually I trade across all timeframes. Constantly switching between them. To get the idea about the price I move from 5 min to 1 day chart all day every day. However this is me.
It is good to pick a timeframe that suits your character. Also consider that it is inhumanly difficult to remain concentrate trading in 5 min chart. 1H chart is the one that fits most of the traders. More aggressive traders could look down to 15 min chart. Busy guys should be happy at 4H chart. At 1H char you can get a lot of trading action. Nice movement with interesting risk reward ratio, and you do not have to sit at the chart all day. Remember. This is a lifetime of trading ahead of you. Make yourself comfortable to enjoy the ride.
There are numerous trading styles that can fit any personality. Choose the one that you feel most comfortable with and make it work for your. Swing trading is beloved by many. However, I could personally never trade it with any success. I would just get bored. Pick the style that you would enjoy. Do not try to fit your personality into the trading system just because you think its profitable. Almost any system can become profitable. There are many small nuances to each style, that can be only mastered by trader fully enjoying his job. Scalping forex strategies are suitable for traders looking for the daily action. Traders who look to employ they trading mastery and sharpen their swords every single day. They must have impeccable discipline as mistakes can be very costly as the margin for error is very narrow (most of the time). Positional trading (swing) can be employed by both busy and patient traders. Breakouts may be suitable for excellent traders. Snipers of forex world.
Find the trading style fitting your personality and make it work. I for years tried to make various strategies work for me and they never did. Until I found a strategy that I felt absolutely comfortable with.
The market is chaotic. Trend exists as long as the market is driven by people looking to make money, with fear, greed and memory. It is always easier to bet on a trend continuation than to find the point of its immediate reversal.
If you're going to identify trend, do so also for higher timeframes (especially if you decide to enter the trade based on 15 min chart). What seems to be a suitable entry into the downtrend in your chart, might be just an end of a downward correction in chart above.
But there is no need to panic. To keep this simple a rule of the thumb can be applied. If you are switching to higher timeframe just multiple the calculation period for your trend identification tool.
Whatever tool you choose it will never be right all the time. You just need a good enough trend identification method. Unavoidably, before the trend reversal, there will be some trades still in the direction of trend that is doomed to end. This is the reality of the market. Trend can be only identified and confirmed after it lasts for a while. And then it can reverse immediately. In a long run, however you will be still much better of trading with the trend.
Tools that can be used for trend identification.
Moving averages: Averages should be mastered by any trader. They are incredibly versatile tool with scalability that just fits all market conditions. Use combination of higher calculation period (2505x125,500x250,1000x500) to identify the main trend. All trades should be taken only in its direction. To identify the main trend look at the fast MA position relative to slow MA position. Fast MA trending above slow – uptrend and vice versa. Faster calculation period MA (7x14, 14x21) should be used as immediate trend identification tool. Helping you to make sure that you don't enter the trade at the beginning of major trend correction. Crossover signalizes possible trend reversal with all MA crosses.
Oscillator trend identification: Oscillating forex indicators such as RSI, Stochastic, CCI or DeMarker are also an excellent tool of trend identification. They can also provide a trader with an easily measurable information on range and momentum. Something that is difficult to do with moving averages. To avoid trading in the range, add central lines creating a tunnel in a middle of oscillators graph (55 and 45 line in RSI separating the ranging conditions from the trending).Price momentum can be determined with great sensitivity by adjusting overbought/oversold zone of the oscillator. Price entering either one of them may be filtered out based on distance of lines from the center. Only the most rapid price movement will approach 80/20 lines of indicator (RSI). Use the same calculation period with tighter overbought/oversold range (55/45) and the trend is correctly estimated.
Using the trendlines. Manually drawn trendline are a great tool. Most of the time they are proffered by experienced traders. The issue with them is that is often times difficult to no make them personal or subjective. Only the most clearly visible lines confirmed by wide trading public should be considered valid. And still. Trader needs to consider price itself approaching the trendline, because often times trendlines will become visible just before the breakout and trend reversal. However, you should still strive to learn how to draw them as they are useful in avoiding breakout and entering the trend on historically significant price levels.
Volumes: Even through they are not particularly accurate in forex marker. Tick activity can tell you a lot about the sustainability of trend in forex. Any trend with decreasing volume should not be trusted. Volume decreasing on counter trend correction on the other hand signalizes good entry point in the trend
The trade signal
The signal will tell you exactly when to enter the trade. The good signal will provide your with good enough price for you enter the trade. Good enough price means tight stop loss and wide margin for profit. Basically, you can try to enter the trade on high/low price in the direction of trend. Or you can look for a breakout.
Breakouts are a complete opposite of high/low price entry approach. Breakout entry can be extremely accurate, but most of the time you would be a better off looking for just a good price to enter the trade.
Again. You just try to find the price that is good enough. There is no perfect entry, and if it happens from time to time. It was only a matter of luck. Entry that looks perfect in the hindsight is nothing more than a product of good luck. There is no such a thing as perfect entry in a long run. Therefore, you shouldn't beat yourself up for a lost trade. All you can strive for a good enough entry.
High/low price entry: This type of entry works the best according to a thousand tests we have performed. Market is chaotically fluctuating around an average price moving either up or down. By entering at high/low price (low in uptrend, high in downtrend). You give yourself a statistically better price to enter. Your stop loss can be tighter and profit margin wider. Price is fluctuating above and below the average price that is moving either up or down.
Good tools to determine the high low price: Price touching the upper bollinger bands in downtrend, and bottom BB in uptrend. Volatility dependent BB tunnel is a fool proof high/low price identification tool. Sensitivity can be adjusted by manipulating deviation and calculation period, to fit any market conditions. Envelopes forex indicator can be utilized in the same fashion. Oscillators entry: entry based on oscillators may be reliable if used correctly. Most of the time it is necessary to connect it with confirming tool such as candle signal. In all cases we never enter immediately upon indicator entering the oversold/overbought zone. Instead, we wait for it to return back to the neutral zone. We enter long upon indicator moving into oversold zone and short upon indicator moving into overbought zone.
MA cross. Crossing of carefully selected combination of moving averages can help you find a good entry just at the correction end.
Formation based signal. Signals based on formation are quite subjective, therefore accuracy can vary greatly. To enter the trade, pick only the best chart/candle formations. For best results do so in confluence with other filters (trend). Candle formations are something different. They should be mastered by any trader looking to read the market with high degree of competence. Correctly read candles can give you a plenty of information on your signal. What is even more important they can tell you when to stay in position and let the profits roll and when it is better to exit the trade.
Momentum/breakout. Unlike the high/low signal. Breakout momentum signal often happens at opposite end of price fluctuations (bottom of the wave in the downtrend, top of the wave in the uptrend). Breakout tends to move rapidly once confirmed. However, this may be tricky because true breakout are often times moving too fast to be take advantage of (that's the purpose of them anyway). Valid breakout occurs trendlines, horizontal support/resistance lines. It can also occur on bollinger bands, or envelopes. To trade breakouts effectively, consider volumes and the manner in which price approaches the zone of the breakout. To master the breakout trading, ability to read chart and candle formations is mandatory.
Confluence of horizontal support breakout/BB 60 breakout. Manual trendlines drawing, horizontal support/resistance drawing. Trendlines properly drawn in the chart can be used to confirm or deny any trading signal. The way price approaches, touches or penetrates the line is the ultimate confirmation of trading signal or trend. It can be connected with trend identification, trade timing and understanding of wave structure of the market at higher timeframes.
After all those years I came to the conclusion that position management is actually more important than trend identification or signal. Even with a random signal strategy can show positive results, with right money and position management employed.
Position management includes placement of stop loss (if any), profit targets placement, trailing stop. But it also includes more advanced and more aggressive methods such as averaging, adding to the winner partial martingale and hedging. Advanced forex trader has all those tools in his arsenal and he can use them as he sees fit.
Managing position with predetermined max loss levels and take profit is a most basic method. To make the strategy work, you often times need to get more creative with the way you manage your trade. By predetermine those levels in advance you actually rob yourself of chance to maneuver and adapt to everchanging market conditions. What might have been a good target hour ago, may be unrealistic now. Lear to maneuvre your trade if necessary by using hedging, averaging and other tools. But be careful. If you use those tools in reckless manner you may end up in much worse situation than you were before.
First thing first: find a good enough trend identification methods with the right signal. Try to make it work with firmly set SL and TP. If necessary apply more aggressive/advanced methods of position management to make your strategy robust and profitable.
Money management is simple at all the times you should risk less than you could afford to lose. Ideally trade with amount so small that no single position could have impact on your judgment and influence your greed/fear. Trade with as little as you can.
Be prepared for he worst case scenario. Then double it and be prepared for that too. Find the worst market situation for your trading strategy. Look at he losses thoroughly. Would you be able to survive them without leveraging down ? If the answer is no, your strategy is not yet fit for the real market.
Never leverage down.
By leveraging down you make it difficult for yourself to gain beck the losses after a draw down. Your strategy should be able to withstand the heaviest draw down without leveraging down and without increasing the risk.
Putting it all together.
Once you create promising forex strategy that you feel comfortable trading. Test it, and test it thoroughly. If necessary get it coded into an MT4 EA and run backtest on high quality market data. This can often times reveal the flaws in your theories and provide you with solid data on historical draw down, gains and risk.
Testing will allow you to trade with confidence and full knowledge. It is always easier to trust a strategy with hard data behind it than some system that you kind of tested.