Successful investors never take risk without careful analysis and ensure that every move they take is part of a larger strategy aligned with their anticipated returns.
Creating a great trading strategy takes time and expertise, but it’s simple enough to get started, adjusting your approach as financial returns vary.
The trick is to develop a strategy that brings together your risk tolerance, your long-term ambitions and uses data-driven analysis to identify opportunities.
The basics of trading strategies
A trading strategy is a set of predefined requirements and rules, which you refer to when you want to decide when to enter or exit a financial position, and how you proceed with the transaction.
Every trader or investor should have a strategy because while they are making decisions on the spot, they are actually making haphazard random guesses.
While you will see a million articles in the media advocating a particular strategy, nothing is ever guaranteed, and your approach will depend on:
- Your trading profile and assets in your portfolio.
- Your trading style.
- Your available capital.
- Your appetite for risk exposure.
Developing a strategy is the easy part – making it less profitable.
Below, we explore the fundamental steps to designing a strategy that works for you, with the best possible chance of success.
Choose a trading market
The first step looks at the wide range of financial markets you could trade in, perhaps stocks, commodities or currencies.
While it is obvious that you must choose your market before creating a strategy, this remains a crucial phase because trading plans are highly dependent on the market in question.
An approach that works brilliantly in the commodities market can fall flat in forex, so it’s no good investing time in developing a precise strategy if it’s not compatible.
Your next task is to learn as much as you can about the culture, environment, risks, and nature of the trading market you have selected.
Develop a trading style
Now we need to think about trading styles, which depend on the time frames you are considering.
Some traders focus on scalping, spending all day carefully monitoring movements and entering or exiting countless trades with lightning-fast execution speeds – The Balance explains this in more detail.
Scalpers can trade huge volumes every day, earning tiny pips on every trade, but using the volume to generate higher profits.
Part-time traders usually opt for swing trades, which don’t require such intensive monitoring and allow you a bit more flexibility in selecting your moves.
A swing trader will likely leave a trade open for a few days, weeks, or months, so choosing a trading style that fits your lifestyle and time commitments is essential.
Comparison of Technical and Fundamental Analysis of Trading Strategy
Once you have a strategy, you can’t sit back and assume it will work – traders will use analytical tools and ongoing measurements to make adjustments and alter their approach based on a multitude of influences. micro or macroeconomic.
Fundamental analysis is just that, so a forex trader:
- Review the economies of the countries in which they hold currencies.
- Keep track of monetary policies and political news.
- Stay ready to move if they predict a denomination is about to change.
Technical analysis is slightly different and uses historical price indicators to estimate future trends or price behavior.
Although both analysis approaches are feasible, great trading strategies incorporate both, so a technical trader will be aware of economic events that could cause their assets to swing.
Likewise, a fundamental analysis trading strategy will always require performance and trajectory monitoring to make informed decisions.
Create a market entry approach
As for the actual trading, you need to choose a trigger event that signals your entry into the market.
This could be a monetary policy announcement or a central bank’s base rate cut, in which case you could go short (or vice versa) in that forex currency.
If you have opted for a technical trading methodology, a technical pattern or indicator will trigger your entry into the market using a candlestick chart to plot movements.
Planning a Trading Strategy Exit
Knowing when to exit is just as vital as choosing your entry time and relies on careful assessment to ensure you don’t miss out on profits or exit too late and exacerbate your losses.
Traders use tools such as stop loss and take profit to manage risk exposure and avoid big mistakes.
In addition to the tools, your strategy must determine the exit conditions, which could reach a particular level of profit or loss.
Technical traders use indicators in the same way as when planning a market entry and will leave as soon as their threshold metric is reached.
Backtest your trading strategy
A completed trading strategy is always subject to change, and backtesting means that you follow a process of:
- Review of historical data on the prices of financial instruments.
- Identify all scenarios where you would have entered or exited the market.
- Analyze how your trade would have worked.
Backtesting is valuable because it shows how your strategy would have worked in real-life situations, generating potential changes or conditions where your entry or exit prompts would have worked against you.
Past performance, of course, does not guarantee any future results; it acts as a “what if” analysis so you can get a good idea of how strong your strategy is.
Review and revision of trading strategies
A trading strategy is never perfect, finished or set in stone for years to come.
Agile trading strategies easily adapt to changing market conditions and allow you to move your position or adjust your trading prompts accordingly.
Create a Risk Tolerance Trading Strategy
Trading involves varying levels of risk exposure, and your attitude towards risk will be a determining factor in the strategy you create.
Risk is also likely to vary, not just due to economic or market factors, but because your tolerance for acceptable risk will also change, perhaps if you experience changes in your finances or recover from a gain. or a significant loss.
You can base your risk acceptance approach on:
- The length of your trades – longer term positions can generally tolerate a higher level of risk and you can trade extremely profitably in volatile markets.
- Shorter-term transactions require low-risk investments in diversified asset classes.
- Ideally, venture capital should be limited to 10% of your trading portfolio, maintaining the same ratio as your portfolio grows.
Experienced traders can allocate 25% or even more to riskier investments, although it’s important to move slowly to protect against market volatility and losses.
It is essential to monitor your risk and make informed decisions when you reach the upper limit of your tolerance, whether you are a seasoned investor or just starting to learn the intricacies of managing a trading strategy. .
How to develop a trading strategy FAQ
What is the most effective trading strategy for beginners?
There is no one-size-fits-all trading strategy that every new trader should adopt. You should weigh all of the above factors, choosing a viable risk exposure, a style that matches your expected time to invest, and a trading product that you are familiar with.
Scalping is perhaps one of the most common strategies, selling as soon as the trade reaches even a small level of profit – but it takes a lot of time and targeted monitoring to react instantly.
Should I backtest a new trading strategy?
Backtesting is extremely important. Although it cannot predict the future, a backtest highlights any element of your entry or exit triggers that would not have worked in a previous scenario.
Defining your entry and exit point is essential, so a backtest will assess whether these triggers are appropriate.
Is there a simple trading strategy I can start with?
New traders without much experience normally start with a technical trading strategy, using modeling software or platforms such as Iress or ProRealTime to make decisions based on numbers rather than broader economic factors.
Horizontal price chart levels are easy to interpret and traders can look for clear price patterns to make fairly sound decisions.
What is expectation in trading and how to calculate it?
Expectation ratios help you determine the expected profit or loss from each trade.
How to develop a day trading strategy?
Day trading means that you buy and sell – or vice versa – securities during the same trading day. This is a general term covering all securities and options, although you cannot normally trade overnight in cash accounts.
The principles of your trading strategy remain consistent, regardless of the trading style you intend to adopt.
This means forming a market ideology, choosing a market and time frame, choosing your analytical tools, and deciding how you will plan your entry and exit triggers.
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