Developing Your Trading Strategy

One of the most common questions I am asked is how you can develop a trading strategy to use in the foreign exchange markets.  Like trading any product, there is a time-tested process to work through to develop a trading strategy or plan that you will be able to implement with confidence.  As simple as it sounds, you need to work out what will and won’t work in the market as you look to develop some trading rules. 

A robust trading plan, which is simply a compilation of your trading rules, will answer the following three questions at a minimum:

• Under what circumstances will you enter a trade?
• How much money will you commit to the trade?
• Under what circumstances will you close the trade?

There are theoretically an infinite number of trading opportunities every day and there are plenty of different strategies.  There is no need to reinvent the wheel with regards to trading strategies.  You can develop some rules based on different components like the trend, chart patterns and key levels like support and resistance. 

Next, is your position sizing. Remember, protecting your trading capital is the most important thing you can do. Determine your risk amount, your maximum limit for each trade and then determine how you will calculate how much money to commit to each trade and therefore how many contracts or units of currency you will trade.

Finally, the most critical part — and that is when to exit. Notwithstanding the importance of mindset and cutting losses, etc., from a technical standpoint, this would be the most common problem inexperienced traders have. The problem is not that traders don’t set initial stop losses, etc., but where they place them.

What market indicators should traders be looking for?

This is another common question I am asked.  There are literally hundreds of technical indicators that have been developed over the years which presents some interesting questions.  If there are hundreds of indicators, then which one(s) should you use?  Do you need to use any indicators?

Numerous texts include the more popular indicators and many people assume that as they are so widely documented, they must be the best indicators to use.  It is widely accepted that many losing traders rely too heavily on these indicators and the very mechanical systems that use them.

What you will also find is that profitable traders who do use them will often take the time to learn the actual mathematical construction of the various technical indicators to fully understand what each is displaying.  The importance of this is that they fully understand what the indicator is designed to achieve and therefore the best way of interpreting it and applying it practically.

There are also numerous other more fundamental indicators which routinely rely on key numbers and data on economies etc.  Like any other indicator, it is important to understand it and determine whether you are going to benefit from using it. 

The truth is that no indicator is infallible, and they often provide false signals. If they don’t provide a marked advantage to you, if they don’t provide you with an edge, then why use them? 

Are there any forms of technical analysis that are particularly suitable for FX?

People often view FX trading requiring a short-term trading style, although this doesn’t need to be the case.   However, the shorter the time frame, the more effective technical analysis seems to work over fundamental analysis. 

Any form of technical analysis which looks at pure price action and how candlesticks form assists greatly with FX trading. 

Technical analysis is the study of actual movements in the price of a financial product.  Technical analysts assume that all fundamental and economic influences on a price are already taken into consideration in the market, so they simply monitor the price action.

I believe that technical analysis is less about trading and more about the study of mass psychology.  We study the way people react in certain situations in the market.  Furthermore, the beauty of technical analysis is that it is equally effective in markets around the world, as human nature is the same around the world. 

Whatever tools and techniques you have been using in other forms of trading can often translate into the world of FX trading.  Whenever you have a price being determined by supply and demand, technical analysis can be applied.   

Regardless of the trading product, studying price action might be the best way to anticipate price movement and identify the most likely outcome.

How should one start out in forex trading while still holding down a full-time job? How should one transition from a full-time job to be a forex trader?

This is always a difficult situation to assess and of course, everyone’s situation is very different.  It is important that people don’t think they can quit their job on Friday and start trading successfully the following Monday.  This ambition is farcical. 

The reality is that developing the necessary skills and attributes to be a successful trader takes time – a lot of it.  We almost need to train ourselves to think very differently and counter intuitively. 

When most people start trading, they never consider whether they are well prepared and have the necessary skills and attributes to be successful. This is likely to be one of the last things on their mind. Somewhere along the path of trading, however, most people come to a realisation that trading is probably not as easy as they first thought.

With this humbling realisation comes a search and investigation into what makes a successful trader. They seek out what they need to do and learn about, in order to make all this money they dreamed of initially. They attend courses, converse with other traders further along the path of trading than themselves and make a committed effort to learning this new craft.

There are many professions in the world where you wouldn’t expect yourself to achieve a certain level of proficiency and skill instantly. You wouldn’t expect yourself to jump in the cockpit of the latest offering from Boeing or Airbus and be piloting it half-way across the world. Yet, some people believe that trading will be easy and you will be profitable from day one. Sadly, this is rarely the case.

You must be patient with yourself and the whole journey. It will take time to acquire and develop the skills necessary to consistently profit from trading.

Whilst still working full time, the most difficult challenge will be finding the time to commit to your trading journey.  You will know when it is the right time to transition to full time trading because you will reach a level of competence where it makes sense to.

Good Luck!

About Stuart McPhee

Stuart McPhee has traded for over 20 years and is the author of the best selling book Trading in a Nutshell, 4th Edition.  He is one of Australia's most compelling speakers on trading and has personally coached high net worth traders all over the world.  Since 2001, he has spoken live in front of tens of thousands of fellow traders from Mumbai to New York, Tokyo to London, Melbourne to Beijing, and many places in between.  He has helped countless traders improve their performance with his expertise in technical analysis, trading psychology, risk management, the trading process and developing a trading plan.