A DIY trading strategy

Today I’d like to take a look at trading strategies.

You can buy trading strategies out of a box. You can create your own. Or you can do what many traders do – something of a hybrid – learning from other people’s strategies and adapting them to your own trading style.

Here we’ll look at what the key components of a trading strategy are, and how simple it is to put one together yourself. I’ll even show you the bare bones of a successful strategy that you can develop in whichever way best suits you.

Have you been wasting your time and money?

One of the biggest mistakes traders make is to boldly jump into the markets, using leverage and “great ideas” or “hunches” with the aim of making themselves hugely wealthy.

It’s the reason why so many traders wipe out their first trading account. Often very quickly.

The result is that they either give up spread betting and retire to lick their wounds. Or they have to dig a little deeper financially and will – hopefully – be more sensible next time around.

Sensible is not about being over cautious – trading involves some risk, and we have to accept that risk if we want to achieve serious returns.

Sensible is about be disciplined, and trading according to a plan.

If you aren’t yet trading with a disciplined trading strategy or plan – then don’t waste any more time setting one in place.

And if you do have a strategy – it’s always good to give that system a quick MOT to check that it’s functioning optimally.

Let’s run through the five key components that any trading strategy should contain …

1. What are you trading?

If you’re trading forex, it’s best to start out with the major pairs that will have the best liquidity and are less choppy that some of the minor pairs. I’d recommend GBPUSD, EURUSD and USDJPY.

If it’s not forex, you might be looking at the FTSE, the Dow Jones, the S&P500, commodities, or individual stocks.

2. Why are you trading?

Before entering any trade you should have a good reason. Successful traders never enter a position because they want the thrill, because they “feel” it’s the right way to go, or simply because they are bored. You need a clear set of rules that will be the criteria for opening a position.

3. When will you trade?

Are you a day trader or will you be holding your positions overnight? Will you trade for an hour each morning, or will you be watching charts all day long? The best times for your trading will be dependent on your lifestyle and what instrument you are trading. Many forex traders go for trading Cable (GBPUSD) at the start of the day as a preferred option.

Also, are there times when you won’t trade? Ahead of important economic announcements, for example? Out of hours, perhaps, when the spreads may be wider, making your trading more expensive?

4. What is the goal of your trade?

It’s all very well opening a trade, but without a clear objective for that trade, it’s very likely to flounder. When you open a trade, you should have a clear idea of what will happen if that trade goes your way, and what will happen if that trade goes against you. Part of the process of placing your trade should also be placing your stop loss and your profit target. That said, you should also be flexible enough that you can adapt these goals if circumstances change while your trade is open.

5. How much will you trade?

Deciding how much you will risk on any trade is a big decision. The first thing you need to accept is that you might be wrong. In fact, depending on your trading strategy, you might be wrong quite often. Losing trades unfortunately don’t tend to spread themselves out nice and evenly through the trading year – they have a nasty habit of coming in runs, and you need to be able to handle a bad run.

For that reason, experienced traders will only ever risk 1–4% of their account on any one trade.

You should also weigh up the amount you win on a losing trade to the amount you will lose on a losing trade. If your average loss is twice as much as your average win, you’ll need to win 10 trades just to cover 5 losing trades.

6. How will you monitor your results?

Trading is a learning process. You can’t expect to begin from a standing start without hitting problems and set-backs. And if we don’t keep a track record of our results and log our successes and failures, we will never progress.

A simple spread sheet is all you need to keep a history of your results and your profits and losses.

Here’s one to get you started …

Most traders will at some point in their trading careers toy around with the double moving average crossover. It has it’s drawbacks, which I’ll cover in a moment, but it would be a mistake to discard this strategy just because it lacks some of the checks and balances that would improve it.

Anyway, here it is:

1. What are you trading? I’m trading Cable (GBPUSD).

2. Why are you trading? I’m watching a 15 minute chart, on which I’ve added the following exponential moving average indicators to it: 10EMA, 20EMA and 50EMA. If the 10 EMA crosses the 20 EMA, and continues on through the 50 EMA, I’ll buy or sell in the direction of the 10 EMA line. If the 10 EMA line is not showing a clear direction, this is a no trade.

3. When will you trade? I am trading from 7am to 11am, avoiding holidays and major economic announcements.

4. What is the goal of your trade? I set my profit target 20 pips away from my entry point, and my stop loss 10 pips away from my entry level. I will watch for obvious support and resistance levels that may affect these targets. I will actively manage my trades with the intention of limiting losses and moving stop levels up to breakeven where possible.

5. How much will you trade? I will risk 2% of my trading fund on any one trade.

6. How will you monitor your results? I will keep a record of each trade, along with my P&L.

If you thought that all trading strategies require a 200-page manual, you may be surprised at just how simple they can be.

As I said before, this is a “bare bones” strategy without all the whistles and bells that can fine tune entry and exit levels. Try throwing in an extra indicator to improve your entry, and one to manage your exit …

However, you could do a lot worse than this bog-basic strategy. Traders often feel that they need complicated charts loaded with indicators, when in fact, if we establish a rule-based system and use something dead simple (like a moving average crossover) we can often find that to be our most lucrative trading.

Until next week,

Mark Rose

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