Successful investors never take a risk without careful analysis and ensure each move they take builds toward a wider strategy aligned with their anticipated returns.
Table of contents
- The Basics Of Trading Strategies
- Picking A Trading Market
- Developing A Trading Style
- Comparing Technical And Fundamental Trading Strategy Analysis
- Creating A Market Entry Approach
- Planning A Trading Strategy Exit
- Backtesting Your Trading Strategy
- Reviewing And Revising Trading Strategies
- Creating A Risk Tolerance Trading Strategy
- How to Develop a Trading Strategy FAQ
- Related Information
Creating a great trading strategy takes time and expertise, but it’s simple enough to get started, tweaking your approach as you go and as financial returns vary.
The trick is to develop a strategy that collates your risk tolerance, long-term ambitions and relies on data-based 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 go about the transaction.
Every trader or investor should have a strategy because if they make decisions on the hoof, they’re effectively making random guesses in a disordered way.
While you’ll 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 portfolio assets.
- Your style of trading.
- Your available capital.
- Your risk exposure appetite.
Developing a strategy is the easy part – making it profitable not so much.
Below we explore the fundamental steps to designing a strategy that works for you, with the best possible chance of success.
Picking A Trading Market
The first stage considers the broad range of financial markets you might trade in, perhaps stocks, commodities or forex.
While it’s obvious that you need to choose your market before creating a strategy, it remains a crucial phase because trading plans depend heavily on the market in question.
An approach that works brilliantly on the commodities market might fall flat on its face in forex, so it’s no good to invest time in developing a precise strategy if it’s not compatible.
Your next task is to educate yourself as much as possible in the culture, environment, risk and nature of your selected trading market.
Developing A Trading Style
Now we need to think about trading styles, which depend on the timeframes you’re looking at.
Some traders focus on scalping, spending the whole day carefully monitoring movements and entering or exiting countless trades with lightning-fast turnaround speeds – The Balance explains this in more detail.
Scalpers can trade huge volumes every day, earning tiny pips on each trade but using volume to leverage higher profits.
Part-time traders usually go for swing trades, which don’t command such intensive monitoring and allow you a little more flexibility to select your manoeuvres.
A swing trader will probably leave a trade open for a few days, weeks, or months, so choosing a trading style that matches your lifestyle and time commitments is essential.
Comparing Technical And Fundamental Trading Strategy Analysis
Once you have a strategy, you can’t sit back and assume it’ll work – traders will use ongoing analysis tools and metrics to make adjustments and alter their approach according to a host of micro or macroeconomic influences.
Fundamental analysis is just that, so a forex trader would:
- Review the economies of the countries in which they hold currency.
- Keep track of monetary policies and political news.
- Remain poised to move if they predict a denomination is about to change.
Technical analysis is slightly different and uses historical price indicators to estimate future patterns or price behaviours.
While both analysis approaches are feasible, great trading strategies incorporate both, so a technical trader will be conscious of economic events that might cause their assets to pivot.
Likewise, a fundamental analysis trading strategy will still require oversight of performance and trajectories to make informed decisions.
Creating A Market Entry Approach
When it comes to the actual trading, you need to choose a trigger event that signals your entry into the market.
That might be a monetary policy announcement or the reduction of a central bank base rate, at which point you could take a short position (or vice versa) on that forex currency.
If you’ve opted for a technical trading methodology, a pattern or technical indicator will instigate your market entry by using a candlestick chart to plot movements.
Planning A Trading Strategy Exit
Knowing when to exit is just as vital as choosing your moment to enter and relies on careful evaluation to ensure you don’t miss out on profits or exit too late and exacerbate your losses.
Traders use tools such as stop losses and take profits to manage risk exposure and avoid big mistakes.
Along with tools, your strategy should determine conditions when you will exit, which could be reaching a particular profit or loss level.
Technical traders use indicators in the same way as for planning a market entry and will leave as soon as their threshold metric is reached.
Backtesting Your Trading Strategy
A completed trading strategy is always subject to change, and backtesting means you run through a process of:
- Reviewing financial instrument historical price data.
- Identifying all the scenarios where you would have entered or exited the market.
- Analysing how your trade would have performed.
Backtesting is valuable because it shows how your strategy would have worked in real-life situations, throwing up potential amendments or conditions where your entry or exit prompts would have been to your disadvantage.
Past performance, of course, doesn’t guarantee any future result; it does act as a ‘what if’ analysis so you can get a good idea about how solid your strategy is.
Reviewing And Revising Trading Strategies
A trading strategy is never perfect, finished, or set in stone for years to come.
Agile trading strategies adapt easily to changes in market conditions and mean you have ways to move your position or adjust your trading prompts accordingly.
Creating A Risk Tolerance Trading Strategy
Trading carries varying risk exposure levels, and your attitude towards risk will be a defining factor in the strategy you create.
Risk is also likely to vary, not solely because of economic or market factors, but because your acceptable risk tolerance will also move, perhaps if you experience changes to your finances or are recovering from a significant gain or loss.
You might base your risk acceptance approach on:
- The length of your trades – longer-term positions can usually tolerate a higher risk level, and you can make hugely profitable trades during volatile markets.
- Shorter-term trades command lower-risk investments in diversified asset classes.
- Risk capital should ideally be restricted to ten per cent of your trading portfolio, retaining that same ratio as your portfolio grows.
Experienced traders can allocate 25 per cent or even more towards riskier investments, although it’s important to move slowly to protect against market volatility and losses.
Monitoring your risk, and making informed decisions when you reach the upper ceiling on your tolerance, is essential, whether you’re a seasoned investor or just starting to become acquainted with the intricacies of managing a trading strategy.
How to Develop a Trading Strategy FAQ
What is the most successful trading strategy for beginners?
There is no universal trading strategy that every new trader should adopt. You need to assess all of the above factors, picking a viable risk exposure, a style that matches your anticipated time for investing and a trading commodity you are familiar with.
Scalping is perhaps one of the most common strategies, selling as soon as the trade reaches even a small profit level – but it needs a lot of time and focused monitoring to respond instantly.
Should I backtest a new trading strategy?
Backtesting is hugely important. While it can’t predict the future, a backtest highlights any element of your entry or exit triggers that wouldn’t have worked in a previous scenario.
Defining your entry and exit point is essential, so a backtest will assess whether those triggers are suitable.
Is there a simple trading strategy I can start with?
New traders without a huge amount of experience normally start with a technical trading strategy, using software or modelling platforms such as Iress or ProRealTime to make decisions based on figures rather than broader economic factors.
Horizontal price chart levels are easy to interpret, and traders can look for clear price patterns to make fairly robust decisions.
What is expectancy in trading, and how do I calculate it?
Expectancy ratios help you determine each trade’s expected profit or loss.
You start with the reward vs risk ratio and multiply that metric by the assigned win ratio, subtracting the resulting figure from your loss ratio.
How should I develop a day trading strategy?
Day trading means you buy and sell – or the other way around – security within the same trading day. It’s a general term covering all securities and options, although you can’t normally day trade within cash accounts.
The principles for your trading strategy remain consistent, whichever trading style you intend to adopt.
That means forming a market ideology, choosing a market and timeframe, picking your analysis tools and deciding how you will plan your entry and exit triggers.
Related Information
Below is a list of related articles you may find of interest.
