Devising a Trading Strategy

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A trading strategy is a set of well-defined rules on which buying and selling decisions are based, with the main objective of generating consistent profits over the long run. It allows us to stay on track and make tangible progress.

Trading strategies also equip us with an edge in the markets. What is an edge you ask?

An edge is something that puts us in a more favorable position to win against other players in a game. 

A trading strategy is a subset of a trading plan and if you don’t have one already, please feel free to click here to start creating your own trading plan.

This guide is catered to those who are new to trading and do not have their own strategy yet. Nonetheless, I believe it will provide insights for the intermediate and seasoned traders. 


Elements

A trading strategy consists of multiple components.

The Major Ones

  • Entry signals
  • Timeframes
  • Exit signals

The Ancillaries

  • Trading sessions
  • Types of securities

We are going to dive into each of these and by the end of this guide, you will be able to create a comprehensive and robust trading strategy with a long-term positive expectancy.


Building a Strategy From Scratch

Setting up a solid foundation

Firstly, we need to know what types of strategies there are. It is like exploring what legos we have so we know what we can work with down the road. 

Here are some of the common sources of inspiration where retail traders discover their trading strategies:

  • Online forums
  • YouTube videos
  • Trading books
  • Social media groups and communities

You can browse through these sources and find ideas but let me save you some time by listing down some of the tried and tested strategies out there.

  • Moving average crossover
  • Range trading
  • Breakout trading
  • Elliot waves trading
  • Trend trading
  • Fibonacci trading
  • Momentum trading
  • Arbitrage trading

Hands – on – Live Example

We are going to build a strategy based on moving average (MA) crossovers.

Overview

The entry signals will be generated when the faster MA crosses to the other side of the slower MA. Technically, a market reversal has to take place for the faster MA to turn and subsequently crossing the slower MA. Therefore, we are mostly focused on market reversals with this strategy, but it can also be turned into a trend trading strategy which I will explain later.


Entry signals

The whole idea of Moving Average Crossover Strategy is to wait for two or more MAs to cross each other, but we are going to use two MAs for the sake of simplicity. And it works!

Parameters of the Moving Averages

There are various settings that we can tweak for our moving averages such as the type, period, and input price, and I am going to show you the parameters of my crossover strategy.

Moving Average 1
Type: Exponential
Period: 14
Color: Red

Moving Average 2
Type: Exponential
Period: 50
Color: Blue

Why did I choose exponential moving averages (EMA) instead of simple moving averages (SMA)?

EMA allocates more weightage to recent price action and thus its ability to track and react to price movements quicker. On the other hand, SMA is more smoothed out and in my opinion,  more suitable for longer-term trading as it removes the noises on the lower timeframes. 


Timeframes

  • Trend determination: Daily, H4
  • Entry signals: M15
Trend Determination

The higher time frames are better for identifying longer-term trends as it shows a bigger picture of what has been happening with the pair.  If the candlesticks on the daily and H4 are making higher lows and higher highs, we know that the security is in a bullish market, and vice versa.

To utilize this information, we are only going to place trades in the direction of the trend as there is a common saying that goes like this “The trend is your friend”. Cliché as it is, but it is true. There is a higher probability of making a winning trade when the trend is in your favor. Furthermore, you have a bigger room for profits by allowing winners to run.

Entry Signals

Entry signals are hunted on the lower timeframe and in our case, the M15. Yes, we can trade with signals generated on the daily timeframe, but how long would it take for a single signal to occur? I checked. It takes more than a few months in most cases. We also have to keep in mind that crossover only occurs when the market is reversing so what if the market keeps trending? We will never get an entry signal.

On the other hand, the even lower time frames like the M1 and the M5 produce too many false signals, ie: the MAs appear to be crossing SOON, but as soon as you place a trade in that direction, they begin to “uncross” which means the crossover fails to materialize.

Thus, the optimal timeframe is the M15 where it eliminates most of the noises on the lower timeframes and is still able to generate trading signals on a consistent basis.


Exit signals

There are multiple exit points that we can use for this strategy;

  • Support and resistance areas
  • Previous day’s low/ Previous day’s high (PDL/PDH)
  • Fixed distance (in pips or in ROI%)
Support and resistance areas

This is for obvious reasons. Price tends to bounce on support and resistance zones and why don’t you want to close your position here? 

My philosophy with this strategy is to “stack it, bag it and move on to the next one”. 

Letting winners run 

Continuing on the point above, you may choose to let the trade run, provided that the underlying trend is in your favor and you believe the price will move further in your direction. In this case, you will use the next support and resistance zones as targets.

PDL/ PDH

These levels tend to be viewed as support and resistance as well so they have the same effects as support and resistance areas.

Fixed distance

If you are a more mechanical type of trader, you may use the number of pips or fixed ROI%  as a parameter for exiting positions instead of a chart-based exit signal. Those who want to make an exact amount for each trade will find this beneficial as it satisfies their needs for everything to be systematic and organised.


The major elements are now completed. Let’s move on to the ancillary components of a solid trading strategy.

  • Trading Session
  • Types of Instruments

Trading session

When selecting our trading session, we need to make sure that the prerequisites are being met. Since our strategy is based on market reversals, supported by a continuation of that reversal, the optimal session must

  1. Have a decent trading volume
  2. When reversals tend to take place for that particular security

Each session has its unique characteristics.  If you have been in the trading industry for long enough, you will notice recurring patterns in various aspects such as volatility, trading volume, average spreads, economic news releases, probability of reversals/ trend continuation, etc.

I will also save you time by sharing with you how GBPUSD behaves (since this is one of my favorites).

GBPUSD Throughout the Day

On most days, the cable is relatively quiet in the Asia session as most of its trading volume is done during the London and New York session. The banks and traders in the Asia Pacific region are mostly focused on their home country currencies such as the Australian dollar, the Japanese Yen, and some other exotic currencies like SGD and HKD.

The volume starts to pick up when London opens. According to my trading strategy, this is the time when I start looking for entry signals. GBP-related news such as UK’s CPI, Retail sales, PMI, etc is usually released around this time. Generally, volatility spikes at the time of announcement and normalizes shortly after. With news, it is also easier for GBPUSD to trend in one direction, until New York Open.

New York Open will usually observe a minor reversal, and if there is no major news for the USD that is due, then the pair will continue to trend slowly. 3 hours later, the London session comes to an end and trading volume dies down. This is when I stop looking at charts and am done for the day.

Obviously, one will be limited by the time zone that they are in. Feel free to make adjustments based on the findings that I have shared. I have also encountered traders who readjust their routine and sacrifice late nights/ early mornings to trade certain sessions but that is entirely up to you.


Type of Instruments

With the continuous expansion and growth of the retail trading industry, more options are made available to the average retail trader. Let’s take my personal experience as an example, I am trading with Alchemy Markets, a regulated multi-asset broker which I find best fulfills my trading needs. 

Initially, I was able to trade more than 80 FX pairs,  Stocks CFDs, and multiple Index CFDs just to name a few. Alchemy Markets also offers metals and energies, and just recently added 24/7 Cryptos to their fleet of products. I was delighted and placed a few trades on ETHUSDT and what surprised me the most was their ultra-tight spreads that go as low as 1 cent on most crypto pairs!

I am mainly focusing on GBPUSD as mentioned above, but I also trade gold. Therefore, I have back-tested this crossover strategy extensively on these two pairs. You should do your own research and find out which pairs work best for you depending on their volatility, their price behavior throughout the day, and the time zone that you are in. 


Closing Thoughts

I appreciate that you went through everything and stay with us until the end. Certainly reading this guide is not sufficient, it is important that you put your head down and get to work on your trading strategy. 

Once you are done mapping out your strategy, it is time to move on to the next phase: Managing your Risk

We will see you in our next articles.

Sign up and trade with Alchemy Markets now.

The only place where you get to trade more than 1000 instruments including Stocks, FX, Cryptos, and many more with ultra-low spreads and institutional grade liquidity.

Disclaimer
Please note that all the information provided in this guide is for information purposes only. You should not construe any such information as trading/ financial/ investment or other advice.

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