How to Build a Trading Strategy

When trading in markets, it is often beneficial to have a strategic approach. During the concept of trading on hunches and whims - and being profitable doing so, may sound attractive; in practice it is much more difficult and far less likely than if one had a formulaic approach with which they look to speculate in markets.

The strategy is ever created

Before the strategy is ever created, the trader first needs to decide which market condition they are looking take advantage of. In the first part of our How to Build a Strategy series, we looked at this topic at length. And as we saw, markets will display 3 primary conditions: Trend, Range, and Breakout.

Each of these market conditions can exhibit markedly different tones. Ranges can commonly take place while quiet markets. The support and/or resistance that define ranges become broken when price breaks out, often from some form of news or stimuli.

Breakouts can be fast and furious, running quickly to a traders stop or limit. Breakouts can be in the extreme volatile, and as such, these strategies need to be built differently than range or trend strategies in regards to money, and risk management.

Bias has begun to set in the market

One a bias has begun to set in the market, longer-term trends can develop. Once again, this is a in a class by itself condition that necessitates an approach different than range or trending markets.

Once a trader has decided which market condition they want to build their strategy for, they at the time need to decide which timeframes they want to analyze and execute their trades on. In The Time Frames of Trading, we explored the more common intervals that traders may want to investigate based on desired holding times.

The straightway step in building a strategy is to begin to design how the trader will be entering trades. As we looked at in Grading Market Conditions, support and resistance can define ranges, thereby defining breakouts during also offering quite a bit of assistance with risk management in trend-based strategies.

As such, it can often benefit the trader by having multiple mechanisms for pointing out which of these levels may or may not be pertinent. In How to Build a Strategy, Part 3: Support and Resistance, we looked at Price Action, Psychological Whole Numbers, Fibonacci, and Pivot Points.

Trader has decided on the mannerisms of support

After a trader has decided on the mannerisms of support and resistance to be utilized in the strategy, they at the time need to find a way to grade the strength of price moves. In How to Build a Strategy, Part 4: Grading Trends, we tied at the same time some of the previously concepts of price action, multiple time frame analysis, and market conditions to help traders see that they can grade how 'strong' a trend has been.

We looked at the fact that during many traders may win more often than they lose, it was the amount of their gains and/or losses that would often predicate their success or failure in markets. We at that time went on to talk about using risk-to-reward ratios in which the trader stands to make more if they are right than they could lose if they are wrong. The picture below will show a 1-to-2 risk-to-reward ratio:

We at the time went on to investigate the concept of leverage, as outlined in How Much Capital Should I Trade Forex With, by Jeremy Wagner. This was the 4th and final installment of the Traits of Successful Traders series, and provides some very insightful information.

One of the key differentiators of the FX Market is the fact that it doesn't close. We discussed this topic at length in the article 'Trading the World.'

The market is open 24 hours a day

Although the market is open 24 hours a day, price action can take on markedly different 'tones' based on what time of the day it is, and where liquidity is being offered from.

At 3AM ET, liquidity begins coming in from London, which many traders consider to be the 'heart' of the FX Market. London is the largest market center, brings in the most liquidity, and shortly afterwards the open -large moves can often be witnessed on the major currency pairs. Traders that were before executing range strategies in the Asian session would want to be cautious here, as support and resistance can be broken much more easily with the onslaught of liquidity coming from London. Traders executing breakout strategies can often find the fast and volatile markets they are looking for afterwards the London Open.

At 8AM, as the United States opens for business moreover liquidity flows into the FX Market. This period is considered the 'overlap,' when both London and New York market centers are trading; and this is often the most voluminous period of the day in the FX market. Fast moves can be abundant, volatility in the extreme high, as the potential for reversals can denigrate even the strongest range strategies.