Trading Strategy Development

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  Introduction

  After completing an analysis of the market, the trader must know he will play in raising or lowering. Moreover, by this time he must decide what portion of its capital to invest in the transaction. And finally, the last step is the actual purchase or sale contract. This is a difficult part of the whole process of trade on margin markets, where a specific date of the opening and closing of positions should be as accurate. The final decision on how and where to enter the market should be based on a combination of technical factors, the principles of money management and types of stock orders.

  Especially the definition of the exact time of the entrance to the market and the exit on the basis of technical analysis is very short-term nature of the analysis and defined as days, hours or even minutes, not weeks and months. But in all cases, use the same technological tools. Below considered the most general terms of such an analysis.

  Strategy for price breaks

  There are three ways how a trader can act in the situation of price breaks:

  • To take a position in advance, in anticipation of a breakthrough;
  • To open a position at the time of a breakthrough;
  • Wait for an imminent downgrade after the break.

  There are arguments for and against each of the three approaches, sometimes used a combined approach. When working with multiple lots trader can open one position in each of the three phases. You can take a small position before the break, and then buy another immediately after the break, and finally the opening of additional positions at the time of the small fall in prices during the correction, following the breakthrough. If a trader sells a few items, then to his decision primarily influenced by two considerations:

  • which means he is willing to risk on this transaction;
  • how aggressively he will act.

  The most conservative trader in this situation would open a long position on the rollback of prices. But, ironically, a tactic of waiting, too, could prove risky - in the sense that, expecting to roll, you can even skip the time of the entry into the market.

  Intersection of trendlines

  This signal allows to enter the market or withdraw from it early enough, especially when crossing meaningful repeatedly "proven" trendline. Of course, this should not be forgotten, and other technical factors.

  In the case of a trend line as the level of support and resistance to open long positions at falling prices to the level of sustained upward trend, but short - with the rise to the level of descending trendline.

  Usage of support and resistance levels

  The breakthrough level of resistance could serve as a signal for the opening of long positions, which can then be protected by using a stop-order. You can arrange for the next level of support or, for greater security, just below the level of a breakthrough, which will now serve as support.

  The rise in prices to the level of resistance at a downward trend and falling to the level of support for the upward trend may be used to open new positions and add lots to the existing profitable positions. In choosing the levels of protective suspension, especially should pay attention to levels of support or resistance.

  Usage of price adjustments

  In the fall of the intermediate upward trend in prices, accounting to a percentage of the previous growth Fibonacci can be used to open new or additional long positions. It should be noted that in this case, an analysis of the percentage of the length correction relates to a very short period of driving the market.

  An appropriate moment to open long position is a 38-second setback in prices, taking place after the break with bullish upward trend. It is advisable to open a short position when the downward trend in the prices bounce up, covering from 38 to 62 range last fall.

  Usage of gaps

  Price gaps formed at bar charts can also be used to select the best moment of the opening or closing of positions. For example, the gaps formed in the process of price increases, then often act as support levels. Therefore, the upward trend to open long positions when prices fall to the upper boundaries of space, or slightly below, inside the gap. Stop orders can be placed under the gap. In downward trend short position opens at a time when prices are raised to the lower limit of space, or even partially fill it. The protective stop orders in this case, is placed over the space.

  Averaging

  Averaging is called a strategy works when you made a mistake, or simply carried out any transaction (the first, coming to your head), and the price has gone against you, and your single-operation has already been at more profitable price. The main drawback of averaging is that you do not know in advance of what the price will go against your market. But averaging requires each time (the first) to invest twice the previous amount of collateral. But if you have a lot of money - you can allow the movement of prices in the 100, 200 or more pips. While such shifts in the market occur infrequently - still it is not the best strategy, especially when you see that a mistake in determining the direction of trend.

  Possible strategies

  • The first strategy is long-term maintenance of an open position (from a few days to several months). Such a strategy used by strategic investors and semiprofessional speculators. Maximum effectiveness in the emerging trends and least profitable in the sideways or sluggish trends. Requires mandatory safety net, and related work on the matter of the stock exchange options. When working on long positions as important as the technical analysis also is important as a fundamental analysis. The proportion of long positions in the practical work of the trader should not exceed 15 of the amount of collateral. Also the analysis for the opening of long positions will assist you in a short game, as follows:
    • a) to determine the long-term resistance levels and support;
    • b) strong long trend will warn you when you work against it on short positions;
    • c) you will have a psychological confidence with the game on a short position in the direction of a long trend.
  • The second strategy is to work in the medium-term trends, which last up to several days. Also desirable insurance options. The most attractive to non-professionals. Average positions are more stable for a profit, although the analysis when deciding to play a bit more complicated. In doing so, the quality of work also depends on the ability to short-game (to choose the time of the opening and closing the position). When you open a secondary position is not only a technical analysis, but also to be seen: there will not be any fundamental news to the time of closing the position whether the closure of a regional market at this time. The psychological factor of the game goes to second place. For all the external stability, be sure to watch the market, because it is able to present any surprises at the wrong time. If you are a medium-term game, based on fundamental factors, it is also closely watch to ensure that technical analysis, at least, not inconsistent with your positions.
  • The third strategy is to position the short opening duration from several minutes to several hours. Adventages: no risk of adverse news, and fundamental changes in prices at the time of your absence. Disadvantages: high costs (commissions, spread, communication services, etc.), a high risk of adverse short-term changes in prices, requires constant monitoring, concentration and tension throughout the day. The main assistant principal when you work will be oscillatory methods of technical analysis (using the rules of choosing the moment of opening). Do not deceive yourself with small gains obtainedusing this tactic. You may risk losing everything fast, for so long and having made so many transactions.

  The most suitable for an unprepared trader is the second strategy (work in the intermediate-term trends, with up to several days in duration).

  Our book describes dozens of indicators of technical analysis, but to use more 3-4 indicators to assess the current market situation is impossible. Otherwise, the analysis would take up too much time and by the time the end results will be out of date.

  A natural question - what indicators to choose from the full diversity? Unfortunately, the single answer to this question does not exist. Indeed, the success of trading does not depend on a set of indicators that you use in the analysis, but because of its methodology.

  The whole trading is based on four pillars.

   

  1. Understanding of the philosophy of analysis.

  Andrew Vedikhin, Deputy Director of Alpari: "Indicators of technical analysis on a weekly, daily, four-hour shift, and the Japanese yen showed a clear signal to sell. It is "clear" the situation is not even in the books, so I have decided to conduct its first transaction for the real account and ... a Loss

   

  The belief in the technical analysis irretrievably lost. The desire to trade currencies disappeared. Instead fear appeared. Fortunately, not lost the desire to think, so I quickly came to the conclusion that the book in vain for the technical analysis was removed to the far-box table. What happened is absolutely logical. Weekly and daily schedule showed the existence of a global downward trend, and a four-time graph shows that the trend movement is under way and probably reached its bottom.

  An ideal moment for selling would have been a situation when large charts had indicated exisiting of global bear trend while the four-hourly chart had indicated bull trend while on the hourly chart reversal patterns of up trend (e. g. bullish divergence) had been noticeable. Thus don’t hurry to blame in an unsuccessful trade the authors of books who gave some recommendations on methods of analysis but try at first to understand and feel the philosophy of analysis. It will help you to find the reason of your mistakes in trading and to avoid them in the future."

   

  2. For the success of the need to know:

   

   

  • Analysis of the market. , Ie to be able to forecast the movement of prices in the future. Type of analysis (technical analysis, chaos theory, a combination of Japanese candles, Demark Theory, an indicator Ishimoku, etc.) is of no importance, above all be able to use them professionally.
  • Trading tactics. , Ie to be able to choose the time to open / close position (more details will be discussed in future releases).
  • Money management. , Ie to be able to limit the risks (to be discussed in more detail in future releases).
  • Psychology. , Ie not be able to take emotional decisions (for more details will be discussed in future releases).

   

   

  3. Levels of support-resistance.

   

  The main rule of a trader: to buy from the level of support, to sell - from the levels of resistance. If your trading tactics shows that the time has come to buy, but the price to a level of support has not yet been reached, do not rush to the opening position.

  4. The correct choice of the periods of analyzed charts.

  As a result, trading on the FOREX market in a few months you will understand that in the currency quotations, there is a "noise" (about 10 pips). The reasons for this «noise» can be very different: a large order in the interbank market, the source of the imperfection of indicative quotes, etc. In any case, is to accept the allegation of the existence of "noise" in the quotation as an axiom.

  Then:

  • Analysis of minute charts will allow to catch the movement of 15 pips (10 pips of them will "noise", ie, 66);
  • analysis of 5-minutok allow traffic to get to 30 pips ( "noise" 33);
  • …
  • analysis of the time charts will allow to catch the movement of 100 pips ( "noise" 10);
  • Analysis dnevok allow catch has 500 pips ( "noise" 2).

  Depending on volatility of the currency pair specific numbers may be different, but the principle remains the same:

   

  In the analysis of small periods trader tries to predict the "noise", while the analysis of large periods of it is already on the market forecast. "Noise" unpredictable because of its chaos. The market - predictable, therefore, if you do not want to rely on the randomness in determining the future price, you have to forget about the analysis of schedules with periods of less than hour. At the weekly and daily schedules by the primary trend, but at the time charts look for a moment to enter the market.

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  What to use: technical or fundamental analysis?

  A dispute over what is better: technical or fundamental analysis — reminds a dispute between materialists and idealists "What is primary?". In my opinion fundamental analysis is much more difficult to study and use than technical analysis.

  It is explained by several factors:

  • There are much less books devoted to the problematics of fundamental analysis. In most books only one small chapter or even nothing is devoted to fundamental analysis. And it is rather difficult (though interesting) at least with relation to the number of necessary books to read specialized literature on macroeconomics and economic theory.
  • Often a fundamental analyst needs a background in economics (high economic education).
  • A fundamental analyst must constantly monitor news, political events etc. Even a short vacation leads to gaps in understanding of the current situation. As recently as yesterday lowering of interest rate led to strengthening of a currency but today everything is vice versa: new factors unaccounted by You due to the absence appeared. And again as in sport you will have to "catch up".

  Anyway it is useful for a fundamental analyst to know some methods of technical analysis. For example to know how to determine support and resistance levels in order to determine properly entry points for a trade.

  Resuming all the above mentioned in my opinion for an inexperienced private investor the most optimal method to forecast the future price dynamics is to use classical technical analysis or its variants: chaos theory, the Ichimoku indicator, Japanese candlestick combination, Demark’s theory etc.

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  First steps in developing one’s own trading strategy

  Any trading tactic must consist of five stages:

  • determining of the global trend;
  • determining of the beginning of the retracement from the global trend;
  • awaiting for the completion of the retracement;
  • receiving a confirmation from another indicator and open a position;
  • placing Stop Loss and Take Profit orders.

  Let’s consider all these stages in detail by the example of a trading tactic based on MACD and Parabolic.

  Let’s suppose that:

  • the trend is upward when the MACD is above zero and there is no bullish divergence from prices i.e. each new high on the prices chart
  • is confirmed by another high of the indicator (the MACD );
  • the trend is downward when the average over MACD is below zero and there is no bearish convergence with prices i.e. each new bottom on the prices chart
  • is confirmed by another bottom of the indicator (the MACD);
  • when the long term average crosses the short term average from top to downward we will consider it the beginning of the downward retracement. The prevailing trend must be upward;
  • when the long term average crosses the short term average bottom-upwards we will consider it the beginning of the upward retracement. The prevailing trend must be downward.
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  Developing one’s own trading tactic: how to determine the global trend (stage 1)

  Let’s consider each stage by the example of a trading tactic based on MACD and Parabolic. We’ll start with the first stage - determining the trend on a long time frame.

  Stage 1. We will determine the direction of the global trend on a daily chart

  Let’s look at the daily chart (Figure 1). We can see that the trend is upward as :

  • Each successive high of the price is higher than the previous one. According to the Dow theory this is an up-trend.
  • As there is no bull divergence between the short term average of MACD and the price it indicates that the uptrend is rather strong.

  

  Determining the direction of the global trend on the daily chart

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  Developing one’s own strategy: how to determine the moment of the beginning of a retracement from the prevailing trend (stage 2)

  To enter the market first of all it is necessary to determine the global trend. I considered it in detail in the previous article. But to make a profitable transaction it isn’t enough to open positions following the trend. It is also necessary to choose the correct entry moment. An ideal entry moment is the ending of a retracement against the prevailing trend. But before we determine this moment we must determine when the retracement started. The second stage of any trading strategy is devoted to this.

  Stage 2. How to determine the moment of the beginning of a retracement against the prevailing trend

  Let’s look again at the daily chart (Figure 1). We can see that the faster average of MACD crosses the slower average from top downward. It indicates possible beginning of a downward retracement.

  

  Figure 1. A signal of downward retracement on the daily chart: the faster average of MACD crosses the slower average from top downward

  If we look at a shorter time frame, at the 4-hour chart we can make sure that it is true (refer to Figure 2).

  

  Figure 2. Determining the beginning of a retracement from the prevailing trend: a bull divergence of the MACD lines on the four-hour chart

  A bullish divergence of the MACD lines on the four-hour chart signals that the retracement has really started.

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  Developing one’s own trading strategy: awaiting for the completion of the retracement (stage 3)

  As I mentioned previously the best moment to open a position following the trend is to wait for the completion of a short term retracement against the prevailing trend. We have already considered how to determine the direction of the prevailing trend and consequently the direction of our transaction. We also know how to determine the beginning of a retracement. In this article I will tell you how to determine properly the end point of a retracement.

  Stage 3. Determining the end point of the retracement

  In our example either bear convergence of MACDA with the price on the four-hour chart or bear convergence of MACDA on the hourly chart will signal the end of the retracement. The signal form the four-hour chart of course will be stronger. But convergence on the hourly chart will be enough to fix the end point of the retracement (refer to Figure 1).

  

  Figure 1. Determining the end point of the retracement

  But to reveal the fact that the retracement has most probably completed is not enough to open a position. We need to get a confirmation from another indicator.

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  Developing one’s own trading strategy: waiting for a confirmation from another indicator and entering the market (stage 4)

  Now we are very close to the moment of opening a position. But before that we must get a confirmation of our ideas from another indicator. In our example it will be Parabolic.

  Stage 4. We wait for a confirmation from another indicator and enter the market

  

  Figure 1. We wait for a confirmation from another indicator and enter the market

  If the price crosses the parabolic line it will indicate it is time to buy (refer to Figure 1). We enter the market at the current price – 1.3223.

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  Developing one’s own trading strategy: placing Stop Loss and Take Profit orders (stage 5)

  So, we are in the market. We only have to place Stop Loss and Take Profit orders and wait for the outcome.

  Recommendations on placing Stop Loss orders

  In the FOREX market in my opinion it is ineffective to use Stop Loss orders closer than at the distance of 40-50 pips from the entry point. Stop Loss orders placed closer will be most probably "sentenced". The point is that entering the market you can’t catch the very bottom or the peak. The error usually constitutes 10-15 pips. Plus spread constitutes several pips. And if we also take into account the market "noise" (10-15 pips), it becomes clear that a Stop Loss order placed at the distance less than 40-50 pips from the entry point has almost no chances to outlive the position.

  Stage 5. Placing Stop Loss and Take Profit orders

  We place a Stop Loss order 15 pips below the last bottom (in order to exclude the «noise»). We place a Take Profit order at a doubled distance (i.e. profit/loss ratio is 2/1). In our example the levels of Stop Loss and Take Profit orders will be 1.3123 and 1.3423 correspondingly.

  The result of this transaction is shown in Figure 1. The execution of the Take Profit order gave a profit of 200 pips that constitutes in money equivalent $ 2,000 per 1 lot (for invested $1,323).

  

  Figure 1. The result of the trade

  The strategy considered above isn’t without lacks and doesn’t guarantee a 100 percent efficiency. My aim was not to offer a universal "machine" for earning money but to show the main principles of creating one’s own trading strategy, namely the fact that any trading tactic consists of five stages:

  • Stage 1. We determine the direction of the prevailing trend
  • Stage 2. We determine the beginning of a retracement
  • Stage 3. We wait for the end of the retracement
  • Stage 4. We wait for a confirmation from another indicator and enter the market
  • Stage 5. We place Stop Loss and Take Profit orders and wait for the outcome
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  Methods of unambiguous identification of graphic figures

  The main problem in technical analysis is the fact that in real life classical figures of reversal or continuation of trend are very rare on charts. Moreover as a rule when it becomes clear that this is a pattern of reversal or continuation of trend in front of You it is too late to do anything. Recommendations given below will help You to react more promptly to appearing of graphic patterns not thinking specially what particular pattern you see.

  A break of a trendline is the basis if each signal in analysis of graphic patterns. Let’s draw a line using the last two highs. We will call it the "upper line". Next we will draw one more line using the last two bottoms and we’ll call it the "lower line".

  Four cases are possible:

  • Both lines are directed upwards. It means the trend is upward.
  • Both lines are directed downwards. It means the trend is downward.
  • The upper line is directed upwards and the lower one is directed downwards. The situation is unclear.
  • The upper line is directed downwards and the lower line is directed upwards.
  • In the last case (the upper line is directed downwards and the lower one is directed upwards) some graphi pattern is forming in the market. What pattern? How is it called? Is it a reversal pattern or a pattern of continuation of trend?

  Answers to these questions are only of curious nature. We will get practical use from such a construction when a break of the upper or lower line occurs. After that we open a position in the direction of the break. Only after one of the lines is broken you are able to answer the questions mentioned above (except for the name of the pattern which isn’t important taking into consideration the fact that classical patterns appear on charts very rarely).

  The conclusions will become more valuable if they are confirmed by bear convergence/bull divergence on oscillators.

  We’ll give an example. We’ll suppose that the trend was upward and the fourth variant formed, then:

  • if the upper line was broken a pattern of continuation of trend formed.
  • if the lower line was broken a reversal pattern formed.
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  Peculiarities of Trading in the Flat Market

  The market may be either flat or in some trend. The trading tactics described before suits a trend market. Whereas in the flat market it does not work. That is why peculiarities of trading in the flat market should be also considered.

  Flat market is a market with quotes fluctuating within a narrow trading channel (200-300 pips).

  In this case it is recommended to enter the market in the direction of the global trend only (specified on the daily/weekly charts) from the support/resistance levels, using bullish divergence / bearish convergence as signals on the H1 charts. Stop Loss order for a short position is placed below the support level, whereas for a long position it is placed above the resistance level.

  If 1 min – 5 min charts are used to enter the market the planned profit may make about 10-20 pips. Such a trading tactics is called scalping. Statistics shows that scalpers lose more than get in the long run.

  Here are the reasons of it:

  • there is a great possibility to take emotional (wrong) decisions;
  • applying small time-frames triggers lots of useless signals in the data analyzed (see "Choosing the periods of the charts analyzed");
  • it is impossible to follow the rules of Money Management;
  • it is quite difficult to specify the true breakout of support / resistance level.
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  A Mechanical Trading System - Myth Or Reality?

  In Internet you can find free of charge or buy for little money a great number of mechanical systems which according to their authors will bring you tens or even hundreds percent of income per month. Most of such "Grails" show very good results when they are tested on historical data but on demo-accounts and live-accounts such systems fail. The point is that it is very easy to write Expert Advisors — mechanical trading systems for MetaTrader 4 — any trader is able to do this. That’s why a great number of such unprofessional "frobs" containing a number of mistakes has appeared in Internet.

  By this post I start a series of articles on how to write one’s own expert advisor, how to avoid common mistakes which distort the real profitability of a mechanical trading system etc.

  At first let’s define what is an Expert Advisor:

  Expert Advisor is an algorithm of executing trades and managing orders programmed in MetaQuotes Language 4 by a trader.

  Of course one can trade on his account manually, but for example in Alpari several tens of currency pairs plus tens of other instruments: CFD on the US stocks, commodity futures etc. - are offered. Just fancy how long it will take you to analyze each instrument. Very often a situation emerges when in an instrument a signal to open a position forms but you miss this favorable moment as you are busy analyzing another instrument. Besides you can’t help sleeping or eating. But you can miss a signal to enter into a transaction when you sleep.

  There are much more reasons to entrust managing of your account to someone who will do this 24 hours a day, 5 days a week, being emotionless at the same time (as emotions severely impact successful trading). To someone who is able to monitor on-line ALL instruments. To someone who will act precisely in accordance with the algorithm programmed by you. And this invaluable helper is an Expert Advisor or in other words a trading algorithm programmed in the MetaQuotes Language 4.

  Everything mentioned above sounds promising and optimistic. But it isn’t so easy. An Expert Advisor does precisely what you order. If your trading strategy is originally loss-making, your Expert Advisor will trade online according to your algorithm not missing a single chance to execute a trade and thus it may bring your trading account to a sorry plight.

  But if your trading strategy is profitable quite soon you may become more prosperous. In the textbook on writing expert advisors on our website you will know not only how to write an expert advisor by yourself but also how to test it properly on historical data.