Perhaps you learn a new trading strategy from a “guru” that is proven to work.
You are so eager to trade and you start putting on your first trade, being sure to follow the rules spelled out by the trading system to the T.
And you get your first winner.
So you take another one.
Boom! Another winner.
You start taking more trades because your confidence grows.
And no one stops trading when he or her is killing the market.
Then you have it. A series of losses. Consecutive losses that shake your confidence.
And no, I’m not talking about the 2-3 losses that wipe out your gains. I’m referring to 7 losses in a row that not only erase your gains but also resulted in a drawdown in your trading account. Now if that sounds like you and you find yourself asking…
Was I just lucky or is my trading strategy just going through a drawdown? If you are in the situation or find yourself in this situation often, then today’s lesson is written just for you.
What a Winning Forex Trading Strategy Needs
To answer the question about whether your trading strategy has stopped working, you need to understand that a winning forex trading strategy requires 3 components.
The 3 components are:
- A trading strategy that has a positive expectancy
- Good risk management
- Excellent execution
If any of the 3 components are missing, chances are that you do not have a winning forex trading strategy and were simply lucky. In today’s lesson, I will address the first component: having a trading strategy with a positive expectancy.
Many traders have the mindset that all you need is good risk management and excellent execution in order to make money. But that’s not true.
Let me show you why.
Suppose you go to a casino to gamble on roulette (a game where they spin the ball)…or really any casino games for that matter where the odds are rigged against you. You could have the best risk management strategies and flawless execution, but will you make any money?
You bet not!
That’s because you do not have an edge over the casino. The casino has a “trading” edge over you. This exact concept applies to forex trading. Without a trading strategy that has a positive expectancy, you can’t make money. Good risk management and excellent execution will not turn you into a profitable trader if you do not have a trading strategy with a positive expectancy.
A trading strategy with a positive expectancy
A winning forex trading strategy needs a positive expectancy. Perhaps you have read trading books that teach you all about chart patterns. Chart patterns like head and shoulders, double tops, flag etc. But does that really give you an edge in the markets? Is trading really that simple?
Now if you been trading for some time, you will probably come to the same conclusion.
It’s not that simple. A winning forex strategy doesn’t come just by blindly follow what a guru or textbook says! If it does, why do you think 95% of traders lose money?
If you were to head to popular trading forex forums like forex factory, you will find a dozen of trading strategies that are being shared. And mind you, they all claim to have a positive expectancy. It’s literally like a eat all you can buffet spread where you’re spoilt for choice.
One strategy doesn’t work? Next.
The other one doesn’t work? Next.
And new traders go down this rabbit hole of chasing after trading strategies after strategies until they run out of determination and claim that trading isn’t for them.
But the truth is that it’s not their fault. I made that mistake myself too (which is why I can recount this experience). So let me ask you, how do you really know someone’s trading strategy has a positive expectancy?
Do you make that conclusion based on trust? Testimonials? Or a screenshot of the big gains in this account (mind you, you do not have context about the winning positions ie did he lost 10 trades before getting this big winner)?
But hey you are not helping! You’re just pointing out what I did wrongly.
I can literally hear you say that. And yes you are right…but don’t worry because in the next few sections, I will provide you with practical tips on how to find a trading strategy that has a positive expectancy.
What you need to understand for now is that EVERYONE claims that they have a winning forex strategy that has a positive expectancy. Don’t believe that, because if you do, you will be slapped by reality.
How to Find out If Your Forex Trading Strategy Has Positive Expectancy
This is probably the question you have right now, so let me address that so you don’t get distracted.
Here’s the thing about this question…
The truth is that nobody will know whether your trading strategy has a positive expectancy. The only objective way to find out is to record down your trades in a trading journal and let the data tell you. The data will not lie to you and tell you what you want to know. No emotions, just the obvious hard truth about whether there is positive expectancy or not.
That’s what I love about data. It’s in your face and it tells you the truth every single time. And my friends, this is precisely why you need to be recording down your trades in a trading journal to improve as a trader.
These metrics are what you need to be paying attention to:
- The date you entered the trade
- The time frame of your entry
- Trading setup that is defined by your trading strategy
- Currency pair/instrument that you traded
- Position size/lot size
- Entry price
- Exit price
- Initial stop loss
- The outcome of trade in dollars
- Amount risk
- Your risk to reward (this can be an excel formula that auto calculate the risk to reward for a given trade)
Do this for the next 100 trades and you will have enough data to work it. Doing a trade journal also trains you to focus on the next 100 trades and the law of large numbers versus focusing on a single trade outcome. The data will give you an objective answer about whether your trading strategy has a positive expectancy or not.
*Pro-tip: Most traders live emotionally on the current trade. If they win, they are happy. If they lose, they are upset. You want to be focusing on the next 100 trades.
Now suppose that you find that your trading strategy doesn’t have a positive edge…
Then…here’s what you should do.
How to Find Proven Trading Strategies
Earlier on, I pointed out how there are dozens of forex trading strategies on forums and promised to teach you how to find proven trading strategies. So let’s talk about that.
Here are the things you want to be looking for when it comes to finding proven trading strategies:
- The strategy is backed by academic research
- There are institutions or hedge funds deploying a similar strategy (this shows that serious money is being invested in this strategy and therefore it is reasonable to conclude that it is somewhat working)
- Your statistical data confirms this. Based on your trading journal that I discussed above, you should have your own data to validate this. Not someone else’s data, not what you hear and not what you read. Your own actual data that show that the strategy has a positive expectancy.
Still confused? Not to worry, because I will share with you 3 generic proven trading strategies. These are generic because they do not go into specific details about how to enter a trade. However, they do point you in the right direction and that’s really handy if you are new to trading.
If you want to learn more trading strategies that work, make sure to check out my article 3 Forex Trading Strategies that Work here.
Proven Trading Strategy 1: Trend Trading
Trend trading is my favorite trading strategy and is beginner-friendly. It is a trading strategy where you try to capture big movements that have been established for a period of time.
Now trend trading works because markets are driven by fear and greed. When the market is trending, traders fear missing out and jump onto the trend.
Let’s take a look at some examples of a trend:
Example of an uptrend
Example of a downtrend
Here are some academic research about trend trading:
- Studies done by Michael Covel who is known as the authority in trend trading
- Andreas Clenow provides an explanation of how hedge funds and institutional traders have been using trend trading to generate spectacular returns
Proven Trading Strategy 2: False Breakouts
This is a trading strategy that can yield great returns when applied correctly. This is because it allows you to catch price at the best levels with a small tight stop loss.
Now before I get into more details about this, it is important to understand that trading is a zero-sum game. This means that for you to make money, someone else has to lose money. And for that to happen, that person’s stop-loss has to be triggered.
Let’s consider this typical scenario:
Price has just broken an important support level. Therefore, traders who trade breakouts will jump in and attempt to trade the breakout of that level. In such a scenario, it would be common for these traders to put their stop loss just above the broken support as they expect prior support to act as resistance.
Suppose that price closes back above support and takes these breakout traders out. Their stop losses would act as fuel for further price advances since their stop-loss order is essentially a buy order to exit their positions.
Understanding this, I can hear you asking about how you can take advantage of this scenario and profit from it.
Well, you can look to enter when price closes back above the support with the expectation that breakout traders cut their loss and fuel the advance of price. Let me show you an example because a picture speaks a thousand words.
Here’s an example:
Proven Trading Strategy 3: Day Trading
Day trading is a short term trading strategy that works. You will typically hold and exit your positions within the day, hence the term day trading. I will not go into greater detail about this strategy because I have written a lesson about this with all the details. You can check it out here.
Why You Need to Know the Strengths & Weakness of Your Chosen Trading Strategy
Hopefully, you have a better understanding of how to choose a profitable trading strategy based on the above. But what is equally important is that you need to know the strengths and weakness of your chosen trading strategy.
Let me burst your bubble.
No trading strategies work in all market conditions. It just doesn’t work like that. A trend trading strategy will obviously not work in a ranging market. That’s a fact and the sooner you can accept that a trading strategy will not work in all conditions, the faster you will progress as a trader.
Your job as a trader is to identify which type of market conditions are favorable for your chosen trading strategy and which are not.
You can use the following 3 step process to identify this:
- Identify the objective of your trading strategy ie are you trying to catch the pullback? the breakout? the range?
- Based on 1, define what kind of market conditions work best for you ie ranging or trending?
- The opposite of 2 is the kind of market conditions that you want to stay out of
Let’s go into an example so that it is crystal clear.
Suppose you want to trade proven trading strategy 2: false breakouts.
Thus your objective is to capture turning points below established support and resistance levels. In such a situation, you want to be trading your strategy in a ranging market where the support and resistance levels are established. And because you want to be trading in a ranging market, that would mean that you will want to avoid trading in a trending market where the support and resistance levels might not be that clear.
In this lesson, I shared a lot of insights as to how to find a trading strategy with a positive expectancy. I also provided examples of 3 proven trading strategies that work. Now if you are confused and don’t know where to start, make sure you download a copy of the free day trading guide that I have prepared for you.
This day trading guide will provide you with a trading strategy that works. But remember, just because it works for me doesn’t mean it will work for you. There are a dozen factors that might affect your results such as trading psychology and personality.
That is why journaling your trades and looking at your records is the ONLY objective way to tell if you have an edge in the market. So make sure you re-read that section above if you missed it.