I’ve been getting plenty of questions about the methodology I use to trade the forex market, basically it is a swing trading system, I try to catch most of the medium term swings. Most of my trades last for 2-3 days.
Here we have a few details about the methodology:
I consider myself to be a market follower
I never try to guess where the market is heading. It’s dangerous to try to guess where the market is heading because most of the time we will make “buying” and “selling” decisions based on what we “think” the market could do, we might have a bias that was formed because of a subjective methodology, what we saw published somewhere else, or what a trading pal told us. More than 10 years of trading experience tell us that it is impossible to get consistent results trading like this.
Instead of trying to guess where is the market heading, I trade based on what the market is telling me. I try to identify the market condition and trade based on this condition. If the market tells me that it has more probabilities to go up, I try to find long opportunities, if it tells me that it has more probabilities to go down, I try to find short opportunities, if it is in ranges, I then adapt the strategy to such market condition.
For some reason I don’t feel comfortable with indicators
Most currency traders based their trading decisions on technical indicators, but most indicators are a simple formula applied to price (close, open, high or low) for a determined amount of periods. This tells us how the markets behaved during the chosen period of time, but believe me, it has nothing to do with how the market will behave in the future.
I enter the market based on price action, the market itself tells to enter the market when it has a higher probability of heading in one direction over another, as simple as that. We get to this point later.
I like to keep the probabilities in my favor…
Most traders based their strategies in a good accuracy. The accuracy of the system refers to the number of positive trades over all trades for a chosen period of time. But there is one slight problem, we never have control over the accuracy of the system, the market decides whether it is going up or down, the accuracy of the previous 10 trades has nothing to do with the accuracy of the next 10 trades.
Instead of trading based on a good accuracy, I trade based on a good Risk-Reward ratio (RRR). The RRR refers to how many pips we are risking and how many pips we are willing to make on one trade in a set of trades. When we based our trades on a good RR ratio, we can have the same amount of winning and losing trades and still get good trading results, this way we will not depend on the accuracy of the system in order to get consistent results. Additionally this helps me trade with less stress.
Having a trading plan helps me trade with more discipline
Every day I analyze the long term charts to determine which currency pairs I am going to look for a trade opportunity: to go long, short and which pairs to stay away from. Then I proceed to analyze the short term charts to determine what the market needs to do to get us ready to trade.
Trade, Risk and Money Management
These are aspects of trading that many forget about, yet they are very important (I would venture to say that they are even more important than market entries). Risk management refers to the methodology used to define how much to risk on each trade. Money Management refers to the methodology used to determine how large our next trade should be (position sizing) and Trade management determined how to manage our trade once we are already in it (partial profits, pyramid in, etc).
When we are really wrong (and a little bit on emotions)
Most traders think that there is a direct relationship between being wrong and a negative (monetary) outcome of one trade. Nothing is farthest from the truth, you could be doing everything right, following every single rule, and still the market could go against you. This is why trading successfully is very difficult, because when it comes to trading 1 + 1 is not always 2. We have to accept the fact the trading is a probabilities game, and the only thing that we need to do is make them play in our favor.
Some traders say you need to get rid of emotions, otherwise is till be almost impossible to trade consistently, but I don’t think of it that way. Emotions are part of us, they keep us alive, and I think there is just no possible way to get rid of them, instead, we need to make them work in our favor.
Ok, now to more interesting things…
Every day, before I even think about placing a trade, I perform an analysis in the daily and 4H charts to determine which currency pairs to trade (and in which direction) and which ones to stay away from. Basically there are 4 types of market condition:
Bullish: The market gets rejected from an important Long term (LT) support level, or the market breaks through an important LT resistance level. Only long opportunities are in play. If the market is in a bullish market condition, it is likely to continue bullish, until it hits the next LT resistance level.
Bearish: The market gets rejected from an important LT resistance level, or the market breaks through an important LT support level. Only short opportunities are in play. If the market is in a bearish market condition, it is likely to continue bearish, until it hits the next LT support level.
At an important level: The market is trading very close to a LT support or resistance level. When the market is trading at an important level, we have two possibilities: it could be ranging either in a well defined range or in a not defined range. It is ranging in a well defined range, we try to trade the range, if it is a not defined range, we do nothing.
Undefined: when the market gets rejected from random levels. In this market condition we do nothing.
This is how I trade, how I define which currency pairs to trade each day.