Selecting a Forex Trading Strategy: What You Need to Know in Brief
Now-a-days with the advent of copy trading technology, there are several ways you can follow the trades of experienced Forex traders.
While this can be an excellent way to generate returns, you need to make sure you select Forex trading strategies that are consistent and robust.
On top of that you have the option to run your own mechanical system (or Expert Advisor) that you can purchase for a fee.
Here’s how to evaluate your options like a pro.
Manual or Auto?
The first factor to consider is if the program you are looking to follow is run by a discretionary trader or is a mechanical system.
Discretionary Trading Strategies (Manual)
Discretionary strategies combine technical and fundamental analysis and trader are placed at the discretion of the program manager.
The advantage of a discretionary trading approach is the ability to respond to changes in the market place more effectively than a computerized strategy. The disadvantage is you are reliant on the trader maintaining a healthy psychology. They may fail to notice a change in the market type, or perhaps they will just have a bad day and over trade.
If you are following a program run by a discretionary manager, see if you can find out their background, their trading approach, and the length of time they have been trading and make sure you are comfortable with what they say.
Computerized Trading Strategies (Auto)
If you want to let technology do the talking, what you’re after is called an ‘expert advisor’ or (less affectionately) a ‘robot’. Robots are pieces of code that execute trades based on certain rules defined by the trader.
The challenge with an EA or a copy trading program that is computerized is that if market conditions change, your robot isn’t going to know any different. It’s going to know what it knew yesterday.
Because of this the performance of the EA need to be carefully monitored for signs that the strategy is no longer working.
The best robots are run by Forex traders who oversee and adjust their rules on the fly. If you are looking at a copy trading program with a mechanical approach then the benefit may be that an experienced manager is running the strategy.
If you choose to run your own expert advisor, then you will need to spend some time getting familiar with the ins and outs of mechanical system trading.
One of the things you many look to do is run a few different EAs, so that when one happens to be bleeding money, another is bringing it in and vice versa.
Avoid Martingale Strategies
You’ve probably heard of a roulette system where you bet twice as much every time you lose. You’d have to lose ten times in a row to go bust; surely it could never happen.
But it does happen, and it will happen. These systems are known as Martingale strategies and they are to be avoided like the plague. When dealing with something as volatile as the forex market, there’s no place at all for such a backwards system.
Length of time in operation.
What you should be looking for is a track record. If a system has been doing well for one day, across one market type, you don’t have nearly enough information to make a reasoned investment decision.
If a strategy has been going strong for several months or preferably years and has weathered several market types, then there is more than enough information to make a proper decision.
Invest in new, hot, systems at your own peril. The phrase flash in the pan comes to mind.
Live vs. Demo
Some Forex trading strategies look great on paper. But all they really have is paper profits.
Avoid strategies that are being traded only on demo accounts. There are several ways for trader to “fudge” results on demo accounts so it is much safer to look for a strategy run on a live account with a history of returns.
What is Myfxbook?
Myfxbook is a database of Forex trading strategies. Traders connect their accounts to Myfxook and it generates performance statistics. The good thing with Myfxbook is you know the results are real, so it has become the industry standard for verifying trading performance.
Here is a sample myfxbook profile:
Here is a breakdown of the terminology you need to know when using myfxbook:
- “Gain” – total historical performance of the program.
- “Drawdown” – the total amount the program has ever gone into the negative. It measures the largest single drop from peak to bottom in the value of a portfolio (before a new peak is achieved).
- “Track Record Verified” (with a green check mark) – is visible when the data myfxbook receives matches the data supplied by the broker about the live account.
- “Monthly” – average percentage of Historical “Gain” divided monthly
- “Real” – is the term that refers to a live account with real money at a particular broker (not a demo account).
- “Profit Factor” – is the sum of winning trades vs losing. The higher the number the better.
- “Monthly Analytics Tab” – this is a good way to look at the monthly historical results to gauge momentum / consistency of the strategy.
How much has the system been down at any one time? Because (make no mistake) there will be drawdowns – periods between highs where things aren’t looking so good.
Different types of systems have different maximum drawdowns. A conservative system that looks to pick off small wins a lot of the time will have a smaller maximum drawdown than a system prepared to risk 20% of its capital chasing a huge win.
Look within yourself and ask yourself in no uncertain terms what your appetite for risk is. If you are prepared to chase a massive win or two, perhaps it’s worth a casual 40% drawdown risk.
If you are keen to stay the course and look for long-term accumulation of small wins, look for a drawdown of 20% or less.
If you fall in love with a system with a huge maximum drawdown, you can simply give it half as much capital as you ordinarily would have. You’ll be halving your returns as well, but half a huge return is still a mighty big win.
When you evaluate a trader over certain timeframes, you should always be looking for a good return. You need to be careful to look at this alongside maximum drawdown though.
A trader who has added 20% to their account in the last two years and only ever been down 7% is much more promising than a trader who has made 25%, but amongst a 40% drawdown or two.
Take a big picture view of the system, based on what you see in front of you. An extreme month could be down to an adverse (or positive) market move. Many extreme months in quick succession would be much more telling either way.
Study the Equity Curve
Equity curves don’t lie. They are a quick way to assess the drawdown vs. returns. They tell you very quickly how good and how consistent the system you’re looking at is.
A consistent curve. This trader has made a lot of small gains over time, and increased their equity in a sustainable and responsible fashion.
When select a Forex trading strategy look for smooth gains – that is a steadily growing equity curve, rather than one that has deep valleys and troughs.
Remain level headed
It can be exciting running an automated trading approach and watching the profits roll in.
But remain level headed. Carefully monitor the strategies you are following and be sure to accept ultimate responsibility for your results.
Even though someone else (or a machine!) is placing the trades it’s your money so you are the one that remains accountable.
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