Trading strategy- Importance, how to build and other important parameters.
What is a trading strategy- A trading strategy is a method of buying and selling in any market with a predefined set of rules. Meaning when we trade based on a strategy our entry, target and stop loss will be fixed, we just need to act accordingly once a signal got triggered.
Why it is important to have a fixed trading strategy- Being a beginner in any market- may be equity, forex or commodity- we face lots of issues mainly due to psychology, sometimes we take entry because of FOMO, sometimes we exit because of fear and sometimes carry a negative trade because of greed. But with a fixed trading strategy all these problems can be resolved up to a certain limit.
How we can form a trading strategy- A strategy can be based on indicators, or can be based purely on price action, or can be a hybrid one, where we can take help of both indicators as well as price action.
Important points while designing a strategy- for any particular strategy there are three major components, apart from entry, exit and SL, and those are- accuracy, risk to reward and frequency. For any particular strategy, Accuracy may be 80 to 90 percent, if the risk to reward is 1:1, and if we increase the risk to reward to 1:2/3/4 then accuracy may decrease, and at the same time at what frequency the setup is giving a buy/sell signal. For highly accurate strategy, RR may decrease, or frequency. Similarly, for a highly accurate strategy, with high RR, frequency may decrease. So, if one is willing to take maximum trades possible, then he or she can go with less RR moderately accurate but frequent setup, or for someone who wants to have less trades, but highly accurate strategy, with high risk to reward, then one can plan accordingly.
Second important point is time frame for building a strategy- if you are good at quick decision making, then can adopt a minimum time frame, such as 1 minute to 3 minutes, and if not exactly master at quick decision making then can plan for a setup, with above 5-minute time frame based on the instrument that you are planning to trade.
How to find important parameters for a strategy- back test is the only option to have an idea about the accuracy, risk to reward and frequency. For example, if we have a setup in which we take trades based on hammer candle or ema crossover, so we need to at least have a manual back tested data of last six months in the particular time frame and in that particular instrument in which we are planning to trade. And after that we need keep log in every day market in that particular instrument in that particular time frame, no matter we have taken trade or not.
Key points while constructing a trading strategy- “KEEP IT SIMPLE”
whatever the strategy you are planning to implement, it must be simple, and no need to have multiple factors. Use less number of indicators possible, and less chart patterns or other data possible. We have to remember that if we blindly buy or sell in any instrument, the profit probability is 50%, and with little modification a 70% accurate, with 1:2 risk to reward strategy is more than enough for us to sustain in the market.
Lastly- all the statements are my personal observation, and few add-ons may be required, which may very person to person, but one thing that can be assured that with one proper setup, confidence can be gained to sustain in the market, and later on can go for evolution.