Forex traders just starting out in the forex market are often unprepared for what lies ahead and, as such, end up undergoing the same life cycle: first they dive in headfirst, usually losing their first account, and then they either give up or take a step back, do a little more research, and open a demo account to practice. Those who do this will often eventually open another live account and experience a little more success, breaking even or turning a profit. To help avoid the losses from hastily diving into forex trading, this article will introduce you to a framework for a medium-term forex trading system to get you started on the right foot, help you save money, and ultimately become a profitable retail forex trader.
Why Medium Term?
So, why are we focusing on medium-term forex trading? Why not long-term or short-term strategies? To answer that question, let’s take a look at the following comparison table:
Now, you will notice that both short-term and long-term forex traders require a large amount of capital – the first type needs it to generate enough leverage, and the other to cover volatility. Although these two types of forex traders exist in the marketplace, they are often positions held by high-net-worth individuals or larger funds. For these reasons, Forex traders are most likely to succeed using a medium-term strategy.
The Basic Framework of a Forex Trader
The framework of the strategy covered in this article will focus on one central concept: trading with the odds. To do this, we will look at a variety of techniques in multiple time frames to determine whether a given trade is worth taking. Keep in mind, however, that this is not a mechanical/automatic trading system; rather, it is a system by which you will receive technical input and make a decision based upon it. The key is finding situations where all (or most) of the technical signals point in the same direction. These high-probability trading situations will, in turn, generally be profitable.
Chart Creation and Markup Selecting a Trading Program
We will be using a free program called MetaTrader to illustrate this trading strategy; however, many other similar programs can also be used that will yield the same results. (For more tips on how to find one, see Forex Automation Software For Hands-Free Trading.) There are two basic things the trading program must have:
the ability to display three different time frames simultaneously
the ability to plot technical indicators, such as moving averages (EMA and SMA), relative strength index (RSI), stochastics and moving average convergence divergence (MACD)
Setting up the Indicators
Now we will look at how to set up this strategy in your chosen trading program. We will also define a collection of technical indicators with rules associated with them. These technical indicators are used as a filter for your trades.
If a forex trader chooses to use more indicators than shown here, you will create a more reliable system that will generate fewer trading opportunities. Conversely, if you choose to use fewer indicators than shown here, you will create a less reliable system that will generate more trading opportunities. Here are the settings that we will use for this article:
Minute-by-minute candlestick chart
RSI (15)
stochastics (15,3,3)
MACD (Default)Hourly candlestick chart
EMA (100)
EMA (10)
EMA (5)
MACD (Default)Daily candlestick chart
SMA (100)Now you will want to incorporate the use of some of the more subjective studies, such as the following:
Significant trend lines that you see in any of the time frames
Fibonacci retracements, arcs or fans that you see in the hourly or daily charts
Support or resistance that you see in any of the time frames
Pivot points calculated from the previous day to the hourly and minutely charts
chart patterns that you see in any of the time frames
Finding Entry and Exit Points
The key to finding entry points is to look for times in which all of the indicators point in the same direction. Moreover, the signals of each time frame should support the timing and direction of the trade. There are a few particular instances that you should look for:
Bullish
Bullish candlestick engulfings or other formations
Trendline/channel breakouts upwards
Positive divergences in RSI, stochastics and MACD
Moving average crossovers (shorter crossing over longer)
Strong, close support and weak, distant resistanceBearish
Bearish candlestick engulfings or other formations
Trendline/channel breakouts downwards
Negative divergences in RSI, stochastics and MACD
Moving average crossovers (shorter crossing under longer)
Strong, close resistance and weak, distant supportIt is a good idea to place exit points (both stop losses and take profits) before even placing the trade. These levels should be set at key levels and only changed if the premise for your trade changes (often as a result of fundamentals coming into play). You can place these exit points at key levels, including:
- Just before areas of strong support or resistance
- At key Fibonacci levels (retracements, fans or arcs)
- Just inside of key trend lines or channels
Money Management and Risk
Money management is key to success in any marketplace but particularly in the forex market, which is one of the most volatile markets to trade. Many times, fundamental factors can send currency rates swinging in one direction only to whipsaw into another in mere minutes. So, it’s important to keep your losses as low as possible by always using stop-loss points and only trading when good opportunities come up.
Here are a few specific ways in which you can limit risk:
- Increase the number of indicators that you are using. This will result in a harsher filter through which your trades are screened. Note that this will result in fewer opportunities.
- Place stop-loss points at the closest resistance levels. Note that this may result in forfeited gains.
- Use trailing stop losses to lock in profits and limit losses when your trade turns favorable. Note, however, that this may also result in forfeited gains.
“If you don't find a way to make money while you sleep, you will work until you die.”
- Warren Buffett
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