Step by Step on How to Trade Forex

Do you struggle with following popular trading techniques and getting no results?

If you’re like a lot of forex traders, you jump from strategy to strategy, hoping to find a forex trading strategy that works.

Let’s get one thing out of the way:
You don’t need hidden chart patterns, magic indicators, or insider secrets from big banks.

Instead, you need a simple system that you like and trust.

This post will help you figure out how to develop a forex trading strategy that works.

We’re going to teach you the same
step-by-step method
we use at ForexSpringBoard.

Before you begin building your strategy, you’ll want to understand some key concepts. If you’re in a hurry, click this link to jump right into the step-by-step process.

What Is a Forex Trading Strategy?

A forex trading strategy is a way to engage in competent currency trading. Strategies contain rules for entering and exiting your trades. This means that you must put together a collection of techniques that you follow consistently.

Set of rules illustration

Contrary to what most people think, strategies don’t have to be difficult.

Tossing a coin and buying when it lands on heads, and selling when it lands on tails, is a trading strategy. It might not be profitable, but if you pair it with proper risk management, you will be around breakeven. That’s better than the average.

There are many benefits to having a strategy, as we’ll explain below.

Why Do You Need a Forex Trading Strategy?

Trading strategies are important for traders of all shapes and sizes.


If you have a small trading account, or a large one, want to support your income, or buy a Ferrari with a EUR/USD license plate, a trading strategy brings structure to your trading and allows you to gain an edge over the market.

Think about it this way:

Wherever you go, you face different rules and boundaries that limit how you can express yourself. You don’t cut the line in the supermarket because you’re tired of waiting and you don’t steal your neighbor’s car because it looks better.

(Well, most of us don’t do these things.)

Now, what if social structures didn’t exist?

Because let’s be honest—chances are, you didn’t create any of them. You were just born into a culture that has its own structure. If that suddenly ceased to exist, you’d face a chaotic and uncertain environment—unless you stepped up and did something.

This is exactly what happens when you start trading.

Unless you trade for an institution, no one tells you what you can or cannot do. You decide when to start a trade and you decide when to end it. However, if you want to see results other than random wins and losses, you need a structure.

That’s where the trading strategy comes into play.

In particular, a strategy allows you to:

  • Stop with intuitive trading
  • See what works and what doesn’t
  • Gain confidence in yourself
  • Organize your day better
  • Become accountable
  • Stop stressing about your trades

Now, to be entirely transparent, most of these benefits apply only if you use your trading strategy as part of a comprehensive trading plan.

Don’t freak out if you never thought that “trading plan” is just another term for a trading strategy. It’s a simple concept and you’ll understand it in no time. Just read the section below.

What’s the Difference Between a Trading Strategy and a Trading Plan?

Having a trading strategy is essential.

However, as in any other business, your trading will be successful only if you have a solid plan laying out what you need to do to achieve your goals.

Let’s put things into perspective through a simple example:

A small store might have a strategy for how it will compete with other small stores in the neighborhood. For example, it decides to focus on providing the freshest veggies by working closely with local farmers.

Small Store Illustration

It might be the best strategy on earth. However, it will yield benefits only if it is part of a plan that outlines how the store will operate and grow.

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From market analysis to accounting and finance, a lot goes into managing a shop. For example, the manager must specify the maximum liabilities he can have without risking the stability of the business.

When you want to be a successful forex trader, you more or less face the same issues.

On the one hand, you want to come up with something that puts you in a better position than other traders. That’s your trading strategy.

However, on the other hand, you must put the strategy into a larger context and consider your circumstances, the maximum risks you take, the markets you trade, psychological questions, and so on. That’s your trading plan.

trading system

You see, the strategy and the plan go hand in hand. You need both. In fact, as we have suggested, your strategy should exist as part of your trading plan.

In this guide, we’ll focus on creating a trading strategy. However, you can also check out our guide on creating a trading plan.

How to Develop a Forex Trading Strategy That Works, Step by Step

Let’s be honest: This is why you are here.

So, without further ado, let’s learn how to develop a forex trading strategy that works.

Before You Begin

Spend some time deciding on your trading style. This is very important because it affects the strategy you’re going to build.

There are four trading styles:

  • Day trading
  • Position trading
  • Swing trading
  • Scalping

We have a dedicated guide to trading styles in which we talk about each in detail.

After you choose a trading style, you should know which type of strategy you’re going to build and select the techniques accordingly.

This will help you choose your timeframe and traded currency pairs.

Step 1: Write a Summary

Whenever we develop a trading strategy, we like to begin with a few sentences that explain the purpose of the strategy and the techniques used to accomplish the purpose.

This is a good way to organize your thoughts. It also helps you get a quick overview of the strategy whenever you’re in doubt or want to show it to someone.

Now, of course, for writing a summary, you must have an idea of the strategy you want to develop. This is where knowing your trading style is beneficial.

That said, you still have to know the techniques to use and the market conditions in which you want to trade.

You don’t have to know every detail yet, but you should be able to give a general description of the strategy you develop.

Here’s an example from a strategy that we recently backtested:

“This strategy strips down trading to the bare essentials. We must always be long in bull markets, be short in bear markets, and stand aside in neutral markets. To determine the market condition, we look at the two most recent highs and the two most recent lows.”

You see, it’s pretty simplistic, but this is exactly the point of a summary.

In the subsequent steps, we’re going to move forward and tackle the essential elements to clarify everything and develop an effective forex trading strategy.

Step 2: Create Recognition Criteria

Arguably, we could have figured out a more user-friendly name for this section, but this is what happens when you spend too much time with charts and data 😂

So, what the heck does “recognition criteria” mean?

Simply put, list every price action concept you are going to use in your strategy and explain which conditions must be satisfied for them to be valid.

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The three examples that every strategy – even 100% indicator-based strategies – must contain are bull, bear, and neutral markets.

What are your definitions for these situations?

Remember, the whole point of a trading strategy is to eliminate subjectivity as much as possible.
You must be able to come up with your own definition for popular concepts and trade accordingly.

For example, if you’re a price action trader, you might say:

  • A bull market is a market that is making higher highs and higher lows.
  • A bear market is a market that is making lower highs and lower lows.
  • A neutral market is defined as any other condition.

On the other hand, if you’re using indicators, you might say:

  • A bull market is a situation in which the price is above the 50-period SMA.
  • A bear market is a situation in which the price is below the 50-period SMA.
  • A neutral market is a situation in which the ADX indicator is below 25 for more than 30 bars.

Apart from market conditions, you might employ other techniques that require a recognition criterion. Support and resistance levels, chart patterns, and candlestick formations are all examples that you must address in a similar fashion.

Step 3: Define the Trading Signals

Investopedia defines “trading signal” as a trigger for action, to either buy or sell a security or other asset, generated by analysis.

That analysis can be done in many ways.

You might use price action techniques such as chart patterns, candlestick formations, or trendlines. You might rely on indicators or you might cut out technical analysis altogether and look at the performance of different economies.

Of course, you can also use a combination of these, so there’s huge versatility here.

Don’t stress much about trading signals when you’re developing your strategy for the first time. There aren’t really superior techniques that would work much better than others.

Successful trading is more about the overall trading plan and your ability to deal with psychological challenges.

That said, it still matters what you do; it’s just that there is no holy grail or some sort of quick way to riches.

First of all,
you should choose the techniques you like.

Trading trends are said to be the best way to approach forex. Yet, trend trading strategies often don’t have a profit target (you’re in the trade until the trend starts to reverse) and they might take a long time to play out. If this sounds bad to you, don’t trade trends.

Secondly,
your strategy should make sense.

You don’t have to make super complicated systems, but you must understand what you are doing. In other words, even if you found your techniques in a YouTube video, you must understand the logic behind them.

Let’s take a look at this swing trading strategy from Andrew Lockwood:

Basically, this strategy uses candlesticks.

If this is something in which you are interested, you can simply take the signals he describes and put them into your strategy.

While you can borrow ideas from anyone,
you must understand the underlying logic and the purpose of each element.

In this situation, you want to capture market reversals. In an uptrend, Bearish Engulfing and Bearish Pin Bar candlestick patterns are both indicating that sellers overpowered buyers during the period that the candle represents.


When these candles appear at a resistance level, where the price reversed multiple times in the past, you have a higher likelihood of catching a market reversal.

Significant support level

Entering on a pending order further increases your chances of a profitable trade because you wait for the market to confirm that a contra-trend move is, indeed, on the way.


You see, trading signals are not some random hocus pocus. If you put something in your strategy, there must be logic to it. When the strategy is ready, you can move on to backtesting to see if your idea works in reality.

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Step 4: Exit Scenarios

Exits can be considered the most important part of a trade, but they are often overlooked.

Before you start a trade, it’s crucial to know how and when you will exit. After all, this is what determines whether you end up with a profit or a loss.

This also means that
there are two kinds of exits: one to realize a profit and one to cut off a loss.

Needless to say, you require both. However, you must prioritize.

Stop Loss

First, you should always identify the risk on the trade.

The risk is the distance between your entry price and your stop loss, and it’s expressed in pips. When opening your trades, the risk should always correspond to about 1% of your account size, meaning you must open an appropriate position size.

Risk on trade

We talk about this in detail when discussing how much money you need to trade forex.

Take Profit

Once you have your risk on the trade, you can move on to identifying an appropriate profit target.

Depending on your strategy, there are many ways you can come up with target levels. For example, Fibonacci ratios, channels, and support and resistance levels are all widely used to identify appropriate stop and profit levels.

(Trend trading strategies, as we already discussed, don’t always have clear profit targets, but you can use trailing stops as a means of exiting both profitable and losing trades.)

Institutively, the distance between the entry price and take profit order is the reward you can gain on the trade.

Reward on trade

Comparing this with the risk, which we defined as the distance between the stop loss and entry price, yields the risk to reward ratio (RR).

Risk to Reward Ratio

The risk to reward ratio measures your potential reward for every dollar you risk. For example, if you have a risk to reward ratio of 1:2, it means you’re hoping to make $2 by risking $1.

Depending on your preferences, you might decide to reject trades that don’t meet your criteria.

In general, when you are a scalper or day trader, you will prefer a smaller RR. On the other hand, when you are a position trader, you will want to see a large RR. Swing trading systems can fall into both categories.

RR for different trading styles

As an alternative to looking for trades with a certain RR ratio, a perhaps even better approach is to have different exit strategies depending on the RR.

For example, if the profit target is close, you can simply exit the trade once the market gets there. However, if the profit target is far, you might want to scale out of your trade or move your stop into breakeven at a certain point.

Conclusion

If you have followed the steps above, you have a solid trading strategy.

The next stage is to start backtesting and make improvements.

We usually backtest on three years of historical market data on at least three different currency pairs. Then we analyze the results and refine the trading signals that produce the most losing trades.

We look for insights such as the situations in which most of the losing trades occurred and how we could mitigate or avoid those situations in the future.

At the same time, we carefully investigate our winners and modify the strategy to better capture those circumstances that led to winning trades.

If you do the same thing, you will eventually have a forex trading strategy that works. It takes time, but it’s worth it.

Step by Step on How to Trade Forex

Source: https://forexspringboard.com/forex-trading-strategy-guide/

Posted by: derivbinary.com