Creating Your Own Strategies

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Create Your Own Trading Strategies

There are many excellent trading strategies out there, and purchasing books or courses can save you time finding one that works, but trading can also be a “do it yourself” career. Many traders spend hundreds or even thousands of dollars looking for a great trading strategy, but building your own can be fun, easy, and surprisingly quick.

To create a strategy, you’ll need access to charts that reflect the time frame to be traded, an inquisitive and objective mind, and a pad of paper to jot down your ideas. Then you formalize these ideas into a strategy and “visually backtest” them on other charts. In this article, we go over the process from start to finish and offer important questions to ask along the way. Once you’re done, you’ll be ready to start creating your strategies in any market and on any time frame.

Time and Place?

Before a strategy can be created, you need to narrow the chart options. Are you a day trader, swing trader, or investor? Will you trade on a one-minute time frame or a monthly time frame? Be sure to choose a time frame that suits your needs.

Then you’ll want to focus on what market you’ll trade: stocks, options, futures, forex, or commodities? Once you’ve chosen a time frame and market, decide what type of trading you’d like to do. As an example, let’s say you choose to look for stocks on a one-minute time frame for day-trading purposes and want to focus on stocks that move within a range. You can run a stock screener for stocks that are currently trading within a range and meet other requirements such as minimum volume and pricing criteria.

Stocks, of course, move over time, so run new screens when needed to find stocks that match your criteria for trading once former stocks are no longer trading in a way that aligns with your strategy.

Creating and Testing Strategies

Creating a strategy that works makes it much easier to stick to your trading plan because the strategy is your work (as opposed to someone else’s). For example, suppose that a day trader decides to look at stocks on a five-minute time frame. She has a stock selected from the list of stocks produced by the stock screen she ran for certain criteria. On this five-minute chart, she’ll look for money-making opportunities.

The trader will look at rises and falls in price to see if anything precipitated those movements. Indicators such as time of day, candlestick patterns, chart patterns, mini-cycles, volume, and other patterns are all evaluated. Once a potential strategy is found, it pays to go back and see if the same thing occurred for other movements on the chart. Could a profit have been made over the last day, week, or month using this method? If you are trading on a five-minute time frame, continue to only look at five-minute time frames, but look back in time and at other stocks that have similar criteria to see if it would have worked there as well.

After you determine a set of rules that would have allowed you to enter the market to make a profit, look to those same examples and see what your risk would have been. Determine what your stops will need to be on future trades to capture profit without being stopped out. Analyze price movement after entry and see where on your charts, a stop should be placed. When you analyze the movements, look for profitable exit points. Where was the ideal exit point, and what indicator or method could be used to capture most of this movement?

When looking at exits, use indicators, candlestick patterns, chart patterns, percentage retracements, trailing stops, Fibonacci levels, or other tactics to help capture profits from the opportunities you see.

Depending on how often you want to look for strategies, you can look for tactics that work over concise periods of time. Often, short-term anomalies occur that allow you to extract consistent profits. These strategies may not last longer than several days, but they can also likely be used again in the future.

Keep track of all the strategies you use in a journal and incorporate them into a trading plan. When conditions turn unfavorable for a certain strategy, you can avoid it. When conditions favor a strategy, you can capitalize on it in the market.

Additional Things to Consider

Using historical data and finding a strategy that works will not guarantee profits in any market. It is for this reason that many traders do not backtest their strategies, applying the strategy on historical data. Instead, they tend to make spontaneous trades. This is a lack of due diligence. It’s important to know a strategy’s success rate because if a strategy never worked, it is unlikely to start working today suddenly. That’s why visual backtesting – scanning over charts and applying new methods to the data you have on your selected time frame – is crucial.

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Many strategies don’t last forever. They fall in and out of profitability, and that’s why one should take full advantage of the ones that still work. If something has worked for the past few months or over the course of the past several decades, it will probably work tomorrow. But if you never looked to the past to test that strategy, you might not even realize it was there, or you might lack the confidence to apply it in the markets tomorrow to make money. Knowing that something has worked in the past will thus also give a psychological boost to your trading.

Trading needs to be done with confidence (not arrogance), and being able to pull the trigger on a position when there is a set-up to make money will require the confidence that comes from looking to the past and knowing that, more often than not, this strategy worked.

Keep in mind you do not need to look for strategies that work 100% of the time. In fact, if you do, you’ll likely find no workable strategies. Look for strategies that net a profit at the end of the day, week, or year(s), depending on your time frame.

The Bottom Line

Strategies fall in and out of favor over different time frames; occasionally, changes will need to be made to accommodate the current market and our personal situation. Create your own strategy or use someone else’s and test it on a time frame that suits your preference. By looking back, you can give yourself some great starting points to make more money and avoid losses as you become more experienced. Track all strategies that you use so that you can use these strategies again when conditions favor it.

How To Create Your Own Trading Strategies

Learn how to create your own trading strategies. Learn what variables to consider, how to come up with entry criteria, how to determine where to take profits and losses, how to manage risk, and how to assess your strategy for viability.

Creating a trading strategy may seem like a daunting task, but it’s actually quite fun. Creating your own strategies forces you to delve into the charts and really notice small things that may put the edge in your favor. You can, and should, go through this same detailed process with someone else’s strategies as well. My trading courses provide a roadmap for how I navigate the markets. Others can use my roadmap, but they still need to know how to read the roadmap…and that only comes from looking at lots of charts, practicing the strategies, and understanding why things are done in a certain fashion. And we only understand why things are done in a certain fashion if we look at lots of charts with an open and inquisitive attitude.

In university, I discovered that I performed a lot better if I didn’t memorize. Instead, I spent time trying to understanding the underlying principles of what I was learning. For example, let’s say you are taking a math class and there is a big formula you’re learning about. Most people memorize and formula and then hope they can solve for the missing variable when asked.

A far better approach is to understand what all the symbols in the formula mean, how they work together, what it provides us with, and how it can be manipulated in other ways. If you really understand what the formula is telling you, and you can put it into words, you don’t need to memorize the formula because you will always be able to recreate it at any time with your understanding. You will also be able to adapt it to different circumstances (which tests often require you to do), whereas the person who simply memorizes likely won’t be able to to do this as well. The point is, immerse yourself in the process and really understand why a strategy is telling you to buy sell at certain times, and you will be far better off than simply trying to blindly follow rules you don’t understand. This applies whether you are using someone else’s strategy or creating your own.

If you come across a strategy that you like and that “sits well with you,” then incorporate that strategy into your trading plan. I encourage all traders to “personalize” any strategies they use, though. I created all my own strategies, so I believe in them. You may like part of my strategy, but may think certain aspects of it should be altered. By all means do! Take what you like from strategies and leave the rest. Test out better ways of doing things. By making it your own and doing your own research you will start believing in your method. And having confidence in your method is a requirement for successful trading because the market is going to constantly make you second-guess yourself to prompt poor decisions. If you aren’t confident enough to stick with your method, you will fall into these traps. You only gain confidence by putting in lots of effort and seeing that your strategy works.

I have been trading full-time since 2005, and I am still so excited about it that I have to share what I am finding and learning. I spend many hours each week just flipping through charts, noting where I could have done something different to increase profits or reduce risk. Often, these insights don’t reveal much, because over many trades I see that I am doing the right thing by sticking to my current plan. But occasionally there is a revelation, and a new strategy is born. I notice something I didn’t see before, even after all these years. Markets are so dynamic that there are countless ways to make money…which also means there are countless ways to lose it as well.

Creating a trading strategy that makes money is truly a joyous event. Let’s look at how you can start to build your own trading strategies, or find ways to make strategies you are currently using better.

How to Create Strategies

For the purposes of this article, we will focus on finding day trading and swing trading strategies. I typically rely solely on price charts for these styles of trading. Therefore, I tend to start my strategy creation journey by looking at charts. The first question therefore is: What charts do I look at?

  • If day trading. Start out by picking one stock, forex pair, or futures contract you will trade. Once you find a strategy that works in one asset, you will likely be able to adapt it to other markets. For forex traders, stick to the EURUSD or GBPUSD. For futures traders, the S&P 500 Emini (ES) is a good one to start with. The S&P 500 ETF (SPY) is good for stock traders starting out, or check out the Day Trading Stock Picks page for other ideas.
  • If swing trading, trading what is hot is a good place to start. Every week or two look at the top performing stocks (can use Finviz to do this). These are the stocks offering the most potential, so we want to analyze their charts and see how we can exploit the movement. You can also choose to find charts based on some other criteria.

The next step is to look at lots of charts. For day trading, this means looking through the last several months of 1-minute, 5-minute, or any other style of intraday charts. For swing trading, it means looking at how all the top performing stocks have moved over the last year (or whatever group you decide you want to take trades in).

Within those charts, we are looking for any major areas where profit could have been made. I typically start by looking at bigger price moves on the chart. I then consider what was happening on the chart that could have tipped me off to get into that trade. How could I have taken advantage of the big move(s)?

We then look at other charts (or days, if looking for day trading strategies) and see if we can find other moves that look similar (we will!). We are looking for similar conditions, across many charts/days, that resulted in the price making a significant move we could have capitalized on.

Our major question now becomes, what precipitated the move? We need to look for ways the market alerted us that a bigger move, in a particular direction, was forthcoming.

Here is a sampling of the questions you want to ask yourself in order to start building your strategy.

Is there a chart pattern, a candlestick pattern, a news event, or do moves tend to occur at a certain time of day?

Did the move start before a certain session (NY, London, Tokyo, etc), near the close, mid-day? Is there any relation to an opening or closing market? (See: Forex Market Hours and Hourly Tendencies).

What is the longer-term trend? What is the short-term trend? Is the short-term trend ending and the price is starting to move back in the long-term direction?

How fast and how far are the recent price waves compared to prior price waves?

Looking At How to Enter

Where could I enter? What precise event would have told me NOW is the time to act? I often use consolidation breakouts and engulfing patterns to signal an entry.

How could I have gotten into the trade (market order, limit order, stop order, stop limit order)? Which order type works best for what I am trying to accomplish?

Looking at my answers from above, how could I take advantage of this opportunity in real-time? Was it even possible to get in at a decent price (consider price gaps and volume)?

Does the pattern I am watching give an entry signal such as a breakout of resistance/support/pattern? Does the price tend to wiggle around a certain dollar amount, or for a number of days (on average), before it takes off?

Are there any technical indicators that could aid in filtering out bad signal or confirming good ones?

Does the asset generally stay within a certain price area for the day?

Consider catalysts, like a regular news event, and how it could be exploited for profit. See Non-Farm Payroll (NFP) Forex Strategies.

Considering the Exit

Getting in is one thing. But we also need to think about who we will get out. The exit is very important and deserves as much consideration as the entry.

What market conditions, chart patterns, or price moves are present once the trend/move (that we entered into) has topped or bottomed and is starting to reverse?

How far does the price tend to run before it pulls back? Do I want to get out before the first major pullback, or is it worthwhile to hold through it?

If my entry criteria disappear, can I use that as an exit?

How can I stay in the move to capture the bulk of it, but also not give up too much profit when it reverses?

Not all trades you enter will work out. For the ones that don’t, consider where to place a stop loss so that the risk is capped and won’t significantly hurt the account.

Are there any indicators that aid in this?

Would a trailing stop have allowed me to capture a large profit? If so, what should my trailing stop be?

Would a fixed number profit target work? For example, if risking $100, could a profit target be placed at a profit target yielding $200, $300, etc.?

Does the asset generally stay within a certain percentage move for the day? All assets have average movements per day, so could this be used in determining when to exit? Think Average True Range, daily range, or other volatility statistics.

Money management

Money management helps us determine if a trade is worth taking, how much we are willing to risk, and whether the potential reward warrants taking the risk in the first place.

Based on the entry point and stop loss, what is the risk in dollars based on the position size? The amount lost if the price hits the stop loss should not be more than 2% of total account equity, and should ideally be less than 1%.

What is the potential profit? This is based on the target, or what the typical trailing stop loss produces based on the charts you looked at.

Based on the above two answers, is the trade worth taking? If the risk is too large, or I am getting into moves too late, I need to adjust. If I am giving up too much profit when prices reverse, I need to adjust.

For day trading, profits should be at least 1.5x risk. For swing trading, profits should be 2x risk. Your average, over the many trades you look at, should be above these figures.

Other Considerations

Do the conditions you identified to trigger a trade occur at other times, and not just before large moves? For example, are you going to get a lot of false signals? Whenever your entry criteria occur, you need to count that as a trade. If the entry criteria result in too many trades (mostly losing ones) you need to refine your conditions.

Can you cut down on false signals by only trading a certain time of day, adding indicators, or filtering out certain patterns? Could you only trade in the dominant trend direction? Or only after the price has made a strong reversal?

If you would have lost a lot of money implementing a strategy, that tells you something worthwhile! Doing the opposite of what you set out to do may be a path to profits. I actually love false breakouts and use them to my advantage all the time. If a strategy is losing you money, someone else is making money! Think about what that group of traders is doing!

In short, you want to analyze your charts looking for opportunities. Examine those opportunities and construct how you could turn those opportunities into real money, without exposing yourself to excessive risk.

Testing the Strategy

Once you have an idea that seems to work on the charts you have been looking at, test it more rigorously. See if the strategy works on recent movements (new charts/different days), looking for at least 50 or more “trade signals.” See if the strategy is still capable of producing a profit.

Check for profitability by adding up the wins and losses and getting a net result. Also factor in commission costs. If the strategy continues to work, start trading it in real-time in a demo account (see 5 Step Plan For Forex Trading Success). If you produce a profit in the demo account (using that strategy) over a few months, then consider trading the strategy with real capital. During demo trading, and even once you start live trading, track your trading statistics to gain insight into what is working well and what could be improved.

By Cory Mitchell, CMT

Check out my Forex Trading Strategies Guide for Day and Swing Traders 2.0 eBook.
Over 300 pages, forex basics to get you started, 20+ forex trading strategies, and how to create your trading plan for success. It’s a course to build your skill step-by-step.

Design Your Trading System in 6 Steps

The main focus of this article is to guide you through the process of designing your own forex trading system.

While it doesn’t take long to come up with a system, it does take some time to extensively test it.

Step 1: Time Frame

The first thing you need to decide when creating your system is what kind of forex trader you are.

This will help determine which time frame you will use to trade. Even though you will still look at multiple time frames, this will be the main time frame you will use when looking for a trade signal.

Step 2: Find indicators that help identify a new trend.

Since one of our goals is to identify trends as early as possible, we should use indicators that can accomplish this.

Moving averages are one of the most popular indicators that traders use to help them identify a trend.

Specifically, they will use two moving averages (one slow and one fast) and wait until the fast one crosses over or under the slow one.

This is the basis for what’s known as a “moving average crossover” system.

In its simplest form, moving average crossovers are the fastest ways to identify new trends. It is also the easiest way to spot a new trend.

Of course, there are many other ways forex traders spot trends, but moving averages are one of the easiest to use.

Step 3: Find indicators that help CONFIRM the trend.

Our second goal for our system is to have the ability to avoid whipsaws, meaning that we don’t want to be caught in a “false” trend.

The way we do this is by making sure that when we see a signal for a new trend, we can confirm it by using other indicators.

There are many good indicators for confirming trends like MACD, Stochastic, and RSI.

As you become more familiar with various indicators, you will find ones that you prefer over others and can incorporate those into your system.

Step 4: Define Your Risk

When developing your forex trading system, it is very important that you define how much you are willing to lose on each trade.

Not many people like to talk about losing, but in actuality, a good trader thinks about what he or she could potentially lose BEFORE thinking about how much he or she can win.

You have to decide how much room is enough to give your trade some breathing space, but at the same time, not risk too much on one trade.

You’ll learn more about money management in a later lesson. Money management plays a big role in how much you should risk in a single trade.

A trader should aways think about the potential loss BEFORE thinking about potential gain.

Step 5: Define Entries & Exits

Once you define how much you are willing to lose on a trade, your next step is to find out where you will enter and exit a trade in order to get the most profit.

Entries

Some people like to enter as soon as all of their indicators match up and give a good signal, even if the candle hasn’t closed. Others like to wait until the close of the candle.

One of the forex traders here in BabyPips.com, Pip Surfer, believes that it is best to wait until a candle closes before entering.

He has been in many situations where he will be in the middle of a candle and all of the indicators match up, only to find that by the close of the candle, the trade has totally reversed on him!

It’s all really just a matter of trading style. Some people are more aggressive than others and you will eventually find out what kind of trader you are.

For example, in the chart below, this trader’s entry was when the candle closed below the support line.

Exits

For exits, you have a few different options.

One way is to trail your stop, meaning that if the price moves in your favor by ‘X’ amount, you move your stop by ‘X’ amount.

Another way to exit is to have a set target, and exit when the price hits that target. How you calculate your target is up to you. For example, some traders choose support and resistance levels as their targets.

In the chart below, the exit is set at a specific price which is near the bottom of the descending channel.

Others just choose to go for the same amount of pips (fixed risk) on every trade.

However you decide to calculate your target, just make sure you stick with it. Never exit early no matter what happens.

Stick to your trading system!

After all, YOU developed it!

One more way you can exit is to have a set of criteria that, when met, would signal you to exit.

For example, you could make it a rule that if your indicators happen to reverse to a certain level, you would then exit out of the trade.

Step 6: Write down your system rules and FOLLOW IT!

This is the most important step of creating your trading system. You MUST write your trading system rules down and ALWAYS follow it.

Discipline is one of the most important characteristics a trader must have, so you must always remember to stick to your system!

No system will ever work for you if you don’t stick to the rules, so remember to be disciplined.

Oh yeah, did we mention you should ALWAYS stick to your rules?

How to Test Your Forex Trading System

The fastest way to test your system is to find a charting software package where you can go back in time and move the chart forward one candle at a time.

When you move your chart forward one candle at a time, you can follow your trading system rules and take your trades accordingly.

Record your trading record, and BE HONEST with yourself!

Record your wins, losses, average win, and average loss. If you are happy with your results then you can go on to the next stage of testing: trading live on a demo account.

Trade your new system live on a demo account for at least two months.

After two months of trading live on a demo account, you will see if your system can truly stand its ground in the market.

If you are still getting good results, then you can choose to trade your system live on a REAL account.

At this point, you should feel very confident with your forex trading system and feel comfortable taking trades with no hesitation.

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