There are, of course, hundreds – probably thousands – of individual forex trading strategies. However, they all fall into one of two basic strategic approaches:
- Great risk/reward ratio:
This strategy is designed knowing that it will likely result in over 50% losing trades – the idea, however, is that winning trades will be sufficiently larger than losing trades to make the strategy profitable overall
- Unfavorable risk/reward ratio:
This strategy is designed so losing trades will, on average, be larger than winning trades, but is designed to produce winning trades approximately 75% of the time or better, thus making the strategy profitable on balance
Right, I know- now you want me to tell you which one to use.
But you’re the only person who can answer that question, because it is about whichever strategic approach YOU are most comfortable using. I highly recommend giving both a good trial run in order to discover which one better suits your personal trading style/risk tolerance. There’s no reason you can’t employ both if you find both approaches about equally satisfactory. For example, you could use one basic strategy for trading EUR/USD and the other for GBP/USD.
Some people will never be comfortable with a strategy that loses more often than it wins, because they just can’t stand taking losses.
Other people won’t be comfortable with a strategy that occasionally takes large losses, even if it wins 4-out-of-5 trades.
Strategy #1 – Lose Small, Win Big
I used this basic strategy successfully in commodity futures trading years ago. I actually used it accidentally – I thought I was using a strategy that would win more often than it lost, but it didn’t turn out that way. When I examined my trades at the end of one month, I found that I was losing about 3-out-of-5 trades. However, I also learned that my average losing trade was about $300, whereas my average winning trade was about $900. So, on average, my outcome for every 5 trades was as follows:
The key to succeeding with this basic type of strategy is having the ability to mercilessly cut your losses short. All it takes is falling in love with one bad trade to ruin your profitability. You know, that trade where your stop is at 1.5390… the market trades down to around 1.5392, and you start thinking, “I’m probably going to get stopped out by a pip or two, and then it’s going to reverse” – so you lower your stop to 1.5380…the market drops down near there, and you start thinking that you’re still going to be right in the long run, but the market may go down a bit further, so you lower your stop to under 1.5350… eventually, you’re stopped out at around 1.5297, and where you were initially risking only a 10 pip loss, you’ve now taken over a 100 pip loss. If you’re going to be profitable with this type of strategy, you simply cannot let that happen.
Strategy #2 – Win Small, Lose Big
This strategy is employed by using take profit targets that should be very easy to hit, while putting your stop loss so far away from the current price that not much short of a major market reversal is going to take you out. You don’t take the common approach of placing stop loss orders just under a recent low – which is, by the way, a spot that professional traders always look to aim for, knowing there are thousands of traders with stops just past that level. Instead, you place your stop someplace where it’s out of the reach of any ordinary, momentary spike, and likely only going to be hit if you’re horribly wrong in your analysis.
The key to this strategy is being willing to (A) be satisfied when your profit target is hit, thus banking a winning trade even if the market continues trading well beyond that point, and (B) being willing to suffer those occasional somewhat-large losses that will occur when your stop does get hit. The thing that will derail this type of strategy from overall profitability is getting cold feet about leaving your stop well away from the current price when the market turns in that direction (chopping the trade off early with a loss). What usually happens then is that you see that the market does turn back in the opposite direction, and that if you’d just left the trade alone, the market never would have stopped you out and would eventually have hit your take profit target instead; but by acting prematurely in the mistaken attempt to cut your loss short, you actually cheated yourself out of a winning trade.
If you want to take a closer look at a strategy using this second basic approach, Winners Edge has recently designed one, a strategy that’s aimed at producing a winning trade percentage of 70-80% or better. This Profit Zones Tool uses the ATR indicator – a technical indicator that is potentially very helpful, but that is used well by only a small percentage of traders. I’d never even heard of the ATR indicator until I ran across a very successful trader who made it the basis of his very, very profitable trading strategy. You can check out the Profit Zones strategy in detail by clicking HERE.
The thing I really like about this strategy is that it focuses where to EXIT a trade rather than on where you get in it. Great entries are great – but it’s your exit point that ultimately determines whether a trade is profitable.
In closing, I just want to make the point that trading discipline is the key to winning with any strategy. The reason that most traders lose money isn’t that they don’t have a decent strategy – it’s that they don’t strictly follow their strategy. Time and again, studies of losing traders have shown that while they think they just haven’t found a good enough strategy, in fact the problem is a lack of trading discipline, not abiding by the rules of whatever strategy they’re using. So, for example, if you want to try out the Profit Zones strategy noted above, employ it as described – don’t start changing the rules in mid-trade.
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Best wishes always,
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