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Components of Trading Strategy in Detail

In the previous article, we had discussed the need to have several components as part of the trading strategy and how they need to be in sync with your mindset so that they work best. With this in mind, the three most important components of any trading strategy are the actual rules of the trading system (like when you will be taking the trade), the entry and the exit. All these three are very important and under no circumstances can any of these three be discarded in favor of anything else. Many traders make the mistake of dropping one of these components from their plan or not sticking to the plan and hence they finally end up in failure. When they do fail, they usually blame the trading strategy rather than themselves and their lack of discipline for it. To these components, as a trader, you can also add other criteria, like trading hours, what disciplinary rules that you will follow what kind of mindset you will need to be in before taking a trade etc. These components can be added depending on what you feel but the first three components are paramount and there can be no strategy without these three.

The first component is the actual rules of the trading system, the rules that will need to be satisfied before you even start thinking of taking a trade. It might be as simple as an inside bar breakout, a break of support/resistance, two MAs crossing each other or may be as complicated as 3 MAs being in sync with stochastic on 2 timeframes pointing in the same direction with RSI being positive etc. A whole lot of trading systems are possible on a variety of timeframes with and without indicators. You can choose to use one of these or even a combination of these or can even come up with your own. But the important thing here is that the rules should be clear, objective, unambiguous and clearly written down and needs to be followed with high discipline.

The next is the entry. This is probably the easiest component for traders as many of them, especially the new ones simply love to enter into a trade and be in it for as long as they can. The entry also needs to have specific set of rules. It is not always necessary that if all the rules in component 1 are satisfied, then it should automatically lead to an immediate entry. Component 1 simply sets the stage for a trade entry but the actual buy or sell can happen much later depending on a different set of rules. Again, it all depends on the strategy as a whole.

The component which is usually the most neglected of all is the exit criteria. Many traders simply love to enter and just be in a trade but they really do not know when to get out of a trade, especially when the trade is running at a loss. This is what makes the exit more important than the entry in many cases. Traders simply need to have the discipline to define strict rules for exit and also even more discipline to ensure that they stick to the rules and get out of the trade when the rules state so. Many forex broker find this so very difficult to do/achieve and this is what causes many traders to fail.

The entry and the exit also need to be in such a way that the risk and the returns are at least equal to each other. The risk: reward ratio is key for any trading strategy and it is always good to have the risk as less as possible when compared to the reward. This is definitely a great thing to have if possible but there have been cases of successful trading strategies even with the R: R ratio being 1.

Now that we are clear on what components need to be there in our forex trading strategy, let’s delve straight into some very interesting and successful trading strategies.