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Automated Trading: How to Choose a Forex Automated Strategy

By , Head Forex Trading Instructor
05 July 2012 03:06 GMT

Would you like to partner with an FX trader who is logical, unemotional and who tirelessly looks for trading opportunities?

Many traders are attracted to automated trading because they can partner with an FX trader with the above characteristics through automated trading. This article will help traders identify an automated strategy that is a good D-E-A-L regarding higher probability trading.

Automated_Trading_How_to_Choose_a_Strategy_body_Picture_3.png, Automated Trading: How to Choose a Forex Automated Strategy

Let’s get started with the 4 step checklist. In my opinion, a strategy is a good D-E-A-L if it can positively answer each element of this acronym:

  1. Description
  2. Entry/Exit Signals
  3. Application
  4. Leverage

A positive result in the 4 items of the checklist is no guarantee the strategy will be profitable…nobody knows what the market is going to give in the next minute, let alone the next day, week or month. Therefore, the objective of the 4 point checklist is to properly identify and implement a forex automated strategy by utilizing appropriate leverage and performance expectations which results in higher probability trading.

Let’s unpack each element of this acronym.

Description

The first thing we should look at when considering an automated strategy is the description of the strategy. Find out what the strategy does and the general logic behind the strategy. Look for buzzwords such as - stop loss, profit target, risk to reward ratios, risk, breakout, trend, momentum, range.

By carefully reading the description, the first thing I want to identify is what type of market condition this strategy is intended to be used in. You see, strategies are designed to do well in only certain market environments. Strategies that can do well in ALL market environments are very difficult to come by.

Therefore, one way to bring realistic expectations is by determining what type of environment the strategy tends to do well in, and then apply that strategy to a market exhibiting the same condition. (More on this in the APPLICATION section.)

Entry/Exit Signals

Many traders spend the most of their time agonizing over the strategy’s entry and exit signals. It is important to understand the general logic behind the strategy, but we don’t want to over emphasize each trade the strategy makes. After all, this strategy will likely produce hundreds or thousands of trades. Therefore, it is the collection of trades generated by the strategy that we are interested in and not each individual trade.

In essence, look at the trade performance as a basket of trades rather than based on each individual trade.

Automated_Trading_How_to_Choose_a_Strategy_body_Picture_2.png, Automated Trading: How to Choose a Forex Automated Strategy

Here are a couple of ways of reviewing trades.

1. Place all of your winning trades in a basket and all of your losing trades in a basket. What is the average winner? What is the average loser? Seek strategies with higher average winners versus average losers.

2. Review the trade performance in baskets of 10 trades. Take a look at your last 10 trades, did the net result add pips to your account or take them away? Seek strategies that add pips in a basket of X trades.

Application

I mentioned above how we want to use the DESCRIPTION to determine the market condition the strategy is designed to thrive in. Once we identify the market condition, we then seek out a market that exhibits that characteristic. This step is often overlooked by traders.

There are generally 2 different types of market conditions with several variations. Today, we are only going to concern ourselves regarding trending markets and non-trending markets (often times called ranges).

These 2 conditions are exclusive of one another. When the market is in a trend, prices are making progress. You will see a series of higher highs and higher lows in an uptrend and a series of lower highs and lower lows in a downtrend.

On the other hand, ranges form when the market is not making progress in one way or the other as the market trades sideways. There are many reasons why trends and ranges development which is beyond the scope of this article. All that we need to be concerned about here is to identify which type of condition our strategy ideally thrives and then find a market that matches the same condition to trade this strategy.

If you are not sure what condition a given currency pair is in, there is a Weekly Strategy Outlook article written in DailyFX that provides guidance for you.

Automated_Trading_How_to_Choose_a_Strategy_body_Picture_1.png, Automated Trading: How to Choose a Forex Automated Strategy

Leverage

The last point of the 4 point checklist is leverage. This is another commonly overlooked area by automated forex traders. Many times, I’ve found that traders will generally utilize a good strategy, but they simply expect too much from it and therefore apply too much leverage. This is generally caused because traders are looking at the upside to the strategy and not planning for any potential losses. To help keep your account capitalized through such drawdowns, it is important to use conservative amounts of leverage or none at all.

In our Traits of Successful Traders series, we suggest utilizing no more than 10 times effective leverage. If you are a conservative trader, consider using even less leverage at 5 times or smaller. The benefit to using smaller amounts of leverage is that when your strategy experiences drawdown, you are risking a small portion of your account and therefore would have more capital left to trade than if you used large amounts of leverage.

Participate in higher probability trading by incorporating the 4 point checklist above. This will help you properly identify and implement a forex automated strategy by utilizing appropriate leverage and performance expectations.

Happy Trading!

---Written by Jeremy Wagner, Lead Trading Instructor, DailyFX Education

To contact Jeremy, email jwagner@dailyfx.com. Follow me on Twitter at @JWagnerFXTrader.

To be added to Jeremy’s e-mail distribution list, send an email with the subject line “Distribution List” to jwagner@dailyfx.com.

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05 July 2012 03:06 GMT