A significant factor in the success of a new forex trading strategy is knowing whether it works or not. Limit the risk by testing it on forex demo accounts. A popular method for testing strategies before pulling the trigger and committing live funds to them is using a demo account.
The first step to designing an effective forex strategy is defining goals; why are you doing this? It determines how you will approach your test design, what data will be helpful, and ultimately how you measure success (or failure).
Regardless of personal preferences, there are general guidelines that can help streamline the development process and provide clarity on results:
- Go with what you know – If trading ideas come to you naturally, start with those. Work out their strengths and weaknesses early to avoid wasting real money/time.
- Set expectations – How much do you expect to make? What will happen if the strategy fails? Where is your threshold for success or failure, and what are the consequences of crossing it?
- Keep things simple – Start with a single trading idea. Test it over different time frames, using multiple indicators across those timeframes. It reduces the number of variables in play, making results easier to parse out.
Iron out how it will be executed
After laying out some ground rules for developing your strategy, ironing out specifics about how it will be executed can now begin. One of these specifics is where to run your tests.
Most brokers have demo accounts so their clients can test strategies before spending money on them; however, they may not have all the same tools available. The key to staying mobile while testing is using real-time data.
If you can’t get live data on your demo account, look for historical data that simulates the same behaviour (a rolling window of 15 minutes works well). As long as these two conditions are met, you should be able to test anywhere you have trading access (including a personal computer), even on a smartphone or tablet.
How to pinpoint weakness
Once strategy development begins in earnest, it becomes obvious where weaknesses reside and what needs to be done to fix them. There are no complex rules here; anything that gives an edge will improve results until it doesn’t anymore. Optimization methods like walk-forward analysis help refine strategies by making minor adjustments at set points in a test and evaluating their impact on results.
The result of these efforts is a strategy that can be confidently and accurately executed with real money. The best part about constructing and executing a forex trading strategy with a demo account is its flexibility; once you’re happy – copy your strategies over to the broker account you’ll be using and execute as live trades.
Just remember, no matter how good it looks now, there is no such thing as a perfect forex trading strategy. Stay flexible, keep testing, and never stop learning.
Four guiding principles
When analysing currency pairs for potential long-term investments, use four guiding principles: trend strength, volatility, value and momentum to determine whether or not to commit funds in any given market environment. Some of the world’s best traders prefer to use only two of the four, momentum and volatility; this is a reasonable approach as long as you keep in mind these are not mutually exclusive ideas.
As an analogy, consider watching television news for stock market updates. If CNN ran their financial segment as some forex traders do, they would show viewers data on just one or two securities per day – with no mention of what other stocks or indices are doing elsewhere throughout the world.
It would be an expected result if not given any context to judge it against other information. The same principle applies when analysing currency pairs without considering the broader picture.
Forex trading strategies will always have limitations due to unavoidable factors within the traded markets. Economic releases generate much of this noise because their impact is felt unevenly across each currency.
When a central bank announces a rate decision, it affects the pair they manage, while others may not be impacted. The more closely correlated a forex trading strategy is with one particular currency, the more difficult it becomes to navigate these market changes.