Submitted by Cesar Zambrano of forexfraud.com
Disclaimer: The author’s views are entirely his or her own and may not reflect the views of innerfx.com
We all know the industry legend that 95% of traders lose money. As a new trader, that means you have less than a 5% chance of succeeding in this business. Of course, these statistics are not necessarily cemented via scientific statistical research, but be assured that the probability of success as a professional trader is not high. Therefore, one of the best studies a person can do when entering into the field of professional trading is to identify why most traders lose.
Basically, there are three primary reasons that a trader loses money.
- Bad risk management
- Bad strategy
- Bad execution of strategy
Although there are a multitude of other reasons that traders fail including psychology, undercapitalization, etc, these three reasons are paramount. The reality is that if a trader can master 1, 2, and 3, he will definitely improve his chances of trading successfully. Many articles and focus is put upon risk management, so we will not focus on that element of the trading skill set; instead, in this article, we are going to discuss strategy and execution of strategy.
In order to trade successfully, it goes without saying that a trader must have a strategy that is historically reliable. Good historical results can never be indicative of future results, but bad historical results can almost assure you that future good results are not possible. Thus, as you find a trading strategy that suits your trading personality, it is imperative that you backtest this strategy in one of two ways to determine whether the strategy yields positive expectancy, meaning it would have made money in the past.
The first way to backtest your strategy is to reduce the strategy to very specific step-by-step procedures. Once the system is deduced to steps, have a programmer code the strategy for you. Then, apply the code to historical charts using demo forex software such as MT4 or Tradestation. Running the code on a demo account will tell you how the strategy would have performed over many years of historical data.
If your strategy is highly discretionary, meaning that it is very difficult to deduce the steps into specific steps that can be coded, then you need to test the strategy manually. This means you need to spend hours and hours scrolling through historical price charts and finding set-ups. Look at each set-up and see how the strategy would have worked out. Was it a winner or loser? How many pips of drawdown, and how much profit, etc etc.
The purpose of this exercise is two-fold. First of all, it will give you invaluable confidence in your strategy. When you see how your approach performs in various market conditions, it will give you much needed confidence to execute the strategy in real-time. Second of all, it will help you to fine-tune the strategy. As you backtest, you will discover specific market conditions that cause the strategy to underperform. What causes a losing streak? Perhaps the strategy does not perform well during times of high volatility as measured by ATR, or perhaps it does not perform well during a rangebound or trending market. Doing this exercise will help you determine when exactly your strategy performs best in a forex account, and then you can weed out potential losing trades before you even take them.
Once you spend sufficient time backtesting your strategy, then your focus should be on forward testing. Forward testing is demo testing the strategy under real-time market conditions. Then, when you feel that there is sufficient data supporting the strategy you can begin trading it real-time, but never stop analyzing your strategy. Every trade you take should be meticulously analyzed in order to determine why the trade worked out or why it did not. Approaching your strategy with this type of investigative attitude will surely help you develop into a professional trader.
