Formulating a Forex Strategy Using The Alignment of Indicators
In today forex faq, we have a trader who ask about some indicators and how it can help him with the trading.
Below is the question:
I’ve used the macd and slows, and rsi, if all are trending down or up. The direction is OK for only for a few minutes. How do we determine a solid direction. Long direction, preferably the British pound and the joy. I would like to master that currency.
From your question, I guess that you are referring to the alignment of MACD, Stochastic and RSI all pointing to a particular direction of trade which is what I often call Confluence of Events. In case some of you do not know what I am saying, below is a picture that I have taken
That sounds like formulating a strategy but you need to have something more than that to make it works and able to make a profits from it.
What you are doing now is what I call formulating your own strategy. You must first do a back testing for at least several months.
For example, you decided to enter a trade when the RSI is overbought, MACD is doing a bearish crossover and Stochastic is overbought. You should then do a back testing by scrolling back the chart to at least 4 months ago and start to record down how many losses and wins you will get based on that entry.
You should also record down the max profits and drawdown per trade so that you can set your stop loss and target profits. From those records, you will then choose one with the best entry point and target profit.
However if you ask me whether it works or not, I will say that you probably need something more than this. You will need a way to validate a trade setup which means that you will not be entering all the trades when these 3 indicators are aligned. This validation will be able to help you filter out some losing trades so that you can get more winning trades in the end.
Do note that it is impossible to win 100% of the time, even when this strategy make some losses, it is normal. It is up to you to slowly fine tune the indicators and optimize your entry to get a better outcome.
Personally I will suggest that you incorporate support and resistance into the strategy. For example, you can enter a trade when these 3 indicators are aligned plus it has hit a major support or resistance level. This will greatly increased your chance of winning compared to just entering based on these 3 indicators alone.
I can’t tell you for sure whether this strategy that you are trying to formulate work or not as I did not do a back test on it. However I believe that you need to do some fine tuning to the indicators to give you a better entry as compared to the default setting of these 3 indicators.
Lastly, where you place the stop loss and target profits is a very important decision as a tight stop loss will stop you out frequently and a loose stop loss will cause you a big loss every time you had a losing trade.
Therefore choosing where to place your stop loss and target profits is very important. I will also suggest that you decide on a level where you will shift your stop loss to breakeven so that your account is being protected.
All these have to come from the back testing records and analysis. You can’t just use the back testing data of one month as it is not sufficient. You need to have at least 4 months of data to be able to give a conclusion.
I hope that I have answered your question and do feel free to email me again if you have any doubt.