What is a trading strategy and how to apply it?

Introduction to the concept of trading strategy and its role in trading

A trading strategy is a set of rules and principles that a trader uses to make decisions about buying or selling financial instruments. The strategy determines what assets a trader will trade, when to open and close trades, and how to manage risks.

Making a strategy is an important element of trading, as this way a trader systematizes his approach to the market, risk management and makes informed decisions based on analysis. It helps the trader to remain disciplined and consistent - and without this, successful trading is impossible.
The goal of a trading strategy is to increase the number of successful profitable trades and minimize possible losses.

To make a trading strategy, you need to answer at least a few questions:

• What will I trade? - You should identify and select certain types of assets and markets that you will trade. There are no restrictions on the choice.
• Where will I trade? - You should identify the venues on which you will trade. If you have decided that the list of what you trade includes both crypto and forex, for example, then here you write down the platforms where you can open positions on these types of assets.
• How will I trade? - is the most interesting question that requires detailed consideration.

Key aspects of the trading strategy

"How will I trade?" - let's return to this question. A trading strategy consists of criteria for opening a trade, prescribed conditions for closing a position, a money management system and risk control methods.
Entry criteria set the moment of opening a trade, for example, when the price reaches a certain level. Exit rules determine when a position should be closed. Predetermined Take Profit levels can also be set.

Capital Management

The purpose of the capital management system is to maximize profits, minimize losses and determine the optimal ratio between potential profit and risk.
At the heart of a money management system is first and foremost the ability to adjust position size. How can the position size be calculated? There are the following methods of position calculation:

• Fixed position size: the trader sets a constant position size that does not change regardless of the market situation. An example would be buying 100 shares in each trade or investing $1,000 in each trade.
• Percentage of Portfolio: A fixed percentage of the total portfolio value is used to determine the position size, for example 5% of the portfolio for each trade.
• Percentage of free capital: a fixed percentage of the available free capital is used for position sizing, e.g. 10% of the free capital in the portfolio.
• Regarding the rank of the trade idea: ideas are ranked by the probability of success, and a larger position size is used for ideas with a higher rank.
• Regarding risk size: the position size is calculated based on the level of risk the trader is willing to accept.
• Regarding the volatility of the asset: the position size takes into account the current volatility of the asset and is calculated based on the number of pips that the price can change over a certain period of time.
• Splitting the entry into parts (ladder entry): the total position size is divided into parts and bought at predetermined levels.

The money management system also pays attention to take profit calculation in trades, presenting two main approaches:

• Fixed take profit: in this case, a constant level of profit is used for each position, usually calculated relative to the size of the set stop loss. This method provides a stable approach to profit taking in each trade.
• Dynamic Take Profit: The take profit level changes depending on the current market condition and current conditions. This method allows for greater flexibility in responding to changes in market dynamics, adapting to variable conditions and increasing the potential for maximum profit.

It is important to realize that not all types are professional and effective.

Risk Controls

A risk control system is a set of rules that assesses initial risks when entering a trade, manages risks while holding a position, and mitigates risks when there are triggers to exit a position.

How to manage risks?

To do this, stop orders should be used.

Stop loss (or stop order) is a price level at which a position is automatically closed to minimize possible losses.
There are two main types of stop losses:

• Fixed stop loss: determined in advance in percentages or monetary units for each position. It implies using the same level of risk for all trades, for example, 1% of the deposit per trade.
• Floating stop-loss: the size of the stop-loss changes according to specific market conditions, volatility level and other factors. This type of stop loss provides flexibility, allowing you to adapt your risk level to the current market conditions.

The use of stop-losses is mandatory, because only with the help of this tool you will secure your deposit from large losses or complete liquidation (in case of using cross-margin, for example).

Another important aspect in risk management is diversification - a strategy aimed at reducing risks by spreading investments between different asset classes and markets. This helps to smooth out the impact of unfavorable changes in one asset type.
Some traders, especially beginners, believe that the main reason for all losses in the market is leverage, but in fact it has nothing to do with it, because with proper risk management, even 125x leverage will not negatively affect your deposit. You can read more about it in our material.

Multicomposition of a trading strategy

A trading strategy can be thought of as a house, where psychology and discipline are the foundation on which the whole strategy is built. It should include logging and statistics, a list of tools for analysis, a trading plan, money management rules, a trading system and risk management aspects.

Keeping a log and statistics in a trading strategy is very important as it allows the trader to track his results. Keeping a log of trades allows a trader to track his results such as profits, losses, frequency of trades, etc. This helps the trader understand how effective their strategy is, what times they are doing better ( for example, during the London session or maybe when the NY opens ), and where changes need to be made. In addition, keeping a log allows you to identify the mistakes a trader makes. This information can be used to avoid these mistakes in the future. Every professional trader keeps such a journal, where he records the details of his trades, analyzes the results achieved, highlights strengths and weaknesses. You can find an example of a trading strategy of one of our traders here.

Types of trading strategies

Trading strategies are divided by several criteria: by trading style, by market condition, by method of analysis.

By trading style:

• Scalping is a trading style in which traders try to make a small profit on each trade by making a large number of trades throughout the day. Scalping is usually used on short-term timeframes such as the minute or 5-minute chart.
• Intraday trading is a style of trading in which traders attempt to profit from changes in the price of an asset within a single trading day. Intraday trading is usually used on longer time frames such as an hourly or 2-hour chart.
• Swing trading is a style of trading in which traders attempt to profit from movements in the price of an asset over several days or weeks. Swing trading is usually used on longer time frames such as a daily or weekly chart.
• Position trading is a style of trading in which traders attempt to profit from large movements in the price of an asset over a period of several months. Position trading is usually used on longer time frames such as weekly, monthly or even yearly charts.

According to the method of analysis: some people use Smart Money strategy, some use Price Action, some are adherents of techanalysis, and some trade only on the basis of fundamental analysis. These are all different trading methods, but as a rule, professional traders prefer to use a certain "mix" of these methods, making the most suitable one for themselves.

By market condition:

• Trend trading is a style of trading in which traders attempt to trade in the direction of an existing trend. Trend trading is usually used on time frames that are in line with the trend.
• Corrective trading is a style of trading in which traders attempt to trade in the direction of a correction of an existing trend. Corrective trading is usually used on time frames that are shorter than the trending period.
• Range trading is a style of trading in which traders attempt to trade within a price range (sideways, range) in which the asset is moving. Range trading is usually used on time frames that correspond to a range of prices.
• News trading is a style of trading in which traders attempt to trade on news that may affect the price of an asset. News trading is usually used on short time frames such as a minute or 5-minute chart.

Many traders have several trading strategies that differ depending on which market is to be traded.

Effectiveness of the trading strategy

Generally, the effectiveness of a trading strategy is determined using some basic methods:

1. PROFIT/LOSS RATIO (Profit Factor): this ratio is a key indicator of a trading strategy's effectiveness, measuring the ratio of total profits from successful trades to total losses from losing trades. Profit/Loss Ratio gives an indication of how successfully a trader is using his capital. The ratio is calculated using the formula: Profit/Loss Ratio = Total Profit / Total Loss. For example, if the total profit is $20,000 and the total loss is $10,000, the Profit/Loss Ratio would be 2. This means that every dollar invested in the trade generated two dollars of profit.
2. RISK/REWARD RATIO: This indicator expresses the ratio of expected profit to risk in each trade. It is calculated as the ratio of expected loss to expected profit: Risk/Reward Ratio = Expected Loss / Expected Profit. For example, if a trader is ready to lose $1,000, expecting a profit of $3,000, the Risk/Reward Ratio will be 1/3. This means that for every dollar the trader risks, he expects to make three dollars in profit.
3. WIN RATE - is a metric that reflects the success of a trading strategy and predicts the probability of future successes. It is calculated by dividing the number of winning trades by the total number of trades executed: Win Rate = Number of winning trades / Total number of trades. For example, if a trader made 100 trades, of which 60 were successful and 40 were unprofitable, the Win Rate will be: Win Rate: 60/100 = 0.6 or 60%. In addition, the Win/Loss Ratio is sometimes used, which expresses the ratio of the number of winning trades to the number of losing trades. In the above example, the Win/Loss Ratio = 60/40 = 1.5. When the Win/Loss Ratio exceeds 1, it indicates that the trader has more successful trades, which is usually considered successful, especially if the average profit from a successful trade exceeds the average loss from a losing trade.

Let's consider these ways of evaluating the effectiveness of a trading strategy on a real example.
Let's imagine that:

• starting amount of assets: $10000
• total assets: $30200
• total profit: $20200
• total losses: $7050
• number of profitable trades: 202
• number of losing trades: 93
• total number of deals: 295
• within one deal the expected loss was 1% of the initial capital, i.e. $100, and the expected profit was conditional 1%, $300.

Let's apply the PROFIT/LOSS RATIO (Profit Factor) method:
Profit/Loss Ratio = Total Profit / Total Loss. Profit/Loss Ratio = $20200/$7050 = 2.86.
Every $1 invested in trading brought $2.86.

Let's move on to the RISK/REWARD RATIO method:
Risk/Reward Ratio = Expected Loss / Expected Profit. Risk/Reward Ratio per trade = $100/$300 = ⅓.

WIN RATE method:
Win Rate = Number of winning trades / Total number of trades. Win Rate = 202/295 = 0.68 = 68%.
This means that 68% percent of the trader's trades were successful.
Win/Loss Ratio = 93/295 = 0.31 = 31% of trades were unsuccessful.

How to check the effectiveness of a trading strategy before it is prescribed?

Once your strategy is formulated, it is time to test it. There are several ways to do this:

• Testing on historical data (backtest): Evaluate the performance of the strategy over a long enough time horizon to see if it performs well in different market conditions. The essence of a backtest is to find similar situations in which you would enter a trade according to your strategy and check on historical data how it would work. You should analyze more than one situation to get objective results.
• Paper trading: Try to apply the strategy on a demo account or in "paper trading" mode. This will allow you to test the strategy in real time without risking your finances. However, it will be much better to use the next option as the demo account does not allow you to fully test yourself in market conditions.
• Testing in the real market with minimal volumes: enter trades on your strategy, but do it on a small deposit. This will allow you to connect the psychology factor and finally make sure of the effectiveness of the strategy and its suitability for you.

Advantages and disadvantages of trading strategies

A trading strategy is a set of rules and principles that a trader uses to make decisions about buying or selling an asset. There are a number of advantages to having a trading strategy:

• Increased trading efficiency. A trading strategy helps a trader make informed decisions realistically based on market analysis. This can lead to improved trading efficiency and increased profits.
• Risk reduction. A trading strategy helps a trader control risk, which in turn reduces the likelihood of large losses.
• Increased discipline. A trading strategy helps the trader to stick to his plan and not make impulsive trades. This definitely affects the trading results in the long run.

Are there any disadvantages to trading strategies?

Only that even the top strategy that works today does not guarantee you success tomorrow. That is, over time and depending on market conditions, a trading strategy definitely needs to be adjusted if you want it to work, of course. It requires constant refinement and revision in case the number of losing trades has increased and the number of profitable trades has decreased. In addition, a backtest should be conducted not only when you are testing a new strategy, but also when you are already working on it in order to make sure that it is effective.

Trading without a strategy: why not?

Blind trading is an approach to trading based on intuition and emotions. In this type of trading, a trader does not use any rules or principles, but simply makes decisions based on his "market feeling". It is this type of trading that turns working in the markets into gambling. Blind trading can be very profitable at one moment: you can get into a trade without a stop and get 1000$ in one trade, but if you get into a trade on the same principle tomorrow, you can lose your entire deposit. That is why it is so important to make a trading strategy and follow it while working on the markets.

Example of trading strategy

Let's consider an example of a trading strategy template. This trading strategy is used in intraday trading.

These rules and principles are fundamental to successful trading. They help to make more informed decisions, reduce risks and increase trading efficiency.
The set of rules and principles may differ for each trader, but it should be clearly structured. It is very important to write down your list honestly to yourself so that it is realistic to follow these principles.

In the trading strategy, as it was written earlier, it is necessary to specify the list of trading pairs that are interesting to the trader, as well as timeframes and favorable time for trading. In addition, it is also important to describe the risk management, which is suitable for a particular trader based on his capital and goals.

This trading strategy information is detailed and structured. It gives the trader a clear idea of how he or she will trade.
Because the trading plan is clearly structured and the trader adheres to it every day, randomness and uncertainty are eliminated. Regular backtests after many trades are important to ensure that winrate remains positive. The trading plan pays special attention to the risk to return (RR) ratio, where a good trade can cover losses in many losing trades.

Entry rules are strict to avoid exposure to market noise.
Position size calculation ensures that the risk per trade is constant and fixed, adhering to the algorithm in all trades.
The advantage built into the trading strategy requires psychological resilience to fluctuations that can affect the balance sheet. Short-term losses should not have a psychological impact.

The strategy also clearly outlines the criteria for entering a trade and the list of instruments used on different timeframes.

Remember that this is just an example that you can customize for yourself. If, based on statistics, you find that you do better trading on certain days or trading sessions than others, feel free to add this point to your trading strategy as it directly affects your success in the markets.

Link to our trading strategy template: https: //thirsty-tuck-7c1.notion.site/9845c5e7120b4810a1d4a44f90aca5f9.

The importance of trading strategies: the CRYPTOLOGY team's opinion

The importance of having a trading strategy cannot be overemphasized. It is probably the main factor that separates professionals from amateurs. Trading without a well-defined strategy turns into a game of chance, where decisions are made on the basis of emotions or intuition.

In addition, working according to a trading strategy makes a trader's life much easier, because having a predetermined plan - a clear instruction - gives an idea of when and under what conditions a trade should be opened or closed. A key aspect of any trading strategy is risk management. A strategy allows you to identify potential losses in advance and limit them to an acceptable level. This means that a trader always knows the maximum loss he or she can incur on each trade and can prepare for that outcome. A trading strategy also helps in maintaining emotional stability, as the trader feels more confident and in control by following a proven plan.

However, it is important to remember that a strategy is not just a set of random rules and cannot be made up in 5 minutes. Each point from your strategy must be tested on multiple market situations. In addition, a trader should be prepared that sometimes the strategy has to be modernized and adjusted to certain market changes, otherwise it will feel like driving in winter on summer tires.

However, if you are having difficulties with your trading strategy or do not understand why a strategy is not working, our mentors are ready to help you solve this problem in our practical workshop.