How to Find Profitable Trading Strategies?

Image by rawpixel.com on freepik

Trading strategy is a must-have for a trader, as it serves to enhance trading success and minimize the number of losing trades. For instance, when a trader engages in random trading, they may have a probability of 50% or even lower. However, by employing a trading strategy, a trader can increase their probability to 70% or even higher.

Of course, a profitable trading strategy has a higher winning rate compared to its losing rate. However, the winning and losing rates are also determined by the risk-to-reward ratio used. Therefore, when selecting a trading strategy, it is important to consider the risk-to-reward ratio employed in that strategy.

Here's an example: a trading strategy has a 60% probability. Simply put, using this strategy in 100 trades, you would win 60 of them and experience 40 losses. If this strategy employs a 2:1 risk-to-reward ratio, where the risk is twice as large as the reward, the actual probability of this method becomes 42%. This is because the total losses amount to 40 x 2 = 80, while the total wins amount to 60 x 1 = 60. Hence, (60 ÷ (80 60)) x 100 = 42%.

To find a profitable trading strategy, conducting a backtest is necessary. Backtesting involves testing a trading strategy on historical price data. It entails simulating trades on formed market charts and recording the outcomes to obtain statistical data regarding the performance of the simulated trading strategy.

The longer the backtesting period used, the more reliable the data generated through this process becomes. Therefore, it is recommended to conduct backtests using at least 5 years of historical price movement data.

Backtesting is actually a simple process, but many people are reluctant to do it. You can start by identifying common patterns such as chart patterns and candlestick patterns. Next, determine which currency pair and timeframe you will use for the backtest. Then, check if the pattern you want to backtest occurs frequently enough in the past year. If yes, you can begin simulating trades for a 5-year period.

For example, suppose you choose the engulfing pattern and want to test it on the EURUSD pair with a Daily timeframe. First, check if there are an adequate number of engulfing patterns that occurred within a one-year period.

Afterward, simulate the use of engulfing patterns in the historical price movement data from the past 5 years. Make sure to add entry points, stop loss (SL), and take profit (TP) levels to obtain comprehensive data regarding the performance of the engulfing pattern.

Don't forget to record each simulated trade, including the number of successful and failed transactions. By doing so, you will gain an understanding of the probability of that trading strategy by the end of the backtest.

Backtestable trading strategies are not limited to traditional patterns such as chart patterns or candlestick patterns. In fact, you can discover your own patterns and test them as well. You can also try using common patterns in different ways. For instance, if the engulfing pattern is commonly seen as a reversal pattern, you can experiment by conducting a backtest considering it as a continuation pattern. Perhaps, with a different approach, you might discover a trading strategy with a higher probability.

However, not all trading strategies can be backtested. Some trading strategies, particularly those based on technical indicator movements, often do not yield accurate results. This is because indicator movements depend on price movements, giving the illusion that indicators can accurately predict future price directions.

 #OPINIONLEADER#