I believe there are a lot of methods to evaluate and select potentially profitable trades.
All methods are divided into fundamental and technical analysis (also applying math).
Fundamental and Technical analysis provide different approaches to analyze financial markets but a main goal is still the same.
It is to be profitable and earn money.
A great debate which type of analysis is better is always a hot topic among traders.
While many traders prefer fundamental analysis and other technical, it is important to state that it is better to use both of them.
If somebody still struggles with trading methods, this article may be of great use.
If there is a debate what is better, just skip it. Take advantages from both methods and do not forget “KISS” which is “keep it simple stupid”.
I wouldn’t like to compare different approaches but instead I would like to show the way of a profitable thinking that is applicable for all trades.
Let’s create a few rules that will help us to create a trading method.
1. It should be as simple as possible. Do not mix different technical indicators with fundamental data.
Technical indicators are derivatives from the market data. Therefore market price is first to take into account.
Get rid of indicators if possible. Overcomplicated process is counterproductive.
2. Define the amount of return. 10% p.a. is a good one to start with. Prove your system firstly whether it is profitable or not by trading small lots and setting your annual target at reasonable level.
3. Define what trend is and follow it. Define your target.
4. Make your own risk calculations and develop Stop Loss technique.
5. Open additional positions to follow trend, pyramiding when previous trade is profitable.
6. A few trades per year are enough to successful trading. Daytrading is usually harmful for a single trader because it takes time, and you will be tired soon enough.
7. Discipline and patience required most of the time. Actually, this is very important to stay calm and close positions as soon as something goes wrong.
What I would like to point out is that chart reading seems to be a scientific approach. Many different configurations on charts seem to repeat over and over again. But technical analysis is not scientific. It provides you many defined shapes such as head and shoulders, triangles, line trends, moving averages showing resistance and support levels. So why not take advantages of technical analysis and apply these shapes to the market? By using these shapes on a daily basis, many traders trying to find as many opportunities as possible mistakenly thinking if there are a lot of recognizable shapes then there is additional possibility to earn extra money! What they really miss is that they will make many trades which leads to losing control over the trading system and self confidence. Better to find the best trade among a set of potential profitable shapes and profit as soon as the trend advances in your direction averaging along the trend. This is what I call pyramiding. If the trend stops and reverts, just take your profits or exit by executing stop losses. Do not panic or hope for the better situation.
Here is an example that shows both positive and negative sides. Let’s take a recent rally of GBP/JPY pair.
It can be seen from a technical point of view, there is a triangle with steady increasing prices along the red line below the triangle.
Someone pushes up the price! Riskless trade! A good sign!
The beginning of the triangle is 5 Aug 2013 with the end in the middle of November.
Another red line above the triangle shows the resistance level.
We just simply found a good technical shape and can predict the price when the resistance line is broken. I marked a target point with a second green line (right one) showing how it was calculated. This is written in many books. So I did as it is written to keep it simple.
Now it is time to wait and not to trade. Why do I need to make trades if I do not know exactly what will happen?
May be the price will go up, may be down.
The first starting point is
1. Here we clearly see, the resistance is broken. Let’s open a single trade and set stop loss near 158. Sometimes price reverts back to the average. If so, we close the position indicating our loss. Instead, the price went up. Our second target is
2. Here we have profit from the first trade and let’s open the second. The same logic we follow at the third point, at 164.40, because it is still 150 pips to the target 166.50. When price accelerates, it actually can reach 168-169 zone until it goes down.
Taking all these into account, here are virtuall trades showing the final result.
Of cause, I did some mistakes. First of all, I didn’t open positions as I wrote.
Instead of smoothing risk along the trade I opened trades around the second point, at 161.90 – 162.10.
The second and usuall mistake is a rate of return. The initial account was $500 000. The return from GBP/JPY trades is $204 829 or nearly 41% per month.
This is due to FX leverage which simply brings additional risk of big losses.
Therefore, it would be better to trade the way discribed above (small lots) instead of making fortune and betting around 161.90 – 162.10 levels.
Imagine what could be if the price declined!
After GBP/JPY advanced to 169, some fundamental news came to the market explaining the reason of the uptrend.
Well, this time I used only technical analysis but when trading stocks it is a big advantage to know fundamental data.