Many elements go into choosing the best currency trading strategies, with the trader’s disposition, amount of time devoted to trading, and trading capital the beginning considerations. Currency trading goes on around the clock. That provides many day trading opportunities, even for a part-time trader. One can also trade successfully using a daily time frame rather than an hourly time frame — or even a three-minute time frame. Generally, the larger the time frame, the more trading capital is needed.
Currency trading strategies divide into two types. One is a purely mechanical system, while the other lets judgment or pattern recognition be the largest aspect of the strategy. The latter systems are called “discretionary systems.” Mechanical systems can be purchased or built if the trader has computer skills. Discretionary systems require a lot of training time for the trader.
Volatility changes and price breakouts are two popular approaches to mechanical systems. The advantage to a mechanical system is that it is unemotional and will never be sick, tired, or stressed. The disadvantages include having long losing streaks that require a lot of capital, both monetary and emotional. Mechanical systems are typically not adaptable to changing conditions.
Learning to trade a discretionary system is a bit like learning to play a musical instrument: Mastery takes time and practice. Discretionary systems often have higher winning percentages, at least on paper. Under the stress of trading, a trader is much more likely to make a poor trading decision than is a computer.
The best currency trading strategies are those with a combination of the highest trader’s edge and the lowest minimum capital requirements. Actual evaluation of currency trading strategies requires that the trader generate some trading data and do some simple arithmetic. The data the trader needs to generate are: the percentage of wins (%W), the average win (AvgW), the average loss (AvgL) and the largest loss. The trader’s “edge” equals %W*AvgW – (1-%W)*AvgL. The term for that equation is “mathematical expectation.”
If the trader’s edge is negative, he will go broke using that currency trading strategy. The size of the edge matters. It is hard to make money if your edge is $1 per trade, unless you are trading many times an hour. Even then, if something goes wrong, you could give back all your earnings in one unexpected loss.
The largest loss is important because it tells the trader the minimum amount of capital needed. That minimum is found by multiplying (1-%W) by itself several times — count the times — until the result is 0.01 (1%) or less. The minimum amount of capital is the largest loss multiplied by the number of times (1-%W) must be multiplied by itself to get to 1 percent or less.
The calculations might look something like this: 270 wins out of 500 trades for %W = 0.54 (54%). The average win might be $75, the average loss might be $60 and the largest loss might be $75. The trader’s edge — the mathematical expectation — would be 0.54*75 - 0.46*60 or $12.90 per trade. The absolute minimum amount of capital needed would be $450. The calculation is: 0.46*0.46*0.46*0.46*0.46*0.46 = 0.0095, which is less than or equal to .01); 0.46 multiplied by itself six times (0.46^6) means at least 6 times the largest loss, or $450.