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Much has been said about having a trading strategy and sticking to the plan, but what exactly do you need to build a profitable one?
If you keep a detailed trading journal (and you should!), you probably have a good idea of which indicators and setups tend to work out in your favor.
This can be as simple as textbook break-and-retest plays, which involve a combination of Fibs, support and resistance, moving averages, and stochastic in a trending market.
Identifying building blocks like these not only makes your strategy potentially more profitable but also helps you maintain the discipline to trust and follow the plan.
1. Market Environment
Understanding the market environment is one of the most important considerations when taking trades. This is why it’s an essential building block for a profitable trading strategy.
Simply put, this means gauging whether asset prices are trending or range-bound. You want to be able to use the right kind of indicators and drawing tools appropriate for the current environment.
In a trending market, asset prices move in a particular direction for a prolonged period of time. During these cases, it makes sense to use the likes of moving averages, Fibs, and trend lines in your strategy.
In a range-bound market, asset prices typically bounce off strong support and resistance levels. A trading strategy that incorporates pivot points, Bollinger Bands, or oscillators could work out better in this case.
Note that a bunch of these technical indicators can be applicable for both trending and ranging markets depending on how you apply them, so it’s really crucial that you know what type of environment you’re trading in!
2. Momentum
Momentum is often associated with physics, referring to the product of the mass and velocity of an object. In trading, momentum looks at how quickly the price of an asset changes over a certain amount of time.
This can be determined either by using complex mathematical formulas in the form of technical indicators or by simply eyeballing price action.
For instance, a steeper and larger rally in the previous four hours compared to price action in the same amount of time in the past is said to have stronger bullish momentum.
Looking at momentum can help you predict the upcoming direction of price action and how quickly or slowly the move might happen. It can also help you gauge if a reversal or breakout from an inflection is bound to take place, as well as the speed of a potential correction within a trend.
3. Inflection Points
These generally refer to support and resistance levels that can guide you in setting entry and exit rules for your trading strategy.
Inflection points can comprise Fibonacci levels, pivot points, areas of interest based on historical price action or psychological numbers, dynamic levels based on technical indicators, or a combination of these.
4. Volume
Another important building block is volume, which tracks the level of market interest in a particular asset. Changes in volume can help identify the best times to enter trades and when to get out.
Volume is often shown as lines or bars underneath the main price chart. The more actively traded an asset is, the higher the volume will be.
Declining volume or shorter bars are typically observed during periods of consolidation while rising volume or longer bars generally accompany breakouts or sustained moves.
5. Timing
Lastly, timing looks into specific periods during which a security usually pulls back or consolidates from an earlier move. An example of this is during the end of trading sessions or overlaps for specific currency pairs.
In knowing these usual correction or consolidation periods, you can be able to time your entries well, catch better prices to buy or sell at, and avoid getting faked out by price spikes that aren’t likely to be sustained.
Of course, these building blocks aren’t set in stone, and you should be able to make some tweaks based on testing or new information that you think can improve your results.
