The goal of this story is to break down into four critical steps necessary to create your trading edge. During this post, I’ll give you some tips from my own experience of over twenty years trading on how to research, test, and trade your edge.
I have experience trading not just forex but also stocks and options as futures and cryptocurrencies. For a period I day traded futures, and among my long-term investments, I have a portfolio of residential rental properties.
The point is, it doesn’t matter what market you trade, or even whether you define yourself as a long-term investor or short-term scalper, you must have an edge. You should be able to explain what your edge is before putting any of your capital at risk.
As forex traders, we define our edge as something we have seen in the market. This event has repeated frequently enough for us to think we can develop a trading strategy around it.
Our edge becomes the advantage we have over other traders. So our trading edge will define what forex pairs to trade and how to trade them. How to trade them will include the entry, exit rules, rules that are triggered when volatility increases or decreases, rules that might trigger when something else unrelated to the instrument you’re trading occurs.
So, in building our forex trading edge, let’s look at the first step:
We have an idea or hunch, something we’ve seen, a hypothesis that we want to prove. Some real-world examples of hunches:
– The EURGBP cross tends to trend. If it increases or decreases by at least 1% in one day, in the two days that follow, price continues by a further 2% in the direction of the travel. – When the S&P500 increases or decreases in value, the USDJPY will typically move in the opposite direction.
– In the week that follows Black Friday, the USDJPY typically increases in value by at least 3%. – 11 am to 11.30 am GMT typically sees New York traders come online. If the EURUSD and GBPUSD crosses have been trending strongly that morning, the US traders will either validate or invalidate that trend. Therefore, if the trend is still structurally strong, i.e. there are no reversal signs on the price chart, we should be able to join the trend.