Forex Order Block Strategy for Beginners
To be successful in forex trading requires a trading strategy – something you can execute in the markets time and time again. Repeat this style of trade for many months or years, and you will see positive returns in the market due to having an edge. As simple as that sounds, creating a forex trading strategy is not easy or simple. This also rings true when looking at forex order block trading.
In this article, we are going to create an order block trading strategy for you to back test, tweak and test, with the aim of providing a solid foundation to build a profitable strategy upon and obtain prop firm funding. Let’s get into it…
Creating A Forex Order Block Trading Strategy
When creating a forex trading strategy, the most important aspect to consider is making it as objective as possible. It’s easy to bring hindsight into the equation when back testing and looking at the markets. However, this won’t help you in a real market trading situation. Therefore, it’s incredibly important to eliminate as much human decision-making as possible and make the strategy very easy to follow. By doing this, human error will be reduced or completely avoided, and you’ll have an objective trading system that could be done by a robot. So, let’s build a foundation for the trading plan to be built upon…
Creating A Trading Strategy
Firstly, a trading plan or strategy should be documented. There’s very little point in even aiming to create a trading plan if you’re going to leave it sitting in your head. Humans, sadly, are very open to influence, bias and frankly forgetting the plan. By storing this strategy in a document, even a physical printed document, you have a standard operating procedure to follow. This will enable better decision-making, faster decision-making, and back testable results with no elements of luck or gambling involved. Not only that, by removing all the human decision-making, there is a lot less stress placed on the trader. You don’t need to be thinking or trying to understand the market completely (which is impossible), you just need to read the plan, match that to the current market situation and execute the trade, as told.
Identifying Forex Order Blocks
Identifying forex order blocks can be challenging at first, as we (retail traders) do not have access to real order flow numbers. This means that traders have to use candlestick formations and market movement to assume the formation of order blocks. However, once you have an eye for doing so, you will be able to identify order blocks with a high degree of accuracy. Order blocks, in their simplest form, are just areas of price where orders have been building up. This will typically look like “Rally, base (consolidation), rally” in the price movement, or vice versa. You will never truly know if there is a large number of orders at that price point, until the price reacts (or doesn’t) upon return. I would highly recommend familiarising yourself with a huge amount of order block content on YouTube, until the point where you can start finding these on your own. Once done, you want to perfect that skill by spending many hours on the charts.
Over time, you’re going to notice that certain styles of order blocks have stronger win rates and price movements than others – this will be amended in your trading plan.
Multi Time Frame Analysis For Entry Points
We’ve established that the first stage in the trading plan is to find an order block, without that, there is not a need to be looking at any price movements within the markets. If we have an established order block, we can move onto the next step of the trading plan – multi time frame analysis. We don’t want to just enter a trade on an order block with no further analysis because we don’t know for sure that there are any orders there. We would just be gambling on a hunch. Instead, wait for the price to reject the order block – then start looking for entries.
In this situation, we can clearly see that price has rejected the order block that we had identified on the 1H timeframe – great!
However, there was no real price action movement on the 1H timeframe, meaning we need to use other time frames to help build our entries. Firstly, looking on the 4H timeframe, price was in a long-standing bearish trend. This bearish trend on the higher time frame would help build a picture for the trade. I would recommend adding a ‘higher time frame confluence’ into your trading plan. Moving down onto the 15-Minute timeframe for an entry point, we can identify a support level (previous resistance), holding nicely. The break of this support would indicate to us that price is rejecting the order block in a very strong fashion, and we need to be looking at taking a trade to the downside.
This should be added to your trading plan. Your trading plan should now be something like this –
- Identify valid order block.
- Identify higher time frame confluence.
- Identify lower time frame entry point using price action analysis.
If you can also find an economic confluence too, that would be great here!
Risk Management Criteria
Now it’s time to enter the trade, and you must be considering all aspects of risk management. Many forex traders are looking to get prop firm funding, so it’ll be important to understand the rules of engagement with your chosen prop firm. In these criteria, you need to clearly define your fixed stop loss value in percentages, your maximum open exposure and maximum daily trades. For those traders serious about becoming funded traders, I would recommend using less than 1% per trade, having only 2 trades open at any one time and having no limit on daily trades opened, provided the other 2 criteria are fulfilled.
You should also have rules implemented for situations where high-impact news is going to affect the currency pairs you’re trading that day. For example, staying out of all positions on NFP day could be a good idea.
Regardless of what you decide to implement in terms of risk management, your main goal should always be to stay alive in the market or in this case, stay funded. Always play on the side of caution, and this should help to keep you much safer in the markets.
Once your risk management criteria have been identified and solidified in your trading plan, you need to think about all the management criteria of the trade. Ideally, you won’t be wanting to net a 1:1 risk to reward ratio in a trade. That would mean that whenever you risked £10, you profited £10 or lost the £10. The issue with this is the fact that your edge in the forex market will always be fairly small, so you need a good risk to reward ratio to be able to make consistent profits. With that in mind, a fairly standard industry practice is to take at least a 1:2 risk to reward out of the market. However, some traders like to ignore the target risk to reward and just find an area of price they think the market will move.
So, you need to consider either…
- Taking a fixed take profit based on risk to reward
- Taking profit based upon market movement
Both of these are completely valid ways to trade, depending on what your back testing shows you to be more profitable over the long term. Once you’ve decided that, you need to also consider when you should be moving to breakeven or if you’re going to move your stop loss to breakeven at all during a trade.
An Example Trading Plan
So, now if we compile all of our steps so far, we should have a skeleton trading plan to start our back testing. It’ll look something like this…
- Identify order block
- Identify higher time frame confluence
- Identify lower time frame entry point using price action
- Confirm fundamental analysis if possible
- Enter the trade with 0.25% risk, stop loss on the last high/low.
- Set a fixed take profit at 0.5% profit on account balance.
- Move the stop loss to breakeven once profit reaches 1:1 risk to reward.
- Extra condition – Do not trade during high-impact US news events.
- Extra condition – Do not trade on Fridays.
- Extra condition – Do not trade outside of London trading hours.
Next Steps – Back testing A Forex Trading Strategy
This is, of course, a very high-level initial trading strategy and isn’t ready for the live markets. Why? Because it has not been tested. Although a lot of the logic appears to be sound, that will not be enough when real trading capital is on the line. At this point, you need to start back testing the trading strategy and logging all trades in a spreadsheet. Look at all relevant data points, including:
- Time taken
- If you moved SL to breakeven at 1:1(for example) risk to reward, what was the outcome
- Entry criteria
- Duration of trade
- News during the trade
All of these data points will be crucial in helping fine tune the strategy. This can be done hundreds of times and various tweaks should be made to the trading plan until you are as profitable as possible, with the least amount of risk. In an ideal world, your trading plan should be so defined by this point that you could actually pay a freelance developer to code this into an EA. If that is possible, you’ll be able to back test thousands of trades in minutes and make a huge number of tweaks until you find that sweet spot.
In Conclusion – How To Create A Forex Order Block Trading Strategy
In summary, this is how you create a forex trading strategy for order blocks. This isn’t a finished strategy that is ready for live market trading, but it’s ready to be back tested and will give you a solid foundation to build on.