How to Use the Scientific Method in Forex Trading

There are many things in life that you don't mind leaving up to chance. Your forex trading is not one of them. 

Forex trading depends heavily on making trading decisions based on current trends, researched information, and taking notes. Mathematics and quick calculations added to a solid strategy.

In order to maximize your potential returns on your forex trading, there is a scientific method that should be included - if not the backbone - in your strategy. 

One of the critical factors in success in trading is that emotional responses are removed and replaced with critical thinking. 

Determining what is accurate and factual, the likely outcome and why it is happening. 

(Photo : Photo by Scott Graham on Unsplash)

What is the Scientific Method?

The scientific method is the process used to explore and prove (or disapprove) a theory. 

Using several steps to achieve an objective: asking questions, making predictions, testing the hypothesis, and reaching an outcome. 

So how can you apply the scientific method to forex trading?

Observation

Before you take any action, you need to have a technical and fundamental understanding of the markets you are trading in. 

Pay attention to how economic events impact the movement of currencies and what the outcome is. 

It is not enough to look at these and make assumptions about what will happen - that goes against the process. 

Instead, you will make detailed notes in a journal and use these as the basis for data-driven decisions in your future trades.

It is also good to mark significant events on a wall calendar to highlight patterns and trends. Go back over several years to get a broader view of the trends. 

Visual aids help, but computer software can be employed too.

Historic Data

Having access to historical data can make it easier to highlight common trends that persist through the years. 

Look at visual charts, base data, unexpected events, price action, and compare with any of your trading records. 

Questions

During your observations, you are likely to come across some questions. Almost all discoveries will start when you ask questions. 

Why did X economic event impact Y currency? 

What global even changed X trend?

Hypothesis

Once you have collated all of the data you are going to use, you should notice some patterns and trends in the data. 

Creating comparison charts with clear visuals can help to uncover differences in pricing, actions and any unexpected patterns.

If you notice any patterns or events, it is wise to research what caused that reaction - using old news articles and research papers. Build a complete picture of the situation - not just the changes themselves.

Again, your trade journal is an invaluable tool for this. Keep note of everything that you notice until you are ready to test your hypothesis. 

Be conscious that it is not only the main event but the price action in the lead-up, the event itself, and what happened afterward. 

Your hypothesis is the theory on how things are going to happen. Your background research and observations will support the idea. 

Testing 

While it might be tempting to test your hypothesis out at soon as possible, you should look for the right moments. 

Choosing the optimal moments to test your hypothesis will accurately represent your observations and potential outcome. 

An accurate test means that your hypothesis is tested under similar or almost identical conditions as the first events. 

You will likely need to test multiple times with numerous experiments and conditions. 

Trade experiments will need to happen several times to see if the predicted outcome was a lucky guess or a fact-based theory. 

As you run various experiments, the outcome is a vital part of your research. Note down all of the details of transactions, time stops, price stops, and anything unexpected. 

Analyzing

After running the experiments several times, you will have a fresh set of data to work with. You will see if the outcomes support your hypothesis or if you missed the mark. 

It is essential to highlight any variations in the hypothesis and the outcome - no matter how small. 

Moving Forward

The trading markets can be volatile, and what is true for several years can change in an instant. It can be difficult to factor in the dynamic nature of the trading market beyond a certain point. 

While variables can add valuable dimensions to your scientific trading method, it is essential to keep an open mind. 

Adjust where required, this will be a critical factor in completing your research to the best of your ability. 

New market patterns can arise and impact your hypothesis and strategy at any point. 

Accepting, processing, and incorporating new data as it arises will give you a better foundation for your next set of hypotheses and future trading. 

Reporting

Once you have tested out your hypothesis multiple times and refined the process, it is time to create a report with the findings. 

Writing a report not only means that you give others access to the work, but it can help you refine the process for the next time. 

Sharing data and findings also open up the study to input from others and help produce a higher quality of work. 

You can also choose to keep your research under wraps. Filing away the work so that you can create a larger body of work - or give yourself a competitive edge. 

Next Actions

Use your research to create a trading system that works on a tested hypothesis will likely increase your potential returns. 

Using your new method, you can adjust your risk management and give more dimension to your trading. 

Fine-tuning your theories with a scientific method will mean that you never make trades based on hunches. Instead, you will be making scientifically sound trading decisions with the research and findings to back it up. 

Trading is based on numbers and patterns - with the proper research, you can use both new and historical data to make predictions that pump up your bottom line.