Why Having An Effective Forex Trading Strategy Is Important
Participating in forex trading presents an opportunity to be part of a global market with significant profit potential. Due to its popularity with day traders , forex has even gained a reputation for quick profits.
In fact, it is as complex and competitive as any other world market. In order not only to be successful, but also to be consistently successful, you need to understand the market and improve your trading strategy.
There are several ways to trade in forex, so it is important to choose an approach that is appropriate to your level of experience, your goals and the context in question. Below, we describe the basics, benefits and drawbacks of nine most popular forex strategies to help you find your ideal shape.
Trading News
As a multinational market, the forex is influenced by global economic events. Understanding economic news events and their potential impact on currency pairs helps traders anticipate market movements or short-term breakouts (intraday or multi-day).
Major (scheduled) news events include:
► Interest rate decisions
► Economic reports on national unemployment rates, inflation rates, gross domestic product (GDP), non-agricultural payroll and national trade balances
► Consumer and business trust surveys
No event is inherently more important than the other. Instead of focusing on one variable, traders examine the relationship between them in conjunction with current market conditions.
It is important to note that forex, like any other global trading market, can be influenced by unscheduled and unique events, such as natural disasters or political changes. These unexpected events, however, are not reliable indicators to be used in a news trading strategy.
Used tools
News traders rely on economic calendars and indices, such as the consumer confidence index (CCI), to anticipate when a change will occur and in which direction the price will move. With that in mind, they will look for a price action to consolidate, which usually indicates that an escape is imminent.
Pros and cons
Trading small breakouts that occur over a short period of time has high potential for profit. Of course, it also carries a greater risk. When the price is consolidated, volatility increases. If you enter a trade too soon, you risk being forced to exit the trade (and suffer a loss) if the leak does not occur immediately or is not sustained.
Getting in early is part of the game, but arriving too early can be unwise. More experienced traders will often wait for confirmation of the leak before acting on a hunch.
Scalping
Scalping is an intraday trading strategy in which traders buy and sell a currency in order to reduce the profits from each transaction. In forex, scalping strategies are usually based on a continuous analysis of price movements and spread knowledge.
When a scalper buys a currency at the current selling price, it does so under the assumption that the price will rise enough to cover the spread and allow it to generate a small profit. For this strategy to be effective, however, they must wait for the offer price to rise above the initial selling price – and invert the currency before the price fluctuates again.
Used tools
As scalpers rely heavily on dissemination, it is important that they have a good relationship with market makers (market makers) who bid and ask for prices for a particular currency. Scalpers will often perform professional trading accounts with brokers to access smaller spreads. Its success also depends on the use of a low-latency platform capable of performing multiple operations at once with speed and accuracy.
To determine the position to be taken, scalpers use technical analysis and pattern recognition software to confirm the direction and timing of the trend, locate deviations and divergences and identify buy and sell signals in the target period. Like other traders of the day, they can also track economic events that are likely to impact short-term price movements.
Pros and cons
If you’re doing a handful of trading a day, earning a few pips per trade can quickly add a substantial sum. But dealing with such a large volume of business also comes with its own challenges.
For any trader, managing more than one trade adds complexity to the process. In such a volatile and fast market, the stakes are amplified. Succeeding as a hot day at work requires unwavering concentration, firm nerves and impeccable timing. If a trader is hesitant to buy or sell, he may lose his (already limited) profit window and decrease his resources.
Day Trading
Day traders earn their title by focusing exclusively on intraday price movements and capitalising on the volatility that occurs in them. These small fluctuations in the market are related to current levels of supply and demand, not to fundamental market conditions.
Used tools
The traders day use a variety of short-term trading strategies. Some exchange news (using calendars and economic indices) and change their focus based on global economic events.
Others may be scalpers who trade the same asset day by day and analyse intraday price movements using technical analysis (such as fast and slow moving averages). If they understand the general direction in which the market is trending on a given day, they can follow the trend and get out of all their positions before the market closes.
Pros and cons
When you analyse price movements in such a short period of time, more false signals are displayed due to the small sample size and the limited context. Identifying a false signal and confirming the validity of your analysis can be tricky – especially when time is of the essence.
For these reasons, day trading usually requires more experience and familiarity with the market. To be successful, day traders must also practice effective money management and be ready to respond quickly if the price moves against them.
Swing Trading
Swing trading is a trend monitoring strategy that aims to capitalise on short-term fluctuations in price momentum. These minor outbreaks and drops may go against the direction of the prevailing trend and thus require a more limited market outlook (by examining 15-minute, hourly, daily and weekly price charts, rather than analysing general market trends) .
As the swing trade requires fast action and close market supervision, it is usually favoured by traders who are available to monitor changes in the moment of the minute-by-minute price. Despite being classified as a short-term trading strategy, this approach requires traders to hold their position overnight (unlike day trading) and can keep them in one trade for a few weeks at a time.
Used tools
This strategy is based on technical and fundamental forms of analysis. On the technical side, traders use momentum indicators and moving averages to analyse price movements over several days. Fundamentally, swing traders often use micro and macroeconomic indicators to help determine the value of an asset.
Pros and cons
Swing trading anticipates rapid price movements across a wide price range – two factors that suggest high profit potential. But greater potential profits naturally come with greater risk. The price momentum can change quickly and without notice, so swing professionals should be prepared to react immediately when the moment changes.
To mitigate the risks of holding your position overnight, swing traders often limit the size of your position. Although a smaller position size decreases their profit margin, it ends up protecting them from suffering substantial losses.
Trading Position
Position trading is a strategy in which traders maintain their position over a long period of time – from a few weeks to a few years. As a long-term trading strategy, this approach requires traders to have a macro view of the market and to sustain minor market fluctuations that offset their position.
Used tools
Position traders typically use a trend-tracking strategy. They rely on analytical data (usually slow moving averages) to identify trend markets and determine optimal entry and exit points. They also conduct a fundamental analysis to identify micro and macroeconomic conditions that can influence the market and the value of the asset in question.
Pros and cons
The success or failure of position trading depends on the trader’s understanding of the market in question and his ability to manage risks. In order to block profits at regular intervals (and therefore mitigate potential losses), some position traders choose to use an objective trading strategy.
Interval Trading
Interval trading is based on the concept of support and resistance. On a price action chart, support and resistance levels can be identified as the highest and lowest point that the price reaches before reversing in the opposite direction. Together, these support and resistance levels create a trading interval between brackets.
In a trend market, the price will continue to break previous levels of resistance (forming higher highs in an uptrend or lower lows in an downtrend), creating a ladder-like pattern of support and resistance. In a comprehensive market, however, the price moves in a lateral pattern and remains within the established limits of support and resistance.
When the price reaches the overbought (resistance) level, traders anticipate a reversal in the opposite direction and sell. Likewise, when the price approaches the oversold (support) level, it is considered a buy signal.
Finally, if the price breaks through this established range, it could be a sign that a new trend is about to take shape. Traders are less interested in anticipating breakouts (which normally occur in trend markets) and more interested in markets that fluctuate between support and resistance levels, with no trends in one direction for an extended period.
Used tools
Interval traders use support and resistance levels to determine when to enter and exit trades and what positions to take. To do this, they often use momentum indicators with bands, such as the stochastic oscillator and RSI, to identify overbought and oversold conditions.
Pros and cons
Operating the falls and outbreaks of various markets can be a consistent and rewarding strategy. As investors are trying to capitalise on the current trend instead of forecasting it, there is also a less inherent risk.
That said, time is exceptionally important. Often, an asset will remain overbought or oversold for an extended period before reverting to the opposite side. To bear less risk, traders must wait to enter a new position until the price reversal can be confirmed.
Trading Trends
Trading Trends, or Trend Trading , is one of the most reliable and simple forex strategies. As the name suggests, this type of strategy involves trading in the direction of the current price trend.
To do this effectively, traders must first identify the direction, duration and strength of the overall trend. All of these factors will tell you how strong the current trend is and when the market can be prepared for a reversal.
In a Trend Trading , the trader does not need to know exactly the direction or date of the reversal; they simply need to know when to leave their current position to guarantee profits and limit losses.
Even when a market is trending, there are small price fluctuations that go against the direction of the prevailing trend. For this reason, Trend Trading favors a long-term approach known as position trading.
When investing in the direction of a strong trend, a trader must be prepared to bear small losses, with the knowledge that his profits will eventually outweigh the losses as long as the general trend is sustained.
For obvious reasons, trend traders favor trend markets or those that fluctuate between overbought and oversold thresholds with relative predictability.
Used tools
To determine the direction and strength of the current trend, traders generally rely on simple moving averages and exponential moving averages, such as the convergence / divergence of the moving average (MACD) and the average directional index (ADX).
All moving averages are lagging indicators that use past price movements to give context to current market conditions. In addition to providing information about the direction and strength of the current trend, moving averages can also be used to measure support and resistance levels.
When the price does not reach the expected support and resistance levels, or when a long-term moving average crosses a short-term moving average, it is believed to signal a reversal. Instead of anticipating the direction of the reversal and entering a new position, trend traders will use these signals to move out of their current position. Once the new trend manifests, the trader will trade again in the direction of the current trend.
Price momentum will change many times before a price change occurs, so momentum indicators, such as the stochastic oscillator and the relative resistance index (RSI), can also be used to help identify exit points. These indicators help traders to identify when the price is approaching overbought or oversold levels and provide information on when a change will occur.
Pros and cons
Trading Trends or Trend Trading does not require traders to know what will happen next, but to understand what is happening now. As such, it tends to be a more reliable and consistent strategy.
In order to operate effectively, however, it is important to confirm the direction and strength of a new trend before entering a position. Although you are not the first to enter the market, being patient will ultimately protect you from unnecessary risks.
Grid Trading
Grid trading is a breakout trading technique that tries to capitalise on a new trend as it takes shape. Unlike other breakout trading strategies, however, grid trading eliminates the need to know which direction the trend will take.
In a grid trading strategy , traders create a network of stop orders above and below the current price. This order grid essentially ensures that, no matter which direction the price moves, a corresponding order will be triggered.
Used tools
Before placing buy and sell orders, traders will first identify support and resistance levels, and will use this bracket range as a guide to set up orders at standard intervals. Support and resistance levels can be calculated using technical analysis or estimated by drawing trend lines on a price graph to connect price peaks (resistance level) and coupons (support level).
As grid trading does not require insight into the direction of the leak, orders can be placed ahead of time. In general, grid operators will outline their strategy after the market closes and prepare orders for the next day in advance.
Pros and cons
The most obvious advantage of this strategy is that you don’t need to know what direction the market is going to take, and you don’t have to stick to the computer to profit.
Even though grid trading does not require immediate action, it still requires careful supervision. If your profit-making values are not triggered immediately after a position is opened (that is, the trend reverses or stagnates before continuing in the same direction), this can leave you vulnerable to losses.
In addition to the risk, traders must also manage the costs inherent in holding multiple open positions. After the trend manifests, it is important to close pending orders in the opposite direction so as not to compile interest on unprofitable positions.
Retraction Trading
A setback refers to an instance when the price reverses the direction for a short period of time before continuing in the direction of the dominant trend. Traders use technical analysis to identify potential retracements and distinguish them from reversals (cases where the price changes direction, but does not correct, forming a new trend).
If the trader expects a temporary dip or a price increase to be a setback, they may decide to maintain their current position on the assumption that the prevailing trend will eventually continue. On the other hand, if they expect the market fluctuation to be an early sign of a reversal, they may choose to move out of their current position and enter a new one, according to the trend reversal.
Used tools
To distinguish between retracements and reversals, many traders will use a form of technical analysis called Fibonacci retracements (based on the Fibonacci ratio). This principle states that a setback will end when the price reaches a maximum Fibonacci index of 61.8%.
For this reason, many traders use this 61.8% ratio to make profit or stop loss orders. Pictured traders who intend to profit from breaking the trend will also use the Fibonacci indices of 38.2% and 50% as entry points and / or profit.
Pros and cons
Although the use of Fibonacci retracements can help you determine when to enter and exit a trade, and what position to take, they should never be used in isolation. The most successful retracement traders confirm the signs of breakout and reversal using other technical indicators, such as moving averages, trend lines, dynamics oscillators and price candlestick patterns.
The importance of maintaining a consistent strategy
Each strategy detailed above has unique advantages and pitfalls. As you choose the strategy to follow, it is important to take into account experience and circumstances. If you are just starting out in forex trading, day-trading strategies that require quick action and require you to manage multiple tradings at a time, may not be ideal learning environments.
Instead, choose a more direct and long-term strategy (such as trading trends) that will give you the time to learn technical analysis, practice smart money management and reflect on your performance. Not every strategy is ideal for all traders.
In the same vein, not every strategy is suitable for all markets. Some strategies work best in trend markets, while others are more effective in changing or volatile conditions. Take some time to understand the market you are dealing with and determine which strategies are best suited to these conditions.
Finally, remember that all operators – no matter how experienced – experience losses. When you lose money on an operation, it doesn’t necessarily mean that you did something wrong or that your approach was flawed.
While technical analysis can help you manage risk, reward and inform your trading decisions, no analysis can predict the future with 100% certainty. Instead of abandoning your strategy every time the market moves against you, practice smart money management and be consistent.
The more time you devote to learning and practicing a particular strategy, the more adept you will become at executing it. Being methodical in your approach will also give you a better understanding of what is working and what is not. If you change your strategy too often or add unnecessary complexity, it will be more difficult to identify which factors are influencing your performance.
When in doubt, stick to the basics, and operate with a tendency to keep the odds on your side.