Foreign Exchange or Forex, for short, involves trading or buying and selling currency pairs. Foreign Exchange rates are determined by the Forex market, which is the world’s largest economic market with the highest liquidity. In other words, Forex is a decentralized, OTC (Over-the-Counter) market for currency trading.
Every day, on an average, 5 trillion USD is exchanged globally, which is the testament to the global reach of Foreign Exchange. Currency pairs are traded at all hours of the day, providing tremendous scope for making profitable trades. While this may be true, Forex also comes with its own set of risks. Nevertheless, with the trading strategy that works, one can certainly minimize the risk associated with Forex.
What are Strategies in Forex Trading?
Basically, Forex trading strategies are rules, analytics, and indicators, which are predominantly derived from technical analysis of the currency trading market. Forex traders may use these strategies to determine whether to buy and sell currency pairs for profitable trades at a given period. In other words, Forex trading strategies that work are the crux of lucrative trading in currency markets or Forex.
Strategies for Forex trading may be derived from charting tools, market analysis, market research, market news, etc. Some of the best strategies are aimed at minimizing the risk factors involved in Forex. Simply put, the application of the best Forex strategies is akin to effective risk management in Foreign Exchange. So, what are the risks in Forex? And, what does risk truly mean in Foreign Exchange?
What are the different risks involved in Forex?
Risk in Forex is the potential to lose money when trading in currencies. The different risks involved are as follows.
Market risk, which is the most common risk where the financial market’s performance would be completely different from what the trader expects. For example: If the trader believed that the USD would increase against EUR, but instead, it failed to cause a loss after the trader purchased the EUR/USD currency pair.
Leverage risk when investors trade using leverages that are larger than their deposit size, leaving scope for the trader to lose additional money other than their deposit. Interest rate risk is caused when the economy gets negatively impacted, which would, in turn, impact the rate of interest.
Liquidity risk, which depends on the liquidity of a particular currency along with the supply and demand of the said currency, may either result in a lucrative trade or huge loss, depending on the market trend.
The risk of ruin is yet another Forex risk where the trader does not possess sufficient funds for the execution of lucrative trades. So, what are the various risk management strategies in the FX market?
Risk Management Strategies
Effective risk management starts with outlining one’s risk profile. What kind of risk-taker are you? Aggressive, moderate, or conservative in your approach to risk-taking in Forex. Establishing your risk profile is of primary importance. Further, to limit the risks, having a thorough knowledge of the fundamental elements of the Forex market is vital. Apart from that, it is also important to gauge your trading capital to stay within limits. Also, regularly researching the markets enables traders to have reasonable expectations where returns on the trade are concerned.
Ultimately, it is your comfort that matters. If your gut feeling urges you to take the risk, go for it. However, when you are uncomfortable, skip the trade. And, always trade only what you are willing to lose or what you could afford to lose.
Are you only into Forex trading, if yes, diversify your financial portfolio for better risk management when you incur losses in Forex trading? If no, consider low-risk investments for financial portfolio diversification.
Stop Loss Trading Strategy
Although not specifically a trading strategy, setting a stop loss is critical even when you have developed a consistent trading strategy. Stop-loss involves assigning a closing price or limit on your trade. Once your trading position reaches the stop loss mark, the trade will automatically close. Rather than a Forex strategy, stop loss is more of a risk management strategy.
Beware of slippage
Stop-loss strategy may not always work in the trader’s favor, especially when the market faces erratic fluctuations. In such instances, the market will present price gaps, and as a result of which, the stop loss, though assigned remains inactive at the preassigned stop losses level. Nevertheless, the stop loss is activated when the levels reach the stop-loss mark next. This deviation from the stop loss application is referred to as slippage.
To overcome slippage, traders utilize to take profit along with stop loss. Take profit enables the closure of trade positions when they reach a predetermined level.
While these are some of the risks accompanying trading opportunities, other carefully crafted strategies that work will further efficient risk management.
How Strategies of Forex Trading Work?
Hypothetically, the proven strategies involved in trading Forex are the derivatives of technical analysis and trading fundamentals. Some of the key elements that play decisive roles in framing a winning trading strategy are the demand and supply, and liquidity of the currency pair, world-wide economic and political news, etc.
Some of the trading strategies Forex traders use could either be automated or manual wherein the case of the former, automated trading signals are generated based on technical analysis. Fundamental analysis is garnered from news, market updates, etc.
As Forex trading today has taken the shape of an OTC market for trading currency, generating trading strategies using sophisticated tools for technical analysis has also become convenient. Moreover, it is also possible to generate strategies for any kind of trading style, whether it is short or long-term trading opportunities. Similarly, fundamental analysis derived from news updates, market talks, expert advice, etc., are also effective sources of Forex market indicators.
What is the Best Strategy for Forex Trading?
Any trading strategies that work are the best Forex trading strategies. Strategies may vary for long and short-term trading. Accordingly, users can apply the right strategy for their preferred trading style or level of trading experience.
Forex Trading Strategies for Beginners
Before you start Forex trading, it is important to understand its fundamentals. While it is easier to get lured by the high rates of profits, one must always remember that Forex is a risky investment opportunity.
As beginners, you can acquire the complete knowledge, right from price movements to holding positions, when you start with a practice or a demo account. Most of the Forex brokers facilitate demo accounts for new traders where your capital remains untouched.
Practice is Key
One of the time-tested adages ‘Practice makes one perfect’ holds true where FX trading is considered. Especially for beginners, understanding the lay of the land before committing to investing huge sums of money is imperative.
Although a very basic and simple trade FOREX strategy, practice is the key, which will help you in the long run. Thus, choosing an online broker with free demo accounts is vital for novice traders. For, such practice accounts enable traders to test out various strategies, a myriad of time frames and trading styles. In other words, a demo account helps to derive a consistent strategic plan with an additional edge to minimize losses.
Choosing the Best Online Forex Broker
Yet another basic strategy involves choosing the right online Forex broker and Forex trading platform. Some of the key considerations here would include good customer support, provision of a demo account, a wide range of research and education tools, the number of currency pairs supported, good leverage ratio, etc. Some of the popular Forex brokers include Forex.com, eToro, IG, to name a few.
Analyzing the Trading Style and Different Time Frames
Broadly, investing in the Forex market is of two types: Long and short-term investments. The term or period the trader holds their position is referred to as the time frame, which may range from a few minutes to years. Different types of Forex trading are based on the various time frames, which are as follows;
- Forex Scalping
- Day Trading
- Position Trading
- Position Trading
Scalping involves holding one’s trading position for a few minutes only. The main objective of Forex scalping is to achieve a few pips of profitable trades before exiting whilst beating the bid/offer spread. Scalping is considered to be one of the most advanced Forex trading strategies for a very short-term basis. Scalpers typically make use of the low time frame charts and other indicators to gain small profits.
Day Trading, on the other hand, involves holding the trading position until the end of a trading day. Yet another type of short tenure trading opportunity, day trading, protects the traders from experiencing overnight market fluctuations and price drops.
Scalping and day trading are two of the ideal trading strategies for beginners. While the short time frame is one of the reasons, there are other advantages such as smaller pips and lower risks, among others.
Swing trading is a short-term trading opportunity that typically lasts for several days. It is similar to scalping; however, the objective is to make profitable trades from short-term price movements. Although a short-term investment, it is time-consuming as swing traders must vigilantly check the statistics every other hour to drive small profits. Nevertheless, users can try out this strategy in combination with scalping and day trading strategy for better risk management.
Position trading is a long-term investment opportunity where the tenure may last for a few months to years. We recommend positional trading for advanced or more experienced traders. Successful position traders have a good knowledge of trading fundamentals; also, they exude tremendous patience and discipline. Position trading is ideal for diversification of the financial portfolio.
Which Time frame is Best for Forex Trading?
One of the most common concerns faced by most of the Forex traders is deciding the ideal time frame for trading. Time frames are basically referred to for speculating the FX market, for both a short and long-term basis. While there is no standard time frame or one size fits them all as every trader has different trading styles and personal goals. Nevertheless, for minimizing risks, a trader can try a combination of different time frames and trading practices for better results.
Below are some of the examples of different time frames that are suitable for various trading styles like positional trading, scalping, etc.
Position Trading Time Frames
Positional trading time frames may either be short or long-termed as position trading lasts starting from a few days to months and years. Position trading time frames are considered to be ideal for advanced traders and long-term investors; this is because following positional trading time frames for the successful execution of trades on a short-term basis may be difficult as it takes longer to develop a trading strategy in Forex. On the other hand, long-term investors find positional trading time frames exceptionally useful for screening grading trends (monthly chart) and potential entry points (weekly chart.)
Time Frames for Swing Trading Strategy
Traders can make use of the swing trading time frames for both swing trading and scalping as the time frame bridges both short and long-term approaches. For the swing trading time frame to become a successful strategy, traders generally refer to the charts multiple times in a single trading day. This way, traders can save time as they do not have to monitor the charts continuously for determining the market trends. Also, when a trading opportunity is spotted on the chart, a trader can set a stop order while monitoring to follow the particular trade’s progress at a later stage.
Advanced Forex Strategies for Advanced Traders
Experienced Forex traders have the experience and skill levels to try certain complex Forex trading strategies listed below.
Price Action Trading
Also referred to as the blade runner trade, this proven strategy is suitable for all currency pairing and time frames. Typically, Price Action trading involves following or copying other trading professionals and successful investors. Central banks, financial institutions, among others, are examples of successful investors. Following such prominent investors is the key to lucrative trades. Apart from advanced traders, the intermediate traders can also implement this trading strategy, which applies to other complex trading instruments as well.
So, what are the price action indicators to look for? When price movements create new highs and lows, which are easy to detect and referred to as impulse is one such price action indicator.
Order Block and Order Flow Strategy
As an advanced trading strategy widely used by financial institutions and banks, it indicates market impulse. Basically, an order block is a settled area depicted by price, before the start of an impulsive momentum. Prominent investors like banks generally accumulate orders for setting a price movement. Identifying these footprints is easier for professional traders closely following the market.
Order flow is another indicator that refers to the continuity of the settled price determined by the preceding order block. Order blocks and order flows strategy is ideal for determining the trading entry and exit points. One may take advantage of order block and flow for executing successful trades.
Triangular arbitrage advanced trading strategy is usually employed by cross rate professional traders. This strategy is indicated by a set of consecutive transactions involving three different pairs of currencies. You can use the triangular arbitrage trading strategy for making locked-in profitable trades with a net flat position.
Trading Strategy for Locating Trading Signal Locations
Referred to as the 4-hour trading strategy, it involves following market trends on a 4-hour base chart to look for ideal trading signals. Here, traders use the 1-hour as the signal to determine the actual positions’ allocation. Readers are advised to note that the 4-hour time frame must be one hour lower than the base chart.
To implement the strategy, two sets of moving average lines would be chosen where one set would be the 34-period MA (moving average) while the other set would be the 55-period MA. The MA lines must be interpreted as price action to determine whether to trade during a particular trend or not. For example:
the following may be used as indicators,
a) 34-MA is above 55-MA
b) Both MA lines slope upwards
To determine a downtrend;
a) 34-MA is below 55-MA
b) Both MA lines slope downwards
Support and Resistance Trading Strategy
Rather than a strategy, support and resistance are concepts in Forex, which can be effectively implemented to minimize losses. Support occurs whenever there is a change in the price movement or when the falling prices stop and begin to fall. It is termed as ‘support’ as it holds up the prices. In contrast, resistance is when the rising price levels stop, change direction, and ultimately fall.
Support and resistance are not always exactly the same. And, most often, they only cover a small price range such that the level could be breached without having to break the level. In other words, support and resistance levels indicate the points where possible price change direction may take place.
Traders buy and sell the currency pairings when supports are in uptrends (for buying), and resistance is in downtrends (for selling.)
Other Proven Forex Trading Strategies
The main objective of trading is gaining pips. Below are some of the proven currency trading strategies, which can be used by both beginners and advanced traders.
Daily Fibonacci Pivot Forex Trading Strategy
Generally used for daily pivots, the Fibonacci Pivot trade strategy can also be utilized for longer time frames as well.
Overlapping Fibonacci Forex Trading Strategy
Although less reliable when compared to the Fibonacci pivot trade strategy, when combined with the confirming signals, they are very accurate.
Bollinger Bands Strategy
Especially ideal for a ranging market, however, it must be used alongside confirming signals for better results.
Carry Trade Strategy
Carry trade strategy enables the trader to take advantage of the differences in the interest rates paid for particular currencies. Here, the trader earns interest when they hold the particular currency for more than a day, but when the same currency is short, the trader will have to pay the interest charges. It is recommended to use the carry trade strategy for currencies with lower interest rates.
Important Elements that Support Trading Strategies
We have discussed strategies for all types of Foreign Exchange trading styles, time frames, skill levels, etc. Now let’s consider the certain core elements involved in trading opportunities, which in turn influence the trading strategies. The underlying elements determine the success rate of any given strategy, whether generated via algorithm analysis or fundamental analysis and these include;
Liquidity: The more liquid the trading asset, the more profit you earn. While Foreign Exchange is the most liquid market, it is essential to trade the most liquid currencies as well.
Volatility: Volatility determines the probable profit range. Similar to liquidity, volatility is directly proportional to both profits and losses. Meaning, greater the volatility, the trade may result in a greater loss or greater profit.
Volume: Also referred to as the average daily trading volume with regard to day trading, the volume is the measure of the number of times a particular asset was traded in a stipulated time. Typically, high volume indicates a significant rate of interest paid for the particular currency. Thus, an increase in volume depicts that a price jump either as an uptrend or a downtrend may soon be expected.
To summarize, not all strategies fare alike for different traders. Thus, the primary focus must involve determining the best Forex trading strategy that works for your style of trading. And, the million-dollar question? What is the secret to succeeding in Forex trading?
How do I Succeed in Forex Trading?
Currency trading market provides ample trading opportunities for earning profits, provided one implements the right Forex trading strategies. In fact, Forex trading strategies are the key to success in Foreign Exchange. While this may be true, acceptance is also crucial, where you must understand that there are chances for you to lose money.
Implementing discipline is a necessity that prevents you from over-trading, which in turn leads to losses due to high volumes and leverage. Trading is akin to gambling when you experience a profitable trade for the first time, painting the profit level will indirectly depend on the number of times you trade. Set a trading limit and attainable goals to avoid over-trading.
Dedication is yet another overlooked element where constant research is required alongside staying up to date with the market. All the information accumulated will help you create a suitable trading strategy, which you can implement when the time is right.
As a clear mindset is vital to make informed decisions, one has to set aside emotions like anxiety and excitement while trading.
Do you have a trading plan? If no, list out your personal goals, trading capital, etc. Once you have made this list, it is important to stay within the bounds of your trading plan.
Last but not least, choose an ideal trading broker and platform, which is highly regulated. Make sure the broker has advanced trading tools like stop loss. Most importantly, the platform must offer a better trading experience.
Forex trading comes with high risks and a greater potential for profits. The risk factor can be minimized with effective trading strategies, which are again of different kinds for different trading styles and time frames.
Analyzing which strategy works best for you is critical, which is achieved by a trial and error method. Most online brokers offer demo accounts to try and test out strategies before implementing them for real.