Highest profits are realized only when the best forex trading strategies are employed by the forex traders. There are many time tested forex strategies that can be used by serious traders. Whereas some of them are based on the effect of the current political and economic scenarios of a country, some others rely on charts and numbers that are based on past performances of the forex market. All the strategies that are explained briefly in this article have different levels of complexity. It is also important to note that whatever may be the strategy that the forex trader wants to apply, the best effects occur only when the trader has sufficient knowledge and experience in the field. This article aims to familiarize the readers with a few well-known forex trading strategies.
Major Forex Trading Strategies
The main categories of forex strategies used by traders include: Fundamental Strategies, Technical Strategies and Popular Strategies. Fundamental forex trading strategies are dependent on the fundamental economic indicators of a nation and other political events that happen in a nation. Technical forex trading strategies rely on the statistical and mathematical models of the currency prices and the analysis thereof. Popular trading strategies are always a combination of the fundamental and technical analyses.
Fundamental Analysis Based Forex Trading Strategies
Forex traders evaluate currencies and the countries much like how equities and companies are evaluated to get a clear idea of the currency’s value. The value of a currency changes due to many factors such as economic growth of the nation and its financial strength. All this information is analyzed by the forex traders to evaluate the value of its currency. Fundamental trading strategies cannot be easily mastered by a newbie forex trader. Given below are some trading methods that use fundamental analysis.
Method #1: Trading the news
This method is all about analyzing important news happenings on different fronts in a nation and understanding the implications that they will have on the currency market. The trader will then place the trades accordingly. The market moves in an unpredictable manner when there are sudden political or economic happenings in any nation. As the forex market operates round the clock, news flows in from all parts of the world. Trading on the basis of economic news and data suits all kinds of traders wherever they are and whichever currency they choose to trade.
Method #2: Trading market sentiment
This forex trading strategy takes advantage of the momentum of the market that is currently prevalent. Any market sentiment is a sum total of all the traders’ prevalent sentiments. This ultimately results in the forex market moving in a specific direction. Market sentiment is a very important aspect and traders should learn to read or feel the same in order to successfully trade currencies. Sometimes it is easy to understand the sentiment, but some other it may not be very obvious.
Method #3: Market Volatility
The forex market is a very volatile market. When the market is volatile, traders get lessons on how to hedge, develop and acquire broad/diverse portfolios, and act on low leverage to exploit the prevailing market condition. There are two different types of volatility. They are historical and implied volatility. The former refers to the normal price action with respect to a period of time (say, a month or year). Abnormal current and future price action is referred to as implied volatility. It often exceeds the historical range when compared with the historical price action.
Method #4: Arbitrage
Arbitrage is based on the premise of the forex trader trying to make a gain from small differences (of the currency) that exist either in the same or different markets. This is primarily a form of speculation. Identifying the right conditions and employing this strategy is not an easy task. Arbitrage strategy best market participants who have best technology systems and have quickest access to information. Arbitrage is best employed when the same currency has two different prices.
Method #5: Interest rates
Any nation’s central bank, adjusts the rates of interest from time to time in order to contain or curb the inflationary trends. This, in turn, has a definitive effect on the currency market and traders assume trading positions accordingly. The central bank of a country does not act as it is a solid body. The interest rate is increased or decreased based on the vote cast by the members of the monetary policy committee. The number of members monetary committee varies from one bank to another. If the interest rate is cut, there will be more money in circulation. This makes it cheaper. If the interest rate is hiked, its value increases.
#6: Carry Trade
The forex trading strategy Carry Trade is different from other forex strategies. While most of the Forex trading strategies follow the concept “buy low/sell high”, Carry Trade relies mainly on the difference in interest rate between the currencies. This means that forex traders can make profit even if the market is stable. When employing this strategy, traders buy a currency with a high differential ratio, meaning the interest rate of the currency they buy will be higher than that of the currency they sell.
#7: Fair Value
Fair Value strategy made use of in various financial markets. In the forex market, the fair value of a currency is determined based on the economic situation in a country. In order to use this forex strategy, traders must have an understanding about a few basic related to the economy, especially the GDP growth of the two economies whose currencies they plan to buy and sell. Other aspects to be considered include the unemployment rate and the inflation data.
Technical Analysis Based Forex Trading Strategies
Some of the other best forex trading strategies are based on the technical analysis. This method is particularly important in day trading. Technical analysis is useful to traders in that it gives them an indication of times when they can enter or exit the market. It also helps the trader to make the most out of the existing market status. Given below are brief explanations of some of the technical analysis based trading strategies.
#1: Fibonacci Indicator
This strategy is employed by forex traders as a long-term plan to make the trades profitable. The indicator mainly uses the ‘Pullback’ and the ‘Trend’, both of which are fundamental in nature. In order to have a complete understanding as to how this strategy works, traders must be familiar with the more fundamental concept called ‘the trend’. It is very difficult to explain each individual price change and determine a pattern as there will be many of them. Traders need to look at the bigger picture in order to see trends. The three key Fibonacci numbers that traders should always remember are 0.382, 0.5, and 0.618. They should also keep in mind 0.764 and 0.236.
Related : How to Use Fibonacci Retracement Tool
#2: Horizontal Levels
These are indicators that help the trader to analyze charts and can be used by itself or as a helping tool in other strategies. Traders can make successful traders just by watching the price changes that are very obvious to them and drawing their horizontal levels. However, a better understanding of the horizontal levels in more complex charts helps them to spot trends that they would have otherwise missed.
Divergence is a tool that helps the traders to learn the price behavior of the currency. This analysis generates patterns that will help to predict the direction of movement of the currency rates. Divergence, a leading indicator, helps traders to significantly increase their profits. This is because the likelihood of trading in the right direction and at the right time increases if this indicator is used along with others such as Moving Averages, Stochastics, RSI, Support and Resistance levels, etc.
This method is mostly put to use by the retail investors. This tool works well in both volatile and the not-so-volatile market conditions. However, candlesticks work optimally when used with other tools. They do not reveal past price action details.
#5: Wedges and Triangles
Currency pair prices generally do not follow a straight-line path when moving up or down. They usually consolidate before breaking out into the next surge or dip when moving up or down. A wedge or triangle is formed during these consolidation periods. This effect is very visible when a chart is viewed using smaller time-frame boundaries.
#6: Head and Shoulders
To really master the candlestick charts, traders have to learn about some of the common patterns. The pattern ‘Head and Shoulders’ is one of the most recognizable and tradable chart patterns. The Head is the higher peak and Shoulders are the two lower ones. This patterns becomes relevant when the support (neckline) is broken.
In Forex trading, hedging is a commonly used strategy to limit risk. Traders choose two currency pairs that are positively correlated (such as EUR/USD and GBP/USD or AUD/USD and NZD/USD) and then take opposite directions on both of them. Hedging helps to reduce the risk of loss during uncertain times.
#8: Elliot wave
The ‘Elliot Wave Theory’, named after Ralph Elliot, is one of the oldest forex strategies. He analyzed the stock price data for around 70 years and found out that human psychology (emotions, fear and greed) drove the market and that it moved iteratively. This is to say that the market switches between optimistic and pessimistic modes. In this strategy, the motive phase unfurls in 5 steps.
Popular Forex Trading Strategies
Some popular forex trading strategies are explained briefly in the paragraphs below.
#1: Multiple Time Frames
As suggested by the name, this method involves tracking the price of a currency pair over many time frames. This action helps to fix high and low points which subsequently help to work out a price trend that the currency rates are following. The changes and patterns are not discernible if viewed over a single time frame.
Scalping is a method that can help a trader to make a lot of money in a short span of time. This is a technique used in intraday trading and involves opening and closing positions quickly one after the other. The method demands a lot of attention and alertness on the part of the trader to make successful trades.
Related : Best Forex Brokers for Scalping
#3: Support and Resistance Levels
The upper end that marks the end of a bullish run is called the ‘resistance’ level and the corresponding lower end of a bearish trend is referred to as ‘support’ level. However, these do not last for very long periods. However, the talent of a trader lies in being able to identify these levels just before the next break.
#4: Trend Trading
Trading currencies following the existing market trend is the safest way to maximize profits. The most important aspect in trend trading is to be able to identify the topmost or the bottom points.
#5: Moving Averages Trading
This indicator can be easily placed on a chart. The moving averages strategy involves waiting for the price of the currency to get close to this level on the chart. When the price nears this level, the trader can decide to buy or sell the currency pair.
#6: Bladerunner Trade
This is an exceptionally good strategy and works across all timeframes and for all currency pairs. This trending strategy picks breakouts from a continuation so as to help traders trade the retests. Candlesticks, pivot points, support and resistance levels and round numbers can be used when employing this strategy. Off-chart indicators are not necessary.
#7: Bolly Band Bounce Trade
This strategy is best suited for a ranging market. Many traders make use of this strategy to great effect by combining it with confirming signals.
#8: Dual Stochastic Trade
The Dual Stochastic Trade makes use of two stochastics: slow and fast. The two stochastics are used in combination to pick spots where price is trending, but is overextended in short term retracements and are about to snap back into the continuing trend.
#9: Pop ‘n’ Stop Trade
Traders who have chased the price as it bounces upward and have often suffered losses because of a sudden reversal would want to keep this strategy in their minds when trading currencies. By employing this simple strategy, they can determine whether the price will continue in the breakout direction or not. This helps them to increase their profits or reduce losses.