Learn how to trade forex using a solid trading strategy
The forex market operates virtually 24 hours a day and coupled with the massive trading volume and liquidity available around the clock, opportunities to profit from currency movements can be found at all times.
However, most retail forex traders have come to know that in order to remain profitable, you need to follow a plan – a proven trading strategy that also needs to be adjusted according to the market or the currency pair you are trading.
Forex trading strategies can be as simple or as complex as you would like them to be. After all, a strategy is simply an outline of the rules that will define when and if a trade is worth taking as well as when to enter and exit said trade.
Traders have found success in forex trading using several different strategies and while some focus on the macroeconomic side of the market and others on the price action and the patterns that arise therein, the most agreed upon rule is to follow the strategy that makes most sense to you.
What is forex
Before getting into what makes a trading strategy viable and what you should consider before choosing one, you should ensure that you understand the fundamentals of forex and why it’s worth taking the time to learn how to trade forex in the first place.
Forex trading takes place on a decentralized market with no single point of authority. A combined network of banks, financial institutions and market participants is what ultimately drives the market prices and absorbs all the trades that are placed.
The first thing you need to understand about currency trading in general is that currencies are traded in pairs. The exchange rate between two currencies is what actually matters, and this is the metric of how forex pairs are quoted in your trading platform.
If you want to trade the dollar because it’s looking strong enough to potentially increase in value, you first need to think about against which currency it’s going to rise against the most. However, since market participants are the ones who make up the market, you need to also take into account which currency pairs are most widely traded.
It’s a well-known fact that major currencies enjoy larger trading volume, higher daily movements and also offer the most competitive rates i.e. are cheaper to trade. Therefore, the major currency pairs which include the EUR/USD, GBP/USD etc. provide higher opportunities for profit.
As such, even if you think the U.S dollar will climb considerably against the currency of a developing economy – most of the time – it’s best to choose a more widely traded currency to take the opposite side of your trade. This is in order to take advantage of the higher trading volume and faster trade execution available in well-performing currencies.
What dictates the rise and fall between currency exchange rates?
While the market can only go either up or down, and you can speculate and profit in both rising and falling markets – it doesn’t mean that predicting its future direction is always that simple.
A currency’s appreciation or devaluation can be the outcome of multiple economic indicators and the overall market sentiment, but a single event can also prove to be similarly impactful.
Announcements from financial institutions and political events can have a positive or a negative effect on a currency’s performance because of how they affect supply and demand.
For example, a report with high unemployment numbers in the U.S will be damaging for the dollar since investors will lose faith in the economy and look to sell the currency for healthier ones.
On the other hand, positive news regarding the economy or the technology sector will have the opposite effect and investors will start buying the dollar in order to profit from its imminent valuation pushing its price even higher.
Finding a viable trading strategy
There are multiple proven forex trading strategies you can find ranging from simple technical analysis setups with support and resistance levels to a fundamental analysis of the global economy.
Most traders and especially the ones who are after short-term trades with similarly quick turnover, focus mainly on technical analysis and price action to make their predictions while fundamental analysis on a macroeconomic level is more useful for long-term traders who hold positions open for weeks or even months at a time.
It should be noted, however, that these two approaches aren’t mutually exclusive, and both these methods of analysis can have a part to play in a successful forex trading strategy.
At its core, a trading strategy consists of the following aspects:
- Tradable assets. You need to adapt your trading strategy according to the currency pair or other financial instrument you will be trading. Some traders trade multiple forex pairs or commodities while others prefer to trade only one instrument exclusively in order to become more fluent in its movements over time.
- Position sizing. Forex trading takes place in lots. One standard lot can amount to 100.000 units of a currency which is quite substantial and not exactly reasonable if you are a beginner just starting out. Therefore, its recommended that you start small with a micro or mini lot to minimize your exposure to the market and protect your account.
- Entry signals. This is the bread and butter of your strategy. Finding a consistent way to identify when it’s favorable to enter the market is a skill that takes time to hone and there are multiple ways you can approach to accomplish this. If you only trade a currency pair when it breaks out of a previously established high or low that’s completely viable.
- Risk management. Most successful traders will agree that risk management is what can make or break a trading strategy. You can have a talent for identifying and predicting trends and where the market will move next but if you aren’t able to close a trade before the market starts moving in the opposing direction, you will never be profitable. Take profit targets and an exit strategy i.e. a stop loss order should always be considered before entering a trade.
As already mentioned, your winning trading strategy may depend on the asset you are trading, the current market climate and how long you are comfortable with holding a position open.
Below is a list of different approaches which you can take into consideration before you formulate your own trading strategy.
A scalping forex strategy involves executing several quick trades which usually don’t last more than a few minutes or hours at most. The goal of trader taking this approach is to close the trade as soon as he achieves a marginable amount of profit.
While the profits of a single trade won’t be considerable, several winning trades can accumulate a substantial amount in a daily trading session. However, this trading strategy can be quite risky as well as stressful as you need to monitor the market for opportunities around the clock and ensure that most of you trades go according to plan.
While the aforementioned scalping strategy is quite popular among both beginner and experienced traders who use technical analysis indicators to plan their trades, day trading can prove to be much easier and more effective.
Day traders look to find a currency pair which is known to make considerable moves throughout the day in order to buy or sell accordingly. Trading this way alleviates the need to monitor your trades throughout the day as long as you have set a predetermined take profit limit in order to close the position while still profitable.
This trading strategy is best for patient traders who don’t mind waiting for days and sometimes weeks for their targets to be hit.
Technical analysis is still the preferred approach here but keeping note of important economic indicators is highly recommended.
A positional trading strategy is exclusively for long-term fundamental traders who enjoy identifying a market trend that will keep developing over weeks or even months. There are several variables to consider when taking such a long-term approach especially since you need to be correct in your predictions for both the currencies in the pair.
This strategy is best followed by experienced traders that have a deep understanding of the market as well as the global economic forces and they interact with each other.