Forex Trading Strategies

Before you can delve into the world of Forex trading, you need to understand that this is a business. Perhaps the most competitive business on the face of the earth.

Even an undergraduate business student can tell you that before you should start any business, you should have a business plan and understand if you have a competitive advantage in the industry. Your business plan should include a detailed strategy that outlines that competitive advantage and explains you can leverage it to maintain sustained profitability.

Similarly, when trading Forex, you should have a forex trading strategy that outlines every single aspect of your day to day operations and gives you a clear understanding of what provides you with the edge to beat the market at its own game. Basically, a trading strategy is a plan you developed to get a positive rate of return from your invested capital. Your Forex Trading Strategies should be properly researched so that you can be certain that the results you expect from it is verifiable and quantifiable. Also, your trading strategy should give you a good idea about its objective consistency.

The problem is if you ask ten different veteran traders about what the best Forex trading strategies is, you will likely get ten different answers - if not more. A quick Google search for best strategies would reveal about 33,800,000 results and if you keep looking for the best strategy to trade, you will likely never find it.

However, don't lose hope as we will tell you a secret.

The secret: you should not waste time trying to find the best forex trading strategies at all!

On the contrary, in the midst of millions of different ways to trade the market, you should try to discover your true north, and invest the time to know yourself first.

Knowing Yourself is Key to Finding the Best Forex Trading Strategies

Before you get to know about what forex technical analysis is, how you can conduct fundamental analysis, or what are the best forex trading strategies, and how you can manage your money, first, you need to figure out what type of trader you are.

Psychologically, are you a patient person? Can you wait to get the fruits of your labor or are you conditioned to instantly reap the benefits of your hard work? Are you comfortable contemplating about something for a long time and take measured actions or do you need to act compulsively and feel busy otherwise you will not be satisfied with your perceived level of productivity?

Then, you need to know how strong your pain threshold is. Can you lose 10 trades in a row and still have the confidence in your trading system to deliver profits in the long run? Or would you simply give up after a few losses and go look for a new strategy that would have a high win rate?

Having answered these deeply personal and subjective questions will not only help you understand what type of trader you should be. Furthermore, it will help you develop your own trading style and pick the best forex trading strategies that suit your personality.

You see, there are only two ways to make money in any financial market - buy low and sell high or sell high and buy it back low. Especially, in a zero-sum market like the Forex market. In a nutshell, a zero-sum market is where your profit will come from an outcome where someone else must lose their capital.

So, knowing how often you want to buy low or sell high, how much you are willing to risk per trade, how long you want to hold on to your positions and what is your average profit targets will make or break your trading strategy.

Before we move into the details about how you can pick the right forex trading strategy for you, let's discuss what actually is a trading strategy and what are some of the mainstream strategies you should know about. Then, we will look into how different money management aspects such as account size and position size can make or break such strategies.

Different Types of Trading Strategies Based on Your Level of Patience

Most articles you read online about Forex trading talk about technical analysis and how fundamental analysis are separate things. The thing is, most proprietary traders do not distinguish themselves as a technical trader, who only read charts or someone who only analyze macroeconomic data and rely on fundamental analysis. Most profitable traders know that it is important to get the market sentiment or the overall direction of the market by analyzing like interest rates, unemployment rate, inflation situation, and other macroeconomic indicators or qualitative data like interpreting what the Chairman of the Federal Reserve have said last night in a Gala event.

However, almost all traders are comfortable labeling themselves to use these five following trading strategies based on their level of patience and availability of time to trade the market:

#1 - Find Out If Forex Scalping Strategies are the Best Forex Trading Strategies for You

Scalping a trading strategy where you try to take advantage of short-term trading opportunities. Scalpers mainly rely on technical analysis try to find profitable trades with minor price changes. Scalpers often trade on the 60-second or 1-minute time frames and heavily rely on Forex trading strategies that incorporate a number of technical analysis based leading indicator that generates a substantial number of signals. Some scalpers end up making 10 to 20 trades in a day if not more.

Figure 1: Example of a Simple Scalping Strategy on 1-Minute Chart

In figure 1, we can see an example of a scaling strategy on the 1-minute chart that generates buy and sell signals based on a simple Stochastics crossover. Since you cannot analyze economic fundamental data on such a low timeframe or use long-term support or resistance levels, scalping strategies often use pure technical analysis to generate trading signals.

If you are an impatient person who needs to do "something" to feel busy throughout the day, scalping strategies could be a good fit for you.

One of the biggest advantages of Scalping strategies is that you find hundreds of trading opportunities every day. Hence, it will enable you to pick the best trade setups that can increase your win rate. A high win rate can help boost confidence among beginners. Moreover, scalping can help you become more disciplined as you will be able to make a lot of trades, which will give you the opportunity to practice your trading strategies. Doing so will give you ample opportunities to follow a well-defined system and gain more confidence as a trader.

However, there are some problems with applying a scalping trading strategy. As a retail trader, who probably don't have a lot of capital to begin Forex trading, it will be difficult to find a Forex broker that offers low transaction costs or spreads. With a scalping forex trading strategy, you will be holding your trades for a few minutes only and have to stick to small profit targets like 10-20 pips on each trade. If you are paying 3 pips spread to buy a Forex pair and paying another 3 pips to sell it within few minutes, and your profit target is only 10 pips, then you are paying almost 60% of your profit as transaction cost to your broker.

Unless your trading system can bear such a high cost of doing business, there is a high probability that it will destroy whatever edge your strategy offered. However, there a lot of brokers who cater to scalpers and offer very negligible spreads.

If you are already thinking about trading Forex with scalping strategies, do take note that this style of trading can give you a lot of stress. Furthermore, if you have a day job, it might be impossible to stay alert and trade actively during market hours.

#2 - Find Out If Forex Day Trading Strategies are the Best Forex Trading Strategies for You

Forex day trading strategies usually generate several trading signals throughout the day, but it also signals an exit point within the same trading day. Compared to scalping, most traders end up trading the market with Forex day trading strategies as it gives them the best of both worlds.

If you are a busy professional with a demanding day job, you can still apply Forex day trading strategies as it does not require you to be glued to the screen the whole day. In fact, if you can find a minute or two every few hours throughout the day, you can just pop open the charts and quickly scan for trading signals generated by a profitable day trading system that you are following.

The beauty of forex day trading strategies is that you trade almost any intraday timeframes, starting from 5-minute charts to 60-minute charts. The timeframe you decide the trade depends on your availability of time. Nonetheless, most day traders end up choosing 15-minute, 30-minute or 1-hour timeframes as slightly longer timeframes generate enough trading signals but also filter out the "noise" in the market that is associated with trading lower timeframes.

One of the advantages of day trading is on the larger timeframes like 30-minute charts, you can clearly see how price action reacts to the long-term support and resistance levels, which you can draw on the Daily (24-hour) timeframe.

Figure 2: Forex Day Trading by Blending Technical Indicators as well as Support and Resistance Levels

In figure 2, you can see how the EUR/USD reacted to the resistance level around 1.1280 after the Stochastics generated a buy signal. With Forex day trading strategies, the benefit of incorporating several trading tools and generating confluence-based signals can help refine the quality of the signals and increase the win rate.

Furthermore, since you will be trading longer timeframes, you will usually have ample time to evaluate the merits of each trade and take better decisions compared to scalping.

However, if you have an intellectually demanding job, day trading can be stressful as well and your performance at the office can take a hit! Before funding your Forex account to become a day trader, weight the opportunity cost of doing poorly in your day job and decide if it is worth your time.

#3 - Find Out If Forex Swing Trading Strategies are the Best Forex Trading Strategies for You

Forex swing trading strategies are best suitable for traders who do not have a lot of time in their hand but has ample patience to keep the trades open overnight or even for a few days. Most people with demanding day jobs end up trading Forex with swing trading strategies as it gives them the flexibility trade the Forex market at their convenience.

Most swing traders use higher timeframe charts like 4-hour or even the Daily charts and hold their trades long enough to capture major price swings with profit targets of hundred to several hundred pips on each trade.

The main advantage of swing trading is the larger timeframe as it allows traders to incorporate fundamental analysis in their Forex trading strategies. With fundamental analysis, swing traders can easily identify the broader direction, then use technical analysis to pinpoint their entry and exit. Doing so reduces the risk of trading against the prevalent trend in the market, which helps increase the win rate of the Forex swing trading strategies.

Figure 3: Forex Swing Trading Strategies Can Incorporate Fundamental Analysis

In figure 3, we can see how a swing trader could have easily recognized that the GBP/USD will turn bearish after the U.S. non-farm employment figure came out at 175K against a forecast of 77K. Once the news was released, a swing trader would wait for a technical confirmation like the Stochastic sell signal in order to enter the market. As you can see, over the next few days, the GBP/USD fell hundreds of pips before the trend reversed.

Before you try to become a swing trader, keep in mind that there are inherent risks associated with Forex swing trading strategies as markets can suddenly change trend overnight when you will probably be away from the screen. Also, given the relatively larger timeframes, you need to use, swing trading involves larger risks per trade as you often need to set a stop-loss order above major support and resistance levels.

#4 - Find Out If Forex Trend Trading Strategies are the Best Forex Trading Strategies for You

A lot of people get confused by the term trend trading because you can find trends in any timeframes. However, Forex trend trading strategies are a completely separate breed of strategies and it is mostly used by large financial institutions, professional traders, and retail traders with ample patience and capital in their hands.

Trend trading has its roots in the extrapolation theory, a concept originated from the realm of behavioral finance, which advocates that market participants form bias based on the existing directional movement of price. Since people put more weight to recent price action, it creates an overall bias in the market and that’s what creates trends in the market. Trend trading strategies try to exploit such long-term bias.

Traders utilizing Forex trend trading strategies trade very selectively and usually hold on to their trades for days if not weeks at a time, which allows them to magnify their profit by accumulating additional positions in the direction of the original trend throughout the holding period.

Figure 4: Opening Multiple Positions in the Direction of the Original Trend

In figure 4, we can see that using a trend following a strategy like Bill William's Chaos Theory, you can gradually scale in and increase your positions to reap the maximum profit from a larger trend.

While trend trading can provide traders large sums of profits from a single, it is difficult to find good trends on larger timeframes as most markets only trend less than 30 percent of the time. Furthermore, beginner traders usually do not have ample capital to set large stop losses required to apply Forex trend trading strategies. So, unless you have the experience, patience, and capital to trade only a few times a month, it is better to stick to day trading strategies or swing trading strategies.

#5 - Bonus - Breakout Trading Strategies

Unlike the four strategies, we discussed earlier, breaking trading strategies are timeframe independent. Meaning, depending on the availability of time and your chosen style of trading, you can trade breakouts on any time frame regardless if you are using a day trading or swing trading strategy.

You see, the bulk of the time you will find Forex markets to trade within narrow ranges and you can easily define the upper boundary or resistance and lower boundary or support by drawing horizontal lines. Once you see the price breaking above the resistance or breaking below the support, it can trigger a lot of pending orders and accelerate the directional movement in either direction that ends up creating trends. With breakout trading strategies, you can easily get into the trend early and ride it before the market started to range again.

Figure 5: Example of a Simple Breakout Trading That Resulted in a Strong Uptrend

In figure 5, we can see that the GBP/USD was ranging between the support around 1.2512 and the resistance around 1.2545. However, the moment price broke and closed above the 1.2545 level on the hourly timeframe, it triggered bulls to bid up to the price that created a strong uptrend. There are many different breakout trading strategies that use various technical indicators to confirm if a breakout is false or not. Nevertheless, if you can master breakout trading, it can prove to be an important weapon in your arsenal.

Money Management is Inherently Linked to Your Trading Strategy

The sooner you realize that money management needs to be catered to your personal psychological state and the different types of trading strategies we discussed earlier, the better you will become at assessing risks and associating the proper money management rules for your chosen Forex trading strategies.

A lot of beginner traders make the mistake of thinking money management is a separate topic to master. They think you can apply almost all money management technique to any given Forex trading strategies, regardless you are a day trader or a scalper. The problem is, different trading strategies have different entry and exit rules. You need to alter your money management technique according to your trading strategy and expected rate of return from that strategy.

For example, a lot of beginner traders risks 2 percent of their capital on each trade. Now, when you are a day trader and only taking one or two trades a day, it might be okay. However, as a scalper who is expected to place over 10 trades an hour, risking 2 percent per trade will wipe out your account faster than you can finish reading this sentence!

Moreover, different people have different risk tolerance levels, which depends on their respective income level, wealth and a myriad of other factors. Hence, when you are investing time to find out your own personality and tweaking your Forex trading strategies, do not forget to assess your risk tolerance and develop your money management discipline accordingly.

The Bottom Line

If you can treat trading as a business and pick the best forex trading strategies according to your personality and risk appetite, it can be a lucrative business to start that can offer an above-average rate of return from your invested capital. However, most people make the mistake of treating Forex trading as a get rich quick scheme and never invest the time to learn and implement a proven strategy and end up losing a lot of hard-earned capital in the process.

If you have the stomach to take away only one thing from this article, then picking a Forex trading strategy, according to your own psychological factors would be it! Do not try to figure out which strategy is best for maximizing your profits, but pick a forex trading strategy that is tailored for your personality and fits your current availability of time and risk appetite.