Forex (foreign exchange market) is a marketplace where currencies are bought and sold. So, as a forex trader you will be dealing with currencies – euro, US dollar, Indian rupee, and many, many more.
What is your strategy?
Having said that, a trader should realize the importance of having the best strategy. Before we even start, it's good to say that knowledge and preparation are essential. You have to get used to working with technical and fundamental analyses, and other tools and charts as well demonstrate a more general understanding of the market. This is crucial because often currencies go up or down due to a major economic or political event.
For example, pro-EU centrist Emmanuele Macron won the presidential election in France, which automatically led to an increase in the euro. Whereas, the Brexit situation in the UK has caused the British pound to retreat against the euro and the US dollar.
The Characteristics Of The Different Forex Strategies
There are many different strategies that exist, and perhaps, before you start trading, it would be a good idea for you to determine your goals. Therefore, to adopt the strategy which suits your needs and skills. Do not be afraid at first to try several different approaches; this is the only way to ensure what worked out well and what didn't. Below you will find the best 7 forex trading strategies a forex trader might employ.
Forex is the process of trading currencies, so do not expect to play Ludo. Your moves will often be pure speculation. Buying and selling currencies is often highly risky, thus most traders open positions on the pure expectation that a currency will gain on another one or lose ground.
For instance, you bet on a currency whose value will go down in the future and the other currency in the pair will go up. Certainly, most traders go for several currency pairs which are very liquid. If you want to be really good at just a few currencies, you need to be an expert in the reasons which usually cause fluctuations (Central bank decisions, political events, etc.) in their prices.
Find The Differences – Arbitrage Strategy
If you want to use the arbitrage strategy, you must have a keen eye for details. This is a great tactic and almost everyone has tried or tries to use when opening or closing positions. Basically, this is a sort of speculation where a player looks for the so-called price inefficiencies.
How Does It Work?
Let's assume you have purchased an asset at a price in a particular market; then you find another one where it's more expensive. If you sell it there, then you make a profit. In our case, a trader buys different currency pairs and benefits from the different prices they have. Many people use this strategy, but these inefficiencies are often spotted and removed before you even entered a position. This approach helps to balance out the market. When the price of a currency rises, the demand will go down and at the same time, traders would try to sell more.
Theoretically speaking, arbitrage has two main criteria and requirements:
- A price inefficiency of one currency does exist in different markets
- The actual price of a product is different from the future price discounted at the interest rate.
Let's imagine for a moment that the prices of buy EUR/USD is 1.1001 and sell EUR/USD is 1.1005. What do you do? You put 10,000 EUR in your first position and you get 11, 001 USD. If you sold this 10,000 EUR, you'd get 10,005 USD. So this is a profit of 4 USD.
Follow the Trends Strategy
If you want to be a good forex trader, you have to become good friends with technical analysis. The two main characteristics are supply and resistance. Support (also known as support level) is generally the lowest level of a currency's price under which it rarely goes. Normally buyers tend to purchase assets at this rate.
In contrast, the resistance level is the highest level of a currency's price and rarely will investors surpass the line. Nevertheless, markets occasionally do break this rule and transcend both levels – below support and above resistance.
Let’s look at it in detail:
EUR/GBP has reached a new low, below the support line. Despite its low price, buyers will stop purchasing this currency pair in hope to become even cheaper. On the other side of the coin, sellers might panic and would like to get rid of their positions in order to mitigate losses. When the trend starts is the moment when people who sell have nothing else to sell and buyers begin to purchase again because the price has reached the bottom.
Here we have two trends: buy markets and sell markets. The former is when the resistance line is broken and the latter when the supply level is breached.
Market Sentiment Strategy
Market sentiment (also known as investor attention) is investor's attitude and expectations of a particular stock's price movement. It's important to understand two major terms – bears and bulls, therefore we often refer to a market as bearish or bullish respectively. If bears are in charge prices tend to go down, whereas bulls try to make a stock's price go higher and higher.
Usually, the sentiment shows what can be expected to happen in the future. If Germany, for example, faces economic problems and screeches to a halt, the euro will be expected to lose ground to the US dollar and the GBP for instance. Why is this important to a forex trader? Pros find the best stocks out there regardless of the fact if they are under – or overvalued.
Fibonacci Indicator – Forex Trading Strategy
Back in the 13th century, a great mathematician, Leonardo de Pisa, discovered a major breakthrough: a sequence of numbers often found in nature – 0, 1, 1, 2, 3, 5, 8, 13, 21, 34 and so on.
Why it's important?
Financial markets and trading rely on and are extremely dependent on analysis, which often includes computing and calculations. No wonder, Fibonacci ratios are often met in Forex trading and are used to support a trader's daily strategy. Following the trend and using the Fibonacci indicator alongside other major tools such as RSI, MACD or Candlestick charts, you can easily place your positions and use these ratios to plan your enter and exit strategies.
In Forex trading, three ratios matter the most – 38.2%, 50%, 61.8% on which the so-called Fibonacci Retracement Lines are based. Sometimes a trader should keep in mind also 23.6% and 76.4%. A minimum retracement (a short period when the price of a stock goes down; they look like small dips on the charts) is at around 32.2%. However, in a weaker trend, retracement can be even spotted at 61.8% or 76.4%. Be careful with this indicator, because there are risks associated with using it. Forex trading is extremely dynamic and often unpredictable, so it's advisable to use all sources of information and strategies to plan your actions.
Carry Trade Forex Strategy
This is a type of fundamental Forex strategy and it's very popular with investors but different than the other strategies at the same time. Usually, most traders are used to volatile environments. Carry trade flourishes, in contrast, in a stable market.
Using this method, carry traders sell a currency with a low-interest rate and purchase one that is paying a higher rate. So, double profit. Once you earn from the fluctuating prices of the currencies and again from the different rate they carry. Beware that this approach is not recommended during an economic crisis and a highly unstable market.
All players in the financial markets, whether they are huge companies, enterprises, or individual traders, try to avoid future losses and, on the other hand, aim at making a profit eventually. This is when hedging comes in handy. Basically, hedging is a sort of insurance for your money when investing. The same applies to Forex trading.
This great strategy allows many people to mitigate the risk of possible losses. There are, of course, different ways to hedge your trading. Some of them are:
Direct Hedging. You place a position which buys a currency pair and at the same time, you sell the same currency pair. For example, USD/AUD.
Multiple Currency Pairs. This is a complex type of hedging, involving trading in different currency pairs. For example, you open positions with USD/JPY and USD/GBP.
Forex Options. Here a trader opens a position for a fixed framework and at a preliminary set strike price. Let's assume you trade GBP/USD at 0.77 and in order to protect yourself from some fluctuations in the prices you set a minimum of 0.76 at which the position is automatically closed.
3 Tips For Beginners
Start with the basics before you begin anything new. Let's take a look at some trading tips that every trader needs to know before they start trading currency pairs.
Know Your Limits
You must decide what kind of orders you will use to enter or exit trades. Market orders or limit orders will you choose? Market orders are executed at the lowest price at the time. There is no guarantee of price.
Limit orders, however, guarantee the price, but not the execution. Limit orders allow you to trade more precisely, as you can set your price for both buying and selling. Options strategies are used by more experienced day traders to hedge their positions.
Trailing stops can be very useful. They track your position at a certain distance as the market changes, protecting profits in the event of a market reversal. You may lose more if you place contingent orders.
Keep Yourself Updated
In addition to knowledge of basic trading procedures, day traders need to keep up on the latest stock market news and events that affect stocks–the Fed's interest rate plans, the economic outlook, etc.
So do your homework. You can make a list of stocks that you want to trade, and stay informed about general markets and companies. Visit reliable financial websites and scan business news.
It is important to be knowledgeable about the forex market. It's a wise investment to take the time to learn about currency pairs and their effects before you risk your capital.
Create a Plan and Stick to it
A trading plan is essential for successful trading. This plan should outline your profit goals, risk tolerance level and methodology. It also need to include evaluation criteria.Once you have a plan, ensure that every trade you consider fits within the plan's parameters. Remember that you are most likely to be rational before placing a trade, and most irrational once it is placed.
Knowing your limits is essential for your success in the future. This means knowing your limits, knowing what you are willing to lose on each trade, setting your leverage ratio according to your needs and not taking on more than you can afford.
Consistency is key to successful trading. Trading is not easy. However, traders will lose money. If you keep your head up, you'll be more likely to win. While it is important to educate yourself and create a trading plan, the true test is adhering to it through patience and discipline.