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Forex Strategies – What works and what doesn’t

Forex Strategies

The forex market is a dynamic market that is under constant evolution and traders are always in the lookout for ways to increase their profits and decrease their losses. The fact is that there are hundreds of forex trading strategies, and it is challenging to understand which one is the most suitable for you. In this article, this will look at the different forex strategies out there, why they work, and when it is time to change your strategy.

Trend Following & Monitoring

Trend following is among the most widely used approaches to the forex trading. At its simplest, this strategy is about defining and tracking the movement of the market. Trend followers who employ this strategy are of the opinion that the market will persist in the existing trend until a reversal signal is obtained.

 The psychology behind trend following is straightforward. The phrase ‘The trend is your friend’ implies that instead of trying to guess on which direction the market is going to move, traders follow the existing trends. For instance, if the market is in an upward trend, a trend follower will be searching for places to invest, given that the trend will persist.

 Trend following is different from other approaches, for example counter-trend trading prop firms where the main aim is to trade in the opposite direction of the trend. Trend following is considered to be a safer strategy as compared to the other forex strategies but it needs a lot of patience and discipline as trends may take some time to form and may even correct themselves in the short term.

 Monitoring tools and indicators of trends

 For traders to be able to follow trends, they require tools and indicators that will enable them to track the trends. Some of the most popular tools include:Some of the most popular tools include:

•                   Moving Averages (MA): Moving averages work by averaging out price data to give a single line that can be easily followed to determine trends. In trading, the trend is usually identified by the use of short-term and long-term MAs such as the 50-day and 200-day MAs.

•                   Relative Strength Index (RSI): The RSI calculates the velocity and the momentum of the price fluctuations. This is useful for the trader in that it provides an indication of when a particular commodity is overbought or oversold, which may lead to a reversal of the trend.

•                   Moving Average Convergence Divergence (MACD): The MACD is a trend following momentum indicator that is the difference between two moving averages. It is usually applied to identify possible buy sell trading signals for forex day trading strategies.

Besides these indicators, trendlines and channels are also used by the traders to have a graphical representation of the trend and its strength. Trendlines are drawn by joining a series of higher tops in an uptrend or lower tops in a downtrend. They are created by drawing horizontal lines parallel to each other that enclose the price action and give a probable range of movement of the price.

Global News Trading

The forex market is influenced by international news stories in a significant manner. This is due to the fact that, economic and political factors such as the Gross Domestic Product, political instabilities and other unforeseen events in the global market can greatly affect the price of currencies. Those traders who are aware of the impact of these factors can devise forex trading strategies that will take advantage of the fluctuations in the market that is caused by the news.

 For instance, actions like changing of interest rates by central banks like the Federal Reserve or the European Central Bank cause fluctuations in currency pairs. If there is an increase in the interest rate more than anticipated then it is beneficial for the currency while a decrease in the interest rate is not good for the currency. Other important news items include employment reports, GDP and inflation rates are also among the important news items that traders look at.

 Timing is very important in the forex day trading strategies. Most traders apply the use of economic calendars to help them know when certain news events are expected to occur and when to trade. These calendars show the dates and times of important economic indicators, and the expected market effect. This knowledge enables the traders to be in a position to predict the market reactions in relation to these events in order to make the right decisions on the right time.

Strategies for Trading on News Events

Forex trading news event based strategy differs from other forex strategies days in the forex market. The first objective is to trade on the higher variability that is typical for large announcements. Here are some common strategies:

 •      Straddle Strategy: This strategy involves entering two orders at the market, one to buy and the other to sell, slightly above and below the current market price at the time of news release. The theory is that the market will gap up or down in one direction after the news and one of the orders will be filled while the other is killed.

 •      Breakout Strategy: Breakout strategy is a concept that aims at establishing key support and resistance levels prior to the release of some news. Buyers come into the market when the price crosses these levels in the hope that the trend will persist in the direction of the breakout.

 •      Fade the News: Sometimes, the first reaction of the market to a piece of news can be overdone, and there is a reversal. Fading the news means going against the first movement of the price, expecting a reversal after the first impulse.

 In any case, risk management is an essential component of news trading. This means that the price movements can be very large and you need to ensure that you have the right stop losses and position size to ensure that your trading account is safe.

Scalping Trading Intervals

Scalping is a high frequency trading technique that involves buy sell securities within a single day, with an intention of making small profits from the price fluctuations. Unlike other forex trading strategies that are based on trends or news, scalping is based on making many trades in a short period of time and making small profits from each trade but there are specific forex strategies days where market is working good.

 Scalping is a very demanding strategy that needs a lot of attention, patience and knowledge about the market. It is most appropriate for those traders who can spend much time observing the markets and who do not mind taking quick decisions.

 Generally, scalpers keep their positions for a few seconds to a few minutes; they do not hold their positions for more than a few minutes. The idea is to make small profits many times over and these profits when compounded give huge profits by forex day trading strategies.

 Methods and Instruments for Scalping

 Scalping is a form of trading that depends on proper strategies and equipment that are used to identify the slightest price changes. Some of the key techniques and tools include:Some of the key techniques and tools include:

•                   Tick Charts and One-Minute Charts: Tick charts or one-minute charts are usually employed by scalpers in order to monitor the market movements. These charts give a detailed picture of the price movements and help scalpers to enter or exit the market at the right time.

•                   Bollinger Bands: Bollinger Bands are used to gauge the level of market activity and to determine when a security is overbought or oversold. When the price gets out of the bands, it may indicate a reversal, and this is where scalpers get their entry points.

•                   Stochastic Oscillator: This momentum indicator relates a specific closing price of a currency to the price span for a specific period. It is used to produce overbought or oversold trading signals and thus assists scalpers in determining when to open or close trades.

 Scalping requires fast execution and narrow spreads as any delay or a wide spread might cost money. Most scalpers like to trade during the most active market time so that their orders are executed at the best possible prices and in the shortest time possible.

Challenges and Risks in Scalping

Nevertheless, scalping is a very efficient strategy that has its own difficulties and drawbacks. Scalping is characterized by high speed and this means that traders have to make their decisions very fast and without much time to research the market. This can lead to mistakes and is not suitable for the beginners at all.

 The primary risks associated with scalping include:

•                   High Transaction Costs: Frequent trading also means that the trader is likely to incur high transaction costs, in case he or she is using a broker who charges high spreads and commissions. These costs can easily offset the profits that are made in the business hence the need to control them.

•                   Emotional Stress: This is because the markets have to be closely watched and decisions made within a short time can be mentally tiring. This is especially so for traders who lack self-control since they are likely to be distracted and hence make bad decisions.

•                   Market Volatility: Scalpers feed on volatility but high volatility is dangerous because it causes unpredictable price movements and slippage which is bad for business.

 For scalping to work, the trader has to have a good plan, adhere to it and always be on the lookout for opportunities. Another aspect of risk control is the stop-loss orders and the size of each trade that must be limited.

Pairs Trading

Pairs trading is a form of trading strategy that does not depend on the direction of the market and it involves the purchasing of one currency pair and the selling of an equally valued currency pair. The concept is to make money from the difference in the rates of two currencies without regard to the direction of the market. This approach can be especially useful in the forex market since the price of one currency is directly related to another because of some economic or political event.  

For instance, a trader might engage in trade the EUR/USD and GBP/USD cross rates, that is, buy the one and sell the other based on an assessment of the relative standing of the currencies in question. If the euro is expected to appreciate against the dollar and pound is still considered to be in a weak position, the trader would go for EUR/USD and against GBP/USD.

Pairs trading can be used to minimize market risk because the trades are normally done in pairs. This means that even if the overall market moves sharply in one direction, the losses from one position may be offset by gains in the other.

Execution and Analysis in Pairs Trading

In order to make a successful pairs trade, one has to look for the right pair and the right time to enter and exit the position. Here are the key steps involved:

•                   Identifying Correlated Pairs: The first process is to determine currencies that have had a relationship in the past. This can be done using statistical tools or correlation matrices that indicate the level of correlation between different pairs.

•                   Analyzing Historical Price Relationships: After correlated pairs are established, traders look at their price history to see whether one currency is relatively too high or too low compared to the other. It is useful in determining which currency should be bought and which one should be sold.

•                   Entering and Exiting Trades: Pairs trade is taken by traders when they have a feeling that the ratio of the two currencies will return to the mean. The trade is exited when the convergence or divergence is as expected and the profits are locked in.

 Pairs trading also take time before the price relationship is realized. The traders also have to be ready to close some of the positions if the correlation between the pairs turns out to be different from expected.

When Is It Time to Change Strategies?

Another important factor that is not easy to decide in forex trading is when to alter or when to discard a particular strategy. In the course of time, market conditions change, and what was once a good strategy may no longer be as effective. It is important to identify that a strategy is not working in the long run in forex trading. Some indicators that your current strategy may no longer be effective include:

•                   Consistent Losses: If you are in a long losing streak, and you are following your plan religiously, then it may be high time to change the plan since it is not fit for the current market.

•                   Increased Market Volatility: When the market is stable, a certain strategy adopted may be effective, but when the market is volatile, the same strategy may not produce the same results. For instance, a trend following system may not perform well in a volatile, trading range environment.

•                   Lack of Clear Trading Signals: If your strategy is based on particular trading signals (for instance, moving average crossovers) and these signals are not given as often or are not as accurate as before, then it is high time to reconsider the strategy.

 The psychological cost of continuing with an ineffective approach is also quite high. Some traders end up ‘waiting’ for the market to turn in their favor, which is a sure way of losing more money. One has to be rational and know when it is time to let go and look for another job.

 Evaluating Market Conditions

 Market conditions are dynamic and therefore what was effective in the past may not be effective in the future. However, for your strategy to be effective it should be reviewed from time to time in order to check the market conditions and make the necessary changes. Key factors to consider when evaluating market conditions include:

•                   Economic Indicators: Fluctuations in interest rates, inflation and GDP have an influence on currency prices and the feasibility of the strategy.

•                   Market Sentiment: Market sentiment can change very fast due to some news, geopolitical events or changes in investors’ behavior. What was effective when the market was bullish might not be effective when the market is bearish.

•                   Technological Advances: New technologies in trading, like algorithmic trading, can also affect the markets and the efficiency of the old strategies.

 Thus, when traders are aware of these factors and ready to change something in their trading plan, they have a higher chance of succeeding and not falling for the traps of using an ineffective strategy.

Steps to Transition to a New Strategy

Change is never easy, especially when it comes to strategies, but it is a crucial move that every trader has to make in the long run when trading in the forex market. Here are some steps to help you make the transition smoothly:

•                   Test New Strategies: When choosing the best strategy, it is advisable to try it on a demo account challenge or backtest it first. It enables you to assess the effectiveness of the strategy without staking actual money on the process.

•                   Backtest Your Strategy: Historical data should be employed to test the new strategy on the past market conditions to determine how it would have fared. This can assist you in finding out the areas of weakness and make corrections before applying the system in real trading.

•                   Start Small: When you start using the new strategy for trading, it is advisable to open small positions. This reduces risk exposure as you build confidence in the strategy’s efficiency at the same time.

•                   Monitor Performance: Monitor the effectiveness of the new strategy and be ready to make some changes if it is necessary. This is the reason why it is important to evaluate your strategy on a continuous basis in order to ensure that it is still effective.

•                   Maintain Flexibility: The forex market is not static and therefore there is no perfect strategy that will last for a lifetime. As such, one should be ready to change the strategies that are used in the market.

 When you follow these steps, you will be able to switch to a new approach and achieve better results in the forex market in the long run.

How to create your strategy

 Formulating a good forex trading plan requires one to consider his or her trading objectives and risk level. These are the factors that should inform all your decisions when formulating your strategy.

 Trading Goals: First of all, it is necessary to determine the goals that you set for your trading. Do you want to make regular income, increase your capital, or diversify your other investments? Your goals will define the kind of strategy that will be appropriate for you.

 Risk Tolerance: Think about the level of risk you want to bear per trade. Do you like to take risks and get higher profits or you prefer to take fewer risks and get fewer profits? Your risk tolerance will determine the kind of strategy you are going to use and the size of your positions.

 In other words, the strategy that you use should be compatible with your objectives and your ability to tolerate risk; this way, you can develop a trading plan that is unique to your situation and will not cause you to lose focus or get distracted.

 Choosing the Proper Equipment and Signs

 After you have defined your objectives and your level of risk, the next step is to choose the instruments and the markers that will serve as the foundation of your plan. The forex market is equipped with a great number of tools, so one should select the ones that will be suitable for him or her. When choosing tools and indicators, it is better to choose those with which you are familiar and which you can use without any discomfort. Using too many indicators in your strategy can be counterproductive because it makes it difficult to decide on a course of action because of the conflicting signs.

 The backtesting and optimization of your strategy

 Forex trading strategy development requires backtesting as a critical stage. It is a simulation that seeks to check how your strategy would have fared under certain market conditions using past data. It assists you in finding out the strong and weak areas of your strategy and correct them before going live and risking your money.

 Steps for Effective Backtesting:

•                   Choose a Reliable Backtesting Platform: Trade on a platform that provides a practice account where you can trade using real market data.

•                   Select Relevant Data: You should also test your strategy on different time frames and market conditions to get the full picture of its efficiency.

•                   Analyze the Results: Pay attention to the patterns in the results that you get. Were you profitable in trending markets but lost money in range-bound conditions? These are the things that you should consider in order to prove your strategy.

 Following backtesting, further tuning of the strategy may be required by fine-tuning the parameters of the indicators or changing the risk management parameters. But be careful with over-optimization of the strategy as it can give you a great strategy in the backtest but a terrible strategy in the live trading. 

FAQs

 1. Which forex trading strategy is the best?

 The best forex trading strategy is one that is most suited to your trading personality and your attitude to risk. Trend following and pairs trading are regarded as rather safe, though their effectiveness depends on the market situation and the trader’s self-discipline.

 2. How frequently should I revise my forex strategy?

 You should always check on your forex strategy after a major shift in the market, or if you have been in the red for a while. However, do not make too many changes for the sake of the short-term results.

 3. Can scalping be used by newbies?

 Scalping is not advisable for those who are new in the forex market because of the fast moving market and the fast decision making that is required. Newcomers may have better chances of success with longer-term approaches such as trend following.

 4. What is the danger of trading based on global events?

 Trading on the basis of events happening in the global market is dangerous since it is characterized by high volatility and unpredictable reactions of the market. One should always practice proper risk management when trading on news and this includes setting up stop loss orders.

 5. How can one tell that a forex strategy is no longer effective?

 Some of the indicators that a forex strategy is no longer effective include; the following; the strategy is continuously making losses, the volatility of the pairs is rising, and there are no clear signals. If these problems remain, it is high time to reconsider or modify your approach.

 6. Can I employ several strategies simultaneously?

 Yes, the traders employ a number of strategies in order to spread the risks and capitalize on various situations. But, it is crucial to make sure that the strategies do not interfere with each other or are not inapplicable together.

Editor team
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Crispus Nyaga Content Creator
Crispus Nyaga is an investment analyst with great experience in financials. His expertise spans various domains, including Petroleum, Statistical Data Analysis, and Technical Analysis. Crispus is proficient in utilizing advanced tools to conduct in-depth market research and data analysis. Also, he has an academic background - holding a Master’s degree in Business from Kenyatta University.
George R. is a wide-ranging expert with experience in analysis and writing. Currently serving as a Senior Writer at 55brokers.com. In addition to this role, he has been the Chief Market and Broker Analyst since June 2020. He has played a crucial role in providing in-depth analysis and insights into the financial markets. With nearly a decade of experience as a Foreign Exchange Trader, George brings a deep understanding of market dynamics and trading strategies. His previous positions include serving as the Chief Market Analyst at SVS Securities Plc.
Eno Eteng is a highly skilled and certified financial technician with a Diploma from the UK Society of Technical Analysts. As a pioneer alumnus of the Tony Elumelu Foundation's (TEF) Entrepreneurship Program (class of 2015), Eno has been a prominent figure in the financial content industry since 2009. Over the years, Eno has crafted more than 5,000 ghost-written articles for major industry players, including InvestooGroup, EasyMarkets, eToro, Spotware Systems, and high-profile clients like the Chief of Staff to the Delta State Government of Nigeria.

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