Forex trading strategies
A forex trading strategy can help a trader determine whether to buy or sell a currency pair. There are numerous trading strategies which can be utilised, each requiring varying levels of technical and fundamental analysis.
All strategies exist on a continuum, ranging from intraminute to intraday, to the long-term analysis of price momentum trends. Traders may choose a single strategy, or combine several, but all can help to improve forex trading potential. View a summary of common trading strategies here.
Choosing a forex strategy
As a currency trader, it pays to understand what drives market volatility, and to be able to recognise the optimum times to buy or sell a currency pair. Trading strategies can be developed using either technical or fundamental analysis, or a combination of both.
Before engaging with a particular strategy, it is wise to identify the type of trader you are, including:
- How much time you can set aside to trading
- What currency pairs you want to focus on
- The size of your position
- Whether you’re going long or short
The following strategies are utilised by traders to open their positions and to help them hopefully close with a profit. The strategy you decide on will correlate to the type of trader you are.
Forex scalping strategy
Traders who prefer short-term trades held for just minutes, or those who try to capture multiple price movements, would prefer scalping. Forex scalping focuses on accumulating these small but frequent profits as well as trying to limit any losses. These short-term trades would involve price movements of just a few pips, but combined with high leverage, a trader can still run the risk of significant losses.
This strategy is typically suited to those that can dedicate their time to the higher-volume trading periods, and can maintain focus on these rapid trades. The most liquid currency pairs are often preferred as they contain the tightest spreads, allowing traders to enter and exit positions quickly.
It should be taken into consideration that when using a scalping strategy, slippage can have a significant effect on the trade, especially if there are no risk management tools like a stop-loss in place.
Day trading
If you want to trade for shorter periods of time, but aren’t comfortable with such fast-paced, multiple trades, day trading is an alternative strategy. This typically involves one trade per day, which wouldn’t be carried overnight, unlike swing trading. Profit or losses are as a result of any intraday price changes in the relevant currency pair.
This type of trading would require sufficient time to monitor the trade, as well as a good understanding of how the economy could affect the pair you’re trading. If major economic news were to hit that day, it could affect your position.
Find out more about day trading strategies and helpful tips.
Swing trading
For traders who prefer a mid-term trading style where positions can be held for several days, there is swing trading, which aims to make a profit out of changes in price, by identifying the ‘swing highs’ or ‘swing lows’ in a trend.
The price movements need to be carefully analysed to identify where to enter or exit the trade. The economic stability or political environment can also be analysed as an indication of where the price is likely to move next.
The ‘swing’, depicted by the oscillations between one value and another, is used to trade the financial instrument of choice. Some traders choose to hold the stock for several days, others may prefer to base their swing upon intra-month price movements.
Choosing a currency pair with a wider spread and lower liquidity can be more suitable when employing a swing trading strategy.
Although this strategy normally means less time fixating on the market than when day trading, it does leave you at risk of any disruption overnight, or gapping.
Learn more about swing trading.
Position trading
The most patient traders may choose position trading, which is less concerned with short-term market fluctuations and instead focuses on the longer term, holding the position for several weeks, months, or even years. The aim of this strategy is that the investment will appreciate in value over this long-term time horizon.
Requirements for this type of forex trading strategy include:
- Large stop losses to prevent being stopped out too early
- Sufficient capital so you don’t receive a margin call
- Ability to stay level headed if the price goes against you
- A good understanding of the market’s fundamentals
This is more suited for those who cannot dedicate hours each day to trading, but have an acute understanding of what that market is doing.
Hedging forex
To protect oneself against an undesirable move in a currency pair, traders can hold both a long and short position simultaneously. This offsets your exposure to potential downside, but also limits any profit.
By going both long and short, you can get an idea of the direction the market is heading, so you can potentially close your position and re-enter at a better price.
Effectively, you’re buying yourself some time in order to see where the market is going, giving yourself the opportunity to improve your position.
Deciding to adopt a forex hedging strategy depends on your amount of capital, as you would need to cover both positions, but also the amount of time you have to monitor the market. It’s also a strategy typically more suitable for traders wishing to hedge one of the more liquid major currency pairs.
Hedging is useful for longer-term traders who predict their forex pair will act unfavourably, but then reverse, as it can reduce some of the short-term losses.
Price action
To trade forex without examining external factors like economic news or derivative indicators, you can use the price action strategy. This involves reading candlestick charts and using them to identify potential trading opportunities, based solely on price movements. Generally this strategy shouldn’t be used alone, but instead alongside another like swing trading or day trading, to help mould traders’ next moves.
Using the price action strategy means you see real-time results, rather than having to wait for external factors or news to break. However, a crucial consideration for those who might use the price action strategy is that it’s very subjective, so while one trader might see an uptrend, another might predict a potential turnaround for that particular forex pair, or that time period.
Take a look at these eight essential forex candlestick patterns.
Summary
Of course, when it comes to forex trading strategies, no one strategy will have success all the time, every time. But these strategies, accompanied by a sensible approach to managing risk, can help highlight trading opportunities across a wide range of forex markets.
Your strategy of choice will depend on the type of trader you are, as well as the time you’re able to allocate to trading. It will also depend on the currency pair you wish to trade. Swing trading might be favoured when dealing with the more volatile pairs, and a position trading strategy might prove more appropriate when trading the less volatile pairs, for example.
Regardless of what strategy you choose, it’s important to employ the necessary risk-management tools, like stop-loss orders.
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Disclaimer: CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.