An Overview of Forex Trading Strategies

Forex is one of the fastest-growing trading opportunities in the market today. Forget stocks and bonds and commodities; forex is one of the most popular asset classes online, for several reasons. It moves quickly; it’s relatively easy to learn and implement; and you don’t have to learn about a lot of different assets and a million moving parts. In some ways, currencies are easier than stocks or commodities to assess, predict, and trade.

This doesn’t mean you don’t have to have a strategy, though. Far from it. Trading forex can be disastrous unless you have strategies in place to help you succeed. Here, I’ll share with you a few forex trading strategies that can help you gain an edge and trade with purpose and direction.

The Basics

We’ll start by covering a few basic strategies that are widely known and used. Some expert traders make use of these from time to time, but most don’t; they are preferable for use by beginners and intermediate traders.

The first is the Trade the News strategy. In other words, trade based off major news and events that happen in the world that impact your chosen currency. If you want to trade euros against the dollar with EUR/USD, for example, you’d trade based on interest rates, European GDP, import and export figures, announcements from the European Central Bank (or its American counterpart, the Federal Reserve), or other happenings in the public arena.

With this strategy, you are basically trading whenever something that drives price appears in the news. Traders pay attention to these things, and when newsworthy events happen, the market responds. Of course, you have to figure out if the event is good or bad for your currency, but trading the news is the most fundamental strategy around.

You can also get into trend trading and range trading. These may sound complicated – and they can be – but these really are fundamental, basic strategies and approaches to trading. Trend trading means taking advantage of strong patterns in price in the market. A bullish currency that keeps going up against another currency is in an upward trend. The yen, for decades, has been in a downward trend against the U.S. dollar (even if it occasionally breaks into an upward trend for a shorter duration of time).

Range trading means taking advantage of a currency’s up-and-down movement between two price levels. These price levels change constantly, but often in the absence of a trend, a pair’s value will yo-yo and vary.

Tools that can help you identify trends and ranges include:

  • Stochastic oscillators: This indicator helps identify trends. There are three signals this indicator produces: crossovers, divergence, and overbought/oversold currencies. When the line that represents the currency’s price crosses over and goes above the signal line, that is a buy signal; when the price line goes under the signal line, that is a sell signal. Also, when the price line goes above 80, that means the currency could be overbought, which is a sell signal ; when the line goes below 20, that represents an oversold currency, which is a buy signal.
  • Moving average convergence/divergence (MACD): The MACD indicator helps you identify changes in the strength, momentum, and direction of a trend. There are two lines; a MACD line and a signal line. When the MACD line crosses up through the signal line, that is a buy signal; when it crosses beneath the signal line, that is a sell signal.
  • Pivot points and support/resistance levels: A pivot point is simply the average of the previous trading day’s high, low, and closing prices. You can use this to derive support and resistance levels, which help you identify a range. A range’s bottom is the support level; the top is the resistance level.

You don’t want to use range-trading tactics – like buying at the bottom and selling at the top – when the currency is in a trend, and you don’t want to use trend-trading tactics when the currency is ranging.

Advanced Strategies

There are more advanced strategies for trading forex out there, and they incorporate other tools and techniques and rely heavily on technical analysis.

Scalping

Scalping is a strategy that relies on quickly entering and leaving positions (i.e. buying currency, holding onto it for just a few minutes, then selling), hoping to make a series of small profits that add up to greater overall profit.

The idea is that certain events – be they related to economic or political events or technical events with price patterns – cause currencies to move sharply in very short timeframes. Scalpers seek to profit and reduce risk by only being exposed for one to five minutes – just long enough to beat the spread. Any longer and you run the risk of the market reversing and costing you money.

Scalping can keep you from losing big, but it does take patience and perseverance. A trader may make 100 trades a day and only be profitable in 55 of them.

Carry Trades and Arbitrage

A carry trade is when you purchase a currency that has a higher rate of interest attached to it than the currency that you’re selling.

For example, the Australian dollar recently has had a much higher rate of interest than the Japanese yen. The Aussie LIBOR overnight rate right now is 3.568%; the rate for the yen, by comparison, is 0.100%. With a carry trade, you would borrow or sell Japanese yen and use that to purchase Australian dollars. You would gain a difference of 3.468% per year on the money in your account. There are risks associated with carry trading, though; you could still lose money if the value declines, especially if you just leave the trade alone.

Arbitrage is when there is pricing inefficiency with one or more currency pairs. For example, if EUR/USD is more expensive than EUR/GBP and GBP/USD, there is the possibility that you could buy euros and pay in dollars, sell the euros for British pounds, and then sell the British pounds for more dollars than you originally paid for the euros.

These inefficiencies don’t happen all the time and can be difficult to spot without training and a little technical help. This is one way, though, that you can profit without any risk as long as your positions cancel each other out. Arbitrage calculators can help you find these opportunities when they appear in the market.

There are other trading strategies that are so advanced that we can’t really go into them here, primarily because they depend on certain indicators, trading platforms, and software packages. Know that any strategy should be tried first with a demo trading account before put into action with real money.

Other pages on our website that relate to forex strategies include:

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