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A forex trading strategy determines the system a forex trader uses to decide when to buy or sell a currency pair. There are various forex strategies that traders can use either technical analysis or fundamental analysis. A good Forex trading strategy allows the trader to analyze the market and execute trades confidently with sound risk management techniques.
Forex strategies can be divided into specific organizational structures that can help traders find the most suitable strategy. The diagram below shows the general structure of each strategy and the relationship between forex strategies.
Forex trading requires combining several factors to come up with a trading strategy that works for you. There are many strategies you can follow, but it is important to understand and be comfortable with the strategy. Each trader has unique goals and resources to consider when choosing the right strategy for them.
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We’ve put them in a bubble chart to easily compare forex strategies across three dimensions. With strategies at the top of the graph on the vertical axis, each trade has a higher “Risk-Reward” ratio, which is a higher reward for the risk taken. Position trading is usually the strategy with the highest risk-reward ratio. On the horizontal axis is the time investment, which shows how much time it takes to actively monitor trades. The most demanding strategy in terms of time resources is head trading due to the frequent trading frequency.
Price action trading involves studying historical prices to formulate technical trading strategies. Price action can be used in conjunction with a single technique or indicator. Essentials are rarely used; however, it is not unheard of to include economic events as a determining factor. As discussed above, there are several other strategies that fall within the scope of price action.
Price trading can be used for different time periods (long, medium and short term). The ability to use multiple timeframes for analysis makes price action trading by many traders.
Price action includes range, trend, day, scalping, swing and position trading. These strategies follow different types of trading requirements which will be detailed below. The examples show the different ways to trade these strategies, how different trades can be, and the different considerations for traders to choose from.
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Interval trading involves identifying support and resistance points where traders will place trades at these key levels. This strategy works well in the market with no significant volatility and no visible trend. Technical analysis is the main tool used with this strategy.
There is no set length for trading as range strategies can work at any time. Risk management is an integral part of this approach, as pitfalls can occur. Finally, the margin trader wants to close the current margin limit.
Oscillators are often used as timing instruments. Relative Strength Index (RSI), Commodity Channel Index (CCI) and stochastic are some of the more popular oscillators. Price action, along with swings, is used to further test signals or breakouts in the range.
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USD/JPY shows a long-term price range over the past few years. The chart above shows specific support and resistance bands that traders use as entry/exit points. The RSI oscillator shows the timing of entry/exit points distinguished by blue/red boxes – blue: overbought and red: oversold.
Intermediate trading can lead to risky results, but that comes with investing for the long term in every trade. Use the following pros to balance your goals and your resources as a trader.
Trend trading is a simple forex strategy used by many traders of all experience levels. Trend trading attempts to make positive profits by exploiting market trends.
Trend trading usually takes place in the medium to long term due to the length of the trends. As with price action, some time-limit analysis may be acceptable in trend trading.
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Entry points are usually determined by an oscillator (RSI, CCI, etc.) and exit points are calculated based on a positive risk-reward ratio. Traders can use distances from the stop level to balance that distance or exceed it to maintain a positive risk-adjustment level. If the stop level is placed 50 pips away, the profit level will be set 50 pips or more away from the entry point.
In the simple example above, EUR/USD is showing a confirmed uptrend with higher highs and lower lows. The opposite would be true for a decline.
When you see a strong trend in the market, trade it in the direction of the trend. For example, strong growth in EUR/USD above.
Using (CCI) as a tool for timing charts, prices responded with a rally every time the CCI dropped below -100 (shown in blue). Not all trades pan out this way, but as the trend continues, each bearish run has led to more buyers entering the market and higher prices. In conclusion, identifying a strong trend is important for an effective trend trading strategy.
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Trend trading can be quite labor intensive with many variables to consider. A list of pros and cons can help you decide if trend trading is right for you.
Position trading is primarily a long-term strategy that focuses on fundamental factors, but technical methods such as Elliott Wave Theory can be used. This strategy ignores smaller market fluctuations because they do not affect the broader market. This strategy can be used in all markets, from stocks to Forex.
As mentioned above, position trading has a long-term outlook (weeks, months or years!) for the more patient trader. It is important to understand how economic factors affect markets or major technical downturns when forecasting trading ideas.
Key levels on longer-term charts (weekly/monthly) hold valuable information for position traders due to their comprehensive view of the market. Entry and exit points can be evaluated using technical analysis as compared to other strategies.
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The German 40 chart above shows a roughly two-year head and shoulders pattern, which is likely to drop below the neck (horizontal red line) after the right hand shoulder. In this selected example, Germany’s 30 down play was technically and thoroughly planned. At the end of 2018, Germany experienced a technical recession that hurt the auto industry along with the US/China trade war. The Brexit negotiations did not help matters, as the UK’s exit from the UK would also have a negative impact on the German economy. In this case, understanding technical patterns as well as having solid fundamentals allowed me to combine technical and fundamental analysis to build a strong trading idea.
Here’s a list of pros and cons based on your goals as a trader and how many resources you have.
Day trading is a strategy designed to trade financial instruments on the same trading day. That is, all positions are closed until the market closes. This can be one trade or multiple trades throughout the day.
A trading time is a very short-term (minutes) or short-term (hours) interval if the trading day opens and closes.
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Traders in the example below would enter positions when price crosses the 8-period EMA along the direction of the trend (blue circle), using a 1:1 risk-reward ratio.
The chart above shows a trading day of moving averages to determine the long-term trend in this case as the price is high.
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