As a trader, you may have come across the phrase, “forex trading strategy.”
Is this some kind of a plan or a system Jim from around the block told you about?
In this guide, we’ll explain the nitty-gritty of forex trading strategies.
If you are new to the world of forex, this guide can help you a lot, so make sure to stick to the end.
Forex trading strategies explained
A forex trading strategy defines a forex trader’s system to determine when to buy or sell a currency pair.
Think of a forex trading strategy as a plan for how you will approach trading. This plan will provide the objective set of rules for buying and selling, running positions, and managing available funds.
Forex trading strategies are objective, consistent, quantifiable, and verifiable. These strategies are based on fundamental or technical analysis so you can minimize the risks associated with forex trading.
When building a forex trading strategy, you should develop the clear goals you want to achieve.
Most of the strategies that are executed are based on fundamental analysis or technical analysis.
They are informed by verifiable market information. The forex trading strategies that rely on technical indicators focus more on market strikes and also their movements. A technical movement, such as a moving average, can be used to execute a trading strategy.
While technical forex trading strategies rely on technical analysis, fundamental strategies rely on fundamental factors such as economic or political factors.
How to develop a forex trading strategy?
Many pro forex traders create and perfect a strategy over time. Some trades are based on a single study, and others are based on broad-spectrum analysis.
Some key elements make up a forex trading strategy. These include timeframe, technical indicators, risk tolerance, and entry/exit points.
Let’s define each one of them in detail:
1. Timeframe
The timeframe is the first thing you must pick when developing your forex trading strategy.
Do you enjoy looking at charts on a daily, weekly, monthly, or even yearly basis? How long do you intend to keep your positions?
These questions will assist you in determining the timeframe you will trade.
Even though you will examine multiple time frames, you will employ this primary period when looking for a trade signal.
2. Technical indicators
Since one of the core components of forex trading strategy is identifying trends as early as possible, we should use indicators that can accomplish this.
Moving averages are one of the most common indicators used by traders to identify trends.
Creating a forex trading strategy also involves avoiding whipsaws, which means you don’t want to be trapped in a false trend.
This is accomplished by ensuring that we can validate it using additional indicators when we see a signal for a new trend.
Many technical indicators, such as MACD, Stochastic, and RSI, are useful for confirming trends.
3. Risk tolerance
Risk tolerance reflects how comfortable you are with the possibility of losing money in exchange for potential benefits.
Those with a steady income or experience in financial markets are more likely to be aggressive. In contrast, those with a lack of trading experience usually chose the less risky path to profitability.
When developing a forex trading strategy, you have to decide how much room is enough to give your trade some breathing space, but at the same time, not risk too much on one trade.
4. Entry and exit points
Your forex trading strategies must have entry and exit points.
Entry points let you take long (buy) or short (sell) positions.
Some traders enter as soon as they see a bullish or bearish candle. Others wait for the trend to develop and then take their positions.
Exit points tell you when to leave a long or short position. It also lets you exit an unprofitable trade.
Forex trading strategy example
Imagine you expect GBP to rise against the USD. The exchange rate between the two currencies is 1.4000. This means it takes $1.4000 to buy one GBP.
You take a good look at the charts. The pair is trending upwards. You are using the RSI as your main indicator. The RSI is above the 70 levels on the daily chart.
When the RSI is above 70, it indicates a strong uptrend. Everything is looking fine for you, and you go long on GBP/USD.
Now, after two days, the price of GBP/USD went from 1.4000 to 1.4100. You have made a cool profit of 100 pips in just two days. On the standard lot, one pip means a $10 change. So, 100 pips mean $1000 profit.
Why should you use a Forex trading strategy?
If you are in this for the long term, you should develop a proper trading strategy to make the investment process smoother.
It is not the same as letting your gut feeling guide you because that may get you into trouble. And you would not want that, not at least in the business where one could lose a lot of money.
Forex trading strategies consist of the rules and principles that a trader has set for themselves. They are likely to be quite granular to prevent a trader from straying away from the strategy in pursuit of what seem sure-fire opportunities.
There are many different trading strategies, and some traders will mix and match established procedures to produce one that is uniquely their own.
Key to any forex strategy is the criteria for entering the market and for leaving it, along with strict adherence to risk management.
If you wish to be successful, you must learn to execute and trade strategy beneficial to you as an investor.
Bottom line
When considering a trading strategy, you need to compare how much time investment is required behind the monitor, the risk-reward ratio and the regularity of total trading opportunities.
Remember that each trading strategy will appeal to different traders depending on personal attributes. So, whatever strategy Jim from the block is applying, you shouldn’t blindly follow it.