Some imagine forex trading as a get-rich-quick scheme, while others see them as a straight-up fraud. The reality is somewhere in the middle — it’s possible to make money from forex day trading, but only with a solid understanding and forex trading strategy to back you up.
Whether you’ve already put some time into learning about forex trading or you’re starting from zero, this guide is here to fill in your gaps. We’ll cover what exactly a forex trading method consists of, and how to tackle the forex challenge of creating the best strategy for your skills and preferences.
Introduction to Forex Trading Strategies
Before we dive into exactly what forex trading strategies are all about, let’s say a few brief words about forex trading itself.
Foreign exchange (forex) trading is all about making a profit due to the changing values of currencies. Since the exchange rates between currencies are always changing, there’s room to profit by purchasing a currency while it’s less valuable (relative to another currency) and selling it when it’s more valuable (relative to another currency). For traders looking to sharpen their skills and access trading capital, a prop firm challenge platform offers an opportunity to practice strategies under real market conditions.
When forex trading, you choose a currency pair — the value of one currency relative to another currency. For instance, if your currency pair is the US dollar (USD) and the British pound (GBP), then USD/GBP would be your currency pair.
As the exchange rate between these two currencies is always changing, there’s space to earn a profit.
The golden question is how exactly you can predict things correctly to make a profit — but that’s what the rest of the article will cover.
What is a Forex Trading Strategy?
Forex trading strategies are different approaches to trading, offering methods and frameworks to guide you through your trading decisions.
Many strategies are pioneered by traders, tailored to the individual as they learn from their own successes and failures. However, there are also more general strategies that traders have been following for decades.
Definition and Purpose
It’s complicated to get trading right. Nobody has a crystal ball to tell them exactly what prices or interest rates will do in the future, and there’s not a secret trick to “beat the market.”
However, traders build strategies over time as they practice trading and learn what works for them. We have some form of strategy for most parts of our life, whether it’s a tried-and-tested method to avoid rush hour or a plan to tread on eggshells around the boss. The same is true of forex trading.
Types of Forex Trading Strategies
While all forex trading strategies have the same aim, you can take many different approaches.
Two of the main types you may come across include:
- Forex day trading. Executing trades within one day rather than leaving positions open overnight and trading over a longer period. The shooter timeframe can make this a higher-risk approach, but it can also be very profitable.
- Forex swing trading. Using a larger timeframe, such as a few weeks or days. Traders aim to capitalize on big price swings in the market to make profits. The longer timeframe means there’s less need to make rapid decisions or to watch the market as intensely as day traders, but it carries its own risks.
We’ll get into some more strategies shortly.
Basics of Forex Trading Strategies
Now we’ve scratched the surface of what a forex trading strategy is all about, let’s take a more detailed look at what to expect.
Manual vs. Automated Systems
Traditionally, forex trading strategies required a trader to analyze graphs on a screen to look for signs that they should buy or sell currencies. This might be the kind of trading you’ve seen represented in movies.
However, in recent times, a very different type of trading has emerged — automated forex trading. Instead of the trader having to handle everything manually, a robot handles this task themselves through an algorithm that has been trained to take certain actions when there are specific market signals.
This saves traders time, opens up the playing field, and reduces the risks of traders making rash decisions due to rash impulses or human biases. However, not all algorithms are made equal, and nobody should put blind faith into an automated system — especially if they don’t know how to trade themselves.
Therefore, the rest of this article focuses on manual trading.
Key Elements of a Trading Strategy
A forex strategy generally contains the following:
- A currency pair. This should be chosen strategically based on the knowledge of the trader.
- Position. The trading transaction made. They can be “long” (your security increases in value when the price increases) or “short” (meaning the reverse is true). The position is closed once the asset is sold.
- Entry point. The price at which you make a trade. Part of trading is choosing an entry point that maximizes your chance of a profit.
- Exit point. The price at which you exit a trade by selling the securities. Again, this is crucial for making a profit.
- Support. A price level below the current market price, at which buyers are expected to buy, turning prices up again.
- Resistance. A price level above the market price, at which traders are expected to sell, turning the price down again.
However, these components are only the bare minimum needed for forex trading. Many traders go way beyond this, which various rules they use to guide them to make the right decisions or indicators they use to inform them.
Developing an Effective Forex Trading Strategy
Now you understand the basics of forex trading strategies, it’s time to dive into how exactly you can develop one that works for you.
Steps to Create a Forex Strategy
The steps to create a forex strategy are as follows:
- Choose your risk tolerance.
- Select a timeframe. Will you be a day trader, a swing trader, or a more long-term trader?
- Evaluate your knowledge and experience. This informs how advanced your strategy should be.
- Decide whether to place a long or short position.
- Choose your currency pair.
Monitoring your position and the market is another major part of trading. Sophisticated forex traders have an in-depth understanding of trends and economic news that will affect the market, which helps them to make predictions.
When to Change Your Strategy
Even if a strategy works well for you initially, there’s no guarantee that it will keepworking forever.
Sometimes, this is beyond your control. The market may change, resulting in a signal no longer being effective. Other times, you might decide you’re not comfortable with the risk level of your strategy due to a volatile market and would prefer to switch to a lower-risk approach instead.
Changing your strategy is generally the smart move in these situations, although you should avoid doing so too often.
Basic Forex Trading Strategy Example
Now, let’s look at the various forms forex trading strategies can take.
Common Forex Trading Strategies
The most simple kind of forex trading is forex position trading, which requires traders to keep a position open and wait until it would be profitable to sell. They’re therefore operating over a long time frame — generally weeks or months, but in some cases it could be years.
Forex scalping is a strategy that focuses on short-term trades. Scalpers frequently buy currency pairs they only hold for a few minutes (or even seconds), aiming to profit from many tiny price changes. In the case of forex trading, scalping often involves leverage, which involves borrowing money from a retail trading platform — helping to boost profits. However, leverage trading also means that any losses will be bigger.
Scalping generally involves trading at the busiest period and with highly liquid currency pairs.
Carry trading is when a trader aims to profit from differences in interest rates between two currency pairs rather than the difference in prices between two currencies. Carry trades can either be positive (buying at a high interest rate and borrowing at a low interest rate) or negative (the opposite). When pursuing a positive carry trade, forex traders hope the currency itself will increase in value.
Advanced Forex Trading Strategies
Those who have an understanding of forex trading already may wish to progress to advanced forex trading strategies. These require an understanding of support and resistance levels, as well as other market indicators.
The “bounce” is a common feature in market performance — it describes the price drops to a certain low level before bouncing back. A bounce strategy aims to profit off this by buying a currency at a low level that it bounced back from in the past, hoping that the same thing will happen again.
A running out of steam strategy is essentially the opposite of the bounce strategy. Instead of focusing on support levels, a running out of steam strategy is all about predicting when prices are about to fall — giving traders an opportunity to profit from shorting. Both strategies require a trader to be able to analyze past activities of the market to predict what could happen in the future based on signals.
It’s also possible for prices to go higher or lower than their resistance and support levels, and breakout and breakdown strategies focus on these possibilities.
A breakout strategy is when prices go higher than their support or resistance levels. When this happens, it means that traders have changed their behavior. It’s no easy task to predict this, but traders who are good at spotting trends have the chance to make a healthy profit.
Similarly, a breakdown strategy can work when traders become more pessimistic and traders are no longer willing to buy at previously resistance levels. In this, traders can benefit from trading.
For a truly advanced strategy, traders could consider an overbought and oversold approach. This relies on math, as traders use an indicator called the Relative Strength Index (RSI). The RSI indicates how quickly and to what extent recent price changes signal that prices are overvalued or undervalued by comparing its strength during different price points.
Traders then look for when the RSI goes below 30% (suggesting an asset is oversold) or above 70% (suggesting it is overbought). These suggest opportunities to profit.
Examples of Forex Trading Strategies
Now that we’ve looked at some examples of basic forex trading strategies and touched on some other frameworks, let’s give some more examples of what these more complex forex trading strategies might actually look like.
First of all, carry trading. Let’s say a trader is trading the currency pair EUR/USD. If they think that interest rates will increase in the US, this would decrease demand for USD, therefore lowering the exchange rate. As a result, by putting a long position on USD or shorting EUR, the trader can make a profit.
Now let’s look at an example of a forex scalping strategy for a trader who is once again trading the currency pair EUR/USD. Traders would want to focus on a period where both the US and EUR markets are open. They would then decide on an entry and exit point for their trade. For instance, if the EUR/USD rate is currently at 1.0520 and the trader expects the value of EUR to increase, you might make an entry order of 1.055 and an exit order of 1.056. This small gain in price would allow the scalper to make a profit.
Learning Forex Trading
There’s a huge difference between reading a few introductory articles or watching a few videos about forex trading and actually diving straight in. There’s a steep learning curve that requires a mix of theory and application — we’ll provide some tips for beginners shortly.
The largest forex trading brokers include:
- AvaTrade
- IG
- Pepperstone
- FxPro
However, it’s best to do your own research and look for a platform with low fees and tight spreads (meaning there’s minimal difference between the rate a broker sells to you and the rate you buy at).
For those who have more trading knowledge and skills, it may also be worth considering platforms that give you more advanced tools, such as charting, automation, real-time alerts, and indicators.
Forex Trading for Beginners
It can be daunting to start forex trading as a beginner, but below, we’ve compiled the best way to help you.
Currency Trading for Beginners
If you’re just getting into forex trading for the first time, it’s best to start with a simpler strategy and smaller amounts of money.
Also, prepare to master your market psychology as well. Forex trading often requires you to make split decisions, which can sometimes lead to foolishness.
Learn to Trade Forex
One of the most effective ways to start learning to trade forex is simply to give it a go. Most brokers offer a demo account, which lets you practice trading without getting real money involved. However, you’ll still see the numbers on the screen as you would during standard trading,
Some traders also find it helpful to learn to trade forex market through copy trading. This is when you follow another trader’s strategies and make the same trades as them. However, if trying this approach, it’s crucial to be careful about who you follow and not to put complete trust in them.
Strategy Modifiers and Adaptations
Even if one strategy works well for you for a few months, it may not keep working forever. Or perhaps you try a strategy that you know worked wonders for an acquaintance and it just doesn’t have the same results for you.
It’s generally necessary to adapt your approach over time depending on the performance of your trades. Below are two ways you can do this.
Hedging in Forex
Hedging is a way that investors and traders reduce their risk exposure.
One way you can achieve this is by holding a long and a short position at the same time. This way, if the currency gains in value, you can fall back on the long position — or, if the opposite happens, you can fall back on the short position.
Of course, this also means that you reduce your profit, so it’s not something to employ all the time. Instead, it’s best to hedge selectively when market conditions warrant it. This can also be a way to figure out what the market is doing to adapt your approach over time.
Price Action Forex Trading Strategy
Price action forex trading is a way of gradually adapting an existing strategy over time and using various aspects of technical analysis, with a focus on price. This is different from many other strategies, which focus on using indicators or predicting trends (such as through the news).
For instance, candlestick charts show the emotions of traders by allocating different colors to represent the size of movements. The chart consists of “candlesticks” that have a real body showing the range between the open price and close price for a day of trading, and vertical lines above and below that show the high and low prices for the day.
This gives a visual representation of the markets that traders can use to deduct future price movements.
Summary of Key Points
- A forex trading strategy consists of a currency pair, a position, entry and exit points, and additional rules and indicators.
- To make a strategy, you need to know your risk tolerance, preferred trading timeframe, and level of experience.
- Some basic fx trading strategies include position trading, carry trading, and scalping.
- More advanced strategies include bounce strategies and breakout strategies.
- Hone your approach over time
Final Thoughts on Forex Trading Strategies
Forex trading isn’t for the faint of heart. But for those who are committed to getting it right, a solid forex trading strategy is essential. You can start to develop your own by figuring out what kind of trader you are and hone your approach over time depending on their effectiveness.
Remember — this is a forex trading journey. You’re not going to one day find the perfect strategy and use it forevermore. Instead, expect to continually hone and adjust your approach.
