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The Best Forex Strategies
The global forex market, being the world’s most liquid financial market, offers many exciting opportunities for traders to profit from exchange rate fluctuations and the development of sophisticated online foreign exchange trading platforms in recent years has attracted many traders to the market – traders who seek an income in addition to their day job or those who wish to trade a new market besides stocks and futures.
Is there a 100% winning strategy in forex?
No, there is no 100% winning strategy in forex trading. Forex trading involves inherent risks, and no strategy can guarantee 100% success due to the unpredictability of currency markets. Traders should focus on risk management, diversification, and continuous learning to improve their chances of success.
TABLE OF CONTENTS
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Trading Forex Strategies
Find out why the forex market is constantly growing, and why an increasing number of people are turning to trade this particular asset class in their quest to accumulate wealth. For those who are new to trading, take a look at the differences between investing and trading, and the various choices of trading time frames.
Spot Forex Market Structure
The forex market has long been the exclusive playground of the big players, namely banks, institutional investors and hedge funds. But the playground is no longer restricted to just them; individuals can also participate in this speculative game. However, independent forex traders can be disadvantaged in some ways due to how the spot forex market is structured. It is essential to know where you, the trader, stand in the overall big picture.
How to Overcome the Odds of Trading Forex
How are you going to tackle the odds that are stacked against you from the start in the forex trading business? In this chapter, I will highlight the three Ms that have brought me success in this field: Mind, Money and Method. Many traders, especially the inexperienced ones, are too fixated on finding the perfect trade setup, the perfect trading system or the strategy that never fails, thus neglecting the other more important aspects that are crucial to good trading performance.
The 10 Rules of Forex Trading
I list here ten rules that I think are important for trading forex. I have split the list into five Dos and five Don’ts.
Dos
- When trying out a new trading strategy, always test it in a demo account, or with a small amount of money, before you commit more money to it.
- Always keep a record of each of your trades, with details of: why you got in, how you got out and why it turned out the way it did.
- Have a personalised trading plan and update it as you learn from the market.
- If you are unsure of a trade, stay out. It is better to miss an opportunity than to have a loss.
- When trading, keep up-to-date with both the fundamentals and technicals affecting the market. A trader in the dark is a trader in the red.
Don’ts
- Don’t trade with money you can’t afford to lose! It will affect you emotionally, and you will most likely lose it to irrational trading.
- Don’t follow someone else’s trading advice blindly. Always know why you are getting into a trade, and how you are going to get out of it.
- Don’t be concerned about being right. Just be concerned about being profitable.
- Don’t over-leverage. Chances are that your account will be decimated before you can recoup your losses and go into profit.
- Don’t revenge-trade the market. Vent your frustrations elsewhere after a loss.
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Strategy #1: Market Sentiment
Market sentiment is simply what the majority of the market is perceived to be thinking or feeling about the market – it is the most important factor that drives the currency market. This is so because traders tend to act based on what they feel and think of certain currencies, regarding their strength or weakness relative to other currencies.
I will assume that when you trade currencies, you don’t blindfold yourself to simply pick any pair to buy or sell, leaving it to randomness to determine your profit/loss statement at the end of the day or month. Market sentiment sums up the overall dominating emotion of the majority of the market participants, and explains the current actions of the market, as well as the future course of actions of the market.
The trend adopted by the forex market is actually a reflection of the current market sentiment, which in turn guides the trading decisions of other traders, whether they should long or short a currency pair. In the process of making educated trading decisions, traders have to weigh a multitude of factors which could influence the bias of a currency, before making up their minds about the current and future state of certain currencies.
One thing to note is that market sentiment is not logical; it is primarily based on traders’ emotions, which is really one of the greatest, if not the greatest, factor in the determination of a currency exchange rate. There are three main types of sentiment when it comes to forming opinions in the forex market:
1. Bullish,
2. Bearish or
3. Just plain confused
If the majority of the market wants to sell that currency, the market sentiment is deemed to be bearish; if the majority wants to buy that currency, the market sentiment is bullish; and when most market participants are unsure of what to do at the moment, the sentiment ends up being mixed. Since the US dollar is the currency on the opposite side of 80% of all foreign exchange transactions, most traders will be concerned with what the market thinks about the US dollar.
Currency prices simply embody the market’s perceptions of reality and the sum total of traders’ emotions. Market sentiment acts like a fickle lover, capable of changing its mind based on certain incoming new information which can upset the existing sentiment. One moment everyone could be buying the US dollar in anticipation of a stronger dollar; the next second they could all be dumping it as they fear the dollar would start to weaken due to the impact of some new piece of information, which is almost always some fundamental news.
Strategy #2: Trend Riding
Many traders live by the often-repeated “the trend is your friend until the end” rule; they are comforted with the knowledge that they are with the majority of the market. Being able to ride on a trend is making full use of the wind direction to steer your ship towards your destination. For a ship to go against the wind requires a tremendous amount of effort – one has to fight the stubborn resistance from the opposing wind.
Indeed, for most of the time, it pays more to be on the side of the current trend than to go against it. In the forex market, trend riders can capture any trend regardless of whether it is rising or falling in an attempt to generate trading profits. Forex tends to have quite trending markets, regardless of which time frame you are looking at – trends are often formed on hourly, daily or weekly charts.
This is due to the fact that currency price movements are very much influenced by the underlying macro economic factors which in turn shape the market players’ views of where currency prices should be heading. With trends possibly having a long lifespan stretching to months, or even years, it is no wonder that many traders and fund managers exalt the strategy of hitching onto trends, with the glorious aim of capturing enormous profits from start to finish.
Trend riding is one of my favourite trading approaches, and I often ride the uptrend or downtrend after the trend has been established, rather than anticipating the move before it happens. I would say that even though the trend is your friend most of the times, one has to use a variety of methods to distinguish between a continuation of the trend and a possible trend reversal. But before you can ride on trends, you first need to identify what the current trend is, and to determine the time frame of the trend.
Stages of a Trend
Execution
- First determine how long you wish to ride the trend for because that will influence the time frame of the trend you will ride on.
- Make sure that the current market sentiment agrees with the technicals. If not,
- Note the gradient of the trendline in both time frames and the number of times it has been tested.
- Confirm trend direction and trend strength with oscillators.
- Enter a limit entry or market entry order based on the hourly or daily trendline, depending on your preferred time horizon.
- Place stop-loss orders at least 20 pips on the other side of the trendline. I will now go through these steps with you with a more detailed explanation of what to look out for when adopting this strategy.
Strategy #3: Breakout Fading
I have increasingly noticed that obvious support and resistance levels on the currency price charts tend to provide the best opportunities for fading breakouts, although it is not always the case. This is not surprising, given the fact that the most well-recognised price levels or chart patterns will be detected by the majority of traders.
Almost everyone is taught the same aspects of technical analysis from books or other sources, and new traders are the ones who tend to most eagerly follow trade recommendations stemming from the formation of certain chart patterns on the currency price charts. Retail traders like to trade breakouts, but institutional, or the more seasoned traders, prefer to fade breakouts, doing exactly the opposite of what the majority is expected to do.
That is one of the main reasons why most breakouts fail – the institutional or seasoned traders taking advantage of the crowd psychology of the retail or inexperienced traders, and winning at their expense. Our strategy is to trade in the direction of institutional activity, by fading breakouts.
Market makers have the information of where their customers’ orders are from their order book. Even if these big players have good intentions, they could still potentially trade against you so as to cover imbalanced trades or to supply liquidity to the market. Of course, trading to maximise profits of their internal accounts cannot be ruled out. A potential conflict of interest can thus exist, and retail traders must know that in order to know how to protect themselves. After all, market makers exist to give profit to their share-holders, not to their customers.
When big players go on a stop hunting spree, false breakouts are likely to be the consequence of that. The crowd may think that the false breakout is due to the sudden turning of the market, but it is most likely the direct result of the games that big players play. Taking out stops placed by the crowd at predictable levels serve their monetary interests. Retail traders must know what these big players are doing. or are thinking of doing in order to join in their game of scooping up money from the majority of the crowd.
False breakouts also arise when market makers execute stops before the interbank market has reached those prices or execute stops that lie just outside the actual trading area. Sometimes you may see that prices have pierced slightly through the breakout level in intraday charts, or even longer-term charts like the daily charts, and then make a quick U-turn back into the pre-breakout price zone.
False breakouts do not just happen because of the tricks institutional players use; they could also be the result of the market running out of steam to reach higher highs or lower lows in a sustained price break. This situation occurs when there are not enough fresh buyers to sustain an upward price move or fresh sellers to sustain a downward price move. The lack of new blood into an already very long or short market often heralds an unexpected turn of the market as the market move becomes attenuated.
Technical Execution
Place a limit or market entry order a few pips below a down trendline or above an up trendline in order to catch the potential bounce. If you are a more aggressive type of trader, you may choose to stagger your entry by placing another order a few pips after the breakout. This is a form of dollar-cost averaging whereby the average cost of entry becomes more favourable for either your long position (fading a downside breakout) or short position (fading an upside breakout). Staggering your entry points can help to optimise your overall cost of entry, and it must be done according to a proper money management plan. Stops should be placed at least 20 – 30 pips beyond the support or resistance, outside of the price zone.
Strategy #4: Breakout Trading
When a price attempts a breakout of a significant support or resistance level, it signals a change in the balance of supply and demand, and such a change may be triggered by a change in market sentiment, or a renewed resolution of bulls or bears of a currency pair, or the unfolding of certain fundamental events. Successful breakouts must be accompanied with a strong surge of momentum in the direction of the price breakout.
Price breakouts can be categorised into two main types:
1. continuation breakouts, and
2. reversal breakouts.
According to the basic tenet of technical analysis, one should always assume the underlying trend to continue unless proved otherwise, and it is no exception in this case.
Continuation Breakout
Reversal Breakout
Sometimes, a current trend may be near its last stage, and could be in the process of reversing as the hype fuelling the trend is extinguished. In such a situation, a breakout could lead to a trend reversal and the beginning of a new trend, hence it being a reversal breakout.
Technical Execution
- Is the currency pair approaching a trendline drawn on the hourly or daily chart? Depending on your holding time frame, you may trade a trendline breakout based on the hourly or daily chart.
- Note the gradient of the trendline.
- Confirm price momentum with the MACD or RSI. The oscillator should preferably be sloping up strongly before the currency pair attempts an upside breakout, or sloping down strongly before the pair attempts a downside breakout.
- Check for reversal chart pattern formations on the hourly and daily charts.
- Wait for the price to close beyond the trendline on an hourly chart.
- Enter a market or stop entry order once the price moves a few pips past the breakout level.
- Your stop should be placed according to how long you intend to hold the position for. Those who prefer a tight stop may place it close to the breakout level in the pre-breakout zone. Alternatively, you may place your stop on the other side of the previous intraday range.
- Your profit target, depending on how long you wish to hold your position open for, could be the next barrier in the form of a trendline or price support or resistance.
Strategy #5: Decreased Volatility Breakout
Trading breakouts is undeniably one of the most popular ways of profiting from the forex market, and an earlier chapter has been devoted to the Breakout Trading Strategy. In this chapter, I will discuss one of my favourite subsets of breakout trading – the Decreased Volatility Breakout. While this strategy is similar to the strategy of trading breakouts, it is specific to a certain condition in the forex market.
Pull up any currency price chart and you will notice that currency movements can be quite volatile as they often fluctuate even in the midst of a trending phase, rallying at one moment and declining the next, or vice versa. Volatility is a measure of the scale of price fluctuations over time. Volatility tends to be high when prices change to a large extent within a short period of time. The reverse is true – volatility tends to be low when prices oscillate more or less close to a certain price level, without deviating much in a short period of time.
It is indeed the volatile nature of the forex market that draws risk-seeking traders and investors to it in search of high profits, for prices have to move by a decent amount in order for profits to be reaped. However, entering the market when prices are experiencing high volatility can be bad for your health – as you face the stress and worry of whether the trade will go your way as prices move up and down sharply.
Strategy #6: Carry Trade
A carry trade is a long-term fundamental trading strategy that involves the selling of a certain currency with a relatively low interest rate, and using the funds to buy a currency which gives a higher interest rate, with the hope that the high-interestrate currency will appreciate against the low-interest-rate-currency.
When these positions are held overnight, carry traders are paid interest on the currency they are long in, and must pay interest on the currency they are shorting. The interesting aspect of this strategy is that the investor or trader is able to gain the difference between these two interest rates, known as the interest rate differential or spread, which can be a hefty amount when leveraged.
A Basic Carry Trade Strategy
- Buy a currency with a high interest rate, and
- Sell a currency with a low interest rate
Currencies and interest rates
- Currencies with typically high interest rates: GBP, NZD, AUD, CAD
- Currencies with typically low interest rates: JPY, CHF.
The Japanese yen and the Swiss franc tend to be on the selling side of the carry trade due to their traditionally low interest rates. Such low-interest-rate currencies are known as funding currencies since they are used to fund the purchase of high interest rate currencies such as the British pound, the New Zealand dollar or the Australian dollar which tend to have high interest rates.
Example: Carry Trade
Here is an example of a carry trade. Let’s say the Japanese yen has an interest rate of 0.25%, and the New Zealand dollar gives an interest rate of 7.25%. Since the New Zealand dollar has a higher interest rate than the Japanese yen, a trader who wishes to profit from a carry trade may buy the New Zealand dollar and sell the Japanese yen at the same time.
An annualised profit of around 7% (7.25% – 0.25%) may be reaped from the carry trade if no leverage is used. This return is based on the assumption that the exchange rate between the New Zealand dollar and Japanese yen remains unchanged throughout the holding period of one year. If that carry trade is carried out with a 10 times leverage, it will increase the unleveraged 7% annualised return to a huge 70% annualised return. The conventional notation of currency pairs is such that JPY and CHF tend to be the counter currency while GBP, NZD and AUD tend to be the base currency in a currency pair.
Hence, traders who are interested in carry trades will long currency pairs like GBP/JPY, AUD/JPY or NZD/CHF, effectively buying the first currency in each pair (which also tends to be the higher-yielding currency) and simultaneously selling the second currency in the pair (which tends to be the lower-yielding currency). Since they are trading these currency pairs in the long direction, they will want the base or highyielding currencies to strengthen in value against the counter or lowyielding currencies.
Points of Entry
Once you have evaluated the fundamental factors that are supportive of a profitable long-term carry trade, the next thing to do is to look at the technical picture of the carry pair that you are interested in (or you can check out the technical outlook first before assessing the fundamental factors). Open up the daily or weekly chart of the pair and see how it has been moving over the intermediate and long-term time frame. Has it been moving in an uptrend, downtrend or sideways? If the overall fundamental picture looks supportive of a carry trade, you may position yourself for a possible uptrend by buying near price or trendline support levels or by trading upside breakouts.
Since carry pairs could be trending upward for quite a while, they make good candidates for trading trendline or price support bounces. Exercise extra caution when you see that the currency pair has been trending south over the intermediate and long-term time frame because that clearly shows a gradual liquidation of long positions by carry traders and investors. In that case, the Carry Trade Strategy is not recommended for that currency pair at that time.
Strategy #7: News Straddling
News that is of great importance to forex traders is generally related to a country’s economic, monetary and political situations, and socio-political events that are happening around the world, with special attention on the Middle-East and isolated countries in Asia like North Korea. The underlying reason why news is so important to forex trading is that each new piece of information can potentially alter the trader’s perceptions of the current and/or future situation relating to the outlook of certain currency pairs.
When people’s opinions or beliefs are changed, they tend to act on these changed perceptions through buying or selling actions in the forex market. Based on the news, these traders will be preparing to cover their existing positions or to initiate new positions. A trader’s action is based on the expectation that there will be a follow-through in prices when other traders see and interpret the same news in a similar way that he or she has, and adopt the same directional bias as the trader as a result.
News is a very important catalyst of short-term price movements because of the expected impact it has on other market players, and this is in a way an anticipatory reaction on the part of the trader as he or she assumes that other traders will be affected by the news as well. If the news happens to be bullish, say for the US dollar, traders who react the fastest will be among the first to buy the US dollar, followed soon by other traders who may react slower to the news or are waiting for certain technical criteria to be met before jumping onto the bandwagon.
And there will be those who join in the buying frenzy at a later stage when they get hold of the delayed news in the morning newspapers or from their brokers. This progressive entry of US dollar bulls over a period of time is what sustains the upward move of the US dollar against another currency, with the USD exchange rate going higher against other currencies.
The reverse is true for bearish news, traders will sell because they know that others will soon be selling, thus pushing the USD exchange rate down. This is based on the assumption that since other traders will be getting the same pieces of news, they will be also tend to be affected the same way. Publicly released news is disseminated to the various newswires. Any trader with access to these wires can tap into the information given out, and react accordingly in the forex market.
However, institutional players do get information that retail traders don’t, as they get privy access to order book information in their computer systems, and may also know something that others don’t through their personal contacts in the industry. In the world of forex trading, there are no rules or restrictions against insider trading! Anyone who possesses information that is known only to a select few can and do trade that information in the forex market.
Sometimes, such news may give an unfair advantage to these institutional players, but at other times, this isolated news access may not translate into real market action if other players do not have that information. Think of it this way: The forex market is dependent on news, for if there is no news, there would be little or negligible price movements in the market. Even if currencies may move according to the technicals sometimes, the technicals have been established previously by news or expectations of future news, and so the influence of news on currency prices is inevitable and inescapable.
Major Economic Data Releases
Here is a general list of economic news that is of significance to the market, especially if they relate to large economies such as the US or the Euro zone (they are not listed in the order of importance):
- Unemployment
- Interest rate decision
- Inflation
- Consumer confidence
- Trade balance
- Home sales
- Industrial production
- Retail sales
- Manufacturing
- Business sentiment
Some news announcements are more important than others, depending on which country the news is related to, the other economic news that is released at the same time, as well as depending on the current hot theme that keeps most financial journalists on their toes, and gets them talking. You can usually get a sense of this by catching up on news reports or analysis distributed by electronic or traditional news media. The theme could change from week to week, or from month to month, or from year to year, depending on the state of the country’s economy. For example, trade balance data in the current month may be more important than the unemployment rate, and in the following year, interest rate decisions may become more important than the trade balance figure.
DATA
RELEASED BY
URL
Non-Farm
Payroll
Released by the US
Department of Labour –
Bureau of Labor Statistics
www.bls.gov
Personal
Consumption
Expenditure
Released by the US
Department of
Commerce-Bureau of
Economic Analysis
www.bea.gov
(Under “Personal
Income
And Outlays”)
US Trade
Balance
Jointly released by the
Bureau of the Census and
Bureau of Economic
Analysis
www.bea.gov
(Under “U.S.
International
Trade in Goods
and Services”)
Treasury
International
Capital Flow
Released by the US
Department of the –
Treasury
www.ustreas.gov
FOMC Rate
Decision and
Minutes of
Meeting
Announced by the
Federal Reserve
www.federal
reserve.gov/FOMC
/default.htm
#calendars
DATA
RELEASED BY
URL
Non-Farm
Payroll
Released by the US
Department of Labour –
Bureau of Labor Statistics
www.bls.gov
Personal
Consumption
Expenditure
Released by the US
Department of
Commerce-Bureau of
Economic Analysis
www.bea.gov
(Under “Personal
Income
And Outlays”)
US Trade
Balance
Jointly released by the
Bureau of the Census and
Bureau of Economic
Analysis
www.bea.gov
(Under “U.S.
International
Trade in Goods
and Services”)
Treasury
International
Capital Flow
Released by the US
Department of the –
Treasury
www.ustreas.gov
FOMC Rate
Decision and
Minutes of
Meeting
Announced by the
Federal Reserve
www.federal
reserve.gov/FOMC
/default.htm
#calendars
There is such a huge selection of events that occur every month which you can take advantage of to make some good profits. Thus, it is useful to keep track of what news and events are the most talked-about and anticipated in the forex market. If certain themes keep rearing their heads in analysis or commentary reports, then you should be aware of any economic data or speeches relating to these themes for they are very likely to have a significant impact on certain currency pairs. News which at the moment is seen as market-moving could have less impact over time, depending on the economic condition of the country they relate to.
The News Straddling Strategy enables traders to take advantage of important events and to profit from them, without needing to rely on any in-house analysts or economists to say what will happen to currency prices if the actual number comes in how many points more or less than the consensus. Hence, time is not wasted in deciphering whether the news is bullish or bearish, as the core of this strategy is to get in and out of the market quickly without slippage. As with all the other strategies, there is always room for you to modify and customise this strategy to suit your personal trading style and preference.