Forex Trading Strategies

Fundamental Strategy

Trading Forex on Fundamental analysis is based on the understanding of underlying elements affecting the economy. Traders develop methods and strategies based on the historical data of certain economy conditions to predict the future moevement of the currency prices. Generally, good economy news will move the currency higher, and bad news will move currency lower.

If you like Fundamental trading, you need to learn and understand the economy condition, political situation, government regulation, relevant economic news, etc. The overall health of economy is important especialy like economic growth rates, interest rates, inflation, unemployment level, GDP, etc. For example, if US intends to increase their interest rate, US currency tends to move higher as people holding US currency in bank will receive a higher interest rate. However this is based on theoritical fundamental analysis. In most of the cases, before US announces the increase of interest rate, the US currency will probably have factored in the increased rate a few days or weeks ago. So when the announcement takes place, the US curreny might not move higher.

During the announcing of certain economic news, the currency tends to be more volatile. The reason is that there are traders who think the effect of the news is good, and another group of traders who analalyse that the effect of the news is bad for economy in the short or long term. Of course, unless there is a clear decision that the news is good or bad, it will be a tug-of-war between the traders and cause the curreny to be very volatile.

There are traders who specilize in trading news. They have their own strategies based on their observation of past historical data during the news announcement. They can achieve a substantial gain as well as high risk loss.

Most retail brokers will discourage traders to trade news. During the news anouncement, brokers can increase the currency spread up to 10 times (and sometimes more). (For the reason of why brokers increase the spread, it is discussed in Structure of Forex Borkers). Brokers sometimes freeze the trading server. That is the reason most of the complains about the brokers come from the traders who trade news.

Most traders will not trade fundamental as it is. This Fundamental information will combine with other strategies to make it more effective in predicting where the currency price is going.

Technical Charting Strategy

The Technical Charting strategy is probably the most popular one. Most of the trading strategies or systems in the market are derived from this Technical Chart. For technical chart trading, traders study the price movement and try to predict the future direction of the price.

One of the most popular charting that is widely use by traders is Japanese Chandlestick. (The other less popular is line chart). In order to facilitate in communicating among traders, traders give very create names to certain formation of Candlestick pattern such as hammer, shooting star, spinning top, doji (long legged, dragonfly, gravestone), engulfing, head and shoulder, double bottom/top, etc. Based on this charting pattern, traders will predict on where the next direction of the price movement.

In order to assist the traders in the technical anaylsis, a lot of Forex Indicators are created or invented. Indicators are mathemetical formula where calculation is based on the specific timeframe of historical price data. Based on these indicators, traders will extract certain information to help them in trading decision. Some of the most popular indicators are Moving Average (MA), Moving Average Convergence and Divergence (MACD), Stochastics, Bollinger Bands, Relative Strength Index (RSI), Williams' Percent Range, etc.

Based on the combinations of a few indicators, chart paterns, candlestick timeframe, canddlestick patterns, and a set of specific rules for entry/exit the trade, a lot of trading strategies are created by traders. Some strategies are very simple to understand, and some are very complicated.

For technical chart trading, you need to understand the proper usage of the indicators and the significant of candlestick pattern formation. There are a lot of forum discussion on strategies based on technical charts and indicators. If you are new to Forex trading, you can visit this Forum to find out more. Some traders create their own system after they have enough market experiences in trading. Note that there is no strategy to produce profitable results forever. All these strategies work for certain market conditions, and you need to apply them at the right time. Therefore, you need to have Forex knowledge in order to trade successfully.

Hedging Strategy

There are quite a lot of ways to implement Hedging Strategy in Forex. Most, if not all, are based on these two type of strategies: Hedging on 1 currency pairs with different directions, and Hedging on multiple currency pairs.

Hedging With 1 Currency Pair

This Forex Hedging technique is to open two positions of currency A in different direction (open a Long position and Short position at the same time). The idea is to offset the losses in one position, and by the profit received in another position, no matter where the currency moves. Then, how do we make money from this Hedging technique ?

In order to profit from the this hedging technique, you need to have Forex knowledge, and understand its market movement. The idea is to take a profit from the winning position at certain price level, and wait for the price to reverse back to the (close to) original position, and close the other opened position with break-even or minor lose. For example, we open a Short and Long position at the price of 1.5000. Assuming that the curreny moves up, and it reaches 1.5100. The current status will be: Long position with a 100 pips (unrealized) profit, and the other Short position with a 100 pips (unrealized) lose (ignoring the spread). Based on our Forex knowledge, we know that this currency has almost reached the peak and would reverse back. Therefore, we quickly close the Long positions to realize a 100 Pips profit. As our prediction is true, the currency moves back to 1.5010, and we close the Short position with a realized lose of 10 Pips. Overall, we gain 90 Pips.

To further take an advantage of this hedge technique, we will open a (positive interest) position with the broker who pays interest, and another (negative interest) position with a broker who does not charge interest. If we hold these two positions long enough, we will gain interests. Note that taking Long position on GBPJPY will gain (positive) interest, and Short position on GBPJPY will pay interest.

Hedging With Mutiple Currency Pairs

This type of technique is not 100% hedged, and it is more complicated as we need to understand the characteristics and colleration of those currency pairs. This hedging strategy usually involves 2 or 3 currency pairs. For example, we Long EUR/USD, and Long USD/CHF. The idea is the same as above where we hedge USD. It would be likely that if EUR/USD goes up, and USD/CHF will come down. Therefore, we offset the losing trade USD/CHF with a profitable one EUR/USD. By holding on these two positions, we can collect the interest from both curreny pairs.

Choosing the currency pairs to hedge is important for this strategy. We need to understand the correlation among those pairs. There is aForum discussion on this correlation hedging strategy in details. However, you need to register (free) in order to access the forum.

Grid Strategy

The Grid Trading strategy is to open up two positions (Long and Short) at pre-determined distance price so that when the current price moves (in any direction), you close the profitable position, and re-open a new one with the same price and direction. You let the losing position stay (with no Stop Loss). When the price zig-zag around them, you will make a profit from this strategy.

Let's look at an example for GBPUSD pair with 20 pips distance. We assume that the current price is at 1.9600. We will create the LONG and SHORT limit orders at 1.9620, 1.9640, 1.9660, 1.9680, and 1.9700. At the same time, we will put the LONG and SHORT orders below the price at 1.9580, 1.9560, 1.9540, 1.9520, and 1.9500. Our target profit is 20 pips. When the price moves up, our upper limit LONG orders will get executed, and if it moves fast enough, it will hit our target profit too. We take profit at every 20 pips, and immediately re-open limit LONG orders at the same price. With all these order in place, if the prices moves back again, our SHORT orders will be executed, and take profit again at every 20 Pips. So if the price zig-zag between these price intervals (1.9500 to 1.9700), we will keep collecting profits. Note that we do not have a Stop Loss.

What if the price moves up and up, and does not retrace back. You will lose money in this situation. Worse still, you will probably have a margin call if you do not have enough money. This type of Grid strategy is good for ranging market, but no good for one way (strong) trending market.

There are quite a lot of other variety of Grid trading strategies such as you only Open Long orders above the current price and Short orders below the current price. Other will only open Long orders only, and no Short orders. Some others do not take profit and no stop loss, and they will take profit when overall positions are making money (at pre-determined target profit). In summary, you must know the current market situation, and apply the right Grid technique accordingly in order to make profit.

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Martingle Strategy

The Martingle is a betting strategy made popular in 18th century France. The technique is to always double up when you lose until you win. For example, if you open 1 Lot GBPUSD Long at 1.9600, and put your Stop Loss at 1.9580. When the price hits your Stop Loss, you will open Long again with 2 Lots at 1.9680 with 20 pips Stop Loss (at 1.9560). If it hits your Stop Loss again, you will open Long with 4 Lots at 1.9560 with 20 Pips Stop Loss, and so on. If you keeps losing, you will keeps open the position with 8 Lost, 16 Lots, 31 Lots, etc. Based on the theory of probability, you will eventually win one time, and overal you still win. But you must be able to sustain the game with your big capital. If you do not, you will lose a lot of money. This type of Martingle strategy is very high risk.

Traders have been implementing a few variety of Martingle strategies to reduce the capital. One of the Martingle derived strategy is to put the Stop Loss at 20 Pips and Profit Target at 60 Pips. With these set-ups, you do not need to always double the Lots. For example, if you lose 2 trades consecutively with 1 Lot (40 Pips loss), and win the third trade with 1 Lot (60 Pips as our Target is 60 Pips), you still make 20 Pips profit. Notice that we only trade with 1 Lot. Other Martingle strategy will flip Long and Short. If you start with Long order and hit your Stop Loss, the next trade will be Short order, and the next will be Long again, and so on.

Scalping Strategy

Scalping is a strategy that you try to make a small profit (usually less than 10 pips) many times (with many trades) with small price changes, with each trade usually lasts in a few seconds or minutes. The strategy is used with the understanding that market is in consolidation pattern (side-way) most of the time before it moves into one direction. The best time to trade the scalping is usually during the time before London market opens, or after the US market closes.

The trade-off of scalping is that the reward/loss ratio does not seem to be attractive as you intend to make a very small profit by paying the spread of currency. However, once traders know the currency behavious, it seems to be easy to make a few pips many times than to try to profit from a big trend movement.

Another issue of scalping is with the broker. Most brokers do not like traders to scalp. You should check with the broker if they allow you to use the scalping strategy

Break-out Strategy

Forex break-out strategy seems to be opposite of the scalping strategy where you take the trade when there is a large price movement into a direction. Although Forex curreny price tends to move side-way most of the time, it will eventually moves into one direction. The idea is that once the current break-outs from its range (consolidation), it will have a big price movement into that direction. The best time to trade break-out is usually at the London market open, and London/US market closes.

Beside timimg, you can use other methods to identify the break-out. Most of the common ways to identify break-out are candlestick formation, chart pattern, news break, support-resistance, forex indicators (such as Bollinger Band) etc.

Swing Strategy

The concept of Swing trading is quite similar to Scalping technique except that you are using a bigger range for profit. Therefore, the Swing technique is more friendly to the brokers who does not allow Scalping.

Forex price moves upward and downward and sideway (consolidation) most of the time. The goal is indetify the low and high while the price fluctuates between the range. We then apply the most common technique where you buy low, sell high, and sell high, buy low.

News Trading Strategy

During significant news release (mostly economic news), the currency will have a large movement. Before news realease, we can put a Long (Buy-Stop) order above the current price, and a Short (Sell-Stop) order at certain distance. Once the news release, no matter where the price moves, as long as it moves into one direction, one of our order will be executed. We will then cancel out the other order. As the price moves a lot, we will make a huge profit from this simple strategy.

However, if the price have a big swing up and down and later consolidate, your two pending orders will be executed. You will probably lose both orders. In this case, your risk is low as you are hedged in both direction. But if the price moves into one direction, the profit is huge if you are successful. That is why a lot of traders who like to trade news.

There are some traders who only trade during news release as they claim that it is easy to make money during that time. However, the News Trading strategy has one caveat. Most brokers do not like you to trade during news release. Brokers will increase the spread (sometimes up to 30 to 40 pips), or they freeze your screen during significant news release. Thare is a reason why brokers have to do this. Please read the article Structure of Forex Borkers to find out the reason. In fact, most of the traders' complains about brokers relate to the news trading.

Carry Trade Strategy

Carry Trade strategy is to take advantage of the different interest between two currencies. The idea is to sell the curreny in a relatively lower interest rate, and use it to buy a currency with a high interest rate. For example, taking a Long position of AUD/JPY will earn an interest as AUD interest rate is 7%, and JPY interest rate is 0.5%. At the same time, traders will push the AUD currency high as more demand on the AUD dollars and push JPY currency low as most people sell it. This Carry Trade strategy will be used when the (Financial) market is in stable conditions.

Most traders will use JPY yen as a carry trade as it is popular for low interest rate. Besides, Japanese government does not have intention to strengthen the Yen.

The risk of the Carry Trade is the uncertainty of exchange rate and un-winding. For example, traders will slowly accumulating interest day by day, and push the AUDJPY high for about 6 months. When it is unwinding (reversing the direction), AUDJPY can possibly drop to the original position in a month.

Support and Resistance Strategy

Support and Resistance is probably one of the most important indicator in Forex Trading. As we know, it is impossible for Forex curreny price to move up forever. Forex curreny price tends to swing up and down (either small or big interval). With this characteristics, we can identify support (bottom position) and resistance (top position). If the swing is big enough, there will be a few supports and resistances between the highest and lowest points.

The idea is to buy at the support and sell at the resistance because the price will usually reverse during those levels. Besides using the price of the low and high to form the support and resistance, the most popular indicator to create support/resistance is Fibonacci where it forms the support and resistance at levels 38.2%, 50%, 61.8%, 78.6%, 1.27%, 2.618% of the two points (high and low). Other indicators to serve as support/resistance are Pivot Points, Moving Average, etc.

The price action of the support/resistance is probably more important than all other indicators. There is no necessary to use all support/resistance indicators in your trading. You use only the ones that you feel comfortable.