Types Of Forex Trading Strategies
Although there are numerous forex trading strategies today, the main ones are either fundamental/or technical. Let’s define each of these strategies first before diving deeper.
Definition: Fundamental Forex Trading Strategies
Fundamental forex trading strategies refer to all forex trading strategies that are based on current events/news. Forex markets are moved by many factors the most notable being current events/news especially those that have an impact on the economy such as employment, interest rate, GDP and inflation news.
Definition: Technical Forex Trading Strategies
These kinds of forex trading strategies originate from forex charts. Forex traders who use these strategies study forex charts using a number of indicators to be able to identify suitable buying and selling points. Sometimes news events can’t be able to tell the direction of the market with accuracy. This is where technical forex trading strategies come in handy.
There are many forex trading strategies which use either fundamental or technical analysis. It is also important to note that some strategies utilize both while others are purely speculative or independent of both fundamental and technical analysis. Let’s first focus on the two main strategies.
A. Fundamental Forex Trading Strategies:
1. Trading The News
To trade using this strategy, simply follow economic news. This is by far one of the most common fundamental forex trading strategies today. As the name suggests, this strategy involves placing trades based on live news events.
Big news announcements from different countries especially the most developed countries have a significant impact on forex market. News on GDP, unemployment rate, inflation, interest rates, home sales, trade balance etc. have a significant impact on forex market.
When trading the news, forex traders are interested in determining whether the news is bad or good for a given currency. For instance, if the U.S. unemployment report comes out at a specific time and indicates that the U.S. has added a significant number of jobs in a particular month, this is good news for the U.S. dollar which simply means forex traders should buy U.S. dollars.
The opposite also applies. If the unemployment news in the U.S. indicates that the unemployment rate has risen, this is obviously bad news for the U.S. dollar which simply means forex traders should sell U.S. dollars.
Trading the news is one of the most direct forex trading strategies in use today. It is however important to make some considerations when trading using this strategy.
For instance, some news events may already be factored in the price resulting in little or no price action. For instance, if the unemployment rate in the U.S. has been improving, a further improvement is expected especially if analysts say so. As a result, news indicating a slight improvement won’t have a great impact.
Furthermore, analysts always give projected figures before live news events on employment so it’s important to place trades only when the unexpected happens i.e. the U.S. adds more jobs than expected.
It is also important to combine this strategy with some technical analysis as will be discussed below to increase the probability of profiting since the market may have already priced some news before the actual news event.
Although most large economies are bound by law to announce major economic news at specific times so that everyone gets the news at the same time, traders can predict what the news will be in some instances using market sentiment. This trading strategy must therefore be used alongside other strategies.
It is also important to take into account other kinds of news such as natural disasters and emergencies/conflict news which also affect forex markets.
Such news many not be anticipated or scheduled in the forex calendar despite having a serious effect on forex markets. An earthquake for instance is bad for the currency of the country in question. It is therefore important take into account such eventualities.
When trading the news, you need to have access to the forex calendar to be able to schedule your trades. The forex calendar is a calendar that highlights all crucial global news that have an impact on forex markets.
2. Fair Value Trading
How do you trade using this strategy? Calculate the fair value of a currency after major economic news.
This forex trading strategy focuses on assessing the fair or real value of a country’s economy in an effort to discover the fair value of the currency of that country. Due to the presumed complexity of estimating the real/fair value of a country’s economy, this strategy is used mostly by seasoned forex traders.
The fair value trading strategy utilizes economic data as well as other factors such as political stability to gauge the size of a country’s economy. The resulting data is compared against the data of another country to asses which country has a stronger economy or shows serious prospects of having a stronger economy in the future.
The fair value trading strategy takes a long-term approach. Using current major news, forex traders can tell which currency has an upper hand in any given currency pair at any given time.
3. Carry Trading
How do you carry trade? Follow interest rate news.
This fundamental forex trading strategy allows forex traders to profit in stable markets. Carry trading doesn’t rely on price movements between any two currencies but rather on differences in interest rates. When you choose to carry trade, you must wait for interest rate news and buy the currency with the higher interest rate. Some considerations must however be made.
For example, there must be an expected interest rate hike on the currency you intent to buy and a corresponding interest rate drop in the currency you want to sell. This consideration maximizes profits.
This fundamental strategy is very profitable but applicable rarely since there must be a sideways movement in rates coupled with a slight price change. Some of the most popular currency pairs for carry trading include; EUR/JPY, AUD/JPY, AUD/USD and NZD/USD since these currency pairs represent stable economies with low-risk currencies.
4. Trading The Market Sentiment
How do you trade using market sentiment? Just follow the market direction after a major news event.
This is another common fundamental trading strategy. This forex trading strategy is common during unpredictable markets. It is important to note that both technical and fundamental analysis can give crystal clear signals on where the market should go but the market still decides to move in the opposite direction.
This is usually the case after major news events. When this happens, some traders chose to still participate in the market. Since they can’t trade based on their fundamental or technical analysis because they will lose, they choose to trade the market sentiment.
This strategy is risky for obvious reasons i.e. you decide to follow the market based on the current market sentiment which can change at any time. Nevertheless, trading based on market sentiment can result in handsome profits since the trend in question is usually very strong. It is therefore important to learn how to detect market sentiment.
In most cases, market sentiment is identifiable as a strong uptrend or downtrend that defies technical and fundamental analysis. You can also tell the market sentiment from price action i.e. by observing how fast the price of a currency pair moves in either direction. The favored direction should tell you what the market sentiment is especially after major news.
5. Volatility Trading
As the name suggests, this forex trading strategy focuses on volatility. Traders using this strategy focus on taking advantage of extreme volatility. One of the most common causes of extreme volatility is major news events.
When the market is reacting after a big news event, there are numerous opportunities for making quick profits. This strategy is however risky for obvious reasons. It is therefore advisable to use tools for protecting your account i.e. a stop loss to avoid huge losses in cases a trend reversals or breakout happens.
Although volatility trading is usually a short-term strategy, it may be applied long-term when the current as well as future price action appears to be abnormal in comparison to historical price action.
For instance, forex traders usually use this strategy when the current as well as the projected future price action exceeds the historical range. Such instances indicate extreme volatility which offer opportunities for quick profits. It is however advisable to guard against the downside for reasons mentioned above.
B. Technical Forex Trading Strategies:
Technical forex trading strategies can use individual or a combination of technical indicators. Below is a list of popular strategies using either one or more technical indicators:
1. Trading Using Fibonacci Indicator
The Fibonacci indicator is one of the most popular technical indicators and is used in forex trading strategies. The indicator is used to identify possible pullbacks i.e. where a trend is most likely to encounter resistance and pull back.
The Fibonacci indicator is a support and resistance indicator. The indicator utilizes linear regression to identify support and resistance points which indicate a change in trend. When trading using this indicator, you just need to plot the indicator on your forex chart to tell support and resistant levels.
2. Trading Using The ADX (Average Directional Index)
As the name suggests, this technical indicator tells the strength of a current trend and is used in forex trading strategies. Many forex traders enter trades when it’s too late i.e. when a trend has lost strength. The ADX is a great indicator for avoiding such instances. By using the ADX, you can be able to tell the perfect time to enter and exit trades.
3. Trading Using The Ichimoku
This indicator shows the support, resistance, momentum and trend directions in forex charts. The Ichimoku cloud utilizes moving averages to plot possible bullish and bearish points in the future. This indicator gives traders a rough idea on what to expect in the future at a glance.
4. Trading Using The MACD
The MACD (Moving Average Convergence Divergence) is another popular technical analysis indicator used to reveal changes in the direction, strength, momentum and duration of trends and is used the MACD in forex trading strategies. simply plot the indicator on your forex chart to assess the direction as well as strength of a trend and place trades accordingly.
5. Trading Using The RSI
From forex trading strategies the RSI (Relative Strength Index) is a technical analysis indicator used to tell the current as well as historical strength or weakness of a certain currency pair based on closing prices. The RSI identifies overbought and oversold levels which are crucial points for gauging momentum.
6. Trading Using Parabolic SAR
The Parabolic SAR is a technical indicator that analyses trending markets. The indicator is similar to many moving average indicators. The main difference is; the Parabolic SAR moves at a higher acceleration making it a perfect indicator to use when the forex market is very volatile and trending.
When trading using indicators, you just need to plot an indicator on a graph and take the appropriate action. Forex trading software contains all major indicators so it shouldn’t be a problem using any technical forex trading strategy above.
There are many other technical trading strategies using other technical indicators. There are actually hundreds of technical indicators. It is however possible to craft wining technical forex trading strategies buy using major technical indicators only.
7. Horizontal Level Trading
This is by far one of the most popular technical forex trading strategies in use today. This strategy involves the use of a number of indicators that analyze horizontal levels to understand trends and predict where the market will go next. This strategy utilizes indicators like MACD and Fibonacci which give traders crucial information about horizontal levels in forex charts.
8. Divergence Trading
These technical forex trading strategy utilizes a number of indicators that help to recognize patterns as well as predict new trends. The basis of this strategy is to help traders identify new trends and get into the market just before a change in trend happens. Indicators such as the MACD, stochastic oscillator and the RSI are very instrumental in crafting divergence trading strategies.
9. Combo Technical Trading
This type of technical trading strategy utilizes a combination of numerous indicators in an effort to find out what works in a given situation. Since different technical forex trading strategies can give conflicting trading signals, this type of technical trading comes highly recommended. When combo trading, use as many indicators as possible before you decide to take a trade.
C. Other Forex Trading Strategies:
There are many other forex trading strategies you can utilize that may not be distinctively technical or fundamental. Most of these strategies are a combination of both fundamental and technical analysis. Others are simply speculative while others are purely independent and centered on factors such as money management. Below is a discussion of some of these forex trading strategies:
1. Arbitrage Trading
Arbitrage trading is one of the oldest speculative forex trading strategies used by forex traders to date. This strategy focuses on identifying market inefficiencies and profiting from them. For instance, a forex trader may focus on identifying two similar currency pairs which show inconsistencies when they shouldn’t.
It’s important to note that forex markets have inconsistencies like any other markets. There will always be instances where a currency pair is undervalued or overvalued given current news/fundamentals as well as other factors such as quote differences given by different brokers. Such instances create opportunities for making profits.
It is however important to note that this strategy requires a considerable amount of resources i.e. the best/quickest forex technologies/systems for it to work effectively. The forex market has many arbitrage players whose sole work is to identify inefficiencies and profit from them.
These players utilize highly efficient technologies. They also have access to large amounts of resources since most market inefficiencies offer small profiting margins. As a result, it is important to use this strategy when you become a seasoned trader or when you get access to the best forex arbitrage systems in the market.
2. Price Action Trading
This forex trading strategy is solely based on price action as the name suggests. As a result, the trading strategy is somewhat speculative. Most traders who use price action to place trades focus on price opening/closing points during short-term time periods.
Candlestick charts offer great price action insights based on open/close points. When the price at any given period closes at a lower point than the initial point, it’s usually a sell signal. The opposite applies. The speculative nature of this strategy calls for a lot of caution. It also requires specific time frames when markets behave predictable.
Stop loss hunting is a great example of price action trading in forex trading strategies. During certain times, the forex market will test stops (known resistance or support levels). In such cases, the market may move predictably until these resistance or support levels have been tested. Institutional forex traders use this strategy.
Retail forex trader can also utilize this strategy by identifying when stop loss hunting is taking place. When trading using price action, it is important to place your stop loss away from the nearest support/resistance levels otherwise your trades can be automatically closed at a loss.
3. Trading Using Forex Robots
This is another forex trading strategy used by forex traders (mostly novice traders) who want to profit from trading without being actively involved in the actual trading process.
Such traders use forex trading robots (software) that automatically detects favorable market conditions placing trades automatically. When trading using forex robots, you don’t need to keep up with news or do any technical analysis.
All you need to do is open a live account and link it to a suitable forex robot. It is however important to note that forex robots don’t guarantee profits. This makes this trading strategy very risky. You can easily lose your money. It is actually better to invest your time and money to learn how to trade yourself.
4. Managed Account Trading
This forex trading strategy involves hiring seasoned forex traders to trade for you in exchange for a commission and/or a percentage of any profits made. There are many seasoned forex traders as well as forex brokers offering managed account trading services.
You can trade using this strategy when you want to trade but lack the time to learn so you choose an expert to trade for you. There are obvious limitations to this strategy i.e. you share profits only, not losses. Also, you are not guaranteed of making profits.
Forex scalping is another popular speculative strategy based on short and quick trades repeated many times. This strategy is common in markets characterized by high liquidity and volatility. Scalping also requires traders to use high leverage since trades last for a very short time i.e. a few seconds. To scalp, you just need to open and close trades very fast in a volatile market after doing basic analysis on trend or considering the effects of news events.
6. Basket Trading
This strategy focuses on tradable correlations between currency pairs. For example, there are currency pairs which usually move in the same direction most of the time i.e. the EUR/USD and the GBP/USD. When basket trading, traders open the same position on both pairs. It is however important to note that correlations between currency pairs aren’t 100% consistent at all the times. This strategy should therefore be followed with a lot of caution.
7. Money Management Strategies
Money management is a very important part of forex trading. This is precisely why money management should be part of all forex trading strategies. It is in fact a trading strategy on its own.
It is important to note that most forex traders lose their money because of poor money management strategies and not because of lack of knowledge or expertise about forex trading.
The simple fact that you can trade with over 100 times the actual size of your forex account makes forex trading a very risky endeavor.
Although high leverage increases a trader’s profits significantly on small moves during favorable trades, high leverage can easily wipe out a forex trader’s trading account when the market goes the opposite direction. This is precisely why you need to use prudent money management strategies or simply, control your risk when trading.
Ideally, you should not risk more than 5% of your trading a/c in any given trade. This calls for using tools like stop loss, opening trades using a suitable lot size, trading using the appropriate leverage etc.
A stop loss allows you to set the maximum amount of money you are willing to lose in a trade if the market goes against you. Lot’s allow you to control your profits as well as losses.
For instance, a large lot size allows you to make huge profits or huge losses with small market moves. Using a large lot size may therefore be appropriate when there is low volatility. All in all, you shouldn’t risk a significant amount of money in a single trade since there is no foolproof forex trading strategy.
The above information summarizes all the major forex trading strategies in use today. After going through the above information, you shouldn’t have a problem understanding the various forex trading strategies as well as choosing suitable strategies that match your trading style.
It is also worth noting that you increase your chances of success by combining these strategies. For instance, you shouldn’t just use forex trading strategies based on fundamentals/news since technical analysis also gives an accurate picture of the market.
Charts and indicators are not enough to predict the future direction of the forex market. Unexpected events can happen i.e. war, political unrest (i.e. Brexit), natural calamities etc. that can render technical analysis useless.
This brings forth the importance of other strategies beyond fundamental and technical analysis. For instance, you need to protect your trading account using tools like stop loss. You should also trade with an appropriate lot size/use appropriate leverage.
Also, it is advisable to consider forex trading strategies very important so it is not random trading. In a nutshell, forex trading strategies instill discipline in trading which is crucial for success.
The forex trading strategies must however be used wisely for you to increase your chances of success. This calls for in-depth research into each and every forex trading strategy you consider using in live trading.