Maintaining discipline is key to succeeding in Forex trading. One way to ensure that you stay on track when trading currencies is by picking the right trading strategy. If your strategy has been backtested and found to be successful, it gives you confidence and helps you to follow your game plan. A consistent trading strategy also provides you with the right entry signals.
When it comes to picking the best Forex trading strategy, there is no a one-size-fits-all solution that applies to all traders equally. The best strategy for you largely depends on your personality, your trading time frame, and your objectives. Many traders experiment with several strategies before settling on one that produces consistent results.
Your trading time frame is one of the most important things to consider when choosing a trading style. There are four basic trading styles:
1. Scalping-- these are very short-lived trades that last for minutes, or in some cases, seconds. The scalper aims to beat bid/offer spreads and skim off a few points from a trade before it closes. Scalp traders typically use tick charts to quickly jump into breakouts and compress periods of low activity.
2. Day trading-- as the name suggests, these trades are exited at the end of the day to avoid being adversely affected by large overnight moves. Day trades typically last several hours. Day traders use price bars that are usually set to one or two minutes.
3. Swing trading-- these are positions that are held for several days by traders looking to profit from short-term price movements. Swing traders typically use bar charts that show every half-hour interval.
4. Positional trading-- this involves making trades based on long-term trends and major price shifts. A positional trader looks at daily charts at the end of each day.
The best Forex strategies invariably use price action, aka technical analysis. Forex technical analysis consists of two main styles: trend following and counter-trend trading. Both of these styles are all about the trader trying to profit by exploiting price patterns.
The concepts of support and resistance are the key tenets of price action. Support is defined as the tendency of the market to rise from a previous low while resistance is the tendency of the market to fall from a previous high. These two key patterns occur because traders tend to judge subsequent prices from the most recent highs and lows.
There's a self-fulfilling aspect to support and resistance levels because traders anticipate price action at these levels and act accordingly. In short, traders tend to buy when prices approach recent lows and sell when they approach recent highs. That said, it's important for you to remember that:
The markets frequently break out of an established range by moving above a resistance level or below a support level. When the support breaks down and the market moves to a new low, buyers usually begin to hold off. This is due to the fact that traders begin to anticipate even cheaper prices and therefore wait for a new bottom to be reached before resuming buying. At the same time, there are other traders who panic and start selling or are forced out of their existing positions. This trend usually continues until the selling pressure is depleted and traders start believing that prices will not fall any further.
Trend-following strategies involve buying once the price has broken through a resistance level and selling once they have fallen through a support level. This system of Forex trading has the good potential for success due to the magnitude of moves involved. Trend-following traders use indicators to tell if a new trend is on the verge of being established, though there is no way to do so with 100% certainty.
The indication that a new trend could be beginning to get established is referred to as a breakout. For instance, a 20-day breakout to the upside means that the price has gone above the highest high over the past 20 days.
Becoming a trend-follower requires a tough mindset because there are likely to be long durations when profits disappear due to market swings. Trends tend to be more disguised when the markets are volatile, meaning trend-following is best when Forex markets are quiet and generally trending in one direction.
A simple but useful trend-following strategy is Donchian Trend, so-named after futures trader Richard Donchian. Donchian Channels are used as indicators of trends that are being established. A 20-day Donchian channel breakout suggests one of the following two options:
But there's a bit more to it.
There's an additional rule that is designed to filter out breakouts that can sometimes go against the long-term trend. The rule is that you should also take into account the direction of the 25-day moving average and the 300-day moving average. If the shorter-term moving average is higher than the longer-term moving average, then go long. If it's lower, then short.
You should exit trades the way you enter them, the only difference being that you should use the 10-day breakout. This in effect means that you should sell if the market moves below the low for the prior 10-days.
Counter-trend strategies are based on the simple premise that most breakouts do not develop into long-term trends. A trader using a counter-trend strategy seeks to take advantage of the tendency of prices to bounce off previous highs and lows. In short, counter-trend strategies rely on support and resistance levels holding, as they tend to in many cases.
There is, however, a big downside risk when a breakout happens and prices move below previous support levels or above previous resistance levels. That's why it's important to constantly monitor the markets for any signs of breakouts. Counter-trend Forex strategies are best when the markets are volatile with strong price swings within a constrained range.
There are many types of technical indicators in the market today. Further, great advances in online trading technologies have now made it possible for traders to develop their individual indicators and trading systems. Nonetheless, the best starting point is by using simple and well-established strategies.
Ultimately, discovering the best Forex strategy for you is more a matter of trial and error rather than an exact science. Luckily, by using a demo account, you can test several trading systems without having to risk your capital.