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What is a Forex Trading Strategy?
A forex trading strategy is a technique used by a forex trader to determine whether to buy or sell a currency pair at any given time.
Forex trading strategies can be based on technical analysis or fundamental, news-based events. The trader’s currency trading strategy is usually made up of trading signals that trigger buy or sell decisions. Forex trading strategies are available on the internet or may be developed by traders themselves.
KEY TAKEAWAYS
- Forex trading strategies are the use of specific trading techniques to generate profits from the purchase and sale of currency pairs in the forex market.
- Manual or automated tools are used to generate trading signals in forex trading strategies.
- Traders working on their own trading systems should backtest their strategies and paper trade them to ensure that they perform well before committing capital.
Basics of a Forex Trading Strategy
Forex trading strategies can be either manual or automated methods for generating trading signals. Manual systems involve a trader sitting in front of a computer screen, looking for trading signals and interpreting whether to buy or sell. Automated systems involve a trader developing an algorithm that finds trading signals and executes trades on its own. The latter systems take human emotion out of the equation and may improve performance.
Traders should exercise caution when purchasing off-the-shelf forex trading strategies since it is difficult to verify their track record and many successful trading systems are kept secret.
Creating a Forex Trading Strategy
Many forex traders start with a simple trading strategy. For example, they may notice that a specific currency pair tends to rebound from a particular support or resistance level. They may then decide to add other elements that improve the accuracy of these trading signals over time. For instance, they may require that the price rebound from a specific support level by a certain percentage or number of pips.
There are several different components to an effective forex trading strategy:
- Selecting the Market: Traders must determine what currency pairs they trade and become experts at reading those currency pairs.
- Position Sizing: Traders must determine how large each position is to control for the amount of risk taken in each individual trade.
- Entry Points: Traders must develop rules governing when to enter a long or short position in a given currency pair.
- Exit Points: Traders must develop rules telling them when to exit a long or short position, as well as when to get out of a losing position.
- Trading Tactics: Traders should have set rules for how to buy and sell currency pairs, including selecting the right execution technologies.
Traders should consider developing trading systems in programs like MetaTrader that make it easy to automate rule-following. In addition, these applications let traders backtest trading strategies to see how they would have performed in the past.
When Is It Time to Change Strategies?
A forex trading strategy works really well when traders follow the rules. But just like anything else, one particular strategy may not always be a one-size-fits-all approach, so what works today may not necessarily work tomorrow. If a strategy isn't proving to be profitable and isn't producing the desired results, traders may consider the following before changing a game plan:
- Matching risk management with trading style: If the risk vs. reward ratio isn't suitable, it may be cause to change strategies.
- Market conditions evolve: A trading strategy may depend on specific market trends, so if those change, a particular strategy may become obsolete. That could signal the need to make tweaks or modifications.
- Comprehension: If a trader doesn't quite understand the strategy, there's a good chance it won't work. If a problem comes up or a trader doesn't know the rules, the effectiveness of the strategy is lost.
Although change can be good, changing a forex trading strategy too often can be costly. If you modify your strategy too often, you could lose out.
Example of a Basic Forex Trading Strategy
Chris is a novice trader. To get started, he calculates exponential moving averages for USD/JPY, a currency pair his research indicates will be profitable, to spot trends in the pair. Subsequently, he trades the pair at opportune times during the next few days to profit off its price changes.
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