Forex trading gives you a chance to trade in the largest market in the world, one that sees an average of more than $6 trillion traded every day. With low capital requirements for getting started and easy access through tools such as eToro’s trading platform, it’s a great way for everyday traders to buy, sell and hold in a truly global market. Low transaction costs and a market that is open 24 hours a day, five days a week are other great benefits.
As with any type of investing, having a strategy to guide your decisions can make a huge difference to whether you succeed or fail. Despite being relatively new as compared to other trading markets, there is certainly no shortage of methods out there. This guide will introduce you to forex trading strategies for beginners. Read on to learn how to choose a forex trading strategy that works for you and discover some of the more popular options.
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What is a forex trading strategy and why is it important to have one?
When it comes to sustained trading, discipline is key. And having some sort of strategy or guiding principles upon which you base your decisions is vital for maintaining discipline over the long term. Now, sometimes these strategies can evolve. And it can be good to know when to make moves that are slightly outside of your strategy. But in general, you want an overarching method of trading that will help you make decisions.
This strategy will guide you in deciding which currencies to buy and sell and when to do so. It will also help you determine which information plays the biggest role in those decisions. Strategies are often built on signals that pop up in the market — when certain factors align to fit your strategy’s specific parameters. Some in the market automate these decisions through building or subscribing to algorithms. Others love the convenience of copy trading, in which moves are made in your account based on other top-performing forex traders from around the world whom you choose to follow. Alternatively, traders can manually scan markets for signals. Strategies can be built on shorter-term analysis (minute-by-minute decision-making) or longer-term decisions.
In short, there is no one single “right” strategy. The best one for you depends on a variety of factors.
How to develop your own forex trading strategy
There is almost no limit to the different parameters that can help you devise a foreign exchange trading strategy. Many people even like to take parts of different strategies and mash them together to form one that fits their own personal circumstances, interests and goals. While phases of the moon and the colour of your socks should probably be left out of the equation, here are some key considerations that are part of just about every forex trading strategy for beginners.
Your personal circumstances
Whether you are performing forex trades or participating in crypto markets, stocks or other investment opportunities, there are a few important factors you need to think about before you get started.
One is your appetite for risk. Older investors with less opportunity to earn in the workforce in the coming years might be interested in more conservative investing that will protect their remaining wealth. Younger traders with more chances to earn money in the years ahead might be able to justify a riskier strategy.
Another factor you need to think about is how much time and effort you want to put into forex trading. For example, some forex day trading strategies might be optimal for traders who have more time to monitor markets throughout the day. Others who don’t have the capacity or desire to do that will need to look at more automated measures, and, therefore potentially different strategies.
Know when and how to get out
No matter your answers to the above considerations, you need to determine with how much capital you are going to enter the market. Regardless of the level of risk in your forex strategy or your past success, you need to make sure that you are never at risk of losing more money than you can afford. How much can you afford to lose if everything goes wrong and there are sudden fluctuations in currency prices found in your forex portfolio?
To make sure you don’t fly past this threshold, you need to have cut-off points. These can be set personally (knowing when to say when) or automated depending on your trading strategy and level of discipline. Even if you trust yourself not to get in too deep when manually inputting your trades, it is smart to establish automated stop loss, which will exit a position if it drops to a certain rate, or limit orders, which will only allow you to purchase if a currency reaches a certain rate.
One of the more attractive aspects of forex trading is leveraging, which gives you more power to enjoy opportunities generated by pips and other market moves. But with this increased spending power comes an increased risk of getting in too deep, so you need to be careful to not over-leverage.
Entry and exit rules
Also referred to as entry and exit points, these are the collections of parameters or conditions that determine when you enter or exit a position with a currency pair. There is no hard and fast rule as to how many conditions your entry and exit rules should have, although it is important to recognise that the more thresholds that need to be hit, the harder it will be to satisfy your entry and exit points. Whichever analysis type you prefer — technical or fundamental — can help you pinpoint which entry and exit points are best for you.
There are two basic forms of forex analysis — technical analysis and fundamental analysis.Technical analysis is more about digging into the numbers. It is built on collecting trends, patterns and other data to look for triggers that signal that it is time to buy, sell or hold. Fundamental analysis is more qualitative. It takes into account things like world news regarding interest rate changes, politics and more and applies them to forecasting how they will affect currency.
Factors that influence the forex market
By knowing the factors that influence the foreign currency exchange market, you can have a better idea of which conditions you want to implement in your forex strategy. These factors include, but are not limited to:
- Inflation. In general, the lower a nation’s inflation rate, the higher the value of its currency and vice versa.
- Interest rates. If a country’s interest rate rises, generally, the value of its currency will, too, as foreign investors are attracted to a higher return. The converse is also true — falling interest rates often mean lower currency value, as there is less international demand.
- Natural disasters. When large economic centres are hit with crises that disrupt manufacturing, production, trade and other pillars of the economy, the value of their currency can take a hit.
- Trade. On the other side of the coin, countries that see an increase in trade demand will also see an increase in demand for their currency, therefore, causing price jumps.
- Economic performance. Countries that are historically stable with relatively solid economic policies, tend to attract more investors, which can make foreign exchange rates go up.
- Political climate. Political stability can play a huge role in the foreign exchange market. Investors will often turn away from currencies from countries that might experience upheaval, especially if that upheaval affects that country’s standing on the international stage.
- Fiscal policy. The decisions made by a country’s federal government regarding allocation of budget, taxation and other aspects can impact a currency’s value.
Testing your system
The chances that you are going to build the perfect trading beast immediately are quite slim. It will take some time to refine the conditions for your forex strategy. The best way to do this is to test your system — with a view to both the past and the future.
Back testing involves taking data from the past and applying your strategy to it. By taking data sets from various points in history, you can find out if you would have been profitable with your strategy or not. This can also help you slightly modify your conditions, but be careful — you can get lost making modifications for specific sets of data from years past and end up tailoring your strategy for a specific point in time that has already come and gone.
Forward testing is when you apply your strategy in real time. Basically, you do everything you would as if you were going to trade forex — without actually making the transactions. By building up a record of trades you theoretically would have made, you can see if you would have been successful with your strategy. It is like practising before playing a real match. eToro’s Virtual Portfolio is one easy way you can test out your trading strategy, trialling your moves and seeing whether they are successful in real time.
While records play a big part in testing your system before you start using it, they perform a similar role in the weeks, months and years after you actually start putting your system into play.
Sure, tracking your profits and losses are important signs of whether you are on the right track or not. But knowing why you have made those profits or losses is what can be really helpful going forward. Keep track of not only the trades you made, but why you made them. Did you read the market correctly? Would you have made more or less had you bought or sold earlier or later? Were your entry and exit points correct? All of these can help you continually refine your forex trading strategy.
Types of forex trading strategies
Building your own forex trading strategy might be hard if you are new to trading (or building strategies). Luckily, there are plenty of different types of established strategies for you to try. You can either follow some of these popular options, or pick and choose different aspects from multiple sources as you develop your own.
The forex day trading strategy is similar to strategies in other types of investing. Forex day traders will open and close the same position on the same day, as opposed to keeping positions open overnight. Day trading can be very time-intensive, which makes it better suited to traders who can analyse market positions in hourly chunks throughout the day.
With a forex scalping strategy, you complete many trades with low margins throughout the day. These are quick “get in” and “get out” moves. The key to forex scalping is completing a high volume of trades and having the discipline to hunt for a lot of small profits that will add up in the end. You also need to pay special attention to any fees associated with trades, as they can dent your personal margin when completing such a high number of trades. To make this style of trading worthwhile, traders are often tempted to leverage greater amounts on each move. This strategy comes with its risks, as where there are potential larger gains, there are also potential larger losses. Some traders can find their profitable trades wiped out by one bad move due to leveraging.
Conducted over a longer period of time than forex day trading, but a shorter period than position trading, forex swing trading strategy is built on the “swings” of the market. By looking at more information than you would gather in a day — say, over the course of multiple days or even weeks — you can see and take advantage of patterns that develop in the form of swings. Swing trading strategy is usually built on more technical analysis.
A position trading strategy is a longer-term strategy. This is where you take a concrete position on a currency and hold that position for a while. That means shorter-term trends and fluctuations are of less interest as the goal is to identify long-term trends. Position traders must often ride out large negative swings, so they need to be sure they have ample capital to do so.
In the forex hedging strategy, you play both sides of the long and short fence. By entering into both long and short positions, you can lessen your profits. But you also give yourself time to make a decision on which side it is better to take a true position.
Portions of the trend trading strategy are used across multiple forex strategies. This is basically where investors follow forex trends to determine if they should buy, sell or hold.
But what if there are no trends to pick up on? That is when the forex range trading strategy can be handy. This can be looked at as a looser way of defining trend concepts to trading. Traders look for general ranges in which currencies will sit for longer periods of time. These ranges, or channels, will give traders a good idea of what and when resistance and support will look like.
The breakout trading strategy sees traders make a move when a currency moves outside, or breaks out of those targeted ranges. A currency that breaks out higher than a previously charted range might be showing that it is going to continue to appreciate, and signal a buy. The same goes for breaking through a lower range and selling.
A forex momentum trading strategy puts a lot of emphasis on the direction a currency’s value is travelling. Traders who follow this strategy feel that a currency that is moving a certain way will continue to experience that momentum going forward — if it is going up, it will continue to go up, and vice versa.
Some more cautious traders prefer forex retracement strategy instead, which sees traders waiting for a currency to “retrace its steps” back the other way before entering. This belief is built on the idea that trends do not occur in a linear fashion. By waiting for the currency to retrace, you can be a bit more sure of the trend.
The reversal trading strategy is probably not the best option for those with limited experience in the foreign currency exchange market. This strategy sees traders using data to try to predict when a trend will reverse, therefore, being able to buy or sell accordingly before the move.
Maybe one of these strategies sounds perfect for you. Or perhaps parts of multiple strategies sound like they could play a part in your overall forex trading plans. Whatever the case may be, having the right tools on your side can help you implement, and modify, your strategy with ease. Check out the available currency pairs on the eToro trading platform and get ready to enter the fascinating world of forex trading.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments. This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past performance of a financial instrument, index or a packaged investment product are not, and should not be taken as a reliable indicator of future results. eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.