Forex trading strategy begins with fundamental and technical analysis. The following explains why this analysis is vital to building a solid forex trading strategy:
Fundamental Analysis
Fundamental analysis is mainly used to better understand long-term trends in the currency market. There are a number of factors that determine the value of a country's currency.
The overall political, economic, and social climates of a specific country are the primary issues measured in fundamental analysis. As you can imagine, it can be difficult measure how these issues affect one another.
Every trader should be aware of the affects of political events, central bank news, non-farm payrolls, consumer price index, imports, exports etc. on the value of currency before forex trading.
Technical Analysis
Technical analysis produces charts and graphs subsequent to scrutinizing past data on volume and price. One of the latest buzzwords in this approach to currency trading analysis is "Fibonacci retracement." Fibonacci was a 12th century, Italian mathematician whose contribution to a modern forex trading strategy consists of his arcs, fans, and retracements. The lines in these mathematical studies are currently used to anticipate a trend change as prices near the lines created by these arcs, fans, and retracements. So some of the more popular forms of technical analysis used in forex are Candlestick Formations, Fibonacci Sequence, Financial Breakouts and Trend Lines.
Traders who are profitable will develop a personal forex trading strategy and perfect it over time. Some people will focus a specific study or calculation, while others use broad spectrum analysis as a means of determining their trades.
Most experts suggest that you try using a combination of both fundamental and technical analysis, with which you can make long-term projections and also determine entry and exit points. Whatever you finally decide, the fact remains that trading is a discipline that requires preparation and hard work.
Your overall personal forex trading strategy should include three vital ingredients; the currency pair you decide to trade, what technical indicators you use for entry/exit plans and sound money management.
Strategy 1 - Simple Moving Average
Successful trading is often described as optimizing your risk with respect to your reward, or upside. Any trading strategy should have a disciplined method of limiting risk while making the most out of favorable market moves. We will illustrate one decision making model which uses a Simple Moving Average ("SMA") technical study, based on a 12-period SMA, where each period is 15 minutes. This is one example of a trading decision making strategy, and we encourage any trader to research other strategies as thoroughly as possible.
We will use a simple algorithm: when the price of the currency crosses above the 12-period SMA, it will be taken as a signal to buy at the market. When the currency price crosses below the 12-period SMA, it will be a signal to "Stop and Reverse" ("SAR"). In other words, a long position will be liquidated and a short position will be established, both with market orders.
Thus this system will keep the traders "always in" the market - he will always have either a long or short position after the first signal. In the chart below, the white line represents the price of USDJPY, the purple line represents the 12-period SMA of USDJPY, and the red line indicates where USDJPY crosses above the SMA, generating a buy signal at approximately 129.90:
This is a simple example of technical analysis applied to trading. Many strategies used by professional traders make use of moving averages along with other indicators or "filters". Note that the moving average method has an element of risk control built in: a long position will be stopped out fairly quickly in a falling market because the price will drop below the SMA, generating a stop-and-reverse signal. The same holds true for a sell signal in a rising market. Note that the SMA is generated automatically by GCI's integrated charting application.
Strategy 2 - Support and Resistance Levels
One use of technical analysis, apart from technical studies, is in deriving "support" and "resistance" levels. The concept here is that the market will tend to trade above its support levels and trade below its resistance levels. If a support or resistance level is broken, the market is then expected to follow through in that direction. These levels are determined by analyzing the chart and assessing where the market has encountered unbroken support or resistance in the past.
For example, in chart below EURUSD has established a resistance level at approximately .9015. In other words, EURUSD has risen up to .9015 repeatedly, but has been unable to move beyond that point:
The trading strategy would then be to sell EURUSD the next time it gets close to .9015, with a stop placed just above .9015, say at .9025. This would have indeed been a good trade as EURUSD proceeded to fall sharply, without breaking the .9015 resistance. Hence a substantial upside can be achieved while only risking 10 or 15 pips (.0010 or .0015 in EURUSD).
Rules of good trading strategy
1. Trading is an investment not an income
It is important to have a realistic expectation of what you can achieve through forex trading. The nature of trading is such that you may make a good return on your initial capital over an annual period, but during that period you may have a number of consecutive losing months, with only a few bumper months inbetween.
2. You can't predict the forex markets
The forex markets are influenced by billions of traders, economic and political events. You simply cannot predict the direction and manner in which the markets will move. Technical and fundamental analysis does much to provide a more educated guess than a simple coin toss but it is important to realise that each of these techniques will have a large failure rate. You will lose a large percentage of the time. Sometimes you will lose on more trades than you gain on.
3. Let profits ride and cut your losses
The only way to make money from forex trading (or any form of trading) is by making enough money on your winning trades to cover your losses and to gain additional profit to grow your capital. It is harder to put into practice than it sounds as psycologically it is much easier to "marry" your losing trades in the hope that the market will turn in your favour and grabbing your profit too soon when you see your hard earned gains slipping away as the market temporarily turns against you.
4. Trade according to a tried and tested system
This is one of the most important forex principles. The only way to cut out emotion in trading and adopt a more business-like and informed approach is to use a system of rules that have been developed and tested on market data. In this way, all the trade decisions have already been made before you even enter the forex market. This is a much less time consuming and less stressful way to trade for a living.
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