Common forex trading strategies

Best Forex trading strategies that work.

You may have heard that maintaining your discipline is a key aspect of trading. While this is true, how can you ensure you enforce that discipline when you are in a trade?

One way to help is to have a trading strategy that you can stick to.

If it is well-reasoned and backtested, you can be confident that you are using one of the successful Forex trading strategies. That confidence will make it easier to follow the rules of your strategy—therefore, to maintain your discipline.

A lot of the time when people talk about Forex strategies, they are talking about a specific trading method that is usually just one facet of a complete trading plan. A consistent Forex trading strategy provides advantageous entry signals, but it is also vital to consider:

Picking the best Forex strategy for you.

When it comes to what the best Forex trading strategy is, there really is no one single answer.

The best FX strategies will be suited to the individual. This means you need to consider your personality and work out the best Forex strategy to suit you.

What may work very nicely for someone else may be a disaster for you. Conversely, a strategy that has been discounted by others, may turn out to be right for you.

Therefore, experimentation may be required to discover the Forex trading strategies that work . Vice versa, it can remove those that don't work for you.

One of the key aspects to consider is a timeframe of your trading style.

The following are some trading styles, from short time-frames to long, which have been widely used during previous years and still remain to be a popular choice from the list of best Forex trading strategies in 2017.

Scalping . These are very short-lived trades, possibly held just for just a few minutes. A scalper seeks to quickly beat the bid/offer spread and skim just a few points of profit before closing. Typically uses tick charts, such as the ones that can be found in MetaTrader 4 Supreme Edition.

Day trading . These are trades that are exited before the end of the day, as the name suggests. This removes the chance of being adversely affected by large moves overnight. Trades may last only a few hours and price bars on charts might typically be set to one or two minutes.

Swing trading . Positions held for several days, looking to profit from short-term price patterns. A swing trader might typically look at with bars showing every half hour or hour.

Positional trading . Long-term trend following, seeking to maximise profit from major shifts in prices. A long-term trader would typically look at the end of day charts.

The role of price action in Forex strategies.

To what extent fundamentals are used varies from trader to trader. At the same time, the best FX strategies invariably utilise price action.

This is also known as technical analysis.

When it comes to technical currency trading strategies, there are two main styles: trend following, and counter-trend trading. Both of these FX trading strategies try to profit by recognising and exploiting price patterns.

When it comes to price patterns, the most important concepts are those of support and resistance.

Put simply, these terms represent the tendency of a market to bounce back from previous lows and highs. Support is the market's tendency to rise from a previously established low. Resistance is the market's tendency to fall from a previously established high.

This occurs because market participants tend to judge subsequent prices against recent highs and lows.

What happens when the market goes near recent lows? Put it simply, buyers will be attracted to what they see as cheap.

What happens when the market goes near recent highs? Sellers will be attracted to what they see as either expensive, or a good place to lock in a profit.

Thus recent highs and lows are the yardstick by which current prices are evaluated .

There is also a self-fulfilling aspect to support and resistance levels. This happens because market participants anticipate certain price action at these points and act accordingly.

As a result, their actions can contribute to the market behaving as they expected.

However, it's worth noting three things:

support and resistance are not iron-clad rules, they are simply a common consequence of the natural behaviour of market participants trend-following systems look to profit from those times when support and resistance levels break down counter-trending styles of trading are the opposite of trend following—they look to sell when there's a new high and buy when there's a new low.

Trend-following Forex strategies.

Sometimes a market breaks out of a range, moving below support or above resistance to start a trend. How does this happen?

When support breaks down and a market moves to new lows, buyers begin to hold off. This is because buyers are constantly seeing cheaper prices being established and want to wait for a bottom to be reached.

At the same time, there will be traders who are selling in panic or simply being forced out of their positions. The trend continues until the selling is depleted and belief starts to return to buyers that the prices will not decline further.

Trend-following strategies buy markets once they have broken through resistance and sell markets once they have fallen through support levels. Trends can be dramatic and prolonged , too.

Because of the magnitude of moves involved, this type of system has the potential to be the most successful Forex trading strategy. Trend-following systems use indicators to tell when a new trend may have begun but there's no surefire way to know of course.

Here's the good news.

If the indicator can distinguish a time when there's an improved chance that a trend has begun, you are tilting the odds in your favour. The indication that a trend might be forming is called a breakout .

A breakout is when the price moves beyond the highest high or lowest low for a specified number of days. For example, a 20-day breakout to the upside is when the price goes above the highest high of the last 20 days.

Trend-following systems require a particular mindset. Because of the long duration—during which time profits can disappear as the market swings—these trades can be more psychologically demanding.

When markets are volatile, trends will tend to be more disguised and price swings will be greater. This means a trend-following system is the best trading strategy for Forex markets that are quiet and trending.

An example of a simple trend-following strategy is a Donchian Trend system.

Donchian channels were invented by futures trader Richard Donchian and are indicators of trends being established. The Donchian channel parameters can be tweaked as you see fit, but for this example we will look at a 20-day breakout.

Basically, a Donchian channel breakout suggests either of two things:

buying if the price of a market goes above the high of the prior 20 days selling if the price goes below the low of the prior 20 days.

There is an additional rule for trading when the market state is more favourable to the system. This rule is designed to filter out breakouts that go against the long-term trend.

In short, you look at the 25-day moving average and the 300-day moving average. The direction of the shorter moving average determines the direction that is permitted.

This rule states that you can only go:

short if the 25-day moving average is lower than the 300-day moving average long if the 25-day moving average is higher than the 300-day moving average.

Trades are exited in a similar way to entry , but using a 10-day breakout. This means that if you open a long position and the market goes below the low of the prior 10 days, you want to sell to exit the trade—and vice versa.

Learn to trade step-by-step with our brand new educational course, Forex 101, featuring key insights from professional industry experts.

Counter-trend Forex strategies.

Counter-trend strategies rely on the fact that most breakouts do not develop into long-term trends. Therefore, a trader using such a strategy seeks to gain an edge from the tendency of prices to bounce off previously established highs and lows.

On paper, counter-trend strategies are the best Forex trading strategies for building confidence because they have a high success ratio.

However, it's important to note that tight reins are needed on the risk management side. These Forex trade strategies rely on support and resistance levels holding. But there is a risk of large downsides when these levels break down.

Constant monitoring of the market is a good idea. The market state that best suits this type of strategy is stable and volatile. This sort of market environment offers healthy price swings that are constrained within a range.

Do note, though, that market can switch states . For example, a stable and quiet market might begin to trend, while remaining stable, then become volatile as the trend develops.

How the state of a market might change is uncertain. You should be looking for evidence of what the current state is, to inform whether it suits your trading style.

Discovering the best FX strategy for you.

Many types of technical indicators have been developed over the years. The great leaps forward made with online trading technologies have made it much more accessible for individuals to construct their own indicators and systems.

You can read more about technical indicators by checking out our education section or the trading platforms we offer. A great starting point would be some of the simple, well-established strategies that have worked for traders already.

By trial and error, you should be able to learn Forex trading strategies that best suit your own style. Go ahead and try out your strategies risk-free with our demo trading account.

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Common Trading Mistakes.

5 Common Trading Mistakes in Forex.

Trading forex can be a rewarding and exciting challenge, but it can be discouraging if you are not alert and careful. Whether you are new to forex trading or an experienced expert, avoiding these common trading mistakes can help to keep your trades on the right track.

1. Not Doing Your Homework.

Currency pairs are closely linked to national economies and are affected by many factors. They are too traded 24/5, meaning there is usually something going on that will move the markets.

Before entering into a trade, make sure you do your homework. Not only should you be aware of the upcoming events that could affect your trade, but you also need to forecast which way the events could swing the markets. Always pay attention to what your technical indicators are telling you and how they compare to fundamental event analysis.

2. Risking More than You Can Afford.

One common trading mistake new traders make is confusing how the leverage works. Familiarize yourself with margin and leverage to help avoid the accidentally putting more capital at risk than you had planned.

Many of the traders find it helpful to set a maximum percentage of the capital that they are willing to risk at one time, usually 2% to 4%. For example, if you have $50,000 of equity and are willing to risk 2% maximum, you would not tie up more than the $1,000 at one time. It is important that you stick to that maximum once you set it.

3. Trading without a Net.

You can’t watch the forex markets 24 hours a day. Stop and limit orders help you get in and out of the market at the predetermined prices. This not only gives the trading platform to execute the trades when you are not available, but it also makes you think through to the end of the trade and set exit strategies before you are actually in the trade, and your emotions get the best of you. Placing contingent orders may not necessarily limit the risk for losses.

4. Overreacting.

A loss never feels good. It can make you irrational and emotional, tempting you to make kneejerk follow up trades that are outside your trading plan.

No trader makes the great trade every time. Accept that loss which is part of the reality of trading and sticks to your plan. In the long run, your trading plan should compensate for the loss; if not, reconsider your plan and adjust.

5. Trading from Scratch.

Using your hard-earned capital to test the new trading plan is almost as risky as trading without the plan at all. Before you start trading real money, open a forex system account and use virtual funds to try out the trading plans and get a feel for the trading platform you are using. Although you will not be affected by the emotions the same way you will be when trading your money, this is also an opportunity to see how you react to trades not going the way and learn from your mistakes without the risk.

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What are the most common market indicators forex traders follow?

There are literally hundreds of technical indicators for forex traders to choose from, however, there are a few which may be considered the most commonly used ones.

The most popular technical indicator used by forex traders is probably the moving average. Whether they use simple, exponential or some other variation of moving averages, nearly all forex traders have one or more of the moving averages plotted on their charts. The 50, 100 and 200 moving averages are considered the major averages for determining overall long-term market trends. Shorter moving averages are more commonly employed on lower time frame charts such as the hourly or 15-minute charts. Moving averages are used by forex traders to determine trends and to identify significant support and resistance levels in a market. Some forex trading strategies are based on crossovers of a short-term moving average over a longer-term moving average.

Pivot points, used to identify major daily support or resistance levels, are also very popular with forex traders. Even traders who do not trade directly off pivot points are usually still aware of the daily pivot level as a potential turning point for market action.

Nearly all forex traders utilize candlestick charting and look for recognizable candlestick patterns as clues to possible future market movement – especially as indicators of possible market reversals.

Many traders complement technical indicators used for identifying trend and support or resistance levels with indicators designed to measure market momentum to assess the strength of price movements. The most popular momentum indicators in forex trading include the moving average convergence divergence (MACD) and the relative strength index (RSI).

As the potential for the likely amount of price movement during a given day can vary with market volatility, forex traders often use volatility indicators, such as Bollinger Bands or the average true range (ATR) indicator.

4 Common Active Trading Strategies.

Active trading is the act of buying and selling securities based on short-term movements to profit from the price movements on a short-term stock chart. The mentality associated with an active trading strategy differs from the long-term, buy-and-hold strategy. The buy-and-hold strategy employs a mentality that suggests that price movements over the long term will outweigh the price movements in the short term and, as such, short-term movements should be ignored. Active traders, on the other hand, believe that short-term movements and capturing the market trend are where the profits are made. There are various methods used to accomplish an active-trading strategy, each with appropriate market environments and risks inherent in the strategy. Here are four of the most common types of active trading and the built-in costs of each strategy. (Active trading is a popular strategy for those trying to beat the market average. To learn more, check out How To Outperform The Market .)

Day trading is perhaps the most well known active-trading style. It's often considered a pseudonym for active trading itself. Day trading, as its name implies, is the method of buying and selling securities within the same day. Positions are closed out within the same day they are taken, and no position is held overnight. Traditionally, day trading is done by professional traders, such as specialists or market makers. However, electronic trading has opened up this practice to novice traders. (For related reading, also see Day Trading Strategies For Beginners .)

[ Learning which strategy is going to work best for you is one of the first steps you need to take as an aspiring trader . If you're interested in day trading, Investopedia Academy's Day Trader Course can teach you a proven strategy that includes six different types of trades. ]

Some actually consider position trading to be a buy-and-hold strategy and not active trading. However, position trading, when done by an advanced trader, can be a form of active trading. Position trading uses longer term charts - anywhere from daily to monthly - in combination with other methods to determine the trend of the current market direction. This type of trade may last for several days to several weeks and sometimes longer, depending on the trend. Trend traders look for successive higher highs or lower highs to determine the trend of a security. By jumping on and riding the "wave," trend traders aim to benefit from both the up and downside of market movements. Trend traders look to determine the direction of the market, but they do not try to forecast any price levels. Typically, trend traders jump on the trend after it has established itself, and when the trend breaks, they usually exit the position. This means that in periods of high market volatility, trend trading is more difficult and its positions are generally reduced.

When a trend breaks, swing traders typically get in the game. At the end of a trend, there is usually some price volatility as the new trend tries to establish itself. Swing traders buy or sell as that price volatility sets in. Swing trades are usually held for more than a day but for a shorter time than trend trades. Swing traders often create a set of trading rules based on technical or fundamental analysis; these trading rules or algorithms are designed to identify when to buy and sell a security. While a swing-trading algorithm does not have to be exact and predict the peak or valley of a price move, it does need a market that moves in one direction or another. A range-bound or sideways market is a risk for swing traders. (For more on swing trading, see our Introduction To Swing Trading .)

Scalping is one of the quickest strategies employed by active traders. It includes exploiting various price gaps caused by bid/ask spreads and order flows. The strategy generally works by making the spread or buying at the bid price and selling at the ask price to receive the difference between the two price points. Scalpers attempt to hold their positions for a short period, thus decreasing the risk associated with the strategy. Additionally, a scalper does not try to exploit large moves or move high volumes; rather, they try to take advantage of small moves that occur frequently and move smaller volumes more often. Since the level of profits per trade is small, scalpers look for more liquid markets to increase the frequency of their trades. And unlike swing traders, scalpers like quiet markets that aren't prone to sudden price movements so they can potentially make the spread repeatedly on the same bid/ask prices. (To learn more on this active trading strategy, read Scalping: Small Quick Profits Can Add Up . )

Costs Inherent with Trading Strategies.

There's a reason active trading strategies were once only employed by professional traders. Not only does having an in-house brokerage house reduce the costs associated with high-frequency trading, but it also ensures a better trade execution. Lower commissions and better execution are two elements that improve the profit potential of the strategies. Significant hardware and software purchases are required to successfully implement these strategies in addition to real-time market data. These costs make successfully implementing and profiting from active trading somewhat prohibitive for the individual trader, although not all together unachievable.

Active traders can employ one or many of the aforementioned strategies. However, before deciding on engaging in these strategies, the risks and costs associated with each one need to be explored and considered. (For related reading, also take a look at Risk Management Techniques For Active Traders .)