A Forex trading strategy is an essential guide that lets you decide when you should buy or sell a currency pair. Have you been struggling to find a strategy that will work for your needs? Do you want to find a strategy that will let you minimize any risks involved in trading? By analyzing different trading strategies, you will able to pick one that best suits your short or long-term trading needs.
When you select your trading strategy, it is important to be mindful of your goals and the resources you possess. Read ahead to customize a trading strategy for your specific goals.
Elements of Analysis
While customizing a Forex trading strategy for yourself, it is important to keep in mind a few factors. These include the Risk versus Reward Ratio and the Time Investment factor.
Risk versus Reward Ratio
In trading, the risk versus reward ratio represents the rewards earned for the risk taken on each trade. If a trading strategy possesses a high risk versus reward ratio, this means that you will get high rewards for the amount of risk incurred in each trade. The position trading strategy possesses a high risk versus reward ratio.
Time investment refers to the amount of time that you spend on actively monitoring your trade. Your trading platform may decrease the time spent. In general, the scalp trading strategy requires extensive time resources as several trades are placed periodically.
These two factors can come to define multiple trading strategies. This is a good place to start analyzing and planning your trading strategy. Here, position trading and scalp trading will be discussed to give you an idea of how these factors can affect your strategy.
Position Trading Strategy
As discussed above, a position trading strategy will give you high rewards for the amount of risk you take. Additionally, it also possesses a low time investment factor where you spend relatively little time actively monitoring the trade. However, this strategy works well for the long-term and focuses strongly on fundamental factors. These are economic factors like Gross Domestic Product (GDP) and retail prices.
While technical indicators are used during analysis, their use is relatively less or coupled with fundamental factors. Such a strategy may span months or years, but the time invested in active monitoring is relatively low.
Do note that this trading strategy will present you with only a few opportunities. These opportunities are, however, highly rewarding. Further, you will need to have a strong knowledge of fundamental factors and technical analysis to proactively pick moments of trade.
For instance, the Brexit negotiations presented multiple trading opportunities for Forex traders in European markets. Traders who used a position trading strategy would benefit from these opportunities. This is because they would have closely analyzed the response of the Forex market to the corresponding economic and political events. Hence, if you have a keen eye on economic fundamentals, position trading might be the strategy for you.
Scalp Trading Strategy
In the Forex scalping strategy, the risk to reward ratio is particularly low. However, this is offset by the substantial opportunities provided by the Forex market. This also means that the time investment is quite high while using this strategy.
You require extensive time resources as you will open and close multiple trading positions across a trading day. While you may individually monitor the trade, you can also delegate the work to a trading platform by activating predefined trading instructions. This may save you some of the time. Further, since the strategy is short-term in nature, liquid currency pairs with a low spread are preferred.
These deals can be closed in as little as thirty minutes and may extend to a few hours. If you opt for this strategy, you do not need an extensive understanding of fundamental factors. However, working knowledge of technical indicators will do you good. Indicators like the moving average and others that identify support and resistance bands will let you know about the right bands to trade within. Other indicators, like Oscillators, are also used by employing various strategies.
It is for trading strategies like scalp trading that a strong knowledge of technical analysis is required. Several of these are based on what are called oscillator indicators. Oscillators, in technical analysis, analyze the momentum of the currency pairs that you will be trading. It traces upward momentum with increasing prices and downward momentum with falling prices.
Oscillators then indicate points in momentum where a price trend is being exhausted and may reverse. These are extreme high and low levels indicated by the oscillator. This lets you identify periods when your trade may display a high risk versus reward ratio.
Typically, when an oscillator indicates an extreme low, you will want to buy or go long. When it indicates an extreme high, you may want to sell or go short.
That being said, an extreme on your oscillator does not always mean that you should place your trade. Instead, take account of other realities like the history of the trend to see what has happened in previous recent extreme positions of your currency pairs. When used well, oscillators can lead to great gains in trade.
Oscillating indicators include RSI, Stochastics, CCI, and MACD indicators, among others. While it may seem complex, read ahead to understand a few oscillating technical analysis strategies. These can decode the nuances of trading for you.
RSI Indicator and Trading Strategy
The Relative Strength Indicator or the RSI is an extremely popular oscillating indicator in Forex trading. The indicator takes into account 14 periods of trade and calculates the ratio between the average gain and loss during this period. RSI indicators are bound on a scale of 0 to 100 and oscillate between this range. Take a look at a typical RSI indicator below.
In the above image, the blue line in the graph at the bottom indicates RSI levels on a scale of 1 to 100. A value of 70 or above suggests that the currency pair is being overvalued. At this position, it is overbought. This suggests that the trend may soon reverse and correct itself to the mean. A value of 80 is a popular level at which currencies are overbought.
Similarly, a value of 30 or below suggests that the currency is being undervalued and may reverse. This is the oversold position. On the RSI indicator, this often occurs at the 20 levels.
The popular 80 and 20 positions suggest that it is best to wait beyond the overbought and oversold indicators of 30 and 70. This will alert you towards any premature reversal and get you a better deal in the near future.
In an RSI indicator, an uptrend indicates a position between 30, often touching 70. During a downtrend, the RSI largely remains below 70 and often touches 30. Consistently following the RSI level is key to identifying trends and extreme positions.
For instance, consider a downtrend where the RSI does not touch 30 during multiple downswings. At some point, it may cross the 70 marks. This may indicate a strengthening trend and predict an uptrend in the near future. Based on this, you may pick trading strategies that best suit your style.
Bullish Trading with RSI
An RSI indicator is said to become bullish when it moves above the horizontal 30 levels. This may be a great time for bull investors to open and close trading positions. A bull in a Forex market refers to a trader who waits for upward trends and executes a trade when there are uptrends. However, be careful as not to confuse a sudden upswing with an uptrend. A good understanding of RSI indicators should help you in avoiding this blunder.
As a general rule, it is wise to understand that an initial upswing in value may not be an indication of an uptrend. Instead, it may simply be an indication of increased demand for the currency by other bullish investors who have also noted the upswing. Establish the existence of an uptrend before you choose to go long on your currency pair.
If you are a bullish investor, you can begin investing in the Forex market during an uptrend above the 30 levels on an RSI indicator. In this way, by analyzing trends, you can execute the trade. Even when there is a downtrend on the RSI indicator, like a bull, you can trade by analyzing positions of individual upswings.
Bearish Trading with RSI
An RSI indicator is said to become bearish if it dips below the horizontal reference line of 70. At this point, a downward trend should be operative. A bear in a Forex market waits for a downtrend in the currency pair. Bears look to profit from undervalued currency. When the bear expects a downtrend, they may occupy short positions in the Forex market.
Bears use a short-selling strategy to place their trade. Instead of the usual buy low and sell high strategy, they do the same in reverse. They sell first, wait for the price to decrease, and then execute the buy.
This is done by borrowing currency at a current market price. At this point, you still owe the borrower currency. As a bear, you wait for a downtrend below RSI 70 and buy the currency again when it is undervalued. Now, you profit from the difference and return the amount of currency you borrowed.
For instance, you may borrow USD and sell it when the USD/CAD pair is at a higher value, say 60, during a predicted downtrend. You now possess a quantity of CAD. At this point, you follow the downtrend. Use RSI indicators to eliminate any sudden downswings and confirm the downtrend. As the USD weakens against the CAD, you can go long and buy USD at a lower price. The difference is your profit.
However, do note that most traders do not stick to a single position but choose to invest as a bull or a bear depending on market conditions. This is also reflective of the currency pairs that you pick. A look at the long-term and RSI history of the currency pair of your choice should sensitize you to the Forex market.
As you understand RSI indicators, you may want to begin using a trading platform. Here, you can place stops on certain positions, as suggested by the RSI indicator. This will let your trading platform stay alert to significant overbought and oversold positions. In this way, the trading platform will execute an order for the best available price for your currency pair.
RSI trade lines can be used in very precise trades involving multiple micro-lots or fewer standard lots. They can also be used for time frames as small as 5 minutes or even a month.
Stochastics Indicator and Trading Strategy
The Stochastics indicator adopts a different measure of oscillation. This indicator is a trusty analysis tool and has been operational for about fifty years now. As with the RSI indicator, it is designed to indicate whether a currency is being overbought or oversold. There are various kinds of Stochastics. In Forex, the Slow Stochastic is popularly used.
In this indicator, a number of periods for analysis are identified, say ‘N.’ Now for this period, the distance between the current market price of the currency pair and the lowest price low are recorded.
The resulting distance is now divided by the difference between the high price and low price for period ‘N.’ A line called %K is created to define this value.
This line is used to graph a moving average line %D. This is placed over %K to indicate trade positions. As with oscillators, momentum changes take place in Stochastics when the %K line and the %D line cross. During crosses, the direction of the %K line can guide traders as to the direction of trade. Note that the indicator can range between 0 to 100.
In the above image, the blue line is the %K line, and the red line is the %D line. At the bottom, in pink and green, you can see the slow Stochastic analysis that lets you in on the short-term uptrends and low trends. Use the analysis to create a strategy for yourself.
The green arrows indicate lows in the currency pair that should prompt you to go long or buy currency. This is done by predicting a corrective reversal and uptrend so that you can profit by selling. Similarly, the red arrows indicate highs and a corresponding downtrend. You should be prompted to go short and sell in these positions.
The above is a basic rule. A superior Stochastic strategy would involve identifying the overbought and oversold positions. As a rule, cross overs above 80 are overbought positions. Now, if there is a cross up above the 80 marks, a downtrend moving lower from overbought levels is indicated. You may want to sell it here.
Similarly, crossovers below 20 are oversold. A cross up in this position may indicate a potential upward trend. You may want to buy it here. Depending on whether your strategy is bullish or bearish, you may want to trade during upward or downward trends, respectively. It is advised that you pay the most attention to crosses in overbought and oversold levels for a high risk to reward ratio in trade.
Watching Oversold and Overbought Trends in Stochastic
A sudden oversold or overbought level is not an immediate indication of a buy or sell signal. Instead, if the indicator stays in either of the two for long, it is best to wait for a slight corrective reversal and subsequent rise and fall.
If we consider oversold, within a trading period, the value may dip slightly below the oversold mark and rise again to indicate an impending falling trend. By considering this, you pay attention to the larger trend as opposed to just one cross over.
When there is a down cross accompanying other judgments of a downtrend, it may be time to sell at the best available price. Hence, slow Stochastic indicators let you execute trades that take account of larger trends in the currency market. By using a Stochastic in a Forex strategy, you can identify periods that will give you a high risk versus reward ratio.
For investors playing bull, Stochastic indicators may alert you to any traps. For instance, it may suggest cross downs at points where the price has previously reversed from a big high. These suggestions let bulls customize their trading strategies to minimize any losses from a coming downtrend. Similarly, the same indication of a downtrend may alert a bear to borrow and short sell. For these reasons, the Stochastic indicator remains a popular analysis tool in Forex.
CCI Indicator and Trading Strategy
The Commodity Channel Index or the CCI, is slightly different from other oscillator indicators. This is because, unlike others, there is no scale from 1 to 100 within which overbought and oversold positions are defined. Instead, there is no upper or lower limit to the overbought and oversold levels. In general, the CCI indicator takes into account 14 periods.
The CCI works by calculating the typical price or the average of the low, close, and high price for 14 periods. The simple moving average is then deducted from the typical price for the same period. Corresponding values sensitive to the mean deviation are then divided by the length of the period. This charts the +100 and -100 values for you.
The above image gives you an idea of what a CCI indicator looks like. The graph below, marked in green, contains the CCI scale with -100, 0, and + 100, with values accommodated beyond the 100 mark.
In this indicator, 0 is defined as the centerline. A trend at and above +100 would indicate overbought and below -100 would indicate oversold levels. Selling is recommended below +100 and buying above -100. As you work with the CCI indicator, you will notice that the values will not fall in the overbought and oversold bracket about 70 to 80% of the time. This means that you will have to wait for extreme values and subsequent corrections.
Here, it is important to take note of the larger trend and then trade when smaller trends surface. For instance, in a USD/CAD pair, there may be a larger downtrend. At this point, you may want to look for points when the position reaches overbought or +100 and above. You may very well know that the larger downtrend will indicate a reversal below the +100 line.
In such a scenario, it may be a good idea to go short and sell within your currency pair. This is done in anticipation of a downward trend in accordance with the larger downtrend. The CCI indicator can be used as a trend indicator by using it together with moving averages. This can indicate levels below -100 and above +100 when the CCI will begin to return to the 0 line.
If you are a bullish investor, you may want to pay attention to values below -100 to watch for corrective uptrends. The reverse is true for a short-selling bear.
In a CCI indicator, the best trades are made by spotting periods when values are ranging and not trending. Trending values indicate upward or downward momentum. Ranging values swing within a set range of upper and lower value consistently for a period of time. Once you identify a range, look for highs and lows.
When price touches the upper range, take note of any CCI indications that momentum is exhausting. This will see the price slowly decline below the +100 level. Look for similar indications when the price is set to rise above the -100 level following a ranging period. This might be the best indicator to sell and buy, respectively.
While other indicators use closing price for calculation, CCI uses the typical price. This is said to better indicate price momentum or whether the price will continue to fall or rise. Since the CCI indicator is very sensitive to momentum, you may want to study periods of exhaustion where momentum slows down. This is when price reversal to the 0 line occurs, and you can execute your buying or selling trading move.
MACD Indicator and Trading Strategy
The final indicator considered is the MACD or the Moving Average Convergence/Divergence indicator. In this method, two moving average lines, Exponential Moving Average (EMA) 12 and EMA 26, are recorded. The difference between the two is recorded to arrive at the MACD line. Over the MACD line, a signal line or the 9EMA line is drawn.
The basic strategy of MACD is as follows. When the MACD line crosses above the signal line, you are prompted to buy. If it crosses below the signal line, you are prompted to sell.
In the above image, the MACD line is indicated in blue and the signal line in red. Unlike other oscillators, the MACD line indicates overbought and oversold signals above and below the 0 line, respectively.
The Zero Line
In the MACD, the 0 line is the central point. When the blue MACD line crosses above the 0 line, an overbought position is reached. When the MACD line falls below the 0 line, an oversold position is reached. This also indicates a corresponding uptrend and downtrend, respectively.
When moving in an uptrend, if the MACD crosses above the signal line, it is indicative of exhausting momentum and a corrective reversal in trend. This is generally a downtrend. At this point, you may want to go long and buy. Similarly, in a downward trend, if the MACD red line crosses below the red signal line, you are prompted to short on currency and sell.
MACD is a great indicator as it gives both oscillation and crossover alerts to you. However, MACD is largely beneficial for trending markets. In Forex markets that are ranging, the MACD may not be able to guide you to forecast fluctuations within range. While using the MACD, it is better to stick to the standard EMA values and time-frames as interpretations may differ if these values are tampered with.
However, if you have a good understanding of Moving averages, feel free to customize the MACD to suit your Forex needs.
As we have seen, Forex trading strategies can help you identify the risk versus reward ratio and time investment that you want to incur. Your trading strategy will also depend on whether you are trading for short-term gains or the long-term. Depending on this, you may choose scaling Forex or position trade, respectively.
Trading strategies don’t just allow you to profit during periods that have a high risk to reward ratio. They also let you explore the various interesting technical indicators that can enhance your strategy. By learning to use the RSI, Stochastics, CCI, and MACD indicators, you can manage trading risks well. Learning these strategies are also fun challenges that can drive you to get better with time.
Further, these indicators will also let you stay alert to market momentum that suits your trading style. They serve as excellent trading guides to both the optimistic bulls and pessimistic bears in the market.
Practice trading new strategies risk free with a demo account from a leading online broker like IC Markets or XTB