Trading Strategies
There are a large number of trading strategies in forex, here we are focusing on only the most popular ones to get you started.
1. Trend following
As the name suggests, traders follow the trend lines and make decisions accordingly. It is the strategy most beginners will adopt because of its simplicity.
2. Moving Averages Crossover
After trend lines, moving averages are the most used indicators. These may or may not be used independently. A lot of times it is not a completely independent strategy though and is incorporated into another.
“A moving average is a consolidation of past market movements for comparison with the current”.
There are two types of moving averages
Simple Moving Average (SMA):It is based on past data. To calculate it the closing prices for a certain period of time in the past is divided by the number of time units. So if the data belongs to the last ten days, the closing prices are divided by 10.
Exponential Moving Average (EMA): It is based on recent data to project more clearly the current price movements.
Moving Average as a strategy
The one under consideration here is SMA. Traders who use these as their main indicators will look at multiple period frames such as the 4 and 9 or 5, 10, and 20 period moving averages.
The plan then is to see if they crossover. A crossover is when the line for the 4 SMA crosses the 9 SMA, i.e. there is an overlapping. It’s important because usually when this happens there will be a reversal. The trader can make use of that reversal and enter here.
The exit depends on the conditions and how strong a trend is so this will have to be based on the trader’s own discretion.
3. Fibonacci trading
We have talked in detail about the importance of Fibonacci numbers in forex before. One trading strategy is following trend lines and looking out for those numbers and levels.
The golden ratio 61.8 is a common reversal level after a retracement. So in a general upwards trend, if the price starts retracing, a lot of times it will get to 61.8% before changing course again and continuing the original up trend.
So traders who look out for this will enter a long position close to 61.8% when price is retracing and when it reverses and starts moving up again, they make a larger profit.
Other retracement levels beside 61.8% in Fibonacci trading include 23.6%, 38.2%, 50%, and 76.4%.
There are also extension levels which serve to indicate new Support and Resistance levels once the previous ones have been broken through. These are likely levels where new Support and Resistance will form. These are 38.2%, 61.8%, 100%, 138.2%, 161.8%.
There is, however, no guarantee for this. These are only likely possibilities.
Therefore, if there are other factors contributing to this and the trader has enough reason to believe that a reversal or new Support and Resistance level is emerging, these are values to look out for.
Fibonacci traders make their entry and exits expecting these levels to be met. When they are, the profit is bigger. This is because they made their move before reversal took place or right before support was hit and then eventually the price difference between entry and exit is higher.
4. V-Shaped Reversal
Economic reports can cause volatility, as we’ve already discussed in the previous chapter, but the nature of that instability and volatility might be different for different reports.
Some reports, such as the GDP or the Trade Deficit, do not cause a lot of confusion. The market direction might change compared to where it was headed before the report but it will be decisive.
Then there are others like the Non-Farm Payroll. A lot of times after the NFP is released there is a V-shaped reversal.
This means a trend in one direction followed by a sharp reversal. The steep upward or downward movement can prove to be both useful and harmful depending on whether the trader saw it coming or not.
If the trader is prepared and they enter at the point of reversal, the sharp move will mean more profits. So if after an economic report that is known to cause such confusion there has been a steady sharp move upwards, the reversal trader will keep an eye out for the downward move to begin and as soon as a candlestick or two appears signaling it, they will immediately enter a short position.
5. Breakouts
When a level that has been tested many times is broken through it is called a breakout. Breakouts are important events during trading and therefore there is a strategy in which trade decisions are made around them.
Like the V-shaped reversal, breakouts are useful when one is quick to spot them. This would mean that a big price action is about to take place and you are entering the market to make the most out of it i.e. the maximum profit that could’ve been made off of that price move.
Breakouts are most easily traceable at the Support and Resistance levels.
The trick is to wait for a candle to appear that shows the price closed below the support or above the resistance. That is when the trader can expect the level to be crossed.
It is interesting to note that for all the talk about support and resistance, we are essentially talking about psychological levels only. There is no physical limitation keeping price restricted to that level.
One way to differentiate between real and misleading breakouts is to only rely on the closing price. Don’t take the shadows into consideration.
The way a trader would trade using breakouts would be to enter the position as soon as it is indicated by a candle to increase the difference between entry and exit point thus increasing profits.
6. Wide range bars
Wide range bar is a candle or bar that is 2 to 3 times longer than the others on the chart showing that major price action took place during that period. It also indicates that there was a large amount of force or momentum behind this price action.
There might be any number of reasons behind this, one common one is an economic news announcement.
A bullish wide range bar in a bearish trend would mark reversal. Similarly a bearish wide range bar in a bullish trend would also mark reversal into the bearish trend.
This information can be used to either exit or enter a trade.
If a trader is holding a long position when the trend is bullish, the appearance of a bearish wide range bar means reversal is probable and so this might be a time to get out since you don’t want to lose the profit you made.
The same would be a signal for a bear to enter as they were planning to go short and waiting for the trend to shift. Entering early on could also mean more profit.
With this the strategies section comes to a close.
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