What are forex trading strategies?
Forex tradingstrategies are methodologies for entering and exiting FX positions. They’re usually based on various analysis techniques – both technical and fundamental – and give traders a way of knowing when to buy or sell a currency pair.
Sometimes, when people refer to a forex strategy, they’re talking about a style of trading – be that position trading, swing trading, day trading or scalping. But really, this is just one factor that helps you choose thebest strategyfor you. That’s because there are a lot of different types of forex trading strategies that range from short timeframes to longer ones.
How to create a forex trading strategy
To create a forex trading strategy, you need to:
- Known your preferred style.For example, day traders might use strategies that focus on daily market trends, while scalpers will look at strategies that take advantage of just 5 or so pips of movement
- Choose your preferred pairs.Knowing which type ofFX pairyou want to trade – be it major, minor or exotic – can help narrow down which strategy will suit you, as they vary in volatility
- Understand your risk tolerance.Some forex strategies can lead to greater profits but at the expense of greater risk. It’s important to know how much you can afford, and never risk more than you wouldn’t mind losing
- Decide how much you want to trade.Knowing whether you’re going to be opening one position a day or 20 will massively influence which type of strategy you’ll use and how much capital you want to risk on each trade
- Allocate your time appropriately.While some strategies can just involve setting a stop and a limit, and letting the position run its course, others are more time intensive and will need you at your desk monitoring the market constantly
- Know when to trade.You’ll also need to understand the ebbs and flows of FX market volume so that you can execute your trades efficiently. This will ultimately depend on what currency pairs you want to trade, for example, USD/GBP is most traded when theNew York and London sessionsoverlap
What are the best forex trading strategies?
The best forex trading strategy will ultimately depend on what type of trader you are, and your preferences, as mentioned above. But some currency trading strategies are more widely used and can be adapted to suit individual traders’ needs.
These include:
- Trend trading
- Range trading
- News trading
- Retracement trading
- Grid trading
- Carry trades
- 50-pips-a-day strategy
- One-hour strategy
Some of these strategies are more top level, giving traders plenty of scope to personalise them, while others are more specific and require attention to detail. Let’s take a look.
1. Trend trading strategy
Trend trading is one of the most popular – and simple – strategies because its only criterion is that you trade in the direction of the current market movement.
To perform this forex trading strategy, you just need to identify the prevailing trend direction and continue analysing the market so that you can exit your position when the market reverses.
One of the biggest benefits of a trend trading strategy is that your timing doesn’t have to be perfect. Waiting for confirmation signals before entering your position can be beneficial and ensure it’s not a false start.
There are always going to be fluctuations within a trend, but most FX traders will set stops and limits that automate their entry and exit points so that these smaller movements don’t matter as much.
A lot of trend trading FX strategies are based onmomentumindicators, which helps traders assess the strength of a trend. These include the stochastic oscillator and relative strength index (RSI) both of which help show when a market’s price is reaching overbought and oversold thresholds.
A trend trader would look to open a long position on the upward legs and a short position on the downward trend.
When using momentumindicators, it’s important to remember that an asset can remain overbought or oversold for an extended period before reversing.
2. Range trading forex strategy
Arange tradingforex strategy is based on the concept of support and resistance lines. It’s aprice action strategywhich uses indicators to find levels at which the market reverses. When combined, these highs and lows create a range.
In a trending market, prices break above and below support and resistance lines, forming higher highs and lower lows. But in a rangebound market, the price rebounds continually between these levels, creating a sideways pattern.
For forex traders, a rangebound market creates the opportunity to put a scalping or swing style of trading into practice. Taking smaller but more frequent profits as the price oscillates between two levels.
Forex traders who subscribe to a range trading strategy aren’t concerned with whether or not a market will break out above these levels, or ‘trend’. They’re looking at much more short-term movements.
Just like with trend trading, momentum indicators tend to be the tool of choice for identifying where these support and resistance levels are. At these price points, momentum in a trend tends to weaken before the price action reverses.
For example, we can see in this AUD/USD price chart that the price is trading between 0.66231 and 0.66450. As the price spikes over the 0.66450 resistance level, it becomes overbought. It then trades lower, finding its trading range again.
Range traders would look to open long positions between 0.66231 and 0.66450 to take advantage of the swing up to the resistance level. And short positions from 0.66450 to 0.66231, to take advantage of the swing down to the support level.
3. News trading forex strategy
The forex market is influenced by a huge number of events and macroeconomic factors. So, understanding the likely impact on currency pairs is vital for any forex trader, but some take it a step further and base their strategy solely on the news.
For the most part, news trading strategies are focused on set events – such as interest rate announcements and data releases – because they’re more reliable and easier to predict than smaller events that take the market by surprise.
Rather than the individual indicators, a news trading strategy’s greatest tool is a goodeconomic calendar. This will help formulate the basis for timings.
But most news traders will also use historical data around previous events to find patterns and make predictions.
This strategy does come with increased risk due to thevolatilitythat can occur around these events. As more traders change and enter positions around announcements, it can make the market price more difficult to predict.
4. Retracement trading forex strategy
Retracement trading involves looking for instances when the market price reverses for a short time before continuing the prevailing trend. Retracements should be distinguished from reversals – when the price reverses and continues in that direction, forming a new trend.
These temporary price movements can be great entry points for forex traders who want to join a trend at a more advantageous price. But they can also provide early indications that a trend is losing momentum and will soon reverse.
To distinguish one type of retracement from another, traders use technical analysis tools, the most popular of which areFibonacci retracements. The idea behind these drawing tools is that a retracement will end once it reaches a Fibonacci ratio level. So, traders often place stop losses or take profit orders at these crucial prices. We can see how this works on this GBP/USD price chart, where retracements bounce back on or around Fibonacci levels.
Attaching a trailing stop loss to your position is also a good idea when trading retracements. These orders protect your profits if the market moves in your favour, by moving up with the price, but also manage your risk by closing your trade if the market moves against you.
5. Grid trading forex strategy
Grid trading involves entering several stop-entry orders – orders to enter the market at a less favourable price than the current level – attached above and below the market price. This so-called ‘grid’ of orders ensures that whichever direction the market moves in, an order will be triggered, and a position will be taken.
Although entering the market at a less favourable price might seem counterintuitive, the idea is to only enter a position when the trend is confirmed.
Most grid traders look for support and resistance levels as a starting point for their grid. These are commonly found using drawing tools, such as trend lines, and moving averages.
By drawing a trendline onto this GBP/USD price chart, we can see a solid line of resistance. A grid trader might place a stop entry for a long position above the resistance line, and a stop entry for a short position below the resistance line. This would ensure that whether the market breaks out beyond the line or reverses lower from it, a position will be triggered and take advantage of the movement.
In this instance, GBP/USD broke out above the resistance level and the long position was triggered.
6. Carry trade forex strategy
One of the most common forex trading strategies is thecurrency carry trade. It involves taking advantage of the interest rate differential in two countries by borrowing a low-yielding currency to buy a higher-yielding currency. In doing so, your funds would appreciate faster than if they were denoted in the low-yield currency.
Some of the most popular carry trades are AUD/JPY and NZD/JPY, given the high interest rate spreads between them.
These trading strategies have all been more general. But the following two forex trading strategies are more focused on time andpipgoals.
7. 50-pips-a-day forex strategy
The 50-pip-a-day strategy aims to take advantage of early movements in highly liquid currency pairs, such as GBP/USD and EUR/USD.
To get started, you’d set your price chart to 1-hour candlesticks. When the 07:00 candlestick ends, you’d place two types of orders:
- A take profit order 50-pips above, and another 50-pip below the 7 am candlestick close
- A stop-loss order between 5 to 10 pips above or below each order as risk management
Then you can leave the position to take its course. The market will move toward one or the other order and activate it, while the other can be cancelled.
This strategy is most well-suited to scalpers, who want to take smaller but more frequent positions, rather than looking at the longer-term price movements of a currency. It’s designed to work in one-hour timeframes.
As a relatively short-term position, there’s a greater degree of risk that the market can turn against the trade. But that’s what the stop loss is there for, to protect you against too much loss. However, profits will always be capped too. Other strategies might result in higher profits but tend to require more analysis and monitoring.
8. One-hour forex strategy
The one-hour forex strategy focuses, as the name suggests, on a 60-minute timeframe for analysis. Focusing on such a small window at a time breaks your trading into more manageable chunks. It’s not dissimilar from the 50-pips strategy that we’ve just looked at but you’re looking at the previous one-hour price chart for a currency pair.
The strategy involves:
- Placing a sell stop entry and a buy stop entry order two pips away from the low and the high of the previous hour’s close
- Setting a take profit order 20 pips away from the entry order
- Measuring the distance between the high and low of the previous hour, and adding two pips on, to get your stop loss distance for each
The idea is that if the market breaks the previous low, the market is likely to breakout downward, and if the market breaks the previous high, it’ll rally higher for a time. The two pips away from these key levels give the market time to confirm the movement before your entry is triggered.
After one of the pending orders has been activated, you can cancel the other. And although your risk is managed by the stop loss, it can be worth using a trailing stop instead to ensure your profits have time to run too.
It’s also most well-suited to scalpers, given that it’s another quick and limited up-side strategy.
This forex strategy doesn’t rely on technical analysis, but a lot of traders will look at the MACD, Bollinger bands or moving averages over a one-hour timeframe to back up their strategy.
Forex trading strategy FAQ
What is the 5-3-1 forex trading strategy?
The 5-3-1 forex trading strategy is more of a guide for creating your own rules around currency trading. It involves focusing on five pairs, three strategies and one time to trade.
Learn more about the5-3-1 trading strategy
How do you use forex signals?
Forex signals send out data-based information directly to you via email, SMS or push notifications, which can help you make decisions about what positions you want to take and when you should enter them.
Learn more aboutusing forex signals in a strategy
What time do forex markets open?
Forex markets are open 24 hours a day, five days a week. But it’s broken up into four main sessions, which are:
- Sydney –10 pm to 7 am UTC
- Tokyo –12am to 9am UTC
- London –8 am to 4 pm UTC
- New York –1 pm to 10 pm UTC
Learn more aboutforex market hours
