Traders use a wide range of FX trading strategies. Each strategy can be customised or tailored to the individual needs of a trader and used in conjunction with other strategies.
When considering which trading strategy is best for you, you need to take into account your personal goals, risk appetite, experience and trading preferences. Before exploring the different trading strategies, we will first outline two key trading methodologies: fundamental and technical analysis.
Traders generally sit in one of two categories: fundamental or technical.
Fundamental traders will look for wider economic variables to determine whether or not a currency pair will appreciate or depreciate. To take a basic example, if an economic report came out that was particularly strong, then it might indicate a currency could appreciate relative to another currency. However, if all traders expected the economic report to be strong (prior to the report being released), the impact of the report would already be ‘priced in’ to the market.
On the other hand, technical analysis utilises chart indicators and patterns to analyse past performance in order to determine whether a currency pair, such as the Euro to US Dollar (EUR/USD), is overbought or oversold. By relying on statistical trends or patterns, like volume and price movement (appreciation/depreciation), traders seek to predict which way a currency pair may swing. Of course, traders can utilise a blend of technical and fundamental analysis to evaluate potential investment opportunities.
In light of the above trading methodologies, below is an outline of a number of approaches and indicators that can be used when trading forex.
Position trading is a strategy where traders hold positions for longer periods of time, usually weeks or months. Position traders will generally utilise fundamental analysis and economic data. However, when opening a new position, position traders might make use of technical analysis.
A position trader may wait until a currency pair reaches a (predetermined) support level before taking a long position and holding it for a few weeks. There is presumably less immediacy associated with this type of trading, as traders are not necessarily concerned with intraday prices and generally open fewer positions (when compared to other trading strategies). However, as is the case with any kind of trading, traders need to have a firm grasp of market fundamentals and position trading largely relies on fundamental analysis.
Simple Moving Average (SMA) is an important technical indicator and one of the most frequently used trading strategies. SMA is used to determine if an asset price will move up or down. It is calculated by taking the closing daily price of an asset and dividing it over the total days to get an average. The line that is created by the SMA is then used, along with other technical indicators, to gauge price movements. An SMA line can be of any duration, however, technical traders tend to follow the 50-, 100- and 200-day moving averages. You can test different strategies utilising our charting system.
An exponential moving average gives more importance to recent closing prices. When using these lines, it is advised to take into consideration that they are lagging indicators which may not respond quickly to sharp changes. Short-term trading periods might not have enough price indicators to be reliable. However, they do give a clear visual picture of overall trends and can be very useful in currency trading. EMAs place more importance on recent data than on older data, so they tend to be more reactive to price changes than SMAs. This makes results from EMAs more efficient and is one of the reasons why they are the preferred average among many traders.
Relative Strength Index (RSI) can be used in tandem with the SMA line for additional clarification on the possible trend of an instrument. RSI demonstrates whether an asset is overbought or oversold, based on an index of 0 - 100. Typically, an asset under 30 is seen as oversold, whereas an asset over 70 is seen as overbought. So, if an asset is under 30, it might be a good time to buy, and it might be a good time to sell if it is over 70. Remember, this is just a general indicator and you will often need to tailor your forex trading strategies depending on the asset in question.
Like the RSI, Bollinger Bands are often used with SMA lines as one of many trading strategies. But Bollinger Bands are inseparable from the SMA line. They are created by calculating the standard deviation from a given SMA line. Standard deviation is simply a measure of volatility. When the bands widen, this is an indication that the market has become more volatile. When they contract, the market has become more stable. A Bollinger Band will have an upper and lower threshold above and below the SMA line. The SMA line is sometimes referred to as the ‘middle’ Bollinger Band1.
These are just 4 of many different forex trading strategies that traders adopt to help enhance their trading success. There are numerous combinations of FX trading strategies and no limit to the number of technical indicators that you can use.
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This article contains general information which doesn't take into account your personal circumstances.
1A screen capture of the Plus500 platform, as of September 2019. Illustrative prices.