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Forex Trading without a strategy is like starting a journey without a map because you never know where your account will end up. You may make money or lose money, but you don’t know which is more likely.
The big advantage of having a forex trading strategy is that you can take some of the guesswork out of trading currencies. Read on to learn more about the best forex trading strategies and how to choose between them to trade currencies successfully.
Choosing a Forex Strategy
Choosing a forex strategy is one of the most important things you can do to help ensure your profitability as a currency trader, so you’ll want to choose a strategy that works.
You also want to choose a strategy that best suits your lifestyle and personality type — not everyone wants to watch trading screens all day or is suited to the pressure of fast-paced or high-risk strategies.
Once you have decided on one or more forex strategy options, you should check how they perform. First, test each strategy through backtesting, which can be done with the popular MetaTrader forex platform if you have simple programming skills.
Check your strategy on a demo account that most online brokers will allow you to open risk-free. If any strategy still looks profitable, you can start trading it on a live account for the final test.
It is usually best to start with smaller trades and then work your way up to larger amounts as you gain confidence in the performance of the strategy and your ability to apply it in a disciplined manner when trading live.
The 5 Best Forex Trading Strategies
There are many successful strategies for forex trading, but not all of them are suitable for every trader. Choose the strategy that best fits your particular situation, including available time, personality type, and risk tolerance. These are covered below based on the time usually involved, ranging from short to long term.
1. Scalping
Scalping is a short term trading strategy that involves taking many small profits on trading positions of very short duration. Scalpers require very fast reaction times as they are usually in and out of trades in seconds or minutes. This fast-paced and somewhat thrilling activity may not be for everyone.
Scalpers also monitor price charts for patterns that can help them predict future exchange rate movements. They tend to use short term tick charts similar to those shown below for EUR/USD analysis. Scalpers generally do best using brokers with tight spreads, guaranteed fast order execution and minimal or 0 order slippage.
2. Day Trading
Day trading is another short term trading strategy that is followed only during certain trading sessions. Day traders generally don’t take positions overnight, so they close all trades each day. This helps reduce exposure to market movements when traders are inattentive to the market.
Most day traders use a trading plan based on technical analysis on short-term charts showing intraday price action. There are many day trading strategies, but one that is popular, is known as breakout trading. Trades are triggered when the exchange rate moves beyond a certain level on the chart for a currency pair and are confirmed when accompanied by an increase in volume.
The 30-minute GBP/USD candlestick chart shows a break below the lows of 2 converging trendlines of the triangle pattern drawn in red. Note that the trading volume also increases when the breakout occurs, thus confirming it.
3. News Forex Trading
Some forex traders with deep pockets and a decent risk appetite might use news trading strategies, although they may not be ideal for forex beginners. These strategies can be based on both fundamental and technical analysis and generally benefit from the volatility that is often seen in the forex market immediately following major news releases.
News traders usually need to monitor the economic calendar for important data releases. They then watch the market closely before the event to determine key support and resistance levels so they can react quickly after the event based on the results. News traders need to maintain strict discipline when managing their currency positions during such a fast market and place frequent stop-loss and take profit orders in the market.
An example of an economic calendar and data release event that news traders might use is the US jobless claims. This data was highly volatile during the COVID-19 shutdown in the US and created considerable fluctuations in the forex market after its release. While the job numbers are dismal, what matters most to the market is how the results differ from market consensus.
In the situation below, the previous unemployment claims figure was 3,176K, the expected figure was 2,500K, and the result was worse than the expected 2,981K. This should put pressure on the US dollar upon release versus other currencies.
4. Swing or Momentum trading
Swing trading, sometimes also known as momentum trading, consists of medium-term trading strategies that aim to capture more of a market’s movements. Swing traders do this by trading both with the main trend and against it when the market is correcting, so they must be willing to hold positions overnight.
Swing traders tend to focus on entry and existing positions based on momentum indicators that provide buy and sell signals. Traders use it to find overbought or oversold markets that they can buy or sell. Swing traders may also buy before support or sell before a resistance level develops on a currency pair’s exchange rate chart.
Some commonly used momentum indicators include the Moving Average Convergence Divergence (MACD) histogram and the relative strength index (RSI). The daily candlestick chart shown below for the GBP/USD exchange rate also shows MACD and RSI in the indicator box.
5. Trend Forex Trading
Trend trading is a popular long-term forex trading strategy that follows the prevailing trend or directional movement in the market for a particular currency pair. This strategy often involves buying on pullbacks in an uptrend or selling on rallies in a downtrend.
Once a trend trader has taken a position in the direction of the trend, you may hold onto it until the market reaches its objective or the trend begins to reverse. Trend traders often use trailing stop loss orders to maintain their profits in the event of a significant reversal.
Many trend traders use technical analysis indicators such as the Average Directional Movement Indicator (ADX) and/or moving averages which smooth out price action so they can better identify trends. They may also use long and short term moving averages and watch for crosses to signal potential reversals.
The 4-hour candlestick chart for EUR/JPY below shows the ongoing uptrend after a significant decline with the 10-day moving average shown in red and ADX in the indicator box below.