Establishing a forex trading strategy helps you to take a more objective approach to your trading. In the short term, you are trading on the basis of tested methods rather than individual hunches. In the long term, you are placing your individual trades within the wider context of your rules for money management.
With a reliable forex trading strategy in place, no single trade should be able to make a disproportionate dent in your bottom line, and you should be able to see each trade as part of your ongoing trading activity.
Forex strategy: money management
Your forex trading strategy should be designed to achieve profits over the long term. As such you need to establish:
The investment capital you want to devote to your forex trading
The profit target you want to achieve by a specific date
The proportion of your investment capital that you are willing to risk on each trade
Your ideal risk-reward ratio, i.e. the level of return you want to target per trade
You can see that your strategy depends not just on the funds at your disposal but also on your attitude to risk. Are you happy to shoot for a high return on your risk or would you rather target a smaller return per trade and hope that your strike rate leads to long-term profitability?
When you consider your money management strategy you’ll want to see a close correlation between your long-term profit target (set against your total capital) and your ideal risk-reward ratio per trade. Otherwise your short-term activity won’t be aligned with your long-term goals.
Forex strategy: choosing your pairs
Rather than try to keep track of the full array of available forex pairs, you’ll probably want to restrict your analysis to a limited number of pairs. These may be the pairs you feel most comfortable trading, or pairs featuring a common currency you feel you understand well.
Do you want to trade the most popular forex pairs, such as EUR/USD, USD/JPY and GBP/USD, where the high levels of liquidity can give you very low trading spreads? Or do you want to look for opportunities among the more exotic pairs?
With the major forex pairs you’ll be able to find copious research and market analysis related to market-moving events, although much of this analysis may be contradictory on the whole. Your choice of pairs to target reflects your approach to forex trading in general and is another key part of your strategy.
Forex strategy: trading on news
Will you rely solely on technical analysis or will you try to incorporate news events in your forex trading strategy? Individual currencies represent geopolitical entities and are therefore highly sensitive to political events and economic data releases.
If you want to make the news a key part of your trading strategy you’ll need reliable news feeds. You’ll also need to establish a routine whereby you monitor the news regularly, for both scheduled economic releases and unscheduled events, and track the effect of particular events upon your chosen forex pairs.
The key to trading the news is timeliness. You are seeking to predict short-term market responses ahead of other forex traders, while keeping risk protection measures in place to guard against sudden reverses.
Forex strategy: reading indicators
When you apply technical indicators to your forex chart you are creating the basis to generate signals to buy or sell. Different combinations of indicators give rise to different systems which you can incorporate with your forex trading strategy.
You might choose to trade when a short-term moving average crosses a longer-term moving average. Or you might trade when the price hits an upper or lower Bollinger Band. It is also useful to follow a system that generates exit points as well as entry points, so you know when to take your profit.
There are too many systems to mention here, but it is important to test any system you are planing to use against historic price data. How often did the signals generated by the system lead to a profitable outcome? Don’t just consider the strike rate, but also the overall profit or loss from following these signals over a period of time.
Whatever system you use, ask yourself: are the indicators helping you to read the trend with confidence? If you feel a system generates proven signals and helps you to read the market, make it a part of your forex trading strategy.
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