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Top 3 forex trading strategies

Top 3 forex trading strategies

It is essential to have a plan when trading forex, that is, when you are buying and selling currency pairs on the forex market. Having a forex trading strategy helps a trader keep focus, but strategies have to be customized to each individual forex trader, taking into account personal motivations and factors. In this article, we cover some of the most popular forex trading strategies used by traders.

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Forex trading strategies
The essence

  • It is important to have a strategy when trading on the forex market.
  • Trading strategies need to be tailored to the individual, there is no one-size-fits-all solution for the "best" forex trading strategies.
  • The three most popular forex trading strategies are trend following, scalping and carry trade.
  • Each forex trading strategy has its own advantages and drawbacks.

Forex trading strategies
Building a forex trading strategy

A forex trading strategy aids traders in determining when or where they should buy or sell a specific currency pair. There are many different simple forex trading strategies, but there is no such thing as the "best" or most successful forex trading strategy, as each may work differently under certain conditions. There is also a wide range of advanced forex trading strategies, with each needing different levels of technical and fundamental analysis.

Every strategy should be uniquely tailored to each forex trader, adapting it to the individual's risk profile, emotions, mental state, motivation, daily schedule and trading time. A strategy to trade forex cannot be simply copied from someone else: you have to use parts from here and there, and put it together like a puzzle, optimizing it into a forex trading strategy that works for you. This can be quite a long process. 

Also, take note that on the forex market traders have to trade on margin, or in other words, trade using borrowed money, also called leverage. Although this can increase your profits on a successful trade, it can also multiply your losses if the trade is unsuccessful.

Below, we detail the three most popular forex trading strategies used by traders.

In order to trade forex, you need to have a suitable account at a brokerage. To get some ideas on where to open an account, check out our most current list of the best forex brokers:

  1. Saxo Bank
  2. Fusion Markets
  3. CMC Markets  
  4. Interactive Brokers
  5. Capital.com

Forex trading strategies
Forex trading strategies

Trend following strategy

Trend following strategies, as the name says, follow the main trends, or direction, in the value of an instrument. The goal of this strategy is to cut losses quickly while letting winning trades continue to run further. The main trading directions can be identified over relatively high time frames: monthly, weekly or daily. In these cases, one candle on a chart translates to one month, week or day. These trends are long enough to determine which side is dominant, buy or sell. Strong trends are considered ones that last longer than a year.

In this forex trading strategy, it is important to identify the key support and resistance levels that represent the top and bottom of a given trading range. Longer time frames give strong support and resistance levels, which are key factors when determining the target and stop-loss prices a forex trader should use. The difference between your entry price and stop-loss will represent your risk, while the difference between your entry price and target price is your potential reward. Good risk/reward opportunities can usually be found at the break of so-called countertrends, or shorter trends that go opposite a longer major trend.

The main tool of risk management here is a stop-loss. It should be set in line with the volatility of an instrument, which is measured by the so-called Average True Range (ATR) indicator. The difference between the entry point and stop-loss should be more than 1 ATR. This way, a random market movement will not hit your stop-loss.

The difference between your entry point and stop-loss will be the amount on which positions should be sized. The size of positions are given in what are called lots. Sizing the lot is an important element of risk management.

In general, 1-2% risk is suggested per position. The bigger the account size, the lower the risk percentage should be. You should also monitor economic data, because major events may cause high volatility or trend reversals that could hit your stop-loss.

Read this detailed description of a forex trade built on trend following strategy.

Scalping

Scalping strategies are about catching small market movements with large positions within a very short time. This is characterized by executing a large number of trades, so it is completely the opposite of holding positions for hours, days, or even weeks.

The time frame of this strategy is low: usually it is done in the 1 minute chart, where 1 candle represents 1 minute of information. Tight spreads and low commissions are very important in this strategy because these costs need be covered by few market movements. You cannot be profitable if you catch 3 pips on the average, while your spread cost is also around 3 pips.

It is essential to follow this strategy only at brokers that provide quick order execution and no slippage. Fast order execution helps maximize your profit by catching the price you aimed at quickly. Trading gaps can also put your profit at risk, therefore this strategy should be executed when there is a low probability of gaps. You can avoid that by not trading at:

  • times of high-volatility economic news
  • low-volume trading times
  • market opening and closing

The time frame of scalping is characterized by large market noise, therefore it is hard for beginners to be profitable using this strategy. This type of strategy has a lot of psychological pressure, so it is not recommended for beginners

Carry trade

Carry trade strategy is about buying a high-interest-rate currency against a low-interest-rate currency. The profit comes from the difference between the high interest you receive and the low interest you pay, plus the favorable exchange rate movement. In other words, carry trade is focused on profiting from a swap and the exchange rate. The time frame of this strategy is months or years.

For example, let’s say that a trader decides to deposit $1,000 into a forex trading account. They choose to buy USD/CHF for a positive carry trade, which has an interest rate differential of 3.25%. Using leverage of 20:1 they can open a $20,000 position for the currency pair, meaning that the deposit is only 5% of the full value. A 3.25% interest rate difference becomes 65% annual interest on an account that is 20 times leveraged.

The monetary policies of central banks are key to a carry trade strategy, mainly with regard to the future directions of interest rates.

A carry trade strategy can result in 3 outcomes:

  • If the currency bought with the higher interest rate appreciates against the currency sold with the lower interest rate, the trader will gain profit on the exchange rate and will receive the positive interest of the full position value.
  • If the currency bought with the higher interest does not change to the currency sold with the lower interest, then the trader will receive the positive interest on the leveraged trade and will not encounter any other profits or losses.
  • If the currency bought with the higher interest rate depreciates against the currency sold with the lower interest, the trader loses on the exchange rate, but will receive the positive interest of the full position value.

Forex trading strategies
FAQ section

What is forex trading?

Forex trading means the buying and selling of currency pairs. You are basically buying one currency while selling another in the hopes of closing the position later with a profit.

What is the most successful or profitable trading strategy?

There are no single "best" forex trading strategies that fit or work for everyone all the time. Forex traders have to find the best strategy for their specific level of expertise, experience and commitment, which may involve combining various aspects of several different strategies. Success and profits can be achieved in any trading strategy if the conditions and timing are right and the forex trader makes the right decisions at the appropriate time.

Is forex trading profitable?

It can be, but it’s certainly not for everyone. The European Securities and Markets Authority (ESMA) requires brokers to emphasize what percentage of retail investor accounts lose money trading CFDs (through which a significant part of forex trading is done). Depending on the broker, this figure is usually between 60-90%.

What is going long or short?

Essentially, this is your expectation on the direction of price movements: if you ‘go long’, you are expecting a price increase, while if you are 'going short' means you are expecting a price decrease.

What drives forex markets?

In general, it can be said that liquidity and market flows dictate short-term price movements on currency markets, while economic fundamentals shape longer-term trends.

Forex trading strategies
Glossary

Currency pair: Forex trading involves exchanging one currency for another, therefore currencies come in twos, in so-called trading currency pairs. A pair is the quotation of two different currencies, with the value of one currency being quoted against the other. The first listed currency is called the base currency, the second currency is called the quote currency. Currencies are expressed with currency symbols, such as USD for the US dollar, GBP for the British pound, and so on.

Financing rate: A financing rate or overnight rate is charged when you hold a leveraged position for more than a day. A typical example of this would be a forex trade or a CFD trade. A leveraged position means you borrow money from the broker to trade. For this borrowed money, you have to pay interest (or in certain cases, can also receive interest). This is the financing rate.

Forex trading: Forex trading means the buying and selling of currency pairs. You are basically buying one currency while selling another in the hopes of closing the position later with a profit.

Leverage: Leverage is an investment strategy of using borrowed money, or debt, rather than fresh equity, to increase the potential return of an investment. Leveraging enables gains to be multiplied, but losses are also multiplied.

Lot: A lot is the number of units of a financial instrument that is traded on an exchange. For stocks, a round lot is 100 share units, but they can also be traded in any number of shares. One option represents 100 shares of the underlying stock, while forex is traded in micro, mini, and standard lots.

Margin: In trading, the margin is the money borrowed from a brokerage firm to purchase an investment. It is the difference between the total value of securities held in an investor's account and the loan amount from the broker. Buying on margin is the act of borrowing money to buy securities. The practice includes buying an asset where the buyer pays only a percentage of the asset's value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the investor's account act as collateral.

Stop-loss order: This is a stop order for minimizing your losses. Once your market or limit buy order is executed and you have an open position, you'll probably want to both secure your profits and minimize your losses, depending on how the market turns. This is what stop orders are designed to do.

Currency swap: A currency swap is an agreement between two parties to exchange their periodic interest-rate payments based on a set amount of money, though in different currencies, for a set amount of time. 

 

For more commonly-used terms and phrases, visit BrokerChooser's financial glossary page. 

 

Further reading:

Author of this article

Krisztián Gátonyi

Author of this article

Krisztián has 15 years of experience in proprietary trading, mainly in the interbank currency market as a foreign exchange risk manager. He received his MSc degree in International Business from the University of Middlesex. He is interested also in real estate and dividend growth investing. His purpose is to help people find the best investment provider.

Krisztián Gátonyi

Senior Broker Expert

Krisztián has 15 years of experience in proprietary trading, mainly in the interbank currency market as a foreign exchange risk manager. He received his MSc degree in International Business from the University of Middlesex. He is interested also in real estate and dividend growth investing. His purpose is to help people find the best investment provider.

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