Currency Trading is the buying and selling of foreign exchange or currencies. It is a very volatile market and can be very daunting for uninformed investors and traders. The biggest risk is that the markets are affected by the news and events, but the actual impact of that news or event is unknown because a currency is traded in pairs and that is precisely why currency trading strategies have grave importance.
The same event may affect both the currencies in the pair positively and thus the overall impact on the pair remains unpredictable. In order to manage the risks, the investors have to use certain efficient currency trading strategies so that they are able to ascertain, with the highest accuracy, the best points for entry and exit and the best time to do so.
A strategy is a set of analysis which is used by the trader to find whether to buy or to sell a currency pair at a given point in time.
There are many currency trading strategies formulated and implemented by successful traders that ensure maximum profits and lowest risks. The strategies trigger buy or sell signals.
They may be based on the fundamental analysis which involves fundamental Indicators like specific events that affect the economy and so on, or they may be based on technical analysis wherein the past trends in currency prices and their behaviour is studied to understand what can be expected in the future.
The efficient currency trading strategy helps in determining which currency pairs to trade in, the size of each position which controls the risk of the trade, the entry points and exit points and specific techniques for the execution of the strategies eventually helping you to start forex trading efficiently.
Currency Trading Strategies Basics
Following are some of the most efficiently used Currency Trading Strategies:
#1 Price Action Strategy:
This is one of the simplest and most commonly used currency trading strategies.
It is simply based on price action and no indicators or techniques. The basis of this strategy is that forex trading is clearly based on price action-bulls and bears. The price action strategy involves understanding who controls the current price, bulls or bears, and then take action accordingly.
If the analysis of the trader says that the market is controlled by bulls and is likely to stay in their control, he should buy and if the market is in control of the bears he should sell. In order to assess who controls the market, the trader can use methods like support and resistance and candlestick analysis.
The biggest strength of the price action strategy is that it works in all market conditions, be it trending or volatile or less volatile or ranging. It makes the strategy quick, efficient and comfortable and helps to eliminate the noise around the highly volatile price movements.
Example of a price action strategy is the Bladerunner Strategy which involves using candlesticks, pivot points, round numbers and support and resistance levels.
#2 Trend Trading Strategy:
Trend Trading is one of the most successful currency trading strategies.
As the name indicates, this strategy involves identifying and following the trend. The trader identifies whether the movement of the currency price is following an upward or downward trend and then chooses his entry point based on it and the relative strength of the trend.
In order to identify the direction of the trend, the traders use various tools like the moving average, stochastic, relative strength indicators and others. This strategy can be effectively used by both new and experienced traders as it is not very difficult to identify trends using specific tools.
Even if the trader is not able to identify the exact beginning of a trend, he may get in as early as possible and make good profits. This strategy can help a trader bail himself out of an imperfect situation also and aligns him with the direction in which pips are available.
The trends are also affected largely by world events like inflation, interest rate policies and government policies, so keeping a vigilant eye on the world news can be very helpful to a trend based trader.
Counter-trend trading is another one of the most successful currency trading strategies.
This strategy is initially a very useful one as it helps to build the confidence of the trader because of the high success rate. The basic premise of this strategy is that the trends reverse themselves. A breakout does not develop into a long-term trend.
When the extremes have been reached, the correction is expected to happen soon and this is what is captured by a counter-trend trader. This approach may actually be more difficult and challenging than the trend following approach.
The most difficult part is to know for sure that what the trader is considering as the extreme high or low, is it actually the extreme?
Predicting a reversal can be way more challenging than predicting a trend because markets are very volatile and may take any direction at any time.
#4 Range Trading Strategy:
Range Trading is one of the most popular currency trading strategies.
It involves trading within a steady and predictable range of prices of a currency. The basis of this strategy is that the prices can hold themselves within a range for a period of time.
The biggest requirement for being successful in this strategy is to be able to identify the favourable price points, i.e. the price levels at which sellers stop selling and buyers are expected to start buying. These Price points are related to the levels of supply and demand of the currency, indicated by the support and resistance.
The trader buys the currency and expects the price to come to a long-term average. Range traders mostly buy and sell at predictable highs and lows of the support and resistance and use certain tools for assessment of support and resistance like relative strength index, stochastic etc.
This strategy is most efficient for currencies and economies that are stable and not largely affected by sudden news events.
#5 Breakout Trading Strategy:
Another one of the effective currency trading strategies is the breakout trading strategy.
Under this strategy, the trader attempts to enter the market at a point where the market is breaking out of a previous trading range. If the price moves higher than the previous resistance level, the trader will want to enter at this breakout point expecting the prices to go further high and similarly if the price breaks the previous support level, the trader will want to sell at the point expecting the market to go further low.
Before a price breaks out, there is a level of consolidation where the prices remain in a tight range and touch the support and resistance several times. This time of consolidation, right before the breakout, is when the trader seeks to enter or exit the market.
Breakout trading strategy is very appealing to the forex traders as there is a lot of volatility in the market and many chances of breakouts, both actual and fake.
The currency trading market is well-known for fake swings as well due to the high volume trading by the supercomputers. These breakouts work out effectively for a lot of traders.
#6 Position Trading Strategy:
One of the long-term currency trading strategies is the Position Trading Strategy. This is the strategy that does not work on an intraday or a short-term basis, but on a long-term basis like for weeks, months, or years.
Following the position trading strategy, the traders take positions looking at long-term macroeconomic trends of the economies. They keep their leverage and lot size low because the attempt is to make big profits due to big price movements over a long period of time.
The most important requirement for position trading strategy is patience and diligence because this strategy does not give immediate gains to many others. The traders do their fundamental analysis and look for macroeconomic trends and then use technical indicators to determine their entry and exit positions, and then simply wait for the favorable outcome which may take months and years!
So, the position traders have to be thorough with their understanding of fundamentals and must be very patient and should have a large capital base. However, position trading is beneficial too as it does not cause daily stress due to small price fluctuations and is less risky and more rewarding in the long run.
#7 Carry Trade Strategy:
Carry Trade is one of the unique currency trading strategies.
Under this strategy, the traders take advantage of the interest rate differential between two countries whose currencies are being traded, along with the profits on the currency price movements. Ideally, when a trader buys a currency and holds it overnight, he is paid the interest rate according to the bank of the currency’s country.
So, in order to make additional gains, the traders follow carry trade and sell out the currency of a country with a low-interest rate and buy the currency of a country with a high-interest rate and benefit from the differentials. This strategy is mostly combined with the trend trading strategy to maximize the gains.