How to build a forex trading strategy
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Forex trading strategy
To trade forex successfully, a set of proven trading strategies, also known as trading plan, and solid risk management rules to stick to. Whether you are a beginner or an experienced trader, here’s how you can build and test the profitability of your own forex trading strategy in 5 steps.
1. Understanding technical analysis
Technical analysis involves using price charts and indicators to analyze market direction. Technical analysis helps you identify possible entry and exit points for your trading positions.
Contrary to fundamental analysis, technical analysis mainly focuses on market patterns and prices. Fundamental analysis, on the other hand, is about the factors that drive the market prices. These two analytical methods can be used independently or combined.
Technical analysis focuses on timing and price patterns, that’s why it is often considered a neutral tool. To find forex trading opportunities based on technical analysis, you need to analyse the current market price and identify possible target levels. While technical analysis does not guarantee outcomes, it provides a calculation of the possibilities for different market moves.
2.Importance of technical analysis
The majority of traders use technical analysis in determining the expected market direction. Market movements are not entirely random. When traders see an emerging pattern, there is a good chance that a lot of other people are also aware of it. You can consider the trend as something that is almost self-fulfilling. In that sense, you can say that traders help create the patterns found in market prices.
For an in-depth look into technical analysis, read our comprehensive technical analysis course.
3. Understanding fundamental analysis
In the previous sections, you learned that technical analysis is focused mainly on trends and price actions. Fundamental analysis has a different approach to assessing the markets, offering a holistic picture of market weaknesses and strengths.
A fundamental analyst takes a look at key events that could affect a specific currency’s strength or weakness. These include political and economic data as well as natural disasters.
In short, a fundamental analyst utilizes all available information in gauging a currency’s strength. Attention is focused on key economic reports and data, including GDP and unemployment data, production data and announcements of interest rates.
4. Fundamental factors that affect forex prices
Natural disasters like hurricanes, tsunamis and flooding can greatly impact a currency’s fundamental strength and weakness. A good example is the tsunami that hit Japan in 2010. It debilitated the country’s manufacturing sector and significantly disrupted the production of automakers and the mobile technology industry.
When demand for products and services from a specific country increases, the demand for that country’s currency also increases.
Economic output and growth
The country’s GDP is among the most important indicators of economic growth. It sums up the production of goods and services in the country providing information on the country’s performance and economic strength.
Inflation – This factor has two key indicators:
Consumer Price Index – This measures the change in average cost of goods and services to consumers.
Producer Price Index – This measures the change in the cost to produce goods and services for producers.
Prevailing interest rates are probably one of the key factors that determine the value of a currency, because they determine the flow of global capital in and out of a country or economic region.
Usually, political instability impacts the demand for the country’s currency negatively. Investors tend to avoid countries and currencies in political turmoil.
A country’s fiscal policies, including government spending, budget planning and taxation can influence investors’ decision on whether to invest or not.
Whatever monetary policies central banks adopt, they have a significant impact on short-term currency demands.
At ThinkMarkets, we have a team of market analysts providing daily and weekly reports on the latest developments in the markets. By opening an account for free, you are automatically subscribed.
5. Choosing your entry and exit points
Forex traders are exposed to trading risks, regardless of their approach. That’s why understanding price action is key to determining when you place your trades and when you exit a position. Here, you will learn the four key price actions concepts used in forex trading to determine entry and exit points
Support & resistance: Support and resistance refer to important trading levels where the price has touched and bounced back multiple times. You can think of them as key points where demand and supply meets.
Breakouts: A breakout, is a break through an established support or resistance level. Breakouts are strong signals, especially when confirmed by other indicators like gaps.
Gaping action: Gaps are important since they signify that buyers (upside) or sellers (downside) are making their moves. But, you have to make sure to confirm a new trend using multiple indicators before you jump in.
Sideways market: A forex market that trades sideways refers to price action within a narrow range of strong support and resistance levels. When a market trades sideways, traders are preparing for a breakout.
6. Managing the trading risk
By now, you should be aware that forex trading involves risks. The market is quite volatile and the bigger your potential gain, the higher the risk. Here are some tips to keep the risk in control.
Although volatile markets can be tempting, a good rule of thumb is to avoid risking more than 2% of your trading account balance on any single trade. Trading more than that would expose you to losses that are hard to recuperate.
Set up stop loss orders to minimize losses
Success in trading does not consist of winning trades only. On the contrary, it is the aggregate of winning and losing trades. That’s what makes stop-losses a key factor when it comes to profitability. Placing stop-loss orders will also eliminate the need to constantly monitor your position.
7. Test your trading strategy
While you cannot replicate the risks involved in trading with real money, a demo environment can help you test the soundness of your investing strategy. Every new strategy needs to go through a period of trial and error before you can confidently invest your hard earned money on it.
For faster strategy testing, you can use Trader’s Gym, a live trading simulator that allows you to replay, pause and re-wind real market action even during the weekend. To get access, open an account for free by choosing Trade Interceptor as your platform and test your strategy in a real trading environment either on desktop or on your mobile phone.
Now that you have a good grasp of the basics of forex trading, it is time to
- Try our free demo
Losses can exceed deposits.