Forex Trading Strategies
Chapter 7
Great generals are famous for producing results. And that is mostly winning. But we’re not here to conquer countries. We are here to conquer the market. This is what strategy is all about.
What are forex trading strategies?
A strategy is a technique to determine whether to buy or sell a currency pair at the right time. They may be based on the 3 types of analysis.
Furthermore, a strategy is usually made of trading signals that trigger buy or sell decisions. You can find countless strategies on the internet or you can just develop on your own.
Do we really need a strategy?
Shouldn’t I just follow the old saying “buy low, sell high”?
That’s true but would you know how low is low and how high is high?
That is why having good tactics without a strategy for how to use them won’t guarantee you success.
Automated vs. Manual
Forex trading strategies can be either manual or automated.
The difference between them is that a manual strategy involves you sitting in front of a computer, and then look for signals and interpret whether to buy or sell.
On the other hand, automated system is about you developing an algorithm that finds signals and executes trades on its own. The good thing about automated system is that it eliminates human emotion and may improve performance.
Support and Resistance
Before we step into actual forex trading strategies, let’s start first with the basics. Like the widely used concepts in forex, support and resistance.
Here’s the most basic concept illustration:
As you can see, the bull market is a zigzag pattern making its way up.
When the market moves up and then pulls back, the highest point before it went down is the resistance. And when the market continues up again, the lowest point reached before it went up is the support.
Over time, support and resistance are continually formed as the market oscillates. The reverse is true for the downtrend.
Bullish and Bearish
Whether the trend is bearish or bullish, you can identify the levels of support and resistance in your chart.
With the help of charts, they are very easy to identify.
In a bullish market, you are going to buy when you see a turn at past resistance becoming a future support. In a bearish market, you are going to sell when you see a turn at past support becoming future resistance.
Here’s an example of Support and Resistance:
What’s the point of Support and Resistance?
The point is to figuring out when to buy and when to sell. It’s the perfect strategy for beginners struggling to find their way. Besides that, think of this as your foundation for the other advanced strategies out there.
Trend Lines
The trend lines strategy is one of the simplest yet effective charting tools. If drawn correctly, they can be as accurate as any other strategies.
The concept is simple. An uptrend line is drawn along the bottom of support areas (valleys). What you have to do is connect two or more low points.
In a downtrend line, a line is drawn along the top of resistance areas (peaks). In other words, a line is drawn over the chart also connecting two or more high points.
When a trend line is broken, this is likely an indication of a change of the mainstream.
Basically, the whole point of trend lines is locate two major highs or lows and connect them. That’s it, really. And yes, it’s that simple.
Here are trend lines in action:
Points to Remember using Trend Lines
Now remember, it takes at least 2 highs or lows to draw a valid trend line. It takes three to confirm a trend line.
The steeper the trend line, the less reliable it is going to be and the better chances it will break.
But with the same horizontal support and resistance levels, trend lines become stronger the more times they are tested.
Last but not the least and most importantly, never force to draw trend lines to fit the market. Quite simply, if they don’t fit, then that trend line isn’t valid.
Forex Trading Strategies for Beginners
Now that you know support and resistance and trend lines, it’s time to begin with the good stuff. Bear in mind that these are the few of the many strategies available out there. But since this your guide for a beginner such as yourself, it’s best to start with simple forex strategies.
Consider this as your training wheels in your journey to become a successful trader. There will always be a plenty of time add or modify strategies after you have mastered the basics. Despite whether you utilize a simple or complex strategy, what matters most is using what always works.
Breakout Strategy
For starters, breakout strategy is an attempt to enter the market once the price moves outside a defined support or resistance areas. Additionally, the breakout can happen at a horizontal or a diagonal level, depending on the price action pattern.
This is one of the best currency trading strategies for beginners.
As you can see, the market is trending up but saw resistance at a horizontal level. After two failed attempts, the market finally breaks through resistance. This indicates a bullish breakout from a key resistance level.
It’s somewhat similar to a bullish breakout, but this time, the market breaks to the downside. After two failed attempts, the market finally breaks through support. This indicates a bearish breakout from a key support level.
Why is this important?
That’s because breakouts often indicates a start of increased volatility. By waiting for a break of a key level, you can use the volatility as your advantage by joining the new trend as it begins.
Further Analysis
This strategy shows a pattern, and there 4 parts of it.
- Support
- Resistance
- Breakout
- Retest
You may have noticed that there are two trend lines instead of one. One trend line is the support while to other is the resistance. Thus, forming a wedge.
A wedge is usually a continuation pattern. That’s why you have to let the market show its movement before making any considerations about future price movements.
Let’s try to apply this in a 4-hour chart.
See how the market formed into a wedge? As the market started to consolidate narrower, it eventually broke wedge support and subsequently retested the support level as new resistance.
Consequently, that retest showed you a perfect opportunity to enter short.
But wait. Remember stop loss (chapter 2)?
To avoid huge losses, place your stop loss above or below the breakout candle, at a minimum. In the case of the previous example, you should place your stop loss above the candle that broke support just like in this example below.
Remember: Retests don’t happen all the time. Sometimes, price will just move in one direction that will leave you behind. This is why you have to use stop loss orders and never hold on to a trade even if you’re hopeful.
Inside Bar Strategy
Another effective forex trading strategy for beginners is the Inside Bar Strategy.
An inside bar refers any period on your chart the forms inside of the previous period.
In other words, the previous candle completely engulfs the inside bar. But remember that we’re referring about the high to low, or the entire range of the candle. So don’t mind about the open or close of either bar.
The engulfing candle is called the mother bar. And this is where we’re going to focus with the mother’s high and low.
Time Frame
Regarding time frame, this strategy works best on the higher time frames.
The reason for this is that you don’t want all the ‘noise’ you get on the lower time frame. But with the daily charts, that noise will be filtered out, producing cleaner price action patterns which is ideal for this strategy.
Also, the strategy works best on the daily time frame or higher. Inside bars don’t occur as often, so the important trade setups become more obvious and easy to see. You’ll find one or two inside bars on the daily chart.
But if you look at a 1-hour chart, you’ll find multiple inside bars in a single day. That would only make it harder for you.
The third key in identifying an inside bar is that it must happen within a strong trend.
Here are two examples that show the difference of having a strong trend and a weak trend.
The price action inside bar that happened within a strong trend was pretty obvious. The example above was an uptrend but they are just as effective in a strong downtrend.
In the illustration above, the inside bars that happened within consolidation were not obvious. This would make every trade difficult because it doesn’t provide clear directional bias.
To summarize, using this strategy is about looking for inside bars that happen on the daily time frame in a STRONG trending market. This is effective either on a strong uptrend or downtrend. After that, you enter the inside bar trade on a break of the mother bar high or low.
Next is about placing a stop loss.
The best place to put a stop loss is below the inside bar low. With this placement, you’ll receive the best reward and it’s relatively a safe place to hide your stop loss order.
Another thing is that the relative size of the inside bar is important and it has something to do with the entry and stop loss placement. This is because of profit targets and risk to reward ration.
The ratio you should always aim for is a 1:2 risk to reward, at minimum. If your stop loss needs to be 50 pips away, then your profit target must be at least 100 pips.
Let’s try an example where the relative size of the price action inside bar would negate the setup based on your profit target.
Form what you can see above, it does look like a valid inside bar setup. With the daily chart on the strong downtrend, everything looks nice.
Next, let’s try with the same setup, but this time we will look back the past weeks to see why this setup wasn’t valid.
That’s right, previous support and resistance levels play a crucial part here. You can use them to determine whether an inside bar is worth trading. So not only relative size of the inside bar to the mother bar is important, support and resistance levels are also important. These two levels help you know what previous price action has done that can truly help you with your trades. Not only is this effective for inside bars but also for any kinds of price action setup.
For now, this would be the best forex trading strategies to use for beginners. But the forex market is filled with hundreds of different strategies waiting to be explored by you. You’ll discover them along the way so don’t worry of missing out.
Forex it’s not about a race on whose going to finish first. What matters most is having an effective strategy. Just remember, if you can’t explain your strategy to a child, don’t use it. So take baby steps and take it slow.
