The foreign exchange (FOREX) market is the international market for currencies and is by far the most heavily traded financial market in the world. On average, over $5 trillion is traded per day in the FOREX market, with much of this volume stemming from speculative trades (professional and retail traders buying and selling currencies in the hopes of making a profit), as opposed to conventional corporate activity.
The advent of online trading has made FOREX trading easily accessible to people all over the world – you can now set up an online trading account within a matter of minutes, with very low deposit requirements. Some part-time, novice traders have been able to generate vast wealth from FOREX trading, but many lose money from trading.
Below are four strategies which you can utilize to trade currencies successfully and prudently:
Breakout trading offers the potential to make significant gains from single trades, as the breakout tends to be quite large, so, if successful, the market moves by quite a big chunk in a short time in your favor.
Traders utilizing this strategy and therefore looking for breakouts, extensively monitor detailed charts, on various time intervals, to spot breakout opportunities.
Traders often wait for the price of a currency to cross a certain point – typically an established resistance level – before quickly entering into a "long" position, hoping the price rapidly climbs after it breaches the resistance level.
This strategy is based on traders using technical analysis – aided by indicators and graphics – to determine overbought and oversold currencies. Typical indicators used by successful range traders include the commodity channel index, stochastics, and the relative strength index (RSI).
If you spot an opportunity where a currency is oversold, you can capitalize on it by purchasing it and waiting for the price to recover once the market realizes it is oversold and demand recovers, driving the value up.
On the flip side, if you spot an opportunity where a currency is overbought, you can capitalize on it by shorting (this may appear as "sell" in your online trading platform) it and waiting for the price to drop once the market realizes it is overbought and demand falls, causing the value to plummet.
It should be noted that this strategy is challenging to employ in a "trending" market, with precise and continued price movements either up or down, so should be avoided in such conditions, especially for beginners.
A trading strategy centered around scalping consists of traders buying and selling currency pairs quickly, sometimes just holding their position for a few seconds, and closing after the market moves a few ticks in their favor. This strategy allows traders to make small profits from trades regularly, but they can quickly add up, with scalpers often closing dozens of such trades per day.
As individual winning trades may only generate a small profit each, it is essential to use a lot of discipline. Cutting your losses on bad trades quickly, for example, will help you protect your profits and starting capital.
This strategy is especially popular in the FOREX market, as there is plenty of liquidity, so traders can easily open and close their positions, as there's lots of supply and demand for a currency at any given moment.
This is certainly the case for "major"/popular currency pairs, such as EUR/USD or GBP/USD. Still, more obscure currency pairs will be far less liquid, so traders should always conduct due diligence before trading a currency.
It should be noted that this is unlikely to be an issue for retail or amateur traders, as their positions are unlikely to be large enough for limited liquidity to be a serious concern unless they are using very high levels of leverage.
This form of trading takes advantage of significant swings/reversals in the value of a currency. For example, if a currency has been trending upwards and a trader spots a reversal trading opportunity, he would take a "short" position, as he expects the price to plummet. He would generate a substantial return if this indeed happened.
If a currency pair has been trending downwards and a trader thinks he has found a reversal trading opportunity, he would take a "long" position/buy the currency, as he expects the price to surge. He would generate a large profit if this indeed went on to happen after he entered the market.
Traders often rely on indicators to help them spot such reversal trading opportunities. Commonly used indicators for reversal trading in the FOREX market include basic trendlines or moving averages.
Reversal trades can be spotted and executed within the trading day (intraday trading), or over a much longer timeframe – perhaps up to several months. For the latter, a trader would use charts showing the price movements of a particular currency pair over a much more extended period than they would for intraday reversal trading.
For a trade or a price movement to classify as a reversal trade, there must be a significant reversal in price (either upwards or downwards.) A small U-turn in price against the trend is instead known as a "pullback."
This strategy is quite different from those listed above, which rely on some level of technical analysis to spot opportunities in the FOREX market and execute their strategies.
Instead, the fundamental analysis consists of Forex traders and speculative investors analyzing and judging how the value of a currency will react and change in response to a real-life event.
Events that can sharply influence currencies' value include interest rate changes, the publishing of trade and economic data, and even political events, such as Brexit. For equities, there are a few extra influencers, such as earnings reports and annual general meetings (AGMs.)
As financial and governmental organizations typically have set dates on which they'll release such data, traders can carry out fundamental analysis in advance and try to gauge market sentiment, and then enter a position before the data is released.
For example, if the Federal Reserve is due to announce its new rate policy tomorrow, and a trader has conducted fundamental analysis and believes the Fed will increase rates (thus causing the value of the US dollar to rise), he would buy US dollars in advance and potentially sell them once their value increases (assuming he was correct.)
Quick Summary of Currency Trading Basics
- The foreign exchange (FOREX) market is the international market for currencies and is by far the most heavily traded financial market in the world.
- Some part-time, novice traders have been able to generate vast wealth from FOREX trading, but many lose money from trading.
- Reversal trading takes advantage of significant swings/reversals in the value of a currency.
- Range Trading is based on traders using technical analysis – aided by indicators and graphics – to determine overbought and oversold currencies.
- A trading strategy centered around scalping consists of traders buying and selling currency pairs quickly, sometimes just holding their position for a few seconds, and closing after the market moves a few ticks in their favor.
- Fundamental analysis consists of Forex traders and speculative investors analyzing and judging how the value of a currency will react and change in response to a real-life event.