To be a successful forex trader you need to develop and adhere to a trading strategy. There are many different strategy’s available and no particular one is good for all traders; rather, each trader needs to develop his or her individual approach to forex. We each have special skills that separate us from others and the forex trader needs to find what works best for him/her. Some traders rely solely on technical analysis while others prefer fundamental analysis, but many successful forex traders use a combination of both to get a broad overview of the market and for plotting entry and exit points.
Technical analysis, or charting, relies on one key concept: Prices move by trends. The common saying in forex and stock trading is ‘The trend is your friend.’ If prices are moving in one direction, the strength of the move can be observed by looking at the chart. Market movements have identifiable patterns that have been studied for many years and a thorough understanding of these trends and how to use the trends to make forex trading decisions form the basis of a good trading strategy.
There are many analytical tools available to study market movements. Forex traders can use computer software or even pen and paper to perform their own analysis. Books abound describing many of these strategies. The beginner forex trader should study each one well and acquire a working knowledge of the concepts. Study each method until it is mastered, then use itthe strategy to fully learn it. Once mastered, move on to the next strategy and repeat. It is a simple practice to “trade” forex simply on paper, without entering any actual trades. In fact, this method is highly recommended until the beginning forex trader builds some confidence.
Support and resistance levels are used in many forex trading strategies. ‘Support’ refers to the price level that is repeatedly seen as the bottom – when the price reaches this level it tends to rise. Prices will seldom fall below the “support” line. At the opposite spectrum is the Resistance levels. Resistance appears to be the peak that a price will reach when buyers and sellers seem to agree. At this apex prices will move up no further. The space in between “resistance” and “support” is known as the “trading range”. Prices can move back and forth within this range for some time. The longer the time frame spent in this range, the more important the signal triggered when prices move outside of the range.
When currency prices break through either support or resistance levels, the prices are expected to continue in that same direction. As mentioned, the longer prices stayed in a trading range, the more significant the “breakout”, if prices move above “resistance” or “breakdown”, if prices fall below “support” For example, if the price rises above the previous resistance level, it is seen as bullish – the price should continue to rise. This signify’s that more buyers have entered the market and this increased “buy” pressure will move prices higher. Conversely, when sellers are too many and buyers few, a “breakdown” could signify prices moving lower again until buyers and sellers once again reach equqlibrium. To find support and resistance levels, price charts need to be analyzed for unbroken support and resistance levels. Charts can be analyzed in any time frame; short term traders will study daily or even hourly charts while the long term trader will use weekly or monthly charts to easily see the long term trend. Traders can use support/resistance levels to determine when to enter or exit a transaction.
Moving averages are another common tool in forex trading strategies. If a trader only uses the closing price of a currency at the end of the day as a guide, it is hard to establish the true direction of the move. Moving averages “smooth” out the large moves and give us a much clearer look at the currency price. One average used is the simple moving average (SMA) shows the average price in a given period of time over a specified period of time. A 10 day SMA simply takes the past 10 day closing price of a currency and averages out the 10 day data. Another popular moving average is a weighted moving average. While similiar to the SMA, the WMA puts more emphasis on the last several days trading. So while still showing a 10 day average, more weight is added to the last couple of trading days to better reflect the true trend. When prices are above the MA, they will tend to stay above the MA line. When the MA is below the line, price decline can be expected as well.
These are examples of trading strategies that can be used individually or in combination. In practice, the forex trader should have a repertoire of trading tools to examine market conditions and to support the findings of one trading method or another. Experienced traders will rely on several, rather than one, key indicators to base their trading decisions on.
Similarly, fundamental analysis can be used to reinforce technical findings, or vice versa. The forex trader will study currency valuations, inflation rates, and other key financial indicators to decide whether a currency is “cheap” or “expensive” Ideally, the forex trader will use several indicators into account when plotting a trading strategy.
Every trading strategy should provide clear guidelines about when to enter a trade, what to expect in terms of market movement, when to exit a trade, and how much loss can be accepted in case the deal moves against the trader. Following these simple guidelines and learning about technical analysis can help you become a successful forex trader.