Wednesday, April 10, 2013

Different Types Of Forex Strategy And Why They Work

By Dean Watt

When we trade the foreign exchange market we have many different ways we can make money. To be able to choose the right strategy we need to understand some basics. First we need to look at two different ways of understanding the market, the first is with fundamental analysis and the other is with technical analysis.

The fundamentals are the economic reasons that currencies pairs will fluctuate against one another and this is the big picture of forex trading. One of the things we can look at is the interest rate decisions made by central banks and other economic news releases.

These economic releases can affect how a currency pair will move against each other. An example of this is if a country has a higher central bank interest rate and another has a lower interest rate. Then a trend will develop in the currency pair as money is borrowed from the lower rate country and put to work in the higher rate country.

Now let us look at the technical trader. These traders use charts to understand how the market will move in the future and they are able to do this because they believe that our emotions are at play in the market and as a result they show up on our charts. As these emotions are always present in the market they produce patterns on the currency charts and a technical trader is looking to trade these patterns.

A profitable pattern is support and resistance as these are areas on a chart where trends have changed direction. When a currency is in a downward trend it will hit an area of support, and when we are in an upward trend we will encounter resistance. Where the multiple trends change direction at a signal price on a chart the effect becomes more pronounced.

If we are looking to trade a currency pair that is in an upward trend we can look at our chart to see if there are any areas of potential resistance. We can do this by examining charts with different time frames (giving more weight to the higher frames). By looking for areas where the trades repeatedly change direction we can identify areas of resistance and when the trend starts to reach this area of resistance we can open a (sell) trade. We are expecting the resistance to hold as it has done in the past and the trend to reverse at this point.

A strategy used by some traders is to combine the techniques outlined above. They will use a fundamental approach to select which currency pairs they wish to trade. While using technical analysis to decide when to open and close their trades. However some traders prefer to only use one approach, the one that works for them.

Once we know how we wish to trade we have to decide how we manage our trades. We can do this by manually opening our trades or we can have our computer do this automatically.

By trading manually we have to select our trades ourselves. We must click the buy or sell button and decide our position size, stop losses etc. We do this by using an interface provided by our forex broker. This interface provides a live feed of currency prices. To open a trade we must watch the live feed and wait until an opportunity appears and once we have opened our trade we must decide when we wish to close it.

Another way we can trade manually is to take a semi-automated approach. In this instance we would use the brokers interface to manage our trades for us and by knowing our opening price and choosing whether we use a buy or a sell order, we select our stop-loss and our take profit points. Then we can let the computer trade for us. Once the trade is open the market will either hit our stop-loss or our take profit orders and this will either give us a loss or a profit.

If we don't want to trade manually we can use an automated trading system instead. We can either buy a trading system that has been developed by someone else or we can program our own trading system.

A computerized trading system runs on a set of trading rules. These rules are programmed into the system and they tell our broker when to open and close the trades. This is done automatically and without our input. When humans trade they suffer from the emotional effect of trading. A computer trading system however does not suffer from this and will follow the trading rules exactly. Unfortunately these rules are a set part of the system so if the market changes then the trading system may become unprofitable.

By taking the time to understand our own preferences we can begin to find a way for us to become successful with our trading.

Some of us will enjoy the excitement that comes with manually running our trading set-ups while others will like a computer to make the decisions for us. There is no right way or wrong way to trade. Only the best way that works for us as an individual and then we will have found our trading strategy that works.

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