To run any business successfully, you need a comprehensive business plan. Forex trading is no different. The forex market is the biggest trading arena in the world and every trader needs a clear plan to succeed. Professional traders treat their trading career as a personal business and have a well-defined, written trading strategy in place. Yet, creating the best forex trading strategy is no easy feat.
In this article by Finestel, we aim to introduce the best forex trading strategies for 2023. We begin by describing what a top-notch trading strategy looks like and what features it includes. Then, we move on and briefly present a few trading strategies for both beginners and professionals and conclude the article by stating the risks associated with trading the forex market.
Table of Contents
Understanding Forex Trading Strategies
A trading strategy or trading plan provides a roadmap for forex traders to safely navigate this ruthless financial market. A complete plan includes many factors and sections, such as analysis tools and methods, entry and exit criteria, and risk management rules, just to name a few. In order to create a functional forex trading strategy, you require both significant knowledge and experience. The strategy should also be well-suited to your personality, as you are the one who eventually pulls the trigger.
The process of trading strategy begins with learning a few key concepts. These include macroeconomics, basic statistics, technical analysis, etc. Macroeconomics is required for determining the long-term trends of different currency pairs by analyzing countries’ monetary policies and other economical factors. Statistics also provide you with a new way of thinking, that is to think in terms of probabilities. Nothing is certain about the financial markets, so you should be able to use statistics to your advantage. Finally, technical analysis enables you to identify entry and exit points based on past price movements.
Why Do You Need a Forex Trading Strategy?
As previously mentioned, forex is the largest financial market worldwide. To bring things into perspective, the daily trading volume of EUR/USD, which is the most liquid forex pair, is significantly bigger than the whole market cap of cryptocurrencies. So, to be able to thrive in the forex market, you would definitely need a robust plan of action, AKA trading strategy.
In a market where the average players are hedge funds, banks, and large investment firms, no individual retail trader can succeed without a plan. Your trading strategy reminds you of your limitations and strengths and makes you follow and repeat a step-by-step routine to find setups and execute. Therefore, your trading plan is your sole weapon to survive in the grandest market of them all.
The Main 3 Categories of Forex Trading Strategies
There are various trading strategies out there, each applicable to certain market conditions. Choosing between these categories also requires you to know your personality, risk tolerance, and limits. Here are the most common categories of forex trading strategies:
- Trend Following: Strategies based on trend following are used in trending markets, as the name clearly suggests. When the price is either clearly bullish or bearish, trend followers enter the market. With the expectation for the trend to continue, they aim to hop on and ride the wave.
- Range Trading: Markets are in rangebound conditions for approximately 70% of the time. Therefore, while being significantly more challenging than trend following, range trading can obviously present more trading opportunities. Therefore, range trading forex strategies are more suitable for intermediate to advanced traders.
- Scalping: The most difficult category of trading strategies is scalping. Scalpers are traders who aim to capture little movements in the market, with no regard to whether the price is ranging or trending. They usually operate on timeframes lower than 15 minutes, and distribute their risk over a large number of trades, as they usually many more take positions than other groups of traders.
Features of Effective Forex Strategies
The best forex trading strategies almost always include a certain number of features. Here are a few building blocks of effective strategies:
- Analysis Method: Your plan should definitely determine which tools and methods of analysis you use to frame your trades. These can range from indicators and price action in technical analysis, to more sophisticated fundamental or sentiment analysis approaches.
- Timeframes: After identifying a few personality traits and time limitations about yourself, you should then choose the type of trader you are. The most common types are position traders, swing traders, day traders, and scalpers. Your strategy must be built on the type of trader you are and the timeframes you trade.
- Entry Criteria: Your trading plan must include clear entry criteria. These rules should tell you when to pass on a potential market move, and when the time is right to execute. Entry criteria are usually based on technical indicators or price action patterns.
- Target Identification: Every trader enters a position expecting the price to reach a certain level. You should allocate a section of your trading strategy to setting precise targets for realizing profits. Some traders also use a fixed amount of gains relative to their risk as their profit-taking technique.
- Stop-loss Placement: To think in terms of probabilities involves planning for the worst-case scenario that you are wrong about market direction. You should have a well-defined stop-loss placing process in your trading strategy to protect your capital against adverse price movements.
- Risk Management: While many consider risk management to be separate from trading strategy, its significance prevents us from omitting it. Your plan should involve robust risk management rules and techniques, such as the process of determining the risk you are willing to take on each trade if you want to have longevity in the forex market.
Forex Trading Strategies that Work
To find the best forex trading strategy, you should first identify your goals and evaluate your level of expertise. Some of the most common trading strategies you can use are listed below.
The Best for Beginners
Here are the most common forex trading strategies for beginners:
- Breakout Entries: One of the most popular strategies is entering on breakouts. This method is widely used by beginners, as it is very simple. For example, to enter on a bullish breakout, you should execute a buy/long order when a certain resistance level is broken. A modified, safer strategy is to enter when the price has completed a pullback, which is to retest and rebound from the broken level.
- Trend Following with Moving Averages: Moving averages are commonly used by traders, as you can use them to follow trends. For instance, when the price is above the moving average, the trend is considered bullish. You can then buy when the price approaches the moving average, as it is capable of acting as a dynamic support level.
- Range Trading Between Levels: A simple strategy for trading when the market is rangebound, is to trade between support/resistance levels. Consider a scenario where the price is trapped between two levels. You can buy when the market approaches the support level and sell when it reaches resistance.
The Best for Pros
If you consider yourself an experienced trader, it might be worth giving these strategies a go:
- Advanced Price Action: This strategy is mostly based on candlesticks. Identifying market structure, major and minor pivots, and candlestick patterns are some of the elements of price action trading. There is a lot of price action material available, varying from books to videos and articles online.
- Smart Money Concepts: One of the newly introduced trading methods is smart money concepts, also known as SMC. To trade SMC, you should first understand what liquidity and order flow are. Smart money traders mostly try to read the hand of market makers and financial institutions and enter their trades with them.
- Volume Trading: Volume is the fuel that drives price movements. Volume traders focus on levels where most volume is traded and try to place trades based on them. They mostly use more advanced indicators like volume profile, footprint, VWAP, etc.
What are the Key Indicators or Tools Commonly Used in Forex Trading Strategies?
The tools and indicators forex traders use are highly reliant on their strategy. Yet, there are some common tools introduced below:
- Support/Resistance Levels: These static price levels are where the price has previously reacted on multiple occasions.
- Moving Averages: Moving averages provide dynamic support/resistance levels. They are also useful in determining the overall market trend.
- Relative Strength Index: Also known as RSI, it belongs to a category of indicators called oscillators. You can use RSI to determine whether the momentum is bullish or bearish. RSI can also demonstrate overbought/oversold conditions that usually lead to reversals.
- Volume: The volume indicator shows the traded volume in each individual candlestick. This indicator can show you when the big players have entered the market. It is mostly used to validate breakouts.
- Classical Price Action Patterns: You have definitely heard of flags, wedges, double tops and bottoms, and channels. These are classical price action patterns that help traders find continuation or reversal entries.
- Fibonacci Retracement: This tool is considered purely mathematical, but it is able to show where corrections are likely to end and the next impulsive move would begin. There are also more advanced Fibonacci-based tools that you can yourself.
Crucial Rules to Remember in Forex Trading
There are some unwritten rules for trading success in every market. Here are the crucial ones for trading in the forex markets:
- Risk Management is Key: Never risk more than you can afford to lose on a single trade.
- Stay Disciplined: Always stick to your routine and your trading plan. Do not deviate from your strategy. “This time is not different”.
- Avoid Overtrading: In trading, quality is better than quantity. Focus on high-probability setups and avoid excessive trading. Patience pays off.
- Journal Your Trades: Keep a detailed trading journal to record your trades, decisions, and emotions. Otherwise, you will not be able to assess your performance and optimize your strategy.
- Understand Market Sessions: Forex markets operate 24/5. Know the times when major markets like London and New York are open to capitalize on large price movements.
- Stay Aware of Economic Events: Economic indicators, central bank decisions, and geopolitical events can significantly impact currency prices. Be aware of the economic calendar, and stay away from trading the news as a beginner
- Backtest Your Strategy: Remember to test your strategy and evaluate its performance with historical data, before using it in real-time market conditions.
- Choose a Reputable Broker: Select highly regulated brokers with a good reputation in the trading community. Also, consider the commission fees, spreads, and slippages when looking for a suitable broker.
How to Make Sure that My Strategies Actually Succeed?
There is no certainty in the financial markets. Additionally, past events may not be repeated in the future. However, having a statistical way of thinking, you can figure out the approximate probability of your success over a string of trades. You can use backtesting and forward testing to evaluate your strategy both with past and live data and figure out your odds of success.
The next step is to create a well-defined risk management plan and stick to it. Risk management has the ability to make terrible strategies look great, and make decent ones perform horribly.
When Should You Change A Forex Trading Strategy?
Strategy hopping is one of the most common issues novice traders encounter. If you have a tested strategy based on logic, you need to stick to it and avoid changing it whenever you stumble upon a losing streak. Keep in mind that no one knows the distribution of wins and losses, and every trader goes through losing streaks. Successful traders are the ones that know how to handle them.
Know the Risks of Trading Forex
While trading forex can be lucrative, it also exposes you to various risks. These risks, if not managed properly, can lead to huge financial losses and affect your life in negative ways.
Here are the main risks associated with forex trading:
- Market Risk: Forex markets are highly volatile and can experience rapid price fluctuations. Prices can be influenced by various factors, including economic data releases, geopolitical events, and central bank decisions. Unexpected market movements can lead to substantial losses.
- Leverage Risk: Leverage allows traders to control a larger position size with a relatively small amount of capital. While leverage can amplify profits, it can also magnify losses.
- Liquidity Risk: While forex is one of the most liquid markets, liquidity can vary depending on the currency pair and market conditions. During times of low liquidity, spreads can widen. This would make it more challenging to execute trades at desired prices.
- Broker Risk: Choosing an unreliable broker can expose you to various risks, including poor execution, slippage, withdrawal issues, and even fraud.
- Black Swan Events: A term used by Nassim Nicholas Taleb, Black Swan events are rare and unexpected events that have a significant impact on the markets. These events can result in extreme market volatility and unpredictable outcomes, leading to massive potential losses.
In this article, we started out by defining what a trading strategy is, and what the best forex trading strategies have in common. We then introduced some of the best trading strategies for both beginners and pro traders and briefly discussed the most common tools and indicators. We finally concluded the article with the unwritten rules for success and the risks associated with forex trading.
The article’s main goal was to provide traders, especially the new ones, with valuable insights and guide them in adopting the best trading strategy for themselves. There might not be one best overall trading strategy for the forex market, but there is a unique one for each trader. The best forex trading strategy is the one that resonates the most with the trader that is going to execute it consistently.
What is the most successful strategy in forex?
There isn't a one-size-fits-all "most successful" strategy, as success depends on various factors including market conditions, risk tolerance, and individual preferences.
What is the easiest forex strategy?
The "easiest" strategy can vary from person to person. However, simple strategies like trend following with moving averages or using support and resistance levels for entry and exit are relatively easier to implement.
Can I use multiple forex trading strategies simultaneously?
Yes, professional traders mostly use multiple strategies simultaneously. But, it is important to prevent getting confused by conflicting signals. So, avoid using too many strategies.
Are there common strategies or patterns followed by successful forex traders?
Successful forex traders often use a mix of technical and fundamental analysis. Yet, their most common characteristic is that they focus on risk management and psychological discipline more than anything else.
Are there any forex trading strategies that are more suitable for beginners?
As previously mentioned, simple strategies like trend following, support and resistance, and breakout trading can be more suitable for beginners.