The forex market is known for being the largest financial market in the world, with a daily volume of over $5 trillion.
Taking into consideration the large volume and the fact that the market is open 24 hours a day, 5.5 days a week, you can’t be surprised by the popularity of the market.
On top of that, the volatility of the market makes for exciting profit opportunities, which draw traders closer and closer to currency trading.
However, the volatility within the forex market can be both a blessing and a curse, because even though it helps traders grow their accounts, it also poses a set of risks that can take a toll on their balance.
To mitigate those risks, traders have started using strategies that are either developed by themselves or borrowed from other traders.
But because traders have different personalities and trading styles, finding a strategy that works is very much based on the trader’s own experiences.
What works for your friend may not work for yourself, simply because you have a different risk appetite or because you like to trade on a different time-frame.
To find a trading strategy that works for you, you need to find your trading style, learn how to manage risks, and test out various options.
We will be exploring all of these aspects below so that you can find a technique that works for you.
Determining your trading style
When it comes to trading styles, they are mostly determined by the time-frame of the trade. Based on these styles, traders have developed strategies to help them earn profits faster and mitigate risks.
To better understand how to choose or build your own strategy, you must be aware of the main styles and strategies used on the market.
Scalping is a very short-term trading style, where trades remain open for merely a few minutes. Scalpers look to beat the bid/offer spread fast, managing to only make a few pips of profit before closing a trade.
Because of its fast-paced rhythm and low time-frame charts it uses, it is considered one of the most advanced trading styles out there.
Day traders exit a trade before the end of the day, avoiding the chance of being affected by large and unpredictable overnight moves.
Usually, trades are open for a few hours, and price bars on charts are set for one to two hours. Day trading is especially suited for beginner traders, who need a simple strategy to learn how the market works.
Traders who choose swing trading as their style tend to keep positions open for several days, but aim to profit from short-term price pattern. A swing trader usually checks the price bars every 30-60 minutes, looking for an opportunity for profit.
A long-term trading style, where traders hold positions for several days and look to make profits from major price shifts. Strategies based on this style require a lot of patience and discipline, which is why they are recommended for experienced traders.
Testing a new forex trading strategy
No matter if you choose to use an existing strategy or develop one on your own before you decide whether it’s reliable or not in the long them, you need to test it out.
To do so, you can use trading simulators, which allow you to test out strategies at any time, even when the market is closed. You can also use a demo account to test a strategy, but be aware that demo conditions are not precisely identical to live trading, meaning you won’t always see accurate results.
If you are planning to use a strategy developed by another trader, is it advised to look for an ongoing live test of Forex trading systems, in order to see how these strategies play out.
After that, you can test it out yourself and see if it fits your trading style.
Understanding and managing risks
To develop an effective trading strategy, you need to be aware of the risks that come with trading currencies. This will help you manage expectations and be prepared for anything the market may throw your way.
When it comes to forex trading, there are several risks you need to take into consideration, such as:
- Currency risks: this is the type of risk associated with currency price fluctuations, which can make the asset more or less expensive to buy
- Interest rate risks: sudden spikes in interest rates affect volatility and FX prices, as the level of spending and investment across an asset will increase or decrease
- Liquidity risks: the forex market is usually highly liquid, but there can also be periods of low liquidity that traders need to be aware of. Liquidity risks affect the trader’s ability to buy or sell assets quickly enough to prevent potential losses.
- Leverage risks: when margin trading, leverage risk represents the risk of magnified losses, as the initial outlay is usually smaller than the actual value of the trade, making it easy for traders to overlook the exact amount of capital that is at risk.
Knowing the risks is one, but managing to work around them is an entirely different story. To safely mitigate risks, traders need to know the market very well so that they can start observing its movement.
One of the most successful ways to manage risks is setting a risk-reward ratio, to quantify if a trade is worth making or not. In any financial market, your ultimate goal is for your profit to outweigh losses, which means even if you lose on individual traders, your overall profit won’t be affected.
To find the risk-reward ratio, you need to compare the amount of money you are risking on a particular trade to the potential amount you are gaining.
Let’s say, for example, that the maximum possible gain on a trade is $600, and the potential loss is $200. The ratio becomes 1:3, and if you were to place ten trades with this ratio and only be successful on 3 of them, you would still make a $400 profit.