The Forex market is hugely liquid, with a vast number of participants. It is also a well-established market. As you might expect, this combination of popularity and time has resulted in traders devising countless strategies.
As a newcomer, the sheer volume of trading techniques available can be daunting and confusing. Some strategies are very complicated, with a steep learning curve. So beginners may find it better to start with a simple Forex strategy.
After all, the simpler the strategy, the easier it is to understand the underlying concepts.
There will be plenty of time to add complex actions after you have mastered the basics. Regardless of whether you adopt a simple or complex strategy, remember that your overarching mantra should always be to use what works.
New traders are generally unable to devote large amounts of time to monitoring developments. For these newcomers to Forex, simple strategies offer an effective but low-maintenance approach.
This article will introduce some simple Forex trading strategies. You can also pick up new strategies from our free webinars.
The first two strategies we will show you, are fairly similar because they attempt to follow trends. The third strategy attempts to profit from interest rate differentials, rather than market direction.
But first things first – what is a trend?
To put it simply, a trend is the tendency for a market to continue moving in a given overall direction. A trend-following system attempts to produce buy and sell signals, that align with the formation of new trends.
There are many methods designed to identify when a trend starts and ends. And many of the simple Forex trading strategies that work have similar methods.
Trend following can produce large profits. In fact, there are traders who have produced outstanding track records using such systems.
But there are also some drawbacks to these strategies:
This means that the strategy tends to generate numerous losing trades. The theory is that these losses will be offset by more infrequent but larger winning trades.
That is a hard pill to swallow in practice.
Also, once the trend breaks down, you tend to give back a healthy amount of your profit. You may have heard the phrase, "the trend is your friend". But you may not be so familiar with the full expression, which adds "until the end".
The end comes when the trend fails and this can be very trying on a trader's psychology.
One big issue with a trend-following system, is that you need deep pockets to properly use it. This is because having a large amount of capital, reduces your chances of going bust during an extended drawdown.
So, trend following is useful as a Forex strategy for beginners to understand, but it may not be ideal for less wealthy beginners.
Now, let's break down our strategies.
The first strategy attempts to identify when a trend might be forming. It looks for price breakouts.
Markets sometimes range between bands of support and resistance. This is known as consolidation.
A breakout is when the market market moves beyond the boundaries of its consolidation, to new highs or lows. When a new trend occurs, a breakout must occur first.
Breakouts are, therefore, seen as potential signals that a new trend has begun.
But the trouble is, not all breakouts result in new trends. In Forex, even such simple strategy must consider risk management. By doing so, you seek to minimise your losses during the trend break-down.
A new high indicates the possibility that an upward trend is beginning, and a new low indicates that a downward trend is beginning. So how can we get a feel for the type of trend we are entering?
The length of the period can help determine the highest high or the lowest low.
A breakout beyond the highest high or lowest low for a longer period suggests a longer trend. A breakout for a short period suggests a short-term trend.
In other words, you can tune a breakout strategy to react more quickly or more slowly to the formation of a trend. Reacting more quickly allows you to ride a trend earlier in the curve but may result in following more shorter-term trends.
So let's looks at a reasonably long-term breakout strategy. The buy signal is when the price breaks out above the 20-day high. And the sell signal is when the price breaks out below the 20-day low.
This is very simple, but there is still a major drawback. Namely, new highs may not result in a new uptrend, and new lows may not result in a new downtrend.
So we are going to experience our fair share of false signals.
Using a stop-loss can help alleviate this problem. To keep things really simple, here's an extremely basic rule for exiting trades. We are going to take a time-based approach. You simply close your position after a certain number of days have elapsed.
This time-based exit side-steps the issue of things becoming tricky when the trend begins to break down. Once you enter a trade, hold it for 80 days and then exit.
Remember, this is a long-term strategy.
If you find these parameters do not yield enough frequent signals, they can be adjusted to whatever suits you best. For example, you can try using hours instead of days for a shorter strategy.
Backtesting your results will give you a feel for the effectiveness of your choices. MetaTrader 4 Supreme Edition offers backtesting, along with a large selection of other useful tools.
Our second Forex strategy for beginners, uses a simple moving average (SMA). SMA is a lagging indicator that uses older price data that most strategies and moves more slowly than the current market price.
The longer the period over which the SMA is averaged, the slower it moves. Often, we use a longer SMA in conjunction with a shorter SMA.
For this simple Forex strategy, we are going to use a 25-day moving average as our shorter SMA, and a 200-day moving average for the longer one.
In the chart above, the 25-day moving average is the dotted red line. You can see that it follows the actual price quite closely. The 200-day moving average is the dotted green line.
Notice how it smooths out the price movement?
When the shorter, faster SMA crosses the longer one, it indicates a change in the trend. When the short SMA moves above the longer SMA, it means newer prices are higher than older ones.
This suggests a bullish trend and is our buy signal.
When the short SMA moves below the longer SMA, it suggests a bearish trend and is our sell signal.
Rather than solely being used to generate trading signals, moving averages are often used as confirmations of overall trend. This means we can combine these two strategies by using the confirmatory aspect of our SMA to make our breakout signals more effective.
With this combined strategy, we discard breakout signals that don't match the overall trend indicated by our moving averages.
Here's an example. If we get a buy signal from our breakout, we look to see if the short SMA is above the long SMA. If it is, we place our trade.
Otherwise, we sit tight.
Our final strategy is essential to know. It's a type of trade that is widely used by professionals too, so it is not purely a beginner Forex strategy. Best of all, it is easy to implement and understand.
The essence of the carry trade is to profit from the difference in yield between two currencies. To understand the principles involved, let's first consider someone who physically converts currency.
Imagine a trader borrows a sum of Japanese yen. Because the benchmark Japanese interest rate is extremely low (effectively zero at the time of writing), the cost of holding this debt is negligible.
The trader then exchanges the yen into Canadian dollars and invests the proceeds in a government bond, which yields 0.6%. The interest received on the bond, should exceed the cost of financing the yen debt.
But there is a drawback.
Obviously a currency risk is baked into the trade. If the yen appreciated enough against the Canadian dollar, the trader would end up losing money. The same principles apply when trading FX, but you have the convenience of it all being in one trade.
If you buy a currency pair where the first-named (base) currency has a sufficiently high interest rate, in relation to the second-named (quote) currency, then your account will receive funds from the positive swap rate.
The amount yielded is correlated to the amount of currency commanded, so leverage is an aid if the strategy pays off. As noted earlier, though, there is an inherent risk that you end up on the wrong side of a move in the currency pair.
So it is important to carefully select the right currencies.
Inertia is your friend with this strategy and ideally you are looking for a low volatility FX pair. It's also important to note that leverage will end up magnifying losses if you get it wrong.
The Japanese yen has long been popular as the funding currency because Japanese rates have been low for so long, and the currency is perceived as stable.
The strategy works well at a time of buoyant risk appetite because people tend to seek out higher-yielding assets. The action of traders implementing the strategy can itself support the strategy because the more people using the strategy, the greater the selling pressure on the funding currency.
This simple Forex strategy has been successful.
But, there's a current problem. The global low interest environment, has narrowed interest rate differentials. When risk appetite collapsed during the credit crunch, many fingers got burned as funds flowed into the safe haven of the Japanese yen.
With the Fed signalling its intention to tighten monetary policy in the future, we may yet find the carry trade coming back into favour.
We hope you have found this introductory guide to Forex trading strategies for beginners useful. After all, anyone can follow these guides.
Just bear in mind that the examples we have shared primarily aim to get you thinking about the principles involved. Don't follow a strategy without first testing it out.