Searching for a trading strategy
Which type of recreation is more suitable for you – fishing or skiing? Answering such a simple question can help you find the most effective trading strategy for you.
There are many ways to make money in Forex, but you need to understand your strengths and weaknesses to choose a profitable forex strategy. Most clients of brokerage companies are sure that there is “the only correct way to trade”.
That’s the main misconception! A person is uncomfortable with changes, and the market is constantly changing. That’s why most traders find it much easier to adopt someone’s “right trading strategy” than to find their own
Fishing and skiing are like trading in the direction of market movement and against it. Fishermen are patient, calm and adhere to a certain model of behavior. Skiers, on the contrary, like thrills, drive and movement, and try to make a profit on corrections. However, you should not rely entirely on the above models, but simply take into account your preferences when choosing a forex or binary options trading strategy.
The second issue of interest to traders is the issue of duration of transactions. Usually, traders who prefer to work within a trend, use mid-term and long-term deals, as the trend develops over months rather than days. Counter-market traders use shorter time intervals.
As a rule, the most effective way to make money on short-term deals is to use hourly charts and target levels of at least 30 points. Target levels of less than 30 pips are considered ineffective because the spread is charged to the trader. Let’s take for example the most liquid EUR/USD pair on the market, the spread (difference between the bid and ask prices) at which is 3 points.
If a trader sets the profit and loss levels to 10 pips from the purchase price, he needs to earn 13 pips (target 10 pips + 3 spread points) or go out on the stop after 7 pips (target 10 pips – 3 spread points). The profit/loss ratio for such short-term trades is too low, which practically destroys the chances of making a profit
Types of analysis
Once a trader is determined with a suitable time frame, he or she needs to decide on the type of analysis that will help him or her make the right trade decisions. There are two main types of analysis: fundamental analysis and technical analysis.
Supporters of fundamental analysis ridicule attempts of technical analysis to predict price movements on current price charts. Bright fundamentalists view technical analysis as a ritual similar to that of fortune-telling on coffee grounds. News, economic reports and comments from financial institutions are the real tools of a fundamentalist.
Supporters of technical analysis, in their turn, point to the inefficiency and inconsistency of fundamental data and claim that any news is taken into account in the quotes of the currency pair, so the charts can be used to predict future price movements. Which one’s right? Nobody’s. Using only fundamental or technical analysis is similar to trying to become a one-armed world boxing champion.
Fundamentalists may argue that demand for oil will push its value to $100 per barrel and will lead to parity of American and Canadian dollars, but if they start selling USD/CAD in the oversold market, when there is a significant divergence between the moment indicator and the price, they will lose money, even if their forecast is eventually justified.
On the other hand, a technical trader may sell from the Fibonacci level, but unexpected economic news may lead to an upward price spike and a breakthrough of several resistance levels. As a result, an open short position brings significant losses
Fundamental analysis – for long-term positions, technical – for short-term positions
Despite all the arguments, it can be safely argued that fundamental analysis is the most appropriate for long-term positions, and technical analysis is the most appropriate for short-term positions. Major economic events, such as GDP growth, interest rates and balance of payments, directly affect the direction of the trend in the long run. Consider, for example, the movement of GBP/USD in 2005 (Figure 1).
At that time, the Federal Reserve Bank of New York raised the federal funds’ interest rate by 200 basis points from 2.25% to 4.25%. The Bank of England, in turn, faced a slowdown in the economy and a decline in the consumer sentiment index, and was forced to reduce the interest rate from 4.75% to 4.5%. As a result, the difference between the interest rates was minimal (by 2006, the interest rates of the US and UK had equalized).
Traders who bet on reducing the difference between interest rates in the long run, got a significant profit from the decline in GBP / USD.
The situation with USD/JPY was directly opposite (Fig.2). As U.S. interest rates rose and Japanese interest rates remained at zero, the pair’s value rose by 20% over the next few months. Traders who predicted such a development, were able to earn significant profits on long-term long deals.
If fundamental analysis is an effective tool for long-term deals, technical analysis is successfully used at short time intervals. This can be explained by the fact that the news does not affect the rate immediately, but gradually – the prices are clamped between the support and resistance levels and are reluctant to break out of this range.
For example, on the hourly chart of EUR/USD (Fig. 3) the price fluctuates between the maximum and minimum values and the trader can get a significant profit by selling from resistance levels and buying at support levels.
The Forex market has a place both for those who are committed to fundamental analysis and those who perform long-term operations, as well as for those who support technical analysis and short-term trading. You can argue endlessly about the pros and cons of fundamental and technical analysis, but you should understand one indisputable truth – you need to use the analysis that suits you best.
Otherwise, no matter how right your approach is, you will fail. The first thing a trader needs to do is to understand himself, not try to guess the market movement
Learn more about the process of creating your trading strategy in the Forex article. Development of a trading strategy