Advanced Forex trading strategy
The foreign exchange market is the largest and fastest growing market in the world. Traditionally, it is the platform through which governments, businesses, investors, travelers, and other interested parties convert or ‘‘exchange’’ currency.
At its most fundamental level, the foreign exchange market is an over-the-counter (OTC) market with no central exchange and clearing house where orders are matched. FX dealers and market makers around the world are linked to each other around-the-clock via telephone, computer, and fax, creating one cohesive market.
Through the years, this has changed with many institutions offering exchange traded FX instruments, but all of the prices are still derived from the underlying or spot forex market.
Before implementing successful trading strategies, it is important to understand what drives the movements of currencies in the foreign exchange market. The best strategies tend to be the ones that combine both fundamental and technical analysis. Textbook perfect technical formations have failed too often because of major fundamental news and events. But trading on fundamentals alone can also be limiting. There will oftentimes be sharp gyrations in the price of currency on a day when there are no news or economic reports. This suggests that the price action is driven by nothing more than flows, sentiment, and pattern formations.
For any type of trader, fundamental or technical, the importance of economic data cannot be underestimated. All traders, fundamental, technical, or both, will find it valuable to know when important economic data are scheduled for release, particularly those that will affect the U.S. dollar. This is because majority of all currency trades are against the greenback, making currencies naturally sensitive to U.S. economic releases.
When it comes to forex, one of the most important things to know is that
currencies do not trade in a vacuum. In many cases, foreign economic conditions, interest rates, and price changes affect much more than just a single currency pair. Everything is interrelated in the forex market to some extent and knowing the direction and how strong this relationship is can be an advantage; it has the potential to be a great trading tool. The bottom line is that unless you only want to trade one pair at a time, it can be very profitable to take into account how pairs move relative to one another.
To trade successfully on an intraday basis, it is important to be selective. Trend trading is one of the most popular strategies employed by global macro hedge funds. Although many traders prefer to range trade, the big profit potentials tend to lie in trades that capture and participate in big market moves.
One of the most useful technical indicators in my experience is Bollinger Bands. Traditionally, Bollinger Bands are used as overbought and oversold indicators, but given the trending nature of currencies, there are more efficient ways to use the bands.
Trading breakouts can be both a rewarding and frustrating endeavor as breakouts have a tendency to fail. A major reason why this can occur frequently in the foreign exchange market is because it is more technically driven than others and as a result, there are many market participants who intentionally look to break pairs out in order to ‘‘suck’’ in other nonsuspecting traders.
One of the best ways to approach currency trading on a fundamental basis is to pair the strongest currency with the weakest. Of course finding that pairing is rarely simple because it is not just about which countries are the strongest or weakest right now but instead which ones will become strong or weak going forward. Finding these currencies can also be challenging because we live in a global economy where the health of one major economy will affect the outlook of another.
Commodities like gold and oil have an important connection to the FX market. Understanding the nature of these relationship can help traders gauge risk, forecast price changes, and understand exposure. Even if commodities are unfamiliar, they will often move on the same fundamental factors as currencies, particularly when it comes to popular instruments such as gold and oil.
Risk reversals are a useful fundamental-based tool to add to your mix of trading indicators. One of the weaknesses of currency trading is the lack of volume data and accurate indicators for gauging sentiment.
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