Another approach to creating forex trading strategies is using technical analysis. Technical analysis is based on the principle of recurring patterns, meaning that what happened in the past can help you predict in which direction prices will move in the future. Since trading in the currency markets happens on a 24-hour basis, there is a lot of price data that you can use for statistical analysis to find patterns that could indicate a trading signal. Using technical analysis is ideal if you are the kind of currency trader who specializes in scalping or short-term trades.
The first step in using technical analysis to create forex trading strategies is to identify what conditions are currently prevailing in the forex market. Is the market flat, in which there are no visible price movements, ranging, in which the price moves between specific support and resistance levels, or trending, where the price is basically just moving in one direction? Once you’ve identified the market conditions, you can now decide which the best technical analysis indicators to use to find trading signals is. These indicators confirm price movements so that you can find trading signals. Samples of indicators are the Relative Strength Index (RSI) which signals if a currency may be overbought or oversold and if a reversal of the price trend may be imminent, and the Moving Average Convergence (MACD) which looks at the difference between two exponential moving averages to help identify the direction of short-term momentum and find buy or sell signals.
There are two ways that indicators form trading signals. Crossovers result when an indicator intersects with a security on a forex chart. When this happens it may be the signal to buy a currency. Divergence, on the other hand, prices and indicators move in opposite directions, which may be a signal that the direction of the price trend is about to experience a major shift. Don’t just look at one indicator but look at the way several of them interact in order to find a trading signal.
Once you’ve identified trading signals, the next step in creating forex trading strategies is to decide what percentage of your account balance you will risk on the trade. You can decide this by computing the risk/reward ratio or how much you will potentially win if your trade is successful as opposed to how much you could lose if your trade goes south. It is recommended that you only enter a trade if your chances to win are two or three times higher than your chances of losing.
Finally, when creating your forex trading strategies, don’t forget to set stop loss orders. There are several approaches you can use to decide where to set your stop losses, including simple equity, which closes your trading position based on the number of pips you lose, chart-based stops, which sets protective stops based on chart indicators such as trend lines and volatility stops which place stop orders further when market volatility is high and closer when there is less volatility.
