Table of Contents
Chapter 1: Educating Yourself About the Forex Market
Chapter 2: Identifying Good Forex Trading Opportunities
Chapter 3: Developing Your Forex Trading Strategy
Chapter 4: Managing Forex Trading Risk
Chapter 5: Become a Successful Forex Trader
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Chapter 3: Developing Your Trading Strategy
– Investment Objectives
– Risk Appetite
– Align Your Strategy to Your Temperament
– Build Knowledge of Markets
– Plan Your Leverage
– Keep it Simple
– Choose the Right Currency Pairs
– What’s Your Plan B
– Commit to Your Strategy
Chapter 3: Developing Your Trading Strategy
Your trading strategy plays a crucial role in determining whether your forex transactions will be successful. Smart investors base their strategies on a thorough analysis of fundamental and technical aspects that impact any currency. There are some basic points that you should consider before you start charting out your strategy. These will determine the kind of approach that will work for you.
Your strategy should be in sync with your goals. The forex market is very volatile and this brings in many variables in your investment. Avoid adding other uncertainties with a mismatch between your strategy and your investment goal. Clearly understand your own investment goals, as they will guide you in your trading strategy. Ask yourself these questions:
- Are you looking for massive gains in a short time or reasonable profits over a longer period?
- What kind of returns do you expect and are these in line with what is achievable in forex?
- What kind of effort and time will you be able to put into forex trading?
- How much funding will you be able to put in and how much can you afford to lose without hurting your finances seriously?
- The answers to these questions will tell you whether your strategy should be aimed at short or long term investments, the risk you can take, and the complexity that you can manage.
Your risk appetite will determine your stop loss limits, your entry and exit prices and the kind of leverage you opt for. You can include diversification into your strategy if you are highly risk averse and would like to spread your risk over many currencies. By doing this, you can balance losses in one currency pair with gains in another.
Align Your Strategy to Your Temperament
Although forex traders come prepared to meet the high risk inherent in this market, a conservative investor can still mitigate his risk. An investor’s temperament largely determines which kind of strategy he should follow.
A trader who is prone to panic reactions is better off following a conservative strategy, while more experienced traders can follow an aggressive approach to make the best of even small fluctuations. For a trader who needs constant action and visible outcomes in a short period, a day trading strategy may be ideal.
The currency of choice will also differ with the investor temperament. Currencies that show high levels of fluctuation during a single day are best for a day trader. For such a trader, fundamental analysis has little value.
For the more patient investors, who are willing to wait long periods to realize their gains, an ideal strategy is one that is devised from long term factors. A combination of fundamental analysis and technical aspects can create a winning strategy. This kind of investor can choose a more stable currency pair where price movements may be slow but more permanent.
Build Knowledge of Markets and the Currency Pair
New entrants into the forex market are best advised to avoid taking on too much too soon. The amount of data that is available on economic factors that influence prices is mind boggling and understanding these and their impact on currencies accurately requires time and practice. It is best for novice traders to focus on a few currencies and gain a thorough understanding of these before they venture into more currencies or complex trading strategies.
Plan the leverage you will use. Leverage helps you make immense gains with a small starting capital but if your investment strategy fails, the same leverage can also wipe out your funds. Always keep the worst case scenario in mind when planning your strategy so that if your trades end in disaster, your losses are at least affordable. Only opt for as much leverage as you can afford even if your broker is willing to offer more.
Traders need to adapt their basic strategies to handle unexpected movements in price. This is easy to manage if the strategy is kept simple. For new investors, avoiding complexities is also helpful in another way. It allows them to see the cause and effect of buy sell decisions clearly thus letting them gain expertise in trading. Expert traders can opt for complicated strategies with stable currencies. With the more volatile ones, where risk aversion is a big consideration, it is best to adopt a straightforward investment plan.
Choose the Right Currency Pairs
Your choice of currency pair can be the difference between a gain and a loss. Use economic indicators to identify currencies that are inherently weak as opposed to your base currency. This lets you start out with an advantage. A stable currency is less prone to volatility even in face of strong influencing factors. However, these factors will affect the weaker one significantly. This results in the weaker currency showing great fluctuation when compared with the stronger one. This fluctuation is the basis of profit in a forex transaction.
When planning your strategy you need to build back up plans. When the markets suddenly turn around and begin moving in an opposite direction, you should be able to quickly adapt to the changed circumstances and still make gains, or at least limit your losses.
Stay committed to your strategy even in face of short term losses. Do not expect huge gains immediately. A new trader may have to tweak his plans before his strategy starts to pay off. It is essential to give enough time for an investment plan to settle in. Many new investors let price movements throw them into a panic and resort to impulsive trading. In forex, frequently changing strategies is a one-way road to huge losses.
Make sure that your goals are reasonable given factors like your risk appetite, temperament and knowledge of forex. If they are, then adopt a clear and effective strategy to achieve the goal. Test out your strategy with demo applications offered by brokers. Although you have no way of knowing a long term outcome in this way, you will get an idea of whether individual trades work the way you expect them to. The strategy you follow will also influence the kind of service you need from your broker.
Remember that what works for one investor may end in disaster for another. Do not try to emulate strategies of other traders without understanding what makes it work. Their goals, temperament and risk appetite may be very different from yours.
Next Chapter: Managing Forex Trading Risk
