Forex Trading Strategy and Risk

 

Forex Trading Strategy, Stops, and Risk

Designing and implementing a trading strategy is essential for every Forex trader. Forex strategies may involve several trading styles (scalping, news-trading, swing, etc.) and multiple timeframes {intraday, daily, weekly, or monthly}.

 

Key Principles for a Successful Forex Strategy

1. A Forex strategy must be compatible with your trading profile and your appetite for risk

2. Forex strategies will prove more efficient when they focus on a couple of Forex assets than when they cover the whole currency market

3. A successful Forex strategy must keep things simple and clear. Overcomplicated strategies tend to fail in the long run as they are very difficult implemented

4. Testing a trading strategy using historical data is a logical step, but keep in mind, the currency market is evolving so past data success is not a promise for future success

Basic Money Management

5. Incorporate always some basic Money Management, and that means (i) a stop-loss (simple or trailing stop) and an (ii) take-profit order

6. Adjust your stop-loss and take-profit according to the major support and resistance levels, and your timeframe

7. Leverage your funds wisely and keep in mind that high-leverage can be catastrophic, especially for beginners. Don't forget that trading leverage increase your risk but also your trading cost

8. Evaluate the results of your trading strategy in the long run and don’t get too enthusiastic/disappointed based on short-term results

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Support and Resistance Levels

The identification of the correct Support and Resistance levels is very important when placing stops. Support and Resistance lines are used to observe where the price has bounced from in the past. You may find that price bounces close the line, but very rarely exactly on the line.

(↑) For Long-Trades

Support Level

The support area indicates a price area where more currency buyers are likely to enter the market.

Resistance Level

An area of resistance always appears above the current price, and it indicates where more currency sellers are likely to enter the market.

(↓) For Short-Trades

■ Support Level

Indicates a price area where more currency sellers are likely to enter the market.

■ Resistance Level

Indicates a price area where more buyers are likely to enter the market

Notes:

(1) These price areas should normally span 20 to 40 pips

(2) The historical levels of support and resistance should be better identified on the daily (D1) or 4-hour (H4) charts

(3) Currencies tend to trade within historical channels. If a currency pair is trading within a recognizable price channel, then it is extremely crucial to adjust your stops according to this channels' two boundaries.

 

News & Intraday Forex Strategies

Trading during news releases is very difficult, especially for novice Forex traders. News releases can generate extreme price swings and that means that stop-loss orders tend to activate and positions get closed.

When important news is about to release, it is better to avoid trading the market. Avoid trading 1 hour before and 1 hour after.

 

Leverage and the Equation of Trading Risk
 
Here is a basic analysis explaining why you shouldn’t use High Leverage when trading Forex:

The opportunity to leverage your funds is seen as one of the greatest advantages of Forex trading. But in reality, high leverage means accepting more risk and more cost than you should:

Higher Leverage → Higher Risk + Higher Trade Cost (1)

Now, if you tend to maintain your positions longer you get further exposed to more unpredictable news and events:

Time Frame Widening → Higher Risk (2)

□ So based on (1) and (2), here is a simple illustration of your risk exposure on every position:

Total Risk Exposure per position = { Leverage x (Position Risk + Trading Cost) } x Time

Now if we assume that:

(i) The position risk can be limited by a stop-loss order, and that

(ii) Your trading cost (spread and commission) is known and fixed, 

then the only two variables are Leverage and the Timeframe.

(iii) When your leverage and timeframe increase simultaneously, then your total trading risk increases in a geometric scale (Leverage X Time Frame).

From all the above, it is better to avoid trading using high-leverage, especially if you keep your positions in longer timeframes than a few hours.

  

Forex Strategies

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