Black Pipper

Forex Dreamers

Roots of Forex Trading Strategies

There may be dozens of strategies in Forex trading. Let’s just talk about the roots.

Nature Of Market:

Everything in the universe has its NATURE. So is the Forex market. So is every currencies pair in this market. For example, GBP/JPY always moves faster, and its wave range is longer than other pairs, such as a hundred pips during a day or even an hour. EUR/GBP generally waves several pips narrowly only within a day. For Americans, EUR/USD and GBP/USD like to sleep in day and dance at night. AUD/USD and NZD/USD look like a twin, they commonly act in the same style, if one of them goes north, another one does not like to go south. But EUR/USD and USD/CHF are doomed to be enemy, while one of them flies up like a hydrogen balloon, the counterpart mostly will drop like a lead ball. And so on, so on.

Once we find this kind of “Nature of Market,” we can develop and figure out some strategies for particular currencies pairs, just follow their nature, predict their moving direction and range. Then we will get our trading strategy and system.

Fundamental Trading:

In the Forex market, many professional analysts like to use a kind of method to predict the future. It is the so-called “Fundamental Analysis.” Based on this method, they develop many different types of strategies to trade Forex. These are strategies of forecasting the future price movements of currencies based on economic, political, environmental, and other relevant factors and statistics that will affect the primary supply and demand of whatever underlies the foreign currencies.

If you like to try Fundamental Trading, you need to learn and understand a lot of finance knowledge. Actually, not only finance experience, you need to be interested in many things in this world, including politics, economy, geography, culture, diplomacy, even military affairs. And you need to study the underlying core elements that influence the economy of a particular entity. For example, when the USA’s GDP or employment report is secure, you begin to get a reasonably clear picture: the general health of America’s economy is good. So the US dollar should be more reliable than other currencies. But how far can the US dollar go? Fundamental Trading may not answer this question very accurately. You may need to come up with other precise tools as to how best to translate this information into an entry and exit points for a particular trading strategy.

Hedge:

In finance, a hedge is an investment that is taken out individually to reduce the risk in another investment. Hedging is a strategy designed to minimize exposure to unwanted business risk while still allowing the business to profit from investment activity.

In FOREX, there are two kinds of similar “hedging” strategies:

1.Buy and Sell the same currencies pair, same lots, same timing. Then let it go. While one of those orders goes north, the counterpart will go south. After the winner takes profit, we can wait for the loser turning around. In a yo-yo market, this method works well.

For example, buy two lots GBP/USD at 2.0003, at the same time, sell two lots GBP/USD at 1.9997. While the rate rises to 2.0053, we close the buy order and make a profit of 50 pips. Now, the sell order will draw down around 50 pips.

Let’s wait for the rate falling down; it will fall usually, especially in the yo-yo market environment. If the price drops down to 2.0037, close the sell order, the sell order will lose 40 pips. Does it hurt? No. Don’t forget the 50 pips we have taken at the buy order. We can get 50-40=10 pips. Furthermore, if the rate keeps falling, let’s say down to 2.0027, we can take 50-30=20 pips, etc.

Some people would doubt it… doesn’t this “strategy” sound like hedging flat for nothing, just paying double spread? Why bother? Well, they are right, because we forgot to mention the critical point: the timing of closing orders. When to close the winning order to set a foundation and when to close the losing order to lock the profit, there are some tricks inside.

Experienced traders use technical analysis skills to decide this vital timing. Believe it or not, those experienced traders say that this method helps them screening false signals out.

This kind of “Yo-Yo Hedge” can work at any currencies pair.

2. Buy (or sell) unequal lots of particular currencies pairs and buy unequal quantities of other kinds of currency pairs, which usually move in the opposite direction. This seems like a “Semi-Hedge” trading strategy. It is created based on “Correlation” between some particular currencies pairs. So it is not suitable for every currency pair.

This kind of hedge has another feature: earning SWAP! You receive interest daily on the held position, which can yield up to 50% per year of your full account balance.

Several pairs can do it. Such as EUR/USD Vs. USD /CHF, GBP/USD Vs. USD/CHF, AUD/USD Vs. NZD/USD, EUR/JPY Vs. CHF/JPY, GBP/JPY Vs. CHF/JPY.

Let’s take the EUR/USD and the CHF/USD pairs.

These pairs are historically negatively correlative 93-98% of the time. That is when one pair goes up the other goes down, and vice versa, up to 98% of the time. In a high leverage account (as high as 400:1 or 500:1), you could earn 50% SWAP interest in a year. How? Let’s say you have $5,000 in your account and a 10% risk margin set. If the net benefit we receive is 1.25% annually, this 1.25% interest will be enlarged to 50% per annum, by the 400:1 leverage.
And, this return does not include the buy low/sell high profits.

But, if the base of this kind of hedge collapses, it means the “Correlation” does not exist anymore, for example, the “Correlation” drops under 50% or lower, there will be a disaster.

Arbitrage:

Some people call “Arbitrage” as a risk-free strategy. But other people call it a trick which looks like the cat pawing chestnuts from a fire. But in theory, its risk is minimum indeed. We introduce three types of arbitrage strategies here:

1. Triangle Arbitrage: Searching for two highly fast-moving pairs (like EUR/USD and USD/JPY), the price of a not-so-fast moving pair like EURJPY should always be derived by multiplying (or dividing, etc.) the fast-moving pairs. So, for example, if EUR/USD is 1.4871 and USD/JPY is 108.24, the logical price of EUR/JPY should be 1.2 x 120 = 160.96. But at the same time, the real EUR/JPY rate is 160.90. The slower moving pair lags behind the logical price, then profit opportunity comes.

In practice, currencies are quoted with a bid-ask spread, so a trader should be careful that he is buying at the quoted ask price and selling at the quoted bid price. Other transaction costs, such as commissions, might also invalidate the apparent free lunch.

More pairs:

AUD/CAD CAD/JPY AUD/JPY
AUD/CAD GBP/CAD GBP/AUD
AUD/CAD USD/CAD AUD/USD
AUD/CHF CHF/JPY AUD/JPY
AUD/CHF GBP/CHF GBP/AUD
AUD/CHF USD/CHF AUD/USD
AUD/JPY EUR/JPY EUR/AUD
AUD/JPY GBP/JPY GBP/AUD
AUD/JPY USD/JPY AUD/USD
AUD/USD GBP/USD GBP/AUD
AUD/USD USD/CAD AUD/CAD
AUD/USD USD/CHF AUD/CHF
AUD/USD USD/JPY AUD/JPY
CAD/JPY EUR/JPY EUR/CAD
CAD/JPY GBP/JPY GBP/CAD
CAD/JPY USD/JPY USD/CAD
CHF/JPY EUR/JPY EUR/CHF
CHF/JPY GBP/JPY GBP/CHF
EUR/AUD AUD/CHF EUR/CHF
EUR/AUD AUD/JPY EUR/JPY
EUR/AUD AUD/USD EUR/USD
EUR/AUD GBP/AUD EUR/GBP
EUR/CAD AUD/CAD EUR/AUD
EUR/CAD GBP/CAD EUR/CAD
EUR/CAD USD/CAD EUR/USD
EUR/CHF AUD/CHF EUR/AUD
EUR/CHF GBP/CHF EUR/GBP
EUR/CHF USD/CHF EUR/USD
EUR/GBP GBP/AUD EUR/AUD
EUR/GBP GBP/CAD EUR/CAD
EUR/GBP GBP/CHF EUR/CHF
EUR/GBP GBP/JPY EUR/JPY
EUR/GBP GBP/USD EUR/USD
EUR/JPY GBP/JPY EUR/GBP
EUR/JPY USD/JPY EUR/USD
EUR/USD GBP/USD EUR/GBP
EUR/USD USD/JPY EUR/JPY
GBP/JPY USD/JPY GBP/USD

2. Hedging Arbitrage:

This technique is the safest ever, and the most profitable of all hedging techniques while keeping minimal risks. This technique uses the arbitrage of roll over interest rates (SWAP) between two brokers.
One broker who pays or charges rollover interest at the end of the day and the other should not charge or pay this kind of rollover SWAP interest. The main idea about this type of Hedge Arbitrage is to open a position of currency (Fore example, the highest SWAP GBP/JPY) at a broker who will pay you a high interest for every night the position is carried, and to open a reverse of that position for the same currency with the broker that does not charge interest for carrying the trade. This way, you will gain the interest or SWAP that is credited to your account, risk-free.

3. Netting Arbitrage:

The main idea behind the strategy is, using differences between cross rates (such as EUR/USD, GBP/USD, and EUR/GBP) at different markets.

For example, suppose you had opened the following positions:

buy one lot EUR/USD at 1.4867;
sell 1 lot EUR/GBP at 0.7600;
and sell 0.76 lot GBP/USD at 1.9586.

The netting/clearing gives the following results:

Long EUR from the first pair and short EUR from the second pair gives zero exposure in EUR.

The long position in GBP from the second pair and short position from the third pair gives zero exposure in GBP.
Short position from the first pair ($148,670.00) in USD and long position from the third pair ($195,860.00*0.76) in USD gives you $183.60 profit without open positions and exposures.

Simple? Not really for small traders, maybe for those “big brothers” only. Because it is really hard to play spread, slippage, stop loss hunting, or so on games against brokers.

Carry Trading:

Carry trading is a well-known trading strategy in which an investor sells a certain currency with a relatively low-interest rate and uses the funds to purchase a different currency yielding a higher interest rate. Then this investor can make a profit from the difference between these two interest rates.
JPY is currently considered to be the most popular currency to use as the low interest yielding currency in the carry trade because its interest rate is the lowest of the world almost at 0. And GBP is currently considered to be the high yielding currency. So are NZD and AUD.

When we buy these currencies pairs: GBP/JPY, AUD/JPY, GBP/CHF, USD/JPY, or EUR/CHF;
Or sell: EUR/AUD, EUR/GBP, AUD/NZD;

Both actions can yield positive SWAP rollover interest. If combining with some kinds of hedge trading, we can make as high as 100% profit annually and keep the risk low.

The big risk in carrying Trading is the uncertainty of exchange rates. Also, these transactions are generally done with high leverage, so a small movement in exchange rates can result in huge losses unless hedged appropriately.

Martingale:

Originally, martingale referred to a class of betting strategies popular in 18th century France. In Forex trading, the strategy lets the trader double his/her order lots after every loss so that the first win would recover all previous losses plus win a profit equal to the original investment. In the example below, you bought one lot of EUR/USD at 1.4650.

Unfortunately, the rate drops. You play it in martingale way, “double down,” buy two lots; you need the EUR/USD to rally from 1.4630 to 1.4640 to break even. As the price moves lower and you add four lots, you only need it to rally to 1.4625 instead of 1.4640 to break even. The more lots you add, the lower your average entry price. Even though you may lose 100 pips on the first lot of the EUR/USD, if the price hits 1.4550, you only need the currencies pair to rally to 1.4569 to break even on your entire holdings. Once the rate goes up one more pip, you will win a lot.

EUR/USD Lots Average or Breakeven Price

1.4650 1 1.4650
1.4630 2 1.4640
1.4610 4 1.4625
1.4590 8 1.4605
1.4570 16 1.4588
1.4550 32 1.4569

The Martingale strategy needs very strict money management, and you must understand that in the beginning, the money will be coming slowly, but if you lose the patience and raise risk level up to much, you may not hang on to the end to see the turn-around.

Anti-Martingale:

The anti-martingale strategy is the opposite of the better-known martingale approach. This approach instead increases order lots after wins, while reducing them after a loss. Using an anti-martingale risk management scheme will increase profits during time periods when a trading approach is working well, while automatically decreasing exposure during portions of the cycle where Trading is unprofitable. This is believed to decrease the risk of ruin for Trading.

Grid:

Basically, the trader sets a series of entry limit orders X pips from the current price, for example, 15 pips. Some experienced traders like to use the Fibonacci Series Numbers (0, 1, 1, 2, 3, 5, 8, 13, …) or Golden Section Numbers to make this grid. Once the price hits the level, the limit order is executed. Then every 15 pips, there is another order at limit price executed. And so on. In a yo-yo market, while the price moves up or down, there always be some limit orders executed.

Once the order is taken profit and the price moves to its original level again, a new limit order shall be executed again, then repeat the same process. Just open orders and take profits in a set of “grid.” It is simple and easy, but hard to deal with when and how to close all orders, especially the Stop Loss. Some experts say we do not need stop loss, but will you take the chance to hold all your positions till “Margin Call?”

Day trading:

This refers to the practice of buying and selling currencies pairs such that all positions will usually be closed within the same Forex the trading day. The day trading idea comes from the stock market. Day traders rapidly buy and sell stocks throughout the day in the hope that their stocks will continue climbing or falling in value for the seconds to minutes they own the stock, allowing them to lock in quick profits.

Day trading is extremely risky and can result in substantial financial losses in a very short period. Under the rules of NYSE and NASD, customers who are deemed “pattern day traders” must have at least $25,000 in their accounts and can only trade in margin accounts.

But in the Forex market, everyone can be a day trader to do day trading. Actually, more than day trading, they can do

“scalping.”

Scalping:

Scalping is a trading style where small price gaps created by the bid-ask spreads are exploited. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds. It means trying to get a few points (1~3 pips only, no greed, no long term) off the market every time. This strategy is based on a fact: approximately 70 to 80% of the time, the market is in a consolidation pattern.

What this means is that for the majority of the time the market is not making significant moves. For example, after the USA market is closed and before the European market is open, the Forex market tends to range in a consolidation channel for hours at a time before making another significant move in one direction. This kind of market behavior pattern is ideal for Forex scalping. Every time you enter the market, wait 10 or 20 minutes, once you have several pips gain than cash it and go.

Scalping has some features:

1. Lower exposure, lower risks. Scalpers are only exposed in a relatively short period.
2. Smaller moves, easier to obtain. The normal wave of the market will give you several pips easily.
3. Large volume, adding profits up. Since the profit obtained per share or contract is very small due to its target of spread, they need to trade largely in order to add up the profits. Scalping is not suitable for small-capital traders.
But be careful, not every broker welcomes this kind of scalping strategy.

If you scalp it too quick and thin, let’s say you just hit one pip every 2 or 3 minutes then run and repeat it again and again within a day, every day, you must feel high, eh? But the broker maybe not happy and bans you. You will be kicked out because of your successful scalping!

Break-Out:

Using the Bollinger Bands indicator on a chart, we will find every Forex currencies pair is waving in a “band,” or a channel. By finding major support and resistance levels with technical analysis, a Breakout strategy trader will buy this pair at the lower level of support (bottom of the band/channel) and sell them near resistance (top of the band/channel). Till now, there is not a Breakout yet.

Once the price breaks the upper range line with larger-than-average volume, or the opposite: the price breaks the lower range line with larger-than-average volume, the chance is coming. The idea of this strategy is that when a currencies pair breaks out of the channel, it usually experiences a large price movement in the direction of the breakout. So buy it at a price breaks the upper range line and continue to hold it until the rate has risen a distance comparable to the height of the range.

If it goes down instead, stop losses as it penetrates the upper range line. Or, sell it at a price breaks the lower range line, and continue to hold it until the rate has fallen a distance comparable to the height of the range. If it goes up instead, stop losses as it penetrates the lower range line.

Pivot:

Besides Support and Resistance levels, many foreign exchange traders like to use another indicator to analyze and predict currency pairs’ price changes; it is so-called: the Pivot Point. To calculate and analyze pivot is a subset of technical analysis, with this benchmark, traders can locate the rotation point of the trend, and this is very helpful for deciding when and where to buy or sell.

Classical Pivot Point, Support, and Resistance Formulas are as follows:

Look at any one chart; the pivot is an average of the previous Bar’s high, low, and closing prices. In the following formula, “H” represents the previous Bar’s high, “L” represents the previous Bar’s low, and “C” represents the previous Bar’s closing price.

Current Bar’s Pivot Point (P)=Previous Bar’s (H+L+C)/3

The first level of support and resistance can be calculated as follows:
First Resistance Level (R1)=(2*P)-L
First Support Level (S1)=(2*P)-H
Likewise, the second level of support and resistance:
Second Resistance Level (R2)=P+(R1-S1)
Second Support Level (S2)=P-(R1-S1)
Since many currency pairs tend to fluctuate between Support and Resistance levels, and these levels are calculated based on Pivot points, so when a trend or breakout trader knows where the pivot point is, it will enable him/her to find out key levels that need to be broken for a move to qualify as a breakout.

News Trading:

The system is developed based on economic news events from around the world. Nearly half of those announcements have moved the market significantly. Before big news is coming, we can buy and sell some currencies pairs at the same time, the same lots, set stop loss prices for them. After the news is released, especially for the big one, both sides of a buy order and sell order will jump significantly. No matter which order is a winner, just let it go. And the loser will hit the Stop Loss, just let it be. The winner’s gain minus the loser’s loss, it is your news trading profit.

For example, Non-Farm Payrolls/Employment Report – The NFP is the most influential news release of every month. It’s announced on the first Friday of the month at 8:30 am EST for the prior month. We can put a buy order, and a sell order at market prices for GBP/USD at 8:29 am EST. Don’t forget, set 30 pips Stop Loss level for them.

Wait 2 minutes only, the news is announced, it is a big one! Then the sell order jumps over 100 pips, and the buy order drops like a brick. The brick hits the Stop Loss, and the pain is over. Totally, your gain could be 100-30=70 pips. Quick and easy, cool enough?
Trend Following:

It is so simple, just follow the trend. Buy it is the most difficult strategy because no one can tell you 100% for sure what is the right TREND. Go to look at a weekly chart of USD/CAD, if you had shorted this pair in September 2001 and held it till September 2007, you know what the trend means.

The most famous trend analysis tool seems the Wave Principle. In the 1930s, Ralph Nelson Elliott discovered that stock market prices trend and reverse in recognizable patterns. Elliott isolated five such patterns, or “waves,” that recur in market price data.

Another trend analysis guru should be W. D. Gann. In 1908, Gann discovered what he called the “market time factor,” which made him one of the pioneers of technical analysis. To test his new strategy, he opened one account with $300 and one at $150.

It turned out to be wildly successful: Gann was able to make $25,000 profit with his $300 account in only three months; meanwhile, he made $12,000 profit with his $150 account in only 30 days! After his results were verified, he became famous on Wall Street as one of the best forecasters of all time.

Back to the chat of USD/CAD, now, please tell me how to follow the trend? Will USD/CAD continues the trend which is going south further to 0.6000, or, another trend going north reversely back to 1.6000?

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