Forex trading strategy
As the largest market in the world, Forex attracts all kinds of investors. Each has a different reason for being in the market, and each uses a different technique and mechanism to achieve his or her investing goals. Although you might not be interested in using these techniques or strategies yourself, it is a good idea to learn about them anyway. They will move the markets and affect your returns.
Most traders in the Forex market today have one ambition to make money fast. Of the markets average daily turnover, $1.2 trillion, more than 90 percent of the trades are speculative. That means that the person or institution investing that money has no other objective than to turn a profit. This is supported by other Forex statistics. More than 40 percent of Forex trades last less than two days, and 80 percent last less than two weeks.
Other participants in the market, however, are concerned less with making money than with protecting it. They want to hedge against currency swings or manage cash flow across international borders. They include giant banks, insurance companies, and multinational corporations such as BMW, Sony, and Wal-Mart, which must report profits from countries all over the world.
These players can select from several different kinds of trading vehicles to best realize their trading strategy and achieve their investing objective. The most widely used vehicle is the spot market, also called cash or simply Forex. Spot trading represents the most basic transaction in Forex. A buyer and seller agree on a price and exchange money within two days. Deal is done. Spot, however, is not the only trading tool available to investors. As in other markets, alternative investing vehicles were developed to satisfy each participants unique needs.
These trading tools called derivatives are forwards, futures, and options and swaps. The last two are derivatives that have become critical players in the foreign exchange market. Each Forex participant can select the vehicle that best suits his or her purpose. For example, Ford Motor Company uses a forward to stabilize its cash flow in foreign revenues. Citibank might prefer a swap to lower its exposure to a specific currency. A hedge fund might select options to take advantage of currency moves.
A good way to understand the concept of choosing an investment instrument is to compare trading to a journey. Anyone planning to travel from, say, Boston to Mexico City can choose from a variety of transportation methods.
Every trade should be part of a thought out strategy. A strategy gives you the discipline to ride winners and cut losers and even adjust to an unforeseen event. Only expert, seasoned trading veterans should trade on a feeling. At that point most would tell you they have identified a unique strategy that works. Otherwise, feelings are often just personal biases that cloud the decision-making process.
The best traders always write out their trading strategy before they enter any market. This prevents them from searching for trades or rationalizing a trade by analyzing previously unrelated data. Objective analysis must be done before the trade is entered into the market. Once the trade is placed, the trader has a vested interest in the outcome, and this affects the decision making process. In the worst case, this vested interest blinds the trader when the environment turns against him.
Every trading strategy should have the following basic elements:
ENTRY POINT: The price at which the strategy gets initiated.
EXIT POINT: The expectation of returns on a trade.
STOP LOSS: The expected downside loss.
liMIT ORDER (Riding stop): A movable order that lets you capture returns in a fact moving market.
This combination of elements is a template that can be used for any and every trade.
Rapid change in the Forex market must be factored into trading strategies. A market that spans the globe is also vulnerable to an increased number of unexpected events that can suddenly and decisively change the trading landscape. It could be a terrorist bomb, the death of a government official, or a surprise international merger. These events can prompt you to enter the market aggressively, hold back on a trade, or redefine your strategy. When contemplating any trade, review possible positive and negative events and the corresponding actions should they occur.
The simple concept is probably the most difficult to put into practice. Undisciplined traders quickly discard their predetermined exit point in the hopes of a quick reversal, allowing a bad trade to snowball. Moreover, every trader has seen his stops hit multiple times, only to see the market then move in his direction. After seeing this a few times, even disciplined traders often diverge from their strategy and remove the stops.
In these cases, traders have rejected an effective tool in Forex the stop loss. Stops are placed to control downside risk. They are trip wires that save your position if the market moves against you. Not all trades are profitable. The key is strictly managing your money so that if you have a wrong trade you can trade again. If you take the same expectation from the day before and view the market solely from the charts, you might miss the fact that the market sentiment has shifted. This could require a change in your strategy.
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