Forex Germany

Forex Trading - Trading Strategies

A variety of different trading strategies are used in FX trading, the most important strategies will be briefly described in the following section.

Scalping

As soon as you study FX trading in more detail, without doubt you will encounter a strategy called Scalping. One of the main reasons is that Scalping is very difficult to implement without system support as offered by different trading systems like MetaTrader 4.

A trader using Scalping will try to benefit from small exchange rate fluctuations by executing a number of transactions and by closing a position within a short time after its opening, if possible, even within a few seconds. The profits of the trades will amount to only a few pips, thus shifting the focus on the risk management of the open position and the ability to limit losses. In this case clinging on to open positions with the expectations that "the market will turn at one point" can lead to disastrous results.

As it is very difficult for the trader to monitor several currencies simultaneously so that he can open or close positions just at the right moment of time, MT4 Expert Advisors are frequently used. In fact, the vast number of Expert Advisors offered in the market are Scalpers, and at a first glance they impress with a brilliant performance - in particular with regards to backtesting. However, the trader needs to bear in mind that a single loss may eliminate the profits achieved during several days' trading activity, as by default the Scalper uses an elevated stop loss limit. Even a strike rate of 95% at a take profit limit of 5 pips and at a stop loss limit of 100 pips may not be sufficient to achieve profits in the long term.

Nevertheless, this example illustrates very well that the right choice of the FX broker is critical to success or failure when using Scalping. If the spread is reduced by only one pip, e.g. by switching the broker, the take profit limit can be increased to 6 pips without having to change the trading strategy itself. Adding one extra pip per trade permits a doubling of the invested capital within one year at an identical strike rate of 95% and 100 trades per month.

A further problem when using Scalping is caused by the FX brokers themselves. Many brokers trade the positions - in particular small positions - via their own dealing desk. This means that the broker's trader receives these transactions for his own account, and he will attempt to close his risk exposure towards the market. But this costs valuable time. If the client offsets his position within 15 seconds upon opening, the client's profit will result in a loss for the broker. This is the main reason why some brokers won't permit Scalpers or demand a minimum holding period of 60 seconds in their terms and conditions so that the dealing desks have enough time to react.

Short Term Trading

It is difficult to draw the border line between short term trading and Scalping. Short term trading will apply if the position is closed only after a few minutes. However, often some Expert Advisors with short term trading features are still sold as Scalpers. Also, take profit limits with a double digit pip range can typically be considered as another indicator for short term trading. Positions are being kept open for several hours, seldom for a few days.

News Trading

A trader applying trading the news will bet on exchange rate movements immediately upon the release of certain information, like employment data, direction of the GDP or election results. One approach is to follow as quickly as possible a trend arising directly out of the news release in order to benefit from the major part of the exchange rate movements, another approach may be to determine the direction of the exchange rate movement beforehand. The former will carry less risk as long as the train is not being missed, the latter will result in increased risks as well as in higher opportunities, though this approach requires much more amount of work.

Often forex brokers who are offering fixed spreads reserve the right, at their discretion, not to accept orders within a certain time frame around well-known news release dates. Frequently brokers offering variable spreads will widen the spreads ahead of news release date so that they won't be surprised by sudden price movements.

Trend Following

Trend following models are frequently orientated towards long-term goals with a possible stop loss level of up to 500 pips and a take profit level in a three-digit range. The idea is to recognize trends and to follow these trends through several weeks or even months. Stop loss levels are positioned at technical support lines and will be adjusted according to the development of the exchange rate.

Traders applying this strategy will need to keep a strict discipline or support a distinct "Trade and forget" attitude in order to persevere through long periods of losses. It is not recommended at all to intervene manually into the existing trading strategies only for the reason that rate moves towards the stop loss limit.

Breakout

Breakout trading attempts to recognize new trends as soon as possible. Usually this strategy aims at a true break away from a rather trendless period and not at trend changes. Breakout strategies tend to be of short term nature, though afterwards it may be possible to follow this new trend in the long term.

Looking at a daily basis, breakout strategies are often used when changing from the Asian to the European session, as the start of the London trading frequently establishes a new day trend. For example, the lows and highs of the Asian session's last trading session constitute the limits which, when being undercut or exceeded, form the basis of the opening direction of the orders.

Martingale

Martingale originates from gambling, but is also very popular in FX trading. The strategy works as follows, a new order will be placed in a defined gap, e.g. every 20 pips, if the first order has gone in the "wrong" direction. The order volume of the new order will be doubled. The trader is expecting that the market will turn into the "right" direction, thus compensating the losses of the previous orders by the profits of the last order.

However, nobody will be successful using Martingale without a safety net - as it would apply to gambling -, since capital availability and the maximum order size are restricted, thus making a continuous doubling of the invested capital impossible. Though the probability of being off base for 10 times in succession is down to 0.1% (mathematicians may correct this figure), this will become true at one point of time.

Grid Trading

The basic setup of grid trading is similar to Martingale although not bearing the same risks. Plain models consist in putting a conceptual grid on a chart with the individual lines being 10-20 pips apart. Once the first line is reached, an order with or against the trend, depending on the model, will be placed. The subsequent orders will be placed in the same direction, - like with Martingale -, however, the order volume will remain the same.

When using more complex models, the first order will be triggered by external parameters and not by the grid lines If the exchange rate does not move into the expected directions, the follow-up orders will be initiated based on the grid information. Orders are placed on the assumption that the initially expected trend is still correct and that the counter movement just represents a brief correction. At the same time the break even point of all orders will be improved by the subsequent orders.

Example: Upon sale of 0.1 lots EUR/USD at 1.4000 the exchange rate is moving towards 1.4045. The exchange rate would need to return to 1.4000 for a closing of the position without loss (leaving out the spread). If further 0.1 lots EUR/USD are being sold for every 10 pips (which means 1.4010, 1.4020, 1.4030 and 1.4040), the break even exchange rate for all orders will improve to 1.4020. When offsetting all orders at 1.4020, this will result in: 1st order -20 pips, 2nd order -10 pips, 3rd order 0 pips, 4th order +10 pips and 5th order +20 pips.

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