Forex Strategies

By | February 18, 2017

Definition

Forex Strategies are a pre-defined set of trading tools that are used to analyse, interpret and successfully implement while trading on the forex markets.

The strategies can either be based on technical analysis- study of chart patterns or fundamental analysis- study of global economic and political events.

Some strategies involve a combination of both.

How to implement

Once the strategy or strategies are defined, it can either be implemented manually or can be automated.

If the strategy has to be manually implemented, the trader has to regularly monitor the trading screen and place the order as and when the strategy comes into play.

To automate strategies, the simplest method is to place a limit or a stop order with an alert to confirm the trade.

But if the order is not pre defined to a particular price or time, the trading system needs to be automated with the broker’s online terminal.

Forex strategies

Forex strategies can be developed for various events and time frames depending on the trader and the trading approach to these markets. The time frame for trading strategies can vary from a minute to well over a year.

Mentioned below are the two trading strategies that can be employed

Technical analysis Strategies

Technical analysis is the graphical study of historical price data to forecast future prices. Based on the direction of the price movement, a trend can be categorized as

  • Bullish trend – represented by higher tops and higher bottoms
  • Bearish trend – represented by lower tops and lower bottoms
  • Sideways – very narrow movements

Based on the direction or category of the trend, the chart patterns can be distinguished between reversals and continuation patterns

Reversal patterns

These patterns occur either at the beginning or at the end of a bullish/ bearish trend and signal a change in the direction of the trend.

Since the time taken for a primary trend to be completely formed is anywhere between six months to a number of years, these chart patterns are used to trade long term, usually between 6- 12 months or more.

Continuation patterns

Normally occur du ring the life time of a primary trend. The y are formed during a period

of consolidation o r narrow price movements and last for a few days to a few months, during an uptrend or a down trend.

The breakout of a continuation patter n is predominantly in the direction of the primary trend.

The following chart provides an illustration of a bullish (up) trend, bearish (down) trend and sideways movement.

primary trend

Some o f the strategies that c an be implemented in technical analysis are

Candlestick patterns

Revers al patterns

  • Dark cloud cover pattern
  • Piercing pattern
  • Bullish engulfing pattern
  • Bearish en gulfing pattern
  • Morning star
  • Evening star
  • Hammer
  • Hanging man

Continuation patterns

  • Upside tasuki gap
  • Downside tasuki gap
  • Rising three
  • Falling three
  • Bullish three line strike
  • Bearish three line strike

Other chart patterns

Reversal patterns

  • Double top
  • Double bottom
  • Head and shoulders
  • Inverse head and shoulders
  • Broadening top
  • Rounding bottom

Continuation patterns

  • Flag
  • Inverse flag
  • Pennants
  • Rising triangle
  • Falling triangle
  • Symmetrical triangle
  • Wedge

Fundamental analysis strategies

Fundamental analysis involves the study of global events being constantly addressed by the media. Fundamental analysis can be split into two factors

Economic analysis

It is the analysis of the global economic activities which consist of global economic indicators released regularly by the governments, central banks and independent agencies of various countries. These indicators determine the health of the economy, which is very crucial in strategising the impact on exchange rates

When economic announcements are directly related to the economic well being of a country, they are called macro economic factors, but if they related only to one or certain sectors of the economy, they are referred to as micro economic factors.

Strategies involving fundamental analysis mostly consist of macro- economic data as they have a larger impact on the economy of a country and hence the forex rates, whereas micro- economics is only limited to a corporate or a particular industry sector.

Unless a microeconomic data causes the systemic collapse of the economy of a country, it is mostly ignored.

Some of the significant macro- economic releases which affect the forex markets are

  1. Interest rate announcements
  2. GDP
  3. Inflation
  4. Unemployment
  5. Trade balance
  6. Industrial production
  7. Retail sales

The macroeconomic releases comprise of corporate sector announcements, some of which are mentioned below

  1. Quarterly earnings
  2. Mergers and acquisitions
  3. Income statement
  4. Assets
  5. Corporate debt
  6. Restructuring

The date and time of major economic events are known in advance although the outcome may vary from the projected view and hence these events are highly anticipated.

Political events

The political environment in a country is macroeconomic in nature and a very

important factor in analysing the forex markets as it can either have a positive or negative impact on the growth of a country, leading to volatility in the exchange rates of that country.

Mentioned below are some of the keenly watched political events

Business climate

If the political environment in a country encourages investments by providing excellent opportunities for investors in terms of modern infrastructure, steady exchange rates and tax incentives, it would lead to high investments by both the domestic and foreign companies thereby assisting the growth of an economy. However, if the environment is not conducive for investors to operate efficiently due to the non-availability of a level playing field, high taxes on profits and poor infrastructure, both domestic and foreign investors will shy away from investing fearing financial losses.

Political instability

Any country which is politically unstable will not be able to carry out economic reforms to the fullest fearing repercussions from coalition partners, thereby damaging economic growth.

Political crisis is not limited to a particular country or region. All countries at some point in time experience political crisis, due to lack of support from other political parties, leading to delays in implementing crucial economic reforms.

Corruption

Corruption reduces the income of a country and in so doing increases fiscal deficit, forcing governments to cut down on capital expenditure such as modernising basic infrastructure and connectivity such as roads, telecom, public utilities which are vital to encourage investments. Corruption also leads to wasteful spending of public money, loopholes in tax collection and allocating scarce resources to the rich and powerful at throw-away prices.

The effects lead to income disparity, increase in external debt and higher taxes.

Civil unrest

Civil unrest is the direct result of corruption, unhealthy business environment and political instability leading to harmful political decisions taken by the Government thereby causing large scale inflation and unemployment. Civil unrest is also caused due to religious conflicts. Civilian unrest can cause large scale damage and disruption to the functioning of an economy.

Wars/ conflicts

A war or a war- like situation can be caused by unfriendly neighbouring countries or internal political instability. This not only affects new foreign investments, but also drives away existing ones as a war/ conflict can cause a flight to investments by foreign investors due to the risk and uncertainty surrounding the situation.

Investors also shift their assets from riskier ones like equities to safe haven currencies and commodities such as gold.

A conflict could lead to a sharp depreciation in the value of the exchange rate until normalcy returns.

To summarise, fundamental and technical analysis are both used as strategies to analyse future trends in the forex markets, although the approach is different.

Forex traders can either use these strategies in isolation or in conjunction.

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