Profitable Forex Strategies and Techniques

Wednesday, November 5, 2008

Profitable Forex Strategies and Techniques

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This article is mostly for people that already know what the Forex market is and at least know the basic concepts. If you have no clue about what this market is or you have never heard about it, I will give you a very brief explanation bellow.

Forex is the acronym for Foreign Exchange Market. This is the biggest and most liquid market of the entire world today. One to three trillion dollars exchange hands at Forex every day. That's a huge amount of money. No stock market exchange of any country come close to this.

This market is huge. It is a sea of money full of sharks and dangerous waters, but it is also the only market where you at least hypothetically can make $1,000,000 in two weeks starting with only $1,000.

I say hypothetically because what happens often is that people blindly gamble their money at Forex without knowing anything about it and they lose their shirt. That's why I say to you: be careful! This market is profitable, but you need to learn the basics well, do your homework and demo trade a lot.

Just remember that 95% of traders lose money, 5% make it and less than 1% become rich at Forex. The nice thing about this market is that you can make money without creating any product or service, selling anything, nor advertising. You just trade some cash and get paid depending on your knowledge and expertise.

This is the market where banks, transnational corporations and individual traders exchange one currency for another. I am talking about the spot Forex market. You can trade at huge leverage as much as 400 to 1, meaning that for every dollar that you have for trading you can trade 400. For example if you have $1,000 on your account you can trade as much as $400,000.

This is dangerous. Most experienced traders won't use such a high leverage. In the other hand, high leverage can be good if you learn how to use it in your favor. Anyway, that's enough for the basics. If you want to learn more about how this market emerged, its history and so, then read my other articles.

Now let's talk about the strategies and how some traders make money at Forex. Let's start by saying that what works for me may not necessary work for you. Trading currencies is risky. That's a fact. But ultimately I discovered a few strategies that could give novice traders a winning edge.

Trading Forex is not as easy as most people think. Today you may be earning a lot and tomorrow you are losing 40% of your starting capital. Novice traders often make the same mistakes over and over again. I will enumerate a few of them bellow.

1. Do not look for a holly grail of trading.

This is for people who are afraid to lose or are too greedy and want to get rich quick. Even when it seems so, The Forex Market is not the place to get rich quick. Yes, you can make a lot of money over time and yes you don't have to sell anything, nor create or advertise any products. Still you have to learn a whole lot about what makes this market tick and what moves the price of the currencies plus how to manage your money effectively so you don't lose your shirt.

Many novice traders spend a LOT of time searching a perfect strategy that will allow them to always win-win and never lose. They want to have guaranteed profits because they can't stand to lose and/or they want to make too much (millions) quick so they can retire fast and buy a mansion in a far distant beautiful tropical island. It doesn't happen.

Don't waist your time. A trading strategy that allows you to have guaranteed profits do not exist. Trading is very risky. That's why it is so profitable. Remember: "no risk, no reward." So, do not try to always win on every trade. It is simply not possible. There is no way to get rid of the fact of uncertainty. What I mean is that no matter how effective your trading strategy may be, sometimes it will fail and you have to be ready to face this fact.

By not trying to find a perfect strategy that turns you into a millionaire fast, you will just save a ton of your own time and efforts. It doesn't exist. If you find it, please don't tell me about it. First I won't believe you. Second I don't need it. You will find out bellow why I say that I won't need it.

2. Use technical analysis and fundamental analysis.

When I started trading I didn't believe in this. I wanted to find a strategy which consisted of money management alone (which I explain bellow). This is not good! Money management is important but you still need the other two. You define ("predict") where the market is heading to depending on how effective your technical and fundamental strategies are.

Mastering technical analysis is the ability to predict future price movements by analyzing past price data and graphical patterns. You get a graphic of certain currencies. Check the data that you observe and based on your knowledge of technical analysis you "predict" with certain degree of accuracy where the market is going.

Many brokers allow you to add technical indicators to the graphs while you are trading. You can try this on a demo account and see how well you are able to define the future price movement of the currencies you plan to trade. One of those brokers is http://www.oanda.com/.

There are many technical indicators. I can't tell which one will be more effective for you. Every trader is different. This is something that you will have to discover by yourself. There is not a hidden secret or magic formula for trading Forex. It is what you do every minute when you are in front of the graphics and checking the news what really counts.

The secret is in your overall knowledge and your decisions. This comes with experience and practice. If you open an account with one of these online brokers you can trade on paper before you trade with real money, so you can learn and practice before you risk any capital.

Let me tell you about a few technical indicators that you can use. You can use the MACD (Moving average convergence divergence), the Bollinger Bands, Pivot Points, RSI, Stochastic, Fibonacci, EMA, Elliot Waves and many others. There are in fact many technical indicators but these are among the most widely known and used.

When you add technical indicators to the graphic the brokers software will automatically perform mathematical calculations to reveal interesting facts and patterns about the graphics that you can't readily see without said indicators. You can use the technical indicators to create your own technical systems.

These systems will never work 100% of the time, but if they work 70% — 80% it may be enough. That's because you can control your risks with money management techniques as I describe bellow.

To further increase your probability of winning and reduce your probability of losing on every trade you can use fundamental analysis. I think that most traders choose one or the other but many traders use both.

Fundamental analysis is to trade the news. What is going on with the countries's economies of the currencies that you are trading? What is the unemployment index? Did something suddenly happen that could drastically affect the price of the currencies?

Trading the news is another effective way to "predict" where the market is going. Many online brokers offer you a link with important financial news. For example www.oanda.com has this feature. You can also find financial news on the following websites:

a) www.bloomberg.com
b) www.businessweek.com
c) www.economist.com
d) money.cnn.com
e) markets.ft.com
f) www.reuters.com
g) http://www.fxstreet.com/

3. Use money management strategies.

You need money management techniques. This is what makes you or breaks you. Put it this way, most traders invest far too much of their trading capital on every trade. It is as follows . . . "Expect to make too much and you will make too little, expect to make little and you will make a lot."

What does it mean? It means that if you try to make a fortune on every trade you will lose your shirt. If you expect to make a little on every trade and you compound your profits, you may make a lot of money over the long run.

The first rule of money management says that you should not risk more than 1% of the money that you have on your account. You control this risk with stop loss and limit orders. When you start trading this may seem as little profits specially if you start with little trading capital. In the other hand if you compound some or all of your profits you may increase your account exponentially over time.

The magic of compound interest is amazing! This is the way that most fortunes are created on the financial markets, little by little. If you gamble your money you may lose it fast.

Many traders do exactly the opposite. Imagine that you open an account with $5,000 and you enter a trade for $1,000. Let's say that the market moves against you and you lose those $1,000. Now you have $4,000 on your account. You think that the price for the currencies is too low, so it should recover. In fact you are pretty sure that it will come back.

Then you invest $1,500 to recover from the previous loss plus realize a $500 profit. The market moves again against you. It kept going in the same direction, something that you didn't expected. What happens? Now you have $2,500 on your account. That's 50% of your initial trading capital. It will be very hard for you to recover from that loss.

In the other hand, if you risk 1% of your money on every trade, you will have $4,900 on your account after that initial loss. It will be much easier for you to recover from those trades.

The second rule of money management is to expect always to receive more profits than the money that you risk to lose. This can be accomplished through limit and stop orders as well as trailing stops.

For example if you expect to make a 25 pips profits on every trade, then you put the stop order at 15 pips bellow or above your entry price. A better way to have a greater expectancy ratio is to use trailing stops as I describe above. A trailing stop allows you to cut the loses short and let your winners ride.

These are the basic techniques that a successful trader should use to generate consistent profits at the Forex Market. This is basic information, but I realize that many people out there don't even know what Forex is, so I didn't want to get into more complex strategies here. You will find information about complex and advanced Forex strategies on my website.

by Nathaniel Tabares

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