Fundamental Analysis in Forex Trading

2022-12-30 2022-12-30
Fundamental Analysis in Forex Tradinglogo

Fundamental analysis in the stock market is considered to be a complex tool. The most successful investors in history, such as George Soros and Warren Buffett, made up their capitals employing fundamental analysis. This article is an ultimate guide to fundamental analysis in Forex trading. Read on, and you will learn how to utilize the best methods and tools of fundamental analysis!

The article covers the following subjects:

What is Fundamental Analysis?

Fundamental analysis is a way to predict future asset prices based on external events and facts. These events and facts are the fundamental factors of the economy. Fundamental factors include:

economic indicators, for example, central banks’ interest rates, Gross Domestic Product (GDP) changes, inflation and deflation rates, employment;

economic outlook;

political factors;

market news and rumors;

seasonal factors;

industries’ correlation;

economic growth, cycles, and other regularities

Fundamental analysis aims to spot the maximum number of essential factors to determine the market’s likely prices.

Fundamental Analysis vs. Technical Analysis: What’s the Difference?

The primary difference between fundamental and technical analysis is in the methods of forecasts. Fundamental analysis suggests a detailed study of the financial and economic indicators of both the subject of the research itself and the outer environment. Technical analysis implies exploring only the price chart to identify patterns or trends, employing a wide range of technical indicators.

Fundamental analysis allows you to identify the fair price of assets and understand how they are undervalued or overvalued at the current time. Fundamental analysis is a method of determining a stock’s real or “fair market” value. The key goal of technical tools is to identify trends and patterns, relevant points to enter and exit trades.

There are also differences in time frames. Fundamental analysis is suitable for long-term investments and fundamental trading, while technical analysis is focused on short-term and medium-term trading opportunities.

Components of Fundamental Analysis

Forex fundamental analysis consists of three key elements:

Economic analysis;

Industry analysis;

Company analysis.

Let us study each of these elements in more detail.

Top-down vs. Bottom-up Fundamental Analysis

There are two major approaches to fundamental analysis in Foreign exchange Forex trading:

Let us explore each of the approaches in more detail:

Top-down Fundamental Analysis

As you see from the above figure, the top-down approach starts with analyzing the global economy and the country’s economy. As a rule, you study factors such as Gross Domestic Product (GDP), the monetary policy of central banks, inflation, interest rate, and the correlation of foreign exchange rates.

After you have analyzed the macro economic indicators, you explore the economic sectors of interest and particular industries. Based on the research, you can choose the most promising investment options. At the final stage, you carry out a fundamental analysis of individual companies’ stocks.

Bottom-up approach

As you see from the above figure, the bottom-up approach suggests analyzing data in the opposite order. That is, you first analyze the securities of a company, its financial statements; next comes the industry and economic sector. At the final stage, you explore the macroeconomic factor relative to the selected companies.

Investors employing the bottom up approach usually believe that particular securities could work out better than the industry or an economic sector as a whole. They explore in detail the current and future performance of each selected company to invest in the most promising assets.

Quantitative and Qualitative Fundamental Analysis

The various fundamental factors can be grouped into two categories: quantitative and qualitative.  Quantitative forex fundamental analysis involves researching the securities market based on statistical and financial data, as well as measurable characteristics of a business. Quantitative analysis is often employed in algorithmic trading strategies to manage significant risks and assess the potential return on investment portfolios.

The fundamental qualitative analysis explores less tangible data. They could be political and economic relations between countries, corporate culture, consumer expectations, brand-name recognition, the correlation between different processes and patterns. For example, a trader likes the company’s products, like Apple, or the company’s key executives, like Tesla. 

Key performance indicators

There is no strict algorithm to analyze economic data. I can define particular fundamental indicators, which are key performance indicators or KPI. Some financial performance indicators are:

The ROE indicator;

The P/E ratio;

The Beta coefficient– Beta (β);

Earnings per share (EPS);

Price/Balance ratio – (P/B Ratio);

The PEG ratio;

P/S ratio;

The dividend payout ratio;

The dividend yield.

All these indicators convey the information on some economic processes. By comparing these factors, the investor assesses the performance of the company or the industry. So, the trader reduces the risks of making a losing transaction.

Return on Equity (ROE)

The return on equity is one of the critical elements of forex fundamental analysis. It determines how efficiently the company uses the capital of its shareholders. The ROE is calculated by dividing equity capital by the company’s net profit using the formula:

ROE = Net_Income/Equity * 100%, 

Where:

For example, if the company earned 10 million euros this year, and the equity is 100 million, the return on equity will be:

ROE = 10 000 000/100 000 000 * 100% = 10%.

The indicator is useful when comparing participants in the same industry or the dynamics of ROE changes over several years. It makes no sense to compare companies from different sectors in terms of this indicator. The specifics of the market have a strong influence on the company’s profitability.

Price-to-Earnings Ratio (P/E Ratio)

Investors use the Price-to-earnings (P / E) ratio in forex fundamental analysis to evaluate companies. It determines how much their stock is undervalued or overvalued. To calculate it, you need to divide the current share price by earnings per share. The latter is calculated by dividing the annual profit by the number of securities issued.

P/E ratio is calculated according to the formula:

P/E = Price / EPS, 

Where:

Sometimes, the price to earnings ratio is described in trading as the company’s capitalization. It means the total relative value of all securities divided by the net profit. The information provided by the indicator and total value or the shareholders equity won’t change.

In practice, the P/E ratio is often calculated using the expected net profit. This happens when the company’s analysts project the net profit. In this case, the market will consider the expected profit, and the P/E will be revised.

Beta (β)

A beta coefficient in forex fundamental analysis measures the correlation of an asset to movements in the overall market or industry. It means how the asset price depends on the general market tendencies. For example, a stock could be compared to a benchmark stock index, such as NASDAQ or S&P 500.

Beta coefficient calculation formula: 

Where:

Cov (k, p) – covariance of the return;

k_i – the return of individual stock i;

p – the return of the portfolio.

For you to understand it better, I will present another, more complex formula:

Where:

k ̀ – expected (average) stock return;

p_i – i-portfolio return (a stock index return over period i)

p ̀ – expected (average) portfolio return;

n – the number of observations.

Coefficient values:

More than 1. The stock price correlates (moves in the same direction) with the stock index. The stock is more sensitive (rise or fall faster) to the stock index’s value changes.

The Beta of a stock equals to 1. The stock’s price movements repeat the movement of the index with 100% accuracy.

From 0 to 1. An individual stock correlates with the stock index. The stock price is less sensitive to the stock index.

The Beta is 0. The stock doesn’t correlate with the index. It means the relative value of an individual stock doesn’t depend on the stock index price movements.

From -1 to 0. The stock price has a negative correlation with the stock index. It means the individual stock moves in the opposite direction of a stock index. The equity’s price is less sensitive to the average market moves than the stock index.

Less than – 1. The stock has a negative correlation with the index. The volatility of such equity is higher than that of a stock index.  

Earnings Per Share (EPS)

EPS shows the company’s profitability. It is calculated by dividing the company’s net income by its total number of outstanding shares.

EPS = NetIncome/TCSO, 

Where:

In some types of analysis, to estimate the shares of the companies with complex capital structure, Diluted EPS is used. The difference from the usual EPS is that the net profit is divided by the adjusted number of shares. Securities such as convertible options, warrants, bonds are deducted from the base number of common shares.

Price-to-Book Ratio (P/B Ratio)

Price-to-Book Ratio (P/B Ratio) helps determine if the company’s stock is undervalued compared to its intrinsic value. The P/B ratio compares a company’s market capitalization, or market value, to its book value. Book value is the value of the company’s total assets without total liabilities.

The P/B formula:

P/B = Price/BVR,

where:

P/B shows what property the investor will acquire by investing a notional dollar in the firm. It is close in meaning to book value per share.

Price-Earnings-Growth Ratio (PEG)

PEG is a variation on the previously discussed P/E Ratio. The multiplier is calculated by the formula:

Where:

The multiplier considers the expected future return. It is used to determine the appropriateness of the price that an investor is willing to pay for income growth in the future.

Price-to-sales ratio (P/S)

The P/S ratio measures the volume of sales. It is calculated using the formula:

P/S = Price/Sales_Ratio, 

Where:

The P/S ratio helps to understand how much an investor should pay for each dollar received from sales. The nature of this parameter is similar to the P/E ratio. However, it is thought to be less accurate since it does not take into account operating costs. Nonetheless, the volume of retail sales updates more often and is easier to predict.

Dividend Payout Ratio

The Dividend Payout Ratio is the percentage of earnings paid to shareholders in dividends. 

The common calculation formula looks like this:

DPR = Total_Dividents/Net_Income, 

where:

Using this coefficient, you can determine the company’s dividend policy and indirectly estimate a security yield.

Dividend Yield

The dividend yield, expressed as a percentage, is a financial ratio (dividend/price). The DY shows how much a company pays out in dividends each year relative to its stock price. The reciprocal of the dividend yield is the price/dividend ratio.

The dividend yield is calculated according to the formula:

DY = Dividend/Price of share * 100%

Dividend Yield is a convenient way to measure the cash profit made from every dollar invested. Or, to put it simply, the return on the investment.

Examples of Fundamental Analysis

Let me explain the evaluation of the financial key indicators on the example of Microsoft.

So, over the past year, the value of MSFT stocks has increased significantly despite the pandemic and lockdowns. At the same time, over the past three months, the price has varied within +/- 4%. I would like to know how the Microsoft stock price will change in the future.

I use the free services produced by simplywall.st and see that the P/E ratio, measuring the payback period for MSFT is 34.1 years (blue arrow). It is shorter than the average payback period in the industry, 51.4 years (turquoise arrow). On the one hand, it means that the stock is potentially undervalued. On the other hand, it could suggest possible fundamental problems limiting the demand for the stocks and pressing down the cash flows.

The chart also represents the P/E of the market, but it makes no sense to compare the previous data with these ones. The average market P/E indicates the overall state of overbought of the high tech industry in general, rather than of a particular company. 

The PEG of 3.2 is a low value. It means that the high market price of the Microsoft stock pays back only partially.

The P/B value is 13.1. It is more than six-fold greater than the US market average and 1.5 times more than the industry average. High P/B means that the Microsoft stock is overvalued.

 

The return on equity (ROE) is also high, at 38.5%. The average ROE in the industry is 12.6%.

Having explored the key performance indicators, I can suggest that Microsoft stocks are valued higher than the market. High ROE and steady long-term uptrend mean that investors are optimistic and expect the company’s stock’s future growth. With this regard, the MSFT P/E is lower than the average industrial indicator. 

So, the stock is undervalued compared to the rivals, and its true value could be higher. So, using fundamental analysis valuation, I could recommend buying the Microsoft stocks. 

The Best Research Tools for Fundamental Analysis

It is difficult to carry out the fundamental analysis in Forex market, stock, or futures market if you manually calculate all the indicators. Currency pairs technical analysts use the price chart indicators to predict the price trends of the EURUSD or any other country’s currency pair. Just like currency traders, stock investors can employ screeners to define the most promising assets and profitable investments.

You don’t necessarily need to use the paid service simplywall.st. There are many free stock screeners. I will present the top stock screeners below:

Finviz

The Finviz screener is popular among investors. It has many filters, it is easy to custom, and it has a free version. The service analyzes the performance of thousands of companies from all over the world, including those, which are not famous among Forex traders.

Yahoo! Finance

It is another tool that will be useful in fundamental analysis of the Forex market and the stock market. Yahoo! Finance is the provider of financial information. In addition to the stock screener and fundamental stock analysis.

It provides a lot of useful information about various financial instruments such as forex markets. You will find the country’s currency quotes, securities rankings, financial and economic reports of companies, press releases.

Criticisms of Fundamental Analysis pros and cons. Disadvantages of Fundamental Analysis.

Fundamental analysis in Forex trading helps investors gather financial information essential to understand current market trends and estimate the potential price growth. Fundamental analysis is useful to make long-term forecasts and evaluate the prospects of an asset. Unlike technical analysis, forex fundamental analysis can’t be used to detail optimal entry points to open positions.

The major flaw is the absence of exact facts and figures. Whatever methods of fundamental study you employ, you will have only general assumptions as an output. Technical analysis tools, conversely, often operate with exact numbers.

Conclusion

Considering the pros and cons of fundamental analysis, professional traders often combine several approaches to studying forex markets. Fundamental factors are used to estimate the prospects. Technical indicators serve to define good points to enter and exit trades. A combined technique lowers the risks as it takes into account a more comprehensive range of factors.

Fundamental vs technical analysis FAQ

P.S. Did you like my article? Share it in social networks: it will be the best “thank you” 🙂

Ask me questions and comment below. I’ll be glad to answer your questions and give necessary explanations.

Useful links:

I recommend trying to trade with a reliable broker here. The system allows you to trade by yourself or copy successful traders from all across the globe.Use my promo-code BLOG for getting deposit bonus 50% on LiteFinance platform. Just enter this code in the appropriate field while depositing your trading account.Telegram chat for traders: https://t.me/litefinancebrokerchat. We are sharing the signals and trading experienceTelegram channel with high-quality analytics, Forex reviews, training articles, and other useful things for traders https://t.me/liteforex

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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What is a Swap in Forex and How to Calculate

2022-12-29 2022-12-29
What is a Swap in Forex and How to Calculatelogo

Everyone trading on the exchange must know and understand what a swap is. In my rather long professional career, I have come across many situations where people lost entire deposits simply because they didn’t know how swaps worked.

In other words, if you understand well what swap is and how it works, you can protect yourself from unnecessary losses and even use swaps for additional profit. This concept is as important as leverage.

The article covers the following subjects:

What are swaps and how are they calculated?

Now let’s figure out what fx swap is.

Foreign exchange swap is the difference in the interest rates of the banks issuing the two currencies, which is credited to or charged from the account when the trading position is kept overnight.

The central banks of each country determine the key interest rate. This is the rate at which the central bank lends to other banks. This rate may change throughout the year. But its starting value is determined at the first meeting of the central bank of the year.

On the foreign exchange market currency pairs are traded. Two different currencies are involved in the transaction, and each of them has its own interest rate.

The currency pair contains the base and the quote currency. The former is the currency we buy and the latter is the currency we buy it with.

The base currency is also called the deposit currency. This is our currency and the exchange uses it on a daily basis. Therefore it must pay us a certain percentage for it.

The quote currency is also called the counter currency. It belongs to the bank and we borrow it from the bank. Therefore we pay interest to the bank for the use of its currency, like with a consumer loan.

A negative swap is when you pay it or a positive when it is paid to you.

If there is a negative swap (with a minus sign), its crediting to your trading account will end when you withdraw the funds (points). If the difference in the interest rates gives a positive swap, the money will not be withdrawn from your trading account, but rather a certain number of points will be credited.

Thus, if the client has an open position at the close of the New York trading session, a swap operation with currencies is enforced. This means the position is simultaneously closed and opened for the new day. But on the client’s trading account there is no actual closing and opening. Rather the credited or charged interest is simply displayed.

However, there is a day when this operation is tripled. This is called a triple swap day. For currency pairs on the forex market, this is Wednesday to Thursday night. This is because settlements on the exchange for a position open on Wednesday are made on Friday. Therefore, the calculations for the position carried over from Wednesday to Thursday are done for the next day. And the next business day after Friday is Monday. This adds up to 3 days and the weekend swaps charge triple.

Swap as a trading strategy is different for each instrument. It wouldn’t be convenient to constantly calculate them, so brokers provide special swap tables. My broker has a swap table you can use here.

How to calculate swap in Forex?

In order to understand when we pay swap and when it is paid to us, let’s talk about how is swap rate calculated in Forex trading when buying or selling:

There is a simple formula, as shown above. The most important parameter of this formula is the rates of the central banks, or rather the difference in the interest rates of the base and quote currencies.

For example, let’s compare rates for one currency pair, the EURUSD for example. The ECB rate is now at 0% (loans are effectively free), and the Fed rate is set at 0.25%.

So if we buy a currency pair, we must subtract the quote currency rate from the base currency rate: 0 – 0.25 = -0.25. This means when buying this pair, the difference in rates is negative, and therefore the swap rate will be negative.

But when selling a pair, on the contrary, we need to subtract the base currency from the quote currency: 0.25 – 0 = 0.25. The swap rate will be positive.

This operation only gives us the positive or negative sign of the swap rate (which means either you pay or get paid). If we want to calculate the swap value itself, we need to substitute all the values ​​into the formula.

Today almost no one uses the formula to calculate the swap rate anymore. Traders either look it up in tables or find it using an fx swap calculator.

Every reliable broker has such a calculator on their website. I gave you an example of my broker’s calculator above.

FX Swaps and Cross Currency Swaps

As I said above, there are several types of swaps. Now let’s take a look at the difference between the three main types of swaps.

Forex swap

Fx swap rates are the financial instrument that represents the difference between the paying interest rates of the banks of the two currencies in a pair, which is credited or charged when an open position is carried overnight.

Cross currency swap

A cross currency swap is a foreign exchange transaction that combines the purchase or sale of a currency on a spot basis with the simultaneous sale (or purchase) of the same currency for a specified period on a forward basis. This means the trader performs a combination of two opposite conversion transactions for the same amount, but with different value dates.

This is the official definition. Now let me explain it in simple terms:

A cross swap on Forex trading is a situation that occurs when two companies participating in trades on the foreign market enter into an agreement with each other. Within this agreement, they sell each other the same amount in different currencies based on their current rate immediately after the swap operation itself and not at a higher interest rate compared to the changes of the market. After a predetermined period, which they have set under the forward contract, they sell these amounts back to each other in accordance with their rate under the forward contract.

Currency interest rate swap on Forex

A currency interest rate on the Forex swap is a simple interest rate swap that is carried out with different currencies.

Despite the fact that this operation is typical for large financial institutions, it also occurs in everyday life.

For example, you have a loan in foreign currency. The only option for you is to take out a new loan to cover the old one. But taking a new loan in foreign currency is a bad option as the stakes are high. But in local currency they are acceptable. At the same time, you happen to have a friend overseas with similar problems. So you take out a loan in your local currency, and he takes out one in his local currency, which is foreign for you. And then you simply exchange these amounts. As a result, you pay interest on his loan, and he does on yours. Everyone wins and you both saved on the interest rate without any risk involved.

To help you understand the difference between the different types of currency swaps, I have made a comparison table:

How a Currency Swap Works – FX Swap Examples

Now let’s take a closer look at how foreign exchange swap works.

I have already mentioned this above. At its core, Fx swap rates are the difference in the interest rates of the central banks of the two countries whose currencies are represented in the pair.

Above, I gave you the formula to calculate the base swap rate. The main parameters of this formula are basically unchanged during the year. And for some currencies, even for several years.

The main parameters are the values ​​of interest swap rates. Except for the current year 2020, changes in interest rates are not frequent. This happens once a year at best.

The variable parameters are the markup and the quote of the currency pair. These parameters can change even more often than once a day. Therefore, if we want to know the exact value of the swap, we need to constantly recalculate the value using a formula or a special calculator.

In addition to being positive and negative, swap rates can also be long and short positions open. In other words, a buy swap and a sell swap.

In my broker’s swap table, it looks like this:

These values ​​in the red columns indicate the swap value in points per one full lot, which will be credited to or charged from the trader’s account if you have your positions open. In other words, if we have an open position to sell the AUDUSD pair, when we carry it overnight a swap short is applied to our position, which is equal to -3.216 points. If we have an open position to buy this pair, Swap Long will be applied, and it will be equal to -3.816 points.

The largest swap value is usually associated with exotic currency pairs such as USDRUB.

If you need to know the swap just before opening the position, you can use the contract specification table:

The situation with swap rates will be slightly different for the euro/dollar pair. The buy swap pip value will be -6.036. In other words, an amount equal to this value per lot will be charged from your account. But the sell swap is equal to 0.392 points. A positive sign means that this value will be credited to your account. So you can actually earn money on a swap.

I have already explained why swap rates can be positive and negative. It’s all about the difference in interest swap rates. If the interest rates of the central banks of currencies differ greatly, then the swap sign will be different when buying and selling.

Calculating the swap fees on a short position

Now let’s take a closer look at how the total swap value is calculated on Forex trading for a sell trade in the EURUSD currency pair.

SWAP (short positions) = (Lot * (quote currency rate – base currency rate – markup) / 100) * current quote / number of days in a year.

However, it should be noted that the value will not be entirely accurate since we do not know the exact markup value.

If the positions open at 1 lot with the current quote at 1.19626 and markup at, for example, 0.20%, the swap size will be:

SWAP (short positions) = (100 000 *(0.25 – (0.0 – 0.20)/100) * 1.19626/365 = 0.163 EUR with an incorrect markup value.

If you perform this operation using a calculator on the broker’s website, you get 0.376 USD, so the difference is only in the markup value.

Swap on a long position

Now let’s look at how the total swap value is calculated for a buy when you trade Forex using the EURUSD pair.

SWAP (long positions) = (Lot * (base currency rate – quote currency rate – markup) / 100) * current quote / number of days in a year.

However, it should be noted that the value will not be entirely accurate since we do not know the exact markup value.

If we open a position of 1 lot with the current quote at 1.19626 and markup at, for example, 0.20%, the swap size will be:

SWAP (long positions) = (100,000 * (0.0 – (0.25 + 0.20) / 100) * 1.19626 / 365 = -1.474 EUR with an incorrect markup value.

If you perform this operation using a calculator on the broker’s website, you get -6.036 USD, so the value of the broker’s markup for a short trade is significantly different.

Can I make money from swap in Forex trading?

After traders learn that they can actually earn on swap in Forex trading, they start to look for pairs with positive swap in order to avoid high risk choices such as trading with CFDs. And there are enough of them, but with one caveat. There are no pairs where all swap rates are positive, but there are pairs where the swap is positive depending on the type of operation.

Below, I have listed the pairs with positive Forex swap. Under certain conditions, we can earn on swaps trading these pairs.

At the moment, this is the entire list of instruments with positive forex swaps that my broker provides. However, their number may vary depending on market conditions. For example, if one of the central banks changes its underlying interest rate or your broker changes the markup value.

In general, if you know that a country has a negative net interest rate, this is the sign that positive Forex swap rates may appear in currency pairs containing the currency of this country. However, traders should remember that a small positive swap in Forex trading will be easily eaten up by a spread and can lead to a high risk of losing money rapidly.

But even if such situations are rare, there are some very simple Forex trading strategies to earn on interest and Forex swap rates differences.

Carry Trade

The most popular trading strategy for making money on swap rates is, of course, the carry trade.

The principle of the strategy is to find the largest difference in interest swap rates of different countries. After that, we group the currency pairs that include the currencies of these countries and find a pair where the swap in one direction is greater than in the others.

After a quick look, I have highlighted the CADCHF pair. Forex buy swap on it is 0.528 points. Therefore, if we buy this currency pair, we will be making money on a positive swap. Since the position must be held for a long time to make a profit, we need to analyze the global chart for growth prospects. This particular pair has a growth potential. Now all that remains is to buy and wait, making a profit from the growth of the rate and a positive swap. However, the strategy requires that we keep the position open for quite a long time.

Swap and Fly

There is another strategy that resembles the previous one — Swap and Fly. The strategy appeared after most forex brokers began to provide the trailing stop option.

We choose an instrument similarly to the first strategy. After we’ve found the pair, we need to find a pattern that’s highly likely to be realized. Candlestick patterns are used more often, but geometric patterns will also work. In our case, this is a flag pattern, after which we expect growth. It’s important not to use mathematical indicators.

After that, order levels are placed with standard rules, which makes the ratio approximately 1:1. After the price starts to grow and goes above the entry point, you need to move Stop Loss to breakeven, I.e. at the level that a position opens. And that’s it. Then you just keep the position until the stop loss is triggered. Of course, you can use a trailing stop and also increase your profit by the rate difference. But this is not the essence of the strategy.

The essence of the strategy is to make money on a positive swap. In our case, it is equal to 0.834 points for a buy position. For a 1 lot trade, it’s about 80 cents. If we can maintain the position for a month, when closed by stop loss there will be no exchange rate difference, but the swap will bring us 21 * 0.8 = 16.8 dollars.

Currency futures strategy

There is another good strategy. I sometimes use it myself. The essence of the strategy is to create an ordinary locked position but with different types of contracts. You know that besides currency pairs, there are also futures, options, trading CFDs, and many other contracts. So, futures are essentially no different from a currency pair. Their most important difference is the absence of a swap. Did you already guess what I’m getting at?

Exactly. I create a locked structure by buying a currency pair with a positive buy swap when trading Forex on market and at the same time selling futures for the same pair on another exchange. The currency pair and futures quotes are usually the same, as are the fluctuations. Therefore, wherever the price goes, I will always have 0 because one side is bought and the other is sold.

The profit will be formed from the positive swap when you trade Forex. Of course, there are nuances, such as the size of the spread and the commission. But you can always account for them in the strategy and compensate either by the duration of the position or by a short-term play on price fluctuations and their future performance.

If you want to know more strategies, learn more about trading CFDs for making money on swaps without a higt risk of losing money rapidly, I recommend that you get specialized training from your broker.

What is swap fee in Forex — islamic accounts

Forex brokers also have special swap-free accounts. They are also called Islamic accounts. An Islamic account is a trading account that does not have any swap charge or fees in the form of an interest rate. According to the laws of Islam, Muslims are prohibited from receiving or giving interest on any kind of activity. So Islamic accounts were created in order for Muslims to be able to use the services of the Forex brokers.

Despite the fact that this type of account was created for Muslims, anyone can open it now. In order to open an Islamic account for yourself, you need to submit an application to your broker.

However, we all understand that brokers are not charity organizations. And if the account is swap-free, the broker will get their money in other ways. Usually this means larger spreads or a fixed commission per trade.

Conclusion

The topic of swap is quite important on the exchange. Many large investors make money not on the difference in exchange rates, but rather on the difference in net interest rates. When you trade Forex in the financial markets, most traders view forex swaps as another type of commission that brokers use to get rich. But if you understand how swap works, you can turn it from an enemy into a reliable ally that will bring you profit regardless of exchange rate fluctuations. Thus, using swap trading first on a demo account with a nominal position will help you understand how this efficient tool works with no need to risk money on complex instruments like trading cfds, or even avoid the high swap charges.

Price chart of EURUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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Best Forex Trading Strategies in 2022 – 2023

2022-12-27 2022-12-27
Best Forex Trading Strategies in 2022 – 2023logo

Are you about to take your first steps in trading but haven’t chosen a strategy yet? Do you want to learn about different types of Forex trading systems for beginners and professionals? This review will look at different types of systems to base your own trading strategy on. Each block discusses the essence of the strategy with an example, entry / exit points and the risk level.

The article covers the following subjects:

What is Trading Strategy in Forex

A trading strategy on the Forex market is an algorithm that allows you to achieve your goal as quickly as possible with an optimal level of risk. The goal is usually to obtain a certain percentage of profit.

The trading system answers the following questions:

What is the goal and how quickly should it be achieved? Based on this, the type of strategy is selected in accordance with the timing, frequency of signals and the risk level.

What are the main trading assets? What is their volatility level?

Which timeframe is selected for analysis, and which one is used for trading?

What tools are used to search for a signal? Is fundamental, technical or graphical analysis used? Which instruments give the main signal, which ones provide an additional one?

What combination of signals constitutes a сue to place a market or pending order, and to exit the Forex market?

What are the risk management rules? How is the volume of the first trade calculated, as well as the volume of subsequent trades in case of profit or loss? How are the stop loss and take profit level calculated? What is the maximum allowable total loss?

What is the algorithm in case of unforeseen situations?

Having a trading plan allows you to quickly respond to any changes. The absence of a strategy equals chaotic actions and wasted time.

How Trading Strategies actually work

How Forex trading strategies work:

You have a strategy, which means you know which actions need to be taken in each case in order to maximize profit or minimize potential loss.

When you have a plan, you understand the end goal. You break it down into several stages and check the efficiency of the strategy at each stage. If you notice that the plan is not working out, rebuild the trading system.

A systematic approach gives you confidence in your actions. If you have a working strategy, you can turn it into an automatic trading system by ordering a trading advisor.

Having a trading strategy also has an emotional aspect. When you have a plan, you clearly follow it without succumbing to emotions. For example, the price went the other way after you opened the trade, but your plan provides for an acceptable loss. So you don’t have to close the trade in a panic. No waiting until the last minute in the hope that the price will turn around – you will just calmly follow your strategy.

Basic Forex Trading Strategies for Beginners

Forex trading strategies for beginners are trading systems that have the following characteristics:

Few indicators. The chart should not be oversaturated so it’s not confusing to the trader.

Large timeframes. Timeframes from H1 are easier to navigate as you have more time for analysis.

Minimal risk. Rare signals with relatively small profits, but a high percentage of triggering.

Accurate interpretation of signals.

All the profitable strategies described below are basic versions. They need to be finalized and indicator parameters need to be adjusted for a specific asset and timeframe.

Positional Trading

Positional trading is a long-term strategy. It is based on the wave theory, according to which the market develops in a cyclical fashion: any growth is followed by a recession. A trader makes a long-term position, taking as much profit as possible from a single wave of price growth or decline, while ignoring local countertrend corrections. The position is closed when the price reverses or goes flat.

Strategy description

Cryptocurrencies and stock assets are best suited for position trading. Currency pairs move in a narrow corridor, while cryptocurrencies and stock assets do not have a growth ceiling and have protracted trends. Timeframes: from H4 and above.

Risk level

Medium. The main risk is stop out. On long timeframes, the cost of a pip is much higher than on minute intervals. Therefore, even a small correction can cost you. The trader must have sufficient margin to sustain the drawdown.

Reward ratio

Profitability of long-term investment – 15-50% per annum.

Length of trade

Long term trading. Trades are kept in the market from several days to several weeks or months.

Entry/exit point

The two best scenarios for entering the market are opening a trade at the moment the market exits a flat or on a fundamental driver. For example, after the release of quarterly or annual reports. Good indicators for determining the trend are the Alligator, ADX, moving averages. Exit the market according to the situation.

Example

Long-term positional trading in shares. Before opening a trade, you need to analyze statistics for individual industries. Explosive growth is recorded in biotech companies, but there is a big risk of falling prices. Technology stocks are doing well, but they have deep drawdowns during general market decline. Retail and consumer stocks are the best option for positional trading.

The screenshot above shows the long-term trend in the price of Coca-Cola shares. After exiting the flat corridor, the share price went up. The duration of local corrections is 1 month. The trade is closed at the moment of consolidation near the trend line and at the moment when it turns from support into resistance. Profitability in 9 months – 12 USD per share or 23% per annum.

Pros and cons

The advantage of positional trading is that in the long term, strong movements are longer and more stable. Market makers do not have enough capital to manipulate the market. After catching a trend at the exit from a flat or on a fundamental factor, you can keep a position in the market with little or no monitoring. On the daily interval, it is enough to check the chart for 5-7 minutes every few hours. Disadvantages: rare signals, lower returns compared to intraday swing systems.

Trend Breakdown Strategy

Breakdown trading is a simple Forex strategy, in which the main signal is a breakdown of a trendline. A bullish trendline is drawn using the lows, while a bearish trendline is drawn using the highs. A breakdown confirmed by patterns and news is a sign of a change in the main direction of price movement.

Strategy description

The strategy is based on the idea of wave market development. Any long-term trend ends with a consolidation or a change in direction. If the price breaks the trend line and bounces back from it after a slight consolidation, there is a trend reversal. This is a medium-term strategy, the best timeframe is H1-H4.

Risk level

Below medium. There is a risk of a false breakout, so it is important to track additional signals.

Reward ratio

Depends on the duration of the trend. On the hourly interval, the yield in 1-2 days can be 100-150 points. Protracted trends can generate an income of 300-400 points.

Length of trade

Signals are relatively rare – on an hourly interval, a signal can appear once in 1-2 weeks. The length of trade is from 12-15 hours to several days, so you need to take into account the fact that single and triple swaps will be charged.

Entry/exit point

The next candle in the new trend direction after the candle that breaks the trend. The presence of consolidation near the trend line indicates that a temporary equilibrium has been established on the Fx market. For example, in an uptrend, buyers are not ready to buy the asset that has risen in price. The majority see that the trend has stopped and start selling the asset at the high, so the price begins to fall. Confirmation signals: formation of reversal patterns, breakdown of key resistance/support levels.

Example

The objective is to build a trend line and wait for its breakdown after getting confirmation from other instruments. Here it is important to distinguish a false corrective breakout from a change in the trend direction.

A strong downtrend is visible on the hourly interval of the AUD/USD pair, which allows us to draw a trend line. The line is drawn based on the high extremes in order to reduce the likelihood of a false breakout (if a breakout occurs, the trend line moves). The screenshot shows that the line is built using the first and fourth highs.

At the end of a trend, volatility increases and the price goes into a temporary correction. We can see the formation of the triangle pattern, the initial range decreases. The sides of the triangle are only occasionally broken down by shadows, which indicates the weakness of sellers – this is a preliminary signal. A relatively clear horizontal resistance level is also present.

The price breaks the upper side of the triangle, then the trend line. As soon as the price breaks through the resistance level (triple confirmation), we open a trade on the next candle. We close the trade after the appearance of two reversal candles in a row (forming the Three Black Crows pattern). Profit with minimal risk is 70 points.

Pros and cons

Suitable for beginner traders who have basic pattern trading skills and know how to build trend lines correctly. Its advantage is that there is time for analysis on long timeframes, a late entry after a trend breakout is not a mistake. The disadvantage is that the new trend may turn out to be a deep correction, so it is advisable to check the chart at least once an hour.

Swing Trading

Swing trading is a Forex trading strategy that involves earning on rollbacks. It is based on the idea that local corrections can be applied to maximize profits. This method of trading is focused on the use of rollback moments (corrective movements) that occur during the formation of a trend.

Strategy description

One of the trading options for this system is to open a trade at the end of the correction and close it at the start of a new correction. The optimal timeframe is from H1-H4. On short intervals, the trend is less stable, so it is less often used in swing trading.

Risk level

Medium. If a strong trend is found, the risk of loss is relatively small, you need to close positions in time at the beginning of a rollback. But the trend is not always stable, the signal construed as the resumption of the trend may turn out to be false, and the correction will continue.

Reward ratio

Depending on the type of swing trading strategy and time frame. On the hourly interval, when trading along the trend, the profitability per trade is 80-100 points.

Length of trade

Swing trading can be used both in intraday strategies and in long-term ones, depending on the chosen timeframe. On the H1 interval, you can catch corrective movements with a depth of 5-7 candles and earn intraday. On intervals from H4, swing trading turns into a long-term trading strategy with trade length of several days.

Entry/exit point

There is an uptrend in the markets, in which downward corrections appear. A trader can use them in the following ways:

Open a trade at the end of the correction in the direction of the trend. For example, you missed the beginning of the trend and you need to find an entry point at the best price.

Open a trade at the bottom of the correction in the direction of the trend, close at the extremum. Wait for the next correction, open a trade again at the bottom of the correction.

Increase the volume of the position at the end of each correction.

Alternate reversing the trade in the direction of the trend and in the direction of correction.

Closing the trade: 50% at the level of the beginning of the correction (return to the last extremum), the remaining 50% – by trailing stop.

Indicators: trend tools with confirming oscillators to find the trend. Reversal patterns, resistance and support levels, Fibonacci levels.

Example

The objective is to find a trend on an hourly interval. In the chart below, there is a horizontal resistance level after a downtrend.

1 – After the breakdown of the resistance and a rebound from it, a series of growing candles appears. This is the beginning of a trend, open a long position.

2 – The first strong reversal – three candles down in a row – close the trade.

3 – The price reverses up, allowing you to draw a trend line. Open a long position.

4 – Three candles down – close the trade.

5 – Rebound from the trend line and a few candles up – open a long position.

6 – Three candles down – close the trade. Despite the fact that there was no correction, it is better not to take risks – wait for the next rollback.

7 – The price does not reach the trend line, but there is a reversal pattern – you can risk opening a trade (weak signal).

8 – Three candles down – close the trade.

The profitability of each trade is 80-100 points, but you need to take swap into account.

Pros and cons

Forex strategy advantages:

More profitability. Unlike the trend strategy, a trader earns more in swing trading. For example, a trend trader earns 100 pips upon closing a trade. A swing trader makes 50 pips on the trend and closes the trade at the start of the correction. The price rolls back 15 pips, the swing trader opens the trade again. Their income is 50 + 65 = 115 points.

Less risk. A position trader waits out the correction and protects the trade with a stop order. If the stop loss is triggered, the loss is equal to the depth of correction. A swing trader closes the trade at the start of the correction. And if the rollback turns into a new trend, the swing trader loses nothing.

The disadvantage of the strategy is that you need to constantly monitor the chart and be able to find the beginning and end of the correction well. Corrections are not always ideal in form and can turn into a flat.

Trend Trading

Trend trading involves opening a trade at the beginning of a trend movement and closing it at the reversal. The trader’s objective is to find the beginning of the trend and avoid mistaking the correction for a reversal and closing the position too soon.

Strategy description

One of the best strategies for trading on the Forex market is to open a position when the price exits a flat or during a trend reversal. Timeframe – from H1. The strategy is well suited for both intraday trading on the foreign exchange market and positional trading on the stock markets.

Risk level

Below medium. The main risk is the late opening of the position. Novice traders can miss the start of the trend and enter the market when it has mostly exhausted itself. If you regularly monitor the chart, set stop loss and take profit, the risk is minimal.

Reward ratio

Depends on the chosen timeframe and risk appetite. On the hourly interval, you can find a trend longer than 24-48 hours. With a daily asset volatility of 80-100 points, you can find a trend with a length of 50 points or more.

Length of trade

Depending on the timeframe. On the interval H4 and above, the strategy turns becomes a medium-term one. Monitor the chart regularly in order to search for a trend reversal.

Entry/exit point

Entry:

Trend with signs of its upcoming ending: the candlesticks become smaller, there is a transition to a flat. The appearance of a reversal pattern and the breakdown of the trend line in the opposite direction is a signal to open a trade.

The moment of the price exiting the flat is signalled by the breakdown of its borders and the appearance of candlesticks with consistently growing bodies.

Get signals from trend indicators and oscillators: Alligator, moving averages, Momentum.

Exit the market in parts. After the price moves in the predicted direction, move stop loss to the breakeven level. Close 50% of the trade when the price passes the predetermined number of points. For example, you are 99% sure that the price will definitely not reverse before it moves by 20 pips – this will be the first target. Insure the remaining 50% of the trade by a 10-15 pips trailing stop, depending on the depth of the average correction.

Example

We open a position based on the signals of the Alligator indicator.

The signal is the divergence of moving averages. In two cases, the signals turned out to be correct, however in the third case, the signal shows the beginning of a long upward movement, but the entry point has not been determined, since the divergence of the moving averages begins on a rollback. Therefore, it is better to filter the indicator signals with additional tools.

Pros and cons

The advantage is that it’s a good strategy for beginners. On long timeframes, the trend is relatively stable, the investor has time to assess the situation, there is no need to constantly monitor the chart. After 50% of the trade has been closed, you don’t have to monitor the chart anymore. It is also possible to earn on individual small trend movements, as shown in the example above. The disadvantage is relatively rare signals. On the Forex market, strong trends appear infrequently, especially on large intervals.

Range Trading

Range trading includes flat trading and channel trading strategies on the Forex market. They are based on the following idea: mostly the price moves in a fixed corridor with a median, which can be represented by a moving average. The price tends to its average value. The further the price moves away from its average value, the more likely it is to reverse.

Strategy description

This strategy has two trading options:

Breakdown trading: the channel is built based on the points where the price reverses most often. If the border is broken down, a trade should be opened in the direction of the breakdown.

Channel trading: the channel is built based on extremums – the points that the price reached and did not break through. A trade should be opened when the price reverses at the border to the middle of the channel.

Risk level

Medium. There is risk of a false breakdown of the channel, as well as the risk of the price continuing to move towards the breakdown of the channel after a trade has been opened.

Reward ratio

Depending on the timeframe. Within a day, the price can give 1-2 signals of 20-30 points each.

Length of trade

The strategy works on intervals from M30 for intraday, medium and long-term strategies. It is not suitable for scalping, since the price has a high impulse movement on minute intervals, which violates the logic of averaging.

Entry/exit point

Options:

High risk. Open a trade after the price exits the channel. Breakdown indicates a strong inertial movement. Close the trade at the slightest signal of a reversal.

Moderate risk. Open a trade after the border of the channel has been broken and the price reverses towards its middle. Close when the price reaches the median line of the channel.

Main technical tools:

Levels, trend lines that define the boundaries of inclined or horizontal channels.

Channel patterns: rectangle, rails, flag, etc.

Channel indicators: Bollinger Bands, Envelopes, Keltner Channel, Darvas Box.

Reversal indicators: Pivot points, heat map.

Overbought and oversold oscillators: Stochastic, MACD, RSI, CCI.

Example

The main indicator is the Keltner Channel with an expansion multiplier of 2. This multiplier value expands the channel, allowing you to find points that the price reaches relatively rarely, and therefore a reversal to them is most likely. The confirming tool is the RSI oscillator.

The signal is the price going beyond the channel and reversing. At this or the next candle, the RSI should touch the 70 or 30 level. If it doesn’t, don’t open the position. Close 50% of the position volume upon the price reaching the middle line of the channel. The other 50% should be insured by a trailing stop 10-15 points long (for the H1 timeframe).

1 – three strong candles from the middle of the channel indicate a strong impulse movement. Then the movement ends, and a reversal occurs. The RSI touches the 70 mark. Profitability is about 40 points.

2 – the price leaves the channel, reverses and returns to it. There are no reversal patterns, so the signal can be described as weak, but it is confirmed by the RSI. Profitability is about 30 points.

3 – the situation is similar to the previous one. Profitability is about 15 points.

4 – the situation is similar to the previous ones, but the signal turned out to be false.

Pay attention to reversal patterns outside the channels. If there are none, the signal is weak.

By changing the multiplier of the indicator, you can change the entering mechanics. For example, with a multiplier of “1”, you can open trades on the breakdown of the channel.

Pros and cons

This is a clear Forex trading strategy suitable for beginner traders. Disadvantage: it takes a long time to adjust the settings of the channel indicators that determine the channel width.

Day Trading

Day trading means opening and closing a position within a trading session to save on swap. You can carry the position overnight if you are confident in the strong trend and the ability to regularly monitor the chart.

Strategy description

Day trading is a strategy defined by the duration of the position in the market. For example, intraday trading includes scalping, swing trading, and trend strategies. The suitable timeframes are М5-Н1.

Risk level

Depends on the type of intraday trading chosen. Scalping has high risk, swing trading has medium risk, and trend strategies have below medium risk.

Reward ratio

In scalping, profitability per day can reach 100 points or more. The profitability of a trend trading strategy with an asset volatility of 70-100 points is 30-50 points.

Length of trade

Day trading refers to short-term strategies with the option of transitioning to medium term.

Entry/exit point

There are no clear rules. Scalping can use oscillators and patterns. Entry/exit points are at price reversal. In trend trading, use trend indicators that show the exit from a flat or a change in trend, as well as levels. Entry/exit points are breakdowns of key levels, signals from moving averages, etc.

Example

One of the options for intraday trading is to look for a strong signal for a trend reversal or exit from a flat, confirmed by graphic or fundamental analysis. You earn on the movement of 5-8 candles.

On the hourly interval of the EUR/USD currency pair, we can see a long uptrend, which should end sooner or later. We draw a trend line according to its corrections. At the top of the trend, a horizontal corridor with two tops forms. At 14:00, a small red candle appears, which means that the price cannot break through the resistance level. There is a balance of buyers and sellers, showing that the buyers are exhausted.

At 15.00 there is a strong candle down. It breaks the uptrend trend line – this is a preliminary signal. Then the price breaks the support level – this is a signal to open a short position. The big downward candlestick is also confirmed by a fundamental factor – the statistics on inflation in the US for August was announced, which coincided with the forecasts and remained at a high level (more than 8%). This means that the Fed will soon raise the discount rate, thus strengthening the USD.

We close the trade either before the time for the swap to be charged, or after the appearance of two consecutive reversal candles after the downtrend slows down. Profit with minimal risk with this Forex strategy was about 25 points.

Pros and cons

The advantage is that it’s suitable for any trading style from scalping to trading with the trend, against the trend or based on fundamental analysis. Also it saves on swap. The disadvantage is the constant need for monitoring the chart.

Retracement Trading

This strategy is a variant of swing trading, but it is built on a unique group of indicators – Fibonacci tools. There are corrections in any trend, and their depth often corresponds to the Golden Section ratios. There are correction levels that are more and less significant, and a breakdown of distant correction levels means a change in the direction of the trend. Also, Fibo correction levels are used to set stop loss and take profit.

Strategy description

After the start of the first correction, a Fibonacci grid is built beginning at the extremum and ending at the beginning of the trend. The level of 23.6% is the first, weak level. 38.2% is the level of the most likely end of the correction. If the price reverses in the direction of the trend, a trade with a take profit at the “0” point should be opened. If the price draws a new extremum, “0” is moved to its level.

Risk level

Medium. The level building method is mathematical, so there is always a chance that the price will reverse between the levels or will not reach the take profit.

Reward ratio

Depends on the timeframe. The distance between correction levels on the H1 timeframe can be 15-35 points.

Length of trade

The strategy is suitable for intraday medium and long-term trading.

Entry/exit point

The entry point is a price rebound from the correction level in the direction of the trend. Take profit should be set at the next level in the trend or point “0”. Stop loss is the next level in the direction of correction. Additional indicators are patterns and oscillators that confirm the reversal.

Example

After the first correction, a Fibo grid is built (blue lines are the extremums for its building).

Correction is determined by the number of candles going against the trend. In the first case, there is no correction, since the level of 0.38 was only tested by a shadow, and subsequent movements near the level 0.23 consist of small candles. In the second situation, there is clear touching of the 0.5 level and an ascending Engulfing pattern – you can open a long position. The fact of the second touching of the level 0.5 is the confirmation of the signal. At level 0, we close 50% of the trade, and insure the remaining 50% with a trailing stop with the length equal to the distance between 0.23 and 0.

As the trend grows, we stretch the Fibo grid.

Note that the price moves between the 0.23 and 0.38 levels for some time. Then it goes to the level of 0.5, from which it rebounds upwards. Trades can be opened at any rebound from the levels of 0.23 and 0.38.

Pros and cons

The maths of this strategy is supported by opposite psychology. Most traders are sure that Fibo levels work, so they are guided by them when placing pending orders. Orders work, so the Fibo method also works. Therefore, the advantage is the understandable logic of the tool. The disadvantage is that you need to develop intuition in order to learn how to intuit the most powerful levels.

The Bladerunner Trade

This strategy is built on the basis of the moving average, which suggests the moment of the beginning of a trend movement. The system is great for beginners, as it provides a clear interpretation of the signals. The best timeframes are M30-H1. Strategy tools: EMA (20), levels, and breakout patterns.

Strategy description

The concept of the strategy is based on 4 main events:

The exit from the consolidation zone is signalled by the breakdown of the border of the side channel by the price.

Breakdown pattern. For example, 3 candles in the direction of the breakdown.

Breakdown of the moving average. After the breakdown of the consolidation zone, the candle should close above/below the moving average. The rest of the candles should also close above/below the EMA (20).

Testing. The price returns to the moving average, touches it, rebounds and goes in the direction of the trend.

The moment of EMA testing confirms the beginning of a strong trend.

Risk level

Relatively low. The strategy uses a combination of several instruments that confirm the exit from the flat and the beginning of the trend. Signals are rare but effective.

Reward ratio

From 30-50 points and above – the trade closes by trailing stop.

Length of trade

The objective is to make the most out of the trend. On M30-H1 timeframes, with relatively rare but accurate signals, you can close a trade intraday and save on swap.

Entry/exit point

Open a trade after the price has tested the moving average and a movement has started in the direction of the trend. Closing is at the discretion of the trader.

Example

The price is in a sideways movement with a clear resistance level but blurred support levels. The first (red) support level has a false breakout – there is no testing of the EMA, the price breaks through it upward.

At the next breakdown, the first three conditions of the system are met:

The price is below the EMA.

There is an exit outside the horizontal corridor at point 1.

There is a formed trend pattern at point 2 – three consecutive descending candles with a consistently increasing body.

At point 3, the price almost touched the EMA – this is the 4th, confirming signal. We can open a short position at the first blue arrow. Point 4 is the final confirmation that the price is now confidently touching the EMA, the touch point coincides with the traced support level, which has now turned into resistance. The second blue arrow points to a candle, after which you can open a short trade with confidence.

Options for closing the position:

On the H1 interval, we close 50% of the trade after making a profit of 30-50 points, and insure the rest with a trailing stop of 15-20 points.

When the next side corridor appears.

When the price line crosses the EMA from the bottom up.

Pros and cons

The advantage of the strategy is in the clear logic of the signal. The breakdown of the consolidation zone with a trend pattern confirmed by the moving average is a strong signal. On the other hand, the Forex market is never unambiguous. Therefore, relying only on the EMA (20) without experimenting with other periods and without adding other indicators is dangerous. Therefore, I recommend using the idea of this strategy but adjusting it for the selected asset and timeframe.

The Pop ‘n’ Stop Trade

This is a classic tactic for opening trades at the end of a sideways movement with the appearance of a clear uptrend or downtrend. The price moves in a narrow sideways corridor for some time, after which it breaks through the resistance or support level, thus indicating the beginning of a trend.

Strategy description

A flat means the market is in a state of uncertainty. It can appear in a trend movement as a temporary respite with consequent continuation of the trend, for example, before the weekend or news release. Alternatively, it means that the trend has run out of steam and the other side will now take revenge. A breakout of the channel borders means the beginning of a trend, which is where a position should be opened. The strategy is suitable for beginners provided conservative risk management on timeframes from H1.

Risk level

Medium for the following reasons:

The breakdown of the flat channel may be false. To confirm the signal, you can use the attempt of the price to return to the channel (breakout of the channel border, return to it and a rebound from it in the direction of the breakdown), trend indicators and oscillators.

A flat corridor rarely has parallel boundaries and clear extrema for drawing. An error in choosing an extremum for drawing resistance/support levels can result in opening the trade too early or too late.

Reward ratio

With a strong trend, you can earn more than 50-70 points. But it is better to close a part of the trade after reaching a profit of 20-25 points.

Length of trade

From several hours to several days. The trend movement lasts at least 8-10 candles. You can close the trade early before the swap is charged, or try to squeeze the most out of the trend by insuring the trade with a trailing stop.

Entry/exit point

Preliminary chart: there is a sideways movement and significant resistance/support levels can be drawn. Shallow breakdowns of levels by shadows are allowed. Preliminary signal: the price breaks down the level and closes beyond it. The body of the candle is relatively large. The second candle continues the breakout and has the same body as the breakout candle. Open a position on the third candle.

To reduce risk, you can wait for a local correction and a price reversal in the direction of the trend (late entry). You can increase risk and open a trade on the next candle after the breakout (second candle). Early entry, but more profit. Closing the trade: 50% – after 30-40 points for the hourly timeframe, the other 50% should be insured with a trailing stop 15-20 points long or a little more than the depth of the average trend correction.

Example

First we need to find a flat section.

After a relatively small downward movement, the price turned into a sideways movement with high volatility. The support level can be drawn using the three points indicated by the arrows. The resistance level is less pronounced, but the chart shows that it is drawn correctly – after the levels were drawn, the price tested both boundaries of the channel several more times.

Signal for trend movement:

The price touches the resistance, bounces off it, moves along it for a while. Sideways candles have small bodies, which indicates small trading volumes and a temporary lull.

Price breaks through resistance. The breakdown candle has a large body and closes almost completely outside the level. Here you can open a trade. But the example of a false breakdown in the middle of a flat section shows that even two growing candles in a row do not guarantee a trend.

The third candle after the breakdown is an upward one. The price is above the EMA (9), which is a confirming signal. You can open a long position.

Please note that after the position was opened, two red candles with long downward shadows appeared. If the stop loss is short, the trade could close early with a loss.

Pros and cons

The advantage is the clear logic of the strategy and behavior of traders. The disadvantage is false breakouts and a trend reversal almost immediately after it starts. Building levels is quite complicated. This is clear in the local breakouts in the chart above.

Advanced Forex Trading Strategies for Pros

This section discusses Forex strategies for traders who are familiar with the basics of technical and fundamental analysis and also looking for options to grow their profit. These systems have a few common characteristics:

Increased risk level. However, more frequent signals allow you to increase the average monthly profitability of the strategy.

More complex combinations of instruments that require attention and quick response.

Less unambiguous interpretations of signals, providing flexibility to the trading system. Entering the market based on less clear signals is at the discretion of the trader, but this approach allows you to open trade “ahead of the curve” and increase profits.

Before launching a trading system, be sure to run it through a strategy tester.

News Trading

This group of trading systems is based on fundamental analysis. The release of statistical data can dramatically affect the opinion of investors. For example, the publication of positive financial statements that fully meet the expectations of traders leads to an increase in the value of the company’s shares.

Strategy description

The main tool is the economic calendar that contains the schedule of releases of financial statements. If the statistics turn out to be better than the forecast, the price of the asset rises, and if they are worse than expected, it falls, even if the statistics are positive. A few minutes before the news release, pending orders are placed in both directions. The trade is closed after the end of the movement at the first signal for a reversal.

Risk level

The strategy is considered high-risk for several reasons:

It is not always possible to accurately predict the reaction of the majority. Before choosing the direction of movement, the price may pass several candles in both directions, triggering stop losses or false pending orders.

Due to high volatility, the spread increases sharply and slippage occurs. The reason is the change in the ratio of buy or sell orders.

The trader must have access to information in real time. Many portals publish statistics with a delay of 10-15 minutes.

Novice traders are advised to stop trading 30 minutes before the release of news and not resume it for 30 minutes after the release of statistics.

Reward ratio

Depending on the depth of movement and its duration. On average, the yield can be 30-50-80 points in 1-4 hours.

Length of trade

News related to economic statistics has a short-term impact on the market. Increased volatility is observed in the first few hours – this is 3-5 candles on the H1 interval. Occasionally, news can set a long-term downtrend. Example: a negative forecast for global GDP during the pandemic led to a long-term drop in the US stock indices.

Entry/exit point

The main tool is any online source of reliable information. Indicators play a secondary role, as the news can easily reverse the price against the trend.

Example

Let’s look at Non-Farm Payrolls. The US Employment Report is published every first Friday of the month. If the actual figure is very different from the forecast, the USD/EUR rate goes up or down.

1. First let’s analyze the economic calendar:

According to the report on July 8, the increase in the number of jobs amounted to 372K, after which this figure was revised upward to 398K. Analysts predicted a decline in growth rates from 398K to 250K. But the actual figure turned out to be 528K. This means that the pessimistic forecast of analysts did not come true – the US economy showed growth.

2. 5 minutes before the publication of the report on August 5 (at 15.25 Moscow time), we set pending buy/sell stop orders on the M5 timeframe at a distance of 5-7 points in 4-digit quotes. Based on the fact that if there is a strong discrepancy between the forecast and the actual figure, one of the pending orders will work.

Positive statistics immediately leads to a strengthening of the dollar, which means a fall in the EUR/USD rate – a Sell Stop order is triggered. We close the trade when the first reversal candle appears or when a reversal pattern appears (in this case, a pin bar). Profit – about 70 points in 40 minutes.

Pros and cons

Advantage – you don’t have to use technical analysis, which can be complicated for beginners. The disadvantage is that you need to be aware of the news all the time and understand which news can have the strongest impact.

Scalp Trading (Scalping)

Scalping is a high-frequency trading strategy that involves opening trades with a profitability of several points. Assets with high volatility and liquidity are best suited for scalping. The trader’s objective is to make the most of the short-term price movement, closing or reversing the position at the first signal. Therefore, the best account type for scalping is ECN, where spreads are close to zero and there is no slippage due to high liquidity.

Strategy description

The most popular timeframes for scalping are M5-M15, less often M1. Trades are kept in the market for 15-30 minutes, rarely up to several hours. If there is a clear trend, scalping can smoothly turn into intraday trading. During the day, scalpers open several dozen trades, simultaneously monitoring the charts of several assets that have a clear direct or inverse correlation.

Risk level

High. The main risk of loss is due to the complexity of forecasting. There are no stable trends on short-term intervals. The price can reverse at any moment under the pressure of market makers who collect stop orders of ordinary traders. On short intervals, high-frequency trading (HFT) robots are often used, which brings chaos into the trend with the volumes of placed and deleted orders.

Reward ratio

On average, profitability per trade is 3-5 points, taking into account the spread. The scalper’s income can be more than 100 points of net profit, taking into account losing trades.

Length of trade

Scalping is a type of short-term trading.

Entry/exit point

The type of indicators used depends on the scalping strategy. For example, for a rebound from key levels one would use a trend line or a resistance/support line. The second option is trading within the channel. Here the main indicator is a channel indicator. The trade is opened at the moment when the price starts to turn outside the channel towards the median value (middle of the channel). The trade is closed after making a profit of several points or when a reversal signal appears.

Example

Scalping works best during moments of fundamental volatility or in areas of consolidation. In a trend movement, scalping turns into swing trading. Therefore, the scalper’s objective is to find the moment when the range of the price movement increases sharply.

The screenshot shows that there are nine fairly strong short-term movements (red lines) and three false unprofitable ones (blue lines) in the 7-hour time frame. Profitable movements have engulfing and pin bar patterns. Assuming the scalper takes advantage of 50% of a given movement minus the spread, each trade would yield 7-10 points.

Pros and cons

The advantage of the strategy is that it allows earning on any assets, any timeframes and in any situation, including a flat. Scalping can always be turned into any other type of strategy. The disadvantage is a high load on the eyes and nervous system. The spread plays a major role, as it takes most of the profit. Therefore, a trader should try to open as many profitable trades as possible, monitoring the market every minute.

Carry trading

Carry trade is a system for generating income on the difference in the rates of Central banks. Each broker has a swap – a commission that is charged or deducted if the trade is not closed within the trading day. If the swap is positive in the direction in which the position was opened, every day the trader will receive a small income.

Strategy description

It involves opening long-term trades on timeframes from H4 and higher for currency pairs exclusively in the direction of price movement with a positive swap. The strategy is often used as a supplement to long-term trend systems.

Risk level

Low. The strategy has two main risks – the price will go in the opposite direction to the forecast or the Central Bank of one of the countries will change the discount rate. In the first case, it is enough to move the stop loss to the breakeven level + spread. The trade will close at zero, but you will earn on the swap. In the second case, the risk is reduced to zero by constantly monitoring discount rates.

Reward ratio

It depends on the amount of the swap and on the length of trade in the market. With a minimum position size of 0.01 lots without leverage in 4-digit quotes, the yield will be about 35-50 USD in 1 year.

Length of trade

Carry trade is a long-term strategy. The longer the trade is held in the market, the larger the income. Swap is calculated daily.

Entry/exit point

The main signal is a positive swap. Any trend indicators will suffice as a tool. They are only needed to determine the direction of the trend and its strength. After moving the stop loss to the breakeven level, you don’t need to monitor the indicators.

Example

1. Let’s find a currency pair with a positive swap. It is better to start the search with the exotic pair – they have protracted trends with slippage. Cross rates often have positive swaps. You can find swap information in the specification.

2. Now we need to analyze the long-term trend. If there are prerequisites for a descending movement, we open a short position.

Pros and cons

The strategy only works if there is a strong trend movement, otherwise the trade will close by stop loss before the trading session ends and the swap is charged. 

Advantage: almost complete absence of risk and additional earnings on the trend movement, provided that the stop order moves with the price.

Disadvantages: the number of assets that have a positive swap and a long-term trend movement is very small. The second disadvantage is that the amount of swap charged is so small that in order to get tangible earnings, the deposit must be several thousand US dollars, even with leverage. Otherwise, it makes no sense to freeze your money when there are more profitable financial instruments.

Grid Trading

Grid strategy involves placing pending orders above and below the current price in the expectation that with any movement, one of the orders will work. Trend strategy: an order to buy is placed above the price, an order to sell – below the price. Countertrend strategy: a sell order is placed above the price, a buy order is placed below the price.

Strategy description

A grid of orders placed at fixed levels is used in markets with high volatility. It works in a flat market with a large range of price movement.

Risk level

High. The trader is required not only to correctly predict the required distance of pending orders, but also the further price movement. In a volatile market, the price may trigger a short pending order and move in the other direction. On the other hand, the price may not reach a long pending order. Expert Advisors solve this issue by setting a grid of pending orders, several on both sides. To compensate for the loss, the Martingale coefficient is used to increase the lot.

Reward ratio

When placing a grid of orders on a short timeframe, you only get a few points of profit. Therefore, this trading option is automated. When trading based on the fundamental analysis of the market, the profitability can be 30-50 points. With profitable trend strategies, where false breakouts are filtered using pending orders, profitability can be 100 points or more.

Length of trade

Depends on the profit targets and the speed of working with orders. Grid trading can be used in scalping with automated placing and removing of pending orders. Comfortable timeframes are М30-Н1.

Entry/exit point

The price is moving in a flat and there is a chance of a false breakdown. Pending orders (buy stop/sell stop) are placed respectively above and below the possible breakdown. If the upward breakdown is not false, a buy stop is triggered – a long position is opened.

The price is moving in a flat and will definitely touch the level from which it will rebound to the middle of the flat corridor. At the levels of a probable reversal, buy limit/stop limit orders are placed.

Tools: reversal patterns, pivot levels, ATR volatility indicator, etc.

Example

The trader needs to predict the direction of price movement after a breakdown and place a relevant pending order.

The chart shows that the price has been moving in a horizontal corridor for some time. There is a clear resistance level but no clear support level. In half the cases the price touches the lower red line and bounces up from it. It even moves near it for some time. But in the other 50% of cases, there are false breakouts with touching of another support level – the blue line. A pending Sell Stop order is set below the blue line. If the next breakdown of the red support level turns out to be false, the price will not reach the order, turning around at the blue level. A break of the blue level will mean the beginning of a strong downtrend.

Pros and cons

Advantage: no matter which direction the price goes, a pending order will work. Disadvantage: the price may turn around after triggering the order.

Bounce Strategy

This is the general name of the group of strategies that involve opening trades at the moment of the price rebounding from the key curves or lines. They have much in common with channel strategies, which have a similar principle of opening trades. The strategy can be used for any assets; the preferred timeframes are from M15 and higher.

Strategy description

Bounce trading options:

Rebound from the trend line. The trend line is built through the first three points. Then a trade is opened at the moment of a rebound from the trend line.

Rebound from the moving average. The reference line is the moving average until the price breaks through it. This example was discussed above in the Bladerunner Forex Strategy.

Rebound from Fibonacci levels. Trades are opened on H1-H4 timeframes upon rebounds from Fibo levels.

Reflection from round key levels.

The flat corridor is not used in bounce trading.

Risk level

Medium. The trend movement consists of short-term corrections. The easiest way to implement the strategy is to draw trend lines based on their extrema. Trading on Fibo levels and moving averages is more difficult, since a breakdown can occur at any time.

Reward ratio

Depends on the timeframe, the width of the trend channel, and the strength of the trend. On average, one trade can take up 5-7 candles or more.

Length of trade

On the M15 timeframe, a trade is held in the market for an average of 2-3 hours. On a daily timeframe – for a week or more.

Entry/exit point

One of the strategy options is trading on rebounds from the trend corridor. The trade is opened on the next candle after the bounce or in the middle of the first candle if it has a much larger body compared to the previous ones. If the price breaks through a little, the trade is opened upon return to the channel. Close the trade at the other border of the channel. Please note that channel indicators cannot be used here, since their channels follow the price. A commonly used tool is the rectangle pattern. Alternatively, you can draw lines through the three points manually.

Example

The objective is to find a trend that can be limited by three point lines. Long timeframes are better suited for this. The price does not always reach the opposite border of the corridor, so you need to look for opportunities to close the trade early.

We build support and resistance lines on the daily timeframe during an uptrend using the points indicated by the red arrows. We open trades on rebounds (blue arrows). Closing is at the discretion of the trader. Since the chart is daily, you can do with 3-5 candles. For example, in the last trade, the price reached only the middle of the corridor.

Pros and cons

The idea of bounce trading is quite logical; channel strategies and swing trading are built on it. But it is important to catch the trend and draw the lines from which the price will rebound more than three times. This is the hardest part. For beginners, the strategy may seem complicated, since it does not have clear instructions. You need to select the tools for determining pivot points and decide on the exit point.

Running out of steam strategy

This is a special case of trading on a trend reversal, when there is no clear formation of the  pattern head/shoulders, double bottom, or double top.

Strategy description

“Bulls / bears are running out of steam” – this is how traders describe a situation when, after an upward or downward movement, the price rests on some kind of ceiling or floor. This is the price above which buyers refuse to buy an asset, or the price below which sellers would not go short. The price tests the level several times, after which it changes direction.

Signal formation:

You can only draw one horizontal level: a resistance line above which the bulls cannot go up, or a support line below which the exhausted sellers cannot go down. You can only draw the second level – there is no formed side channel.

The price tests the level three times on a long section.

There are no obvious reversal patterns.

Open a trade after the third rebound. Close according to the situation.

Risk level

High. The third retest may be followed by a fourth one. A breakdown or a false breakdown of the level is possible. In both cases, the trade will close by stop loss.

Reward ratio

Depends on the strength of the trend. Profitability can be from 20-30 points.

Length of trade

This is a long term strategy. To eliminate price noise and the influence of market makers, you need a timeframe from H1. Signal formation can take several days. An open trade is held in the market for more than 1 day.

Entry/exit point

Open a trade after the third touching of the level on the next candle after the reversal.

Example

In theory, one can draw the upper resistance level. But the price repeatedly tries to get to it. Support levels are not pronounced – each of the drawn levels can be one. But the downward trend still began, marking a slight upward correction. The entry moment is ambiguous. Two long candles down after a resistance bounce seem to be a good moment, but it is better to wait for the moment of correction and open a trade after it ends.

Pros and cons

This principle is hardly a separate strategy, but in some sources it is given special attention. The strategy shows that a trend change can take a long time. And the price can draw any chaotic shapes without a clear flat before changing direction. Its advantage is that the trend comes sooner or later and the signal is strong. The disadvantage is that you need a large deposit to withstand the next return to a key level if the trade is already open.

To interpret the strength of the movement momentum, you can use the Currency Strength Indicator oscillator.

Breakout Strategy

Breakout strategy involves opening a trade in the event of a breakout of a key level. This is a symbiosis of trend and channel strategies. The trend often encounters levels at which the orders of sellers and buyers are in equilibrium. The price moves along the level for some time and then a reversal (a new trend or correction) or a breakdown of the level is possible. Opening a trade after a breakout is referred to as the Breakout Strategy.

Strategy description

The idea of the strategy is based on the fact that a breakout of the level where the price has consolidated means that the trend has not yet exhausted itself. If you missed the opportunity to open a trade at the beginning of the trend and suspect that it may end at any moment, a breakout is the moment to jump in.

Risk level

Medium. Breakouts may be false. On the other hand, if it is confirmed by fundamental factors, i.e. the price continues to move after the news, the risk is lower.

Reward ratio

On the hourly interval, you can earn 30-50 points, with some luck even 70-100 points.

Length of trade

Depends on the strength of the trend. On average, you can manage to cover 4-6 candles.

Entry/exit point

The trend has a pronounced movement. Then there is a temporary pause and a flat occurs. The price periodically tries to break through in both directions and returns to the sideways corridor. A breakout in the direction of the trend with a confirming pattern is a signal to open a trade on the next candle after the breakout. Close the trade based on actual the situation. Closing signals: reversal patterns, trailing stop, etc.

Example

1 – after the start of the downward movement the price drew the first reversal point. Although the downward movement was short, it can be described as a trend movement, since the length of the candles is much longer than the previous ones.2 – the end of the correction.3 – the price again rests on the same level – you can draw a support line.4 – correction ends, a resistance line is formed.5 – confirmation of the support as a strong level. The candlesticks have almost no downward shadows. This suggests that buyers are in no hurry to buy the asset, and at the end of the hour the price will remain at its lowest value.6 – a false breakout of the resistance line and a strong series of downward candles with a breakdown of support.7 – open a short position.

Close the trade after the appearance of two consecutive upward candles or by trailing stop.

Pros and cons

The advantage of the strategy is that the signal confirms the further price movement. Disadvantage: such strong trends are rare, and there are many false signals on the M15-M30 intervals due to the instability of the movement.

Overbought and Oversold Trading Strategy

This trading strategy is based on the fact that a trend cannot last forever. Sooner or later, the price climbs so high that buyers refuse to buy the asset, or falls so low that sellers refuse to sell the asset at a loss, hoping for growth. Or buyers finally see a favorable price and agree to buy the asset.

When there are no buyers, sellers appear, and their volumes reverse the price down. At the pivot point, the asset is overbought. But a reversal rarely occurs instantly and clearly. Buyers begin to buy the depreciating asset again, and the price goes up to the overbought level. This is how the supply zone is formed. It’s vice versa for the oversold zone – this is how the demand zone is formed.

Strategy description

The trader’s objective is to correctly identify the demand and / or supply zones and place pending orders in them, filtering out false breakouts of the zone borders. Then wait in the zones for a price reversal and the formation of a reversal trend.

Risk level

Above medium. For example, in theory, a downward reversal should occur anyway. But the reversal may again be followed by an increase in the volume of buyers. This kind of back-and-forth can go on for a long time. But as soon as the buyers realize that the sellers are not yet ready to sell the asset en masse, which means they are counting on continued growth, the price will continue to grow. Such rallies are especially evident on the cryptocurrency market.

Reward ratio

Depending on the timeframe. On the hourly interval, you can catch a trend that will give you at least 30-50 points per day.

Length of trade

Depending on the timeframe. The strategy is suitable for intraday trading with the possibility of holding a trade for up to several days. However, the zones are best viewed on timeframes from H4 and higher.

Entry/exit point

Define overbought and oversold zones in the chart. As soon as reversal patterns and other reversal signals appear in them, open a trade in the direction of the reversal. The strongest signal is a retest of the far line of the zone. Close the trade at the end of the trend as soon as the price reaches the opposite zone.

Example

Long-term Forex strategy for the H4 timeframe.

On the H4 timeframe, there was an uptrend, which with high volatility began to turn into a flat.

We can build a support level (red horizontal) and a resistance level (blue horizontal) through points “1”. These are the near levels of the future zones of demand (lower zone) and supply (upper zone).

Another reversal forms at point “2”. From the point of view of the level theory, it is a “false breakdown” – it breaks through the previous resistance but does not continue the trend. It builds a far resistance level. The distance between the blue lines is the supply zone.

On the next upward movement, the far resistance line is broken. The return to the zone is a retest of the far resistance level, showing that buyers cannot set an uptrend even on the second attempt. We open a short position at point “3”.

The price breaks through the support level and reverses up. At point “4” we close the short position. Then we draw a far support level at the pivot point. The distance between the red lines forms the demand zone.

At point “5”, the price enters the demand zone again, retests the far support level and goes up – we open a long position.

At point “6”, when the price touches the near resistance level, we close the position.

This example shows how, on a long-term interval, you can consistently pull out signals from the formed supply and demand zones in compliance with the level retest rule.

Pros and cons

The strategy does not have a clear framework for the interpretation of signals. Each trader determines the boundaries of the zones and sets limits on false breakouts at their own discretion. Despite the clear logic, there is no unambiguity in this strategy that provides for a high risk. Oscillators do not help to determine the ranges of overbought and oversold zones in this case. And the zone itself may turn out to be a consolidation zone, beyond which the trend will continue.

Daily Fibonacci Pivot Trade Strategy

This is a Fibonacci levels strategy with the additional confirming Pivot Points indicator. One can also trade on corrections or trend continuation between Fibo levels. But the confirmation is the signals of both indicators coinciding.

Strategy description

In a trending market, Fibonacci levels are built at the beginning of the first correction. The preliminary signal is the price bouncing off the Fibo level in the direction of the trend. At the same time, the level coincides with S1/S2/S3 or R1/R2/R3.

Risk level

High. This Forex strategy needs to be carefully adjusted for a specific asset and timeframe. Without long testing, there is a high risk of getting a lot of false signals.

Reward ratio

On the H4 timeframe, the distance between the levels is about 40 points.

Length of trade

This is a long-term strategy, the trade is kept in the market from several days to several weeks.

Entry/exit point

During the correction, the price touches the Fibo level, which coincides with the Pivot levels. Then it reverses. Open a position in the middle of the pivot candle. The nearest target is the next trend level.

Example

In the chart, it looks like this. Even with the S1/R1 levels left, the chart is oversaturated with lines, although one entry point on the correction is still visible. A piece of advice: it is difficult to perfect this strategy on the history of quotes. Use a demo account and set the lowest value of the “Number of reverse values” in the indicator settings – 2. In this case, the indicator will take into account 6 candles for the H4 interval, and 24 candles for the H1 interval. And it will calculate two level values.

Pros and cons

The Fibonacci levels are a good tool once you get used to it. But the combination with Pivot points turns a relatively easy Forex strategy into a complex professional system. Pivot points have different formulas: Camarilla, Fibonacci, Woody, etc. Which formula should be applied at what point is the real question. You can play with the parameters for a long time on the history of quotes, but this does not guarantee the result on a real account.

Overlapping Fibonacci Trade Strategy

The strategy is built on two Fibonacci grids built in the same trend. The first grid is built through the beginning of the trend and its extremum. As new extrema appear, the grid stretches. The second grid is built through the extremum of the first correction and the extremum of the trend. Both grids have different start points and the same end point.

Strategy description

When the levels of both Fibonacci grids match, it’s considered a strong horizontal line. When the price rebounds from it, open a trade with the target level at “the next trend level or extremum level” (level 0).

Risk level

High. Attempts to build grids so that the levels finally match will often lead to wishful thinking.

Reward ratio

Depends on the timeframe. On the H4 timeframe, the distance between the levels is about 40 points. On the hourly interval, you can earn 15-20 points on a short movement.

Length of trade

Depending on the timeframe. If the trade is closed at the next Fibo level, the strategy for the H1 interval will be intraday.

Entry/exit point

Enter when the price rebounds from the correction at the double Fibo level in the direction of the trend. A double level breakout and a return to the trend are allowed. The position should be opened at the moment of the breakout of the double level along the trend. Exit at the next Fibo level along the trend.

Example

Two grids superimposed on each other are not very convenient from a visual point of view: there are too many lines and selected zones in the chart. And if you add other indicators, you get chaos. However, you can still find some patterns. For example, the matching level of 0.5 and 0.618 really turned out to be strong. Also, in some areas, movements between the levels of different grids are visible. They are small, you can’t earn much from them. But they can be used for trading on lower timeframes, as they will allow you to find earlier entry points.

Pros and cons

The idea of confirming a signal with a similar indicator with different settings is considered one of the most effective methods. There are strategies based on several stochastic indicators, moving averages, etc. But in this case, it will work only when you learn to intuitively determine the start and end points of the trend. If the first Fibo grid is built at the beginning of the trend and its extremum, no problem. But which correction point should be used for the second grid then? What if there are two corrections, do you build two Fibo grids? Only you can answer these questions when you gain experience and develop your intuition. Building grids at random will give you false signals.

Summing up the trading strategies

In this block, you will find a summary table with ranking from 1 to 19 for all the above strategies based on the chosen criteria. 1 is the simplest strategy recommended for beginners, while 19 is the most complex professional trading system. The ranking is subjective. If you have a different opinion, you want to share your experience and your strategy, or you have questions about these systems, please join the discussion in the comments.

Strategy: Positional trading

Risk level: Medium

Reward ratio: 15-50% per annum 

Length of trade: Several weeks

Entry points: Start of a long-term trend

Exit points: Trend reversal, transition to a flat. Exit by trailing stop

Pros: Steady trend on a long timeframe. No need to constantly monitor the chart

Cons: Rare signals. Relatively low returns

Total ranking: 9

Strategy: Trend Breakdown strategy

Risk level: Below medium

Reward ratio: 100-150 pips in several days

Length of trade: 12-15 hours to several days

Entry points: Next candle after the trendline is broken at reversal

Exit points: Reversal patterns, trend movement decay

Pros: Clear signal logic. The trader has time for analysis. Late entry allowed

Cons: You need to watch the chart to avoid losing on a deep correction

Total ranking: 1

Strategy: Swing trading

Risk level: Medium

Reward ratio: Trend trading on the hourly intervalyields 80-100 points

Length of trade: Several hours to several days

Entry points: Price reversal in the direction of the trend after the end of the correction

Exit points: 50% when the price reaches the level of the beginning of the correction. The remaining 50% – by trailing stop

Pros: Clear signal logic. Relatively high profitability from skipping correction areas

Cons: Constant chart monitoring. There is a risk that the correction will turn out to be a new trend

Total ranking: 6

Strategy: Trend trading

Risk level: Below medium

Reward ratio: 40-50 points for intraday trading

Length of trade: Intraday trading with the option of transitioning to medium-term trading

Entry points: The end of the trend, its reversal, or exit from the flat confirmed by patterns and trend indicators

Exit points: After reaching the target profit, a part of the position is closed, the rest is insured by trailing stop. Exit by levels, reversal patterns

Pros: The trader has time to evaluate the chart; stable trends on hourly or higher intervals

Cons: Relatively rare signals

Total ranking: 4

Strategy: Range trading

Risk level: Medium 

Reward ratio: 20-30 pips on the hourly timeframe

Length of trade: Intraday

Entry points: Price reversal outside the channel in case of a breakdown towards its middle or at the moment of price rebound without breakdown

Exit points: 50% at the middle of the channel, 50% – by trailing or when the price touches the opposite border of the channel

Pros: Relatively accurate signals with clear interpretation

Cons: It is hard to select the proper settings of indicators that determine the channel width

Total ranking: 12

Strategy: Day trading

Risk level: High for scalping, below medium for a trend strategy

Reward ratio: 70-100 points for a trend strategy with a high asset volatility

Length of trade: Intraday trading with an average length of trade of 8-12 hours

Entry points: Moments of a trend reversal or exit from a flat identified by reversal patterns, trend indicators, oscillators

Exit points: At the end of the trend: reaching key levels, 30 minutes before the release of the news, the appearance of reversal patterns

Pros: Saving on swap. Different types of strategies can be applied

Cons: Constant chart monitoring

Total ranking: 5

Strategy: Retracement trading

Risk level: Medium

Reward ratio: 15-35 points per hour

Length of trade: Intraday, medium and long-term trading

Entry points: End of correction, reversal in the direction of the trend with a rebound from the Fibo level

Exit points: Conservative version of the long-term strategy – 100% of the trade is closed upon reaching the closest Fibo level along the trend. Aggressive version – 50% of the trade is closed at 0, 50% is insured by trailing stop

Pros: The system is backed by the psychology of the majority

Cons: Requires intuition to spot strong levels

Total ranking: 14

Strategy: The Bladerunner trade

Risk level: Below medium

Reward ratio: From 30-50 pips

Length of trade: Intraday

Entry points: Matching of the key level and the point where the price tests the moving average 

Exit points: By reversal pattern, by trailing stop

Pros: Clear logic of signals

Cons: Rare signals

Total ranking: 2

Strategy: The Pop ‘n’ Stop trade

Risk level: Medium

Reward ratio: Conservative option – 25-30 points, aggressive – 50 points and more

Length of trade: Several hours to several days

Entry points: Price exiting from a flat (breakout of the corridor border), beginning of a trend

Exit points: Reversal patterns, smaller bodies of candles, transition to a flat

Pros: Clear logic of signals

Cons: Risk of false breakouts

Total ranking: 7

Strategy: News trading

Risk level: High

Reward ratio: 30-50 points

Length of trade: Several hours

Entry points: News release. You can use pending orders

Exit points: Trend decay

Pros: Quick earnings on a sharp surge in volatility

Cons: High probability of exiting by stop loss due to volatility, risk of predicting the direction of movement wrong

Total ranking: 13

Strategy: Scalping

Risk level: High

Reward ratio: 50-100 points – depends on the number of trades

Length of trade: Short-term

Entry points: Any approaches to finding signals to enter the market

Exit points: Any approaches to finding signals to exit the market

Pros: The strategy is suitable for any asset and any market condition, including flats

Cons: Emotional stress of opening dozens of trades a day

Total ranking: 16

Strategy: Carry trading

Risk level: Below medium

Reward ratio: Depends on leverage, position size and swap size

Length of trade: Long-term

Entry points: Positive swap coinciding with long-term price movement

Exit points: By trailing stop or before the discount rate changes

Pros: No risk if you correctly forecast the direction of price movement and move the stop order to the breakeven level in time

Cons: Limited number of assets with positive swap. Large deposit and leveraged trading required

Total ranking: 3

Strategy: Grid trading

Risk level: High

Reward ratio: 30-50 points

Length of trade: Mostly intraday 

Entry points: By pending order

Exit points: By trailing stop

Pros: The order will work regardless of the direction the price goes

Cons: Difficult to calculate the length of pending orders

Total ranking: 15

Strategy: Bounce strategy

Risk level: Medium

Reward ratio: 5-7 candles

Length of trade: Several hours with M15 interval

Entry points: On the next candle after the rebound from the channel border

Exit points: Upon reaching the opposite channel border

Pros: Several signals can appear in one movement

Cons: No clear guidelines for identifying signals

Total ranking: 8

Strategy: Running out of steam

Risk level: High

Reward ratio: from 20-30 points

Length of trade: Intraday, long-term

Entry points: At the moment of rebound from the resistance level for a short position, from a support level for a long position

Exit points: Depending on the situation

Pros: In case of a change in the direction of the trend, you can catch a strong movement

Cons: No clear guidelines for interpreting entry signals

Total ranking: 17

Strategy: Breakout strategy

Risk level: Medium

Reward ratio: 50-70 points

Length of trade: Several hours to several days

Entry points: Trend continuation after a small horizontal movement

Exit points: Reversal patterns

Pros: High probability of trend continuation in case of a breakout

Cons: Risk of false breakout, rare signals

Total ranking: 10

Strategy: Overbought and oversold

Risk level: Above medium

Reward ratio: 30-50 points per hour

Length of trade: Several hours to several days

Entry points: By reversal patterns in supply and demand zones

Exit points: End of the trend, price reaching the opposite zone

Pros: Clear logic of the strategy, but identifying the boundaries of the zones is at the discretion of the trader

Cons: No clear interpretation of signals

Total ranking: 11

Strategy: Daily Fibonacci Pivot Trade

Risk level: High

Reward ratio: Around 40 points for the H4 interval

Length of trade: Long-term

Entry points: The end of the correction coincides with one of the Fibo levels and Pivot reversal level

Exit points: First Fibo level in the direction of the trend

Pros: Double signal confirmation

Cons: Difficult signal interpretation

Total ranking: 18

Strategy: Overlapping Fibonacci Trade

Risk level: High

Reward ratio: Around 40 points for the H4 interval

Length of trade: Long-term

Entry points: End of correction coinciding with both Fibo levels of two different grids

Exit points: First Fibo level in the direction of the trend or level 0, which is the same for both grids

Pros: Double confirmation of signals

Cons: Rare signals. Hard to identify the points on which the second Fibo grid is built

Total ranking: 19

A simple strategy does not mean a profitable one. Just as a complex professional trading system does not guarantee profitability. The number of indicators isn’t the deciding factor either: trying to double confirm a signal not so much increases the chance of success as it reduces their frequency. A successful strategy is one that you understand well, that suits your goals and brings satisfaction and comfort instead of fatigue.

How to find such a Forex trading strategy:

Try different trading systems on a demo account and find what you like best. With LiteFinance, you can use a demo account without registration.

Don’t chase profitability. Initially, your goal should be gaining experience.

Experiment. Introduce your own elements into the strategy, customize it, etc. Change timeframes, try the system on different assets, set different risk levels. Try to work with different indicators.

Believe in yourself, don’t be afraid to try something new and you will succeed. Good luck!

Frequently asked questions about Forex strategies

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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XAUUSD: Elliott wave analysis and forecast for 23.12.22 – 30.12.22

2022-12-23 2022-12-23
XAUUSD: Elliott wave analysis and forecast for 23.12.22 – 30.12.22logo

Main scenario: consider short positions from corrections below the level of 1824.57 with a target of 1721.07 – 1696.78.

Alternative scenario: breakout and consolidation above the level of 1824.57 will allow the pair to continue rising to the levels of 1851.11 – 1920.84.

Analysis: a descending correction appears to have formed as the fourth wave (4) of larger degree on the daily chart, with wave С of (4) completed inside. The fifth wave (5) appears to be forming on the H4 chart, with the first counter-trend wave of smaller degree i of 1 of (5) completed as its part. On the H1 chart, a local correction started developing as wave ii of 1 of (5), with wave (а) of ii continuing forming inside. If the presumption is correct, the pair will continue to drop to the levels of 1721.07 – 1696.78. The level of 1824.57 is critical in this scenario as a breakout will enable the pair to continue rising to the levels of 1851.11 – 1920.84.

Price chart of XAUUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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Bullish Engulfing Candlestick Pattern: What Is and How to Trade

2022-12-22 2022-12-22
Bullish Engulfing Candlestick Pattern: What Is and How to Tradelogo

The Bullish Engulfing pattern signals a soon bearish-to-bullish reversal of an ongoing trend. The bullish engulfing candle is a bullish candle whose closing price is higher than the previous day’s opening after opening lower than the previous day’s close. This is a reversal pattern in candlestick analysis. 

The article covers the following subjects:

What is a Bullish Engulfing Candle Pattern?

The bullish engulfing pattern consists of two Japanese candlesticks, the second of which is bullish and engulfs the first one.

A bullish engulfing pattern appears at the low of a downtrend and indicates that the price has reached a strong support level and buying pressure is rising.

This pattern can often be seen when trading in the Forex market. It is most pronounced in the stock charts since gaps on these instruments are more common, and a bullish engulfing is easier to find in the chart. Also, the formation can be found in the commodity and cryptocurrency markets.

So, for example, in the daily chart of Ford Motor Co shares, after the appearance of a series of bullish engulfing patterns, the trend turns up.

The price reaches a strong support level and rebounds three times from it. This is a signal to open a buy position.

How to Find Engulfing Candlestick Patterns?

It is easy to find a bullish engulfing pattern in a candlestick chart. The pattern should meet three criteria:

It is necessary to determine in which direction the price is heading. In the case of a bullish engulfing pattern, there should be a pronounced downtrend, as the formation appears at the bottom. A downtrend could be either long-term or short-term. However, situations may arise when an asset is in a long-term consolidation, forming a new springboard for growth. 

 It is important that the body of the second bullish candle covers the body of the first candle. The shadows do not matter.

The second candle should be bullish, it is usually white or green. The first one should be small and bearish, red or black. However, there are exceptions when the colors of the first and second bullish engulfing candles match. For example, if the real body of the first candle is small or completely absent. A small candlestick body or its absence characterizes the Doji candlestick pattern, which is also a sign of an imminent bullish price reversal and highlights the indecision in the market.

Bullish Engulfing Candlestick Pattern in Trading

In trading any asset, it is important first to determine the support and resistance levels to spot a potential pivot point. In addition, it is important to control trading volumes and the location of large limit and market orders by the Depth of the Market. Based on these data, in conjunction with candlestick and indicator analysis, it is possible to determine a more advantageous entry point.

I emphasize that the bullish engulfing candlestick pattern belongs to the category of reversal patterns, thanks to which a trader can easily determine the pivot level.

Factors that increase the likelihood of a trend reversal when a bullish engulfing pattern appears: 

The first candlestick in the pattern is short, while the second bullish candle is quite long. This suggests that the bears are losing their grip, and the bulls are taking control of the market.

The bullish engulfing pattern is formed following a long downtrend.

A bullish candle is formed on a large trading volume, which indicates a consensus among market participants at a certain price level, and the market turns bullish.

Another factor that reinforces the trend reversal is when the second candlestick is bigger than a few previous ones.

Confirmation of Engulfing Pattern

There are many price action patterns and combinations in candlestick analysis that can confirm a bullish engulfing pattern. In addition, to make sure that the trend is reversing when the engulfing pattern appears, you can use the simplest technical analysis indicators. It is enough to add RSI, MACD or Stoch stochastic indicators to the chart, which will allow you to determine in advance the zones where the trend can potentially reverse.

If a bullish engulfing pattern forms in such a zone, and there are other candlestick patterns confirming the bullish reversal, one should consider a buy trade. Larger price patterns, such as double bottoms, falling wedges, ascending triangles, and so on, can also serve as confirmation of the engulfing pattern.

Let’s take a closer look at the four-hour EURUSD chart. The figure below displays a downtrend. There are a lot of bullish reversal signals at the trend low: 

There is a falling wedge pattern, and the price breaks it out upside;

The RSI indicates a bullish divergence, which warns that the bearish trend is exhausting and the price could turn up;

The RSI rebounds from the lower border;

The MACD breaks the zero level upside;

There is a series of reversal patterns: a hammer, an inverted hammer, and a bullish engulfing. 

The combination of these signals means the price has reached the local low, and one could enter a long trade.

Reduce Your Risk with Stop Loss

Before you open a trading position and set stop-loss levels, you need to determine the support and resistance levels.

When you have identified a bullish engulfing pattern and entered a long trade, you should set a stop-loss order below the pattern or the support level. If the engulfing pattern is confirmed using other candlestick patterns or technical indicators, and there is also confidence that the trend is changing its direction, then you can set a stop loss below the previous local lows. For example, as in this example, a stop loss can be placed below the formed hammer reversal pattern.

In both cases, you should calculate the risks and act according to money management rules, as any trader aims at gaining profits, not losing money. Avert high risk, although the potential profit could be lower. 

Support and Resistance levels

Support and resistance levels are one of the most important components of trading because, due to the correct definition of these levels, you can develop a profitable and effective trading strategy.

In fact, a bullish engulfing signal, combined with other patterns at a certain support level, is a warning to market participants that a reversal is imminent. And the resistance level, in this case, is an approximate take-profit target. That is, by determining the support and resistance levels, you can find more profitable entry and exit points while reducing risks.

The XAUUSD chart below shows the distribution of key support and resistance levels. Since the bullish engulfing pattern suggests the price should go up and there is a pronounced uptrend in the chart, we are more interested in resistance levels to determine take-profit points.

Following a long consolidation, the support level is determined, where the bullish engulfing pattern has formed. At this point, a buy trade should be entered, and a stop loss is set below the support level.

Having analyzed the chart for previous periods, resistance levels were determined in a grid order. Therefore, the take profit must be placed in grid order with a taking of 50% profit from the total volume of the transaction.

When the highest resistance level is reached, the price forms a bearish engulfing pattern. It is a signal to exit the trade with a profit.

As you can see, support and resistance levels have a strong advantage, as they indicate the liquidity accumulation levels, whose breakout determines the further price movement.  

Engulfing Pattern Examples

Let us look at the bullish engulfing candle in forex trading. I will use the USDCHF chart as an example. You can see in the chart below that the price has drawn a bullish engulfing pattern at the support level.

In addition, if we consider individual candlesticks, a doji pattern forms on the first day, which indicates indecision in the market. On the second day, a bullish inverted hammer candlestick appears, which indicates a reversal. The first engulfing pattern is confirmed by another inverted hammer and a bullish engulfing.

As you see, following the bullish patterns, a three-week rally starts.

In such a case, it is relevant to enter a buy trade with a stop loss below the support level.

Let us look at another bullish engulfing pattern in the daily ETHUSD chart. You can see that the asset has been accumulating for some time, and an uptrend starts following a bullish engulfing candlestick pattern.

Furthermore, there is a hammer pattern within the two-candlestick engulfing pattern, which indicates a soon bullish reversal. The bullish engulfing can be confirmed by an inverted hammer pattern, which is also a reversal pattern. Following this combination, a long-term bullish trend starts.

A clearer and correct construction of the bullish engulfing pattern can be seen in the daily stock chart of Netflix, Inc. Following a downtrend, the price starts turning up near a support level, having formed a series of bullish engulfing patterns. In addition, a hammer and inverted hammer patterns confirming the price reversal have formed.

Also, you can see a three white soldiers trend continuation pattern, following which the price corrects down a little and continues rising to the resistance level. 

How to trade the Bullish Engulfing pattern

Let us look at a step-by-step plan to trade a bullish engulfing pattern. I will use the hourly EURCAD price chart as an example of short-term trading.

1. Define the pattern and support/resistance levels

In trading the bullish engulfing candle, after choosing an asset for trading, it is necessary to determine the bullish engulfing candle pattern in the chart, as well as the support and resistance levels. The figure below shows the formation of a three-candlestick morning star reversal pattern, which included the bullish engulfing pattern.

2. Add technical indicators analysis

The next step is to add the MACD and RSI stochastic indicators to the chart to determine the overbought and oversold zones. In this case, the RSI indicator shows that the values have reached the lower limit and gone lower into the oversold zone. In addition, this is accompanied by a bullish divergence, which warns of a trend reversal up.

The MACD indicator also shows an upward crossing of the zero zone, which is a sign of a trend reversal.

3. Confirm the pattern using other candlestick patterns

You can see below that candlestick patterns confirming a bullish engulfing pattern appear in the chart. The bullish sentiment is confirmed by a hammer and an inverted hammer.

4. Enter a trade, define the target profit and a set stop-loss

When you make sure that the trend is about to reverse up, you need to enter a long trade and set a stop loss. A buy position should be opened only when the bullish engulfing pattern is confirmed. In our example, the bullish engulfing is proven by technical indicators and two reversal candlesticks. A stop loss should be set beyond the support level, below the shadow of the engulfing candle.

The target is set around the upper resistance, as the highest liquidity for the instrument is there.

5. Take Profit

You can take the profit both partially and fully when the target is reached.

A more conservative strategy suggests exiting the trade in parts. 

As you see, the target is reached in seven days, and the profit is 2614 pips.

Bullish and Bearish Engulfing Pattern Difference

The difference between bullish and bearish engulfing patterns is that the pattern should form at the right place to work out correctly.

That is, a bearish engulfing occurs at the high and signals the end of an uptrend, while bullish engulfing forms at the low and warns of an upward reversal. Both bullish and bearish engulfing patterns mean the trend reversal, only in different directions.

Conclusion

Summing up, it should be emphasized that the bullish engulfing refers to reversal patterns and warns traders about the growing bullish activity at the low of a downtrend.

To trade a bullish engulfing candlestick with a profit, the reversal should be confirmed by other candlestick patterns and technical indicators. 

You can try trading the bullish engulfing pattern in the convenient and user-friendly LiteFinance trading terminal without registration on a free demo account. 

Bullish Engulfing pattern FAQs

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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Dollar: so short-sighted. Forecast as of 21.12.2022

2022-12-21 2022-12-21
Dollar: so short-sighted. Forecast as of 21.12.2022logo

It is difficult to say precisely how financial markets will react to the BoJ’s verdict. Will investors be satisfied with the current yield growth, or will they demand more? Let’s discuss this topic and make up a trading plan for EURUSD.

Weekly US Dollar fundamental forecast

Did the Bank of Japan ruin Christmas for the financial markets? Maybe they will be encouraged by the BoJ’s decision to expand the target range of bond yields. The precedent has been created, and as a result, one of the largest central banks in the world went along with the investors. Why shouldn’t the Fed do the same? As a result, the “do not fight against the Fed” principle does not look as intimidating as it used to be. This may cause a rally in stock indices and EURUSD.

On paper, the BoJ verdict will increase the risks of capital repatriation to Japan, leading to higher bond yields worldwide. The yen and the US dollar should benefit the most from this. The greenback will strengthen due to the increase in US debt market rates and the yen due to the closing of carry positions by traders after the cost of funding increases. The popularity of playing on the difference of currency exchange rates has been actively growing recently, but the Bank of Japan ruined Christmas for its fans.

Carry trade index dynamics

Source: Bloomberg.

Although the expansion of the BoJ’s targeting range is nothing compared to the Fed’s aggressive rate hike, investors fear it will mark the end of the easy money era. Indeed, the capitalization of the negative-yielding global debt market, which once reached $18 trillion, is steadily moving toward zero. This is bad news for risky assets because funding is getting more expensive daily.

Dynamics of global negative-yielding debt index

Source: Bloomberg.

There are fears that the Bank of Japan has only provoked investors. Goldman Sachs warns that expanding the bond’s target yield range is just the first step. In 2023 BoJ will raise the overnight rate.

On the other hand, there is a law of diminishing returns in the financial markets. The central bank’s unexpected decision is shocking at the very beginning. Later, the effectiveness of its impact on the market decreases. Therefore, the current growth of treasuries and the associated strengthening of the US dollar may be temporary. The future rates on Treasury bonds will only react to the approaching recession and slowing inflation. This scenario suits EURUSD.

Goldman Sachs’ research on the Fed’s monetary restriction was based on the law of diminishing returns. It is generally accepted that the restriction affects the economy with a time lag. Bank officials agree but argue that a rate hike has its biggest impact after six months and then weakens. If so, then the current inflation slowdown may be temporary, and its acceleration in 2023 will be the basis for the Fed to increase the rate above 5.25%.

Weekly EURUSD trading plan

Thus, the future of Forex is vague. Market participants have to rely on current data. The key question is, will there be another Santa Claus rally? It is reasonable to place pending orders at the level of 1.0575 for sales and at 1.0655 for purchases.

 

Price chart of EURUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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Yen stabilizes. Forecast as of 19.12.2022

2022-12-19 2022-12-19
Yen stabilizes. Forecast as of 19.12.2022logo

In less than two months, the USDJPY pair sank 10%. Did the BoJ’s foreign exchange intervention help the yen? Or has the US dollar lost its status as the main safe-haven currency? Maybe, the yen is supported by an impending global recession? Let’s talk about this topic and make up a trading plan.

Weekly yen fundamental forecast

The dollar and the European currencies were jumping up and down in mid-December, while the yen has stabilized. The yen volatility is falling, and the options market gives a 70% chance that USDJPY will trade in the range of 135.6-139.7 by the end of the year. The USDJPY should be trading flat, even despite the talks about a possible end to the BoJ ultra-easy monetary policy in 2023 and the growing risks of a global recession. This is how the market works. The trends are followed by consolidations, and consolidations are replaced by new trends. Can the USDJPY traders take a rest?

The reasons for the USDJPY 10% drop from October highs are to be argued. Some analysts suggest the trend must have been turned down because of the BoJ FX interventions. Others argue that the BoJ interventions would not have been efficient but for the slowdown in the Fed’s monetary tightening. Besides, the dollar could be weakening because it has lost its status of a major safe haven. I believe the truth is somewhere in between.

Currency intervention would hardly have succeeded if but for the Fed’s willingness to slow down the monetary tightening pace. However, the USDJPY bulls have been discouraged. The yen looks more attractive than the greenback as a safe haven when Treasury yields fall. In this regard, the drop in Treasury yields and rising expectations of a global recession have become the main drivers for the USDJPY downtrend.

Dynamics of recession risks in world’s leading economies

    

Source: Bloomberg.

Furthermore, the BoJ’s willingness to turn hawkish in 2023 could lead to turmoil in money markets and strengthen the yen. According to Reuters source familiar with the matter, the BoJ could abandon the yield curve control policy rather than widen the target range. In the second case, there will be rising risks of a rate hike, which will encourage investors to enter longs.

The BoJ’s abandonment of its ultra-easy monetary policy will hit Japan’s banking. A rise in the Japanese bond yields could affect the bond yields all over the world, including Treasuries.

Dynamics of bond yields

Source: Bloomberg.

I don’t think the BoJ will cancel monetary stimulus. The regulator sticks to its wait-and-see attitude, while other central banks have aggressively raised rates. And now, when global central banks will have to lower interest rates amid the impending recession, the Japanese central bank can safely remain passive.

Weekly USDJPY trading plan

The main USDJPY bearish driver is the global recession. Continuous monetary tightening by the world’s leading central banks will bring it closer. I do not rule out a short-term strengthening of the greenback, but the medium-term trend will remain down. When the price breaks out the resistance at 138, one could enter short-term purchases, followed by medium- and long-term sell trades when the market rebounds from resistances at 139.5, 140.5, and 141.4.

Price chart of USDJPY in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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Standard deviation indicator

2022-12-16 2022-12-16
Standard deviation indicatorlogo

How do we determine current volatility and trend strength? At which distance from the price mean value and market entry point should we place a stop loss? Is the market flat at the moment? The Standard deviation indicator can answer all those questions. Read on to find out how it works and how it is used in trend strategies combined with other technical indicators.

The article covers the following subjects:

What Is a Standard Deviation Indicator

Trading borrowed the idea of standard deviation from descriptive statistics, which is a branch of mathematical analysis. The standard deviation is an indicator of the data average deviation value compared with their mean value over a chosen period. In statistics, it’s denoted by the Greek letter (σ), or sigma.

Before examining the Standard deviation indicator, let’s recall why a trader should consider volatility and what SMA means.

Volatility

Volatility means a price change range over a certain time period. In trading, it is used in the following ways:

For trend identification. If there is no volatility, there is no trading. If the price doesn’t deviate from its average value, it’s impossible to open a trade. The increased volatility comes with bigger price moves.For identifying a trend’s end and an eventual reversal. If volatility reaches its peak, the trend is about to end. The extremums are visually compared with similar extremums over the previous periods.For placing stop orders. If market volatility is moving in both ways, at which distance from an open trade should we place a stop loss so that the price line doesn’t touch it? – According to larger time frames’ mean volatility. Take Profit orders can be placed in the same way.

There are different ways of measuring volatility. For example, 1-day volatility on a daily chart time frame is the distance between High and Low prices expressed in points. These values can be found in the calculator on the site of Investing, for example.

Volatility can also be measured relative to the moving average: the higher the price, the higher volatility.

Another method suggests comparing the current price change in % with the previous period’s closing price. If the change range doesn’t exceed 3%, volatility is low. If the price moves by 10%, the market is experiencing high volatility. These values are relative and depend on a currency pair.

Simple moving average

The SMA is a technical analysis indicator calculated as the average of chosen prices. Its disadvantage is that it doesn’t consider price volatility inside a price movement range. Let’s take two numerical sequences as an example:

8, 7, 12, 2, 6.-30, 66, 7, 12, -20.

Can we say they are identical as the SMAs are equal to 7 in both cases? No, we can’t. The price ranges are different even if their averages are the same. This variation of prices is called “volatility”.

What Is Standard Deviation

In trading, the arithmetical mean is a simple moving average. The price can deviate from it. The more the price deviates from its average value, the higher the volatility. Price volatility is measured by the Standard Deviation (StdDev) indicator.

The Standard Deviation is a trend indicator: it serves to identify the moments of trend strengthening. The high volatility reflects a strong market trend. Since Standard Deviation measures price deviation from the average price value in both directions, this tool is also used in channel indicators. If the indicator’s value is relatively small, the market is bored and a price spike should be expected. Inversely, when the indicator’s value is too high or even extreme, traders’ activity will slow down soon.

Specifics of Standard Deviation Indicator:

The Standard Deviation Forex Indicator is efficient when applied to high and medium volatility tools.

It is used in trend strategies to determine when the price leaves a flat range and starts trending. It isn’t suitable for scalping due to lags.

You’d better use it for currency pairs than for stocks or commodities. The currency market behavior is characterized by frequent trend changes and deep corrections during which we can search for entry points. The stock market behavior is more stable.

The optimal time frame starts at M30. On shorter time frames, such as M1-M5, there can be chaotic price moves that interfere with the indicator’s construction logics.

The Standard Deviation Forex Indicator often moves horizontally in lower points and rarely indicates a horizontal plateau at extremums. After growth begins, movements are most often wavy.

One of efficient strategies is looking for growing volatility on a longer time frame and using this move 1-2 time frames lower.

Advantages of Standard Deviation Indicator:

Simple reading. The higher the indicator measures, the higher price volatility.

Disadvantages of Standard Deviation Indicator:

Lags. The price blue line may have already left the flat zone while the indicator says volatility is low.It doesn’t show a trend direction. When the standard deviation line starts growing, the price moves from its average value more and more, but the deviation can be upward or downward.

Trades aren’t usually opened based on a volatility level alone, so Standard Deviation reading is rarely used in independent trading systems. It can be combined with trend technical indicators as a tool for signal confirmation. I’ll analyse some interesting strategies based on a combination of Standard Deviation with another volatility indicator, ATR, and Fibonacci levels.

How to calculate standard deviation

Standard Deviation indicator is a mean-square deviation. Standard deviation measures the degree of dispersion of random variables. Its calculation formula is:

, where:

N – means number of price values in a set specified in the indicator’s settings.Хi- i-th member in the set. By default, it is each candlestick’s closing price over the chosen time period.Xavg- X is the arithmetic mean of all price values in the set. In technical analysis terms, it’s a simple moving average (SMA).

Here’s step-by-step calculation of the indicator’s value:

Calculate the arithmetic mean value over the chosen period. For example, if the period is set at 20, the price arithmetic mean is calculated for the last 20 candlestick price bars. Closing prices are used by default.Subtract the result from each price’s value.Square the values and sum them up.The final value is divided by the number of values in the series, i.e. the number indicated in standard settings as the period.Extract the square root of the result. This is the standard deviation.

An example of standard deviation calculation in Excel:

Calculation stages:

1. Enter the price values in column B. You can take these values from MT4 or ask your broker. The number of lines corresponds to the indicator’s period. By default, the table has 20 lines.

2. Enter the formula

=AVERAGE(B2:B21)

in cell С21.This is the arithmetic mean, called “simple moving average” in technical analysis.

3. Calculate the difference of the price’s each value and the arithmetic mean. Enter

=B2-$C$21

in cell D1. Apply the formula to all the cells.

4. Calculate the square of values. Enter the formula =D2^2 in cell E2. Apply the formula to all the cells.

=D2^2

5. Sum all the previous column values in cell F21 and divide the result by 20 in cell G21.

6. Calculate the standard deviation in cell Н21 using the formula

=G21^(1/2)

You can find the table’s template here. You can also find standard deviation calculators on the internet, but copying quotes into them isn’t convenient whereas they can be easily uploaded to Excel.

Standard Deviation in trading – strategies and tips

Standard Deviation Forex indicator is used in trend trading. If the indicator is at its peak or is growing most of the time, it’s too late to open a trade. Wait for a flat period or a trend reversal. A signal to open a trade is the indicator’s line growing from its lows.

1. Strategy of Trading flat breakouts

It’s a conservative investment strategy. The price deviation isn’t much higher than its mean value in a flat range, and the indicator is located at the bottom. A signal to open a trade is produced when StdDev starts growing and goes outside the flat range. Once the candlestick breaks out the flat range, open a trade on the next candlestick following the trend. Close the trade once the indicator measures start reversing.

Example

StdDev’s penultimate wave was trending down and then switched to a sideways trend. The indicator’s maximum value in a horizontal range was 0.0009. In point 1, the price line broke out the resistance level, and the green candlestick closed almost at the previous local peak’s level. StdDev started growing simultaneously, reaching the value of 0.0011. A trade was opened.

In point 2, on the red candlestick that could predetermine a reversal, StdDev started to reverse too. The trade was closed. The profit could be at least 300 points in 5-digit quotes.

2. Strategy of identifying an early trend reversal

It’s an aggressive strategy that implies an early opening of trades based on Standard Deviation waves. Its advantage is that it allows solving the issue of lags. Signals are produced more often as we don’t need to wait for a flat range, but they are often false signals compared with the previous strategy.

Conditions for opening trades:

Draw a support level for StdDev through its lows. Take a period of 2-3 weeks for the H1 time frame.Open a trade once the indicator has crossed the support level and continued growing.The trade’s direction is identified as follows: if the previous wave’s half was trending downwards, open a long position. If the previous wave’s half was trending upwards, open a short position.

If a flat range preceded the previous wave’s half, follow the previous strategy. If the wave has two and more tops, divide it by half. If the wave can’t be clearly identified, is asymmetrical, or its beginning and end can’t be clearly identified, ignore the signal.

Example

The indicator touches the level in 4 points. The wave’s half located before point 1 was trending up, so we open a short position in that point. The same is true of point 2. In point 3, there’s a double-top wave, so we calculate its half from the bottom. The trend is upward, so we open a short position in that point. The chart’s flat in point 4. We don’t open a trade until candlesticks point to a trend direction.

We’d better ignore the signal or search for its confirmation as such signals are indecisive in such situations. We can’t clearly identify the wave in the first case, and the wave is asymmetrical in the second case.

High standard deviation

There’s a numerical sequence of the last five candlesticks’ closing prices: 4, 5, 3, 4, 6. The dispersion is relatively small. The arithmetic mean is 4.4. The minimum and maximum prices will be 3 and 6, which is 31.8% and 36.4%, respectively. Let’s say such standard deviations are a normal situation corresponding to a flat range for that tool over that time period.

The price starts gradually growing. There’s another sequence three candlesticks later: 4, 6, 10, 14, 13. The average price is now 9.4. The minimum and maximum values are now 4 and 14, which is 57.45% and 48.93%. In the first case, the price deviated from its arithmetic mean by one third on average; now the price has deviated by 50% on average.

Volatility is growing. Now let’s check the deviation readings. In the first case, they are:

In the second case, they are:

The standard deviation increased by more than 3 times amid the growth of price and volatility. A high standard deviation means that the price changes in either direction. The Standard deviation growing with every candlestick means the market is trending, and the price deviates more and more from its average value in either direction. Once the Standard Deviation reaches its peak, the following scenarios are possible:

The price moves into a flat range. The price range looks like these three candlesticks later: 14, 13, 15, 14, 12. The arithmetic mean grows and the SMA moves higher in the chart than in the first situation. However, the standard deviation returns to the level of 0.5099 again. The indicator’s chart will display a wave with flat values of 0.5099 and a peak value of 1.9391.

The price will reverse. The price range will look like this three candlesticks later: 14, 13, 8, 5, 7. The SMA’s indicator value will equal 9.4 and the Standard Deviation Indicator’s value will be 1.7493, which is practically the same level despite the trend direction change.

It looks like the following:

The question is what should be called “a high standard deviation”. To understand how long a market trend will last, we need to compare the current Standard Deviation value with other visual extremums.

The dotted line in the screen above is at the Standard Deviation’s average level. Most often, the indicator was below that level or crossed it for a short time. Thus, the values located much higher than that level can be considered high.

The local extremum is in point 1. The flat range starts when the indicator’s line is reversing. The flat areas are marked as red rectangles in the screen shot.StdDev continues growing in point 2 located at the same level as point 1. It means the trend is uninterrupted, but may end soon. The indicator’s line reverses in point 3, and a flat range begins.In point 4, with StdDev’s peak value, there’s a trend reversal. Since the reverse ascending movement isn’t as powerful as the previous descending one, the indicator goes down.Flat range emerges in points 5 and 6 when the indicator is reversing.

Conclusion. A high standard deviation may mean that an uptrend or a downtrend continues, but it’s already too late to enter the market. The standard deviation’s peak value and subsequent reversal mean the trend will reverse or turn into a flat range.

Low standard deviation

A low standard deviation means that the price holds onto its average level calculated over a certain time period. It can mean the following:

1. The market is flat. The volumes of bulls’ and bears’ orders are almost the same, or trade volumes aren’t big enough. The asset holds on to its average price level.

Example:

The 20 EMA, corresponding to StdDev’s period of 20, is added into the chart. The standard deviation line is moving at the bottom, close to the level of 0.0009. A low standard deviation corresponds to a flat area, where prices move in a narrow trading range. Once the price breaks the range’s lower limit, the standard deviation starts growing and the price starts deviating fast from the SMA.

2. The current price movement is smooth. The price changes step by step with a small deviation from its previous value.

Example:

StdDev’s result can be called low compared with peak values and waves in the shaded area. Still, that segment is trending smoothly down.

Conclusion. A low standard deviation can indicate a flat area or a smooth ascending or descending trend.

Attention: the time period set in the Standard Deviation Forex indicator’s settings is essential here. For example, the deviation in the numerical sequence of 5, 6, 30 for period 3 will be a relatively low standard deviation (4.4759). In contrast, the standard deviation in the numerical sequence of 4, 3, 6, 5, 7, 5, 6, 5, 6, 30 for period 10 will be relatively high (5.3108.) The longer a stable price range and the sharper a price change on the last candlestick, the higher the standard deviation.

How to set the Standard Deviation Indicator

Many basic trading platforms include this indicator. As for LiteFinance’s platform, you can install it in the following way:

1. Open the platform. Click on “For beginners” – “Open a demo account” in the top menu bar on LiteFinance’s site. Registration isn’t required: you go straight to the embedded trading platform.

2. Choose your trading instrument, click “Trade” on the left panel and open the chosen currency pair’s chart.

3. Pick Standard Deviation on the list of indicators.

It will appear under the price chart. Click on the gear sign to see the settings.

The default settings are:

1. Length, or the period, — the number of candlesticks that will be considered for calculation. The default data set is twenty last candlesticks.

The bigger the period, the faster and sharper the indicator reacts to price changes.The smaller the period, the less sharp the indicator’s moves are.

That is one of StdDev’s essential differences from other volatility indicators. For example, the SMA slows down when a period increases: the longer the set, the less weighty the last price is. With StdDev, everything is the other way round.

2. Source: the price that is included into calculation.

Close – candlestick’s closing price.Open – candlestick’s opening price.High – the peak value of a price in a set, the upper-extreme of a shadow.Low – the lowest value of a price in a set, the lower-extreme of a shadow.Median: price = (High + Low)/2.Median HLC: price = (High + Low + Close)/3.Median HLOC: price = (High + Low + Open + Close)/4.

3. Accuracy/precision – a number of digits after the decimal point in the indicator’s value displayed on the right on the scale.

The “Style” tab allows choosing the indicator line’s color or width, or changing it into a dotted line.

The indicator is placed under the chart line in the form of a line moving upwards and downwards relative to zero in an unlimited range. The higher the indicator’s value, the higher market volatility is.

The price type can be left as Close by default. Below there’s a StdDev chart featuring various price types. There’s almost no difference in line drawing, except that the indicator built through Close prices is 1-2 candlesticks ahead of the others.

Standard Deviation for MT4

StdDev settings in Mt4 are slightly different from those in LiteFinance’s profile. Still, the indicator is included as a basic one in MT4. You can find it here: “Insert”https://www.litefinance.org/”Indicators”https://www.litefinance.org/”Trend”.

Settings:

The main difference is that you can change a MA type. The basic version uses the SMA (simple moving average), but you can pick the SMMA (Smoothed Moving Average) or the LWMA (linearly weighted moving average).

The choice of the MA is critical as the line’s smoothness and amplitude’s size will be different. There doesn’t exist the best option. Advice: choose your parameters based on a market situation and an asset you are trading.

Modifications and other indicators based on Volume Standard Deviation Indicator:

Juicenew, the indicator based on StdDev. It’s visually convenient. There is a histogram with 2 columns colored in different colors in place of a line that can be interpreted differently. Signals can be interpreted unambiguously, without disputable moments: if there’s a signal, there’s a signal. You can download this MT4 indicator here.Bollinger Bands, a standard channel indicator included in many trading platforms. It consists of three lines: the central line is a regular moving average. The lines marking the channels’ borders are moving averages shifted by a certain number of standard deviations (StdDev). Bollinger Bands are usually displayed on charts as graphical overlays that complement other indicators enabling traders to review and predict potential trading opportunities.

Trading strategies combined with Standard Deviation Indicator

Here are two trading strategies which exemplify the use of StdDev. The first one combines StdDev with ATR, another volatility indicator. The second one implies trading Fibonacci levels and using StdDev as an auxiliary indicator.

Standard Deviation and ATR

ATR is used to measure market volatility. You can read about it in the article “ATR indicator: volatility under trader’s control”[1].

Input data:

Currency pair: GBPUSD.Time frame: H1.Settings: StdDev (20), ATR (20). The periods of both volatility indicators must be the same.

The strategy consists in opening a trade when the trend grows stronger, confirmed by both indicators’ readings.

Conditions for opening a trade:

ATR crosses its support level from below or pulls back from it in an ascending direction and continues growing.StdDev crosses its support level from below or pulls back from it in an ascending direction and continues growing.

On the candlestick following the concurrence of both conditions, open a trade in the trend’s direction. Place a stop loss past the local extremum.

Market exit options:

When a reversal pattern, for example, a pin bar, is forming.When one of the volatility indicators starts reversing.

Don’t open a trade if

one of the indicators has just pulled back from the support level and the other has already covered a 50% distance to the resistance level.highly important economic news is expected.

Example

The first step is drawing support levels for both indicators. To do that, we need to scale down the chart as much as possible and draw a horizontal line through the levels at which the indicators were reversing most often. Then, reset the scaling and extend the levels’ lines as the price moves further.

Both conditions are observed in point 1. StdDev is the first to break its support level and go up. Wait for confirmation from ATR. Once you get it, open a short position. Falling candlesticks confirm the direction. A stop loss is placed past the nearest local maximum, 2-3 points away from the shadow’s end. Close the trade when ATR is reversing. The pin bar formed by the green candlestick confirms that the decision is right.

Both conditions are also observed in point 2, but the question is when to close the trade. Following ATR, the trade could be closed ahead of time. Unfortunately, there’s no common recommendation concerning market exits, so let the situation guide you. The same is true of point 4.

Point 3. A long position could have been opened if the indicators’ signals had coincided, but both indicators reversed immediately. These are false signals, so don’t wait for the stop loss to work out and close the trade.

Standard Deviation and Fibonacci correction levels. Practical example.

The strategy is called “Fibonacci levels and StdDev scalping”. Scalping correction levels means catching the main trend, waiting for a local retracement to Fibo levels and opening a trade in the trend’s direction with a take profit placed at the next level. You can check the article What is Fibonacci retracement? for more information on Fibonacci levels and their derivative tools.

Identifying the market entry point can be problematic for a few reasons:

The signal is the price’s pullback in the main trend’s direction from the level of 0.382. However, the price won’t probably reach it, having reversed inside the range’s green shaded area. Shall we then open a trade? Or is it a correction inside a correction?After having retraced from level 0.382, will the price continue moving in the trend’s direction once level 0.236 has been reached? Or will this level be a consolidation area?

The Standard Deviation indicator will answer these questions.

Step 1 Preliminary analysis.

Scale down the M15 time frame chart of the GBPUSD currency pair and draw a 20-period support level for StdDev. The level is drawn through visual minimums. Place the Fibonacci grid onto the uptrend. Just in case, place the SMA (25) into the chart too.

Step 2 Analysis of current situation, search for prospective opening points.

Having reached the maximum, the price goes flat: the price line is moving down to the first correction level and touches it twice. However, the correction is weak: StdDev is moving horizontally along its support level close to zero.

Two scenarios are possible here:

The price will break out the correction level of 0.236 and move down. The correction’s ending at level 0.382 will be a signal to open a trade.The price will pull back from level 0.236 and move upwards to set a new maximum.

The standard deviation forex indicator will hint at the trend’s start point.

Step 3 Opening of a trade.

The situation then develops as follows: the correction does break out the key level of 0.236 and goes down. StdDev then starts growing, but it would be false to open a short position based on that signal because

StdDev doesn’t show a trend direction. Traders’ activity growth only means that the price went outside the flat range, but it can reverse at any moment.Fibonacci correction levels are the key indicator, and its signals are the main ones.

The correction ends before level 0.382 and the price reverses upwards. StdDev grows. A trade is opened.

According to a conservative scenario, a trade is closed when a price has reached the closest Fibonacci level. In our case, it’s level 0.236. The profit is over 7 dollars in just 30 minutes.

Resumé. FAQ on standard deviation

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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