Forex Trading Strategies for Beginners | BY HEIDI

 

Forex for Beginners

Forex trading strategies best suited to beginners have the following characteristics, which are not easy to find together:

Profitable / reliable

Simple / easy to follow

Clear rules

Conservative

Useful as a learning aid

Uses higher time frames

As few indicators as possible

Big claims are often made for a large number of trading strategies, but the only trading strategies which have clear rules and are reliably profitable over the long-term are those which rely upon trend following or momentum principles as one category, and mean-reversion strategies as the other (mean reversion is when a price tends to return to its average value). There are a lot of other strategies which rely upon various quirks or fundamental or sentimental criteria, but these either tend to not be profitable over the long-run or are overly complicated and requiring of more discretion than a beginner can safely exercise.

It is also important that the new trader is not exposed to large losses, no matter how temporary, as they can be psychologically crushing to even experienced traders. This is why the best Forex trading strategies for beginners allow for low risk and small position sizing of trades.

Time frame is also important, as a major reason why most beginner Forex traders fail is due to their being encouraged to trade on shorter time frames. Trading profitably with shorter time frames is an acquired skill, so it is best for beginners to stick to using daily charts and perhaps using 4 hour or hourly charts at the same time to find more precise, lower-risk trade entries. Of course, beginners may not have a lot of time to devote to Forex trading, or want to get used to it slowly, which is another reason why the trading strategies outlined here may be traded on only the daily or weekly time frames. This means that it will only take a few minutes of your time once per day or per week to trade them.

The final factor in determining a good trading strategy for beginners is whether the strategy provides some room for learning. The beginner trader should be able to learn using a strategy with a positive expectancy, but the strategy should offer more than just pushing buttons according to set rules. The best way this can be accomplished is for the strategy to have clear rules, but for the beginner trader to record their own optimism about each trade before it is taken once they have some experience in using the strategy. Then after, say, 20 trades, the trader can check their records to see how well their expectations matched the results of the trades. Once the beginner trader has established an ability to determine correctly in advance which trades are likely to turn out better, the trader might decide to risk more on the favored trades, or to pass on entering the unfavored trades. In this way, the new trader can build up their trading skills, while still trading and hopefully making money.

The best way to get started is to identify some simple trading strategies that have a good track record of working in Forex.

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The Best Simple Trading Strategies 

The best simple trading strategies for beginners should be technical strategies based on either momentum or mean-reversion principles, easy to follow, and conservative. In this section, I will set out the detailed rules of some trading strategies which new traders can use to both profit and improve their trading.

1. The 50-Day Breakout Forex Trading Strategy 

It has been well established by academic research that the price movement of liquid financial instruments shows a momentum effect. This means that when prices are moving strongly in one direction, it is more likely that this directional movement will continue over the short-term than reverse. Also, it is likely that any further movement in the direction of the trend will be stronger than any movement against the trend.

We can use this momentum property to see that when prices are breaking to new long-term highs or lows, we have an edge on our side which we can use to profit.

We should make sure to only apply this rule to the most liquid Forex currency pairs, as if we check historical performance over the past twenty years or so, we can see that the currency pairs whose breakouts were the most profitable in this way were the EUR/USD and USD/JPY currency pairs. So only these two currency pairs should be traded when using this trading strategy. This might sound overly restrictive, but trading these two pairs will give you exposure to the three major global currencies and almost a majority of global Forex volume - 41% of all the foreign exchange transactions conducted globally are within these two currency pairs, while the USD is a party to approximately 80% of global transactions by volume.

What is this strategy based upon? Looking back over historical data from the summer of 2001 until March 2020, we can see that when the EUR/USD or USD/JPY currency pairs have closed at new 50-day highs or lows, the following volatility-adjusted statistics were observed one day and eight days later:

Forex Market Volatility

We can see that when we got a daily close at a new 50-day high price, there was an edge in favor of the directional move continuing.50-day breakout strategy back test results

Only one indicator is used in this trading strategy, the Average True Range (ATR) indicator set to 15 days on a daily chart. Everything else can be accomplished with a naked price chart.

Strategy Rules:

Only trade EUR/USD and USD/JPY currency pairs.

Monitor daily chart for entry signal, which is a new 50-day high or new 50-day low closing price. Just count 50 candlesticks to the left if you think you see a new high or low closing price. The horizontal line chart tool can be used to check this in almost all charting packages. The closing price should be higher or lower than all the previous 50 closing prices, not from the highest or lowest prices achieved by the wicks of previous candlesticks.

Entry signal: a new 50-day high closing price is a signal to enter a long trade. A new 50-day low closing price is a signal to enter a short trade.

Trade entry: if you are trading only on the daily time frame (which is recommended), a trade should be entered right away after the entry signal is generated.

Risk / Position size / Leverage: you should only risk 0.25% of your account equity per trade at most. If you apply this position sizing strategy, it means that if you have $2,000 in your account, you should risk $5 on the trade. Divide this amount by the stop loss you are going to use: in the example below it is 50 pips, so there you would know to size the trade so you are risking 10 cents per pip (in EUR/USD, that would be 0.01 lots or 1 micro-lot).

Stop loss: this should be based upon the value of the ATR indicator set to 15 days. Tighter stop losses tend to ensure greater overall profitability although they also lower the win percentage. I recommend as the best balance between the two a stop loss set to half of the value of the ATR indicator. For example, if you see a new 50-day high daily close in EUR/USD at 1.1500, and the ATR indicator set to show the average range of the past 15 days shows this as 100 pips, you would use a 50 pip stop loss.

Trade management: after 2 days from the trade entry, if the trade is still open, move the stop loss to break even. If the market price is worse than the stop loss, close the trade at the market price. This is an application of the old trading maxim “cut losers short and let winners run”.

Trade frequency: you can have more than one trade in the same direction in the same currency pair at the same time, but as you will be moving stop losses to break even after 2 days, you will not have more than two trades at risk at the same time in the same currency pair.

Exit strategy: you can choose between simply using a time-based exit, which should be between 5 and 8 days (the upper limit has historically given the most profitable performance) after entering the trade, or some kind of a trailing stop once the price has reached a floating profit at least double the risk. For example, if your stop loss were set at 50 pips, you would begin applying the trailing stop once the trade has reached a profit of 100 pips.

These are the complete rules for my 50-day breakout Forex trading strategy. Beginner traders can trade this knowing that this strategy has performed well in recent years, but should be aware that most trades are not winning trades – you can however expect to win more on the winning trades than you lose on the losing trades. I have allowed some flexibility on the rules for an exit strategy as this is an area where beginners need to do a lot of learning. Most traders find exits challenging, as they can also be psychologically difficult. Beginners will probably find it useful to start by following a strict time-based exit strategy, but at the end of each day to make a note whether they wanted to exit the trade or not. Then the beginner trader can compare whether their mental “discretionary” exit strategy outperformed the time-based exit strategy after a series of trades, maybe at least twenty trades would give a fair sample. Many traders will be surprised to find that they will get better results just exiting after the same number of days each time than by trusting their faith in price action indicating that it is time to get out of the trade. Judging the price movement yourself to trigger your own trade exit signal is very challenging for most people, so this is a good method you can use to practice mentally without harming your trading account.

I mentioned that it is possible to trade this strategy on a shorter time frame than the daily chart. I recommend that beginners start with the daily chart and stick to it, but more experienced traders can drop down to the 4 hour or even hourly chart once the daily chart has given a trade entry signal to try to find a more precise entry. Most traders will find this does not improve their overall performance with this strategy.

2. The Breakout-Pullback Forex Trading Strategy 

Another strategy that can be recommended for beginners is a variation on the 50-day breakout trading strategy. It is the same, with just two changes to the rules:

After you get the 50-day high or low close, you wait for another day. If at the end of that second day the day closes in the opposite direction to the breakout, you have a trade entry signal. So, you are waiting for the price to “pull back” immediately after the breakout.

Entry is more challenging here as the price may still be pulling back against the trend strongly, so it could be a good idea to drill down to the 4 hour or hourly time frame and only enter when you have a candlestick close above the previous 2 candlesticks’ respective closing prices (if you are looking for a long trade), or below them (if you are looking for a short trade).

What is this strategy based upon? Looking back over historical data from the summer of 2001 until March 2020, we can see that when the EUR/USD or USD/JPY currency pairs have closed at new 50-day highs or lows, and then closed in the opposite direction the next day, the following volatility-adjusted statistics were observed one day and eight days later:

50-day breakout/ pullback trading strategy

We can see that when we got a pullback following a daily close at a new 50-day high or low price, there was an edge in favor of the directional move continuing. This edge was even stronger over the short-term than it was shown to be in the breakout strategy, with a stronger expectancy of a positive close the following day.50-day breakout/pullback strategy back test results

3. Weekly Multi Time Frame “Buy the Dips” Trading Strategy 

I have explained elsewhere several trading strategies based upon trading the weekly time frame. One of these strategies which can be suitable for beginner Forex traders is the “buy the dips” trading strategy. This strategy recommends identifying trade opportunities on the weekly time frame and using the 4 hourly or hourly chart to identify an entry signal, which I explained above. It can also be possible to use a daily chart here to find the entry signal. The important thing is that a hard stop loss is always used which is less than the value of the 15-day ATR indicator at the time of the trade entry.

Just as in the other trading strategies already outlined, it is important not to risk more than 0.25% of the value of your account on any single trade.

4. A Simple Range-Trading Strategy 

Most of the time, markets are not trending, and all of the strategies I have already outlined in this article are only active in trending market conditions. While it is true that you will never become a successful, profitable trader unless you learn to trade patiently, it can be good to have another tool in your trading kit for those periods where we have no trends in the two major Forex currency pairs.

The first step here is to identify when conditions are ranging. This can be done by checking that neither the EUR/USD nor the USD/JPY currency pairs are making new 50-day highs or lows.

The second step is to find a currency pair which has been moving sideways for the past 50 days on relatively high volatility. The way to find a currency pair which has been going sideways for the past 50 days is to pull up a daily price chart and use the horizontal line tool to draw horizontal lines at the highest and lowest points of the last 50 days of candlesticks. Alternatively, you can use the Donchian Channel indicator set to 50 days. If the lines look relatively flat across the screen, you have a currency pair which you can trade intelligently with this Forex range trading strategy.

You should then set up the ATR indicator against the daily price chart and apply it. In one, set the time period to 50 days, in the other, set the time period to 200 days. If the value of the 50-day ATR is at least 1.2 times the value of the 200-day ATR, it tells you that volatility is relatively high compared to the long-term, but we can see that the price has lacked direction.

You are now ready to wait for a trade entry signal. Unlike the other trading strategies already discussed here, you are trading against a breakout, so your trade direction is in the opposite direction. A trade entry signal is given when the wick of a daily candlestick goes past the 50-day high or low, but the candlestick closes in the other direction, ideally closing in the other half of its price range. For example, you see a daily candlestick have a wick whose bottom is below the lowest price of the past 50 days, but it closes up, and the close is well within the top half of the daily candlestick’s range. This gives you a long trade entry signal.

A good example of such a long trade entry signal is shown below in a daily chart showing the CHF/JPY currency cross. The ATR 50 value is more than 1.2 times the value of the ATR 200, and the horizontal lines at the top and bottom of the chart which were drawn two days ago show that the last 50 days have seen sideways action overall. Note how yesterday the wick of the daily candlestick just breached the 50-day low at 109.21, but then rose strongly from there. This could have been used to take a long trade entry yesterday when the bullish candlestick closed within the top half of its price range. The stop loss would be just below the low of the entry candlestick at 109.17.

Long trade entry signal

Long Entry Signal in Forex Range-Trading Strategy

The stop loss should be placed 1 pip beyond the high or low of the candlestick which exceeded the 50-day high or low.

Trade management is less important in this kind of range trading strategy. For a trade exit strategy, it is best to use as a target the other boundary of the range. For example, if you took a short trade from a bearish reversal at the 50-day high, the 50-day low can be your take profit target for a trade exit. Of course, if the price gets close to the target and shows clear signs of running out of momentum or looks as if it already reversing against you, it will probably make sense to exit early.

Bottom Line 

Forex beginners can benefit from using the best simple trading strategies which work in Forex, because these strategies are relatively easy to follow, and because they have a track record of being profitable over the long-term, putting odds more in favor of profitability. Finally, these strategies outlined here are combined with tips for using them to learn how to become a better Forex trader, by comparing signals and trade outcomes with how you feel at the time, to learn whether you have begun to develop skills which will allow you to trade more profitably than an algorithm.