Key forex and futures trading concepts and strategies
Here are some of the most useful forex and futures trading strategies that we have come across and use in our own trading.
We have over 30 years trading experience and can assure you that you really need look no further than these to earn a very good and consistent living from trading the forex and futures markets.
However – whilst the strategies that you use are undoubtedly important ultimate success in trading also depends on other factors that novice traders are generally less aware of.
You may rest assured that these areas and well covered on both pro-trader training courses.
Firstly before we look at specific forex and futures trading strategies let us just remind ourselves of the different types of market that we may encounter.
The six main market states:
There are broadly speaking six main market states that you will encounter in your trading
The market consistently moves in one direction with only minor retracements against the direction of the trend. The market can either be in a Bull trend (rising) or Bear trend (falling). These are generally the easiest types of markets to trade.
Choppy or sideways Market
This is a market with no clear trend direction it is just chopping around, sometimes rising sometimes falling, often staying within some form of defined trading range.
High volatility or low volatility
Both trending markets and choppy markets can then each be further subdivided into high volatilty and low volatilty versions.
The six main market states are therfore:
Bull market trending with high volatility
Bull market trending with low volatility
Bear market trending with high volatility
Bear market trending with low volatility
Choppy market with high volatilty
Choppy market with low volatility
For instance a bull market can either be trending up smoothly or trending up but in a volatile fashion with big swings against the prevailing trend. The same would apply to a Bear market. Whilst a choppy market can chopping with and in wide ranges (high volatility) with and in narrow ranges (low volatility)
Most trading systems and methods will not trade equally well across all market states. Different systems and methodologies will have their own favourite market states where they excel whilst when they encounter other market states they may just break even or even lose money.
The easiest type of market to trade is generally considered to be a smoothly trending Bull or Bear market.
Five broad trading concepts
Most individual trading strategies are based around one or more of these five trading concepts
Breakout trading is probably the most common technique used to trade.
The trader identifies key price support and resistance levels (using a variety of techniques) and then buys upside breakouts through resistance levels and sells downside breakouts through support levels.
The expectation is that once price breaks through a support or resistance level it should continue to move in that direction thereby creating a trading opportunity.
Breakout trading is relatively simple to apply and often uses precise, easily and clearly defined levels so that the use of confirming indicators is often greatly reduced or eliminated entirely (so called "price action" trading).
Breakout trading has the advantage that you can never miss a big trending move because for any big move to take place price must first breakout through some form of previous high or low.
Probably more money has been made in the markets trading breakouts than any other single method.
The main problem with breakout trading is “false breakouts” where the market breaks out to a new high or low and then immediately reverses.
So called “buying the dips” or “selling the rallies”.
When are market is, for instance, in a clearly defined trend and the trader is confident the trend will continue they will try and enter in the direction of that trend but first wait for a minor retracement.
A retracement is a reversal against the prevailing trend so the trader would wait for a dip in a rising market or a minor peak in a falling market before entering the trade in the direction of the trend.
The logic is that often after a significant move in one direction the price will temporarily reverse as traders that participated in the move may become nervous or decide to bank their profits whilst other participants may begin to feel that the move has gone to far in one direction and place trades in anticipation of a reversal.
One of the main advantages of retracement trades is that they offer the trader a better entry point into an existing trend. So a trader who wants to participate in an established uptrend may first wait for a retracement or reversal against that trend and then enter long at the bottom of that dip just as it starts to reverse back up in the direction of the longer term.
The difficulty with retracement trades is that sometime the retracement does not end as expected but develops into a new opposite trend and price therefore continues moving in the direction of the retracement rather than reversing back in the direction of the original trend as anticipated.
To reduce the incidence of this occurring traders will often look at other "confirming" indicators (such as Japanese candlestick patterns, RSI, MACD, etc) to try and confirm that the retracement has indeed ended and that price will now continue moving in the direction of the longer term trend.
Reversals or “bounce trades” are generally used when the market is range bound or chopping sideways with no clear direction.
Identify support and resistance levels. Where price has previously bounced off and trade the next bounce either upwards or downwards.
Again traders will often look for “confirmations” of the bounce by referencing other indicators such as overbought/oversold oscillators like RSI or stochastics. They may also look for candlestick or some other price pattern in an attempt to confirm the bounce.
Traders are looking for bounce off support and resistance levels such as previous significant highs and lows, Pivot levels, Fibonacci levels, moving averages acting as support and resistance etc.
Often trade percentages can be improved by only taking trades where these levels overlap ie at a pivot level that is also very close to a significant moving average level.
Often reversal trades are relatively short term trades as the price is expected to continue oscillating within its trading range.
Momentum trading is mainly concerned with following the force or impetus of the current move in the expectation that it will continue further under the momentum already established.
As our "O" level Physics would tell us “A body in motion remains in motion” until some external force acts upon it.
Traders are betting that because of the already displayed force of the move that it will continue for long enough to allow them them to hop on and ride it a little further before it begins to lose its energy.
So traders are looking for fast powerful moves which for instance may well occur after news announcements or on the release of other data. On the news release suddenly all participators are re-evaluating their positions in the light of this new information and rush to re-position themselves in the "right" direction.
Often the majority are therefor trying to position themselves in the same direction which causes an excess or imbalance or buying or selling activity which only serves to exaggerate the magnitude of any such move.
There are all sorts of variations on this basic concept and short term traders often use these types of methods combining them with for instance breakouts.
So they looking for a classic breakout through a support or resistance level but which is also occurring with significant momentum behind it ie they want to see price "punch" straight through significant levels with both force and conviction.
The momentum acts as confirmation for the breakout and suggest a powerful move that may well continue for some time.
A common day trading method is scalping.
This strategy involves executing trades based upon very small fluctuations in the price.
A scalper is looking to bank very small winning trades or very small losing trades – often just a matter of gaining or losing a few pips.
The intention is to be in and out of the market within just a few seconds or minutes.
A modern day variation of this is known as "high frequency trading" where trades are being opened and closed in quite literally the blink of an eye.
Whilst scalping can be profitably executed for professional or institutional traders it is almost impossible for the small home based trader to consistently make money using these methods. This is because they first have to overcome the Brokers (or spread bet companies) spread.
The small trader is therefore at the very significant disadvantage of always having to buy at the quoted high price and sell at the quoted low price. This means that each trade starts off as a loser before price has even moved.
So far from you scalping the markets your broker or market maker is actually scalping you . This is because if you always buy from him at the high price and sell back to him at the low price - he must be doing the opposite - so he is always selling to you at the high price and buying back from you at the low price. A very profitable business - for the broker - because even if price never moves he still makes a handsome profit !
Don’t try and scalp it will not work for small home based traders
Six common trading strategies
Moving average crossovers.
Trading systems based on the crossover of two or more moving averages of different lengths is perhaps the most common trading strategies used by home based forex and futures traders.
There are all sorts of variations and refinements on this method but often you are seeking to buy when the shorter moving average moves above the longer moving average and vice versa.
The “correct” moving average lengths vary and have to be calculated for each market and indeed each time frame and change over time.
Other variations include calling for three moving averages to be correctly aligned where you create a "no trade" zone.
The moving averages themselves can be calculated in variety of different ways such as simple, exponential,weighted etc
Channels, Envelopes, Bands
Again all sorts of variations on the basic theme but essentially a channel line is calculated above current price and another calculated below current price.
This can be calculated in a host of different ways but probably the most common would be a channel defined by the highest high and lowest low of some past number of bars (a Donchian channel).
The upper and lower bands can also be constructed above and below the market using some other method. Such as a moving average envelopes where the trader plots a moving average and then offsets it above and below current price.
We could also use some measure of volatility to create the envelope such as Bollinger bands which starts by plotting a moving average and then calculates the width of the envelope using standard deviation of price.
The number of ways to calculate the bands are literally endless but howsoever the band is created a trade is taken when price either breaks through or bounces off the bands.
Breakout traders would buy the upside breakout through the top band and sell the downside breakout through the bottom band.
Reversal traders would sell the bounce down from the top band and buy the bounce up off the bottom band on the assumption that price should remain inside the bands and be constrained by them.
Can both methods work ? .........absolutely - fortunes have been made trading bands in both ways.
This method calculates support and resistance levels based on some measure of previous volatility to calculate an upper and lower level.
A typical volatility breakout may for instance take a percentage of yesterdays range and add that to today's opening price to get the upper level and deduct it from today's opening price to get the lower level.
When price breaks out above this level the trader would buy and when price breaks out below this level the trader would be a seller.
Other "mean reversion" traders may choose to do the exact opposite believing that when price has reached the top band it has become overextended and is likely to reverse and vice versa with the bottom band.
Oscillators are technical indicators that generally move within a set range, such as zero to 100, which indicates the extent to which the market is considered to be overbought or oversold (too high or too low)
Typical oscillators include RSI , Stochastics, and Rate of Change (ROC).
Many other indicators can also be turned into overbought/oversold oscillators such as moving averages which would measure the degree to which price is above or below its moving average.
Reversal traders may look for a market to reverse as it becomes say too overbought (a high oscillator number). They would sell as as the oscillator turns down from that high number in anticipation of price continuing to fall to more “normal” levels.
Oscillators can work well in choppy markets that are constantly changing direction but are terrible in trending markets where the oscillator values can and do remain overbought or oversold for protracted periods of time whilst the market keeps happily trending upwards or downwards.
A massive subject but a price patterns can be as simple as a single bar having a higher high than the prior bar or as complicated as a multi-bar head-and-shoulders pattern forming over several years.
Many forex traders like to trade or at least pay attention to Japanese candlestick patterns of which there are many hundreds.
Simple price patterns such as higher highs and higher lows can be used to define trends.
Many people have made fortunes from trading surprisingly simple price patterns. Probably the most successful trader using this type of trading Toby Crabel.
Seasonals - Time of day/day of week/week of year etc
Time-based trading methods, based either on the time of day or the day of week or month of year or season of year etc are much traded in all markets.
We have all heard of the old stock market saying "Sell in May and go away....) which shows that the vast bulk of stock market profits have arisen in the "good" six months of the trading year (October/November - March/April) whilst the bad six months have delivered little better than break-even over the last 100 years for most of the world's stock markets.
These seasonal patterns can also be very prevalent and persistent in the commodities markets where they are often based around the growing cycles for the agricultural's and meats and other interesting tendencies for markets such as Gold.
Forex also has its own seasonal tendencies. For instance often time of day is used as a forex filter ie only take trades at times when you have the highest volumes – generally the overlaps between the three sessions (Europe/USA/Far East) when two of these markets are trading together you tend to get high volumes and volatility.
OK so there you have it - six types of markets, five trading concepts and six trading strategies
Of course there are a never ending series of refinements on these concepts and strategies listed but I would say 90% of profitable traders will be using one or more probably a combination of these methods to make virtually all of their money.
Trading is very much a case of the law of diminishing incremental returns. Once you start getting into too much detail you have to put in massive amounts of research to often garner very small marginal gains - so do not rush to make it any more complicated than indicated above.
Trading is most definitely a case of making sure that you keep it as simple as possible.
If you stick to the broad strategies and concepts listed above I promise that you will be well on your way to trading success !