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What are the best forex trading strategies? Of course, this is a question that I am asked many times a day and it is very important. When you start trading, you need to develop a specific trading strategy and focus all your attention and energy on doing it. Most traders never do this and then fall victim to system jumping.
In this guide, I’ll explain the differences between the different types of strategies, their assumptions, when they work best, and what you need to know when choosing a specific forex trading strategy.
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As you will see, each trading strategy and style tries to capture different market behavior. This will also be one of the most important points because I am a big believer in expertise. Instead of trying to trade all the time, you should pick a specific market behavior and try to be the best at it.
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Following the trend is the approach most traders experience in the first place because “the trend is your friend” has been around for decades.
As the name suggests, trend following is a trading style where the trader has to wait for a fixed trend to jump in the market. Therefore, trend-following traders should wait patiently for the true trend to emerge.
The image below shows part of the market movement that is usually recorded by trend following traders. Red areas highlight market turning points and blue areas are trend-following phases.
Many amateurs make the mistake of trying to predict a new trend before it exists and jump into it too soon. Those traders, even though they believe they are trend traders, are actually contrarian traders.
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Since trend traders still have to wait for the trend to be confirmed, the question that arises is: When is a trend confirmed?
Early Trend Additional traders try to enter a new trend as soon as possible, which can lead to premature and wrong signal execution. The advantage is that the potential reward/risk ratio is much higher.
Late trend traders await further confirmation. Of course, it may happen that they are too late, but their signals are often stronger. The trade-off is that the reward/risk ratio is not as high, although the royalties are higher.
When it comes to trading instruments, a trend trader can choose from a wide variety. Momentum indicators such as MACD, RSI or STOCHASTIC are often popular.
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In the picture below, the STOCHASTIC is plotted and one way to enter the trend after trading is to wait for the STOCHASTIC to reach the bottom or top area. Many traders make this mistake and believe that it could be a sign of a reversal which is completely false. A very high or very low statistic indicates a strong trend.
Of course, the moving average is another popular trend after the instrument. Two moving averages work perfectly as a crossover signal in the image below. Each time the moving averages are crossed, a new trend begins. The great thing about such a crossover system is that traders automatically avoid picking highs and lows because moving averages take time to cross.
The Ichimoku indicator is another trailing trend tool. It is similar to a moving average crossover system but the location is different. A classic Ichimoku position is given when the price breaks out of the “cloud” while the two Ichimoku lines move in the same direction.
Cashback is a different type of post-trade process. Money back traders look for a consistent trend and deal with so-called correction phases. Price movement corrections are in the opposite direction of the basic trend.
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In the image below, the market was in an uptrend and pullbacks (corrections) were short periods when the price moved in the direction or against the trend.
A pullback or weights trader enters trades for price continuation in the direction of a trend or even when the market is moving down. The danger of the second approach is that the retreat does not turn around. But the upside is that the reward/risk ratio may be higher.
It doesn’t always pull back the market. The example on the left shows a market where the price only moved lower but never pulled back. The second and third phases have multiple pullbacks and offer good entry opportunities for money-back traders.
As you can already see, retracement and post trend overlap a lot, and post trend traders often also trade retracement as a natural progression.
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Of course, there are different ways how to create a pullback in your charts. There are 3 examples in the picture below.
Moving averages are also a popular tool for retracement. A pullback can be traded when the price is in a trending market and reverts to the moving average. Either, the trader trades the price when it reaches the moving average or waits for the price to resume the trend.
As we’ll see when we talk about breakout trades, we can also trade so-called price patterns like pullbacks. In the image below, the price was in a clear decline when the head and shoulders formed. In such a context, the formation of head and shoulders becomes a trend-following pattern and can be considered as a pullback. The lines between backtracking and gear following are blurred here.
Therefore, reverse trades can also be considered very early post-trade trends. However, it is usually more efficient to choose between classic trend following and reversal as each trading approach has its own unique characteristics.
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The image below shows a chart with different market stages and trend stages. Trend-following traders usually go for an early or mature trend. A contrarian trader starts paying attention to the market when the market enters the maturity stage. This usually happens when at least 2 or 3 rib waves form.
The trader risks premature reversals and constantly operates in a contrarian mindset. Many failed reversal traders try to predict market swings before they happen. The grid drives traders here because they believe that the earlier they are, the closer they can get to the absolute high/low, resulting in a much higher reward/risk ratio.
When it comes to reversal tools, divergences are the classic confirmation. RSI divergence indicates tired trends where trend strength is waning. When an adult trend gives you an RSI divergence, a reversal can often occur.
The RSI is usually a trend indicator, but it can also work very well as a reversal tool when the RSI shows that a trend is losing strength. MACD or STOCHASTIC can also be used as a reversal tool.
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I see myself as a classic reversal or very early trend follower. As a trend follower, I’ve never been comfortable following these trends, and when I learned that reversals aren’t about predicting reversals before they happen, reversals became a fun way to trade.
A breakout describes a departure from a stabilizing pattern. Consolidation patterns, as the image below shows, can occur at market turning points (tops and bottoms for reversals) or during stable trends.
The screenshot below shows how integration and breakout are the link between two market stages. Consolidation can occur at market turning points and breakouts are trend reversal signals. If a consolidation occurs during a steady trend, a breakout will enter the trend after the signal.
The image below again highlights this feature and reveals how breakouts combine different market phases. As a trader, it is usually best to choose a specific type of failure. Trying to deal with all failures can lead to bad results and confusion, as each stage of the market behaves differently and therefore requires a different set of tools, signals and understanding.
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Breakout traders are pattern traders, and breakout traders usually look for lateral consolidations, heads and shoulders, wedges, and any other form of consolidation. The following scenario shows a wedge, which is a so-called consolidation pattern. Wedge characteristics indicate that the previous uptrend is winding down, as the price cannot easily go higher. A losing trader then waits for the market to make a significant move in the opposite direction and break out of the pattern.
Breakout trading is very versatile, which is why it’s so important to determine whether you want to be a trend, reversal, or pullback trader. Each market phase follows its own unique rhythm and should be approached differently.
As I said, even though I see myself as a reversal/early post trader, I also say that I trade the breakouts. It helps me define my business persona even more. I want to see clear patterns with a well-defined breakout point at a market turning point.
Most traders are never sure what defines them and knowing the differences and overlaps can be helpful in determining your trading strategy.
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I trade various reversal and breakout patterns, but one of them is the classic head and shoulders. Head and shoulders pattern
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