As an investor in stock markets, you must have often come across the term: forex trading or currency trading. Well, it might be perhaps not as popular as investing in stocks, but it is definitely an investment segment with good opportunities. You must, however, know the right trading strategies to get returns from your investments in the forex exchange. But before that let’s understand the key concepts of the foreign exchange market.
Global forex exchange
The global foreign exchange market comprises investors from different countries, investing in the major currencies of the world. Apart from individual investors, there are participants such as corporates, national banks, forex broker companies, investment management companies, and so on. You can invest in global currency trading in two ways :
- Currency market futures
Here, you can take positions of the major currencies. It requires entering into a formal contract to purchase or sell currencies at a predetermined price on a specified future date.
- Spot market/cash market
In contrast to currency market futures, spot or cash market provides the facility of buying or selling on foreign currencies, for immediate physical delivery, on a predetermined spot date. The forex exchange rate on currencies is known as spot exchange rate.
Forex trading in India
In India, you can only trade in currency futures, and there is no provision for spot/cash transactions. Currency trading is allowed in stock exchanges, like the Bombay Stock Exchange, National Stock Exchange and Multi Commodity Exchange of India Ltd (MCX). The currency trading marfket is open from 9pm to 5pm, and you are required to open a forex trading account. You can trade in currency futures on only four currency pairs: Indian Rupee (INR) vs Euro (EUR), INR vs Great Britain Pound (GBP), INR vs United States Dollar (USD) and INR vs Japanese Yen (JPY). Further, forex trading in India allows cross-currency futures and options in three currency pairs : EUR vs USD, GBP vs USD and USD vs JPY.
Example of a basic forex trading strategy
Traders’ decision to trade forex depends on technical analysis or market news, which triggers trade signals such as buy and sell decisions. Most successful forex traders build a strategy over time.
Here is an example of a basic forex trading strategy that will help you understand how forex trading is influenced by changes in the international market.
Let’s assume a trader expects the value of the US dollar to rise. The current rate of exchange between AUD/USD is 0.67. It implies that it takes USD 0.67 to buy AUD 1.00.
Assume that the trader was right and that, indeed, the interest rate in the USA changes. The dollar has become stronger, and the exchange rate of AUD/USD changes to 0.45, meaning it will now take USD 0.45 to buy AUD 1.00. If the trader had gone long on AUD and short on USD, he could profit from the changes in the foreign exchange rate.
Some good Forex exchange trading strategies
According to market experts, all the good forex trading strategies involve both technical and fundamental analysis to assess the suitability of buying and selling of currency pairs. A good currency trading strategy can help you to not only receive returns from your investments but also to have a sound risk-management system in place. Here’s a list of some good forex trading strategies:
- Price action trading: Here, you are required to study the historical prices of currencies. You can use the following technical techniques within the overarching framework of this strategy:
- Length of trade: You can use different time periods, like short-term, medium-term, and long-term to analyze the price of currencies.
- Entry and exit points: Knowing the support level ( the low price point of a currency over a period of time) along with the resistance level ( the high price level of a currency over a period of time) to determine the entry ( purchase) and exit (selling) points respectively. You can know both the points for forex trading using :
- Fibonacci retracement: Using the mathematical Fibonacci’s sequence of numbers, you are required to identify a major movement of currency price and then apply it to the starting point.
- Candlestick charts: This can allow you to visually identify the price fluctuations such as the highs and lows.
- Identification of trends : You can identify trends via the price action mechanism to identify trends, assess a viable risk-management model and determine your entry position.
- Oscillators :This can help you identify the risk to reward ratio, especially when the market price correction of a particular currency is reaching its end. Relative Strength Index (RSI), Commodity Channel Index (CCI) and stochastics are among the common examples for oscillators.
- Technical indicators: These include chart analysis tools to measure variables such as price averages, market volatility etc. The indicators can help you know about the price movement of currencies.
- Range trading strategy: This technical analysis involves identifying the key support and resistance levels to determine the timing for execution of currency trading. At times, price action is used together with oscillators in this strategy. While this forex trading strategy can allow for a greater number of trading opportunities along with identification of a suitable risk to reward ratio, the process involved for technical analysis is often lengthy and cumbersome.
- Trend trading strategy: You can use this forex exchange trading strategy by identifying the directional strength of the market. You can use variables such as length of trade and entry/exit points to buttress this strategy. Though strong trends can allow you to zero in on a suitable currency trading strategy, this again is time-consuming, given the multiplicity of variables required for technical analysis.
- Position trading strategy: This long-term forex exchange trading strategy primarily considers fundamental factors. Here, minor fluctuations of currency prices are not considered. While this strategy is less time-consuming, it provides for determining a suitable risk to reward ratio.
- Day trading strategy: Here, all positions are closed in a day’s trading session. It can provide for a greater number of forex trading opportunities.
- Forex scalping strategy: This currency trading strategy involves frequent short-term trades, within a short time interval, for getting minimal returns. The time period can range from 30 minutes to 1 minute. It provides for the largest number of currency trading opportunities, although the risk to reward ratio is low.
- Swing trading: This is a medium-term speculative forex exchange trading strategy, where you have to consider: trending markets and range bounds (buying at support trends and selling at resistance trends). To determine entry and exit points oscillators and indicators are used.
- Carry trade strategy: A key forex trading strategy involves borrowing a particular currency at a lower rate and simultaneously investing in a currency that provides a high yield rate. This can provide for a positive carry of trade. This strategy is directly contingent upon interest rate fluctuations of the particular currencies.
Thus, you can choose a viable strategy for trading in the foriegn exchange market after considering crucial factors, like trading opportunities, risk to reward ratio, and the time involved in carrying out the fundamental/technical analysis. For forex trading in India, do remember to choose a reliable financial partner for opening your forex trading account. Look for features, like hassle-free account opening, zero AMC, zero percent brokerage, and decades of trust.
What is a forex trading strategy?
Foreign exchange trading strategies involve a set of rules and techniques that guide traders to make informed decisions regarding buying or selling currency pairs in the foreign exchange market. A forex strategy outlines the entry and exit points, risk management principles, and indicators to analyse price movements.
How can I start forex trading in India?
In India, foreign exchange trading takes place at the National Stock Exchange, the Bombay Stock Exchange, and the Metropolitan Stock Exchange. You must first find a reputed online foreign exchange broker and open a foreign exchange trading account to start trading.
How do I develop a forex trading strategy?
Developing forex strategies involve considering various factors, such as personal trading goals, risk tolerance, preferred timeframes, and trading style. Traders use technical analysis, fundamental analysis, or a combination of both to develop a strategy that suits their individual preferences.
How can I test the effectiveness of a forex trading strategy?
You can test the effectiveness of a forex trading strategy using historical data through backtesting or using demo accounts. The backtesting method involves applying the strategy to past market data to evaluate its performance. Demo accounts allow traders to test their strategies in real-time market conditions without risking real money.