We love trading forex (FX) markets. It’s usually our highest-returning asset class from a profit perspective. Trading FX markets is much different than investing in the stock market. With a stock, you can analyze its fundamentals, read an income statement, and determine a roughly right range of fair value.
Currencies (i.e., FX markets) aren’t like that—the most prominent players in the game trade FX. I’m talking about billion-dollar institutions, sovereign wealth funds, even governments that buy/sell in the FX market. To trade profitably (and consistently) in FX markets, you need a gameplan—a blueprint to analyze each currency market and make trades with precise risk control and predetermined profit targets.
While there are myriad ways to analyze FX markets, we’ll highlight our favorite: technical analysis. There are two ways we use technical analysis (TA) in our FX trading. First, we trade classical chart breakouts/breakdowns. Second, we’ll trade volatility breakouts and failed volatility breakouts using Bollinger bands.
FX Trading: The Basics
There are a few basic rules you must learn before trading in FX markets. First, currencies always trade in pairs. For example, if you want to trade the US Dollar, you must trade it paired with another currency, like the Euro. In this instance, you would buy the USD/EUR currency pair.
Currency pairs lead us to our second basic rule. The first currency in a pair is always the currency in which you’re taking a directional bet. Let’s use our USD/EUR example from above. If we want to bet that the USD will rise against the EUR, we will buy that currency pair. If we thought the USD would trade lower relative to the EUR, we would either sell short the USD/EUR or go long the EUR/USD pair.
Lastly, we’ll talk about pips. Don’t worry if you haven’t heard the word ‘pips’ before; it’s exclusive to the FX community. ‘Pip’ stands for Point in Percentage, representing the fourth decimal place in a currency pair. For example, say the Swiss Franc (CHF) moved from 1.4050 to 1.4100. That would signify a 50 pip move. Stay with me!
Pips have a range of values depending on how many units (or lots) you buy of a currency. If you buy 1,000 units (called a micro lot), a pip is worth $0.10. If you bought 10,000 units (mini lot), each pip is worth $1. If, however, you purchased 100,000 units (standard lot), each pip would have $10 in value.
Now you can see the inherent leverage traders have in FX markets.
Let’s talk about technical analysis.
Why You Should Use Technical Analysis in FX Trading
FX trading is one of the most demanding markets to trade for beginners (and advanced) traders. The best traders trade currencies, and you’re competing against some of the largest pools of money in the world.
So what will give you an edge against the competition? It isn’t in the fundamental analysis (i.e., trying to guess macro trends like country-specific economic cycles, etc.). Your advantage will come from a technical analysis of the stock chart and price action.
We do that in two ways: classical breakouts and volatility/failed volatility breakouts. Let’s examine these in more detail.
Classical Charting in FX Markets
Classical charting is about finding simple, repeatable geometric patterns on a stock chart. For the most part, we’re looking for the following patterns:
- Symmetrical Triangle
- Inverse Head and Shoulders
- Head and Shoulders Top
- Ascending/Descending Triangles
We won’t cover all these patterns, but if you want to learn more about specific patterns, check out our article here.
There are two reasons we trade with classical chart patterns. First, patterns give us a precise entry point into a trade. Whether it’s a breakout from resistance or a breakdown below support. Charts show us where to enter.
Second, charts provide exact risk/reward parameters and profit targets. When combined with strict risk management, classical charting offers the investor some of the clearest return profiles per trade.
No strategy is perfect, however, and classical charting has its flaws. Classical charting has a higher failure rate than other trading strategies. This isn’t an inherently bad thing (assuming strong risk management). But it does require a specific personality to trade well.
Ask yourself, “can I handle losing ten trades in a row and still take the next set-up?” If your answer was no, you might like our second strategy.
Volatility/Failed Volatility Breakouts (VBO/FVBO) FX Strategy
The VBO and FVBO FX strategy rely on many of the same premises from our classical charting strategy. The system creates precise entry/exit points, which lends itself to easy-to-understand risk/reward measurements.
The main difference between the two strategies is the type of trade and hit rate percentages (i.e., how many trades you win as a percentage of total trades placed). In short, the strategy uses Bollinger Bands to measure when a stock has broken out of its normal volatility range. Then, if the next day’s bar closes inside the “breakout” bar, we place a buy (or sell) order in the direction of the second day’s bar.
For example, say a stock sells off hard and closes the day outside its Bollinger band. The next day it reverses and closes inside the band but not above the previous day’s high. In this example, we would place a buy stop order above the high of that current day. Our stop is either at the low of the present day’s candle or the previous day’s candle.
Find Your Perfect FX Trading Strategy
So there you have it! Two great strategies to get you started in FX markets. Remember, FX markets are highly leveraged, and you can easily blow up. Risk management is crucial in this arena.