Jared F. Martinez (The FX Chief™) is an author, forex mentor, educator, market analyst and entrepreneur, as well as the founder of Market Traders Institute, Inc. (MTI).
Developing a winning forex investment plan is not unlike piecing together winning strategies for other asset classes. First and foremost, you must assess what kind of investor you are.
Are you hoping to catch big profits from day-trading? If day-trading isn’t your cup of tea, perhaps you’re a swing trader that wants to be in a trade for a few days or few weeks. Or maybe you’re a longer-term forex investor, in which case currency Exchange-Traded Funds (ETFs) or a managed futures account may work best to help you accomplish long-term financial goals.
Remember that an investment strategy is NOT a system. Trading systems are mechanical and rigid. Even the good ones can only be altered so much. On the other hand, an overall investment plan or strategy should be fluid and be able to change as your objectives change.
A winning forex strategy should be able to deliver profitable results in a variety of market conditions. Knowing that, let’s take a look at a few ways to develop a top-flight trading strategy.
Choose the Right Currency Pairs to Trade
As the forex market has grown, so have the available options for traders. Even rookie forex traders know about the major currencies; the European Euro (EUR) aka Fiber, British Pound (GPB) aka Sterling, U.S. Dollar (USD) aka Greenback, Swiss franc (CHF) aka Swissy, Japanese Yen (JPY), Canadian dollar (CAD) aka Loonie, and the Australian Dollar (AUD) aka Aussie. Forex investors now have access to more currencies known as exotics. These exotics include the Mexican Peso, Brazilian Real, Thai Baht and South African Rand.
Now, it may sound intriguing and alluring to play the exotics, but be assured that the risks and the costs are higher. If you trade a major pair like the euro/US dollar (EUR/USD), you might have a bid/ask spread of just one or two pips simply because this is a highly liquid pair and one that thousands of investors trade every day.
On the other hand, if you invest in a more exotic pair like the US dollar/Thai Baht, you may see a spread of five pips or more and that’s your cost to enter the trade. In addition, it’s harder to get off an exotic trade because the exotic currencies are far less liquid than their major counterparts. So proceed with caution if you’re considering an exotic currency pair.
Keep Your Losses Small, Let Your Winners Run
Seems simple, doesn’t it? Yes, it does, but it’s surprising how many investors don’t follow this advice. This applies to the trading asset class, but especially to forex, where the use of leverage puts the investor who isn’t cautious at risk of losing more than his initial investment.
So how do you keep your losses small? Regardless of what type of forex investor you are, assess your risk BEFORE you get into the trade. Decide how much you are willing to lose and if the trade goes against you; don’t let it go any further than your predetermined loss threshold. Don’t turn a losing trade into a disastrous investment.
On the flip side, we don’t want to cut a winning trade short or let it turn against us. The way to do this is by using protective stops. Once your profit goal is reached, set a protective stop at that price and let the trade ride.
The worst thing that can happen is that the trade goes against you, but you’ve already locked in some profit. If the trade keeps going your way, move your stop order to lock in even more profits.
Know Why You’re Investing in a Particular Currency
While many investment experts believe the market acts at random, that doesn’t mean you should pick currencies to invest in at random. Since the forex market is more volatile than stock or bond markets, we cannot hold forex investments for months or years as we might be able to do with stocks and fixed income. This volatility makes asset selection critical.
Are you going long on the Canadian dollar because oil prices are rising? That’s a sound investment thesis, but if you’re just buying a currency because you think it’s going to do what you want it to, you might be better off heading to a casino and gambling. When you buy stocks, you probably have a logical reason for doing so. Forex should be no different.
Research and Test Your Strategies
With all the advancements in technology, it is possible for traders to test their strategies on demo accounts without risking a penny. This is a wise move, especially for those new to forex investing.
In conjunction with testing your strategy, there are plenty of free resources available for you to research how various currencies act during a variety of market conditions. Since these conditions invariably repeat themselves over history, it is worth looking back at past trends in order to get a leg up on the future.