3 basic strategies from professional traders

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This article will look at Forex trading for beginners, and will introduce some simple Forex trading strategies. In particular, this article will guide you through three key Forex trading strategies that beginners can use, namely, the Breakout strategy, the Moving Average Crossover strategy, and the Carry Trade strategy.

The Forex market (Foreign Exchange Market or FX) is hugely liquid, with a vast number of participants. It is also a well-established market. As you might expect, the combination of popularity and time has resulted in professional FX traders devising countless trading strategies. As a day trading beginner who might simply be searching for beginner’s trading guides on how to learn to trade Forex, or even a intermediate FX trader seeking some useful trading strategy guides to improve their knowledge and skills, the sheer volume of trading techniques available can be daunting and confusing.

Some day trading strategies are very complicated, with a steep learning curve. So Forex beginners may find it better to start with a simple and easy Forex strategy.

After all, the simpler the strategy, the easier it is to understand the underlying concepts. There will be plenty of time to add complex actions after you have mastered the basics. Regardless of whether you adopt a simple or complex strategy, remember that your overarching mantra should always be to use what works. New traders are generally unable to devote large amounts of time to monitoring developments. For these newcomers to Forex, simple strategies offer an effective but low-maintenance approach.

Three Beginner Forex Trading Strategies

The first two strategies we will show you are fairly similar because they attempt to follow trends. The third strategy attempts to profit from interest rate differentials, rather than market direction.

But first things first – what is a trend?

To put it simply, a trend is the tendency for a market to continue moving in a given overall direction. A trend-following system attempts to produce buy and sell signals that align with the formation of new trends. There are many methods designed to identify when a trend starts and ends. Many of the simple Forex trading strategies that work have similar methods. Trend following can produce large profits. In fact, there are traders who have produced outstanding track records using such systems.

But there are also some drawbacks to these strategies:

  • They are difficult to stick with
  • Large trends can be infrequent
  • The conditions that signify the potential beginning of a trend, are not frequent.

This means that the strategy tends to generate numerous losing trades. The theory is that these losses will be offset by more infrequent but larger winning trades. That is a hard pill to swallow in practice. Also, once the trend breaks down, you tend to give back a healthy amount of your profit. You may have heard the phrase, “the trend is your friend”, but you may not be so familiar with the full expression, which adds “until the end”. The end comes when the trend fails, and this can be very trying on a trader’s psychology.

One big issue with a trend-following system is that you need deep pockets to properly use it. This is because possession of a large amount of capital reduces your chances of going bust during an extended drawdown. So trend following is useful as a Forex strategy for beginners to understand, but it may not be ideal for less wealthy beginners. Now, let’s break down our strategies. The first strategy attempts to identify when a trend might be forming. It looks for price breakouts.

Breakout

Depicted: GBP/USD – Admiral Markets MetaTrader 4 Supreme Edition (MT4SE) – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

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Markets sometimes range between bands of support and resistance. This is known as consolidation. A breakout is when the market market moves beyond the boundaries of its consolidation, to new highs or lows. When a new trend occurs, a breakout must occur first. Breakouts are, therefore, seen as potential signals that a new trend has begun. But the trouble is, not all breakouts result in new trends.

In Forex, even such simple strategies must be used with risk management. By doing so, you seek to minimise your losses during the trend break-down. A new high indicates the possibility that an upward trend is beginning, and a new low indicates that a downward trend is beginning.

So how can we get a feel for the type of trend we are entering?

The length of the period can help determine the highest high or the lowest low. A breakout beyond the highest high or the lowest low for a longer period suggests a longer trend. A breakout for a short period suggests a short-term trend. In other words, you can tune a breakout strategy to react more quickly or more slowly to the formation of a trend. Reacting quicker allows you to ride a trend earlier in the curve, but may result in following more shorter-term trends.

Let’s take a look at a reasonably long-term breakout strategy:

The buy signal is when the price breaks out above the 20-day high, and the sell signal is when the price breaks out below the 20-day low. This is very simple, but there is still a major drawback. Namely, new highs may not result in a new uptrend, and new lows may not result in a new downtrend. So we are going to experience our fair share of false signals.

Using a stop-loss can help to alleviate this problem. To keep things really simple, here’s an extremely basic rule for exiting trades: We are going to take a time-based approach. You simply close your position after a certain number of days have elapsed. This time-based exit side-steps the issue of things becoming tricky when the trend begins to break down. Once you enter a trade, hold it for 80 days and then exit.

Remember, this is a long-term strategy. If you find these parameters do not yield enough frequent signals, they can be adjusted to whatever suits you best. For example, you can try using hours instead of days for a shorter strategy. Backtesting your results will give you a feel for the effectiveness of your choices. MT4SE offers backtesting, along with a large selection of other useful tools.

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Moving Average Crossover

Our second Forex strategy for beginners uses a simple moving average (SMA). SMA is a lagging indicator that uses older price data than most strategies, and moves more slowly than the current market price. The longer the period over which the SMA is averaged, the slower it moves. Often, we use a longer SMA in conjunction with a shorter SMA. For this simple Forex strategy, we are going to use a 25-day moving average as our shorter SMA, and a 200-day moving average for the longer one.

Depicted: EUR/USD – Admiral Markets MetaTrader 4 Supreme Edition (MT4-SE) – Disclaimer: Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admiral Markets (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.

In the chart above, the 25-day moving average is the dotted red line. You can see that it follows the actual price quite closely. The 200-day moving average is the dotted green line. Notice how it smooths out the price movement? When the shorter, faster SMA crosses the longer one, it indicates a change in the trend. When the short SMA moves above the longer SMA, it means newer prices are higher than older ones.

This suggests a bullish trend, and this is our buy signal. When the short SMA moves below the longer SMA it suggests a bearish trend, and this is our sell signal. Rather than solely being used to generate trading signals, moving averages are often used as confirmations of overall trends. This means that we can combine these two strategies by using the confirmatory aspect of our SMA to make our breakout signals more effective.

With this combined strategy, we discard breakout signals that don’t match the overall trend indicated by our moving averages. Here’s an example: If we get a buy signal from our breakout, we should look to see if the short SMA is above the long SMA. If it is, we should place our trade. Otherwise, perhaps it’s better to wait.

Carry Trade

Our final strategy is essential to know. It’s a type of trade that is widely used by professionals too, so it is not purely a beginner Forex strategy. Best of all, it is easy to implement and understand. The essence of the carry trade is to profit from the difference in yield between two currencies. To understand the principles involved, let’s first consider someone who physically converts currency.

Imagine a trader borrows a sum of Japanese Yen. Because the benchmark Japanese interest rate is extremely low (effectively zero at the time of writing), the cost of holding this debt is negligible. The trader then exchanges the yen into Canadian dollars and invests the proceeds into a government bond, which yields 0.6%. The interest received on the bond should exceed the cost of financing the Yen debt.

But there is a drawback:

Obviously a currency risk is baked into the trade. If the Yen appreciated enough against the Canadian dollar, the trader would end up losing money. The same principles apply when trading FX, but you have the convenience of it all being in one trade. If you buy a currency pair where the first-named ”base currency” has a sufficiently high interest rate, in relation to the second-named ”quote currency”, then your account will receive funds from the positive swap rate.

The amount yielded is correlated to the amount of currency commanded, so leverage is an aid if the strategy pays off. As noted earlier though, there is an inherent risk that you could end up on the wrong side of a move in the currency pair. It is therefore important to carefully select the right currencies. Inertia is your friend with this strategy, and ideally you are looking for a low volatility FX pair. It’s also important to note that leverage will end up magnifying losses if you get it wrong.

The Japanese Yen has long been popular as the funding currency, because Japanese rates have been low for so long, and the currency is perceived as stable. The strategy works well at a time of buoyant risk appetite, because people tend to seek out higher-yielding assets. The action of traders implementing the strategy can itself support the strategy, because the more people using the strategy, the greater the selling pressure on the funding currency.

But, there’s a current problem. The global low interest environment, has narrowed interest rate differentials. When risk appetite collapsed during the credit crunch, many fingers got burned as funds flowed into the safe haven of the Japanese Yen. With the Fed signalling its intention to tighten monetary policy in the future, we may yet find the carry trade coming back into favour.

If you’re interested in trading on popular currency pairs such as CADJPY and EURUSD or perhaps more exotic currency pairs such as GBPPLN and USDRON, you can do so by opening a Forex & CFD trading account with Admiral Markets!

Final Thoughts

We hope that you have found this introductory guide to Forex trading strategies for beginners useful. Bear in mind that the examples we have shared primarily aim to get you thinking about the principles involved. Don’t follow a strategy without testing it first. Feel free to put your strategies to the test with our risk-free Demo trading account, where you can trade using virtual currency, with a starting amount of $10,000.

And don’t forget to regularly check our education section for more free insights, articles and tutorials. Additionally, if you are feeling confident, and would like to test out some more advanced trading strategies, why not read our guide on the best forex trading strategies? And find out what the best trading strategy is for you.

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A demo account is the perfect place for a beginner trader to get comfortable with trading, or for seasoned traders to practice. Whatever the purpose may be, a demo account is a necessity for the modern trader. Open your FREE demo trading account today by clicking the banner below!

About Admiral Markets
Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world’s most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.

What are some basic Forex trading strategies?

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In the first installment in a series, we look at some of the basic requirements to set up a proper trading plan.

Whilst trading on the forex markets is not something to be taken lightly, the actual organization of it all is not that tough to understand. Being organized always helps so if you have a clear plan on how to go about doing this whilst also letting emotions get out of the picture.

A structure plan – like building a business

Trading is a volatile and unpredictable pastime, so if you don’t set out a proper plan, you’ve got no method of gauging your success. Incidentally, research has s.

Basic Basis Trading Strategies

As the popularity and trading volumes of BitMEX grow, I repeatedly receive questions from traders about how to execute interest rate trades using BitMEX products. As I discussed in my previous article, a Eurodollar is a USD deposit held outside of America. The interest rate or basis trades I will describe below all take advantage of higher Eurodollar interest rates in Bitcoin.

A spot Bitcoin exchange essentially is a pseudo-bank that offers USD deposits (aka Eurodollars). The interest rate on these Eurodollars is high mainly because of counterparty risk. There is no deposit insurance, and exchanges routinely get hacked or steal customers’ money.

Traders on derivative exchanges would like to own more Bitcoin than they have cash to purchase. Market makers and arbitrageurs who are usually short Bitcoin, hedge themselves by purchasing it with USD held on the underlying exchanges.

These traders supply USD to speculators for a positive rate of return. This interest or basis compensates them for counterparty risk and the opportunity cost of capital. The three basic basis strategies I will describe below allow traders to capture this basis as profit.

First, it is necessary to have an elementary understanding of the futures and swap contracts that BitMEX offers.

Futures Contract: The buyer or seller is entitled to the difference between the entry and settlement price at maturity. Buyers and sellers pay and receive fixed interest rates depending on whether the basis is positive or negative respectively at entry. Basis is the difference between the futures and spot price.

For the following examples I will use the BitMEX Bitcoin / USD 100x Leveraged 31 March 2020 Futures Contract, XBTH17. Each contract is worth $1 of Bitcoin.

Swap Contract: This derivative is similar to a futures contract, but there is no settlement date. Traders are free to hold their position for as long as their capital allows. To anchor the swap price to the underlying spot price, interest rate payments are exchanged between longs and shorts depending on whether the swap is trading at a premium or discount. A swap contract is an exchange of floating interest rate payments for price performance.

For the following examples I will use the BitMEX Bitcoin / USD 100x Leveraged Swap Contract, XBTUSD. Each contract is worth $1 of Bitcoin.

Both XBTUSD and XBTH17 use the same underlying index. Therefore, trading one against the other in the same quantity eliminates any Bitcoin / USD price risk.

Future vs. Spot

This is the simplest basis trade. This strategy is commonly called cash and carry. Basis can be positive or negative, but usually futures trade more expensive than spot. This is because speculators who are short Bitcoin can only make 100%, but infinity is the maximum return for longs.

Mechanics

  1. Buy $1,000 worth of Bitcoin.
  2. Sell 1,000 contracts of XBTH17.
  3. At expiry, sell the remaining physical Bitcoin.

Margin Considerations

You must deposit at least 1% of the Bitcoin value of the XBTH17 position with BitMEX. The remaining Bitcoin you should store yourself in a properly secured Bitcoin wallet. If the XBTH17 price rises, your position is at risk of being liquidated.

If you are completely comfortable with BitMEX counterparty risk, then deposit the full Bitcoin value. By using 1x leverage, you cannot be liquidated. Otherwise you will have to monitor your liquidation price and occasionally top up your BitMEX account.

Profit Potential

The basis captured is your profit. You must hold the trade until XBTH17 expires to realise the full amount.

Risks

If you do not fully margin the XBTH17 position, you risk getting liquidated if the price rises before you can deposit additional margin on BitMEX.

Swap vs. Spot

This has become a very popular trade due to the historically positive funding rate. A positive funding rate means that longs pay shorts every eight hours. Since May 2020, XBTUSD shorts have been paid a total of 37.60% of interest (47.16% annualised).

Mechanics

  1. Buy $1,000 worth of Bitcoin.
  2. Sell 1,000 contracts of XBTUSD.
  3. Unwind the trade when you believe funding will turn negative for an extended period of time.

Margin

The margin considerations are the same as with the previous trading strategy.

Profit Potential

It is impossible to know the exact amount of profit before entering the trade. This is because the funding rate changes every eight hours. This is the definition of being long a floating rate instrument.

As mentioned earlier, over the past nine months, this strategy yielded a positive 35.58% outright profit.

Risks

The funding rate can and does go negative. When the funding rate goes negative, you lose money. Depending on when you enter the trade, you could experience long periods where you pay funding every eight hours.

During prolonged periods of negative funding, many traders unwind the position rather than continue to bleed. Bitcoin has been in a bull market since this product was launched, it will be interesting to observe the funding rates during a prolonged sideways or bear market.

Future vs. Swap

This is the most advanced strategy I will present today. This is a fixed vs. floating interest rate trade. Unlike the previous two strategies, the performance can be amplified using leverage on both legs of the trade.

Sell Future vs. Buy Swap Mechanics

This is referred to as a curve flattener. If the futures basis decline is greater than the interest you pay being long swap, either due to time decay or an outright movement in the implied interest rate, you make money.

  1. Sell 1,000 XBTH17 contracts.
  2. Buy 1,000 XBTUSD contracts.

If you place the trade when XBTH17’s basis is positive, wait until expiry, and then sell the XBTUSD contracts.

If you plan to trade around the XBTH17 basis, wait for the XBTH17 basis to fall sufficiently, then buy back XBTH17 and sell XBTUSD to unwind the trade at a profit. You will employ this strategy when the XBTH17 basis is already negative but you expect it to decline even further.

Selling XBTH17 at a negative basis means you bleed money each day until expiry (aka negative carry or negative theta). I tend to avoid any situation where my fixed interest leg is entered into at negative carry. It makes turning an eventual profit more difficult.

This type of trade is also a bearish trade with respect to Bitcoin spot movements. During a quick and sharp drop, traders will short futures and swaps. The futures’ basis will decline and turn negative, and the swap funding rate will go negative as well. In this situation, profits due to movements in interest rates will accrue on both legs.

Buy Future vs. Sell Swap Mechanics

This is referred to as a curve steepener. If the futures basis rise is greater than the interest paid being short swap, either due to time decay or an outright movement in the implied interest rate, you make money.

  1. Buy 1,000 XBTH17 contracts.
  2. Sell 1,000 XBTUSD contracts.

If you place the trade when XBTH17’s basis is negative, wait until expiry, and then buy back the XBTUSD contracts.

If you plan to trade around the XBTH17 basis, wait for the XBTH17 basis to rise sufficiently, then sell XBTH17 and buy back XBTUSD to unwind the trade at a profit. You will employ this strategy when the XBTH17 basis is already positive but you expect it to rise even further. Buying XBTH17 at a positive basis means you bleed money each day until expiry.

This type of trade is also a bullish trade with respect to Bitcoin spot movements. During a bull market, traders will buy futures and swaps. The futures’ basis will rise and turn positive, and the swap funding rate will go positive as well. In this situation, profits due to movements in interest rates will accrue on both legs.

Profit Potential

The interest rate differences captured are small. In order to earn a respectable return on equity, leverage must be employed. If the interest rate differential received is 1% unlevered, your return on capital is only 0.5%. Each leg must be margined separately.

Using the same example but with 10x leverage, your return on equity increases to 5%. The one benefit to curve trades is that you do not need to hold until expiry of the futures contracts. You can go one way, then reverse quickly as conditions change. In this way, you become an interest rate day trader.

Speculating on curvature is more difficult, but there are less people employing such strategies. Those who understand the mechanics will be presented with many no-brainer profit opportunities.

Risks

For a curve flattener, you are long swap. If the total net swap funding payments (i.e. the funding rate is positive) exceed the basis income from selling the futures contract, you lose money.

For a curve steepener, you are short swap. If the total net swap funding payments (i.e. the funding rate is negative) exceed the basis income from buying the futures contract you lose money.

In general, when the futures basis is positive, longs pay and shorts receive swap funding. When the futures basis is negative, longs receive and shorts pay swap funding. This is because traders will arbitrage the two products to keep the interest rate differentials in line. Profiting from this strategy requires excellent foresight into how the interest rate curve will move.

Conclusion

The most important part of the three strategies that I outlined is that none of them take any Bitcoin price risk. Bitcoin to basis traders is just another asset with an interest rate curve that can be arbitraged. This curve becomes distorted during highly leveraged speculator induced spot price moves. This allows savvy traders to earn excellent volatility adjusted returns.

Basic Basis Trading Strategies

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