Trend following strategy

Trend following strategies, as the name says, follow the main trends, or direction, in the value of an instrument. The goal of this strategy is to cut losses quickly while letting winning trades continue to run further. The main trading directions can be identified over relatively high time frames: monthly, weekly or daily. In these cases, one candle on a chart translates to one month, week or day. These trends are long enough to determine which side is dominant, buy or sell. Strong trends are considered ones that last longer than a year.

In this forex trading strategy, it is important to identify the key support and resistance levels that represent the top and bottom of a given trading range. Longer time frames give strong support and resistance levels, which are key factors when determining the target and stop-loss prices a forex trader should use. The difference between your entry price and stop-loss will represent your risk, while the difference between your entry price and target price is your potential reward. Good risk/reward opportunities can usually be found at the break of so-called countertrends, or shorter trends that go opposite a longer major trend.

The main tool of risk management here is a stop-loss. It should be set in line with the volatility of an instrument, which is measured by the so-called Average True Range (ATR) indicator. The difference between the entry point and stop-loss should be more than 1 ATR. This way, a random market movement will not hit your stop-loss.

The difference between your entry point and stop-loss will be the amount on which positions should be sized. The size of positions are given in what are called lots. Sizing the lot is an important element of risk management.

In general, 1-2% risk is suggested per position. The bigger the account size, the lower the risk percentage should be. You should also monitor economic data, because major events may cause high volatility or trend reversals that could hit your stop-loss.

Read this detailed description of a forex trade built on trend following strategy.

Scalping

Scalping strategies are about catching small market movements with large positions within a very short time. This is characterized by executing a large number of trades, so it is completely the opposite of holding positions for hours, days, or even weeks.

The time frame of this strategy is low: usually it is done in the 1 minute chart, where 1 candle represents 1 minute of information. Tight spreads and low commissions are very important in this strategy because these costs need be covered by few market movements. You cannot be profitable if you catch 3 pips on the average, while your spread cost is also around 3 pips.

It is essential to follow this strategy only at brokers that provide quick order execution and no slippage. Fast order execution helps maximize your profit by catching the price you aimed at quickly. Trading gaps can also put your profit at risk, therefore this strategy should be executed when there is a low probability of gaps. You can avoid that by not trading at:

• times of high-volatility economic news
• low-volume trading times
• market opening and closing

The time frame of scalping is characterized by large market noise, therefore it is hard for beginners to be profitable using this strategy. This type of strategy has a lot of psychological pressure, so it is not recommended for beginners. 

Carry trade

Carry trade strategy is about buying a high-interest-rate currency against a low-interest-rate currency. The profit comes from the difference between the high interest you receive and the low interest you pay, plus the favorable exchange rate movement. In other words, carry trade is focused on profiting from a swap and the exchange rate. The time frame of this strategy is months or years.

For example, let’s say that a trader decides to deposit $1,000 into a forex trading account. They choose to buy USD/CHF for a positive carry trade, which has an interest rate differential of 3.25%. Using leverage of 20:1 they can open a $20,000 position for the currency pair, meaning that the deposit is only 5% of the full value. A 3.25% interest rate difference becomes 65% annual interest on an account that is 20 times leveraged.

The monetary policies of central banks are key to a carry trade strategy, mainly with regard to the future directions of interest rates.

A carry trade strategy can result in 3 outcomes:

• If the currency bought with the higher interest rate appreciates against the currency sold with the lower interest rate, the trader will gain profit on the exchange rate and will receive the positive interest of the full position value.
• If the currency bought with the higher interest does not change to the currency sold with the lower interest, then the trader will receive the positive interest on the leveraged trade and will not encounter any other profits or losses.
• If the currency bought with the higher interest rate depreciates against the currency sold with the lower interest, the trader loses on the exchange rate, but will receive the positive interest of the full position value.