Forex CFDs Trading Strategies

The foreign currency exchange (forex) market is a popular investment option with both amateur traders and experts.  Simplicity and Transparency are factors that allow anyone to create a decent trading strategy.

In this article, Market10 looks at forex trading through CFDs (contracts for difference). You can learn more about CFD basics and methodology in our introductory article.

Ways to trade forex

Forex trading works very similarly to stocks and shares. Among the most popular forex options is spot trading. Here, you buy one currency using another currency at the current exchange rate between them. Hence, you own that value of the bought currency, either physically or in a digital wallet.

In forex spot trading, the value of the currency you own has to strengthen against other currencies. For example, you can buy US Dollars with Euros and when the US currency strengthens, convert it back to a larger amount of Euros than you invested. This is the traditional way of trading forex, but it ordinarily lacks volatility.

Factors that influence forex rates

A nation’s currency is backed by the huge reserves of powerful central banks and monetary authorities. Because of this, fluctuations in minor data indicators have a minimal effect on a currency’s exchange rate. Instead, forex is a field largely influenced only by macroeconomic data.

Before you begin to trade forex, particularly in the fast-paced and potentially high-risk world of forex CFDs, understand these major influences on forex rates:

Political stability

Foreign investment plays a major role in the strength of any nation’s currency. To be an attractive investment destination, the country must show itself to be a politically and socially stable environment.

Economic performance

Intimately tied to political stability, positive economic performance is indicative of efficient policy. Since most government policies are long-term visions created to generate economic success, their effect is seen very readily in the economic health of the country. This positive performance invites further national and international investment.

Current account deficit

A country’s current account is a measure of the value of goods and services. It buys from international trade partners against the value of what it sells to them. A positive current account balance indicates that the country is receiving more foreign currency than it is spending. A current account deficit indicates the opposite, and usually points to a failure to produce valuable goods and services.

There is an exception to that rule, though. Emerging economies, where large swathes of the population are entering the middle class and acquiring massive purchasing power may tilt the balance into the red. However, this willingness to spend is good for the nation and usually ultimately strengthens the currency.

Relative inflation

Historic evidence shows very clearly that inflation is unavoidable. This means that the true value of every unit of currency is gradually falling. In that sense, the ability of a country’s domestic inflation rate to stay below the world average, particularly in comparison with the major currencies bodes well for a strong national currency.

National interest rates

High interest rates are good for banks and other financial institutions which lend to individuals and firms. Central banks usually lower interest rates when the country is struggling financially to prevent large numbers of loan defaults. Since there is such a close correlation between the strength of a nation’s banks and its economic resilience, high rates indicate a strong currency.

Newly-released figures for macroeconomic data can cause significant changes in all markets, including shares and forex trade. It is always prudent to consider entering a predetermined stop loss and/or take profit triggers on your trades to minimise the risks involved due to leverage.

Basic forex trading strategies

As it is with any instrument, there is no ‘one size fits all’ solution for successful forex trading. An individual’s psychology, resistance to loss and appreciation of profit, as well as the ability to adhere to a plan all affect what works best for them.

There are three distinct strategies to trade forex based on timeframes.

Day trading

As the name suggests, this is based on taking a position on a currency and closing it out before the end of trade for the day. However, day trading can be as short as an hour or even minutes.

This is a popular strategy for those new to forex because it gives them the opportunity to familiarize themselves with general currency trends. Since forex trade continues across time zones, day trading also insulates an investor against major overnight changes.

Position trading

Position trading is a favourite of CFD traders, whose research leads them to believe that a particular currency will gain significant value in the future as a result of developments already in motion today. It is also an attractive option if you want to park your money in a ‘safe’ currency for the long-term.

Swing Trading

If you look closely at the forex charts for any currency pair, you will notice that there are minor corrections and reversals within every general trend. These differences present an opportunity to make considerable profits since trading against the trend is generally unpopular. Swing traders can consider time frames of hours to days.