The importance of adaptation in forex trading

Every forex trader dreams of finding the ‘holy grail’ trading strategy which produces consistent profits and guarantees to make a trader successful in the shortest time possible. Whilst it is not impossible to find such a strategy, it is very unlikely that it will be successful all of the time and there will almost certainly be period when it does not perform and generate profits. The reason for this is that trading systems and strategies are rigid by nature and comply with a fixed set of rules. This is part of what makes them successful and allows them to trade the markets robotically. However, it is also often their downfall as they have limited ability to adapt to different market conditions unless the trader can recognise when the strategy should not be applied.

Different market conditions affect forex trading strategies

The skill in being a successful forex trader is precisely the ability to see which strategies are suitable for different market conditions. The ability to adapt to these is the single most important element in being consistently profitable and also a reason why lots of new forex traders become disillusioned when there trading success begins to nosedive. Many of these will have traded profitably with a strategy, after extensive back testing, only to find that they are experiencing larger drawdowns after several months of success. Whereas consistent profits should indicate that a trader is doing well, when losses also become consistent, a temporary change of approach is likely to be needed.

Many of the most successful traders and authors of forex trading guides point out that they have an ‘arsenal’ of trading tools and strategies which they use depending on market conditions. This does not necessarily mean that they have two completely different methods of trading, although many will have more than this, but that they can see when adjustments need to be made, such as lowering or increasing take profit levels or switching to a different currency pair altogether. Although it is fairly simple to say that these master traders have years of experience to make these adaptations throughout the trading day or month, the principle of recognising when trading is not working can be used by both new and experienced forex traders.

Recognising that a forex strategy is not working will lead to success

Recognising that there is a problem with a trading strategy and taking the time to consider why it has performed during back-tests but not in the live markets is an important step. A lot of new traders will feel that this is down to their luck, which is not correct. The only way to resolve this will be to look at all of the elements which affect the trade, including the broader market. Asking some simple questions such as whether the market trend has changed since completing the successful back-testing, whether the profit to risk ratios are correct and, crucially, if trading with real money has affected your trading technique, are important to analyse the problem. Looking at how these elements can be adapted to return the strategy back to being profitable sets a course for successful and consistent trading.

Trading the news

Forex markets are driven by a number of variables in both the short and long term. The most influential of these, in the short-term at least, are the release of markets-sensitive information which generally falls under the umbrella term ‘news’. This information can range from the release of macroeconomic data regarding the economic health of a specific economy or region to the start of a conflict many miles away. The common factor in each of these news releases is that they directly influence the direction of currency markets and can provide excellent opportunities for traders who correctly interpret the data.

Economic data and news events affecting the forex markets

From the perspective of all fundamental analysts, news which is related to large economic information is the driver of currency values and can be considered the most important information available. A classic example of just how influential data like this is can be seen whenever interest rate information, GDP data or employment figures are released. Possibly the most famous news release, which effects almost every currency pair globally, occurs on the first Wednesday of each month when the US employment figures are released. For traders who have an idea of whether these planned news releases will be positive or negative provides an excellent opportunity to make short term profits as the markets swing higher or lower.

The other form of news trading opportunities available to forex traders are the spontaneous releases of information, often based on geopolitical events rather than economic information. These announcements of conflict, trade embargos and commodity price spikes all have powerful knock-on effects for currency pairs. Any news which january be seen as restrictive for the flow of currency exchange in the short term, such as trade restrictions, will negatively affect the currency of the region or country involved. Similarly, there are some currencies such as the US Dollar which are seen as ‘safe haven’ currencies (those which are least likely to collapse if the markets implode), and which benefit from increased demand during times of global instability or conflict.

Methods of trading forex news releases

There are several methods to trade news releases which will favour different trading personalities. For those looking to make sure but steady gains over the longer term, investing in a currency from a healthy economy and where interest rates are kept relatively high to avoid inflation will ensure the medium-term demand for these currencies against currencies with lower interest levels. Usually, these currencies can be traded equally successful after the initial news release when the market has settled and a longer term trend has been established.

However, for those who want to trade in the thick of the action, or immediately after this news hits the markets, there are also a number of ways to gain profitably from the large swings which occur in the minutes after the markets react. One way is to simply take a position based on previous research with a large enough stop-loss to sustain a temporary swing against your position. Perhaps a more sensible way, however, will be to allow a ten minute ‘cool-off’ period between the release of data and entering a trade. This method will allow the volatility caused by those forex traders panicking to close and open positions and will provide an opportunity to interpret which way the news is directing the market.

The advantages of trading forex cross pairs

Cross pairs can be described as those currency pairs which do not include the US dollar. The reason why they are categorised in their own group is that, not long ago, all non-US dollar currency transactions would have required an exchange in to US dollars before being converted in to the required currency. Due to the fact that most governments have large US dollar reserves the way that commodities are priced in US dollars has led to it becoming the naturally dominant global currency. This meant that a transaction such as converting sterling in to Japanese Yen would have required the sterling to be converted in to US dollars and then in to Japanese yen and effectively two transactions for one conversion. The arrival of cross pairs, however, means that the less popular currencies can be traded directly against each other and offer some interesting advantages.

Advantage 1: Trading during volatile markets

The first advantage to trading non-US Dollar currencies is that traders can avoid a number of key dollar-sensitive events, or at least limit their exposure. One example of this is the high risk of trading during the non-farm payroll announcements, either immediately before during or after. This announcement hits the forex markets on the first Wednesday of each month and can cause wild swings and volatility in the major currency pairs (those which directly trade with the US dollar). Since almost all currency markets are affected by this event, the cross pairs offer a more conservative way to trade these events whilst hopefully avoiding the extreme volatility that is often experienced on the US dollar pairings.

Advantage 2: Cross pairs offer increased trading opportunities

An additional advantage to trading cross pairs is that these markets can lead to greater opportunities for profitable trades. Whilst the major currency pairs will move with and against one another as the strength of the US dollar rises and falls, the cross pairs allow new price movements in the markets as they are not forced to follow the US dollar. This means that there is a high potential for different set-ups on these lower-liquidity markets and the moves can often be large and highly rewarding for those traders wanting to look for trading opportunities elsewhere. Since the majority of forex traders will be looking towards the major currency pairs to identify their trading setups, cross pairs offer an excellent alternative when US dollar pairings fail to produce any significant trades.

Advantage 3: Higher interest rates and carry trades

One final advantage of cross pair trading is the ‘carry trade’ where traders can take advantage of the higher interest rates provided by these currencies. As a long term strategy, traders hold a currency for a long period in order to both make the gains as its value increases but also to be rewarded with the higher interest rates. A recent example of this was the Australian dollar which maintained interest rates above 4%, increasing the demand and value of the currency whilst earning those who had large enough holdings a good baseline return on their trade.

Trading on multiple time frames

Choosing the best time frame can be one of the most difficult decisions when starting out trading forex. Timeframes dictate the length of time each bar on a price chart takes to form and therefore how much historical information each chart contains. Often, the choice of timeframe (which range from one minute to one month) is dictated by personal circumstance; how much screen-time we have available, our jobs, family commitments etc. Whilst all time frames essentially convey the same information for any given currency pair, the opportunities and available trades between them can vary enormously. Most new traders are encourages to trade from the daily timeframe to begin with, taking time to spot setups, organise stop-losses and learn the art of entering correctly without the noise and distractions of the lower, faster charts. Whether this is the best strategy is subject to debate and a number factors to consider will influence which timeframe is the most profitable for each individual trader.

Higher time frame trading

If we look at the higher time frames, such as the daily, weekly or even monthly charts, the formation of each bar takes some time and developments in both technical analysis and price action trading take time to form. This helps traders to make calculated and thought-out trading decisions and diminishes the influence of adrenaline that affects decision-making in high-speed trading. Spotting chart patterns, candlestick formations as well as the underlying trend in a market is excellent on these charts and the probability of success is very high using these techniques. However, the downside to waiting several days or months for a pattern to emerge is that there are not a great number of trades available to take. Having said this, the number of pips to be gained from a successful trade on a high time frames are far higher than moves the 5 or 1 minute so these high-probability setups are well worth waiting for.

Lower time frame trading

One of the benefits of trading the lower timeframes is the number of opportunities that occur each day. From the hourly down to the 1 minute charts many new traders prefer to practice on these rather than the daily or weekly timeframes. Since stop-loss positions can be much shorter and trades lower risk in this respect, looking for trade setups on the lower timeframes can be very rewarding. However, the temptation to over-trade is also very high and traders should have a strict trading plan to avoid chasing every market move. An additional problem with the very low timeframes, such as the 5 minute and 1 minute charts, is that there is a tendency for the market ‘noise’ at these levels to distort the price charts. This means that the same setups january not be as reliable at these levels and the use of additional confirmation tools such as indicators and technical signals should be used to confirm the validity of each setup.

Combining time frames for higher-probability trades

Many professional forex traders advocate using multiple time frames in order to get a good overview of the entire market. Whilst trades will be entered below the hourly chart time frame, using the higher time frames for trend analysis and technical analysis will increase the probability of a trade’s success. These higher time frames will ensure trading in the direction of the trend, and avoid trades being taken in to key areas of support, resistance or against a major pattern formation.

Making the most out of candlestick trading strategies

The potential success from trading candlestick signals alone is enough for many forex traders to simply watch the markets for these high probability setups. However, as with any trading strategy, they do not always yield positive outcomes and the potential to risk too much on what appears to be a definitive buy or sell signal from a candlestick setup january be the undoing of some traders. Whilst the temptation to enter a large trade on a clear-cut pin bar (shooting star) or engulfing candle is often great, there are several rules that candlestick traders can apply in order to increase their chances of success.

Mapping the price charts

The first addition to any candlestick setup should be an overall analysis of where the forex pair is trading in relation to the clear buy or sell signal. This is not a universal analysis of all available indicators, which can result in the dreaded “analysis paralysis” but a broad understanding of the price action that creates the signals in the first place.  By creating a ‘map’ of the market, using recent and historical support and resistance zones, forex traders can identify those areas where price action, and therefore candlestick trading signals, are going to be most effective. It will also help traders avoid trading directly in to areas which have historically caused problems for price and eliminate the frustration of only recognising this after the trade has been taken. Plotting these lines of basic support and resistance will therefore add to the trading edge provided by high-probability candlestick setups.

Applying psychological indicators

Additionally, forex traders will improve their profitability add further psychological markers on their charts. A perfect pin bar or shooting star setup will have double the meaning to everyone if it is located at the 38.2% or 50% Fibonacci retracement areas.  The rationale here is that not only will you be trading alongside the majority of candlestick traders, but you will also be trading in agreement with the large majority of forex traders who observe these important trading levels.

Trade size is important however obvious the setup

Managing the size of the trade is something that price action traders are required to learn fairly quickly in order to be profitable. This stems from the enthusiasm that traders experience when they see a so-called ‘no brainer’ setup on their charts. Remembering that the forex market does not adhere to these rules, however obvious, will keep the trade size in check for even the most attractive candlestick setups. Maintaining trade below the recommended 3% of total trading capital will ensure that price action traders can continue trading tomorrow.

Trading against the grain

Contrarian candlestick trading is something which will not appeal to everyone but can be helpful for forex traders to close a losing position as quickly as possible. When a candlestick setup goes bad, for example a bearing shooting star is engulfed by a bullish candle, some traders take this as a demonstration of market strength and jump in contrary to the setup. For many, realising that a setup has failed can also provide an excellent exit strategy if executed immediately.