Too much information? Analysis paralysis? Worried and confused about Forex Trading? Here we will clarify the 3 fundamental types of Forex Systems.
Trend Following
The most common type of trading system. If you carefully think about it, it's pretty clear why this is the most common type of trading: as the majority of market participants align themselves to one side, the market, a product of the participants' decisions, will also go one-way. If the majority of the EUR is going up, it means that the majority of traders are going up.
By following the trend, you're following the crowd. And because of this, your probability of making winning trades is higher. You won't be arguing with the market, but rather you'll be agreeing with it. Moreover, you'd be making fewer trades.
You still need entry and exit rules, and the discipline to follow them. Here are a couple of tips:
Trend Following Entry/Exit Tips:
1. When the trend is up, enter on support. Look for buying at specific levels.
2. Trail your trade using the continuously forming mini-supports to maximize your profit.
That about briefly summarizes trend following, so let's look at the next trading method.
Fading
Fading is the opposite of trend following; it's arguing with the market's trend. Essentially, it's bottom picking. What're the potential rewards for fading?
A definite pro of bottom and top picking is that when you're right, your reward is huge. Let's say your reward was 9 times the amount you risked so your reward to risk ratio was 9:1. This means that you could've been wrong 8 times but still generate capital. Of course, your system has to be positive, you can't just guess, hope, and pray, unless you want to lose money.
A few price action triggers include a doji and a close below the recent low or above the recent high. Fading is very a different trading style from trend following. Now let's discuss the last forex trading strategy.
Breakouts
This type of trading is entering when price makes a new high or low. If the market breaches the 52 week high, you might want to enter then. Or if the market breaches the past 20 week's low, you might want t short it then. The keyword is "breach". Of course, you should make sure that your system has a positive edge and is profitable. Breakout trading is just another way of entering the market. Of course, the way you exit a trade is totally up to you; you might want to trail by the most recent lows. Or perhaps you'll have a predetermined exit.
So what's the difference between trend following and breakout trading? Ok, they might seem pretty similar, and they kind of are. The key difference is the entry. With breakout trading, you enter with the breach of a prior high or low. With trend following, a breach doesn't have to occur, but rather you can enter on a dip.
Where Do I Go From Here?
That last paragraph brings up another important point. You can trade however you want. These trading styles are just to expose you to different ideas. Of course, if you want to, you can follow the trend and enter on a breach on only the trend's side. You can use whatever combination that suites you.