How to Become a Successful Forex Trader

Starting in the forex market often results in a life cycle that involves diving in head first, giving up, or taking a step back to do more research and open a demo account to practice. From there, new traders may feel more confident to open another live account, experience more success, break even, or turn a profit. That is why it's important to build a framework for trading in the forex markets, which we outline below.

The Basic Forex Trading Framework

Forex trading is basically about catching the changing values of currency pairs. So if you think the value of the pound will increase against the U.S. dollar, you can buy them with dollars and make a profit by selling the pound when it rises. Forex trading is commonly used by speculative traders and as a hedging strategy.

The framework covered in this article focuses on one central concept: trading with the odds. To do this, we look at a variety of techniques in multiple timeframes to determine whether a given trade is worth taking. Keep in mind that this is not intended to represent a mechanical/automated trading system. Rather, it's meant to be a discretionary system.

You may choose to act on signals you observe or dismiss them. The key is finding situations where all (or most) of the technical signals point in the same direction. These high-probability trading situations will, in turn, generally be profitable.

Focus on Medium-Term Forex Trading

Why do we foxus on medium-term forex trading rather than long- or short-term strategies? To answer that question, let's take a look at the following comparison table:

You'll notice that both short-term and long-term traders require a large amount of capital where the first type needs it to generate enough leverage, and the other to cover volatility.

Although these two types of traders exist in the marketplace, they are comprised of high-net-worth individuals (HMWIs), asset managers, or larger institutional investors. This is why retail traders are most likely to succeed using a medium-term strategy.

Forex Chart Creation and Markup

Selecting a Trading Program

We will be using a free program called MetaTrader to illustrate this trading strategy. However, many other similar programs can also be used that will yield the same results. There are two basic trading program requirements:

• The ability to display three different timeframes simultaneously
• The ability to plot technical indicators, such as moving averages (exponential and simple), relative strength index (RSI), stochastics, and moving average convergence divergence (MACD)

Setting up the Indicators

Now let's look at how to set up this strategy in your chosen trading program. We will also define a collection of technical indicators with rules associated with them. These technical indicators are used as a filter for your trades.

If you choose to use more indicators than shown here, you will create a more reliable system that will generate fewer trading opportunities. Conversely, if you select fewer indicators than shown here, you will create a less reliable system that will generate more trading opportunities. Here are the settings that we will use for this article:

• Minute-by-minute candlestick chart
• RSI (15)
• Stochastics (15,3,3)
• MACD (Default)
• Hourly candlestick chart
• EMA (100)
• EMA (10)
• EMA (5)
• MACD (Default)
• Daily candlestick chart
• SMA (100)

Adding in Other Studies

Now you will want to incorporate the use of some of the more subjective criteria, such as the following:

• Significant trendlines that you see in any of the timeframes
• Fibonacci retracements, arcs or fans that you see in the hourly or daily charts
• Support or resistance that you see in any of the timeframes
• Pivot points calculated from the previous day to the hourly and minutely charts
• Chart patterns that you see in any of the timeframes

In the end, your screen should look something like this:

Finding Forex Trading Entry and Exit Points

The key to finding entry points is to look for times all of the indicators points in the same direction. The signals of each timeframe should support the timing and direction of the trade. There are a few particular bullish and bearish entry points:

Bullish

• Bullish candlestick engulfing or other formations
• Trendline/channel breakouts upwards
• Positive divergences in RSI, stochastics, and MACD
• Moving average crossovers (shorter crossing over longer)
• Strong, close support and weak, distant resistance

Bearish

• Bearish candlestick engulfing or other formations
• Trendline/channel breakouts downwards
• Negative divergences in RSI, stochastics, and MACD
• Moving average crossovers (shorter crossing under longer)
• Strong, close resistance and weak, distant support

Placing the Trade

It is also a good idea to place exit points (both stop losses and take profits) before even placing the trade. These points should be placed at key levels and modified only if there is a change in the premise for your trade (oftentimes as a result of fundamentals coming into play). You can place these exit points at key levels, including:

• Just before areas of strong support or resistance
• At key Fibonacci levels (retracements, fans, or arcs)
• Just inside of key trendlines or channels

Money Management and Risk in Forex Markets

Money management is key to success in any marketplace, but particularly in the volatile forex market. Many times fundamental factors can send currency rates swinging in one direction – only to have the rates whipsaw into another direction in mere minutes. So, it is important to limit your downside by always utilizing stop-loss points and trading only when your indicators point to good opportunities.

Here are a few specific ways in which you can limit risk:

• Increase the number of indicators that you are using. This will result in a harsher filter through which your trades are screened. Note that this will result in fewer opportunities.
• Place stop-loss points at the closest resistance levels. Note that this may result in forfeited gains.
• Use trailing-stop losses to lock in profits and limit losses when your trade turns favorable. This may also result in forfeited gains.

Examples of Forex Trading

Let's take a look at a couple of examples of individual charts using a combination of indicators to locate specific entry and exit points. Again, make sure any trades that you intend to place are supported in all three timeframes.

In Figure 2, above, we can see that a multitude of indicators are pointing in the same direction. There is a bearish head-and-shoulders pattern, a MACD, Fibonacci resistance and bearish EMA crossover (five- and 10-day). We also see that Fibonacci support provides a nice exit point. This trade is good for 50 pips and takes place over less than two days.

In Figure 3, above, we can see many indicators that point to a long position. We have a bullish engulfing, Fibonacci support, and a 100-day SMA support. Again, we see a Fibonacci resistance level that provides an excellent exit point. This trade is good for almost 200 pips in only a few weeks. Note that we could break this trade into smaller trades on the hourly chart.

The Bottom Line

Anyone can make money in the forex market, but it requires patience and following a well-defined strategy. Therefore, it's important to first approach forex trading through a careful, medium-term strategy so that you can avoid larger players and becoming a casualty of this market.

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