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FOREX Best Trading Method
by Jonathan Roe
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Overview
Forex is one of the most difficult markets to trade due to the relative nature of currency pairs. For example, you could be correct in thinking that the dollar is going to strengthen. As a result, you sell the euro to buy the dollar. If the dollar strengthens as you expected, but the euro strengthens even more compared to the dollar, then you will lose money. Given the difficulty in accurate economic forecasting, many traders turn to technical analysis to make money in the forex markets.
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Trends
The key to any trading is to always trade with the trend. This is an old trading cliché but it holds true. Anybody can make money as long as they are trading in the same direction the market is heading. The difficult part is accurately identifying the direction of the long-term trend. One simple way to do so is to use a pair of technical indicators such as Parabolic SAR along with a moving average. The moving average provides the baseline for the trend and the parabolic SAR helps you avoid short-term corrections since it is more responsive to price oscillations. For example, if the current price is below the 200-day moving average as well as the dots represented by the parabolic SAR indicator, then you would go short. If the price is below the 200-day moving average but the dots of the parabolic SAR are below the price, then you would do nothing. In this strategy you would hold onto the trade until the two indicators no longer provide the same message.
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Carry Trade
The carry trade is a common forex trading method that makes use of interest rate differentials among currency pairs. The most famous example is the yen carry trade. Traders will sell yen, since it has an interest rate close to zero, and buy other currencies such as the dollar, euro, or pound, which traditionally have higher interest rates. The trader then gets to pocket the difference between the two rates. While this strategy doesn't seem all that exciting, given the high amounts of leverage possible with foreign exchange trading, you can quickly accumulate double or triple digit annualized returns simply from the interest rate differentials. The downside of this strategy is that if the currency with the low interest rate appreciates against the currency with the high interest rate, you can have the gains from the interest earned completely wiped out.
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Combining the Two
The best forex trading method is to combine trend following with the carry trade. This allows you to always trade with the trend, collect money on the interest differential, and use lower leverage. This strategy is a slightly more active strategy than the basic carry trade but it can still be done by people who can only look at their account once per day. To do this strategy, identify currency pairs that provide a high interest rate differential and then wait for the moving average and parabolic SAR indicators to signal the pair is trending in the direction that will allow you to collect on the interest differential. Close out the trade when the two trend indicators no longer match up.
