Numerous Forex traders, particularly armature Forex traders, may experience feelings of disorientation and confusion in the market. They believe they can earn money, but they struggle to do it consistently. Some conclude that the market is random or that they are victims of dishonest Forex brokers, but these are often merely excuses.
The market is not random, and even if your Forex broker is less than ideal, you may still profit if you take the time to think about the market and trade top-down. I will demonstrate a strategy for selecting currency combinations that statistically yields positive returns.
What are Momentum Trading Strategies in Forex?
"Momentum" simply means to purchase something if it is increasing in value and to sell it if it is decreasing in value. Numerous academic studies have shown that adopting this strategy to all types of speculative markets is beneficial over time and provides a successful trading "edge."
Another sort of Forex momentum strategy is a "best of" momentum trading strategy, which invests in the assets that are doing the best and sells those that are performing the worst. This also works well and often results in a higher reward-to-risk ratio than basic momentum tactics.
I will detail a Forex "Best of" Momentum Strategy that I devised below, complete with back test results.
Selecting Pairs for a Forex "Best of" Momentum Trading Strategy
The first step in the method is to generate an excel spreadsheet that displays the price movements for a universe of 28 Forex pairs and crosses over the previous three months. It is easiest to calculate this each weekend using weekly open and close prices, since 13 weeks approximates 3 months perfectly.
I utilize the 28 pairings and crosses generated by the world's seven main currencies. There is no reason why you cannot add currencies; but, the more unusual the currency, the more costly it becomes to trade.
Choose six currency pairs/crosses that have had the greatest significant movement during the last 13 weeks. These are the pairs/crosses that you will be trading this week. You will trade in the movement's direction. For instance, if EUR/USD has moved by 5%, the greatest movement of any pair, you will be seeking to short that pair.
This approach has shown a statistical likelihood of creating a trading advantage over the last 6.75 years. Without further refining the approach or using leverage, this method generated a total return of 187.10 percent, which translates to an extremely excellent yearly return of 17.01 percent! The average week had a return of 0.53 percent, while the median week generated a return of 0.43 percent. Annual returns on average were 23.63 percent, while the median was 19.08 percent. The graph below illustrates the performance.
You may wonder why a three-month look-back time is used. It is just the time period that has shown to be most effective over the previous seven years or so. Prior to the 2008 financial crisis, a six-month timeframe worked well. Over the previous seven years, using a six-month timeframe has also proven beneficial, although at a significantly lower rate than three months. Shorter intervals of less than three months seem to be too rapid, whereas longer periods of more than six months appear to be too sluggish.
Trading Selected Foreign Currency Pairs
It should be feasible to improve the overall performance by using a position trading strategy on the pairs/crosses and directions selected for each week.
My preferred technique is to use moving average principles. I like to use an hourly chart with a three-period exponential moving average and a ten-period simple moving average. When an hourly candle closes in the direction of the trend and the 3 EMA crosses the 10 SMA in the same direction, I open a trade – but only if the price is also above the 40 and 240 SMAs. This filter might assist you in avoiding transactions if the momentum is not really there.
Of course, everyone has a favourite momentum trading technique, and employing an indicator such as the RSI (Relative Strength Index) passing 50 on all time frames with a setting of, say, 10 periods may also perform quite well. Essentially, any momentum indicator may be utilized. Naturally, you may pay attention to support and resistance as well: but buy near support if the trend is long, and sell near resistance if the trend is down, after a pullback. Generally, the greatest outcomes come from waiting for pull-backs.
I like to utilize the 20-day Average True Range for stop losses. It takes skill to handle stop losses manually, but with enough experience, you can understand which ones to eliminate: these are often transactions that go against you from the start. If the trade goes your way by about 1 ATR, you may try to add to the position upon future moving average crossings, breakouts, or anything you like: leveraging breakouts to add to positions can work quite well. When you have around three trades open, consider taking partial gains and/or setting your stop loss levels higher to lock in profits.
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