Beginning Forex Traders Step-By-Step Guide (Backtest & Strategy)
Last Updated on June 23, 2023
The Foreign Exchange or Forex market is one of the largest financial markets in the world in terms of trading volume, which is why it attracts many new traders every day. But what is forex trading, and how do you get started? What is forex trading for beginners strategy?
Forex trading for beginners is the act of buying and selling different currencies with the aim to make profits from fluctuating exchange rates. The exchange rate differences are usually small, so traders use leverage to increase their potential profits. There are many strategies you can use to trade the market, but you need to back-test them to find out the ones that can make money.
In this post, we provide a basic guide to forex trading strategy for beginners. We end the article by showing a backtested forex trading strategy for beginners.
The strategies are taken from our source of trading strategy types. The strategies are an excellent resource to help you get some trading ideas.
What is forex trading?
Forex trading is the process of buying and selling currencies to make a profit. It is basically speculating on the direction of the exchange rates of various currencies and using leverage to maximize profits. That is, forex traders exchange one currency for another, betting that the value would increase or decrease so that they profit from the difference in value. Before making their bets, they analyze different factors that can affect the value of the currency over another, such as trade flows and economic, political, and geopolitical events which affect the supply and demand of the currencies.
Apart from profit-making, there are other reasons why you might want to exchange one currency for another. For example, if you are traveling to the UK from the US, you will need to convert your US dollars to the British pound in other to purchase items in the UK.
However, our focus here is on currency speculation by retail traders. Forex trading is done over the counter through online brokers, as the forex market has no central marketplace or exchange. These brokers give traders access to the market via electronic networks and trading platforms.
Understanding the basics of forex trading
In forex trading, currencies are quoted in pairs. These pairs tell you which currency is traded against the other. An example of a currency pair is the GBP/USD, which is short for the Great Britain pound vs the United States dollars.
The first currency in a currency pair is called the base currency while the second currency is called the quote currency. You will usually buy the base currency with the quote currency and sell the base currency to get the quote currency. So, let’s say you pull up your chart and see GBP/USD trading at 1.2009. It means that one pound is worth 1.2009 dollars. So, if you want to get 1 pound you would need exactly 1.2009.
Categories of currency pairs
Currency pairs are divided into three categories namely major, minor, and exotic pairs. The major pairs are currencies from major economies that are quoted against the United States dollars. An example is the GBP/USD. Minor pairs are crosses that do not include United States dollars. An example is EUR/JPY (Euros against the Japanese Yen). Exotic pairs are currency pairs from developing countries or emerging markets as they are called. The major pairs by far have the most liquidity, with the EUR/USD being the most traded amongst all.
The concept of pip in forex
A pip refers to the smallest movement in the price of any currency pair. Let’s say you looked at your price chart, and the EUR/USD is trading at 1.0023. A minute later, you notice that it is trading at 1.0024. The pair has gained one pip. Most pairs are quoted in four decimals, except the JPY, XAU, and XAG which are quoted in two to three decimals. A pip is any value change in the last decimal of the pair.
So, if you open an order to buy EUR/USD at 1.0009 and you later closed the trade by selling at 1.0056, you would have made 47 pips in profit. How do we arrive at 47 pips? Simple: by calculating the difference between the sell and buy prices (1.0056 – 1.0009 = 47). Note that, for simplicity’s sake, the broker’s spread and commission are not included.
The concept of lot and position sizing in forex trading
A lot is the unit of measurement in forex used for measuring the position size (amount of). Lot or position size and pips go hand in hand. The lot size you use will determine the monetary value of each pip gain or loss. There are three levels: standard, mini, and micro lots.
|
Lot size |
Amount ($) |
Value per pip ($) |
|
Standard lot |
100, 000 |
10 |
|
Mini lot |
10, 000 |
1 |
|
Micro lot |
1000 |
0.1 |
Using the example from the previous session, your 47-pip profit would amount to $470 if your position size was 1 standard lot ($10 * 47 pip), $47 if your position size was 1 mini lot, and $4.7 if your position size was 1 micro lot.
The concept of margin and leverage
You don’t need to have big capital to trade forex, thanks to leverage. Leverage is the idea of borrowing money from your broker to increase your position size and, by extension, your potential profits. To be able to borrow, you must deposit a required fraction of the trade’s worth, which is referred to as the initial margin. The margin is measured as a percentage of the trade’s worth, while leverage is measured as a factor by which your initial margin is magnified to get the total worth of the trade. So, the margin and leverage are inversely related. If the broker offers you a 2% margin, then the available leverage is 50x.
Forex trading strategy (example)
A forex trading strategy is a technique a forex trader uses to know when to buy and when to sell a currency pair. It can be based on technical analysis, fundamental analysis, or the volatility from news releases. The most important thing is that it tells the trader when to enter and when to exit a trade. Some may also include how to manage an ongoing trade, such as when to move your stop loss to breakeven or how to trail profit.
While there are many forex trading strategies on the internet, it is much better to develop your strategies yourself. You may want to start with a simple trading strategy. For example, suppose you notice that a specific currency pair tends to rebound from a particular support or resistance level. In that case, you can formulate a strategy based on that by specifying the range of the rebound or using a candlestick reversal candlestick to know when the price is about to reverse.
Most commonly used forex trading strategies for beginners
There are over a thousand forex trading strategies – from aggressive to conservative approaches. Here are some of the most commonly used forex trading strategies by beginners:
Trend-following
This is one of the most common strategies that a beginner can use because it is easy. It is based on the popular slogan: “The trend is your friend.” There are many ways to use this strategy. Some use the moving average indicator to identify a trend, while others use trendlines.
When using the moving average indicator, the direction and slope of the indicator line show the direction of the trend. In an uptrend (the indicator sloping upward), the price crossing back above the indicator after falling below it is a signal to go long, while the price falling below the indicator is a signal to exit.
In a downtrend (the indicator sloping downward), the price crossing below the indicator is a signal to go short.
Instead of the moving average, a trader can use a trendline. The rule is often the same: the price bouncing off the trendline is a signal to enter a trade in the right direction.
Trendline breakout strategy
Trendlines can be traded in several ways. It can be used as a support and resistance line and also as a breakout strategy.
In a downtrend, trendlines are drawn above the price and are drawn by ensuring the line makes a minimum of three touches to be considered valid. A bullish breakout occurs when the price break above the trendline. This is a common strategy used by breakout traders.
Trendlines are usually drawn below the price in an uptrend. As with the bullish breakout, a bearish breakout occurs when the price violates the line to the downside. Further confirmation should also be used when trading the trendline to avoid being caught in a fake-out.
Moving average crossover strategy
This strategy employs the use of two moving averages to generate buy and sell signals. Let’s take a look at the chart below for proper understanding.
In the chart above, you can see two moving averages: 10-period (as a green line) and 20-period (red line). Buy signals are usually generated whenever the shorter-period moving average crosses above (golden cross) the longer-period moving average as can be seen on the chart. Likewise, a sell signal is given if the short-period moving average crosses below (death cross) the longer-period moving average. The moving average strategy is suitable for day trading and other forms of short-term trading.
Forex trading for beginners strategy backtest – does it work?
We presented a few types of trading strategies in the section above. But how do you know if they work?
There’s only one way to find out. You need to backtest (why backtesting works). By backtesting your strategy, you find out if it has worked in the past. In no way is that a guarantee that it will work in the future, but it’s a strong indication you are on to something.
A forex strategy might offer a tremendous advantage, though: the strategy most likely offers good diversification from your other trading strategies, especially if you are trading stocks or stock market indices.
As an example, let’s go on to backtest a couple of strategies with trading rules and settings.
We backtest the EURJPY currency pair. This pair has the “advantage” that it behaves a little like stocks. This might make it easier to find profitable strategies, but then again, it might then be less likely it offers any diversification from your stock strategies.
We employed strategies from our monthly trading edges and found at least two trading strategies that work on the EURJPY pair. Let’s look at them:
Forex trading for beginners strategy backtest no 1
The first strategy is the monthly trading edge of May 2021 – strategy number 7 on our single strategies and bundles page. We backtested the strategy on the EURJPY by using forex data (not futures). Below is an Amibroker backtest report (equity curve):
There are 198 trades, the average gain per trade is 0.64%, the win ratio is 75%, the max drawdown is 14%, and the profit factor is 3.1.
- What is an acceptable max drawdown in forex?
- How to calculate win rate in trading
- Profit factor calculator
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As you can see, the strategy has worked pretty well over the last decade!
Forex trading for beginners strategy backtest no 2
We have another monthly trading edge that works well on the EURJPY pair: the edge from August 2021 (the edge is strategy no one on our strategy page). However, we modified the parameters slightly and we got the following equity curve:
The strategy has 138 trades, the average gain per trade is 0.4%, the win rate is 71%, max drawdown is 19%, and the profit factor is 2.
It’s not optimal statistics and performance metrics, but if it can offer diversification from your other strategies it might be an excellent idea to trade it.
Forex trading strategies for beginners
We have written over 1200 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.
FAQ forex trading for beginners strategy
Let’s end the article with a few frequently asked questions:
What is forex trading and how does it work?
Forex trading is the buying and selling of currency pairs on the foreign exchange market with the aim of making a profit. It involves taking positions on currency pairs in order to speculate on their future price movements. Forex traders take advantage of the changing values of currencies to make a profit.
Please keep in mind that forex trading is very difficult. As a matter of fact, we believe most traders are better off learning to trade and invest in stocks instead.
What are the different types of Forex trading strategies?
There are several different types of forex trading strategies. These include day trading, swing trading, scalping, position trading, and trend following. A trader usually chooses a strategy that suits their trading style and risk appetite.
Which forex strategy is best for beginners?
In trading, there is no “best” or “worst”. If you make one dollar trading strategy A, that is just as valuable as one dollar from strategy B. Furthermore, you don’t necessarily make more money by making “complex” strategies.
However, as indicated many times in this article, we believe forex trading is difficult and most traders end up penniless.
Which type of trading strategy is best for beginners?
In trading, there is no “best” or “worst”. If you make one dollar trading strategy type A, that is just as valuable as one dollar from strategy type B. Furthermore, you don’t necessarily make more money by making “complex” strategies.
What should I look for in a forex broker?
When selecting a forex broker, it is important to look for a broker that is regulated by a reputable financial authority. It is also important to ensure that the broker offers competitive spreads and low trading costs, as well as a wide range of currency pairs to choose from.
How do I manage risk when trading forex?
One of the most important aspects of trading forex is risk management. This might involve setting a stop-loss order, which is an order that automatically closes out a position when it reaches a certain price. This might help to protect a trader’s capital from large losses.
Other risk management techniques include using leverage wisely, setting clear goals, and never risking more than you can afford to lose.
But above all, you need to backtest your strategy to make sure you have a positive statistical edge. If you don’t backtest, you are trading blind.
What resources are available to help me learn how to trade forex?
There are a number of resources available to help traders learn how to trade forex. These include books, videos, and online courses. Many brokers also offer free educational materials, such as webinars and trading tutorials. It is important to research and practice with a demo account before trading with real money.
We are also confident that you can learn a lot by reading some of the articles on this website.