Forex Trading For Beginners Strategy (Backtest)

Last Updated on September 22, 2022 by Oddmund Groette

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?

Forex trading 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.

We end the article by showing a backtested forex trading strategy for beginners.

In this post, we provide a basic guide to forex trading strategy for beginners.

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, if you notice that a specific currency pair tends to rebound from a particular support or resistance level, 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.

Forex beginner strategy (trend following)
Forex beginner strategy (trend following)

In a downtrend (the indicator sloping downward), the price crossing below the indicator is a signal to go short.

Forex beginner strategy (trend following short)
Forex beginner strategy (trend following 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.

Forex beginner strategy (trend following long)
Forex beginner strategy (trend following long)

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.

Forex beginner strategy (bullish breakout)
Forex beginner strategy (bullish breakout)

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.

Forex beginner strategy (bearish breakout)
Forex beginner strategy (bearish breakout)

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.

Forex beginner strategy (moving average crossover)
Forex beginner strategy (moving average crossover)

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 strategy for beginners (backtest)

A forex trading strategy for beginners is coming soon.

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