Prior to risking you first dollar in the capital markets, you should spend time designing a trading strategy that you perceive will generate returns. There are several types of strategies you can use but the success will depend on whether the strategy you choose is one that you are comfortable trading. One of the first concepts you should tackle is determining your trading personality and then match your trading personality with a trading style. Some of the most popular online trading strategies include trend following, momentum and contrarian trading methods.
What is your Trading Personality?
You should ask yourself some questions before you attempt to find a trading strategy. Do you like finding bargains, and before you shop for an item to you spend hours trying to find the best deal? Do you like to take a contrarian view or do you like to move with the trend. Once you answered these question you can then try to find a trading strategy that is in line with your trading personality.
Trend Following
There are several types of trading strategies and one of the most popular is trend following. Here you are trying to identify a trend where price move in one direction for an extended period. Markets generally trend approximately one third of the time, which means they consolidate and trade sideways the other 2-thirds. One of the most common trend following strategies is the moving average crossover trading strategy. Here you are looking for a scenario where a short-term moving average crosses above or below a longer-term moving average. A moving average is the average of a specific period. When you add a new period (day) to the moving average, the first period in the calculation is dropped.
In the chart of the EUR/USD when the 20-day moving average crosses above the 50-day moving average a medium term up trend is considered in place. When the 20-day moving average crosses below the 50-day moving average, a short-term downtrend is considered in place.
Contrarian Trading Strategies
Trading market sentiment is also another popular way to find a security or currency pair that is poised to change direction. The relative strength index (RSI) developed by J Wells Wilder, is a momentum oscillator that describes sentiment. The index measures prices over the past 14-periods and generates an index from 1-100. RSI index readings above 70 are considered overbought while RSI readings below 30 are considered oversold. When sentiment is too high and your see a RSI reading above 70, the market is overbought and you can considered selling. When sentiment is depressed and you see and RSI reading below 30 you can consider purchasing the currency pair.
Momentum Strategies
Many people like to trade markets were they what momentum accelerate and then jump on the train to catch a move and jump off before the prices begins to decelerate. One of the best momentum indicators is the MACD (moving average convergence divergence) index. The MACD generates buy and sell crossover signals that describe when positive and negative momentum are accelerating.
Summary
Prior to risking capital, you should determine your trading personality and find a trading strategy that fits with your personality. Whether you like contrarian sentiment indicators or trend following strategies you need to find a strategy that you can trade that makes sense to you.