Many forex traders don’t know where to begin when it comes time to implement a trading strategy. All the education in the world isn’t going to be of use without an example of what a trading system looks like. In this article, I’ll show you a simple, but effective, forex trading strategy that is constructed using some very basic tools.

Throughout my career in the forex industry, teaching thousands of traders how to profit, I’ve always suggested to start with a trend following approach to trading currencies. I do the same thing with my current clients. Naturally, I’m going to share a trend following approach with you.

I firmly believe in following trends in the forex market for one simple reason: they’re huge. Big trends in the forex market occur every year. You can usually identify them in the early stages and ride them for big gains. Trading trends in the forex market is by far the easiest way to make money trading currencies. I would even argue that it’s the most profitable way.

Trend Identification

The first component of this system is defining and identifying a trend. I need to define both upward and downward trends. To do this, I’m going to use two tools:

• 5 Day Exponential Moving Average (EMA)
• 20 Day Exponential Moving Average (EMA)

These two moving averages will help us to consistently and objectively define the trend. They work together like this:

• The trend is up if the 5 Day EMA is greater than the 20 Day EMA
• The trend is down if the 5 Day EMA is less than the 20 Day EMA

It’s pretty simple, but highly objective. There’s no arguing with the rules. Either the 5 Day EMA is above or below the 20 Day EMA and the trend is either up or down, respectively.

I like the 5 Day and 20 Day EMAs because they tend to work together pretty well during trending periods. You could substitute different parameters depending on the time horizon that you want to target. For instance, bigger parameters like a 50 and 200 Day EMA would lead to bigger, longer lasting trends.

Entry Points

To spot entry points, I like to use a Full Stochastic with the (5,3,3) settings. I prefer the Full Stochastic over the Fast or Slow Stochastic. The reason is that the Full Stochastic tends to be a little smoother when it comes to timing the turns of a currency pair.

The Full Stochastic generates buy and sell signals quite frequently. A buy signal is generated when the Fast Line, or %K, crosses above the Slow Line, or %D. A sell signal is generated when the Fast Line, or %K, crosses below the Slow Line, or %D.

To take entry points, I simply align the buy signals in the Full Stochastic when the EMAs are in an upward trend; I enter short positions when the Full Stochastic generates a sell signal during downward trends in the EMAs.

Exit Points

I use the moving averages to define exit points in the following way. If I’m in a long position, I’ll ride it as long as the 5 Day EMA trends above the 20 Day EMA. I’ll exit the long position as soon as the 5 Day EMA crosses below the 20 Day EMA. If I’m in a short position, I’ll ride it as long as the 5 Day EMA trends below the 20 Day EMA. I’ll exit the short position as soon as the 5 Day EAM crosses above the 20 Day EMA.

Stop Losses

Stop losses are a critical component of any forex trading strategy. In this particular strategy, using the 5 and 20 Day EMAs and the Full Stochastic (5,3,3), I like to reference the 14 Day Average True Range (ATR) for my stop loss. I’ll set my stop 1 to 2 ATRs away from my entry point. Using the ATR enables me to adjust my stop across different currency pairs, which display different volatility characteristics.

Currency Pairs

When I’m using this strategy, I like to stay diversified. I do so by not trading too many overlapping pairs. For instance, I would never be in the same positions at the same time:

1. Long EUR/USD
2. Long GBP/USD
3. Short USD/CHF
4. Short USD/JPY

These four positions are all short the U.S. dollar; they are all closely correlated. If the dollar suddenly rallied, I would be in big trouble. To combat this risk, I try to spread my positions across different currency pairs that move somewhat independent of one another. Applying a little common trading sense in this regard will go along way.

Summary

This is a good forex trading strategy that you can use, especially if you’re new to the forex market. It covers all of the essential elements of a trading system, such as entry points, exit points, stop losses, and diversification. It’s profitable over time, but has its limitations. All trading systems have advantages and disadvantages, which you’ll only discover after gaining some experience actually applying the systems in the market. A good way to gain experience is to paper trade any system for a few months.