Winning Online Forex Trading Techniques

Note: This is part 2 of 3 of a tutorial series about online forex trading. Part 1 and part 3 can be found here and here.

Now that you’ve been introduced to online forex trading and the forex markets, you’re probably wondering how to make money as a trader. What kind of techniques and methods are available for you to make money without it being blind luck or gambling?

I can tell you that there are hundreds of products out there that claim to be the perfect system. These products have forex robots, automatic trading signals and what have you. The creators of these products have made hundreds of thousands of dollars in sales, simply because everyone in the forex market is looking for some sort of Holy Grail; a product that will make them consistent profits on autopilot. But that sounds too good to be true, and it is (otherwise everyone would be a millionaire by now).

One way of making money trading forex is to find a really good trader with a proven track record like Timothy Sykes or Oscar Carboni. These are two traders who operate in different markets but both have track records of making consistent profits over the last years. They run a membership site where you pay a monthly fee in return for weekly trade recommendations. In other words, they do the research and come up with profitable trading recommendations based on their experience and in return for a monthly fee you can profit from their research and experience.

The other way to make money with online forex trading is to learn how to do your own analysis, and find a proven system (or modify one) that will allow you to be right 6/10 times or more. There are two ways of doing analysis to determine winning trades, but there is only 1 way that works. Let me explain…

Fundamental Analysis

Fundamental analysis is what you learn about in school and university. It means that you look at the underlying fundamentals of whatever it is that you’re analyzing (forex,stocks,commodities etc.) to determine a profitable trade. In the case of online forex trading, it would be the fundamental situation of the two respective countries of the currency pair you want to trade.

Let’s take Eur/Usd as a forex pair example. According to fundamental analysis, you would analyze the economic situation of Europe and of America, and you would come to a conclusion that’ll give you an opinion of which direction Eur/Usd is going in the future.

I personally think there are two problems with fundamental analysis:

1-) You need to have some serious knowledge about economics and you need to have experience of what happens when fundamental economic changes occur (monetary policy changes, presidential elections,unemployment etc.) in order to make profitable trades based only on fundamental analysis. Most people don’t have that knowledge and there are just too many possible factors that affect a country’s growth to be able to make a calculated decision.

2-) Even when you are correct with the direction of your fundamental analysis, you’ll probably be wrong with the timing. It often takes much longer (months or years) for a change in direction based on a country’s economic policies to materialize. You have very little ability to predict the short term based on the fundamental analysis and in today’s economic conditions, currencies are very volatile (meaning there are large swings to the upside and to the downside without real fundamental reasons). As a forex trader, these swings will really cripple you if you are biased to a single vision.

Technical Analysis

Technical analysis is the study of price action, and it’s the best way to determine profitable entry and exit points for forex trading.

What I mean by “The study of price action” is that every movement between all currency pairs gets recorded and can be plotted on a graph or chart. These charts are automatically made by your broker’s trading platform that you use to make your trades, do your analysis and keep track of your profits and losses.

It’s not possible for me to explain the concept of technical analysis in just a few paragraphs. There are entire books dedicated to it, but if there is enough demand from the readers then I’ll happily create another monster post explaining it in as much detail as possible.

Time-Frames

Since all price action is recorded and available to all forex traders, it is possible to see this data in all sorts of different time-frames to help you with your analysis. You’re able to view every currency pair in charts where data is sorted per tick (the smallest possible movement), per 5 minutes, per hour, per 4 hours, per day, per week, per month, per year and everything in-between.

From the 2 examples above, the 5 minute chart covers 2 days, while the daily chart covers almost 4 months.

Why would you want all these different time-frames, isn’t that really confusing?

Well, firstly it depends on what kind of trades you do. The smaller the time-frame, the more short-term the analysis is that you can do. A 5 minute chart will allow you to predict what will happen in the next hours, but a daily chart will help you predict what will happen over the coming weeks.

You can literally make dozens of trades per day, grabbing a few pips with every trade. This method of trading is called scalping, and is very intensive because you can get 20 of these tiny trades right but if you slip up once you can lose all your profit and more for the day.

You can also do what is called “day-trading”, which means that you take a position for the day, but you close it before the end of the daily trading session. For this kind of trading you would usually combine 15 minute charts with 4 hourly charts to make your trades and determine entry and exit points.

There are many other styles that require different types of time-frames.

Chart Types

Besides all the different time-frames on charts, there are also different types of charts.

The three most common ones are the bar chart, the candlestick chart and the line chart.

These different types of charts have been created over the years by various traders with the purpose of trying to get a better edge for analyzing the markets. There are different rules and methods for analyzing each type of chart, and most traders have a preference for a type of chart they believe works best for them.

Personally I prefer the candlestick type charts because of the patterns that they create, and the signals for good trades that they generate. Candlestick charting is a small study on it’s own, and you can learn more about it here.

Patterns

A technical trader bases his trades on repetitive patterns that constantly occur on the charts. Throughout history, and on all different time-frame charts, there are repetitive patterns that can be used to execute high-probability trades (trades with a high chance of behaving as expected).

Repetitive patterns are formations created by the buying and selling of the currency pairs, and by the psychology of the markets. A HUGE part of the reason why currencies (and stocks or other markets) move in a direction is because of the sentiment and psychology of the participants, and not always because of the actual value that the currency or stock has.

Another thing you need to understand is that currencies can’t only move in one straight direction. There are always pull-backs, consolidations (where the price action hovers and congests in order to release built-up buying or selling-pressure) and false break-outs (meaning there is a spike in one direction but immediately after the direction reverses). All these reasons cause patterns to be created, and these patterns happen over and over again, although always in a slightly different form.

If you ask me why these repetitive patterns exist, I would say that it’s because there are so many millions of traders who follow the same rules so that technical analysis kind of becomes a self-fulfilling prophecy. It exists because we believe and make it exist. Either way, repetitive patterns appear over and over, on every type of chart, on every time-frame.

By studying the common types of patterns (there are books dedicated to these patterns) and how they usually behave, you can make your trades based on the expected behaviour of these patterns and profit from them. Patterns usually have fixed rules, so that your losses are smaller than your profits.

If you stick to the rule of not risking more than 5% of your account on a single trade, and only trade certain types of patterns, it’s pretty much certain that you’ll be a winning forex trader.

As I mentioned above, I’m not going to give a very detailed explanation of technical analysis with all the patterns, because it’s simply too much information. I’m going to give you examples of the 3 most commonly traded patterns in the forex markets.

Trendlines

The trendline is the most basic technical analysis tool, but you can use it to make profitable trades with. When a market moves in a certain direction (called “trending”), then it usually stays at a fixed ascending or descending angle at which you draw a straight line, called a trendline. You would make a trade when (after a long move in one direction) a trendline is broken, and you would try to profit by following the direction of the break.

In the case of the example below, at the break of the trendline you would go short to ride the move down.

Double Top & Double Bottom Pattern

Double tops and double bottoms are patterns that occur regularly in trending markets (markets moving in a certain direction). They are high probability trades, and often very profitable. The rule is simple:

When you see a double top, sell a double top. When you see a double bottom, buy a double bottom.

Wedge Patterns

Wedge patterns (or triangles) are also very profitable patterns. They usually occur in periods of consolidation after big moves in one direction (when the market needs a bit of a break before continuing).

When price action consolidates in these wedge formations, there is a lot of buying or selling pressure built up, and once the price action finally breaks out of the wedge, it’s often very strong in one direction.

An ascending wedge usually results in a breakout to the downside, and a descending wedge usually results in a breakout to the upside. Asa general rule, price action usually breaks out of the wedge formation at 66% into the wedge formation.

Indicators

The final aspect of technical analysis are helpful tools referred to as “indicators”.

There are literally dozens of different indicators that you can add to your charts. These indicators are developed by many different traders over the years to try to develop a winning system, and there are quite a few helpful ones that can aid you in making better decisions for your entry and exit points of your forex trades.

Indicators are mathematical formulas and algorithms based on the price action of the chart you’re looking at. They try to pinpoint (or indicate) turning points in the markets (tops and bottoms) by determining when the price action has moved in one direction for too long, and are usually in the form of an oscillator. An oscillator means that there is a bottom and a top, and the indicator is confined to move up and down between the top and bottom. When indicators reach the top of their range, prices are usually reaching “overbought” levels, meaning that it’s time for the market to rest or reverse direction. Visa versa, when indicators reach the bottom of their range, prices are usually reaching “oversold” levels and the market again needs to rest or reverse direction.

An indicator is not a holy grail, it’s just an additional tool that combined with other technical analysis will help you make a calculated decision.

Once again, I’m not going to list or explain all available indicators of online forex trading. I’m going to give you examples of the 3 most commonly used indicators and tell you what they are good for.

RSI Indicator- Relative Strength Index

RSI stands for relative strength index. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing prices of a recent trading period. The RSI is classified as a momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price. The RSI computes momentum as the ratio of higher closes to lower closes: stocks which have had more or stronger positive changes have a higher RSI than stocks which have had more or stronger negative changes.

To be honest, I don’t really know how it works, but I know it’s helpful on the charts. When the RSI is above 50, it’s bullish (upwards for chart price action) and below 50 is bearish (downward for price action). When the RSI gets above the 70 level, price action becomes overbought and possible tops or reversals could be imminent. When the RSI gets below the 30 level, price action becomes oversold and possible bottoms or reversals could be imminent.

Slow Stochastics Indicator

The Slow Stochastics is another momentum oscilator. This method attempts to predict price turning points by comparing the closing price of a security to its price range.

Again, it’s not important to know how it works, you just need to know that it’s a helpful indicator to aid you in making and executing better forex trades. Just like with the RSI indicator, there are overbought and oversold levels that will warn you when price change could be imminent.

A thing I like about the Slow Stochastics is that once it crosses to the upside or downside, it usually continues in that direction until it has reached overbought or oversold levels. That is helpful to let you decide how much longer you should stay in a trade and how much further it potentially has to go.

MACD Indicator

MACD stands for Moving Average Convergence Divergence.It is used to spot changes in the strength, direction, momentum, and duration of a trend in a stock’s price. The MACD is a computation of the difference between two exponential moving averages (EMAs) of closing prices. This difference is charted over time, alongside a moving average of the difference. The divergence between the two is shown as a histogram or bar graph.

The thing I’ve noticed about the MACD indicator is that it is a very slow-moving indicator. What I mean by that is that in the time it takes for the MACD to complete one oscillation (top to bottom), the RSI or Slow Stochastics may have done 2 or 3 complete oscillations.

This is why you need to use multiple indicators to bade your trades on, so that you can choose as close to the perfect timing as possible when all indicators give you a signal at the same time. This give you the highest chance of making a profit from your trade.

Divergence Trading Technique

Divergence trading is one of my favorite online forex trading techniques. It’s based on a divergence between the price action and the indicators (I usually only use the RSI indicator to find and trade divergences).

It works as follows: when the movement in price action is not confirmed by the RSI indicator, then it’s usually a sign of an imminent change of direction.

So, when the price action makes a high and then a higher high, but the RSI movement makes a high and a lower high, this is called a negative divergence. (Look at the chart below, it’s an example of a negative divergence).

Divergence trading works for catching trend changes in both directions. When price action makes a low and then a lower low,but the RSI makes a low and a lower high (non-confirmation of the price action), you can trade on the expectation of the price action moving considerably higher.

Moving Average Trading Technique

Another online forex trading technique I’m a big fan of is based on different types of moving averages. A moving average is an indicator that you can add to your chart that will create a continuous line, based on the average of X periods of the time-frame chart you add it to. If you choose a moving average of 100, and your chart has a time-frame of 1 hour, then your moving average will always be the average of the last 100 hours.

Moving averages are a great tool to use for helping you determine entry and exit points for profitable trades because of the fact that the price action can only move a maximum amount of pips away from the average before it needs to consolidate or pull-back to that average.

Important moving averages are the 21, 50 and 100 MA. The smaller the number, the closer that average stays to the price action. Buy and Sell signals can be generated by seeing when different types of moving averages (on the same chart) cross each other. For example, if a 21MA would cross down through a 50MA, it would be a sell signal. If a 50MA would cross up through the 100MA, it would be a buy signal (theoretically speaking).

In the chart below I’ve just made an example with the 21MA (Blue) and the 50MA (Green). You can see how buy and sell signals are generated every time they cross, signals that you can use to make profitable trades with. The most profitable signal would be on the left of the chart where the 21MA crosses down through the 50MA. This would be a sell signal and would have resulted in a profit of over 100 pips.

What you must know is that the cross signals don’t always produce similar price action moves, and sometimes there will be multiple crosses of the averages in a row without anything happening and can deceive you into making trades that will lose money. This is part of the online forex trading game, because if there were any guarantees, everyone would be rich.

4 Golden Rules for Online Forex Trading

If you’re interested by what you’ve read so far and you’re considering opening a forex trading account, I highly suggest you live by the following 4 rules at all times. Trust me, it will save you from blowing your account and from losing all your money.

Golden Rule 1: Always Use A Stop Loss

As a forex trader a stop loss is your best friend. It will help you keep your maximum loss to a predetermined amount and will prevent you from getting emotionally attached to your trade.

Emotional attachment to your trades leads to you holding on to a losing trade for so long that the loss becomes huge or even causes you to go broke. Many beginners make the mistake of holding on to a losing trade, doubling or tripling up thinking that “it’ll come back” and watching their whole account disappear on a single wrong trade.

Do NOT trade without stops. Leave your ego at the door, wrong is wrong. Be a man (or woman) and accept the loss when your analysis is wrong. Regular losses are part of the online forex trading game, but the losses will be acceptable if you use a stop loss in accordance with the next rule:

Golden Rule 2: Never risk more than 3-5% of your account on a single trade.

For every trade you make, you should set a stop loss so that if it gets hit you will lose a maximum amount equal to 5% of your account size. This means that if you have $1000 in your account, you can’t lose more than $50 on a single trade.

You’ll need to adjust your trade position size so that your stop is at maximum 5% of your account. If you’re just starting out with online forex trading, I recommend no more than 3% account risk on a single trade.

The reason is that when using this rule of stops equal to a maximum of 5% of your account, you can make 33 wrong trades in a row before you blow your account or go broke. You will not lose your account in one or two single trades like the majority of beginning forex traders do.

If you use a proven system based on technical analysis to determine your trades (entry and exit points), then it will be rare if you have more than 8 losing trades in a row… very rare.

Rule #1 and #2 are key to your success with online forex trading. Stick to them religiously.

Golden Rule 3: Use technical analysis

You will hear many old school analysts talking about using fundamental analysis, basing trades on the economy and fundamentals of a country or company, but as I explained earlier in the article fundamental analysis is weak for determining entry and exit points for profitable trades with online forex trading.

While fundamentals certainly play a role in the price action and fluctuations of currencies, they usually take much longer periods of time to materialize. Technical analysis will help you determine profitable entry and exit points to a much better degree that fundamental analysis or any other type of system.

When you trade according to a system based on technical analysis, you trade what you see on the charts and not according to your opinion or hunch. Just like when you bake a cake, you want to follow an exact recipe with set amounts of each ingredient. If you just mix ingredients, you’ll never know what cause the recipe to be good or not, and you won’t be able to replicate it.

Golden Rule 4: Don’t over-trade.

If you have had a winning session or a few winning sessions, take a break. Just like with anything in life, sometimes with online forex trading you get really lucky. You make 3, 5 or 8 winning trades in a row and this is when you should become more careful, not more confident. Don’t let your streak of successes build your ego up into letting you think that you are the best trader in the world and cannot make mistakes.

The biggest danger comes when you think you can step away from your rules of not risking more than 5% of your account on a single trade and when you trade without a stop because you think that your vision is never wrong.

Stay humble and cautious and stick to your trading rules!

I’ve personally opened an account with eToro where I deposited an amount of $500. I chose eToro because they are reputable, they have a very neat web-based trading platform and mobile trading app and on top of that they give one of the best new account bonuses available. (A $1000 deposit will give you $250 instant cash bonus).

I’ll go into detail about how to get started with online forex trading (opening an account) in the next post. I suggest that you wait to read them first before depositing money but if you want to get a feel for forex trading, you can download a free practice account from eToro below where you’ll get virtual money to trade real markets with. (It’s a simulation, so you get $50,000 virtual money in your account that you can use to make trades on the actual forex markets in real-time without risking a penny of your own money).

If you have any questions feel free to leave a comment below! I’ll reply to everyone personally.

Remember that this is part 2 of 3 of a tutorial series about online forex trading. Part 1 can be found here.