Potent foreign exchange trading comes through simplicity – applying a good strategy with consistency, and with heed to risk and money management techniques. However, that does not mean traders can become successful simply by learning and applying a few simple foreign exchange trading tricks. In this article, we flirt with a couple of the more advanced techniques and concepts that are likely to be found nearer the end of your forex 101 book.
2 Advanced Foreign Exchange Trading Concepts
1. Trading Divergences. It’s probably the first somewhat advanced concept that you’ll learn as a foreign exchange trader. Divergences are really powerful things to spot on your charts. They are powerful because they are often a prelude to dramatic price movements. When you see a divergence emerge on your charts its time to smack your lips and act on what the divergence is telling you.
A simple divergence is when price action moves in one direction, while a key trading indicator does something completely polar. There are different types of divergences, such as hidden divergences and standard divergences. They can also be bearish or bullish depending on the situation. We’ll go through an example of a straightforward standard divergence below.
There is a clear bull run on the EUR/USD chart, and you see that the price action has been making higher highs as you would expect. However, you notice that on both MACD and Stochastic the most recent peak is lower than the previous one. That’s one interesting thing to see on your charts. It infers that although the bulls have gotten carried away with lifting price to ever higher new echelons, the indicator shows definite price exhaustion. In this instance, because the Stochastic and the MACD show lower subsequent highs, it is a negative divergence – we would then expect price action to follow the two indicators and drop steeply. While divergences can take a little getting used to, they are one of the most powerful foreign exchange trading spots out there.
2. Currency Correlations. The more astute traders, even at their beginnings, might spot that some currency pairs seem to rise and fall together. This is not coincidence – some currencies are closely correlated, which means they tend to rise and fall in unison. This is an incredibly important concept to understand as you trade more – especially when you trade multiple currency pairs all at once. Currency correlations can serve to magnify a traders risk if they are not aware of them. This can be especially dangerous when a foreign exchange trader operates a highly leveraged account, as two positions that have positive correlations can damage trading equity if closed at a loss. Just as some currency pairs will have a positive correlation (move up and down together), others will have a negative correlation – when one pair rises, the other will fall. So which pairs are correlated and to what degree? Answering that question is somewhat tricky – the correlation between currencies is fluid. While they often last for a very long time, they do in the end change – so it’s not as easy as publishing a list of correlated currencies (it would eventually get out of date). As different countries change their economic drivers (such as interest and tax rates) it has an effect on the currency, and so will also impact the overall currency pair correlations.
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