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Forex Trading Strategies

Free Forex trading strategies and methods.

Forex Trading Strategies

Postby admin » Thu Oct 04, 2012 8:38 pm

Trend Following:
Trend following is an investment strategy that tries to take advantage of long-term, medium-term, and short-term moves that sometimes occur in various markets. The strategy aims to take advantage of a market trend on both sides, going long (buying) or short (selling) in a market in an attempt to profit from the ups and downs of the stock or futures markets. Traders who use this approach can use current market price calculation, moving averages and channel breakouts to determine the general direction of the market and to generate trade signals. Traders who subscribe to a trend following strategy do not aim to forecast or predict specific price levels; they initiate a trade when a trend appears to have started, and exit the trade once the trend appears to have ended.

Pair Trading:
The pairs trade or pair trading is a market neutral trading strategy enabling traders to profit from virtually any market conditions: uptrend, downtrend, or sidewise movement. This trading strategy is categorized as a statistical arbitrage and convergence trading strategy.

Delta Neutral Strategies:
In finance, delta neutral describes a portfolio of related financial securities, in which the portfolio value remains unchanged due to small changes in the value of the underlying security. Such a portfolio typically contains options and their corresponding underlying securities such that positive and negative delta components offset, resulting in the portfolio's value being relatively insensitive to changes in the value of the underlying security.

In economics and finance, arbitrage /ˈɑrbɨtrɑːʒ/ is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. When used by academics, an arbitrage is a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state; in simple terms, it is the possibility of a risk-free profit at zero cost.

Conditions for Arbitrage:
Arbitrage is possible when one of three conditions is met:
The same asset does not trade at the same price on all markets (the "law of one price").
Two assets with identical cash flows do not trade at the same price.

An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate (or, the asset does not have negligible costs of storage; as such, for example, this condition holds for grain but not for securities).

Arbitrage is not simply the act of buying a product in one market and selling it in another for a higher price at some later time. The transactions must occur simultaneously to avoid exposure to market risk, or the risk that prices may change on one market before both transactions are complete.

In practical terms, this is generally only possible with securities and financial products which can be traded electronically, and even then, when each leg of the trade is executed the prices in the market may have moved. Missing one of the legs of the trade (and subsequently having to trade it soon after at a worse price) is called 'execution risk' or more specifically 'leg risk'.

In the simplest example, any good sold in one market should sell for the same price in another. Traders may, for example, find that the price of wheat is lower in agricultural regions than in cities, purchase the good, and transport it to another region to sell at a higher price. This type of price arbitrage is the most common, but this simple example ignores the cost of transport, storage, risk, and other factors.

"True" arbitrage requires that there be no market risk involved. Where securities are traded on more than one exchange, arbitrage occurs by simultaneously buying in one and selling on the other.
See rational pricing, particularly arbitrage mechanics, for further discussion.

Mean Reversion:
Mean reversion is a mathematical methodology sometimes used for stock investing, but it can be applied to other processes. In general terms the idea is that both a stock's high and low prices are temporary, and that a stock's price tends to have an average price over time.

Mean reversion involves first identifying the trading range for a stock, and then computing the average price using analytical techniques as it relates to assets, earnings, etc.

When the current market price is less than the average price, the stock is considered attractive for purchase, with the expectation that the price will rise. When the current market price is above the average price, the market price is expected to fall. In other words, deviations from the average price are expected to revert to the average.

The Standard deviation of the most recent prices (e.g., the last 20) is often used as a buy or sell indicator.
Stock reporting services (such as Yahoo! Finance, MS Investor, Morningstar, etc.), commonly offer moving averages for periods such as 50 and 100 days. While reporting services provide the averages, identifying the high and low prices for the study period is still necessary.

Mean reversion has the appearance of a more scientific method of choosing stock buy and sell points than charting, because precise numerical values are derived from historical data to identify the buy/sell values, rather than trying to interpret price movements using charts (charting, also known as technical analysis).

Scalping (trading) is a method of arbitrage of small price gaps created by the bid-ask spread. Scalpers attempt to act like traditional market makers or specialists. To make the spread means to buy at the bid price and sell at the ask price, to gain the bid/ask difference. This procedure allows for profit even when the bid and ask do not move at all, as long as there are traders who are willing to take market prices. It normally involves establishing and liquidating a position quickly, usually within minutes or even seconds.

The role of a scalper is actually the role of market makers or specialists who are to maintain the liquidity and order flow of a product of a market. A market maker is basically a specialized scalper. The volume a market maker trades are many times more than the average individual scalpers. A market maker has a sophisticated trading system to monitor trading activity. However, a market maker is bound by strict exchange rules while the individual trader is not. For instance, NASDAQ requires each market maker to post at least one bid and one ask at some price level, so as to maintain a two-sided market for each stock represented.

Transaction Cost Reduction:
Most strategies referred to as algorithmic trading (as well as algorithmic liquidity seeking) fall into the cost-reduction category. Large orders are broken down into several smaller orders and entered into the market over time. This basic strategy is called "iceberging". The success of this strategy may be measured by the average purchase price against the volume-weighted average price for the market over that time period. One algorithm designed to find hidden orders or icebergs is called "Stealth". Most of these strategies were first documented in 'Optimal Trading Strategies' by Robert Kissell.

Strategies that only Pertain to Dark Pools:
Recently, HFT, which comprises a broad set of buy-side as well as market making sell side traders, has become more prominent and controversial. These algorithms or techniques are commonly given names such as "Stealth" (developed by the Deutsche Bank), "Iceberg", "Dagger", "Guerrilla", "Sniper", "BASOR" (developed by Quod Financial) and "Sniffer". Yet are at their core quite simple mathematical constructs. Dark pools are alternative electronic stock exchanges where trading takes place anonymously, with most orders hidden or "iceberged." Gamers or "sharks" sniff out large orders by "pinging" small market orders to buy and sell. When several small orders are filled the sharks may have discovered the presence of a large iceberged order.
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