A forex strategy can be constructed with fundamental or technical tools, or a combination of both. A fundamental strategy performs better with a longer horizon due to the weaker relationship between fundamental events and forex market developments in the shorter term. A technical strategy would perform with equal success in both short and long term markets (although its degree of success is a matter of debate among traders.).
Regardless of one’s approach, it is natural that a degree of technical analysis must be present in any trader’s methodology due to the need to maintain benchmarks and numerical criteria for record keeping, and the analysis of trade results.
The following is a step-by-step guide to a hybrid strategy employing both long and short term methods.
1. Determine the market, the currency pair, and the risk profile of the trade
For a short term strategy, fundamental analysis finds its greatest use at this stage. Latest news must be analyzed, and a fundamental explanation of historic trends in the currency pair must be obtained through fundamental analysis in order to establish the risk profile of the trade. We’ll then need to identify potential cases where the trade must be closed regardless of technical patters.
2. Decide on the timeframe, and dominant pattern of the trade that will be taken
We need to decide whether the pair we’ll trade is in a range pattern, or is trending perceptibly. The choice of technical tools will depend strongly on this distinction, and this is arguably the most important phase of analysis.
3. Identify the strongest signals on the relevant indicators
Due to the nature of technical analysis, just about every indicator will emit some kind of signal when applied to the price data, but our task is to identify the strongest ones among them, depending on the type of market, and to devise our strategy in accordance. Divergences, and various flag patterns are some of the examples that can create a basis for strategy creation.
4. Create a stop-loss, take profit aim through a combination of indicators
Our trade will have its own numerical risk controls (in the stop-loss order), but the best way of creating a combination of indicators is using each one of them for the purpose of defining the plausible range of our trade. For instance, in a trend trade, we may decide to create the upper bound (where profits will be taken) on the basis of a value of the RSI, and the lower bound (where the trade must be liquidated) on the basis of a certain moving average crossover.
Creating a technical strategy is not difficult, and the success and failure of the account (and not necessarily the trade) will likely depend on the implementation of money management methods, rather than on the strategy itself.
Next step: Range Trading