Foreign exchange trading, commonly known as forex trading, has become very popular globally, and South Africa is not exempted from this. Thus, the chance of getting high returns and the expanding opportunities to trade on the global level makes forex trading an attractive field for South African investors. Nevertheless, like any other business, investment in forex has its risks, and this means that one has to be strategic. As a vital concept of trading, diversification can assist traders to minimise the risks and increase the chances of making profits. This article discusses several forex trading methods that any trader in South Africa can use to increase his or her returns.
Understanding forex trading
To truly answer the question of ‘what is forex?’ It is necessary to start with some basic knowledge of forex trading before moving to the strategies. The forex market is the biggest and most volatile market in the world, with daily trading volumes of more than $6 trillion. It entails the process of trading one currency for another, for instance, USD/ZAR or EUR/USD, where traders seek to make profits from changes in the exchange rates.
The forex market is an active market, working around the clock, five days a week and thus offers a lot of convenience to its traders. This is due to the fact that the trading of various financial instruments goes on throughout the day due to the overlapping of business hours of different financial centres across the globe.
Why diversify in forex trading?
Risk management in forex trading is the process of reducing the exposure of your investments to various currency pairs, entry and exit methods, and even time frames. This approach minimises losses when some of the currency pairs or strategies produce negative results. Thus, traders can develop a more stable and less risky approach to their trades when they diversify.
Strategies in forex trading for diversification
1. Trend following
Trend following is one of the most used strategies by forex traders. It entails the identification of buy and sell signals in the direction of the current trend in the market. The rationale is that price will sustain the trend for some time in the future. Traders employ technical indicators like the moving averages, trend lines among others to examine the trend’s direction and momentum.
Pros: May generate good returns during the periods of trending markets.
Cons: Can be detrimental in sideways or range bound markets.
Therefore, focusing on USD/ZAR pair is recommended for South African traders because this pair often displays high volatility and tends to produce long lasting trends which depend on economic indicators and political events.
2. Range trading
Range trading focuses on determining specific levels that act as support and resistance and take place within a specific range. The traders purchase at the support level and tend to sell at the resistance level with an aim to make a profit out of the Price Action within the Range.
Pros: Applicable in a stable market with no tendency.
Cons: May cause losses especially in the trending or highly volatile markets.
This strategy entails understanding the technical analysis and the ability to wait for the right time of entry and exit.
3. Carry trade
Carry trade is a method of trading in which a trader tries to benefit from the difference in the interest rates of two currencies. They borrow at a low interest rate and lend at a high interest rate to gain the difference in the two rates of interest. The variation in the interest rates between the two financial instruments becomes the trader’s gain.
Pros: Opportunities to generate consistent profits from the spread between two interest rates.
Cons: Losses that may occur if the exchange rates are not in the company’s favour.
South African traders can look at pairs such as AUD/JPY or NZD/JPY where interest rate differentials can be starker.
4. Scalping
Scalping is a type of trading that aims at placing many trades in a day and taking small profits from small price changes. Scalpers are interested in getting a profit from small changes in the price, which is why they use positions for a short time, from several seconds to several minutes.
Pros: It can be profitable in the long run if the plan is implemented well.
Cons: Takes a lot of time, focus and fast critical thinking.
Scalping is suitable for traders who can afford to invest lots of time in tracking the markets and can endure stress.
5. Swing trading
Swing trading requires taking positions that are held for a few days to no more than a few weeks with the goal of capturing/reaping gains from short term to mid term trends. This strategy operates based on analysing the market in an attempt to determine the possible price fluctuations.
Pros: Not as time consuming as day trading or scalping; high profit margins are possible.
Cons: It takes time and one has to be willing to take a loss when the market is closed for the night.
This type of trading is suitable for traders who want to spend some time analysing the market but do not have to watch the market minutely.
6. News trading
News trading is based on making a profit from fluctuations that occur after important news or events have occurred. Traders examine the data on employment, interest rates, and GDP in order to foresee the markets’ response.
Pros: It can result in generating high profits due to a large amount of price fluctuations.
Cons: Very unstable and challenging; often demands timely actions and profound knowledge of the big picture.
To illustrate, the ZAR is sensitive to the decisions that the South African Reserve Bank makes, such as changing the interest rates; therefore, SA traders need to follow the news both locally and internationally.
Strategies for developing a forex portfolio
Combine Multiple Strategies: There is no harm in adopting more than one strategy in the process of trading as a way of diversifying. For example, a trader can use trend following for long term trade while at the same time using scalping for short term trades. Thus it can help in managing the risks and benefits of the system.
Trade Different Currency Pairs: Trading across different currencies also helps to reduce risk. A South African trader may trade the majors, such as EUR/USD and GBP/USD, as well as the minors or emerging market pairs, such as USD/ZAR. This approach diverts exposure across various economies and thus doesn’t depend a lot on the performance of one currency.
Manage Risk Effectively: Forex trading involves risks and that is why risk management is very important. Some of the strategies include placing stop loss orders, proper position sizing and the need to follow the set trading plan. Diversification itself, is a risk management strategy which minimises the effect of a single losing trade on the overall portfolio.
Continuous Learning and Adaptation: Therefore, the forex market is very volatile and it is influenced by key events, economic changes and even technology. Learner-ness and flexibility are crucial for the future viability of a company. South African traders must always know the market trends, fine-tune their plans, and always be ready for new possibilities.
