Do you want to trade Forex over longer timeframes? If so, please read on. This article will explain how to trade long-term using fundamental analysis. It’s how professionals approach their positions.
If you’re unfamiliar with fundamental analysis, this article isn’t your best starting point. Instead, please read my introductory article.
Central bank policy divergence
To trade long-term, you just need to track something called central bank policy divergence. This phrase might sound complex, but its concept is actually very simple.
Central banks are usually tackling one of two problems. The first is slow economic growth, representing by sluggish GDP and high unemployment. The second is the rate of inflation, which most major central try to keep at an annual rate of 2%.
To address these problems, central banks employ monetary policy tools. For example, to address slow growth and high unemployment, a central bank might cut its interest rates or introduce quantitative easing.
Policy divergence is simply the policy programme a central bank adopts to solve its problem.
Matching policy extremes
Now you understand central bank policy divergence, your next task is to match policy extremes.
It’s important to recognise that long-term trading is more unpredictable than short-term trading. So it’s vital that you stack the odds in your favour when predicting price movements. One way to do this is by matching central banks (and their respective currencies) that have extreme opposite policy approaches.
For example, one central bank might be talking about cutting its interest rate because of slow economic growth. In this instance, it’s likely that a downward move for its currency is in its infancy. If interest rates cuts are announced further down the line, the move will continue to play out. This is clearly a good currency to look to sell.
Meanwhile, there could be another central bank which is talking about increasing its interest rates because of high inflation. This would act to strengthen its currency over the long-term.
Hopefully, you can see that these two currencies are ideal to pair together (remember, all currencies are traded in pairs) because the fundamentals suggest they will move in opposite price directions. Following this approach ensures you have a high chance of the pair going in one stable direction.
You can attempt this approach by just identifying one central bank’s policy divergence. However, your ability to predict a stable price movement will be hampered. It’s better to identify two central banks (and their respective currency) that have opposite policy programmes.
Timing is critical
When you place your trade is also key to long-term trading success. They key is to time your position based on when the bank shifted direction.
For instance, a central bank may have cut its interest rate multiple times already. As the central bank is already midway into a ‘cutting cycle’, your prospective trade has less room to run. It would be better to open your trade at the start of the cutting cycle.
If a central bank has surprised the markets by changing its policy direction, it’s the perfect time to open a position.
The ideal scenario is to identify a pair made of two currencies that have each just been impacted by some new tone from their central bank. Clearly, this can turn into an exciting long-term trend which you can profit from.
In summary, there are two key points when looking to trade long-term with fundamental analysis:
- Trade currencies with strongly opposite central bank policies driving them.
- Look for opportunities where the central bank has only very recently started moving in the direction of that policy.
A real trade example
If you trade longer term, the best way to manage the trade is to take cues from experts and the central banks.
For example, when I traded the Bank of Japan quantitative easing announcement in 2013. I relied on the fact the bank themselves set a target of 1.10 for the USDJPY pair.
Specifically, they stated that they would keep devaluing the yen until that pair reached their target price. This provided a clear framework for my trading from that point.
Keep in mind that stop losses should be relative to your target size. If you are holding for a few weeks for hundreds of pips, then you will need a stop loss of several hundred pips to ride out any short-term volatility. Trading this way (without leverage) is a must to protect your account.
Limit your open positions
Another word of advice: you don’t need many of these moves to make a very good return on your account. For example, 1000 pips is approximately a 10% return if you are trading with zero leverage.
Over the course of a year, there are plenty of large moves in response to central bank policy changes. Being patient and waiting for the best ones is your key to making healthy profits.
If you check the markets around a full-time job, then this is a perfect strategy. Once you find an opportunity, all you need to do is monitor the news to make sure that the policy is still on track as the move plays out.
Your move is likely nearing an end when it’s clear that the central bank’s current policy has run its course. Let’s look at an example. A central bank may have been cutting interest rates for one year and unemployment has fallen. As such, the central bank has started to talk more positively about the economy and growth. This could be a good point to exit your position. You could even start looking for a reversal.
How to trade long-term fundamental analysis
I hope you have found this article useful. If you have any questions, please leave them in the comments below. I’ll try to answer as many as I can.