How to Use Forex Bounce Strategy

by Tom Streissguth, Demand Media
    Price trends as indicated by the EMA are the basis of the bounce strategy.

    Price trends as indicated by the EMA are the basis of the bounce strategy.

    Forex ("FOReign EXchange") traders speculate on the rise and fall of currency pairs: two major currencies, such as the U.S. dollar and euro, that rise and fall with the relative strength of each currency. Traders looking for quick profits in this fast-moving market can make use of the bounce strategy. Using short-period price charts, the trader sets a moving average line and plays the "bounce" off that line when the currency pair reaches it. This technique, which can also apply to day trading in stocks, requires careful and constant attention to the market in active trading periods.

    Setting Up

    With your forex brokerage account active, select a short-term price chart of the currency pair you are trading. A 15- or 5-minute chart works well with the bounce strategy, which is designed for short-term trading in which you open and close a position within an hour, and often quite a bit faster. The bounce strategy can work whether a currency pair is trending higher or lower; in the forex market, traders can either buy ("go long") or sell ("short") an individual pair.

    Moving Average

    Display an exponential moving average, or EMA, that measures the average closing price of the currency pair over the last 25 to 50 trading periods. Your online broker should provide this basic technical indicator through a pull-down menu or similar device. Select the EMA period and have it display on your chart in a contrasting color so that it is easy to compare with the price indicators. Varieties of the bounce strategy use multiple EMAs in combination; or require that you confirm a longer-term trend by comparing it with a much shorter period; 1-hour with 5-minute charts, for example.

    Considerations

    The bounce strategy is based on the theory that a sharp trend in price will eventually retrace to the moving average, then bounce off that average and resume its previous move. In the currency market, the bounce strategy works because many active traders are taking their cues from the EMA indicator, moving the market together with the dominant trend when there is no fundamental or market-moving news to consider.

    Uptrends

    If the price of your pair is trending up and fluctuating above its moving average, buy the pair after it bounces off the moving average. When the price falls below the EMA line, set a limit buy order just above the line. After the order fills -- if it does -- ride the pair up until the price stalls, then close it out by entering a sell trade. Set your stop about 20 pips below the entry point. Currency traders deal in "pips," an acronym for "percentage in point." This is the smallest increment of value in the pair, as tracked by the forex market. You're looking to take a small profit in the bounce, not hold the trade open for a large gain.

    Downtrends

    If your pair is trending down and hovering below the moving average, you will short the pair when it rises to the EMA and then retreats. If the pair rises above the EMA, set a limit sell order just below the line. When the pair moves down, resuming its dominant trend, your order will fill; you ride the move until it stalls, then close the trade with an offsetting buy order. Set a stop of about 20 pips above the entry price. Never keep your position open if you're ending your session, whether you're long or short. The idea is a short-term gain, which you can repeat every time the price hits the EMA.

    Warnings

    Don't use the bounce strategy at the market openings, when announcements or news surprises tend to move the prices in unpredictable ways. Also, don't try the bounce when the currency pair you're trading is moving aimlessly around the EMA, and no trend is present. Always consider the dominant trend, as shown on your 15-minute chart by the general direction of the pair over the last 24 hours. Always trade using stop-loss orders, and don't risk more than 2 or 3 percent of your capital on any single trade.

    About the Author

    Tom Streissguth has worked for over 15 years in the legal field as a writer and legal assistant, and has authored numerous articles on Social Security disability law. He has many nonfiction and reference titles in print, including works for The Gale Group and Lerner. He holds a Bachelor of Arts from Yale University.

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