Forex Day Trading

What is Forex Day Trading?

One of the most popular ways of participating in the financial markets of the world is through a discipline known as day trading. Day trading is the active buying and selling of financial instruments within short-term, intraday time frames.

In contrast to more traditional forms of capital investment, day trading aims to achieve profitability through frequently entering and exiting a market. Instead of buying or selling a security and waiting weeks or months for capital appreciation, day traders take many small gains and losses every day in the quest for a positive bottom line.

The main goal of day trading is simple: achieve long-term profitability through executing as many winning trades as possible. To put it another way: the primary objective of a day trader is to ensure that profit outweighs loss and victories are always greater than defeats.

Elements Of Day Trading

There are several major facets of short-term trading that must be thoroughly addressed within the context of a comprehensive trading plan before an individual starts the process.

Analytics

One of the key decisions for any forex day trader is whether to focus on fundamental or technical analysis. Fundamental analysis is the study of market underpinnings in an attempt to identify potential trends in price. On the forex market, the vital fundamentals are central bank actions, economic performance and governmental policies.

Conversely, technical analysis involves the direct study of current and past price action. When adhering to technical analysis, foreign exchange market participants apply various tools and indicators to craft trading decisions.

Trade Selection

Depending on each trader's analytical base—fundamental or technical—concrete guidelines governing the identification of a trading opportunity are necessary. Ideally, trade selection is driven by a statistically verifiable "edge," or positive expectation. Predefined criteria pertaining to trade setups enable the trader to enter the market consistently and with confidence.

Trade Management

Upon entering the market, management of the newly opened position becomes a task crucial to the trader. The employment of protective stop-loss orders, in addition to profit targets, are basic methods of preserving capital while maximising the potential for gain. Trailing stops and proactively scaling in and out of positions are more complex examples of market exit strategies.

Being aware of factors such as volatility, the economic calendar and trading volume is also necessary. Without question, managing open positions competently is an integral part of securing long-term profitability.

Money Management

A comprehensive money management strategy is an absolute necessity when trading on an intraday basis. The proper use of leverage is a key part of determining the correct position size and aligning risk vs. reward. Through administering sound money management principles, a trader can avoid the many problems related to a dwindling account balance.

Intermediate-term trading, swing trading and long-term capital investment implement the use of a time horizon measured in days, weeks, months and years. Active day trading is concerned with time denominations of hours, minutes and seconds. So, if you're day trading the US dollar (USD) or British pound (GBP), your investment horizon is guaranteed to be less than 24 hours.

There is rarely ample time to craft quality trading decisions on the fly. Without first performing the necessary due diligence regarding the three key areas of day trading, an individual new to the market is likely to fall victim to many avoidable dangers.

Day Trading The Forex Market

Perhaps the most appealing venue for an aspiring day trader is the foreign exchange (forex) market. The forex market is an over-the-counter (OTC) market specialising in the trade of global currencies. The average daily traded volume measures anywhere from US$3.5 trillion to US$5.5 trillion. In comparison, the average daily traded volume for the New York Stock Exchange (NYSE) typically trades between a value of US$30 billion and US$100 billion.[1]

Short-term currency trading on the forex market affords participants several distinct advantages:

  • Variety: In addition to forex pairs based upon the eight global "major" currencies, many smaller, regional currency pairings are also available for trade.
  • Liquidity: The daily volume of trade is enormous. Large volumes ensure that a trader can interact with the market efficiently.
  • Leverage: Forex currency pairings are traded heavily on margin. In forex, leverage is used to either buy or sell large quantities of currency.
  • Opportunity: The forex market is open for trading 24 hours a day, five days a week. Extensive trading sessions produce a greater number of trading opportunities, no matter the currency pair or approach.

A group of diverse currency pairs, optimal liquidity and enhanced leverage make the forex an extremely popular trading venue. Regardless of whether one specialises in the trade of shares, futures, or cryptocurrencies, the forex can be a welcomed addition to anyone's portfolio.

Example Of A Forex Day Trade

In the world's currency markets, there are a multitude of forex day trading strategies being implemented at any given time. A few of the most popular trading stratgies are breakout, scalping and momentum-based trading plans. Ultimately, the responsibility falls upon each forex day trader to decide which type of strategy is best suited to their available capital and time resources.

To illustrate how day trading currencies works, let's assume that Erin the euro (EUR) scalper is interested in the current volatility of the EUR/USD. Erin implements an involved short-term trading strategy that is based on buying or selling defined support and resistance levels. Accordingly, Erin focusses on crafting viable trading strategies per the adopted trade selection, position management and money management guidelines.

Identifying A Positive Expectation Trade

Shortly after the London market opens (7 a.m. GMT), Erin notices that the USD is falling against the majors. This price action may be attributed to several factors, namely a surprisingly dovish tone from the United States Federal Reserve (Fed). Subsequently, the EUR/USD is on a steady climb and approaching a key 50-day simple moving average (SMA) at 1.2000.

To capitalise on the price action, Erin enters a sell limit order from the 50-day SMA at 1.2000. When the EUR/USD reaches this level, a new short position will open from perceived topside resistance.

Applying Risk Management Principles

On the forex market, risk management has two essential components: applied leverage and stop loss location. In order to place a sound, properly structured trade, Erin must formally address each issue.

Applied leverage is the position size being assumed in the live market. In forex, a trade's position size is the amount of currency being purchased or sold. Measured in "lots," forex positions most commonly come in standard (100,000 units), mini (10,000 units) and micro (1,000) allocations. The cardinal rule of applied leverage is this: the greater the position size, the greater the per pip value and required margin.

Choosing an appropriate position size is vital to success and is dependent on the trader's account balance and prevailing market volatility. Assume that Erin has a US$1,000 account size and the market conditions facing the EUR/USD aren't extreme. Accordingly, a position of three mini lots of EUR/USD is deemed ideal, pricing out at US$3.00 per pip.

Aligning Risk To Reward

In addition to applying the proper leverage, Erin must find an ideal stop loss location. A stop loss, or "stop" for short, is an order that limits the negative impact of an unfortunate move in price. Stop losses insulate the trading account balance from unwarranted drawdowns and are powerful risk management tools.

Functionally, protective stops rest at market until price action rises or falls to the specified level. At that point, the order is filled at the best available market price.

Because Erin is a scalper, the EUR/USD short trade's stop loss is tight; this means that the number of pips being risked is not overly disproportionate to the trade's profit target. While other forex day trading strategies aim to capture positive price movements upwards of 3, 4, or 5 times the number of pips being risked, scalpers frequently aim for a 1:1 or slightly sub-1:1 risk vs reward ratio.

An ideal stop loss location depends on the strategy. For Erin's short intraday trade, a stop loss is placed just above the 50-day SMA at 1.2011. When coupled with a profit target at 1.1989, the scalp trade has a manageable 1:1 risk vs reward ratio. Accordingly, a winning percentage modestly above 50% can generate long-run profitability.

Trade Execution

One of the best things about the modern forex marketplace is that trade execution is user friendly. All one needs to start trading is a good idea, venture capital, an internet connection and computing power—the software trading platform does the rest.

To execute the EUR/USD short scalp, Erin only needs to follow the three-step progression below:

  1. Enter a "sell limit" order for 3 mini lots of EUR/USD at 1.2000. This may be accomplished from either a supported EUR/USD chart or trading DOM.
  2. Align the stop loss and profit targets for the trade. For manual entry, Erin can place the stop loss at 1.2011 (buy stop market order) and profit target at 1.1989 (buy limit order) by hand. Or, a one-cancels-the other (OCO) order may be utilised, which automatically places the stop loss and profit target at market once the entry order has been elected.
  3. Observe the trade's evolution. If the unexpected occurs, Erin can instantly exit the position by sending a buy market order to market.

There are numerous trading tools available for those interested in streamlining trade execution. Automated systems, algorithmic trading, server co-location and advanced order types are only the tip of the iceberg. No matter what your forex day trading strategy may be, these devices can help simplify placing and executing any type of trade.

Summary

The forex market is often viewed as a day trader's dream. Frequent opportunity coupled with the availability of financial leverage are attractive characteristics to anyone interested in pursuing a career as a professional day trader. No matter if one is an intraday scalper, momentum, or breakout trader, the forex market has a suitable currency pair for the endeavour.

Unfortunately, common pitfalls such as overtrading and the improper use of leverage can lead to substantial capital loss. Although the development of a comprehensive trading plan can help mitigate these issues, short-term trading remains a formidable challenge not suitable for everyone. However, through the implementation of strong analytics, as well as prudent risk and money management principles, it is possible to consistently make money trading forex.

This article was last updated on 18th October 2021.

Russell Shor

Russell Shor

Senior Market Specialist

Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…

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