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Day trading in forex

The term ‘day trading’ is well defined when we think of equity markets, where traders look to close out of positions before the official close of the stock market.

The term ‘day trading’ is well defined when we think of equity markets, where traders look to close out of positions before the official close of the stock market. Primarily, this is to avoid ‘gapping’ risk when the market re-opens the following day, however, it also allows traders to have greater control and focus their trading in a defined period.

In the world of forex trading, where the markets are open 24/5, aside from the Monday markets re-open or when we’re treated to important breaking news, we don’t have the extent of gapping risk as you would in stock markets, which close every day for an extended period and has to subsequently price in new information.

Therefore, our overriding consideration when day trading forex is primarily focused on which session to trade - there are three – Sydney (or Tokyo), London and New York. To a lesser extent, some day traders will also consider the costs or benefits of holding a position over the FX ‘rollover’ period and subsequently being debited/credited the overnight funding charge (see details here).

Why day trade?

Trading, so short-term that you are in and out of positions within a defined window, through the 24-hour period, is not for everyone. It can be intense, notably for discretionary traders, where it is a prerequisite to be in front of the trading platform with access to news through a chosen period, to make informed trading decisions. And, who would shy away from distractions that can impact the psyche and emotional state. However, for traders who can be more active in the markets, day trading can be a prosperous hunting ground.

Of course, the increased adoption of automated (or algorithmic) trading, and the use of Expert Advisors (EA’s), mitigates the need to be in front of the screens during a set period and blocks out all emotions. For more info on automated trading with Pepperstone

The important characteristics of each trading session

While many will fit their trading around their lifestyle and personal circumstances, for traders who can afford to do so, it can be highly beneficial to fit their trading around one of the three trading sessions that best suits their strategy. So, understanding the key characteristics of each (of the three) sessions can be a clear advantage for day traders.

The overriding characteristics to consider are volatility, typical trading range, and liquidity.

Day traders tend to like movement in markets, as volatility and range expansion creates opportunity for short-term market participants. Event risk, notably in the form of economic data releases or central bank speakers, are obvious drivers of volatility and market movement.

With the USD being one side of 88% of all FX trades^, it makes sense that we see increased volatility during late London/early US trade, given the bulk of US economic data is released during this period.

Trading EURUSD

For example, in EURUSD, if we break it down and take a look at the daily ranges over each of the three trading sessions (we’ve selected a one-month period) – Australia (blue), London (green) and US (red) – we can clearly see that EURUSD hardly moves during Asian trade, and by far the largest trading ranges (high to low in price) are seen in London. In most short-term strategies, day traders will prefer to trade the London session when focusing on EURUSD.

Trading EURUSD

In USDJPY, the split in the size of the trading ranges is far more evenly distributed, although, again, when we do see outsized moves they tend to come in London and US trade.

Trading USDJPY

For USDCNH (Chinese yuan traded in Hong Kong), we see the absolute size of the daily ranges, whatever the session, are lower than that of EURUSD and USDJPY and would certainly be lower than the likes of GBPJPY and AUDJPY. Here, it is not just about what session to trade but whether day traders want to trade a currency pair with limited daily moves.

Trading USDCNH

Perhaps this is more fitting for those who trade on higher time frames, such as position traders.

Strategies to deploy

Day traders need to deploy strategies that ultimately provide an edge, and which allows them to grow the capital in the trading account, which is why we trade. The question is, do we go about our trading in a reckless or disciplined fashion? To do this, traders can adopt one or multiple, day trading styles. Ranging from scalping, trading technical breakout, and momentum, to mean reversion and pivot points.

However, the objective is to trade in and out of positions and ultimately, holding no open positions into a prolonged period, when you’re not able to be in front of the trading screens.

As with any trading strategy, we need to think about the risk-to-reward trade-off. Day traders need to think about how much risk they are taking when they open a trade, and there is no better way of measuring your potential risk than with a stop loss upon opening the position.

The distance between the stop loss and entry is what we are willing to risk, and we can calculate our potential loss by multiplying the number of pips at risk by the position size. When we know our risk, we can understand the reward (profit target) we need to target.

Achieving correct position sizing, especially in proportion to the size of the trading account, is also of paramount importance. Running a wider stop loss when volatility is high and price is moving more aggressively should be considered, but this should then be offset by a smaller position. On the other hand, if there is subdued volatility through broader financial markets, we can afford to run a closer stop and increase our position size.

Some traders will place a hard 1% or 2% of their portfolio as margin to open a trade, but this doesn’t adjust to changes in broad market volatility, and in this vein, running a smaller position when volatility is high can be beneficial as there is greater leverage in the market.

Other core considerations:

  • Chart timeframe - While this is a function of strategy, day traders tend to trade off lower timeframes, such as 15 and 30 minutes or hourly charts. With scalpers typically trading off very high-frequency charts, such as 1 to 5-minute charts.
  • The cost to trade - Given day traders often trade more frequently than say swing or position traders, spreads are important
  • Manage risk – It is important to understand key event risk in the trading session you trade, such as economic data, central bank speeches or a political event. Traders are essentially managers of risk, so being aware of events that can cause sudden sharp moves in price are essential. Day traders will often close positions that could be affected by risk, especially when the outcome could be binary in nature.

The goal of day trading

The goal of day trading is to have a strategy which you have genuine confidence in, that provides you with a positive expectancy and that when you are in front of the trading screens it is just you and the markets, everything else is noise.

Trading only one session allows you to have a life outside of trading, where at the end of your session you have no exposure to the markets and you can close the page on that session, leave the markets behind, regroup and get the mind right to be fully up to the challenge to take on the markets again.

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* All charts sourced from Bloomberg. Pepperstone doesn’t represent that the material provided here is accurate, current or complete, and therefore shouldn’t be relied upon as such. The information provided here, whether from a third party or not, isn’t to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product or instrument; or to participate in any particular trading strategy. We advise any readers of this content to seek their own advice. Without the approval of Pepperstone, reproduction or redistribution of this information isn’t permitted.