5 Essential Tools Every Day Trader Should Use
Day trading is a commonly used term in Forex markets and quite simply it’s the idea that a trader holds positions intraday - but not overnight.
There may be various reasons for a trader’s decision not to take on and hold positions overnight. But as with many things in Forex, it often comes down to what suits the individual's trading style and the time that they can commit to trading.
There are some potential monetary benefits to day trading of course. Positions opened and closed on the same business day will not attract rollover interest or swap charges.
Going home with a flat book, or if you prefer having no overnight market exposure, also means that you may sleep better.
Carrying positions overnight can be a stressful thing and it’s not for everyone. After all, Forex markets operate 24 hours a day, 5 days per week. Even if you are trading for 8 hours a day that still leaves 16 hours of the trading day when you are not watching the markets and within which prices can move.
Various combinations of these factors mean that day trading is the most popular style among our clients. With that in mind then, what are the 5 tools that day traders should be aware of and use?
1) Economic Calendar
The FX markets are often said to be driven by macro-economic data and news releases. Most of these data points are issued in time series, that is at regular intervals. Be they weekly, monthly or perhaps quarterly.
The release dates of key data points are known in advance and they form the backbone of the economic calendar. Even if you trade using only Technical Analysis, you should still pay attention to the timings of key data releases. Simply because this data moves markets. That’s why the economic calendar is a very useful part of the day traders tool box.
Not all economic releases carry the same level of importance, as far as the markets concerned, however. As such data releases can be sorted into three distinct groups that are based on their anticipated market impact. Those categories are High, Medium and Low impact releases.
What’s more, thanks to the globalised nature of the foreign exchange markets. We now receive data releases instantaneously around the world, from both the developed and emerging economies.
It follows then that a major data point from the US economy will likely carry more market weight, than a low impact news item from a developing country. The good news for day traders is that the modern economic calendar can be configured to filter and screen for upcoming events, both by impact and individual currency.
So, if as a trader you are only interested in Asian pairs and crosses you can filter the calendar to show you only items that are related to those names.
This is done by simply by ticking or unticking the relevant boxes, as seen in the image below. You can also choose to filter the calendar by the level of expected market impact.
Remember though that even if you are only trading one pair, for example AUDUSD. Data releases from major regional economies such as China and Japan can have a significant impact on other exchange rates and not just their own local crosses and pairs.
Pepperstone clients can access our economic calendar at https://pepperstone.com/en/client-resources/economic-calendar
2) Intraday Charts
If you are day trading then it makes sense to utilise intraday charts. That is charts with a time frame of less than one business day.
Bear in mind though that even as a day trader, you will probably find it useful to look at or reference charts, that are drawn over longer time frames.
These longer-term charts will often provide much needed context for shorter-term price action. For example, around longer-term support and resistance lines or in identifying key period highs and lows.
But whether you are scalping or swing trading intraday, you are going to be most concerned with what’s happening to a price right now.
As such charts that plot the evolution of that price over say 1, 5 or even 15 minute periods are going to be most applicable to you. The good news is that our MT4 and CTrader platforms have a state of the art charting systems built in and contain just this functionality.
So, if short-term trends in EURUSD are what you are looking to trade - you can have charts open that show you the price action over say, three shorter term time frames in that pair. Whilst having a fourth chart open, perhaps displaying Dollar index or another instrument of your choice.
In fact, that is just the configuration you can see in the image below:
If you are trading from charts, as most day traders are, then it makes sense to consider the use of indicators and other charting tools, to inform your trading decisions.
Once again, our MT4 and cTrader platforms are fully equipped to help.
In the image above I have added two such indictors to the charts found on the left-hand side of the graphic.
In the top chart - a one minute plot of EURUSD - I have added a 10 period Moving Average - the red line. A moving average is simply a rolling plot of the price, averaged out, over a given time frame or number of periods. In this case 10 rolling 1 minute periods.
Moving averages can help confirm the direction of price action i.e. the trend. And to highlight areas where a price may encounter support or resistance. Traders may also choose to use two or three MA lines in conjunction with each other. For example, 3 and 10 period lines.
The thinking here being that the 3-period line moves much more quickly, or if you prefer, is more sensitive, than an average calculated over 10 periods. Thus the 3-period line can act as early warning signal about where the price may be heading next. Whilst the interaction of both Moving Averages with the price line also yields useful information.
In the image above the price line for EURUSD is in drawn in green. Whilst the 10 period MA line is shown in red and the 3 Period MA is drawn in magenta.
We can clearly see a trading opportunity in the middle of the chart as the price line breaks below the 10-period line and then quickly moves down through the 3-period line as well.
Note also that to the right-hand side of the chart both moving averages are continuing to trend lower which might well suggest that the price will follow suit and do the same.
B.Relative Strength Indicator
RSI is another commonly used day trading tool. Also known as the Relative Strength Indicator this tool was developed by US polymath Welles Wilder, who brought the indicator to the attention of the trading world in 1978. The indicator compares current price action with the historic over a set number of rolling periods (most often 14). That comparison determines the impact that the current price action is having.
Readings from the indicator are expressed as values between 0 and 100 - though these extremes are rarely, if ever reached. As it’s a rolling calculation, the RSI 14 reading can be drawn as a line on a chart. What’s more, there are established oversold and overbought boundaries found at readings of 30 and 70 respectively. Those levels provide a clear visual guide as to when an instrument may have moved too far in either direction and may, therefore, be due for a correction.
In the example below I have added an RSI 14 chart to a 15-minute plot of the Dollar Index.
You can clearly see that the RSI 14 line (the blue line in the lower chart) moves to a reading of 30 at the same time as Dollar index itself trades lower. The RSI 14 then starts to rally in conjunction with the price line of the trade weighted Dollar. Remember though that the 70 and 30 levels annotated in the RSI chart are merely guides and that a price can continue to extend higher or lower, regardless of what its RSI 14 reading says.
RSI is often used in conjunction with other indicators. A common pairing is with the stochastic oscillator. This oscillator is designed specifically to identify tops and bottoms, that occur within price action. The stochastic oscillator was developed by in the late 1950s by a Chicago futures trader George Lane.
Lane believed that his indicator moved independently of factors such as volume or other measures of trading activity. But instead concentrated on the speed or rate of price change.
Lane also believed that this rate of price change would change before the price itself. These turning points are flagged by the indicator when the so called %K line interdicts with its own 3 period moving average, known as %D.
The image above is of a 5-minute plot of EURUSD with the stochastic oscillator attached (see the middle chart).
You can see that an oscillator reading above 80 has often preceded a downward move in the Euro. At the same time as the grey %K line crosses down through the three-period moving average or % D line, drawn in red.
Though similar to RSI, with overbought and oversold levels at 80 and 20 respectively. Stochastics are less sensitive to specific timescales than RSI. The combination of these two indicators is often utilised by those who like trade intraday ranges. And who are therefore looking for confirmation that a price could sell off from established resistance or bounce away from support.
Note that overbought or oversold readings in RSI and or the stochastic oscillator, that are found at support or resistance levels, are considered to be stronger signals. Than those found at other points within a chart.
Another indicator which is popular among day traders are Bollinger Bands. They were developed and popularised by John Bollinger in the 1980’s, who later trade marked the name.
These Bollinger bands seek to identify and plot the relative performance of the current price versus that of prior trades. That is how high or low the current price is when compared to historic trades, that occurred over a specific number of prior periods. Usually this is set at 20 periods.
The bands are plotted as lines that appear on either side of the instrument price on a chart. The indicator also contains a plot of the moving average of, the upper and lower bands. Traders interact with the bands in various ways for example buying the underlying instrument when it touches the lower band and selling it on any rise to the indicators moving average.
Whilst other traders are on alert for breaches, by price, of either the upper or lower bands. Which are indicative of a breakout in the price, in that direction of travel. The bands can also say something about current levels of volatility such that when the bands are close together volatility is low. As they move further apart volatility is likely to be rising.
The chart below is a 15-minute plot of USD JPY or Dollar Yen with Bollinger bands applied. Note how the price ranges between the upper and lower bands and how the moving average plot (the middle of the three red lines) can act as support or resistance in the short-term.
E.Williams Percentage Range (Williams % R)
Another indicator that attempts to identify and define tops and bottoms in the price action and the range of a given instrument. The Williams %R compares prior highs and prior lows over a specific period, in relation to the most recent close. That is the closing price of the prior period. Be that a day or a 5-minute period. Unlike many other indicators the Williams % R has negative scaling, or values between -100 and 0. It classically compares the current close with the highest highs and the lowest lows registered over the preceding 10 periods. In this case values of -80 or lower are seen as oversold whist those at -20 or higher are overbought. Though Williams himself did not consider these readings to be outright buy or sell signals.
Rather he sort confirmation about potential price reversals from the length of time that % R spent at these levels.
Specifically, he wanted to see gaps of at least 5 periods between the occurrences of the extreme overbought and oversold readings (of 0 and -100) before acting. And having seen 5 clear periods between signals, he would wait to see the % R reading move backwards through these extreme levels before pulling the trigger. Today the Williams % R is often used to identify potential price reversals. For example, if an instrument has an overbought reading of -20 or greater but that reading then falls to -50. Traders will see this as a sign that the price is likely to move lower.
The chart below shows a 15-minute plot of the AUDUSD pair with the Williams % R indicator attached in the lower chart. Note how readings of -20 or higher (%R overbought levels) have been followed by moves lower in the AUDUSD rate or price.
4) Smart Trader Tools
To aide our clients trading Pepperstone offers its customers access to a dedicated suite of Smart Trader Tools for use with the MT4 platform.
One such tool is the Alarm Manager, software that features custom alarms and alerts. That you can use to be notified about important events, as they happen.
For example, you can receive alerts to remind you about important economic data releases. Or to alert you to the interaction between two moving averages, say a 10-period average crossing down through a 20-period line.
Alarm Manger can also alert you, as and when specific values are breached in indicators such as RSI 14. Such that you can receive an alert, if the RSI 14 for a specific instrument, exceeds a reading of 70 or falls below 30.
The Alarm Manger is fully customisable and can send you alerts and notifications via email and text (SMS). Or via audio alerts and pop-ups on your trading platform.
Further information on all of our Smart Trader Tools can be found here.
There is an old saying among technical traders that the trend is your friend.
What this means is that the direction of travel in the price of an instrument can often be a very good guide, as to where that price is heading next. Momentum is all about trading with the prevailing trends for as long as they last.
Trends fall into three basic categories which are: up, down and sideways or range bound.
Identifying a trend is a relatively straight forward process and doing so forms the backbone of much technical analysis.
An uptrend can be defined as a consecutive series of higher highs and higher lows registered over a given period. Whilst a downtrend is simply a series of consecutive lower lows and lower highs posted over a specified time frame.
To allow us to quantify price action in these terms we simply need to log the High, Low, Open and Closing prices, for an instrument over a pre-defined period.
We can then plot these items on a candlestick or bar chart. Luckily, we don’t have to record this data manually as our charting packages do the legwork for us.
The image below shows a one minute candle stick plot of EURUSD. I have highlighted a short-term uptrend in the first ellipse and a downtrend in the second one.
These are not text book examples of these trends. But then the real world rarely meets those criteria. The trends highlighted below are however, typical of the sort of shorter term trends that day traders are looking for.
Of course, the skill here is to identify the trend early. To join it for as long as possible and then trade out. As and when it finishes or changes direction. At which point you may wish to consider trading in the direction of the new trend, as and when it forms.
We can use the cross-hair cursor and data window within MT4 to identify the HLOC values for a candle or bar in a chart. And we can draw horizontal lines on the chart at key points.
For example, at the 5-minute or daily high or low, or indeed at both. A price testing at or breaking such horizontal lines provides useful intelligence to day traders. And of course, once a trend is established we can draw a sloping trend line, to show us where any continuation in that trend may take the price.
To discover more about day trading and the tools that can be used to support it please contact your Pepperstone Account Manager.
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