The forex market is one of the largest financial markets in the world and there are millions of participants who are exchanging currencies daily. Forex trading is known as a lucrative activity that provides traders with a plethora of opportunities to gain profits.
As with any type of investing, traders need a solid plan before they take to the markets, or they risk losing all their capital. An effective trading plan is often the very difference between success and failure, and it ensures that traders have something that they can fall back on, rely on, and improve over time.
There are several different types of trading strategies that can be applied to different markets and subsequently, different financial instruments. Despite the variety of strategies, one of the most used in the forex market today is day trading.
This article explores everything that you need to know about day trading strategies, and it also provides some of the best that is being used by experts today.
What is day trading?
Day trading is not a new concept, it is one that is frequently used in the trading community. As the name suggests, day trading involves trading forex pairs within a short window of time which can last minutes or hours within one single trading day.
The aim behind day trading strategies is for the trader to make several small profits, often only a few pips, which add up to larger gains over time. Day traders can enter the market with a specific currency pair at 08h00 am, turn around and they could sell at around 12h00 pm during the same day, and repeat this process with another forex pair.
Day traders cannot be compared with investors who are long-term thinkers or planners, the focus is on short-term trading and small profits. Day traders are continually active, and they are often caught in front of their trading terminals for great durations, allowing them to cash in on any trading opportunities even before they occur.
Day traders are always ready, and they ensure that they have the necessary charting technologies and subsequent technical indicators. There are many day traders who buy and sell forex based on current events and trends.
They are also prepared to cash in on opportunities that may arise from certain events such as product launches, profit and earnings releases, and several others.
Day traders are some of the most educated and well-prepared traders, and they are often well-funded as well. The strategies that these day traders use also consist of high leverage ratios, and a variety of short-term strategies for different market conditions and scenarios.
Why is day trading so popular?
Amidst other investment alternatives, day trading has seen an increase in popularity for several reasons, including some of the following:
- Cash up is easy when you use day trading strategies as you can immediately cash out your position when you sell.
- With day trading, you do not need a large amount of capital to start, especially when compared to other investment options.
- Small management costs as you trade by yourself, with most day traders walking away with a 20% to 30% return on investment.
- There is no discrimination as the forex market is fair towards everyone.
Why are forex trading strategies important?
Even though there are many trading strategies available, it remains crucial that traders use one. Traders must note that their trading performance will depend on the strategy that they choose as well as how well it is executed.
Trading strategies are a key component if traders want to stay on the competitive lead lap and it allows them to take a proactive approach. Strong forex day trading strategies can give traders a competitive edge, and it can make them better traders at the end of the day.
Trading strategies only serve one main purpose, and that is to generate profits through the strategic buying and selling of forex pairs. They instill discipline and they also help traders protect their capital from frantic, directionless trading.
How to develop a Forex Trading Strategy
Step 1 – Write a summary
The first step involves writing a few sentences which will explain the purpose of your day trading strategy along with the techniques that you plan to use to accomplish that purpose.
You can easily research different techniques and choose the ones that suit your circumstances. This is a good start in organizing your thoughts and it provides you with a quick overview of the strategy, especially if you are in doubt or if you want to show it to someone.
For the summary, you must have an idea of the strategy that you want to develop, and this involves knowing what your unique trading style is. There are many different trading styles and for day trading, there are some requirements including the time to educate yourself, practice trading, and develop, adapt, and test your trading strategy.
In addition to this, you must also know the techniques that you plan to use to accomplish your purpose and you must familiarise yourself with the market conditions in which you wish to trade.
Step 2 – Create recognition criteria
Recognition criteria refer to the price action concepts that you wish to use in your strategy with a subsequent explanation of the conditions which must be satisfied for them to be valid.
Three examples that each strategy must contain are bull, bear, and neutral markets. As a price action trader, for instance, the following would apply:
- A Bull market is one where there are higher highs and higher lows.
- A Bear market is one that is making lower highs and lower lows.
- A neutral market is defined as any condition other than those mentioned above.
If you are using indicators, you can say the following regarding the recognition criteria:
- A Bull market is a market in which the price is above the 50-period SMA.
- A Bear market is one where the price is below the 50-period SMA.
- A neutral market is a situation where the ADX indicator is below 25 for more than 30 bars.
Despite the market conditions, you may employ a plethora of other techniques which will still require recognition criteria such as support and resistance levels, chart patterns, candlestick formations, and several others.
Step 3 – Define the trading signals
Simply defined, a trading signal is a trigger for the action, either to buy or sell a forex pair, generated by analysis. An analysis can be done in several different ways and traders can use price action techniques such as chart patterns, trendlines, candlestick formations, or others.
You may rely on technical indicators, or you can leave out the technical analysis altogether and only consider the performance of different economies with fundamental analysis. There are also many traders who use a combination of these, so you should not feel that there is only one option.
It is vital that traders do not spend a lot of time worrying about trading signals, especially when they are developing their own day trading strategy for the first time. There is no set standard or holy grail for trading strategies and each trader will find something that works for them, catering towards their own unique trading style.
Success in trading is more associated with the overall trading plan and the trader’s ability to deal with psychological challenges. Traders must consider the techniques that they like, as this will increase the sustainability of those techniques and the dedication of the trader to improve them.
Another crucial consideration is that the trading strategy must make sense and be simple to use and remember. You do not need to make your strategy complicated and you need to know what you are doing.
Step 4 – Exit Scenarios
Exits are one of the most important parts of a trade and they are often overlooked by many traders. Before you start a trade, you must ensure that you know how and when you must exit as it will determine whether you make a profit or a loss.
It also means that there are two kinds of exits, one to realize profit and another that cuts off a loss. It is important for traders to use both but know when exactly and where they must be used, and how.
The first step is to identify the risk on the trade which is the distance between the entry price and the stop-loss expressed in pips. When opening trades, they must correspond to around 1% of the account size, meaning that you must ensure that you open an appropriate position size.
Once you have your risk on the trade, you can identify an appropriate profit target. Depending on the strategy that you use, there are many ways to determine target levels.
Institutively, the distance between the entry price and the take profit level or order is the reward that you could gain on the trade.
This measures your potential reward for every bit of capital that you risk on a trade. It is ideal that traders have a risk/reward ratio of either 1:2, where the risk is one and the reward is double the risk, or 1:3, where the risk is one and the reward is thrice that of the risk.
Step 5 – Backtest your trading strategy and make improvements
When you have developed your trading strategy, the next step is to backtest it on at least three years’ worth of historical data on at least three different currency pairs. Once done, the results are analyzed and the trading signals which produce the most losing trades are refined.
You must also look for certain insights such as situations in which most of these losing trades occurred, how they could be mitigated or how to avoid such a situation in the future.
Simultaneously, you must carefully investigate the winners and modify your trading strategy to better capture such circumstances which lead to winning trades.
Pros and Cons of Day trading
One of the main advantages of day trading is that traders do not need to learn about the economic fundamentals and neither do they need to worry about long-term trends. Day trading is also known to present an extremely high number of trading opportunities, providing traders with significant profit potential, especially if they have an effective trading strategy.
At the end of the day, day traders will always close their positions, exempting them from costly fees and overnight risk.
In having gone through the advantages, it is also necessary to cover the cons or disadvantages of day trading. Day trading is one of the most exciting trading strategies, but it is one that can be very time-consuming.
Day trading also places traders in many stressful situations as a result of rapid changes in market trends. Day trading is extremely risky and there are many beginners who fail before they truly get the hang of it as a result of the risk factors.
However, if traders put the necessary time in and they are patient in learning how to become successful day traders, they can make this strategy work.
Best Forex Day Trading Strategies of 2021
Scalping is a popular day trading strategy that focuses on capitalizing on minute price changes, with the driving force behind quantity. Traders buy when the price is low, and they sell once the trade becomes profitable by using stop loss and take profit levels.
This strategy consists of the price clearing from a certain level of the trader’s chart with increased volume. Traders enter a long position once the forex pair breaks above resistance.
Traders can also enter a short position when the forex pair breaks below support.
Trading the News
Traders can use trends in news during the day to buy when good news is announced and short sell when there is bad news. This, however, is very risky as a result of the high volatility that it causes in the market.
Where some traders can earn great profits, others are at risk of losing significant amounts of capital.
Following the trend
When using this strategy, traders will buy when the price of a currency pair rises and sell short once they have reached their peak and they show signs of decreasing.
What is day trading?
It involves buying and selling forex pairs within the same day, or multiple times during the day.
Can you make a profit by using a forex day trading strategy?
Yes. However, day traders focus on small profits with every trade.
Can you be successful when you use a forex day trading strategy?
Yes, you can be successful when you use day trading strategies.
Should every trader have a strategy when they trade forex?
Yes, you cannot start trading without having a solid strategy.
How many forex day trading strategies are there?
There are many different trading strategies you can use when you day trade such as scalping, trend trading, trading the news, breakout, and several others.
How do I know which forex day trading strategy is perfect for me?
You need to evaluate your needs and expectations and know what your trading style is before you can determine whether day trading is perfect for you.
Can I use the same trading strategy for different asset classes?
There are some trading strategies that can be used for different asset classes, such as trend trading. However, there are some strategies that can only be used on certain asset classes.
Day trading can be used for several asset classes such as cryptocurrencies, forex, and shares, among others.