Manage Your Risk Appetite in Forex Trade to Be Effective

Using a simple strategy for day trading the major pairs may be the most sensible approach for new and part time traders

Feb 15 • Forex Trading Articles • 4622 Views • Comments Off on Using a simple strategy for day trading the major pairs may be the most sensible approach for new and part time traders

Discussions have raged since the birth of internet trading and the creation of trading forums, regarding which overarching trading style/method represents the best option for both new and part time traders. Is it scalping, day trading, swing trading, or longer term investment/position trading? All have merits, none are wrong and so many times we’ll read suggestions that you should match your personality to the trading style you believe is most suited to you, combining it with the time you have to dedicate towards trading. And whilst such a suggestion is not without merit, it ignores one underlying aspect; the underlying market conditions and state of the market at any one time.

Day trading could be described as a form of trading which involves buying and subsequently selling financial securities, such as; equities, options, futures, derivatives and currencies within the same trading day. The key defining principle of day trading is that all positions will generally be closed, before the market close of the trading day.

What is a day traders’ key objective?

Our key objective as a day trader is to take profits out of the market on a daily basis, by trying to take advantage of price movements in highly liquid markets, theoretically the more volatile the market, the favorable conditions for day traders, irrespective of the longer-term direction of the market. As day traders we’re not committed or biased to direction, as we constantly adapt to the prevailing market conditions, at any given time.

Which currency pairs to trade?

With a significant rise in turnover by approx. 60% since 2010, liquidity has increased in the major currencies over recent years and therefore ultimately the price we pay to conduct transactions in our marketplace has collapsed, particularly with regards to the price of trading the major currency pairs. Spreads of circa 0.5 pips or less are now consistently common place for our three main pairs; EUR/USD, USD/JPY and GBP/USD. With this in mind surely day traders should look to build a day trading strategy based on trading these pairs.

What strategy to employ?

Risk (as always) should be the key consideration when building our strategy, fortunately if we day trade and don’t hold trades overnight by adopting an EOD (end of day) policy into our trading plan, then part of our risk objective is taken care of. If we only trade one of the major pairs exclusively, or look for opportunities on the three if and when they appear, then by accident or design, our risk should be significantly controlled. How so? Well let’s consider this possible scenario; we accept that most days, even during ranging periods, our chosen pairs will either rise through R1, or fall through S2. Therefore, if we trade the three pairs, we should in theory get a maximum of six trading opportunities a day, one bullish one bearish. But that’s in skittish, oscillating, whipsawing trading conditions. Whereas in reality, if we backtest over a significant period of time, we discover that once a day trend is established the currency pair tends to stay in the identified direction and momentum.

 

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For example; if EUR/USD breaches R1, then there’s a higher than average probability that price will stay bullish/above the PP (daily pivot point). Therefore realistically we should get three day trading opportunities if we trade three pairs. As an example USD/JPY may be bullish, EUR/USD and GBP/USD bearish, so we have three opportunities to trade, the chances of overtrading are significantly reduced. If we only trade EUR/USD then we might only get that one opportunity per day; we’ve disciplined ourselves to only enter the trade if it triggers/falls below S1, or triggers/rises above R1. So we should only be looking to take that one trade a day. As an example; EUR/USD rises above R1, we risk 0.5% of our account to make gains above 0.5%, perhaps looking for a rise in the currency pair of 0.3%.

Summation.

•    Day trading, particularly if you’re based in Europe or the USA, offers up tremendous opportunities for you to adapt your trading around your working day, to eventually consider becoming full time.
•    Day trading the most liquid pairs, with the tightest spreads, consistently represents the best value for money and you’ve less chance of experiencing slippage and poor fills.
•    In ranging markets, our daily trading strategies can still perform extremely well, we only need our forex pair to rise (or fall) by circa 0.5% in a day, to be able to consistently trade efficiently.
•    In isolating key pairs to a day trading strategy, we should immediately render over trading obsolete.

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