Forex day trading in a nutshell
While most amateur investors focus on retirement and other long-term goals, “day trading” means buying and selling financial instruments within the same day. Instead of basing trades on long-term financial data and macroeconomic trends, the emphasis is on timing the market and hopefully making a quick buck off very short-term price movements. When done in the foreign exchange market, it is obviously called forex day trading.
Day traders follow numerous distinct strategies. In general, though, their aim is to do enough research to know that a particular currency pair is likely to rise (or fall) within a single day. They can then take a long (or short) position when the trading day starts and close it before the market does. “Scalping” is an even shorter-term strategy, by which any given asset may be held for only minutes.
If you don’t want to be glued to your screen while scalping but also don’t have the patience to hold investments for several weeks to years, day trading could be the right option for you. To a large extent, this choice will be determined by your risk tolerance and investor personality.
One incentive to day trade forex markets is that, if the trade is closed before 5 pm ET (10 pm GMT), a trader can avoid the overnight swap. This swap or rollover is either paid or received by the trader, depending on whether the currency they borrowed or bought has the higher interest rate of the currency pair. One example of how this is applied is carry trades, which are held for multiple weeks with the principal goal of benefiting from this overnight swap.
How much can you earn in a day by trading forex?
This answer depends completely on each trader’s individual circumstances. Like with any form of investing, the more money you put into forex day trading, the more you stand to gain or lose from it.
However, to give you an idea of the potential, let’s look at an example. The most actively traded and liquid forex pair is the euro/US dollar. The figure varies over time, but let’s say the average daily trading range, in pips, for EUR/USD is about 50 pips. (Note: A pip is the smallest increment an exchange rate can move. This term, and other forex concepts, are explained in this article.)
Now, if you guessed market trends correctly and bought at the start of the day, selling just before market close, you would make 50 pips. (Alternatively, if EUR/USD is in a downtrend and you sell short when trading opens and close the trade at the end of the day, you still make 50 pips.)
For a standard lot of 100,000 euros, each pip on EUR/USD is worth $10 to you. So, if you made 50 pips, you would make $500 on the trade.
For a mini lot of 10,000 euros, the pip value for EUR/USD is $1, so a 50-pip profit translates to $50.
Now, let’s consider how much money you would need in your trading account with your online forex broker to make the above scenarios possible.
Assuming leverage of 30:1, you need to have a margin of $1 in “real money” for every $30 invested. That means, to take out a 100,000 EUR position, you will need the equivalent of 3,300 euros as a minimum margin requirement.
However, you should also consider the position sizing rule of risking no more than 5% of your account on any one trade. In this case, if you are prepared to lose 50 pips over one day of trading, or in other words lose $500 on a standard lot trade, you would want to have a minimum of 10,000 euros in your account. (500 = 5% of 10,000).
Most forex day traders also take advantage of the fact that there are lots of currency pairs. If you place 5 trades per day, winning three trades for a profit of $1,500 but losing on two for a loss of $1000, then you would come away with a $500 profit for the day.
Is forex suited to day trading?
Forex is very well suited to day trading because trading is open 24 hours per day – there is always a currency suited to your time zone. Forex day traders will typically select between one and five favoured forex pairs and trade those every day. Tracking too many currency pairs is too difficult for short-term trading, unless you have an algorithm to help you like a forex robot or EA.
Many forex traders will stick to the major forex pairs like EUR/USD we already mentioned, GBP/USD (the British pound) or USD/JPY (the Japanese yen). Others will scan charts for technical analysis setups and then trade those forex markets that have a trading setup that strikes them as favourable.
Can you get rich by day trading forex? Yes, you can but a lot of things affect whether that’s the result you achieve. Unlike equities, forex is essentially a zero-sum game, and you have to be either smart or lucky to get ahead.
The highs and lows of day trading forex
Day trading forex is a good fit for you if:
- You prefer your trades to be finished within a day
- You have the time to monitor the daily price swings
- You can make rational decisions quickly
Day trading might not be your best bet if:
- You prefer to give each trade the time it needs to finish
- You like longer-term trading styles better
- You have a job and not enough spare time
What is required to start day trading?
This is perhaps what makes forex day trading so appealing as a source of income: very little is needed to get started other than some money to invest, a smartphone or laptop, and a reliable internet connection. Aside from these resources, though, some forex trading education is essential. You’ll need to learn technical analysis and fundamental analysis as well as good risk management to make sure you don’t lose too much when you are still finding your forex feet.
Types of forex day trading strategies
Any of these philosophies and tactics can easily occupy a book, never mind an article. For now, let’s just present them in bare-bones outline to give you a better idea of what day trading forex involves.
Trend trading
The idea behind this strategy is to identify the direction the forex market you are trading is going. Once the trend direction is established, the trader will look for the best price entry point to trade in the same direction as the trend. In general, therefore, if the trend is up, the forex trader will buy, whereas if the trend is down, the trader will sell short.
Finding tops and bottoms
In this case, the trader has identified a trend but thinks it is going to reverse. So, they place a counter-trend trade. If the trend is up but they think the market has topped, they will sell short. If the trend is down but they think the currency pair has bottomed, they will buy.
Mean reversion
The concept underlying this strategy is that prices tend to move too quickly in one direction, and when they have, they will more often than not revert back toward the average (or mean) price of the past few trading sessions.
Breakouts
A breakout happens when the price moves above a previous area of resistance or falls below a previous area of support. The breakout is supposed to indicate that a price trend has resumed. A breakout trader would trade with the momentum, in the direction of the breakout.
News
Some “fundamental” forex trading strategies pay less attention to charts and the trend of the market and focus on the reaction of the price to a particular news event. In forex markets, news traders tend to focus on the weekly economic calendar to trade economic data releases like GDP or the consumer price index (CPI).
In conclusion
Forex day trading is a cutthroat, fast-paced game in which the participants collectively lose as much money as they gain. If you have the inclination and the time to educate yourself, by all means, open a demo account on some investing website and see how well you fare. If you should have a knack, you’ll be able to hone your skills. If you can’t quite get the results you were hoping for, you’ll discover this fact without risking any real money, and be able to focus your energy on more stable investments.
