With the market meltdown in early 2000 and the SEC requiring larger holdings for pattern day traders in the stock and options markets, all that went away. Suddenly, trading was just for head cases and hedge funds: normal people stayed away.
But in the last couple of years, those same quick draw impulses have started showing up in the markets again. This time, instead of stocks and options, day traders have their sites aimed at the forex (foreign currency exchange) markets. And why not? The forex market is almost always open, the required liquidity is very low (you can open an account with as little as $100), and the leverage is enormous – a successful trade can reap measurable profit when the markets move fractions of a penny. On top of that, regulatory agencies haven’t yet figured out how to make forex day trading illegal!
While getting into the market is easy – you could have a new account open and trading tomorrow, in some cases – getting money out of the market is a little tougher. Trading always involves risk of loss, and when people focus on ultra short time frames (as in day trading) being frequently whipsawed out of positions for a loss looms as a humongous threat. How can we put together a forex day trading system that offers more promise than peril? Here are some primary considerations:
Before any other consideration it is important to understand that it’s NOT necessary to day trade to make good money in the forex markets. Listening to many of the purveyors of forex trading systems you might be surprised to know that you can actually enter positions with the intent of holding them for weeks (or months), and make good money doing so. One of my most profitable systems works on a weekly time frame – it has a very good win/loss percentage, a great risk/reward ration, and takes less than 5 minutes a week to make any changes to pending orders. If you really want to day trade forex, by all means do so; but don’t make the mistake of thinking it is the ONLY way to bring money home from the markets.
You need a day trading system which captures good chunks of pips. This translates into focusing on particular times of day for particular currencies: the highly traded EUR/USD is much more reliably active during from about midnight until 5:00 PM (EST) the following day. From 5:00 PM to 12:00 AM the primary centers where it is traded are closed, so the activity is jittery and less prone to trending moves. Get to know each of the major currencies and how they trade through the entire 24 hour day.
The trend is your friend. This is about as old a saw as you are likely to find in the chest of cliches, but it remains as useful to the trader as ever. There are loads of ways we can identify a trend; I suggest keeping it simple, and confine most of your trading to periods when both longer and shorter time frames agree on direction. If you can’t bear to shut down trading because the short term is moving counter to the longer term, be sure to reduce your trade size. You’ll have more losing trades, but you’ll have less on the line, too.
With these considerations in mind, a forex day trader might put together a trading system with rules like this:
Focus on EUR/USD or GBP/USD
Trade from early morning to 5:00PM (EST) – that doesn’t mean glued to a computer all that time, but that is the window in which your trades will be placed
Establish broad trend direction with 20 DAY SMA. Trend is up when both open and close of bar are above SMA.
Trades set up on 30 minute chart. Prepare to go long when both open and close of latest bar is above 20 period SMA, and the high of the bar is below the high of the previous bar
Put a buy-stop in place three pips above the high of pullback bar (use more pips if your broker has wide spreads)
Once in the trade, use a two-bar low trailing stop
This is just a simple trend pullback system, and will have a significant number of losing trades. But it will also catch some really strong moves you might otherwise miss. THIS SYSTEM IS NOT THE HOLY GRAIL, AND INVOLVES RISK – EVALUATE ITS VALUE TO YOU BY PAPER TRADING IT FOR SOME TIME PRIOR TO TRADING IT WITH REAL MONEY!
Also realize that a system like this is only one part of complete trading plan. You also need to establish who you will trade with, will there be complementary trading systems used, how much will you risk on each trade, etc. For more information about creating a plan which will let you trade as a business (instead of trading like a gambler), see my blog at http://timoroustrader.com/blog1/ and register to get a complementary copy of “How to Make Your Own Trading Plan”. Don’t make another trade without it!
