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Forex Trading for Beginners
This Forex Trading for Beginner’s Guide will give you all the information you need so you can start trading Forex. You’ll learn what forex trading is, how to trade forex, how to make your first trade, plus our best forex trading strategies. By the end of this guide, you’ll be equipped with the right knowledge to tackle the world’s largest capital market. As a bonus, we’re also going to reveal the best forex trading platforms.
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The Foreign Exchange Market is by far the biggest market in the world in terms of liquidity and trading volume. It’s estimated that, on average, more than $5 trillion are transacted on a daily basis. Clearly, the forex market is huge. Developing an effective forex trading strategy can earn you an almost limitless amount of money over time. It’s no surprise, trading in the Forex market is so exciting. Forex trading is free and it’s very cheap to get started as a trader in the FX market.
Successful forex trading is made possible due to leverage. Once you are able to hone your skills, you may be able to trade forex full time.
There are many reasons why you should learn to trade. The best forex trading strategies will empower you to earn a considerable amount of money over time. This doesn’t mean there aren’t disadvantages to Forex trading. There are pros and cons of trading forex that you need to factor in. If you want to have a good starting experience, you need to have a 360-degree view of the FX market.
You need the best forex training for beginners that is currently available. Once you are trained, you can learn how the Forex 24-hour trading market can give you access to trading, through the four major trading sessions (London, New York, Tokyo, and Sydney) regardless of your time zone.
Let’s get started and learn the inner workings of forex trading and how it works.
What is Forex Trading? A Basic Overview
Forex is an abbreviation for the foreign exchange market. In the financial world, Forex trading is also known as FX trading, currency trading, or foreign exchange trading which can be used interchangeably.
Unlike stocks which are traded on a stock exchange like the NYSE, the global Forex market is a decentralized market. Most Forex transactions are carried out over-the-counter or off-exchange. Stocks are listed on physical public exchanges, but Forex currencies have no physical location.
Check out the step-by-step process to follow before you start engaging in the over-the-counter market: Over-the-Counter Trading – How the Whales Trade.
The biggest players that operate in the FX market are the big banks, governments, major corporations, and hedge funds. These are also referred to as being the institutional market players. However, there are also quite a few individual traders involved in the market as well. These individuals are referred to as the retail crowd
The retail crowd is a diverse group. These can be consumers who want to buy goods from another country, travelers who’re looking to travel overseas, businesses conducting trade abroad or investors and traders who wish to take advantage of the price fluctuations in the Forex market. Now that we know the two parties let’s move on to the next section – How does Forex trading work?
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How Does Forex Trading Work?
For example, if the price of the EUR/USD exchange rate is 1.1150 it suggests that we can get 1 euro for every 1.1150 US dollars.
Also, learn how to make money in the stock market fast with the CANSLIM formula.
How to Trade Forex for Beginners?
The basic foundation of trading in the foreign exchange market consists of understanding how currencies are quoted and what the exchange rates represent. In the Forex market, all currencies are quoted in pairs. This is why the act of Forex trading involves simultaneously buying one currency against another currency, which is sold.
Let’s now examine how many types of currency pairs you can encounter in the FX market.
Type of Currency Pairs
Depending on how much trading volume a currency is carrying out, we can split currencies into three major categories:
- Major Currency Pairs: These are all the currencies that are traded against the US Dollar, the world’s reserve currency. Eg: EUR/USD, GBP/USD, and USD/PY. The major pairs offer the biggest liquidity with EUR/USD being the most liquid currency pair.
- Minor Currency Pairs: Also referred to as cross pairs and are currency pairs that don’t trade against the US Dollar. Eg: EUR/GBP or EUR/CHF. They offer less liquidity for trading.
- Exotic Currency Pairs: Also referred to as minor pairs, are currencies linked to the emerging economies around the world. Eg: South African Rand, Brasilian Real, and Turkish lira.
As you can see, the American Dollar plays a major role in the forex market.
Next, we need to clarify how to read currency pairs and why we use a three-letter quotation system.
How to Read and Understand Forex Quotes
The standard quotation system uses a three-letter abbreviation system and will always involve two currencies where the first currency listed on the left is the Base currency while on the right is the quote currency. The quoted price indicates how much of Quote currency is required to buy/sell one unit of Base currency.
The next thing to understand is that currency pairs always have two prices: the Bid price and the Ask price. This is the two-way quote system used for buying and selling of currencies. In simple terms, the Bid price is the price at which you can sell while the Ask price is the price at which you can buy.
How to Use Forex Orders
Generally speaking, a Forex Order is a command given to your broker that shows:
- What currency pair to buy/sell.
- The direction of your trade (Long or Short).
- The price to buy/sell.
- Where to Take Profit.
- Where to Exit.
- How much quantity to buy/sell.
- The type of order.
Direction wise, a Forex Order can be used to do two things:
- Buy (Long) – If you expect the currency pair to rise, we use a buy order that is executed at the Ask price and closed at the Bid price.
- Sell (Short) – If you expect the currency pair to fall, we use a sell order that is executed at the Bid price and closed at the Ask price.
There are five common order types that anyone can use to enter and exit a position in the Forex market:
- Market orders are designed to open a trade immediately at the best available market price. It can be used for both buying and selling. This order guarantees that the trade will be executed, but in volatile markets, the entry price can be slightly different than the last price quoted.
- Limit Order is designed to open a trade at a specific price and an expiration date. It can be used for both buying and selling. This order only guarantees that your trade will be executed at the desired price. For longs, the trigger price needs to be below the market price. For shorts, the trigger price needs to be above the market price.
- Stop Order is designed to buy when the trigger price is above the current market price and sell when the trigger price is below the current market price.
- Stop-loss order is designed to limit your losses and avert from potentially losing all your capital. If you’re buying and the exchange rate starts to go down the stop-loss order will automatically liquidate your position and minimize the loss.
- Take profit order is designed to close a profitable trade and lock in the profits.
This is the process to learn how to trade Forex for beginners. Once you are more familiar with the forex market, you will be able to use the London Breakout Strategy and various other forex trading strategies.
How to Open Your First Forex Trade
The first step you need to undertake is to open a practice account with your favorite Forex broker. This will give you a trading platform from where you can access the Forex market.
If you don’t want to wait for a particular exchange rate to be reached to open your first trade you can instruct your trading platform to open the trade at the current price level. This is called entering at the current market price.
You can instruct your trading platform where your stop loss, take profit and how much quantity you want to trade aka the position size. Your trading platform will do the rest.
In order for you to make a profit the market needs to go up after you bought. The same is true in reverse if you shorted the market; the price needs to go down to make a profit.
Leverage, Volume and Margin Requirements.
To invest and trade in the Forex market, you need to understand how margin trading works. Basically, whenever you open a trade you only need to put up as collateral a certain amount of your balance. This deposit is referred to as the margin requirement.
This means that you don’t have to cover the full position size, but only deposit a fraction of it to cover the possible losses. As long as your trade is active, your FX broker will lock up the required margin and only free it back to you once the position is closed. This enables traders to execute much larger trades than they could otherwise afford.
The margin requirement depends on three things:
- The instrument you trade: EUR/USD, GBP/USD, USD/JPY etc.
- Position size: This is the amount you buy or sell and it’s measured in lots. For example, 1 standard lot has a nominal value of $100,000 and it’s worth $10 for every pip movement. For example, if you want to trade $50,000 of EUR/USD that equates to 0.5 mini lots and it’s worth $5 for every one pip movement in the exchange rate.
- Leverage: Allows you to control bigger sums of money by borrowing from your FX broker so you can boost the profits of a trade. The standard leverage offered by most brokers is 1:50 and it can go as high as 1:500. Using a 1:50 leverage it means that you can control with every $1 from your account $50 in buying power. For example, if you invest $10,000 with a broker that provides you with 1:50 leverage it means that your total buying power is $500,000 (50 x $10,000).
The forex instrument, position size, and leverage you choose will depend on your working capital and your forex trading objectives.
How to Calculate Forex Margin
The margin requirement can be calculated using the following formula:
Margin Requirement = (Contract Size * Lot Size * Price) / Leverage.
For example, if you want to buy 0.8 lots of EUR/USD at the current market price of 1.1150 and using a leverage of 1:100 you need to have in your account at least $892 to open that position. In other words, with only $892 you can control a position size of $80,000 (0.8 lots) which is your buying power. Because of this, forex trading for beginners might be more affordable than you assumed.
Margin Requirement = (100,000 * 0.8 * 1.1150) /100 = $892
Again, if you haven’t checked it out already, we highly encourage using a forex position calculator while trading.
Let’s now study some of the market catalysts that can drive a currency pair.
What Drives the Forex Exchange Rate
The value of the currency pair can be driven by several factors including:
- How well a country’s economy is doing?
- Geopolitical events and how stable is a government.
- Central Bank’s monetary policy.
- Interest rates
- News reports and economic data.
- Supply and Demand.
These are a few of the factors that can influence the value of a currency.
Best Forex Trading Platform for Beginners
The best forex trading platform for beginners is the MetaTrader4 platform developed by MetaQuotes Software. The MT4 platform is one of the most popular Forex trading platforms utilized by millions of retail Forex traders around the world. Its features can be used by both experienced and beginning forex traders alike.
The MetaTrader 4 is free and it comes with many built-in features. There are countless technical indicators that can help you analyze a Forex price chart. Additionally, you can use the MT4 to build your own automated trading strategy and backtest any kind of trading ideas you might have.
Learn how to backtest your trading strategies even if you don’t have any experience with our Beginners’ Guide to Effective Backtesting.
Alternatively, you can use the web-based trading platform TradingView, which is another free Forex trading platform that has the same features as the MT4 platform and much more.
Without a forex trading strategy to advance your trading skills, a trading platform is useless. This is why we want to also explore the wide range of forex trading strategies
Below you’ll discover what are the different types of forex trading strategies that work.
Forex Trading Strategies for Beginners
Forex traders employ different trading styles that mostly fit their own personalities. We can break down Forex market trading strategies into four distinctive trading edges that can be used in different market environments:
While these are the most popular active FX trading strategies, Forex traders can use these concepts to innovate and develop well-versed Forex systems through the use of fundamental analysis and/or technical analysis. There are many tools a Forex trader can use to gain an edge in the FX market like Forex chart patterns, technical indicators, statistics and much more.
Check out a top-down approach to fundamental analysis of stocks: Fundamental Analysis of Stocks – 5 Financial Ratios to Follow.
In order to time the Forex market, you can apply a Forex strategy that is designed to improve your trading:
- Forex trend trading strategies
- Forex momentum trading strategies
- Forex range trading strategies
- Forex reversal trading strategies
- Forex breakout trading strategies
- Forex Carry Trade strategies
As a novice Forex trader, you have a wide variety of Forex trading strategies so you can take advantage of the currency price fluctuations. Since the market conditions are constantly changing, make sure you get familiarized with different types of Forex trading strategies.
Final Words – Forex Trading for Beginners
The basic mechanics of trading the forex market are similar to any other market. Buy low and sell high in the hope to generate a profit. Due to its unique characteristics, the forex market provides a wide range of trading opportunities that no other market does. The forex market, therefore, is very suitable for the novice trader that is looking to either make an extra income or a full-time trading career.
Forex trading for beginners can be extremely competitive. So, make sure you learn how to trade forex for beginners before you risk your hard-earned money. Learn as much as you can about the ins and outs of FX trading so, you’ll always be prepared to safely navigate the Forex market.
For more trading tips and tricks make sure you follow our Top 10 Forex Blogs list. The more you can learn about forex trading strategies, the more likely you’ll be able to become a successful trader.
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Forex Trading Strategies For Beginners Free PDF Download
I know that it can be incredibly time-consuming, frustrating and just annoying researching Forex trading strategies and different trading styles.
The huge problem is that it is often hard to know if you should use a strategy, if that strategy suits you and your lifestyle, and if it is worth your precious time learning and trading with it.
These are all pretty important to know before you begin devoting your time to learning, trading and mastering them.
In today’s lesson I go through four Forex trading strategies you can learn and use in your trading now.
A quick note before you go through them; I highly recommend you find one strategy that you like, suits you best and your lifestyle and personality. Master the heck out of that one strategy first and become profitable with it.
It is far faster to learn, master and become profitable with one strategy, than trying to learn a whole bunch at the same time. You can always add more and more strategies when you are profitable, but profits are the key.
This is an in-depth guide, so I have added a table of contents for ease of use below;
Swing trading is looking to profit from the next swing the markets make.
As a swing trader you will often be using the higher time frames such as the 4 hour and daily charts and looking to capture large market swings and moves.
As a swing trader you don’t just have to use higher time frames, but you are not breakout trading, false breakout trading or scalping. You are looking to profit from larger swings.
When breakout trading you are looking for really fast price movement and to profit from explosive breaks of important support and resistance levels. If you miss crucial moments, it will often mean you miss the trading opportunity you were waiting for.
Swing trading is not as stressful and you will often have the levels you want to find and then enter your trades at pre-marked so you know when price moves into a level to look for a trade setup.
Because price is not breaking out and making explosive breakout moves, and is often moving over longer periods, you have more time to make your trading decisions and is a less stressful way to trade.
I have attached an example swing trade on the chart below. If price is in an uptrend you would look to identify where the next swing low is going to occur and where you would like to hunt for long trades.
If price moved into this level you would be watching for bullish price action trigger signals to get long and for price to make its next swing higher for you to make profits.
See chart example of this below;
Why You Should Swing Trade
– You have to study full-time or have a job, but still want to trade
– You want to trade higher time frames like 4hr, daily and weekly charts
– You don’t want to use the smaller paced time frames
– You are happy to make less trades that are higher in quality
Why You Shouldn’t Swing Trade
– It does not involve entering fast-paced intraday breakout trades hunting for quick wins
– Whether on the smaller or higher time frames it can take time to play out
– You are not moving in and out of your trades quickly
Swing trading can suit a wide variety of traders who are looking to make quality trades and enter into the next swing in the market.
If however, you are looking for a strategy that is fast paced, you are in and out of your trades quickly and you can make many trades in a short period, you may want to use another strategy.
I have an in-depth guide you can use to learn more about swing trading at; Swing Trading Price Action Quick Guide
False Breakout Trading Strategy
A false break can be a very high probability trading setup when you have mastered it and play it at the best areas.
The false break occurs when price looks to breakout of a support or resistance level, but then quickly snaps back in the other direction, false breaking a large portion of the market out.
When the first breakout begins price is looking to breakout and through a support or resistance. In this example we will say price is looking to breakout and through a resistance level.
When price begins to breakout higher a large portion of the market begin to look for the resistance to break and will enter long trades, often setting their stop loss just on the other side of the resistance.
When price begins to move back lower, the market participants who were long and looking for the resistance to break begin to get stopped out of their long trades. As price gains momentum back lower more and more stops are eaten and price completes the false break.
The false break trading strategy opens a lot of potential high probability trading opportunities for you because it can be used on many different markets, many time frames and can be used at the major support and resistance levels.
I have attached an example Bearish Engulfing Bar = BEEB false break of a major level below;
Why You Should Use False Breakout Trading
– Can be traded on many time frames
– Can be used in many markets and pairs
– Can be traded with many triggers as the major entry
– Often entering when the majority of the market has been stopped out entering in the wrong direction
Why You Shouldn’t Use False Breakout Trading
– Can be stopped out quickly if you get it wrong
– Moves can be explosive and quickly lead to a loss
Once you have mastered false break trading it can be incredibly high probability. You will be looking to enter the market when the majority have been false broken in the wrong direction and you can often enter into explosive moves.
You can also use this strategy on many markets and time frames with many triggers for entry.
You can read an introduction guide to using the false break at; False Break Forex Trading Quick Guide
As a scalper you are looking to get in and out of your trades quickly and profit from smaller moves in the price action.
Whilst you are looking to make far smaller pip targets, you are looking to do it in far shorter amounts of time than other strategies.
As a scalper you are capitalizing on the bigger markets volatility and quick price movements to make your profits.
A swing trader is looking to enter trades on the 4 hour or daily charts and then hold those trades for hours or days. When scalping you are generally holding your trades for minutes at a time, depending on how small the time frame.
Some traders love scalping as it offers them more potential trading opportunities, they do not have to hold for extended periods and they can close their trades and finish for the session.
Below I have included an example 5 minute chart showing price testing a key level and then forming a huge false break pin bar reversal to get short.
You can learn how to scalp the market with price action and two simple strategies at; Price Action Scalping: Quick Guide
Why You Should be a Scalper
– Fast-paced movements firing off more trading opportunities
– In and out of the markets quickly with little trade hold time
Why You Shouldn’t be a Scalper
– A lot less time to make good trading decisions
– Often leads to more trader errors
– Things can blow out and go wrong very quickly
– Trade costs such as spreads will affect bottom line more heavily
Scalping is not for everyone and is not for the faint of heart.
Whilst most traders start out on the smaller time frames and looking for as many trades as they can humanly find, this does NOT mean it suits them or that it is what they should be doing.
If you are going to scalp trade you need to have every part of your trading style locked down and be ready for all market circumstances that will come your way.
Longer Term Position Trading
Position trading is a trading style where you are looking to hold trades over much longer periods and take a ‘position’ in the market.
This style of trading is normally carried out on the daily, weekly and monthly charts.
As a position trader, you will often be trying to use the overall larger trend to gain the best positions and capture long running trades.
The key to position trading is knowing how to cut your losses relatively soon, whilst maximizing the times you make large running winners. This will often involve pyramiding into your winning positions adding further positions as price moves in your favor.
The best markets for position traders are the clearly trending markets where price is making a clear move in one direction. The weekly chart example I have added below shows an obvious trend higher that is perfect for a position trader.
This is the type of market that is making regular higher highs and higher lows. This gives the position trader a chance to not only add to their position, but use the swing points as areas to move their stop as a trail to lock in profits as the market moves.
Why You Should be a Position Trader
– Requires far less time because not always watching charts
– Less stress because not always watching the markets and the short-term moves don’t affect your outcome as much
Why You Shouldn’t be a Position Trader
– Long trade hold times
– Large stop sizes to hold trades
– Using portion of account for days and weeks on end whilst other opportunities are happening
– Far less trading opportunities
If you don’t have the time to monitor the markets as frequently and are happy to let your trades ride for longer periods of time, then position trading may be for you.
If however; you don’t want to wait long periods for your trades to play out, use huge stops or make smaller amounts of trades, then I would suggest another strategy.
What Forex Trading Strategies Should You Use?
Each trading strategy and style comes with its pros and cons. Some strategies you simply will not be able to use either because they don’t suit your time frame and lifestyle or because they are not suited to your personality.
To see what Forex trading strategies suit you best, a nswer these three questions;
How Much Time do You Have?
This is probably the most crucial question you need to consider.
You need to think about how much time you have to first learn the strategy and then implement it.
If you only have a few minutes each day to monitor the markets, then scalping is not going to be suitable for you at all as you simply will not have the time to make the trades. You could look at position trading or swing trading.
You also need to think about how much time you are willing or able to invest in learning your chosen strategy.
What Personality Style do You Have?
Different personalities are suited to different trading strategies.
You may be a trader who wants to be in the markets, making trades and who is happy to stare at your screen for hours on end.
Or, you may want to use trading to make money, but not spend all of your time watching screens and monitoring every pip movement.
Every trader is different and this is something you need to take into account when you choose your strategy. Don’t choose a strategy that will have you watching every pip movement if you are far more suited to making a trade, setting your stop and profit orders and then coming back later.
What Are You Trying to Achieve?
Are you trying to create a lifestyle with more free time, possibly more time with your family and choosing what you do and when?
Or, are you trying to make as much money as possible and are happy to spend all of your time in the markets day in and day out?
Most traders come to trading for money and lifestyle. When choosing your strategy, think about what you are trying to set up and achieve with your trading.
Yes, there is a lot to learn, and there are a lot of other Forex trading strategies such as breakout trading, price flip trading and trend or momentum trading, but you only need to start with one strategy.
Find the one strategy that suits you the best, practice the heck out of it on your demo and then become profitable with it.
Once you have become profitable with your first strategy you can add more and more. After becoming profitable and successful learning the first strategy, adding the second, third and fourth becomes a lot quicker as you are using the same base methods.
I hope this in-depth lesson helps you find a strategy to find success with.
Let me know your thoughts on this lesson and any questions in comments section below;
10 Day Trading Strategies for Beginners
Basic Day Trading Tips
Day trading is the act of buying and selling a financial instrument within the same day or even multiple times over the course of a day. Taking advantage of small price moves can be a lucrative game—if it is played correctly. But it can be a dangerous game for newbies or anyone who doesn’t adhere to a well-thought-out strategy. What’s more, not all brokers are suited for the high volume of trades made by day traders. Some brokers, however, are designed with the day trader in mind. You can check out our list of the best brokers for day trading to see which brokers best accommodate those who would like to day trade.
Online brokers on our list, including Tradestation, TD Ameritrade, and Interactive Brokers, have professional or advanced versions of their platforms that feature real-time streaming quotes, advanced charting tools, and the ability to enter and modify complex orders in quick succession.
Let’s take a look at some general day trading principles and then move on to deciding when to buy and sell, common day trading strategies, basic charts and patterns, and how to limit losses.
- Day trading is only profitable when traders take it seriously and do their research.
- Day trading is a job, not a hobby or passing fad of a pastime. Treat it as such—be diligent, focused, objective, and detach emotions.
- Here we provide some basic tips and know-how to become a successful day trader.
Day Trading Strategies
1. Knowledge Is Power
In addition to knowledge of basic trading procedures, day traders need to keep up on the latest stock market news and events that affect stocks—the Fed’s interest rate plans, the economic outlook, etc. So do your homework. Make a wish list of stocks you’d like to trade and keep yourself informed about the selected companies and general markets. Scan business news and visit reliable financial websites.
2. Set Aside Funds
Assess how much capital you’re willing to risk on each trade. Many successful day traders risk less than 1% to 2% of their account per trade. If you have a $40,000 trading account and are willing to risk 0.5% of your capital on each trade, your maximum loss per trade is $200 (0.005 x $40,000). Set aside a surplus amount of funds you can trade with and you’re prepared to lose. Remember, it may or may not happen.
3. Set Aside Time, Too
Day trading requires your time. That’s why it’s called day trading. You’ll need to give up most of your day, in fact. Don’t consider it if you have limited time to spare. The process requires a trader to track the markets and spot opportunities, which can arise at any time during trading hours. Moving quickly is key.
4. Start Small
As a beginner, focus on a maximum of one to two stocks during a session. Tracking and finding opportunities is easier with just a few stocks.
Recently, it has become increasingly common to be able to trade fractional shares, so you can specify specific, smaller dollar amounts you wish to invest. That means if Apple shares are trading at $250 and you only want to buy $50 worth, many brokers will now let you purchase one-fifth of a share.
5. Avoid Penny Stocks
You’re probably looking for deals and low prices, but stay away from penny stocks. These stocks are often illiquid, and chances of hitting a jackpot are often bleak. Many stocks trading under $5 a share become de-listed from major stock exchanges and are only tradable over-the-counter (OTC). Unless you see a real opportunity and have done your research, stay clear of these.
6. Time Those Trades
Many orders placed by investors and traders begin to execute as soon as the markets open in the morning, which contributes to price volatility. A seasoned player may be able to recognize patterns and pick appropriately to make profits. But for newbies, it may be better just to read the market without making any moves for the first 15 to 20 minutes. The middle hours are usually less volatile, and then movement begins to pick up again toward the closing bell. Though the rush hours offer opportunities, it’s safer for beginners to avoid them at first.
7. Cut Losses With Limit Orders
Decide what type of orders you’ll use to enter and exit trades. Will you use market orders or limit orders? When you place a market order, it’s executed at the best price available at the time—thus, no price guarantee.
A limit order, meanwhile, guarantees the price but not the execution. Limit orders help you trade with more precision, wherein you set your price (not unrealistic but executable) for buying as well as selling. More sophisticated and experienced day traders may employ the use of options strategies to hedge their positions as well.
8. Be Realistic About Profits
A strategy doesn’t need to win all the time to be profitable. Many traders only win 50% to 60% of their trades. However, they make more on their winners than they lose on their losers. Make sure the risk on each trade is limited to a specific percentage of the account, and that entry and exit methods are clearly defined and written down.
9. Stay Cool
There are times when the stock markets test your nerves. As a day trader, you need to learn to keep greed, hope, and fear at bay. Decisions should be governed by logic and not emotion.
10. Stick to the Plan
Successful traders have to move fast, but they don’t have to think fast. Why? Because they’ve developed a trading strategy in advance, along with the discipline to stick to that strategy. It is important to follow your formula closely rather than try to chase profits. Don’t let your emotions get the best of you and abandon your strategy. There’s a mantra among day traders: “Plan your trade and trade your plan.”
Before we go into some of the ins and outs of day trading, let’s look at some of the reasons why day trading can be so difficult.
What Makes Day Trading Difficult?
Day trading takes a lot of practice and know-how, and there are several factors that can make the process challenging.
First, know that you’re going up against professionals whose careers revolve around trading. These people have access to the best technology and connections in the industry, so even if they fail, they’re set up to succeed in the end. If you jump on the bandwagon, it means more profits for them.
Uncle Sam will also want a cut of your profits, no matter how slim. Remember that you’ll have to pay taxes on any short-term gains—or any investments you hold for one year or less—at the marginal rate. The one caveat is that your losses will offset any gains.
As an individual investor, you may be prone to emotional and psychological biases. Professional traders are usually able to cut these out of their trading strategies, but when it’s your own capital involved, it tends to be a different story.
Deciding What and When to Buy
Day traders try to make money by exploiting minute price movements in individual assets (stocks, currencies, futures, and options), usually leveraging large amounts of capital to do so. In deciding what to focus on—in a stock, say—a typical day trader looks for three things:
- Liquidity:Liquidity allows you to enter and exit a stock at a good price. For instance, tight spreads or the difference between the bid and ask price of a stock, and low slippage or the difference between the expected price of a trade and the actual price.
- Volatility:Volatility is simply a measure of the expected daily price range—the range in which a day trader operates. More volatility means greater profit or loss.
- Trading volume: This is a measure of how many times a stock is bought and sold in a given time period—most commonly known as the average daily trading volume. A high degree of volume indicates a lot of interest in a stock. An increase in a stock’s volume is often a harbinger of a price jump, either up or down.
Once you know what kind of stocks (or other assets) you’re looking for, you need to learn how to identify entry points—that is, at what precise moment you’re going to invest. Tools that can help you do this include:
- Real-time news services: News moves stocks, so it’s important to subscribe to services that tell you when potentially market-moving news comes out.
- ECN/Level 2 quotes: ECNs, or electronic communication networks, are computer-based systems that display the best available bid and ask quotes from multiple market participants and then automatically match and execute orders. Level 2 is a subscription-based service that provides real-time access to the Nasdaq order book composed of price quotes from market makers registering every Nasdaq-listed and OTC Bulletin Board security. Together, they can give you a sense of orders being executed in real time.
- Intraday candlestick charts:Candlesticks provide a raw analysis of price action. More on these later.
Define and write down the conditions under which you’ll enter a position. “Buy during uptrend” isn’t specific enough. Something like this is much more specific and also testable: “Buy when price breaks above the upper trendline of a triangle pattern, where the triangle was preceded by an uptrend (at least one higher swing high and higher swing low before the triangle formed) on the two-minute chart in the first two hours of the trading day.”
Once you have a specific set of entry rules, scan through more charts to see if those conditions are generated each day (assuming you want to day trade every day) and more often than not produce a price move in the anticipated direction. If so, you have a potential entry point for a strategy. You’ll then need to assess how to exit, or sell, those trades.
Deciding When to Sell
There are multiple ways to exit a winning position, including trailing stops and profit targets. Profit targets are the most common exit method, taking a profit at a pre-determined level. Some common price target strategies are:
|Scalping||Scalping is one of the most popular strategies. It involves selling almost immediately after a trade becomes profitable. The price target is whatever figure that translates into “you’ve made money on this deal.”|
|Fading||Fading involves shorting stocks after rapid moves upward. This is based on the assumption that (1) they are overbought, (2) early buyers are ready to begin taking profits and (3) existing buyers may be scared out. Although risky, this strategy can be extremely rewarding. Here, the price target is when buyers begin stepping in again.|
|Daily Pivots||This strategy involves profiting from a stock’s daily volatility. This is done by attempting to buy at the low of the day and sell at the high of the day. Here, the price target is simply at the next sign of a reversal.|
|Momentum||This strategy usually involves trading on news releases or finding strong trending moves supported by high volume. One type of momentum trader will buy on news releases and ride a trend until it exhibits signs of reversal. The other type will fade the price surge. Here, the price target is when volume begins to decrease.|
In most cases, you’ll want to exit an asset when there is decreased interest in the stock as indicated by the Level 2/ECN and volume. The profit target should also allow for more profit to be made on winning trades than is lost on losing trades. If your stop loss is $0.05 away from your entry price, your target should be more than $0.05 away.
Just like your entry point, define exactly how you will exit your trades before entering them. The exit criteria must be specific enough to be repeatable and testable.
Day Trading Charts and Patterns
To help determine the opportune moment to buy a stock (or whatever asset you’re trading), many traders utilize:
- Candlestick patterns, including engulfing candles and dojis
- Technical analysis, including trend lines and triangles
- Volume—increasing or decreasing
There are many candlestick setups a day trader can look for to find an entry point. If used properly, the doji reversal pattern (highlighted in yellow in the chart below) is one of the most reliable ones.
Typically, look for a pattern like this with several confirmations:
- First, look for a volume spike, which will show you whether traders are supporting the price at this level. Note: this can be either on the doji candle or on the candles immediately following it.
- Second, look for prior support at this price level. For example, the prior low of day (LOD) or high of day (HOD).
- Finally, look at the Level 2 situation, which will show all the open orders and order sizes.
If you follow these three steps, you can determine whether the doji is likely to produce an actual turnaround and can take a position if the conditions are favorable.
Traditional analysis of chart patterns also provides profit targets for exits. For example, the height of a triangle at the widest part is added to the breakout point of the triangle (for an upside breakout), providing a price at which to take profits.
How to Limit Losses When Day Trading
A stop-loss order is designed to limit losses on a position in a security. For long positions, a stop loss can be placed below a recent low, or for short positions, above a recent high. It can also be based on volatility. For example, if a stock price is moving about $0.05 a minute, then you may place a stop loss $0.15 away from your entry to give the price some space to fluctuate before it moves in your anticipated direction.
Define exactly how you’ll control the risk on the trades. In the case of a triangle pattern, for instance, a stop loss can be placed $0.02 below a recent swing low if buying a breakout, or $0.02 below the pattern. (The $0.02 is arbitrary; the point is simply to be specific.)
One strategy is to set two stop losses:
- A physical stop-loss order placed at a certain price level that suits your risk tolerance. Essentially, this is the most money you can stand to lose.
- A mental stop-loss set at the point where your entry criteria are violated. This means if the trade makes an unexpected turn, you’ll immediately exit your position.
However you decide to exit your trades, the exit criteria must be specific enough to be testable and repeatable. Also, it’s important to set a maximum loss per day you can afford to withstand—both financially and mentally. Whenever you hit this point, take the rest of the day off.
Stick to your plan and your perimeters. After all, tomorrow is another (trading) day.
Once you’ve defined how you enter trades and where you’ll place a stop loss, you can assess whether the potential strategy fits within your risk limit. If the strategy exposes you too much risk, you need to alter the strategy in some way to reduce the risk.
If the strategy is within your risk limit, then testing begins. Manually go through historical charts to find your entries, noting whether your stop loss or target would have been hit. Paper trade in this way for at least 50 to 100 trades, noting whether the strategy was profitable and if it meets your expectations. If it does, proceed to trading the strategy in a demo account in real time. If it’s profitable over the course of two months or more in a simulated environment, proceed with day trading the strategy with real capital. If the strategy isn’t profitable, start over.
Finally, keep in mind that if trading on margin—which means you’re borrowing your investment funds from a brokerage firm (and bear in mind that margin requirements for day trading are high)—you’re far more vulnerable to sharp price movements. Margin helps to amplify the trading results not just of profits, but of losses as well if a trade goes against you. Therefore, using stop losses is crucial when day trading on margin.
Now that you know some of the ins and outs of day trading, let’s take a brief look at some of the key strategies new day traders can use.
Basic Day Trading Strategies
Once you’ve mastered some of the techniques, developed your own personal trading styles, and determined what your end goals are, you can use a series of strategies to help you in your quest for profits.
Here are some popular techniques you can use. Although some of these have been mentioned above, they are worth going into again:
- Following the trend: Anyone who follows the trend will buy when prices are rising or short sell when they drop. This is done on the assumption that prices that have been rising or falling steadily will continue to do so.
- Contrarian investing: This strategy assumes the rise in prices will reverse and drop. The contrarian buys during the fall or short-sells during the rise, with the express expectation that the trend will change.
- Scalping: This is a style where a speculator exploits small price gaps created by the bid-ask spread. This technique normally involves entering and exiting a position quickly—within minutes or even seconds.
- Trading on news: Investors using this strategy will buy when good news is announced or short sell when there’s bad news. This can lead to greater volatility, which can lead to higher profits or losses.
Day trading is difficult to master. It requires time, skill and discipline. Many of those who try it fail, but the techniques and guidelines described above can help you create a profitable strategy. With enough practice and consistent performance evaluation, you can greatly improve your chances of beating the odds.
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