Day trading the Forex market – How does it work?

If you’re new to the world of Forex trading, chances are that your first trade was on a very short time frame, where you can see the candlestick going up or down with each incoming tick. Whether you have made profits this way or not, this short-term trading style has a name – it’s called scalping.  While this might be exciting at first, short-term price movements mostly consist of market noise, making it very hard to reap profits out of them.

An alternative trading style that many retail Forex traders have adopted is day trading. Day trading uses longer-term time frames compared to scalping, making the trades considerably more predictive with plenty of trading opportunities throughout the week. In this article, we’ll cover what day trading in Forex is, how it differs from other trading styles, and how to day trade Forex with the most popular trading strategies. Let’s start!

Forex day trading vs other trading styles

As mentioned in the introduction, day trading is only one of a number of different trading styles. The main trading styles include scalping, day trading, swing trading, and position trading, and each of them has certain advantages and disadvantages over the other ones.

Scalping is a very short-term trading style. Scalpers often use 1-minute or 5-minute charts to find trading opportunities, and close their trades when they make a few pips of profit. This means that scalpers need to open a high number of those trades to make a decent profit during the day. Higher transaction costs are also an issue with scalping.

Day trading is probably the sweet spot for retail Forex traders. It uses longer time frames compared to scalping, but still shorter ones when compared to swing trading and position trading. This means that day traders don’t have to stay stuck in front of their trading platform all day long, but they still have to manage their trades throughout the day.

Day traders use various technical tools to enter their trades, such as channels, trend lines, Fibonacci levels, and chart patterns, to name a few. Using these tools, day traders usually base their trading strategy around breakouts, trend-following techniques, and counter-trend techniques, which we’ll cover soon in more detail. Compared to scalpers, day traders also have significantly lower transaction costs, as they don’t open dozens of trades during the day. This makes the Forex day trading market also suitable for beginners.

Swing trading uses slightly longer time frames than Forex day trading – usually the daily charts. Swing traders try to catch the swing highs and swing lows on the charts, and don’t worry much about short-term price fluctuations. Profits targets in swing-trading setups can easily exceed 100 pips, as swing traders hold their trades over a period of a few days or even a few weeks. Since fundamentals might play an important role over the course of a few weeks, swing traders need to be aware of major fundamental developments on the market.

Position trading is the most long-term trading style. Position traders base their trading decisions mostly on fundamentals, and use technical levels only to enter a trade. These trades can be easily held over a period of a few months, or even more than a year, making position trading only suitable for traders who have larger account sizes and a good knowledge of Forex fundamental analysis.

What is a Forex day trader?

By now, you’ve learned the main difference between day trading and the other trading styles, so let’s explain how to be a Forex day trader and how a trader's day might look.

Forex day traders trade the market using day trading strategies, such as chart pattern breakouts for example. Day traders usually start their trading day in the morning, looking at how the markets reacted during the previous trading session and analysing potential trading opportunities. Once they find a promising setup, day traders need to wait for confirmation to enter the trade. This confirmation often comes in the form of candlestick patterns, or the price breaking a recent high or low.

Once a day trader places their trade, they still need to manage the trade during the day, looking for signs that the setup has become invalid or that a news report has had an impact on the trade.

After the end of the trading day, day traders may close their trades or even hold them overnight. However, in this case, if you do this make sure to have proper Stop Loss orders placed on your trades, as overnight news may hit your active trades hard. For this reason, day traders usually don’t hold their trades over the weekend.

Forex day trading strategies

Here’s how to get into Forex day trading. The most popular day trading strategies to trade the Forex market are breakout, trend-following, and counter-trend strategies.

Breakout trading

As its name suggests, this strategy is based on breakouts of chart patterns, channels, trend lines, or horizontal support and resistance levels. When a chart pattern or major technical level breaks, this usually leads to increased buying or selling momentum, depending on the direction of the breakout. Breakout traders want to catch this momentum as soon as the breakout happens, and therefore often use pending orders on the market. Placing a price alert directly on the chart is also a convenient way to catch a breakout, but for this you’d have to be in front of your platform to open the actual trade.

To determine the ideal place for your Stop Loss level, you need to check where the price would invalidate the traded setup. In the event of a chart pattern breakout to the upside, this could be located below the actual chart pattern, or below a recent swing low. When placing Stop Losses, pay attention to the reward-to-risk ratio of your trade – if it’s below 1, or too low according to your personal risk management guidelines, you shouldn’t take the trade. There will be plenty of other breakout setups in the future.

News and other fundamental events may trigger a break of a chart pattern or major technical level, which means that day traders who follow the market from a fundamental perspective may have an advantage over traders who don’t.

break of wedge pattern

The chart above shows what a typical breakout trade looks like. In this example, the trader would enter with the close of the breakout candle, placing a Stop Loss below the recent swing low and a profit target equal to the height of the bullish wedge pattern. However, determining the exit levels (Stop Loss and Take Profit) depends on your personal risk preference, and you could also place them on different levels than those mentioned above.

Breakouts of chart patterns are an extremely popular way to day trade the Forex market, have a proven track-record, and are easy to spot on the chart if you have a decent trading background.

Trend-following trading

Another popular way to day trade the Forex market is by using a trend-following approach. The best trades come if you manage to catch a trend early in its stage. All financial markets like to trend, and the Forex market is no exception there. In fact, one of the basic premises of technical analysis is that markets like to trend, and almost all technical tools serve the sole purpose of identifying trends and trend reversals in their development. Trend-following is probably the best way to day trade Forex.

But how do you identify a trend properly? The best way is by performing a peak and trough analysis. Peaks and troughs refer to the higher highs and higher lows that characterise uptrends, and lower lows and lower highs that characterise downtrends. If you spot a higher high and higher low, a trend-following strategy would suggest to enter with a long position, with a Stop Loss just below the recent higher low. On the other hand, in the case of lower lows and lower highs, a trend-following day trader would look to enter with a short position with a Stop Loss just above the recent swing high.

Determining the profit targets with trend-following techniques is slightly more complicated than placing Stop Losses. While traders can identify an obvious recent swing high or resistance level to place a profit target, you need to make sure to ride the trend long enough and not exit too early. Catching trends is one of the most rewarding events for a trader!

buy

A trend-following trade setup is shown on the chart above. The EUR/USD pair made consecutive higher highs and higher lows, as shown on the chart, which are connected together through a rising trend line. Once the price reaches the trend line, a trader can enter with a position in the direction of the overall trend, and place a Stop Loss order just below the trend line, i.e. recent swing low.

Using trailing stops is also an efficient way to ride a trend as long as it’s active. Trailing stops automatically move your Stop Loss with each price movement that goes in your favour. A one pip upwards movement on the chart above would also move your Stop Loss up one pip.

Counter-trend trading

Counter-trend day trading strategies are based on trades that go in the opposite direction of the general trend. This means, counter-trend traders would enter with a short position during an uptrend, and with a long position during a downtrend. Now, this may seem counterintuitive at first, as the largest price movements are inside the primary trend. Indeed, counter-trend trading is way riskier than trading in the direction of the trend, and if you’re new to the world of Forex trading you might want to skip this strategy. Otherwise, continue reading.

Each move in the direction of the primary trend is followed by a market correction that sends the price in the opposite direction. This happens because traders who have entered the trend earlier are now locking in profits. In the case of uptrends, sellers may also jump into the market if they perceive the current price to be too high, and conversely in downtrends, buyers may start to load their long positions if they perceive the price as too low. Whatever the reason behind a market correction, the main point is that they can be measured, analysed, and finally traded.

Let’s see how to day trade Forex with a counter-trend strategy. Ideally, each market correction should retrace to around 50% of the initial move. If a trader spots a potential top of the initial move, they could enter short and trade the correction. Similarly, if a trader spots a bottom of the initial move, they would enter with a long position based on a counter-trend strategy.

Fortunately, traders have various tools to measure market corrections, potential retracement levels, and tops and bottoms of initial moves. The Fibonacci tool is widely-used to measure where the price may retrace after an uptrend tops or a downtrend bottoms. Popular Fibonacci retracement levels include the 38.2%, 50%, and 61.8% levels. As you can see, those levels are around the 50% mark, with 11.8% added above and below the 50% level. The reason for these uneven numbers lies in the way they’re calculated – they’re based on the Fibonacci sequence. Without going into too much detail now, here’s what a counter-trend trade setup looks like.

uptrend

The chart above shows typical counter-trend trades during an uptrend. The Fibonacci retracement tool is drawn between a recent swing low and a recent swing high, and the price respected important Fib levels on our chart. As you’ve noticed, Fib (or Fibonacci) levels are used as profit-targets in a counter-trend strategy, but can also be used to enter the trade in a trend-following strategy. Finding tops and bottoms of initial movements to actually enter the trade could be based on chart and candlestick patterns, trend line and horizontal support and resistances, channels, and any other technical tool.

Conclusion – How to day trade Forex

In this article, we’ve covered what Forex day trading is and listed popular day-trading strategies. The question is not “Can you day trade Forex?”, but rather "How to gain enough trading experience to find good day trade setups?".

The Forex day trading market offers many lucrative trading opportunities, and with the examples mentioned above you might easily find your next trade of the day on Forex.

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