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Forex 101 | Part 4: Building your forex day trading strategy

A forex trading strategy is a plan on how you want to trade the markets. There are many day trading strategies, and they can include different forms of analysis.

Most common day trading strategies include using a combination of technical indicators or trading based on news events.

All of them qualify as a day trading strategy because the end goal is to find profitable trading opportunities.

Welcome to this next part of the forex day trading course.

In this guide, you will learn how to build your forex trading strategy. But first, a quick recap of what we have learned so far.

  • Basics of the forex market: In this section you learned what the forex markets are all about. You now have an idea of how to trade forex
  • Fundamental and technical analysis: In this section you learned the differences between forex fundamental and technical analysis. You also learned why it is important to use both when day trading
  • Forex charts: From the different ways to analyze the forex markets, here, you learned what are forex charts. You may find many different types of forex charts. This is useful because in this part, we will apply the concepts learned.

If you haven't read the previous guides to day trading forex, then we highly recommend you read them first.

The goal of day trading is to buy and sell currency pairs. You buy when the price is low and sell when the price is high!

This sounds simple on paper, but difficult to implement. You need to have good risk management skills to succeed in the forex market.

What is a forex trading strategy?

A forex trading strategy is a plan on how you want to trade the markets. There are many day trading strategies, and they can include different forms of analysis.

Most common day trading strategies include using a combination of technical indicators or trading based on news events.

All of them qualify as a day trading strategy because the end goal is to find profitable trading opportunities.

A forex trading strategy is classified into swing trading strategy or day trading strategy.

A swing trading strategy requires you to be adept at day trading. As a beginner to forex, this guide will focus on the latter.

What does day trading mean?

Day trading is another word for short-term trading. You can day trade any markets, from forex to stocks. Day traders open and close a trade during the trading session.

When you day trade the forex markets, you are looking at short-term time frame. This time frame can range from the 15-minute chart or lower up to the 1-hour chart.

But make no mistake, when you day trade forex, you will also look at the 1-day or even the 1-week time frame.

Day trading is used in the futures and the forex markets.

As a day trader, you need a good margin account. This is because you will be trading on leverage. Therefore, having sufficient trading capital is important.

You also need to acknowledge the fact that day trading requires your time. You cannot set up a trade and walk away and expect it to make money for you.

Types of day trading strategies to use in the forex market

Traders can use a system focusing on price movements, or indicators or a combination of both. At the end, there are two main aspects.

Price and support and resistance which you will find in any strategy that you pick.

There are different approaches you can apply for trading forex. But all trading strategies can be one of the following types as below.

Breakout trading

This is a forex day trading strategy that focuses on rapid price action movement. There is a high risk of losing when using this strategy.

This trading style requires minimal time to set up. Many mechanical trading systems use the breakout method. Profits and losses are quick with the breakout trading. You will not be using too many indicators with breakout forex trading strategies.

Therefore, traders should be adept at reading price charts. Price action will play an important role.

There are also a few breakout trading methods that use indicators as well.

Volatility is your best friend when using a breakout day trading strategy

Trend trading

The trend trading style requires a bit more time to evolve. You may have to wait for a day or two until the right trading conditions appear in the market.

When the signal is triggered, this day trading strategy can give you good results.

Patience is very important to be a successful day trader using trend-following strategies. In this trading style, the trend is your friend!

Because the day trading opportunities are so little, you will have to monitor multiple instruments at the same time. This can get tiresome.

There will be times when you will have to sit on your hands for prolonged periods of time. This is when you may end up taking unnecessary risk.

Counter trend trading

This is the same as trend trading except that it takes a contrarian approach. A forex day trader will be taking opposite positions to the trend. This happens because prices can zig-zag their way.

Therefore, counter-trend movements or retracements are quite common. These counter-trend day trading strategies can be risky, but highly rewarding.

There is a high risk of losing with this trading style if you are not careful. In forex day trading, you will never know whether the market is reversing or continuing its trend. It is quite possible that you may give back the profits made with counter-trend trading.

In counter-trend trading, you will be relying on the momentum in the forex market.

This is one of the most advanced day trading strategies from this list. Hence, traders should be careful when trading against the trend.

The table below summarizes the pros and cons of the three-day trading strategies.

Trading styleProsCons
BreakoutDynamic and rapid price movements can be fun to trade, but also stressful require little time for analyzing the marketsRequires good money management skills over trading can be a huge risk-prone to fake market movements
Trend FollowingYou trade in the direction of the market considered a safer way to trade requires a good knowledge about trends across different time framesNot very frequent trading opportunities you may have to spend a bit more time to pick the right forex pairs to trade does not work when the markets are choppy or moving sideways
Countertrend tradingYou trade the retracements in the trends can be rewarding as profits are also quickerRequire a good knowledge about trends and markets in generalOverall risky as prices can reverse, defying logic needs good money management skills to limit losses difficult to distinguish between a retracement and a reversal

How to create a day trading strategy in 5 steps

Let's now get into the technicalities of creating your first trading strategy.

Because there are many day trading strategies, it is important to recognize your trading style.

Some forex traders are patient, while others prefer quick results. Hence, a forex method that works for one trader will not work for the other.

This is a common trap that many forex traders fall into to. To help you avoid this, follow the five steps to creating a forex day trading system.

#1. Understand your character

  • Are you an impatient person in general?
  • Do you like to get things done quickly?
  • Do you hate waiting?

If you fall into such a category, then you should focus on day trading strategies that can complement your personality. A forex day trading system is highly personal.

While you can use a commonly available method, you will eventually tweak it to your liking.

Therefore, if you can understand your personality, you will be better at picking a trading system that you are more comfortable with.

#2. Do you have the time?

The amount of time you can dedicate to forex trading will influence the strategy you want to use. Some require a lot of time, while others not so much.

If you have a day job, then carefully pick a day trading method that can fit in with your lifestyle. If you do not have the time to trade forex, you could look at spending time on the weekends.

This is when the markets are closed. It will help you to identify potential trade set ups you can use over the week. In some cases, a forex day trading system may require you to monitor your trades throughout the day.

Try to avoid such methods for obvious reasons.

#3. Do you have sufficient capital to trade?

There are some forex day traders who target just a few pips.

The way these forex traders make money is by trading bigger lots. This means you need to have a larger trading capital, and perhaps higher leverage too.

It is pointless to use a day trading method targeting just 5 pips, by trading with a micro-lot.

May forex day traders think of making money by trading with just $100. This is not enough to get you very far. Even if you use high leverage, it won't help because your risks also grow with this.

Retail investor accounts lose money very easily. To avoid this, you should first practice forex day trading on a demo account. You can then gradually move toward using a micro-trading account or a cent-account.

This way, you can gain familiarity with the type of strategy you will be using to day trade.

#4. What is your risk tolerance?

Traders react differently when they lose money.

Knowing how much loss you can take is important. If you get upset on too many losing trades, then you will have to consider a different day trading style.

Trading psychology is an important aspect of the forex market. We cover this in detail in the next part of this trading guide.

Risk tolerance is all about understanding that you can lose money when trading. Therefore, it is recommended that you trade with capital that you can afford to lose. Different forex day trading methods have different risk tolerances.

Identifying this early on can help you keep your losses to a minimum.

#5. Do you understand the indicators used?

Day traders can randomly pick one of the many forex trading strategies available publicly.

Each of these trading strategies uses different indicators. There are some trading systems using price movements too.

Knowing what is in your trading system is important.

This will help you to understand the strengths and weaknesses in your trading strategy. Also spend time to read about the indicators used in your forex day trading system.

Five common forex trading mistakes and how to avoid them

While having a trading system is good, there are still areas where traders can fall into a trap. In this part of this guide, we will look at some commonly made mistakes when trading forex.

Learn how you can avoid these mistakes.

Mistake #1: Not having a trading plan

If you don't have a trading plan, you are bound to lose.

Professional traders use a trading plan to help them stay grounded. You can read more about the importance of a trading plan in forex day trading.

A trading plan helps you to manage the risk of losing money when trading. This is a good practice to maintain right from the start.

Developing this habit also helps you to control your emotions especially when you hit a string of losing trades.

Mistake #2: Using tight stop loss

Have you noticed how often your trades get stopped out? Do you notice that right after being stopped out, price moves in the opposite direction?

What the trader is left with is a losing trade that could have been profitable.

Using stop loss is good, but you also need to give your trade some breathing space.

Find a balance within your risk management to ensure that your trades can move around a bit without impacting your PnL too much.

The stop loss levels can also vary depending on the time of the day. During the U.S. session, you may see higher volatility compared to the Asian session. This can also increase with high-impact news events like an interest rate decision.

Avoid using tight stop loss, depending on the market context. This will help to ensure that your trades have a better chance of turning a profit.

Mistake #3: Using too much of technical analysis

Traders already know that there are different approaches to technical analysis. You do not have to use all of them. Very often, traders end up using too many indicators or chart patterns.

What happens, in the end, is a cluttered trading system. Traders can barely see what price is doing when using such strategies. Another downside of analyzing the markets too much is that you will end up confused.

Avoid analysis paralysis by sticking to just a few methods of analysis. This is more than sufficient especially if you can be familiar with these types of analyses.

But remember that no matter how thorough you are, there are times such as when trading news events. During such periods, market volatility picks up. All the hard work you put in can be invalidated in a jiffy!

Traders should hence be careful especially with trades around high-impact news releases.

Mistake #4: Not knowing what market you trade

Even though you are trading in the foreign exchange markets, not every currency pair is the same. Different forex pairs have different attributes. Some are volatile than others.

Therefore, when you blindly apply a strategy to a market that you are not familiar with, you can start to lose money.

To avoid this, day traders should take time to understand the market they want to trade. If it is the EUR/USD for example, learn the fundamentals. Figure out what affects the currency pair, and the price moves it makes.

Things like interest rate decisions can make this currency pair volatile in the short term, but not so much in the long term.

Mistake #5: Maintain a good risk/reward ratio on your trades

Sometimes you will come across trading opportunities that look nice. But they have a bad reward ratio. Traders who ignore this rule are at a higher risk of losing money.

A good risk to reward ratio is important to help you make money in forex consistently. This is crucial because even with a bad trading system, you can still make money.

The trick with this method is to find a balance between your trading system, risk management, and the market itself.

It will take years for you to master this, but with enough practice, you can get there eventually.

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Disclaimer

The information provided is of a general nature and is not intended to be personalised financial advice. The information provided is not intended to be a substitute for professional advice. You may seek appropriate personalised financial advice from a qualified professional to suit your individual circumstances.

Trading in Rockfort Markets derivative products may not be suitable for everyone as derivative products may be considered as high risk. Please ensure that you understand the risks involved. A Product Disclosure Statement can be obtained here and should be considered before trading with us.

William B.

June 23, 2021

  • Reading time: 7 mins
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