What is forex day trading? — Complete beginner's guide

Forex day trading involves having a trader open and close positions on one or multiple currency pairs within the same trading day. This could last anything from a few minutes to a few hours. However, they generally ensure that all positions are closed before the end of the trading day.

A trader will rarely keep a position open overnight. This could also eliminate the potential risk of overnight fees and price gaps that could occur when the market is closed.

As previously mentioned, these traders typically focus on short-term price fluctuations, trying to take advantage of those small and quick market movements. This is why they generally trade currency pairs that have higher liquidity and volatility.

Because this is a short-term trading style, it might be best suited for forex traders who have sufficient time during the day to monitor and analyse the markets and charts for potential trading opportunities.

That said, this trading style also requires discipline, focus, and dedication when analysing smaller time frames and making quick trading decisions on when to enter and exit a position.

We mentioned that day trading in the forex market requires much more time to monitor the charts while making quick trading decisions when an opportunity presents itself. Because these traders are looking to take advantage of short-term price movements, it’s completely different from traditional but-and-hold investing, which focuses on long-term price movements.

Now, seeing as they focus on these short-term price movements, there are certain factors they might want to keep in mind which could influence the actual price movements in the market, such as:

• Trading volume: The trading volume refers to the amount of time a currency pair is bought and sold over a specific period of time. When the trading volume is high, it indicates a lot of interest in that particular currency pair, whereas if the volume is low, it indicates a lack of interest from buyers and sellers.
• Liquidity: This indicates the ease at which a currency pair can be bought or sold without significantly affecting the price. When a currency pair is experiencing high levels of liquidity, it indicates many market participants are willing to buy or sell that specific currency pair, compared to lower levels of liquidity, indicating fewer market participants are willing to buy or sell a particular currency pair.
• Volatility: It measures the price fluctuations of the currency pair over a period of time. When a specific currency pair experiences high volatility, it indicates that price changes are quicker and more significant. This could be advantageous for traders looking for opportunities in the market, but it could also present a certain degree of risk when entering a position.

There are generally four common mistakes many novice forex traders make when starting day trading. Below is a breakdown of each of these common mistakes and how they could possibly go about avoiding making them.

1. Averaging down

Averaging down is a term for adding to a losing position, which many traders struggle to avoid when the market starts moving against them.

When this happens, a trader is effectively doubling up on a long position or doubling down on a short position, meaning their new entry points might look more attractive than their original one. However, by adding to a losing position, a trader could increase their risk significantly.

When the price starts moving against their positions, many struggle to control their emotions, which could cause them to abandon their trading plan and ignore their risk management strategy.

The primary issue with this situation is that a losing position is being maintained and compounded when the market already suggests that the original idea has failed. This could result in significant losses because no one knows how long the trend will likely continue.

Essentially, this could result in a trader having to get a higher return on their remaining funds to recover from the lost capital. For example, if a trader loses 50% of their funds, they’ll need to make a 100% return on future trades to restore their initial capital level.

2. Preparing forex trades for news

Many traders might know that certain important news and economic events, such as central banks raising or lowering the interest or when the non-farm payroll is released, could cause significant price swings in the forex market. Yet, the direction the market could go is unknown.

While many traders see these events as advantageous, they could also include some significant risks, mainly because, as mentioned, the direction the market could go is unknown.

For example, a trader could open a long (buy) position just before these events are released, and as soon as they are, the price could spike downward, triggering their stop-loss order.

It might be best to wait for the market to subside after these news and economic events to better understand whether the market will continue with the current trend or start a new one. This could help avoid any liquidity concerns and better manage risk.

3. Putting more than 1% of your capital at risk

Many traders abide by a general rule of not risking more than 1% of their capital per trade. This is because taking excessive risk does not necessarily lead to substantial profits. Traders who generally do this might run the risk of losing all their capital.

For example, if a trader has a $5000 account, they could decide to risk only $50 per trade, following this rule.

This rule tries to keep traders’ remaining funds safe so that when a loss occurs, they can afford and recover from it.

There is also the option for those traders who are extra cautious to take a different approach and only risk 1% of their capital per trading day instead of 1% per trade.

For example, if a trader has a $10,000 account and decides to risk only 1% of their capital per trading day, that will come down to $100 per day.

4. Unrealistic trading expectations

Often, traders enter the market with unrealistic expectations, such as making a certain amount of money every month without giving it any proper thought. Trading takes discipline, time, patience, and practice.

Unrealistic expectations and failure to achieve them could affect a trader’s emotional state. However, a well-structured forex trading plan could help traders avoid entering the market with unrealistic expectations and/or avoid emotional trading.

A trading plan could be seen as rules and guidelines to follow in order to potentially reach their trading goals while stating realistic expectations that could be achievable.

For example, they could set realistic expectations, such as growing their portfolio by 5% every month or by 10% annually. These expectations will generally be unique to every trader and should align with their overall trading goals.

Traders have many different strategies available, many of which can be combined. However, a trader's specific strategy generally depends on personal preference and alignment with their trading goals and objectives.

Below is a list of five popular strategies used in forex day trading with a detailed description of each.

Trading trends

Trend trading involves examining the direction of an existing trend and making decisions based on that direction. The basis behind trend trading is expecting the trend to continue for some time, with traders keeping their positions open until their take-profit levels are reached or when a reversal occurs.

When a currency pair uptrends, the price will make consecutive higher highs and higher lows. Traders could look to open a long (buy) position at the start of the trend or after it forms a higher low, continuing the uptrend.

They could close their positions at the end of the trading day or when they reach their desired take-profit levels.

When a currency pair trends downward, the price will make consecutive lower highs and lower lows. Traders could look to open a short (sell) position at the start of the trend or when the price has finished making a higher low, possibly continuing the downtrend.

They could again close their position at the end of the trading day or when they have reached their desired take-profit levels.

Traders could implement strategically placed stop-loss orders to protect their positions if the price moves against them. A stop-loss order is placed at a predetermined level away from the current market price, which, once reached, automatically closes the position, limiting any further losses to a trader’s accounts.

Mean reversion

Mean reversion is based on the idea that the market has an average level to which it will return following a significant price change.

Traders using this strategy will generally employ technical analysis indicators such as moving averages to better understand currency pairs whose current performance is significantly different from their historical average.

If traders can identify a currency pair with a significant price change compared to its mean, they could take advantage of the market’s return to its average level.

Trading on news

A trader using this strategy will generally look at the latest and most important news and economic events to assist with their decision-making process and identify potential trading opportunities.

They tend to look at news and economic events, such as interest rate announcements or the Federal Open Market Committee (FOMC) meeting, that could bring a certain level of volatility to a currency pair to try to capitalise on those moments of increased volatility.

Traders who generally follow this strategy might have a broader outlook on the forex market. Certain news and economic events could affect various currency pairs simultaneously, ultimately influencing their decision-making regarding which currency pairs they might want to trade.

Fibonacci retracement trading

Retracements in the market can be challenging to spot, which is why some traders might use the Fibonacci retracement tool to assist in spotting them and also look for possible entry and exit points.

The premise behind this tool is that it follows the Fibonacci golden ratio equation, which is the numbers 23.6, 38.2, 50, and 61.8. Once placed on the charts, a trader will see six lines: the first is at 100%, the second at 50% and the third at 0%. The remaining three lines are at 61.8%, 38.2%, and 23.6% levels.

These levels could be seen as potential support and resistance levels, as well as possible entry and exit points where the market could reverse once reached.

This tool works by having the trader look for the highest point of interest and drag the tool across the chart towards the lowest point of interest when the market is in an uptrend. 

The opposite is true when the market is in a downtrend, where the trader would start at the lowest point of interest and drag it towards the highest point of interest.

In theory, when the price retraces and reaches one of the golden ratio levels, traders could look for a possible entry point: either a long (buy) position when the market is in an uptrend or a short (sell) position when the market is in a downtrend.

Traders could also incorporate certain candlestick patterns to confirm their entry points further.

Breakout trading

With a breakout trading strategy, a trader would look at a currency pair trading in a strong ranging market, meaning it’s trading between support and resistance levels, waiting for the price to break out of one of these two levels.

Once the price breaks out of resistance, they could consider opening a long (buy) position, and if the price breaks out of support, they could consider opening a short (sell) position.

Traders might want to be careful of possible fake-outs. These are false signals in which the price appears to move in the desired direction but quickly reverses soon after. They can take the form of a bull trap or bear trap.

With this strategy, traders could also incorporate certain candlestick patterns in order to provide further confirmation regarding the significance of the breakout.

Advantages

• Forex day traders aren’t exposed to adverse price movements or price gaps that could occur when the market is closed.
• They also avoid paying overnight fees, seeing as they close all their positions before the end of the trading day.
• Volatility in the forex market could provide traders with many opportunities.
• Forex day trading is mainly done through leverage, which allows them to open a much bigger position with only a small amount of capital, posing the possibility of magnifying any potential profits.

Disadvantages

• Even though volatility could provide opportunities, it could also present a certain level of risk due to the quick price movements.
• Even though profits could be magnified, there is also the potential risk of losses being magnified because the result of a trade is based on the entire size of the position, not just a trader’s margin capital.
• Unlike longer-term strategies, day trading forex requires many hours in front of the charts looking for potential short-term trading opportunities.

Let’s take a closer look at some essential factors that a trader might want to consider before starting forex day trading.

• Before starting day trading, traders might want to research the forex market and educate themselves on its various aspects, including the currency pairs they plan to trade.
• Once they have a solid foundation of market knowledge, they could develop their forex trading plan.
• Next, they might want to consider the amount of risk they’re willing to take. This could be the amount of risk they’re willing to take per trade and per day.
• After deciding the amount of risk, they could determine what strategy to use. It might be essential to remember that the chosen strategy should align with the trader's risk tolerance.
• Together with the strategy, a trader might also want to decide if they will need technical analysis indicators, possibly forming part of their entire strategy. Also, what fundamental analysis aspects might they want to incorporate if required?
• Once that is finished, they can sign up with their chosen broker. This allows them to test their chosen strategy in a risk-free environment by opening a demo account before moving to a live account.
• Lastly, to keep a record of all trading activities, a trader could create a trading journal to write down certain information such as the market condition before entering a position, the entry and exit points, reasons for taking a trade, their emotional state before, during, and after a trade, and the results of the trade, whether a profit or a loss. This could also serve as a learning tool, allowing them to revisit past trades and make necessary adjustments if needed.