Forex trading requires putting together multiple factors to formulate a trading strategy that works for you. There are countless strategies that can be followed, however, understanding and being comfortable with the strategy is absolutely essential. Every trader has unique goals and resources, which must be taken into consideration when selecting the suitable strategy.
There are many different types of trading styles and techniques available to the market trader. You might consider yourself a short-term trader or a long-term trader, or possibly somewhere in between. But what does that really mean?
These terms tend to be relative, and mean different things to different traders.
For example, short term for one trader could mean several minutes, while short term for another trader could mean several days. In this blog, I want to clearly define the various trading styles and the characteristics of each.
Discretionary vs Automated Trading Approach
Before I dive into the different trading styles and strategies available to the market trader, we should first understand the method in which the trader will execute their trades.
When it comes to trading the markets, there are essentially two primary execution approaches that a trader can utilize. The first is a discretionary approach, wherein, the trader uses their judgement and discretion when executing and managing their trades.
The second is a system based or automated trading approach, wherein the trading system is responsible for initiating and managing the trade. In a system-trading environment, the trader’s primary responsibility is in the initial setup and programming of the automated trading system and regular monitoring of the system to ensure that the system is functioning in a proper manner.
The choice of which execution approach you prefer will depend on your psychological makeup and comfort level. For example, if your personality is one where you prefer to be in control of trading related decisions, then a discretionary based approach may be more suitable for you.
If on the other hand, you are comfortable with letting a rule based trading algorithm execute trades in the market, then a system based approach may be something that would work for you.
All the trading styles that we will discuss in the upcoming sections can be either discretionary based or system based. Keep in mind that a discretionary trader can be systematic in that he or she follows a strict rule based strategy, but applies certain discretion in the process. But a system trader cannot be discretionary, and must follow all trades provided by their automated trading program, in order to truly qualify as a system trader.
It is important to ask yourself which type of trading approach you are more comfortable with, and then narrow in on the trading style that would best compliment that for you.
Trading Style #1 – Scalping
Scalping is a fast-paced trading style that can be highly intense and often times carries with it a good deal of stress. Scalping involves looking for a steady stream of opportunities in the market. Scalpers can often trade 20, 30, or in excess of 50 positions during a trading session. Most scalpers tend to be in and out of their position within minutes.
Scalpers are typically using a good deal of leverage and are looking for small minor moves that they can take advantage of with regular frequency. For example, a Scalper trading the EURUSD could trade a dozen or more positions on a smaller time frame such as the 1 minute or 2-minute chart based on a breakout on the daily chart.
Scalping is quite popular in the Equities markets, where these traders can utilize Level 2 data to route orders for the best pricing and fastest execution. But if you are interested in scalping the Equities market, you should be aware of the Pattern Day Trader rule in the United States, which requires a trading account of at least $25,000 to qualify for executing multiple round turns during the trading session.
As you might imagine, one of the biggest drawbacks of using a Scalping trading style is the high cost of transaction fees associated with the large turnover generated by these trading activities. Many times, the transaction costs in the form of commissions can eat into 60-70% or more of a trader’s gross profit. So, scalpers need to ensure that they are receiving the lowest commission rates possible from their broker and any exchanges in order to have a chance at succeeding with this approach.
These days Scalpers that are discretionary based have a lot of competition from High Frequency trading firms. HFT’s are the ultimate scalpers, and can typically take hundreds if not thousands of trades throughout the daily trading session. It’s no wonder that computer algos tend to dominate the scalping arena.
Trading Style #2 – Day Trading
Day Trading is somewhat similar to Scalping in that traders are looking to enter and exit their position during the same trading session. But a major distinction between the two is that Day traders tend to have a longer time horizon than most scalpers.
Day traders are usually not in and out of positions within minutes. They typically employ day trading techniques that look for larger swings during the day that they can capture. As such, a day trader can stay with a position for as little as 30 minutes to several hours or the entire trading session from open to close.
Most day traders will put on about two to five positions per day depending on the volatility in the market. Although transaction costs can weigh on a daytrader bottom line, they are not nearly as pronounced are they are for Scalpers. And while a large majority of Scalpers tend to focus on automated trade execution models, many day traders are still discretionary in nature.
Aside from some day traders that focus on news trading, the majority of day traders are technically oriented. They are not as concerned with large macro-economic trends since their time horizon does not require projections beyond several days to a week.
To be an effective day trader, you should have the disciple to ensure that you are closing out all open positions by the end of the trading day. Some novice day-traders have a difficult time exiting losing trades at the end of the session because they still believe that prices will turn around. They let a short-term day trade turn into a swing trade or worse a longer-term position.
Every successful day trader knows that the markets will always be there and that they can always re-engage their position if they need to. But they realize that what is critical and essential for them as a day trader is to go home flat each day and start anew every morning. Their risk plan calls for being flat at the close and that’s exactly what disciplined day traders do.
Trading Style #3 – Swing Trading
Swing trading involves trading with a time horizon of about a day to less than several weeks. Swing traders typically trade the 240 minute and 480 minute charts in the Forex Market, and the 60 minute and 120 minute charts in the Equities and Futures markets. Swing traders have the best of both worlds when it comes to frequency of trades, and the cost of trading.
As for frequency, swing traders have ample opportunities to trade the market, and it is typical for these traders to take 8-12 positions per month, which could translate to 100-150 trades per year. From this perspective, it is an excellent style of trading for beginning traders because of the large number of opportunities available for testing and honing their skills in the market.
The cost of trading in the form of dealing spreads and commissions is also greatly reduced with swing trading. The lower frequency of trading compared to day trading and scalping coupled with higher Pip targets makes swing trading one of the most attractive trading styles for professional speculators.
Another major advantage of swing trading techniques is that many technical patterns that form on these relatively higher timeframes are much more accurate and reliable. For example, a support level formed on the 240-min chart on the EURUSD is much more important than a support level formed on a 15-minute chart. And the same goes for chart patterns as well. A head and shoulder pattern forming on the 120-minute chart is far superior to the same pattern appearing on the 5-minute chart.
There are countless trading techniques in the market that can be employed with a Swing Trading style. You can be a mean reverting trader selling the tops and buying the bottoms of Bollinger Band extremes, or you can be a Momentum trader buying breakouts from S/R levels, or you can buy dips within an uptrend or sell rallies within a downtrend. Choosing the best trading technique will depend on your own personality and skill set.
Trading Style #4 – News Trading
News trading is a subset of fundamental analysis. News traders seek to capture a price move after a scheduled news announcement. Economic events such as US Non-Farm Payroll, Central Bank rate statements, Inflation reports such as PPI and CPI, and Quarterly GDP reports can produce increased volatility in the market.
Usually when the figures from the scheduled news announcement deviate materially from analysts’ consensus, then a sharp reaction can occur in the market. Sometimes prices can soar by 150 pips or more within seconds, and also conversely drop 150 pips or more within seconds.
News trading can be quite tricky and risky as these types of knee jerk reactions can sometimes occur on both the long and short side of the market, making it difficult to gauge the true direction the market is headed in. Strict money management rules and hard stop losses are a must for news traders due to the heightened risk during these times in the market.
There are various strategies and techniques that a news trader can use to take advantage of their trade ideas. They can buy or sell a currency pair outright in the forex market, make use of a leveraged futures position, or even construct a position using FX options.
Regardless of the technique used, it is important to note that just before these scheduled news events, the price of certain pairs that could be affected by the report, usually trade in a consolidation range, as traders are awaiting the news event. And as the important economic report draws nearer, the dealing spreads will tend to widen as market making forex brokers are looking to balance their books to protect themselves from potentially adverse price shocks as well.
Some news traders prefer an intraday trading technique wherein they initiate a trade immediately following the news event. Other news traders prefer to wait for the market to cool down a bit and wait for a pullback before entering into the direction of the intraday trend created by the news event.
Trading Style #5 – Trend Trading
Trend Trading is a popular trading strategy among many Commodity Trading Advisors (CTAs) and Professional Hedge Funds. Trend Trading was originally popularized by world renown traders Bill Eckhardt and Richard Dennis through their “Turtles” Experiment.
If you’re not familiar with the Turtles story, it would be advisable for you to do some reading into this. But to explain briefly, these two men made a bet to see whether they could teach regular people from a diverse set of backgrounds their trend following methodology to see if these traders could be trained to succeed in the markets.
The results of the experiment showed that, in fact, traders could be trained to succeed and be profitable in the markets. Some of the original Turtles have gone on to become hugely successful private traders, and hedge fund managers.
The idea of trading with the trend appeals to many traders. We know from the law of physics that all things follow the path of least resistance. Most trend traders are longer term in nature. They tend to focus on the daily and weekly chart, looking for moving markets.
The primary goal of a trend trader is not to predict where the market might be going, but rather to join a market that is already showing signs of strong movement in a particular direction. Trend traders seek to jump on emerging and established trends and plan on staying in them for as long as the market continues to move in their desired direction.
A major difficulty that many newer traders have with trend following lies in their ability to spot and get aboard a trending market before it’s too late. By the time most retail traders get into a trending market, most of the move is likely already exhausted. So, the trick is to be able to spot an emerging trend and get in as close to the beginning or middle of the trend as possible.
Trading Style #6 – Macroeconomic Trading
Macroeconomic traders are primarily focused on long-term fundamental data that drives a country’s economy. These traders are long term in nature and can often hold onto a position for months if not years, and many only have a handful of positions open throughout the course of a year. These traders obviously like to pick their positions carefully as their limited bets can make or break their year.
Some of the most important economic data that macroeconomic traders like to study include a country’s GDP relative to its peers, the current Inflation and Employment situation, the interest rate environment and trade balance data.
It is from this primary set of data that the Macroeconomic trader can begin to build a forecast for what they expect for a particular country, and its exchange rate with respect to other counties.
Successful macro-economic traders can spot emerging trends within the current business cycle and position themselves to get into a market before many others are aware of an impending change. These traders tend to be very aware of overall market sentiment and look for early shifts in sentiment and mass trader psychology to forecast the next likely path within the economic cycle.
Although macro-economic traders rely mainly on fundamental techniques for trade evaluation, they often use technical analysis to help them time their trades for optimal entry and exit.
An important analytical technique implemented by many macroeconomic traders is the use of inter-market analysis. They routinely study the cause and effect relationships among various asset classes.
For example, macro-economic traders want to know:
How are government bonds moving in relation to stocks?
What effects are certain currencies are having on crude oil prices?
Where are commodity prices in relation to US Dollar?
What relationship if any exists between Gold and Equities?
These are just some of the questions that Macroeconomic traders try to answer before making an informed forecast.
Trading Style #7 – Carry Trades
Carry trades are used by many large institutions around the globe to try to earn significant interest income. Essentially with a currency carry trade, you are buying a higher interest yielding currency, and financing that with a lower interest yielding currency.
So, for example, if the Australian Dollar has a 4 percent interest rate and the Japanese Yen has a 1 percent interest rate, then buying the AUD/JPY pair would yield a net 3 percent interest rate, and it is considered a positive carry.
If on the other hand, you sold the AUD/JPY pair then you would pay a 3 percent interest rate instead. This is considered a negative carry trade. Directional traders should be aware of the carry trade effect when they are buying and selling currencies, because the negative carry cost can sometimes eat into the potential gains beyond their expected return.
You may be wondering why such a low interest rate would appeal to speculators or institutions utilizing the carry trade approach. Well the important thing to remember with this forex trading technique is that you earn or pay that interest on the notional value, so a leveraged position could likely earn many multiples of interest rate differentials. For example, based on the 3% we mentioned earlier, a 10:1 leveraged position could potentially earn 30% yearly interest.
Now although a carry trade sounds like a no-lose proposition, in fact, you still have to take into consideration the potential market fluctuations while you are holding the carry trade. Depending on whether the market moves in the direction of the positive carry or opposite to it, you will realize a gain or loss beyond the leveraged interest rate differential.
So essentially, the best carry trades are ones that have an attractive interest rate differential and one in which you have a market bias as well in the direction of the positive carry. This would be an optimal carry trade situation. But keep in mind that carry trades are not without risk, so it is important that you have a solid plan in place if the market begins to move rapidly against your desired direction.
Trading Style #8 - Range Trading
A Range-Bound market is a condition where there is price congestion within a range on the price chart. This means that the general price action is situated between two specific levels – the high of the range and the low of the range.
Some traders refer to a Range Bound market as Price Consolidation, Congestion Phase, or Flat Market.
In simple terms, when a Forex pair is not trending upwards or downwards, it is ranging, meaning that the price is moving sideways within a horizontal channel.
The highest point within the price consolidation is considered a resistance area. Contrary to this, the lower price within the range is considered a support area. These two areas should to be considered as a zone rather than as a fixed horizontal price. The high and the low points of the horizontal channel help us visualize the state of the current range for the currency pair.
These types of Ranges in Forex can appear regularly, however, they tend to occur often during low trading volume periods. Since the volumes are low the bears and the bulls cannot overpower each other, creating a flat price action.
In this blog, we discussed many different forex trading styles and currency trading techniques. Starting with the ultra-short term scalping method to the longer term macroeconomic and carry trading methodologies, along with many other trading styles in between. In addition, we discussed the use of discretionary vs automated trading systems and some of the characteristics of each.
With this knowledge, you should now be able to decide which trading style best suits your personality and couple that with a trade execution style that aligns with your temperament. For example, my trading style in the FX market is focused on a discretionary based swing trading style. This is what works best for me and I stick with that. Now it’s your turn to explore the different options available to you and decide the best combination for you.
Developing and applying a Forex strategy with a distinct edge plays a crucial role in the success of a trader. Therefore, it is essential to learn and test different currency trading techniques so that you can get some idea as to what style of trading you are most comfortable with.
Let's discuss a few different types of market strategies which should help you with your own evaluation process.
FX Trading Strategies Explained
In my previous blog 'What Is a Trading Strategy And How To Build One' we covered what is a trading system and how to build one.
At a basic level, a Forex trading strategy represents a set of trading rules within a trading plan that is implemented to generate profit from currency fluctuation.
Since there is no possibility of any FX trade strategy being correct 100% of the time, the primary goal is to enhance the odds in the trader’s favour, and apply the given edge in the market with as much frequency as the market allows.
Forex traders have a wide array of trading tools at their disposal to develop their trading strategies. The tools and techniques used will depend a lot on whether a trader is a technical analyst or fundamental analyst.
For a technical trader for example, some of these tools are price derivatives such as indicators, oscillators, and moving averages. Other type of analysis could be implemented on a naked chart using price action, where traders directly analyse price using tools such as trend lines, channels, chart patterns, candle formations, etc.
Types of Strategies for Forex Trading
There are two primary classes of Forex market analysis – technical analysis and fundamental analysis.
Technical Forex Trading Strategies
Technical trading strategies are based on chart analysis and by examination of previous price fluctuation. Looking at previous price action, traders make an assumption for what the future price action is most likely to do.
When building a technical Forex trading strategy, traders can choose from a multitude of studies, and in fact technical analysis itself has many sub-categories within it that a trader can explore.
Some of the most popular building blocks for a trading strategy include technical indicators such as Moving Averages, MACD, Stochastic, Relative Strength Index, Volume, Bollinger Bands, and Keltner channels to name a few.
Most forex trading platforms have dozens of technical indicators built-in. Some platforms even allow you to create and back test strategies using their built-in indicator library in an easy to use environment based on conditional rules without any programming knowledge required.
Fundamental Forex Strategy
Fundamental analysis relies on economic and geo-political news releases and data to drive the trade decision process. Since every currency represents the economic performance of its respective country, fundamental traders use information about a country’s economic health to determine future price moves of a currency pair.
If a country announces a better-than-expected figure for an important economic report, this may boost the bullish sentiment in the currency, leading to a price increase. If a country announces a worse-than-expected figure for an important economic report, this may trigger the bearish sentiment in the currency, leading to a price decrease.
For example, if the EU Central Bank announces that it will increase the interest rate in the Eurozone, a fundamental trader may believe that this is likely to decrease the price of the Euro versus other major currencies.
Their reasoning could be based on the assumption that an increase in rates is likely to result in less attractive spending conditions in the country (loans are expensive). And a deteriorating spending condition would be reflected in the Euro becoming more devalued.
So, the fundamental trader may contend that if the European Union decreases the Eurozone interest rates, we will most likely see a decrease in the EUR/USD exchange rate – Euro depreciates versus the American Dollar.
This may or may not happen obviously, however, this is an example of how a fundamental analyst would likely arrive at a trading decision, which is a stark difference to how a technical trader approaches the market.
So generally, fundamental traders typically use economic news releases and data to speculate on price moves. If the news release is more optimistic than expectations, a fundamental trader may buy the respective currency on the assumption that it will appreciate.
If the news release is more pessimistic than expectations, then a fundamental trader is likely to sell that respective currency assuming that it will depreciate.
It is important to note that expectations are as important is not more to the news trader than the actual figure, because it is the divergence between what is actually reported and what the prior consensus expectations were that will fuel the price movement.
Technical Traders vs. Fundamental Traders
As we have touched on this far, Forex traders are often divided into two sides based on their analysis approach – technical analysts and fundamental analysts. My style is based on something balanced in between both.
Technical analysts believe that future price moves can be forecasted based on chart analysis techniques. They believe that most available information is already priced into the market.
Many fundamental analysts believe that technical analysis is merely a self-fulfilling prophecy and that the best way to analyse currency movements is thru the study of economic, political, and social conditions of countries – the fundamental data.
The truth is that both technical and fundamental analysis has their merits and drawbacks, and there should be no reason to approach them in a mutually exclusive manner.
Technical traders who rely primarily on their chart would surely benefit from having a basic understanding and knowledge of a country’s fundamentals. At the same time, fundamental analysts can benefit greatly from the use technical methods for better market timing of their fundamentally based market outlook.
Forex Strategy Examples
Now that you are familiar with the two primary types of Forex trading philosophies, we will move on to illustrating three simple strategies that you can add to your toolbox. We will take a look at a few trade examples using price action analysis, technical indicators, and economic news releases.
Forex Trading Strategy Using Chart Patterns
The first strategy we will discuss relies on traditional technical analysis. Pure price action analysis is typically implemented on naked charts that contain no trading indicators or oscillators. Price action traders often use horizontal and diagonal lines to find key support and resistance areas on the chart.
The image above shows three trade setups based on pure price action analysis. The chart we are using is the hourly chart of the EUR/USD.
The first pattern we notice on the chart is a Falling Wedge formation, which we have marked with orange. The price action moves downward as the tops are decreasing with higher intensity than the bottoms. The EUR/USD price gradually reaches the support at $1.0580. Soon after, price breaks the wedge through the upper level and begins to move in a bullish direction.
You could go long at the breakout placing a stop loss order below the lowest point of the Wedge. You would want to hold the trade for a minimum price move equal to the size of the Wedge at its widest part. This is the measured move projection for the falling wedge.
The bullish run propelled the price to the resistance at $1.0715 where the EUR/USD started consolidating again. The range resembles an Ascending Triangle, which we have marked in yellow.
The Ascending Triangle has the potential to push the price towards a move equal to the triangle’s size at its wider part. However, the directional potential of the pattern is unknown. Therefore, you should wait and carefully watch the price action for a breakout through one of the two levels.
In this case, the break is to the downside. Therefore, you could short the EUR/USD pair at the breakout, placing a stop loss order above the upper level of the pattern. Then you would hold the trade for a minimum price move equal to the size of the triangle.
On the way down the price action creates another triangle pattern – Expanding Triangle (blue). Since the triangle is inclined downwards, it has a bullish potential. Therefore, you could position to buy the EUR/USD when the price action breaks the pattern through the upper level, placing a stop loss order below its lowest point. Again, you would want to hold the trade for the price move equal to the size of the pattern measured by its widest part.
FX Strategy Using 2 SMA + Volume
If you prefer a more systematic type of approach, you can develop a strategy based on a combination of technical indicators. Most indicators are mathematical derivatives of price that can be programmed and automated to generate trading signals.
Some indicators are plotted directly on the price chart (Moving Averages, Bollinger Bands, and Parabolic SAR), while others are added to the bottom in a separate field below the chart (MACD, Stochastic, RSI, or Volume Indicator).
The example we will look at now combines three indicators – a 20-period Simple Moving Average, a 50-period Simple Moving Average, and a Volume Indicator. Since the 20-period SMA is faster than the 50-period SMA, we would use that as the trigger SMA. So, we will open trades when the 20 SMA crosses the 50 SMA. If the crossover is to the upside we will go long. Conversely, if the crossover is bearish, we will go short.
We will also add an important filter to weed out low probability trade signals. We will use the Volume indicator as our filter. So, we will only take signals that are created during recent high or increasing trading volumes.
We will place the stop at a relative distance near an important swing to protect our account from an adverse price move. And finally, we will hold the trade until the SMA crosses in the opposite direction.
The example on the chart above takes place on the H1 chart of the GBP/USD Forex pair. The blue curved line you see on the chart is the 20-period Simple Moving Average. The red curved line, which is smoother, is the 50-period SMA.
The chart starts with a bullish SMA crossover where the blue 20 SMA crosses the red 50 SMA in the bullish direction. This happens during a relatively high period of recent trading volumes. We place a stop loss order near a recent swing and at a reasonable distance below the entry point.
Price action initially fails to move in the bullish direction immediately, and price pulls back creating the magenta resistance line you see on the chart. Eventually price does breaks thru the resistance zone and begins to move higher.
A week later the price action starts to decrease and the two SMAs gradually start to converge. Then, the blue 20-period SMA crosses below the red 50-period SMA, which gives us an exit signal.
News Scalping Forex Strategy
The last trading strategy we will take a look at involves a fundamental analysis approach based on a scheduled economic news event.
Every morning you should pull up an economic calendar to find out what important news and events are scheduled for the trading day. This is especially important for news traders who are looking for potential volatility plays that may offer scalping opportunities.
News scalping is not for the faint of heart and timing and execution is of great importance with this type of trading. In addition, you should ensure that bid/ask spreads are not so wide that it would drastically limit the potential profit on the trade. You need to be extremely quick in opening your trades since the market reacts almost instantly. You should place a stop fairly liberally as knee jerk reactions in both directions are often common.
Now let’s take a look at an example of a news release scalp trade.
The example you see above takes place on the 1-minute chart of the EUR/USD chart. We will demonstrate how to scalp for a quick short-term price move resulting from an economic data report.
In this example case, we take the release of the US ADP Nonfarm Employment Change. The figure released is 246K, which is 81K more than the expectation of 165K. This means that the US ADP Nonfarm Employment Change is more optimistic than consensus estimates, and as a result, this is bullish for the Dollar and we should have at least a short term move down for the EURUSD pair.
We instantly short the EUR/USD on the print of this data, again, on the assumption that the US Dollar will increase versus its European counterpart as a result of an immediate reaction to the better than expected US data release. We short the EUR/USD and place a stop loss order at a relative distance from the entry point.
As you can see, the EUR/USD price drops quickly and sharply affected by the optimistic US data release. Keeping in mind that this is a scalp trade, we hold the trade around 5 minutes and then exit the market.
Note that if the data release was worse than expected (pessimistic), you would have bought the EUR/USD on the assumption that the USD will depreciate versus the EUR. In other words: To short the EUR/USD based on economic data release, you either need positive data coming from the United States, or negative data coming from the Eurozone. On the contrary, to buy the EUR/USD based on economic data print, you either need good economic data from the Euro-Zone in relation to expectations or bad data from the United States in relation to expectations.
It works the same way with other currency pairs and the respective economies they represent. This is a rather generalized explanation, but serves to illustrate the thinking and mind-set when trading the news for short term reactions.
There are two primary types of Forex trading approaches:
Technical Analysis – Involves the use of trading tools like indicators, oscillators, candle patterns, chart patterns, trend lines, channels, support, and resistance levels.
Fundamental Analysis – Involves the use of economic indicators and data releases.
You should choose a forex trading strategy that is best suited to your own personality.
You should keep in mind that technical and fundamental analysis are not mutually exclusive approaches. You should combine them into a cohesive trading strategy to gain benefits from both viewpoints.
Three basic trading strategies we discussed are: Chart Pattern Trading: Using price action analysis to spot chart formations. 2 SMA + Volume Indicator: Dual SMA crossover supported by increasing trading volumes. News Scalping: Waiting for impactful news releases to take advantage of short term volatility expansions.
Popular Short Term Trading Strategies
Before allocating any money in the markets, a trader needs to decide on the trading timeframe that they will be focusing on. This should be clearly spelled out within each individual trader’s business plan. There are three primary types of trading time horizons that can be implemented– long term, intermediate term, and short term. Today we will focus on the short-term trading timeframe and strategies.
What is Short Term Forex Trading?
Short term is a relative term. Short term for a position trader could mean weeks. In contrast, short term to a scalper could mean less than a few minutes. In this article, we will define short term Forex trading as day trading, which involves the opening and closing of Forex trades within a 24-hour trading session.
A short-term currency trader typically aims for small to moderate gains but initiates a large amount of trades over a specified period. Many short term traders feel that they can take better advantage of their “Edge” by relying on the large sample size that can be produced by frequent trading. The more trades that the short-term Forex trader implements, the closer he can get to his perceived “Edge” over time.
Let’s take a look at this a bit closer. For example, if your strategy has a 60% win rate, then there is a 40% chance that every trade will be loser. Based on this Win Loss ratio, it would not be unheard of to get four, five, six or more consecutive losing trades. The reason for this is that the distribution of your wins and losses can take many forms within that 60-40 Win Loss profile. Short term traders typically have a large frequency of trades which helps them to counterbalance the effects of these types of multiple losses quicker than longer term traders.
Short Term Trading Time Frames
The most popular short term time frames for Forex trading are M30, M15, and M5 and M1. As a short term trader, you need to make sure that your data provider is giving you real time intraday data and not delayed or end of day data.
The lower the time frame you work with the more granular you can get and the more candles you will see within the daily data. For example, within a day, you will get six 4-hour candles, twenty-four M60 candles, forty-eight M30 candles, ninety-six M15 candles, and two hundred eighty eight M5 candles.
Short Term Forex Traders
As we have defined earlier, a short term Forex trader is one who conducts his trades intraday and closes out their position within a trading session or a 24 hour period. A short term currency trader will typically open multiple trades aiming for relatively small profits from each trade. Successful short term Forex traders have back-tested their trading strategies, either manually or thru computerized back-testing software. The goal of many short-term day traders is to produce a steady monthly income based on the implementation of their strategy in the market.
Best Short Term Trading Strategies
Now that you are familiar with the short term trading concept, we will discuss three trading strategies for implementing trades within this timeframe. We will use smaller time frame charts to illustrate the approaches and the trades will be discussed at the intraday level to demonstrate the full short term trading experience.
Short Term Support and Resistance Trading
Support and resistance trading is one of the best ways to approach the Forex market in the short term. The idea behind this technical approach is to look for important levels on the chart and to trade a breakout from the levels. If the price action breaks a support level downwards, you should open a short trade. If the price breaks a resistance level upwards, then you should engage in the market with a long trade.
The risk management rules of this trading strategy are very easy and straightforward. Simply put a stop loss order beyond the level, which you are trading. For example, if you trade long after a resistance breakout, you should place a stop order below that resistance level. If you are trading short after a support breakout, you should put a stop above that support area.
You should use price action rules to determine your optimal exit from the trade. With a short term trading approach, you want to get out of the trade quickly, and make sure you are not turning your short term trade into some sort of longer term position.
This may seem obvious, but it is a very important concept to understand. Sometimes knowingly or unknowingly, short term traders let their position get out of control, usually when they are losing. And when this happens a trade that was supposed to be limited to a daily session, has now turned into a big losing trade which the “short-term” trader is still holding after a week or longer. So, know the timeframe you are trading and make certain you are placing your stop loss and take profit within your intended trading timeframe.
We are looking at the M5 chart of the EUR/USD. The image suggests a trade taken based on a daily support breakout.
The support level is located at 1.0620, and it has been tested three times. Each of the three tests is noted with the respective black arrow on the chart. On the last attempt, when the price action interacts with the 1.0620 support, we see a strong bearish bar, which indicates a bearish breakout.
This is a short-term signal to sell the EUR/USD based on a breakout in the daily support level. If you decided to trade this opportunity, you would need to protect your trade with a stop loss order. The proper place for your stop would be a bit beyond the broken support. The red horizontal line on the chart suggests an appropriate location for the stop loss order.
The EUR/USD price drops afterward. In this case, we can use a fixed target on the chart. Notice the two tops above the daily support level. These tops are located at approximately the same level. Therefore, we can use the distance between the daily support and the level of the two tops to apply a reasonable scope for the potential price decrease. The two blue arrows show how we measure that distance and then apply it starting from the broken support line.
You should close your trade when you see the price action reach this level. Notice upon reaching this level, a reversal appears shortly afterward.
Short Term Trend Trading
The next strategy we will discuss for the short term horizon is trend trading. This strategy involves catching intraday trends and riding them until exhaustion. In addition to this, when an intraday trend gets interrupted, you can consider opening a trade in the direction of the new breakout.
The rules of this short-term trend trading strategy are simple. If you see a Forex pair bounce from the same trend line for the third time, then we will assume that a trend is likely emerging and look to trade the pair in the direction of the emerging trend impulse.
This trend line trading approach requires the usage of a stop loss order for protecting your trade. Your stop should be located beyond the third bounce swing, which you use to open the trade. Then as the price moves in the intended direction of your trade, you can manually adjust the stop loss order, so that it will be tight under the trend line. You should hold your trade until the price action breaks the trend line.
When the breakout appears, you should close the trade. This will create another opportunity on the price chart, which is in the direction contrary to your previous trade. Now you can trade the market in the direction of the breakout. There are some additional details and rules that should be followed when you trade trend breakouts. Firstly, when the price breaks the trend line, you should first wait for a pullback. Then you can enter the trade when the price action breaks the swing created after the trend breakout.
This time the stop loss order should be located in the middle of the distance between the top of the trend and the first bottom outside the trend. At the same time, you should hold your trade for a minimum price move equal to half the trend size.
On the chart above, we are analysing the 1-minute USD/JPY Forex pair. The image on the left side of the chart shows a bullish trend emerging in the pair.
The trend is marked with the yellow bullish line on the chart. The two black arrows you see at the beginning of the chart mark the two bottoms we use to build the trend line. The green arrow marks the third bounce, which is a short term signal in the bullish direction. We need to place a stop loss order right below the swing bottom created as shown on the image.
As you can see, the price shoots up quickly afterward. There are four more bullish impulses on the way up. The last three of these impulses are relatively big, compared to the initial trending legs. You can adjust your stop loss upwards so that it will always be tight below the trend.
You would want to close the trade at the moment when the price action breaks the trend line downwards. This is shown in the red circle on the trend line.
See that after breaking the trend line the price creates a bottom, marked with the black horizontal line. This level should be used to short the USD/JPY if the price breaks it downward. If the price moves below this first bottom, then this is a strong reversal indication. Note that the price action creates one more test of the black horizontal level before breaking it.
After the breakout through the first bottom outside the trend, you have the opportunity to short the USD/JPY on the assumption that the trend is reversing. At the same time, you should place a stop loss order right in the middle of the distance between the top of the trend and the black line indicating the first bottom outside the trend.
Then you could hold the trade for a minimum price move equal to half the size of the previous bullish trend. The size of the trend is marked with the long blue arrow. The smaller blue arrow measures half of the trend. You should close your trade at the moment when the price action reaches the distance equal to half the size of the trend.
Short Term Trading with Candle Patterns
This is another trading strategy which is commonly used by short term Forex traders. This strategy involves scalping the market using candle patterns. The chart timeframe we will be focusing on are the M1, M5 and M15.
For this strategy, you would be looking for reversal candle patterns on the chart, and enter in the direction indicated by the specific candle pattern. Your short term candle pattern signal comes when the price breaks through the level marking the tip of the candle pattern.
You should protect each of your candle scalp trades with a stop loss order. A good place for your stop would be the level at the opposite side of the candle pattern you are trading, including the candlewicks.
After you enter the market on a reversal candle pattern, you should hold the trade for a minimum price move equal to the size of the candle pattern. This means that you should be taking the distance between the candle’s low at the lower candlewick and its high at the upper candlewick.
Above you will see an example of how to scalp a candle pattern. This is the M5 chart of the EUR/USD, and the pattern we are looking at is an Inverted Hammer.
You could buy the EUR/USD pair when the price action breaks the upper level of the Inverted Hammer candle. Then you would place a stop loss order below the lower candlewick of the candle as shown on the image.
The blue arrows measure and apply the size of the Inverted Hammer. Your target is located at the top of the upper blue arrow. You would close the trade when the EUR/USD reaches this level. This is a quick strategy to setup. Speed is of essence when trading short term patterns like these.
Now let’s analyse another candle pattern example:
This time we are viewing the 5-minute chart of the GBP/USD. The candle pattern we demonstrate is the bullish Harami, located in the black rectangle on the chart.
You could buy the GBP/USD pair when the price action breaks the upper level of the bullish Harami. This is an indication that the previous bearish price action is likely to reverse. You would place a stop loss below the pattern as shown on the image. This way your trade will be protected in case the price moves against you. You would look to hold the trade for a minimum price move equal to the total size of the bullish Harami. The target is measured and applied with the blue arrows on the image. Whenever the price action reaches the distance equal to the size of the Harami, you would exit the trade. This bullish Harami trade setup lasted for about 40 minutes.
Short term Forex trading typically involves trading strategies, which are open and closed on the same trading day.
Short term traders aim for relatively small gains but have a large frequency of trades.
Short term trades are taken on smaller time frame charts such as M30, M15, M5, and M1.Scalp trading is ultra-short term and involves trades that can last just minutes.
Three popular short term Forex trading strategies are:
Short Term Support and Resistance Trading: You aim to trade breakouts from key levels. You would open your trade in the direction of the breakout placing a stop beyond the key level. You should use price action rules to determine your exit point on the chart.
Short Term Trend Trading: You try to hop into emerging trends. One way is by using a trend line tool and placing a stop below the trend line. You would trail the stop as the price moves in your direction. You stay in the trade until the price breaks the trend. You can also trade the trend breakout. For the trend breakout, you would aim for a price move equal to half the prior trend move.
Short Term Candle Pattern Trading: You would scan the chart for reversal candle patterns on small time frames (M15, M5, and M1). When you find a reversal candle pattern, you open a trade after the price breaks its high/low level in the expected direction. You put a stop at the opposite side of the pattern and hold the trade until the size of the candle is completed as a distance starting from the moment of the breakout.