Trading in the foreign exchange, or FOREX, markets is a high risk, high-return form of investing. You can, however, take steps to reduce risks somewhat. One popular way is to do only day-trading, in which you never hold a FOREX position overnight. In this article, we’ll explore this and other techniques you can employ to help lower your risk profile when trading FOREX.
By definition, FOREX day traders have a very small time horizon for holding a trade: one day or less. This level of trading nimbleness requires access to real-time information and online trading software. Day trading techniques depend on technical analysis: predicting future prices by studying prior price and volume data. A FOREX day trader uses technical signals to trigger quick trade entry and exit.
FOREX day traders use real-time price/volume charts to investigate previous price patterns for specific currency pairs. Most trading software provides chart support. Using charts, traders identify price trends, entry and exit prices, and statistical data such as moving averages. Specialized charts, such as candlesticks, help traders identify large amounts of data efficiently. Experienced day traders can quickly scan charts to discover critical price points for trading.
A trigger is some event that signals a day trader to enter or exit a position. Successful day trading techniques require the proper interpretation and management of triggers. Two basic types of triggers involve price trends and momentum. A FOREX robot is a trading system that automatically places trades based on trader-supplied trend and momentum triggers.
An uptrend is recognized by higher high and higher low prices within a specified contiguous time period; downtrends are the mirror image. A trend is broken when the current price moves below a previous low for an uptrend or above a previous high for a downtrend. Traders use trends and trend breaks in sophisticated algorithms that signal when to open or close positions.
Momentum is measured by price differences over two time periods; these price differences are often “smoothed out” via exponential moving averages (EMAs). In a time-series moving average, the oldest price is removed each day as the newest one is added to the average. EMA’s weight each day’s price by its age, so that older prices carry less weight. The number of days included in the moving average determines how responsive the average is to change. Momentum traders look for signals that compare current prices to various moving averages.
Day traders must react quickly when events turn against them. Therefore, a standard day-trading technique is to always enter a stop-loss order on any open position. A stop-loss basically closes a position if it loses a predetermined amount of money. A trailing stop-loss works on a percentage basis and can rise with current prices. For instance, a ten-percent trailing stop will trigger if the price of your currency pair declines by ten percent. If however your position first gains five percent, the trailing stop-loss will be reset five percent higher. This way, traders can “ride” their winning positions and maintain downside protection.
Learn and Practice
Do not attempt FOREX trading until you are very comfortable with all the jargon and have a feel for how currency prices move. The best way to practice and hone your skills is to open a demonstration account with a FOREX broker, which is an account that only simulates the trades you enter – no money is actually spent. Keep track of your results and only go live when your strategy provides consistent winnings. If you don’t know the amount at risk, don’t trade!