There are many reasons why people want to trade in the forex market. And one of the major reasons is that it requires the least amount of capital to start day trading. Forex trading offers the flexibility of trading times as it is open to trade 24 hours a day during the week and has a lot of profit potential with brokers providing leverage to trade.
Forex trading is volatile in nature which is one of the reasons that one can make huge profits or lose a similar amount. And if you are not an experienced trader, then there is a very good chance of losing substantial sums.
Understand the Risk you are willing to take before Profits
To start forex trading, you must understand the risk you are willing to take. This means how much are you willing to lose on your trading account. Based on this you can define how much you can risk per trade. So you must keep your risk on each trade as small as possible, like 1% of total account value or even less.
Let’s suppose you have a $1,000 account, you shouldn’t lose more than $10 on a single trade. This may seem small, but a losing streak can make it 50$-100$ if you lose 5 or 10 trades in a row. Even if you have the best day-trading strategy there will be strings of losses.
Forex Day Trading Strategy
What is Forex day Trading Strategy? Forex Day trading means when you don’t hold a trade overnight. You look for trade opportunities during trading hours and hold a trade for few hours. Based on the market movement you close the trade with a profit or loss within the same day.
A trading strategy can potentially have many components and can analyze for profitability in many ways based on complexity and variables considered to enter or exit a trade.
Following are a few factors to consider when making a trading strategy.
- Win Rate
- Risk/Reward
- Leverage
- Consecutive Wins
- Drawdown
Importance of Win Rate in Forex Day Trading
Your win rate reflects the number of winning out of total trades. But, if you win 60 out of 100 trades; that means your win rate would be 60%. A win rate above 50% is ideal for most of the day traders. Even 60% is attainable. With a 50% win rate, you can be profitable if your strategy has a good risk-reward ratio.
Risk/Reward Ratio
Risk/reward defines how much capital you are risking for a certain profit. Suppose a trader loses 20 pips/points on losing trades but makes 30 on winning trades, he is making more on the winning trades than he is losing on losing trades. This means one can still make profits even if he is right only half of the trades.
Therefore, a good trading strategy must have a higher reward and lower risk ratio. Traders who can successfully trade and strive the Forex Trading always have a higher reward and lower risk trading strategy.
A higher win rate for trades means more flexibility with your risk/reward, and a high risk/reward means that your win rate can be lower, and you’d still be profitable.
Sample Trading Account
Account Balance: $ 10,000
Win Rate: 60%
Risk per Trade: 1%
Stop Loss: 10 Pips
Target Profit: 15 Pips
Risk/Reward Ratio: 1.5
Average Daily Trades: 5
Average Monthly Trades: 100
Forex Trading Profit Per Day = Winning pips – Losing Pips = 45 – 20 = 25 Pips
Forex Trading Profit Per Month = 500 Pips or $ 5,000
The trader has $10,000 capital and a very good win rate of 60% on trades. He risked only 1% of the total capital of $100 per trade. 1% risk is controlled by using a stop-loss, where trade is automatically closed if loss reaches 1% of capital. In our example, a stop-loss is placed 10 pips away from the entry price, with a target profit 15 pips away. Here the reward is 1.5 times the amount risked for each trade. The risk/reward ratio is calculated by diving the target profit pips (15) by stop-loss pips(10) divided by 5 pips). Here the thumb rule is to have winning trades bigger than losing trades.
On an average trading day during active trading hours, it’s easily possible to make around five trades using the above sample values. On average there are 20 trading days in a month, and the trader is making 100 trades. With 60% win rates he will be making around 5,000$ per month or 250$ daily if he trades 5 times in a day.
Brokers & Trading Leverage
Forex brokers offer leverage up to 500 to 1 on major currency pairs. Let’s say the trader is using 200 to 1 leverage, and this is more than enough leverage for forex day traders. As the trader has $ 10,000 capital in his trading account, and he has a leverage of 200, which means the trader can take positions worth up to $ 2,000,000. While risk is still limited to the capital available in trading account i.e $10,000. This way trader’s risk is limited to only a small portion of the deposited capital.
Most forex brokers don’t charge any commission for trading, but they have spread between buy or sell sides of the trade. Spread is the difference between the bid and ask, and this makes it somewhat difficult for day traders to profit from day trading. There is another type of brokerage where brokers only charge a commission to open and close a trade. These are usually referred to as ECN brokers. They offer a very small to 0 spread, making it easier to trade profitably. And commissions are approx $5 for $100,000 trade.
Forex Day Trading Currency Pairs
If you’re day trading a currency pair like the USD/CAD, you can risk $50 on each trade, and each pip of movement is worth $10 with a standard lot (100,000 units worth of currency).5 Therefore, you can take a position of one standard lot with a 5-pip stop-loss order, which will keep the risk of loss to $50 on the trade. That also means that a winning trade is worth $80 (8 pips x $10).
This Cal shows how much a forex day trader could make in a month by executing 100 trades:
55 trades were profitable: 55 x $80 = $4,400
45 trades were losers: 45 x ($50) = ($2,250)
Gross profit is $4,400 – $2,250 = $2,150 if no commissions (win rate would likely be lower though)
Net profit is $2,150 – $500 = $1, 650 if using a commission broker (win rate would likely be higher though)
Assuming a net profit of $1,650, the return on the account for the month is 33% ($1,650 divided by $5,000). That may seem very high, and it is a very good return. See below for more on how this return may be affected.
Slippage Larger Than Expected Loss
It won’t always be possible to find five good day trades each day, especially when the market is moving very slowly for extended periods.
Slippage is an inevitable part of trading. It results in a larger loss than expected, even when using a stop-loss order. It’s common in very rapidly moving markets.
To account for slippage in the calculation of your potential profit, reduce the net profit by 10%. (This is a high estimate for slippage, assuming you avoid holding through major economic data releases.) That would reduce the net profit potential generated by your $5,000 trading capital to $1,485 per month.
You can adjust the scenario above based on your typical stop-loss and target, capital, slippage, win rate, position size, and commission parameters.