In recent times there has been a huge increase in the number of people trading currencies or forex as it is more commonly known. Most of those taking up this venture have turned to day trading as opposed to position trading or swing trading as their chosen approach. As a longer term trader myself, I am at a loss as to why so many choose to day trade when it is highly inefficient and ultimately costs a lot more in both time (sat in front of a pc all day) and money (commissions or cost of the spread). I can though easily see why the retail providers of forex trading facilities prefer day traders to any other type of trader and that is because it is much more profitable for them. As such they will market their services in such a way as to encourage potential clients to choose day trading over any other type of trading. The key reason given by those who advocate day trading is that the level of risk is much less than if you hold positions overnight. However, the evidence for this is seriously lacking. Whilst it is true that at the end of every day you have no positions open, it does not mean that you will incur less losses as a result of trading than someone who does hold positions overnight. You may well ask why this is the case and to answer this we will look at the key differences between day trading and holding positions on a longer timeframe:
The smaller the timeframe the more random the movement and noise
Most traders use some form of technical analysis (TA) as a basis upon which to determine when to enter and exit a trade. TA generally works much better on a longer timeframe than a shorter one. For example, a market may be trending on an End-Of-Day (EOD) timeframe but during the day could easily be whipsawing around and often directionless. Most people who day trade will be looking for some form of support or resistance points to enter and exit a trade but these are rarely honoured consistently on an intra-day basis during market noise. It is only at the end of the day when price has closed that the true picture of what the longer term situation is can be known. This makes sense because there is more information in a higher timeframe candle or bar than that of a lower timeframe such as 1 minute, 5 minute or even hourly.
Market manipulation is easier on a short term basis
Larger market participants have the ability to buck a market but only on a short term basis as it would take enormous resources to do so on any longer timeframe. As such you may have observed price action reaching a point in your analysis that gives the set up for an entry. However, it can and often does easily coincide with an attempt by a large market participant to deliberately move the market in a direction opposite to that given by a technical set up. This happens more often than many would imagine and creates another completely unknowable obstacle to achieving trading success during the day. This is not the case for those taking longer term positions because no market participant can change the overall longer term market dynamic. This is not to say that markets do not whipsaw or move between key support and resistant levels on a longer timeframe but they are much more easily observed and traded.
Commission costs relative to profit are much higher
By its very nature, day trading requires placing several trades during any given day. When I used to day trade I would often place between 5 and 15 trades during a day. As I used direct market access (DMA) then my commissions were as cost effective as they could be but they still added up relative to the profit per trade that I was making. If you use a spread betting firm or bucket shop the spread equivalent costs per trade are even greater. As an example, if you were to trade the GBP/USD with a spread of only 2 pips and make say 5 trades during a day at $10 per pip then you are paying at least $100 in equivalent commission costs. To cover just the cost you would have to have a market move of at least 10 pips on one trade with all others being breakeven. To make a significant profit would require a much greater move which on an intra-day basis is not as easy as many think. The opposite is true for positions held on an overnight basis because it is normal to only have placed a single trade and the target profit is much greater than any move during the day.
Currency trading is less likely to be affected by overnight news
One of the main cases for not trading overnight positions is that unexpected news can cause a large move in the market. Whilst this is true for those who trade other instruments such as stocks, futures or the indices it is not the case for currencies. The key reason is that news which has the greatest effect on currency valuations is “economic” and almost all times when economic news is due is known in advance. For example, it is well known that the US releases the results for the Non Farm Payroll (NFP) on the first Friday of a new calendar month and that this is released at 8.30am EST Now a move in the USD against other currencies will usually happen if the result has deviated from that which is predicted. However, this is a short term move and the currency will most likely return to its longer term pattern whether that is trending, whipsawing or moving between support and resistance. But if there was some other unexpected positive news that caused the Dow to jump up suddenly (maybe a cure for cancer is announced) there is much less reason why the USD would jump as well at the same time as the benefit would be international and not nation specific.
In part two I will be covering more reasons why day trading is not more risky than swing and position trading as well as other benefits for those traders who have opted for longer term trading approaches.