Forex day trading is one of the most popular ways of trading in financial markets that involves buying and selling a financial asset within a single day. Newbie traders often consider day trading an opportunity to make quick profits. However, more than 90% of day traders lose money simply because they ignore the risks of day trading.
Generally, day traders focus on short-term price movements, targeting small profits through frequent tradings. It is an idea to add all the small profits made from several entries and build a significant gain at the end of the day or week.
Day trading can only be profitable in the long run if you know how to manage the risks and handle the pressure of high-frequency trading.
This article aims not to discourage day trading but to let you know the common obstacles to overcome while being on the mission of becoming a successful day trader.
This guide explains how day trading works and the risk management strategy to follow for protecting the trading capital.
Does day trading work?
Day trading mainly works for experienced traders who are well versed in their trading principles and stick to a solid risk management strategy.
Since the financial markets are so dynamic, the price keeps forming short- and long-term trends based on the balance between supply and demand. Day traders weigh more on the short-term price movement since it suits their day-in and day-out trading strategy.
They stick to the current market momentum and target buying at low or selling at high prices. Once an entry has been made, a day trader targets an exit before the day closes, whether it makes a profit or loss.
Let’s have a look at an example of day trading:
It is a 15-minute EURUSD chart where the price was in a bullish move from the very beginning of the day open. The trendline across the chart works as a support line following the overall uptrend market. The strategy is to wait for a pullback near the trendline support and enter long, targeting an exit at a higher price.
Once the price returns near the trendline, it plotted multiple bullish pin bars rejecting the support line, indicating a further bullish move within the current uptrend. The buy setup formed during the mid-London session, suggesting a possible long-entry at this point will get enough time to move forward before the day closes.
So, we trigger a buy order at the break of the respective pin bar’s high, with a 15-pips stop-loss limit below the trendline support. Later, the price rejoins the current uptrend and hits a 30 Pips profit 6 hours before the day closes. According to the day trading strategy, it is a perfect long opportunity that brings a 2R profit (compared to the SL) within the same trading day.
Like the above example, professional day traders assess the current trend, level, and price-action signals before deciding on an entry. They stick to a highly probable trading strategy that helps them win more and lose less, making the day trading work for them.
Day trading risk management
Risk management is a strategy that safeguards the trading capital. It helps you determine your risk budget for each trade compared to your total investment.
Market experts recommend the “1% risk rule” as the best risk management strategy for beginners. According to this rule, you’ll only risk 1% of your entire capital for each trade. For instance, if you have a $15,000 trading account, you can only risk $150 per trade.
Limiting the risk in such a way makes sure you are not losing more than 1% on a single trade during unfavorable market conditions.
Maintaining a specific profit target for each trade is a part of the risk management for day trading. Professional day traders suggest a target of 1.5% to 2% profit per trade. When your risk budget is 1%, your risk-to-reward ratio (RR) becomes 1:2. If you day trade within a 1:2 RR, you’ll remain profitable even if you lose 60% of your trades.
For example, your trading capital is $10,000. Based on the 1% risk and 2% profit rule, your loss budget is $100, and the profit target should be $200 per trade. Suppose you win four times and lose six times out of ten trades. Hence, your loss from the six losing trades is $600 ($100 X 6). On the other hand, your profit from the four winning trades is $800 ($200 X 4). That means you are still in a $200 profit even after losing 60% of your trades.
The above example shows how the 1:2 RR strategy protects your account while losing more trades than winning. However, you might not expect only a $200 profit after executing ten trades with a $10,000 account.
There are no guaranteed day trading strategies that work 100% of the time. Although, as a day trader, you always need to focus on improving your winning rate, ensuring a steady growth of the trading capital.
What are the risks of day trading
High market volatility works as a two-edged sword. It may go in your favor, helping your trade to reach the profit target. Contrarily, it can cause a significant loss. Generally, day traders use a tight loss budget which puts them at risk of hitting the stop-loss during large price spikes.
On the other hand, long-term traders apply a wider SL that helps them survive during random changes in market sentiments. So, while anticipating day trading opportunities, it is essential to closely examine the price formation and filter solid signals before deciding on an entry.
Since day traders aim for short-term trading opportunities, they usually stick to 1-minute to 4-hour charts. Such short timeframes usually generate frequent trade signals that may tempt to fall for greed and overtrade. Making excessive trade entries simultaneously damages the trading quality and inevitably puts you in a vulnerable position.
The best way to avoid the over-trading trap is to strictly follow the “1% risk” rule. It will help you stick to your loss budget per trade and avoid being carried away by low-quality signals. Professional day traders only target 1 to 2 successful trades per day. They focus more on higher winning rates and high-quality decision-making than trade quantities.
Missing out on large profit opportunities
Day traders do not wait to see what happens tomorrow. They exit all the holding positions before the day closes. However, a trade you’ve previously entered may keep going in your favor for the next 2 to 3 days, offering bigger profits. Missing out on such opportunities may increase your frustration and anxiety over day trading unless you learn to trade without emotion.
High trading cost and commission
Frequent trading involves a higher trading cost due to spreads and commissions. Some brokers do not charge trading commissions but usually apply larger spreads. If you use higher leverage, the cost increases further due to the interest incurred with the leveraged funds. So, before beginning to day trade, closely review your broker’s trading fee structures and plan your trades accordingly.
So, now you’ve learned how day trading works and the common risks involving this exciting trading style. If you are a novice day trader, make sure you follow proven day trading strategies that work. Many traders get tempted by day trading robots, thinking of generating profits automatically. However, such software may not work in all market conditions and cause extensive losses.
Also, consider an ideal risk management strategy that minimizes your day trading risks. Consider starting with a demo account and keep trading until you develop a day trading strategy that works and meets your expectations.
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