What is Day trading?
Forex trading is the act of buying or selling one currency in exchange for another with the aim of benefiting from the differential in value between both currencies within a given period of time. This means that for a forex trade to be valid,
- Two currencies must be involved in the trade. This is why the spot forex market quotes currencies in pairs e.g. EUR/USD, GBP/JPY, etc.
- Some period of time must elapse in order to allow for a reasonable value differential between both currencies in the trade.
Day trading is a style of financial trading in which the trader involved opens and closes a spot forex position within the same trading day. The forex market is typically a 24/5 market, with the market opening as from 9pm GMT on Sunday night to 9pm GMT on Friday night. However, a trading day in forex starts at 9pm GMT on one day and ends at 9pm GMT the following day, giving a 24-hour cycle. The fast paced nature of the forex market means that it is possible to open a position and close the same position within a trading day. This is possible as a result of the following factors:
- The forex market is a highly leveraged market. Therefore, even though currency moves are relatively inconsequential (1/1000th of a percentage point is the unit of currency movement), tiny moves can be multiplied using leverage to produce reasonable profits in addition to reasonable losses.
- Certain fundamental influences such as economic news calendar events, can cause a dramatic shift in market bias for one currency over another currency in a pairing, producing an opportunity to make money in minutes or a few hours.
It is possible for a day trading deal to last longer than one day. When this happens, the deal is automatically renewed at 22:00 GMT each night until the deal closes. Upon renewal you will be charged a fee for rolling the deal for an extra 24 hours. This fee will be collected once a day when the deal is renewed. The fee will be collected form your Free Balance in your trading account, and if there is no sufficient free balance then your credit card will be debited. If there is no credit card, the next time you have a free balance and execute a withdrawal from your account, the amount owed due to non-payments of the rolling fee will be deducted from the amount you have withdrawn.
Day trading is typically carried out by traders who do not have the tens or hundreds of thousands of dollars that many professional traders on ECN platforms have. The majority of traders in the retail end of the market will only have a few hundred or a few thousand dollars available to them. These traders will therefore not want to subject their accounts to payment of the swap fees or commissions that are incurred for leaving long positions on lower interest currencies overnight. So opening and closing trades with profits within the same trading day may be the way to go for this category of traders.
“Buying or selling one currency in exchange for another with the aim of benefiting from the differential…”
Advantages of Day Trading
Day trading has several advantages.
- A successful day trader may see profits compounded within a very short time.
- Day trading ensures that capital is not unduly tied up in trades. Some trades take several weeks to deliver on their profit potential. In this time period, a day trader may open and close positions on several trades, and potentially achieve returns that could surpass those of position trades. The emphasis here is on the word “potential”, as day trading does not automatically make a trader profitable. The necessary work still has to be put in by the trader to ensure profitable trades.
- Day traders who open long positions in low-interest yielding currencies such as the US Dollar or Japanese Yen, may consider avoiding paying the rollover or swap rates associated with leaving positions overnight.
Disadvantages of Day Trading
Day trading also has some disadvantages.
- Day traders basically have to rely on intraday action to make their decisions. Some of this intraday action in the markets has been likened to “market noise”, which does not always give clear direction and can lead to errors in judgement.
- Day traders cannot participate in the carry trade, which involves aiming to profit from interest paid on long positions that have been taken on high-yielding currencies that have been left overnight for a significant period of time.
- As an extension of point (b) above, earnings from swap rates paid to traders on overnight long positions on high-yielding currencies are missed.
- Day trading has also been criticized as being too speculative in nature.
Many retail forex trading platforms allow their traders to carry out day trading, and it is a trading style worth exploring for those who prefer to see the results of their forex trading activity in one day. Find out more about forex trading.
Day trading is becoming more popular now that more people use the Internet. It is one of the Forex instruments (or products) offered by easyMarkets.
Be sure to also read Leveraged Trading after this article.
Day trading on the easyMarkets® platform.
A day trading deal involves four main steps:
- Decide to perform a Forex deal
- Decide the deal you want to make and build it in your online account
- Monitor the deal in your account
- Close the deal
Here is an example using the four steps in detail:
Step 1: You decide to perform a Forex deal.
You believe AUD will fall in value because you have followed the market and you think a fall is most possible in the near future. You decide to sell AUD before the fall and buy after the fall. This way you will make a profit if indeed AUD falls.
Step 2: Decide the deal you want to make
You choose the currency pair to trade. You choose to trade AUD/USD, which means you buy or sell AUD against the USD. Once the AUD falls to the level you expect, you close the deal. You then get more AUD for the amount of USD you bought.
Here is an example, putting aside the spread issue: assuming the rate for AUD/USD is 0.7317. This would mean 1 AUD costs 0.7317 USD. It also means you receive 0.7317 USD if you sell 1 AUD. If AUD weakens (i.e. the rate decreases), and falls to 0.7263, you will pay 0.7263 USD to buy one AUD (AUD is now worth less), so buying back the AUD at 0.7263 in exchange for USD again will get you 0.7263 USD at a profit of 0.054 AUD. In this example, assuming you sold 5,000 USD, you have made 50 AUD profit. Sellin 5,000 USD only requires 50 AUD security deposit if you are using a 1:100 leverage. So in this hypothetical case, by investing 50 AUD you made 50 AUD profit. However, if the AUD would have increased to 0.7371, you would have lost your 50 AUD security deposit.
In real life however, the market maker is charging a spread, which is the difference between the bid and ask price at any given moment. However, the idea is that the change in the exchange rate exceeds the value of the spread (typically 2-3 pips) which still enables a profit to the investor.
Next you decide the amount you want to trade. You do not have to buy the whole amount because you can use leveraged trading. The most common leverage is 1:100.
Then you choose how much you want to risk. This is your investment.
You can set the Stop-Loss rate next. This is the rate at which your deal will automatically close if it goes against what you expect. While your deal is still open, you can change this rate at any time. At easyMarkets we require you to set a Stop-Loss rate to ensure you do not lose more than you are what you are willing to lose.
Step 3: Monitor your account
Logging into your online account at easyMarkets, you can look at how your account is progressing 24 hours a day, seven days a week. This gives you the chance to open and close deals or to change your deal whenever you want.
Step 4: Close the deal
You can choose to close the deal when you decide. If you have set a Stop-Loss rate and the deal reaches that rate, it automatically closes. Some traders find Stop-Loss rates a good way to make sure they do not lose more than the limit they set. The deal can also close automatically if you set a Take Profit rate. You are not required to set a Take Profit rate but it does mean that you are freed from constantly monitoring your positions.