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.
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.