An FX Day Trading Strategy That Actually Delivers

Learn an effective day trading strategy that combines both Fundamental and Technical Analysis.
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Finding a day trading strategy that works can be challenging. Especially with the thousands of different ones available on the internet.

Many traders don’t know where to begin to find a strategy that will work for them. However, most retail traders only focus on the Technical aspect of trading.

With so many Technical indicators and tools, it leaves many traders confused. Which ones should they use, and which ones should they discard?

This confusion often causes a never-ending spiral of back-testing various indicators and robots. Luckily, we have some good news for you today.

Traders can solve a lot of these issues by incorporating Fundamental Analysis. The Fundamentals give us the underlying reasons for the moves in the market.

A lot of simple Technical strategies can work successfully. This is especially true if you know which way the market should be moving.

This is where a knowledge of the Fundamentals can help you.

Including this simple step in your trading can remove much uncertainty. It also gives the freedom to trade with a less complicated Technical approach.

The best trading strategies are the ones that include both Technical and Fundamental Analysis.

In this article, we will discuss what steps to include in a Day Trading strategy:

  • How to find high probability currency pairs to trade
  • Market Sentiment
  • Intermarket Analysis
  • Economic Indicators
  • Determining the sustainability of a trade
  • How to find high probability areas on the charts
  • Putting it all together

How To Find High Probability Currency Pairs To Trade

Your number one aim in day trading should be to pair a weak currency against a strong currency. That is the first and most important step.

Even if you take a bad entry position, the right direction can still give you a winning trade.

The first step in a day trading strategy should be to find a fundamental driver for the markets to move. Find a reason to enter a trade.

It should be about more than an indicator showing you to sell. It’s also about more than just the longer-term fundamental bias for the currencies.

Remember, this is a day trading strategy. Which means we are looking for intraday influences on the currency pair.

Fundamental drivers don’t have to be things that are valid over weeks or months. It might be important events occurring on a specific day that can affect a currency’s strength.

Now, there are three essential factors to consider when finding high probability pairs. These three factors are Market Sentiment, Intermarket Analysis and Economic Indicators.

We will spend some time looking at these three factors individually.

Market Sentiment

According to Wikipedia, Market Sentiment is the general mood or attitude ofinvestors. It’s the way the market feels.

That might sound strange at first. But remember that the market consists of thousands of traders.

All these traders are driven by emotions like fear and greed on a daily basis.

Price movements reflect the way the market feels about a particular financial instrument. It can provide us with a significant edge in our trading if we know what to look for.

The important thing about mood is that it can change very quickly. Market sentiment can change very rapidly or last for months at a time.

It depends on what the markets are focusing on at any given time. It’s important to know that sentiment can be different from longer-term fundamentals.

For example, we might have a bullish long-term bias on a specific currency. However, events in the market might create attractive selling opportunities on that currency.

In Day Trading, many different catalysts can alter short-term sentiment. It can be anything and everything that causes a change of mood in the markets.

Some examples of popular catalysts are:

  • Economic Data releases
  • Central Bank Monetary Policy decisions and announcements
  • Geopolitics
  • Changes in other asset classes
  • Natural Disasters

These are just a few examples. A big factor in the impact these catalysts will have is in their uncertainty.

Uncertainty can be a big driver in the markets. When unexpected things happen, we often see corresponding moves in the price.

In contrast, muted reactions are common when things occur that everyone is expecting. The reaction might be muted with an interest rate hike if everybody expects it to happen.

As a result, the market might trade in the opposite direction the moment the event occurs. This type of reaction is called ‘buy the rumour, sell the fact’.

However, when something happens when no one was expecting it, the reaction can be massive.

The easiest way to tap into the mood and expectations of the market is with a Forex News service. Some examples of this are ForexSource, RanSquawk, ForexLive, Bloomberg and Reuters.

These tools help us to stay up to date with all the current events that are affecting sentiment.

Intermarket Analysis

The next factor to consider is Intermarket Analysis.

What is Intermarket Analysis? According to Investopedia, it’s the study of how moves in certain asset classes can affect other related markets.

Forex is not the only asset class in the financial markets. The three most important asset classes which can impact the Forex market is:

  • Fixed Income (Bonds)
  • Equities (The Stock Market)
  • Commodities

Big moves in any of these three can have a massive impact on the Forex Market.

1. Fixed Income (Bonds)

The Bond market and currencies are both profoundly affected by interest rates. Both currencies and bond yields appreciate and depreciate as interest rate expectations change.

In the example below, we can see this in the correlation between the Dollar and US 10-year treasury yields.

So, how can this be useful for me as a Day Trader?

Moves in bond yields can cause corresponding short-term movements in the respective currency.

Thus, traders should watch out for big moves in government bond yields. This can provide a possible catalyst for expecting strength in the corresponding currency.

It’s important to note that rising bond yields are not always positive for a currency. Countries that have a higher chance of defaulting on debt need to pay higher yields.

If they don’t offer higher yields, investors won’t buy their riskier bonds. Thus, when a country goes through economic turmoil, their bond yields will rise.

However, in such cases, the rise in bond yields would be negative for the currency. An excellent example of this was the rise of Italian 10-year bond yields in 2018.

The example above shows how the Euro moved inversely to Italian 10-Year bond yields.

Every time the yields spiked the Euro would depreciate. This provided some excellent Day Trading opportunities to short the Euro.

2. Equities (The Stock Market)

The Equities market can also show us high probability pairs to trade. This is due to its high sensitivity to changes in risk sentiment.

As a riskier asset, investors are quick to rotate out of Equities during times of uncertainty. According to Bloomberg, this is known as risk-off sentiment.

Safe-haven currencies like the Yen and Swiss Franc usually appreciate when this happens.

When investors are feeling positive, they rotate back into riskier assets like stocks. This is called risk-on sentiment.

This causes high beta currencies like the Aussie and Kiwi Dollars to strengthen.

Equities are usually the first market to respond to changes in the risk sentiment. As a result, traders use moves in equities to take advantage of risk-based trades.

3. Commodities

Commodities are another important consideration of intermarket analysis. The reason for this is due to the dependency that certain economies have on commodity prices.

Commodities form a big part of certain country’s exports. Let’s take Oil as an example.

Canada is the world’s fourth largest producer of oil. It contributes to roughly 10% of Canada’s total GDP.

Thus, when there are big moves in oil prices, it can affect the Canadian dollar. When oil prices rise, there is a good chance the Canadian dollar will rise as well.

The opposite is also true when the price of oil goes down.

Another good example would be Australia’s dependence on base metals. In 2017, Iron Ore and Coal contributed 30% of their total exports.

This means when metal prices fall or rise it usually affects the Aussie Dollar.

Economic Indicators

What are Economic Indicators? According to Wikipedia, they are statistics which track the performance of an economy.

There is a good chance that you have heard of some of these indicators before. A few of the most common ones are mentioned below:

  • CPI (Consumer Price Index)
  • GDP (Gross Domestic Product
  • Retail Sales
  • Unemployment Rate

There are hundreds of economic indicators released on a weekly basis. According to the CME group, these indicators can cause lots of volatility in the markets.

The release and expected release of these indicators can provide excellent trading opportunities. It all comes down to what the market was or is expecting from them.

The markets price in the expected release of economic data. So, what happens when the actual numbers don’t match the expectations?

When this happens, the market can react frantically trying to re-price the actual data. Big deviations in economic data can be a significant driver of market sentiment.

Evaluating this should be part of your sentiment analysis daily.

Determine The Sustainability Of A Day Trade

Now we need to spend some time on the bigger picture Fundamentals as well.

We already learnt that market sentiment is a fundamental short-term driver. However, what about the longer-term Fundamentals?

Do we need to know the longer-term fundamental bias as Day Traders? The answer is yes.

This will help us when we need to evaluate the sustainability of a trade. Some Day Trades can stay open for a couple of hours and some for a couple of days.

An excellent example of this is when the price has pulled back against a longer-term trend. Let’s Imagine for a second that the market is very bullish on a specific currency.

Let’s suppose that short term factors caused a big pullback against that currency.

Great opportunities arise when sentiment aligns back in line with the longer-term bias. In such a case a day trade might be held for a bigger profit.

However, what if the trade is against the medium or long-term trend? That will then cause holding times to be shorter.

How To Find High Probability Areas On The Charts

You’ll notice that only now we are looking to our Technical Analysis. Our reason for trading did not start by looking at the charts.

We use our Fundamental Analysis to find the highest probability pairs to trade. Then we use Technical Analysis to find the highest probability entries on the charts.

When it comes to Technical Analysis, we believe that less is more. We prefer using simple approaches that are easy to understand and implement.

Our primary goal is to look for areas of confluence on the charts. Especially areas that confirm good support and resistance zones.

For simplification, we have divided our Technical approach into easy-to-follow steps.

Step 1: Find the most recent swing points on the chart

Our Technical Analysis starts by looking at the most recent price moves. We identify the most recent swing points on the charts.

More specifically, we find the high and low points of the previous day. Below is an example of what this might look like.

Some Daily Pivot indicators can do this for you automatically. Finding the previous day’s swings give us an easy to use marker.

They also provide good support and resistance levels for stop loss and take profits. But we’ll get to that in a later step.

Step 2: Draw in a Fibonacci Retracement between yesterday’s swing points

In the second step of our process, we draw in a simple Fibonacci Retracement. It’s important to realise that we draw our Fib dependant on our trade direction.

If our bias for the currency pair is bearish, we’ll draw our Fib from the prior day’s swing high to the swing low. When our bias is bullish, we draw the Fib from the swing low to the swing high.

Below is an illustration of what step 2 might look like.

Drawing the Fibonacci between the prior day’s swings gives us good intraday levels to work from. Adjust the Fib if the price has moved above or below the prior day’s last swing.

Above is an example of how we’ll draw the Fibs if the price moved outside the swings. The prior day’s swings are just a marker.

The idea is that we wait for the price to pull back to one of the Fib levels. Once the price has pulled back, we can look to take entries on our selected pair.

The Fib levels that we consider important include the 38.2, 50.0 and 78.6 Fib levels. A pullback to one of these levels could be a good entry opportunity.

Step 3: Make use of a regression channel (or equivalent) for better entry locations

This is an optional step for more conservative traders. We never know how far the price might pull back.

For this reason, some traders prefer to use extra confirmation to time entries better. An example of a regression channel can see below.

 

Something like a regression channel can be a great help. Instead of taking an entry at a Fib level we can wait for a break of the channel.

The only challenge here is that sometimes we can miss out on a few extra pips. Remember that the market is dynamic so a channel might not always be the best approach.

Step 4: Draw in a Fibonacci Expansion to find possible profit target locations

In our fourth step of the process, we draw in a Fibonacci Expansion. The expansion requires you to select the same swing points you used for you Fib retracement.

Additionally, you also need to select the swing high or low of the retracement. It will be dependant on your trade direction.

Above is the same chart we used in the above examples with the Expansion added.

We usually look for the 100.0 expansion level as a first possible target. However, anything can happen with market sentiment in a short space of time.

For this reason, you need to be more flexible with your profit target with Day Trades. Be willing to sacrifice a couple of pips if you think the sentiment is changing.

In the case of a sell trade, you’ll need to select the swing high of the retracement. For buy trades, you’ll need to select the swing low of the retracement.

Step 5: Stop losses should be anchored at significant previous swing points

The dynamic nature of the market means we never know how far a pullback can go. For this reason, we believe it best to anchor stop loss at significant swing points.

In the example below, we used the same chart as in the other examples to illustrate this.

The stop loss is best suited at a location where you know you are wrong about the trade. When price moves past significant swings, it usually invalidates trade ideas.

Find the location where the price should not be able to reach if you are right about the trade. That is usually the best location for your stop loss.

With this approach, it gives the price enough space to manoeuvre. It usually also provides the trade with enough time to develop.

You can start to move your stop loss as the price starts to make new swings. Just be careful not to move it too close too quick.

Step 6: Look for possible confluence areas

Once all of the tools are drawn in look for confluence areas. This means, look for areas where support and resistance overlap.

This could as simple as a fib level overlapping with another support and resistance zone. Any confluences like this gives extra credit that specific level.

We’ll go over this with a chart example in the next section. The Fib Expansion can be an excellent tool to use to find potential places for profit targets.

Putting It All Together

Now it’s time to see how we put all of the information together. We’ll do that by going through the various steps we outlined step by step.

We’ll go through an actual Day Trade that was selected using the above process. In this example, our analysis showed that the NZDUSD was a high probability pair to choose.

The first step was to conduct our Fundamental Analysis. Market Sentiment was bullish on the NZDUSD pair in the short-term.

The sentiment came from better than expected GDP numbers for New Zealand. At that time, growth was a big focus point for the RBNZ.

This made the beat on growth numbers more significant. The sentiment was also turning more bearish on the USD in the short-term.

This was due to expectations that the Federal Reserve would stop hiking rates. As a result, we had both a strong and a weak currency to choose from.

After we had our pair selection, we moved to the charts. Below is an example how we followed the Technical Analysis steps.

The initial move upwards in the pair was due to the GDP news. Notice how the price pulled back to the 61.8% before resuming the uptrend.

In this example, the 50.0 Fib level had confluence with the 0.6750 price level. Also, our 100.0 Fib expansion level had confluence with the 0.6850 level.

This gave us a good opportunity to re-enter the move at a better price. As the price moved in our favour, we could have moved our stop upwards.

In this case, the confluence gave us extra conviction for our entry and profit locations on the chart.

Summary

In this article, we went over a simple and straightforward Day Trading strategy. This strategy combines both Fundamental and Technical analysis.

We learnt that the Fundamentals are essential to a good trading strategy. This is especially true when we’re trying to pair weak and strong currencies.

The Technical Analysis approach in this strategy may seem too simple for some. However, that is the point.

There is no need for overly complicated systems to trade profitably. What traders need is a healthy balance between the Fundamentals and the Technicals.

We wish you all the best in your Day Trading.

If you have any questions or comments, feel free to let us know in the comment box below.

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