5 Forex Day Trading Challenges & How to Overcome Them

Aug 12, 2021

Forex day trading seems to have a particular appeal to new traders.

Here I highlight five hidden challenges of day trading, and offer some suggestions on how to overcome them.

With the potential for quick profits and the excitement of the rapidly moving markets, forex day trading seems to be gaining popularity.

I suspect this is fueled by the hordes of trading gurus who portray the ideal trader lifestyle – you sit on a beach with your cocktail, execute a few trades with the click of a button, and close them shortly after with a bunch of pips in hand. Done for the day!

But is it really that easy? Here are some challenges you may not have expected.

What is Forex Day Trading?

Day trading is a short-term trading style, where you are typically take a few trades a day and close them out when the day is over.

Unlike the equity markets, forex markets are open 24 hours a day. Forex day traders usually trade the respective business hours of their time zone. For example, a European trader will trade the London session, while an American trader will trade the New York session.

Why is Forex Day Trading Popular?

1. Small Market Exposure

Since you’re holding trades for only a few hours, you’ll have less exposure to adverse price moves. 

Price moves arising from economic reports are relatively easy to avoid, but those arising from geopolitical events tend to be more extreme and unpredictable.

Take Brexit for example. Contrary to market expectations, the UK voted to leave the EU, making the GBPUSD crash to its lowest level in 30 years.

2. High Trading Frequency

Since you’re typically executing a few days per day, you won’t have to wait long for your edge to play out.

Compared to swing or position trading, you should be able to accrue profits more quickly and regularly.

This means fewer losing weeks/months/years, which is a big deal if you’re trading for income. 

3. Short Working Hours

Day trading tends to give a nice sensation of a short workday. 

You fire up your computer, trade for a few hours, and you’re off for the rest of the day. Longer-term traders, on the other hand, often need to monitor their positions throughout the day.

The working hours may not be as short as they initially appear, however.

If you day trade manually, you’ll likely have to spend some time before the market open searching for potential trade setups. If you’re an algorithmic trader, you’ll first have to invest the time and energy to develop a profitable strategy.

Five Challenges of Forex Day Trading

With the benefits above, you may be wondering why day trading isn’t the mainstay of every retail forex trader.

Here are five challenges that stand in the way of profitable day trading, and how you can overcome them.

1. High Transaction Costs

Transaction costs are an unfortunate reality of trading.

Since these are proportional to trading frequency, day traders tend to pay the highest transaction costs.

Together with the small average trade of short-term strategies, these transaction costs can erode a significant chunk of your profits. 

When backtesting your day trading strategy, be sure to simulate transaction costs as realistically as possible.

Below I compare the equity curves of a strategy that trades about 15 times per month – one has no transaction costs included, the other includes a 2-pip spread and $7 commission.  

Over 10 years, the transaction costs reduce net profit by a whopping 42%!

To minimize your transaction costs, you can check out Myfxbook’s free broker spread comparison table

Some of these are ECN brokers. Compared to dealing desks, these offer price feed transparency and tighter spreads, but charge a commission per trade.

You can use the comparison table to shortlist a few well-regulated brokers in your region. 

Using your lot sizes, you can then get a good estimate of each broker’s transaction costs.

2. Random Noise

If you’re day trading the lower timeframes, there’ll be plenty of noise on your forex charts.

Noise is random price movement that obscures any underlying market direction. It is a natural consequence of the millions of market participants, each transacting for different agendas. 

In general, trading in the direction of the trend will improve your win rate. 

To mitigate the effects of noise, you can:

  1. Use a noise filter like the Kaufman Efficiency Ratio
  2. Avoid high impact news events (more on that later)
  3. Use higher timeframe charts to detect longer-term trend direction

Or better yet, you can trade a higher timeframe instead.

Higher timeframes tend to distill out the noise, helping you detect trends arising from the market’s underlying fundamentals.

3. Entry & Exit Precision

Time is of the essence in day trading.

A precise entry helps you accrue profits quickly, giving you more flexibility when choosing an exit.

Likewise, a good exit limits your downside and maximizes profit retention. 

With the markets evolving quickly on the small timeframes, together with the short holding periods, your entries and exits need to be very precise.

Missing an entry or exit by only a few pips could drastically affect your expectancy. 

Here’s an example of how the type of entry can affect a 5-minute day trading strategy.

Over a 10-year backtest, the stop entry significantly outperforms the market entry. 

One way to improve your entry and exit precision is to chart your strategy’s expectancy as a function of your holding period.

Here’s a quick summary of the linked post above:

Let’s say you want to evaluate a Bollinger Band breakout entry, so you program a strategy containing only that entry and a bar-based time exit.

By optimizing the number of bars used for the exit, you can plot the following graph.

How can you use this graph to refine your entries and exits?

Notice how the expectancy hovers around the breakeven point until about 20 bars into the trade. You may wish to delay your entry by 20 bars, or get better value by entering on a limit order.

Likewise, the plateau and eventual fall in expectancy after 70 bars indicate that trades should not be held beyond that point. You can exit your trades or start tightening your stops after 70 bars have elapsed.

4. Sensitivity to News

Unlike the equity markets, where earnings reports are released quarterly, forex markets are frequently exposed to a large range of economic reports.

On the lower timeframes, markets are extremely sensitive to changes in fundamentals. The chart below shows how a EUR interest rate announcement can introduce a large amount of noise, despite it going according to market expectations. 

You can easily be stopped out of a position due to noise alone; your entry’s probabilistic edge is essentially nullified. 

To mitigate this, you need to be aware of any upcoming medium to high-impact economic reports, and plan your trading activities beforehand. Here’s an example:

Say you’re day trading the 5-minute EURUSD, and there’s an upcoming nonfarm payrolls release at Friday 8:30am Eastern Time.

Markets are typically quiet before a major news release, so you decide not to execute any trades after lunch on Thursday.

On Friday, to avoid the noise immediately before and after the release, you decide to only allow entries after 10:30am.

Of course, the above doesn’t apply if you’re trading the news, in which case you would enter the market immediately after the news release.

5. High Frequency Traders

If you’re trading the smallest timeframes, like the tick or 1-minute chart, chances are you’ll be going up against the high frequency trading firms.

These firms hire armies of PhDs, pay smaller commissions, and probably have the best IT infrastructure that money can buy. If you’re an individual retail trader, you don’t stand much of a chance. 

Retail traders usually find more success on the higher timeframes, where smoother price moves are relatively common and easy to profit from. With more pips captured per trade, you can still bag handsome profits with the reduced trading frequency.

Wrapping Up

As much as I would love to be a forex day trader, I prefer not to swim against the tide.

From my personal experience, the higher timeframes are much more profitable for retail traders. My best strategies are usually on the 15 to 60-minute timeframes. 

That’s not to say you’re doomed to fail as a forex day trader. You can definitely be a profitable day trader; just be prepared to work harder to tame the day trading beast.

So keep an open mind when selecting a trading timeframe. Trading preferences are certainly important, but you may have to strike a compromise with profitability.

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