Commander in Pips: Since we have done all the preliminary discussion let’s pass right to today's topic. There are two major groups to classify you as a trader – based on time frame you intend to trade, and, second – based on way how you intend to trade mechanically or manually.
Commander in Pips: Well, it means that you develop some computer program that makes trades instead of you. Your task here is to invent an algorithm and test the program to be sure that this system is profitable. We will discuss this approach in more detail a bit later. Here we will just give the advantages as disadvantages of this method.
Pipruit: What does it mean to trade “mechanically”?
Time frame gradation
Scalpers are those who trade on very short-term time frames. Usually they hold position from a few seconds to some minutes at the most. This type of trading demands extreme concentration, a fast mind and thinking, very detailed preparation, outstanding discipline and diligence. Price changes so fast, that if you will lose momentum – you could finish with significant losses. To become a scalper you need a lot of experience. Since scalpers’ profit in each trade is small and the amount of trades large – their primary task is to take these pips as quickly as they can. A scalper has to stick with the market and sit in front of the monitor without any break and no distractions at all. Among the other reasons this way of trading will be acceptable for those who can spend several hours right within the market, but can’t sit with it all day long.
Since scalp trading is so intensive, it demands significantly more rest. In general, intraday trading demands more rest. Scalp trading and extreme concentration, tense, emotional and physical anxieties are the same.
If we turn to profit objective, this kind of trading is mostly based on large numbers law. Since the amount of trades are large and profit/loss in each trade is small – the major task here is to stay with small profit in day-by-day trading but long-term period profit will be significant.
Here are some specific issues of scalping:
- very fast trading and thinking process;
- close focus without any distraction on charts with some hours, usually 2-4 at the most;
- For those who has a lack of patience this could be some solution, but not always – if this is a lack of discipline also;
- Fast mind – trader has to have ability to change view on the market fast and be open-minded to fast market signals;
- Scalp trading demands outstanding knowledge of market mechanics, speed and sharpness in trades’ execution and order placement;
- It demands a very good brokerage;
- Expenditures on software and hardware are greater;
- Result of trading is accumulation small profit (or loss) mostly according to large numbers law, but not a few trades with significant profits (or loss);
- Your task will be to grab money from pit traders. You have to be extremely smart to do this;
So, if something here is not suitable for you, then probably it is either too early to become a scalper or this is not quite suitable for you. For instance, if you fall under stress trying to accommodate with fast market moves or you can’t change your mind quickly or you prefer to think and re-think your analysis before pulling the trigger.
If you’ve studied previous chapters well, you probably will agree with me on the following issues:
- Since you trade fast and small moves – you need trends on the lowest time frames. That is possible on most liquid pairs and during the most tough trading time. Hence major pairs are preferable for scalp trading, especially during sessions overlapping mostly Europe and US trading sessions;
- You need the tightest spreads, since you make a lot of trades. That’s why the number of pairs becomes even narrower – EUR/USD, Cable, USD/CHF and USD/JPY are suitable. As we've said earlier it’s better to focus on some single pair first – this will let you to feel the market and understand it’s breath;
- Spreads and fees become the real force against you. Be sure that your profit is greater than spreads paid at the end of the day;
- If you’re a scalper, may be it is better to stay out of the market during news and events. Volatility and splashes are extremely strong during this time. Sometimes you even will not be able to enter the trade during a news release, since the context will change very fast. It’s better to wait for a few minutes and continue trading after the release.
This type of trading is a bit slower than scalping, but still, it limited to a single trading day. If you feel that scalping is too fast, but you do not want to hold position overnight – forex day trading could be your variant. The feature of day trading is that the trader usually makes 1-3 trades during the day, based mostly on 30 min – 4 hour charts. Lower time frames he uses for searching for patterns that could give him/her the trigger point. This type of trading is not so tough, since it lets you prepare to it in the beginning of the day and has much less emotional, tense and physical anxiety during the day than scalping. After entering the trade (or when you are just waiting for it to reach entry point) you can dedicate yourself to some other short-term occupation around – for instance study in a trading-room, reading forex books or creating a trading plan for other markets. Still this type of trading demands some issue that will not be suitable for most people. Although you’re not so stressed and glued to your charts – it demands you to keep on eye on the market from time to time and especially when your alert on entry/exit points will call. So you always have to be somewhere around. Usually day trader closes all positions by the end of the day.
Here are some specific issues of forex day trading:
- acceptable speed of thinking – you have a lot of type to prepare;
- Just monitoring of position and alerts through the day. Close focus on action only during the execution of trades. So, day trading couldn’t be combined with day job – you have to be always somewhere around.
- Demands more patience than scalping and discipline;
- Demands not such fast mind – you probably will have a lot of time to reassess the current situation if your initial plan was destroyed by price action;
- Day trading still demands some knowledge of market mechanics, sharpness in trade execution and order placement;
- Since this is still intra day trading - expenditures on software and hardware are solid;
- Result of trading is more as single trade result now, since number of trades within the day is small;
- positions are typically closed by the end of the day;
- Demands much more attention to previously happened news and events because the market feels significant impact by them. This will help you to estimate market direction.
- Almost any pair is acceptable for trading, maybe except some extra-exotic. Spreads are not so crucial here.
Although we might say that day trader is a positional one from the scalp trader point of view, but to keep within hierarchy, let’s call those who holds position overnight or longer as positional traders. Positional traders usually trade at daily and higher time frames. Positional trading has one big advantage – you can combine it with your day job. If you can’t monitor your position throughout the day, but have some hours every day to be with market – this is your choice. Positional trader focuses mostly on medium term swings and patterns on the market and could hold a position from few days to months or even years. This type of trading demands a lot of patience, diligence and discipline, since you place trades for an extended period of time and you can’t do another 3 or 4 in short time as in scalp trading to offset the loss in the current one.
Here are some specific issues of positional trading:
- From the one point of view you will have a lot of time to plan the trade and even to monitor starting moments if it’s realizing. The reverse side of that process is that planning demands extra scrutiny;
- You do not need to monitor your position through the day – just keep an eye on it at the end of the day;
- Demands extreme patience and discipline;
- Positional trading does not demand solid knowledge of market mechanics;
- Expenditures on software and hardware are not so solid. You may even use daily chart and delayed intraday, say, hourly charts;
- Result of trading is strongly linked to any one particular trade;
- Demands including of fundamental analysis or at least understanding current economy situation and how it could influence on pair dynamic. Fundamental analysis becomes very important if you hold positions for months or even years;
- Carry trade becomes significant, especially if you trade on weekly and monthly charts;
- Almost any pair is acceptable for trading. Spreads are not so crucial here;
- Demands higher assets value or lower lot size, since the stop loss orders will be much wider;
- Since larger time frame suggests higher volatility and fluctuation, it demands strong self-control to stay calm if temporal price moves against your position.
- With super long-term trading you also have to stay calm during multiple retracements against you that also will not be shallow.
- Also you have to be absolutely confident and have 100% trust in your analysis. Also you capital should be solid.
So, if you compare your character traits with those that we’ve just appointed you will be able to understand what type of trading is more suitable for you. The major thought here is extreme fast and extreme slow types of trading are the most difficult, although their difficulties are also different. Still there is simple decision could be made – if you have day job, school or college – your way to start is a positional trading on the daily time frame.
Commander in Pips: Yes, they are the most acceptable types for newbie traders.
Pipruit: Yep, looks like this is my type. Still I also like day trading, may be I will have a possibility later to shift to it…
Trading Type gradation
Commander in Pips: Ok here we will take a fast look at other gradation of trading – mechanical and analytical. Since discussion of creating automated trading systems is still ahead of us – we will not discuss it in details but only appoint the difference between these two types of trading.
If all done well…
- Your hard work that lasts for a long months that is dedicated to creation and testing of your mechanical trading system is over. There is no stress, since you will not be glued to the market and your system will make trades by itself. You have superb confidence with it, since you have included all aspects and potential surprises that could market give you;
- This system generates sufficient money cash flow that allows you to live as you want and look at your growing profits from time to time;
In reality something is always wrong…
- Since you have tested your system on historical data, you are not absolutely sure that it will work with same results in reality. You have to spend days and weeks with your PC for optimization and testing after you’ve launched it;
- When you see one large drawdown, then another one – you start to worry about your trading capital, and decide for diversification develop 1, 2 or may be 3 another systems that will smooth drawdown;
- Stress reaches crucial levels, when you see how your system bombs your trading account and you can do nothing, except just following its orders;
- Suddenly you understand that sum that you reserved as potential spread + slippage seemed to not be enough;
- You have to pay more and more to software programmers. Can you be sure that they have done all the stuff correctly?
- Sooner or later all mechanical systems will break.
If all done well…
- You study with best mentors and your risk/reward ratio has reached outstanding numbers;
- You live as you want where you want and how you want. Trade when you need or want;
- Your skills become really good and your capital is growing day by day, so you start even to think about purchasing of some real estate or luxuries;
In reality something is always wrong…
- You have started with one trading approach, then with the other and so on, pass through many different mentors, but still can’t reach the consequent profit with trading;
- Money that you’ve spend on study within these years is hardly offset by the profit that you’ve made;
- Since you’ve decided to trade full time, your savings are melting day by day and you start to feel stress. If you will not turn to some profitability, you will have to find a job;
- Stress and sticking to the monitor force you to get mistrusted - will you ever understand what “live as you want where you want and how you want” means.
So, as you can see there are a lot of problems as with first way as with another one. Still I can make your choice a bit easier. The point is that to create an algorithm for any mechanical trading system you need to know different types of analysis, understand how indicators and other technical stuff work. In other words, you have to start with some analytical approach first. In fact, mechanical approach have two major advantages – no stress (it makes trade independently from you), trading 24/5 time – when you eat, sleep and occupied with other business. Mechanical systems could be solution for those, who have extreme lack of discipline and patience.