How to Be a Short-Term Forex Trader

Colleagues in office pointing at wall mounted graphical screen having discussion
Flipside/Getty Images

Short-term trading the Forex market has always been popular for traders that are lacking time but enjoy the excitement of being exposed to the market. However, recent events like central bank policy of caused short-term trading to become the preferred, and sometimes only mode that many FX traders will engage with the market.

Is Long-Term Trading Dead?

Traders who have read books like Market Wizards by Jack Schwager are no doubt enthralled by the multi-year trends that many of these wizards were able to take advantage of in the market.

However, the economic environment that acted as a foundation for these traders has fundamentally disappeared. The 1980s was a time of inflation, and now, by evidence of a consistently falling neutral rate Central Bankers are constantly worried about low inflation or deflation in some areas of the world like Japan.

The current environment has led to some trends lasting multiple months, but most strong moves have been mean-reversion moves within a larger range. Range-bound markets occur when there is a clearly defined price support or floor range and a clearly defined price resistance or ceiling.

The clearest evidence of the decline of long-term trend trading has come from the decline of the hedge fund industry that has been replaced by high-frequency trading firms also known as quantitative funds. Historically, as detailed in many trading books, hedge funds have been able to find little-known, yet highly valued assets and companies and ride that trend for others catch on to the potential.

On the opposite side of the spectrum, high-frequency trading funds and quantitative funds trade within a second or less to catch small statistical fluctuations to their benefit.

The lack of long-term trends in addition to the widespread access to information has left old-school hedge funds with little edge and large fees that are increasingly becoming shunned by the market.

While long-term trading may not be officially dead, short-term trading has become a more favorable approach for institutions and individuals alike.

So what are the benefits of short-term trading and how should one look to approach the market with a shorter-term focus?

Narrowed Focus

A short-term Forex trader often benefits from nearing their focus to only a few currency pairs and only a few key levels to help guide their trading decisions. If you are looking for currencies to focus on, you could do much worse than learning what are the strongest and weakest currencies at any given time. Typically, short-term traders still focus on selling weak currencies that appear overbought in the near-term and buying stronger currencies that appear oversold and short-term.

The benefit of a narrowed focus is that when you are only looking at 2 to 4 currencies, such as to very strong to very weak currencies you're easily able to identify when a trading opportunity has arisen because the short-term move has gone far against the longer-term trend. Additionally, a trader taking this approach can place tighter stops because they are looking for a quick retracement towards the longer-term trend.

Narrowed Exposure

As mentioned briefly in the prior point, shorter-term traders should look to narrow their exposure at all times.

Put bluntly; the market should never be able to take more from you than you’re looking to take from the market.

A short-term trader that is looking for a percentage of the average true range should only be willing to risk 10 to 15 pips so that a small loss does not turn into a large loss, which has a bad habit among traders of turning into a long-term position until the trade hopefully turns around. As someone who has been around the industry for a long time and has talked to thousands of traders, cutting losses short is painful but necessary for a trading career.

The adage of “cut your losses short, and let your profit’s run” is often replaced and practiced by the undisciplined trader with letting your losses run and cutting your profits short. Please be a disciplined trader and follow the former’s advice.

Short-Term Trading Indicators

Lastly, short-term traders do not need to worry about a closet full of trading indicators. Some of the more successful short-term traders have either used a longer-term indicator like Ichimoku Cloud on a 15 minute or one-hour chart or use simple indicators like average true range, a couple of moving averages, opening range breakout, or pivot levels. Please note, they do not use all of these on the same chart but will find one that allows them to identify the clean entry point in their focused currency with tight risk and excellent upside.

Short-term trading might cause your blood pressure to go up at first, and reduce the thoughts of setting it and forget it profitable trading systems that many people come in the market with at first. However, building an appropriate strategy that allows you to narrow your focus of the best currencies to trade in a given market and limiting your risk while using a handful of indicators has the potential to lead to a good trading career.