Mini Pullback Day Trading Forex Trading Strategy

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Mini Pullback Day Trading Forex Trading Strategy

Day trading is probably one of the most attractive types of strategy among traders, especially among beginners. I’m not sure what it is but day trading just has that certain appeal to it that makes people think it is cool.

Scalpers, Day Traders, Swing Traders and Position Traders

Personally, I do like day trading because it allows you to get the best of both worlds being in the middle of the holding time spectrum.

On one end of the spectrum are the scalpers. To me, they are those who would hold positions for just a few minutes, even within the same minute candle. On the other end are the swing and position traders, they are those who would hold positions for several days and even months. In the middle are the day traders, those who hold positions for several minutes to hours, but never more than a day. All are great, all are profitable, all have their own pros and cons.

There are several pros and cons between all of them, but I think the two most important considerations are predictability and spreads or fees.

With regards to predictability, both have their own advantages and disadvantages. Scalpers who live on the minute chart have the advantage of being able to feel the market based on how it is moving on the tick level, observing how the market responds on every minute price point. The lesser time your position is in the market, the lesser time it could be affected by unforeseen events and market movements that could adversely affect your trade. However, the 1-minute chart is plagued with market noise, not because of the events that occurred within the holding period, but because of the effect of large transactions on each minute candle. A 100-lot transaction would have a profound effect on a minute candle as compared to a daily candle where swing traders make a living. However, the longer the position is open, the longer it is exposed to unforeseen events that could change market sentiment. More fundamental news releases could happen in a span of three days to a couple of weeks compared to a few minutes. It is up to the trader to find his or her own sweet spot on this spectrum.

Next, the spread or fees. Scalpers and swing traders pay the same standard fees for the same position size, whether it is in the form of a spread or commission. The difference is the amount of pips they gain in relation to the spread or commission. Let’s say, for a position to breakeven, price has to move 1.5 pips in favor of the trade setup direction. Swing traders would find the 1.5 pips peanuts compared to their targets, but for scalpers that 1.5 pips may be the difference between a profit and a loss. That is because price could move only so much within a given period of time. The longer the position is open, the farther price could move. So, let’s give this to the swing traders.

But swing traders are also plagued by fees that scalpers and day traders won’t ever have to worry about – swap fees. These are fees you incur for holding a position overnight. The more days you hold a position, the bigger the swap profit or loss. But mostly it is for a loss because banks also put in a hefty hidden spread on the swap fees.

Given, these pros and cons, we could argue that being in the middle might be a good option. We enjoy the predictability with lesser noise, and more bang for the buck on spreads and commissions without the swap fees.

A Good Way to Day Trade

There are many different ways to day trade. You could trade mean reversions, breakouts, bounces off supports and resistances, etc. Whatever you fancy. But I think one of the better ways to day trade would be to trading pullbacks on trending markets or breakouts. This allows traders to not chase price and enter the market at a market contraction, the phase prior to the rapid expansion which traders earn from.

Pullbacks are those lull moments during a trending market when price would reverse a little for a very short while prior to resuming the trend direction. By entering at this phase, we could enter at a good price and enter at a logical entry point with lesser probability of entering the market at the peak or bottom. This market pullback on a trending currency pair is very common intraday. It is very unlikely that you wouldn’t find at least one currency pair trend intraday, and it is very unlikely that a trending currency pair would have no pullbacks which we can exploit.

Strategy Concept

This day trading strategy would be hinged around entering the market on those pullbacks at a specific area around a very common moving average used for this purpose, the 20 Exponential Moving Average (EMA). What we will be looking for is a market that has just started to trend or is currently trending. Then, we will wait for a pullback to the area of the 20 EMA. As price reaches the 20 EMA, price should reject the price around that area and resume the trend direction.

To identify if price already resuming going the direction of the trend, we will be using another moving average, the 8-period Simple Moving Average (SMA). We will be looking for price to go over the 8 SMA in the direction of the trend and closing beyond it. Then we enter the trade in the direction of the trend.

We will also be targeting the swing points prior to the pullback. This is because swing highs and lows are natural supports and resistances where price could reverse on.

Timeframe: 5-minute chart

Currency Pair: any high volume, high volatility currency pair with a spread or commission breakeven of less than 1.8 pips

Trading Session: London and New York sessions

Buy Trade Setup

Entry

  • Price should be above the 20 EMA (brown)
  • Wait for price to pullback and touch the 20 EMA
  • Wait for price to close above the 8 SMA (gold)
  • Enter a buy market order at the close of the candle

Stop Loss

  • Set the stop loss at the low of the candle

Take Profit

  • Set the take profit target at the swing high prior to the pullback

This trade setup was the first pullback from a breakout from a contracting market condition. The take profit at the swing high was easily reached within 25 minutes, with little resistance from bears. However, as price hit the target, price pulled back for another setup, which would also have been profitable, plus some.

Sell Trade Setup

Entry

  • Price should be below the 20 EMA (brown)
  • Wait for price to pullback and touch the 20 EMA
  • Wait for price to close below the 8 SMA (gold)
  • Enter a sell market order at the close of the candle

Stop Loss

  • Set the stop loss at the high of the candle

Take Profit

  • Set the take profit target at the swing low prior to the pullback

This sample trade is the second pullback from a bearish market reversal. The first pullback was a bit wild printing a long bearish pinbar candle. That could have been traded, but reward-risk ratio would be negative. On the sample setup, the pullback was nice and steady, allowing for a more tamed bounce below the 20 EMA, giving us a better reward-risk ratio. The trade setup was for a profit in 15 minutes time and would even have pushed further.

Conclusion

This is a common strategy that many day traders use. Traders often trade bounces off the 20 EMA on a trending market condition. The difference with this strategy is that we have a trigger 8 SMA which we base our decision on whether it is time to enter the market or not. This allows for added confirmation.

However, we should avoid trading low reward-risk ratio trades caused by either shallow swing high or low targets, strong pullbacks beyond the 20 EMA, or strong bounces allowing for little room for price to move to.

Also, avoid trading on overextended trends. This is because longer trends that have pulled back several times have higher pressures to reverse.

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