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Table of Contents

Risk Warning ................................................................................................................... 3

The Foundations of Daytrading ....................................................................................... 4

What is Daytrading? ........................................................................................................ 4

How Long is the Trading Day? ........................................................................................ 6

Daytrading Psychology .................................................................................................. 10

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Risk Warning

Trading Foreign Exchange and other Derivatives involves a significant and substantial risk of loss and may not be suitable for everyone. You should carefully consider whether trading is suitable for you in light of your age, income, personal circumstances, trading knowledge, and financial resources. The information in this material and the links provided are for general information only and should not be taken as constituting personal investment advice. Only true discretionary income should be used for trading Foreign Exchange and Derivatives. Any opinion, market analysis, or other information of any kind contained in this material is subject to change at any time. All trade ideas and trading scenarios found in this material are hypothetical. Past performance is not necessarily indicative of futures results. Nothing in this material should be construed as a solicitation to trade Foreign Exchange or Derivatives. If you are considering trading Foreign Exchange or Derivatives, before you trade make sure you understand how the markets operate, understand how ThinkForex is compensated, understand the ThinkForex trading contract rules, and are thoroughly familiar with the operation of and the limitations of the platform on which you are going to trade. A Financial Services Guide (FSG) and Product Disclosure Statement (PDS) for these products is available from TF GLOBAL MARKETS (AUST) PTY LTD by emailing compliance@thinkforex.com. The FSG and PDS should be considered before deciding to enter into any Derivative transactions with TF GLOBAL MARKETS (AUST) PTY LTD. The information contained in this material and on the ThinkForex website is not directed at residents of any country or jurisdiction where such distribution or use would be contrary to local law or regulation. 2013 TF GLOBAL MARKETS (AUST) PTY LTD. All rights reserved. AFSL 424700. ABN 69 158 361 561. Please note: ThinkForex does not service US entities or residents.

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The Foundations of Daytrading

Applying the idea of daytrading in the forex markets brings up many questions:

• What is daytrading and why is it a strategy? • When should I apply the strategy of daytrading? • What times of the day are more and less volatile? • What impact does the economic calendar have on my trades and follow-through? • Will daytrading make me a better trader?

I will answer all these questions as we proceed and I will remind any trader considering entering the world of short term trading or “daytrading” that it is a strategy to consider and always NOT the only or best depending upon the time of day and market sentiment.

These are all valid and important to consider because they all apply to how a trader will organize their “day” of daytrading within a market that does not close day to day but rather week to week.

What is Daytrading?

Most traders who are attracted to daytrading love the appeal of multiple, short-term trades, with limited risk, and the activity (and dare I say “excitement”) that goes along with it. I will add that any type of trader will benefit from the types of skills a daytrader develops including lightening-speed order entry, the ability to make quick decisions at specific price levels, an understanding of price action momentum as it pertains to major and minor psychological levels, as well as an understanding of the rhythm of the trading day. Daytraders are also masters (by necessity) of risk and reward. If you think the following discussion is for the hyperactive trader only, think again, it’s for everyone. So let’s start with a definition of daytrading if for no other reason so that we are operating from the same idea of what it is.

In the mid to late 90’s I was deep into daytrading and this was when tech stocks were moving wildly, swiftly, and somewhat predictably higher. I sat in front of multiple monitors, sometimes with CNBC or a “squawk box” audio of the action in the S&P500 pit in the background. Each day was a methodical “scramble” for stocks in play and on the move. In a world that was counted in the tens of thousands of symbols, finding the names to focus on was key and frankly the most exhausting part (but more on that later). I worked in one of the many trading offices that were popping up across the U.S. and the world where traders would come to “work” to sit down in front of their computer station and trade their own money. There was camaraderie and competition and it was an energetic, caffeine-fueled environment. It was a large room of like-minded, market obsessed individuals where we didn’t have to explain our love of the markets that why this was not “gambling”.

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After having a good degree of success, the owners of the office gave me a private “corner” office and asked me to trade some of their own money. Flattered and isolated, I found I did thrive in the bubble of my private office. I could finally sit with my own ideas and theories and much of what you are reading comes from those years in the equities markets, then futures markets - daytrading - based upon a hybrid of price, technicals, and fundamentals. In that office I really came into my own as a trader.

It’s interesting that many traders who have participated on multiple markets (futures, forex, stocks, options, CFDs) do not bring the knowledge and experience of those markets to the next; the psychology of price and the market participants does not vary. Now that my day is focused mainly on forex, I can say that I do not miss the exhaustion of looking across thousands of stock names to find “the ones” that I would trade. In fact I enjoy the dozen or so markets that I trade regularly. I know them like old friends: Their habits, fears, and quirks.

Contrary to some opinion, daytrading was born of a need to control risk. Being “flat” (with no open positions) at the end of the day is and will always be a way to control of the risk of the unknown. It’s more applicable in markets that are traded on an exchange and “close” where gaps and the lack of accessible, liquid markets makes the opening a daily uncertainty of volatility. For a trader in the 24-hour, 5 1/2 days a week, global markets of the foreign exchange, the “day” of daytrading means something entirely different. Consider that forex traders do not have the sort of daily inaccessibility that nearly every other market does and define a “day” based upon 1) Either where they live and 2) The different, main financial centers around the world. A daytrader in the forex market has their own “day” and then can consider the other “days” (sessions, financial centers) that will overlaps with theirs. I have traveled, traded, and taught all over the world and for the most part people from any country have a similarly scheduled work day. In around 8:00am, lunch sometime between Noon and 2:00pm, and out around 5:00pm. So when considering a “day” the first thing I ask myself is: Who’s awake? Which is to say who’s working? Sydney, Tokyo, Hong Kong, Singapore, Paris, Frankfurt, London, and New York: Who’s up and working? More detailed questions are: Who’s opening (with the first 20-30 minutes of the work day), who is at lunch, and then who is closing (the last 30-minutes of the work day).

Applying the strategy of daytrading simply means that a trader will be looking through the eyes of a shorter-term time frame, usually 15-minutes or less in an effort to find clarity and an entry to commit to up until the time that their work day is done or until such a time comes that they will no longer be able to pay attention to the markets. This too however is changing with trading platforms on mobile devices. We are more attached to the market and the ability to stay connected has now far exceeded the desk and chair. Personally, while I will only set up trades at my desk, I will manage them sometimes far from it through my phone, tablet, or laptop. This too is changing what the word “day” as it applies to trading means. That also makes understanding the rhythm of the trading day all the more important.

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How Long is the Trading Day?

A daytrader’s rhythm has both the expected rhythm of the daily market behavior cycle and the unpredictability of news and data as well as unscheduled economic, political, and world events. The daily rhythm is actually the one that most traders tend to overlook because it’s the same day-after-day. While each financial center has it’s own equities markets to consider and individual economic releases, I will use the U.S. session because the three most traded pairs involve the U.S. dollar. (The psychology of any financial center will follow the same basic rhythm while individual market open and close times as well as data release time will vary.)

Upon the start of the trading day, it’s vital to look back on the sessions that led into the time you are trading. That includes economic data releases, headlines/sentiment, as well as price movement; this can be done with just a little meaningful time spent looking at an economic calendar and doing some basic Google searches for currencies and central banks (e.g. euro, yen, BOJ, ECB)

Additionally, I like to draw vertical lines on the Paris/Frankfurt, London, and Asian close times which translates to 2:00am EST, 3:00am EST, and 4:00am EST on five minute charts. It’s also important for me to note any change in sentiment between 7:00am and 8:00am EST as the New York begins to gear up for the trading day. Make note of the support and resistance of previous sideways ranges for the day, accelerations higher or lower, and make note of when these occurred. Very often these will be the reactions to data that was released earlier that day. For a forex trader, the “day” is defined in “global” terms with the Sydney open.

This pre-trading preparation will allow you to find the rhythm of the market as you enter it. Unless you are getting involved at the beginning of the Asian session with the Sydney open, you are wading into a river that is already flowing.

When the equities market(s) for that region begin expect another increase in volatility and with it the potential for a change in the risk sentiment. Equities will reflect a fairly accurate

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gauge of risk sentiment and whether there will be risk appetite or aversion. Knowing which is dominating will allow you to better understanding where trading capital is flowing and why. (e.g. risk appetite increasing yen weakness). At this point - with the equities markets open - keep in mind that there is a 20-30 minute “clearing”. In any market where there is an open and close, the market makers will be executing the trades on their books. While this is mainly a equities activity it still has baring on the risk in the market, and effects a forex trader’s day most especially for the yen, but also for “comm-dolls” (commodity currencies) like the Australian, New Zealand, and Canadian dollars. In the U.S. this equities driven risk picture will effect the U.S. dollar. From the clearing on, there will be some distinct “reversal” times in the equities markets (outside of economic data releases) that can also change the risk picture. For the U.S. these times are 10:00/10:05am, 10:30am, the European close at 11:30am EST and also the beginning of the “lunch time doldrums” that last until 2:00pm, then the bonds close at3:00pm, until the market close at 4:00pm EST. After the U.S. equities market closes and until Sydney opens and the most dangerous and unreliable time to view price action as a reflection of true market sentiment. In fact between the U.S. close and the overlap of Sydney, Tokyo, and Hong Kong should be seen as a time to take a break and recharge for the next well-participated trading session.

Despite all the equities opens, reversal times, and market overlaps, there is a predicable element to price ranges and both the uncertainty of events the market has not (yet) discounted. Market participants do like to be surprised. The process of “discounting” tries to take into consideration the most likely outcome or scenario and price it into the market (commonly referred to as being “baked into the cake”). Surprise comes mainly as traders deal with unforeseen events or being “wrong” about what was discounted into the market. For some daytraders the volatility is opportunity and for others it is risk. Too much or too little is generally not helpful to anyone. But what’s too little or too much? This can sound entirely subjective until I share my “secret weapon” with you.

One fact of short-term time frame trading (aka “daytrading”) remains - and by now I hope you see - that daytrading really is more accurately described as “short term trading” when it comes to the 24-hour forex market. Traders can expect daytrading to be a magic bullet with expectations of a certain frequency of trading and certain risk/reward expectations but this is all contingent on the way in which the market is moving (or not moving) based on a number of factors from market sentiment and headlines to economics data releases and unforeseen global events. In fact, even the way the market chooses which fundamentals to focus on for a particular session may center around the major headlines of the day to more randomly chosen elements of central bank stances and economic undercurrents to downright volatile and often illogical discounting based on expectations of central bank action. It can be a tough road for a daytrader who doesn’t do their homework! One of the ways to understand just how volatile a market is based on a these factors is to look at historical price range rhythms.

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If the word “rhythm” seems to be a constant, there is a reason: Daytrading is like a dance. If you don’t hear the beat, it’s very tough to dance. Understanding a pairs price movement range both hourly and daily offers an “edge” to any daytrader yet it is seldom used.

A few years ago I was working with a company who’s most well known tool was chart pattern recognition. However they had come to me with a question and to show me what they were doing with all the price data they had coming into their servers. Aside from identifying and alerting chart patterns, they realized they could also take this data and show traders the historical price action for each hour of the day based on a three-month look back. In other words, rather than simply telling a trader that the EUR/USD is currently trading at 30 pips per hour, they could print a graph showing a trader that usually the EUR/USD can trade on average 30 pips per hour but up to 48 and as low as 11 for the 8:00 to 9:00am EST hour. This was less about telling me what the pip movement was now (I could calculate that simply by looking at a hourly candle and doing the arithmetic from the current high to low). This data told me what I could expect and was calculated by what the pair has done in recent months.

One of the most consistent mistakes I see traders make is based upon faulty or unrealistic expectations for price movement. At the core of this error is simply not having a specific tool that offers the answer traders need. I think that most traders know that anecdotally there is a rhythm to the trading day, but few know what pip movement accompanies the increased and decreases in volatility.

(Courtesy of Authochartist.com)

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Most traders will decide how much they think a pair will move based upon their chart which is not entirely accurate because most often it’s determined by what the pair had done earlier in the day or the prior session. The way to do it is to look back at what the pair had done during the same hours over a handful of sessions. This means that if I am going to trade the European session I will look to see how the market behaved between 2:00am EST and 11:30am EST and use the rhythm and price movement I see occur most frequently between those hours. An additional point of information is needed as well and that is making sure to consider what type of data may have pushed the price movement higher. To do this manually can be time consuming but certainly well worth the effort, but here’s how I do it using the “price movement range buy hour of day”.

Let’s take the GBP/USD. The “cable” as it’s known is one of the big three most traded pairs and the most volatile of the three.

The GBP/USD has a rhythm of its own as does every pair and this includes not just when the pair’s range contracts and expands but also how many pips it moves hour to hour. The upper and lower ranges of the price movement can also change. Do not think its fixed but these types of changes in the “extremes” usually happen over time or occur when there is a significant event such as a central bank surprise or geo-political event.

Unlike most currencies that trade against the U.S. dollar, the GBP/USD consistently has its most volatile trading range during the European, UK, Asian overlap. Note that the European, UK, and U.S. overlap is significant as well. This bodes well for daytraders that are looking for volatility and at a consistent time. The GBP/USD is a popular choice for short-term traders as are many of the GBP-related pairs. Taking a closer look at the pips you can see that from the European open to the U.S. open the pair averages 20 to 30 pips per hour. For a daytrader this represents both potential risk and reward. If there is a scheduled economic release that impacts the U.S. dollar or the pound sterling, the pip movement can easily increase to over the average towards the higher end of the range and beyond. Preparing for this is usually as simple as glancing at an economic calendar and then being prepared of the average to the high end of movement.

(Courtesy of Authochartist.com)

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A daytrader should very rarely be surprised by when volatility increases and how much it is capable of increasing to. Daytraders - because of the tighter price movement inherent to a daily time frame - are masters of risk/reward because one misguided decision about the validity of a single trade does have to capacity to wipe out a day’s worth (or more!) of wins. Knowing when a pair is behaving beyond the normal price movement range can mean a bigger win, true, but more often it’s a warning that the market is digesting something new or different and the risks associated with that are almost always higher. From my years actively daytrading, I know successful daytraders respect the clock as much as they do their charts!

Daytrading Psychology

If it seems I have been in some ways preoccupied with the time aspect of daytrading up until now, you would be right. It is just that important! And now we will transition to the importance of major and minor psychological price levels (I consider them the invisible support and resistance on all charts) as well as the momentum they can stop and create.

If you have spent any time at all in front of Level II or DOME (Depth of Market Expanded) on a charting platform you have already seen first-hand the way in which the dance between bids and asks behaves; you have seen the way bids disappear when there is panic in the market and the way buyers will climb over one another when they want to buy. The Level II or DOME shows the price level (and size although not always “truthfully”) that people want to buy and sell at. It’s an active view of what ultimately plots the bars or candles on your chart. Back in the early nineties this was novel information and frankly for a while did offer traders an edge in order entry and (very!) near-term momentum. Personally I found this information a little too distracting. I am not by nature nor practice a “scalper” - as cost per trade becomes as much a factor as momentum. I am not interested in that slight of an edge and this is less chart-based trading to me as it is an execution of skillful order entry and price reading. I guess some could argue is pure trading too but for me I like to see more sustained organization of momentum that could result into a trend, even if it is an intraday, five-minute chart trend. None-the-less I did learn a lot about the way orders are filled and the way price behaves around four particular levels.

If you are watching and paying attention (they are NOT the same thing!) to Level II, DOME, and time and sales data over the course of a few years, it should be expected you will pick up a few things about the nature of order execution. For me the appeal of this data was because I had never been to a trading floor and this was an electronic version of what I imagined went on there…minus the elbows, yelling, and tall traders. There were certain price levels that more-often-than-not were where floors and ceilings were put in and/or breakouts and breakdowns occurred. These were the 20, 50, 80, and 00 levels. Back then I was watching stocks, so these were the 20 cent, 50 cent, 80 cent, and the “handles”. For forex traders it translates into the 20, 50, 80 pip levels and the “figures”. The most important

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of these is the “figures” or “handles” which are the “00” levels like 1.3000 in the EUR/USD or 99.00 in the USD/JPY. There is certainly a psychology to whole round numbers and the parity level would take the most important price level in any pair.

What am about to explain may be easier to see live than in explanation but since the concept discussion must begin somewhere, let’s start here: I call this “price action momentum” or “psychological level momentum” and since most of what I know about trading was self-taught from years of observation I will also add, feel free to call it whatever you want, the name concerns me less as long as you grasp the concept.

Psychological levels often have what appears on the chart a magnetic quality in that these levels can push price in a direction. I sometimes look at it as gravitational pull as well but since I am no physicist, this may not be the perfect direction. But again, trading lingo is supposed to offer a meaning for what we see in price and on the charts, that said, psychological levels can change the way price action moves. The explanation for this phenomena is easier to describe: We tend to think in round numbers. If inviting a friend to

lunch, you will likely say “I will meet you at 12:00 or 12:30” (think “00” and “50” pips levels) you will not likely say “12:17 or 12:42”. We place orders very often at levels we think in. Because of this, we have company. The restaurant is busier at Noon than 1:30 and if you do miss the common rush times

Noon, 12:30, 1:00 you can often slip in during a lull, perhaps quarter till or 20 minutes after the hour. Still with me?

Price levels are very similar. While 1.3015 may not be too busy with pending stop and limit orders, 1.3000 will be thick with pending orders. Some traders will attempt to step in front of size of a major “00” or “000” level by selling at 1.2995 if they feel 1.3000 will hold as resistance. If they view 1.3000 as support, they will step in front of size by buying ahead of the 1.3000 buy stops and limits at 1.3005. So there is absolutely a reaction to these levels. To a lesser degree you will see similar reactions at the 50 pip level as well as the 20 and 80. The 20 and 80 are minor psychological level in that they are still relevant but may not have the same impact on momentum as the 50 and 00.

Let’s take this a step further and make this more practical to the daytrader.

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As far as decision levels on a chart go, the 20, 50, 80, and 00 levels should always be respected as the stealthy, invisible support and resistance lines that daytraders see no matter what is already drawn on their chart. The fact that these are decision levels simply means that the price means something to both buyer and sellers but ultimately it will come down to which group “owns” the level by either defending it or breaking through it. The way in which price is rejected from a minor or major psychological level will reveal a lot about where it’s most likely to head next.

Understanding the way in which price rejection and acceleration at or through a major or minor psychological level starts with understanding WHO won the most recent battle. This offers insight into the near-term momentum that is moving the market and can be seen very clearly on a five-minute chart. As a general rule if price action is rejected at a psychological level it will return in the direction from which it came. If it breaks through a psychological level, it will attempt to trade towards the next level (e.g. breaking higher through 1.3000 and then heading toward 1.3020) Daytraders are masters at understanding this and frankly all traders should at very least respect the way in which price action moves towards and through psychological levels to determine more accurate and realistic entries and exits. Case in point, regardless of the time frame I would prefer to place most of my entries around psychological levels (and notice I did not say at the psychological level because I will often try and step out in front of size when necessary or use the momentum of a break when it’s applicable). The exceptions occur when there are other relevant levels in play such as moving averages, gaps, previous highs and lows, trendlines, and Fibonacci levels and this is not an exhaustive list but certainly more of the most common situations. Ideally the psychological level will be in close proximity to one of those levels and then you know you have what could be a very strong and possibly active decision level.

All daytrading is not breakout/breakdown oriented price action momentum. Quite the contrary: There are a number of daytraders who seek to capitalize on intraday trends. This is an aspect of short-term, intraday trading that is popular but not always discussed and that is how to follow an intraday trend with no commitment to the longer-term follow-through.

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There are absolutely times of year, certain risk environment, as well as particular market trends that this is most effective.

Intraday trends as they apply to the forex market must begin with the entire day, not just the financial center(s) that are open at the time you are trading. This in fact is the same way I trade Dow and S&P futures: I will drop vertical lines at the European and UK opens as well as the Asian close. This is because to know what may happen moving forward, we must know what has already happened and this includes economic releases as well as highs, lows, and trends that occurred up until the point we sat down at our desk to look at the charts and the market. Even traders who do not think of themselves as daytraders or as having a longer-term outlook can absolutely benefit from the knowledge a daytrader has about price levels, time, and intraday volatility. This will make any trader a more complete trader.