I have had the privilege to tutor many intermediate and beginner forex traders in Kenya. Almost all the traders I have dealt with ask one common question:
“What should I do right now, should I buy or sell?”
The question reminds me of when I first started trading online forex.
The truth is that there is no definite answer to this question. What you do at any particular time depends on what type of a trader you are.
There are 5 broad types of forex traders:
- Day traders
- Swing traders
- Position Traders, and
- Mechanical traders
Your forex trading strategy depends on which type of a trader you are. Understanding what type of a trader you are will help you refine your forex trading strategy and avoid trading from fear, greed and faith, which are the three greatest pitfalls to successful trading.
Before we discuss the 5 types of forex traders, I would like to share with you the results of an experiment that I conducted with two of my forex students, who I shall call John and Mary.
At the beginning of the experiment, I gave both John and Mary a simple trading strategy that they were to follow. The strategy consisted of a plan on when to go short and when to go long.
To make things easier for them, I sent both of them daily SMS alerts to remind them to watch out for trade setups.
After one month, I evaluated their trading results, which were very different. John had made net returns of 40% on his account while Mary had only managed 10%. Several factors make these results very interesting:
- Both Mary and John started with the same amount of capital
- Both of them carried out the same number of trades
- Both of them had excellent entry strategies
So, how could their results be so different?
After carefully analyzing their trades, I discovered where the discrepancy emanated. While both of them had good entry strategy, Mary constantly interfered with her trades. She would get anxious, abandon the strategy and exit trades before they ran their course.
On the other hand, John stuck to his entries and exits. He left his trades run their full course. He either got stopped or hit his targeted profit.
Both traders had a similar strategy, but their personalities were very different. The message from this experiment is very clear. What you need is not a forex trading strategy, but a trading strategy that marries with your personality.
There is nothing like a perfect strategy in forex trading. The best strategy is the one that suits your personality.
The 5 Types of Traders in the Forex Market
Your personality plays a very important role in determining your forex trading strategy. Are you impatient? Do you get anxious? Do you have a strong appetite for risks? These are some of the personality traits that will dictate which strategy best fits you.
Basically, the only difference between the 5 types of traders is the timeframe that a position is held open. The timeframe increases from scalpers to day traders, swing traders and finally to position traders. The exception is Mechanical traders, who do not heed to any specific time frames.
If forex trading was a superhighway, scalpers would be the individuals on the fast lane. I like to think of them as guerrilla traders. They enter the market multiple times a day, each position they open lasting only a few seconds or minutes. Scalpers can make up to 10 pips on every position that they open.
A scalper’s trading strategy relies on the busiest hours of the forex market, typically when there are two sessions overlapping. Scalpers spend most of their time trying to spot trend changes on the charts. Additionally, a scalper must be able to make snap decisions in order to capture more profits when a trend is changing.
If you are intending to scalp the forex markets, here are the 3 cardinal rules that you must follow:
- Spreads: Since you will be opening and closing many positions, you need to trade on currencies with the minimal spreads. The major pairs (USD/JPY, GBP/USD and EUR/USD) usually have the best spreads for a scalper.
- News: Scalpers avoid trading during major news announcements. Major news, such as the NFP usually stir different emotions in the forex market and cause inexplicable swings in the major currency pairs.
- Leverage: Since they are only targeting small pips on their trades, scalpers must use high leverage to amplify their profits.
Because scalping is fast-paced, many scalpers result to using forex trading software to execute trades on their behalf. You can read about the other two most successful forex scalping strategies here.
A common characteristic with day traders is that they do not like to hold open positions overnight. They open a position at the start of the trading day and close it at the end of the day. Depending on the currency pair they are trading, day traders can make anywhere between 20-40 pips per trade.
Day traders rely on the M15 and M30 chart windows to analyze the forex market.
Day traders care most about closing all open positions at the end of the trading day. Most of them do not care whether the position is at a loss or profit. All that matters is that the position be closed at the end of the day.
Unlike scalpers who avoid trading the news, day traders rely on news to plan and execute their trades. Additionally, a day trader must be able to spot breakouts as they happen.
Swing traders keep positions open for more than a day but never more than a week. Swing trading is most suited to persons who juggle forex trading with their daytime jobs. Swing trading can yield anywhere between 50-150 pips.
Swing traders have larger profit targets and stop loss levels. Since their profit targets are high and they place far lesser trades than scalpers and day trades, swing traders are less bothered by forex spreads. They can afford to trade currencies with higher spreads.
However, to be pretty sure, swing traders usually have to wait for a few confirmation signals before they open positions.
Position traders are the exact opposite of scalpers. If forex trading was athletics, they would be the marathoners. They can hold a position open for weeks to months. Position traders understand the fundamentals that drive the forex markets and are able to spot trends that can lead to long term profits early on. The profit potential on their trades is usually above 500 pips.
Position traders use the D1, WI and even MN chart windows to analyze the forex market.
Two characters distinguish position traders from the other types of forex traders. They are voracious and astute readers on the financial markets, and they have a very large trading accounts. The large accounts helps them withstand losses should trades go against them for an extended period of time.
Mechanical traders do not care about time frames. They are usually the beginners in forex markets. They are the traders who have learned how to use specific technical indicators, back tested them, and now all their care is implementing the indicators on their preferred trading platform.
Most mechanical traders end up coding their strategies into forex trading software that does the trading on their behalf. The main disadvantage with this type of trading is the false sense of security that it creates. If interest rates change or the central banks take proactive measures to correct liquidity, mechanical traders may suffer prolonged losses if they do not take measure to adjust their forex software to reflect these changes.
Your Perfect Forex Trading Strategy
The perfect forex trading strategy is the one that fits your personality traits and your lifestyle. If you have a lot of time to analyze the charts and you love action-packed trading, you will probably end up being a scalper. If you are juggling a daytime job and forex trading, swing trading will probably fit you best.
I would like to hear from you. Heck, I would even like to help you sharpen your forex trading strategy. Leave a comment below letting me know what type of a trader you think you are, and why.