Produce Profit With a Simple Risk-Controlled Forex Day Trading Strategy
Many people like trading foreign currencies on the foreign exchange (forex) market because it requires the least amount of capital to start day trading, trades 24 hours a day (during the week) and offers a lot of profit potential due to the leverage provided by forex brokers. The key question everyone has is “How much money can I make forex day trading?” The following scenario shows the potential, using a risk-controlled forex day trading strategy.
Forex Day Trading Risk Management
Every successful forex day trader manages their risk; it is one of, if not the, most crucial elements of ongoing profitability.
To start, you must keep your risk on each trade very small, and 1 percent or less is typical. This means if you have a $3,000 account you shouldn’t lose more than $30 on a single trade (see Forex Position Sizing). That may seem small, but losses do add up, and even a good day-trading strategy will see strings of losses. Risk is managed using a stop loss order, which will be discussed in the Scenario sections below.
Forex Day Trading Strategy
While a strategy can potentially have many components and can be analyzed for profitability in various ways, a strategy is often ranked based on its win-rate and risk/reward ratio.
Your win rate represents the number of trades you win out a given total number of trades. Say you win 55 out of 100 trades, your win rate is 55 percent. While it isn’t required, having a win rate above 50 percent is ideal for most day traders, and 55 percent is acceptable and attainable.
Risk/reward signifies how much capital is being risked to attain a certain profit. If a trader loses 10 pips on losing trades but makes 15 on winning trades, she is making more on the winners than she’s losing on losers. This means that even if the trader only wins 50 percent of her trades, she will be profitable. Therefore, making more on winning trades is also a strategy component many forex day traders strive for.
A higher win rate for trades means more flexibility with your risk/reward, and a high risk/reward means your win rate can be lower and you’d still be profitable. For a more thorough discussion on win rate and risk/reward see: Day Trade Better Using Win Rate and Risk-Reward Ratios.
Scenario: How Much Money Can I Make Forex Day Trading?
Assume a trader has $5,000 in capital, and they have a decent win rate of 55 percent on their trades. They risk only 1 percent of their capital or $50 per trade. This is accomplished by using a stop-loss order. For this scenario, a stop-loss order is placed 5 pips away from the trade entry price, and a target is placed 8 pips away.
This means that the potential reward on each trade is 1.6 times greater than the risk (8/5). Remember, you want winners to be bigger than losers.
While trading a forex pair for two hours during an active time of day (see: Best Time of Day to Day Trade Forex) it’s usually possible to make about five round turn trades (round turn includes an entry and exit) using the above parameters. If there are 20 trading days in a month, the trader is making 100 trades, on average, in a month.
Forex brokers provide leverage up to 50:1 (more in some countries). For this example, assume the trader is using 30:1 leverage, as usually that is more than enough leverage for forex day traders. Since the trader has $5,000, and leverage is 30:1, the trader is able to take positions worth up to $150,000. Risk is still based on the original $5,000; this keeps the risk limited to a small portion of the deposited capital.
Forex brokers often don’t charge a commission, but rather increase the spread between the bid and ask, thus making it more difficult to day trade profitably. ECN brokers offer a very small spread, making it easier to trade profitably, but they typically charge about $2.50 for every $100,000 traded ($5 round turn).
If you’re day trading a currency pair like the GBP/USD, you can risk $50 on each trade, and each pip of movement is worth $10 with a standard lot (100,000 units worth of currency). Therefore you can take a position of one standard lot with a 5-pip stop-loss order, which will keep the risk of loss to $50 on the trade. That also means a winning trade is worth $80 (8 pips x $10).
With all that out of the way, this estimate can show how much a forex day trader could make in a month by executing 100 trades:
- 55 trades were profitable: 55 x $80 = $4,400
- 45 trades were losers: 45 x ($50) = ($2,250)
Gross profit is $4,400 – $2,250 = $2,150 if no commissions (win rate would likely be lower though)
Net profit is $2,150 – $500 = $1, 650 if using a commission broker (win rate would be like be higher though)
Assuming a net profit of $1,650, the return on the account for the month is 33 percent ($1,650/$5,000). This may seem very high, and it is a very good return. See Refinements below to see how this return may be affected.
It won’t always be possible to find five good day trades each day, especially when the market is moving very slowly for extended periods of time.
Slippage is an inevitable part of trading. It results in a larger loss than expected, even when using a stop loss order. It’s common in very fast moving markets. To account for slippage in your potential profits calculation, reduce the net profit by 10 percent (this is a high estimate for slippage, assuming you avoid holding through major economic data releases). This would reduce the net profit potential generated by your $5,000 trading capital to $1,485 per month.
You can adjust the scenario above based on your typical stop loss and target, capital, slippage, win rate, position size, and commission parameters.
The Final Word
This simple risk-controlled strategy indicates that with a 55 percent win rate, and making more on winners than you lose on losing trades, it’s possible to attain returns north of 20 percent per month with forex day trading. Most traders shouldn’t expect to make this much; while it sounds simple, in reality, it’s a bit more difficult.
Even so, with a decent win rate and risk/reward ratio, a dedicated forex day trader with a decent strategy can make between 5 percent and 15 percent a month thanks to leverage. Also remember, you don’t need much capital to get started, and $500 to $1,000 is usually enough.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.