cmc markets trading smart series: intraday trading challenges

Intraday Trading ChallengesTHE CMC MARKETS TRADING SMART SERIES

CMC Markets | Intraday Trading 2

Possibly the most difficult type of trading to come to terms with is intraday trading (also known simply as ‘day trading’). Yet intraday trading carries with it the most romantic connotations: traders frequently aspire to it as they see it as the area where most of the action happens. In this guide, we discuss various strategies you can use to make trading in short timeframes more precise.

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The idea of intraday trading is, essentially, to utilise strategies that will

keep traders in positions for a short period of time while generating

consistent profits. The other upside – apart from the potential-for-

profit side of things – is that it is possible to remain exposed to the

market for the shortest period of time possible. The point of this is that

you will not be so exposed to news-driven ructions that can adversely

impact longer term position-holders. The final piece of upside for you is

that, as a day trader, you can simply close your positions and not have

a care in the world about what will happen in the market overnight.

While the upsides of day trading need little in the way of introduction,

the downsides do need to be discussed, because prospective traders

(being the optimists that they are) do not spend nearly enough time

thinking about them when confronted with a long list of benefits. The

first issue to deal with is that the level of risk that you take on a per-

trade basis still needs to be small relative to your returns. This may not

sound like a big issue, but when you are trying to make your returns in

a short space of time then the upsides are going to be a lot smaller as

well. At the same time, because of your timeframe you need to have

the ability to find new positions frequently. While a trend trader can

carry a good position for months, this is not possible for the day trader

who needs to lock in profits nice and quickly.

Some would argue that this list of requirements is simply impossible to

achieve, but the results of traders who specialise in this area would beg

to differ. In this guide we will look at the way in which you need to manage

your trading book, and also at how you can reduce the timeframe of

existing methodologies you already use to suit this type of trading.

Starting your day

Once upon a time, the idea of day trading would mean that you were

largely focused on the hours in which the local share market was open

for trade. While this is still an option for traders, it is probably not the

most practical for you to be looking at. This is because the share

market is exposed to gapping at the open of each session where

news and sentiment from overnight is immediately priced in. While

this doesn’t mean that opportunities aren’t still available for traders, it

does potentially lessen the amount of potential upside. For this reason,

this guide focuses on indices and foreign exchange markets which

trade either extended hours or 24 hours a day. While you shouldn’t

feel limited to these, or even feel that these are the best options, they

allow very effective stop placement and also allow traders to deal at

any time that suits them, which is naturally advantageous.

The first step that you are likely to take is to work out the broad trends

you are interested in. This will mean looking to determine if you are

near inflection points on the more macro market trends. For instance,

if you take a look at the EUR/USD and see that it has moved toward

a key support level, then this will likely be one of the potential trades

you will look at. If you are trading a bearish reversal on a daily chart

then this will likely put you a bearish bias even if you are dealing on an

intraday basis. The rationale would be that the prevailing trend is now

negative, so you would typically be looking to trade the broad trends

and even the short-term trends that occur in that direction. If you have

identified the prevailing trend of a market, then it makes good sense to

align your overall strategy in that direction and not just the long term.

It is a fairly logical conclusion that this will be the prevailing direction

of the market. This means that your first step of the day must be

to determine the direction of trends of instruments that you plan to

deal in on the day. If you are dealing in foreign exchange, the impact of

news releases throughout the day can have a very large impact on the

performance of currency pairs. Unfortunately, this performance happens

in the blink of an eye, so it means that unless your position is already set

when the news is released, then you can largely say that you have missed

out. A common strategy is to avoid intraday trading over the release of

economic data because of the extreme volatility that can take place

immediately after it is released – particularly if the data is significantly

different to that of expectations. In the lead-up to major data releases,

news services such as Bloomberg and Reuters survey a large number of

economists in order to get their views on the levels at which the data will

be released. The market will generally start to price itself based on these

expectations, so when the actual data is released it may mean that prices

will adjust significantly in order to be correctly priced based on reality.

Traders are often able to see prices move in the lead-up to data

releases, and this can show that sentiment is shifting ahead of the

data release. Given the size of the FX market, it is safe to assume that

it is not one or two people moving the market so the move in sentiment

must be quite wide reaching. This is not to say that it is necessarily

correct, but it gives you a good idea as to which way money is moving,

which is very important.

Long and short positions

One of the strategies that a lot of novice traders get into involves

taking a long and a short position in the same currency (sometimes

using more than one account) right before the news release and placing

a close stop loss on both of them. Once the data is released, the hope

is that market will move rapidly in one direction, which will see one trade

stopped out and the other significantly in profit. Sounds simple – but

here’s the rub. Even though gaps in the FX market are significantly less

common than equity markets, when they happen the impact is the

same: no trading occurs with them. This means that if the move in price

is significant, there will likely be a very large gap in price, which means

that the trader trying to use this strategy will see significant slippage

on the stop loss that they have placed. In reality, this has nothing to

do with the CFD provider that you use and is instead a function of the

ways in which markets operate.

Something that can also occur when news is released is the market will

move sharply in one direction, and then swing aggressively and reverse

at least a portion of the price movement. This means that a strong

Trading strategy and intraday trading


profit can evaporate quickly if you are not very careful. Depending

on where you are in the world, it may mean a late night – but it is

well worth watching the charts one night when the US Non-Farm

Payroll data is released. This is the biggest piece of economic data

in the world and has the power to seriously shift markets as well as

forecasts for where the US and the global economy is headed. For

this reason, it is the one to watch out for because you will likely get

a decent response from the FX market even if the figures come out

largely in line with expectation. Be sure that you know at the start of

the day exactly what data is being released and decide whether or not

you are going to be carrying positions while this data is released.

Know how sentiment has changed during the night

For people who trade equities, the big gauge of sentiment that people

look to is what happened in the US markets. If the markets were

higher, then this is generally bullish, and vice versa. This type of

information is of use for you regardless of what market you are trading

because it starts to provide an idea as to how traders are thinking

when it comes to a positive or negative attitude toward risk levels.

Taking a broad brushstroke approach to signals of positive or negative

risk attribution, a trader can look to some currencies being pro-risk and

others being anti-risk. The idea of ‘risk-on’ and ‘risk-off’ sessions can

be seen in the same way. Typically the market will look to the US dollar,

the Swiss franc and the Japanese yen as being safe haven currencies.

The ‘risk’ currencies are generally seen as things like the Australian

dollar, the New Zealand dollar and the Canadian dollar. These last three

are also regarded as commodity currencies because of the nature of

where much of their sovereign wealth is derived from. Typically, any

currency outside of the US dollar will be considered a risk currency to

one extent or another. Interestingly, at the time of writing, we have

gone through a phase where the US has struggled to increase their

debt ceiling, which has again concerned the world about the state of

the US dollar as the reserve currency. Nonetheless, the US dollar is not

likely to be overtaken anytime soon and stripped of its mantle.

If you are trading currencies, you may think that this is all that you

need to look at. However, you can readily gauge sentiment from a

number of different sources. The next one to look at is the bonds. In

this area you will typically be assessing the price of US bonds and

the European bonds. Essentially, when you look at these very solid

products (the US government bonds are often seen as a proxy for a

risk-free product) you are getting one of the best views of sentiment

that you possibly can. In basic terms, if the price of bonds is rising then

there is clearly greater demand for a low-risk product, which would

suggest that overall sentiment is not particularly strong. Alternatively,

if bond prices are falling then it would suggest that money is flowing

out of this area and seeking higher returns in assets with higher risk.

This is a simple assessment of what is a complex issue, but what it

really illustrates to you as the trader is the need to try and determine

where money is flowing and what this flow of money suggests about

sentiment. In the previous paragraph, you saw the suggestion that an

increase in bonds may suggest higher demand for risk assets. If at the

same time you looked at the global share markets and saw that they

were generally lower, then this would certainly add evidence to your

assessment. No matter what you are trading, then, you do not want to

neglect the share markets, because as a gauge of sentiment they can

be very useful to you.

While this all sounds very simple (and as a quick exercise it probably

will be) the thing that you need to remember is that all of this

sentiment is already priced into the market. So looking at where

sentiment has gone doesn’t give you an edge over other traders on

its own, but it does allow you to start isolating trends in sentiment.

You can start to ascertain what are the key drivers of sentiment at

the moment and look at how sensitive the overall markets are to news

releases and data.

Consequences of reducing your timeframe

When you develop technical methods of trading it is very likely that you

will be using daily charts as your starting point. While it is the dream

of many traders to work intraday, the reality is that it is not likely to be

where the first trades are made. A good reason for this is that dealing

in the very short term requires extremely well thought-out strategy and

no hesitation at all to close out losing positions.

Happily, for the most part, the methods you use can likely be kept

consistent – you can simply apply them over a shorter timeframe.

This sounds very simple, which is why you should be a bit suspicious,

because there is a downside to this. CFDs have enabled people

to trade very cheaply compared to prices of yesteryear, which is

something to be cheerful about in the first place, but the price of

dealing isn’t free. This means that if you are dealing in the shorter

term then your cost of dealing overall will certainly rise. This happens

because you are dealing more frequently, and also because the profits

that you will be aiming to make will be significantly smaller relative to

those that someone like a trend-follower would be aiming to make.

The essence of this is that the shorter the timeframe becomes, the

smaller your profit/loss ratio will likely become – which means that your

win/loss ratio needs to improve to account for this. This sounds so

simple, but anyone who has traded for any length of time will know that

to be able to ‘just improve’ is essentially utopia for traders, so to speak

flippantly about it is clearly ridiculous. Failing though to have a view to

improving this will be to miss a key component of successful short-term

trading. While looking at specific methodologies is outside the scope

of this guide, the trader does need to establish extremely precise entry

and exit methods, because there is simply no room for second guessing

when it comes to decisions to open and close positions. While this

should really be a feature of any strategy, it is of supreme importance

in this case due to the fact that you have a lot less profit margin to be

working with. It is on this point of comparison that the trader needs to

be very confident in their desire to be an intraday trader, because it is

you doing more of the work for your profits and less of the market.

With the idea of superior precision in mind, you may find that setups

involving things like moving average crossovers are less useful

compared to trend reversals and support/resistance levels. The reason

for this is that the latter will typically offer you a very clear entry level,

and of at least equal importance is the precision of your stop loss


levels. Importantly, too, the style of setup that has been mentioned

here will often allow you to employ very close stop losses too. Traders

should be very careful using short-term support/resistance levels in

many markets, including foreign exchange.

While this is a very well-known means of trading, the breakouts of

these levels in the short term can often prove to be bull or bear traps,

meaning that you get a minor break and then a quick reversal. This

is really frustrating if you have been stalking the trade for hours.

Sometime a subsequent break of the level will hold, but if you have

already been stopped out once you may (not surprisingly) feel a little bit

timid having another go at the same setup.

Chart 1 shows an example of how tricky some breakouts can be to deal

with. Initially, the breakout occurred to the upside on this hourly chart.

However, you can see that the breakout was far from clear, with the

price trading on both sides of the S/R line for around four hours. You

can see then in the right-hand circle that the price breaches the S/R

line to the downside, which would have seen the trader knocked out of

the trade if they had moved their stop loss higher. You can see that this

price managed to move higher and get up toward a standard profit point

based on this type of setup. As you can see, you should be very cautious

approaching these setups because they will frequently play out in a much

less tidy fashion than you will see on any demonstrative diagram. It also

means that your stop loss will likely need to be placed further away from

your entry level than you may otherwise have hoped for. You will likely

need to reduce your position size accordingly, as you will otherwise be

risking above a reasonable amount on a per-trade basis.

Striking a risk: reward balance

If you are expecting to make a gain of 5% on a trade, do you risk the

same amount of capital whether you expect it to take an hour or a

month to occur? From a purely philosophical perspective, the answer

would be yes. If you have the same risk:reward profile and the same

win/loss ratio, then clearly this is the correct course of action to take

because you are making the same profit much more quickly. The reality

of the situation, however, is that the question being asked is nowhere

near this simple. Even beyond the simple fact that making 5% in a day

is not going to be nearly as achievable as making it in a month, the

intraday trader has to deal with the psychological difficulty of making or

losing money much more quickly.

Imagine if there is a negative swing in the market and five positions

that you opened an hour ago are stopped out in quick succession. The

fact that this happened so quickly does not make your trading strategy

any more or less viable, but it can weigh very heavily on the trader.

Given the speed this can happen, this type of trading is only really

suitable for someone who is well conditioned at higher market

timeframes. It takes a lot of mental nerve to be able to look beyond the

ultra short-term ructions in the market and to persist with a strategy

without having your confidence shaken even a little bit. The other side

of the coin is also valid: this type of trader cannot allow themselves to

get out of control after they have had a good string of winning trades

either. Simply they must be able to persist with their plan through

positive and negative trading conditions.

Chart 1


So you can see here that this is largely an illogical argument to be

making. If you have a winning strategy, then you should be exploiting it

as frequently as possible. Beyond this fairly obvious factor relating to

your expected outcomes, you need to be confident that you will behave

rationally in the face of adverse trading conditions. Annoyingly, this is an

argument that has little to do with the soundness of a trader’s strategy

and everything to do with the behaviour of the individual trader.

Other alerts for turnarounds

When it comes to very short-term timeframes, you will likely need to

start focusing more of your market observation of price movement.

When you are looking at price you are looking for trading formations

that occur and worrying less about confirming tools like indicators and

oscillators.

You may feel that this is removing one of your major weapons for

trading, but the payoff will hopefully be superior risk:reward ratios due

to less degrees of confirmation being required before placing trades.

You should check out our guide to candlestick patterns and look at

the engulfing pattern and tweezers. These two setups can be an ideal

starting point to quickly determine points of short-term reversal in

price. With these particular setups you will likely be aiming for a very

conservative risk:reward ratio, unlikely to be higher than 1:2. This may

sound significantly smaller than you are used to, but if you are trying to

capture minute gains then this is what you should be prepared for.

Thomas Bulkowski, who conducted statistical studies on the high

levels of reversal that the engulfing pattern was able to pinpoint,

at the same time noted the very weak level of continuation that it

pre-empted. You can deduct two things from this. Firstly, that many

methods are not designed to capture significant price moves, and

secondly that in order to be successful at this type of trading you will

need to dedicate significant time to scanning the market and then

quickly placing trades when the setups arise.

Keep in mind that this type of trading has no resemblance to longer

term methods such as trend following so it becomes much more

difficult to capture ongoing movements in the market. You may find

that you need to develop an alternative focus that is happy with the

small gains you can capture rather than lamenting the gains that

you left on the table. The old mantra of cut your losses and let your

profits run doesn’t apply in the same way when your profits can

evaporate very quickly.

SummaryWhile, for many, the idea of intraday trading may seem utopian, you

need to be very clear that the shorter your trading timeframe becomes,

the more precision is required in all facets of your trading. Typically, you

will be dealing within a very narrow range of price, so timing of your

entry and exits needs to be planned according to a well thought-out

strategy and without any hesitation on your part.

You will find that you can apply most technical methods to this type

of trading, but you should probably focus more on those that require

only price confirmation for the setup. The more indicators you apply,

the more lag there will be on the entry and the exit. This may be

satisfactory, but it may also impact your success – so you need to be

mindful of this factor during the testing phase.

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