What Kind of Currency Trader Are You? Part I

Good Day Currency Traders!

It's often said that to trade foreign currencies, you have to decide what kind of currency trader you are. In other words: Are you cut out to be a day trader? A swing trader? Maybe a carry trader? Or a long-term position trader?

Day trading has become so glorified that some think it's the ONLY kind of currency trading out there. But the truth is: There are plenty of trading styles out there.

This week, I'm going to take a look at each of these styles so you can determine which will work best for you and your situation.

Today, I'll start with the easiest (in my opinion).


The Long-Term Invest and
"Go Fishing" Currency Trader

First we have the position trader. A position trader is a long-term FX trader who buys foreign currency positions, and holds them for six months to a year - sometimes even longer. It's the "buy and go fishing" way to trade currencies.

This type of trader has a well funded account (typically anywhere from US$25,000 to over US$1 million) depending on how large the trades are you want to place. As a position trader, you have to trade a very small amount compared to what you have in your account. Why? Because you're holding a position for so long.

Your position has to be able to swing 1,000-3,000 pips or more without wiping out your entire account.

How do you know where a particular currency pair should go? Well, when you're basing a trade off of something six months to a year or more off in time, you have to strictly rely off of the underlying fundamentals of the country that's behind that currency.

If you're this type of trader, then you have a strong view on where inflation is headed for a long time, and where interest rates are also headed to combat that inflation. So you can afford to take a long-term position.

As this type of trader, you do NOT care if a particular currency pair goes against you hundreds or even thousands of pips in the short-term. You're not concerned because you are trading based on a long-term view.

Once you feel that a rate hiking or cutting cycle is over...or once you see the economy's fundamentals are starting to change, then you'll sell off your position OR you may reverse your position into a long-term short position if you feel that the economy will erode for quite some time.

Patience, Patience, Patience...
and a Large Trading Account

As this type of trader, you have to be very patient and well capitalized for the position you're holding. You're not easily swayed by short-term news events. You care more about the "trend" of the long term economic announcements than you do about short-term swings in your position.

As a long-term trader, you would only put on one to two mini lots per US$10,000 in your account maximum. Some will only put on a mini lot per US$15,000 to US$20,000.

Your only concern is being well capitalized enough to make it through all of the swings and ripples along the way as they take the long journey on towards their eventual goal.

Taking long-term positions can be one of the most lucrative styles of trading, but in truth, few FX traders use this trading style because it's not as fast-paced. You have to have a long-term mentality of a value investor really than that of a trader.

You also have to be certain about the fundamentals of a particular country. And in these volatile markets, long-term fundamentals are difficult to gauge.

Remember, as this type of trader, you're looking for long-term giant swings in your favorite currency pair. So say if you were betting the euro would go up versus the dollar (EUR/USD), you would want your position to move 1,000 to 3,000 pips over the course of several months.

In other words, you're looking for long term appreciation/depreciation of a currency.

Good Day Currency Traders!

As I said on Monday, there are many different types of traders in the foreign-exchange spot market. You can be a long-term position trader, day trader, swing trader or even a carry trader.

To give you some insight on which kind of trader you might be, I will talk about two more styles of trading today: Carry trading and swing trading.

Carry trading will actually sound very similar to the position trading I discussed on Monday because carry traders hold positions for months or even up to a year.

However, they are mainly concerned about the daily interest they earn, rather than the profits from the currency appreciation (for carry traders, currency appreciation is just an added bonus).

Carry traders aim for daily interest, so they buy a very high interest yielding currency against a very low interest yielding currency. They do this because they want to collect the difference between those two interest rates.


The Simplest and the Toughest Strategy Depending on the Year

I'll be honest. There are times when this is the easiest trading style in the world and there are other times when this is one of the toughest. Why?

Because you need a couple of things to complete a successful carry trade.

First of all, you need to place a trade that's either heading sideways or up. But it CAN NOT be going down in its long-term trend or it erases all of the daily interest you gained and then some.

The other thing that a carry trade needs to flourish is a low to medium amount of volatility. You CAN NOT have a high level of volatility.

If you're earning US$20 a day on a pair in interest but the pair swings up and down US$400 a day either way, then that can scare every other carry trader away from your trade. They'll not see a lot to be gained in light of the amount of risk they're taking on.

However, I say this style of trading can be very easy at times. Here's why. Carry trading currencies is like investing in stocks with dividends. If you've been tracking the S&P 500 for the last several years, you're well aware that the stock market has basically gone nowhere.

So why do many investors still buy stocks? Answer: Because of dividends. Their stock dividends pad their trading accounts and give them an extra boost in their returns. It also aids the overall investment's return over time. For instance, if a stock only returned 5% that year but also had a 5% dividend, then you really earned 10% in your total return for that year.
The Dividend Paying FX Trade

In the same way, a carry trader gets interest daily, seven days a week credited to their account. However, over time usually more investors want to buy this trade too. When they pile in, it causes your long-term trade to rise in value.

At the same time, many traders don't want to sell the pair too quickly — usually because it's paying these big fat interest payments each day. So the selling pressure typically isn't nearly as strong as the buying pressure in this type of currency pair. Thus the pair goes up over time as an added bonus.

Note: When inflation is high and headed higher, the country's central bank is likely to raise rates to "choke off" that inflation. The thought of high rates or rates going higher attracts large sums of money to that currency. So carry traders look for these attributes to "support" their carry trade while they collect that interest.

Now back to the tougher side of the carry trade. A carry trade in itself involves buying a low-yielding interest pair, and investing in a higher yielding currency.

For example, GBP/JPY (the British pound vs. the Japanese yen), was a strong carry trade for some time while the Bank of Japan (BOJ) held Japan's rates right around zero.

This can be an extremely profitable trade. But here's the rub: When markets get shaky and unstable like they are now, you really have a hard time finding a carry trade that can hold up during all of that.

We're in one of those environments right now. All I have to do is remind you about Bear Stearns, oil prices, Fannie Mae, Freddie Mac, the falling housing market, etc. and you can quickly see why this trade struggles. Answer: Enormous volatility and uncertainty.

So even though this strategy is a long-term trade that last months, traders flock to this carry trade because traders see interest credited to their accounts on a DAILY basis. That's pretty exciting.


Swing to the Left...Profits...Swing to the Right...Profits

The next type of trader is a very common type of trader in the FX markets. It's called the Swing Trader.

The swing trader looks for large swings back and forth in the currency market that can last from days to weeks. They typically are "technical" traders that use charts predominately to make their decisions. They'll use longer term charts such as the four-hour and daily charts for their analysis.

These traders want the currency pair to appreciate or depreciate in the short-term. But they are willing to give the trade some time to "head in the right direction" based on their views.

Swing traders use trend lines and other technical indicators like the Moving Average Convergence/Divergence (MACD), Relative Strength Index (RSI), Slow Stochastics, and Moving Averages, etc. to help them steer their course and make their trading decisions.

So if you're a visual person, like the charts and have a medium sized trading account (US$2,000 to US$10,000) with a bit of patience to hold trades for a couple of days to a couple of weeks, then you might be comfortable being a swing trader.

This is one of the most common styles of trading because swing traders use shorter, more concentrated timeframes for each trade. It also doesn't require a lot of capital and swing traders have some time to let their trades play out; but it doesn't take long before they collect their gains.

Okay, you've now gotten the full story on position traders, carry traders, and swing traders. I'll be back here tomorrow to talk about the most popular type of FX trading — day trading