Why I Vastly Prefer Long-Term Forex Trading

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Includes: FXB, UUP
by: Discount Fountain

Summary

A long-term approach with forex trading allows for potentially greater profits with less capital investment.

Short-term trades have the disadvantage of triggering premature stop losses when taking risk and return into account.

A short GBP/USD position is one example of a long position that is faring well under current market conditions.

If you trade the forex markets regularly, chances are that a lot of your trading is of the short-term variety; i.e. your trades may well last less than five minutes, and all your trades are based on technical indicators, such as Simple Moving Averages, Bollinger Bands, Charts and Patterns, and so on. From my experience, there is one major flaw with this type of trading: high-speed computers and algorithms will spot these patterns faster than you ever will.

When I initially started trading, my strategy was similar to that of many short-term traders. That is, analyze the technicals to decide on a long or short position (or even no position in the absence of a clear trend), and then wait for the all-important breakout, i.e. breach of a previous range to confirm a particular trend, and then run along with it for a profit. I can't tell you how many times I would open a position after a breakout, only for the price to move back in the opposite direction - with my stop loss closing me out of the trade. More often than not, the traders who make the money are those who are adept at anticipating such a breakout before it happens. As mentioned, computers can take such up-to-the-second information to discern when this will happen - humans will never be able to calculate changes in volatility, pattern formations and the like faster than those high speed computers built by programmers with skills to rival the likes of Bill Gates or Bjarne Stroustrup. My advice? Don't try to take on the hedge funds in this game - you won't win.

Additionally, there are practical considerations when it comes to this type of trading. First of all, while having a stop loss is always necessary irrespective of your time horizon, the absence of one during a short-term trade can prove fatal. Since a short-term trader is looking to make money on far fewer pips than a long-term trader, this invariably requires a greater degree of capital or leverage. A trade that goes significantly in the opposite direction to what you anticipate will likely wipe out your initial investment. Moreover, setting a stop loss at a range so as to avoid losing vast sums of money means you are not giving a position the chance to work for the long term.

For instance, let's consider the long EUR/USD position below. We can see a sudden breakout from 1.0568 to 1.0575 at 12:30 in the chart. Assume that our stop loss is set at 1.0570. We can see that after opening a position after the breakout has breached range - let's say 1.0572 - the trade eventually dips back to 1.0569 before rising again to a level of 1.0578.

Source: OANDA

Clearly, a stop loss designed to prevent significant losses will close out our trades more often than not. Indeed, short-term forex trading often demands that this is the case if your goal is to prevent losing a significant amount of money. For instance, let us assume that you have a risk-return ratio preference of 1:2. In a particular trade, you will set a stop loss if your position goes down 5%, while taking profit if the position rises 10%. Statistically, you will more often than not have losing trades. Of course, you can get lucky and have more winners than losers, but are you not effectively just rolling the dice at this point?

Which brings me to long-term forex trading. Remember that old saying that stock market professionals use - "It is about time in the market, rather than timing the market". The forex market works to quite a similar degree. It does, of course vary in the sense that you cannot simply expect to hold a currency until retirement expecting it to continuously appreciate in value! However, when you start trading forex over the context of a week, a month - even several months - you are no longer trading on the basis of technicals. You are now trading on the basis of economic factors. In this regard, doing a reasonable amount of research and staying abreast of market developments means that long-term trading can prove a much more sustainable strategy.

Let's take the example of a short GBP/USD position. Right now, uncertainty regarding the UK General Election and the possibility of a hung parliament has seen the GBP/USD trade lower over the past two months. While there was a slight rebound throughout the latter half of March, the currency overall has depreciated against the USD.

Source: OANDA

Based on this simple thesis, we can reasonably expect that the GBP is more likely to depreciate as May 7 draws nearer. In this regard, following the long-term trend since March would have proven far more sustainable than simply attempting to jump in and out. Moreover, long-term trading gives us more pips to play with. This means that we can afford to invest less into a position or use less leverage because our goal is to make a profit over a longer time-span. Additionally, we can afford to set a stop loss at a wider range, e.g. 30%, since we do not need to invest as much capital to yield a similar profit over a longer term. In this way, we are limiting the real dollar loss of our trade. Sure, it may not have the adrenaline associated with short-term trading, nor will you see profits yielded as quickly. However, if you are approaching this from a long-term standpoint, it is easy to see why this approach is more sustainable.

To conclude, I vastly prefer long-term trading because it allows more of a chance to trade on the bigger picture, while concurrently allowing for a greater bandwidth to set a stop loss at a lower commitment of capital. For these reasons, long-term trading remains my weapon of choice.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.