How Long Should You Hold FX Trades?
02/03/2014 9:00 am EST
By analyzing intrinsic (market-related) and extrinsic (outside) risk factors and considering their unique trading style and risk tolerance, traders can determine the proper time frame in which to trade, says Fan Yang of FXTimes.com.
Market participants vary in trading style as much as they vary in personality. One aspect of trading is the time frame used.
While there are traders who are more like investors, looking for somewhere with a long-term advantage to park their money, others trade within a specific session and are in and out of the market frequently.
It is important to consider the exposure to intrinsic risks compared to external risks when selecting a time frame in which to trade.
When considering whether to trade intra-session moves or weekly swings or invest with a long-term bias, think about the logistics of trading and the risks involved.
Intrinsic risks refer to those that exist within the market. For example, in the forex markets, whether the European Central Bank (ECB) will surprise with talk of a rate hike when everyone was anticipating a rate cut is an intrinsic risk.
Even geopolitical or geographical surprises such as a toppled regime or a major earthquake that affects a significant resource in the economy are intrinsic risks in currency trading. Political instability in oil-producing nations, for example, might push up oil prices, and in turn, we might see a rise in the Canadian dollar, or loonie. (Oil prices and the loonie are correlated).
The Japanese earthquake/tsunami/nuclear crisis in March 2011 weakened the Japanese yen (JPY) in the immediate aftermath due to repatriation of funds to help the nation rebuild. (Repatriation means the Japanese yen flooded back to Japan, creating a surge in supply, and thus a provided a drag to JPY.) As a trader, the longer your position is in the market, the more exposure you have to intrinsic risks.
Extrinsic risks refer to those outside the realm of market influence. For example, if your computer freezes as the market starts moving and giving you signals, you have a risk of missing a trade, or not being able to get out of a bad one. (That’s why stops are important).
Internet connection falters just as you are ready to open some positions. There are always risks associated with the way you trade.
Even if you call in, there is a chance of high volume and an inability for your broker to serve you by giving a price you were looking for. Traders need to be aware of these risks as well. External risks cause problems in trading logistics and over time can add up and cripple performance results.
Short-term, high-frequency traders are exposed to extrinsic risks the most. Think about it: these traders are in and out of the market constantly. They need to monitor the market because these signals come in even five-minute intervals and a little coffee break spent away from the computer can be the missed opportunity for that session.
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Long-Term Trading Advantage/Short-Term Disadvantage
As a long-term trader, you will have to be concerned mostly with possible changes in sentiment and fundamentals that can change the direction of the market because it gets to your target level. The advantage is that you can stay above the everyday noise if certain long-term factors like interest rate expectations support your trade. (If country A is expected to raise interest rates earlier than country B, then the A/B currency has a bullish bias.) Holding on a position will give you some gains in interest rollover (benefit of a carry trade).
Also, extrinsic risks are limited. This is because you have more time to set up your exit and entry. It is also because relative to the potential reward (or loss), the difference in price you get to the price you wanted is not as significant.
For example if your trade has a reward target of 200 pips, and you miss 15 pips in the entry and another 15 pips in the exit prices, it might not impact your trade performance significantly. Conversely, a trade with a 50-pip target could go very wrong if you had the same problem.
Long-Term Trading Disadvantage/Short-Term Advantage
The longer a position is open, the better the chances that some additional factor will enter the market to shake things up. Sometimes it’s for the better; sometimes for the worse. So is this actually a disadvantage?
Well, a trade should be based on the decision that one currency has an edge on another. But things change, and no matter how smart you are, you can’t consistently predict the future.
Allowing a trade to be exposed for a long period of time can mean an initially thought-out trade turning into a gamble. The short-term trader is not going to deal with so many risk events within the period of the trade. Some even stay away from specific fundamental factors and trade only when the reaction is clear. Then, before another fundamental factor influences the market, he or she is out of the trade or is then setting up for a completely different trade.
The advantage of traders in the small time frame is having more agility to maneuver between intrinsic risk factors.
The decision is yours. There is always this trade-off of exposure to intrinsic versus extrinsic risk. You have to decide which is more important to you as a trader.
It might not be apparent to you if you are a beginning trader, so do spend some time seriously demo trading to find out what time frame you prefer.
By Fan Yang, contributor, FXTimes.com