The number of trades that Forex traders make on a regular basis not only depends on the trading strategy they utilise, but also on the timeframe they trade. Inexperienced traders are often attracted to short-term timeframes, which offer faster trading action than long-term timeframes. However, this comes with its drawbacks, and there are many benefits of trading longer-term timeframes over shorter-term ones. Some of them are addressed in this article.
In retail Forex trading, there are two broad types of trading styles when reference is made to the frequency of trades made in the Forex market:
a) High frequency trading
b) Low frequency trading
Now let's take a look at two common types of trading to determine which is best
High frequency trading
For the purposes of this article, high frequency trading does not refer to the multiple fast paced trades that are placed by automated trading algorithms, but the multiple trades placed on short term charts by human retail traders. In fact, this is the style of trading adopted by most retail traders in the market today. There is the erroneous belief that the more trades that are made, the higher the chance that money will be made. This is the style of thinking that has consumed those whom Robert Kiyosaki has described as being in the rat race, where money is a direct function of time. The more hours clocked at work, the greater the financial rewards. In Forex trading, this has been proven not to be the case. The less time that is spent, the more likely that you will have a clearer head to pick out trades with very high reward to risk potential. Those who stare at charts too long and take too many trades are liable to fall into the following traps:
- You overestimate your capacity and technical capabilities.
- You tend to use up precious margin and leave very little for high probability trade opportunities that may come up in the future.
- You do not allow for opportunities to fall well into place.
- You start to see opportunities which do not really exist.
- You overtrade and start to chase the market to recover your losses.
All these lead to trade mistakes and losses. Is it surprising that 95% of retail traders end up losing money? The statistics do not lie.
So, if the stats clearly show that manually-driven high frequency trading is not profitable, why do people still do it? One reason is overconfidence. If a few wins are recorded, high frequency trader tends to get a false sense of ability. So transient success is then attributed to ability and not random luck, which serves as a positive feedback mechanism that causes these traders to trade more aggressively and take more risks. Once extra risks are taken, losses can easily nullify any previous profits. Panic sets in, leading to frantic attempts to recover losses, which lead to more losses and before long, a margin call from the broker.
Low frequency trading
As opposed to high frequency trading, low frequency trades mean that very few trades taken over a monthly cycle, usually because these trades are constructed on long term charts (such as the daily charts), and take more to evolve but end up delivering better returns on investment.
It is possible to construct a trade on the daily chart which can take up to 2 weeks to complete. Ask yourself: which is better? Taking 4 trades a month with a possibility of delivering up to 400 pips on a trade, or chasing so many trades that only give 20 or 30 pips a trade in profit with a greater chance of loss?
All position and long-term traders know that the daily chart is a better indication of the trend than short term charts. Trends come in three phases: (1) major trends, that last for more than 6 months, (2) intermediate trends, that are basically corrections of the primary trend, and (3) minor trends, which act as noise on shorter-term timeframes.
What may seem to be an uptrend in a short-term chart may actually be an upside retracement (intermediate trend) on a daily chart. High frequency traders who use the false information provided by the short-term charts to go long, will end up being blown off course by the low frequency traders who are actually waiting to sell on the short-term rally in the direction of the underlying trend. Due to the fact that the institutional traders who control market volume trade on long term charts, it is a question of a huge river current blowing away a small boat. You can only ride a small boat on a river as long as there is no countercurrent. Once that massive countercurrent comes, even the best small boat rowers will be blown off course with the current.
Here’s why low frequency trading is a better way to trade:
- You spend less time in front of your computer screen, which is good for your eyes and your general health.
- Your chances of trading with the trend are enhanced. It is like using the sails, so the wind works in your favour, rather than manually rowing against a huge current.
- Your trading workload is less.
- There is potential for more reward-to-risk for each trade.
- The trade setups of low-frequency trades usually have a much larger probability than high-frequency trades.
- You have more time to yourself to do the things that matter in life.
Low-frequency vs. high-frequency: the facts
Your potential profits or losses in a trade should be considered as a function of the R-factor. The R-factor is defined as how much money you stand to make over a specific time period in relation to the trade risk (R).
If you risk $500 as Stop Loss in a trade, your R-value is $500. Any profit you make in terms of cash will be a multiplied figure of the R-factor. So, if you end up making $1,000 in a month, your R-factor is 1,000/500, which is 2, and your profit is a 2R rate of return.
You should always use the R-factor as this is a true way to evaluate your performance. Trading is not about percentage earned; it is about the reward to risk.
One trader may take 100 trades to achieve an R-factor of 5, while another trader may take only 10 trades to achieve the same 5R return. What sense would it make for a traveler take a route that would entail 10 hours of travel when they could take another route that would get to the same destination in half the time or even less? Less fatigue, more time to do other things, less stress, and better capacity utilisation.
In addition, spotting trading opportunities on larger timeframes is usually much easier than on noisy short-term timeframes. Chart patterns, candlestick patterns, channels, trend lines, support & resistance lines, Fibonacci retracements, pivot points, and any other technical tool has a much larger probability of success on daily timeframes than the 5-minute timeframe, for example.
The Forex market is a market that loves to trend, and focusing too much on a minor trend on short-term trendlines and market noise leads to missed high-probability opportunities on longer-term timeframes.
The major lesson to learn here is this: the same R-factor over a specific time period can be achieved with less frequency of trading. This is achieved by focusing on trade quality and not trade quantity. Start now to take trades off daily charts. You are more likely to get better results with less stress and energy than if you trade off short term charts. If nothing else convinces you, then these two charts should:
Daily chart showing price progression for EURUSD after a pennant formation
This is a daily chart for the EURUSD pair. A clear pennant pattern has formed, leading to a bullish breakout to the upside which resulted in a profitable trading opportunity. Indeed, the profit of this trade was over 500 pips. Any good technical trader can spot this and trade it with ease. One glance, one trade, and hundreds of pips in a few days. Now compare the same setup on a 30-minute chart:
How does a high frequency trader ever spot the clear setup seen on the daily chart using a 30-minute chart as shown above? The answer is simple: it's not possible. All that will occur here are whipsaws, and error-filled trades.
The choice to be made here is clear: low-frequency trading on longer-term charts is the way forward. In addition to the already mentioned advantages of low-frequency over high-frequency trading, there is one more: transaction costs. Taking a lower number of trades with the potential to gain a large number of pips has also significantly smaller transaction costs compared to high-frequency trades, which only adds to the benefits of low-frequency trading.