First, let’s start with an exponential moving average. When you want a moving average that will respond to the price action rather quickly, then a short period EMA is the best way to go. These can help you catch trends very early, which will result in higher profit. In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits!
The downside to the choppy moving average is that you might get faked out. Because the moving average responds so quickly to the price, you might think a trend is forming when in actuality; it could just be a price spike.
With a simple moving average, the opposite is true. When you want a moving average that is smoother and slower to respond to price action, then a longer period SMA is the best way to go.
Although it is slow to respond to the price action, it will save you from many fake outs. The downside is that it might delay you too long, and you might miss out on a good trade.
So which one is better? It’s really up to you to decide. Many traders plot several different moving averages to give them both sides of the story. They might use a longer period simple moving average to find out what the overall trend is, and then use a shorter period exponential moving average to find a good time to enter a trade.
In fact, many trading systems are built around what is called “Moving Average Crossovers”. Later in this course, we will give you an example of how you can use moving averages as part of your trading system.
Time for recess! Go find a chart and start playing with some moving averages. Try out different types and look at different periods. In time, you will find out which moving averages work best for you. Class dismissed!
quinta-feira, 21 de fevereiro de 2008
Exponential Moving Average (EMA)
Although the simple moving average is a great tool, there is one major flaw associated with it. Simple moving averages are very susceptible to spikes. Let me show you an example of what I mean:
Let’s say we plot a 5 period SMA on the daily chart of the EUR/USD and the closing prices for the last 5 days are as follows:
Day 1: 1.2345Day 2: 1.2350Day 3: 1.2360Day 4: 1.2365Day 5: 1.2370
The simple moving average would be calculated as(1.2345+1.2350+1.2360+1.2365+1.2370)/5= 1.2358
Simple enough right?
Well what if Day 2’s price was 1.2300? The result of the simple moving average would be a lot lower and it would give you the notion that the price was actually going down, when in reality, Day 2 could have just been a one time event (maybe interest rates decreasing).
Let’s say we plot a 5 period SMA on the daily chart of the EUR/USD and the closing prices for the last 5 days are as follows:
Day 1: 1.2345Day 2: 1.2350Day 3: 1.2360Day 4: 1.2365Day 5: 1.2370
The simple moving average would be calculated as(1.2345+1.2350+1.2360+1.2365+1.2370)/5= 1.2358
Simple enough right?
Well what if Day 2’s price was 1.2300? The result of the simple moving average would be a lot lower and it would give you the notion that the price was actually going down, when in reality, Day 2 could have just been a one time event (maybe interest rates decreasing).
The point I’m trying to make is that sometimes the simple moving average might be too simple. If only there was a way that you could filter out these spikes so that you wouldn’t get the wrong idea. Hmmmm…I wonder….Wait a minute……Yep, there is a way!
It’s called the Exponential Moving Average!
Exponential moving averages (EMA) give more weight to the most recent periods. In our example above, the EMA would put more weight on Days 3-5, which means that the spike on Day 2 would be of lesser value and wouldn’t affect the moving average as much. What this does is it puts more emphasis on what traders are doing NOW.
It’s called the Exponential Moving Average!
Exponential moving averages (EMA) give more weight to the most recent periods. In our example above, the EMA would put more weight on Days 3-5, which means that the spike on Day 2 would be of lesser value and wouldn’t affect the moving average as much. What this does is it puts more emphasis on what traders are doing NOW.
When trading, it is far more important to see what traders are doing now rather than what they did last week or last month.
Simple Moving Average
A simple moving average is the simplest type of moving average (DUH!). Basically, a simple moving average is calculated by adding up the last “X” period’s closing prices and then dividing that number by X. Confused??? Allow me to clarify.
If you plotted a 5 period simple moving average on a 1 hour chart, you would add up the closing prices for the last 5 hours, and then divide that number by 5. Voila! You have your simple moving average.
If you were to plot a 5 period simple moving average on a 10 minute chart, you would add up the closing prices of the last 50 minutes and then divide that number by 5.
If you were to plot a 5 period simple moving average on a 30 minute chart, you would add up the closing prices of the last 150 minutes and then divide that number by 5.
If you were to plot the 5 period simple moving average on the a 4 hr. chart………………..OK OK, I think you get the picture! Let’s move on.
Most charting packages will do all the calculations for you. The reason we just bored you (yawn!) with how to calculate a simple moving average is because it is important that you understand how the moving averages are calculated. If you understand how each moving average is calculated, you can make your own decision as to which type is better for you.
Just like any indicator out there, moving averages operate with a delay. Because you are taking the averages of the price, you are really only seeing a “forecast” of the future price and not a concrete view of the future. Disclaimer: Moving averages will not turn you into Ms. Cleo the psychic!
If you plotted a 5 period simple moving average on a 1 hour chart, you would add up the closing prices for the last 5 hours, and then divide that number by 5. Voila! You have your simple moving average.
If you were to plot a 5 period simple moving average on a 10 minute chart, you would add up the closing prices of the last 50 minutes and then divide that number by 5.
If you were to plot a 5 period simple moving average on a 30 minute chart, you would add up the closing prices of the last 150 minutes and then divide that number by 5.
If you were to plot the 5 period simple moving average on the a 4 hr. chart………………..OK OK, I think you get the picture! Let’s move on.
Most charting packages will do all the calculations for you. The reason we just bored you (yawn!) with how to calculate a simple moving average is because it is important that you understand how the moving averages are calculated. If you understand how each moving average is calculated, you can make your own decision as to which type is better for you.
Just like any indicator out there, moving averages operate with a delay. Because you are taking the averages of the price, you are really only seeing a “forecast” of the future price and not a concrete view of the future. Disclaimer: Moving averages will not turn you into Ms. Cleo the psychic!
On the previous chart, you can see 3 different SMAs. As you can see, the longer the SMA period is, the more it lags behind the price. Notice how the 62 SMA is farther away from the current price than the 30 and 5 SMA. This is because with the 62 SMA, you are adding up the closing prices of the last 62 periods and dividing it by 62. The higher the number period you use, the slower it is to react to the price movement.
The SMA’s in this chart show you the overall sentiment of the market at this point in time. Instead of just looking at the current price of the market, the moving averages give us a broader view, and we can now make a general prediction of its future price.
Moving Averages
A moving average is simply a way to smooth out price action over time. By “moving average”, we mean that you are taking the average closing price of a currency for the last ‘X’ number of periods.
Like every indicator, a moving average indicator is used to help us forecast future prices. By looking at the slope of the moving average, you can make general predictions as to where the price will go.
As we said, moving averages smooth out price action. There are different types of moving averages, and each of them has their own level of “smoothness”. Generally, the smoother the moving average, the slower it is to react to the price movement. The choppier the moving average, the quicker it is to react to the price movement.
As we said, moving averages smooth out price action. There are different types of moving averages, and each of them has their own level of “smoothness”. Generally, the smoother the moving average, the slower it is to react to the price movement. The choppier the moving average, the quicker it is to react to the price movement.
segunda-feira, 18 de fevereiro de 2008
The best investment you can ever make is in yourself.
Don’t spend your money on a company that promises huge returns; even if they show you their track record. It might look pretty and colorful; and I’m sure that the line on the graph that seems to keep going higher and higher makes it look like there is no way you could lose money, but don’t let them fool you. In fact, I could take my broker statement right now, touch it up with Photoshop and voila! – I have now just become the most successful trader on the planet. Pretty impressive huh? I know I’m laying it on pretty thick, but I really want to prevent you from falling into any traps. Instead of giving your hard earned money to someone else, you could put that money aside into a trading account and take the time to educate yourself.
Notice that I didn’t say you should put your money into a trading account and start trading.
Keep that money in your account and gradually add to it as you continue to learn. Before you know it, your account size will be bigger than you realized, and to top it off, you’ll have a wealth of Forex education under your “traders” belt.
So remember, Forex scams DO exist. Be wary of them and hold onto your money. The good news is that there ARE legitimate Forex companies out there. Make sure you do thorough research on a company if you are thinking about giving them a shot. Ask other traders on the forums if they've had experiences with them. There is a wealth of information on the Internet so do your homework and you’ll be just fine.
Notice that I didn’t say you should put your money into a trading account and start trading.
Keep that money in your account and gradually add to it as you continue to learn. Before you know it, your account size will be bigger than you realized, and to top it off, you’ll have a wealth of Forex education under your “traders” belt.
So remember, Forex scams DO exist. Be wary of them and hold onto your money. The good news is that there ARE legitimate Forex companies out there. Make sure you do thorough research on a company if you are thinking about giving them a shot. Ask other traders on the forums if they've had experiences with them. There is a wealth of information on the Internet so do your homework and you’ll be just fine.
Forex Scams
One of the first things you must learn about the Forex market is that although it is enjoyable and exciting, there is no magic button that will instantly turn your pennies into millions of dollars. You may have already heard about Forex scams that are filling the marketplace. These companies purposely mislead people into thinking that making money in the Forex is easy and that they have found the “Magic Solution” to raking in booku bucks with a simple click of a button.
Sadly, the number of Forex scams is rising. The Commodities Futures Trading Commission (CFTC) released a report citing that in recent years, they have seen a sharp increase in the rise of Foreign Exchange scams. The CFTC warns consumers to be cautious of sales solicitations in newspapers, radio or television. You’ve probably even seen some of these companies. I hear about them all the time from people whenever I try to explain the Forex. The first thing they say is that they think the Forex is a scam. That makes me so angry! The Forex is a tremendous investment opportunity for people and because of these scammers, they miss out on a good way to make money.
The truth is that no matter how you slice or dice it, education is the only fool proof way to consistently make money in the Foreign Exchange. Even after you finish reading through BabyPips.com, your journey as a FX trader is only the beginning. I have never met a successful Forex trader who stopped learning. There is always something new to learn and you must actively seek out as much information as you can.
Sadly, the number of Forex scams is rising. The Commodities Futures Trading Commission (CFTC) released a report citing that in recent years, they have seen a sharp increase in the rise of Foreign Exchange scams. The CFTC warns consumers to be cautious of sales solicitations in newspapers, radio or television. You’ve probably even seen some of these companies. I hear about them all the time from people whenever I try to explain the Forex. The first thing they say is that they think the Forex is a scam. That makes me so angry! The Forex is a tremendous investment opportunity for people and because of these scammers, they miss out on a good way to make money.
The truth is that no matter how you slice or dice it, education is the only fool proof way to consistently make money in the Foreign Exchange. Even after you finish reading through BabyPips.com, your journey as a FX trader is only the beginning. I have never met a successful Forex trader who stopped learning. There is always something new to learn and you must actively seek out as much information as you can.
quinta-feira, 14 de fevereiro de 2008
Money Management
This section is one of the most important sections you will ever read about trading.
Why is it important? Well, we are in the business of making money, and in order to make money we have to learn how to manage it. Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regards to their total account size. They simply determine how much they can stomach to lose in a single trade and hit the “trade” button. There’s a term for this type of investing….it’s called GAMBLING!
When you trade without money management rules, you are in fact gambling. You are not looking at the long term return on your investment. Instead you are only looking for that “jackpot”. Money management rules will not only protect us, but they will make us very profitable in the long run. If you don’t believe me, and you think that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes to win a big jackpot, and in fact, many people do win. So how in the world, are casino’s still making money if many individuals are winning jackpots? The answer is that while even though people win jackpots, in the long run, casino’s are still profitable because they rake in more money from the people that don’t win. That is where the term “the house always wins” comes from.
The truth is that casinos are just very rich statisticians. They know that in the long run, they will be the ones making the money—not the gamblers. Even if Joe Schmoe wins $100,000 jackpot in a slot machine, the casinos know that there will be 100 more gamblers who WON’T win that jackpot and the money will go right back in their pockets.
This is a classic example of how statisticians make money over gamblers. Even though both lose money, the statistician, or casino in this case, knows how to control their losses. Essentially, this is how money management works.If you learn how to control your losses, you will have a chance at being profitable.
You want to be the rich statistician…NOT the gambler because in the long run, you want to “always be the winner.”
So how do you become this rich statistician instead of a loser?
Why is it important? Well, we are in the business of making money, and in order to make money we have to learn how to manage it. Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regards to their total account size. They simply determine how much they can stomach to lose in a single trade and hit the “trade” button. There’s a term for this type of investing….it’s called GAMBLING!
When you trade without money management rules, you are in fact gambling. You are not looking at the long term return on your investment. Instead you are only looking for that “jackpot”. Money management rules will not only protect us, but they will make us very profitable in the long run. If you don’t believe me, and you think that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes to win a big jackpot, and in fact, many people do win. So how in the world, are casino’s still making money if many individuals are winning jackpots? The answer is that while even though people win jackpots, in the long run, casino’s are still profitable because they rake in more money from the people that don’t win. That is where the term “the house always wins” comes from.
The truth is that casinos are just very rich statisticians. They know that in the long run, they will be the ones making the money—not the gamblers. Even if Joe Schmoe wins $100,000 jackpot in a slot machine, the casinos know that there will be 100 more gamblers who WON’T win that jackpot and the money will go right back in their pockets.
This is a classic example of how statisticians make money over gamblers. Even though both lose money, the statistician, or casino in this case, knows how to control their losses. Essentially, this is how money management works.If you learn how to control your losses, you will have a chance at being profitable.
You want to be the rich statistician…NOT the gambler because in the long run, you want to “always be the winner.”
So how do you become this rich statistician instead of a loser?
quarta-feira, 13 de fevereiro de 2008
How to Calculate Pivot Points
The pivot point and associated support and resistance levels are calculated by using the last trading session’s open, high, low, and close. Since Forex is a 24-hour market, most traders use the New York closing time of 4:00pm EST as the previous day’s close.
The calculation for a pivot point is shown below:
Pivot point (PP) = (High + Low + Close) / 3
Support and resistance levels are then calculated off the pivot point like so:
First level support and resistance:
First support (S1) = (2*PP) – High
First resistance (R1) = (2*PP) – Low
Second level of support and resistance:
Second support (S2) = PP – (High – Low)Second resistance (R2) = PP + (High - Low)
Don’t worry you don’t have to perform these calculations yourself. Your charting software will automatically do it for you and plot it on the chart.
Also keep in mind that some charting software also provides additional pivot point features such as a third support and resistance level and intermediate levels or mid-point levels (levels in between the main pivot point and support and resistance level).
These “extra levels” aren’t as significant as the main five but it doesn’t hurt to pay attention to them
The calculation for a pivot point is shown below:
Pivot point (PP) = (High + Low + Close) / 3
Support and resistance levels are then calculated off the pivot point like so:
First level support and resistance:
First support (S1) = (2*PP) – High
First resistance (R1) = (2*PP) – Low
Second level of support and resistance:
Second support (S2) = PP – (High – Low)Second resistance (R2) = PP + (High - Low)
Don’t worry you don’t have to perform these calculations yourself. Your charting software will automatically do it for you and plot it on the chart.
Also keep in mind that some charting software also provides additional pivot point features such as a third support and resistance level and intermediate levels or mid-point levels (levels in between the main pivot point and support and resistance level).
These “extra levels” aren’t as significant as the main five but it doesn’t hurt to pay attention to them
terça-feira, 12 de fevereiro de 2008
Commodity Currencies
What is a commodity currency?
In this crazy trading universe we call the Forex, a commodity currency is a currency whose country's exports are largely comprised of raw materials (precious metals, oil, agriculture, etc.).
There are dozens of countries that fit this description, but the most actively traded currencies are the New Zealand Dollar, Australian Dollar, and the Canadian Dollar. Because their currencies are all called dollars, they are also known as the commodity dollars or "Comdolls" for short.
These three currencies are among the major currency pairs, which mean they have great liquidity and volatility for active trading.
In this crazy trading universe we call the Forex, a commodity currency is a currency whose country's exports are largely comprised of raw materials (precious metals, oil, agriculture, etc.).
There are dozens of countries that fit this description, but the most actively traded currencies are the New Zealand Dollar, Australian Dollar, and the Canadian Dollar. Because their currencies are all called dollars, they are also known as the commodity dollars or "Comdolls" for short.
These three currencies are among the major currency pairs, which mean they have great liquidity and volatility for active trading.
The Carry Trade
Did you know there is a trading system that can make money if price stayed exactly the same for long periods of time?
Well there is and it’s one the most popular ways of making money by many of the biggest and baddest money manager mamajamas in the financial universe!
It's called the Carry Trade.
A carry trade involves borrowing or selling a financial instrument with a low interest rate, then using it to purchase a financial instrument with a higher interest rate. While you are paying the low interest rate on the financial instrument you borrowed/sold, you are collecting higher interest on the financial instrument you purchased. Thus your profit is the money you collect from the interest rate differential. For example:
Let's say you go to a bank and borrow $10,000. Their lending fee is 1% of the $10,000 every year. With that borrowed money, you turn around and purchase a $10,000 bond that pays 5% a year.
What's your profit?
Anyone?
You got it! It's 4% a year! The difference between interest rates!
By now you're probably thinking, "That doesn't sound as exciting or profitable as catching swings in the market." However, when you apply it to the spot forex market, with its higher leverage and daily interest payments, sitting back and watching your account grow daily can get pretty sexy.
Well there is and it’s one the most popular ways of making money by many of the biggest and baddest money manager mamajamas in the financial universe!
It's called the Carry Trade.
A carry trade involves borrowing or selling a financial instrument with a low interest rate, then using it to purchase a financial instrument with a higher interest rate. While you are paying the low interest rate on the financial instrument you borrowed/sold, you are collecting higher interest on the financial instrument you purchased. Thus your profit is the money you collect from the interest rate differential. For example:
Let's say you go to a bank and borrow $10,000. Their lending fee is 1% of the $10,000 every year. With that borrowed money, you turn around and purchase a $10,000 bond that pays 5% a year.
What's your profit?
Anyone?
You got it! It's 4% a year! The difference between interest rates!
By now you're probably thinking, "That doesn't sound as exciting or profitable as catching swings in the market." However, when you apply it to the spot forex market, with its higher leverage and daily interest payments, sitting back and watching your account grow daily can get pretty sexy.
segunda-feira, 11 de fevereiro de 2008
Discovering Your Trading Personality
Forex traders come in many different shapes and sizes. There are male traders, female traders, fat traders, skinny traders, beautiful traders, ugly traders, slow traders, fast traders, professional traders, amateur traders, fur traders … and the list goes on.
Each trader has their own personality, their own personal schedule, their own appetite for risk, their own pain threshold and their own bankroll.
Some traders might have several things in common, but most will be different. The point is each of you are unique. And depending on your personality, personal preferences, and situation, how you trade will be a driving factor in determining your success.
In order to figure out how you should trade, you must first uncover your own “trading personality.” Your trading personality will determine the trading style and method that’s compatible for you.
Trading is not like a t-shirt. There is no one-size-fits-all. There is no single plan for all traders.
I challenge you to perform a self-assessment on your personality, behaviors, beliefs, and mindset. Do you consider yourself disciplined? Are you risk averse or a big risk taker? Are you indecisive or spontaneous? Are you patient or a firecracker? Would you prefer to go bungee jumping or visit a museum? Do you like your martini shaken or stirred?
An excellent way to help you with your self-assessment is to keep a trading journal. It will help you to analyze your thought processes after the trade, and identify your strengths and weaknesses in your trading. Understanding your personality is one thing, but understanding it while you trade is a totally different story. A trading journal allows you to review your wining and losing trades and pinpoint specific reasons on why you won or lose.
Now, before we dive in to the different components of trading styles, let’s look at the profiles of a few traders, their trading personalities, and how it’s affected their lives outside of trading.
Each trader has their own personality, their own personal schedule, their own appetite for risk, their own pain threshold and their own bankroll.
Some traders might have several things in common, but most will be different. The point is each of you are unique. And depending on your personality, personal preferences, and situation, how you trade will be a driving factor in determining your success.
In order to figure out how you should trade, you must first uncover your own “trading personality.” Your trading personality will determine the trading style and method that’s compatible for you.
Trading is not like a t-shirt. There is no one-size-fits-all. There is no single plan for all traders.
I challenge you to perform a self-assessment on your personality, behaviors, beliefs, and mindset. Do you consider yourself disciplined? Are you risk averse or a big risk taker? Are you indecisive or spontaneous? Are you patient or a firecracker? Would you prefer to go bungee jumping or visit a museum? Do you like your martini shaken or stirred?
An excellent way to help you with your self-assessment is to keep a trading journal. It will help you to analyze your thought processes after the trade, and identify your strengths and weaknesses in your trading. Understanding your personality is one thing, but understanding it while you trade is a totally different story. A trading journal allows you to review your wining and losing trades and pinpoint specific reasons on why you won or lose.
Now, before we dive in to the different components of trading styles, let’s look at the profiles of a few traders, their trading personalities, and how it’s affected their lives outside of trading.
sábado, 9 de fevereiro de 2008
Pivot Points
Professional traders and market makers use pivot points to identify important support and resistance levels. Simply put, a pivot point and its support/resistance levels are areas at which the direction of price movement can possibly change.
Pivot points are especially useful to short-term traders who are looking to take advantage of small price movements.
Pivot points can be used by both range-bound traders and breakout traders. Range-bound traders use pivot points to identify reversal points. Breakout traders use pivot points to recognize key levels that need to be broken for a move to be classified as a real deal breakout.
The pivot point and associated support and resistance levels are calculated by using the last trading session’s open, high, low, and close. Since Forex is a 24-hour market, most traders use the New York closing time of 4:00pm EST as the previous day’s close.
The calculation for a pivot point is shown below:
Pivot point (PP) = (High + Low + Close) / 3
Support and resistance levels are then calculated off the pivot point like so:
First level support and resistance:
First support (S1) = (2*PP) – High
First resistance (R1) = (2*PP) – Low
Second level of support and resistance:
Second support (S2) = PP – (High – Low)Second resistance (R2) = PP + (High - Low)
Don’t worry you don’t have to perform these calculations yourself. Your charting software will automatically do it for you and plot it on the chart
Also keep in mind that some charting software also provides additional pivot point features such as a third support and resistance level and intermediate levels or mid-point levels (levels in between the main pivot point and support and resistance level).
Pivot points are especially useful to short-term traders who are looking to take advantage of small price movements.
Pivot points can be used by both range-bound traders and breakout traders. Range-bound traders use pivot points to identify reversal points. Breakout traders use pivot points to recognize key levels that need to be broken for a move to be classified as a real deal breakout.
The pivot point and associated support and resistance levels are calculated by using the last trading session’s open, high, low, and close. Since Forex is a 24-hour market, most traders use the New York closing time of 4:00pm EST as the previous day’s close.
The calculation for a pivot point is shown below:
Pivot point (PP) = (High + Low + Close) / 3
Support and resistance levels are then calculated off the pivot point like so:
First level support and resistance:
First support (S1) = (2*PP) – High
First resistance (R1) = (2*PP) – Low
Second level of support and resistance:
Second support (S2) = PP – (High – Low)Second resistance (R2) = PP + (High - Low)
Don’t worry you don’t have to perform these calculations yourself. Your charting software will automatically do it for you and plot it on the chart
Also keep in mind that some charting software also provides additional pivot point features such as a third support and resistance level and intermediate levels or mid-point levels (levels in between the main pivot point and support and resistance level).
Fundamental Analysis
Forex traders who utilize Fundamental analysis often keep one eye focused on the market and the other on a television set tuned to CNN. They will study the news for information on political climate, international relations, natural disasters and other worldly events in order to determine what might be coming up in the trading arena.
Fundamental factors that many traders use when deciding whether to stay with a trade or sell, besides those already mentioned, include unemployment rates, inflation, fiscal policy changes, and stocks/bonds/money markets. If an Earthquake occurs in India, for example, fundamental analysts will keep a close eye on the impending changes in the value of Indian currency to determine when to buy or sell.
Fundamental analysis studies the causes of market movements. This distinguishes it from technical analysis, which focuses on the effects brought about from those changes. Traders can often use fundamental analysis as a back-up system to confirm whether the market would support a trade that was recommended through technical analysis
Fundamental factors that many traders use when deciding whether to stay with a trade or sell, besides those already mentioned, include unemployment rates, inflation, fiscal policy changes, and stocks/bonds/money markets. If an Earthquake occurs in India, for example, fundamental analysts will keep a close eye on the impending changes in the value of Indian currency to determine when to buy or sell.
Fundamental analysis studies the causes of market movements. This distinguishes it from technical analysis, which focuses on the effects brought about from those changes. Traders can often use fundamental analysis as a back-up system to confirm whether the market would support a trade that was recommended through technical analysis
sexta-feira, 8 de fevereiro de 2008
Be Cool
To become a successful trader, you have to stay rational and emotionally detached.
Many novice traders ride an emotional rollercoaster, feeling on top of the world after a win, but down in the dumps after a loss.
In contrast, most professional traders stay calm and relaxed even after a series of losses. They don't let the natural ups and downs of trading affect them emotionally.
As a winning trader you'll want to do the same - stay composed and as unemotional as possible. We know it can get tough. Even the seasoned trader will lose composure and let emotion take charge. It's a natural thing - many novice traders would start doubting their methods and decisions.
One the other side of the coin, when things are going well, it's normal to feel excited or like a supreme being. Nothing can stop me now, I'm invincible! It's this overconfidence that can certainly lead to problems. Any time things start to go your way, you feel safe, and you think there's a little more room for unnecessary risk. Your euphoric state clouds your judegement and you figure that things can only get better. When times are golden, it's very easy to forget about your plan or process.
This emotional roller coaster most often finds a home with the novice trader.
A novice trader is more likely to risk too much capital during a single trade and risk management goes out the door. If that "big risk" turns successful, blissfulness follows the victory. But with a disastrous loss on that "big risk," the joy transforms into a feeling of utter failure.
The key to curbing, or at least minimizing, your losses is through proper risk management. Smaller loses are definitely easier to stomach than those monster losers.
Remember that trading is not like online poker or gambling - it's a business. And as the person making the decisions, you don't want to run the business on pure emotion. You want to be objective in your decision making. This objectivity will make it easier to examine and consider new trading opportunities as they become available.
So, at the heart of the issue, what can you do to control your emotions? For one, understand that you'll win some and you'll lose some. At times you'll be profitable in your trading, and at other times you won't be. Coming to grasps with this simple fact will definitely help. Second, trade with enough money to allow for a buffer when those losing trades come. Be ready to handle the losses, because they WILL come! That's just how the market works. Third, try not to have a house party after every win. Higher highs are great, but a stretch of losers following your wins will put you into those lower lows. And they're no fun at all.
Emotional stability, matched with proper risk management, is the name of the game. Trading can cause you to become emotional and lose control (and money), but the most successful traders can minimize those peaks and valleys, resulting in a calm and rational trading mind. That kind of mind ultimately leads to increased odds of financial success. Be cool...
Many novice traders ride an emotional rollercoaster, feeling on top of the world after a win, but down in the dumps after a loss.
In contrast, most professional traders stay calm and relaxed even after a series of losses. They don't let the natural ups and downs of trading affect them emotionally.
As a winning trader you'll want to do the same - stay composed and as unemotional as possible. We know it can get tough. Even the seasoned trader will lose composure and let emotion take charge. It's a natural thing - many novice traders would start doubting their methods and decisions.
One the other side of the coin, when things are going well, it's normal to feel excited or like a supreme being. Nothing can stop me now, I'm invincible! It's this overconfidence that can certainly lead to problems. Any time things start to go your way, you feel safe, and you think there's a little more room for unnecessary risk. Your euphoric state clouds your judegement and you figure that things can only get better. When times are golden, it's very easy to forget about your plan or process.
This emotional roller coaster most often finds a home with the novice trader.
A novice trader is more likely to risk too much capital during a single trade and risk management goes out the door. If that "big risk" turns successful, blissfulness follows the victory. But with a disastrous loss on that "big risk," the joy transforms into a feeling of utter failure.
The key to curbing, or at least minimizing, your losses is through proper risk management. Smaller loses are definitely easier to stomach than those monster losers.
Remember that trading is not like online poker or gambling - it's a business. And as the person making the decisions, you don't want to run the business on pure emotion. You want to be objective in your decision making. This objectivity will make it easier to examine and consider new trading opportunities as they become available.
So, at the heart of the issue, what can you do to control your emotions? For one, understand that you'll win some and you'll lose some. At times you'll be profitable in your trading, and at other times you won't be. Coming to grasps with this simple fact will definitely help. Second, trade with enough money to allow for a buffer when those losing trades come. Be ready to handle the losses, because they WILL come! That's just how the market works. Third, try not to have a house party after every win. Higher highs are great, but a stretch of losers following your wins will put you into those lower lows. And they're no fun at all.
Emotional stability, matched with proper risk management, is the name of the game. Trading can cause you to become emotional and lose control (and money), but the most successful traders can minimize those peaks and valleys, resulting in a calm and rational trading mind. That kind of mind ultimately leads to increased odds of financial success. Be cool...
quinta-feira, 7 de fevereiro de 2008
Concentrate or Lose Money
You can be highly motivated to trade, have abundant capital, and a dummy-proof trading system, but if you don't apply your FULL concentration to the trade that you have on at the moment, you'll rarely make profits. It's imperative that you learn to concentrate while executing a trade and meticulously monitor the market while you're in the trade.
While in school did you have trouble studying in a noisy library or a crowded Starbucks? It's easy to concentrate when we are in a quiet room and when we are calm and at ease. But trading is often chaotic and full of stress. It's easy to become shaken and lose your ability to concentrate.
When you aren't fully focused on your ongoing experience, it's easy for self-doubts to creep into your consciousness. You may start having second thoughts and may want to sabotage your trading efforts.
The more you can stay focused on your ongoing experience, the more you can trade effortlessly and skillfully. But how can you concentrate more easily?
First, it's useful to remember that concentration takes psychological energy, and your supply of psychological energy has limits. If you want to maintain your focus, you must be rested and relaxed. Get proper sleep and nutrition. If you're tired or hungry, you won't be able to keep your mind focused on trading.
Second, it's important to control your stress levels. Stress depletes psychological energy. Even when you are excited rather than agitated by stress, your psychological energy is depleted a little bit each time you encounter an event that gets your adrenalin pumping. The best way to limit stress is through risk management. If you know that you are doing your best to keep potential losses to a minimum, you'll feel more comfortable and can focus most of your psychological attention on trading.
Concentration is essential for profitable trading. The more you concentrate, the more you feel you are in control. And when you feel your body and mind are in sync with the markets, you'll trade profitably.
While in school did you have trouble studying in a noisy library or a crowded Starbucks? It's easy to concentrate when we are in a quiet room and when we are calm and at ease. But trading is often chaotic and full of stress. It's easy to become shaken and lose your ability to concentrate.
When you aren't fully focused on your ongoing experience, it's easy for self-doubts to creep into your consciousness. You may start having second thoughts and may want to sabotage your trading efforts.
The more you can stay focused on your ongoing experience, the more you can trade effortlessly and skillfully. But how can you concentrate more easily?
First, it's useful to remember that concentration takes psychological energy, and your supply of psychological energy has limits. If you want to maintain your focus, you must be rested and relaxed. Get proper sleep and nutrition. If you're tired or hungry, you won't be able to keep your mind focused on trading.
Second, it's important to control your stress levels. Stress depletes psychological energy. Even when you are excited rather than agitated by stress, your psychological energy is depleted a little bit each time you encounter an event that gets your adrenalin pumping. The best way to limit stress is through risk management. If you know that you are doing your best to keep potential losses to a minimum, you'll feel more comfortable and can focus most of your psychological attention on trading.
Concentration is essential for profitable trading. The more you concentrate, the more you feel you are in control. And when you feel your body and mind are in sync with the markets, you'll trade profitably.
quarta-feira, 6 de fevereiro de 2008
Cross-rates, pips, figure
These terms - cross rate and pip - are ones of the main terms in forex trading.
First of all some words about cross-rates.
Cross-rate is the parity between two currencies which follows from their Forex currency exchange rate in relation to a Forex rate of the third currency.
Pairings of non-US dollar currencies are known as “crosses.” We can derive cross exchange rates for the GPB, EUR, JPY and CHF from the aforementioned major pairs. Exchange rates must be consistent across all currencies or else it will be possible to “round trip” and make profits without risk.
Example
Assume that the following major exchange rates are known:
EUR/USD = 1.0060/65
GBP/USD = 1.5847/52
USD/JPY = 120.25/30
USD/CHF = 1.4554/59
To calculate GPB/CHF
GBP/USD: Bid: 1.5847 Offer: 1.5852
USD/CHF: 1.4554 1.4559
GBP/USD X USD/CHF = 1.5847 X1.4554 1.5852 X 1.4559
"Pips" - point - a minimal possible currency fluctuation. Different instruments (currency pairs) are quoted with different accuracy, i.e. with different number of characters in the quotation. The major part of currencies are quoted with 0.0001 accuracy, some, for example, yen and its cross-rates - with 0.01 accuracy. As big figures of quotations change quite slowly, quotations, as a rule, are given in contracted form: EUR 10/15, which means, for example, EUR/USD 1.1310/1.1315. When quotations change, for example, USDJPY=121.44 to USDJPY = 121.45 or GBPUSD = 1.6262 to 1.6263, they say, that the price has changed by 1 point. In the above examples dollar went up by 1 point relatively to yen (which went down by 1 point), pound went up by 1 point, as well.
The value of 1 point in US dollars differs not only for various currencies, but also for one and the same currency with different quotations this value can be different, besides, the value of one point depends on the amount of deal.
In general, the algorithm used to calculate the value of one point of each currency in US dollars can be expressed with the following formula:
Value of the point = Amount of deal * Point
When using this formula, you get the results of calculations in the quoted currency. In order to recalculate the value of one point from the quoted currency to US dollars, you should divide the result by ASK (Offer) rate of the quoted currency against US dollars - if the quoted currency has direct rate, or to multiply by BID rate of the quoted currency against US dollar - if the quoted currency has reverse rate.
For example:
There's a position USD 200000, on the market of USDJPY
Accordingly, value of one point = 200000 * 0.01 = JPY 2000
If now the current rate is USDJPY 118.62/68, then value of one point in USD will be 2000/118.68 = USD 16.85
There's a position EUR 300000, on the market of EURGBP
Accordingly, value of one point = 300000 * 0.0001 = GBP 30
If now the current rate is GBPUSD 1.6101/07, then value of one point in USD will be 30*1.6101= USD 48.30
There's a position GBP 100000 on the market of GBPUSD
Accordingly, value of one point = 100000 * 0.0001 = USD 30
And one more term is "figure".
The following example will demonstrate the connection between pips and figures:
Currencies are quoted using four positions after the decimal point, which means that one pip is 1/10,000 of the currency unit. In the above example, EUR/USD, there is a difference of 4 pips between “buy” and “sell,” but there is no difference in the value of the figures.
This is not the case when the Japanese yen is the currency being quoted. Due to the high denomination of the yen against the USD, e.g. 121.23 – 121.39, the yen is quoted two positions after the decimal point only. In this case one pip is equal to 1/100 of the Japanese currency unit.
When asked over the phone, the dealer will tell you only the values of the pips, presuming that you are aware of the market and know the value of the figures. If you are not sure about the figure, don’t forget to ask.
First of all some words about cross-rates.
Cross-rate is the parity between two currencies which follows from their Forex currency exchange rate in relation to a Forex rate of the third currency.
Pairings of non-US dollar currencies are known as “crosses.” We can derive cross exchange rates for the GPB, EUR, JPY and CHF from the aforementioned major pairs. Exchange rates must be consistent across all currencies or else it will be possible to “round trip” and make profits without risk.
Example
Assume that the following major exchange rates are known:
EUR/USD = 1.0060/65
GBP/USD = 1.5847/52
USD/JPY = 120.25/30
USD/CHF = 1.4554/59
To calculate GPB/CHF
GBP/USD: Bid: 1.5847 Offer: 1.5852
USD/CHF: 1.4554 1.4559
GBP/USD X USD/CHF = 1.5847 X1.4554 1.5852 X 1.4559
"Pips" - point - a minimal possible currency fluctuation. Different instruments (currency pairs) are quoted with different accuracy, i.e. with different number of characters in the quotation. The major part of currencies are quoted with 0.0001 accuracy, some, for example, yen and its cross-rates - with 0.01 accuracy. As big figures of quotations change quite slowly, quotations, as a rule, are given in contracted form: EUR 10/15, which means, for example, EUR/USD 1.1310/1.1315. When quotations change, for example, USDJPY=121.44 to USDJPY = 121.45 or GBPUSD = 1.6262 to 1.6263, they say, that the price has changed by 1 point. In the above examples dollar went up by 1 point relatively to yen (which went down by 1 point), pound went up by 1 point, as well.
The value of 1 point in US dollars differs not only for various currencies, but also for one and the same currency with different quotations this value can be different, besides, the value of one point depends on the amount of deal.
In general, the algorithm used to calculate the value of one point of each currency in US dollars can be expressed with the following formula:
Value of the point = Amount of deal * Point
When using this formula, you get the results of calculations in the quoted currency. In order to recalculate the value of one point from the quoted currency to US dollars, you should divide the result by ASK (Offer) rate of the quoted currency against US dollars - if the quoted currency has direct rate, or to multiply by BID rate of the quoted currency against US dollar - if the quoted currency has reverse rate.
For example:
There's a position USD 200000, on the market of USDJPY
Accordingly, value of one point = 200000 * 0.01 = JPY 2000
If now the current rate is USDJPY 118.62/68, then value of one point in USD will be 2000/118.68 = USD 16.85
There's a position EUR 300000, on the market of EURGBP
Accordingly, value of one point = 300000 * 0.0001 = GBP 30
If now the current rate is GBPUSD 1.6101/07, then value of one point in USD will be 30*1.6101= USD 48.30
There's a position GBP 100000 on the market of GBPUSD
Accordingly, value of one point = 100000 * 0.0001 = USD 30
And one more term is "figure".
The following example will demonstrate the connection between pips and figures:
Currencies are quoted using four positions after the decimal point, which means that one pip is 1/10,000 of the currency unit. In the above example, EUR/USD, there is a difference of 4 pips between “buy” and “sell,” but there is no difference in the value of the figures.
This is not the case when the Japanese yen is the currency being quoted. Due to the high denomination of the yen against the USD, e.g. 121.23 – 121.39, the yen is quoted two positions after the decimal point only. In this case one pip is equal to 1/100 of the Japanese currency unit.
When asked over the phone, the dealer will tell you only the values of the pips, presuming that you are aware of the market and know the value of the figures. If you are not sure about the figure, don’t forget to ask.
Forex is a risky Business
Although every investment involves some risk, the risk of loss in trading off-exchange Forex contracts can be substantial. Therefore, if you are considering participating in this market, you should understand some of the risks associated with this product so you can make an informed decision before investing.
As stated in the introduction to this topic, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital – i.e., funds you can afford to lose without affecting your financial situation. There are other reasons why Forex trading may or may not be an appropriate investment for you, and they are highlighted below.
In Forex you are trading substantial sums of money, and there is always a possibility that a trade will go against you. There are several trading tools that can minimize your risk, yes, but eliminate it, no. With caution, and above all education, the Forex trader can learn how to trade profitably and minimize loss.
The Scams and fraud
Forex scams were fairly common a few years ago. The industry has cleaned up considerably since then. Still, you should exercise caution before signing up with a Forex broker by checking their background.
Reputable Forex brokers will be associated with large financial institutions like banks or insurance companies, and they will be registered with the proper government agencies. In the United States, brokers should be registered with the Commodities Futures Trading Commission or a member of the National Futures Association. You can also check with your local Consumer Protection Bureau and the Better Business Bureau.
The market could move against you
No one can predict with certainty which way exchange rates will go, and the Forex market is volatile. Fluctuations in the foreign exchange rate between the time you place the trade and the time you close it out will affect the price of your Forex contract and the potential profit and losses relating to it.
You could lose your entire investment
You will be required to deposit an amount of money (often referred to as a "security deposit" or "margin") with your Forex dealer in order to buy or sell an off-exchange Forex contract. As discussed earlier, a relatively small amount of money can enable you to hold a Forex position worth many times the account value. This is referred to as leverage or gearing. The smaller the deposit in relation to the underlying value of the contract, the greater the leverage. If the price moves in an unfavorable direction, high leverage can produce large losses in relation to your initial deposit. In fact, even a small move against your position may result in a large loss, including the loss of your entire deposit. Depending on your agreement with your dealer, you may also be required to pay additional losses.
You are relying on the dealer's creditworthiness and reputation
Retail off-exchange Forex trades are not guaranteed by a clearing organization. Furthermore, funds that you have deposited to trade Forex contracts are not insured and do not receive a priority in bankruptcy. Even customer funds deposited by a dealer in an FDIC-insured bank account are not protected if the dealer goes bankrupt.
There is no central marketplace
Unlike regulated futures exchanges, in the retail off-exchange Forex market there is no central marketplace with many buyers and sellers. The Forex dealer determines the execution price, so you are relying on the dealer's integrity for a fair price.
The trading system could break down
If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority.
You could be a victim of fraud
As with any investment, you should protect yourself from fraud. Beware of investment schemes that promise significant returns with little risk. You should take a close and cautious look at the investment offer itself and continue to monitor any investment you do make.
Types of Risks
Even through you are dealing with a reputable broker, there are risks to Forex trading. Transactions are unexpected and depend on volatile markets and political events.
Exchange Rate Risk: refers to the fluctuations in currency prices over a trading period. Prices can fall rapidly unless stop loss orders are used.
Interest Rate Risk: can result from discrepancies between the interest rates in the 2 countries represented by the currency pair in a Forex quote.
Credit Risk: is the possibility that 1 party in a Forex transaction may not honor their debt when the deal is closed. This may happen when a bank or financial institution declares insolvency.
Country Risk: is associated with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with "exotic" currencies than with major countries that allow the free trading of their currency.
How to limit risks?
There are some ways to limit risk and financial exposure. Every trader should have a trading strategy; i.e., knowing when to enter and exit the market, and what kind of movements to expect. Developing strategies requires education, which is the key to limiting risk. The basic rule which trader follows aal time: Never use money that you cannot afford to lose.
Every Forex trader needs to know at least the basics about technical analysis and how to read financial charts. He should study chart movements and indicators and understand how charts are interpreted.
Stop-Loss Orders
Even the most knowledgeable traders, can't predict with absolute certainty how the market will behave. For this reason, every Forex transaction should take tools to minimize loss.
Stop-loss orders are the most common way to minimizing risk. A stop-loss order contains instructions to exit your position if the price reaches a certain point. If you take a long position (expecting the price to rise) you would place a stop loss order below the current market price. If you take a short position (expecting the price to fall) you would place a stop loss order above the current market price.
Stop loss orders can be used in conjunction with limit orders to automate Forex trading.
As stated in the introduction to this topic, off-exchange foreign currency trading carries a high level of risk and may not be suitable for all customers. The only funds that should ever be used to speculate in foreign currency trading, or any type of highly speculative investment, are funds that represent risk capital – i.e., funds you can afford to lose without affecting your financial situation. There are other reasons why Forex trading may or may not be an appropriate investment for you, and they are highlighted below.
In Forex you are trading substantial sums of money, and there is always a possibility that a trade will go against you. There are several trading tools that can minimize your risk, yes, but eliminate it, no. With caution, and above all education, the Forex trader can learn how to trade profitably and minimize loss.
The Scams and fraud
Forex scams were fairly common a few years ago. The industry has cleaned up considerably since then. Still, you should exercise caution before signing up with a Forex broker by checking their background.
Reputable Forex brokers will be associated with large financial institutions like banks or insurance companies, and they will be registered with the proper government agencies. In the United States, brokers should be registered with the Commodities Futures Trading Commission or a member of the National Futures Association. You can also check with your local Consumer Protection Bureau and the Better Business Bureau.
The market could move against you
No one can predict with certainty which way exchange rates will go, and the Forex market is volatile. Fluctuations in the foreign exchange rate between the time you place the trade and the time you close it out will affect the price of your Forex contract and the potential profit and losses relating to it.
You could lose your entire investment
You will be required to deposit an amount of money (often referred to as a "security deposit" or "margin") with your Forex dealer in order to buy or sell an off-exchange Forex contract. As discussed earlier, a relatively small amount of money can enable you to hold a Forex position worth many times the account value. This is referred to as leverage or gearing. The smaller the deposit in relation to the underlying value of the contract, the greater the leverage. If the price moves in an unfavorable direction, high leverage can produce large losses in relation to your initial deposit. In fact, even a small move against your position may result in a large loss, including the loss of your entire deposit. Depending on your agreement with your dealer, you may also be required to pay additional losses.
You are relying on the dealer's creditworthiness and reputation
Retail off-exchange Forex trades are not guaranteed by a clearing organization. Furthermore, funds that you have deposited to trade Forex contracts are not insured and do not receive a priority in bankruptcy. Even customer funds deposited by a dealer in an FDIC-insured bank account are not protected if the dealer goes bankrupt.
There is no central marketplace
Unlike regulated futures exchanges, in the retail off-exchange Forex market there is no central marketplace with many buyers and sellers. The Forex dealer determines the execution price, so you are relying on the dealer's integrity for a fair price.
The trading system could break down
If you are using an Internet-based or other electronic system to place trades, some part of the system could fail. In the event of a system failure, it is possible that, for a certain time period, you may not be able to enter new orders, execute existing orders, or modify or cancel orders that were previously entered. A system failure may also result in loss of orders or order priority.
You could be a victim of fraud
As with any investment, you should protect yourself from fraud. Beware of investment schemes that promise significant returns with little risk. You should take a close and cautious look at the investment offer itself and continue to monitor any investment you do make.
Types of Risks
Even through you are dealing with a reputable broker, there are risks to Forex trading. Transactions are unexpected and depend on volatile markets and political events.
Exchange Rate Risk: refers to the fluctuations in currency prices over a trading period. Prices can fall rapidly unless stop loss orders are used.
Interest Rate Risk: can result from discrepancies between the interest rates in the 2 countries represented by the currency pair in a Forex quote.
Credit Risk: is the possibility that 1 party in a Forex transaction may not honor their debt when the deal is closed. This may happen when a bank or financial institution declares insolvency.
Country Risk: is associated with governments that may become involved in foreign exchange markets by limiting the flow of currency. There is more country risk associated with "exotic" currencies than with major countries that allow the free trading of their currency.
How to limit risks?
There are some ways to limit risk and financial exposure. Every trader should have a trading strategy; i.e., knowing when to enter and exit the market, and what kind of movements to expect. Developing strategies requires education, which is the key to limiting risk. The basic rule which trader follows aal time: Never use money that you cannot afford to lose.
Every Forex trader needs to know at least the basics about technical analysis and how to read financial charts. He should study chart movements and indicators and understand how charts are interpreted.
Stop-Loss Orders
Even the most knowledgeable traders, can't predict with absolute certainty how the market will behave. For this reason, every Forex transaction should take tools to minimize loss.
Stop-loss orders are the most common way to minimizing risk. A stop-loss order contains instructions to exit your position if the price reaches a certain point. If you take a long position (expecting the price to rise) you would place a stop loss order below the current market price. If you take a short position (expecting the price to fall) you would place a stop loss order above the current market price.
Stop loss orders can be used in conjunction with limit orders to automate Forex trading.
Profiting From Carry Trade Candidates
With the introduction of the carry trade into the mainstream audience, yen currency pairs have become the speculator's pair du jour. Currency crosses like the GBP/JPY and NZD/JPY have been able to net small intraday - or even longer term - profits for the currency trader as speculation continues to support the bid tone. But how can one enter into a market that is already seemingly overheated? Even if a trader could, what would be a good price, and doesn't everything that goes up come down? The answer is easier and simpler than most believe. In this article we'll show you how to use carry trades to profit from overwhelming market momentum.
All About The Carry Trade
First, let's take a look at the carry trade. In short, the carry trade is used when an investor or speculator is attempting to capture the price appreciation or depreciation in a currency while also profiting on the interest differential. Using this strategy, a trader is essentially selling a currency that is offering a relatively low interest rate while buying a currency that is offering a higher interest rate. This way, the trader is able to profit from the differential of interest rates.
For example, taking one of the favored pairs in the market right now, let's take a look at the New Zealand dollar/Japanese yen currency pair. Here, a carry trader would borrow Japanese yen and then convert it into New Zealand dollars. After the conversion, the speculator would then buy a Kiwi bond for the corresponding amount, earning 8%. Therefore, the investor makes a 7.5% return on the interest alone after taking into account the 0.5% that is paid on the yen funds.
Now on the earning side of the trade, the investor is also hoping that the price will appreciate in order to make further gains on the transaction. In this case, anyone that has invested in the NZD/JPY trade has been able to reap plenty of benefits. For 2007, not only were traders able to benefit from a 7.5% return, they also benefit from a currency that has appreciated by 20.6% since the beginning of the year - a far cry from your ordinary U.S. Treasury bond. (For more on this strategy, see Currency Carry Trades Deliver.)
Flags and Pennants: Easy and Simple
With the currency rising the way it has, how can a trader really capture market profits in the bull market? One such formation that has proved to be a great setup may be the all too familiar: flag and/pennant formations. This has been especially useful in carry currency crosses such as British pound/Japanese yen and New Zealand dollar/Japanese yen. Both formations are used in similar capacities; they are great short-term tools that can be applied to capture nothing but continuations in the foreign exchange market. They are both even more applicable when the market, especially in the case of carry trade currencies, has been trading higher and higher in every session. (For more insight, read Analyzing Chart Patterns: Flags and Pennants.)
To get a better sense of how this works, let's quickly review the differences between a flag and a pennant:
* A flag formation is a charting pattern that is indicative of consolidation following an upward surge in price. The name is attributed to the fact that it resembles an actual flag with a downward-sloping body (due to price consolidation) and a visually evident post. Targets are also very reliable in flag formations. Traders who use this technical pattern will reference the distance from the bottom of the post (significant support level) to the top. Subsequently, when the price breaks the upper trendline of the flag, the distance of the post will more often than not be equivalent to the next level of resistance.
* A pennant formation is similar to the flag formation - it differs only in the form of consolidation. Instead of a body of consolidation that moves in the opposite direction of the post (as in the case of a flag), the pennant's body is simply a symmetrical triangle. Although pennants have been known to slope downward as well, the textbook formation has also been noted as a symmetrical triangle, hence the name.
Trade Setup
Let's take a look at a real-life example using the British pound/U.S. dollar in July 2007. Here, a 60-minute short-term chart offers a great opportunity in the GBP/USD in Figure 1. After convincingly breaking through resistance at the pivotal 2.0200 trendline, the underlying currency proceeds to top out at 2.0361 and consolidates. Forming a flag technical pattern, we note that the post is 160 pips in length and apply it when the currency breaks through the top trendline at 2.0330. As you can see, the estimate rings true as the pound sterling gains against the U.S. dollar far above market targets and tops out at 2.0544 before consolidating again.
Source: FX Trek Intellicharts
Figure 1: A perfect flag formation in the GBP/USD
Flag and Pennants in Carry Candidates
Similar setups are seen in the cross currency pairs, giving the trader plenty of opportunities in the currency market, with or without dollar exposure. (For more on these pairs see, Make the Currency Cross Your Boss.) Taking another market favorite, the British pound/Japanese yen, let's take a look at how this method can be applied to the chart.
In the short-term 60-minute chart in Figure 2, a typically long flag formation is coming around in the GBP/JPY currency pair. In order to establish the formation initially, it is recommended that the chartist draw the topside trendline first. This rule is a must as an initial drawing of the bottom trendline may lead to varying interpretations. Once the initial downward-sloping trendline is drawn, the bottom is a simple duplicate. Here, the trader will make sure to note a touch by the session bodies rather than the wicks in verifying the formation as true. This is to isolate only true price action and not volatility or common "noise" that may occur in the short term.
In Figure 2, the bottom trendline has been pushed slightly higher to incorporate the bodies rather than the wicks. Next, we measure the post. In this case, referencing a major support level at 245.69, we calculate the differential with the top of the move at 248.93. As a result, the distance between the two prices is 324 pips. Theoretically, this will place our ultimate target at 251.74 on a break of the trendline at 248.50.
Source: FX Trek Intellicharts
Figure 2: An extended flag formation offers plenty of opportunity.
Trading Rules
When placing the entry, always make sure of two things:
1. The trade is on the side of carry. This means that the speculator is always buying the higher interest rate currency. In this case, the trade is going long pound sterling and gaining 5.25%.
2. Always place the buy entry after the candle close. Applying a buy order after the break of the top trendline ensures that the trendline has been broken. Placing the entry before the close above the trendline may subject the order to being hit on possible market noise above the resistance barrier. This may leave the trader in an unfavorable position as consolidation continues.
Taking into account both rules, we place the entry on the close or slightly below, at 248.77. Risk takers will likely hold the carry trade until the full move has been completed. However, a more conservative strategy, and one that works more often than not, involves placing an initial target at the halfway mark. Taking into consideration the break at 248.50 and half of the full forecast of 324 pips, initial targets should be set at 250.12 with the corresponding stop five pips below the session low.
Step by Step
Now let's take a look at a step by step process that will allow traders to enter on the carry trade momentum in the market. Figure 3 shows a great opportunity in the New Zealand dollar/Japanese yen cross pair. Following the complete downturn that occurred July 9 - July11, 2007, a visual burst can be seen by chartists as bidders take the currency higher over the next 48 hours, establishing a temporary top at Point A.
Source: FX Trek Intellicharts
Figure 3: Following A Sharp Decline, NZDJPY Vaults Higher Off Of Support
Now we set the stage (Figure 4):
1. After consolidation, draw the topside trendline first, completing the formation with the duplicate bottom trendline giving the chartist the flag boundaries.
2. On a sign of a trendline break, measure the distance from the bottom of the post to the top. In this instance, the bottom support of the post is 93.81 with the top at 95.74. This gives the trader a potential for 193 pips on the trade after a break of the top trendline.
3. Once there is a confirmed break of the trendline, place the entry that is at the session close or lower of the finished candle. In this case, the break occurs approximately at 95.40 with the entry being placed at that session's close of 95.46 (Point C). Subsequently, a corresponding stop is placed five pips below the session low of 95.37. Ultimately, the position is well within normal risk parameters as it is risking 14 pips to make 193 pips.
4. Set initial and full targets. With the full move estimated at 193 pips, we get a partial distance of 96 pips (193 pips / 2). As a result, the initial target is set for 96.42 (Point B).
5. Set contingent trailing stops. Once the initial target is achieved, the overall position should be reduced by half with the rest being protected by a trailing stop set at the entry price (or break-even). This will allow for further gains while protecting against adverse moves against whatever is left. Longer term strategies will hold to the entry price as the ultimate stop, promoting a worst-case scenario of break-even.
Incidentally, the initial target is achieved right before a slight retracement in the NZD/JPY currency in the example. Subsequently, the position remains on target for further gains as it continues to trade above the entry price.
Source: FX Trek Intellicharts
Figure 4: Trade setups in the NZD/JPY
Conclusion
Flags and pennants can accurately support profitable trading in the currency markets by assisting in the capture of overwhelming market momentum. In addition, applying strict money management rules and using a trained and disciplined eye, a trader can boost returns while helping the overall portfolio in capitalizing on the yield offered through the interest rate differential. Ultimately, sticking to those two tenets of market price and yield, FX investors can't go wrong being long on carry.
By Richard Lee,
Access Investopedia's Forex Advisor FREE Report - The 5 Things That Move The Currency Market
Richard Lee is a currency strategist at Forex Capital Markets LLC. Employing both fundamental models and technical analysis applications, Richard contributes regularly to DailyFX and Bloomberg. He has extensive experience in trading the spot currency markets, options and futures. Before joining the research group, Richard traded FX, equity and equity derivatives for a private equity consortium. Richard graduated from Pennsylvania State University with a Bachelor of Arts in economics and a Bachelor of Science in French with an emphasis in international business.
All About The Carry Trade
First, let's take a look at the carry trade. In short, the carry trade is used when an investor or speculator is attempting to capture the price appreciation or depreciation in a currency while also profiting on the interest differential. Using this strategy, a trader is essentially selling a currency that is offering a relatively low interest rate while buying a currency that is offering a higher interest rate. This way, the trader is able to profit from the differential of interest rates.
For example, taking one of the favored pairs in the market right now, let's take a look at the New Zealand dollar/Japanese yen currency pair. Here, a carry trader would borrow Japanese yen and then convert it into New Zealand dollars. After the conversion, the speculator would then buy a Kiwi bond for the corresponding amount, earning 8%. Therefore, the investor makes a 7.5% return on the interest alone after taking into account the 0.5% that is paid on the yen funds.
Now on the earning side of the trade, the investor is also hoping that the price will appreciate in order to make further gains on the transaction. In this case, anyone that has invested in the NZD/JPY trade has been able to reap plenty of benefits. For 2007, not only were traders able to benefit from a 7.5% return, they also benefit from a currency that has appreciated by 20.6% since the beginning of the year - a far cry from your ordinary U.S. Treasury bond. (For more on this strategy, see Currency Carry Trades Deliver.)
Flags and Pennants: Easy and Simple
With the currency rising the way it has, how can a trader really capture market profits in the bull market? One such formation that has proved to be a great setup may be the all too familiar: flag and/pennant formations. This has been especially useful in carry currency crosses such as British pound/Japanese yen and New Zealand dollar/Japanese yen. Both formations are used in similar capacities; they are great short-term tools that can be applied to capture nothing but continuations in the foreign exchange market. They are both even more applicable when the market, especially in the case of carry trade currencies, has been trading higher and higher in every session. (For more insight, read Analyzing Chart Patterns: Flags and Pennants.)
To get a better sense of how this works, let's quickly review the differences between a flag and a pennant:
* A flag formation is a charting pattern that is indicative of consolidation following an upward surge in price. The name is attributed to the fact that it resembles an actual flag with a downward-sloping body (due to price consolidation) and a visually evident post. Targets are also very reliable in flag formations. Traders who use this technical pattern will reference the distance from the bottom of the post (significant support level) to the top. Subsequently, when the price breaks the upper trendline of the flag, the distance of the post will more often than not be equivalent to the next level of resistance.
* A pennant formation is similar to the flag formation - it differs only in the form of consolidation. Instead of a body of consolidation that moves in the opposite direction of the post (as in the case of a flag), the pennant's body is simply a symmetrical triangle. Although pennants have been known to slope downward as well, the textbook formation has also been noted as a symmetrical triangle, hence the name.
Trade Setup
Let's take a look at a real-life example using the British pound/U.S. dollar in July 2007. Here, a 60-minute short-term chart offers a great opportunity in the GBP/USD in Figure 1. After convincingly breaking through resistance at the pivotal 2.0200 trendline, the underlying currency proceeds to top out at 2.0361 and consolidates. Forming a flag technical pattern, we note that the post is 160 pips in length and apply it when the currency breaks through the top trendline at 2.0330. As you can see, the estimate rings true as the pound sterling gains against the U.S. dollar far above market targets and tops out at 2.0544 before consolidating again.
Source: FX Trek Intellicharts
Figure 1: A perfect flag formation in the GBP/USD
Flag and Pennants in Carry Candidates
Similar setups are seen in the cross currency pairs, giving the trader plenty of opportunities in the currency market, with or without dollar exposure. (For more on these pairs see, Make the Currency Cross Your Boss.) Taking another market favorite, the British pound/Japanese yen, let's take a look at how this method can be applied to the chart.
In the short-term 60-minute chart in Figure 2, a typically long flag formation is coming around in the GBP/JPY currency pair. In order to establish the formation initially, it is recommended that the chartist draw the topside trendline first. This rule is a must as an initial drawing of the bottom trendline may lead to varying interpretations. Once the initial downward-sloping trendline is drawn, the bottom is a simple duplicate. Here, the trader will make sure to note a touch by the session bodies rather than the wicks in verifying the formation as true. This is to isolate only true price action and not volatility or common "noise" that may occur in the short term.
In Figure 2, the bottom trendline has been pushed slightly higher to incorporate the bodies rather than the wicks. Next, we measure the post. In this case, referencing a major support level at 245.69, we calculate the differential with the top of the move at 248.93. As a result, the distance between the two prices is 324 pips. Theoretically, this will place our ultimate target at 251.74 on a break of the trendline at 248.50.
Source: FX Trek Intellicharts
Figure 2: An extended flag formation offers plenty of opportunity.
Trading Rules
When placing the entry, always make sure of two things:
1. The trade is on the side of carry. This means that the speculator is always buying the higher interest rate currency. In this case, the trade is going long pound sterling and gaining 5.25%.
2. Always place the buy entry after the candle close. Applying a buy order after the break of the top trendline ensures that the trendline has been broken. Placing the entry before the close above the trendline may subject the order to being hit on possible market noise above the resistance barrier. This may leave the trader in an unfavorable position as consolidation continues.
Taking into account both rules, we place the entry on the close or slightly below, at 248.77. Risk takers will likely hold the carry trade until the full move has been completed. However, a more conservative strategy, and one that works more often than not, involves placing an initial target at the halfway mark. Taking into consideration the break at 248.50 and half of the full forecast of 324 pips, initial targets should be set at 250.12 with the corresponding stop five pips below the session low.
Step by Step
Now let's take a look at a step by step process that will allow traders to enter on the carry trade momentum in the market. Figure 3 shows a great opportunity in the New Zealand dollar/Japanese yen cross pair. Following the complete downturn that occurred July 9 - July11, 2007, a visual burst can be seen by chartists as bidders take the currency higher over the next 48 hours, establishing a temporary top at Point A.
Source: FX Trek Intellicharts
Figure 3: Following A Sharp Decline, NZDJPY Vaults Higher Off Of Support
Now we set the stage (Figure 4):
1. After consolidation, draw the topside trendline first, completing the formation with the duplicate bottom trendline giving the chartist the flag boundaries.
2. On a sign of a trendline break, measure the distance from the bottom of the post to the top. In this instance, the bottom support of the post is 93.81 with the top at 95.74. This gives the trader a potential for 193 pips on the trade after a break of the top trendline.
3. Once there is a confirmed break of the trendline, place the entry that is at the session close or lower of the finished candle. In this case, the break occurs approximately at 95.40 with the entry being placed at that session's close of 95.46 (Point C). Subsequently, a corresponding stop is placed five pips below the session low of 95.37. Ultimately, the position is well within normal risk parameters as it is risking 14 pips to make 193 pips.
4. Set initial and full targets. With the full move estimated at 193 pips, we get a partial distance of 96 pips (193 pips / 2). As a result, the initial target is set for 96.42 (Point B).
5. Set contingent trailing stops. Once the initial target is achieved, the overall position should be reduced by half with the rest being protected by a trailing stop set at the entry price (or break-even). This will allow for further gains while protecting against adverse moves against whatever is left. Longer term strategies will hold to the entry price as the ultimate stop, promoting a worst-case scenario of break-even.
Incidentally, the initial target is achieved right before a slight retracement in the NZD/JPY currency in the example. Subsequently, the position remains on target for further gains as it continues to trade above the entry price.
Source: FX Trek Intellicharts
Figure 4: Trade setups in the NZD/JPY
Conclusion
Flags and pennants can accurately support profitable trading in the currency markets by assisting in the capture of overwhelming market momentum. In addition, applying strict money management rules and using a trained and disciplined eye, a trader can boost returns while helping the overall portfolio in capitalizing on the yield offered through the interest rate differential. Ultimately, sticking to those two tenets of market price and yield, FX investors can't go wrong being long on carry.
By Richard Lee,
Access Investopedia's Forex Advisor FREE Report - The 5 Things That Move The Currency Market
Richard Lee is a currency strategist at Forex Capital Markets LLC. Employing both fundamental models and technical analysis applications, Richard contributes regularly to DailyFX and Bloomberg. He has extensive experience in trading the spot currency markets, options and futures. Before joining the research group, Richard traded FX, equity and equity derivatives for a private equity consortium. Richard graduated from Pennsylvania State University with a Bachelor of Arts in economics and a Bachelor of Science in French with an emphasis in international business.
Get To Know The Major Central Banks
The one factor that is sure to move the currency markets is interest rates. Interest rates give international investors a reason to shift money from one country to another in search of the highest and safest yields. For years now, growing interest rate spreads between countries have been the main focus of professional investors, but what most individual traders do not know is that the absolute value of interest rates is not what's important - what really matters are the expectations of where interest rates are headed in the future. Familiarizing yourself with what makes the central banks tick will give you a leg up when it comes to predicting their next moves, as well as the future direction of a given currency pair. In this article, we look at the structure and primary focus of each of the major central banks, and give you the scoop on the major players within these banks. We also explain how to combine the relative monetary policies of each central bank to predict where the interest rate spread between a currency pair is headed.
Examples
Take the performance of the NZD/JPY currency pair between 2002 and 2005, for example. During that time, the central bank of New Zealand increased interest rates from 4.75% to 7.25%. Japan, on the other hand, kept its interest rates at 0%, which meant that the interest rate spread between the New Zealand dollar and the Japanese yen widened a full 250 basis points. This contributed to the NZD/JPY's 58% rally during the same period
On the flip side, we see that throughout 2005, the British pound fell more than 8% against the U.S. dollar. Even though the United Kingdom had higher interest rates than the United States throughout those 12 months, the pound suffered as the interest rate spread narrowed from 250 basis points in the pound's favor to a premium of a mere 25 basis points. This confirms that it is the future direction of interest rates that matters most, not which country has a higher interest rate.
The Eight Major Central Banks
U.S. Federal Reserve System (The Fed)
Structure - The Federal Reserve is probably the most influential central bank in the world. With the U.S. dollar being on the other side of approximately 90% of all currency transactions, the Fed's sway has a sweeping effect on the valuation of many currencies. The group within the Fed that decides on interest rates is the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board plus five presidents of the 12 district reserve banks.
Mandate - Long-term price stability and sustainable growth
Frequency of Meeting - Eight times a year
Key Policy Official - Ben Bernanke, Chairman of the Federal Reserve. Following former chairman Alan Greenspan's retirement in January 2006, U.S. President George W. Bush tapped Bernanke to head the Federal Reserve, given his four years of experience on the Fed board of governors. His views differ from Greenspan's in that he believes in inflation targeting and printing money to avoid deflation. The historic change of power at the U.S. central bank marks the first time in two decades that an academic, who may focus more on mathematical and econometric models, is chairing the Fed.
European Central Bank (ECB)
Structure - The European Central Bank was established in 1999. The governing council of the ECB is the group that decides on changes to monetary policy. The council consists of the six members of the executive board of the ECB, plus the governors of all the national central banks from the 12 euro area countries. As a central bank, the ECB does not like surprises. Therefore, whenever it plans on making a change to interest rates, it will generally give the market ample notice by warning of an impending move through comments to the press.
Mandate - Price stability and sustainable growth. However, unlike the Fed, the ECB strives to maintain the annual growth in consumer prices below 2%. As an export dependent economy, the ECB also has a vested interest in preventing against excess strength in its currency because this poses a risk to its export market.
Frequency of Meeting - Bi-weekly, but policy decisions are generally only made at meetings where there is an accompanying press conference, and those happen 11 times a year.
Key Policy Official - Jean-Claude Trichet, president of the European Central Bank. Prior to succeeding Wim Duisenberg as ECB president in November 2003, Trichet was the president of Bank of France. He has a reputation for being a cautious and forthright banker, though many criticize his slow response to European economic stagnation and high unemployment. Typically seen as a hawk with a bias toward making preemptive moves to ward off inflation, Trichet has the huge responsibility of managing the monetary policy of 12 nations.
Bank of England (BoE)
Structure - The monetary policy committee of the Bank of England is a nine-member committee consisting of a governor, two deputy governors, two executive directors and four outside experts. The BoE, under the leadership of Mervyn King, is frequently touted as one of the most effective central banks.
Mandate - To maintain monetary and financial stability. The BoE's monetary policy mandate is to keep prices stable and to maintain confidence in the currency. To accomplish this, the central bank has an inflation target of 2%. If prices breach that level, the central bank will look to curb inflation, while a level far below 2% will prompt the central bank to take measures to boost inflation.
Frequency of Meeting - Monthly
Key Policy Official - Mervyn A. King, governor of the Bank of England. Prior to assuming the role of BoE governor on June 30, 2003, King was a professor at the London School of Economics. Initially joining the BoE in 1990, he became an executive director and chief economist in March 1991 and was promoted to deputy governor in 1997. King's "Goldilocks" monetary policy, which is neither too restrictive nor too accommodative, has propelled the U.K.'s economy into its longest streak of uninterrupted growth in 200 years.
Bank of Japan (BoJ)
Structure - The Bank of Japan's monetary policy committee consists of the BoJ governor, two deputy governors and six other members. Because Japan is very dependent on exports, the BoJ has an even more active interest than the ECB does in preventing an excessively strong currency. The central bank has been known to come into the open market to artificially weaken its currency by selling it against U.S. dollars and euros. The BoJ is also extremely vocal when it feels concerned about excess currency volatility and strength.
Mandate - To maintain price stability and to ensure stability of the financial system, which makes inflation the central bank's top focus.
Frequency of Meeting - Once or twice a month
Key Policy Official - Toshihiko Fukui, governor of Bank of Japan. A lifelong bureaucrat, Fukui joined the bank of Japan in 1958 and held various posts before succeeding Masaru Hayami as governor on March 19, 2003. Although Fukui has a reputation for being conservative, he has implemented new policies geared toward greater transparency, such as publishing BoJ economic outlooks and detailed minutes of policy meetings. On March 9, 2006, he ended the five-year-old ultra-loose monetary policy and prepared for a return to conventional rate targeting.
Swiss National Bank (SNB)
Structure - The Swiss National Bank has a three-person committee that makes decisions on interest rates. Unlike most other central banks, the SNB determines the interest rate band rather than a specific target rate. Like Japan and the euro zone, Switzerland is also very export dependent, which means that the SNB also does not have an interest in seeing its currency become too strong. Therefore, its general bias is to be more conservative with rate hikes.
Mandate - To ensure price stability while taking the economic situation into account
Frequency of Meeting - Quarterly
Key Policy Official - Jean-Pierre Roth, chairman of the Swiss National Bank. Roth has spent most of his professional career at the SNB, starting in 1979; he assumed the role of chairman of the governing board in 2001. Roth is also a member of the board of directors of the Bank for International Settlements and is governor of the International Monetary Fund for Switzerland.
Bank of Canada (BoC)
Structure - Monetary policy decisions within the Bank of Canada are made by a consensus vote by Governing Council, which consists of the Bank of Canada governor, the senior deputy governor and four deputy governors.
Mandate - Maintaining the integrity and value of the currency. The central bank has an inflation target of 1-3%, and it has done a good job of keeping inflation within that band since 1998.
Frequency of Meeting - Eight times a year
Key Policy Official - David Dodge, governor of the Bank of Canada. Princeton-educated Dodge held various public offices and taught at a few universities throughout the U.S. and Canada before taking office as the central bank governor in 2001. He is known for being frank and open about his beliefs, and has also been credited for carefully balancing inflation with currency appreciation. Mark Carney is set to replace Dodge in February 2008.
Reserve Bank of Australia (RBA)
Structure - The Reserve Bank of Australia's monetary policy committee consists of the central bank governor, the deputy governor, the secretary to the treasurer and six independent members appointed by the government.
Mandate - To ensure stability of currency, maintenance of full employment and economic prosperity and welfare of the people of Australia. The central bank has an inflation target of 2-3% per year.
Frequency of Meeting - Eleven times a year, usually on the first Tuesday of each month (with the exception of January)
Key Policy Official - Glenn Stevens, governor of the Reserve Bank of Australia. Stevens has been with the RBA since 1980. Prior to succeeding Ian Macfarlane, Stevens held a variety of positions at the RBA, from head of the Economic Analysis Department to deputy governor in December 2001. As with his predecessor, he is expected to keep a close eye on inflation, which is expected to be a challenge as the Australian economy continues to boom.
Reserve Bank of New Zealand (RBNZ)
Structure - Unlike other central banks, decision-making power on monetary policy ultimately rests with the central bank governor.
Mandate - To maintain price stability and to avoid instability in output, interest rates and exchange rates. The RBNZ has an inflation target of 1.5%. It focuses hard on this target, because failure to meet it could result in the dismissal of the governor of the RBNZ.
Frequency of Meeting - Eight times a year
Key Policy Official - Alan Bollard, governor of the Reserve Bank of New Zealand. Before his appointment as governor of the RBNZ in September 2002, Bollard served as secretary of the treasury, chairman of the NZ Commerce Commission and director of the NZ Institute of Economic Research. Known as a strong inflation hawk with extensive economic training, Bollard has condemned large current account deficits and raised New Zealand interest rates to a high level of 8.25%. (For further reading, see Current Account Deficits and Understanding The Current Account In The Balance Of Payment
Putting It All Together
Now that you know a little more about the structure, mandate and power players behind each of the major central banks, you are on your way to being able to better predict the moves these central banks may make. For many central banks, the inflation target is key. If inflation, which is generally measured by the consumer price index, is above the central bank's target, then you know that it will have a bias toward tighter monetary policy. By the same token, if inflation is far below the target, the central bank will be looking to loosen monetary policy. Combining the relative monetary policies of two central banks is a solid way to predict where a currency pair may be headed. If one central bank is raising interest rates while another is sticking to the status quo, the currency pair is expected to move in the direction of the interest rate spread (barring any unforeseen circumstances).
A perfect example is EUR/GBP in 2006. The euro broke out of its traditional range-trading mode to accelerate against the British pound. With consumer prices above the European Central Bank's 2% target, the ECB was clearly looking to raise rates a few more times. The Bank of England, on the other hand, had inflation slightly below its own target and its economy was just beginning to show signs of recovery, preventing it from making any changes to interest rates. In fact, throughout the first three months of 2006, the BoE was leaning more toward lowering interest rates than raising them. This led to a 200-pip rally in EUR/GBP, which is pretty big for a currency pair that rarely moves
Curious to learn more about central banks and monetary policy? Check out What Are Central Banks?, Formulating Monetary Policy and the Federal Reserve Tutorial.
By Kathy Lien, Chief Strategist, FXCM
Access Investopedia's FREE Forex Report - The 5 Things That Move The Currency Market
Kathy Lien is Chief Strategist at the world's largest retail forex market maker, Forex Capital Markets in New York. Her book "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Swings" (2005, Wiley), written for both the novice and expert, has won much acclaim. Easy to read and easy to apply, this book shows traders how to enter the currency market with confidence - and create long-term success! Kathy has taught currency trading seminars across the U.S. and has also written for CBS MarketWatch, Active Trader, Futures Magazine and SFO Magazine. Follow her blog at www.kathylien.com
Access Investopedia's FREE Forex Report - The 5 Things That Move The Currency Market.
Examples
Take the performance of the NZD/JPY currency pair between 2002 and 2005, for example. During that time, the central bank of New Zealand increased interest rates from 4.75% to 7.25%. Japan, on the other hand, kept its interest rates at 0%, which meant that the interest rate spread between the New Zealand dollar and the Japanese yen widened a full 250 basis points. This contributed to the NZD/JPY's 58% rally during the same period
On the flip side, we see that throughout 2005, the British pound fell more than 8% against the U.S. dollar. Even though the United Kingdom had higher interest rates than the United States throughout those 12 months, the pound suffered as the interest rate spread narrowed from 250 basis points in the pound's favor to a premium of a mere 25 basis points. This confirms that it is the future direction of interest rates that matters most, not which country has a higher interest rate.
The Eight Major Central Banks
U.S. Federal Reserve System (The Fed)
Structure - The Federal Reserve is probably the most influential central bank in the world. With the U.S. dollar being on the other side of approximately 90% of all currency transactions, the Fed's sway has a sweeping effect on the valuation of many currencies. The group within the Fed that decides on interest rates is the Federal Open Market Committee (FOMC), which consists of seven governors of the Federal Reserve Board plus five presidents of the 12 district reserve banks.
Mandate - Long-term price stability and sustainable growth
Frequency of Meeting - Eight times a year
Key Policy Official - Ben Bernanke, Chairman of the Federal Reserve. Following former chairman Alan Greenspan's retirement in January 2006, U.S. President George W. Bush tapped Bernanke to head the Federal Reserve, given his four years of experience on the Fed board of governors. His views differ from Greenspan's in that he believes in inflation targeting and printing money to avoid deflation. The historic change of power at the U.S. central bank marks the first time in two decades that an academic, who may focus more on mathematical and econometric models, is chairing the Fed.
European Central Bank (ECB)
Structure - The European Central Bank was established in 1999. The governing council of the ECB is the group that decides on changes to monetary policy. The council consists of the six members of the executive board of the ECB, plus the governors of all the national central banks from the 12 euro area countries. As a central bank, the ECB does not like surprises. Therefore, whenever it plans on making a change to interest rates, it will generally give the market ample notice by warning of an impending move through comments to the press.
Mandate - Price stability and sustainable growth. However, unlike the Fed, the ECB strives to maintain the annual growth in consumer prices below 2%. As an export dependent economy, the ECB also has a vested interest in preventing against excess strength in its currency because this poses a risk to its export market.
Frequency of Meeting - Bi-weekly, but policy decisions are generally only made at meetings where there is an accompanying press conference, and those happen 11 times a year.
Key Policy Official - Jean-Claude Trichet, president of the European Central Bank. Prior to succeeding Wim Duisenberg as ECB president in November 2003, Trichet was the president of Bank of France. He has a reputation for being a cautious and forthright banker, though many criticize his slow response to European economic stagnation and high unemployment. Typically seen as a hawk with a bias toward making preemptive moves to ward off inflation, Trichet has the huge responsibility of managing the monetary policy of 12 nations.
Bank of England (BoE)
Structure - The monetary policy committee of the Bank of England is a nine-member committee consisting of a governor, two deputy governors, two executive directors and four outside experts. The BoE, under the leadership of Mervyn King, is frequently touted as one of the most effective central banks.
Mandate - To maintain monetary and financial stability. The BoE's monetary policy mandate is to keep prices stable and to maintain confidence in the currency. To accomplish this, the central bank has an inflation target of 2%. If prices breach that level, the central bank will look to curb inflation, while a level far below 2% will prompt the central bank to take measures to boost inflation.
Frequency of Meeting - Monthly
Key Policy Official - Mervyn A. King, governor of the Bank of England. Prior to assuming the role of BoE governor on June 30, 2003, King was a professor at the London School of Economics. Initially joining the BoE in 1990, he became an executive director and chief economist in March 1991 and was promoted to deputy governor in 1997. King's "Goldilocks" monetary policy, which is neither too restrictive nor too accommodative, has propelled the U.K.'s economy into its longest streak of uninterrupted growth in 200 years.
Bank of Japan (BoJ)
Structure - The Bank of Japan's monetary policy committee consists of the BoJ governor, two deputy governors and six other members. Because Japan is very dependent on exports, the BoJ has an even more active interest than the ECB does in preventing an excessively strong currency. The central bank has been known to come into the open market to artificially weaken its currency by selling it against U.S. dollars and euros. The BoJ is also extremely vocal when it feels concerned about excess currency volatility and strength.
Mandate - To maintain price stability and to ensure stability of the financial system, which makes inflation the central bank's top focus.
Frequency of Meeting - Once or twice a month
Key Policy Official - Toshihiko Fukui, governor of Bank of Japan. A lifelong bureaucrat, Fukui joined the bank of Japan in 1958 and held various posts before succeeding Masaru Hayami as governor on March 19, 2003. Although Fukui has a reputation for being conservative, he has implemented new policies geared toward greater transparency, such as publishing BoJ economic outlooks and detailed minutes of policy meetings. On March 9, 2006, he ended the five-year-old ultra-loose monetary policy and prepared for a return to conventional rate targeting.
Swiss National Bank (SNB)
Structure - The Swiss National Bank has a three-person committee that makes decisions on interest rates. Unlike most other central banks, the SNB determines the interest rate band rather than a specific target rate. Like Japan and the euro zone, Switzerland is also very export dependent, which means that the SNB also does not have an interest in seeing its currency become too strong. Therefore, its general bias is to be more conservative with rate hikes.
Mandate - To ensure price stability while taking the economic situation into account
Frequency of Meeting - Quarterly
Key Policy Official - Jean-Pierre Roth, chairman of the Swiss National Bank. Roth has spent most of his professional career at the SNB, starting in 1979; he assumed the role of chairman of the governing board in 2001. Roth is also a member of the board of directors of the Bank for International Settlements and is governor of the International Monetary Fund for Switzerland.
Bank of Canada (BoC)
Structure - Monetary policy decisions within the Bank of Canada are made by a consensus vote by Governing Council, which consists of the Bank of Canada governor, the senior deputy governor and four deputy governors.
Mandate - Maintaining the integrity and value of the currency. The central bank has an inflation target of 1-3%, and it has done a good job of keeping inflation within that band since 1998.
Frequency of Meeting - Eight times a year
Key Policy Official - David Dodge, governor of the Bank of Canada. Princeton-educated Dodge held various public offices and taught at a few universities throughout the U.S. and Canada before taking office as the central bank governor in 2001. He is known for being frank and open about his beliefs, and has also been credited for carefully balancing inflation with currency appreciation. Mark Carney is set to replace Dodge in February 2008.
Reserve Bank of Australia (RBA)
Structure - The Reserve Bank of Australia's monetary policy committee consists of the central bank governor, the deputy governor, the secretary to the treasurer and six independent members appointed by the government.
Mandate - To ensure stability of currency, maintenance of full employment and economic prosperity and welfare of the people of Australia. The central bank has an inflation target of 2-3% per year.
Frequency of Meeting - Eleven times a year, usually on the first Tuesday of each month (with the exception of January)
Key Policy Official - Glenn Stevens, governor of the Reserve Bank of Australia. Stevens has been with the RBA since 1980. Prior to succeeding Ian Macfarlane, Stevens held a variety of positions at the RBA, from head of the Economic Analysis Department to deputy governor in December 2001. As with his predecessor, he is expected to keep a close eye on inflation, which is expected to be a challenge as the Australian economy continues to boom.
Reserve Bank of New Zealand (RBNZ)
Structure - Unlike other central banks, decision-making power on monetary policy ultimately rests with the central bank governor.
Mandate - To maintain price stability and to avoid instability in output, interest rates and exchange rates. The RBNZ has an inflation target of 1.5%. It focuses hard on this target, because failure to meet it could result in the dismissal of the governor of the RBNZ.
Frequency of Meeting - Eight times a year
Key Policy Official - Alan Bollard, governor of the Reserve Bank of New Zealand. Before his appointment as governor of the RBNZ in September 2002, Bollard served as secretary of the treasury, chairman of the NZ Commerce Commission and director of the NZ Institute of Economic Research. Known as a strong inflation hawk with extensive economic training, Bollard has condemned large current account deficits and raised New Zealand interest rates to a high level of 8.25%. (For further reading, see Current Account Deficits and Understanding The Current Account In The Balance Of Payment
Putting It All Together
Now that you know a little more about the structure, mandate and power players behind each of the major central banks, you are on your way to being able to better predict the moves these central banks may make. For many central banks, the inflation target is key. If inflation, which is generally measured by the consumer price index, is above the central bank's target, then you know that it will have a bias toward tighter monetary policy. By the same token, if inflation is far below the target, the central bank will be looking to loosen monetary policy. Combining the relative monetary policies of two central banks is a solid way to predict where a currency pair may be headed. If one central bank is raising interest rates while another is sticking to the status quo, the currency pair is expected to move in the direction of the interest rate spread (barring any unforeseen circumstances).
A perfect example is EUR/GBP in 2006. The euro broke out of its traditional range-trading mode to accelerate against the British pound. With consumer prices above the European Central Bank's 2% target, the ECB was clearly looking to raise rates a few more times. The Bank of England, on the other hand, had inflation slightly below its own target and its economy was just beginning to show signs of recovery, preventing it from making any changes to interest rates. In fact, throughout the first three months of 2006, the BoE was leaning more toward lowering interest rates than raising them. This led to a 200-pip rally in EUR/GBP, which is pretty big for a currency pair that rarely moves
Curious to learn more about central banks and monetary policy? Check out What Are Central Banks?, Formulating Monetary Policy and the Federal Reserve Tutorial.
By Kathy Lien, Chief Strategist, FXCM
Access Investopedia's FREE Forex Report - The 5 Things That Move The Currency Market
Kathy Lien is Chief Strategist at the world's largest retail forex market maker, Forex Capital Markets in New York. Her book "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Swings" (2005, Wiley), written for both the novice and expert, has won much acclaim. Easy to read and easy to apply, this book shows traders how to enter the currency market with confidence - and create long-term success! Kathy has taught currency trading seminars across the U.S. and has also written for CBS MarketWatch, Active Trader, Futures Magazine and SFO Magazine. Follow her blog at www.kathylien.com
Access Investopedia's FREE Forex Report - The 5 Things That Move The Currency Market.
Mistakes in a Trading Environment
When it comes to trading, one of the most neglected subjects are those dealing with trading psychology. Most traders spend days, months and even years trying to find the right system. But having a system is just part of the game. Don't get us wrong, it is very important to have a system that perfectly suits the trader, but it is as important as having a money management plan, or to understand all psychology barriers that may affect the trader decisions and other issues. In order to succeed in this business, there must be equilibrium between all important aspects of trading.
In the trading environment, when you lose a trade, what is the first idea that pops up in your mind? It would probably be, “There must be something wrong with my system”, or “I knew it, I shouldn't have taken this trade” (even when your system signaled it). But sometimes we need to dig a little deeper in order to see the nature of our mistake, and then work on it accordingly.
When it comes to trading the Forex market as well as other markets, only 5% of traders achieve the ultimate goal: to be consistent in profits. What is interesting though is that there is just a tiny difference between this 5% of traders and the rest of them. The top 5% grow from mistakes; mistakes are a learning experience, they learn an invaluable lesson on every single mistake made. Deep in their minds, a mistake is one more chance to try it harder and do it better the next time, because they know they might not get a chance the next time. And at the end, this tiny difference becomes THE big difference.
Mistakes in the trading environment
Most of us relate a trading mistake to the outcome (in terms of money) of any given trade. The truth is, a mistake has nothing to do with it, mistakes are made when certain guidelines are not followed. When the rules you trade by are violated. Take for instance the following scenarios:
First scenario: The system signals a trade.
1. Signal taken and trade turns out to be a profitable trade.
Outcome of the trade : Positive, made money.
Experience gained: Its good to follow the system, if I do this consistently the odds will turn in my favor. Confidence is gained in both the trader and the system.
Mistake made: None.
1. Signal taken and trade turns out to be a loosing trade.
Outcome of the trade: Negative, lost money.
Experience gained: It is impossible to win every single trade, a loosing trade is just part of the business; our raw material, we know we can't get them all right. Even with this lost trade, the trader is proud about himself for following the system. Confidence in the trader is gained.
Mistake made : None.
1. Signal not taken and trade turns out to be a profitable trade.
Outcome of the trade: Neutral.
Experience gained: Frustration, the trader always seems to get in trades that turned out to be loosing trades and let the profitable trades go away. Confidence is lost in the trader self.
Mistake made: Not taking a trade when the system signaled it.
1. Signal not taken and trade turns out to be a loosing trade.
Outcome of the trade: Neutral.
Experience gained: The trader will start to think “hey, I'm better than my system”. Even if the trader doesn't think on it consciously, the trader will rationalize on every signal given by the system because deep in his or her mind, his or her “feeling” is more intelligent than the system itself. From this point on, the trader will try to outguess the system. This mistake has catastrophic effects on our confidence to the system. The confidence on the trader turns into overconfidence.
Mistake made: Not taking a trade when system signaled it
Second Scenario: System does not signal a trade.
1. No trade is taken
Outcome of the trade: Neutral
Experience gained: Good discipline, we only need to take trades when the odds are in our favor, just when the system signals it. Confidence gained in both the trader self and the system.
Mistake made: None
1. A trade is taken, turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: This mistake has the most catastrophic effects in the trader self, the system and most importantly in the trader's trading career. You will start to think you need no system, you know better from them all. From this point on, you will start to trade based on what you think. Confidence in the system is totally lost. Confidence in the trader self turns into overconfidence.
Mistake made: Take a trade when there was no signal from the system.
1. A trade is taken, turned out to be a loosing trade.
Outcome of the trade: negative, lost money.
Experience gained: The trader will rethink his strategy. The next time, the trader will think it twice before getting in a trade when the system does not signal it. The trader will go “Ok, it is better to get in the market when my system signals it, only those trade have a higher probability of success”. Confidence is gained in the system.
Mistake made: Take a trade when there was no signal from the system
As you can see, there is absolutely no correlation between the outcome of the trade and a mistake. The most catastrophic mistake even has a positive trade outcome, made money, but this could be the beginning of the end of the trader's career. As we have already stated, mistakes must only be related to the violation of rules a trader trades by.
All these mistakes were directly related to the signals given by a system, but the same is applied when getting out of a trade. There are also mistakes related to following a trading plan. For example, risking more money on a given trade than the amount the trader should have risked and many more.
Most mistakes can be avoided by first having a trading plan. A trading plan includes the system : the criteria we use to get in and out the market, the money management plan : how much we will risk on any given trade, and many other points. Secondly, and most important, we need to have the discipline to follow strictly our plan. We created our plan when no trade was placed on, thus no psychology barriers were up front. So, the only thing we are certain about is that if we follow our plan, the decision taken is on our best interests, and in the long run, these decisions will help us have better results. We don't have to worry about isolated events, or trades that could had give us better results at first, but then they could have catastrophic results in our trading career.
How to deal with mistakes
There are many possible ways to properly manage mistakes. We will suggest the one that works better for us.
Step one: Belief change.
Every mistake is a learning experience. They all have something valuable to offer. Try to counteract the natural tendency of feeling frustrated and approach mistakes in a positive manner. Instead of yelling to everyone around and feeling disappointed, say to yourself “ok, I did something wrong, what happened? What is it?
Step two: Identify the mistake made.
Define the mistake, find out what caused the mistake, and try as hard as you can to effectively see the nature of that mistake. Finding the mistake nature will prevent you from making the same mistake again. More than often you will find the answer where you less expected. Take for instance a trader that doesn't follow the system. The reason behind this could be that the trader is afraid of loosing. But then, why is he or she afraid? It could be that the trader is using a system that does not fit him or her, and finds difficult to follow every signal. In this case, as you can see, the nature of the mistake is not in the surface. You need to try as hard as you can to find the real reason of the given mistake.
Step three: Measure the consequences of the mistake.
List the consequences of making that particular mistake, both good and bad. Good consequences are those that make us better traders after dealing with the mistake. Think on all possible reasons you can learn from what happened. For the same example above, what are the consequences of making that mistake? Well, if you don't follow the system, you will gradually loose confidence in it, and this at the end will put you into trades you don't really want to be, and out of trades you should be in.
Step four: Take action.
Taking proper action is the last and most important step. In order to learn, you need to change your behavior. Make sure that whatever you do, you become “this-mistake-proof”. By taking action we turn every single mistake into a small part of success in our trading career. Continuing with the same example, redefining the system would be the trader's final step. The trader would put a system that perfectly fits him or her, so the trader doesn't find any trouble following it in future signals.
Understanding the fact that the outcome of any trade has nothing to do with a mistake will open your mind to other possibilities, where you will be able to understand the nature of every mistake made. This at the same time will open the doors for your trading career as you work and take proper action on every mistake made.
The process of success is slow, and plenty of times it is attributed to repeated mistakes made and the constant struggle to get past these mistakes, working on them accordingly. How we deal with them will shape our future as a trader, and most importantly as a person.
In the trading environment, when you lose a trade, what is the first idea that pops up in your mind? It would probably be, “There must be something wrong with my system”, or “I knew it, I shouldn't have taken this trade” (even when your system signaled it). But sometimes we need to dig a little deeper in order to see the nature of our mistake, and then work on it accordingly.
When it comes to trading the Forex market as well as other markets, only 5% of traders achieve the ultimate goal: to be consistent in profits. What is interesting though is that there is just a tiny difference between this 5% of traders and the rest of them. The top 5% grow from mistakes; mistakes are a learning experience, they learn an invaluable lesson on every single mistake made. Deep in their minds, a mistake is one more chance to try it harder and do it better the next time, because they know they might not get a chance the next time. And at the end, this tiny difference becomes THE big difference.
Mistakes in the trading environment
Most of us relate a trading mistake to the outcome (in terms of money) of any given trade. The truth is, a mistake has nothing to do with it, mistakes are made when certain guidelines are not followed. When the rules you trade by are violated. Take for instance the following scenarios:
First scenario: The system signals a trade.
1. Signal taken and trade turns out to be a profitable trade.
Outcome of the trade : Positive, made money.
Experience gained: Its good to follow the system, if I do this consistently the odds will turn in my favor. Confidence is gained in both the trader and the system.
Mistake made: None.
1. Signal taken and trade turns out to be a loosing trade.
Outcome of the trade: Negative, lost money.
Experience gained: It is impossible to win every single trade, a loosing trade is just part of the business; our raw material, we know we can't get them all right. Even with this lost trade, the trader is proud about himself for following the system. Confidence in the trader is gained.
Mistake made : None.
1. Signal not taken and trade turns out to be a profitable trade.
Outcome of the trade: Neutral.
Experience gained: Frustration, the trader always seems to get in trades that turned out to be loosing trades and let the profitable trades go away. Confidence is lost in the trader self.
Mistake made: Not taking a trade when the system signaled it.
1. Signal not taken and trade turns out to be a loosing trade.
Outcome of the trade: Neutral.
Experience gained: The trader will start to think “hey, I'm better than my system”. Even if the trader doesn't think on it consciously, the trader will rationalize on every signal given by the system because deep in his or her mind, his or her “feeling” is more intelligent than the system itself. From this point on, the trader will try to outguess the system. This mistake has catastrophic effects on our confidence to the system. The confidence on the trader turns into overconfidence.
Mistake made: Not taking a trade when system signaled it
Second Scenario: System does not signal a trade.
1. No trade is taken
Outcome of the trade: Neutral
Experience gained: Good discipline, we only need to take trades when the odds are in our favor, just when the system signals it. Confidence gained in both the trader self and the system.
Mistake made: None
1. A trade is taken, turns out to be a profitable trade.
Outcome of the trade: Positive, made money.
Experience gained: This mistake has the most catastrophic effects in the trader self, the system and most importantly in the trader's trading career. You will start to think you need no system, you know better from them all. From this point on, you will start to trade based on what you think. Confidence in the system is totally lost. Confidence in the trader self turns into overconfidence.
Mistake made: Take a trade when there was no signal from the system.
1. A trade is taken, turned out to be a loosing trade.
Outcome of the trade: negative, lost money.
Experience gained: The trader will rethink his strategy. The next time, the trader will think it twice before getting in a trade when the system does not signal it. The trader will go “Ok, it is better to get in the market when my system signals it, only those trade have a higher probability of success”. Confidence is gained in the system.
Mistake made: Take a trade when there was no signal from the system
As you can see, there is absolutely no correlation between the outcome of the trade and a mistake. The most catastrophic mistake even has a positive trade outcome, made money, but this could be the beginning of the end of the trader's career. As we have already stated, mistakes must only be related to the violation of rules a trader trades by.
All these mistakes were directly related to the signals given by a system, but the same is applied when getting out of a trade. There are also mistakes related to following a trading plan. For example, risking more money on a given trade than the amount the trader should have risked and many more.
Most mistakes can be avoided by first having a trading plan. A trading plan includes the system : the criteria we use to get in and out the market, the money management plan : how much we will risk on any given trade, and many other points. Secondly, and most important, we need to have the discipline to follow strictly our plan. We created our plan when no trade was placed on, thus no psychology barriers were up front. So, the only thing we are certain about is that if we follow our plan, the decision taken is on our best interests, and in the long run, these decisions will help us have better results. We don't have to worry about isolated events, or trades that could had give us better results at first, but then they could have catastrophic results in our trading career.
How to deal with mistakes
There are many possible ways to properly manage mistakes. We will suggest the one that works better for us.
Step one: Belief change.
Every mistake is a learning experience. They all have something valuable to offer. Try to counteract the natural tendency of feeling frustrated and approach mistakes in a positive manner. Instead of yelling to everyone around and feeling disappointed, say to yourself “ok, I did something wrong, what happened? What is it?
Step two: Identify the mistake made.
Define the mistake, find out what caused the mistake, and try as hard as you can to effectively see the nature of that mistake. Finding the mistake nature will prevent you from making the same mistake again. More than often you will find the answer where you less expected. Take for instance a trader that doesn't follow the system. The reason behind this could be that the trader is afraid of loosing. But then, why is he or she afraid? It could be that the trader is using a system that does not fit him or her, and finds difficult to follow every signal. In this case, as you can see, the nature of the mistake is not in the surface. You need to try as hard as you can to find the real reason of the given mistake.
Step three: Measure the consequences of the mistake.
List the consequences of making that particular mistake, both good and bad. Good consequences are those that make us better traders after dealing with the mistake. Think on all possible reasons you can learn from what happened. For the same example above, what are the consequences of making that mistake? Well, if you don't follow the system, you will gradually loose confidence in it, and this at the end will put you into trades you don't really want to be, and out of trades you should be in.
Step four: Take action.
Taking proper action is the last and most important step. In order to learn, you need to change your behavior. Make sure that whatever you do, you become “this-mistake-proof”. By taking action we turn every single mistake into a small part of success in our trading career. Continuing with the same example, redefining the system would be the trader's final step. The trader would put a system that perfectly fits him or her, so the trader doesn't find any trouble following it in future signals.
Understanding the fact that the outcome of any trade has nothing to do with a mistake will open your mind to other possibilities, where you will be able to understand the nature of every mistake made. This at the same time will open the doors for your trading career as you work and take proper action on every mistake made.
The process of success is slow, and plenty of times it is attributed to repeated mistakes made and the constant struggle to get past these mistakes, working on them accordingly. How we deal with them will shape our future as a trader, and most importantly as a person.
Incorporating Price Action into a Forex Trading System
Trading the Forex market has become very popular in the last few years. But how difficult is it to achieve success in the Forex trading arena? Or let me rephrase this question, how many traders achieve consistent profitable results trading the Forex market? Unfortunately very few, only 5% of traders achieve this goal. One of the main reasons of this is because Forex traders focus in the wrong information to make their trading decisions and totally forget about the most important factor: Price behavior.
Most Forex trading systems are made off technical indicators (a moving average (MA) crossover, overbought/oversold conditions in an oscillator, etc.) But what are technical indicators? They are just a series of data points plotted in a chart; these points are derived from a mathematical formula applied to the price of any given currency pair. In other words, it is a chart of price plotted in a different way that helps us see other aspects of price.
There is an important implication on this definition of technical indicators. The fact that the readings obtained from them are based on price action. Take for instance a long MA crossover signal, the price has gone up enough to make the short period MA crossover the long period MA generating a long signal. Most traders see it as “the MA crossover made the price go up,” but it happened the other way around, the MA crossover signal occurred because the price went up. Where I'm trying to get here is that at the end, price behavior dictates how an indicator will act, and this should be taken into consideration on any trading decision made.
Trading decisions based on technical indicators without taking price action into consideration will give us less accurate results. For example, again a long signal generated by a MA crossover as the market approaches an important resistance level. If the price suddenly starts to bounce back off that important level there is no point on taking this signal, price action is telling us the market doesn't want to go up. Most of the time, under this circumstances, the market will continue to fall down, disregarding the MA crossover.
Don't get us wrong here, technical indicators are a very important aspect of trading. They help us see certain conditions that are otherwise difficult to see by watching pure price action. But when it comes to pull the trigger, price action incorporation into our Forex trading system will definitely put the odds in our favor, it will generate higher probability trades.
So, how to create a perfect Forex trading system?
First of all, you need to make sure your trading system fits your trading personality; otherwise you will find it hard to follow it. Every trader has different needs and goals, thus there is no system that perfectly fits all traders. You need to make your own research on various trading styles and technical indicators until you find a concept that perfectly works for you. Make sure you know the nature of whatever technical indicator used.
Secondly, incorporate price action into your system. So you only take long signals if the price behavior tells you the market wants to go up, and short signals if the market gives you indication that it will go down.
Third, and most importantly, you need to have the discipline to follow your Forex trading system rigorously. Try it first on a demo account, then move on to a small account and finally when feeling comfortably and being consistent profitable apply your system in a regular account.
Most Forex trading systems are made off technical indicators (a moving average (MA) crossover, overbought/oversold conditions in an oscillator, etc.) But what are technical indicators? They are just a series of data points plotted in a chart; these points are derived from a mathematical formula applied to the price of any given currency pair. In other words, it is a chart of price plotted in a different way that helps us see other aspects of price.
There is an important implication on this definition of technical indicators. The fact that the readings obtained from them are based on price action. Take for instance a long MA crossover signal, the price has gone up enough to make the short period MA crossover the long period MA generating a long signal. Most traders see it as “the MA crossover made the price go up,” but it happened the other way around, the MA crossover signal occurred because the price went up. Where I'm trying to get here is that at the end, price behavior dictates how an indicator will act, and this should be taken into consideration on any trading decision made.
Trading decisions based on technical indicators without taking price action into consideration will give us less accurate results. For example, again a long signal generated by a MA crossover as the market approaches an important resistance level. If the price suddenly starts to bounce back off that important level there is no point on taking this signal, price action is telling us the market doesn't want to go up. Most of the time, under this circumstances, the market will continue to fall down, disregarding the MA crossover.
Don't get us wrong here, technical indicators are a very important aspect of trading. They help us see certain conditions that are otherwise difficult to see by watching pure price action. But when it comes to pull the trigger, price action incorporation into our Forex trading system will definitely put the odds in our favor, it will generate higher probability trades.
So, how to create a perfect Forex trading system?
First of all, you need to make sure your trading system fits your trading personality; otherwise you will find it hard to follow it. Every trader has different needs and goals, thus there is no system that perfectly fits all traders. You need to make your own research on various trading styles and technical indicators until you find a concept that perfectly works for you. Make sure you know the nature of whatever technical indicator used.
Secondly, incorporate price action into your system. So you only take long signals if the price behavior tells you the market wants to go up, and short signals if the market gives you indication that it will go down.
Third, and most importantly, you need to have the discipline to follow your Forex trading system rigorously. Try it first on a demo account, then move on to a small account and finally when feeling comfortably and being consistent profitable apply your system in a regular account.
Don't Catch the Falling Knife!
If you can't beat em ...
Don't join em!
If a stock insists on crashing ...
Don't ride it down!
When a stock's price falls quickly and far, it is always doing so for a certain reason!
Often bad news, earnings or something similiar is to blame. Most of the time, when this happens, the stock enters into a very bearish downtrend, which continues for several weeks or months or even much more.
Sometimes that trend can keep on going on and on until the company's final bankruptcy.
If you can distance yourself from the situation, and take out the emotional element, you will see that when this happens, you have a genuine opportunity to save some money:
Sell it ... and avoid losing more!
Still in the falling stock and you're waiting for a rebound? Forget it. Its not going to happen. Take your losses and move on!
Anytime a stock is on a downtrend, despite what hype you may hear, it is most likely not "highly undervalued" and not "ready to pop any moment."
Everyone wants to believe that all stocks are going up. This is because most investors are just that, investors. They are not traders. Investors most of the times, buy and hold, and want stocks to go up.
Traders, on the other hand, understand that this perfert world does not exist, and will take advantage of it and you ... "the investor."
Stocks do go up and many times do go down ...
To take advantage of that, you must identify when the time is right to buy, and when to sell!
Don't join em!
If a stock insists on crashing ...
Don't ride it down!
When a stock's price falls quickly and far, it is always doing so for a certain reason!
Often bad news, earnings or something similiar is to blame. Most of the time, when this happens, the stock enters into a very bearish downtrend, which continues for several weeks or months or even much more.
Sometimes that trend can keep on going on and on until the company's final bankruptcy.
If you can distance yourself from the situation, and take out the emotional element, you will see that when this happens, you have a genuine opportunity to save some money:
Sell it ... and avoid losing more!
Still in the falling stock and you're waiting for a rebound? Forget it. Its not going to happen. Take your losses and move on!
Anytime a stock is on a downtrend, despite what hype you may hear, it is most likely not "highly undervalued" and not "ready to pop any moment."
Everyone wants to believe that all stocks are going up. This is because most investors are just that, investors. They are not traders. Investors most of the times, buy and hold, and want stocks to go up.
Traders, on the other hand, understand that this perfert world does not exist, and will take advantage of it and you ... "the investor."
Stocks do go up and many times do go down ...
To take advantage of that, you must identify when the time is right to buy, and when to sell!
Creative Accounting
The science of math is not only restricted to eccentric nerds ...
Call it what ever you want:
Creative accounting, messing or fooling around with the numbers, the fact of the matter is that this "math" has taken a place on business accounting.
Executives and many other managers often benefit for sometimes long periods of time before their mathematical operations are fully exposed. On the other hand many investors are often left standing in the cold with empty pockets!
The majority of analysts, investors, and newspeople are many times intrigued by certain companies sudden growth scenarios. And although such stories do last for quite a long time, they are far from clear.
The business community has many times seen its share of paper wealth to be demolished into absolute shambles. The dot-com bubble itself was fueled and failed by creative accounting.
Many companies are getting busy with their creative accounting procedures and scenarios and add a significant paper boost to their gross profit margins.
They are so eager to record the sales at full value that they also hide many kinds of costs. One might argue that such companies are misinforming investors by emphasizing gross revenues.
Investors must keep guard against such creative accounting practices and ...
Maintain a close monitoring on the revenues, profits and market share of the companies.
Call it what ever you want:
Creative accounting, messing or fooling around with the numbers, the fact of the matter is that this "math" has taken a place on business accounting.
Executives and many other managers often benefit for sometimes long periods of time before their mathematical operations are fully exposed. On the other hand many investors are often left standing in the cold with empty pockets!
The majority of analysts, investors, and newspeople are many times intrigued by certain companies sudden growth scenarios. And although such stories do last for quite a long time, they are far from clear.
The business community has many times seen its share of paper wealth to be demolished into absolute shambles. The dot-com bubble itself was fueled and failed by creative accounting.
Many companies are getting busy with their creative accounting procedures and scenarios and add a significant paper boost to their gross profit margins.
They are so eager to record the sales at full value that they also hide many kinds of costs. One might argue that such companies are misinforming investors by emphasizing gross revenues.
Investors must keep guard against such creative accounting practices and ...
Maintain a close monitoring on the revenues, profits and market share of the companies.
Money
"Money is like a sixth sense without which you cannot make a complete use of the other five."
William Somerset Maugham (1874 - 1965)
Money permeates every relationship in life, every interpersonal interaction:
Friendship and Courtship,
Partnerships,
Investments,
Living Together,
Marriage,
Divorce,
Death and etc!
Money is a commodity which takes on other meanings and emotions.
Money becomes the emotional football that everybody may use to throw back and forth at all others and never resolve their real issues.
Workers earn it,
Spendthrifts burn it,
Bankers lend it,
Women spend it,
Forgers fake it,
Taxes take it,
Dying leave it,
Heirs receive it,
Thrifty save it,
Misers crave it,
Robbers seize it,
Rich increase it,
Gamblers lose it,
Stock brokers sometimes (?) multiply it and ...
We will all always can use it!
William Somerset Maugham (1874 - 1965)
Money permeates every relationship in life, every interpersonal interaction:
Friendship and Courtship,
Partnerships,
Investments,
Living Together,
Marriage,
Divorce,
Death and etc!
Money is a commodity which takes on other meanings and emotions.
Money becomes the emotional football that everybody may use to throw back and forth at all others and never resolve their real issues.
Workers earn it,
Spendthrifts burn it,
Bankers lend it,
Women spend it,
Forgers fake it,
Taxes take it,
Dying leave it,
Heirs receive it,
Thrifty save it,
Misers crave it,
Robbers seize it,
Rich increase it,
Gamblers lose it,
Stock brokers sometimes (?) multiply it and ...
We will all always can use it!
Liquidity
There are two aspects of liquidity:
A. How readily an asset can be turned into cash (the ease with which buyers and sellers can be brought together and can agree on a price) is called liquidity.
An important consideration in assessing risk is how liquid various financial assets are. Therefore, assets that are less liquid tend to have a wider spread between the "bid" (the price offered by a would-be buyer) and the "ask" (the seller's asking price).
Cash is King!
You need cash and liquidity for freedom and security. The cash in reserve provides money for not only emergencies but opportunities as well.
A cash reserve provides the foundation for your entire financial position. You should get your cash reserve in order before taking on any risky investments with money you can not afford to lose!
Boring but prudent!
Five to six months "salary or seven to eight months" expenses are guidelines generally considered reasonable for emergency reserve funds.
B. An important factor when choosing which stocks to buy is liquidity.
This type of liquidity is best measured with volume. Higher the average daily volume is, higher the liquidity is.
High liquidity ensures that at the moment when we want to buy or sell shares, there will be enough sellers/buyers on the other side of the fence!
A. How readily an asset can be turned into cash (the ease with which buyers and sellers can be brought together and can agree on a price) is called liquidity.
An important consideration in assessing risk is how liquid various financial assets are. Therefore, assets that are less liquid tend to have a wider spread between the "bid" (the price offered by a would-be buyer) and the "ask" (the seller's asking price).
Cash is King!
You need cash and liquidity for freedom and security. The cash in reserve provides money for not only emergencies but opportunities as well.
A cash reserve provides the foundation for your entire financial position. You should get your cash reserve in order before taking on any risky investments with money you can not afford to lose!
Boring but prudent!
Five to six months "salary or seven to eight months" expenses are guidelines generally considered reasonable for emergency reserve funds.
B. An important factor when choosing which stocks to buy is liquidity.
This type of liquidity is best measured with volume. Higher the average daily volume is, higher the liquidity is.
High liquidity ensures that at the moment when we want to buy or sell shares, there will be enough sellers/buyers on the other side of the fence!
Swing Trading
A swing trade is one that is entered with the idea of profiting from the natural ebb and flow of a stock's daily movements.
In investing and stock trading swing trades are usually initiated in an area of significant support (or resistance, for shorts), and seek to capture between 3% to 6% in profits, depending on the situation.
Typically held for a period of two to five (or more) days, swing trades take advantage of a very profitable market niche overlooked by most active investors.
Swing trading is too brief for large institutional concerns to take advantage of and, at the same time, too lengthy for day traders (who typically don't hold positions overnight) to be comfortable with, this time frame offers the perfect opportunity for independent traders who possess the expertise necessary to profitably exploit it!
In investing and stock trading swing trades are usually initiated in an area of significant support (or resistance, for shorts), and seek to capture between 3% to 6% in profits, depending on the situation.
Typically held for a period of two to five (or more) days, swing trades take advantage of a very profitable market niche overlooked by most active investors.
Swing trading is too brief for large institutional concerns to take advantage of and, at the same time, too lengthy for day traders (who typically don't hold positions overnight) to be comfortable with, this time frame offers the perfect opportunity for independent traders who possess the expertise necessary to profitably exploit it!
Pessimistic Vs Optimistic: Investing Attitudes
One major thing that all the investors must learn is that attitude really matters. In fact, in investing it is simply amazing how much difference an attitude can make!
There is a basic and consistent feature among investors that are successful:
Positive Attitude!
An investor with a positive (optimistic) attitude is more likely to make money than one with a negative (pessimistic) attitude.
An investor with a pessimistic attitude is more likely to give up hope and abandon a successful system and invest on emotions.
He is more likely to focus on bad investments rather than good ones.
He is more likely to think he is always right, rather than learn from others.
He is more likely to lose money, given the same recommendations than someone who has a positive attitude.
He is more likely to be mad or upset or stressed out at the end of the day and more likely to bring that back the next morning.
On the other hand, the investor with an optimistic attitude realizes that not all choices are winners, that over the long run, with patience and discipline, he will make money.
He sets aside his pride and lets himself learn valuable investing lessons.
He understands that everyone makes mistakes, including himself and realizes that if you learn from a mistake, it can be a good thing.
He is more likely to make money, given the same recommendations than someone who has a negative attitude.
He is more likely to be happy at the end of each day, and more likely to start investing with a positive attitude the next day.
These cycles continue on and on and on ...
That is why most successful people are optimists and most unsuccessful people are pessimists.
Investors must learn the value of this quality and always look on the bright side of life!
There is a basic and consistent feature among investors that are successful:
Positive Attitude!
An investor with a positive (optimistic) attitude is more likely to make money than one with a negative (pessimistic) attitude.
An investor with a pessimistic attitude is more likely to give up hope and abandon a successful system and invest on emotions.
He is more likely to focus on bad investments rather than good ones.
He is more likely to think he is always right, rather than learn from others.
He is more likely to lose money, given the same recommendations than someone who has a positive attitude.
He is more likely to be mad or upset or stressed out at the end of the day and more likely to bring that back the next morning.
On the other hand, the investor with an optimistic attitude realizes that not all choices are winners, that over the long run, with patience and discipline, he will make money.
He sets aside his pride and lets himself learn valuable investing lessons.
He understands that everyone makes mistakes, including himself and realizes that if you learn from a mistake, it can be a good thing.
He is more likely to make money, given the same recommendations than someone who has a negative attitude.
He is more likely to be happy at the end of each day, and more likely to start investing with a positive attitude the next day.
These cycles continue on and on and on ...
That is why most successful people are optimists and most unsuccessful people are pessimists.
Investors must learn the value of this quality and always look on the bright side of life!
Investing Basics
What motivates a person to invest, rather than spending his money immediately?
The most common answer is savings -- the desire to pass money from the present into the future.
People anticipate future cash needs, and expect that their earnings in the future will not meet those needs. Another motivation is the desire to increase wealth, i.e. make money grow.
Sometimes, the desire to become wealthy in the future can make you willing to take big risks.
The purchase of a lottery ticket, for instance only increases the probability of becoming very wealthy, but sometimes a small chance at a big payoff, even if it costs a dollar or two, is better than none at all!
When you invest, you are increasing your income and building the value of your assets!
It's never too soon to start thinking about investing. Investing means putting your money to work earning more money. Done wisely, it can help you meet your financial goals.
You don't have to be wealthy to be an investor. Investing even a small amount can produce considerable rewards over the long term, especially if you do it regularly.
Investing means you have to make decisions about how much you want to invest and where to invest it.
To choose wisely, you need to know what choices you have and what risks you take when you invest in different ways.
If you want to invest, you have a wealth of opportunities. Selecting the best investment depends on your financial goals and general market conditions.
The right investment is a balance of three things:
1. Liquidity - How accessible is your money?
2. Safety - What's the risk involved? and
3. Return - What can you get back on your investment.
You can find many things to invest in, but the basic three:
Stocks, bonds and cash should be the core of any investment portfolio.
The most common answer is savings -- the desire to pass money from the present into the future.
People anticipate future cash needs, and expect that their earnings in the future will not meet those needs. Another motivation is the desire to increase wealth, i.e. make money grow.
Sometimes, the desire to become wealthy in the future can make you willing to take big risks.
The purchase of a lottery ticket, for instance only increases the probability of becoming very wealthy, but sometimes a small chance at a big payoff, even if it costs a dollar or two, is better than none at all!
When you invest, you are increasing your income and building the value of your assets!
It's never too soon to start thinking about investing. Investing means putting your money to work earning more money. Done wisely, it can help you meet your financial goals.
You don't have to be wealthy to be an investor. Investing even a small amount can produce considerable rewards over the long term, especially if you do it regularly.
Investing means you have to make decisions about how much you want to invest and where to invest it.
To choose wisely, you need to know what choices you have and what risks you take when you invest in different ways.
If you want to invest, you have a wealth of opportunities. Selecting the best investment depends on your financial goals and general market conditions.
The right investment is a balance of three things:
1. Liquidity - How accessible is your money?
2. Safety - What's the risk involved? and
3. Return - What can you get back on your investment.
You can find many things to invest in, but the basic three:
Stocks, bonds and cash should be the core of any investment portfolio.
Investing in Art
Many of our clients are art lovers, own collections or investing in art, specifically in Greek art, and are actively buying and selling in the art markets all over the world.
In their art quest they require someone who understands and appreciates the significance and pleasure of investing in Greek art of high value.
As a result, we are now offering varying degrees of services related to Greek art and we are actively helping many investors to build their collections.
We have developed ArtInvesting a unique and personal service offered by us, which was established in order to complement the reliability and discretion of our brokerage with an appreciation and love of Greek art.
We offer art research, acquisitions, sales, collection planning, financing and curatorial management. As an exclusive service to our clients, we offer confidentiality, objectivity and a professional approach to art investment.
Based upon your needs, we will locate and research exclusive market opportunities for the purchase and sale of Greek art, devise a focused strategy and act on your behalf to access our exclusive network of buyers and sellers from our client base.
We work closely with recognised experts and market professionals to guarantee you the highest standard of service available in the Greek art market. Our experts enjoy high recognition and can always give their advice on the buying and selling of art.
Art and Economic Performance
Through the centuries, many investors have chosen to invest a good part of their wealth in art and other collectibles.
Although putting money into art may not be as straightforward as investing in bonds or equities, the art market is attracting increasing interest.
As a result, we are now seeing a lot more new and old investors that are looking to put their money at art.
In their art quest they require someone who understands and appreciates the significance and pleasure of investing in Greek art of high value.
As a result, we are now offering varying degrees of services related to Greek art and we are actively helping many investors to build their collections.
We have developed ArtInvesting a unique and personal service offered by us, which was established in order to complement the reliability and discretion of our brokerage with an appreciation and love of Greek art.
We offer art research, acquisitions, sales, collection planning, financing and curatorial management. As an exclusive service to our clients, we offer confidentiality, objectivity and a professional approach to art investment.
Based upon your needs, we will locate and research exclusive market opportunities for the purchase and sale of Greek art, devise a focused strategy and act on your behalf to access our exclusive network of buyers and sellers from our client base.
We work closely with recognised experts and market professionals to guarantee you the highest standard of service available in the Greek art market. Our experts enjoy high recognition and can always give their advice on the buying and selling of art.
Art and Economic Performance
Through the centuries, many investors have chosen to invest a good part of their wealth in art and other collectibles.
Although putting money into art may not be as straightforward as investing in bonds or equities, the art market is attracting increasing interest.
As a result, we are now seeing a lot more new and old investors that are looking to put their money at art.
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