Chapter 2
Getting Ready to Trade
CHAPTER OBJECTIVES
In this chapter, you will learn the following:
• How to handle the emotions that come with trading Forex
• How to evaluate your risk tolerance
• The importance of trading support groups
• How to evaluate your available funds for Forex trading
• Where to look for and evaluate market information
Having a working knowledge on the basics of Forex is the first step to knowing if you are ready to trade. Thorough study of the market, knowledge of trading platforms, and time spent paper trading with a demo account will allow you to go a long way into your trading career and allow you a good chance to be successful. The next step should be to figure out if Forex trading is a good fit for you. Some of the things to consider about trading are the time commitments to learn a good system of trading, getting to know your way around the markets, economic indicators, etc. You should also think about how currencies markets and 24-hour trading will fit into your daily routine with your other personal obligations such as family and friends, and how to handle the ups and downs of your fortunes when trading. When you are just getting started with Forex trading it is best to remember that a solid backup plan will give you the reassurance and safety net you need to help get your trading business off the ground successfully and guide you through the rough spots.
Most jobs come with emotional stresses and strains, but Forex trading ties your income levels to an unpredictable market which can add significant amounts of stress to your day. The higher the stress levels, the stronger the emotions that can run through you in a moment, causing a chain reaction before you may realize it. For example if a foreign exchange (FX) trader is running on a highly profitable day, they can be on an emotional high and have a feeling that they are on top of the world. On the flip side, a losing day could darken your mood and help move you towards a negative losing pattern instead of making the “day-over” call and closing up shop for the day. Trading can also get you to the point where you are trading for the thrill of it and making money becomes secondary. In fact, some Forex traders purposely seek out the wild ride of the markets, enjoying the ups and crashing hard with the downs, much like the thrill of a roller coaster ride. If you find that this is you, that’s fine, just trade with a smaller amount of cash that you are willing to risk to the fullest and not be afraid to lose. On the other hand, professional currency traders know how to stand back, take in the larger picture, and see the job of trading as just that: a job that produces income, has trading hours, requires risk management, etc., and have a life outside of the trading room.
Even though a professional horse trainer would be excited when a new client brings him a potential race winner or a temperamental thoroughbred racehorse, the horse trainer would still perform the same basic assessment to the horse including the vet checks, hot walks, grooming, shoeing, and warm-up gallops that are part of a professional trainer’s daily routine. He would not be overly impressed by bloodline, breeding, or even a recent winning streak. A true pro knows how to get the best out of his skills on a daily basis and uses all his tools and experience to the best of his knowledge to maintain a sound training program, trusting in his long-term methods. A trainer won’t stop feeding an animal if it doesn’t perform as expected or tell an owner his horse can’t run. Similarly, as an FX trader, you will be “training with” high performance, hot-blooded, extremely unpredictable Forex markets (the thoroughbred), and you will use every tool in your toolbox to do so.
Running your Forex trading accounts like a business is the key for a healthy, long-term trading career. Even if your emotions are tied to every trade, you can keep a cool head to strategically plan entry/exit points. Keep in mind that entry points are the points that you make your initial buy or sell of a currency pair. Exit points are where you close out the trade. Keeping a calm head with a sensible approach will help alleviate the wild emotional swings many new traders face. Forex traders share many stories of exciting market swings that make them instant wealth (on paper with unrealized gains) only to have their trade close out badly and lose the profits. These are the traders who you can learn from when they say “what was I thinking?” or “I should have taken the profits.” These traders rode the wave, and even after seeing the crest, still failed to close out their trade because they sought an even higher wave. Good tools in your trading toolbox won’t matter if you cannot master your emotions in the middle of a rocky moment. It is best to learn to harness the power of your emotions and you will be well on your way to a high-profit, low-emotion, successful Forex trading career.
Next, consider your available time commitment to FX trading. Getting up to speed on market research, your trading preferences, and your personal market knowledge can take a few weeks to several year-long seasons. Give yourself time to learn, because just as any other new job has a learning curve, so will currency trading. Read financial magazines, websites, news feeds, and books aimed at day traders as much and as often as you can. The Wall Street Journal and Financial Times are excellent resources to find help getting acquainted with the structure and flow of the markets. The more information you have, the better your trades will be when you start making them.
Being a successful day trader is not about throwing good money after bad. The long-term, successful trader is always learning, always exploring markets and trends, and always thinking about ways to make his or her trades work for them. Many new traders hastily throw their hard-earned money into the market to follow the latest trend, only to lose it all very quickly when the day’s hysteria blows over. Starting out slowly is a good idea when starting something new. No one expects to have flawless trades, a perfect portfolio hedge, and huge gains in the first day of learning how to trade. Keep your expectations realistic, and commit to what you can learn on a steady, daily pace to grow your knowledge base. For example, learn all you can about your specific trading platform software, run the demo, read the help notes, find out how to open and close trades, and practice with real-time data if the software allows.
Some traders are so new to the scene, they haven’t figured out which button to hit to place a trade, or how to close it down on their trading screen. Take the time to slow down and learn your new software trading platform inside and out. You wouldn’t drive a stick-shift car if you only knew automatic transmissions, so why try running an FX trading account when you don’t know what your software does or doesn’t do? Take the time to open an account, learn how to properly operate it, and find out what sort of trades interest you.
Keep in mind that it also requires a time investment on your part to sit down in front of the computer and to stay vigilant while the market moves up and down, in order for you to capture gains. Some markets can be traded overnight or in the evenings, while many of them are only open during the mornings and early afternoons. The best educated traders do their research before placing trades, so think about getting up earlier to stay on top of the news. It is still entirely possible to be a part-time trader. Trades can be made after regular work hours during the week or on Sunday afternoons. You may face a few limitations on what is available to trade at those hours; however, it is a great way to get up to speed on the markets with a reduced schedule of availability.
What sort of risk taker are you? Can you live with a lot of uncertainty or are you a $5 cash in the hand is better than $20 in an hour type of person? There is always risk involved in Forex trading, some of which can be reduced. There are risks associated with everything, including a regular “day job”—you could be hit by a bus during your morning commute or your job might be transferred overseas at a moment’s notice. For example, when an Emergency Room doctor has a bad day, he loses a patient and someone dies. But if a retail store cashier has a bad day and counts out the wrong change, he or she still goes home with a paycheck. Of course the ER doctor risks more every day and earns more in salary, but saving a life is a much larger reward to receive than a steady $8.00/hr paycheck the low-risk, low-gain cashier earns. However, most people would agree that risking their daily paycheck leaves them weak in the knees and shaky before the morning coffee break rolls around. “Opportunity risk” is the idea that the Forex trader who makes a successful living trading full time has passed up the opportunity to earn regular income from a lower stress job. This is not a one-size-fits-all type of career path. No one but you can make the assessment of whether it is right for you.
Any time you put your own money on the line to make a living, you invite risk. Forex trading involves a different level of risk that’s not for everyone. Many low-risk careers offer steady jobs with convenient bi-weekly salaries and plenty of great benefits as well. There is no reliable paycheck in trading. Your net profits make you break even, or have far more or far less than when you started the day. Putting your hard-earned money into something that may or not be fruitful can be addictive or depressing, depending on what your attitude is. Taking on risk to gain rewards in the form of profit can tempt even the most sophisticated Forex trader to knock on potential’s door more often. These traders are the ones who know that in order to gain more, you must risk more. Before you jump on a hot market tip or trend, decide what your acceptable risk level is. In other words, manage your risk ahead of time, so it doesn’t manage you.
Develop your unique risk-level management with a good dose of common sense mixed with mathematics and market knowledge. This will help to shore up your risk levels and protect your assets by lowering the profit margins. While it is possible to hedge all of your risk away, you also may give up any real profit. Find a profitable balance between your risk comfort level and the profits you seek and you’ll enjoy a long career as a skilled day trader.
As with any business, certain tools are required in the old toolbox. For Forex traders, this includes cash. You don’t have to have thousands of dollars to get started. Some accounts can be opened with as little as $250, $100, or even $10. (Oanda www.oanda.com allows an account to be opened with $1!) While FX trading can be started with small balances, a good amount of learning, profit (in relation to the cash balance), and excitement can be had with a smaller cash deposit. Keep in mind that the typical Forex account offers up to a 50:1 margin, so this would mean a $12,500 to $500 available currency trading account.
In the beginning, a novice trader can get their feet wet in the market slowly. Perhaps you have the evenings free to read market news, study trends, and make small, quick trades while relaxing on the couch. Start out with the habit of taking the time to train and learn the basics before you involve a real cash balance. Some traders start out small to learn the ebb and flow of the market and also realize a tiny profit at the same time. Having an extra $20 to spend on lunch the next day, due to your small, practice trades from the night before can be a great feeling and will encourage you to keep trying. It also imprints how your trading platform software works, builds confidence, and prepares you for making larger trades in the future.
Small dollar amounts are not to be taken lightly. Don’t fall for the idea that small cash accounts equal small profits and you should instead jump into higher risk levels for higher gains. Poor position size, bad margin management, and a couple of poorly placed trades can slam the door on any gains and close out even the tiniest accounts.
Getting used to the demo feature on your trading platform, doing a couple test trades, and getting into the habit of checking the news and resources, puts you in a better position to use real money. Get used to that winning feeling on the trades you researched, planned for, and added in the profit column of your balance sheet. Gradually, over time, you can build up your account and trade larger amounts. Eventually, when you’re up to full-time trading, you’ll be able to draw a salary from your account. In the meantime, be sure to use funds you can live without for a while and certainly not your rent money! Use your latte coffee money or brown bag your lunches to get that extra cash put aside for trading. It will be put to good use and eventually pay you back. Grow your account by plowing the profits you have made back into the trading account.
Now that you’re confident in your ability to conquer your emotions, have established a solid risk tolerance, and have a small cash amount to trade with, the last part is learning how to work by yourself. Full-time or part-time, most Forex trading is done alone. Today’s superfast computers, with easy-to-use software programs and trading platforms enable day traders to either work in the city or on the outskirts of town. Forex traders can have their home offices in the most rural part of Montana or in heavily populated New York City. Either way, the best part or Forex trading is that you can work from home, in your slippers if you want, taking breaks as needed, all the while keeping an eye on your trades. The downside is that it can get a bit lonely all by yourself, especially if you happen to be one of those types who prefer to be on the more social end of the office friendliness chart.
If you’re one who likes to chat at lunch, tell jokes around the water cooler, or hang out with office buddies after work, you may miss the social interaction that a regular job offers. Being alone works great for extended periods of intense concentration, but has its drawbacks when you’re looking for feedback on a trade or chitchat during some downtime. Other drawbacks of working alone include the lack of peer support as to whether or not to place a trade: “Is this a good trading opportunity?” “What do you think of today’s labor report?” Or even, “What do you think of the EUR/SEK pair at this price?” These are some of the questions that can’t easily be asked of your officemates. At a regular job there is also some sort of supervisor; it seems that everyone has a more experienced person to consult about a question or issue. When you work alone trading Forex, you will have to make your own decisions as to what is a good trade, when it is a good time to trade, how much to trade, and even when to take your profits. At the same time, once you get good at doing your own thing, you can take your profits of an overnight long AUD/USD trade by 8a.m. Eastern time and close up shop. In this case, you might have discovered that you knew the market well enough to make the right call without any help, and that you’ve made your daily wage by the time the day is just starting for most people.
This is one of the best parts of Forex trading: It can be run like a business, you can be your own boss, and you can pay the bills with the profits. There are tales of people learning to trade Forex and slowly building up enough experience and confidence to have a big enough balance to get to the point where they can make a 5% return on their cash balance very safely and very consistently. These returns can be made with only one or two safe trades a week. These traders keep a large balance in their accounts, and trade at a high margin. They look for only the best trades, and they make the money consistently. It is quite easy to make 20%–30% per month in returns by trading very infrequently (which is actually a very safe way to go about Forex trading). The money can then be rolled over and the account can build up over time, or the profits can be taken out at the end of the month, with the cash going directly into your checking account and then used to pay for the mortgage, rent, bills, car payment, or other necessities. This type of trading usually occurs after about a year or two of learning.
If you would like to get to this level of trading and consistecy, the best method is to trade trying out different styles at a variety of risk levels using a small amount of cash. This will allow you a really good opportunity to learn all there is to know about the business. With this method, you can get all the experience you need to see opportunities before they come up, as well as gain the knowledge as to when to take your profits. If this is your goal—to earn a consistent 20%–30% each trading month—then trade as often as you can, week after week, month after month.You will gain skills quickly, and you can build confidence and trade with bigger and bigger cash balances as you earn your successful trades.
Many Forex traders decide the issues related to working solo are not that bad. The list of advantages of successful Forex trading can be much longer than the list of disadvantages. However, the social isolation that comes from working with your trading account instead of in an office full of people can make or break the Forex trader and should be taken under serious consideration.
For example, you are the only one liable for the decisions about your trading choices and accounts. Your personal satisfaction is the only performance review you’ll receive. Treat currency trading like a regular day job from day one and you’ll be able to maintain a businesslike attitude regarding your trades much easier. Keep a regular work schedule, set regular reviews of your trading activity, wear business clothes if that helps enhance your performance. Be sure to set a quitting time as well, in order to create ownership of your time and know that the trading day ends eventually. Socialize with friends regularly and take a real vacation (away from your computer) just like you would at a normal Monday through Friday 9:00 to 5:00 job.
Being your own boss also means you get to decide when to promote yourself. Perhaps you’ll reward your much larger portfolio by venturing into new, more exotic trading pairs. Or perhaps you’ll promote yourself to “senior trader” and give yourself a bigger year-end bonus as a reward to yourself because of maintaining a profitable account for 6, 9, or 12 straight months.
Like-Minded Traders and Other Support Groups
The more experience you gain over time, the more ups and downs you will face in your trading. Sometimes, the market will seem to have a life of its own, roaring ahead like a runaway freight train and everyone and their brother is in up to their necks pitching trades and making money. Traders will see bad days too, with whole portfolios wiped out, grinding down the best seasoned pros to their wit’s end with endless streams of bad-to-worse scenarios. It is enough to strain even the most experienced traders and also why a good support group is a key to staying with Forex trading.
Being a member of a large, impersonal group can offer enjoyment and a feeling of fitting in that many find comforting. The news outlets can combine to make a trader feel less alone—when they are reporting the market intensity is widespread and lasting, you get the feeling you’re not so alone after all, but part of a much greater financial machine. Live footage and interviews from the world’s trading pits can make your home office feel very connected and at the center of the fates and fortunes of a much larger community.
Feeling part of the financial community can make trading a very enjoyable experience. Perhaps you’ve dove into your technical analysis and take a break to catch a news story about the one of your currency pair’s homeland news and economic conditions. Not only is it vital to stay on top of such relevant information, it can also bring a foreign country’s finances into your backyard and shape a new picture of it in ways you never thought possible. Making that kind of deeper association or a big-picture connection offers a unique sense of belonging to something bigger than yourself and your office.
Don’t rule out the periodicals that are available in print, too, for another source of support. The Wall Street Journal and other similar daily newspapers report the news like CNBC, but include more in-depth articles. Monthly trade publications such as Futures Magazine write for audiences of full- and part-time traders with content that features problems many day traders face, such as money management, “what went wrong” scenarios, seasonal trading, and more. From beginner to expert, all day traders can gain knowledge and great examples from these resources.
Try a professional network like LinkedIn to find other traders who can relate to you and your situation. A basic account at www.LinkedIn.com is free to sign up for and you can find groups, newsletters, and individuals with whom to network, chat, and receive advice from on trading, Forex, economics, risk management, and a multitude of other topics. There are foreign exchange trading groups, quantitative trading groups, hedge fund groups, and more.
After joining a group, you can view the listings of other members to single out those with whom you’d like to network. Be picky or be liberal with your connections. Then contribute regularly, read and learn through posting comments, review the forums, and keep up on the latest news with your new group. Also, these groups can alert you to what others think in your profession, what they favor, and their overall impressions of the market. This information can be refreshing and enlightening as you combine your research with what others have posted on the groups and forums. Getting an e-mail from one of your online connections confirming your thoughts is helpful. Friends from online communities like LinkedIn allow you to connect with just about anyone the world over.
A close network of family and friends never hurts either. Being able to unwind over a weekend can bring relief to an otherwise crazy market run. Take advantage of those around you and take a break from the currency trading routine to get out of your head and your profit margins. Family and friends are an excellent source of fresh perspectives regardless of whether they follow the markets or have any idea what you do for a living.
Lastly, it’s not as hard as you think to find other people discussing the market. Your farmer’s market, your local gym, your doctor’s waiting room, in the checkout line, on the train, or waiting for the bus are all excellent places for finding like-minded people who enjoy following the markets and the economy. Taking all things into consideration includes time, money, and risk-oriented responsibilities.
A key idea with Forex trading is that with additional responsibilities and restrictions on your time, money, and risk, FX trading becomes progressively more stressful. Try to keep it fun by reducing the dollar amount at risk during difficult or highly stressful periods of your life. If you find your life becoming too stressful, or feel your time is best devoted somewhere else for a period of time, or just that the currency market is not offering up any good trades, then trim down the balance in your FX account. Believe it or not, those types of days come more often than not, and the best way to deal with them is to treat these times as a lack of trading opportunity. During these periods, it might be best to withdraw some of the cash from your Forex account and enjoy the money in a more productive fashion. There is a saying in trading: Sell in May and go away. This usually means that the summer is a time to enjoy your winnings and your life beyond the computer screen and financial markets. It also means that many of the other traders in the world (including bond, equities, and commodities traders) will close out and take time off during the summer months as well. Because of this, trading is usually a bit more difficult, and profits may come a bit slower.
Time is short and even shorter when you have family or obligations that compete for your time. Raising a family with young children or perhaps providing care for an elderly family member can take up nearly your entire day, leaving you with small bits of time here and there to study the market and place trades. Perhaps in this case, you could start trading part-time in the afternoons. The FX market is open 24 hours a day from Sunday night until Friday afternoon. Research the markets during the day at baby’s nap time or whenever you get a moment. The bits and pieces of knowledge you’ll gain will add up over time to make a difference in your trading.
Maybe you’ve enjoyed learning about the markets and are very interested in taking the next step to post your first real-time trade. But perhaps you’re very limited in the amount of cash to day trade with, or simply cannot assume the additional risks that FX trading brings. If so, try a free demo account offered through a brokerage. Start out the fund with an imaginary deposit and place real-time trades using the exact same software and trading platform as for a live account. Many brokers use demo accounts to test their trading platforms’ functionality. Day traders can use the demos as a test for their latest tip or market theory to place live trades and see what happens in real time but with no risk. Using tools such as these can help refine a trading idea, test a theory, and practice using your market-trading knowledge.
Having a designated fall-back plan, or backup plan, is an excellent way to alleviate the pain of ugly market trends, wild swings, and volatility. Many day traders include a backup plan that they will implement when they find it hard to make profitable trades within preferred risk-tolerance ranges. The summer of 2010 was a perfect example. European nations were overwhelmed with individual countries’ debt and the Euro was losing value against the U.S. dollar for several weeks. On one weekend, UBS, a Swiss brokerage house and investment bank (http://www.ubs.com/), released an update that stated the Euro would fall even further in the upcoming six to nine months and the performance was “disappointing.” Meanwhile, another news outlet, Market Watch (www.marketwatch.com), reported the upcoming week could prove to be very difficult for currency traders unless they were braced for extremely wild market swings.
Your backup plan can be put into place to cover just these types of situations. It will provide you with some form of riskless or low-risk activity to keep you out of high-risk scenarios such as these. A backup plan can include cushioning your account by other means, such as with a side job or other venture you can turn to as needed while the market sorts itself out.
Uncertain times like these also give you the opportunity to take some of your profits out of your account and spend them on a much-needed vacation or other enjoyable activity. Falling currency, a banking crisis, rocky economy stories, and a barrage of bad news can hype up the already swooning market even further. Forex trading does involve risk; however your money does not always have to be put at risk. You control your account, your trades, and your appropriate risk level. Knowing ahead of time that some days it is okay to sit out of an unpredictable market can make you a savvy day trader.
Every day, your skill level will increase as you learn how to find day-trading ideas by listening to the market. There are countless sources of information available to you as a Forex trader, some more reliable than others. Deciding how much information, the source, and the quality of the information are important issues to consider when reviewing news on the market. While your brokerage, cable TV, and Internet news feeds can provide a lot of data, the question you need to ask is how this information helps you make a better decision on what trades to analyze and set up.
How Much Information Is Enough?
In a perfect trade, the best scenario is when the market has priced a Forex pair too low or too high. This means that the market has too many or too few buyers or sellers of the trade, and during the short term (the trading cycle), there is an opportunity for other traders to move in. How market traders react to the too low or too high price can cause the markets to change course, even a small amount. This scenario is best considered for an immediate short-term time frame when evaluating such a situation. One of the best ways to seek out trading scenarios is when you can place a trade while the momentum goes in your direction, then plan to close out of it as soon as it proves profitable.
By using a wide variety of information to help interpret the market’s levels, a Forex trader can find the best entry and exit points. If you are still working with a demo account and in training mode, you should first learn what Forex pairs are the best to trade, as well as when the best time is to place an order and the exit points. In order to get an overview of the entire market, a Forex trader needs to review and listen to as much daily market information as time permits.
When you are first learning how to trade, it is best to read, listen to, or watch four or five different news sources in order to get up to speed on the flow of the market before placing your first trade of the day. This process will help you to have the proper mindset for a profitable day of Forex trading, especially if you have been away from your trading desk for a few days.
Doing some due diligence work when you read and listen to market reports will help you focus on the facts and how specific FX pairs (and also economic zones) are doing. It will also come in handy when you need to put yourself in another trader’s shoes to think about how she will react to the same market news. Role playing in your trades, or seeing it from a different perspective, will enable you to foresee the trading day ahead clearer and help you to avoid pitfalls. All public sources of information should be considered general insight into the market, but not the sole determining factor for your currency trading activity.
Of course, using your brokerage’s reports and newsletters are a key to staying on top of the Forex news. Checking your 5-minute, 1-minute, and 30-second charts for the day’s entry/exit points is the next step. Before you head into a trading session, try to have the market overview of which economic zones and currency pairs you would like to focus on during the session. Use your own individual ideas based on your trusted sources of information plus the technical analyses from the short time-frame charts.
Having a set routine for digesting the day’s market information will also help you focus on the task at hand: analyzing the currency markets and economic news, looking for setups, and placing trades. Starting with the news feeds, review reports and long time-frame charts, then move on to short time-frame charts. This allows you to roll into the day’s market with the proper pace and mood. You can decide to follow a single currency pair or you can watch several at one time. One of the best ways to learn how to trade is to get into the habit of watching a trade develop, as it happens, on a short time-frame chart and noting the movements. When you begin to observe a pattern, you can then begin to place your trades.
Where to Source Your Trading Ideas
Current information flows quickly in and out of the market. You’ll begin to rely on your trusted sources (central banking websites, brokers’ reports, well-known news feed sources) and general market chatter to get the best feel for trading suggestions. Reports and summaries present a logical view of the market and are typically based on mathematics, previous market activity, fundamentals, and technical indicators (as opposed to market chatter, which can be more opinion and sensationalism than fact). The more-detailed reports can be read when you’re off and away from your trading desk. Reviewing them will give you a deeper understanding of the underlying dynamics of the market and the analyst’s reasoning process.
Let’s say, for example, a report comes across your desk that a more cautious stance will be observed in the market for the rest of the month. You might also find out that the S&P 500 moved into an overbought range. An overbought range means that the fundamentals are seeing the stocks in the range have reached a general high average P/E (price/earnings ratio), meaning the prices are too high versus the anticipated earnings of the companies. Add into that a report that the S&P is stuck at a resistance spot for over a week, and you can infer two things: One, the S&P is topping out, and two, it will probably linger there for a while and might stall out. Worse than a stall would be a correction (overvalued market is sold off to realistic levels). Knowing all this, you would realize that now is a good time to go to a “risk off” stance in your Forex portfolio. This is because when the market is overbought and ready for a correction, Forex trades that are more conservative will profit greatly when the market has a reversal of fortune.
When the world’s stock indices, such as the DAX, CAC 40, FTSE 100, and S&P 500, move downwards during a trading day, Forex trades that are “risk off” will usually win big. Keep in mind that risk off Forex trades are trades that short the high-yielding currencies of high-growth countries and long the low-yielding currencies of lower-growth countries. Classic examples of risk off Forex trades would be a long EUR/SEK trade, a short AUD/USD trade, and a short NZD/JPY trade. As you can see, in each of these trade setups, the currency that is shorted is a currency that has traditionally been that of a high-growth economy. Sweden of late has had a much more stable and growth-oriented economy than mainland Europe.
Sweden’s economy and the Swedish Krona (SEK) have long been associated with being a high-beta currency—a currency whose upward and downward movements closely track those of the stock market. Not only is the SEK known for following the stock market, but trades that are long the SEK are known to perform quite well when the market is moving up, and trades that are short the SEK are known to also perform quite well when the market is moving down (as shown in Figure 2-1).
FIGURE 2-1 • Illustration Showing the Close Relationship of the USD/SEK Proxy Exchange Traded Fund (FXS) and the S&P 500
A really good way to trade Forex and win consistently is to do what is known as “trade risk.” Trading risk is simple: If the signs of the market tell you that the market is moving or going to move up or down, set up your trades for risk or risk off. Trading risk can be one of the easiest ways to consistently win in the currency market. All it takes is to observe what currency pairs react well or not so well to up and down markets. Make some observations as to what is working in the current market. AUD, NZD, SEK are good consistent ways to trade risk. You can also get creative and have some of the more exotic high-growth, high-yield currencies work in your favor. Good trades to look for are short EUR/HUF, and short EUR/PLN, as the Hungarian and Polish economies are considered growing economies and are more on the risk side of their trading partner, the EUR. If you would like to split the vote, so to speak, you could place a short EUR/CZK, as the Czechoslovakian economy has been especially promising. Again, these trades would short the EUR in a good market, in order to capture the gain of the high-growth Eastern European countries. At the same time, the trade would be reversed, with a long EUR if the market was in a downturn, as historically the high-growth currencies would fall in value against the more conservative Euro.
Market chatter is a term used for short-term news reports on the marketplace. Don’t forget, a lot of other people are using the exact same reports and reading the same information. The key is to read between the lines and understand the impact of the news itself on the herd mentality of the market. Experienced traders will know what to expect because they’ve seen more market reactions than a novice trader. Keep in mind that the general knowledge plus the long-term reports will indicate if a Forex pair is under or over prices. Your short-term reports, including wire reports with buy and sell points, are best thought of as a suggestion for what day traders are thinking in general. Most will be focused on the same buy/sell points because everyone is reading the same news. However, it is precisely because of this that you should never place your trades based only on these types of reports.
Cutting through the Noise
When you’re in a crowded room, it can be hard to hear yourself think, let alone what your friend right next to you is saying. Shouting across the room to catch someone’s attention doesn’t work, so what can you do instead? Most people would raise a hand and start waving it to catch someone’s eye. Flagging your attention by using the eyes instead of the ears sometimes works better to cut through the noise, so keep that in mind when you’re reviewing tons of news reports and analysis. The answer might be staring you in the face. Market movement and predictions are not absolute sciences, but experience will help show you how best to see the market and any waving flags of opportunity.
Be highly selective when you choose an information source. When the market is running hot, you’ll start to think of trading automatically during the day. Get to the point where you’re the expert and you’ll have an easier time of reducing the general market news to a degree of background chatter instead of a focal point. While you scan the Wall Street Journal, monitor CNBC, and read reports, you need to selectively find the points of vital information that are key to your customized trading system and use it to your best advantage.
The market is made up of rational, logical products that are sold in an easy-to-understand manner. Your information sources may be reliable and factual; however, investors and traders are combining money with emotions and greed, and this is always a tricky combination. The herd mentality of the market, along with a variety of trained investors making educated trades, can open the door to an emotional and illogical marketplace. Similar to counting cards in Vegas, breezing through the markets is a foolish venture, and relying on an information source to predict any type of accuracy is extremely unlikely to work. There are simply too many variables to account for in the marketplace. However, this is exactly what the big hedge funds and investment banks try to do. They utilize the best logic, statistics, and complex mathematics and try to apply them to an unpredictable market that is driven by underlying human emotion. The market is just like a difficult, hot-blooded thoroughbred—some days he’ll run, some days he won’t. Over time, a day trader will eliminate the noise of the outside chatter, find the key points she is looking for to get her individual plan in motion, and learn to recognize the view of the market from an insider’s view of the traders’ ideas and feelings.
What Should You Listen To?
As a Forex trader, you are in business for yourself. You are responsible for all issues surrounding your business, such as turnaround time, technical issues, software, market analysis, and functionality. It is essential that you identify your trusted sources of information.
Let’s say you’re a home builder and want to build a new home. However, you know your limitations. You’re not an expert in architecture or plumbing or electricity, so you subcontract out these important functions so you can get high quality expertise. Perhaps you know people you trust to recommend subcontractors to you or perhaps you look them up on the Internet to read reviews of what others say. You wouldn’t just hire the first guy to knock on your door who gives you an estimate to put in plumbing. Nor would you buy a set of plans from the Internet and hope for the best when it came time to dig a foundation. Planning out your site, making a detailed survey, and checking for code restrictions and setback rules are important items you need to address before hauling in a cement mixer.
Still, when you go to pick out your new tile, and some other customers are talking about their tile guy, you’d like to listen in as much as possible, right? It suddenly matters to you what others are saying, even if it is not directed at you specifically. Friendly chatter can be informative and relevant for future use. But, the question remains, how likely are you to believe this information from random strangers?
Would you pay close attention to your hairstylist when they talk about how their contractor messed up their new roof? Or would you want to hear more from the other home builders who have had bad luck with a certain roofing contractor? You would want to avoid a sloppy roofer and save yourself time and money by finding a better one that does the job right. You will be more selective in choosing your preferred information sources after family and friends have fully exhausted themselves telling you horror stories of their contractor nightmares.
The same thing will happen when you selectively listen to preferred information sources for market research and tune the rest out. The horn blowers and worriers should be easy to peg, as will be the panic-prone types. As a trader, you’ll recognize that investors and traders like talking about money quite a bit. People in the markets enjoy discussing their latest big deals, the huge profits they made, how much they have in their accounts (or how little), and even bragging about the major wins and how they did it. Everyone is full of good stories. You’ll also find out everyone has an opinion and money has a unique way of evening the playing field as related to profits and losses.
Questions to Think About
It will come as no surprise that TV news fills time slots with advertising. What you may not realize is that they also add in stories to fill time on-air as well. Sometimes these fills offer details, sometimes they are simply a bridge to the next story, and sometimes they’re just fluff. Periodicals and magazines sell full page ads for the same reasons. The question you need to ask is: Are they selling something or telling me something important that I need to apply to my trading needs? What is the source of the information? Is the publisher of this magazine known for fluff articles or is this serious reporting that is factual and objective? At the end of the trading day, it is your decision and your money. Learn, research, and grow your knowledge base and you’ll enjoy the day trading system a lot more.
Internet Forums and TV
Internet forums and TV are two types of information sources that have the leading edge when it comes to updating their content quickly. Both can change what they decide to include in their news stories as events unfold. Online forums, such as news feeds, chat rooms, or market recommendation sites, and TV are often very reactionary to the day’s news, and their writing styles skew toward sensationalized storytelling (meaning they make out stories to be more dramatic than they actually are). A great way to think of the fast-moving reporting style of Internet news and TV is like a giant shallow scoop. Hundreds of stories will run into the scoop and, while a few get filtered further down, most are just surface depth stories with a sound bite or two added in.
Driving the TV news and Internet forums is the basic information you need to follow. You’ll want to keep up to speed on the overall market news, but keep it general. Do not rely on these outlets to provide a true, reliable prediction of a market trend or recommendation for trading activities. Basing your decisions to buy or sell on these news outlets’ reports is not advised. In fact, some of the bigger full-service wealth management investment firms will flat out tell their clients to just turn off CNBC when the market raises or lowers significantly in a trading day.
Although the top priority in FX trading is preserving capital, your second goal should be capital gains. Each trading day should always be approached with the attitude that a cash position is the safest position. Any trading you wish to accomplish should be done only when you have a realistic prospect of a gain. Therefore, your trading business should be taking only selective risks relative to the would-be gain.
Now with the first part of your plan of capital preservation in place, you can enter trades with an idea of how the market will move in the near future with a reasonable amount of certainty. Let’s say that the S&P 500 trends in one direction for three or four days and then backs down. A reasonable assumption is that if the S&P 500 is up for three days straight, then it (and most likely several similar risk-sensitive trades like USD/SEK, AUD/JPY) will be ripe for the sell off and allow you to begin profit taking. On closer observation, you may have noticed a large multiday run up in the market. Big gains at the close of the week make for very happy traders because they can enjoy their gains over the weekend and sell on Monday to ensure their profits. If this is the case, you would make a long position in risk adverse currency, or a risk-off trade.
There is a great amount of anticipation and secrecy surrounding economic news reports. Predictions from leading brokerages, TV news anchors, and Internet forums will abound. Sometimes the news comes out and it is not what was expected. This can cause a ripple effect, with the market moving up or down according to how accurately the predictions were. On the flipside, if the predictions match the actual report, the market is already priced for what was expected, meaning the values of the trades had covered the prices. The market will sell off anyway, as everyone is aware of the actual numbers and profit taking occurs. A much more complicated trading day happens when multiple regions release economic news reports simultaneously, such as Asia, Europe, and the United States. The outcomes cannot be predicted with reasonable accuracy due to too many variables, and it is best to not have any trading positions in your account, especially any related to the sector the reports are highlighting. In other words, news days should be avoided if capital preservation is your top priority. The markets will still be there on the next day, and you have the option of trading after the news comes out.
So, what does it take to get ready to trade Forex, plain and simple? It takes knowing the skill levels, risk levels, and reward levels of Forex trading. If you don’t get it now, keep reading. We’ll go over it again and again throughout this book.
1. Trading in the Forex markets can lead to a “thrill-seeker” trading style.
A. True
B. False
2. The best way to get yourself ready to begin trading Forex is to:
A. Jump right into it without any preparation
B. Read this book
C. Study all you can about the economy and learn as much as you can
D. B & C
3. Before trading Forex it is best to know how well you know your:
A. Technical knowledge
B. Time management skills
C. Market skills
D. Risk tolerance
E. B, C, & D
4. Interpersonal relationships will keep you fresh and able to take the stress of FX trading.
A. True
B. False
5. The best opportunity to trade Forex is when the market has mispriced the currencies. This is because:
A. Mispriced currencies never happen
B. Mispriced currencies are impossible to detect
C. Other traders have overreacted to market news
D. Other traders have either sold or bought a currency with emotion and not fact
E. Both C & D
6. The newscaster on the market news channel CNBC says the world stock market indexes are all down over 2% for the day. You can conclude that the market is trading:
A. In high volume
B. Seasonally low
C. Risk off
D. Risk on
E. High risk
7. When looking at, listening to, or reading market chatter it is best to:
A. Take it all at face value
B. Use it all because it is all very important
C. Listen to none of it
D. Evaluate it with the thought that you are the expert
8. The combination of_____and_____can add up to a difficult Forex trading environment.
A. Logic and trust
B. Knowledge and facts
C. Goals and limits
D. Emotions and greed
9. Your Forex trading should only be done in a selective manner with the highest chance for gain.
A. True
B. False
10. Sometimes when market news comes out it has a far-reaching, widespread:
A. Ripple effect, causing markets worldwide to move
B. Panic, causing markets to go risk off
C. Feelings of well-being, causing markets to go risk on
D. All of the above
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