Forex day trading

Forex day trading is the style of the short-term speculator. The reasoning behind a day trading style, is that there are times when exceptionally fast market developments allow exceptional profits in a very short time. Day traders in general will not hold a position for more than a few days, and the best among them are alert, quick, decisive and disciplined about what they want from the market, and the ideal conditions for a trade.

This method requires that the trader be nimble, and that he flee from danger like a rat, and chase opportunity like a cheetah. Needless to say, such speed and alertness require strong nerves and will from the trader, and it’s crucial to know where and when to act without hesitation when the decision is made. Successful forex day traders have, in fact, predefined expectations from the market, and they will only react to the “perfect" scenario, where the conditions are ripe. Indeed, there are circumstances where a quick profit can be made by quick reaction to incoming data. The bull market of the 90’s was an exceptionally lucrative time for day trading stocks, as initial public offerings allowed massive profits to be made through the indiscriminate daily purchase of new firms.

Trading styles

What is a trading style? It’s simply what a trader or speculator enjoys or feels most comfortable doing while interacting with the market. They can be valid for both long and short term trading, and for different styles different indicators and technical patterns have greater significance. Nonetheless, we should always keep in mind that the market is not bound to submit to our choice of style. The day trader could easily find himself in a swing trading situation, and the swing trader may end up following the trend, depending on how the market decides to behave.

What is the proper style for a beginning trader?

There are in fact only two types of trading: long-term and short-term. While the beginning trader is excited about his “debut”, and desirous of maximal profits over a short period of time, the fact is that at his level of experience and knowledge, he’s the least suited to a short-term trading method. Because of the shorter periods of exposure to the market’s whims, scalping or day trading may sound like the surest ways to success for the beginner. But, because the market’s behavior is more or less random in the short term, the habitual day trader or scalper may in fact be exposing himself to much greater risk by minimizing foresight and predictive capability. It’s hard to know what the next move will be when dancing in the arms of the bipolar short-term market.

The beginner may benefit from some short-term, very low-risk trading activity to gain understanding of the various trading concepts and tools of technical analysis. But, as soon as he’s willing to embark on serious activity, he’d be well-advised to focus on trading psychology, rather than trading style.

Of course, once the trader feels confident that he knows what he’s doing and has a reasonable amount of experience and knowledge about the markets, he can make his own choices about which trading style, which indicators and which currency pair he’s most interested in trading. But, it’s important to keep in mind that the best style is a flexible style, and that adaptability and humility are better than any preconception about the kind of trader we’d like to be. Let the market make the choices. How much control do we have over its decisions, anyway?

Let us take a look at the several different kinds of trading styles for short term activity.

Forex Technical Analysis

The beginnings of technical analysis is usually dated to the Dow theory, and to the early part of the 20^th century. Over the years, many contributors have created indicators, oscillators and moving averages of all sorts to increase the arsenal which the trader can utilize to understand the forex market. But the basic principles of technical analysis have remained the same:

• Prices discount all available information
• Prices trend (in other words, price movements are not random)
• Historical data is useful for predicting future developments

As noted previously, technical analysis is useful for analyzing price patterns that emerge as a result of global economic activity. Thus, it’s different from fundamental analysis: Its effectiveness is greatest when market participants are the most emotive; the total turnaround in the market is constant with little new money entering or exiting; and economic fundamentals are of short-term value only.

This may perhaps appear counterintuitive to what many have come to believe over the years. But in fact, those who are most successful in using technical analysis are those who follow the long-term trend, and the long-term trend is merely another name for what is called the “big picture”, as painted by fundamental analysis.

Technical studies are useful for determining entry and exit points, because the information provided by fundamental analysis is too vague when it comes to price and quotes. While not precise, technical analysis does provide the trader with a number of tools for determining points of action, and the trader can use any method that he feels comfortable with, provided he knows what he's doing.

On a final note, although the new forex trader may perhaps be overwhelmed by the vast number of indicators and such that are available for his use, the good news is that only one from a each type of indicator will usually provide all the data necessary for trading. Later, we will examine indicators in detail.

Forex Fundamental Analysis

As we mentioned before, prices do not cause prices. The reasons that lie behind price movements in the forex market are the subject of fundamental analysis, and those familiar with trading stocks should have little trouble in becoming familiar with fundamental analysis of currencies. Just as stock traders measure the health of a publicly-traded company by examining its balance sheet, indebtedness and cash flow statistics, the forex trader decides on the soundness of a nation’s economy by considering such things as central bank interest rate differentials (which is the difference between the borrowing costs as decided by the central banks of different countries), trade surplus or deficits, along with employment trends, productivity, and a number of other factors.

Fundamental analysis states the causes of major price movements in a straightforward and clear manner. For instance, because of the ease of borrowing and the resultant abundance of global liquidity in recent years, the interest rate differential between two nations’ central banks has been the most important indicator in determining price trends in the forex market. While this is unlikely to remain so in today’s difficult environment, interest rates will remain one of the most important drivers of currency market trends for as long as financial actors are free to move capital across national borders.

Fundamental analysis attempts to discover and predict the causes of forex trends, and in doing so it uses a number of indicators to present a comprehensive picture of global finance. But beyond the indicators themselves, what really causes a currency pair to move in a particular direction? Are currency movements really decided by statistics and news flow only?

This question brings us to another definition of fundamental analysis: Fundamental analysis attempts to predict money flows into and out of a particular currency. Statistics are significant only as far as the markets regard them as a basis for directing cross-border money flows. A nation can have very low unemployment, a high current account surplus, excellent productivity rates, and very good statistics in general, and its currency can still do poorly against others — if, despite all those advantages, there’s a greater supply of it with respect to total demand. In other words, no indicator, no statistic or standard is enough to magically appreciate a currency versus another, if the general economic environment (i.e. the financial markets in general), is unwilling to make use of the advantages that a sound and healthy economy provides.

Later we will return and take a deeper look at fundamental analysis.

The strength of fundamental analysis lies in its ties with economic events at the root level. It is relatively straightforward about its descriptions, and its rules and principles are often simple and easy to understand. And, the fact that fundamental causes decide the major trends in forex markets is indisputable. The trader possesses a very reliable tool in this kind of analysis. The problem with fundamental analysis, on the other hand, is twofold: it’s very poor as a timing indicator; and markets do not always react to its dictates in a rational manner. What must be remembered when the market value of a currency is a lot different from its fundamental value, is that the market would not have tolerated an irrational quote if some people somewhere were not making a great profit from that irrationality. It is therefore imperative that the analyst identify the abnormality, examine the causes of it, and formulate a strategy to exploit the discrepancy.

If fundamental analysis is a poor method for deciding on the timing of a trade, what will you, the trader, use to define your entry and exit points? Which method will allow you to decide when to take a profit or accept a loss? This question leads us to introduce the subject of technical analysis.

Forex analysis — analyzing the forex market

So we know what the forex market is, and we know what we want to do with it: We want to make money. How do we make money? That’s where we must understand forex analysis.

Forex analysis is the tool with which people aim to make sense of the seemingly random developments in a typical day’s price action. Without analysis, all we’d have is a massive list of price quotes that's updated on our screens every single second, and there would be no way of making any sense of it.

As with every other event in nature, developments in the currency market manifest themselves through cause and effect which are analyzed through the two branches of forex analysis: fundamental and technical. One problem people often have when studying forex analysis is failing to understand that price action is the result of a series of events that are independent of the price action itself. In other words: prices do not cause prices. The study of those economic and political factors which cause price movements is called fundamental analysis. Prices do, however, create patterns (such as head and shoulders, triangles, double tops or bottoms, etc.), the study of which is the subject of technical analysis.

What causes prices to move in a particular direction? Obviously this is the most important question that one must have answered in order to make a profit in currency trading. Major geopolitical and economic events undoubtedly create the powerful, long lasting undercurrents in the forex market. But, there are factors such as daily trade flows, cross-border mergers, currency options expiration-related activity, and other psychological factors which distort the underlying picture for those who are not very familiar with currency trading.

But let’s first briefly examine the two types of analysis that we just mentioned, before returning to the subject of the previous paragraph.

Forex

Major currencies and currency types

There are a lot of nations in the world and consequently a large number of currencies to choose from when trading. The currencies of Brazil, Russia, China, the Eurozone, Turkey, Japan, South Africa and Canada are popular with large and small traders, for different reasons. What the market values most in a trade can change depending on government policies and the global economic environment. For example, during the flowery days of the carry trade, many traders would simply long (buy) the currency offering the highest interest rate, and short (sell) the one offering the lowest interest rate, with little consideration given to the underlying economic soundness. Such a strategy is less likely to be profitable in today’s chaotic environment with interest rates racing lower across the globe, and fundamental economic strength is once again the major concern in deciding on currency allocations.

In order to simplify the matter, let us group the currencies into four types and examine each of them briefly:

Reserve Currencies

There’s really only one true reserve currency in the world with dominance of about two-thirds of central bank accounts, and it is the US dollar, the currency of international trade. But there are also others, such as the Swiss Franc, Japanese Yen and to a greater extent, the Euro, which play the same role, and as such are of higher quality and offer greater safety in times of trouble.

Commodity Currencies

These are currencies of nations with a heavy dependence on commodity exports, such as the Canadian and Australian dollars or the Brazilian real, and their performance is closely related to the performance of the global commodity markets.

Exporter Currencies

These are currencies of the likes of Singapore, Malaysia, Taiwan, or China — although it’s difficult to trade the Ren Min Bi (RMB) due to capital controls — with healthy external trade surpluses. These nations often have a high private and corporate savings ratio, and are better placed to survive periods of financial difficulties as they have little need for external borrowing. As exporters, they will most often choose to keep their currencies priced lower against competitors to keep their products more competitive in the global markets.

High risk, high deficit, high yield currencies

In analogy with the bond market, one could also term these currencies junk currencies, in that the economies are usually dependent on external financing, with greatest domestic activity concentrated in real estate, finance, and tourism-related industries. Many emerging markets are members of this group, but there are also other, relatively advanced nations such as (alas!) the UK, or Iceland, which nowadays can be considered to belong to this category. Further examples would be Turkey, Romania and Hungary — as a group, they have suffered the worst of the troubles of 2008.

What use is this categorization to the trader? It's mainly for those who want some diversification in their currency portfolios, in accordance with the ancient wisdom of not putting all eggs in the same basket. The above categories suggest that good diversification cannot be achieved by, for example, allocating long positions to both the Turkish lira, and the Romanian leu in the same account, as both of these currencies share the junk status. Nor can the trader claim to diversify his positions by buying the Brazilian real, and selling both the Swiss franc and the Japanese yen to fund the purchase. Both the franc and the yen are exporter currencies, and they are likely to make similar moves in response to financial developments. Forex brokers and websites sometimes offer correlation charts (which depict the price relationship between currency pairs during a specific time period), and the interested reader can learn more on this subject by studying them. But in general, positions in different currencies in a single category are likely to react like a single position of a single currency to market events; the trader should always keep this in mind when managing his account.

Margin trading and leverage accounts

It’s very important that the trader gain a good grasp of these two concepts before engaging in any deals, because leverage and margin determine the lifespan of any trading account in a far more decisive manner than either technical or fundamental analysis.

Margin trading is trading with borrowed funds, and is closely related to leveraging. The broker allows the trader to control a far greater amount of money in the market in exchange for a small deposit of funds, with the understanding that the sum borrowed must be returned in exact amount, with any losses or profits returned to the account of client (the trader).

The amount that the client can control is determined by a number called the leverage ratio, and even the occasional observer can notice this number being proclaimed loudly by brokers in the advertisements that they scatter everywhere online. It’s not that difficult to grasp what the leverage ratio does: it simply multiplies the trader’s potential losses and gains in the market by the specified amount. For instance at a leverage ratio of 1/100, the client (you) will be able to control 100,000 USD which makes a standard lot, for a deposit of a mere 1,000 USD, and every single pip gain or loss will be multiplied a hundred times. To put this in a better perspective, you need a movement of just 1% in the price quote before your account is doubled — or wiped out.

One will often come across notices on broker websites making the claim that leverage is a double-edged sword; that you can both lose and gain massively depending on what you do. But high leverage, for sure, is a sword with only one edge, and we will discuss why it is so later.

Forex pips and lots

Forex pips and lots

A pip is the smallest amount of movement a price quote can make. In other words, each tick of the price quote is a pip. When EUR/USD moves from 1.2786 to 1.2787, for example, it has moved by one pip. You could also call it a point or a tick, but in forex traders’ jargon, pip is the word.

It’s a good idea to measure your profit or loss in pips rather than in the amount you actually lose or earn, since the trader’s performance can only be valued through his success in gathering pips. For instance, supposing trader A has a beginning capital of 100 USD, and trader B has only 10, it would take trader B ten times as much in terms of pips to achieve the same gain that was acquired by trader A in absolute dollar terms. In terms of their prowess in the market, however, if trader B were to make just 1/10 of what trader A makes, they’d still be equal, due to the the difference between their starting capital. This same logic can be utilized when assessing one’s own prowess, and if a diary is kept, it’s always better to note the loss or profit in pips, rather than cash, so as to keep a better track of performance.

It must also be remembered that one pip in the currency pair that is traded may not be the same amount in the trader’s base currency, that is, the currency with which he funds his account. For instance, if your currency is the British Pound, and you’re trading the EUR/USD, one pip movement in the currency pair would be a different amount in your base currency, depending on the quotes.

Another important term in trading forex is the lot, which is the smallest amount of currency you can trade at a particular level of leverage, and the standard lot size is 100,000 USD. Among today’s forex brokers, there are those who allow traders to enter bids without the use of lots (sometimes called mini lots), and the inexperienced trader may seek them before gaining enough confidence to start trading with a higher volume.

Currency pairs — Understanding and reading forex quotes

Our first grade in forex literacy is for understanding how to read the price quote. In forex, currencies are always quoted in pairs. In other words, it’s only possible to value a currency in terms of another one. If you want to buy 100 Euros, how are you going to pay for it? If you were to pay in euros, you’d not be currency trading, and when you use another currency to fund your purchase of the euros, you’re actually creating a forex quote.

It’s actually quite easy to evaluate forex quotes once you get the hang of it, and the fastest way to learn is by considering some examples:

EUR/USD 1.2786

So what does the above quote tell us? What it says is that 1 Euro is able to buy 1.27 units of the US currency. Or, continuing on our previous transaction, we would have to pay

127 USD for 100 Euros we wanted to buy.

But in fact this value is only the average of the bids (price to buy) and offers (price to sell) for a currency pair at a particular time. The bid-ask spread is usually very low for the most liquid pairs, such as the EUR/USD, but at times of illiquidity in the markets, as before a statistical news release, or a central bank decision, the spread can widen to much greater levels.

The quote represents the best pricing that the world market offers for a currency pair at a particular moment. A quote on a computer does not usually include all of the offers and bids all over the world, but because of the very liquid nature of the forex market, any significant difference in quotes across different parts of the world is very quickly eliminated through computer-based, automatic arbitrage, and consequently, except at times of market turmoil the difference between regional quotes is quite low.

So let’s say return to the EUR/USD quote. Our quote is at 1.2786, and the bid-ask spread is at 0.009, as stated by the broker. What this means is that there’s a difference of 0.9 cent between what you pay to buy the same currency pair, and what you’d receive if you were selling it. There’s always a spread in even the most liquid markets, but the spread is usually widened further by the brokerage firm, so that it can make a profit from the individual traders’ deals.

The important point to keep in mind when evaluating quotes is that one quote is valid for only a fraction of a second. At times of market tension, great fluctuations can occur within the scope of one minute, rendering the quote almost useless. Despite the great focus on prices and price patterns among many traders, it’s always advisable to keep the time of the day, of the year, and the emotional atmosphere of the market in mind while deciding on what we should do about a particular quote. For example, quotes during the last few weeks of the year, or in the Thanksgiving week, or at about an hour before the opening of the US market have far less value in determining future price direction and trends than those seen during an ordinary business day at regular hours. So, to repeat, the trader must not only know the price quote at a given moment, but also the seasonal, hourly, and emotional backgrounds that influence the quote before he decides to make a trade on the information.

That skill can be gained through practice, and is perhaps easier learned through experience than reading.

Introduction to the forex market

Introduction to the forex market

Many of us have been fascinated by the shiny, colorful world of currencies as children, and even those of us who have little interest in the forex market have engaged in some form of currency trading while traveling outside their homeland. And these days, one will easily find people discussing the advantages and weaknesses of the US dollar even in a casual gathering.

The forex market is the currency market: it’s where the value of each currency is determined versus every other currency in the world. If you exchange one US dollar for its equivalent value in Euros, you’re already a part of the forex market, and are creating the quotes you see reported on TV screens every day. There’s no difference between the actions of a tourist at an exchange bureau, and the transactions of banks in the international market, apart from size and maturity terms.

In today’s integrated and specialized economies it’s rare to find all the components of any product produced inside one country’s borders, and so, international trade is a major creator of global forex volume. Deepening financial interactions across the globe through partnerships, buyouts of firms and international loans, along with ever complex tools of investment have been increasing the size of the forex market in recent years. If global trade and finance were the body of world economy, the forex market would be the circulatory system; in other words, there doesn’t exist a deeper, more liquid market than that of currency trading. Almost every political or economical event of long-term significance is reflected in its workings, and understanding it results in a very good comprehension of finance and economics in general.

Participating in such a vast and significant mechanism can be a rewarding and exciting experience for the individual investor. But while this is true, success during your interactions with the giants will require more than a bit of diligence and patient study. The rewards can be immense: famous investors such as George Soros, Jim Rogers, large Wall Street firms such as Goldman Sachs, or banks like Citibank all make millions of dollars each year from trading in the forex market. In fact George Soros is notorious as being the man who broke the Bank of England: Through successful speculations, he was able to make 1 billion dollars in just about a week.