Forex Leverage: A Double-Edged Sword
by Grace Cheng,See Grace's Forex blog at www.gracecheng.com,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
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One of the reasons why so many people are attracted to trading forex compared to other financial instruments is that with forex, you can usually get much higher leverage than you would with stocks. While many traders have heard of the word leverage, few have a clue about what leverage is, how leverage works, and how leverage can directly impact their bottom line. (To learn more, see How does leverage work in the forex market?)
What is leverage?
Leverage involves borrowing a certain amount of the money needed to invest in something. In the case of forex, that money is usually borrowed from a broker. Forex trading does offer high leverage in the sense that for an initial margin requirement, a trader can build up - and control - a huge amount of money.
To calculate margin-based leverage, divide the total transaction value by the amount of margin you are required to put up. (For more insight, check out Margin Trading.)
Margin-Based Leverage =
Total Value of Transaction
Margin Required
For example, if you are required to deposit 1% of the total transaction value as margin and you intend to trade one standard lot of USD/CHF which is equivalent to US$100,000, the margin required would be US$1,000. Thus, your margin-based leverage will be 100:1 (100,000/1,000). For a margin requirement of just 0.25%, the margin-based leverage will be 400:1, using the same formula.
Margin-Based Leverage Expressed as Ratio Margin Required of Total Transaction Value
400:1 0.25%
200:1 0.50%
100:1 1.00%
50:1 2.00%
However, margin-based leverage does not necessarily affect one's risks. Whether a trader is required to put up 1% or 2% of the transaction value as margin may not influence his or her profits or losses. This is because investor can always attribute more than the required margin for any position. What you need to look at is the real leverage, not margin-based leverage.
To calculate the real leverage you are currently using, simply divide the total face value of your open positions by your trading capital.
Real Leverage =
Total Value of Transaction
Total Trading Capital
For example, if you have $10,000 in your account, and you open a $100,000 position (which is equivalent to one standard lot), you will be trading with a 10 times leverage on your account (100,000/10,000). If you trade two standard lots, which is worth $200,000 in face value with $10,000 in your account, then your leverage on the account is 20 times (200,000/10,000).
This also means that the margin-based leverage is equal to the maximum real leverage a trader can use. And since most traders do not use their entire accounts as margin for each of their trades, their real leverage tends to differ from their margin-based leverage.
Leverage in Forex Trading
In trading, we monitor the currency movements in pips, which is the smallest change in currency price, and that could be in the second or fourth decimal place of a price, depending on the currency pair. However, these movements are really just fractions of a cent. For example, when a currency pair like the GBP/USD moves 100 pips from 1.9500 to 1.9600, that is just a $0.01 move of the exchange rate.
This is why currency transactions must be carried out in big amounts, allowing these minute price movements to be translated into decent profits when magnified through the use of leverage. When you deal with a large amount like $100,000, small changes in the price of the currency can result in significant profits or losses.
When trading forex, you are given the freedom and the flexibility to select your real leverage amount based on your trading style, personality and money management preferences.
Risk of Excessive Real Leverage
Real leverage has the potential to enlarge your profits or losses by the same magnitude. The greater the amount of leverage on capital you apply, the higher the risk that you will assume. Note that this risk is not necessarily related to margin-based leverage although it can influence if a trader is not careful.
Let's illustrate this point with an example (See Figure 1).
Both Trader A and Trader B have a trading capital of US$10,000, and they trade with a broker that requires a 1% margin deposit. After doing some analysis, both of them agree that USD/JPY is hitting a top and should fall in value. Therefore, both of them short the USD/JPY at 120.
Trader A chooses to apply 50 times real leverage on this trade by shorting US$500,000 worth of USD/JPY (50 x $10,000) based on his $10,000 trading capital. Because USD/JPY stands at 120, one pip of USD/JPY for one standard lot is worth approximately US$8.30, so one pip of USD/JPY for five standard lots is worth approximately US$41.50. If USD/JPY rises to 121, Trader A will lose 100 pips on this trade, which is equivalent to a loss of US$4,150. This single loss will represent a whopping 41.5% of his total trading capital.
Trader B is a more careful trader and decides to apply five times real leverage on this trade by shorting US$50,000 worth of USD/JPY (5 x $10,000) based on his $10,000 trading capital. That $50,000 worth of USD/JPY equals to just one-half of 1 standard lot. If USD/JPY rises to 121, Trader B will lose 100 pips on this trade, which is equivalent to a loss of $415. This single loss represents 4.15% of his total trading capital.
Refer to the chart below to see how the trading accounts of these two traders compare after the 100-pip loss.
- Trader A Trader B
Trading Capital $10,000 $10,000
Real Leverage Used 50 times 5 times
Total Value of Transaction $500,000 $50,000
In the Case of a 100-Pip Loss -$4,150 -$415
% Loss of Trading Capital 41.5% 4.15%
% of Trading Capital Remaining 58.5% 95.8%
Figure 1: All figures in U.S. dollars
Excessive Leverage Can Kill
With a smaller amount of real leverage applied on each trade, you can afford to give your trade more breathing space by setting a wider but reasonable stop and avoiding risking too much of your money. A highly leveraged trade can quickly deplete your trading account if it goes against you as you will rack up greater losses due to bigger lot sizes. Keep in mind that leverage is totally flexible and customizable to each trader's needs. Having an aim of trading profitably is not about making your millions by the end of this month or this year.
For more on trading this market, see the Forex Market tutorial.
by Grace Cheng (Contact Author | Biography)
Grace Cheng is a forex trader, creator of the PowerFX Course and author of "7 Winning Strategies for Trading Forex" (2007, Harriman House). This revealing book explains how traders can use various market conditions to their advantage by tailoring a strategy to suit each one. The book is a perfect complement to the PowerFX Course. The PowerFX Course, designed for both new and current traders, teaches tools and trading approaches that combine technicals, fundamentals and the psychology of trading forex. It also includes Grace's proprietary tips and tricks. Grace's works have been published in The Trader's Journal, Technical Analysis of Stocks & Commodities, Smart Investor and other leading trading/investment publications.
Visit her popular forex blog at www.GraceCheng.com.
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Thursday, March 12, 2009
Forex: Venturing Into Non-Dollar Currencies
Forex: Venturing Into Non-Dollar Currencies
by Brian Bloch (Contact Author | Biography)
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Although it is highly advisable for American investors not to rely too much on the domestic market, any investments in non-dollar currencies entail exchange-rate risks. Nonetheless, these risks can be managed and even turned into opportunities. Read on to learn about how to manage the risk in foreign investments. (For related reading, see Broadening The Borders Of Your Portfolios.)
Essential Diversification – But At a Price
The positive side of foreign investments is that they are an important and often essential part of portfolio diversification. Making foreign investments, however, does not mean that the investor is speculating in foreign currencies, although the risk may still be substantial. After all, a low American dollar, for example, is bound to rise at some point, which will substantially reduce the value of money coming back into the U.S. On the other hand, a high U.S. dollar means the exact opposite to non-American investors because they will be looking to take their money out of the U.S. and return it to their home countries, where it will be more valuable.
Currency Fluctuations
For example, in early 2000, the dollar was worth 1.25 euros, but by the end of 2004, it was worth only 0.73 euros. During this period, foreigners investing in America saw the effective value of their investments decline by 40%. (For related reading, see A Primer On The Forex Market.)
Then there is the issue of yen loans. For years, the incredibly low Japanese interest rates encouraged people to borrow yen to invest elsewhere. However, if the yen were to rise substantially before such a loan is repaid, the borrower could be in trouble. The gains from low interest rates can rapidly be wiped out and worse. In fact, many Austrians took out yen loans in the '90s and some of them wound up with losses of up to 50%, as interest rates moved substantially over time. (To learn more, see Forces Behind Interest Rates.)
Another good example of the risks that arise in foreign investments is illustrated by what can happen to immigrants. For example, retired people on fixed incomes from South Africa living in the U.S., became very poor very fast in the '80s when the South African rand weakened and the capital they held in their home countries was devastated.
Despite the risk and volatility, however, foreign diversification remains a necessary part of the investment process. Currency fluctuations are a fundamental element of such investments. However, if investors on one side of the Atlantic lose 40%, those on the other side gain precisely the same amount. If you decide to add foreign investments to your portfolio, you need to manage you risk by setting yourself up to benefit from a thriving currency.
Managing the Risks
Currency risk can be limited but this may also come at a price, which may come in the form of increased cost or complexity.
Foreign Funds
The simplest way to avoid currency risk is to invest in a fund that is denominated in dollars. This way, you will have the diversification advantage of a foreign fund with a reduced currency risk. This risk is instead assumed by the issuer of the fund. (To learn more, see Go International With Foreign Index Funds.)
Options and Futures
A more complicated way of avoiding currency risk is though options or futures. To do this, you either need a lot of financial knowledge or a good advisor. In plain English, the basic method is to cancel out currency risk by taking out an opposing investment. For instance, if you purchase an investment in euros (effectively buying the currency), you can arrange to sell the same amount of euros at a later date, so that the gains from the one transaction will match the losses of the other. You are then left with just the investment itself and no gamble on the exchange rate. As you can imagine, this is not as straightforward in practice and some of the instruments used are very sophisticated. (For more insight, see A Beginner's Guide To Hedging.)
Loans
It is also possible to take out a loan in the same currency as the foreign investment. But again, the interest rate is critical. Even if the currency risk is hedged (avoided), changes in interest rates between the U.S. and the other country can still cause risks and losses.
Speculation
Foreign investments can be used quite deliberately to speculate or bet on currency changes. You could buy euros, Australian dollars or just about any other currency, simply because you think its value will rise, or that the interest rate will move in the right direction. The most common way to speculate in currencies is through interest certificates or options. In short, the certificates are assets whose value depends on money market developments in that particular currency. Both interest rates and the level of the currency matter. For more risk-friendly investors, there are all sorts of options, which can leverage your money. (For further reading, check out Make The Currency Cross Your Boss.)
Structured Products
Finally, the investment industry offers many so-called mixed, or structured, products which are based on various combinations of equities, bonds and possibly other asset classes as well. These may have some form of built-in currency protection, allowing you varying degrees of currency-risk management. (For related reading, see Are Structured Retail Products Too Good To Be True?)
Conclusion
As is always the case, it is essential that you understand the products in which you invest and their associated levels of risk. It is also important to remember one of the most basic rules of portfolio construction: Even if an investment is risky in itself, by diversifying your portfolio as a whole, the net effect may be to lower the total level of risk. (To read more about this concept, check out A Guide To Portfolio Construction and Achieving Better Returns In Your Portfolio.)
Consequently, there is no need to shy away from currency risk entirely. In fact, some is often necessary and a bit of non-dollar speculation may make your portfolio safer over time. But take on only as much risk as is good for your portfolio - and your peace of mind.
by Brian Bloch, (Contact Author | Biography)
Brian Bloch started his career as a business academic and moved into management journalism in the late '90s. His experiences as an investor with the financial industry led him into the personal finance area a few years ago, and he finds this line of work particularly rewarding and fascinating. As part of his personal finance work, Brian assists investors who have claims against brokers or firms. See his homepage at www.brian-bloch.com
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by Brian Bloch (Contact Author | Biography)
Email ArticlePrint Comments
Although it is highly advisable for American investors not to rely too much on the domestic market, any investments in non-dollar currencies entail exchange-rate risks. Nonetheless, these risks can be managed and even turned into opportunities. Read on to learn about how to manage the risk in foreign investments. (For related reading, see Broadening The Borders Of Your Portfolios.)
Essential Diversification – But At a Price
The positive side of foreign investments is that they are an important and often essential part of portfolio diversification. Making foreign investments, however, does not mean that the investor is speculating in foreign currencies, although the risk may still be substantial. After all, a low American dollar, for example, is bound to rise at some point, which will substantially reduce the value of money coming back into the U.S. On the other hand, a high U.S. dollar means the exact opposite to non-American investors because they will be looking to take their money out of the U.S. and return it to their home countries, where it will be more valuable.
Currency Fluctuations
For example, in early 2000, the dollar was worth 1.25 euros, but by the end of 2004, it was worth only 0.73 euros. During this period, foreigners investing in America saw the effective value of their investments decline by 40%. (For related reading, see A Primer On The Forex Market.)
Then there is the issue of yen loans. For years, the incredibly low Japanese interest rates encouraged people to borrow yen to invest elsewhere. However, if the yen were to rise substantially before such a loan is repaid, the borrower could be in trouble. The gains from low interest rates can rapidly be wiped out and worse. In fact, many Austrians took out yen loans in the '90s and some of them wound up with losses of up to 50%, as interest rates moved substantially over time. (To learn more, see Forces Behind Interest Rates.)
Another good example of the risks that arise in foreign investments is illustrated by what can happen to immigrants. For example, retired people on fixed incomes from South Africa living in the U.S., became very poor very fast in the '80s when the South African rand weakened and the capital they held in their home countries was devastated.
Despite the risk and volatility, however, foreign diversification remains a necessary part of the investment process. Currency fluctuations are a fundamental element of such investments. However, if investors on one side of the Atlantic lose 40%, those on the other side gain precisely the same amount. If you decide to add foreign investments to your portfolio, you need to manage you risk by setting yourself up to benefit from a thriving currency.
Managing the Risks
Currency risk can be limited but this may also come at a price, which may come in the form of increased cost or complexity.
Foreign Funds
The simplest way to avoid currency risk is to invest in a fund that is denominated in dollars. This way, you will have the diversification advantage of a foreign fund with a reduced currency risk. This risk is instead assumed by the issuer of the fund. (To learn more, see Go International With Foreign Index Funds.)
Options and Futures
A more complicated way of avoiding currency risk is though options or futures. To do this, you either need a lot of financial knowledge or a good advisor. In plain English, the basic method is to cancel out currency risk by taking out an opposing investment. For instance, if you purchase an investment in euros (effectively buying the currency), you can arrange to sell the same amount of euros at a later date, so that the gains from the one transaction will match the losses of the other. You are then left with just the investment itself and no gamble on the exchange rate. As you can imagine, this is not as straightforward in practice and some of the instruments used are very sophisticated. (For more insight, see A Beginner's Guide To Hedging.)
Loans
It is also possible to take out a loan in the same currency as the foreign investment. But again, the interest rate is critical. Even if the currency risk is hedged (avoided), changes in interest rates between the U.S. and the other country can still cause risks and losses.
Speculation
Foreign investments can be used quite deliberately to speculate or bet on currency changes. You could buy euros, Australian dollars or just about any other currency, simply because you think its value will rise, or that the interest rate will move in the right direction. The most common way to speculate in currencies is through interest certificates or options. In short, the certificates are assets whose value depends on money market developments in that particular currency. Both interest rates and the level of the currency matter. For more risk-friendly investors, there are all sorts of options, which can leverage your money. (For further reading, check out Make The Currency Cross Your Boss.)
Structured Products
Finally, the investment industry offers many so-called mixed, or structured, products which are based on various combinations of equities, bonds and possibly other asset classes as well. These may have some form of built-in currency protection, allowing you varying degrees of currency-risk management. (For related reading, see Are Structured Retail Products Too Good To Be True?)
Conclusion
As is always the case, it is essential that you understand the products in which you invest and their associated levels of risk. It is also important to remember one of the most basic rules of portfolio construction: Even if an investment is risky in itself, by diversifying your portfolio as a whole, the net effect may be to lower the total level of risk. (To read more about this concept, check out A Guide To Portfolio Construction and Achieving Better Returns In Your Portfolio.)
Consequently, there is no need to shy away from currency risk entirely. In fact, some is often necessary and a bit of non-dollar speculation may make your portfolio safer over time. But take on only as much risk as is good for your portfolio - and your peace of mind.
by Brian Bloch, (Contact Author | Biography)
Brian Bloch started his career as a business academic and moved into management journalism in the late '90s. His experiences as an investor with the financial industry led him into the personal finance area a few years ago, and he finds this line of work particularly rewarding and fascinating. As part of his personal finance work, Brian assists investors who have claims against brokers or firms. See his homepage at www.brian-bloch.com
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Currency ETFs Simplify Forex Trades
Currency ETFs Simplify Forex Trades
by John Jagerson (Contact Author | Biography)
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Investing in any market can be volatile. Minimizing risk while retaining upside potential is paramount for most investors - that's why an increasing number of traders and investors are diversifying and hedging with currencies. Different currencies benefit from some of the same things that may hurt stock indexes, bonds or commodities and can be a great way to diversify a portfolio. However, digging into currencies as a trader or investor can be daunting.
New currency exchange-traded funds (ETFs) make it simpler to understand the forex market (the largest, most liquid market on the planet), and use it to diversify risk.
Now, you can have General Electric (NYSE:GE) and the British pound in your portfolio by holding the CurrencyShares British Pound ETF (PSE:FXB) in the same account. Have an IRA? Sprinkle some euros in there by holding the CurrencyShares Euro ETF (PSE:FXE), and offset some downside risk of your S&P 500 holdings. Read on to learn more about this unique way of using currencies to diversify your holdings. (For more on ETFs, see Introduction To Exchange-Traded Funds and Advantages Of Exchange-Traded Funds.)
Hedging Against Risk
Every investor is exposed to two types of risk: idiosyncratic risk and systemic risk. Idiosyncratic risk is the risk that an individual stock's price will fall, causing you to accumulate massive losses on that stock. Rooting this kind of risk out of your portfolio is quite simple. All you have to do is diversify your account across a broad range of stocks or stock-based ETFs, thus reducing your exposure to a particular stock. (To learn more, read The Importance Of Diversification and Do You Understand Investment Risk?)
However, diversifying across a broad range of stocks only addresses idiosyncratic risk. You still have to face your account's systemic risk.
Systemic risk is the exposure you have to the entire stock market falling, causing you to accumulate losses across your entire diversified portfolio. Minimizing the exposure of your portfolio to a bear market used to be difficult. You had to open a futures account or a forex account and try to manage both it and your stock accounts at the same time. While opening a forex account and trading it can be extremely profitable if you apply yourself, many investors aren't ready to take that step. Instead, they decide to leave all of their eggs in their stock market basket and hope the bulls win. Don't let that be you. (Want to give currencies a shot? Read Wading Into The Currency Market.)
Currency ETFs are opening doors for investors to diversify. You can now easily mitigate systematic risk in your account and take advantage of large macroeconomic trends around the world by putting your money not only into the stock market but also in the forex market through these funds. (For more see, A Beginner's Guide To Hedging.)
How Currency ETFs Work
ETF management firms buy and hold currencies in a fund. They then sell shares of that fund to the public. You can buy and sell ETF shares just like you buy and sell stock shares. Investors value the shares of the ETF at 100 times the current exchange rate for the currency being held. For example, let's assume that the CurrencyShares Euro Trust (PSE:FXE) is currently priced at $136.80 per share because the underlying exchange rate for the euro versus the U.S. dollar (EUR/USD) is 1.3680 (1.3680 × 100 = $136.80).
You can use ETFs to profit from the exchange rate of the dollar versus the euro, the British pound, the Canadian dollar, the Japanese yen, the Swiss franc, the Australian dollar and a few other major currencies. (For more on this market, see Common Questions About Currency Trading.)
What makes currencies move?
Unlike the stock market, which has a long-term propensity to rise in value, currencies will often channel in the very long term. Stocks are driven by economic and business growth and tend to trend. Conversely, inflation and issues around monetary policy may prevent a currency from growing in value indefinitely.
Currency pairs may trend as well, and there are simple factors that influence their value and movement. These factors include interest rates, stock market yields, economic growth and government policy. Most of these can be forecasted and used to guide traders as they hedge risk in the rest of the market and make profits in the forex.
Economic Factors and Currency Trends
Here are two examples of economic factors and the currency trends they inspire.
Oil and the Canadian Dollar
Each currency represents an individual economy. If an economy is a commodity producer and exporter, commodity prices will drive currency values. There are three major currencies that are known as "commodity" currencies that exhibit very strong correlations with oil, gold and other raw materials. The Canadian dollar (CAD) is one of these. (For more on how this works, read Commodity Prices And Currency Movements.)
One ETF that can be traded to profit from the moves in the CAD/USD pair is CurrencyShares Canadian (PSE:FXC). Because the Canadian dollar is on the base side of this currency pair, it will pull the ETF up when oil prices are rising and it will fall when oil prices are declining. Of course, there are other factors at play in that currency's value but energy prices are a major influence, and can be surprisingly predictive of the trend.
This is especially useful for stock traders because of the effect that higher energy prices can have on stock values. Additionally, it provides another way for stock traders to speculate on rising commodity prices without having to venture into the futures market. (For on this topic, check out Currency Moves Highlight Equity Opportunities.)
In Figures 1 and 2, you can see 18 months of prices for the Canadian dollar compared to oil prices over the same period.
Figure 1: Crude oil (continuous)
Source: MetaStock Pro FX
Figure 2: Canadian dollar
Source: MetaStock Pro FX
As you can see, there is a strong positive correlation between these two markets. This is helpful as a hedge against stock volatility as well as the real day-to-day costs of higher energy prices.
Short-term traders may look for a breakout in oil prices that is not reflected in the value of the Canadian dollar immediately. When these imbalances occur, there is opportunity to take advantage of the move the market will make as it "catches up" with oil.
Long-term traders can use this as a way to diversify their holdings and speculate on rising energy prices. It is also possible to short the ETF to take advantage of falling oil prices.
Interest Rates and the Swiss Franc
There are several forex relationships that are impacted by interest rates, but a dramatic correlation exists between bond yields and the Swiss franc. One ETF that can be used to profit from the Swiss franc, or "Swissie", is the CurrencyShares Swiss Franc Trust (PSE:FXF). The currency pair is notated as CHF/USD. When the Swissie is rising in value, the ETF rises as well, as it costs more U.S. dollars to buy a Swiss franc.
The correlation described here involves the 10-year bond yield. You will notice in Figures 3 and 4 that when bond yields are rising, the Swissie falls, and vice versa. Depending on interest rates, the value of the Swissie will frequently rise and fall with bond yields.
Figure 3: 10-Year Bond Yields (TNX)
Source: MetaStock Pro FX
Figure 4: Swiss franc
Source: MetaStock Pro FX
This relationship is useful not only as a way to find new trading opportunities but as a hedge against falling stock prices. The stock market has a positive correlation with bond yields; therefore, if yields are falling, the stock market should be falling as well. A savvy investor who is long the Swissie ETF can offset some of those losses.
Conclusion
Currency ETFs have opened the forex market to investors focused on stocks. They adds an additional layer of diversification and can also be used effectively by shorter term traders for quick profits. There are even options available for most of these ETFs.
by John Jagerson, (Contact Author | Biography)
John Jagerson has worked in the capital markets and private equity for most of his career, including investing, writing and money management. He currently manages a registered CTA and contributes to www.pfxglobal.com, the companion site to the book "Profiting With Forex" by John Jagerson and S. Wade Hansen.
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by John Jagerson (Contact Author | Biography)
Email ArticlePrint Comments
Investing in any market can be volatile. Minimizing risk while retaining upside potential is paramount for most investors - that's why an increasing number of traders and investors are diversifying and hedging with currencies. Different currencies benefit from some of the same things that may hurt stock indexes, bonds or commodities and can be a great way to diversify a portfolio. However, digging into currencies as a trader or investor can be daunting.
New currency exchange-traded funds (ETFs) make it simpler to understand the forex market (the largest, most liquid market on the planet), and use it to diversify risk.
Now, you can have General Electric (NYSE:GE) and the British pound in your portfolio by holding the CurrencyShares British Pound ETF (PSE:FXB) in the same account. Have an IRA? Sprinkle some euros in there by holding the CurrencyShares Euro ETF (PSE:FXE), and offset some downside risk of your S&P 500 holdings. Read on to learn more about this unique way of using currencies to diversify your holdings. (For more on ETFs, see Introduction To Exchange-Traded Funds and Advantages Of Exchange-Traded Funds.)
Hedging Against Risk
Every investor is exposed to two types of risk: idiosyncratic risk and systemic risk. Idiosyncratic risk is the risk that an individual stock's price will fall, causing you to accumulate massive losses on that stock. Rooting this kind of risk out of your portfolio is quite simple. All you have to do is diversify your account across a broad range of stocks or stock-based ETFs, thus reducing your exposure to a particular stock. (To learn more, read The Importance Of Diversification and Do You Understand Investment Risk?)
However, diversifying across a broad range of stocks only addresses idiosyncratic risk. You still have to face your account's systemic risk.
Systemic risk is the exposure you have to the entire stock market falling, causing you to accumulate losses across your entire diversified portfolio. Minimizing the exposure of your portfolio to a bear market used to be difficult. You had to open a futures account or a forex account and try to manage both it and your stock accounts at the same time. While opening a forex account and trading it can be extremely profitable if you apply yourself, many investors aren't ready to take that step. Instead, they decide to leave all of their eggs in their stock market basket and hope the bulls win. Don't let that be you. (Want to give currencies a shot? Read Wading Into The Currency Market.)
Currency ETFs are opening doors for investors to diversify. You can now easily mitigate systematic risk in your account and take advantage of large macroeconomic trends around the world by putting your money not only into the stock market but also in the forex market through these funds. (For more see, A Beginner's Guide To Hedging.)
How Currency ETFs Work
ETF management firms buy and hold currencies in a fund. They then sell shares of that fund to the public. You can buy and sell ETF shares just like you buy and sell stock shares. Investors value the shares of the ETF at 100 times the current exchange rate for the currency being held. For example, let's assume that the CurrencyShares Euro Trust (PSE:FXE) is currently priced at $136.80 per share because the underlying exchange rate for the euro versus the U.S. dollar (EUR/USD) is 1.3680 (1.3680 × 100 = $136.80).
You can use ETFs to profit from the exchange rate of the dollar versus the euro, the British pound, the Canadian dollar, the Japanese yen, the Swiss franc, the Australian dollar and a few other major currencies. (For more on this market, see Common Questions About Currency Trading.)
What makes currencies move?
Unlike the stock market, which has a long-term propensity to rise in value, currencies will often channel in the very long term. Stocks are driven by economic and business growth and tend to trend. Conversely, inflation and issues around monetary policy may prevent a currency from growing in value indefinitely.
Currency pairs may trend as well, and there are simple factors that influence their value and movement. These factors include interest rates, stock market yields, economic growth and government policy. Most of these can be forecasted and used to guide traders as they hedge risk in the rest of the market and make profits in the forex.
Economic Factors and Currency Trends
Here are two examples of economic factors and the currency trends they inspire.
Oil and the Canadian Dollar
Each currency represents an individual economy. If an economy is a commodity producer and exporter, commodity prices will drive currency values. There are three major currencies that are known as "commodity" currencies that exhibit very strong correlations with oil, gold and other raw materials. The Canadian dollar (CAD) is one of these. (For more on how this works, read Commodity Prices And Currency Movements.)
One ETF that can be traded to profit from the moves in the CAD/USD pair is CurrencyShares Canadian (PSE:FXC). Because the Canadian dollar is on the base side of this currency pair, it will pull the ETF up when oil prices are rising and it will fall when oil prices are declining. Of course, there are other factors at play in that currency's value but energy prices are a major influence, and can be surprisingly predictive of the trend.
This is especially useful for stock traders because of the effect that higher energy prices can have on stock values. Additionally, it provides another way for stock traders to speculate on rising commodity prices without having to venture into the futures market. (For on this topic, check out Currency Moves Highlight Equity Opportunities.)
In Figures 1 and 2, you can see 18 months of prices for the Canadian dollar compared to oil prices over the same period.
Figure 1: Crude oil (continuous)
Source: MetaStock Pro FX
Figure 2: Canadian dollar
Source: MetaStock Pro FX
As you can see, there is a strong positive correlation between these two markets. This is helpful as a hedge against stock volatility as well as the real day-to-day costs of higher energy prices.
Short-term traders may look for a breakout in oil prices that is not reflected in the value of the Canadian dollar immediately. When these imbalances occur, there is opportunity to take advantage of the move the market will make as it "catches up" with oil.
Long-term traders can use this as a way to diversify their holdings and speculate on rising energy prices. It is also possible to short the ETF to take advantage of falling oil prices.
Interest Rates and the Swiss Franc
There are several forex relationships that are impacted by interest rates, but a dramatic correlation exists between bond yields and the Swiss franc. One ETF that can be used to profit from the Swiss franc, or "Swissie", is the CurrencyShares Swiss Franc Trust (PSE:FXF). The currency pair is notated as CHF/USD. When the Swissie is rising in value, the ETF rises as well, as it costs more U.S. dollars to buy a Swiss franc.
The correlation described here involves the 10-year bond yield. You will notice in Figures 3 and 4 that when bond yields are rising, the Swissie falls, and vice versa. Depending on interest rates, the value of the Swissie will frequently rise and fall with bond yields.
Figure 3: 10-Year Bond Yields (TNX)
Source: MetaStock Pro FX
Figure 4: Swiss franc
Source: MetaStock Pro FX
This relationship is useful not only as a way to find new trading opportunities but as a hedge against falling stock prices. The stock market has a positive correlation with bond yields; therefore, if yields are falling, the stock market should be falling as well. A savvy investor who is long the Swissie ETF can offset some of those losses.
Conclusion
Currency ETFs have opened the forex market to investors focused on stocks. They adds an additional layer of diversification and can also be used effectively by shorter term traders for quick profits. There are even options available for most of these ETFs.
by John Jagerson, (Contact Author | Biography)
John Jagerson has worked in the capital markets and private equity for most of his career, including investing, writing and money management. He currently manages a registered CTA and contributes to www.pfxglobal.com, the companion site to the book "Profiting With Forex" by John Jagerson and S. Wade Hansen.
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The Five-Minute Forex "Momo" Trade
The Five-Minute Forex "Momo" Trade
by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Some traders are extremely patient and love to wait for the perfect setup while others are extremely impatient and need to see a move happen quickly or they'll abandon their positions. These impatient traders make perfect momentum traders because they wait for the market to have enough strength to push a currency in the desired direction and piggyback on the momentum in the hope of an extension move. However, once the move shows signs of losing strength, an impatient momentum trader will also be the first to jump ship. Therefore, a true momentum strategy needs to have solid exit rules to protect profits while still being able to ride as much of the extension move as possible.
In this article, we'll take a look at strategy that does just that: the Five-Minute Momo Trade.
What's a Momo?
The Five Minute Momo Trade looks for a momentum or "momo" burst on very short-term (five-minute) charts. First, traders lay on two indicators, the first of which is the 20-period exponential moving average (EMA). The EMA is chosen over the simple moving average because it places higher weight on recent movements, which is needed for fast momentum trades. The moving average is used to help determine the trend. The second indicator to use is the moving average convergence divergence (MACD) histogram, which helps us gauge momentum. The settings for the MACD histogram is the default, which is first EMA = 12, second EMA = 26, signal EMA = 9, all using the close price. (For more insight, read A Primer On The MACD.)
This strategy waits for a reversal trade but only takes advantage of it when momentum supports the reversal move enough to create a larger extension burst. The position is exited in two separate segments; the first half helps us lock in gains and ensures that we never turn a winner into a loser. The second half lets us attempt to catch what could become a very large move with no risk because the stop has already been moved to breakeven.
Rules for a Long Trade
Look for currency pair trading below the 20-period EMA and MACD to be negative.
Wait for price to cross above the 20-period EMA, then make sure that MACD is either in the process of crossing from negative to positive or has crossed into positive territory no longer than five bars ago.
Go long 10 pips above the 20-period EMA.
For an aggressive trade, place a stop at the swing low on the five-minute chart. For a conservative trade, place a stop 20 pips below the 20-period EMA.
Sell half of the position at entry plus the amount risked; move the stop on the second half to breakeven.
Trail the stop by breakeven or the 20-period EMA minus 15 pips, whichever is higher.
Rules for a Short Trade
Look for the currency pair to be trading above the 20-period EMA and MACD to be positive.
Wait for the price to cross below the 20-period EMA; make sure that MACD is either in the process of crossing from positive to negative or crossed into negative territory no longer than five bars ago.
Go short 10 pips below the 20-period EMA.
For an aggressive trade, place stop at the swing high on a five-minute chart. For a conservative trade, place the stop 20 pips above 20-period EMA
Buy back half of the position at entry minus the amount risked and move the stop on the second half to breakeven.
Trail stop by lower of breakeven or 20-period EMA plus 15 pips
Long Trades
Figure 1: Five-Minute Momo Trade, EUR/USD
Source: FXtrek Intellichart
Our first example in Figure 1 is the EUR/USD on March 16, 2006, when we see the price move above the 20-period EMA as the MACD histogram crosses above the zero line. Although there were a few instances of the price attempting to move above the 20-period EMA between 1:30 and 2:00 EST, a trade was not triggered at that time because the MACD histogram was below the zero line.
We waited for the MACD histogram to cross the zero line and when it did, the trade was triggered at 1.2044. We enter at 1.2046 + 10 pips = 1.2056 with a stop at 1.2046 - 20 pips = 1.2026. Our first target was 1.2056 + 30 pips = 1.2084. It was triggered approximately two and a half hours later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 1.2157 at 21:35 EST for a total profit on the trade of 65.5 pips.
Figure 2: Five-Minute Momo Trade, USD/JPY
Source: FXtrek Intellichart
The next example, shown in Figure 2, is USD/JPY on March 21, 2006, when we see the price move above the 20-period EMA. Like in the previous EUR/USD example, there were also a few instances in which the price crossed above the 20-period EMA right before our entry point, but we did not take the trade because the MACD histogram was below the zero line.
The MACD turned first, so we waited for the price to cross the EMA by 10 pips and when it did, we entered the trade at 116.67 (EMA was at 116.57).
The math is a bit more complicated on this one. The stop is at the 20-EMA minus 20 pips or 116.57 - 20 pips = 116.37. The first target is entry plus the amount risked, or 116.67 + (116.67-116.37) = 116.97. It gets triggered five minutes later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 117.07 at 18:00 EST for a total average profit on the trade of 35 pips. Although the profit was not as attractive as the first trade, the chart shows a clean and smooth move that indicates that price action conformed well to our rules.
Short Trades
On the short side, our first example is the NZD/USD on March 20, 2006 (Figure 3). We see the price cross below the 20-period EMA, but the MACD histogram is still positive, so we wait for it to cross below the zero line 25 minutes later. Our trade is then triggered at 0.6294. Like the earlier USD/JPY example, the math is a bit messy on this one because the cross of the moving average did not occur at the same time as when MACD moved below the zero line like it did in our first EUR/USD example. As a result, we enter at 0.6294.
Our stop is the 20-EMA plus 20 pips. At the time, the 20-EMA was at 0.6301, so that puts our entry at 0.6291 and our stop at 0.6301 + 20pips = 0.6321. Our first target is the entry price minus the amount risked or 0.6291 - (0.6321-0.6291) = 0.6261. The target is hit two hours later and the stop on the second half is moved to breakeven. We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half is then closed at 0.6262 at 7:10 EST for a total profit on the trade of 29.5 pips.
Figure 3: Five-Minute Momo Trade, NZD/USD
Source: FXtrek Intellichart
The example in Figure 4 is based on an opportunity that developed on March 10, 2006, in the GBP/USD. In the chart below, the price crosses below the 20-period EMA and we wait for 10 minutes for the MACD histogram to move into negative territory, thereby triggering our entry order at 1.7375. Based on the rules above, as soon as the trade is triggered, we put our stop at the 20-EMA plus 20 pips or 1.7385 + 20 = 1.7405. Our first target is the entry price minus the amount risked, or 1.7375 - (1.7405 - 1.7375) = 1.7345. It gets triggered shortly thereafter. We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half of the position is eventually closed at 1.7268 at 14:35 EST for a total profit on the trade of 68.5 pips. Coincidently enough, the trade was also closed at the exact moment when the MACD histogram flipped into positive territory.
Figure 4: Five-Minute Momo Trade, GBP/USD
Source: FXtrek Intellichart
Momo Trade Failure
As you can see, the Five Minute Momo Trade is an extremely powerful strategy to capture momentum-based reversal moves. However, it does not always work and it is important to explore an example of where it fails and to understand why this happens.
Figure 5: Five-Minute Momo Trade, EUR/CHF
Source: FXtrek Intellichart
The final example of the Five Minute Momo Trade is EUR/CHF on March 21, 2006. In Figure 5, the price crosses below the 20-period EMA and we wait for 20 minutes for the MACD histogram to move into negative territory, putting our entry order at 1.5711. We place our stop at the 20-EMA plus 20 pips or 1.5721 + 20 = 1.5741. Our first target is the entry price minus the amount risked or 1.5711 - (1.5741-1.5711) = 1.5681. The price trades down to a low of 1.5696, which is not low enough to reach our trigger. It then proceeds to reverse course, eventually hitting our stop, causing a total trade loss of 30 pips.
When trading the Five Minute Momo strategy the most important thing to be wary of is trading ranges that are too tight or too wide. In quiet trading hours where the price simply fluctuates around the 20-EMA, the MACD histogram may flip back and forth causing many false signals. Alternatively, if this strategy is implemented in a currency paid with a trading range that is too wide, the stop might be hit before the target is triggered.
Conclusion
The Five-Minute Momo Trade allows traders to profit on short bursts of momentum, while also providing the solid exit rules required to protect profits.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
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by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Some traders are extremely patient and love to wait for the perfect setup while others are extremely impatient and need to see a move happen quickly or they'll abandon their positions. These impatient traders make perfect momentum traders because they wait for the market to have enough strength to push a currency in the desired direction and piggyback on the momentum in the hope of an extension move. However, once the move shows signs of losing strength, an impatient momentum trader will also be the first to jump ship. Therefore, a true momentum strategy needs to have solid exit rules to protect profits while still being able to ride as much of the extension move as possible.
In this article, we'll take a look at strategy that does just that: the Five-Minute Momo Trade.
What's a Momo?
The Five Minute Momo Trade looks for a momentum or "momo" burst on very short-term (five-minute) charts. First, traders lay on two indicators, the first of which is the 20-period exponential moving average (EMA). The EMA is chosen over the simple moving average because it places higher weight on recent movements, which is needed for fast momentum trades. The moving average is used to help determine the trend. The second indicator to use is the moving average convergence divergence (MACD) histogram, which helps us gauge momentum. The settings for the MACD histogram is the default, which is first EMA = 12, second EMA = 26, signal EMA = 9, all using the close price. (For more insight, read A Primer On The MACD.)
This strategy waits for a reversal trade but only takes advantage of it when momentum supports the reversal move enough to create a larger extension burst. The position is exited in two separate segments; the first half helps us lock in gains and ensures that we never turn a winner into a loser. The second half lets us attempt to catch what could become a very large move with no risk because the stop has already been moved to breakeven.
Rules for a Long Trade
Look for currency pair trading below the 20-period EMA and MACD to be negative.
Wait for price to cross above the 20-period EMA, then make sure that MACD is either in the process of crossing from negative to positive or has crossed into positive territory no longer than five bars ago.
Go long 10 pips above the 20-period EMA.
For an aggressive trade, place a stop at the swing low on the five-minute chart. For a conservative trade, place a stop 20 pips below the 20-period EMA.
Sell half of the position at entry plus the amount risked; move the stop on the second half to breakeven.
Trail the stop by breakeven or the 20-period EMA minus 15 pips, whichever is higher.
Rules for a Short Trade
Look for the currency pair to be trading above the 20-period EMA and MACD to be positive.
Wait for the price to cross below the 20-period EMA; make sure that MACD is either in the process of crossing from positive to negative or crossed into negative territory no longer than five bars ago.
Go short 10 pips below the 20-period EMA.
For an aggressive trade, place stop at the swing high on a five-minute chart. For a conservative trade, place the stop 20 pips above 20-period EMA
Buy back half of the position at entry minus the amount risked and move the stop on the second half to breakeven.
Trail stop by lower of breakeven or 20-period EMA plus 15 pips
Long Trades
Figure 1: Five-Minute Momo Trade, EUR/USD
Source: FXtrek Intellichart
Our first example in Figure 1 is the EUR/USD on March 16, 2006, when we see the price move above the 20-period EMA as the MACD histogram crosses above the zero line. Although there were a few instances of the price attempting to move above the 20-period EMA between 1:30 and 2:00 EST, a trade was not triggered at that time because the MACD histogram was below the zero line.
We waited for the MACD histogram to cross the zero line and when it did, the trade was triggered at 1.2044. We enter at 1.2046 + 10 pips = 1.2056 with a stop at 1.2046 - 20 pips = 1.2026. Our first target was 1.2056 + 30 pips = 1.2084. It was triggered approximately two and a half hours later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 1.2157 at 21:35 EST for a total profit on the trade of 65.5 pips.
Figure 2: Five-Minute Momo Trade, USD/JPY
Source: FXtrek Intellichart
The next example, shown in Figure 2, is USD/JPY on March 21, 2006, when we see the price move above the 20-period EMA. Like in the previous EUR/USD example, there were also a few instances in which the price crossed above the 20-period EMA right before our entry point, but we did not take the trade because the MACD histogram was below the zero line.
The MACD turned first, so we waited for the price to cross the EMA by 10 pips and when it did, we entered the trade at 116.67 (EMA was at 116.57).
The math is a bit more complicated on this one. The stop is at the 20-EMA minus 20 pips or 116.57 - 20 pips = 116.37. The first target is entry plus the amount risked, or 116.67 + (116.67-116.37) = 116.97. It gets triggered five minutes later. We exit half of the position and trail the remaining half by the 20-period EMA minus 15 pips. The second half is eventually closed at 117.07 at 18:00 EST for a total average profit on the trade of 35 pips. Although the profit was not as attractive as the first trade, the chart shows a clean and smooth move that indicates that price action conformed well to our rules.
Short Trades
On the short side, our first example is the NZD/USD on March 20, 2006 (Figure 3). We see the price cross below the 20-period EMA, but the MACD histogram is still positive, so we wait for it to cross below the zero line 25 minutes later. Our trade is then triggered at 0.6294. Like the earlier USD/JPY example, the math is a bit messy on this one because the cross of the moving average did not occur at the same time as when MACD moved below the zero line like it did in our first EUR/USD example. As a result, we enter at 0.6294.
Our stop is the 20-EMA plus 20 pips. At the time, the 20-EMA was at 0.6301, so that puts our entry at 0.6291 and our stop at 0.6301 + 20pips = 0.6321. Our first target is the entry price minus the amount risked or 0.6291 - (0.6321-0.6291) = 0.6261. The target is hit two hours later and the stop on the second half is moved to breakeven. We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half is then closed at 0.6262 at 7:10 EST for a total profit on the trade of 29.5 pips.
Figure 3: Five-Minute Momo Trade, NZD/USD
Source: FXtrek Intellichart
The example in Figure 4 is based on an opportunity that developed on March 10, 2006, in the GBP/USD. In the chart below, the price crosses below the 20-period EMA and we wait for 10 minutes for the MACD histogram to move into negative territory, thereby triggering our entry order at 1.7375. Based on the rules above, as soon as the trade is triggered, we put our stop at the 20-EMA plus 20 pips or 1.7385 + 20 = 1.7405. Our first target is the entry price minus the amount risked, or 1.7375 - (1.7405 - 1.7375) = 1.7345. It gets triggered shortly thereafter. We then proceed to trail the second half of the position by the 20-period EMA plus 15 pips. The second half of the position is eventually closed at 1.7268 at 14:35 EST for a total profit on the trade of 68.5 pips. Coincidently enough, the trade was also closed at the exact moment when the MACD histogram flipped into positive territory.
Figure 4: Five-Minute Momo Trade, GBP/USD
Source: FXtrek Intellichart
Momo Trade Failure
As you can see, the Five Minute Momo Trade is an extremely powerful strategy to capture momentum-based reversal moves. However, it does not always work and it is important to explore an example of where it fails and to understand why this happens.
Figure 5: Five-Minute Momo Trade, EUR/CHF
Source: FXtrek Intellichart
The final example of the Five Minute Momo Trade is EUR/CHF on March 21, 2006. In Figure 5, the price crosses below the 20-period EMA and we wait for 20 minutes for the MACD histogram to move into negative territory, putting our entry order at 1.5711. We place our stop at the 20-EMA plus 20 pips or 1.5721 + 20 = 1.5741. Our first target is the entry price minus the amount risked or 1.5711 - (1.5741-1.5711) = 1.5681. The price trades down to a low of 1.5696, which is not low enough to reach our trigger. It then proceeds to reverse course, eventually hitting our stop, causing a total trade loss of 30 pips.
When trading the Five Minute Momo strategy the most important thing to be wary of is trading ranges that are too tight or too wide. In quiet trading hours where the price simply fluctuates around the 20-EMA, the MACD histogram may flip back and forth causing many false signals. Alternatively, if this strategy is implemented in a currency paid with a trading range that is too wide, the stop might be hit before the target is triggered.
Conclusion
The Five-Minute Momo Trade allows traders to profit on short bursts of momentum, while also providing the solid exit rules required to protect profits.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
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Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
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Forex: The Memory Of Price Strategy
Forex: The Memory Of Price Strategy
by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Is there anything more annoying than getting stopped out of a short trade on the absolute top tick of the move or being taken out of a long trade on the lowest possible bottom tick, only to have prices reverse and then ultimately move in your direction for profit? Anyone who has ever traded currencies has experienced that unpleasant reality more than once. The memory of price setup is specifically designed to take advantage of these spike moves in currencies by carefully scaling into the trade in anticipation of a reversal. Read on to find out how to use it in your next trade.
The Strategy
The memory of price setup should appeal to traders who despise taking frequent stops and like to bank consistent, small profits. However, anyone who trades this setup must understand that while it misses infrequently, when it does miss, the losses can be very large. Therefore, it is absolutely critical to honor the stops in this setup because when it fails it can morph into a relentless runaway move that could blow up your entire account if you continue to fade it. (For background reading, see Place Forex Orders Properly.)
This setup rests on the assumption that the support and resistance points of double tops and double bottoms exert an influence on price action even after they are broken. They act almost like magnetic fields, attracting price action back to those points after the majority of the stops have been cleared. The thesis behind this setup is that it takes an enormous amount of buying power to exceed the value of the prior range of the double top breakout, and vice versa for the double bottom breakdown. In the case of a double top, for example, breaking above a previous top requires that buyers not only expend capital and power to overcome the topside resistance, but also retain enough additional momentum to fuel the rally further. By that time, much of the momentum has been expended on the challenge to the double top, and it is unlikely that we will see a move of the same amplitude as the one that created the first top. (To learn more, read Trading Double Tops and Double Bottoms.)
Determining Risk
We use a symmetrical approach to determine risk. Using our double-top example, we measure the amplitude of the retrace in the double top and then add that value to the swing high to create our zone of resistance.
Figure 1: The memory of price, EUR/USD
Source: FXtrek Intellichart
In Figure 1 the price pushes higher above the initial swing high of 1.2060, but cannot extend the up move by the full amplitude of the initial retracement. We see this happen quite often on the hourly charts as well as daily charts. On the dailies, the setup will suffer fewer failures because the range extensions will be much larger, but it will also generate larger losses. Therefore, traders must weigh the advantages and disadvantages of each approach and adapt their risk parameters accordingly.
Rules for the Short Trade
Look for an established uptrend that is making consistently higher lows.
Note when this up-move makes a retrace on the daily or hourly charts.
Make sure that this retrace is at least 38.2% of the original move.
Enter short half the position (position No.1) when the price rallies to the swing high, making a double top.
Measure the amplitude of the retrace segment.
Add the value of the amplitude to the swing high and make that your ultimate stop.
Target 50% of the retrace segment as your profit. So, if the retrace segment is 100, target 50 points as your profit.
If the position moves against you, add the second half of the position (position No. 2) at the 50% point between the swing high and the ultimate stop.
Keep the stop on both units at the ultimate stop value.
If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.
Rules for the Long Trade
Look for an established downtrend that is making consistently lower highs.
Note when this down-move makes a retrace on the daily or hourly charts.
Make sure that this retrace is at least 38.2% of the original move.
Enter long half the position (position No.1) when the price falls to the swing low making a double bottom.
Measure the amplitude of the retrace segment.
Add the value of the amplitude to the swing low and make that your ultimate stop.
Target 50% of the retrace segment as your profit. If the retrace segment is 100, target 50 points as your profit.
If the position moves against you, add the second half of the position (position No.2) at the 50% point between the swing low and the ultimate stop.
Keep the stop on both units at the ultimate stop value.
If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.
Short Trades
Lets see how this setup works on both the long and short time frames.
Figure 2: The memory of price, GBP/USD
Source: FXtrek Intellichart
Let's look at a long setup in GBP/USD, which begins to form on November 12, 2005, notice that prices first rally but then begin to drop, setting up for a possible double bottom. According to the rules of our setup, we take half our position at 1.7386, expecting prices to bounce back up. When this setup is traded on the daily charts, the stops can be enormous. In the case of this long setup the stop is more than 500 points large. The amplitude of the counter-move up is 1.7907-1.7386 = 521 points.
A wide stop is necessary because a trader should never risk more that 2% per trade. On a hypothetical $10,000 account, the trader should never trade more than two mini lots which are 10,000 units where a one-point move is worth $1. This will already violate our "no more than 2% risk per trade" rule because the total drawdown will exceed 7.5% if the setup fails (521 points + 260 points =$780 or 7.8% on a $10,000 account). You can compensate for this risk by toning down the leverage if you are trading the memory of price strategy, although the high probability nature of the setup allows us to be more liberal with risk control. Nevertheless, the bottom line is that on the dailies, leverage should be extremely conservative, not exceeding a factor of two. This means that for a hypothetical $10,000 account the trader should not assume a position larger than $20,000 in size.
As the trade proceeds, we see that the support at 1.7386 fails; we therefore place a second buy order at 1.7126, halfway below our ultimate stop of 1.6865. We now have a full position on and wait for market action to respond. Sure enough, having expended so much effort on the downside move, prices begin to stall way ahead of our ultimate stop. As the price bounces back, we sell the one lot, which we purchased at 1.7126, back at 1.7386, our initial entry point in the trade, banking 260 points for our efforts. We then immediately move our stop on the remaining lot to 1.7126, ensuring that the trade will lose us no capital should the price fail to rally to our second profit target. However, on November 23, 2005, the price does reach our second target of 1.7646, generating a gain of another 260 points for a total profit on the trade of 521 points. Therefore, what could wind up as a loss under most standard setups because support was broken by a material amount turns into a profitable, high probability trade.
Now let's take a look at the setup on a shorter time frame using the hourly charts. In this example, the GBP/USD traces out a countertrend move of 177 points that lasts from 1.7313 to 1.7490. The move starts at approximately 9 a.m. EST on March 29, 2006, and lasts until 2 p.m. EST the following day. As the price trades back down to 1.7313, we place a buy order and set our stop 177 points lower at 1.7136. In this case, the price does not retreat much more, leaving us with only the first half of the position as it creates a very shallow fake out double bottom.
We take our profits at 50% of risk, exiting at 1.7402 at 8 p.m. EST on April 3, 2006. The trade lasts approximately four days, with very little drawdown, and produces a healthy profit in the process. On the shorter time frames, the risk of this setup is considerably less than the daily version, with the ultimate stop only 177 points away from entry, versus the prior example where the stops were 521 points away.
Figure 3: The memory of price, GBP/USD
Source: FXtrek Intellichart
Short Trades
Turning now to the short side, we look at the daily chart in the EUR/USD trading a relatively small retrace at the beginning of 2006 from 1.2181 to 1.2004. As price once again approaches the 1.2181 level on January 23, 2006, we go short with half of the total position, placing a stop at 1.2358. Prices then verticalize, and at this point the strategy of the setup really comes into play as we short the second half at 1.2278.
Prices push higher, beyond even our second entry, but the move exhausts before hitting our stop. We exit half of the trade as prices come back to 1.2181 and move our stop to breakeven on the whole position. Prices then proceed to collapse even further as we cover the second half at 1.2092, banking the full profit on the trade.
Figure 4: The memory of price, EUR/USD
Source: FXtrek Intellichart
In another short example of this setup, we look at the hourly chart in the USD/JPY as it forms a retrace between 8 a.m. EST March 29, 2006, and 8 a.m. EST March 30, 2006. The amplitude of that range is 118.22 to 117.08, or 116 points. We then add 116 points to the swing high of 118.22 to establish our ultimate stop of 119.36. As it trades back up to 118.22 on April 3, 2006, we short half of our position size and then short the rest of the position at 118.78. Prices do not trade much higher and by 10 a.m. EST the next day we are able to cover half of our short at 118.22. Just 10 hours later, at 8 p.m. EST, we are able to close out the rest of the position for profit.
Figure 5: The memory of price, USD/JPY
Source: FXtrek Intellichart
This example illustrates once again the power of this setup on the shorter time frames. The small risk parameters and the relatively short time frames allow nimble forex traders to take advantage of the natural daily ebb and flow of the markets. Clearly this setup works best in range-bound markets, which occurs a majority of the time.
When This Trade Fails
The gravest danger to the memory of price setup is a one-way market during which prices do not retrace. This is why keeping disciplined stops is so essential to the strategy because one runaway trade could blow up the trader's entire portfolio.
Figure 6: The memory of price, USD/JPY
Source: FXtrek Intellichart
In the preceding example, we see how the daily trend on the USD/JPY pair during the fourth quarter of 2006 reached such powerful momentum that traders had no chance to recoup their losses, and shorts were simply steamrolled. Starting with the initial entry on September 20, 2005, off the countertrend move at 111.78, we proceeded to short the pair at half position value, adding yet another half position seven days later on September 27, 2005, at 113.33. Unfortunately, prices did not pause in their ascent, and the whole trade was stopped out at 114.88 on October 13, 2005, for a total loss of 465 points ((114.88-111.78) + (114.88-113.33) = 465).
Conclusion
The memory of price strategy works well for traders who don't like to take frequent stops and prefer to bank small profits along the way. Although losses can be large when the strategy does miss, it can prevent traders from being stopped out of a short trade on the top tick or a long trade on the lowest possible bottom tick right before prices reverse and move in the trader's favor.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
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by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Is there anything more annoying than getting stopped out of a short trade on the absolute top tick of the move or being taken out of a long trade on the lowest possible bottom tick, only to have prices reverse and then ultimately move in your direction for profit? Anyone who has ever traded currencies has experienced that unpleasant reality more than once. The memory of price setup is specifically designed to take advantage of these spike moves in currencies by carefully scaling into the trade in anticipation of a reversal. Read on to find out how to use it in your next trade.
The Strategy
The memory of price setup should appeal to traders who despise taking frequent stops and like to bank consistent, small profits. However, anyone who trades this setup must understand that while it misses infrequently, when it does miss, the losses can be very large. Therefore, it is absolutely critical to honor the stops in this setup because when it fails it can morph into a relentless runaway move that could blow up your entire account if you continue to fade it. (For background reading, see Place Forex Orders Properly.)
This setup rests on the assumption that the support and resistance points of double tops and double bottoms exert an influence on price action even after they are broken. They act almost like magnetic fields, attracting price action back to those points after the majority of the stops have been cleared. The thesis behind this setup is that it takes an enormous amount of buying power to exceed the value of the prior range of the double top breakout, and vice versa for the double bottom breakdown. In the case of a double top, for example, breaking above a previous top requires that buyers not only expend capital and power to overcome the topside resistance, but also retain enough additional momentum to fuel the rally further. By that time, much of the momentum has been expended on the challenge to the double top, and it is unlikely that we will see a move of the same amplitude as the one that created the first top. (To learn more, read Trading Double Tops and Double Bottoms.)
Determining Risk
We use a symmetrical approach to determine risk. Using our double-top example, we measure the amplitude of the retrace in the double top and then add that value to the swing high to create our zone of resistance.
Figure 1: The memory of price, EUR/USD
Source: FXtrek Intellichart
In Figure 1 the price pushes higher above the initial swing high of 1.2060, but cannot extend the up move by the full amplitude of the initial retracement. We see this happen quite often on the hourly charts as well as daily charts. On the dailies, the setup will suffer fewer failures because the range extensions will be much larger, but it will also generate larger losses. Therefore, traders must weigh the advantages and disadvantages of each approach and adapt their risk parameters accordingly.
Rules for the Short Trade
Look for an established uptrend that is making consistently higher lows.
Note when this up-move makes a retrace on the daily or hourly charts.
Make sure that this retrace is at least 38.2% of the original move.
Enter short half the position (position No.1) when the price rallies to the swing high, making a double top.
Measure the amplitude of the retrace segment.
Add the value of the amplitude to the swing high and make that your ultimate stop.
Target 50% of the retrace segment as your profit. So, if the retrace segment is 100, target 50 points as your profit.
If the position moves against you, add the second half of the position (position No. 2) at the 50% point between the swing high and the ultimate stop.
Keep the stop on both units at the ultimate stop value.
If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.
Rules for the Long Trade
Look for an established downtrend that is making consistently lower highs.
Note when this down-move makes a retrace on the daily or hourly charts.
Make sure that this retrace is at least 38.2% of the original move.
Enter long half the position (position No.1) when the price falls to the swing low making a double bottom.
Measure the amplitude of the retrace segment.
Add the value of the amplitude to the swing low and make that your ultimate stop.
Target 50% of the retrace segment as your profit. If the retrace segment is 100, target 50 points as your profit.
If the position moves against you, add the second half of the position (position No.2) at the 50% point between the swing low and the ultimate stop.
Keep the stop on both units at the ultimate stop value.
If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.
Short Trades
Lets see how this setup works on both the long and short time frames.
Figure 2: The memory of price, GBP/USD
Source: FXtrek Intellichart
Let's look at a long setup in GBP/USD, which begins to form on November 12, 2005, notice that prices first rally but then begin to drop, setting up for a possible double bottom. According to the rules of our setup, we take half our position at 1.7386, expecting prices to bounce back up. When this setup is traded on the daily charts, the stops can be enormous. In the case of this long setup the stop is more than 500 points large. The amplitude of the counter-move up is 1.7907-1.7386 = 521 points.
A wide stop is necessary because a trader should never risk more that 2% per trade. On a hypothetical $10,000 account, the trader should never trade more than two mini lots which are 10,000 units where a one-point move is worth $1. This will already violate our "no more than 2% risk per trade" rule because the total drawdown will exceed 7.5% if the setup fails (521 points + 260 points =$780 or 7.8% on a $10,000 account). You can compensate for this risk by toning down the leverage if you are trading the memory of price strategy, although the high probability nature of the setup allows us to be more liberal with risk control. Nevertheless, the bottom line is that on the dailies, leverage should be extremely conservative, not exceeding a factor of two. This means that for a hypothetical $10,000 account the trader should not assume a position larger than $20,000 in size.
As the trade proceeds, we see that the support at 1.7386 fails; we therefore place a second buy order at 1.7126, halfway below our ultimate stop of 1.6865. We now have a full position on and wait for market action to respond. Sure enough, having expended so much effort on the downside move, prices begin to stall way ahead of our ultimate stop. As the price bounces back, we sell the one lot, which we purchased at 1.7126, back at 1.7386, our initial entry point in the trade, banking 260 points for our efforts. We then immediately move our stop on the remaining lot to 1.7126, ensuring that the trade will lose us no capital should the price fail to rally to our second profit target. However, on November 23, 2005, the price does reach our second target of 1.7646, generating a gain of another 260 points for a total profit on the trade of 521 points. Therefore, what could wind up as a loss under most standard setups because support was broken by a material amount turns into a profitable, high probability trade.
Now let's take a look at the setup on a shorter time frame using the hourly charts. In this example, the GBP/USD traces out a countertrend move of 177 points that lasts from 1.7313 to 1.7490. The move starts at approximately 9 a.m. EST on March 29, 2006, and lasts until 2 p.m. EST the following day. As the price trades back down to 1.7313, we place a buy order and set our stop 177 points lower at 1.7136. In this case, the price does not retreat much more, leaving us with only the first half of the position as it creates a very shallow fake out double bottom.
We take our profits at 50% of risk, exiting at 1.7402 at 8 p.m. EST on April 3, 2006. The trade lasts approximately four days, with very little drawdown, and produces a healthy profit in the process. On the shorter time frames, the risk of this setup is considerably less than the daily version, with the ultimate stop only 177 points away from entry, versus the prior example where the stops were 521 points away.
Figure 3: The memory of price, GBP/USD
Source: FXtrek Intellichart
Short Trades
Turning now to the short side, we look at the daily chart in the EUR/USD trading a relatively small retrace at the beginning of 2006 from 1.2181 to 1.2004. As price once again approaches the 1.2181 level on January 23, 2006, we go short with half of the total position, placing a stop at 1.2358. Prices then verticalize, and at this point the strategy of the setup really comes into play as we short the second half at 1.2278.
Prices push higher, beyond even our second entry, but the move exhausts before hitting our stop. We exit half of the trade as prices come back to 1.2181 and move our stop to breakeven on the whole position. Prices then proceed to collapse even further as we cover the second half at 1.2092, banking the full profit on the trade.
Figure 4: The memory of price, EUR/USD
Source: FXtrek Intellichart
In another short example of this setup, we look at the hourly chart in the USD/JPY as it forms a retrace between 8 a.m. EST March 29, 2006, and 8 a.m. EST March 30, 2006. The amplitude of that range is 118.22 to 117.08, or 116 points. We then add 116 points to the swing high of 118.22 to establish our ultimate stop of 119.36. As it trades back up to 118.22 on April 3, 2006, we short half of our position size and then short the rest of the position at 118.78. Prices do not trade much higher and by 10 a.m. EST the next day we are able to cover half of our short at 118.22. Just 10 hours later, at 8 p.m. EST, we are able to close out the rest of the position for profit.
Figure 5: The memory of price, USD/JPY
Source: FXtrek Intellichart
This example illustrates once again the power of this setup on the shorter time frames. The small risk parameters and the relatively short time frames allow nimble forex traders to take advantage of the natural daily ebb and flow of the markets. Clearly this setup works best in range-bound markets, which occurs a majority of the time.
When This Trade Fails
The gravest danger to the memory of price setup is a one-way market during which prices do not retrace. This is why keeping disciplined stops is so essential to the strategy because one runaway trade could blow up the trader's entire portfolio.
Figure 6: The memory of price, USD/JPY
Source: FXtrek Intellichart
In the preceding example, we see how the daily trend on the USD/JPY pair during the fourth quarter of 2006 reached such powerful momentum that traders had no chance to recoup their losses, and shorts were simply steamrolled. Starting with the initial entry on September 20, 2005, off the countertrend move at 111.78, we proceeded to short the pair at half position value, adding yet another half position seven days later on September 27, 2005, at 113.33. Unfortunately, prices did not pause in their ascent, and the whole trade was stopped out at 114.88 on October 13, 2005, for a total loss of 465 points ((114.88-111.78) + (114.88-113.33) = 465).
Conclusion
The memory of price strategy works well for traders who don't like to take frequent stops and prefer to bank small profits along the way. Although losses can be large when the strategy does miss, it can prevent traders from being stopped out of a short trade on the top tick or a long trade on the lowest possible bottom tick right before prices reverse and move in the trader's favor.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
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Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
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How To Pay Your Forex Broker
How To Pay Your Forex Broker
by Selwyn Gishen (Contact Author | Biography)
Email ArticlePrint Comments
The forex market, unlike other exchange driven markets, has a unique feature that many market makers use to entice traders to trade. They promise no exchange fees or regulatory fees, no data fees and, best of all, no commissions. To the new trader just wanting to break into the trading business, this sounds too good to be true. Trading without transaction costs is clearly an advantage. However, what might sound like a bargain to inexperienced traders may not be the best deal available - or even a deal at all. Here we'll show you how to evaluate forex broker fee/commission structures and find the one that will work best for you.
Commission Structures
There are three forms of commission used by brokers in forex. Some firms offer a fixed spread, others offer a variable spread and still others charge a commission based on a percentage of the spread. So which is the best choice? At first glance, it seems that the fixed spread may be the right choice, because then you would know exactly what to expect. However, before you jump in and choose one, there are a few things you need to consider.
The spread is the difference between the price the market maker is prepared to pay you for buying the currency (the bid price), versus the price at which he is prepared to sell you the currency (the ask price). Suppose you see the following quotes on your screen: "EURUSD - 1.4952 - 1.4955." This represents a spread of three pips, the difference between the bid price of 1.4952 and the ask price of 1.4955. If you are dealing with a market maker who is offering a fixed spread of three pips instead of a variable spread, the difference will always be three pips, regardless of market volatility. (For more, see Common Questions About Currency Trading.)
In the case of a broker who offers a variable spread, you can expect a spread that will, at times, be as low as 1.5 pips or as high as five pips, depending on the currency pair being traded and the level of market volatility.
Some brokers may also charge a very small commission, perhaps two-tenths of one pip, and then will pass the order flow received from you on to a large market maker with whom he or she has a relationship. In such an arrangement, you can receive a very tight spread that only larger traders could otherwise access.
Different Brokers, Different Levels of Service
So what is the bottom line effect of each type of commission on your trading? Given that all brokers are not created equal, this is a difficult question to answer. The reason is that there are other factors to take into account when weighing what is most advantageous for your trading account.
For example, not all brokers are able to make a market equally. The forex market is an over-the-counter market, which means that banks, the primary market makers, have relationships with other banks and price aggregators (retail online brokers), based on the capitalization and creditworthiness of each organization. There are no guarantors or exchanges involved, just the credit agreement between each player. So, when it comes to an online market maker, for example, your broker's effectiveness will depend on his or her relationship with banks, and how much volume the broker does with them. Usually, the higher-volume forex players are quoted tighter spreads. (For more, see Getting Started In Forex.)
If your market maker has a strong relationship with a line of banks and can aggregate, say, twelve banks' price quotes, then the brokerage firm will be able to pass the average bid and ask on to its retail customers. Even after slightly widening the spread to account for profit, the dealer will be able to pass a more competitive spread on to you than competitors that are not well capitalized.
If you are dealing with a broker that can offer guaranteed liquidity at attractive spreads, this may be what you should look for. On the other hand, you might want to pay a fixed pip spread if you know you are getting at-the-money executions every time you trade. Slippage, which occurs when your trade is executed away from the price you were offered, is a cost that you do not want to bear.
In the case of a commission broker, whether you should pay a small commission depends on what else the broker is offering. For example, suppose your broker charges you a small commission, usually in the order of two-tenths of one pip, or about $2.50 - $3 per 100,000 unit trade, but in exchange offers you access to a proprietary software platform that is superior to most online brokers' platforms, or some other benefit. In this case, it may be worth paying the small commission for this additional service.
Choosing a Forex Broker
As a trader, you should always consider the total package when deciding on a broker, in addition to the type of spreads the broker offers. For example, some brokers may offer excellent spreads but their platforms may not have all the bells and whistles that are offered by competitors. When choosing a brokerage firm, you should check out the following:
How well capitalized is the firm?
How long has it been in business?
Who manages the firm and how much experience does this person have?
Which and how many banks does the firm have relationships with?
How much volume does it transact each month?
What are its liquidity guarantees in terms of order size?
What is its margin policy?
What is its rollover policy in case you want to hold your positions overnight?
Does the firm pass through the positive carry, if there is one?
Does the firm add a spread to the rollover interest rates?
What kind of platform does it offer?
Does it have multiple order types, such as "order cancels order" or "order sends order"?
Does it guarantee to execute your stop losses at the order price?
Does the firm have a dealing desk?
What do you do if your internet connection is lost and you have an open position?
Does the firm provide all the back-end office functions, such as P&L, in real time?
Conclusion
Even though you might think you are getting a deal when paying a variable spread, you may be sacrificing other benefits. But one thing is certain: As a trader you always pay the spread and your broker always earns the spread. To get the best deal possible, choose a reputable broker who is well capitalized and has strong relationships with the large foreign exchange banks. Examine the spreads on the most popular currencies. Very often, they will be as little as 1.5 pips. If this is the case, a variable spread may work out to be cheaper than a fixed spread. Some brokers even offer you the choice of either a fixed spread or a variable one. In the end, the cheapest way to trade is with a very reputable market maker who can provide the liquidity you need to trade well.
by Selwyn Gishen, (Contact Author | Biography)
Selwyn Gishen is a trader with more than 15 years of experience trading forex and equities for a private equity fund. For the past 35 years, he has also been a student of metaphysics, and has written a book called "Mind: How Changing Your Mind Can Change Your Life!" (2007). Gishen is the founder of FXNewsandViews.Com and the author of a forex trading guide entitled "Trading the Forex Markets: A Foundation Course for Online Traders". The course is designed to provide the trader with all the aspects of Gishen's Fusion Trading Model.
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Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
Copyright © 2009 Investopedia ULC. All Rights Reserved | Terms of Use | Privacy Policy | Advertise
by Selwyn Gishen (Contact Author | Biography)
Email ArticlePrint Comments
The forex market, unlike other exchange driven markets, has a unique feature that many market makers use to entice traders to trade. They promise no exchange fees or regulatory fees, no data fees and, best of all, no commissions. To the new trader just wanting to break into the trading business, this sounds too good to be true. Trading without transaction costs is clearly an advantage. However, what might sound like a bargain to inexperienced traders may not be the best deal available - or even a deal at all. Here we'll show you how to evaluate forex broker fee/commission structures and find the one that will work best for you.
Commission Structures
There are three forms of commission used by brokers in forex. Some firms offer a fixed spread, others offer a variable spread and still others charge a commission based on a percentage of the spread. So which is the best choice? At first glance, it seems that the fixed spread may be the right choice, because then you would know exactly what to expect. However, before you jump in and choose one, there are a few things you need to consider.
The spread is the difference between the price the market maker is prepared to pay you for buying the currency (the bid price), versus the price at which he is prepared to sell you the currency (the ask price). Suppose you see the following quotes on your screen: "EURUSD - 1.4952 - 1.4955." This represents a spread of three pips, the difference between the bid price of 1.4952 and the ask price of 1.4955. If you are dealing with a market maker who is offering a fixed spread of three pips instead of a variable spread, the difference will always be three pips, regardless of market volatility. (For more, see Common Questions About Currency Trading.)
In the case of a broker who offers a variable spread, you can expect a spread that will, at times, be as low as 1.5 pips or as high as five pips, depending on the currency pair being traded and the level of market volatility.
Some brokers may also charge a very small commission, perhaps two-tenths of one pip, and then will pass the order flow received from you on to a large market maker with whom he or she has a relationship. In such an arrangement, you can receive a very tight spread that only larger traders could otherwise access.
Different Brokers, Different Levels of Service
So what is the bottom line effect of each type of commission on your trading? Given that all brokers are not created equal, this is a difficult question to answer. The reason is that there are other factors to take into account when weighing what is most advantageous for your trading account.
For example, not all brokers are able to make a market equally. The forex market is an over-the-counter market, which means that banks, the primary market makers, have relationships with other banks and price aggregators (retail online brokers), based on the capitalization and creditworthiness of each organization. There are no guarantors or exchanges involved, just the credit agreement between each player. So, when it comes to an online market maker, for example, your broker's effectiveness will depend on his or her relationship with banks, and how much volume the broker does with them. Usually, the higher-volume forex players are quoted tighter spreads. (For more, see Getting Started In Forex.)
If your market maker has a strong relationship with a line of banks and can aggregate, say, twelve banks' price quotes, then the brokerage firm will be able to pass the average bid and ask on to its retail customers. Even after slightly widening the spread to account for profit, the dealer will be able to pass a more competitive spread on to you than competitors that are not well capitalized.
If you are dealing with a broker that can offer guaranteed liquidity at attractive spreads, this may be what you should look for. On the other hand, you might want to pay a fixed pip spread if you know you are getting at-the-money executions every time you trade. Slippage, which occurs when your trade is executed away from the price you were offered, is a cost that you do not want to bear.
In the case of a commission broker, whether you should pay a small commission depends on what else the broker is offering. For example, suppose your broker charges you a small commission, usually in the order of two-tenths of one pip, or about $2.50 - $3 per 100,000 unit trade, but in exchange offers you access to a proprietary software platform that is superior to most online brokers' platforms, or some other benefit. In this case, it may be worth paying the small commission for this additional service.
Choosing a Forex Broker
As a trader, you should always consider the total package when deciding on a broker, in addition to the type of spreads the broker offers. For example, some brokers may offer excellent spreads but their platforms may not have all the bells and whistles that are offered by competitors. When choosing a brokerage firm, you should check out the following:
How well capitalized is the firm?
How long has it been in business?
Who manages the firm and how much experience does this person have?
Which and how many banks does the firm have relationships with?
How much volume does it transact each month?
What are its liquidity guarantees in terms of order size?
What is its margin policy?
What is its rollover policy in case you want to hold your positions overnight?
Does the firm pass through the positive carry, if there is one?
Does the firm add a spread to the rollover interest rates?
What kind of platform does it offer?
Does it have multiple order types, such as "order cancels order" or "order sends order"?
Does it guarantee to execute your stop losses at the order price?
Does the firm have a dealing desk?
What do you do if your internet connection is lost and you have an open position?
Does the firm provide all the back-end office functions, such as P&L, in real time?
Conclusion
Even though you might think you are getting a deal when paying a variable spread, you may be sacrificing other benefits. But one thing is certain: As a trader you always pay the spread and your broker always earns the spread. To get the best deal possible, choose a reputable broker who is well capitalized and has strong relationships with the large foreign exchange banks. Examine the spreads on the most popular currencies. Very often, they will be as little as 1.5 pips. If this is the case, a variable spread may work out to be cheaper than a fixed spread. Some brokers even offer you the choice of either a fixed spread or a variable one. In the end, the cheapest way to trade is with a very reputable market maker who can provide the liquidity you need to trade well.
by Selwyn Gishen, (Contact Author | Biography)
Selwyn Gishen is a trader with more than 15 years of experience trading forex and equities for a private equity fund. For the past 35 years, he has also been a student of metaphysics, and has written a book called "Mind: How Changing Your Mind Can Change Your Life!" (2007). Gishen is the founder of FXNewsandViews.Com and the author of a forex trading guide entitled "Trading the Forex Markets: A Foundation Course for Online Traders". The course is designed to provide the trader with all the aspects of Gishen's Fusion Trading Model.
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Getting Started In Forex
Getting Started In Forex
by Justin Kuepper,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
The forex (FX) market has many similarities to the equity markets; however, there are some key differences. This article will show you those differences and help you get started in forex trading.
Choosing a Broker
There are many forex brokers to choose from, just as in any other market. Here are some things to look for:
Low Spreads - The spread, calculated in "pips", is the difference between the price at which a currency can be purchased and the price at which it can be sold at any given point in time. Forex brokers don't charge a commission, so this difference is how they make money. In comparing brokers, you will find that the difference in spreads in forex is as great as the difference in commissions in the stock arena.
Bottom line: Lower spreads save you money!
Quality Institution - Unlike equity brokers, forex brokers are usually tied to large banks or lending institutions because of the large amounts of capital required (leverage they need to provide). Also, forex brokers should be registered with the Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). You can find this and other financial information and statistics about a forex brokerage on its website or on the website of its parent company.
Bottom line: Make sure your broker is backed by a reliable institution!
Extensive Tools and Research - Forex brokers offer many different trading platforms for their clients - just like brokers in other markets. These trading platforms often feature real-time charts, technical analysis tools, real-time news and data, and even support for trading systems. Before committing to any broker, be sure to request free trials to test different trading platforms. Brokers usually also provide technical and fundamental commentaries, economic calendars and other research.
Bottom line: Find a broker who will give you what you need to succeed!
Wide Range of Leverage Options - Leverage is necessary in forex because the price deviations (the sources of profit) are merely fractions of a cent. Leverage, expressed as a ratio between total capital available to actual capital, is the amount of money a broker will lend you for trading. For example, a ratio of 100:1 means your broker would lend you $100 for every $1 of actual capital. Many brokerages offer as much as 250:1. Remember, lower leverage means lower risk of a margin call, but also lower bang for your buck (and vice-versa).
Bottom line: If you have limited capital, make sure your broker offers high leverage. If capital is not a problem, any broker with a wide variety of leverage options should do. A variety of options lets you vary the amount of risk you are willing to take. For example, less leverage (and therefore less risk) may be preferable for highly volatile (exotic) currency pairs.
Account Types - Many brokers offer two or more types of accounts. The smallest account is known as a mini account and requires you to trade with a minimum of, say, $250, offering a high amount of leverage (which you need in order to make money with so little initial capital). The standard account lets you trade at a variety of different leverages, but it requires a minimum initial capital of $2,000. Finally, premium accounts, which often require significant amounts of capital, let you use different amounts of leverage and often offer additional tools and services.
Bottom line: Make sure the broker you choose has the right leverage, tools, and services relative to your amount of capital.
Things To Avoid
Sniping or Hunting - Sniping and hunting - or prematurely buying or selling near preset points - are shady acts committed by brokers to increase profits. Obviously, no broker admits to committing these acts, but a notion that a broker has practiced sniping or hunting is commonly believed to be true. Unfortunately, the only way to determine which brokers do this and which brokers don't is to talk to fellow traders. There is no blacklist or organization that reports such activity.
Bottom line: Talk to others in person or visit online discussion forums to find out who is an honest broker.
Strict Margin Rules - When you are trading with borrowed money, your broker has a say in how much risk you take. As such, your broker can buy or sell at its discretion, which can be a bad thing for you. Let's say you have a margin account, and your position takes a dive before rebounding to all-time highs. Well, even if you have enough cash to cover, some brokers will liquidate your position on a margin call at that low. This action on their part can cost you dearly.
Bottom line: Again, talk to others in person or visit online discussion forums to find out who the honest brokers are.
Signing up for a forex account is much the same as getting an equity account. The only major difference is that, for forex accounts, you are required to sign a margin agreement. This agreement states that you are trading with borrowed money, and, as such, the brokerage has the right to interfere with your trades to protect its interests. Once you sign up, simply fund your account, and you'll be ready to trade!
Define a Basic Forex Strategy
Technical analysis and fundamental analysis are the two basic genres of strategy in the forex market - just like in the equity markets. But technical analysis is by far the most common strategy used by individual forex traders. Here is a brief overview of both forms of analysis and how they apply to forex:
Fundamental Analysis
If you think it's difficult to value one company, try valuing a whole country! Fundamental analysis in the forex market is often very complex, and it's usually used only to predict long-term trends; however, some traders do trade short term strictly on news releases. There are many different fundamental indicators of currency values released at many different times. Here are a few:
Non-farm Payrolls
Purchasing Managers Index (PMI)
Consumer Price Index (CPI)
Retail Sales
Durable Goods
Now, these reports are not the only fundamental factors to watch. There are also several meetings from which come quotes and commentary that can affect markets just as much as any report. These meetings are often called to discuss interest rates, inflation, and other issues that affect currency valuations. Even changes in wording when addressing certain issues - the Federal Reserve chairman's comments on interest rates, for example - can cause market volatility. Two important meetings to watch are the Federal Open Market Committee and Humphrey Hawkins Hearings.
Simply reading the reports and examining the commentary can help forex fundamental analysts gain a better understanding of long-term market trends and allow short-term traders to profit from extraordinary happenings. If you choose to follow a fundamental strategy, be sure to keep an economic calendar handy at all times so you know when these reports are released. Your broker may also provide real-time access to such information.
Technical Analysis
Like their counterparts in the equity markets, technical analysts of the forex analyze price trends. The only key difference between technical analysis in forex and technical analysis in equities is the time frame: forex markets are open 24 hours a day. As a result, some forms of technical analysis that factor in time must be modified to work with the 24-hour forex market. These are some of the most common forms of technical analysis used in forex:
The Elliott Waves
Fibonacci studies
Parabolic SAR
Pivot points
Many technical analysts combine technical studies to make more accurate predictions. (The most common is combining the Fibonacci studies with Elliott Waves.) Others create trading systems to repeatedly locate similar buying and selling conditions.
Finding Your Strategy
Most successful traders develop a strategy and perfect it over time. Some people focus on one particular study or calculation, while others use broad spectrum analysis to determine their trades. Most experts suggest trying a combination of both fundamental and technical analysis, with which you can make long-term projections and also determine entry and exit points. But in the end, it is the individual trader who needs to decide what works best for him or her (most often through trial and error).
Things to Remember
Open a demo account and paper trade until you can make a consistent profit - Many people jump into the forex market and quickly lose a lot of money (because of leverage). It is important to take your time and learn to trade properly before committing capital. The best way to learn is by doing!
Trade without emotion - Don't keep "mental" stop-loss points if you don't have the ability to execute them on time. Always set your stop-loss and take-profit points to execute automatically, and don't change them unless absolutely necessary. Make your decisions and stick to them!
The trend is your friend – If you go against the trend, you had better have a good reason. Because the forex market tends to trend more than move sideways, you have a higher chance of success in trading with the trend.
Conclusion
The forex market is the largest market in the world, and individuals are becoming increasingly interested in it. But before you begin trading it, be sure your broker meets certain criteria, and take the time to find a trading strategy that works for you. Remember, the best way to learn to trade forex is to open up a demo account and try it out.
Here are some useful resources:
Economic calendar: http://mam.econoday.com/index.html
FOREX brokers: http://www.fxstreet.com/nou/brokers/senseframestaula.asp
FOREX forum: http://moneytec.com/
FOREX news: http://forexnews.com/
by Justin Kuepper, (Contact Author | Biography)
Justin Kuepper has many years of experience in the market as an active trader and a personal retirement accounts manager. He spent a few years independently building and managing financial portals before obtaining his current position with Accelerized New Media, owner of SECFilings.com, ExecutiveDisclosure.com and other popular financial portals. Kuepper continues to write on a freelance basis, covering both finance and technology topics.
Sponsored Links
MARKETPLACE
TRADING CENTER
Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
Copyright © 2009 Investopedia ULC. All Rights Reserved | Terms of Use | Privacy Policy | Advertise on Investopedia
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by Justin Kuepper,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
The forex (FX) market has many similarities to the equity markets; however, there are some key differences. This article will show you those differences and help you get started in forex trading.
Choosing a Broker
There are many forex brokers to choose from, just as in any other market. Here are some things to look for:
Low Spreads - The spread, calculated in "pips", is the difference between the price at which a currency can be purchased and the price at which it can be sold at any given point in time. Forex brokers don't charge a commission, so this difference is how they make money. In comparing brokers, you will find that the difference in spreads in forex is as great as the difference in commissions in the stock arena.
Bottom line: Lower spreads save you money!
Quality Institution - Unlike equity brokers, forex brokers are usually tied to large banks or lending institutions because of the large amounts of capital required (leverage they need to provide). Also, forex brokers should be registered with the Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). You can find this and other financial information and statistics about a forex brokerage on its website or on the website of its parent company.
Bottom line: Make sure your broker is backed by a reliable institution!
Extensive Tools and Research - Forex brokers offer many different trading platforms for their clients - just like brokers in other markets. These trading platforms often feature real-time charts, technical analysis tools, real-time news and data, and even support for trading systems. Before committing to any broker, be sure to request free trials to test different trading platforms. Brokers usually also provide technical and fundamental commentaries, economic calendars and other research.
Bottom line: Find a broker who will give you what you need to succeed!
Wide Range of Leverage Options - Leverage is necessary in forex because the price deviations (the sources of profit) are merely fractions of a cent. Leverage, expressed as a ratio between total capital available to actual capital, is the amount of money a broker will lend you for trading. For example, a ratio of 100:1 means your broker would lend you $100 for every $1 of actual capital. Many brokerages offer as much as 250:1. Remember, lower leverage means lower risk of a margin call, but also lower bang for your buck (and vice-versa).
Bottom line: If you have limited capital, make sure your broker offers high leverage. If capital is not a problem, any broker with a wide variety of leverage options should do. A variety of options lets you vary the amount of risk you are willing to take. For example, less leverage (and therefore less risk) may be preferable for highly volatile (exotic) currency pairs.
Account Types - Many brokers offer two or more types of accounts. The smallest account is known as a mini account and requires you to trade with a minimum of, say, $250, offering a high amount of leverage (which you need in order to make money with so little initial capital). The standard account lets you trade at a variety of different leverages, but it requires a minimum initial capital of $2,000. Finally, premium accounts, which often require significant amounts of capital, let you use different amounts of leverage and often offer additional tools and services.
Bottom line: Make sure the broker you choose has the right leverage, tools, and services relative to your amount of capital.
Things To Avoid
Sniping or Hunting - Sniping and hunting - or prematurely buying or selling near preset points - are shady acts committed by brokers to increase profits. Obviously, no broker admits to committing these acts, but a notion that a broker has practiced sniping or hunting is commonly believed to be true. Unfortunately, the only way to determine which brokers do this and which brokers don't is to talk to fellow traders. There is no blacklist or organization that reports such activity.
Bottom line: Talk to others in person or visit online discussion forums to find out who is an honest broker.
Strict Margin Rules - When you are trading with borrowed money, your broker has a say in how much risk you take. As such, your broker can buy or sell at its discretion, which can be a bad thing for you. Let's say you have a margin account, and your position takes a dive before rebounding to all-time highs. Well, even if you have enough cash to cover, some brokers will liquidate your position on a margin call at that low. This action on their part can cost you dearly.
Bottom line: Again, talk to others in person or visit online discussion forums to find out who the honest brokers are.
Signing up for a forex account is much the same as getting an equity account. The only major difference is that, for forex accounts, you are required to sign a margin agreement. This agreement states that you are trading with borrowed money, and, as such, the brokerage has the right to interfere with your trades to protect its interests. Once you sign up, simply fund your account, and you'll be ready to trade!
Define a Basic Forex Strategy
Technical analysis and fundamental analysis are the two basic genres of strategy in the forex market - just like in the equity markets. But technical analysis is by far the most common strategy used by individual forex traders. Here is a brief overview of both forms of analysis and how they apply to forex:
Fundamental Analysis
If you think it's difficult to value one company, try valuing a whole country! Fundamental analysis in the forex market is often very complex, and it's usually used only to predict long-term trends; however, some traders do trade short term strictly on news releases. There are many different fundamental indicators of currency values released at many different times. Here are a few:
Non-farm Payrolls
Purchasing Managers Index (PMI)
Consumer Price Index (CPI)
Retail Sales
Durable Goods
Now, these reports are not the only fundamental factors to watch. There are also several meetings from which come quotes and commentary that can affect markets just as much as any report. These meetings are often called to discuss interest rates, inflation, and other issues that affect currency valuations. Even changes in wording when addressing certain issues - the Federal Reserve chairman's comments on interest rates, for example - can cause market volatility. Two important meetings to watch are the Federal Open Market Committee and Humphrey Hawkins Hearings.
Simply reading the reports and examining the commentary can help forex fundamental analysts gain a better understanding of long-term market trends and allow short-term traders to profit from extraordinary happenings. If you choose to follow a fundamental strategy, be sure to keep an economic calendar handy at all times so you know when these reports are released. Your broker may also provide real-time access to such information.
Technical Analysis
Like their counterparts in the equity markets, technical analysts of the forex analyze price trends. The only key difference between technical analysis in forex and technical analysis in equities is the time frame: forex markets are open 24 hours a day. As a result, some forms of technical analysis that factor in time must be modified to work with the 24-hour forex market. These are some of the most common forms of technical analysis used in forex:
The Elliott Waves
Fibonacci studies
Parabolic SAR
Pivot points
Many technical analysts combine technical studies to make more accurate predictions. (The most common is combining the Fibonacci studies with Elliott Waves.) Others create trading systems to repeatedly locate similar buying and selling conditions.
Finding Your Strategy
Most successful traders develop a strategy and perfect it over time. Some people focus on one particular study or calculation, while others use broad spectrum analysis to determine their trades. Most experts suggest trying a combination of both fundamental and technical analysis, with which you can make long-term projections and also determine entry and exit points. But in the end, it is the individual trader who needs to decide what works best for him or her (most often through trial and error).
Things to Remember
Open a demo account and paper trade until you can make a consistent profit - Many people jump into the forex market and quickly lose a lot of money (because of leverage). It is important to take your time and learn to trade properly before committing capital. The best way to learn is by doing!
Trade without emotion - Don't keep "mental" stop-loss points if you don't have the ability to execute them on time. Always set your stop-loss and take-profit points to execute automatically, and don't change them unless absolutely necessary. Make your decisions and stick to them!
The trend is your friend – If you go against the trend, you had better have a good reason. Because the forex market tends to trend more than move sideways, you have a higher chance of success in trading with the trend.
Conclusion
The forex market is the largest market in the world, and individuals are becoming increasingly interested in it. But before you begin trading it, be sure your broker meets certain criteria, and take the time to find a trading strategy that works for you. Remember, the best way to learn to trade forex is to open up a demo account and try it out.
Here are some useful resources:
Economic calendar: http://mam.econoday.com/index.html
FOREX brokers: http://www.fxstreet.com/nou/brokers/senseframestaula.asp
FOREX forum: http://moneytec.com/
FOREX news: http://forexnews.com/
by Justin Kuepper, (Contact Author | Biography)
Justin Kuepper has many years of experience in the market as an active trader and a personal retirement accounts manager. He spent a few years independently building and managing financial portals before obtaining his current position with Accelerized New Media, owner of SECFilings.com, ExecutiveDisclosure.com and other popular financial portals. Kuepper continues to write on a freelance basis, covering both finance and technology topics.
Sponsored Links
MARKETPLACE
TRADING CENTER
Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
Copyright © 2009 Investopedia ULC. All Rights Reserved | Terms of Use | Privacy Policy | Advertise on Investopedia
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www.investopedia.com
Place Forex Orders Properly
Place Forex Orders Properly
by Grace Cheng,See Grace's Forex blog at www.gracecheng.com,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
When you place orders with a forex broker, it is extremely important that you know how to place them appropriately. Orders should be placed according to how you are going to trade - that is, how you intend to enter and exit the market. Improper order placement can skew your entry and exit points. In this article, we'll cover some of the most common forex order types. (For the latest news on currencies, check out Currency Market News at Forbes.com.)
Types of Orders:
Market Order
This is the most common type of order. A market order is used when you want to execute an order immediately at the market price, which is either the displayed bid or ask price on your screen. You may use the market order to enter a new position (buy or sell) or to exit an existing position (buy or sell). (For more insight, see The Basics Of Order Entry and Understanding Order Execution.)
Stop Order
A stop order is an order that becomes a market order only once a specified price is reached. It can be used to enter a new position or to exit an existing one. A buy-stop order is an instruction to buy a currency pair at the market price once the market reaches your specified price or higher, which is higher than the current market price. A sell-stop order is an instruction to sell the currency pair at the market price once the market reaches your specified price or lower, which is lower than the current market price.
Stop orders are commonly used to enter a market when you trade breakouts.
For example, suppose that USD/CHF is rallying toward a resistance level and, based on your analysis, you think that if it breaks above that resistance level, it will continue to advance higher. To trade this opinion, you can place a stop-buy order a few pips above the resistance level so that you can trade the potential upside breakout. If the price later reaches or surpasses your specified price, this will open your long position.
An entry stop order can also be used if you want to trade a downside breakout. Place a stop-sell order a few pips below the support level so that when the price reaches your specified price or goes below it, your short position will be opened.
Stop orders are used to limit your losses.
Everyone has losses from time to time, but what really affects the bottom line is the size of your losses. Before you even enter a trade, you should already have an idea of where you are going to exit your position should the market turn against it. One of the most effective ways of limiting your losses is through a pre-determined stop order, which is commonly referred to as a stop-loss.
If you have a long position on, say the USD/CHF, you will want to the pair to rise in value. In order to avoid the possibility of chalking up uncontrolled losses, you can place a stop-sell order at a certain price so that your position will automatically be closed out when that price is reached.
A short position will have a stop-buy order instead.
Stop orders can be used to protect profits.
Once your trade becomes profitable, you may shift your stop-loss order in the profitable direction so as to protect some of your profit. For a long position that has become very profitable, you may move your stop-sell order from the loss to the profit zone to safeguard against the chance of realizing a loss in case your trade does not reach your specified profit objective, and the market turns against your trade. Similarly, for a short position that has become very profitable, you may move your stop-buy order from loss to the profit zone in order to protect your gain.
(To read more about setting stops, see Stop Hunting With The Big Players.)
Limit Order
A limit order is placed when you are only willing to enter a new position or to exit a current position at a specific price or better. The order will only be filled if the market trades at that price or better. A limit-buy order is an instruction to buy the currency pair at the market price once the market reaches your specified price or lower, and is lower than the current market price. A limit-sell order is an instruction to sell the currency pair at the market price once the market reaches your specified price or higher, and it is higher than the current market price.
Limit orders are commonly used to enter a market when you fade breakouts.
You fade a breakout when you don't expect the currency price to break successfully past a resistance or a support level. In other words, you expect that the currency price will bounce off the resistance to go lower, or bounce off the support to go higher.
For example, suppose that based on your analysis of the market, you think that USD/CHF's current rally move is unlikely to break past a resistance successfully. Therefore, you think that it would be a good opportunity to short when USD/CHF rallies up to near that resistance. You can then place a limit-sell order a few pips below that resistance level so that your short order will be filled when the market moves up to that specified price or higher.
Besides using the limit order to go short near a resistance, you can also use this order to go long near a support level. For instance, if you think that there is a high probability that USD/CHF's current decline will pause and reverse near a particular support level, you may want to take the opportunity to long when USD/CHF declines to near that support. In this case, you can place a limit-buy order a few pips above that support level so that your long order will be filled when the market moves down to that specified price or lower.
Limit orders are used to set your profit objective.
Before placing your trade, you should already have an idea of where you want to take profits should the trade go your way. A limit order allows you to exit the market at your pre-set profit objective. If you long a currency pair, you will use the limit-sell order to place your profit objective. If you go short, the limit-buy order should be used to place your profit objective. Note that these orders will only accept prices in the profitable zone.
Execute the Correct Orders
Having a firm understanding of the different types of orders will enable you to use the right tools to achieve your intentions - how you want to enter the market (trade or fade), and how you are going to exit the market (profit and loss). While there may be other types of orders, market, stop and limit orders are the most common of them all. Be comfortable using them because improper execution of orders can cost you money.
To read more, see The Stop-Loss Order: Make Sure Your Use It, A Logical Method Of Stop Placement and Trailing-Stop Techniques.
by Grace Cheng (Contact Author | Biography)
Grace Cheng is a forex trader, creator of the PowerFX Course and author of "7 Winning Strategies for Trading Forex" (2007, Harriman House). This revealing book explains how traders can use various market conditions to their advantage by tailoring a strategy to suit each one. The book is a perfect complement to the PowerFX Course. The PowerFX Course, designed for both new and current traders, teaches tools and trading approaches that combine technicals, fundamentals and the psychology of trading forex. It also includes Grace's proprietary tips and tricks. Grace's works have been published in The Trader's Journal, Technical Analysis of Stocks & Commodities, Smart Investor and other leading trading/investment publications.
Visit her popular forex blog at www.GraceCheng.com.
Sponsored Links
MARKETPLACE
TRADING CENTER
Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
Copyright © 2009 Investopedia ULC. All Rights Reserved | Terms of Use | Privacy Policy | Advertise on Investopedia
Investopedia Partners: AOL Money & Finance
www.investopedia.com
by Grace Cheng,See Grace's Forex blog at www.gracecheng.com,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
When you place orders with a forex broker, it is extremely important that you know how to place them appropriately. Orders should be placed according to how you are going to trade - that is, how you intend to enter and exit the market. Improper order placement can skew your entry and exit points. In this article, we'll cover some of the most common forex order types. (For the latest news on currencies, check out Currency Market News at Forbes.com.)
Types of Orders:
Market Order
This is the most common type of order. A market order is used when you want to execute an order immediately at the market price, which is either the displayed bid or ask price on your screen. You may use the market order to enter a new position (buy or sell) or to exit an existing position (buy or sell). (For more insight, see The Basics Of Order Entry and Understanding Order Execution.)
Stop Order
A stop order is an order that becomes a market order only once a specified price is reached. It can be used to enter a new position or to exit an existing one. A buy-stop order is an instruction to buy a currency pair at the market price once the market reaches your specified price or higher, which is higher than the current market price. A sell-stop order is an instruction to sell the currency pair at the market price once the market reaches your specified price or lower, which is lower than the current market price.
Stop orders are commonly used to enter a market when you trade breakouts.
For example, suppose that USD/CHF is rallying toward a resistance level and, based on your analysis, you think that if it breaks above that resistance level, it will continue to advance higher. To trade this opinion, you can place a stop-buy order a few pips above the resistance level so that you can trade the potential upside breakout. If the price later reaches or surpasses your specified price, this will open your long position.
An entry stop order can also be used if you want to trade a downside breakout. Place a stop-sell order a few pips below the support level so that when the price reaches your specified price or goes below it, your short position will be opened.
Stop orders are used to limit your losses.
Everyone has losses from time to time, but what really affects the bottom line is the size of your losses. Before you even enter a trade, you should already have an idea of where you are going to exit your position should the market turn against it. One of the most effective ways of limiting your losses is through a pre-determined stop order, which is commonly referred to as a stop-loss.
If you have a long position on, say the USD/CHF, you will want to the pair to rise in value. In order to avoid the possibility of chalking up uncontrolled losses, you can place a stop-sell order at a certain price so that your position will automatically be closed out when that price is reached.
A short position will have a stop-buy order instead.
Stop orders can be used to protect profits.
Once your trade becomes profitable, you may shift your stop-loss order in the profitable direction so as to protect some of your profit. For a long position that has become very profitable, you may move your stop-sell order from the loss to the profit zone to safeguard against the chance of realizing a loss in case your trade does not reach your specified profit objective, and the market turns against your trade. Similarly, for a short position that has become very profitable, you may move your stop-buy order from loss to the profit zone in order to protect your gain.
(To read more about setting stops, see Stop Hunting With The Big Players.)
Limit Order
A limit order is placed when you are only willing to enter a new position or to exit a current position at a specific price or better. The order will only be filled if the market trades at that price or better. A limit-buy order is an instruction to buy the currency pair at the market price once the market reaches your specified price or lower, and is lower than the current market price. A limit-sell order is an instruction to sell the currency pair at the market price once the market reaches your specified price or higher, and it is higher than the current market price.
Limit orders are commonly used to enter a market when you fade breakouts.
You fade a breakout when you don't expect the currency price to break successfully past a resistance or a support level. In other words, you expect that the currency price will bounce off the resistance to go lower, or bounce off the support to go higher.
For example, suppose that based on your analysis of the market, you think that USD/CHF's current rally move is unlikely to break past a resistance successfully. Therefore, you think that it would be a good opportunity to short when USD/CHF rallies up to near that resistance. You can then place a limit-sell order a few pips below that resistance level so that your short order will be filled when the market moves up to that specified price or higher.
Besides using the limit order to go short near a resistance, you can also use this order to go long near a support level. For instance, if you think that there is a high probability that USD/CHF's current decline will pause and reverse near a particular support level, you may want to take the opportunity to long when USD/CHF declines to near that support. In this case, you can place a limit-buy order a few pips above that support level so that your long order will be filled when the market moves down to that specified price or lower.
Limit orders are used to set your profit objective.
Before placing your trade, you should already have an idea of where you want to take profits should the trade go your way. A limit order allows you to exit the market at your pre-set profit objective. If you long a currency pair, you will use the limit-sell order to place your profit objective. If you go short, the limit-buy order should be used to place your profit objective. Note that these orders will only accept prices in the profitable zone.
Execute the Correct Orders
Having a firm understanding of the different types of orders will enable you to use the right tools to achieve your intentions - how you want to enter the market (trade or fade), and how you are going to exit the market (profit and loss). While there may be other types of orders, market, stop and limit orders are the most common of them all. Be comfortable using them because improper execution of orders can cost you money.
To read more, see The Stop-Loss Order: Make Sure Your Use It, A Logical Method Of Stop Placement and Trailing-Stop Techniques.
by Grace Cheng (Contact Author | Biography)
Grace Cheng is a forex trader, creator of the PowerFX Course and author of "7 Winning Strategies for Trading Forex" (2007, Harriman House). This revealing book explains how traders can use various market conditions to their advantage by tailoring a strategy to suit each one. The book is a perfect complement to the PowerFX Course. The PowerFX Course, designed for both new and current traders, teaches tools and trading approaches that combine technicals, fundamentals and the psychology of trading forex. It also includes Grace's proprietary tips and tricks. Grace's works have been published in The Trader's Journal, Technical Analysis of Stocks & Commodities, Smart Investor and other leading trading/investment publications.
Visit her popular forex blog at www.GraceCheng.com.
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Devising A Medium-Term Forex Trading System
Devising A Medium-Term Forex Trading System
by Justin Kuepper,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
Retail traders just starting out in the forex market are often unprepared for what lies ahead and, as such, end up undergoing the same life cycle: first they dive in head first - usually losing their first account - and then they either give up, or they take a step back and do a little more research and open a demo account to practice. Those who do this will often eventually open another live account, and experience a little more success - breaking even or turning a profit. To help avoid the losses from hastily diving into forex trading, this article will introduce you to a framework for a medium-term forex trading system to get you started on the right foot, help you save money and ultimately become a profitable retail forex trader.
Why Medium Term?
So, why are we focusing on medium-term forex trading? Why not long-term or short-term strategies? To answer that question, let’s take a look at the following comparison table:
Type of Trader Definition Good Points Bad Points
Short-Term (Scalper) A trader who looks to open and close a trade within minutes, often taking advantage of small price movements with a large amount of leverage. Quick realization of profits or losses due to the rapid-fire nature of this type of trading. Large capital and/or risk requirements due to the large amount of leverage needed to profit from such small movements.
Medium-Term A trader typically looking to hold positions for one or more days, often taking advantage of opportunistic technical situations. Lowest capital requirements of the three because leverage is necessary only to boost profits. Fewer opportunities because these types of trades are more difficult to find and execute.
Long-Term A trader looking to hold positions for months or years, often basing decisions on long-term fundamental factors. More reliable long-run profits because this depends on reliable fundamental factors. Large capital requirements to cover volatile movements against any open position.
Now, you will notice that both short-term and long-term traders require a large amount of capital - the first type needs it to generate enough leverage, and the other to cover volatility. Although these two types of traders exist in the marketplace, they are often positions held by high net-worth individuals or larger funds. For these reasons, retail traders are most likely to succeed using a medium-term strategy.
The Basic Framework
The framework of the strategy covered in this article will focus on one central concept: trading with the odds. To do this, we will look at a variety of techniques in multiple time frames to determine whether a given trade is worth taking. Keep in mind, however, that this is not a mechanical/automatic trading system; rather, it is a system by which you will receive technical input and make a decision based upon it. The key is finding situations where all (or most) of the technical signals point in the same direction. These high-probability trading situations will, in turn, generally be profitable.
Chart Creation and Markup
Selecting a Trading Program
We will be using a free program called MetaTrader to illustrate this trading strategy; however, many other similar programs can also be used that will yield the same results. There are two basic things the trading program must have:
the ability to display three different time frames simultaneously
the ability to plot technical indicators, such as moving averages (EMA and SMA), relative strength index (RSI), stochastics and moving average convergence divergence (MACD)
Setting up the Indicators
Now we will look at how to set up this strategy in your chosen trading program. We will also define a collection of technical indicators with rules associated with them. These technical indicators are used as a filter for your trades.
If you choose to use more indicators than shown here, you will create a more reliable system that will generate fewer trading opportunities. Conversely, if you choose to use fewer indicators than shown here, you will create a less-reliable system that will generate more trading opportunities. Here are the settings that we will use for this article:
Minute-by-minute candlestick chart
RSI (15)
stochastics (15,3,3)
MACD (Default)
Hourly candlestick chart
EMA (100)
EMA (10)
EMA (5)
MACD (Default)
Daily candlestick chart
SMA (100)
Adding in Other Studies
Now you will want to incorporate the use of some of the more subjective studies, such as the following:
significant trendlines that you see in any of the time frames
Fibonacci retracements, arcs or fans that you see in the hourly or daily charts
support or resistance that you see in any of the time frames
pivot points calculated from the previous day to the hourly and minutely charts
chart patterns that you see in any of the time frames
In the end, your screen should look something like this:
Finding Entry and Exit Points
The key to finding entry points is to look for times in which all of the indicators point in the same direction. Moreover, the signals of each time frame should support the timing and direction of the trade. There are a few particular instances that you should look for:
Bullish
bullish candlestick engulfings or other formations
trendline/channel breakouts upwards
positive divergences in RSI, stochastics and MACD
moving average crossovers (shorter crossing over longer)
strong, close support and weak, distant resistance
Bearish
bearish candlestick engulfings or other formations
trendline/channel breakouts downwards
negative divergences in RSI, stochastics and MACD
moving average crossovers (shorter crossing under longer)
strong, close resistance and weak, distant support
It is a good idea to place exit points (both stop losses and take profits) before even placing the trade. These points should be placed at key levels, and modified only if there is a change in the premise for your trade (oftentimes as a result of fundamentals coming into play). You can place these exit points at key levels, including:
just before areas of strong support or resistance
at key Fibonacci levels (retracements, fans or arcs)
just inside of key trendlines or channels
Let's take a look at a couple of examples of individual charts using a combination of indicators to locate specific entry and exit points. Again, make sure any trades that you intend to place are supported in all three time frames.
Here we can see that a multitude of indicators are pointing in the same direction. There is a bearish head-and-shoulders pattern, an MACD, Fibonacci resistance and bearish EMA crossover (five- and 10-day). We also see that a Fibonacci support provides a nice exit point. This trade is good for 50 pips, and takes place over less than two days.
Here we can see many indicators that point to a long position. We have a bullish engulfing, a Fibonacci support and a 100-day SMA support. Again, we see a Fibonacci resistance level that provides an excellent exit point. This trade is good for almost 200 pips in only a few weeks. Note that we could break this trade into smaller trades on the hourly chart.
Money Management and Risk
Money management is key to success in any marketplace but particularly for the forex market, which is one of the most volatile markets to trade. Many times fundamental factors can send currency rates swinging in one direction only to whipsaw into another in mere minutes. So, it is important to limit your downside by always utilizing stop-loss points and trading only when good opportunities arise. Here are a few specific ways in which you can limit risk:
Increase the amount of indicators that you are using. This will result in a harsher filter through which your trades are screened. Note that this will result in fewer opportunities.
Place stop-loss points at the closest resistance levels. Note that this may result in forfeited gains.
Use trailing stop losses to lock in profits and limit losses when you trade turns favorable. Note, however, that this may also result in forfeited gains.
Conclusion
Anyone can make money in the forex market, but it requires patience and a well-defined strategy to follow. This article gave you a framework from which you can build your own unique, profitable trading system using indicators with which you feel comfortable.
by Justin Kuepper, (Contact Author | Biography)
Justin Kuepper has many years of experience in the market as an active trader and a personal retirement accounts manager. He spent a few years independently building and managing financial portals before obtaining his current position with Accelerized New Media, owner of SECFilings.com, ExecutiveDisclosure.com and other popular financial portals. Kuepper continues to write on a freelance basis, covering both finance and technology topics.
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Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
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by Justin Kuepper,
FREE Forex Report - The 5 Things That Move The Currency Market (Contact Author | Biography)
Email ArticlePrint Comments
Retail traders just starting out in the forex market are often unprepared for what lies ahead and, as such, end up undergoing the same life cycle: first they dive in head first - usually losing their first account - and then they either give up, or they take a step back and do a little more research and open a demo account to practice. Those who do this will often eventually open another live account, and experience a little more success - breaking even or turning a profit. To help avoid the losses from hastily diving into forex trading, this article will introduce you to a framework for a medium-term forex trading system to get you started on the right foot, help you save money and ultimately become a profitable retail forex trader.
Why Medium Term?
So, why are we focusing on medium-term forex trading? Why not long-term or short-term strategies? To answer that question, let’s take a look at the following comparison table:
Type of Trader Definition Good Points Bad Points
Short-Term (Scalper) A trader who looks to open and close a trade within minutes, often taking advantage of small price movements with a large amount of leverage. Quick realization of profits or losses due to the rapid-fire nature of this type of trading. Large capital and/or risk requirements due to the large amount of leverage needed to profit from such small movements.
Medium-Term A trader typically looking to hold positions for one or more days, often taking advantage of opportunistic technical situations. Lowest capital requirements of the three because leverage is necessary only to boost profits. Fewer opportunities because these types of trades are more difficult to find and execute.
Long-Term A trader looking to hold positions for months or years, often basing decisions on long-term fundamental factors. More reliable long-run profits because this depends on reliable fundamental factors. Large capital requirements to cover volatile movements against any open position.
Now, you will notice that both short-term and long-term traders require a large amount of capital - the first type needs it to generate enough leverage, and the other to cover volatility. Although these two types of traders exist in the marketplace, they are often positions held by high net-worth individuals or larger funds. For these reasons, retail traders are most likely to succeed using a medium-term strategy.
The Basic Framework
The framework of the strategy covered in this article will focus on one central concept: trading with the odds. To do this, we will look at a variety of techniques in multiple time frames to determine whether a given trade is worth taking. Keep in mind, however, that this is not a mechanical/automatic trading system; rather, it is a system by which you will receive technical input and make a decision based upon it. The key is finding situations where all (or most) of the technical signals point in the same direction. These high-probability trading situations will, in turn, generally be profitable.
Chart Creation and Markup
Selecting a Trading Program
We will be using a free program called MetaTrader to illustrate this trading strategy; however, many other similar programs can also be used that will yield the same results. There are two basic things the trading program must have:
the ability to display three different time frames simultaneously
the ability to plot technical indicators, such as moving averages (EMA and SMA), relative strength index (RSI), stochastics and moving average convergence divergence (MACD)
Setting up the Indicators
Now we will look at how to set up this strategy in your chosen trading program. We will also define a collection of technical indicators with rules associated with them. These technical indicators are used as a filter for your trades.
If you choose to use more indicators than shown here, you will create a more reliable system that will generate fewer trading opportunities. Conversely, if you choose to use fewer indicators than shown here, you will create a less-reliable system that will generate more trading opportunities. Here are the settings that we will use for this article:
Minute-by-minute candlestick chart
RSI (15)
stochastics (15,3,3)
MACD (Default)
Hourly candlestick chart
EMA (100)
EMA (10)
EMA (5)
MACD (Default)
Daily candlestick chart
SMA (100)
Adding in Other Studies
Now you will want to incorporate the use of some of the more subjective studies, such as the following:
significant trendlines that you see in any of the time frames
Fibonacci retracements, arcs or fans that you see in the hourly or daily charts
support or resistance that you see in any of the time frames
pivot points calculated from the previous day to the hourly and minutely charts
chart patterns that you see in any of the time frames
In the end, your screen should look something like this:
Finding Entry and Exit Points
The key to finding entry points is to look for times in which all of the indicators point in the same direction. Moreover, the signals of each time frame should support the timing and direction of the trade. There are a few particular instances that you should look for:
Bullish
bullish candlestick engulfings or other formations
trendline/channel breakouts upwards
positive divergences in RSI, stochastics and MACD
moving average crossovers (shorter crossing over longer)
strong, close support and weak, distant resistance
Bearish
bearish candlestick engulfings or other formations
trendline/channel breakouts downwards
negative divergences in RSI, stochastics and MACD
moving average crossovers (shorter crossing under longer)
strong, close resistance and weak, distant support
It is a good idea to place exit points (both stop losses and take profits) before even placing the trade. These points should be placed at key levels, and modified only if there is a change in the premise for your trade (oftentimes as a result of fundamentals coming into play). You can place these exit points at key levels, including:
just before areas of strong support or resistance
at key Fibonacci levels (retracements, fans or arcs)
just inside of key trendlines or channels
Let's take a look at a couple of examples of individual charts using a combination of indicators to locate specific entry and exit points. Again, make sure any trades that you intend to place are supported in all three time frames.
Here we can see that a multitude of indicators are pointing in the same direction. There is a bearish head-and-shoulders pattern, an MACD, Fibonacci resistance and bearish EMA crossover (five- and 10-day). We also see that a Fibonacci support provides a nice exit point. This trade is good for 50 pips, and takes place over less than two days.
Here we can see many indicators that point to a long position. We have a bullish engulfing, a Fibonacci support and a 100-day SMA support. Again, we see a Fibonacci resistance level that provides an excellent exit point. This trade is good for almost 200 pips in only a few weeks. Note that we could break this trade into smaller trades on the hourly chart.
Money Management and Risk
Money management is key to success in any marketplace but particularly for the forex market, which is one of the most volatile markets to trade. Many times fundamental factors can send currency rates swinging in one direction only to whipsaw into another in mere minutes. So, it is important to limit your downside by always utilizing stop-loss points and trading only when good opportunities arise. Here are a few specific ways in which you can limit risk:
Increase the amount of indicators that you are using. This will result in a harsher filter through which your trades are screened. Note that this will result in fewer opportunities.
Place stop-loss points at the closest resistance levels. Note that this may result in forfeited gains.
Use trailing stop losses to lock in profits and limit losses when you trade turns favorable. Note, however, that this may also result in forfeited gains.
Conclusion
Anyone can make money in the forex market, but it requires patience and a well-defined strategy to follow. This article gave you a framework from which you can build your own unique, profitable trading system using indicators with which you feel comfortable.
by Justin Kuepper, (Contact Author | Biography)
Justin Kuepper has many years of experience in the market as an active trader and a personal retirement accounts manager. He spent a few years independently building and managing financial portals before obtaining his current position with Accelerized New Media, owner of SECFilings.com, ExecutiveDisclosure.com and other popular financial portals. Kuepper continues to write on a freelance basis, covering both finance and technology topics.
Buzz up!on Yahoo!
Sponsored Links
MARKETPLACE
TRADING CENTER
Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
Copyright © 2009 Investopedia ULC. All Rights Reserved | Terms of Use | Privacy Policy | Advertise on Investopedia
Investopedia Partners: AOL Money & Finance
www.investopedia.com
Wednesday, March 11, 2009
Uncover Forex Profits With The Turn Trade
Uncover Forex Profits With The Turn Trade
by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Most traders have an extremely hard time trading with the trend. This observation may seem counterintuitive, as the majority of traders claim that trend trading is their preferred approach to the market. However, after analyzing the records of thousands of retail traders, we are convinced the opposite is true. While everyone pays lip service to the idiom of "The trend is your friend", in reality, most traders love to pick tops and bottoms and constantly fade rather than trade with the trend. In this article, we'll cover the turn trade, a setup which allows traders to have their cake and eat it too: buying low and selling high while still trading with the trend. (For related reading, see Inside Day Bollinger Band Turn Trade.)
Turn Trade Basics
The turn trade recognizes the desire of most traders to find turns in the price action (that is to buy low and sell high), but it does so in the overarching framework of trading with the trend. The setup uses multiple time frames, moving averages and Bollinger band "bands" as its tools of entry. (For background reading, see The Basics Of Bollinger Bands.)
Getting Started
We begin by looking at the daily charts to ascertain whether a pair is in a trend, and used a 20-period daily simple moving average to determine the trend. In technical analysis, there are a number tools that can help us diagnose trend, but none is as simple and effective as the 20-period SMA. It includes a full month's worth of data (20 business days) and, as such, it provides us with a very good idea of an average price. Therefore, if price action is above the "average" price, we assume the pair is in an uptrend and vice versa.
Next, we move to the hourly charts to pinpoint our entries. In the turn to trend setup we will only trade in the direction of the trend by buying highly oversold prices in an uptrend and selling highly overbought prices in a downtrend. How will we determine our overbought and oversold extremes? The answer is by using Bollinger band "bands" to help us gauge the price action. Bollinger bands measure price extremes by calculating the standard deviation of price from its 20-period moving average. In the case of hourly charts, we will use Bollinger bands with three standard deviations (3SD) and Bollinger bands with two standard deviations (2SD) to create a set of Bollinger band channels. When price trades in a trend channel, most of the price action will be contained within the Bollinger band "bands" of 2SD and 1SD.
Why do we use the 3SD and 2SD settings in this particular setup? Because the Bollinger band rule applies to price action on the daily scale. In order to properly trade the hourly charts, which are more short term and therefore more volatile, we need to accommodate to those extremes in order to generate the most accurate signals possible. In fact, a good rule of thumb to remember is that traders should increase their Bollinger band values with every decrease in time frame. So, for example, with five-minute charts, traders may want to use Bollinger bands with setting of 3.5SD or even 4SD to focus on only the most oversold or overbought conditions.
Moving back to our setup, after having established the direction of the trend, we now observe the price action on the hourly charts. If price is in an uptrend on the dailies, we watch the hourlies for a turn back to the trend. If price continues to trade between the 3SD and the 2SD lower Bollinger band "bands", we stay away, as it indicates a strong downward momentum.
The beauty of this setup is that it prevents us from guessing the turn prematurely by forcing us to wait until the price action confirms a swing bottom or a swing top. In our example, if the price trades above the 2SD lower Bollinger band on the closing basis, we enter at market using the prior swing low minus five points as the stop. We set our target for the first unit at half the amount of risk; if it is hit, we move the stop to breakeven for the rest of the position. We then look for the second unit to trade up to the upper Bollinger band and exit the position only if the pair closes out of the 3SD-2SD Bollinger band channel, suggesting that the uptrend move is over.
Rules for the Long Trade
On the daily setup, place a 20-period SMA and make sure that the price is above the moving average on a closing basis.
Take only long trades in the direction of the trend.
Move to the hourly charts and place two sets of Bollinger bands on the chart. The first pair of Bollinger bands should be set to 3SD and the second pair should be set to 2SD.
Once the price breaks through and closes above the lower 3SD-2SD Bollinger band channel on an hourly basis, buy at market.
Set stop at swing low minus five points and calculate your risk (Risk = Entry Price - Stop Price). (Traders who want to give the setup a little more room can use swing low minus 10 points as their stop.)
Set a profit target for the first unit at 50% of risk (i.e., if you are risking 40 points on the trade then place a take-profit limit order 20 points above entry.)
Move the stop to breakeven when the first profit target is hit.
Exit the second unit when the price closes below the upper 3SD-2SD Bollinger band channel or at breakeven, whichever comes first.
Rules for the Short Trade
On the daily setup, place a 20-period SMA and make sure that the price is below the moving average on the closing basis.
Take only short trades in the direction of the trend.
Move to the hourly charts and place two sets of Bollinger bands on the chart. The first pair of Bollinger bands should be set to 3SD and the second pair should be set to 2SD.
Once price breaks through and closes above the upper 3SD-2SD Bollinger band channel on an hourly basis, sell at market.
Set a stop at swing low plus five points and calculate your risk (Risk = Entry Price - Stop Price). (traders who want to give the setup a little more room can use swing high plus 10 points as their stop.)
Set profit target for the first unit at 50% of risk (i.e., if you are risking 40 points on the trade, then place a take-profit limit order 20 points above entry).
Move stop to breakeven when the first profit target is hit.
Exit the second unit when price closes above the lower 3SD-2SD Bollinger band channel or at breakeven, whichever comes first.
The Turn Trade In Action
Now let's look at some examples:
Figure 1: Turn to the Trend, EUR/CHF
Source: FXtrek Intellichart
Taking a look at the EUR/CHF daily chart in Figure 1, we see that since the middle of March 2006, EUR/CHF has traded above its 20-day SMA, indicating that it is in a clear uptrend.
Figure 2: Turn to the Trend, EUR/CHF
Source: FXtrek Intellichart
Turning to the hourlies, we wait until the pair breaks out of the lower Bollinger band 3SD-2SD zone to go long at market at 6pm EST on March 15, 2006, at 1.5635 with a stop at 1.5623, risking only 12 points. (Note that EUR/CHF tends to be a very low volatility currency pair providing us with very small risk setups. Because the risk is so small, we may choose to set our target at 100% of risk rather than the usual 50% of risk.)
Regardless of our choice, we are able to take profits at 3am EST on March 16, 2006, at 1.5651, banking 16 points on the first unit. We then move our stop to breakeven on the rest of the position and target the upper Bollinger band. We wait for the price to pierce the upper Bollinger band, trade within it; only when it falls out of the upper Bollinger 3SD-2SD band channel do we exit the rest of the position at 1pm EST on March 16, 2006, at 1.5692, earning 57 points on the second lot. Not bad for a trade on which we risked only 12 points.
Figure 3: Turn to the Trend, USD/CAD
Source: FXtrek Intellichart
The example of USD/CAD shown in Figure 3 and Figure 4 shows a classic turn to trend setup after it establishes an uptrend on March 7, 2006.
Figure 4: Turn to the Trend, USD/CAD
Source: FXtrek Intellichart
We move from the dailies to the hourly charts and wait until the prices recover above the lower Bollinger band, entering a long at market at 11am EST on March 16, 2006, at 1.1524. We place our stop at 1.1505, which is the swing low minus five pips for a miniscule 19-point risk.
At 10pm EST on March 16, 2006, as price makes a burst upward, we sell half the position at 1.1540 and move our stop to breakeven, locking in 16 points of profit. After the price makes another burst higher, we exit at the first hint of weakness, when the hourly candle closes below the 3SD-2SD Bollinger band zone. This occurs at 11am on March 17, 2006, and we close out the rest of our position at 1.1587, for a 63-point profit on the second half of the trade.
Figure 5: Turn to the Trend, GBP/USD
Source: FXtrek Intellichart
The example in Figure 5 shows a short trade. On February 15, 2006, we look at the daily chart and see that the GBP/USD is trading below its 20-day SMA, which indicates that it is in a clear downtrend.
In Figure 6, we turn our attention to the hourly chart and try to enter a high probability short when the price becomes overbought on a shorter-term time frame. We do this by waiting for the GBP/USD to close below the 3SD-2SD upper Bollinger band channel, at which time we sell at market (1.7440) and place our stop at approximately 1.7500, risking 60 points. As per our rules, we cover half the position at 1pm EST when price approaches the 1.7410 level, which is 30 points, or 50% of our risk.
Next, we move our stop at breakeven and hold the position, targeting the lower 3SD Bollinger band. Notice that the downtrend re-establishes itself with a vengeance and the price declines into our zone. We stay in the trade until the price breaks back out of the lower Bollinger band channel, indicating that downward momentum is waning. At 6am on February 16, 2006, we cover the rest of the trade at 1.7338, for a profit of 102 points.
Figure 6: Turn to the Trend, GBP/USD
Source: FXtrek Intellichart
Figure 7 shows another good example of why we always scale out of our positions. On March 15, 2006 USD/CHF is in a downtrend, but the pair begins to trade back up to the 20-period SMA on the dailies. Because we can never be certain beforehand whether this is a retrace or a real turn in the trend, we adhere to the rules of the setup to control our risk.
Figure 7: Turn to the Trend, USD/CHF
Source: FXtrek Intellichart
Looking on the hourly charts in Figure 8, we see that at 1pm EST on March 21, 2006, the price closes below the upper Bollinger band 3SD-2SD level, and we enter a short at market at 1.3021. Our stop is placed five points above the swing high at 1.3042, for total risk of 21 points.
At 6pm EST on March 21, 2006, the price reaches our first target of 1.3008, and we cover one lot for 12 points of profit or approximately 50% of risk. We simultaneously move our stop to breakeven. At this point, the trade begins to move against us, but our breakeven stop insures that we do not lose any money and, in fact, still bank 12 points of profit on the first half of the position.
Figure 8: Turn to the Trend, USD/CHF
Source: FXtrek Intellichart
When The Setup Fails
Finally, let's take a look at an example of a failed setup in Figure 9. Starting on March 3, 2006, the EUR/GBP breaks above the 20-period SMA and establishes an uptrend on the daily charts.
Figure 9: Turn to the Trend, EUR/GBP
Source: FXtrek Intellichart
Using our turn to trend approach, we wait for the pair to make a swing low in the 3SD-2SD Bollinger band zone and then enter long at .6881 at 10am EST on March 14, 2006. The swing low was created at 7am EST that same day at .6878, so we place our stop at .6873, five points below the swing low, risking a total of eight points. Note that the EUR/GBP pair is a very slow-moving cross with very high pip values. A point in the EUR/GBP is worth approximately 175% of a point in EUR/USD, so an eight-point risk in EUR/GBP would translate into a 14-point risk in EUR/USD.
Figure 10: Turn to the Trend, EUR/GBP
Source: FXtrek Intellichart
Initially, the price makes a small rally but then drops to .6873 at noon EST on March 14, 2006, taking out our stop. This turns out to be the exact low of the move, and many traders may find it incredibly frustrating to be taken out of a trade just before it has a chance to turn around and generate profits. Not us, however. We realize that getting stopped on a bottom tick is just a part of trading and will probably happen more times than we care to remember. Far more important is to appreciate the risk management aspect of the trade, which leaves us only with a slight loss of eight points, thus preserving our capital and allowing us to look for other high probability setups.
To truly appreciate the importance of this dynamic, just imagine the following scenario. Instead of a stop loss, we leave the trade open and instead of turning around, it proceeds to drop even further. Before long, we may be looking at a floating loss in hundreds of points - something that would be inordinately more difficult to make up than our initial small eight-point stop.
Conclusion
Most traders love to pick tops and bottoms, rather than trade with the trend. The turn trade allows you to do both by using multiple time frames, moving averages and Bollinger band "bands" as its tools of entry.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
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by Kathy Lien and Boris Schlossberg (Contact Author | Biography)
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Most traders have an extremely hard time trading with the trend. This observation may seem counterintuitive, as the majority of traders claim that trend trading is their preferred approach to the market. However, after analyzing the records of thousands of retail traders, we are convinced the opposite is true. While everyone pays lip service to the idiom of "The trend is your friend", in reality, most traders love to pick tops and bottoms and constantly fade rather than trade with the trend. In this article, we'll cover the turn trade, a setup which allows traders to have their cake and eat it too: buying low and selling high while still trading with the trend. (For related reading, see Inside Day Bollinger Band Turn Trade.)
Turn Trade Basics
The turn trade recognizes the desire of most traders to find turns in the price action (that is to buy low and sell high), but it does so in the overarching framework of trading with the trend. The setup uses multiple time frames, moving averages and Bollinger band "bands" as its tools of entry. (For background reading, see The Basics Of Bollinger Bands.)
Getting Started
We begin by looking at the daily charts to ascertain whether a pair is in a trend, and used a 20-period daily simple moving average to determine the trend. In technical analysis, there are a number tools that can help us diagnose trend, but none is as simple and effective as the 20-period SMA. It includes a full month's worth of data (20 business days) and, as such, it provides us with a very good idea of an average price. Therefore, if price action is above the "average" price, we assume the pair is in an uptrend and vice versa.
Next, we move to the hourly charts to pinpoint our entries. In the turn to trend setup we will only trade in the direction of the trend by buying highly oversold prices in an uptrend and selling highly overbought prices in a downtrend. How will we determine our overbought and oversold extremes? The answer is by using Bollinger band "bands" to help us gauge the price action. Bollinger bands measure price extremes by calculating the standard deviation of price from its 20-period moving average. In the case of hourly charts, we will use Bollinger bands with three standard deviations (3SD) and Bollinger bands with two standard deviations (2SD) to create a set of Bollinger band channels. When price trades in a trend channel, most of the price action will be contained within the Bollinger band "bands" of 2SD and 1SD.
Why do we use the 3SD and 2SD settings in this particular setup? Because the Bollinger band rule applies to price action on the daily scale. In order to properly trade the hourly charts, which are more short term and therefore more volatile, we need to accommodate to those extremes in order to generate the most accurate signals possible. In fact, a good rule of thumb to remember is that traders should increase their Bollinger band values with every decrease in time frame. So, for example, with five-minute charts, traders may want to use Bollinger bands with setting of 3.5SD or even 4SD to focus on only the most oversold or overbought conditions.
Moving back to our setup, after having established the direction of the trend, we now observe the price action on the hourly charts. If price is in an uptrend on the dailies, we watch the hourlies for a turn back to the trend. If price continues to trade between the 3SD and the 2SD lower Bollinger band "bands", we stay away, as it indicates a strong downward momentum.
The beauty of this setup is that it prevents us from guessing the turn prematurely by forcing us to wait until the price action confirms a swing bottom or a swing top. In our example, if the price trades above the 2SD lower Bollinger band on the closing basis, we enter at market using the prior swing low minus five points as the stop. We set our target for the first unit at half the amount of risk; if it is hit, we move the stop to breakeven for the rest of the position. We then look for the second unit to trade up to the upper Bollinger band and exit the position only if the pair closes out of the 3SD-2SD Bollinger band channel, suggesting that the uptrend move is over.
Rules for the Long Trade
On the daily setup, place a 20-period SMA and make sure that the price is above the moving average on a closing basis.
Take only long trades in the direction of the trend.
Move to the hourly charts and place two sets of Bollinger bands on the chart. The first pair of Bollinger bands should be set to 3SD and the second pair should be set to 2SD.
Once the price breaks through and closes above the lower 3SD-2SD Bollinger band channel on an hourly basis, buy at market.
Set stop at swing low minus five points and calculate your risk (Risk = Entry Price - Stop Price). (Traders who want to give the setup a little more room can use swing low minus 10 points as their stop.)
Set a profit target for the first unit at 50% of risk (i.e., if you are risking 40 points on the trade then place a take-profit limit order 20 points above entry.)
Move the stop to breakeven when the first profit target is hit.
Exit the second unit when the price closes below the upper 3SD-2SD Bollinger band channel or at breakeven, whichever comes first.
Rules for the Short Trade
On the daily setup, place a 20-period SMA and make sure that the price is below the moving average on the closing basis.
Take only short trades in the direction of the trend.
Move to the hourly charts and place two sets of Bollinger bands on the chart. The first pair of Bollinger bands should be set to 3SD and the second pair should be set to 2SD.
Once price breaks through and closes above the upper 3SD-2SD Bollinger band channel on an hourly basis, sell at market.
Set a stop at swing low plus five points and calculate your risk (Risk = Entry Price - Stop Price). (traders who want to give the setup a little more room can use swing high plus 10 points as their stop.)
Set profit target for the first unit at 50% of risk (i.e., if you are risking 40 points on the trade, then place a take-profit limit order 20 points above entry).
Move stop to breakeven when the first profit target is hit.
Exit the second unit when price closes above the lower 3SD-2SD Bollinger band channel or at breakeven, whichever comes first.
The Turn Trade In Action
Now let's look at some examples:
Figure 1: Turn to the Trend, EUR/CHF
Source: FXtrek Intellichart
Taking a look at the EUR/CHF daily chart in Figure 1, we see that since the middle of March 2006, EUR/CHF has traded above its 20-day SMA, indicating that it is in a clear uptrend.
Figure 2: Turn to the Trend, EUR/CHF
Source: FXtrek Intellichart
Turning to the hourlies, we wait until the pair breaks out of the lower Bollinger band 3SD-2SD zone to go long at market at 6pm EST on March 15, 2006, at 1.5635 with a stop at 1.5623, risking only 12 points. (Note that EUR/CHF tends to be a very low volatility currency pair providing us with very small risk setups. Because the risk is so small, we may choose to set our target at 100% of risk rather than the usual 50% of risk.)
Regardless of our choice, we are able to take profits at 3am EST on March 16, 2006, at 1.5651, banking 16 points on the first unit. We then move our stop to breakeven on the rest of the position and target the upper Bollinger band. We wait for the price to pierce the upper Bollinger band, trade within it; only when it falls out of the upper Bollinger 3SD-2SD band channel do we exit the rest of the position at 1pm EST on March 16, 2006, at 1.5692, earning 57 points on the second lot. Not bad for a trade on which we risked only 12 points.
Figure 3: Turn to the Trend, USD/CAD
Source: FXtrek Intellichart
The example of USD/CAD shown in Figure 3 and Figure 4 shows a classic turn to trend setup after it establishes an uptrend on March 7, 2006.
Figure 4: Turn to the Trend, USD/CAD
Source: FXtrek Intellichart
We move from the dailies to the hourly charts and wait until the prices recover above the lower Bollinger band, entering a long at market at 11am EST on March 16, 2006, at 1.1524. We place our stop at 1.1505, which is the swing low minus five pips for a miniscule 19-point risk.
At 10pm EST on March 16, 2006, as price makes a burst upward, we sell half the position at 1.1540 and move our stop to breakeven, locking in 16 points of profit. After the price makes another burst higher, we exit at the first hint of weakness, when the hourly candle closes below the 3SD-2SD Bollinger band zone. This occurs at 11am on March 17, 2006, and we close out the rest of our position at 1.1587, for a 63-point profit on the second half of the trade.
Figure 5: Turn to the Trend, GBP/USD
Source: FXtrek Intellichart
The example in Figure 5 shows a short trade. On February 15, 2006, we look at the daily chart and see that the GBP/USD is trading below its 20-day SMA, which indicates that it is in a clear downtrend.
In Figure 6, we turn our attention to the hourly chart and try to enter a high probability short when the price becomes overbought on a shorter-term time frame. We do this by waiting for the GBP/USD to close below the 3SD-2SD upper Bollinger band channel, at which time we sell at market (1.7440) and place our stop at approximately 1.7500, risking 60 points. As per our rules, we cover half the position at 1pm EST when price approaches the 1.7410 level, which is 30 points, or 50% of our risk.
Next, we move our stop at breakeven and hold the position, targeting the lower 3SD Bollinger band. Notice that the downtrend re-establishes itself with a vengeance and the price declines into our zone. We stay in the trade until the price breaks back out of the lower Bollinger band channel, indicating that downward momentum is waning. At 6am on February 16, 2006, we cover the rest of the trade at 1.7338, for a profit of 102 points.
Figure 6: Turn to the Trend, GBP/USD
Source: FXtrek Intellichart
Figure 7 shows another good example of why we always scale out of our positions. On March 15, 2006 USD/CHF is in a downtrend, but the pair begins to trade back up to the 20-period SMA on the dailies. Because we can never be certain beforehand whether this is a retrace or a real turn in the trend, we adhere to the rules of the setup to control our risk.
Figure 7: Turn to the Trend, USD/CHF
Source: FXtrek Intellichart
Looking on the hourly charts in Figure 8, we see that at 1pm EST on March 21, 2006, the price closes below the upper Bollinger band 3SD-2SD level, and we enter a short at market at 1.3021. Our stop is placed five points above the swing high at 1.3042, for total risk of 21 points.
At 6pm EST on March 21, 2006, the price reaches our first target of 1.3008, and we cover one lot for 12 points of profit or approximately 50% of risk. We simultaneously move our stop to breakeven. At this point, the trade begins to move against us, but our breakeven stop insures that we do not lose any money and, in fact, still bank 12 points of profit on the first half of the position.
Figure 8: Turn to the Trend, USD/CHF
Source: FXtrek Intellichart
When The Setup Fails
Finally, let's take a look at an example of a failed setup in Figure 9. Starting on March 3, 2006, the EUR/GBP breaks above the 20-period SMA and establishes an uptrend on the daily charts.
Figure 9: Turn to the Trend, EUR/GBP
Source: FXtrek Intellichart
Using our turn to trend approach, we wait for the pair to make a swing low in the 3SD-2SD Bollinger band zone and then enter long at .6881 at 10am EST on March 14, 2006. The swing low was created at 7am EST that same day at .6878, so we place our stop at .6873, five points below the swing low, risking a total of eight points. Note that the EUR/GBP pair is a very slow-moving cross with very high pip values. A point in the EUR/GBP is worth approximately 175% of a point in EUR/USD, so an eight-point risk in EUR/GBP would translate into a 14-point risk in EUR/USD.
Figure 10: Turn to the Trend, EUR/GBP
Source: FXtrek Intellichart
Initially, the price makes a small rally but then drops to .6873 at noon EST on March 14, 2006, taking out our stop. This turns out to be the exact low of the move, and many traders may find it incredibly frustrating to be taken out of a trade just before it has a chance to turn around and generate profits. Not us, however. We realize that getting stopped on a bottom tick is just a part of trading and will probably happen more times than we care to remember. Far more important is to appreciate the risk management aspect of the trade, which leaves us only with a slight loss of eight points, thus preserving our capital and allowing us to look for other high probability setups.
To truly appreciate the importance of this dynamic, just imagine the following scenario. Instead of a stop loss, we leave the trade open and instead of turning around, it proceeds to drop even further. Before long, we may be looking at a floating loss in hundreds of points - something that would be inordinately more difficult to make up than our initial small eight-point stop.
Conclusion
Most traders love to pick tops and bottoms, rather than trade with the trend. The turn trade allows you to do both by using multiple time frames, moving averages and Bollinger band "bands" as its tools of entry.
by Kathy Lien and Boris Schlossberg, (Contact Author | Biography)
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Kathy Lien is an internationally published author and the director of currency research at GFT. Her trading books include: "Day Trading the Currency Market: Technical and Fundamental Strategies to Profit form Market Swings" (2005), "High Probability Trading Setups for the Currency Market" E-Book (2006) and "Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game" (2007). Lien also runs an FX Signal Service, BKForex Advisor, with Boris Schlossberg - one of the few investment advisory letters focusing strictly on the 2 trillion/day FX market.
Buzz up!on Yahoo!
Sponsored Links
MARKETPLACE
TRADING CENTER
Financial Terms (Listed Alphabetically): # | A | B | C | D | E | F | G | H | I | J | K | L | M | N | O | P | Q | R | S | T | U | V | W | X | Y | Z
Home | Dictionary | Articles | Tutorials | Exam Prep | Ask Us | Stock Simulator | Stock Community | Stock Ideas | Free Tools | Contact Us
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