Forex Knowledge hub PART-4
In this particular case, you would’ve made a massive pip gain. You could’ve bought yourself something nice after this trade! You can see that when the moving averages cross in the opposite direction, it was a good time for us to exit. Of course, not all your trades
will look this sexy. Some will look like ugly heifers, but you should always remember to stay disciplined and stick to your trading system rules.
School of Pipsology - 161
In this example, we can see that our criteria is met and at this point we would enter short. Now we would record our entry price, our stop loss and exit strategy, and then move the
chart forward one candle at a time to see what happens. I’ll bet you a $1000 that I’m righton this trade.
School of Pipsology - 162
Well, isn’t that amazing?! It just so happens that I’m right again! You can see that we would’ve stayed in this trade until the moving averages crossed again and RSI went back to 50.
We know you’re probably thinking that this system is too simple to be profitable. Well the truth is that it is simple. You shouldn’t be scared of something that’s simple. In fact, there
is an acronym that you will often see in the trading world called KISS. It stands for Keep It Simple Stupid!
It basically means that trading systems don’t have to be complicated. You don’t have to have a zillion indicators on your chart. In fact, keeping it simple will give you less of a headache.
The most important thing is discipline. We can’t stress it enough. Well, yes we can. YOU MUST ALWAYS STICK TO YOUR TRADING SYSTEM RULES!
If you have tested your system thoroughly through back testing and by trading it live on a demo for at least 2 months, then you should feel confident enough to know that as long
as you follow your rules, you will end up profitable in the long run.
School of Pipsology - 163
Trust your system and trust yourself!
Summary
There are many systems out there that work, but many traders lack the discipline to
follow the rules and as a result, still end up losing money.
Your trading system should attempt to accomplish 2 goals:
1. Be able to identify a trend as early as possible
2. Be able to find ways to avoid whipsaws (confirm your trend)
If it is profitable, then you trade your system live on a demo account for at least 2 months.
This will help you get an idea of how you would trade your system when the market is moving. It is a lot different trading live than manually backtesting.
Once you’ve demo traded your system for at least 2 months and you are still profitable, you are then ready to trade your system live with real money. However, you must always
remember to stick to your rules no matter what!
There are 6 steps to developing your system:
1. Find your timeframe
2. Find indicators to help you identify trends early
3. Find indicators to help you avoid whipsaws and confirm your trend
4. Define your risk
5. Define your entry and exit
6. Write your trading system rules down and ALWAYS stick to those rules!
There are 3 phases to testing your system:
1. Back test- go back and time and move your chart forward one candle at a time. Trade your
system according to its rules and record your trades to see if it ends up being profitable.
2. If it is profitable, then you trade your system live on a demo account for at least 2 months.
This will help you get an idea of how you would trade your system when the market is
moving. It is a lot different trading live than manually back testing.
3. Once you’ve demo traded your system for at least 2 months and you are still profitable,
you are then ready to trade your system live with real money. However, you must always
remember to stick to your rules no matter what!
School of Pipsology - 164
Market Hours So far, all the lessons we have taught you deal with “how” to trade the forex market. But
another important lesson that you need to learn is “when” to trade the forex market. Yes, it is true that the forex is open 24 hours a day, but that doesn’t mean it’s always active the whole day. You can make money in the forex when the market moves up, and
you can even make money when the market moves down. However, you will have a very difficult time trying to make money when the market doesn’t move at all. This lesson will
help determine when the best times of the day are to trade. Market Hours
Before looking at the best times to trade, we must look at what a 24hr. day in the forex world looks like. The forex can be broken up into three major trading sessions: the Tokyo Session, the London Session, and the U.S. Session. Below is a table of the open and close times for each session:
School of Pipsology - 165
You can see that in between each session there is a period of time where two sessions are open at the same time. From 3-4 a.m. EST, both the Tokyo and London markets are open,
and from 8-12 p.m. EST, both the London and U.S. markets are open. Naturally, these are the busiest times during the market because there is more volume when two markets are
open at the same time.
As you can see, the London session usually shows the most movement.
Now let's see which days of the week are best for trading...
School of Pipsology - 166
Best Days of the Week to Trade
Best Days of the Week to Trade Forex
Ok, so now we know that the London session is the busiest out of all the other sessions, but there are also certain days in the week where all the markets tend to show more movement. Below is a chart of average pip range for the 4 major pairs for each day of the week:
You can see that during the middle of the week is where the most movement is seen on all
4 major pairs. Fridays are usually busy until 12pm EST and then the market pretty much
drops dead until it closes at 5pm EST. This means we only work half-days on Fridays. The
weekend always starts early! Yippee!
So based on these three simple pieces, we’ve learned when the busiest times of the market are. These are the best times to trade because they give us a higher chance of success.
If you're feeling down in the dumps and wish to lose money, these are the times to trade...
School of Pipsology - 167
When to Trade if You Want to Lose Money
Here at BabyPips.com, we don’t like to force our opinions on you. Instead, we want you to
make your own decisions when it comes to your own trading. If you really do not want to trade during the busier times of the market when trade volume and pip movement is highest and where you will make money easier, then by all means, feel free to trade on
these times mentioned below. We guarantee you’ll have a more difficult time trading! Fridays: Fridays are very unpredictable. This is a good day to trade if you want to lose all the profit you made during the rest of the week.
Sundays: There is very little movement on these days. Trade this day if you want to start off your week with NEGATIVE pips.
Holidays: Banks are closed which means very little volume for whatever country is having the holiday. Holidays are great to trade when you would rather lose your money than take
a day off and enjoy the other finer things in life.
News Reports: No one really knows where the price will go when a news report comes out. You could lose a fortune trading during news releases if you don't know what you're doing. Price acts like a drunken monkey during these times and become unpredictable.
Can't Trade During Busy Market Hours?
What to do if you can’t trade during the busy market hours
If you live in a crappy time zone or you have a day job, then you probably can’t sit in front of a computer during the busy market hours. If this describes you, then I have a few solutions for you:
• Move to a better time zone. Move to London preferably. Sure you’d have to pack up and start a whole new life, but hey, at least you can trade right?
• Trade at work (be sure you have some “real” work ready just in case your boss sneaks up
behind you and asks what you’re working on). I also recommed you master the ALT-TAB key combination (if you use Windows) so you can quickly switch windows at a moment's notice. This option can be the ultimate perk because your employer is basically paying you
while you trade forex. Gettin' paid while gettin' paid if you know what I'm sayin'.
• Become a swing or position trader. As a swing/position trader, you won’t have to constantly monitor the markets and you can check or look at them when you get off work.
School of Pipsology - 168
• Trade a different session even if it’s not the busiest one. If you can’t trade the London or U.S. session, then trade the Tokyo session. However, you should be disciplined and trade
it every day. You will start to learn how it moves and can develop strategies that are specific to that session.
We think 3 and 4 are your best options, but again, the choice is up to you.
Even if you can’t trade, it’s good to watch the charts for a full session. By getting use to
seeing the price movement in action, you can actually see the real story of the currency. Watching the charts live is very different then looking at past charts.
Even if you can’t actually trade the market, make mental notes of when you would take trades while you’re watching the charts live. Practice makes perfect, and the more you do
it, the better you’ll get at it.
The Choice Is Yours There you have it! We’ve given you all the information you need regarding when the best
times to trade are. All you have to do now is decide whether or not you would rather trade when it’s easier to make money, or if you’d rather do it the hard way.
Summary
Busiest/Best times to trade:
• When 2 sessions are overlapping: 3-4am EST and 8am-12pm EST
• The London session is the busiest out of the other two.
• The middle of the week typically shows the most movement.
Worst times to trade:
• Fridays
• Sundays
• Holidays
• News Events
• During Desperate Housewives or American Idol episodes
School of Pipsology - 169
Money Management
This section is one of the most important sections you will ever read about trading.
Why is it important? Well, we are in the business of making money, and in order to make
money we have to learn how to manage it. Ironically, this is one of the most overlooked areas in trading. Many traders are just anxious to get right into trading with no regards to
their total account size. They simply determine how much they can stomach to lose in a single trade and hit the “trade” button. There’s a term for this type of investing….it’s called GAMBLING!
When you trade without money management rules, you are in fact gambling. You are not looking at the long term return on your investment. Instead you are only looking for that
“jackpot”. Money management rules will not only protect us, but they will make us very profitable in the long run. If you don’t believe me, and you think that “gambling” is the way to get rich, then consider this example:
People go to Las Vegas all the time to gamble their money in hopes to win a big jackpot, and in fact, many people do win. So how in the world, are casino’s still making money if many individuals are winning jackpots? The answer is that while even though people win
jackpots, in the long run, casino’s are still profitable because they rake in more money from the people that don’t win. That is where the term “the house always wins” comes from.
The truth is that casinos are just very rich statisticians. They know that in the long run, they will be the ones making the money—not the gamblers. Even if Joe Schmoe wins $100,000 jackpot in a slot machine, the casinos know that there will be 100 more gamblers who WON’T win that jackpot and the money will go right back in their pockets.
This is a classic example of how statisticians make money over gamblers. Even though both lose money, the statistician, or casino in this case, knows how to control their losses. Essentially, this is how money management works.If you learn how to control your losses,
you will have a chance at being profitable.
You want to be the rich statistician…NOT the gambler because in the long run, you want to “always be the winner.”
So how do you become this rich statistician instead of a loser?
School of Pipsology - 170
Drawdown and Maximum Drawdown?
So we know that money management will make us money in the long run, but now we’d like to show you the other side of things. What would happen if you didn’t use money
management rules?
Consider this example:
Let’s say you have a $100,000 and you lose $50,000. What percentage of your account
have you lost? The answer is 50%. Simple enough. Now, what percentage of that $50,000
do you have to make in order to get back to your original $100,000? It’s not 50%--you’d have to make back 100% of your $50,000 to get back to your original $100,000. This is called drawdown. For this example, we would’ve had a 50% drawdown.
The point of that little illustration is that it is very easy to lose money and a lot harder to make it back. We know you’re saying to yourself, “I’m not going to lose 50% of my account
in one trade.” Well we would certainly hope not!
However, what if you lost 3, 4, or even 10 trades in a row? That couldn’t possibly happen to you, right? (Sarcasm used) You have a trading system that wins 70% of the time, so
there is NO way you could lose 10 trades in a row. (Even more sarcasm used)
Well, while you may have a good system, consider this example:
In trading, we are always looking for an edge. That is the whole reason why traders develop systems. A trading system that is 70% profitable sounds like a very good edge to have. But just because your trading system is 70% profitable, does that mean for every
100 trades you make, you will win 7 out of every 10?
Not necessarily! How do you know which 70 out of those 100 trades will be winners? The answer is that you don’t. You could lose the first 30 trades in a row and win the remaining 70. That would still give you a 70% profitable system, but you have to ask
yourself, “Would you still be in the game if you lost 30 trades in a row?”
This is why money management is so important. No matter what system you use, you will eventually have a losing streak. Even professional poker players who make their living through poker go through horrible losing streaks, and yet they still end up profitable.
School of Pipsology - 171
The reason is that the good poker players practice money management because they know that they will not win every tournament they play. Instead, they only risk a small
percentage of their total bankroll so that they can survive those losing streaks. This is what you must do as a trader. Only risk a small percentage of your “trading bankroll” so that you can survive your losing streaks. Remember that if you practice strict
money management rules, you will become the casino and in the long run, “you will
always win.”
Let me illustrate what happens when you use proper money management and when you don't...
Don't Lose Your Shirt
Here is a little illustration that will show you the difference between risking a small percentage of your capital compared to risking a higher percentage.
You can see that there is a big difference between risking 2% of your account compared to risking 10% of your account on a single trade. If you happened to go through a losing
School of Pipsology - 172
streak and lost only 19 trades in a row, you would’ve went from starting with $20,000 to having only $3,002 left if you risked 10% on each trade. You would’ve lost over 85% of
your account! If you risked only 2% you would’ve still had $13,903 which is only a 30% loss of your total account.
Of course, the last thing we want to do is lose 19 trades in a row, but even if you only lost 5 trades in a row, look at the difference between risking 2% and 10%. If you risked 2% you
would still have $18,447. If you risked 10% you would only have $13,122. That’s less than what you would’ve had even if you lost all 19 trades and risked only 2% of your account!
The point of this illustration is that you want to setup your money management rules so
that when you do have a drawdown period (losing streak) you will still have enough capital to stay in the game. Can you imagine if you lost 85% of your account? You would have to make 566% on what you are left with in order to get back to breakeven. Trust me,
you do NOT want to be in that position. In fact, here is a chart that will illustrate what percentage you would have to make to breakeven if you were to lose a certain percentage
of your account. You can see that the more you lose, the harder it is to make it back to your original
account size. This is all the more reason that you should do everything you can to protect your account.
So by now, I hope you have gotten it drilled in your head that you should only risk a small percentage of your account in each trade so that you can survive your losing streaks and
also to avoid a large drawdown in your account. Remember, you want to be the casino…NOT the gambler!
School of Pipsology - 173
Risk to Reward
Another way you can increase your chances of profitability is to trade when you have the
potential to make 3 times more than you are risking. If you give yourself a 3:1 reward/risk
ratio, you have a significantly greater chance of ending up profitable in the long run. Take a look at this chart as an example:
In this example, you can see that even if you only won 50% of your trades, you would still make a profit of $10,000. Just remember that whenever you trade with a good risk to
reward ratio, your chances of being profitable are much greater even if you have a lower win percentage.
Summary
Be the casino, not the gambler! Remember, casinos are just very rich statisticians! Drawdown is a reality and WILL happen to you at some point. The less you risk in a trade,
the less your maximum drawdown will be.
The more you lose in your account, the harder it is to make it back to breakeven. Trade only a small percentage of your account. The smaller the better. 3% or less is
recommended.
School of Pipsology - 174
It is desirable to trade when you have a high risk to reward ratio. The higher the ratio, the less you have to be right.
Why Have a Trading Plan?
Uh oh! You’ve learned so much and have come so far in your education, and yet you're still haven't graduated high school. No, you’re not dumb, BUT you didn’t have a trading
plan. Our point is that you can fill your mind with plenty of information, but without a good trading plan and the discipline to stick to it, you will NEVER be profitable. Think of your trading plan as your map to success. It will be a constant reminder of how
you will make money in this market. Of course it’s not required, and if you can make your living by trading without a plan, we will bow down and hail you as the Market Zeus of the Forex.
So you CAN trade without a plan if you want, but before you make that decision, let us give you a few reasons WHY you should have one.
Why Have a Trading Plan?
Reason 1: It keeps you in the right direction
Consistency is very important to have in your trading routine because it allows you to truly
measure how successful you are as a trader. If you have a sound trading system but
always break your rules, how can you ever really know how good your system really is?
Your trading plan will keep you on target. Read it every day and stick to it.
Reason 2: Trading is a business and successful businesses ALWAYS have plans I have never seen a successful business not start out with a plan. Do you honestly think
Walmart was just created on a whim and then magically became successful? Or what
about McDonalds? I’m sure almost anyone can make a better hamburger than
McDonalds, but the difference between them and the individual is that they have a successful business plan that guides them to success.
In the same way, you can relate the McDonald’s story to your trading career. Whether it’s by luck or experience, everyone can make money in the forex. However, the difference
School of Pipsology - 175
between a losing trader and a successful trader is the PLAN. If you have a good trading
plan and you are disciplined enough to stick to it, you will be successful!
Now you know why you should have a trading plan. Let's find out what makes up a trading
plan...
What Should be in Your Trading Plan?
Trading plans can be as simple or complex as you want it, but the most important thing is
that you actually HAVE a plan and you FOLLOW the plan. With that said, here are some of
the essentials that every trading plan should have.
1. A trading system
This is the heart of your trading plan. This system should be one that you have thoroughly
backtested, and have traded for at least two months on a demo account.
Include all the necessary information about your system such as: time frames you use, criteria for entries and exits, how much you risk during each trade, which currency pair(s)
you trade and how many lots you trade.
Example: I am an intra-day trader and I trade off of the 10 minute charts. I enter when there is a moving average crossover and all my indicators support the direction. I only trade the EUR/USD and I risk no more than 2% of my account on each trade. For now, I
trade 5 mini lots and will increase my lot size according to my 2% money management
rules.
2. Your trading routine
This is a crucial part of your plan because it will determine three very important things:
when you will analyze the market and plan your trades, when you will actually watch the
market to take trades, and when you will evaluate your actions during your trading day.
3. Your mindset
Ask any trader out there and they will all tell you that one of the hardest things to do
when trading is to take out your emotions from it. This section of your trading plan will
describe what frame of mind you will be in when you are trading.
Example:
• I will see what is on the charts and not what I want to see.
School of Pipsology - 176
• No matter how biased I am towards a direction, I will make sure to trade only what my
eyes see and not what my feelings tell me.
• I will not get “revenge” on the market if I lose on a trade.
• I will not beat myself up if I make a losing trade. Instead I will take it as a learning
experience and move on.
4. Your weaknesses
Yes, we all have our weaknesses. We just don’t like talking about them. But ask yourself
this, “How will you ever get better, if you don’t admit to what you need to work on?” This
section will be an objective way to keep track of things that you need to work on in order
to become a better trader.
Example:
• I tend to overtrade. Whenever I lose on a position, I get upset and immediately try to get
“revenge” on the market.
• I tend to exit early on trades.
• I don’t stick to the rules of my system every time
• I don’t stick to my money management rules every time
5. Your goals
“To make a lot of money” is not a good goal. Sit down and really think about what you want to accomplish as a trader. Do you want to trade for a living? How much return can
you realistically expect from trading based on your knowledge and experience? Your goals
don’t even have to be about making money. Maybe you would like to be more disciplined
or gain more confidence. These goals can be personal. What do YOU want to get out of this? Use these goals as your motivation when times get tough. These goals will be your
vision, and you must always keep your eyes on the prize!
6. Your trading journal
This will be a valuable tool to helping you become a better trader. Make sure you log all your trades and why you took them. Later down the road you can look back and evaluate
your trades and see how you are progressing. I’ve looked back at my trade journal and have seen just how much I’ve grown as a trader. My first entries were very basic and as
I’ve progressed, my trades make more sense to me now. I’ve gained a lot of confidence throughout my career and by looking back at my trades, I’ve really been able to evaluate
myself and see if I am getting closer to my goals. This tool will help you tremendously in the long run, so take a few minutes each day and log your trades. You’ll be happy you did!
School of Pipsology - 177
Summary
Your trading plan will be your trading “bible”.
Read it everyday and stick to it.
You can have all the trading tools in the world, but if you don’t have a plan on how you
will use them, you will never be successful.
Remember, you are starting a business, and if you want your business to succeed, you
need to have a PLAN!
School of Pipsology - 178
Discovering Your Trading Personality
Forex traders come in many different shapes and sizes. There are male traders, female
traders, fat traders, skinny traders, beautiful traders, ugly traders, slow traders, fast
traders, professional traders, amateur traders, fur traders … and the list goes on. Each trader has their own personality, their own personal schedule, their own appetite for
risk, their own pain threshold and their own bankroll.
Some traders might have several things in common, but most will be different. The point is each of you are unique. And depending on your personality, personal preferences, and
situation, how you trade will be a driving factor in determining your success.
In order to figure out how you should trade, you must first uncover your own “trading personality.” Your trading personality will determine the trading style and method that’s
compatible for you.
Trading is not like a t-shirt. There is no one-size-fits-all. There is no single plan for all
traders.
I challenge you to perform a self-assessment on your personality, behaviors, beliefs, and mindset. Do you consider yourself disciplined? Are you risk averse or a big risk taker? Are
you indecisive or spontaneous? Are you patient or a firecracker? Would you prefer to go bungee jumping or visit a museum? Do you like your martini shaken or stirred?
An excellent way to help you with your self-assessment is to keep a trading journal. It will
help you to analyze your thought processes after the trade, and identify your strengths and weaknesses in your trading. Understanding your personality is one thing, but understanding it while you trade is a totally different story. A trading journal allows you to
review your wining and losing trades and pinpoint specific reasons on why you won or lose. Now, before we dive in to the different components of trading styles, let’s look at the profiles of a few traders, their trading personalities, and how it’s affected their lives
outside of trading.
School of Pipsology - 179
Trading Personality Types
Pete the Position Trader
Pete is a busy man with a demanding wife, eight kids, four dogs, three cats, two hamsters,
and a pet komodo dragon. It would be impossible to support such a large family on a
meager salary, so fortunately, Pete is a successful doctor.
Pete doesn’t like to sit in front of the computer all day. But he does enjoy reading about
the world’s economies and has a short list of countries which he keeps up with their economic data releases. Pete prefers to position trade. This means when he enters a trade, his holding period is between a few weeks to a couple of months. He only trades
several times a year. Often, at the end of the year, he can recount his number of trades on one hand.
In order to do this, he uses discretionary fundamental analysis. This means he takes an hour or two every week to see what the economic reports (like GDP, employment data, CPI, etc.) are indicating to him. He then makes a decision on which way to trade, but does
not automatically go with the signals. Because Pete’s trades are longer term in nature, his profit targets are huge – but so are his stop losses! His stop losses usually range between
100-500 pips while his profit targets range from 500-1,000 pips or more. His trades have a big reward-to-risk ratio, which allows him to minimize his losses when he’s wrong, but hit the jackpot when he’s right.
Pete really enjoys being a position trader because it allows him to have a life. With his current work and family obligations, Pete clearly doesn’t have the time to devote to being
a day trader. His trading personality doesn’t require him to make a decision in the heat of the moment and allows him to look for longer-term trends. As a position trader, he can
juggle a busy career with his demanding wife, eight kids, four dogs, three cats, two hamsters and Komodo dragon.
Sam the Swing Trader Sam is a single guy who owns a small coffee shop around the corner, where he works part
time. He has also been trading on the side for a while now, and now his schedule is at the
point where he is able to watch the market an hour or two a day.
Sam prefers to hold trades in a shorter time frame than Pete the Position Trader. He attempts to predict the short-term fluctuation in a currency pair’s price, and is willing to
School of Pipsology - 180
hold his trades open for more than a day, or even a few days, to give the price movements
some time and capture additional momentum. On some trades Sam will generally be in a
position from several days to even a week.
Sam dedicates an hour each day and/or evening to go over the market. The first half of his hour is spent reading the major economic news of the day and what news reports are
coming out within the next 24 hours. Based on what’s going on globally, he determines whether the currencies he is watching will see volatility or not. Since he only watches two
or three pairs at the most, it doesn’t take him long to read the major reports of the day. After Sam has finished reading the economic news and reports, he determines if the market will trend or range for the next few days, or even weeks. He pulls up his charts and
uses technical analysis to find good entry and exit points. His tools to find support and
resistance include Fibonacci retracements, channels, trend lines, moving averages, etc. He
then sets limit orders with stops and profit target levels, so it’s all practically automated when he enters and exits a trade.
Sam has been pretty successful. He is able to mentally weather the daily swings a swing trader has to go through. His losses have been limited to 50–100 pips, while his gains have
ranged between 100–500 pips.
Sam usually checks his position once or twice a day just to make sure unforeseen events
haven’t significantly affected his positions, and the rest of his day is spent doing whatever
he wants, whether it’s working, hanging with buddies, or browsing internet auction websites for comic books to add to his collection.
Diona the Day Trader
Diona is extremely impatient and feels she always “needs to be doing something.” Her
trading style consists of trade positions that are opened and closed in one day or less. Some days, she may only trade once. Other days, she may trade several times before the
market closes. The bottom line is that she exits all positions by market close (5 p.m. EST)
or when a session, such as the European or Asian session, ends. As a day trader, Diona
feels the need to be in the market at all times because she’s afraid of missing a good trade. She is also risk averse and is scared of losing too much per trade, so she uses small
stop losses.
Diona has spent years developing a consistent method of taking profits out of the market.
Her account is big enough where she could quit her job, and she watches the market full
time now. While she is aware of news releases on any given day, Diona mainly relies on
technical analysis when trading. She has been using technical tools such as oscillators
School of Pipsology - 181
(MACD, RSI, Stochastic) and moving averages, which automatically signal her to enter and exit high probability trades. She just follows the signals.
Most days, Diona goes for 10–50 pips or more while limiting her losses to 10–20 pips, but
occasionally she will scalp the market. Scalping is a method where she trades larger lots and takes less pips (usually 5-10) out of the market. Most of her scalp trades last for a few
minutes or even seconds!
The day trading and scalping methods allows Diona to make one to several trades per day and satisfy that “need to be doing something.” Her confidence in the system allows her to
stay with the plan and stick with the rules. She does not have to decide whether or not to
enter a trade – the charts do it for her! However, Diona knows that her system is not perfect. She loses a little less than half of her trades, but her average win is almost twice
her average loss. Over the long run she has consistently profited from the market. She is now able to work from home, be her own boss and take time off to travel whenever she chooses.
What Kind of Trader Am I?
So, what kind of trader am I?
Well, one of the first questions to ask is, “how much time do I have to trade currencies
and how long can I comfortably be in a position?”
We can identify different trading personalities by timeframe. Take a look at these
different styles and see which one may fit you.
• Scalping – Scalpers are very short-term traders, usually in and out of trades within
seconds. Most forex brokers discourage this type of trading. It’s also extremely dangerous
due the high number of lots required to make a decent profit off a couple pips. Not for the
faint of heart or shallow pockets.
• Day traders – Day traders open and close positions in the same trading session.
• Swing traders – Swing trading holds trades for days.
• Position trading – Long term position traders hold trades from weeks to months at a time.
Next question to ask is, “how do I want to analyze the market and decide on which trades
to take?”
• Technical Analysis – using charts and technical indicators to analyze the past price
movements of a currency pair to possibly see where the price may go in the future.
School of Pipsology - 182
• Fundamental Analysis – Watching and analyzing economic news reports and indicators
such as GDP, CPI, Employment data, or any political news that may affect a country’s
economy and their currency.
And finally are you a system trader, or are you a discretionary trader?
• System Trader – a system trader or mechanical trader tends to take to signals from system
of technical indicators to automatically enter and exit trades. For instance, if the stochastic
indicator shows that the currency pair is oversold, the system trader will automatically
enter a buy on the currency pair.
• Discretionary trader – this trading style usually refers to traders who use both technical
and fundamental analysis. A trader’s technical method may signal a possible trade entry,
but his or her analysis of the fundamental landscape may show a different story on the same pair.
Summary
Succeeding in forex trading takes hard work, lots of time, and some blood, sweat and tears. New traders need to be realistic right from the start. Beginners should start small
and constantly evaluate their profitable trades as well as their failures.
Like I said earlier, trading is not like buying a t-shirt. One size does not fit all. Before you can succeed in trading, you must spend time doing homework, learning your personal
strengths and weaknesses, and assessing your personal schedule, trading capital and trading experience.
Take the time to answer these questions, and also look back at your trading journal to see
how you fared in different trading situations. Only then will you be able to decide on a
trading personality that’s compatible for you.
School of Pipsology - 183
Trading the News
Trading the news is becoming a popular technique to trade the forex markets … and why
shouldn’t it be? Time and time again you see currency pairs move 50 to 100 pips within minutes or even seconds after a major news release. When you see that, I bet you’re
thinking, “50 to 100 pips!? That’s easy money!” Maybe it is, and maybe it isn’t. It all depends on how prepared you are to trade a news release.
The goal of this lesson isn’t to give you a specific “Trading the News” strategy. The goal is
to point you in the right direction and show some of the risks involved with trading these events, because here at BabyPips.com, we want to help you help yourself in developing
your own methods that fit YOU best.
Why Trade the News?
Trading news releases can be a significant tool in your trading arsenal. If you want, it can be your only weapon altogether. Economic news reports often spur strong short-term moves in the market, which are great trading opportunities for breakout traders. And with
the forex being open 24 hours a day and a true worldwide market, there are plenty of opportunities almost every trading day to catch market volatility (aka a lot of pips!) kicked
off by an economic news report.
Which Pairs Should I Trade?
Here is a list of the top currencies and countries in which you should focus on for news
trading:
Symbol Country CurrencyNickname
USD United States Dollar Buck
EUR European Union Euro Fiber
JPY Japan Yen Yen
GBP Great Britain Pound Cable
CHF Switzerland Franc Swissy
CAD Canada Dollar Loonie
School of Pipsology - 184
AUD Australia Dollar Aussie
NZD New Zealand Dollar Kiwi
Now, there are plenty more currencies available to trade, but this list is based on the size of each country’s economy, frequency of news releases and the trading liquidity of their currency.
When are News Releases uh Released?
The list below displays the times when the most important economic data are released for each of the countries. Make sure you know them or go broke.
Symbol Country Time (GMT)
USD United States 13:30 - 15:00
EUR Germany 07:00 - 11:00
EUR France 07:45 - 09:00
EUR Italy 08:45 - 10:00
JPY Japan 23:50 - 04:30
GBP Great Britain 07:00 - 09:30
CHF Switzerland 06:45 - 10:30
CAD Canada 12:00 - 13:30
AUD Australia 22:30 - 00:30
NZD New Zealand 21:45 - 02:00
Tradeable Reports
With all of these countries to choose from, there are easily five to ten economic news
releases almost every day! Also, the great thing about focusing on news releases is that
School of Pipsology - 185
they are scheduled in advance, so you know exactly when you can schedule your trading hours.
You may be thinking that five to ten news releases per day may be a lot to keep up with,
but you really do not have to pay attention to every single report – you can pick and choose. There are a few key reports, most of which come out every month, that produce a significant amount of pip movement.
For this lesson, we will focus on U.S. news and economic reports, mostly because the U.S. dollar is involved in a majority of currency trades, and therefore tends to have the most
significant impact on the currency markets. Here is a list of some of the top U.S. market
moving reports:
• Employment Growth
• Interest Rate decisions
• Trade Balance
• Gross Domestic Product
• Retail Sales
• Durable Goods
• Inflation reports (Consumer Price Index and Producer Price Index)
• Foreign Purchases report (TIC Data)
Every country has a set of major reports similar to this list and can be as potentially
volatile. Again, since these reports are scheduled in advance there are plenty of websites
on the Internet with schedules and potential volatility rankings.
Things to Know When Trading News Reports
Now that we know “how” and “when” you can trade news reports, there are a few key
concepts you should know before placing your first news trade.
• While the actual news number or report is essential to the long-term movement of a
currency pair, in the short-term the difference between the market expectations and the
actual release is what causes potential breakout opportunities. This means economic
numbers and reports that come out as the market expected generally do not cause a strong market reaction.
• The quieter the market is before a news release, the more the market is poised for a
significant move. Think about it: In a quiet market, less and less traders are buying and
selling, possibly waiting for some sort of catalyst (like a news report maybe?). When this
“catalyst” takes place, all of these traders waiting on the sidelines jump in at the same
time causing a huge move in the market. So, the more traders wait (the quieter the
market), the more will jump in after a news report (huge pips and a new Ferrari, right?).
• Depending on the significance of the economic report, and the amount of deviation of the
actual to the forecasted number, news breakout opportunities are generally short-lived
School of Pipsology - 186
and may last for only a few minutes or even a few seconds. Trading news releases may be
better suited for scalpers and day traders.
Trade at Your Own Risk!
Before I pursue anything, I like to know exactly what I’m getting into. The same especially
goes for trading. We’ve heard the benefits and why we should “trade the news,” but more
importantly we should know the risks.
Slippage Market volatility can increase geometrically during news releases, which means the price
can move as little as 5 pips to 20 pips (or even 50 pips and more during major news releases) in the matter of seconds. If you try to get your order filled during this type of
volatility, you will probably get filled at a much different price than you anticipated. This is
especially risky with limit entry orders.
For example, I once placed an order with a broker (one that guaranteed fixed spreads, but
not execution) 15 minutes before a major news release on EUR/USD. Right before the release, the market was at 1.2320. I set my limit order to go long at 1.2360, with a profit
level of 1.2383. The news came out bad for the U.S. dollar, which caused the market to shoot up 80 pips as soon as it was released. My long order was triggered, but unfortunately, I got filled in at 1.2390 – 30 pips above my limit price!! After the market
settled for a bit, my profit target price was executed at a loss because it was set below the
price at which I got filled in. Fortunately, it was only a 7 pips loss, but it was a costly lesson learned.
Order Freeze Some brokers prevent limit and market orders right before a major news release (some up
to 30 minutes to an hour beforehand). This usually occurs with brokers who guarantee fixed spreads.The reason your trading platform “locks up” is not because the platform
“crashed”, it’s because the spread is too wide and if the brokers offered them with their fixed spreads, they would lose money.
Volatility/ Whipsaws
During major news reports and economic releases the market can swing 20 to 50 pips in a second! News volatility can be very dangerous, even for experienced traders. You may
School of Pipsology - 187
catch the strong initial move, but like so many times in these situations, it can turn against
you into a losing trade just as fast.
Spreads Some brokers may guarantee execution but do not guarantee spreads, and during news
events you’ll see spreads widen dramatically (I’ve seen a 3-pip spread turn into a 14-pip spread during a report). If you like to take small profits like 5 to 10 pips, this will hurt your
chances of profitability and possibly keep you in a potentially losing trade.
News Trading Methods
Straddles
Straddles are really easy to set up and require very little thinking, but it is probably the
riskiest method of trading the news. To set up a straddle, you basically put a limit order to go long a few pips above the market before a news report, and simultaneously put in a
limit order to go short a few pips below the market. If the report creates enough volatility your orders will be automatically triggered, and your stops and profit levels will also be
automatically executed if hit. Simple as that.
Again, it sounds easy, but be very cautious with this method in that both long and short orders can be triggered, and if profit targets and stops are set incorrectly, you can be
stopped out for maximum loss on both orders. Also, you run the inherent risks of slippage. "Trading the Numbers"
This seems to be a more preferred method by many, in that you determine whether or not the news report is worth trading at all – a lot less risky than straddles. First, you must determine the significance of the news report being released. Not every news report release is tradable; either it wouldn’t cause a stir in the market, or that the initial volatility would be so crazy that it would be too dangerous to enter a trade.
Ask yourself what kind of environment the market has been in recently. In other words,
what has been affecting the market lately?
For example, maybe the Federal Reserve has been concerned with inflation. In this scenario, any inflation-related data (consumer price index, hints on future monetary policy) would be closely watched by the Fed – and what the Fed is watching, traders are
School of Pipsology - 188
watching. Any news reports of this level may be great opportunities to trade, as long as you are conscious of the risks.
The second step is to watch the news release and see if the report or economic number being released is inline with what the market is expecting. Obviously, if the report or
number was a good one and/or a good surprise for a country, then you would go long its currency, and vice versa.
For example, in the next U.S. employment report, the market was expecting 200K new jobs, and the number came out at 300K. It’s a surprise to the upside, and more jobs signal
strength and growth in the U.S. You would go long as soon as the report is released and hope to catch a portion of the move. If the report came in pretty much as expected, then
there would be no trade.
Summary
That’s pretty much it….is it really that easy??? Heck no!! Well, maybe not at first. You’ll have to
practice and trade many different reports before you get a feel of which news reports will make
the market move, how much of a surprise is needed for the market to move, and which reports to
avoid. Like in any other trading method, your success depends on your preparation and confidence
in your systems and methods. This will take time and practice. Do a little homework and study the
economic indicators on why they are important. Nothing worth having comes easy, so stick with it
and you’ll find that trading news reports will be very rewarding once you get the hang of it.
School of Pipsology - 189
Getting Sentimental with Forex Trading
Sentimental analysis is what it sounds like – gauging the market sentiment. What does
that mean? Well, as traders, a part of our job is to determine if a market is bullish, bearish, overbought, oversold, and to plan a trade for those market conditions – basically
putting all of the things we’ve learned up until this point all together.
So how do we do that? What tools can we use? And how do we react to certain
conditions? Well, that’s what we’re going to find out today – we’re going to take a look into sentiment analysis in forex trading.
Now there are a couple of ways to gauge different market conditions. Does anyone know
what those two things are? You guessed it: technical and fundamental analysis. Now, in
the School of Pipsology, we’ve covered most of the commonly used technical indicators out there for forex trading, so you should be an expert at that already right?
But how about the fundamental tools? What fundamental tools are available to gauge sentiment?
Well, in stocks and options, sentiment is measured using volume data. For instance, if a
declining stock suddenly reversed on high volume that means the market sentiment may
have changed from bearish to bullish. Or if a stock price was rising on gradually declining
volume, then that may be a sign of an overbought market.
But have you ever seen volume data on any forex charts?
Probably not. Being that the foreign exchange does not have a centralized market, volume data cannot
be accurately calculated. So, where’s a trader to go to get such valuable data? That’s where the COT report comes in.
Commitment of Traders Report
The Commodity Futures Trading Commission publishes the Commitment of Traders report
(COT) every Friday, and it measures the net long and short positions taken by traders in
the futures market. It is a great resource to gauge market sentiment from the “big
School of Pipsology - 190
players” because of their large positions they are required to report to the government. Of
course, it is very important to see what the “smart money” is up to because they move the
markets and it may have an impact on your positions.
Below, we have an example of the Swiss Franc COT report taken from August 22, 2006
Check it out:
The report is pretty straight forward, but here’s a quick run down of what each category
is.
• Non-Commercial - This is a mixture of individual traders, hedge funds, and financial
institutions. For the most part, these are traders who looking to trade for speculative
gains.
• Commercial - These are the big businesses that use currency futures to hedge.
• Long - number of long contracts reported to the Commodity Futures Trading Commission
(CFTC).
• Short - number of short contracts reported to the CFTC.
• Open interest- this column represents the number of contracts out there that have not
been exercised or delivered.
• Non-reportable positions;- These are the open interest positions of traders that do not
meet the reportable requirements of the CFTC.
• Number of traders- total number of traders who are required to report positions to the
CFTC.
School of Pipsology - 191
• Reportable positions;- the number of options and futures positions that required to
report according to CFTC regulations.
In the center of the report we see “CHANGES FROM 08/15/06.” This section shows the
change in Open Interest and the changes in the Long and Short positions from the
previous week.
How to Use the COT Report
Because the COT report is published weekly, it would be more suitable for longer term
traders to use as a market sentiment indicator. So, how do we do that? Well, besides
using the changes in open interest and changes in the number of long and short contracts
as a volume indicator, my favorite way to use the COT report is to find extreme net long
and net short positions. This can be great indicator that a market reversal is around the
corner because if everyone is long a currency, who is left to buy? No one. And if everyone
is short a currency, who is left to sell? Again, no one. The only thing a market can do is go
the other direction. Here’s a chart example:
This is an example chart of the US Dollar Index from freecotcharts.com. In the top half of
the chart we have the price action of the USD index futures with each bar representing
weekly data. On the bottom half of the chart we have data on the net long/short positions
broken down into three categories: Commercial (Blue), Large Non-commercial (Green),
and Small Non-commercial (Red). We will pay attention to the Large Non-commercial
School of Pipsology - 192
positions since commercial positions are for hedging and small retail traders aren’t really a
factor.
Let’s examine this chart and see what it can tell us. We can see that the US Dollar began a
nice little bull run at the start of 2005. As the value of the net long positions of large
speculative traders (green line) rose, so did the price of the USD futures index. In the first
week of July 2005, net long positions grew to over 20K contracts. This was an extreme area of longs and soon after the market began to sell off USD index futures. The USD index
price dropped from 91 to 86, but it only proved to be a retracement as the index rallied to
a new high of about 93.16 and higher level of 29K net long contracts.
As you have probably already asked yourself, “with this many longs who is left to buy?” Not too many traders really. With the market appearing overbought in November 2005,
we began to see the number of long USD index futures contracts decline and a drop in the index price from 93 all the way down to about 84. Wow, can you imagine if you positioned
yourself before this move?
By now I bet you’re asking, “I trade the spot forex market not futures. How does this apply to my trading?” Great question! Since we’re already taking a look at the US Dollar,
let’s look at one of the best vehicles to trade the Greenback in the spot forex market:
EUR/USD.Here’s a weekly chart of EUR/USD:
School of Pipsology - 193
If we had applied what we learned in the previous section by positioning ourselves for market reversals, we could have caught two significant moves from July 2005 to May 2006in EUR/USD.
First, in July 2005, if a trader saw the extreme levels of net longs in the USD index futures,
this trader would catch the possible upcoming selloff of the Greenback by buyingEUR/USD. This trader would’ve been proven right, and paid off handsomely as this position could have caught a maximum of 700 pips. Again, if this trader were so astute to
catch the extreme level of long USD index futures contracts in November 2005, buying EUR/USD would have been the best bet as the pair rallied from about 1.1650 to almost
1.3000….wowzers!!! That’s over 1300 pips gained! So, from July 2005 to May 2006, atrader could have caught almost 2000 pips just using the COT report as a market reversal
indicator. Pretty good, eh??
Summary
Now, before we get all excited and start betting the farm on what the COT reports says,
let’s remember a couple of things.
First, this is just one example of how the COT report can signal market reversals. I could sit here and post examples all day, but the best thing for your trading education is to review
past COT data and charts, which is freely available all over the internet. I’m a firm believer in backtesting, not just to see if a strategy works, but how a strategy may fail me at certain
times. This technique does not always correlate to market reversals, so take the time to study this report, and get your own feel of what works and what doesn’t. Second, market prices aren’t driven by COT reports, MACD, Stochastics, Fibonacci
numbers, or anything like that - the markets are driven by millions of people reacting to fundamental reports, economic analysis, and politics. Use these tools in conjunction with
what’s going on in the world, and you can gain a serious edge and insight to what the market is feeling and be prepared to act on it.
School of Pipsology - 194
What is the U.S. Dollar Index?
If you’ve traded stocks, you’re familiar with all the indices available such as the Dow Jones
Industrial Average (DJIA), NASDAQ Composite Index, Russell 2000, S&P 500, Wilshire 5000,
and the Nimbus 2001. Oh wait, the last one is actually Harry Potter’s broomstick.Well if U.S. stocks have an index, the U.S. dollar can’t be outdone. For currency traders like
us, we have the U.S. Dollar Index (USDX).
The U.S. Dollar Index consists of a geometric weighted average of a basket of foreign
currencies against the dollar.
Come again?! Okay before you fall asleep on us after that super geeky definition, let’s
break it down.
It’s very similar to how the stock indices work in that it provides a general indication of the
value of a basket of securities. Of course, the “securities” we’re talking about here are
other major world currencies.
The Basket
The U.S. Dollar Index consists of six foreign currencies. They are the:
1. Euro (EUR)
2. Yen (JPY
3. Cable (GBP)
4. Loonie (CAD)
5. Kronas (SEK)
6. Francs (CHF)
Here’s a trick question. If the index is made up of 6 currencies, how many countries are
included?
If you answered “6”, you’re wrong. If you answered “17”, you’re a genius.
There are 17 countries total because there are 12 members of the European Union plus
the other five (Japan, Great Britain, Canada, Sweden, and Switzerland).
School of Pipsology - 195
It’s obvious that 17 countries make up a small portion of the world but many other
currencies follow the U.S. Dollar index very closely. This makes the USDX a pretty good
tool for measuring the U.S. dollar’s global strength.
The USDX Components
Now that we know what the basket of currencies are, let’s get back to that “geometric
weighted average” part. Because not every country is the same size, it’s only fair that each
is given appropriate weights when calculating the U.S. Dollar Index. Check out the current
weights:
As you can see, with its 12 countries, euros make up a big chunk of the U.S. Dollar Index.
The other five make up less than 43 percent.
Here's something interesting: When the euro falls, which way does the U.S Dollar Index
move?
The euro makes up such a huge portion of the U.S. Dollar Index, they might as well call this
index the "Anti-Euro Index". Because the USDX is so heavily influenced by the euro, people
School of Pipsology - 196
have looked for a more "balanced" dollar index. More on that later though. First, let's go
to the charts!
How to Read the U.S. Dollar Index
Here’s a chart of the U.S. Holler at the Dollar Index:
First, notice that the index is calculated 24 hours a day, seven days a week. The USDX
measures the dollar’s general value relative to a base of 100.000. Huh?!
Okay. For example, the current reading says 86.212. This means that the dollar has fallen
13.788% since the start of the index. (86.212 - 100.000).
If the reading was 120.650, it means the dollar’s value has risen 20.650% since the start of
the index. (120.650 – 100.00)
The start of the index is March 1973. This is when the world’s biggest nations met in
Washington D.C. and all agreed to allow their currencies to float freely against each. The
start of the index is also known as the “base period”.
The U.S. Dollar Index Formula
This is strictly for the grown and geeky. Here is the formula to calculating USDX:
School of Pipsology - 197
USDX = 50.14348112 × EURUSD^(-0.576) × USDJPY^(0.136) × GBPUSD^(-0.119) ×
USDCAD^(0.091) × USDSEK^(0.042) × USDCHF^(0.036)
Trade-Weighted U.S. Dollar Index
There is also another kind of dollar index used by the Federal Reserve. It is called the
“trade-weighted U.S. dollar index”.
The Fed wanted to create an index that could more accurately reflect the dollar’s value
against foreign currencies based on how competitive U.S. goods are compared against
other countries.
The main difference between the USDX and the trade-weighted dollar index is the basket
of currencies used and their relative weights. The weights are based on annual trade data.
Currencies and Weights
Here is the current weighting of the index:
Euro area 18.08
Canada 16.293
Japan 10.035
Mexico 9.823
China 13.377
United Kingdom 4.822
Taiwan 2.755
Korea 4.047
Singapore 2.061
Hong Kong 2.035
Malaysia 2.11
School of Pipsology - 198
Brazil 1.955
Switzerland 1.412
Thailand 1.416
Philippines 0.825
Australia 1.212
Indonesia 0.878
India 1.145
Israel 1.039
Saudi Arabia 0.665
Russia 0.924
Sweden 1.167
Argentina 0.46
Venezuela 0.451
Chile 0.591
Colombia 0.423
Total 100
*Weights as of December 15, 2005
For more information on exchange rate indexes for the U.S. dollar, see "Indexes of the
Foreign Exchange Value of the Dollar"
Weights for the broad index can be found at
http://www.federalreserve.gov/releases/H10/Weights
If you’d like to see historical data, check out
http://www.federalreserve.gov/releases/h10/Summary/
School of Pipsology - 199
The Carry Trade
Did you know there is a trading system that can make money if price stayed exactly the
same for long periods of time?
Well there is and it’s one the most popular ways of making money by many of the biggest
and baddest money manager mamajamas in the financial universe!
It's called the Carry Trade.
A carry trade involves borrowing or selling a financial instrument with a low interest rate,
then using it to purchase a financial instrument with a higher interest rate. While you are
paying the low interest rate on the financial instrument you borrowed/sold, you are
collecting higher interest on the financial instrument you purchased. Thus your profit is
the money you collect from the interest rate differential. For example:
Let's say you go to a bank and borrow $10,000. Their lending fee is 1% of the
$10,000 every year. With that borrowed money, you turn around and purchase a $10,000
bond that pays 5% a year.
What's your profit?
Anyone?
You got it! It's 4% a year! The difference between interest rates!
By now you're probably thinking, "That doesn't sound as exciting or profitable as catching
swings in the market." However, when you apply it to the spot forex market, with its
higher leverage and daily interest payments, sitting back and watching your account grow
daily can get pretty sexy.
How Does the Carry Trade Work for Forex?
School of Pipsology - 200
No comments:
Post a Comment