Bless My Pips
Contains a detailed explanation of over twenty Japanese candle patterns, about twenty indicators, fundamental events, chart patterns, Elliott waves and Fibonacci levels.
This book is a must for all first time Forex traders!
A Forex Trader’s Guide to the Currency Market Steven Lombardi
Bless My Pips
Bless My Pips A Forex Trader’s Guide to the
Currency Market
Steven Lombardi
Cover Design and Pictures by Sayuri Ozawa
Copyright Š 2010 by Forex Club Financial Company All Rights Reserved. No part of this book may be reproduced in any many manner without the express written consent of the publisher, except in the case of brief excerpts in critical reviews or articles. All inquiries should be addressed to Forex Club Financial Company, 1200 South Ave, Suite 203, Staten Island, NY 10314 or info@fxclub.com. www.fxclub.com ISBN 978-0-578-05846-7 Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit, including but limited to special, incidental, consequential, or other damages.
Introduction
Contents
9
SECTION ONE: FOREX BASICS 1.1 History of the Market 1.2 Why Choose forex? Comparing forex to Stocks 1.3 Examples of How Money Is Made and Lost in Forex 1.4 Market Hours 1.4.1 Currency Pairs 1.4.2 Spreads 1.4.3 Leverage 1.4.4 Market Orders 1.5 Intro to Technical and Fundamental Analysis 1.6 Trading with the ExpressFX Platform
11 13 15 19 21 23 29 33 35 39 43
SECTION TWO: FOREX CHARTS 2.1 Line Charts 2.1.2 Bar Charts 2.1.3 Candle Charts 2.1.4.1 Japanese Candlestick Patterns Long Candle Short Candle Spinning Tops Marubozu Candle Doji Candle Dragonfly Doji Gravestone Doji Four-Price Doji Deviant Doji Paper Umbrella Hammer Inverted Hammer Hanging Man Shooting Star Engulfing Pattern Harami
53 55 57 59 61 61 63 64 65 66 67 68 69 70 72 73 74 75 76 77 81
Harami Cross Dark Cloud Cover Piercing Line Morning Star Evening Star Abandoned Baby Tweezers The Bear’s Tweezers Bull’s Tweezers Windows 2.2 Support and Resistance Lines 2.3 Pivot Points 2.4 Chart Patterns
82 83 84 85 86 87 89 89 90 92 95 101 105
SECTION THREE: FUNDAMENTAL ANALYSIS 3.1 Who and What Affects Market Movement 3.2 The Major Events 3.3 Examples of How News Moves Price
119 121 123 129
SECTION FOUR: TECHNICAL ANALYSIS 4.1 List of Forex Indicators 4.2 Elliott Wave 4.3 Fibonacci
133 137 155 161
SECTION FIVE: TRADING SYSTEMS 5.1 Market Psychology 5.2 Forex Trading Best Practices 5.3 Creating a Trading System 5.4 Trading on a Live Account
167 169 173 177 181
Conclusion
185
With the deepest dedication to you, curious investor.
Introduction
U
SUALLY these books begin with the author stating how she or he got into the currency market. They might recount an anecdote of their college years, when they made XXX amount of dollars on a chance trade. Other authors use these first sentences to describe how awesome and immense the currency market is. I’m not going to follow suit. I’d like to begin this book by offering you flattering compliments. Think of it as an added incentive to keep you reading. That said, did you lose weight, Champ? It’s a very good look. And I must say that I love what you did to the place, you’re an artist. There you have it; you just received a good dose of compliments and the general “voice” of this book. You picked this book up because you want to learn about the forex market and how to trade successfully on the forex markets. To a first-time trader, this can sound like a daunting task. Reader, fear not. I’m going to walk you through everything you need to know about the forex markets and will do so in a manner that’s friendly, fun, soothing, and very easy to comprehend. There’s a lot of information in this book but I know you’ll be able to fly through it and understand everything completely. If at any point you find that there’s something that’s unclear, please visit our website at www.fxclub.com to find your answer. And if your answer isn’t there, you can send your question to info@fxclub.com and Forex Club’s expert customer service team will be sure to give you an answer. It’s important for you to realize that even professional forex traders make losses from time to time. All biases aside, I want you to view every trade you make, every price movement you watch, and every emotion you feel – good or bad – as a learning experience. As a novice to the market, you are a clump of clay; formless, colorless and with no direction as to what you will become. Every step forward that you take in your learning process will mold you into something better than you were. When you are happy with a trade that you made, bless your pips, and
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learn how to duplicate that trade. When you’re upset with a trade that you made, move through it, and learn from your mistake. So, sit down someplace nice, make yourself cozy, and pour yourself a nice drink. Let’s learn about forex.
Section One
Forex Basics
1.1
History of the Market
M
OST of us have had firsthand experience with the forex market. Some may have placed their money into savings in a currency more stable than their own, while others may have converted currencies at an exchange booth in an airport prior to traveling abroad. On that trip to Sweden or New Zealand, you may have noticed that the price at which your money was being exchanged was never quite the same two days in a row. On some days, you were able to squeeze out a few more pennies for bucks and on other days, those Swedes robbed you of some cents. When you saw this happen, you may have asked yourself, “Why is this happening?” The day is September 1, 1939, and Germany’s forces have just moved into Poland, sparking a little conflict that would later be known as World War II. Let’s fast forward to July 1944, fourteen months shy of the war’s end. In Bretton Woods, New Hampshire, representatives from the Allied nations gathered to discuss how they would go about restoring the global economy that has been decimated by the war. Their solution was the Bretton Woods system. Under the Bretton Woods system, all currencies involved with the pact were pegged against the United States dollar (which was pegged to gold at $35.00 an ounce.) This system remained in practice for some decades after, but it underwent many reforms to keep up with the world’s changing economy. It wasn’t until the early 1970’s that the practices of the Bretton Woods system were dissolved for various reasons, such as a weakening dollar as a result of the Vietnam War, and to combat a would-be liquidity crisis, among other reasons, after which currencies were able to fluctuate at their own accord. If the price of anything fluctuates, an investor is always nearby trying to exploit ways to profit off the fluctuations. Hence, since the price of currencies fluctuated, investor entities bought and sold large sums of currencies
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against other currencies in an attempt to make profits from these fluctuations (although losses also occurred). Today, the forex market is the largest market in the world, trading sums of approximately 1 – 3 trillion dollars per day. Several entities participate in the market, including: • • • • • • •
Central banks Commercial banks Market makers Investment firms Brokerage firms Firms that perform foreign trade operations Private individuals
You and I fall into the latter category. Only recently have private individuals been allowed to trade on the currency markets. Thanks to the aid of brokers’ technological advancements that allowed traders to access the market and to the allowance of high leverages that made trading on the forex market worthwhile, the presence of private individuals in the marketplace has thrived.
1.2
Why Choose forex? Comparing forex to Stocks
I
F you’d like to diversify your portfolio, you have dozens of choices. You can invest in stocks, commodities, options, real estate, or a crazy yet oddly clever idea that your brother-in-law had. Like I said before; if the price of anything fluctuates, you can invest in it. So why choose forex? 1 Let’s take a look at how forex compares with stocks (fig. 1.2), since the stock market seems to be the first choice for many prospective investors.
1 Trading foreign currencies on a margin carries a high level of risk and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade, you should carefully consider your investment objectives, level of experience, and appetite for risk. The possibility exists that you could sustain a loss of some or all of your initial investment; therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. 15
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Fig. 1.2 Forex vs. Stocks
Leverage We’ll look at leverage in greater depth later on in this section. For now, know that leverage is a loan given to a trader by your broker to intensify their results while trading. In stock trading, investors are allowed a leverage of 2:1, which means that their broker will allow them a loan of $2 per every $1 the investor puts into a trade. In the forex market, brokers can give their traders a leverage of 50:1, which means they’ll lend the investor $50 per every $1 they invest into a trade. I placed this as an advantage because a high leverage allows a trader to be more exposed to the forex market, but always keep in mind that with great leverage comes great responsibility. Leverage can increase your profits and your losses.
24 Hour Trading I’ll introduce you to the different trading sessions in a little bit, but for
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now just know that you can trade 24 hours a day, 5.5 days a week on the forex market.
Great Liquidity There is a great amount of liquidity on the forex market, meaning that if you want to buy or sell a currency at a certain price, chances are that you’ll get it. For example, let’s say you’re trading stocks and you invest all of your money in company ABC. Their stock plummets and you try like a mad man (or mad woman, we’re not here to discriminate) to sell off that stock. Not many people out there will want to buy a losing stock; hence you may be stuck without a buyer taking that stock off your hands. Since trillions of dollars traded on the forex market every day, the market is extremely liquid. If you open a position or place an order, Forex Club will guarantee* that the trade is opened for the price you bought it at and will guarantee that all of your orders are filled. *Providing the market trades at those levels.
Limited Trade Decisions In an attempt to avoid making this book sound dated (as I anticipate new currency pairs in the near future), I’ll tell you that there is a liberal number of about five dozen popular currency pairs on the forex market that are commonly traded compared to the thousands of stocks offered on the stock market, making your decision of what pair to trade incredibly easier than picking out a winning stock.
Accessible Information Traders on the forex market also have great exposure to the information that causes price to move. This information, such as news releases and speeches given by influential government officials, is outlined on economic calendars. By looking at economic calendars, a trader will always have an idea of what news event is coming up and how this news event will affect the price of currencies. I’ll delve deeper into this topic later on in the section on fundamental analysis.
1.3
Examples of How Money Is Made and Lost in Forex
N
OW that you have an idea of what the market is and why forex trading is more convenient than trading stocks, I’m going to give you some examples of how money is made and lost on the forex market to better your understanding of what you’re getting into. On the forex market, traders can make money or lose money by exchanging currencies. The profit and loss occur when the price of these currencies fluctuate. Ideally, a trader aims to buy a currency at a low cost and sell it off at a higher cost. Alternately, a trader could aim to sell off a currency at a high cost and buy it back when it
Fig 1.3 GBP/USD Chart 19
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In Fig 1.3, a trader aspires to make money online by trading the GBP/ USD. Using leverage, a trader can attempt to earn money with a modest deposit. With a leverage of 50:1 ,2a trader can buy or sell up to $10,000 with an original investment of $200. If the trader sold $10,000 GBP against USD at 1.6650 and two weeks later bought at 1.5800, let's see how much money he or she would have made: (1.6650-1.5800) X $10,000 = $850 You could have turned your $200 into $850. Now let’s look at that through the reverse side of the trade: if a trader were to buy at 1.6650 and hold his position during the downtrend, he would have lost his deposit. Forex trading involves substantial risk of loss and is not suitable for all investors. As a trader, it’s your responsibility to follow good trading practices to manage your risks. In this book, I’ll offer you great information on how to manage your risks and create a trading system that, if used properly, will maximize your profits and minimize your losses.
2 *The high degree of leverage can work against you as well as for you.
1.4
Market Hours
T
HE forex market is a global entity that allows for 24 hour trading, 5 days a week. An easy way to look at the market is to compare it to a 24 hour deli. The deli is always open, but the same person isn’t always running the shift. Let’s take a look at the worker’s name tag. If you live and trade in New York, you may find that the worker of the graveyard shift has a name tag that reads, “Hello! My name is Asian Session!” The worker who works the early morning shift to lunch time is the London Session, and the worker working the same hours as you is the U.S. Session. Each one can provide you with the same great service and products. Here’s a chart that contains the forex market hours: TIME ZONE
EST
GMT
Tokyo Open
7:00 PM
00:00
Tokyo Close
4:00 AM
09:00
London Open
3:00 AM
08:00
London Close
12:00 PM
17:00
U.S. Open
8:00 AM
13:00
U.S. Close
5:00 PM
22:00
You may have noticed that I included Eastern Standard Time as well a Greenwich Mean Time. Why did I choose to use these two time sessions? The answer is simple – because I’m biased. I live and work in the EST zone, so I’m going to place certain times for things like webinar events, trading contest times, or news releases in EST so that it’s easier for me and the team. The forex market exists in every inch of the world that is graced by sunlight. As a trader of the forex market, it’s important for you to fully understand 21
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GMT and different time zones. By knowing the different time zones, you’ll know exactly which session you’re in and what news is making what currency pair jump. In looking at the previous chart, you may have noticed time periods in which two trading sessions over lap one another. Tokyo and London are in shop from 08:00 (GMT) – 09:00 (GMT) while London and New York are working together from 13:00 (GMT) – 17:00 (GMT). Get out your maps and calculators and find out when these times occur in your neck of the woods, because these two periods of time are when the market is its busiest. A busy market means more volatility. The busiest days on the forex market are Tuesday and Wednesday, and the busiest session is the London session. During these days and times, the market does its biggest moves. You should think of big moves on the market as little gifts from a dear friend. Little moves on the market, however, are more like the smelly little gifts that your dog leaves on your carpet. Low volatility in the market is not your friend. Many traders find that they make their most frequent losses during times of low volatility. Sunday is the slowest day on the market and the second-slowest day is Friday. Low volatility also occurs during holidays when banks are closed. Keep an eye on the economic calendar on www.fxclub.com to make sure that you avoid trading on a holiday. As a forex trader, your job is to harness market volatility. When Japanese candles (mentioned later) start stretching, traders want to get into the right side of the trade to make profit – but the risk of loss is always present.
1.4.1
Currency Pairs
A
currency pair is exactly what the name implies: a pair of currencies. The concept of a currency pair can be hard to grasp at first. The idea behind a pair is that you can buy one currency for the other, or you can sell off one currency in exchange for another. The world is a big place, and there are dozens of currencies out there, so I’ll just go through all of the most popular currencies. Country
Currency
Slang
Symbol
Australia
Dollar
Aussie
NZD
Canada
Dollar
Loonie
CAD
European Union
Euro
Fiber
EUR
Great Britain
Pound
Cable
GBP
Japan
Yen
Yen
JPY
New Zealand
Dollar
Kiwi
NZD
Switzerland
Franc
Swissy
CHF
United States
Dollar
Buck
USD
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A trading pair consists of a base currency and a quote currency. The first currency listed in the pair is the base currency, while the second currency is the quote currency. What a trader is doing when he or she places a trade is buying or selling the base currency using the quote currency. Here, let’s look at a pair:
EUR/USD That’s the Eurodollar, the most popular pair traded today. In the case of the EUR/USD pair, the Euro is the base currency, and the USD is the quote currency. If you’re trading the EUR/USD, you are buying or selling Euros using the United States dollar.
Fig 1.4.1.1 Buying versus selling
In Fig 1.4.1.1 is the EUR/USD as shown in the ExpressFX platform. Your goal is to make money on this trade. In order to do that, you’ll have to evaluate whether price will go up or down. At first, this may seem like a gamble, but as you continue reading, you’ll find out that there are proven ways to estimate which way price will move. For now, do you think price will move up or down? If you think price lines are going to move up, you would want to buy, or go long on the EUR/USD. In this instance, you would purchase Euros using United States Dollars. If you think price lines are going to move down, you would want to sell, or go short on the EUR/USD. In this instance, you would sell off Euros for United States Dollars. There are different groups of currency pairs, each with its own name,
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style, and personality. The first group we’ll look at is that of the major currency pairs. As a first-time trader, it would be a good idea to trade a major currency pair because they are the most popular pairs; you can find the most information, signals, and analysis for them. Here’s a look at the six majors: Majors Euro/United States dollar (EUR/USD) British pound/United States dollar (GBP/USD) United States dollar/Japanese yen (USD/JPY) United States dollar/Swiss franc (USD/CHF) Australian dollar/United States dollar (AUD/USD) United States dollar/Canadian dollar (USD/CAD)
We also have a group of currencies called crosses. A cross is a currency pair that does not have the USD as its base or quote price. Here’s a look at some crosses: Crosses Canadian dollar/Japanese yen (CAD/JPY) Swiss franc/Japanese yen (CHF/JPY) Euro/Swiss franc (EUR/CHF) Euro/Japanese yen (EUR/JPY) Australian dollar/Swiss franc (AUD/CHF)
The list of crosses goes on, but you get the point. If you don’t see a USD in the pair, it’s a cross. Each pair has its own personality. Think of each pair as a unique animal. Some animals are nocturnal and move the most at night. Some are sluggish, while others are quick. Some animals move in similar directions while others move in opposite directions.
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I’m going to focus a little bit on this idea of recognizing which pairs move in similar directions because it can be quite helpful for you. If you know that two different pairs move alike, you can “hedge” a position, or diversify a profit that you’re already making.
Pairs that Move Similarly AUD/USD and EUR/USD AUD/USD and GBP/USD EUR/USD and GBP/USD EUR/USD and NZD/USD USD/CHF and GBP/USD
Fig 1.4.1.2 EUR/USD and AUD/USD
In fig. 1.4.1.2, you can see the EUR/USD chart on top and an AUD/ USD chart on the bottom. They look pretty similar, don’t you think? I think so. We also have currency pairs that move opposite from one another. Those pairs are:
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Pairs that Move Oppositely AUD/USD and USD/CAD AUD/USD and USD/JPY EUR/USD and USD/CHF GBP/USD and USD/CHF GBP/USD and USD/JPY
Fig 1.4.1.3 USD/CAD and AUD/CAD
There you have – actual proof that what I said is correct. In fig. 1.4.1.3, we have two charts of pairs that are known to move oppositely from one another: the AUD/USD and the USD/CAD. They almost look like a mirror reflection of one another. Now that you have an idea of what currency pairs are and how they move, I’m going to talk about how you can buy yourself into a trade.
1.4.2
Spreads
I
N the forex market, a trader pays his or her broker a spread cost in order to initiate a trade. Spread costs are usually a fraction of a cent. The smallest increment of a currency is called a pip. Spreads usually range from 1 to 15 pips, depending on which currency pair you’re trading, although some exotic pairs may cost even more. You can find out how much a broker is charging for a spread by looking at the “bid/ask” price. In the industry, we call it the bid/ask price, but on forex Club’s platforms we simply call it the “sell/buy” price because that seems to be easier to understand.
Fig 1.4.2 Sell/Buy price as featured in Rumus
Fig 1.4.2 shows the currency pair EUR/USD. You’ll notice that there are two buttons: a sell button that has the price of 1.4016 on it and a buy button that has the price of 1.4019 on it. The difference between these two costs is three pips (1.4019 minus 1.4016 equals .0003). This means that you’ll pay three pips spread to trade this pair. After factoring in spread costs, this also means that price has to move three pips in favor of your trade before you can profit. On the forex market, traders initiate trades in lots. A lot is equivalent to 100,000 units of currency. Don’t get intimidated, it sounds like a large amount of money but it can be accessible because a trader can trade fractions of a lot with forex Club. On the very easy to use ExpressFX platform, a trader 29
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can even open a position for whatever amount of money he or she wants to trade simply by typing in the amount into the trading platform. To give you an idea of how many pips a trader can make per trade and how much spread costs depend on the amount of money placed into the trade, look at the table below: Units of EURUSD Traded
1,000
10,000
100,000
1 pip =
$0.10
$1.00
$10.00
So, for example, if you were to trade one thousand on the EUR/USD, you would have to pay three pips spread which equates to $0.30 and would make or lose $0.10 each time price moves a tick up or down. 1,000 units is the smallest trade size allowed by Forex Club and will cost you ten dollars of your money to trade using 50:1 leverage. 3 The chart above deals only with the EUR/USD. When dealing with a currency pair containing JPY, one pip is equal to .01, instead of .0001. Moreover, to calculate the pips per profit for different pairs, you would need to use a slightly more complex equation. Pairs containing CHF or CAD as a quote currency have a pip price equal to one dollar divided by the USD quote currency rate per 10,000 units traded. If the instrument contains GBP or AUD as a quote currency, the pip price would be $1 multiplied by the USD quote currency rate per 10,000 units. Finally, the JPY pip rates equal one hundred dollars divided by the USD/JPY rate per 10,000 units. If that sounds difficult, I advise you get your hands on a practice account and get firsthand experience of P/L levels per transaction sizes using different currency pairs. When you look at the sell/buy price, you’ll always notice that the buy price is greater than the sell price. When a trader opens a sell position, she must buy back a new position in order to close her deal. For example, if I sell off $10,000 EUR/USD and lose $20.00, I can’t just wave a magical wand and close the position. I’ll have to buy $10,000 EUR/USD to have the position closed. To revisit a thought previously mentioned, if you want to make money on 3 The high degree of leverage can work against you as well as for you.
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the market, you have to make sure that price moves favorably in the direction of your trade more than what you paid for the spread. In other words, if you paid three pips spread to initiate a EUR/USD trade, price has to move in your direction greater than three pips in order for you to make profit. If you close a position with three pips profit, this means that your trade broke even. If you close a position with less than three pips profit, this means you lost money. Spreads can be hard to understand at first and they’re not especially exciting to talk about. The people at Forex Club understand this. This is why they offer a totally unique and very lucid solution to trading with spreads called zero spread trading (which is exclusive to the ExpressFX platform.) The way it works is very simple – a trader only has to pay $0.40 per every one thousand units of currency he trades on any pair offered on the ExpressFX platform. There is also a commission return feature, which instantly refunds the commission cost that you paid the moment one of your trades becomes unprofitable. As the saying goes, “Trade with zero spread and pay commission only when you profit!” It’s a good saying.
1.4.3
Leverage
I
N the previous section that I said you could buy 1,000 units of currency with just twenty dollars of your money. So how do you get that extra money? Hold up an old lady? Rob a liquor store? Sell your body to science? Nay, you use leverage. Leverage is a personal loan given to each individual trader by his or her broker to intensify that trader’s results. When a broker talks about leverage, you’ll usually see two numbers that look like this:
:1 The broker is telling you that it is willing to lend you X amount of dollars for every one dollar you place into a trade. Leverage is an essential part of the forex industry because a trader needs to command a large sum of money in order to see results. Common leverages offered by brokers are 10:1, 20:1, and 50:1. My personal opinion is to use a limited amount of leverage. A leverage such as 20:1 is a nice safe amount. If you use 50:1 leverage all the time, you’re intensifying the amount of money that you can win, but you’re also intensifying the amount of money that you can lose. To give you a better understanding of how your trades are intensified, take my example below: You’re a trader who deposits $1,000 into a trading account. Using the leverage of up to 50:1 provided by Forex Club, you can trade with up to $50,000.00 units of currency (50 multiplied by $1,000). Let’s say you were to place your entire amount into a trade while using all the leverage. With $50,000.00 of currency placed in a trade, every time price moves up or down one pip, you will make or lose $5.00. The forex market is very volatile, so price can jump dozens of pips in just minutes. Let’s say price moves in your favor ten pips in a minute with 33
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the above trade; that means you just made fifty dollars in just one minute! But what happens if you weren’t so lucky and price moves against you? That fifty dollars could just as easily be lost. In that case, you’d be wishing that you hadn’t placed all of your eggs into that basket. Please understand that using high amounts of leverage can be dangerous. I highly recommend that you trade different amounts of money with different leverages on a risk-free, no cost, practice account offered on www.fxclub.com so that you can fully realize the pros and cons of leverage. Recently, it was made mandatory that all leverages be limited to 50:1. Prior to this, traders could use leverages of 500:1 or higher - financial suicide. On the forex market, the amount of money that you put into your account doesn’t necessarily correlate with how well you do. If you risk a large amount, you can profit or lose a large amount. Be smart when deciding the amount you want to trade and don’t get too greedy. As a Chinese proverb says, “Cross the river one stone at a time.”
1.4.4
Market Orders
A
market order is an order to buy or sell into a currency. Orders are what enable you to enter into a trade on the forex market. By placing a market order, you’re telling your broker to initiate an immediate trade to open or close a position. There are simple buy/sell orders, which enable a trader to buy or sell a currency pair, and then there are orders that are slightly more complex.
Take-Profit and Stop-Loss Orders You have a feeling in your bones that a currency pair is going to leap up a hundred pips. You want to sit by your computer all day, close price when it hits its zenith, and rake in all that cash, but you looked out the window and saw the sun and remembered how much you love being outside. So, instead of trading, you strap on your sneakers and run outside to frolic in the grass. While you are in mid-frolic, price jumps up a hundred pips. You just missed out on your trade. Has this situation ever happened to you? Probably not. While frolicking in the grass may not be on the top of your to-do list, there are millions of things that can distract us from our work and our trading. It is humanly impossible to stare at price charts all day long, because as the saying goes, “life happens.” Imagine if you could look at a chart all day. Your eyes would shrivel up into little beady raisins. You don’t want beady-raisin eyes; they look disgusting. In the attempt to save the eyes of traders around the world (and for various other reasons, I’m sure), take-profit and stop-loss orders were created. A trader can set take-profit and stop-loss orders the moment he or she opens a new position. By setting a take-profit position, you ensure that your
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position will close after you make a certain amount of profit that has been predetermined by you. Look at fig 1.4.4.1 to see what the take-profit order looks like in the ExpressFX platform.
Fig 1.4.4.1 Setting Take Profit in ExpressFX
Adversely, by setting a stop-loss order, you can have your position automatically closed when you’ve incurred a certain amount of losses. Fig 1.4.4.2 shows you what the stop-loss order looks like in the ExpressFX platform.
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Fig 1.4.4.2 Setting Stop Loss in ExpressFX
Once price has hit a level to activate either take-profit or stop-loss orders, Forex Club guarantees that the order will be “filled,” or that the order will go through at the price at which you set it. In fig. 1.4.4.3, you’ll find an example of what the take-profit and stop-loss orders actually look like on the ExpressFX trading platform. In the example, I’m betting that the United States Dollar will weaken against the Canadian Dollar. In other words, I’m selling USD/CAD. The current price value can be seen as a red line running across the chart. Slightly above that red line is a solid green line, which is the price at which I sold the currency pair for. Now look for the orders – they appear as dotted green lines above and below price’s current value. The dotted green line on the top of the page is the stop-loss order. Said order is signified by a sad face. The dotted green line below the current price value is the take-profit order. This order is signified as a happy face.
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Fig 1.4.4.3 Orders as they appear in ExpressFX
The moment price hits one of the dotted green lines, the position will automatically close and I will either be rewarded with the profits or kick the dirt thinking about the losses.
1.5
Intro to Technical and Fundamental Analysis
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RADERS use many different methods to estimate whether price will move up or down. I knew a trader from Chicago who would shake his magic 8 ball before opening a position. A friend from Atlantic City would always travel up the boardwalk and ask the old white eyed palm reader if he should go long or short on EURUSD. There was another trader from Haiti who used to throw chicken bones and read the way they landed before opening a trade. These traders had one thing in common… they were all very, very bad at trading forex. Traders use two methods of analysis to estimate how price will react. These methods are called technical and fundamental analysis. Both methods are very different from one another, but they’re both very effective and must be considered by all traders who hope to last on the forex market. Humans have brains that process information and rationalize it according to their emotions. Computers have motherboards that process information to provide definitive, hard answers. Fundamental analysis relies heavily on the brain, while technical analysis relies on the computer. With fundamental analysis, you’ll be analyzing news, natural disasters, speeches and the way speeches are spoken; while with technical analysis, you’ll be analyzing the answers of complex equations given to you by your computer. Fundamental traders believe that price is a momentary thing. The past does not matter. Burn those price charts that you have from 2008, because our destination is the future. The only thing that matters to a fundamental trader is the present. The future of price will be determined by the release of news events, natural disasters, or speeches from powerful political or social figures.
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The fundamental trader’s Bible is the economic calendar. You can find an economic calendar on the Forex Club Web site by visiting http://www.fxclub. com/economic-calendar/. On the economic calendar, you can find all of the global events that cause price to move. These events can include bank releases of interest rates, unemployment rates, vehicle sales … anything that directly correlates with a country’s economy. Let me take you a bit deeper into the forex market to show you why these events affect price so much. The heart, brain, and nerves of the forex market are its traders. This means that the forex market is being controlled by thousands of men and women who are doing everything in their power to make money. If a large number of these men and women buy into a currency, the currency will strengthen. In the opposite scenario, if these men and women sell off a currency at a rapid rate, the currency will weaken. This is the reason why fundamental traders trust the economic calendar – the calendar releases up-to-date news on the important economic indicators that will trigger moments of excessive buying or selling. If the outcome of these reports is better than expected, that means the country’s economy is strong. That cues the men and women to buy into this country’s currency, hence, making it stronger. Of course, if the outcome of the reports is poorer than expected, these traders will sell off the currency, making it weaker. It should be noted that these men and women are mad – they’re indecisive and driven by greed. There have been instances where they disregarded the economic calendar information or went against it. I’ll go into further detail of fundamental analysis in section 3; I’ll tell you more about these men and women – a rundown of the major events that cause price to move. We’ll look at past examples of when big news events caused price to move and when big news events had no effect on price at all.
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Fig 1.5.1 News as is shown in ExpressFX
A fundamental trader would see Fig 1.5.1 and say, “Hey, price just went up because of the XYZ news event that was just released.” Now, whereas fundamental analysis don’t care about past price movement, technical analysis relies heavily on historical data. By using mathematical equations, technical analysts gather past data and use the information given to them to weave indicators that they place onto charts or to look for chart patterns that emerge. Thanks to platform advancements, traders such as you and I don’t even need to pick up a calculator to process these complex equations. All you need to do is click a button and presto, the trading platform will do all of the plotting for you; it’ll be up to you to interpret the actual charts. There are different types of software and companies that offer technical analysis for free. With Forex Club, you can get free market signals courtesy of Autochartist when you sign up for an account. Traders who have a live account with Forex Club will get technical analysis courtesy of award winning Trading Central.
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Fig 1.5.2 Indicators plotted on EURUSD
In fig 1.5.2, I used Forex Club’s advanced Rumus platform to plot what a technical trader’s chart may look like. Every single line in that chart tells a technical analyst something very important about the market. The lines are like a different language, a language that you must learn to speak and read in order to understand what the forex market is telling you. I’ll go into detail about technical indicators in the next section and in section 4. Don’t let the picture above intimidate you – once you know what each indicator means (and I’ll tell you what about twenty of them mean), you’ll have a much easier time reading and understanding the charts.
1.6
Trading with the ExpressFX Platform
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AKE your keyboard and place it on the floor. Now get your dog. If you don’t have a dog, a cat, ferret, gerbil, hamster, or any other small creature will do. In the event that you don’t have any pets, take off your right shoe and sock. Do you have that all ready? Good. The next step is to get Forex Club’s ExpressFX platform. You can download the platform at www.fxclub.com/ expressfx. Have the software running on your computer, and then allow your pet to walk across the keyboard. If no pet is readily available, place your foot firmly against your keyboard. Chances are good that you just placed a trade using ExpressFX. It’s that easy. Forex Club’s programmers worked very hard to create the simplest, most user-friendly forex trading platform ever created. The thought process behind the creation of this platform was very simple; the Forex market can be a tricky thing to conquer, but the tool you use to enter the market shouldn’t be. As your teacher, I’d like you to read this book and other books to help optimize the amount of money you can make while minimizing losses on the forex market. I don’t want you to have to pick up a 400-page manual that talks about how to plot a simple price chart on some complex trading platform. If you haven’t already done so, go online and visit www.fxclub.com/ expressfx/. On this page, you will be able to register for a practice account and download the software. Both processes will take you only a few seconds, depending on how long it takes you to write your name and email address. With the ExpressFX practice platform, you can place risk-free trades on the forex market using “virtual money.” We’ll supply you with fifty thousand virtual dollars to trade with as you please. With this virtual money, you can
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get a better understanding of how much money you could expect to make or lose on the market depending on your trade amount. Practice accounts are essential for all traders. Newbies need them to get firsthand experience in the forex market prior to placing one of their hardearned dollars at risk. Veteran traders need them to test out new strategies. Regardless of your skill level, you will always want to keep a practice account at hand, so make sure that your write down your ExpressFX username and password, and store it somewhere safe. When you first launch the platform, you’ll find a login area at top center, price quotes to the right of the login area, a large area in the center of the screen where we see price movement, and a news section below that. We want to focus on the login part at first, seen in fig 1.7.1.
Fig 1.7.1 Platform log in screen
Here is where you enter the information that was provided to you when you registered for your ExpressFX platform. Once you’ve entered the correct account number and password, click Enter to access to the platform. You’ll notice that your password is a mess of random numbers and letters that are in no way easy to memorize. The first step that I always take once I open a new trading platform is to change the password. I usually like entering a password that’s very memorable to me. Something like killerrobot1386.
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Please feel free to enter a password that’s easy for you to remember; doing so will make future log ins a breeze.
Fig 1.7.2 Preparing to change password to killerrobot1386
To change your password, click on the Settings tab and scroll down to “change password” (seen in fig 1.7.2). In order to change your password, you’ll be required to enter your current password followed by your new password. Now that we have our platform opened and a nifty new password created, let’s look down at the ExpressFX’s most prominent feature: the price chart (fig 1.7.3).
Fig 1.7.3 Price charts in ExpressFX
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On the top left of the chart is the trading pair that we use followed by the time frame. In this case, our trading pair would be EUR/USD, and the time frame is by the hour. Above the chart are eleven tabs, each one labeled with a different trading pair. You can switch between charts to view these other currency pairs simply by clicking on the tabs. If you’d like to view the charts in different time frames, click on the small upside-down triangle beside the given time and make your choice. On the ExpressFX platform, traders can view currency pairs over the course of hours, days, weeks, months, or a year. The time has come, reader. I would like for you to now pick out your favorite currency pair. Will you be like 27 percent of the traders currently trading forex and choose the EUR/USD? Maybe you’re feeling dangerous and would like to trade the volatile GBP/JPY? Or maybe you’ll pick the EUR/ CHF, because that pair happens to have all of your favorite letters in it. Call me old fashioned, but for this example, I’ll pick the trusty, good ‘ol EUR/USD. Now it is time for me to place my trade. On the ExpressFX platform, you’ll notice that the top left button says “trade,” and shows a picture of currency being wrapped by two blue arrows. Give that button a click. Once you click the button, you’ll notice that a pop up window appears. That window will look something like fig 1.7.4.
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Fig 1.7.4 It takes two to tango
This is the first step to opening a trade. From here, you may enter your currency pair and choose which direction you think the pair will move. Here’s a rule of thumb for all first-time traders –enter the currencies according to how they show up in the currency pair. For example, if you’re trading EUR/USD, make sure that the first currency you choose, which appears in the “I expect that” row, is EUR and the last currency you choose, which appears in the “against” row, is USD. If the pairs match up in this way, it will be much easier for you to understand which position you’re opening using the “up” (buy order) or “down” (sell order) feature. When you’re all settled on which direction you think the currency is going to head, click the continue button. Our next step is to pick the amount of money you wish to place into your trade. The ExpressFX practice account is preset with fifty thousand units of currency. You’ll notice the lowest amount that you can trade is one thousand and the largest amount by default is five million. This seems like a lot of money, but it is attainable through using Forex Club’s 50:1 leverage. 4 4 The high degree of leverage can work against you as well as for you.
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Fig 1.7.5 Setting my trade for a buck a pip
For the trade featured in fig 1.7.5, I’m prepared to place ten thousand units of currency at risk in hopes of making a profit. That’s a good safe amount, in my opinion. After you have chosen the amount of money that you’d like to trade, the next step is to set your take-profit. Remember that order? It’s the one that closes your position the moment you’ve made a certain amount of profit. And after you set your take-profit order, you can set your stop-loss order (the one that closes your position when you’ve made a certain amount of losses.) Once you’ve set these two limit orders, you’ll be brought to the final step in your opening a position journey. Rejoice, reader. You are about to make the transition from average Joe to forex trader. A pop up screen will appear confirming your order. When you see this, you have to hit the “request price” button. Now it’s time to act quickly! The ExpressFX platform will show you a quote for four seconds before recalculating the next quote. Why the rush? At Forex Club, we utilize the request for quote feature, which ensures that the price that you request is the price you get – guaranteed, regardless of current market conditions. Without this feature, slippage could occur. Slippage occurs
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when price moves extremely fast precisely while you are trying to initiate an order. The market is moving so quickly that a broker can’t quite pin point the price you think you’re getting. As a result, price slips out of the broker’s hands for a moment and you end up in a position a few pips away from the opening price that you wanted. In other words, you may lose out on money because of a broker’s poor execution. Forex Club guarantees no slippage on their ExpressFX and Rumus platform. If you like the quote presented to you at step 5, click on confirm button to enter your trade (fig 1.7.6).
Fig 1.7.6 Confirming your trade
It’s time to make your business cards. Forex Trader Extraordinaire would be a good header for the card – it has a good ring to it. Send a few to the family; they’d be proud. After you place a trade, it’s time to follow the trade to see how your position is doing. You can view the trade and all of its details in the white area above the charts. Here, you can see the trade size, currency pair, price,
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current P/L (profit and losses), your orders, and how much commission will be returned to you if you are in a failed trade. In fig 1.7.7, you can find two different instances in which a trader is making profit or losing money.
Fig 1.7.7 Making money or making losses
At any time during your trade, you can change your take-profit or stoploss order by clicking on the limits button located at the top of the platform. The ExpressFX platform has some features located to the right of the price chart. There are two magnifying glasses to zoom into and out of the market, a drawing tool to plot lines on your charts, an auto-adjust tool that keys into your trade and a tool to change the line chart into a candle chart (explained later). All of these tools are very useful for a novice, and I suggest you play around with all of them. When you’re ready to close your position, simply hit the close position button, seen in fig 1.7.8.
Fig 1.7.8 The trade is over
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The request for quote pop up will appear to lock in on a closing price, so make sure that you click to request it within four seconds or you’ll have to request for another quote. Once you have clicked on the button that has appeared, you have successfully opened and closed a forex trade. Congratulations; you’re now a trader.
Section Two
Forex Charts WHEN you look at the price chart, you’re looking at the ideas and expectations of the thousands of men and women who are currently trading on the forex market. Price charts show the current and past values of a currency pair. You can find out how much a currency pair is currently worth by looking at the numbers to the right of the chart. The price shown is the price of the base currency’s worth in exchange for the quote currency. For example, you know that in the pair EUR/USD, the euro is the base currency and the United States dollar is the quote currency. If the price of the EUR/USD is 1.4000, that means that you can buy one euro using 1.4000 United States dollar. Let’s take it one step farther; if we switched the equation around we’d find that we could buy one United States dollars using 0.7146 Euros (1 unit divided by the value of 1.400 equals 0.7146). Each different type of chart has its own unique qualities, but they all share a universal feature: Price charts are divided into different price intervals.
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These different price intervals are: • • • • • • •
Tick Minute Hourly Daily Weekly Monthly Year
The smaller the increment of time you choose, the less past information you can see. This has its advantages and disadvantages; most chartists need past data to help them plot lines called support and resistance, lines which help them determine if price is going to break out (move rapidly in a certain direction), but use smaller time intervals to narrow in on an entry point. I’ll tell you all about these support and resistance lines later on in this section. But for now, onto the charts.
2.1
Line Charts
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HIS is one of the more basic charts. With line charts, the last closing price of each interval is shown at the end of the line, or rather at the point farthest to the right. When looking at this chart in small time intervals, you will notice that price has a tendency to jump up and down, forming acute edges. It’s nearly impossible to get any meaningful indication of future price movements from this information alone. If you take a step back and look at line charts in intervals of months, you’ll notice that these jagged little spiked lines are more smoothed out. Line charts are one of the easiest charts to read, but they don’t provide traders with great insights in technical analysis.
Fig 2.1 A line chart of the EUR/CHF
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2.1.2
Bar Charts
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HE bar chart expands on information not given on line charts. On a bar chart, traders can find four key prices in any time interval:
• • • •
High (the highest price in the interval) Low (the lowest price in the interval) Open (the first price in the interval) Close (the last price in the interval)
On bar charts, the time intervals are extremely relevant. Each bar on the graph represents one unit of time that is determined by the interval of the chart. For example, if you’re looking at an hour chart, each bar represents one hour. If you’re looking at a minute chart, each bar represents a minute. If you’re looking at a weekly chart, each bar represents – you guessed it – a week. The open price signifies the exact price of the currency pair at the moment the time interval began. If we’re looking at an hour bar chart, for example, the beginning of each hour would be marked by the open price. If we’re looking at a daily bar chart, the beginning of each day would be marked by the open price and so on and so forth. You may notice that the bar tends to stretch or shrink after the opening price. The stretching and shrinking of the bar represents the fight for market dominance. The way I usually imagine it is that there is a gigantic bull and a gigantic bear. They both have human-like hands and are holding a tremendous rope. The gigantic bull and bear are trying to pull the rope towards themselves with all their might. The bull and bear are not alone; they have cheerleaders – thousands of them. And each one of them is mad, indecisive, and greedy. The more fans either animal has, the more it will pull on its rope. We can see how well either animal is pulling by looking at the bars. If the bar is sinking down, the bear is winning. If the bar is rising up, the bull is winning. 57
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After the time interval is done, the bar ends and a little notch can be seen which represents the closing price. The close price will provide two definitive gifts: the high and low price. The high represents the highest point that price hit from the moment the bar opened until the moment the bar closed. Likewise, the low represents the lowest point price hit between the open and close times. All of these aspects are illustrated in fig 2.1.2.
Fig 2.1.2 Open, high, low and close (OHLC) prices on a bar graph
The concept of having open, close, high and low points that are separated by time intervals is widely used. There are other charts that follow the same idea as the bar chart, but they are illustrated differently.
2.1.3
Candle Charts
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F you search the Internet for forex charts, I bet that nine times out of ten the charts that you find will be Japanese candlesticks. Japanese candlesticks are the world’s oldest form of technical analysis. They were originally created in seventeenth century Japan by Munehisa Homna as a way to track the price of rice. It wasn’t until 1985 that this form of charting reached the West, although the West was already utilizing bar charts, the function of which was very similar to that of candles. Strange, eh? To reiterate, candles follow the same rules of open, close, high and low prices as do bar charts. To further illustrate how these four prices are created, I’ve included fig 2.1.3 below to clearly indicate the different price levels over a specific interval of time.
Fig 2.1.3 A candlestick. It doesn’t get easier than that.
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You can see that the high and low prices are illustrated by thin black lines that form below or above the open and close price. These lines are called shadows or wicks. The thick part of the candle that exists between the open and close price is called the body. The bodies of candles are color coded in accordance to the direction that price is traveling. If the open price is less than the close price, this means that price went up. This is illustrated with a white candle. This is a bullish candle. In order to have made money trading this candle, you would have had to been in a long or buy position. If the open price is greater than the close price, the candle will be black. That means that price moved down. Black candles tell us that the market made a bearish move. In order to have made money in this scenerio, you would have to have been in a short or sell position. Candles are like snowflakes; each one is unique. Some candles are white; others are black. Some candles have long wicks, some have short wicks, and some have no wicks at all. Each one of these little discrepancies tells a trader a great deal of information about the market. When a professional trader looks at candles, she doesn’t see different colored lines. She sees messages and gestures. Every movement that a candle makes is the forex market making a muted sound. The market is communicating to us and those who understand the forex language are the ones who will profit the most. One of the easiest ways to learn a foreign language is with a translation dictionary. Think of this next section as a Forex-English dictionary: candlestick edition. Feel free to crease the next page over for future use, it will take you a few days of hands-on experience and chart watching to fully understand what each candle is telling you.
2.1.4.1
Japanese Candlestick Patterns Forex-English dictionary: candlestick edition
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ET’S start with the basics, and then I’ll ease you into the more difficult types of candles.
Long Candle Most of the different types of candles in this list have romantic, imaginative names that are both mystical and hypnotic. Not the long candle. You can’t get a more unimaginative name then long candle. A long candle is just that: a candle that is longer than the average candles on the chart. Some of the philosophers among us may ask, “What is a long candle? Who is to say when a candle is long?” One method to find the average size of candle involves tracing volume amounts with a moving average over a fairly long time (say sixty-five days) to determine an average candle length, in which to compare the long and short candles. Or you can just use your eye to determine which candles look longer than the other. This method isn’t an exact science, but eyeing the candles will work just fine. A long candle signifies a period in which the men and women of the market are buying or selling a currency pair at a rapid pace. Remember that tug of war between the gigantic bull and bear? When we see a long candle on the market, this means that one of the two won by a substantial amount. How can you tell whether the bulls or the bears won? You can find out by simply looking at the color of the candle’s body. Long white candles indicate a period of excessive buys, which means that the bulls are victorious. Long black candles indicate a period of excessive sells, which means the bears are victorious.
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Fig 2.1.4.1 Assorted candles
In fig 2.1.4.1, I’ve listed five different types of candles, the middle candle being the long candle.
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Short Candle These small candles represent a period of time in which the open price is very close to the close price. Essentially, the bulls and bears are fairly even here. Neither one can muster up the strength to make a meaningful big move. I say meaningful because the open and close prices are considered the most emotional moments for price.
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Spinning Tops These candles aren’t half as fun as their name implies. Spinning tops are typically short candles, but it’s not the size of the candle’s body that we consider when identifying these candles – it’s the size of their shadows (or wicks). Spinning top candles have shadows that are much longer than their bodies. What this candle tells you is that the bulls and the bears are fairly even, but only after a furious fight. Think back to the tug of war analogy – the bull and the bear are at a tie, but only after giving one another some ground. Their freakishly evolved human-like hands are probably beet red from tugging that rope. Ouch.
Fig 2.1.4.2 Spinning tops
A spinning top candle indicates a moment of indecision. The bulls and bears are fairly even here, and the men and women who are by the sidelines cheering are torn regarding which direction they should go.
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Marubozu Candle A marubozu candle is a candle that has either no upper shadow or no lower shadow – hence, its name, which translates to “bald.” In very rare cases, the marubozu has neither a top nor bottom shadow. Take a minute to think about what’s happening to the market here. The highs or lows are equal to the opens or closes, which is the reason why we have no shadows. If you see a black marubozu candle, this means that the sellers have had complete control of the time interval in which the candle was formed. The moment the candle opened, the bears gathered their numbers and did everything they could to drive price down, and it worked wonderfully until the moment that the candle closed. Adversely, if you see a white marubozu candle, the buyers were in complete control from the moment the candle opened until its close.
Fig 2.1.4.3 Mmm, marubozu bar
Fig 2.1.4.3 features a picture of a black marubozu or, as I sometimes like to call them, a dark chocolate marubozu. It’s a tasty candle, folks. These candles signify the strength of the buyers or sellers, depending on the color the marubozu. They can also signify a strong continuation signal, which means that if you see a marubozu, chances are pretty good that the next few candles forming on the chart will move in the same direction as that marubozu.
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Doji Candle The translation for doji is “unskillfully made.” Doji candles have no body, which means that their open and close prices are equal. Of all the different candles, the doji is probably the easiest to spot on a graph. It looks like a plus sign. When we spoke about the spinning top candles, I discussed how the bulls and bears were about even, signifying indecisiveness. With doji candles, the bulls and bears aren’t almost even – they are in a dead heat. A doji signifies a major moment of indecision. By itself, the doji is a neutral pattern, but when paired with some of the more complex candlestick patterns, the doji can signal a meaningful move on the market.
Fig 2.1.4.4 The unskillful doji
In fig 2.1.4.4, we can see a doji candle – or to be more exact, a long-legged doji.
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Dragonfly Doji This is where the names of the dojis start to get interesting. The history of the dragonfly doji’s name is a little shrouded in mystery, but many believe that this doji was named after the dragonfly because the insect is a graceful flyer that can hover and soar up with utter control and ease. A dragon fly doji occurs when a currency pair has made the same open, high and close price, but it has a different low price. This doji can has one long shadow below it. On the chart, it looks like an upper case T. Dragonfly dojis typically occur after a long period of selling. We’ll have a few black candles indicating a mighty move by the bears which will end the moment this dragonfly doji appears. Now it’s time for price to fly up on the wings of the dragonfly. We call this a trend reversal signal. Spot the picture of a dragonfly doji in fig 2.1.4.5.
Fig 2.1.4.5 The dragonfly doji
The dragonfly doji is an indication that a bullish market may appear.
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Gravestone Doji The gravestone doji is the dragonfly’s opposite. The gravestone doji got its name in the days when traders could only make profit if the market was moving up. When they saw this signal, they knew that all hopes of future profits were dead … at least for a short period of time. The gravestone doji is formed when price makes a same open, low and close price, but it has a different high price. In other words, we have a doji that has no lower shadow and one long upper shadow.
Fig 2.1.4.6 A series of candles leading to a gravestone doji
In fig 2.1.4.6 you can see a picture of a gravestone doji. The gravestones appear at the end of a bullish movement and signify that the bears are about to take control. Please note that reversal signals don’t automatically trigger a new trend. After such a signal appears, the market tends to drift sideways for a short period of time before price plows into a certain direction. Keep this in mind when you’re trading.
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Four-Price Doji The four-price doji appears when the open, close, high and low price are all the same. It looks like a dash, or a subtraction sign.
Fig 2.1.4.7 Four-price doji
Fig 2.1.4.7 is a picture of a four price doji. During your trading adventures, if you were to ever see a four price doji, it would signify total indecisiveness in the market or that some sort of error occurred on your trading platform. You won’t see them often, but may spot a few on a one minute chart on some Sunday afternoon.
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Deviant Doji Nothing in this world is perfect, and as I stated before, candles are like snowflakes – each one is unique. You may notice that a doji almost looks like a gravestone, except it has a small shadow on its bottom. You might also spot a candle that has an extremely small body; this may or may not be a doji. These imperfections happen on the forex market. They’re called deviant dojis. In the case of the standard doji, I accept that if the actual body of the doji is 10 percent of the entire candle, it’s a doji, as seen in fig 2.1.4.8.
Fig 2.1.4.8 Appropriate body-to-candle ratio of a doji
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Getting back to the gravestone and dragonfly dojis, use your own discretion when deciding if a candle is a deviant. I’ve included some examples of what a deviant gravestone and deviant dragonfly may look like in fig 2.1.4.9.
Fig 2.1.4.9 Deviant gravestone and deviant dragonfly dojis
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Paper Umbrella Essentially, a paper umbrella (fig 2.1.4.10) is almost like a dragonfly doji, except that this candle has a body. When we see this, what is happening in the market is that the price of a currency pair’s open, close and high are fairly similar, while its low price is much lower.
Fig 2.1.4.10 These paper umbrellas never appear in Tiki drinks
So the only difference is a little candle body. Big deal, right? Not really. The market is basically telling us the same thing as it would be telling us if we were to see a dragonfly doji. It doesn’t matter if the candle is black or white; a paper umbrella form on your charts is an indication that a bullish trend may occur.
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Hammer This is where the candles start to get more complex. Until now, all of the candles that we viewed were independent of one another. Now we’re going to move away from individual candles to look at what happens when we see several candles form into common patterns that have been known to cause price movements in the past. We’ll start it off with a simple candle called the hammer. The hammer candle looks exactly like the paper umbrella candle. The only difference between the hammer and paper umbrella candle is location. In order to have a hammer, we need to be in a bearish market. In other words, there must be a succession of black candles making their way down the chart before this candle can appear.
Fig 2.1.4.11 Stop – hammer time
You can see a picture of a hammer in fig 2.1.4.11. The properties of this candle are the same as those of the paper umbrella; price has made similar open, high, and close prices, but there is a lower low price. And, just as with the paper umbrella, the actual color of the hammer’s body doesn’t matter. No discrimination. Sometimes we need additional signals before we can enter into a trade. In the case of the hammer, if the hammer is followed by a black dragonfly or white candle, the old trend has come to an end, and a bullish trend may occur. If the hammer is followed by a black candle, we are entering into an uncertain market.
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Inverted Hammer An inverted hammer looks just like it sounds – it is a hammer that has been inverted or flipped around. When an inverted hammer occurs on the market, we know that price has made similar open, close and low prices, and a high price that exceeds all others.
Fig 2.1.4.12 Stop – inverted hammer time
Fig 2.1.4.12 shows a picture of an inverted hammer. Personally, I think this should be called a shoebox with a pencil sticking out of it candle – but who am I to rewrite history? In order to have an inverted hammer, we’re going to need the same location as what is needed to make a hammer – the pattern must occur at the bottom of a downtrend. Just as with hammers, the color of an inverted hammer’s body doesn’t matter; an inverted hammer, like a hammer, signifies that the bulls are about to take charge.
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Hanging Man In talking about the last few candles, I explained the candle formations that indicated bullish trends. Some of you bear fans might have felt left out. Fear not, bear fans! You, too, have candles that signify bearish trends. The hanging man got its name for obvious reasons – it looks like a man who is hanging at the top of a hill. To further illustrate this, I drew a small dead face on the hanging man candle picture (fig 2.1.4.13). The formation of the candle is similar to that of the hammer or paper umbrella (similar open, high, and close prices, with a lower low price) and, as with some of the other candles, the color of the hanging man’s body does not matter. In order to have a hanging man candle, we need to be in an uptrend. The bulls have to be in contro,l and the white candles need to be pushing price up.
Fig 2.1.4.13 Hanging man
The bear was a good friend of that man who is hanging. Now that his friend has passed away in an unfortunate manner, the bear’s desire for vengeance must be sated. If a hanging man is followed by a black candle or gravestone, the old trend is over, and we are entering a bearish market. If a hanging man is followed by a white candle, we are entering an uncertain market.
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Shooting Star This is a bearish signal that looks very similar to an inverted hammer. Where inverted hammers occur at the bottom of a downtrend to signify a reversal trend, the shooting star occurs at the top of an uptrend. Shooting stars are fairly weak indicators; before considering opening a new position, one should seek additional confirmation. As with the last few candles that I told you about, shooting stars can be either black or white; their color does not matter.
Fig 2.1.4.14 The shooting star formation
Fig 2.1.4.14 shows a picture of what a shooting star may look like. A shooting star that is followed by a long black candle is a good indication that a bearish trend will emerge.
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Engulfing Pattern Keep an eye out for these, because engulfing patterns are very trusty candle formations. An engulfing pattern occurs when one candle of a certain color is followed by a new candle of the opposite color whose size is large enough to engulf the first candle. The actual color of each candle in the engulfing pattern will tell you whether price will move up or down, so it’s important to pay attention to their colors. Before we can consider a pattern to be an engulfing pattern, we must have a strong uptrend or a strong downtrend. Let me paint the picture for you… You’re watching your charts and notice a lot of long white candles forming. You are watching an uptrend occur right before your eyes. Spotting the uptrend, you decide to go long and buy into the position. Suddenly you start to notice that the profits you were making stopped increasing and are starting to shrink. Worried that you’re going to incur more losses, you close your position. You notice that the last white candle in this uptrend was a short candle. Now price is beginning to fall and a black candle is forming. This isn’t just any black candle; it’s a long black candle, one that’s longer than the previous, shadows and all. The time interval ends and you study the last candle. These last two candles price made will look like the candles seen in fig 2.1.4.15.
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Fig 2.1.4.15 A bearish engulfing pattern
Since you were clever enough to read this chapter, you know that these candles on your chart right now are an engulfing pattern. It’s not just any engulfing pattern; it’s a bearish engulfing pattern.
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So, to review, you need three things in order to spot an engulfing pattern: 1. You’ll need a strong uptrend or downtrend 2. You’ll need two side-by-side candles of different colors 3. You’ll need the second candle to be larger than the first candle
Fig 2.1.4.16 A bearish engulfing pattern
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If we are in an uptrend and a small white candle is followed by a large black candle, this is an indication that a bearish trend may occur (fig 2.1.4.16).
Fig 2.1.4.17 A bullish engulfing pattern
If we are in a downtrend and a small black candle is followed by a large white candle, this is an indication that a bullish trend may occur (fig 2.1.4.16).
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Harami If you were to switch the position of the engulfing pattern’s candles so that the long candle occurred before the short candle, you will see the harami pattern (fig 2.1.4.18).
Fig 2.1.4.18 Illustrating the difference between the engulfing and harami patterns
Harami is the Japanese word for pregnant, since the formation itself looks like a pregnant woman. In the bearish harami, the first candle is a long white candle, which represents a pale mother. The short black candle in front of her represents her child: a small dark bundle of joy that is attached indefinitely until birth. When a trader spots this formation, he knows that the market itself is pregnant and ready to give birth to a trend from which its traders can profit. The two candles that signal a bearish harami formation are a long white candle followed by a short black candle (the baby); these form at the end of an uptrend. It’s important to note that the smaller the baby is, the stronger the bullish trend. If you spot a long black candle followed by a short white candle at the end of a downtrend, you just spotted a bullish harami formation, which signifies a period of buying.
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Harami Cross The harami cross follows the same principles as the harami. Similar to the harami, the harami cross occurs when a long candle is followed by a short candle. However, in the case of the harami cross, this short candle is a doji. Remember when I said that the smaller the baby, the more potent the trend? This applies even more so with the harami cross, since the baby is a doji (fig 2.1.4.19).
Fig 2.1.4.19 The harami cross
If you spot a long white candle at the end of an uptrend followed by a doji, this is an indication that a bearish trend may occur. If you spot a long black candle at the end of a downtrend followed by a doji, this is an indication that a bullish trend may occur.
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Dark Cloud Cover Dark cloud cover candles probably got its name from the bearish trends that follow the pattern’s formation. Remember, back when Japanese candlesticks were invented, people couldn’t make profit in a down market – only when price moved up. The name of this one might sound a bit ominous, but the opportunities that this formation can offer the modern trader are anything but ominous. In order to have a dark cloud cover candle, we have to be in an uptrend. The first candle in this pattern has a long white body. In order for this pattern to occur, price has to open higher than the previous candle bar’s high. In other words, you’re going to notice one long white candle and to its right one long black candle which appears to be hovering slightly above the white candle. To better illustrate this, look at fig 2.1.4.20 to see what the dark cloud cover pattern looks like. Please note that the first candle’s closing price is not equal to the next candle’s open price. Price made a quick leap, leaving a gap.
Fig 2.1.4.20 Dark cloud cover, the preferred pattern of Batman
If you see the above pattern at the end of a bullish trend, this signifies that we are entering a bearish trend.
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Piercing Line The piercing line formation is similar to the dark cloud cover formation. Where the dark cloud cover formation marked a bearish signal at the end of an uptrend, the piercing line formation marks a bullish signal at the end of a downtrend. At the end of a downtrend, we need to have two candles: a long black candle followed by a long white candle. The white candle’s open price must be below the black candle’s low price. In other words, if you’re looking at these candles on a chart, the white candle will seem to be hovering below the black candle (fig 2.1.4.21). Again, notice how the black candle in the end of the downtrend’s close price is not equal to the following white candle’s open price.
Fig 2.1.4.21 The piercing line can be seen after the downtrend
The piercing line formation signifies that a bullish trend may occur. However, you shouldn’t be too hasty with this formation. If, for example, you see that the bar following the white bar is a black bar that sinks down below the white bar’s low price, this signals a continuation pattern, which means that the market will remain in a bearish trend. It would be smart to take some time with this formation and wait for a confirmation signal.
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Morning Star The morning star formation is a pattern that consists of three candle sticks. This pattern is a reversal signal that appears at the end of a bearish trend. The first candle in this formation is a long black candle. Beside this candle is a second candle, the star. This second candle’s color is irrelevant. The only thing we’re looking at is the size of this candle and its position in relation to the first candle. We want this second candle to open lower than the first candle’s close; in other words, we want the smaller candle to look like it’s hovering below the first candle. The final candle in this formation is a long white candle. This third candle should close above the first candle’s midpoint in order to validate the formation.
Fig 2.1.4.22 Morning star formation
If all three candles are in place (fig 2.1.4.22), you have a morning star formation, which signals a bullish trend.
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Evening Star Similar to the morning star pattern, the evening star pattern consists of three candlesticks. Where the morning star occurred at the end of a bearish market, signifying an uptrend, the evening star occurs at the end of a bullish market, signifying a downtrend. There are three pieces to the puzzle with the evening star. The first is the long white candle. This long white candle is followed by a short candle, which is known as the star. The star’s location is very important. The short candle must open higher than the first candle’s close. In other words, we want the second candle to be hovering above the first. The third candle in this formation is a long black candle, which signals that many more black candles will appear in the future. See a picture of the evening star formation in fig 2.1.4.23.
Fig 2.1.4.23 The evening star formation
The third black candle is very important in this formation. The longer this black candle is, the stronger you can expect the emerging trend to be. When you see this, it’s an indication of a bearish trend.
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Abandoned Baby When we look at morning and evening star patterns, it’s very important to note that there are several key ingredients necessary to ensure that the pattern will work correctly and strongly. The first indication that the morning and evening star are strong is the actual star, or the second candle. The smaller the second candle is, the more potent the reversal pattern. If, for instance, the star is a doji, we can expect a strong trend to emerge. The second indication of a strong reversal is the gap that appears between the first candle and the star. The larger the gap, the more potent the signal. In the rare instance that there is a complete gap between the first candle and the star, which means that the first candle’s high is lower than the second candle’s low (or the first candle’s low is lower than the second candle’s high), we have an extremely powerful indication of a strong trend. Our last indication that the trend is strong is that the third candle overwhelms the first candle, meaning that if the third candle’s close is higher than the first candle’s open. Adversely if the evening star’s third candle’s close is lower than the first candle’s open, this also indicates a power signal. If all three of these indications are present, we have one of the strongest candle formations: the abandoned baby formation (fig 2.1.4.24).
Fig 2.1.4.24 Where is this baby’s mother?
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It is important to note how the patterns form in relation to the morning and evening star patterns. If you see that the formation looks like a morning star and all three indications of the abandoned baby are present, this is a powerful bullish signal. If the formation looks like an evening star pattern and the abandoned baby’s indications are present, this is a powerful bearish signal.
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Tweezers The Bear’s Tweezers In order to have a tweezer formation that signifies a bearish outbreak, There must be one white candlestick at the end of the uptrend that has a long upper shadow. The next candle in the chart must be a black candle with a long upper shadow that has the same high point as the previous candle.
Fig 2.1.4.25 Bearish tweezers
Bearish tweezers can be seen in fig 2.1.4.25. If you spot this trend on the chart, it is an indication of a bearish trend.
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Bull’s Tweezers As you noticed by now, almost every candle formation works both ways, which means that if a certain candle pattern produces a bearish signal, there is probably an opposite pattern, which may or may not have a different name, that produces a bullish pattern. In order to have a tweezer formation that signifies a bullish trend, the first thing we need is a downtrend. At the end of the downtrend, we have a black candle with a long shadow, or we may even have a dragonfly doji. The following candle is a white candle that is making a low that is similar to that of the first.
Fig 2.1.4.26 Bullish tweezers
Fig 2.1.4.26 shows bullish tweezers. If you see this, it’s an indication that the market is poised to move upward. It should be noted that these candles don’t necessarily have to be next to one another to signify a tweezer. If you notice that there are candles between two tweezer candles that make similar highs or lows, this only strengthens the possibility of a future trend occurring.
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Fig 2.1.4.27 These tweezers are spaced far apart
In fig 2.1.4.27, you can notice that we have a quite a few candles appearing between this tweezers pattern. In the West, we have a different name for this pattern, which I’ll go into more detail with in section 2.4.
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Windows While describing the morning star, evening star, and abandoned baby formations, I noted that there were instances when a close price may differ from the following candle’s open price. I described this by stating that the candles were hovering above or below one another. These instances are called price gaps. If we’re in a bearish trend, a price gap, also known as a window, occurs when a black candle has an opening price greater than the previous candle’s low. If we’re in a bullish trend, a window occurs when a white candle’s opening price is greater than the previous candle’s high. If you had a hard time comprehending that, take a look at fig 2.1.4.28.
Fig 2.1.4.28 Bear windows
Fig 2.1.4.28 shows a price gap that occurred when the bears were in control. Look at the second-to-last candle in this pattern. Its low price is higher than the next candle’s high price. There is literally a gap, or window, between these two candles. Windows can indicate a continuation of the trend. If you see a few black candles and notice a gap between the last two, there’s a good chance that the next few candles will also be black. Likewise, when you see a gap occur between two white candles, price may go up, as seen in fig 2.1.4.29.
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Fig 2.1.4.29 Bull windows
However, there is more to windows than just signifying a continuation pattern. The low price of a white candle that occurs after a window in a bullish market also acts as a support line for future bars.
Fig 2.1.4.30 A continuation, plus support or resistance? Score.
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And vice versa, the high price of a black candle that forms after a window acts as a resistance line for future price (fig 2.1.4.30). So, what exactly are support and resistance lines? Go on and turn the page to find out.
2.2
Support and Resistance Lines
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OW that I’ve given you more candlesticks patterns than you probably know what to do with, it’s time to drill in some more valuable and extremely vital information about the forex market. Remember the analogy in which price was represented by a gigantic bull and bear engaged in a tug-of-war? Let’s forget that analogy for a bit. For this section, the information I provide for you may be easier to understand if you think of price as a ball. I’m sure that you’ve played with a ball before. What happens when you take the ball and drop it onto the floor? Simple answer: The ball bounces back up towards you. But what happens if, say, this ball of yours is extremely heavy? You have a two-thousand-pound ball that you manage to drop onto the floor. That ball is going to crash through your floor and end up somewhere in your basement. On the forex market, support lines act like floors from which price can bounce up while resistance lines act like ceilings from which price pushes off.
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Fig 2.2.1 Good ol’ support and resistance lines
You can see in fig 2.2.1 how price bounces off of these support and resistance lines. By knowing where support and resistance levels exist on a chart, a trader can either attempt to trade off of these levels to make quick profit on the bounces or wait until one of the support or resistance lines is broken. Whenever price is heavy and can break through this floor or ceiling, price is going to soar or plummet in that direction (much like how I’d imagine a bowling ball would plummet if dropped on a glass floor). However, more often than not, price bounces off of these lines rather than breaking through them. Now would be a good time to reiterate this golden rule of the forex market: Price moves three ways. Price Can Move: 1. UP 2. DOWN 3. SIDEWAYS
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This is an important rule to consider when plotting out support and resistance lines. When plotting your support and resistance lines, you’ll notice that the trend you’re following will either be a bullish trend (heading upward), a bearish trend (heading downward) or a range (moving sideways). From my personal experience, I would suggest that you go long on the bullish trends, go short on the bearish trends (both obvious suggestions), and do nothing at all in a range. There’s nothing more frustrating than placing a trade in a market that isn’t moving. So, now that you have a general idea of what support and resistance lines can tell you about price movements, let’s talk about how to plot them.
Drawing Support Support and resistance lines are not exact levels. They are rough estimations that most traders spot simply by looking over a graph. When you learn to plot these lines yourself, you may notice that sometimes the shadow of a candle just barely dips past a support or resistance line, testing out this new level before price bounces back. Always take caution when looking for a breakout. Make sure that you have candle body penetration, not just shadow penetration, before trading a breakout.
Fig 2.2.2 Support and resistance lines again!
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In fig 2.2.2, we can see that the support line is indicated by the flat line on the bottom. In this case, price has made similar lows and is moving sideways, indicating that we’re in a range. Now is not an opportune time to trade unless you plan on trading between the support and resistance lines. This too, however, might not prove to be profitable because of the minimal market movement. If we’re in an upward-moving market, our candles or bars are bound to make higher lows. Heck, if we’re in an upward-moving market, our candles or bars will be making higher everything. But for plotting support lines, we’re only interested in the lows. In some instances, you may notice that if you trace a finger along these lows, you have a straight diagonal line. This diagonal line is your support line (see fig 2.2.3).
Fig 2.2.3 Drawing support in an uptrend
A support line has the same function whether it is horizontal or diagonal. Price is going to either bounce off it, or plow through it.
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Drawing Resistance Now that we got the floors out of the way, it’s time to focus on the ceilings. Resistance lines provide traders with the same information that support lines offer – they tell a trader that price will either bounce off of them or penetrate through them and create a momentous market move. However, resistance lines are drawn by tracing highs, as seen in fig. 2.2.6.
Fig 2.2.6 Drawing resistance in a downtrend
2.3
Pivot Points
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OME traders just aren’t satisfied with one line of support and resistance. Some traders want seven support and resistance lines. That’s fine; I’m a firm believer of the more, the merrier. Pivot points are indicators that are used by traders to automatically plot key points of support and resistance. The only thing you need to do in order to plot these lines is log into Forex Club’s Rumus platform, click on Pivot Point, and drag it right onto the screen. Voila, you have support and resistance lines that have been plotted onto your chart using mathematic equations. The equation to find pivots points is as follows: Resistance 3 = High + 2*(Pivot - Low) Resistance 2 = Pivot + (R1 - S1) Resistance 1 = 2 * Pivot - Low Pivot Point = ( High + Close + Low )/3 Support 1 = 2 * Pivot - High Support 2 = Pivot - (R1 - S1) Support 3 = Low - 2*(High - Pivot) Lucky for you and me, we don’t have to plug numbers into these equations in order to plot lines on charts. That’s the beauty of indicators; the computer will do all of the work for you.
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Fig 2.3.1 Pivot lines plotted on an hour chart
In fig 2.3.1, you can see the pivot points that have been automatically loaded onto the chart thanks to Forex Club’s advanced Rumus trading platform. Each and every day, you’ll notice that the pivot points on your charts will be plotted at different levels, depending on historical market data.
Fig 2.3.2 Pivot lines shown over the course of days
By looking at the central line (known as the actual pivot point line), traders can get a sense of how the market responded the day before – and thus
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get a sense of how it’s currently responding in contrast with price from the day before. Here are some tips that will help you harness the power of pivot points. You should know that the most important aspects of the pivot point indicator are the actual pivot point, the first line of resistance, and the first line of support. The second and third support and resistance lines indicate that the market is either overbought or oversold. It’s important to look at the location in which price opens with regard to where the pivot point line is. If price is above the pivot point line, this means that we should consider holding mostly long positions throughout the day. However, if price is below the pivot point line, we should consider holding mostly short positions throughout the day. Pivot points are opportune tools to use in ranging markets if you feel bold enough to place a trade in them, as price often has a good chance of bouncing off of the first levels of support and resistance.
2.4
Chart Patterns
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HINK of price like an animal. Animals have habits that they exhibit. For example, a man may have the habit of bending down and picking up a coin that he has dropped. Will he pick up the coins every time? Maybe; maybe not. Now let’s say that before this man bends down to pick up this coin, he does a small gesture that further confirms his future action. This action can be something small, such as a quick tug at his pants so that his knees don’t get caught up against the fabric when he bends down. If we were placing bets on whether the man would bend down and pick up the coin, the moment he tugs on his pants, we would all say that he will pick it up. That is his pattern. The man and the market are one and the same. If you haven’t fully realized it yet, do so now; price moves because we, the speculate traders, want it to move. Some of us want it to move more than others and will therefore place more money into our trades. Even though trillions of dollars are surging through the markets every day, even the most menial amounts of cash influences price movement. The market is a living, moving thing, much like the man who has dropped the coin. All living things exhibit some sort of patterns in their daily life. The forex market has moments in which it tugs at its pants. These tugs are called chart patterns. You’ve already seen some simple chart patterns in the Japanese candlestick section, but now let’s look at larger patterns that occur on the markets every day. You may ask – how large are these patterns that we’re talking about? The reversal and continuation patterns discussed in this section can occur throughout all different sorts of time frames. According to Charles Dow, there are three different types of trends that occur over specific time frames. The longest time frame is known as a major time frame. We say that a pattern 105
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occurs over a major time frame if the time period spans from a year to several years. The next-smallest pattern occurs during an intermediate time frame. This pattern generally occurs between time frames of three weeks to three months. The smallest pattern is called a minor trend, and it typically occurs over the course of minutes to hours, no longer than three weeks.
Triangles Say what you will, triangles are my favorite shape. Some people prefer the smoothness of a circle, or the sturdiness of a square. Not I. During my career as a trader, circles and squares have done nothing for me to indicate future price trends. I like triangles because when I spot them on the market, I know price is going to start moving. In order to plot out triangles and the other formations that I’m going to list for you, you will have to know how to plot support and resistance lines. This is essential! If you go off and start plotting lines that you don’t fully understand, you will make mistakes and end up drawing something like this:
Fig 2.4.1 Chart monster
Let’s not go off and draw monster faces on our charts. If you haven’t fully digested the support/resistance section, I suggest that you go back and read it. Three different types of triangles can be spotted on your charts. These triangles include symmetrical, ascending, and descending triangles. They
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all share one characteristic – price in all three triangles converges to a certain point. This is where the actual triangle shape comes from. Let me give you an example of a symmetrical triangle. We call it symmetrical because the support and resistance lines that we plotted to form the triangle are symmetrical; each line is pitched at a similar angle.
Fig 2.4.2 Symmetrical triangle pattern
Fig 2.4.2 will better help you understand what I meant when I said that price is converging to a certain point. What’s happening on the market is that the bull and the bear are getting tight. Neither one can gain ground on the other. The fight intensifies. Each beast is pulling with all of its might and inching up the rope until boom, we reach the point of convergence. Back in the section 2.2 I said that if price breaks through a support or resistance line, it will soar in the direction in which the line was broken. When these support and resistance lines converge to a certain point, one of these lines will break – guaranteed. So where should you trade? Do you assume that price will make breakout past the resistance line and buy or do you assume that price will break through the support line and sell? Typically, symmetrical triangles don’t have a bias to where the breakout
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will occur, ascending triangles have a bullish bias, and descending triangles have a bearish bias. Play it safe, though. When it comes to triangles, we don’t assume. We simply sit and wait until price breaks either line, and then we ride the trade. Now let’s take a look at the difference between the ascending and descending triangles. Again, they both share the principal of price converging to one point and they both guarantee that either a support or resistance line will be broken. An ascending triangle occurs when candles are making similar highs. In other words, the resistance line that we draw on top of the candles is a horizontal or nearly horizontal line. The only reason the support and resistance lines are converging is because the candles are making higher lows. In laymen’s terms, when we trace the support line, we notice that it’s moving up, as seen in fig 2.4.3.
Fig 2.4.3 Ascending triangle pattern
As I mentioned before, ascending triangles typically lead to a bullish breakout, but this is not always the case. As a trader who is trying to maximize profits while minimizing losses, it would be smart to wait for the moment in which a support or resistance line is broken before entering a trade.
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The ascending triangle’s doppelganger is the descending triangle, seen in fig 2.4.4. Descending triangles’ candles are making similar lows. That is to say, when we trace our support line, we notice that it’s horizontal or nearly horizontal. In this case, the lower highs are driving the resistance line down to a point of convergence.
Fig 2.4.4 Descending triangle pattern
Chart Pattern 101 says that this is a bearish signal, but this isn’t always the case. Wait for confirmation after the breakout before opening a trade.
Double Tops and Double Bottoms In the market place, double tops and double bottoms occur when the market tries to breakthrough a previous high or low, but doesn’t have the strength to do so. Here’s a quick analogy of what’s happening on the market. I’m going to shy away from the monster bull and bear locked in eternal tug-of-war for the sake of keeping things fresh. An easy way to think of it is to imagine the currency candles on your chart as a person trying to swim upstream. He goes as far as they can, gets exhausted, and is pulled back by the current. He makes one more valiant attempt to swim upstream to make it to the same spot as he did
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before. However, now that he’s really tired, there’s no other option but to float downstream. This, to an extent, is what happens in the market place. Double-tops occur after a bullish trend. We can spot a double top occurring when price makes a new high, recedes back down and then builds up enough momentum to create the same high. Price can’t push through this resistance line. Failing to break through, there’s no place left for price to go except down. The pattern belongs to the bears. If you spot a double-top formation, the bias for the trend will be bearish.
Fig 2.4.5 A double-top formation (looks a lot like tweezers, no?)
In fig 2.4.5, we see a double-top. Note that the formation looks like a large M. Let’s flip the double top upside down to find the bull’s formation. A double-bottom occurs at the end of a downtrend. With this formation, price can’t quite seem to break through a support line after two valiant efforts.
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Fig 2.4.6 Here’s a double-bottom featured as a smooth line
The double-bottom formation looks a lot like a large W. When you see this formation, brace yourself for a bullish outbreak.
Head and Shoulders In the East, they have a flowing, poetic name for this pattern called the three mountains formation. In the West, this pattern shares a name with a dandruff shampoo. Makes you think. The head and shoulders formation occurs at the end of an uptrend. Price makes two similar highs and one high that surpasses the others. The first and third highs are similar, while the second or middle high is higher. When you look at this formation on a chart, it looks a lot like a person’s head and shoulders (that is, if he is wearing spiked shoulder pads.)
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Fig 2.4.7 Head and shoulders, or head and spikes?
Fig 2.4.7 shows a head and shoulders formation and a professional wrestler. Similar, no? When spotting a head and shoulders formation, you’ll notice that the lows it the formation reach a similar point, making a support line. This support line is called the neckline. The moment price comes off of the second shoulder and breaks this neckline is when we have confirmation of a bearish trend.
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Reverse Head and Shoulders A similar formation to the head and shoulders occurs at the end of bearish trend when price makes three consecutive lows, the second being lower than the first and third. We call this formation a reverse head and shoulders pattern (seen in fig 2.4.8).
Fig 2.4.8 A reverse head and shoulders
If all goes according to plan, price should break through the neckline, indicating a period of buying.
Channel A channel formation occurs when support and resistance lines are parallel to one another. Channels can form in the three different ways that price moves: up, down, or sideways. We call channels continuation patterns, since price has a tendency to break out in the direction of the trend.
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Fig 2.4.9 An ascending channel
Fig 2.4.9 shows an ascending channel. Though it may be hard to notice without the aid of support and resistance lines, price here has reached some sort of equilibrium. If you spot a channel formation, you can either trade with the trend or wait for the breakout.
Wedge The wedge is the hybrid freak child of a triangle/channel affair. Wedges are very similar to triangles in that both formations include support and resistance lines that converge to a certain point. Wedges are also similar to channels, as their lines of support and resistance are moving in a similar path (be it bearish or bullish). Since the support and resistance lines of a wedge must be heading in a similar path, there can only be two types of wedges: falling wedges or rising wedges (if the support and resistance lines were evenly pitched, we’d just call it a symmetrical triangle).
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Fig 2.4.10 A bullish wedge pattern
See the falling wedge pattern shown in fig 2.4.10. Note that the support and resistance lines are both slanted downwards. This is the only reason why we don’t refer to this pattern as a triangle; because price is making lower lows, not similar lows. The falling wedge is a bullish pattern, but it would be smart to wait until either the support or resistance line was broken before opening your position. If price is making higher highs and higher lows while converging to a certain point, we have a rising wedge (seen in fig 2.4.11).
Fig 2.4.11 Bearish wedge pattern
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Rising wedge patterns are bearish signals, but again, it’s always smarter and safer to wait until a support or resistance line is broken before entering into a trade.
Flags and Pennants Flag and pennant patterns occur after the market has made a powerful up or down trend. To better visualize what’s happening during a flag pattern, think of the powerful up or down trend as the flag’s “pole” and the support and resistance lines formed during the sideways market as the flag’s or pennant’s “cloth.” Flag patterns happen quite often in the market. Traders should take note of when price begins to level out after a powerful trend. Depending on the slope of the support and resistance lines used to draw the “flag,” this can be an indication of a continuation pattern. I think playing it safe would be best – don’t try to guess where price will move. Wait until a resistance or support line is broken to place your trade.
Fig 2.4.12 Look at all of those flags and pennants
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In fig 2.4.12, you can find all of the different varieties of flags and pennants. Note that pennants are formed when support and resistance lines are converging at a certain point, while the support and resistance lines of flags follow an even trend.
Section Three
Fundamental Analysis Most traders believe that they can get by with just the technicals. Technical analysis is on the rise and every year we have new indicators being created and new technical strategies being developed – but let’s not forget about our fundamental analysis! Some of the market’s biggest moves are caused by fundamental analysis. Let’s remember back to section 1.5, Intro to Technical and Fundamental Analysis. In that section, I wrote the following: Fundamental traders believe that price is a momentary thing. The past does not matter. The only thing that matters to a fundamental trader is the present. The future of price will be determined by the release of news events, natural disasters, or speeches from powerful political or social figures. The fundamental trader’s Bible is the economic calendar. You can find an economic calendar on the Forex Club Web site by visiting http://www.fxclub.com/economic-calendar/. Before I go into more information about fundamental analysis, I would like to share two tips with you:
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1) Use both fundamental and technical analysis. Do not trust one more than the other. 2) Do not trade before big news events. Wait for news to be released and then ride the trend.
3.1
Who and What Affects Market Movement
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ERE’S a list of all of the market’s main participants:
• • • • • • •
Central banks Commercial banks Market makers Investment firms Brokerage firms Firms that perform foreign trade operations Private individuals
We are the private individuals. Looking at the growth of retail forex companies, I’d say that we are the most rapidly growing segment of the market. Unfortunately, our impact on the market is miniscule when compared to the other participants. Private individuals are simply riding on the coat tails of banks and large corporations. So why do news events move price? Psychology is the name of the game. When you look at an economic calendar, you’ll note that there is a price beside each event entitled something along the lines of “survey amount,” or “forecast amount,” or “projected amount.” No matter what you call it, it signifies the same thing – this amount is an estimate made by the country as to what the economic outcome of the event should be. If the forecast/survey/projected amount is different from the actual amount, this means that the country’s economic state isn’t what economists thought it would be. Traders see any discrepancy in the economic figures as validation for buying or selling that economy’s currency. 121
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Price is also affected by speeches from government officials and events such as natural disasters or terrorists attacks. With regards to speeches, it’s sometimes not what is said but rather how it is said. Here’s a hypothetical example for you – let’s say that the president of country XYZ decided to take the podium after the news of his unemployment claims were released. He wants to ensure his people that the economy is okay and that they have nothing to fear. The president opens his speech by stating, “Fellow countrymen, we have nothing to fear! Our factories are filled with happy workers who are making great wages that allow them to buy the newest cars and the largest homes! This news release is simply a small bump that will be smoothed out in history as we work hard to continue to prove that country XYZ has a healthy economy!” Enlightening, no? Too bad the whole time that the president spoke, we saw that the otherwise charismatic and confident man was fighting to keep his knees from wobbling. There were tears in his eyes the whole time. His voice was trembling like a Chihuahua in an ice box. Speculators make it a point to pay attention to small nuisances in speeches to determine if what the suits are saying is real or embellished.
3.2
The Major Events
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OZENS of economic events occur each day affect price. Not all events are equal. Each economic event has a different weight or importance, so you may find that one event moves the market more than another event does. This makes complete sense, though. If you’re a trader on the forex market, which event would you pay more attention to – new home sales or popsicle sales? The number of economic events that occur each day varies. There are slow days when only about half a dozen events occur and then there are busy days when we have a few dozen events occurring. I’m not going to list every economic event, because many of the minor events form small burps in the market. I’m going to list some the majors events that have been known to move price. Get your folding fingers ready to fold over the next page for future reference. Here’s the big list of big economic events (in alphabetical order).
The Big List of Big Economic Events (in alphabetical order) The Beige Book This is the summary of Commentary on Current Economic Conditions by the Federal Reserve District. Commonly known as the “Beige Book,” this report is published eight times per year, and is used as a basis of discussion at the FOMC. Each Federal Reserve Bank gathers anecdotal information on current economic conditions in its district through reports from bank and branch directors and from interviews with key business contracts, econo-
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mists, market experts, and other sources. The “Beige Book” summarizes this information by district and sector. As of May 1995 the Federal Reserve Board of Governors started releasing the “Beige Book” in electronic format.
Building Permits Building permits, released with housing starts statistics, indicates future housing activity – a permit is filed before construction begins.
Business Sales Business Sales and Inventories data cover manufacturers, retailers and merchant wholesalers. The three components of business sales are released separately and are available prior to the release of total business sales with the following statistics: retail sales, manufacturers’ shipments, and sales of merchant wholesalers. The data of manufacturing and wholesale inventories are also reported beforehand. Retail inventories are the only part of this report that is not known ahead of the release. The inventory statistics are a major ingredient to the inventory investment component of GDP. An increase in inventory building also signals rising credit demands by corporations to finance the inventories.
Cash Rate The cash rate is a key overnight interest rate used by Australia and New Zealand to set monetary policy. The cash rate is comprised of the interest rates charged on overnight loans between banks.
Consumer Confidence U.S. Consumer Confidence is measured by two widely followed confidence reports (1) University of Michigan, (2) The Conference Board. Over the long term, these surveys work together and serve as a reflection of the nation’s mood. Consumers are more inclined to spend when they feel confident about their financial and employment prospects. Both the index of consumer confidence from the Conference Board and the index from the University of Michigan are good leading indicators of consumer spending.
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The University of Michigan’s index of consumer expectations is one of the components of the leading economic indicators. CPI Consumer Price Index is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals. The weights of the components are based on consumer spending patterns. For example, an item that makes up 20 percent of the average households budget would have the same weight in the CPI. The food and beverage components have a relative importance of about 16 percent in the CPI, so a 1 percent rise in food prices would contribute 0.16 points to the change in the overall CPI. The CPI covers both goods and services. Here it differs from the Producer Price Index, which only covers goods. The other difference between the two indexes is that the CPI covers costs facing consumers, while PPI covers purchases and/or wholesalers.
Employment Statistics The employment report released by the Bureau of Labor Statistics is probably the single most important economic series for the financial markets, and is generally viewed as one of the best concurrent measures of business activity. The report covers two surveys. One is business establishments (payroll survey), which measures employment in nonagricultural industries. The second is the household survey and measures civilian non-institutional employment of citizens aged sixteen years old and older, which includes agricultural workers and the self-employed.
FOMC Meeting Minutes The Federal Open Market Committee consists of twelve members, seven of which are members of the Board of Governors of the Federal Reserve System. One of the remaining five is the president of the Federal Bank of New York, and the remaining four memberships, which carry a one-year term, consist of a rotating selection of the presidents of the eleven other Reserve Banks. The FOMC holds eight regularly scheduled meeting per year to direct the conduct of open market operations by the Federal Reserve Bank of New York in a manner designed to foster the long-run objectives of price stability
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and sustainable economic growth. The FOMC also establishes policy relating to system operations in the forex exchange markets. Meetings are usually scheduled for Tuesdays. At the first and fourth meetings of the year, which are scheduled for two-day periods, the FOMC considers its long-run objectives for the money and debt aggregates as well as the current conduct of open market operations. The minutes of each meeting are made available three weeks after the meeting.
GDP Gross Domestic Product is the value of all final goods and services produced in the country. GDP is the broadest measure of economic activity and the principal indication of economic performance. Built as a system of inter-locking sector accounts, the GDP report provides the most comprehensive reading of the nation’s health. Also released with GDP statistics is the GDP deflator. Two calculations of the GDP deflator are reported: an implicit deflator and a fixed-weight deflator. The implicit deflator is the ratio of current-dollar GDP to constant dollar GDP. The fixed-weight deflator is the sum of the deflators for individual components of GDP with each component weighted by its share of real GDP in the base period, and, is consequently a better gauge of inflation.
70.45% – Personal consumption expenditures 16.97% – Gross private domestic investment 17.96% – Government consumption expenditures and gross investment 5.41% – Net exports in goods and services
Housing Starts Housing starts represent the beginning of construction of houses or apartment buildings. Since housing activity usually leads the business cycle, this economic release can be useful in spotting cyclical turning points.
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Inflation Report A country’s inflation report contains a projection of the currency’s inflation and the economy’s growth over a set period of time.
New Home Sales New home sales or the pace of new single-family home sales indicates the future course of housing construction. The ratio of the inventory of unsold homes to home sales – which is the month supply of homes at the current selling rate – suggests the need for new construction.
Non-Farm Employment Change The non-farm employment change is the measurement of a piece of information released by the Bureau of Labor Statistics that represents the total number of employed people working in all professions except for government, household, nonprofit, and farm. This information is typically released on the first or last Friday of each month and has been known to move the market considerably.
PMI The Institute for Supply Management releases two reports monthly: manufacturing and non-manufacturing. The manufacturing report is released on the first business day of the month and the non-manufacturing report comes out a few days later. The manufacturing report receives the most attention because of its timeliness and track record in marking turns in manufacturing activity. The respondents to the survey state whether various measures of economic performance in their company increased, decreased or remaining the same. The results of the survey are combined into a composite figure which is reported as a diffusion index. A reading above 50 percent for a diffusion index means that the indicator is expanding, while below 50 percent signifies contracting activity. The Buffalo, Cleveland, Chicago, Detroit, Houston and New York indicies are regional manufacturing reports.
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PPI Producer Price Index measures prices received by producers at the first commercial sale. The report measures prices for goods at three stages of production: finished, intermediate and crude. The index for finished goods generally receives the most attention. Change in this index is the first aggregate inflation measure available for the month. Food and energy are large components of PPI. As with the CPI, the PPI excluding food and energy is a good measure of underlying inflation. Food and energy prices are often affected by temporary and non-economic factors such as weather. The PPI for consumer goods can be a good indicator of the goods component of the CPI, which represents about half of the CPI. Capital goods prices measure costs facing the industry. The crude and intermediate indices track prices at the early stages, and suggest future changes in finished goods index.
Press Conference Government officials hold press conferences to address a certain aspect of a country’s economy. How much effect these press conferences can have on a currency depends on how hawkish or dovish the officials are and on the overall sentiment of their speech’s content.
Retail Sales The retail sales report details the dollar value of purchases made at retail stores: (e.g. auto dealers, department stores, etc.). The first retail sales figure for a month (the advance report) is based on incomplete information, and is subject to much revision. However, it is the first available indicator of consumer spending on any major scale. It is useful to divide retail sales statistics into auto and non-auto components. Auto sales constitute about 20 percent of retail sale and thus have a strong influence on the total. As auto sales can be very volatile, they can obscure the underlying pattern of consumer spending. With some adjustments, the retail sales report is a good guide to the goods component of the personal consumption expenditures statistics, which is part of GDP and is released with personal income later in the month. Figures from January 1992 to the present have been revised and reclassified into new categories. Comparison of figures prior to 1992 with those after 1992 should be made with caution.
3.3
Examples of How News Moves Price
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RADING the news can be tricky. Price can moves with the news, against the news, or not move at all. Unless you have some sort of psychic ability or a time machine, there is no way to know how price will react to the release of news events until after the fact. Below, I will show you two examples of when price moved with news and when priced moved against news. In both examples, I chose to use non-farm payrolls, because I believe that the NFPs are one of the more potent news releases.
When News Works Here is a great example of when trading the news can be extremely profitable. Let’s look at the December 4, 2009 release of the non-farm payrolls (fig 3.3.1). The forecasted amount for this day’s NFP was -119K. What was the actual outcome? -11! That is an astounding difference, which showed great potential for the recovery of the U.S. economy.
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Fig 3.3.1 EUR/USD day chart with information shown for the 4/12/2009 candle
By looking at that day’s candle and subtracting the close price from the open price, we find that price advanced 224 pips in favor of the USD. Not only was it a day of gains for the bears, but this news also helped push price down over a period of weeks.
When News Doesn’t Work Sometimes the market does strange things. Take the May 8, 2009 release of the non-farm payrolls, for example. This month’s projected number was -590K. The actual amount was -539K. In other words, the report came out 51K better than expected. When we look at NFP data, we can also see that May 2009 saw the best outcome for non-farm payrolls since August 2008. How does the market react to this information?
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Fig 3.3.2 EUR/USD day chart with information shown for the 8/05/2009 candle
As you can see from the chart provided by Forex Club’s Rumus platform, this release of information did very little to strengthen the USD. By looking at that day’s candle, we can see that price closed at 1.3632, meaning that the USD made a 234 pip loss to the EUR. Apparently, the non-farm payroll wasn’t influential enough to stop the bullish uptrend that was occurring.
Section Four
Technical Analysis In this section, I will be talking about market indicators. Indicators are used by traders to determine information that would otherwise be unknown to them from looking at price charts alone. Indicators provide insights that can help traders to estimate when to enter a trade and when to liquidate a position. Please note that while indicators appear to be very powerful and accurate when we look at them against past price movements, they cannot give a definitive answer as to where price will move. Following indicators does not guarantee profit. Indicators can only provide ideas for a trader to use to guesstimate future market movement. Nevertheless, I encourage all traders to use indicators. Technical analysis relies on the ideas that price moves in patterns and that these patterns will occur again and often. The basic principles of technical analysis are: • Price is everything All of the factors (economic, psychological, political, etc.) that can influence the price have already been taken into account by the market and are included in the price. Therefore, only the study of the dynamics of price is essential. The reasons for these dynamics are not important. The key is to study the past flow to predict the future flow.
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• Price moves in trends
As a rule, price does not jump spontaneously and erratically up and down like a demented grasshopper. It moves in trends over time. • History repeats itself
There’s a saying that if you don’t learn from history, you are doomed to repeat it. Technical analysts, however, are determined to learn from history and bet that trends that have occurred in the past will occur again in the future. Do you remember the Japanese candle formations in section 2.1.4, the pivot points in section 2.3, and the chart patterns shown in section 2.4? In each section, you read about price formations or equations plotted onto price charts that have been known to indicate that price will move in a familiar direction. The candle formations, pivot points, and chart patterns are all forms of technical analysis. Technical analysts use more than chart patterns, resistance, and support lines to determine where price will move, though. They also use indicators. An indicator is a mathematical equation that gathers market data to plot new lines onto a chart. Traders are able to read these indicator lines in relation to current price levels to determine where price will move. The pivot point mentioned in section 2.3 is a good example of what you can expect from indicators. Do you remember that long, complicated equation that I gave you before showing you the pivot point? You should expect equally, if not more, complicated equations in the following sections. The good news is that you don’t have to know what each and every equation is. You only need to concern yourself with the translations of each of the indicator’s lines on the charts.
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Technical analysts also use tools called oscillators. Oscillators and indicators are very similar. Where an indicator is an equation that offers further insight on a currency pair, an oscillator is an equation that offers further insight on an indicator. In that sense, you could call an oscillator an indicator’s indicator... but we just call them oscillators. Before you plunge in and start using indicators, it would be very helpful to log into Forex Club’s ExpressFX platform and fool around on a practice account, if you haven’t already. I only suggest this because indicators are not offered on the ExpressFX platform, as they are too complex for the capability of ExpressFX platform. Only after you fully understand your trading platform’s overall functionality and have a general sense of market movement should you start experimenting with indicators. The following list contains all of the indicators available on Forex Club’s Rumus trading platform. I’m going to include information about the indicator’s equation, what it shows a trader and most importantly, how a trader can make money using it.
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4.1
List of Forex Indicators Acceleration Deceleration Oscillator (AC)
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HIS oscillator is comprised of the nought line (featured as a blue line in the Rumus platform), the AC Red and the AC Green. The point of this oscillator is to measure the acceleration and deceleration of the driving force of the market.
How do traders read this indicator? Open Rumus and drag the Acceleration Deceleration Oscillator (AC) onto a chart. Look at the vertical lines. When these vertical lines are above the nought line (blue) and there are two green bars next to one another, this is an indication to buy. If the lines are below the nought line and there are two red bars next to one another, this is an indication to sell.
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Here’s an example:
Fig 4.1.1 AC Oscillator
In fig 4.1.1, we see five instances where positions could be opened according to the AC indicator.
Accumulation/Distribution Line Created by Marc Chaikin, this volume indicator measures the supply and demand of a currency by calculating the amount of people going long or short on a trade. The formula for the Accumulation/Distribution indicator is: Acc/Dist = ((Close – Low) – (High – Close)) / (High – Low) * Period's volume When the indicator rises, this signifies a period of buying; many traders are speculated to be buying this specific currency. A decrease in the indicator signifies a period in which traders are selling the pair.
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Fig 4.1.2 Accumulation/Distribution line
In fig 4.1.2, we can speculate that many traders are going long on the GBP/USD, as the Accumulation/Distribution line appears to be at a fifteen day high. Price later rallied up, just as the Accumulation/Distribution line had indicated.
Aroon Indicators The Aroon Indicator was created by Tushar Chande. Its purpose is to identify trends and trend reversals.
How it works: The indicator is made up of two lines; the Aroon Down (blue in Rumus) and the Aroon Up (green in Rumus). As the names suggest, the Aroon Up measures the strength of uptrends while the Aroon Down measures the strength of downtrends. Look towards the right of the indicators, and you’ll see a graph with values from 0-100. The higher up on the graph the Aroon lines cross, the stronger the trend. When the Aroon Up moves above the Aroon Down, this indicates a bullish move. When the Aroon Down moves above the Aroon Up, this indicates a bearish move.
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Fig 4.1.3 Aroon indicators
In fig 4.1.3, we see the Aroon Down crossing the Aroon Up from below, indicating a downtrend. If you followed this indicator, you could have made roughly 300 pips on this downtrend. The downtrend continues until the Aroon Down crosses the Aroon Up from above at a relatively weak value of approximately twenty, indicating an uptrend. If you were to reverse your position and sell, as indicated by the Aroon lines, you would make an additional 150 pips on the uptrend!
ADX Indicator It’s full name is Average Directional movement Index, but we like to call it ADX for short. This indicator was created by Welles Wilder as an instrument to measure a trend’s strength.
The formula for ADX is: ADX = modify moving average of DX DX = 100 x ( (+DI - -DI)/( +DI + -DI) ) +DI = +DMn / TRn , -DI = -DM / TRn +DM = Ht - Ht-1 , -DM = Lt - Lt-1 CL = Ct - Ct-1 TR = largest of +DM,-DM ,and CL
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Where : +DI = current positive directional index -DI = current negative directional index +DMn = current modified moving average of +DM +DM = current positive directional movement value Ht = current hign Ht-1 = previous high Lt = current low Lt-1 = previous low -DMn = current modified moving average of -DM -DM = current negative directional movement value TRn = current modified modified moving average of the true range TR = true range n = number of periods DX = current DX Reference from : J.Welles Wilder Did you get that? If not, that’s fine. You don’t need to be a math champion to plot these graphs. You can easily graph the ADX and, all of the other indicators by using our Rumus platform.
Making the trade: In the Rumus platform, the ADX line is a yellow line, while the DI+ line (Positive Directional Indicator) is red and the DI- line (Negative Directional Indicator) is blue. When the ADX (yellow line) is above 40, this indicates a strong trend. When the ADX is below 25, this indicates a weak trend. If you see the ADX indicator moving below 20, this is a sign that a new trend is developing, and that it may be a good time to make a move. When the +DI (red) line crosses above the –DI (blue) line, this is an indication to buy. When you see the –DI (blue) line crossing above the +DI (red) line, this is an indication to sell
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Fig 4.1.4 ADX indicator
In fig 4.1.4, you can see that the ADX value (yellow line) is very low at 16, indicating that a new trend is emerging. At the same time, our -DI (blue) line is crossing above our +DI (red) line. What’s the result? In this case, if you followed the ADX’s rules, it resulted in a 185 pip profit.
Alligator Indicator The Alligator indicator builds on what the MACD indicator (mentioned later) lacks. The indicator consists of three lines; all of which are smoothed moving averages. There’s the blue line (considered the Alligator’s Jaw), which is a 13 period Moving Average moved 8 bars into the future, the red line (considered the Alligator’s Teeth), which is an 8 period Moving Average moved 5 bars into the future, and the green line (considered the Alligator’s Lips), which is a 5 period Moving Average moved three bars into the future. The concept of the Alligator is similar to that of the MACD. When the Alligator’s lips (the green line, which is the fastest line here) crosses the other lines from above, the action to take is a short position. When the lips are crossing the other lines from below, the action is a long position. When all three lines are moving together as a whole, the alligator’s mouth is wide open, and the action to take is to hold one’s position until its jaws snap close.
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Fig 4.1.5 Alligator indicator
In fig 4.1.5 (a GBP/USD hour chart), we can see three instances when the Alligator’s jaws were wide open. If you followed the indicator and had patience, you could have made more than 500 pips in the ten day span.
Awesome Oscillator The Awesome Oscillator is a neat indicator that has several different types of interpretations.
Zero Line Cross: The first indication to buy or sell is the most obvious one. A buy signal is indicated when the AO green line passes above 0, and a sell signal is indicated with the AO red line passes below 0.
Saucer: Slightly more complex: When two red bars are followed by a green bar above the zero line, this is a buy signal. Conversely, if two green bars are followed by a red bar below the zero line, this is a sell signal.
Twin Peaks: A buy signal is created when the histogram is below the zero line and the last indicators low is higher than the preceding low. The histogram must remain below zero between these two troughs. When the higher low is made and followed by a green bar the buy signal is generated.
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A sell signal is created when the histogram is above the zero line and the last bars high is lower than the preceding peak. The histogram must remain above zero line between the two peaks. When the lower high is made and followed by a red bar a sell signal is generated.
Bollinger Named after its creator, John Bollinger, this indicator is used by traders to compare relative price and volatility. The Bollinger indicator consists of three lines. The outer bands act as resistance points. If price touches the upper band, the pair is considered overbought. If price touches the lower band, it’s considered underbought. What does this mean? It means that if prices touches one of the bands, there’s a very good chance that it’ll bounce back.
Fig 4.1.6 Bollinger bands
If you take a look at fig 4.1.6, you’ll see that when price touches the bands, it has a very good tendency to bounce back to the middle band.
CCI The Commodity Channel Index is a momentum indicator created by Donald Lambert. The CCI measures price in relation to its moving average. This signals when the market is overbought or oversold or when a trend is weakening.
How it’s used: Most traders use this indicator to see if a currency is overbought or oversold. When the CCI is above 100, this is a bullish signal. When the CCI is below -100, this is a bearish signal. In addition, some traders also believe that a cross from a negative to posi-
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tive is potentially a bullish sign, while a cross from positive to negative is potentially a bearish sign.
Fig 4.1.7 Commodity Channel Index
In fig 4.1.7, the CCI line is at -250, indicating an extremely bearish signal after price dipped about 300 pips. Using this indicator, a trader would have known to cash in on the pips and go long while the currency recouped.
Ichimoku Cloud The Ichimoku cloud was created by a journalist known by the pseudonym Ichimoku Sanjin. It receives its name from the most noticeable aspect of the actual indicator; the Ichimoku cloud or kumo. The Ichimoku cloud is a series of five formulas and lines that, at first glance, can look very intimidating to a first-time trader. The indicator is made
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up of two Senkou lines (the area between these lines is shaded in, making the cloud), a Tenkan line, a Kijun line and a Chikou span.
Formulas: Tenkan Line
= (highest high + lowest low) / 2 calculated over last nine periods
Kijun Line
= (highest high + lowest low) / 2 calculated over last twenty-six periods
Chikou Span = (most current closing price plotted twenty-six time periods back) Senkou Span A = (Tenkan line + Kijun Line) / 2 plotted twenty-six time periods ahead Senkou Span B = (highest high + lowest low) / 2 calculated over past fifty two time periods, sent twenty-six periods ahead.
The Kumo The actual Ichimoku cloud, or kumo, represents resistance and support levels. If price moves above the cloud, we’re in a bullish trend and the top of the cloud turns into the first support level, while the bottom of the cloud turns into the second support level. If price moves below the cloud, we’re in a bearish trend, and the bottom of the cloud acts as a resistance level, while the top of the cloud turns into the second resistance level. If price is moving within the cloud, there’s no bias to the trend.
Tenkan and Kijun Lines The market will move upwards when price is above the kijun (shown purple in Rumus) line. When price is below the kijun (purple) line, the market will move down. The tenkan (shown red in Rumus) line will show the direction of the trend. These lines will tell us whether the trend is going to be bullish or bearish. When the tenkan (red) line crosses the kijun line (purple) from below, this tells us that the signal is bullish. When the tenkan (red) line crosses the kijun (purple) line from above, this tells us that the signal is bearish.
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The Chikou Span The chikou span (shown black in Rumus) shows us what price was twentysix periods ago. How does this help us? Since price tends to move in trends, it gives us some insight to how strong a trend is. When the chikou span is below price, this indicates a bearish trend. When the chikou span is above price, we have a bullish trend.
Fig 4.1.8 The Ichimoku cloud in all its glory
Let’s look at fig 4.1.8 from a GBP/USD hour chart. The chikou is below price, indicating a bearish trend. In the example above, we see that the kijun crosses above the tenkan when price is at 1.6017. Price then plows through both resistance levels of the kumo. If we follow the rules of Ichimoku and sell when these lines cross, and we close when the kijun crosses back below the tenkan at 1.5783, we will make a 234 pip profit.
MA The moving average indicator is one of the oldest and most widely expanded upon indicators. As the name suggests, the moving average reveals the average of price over a specific period of time. The moving average has different variants, all of which follow the same general principal of showing the average levels of price over a specific period. Those variants include:
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SMA The SMA is the simple moving average. The following formula is used to calculate SMA: SMA = P1 + P2 + P3 +…+ Pn n Where P is the currency price being averaged, andn is the number of time periods in the moving average (selected by the trader). In other words, a five-day SMA is calculated by the sum of the closing prices of the last five days divided by five. The simplicity of the SMA is its one big drawback. Each price has the same “weight” or importance, meaning that old information is as important as new information. When the price at the end of the day jumps, our SMA jumps. This is good, as we want our indicator to respond to changes on the market, but SMA also jumps when the same price information is dropped from the equation five days later and has nothing to do with the current state of the market. The most common time periods used with SMA are three, five, ten and twenty days.
WMA The WMA is the weighted moving average. The WMA was created to solve the SMA’s drawback. Each price is weighted, with more weight put on recent data and less weight on past data. Here are the calculations for a fiveday WMA:
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5-day weighted moving average Day #
Weight
Price
Weighted
1
1
*
25.00
=
25.00
2
2
*
26.00
=
52.00
3
3
*
28.00
=
84.00
4
4
*
25.00
=
100.00
5
5
*
29.00
=
145.00
Totals:
15
=
406.00
Average
/ 15
27.067
In our example the weight on the first day is 1 while the weight on the most recent day is 5 but you can assign whatever weights you want. The main drawback with the WMA is that it gets overly complex with longer periods of time and is best used shorter periods.
EMA This one is the exponential moving average. The equation is as follows: EMA = EMA(t-1) + (2/(n+1))*(Pt – EMA(t-1)) Where Pt = the current price; n = length of EMA (chosen by trader) As you can see, each new value of EMA contains information about the preceding EMA, EMA (t -1). Consequently, EMA considers price history in its entirety. Information does not disappear abruptly but rather fades away. EMA can be calculated for any period of time.
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MACD This is the Moving Average Convergence/Divergence, created by Gerald Appel. This is a very simple indicator to read and can indicate when a trader should buy or sell a position. The indicator is composed of two lines: the MACD fast (seen as a solid red line in Rumus) and MACD slow (seen as a dotted blue line in Rumus). When the MACD fast (red) line crosses the MACD (blue) line from above, this is an indication to sell. When the MACD fast (red) line crosses the MACD (blue) line from below, this is an indication to buy.
Fig 4.1.9 Moving Average Convergence/Divergence
In fig 4.1.9, we can see that by following the indicators closely and opening positions accordingly to where the MACD Fast and MACD Slow lines intersect, we could perform back to back buy and sell positions and make a considerable profit. In theory, you can open and close positions each time the MACD fast and MACD slow lines cross, and you will make a profit. The only problem here is estimating when the indicators will cross. By using Forex Club’s ActTrader platform, a trader can input algorithms that will automatically open and close positions when the MACD lines cross.
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Parabolic SAR This is the parabolic stop and reversal. The parabolic SAR indicator is used to identify downtrends and uptrends in the market and is used by some traders as a trailing stop indicator. The indicator is comprised of PSAR dots, which appear either above price, indicating a downtrend, or below price, indicating an uptrend.
Fig 4.1.10 Parabolic stop and reversal
In fig 4.1.10, traders can see that when the PSAR dots are below the price bar, the indication is a bullish trend. A PSAR dots pattern above price is a clear indication of a bearish trend.
Price Oscillator The price oscillator is the difference between two moving averages. Traders use this oscillator to determine trends.
How to read it: Bullish trends:Â Using the price oscillator, we know that a bullish trend is occurring when: A. Price makes a lower low while the oscillator makes a higher low. B. Price makes a higher low while the oscillator makes a lower low.
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Bearish trends: Using the price oscillator, we know that a bearish trend is occurring when: A. Price makes a higher high while the oscillator makes a lower high. B. Price makes a lower high while the oscillator makes a higher high.
Fig 4.1.11 Price Oscillator
In fig 4.1.11, we see that a bullish hidden divergence is forming, since price is making a higher low while the oscillator makes a lower low. The result is a bullish trend that could win you approximately 150 pips.
RSI Indicator This is the relative strength index indicator. This indicator can tell a trader whether a currency is overbought or oversold.
Formula: RSI = 100 – (100 / 1+RS) RS= Average of x days’ up closes / Average of x days’ down closes If you look at the RSI indicator, you’ll see that the indicator is measured from between 0 and 100. If the indicator is above 70, the currency is considered overbought, and if the indicator is below 30, it’s underbought.
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Fig 4.1.12 RSI Indicator
Look at fig 4.1.12. Towards the left side of the chart, you can see that the RSI indicator deemed the currency underbought. If you opened a long position when the indicator dipped, you could have made roughly 200 pips.
Stochastic Indicator If you’re a fan of the RSI and MACD indicators, the Stochastic indicator will be perfect for you. This indicator is a combination of both indicators, giving traders a clear point of entry (via moving averages) while showing whether the currency is overbought or underbought. Let’s take a look at fig 4.1.12 using Stochastic Indicators.
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Fig 4.1.12 Stochastic Indicators
As you can see, all entry points are labeled using moving averages, and the trader has a good idea of whether the currency is underbought or overbought.
Zig Zag The zigzag indicator focuses only on important price reversals to give traders a very plain and rigid view of how price has moved. On its own, it doesn’t look very useful, but I’m sure you’ll be able to find very good use for it after you read the next section on Elliott waves. Now that you have all those indicators, you’ll be able to plot them and translate their meanings. Indicators do provide a great insight to price, but there isn’t a person alive who could tell where price will move in the future. You’ll learn the limitations of indicators by looking at charts that show a period where moving averages almost crossed, but haven’t yet or at Bollinger bands that seem an impossibly far distance away from current price levels. Nevertheless, indicators are a fantastic weapon that should be wielded by all traders, including you.
4.2
Elliott Wave
O
NCE upon a time, an accountant and engineer named Ralph Nelson Elliott became seriously ill and had to be confined to his bed. To pass the time, Elliott studied price movements on the Dow-Jones index. Elliott was able to make some very successful predictions using his own homegrown theories, and later published these theories in the Financial World magazine. Some people have an ear for music. Elliott had an ear for the market. In his publication, he wrote that wave cycles of the Dow-Jones index were subject to specific rhythms that he was able to spot. He wrote that these prices fluctuated naturally, much like how waves of the ocean rise, fall, and repeat. Thanks to a period of alone time in bed for Mr. Elliott, traders can now utilize his findings to help them trade the markets. Below, you’ll find the general principles of the Elliott wave theory. It may seem like a foreign language at first, but once you compare what you read with the picture chart that you see, you’ll be able to make more sense of what you’re reading.
General Principles of the Elliott Wave • Price moves in “waves.” A wave is a generalized direction in which price travels. Simply put, a wave occurs when a trend occurs. • A falling wave is always followed by a rising wave, while a rising wave is always followed by a falling one. Price is always trying to correct itself to find a perfect ground that it will never reach. • Waves are separated into many different parts and sub-waves. There are “impulse waves” that follow the direction of the trend. These impulse waves are numbered 1, 3, 5, A, and C and their subwaves are (1), (3), (5), (A), and (C). • Up waves 1, 3, and 5 consist of five smaller waves that zigzag (1), (2), (3), (4), and (5). 155
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• Down waves 2 and 4 consist of three smaller waves (A), (B), (C); • Down waves A and C consist of five smaller waves (A), (B), (C), (D) and (E). • Up wave B consists of three smaller waves (1), (2), and (3) • A wave traveling in any direction is always a sub-wave of a more powerful wave. In the words of Qui-Gon Jinn, “There’s always a bigger fish.” What may seem like a large wave is just a piece of a larger wave. In the example below, waves 1, 2, 3, 4, and 5 are the five wave sequences of a larger wave.
Fig 4.2.1 Illustrating the impulse and correction waves
A five wave impulse is always followed by a three wave correction. To break that down into simple language, when you see five waves heading in a general direction, they will be followed by three waves heading in the opposite direction. Any trend will always follow this eight wave cycle. How the waves can be sub-divided depends on their direction in relation to the larger wave they are a part of.
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The impulse waves (1), (3), (5), (A), and (C) all divide into five subwaves; and corrective waves (2), (4) and (B) each divide into three sub-waves, corrective waves are always shorter than impulse waves. Keeping these rules in mind, we can tell where we are within a wave at any time. For example: • If you just noticed that five waves traveled downward, then at that moment you can then say that you are in wave (A) of a three- wave (A)-(B)-(C) fall. Therefore, you can expect a correction wave (B) where price will rise and then a period (C) where price will continue to fall. • During a bear market, a three-wave increase in prices should be followed by a renewed trend of falling price, and a revival in five waves is a signal to us that the market is turning bullish.
Fig 4.2.2 Illustrating sub-waves
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Take a few minutes to let that all sink in. I’m going to take a few pages to give you a rundown of the properties of each Elliott wave. These explanations are not fully complete; in other words, that there is a ton more research and information out there about the Elliott wave theory. But, since this book is geared towards first-time traders, I’ll just give you the essential information you should know about each wave. Wave 1: Almost half of all first waves are conceived at the bottom of the market and are just “rebounds” from the lowest levels. The first wave is the shortest of the up waves, although sometimes it is very dynamic. Wave 2: Wave 2 never retraces 100 percent of wave 1. Wave 3: Wave 3 is usually the longest and is the most dynamic of all five impulse waves. Wave 3 passes wave 1’s high, signaling to traders to open positions in the direction of the wave. Volumes rise sharply. Wave 3 is never the shortest wave in price movement terms. Wave 4: This wave usually has a complex structure. Like wave 2, it is a phase of correction or consolidation. Unlike wave 2, triangles usually appear on wave 4 (remember triangles?). Important rule: the base of wave 4 never overlaps the maximum of wave 1. Wave 5: This wave is usually much less dynamic than wave 3. During this wave, many indicators (oscillators) lag behind the flow of prices, and negative divergences appear, warning of the approach of the market top. Wave A: The most convincing sign of the appearance of this wave is its sub-division into five sub-waves, this happens as an increase in volume corresponds to the fall in price. Wave B: This wave is the “rebound” of prices against the new trend that began with wave A. For wave B, low volume is typical. At the same time, a double-top forms (I know you remember those). Sometimes wave B even overlaps the peak of wave 5. Wave C: Wave C frequently drops much lower than wave A's minimum. A trendline drawn using wave 4 and wave A gives
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us the classic head and shoulders chart pattern (known only to me as head and spiked shoulders). Reading this information straight through can be hard to absorb at first, so make sure to reread this chapter for more charity, using the graphs provided.
4.3
Fibonacci
E
LLIOTT made his wave theory in the 1930’s. If it weren’t for the help of a man who died lifetimes before Elliott was born, he wouldn’t have been able to develop his wave theory. Let’s rewind a few hundred years to the thirteenth century, to a time when Italian mathematician Leonardo Pisano (1175-1240) was hard at work trying to introduce the Hindu-Arabic decimal system to his countrymen, who only knew the Roman numeral system. Pisano, who often referred to himself as Fibonacci, was born in Pisa, Italy, and educated in North Africa, where his father worked. It was thanks to his North African education that Fibonacci was first exposed to the decimal system. As he grew, it became increasingly evident that the decimal system was superior to Roman numerals, which were being used in Europe. Fibonacci wrote a book that was completed in 1202 called Liber Abaci (The Book of the Abacus, or The Book of Calculation), in which he introduced the decimal system to European mathematicians. In chapter twelve of Liber Abaci, Fibonacci set out to solve an age-old question that has been plaguing men for centuries: If you breed a pair of rabbits in an enclosed place for a year, how many rabbits can you expect in that year? I know what you’re thinking – why should I care about rabbits? These rabbits gave us a number value that has a natural, almost mystical quality, and have been used to create some of our world’s natural wonders. More importantly for you and I, these numbers can predict where the markets will move. In his equation, Fibonacci set up a few rules. Firstly, a rabbit is able to reproduce one month after its birth. Secondly, a rabbit is pregnant for one month before it gives birth. Thirdly, rabbits never die. They’re in a hawk proof room with an unlimited water and food supply. Finally, all pregnant rabbits give birth to a pair of new rabbits – no more, no less. The problem started with one pair of rabbits. At the end of the first month, there are two pairs 161
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of rabbits: one that is able to breed and one that is too young to breed. In the next month, we have three pairs (two can breed, one cannot) and in the third month, we have five pairs. If we fast forward a few months to the tenth month, Fibonacci says that we will have 144 pairs, which will multiply to 293 pairs by the end of the eleventh month. In the eleventh month, 144 more rabbits will be born, bringing our grand total to 377 rabbits. That is a lot of rabbits. Fibonacci’s sequence of numbers is as follows: 1,1,2,3,5,8,13,21,34,55,89,144,233,377 and on and on. One thing you may notice is that if you add the sum of any two adjacent figures, you’ll end up with your next number. Check it out: 1+1=2; 1+2=3; 2+3=5; 3+5=8; 5+8=13 et cetera. Furthermore, the ratio of any number in the sequence to the following number gradually approaches 0.618. Take a look: 1:1 = 1 1:2 = 0.5 2:3 = 0.67 3:5 = 0.6 5:8 = 0.625 8:13 = 0.615 13:21 = 0.619 and so on. If you wanted to do something crazy and find the ratio of any number against the preceding number, you would find that the answer would be numbers that gradually reach 1.618. For example: 13:8 = 1.625 21:13 = 1.615 34:24 = 1.619
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In both cases, the higher the numbers in the ratio, the closer they approach 0.618 and 1.618. You can find other interesting ratios that approach similar numbers, too (for example, the number 0.382 is found from the ratio of any number to the number next to it (i.e., 8:21, 13:24) while 2.618 is found from the ratio of any number to the number preceding (i.e., 21:8, 24:13). Although Fibonacci developed a method to reach these two numbers, he was not the first to discover them. The ancient Greek and Egyptian mathematicians had working knowledge of these two numbers. They called these numbers the “golden ratio” or “golden section.” This number was used to develop music, fine arts, architecture and biology. The Greeks used this ratio when building the Parthenon and the Egyptians used it to build the great pyramid at Giza. This golden ratio was used by the likes of Pythagoras, Plato, and Leonardo da Vinci. So why is this number important to you as a trader? Thanks to Fibonacci’s findings, traders have used the golden ratio to predict where price will move after price rebounds and to plot support and resistance lines. These price rebounds are known as retracements or as corrections. In the beginning of this section, I mentioned that Elliott couldn’t have made his wave theory had it not been for Fibonacci’s findings. This is because each wave in Elliott’s theory corresponds to Fibonacci’s numbers. By using the golden ratio, we can even figure out where we are in the Elliot wave cycle, which helps us to determine where price will move in the near future.
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Fig 4.3 Fibonacci retracements plotted on an Elliot impulse waves
In the Rumus platform, you can access Fibonacci lines. To plot a Fibonacci line in a downward trending market, your first step would be to click on the highest high. Feel free to use your zig zag indicator to help you spot these high points. Now you have to drag this line down to the lowest low. Adversely, if we’re in an upward trending market, we should trace the Fibonacci lines from the lowest low to the highest high. The software will automatically plot all of the levels that you choose to plot. These lines are price retracement levels, or in laymen’s terms, the “rebound” levels. The most common price retracement levels are 38%, 50%, and 62%. In the Rumus platform, you’d plot them as 0.382, 0.500 and 0.618. These are used as support and resistance lines. When plotting extension levels, or the levels of support and resistance that occur beyond current market highs or market lows, you’d plot 1.618, 261.8 and 423.6. Two of these numbers are directly derived from the golden ratio (38% coming from .382 and 62% coming from .618). Mr. Dow had a similar idea, but preferred using 33% and 66%.
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It’s important to note that the popularity of Fibonacci numbers is enormous. With so many traders trusting in them, the sheer volume of their trades in relation to where Fibonacci lines appear is enough to move the market.
Section Five
Trading Systems If you read this book from the cover to this very sentence, congratulations! You have just absorbed a considerable amount of information about the forex market. As an old song once stated, “It don’t mean a thing if it ain’t got that swing.” In our case, that swing is your hard-earned cash. All of the lessons, tricks, and tips you read about in this book can be instantly erased from your memory, forgotten, or ignored the moment you start trading with your money. I’m sure that by now you’ve placed a few trades on a practice account. You may have even plotted a few indicators or spotted some powerful trends that won you a pretty hefty amount of “virtual money” on your practice account. It probably felt very rewarding. You may have plotted a few trades and let them sit over night while you slept like a baby, only to find in the morning that you made a considerable loss. No worries, right? It’s just a practice account. The rules change when you place real money into your account. You’re going to experience feelings that would not affect if you were using a practice account. Do not fear these emotions. After all, it is emotions and the acknowledgement of these emotions that make us human. If you are able to
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conquer your emotions, conquering the forex market will come more easily for you.
5.1
Market Psychology
L
ET’S take a moment for some much needed self-analysis. March yourself right up to a mirror, stare yourself dead in the eye and say, “Who are you?” Now think hard on that question. Notice how your eyebrows shuffle around while you’re in deep thought. Who are you? “Have I ever thought about this question before?” you briefly think, and then you resume your sousearching. The answer may come to you now, it may come to you ten years from now, or it may come to you during your last breath. Think back on your childhood memories and all of the joys and pains that you felt. Think back on your birthdays, your best friends, and your worst enemies. What was it about your friends that made you bond, and what did you hate about your enemies? Why did your enemies hate you? Think back on your favorite toy, whether it was a ball, a doll, a blanket, whatever – did you ever misplace that object? How did that make you feel? Are you the sort of person who spends lavishly or saves each hard-earned penny? Do you pick up change that you see on the sidewalk, or is the effort of bending down more trouble than the cents are worth? If you ask yourself these questions and billions of more like them, you may gain complete understanding of your true self. Humans are interesting creatures who often project different dispositions to different people. We hide our fears to some, while displaying them to people around whom we feel more comfortable. Sometimes, we even hide our deepest fears from ourselves. When you trade with real money on the forex market, you may find that you have acquired different fears. Even if you are, for example, someone who spends money freely and doesn’t care too much about personal savings, you may find it very hard to lose money on the forex market. Adversely, if you are someone who gets teary-eyed at the thought of dropping a coin down a
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storm drain, you may find that you’re not deeply affected by losses made while trading. Greed and fear are the names of the game. These two emotions are feelings that haunt every trader. Greed as you watch your hard earned money multiply by the second. Fear that the market will turn on you at any moment; that your hard earned cash would vanish before your eyes. Both emotions can be costly if you allow them to overwhelm your senses, but if you keep your feelings in check, they can also help you to profit greatly. Greed kicks in when the market is in a frenzy. An example would be when most traders notice a powerful trend occurring. They want to ride on the coat tails of this trend in order to get soaring profits. So what do you, as a trader, do? You trade with the trend. You are now driven by greed to hold the position. This is good; in this case you would be making money. But, alas, nothing in life is as simple as clicking a button and making money. No, you must click a button and then govern your emotions. The greed intensifies as you watch your profits and losses hit limits you’ve never seen them hit. Just one more minute, you say, and then you’ll close your position. Just one more minute. Just another minute. Then you begin to change the rules a little. You’ll close the position if it reaches a new level. Price makes new moves and all the while you’re compromising with yourself. In this hypothetical situation, you’re making profits. But in your greed, you overlooked something. It could be a support or resistance breach, a chart pattern, a warning from an indicator, anything. Perhaps you and the other greedy traders like you overbought or oversold a currency, causing a correction. Suddenly the market turns on you, and you find that those tremendous profits have dwindled, or even turned into tremendous losses. What do you do now? Do you hold the position hoping that price returns to its levels or do you just take your profit as is? The rational man would take his profits. Alas, many a rational man , blinded by greed, chooses to hold his position to get their profits back up. He may find that their hard-earned profits dwindle to nothing. Never overlook your fear, but never let your fear take control of you. The main component that feeds into fear is the thought of the pains you will feel if you lose your money. No one wants to lose his or her money. Let’s face it; we live in an age in which it’s believed that money can buy us happiness. Can
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money buy us happiness? The question is open to debate. Money can buy us comfort, and to most people, comfort equates to happiness. If you are the type of person who needs to have a certain amount of money set off somewhere untouched to act as an anchor of comfort, you may have a strong fear of losing money. Unlike greed, which often causes direct losses, fear often prevents traders from making profits. This fear prevents a trader from buying a new high or selling a new low. Instead, he sits on the sidelines, watching a huge bull and a huge bear pull on a rope. If his fears are correct and price moves against him, there is a sense of relief. However, if his fears turn out to be irrational and price soars in the direction that they wanted to trade, he feels regret. Unless you have attained Zen or live on a higher plane of existence, you will feel these emotions. Look yourself in the mirror and ask, “Who are you?” Once you get your answer, you’ll be better equipped to dealing with the nullification of greed and fear.
5.2
Forex Trading Best Practices
A
S a forex trader, your job is to maximize your profits while minimizing your losses. The best way to go about maxing out profits and cutting losses is to follow forex’s best practices; however, there is no guarantee that you will make a profit and there will always be the possibility of incurring losses. Don’t take these lessons for granted – it’s better that you learn them from this book than you learn them from your personal (possibly negative) experiences.
Use limited leverage Leverage, can be the greatest pat on the back or the hardest punch in the face. Leverage increases your exposure to the markets by up to a fifty times. You can make a whole lot of money using leverage, but you can also lose all of your money using it. Let’s say you have a deposit of $1,000. If you place every dollar into a trade using the maximum leverage of 50:1, you can control a $50,000 trade on the forex market. If you’re trading the EUR/USD, that means that each point you move will equate to $5.00. If the market moves a hundred points against you, you just lost all of your money. The amount that a pair moves varies from day to day, but seeing a currency pair move 100 pips or more in a day is not unheard of. Let’s keep things safe. My rule of thumb is to use a leverage of 10:1 to 20:1. This way, your losses will not be as austere as if you used, say, 50:1 leverage. Sure, your profits won’t be as large, but that’s okay. The forex market isn’t a get-rich-quick device that you can use to buy that new yacht you had your eye on. It’s a market in which you can make steady profits that will ideally grow over time. Slow and steady wins this race.
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Have a realistic idea of how much you can make I wrote this tip in regards to your take-profit and stop-loss orders. Before you enter a trade, know how much money each move on the market will equate to. If, for example, you find that with the money you’re placing on a trade, each move on the market will equate to $1, don’t set your take profits and stop losses at $1,000. The orders will basically be useless, unless some unlikely occurrence moves the market price 1,000 pips. Consider the time frame that you’re trading for, whether it be a one-day trade (a trade that occurs over a one-day period), a swing trade (a trade that occurs over several days), or a long-term trade, and place your orders appropriately.
Realize the risk Every dollar that you place into a trade is at risk of being lost. I will use comparisons between trading on the forex market and buying a lottery ticket to better illustrate this idea. Personally, when I spend a couple of dollars on a scratch off, I consider it money lost. I am spending the money on this lottery ticket because I can afford to lose it and because the loss of this money won’t otherwise affect my life. If I win – hey, it’s a good day. If I lose, it’s no problem. This isn’t to say that forex trading is like gambling on lotto tickets. No way; far from it. The possibility of losses is far greater on the forex market than on lottery tickets. In addition, you know from reading this book that there are methods that you can use to help you place winning trades, where as lottery is simply blind luck. What I am saying is that you should consider every dollar that you place into a trade money that is already lost. I understand that we’re not all millionaires and we all can’t just “lose” a hundred dollars every day on the forex market, but if you consider each dollar that you place into a trade money lost, you’ll slowly find that those greedy and fearful emotions that most traders tend to feel while trading on the market will begin to dissolve. The idea is a bit of a catch-22, but if you divorce yourself from all emotional attachment to your money, you will do better on the forex market. In other words, a tip to help you make money is to not care about making money.
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Only trade 2%-5% of your account This tip is slightly related to tip number 1, in that both tips encourage traders to place a limited amount of money into each trade. The magic number that most professional traders swear by for opening a position is 2% to 5% of their trading balance for each trade. If you have an account of five hundred dollars, your safest bet would be to trade 2% of that, or ten dollars. With leverage, that equates to having a buying power of 1,000 units of currency. If you’re not happy with the results that you’ll get by trading 1,000 units of currency (you’ll be seeing profits and losses of cents), you should start trading with more money in your account.
Set Risk-to-Reward Ratios When creating a personal trading system, you should ask yourself how much money you would like to make from a trade and stick to that amount. Different traders tend to follow a different set of rules, but they all follow the same risk-to-reward rule. Using this rule, a trader will set a percentage of money that he is willing to risk and a percentage of money that he is willing to gain prior to entering a trade. For example, if you are willing to risk a hundred dollars and profit two hundred dollars, your risk-to- reward ratio would be 1:2. Many professional traders agree that 1:3 is a good risk to reward ration.
Have a clear entry and exit plan There’s enough information in this book to inform you of the proper times to enter the market, and of times when you shouldn’t enter into the market. Use the information that I’ve given you about technical indicators, support and resistance lines, chart patterns, Elliot waves, Fibonacci lines, and the fundamental factors to estimate the proper times to enter a trade and the proper times to exit a trade. If you’re ever uncertain about whether or not you should enter a trade, you probably shouldn’t enter a trade. When I look at a chart, I can say that X currency is going to rise because of Y reasons. When I can’t do this, I don’t sweat it. I just power down my trading platform and go out fishing.
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Don’t revenge trade The markets can be as rewarding as they are cruel. If you adapt a suitable trading strategy that works well to meet your trading goals, there is a possibility of success on the market. However, no one can dream to run until he first learns to walk. In all probability, you will find that at one point or another, you will incur losses. That’s fine. What’s not fine is trying to make up your losses by quickly placing a large, irrational, poorly planned trade right after making a loss to recover some ground. It doesn’t work that way, friend. Be Zen. This tip is coming from the heart. I’m bleeding on this paper right now. When forex trading and I first began to tango, I often got frustrated from a losing trade and went off to place half of my account at risk to make up lost grounds. Sometimes it worked, sometimes it didn’t. And when it didn’t work, I felt insult added to misery. I want to make people happy. I want you to be successful on the forex market. Hear me out, don’t revenge trade.
5.3
Creating a Trading System
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S a forex trader, you should treat the time you spend trading as time spent in a career. You may already be working a 9-5 job, which means that this new career choice will only be a part-time job. That’s okay; the frequency and times at which you trade are not important here. What’s important is how you treat trading on the forex market. Most people find that if they have a set schedule, they can go about completing tasks at hand with greater ease and efficiency. Almost everyone has a schedule or set rules to which they adhere, whether it is morning routine, exercise plan, work schedule, or bedtime preparations. Call me an Apollonian, but when it comes to getting my work done, I like having a schedule and set number of rules. Many forex traders will agree with me on that. Forex traders adhere to something called a trading system. A trading system is a personal set of rules that each trader sets up for him or herself. Trading systems are as unique as the people who create them. They can change over time, be totally reinvented, or stay completely the same over a trader’s entire career. What you need to do is create a trading system that you’ll know like the back of your hand. You can form it however you’d like, and once you complete it, it should match your personality and risk appetite. I can’t tell you how to create your trading system; I can only set you on the path to create your own. Like a Jedi master who is sending his Padawan off to create his or her lightsaber, I give you these lessons that you must complete before you can become a forex master.
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Choose a Time Frame Your first step to mastering the market is to work out a schedule. You must decide when in the day you are available to look at the charts. For those who are working 9-5 jobs, the options may be limited for obvious reasons. Pick a time that you can devote to the charts. Work this into your daily routine – forex will now be what you do during this part of your daily routine. Now you must consider how much time you can devote to looking at the charts. This will influence which time frames of charts you should look at. Are you going to be the trader who stares at charts nonstop for hours on end, or the trader who will check in on his or her trades a few times a day? You must decide that for yourself. Once you’ve devoted a time for trading and have decided how often you will look at the charts, it’s time to pick a time frame of charts that is easy to read and identify trends with. You may prefer to look at day charts, or hour charts. Perhaps you want something that covers a smaller period of time, and will choose to look at minute or tick charts. Find your chart time, but remember to not limit yourself to only this chart time frame, because there’s always a bigger picture with the forex market.
Choose a Currency Pair Each currency pair is its own animal. Although many pairs moving similarly or oppositely, each component’s movements are wholly unique. Your next step towards mastering your system is to pick a currency pair that you are comfortable with. You must study this animal to see how it moves throughout the day. Notice how news affects this animal. Notice if there are any other currency pairs that move similarly to this animal. You may find that one currency pair moves slightly faster than you pair, in which case you may be able to look to that one for indications of where your currency pair will move. You must become an explorer, an adventurer and an observer. You will jump into the bush and spy on this animal’s every movement. As time goes on, you will become an expert of this currency pair.
Choose Your Technical Analysis Now that you have devoted a set period of time to look at a specific currency pair, it’s time to choose your indicators. Indicators will give you the
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edge on the market by revealing certain information that may otherwise be unknown to you from looking at price charts alone. Pick your volume indicators, or trend spotting indicators, or moving average indicators. Remember to not over complicate your chart. If you start to notice that your price lines are being drowned by bright indicator lines, it may be time to cut down on your indicator usage.
Choose Your Risk-to-Reward Ratio And while you’re at it, develop financial goals that you wish to accomplish.
Practice, Practice, Practice Apply your trading system to a practice account. If you find that you’re making consistent back-to-back wins on your trades, it’s time to start trading on a live account with real money. While trading on a live account, if you make a considerable loss, give yourself a break from live trading. Go back to a practice account and analyze your failed position. Learn what went wrong with the failed trade, and continue to trade on your practice account. If you find that you’re continuing to make back-to-back winning trades with your practice account, you may resume live trading again.
5.4
Trading on a Live Account
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E’VE come to the end of our journey, reader. It’s been fun. If you’ve studied these lessons thoroughly, you should now be well prepared to trade on the forex market. The only thing you need now is a trading account. Forex Club can offer you everything you need to get started on the forex market. If you would like to learn even more about forex trading, you can watch their online videos at http://www.fxclub.com/intro-to-forex/. To open a trading account with Forex Club, visit their official site at www. fxclub.com and click on the “Open Live Account” button, which is featured as a black button on the left-hand side of the screen.
Fig 5.4 Forex Club’s homepage
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When you choose to trade with Forex Club, you’re not only choosing to place your trust in a company that is regulated by the NFA (regulation #0358265), you’re placing your trust in a company that is willing and eager to teach its traders how to make better educated trades. Forex Club prides itself on the abundant amount of quality educational materials that we can offer traders. If you have any questions, we are here to answer them. Please feel free to call us toll free at 1 (800) 881-3809 or contact us by email at info@fxclub.com. If you’d like to ask me any specific questions about the forex market or trading strategies, you can always visit our forums and post a question. My name on the forums is Mayday, and I can answer any question you may have.
Regulation Anyone can make a forex Web site and sell you empty promises with hefty price tags. In the United States, a third-party government regulation agency known as the National Futures Association is working very hard to ensure that traders or prospective traders are not mislead or cheated out of their money. You can find an NFA search on this Web page: http://www.nfa.futures. org/basicnet/ where traders can submit the NFA ID numbers of brokers to see if any claims have been filed against said broker.
Unique Advantages In addition to caring about our traders’ education, Forex Club offers unique advantages that you won’t find anywhere else. • No Spreads and Commission refunds On our simplistic ExpressFX platform, traders do not have to worry about calculating spread costs. Instead, traders pay a commission cost of $0.40 per trade on all pairs available on the platform. If your trade dips into a loss, you will instantly be refunded your commission fee. Zero spreads and pay commission only when you profit.
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• Position U-Turns Another unique advantage that Forex Club offers is called position U-Turns. With position U-Turns, a trader can switch his or her position from buy to sell or sell to buy without closing the position. This is a great feature if you want to cut losses or ride out a reversal trend to intensify your profits. • Leverage in the base currency Forex Club offers leverage in the base currency. What does that mean? Let’s say that you want to fund your account with five hundred U.S. dollars. With other brokers, if you wanted to trade a pair like EUR/GBP, you would have to convert the currency you deposited into your account to the base currency in order to place a trade. Who wants to sit around and calculate their total exposure to the markets? Better question – who wants to limit their exposure to certain currency pairs? At Forex Club, we offer leverage in the base currency. If you want to command 500 GBP using 500 USD, go right ahead; we won’t stop you. • Guaranteed no slippage and no requotes* • Guaranteed fixed spreads and filled on stop/limit orders* • Great market trading signals *On the ExpressFX and Rumus platforms Market trading signals are forecasts given to you either by a software computer or by an actual analyst. At Forex Club, all traders are given Autochartist market signal software. This program automatically finds emerging chart patterns in the market and alerts you of these signals. Forex Club also offers signals from actual professional analysts. Trading Central is a world renowned research provider for individual and professional market investors. The signals offered by Trading Central are perfect for traders who are looking for trading ideas or who want confirmation on their trades. • News uploaded into platforms
You won’t miss out on any news releases, as Dow Jones news feeds, Bloomberg and price quotes are fed directly into all of our trading platforms. When you’re ready to trade, we’ll be here to help you every step of the way. Until then, I’d like to leave you with the parting words of the Introduction to Forex Trading book, written by Slava Taran and Dennis Carr, which was the first book on trading forex I’ve ever read.
And in Conclusion: HARLEY-DAVIDSON
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HE photograph and the text that you see in the figure below is an original Harley Davidson advertisement. Everyone is familiar with this company: it produces powerful motorcycles. However, for many people a Harley is much, much more than a mere motorbike. It’s a dream, another way of life, symbolizing freedom and individuality. It’s a revolt against boring convention and the dull compulsion of the economic. It is a dusty leather jacket, the wind in your ears and the whole world at your feet… What do you think this elderly man is dreaming about and regretting?
This is the text accompanying the photo: If I had my life to live over, I’d try to make more mistakes next time. I would relax. I would be sillier than I have been this trip, I know of very few things I would take seriously. 185
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I would take more chances, I would take more trips. I would climb more mountains, swim more rivers and watch more sunsets. I would eat more ice creams and less beans. I would have more actual troubles and fewer imaginary ones. You see, I am one of those people who live prophylactically and sanely and sensibly, hour after hour, day after day. Oh, I have had my moments and, if I had to do it over again, I would have more of them. In fact I’d try to have nothing else. Just moments, one after another. If I had to live my life over, I would start bare-footed earlier in the spring and stay that way later in the fall. I would play hooky more. I would ride on more merry-go-rounds. I’d pick more daisies. Forex, just like Harley, is more than a mere trade, business or interesting pastime. It is, if you will, a way of living, the basis of which is the belief that a person can achieve tremendous material and spiritual freedom, thanks to his or her own mind. Look into the eyes of this old man once again. Ask yourself to what extent you are richer than this old man. Your priceless treasure is time. What do you want from your life? Would you like to fill it with adventures, discoveries, battles and victories? Would you like to stand out from the crowd, to be free and a true individual? Then… look for your own Harley, try to catch your dream. Try it and see. Life is so short! Good luck!
The greatest investments don’t come in the form of a winning stock or a strengthening currency – the greatest investments come in the form of learning materials. Education and knowledge of the markets continue to be the backbone of every successful investor’s trades. By knowing what moves the markets and the small nuances that price makes prior to a breakout, investors can trade on the markets in a fashion that will both maximize profits while minimizing losses. The information provided in Bless My Pips is offered in a straight forward and easy to understand fashion. Readers will learn about key aspects of the currency trading market ranging from simple information, like the market’s trading hours, to more complex information, like understanding Elliott Waves. A first time trader to Forex can’t hope to be profitable without the proper understanding of the markets. Bless My Pips is the perfect educational foundation for all first time investors. Even if you have never heard of the Forex market before, this book can prepare you to trade currency with confidence.
ISBN 978-0-578-05846-7
Phone: 1-800-881-3809 Email: Info@FXClub.com www.fxclub.com
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