Sunday, July 12, 2009

9 Tricks Of The Successful Trader

by Selwyn Gishen

For all of its numbers, charts and ratios, trading is more art than science. And just as in artistic endeavors, there is talent involved, but talent will only take you so far. The best traders hone their skills through practice and discipline. They perform self analysis to see what drives their trades and learn how to keep fear and greed out of the equation. In this article we'll look at nine steps a novice trader can use to perfect his or her craft; for the experts out there, you might just find some tips that will help you make smarter, more profitable trades, too.

Step 1. Define your goals and then choose a style of trading that is compatible with those goals. Be sure your personality is a match for the style of trading you choose.

Before you set out on any journey, it is imperative that you have some idea of where your destination is and how you will get there. Consequently, it is imperative that you have clear goals in mind as to what you would like to achieve; you then have to be sure that your trading method is capable of achieving these goals. Each type of trading style requires a different approach and each style has a different risk profile, which requires a different attitude and approach to trade successfully. For example, if you cannot stomach going to sleep with an open position in the market then you might consider day trading. On the other hand, if you have funds that you think will benefit from the appreciation of a trade over a period of some months, then a position trader is what you want to consider becoming. But no matter what style of trading you choose, be sure that your personality fits the style of trading you undertake. A personality mismatch will lead to stress and certain losses.

Step 2. Choose a broker with whom you feel comfortable but also one who offers a trading platform that is appropriate for your style of trading.

It is important to choose a broker who offers a trading platform that will allow you to do the analysis you require. Choosing a reputable broker is of paramount importance and spending time researching the differences between brokers will be very helpful. You must know each broker's policies and how he or she goes about making a market. For example, trading in the over-the-counter market or spot market is different from trading the exchange-driven markets. In choosing a broker, it is important to read the broker documentation. Know your broker's policies. Also make sure that your broker's trading platform is suitable for the analysis you want to do. For example, if you like to trade off of Fibonacci numbers, be sure the broker's platform can draw Fibonacci lines. A good broker with a poor platform, or a good platform with a poor broker, can be a problem. Make sure you get the best of both.

Step 3. Choose a methodology and then be consistent in its application.

Before you enter any market as a trader, you need to have some idea of how you will make decisions to execute your trades. You must know what information you will need in order to make the appropriate decision about whether to enter or exit a trade. Some people choose to look at the underlying fundamentals of the company or economy, and then use a chart to determine the best time to execute the trade. Others use technical analysis; as a result they will only use charts to time a trade. Remember that fundamentals drive the trend in the long term, whereas chart patterns may offer trading opportunities in the short term. Whichever methodology you choose, remember to be consistent. And be sure your methodology is adaptive. Your system should keep up with the changing dynamics of a market.

Step 4. Choose a longer time frame for direction analysis and a shorter time frame to time entry or exit.

Many traders get confused because of conflicting information that occurs when looking at charts in different time frames. What shows up as a buying opportunity on a weekly chart could, in fact, show up as a sell signal on an intraday chart. Therefore, if you are taking your basic trading direction from a weekly chart and using a daily chart to time entry, be sure to synchronize the two. In other words, if the weekly chart is giving you a buy signal, wait until the daily chart also confirms a buy signal. Keep your timing in sync.

Step 5. Calculate your expectancy.

Expectancy is the formula you use to determine how reliable your system is. You should go back in time and measure all your trades that were winners, versus all your trades that were losers. Then determine how profitable your winning trades were versus how much your losing trades lost.

Take a look at your last 10 trades. If you haven't made actual trades yet, go back on your chart to where your system would have indicated that you should enter and exit a trade. Determine if you would have made a profit or a loss. Write these results down. Total all your winning trades and divide the answer by the number of winning trades you made. Here is the formula:

E= [1+ (W/L)] x P – 1


W =
Average Winning Trade
L = Average Losing Trade
P = Percentage Win Ratio

If you made 10 trades and six of them were winning trades and four were losing trades, your percentage win ratio would be 6/10 or 60%. If your six trades made $2,400, then your average win would be $2,400/6 = $400. If your losses were $1,200, then your average loss would be $1,200/4 = $300. Apply these results to the formula and you get; E= [1+ (400/300)] x 0.6 - 1 = 0.40 or 40%. A positive 40% expectancy means that your system will return you 40 cents per dollar over the long term.

Step 6. Focus on your trades and learn to love small losses.

Once you have funded your account, the most important thing to remember is that your money is at risk. Therefore, your money should not be needed for living or to pay bills etc. Consider your trading money as if it were vacation money. Once the vacation is over your money is spent. Have the same attitude toward trading. This will psychologically prepare you to accept small losses, which is key to managing your risk. By focusing on your trades and accepting small losses rather than constantly counting your equity, you will be much more successful.

Secondly, only leverage your trades to a maximum risk of 2% of your total funds. In other words, if you have $10,000 in your trading account, never let any trade lose more than 2% of the account value, or $200. If your stops are farther away than 2% of your account, trade shorter time frames or decrease the leverage.

Step 7. Build positive feedback loops.

A positive feedback loop is created as a result of a well-executed trade in accordance with your plan. When you plan a trade and then execute it well, you form a positive feedback pattern. Success breeds success, which in turn breeds confidence - especially if the trade is profitable. Even if you take a small loss but do so in accordance with a planned trade, then you will be building a positive feedback loop.

Step 8. Perform weekend analysis.

It is always good to prepare in advance. On the weekend, when the markets are closed, study weekly charts to look for patterns or news that could affect your trade. Perhaps a pattern is making a double top and the pundits and the news is suggesting a market reversal. This is a kind of reflexivity where the pattern could be prompting the pundits while the pundits are reinforcing the pattern. Or the pundits may be telling you that the market is about to explode. Perhaps these are pundits hoping to lure you into the market so that they can sell their positions on increased liquidity. These are the kinds of actions to look for to help you formulate your upcoming trading week. In the cool light of objectivity, you will make your best plans. Wait for your setups and learn to be patient.

If the market does not reach your point of entry, learn to sit on your hands. You might have to wait for the opportunity longer than you anticipated. If you miss a trade, remember that there will always be another. If you have patience and discipline you can become a good trader.

Step 9. Keep a printed record.

Keeping a printed record is one of the best learning tools a trader can have. Print out a chart and list all the reasons for the trade, including the fundamentals that sway your decisions. Mark the chart with your entry and your exit points. Make any relevant comments on the chart. File this record so you can refer to it over and over again. Note the emotional reasons for taking action. Did you panic? Were you too greedy? Were you full of anxiety? Note all these feelings on your record. It is only when you can objectify your trades that you will develop the mental control and discipline to execute according to your system instead of your habits.

Bottom Line

The steps above will lead you to a structured approach to trading and in return should help you become a more refined trader. Trading is an art and the only way to become increasingly proficient is through consistent and disciplined practice. Remember the expression: the harder you practice the luckier you'll get.

The Pure Fade Trade

by Kathy Lien

Everyone wants to be the hero and claim that he or she picked the very top or bottom of a currency pair. However, aside from bragging rights, is there really anything that pleasant about repeatedly selling at every new high in the hope that this one will finally be the top?

One of the biggest pitfalls encountered by novice traders is arbitrarily picking a top or bottom with no indicator support. The pure fade trade is an intraday strategy that picks a top or bottom based on a clear recovery following an extreme move. Here we'll cover this strategy and show you how you can put it to use.


The strategy looks for an intraday reversal by using a combination of three sets of Bollinger bands and the relative strength index (RSI) on hourly charts. The trade sets up when the RSI hits either an overbought or oversold level. Overbought is defined as an RSI above 70, while oversold is defined as an RSI below 30. This signals that we can start looking for a possible reversal.

However, rather than just immediately buying in the top of a trend reversal based solely upon RSI, we add in three sets of Bollinger bands to help us identify the point of exhaustion. The reason we use three sets of Bollinger bands is because it helps us to gauge the extremity of the move along with the extent of the possible recovery.

Created in the 1980s by John Bollinger, the Bollinger bands strategy was originally based on two standard deviations (SD) above and below the 20-day moving average. The theory was then to buy or sell when the prices hit the Bollinger band because using two standard deviations ensures that 95% of the price action will fall between the two bands.

In our strategy, we add on a third standard deviation Bollinger band. When prices hit the third band on any side, we know that the move is within the 5% minority, which characterizes the move as "extreme". When we move away from the third standard deviation Bollinger band and into the zone between the first and second standard deviation Bollinger bands, we know that the currency pair has hit its extreme point at the moment and is moving into reversal phase. Finally, one last thing that we look for is for at least one candle to close fully between the second and first standard deviation bands. This last rule helps to screen out fake moves and ensures that the previous move is really an exhaustion. This is a low-risk, low-return trade for those who simply want to scalp the market for small profits. Only hourly charts are recommended for the strategy.

Rules for a Long Trade
  1. Look for the relative strength index to be lower than 30.
  2. Watch for the price to hit the three standard deviation Bollinger band (SD BB).
  3. Wait for the candle to move from the 3SD-2SD BB zone into the 2SD-1SD BB zone on hourly charts.
  4. After one candle closes fully within the 2SD-1SD BB zone, buy at market.
  5. Place a stop at swing low minus 10 pips.
  6. The first target for half of the position is the amount risked; move the stop to breakeven.
  7. The second target is the tag of the second SD BB on the topside.
Rules for a Short Trade
  1. Look for the relative strength index to be greater than 70.
  2. Watch for the price to hit the three standard deviation Bollinger band (SD BB).
  3. Wait for the candle to move from the 3SD-2SD BB zone into the 2SD-1SD BB zone on hourly charts.
  4. After one candle closes fully within the 2SD-1SD BB zone, sell at market price.
  5. Place stop at swing high plus 10 pips.
  6. The first target for half of the position is the amount risked; move the stop to breakeven.
  7. The second target is the tag of the second SD BB on the downside.
The Fade Trade in Action

Let's explore some examples:

The first example is the EUR/USD from February 22, 2006 (Figure 1). The currency pair started breaking down shortly after the London open and hit our radar screen when we saw RSI dip below 30, around 6am EST. We checked the Bollinger bands and saw that the price also hit our third standard deviation band at that time and was trading between the third and second standard deviation Bollinger bands.

We watched closely for a full close within the second and first standard deviation Bollinger bands, at which time we bought at market. Our trade was triggered at 9am EST, and we entered into a long position at 1.1884. We immediately placed our stop at the swing low of 1.1862, risking 22 pips on the trade.

Figure 1: Pure Fade, EUR/US
Source: FXtrek Intellichart

Because our first take-profit is the amount that we risked, we put in an order to sell half of the position at 1.1906. The order gets triggered four hours later at 1pm EST. We move our stop to breakeven and get ready to sell the second half when the price hits the second standard deviation Bollinger band on the topside. The remainder of the position is eventually closed out at 1.1939 for a total trade profit of 55 pips.

Figure 2: Pure Fade, NZD/USD
Source: FXtrek Intellichart

The next example is the NZD/USD on February 26, 2006. Like the EUR/USD in the previous example, the currency pair range traded down going into the open of the Asian markets, when New Zealand economic data is typically released. Our pure fade trade set up when we saw RSI dip below 30 at 6pm EST. We checked to see that the price had also hit our third standard deviation Bollinger band at that time.

We then watched carefully for a full bar close between the second and first standard deviation Bollinger bands. This happened at 9pm EST, at which time we went long at the open of the next bar, or at 0.6583. We placed our stop at the swing low of 0.6568, risking a total of 15 pips on the trade. The risk is very small, which puts our profit at a very achievable 0.6598. This level is reached at 8am EST the next day, at which time we move our stop to breakeven and target the second deviation Bollinger band on the top side for the remainder of our position. The band is hit and we exit at 0.6605, for a total trade profit of 18.5 pips.

Short Side

On the short side, we look at an example in USD/JPY from March 10, 2006. Going into the open of the U.S. markets, we watched USD/JPY trade quietly in a tight range. Shortly after the typical 8:30am EST U.S. numbers, the currency pair hit our radar screens when RSI broke above 70, the benchmark for overbought conditions. At the same time, the price hit the third standard deviation Bollinger band and we watched for a full close between the second and first standard deviation bands. This happened three hours later and we entered a short USD/JPY position at 119.03.

Our stop is the swing high of 119.13, putting our risk at a tiny 10 pips. Our first target was 118.93, which was triggered at 3pm EST. Once our target was hit, we moved our stop on the remainder of the position to breakeven and looked to take profit once we hit the second Bollinger band on the downside.
Figure 3: Pure Fade, USD/JPY
Source: FXtrek Intellichart

At 4am EST the following day, we exited the remainder of our position at 118.80 for a total trade profit of 16.5 pips, before the position reversed course and started rallying once again. As you can see, the pure fade trade takes small profits quickly in times of trend exhaustion; however, more often than not, the trend continues course after prices hit the second Bollinger band in the opposite direction.

Figure 4: Pure Fade, GBP/US
Source: FXtrek Intellichart

The GBP/USD chart above is another good example of a short fade trade. On March 16, 2006, we watched the GBP/USD trade in a tight range going into the release of February U.S. consumer prices. The dollar began to sell off shortly after 8:30am EST, after the softer-than-expected report, and continued to push the GBP/USD higher for the next seven hours.

The currency pair hit our radar screen at noon EST when RSI broke above 70. We checked to see that the price was also tagging the third standard deviation Bollinger band on the top side, and we began to look for an opportunity to go short the GBP/USD when we saw a full bar close below the third and second standard deviation Bollinger band zone. This occurred at 4pm EST at which time we went short at the open of the following bar, or 1.7569.

We placed our stop at the swing high of 1.7594, risking 25 pips. The target for the first half of our position is the entry minus the amount that we risked, or 1.7544. After we entered into our position, the GBP/USD began to gradually sell off, triggering our take-profit order at 10pm EST. We then looked to exit the remainder of the position when the price hit the first standard deviation Bollinger band on the opposite side. This occurred the following day, giving us an exit of 1.7527 and earning us a total of 33.5 pips on the entire trade.

At this point, some traders looking at the charts may say, "Oh wow, the second half was triggered at 3am EST. I'm asleep!" It is very likely that you will not be able to spend the entire wee hours with your eyes glued to the computer screen, so for those who just want a target to place the second take-profit order, two times risk would be a good level. In this case, we could have placed our second exit order at 1.7519.

When It Failed

Of course, no one strategy can be accurate 100% of the time, so the last example is one where the trade did not end up in a profit. The GBP/JPY chart above is from February 14, 2006. At 7pm EST, or at the Asian market open, GBP/JPY began to break out of its post-U.S./pre-Asian price consolidation. RSI breached the 30 oversold mark, and the price hit the third standard deviation Bollinger band, which put the currency on our radar screen, where we looked for an opportunity to go long.
Figure 5: Pure Fade, GBP/JPY
Source: FXtrek Intellichart

We waited until four hours later and saw a candle open and close fully within the first and second standard deviation Bollinger bands, so we looked to buy at the open of the next candle. Our entry price is 204.52. We put our stop at the swing low, or 204.34, risking a total of 18 pips. Following our rules of taking profit on the first half of our position by the amount risked, we put an entry order to sell half at 204.70. GBP/JPY, however, was unable to sustain its momentary relief rally and proceeded to extend its weakness. We were stopped out at 204.34, two hours later, but because the risk was small, the loss would have had a minimal impact on most trading accounts.


Picking a top or bottom without indicator support is a recipe for failure. The pure fade trade is an intraday strategy that picks a top or bottom based on a clear recovery following an extreme move. It isn't foolproof, but if applied correctly, it can be a profitable strategy for forex traders.

Saturday, July 11, 2009

The Currency Market Information Edge

The global foreign exchange (forex) market had an average daily turnover of $3.2 trillion as of April 2007, an increase of 69% from the previous year, according to the 2007 Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity, conducted by the Bank for International Settlements. It is by far the largest financial market in the world, and its size and liquidity ensure that new information or news is disseminated within minutes. However, the forex market has some unique characteristics that distinguish it from other markets. These unique features may give some participants an "information edge" in some situations, resulting in new information being absorbed over a longer period.

Unique Characteristics of the Forex Market

Unlike stocks, which trade on a centralized exchange such as the New York Stock Exchange, currency trades are generally settled over the counter (OTC). The OTC nature of the global foreign exchange market means that rather than a single, centralized exchange (as is the case for stocks and commodities), currencies trade in a number of different geographical locations, most of which are linked to each other by state-of-the-art communications technology. OTC trading also means that at any point in time, there are likely to be a number of marginally different price quotations for a particular currency; a stock, on the other hand, only has one price quoted on an exchange at a particular instant.

The global forex market is also the only financial market to be open virtually around the clock, except for weekends. Another key distinguishing feature of the currency markets is the differing levels of price access enjoyed by market participants. This is unlike the stock and commodity markets, where all participants have access to a uniform price.

Market Participants

Currency markets have numerous participants in multiple time zones, ranging from very large banks and financial institutions at one end of the spectrum, to small retail brokers and individuals on the other. Central banks are among the largest and most influential participants in the forex market. However, on a daily basis, large commercial banks are the dominant players in the forex market, on account of their corporate customers and currency trading desks. Large corporations also account for a significant proportion of foreign exchange volume, especially companies that have substantial trade or capital flows. Investment managers and hedge funds are also major participants.

Differing Prices

Banks' currency trading desks trade in the interbank market, which is characterized by large deal size, huge volumes and tight bid/ask spreads. These currency trading desks take foreign exchange positions either to cover commercial demand (for example, if a large customer needs a currency such as the euro to pay for a sizable import), or for speculative purposes. Large commercial customers get prices from these banks that have a markup embedded in them; the markup or margin depends on the size of the customer and the size of the forex transaction. Retail customers who need foreign currency have to contend with bid/ask spreads that are much wider than those in the interbank market.

Speculative Positions Vs. Commercial Transactions

In the global foreign exchange market, speculative positions outnumber commercial foreign exchange transactions, which arise due to trade or capital flows, by a huge margin, although the exact extent is difficult to quantify. This makes the forex market very sensitive to new information, since an unexpected development will cause speculators to reassess their original trades and cause them to adjust these trades to reflect the new information. For example, if a company has to remit a payment to a foreign supplier, it has a finite window in which to do so. The company may try to time the purchase of the currency so as to obtain a favorable rate, or it may use a hedging strategy to cover its exchange risk; however, the transaction has to occur by a definite date, regardless of conditions in the foreign exchange market. On the other hand, a trader with a speculative currency position seeks to maximize his or her trading profit or minimize loss at all times; as such, the trader can choose to retain the position or close it at any point. In the event of new information, the adjustment process for such speculative positions is likely to be almost instantaneous. The proliferation of instant communications technology has caused reaction times to shorten dramatically in all financial markets, not just in the forex market. However, this "knee jerk" reaction is generally followed by a more gradual adjustment process as market participants digest the new information and analyze it in greater depth.

Information Edge

While there are numerous factors that affect exchange rates, from economic and political variables to supply/demand fundamentals and capital market conditions, the hierarchical structure of the forex market gives the biggest players a slight information edge over the smallest ones. In some situations, therefore, exchange rates take a little longer to adjust to new information.

For example, consider a case where the central bank of a major nation with a widely-traded currency decides to support it in the foreign exchange markets, a process known as "intervention." If this intervention is unexpected and covert, the major banks from which the central banks buy the currency have an information edge over other participants, because they know the identity and the intention of the buyer. Other participants, especially those with short positions in the currency, may be taken by surprise to see the currency suddenly strengthen. While they may or may not cover their short positions right away, the fact that the central bank is now intervening to support the currency may cause these participants to reassess the viability and implications of their short strategy.

Example – Forex Market Reaction to News

All financial markets react strongly to unexpected news or developments, and the foreign exchange market is no exception. Consider a situation in which the U.S. economy is weakening, and there is widespread expectation that the Federal Reserve will reduce the benchmark federal funds rate by 25 basis points (0.25%) at its next meeting. Currency exchange rates will factor in this rate reduction in the period leading up to the expected policy announcement. However, if the Federal Reserve decides at its meeting to leave rates unchanged, the U.S. dollar will in all likelihood react dramatically to this unexpected development. If the Federal Reserve implies in its policy announcement that the U.S. economy's prospects are improving, the U.S. dollar may also strengthen against major currencies.


While the massive size and liquidity of the foreign exchange market ensures that new information or news is generally absorbed within minutes, its unique features may result in new information being absorbed over a longer period in some situations. In addition, the hierarchical structure of the forex market can give the biggest players a slight information edge.