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The two main schools of thought when it comes to market analysis is fundamental analysis and technical analysis. Though they are not mutually exclusive, most traders will fall into one category or the other.

From the analysis standpoint, both fundamental and technical analysis provide their unique advantages and drawbacks. In this lesson, we will discuss the pros and cons of each of these analytical approaches.

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Technical Analysis in Forex

So, what is technical analysis? Technical analysis is a method of forecasting that is based on the study of past price movements. Often you will hear that technical analysis is more of an art that a science. This is so because when we are trying to predict future price movements with technical analysis, there can be many nuances, which can sometimes lead to different conclusions.

The primary tool for technical analysis is price data.  Regardless of the chosen timeframe, price data is the most important consideration. Essentially technical analysis provides a framework where an analyst can make informed decisions in the market by studying the current price action and comparing that to previous historical occurrences.

Technical analysis can be applied across many different markets including stock indices, currencies, commodities, individual stocks, and futures. So long as a market has a good amount of liquidity, and is not easily prone to outside influences, technical analysis can be applied in an effective manner.

One example where technical analysis may not be that effective, due to the lack of liquidity and propensity for outside influences to effect price, would be a very thinly traded penny stock.

The three primary tenets of Technical analysis are the following:

  •       Price discounts everything else in the market
  •       Price moves in observable trends
  •       History tends to repeat itself

Price Discounts Everything –  Technical analysts believe that the currently traded price reflects all known information available to market participants.  And any new information that is presented is quickly reflected into the price of the security.

Price Moves in Observable Trends – Trends exist in the market, and the technician believes that these trends move in a predictable non-random fashion that can be observed by the trained eye. A trend tends to emerge from trading range activity, then as the trend matures, it eventually moves back into a consolidation phase, before a new trend phase emerges again.

History tends to repeat itself – The markets display a repetitive, recursive nature within its price data. Although no two patterns within the price history look exactly the same, there can be quite a resemblance that cannot be explained away by noise or randomness. These repeating patterns can be seen in chart formations, candlestick patterns, momentum footprints, volume and other forms of price related data.   

Fundamental Analysis in Forex

What is Fundamental Analysis? Fundamental analysis is a form of market analysis that seeks to determine the underlying value of a security through the study and assessment of economic data. Within the foreign exchange market, the fundamental analyst attempts to evaluate the overall conditions within an economy using various economic data such as GDP, Employment, Inflation, Interest rates and more.

In the forex market, central bank activity is very closely monitored by fundamental analysts. Upcoming interest rate decisions, meetings, and speeches by high ranking central bank officials are extremely important to a fundamental trader.

Fundamental analysts will try to gauge the overall market conditions using various economic reports in an attempt to find mis-pricings that can lead to trading opportunities. Fundamental traders can be short term traders that try to capture price moves during potentially high volatile periods such as US Non-Farm payrolls report or they can be long term macroeconomic position traders that are more interested in multi month or multi year trends.

Unlike technicians, fundamental analysts are more concerned with the why rather than the what. Fundamental traders are looking for answers as to why the economic conditions are the way they are, or try to justify their forecasts based on the why factor. The technician on the other hand, is much less concerned with the why, and much more focused on the price action in front of them.

One big driver of a currency’s value is the country’s current interest rate. When a particular country’s interest rate is higher relative to others with similar economic conditions, foreign investment and capital will flow into the country with a relatively higher interest rate. Investors are always looking for higher yields and as such a higher relative interest rate will tend to attract more capital from the global markets. 

Some fundamental traders often use the forex market to simultaneous buy high yielding currencies against those offering lower yields. This strategy, called the carry trade, is quite popular among longer term fundamental traders and large global investment funds.

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Advantages of Technical Analysis

Let’s take a look at some of the benefits of using technical analysis:

Applicable to Any Timeframe – Regardless of whether you are a short term, intermediate term or long-term trader, you can apply technical analysis tools to your decision-making process.

Ability to Analyze Trends – There are many different studies that a technical analyst can use to analyze the current trend of the market. These include moving averages, trend lines, channels, swing highs and lows, and support and resistance, among other things.

Help with Market Timing – The primary job of a trader is to find the best trading opportunities available and then apply the right timing in executing the trade. Technical analysis tools assist traders in entering, managing and exiting their positions in a methodical and efficient manner.

 Ideas Can Be Programmed – Many concepts within technical analysis can be coded and developed into algorithmic trading systems. These types of automated systems help reduce the negative emotions associated with trading. Once you have the rules programmed with your trading system, you can step back and let the algorithm execute your rule-based system in the market.

Reveals the Mood of the Market – By studying price action and performing chart analysis, you can gain a better understanding of where sentiment extremes lye within a particular market. You will be equipped to identity extremes in investor sentiment both during runups and selloffs. Additionally, you will gain insights into where future demand and supply exists, so you can position yourself on the right side of the market before the crowd does.

Simpler and Less Time Consuming – Fundamental analysis often involves many variables and moving parts, such as Interest Rates, Inflation, Consumer Sentiment, Money Supply and a host of other factors. This can lead to over complicated models, that only PHDs in economics may be able to understand. On the other hand, technical analysis models are usually much more simplified and easier to build and implement since the primary variable or building block is price action.

Disadvantages of Technical Analysis

Here are some drawbacks of technical analysis:

Mixed Signals – There will be instances when your technical analysis tools will provide mixed or conflicting signals. For example, based on your analysis of support and resistance, you may be getting a buy signal, however, your complimentary MACD indicator may be suggesting a sell scenario.

This type of scenario does occur from time to time, and can be quite frustrating. At that point, a trader must decide whether to take the trade or pass on it based on the conflicting analysis.

Analysis Paralysis – This is a condition where traders overanalyze to the point where they become paralyzed to act. This usually occurs when the trader is trying to line up all their ducks in a row, which rarely happens in real time trading. In trading we are dealing in probabilities and not certainties. We have to act based on incomplete information most if not all of the time. With so many technical tools available to the trader, some fall into the trap of over analyzing and not being able to make a trading decision. The best solution to this problem is reducing the clutter and going back to the basics.

Can be Influenced by our Biases – Although technical analysts rely on price as their primary analysis tool, certain biases can influence the way that they perceive the information that they gather from the charts. For example, if you have a bullish bias in the EURUSD pair, you will subconsciously look for and validate long opportunities, while suppressing or ignoring signals that are pointing to a weakening condition in the EURUSD. Many times, we will not even be aware that this is happening, and so it’s imperative that we try to truly keep an open mind while analyzing the charts.

Interpretations can Vary –  As we pointed out earlier, technical analysis is more of an art than a science. Two technicians can look at the same price chart, and sometimes come up with two polar opposite interpretations. This is not all that uncommon, and one of the culprits of this is our internal biases as we have touched upon earlier. In addition, chart patterns that seem clear in hindsight can be quite subjective in real time. And so, interpretations can be different from one technical analyst to the next as the price action is unfolding.

Advantages of Fundamental Analysis

Let’s take a look at some of the benefits of using fundamental analysis theory:

Can Help Explain Price Movements – Major economic news and reports can quickly drive the market prices in one direction or the other. This is especially true when the figures for an economic release are unexpected or diverge significantly from the consensus numbers.

Provide Insights into Global Markets – Taking a fundamental approach to analysis helps the analyst to better understand what is happening in a particular country’ economy and in other economies around the world. It provides broad insight into global market conditions.

Finding Valuation – Every financial instrument or asset has a certain value associated with it. It is a trader’s job to find assets where there may be a discrepancy between the true value of an asset and the currently traded market price. Fundamental analysis can help a currency analyst in this regard by studying interest rates, inflation, consumer sentiment, industrial production, and other relevant factors.

Long Term Trend Analysis – The true power of fundamental analysis is in helping a trader craft a long-term view of a particular currency pair or asset.  Most data points within economic reports are typically compared and analyzed on a relative basis. For example, asking the question, what is the unemployment figures today compared to last month, last quarter, and last year? This will help in knowing what the current trend is as it relates to unemployment, and then we can use that information, along with other economic data, to predict the potential impact on the price of a currency pair over the longer term. 

Disadvantages of Fundamental Analysis

Here are some drawbacks of fundamental analysis:

Information Overload – Fundamental analysis is a very broad and deep subject. There is so much information available to traders and investors that digesting all of it can be quite overwhelming to say to least. This can sometimes lead to confusion and result in being counter productive at times.

Not Well Suited for the Short Term – Although economic data and reports are released regularly throughout the month, trading the news on a short-term basis poses many challenges including widening bid ask spreads around news events and unpredictable volatility spikes. As such many fundamental traders tend to focus mainly on the larger term horizon.

Lack of Market Timing – Fundamental analysis can provide us insights into the bigger picture view, but it typically cannot provide us with an objective and reliable method for timing our entries and exits. And in trading, timing is everything. You can be right on the direction, but if you are wrong on the timing, your trade will most likely result in a loss. As such, fundamental analysts typically need to rely on technicals or some other technique for entering and exiting trades.

Highly Subjective – Although fundamental data is fairly clear cut, the assumptions that you can draw from such data can vary greatly among economists and analysts. For example, one analyst can cite many different reasons why they believe that rising interest rates will be favorable to the economy, while another analyst can cite just as many reasons for why they believe that rising interest rates will have an adverse effect on the economy.

Technical Analysis Tools

Regardless of whether you consider yourself a technical analyst or fundamental analyst, you must become familiar and proficient in using certain analytical tools to assist you in your analysis. Let’s take a look at some of the primary tools that technicians and fundamental traders use.

Popular Tools Used By Technical Analysts

Currency Correlation Tool – Price movements of certain currency pairs tend to be related. A positive correlation occurs when the price of two pairs tends to move in the same direction. A negative correlation exists when the price of two pairs tends to move in opposite directions. Currency pairs that do not display any price relationship are said to be uncorrelated.  A currency correlation table allows a trader to quickly find these relationships.

It’s important to know the correlation between pairs that you are interested in trading or already have a position in because it will help to reduce your overall position risk.

Forex Volatility Tool – A currency volatility tool provides a typical pip range that can be expected within a specified period of time. This could be the average over a period such as one hour, one day, one week, or some other specified period. Knowing the volatility of a currency pair can help a trader in selecting the right pairs to trade and in setting realistic profit targets.

Both the volatility tool, and the aforementioned currency correlation tool can be found at Mataf.net, a popular site that provides a wide array of tools for forex traders.

Technical Indicators and Oscillators – This is a favorite among technical traders. There are many different technical tools available. There are momentum indicators such as MACD, RSI, and Williams %R. There are trend indicators such as moving averages, and trend lines. There are volatility bands, such as Bollinger Bands and Keltner channels. Technicians try to find confluence among various technical studies in order to narrow in on high probability trading opportunities.

Price Action Analysis – Price is the single most important tool within a technician’s toolbox. The current price reflects the motivations of all market participants and the supply and demand balance at any given point in time. Many technical traders rely exclusively on price action analysis, combining support and resistance levels, and candlesticks to gauge the potential movements of price going forward.

Chart Pattern Analysis – Chart analysis is also a very popular technique used by some technicians. Some traditional chart patterns include Head and Shoulders, Double Top and Double bottoms, and Cup and Handle formations. There are also Fibonacci based patterns, such as a Gartley, Bat, or Butterfly.

Furthermore, there are candlestick patterns and more advanced technical analysis patterns such as Elliott waves that can be analyzed as well. As humans we have a natural tendency towards pattern recognition, and this translates into our desires to look for patterns within price charts.

Fundamental Analysis Tools

Economic Calendar – One of the key day to day tools for a fundamental trader is the economic news calendar. There are many different sources that make this available including Econoday, Forex Factory, and Trading Economics. A favorite among many forex traders is the Forex Factory economic calendar. It lists all scheduled economic reports, along with other important geo-political events. It provides a color-coded system where you can sort by low, medium, and high impact events. Short term news traders try to capture intraday profits during high impact news events, while macro fundamental traders rely on it to help them build a longer-term outlook for a particular currency pair or country.

Financial Newswires – Some professional traders rely on financial newswires such as Reuters, Bloomberg, or the Financial Times, in order to get the news that they need. Many well known financial newswires, such as these, offer streaming and real time news as it happens and provides worldwide coverage through hundreds if not thousands of publications and sources from around the globe. Many traders and investors that trade fundamentals rely heavily on these services.

Analyst Reports – Fundamental traders need to keep up with the latest economic releases and news events of the day, and while and economic calendar and financial newswires are essential tools in helping to shape a view of the market, it also helps to get additional insights and perspectives from other analysts as well. There are a handful of highly sought-after fundamental analysts that provide ongoing and timely foreign exchange and macro-economic analysis.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download
Final Thoughts

So, you might be asking, technical analysis vs fundamental analysis, what type is better? Well personally, I prefer to use technical analysis in my trading as it provides a complete framework from which to analyze, enter, manage and exit trades. And so, I urge all traders to learn technical analysis, even if it’s only at a basic level.

Other traders swear by fundamental analysis, and yet another group of traders use a combination of both. There is no right or wrong answer. You just have to really learn and apply both approaches for yourself and see what works best for you.

The post Technical Analysis vs Fundamental Analysis In The FX Market appeared first on Forex Training Group.

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If you’ve been thinking about venturing into the world of cryptocurrencies but don’t know where to start, then this cryptocurrency investment guide should help you get started. Contrary to what you may have heard or think about cryptocurrency investing, it is just another asset class, not much unlike investing in stocks, bonds or options.

But as a crypto investing beginner, you will have to put in some time to learn the basics. Once you have a good foundation, then you will surely become more comfortable in the space and gain more confidence. In this article, we will provide some cryptocurrency investing tips and advice that should prove useful along your journey.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download
Cryptocurrency Market

To say that the cryptocurrency market has seen a huge surge in interest would be an understatement. It all stated in 2009, when the first cryptocurrency, Bitcoin, was introduced. It wasn’t until about 4 years later in 2013 that it started to gain recognition.  The Bitcoin price surge started in 2017 as more and more investors began to flow into the market.

Fast forward to mid 2018, and though the market cap for Bitcoin and other cryptocurrencies have fallen dramatically from their highs, the interest in them has not waned. In fact, as of now there are close to 1600 altcoins available in the marketplace.

There are many people that are adamant that cryptocurrencies are a phase, and will not last. Others argue the other end of the spectrum, believing that this is the new era of trade and that cryptos are here to stay and will eventually replace fiat currency. No one knows for sure what the answer is, but most likely the future of cryptocurrencies lyes someone in between these two extreme viewpoints.

Many individuals that invested early in cryptocurrencies have seen their net worth rise dramatically. There is still potentially alot of upside in the cryptocurrency market, but it will not be without some downside volatility. Investors interested in allocating some of their funds to the cryptocurrency market should be keenly aware of the risks involved and buckle in for the ride. 

Blockchain Technology

To understand how cryptocurrencies work, you must understand the underlying technology behind it.  Blockchain is the technology that enables cryptos such as Bitcoin.  Essentially, a blockchain is a digital ledger that is publicly available which is responsible for tracking and recording transactions. There is a network of nodes communicating internally that oversees this entire process.

A practical example should help you understand this better. Let’s say that Joe has purchased a mountain bike from David using Bitcoin. When Joe initiated payment using Bitcoin, his request was sent through the blockchain which verified that Joe had the necessary Bitcoin to transfer to David. When this verification was complete, the public ledger was updated to reflect a reduction in the number for coins in Joe’s Bitcoin address while simultaneous adding that corresponding amount to David’s bitcoin address.

Although our example above involved using blockchain for the transfer of a cryptocurrency for commercial purposes, there are many other use cases for Blockchain. In fact, any type of information which has storage capacity can be powered by Blockchain technology. A simple way to think about this is that Cryptocurrencies cannot operate without Blockchain, whereas Blockchain can exist without Cryptocurrencies.

Major Cryptocurrency Investment Opportunities

When some investors think about cryptocurrency investing and trading, the first thing that typically pops into their head is Bitcoin. In fact, many people interchange the word cryptocurrency and Bitcoin, believing it to be the same thing.

Those that are a little better versed in this area know that Bitcoin is just one type of cryptocurrency. It is in fact the first to come on the scene and the one with the largest market cap, but again it is only one of many. The other 6 major cryptocurrency investing options that investors should know about is Ethereum, Ripple, Litecoin, Bitcoin Cash, EOS, and Cardano. We will discuss some characteristics of each now.

Bitcoin – The largest cryptocurrency by a big margin. It currently boasts a 45% share of the total crypto market. Bitcoin has skyrocket in value from about $ 70 in mid 2013 to almost 20,000 in December 2017. Bitcoin has fallen over 65% since then. Many bitcoin analysts feel that the correction is over and a new bull trend should emerge soon.

Ethereum – As the second largest cryptocurrency, it saw an astonishing growth of over 2800% in 2017. One of the biggest selling points for Ethereum is that it offers a very unique solution. Ethereum allows potential developers to build their blockchain projects using the Ethereum platform. As a result, Ethereum enthusiasts believe that this will help propel the price of the crypto in the very future and beyond.

Ripple – The third largest cryptocurrency by market cap. It essentially moved from almost $0 to its high of $2.40 by the end of 2017. As with the other cryptocurrencies the prices have fallen quite a bit. Ripple’s applications go beyond the typical digital currency realm. Its blockchain enables faster, more secure international payment transfers as well. It has partnered with many Tier 1 banks to buildout innovative solutions for the financial industry.

Litecoin – This cryptocurrency skyrocketed from around $4 in early 2017 to a high of almost $360 by the end of that year. Since then, as with all the other major cryptos, the price has been under pressure. The original intent behind Litecoin was to improve upon Bitcoin’s technology. And in that respect, it has succeeded. Litecoin is able to process transactions 5 times as fast as Bitcoin.

Bitcoin Cash – This was segmented from the original Bitcoin and launched in mid 2017. Since then, Bitcoin Cash has become one of the most popular cryptocurrencies to trade. As of now, the amount of Bitcoin and Bitcoin Cash in circulation is about the same. Bitcoin Cash has 8 times the block size compared to the original bitcoin, which translates to increased processing efficiency. The price of BCH skyrocketed from about $500 in the summer of 2017 to over $4,000 by the end of 2017.

EOS –  EOS was launched in the summer of 2017. It is most similar to Ethereum and allows developers to build their applications on top of its platform. Its technology is strikingly enhanced allowing capacities of upto 100,000 transactions per second. It is also more versatile from the programming perspective than Ethereum allowing multiple coding languages to be utilized. One notable aspect of the price of EOS is that is has been impacted to a much lesser degree by the 2018 market decline in the overall crypto market.

Cardano –  The founder of Cardano, Charles Hoskinson, is also the co-founder of Ethereum. And it too is a direct competitor of Ethereum, as it allows for developers to build their application using its platform. Cardano has many advancements in its technology compared to Ethereum. The price of Cardano rose from the $0.20 mark in mid-October 2017 to over $1.00 in just a few months. Since then, it has fallen sharply along with its other crypto counterparts.

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Cryptocurrency Exchange Investing

By now you should be getting a little more familiar with cryptocurrencies. So, the next obvious question investors face is how and where do I go to purchase a particular digital currency? Typically, you would buy and sell your cryptocurrency through organized cryptocurrency exchanges. This is the most common method for trading and investing in cryptocurrencies online. There are a host of different exchanges out there that you can use. You will have to consider what features are most important to you when deciding on a crypto investing platform. Some considerations will include the cryptocurrencies offered, liquidity, spread, fees, and platform user friendliness.

To help you get started, I have created a list of 9 reputable cryptocurrency exchanges that you might want to consider.

Coinbase – One of the most popular and widely used platforms for buying and trading digital currencies. It has an excellent reputation and the stored currency is guaranteed through Coinbase insurance.

Kraken – Based on Euro volume it is the largest Bitcoin exchange in the world. They offer leveraged margin trading accounts for more experienced investors and traders. In addition, they provide many different digital currency options beyond Bitcoin, Ethereum, and Ripple.

Poloniex – They are a leading cryptocurrency exchange founded in 2014. They offer extensive trading tools on their platform for more active traders and investors. In addition, they offer a volume based pricing platform which is more attractive for active traders.

Bitstamp – One of the oldest exchanges around, Bitstamp has been in existence since 2011. Bitstamp is well known for its platform security features, including a fully backed cold storage service. Their initial deposit fees, however, tend to be a bit higher than many other crypto exchanges.

Bitsquare – A decentralized peer based exchange that enables clients to trade bitcoins using paper currency or cryptos. Those that want the highest level of privacy find Bitsquare fits their needs quite nicely.

Gemini – A US based Bitcoin exchange that is licensed and regulated. They must comply with very strict compliance measures and maintain the highest standards. Depositors’ funds are held at an FDIC insured bank and the digital currencies are housed in cold storage. They currently service clients in the US, Hong Kong, Singapore, Canada, and the United Kingdom.

Binance – A Malta based cryptocurrency exchange known for its low fee structure and deep liquidity. In fact, they have the most volume traded compared to nearly all other cryptocurrency exchanges. They charge about .05 % on a per trade basis.

There are a multitude of coins that you can purchase, including Bitcoin, Litecoin, and Ethereum. In addition, when you purchase any of these three mentioned coins, you have the ability to convert those holdings into many other altcoins. Binance also has an excellent cryptocurrency investing app that is worth looking into.

CoinMama – One of the larger bitcoin exchanges that allow purchases via a credit card. Their daily and monthly limit for purchases via credit card are much higher than other competitor exchanges. You can acquire upto $5,000 of coins per day or upto $20,000 per month with CoinMama.

LocalBitcoins – A peer to peer crypto exchange. It’s a platform that allows you to trade directly with other individuals in major metropolitan cities around the globe. You would setup an account with them and they maintain a rating system for those that have used to the platform.

Risks and Rewards of Cryptocurrency Investing

One of the biggest attractions of the cryptocurrency investing game, is the ability to make outsized gains in a relatively short period of time. This is what draws most investors to the asset class. For many investors, a small to moderate allocation percentage to cryptocurrencies would likely be a sound decision, and could help bolster the overall performance of their portfolio. That’s the upside.

The downside is that this asset class as a whole is still relatively new and highly unstable. So, the prudent investor should be aware of the risks present when investing in cryptocurrencies, and limit their risk exposure to a level that they are comfortable with.

Let’s take a look at some of the risks and challenges Cryptocurrencies face:

Liquidity Concerns –  Liquidity is king when it comes to trading any financial instrument. Essentially, liquidity is defined as the ease and efficiency at which you can buy or sell an asset with minimal slippage. Unfortunately, since cryptocurrencies are an emerging asset class, it does not have a great deal of liquidity.

You may be able to buy and sell it in normal market conditions in a relative frictionless manner, but the risk is greatly heightened during more turbulent times or events. It is during these times that it may be very hard to unwind one’s holdings as desired in an efficient manner.

Uncertain Regulatory Landscape –  There is a good deal of regulatory risk when it comes to investing in cryptocurrencies. To curve fraud, manipulation, hysteria or panic in these coins, government agencies can and will likely intervene and take steps to put regulatory restraints on this asset class. This can have a dramatic impact on the price of many cryptocurrencies.

Valuation Challenges – When you buy a stock in a company, there are many fundamental factors that you can gather and study to evaluate the “fair” price of the stock. There is no such level of transparency in cryptocurrency investment analysis, which makes it much more difficult to arrive at a “fair” price.

We have seen hysteria drive prices up to excessive levels, and panic drive prices back down in these assets. Cryptocurrencies tend to be driven up and down by human emotions rather than valuations.

Correlation Risk –  It is important to consider correlation when investing in different asset classes, or instruments within the same asset class. For example, in the stock market, if you invest in Apple, Facebook, and Google, then you may perceive that you are diversified since you are investing in three different companies. But in fact, all three of these companies are within the same sector and are highly correlated.

The same goes for cryptocurrencies. Most crypto coins are highly correlated. As such you should not fall into the trap of thinking that by spreading out your investment over many different coins, that this will somehow provide you a reasonable amount of diversification. This type of cryptocurrency investment diversification would not be considered a true level of asset diversification because of the high correlation factor among the various coins.

Portfolio Allocation

No discussion of investing would be complete without touching on the topic of portfolio allocation. Let’s say that you have decided to invest in cryptocurrencies, have done your necessary due diligence, and are ready to commit your hard-earned capital in the market. How much should you invest?

The answer to that is not so cut and dry. Each investor will have to decide on the amount that they would like to allocate to crypto investments given their age, risk profile, financial situation, and emotional makeup. That may not be the answer you wanted to hear, but it is the reality of it.

But having said that, and generally speaking, if you are an aggressive investor, you may consider upto 20% of your portfolio in cryptos and 80% in traditional assets. If, on the other hand, you consider yourself a conservative risk averse investor, then maybe a 5-10% allocation may fit your needs.

The most important thing to keep in mind is that investing in cryptocurrencies is by its very nature a risky speculative bet, so you should only commit funds that you are willing to part with, as that might very well happen. It is always better to be prepared first than sorry later. So, sure you very well may make a small or large fortune in your crypto investments, but you must be willing to assume the risks as well for that luxury.

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Final Thoughts

This article was aimed at providing you with some cryptocurrency investing basics. After reading this article, some of you may decide that you want to research further the investment opportunities available in the cryptocurrency market. Others of you may decide that this asset class does not align with your personal financial goals. Whatever you decide makes sense for you, you should do it with an open mind and consider both the potential rewards and risks involved. 

What I believe that you should not do is to steer away from investing in cryptos because you find that it is too difficult to understand or fear that the learning curve is too steep. That would be doing disservice to yourself and your intellect. Go forth and do the necessary research, and then make a decision based on that. By doing so, you will walk away more satisfied with your decision, whatever that may be.

The post How To Get Started Investing in Cryptocurrencies appeared first on Forex Training Group.

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Many forex traders are aware of what Pivot Points are and may even incorporate these support and resistance levels into their trading strategy. But did you know that there are many different variations of Pivot Points?

In this article, we will take a closer look at five major types of Pivot Points – Standard Pivot Points, Woodie’s Pivot Points, Camarilla Pivot Points, Fibonacci Pivot Points, and Demark Pivot Points. We will define each type and compare and contrast each variation.

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Pivot Point Basics

Pivot points are used by forex traders to locate potential support and resistance areas.  They are levels where price interaction may cause a reaction. In addition, Pivot points help traders gauge the bias and sentiment in the market over a given time interval.

Pivot points were originally used by floor traders in the futures markets. Most floor traders were short term day traders in nature. Before the start of the morning session, many floor traders would calculate the Pivot Points of the financial instrument they traded, using the prior day’s high, low and close. This would help them identify important levels during the day, and keep them on the right side of the market.

Pivot levels can be applied to the Equities, Futures, and Forex markets. They are particularly helpful in the FX Markets and their derived levels tend to be respected during the trading session.  There are three major sessions in Forex – the US session which opens at 8:00 am EST, the European session which opens at 2:00 am EST, and the Asian Session which opens at 7:00 pm EST.

When there is higher volume in the markets, the Pivot levels tend to lead to more breakout opportunities, and when there is lower volume in the markets, such as periods in between one session’s closing and the next session’s opening, we tend to see price action range between two levels.

Pivot points are considered leading indicators as they have predictive qualities. Many forex traders prefer to use Pivot points over many other types of horizontal levels, as they are more objective and easy to understand. However, some fundamentalists and even some technicians argue that Pivot Points only work because they have become a self-fulfilling prophecy. There may be some truth in this assertion, but so long as their application proves to be profitable in the markets, traders will continue to employ them within their trading programs.

Trading With Pivot Points

The concept of support and resistance is one of the most important ideas when trading the markets. Trading without knowing where potential turning points may occur is akin to skydiving without a parachute. Sooner or later it will ruin you. Pivot points are a tool that can help traders recognize points of interest where traders are likely to see increased order flow. Keep in mind that many traders tend to place stop loss orders and take profit targets around these levels so there exists a higher likelihood of activity that can cause price rejections or breakouts from these levels.

Intraday traders tend to rely on daily pivot levels which are calculated from the prior’s day’s high, low and close. These traders are usually trading the short term timeframes such as the 5, 10 or 15 minute intervals. But trading with Pivot points is not the exclusive realm of short term traders. Many swing and intermediate term traders also use pivots, but they tend to rely more on weekly or monthly pivots.

Although there are many different methods to incorporate pivots into your trading, there are three primary strategies for trading with Pivot levels. The first is using the levels to initiate breakout trades. The second is using the levels to take reversal trades. And finally, traders can employ pivots as a take profit mechanism or to scale out of trades.

Let’s take a look at a few examples: The first example is a breakout trade setup using Pivot Points:

In the chart above, you will notice the circled area with a strong bear candle that breaks the Support 1 level, and closes below it. This is considered a pivot point breakout setup. 

The next example is a reversal trade setup using Pivot Points:

This chart highlights what a Pivot level reversal trade would look like. You will notice that price was moving steadily higher and then approached the Pivot (P) level. As soon as it hit this level, we saw a hammer candle form. And also after the following candle was completed, an evening star pattern was visible on the chart. The price retested the Pivot (P) level and dropped sharply lower afterwards.

Standard Pivot Points

Standard Pivot Points are also commonly referred to as Floor Pivots or Classical Pivot Points. These terms are often used interchangeably, but the important point to remember is that they are the most common type of pivots that traders use.

The calculation of the Standard Pivots starts with the baseline Pivot Point (P). You can simply calculate (P) by taking the high, low, and close and diving that by 3. This is the center or mid-point from which the two support levels (S1, S2) and the two resistance levels (R1, R2) are calculated.

Here is the calculation for the Pivot Point (P):

Pivot Point (P) = (High + Low + Close) / 3

Once the Pivot Point (P) has been computed, then we can move on to compute the other values.

To calculate the first support level (S1) , we would multiple the pivot value by 2, and then subtract that from the high of yesterday.

Here is the calculation for Support 1 (S1):

S1 = (Pivot Value X 2) – Yesterday’s High

Next, we can move on to computing the first Resistance level (R1). To calculate R1, you would also multiply the Pivot value by 2, and then subtract that from the low of yesterday.

Here is the calculation for Resistance 1 (R1):

R1 = (Pivot Value X 2) – Yesterday’s Low

Now we have the first level of support and resistance, next we would calculate the second level of support and resistance. The second level of support (S2) will be lower than (S1), and the second level of resistance (R2) will be higher than (R1).

To calculate the second level of Support (S2), we would need to subtract the difference between the High and Low and then subtract that from the Pivot value.

Here is the calculation for Support 1 (S2):

S2 = Pivot Value  – (High – Low)

The second level of Resistance is computed in a similar fashion. To get the result for R2, simply take the difference between the High and Low and add that to the Pivot Value.

Here is the calculation for Support 1 (R2):

R2 = Pivot Value  + (High – Low)

The chart above shows five days of activity for the EUR/USD pair using the 15 minute time series. The standard pivot point indicator is also plotted on the chart. You will notice the Resistance levels marked in green, the Support levels marked in Red, and the Pivot (P) levels marked in black. Notice how many of these areas saw reactions as price approached the levels.

Woodie’s Pivot Points

Now let’s turn our attention to Woodie’s Pivot Points. Woodie’s Pivot Points are calculated as per below:

R2 = PP + (High – Low)

R1 = (2 X PP) – Low

PP = (High + Low) + (2 x Closing Price) / 4

S1 = (2 X PP) – High

S2 = PP – (High + Low)

As you may have noticed the Woodies Pivot calculation is quite different than the standard pivot points formula. One of the primary differences is that the Woodie’s formula puts more weight on the closing price. Notice that the Pivot Point (PP) calculation involves multiplying the closing price by 2, and then adding the High and Low. From this you would divide by 4 to get the PP level.

This might sound a bit confusing at first, but essentially it works similar to an Exponential Moving Average, where the latter data is weighted more heavily than the earlier data. Also as a side note, you will often find in the FX market that the opening price is the same as the closing price. This is due to the fact that FX markets trade 24 hours a day.

Camarilla Pivot Points

Camarilla Pivot Points were invented by Nick Scott in the late 1980’s. They are similar in concept to Woodie’s in that they use the prior day’s closing price and range to compute the levels.

But instead of 2 Resistance levels, and 2 Support levels, the Camarilla equation calls for 4 resistance levels and 4 support levels. Add to that the Pivot Point level, and there are a total of 9 levels plotted for Camarilla. Also, an interesting part of the Camarilla equation is that a special multiplier is included in the formula.

Let’s take a look at the Camarilla Pivot point formula:

R4 = Closing + ((High -Low) x 1.5000)

R3 = Closing + ((High -Low) x 1.2500)

R2 = Closing + ((High -Low) x 1.1666)

R1 = Closing + ((High -Low x 1.0833)

PP = (High + Low + Closing) / 3

S1 = Closing – ((High -Low) x 1.0833)

S2 = Closing – ((High -Low) x 1.1666)

S3 = Closing – ((High -Low) x 1.2500)

S4 = Closing – ((High-Low) x 1.5000)

As you can see, we have a total of 4 Resistance levels, and a total of 4 Support Levels. Many intraday traders utilize the Camarilla levels to fade price moves when then reach the R3 or S3 level.

The idea is that the markets are cyclical in nature, and that a strong price move from the prior session, should tend to revert back within its value range the following day. Stops could be placed at the R4 or S4 levels. If, however, price action continues beyond the R4 or S4 level, then a stop and reverse can be initiated in anticipation for a strong trend day and continued price move beyond the R4 or S4 level.

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Fibonacci Pivot Points

Fibonacci studies such as retracements, extensions, and projections are quite popular in the Forex market. The primary Fibonacci levels that traders watch most closely are the 38.2% and 61.8% retracement levels.

But did you know that you could incorporate these Fibonacci levels into a Pivot Point calculation as well? In fact, it is very similar to the Standard pivot points, with the additional inclusion of the 38.2% and 61.8% and 100% ratios. 

Here is the formula for calculating Fibonacci Pivot Points:

Resistance 1  = Pivot + (.382 * (High  –  Low))

Resistance 2 = Pivot + (.618 * (High  –  Low))

Resistance 3  = Pivot + (1 * (High  –  Low))

Pivot Point  = (High + Low + Close) / 3

Support 3  = Pivot – (1 * (High  –  Low))

Support 2  = Pivot – (.618 * (High  –  Low))

Support 1  = Pivot – (.382 * (High  –  Low))

So, for Fibonacci pivot levels, we start by computing the pivot point as we would the standard pivot point, using H+L+C / 3. Then we would multiply the prior days’ range with the specified Fibonacci ratio. Finally, you would either add the result to the pivot point to calculate the Resistance levels, and you would subtract the result from the pivot point to compute the Support levels.

Demark Pivot Points

Demark Pivot points were introduced by Tom Demark, a famous technical analyst and trader. Demark Pivots are very different from other types of Pivot Points that we have discussed thus far.

These pivot points have a conditional nature based on the relationship between the opening price and the closing price.  Demark uses the number X to compute the upper resistance level and the lower support line.

Here is how you calculate Demark Pivot Points:

If Close > Open, then X = (2 x High) + Low + Close

If Close < Open, then X = High + (2 x Low) + Close

If Close = Open, then X = High + Low + (2 x Close)

Pivot Point = X/4

Resistance 1  = X/2 – Low

Support 1  = X/2 – High

Demark Pivot Points place more emphasis on the recent price action. Many Demark traders use Demark Pivot Points in conjunction with TD lines to find intraday support and resistance levels in the market. TD lines are much more objective than traditional trend lines. They are drawn from left to right based on the demand points in an uptrend and supply points in a downtrend. The objective is to find points along the TD line that are most likely prone to a breakout move.

Pivot Points and Technical Confluence

An important consideration for trade entry by many successful speculative traders is the concept of confluence. This is when a number of technical indicators or studies line up within a tight narrow range to provide a high probability trading signal.

Pivot Points can be combined with other technical factors to create a confluent trading setup. For example, let’s say that you plot a bullish trend line using the 30 minute chart. Also, you have added the Standard Daily Pivot point study on your chart. You can look to place a long trade when price rejects the trend line and starts to move up while simultaneously price is also breaking and pulling back to a daily Pivot level such as S1 or R1.

This type of confluent support provided by the up sloping trend line and the Pivot point level would strengthen the trade signal, since you would have two non-correlated technical studies providing you the same signal at a specific time.

This is just one example, but you can use a host of other studies to combine your pivot analysis with. Some of the more reliable confluent signals to trade with alongside Pivot points include horizontal support and resistance, trend lines, moving averages, Fibonacci Levels, Bollinger bands, and candlestick patterns.

And some traders actually prefer to use a combination of three different timeframes to find overlapping pivot levels. By incorporating the Daily, Weekly, and Monthly pivots, you would look for tight clusters. These areas are likely to be closely watched by many traders, and can provide for opportune mean reverting trade setups in many cases. 

Let’s take a look at what trading confluence looks like using pivot points. Below you will see a chart of the EURUSD using the 15 minute timeframe. Notice that the price action was range bound for most of the period shown. We were able to draw a horizontal price support line on the chart. (marked in Blue).

Towards the end of the price action on this chart, you will see that price was moving down, and hit the horizontal price support and the overlapping S1 level support. In addition to that, as soon as price converged on this level, we saw a nice hammer candle with a long lower wick. After the reversal candle formed, priced bounced out of this area and shot up above the Pivot level and almost reached the R1 level within a short span of time.

Pivot Point and Technical Confluence Trading Strategy

As we have touched on in the prior section, it is important to combine Pivot Points with other technical studies in order to create a high confidence trade setup. In this section, we will take a look at a Pivot Point trading strategy that incorporates the Daily Standard Pivot Point Indicator,  150 Period Moving average, and Fibonacci retracement levels.

This strategy will look for a recent test and bounce from the 150 period moving average that aligns with a recent bounce from a primary Fibonacci retracement and Pivot Point level. Once we have these conditions met, then we will enter into the trade on the close of a strong reversal candle.

The stop loss placement will be just beyond the swing point created by the reversal. Our exit on the trade will the next higher pivot point level in case of a long trade, and the next lower pivot point level in case of a short trade.

The chart below displays about three days of price action on the EUR/USD currency pair. 

As you can see, price started off trading in a tight range for about two days. The 150 period Simple Moving Average (SMA) was headed down but soon price crossed it to the upside taking out taking out the Pivot (P) level, R1 level, and ultimately was halted at the R2 resistance level. Then price dropped back down sharply near the Pivot (P) level. We saw another bounce back to retest the R2 level, which contained the price action from a further price increase.

Afterwards prices started to decline slowly and in a much lower volatility environment. At this point, we could prepare for a test of the Pivot (P) level, which also coincided with a 38% Fib retracement measured from the major swing low two days earlier. Prices pushed below this zone but was rejected as it approached the 150 period SMA, which was slightly below the overlapping Pivot and Fib support area.

This was the setup that our strategy calls for, and as soon as prices closed higher in a decisive manner, we would enter a long trade. You will notice the large green bar within the magnified area. That would be our preferred entry point. The stop loss would be placed below the swing low created by this price rejection. And our target would be the next higher Pivot line, which in this case was the R1 level.

As you can see prices moved rapidly after testing this confluence support area and went directly to the R1 resistance area. As per our exit strategy, we would have had our take profit target just below this RI level.

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In this article, we discussed the five major variations for the Pivot Point Indictor. They can be classified as Standard Pivot Points, Woodie’s Pivot Points, Camarilla Pivot Points, Fibonacci Pivot Points, and Demark Pivot Points. The most popular and widely used is the Standard Pivot point indicator. However, each variation has its following among forex and futures traders.

Obviously, the question arises as to, Which type of Pivot Point is the best to use? Well, the answer to that is not so clear cut. There will be times when certain types of pivot points adhere to price action better than others. But as a matter of preference, I generally like to use the Standard Pivot Points, as those are levels that most traders have marked and keep a close eye on. I find that they tend to have better price reactions. In any case, you should test each and see which works best for your preferred trading instruments.

The post Comparing the Different Types of Pivot Points appeared first on Forex Training Group.

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The Service and Manufacturing sectors comprise the majority percentage of US GDP. As such it is important to gauge the overall health of these components. One of the most useful sentiment studies that can help traders and investors to forecast future economic trends is the ISM PMI Manufacturing report, and the ISM Non-Manufacturing report. We will discuss both of these key economic releases in this article.

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What is the ISM Non-Manufacturing Report ?

The Non Manufacturing Purchasing Managers Index (PMI) is released by the Institute of Supply Management (ISM).  The Institute was founded in 1915, and was the first supply management institute in the world. The report on business is a composite index that helps measure the economic health of the US economy. 

Though the Manufacturing PMI has been around for much longer, there was a need to measure the economic situation within the service sector as well. This is especially true since the service sector is attributed a majority percentage of US GDP in real terms As such the ISM Non-Manufacturing report was born. This report has been published by ISM starting in 1998.

The data is compiled from surveys of approximately 400 purchasing managers in over 65 various non-manufacturing industries including mining, agriculture transportation, retail, and more. The report is released on a monthly basis on the third day of each month and reflects the data for the previous month. The Non Manufacturing Composite Index (NMI) is based on four equally weighted indicators: New Orders, Business Activity, Employment, and Supplier Delivery. All of these indicators are seasonally adjusted expect for the Supplier deliveries.

Generally speaking, when the index is over 50, it demonstrates that the economy is growing, while an index of less than 50 signals a contracting economy. In addition, a better than expected reading is usually bullish for the US Dollar, and conversely a lower than anticipated reading is usually bearish for the US Dollar. Positive readings over time will also tend to help boost stock prices.

Typically, the ISM Non-Manufacturing Index has a somewhat diminished market impact compared to the Manufacturing PMI release. One reason for this is that the non-manufacturing sector is generally much less volatile and more foreseeable than its US Manufacturing Index counterpart.

What is the ISM PMI Manufacturing Index ? 

In the previous section, we discussed the ISM Non Manufacturing report, and in this section, we will talk about the ISM PMI Manufacturing economic release. It measures the manufacturing output for a particular time horizon.  The ISM PMI Manufacturing report is released every month, on the first business day of the month. The data reflects the prior month’s activity.

The manufacturing sector is an integral component of the overall economic health of a country. Although the manufacturing sector of the US economy is less than 15% of total GDP, it is nevertheless an important economic report and often highly watched by many Forex traders.

The report is produced by ISM and is a diffusion index, which basically means that it has various components that comprise the index.  The resulting number is then updated to take into account seasonality factors. The PMI Index composite takes into account the following indicators: New Orders, Employment, Supplier Deliveries, and Inventories.

The ISM Manufacturing report is gathered by surveying over 400 Purchasing and Supply managers about their future expectations on production, inventories, employment, and new customer orders. The benchmark number is 50 for the index. So, if the number is higher than 50 then this hints of economic growth, while a reading of 50 or lower is considered to be contractionary.

The ISM PMI index is considered to be a leading indicator. It helps foretell future spending and expenditures that contribute to economic expansion. The indicator tends to reflect changes before the economy does. If there is an uptick in the PMI index, meaning there is more manufacturing output, then this is likely to lead to stronger economic considerations. And contrary to this, if there is a downtick in the PMI manufacturing index, meaning there is less manufacturing output, then this is likely to lead to weaker economic conditions.

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Significance of the ISM reports

 The ISM Non-Manufacturing Index is a fairly new indicator compared to the ISM Manufacturing Index. However, it is becoming increasing important as the service sector takes up a larger and larger portion of US GDP. In fact, the service sector is the fastest growing component of the US economy.

Between both of these reports, a trader or investor can get important sentiment data covering all industries that account for more than 90% of overall GDP in the United States.  These reports are released during the first few days of the month, and as such they can sometimes set a tone for the markets for the rest of the month. In addition, these reports can provide clues into the Non-Farm Payroll report that is released on the first Friday of every month.

The Non Manufacturing ISM Index can trend in one direction or another for many months, and this can provide valuable long term information on the state of the service sector.  One of the major benefits in evaluating the ISM report is that the data provides valuable insight on a national basis rather than on a regional level. Some of the local purchasing managers’ surveys include the Philadelphia Fed report, the Empire State Manufacturing Report, and the Chicago Purchasing Managers Index. 

There are some downsides that traders and investors need to be aware of with the ISM reports.  As we have mentioned earlier, these reports are comprised from surveys. As such, the data can sometimes be quite subjective rather than based on empirical statistics.

For example, Purchasing managers being surveyed could be overly influenced by a host of factors including recent orders, internal company meetings, or their own pre-set biases.

Those looking for long term data will find that the Non-Manufacturing Index data only goes back to 1998. This, however, is not the case for the Manufacturing Index which can be tracked back to 1948.

Dissecting the ISM Report

As we have learned thus far, the ISM Purchasing Manager reports for both the Manufacturing and Non-Manufacturing sectors can be seen as a barometer for the US economy and tends to be a leading indicator for future economic growth. So, if Purchasing managers are optimistic and reporting upticks in spending, then traders can assume the possibility of better corporate earnings going forward.

Let’s now take a deeper dive into the report:

Below you see the “Non-Manufacturing Survey Results at a Glance” portion of the ISM Non Manufacturing Report on business for the June 5, 2018 release date.  The full report can be found here:

The beginning of the release posts the all-important headline number, the NMI PMI which in this example is 58.6. This is the number that the market is anticipating. Day traders will try to position themselves for potential short term price spikes based on this figure. As we have touched upon earlier, the NMI is a composite index based on four primary indicators: Business Activity, New Orders, Employment, and Supplier Deliveries. You will notice each of these components listed separately below the NMI PMI figure.

We also see the prior months Index figure and the Percent Point change between the two months. The Direction and rate of change column provides quick insight into the state of the economy based on these figures. For example, 58.6 is the most current figure and that forecasts a faster than normal growing economy.

On the far right of the column you will find details on the ISM Manufacturing numbers as well. This is useful in comparing the two component reports. For example, the Manufacturing PMI data for the month was recorded to be 58.7, and that was an increase from 57.3 from the previous month. At the same time, the percent point increase in the Manufacturing Index (+1.4) is lagging behind the Percent point change for the Non Manufacturing sector (+1.8).

There are many different way to read into and analyze these figures. but at the bare minimum, a trader should be familiar with the headline number and be able to quickly compare it to the previous month’s figure.

Trading the ISM Numbers

As we have learned in the earlier section, an ISM composite index number above 50 indicates that the US economy is expanding. In addition, when the number has been above the 50 baseline for several months, it tells us that the economy is stable and strong.

Conversely, when the number is below 50 it indicates that the US economy is contracting. And a number that has been below the 50 baseline for several months, can warn us of a potential recession.

Aside from the longer term forecast that we can make using the ISM figures, short term traders, can take advantage of the ISM economic release for short term price movements. One of the more popular types of news trading methodologies using the ISM report is to trade a divergence between expected results and the actual figure that came in.

For example, if economists are expecting a reading over 55 and the actual index composite comes in at 52 or 53, then the market may react to this discrepancy after the release. In this case, fundamental news traders would likely expect the lower than expected figure to be bearish for the Dollar, and a day trading opportunity could exist to ride the short term momentum on a weakening Dollar.

You could sell the USD/JPY pair for example, or buy the EUR/USD pair for a short term day trade or scalp.  However, this trading idea is a generalization and traders need to keep in mind other news events and/or technical levels that could override the ISM reading.

Take a look at the chart below which shows the price action after the Mar 1, 2018 Manufacturing PMI report:

This is the 30-minute EUR/USD chart leading upto the March 1, 2018 Manufacturing PMI release. The Index came in at 60.8 and was higher than expected. The economists’ forecast was for 58.7. In addition, it was higher than the previous month’s number of 59.1. Both of these would have likely contributed to an expectation for a strong dollar rally for the day. But things are not always as they seem in the forex markets.

As you can see, the price action leading up to the ISM Manufacturing report was quite choppy and moving sluggishly to the downside.

Just after the ISM Manufacturing release, the price moved higher and closed the 30 minute bar decidedly bullish. The next 30 minutes shows additional strength and the bullish price movement continued for several more hours.

Before long the EURUSD pair was up over 100 pips. But we were expecting the Dollar to rise based on the strong ISM figures? Instead the Dollar fell sharply to the Euro on this better than expected news. Why is that?

Well if we dig a little deeper we can see that from the technical standpoint we had a bullish hammer candle formation near a major support zone in the EURUSD.

And at the same time that the ISM PMI economic report was released, we had another important fundamental event occurring.  Fed chairman Powell was testifying before the Senate Banking committee.

Both these factors diluted the positive ISM report and caused the Dollar to fall sharply on the day. So, the point is that, regardless of how good an economic release appears, we must always be cognizant of other factors that can influence our position so that we can take that information into consideration as well.

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The ISM PMI Manufacturing and Non-Manufacturing releases are anticipated by market participants, and can help a trader understand the underlying economic conditions and trends that exist. We have looked at the important components that comprise the reports and how investors can read the actual report.

We have discussed some advantages that the ISM release offers to traders, and a few drawbacks as well. The major drawback of the report is that is a fairly subjective rather than being highly data driven. This can lead to erroneous assessments at times.

Finally, we have demonstrated that the releases can be used by traders for short term opportunities, but that caution needs to be applied because relying solely on the release numbers without taking the overall market content or other factors into your decision process can lead to unanticipated consequences.

The post Understanding the ISM Manufacturing PMI and Non-Manufacturing Reports appeared first on Forex Training Group.

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Breakout trading is a time tested strategy that has been used by some of the largest traders and hedge funds in the industry. There are a multitude of ways that a retail trader can incorporate a breakout style into their trading plan.

One of the oldest and simplest technical indicators used to trade breakouts is the Donchian Channel. In this lesson, we will learn the nuts and bolts of the Donchian Channel indicator, and then construct some trading strategies around it.

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Introduction to the Donchian Channel

The creator of the Donchian channel was a renown trader named Richard Donchian. During his trading career in the mid 1900’s, he was seeking ways to capture large price movements in the market and in fact, the Donchian channel technique is considered to be one of the earliest forms of trend following systems.

The Donchian indicator plots two primary lines which are based on the high and low price over a specified period of time. You can also add a middle line which is the average of the upper resistance line and the lower support line of the Donchian Channel. It is perhaps one of the simplest channel indicators to understand. Think of it as a simple N bar breakout.

Donchian analysis can be applied to any liquid market including forex, futures, and stocks. And it is versatile enough to trade across many different timeframes. The simplicity of this indicator contributes to its robustness across many different instruments and trading timeframes.

One of the earliest adopters of the Donchian technical trading concept were a famous group of traders called “The Turtles”. The Turtle trading strategy used two variations of the Donchian channel breakout- the 20 day breakout, and the 55 day breakout. Today, many traders that utilize the Donchian price channel tend to use the 20 period as the look back period.

You may be wondering if the Donchian channel is similar to the Bollinger band, since both tend to have a setting of 20 periods, and both are channel bands. Although they appear to be similar, they are quite different. Keep in mind that the Donchian channel indicator’s only variable input is the look back period. It does not take in a user input for volatility like the Bollinger Bands do.

That being said a trader can still gauge the volatility of a currency pair or financial instrument using the Donchian channel method.  Generally, the wider the width of the Donchian channel, the more volatile the market, while the narrower the Donchian channel, the less volatile the market. Also, price action can pierce the Bollinger Bands, but you will not see that type of characteristic with the Donchian channel, as its bands are measuring the high and low of the specified period.

The Donchian channel is primarily a breakout type trend following indicator that provides two different types of breakout signals. We will be discussing this in more depth in the following sections.

Take a look at the image below which shows the Donchian channel plotted on a price chart.

You will notice there are three lines that comprise the Donchian Channel – the Upper Resistance Line, the Lower Support Line and the Centerline.

How to Calculate Donchian Channels

As we have touched on earlier, the Donchian Channel only requires the look back period for the input. The indicator then takes the user defined look back period and calculates the upper resistance line and the lower support line. These two lines are then plotted on the price chart. As an option, a trader can add a third line, the centerline. The centerline is calculated and plotted as the average of the upper and lower band. Generally, the default value of the look back is 20 periods.

So, to summarize the Donchian Indictor calculation:

Upper Line of Donchian – Highest price for the last N bars.

Lower Line of Donchian – Lowest price for the last N bars.

Centerline – (N period High + N period Low) /  2

For example, let’s assume we are looking at the hourly chart of the EURUSD currency pair and were using a look back of 20 periods for our Donchian indicator setting. Say that the 20 hour high was 1.3210 and the 20 hour low was 1.3150. Based on this, the Donchian indicator would plot an upper resistance line at 1.3210 and a lower support line at 1.3150. The centerline would be drawn at 1.3180.

As you can see, the Donchian indicator is very straight forward and easy to comprehend. But as simple as it is, you should not underestimate its effectiveness in finding good trading opportunities in the market.

Donchian Channel Signals

The Donchian Channel is typically used as a  breakout indicator. There are essentially two main types of breakout signals that the Donchian Band provides. One is the break of the Upper Resistance line or the Lower Support line. The second type of breakout signal that you can utilize is the Centerline cross. The Donchian channel strategy was primarily created to take advantage of potential trends, so when you enter the market using any of these two breakout signals, you can be sure that you will catch almost every emerging trend in the currency pair.

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Donchian Band S/R Breakout Signal

Trend traders typically enter in the direction of a breakout expecting a strong follow through which would lead to a trending price move. Using the Donchian Band, a buy signal occurs when prices hit the upper band, and a sell signal occurs when prices hit the lower band.

You should keep in mind that the Donchian channel reprints on the chart and as such you need to keep a careful eye out so that you can act quickly when the price has breached a Donchian S/R level. If your charting software allows it, it would be best to set price alerts so that you do not miss the breakout opportunity.

Some traders prefer to enter every breakout, while other traders prefer only to trade breakouts that occur on high volume or high momentum. The reason for this is that there is a higher likelihood of price follow-through if the breakout occurs on high volume and/or with high momentum. Essentially, it would be confirming that there is some real strength behind the breakout that would help propel prices in the direction of the breakout. Filtering trades based on high volume or momentum will lead to less whipsawing and higher win rates, however, the downside is that you may miss some strong moves due to the additional filtering process.

You will have to decide which method is more suitable for your temperament.  When trading the FX markets, where volume data is not readily available, you may want to use a momentum based filter such as RSI or MACD. When trading currencies in the futures market, where volume data is available, you can consider either filtering with Volume or Momentum. Let’s take a look at an example below that shows the Donchian Channel S/R breakout signal on the price chart.

Notice on the chart that prices were trading in a range, and then there was a breakout bar that closed below the lower Donchian channel line. This would be considered a Donchian support line breakout.

Donchian Centerline Breakout Signal

As we have touched on earlier, the Donchian channel is comprised of two primary lines, the upper resistance line and the lower support line. The user has the option to add an additional third line. This is the centerline, and is the average of the upper and lower line.

The centerline has several useful applications. Firstly, it can be used as a breakout signal to enter a new position. When prices cross over the centerline to the upside, you could buy and when prices cross the centerline to the downside, then you could sell. Aggressive traders would enter at the centerline to initiate a new position rather than wait for the S/R line to be breached. 

In addition to using the centerline to get into a new position, traders can also utilize the centerline as a means of adding to positions. Usually this type of scenario plays out after a minor retracement within a trend is followed by a resumption of price in the direction of the prevailing trend. This allows a trader to add positions as price is moving in the intended direction.

Another useful way to incorporate the Donchian centerline is use it as an exit strategy. So, if you are in a long trade, you would wait for prices to cross below the Donchian centerline and then you would exit the trade and vice versa for a short position. This method will allow you to capture a large portion of a trend move while keeping your open profit protected against a significant adverse price move.

It is an excellent way to protect your profits and keeps the trader disciplined in their trade management. It will help you to stay with the trend and avoid getting out too early. At the same time, it will help you to lock in profits when you are feeling overconfident in your winning position.

Let’s take a look at the Donchian Centerline Breakout:

The price action has been trending downward and then retraced to the upside, crossing the Donchian centerline. Then price quickly fell and closed below the centerline. The breakout bar has been magnified on the chart. This is considered a Donchian Centerline Breakout signal.

Donchian Channel Trading Strategies

By now you should have a good understanding of Donchian bands, and it relevance to trend trading. Now we will dig a little deeper and construct a few trading strategies using the Donchian channel in forex. These strategies should provide some insights on how to best trade with the Donchian indicator, and should inspire you to come up with some unique ideas of your own that you can run a backtest for and validate.

Donchian Centerline with 200 Period SMA

The first strategy that we will describe combines the Donchian centerline with the 200 Period SMA ( Simple Moving Average). The idea behind this trading system is to try to capture moves in the direction of the longer term trend. The 200 SMA is used to indicate the longer term directional bias on the trade.

So, if price is currently below the 200 period SMA, we will only be looking to take short trades. And similarly, if price is currently above the 200 period SMA, we will only be looking to take long trades. This will help keep us on the right side of the market for the most part.

Our trade entry signal will be based on the Donchian centerline. Assuming that the 200 Period SMA filter has been met, a long trade will be initiated when price crosses and closes above the 20 Period Donchian Centerline.

And on the flip side, assuming that the 200 period SMA filter has been met, a short trade will be initiated when price crosses and closes below the 20 Period Donchian Centerline. This is a simple, yet robust entry technique.

Now for the stop loss placement, we will place a stop at the most recent swing just before the Donchian centerline cross. And for the take profit target, we will close and exit the trade when prices cross over the Donchian centerline in the opposite direction.

Let’s now turn our attention to the currency price chart below which illustrates this strategy in more detail:

Above is the 4 hour chart of the USDCHF currency pair. Prices were trading in a tight consolidation range around the 200 Period SMA. Then there was a strong upside bar that broke through the Centerline. The same bar also closed above the 200 SMA. This breakout bar has been noted and magnified on the chart. So, the signal to enter would occur at the close of this bar. Our stop would be placed just below this bar.

From there prices quickly moved higher. Six bars after the entry signal, a shooting star pattern appeared on the chart. which would have warned us that an impending price decline was possible. Afterwards, prices started to consolidate a bit but then moved higher breaking above the shooting star formation. Shortly thereafter, a second shooting star pattern appeared, which would again be a warning that a retracement or reversal was likely imminent.  Price started to fall after this second shooting star pattern was seen. Eventually price crossed the Donchian centerline and closed below it. You can see the Exit Bar has been noted and magnified on the chart. This would have served as our exit signal on the trade.

Donchian Bollinger Band Squeeze

This next setup that we will discuss is one that I really like and refer to often in low volatility environments. It is called the Donchian Bollinger Band Squeeze strategy. This setup combines the Donchian Channel and the Bollinger Bands. It is a great combination to find low volatility markets where prices are likely to breakout soon. The logic behind this Donchian trading system lyes in the premise that markets are cyclical by nature. There will be periods of low volatility followed by high volatility and back again. This is how the market breathes and is the natural ebb and flow of most currency pairs and other financial instruments.

The setup occurs when both the Upper and Lower Bollinger band lines are contained within the Donchian Channel. The setting used for the Donchian bands is the default 20 period look back. And for the Bollinger Bands, we will also use the default setting of 20 periods, however for that standard deviation, we will use 2.5 rather that 2. This tends to work better in locating lower volatility conditions that are poised to make a move.

The entry signal will be based on the Donchian Upper and Lower lines. So, the trading system will look to enter long when the Bollinger bands have been recently contained within the Donchian Channel and price breaks and closes above the upper resistance of the Donchian band. And conversely, the trading system will look to enter short when the Bollinger bands have been recently contained within the Donchian Channel and price breaks and closes below the lower support of the Donchian band. It is important to keep in mind that the Bollinger bands do not necessarily need to be within the Donchian channel at the time of the breakout.

For the stop loss placement, we will put in the stop at the most recent swing just before the breakout. And for the take profit target, we will close and exit the trade based on a 1.5 : 1 RVR (reward to risk ratio).

You can refer to the trading example below which details the Donchian Bollinger Band Squeeze setup:

In the above chart, we have the price action for the USDCHF pair using the 240 minute timeframe. Starting with the left side of the chart, we can see that prices were heading higher and made three minor tops prior to a swift price drop. After the price decline, prices began to consolidate and trade in a tight narrow range for several days. Towards the latter part of this low volatility market condition, the Bollinger Bands entered inside the Donchian channel. 

This scenario confirms the trade setup, and we would be preparing for a breakout of either the lower Donchian support line or the upper Donchian resistance line. In this case, prices broke to the downside with a high momentum bar that closed beyond the Donchian Support line. The breakout bar that serves as the entry signal has been noted on the chart.

The stop loss would be place above the recent swing level and the upper wicks within the consolidation range. After the entry, prices traded sideways for a few days before moving sharply lower and hitting our take profit target. The take profit target, which is based on the 1:5 : 1 Reward to Risk ratio has been marked on the chart.

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As we have learned in this article, Donchian channels are a simple yet effective tool for trading breakouts. The general principles behind the indicator have been an inspiration to many traders around the world, particularly to trend following system traders. In fact, many of the greatest traders in the world including the famous “Turtles” used a variation of the Donchian channel to build their trend following system models.

The true power of the Donchian indicator is realized when you are able to combine it with other technical studies such as Moving Averages, Momentum, or Bollinger Bands to create a robust trading methodology. Now it’s your turn to take what you have learned and start applying it in the markets or even better to start building upon these concepts to improve on the ideas presented so that you can carve out your own variation of a Donchian channel trading system.

The post Capturing Profits Using Donchian Channel Breakouts appeared first on Forex Training Group.

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Momentum is one of the most important concepts in technical analysis. Momentum can be measured by various trading indicators including RSI, Stochastics, Williams %R, and the Momentum Indicator among others. 

In this lesson, we will discuss the Momentum Indicator. We will learn what this indicator is, how to calculate it, and what types of signals it provides. With that foundation, we will then discuss some strategies for trading with the Momentum indicator and how it can be combined with other technical studies.

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What is the Momentum Technical Indicator?

The Momentum Indicator falls within the Oscillator class of technical trading indicators. The indicator oscillates to and from the 100 centerline, which may or may not be displayed based on the indicator settings. In addition, the Forex Momentum Indicator is considered a leading indicator, which means that it can often foretell potential trend changes before they occur.

The Momentum Indicator essentially measures the rate of change or speed of price movement of a financial instrument. It measures the most recent closing bar to a previous closing bar n periods ago. By analyzing the rate of change, we can gauge the strength or “momentum” in a forex currency pair or financial instrument. Waning momentum suggests that the market is becoming exhausted and may be due for a retracement or reversal. An accelerating momentum condition suggests that the trend is strong and likely to continue. Many momentum trading techniques such as a breakout of a recent range relies on this idea of accelerating momentum.

The Momentum indicator in forex is a very versatile indicator and can be used in several different ways. It can be utilized as a trend confirmation signal, as well as a trend reversal signal. It is the trader’s job to understand the market environment that exists, and apply the most appropriate signal with that context in mind.

For example, in a trending environment, we would want to consider continuation signals, while in a range bound market, we would want to consider Mean Reversion type signals.  We will take a closer look at this in the later sections. But for now, it is important to keep in mind, that the Momentum trading indicator provides useful information in both range bound markets, and trending market conditions.

The Momentum indicator consists of a single line, however, many traders also prefer to add a secondary line on the indicator which acts to smooth the signals. The second line is typically an X period Moving Average of the Momentum indicator. A popular setting for the X period look back is 9, 14, or 21. Keep in mind that the shorter the X period setting is, the more noisier the signal can be, which can lead to false signals. Longer period inputs for the X setting will result in better quality signals, however, the signals will tend to occur much later. 

Typically, the MT4 Momentum indicator will be displayed in a separate window at the bottom of the chart panel. Let’s take a look at the MT4 chart below which displays the 10 period Momentum indicator, along with the 21 period Simple Moving Average. The Momentum line is shown in blue and the Simple Moving Average is shown in Cyan.

Calculating the Momentum Indicator

The Momentum Indicator compares the current closing price to a specified closing price “n” periods in the past. The “n” period is an input value that is determined by the trader. Most charting software programs use momentum indicator settings of 10 or 14 for the input value. So then, if you set “n” to 10, that would compare the current closing price to the closing price 10 periods ago. Here is the calculation for the Momentum Indicator:

M = (CP / CPn) * 100

Where M = Momentum, CP = Closing Price, n = close price n bars ago.

Let’s take an example using the following inputs:

CP    = 109.10

CPn  = 102.50

M = (109.10 / 102.50) * 100

M = 106.43

Your charting program will automatically plot the output values, but it is important to understand how the calculation is done.

Momentum Indicator Signals

The forex momentum oscillator helps identify the strength behind price movement. We can use momentum to pinpoint when a market is likely to continue in the direction of the main trend. In addition, the momentum study can help us to identify situations when the price action is losing steam so that we might prepare ourselves for a potential trend reversal. The three primary signals that the Momentum indicator provides is the 100 Line Cross, the Moving Average Cross, and the Divergence signal. We will go through each of these signal types in the following section.

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100 Line Cross

One type of signal provided by the Momentum Indicator is the 100 Line Cross. When price moves from below the 100 Line and crosses it to the upside, it indicates that prices are moving higher and that you may want to trade from the bullish side. And similarly, when price moves from above the 100 Line and crosses it to the downside, it indicates that prices are moving lower and that you may want to trade from the bearish side.

Keep in mind, that you should not use the 100 Line cross in isolation as it can be prone to whipsawing. The point is to keep an eye out for where price is in relation to the 100 Line and use other filters to find the best entry opportunities. For example, in an uptrend, you may want to wait for prices to pullback to or below the 100 line from above, and enter after price crosses back above the 100 line. You could filter that condition with something such as a 3 bar breakout for entry.

Take a look at the chart below which illustrates this:

Crossover Signal

As we noted before, you can add a second line to the Momentum Chart Indicator. Typically, that would be a Simple Moving Average of the Momentum Indicator itself. The length of the moving average could be whatever the trader chooses, but a common setting is a 10, 14, or 21 period moving average.  You must have both the Momentum line and the MA line plotted in order to utilize the crossover signal.

The basic idea is to buy when the momentum line crosses the Moving average from below, and sell when the momentum line crosses the Moving average from above. This by itself would be a very rudimentary application, but we can enhance these types of signals by taking trades only in the direction of the underlying trend or taking signals only after an Overbought or Oversold condition has been met. Take a look at the chart below which shows a Momentum Crossover Buy Signal coupled with an RSI oversold reading.

Momentum Divergence Signals

Momentum Divergence is a very simple but powerful concept in technical analysis. A bullish divergence occurs when prices are making lower lows, but the Momentum indicator (or other oscillator) is making a higher lows.  On the same line of thinking, a bearish divergence occurs when prices are making a higher high, but the Momentum indicator (or other oscillator) is making a lower high.

This dichotomy or divergence provides early clues to the trader of weakening momentum which could lead to a price retracement or a complete trend reversal. Momentum divergences tend to occur at market extremes where prices have pushed too far, and like a rubber band effect, it needs to revert into a value area.

Divergences work well in range bound market conditions. But during strong trending markets, divergences will tend to give many false signals along the way. And so, it is important not to use divergence in isolation. Understanding what is occurring on the larger time frame is often very helpful in filtering out low probability trades. Looking for key support and resistance areas and using that as a backdrop to lean on a divergence setup can increase your odds of a winning trade substantially.

During a trending market condition, you can also look for a pullback where price action is diverging from the Momentum indicator. A divergence trade setup that is aligned with the overall trend is likely to provide a higher success rate, than bucking a strong trend and trying to pick a top or bottom. When attempting a counter trend trade with momentum divergence, it is important that you have additional evidence that a trend reversal is likely. No matter how far a market has extended or how good a counter trend divergence signal looks, it could very well be a false signal, and the market could continue to trend. Keep in the mind the old adage that says, “the markets can remain irrational for longer than you can remain solvent”.

Let’s take a look at a few divergence examples. The first example below occurs within a range bound market.

Take note on the far right of the chart, price action makes a higher high and the Momentum Oscillator makes a lower higher. This is a good quality divergence setup that occurs within a range bound market condition. Now let’s take a look at some momentum divergences that occurred during a strong price decline.

On the chart above, you will notice that price is in a strong downtrend. There are three Momentum divergence signals  noted on the chart. All three proved to be false signals as price action continued to trend to the downside. This should make you think twice about trading divergences during strong trends.

Trading Strategy using Momentum Indicator

By now you should have a good understanding of what the Momentum indicator is, how it is constructed, and some of the trading signals that it provides.  We will now shift our focus and discuss some trading strategies that we can use when trading with Momentum.

Momentum Divergence with Zig Zag Pattern

The first Momentum system that we will discuss combines the Momentum Indicator, Divergence setup, and the Zig Zag pattern.  We have already outlined the details of the divergence pattern, so now I will briefly explain what a Zig Zag Pattern is.

A Zig Zag Pattern is a fairly simple pattern that is rooted in the Elliott Wave theory. It consists of three waves – A, B, and C. Wave A is the initial wave of the pattern, which is retracement by the second leg, Wave B. Wave B must retrace less than 100% of Wave A. The final wave, Wave C, moves in the same direction as Wave A and must extend beyond it. Here is a diagram which illustrate the Zig Zag pattern:

So now let’s combine all three elements to create the trading strategy. Firstly, what we are looking for is an overall trending market. Secondly, we want to see a Zig Zag correction within that trending market. And then, finally we want to wait to see if a divergence formation occurs within the Zig Zag pattern.

If we can confirm the divergence between the Momentum indicator and price, then that will be our trade setup. Our actual entry signal will occur on the break of the trend line that extends from the beginning of Wave A and connects to the beginning of Wave C. We will call this the A-C trend line.

As for trade management, we will look to place our stop loss beyond the most recent swing created prior to the A-C trend line breakout. And for the take profit target, we will target an area just inside the beginning of Wave A.

Let’s take a look at this Momentum Divergence with Zig Zag setup in action:

The currency chart above shows the price action on the 4 hr. USD/CHF pair. You can see from the far left of the chart, that the USD/CHF pair has been in a steady downtrend. At some point, price action begins to turn up and soon we see a Zig Zag pattern forming on the chart. Also at the same time, we see that a Bearish Divergence pattern is forming as well between the price and the Momentum Indicator. The dashed yellow lines represent the divergence formation. All of this evidence points to a possible reversal, so we want to be positioned to the short side.

Recall per the strategy described, we would want to wait until we have a break and close beyond the A-C trend line of the Zig Zag pattern. You will notice the A-C trend line is marked with a dashed red line. Sometime after the divergence pattern has formed, we have a strong break and close beyond the A-C trendline. This is the entry signal that we are waiting for, and we would want to initiate a short trade here.

The stop loss would be placed just above the Pin Bar that was created several bars back. You can spot this by locating the bar with the relatively high wick to the upside. Just after the entry, price action tested the broken A-C trendline and then  moved sharply to the downside. We would exit the trade just before price reaches the beginning of the Zig Zag pattern. I have noted the take profit target area on the chart.

Momentum Divergence with Support and Resistance

Regardless of the trading system used, every trader should take the time to understand the fundamental concepts of Support and Resistance. Support levels are areas where price is likely to stall or find demand (buying pressure). Resistance levels are areas where price is likely to stall of find supply (selling pressure). When a support level breaks, it turns into new resistance. When a resistance level breaks, it turns into new support. It is important to note that Support and Resistance should be viewed as zones or areas rather than a fixed line.

One of the major mistakes that traders make is that they typically only look at one timeframe – their trading timeframe.  By doing this, they lose sight of what is going on in the bigger picture and sometimes trade right into a key support and resistance level without even knowing it. So, it is critical to know where major support and resistance areas are so that you can navigate your trading within that framework.

In this next strategy, we will be combining the Momentum indicator using the divergence pattern again, but this time we will trade the divergence off of a key higher timeframe level.  So, if you were trading the 60 minute chart, your key levels would be plotted off the 240 minute chart, which is the next higher timeframe. Or if you were trading the 240 minute chart, your key levels would be plotted off the daily chart. Typically, the higher timeframe will be 4x to 6x your trading timeframe.

In this Momentum strategy, we will first wait for price to approach a key S/R level based on the higher timeframe. Then, we want to watch the price action closely and wait to see if a divergence pattern forms near the S/R level. Once we confirm the divergence between the Momentum Oscillator  and price has occurred, then we will consider that a potential trade setup is progressing. Our actual entry signal will occur on Momentum Indicator crossover.

We will need to place a stop loss order in the market. For the stop loss, we will use the most recent swing prior to the Momentum crossover signal. For the exit, we will wait for the Momentum Indicator crossover in the opposite direction.

Let’s look at an example of this Momentum Indicator strategy in the market.

The above chart displays the price action for the NZDUSD pair on the 2 hr. timeframe. Take note of the solid red line on the chart. That red line represents key resistance area for the 10 hr. timeframe. Keep in mind for this strategy, we want to use the higher timeframe to mark major support and resistance levels.

We can see from the price action beginning at the left side of the chart, that the NZDUSD was in a downtrend. As the down move began to subside, prices started to reverse and trade to the upside. Price action put in the first significant top during the up move, and soon after price action was beginning to test the major resistance area. As price moved into resistance, we were able to notice that a nice divergence pattern was forming as well. This clued us into a potential bearish trade setup.

Based on the strategy rules described, we would have to wait for the Momentum indicator crossover signal now before we could execute the trade. And in fact, that signal occurred shortly after the resistance test. As a result, we would have entered a short position and placed our stop loss order above the recent swing high as noted on the chart. Prices quickly dropped and several days later a crossover signal occurred to the long side on the Momentum indicator. This crossover serves as our exit and we can close the trade with a nice profit on the trade.

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As we have discussed, there are three primary trading signals that can be generated with the Momentum Indicator. These signals include the 100 Line Cross, the Momentum Crossover, and the Divergence signal.  The best Momentum indicator signal is the Divergence signal. But regardless of which type of Momentum signal you employ, it is highly recommended that you make use of confluence by incorporating other technical studies into the mix. You should not trade the Momentum indicator without first analyzing the underlying market condition.  If you stick to that guideline, then you will be less prone to whipsaws and false setups.

You should now be more knowledgeable about the..

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One of the most fascinating aspects of human behavior, is our tendency to become consumed by the next big thing. And many times, we become so enthralled that our sense of reality and our rational thinking become compromised.

In this lesson, we will discuss seven major financial hysterias that eventually lead to panic and subsequent market crashes. We will learn what led up to these various bubbles, and see if there are any root causes that are similar among them. What can we learn from history so that we can prevent ourselves from getting caught up in future market hysterias? We will do our best to answer this key question.

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Tulip Mania of 1637

Many market professionals believe that the current cryptocurrency mania is a bubble that is primed to burst soon. But before there was Bitcoin, Ethereum, and Litecoin there were Tulips.

How much would you pay for a Tulip bulb? Probably not too much I would imagine. But back in the early 17th century in the Netherlands, certain types of tulip bulbs were being sold for the price of a house, if you can believe that. 

The Tulip mania was one of the first recorded speculative bubbles in history, and is a classic example of how ordinary investors can lose all sense of reality when they are consumed by mass delusion.

It all started in the late 1500s when a local botanist named Carolus Clusius in the Netherlands began to cultivate tulips at the University of Leiden. During his work at his botanical garden, he started to notice that some of the petal colors of the flower began to change colors and this created unique patterns that were quite interesting in shape.

As a result, other local botanists and aficionados began to show interest in purchasing these multi colored tulips and commenced trading these tulips amongst themselves. As word got out, more and more people were intrigued and eventually Tulip brokerages were formed in an effort to facilitate trade for investors.

The prices for these tulips started to rise to extraordinary levels by the mid 1620’s. In fact, some investors where trading their real estate holdings in exchange for certain highly sought after Tulip bulbs such as the Semper Ausustus. The Semper Augustus tulip bulb resembled a candy cane pattern. By 1637, almost everyone was caught up in the craze and the prices reached astronomical levels. And in just over one month in 1637, the prices rose over 1000% for these flowers.

Later that year, as some individuals and investors began to take profit and sell their tulip holdings, prices started to fall. As prices fell, more people began to sell their stock of tulips. In addition to those who sold for profit, late investors started to get nervous and they too fearing a decline in price of tulips fueled the collapse.

And within a very short span of time, there was widespread panic as people seem to have come to their senses, and started to unload their inventory for whatever prices they could get. It is at this time the Dutch government tried to intervene to mitigate the damages and losses, but it was to no avail as many families lost their entire life’s savings during this collapse.

South Sea Bubble of 1720

The South Sea Bubble involved an international British trading firm that was given exclusive authority to trade with the Spanish colonies in the West Indies and South America as part of an agreement with the British government after the War of the Spanish Succession.

The South Sea Company was organized in 1711 by John Blunt and Robert Harley. During this time, England was involved in the War of the Spanish Succession, and the government was seeking funding for the ongoing war efforts. The South Sea Company agreed that in return for taking on a portion of the governments war debt’s it would be granted exclusive trading rights with the Spanish colonies. This seemed to be a win win scenario for both the British government and the South Sea company. The British government would get the necessary funding for their war efforts, and the South Sea company would be able to reap untold riches from this trading monopoly.

The South Sea company was able to sell shares to the public and in addition to the highly lucrative trading profits, investors would also earn a 6% return on their capital which was to be paid directly by the British government.

In an all-out effort to spark investor interest and attract more and more investors, the South Sea company began to aggressively tout the abundance of gold, silver and other metals that were going to be brought back to the country. In addition, one of the company’s directors, John Blunt, even incorporated a risky program to lend potential investors money to buy shares of the company. As a result of this, investors began to buy shares of the South Sea Company in droves.

During this time, the stock price for the South Sea company was souring. In fact, by the summer of 1720, the share price of the company peaked to over £1000. But the company’s profits were nowhere in line with the public image it had created for itself.

And so eventually as the promises made were not coming to fruition, selling ensured and prices began to drop. This selling was fueled by those investors who borrowed money to purchase shares of the company and were unable to keep up with their monthly installment. These leveraged investors had to sell their shares to fulfill their obligations and as a result the share price in the South Sea Company began to take heavy toll.

Within a span of a few months, the share price for the South Sea company fell by over 85%. Many mom and pop investors and well to do aristocrats lost their savings and fortunes during this crash. One famous South Sea company investor was none other than Sir Isaac Newton, who lost in excess of £20,000 which would be valued at over £ 250 million in today’s monetary terms. He later fittingly said that “ I can calculate the movement of stars, but not the madness of men”.

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The Stock Market Crash of 1929

The Stock Market Crash of 1929 was the worst stock market decline in percentage terms wiping away almost 90% of the value of the Dow Jones Index within four years.

The stock market downturn started on October 24, 1929 which is often referred to as Black Thursday. The Dow Jones Average opened at 305.85 and fell sharply from the open. It lost 11 percent intraday on extremely high volume. Major Wall Street banks stepped in to try to bolster the market by buying shares to stabilize prices. This strategy did work temporarily as the Dow only posted a loss of 2% that first day. The next day, Dow posted a positive gain, but the following day closed down again which erased the prior day’s gain.

The following trading day, Black Monday, saw a decline of about 13 % for the Dow, falling to 260.64. And on Black Tuesday, the next day, Dow continued its downward slide, falling another 12 % to 230.07. The share market drop during these two days wiped away 25% of the value of the Dow. As investors began to panic, further selling ensued and a bear market leading to the Great Depression was underway. 

Prior to the share market crash of 1929, the economy was in full swing and booming. And with the advent of a concept called “margin”, many people who had never before invested in the stock market became active participants.

Brokerage firms were now financing investment in the stock market with just 15 % or 20% down. Even banks joined in, and used depositors’ funds to buy stocks on margin. All of this frenzy led to share price overvaluations, as more and more investors jumped into the market.

As soon as the stock market plunged it wiped out most if not all of the equity of leveraged investors and forced many to liquidate other assets to meet their obligations. In addition, many banks were bankrupt overnight, as they gambled their depositors’ funds in the market, and many only had 5% or 10% left to pay depositors’ claims. Later, in response to these bank failures, President Roosevelt created the Federal Deposit Insurance Corporation to insure customer deposits.

It would not be until 25 years later, in 1954 that the Dow Jones would reach 383, the previous high prior to the Crash of 1929. The Stock Market Crash of 29 has the distinction of being the worst stock market crash in history.

Black Monday – Stock Market Crash of 1987

The infamous day Monday, October 19, 1987 is known as Black Monday. This is the day when equity markets around the world were shaken by a widespread selling frenzy.  The Dow Jones plunged over 500 points, which account for a historic single day drop of 22%. This type of single day Dow Jones crash event had never been seen before, not even during the Great Crash of 1929.

And by the end of the month, most Stock Markets around the world were in disarray. The Australian market was down 41%, the Hong Kong market was down 45%, the United Kingdom market was down 26%, and the worst hit was the New Zealand market which had fell almost 60% from its recent high.

So, what caused the 1987 crash? Though the causes cannot not be known for certain, many professionals have put much of the blame on computerized programs that created large quantities of sell orders in the market, and triggering stop loss levels one after another, which eventually spiraled out of control.

This was a time when computerized trading was in its infancy and its impact on the market were not yet fully stress tested. In addition, during this period, leveraged equity index futures products and portfolio insurance products were also introduced. This combination was ripe for an over-leveraged trading environment and where programmed arbitrage trading strategies started to emerge.

The Federal Reserve chairman at the time, Alan Greenspan, quickly sought to aggressively cut interest rates in an effort to stabilize the economy by adding liquidity to the marketplace. After the crash, exchanges began to institute “circuit breakers”, in an effort to reduce market risk from anomalies. Circuit breakers would result in a halt to trading when the daily price movement in the market has reached a dangerous or  excessive level.

Many professional traders, institutions, and everyday investors were devastated by the crash of 87, and some of the old timers today can still recall exactly where they were and what they were doing on Black Monday. It is a day that most who lived it will likely never forget.

Asian Financial Crisis of 1997

The Asian financial crisis began with the collapse of the Thai baht, resulting from the Thai government’s inability to support its currency peg to the US Dollar. The Thai baht became a floating currency and devalued sharply as the country was on the verge of bankruptcy.  This crisis spread to other Southeast Asian nations as well including Indonesia, Philippines, Malaysia, and South Korea among others.

As a result, these countries’’ stock indices and currencies slid dramatically. Many of these countries had huge Debt ratios, with some topping 170% of their Gross Domestic Product (GDP). A few countries in the region fared a bit better during the Asian crisis, and were less affected by it. Among them were Japan, Singapore, and Taiwan.

The International Monetary Fund (IMF) was forced to deal with this ongoing crisis, and created a bailout package consisting of over $ 100 billion to help stabilize the region. The IMF did place strict contingencies on these countries requiring them to increase their interest rates, reduce overspending, and raise taxes to increase government revenues. This program was a success and eventually after several years, the troubled countries were able to start recovering from the crisis.

Like many other market crashes before it, the Asian crisis was brought on by asset overvaluations, excessive borrowing, over leverage, and unsustainable growth.

Internet (Dot Com) Bubble of 2000

The Internet Bubble of 2000, also referred to as the Dot Com Bubble occurred not too far in the distant past. And so, it is still fresh in the minds of many traders and investors alike.

Unlike anything else prior to it, the Internet has affected the lives of everyone and has brought change to nearly every industry. This was the Gold Rush of that present time. The new age of the Internet welcomed aspiring entrepreneurs to build and create businesses that would change their generation and many generations to come.

During the mid 1990’s as the Internet was becoming mainstream, it created enormous opportunities for  online companies. Both private and institutional money was pouring into online ventures like never before. Countless investors were drawn in to grab their stake within the World Wide Web and carve out a fortune along the way.

As the Dot Com fervor was building up, many investors completely ignored the basic fundamental metrics that they held so dear in the past. No longer were they focusing on corporate cash flow, profit margins, or reasonable P/E ratios; but rather they made huge bets on growth projections that turned out to be unrealistic. In fact, many internet startups were routinely being valued based on 75% or more growth over the coming 5 year period. Of course, some companies such as Amazon and Ebay become hugely successful, but by and far, most other internet startups proved to be a flop.

By the end of first quarter of 2000, investors started to become wary of the exorbitant valuations, and things went downhill from there. Stocks began to fall, particularly in the technology sector, and the Dot Com dreams of many entrepreneurs came to an abrupt end.  The NASDAQ,  which is a tech heavy composite had risen from the 1000 level in 1995 to over 5000 by year 2000. It was due for a major correction. In fact, the majority of stocks and indices fell sharply until the market finally bottomed in 2002. During this period, the market wiped away over 5 trillion dollars in wealth, destroying the dreams and savings of many investors along the way.

The Dot Com bubble of 2000 is a perfect example of exuberance gone amuck. When our good judgement is taken over by mass hysteria in the market, it can be a dangerous time for us financially.

Housing and Subprime Crisis of 2008

The Housing and Subprime crisis, which led to the Stock Market Crash of 2008, is the most recent major collapse witnessed in the US Stock Market and other Equity Indices abroad.

The story begins back in the 1990’s when the US government started to create programs that would make buying a home more affordable, especially for those with less than perfect or troubled credit. They instituted these programs mainly through Freddie Mac and Fannie Mae, which acted as government backed mortgage lenders. Mortgage originators could sell the mortgages back to Freddie and Fannie, who in turn would hold these mortgages.

As a result, originators began to write more and more mortgage loans, and many of these were of sub-prime quality. Interest only loans become popular, and many borrowers were approved for mortgages they could not afford or would never qualify for in the past. At first, this did not cause any major concerns among lenders, as the housing market was steadily rising year in and year out.

As Main Street mortgage brokers were writing a historic number of new mortgages, Wall Street also got in on the action. They started to create and promote mortgage backed securities (MBS), which is a security comprised of a pool of mortgages . The MBS would pay investors attractive interest rates. And investors perceived this as a “low risk” investment since the securities were back by mortgage loans.

In addition, Wall Street introduced a new type of credit derivative called credit default swaps. Credit Default Swaps were similar to insurance policies. They were designed to protect against a company’s default. But a major flaw with CDS was that they were not regulated, and as such, premium writers were not required to segregate and allocate a reserve, as typical insurance companies are required to do. All of these factors lead to a highly over-leveraged environment that was susceptible to systemic risk .

As the housing market began to show signs of fatigue, a major downturn in the market began to ensue. There was a period of 3 weeks between September and October 2008 wherein the Dow Jones Industrial Average sank more than 3500 points from its recent high. This was a huge stock market drop and accounted for more than a 30% decline in the value of the Dow.

Many would argue that what lead to the Subprime Crisis of 2008 originally started with the best of intentions. Who could have predicted that putting more people in homes could lead to such a tragic end? Isn’t buying a home supposed to be the “American Dream”? At least in this case, it turned out to be more of a nightmare than a dream for many homeowners and investors.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download

In this article, we have discussed seven major market bubbles, starting with the Tulip Mania of 1637 to the most recent Subprime Financial Crisis of 2008. Although the times when these various financial crashes occurred are all different, and the events surrounding them are quite unique, there are also many similarities that exist.  The most prominent of which is that we as human beings are prone to overreactions and give in to mass psychology even though we pride ourselves in being rational thinkers. And this characteristic flaw in all of us is present within our DNA, and the financial market acts as a medium that bears that footprint.

Can the stock market crash again, and if so can we prevent the next stock market crisis? As for the first question, that would be an unequivocal YES. The stock market can and will crash again. And for the latter part of the question, I don’t believe that we can prevent it as history has shown us that investors tend to have very short memories. And so, unfortunately, we will always have boom and bust cycles.

In essence, the question becomes not “Will the market crash again”, but rather “When is the next stock market crash coming”? So, for the astute trader and investor, it is critical that we learn the important lessons from stock crash history, so that we can take the necessary steps to protect ourselves and mitigate any financial damage caused by the next big financial collapse.

The post History of the Greatest Stock Market Crashes and Bubbles appeared first on Forex Training Group.

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For many of us, math has never been our greatest strength. In fact, the mere idea of using math formulas for trading is something that garners fear in many traders.

In this lesson, we will be discussing some of the more important math formulas that every trader should learn and have a good understanding of if they want to succeed in the market. But the good news is that most of these trade related math concepts are actually fairly simple and easy to understand even for those that are mathematically challenged.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download
Pip Values

Movement in currency pairs are measured in pips. Within the currency exchange rate, the minimum pip can be seen in the fourth digit after the decimal place for most currency pairs. The exception to this rule are Yen pairs wherein their minimum pip can be seen in the second digit after the decimal place.

For example, if the EUR/USD currency pair rises from 1.3510 to 1.3530, that would be considered an increase of 20 pips for the EUR/USD pair. And on the other hand, if the USD/JPY currency pair rises from 95.10 to 95.40, that would be considered an increase of 30 pips for the USD/JPY pair.

Depending on which currency pair you are trading, the value of a pip will be differ. It is also important to note that a standard lot is 100,000 units of a currency. A mini lot is 10,000 units of a currency, and a micro lot is 1,000 units of a currency.

You can use the forex math formula below to calculate the pip value of a currency pair:

Value of a pip = 1 pip / exchange rate  x  trade size

Here is an example using EUR/USD

  • One Pip = 0.0001
  • Base Currency: EUR
  • Exchange Rate: 1.2500
  • Trade Size:  100,000 ( 1 lot)

Pip Value = 0.0001 / 1.2500  x  100,000

= 8 EUR

Here is a second example using USD/JPY

  • One Pip = 0.01
  • Base Currency: USD
  • Exchange Rate: 95.50
  • Trade Size:  100,000 ( 1 lot)

Pip Value = 0.01 / 95.50  x  100,000

= 10.47 USD

And a third example using GBP/CHF

  • One Pip = 0.0001
  • Base Currency: GBP
  • Exchange Rate: 1.3220
  • Trade Size:  100,000 ( 1 lot)

Pip Value = 0.0001 / 1.3220  x  100,000

= 7.56 GBP

Margin and Leverage

Many novice forex traders tend to confuse margin and leverage. Though they are closely tied, you should understand the difference between the two, and know how to calculate each.

So, what is leverage in trading? Leverage gives a trader the ability to control a larger position by using a small portion of their own funds and borrowing the rest from their broker.

What is Margin? Margin is the good faith deposit required by your broker to allow you to open a position. Using these funds coupled with other client funds, the broker can then place trades with their liquidity providers and interbank partners.

Leverage can be calculated using the forex trading math formula below:

Leverage = Trade Size / Account Size

Let’s take a practical example to demonstrate this.

Say you decide to enter into a position in a financial instrument with a notional value of $100,000. You only have $ 2,000 in your trading account. So, you would be controlling $ 100,000 with the $ 2,000 that you have.

Leverage =  $100,000 / $2,000 = 50

So, the effective leverage in this example would be expressed as 50:1

Now let’s say you decide instead to enter into a position with the same notional value of $100,000, but you have $ 5,000 in your trading account. So, you would be controlling $ 100,000 with the $ 5,000 that you have.

Leverage =  $100,000 / $5,000 = 20

So, the effective leverage in this example would be expressed as 20:1

Brokers in the United States offer upto 50:1 leverage for forex trading, while Forex brokers in other jurisdictions can offer leverage upto 500:1 in some cases. But is very important to keep in mind that leverage should be used responsibly as it acts to not only amplify returns, but also magnifies losses.

Position Sizing

Position Sizing is one of the most important and frequent calculations that you will need to make as a forex trader. In fact, before any trade that you consider entering into, you should calculate the proper position size based on your pre-defined position sizing model.

One of the simplest and most effective position sizing models is a fixed fractional model. With this position sizing strategy, you would risk a maximum of X% of your trading account on any single trade. I would suggest 1 – 2%  risk per trade as a good value for the fixed fractional risk.

Once you have determined how much you plan to risk on a per trade basis, then you would start by determining where the most logical stop should be placed on a particular trade. You should look at where the most recent swings are, where Support and Resistance areas are and/or use some other technical considerations. One you have located a level where you plan on placing your stop loss, measure the distance in pips between this level and your intended entry. Then jot that number down and keep it handy.

Now the next step is to determine the value of each pip. We have discussed how to calculate the value of a pip in the previous section. Once you have this value, you are ready to calculate your position size.

Here is the trading math behind Position Sizing:

Current Account Size  x  Risk Per Trade /  Distance between Entry and Stop  x  Value of Pip

Let’s take a look at concrete example:

  • Current Account Size: $ 10,000
  • Fixed Fractional Risk Per Trade = 2%
  • Distance between Entry and Stop:  80 Pips
  • Value of each Pip: $ 10

$ 10,000 x .02 / 80 x 10 =  .25 Lots

So, in this example, based on our $ 10,000 account with a 2% risk per trade model, and placing a stop at our desired location, we would be allowed to take a maximum position size of .25 lots on this trade.

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Trade Expectancy

Trade Expectancy is one of the most important metrics that a trader should be aware of. But what does it mean? In a nutshell, trade expectancy is the average profit or loss that can be expected on each trade based on your average Win Percentage, Avg Win Size and Avg Loss Size.

Here is the mathematical formula for Trade Expectancy:

( Win % x Avg Win Size) – ( Loss % x Avg Loss Size)

Let’s take a look at this more closely using a Trend following system. Typically trend following systems tend to have low win rates, but relatively large average wins compared to average losses.

  • System Type:  Trend Following
  • Win Percentage: 35%
  • Avg Winning Trade : $ 1200
  • Avg Losing Trade : $ 400

Let’s plug in the numbers:

Trade Expectancy = ( .35 x 1200) – ( .65 x 350)

=  $ 192

So, this trend following system has a trade expectancy of $ 192, which is the average expected profit from each trade.

Now let’s look at yet another example. This time we will look at a Mean Reversion strategy. Mean reversion strategies tend to have higher win rates, and the average wins and losses are somewhat similar.

  • System Type:  Mean Reversion
  • Win Percentage: 60%
  • Avg Winning Trade : $ 575
  • Avg Losing Trade : $ 525

Let’s plug in the numbers:

Trade Expectancy = ( .60 x 575) – ( .40 x 525)

=  $ 135

So, this Mean Reversion system has a trade expectancy of $ 132, which again is the average expected profit from each trade.

Many traders make the mistake of only relying on win rates when evaluating trading systems. But as you can see, based on the trade mathematics of the Expectancy formula, win rate is only part of the equation, and you must also take into consideration a system’s Avg Win and Avg Loss numbers to truly realize the edge that a system provides.

Currency Correlation

How many times have you entered positions in multiple currency pairs and noticed that their price movements were related? For example, if you are long in EUR/USD, GBPUSD, and AUDUSD you may think that you have three unrelated positions but in fact, it is as if you have just one big position against the US dollar.

To understand this better, you have to know what currency correlation is and how it can impact the overall risk in your portfolio.

Currency correlation is a statistical measure of how different currency pairs move in relationship to each other. Currency correlations can be positive, meaning that two currency pairs move in the same direction. Currency correlations can be negative, meaning that two currency pair move in opposite directions. And finally, currency correlation can be neutral, meaning there is no discernible price relationship between the two currency pairs.

The forex mathematics behind currency correlation can be quite complicated, so we will not get into that in this lesson. But fortunately for us, we do not need to know the trade math because there are many currency correlation tools available in the market that makes it easy for use to do our correlation analysis. Most currency correlation tools are presented in a table format.

The following summary provides a fast and easy way of interpreting a currency correlation table’s values.

  • 0 to 0.2 – There is no correlation
  • 2 to 0.4 – Low or weak correlation
  • 4 to 0.7 – Moderate correlation
  • 7 to 0.9 – High or strong correlation
  • 9 to 1.0 – Extremely strong correlation

Remember that a positive value means that the pairs move in the same direction, while a negative value means they have an inverse relationship.

Maximum Drawdown

As traders, we know that we will have losing trades and that they are a natural part of trading. But it is important to know what our strategy’s maximum drawdown has been historically so that we can have some ideas of what we might expect in terms of equity loss in the future.

Essentially, maximum drawdown is the maximum loss in equity that our portfolio incurs over a period of time.  It is the largest drop from a previous equity peak to the lowest point after the peak. We can calculate the maximum drawdown after a new peak has been put in place on the equity curve.

Here is the math formula for calculating Maximum Drawdown:

Max DD = Equity Peak – Equity Low / Equity Peak

Let’s take an example:

Say that you have a starting balance of $ 10,000, and it increases to $ 15,000. Later on, your account falls to $ 8,000 and eventually increases to $ 17,000.

What is your Maximum Drawdown in this scenario?

Max DD = $ 15,000 – $ 8,000 / $ 15,000

= 46.6%

So, the Max Drawdown in this case is 46.6%.

Drawdowns can be very dangerous to the financial health of a trader because, as your drawdown increases the return needed to recover becomes larger and larger.

Let take a look at the table below:

Capital Loss (%)                               Gain need to Recover (%)

5                                                                                 5.3

10                                                                               11.1

20                                                                               25

30                                                                              42.9

40                                                                              66.7

50                                                                              100

As you can see, the larger the max drawdown or capital loss the higher the percentage gain is needed to recover the losses. For example, to recover from a 50% loss you need to make a 100% gain. This is one reason why it is critical for traders to trade small so that they can try to keep drawdowns to a tolerable level.

Risk of Ruin

I would venture to guess that most retail traders have either never heard of Risk of Ruin or if they have they do not really understand its power when it comes to risk analysis in the markets.

Risk of Ruin is the likelihood or probability that a trader will lose a predetermined amount of trading capital wherein they will not be able to continue trading. Many traders assume that Risk of Ruin has to mean loss of 100% of capital, but it does not have to. It could be any percentage that the trader determines will be the point at which they will stop trading a system. It could be 25%, 50%, 75%, 100% or whatever loss level the trader decides on.

The Risk of Ruin is calculated as follows:

Risk of Ruin = ((1 – Edge) / (1 + Edge)) ^ Capital Units

Where Edge is the defined as the probability of a Win or the Win%.

There are several simulators available for free that you can use to calculate the risk of ruin.

The one we will use in our example can be found here

So, let’s look at a strategy that is just barely profitable to see how we can greatly reduce the risk profile of such a strategy. We will use the following assumptions and plug that into the Risk of Ruin simulator:

  • Probability of Win:  45%
  • Win:Loss Ratio: 1.30
  • Risk Amount : 5%
  • Number of trades : 300
  • Iteration: 1000 (# of simulations it will run)
  • Loss Level % : 40% (our predetermined ruin point)

Based on the following assumptions, this strategy would have a risk of ruin (reaching a 40% loss level) of about 58%. (If you hit calculate on the simulator, it will run the simulations again so the ROR number may vary a bit)

So, what if we wanted to get our Risk of Ruin down to below 2%, what should we do? Well the factor that we would have the most control over is the Risk amount, and so we should look to adjust that input.

Ok so we will keep all the variables the same, except we will adjust the Risk amount to 2.5%. Well by doing that, you will notice that our Risk of Ruin  has in fact decreased from around 58% to about 20%. An improvement for sure, but still not below our target of 2%. So, let’s go back to the drawing board, and adjust the Risk amount to 1.25%. What does that do? Well that looks like a winner. Our Risk of Ruin is hovering around 2% and so based on this, we can only use a position size 1.25% per trade in order to achieve a ROR of less than 2% trading this system.

Although the hypothetical example above illustrates the concept of Risk to Ruin using a 2% threshold, it would serve the trader best to seek a Risk of Ruin as close to 0 as possible

Profit Factor

Profit Factor measures the profitability of your trading system or strategy. It is one of the most simple but useful metrics related to system performance.

Profit Factor can be calculated in one of two ways:

Profit Factor = Gross Winning Trades / Gross Losing Trades

Profit Factor = (Win Rate x Avg Win) / (Loss Rate x Avg Loss)

A profit factor of less than 1 means that the trading strategy is a losing strategy.

A profit factor of 1 to 1.50 means that the trading strategy is moderately profitable

A profit factor of 1.50 to 2.0 means that the trading strategy is highly profitable

A profit factor above 2 means that the trading strategy is extremely profitable.

Let’s take an example with the following metrics:

  • Probability of Win:  55%
  • Avg Win:  $ 500
  • Avg Loss: $ 350

Can you figure out the Profit Factor of this system?

Profit Factor = (.55 x 500) / (.45 x 350)

= 1.75

This system has a Profit Factor of 1.75, a highly profitable trading strategy.

Let’s take a look at one more example:

  • Probability of Win:  45%
  • Avg Win:  $ 650
  • Avg Loss: $ 550

Can you figure out the Profit Factor of this system?

Profit Factor = (.45 x 650) / (.55 x 550)

= 0.97

This system has a Profit Factor of 0,97, meaning that this is a losing strategy.

R Multiples

The concept of R Multiples was first introduced by renown psychologist Dr. Van Tharp. R Multiple sounds like an esoteric term but it is fairly straightforward and easy to understand.

R Multiple essentially measures Risk to Reward for a particular trade. R stands for Risk and is usually denoted as 1R ( the risk in the trade). The multiple of R is your reward as compared to your Risk. So, a 3R trade for example, would simply mean that for every unit of risk you are taking, your potential profit is 3 times that risk or 3R.

As you can see by using R multiples, it allows us to standardize our risk measures and easily gauge the Risk profile of a trade.

Let’s take a look at a few examples to demonstrate:

A trade with a 50 pip stop and 100 pip target is a 2R trade.

A trade with a 70 pip stop and a 210 pip target is a 3R trade.

A trade with a 120 pip stop and a 60 pip target is a 0.5R trade.

I think you get the basic gist of it now.

By combining the Risk to Reward and using the R Multiple we can quickly and easily assess the viability of a trade setup and the potential payoff.

You can use R Multiples beyond single trade events also. For example, R Multiples can be used to express Portfolio performance, Max Drawdown as well as other related trade metrics. Basically, you would view these metrics from the lens of 1 unit of risk.

Let’s look at some examples:

If you risk approx. $ 500 per trade and at the end of the year your trading profit is equal to $20,000, then your Yearly Performance is expressed as 40R.

If you risk approx. $ 250 per trade and experience a $ 3000 Drawdown, then the Drawdown can be expressed as 12R.

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As traders, we must always be working to strengthen our edge in the market, and this all starts with using basic math in trading to understand risk. We can then  apply the necessary forex mathematical tools and calculators that we have available to us.

We have discussed many different forex math formulas that are relevant to forex traders. At this point, I would urge you to practice using everything you have learned and apply it to your own trading methodology.  The more you understand these simple math formulas and calculators for traders, the better you will be at applying it to your own trading and to improving your risk management skills. And maybe above all, you will no longer be fearful of using math in trading.

The post Essential Math Guide for Forex Traders appeared first on Forex Training Group.

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Every day thousands of trader’s flock to the Forex and Futures markets in hopes of making it big. And for good reason, there is certainly alot of money that can be made trading these markets.

But just like everything else in life, you must be at the top of your game in order to succeed. In this article, we will discuss some common mistakes and pitfalls that new traders should be aware during their trading journey, so that they can take the necessary steps to overcome them.

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Lack of Preparation

If you want to know why many newbie forex traders fail, one of the most common reasons is the lack of preparation. Trading is one of the toughest professions out there. It’s extremely competitive and difficult to maintain an edge in the market even when you are well prepared. So, you can imagine what likely happens to those that do not take the necessary time to prepare for the trading day. But being ill equipped to face the market is exactly what a lot of beginners do.

They feel as though they can just wing it and as a result do not have any type of routine prior to the trading session. As a matter of analogy, one would never expect an amateur, untrained high school tennis player to face the likes of Roger Federer on the tennis court and have any reasonable expectation of winning. That seems almost too obvious. But when it comes to trading, new traders often forget this.

You have to understand that you are competing with major institutions, hedge funds, CTAs, and other market professionals who are very well prepared and for you to compete on the same playing field, you must at the very least do your homework each day about the markets you plan on trading.

Whether you are a fundamental trader or technical trader, you should have a daily routine that you follow, so that when your desired setup occurs, you just act on executing it in a flawless manner and without reservation.

Not Using a Stop Loss

As traders, our primary role is that of a Risk Manager. We must manage risk above all else. And one of the best ways to manage risk is by using a Stop loss order on every trade. I would go as far as saying that not only should you use a stop loss on every single trade, but you should also put in a hard stop the moment you enter a position.

But many novice traders either prefer to use a “mental stop”, wherein they have a predetermined level where they will plan to exit for a loss or worse they will refuse to use a stop loss altogether as they are so sure about a position that they just don’t think they need one. Both of these arguments are flawed.

As for the first argument for using a mental stop instead of a hard stop, I believe it’s just an excuse for a trader to give themselves more time to stay in the trade. If they have already determined the invalidation point for the trade, then no additional time should be given on the trade, and hence a hard stop should have been the preferred risk control mechanism used.

Now for the second argument for not using stop losses – not feeling that you need one because you are sure the market will go your way. To that I can only say the following:

“The only Certainty in the market is Uncertainty”.

Large unexpected losses resulting from not using stop losses is a newbie trading mistake that is completely avoidable.

Trading with Poor Risk to Reward

Many beginning traders mistakenly believe that the best trading systems are those with the highest win rates. As a result, they routinely gravitate towards strategies that have a 70%, 80%, or even 90% win rate. But these strategies often have a high risk of ruin because they typically have very low reward to risk ratios associated with them.

Let’s take a look at two examples below. One of which is a high win rate strategy and the other is a moderate win rate strategy:

Strategy A wins 70% of the time and the average Win to Loss is .50 : 1, meaning that the amount per winning trade is half the amount per losing trade.

Strategy B wins 40% of the time and the average Win to Loss is 2 : 1, meaning that the amount per winning trade is 2 times the amount per losing trade.

Which of these two strategies do you think is more profitable?

If you answered Strategy B, then you would be correct. Even though this strategy has a much lower win rate, its higher

Avg Win: Avg Loss ratio makes it a more profitable trading strategy.
Let’s take a look and see why this is the case:
The Trade Expectancy for Strategy A is calculated as follows: (assuming $ 500 Avg Win)
(Win % x Average Win Size) – (Loss % x Average Loss Size)

(.70 x 250) – (.30 x 500) = $ 25 per trade

The Trade Expectancy for Strategy B is calculated as follows (assuming $ 500 Avg Win)
(Win % x Average Win Size) – (Loss % x Average Loss Size)

(.40 x 500 ) – (.60 x 250) = $ 50 per trade

Traders should not believe the forex trading myth that higher win rate systems are better than lower win rate systems. Traders should focus not only on Win rates but also take into consideration the Risk Reward profile for each trade.

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Getting Impatient and Over Trading

The very thing that attracts many new traders to the world of forex trading is often the thing that leads to their financial failure in the markets. What I am referring to is the lure of fast money and 24/5 action.

Novice traders think that in order to make money in the markets, they have to be trading all the time, around the clock. This could not be further from the truth. In fact, I would argue the exact opposite. Instead of trading the fast paced 3 minute or 5 minute timeframe, you would be much better off financially and emotionally by trading higher timeframes such as the 120 minute or 240 minute chart.

Aside from the fact that these higher timeframes offer better quality setups, they also have the advantage of reduced transaction costs due to less frequent trade turnover.

However, this is one of those forex trading mistakes that new traders are reminded of but rarely take heed of until they blow up an account or two and begin to study what went wrong. Eventually, if they’re lucky, they will come to the self-realization that it’s not how often you trade that matters at the end of the day, but rather how well you trade that really matters. Remember as traders, we are not getting paid by the hour, so take a step back and start concentrating on taking the best trades not the most trades.

Not Applying Proper Position Sizing

Professional traders know that position sizing is critical to success in the markets. In fact, it is often the difference between trading success and failure. They typically have very strict parameters for position sizing and often use a fixed fractional model, a fixed ratio model, a fixed contract per account size model, or something else.

But the point is that they have a detailed position sizing strategy that will let them know exactly how many lots or contracts they will allocate on a trade. No guesswork, or gut feelings are involved in the process.

For example, a professional trader, based on his trading plan, may allocate 2% of capital on any trade. This would be considered a 2% fixed fractional model. So, if the trader has a $ 50,000 account, then the maximum allowable risk would be $ 1,000. And if the trader has decided based on their chart analysis that the most logical stop level is $ 450 from the entry, then they would be allowed to allocate a maximum of 2 lots on that particular trade.

Beginning and amateur traders typically allocate risk based on their how they feel about their recent string of trades instead of relying on a preplanned position sizing model. They tend to trade way too big after a recent string of winners and often get caught on the wrong side of the market when they are most aggressive, which in turn leads to large losses. These amateaur trading mistakes related to position sizing should be dealt swiftly if you want to stay in the game for any reasonable amount of time.

Micro-Managing Trades

Trade management is possibly one of the hardest aspects of trading. And the reason for this is that the moment that you enter a trade, all of your objectively will go out the window. You will become biased and begin to see what you want to see and your subconscious mind will filter out things that are not in line with your trade bias. This may seem hard to believe for some, but it is a matter of fact.

When you are in a trade, it feels uncomfortable to do nothing. But many times, doing nothing is the best thing to do. We have a desire to constantly monitor, adjust, and micro mange the position to the point where it becomes counterproductive.

You have to try to overcome these trade management mistakes. And one of the best ways of doing that is by using a Set and Forget type of trade management policy. Within this trade management style, you do all your analysis prior to execution, when you are the most unbiased. You determine and set your stop loss and profit target in the market the very moment that you enter the position. And then you let the market do its thing. There is nothing more you can or should do about that open position. Instead take your dog for a walk, go to the Gym, or look for the next trade setup.

Have a Shiny Object Syndrome

One of the things that we all value in our professional and personal life is the ability to have choices. Having choices is a wonderful thing in most parts of our lives, but in trading, it can sometimes hold us back from realizing our full potential.

What do I mean by that? Well quite simply, having the freedom of choice in terms of trading strategies and systems can often lead us down an endless path for perfection.

You know what I mean, the search for that holy grail trading system that will make us rich beyond our wildest expectations. If you have been around this game for any length of time, you know that there is no Holy Grail trading system out there. Goldman Sachs doesn’t have it, J.P. Morgan doesn’t have it, and as retail traders we will certainly will never have it. The sooner that novice traders realize this, the faster they can get to the business of trading.

Successful traders have a defined edge and they apply that edge in the market whenever the opportunity arises. They know that they will make mistakes in trading, and that there will be losing trades, even a string of them, but that does not deter them from sticking to their strategy.

Beginning traders should also focus on picking a methodology that suits their own personality and learn everything about it. Then they should apply the strategy in the market, and give it enough time for the odds to play out. Only once they have given the particular trade methodology an honest go, should they consider pulling the plug and moving on to some other strategy.

Not Keeping Good Records

Any successful business owner will tell you that keeping and maintaining good records is essential. Not only is it required for tax purposes, but just as importantly, good record keeping allows a business owner to know where revenue and expenses are coming from. They can use that information to cut unnecessary expenses and increase customer value to attain a healthier bottom line.

Trading is not too much different if you think about it. As a trader, our revenues are profits from winning trades, and our primary expenses are our losses from losing trades. If we do not have a detailed journal of our thought process and events surrounding our trades, how can we ever expect to boost our results? In short, we cannot.

Therefore, it is essential that traders keep a trading diary, and review it on a regular basis. This is probably one of the best beginner trading tips that I can offer. Take a look at what is working and do more of that. At the same time, review what is not working and try to cut that out of your trading plan.

If you are serious about trading and are treating it as a real business and not just some side hobby, you have to start by committing to having a personal trading journal. It’s not that sexy, but it will do wonders for your trading. And if you find yourself leading astray from this routine, remember the adage – What gets measured, gets improved.

Averaging Losing Trades

Averaging losing trades has to be the biggest cardinal sin of them all, but it is one that almost every trader has made at some point in their careers.

Murphy’s law tends to be especially cruel to traders that average their losing trades, as it is usually when you are the most aggressive in a position that you tend to lose the most amount of money.

Many traders are enticed by averaging losers, because on the surface it almost seems like a sure bet. Let’s look at it from the perspective Roulette for a moment. You have close to a 50% chance of winning or losing by placing a bet on Red or Black.

You decide that you will double your bet size every time you lose, and as a result you should come out ahead. So, you begin with $ 100 dollars, and double your bet every time you lose. Here is what that scenario would look like after 8 consecutive losses, which is common both in roulette and trading:

1st loss : $ 100
2nd loss : $ 200
3rd loss: $ 400
4th loss: $ 800
5th loss : $ 1,600
6th loss: $ 3,200
7th loss: $ 6,400
8th loss: $ 12,800

Though this is a rather simplified example, it should serve to show you that averaging losers is a horrible strategy in roulette and an even worse strategy in the markets. Eventually, sooner or later, you are asking to get your account blown up. Averaging losing trades and trading too much size is without a doubt the biggest reasons why many newbies fail at trading.

Tendency to Internalize Losses

One of the most common mistakes that beginning traders make is that tend to equate losses with failure. And this is especially true for those that are accomplished in their own profession such as Doctors, Lawyers, Engineers and other highly successful individuals. They are used to getting things right and achieving their goals. And so, they bring this mentality to the markets and it tends to cause havoc on their psyche.

First and foremost, anyone that is entering the trading world, should realize losses are a natural part of trading. They must accept this and believe this in their core being in order truly overcome the negative emotions associated with losing trades.

Professional traders, on the other hand, have come to realize that trading is a game of probabilities and that no single trade or even a string of trades has much meaning in the whole scheme of things. So, a winning trade or a losing trade does not affect their emotional makeup.

Amateur traders are much more effected by recency bias, meaning their mood and actions in the market are heavily influenced by their most recent trade performance. These traders should take necessary steps to train their brains to view losses as a necessary cost of doing business rather than a reflection on their intelligence or judgement.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download

In this lesson, we have discussed the top trading mistakes that new traders make. The first step in fixing your mistakes is to acknowledge them. Take some time to go over each of these common trading mistakes and see which ones are the most relevant to you.

You should make a concerted effort to work on improving each area of weakness. Keep in mind that there is no final destination when it comes to trading. We must all be improving all the time. Even the 30 or 40 year veteran in the trading business will tell you that they are still learning something new all the time, and constantly looking for ways to increase their trade efficiency.

If you put in the necessary time for self-reflection and an honest effort at making incremental improvements, then you have a chance at success in the markets. Anything short of that, you are doing yourself a disservice and not giving yourself a fair shot to compete successfully in the market.

The post Top 10 Common Trading Mistakes That Beginner Traders Make appeared first on Forex Training Group.

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There are many different types of trading styles and techniques available to the market trader. You might consider yourself a short-term trader or a long-term trader, or possibly somewhere in between. But what does that really mean? These terms tend to be relative, and mean different things to different traders.

For example, short term for one trader could mean several minutes, while short term for another trader could mean several days. In this article, we want to clearly define the various trading styles and the characteristics of each.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download
Discretionary vs Automated Trading Approach

Before we dive into the different trading styles and strategies available to the market trader, we should first understand the method in which the trader will execute their trades.

When it comes to trading the markets, there are essentially two primary execution approaches that a trader can utilize. The first is a discretionary approach, wherein, the trader uses their judgement and discretion when executing and managing their trades.

The second is a system based or automated trading approach, wherein the trading system is responsible for initiating and managing the trade. In a system trading environment, the trader’s primary responsibility is in the initial setup and programming of the automated trading system and regular monitoring of the system to ensure that the system is functioning in a proper manner.

The choice of which execution approach you prefer will depend on your psychological makeup and comfort level. For example, if your personality is one where you prefer to be in control of trading related decisions, then a discretionary based approach may be more suitable for you.

If on the other hand, you are comfortable with letting a rule based trading algorithm execute trades in the market, then a System based approach may be something that would work for you.

All the trading styles that we will discuss in the upcoming sections can be either discretionary based or system based. Keep in mind that a discretionary trader can be systematic in that He or She follows a strict rule based strategy, but applies certain discretion in the process. But a system trader cannot be discretionary, and must follow all trades provided by their automated trading program, in order to truly qualify as a system trader.

It is important to ask yourself which type of trading approach you are more comfortable with, and then narrow in on the trading style that would best compliment that for you.

Trading Style #1 – Scalping

Scalping is a fast-paced trading style that can be highly intense and often times carries with it a good deal of stress. Scalping involves looking for a steady stream of opportunities in the market. Scalpers can often trade 20, 30, or in excess of 50 positions during a trading session. Most scalpers tend to be in and out of their position within minutes.

Scalpers are typically using a good deal of leverage and are looking for small minor moves that they can take advantage of with regular frequency. For example, a Scalper trading the EURUSD could trade a dozen or more positions on a smaller time frame such as the 1 minute or 2-minute chart based on a breakout on the daily chart.

Scalping is quite popular in the Equities markets, where these traders can utilize Level 2 data to route orders for the best pricing and fastest execution. But if you are interested in scalping the Equities market, you should be aware of the Pattern Day Trader rule in the United States, which requires a trading account of at least $25,000 to qualify for executing multiple round turns during the trading session.

As you might imagine, one of the biggest drawbacks of using a Scalping trading style is the high cost of transaction fees associated with the large turnover generated by these trading activities. Many times, the transaction costs in the form of commissions can eat into 60-70% or more of a trader’s gross profit. So, scalpers need to ensure that they are receiving the lowest commission rates possible from their broker and any exchanges in order to have a chance at succeeding with this approach.

These days Scalpers that are discretionary based have a lot of competition from High Frequency trading firms. HFT’s are the ultimate scalpers, and can typically take hundreds if not thousands of trades throughout the daily trading session. It’s no wonder that computer algos tend to dominate the scalping arena.

Trading Style #2 – Day Trading

Day Trading is somewhat similar to Scalping in that traders are looking to enter and exit their position during the same trading session. But a major distinction between the two is that Day traders tend to have a longer time horizon than most scalpers.

Day traders are usually not in and out of positions within minutes. They typically employ day trading techniques that look for larger swings during the day that they can capture. As such, a day trader can stay with a position for as little as 30 minutes to several hours or the entire trading session from open to close.

Most daytraders will put on about two to five positions per day depending on the volatility in the market. Although transaction costs can weigh on a daytrader’s bottom line, they are not nearly as pronounced are they are for Scalpers. And while a large majority of Scalpers tend to focus on automated trade execution models, many day traders are still discretionary in nature.

Aside from some day traders that focus on news trading, the majority of day traders are technically oriented. They are not as concerned with large macro-economic trends since their time horizon does not require projections beyond several days to a week.

To be an effective day trader, you should have the disciple to ensure that you are closing out all open positions by the end of the trading day. Some novice day-traders have a difficult time exiting losing trades at the end of the session because they still believe that prices will turn around. They let a short-term day trade turn into a swing trade or worse a longer-term position.

Every successful day trader knows that the markets will always be there and that they can always re-engage their position if they need to. But they realize that what is critical and essential for them as a day trader is to go home flat each day and start anew every morning. Their risk plan calls for being flat at the close and that’s exactly what disciplined daytraders do.

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Trading Style #3 – Swing Trading

Swing trading involves trading with a time horizon of about a day to less than several weeks. Swing traders typically trade the 240 minute and 480 minute charts in the Forex Market, and the 60 minute and 120 minute charts in the Equites and Futures markets. Swing traders have the best of both worlds when it comes to frequency of trades, and the cost of trading.

As for frequency, swing traders have ample opportunities to trade the market, and it is typical for these traders to take 8-12 positions per month, which could translate to 100-150 trades per year. From this perspective, it is an excellent style of trading for beginning traders because of the large number of opportunities available for testing and honing their skills in the market.

The cost of trading in the form of dealing spreads and commissions is also greatly reduced with swing trading. The lower frequency of trading compared to day trading and scalping coupled with higher Pip targets makes swing trading one of the most attractive trading styles for professional speculators.

Another major advantage of swing trading techniques is that many technical patterns that form on these relatively higher timeframes are much more accurate and reliable. For example, a support level formed on the 240-min chart on the EURUSD is much more important than a support level formed on a 15-minute chart. And the same goes for chart patterns as well. A head and shoulder pattern forming on the 120-minute chart is far superior to the same pattern appearing on the 5-minute chart.

There are countless trading techniques in the market that can be employed with a Swing Trading style. You can be a mean reverting trader selling the tops and buying the bottoms of Bollinger Band extremes, or you can be a Momentum trader buying breakouts from S/R levels, or you can buy dips within an uptrend or sell rallies within a downtrend. Choosing the best trading technique will depend on your own personality and skill set.

Trading Style #4 – News Trading

News trading is a subset of fundamental analysis. News traders seek to capture a price move after a scheduled news announcement. Economic events such as US Non-Farm Payroll, Central Bank rate statements, Inflation reports such as PPI and CPI, and Quarterly GDP reports can produce increased volatility in the market.

Usually when the figures from the scheduled news announcement deviate materially from analysts’ consensus, then a sharp reaction can occur in the market. Sometimes prices can soar by 150 pips or more within seconds, and also conversely drop 150 pips or more within seconds.

News trading can be quite tricky and risky as these types of knee jerk reactions can sometimes occur on both the long and short side of the market, making it difficult to gauge the true direction the market is headed in. Strict money management rules and hard stop losses are a must for news traders due to the heightened risk during these times in the market.

There are various strategies and techniques that a news trader can use to take advantage of their trade ideas. They can buy or sell a currency pair outright in the forex market, make use of a leveraged futures position, or even construct a position using FX options.

Regardless of the technique used, it is important to note that just before these scheduled news events, the price of certain pairs that could be effected by the report, usually trade in a consolidation range, as traders are awaiting the news event. And as the important economic report draws nearer, the dealing spreads will tend to widen as market making forex brokers are looking to balance their books to protect themselves from potentially adverse price shocks as well.

Some news traders prefer an intraday trading technique wherein they initiate a trade immediately following the the news event. Other news traders prefer to wait for the market to cool down a bit and wait for a pullback before entering into the direction of the intraday trend created by the news event.

Trading Style #5 – Trend Trading

Trend Trading is a popular trading strategy among many Commodity Trading Advisors (CTAs) and Professional Hedge Funds. Trend Trading was originally popularized by world renown traders Bill Eckhardt and Richard Dennis through their “Turtles” Experiment.

If you’re not familiar with the Turtles story, it would be advisable for you to do some reading into this. But to explain briefly, these two men made a bet to see whether they could teach regular people from a diverse set of backgrounds their trend following methodology to see if these traders could be trained to succeed in the markets.

The results of the experiment showed that, in fact, traders could be trained to succeed and be profitable in the markets. Some of the original Turtles have gone on to become hugely successful private traders, and hedge fund managers. 

The idea of trading with the trend appeals to many traders. We know from the law of physics that all things follow the path of least resistance. Most trend traders are longer term in nature. They tend to focus on the daily and weekly chart, looking for moving markets.

The primary goal of a trend trader is not to predict where the market might be going, but rather to join a market that is already showing signs of strong movement in a particular direction. Trend traders seek to jump on emerging and established trends and plan on staying in them for as long as the market continues to move in their desired direction.

A major difficulty that many newer traders have with trend following lyes in their ability to spot and get aboard a trending market before it’s too late. By the time most retail traders get into a trending market, most of the move is likely already exhausted. So, the trick is to be able to spot an emerging trend and get in as close to the beginning or middle of the trend as possible.

Trading Style #6 – Macro-Economic Trading

Macroeconomic traders are primarily focused on long term fundamental data that drives a country’s economy. These traders are long term in nature and can often hold onto a position for months if not years, and many only have a handful of positions open throughout the course of a year. These traders obviously like to pick their positions carefully as their limited bets can make or break their year.

Some of the most important economic data that macro-economic traders like to study include a country’s GDP relative to its peers, the current Inflation and Employment situation, the interest rate environment and trade balance data.

It is from this primary set of data that the Macro economic trader can begin to build a forecast for what they expect for a particular country, and its exchange rate with respect to other counties.

Successful macro-economic traders can spot emerging trends within the current business cycle and position themselves to get into a market before many others are aware of an impending change. These traders tend to be very aware of overall market sentiment and look for early shifts in sentiment and mass trader psychology to forecast the next likely path within the economic cycle.

Although macro-economic traders rely mainly on fundamental techniques for trade evaluation, they often use technical analysis to help them time their trades for optimal entry and exit.

An important analytical technique implemented by many macro-economic traders is the use of inter-market analysis. They routinely study the cause and effect relationships among various asset classes.

For example, macro-economic traders want to know:

How are government bonds moving in relation to stocks?

What effects are certain currencies are having on crude oil prices?

Where are commodity prices in relation to US Dollar?

What relationship if any exists between Gold and Equities?

These are just some of the questions that Macroeconomic traders try to answer before making an informed forecast.

Trading Style #7 – Carry Trading

Carry trades are used by many large institutions around the globe to try to earn significant interest income. Essentially with a currency carry trade, you are buying a higher interest yielding currency, and financing that with a lower interest yielding currency.

So, for example, if the Australian Dollar has a 4 percent interest rate and the Japanese Yen has a 1 percent interest rate, then buying the AUD/JPY pair would yield a net 3 percent interest rate, and it is considered a positive carry.

If on the other hand, you sold the AUD/JPY pair then you would pay a 3 percent interest rate instead. This is considered a negative carry trade. Directional traders should be aware of the carry trade effect when they are buying and selling currencies, because the negative carry cost can sometimes eat into the potential gains beyond their expected return.

You may be wondering why such a low interest rate would appeal to speculators or institutions utilizing the carry trade approach. Well the important thing to remember with this forex trading technique is that you earn or pay that interest on the notional value, so a leveraged position could likely earn many multiples of interest rate differential. For example, based on the 3% we mentioned earlier, a 10:1 leveraged position could potentially earn 30% yearly interest.

Now although a carry trade sounds like a no-lose proposition, in fact, you still have to take into consideration the potential market fluctuations while you are holding the carry trade. Depending on whether the market moves in the direction of the positive carry or opposite to it, you will realize a gain or loss beyond the leveraged interest rate differential. 

So essentially, the best carry trades are ones that have an attractive interest rate differential and one in which you have a market bias as well in the direction of the positive carry. This would be an optimal carry trade situation. But keep in mind that carry trades are not without risk, so it is important that you have a solid plan in place if the market begins to move rapidly against your desired direction.

Download the short printable PDF version summarizing the key points of this lesson….Click Here to Download

In this lesson, we discussed many different forex trading styles and currency trading techniques. Starting with the ultra-short term scalping method to the longer term macroeconomic and carry trading methodologies, along with many other trading styles in between.  In addition, we discussed the use of discretionary vs automated trading systems and some of the characteristics of each.

With this knowledge, you should now be able to decide which trading style best suits your personality and couple that with a trade execution style that aligns with your temperament. For example, my trading style in the FX market is focused on a discretionary based swing trading style. This is what works best for me and I stick with that. Now it’s your turn to explore the different options available to you and decide the best combination for you.

The post Exploring The Different Types of Trading Styles and Techniques appeared first on Forex Training Group.

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