familiar with, and that can require a different perspective and trading
strategy. In 2005, Rick Santelli, a respected commentator on
the Chicago Mercantile Exchange, once said, “This bond market is
not your dad’s bond market,” referring to unique changes in fixedincomes
trading behavior. Santelli’s comment can just as easily be
applied to the Forex market.
If you know stock markets very well in the U.S., you may be
aware of their rhythms. This refers to the rises and dips in trading
activity from 9:30 a.m. to 4 p.m. EST. Some of these changes in
activity are based on human behavior. Just before most traders go
to lunch, there tends to be a noticeable rise in trading volume as
they squeeze in trades before they take their break.
The Forex market also displays these kinds of patterns, but
over a 24-hour time period. Trading, for example, tends to pick up
at certain times that correspond to the trading schedules of different
cities. For example, trading always gets brisk around 4 a.m.
EST, when London opens. It sags again at 11 p.m., when Tokyo
closes and before London opens. It jumps when New York opens
and just before London closes.
Doing a Test Run
A good method to learn how the Forex market works is to take a
practice run before you do the real thing. Fortunately, many retail
platforms offer investors the chance to trade a simulated account for
several months. You can use this opportunity to develop a trading
strategy, become accustomed to new market conditions and movements,
and learn how the platform works. (A list of major Forex
firms that offer demo accounts is provided in Chapter 8, “Inside a
Forex Platform,” in the sidebar titled, “Forex Trading Platforms.”)
An investor should always take a practice run with any platform
before trading with real funds, regardless of his or her experience.
The concept that the season is made in the preseason is true.
The more real you make your “paper” trades, the better equipped
you will be to handle real market conditions. Mistakes are common
when the adrenaline is pumping during a heated trade. And
calling your FCM to say “I made a mistake” will not be taken
lightly. Rarely does the FCM change a trade.
The key to making this trial run successful is to execute plans
rather than just trades. Keep a careful log of your moves and what
strategy you are following. Make all your mistakes “profitable” by
learning what went wrong and why, and how you can prevent it
from happening again.
Strategy: Creating an Approach Model
Every trader needs to develop his or her own approach to the Forex
market—one that is both successful and a match between the
trader’s personality and trading behavior. A good match between
the trader and his approach will be more profitable and will allow
the trader to locate flaws quickly and make adjustments. The size
and scope of the Forex market can make developing an approach
intimating for most traders. Where do you begin?
A classic model is the inverted pyramid approach, shown in
Figure 6.1. In this model you can pinpoint trades while evaluating
all the risks associated with them. Most brokers, traders, and dealers
follow this model—consciously or just instinctively.
The basic approach is to select a currency pair to trade. Then
consider all the trade’s macroeconomic factors at the top of the
inverted pyramid. As you go down the pyramid, list technical considerations
until you get to the tip. The pyramid should show the
trader all the factors related to a trade. Depending on his or her
style, the trader can weight the pyramid accordingly. Fundamental
traders, for example, stay on the top portion of the pyramid,
weighting it 100%, and pure technical traders inhabit the bottom.
Here is how a trader uses the inverted pyramid model:
1. Macro overview—This is a broad look at the overriding feeling
of the world. What is the world facing? Is it global terrorism,
SARS, impending war, oil prices, or the Christmas
shopping season? Is the mood optimistic or pessimistic? The
best way to gauge this is to watch any credible 24-hour news
station, such as CNN or BBC.
2. Market specifics—This is where you review the actual currency
markets. What are the markets looking at? If it’s important,
every analyst will be talking about it. Is it a G7 meeting,
a central bank rate meeting, the latest comments from Alan
Greenspan, or a major move in another asset class that could
affect currencies? For example, suppose you are considering
selling U.S. dollars and buying Swiss francs because you are
worried about global uncertainty. Then you discover that the
Swiss population is about to vote on a referendum to join the
euro. Perhaps waiting for the referendum risk to dissipate
would be smarter.
Market sentiment—At this point, a trader should get a strong
handle on the overall market sentiment. The market sentiment
is the general feeling surrounding the currency market. This
behavior indicator is critical in developing a smart trade. Is
the market looking for a big move? Is the market confused
regarding what direction it should be heading toward? The
easiest way to gauge market sentiment is to read analyst
reports and watch live news channels. Eventually, you will be
able to piece together a complete picture of the market.
3. Indicators and price changes—Now that you have a good
understanding of the known macro environment, you should
have an idea of currency pairs that will be volatile. These are
the currency pairs you should focus on. (With a world of economic
indicators, monitoring everything is impossible.) What
are the important indicators, and what are non-events? Each
indicator affects markets differently. The key to filtering out
the noise is a solid grasp of the macro environment. Also consider
the recent movement of prices. Is there a clear trend or
spiky volatility?
At this point you should focus on the potential for a trade. By
considering the three factors just listed, you should be able to narrow
down the most probable currency pairs. At the next stage of
the process, technical considerations offer the best way to define
trading points:
4. Basic technicals (support and resistance)—Whether or not
you rely on technicals, you should realize that technical
“floors” and “ceilings” have become valid psychological trading
levels. Any veteran in the market will tell you that traders
sit on those levels. By watching technical patterns, you can
begin to formulate a view on a specific currency pair’s directional
movement.
Specific currency market sentiment—Once a currency pair is
chosen, its unique market sentiment should be reviewed.
5. Micro indicators—This is the fine-tuning of a strategy by
defining actual entry and exit points before a trade is executed.
Each trader must find the technical indicator that is
effective for his or her strategy. Some like stochastic indicators
(involving chance or randomness); others prefer weighting
moving averages.
Here’s a real-life example of using the inverted pyramid strategy:
Wednesday, December 1, 2004
• Step 1—At 5:30 a.m. New York time, a scan of the BBC
shows that the world is relatively quiet, warily waiting for the
holidays. News on Iraq and the war on terrorism is being
played down, and President Bush is visiting Canada. Ukraine
is showing political instability after its election, but the risk of
anything truly affecting the global marketplace is limited, so
it’s not worth reviewing.
• Step 2—The biggest news is about the U.S. dollar and its
decline against other major currencies, especially the euro.
The day before, the USD/EUR went to new all-time highs—
reaching the 1.333 area. The huge current U.S. account
deficit, exacerbated by Congress’s recent passing of $800 billion
in new debt, combined with a war that is not progressing,
have fueled already-rabid speculation against the U.S. dollar.
The ECB’s Trichet calls the euro’s rise “brutal,” but the market
is unconvinced that this verbal intervention will lead to
any effective action. The dollar market is clearly in a negative
environment, and the way it disregards higher-than-expected
U.S. Q3 GDP numbers tells me that normal indicators will not
reverse this downward trend.
• Step 3
Economic and Monetary Union (EMU)
10.00 PMI Manufacturing (Nov)
11.00 GDP (Q3) Q/Q Y/Y
11.00 Unemployment Rate (Oct) U.S.
14.30 Personal Income (Oct) M/M
14.30 Personal Spending (Oct) M/M
14.30 PCE Deflator (Oct) Y/Y
14.30 PCE Core Deflator (Oct) Y/Y
16.00 Construction Spending (Oct)
16.00 ISM Manufacturing (Nov)
16.00 ISM Prices Paid (Nov)
16.30 DOE U.S. Crude Oil Inventories (Nov 26)
16.30 DOE U.S. Gasoline Inventories
20.00 Fed’s Beige Book
Domestic Vehicle Sales (Nov)
Events
11.00 European Commission 4th Qtr and 1st Qtr GDP Forecast
18.30 BOE King speaks
20.10 Fed’s Yellen speaks on U.S. economic outlook
Step 4—The trading environment from the days before allows
me to rule out any real market impact from the list of indicators.
Even the meeting with Fed governor Yellen, or the
release of the Fed’s beige book, which normally would have
market impact, won’t stop the dollar’s slide this time.
Step 5—Considering the market from a technical viewpoint, I
see that support is around 1.3230, which it hit two days in a
row and bounced right up. Resistance is seen at 1.3330, the
day’s high. It is also the all-time high for EUR/USD. This is a
major point of resistance. There is a good probability that if
either of these numbers breaks, the currency will move
sharply in that direction.
Given the complete picture, this setup has the makings of a
strong USD decline; a really simple play would be a buy
EUR/USD above the resistence at 1.3330. Stops and limits
should be pre-defined by your overall trading strategy.
Read More: Tips Before You Trade
