RISING MARKETS ARE ALWAYS GOOD?

Traders who choose to follow our contrarian ripple trading method will be
beneficiaries of a fringe benefit that they are freed from the tyranny of the
“markets going up are good—markets going down are bad” syndrome. It is
typical in the financial press and TV business news to hear talk of a good
day on the market when stocks are up and, in solemn tones, a bad day on
the market when the Dow is down. This view of the markets is shared by
most of the investing public and by professionals as well. It comes about
because most investors and traders are firmly on the long side and, having
bought into their stock positions, they now only feel smart if these go up.

Conversely, they can feel dumb if the stock they bought at $50 goes down
to $48. This view of up equals good and down equals bad is irrational. The

only people who should feel good about a market going up are those who
are fully invested and waiting to sell their positions. For anyone who has
cash and wishes to invest it, a falling market should be a welcome sight.
For most people, however, this is an alien mindset.

By the very nature of our trading strategy and philosophy, we tend only
to be fully invested in stocks following a fairly long period of market weakness
and we are absolutely never fully in cash. As a result, a market moving
up makes us feel good about the fact that we can take profits on some of
the stocks we have bought in recent days. However, a market moving down
also makes us feel good about the purchases that the downward movement
opens up under our method. This even holds true when the market takes
a major tumble, such as that of February 27, 2007. On that day, the Dow
dropped 413 points or over 3 percent, but intraday was showing a loss of
543 points owing to trading-volume-related technical glitches that affected
the computers that calculate and feed the Dow index numbers to market
participants. We are content in such a market pull-back to let our riding
of the ripples pull us back into stock positions where buy signals flash as
those stocks that we have previously sold drop back to the last purchase
price. In the case of the February 27, 2007, market drop, we did exactly this,
ripple trading back into eight stock positions on that day that we had previously
sold in the preceding days or weeks, including one, Weatherford
International (WFT) that we bought, sold and bought back that day. The
one stock we bought that day that was not a ripple trade was Texas Instruments
(TXN). (See the appendixes for details.) Meanwhile, it was positive
news for us that the market was finally making a significant move downwards,
allowing us to ripple trade back into these stocks.

One market scenario that can give us the blahs is the listless one where
the market moves sideways for long periods and stocks in general are going
nowhere, neither up nor down. Luckily this happens only quite rarely. Even
in a year such as 2005, when the market did indeed go mostly sideways,
there were fluctuations within that narrow trading range that provided
good ripple trading opportunities. A good fluctuating market is always the
one that best suits our trading method. A market that goes up or down
strongly for a long period—such as the bullish market of the last half of
2006 and the beginning of 2007 that topped out February 20—is also not a
favorite of ours, as the opportunities to trade the ripples are much reduced
as a result. However, no market is ever completely without short-term fluctuations,
and you will find us buying to some extent in every market phase.
Read More : RISING MARKETS ARE ALWAYS GOOD?

Option Status Relative to the Underlying Stock

ITM
A call option is said to be ITM when the underlying stock is trading for
more than the option's strike price. By contrast, a put option is ITM when
the underlying stock is trading for less than the option's strike price.
When the strike price of a call option is less than the current price of the
underlying security, the call holder can exercise the option and effectively
acquire the underlying stock for less than the current market price. On
the other hand, the put holder can exercise the put in order to sell the
underlying stock for more than its current market price. For example, if
XYZ is trading at $53, an April 50 call is considered ITM by $3-while the
April 55 put is considered $2 ITM. Note that the value of an option is at
its greatest when it is ITM.

ATM
An option is said to be ATM when the underlying stock is trading at the
same level as the option strike price. In this case, the investor stands to
neither gain nor lose on the option (that is, over and above the initial
capital outlays). For example, the XYZ April 50 call and put will both be
trading ATM when XYZ is trading at $50. Although technically an
option is ATM only when the underlying stock is trading at exactly the
strike price, whenever the underlying stock is trading close to a strike
price, the common practice is to refer to the options at that strike as
ATM options.

OTM

A call option is said to be OTM when the underlying stock is trading for
less than the option's strike price.A put option, by contrast, is OTM when
the underlying stock is trading for more than the option's strike price. The
value of an option is at its lowest when it is OTM.

Therefore, in the case of a call, if the strike of a call is more than the
current price of the underlying security, then the call is said to be OTM
because the holder has the right to purchase stock at a higher price than
the underlying stock's current price. For example, when XYZ is trading at
$48, the April 50 call is said to be OTM by $2.

Similarly, if the strike price of a put is less than the current price of
the underlying security, the put is said to be OTM. You have the right to
sell the underlying stock for the put option for less than the value at
which the stock is trading in the marketplace. Therefore, ifXYZ is trading
at $48, the April 50 put will be ITM by $2. But ifXYZ increases to $53,
the April 50 put will now be OTM by $3 (and, correspondingly, the April
50 call will be ITM by $3).

For an overview, suppose that XYZ is trading at $50 a share. The various
April calls and puts shown next would be in, at, or out-of-the-money as
follows: Figure 4-1 is an example of option strike prices where the underlying
is trading $50/share. As the underlying price fluctuates the options
will fluctuate from being in, at, and out-of-the-money:
Read More: Option Status Relative to the Underlying Stock

Carry Trade Strategy Ideas

Is it possible to earn some passive income while you hold certain currency positions
over a period of time? The spot forex market offers just that opportunity. The Carry
Trade Strategy is a popular way of trading the global forex market, and is a strategy
highly favoured by large financial institutions such as hedge funds, pension funds
and banks. What makes carry trades so desirable is the possibility of earning
interest, which is a unique aspect that traders – both big and small alike – can take
advantage of.

All currencies in the world have interest rates attached to them, and these rates are
decided by each country’s central bank. For example, the Federal Reserve Bank in
the US determines the country’s interest rates while the Bank of England sets the
United Kingdom’s interest rates. Since each country sets its own interest rate,
countries – or, rather, their currencies – are bound to have varying interest rates.

Some countries may have relatively higher interest rates while others may have
relatively lower rates. How can traders exploit the fact that some currencies have
much higher interest rates than others? Let me introduce you to the concept of a
carry trade.


What Is A Carry Trade?
A carry trade is a long-term fundamental trading strategy that involves the selling
of a certain currency with a relatively low interest rate, and using the funds to buy
a currency which gives a higher interest rate, with the hope that the high-interestrate
currency will appreciate against the low-interest-rate-currency. When these
positions are held overnight, carry traders are paid interest on the currency they are
long in, and must pay interest on the currency they are shorting. The interesting
aspect of this strategy is that the investor or trader is able to gain the difference
between these two interest rates, known as the interest rate differential or spread,
which can be a hefty amount when leveraged.

A Basic Carry Trade Strategy
1. Buy a currency with a high interest rate, and
2. Sell a currency with a low interest rate

Currencies and interest rates
• Currencies with typically high interest rates: GBP, NZD, AUD, CAD
• Currencies with typically low interest rates: JPY, CHF

The Japanese yen and the Swiss franc tend to be on the selling side of the carry
trade due to their traditionally low interest rates. Such low-interest-rate currencies
are known as funding currencies since they are used to fund the purchase of high
interest rate currencies such as the British pound, the New Zealand dollar or the
Australian dollar which tend to have high interest rates.


Example: carry trade
Here is an example of a carry trade. Let’s say the Japanese yen has
an interest rate of 0.25%, and the New Zealand dollar gives an
interest rate of 7.25%. Since the New Zealand dollar has a higher
interest rate than the Japanese yen, a trader who wishes to profit
from a carry trade may buy the New Zealand dollar and sell the
Japanese yen at the same time. An annualised profit of around 7%
(7.25% - 0.25%) may be reaped from the carry trade if no leverage is
used. This return is based on the assumption that the exchange rate
between the New Zealand dollar and Japanese yen remains
unchanged throughout the holding period of one year. If that carry
trade is carried out with a 10 times leverage, it will increase the
unleveraged 7% annualised return to a huge 70% annualised return.

The conventional notation of currency pairs is such that JPY and
CHF tend to be the counter currency while GBP, NZD and AUD tend
to be the base currency in a currency pair. Hence, traders who are
interested in carry trades will long currency pairs like GBP/JPY,
AUD/JPY or NZD/CHF, effectively buying the first currency in each
pair (which also tends to be the higher-yielding currency) and
simultaneously selling the second currency in the pair (which tends
to be the lower-yielding currency). Since they are trading these
currency pairs in the long direction, they will want the base or highyielding
currencies to strengthen in value against the counter or lowyielding
currencies.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets

When is a trend not a trend?

When it’s a range. A trading range or a range-bound market is a market that remains confined within a relatively narrow range of prices. In currency pairs, a short-term (over the next few hours) trading range may be 20 to 50 pips wide, while a longer-term (over the next few days to weeks) range can be 200 to 400 pips wide.

For all the hype that trends get in various market literature, the reality is that most markets trend no more than a third of the time. The rest of the time they’re bouncing around in ranges, consolidating, and trading sideways.

Although medium-term traders are normally looking to capture larger relative price movements — say, 50 to 100 pips or more — they’re also quick to take smaller profits on the basis of short-term price behavior. For instance, if a break of a technical resistance level suggests a targeted price move of 80 pips higher to the next resistance level, the medium-term trader is going to be more than happy capturing 70 percent to 80 percent of the expected price move. They’re not going to hold on to the position looking for the exact price target to be hit.

Margin Investors Learn the Hard Way That Brokers Can Get Tough on Loans

For many investors, Friday, April 14, was a frightening day, as the Nasdaq Composite Index plunged a record 355.49 points, or 9.7%. For Mehrdad Bradaran, who had been trading on margin—with borrowed funds—it was a disaster.

The value of the California engineer’s technologyladen portfolio plummeted, forcing him to sell $18,000
of stock and to deposit an additional $2,000 in cash in his account to meet a margin call from his broker,
TD Waterhouse Group, to reduce his $52,000 in borrowings.

At least the worst was over, Mr. Bradaran figured, as tech stocks soared the following Monday—only to learn Monday evening that Waterhouse’s Santa Monica, Calif., branch had sold an additional $20,000 of stock “without even notifying me,” he says. His account, which had been worth $28,000 not including his borrowed funds, is now worth just $8,000, he says. “If they had given me a call, and I had deposited the money, I would have gained back at least half” of the $20,000 in losses when the market rebounded, he claims.

Mr. Bradaran is one of many investors who have discovered that buying stocks with borrowed funds—always a risky strategy—can be riskier than they ever imagined when the market is going wild. That’s because some brokerage firms exercised their right to change marginloan practices without notice during the market’s recent nose dive.

The result: Customers were given only a few hours or less to meet a margin call, rather than the several
days they typically are given to deposit additional cash or stock in their brokerage account, or to decide which securities they want to sell to cover their debts. And some firms, such as Waterhouse, also sold out some customers’ accounts without any prior notice, as they are allowed to under margin-loan agreements signed by customers.

Investors generally can borrow as much as 50% of the value of their stocks. Once the purchase is completed

an investor’s equity—the current value of the stocks less the amount of the loan—must be equal to at least 25% of the current market value of the shares.

Many brokerage firms set stricter requirements. If falling stock prices reduce equity below the minimum,
an investor may receive a margin call. The actual amount an investor must fork over to meet a margin call can be a multiple of the amount of the call. That is because the value of the loan stays constant even when the market value of the securities falls.

Many investors were stunned by their firms’ actions, either because they didn’t understand the margin rules
or ignored the potential risks. There aren’t any public statistics on the number of investors affected, but the
margin calls accompanying April’s market roller coaster have clearly hit a nerve.

Some clients of other brokerage firms were affected as well. Larry Marshall, the owner of an executivesearch
firm who lives in Malibu, Calif., says Merrill Lynch & Co. told him the Monday after the market’s  drop that he would have to meet an $850,000 margin call immediately. Normally, he says, the firm gives him three to five days to come up with additional funds.

A Merrill Lynch spokeswoman says “as a matter of good business practice in periods of extreme volatility,
offices may be asked to exercise the most prudent measures—clearly outlined in our margin policy—to responsibly manage the risk associated with leveraged accounts.”

Clearly, a lot of investors would have benefited from additional time because of the market’s sharp rebound.
But they, and the brokerage firms on the hook for their loans, could have been in even worse shape if stock
prices had continued to plummet.
SOURCE: Abridged from Ruth Smith, “Margin Investors Learn the Hard Way That Brokers Can Get Tough on Loans,” The Wall Street Journal, April 27, 2000.

Types of Transaction In Forex Market

The participants in the foreign exchange markets effect transactions for various purposes,
principally arsing from the need to cover or hedge other financial or commercial operations,
although in practice it is sometimes difficult to draw a clear line between these categories. For
example, covering and hedging operations may well contain elements of speculation. Whatever
the nature of the transaction, they are initiated by the banks’ clients or by banks themselves
for their own account.

The following are examples of those types of transaction, undertaken by all categories of
market participants, which are commonplace in the foreign exchange market today.

Commercial Transactions
For commercial transactions, manufacturing companies who buy in raw materials from abroad
and export finished products undertake both purchases and sales of foreign exchange, always
dependent upon the companies’ domicile and the currency used for invoicing.

Importers of goods, whether acting as principles or intermediaries, will undertake purchases
of foreign currency. Contractors involved in overseas projects will be market participants
as both buyers and sellers of foreign currency. Also, international insurance, shipping, air
transport and travel companies have need of frequent involvement in the market, as do any
other individuals or companies offering services overseas.

Funding
Banks and multinational corporations require specific wholesale funding for their commercial
loan or other foreign investment portfolios, alongside day-to-day funding requirements of their
net currency cash flows.

Hedging
The hedging of any open currency exposure is frequently better handled through off-balancesheet
products, such as currency options, which ultimately will have an effect on the foreign
exchange market. Also, companies involved in direct commercial investment overseas,
the purchase and maintenance of plant and materials, or those financing operations of foreign
based subsidiaries, will be frequent participants in the market, as will property companies
or individuals involved in the purchase and sale of property overseas. They may seek
foreign currency financing or may convert local currency funding via the foreign exchange
market.


Portfolio Investment
Added to this group are banks and other entities involved in portfolio investment overseas,
or dealing in foreign securities, who will, for position establishment and profit realization
purposes, be both buyers and sellers of foreign currencies.

Personal
On the personal transaction front, tourists, immigrants and emigrants making outward and
inward remittances in foreign currency make up the bulk of the volume, if not the value, of
retail foreign exchange business transacted in the market. Royalties, commissions, patents and
copyrights from abroad will also be transacted in the market.
Source: A Foreign Exchange Primer

Long-Term Loans

Plant and equipment purchases and other long-term investments,
including acquisitions of other companies, are typically
financed with term loans covering periods of one to 10 years,
with terms between three and five years being the most common.

Term loans are designed to finance a major cash outlay
and spread the repayment of the loan, including interest, over
a period of time roughly corresponding with the cash flow that
will be available to service the debt. Permanent increases in
working capital, such as those that may arise from entering
new markets, may also be financed in this way.

Term loans are usually tailored to the needs of the borrower,
so no two are exactly alike. However, these loans typically
include a common set of terms and conditions. Besides
the obvious elements required in any loan contract, such as the
interest rate and the payment period, borrowers are subjected
to a series of covenants that mandate certain actions while
prohibiting others. For example, the contract may specify that
the borrower agrees to continue in essentially the same business
over the term of the loan, to grant the bank access to its
books, and to maintain adequate insurance. Submission of financial
statements on a regular basis will also be required. In
addition, the borrower may be prohibited from taking on
other debts without the bank’s consent.

It is also common for banks to impose certain financial tests
on the borrower. For example, the company will be required to

maintain minimum levels of working capital and not to exceed
maximum levels of indebtedness, lease obligations, and dividend
payments. There may also be constraints imposed on the
pay raises that are granted over the loan period to certain corporate
employees. Failure to meet any of these requirements
will put the borrower in “technical default.” This means that
even if all interest and principal payments are made on time,
the company has still violated the loan contract. As a result, the
borrower may be required to renegotiate the debt, with new
terms that are certain to be more onerous and expensive than
the original contract. For many banks, technical defaults are
more common than borrowers defaulting because of their inability
to make the required cash payments.

Another popular form of bank lending is the “revolving
credit,” which combines elements of term loans and lines of
credit. These are formal agreements that require the bank to
lend money provided the borrower is not in default on any of
the terms and conditions in the agreement. The terms and conditions
of the loan are extensive, and the bank expects a commitment
fee in exchange for the service. As with lines of credit,
revolving credits are used mostly for funding working capital.

But there are two important differences. First, the term for revolving
credits can be far longer than for informal lines of
credit, with one, two, or three years being the most common.
Second, revolving credits are not subject to the “cleanup” provision
that is a normal requirement for unsecured lines of
credit. Under a cleanup, typically invoked on an annual basis,
the borrower is expected to pay off all outstanding borrowings.

The cleanup is designed to demonstrate that a company’s need
for the bank’s funds is only temporary and that it has adequate
capital resources to operate the business. Secured lines of credit

don’t follow this practice because the collateral pledged against
the loan is considered sufficient protection for the bank. Likewise,
revolving credits don’t require cleanup. Instead, the borrower
expects to be on the bank’s books for the entire term of
the agreement. But just as for any line of credit, banks insist on
commitment fees before agreeing to revolving credits.



Read More : Long-Term Loans

Using Stock Sectors And Groups For Better Trading

This is for equity traders and stock option traders. There are two approaches
you can use to decide what stocks to trade. One is called a topdown
approach, and the other is called a down-up approach. Here are the
differences:
1. Top-down approach:
a. Sector
b. Group
c. Individual

In using this approach, you start the analysis at the sector level
and work your way downward to individual stocks. Traders using this
approach first look at the stock sector charts. Then they analyze the
groups, and then pick the best individual stocks to trade, thus the name
“top-down approach.”

You can use this approach by looking for sectors that have been
sleepy for awhile. Then look at the most sleepy stock groups within
that sector. Then, choose the best or longest-sleeping individual stock
in that group and use the Pyramid Trading Point to enter.

Another way to use this top-down approach would be to look for
the strongest trending sector, up or down. Then wait for an ART Reversal
to form and find the best group in the sector. Finally, identify
the best individual stock that has also formed the pattern you are
looking for.

Maybe you want to look for a strong trend and a pullback, and then
a reversal pattern back in the direction of the trend. Or you may want
to go short off the ART Reversal and trade the correction. There are
different patterns to look for, depending on how you want to trade and
what makes you comfortable.

2. Down-up approach:
a. Individual
b. Group
c. Sector


In this approach you will find the individual stock first and then
analyze the group and finally the sector to see how the stock is behaving
in relation to its peers. This can be helpful when you are getting a
signal to go long on an individual stock, but the volume is a bit low and
you are wondering why.

If you look at the group and it is in a downtrend, and your individual
stock is generating a long position on low volume with no positive
news out, then I might question going long. Again, if it is in play by
either momentum traders or position traders, you will see significant
volume on the time frame you are trading. The more volume, the more
players are participating.

This down-up approach has saved me many times from going into
the market when it is not ready to move. It will show you when the
market is being manipulated on low volume by market makers. Real
trends take “outside paper” coming from off the floor to move prices
significantly.

Many traders worldwide need to be participating for a significant
trend to develop. Significant trends occur when traders from many different
time frames are participating in the trend.

When using the ART top-down or down-up approach, you can get
an idea of who is involved in that stock you are about to trade. If
the sector is not performing well, chances are that long-term investors
are not buying now. They may be holding or waiting to buy, but they
are most likely not buying a downtrending sector or group. It is possible
that they have sold their positions already.

This is why bullish trading swings remain small until sectors turn
around. Without the investor group’s money to add buoyancy to a stock
in a poor sector, smaller short-term traders can then cause these stocks
to sell off more dramatically by shorting the stock, especially if the
significant money is not buying the stock at that time.

By keeping trading techniques and ideas as simple as possible,
you can quickly confirm a trade without getting bogged down with too
much information. When I look at groups or sectors, it does not take
me more than a few minutes and sometimes less to confirm a signal.
It needs to be that quick or you will never use it, especially if you
are trading intraday. You can use intraday charts for groups and sectors,
too, if you have intraday data for them.

If you are a scalper or trading under 10 minutes, it becomes impractical
to view groups and sectors and stay focused on that short
time frame. Activity in groups and sectors probably won’t be of much
help under a 15-minute time frame and is best used for 60-minute, daily,
and weekly charts.
Read More: Using Stock Sectors And Groups For Better Trading

BEWARE OF TAKING PROFITS TOO EARLY

“You can’t go broke taking a profit” is something I’ve heard many times
over the last 30 years. But what I’ve found is that you can go broke taking
a profit.

Every method has a certain number of losses and a certain number
of gains. That is the nature of every method. There can be variances
around that number for short periods of time but not over the long run.
Let’s go back to our example of losing $1.00 on each losing trade and
making $2.50 on each winning trade and 45 percent of our trades are
winners.

We know through simple math that this is a winning method. But what
if we took profits every time we had a $1.00 profit? That would make this a
money-losing method immediately. We are losing on more trades than we
are winning so making/losing equal amounts of money on each trade is a
surefire way to lose money.

Realistically, though, taking quick profits will likely boost the number
of winning trades to losing trades. This may be enough to make this a profitable
system. However, we would have to boost the number of winning
trades compared to the losing trades by a large amount to equal the profits
of the original ratio.

All methods have losing trades. That is the price of playing the game.
We need a certain number of winning trades of a certain size to pay for
those losses. The winning trades that are beyond that level create the profit
for us.

Every method has a natural profile of winning and losing trades, their
size and frequency. Let’s assume that you are using a winning method.
Cutting the size of the winners will usually cause a higher number of
winners but at a much smaller size. I may cut the size of the winner from
$2.50 to $1.00. The average size of my winner is now just 40 percent of
the previous size. That means that I must have 150 percent more winners
than I did before to equal the dollars that I had made before in my trading.

Remember that I was making only 45 percent of my trades as profits with
the remainder being losses. Adding 150 percent of the 45 percent winners
would mean that I would have to have more winners than I have trades to
equal the profits of the original method. That’s impossible.

Basically, the base method lost on slightly more than 50 percent of
the trades but the winning trades were 2.5 times the size of the losing
trades. It is impossible to make as much money as this method if I cut
the profits to only 1 times the size of the losing trades because I would
have to have more winning trades than I have trades to make that much
money.


It comes back to the old trading adage of letting your profits run and
cutting your losses.
We need to be careful when we take profits too early. Most of the
techniques in this book are trend-following techniques. That means that
we want to follow the trend as long as it is trending. Generally, we have
no idea of how far a trend will go. So we want to give that method
as much room as possible to let the trend make us as much money as
possible.

Basically, we let the trend run until we are stopped out. I have said
that protective stops should have two attributes. First, they should filter
out random noise. We don’t want to be stopped out because of some blip
in the market, only because something significant has happened. Second,
we only want to be stopped out when we are wrong.

In the case of a trend-following technique, we only want to be stopped
out when the trend is no longer our friend and the market has turned neutral
or bearish. So why would we ever want to take profits before getting
stopped out? There are two reasons: psychological profits and confirmations.
We’ll explore both in the pages that follow.
Source:  How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading)

Options Execution

The options trading floor is still an open-outcry system, but technology
is changing rapidly: Many orders are still executed the old way (floor
execution), with hand signals, screaming, and paper and pencil. As this
style oftrading gives way to faster methods of execution, brokerage firms
can pass along savings by bypassing the staff that is needed to execute
orders in the traditional floor-execution method.

The option exchanges of today are actually hybrids of an open-outcry
system and a fully electronic execution, as with NASDAQ. As far as electronic
execution, the auto-exchange system of the trading floor is fully
automated-involving only the investor and the exchange computer systems.

This system eliminates the need for floor and retail brokers.
Let's walk through the three methods of executing an options orderfrom
the traditional floor execution to the extremely fast fully automated
system.

Floor Execution.
The most common way to trade options is to phone
your broker, who will then send your request to the trading floor (where the

order will be given to a floor broker). A floor broker is an individual who
executes orders on a commission basis on the trading floor ofan exchange.
The floor broker will then announce the order in the trading pit, where the
options on that specific issue trade. Open-outcry bidding for the order
ensues among the market makers who are in the pit. Open outcry is a
method of trading in which the floor broker calls out the specific details of
a buy or sell order so that the information is available to all of the traders
in the trading crowd. Ifyour order is a market order and states that you are
willing to pay (sell) the ask/offer (bid) listed by the market maker, your
order will be executed (traded) right away and the broker will contact your
brokerage firm to notify you. The option contract(s) will then be placed in
your trading account, where you will have an open position (an existing
position that has not yet been closed out). In order to close out the position,
you must either 1) sell the option(s) that you bought, 2) buy back the
option(s) that you sold, or 3) exercise your option(s), thereby converting
your position into a position in the underlying security.

Phone Orders. 
Placing phone orders has almost become outdated.
This process generally takes a long time to execute by today's standards
because of all of the individuals who are involved.
Step by step, here is the process:
• The customer calls his or her broker in order to place an order.
• The broker calls the phone clerk on the trading floor.
• The phone clerk hands the order to a runner.
• The runner runs the order to the floor broker.
• The floor broker asks for the market and trades the order.
• The floor broker hands the filled order back to the runner.
• The runner runs the completed order back to the phone clerk.
• The phone clerk calls the retail broker to tell him or her that the
order is filled and at what price.
• The retail broker calls the customer to let him or her know that the
order is filled and at what price.

As you can see, there are many people in the middle (which slows
down the process), and communication becomes important. If anyone in
the chain forgets something or misunderstands something, the order can
be executed incorrectly.
Read More: Options Execution

Research The Consensus

Another insight into market positioning and the value of determining
the consensus view can be gained from the activity surrounding
economic data releases—but this time from the
activity in advance of the release. Surveys are readily available
from media services that quantify the expected responses to the
release of each specific data item. While the consensus number
is valuable in determining the net view of the overall market, it
is also worth looking a little deeper. If you examine the details,
these surveys usually show how many forecasters are bullish and
how many are bearish. They also show whether there is a wide
divergence in expectations or relative agreement among participants.

If the forecasts are grouped tightly together, it suggests
that the market has a high degree of confidence.
From a trading perspective, this means that an unexpected
outcome should have a major impact on the price of the
underlying currency or stock, or on the market as a whole. If a
significant majority of forecasts are bullish, for example, a bullish
outcome is likely to have less market impact than a bearish
result. It is the nature of the economic release relative to the
consensus expectation, combined with the price action after
the release, that provides the best available guide to overall
market positioning in a particular stock or currency. Once the
process of market positioning is understood, this knowledge

can be used by warrior traders to profit in similar situations in the future.

Concentration within Consensus
Knowing how to read and act based on the degree of concentration
within consensus is the mastering of this art. The consensus
forecast for any economic data release is just a number,
and this will be adopted as the overall market consensus. While
it looks the same for every release, there are secrets within.
There are often quite significant differences (and distinctions)
in the detail behind various consensus forecasts. I call this
the degree of concentration within the consensus. Regardless of
whether there is a wide range of forecasts that are evenly distributed
or a narrow concentration of forecasts from all contributors,
an overall final average and consensus will be
distilled by the market. Unless the detail of the survey that led
to the final consensus number is looked at, traders have no way
of knowing whether the market is diverse in expectation or
highly concentrated. This is important in understanding the
potential price reaction to the data when they are released.

When the actual result diverges from the consensus expectation,
market price reaction will be dramatically different
depending on whether the consensus expectation was backed
by a concentrated narrow range of forecasts or by a widely dispersed one.

If the market is positioned over a wide range, unless the
result is completely outside the entire range (which does happen),
the whole market is not required to move toward what is
an unexpected reality. If, however, the entire market was narrowly
focused on a particular outcome and the actual result was
different even to a relatively small degree, the entire market has
to adjust to the unexpected reality. Obviously, the power of the

movement will be significantly greater when the consensus is
concentrated.
Read More: Research The Consensus

The Inherent Instability in the Forex Market

Swings in currency value always seem obvious in hindsight, but
those caught up in them almost never know exactly when, or how
much, a currency will move. That is because the “X factor”—the
element of the unexpected that is present in all markets—is far
more potent in the foreign exchange market.

Clive Crook, in the Economist (May 2, 2003), explains why. It
is conventional wisdom that increased trade in goods and services
is beneficial because it offers consumers more choices. Americans,
for example, can match their tastes and preferences to a wide variety
of automobiles, mostly because of open trade. The Forex market
is good for the same reason—it offers people more choices.

They can also invest in currencies from around the world, each
with different strengths and weaknesses. But, as Crook darkly
notes, the increase in the number of choices also increases the
chances that the investor will make a bad investment. And whereas
most people can tell a well-made car from one of poor quality, currencies
are far more difficult to understand and judge.

For one thing, investors are less able to make an intelligent
decision about something in a foreign business culture than
about something that is near and familiar. Hence, investing in
foreign capital raises the odds that investors will make lesssound
selections.

This would not be as serious if investors were stung only when
markets went down and investments went sour. Yet dramatic currency
swings are rarely so kind. They can quickly spill into surrounding
financial sectors and trigger a series of falling dominoes
of failed institutions—companies, funds, banks, central banks,
and governments. Individuals, who may have no interest in or

understanding of the foreign exchange market, can ultimately be
just as devastated as the investors.

Crook writes about why investor ignorance of the forces
behind currency movement compounds the likelihood of a destabilizing
crash. “Investors tend to deal with uncertainty in ways that
aggravate the problem. If information about underlying value is
absent or obscure, they are likely to become preoccupied with the
views of other investors.”

This isn’t necessarily a bad thing, observes Crook, because one
investor can learn something important that is spread quickly to
the rest of the investing community. But “now and then, it degenerates
into crowd hysteria.”

Several times in history, investors have acted more like sheep
than investors who respect reality, and not just in the Forex markets.
The stock bubble of the late 1990s is a good example, when
seasoned market watchers such as Warren Buffet withdrew in disgust
from the markets because the valuations were so out of line
with earnings.

Because it is difficult for investors to understand what conditions
are like in another part of the world, the global currency market
is therefore prone to these wild, speculative swings.

Another factor, however, makes the currency markets even
more susceptible to swings—leverage. Through leverage, as you
have read, an investor with modest assets can draw on enormous
sums to invest in the foreign currency market, thus making an
oversized impact. I have strongly recommended that the average
investor avoid this temptation. Through leverage, it may be possible
to win big, but it is also possible to lose even bigger.

These losses wipe out the individual investor, but they also
affect the various lenders who loaned the investor the money in the
first place, who often didn’t fully understand the risk they were

taking on. Thus, financial institutions can suddenly melt away after
the disastrous trades of one dealer.
Read More: The Inherent Instability in the Forex Market

Avoiding Fraud and Safe Yourself In Trading World

Generally speaking, foreign currency futures and options contracts
may be traded legally on an exchange or board of trade that has
been approved by the CFTC. Even where currency trading does not
occur on a commission-approved exchange or board of trade, it
can be conducted legally. In such a case, generally speaking, one or
both parties to the trade must be (or must be a regulated affiliate
of) a bank, insurance company, registered securities broker-dealer,
futures commission merchant or other financial institution, or an
individual or entity with a high net worth.

Where Forex firms do not fall into these categories of regulated
entities and engage in foreign currency futures and options
transactions with or for retail customers who do not have a high
net worth, the CFTC has jurisdiction over those firms and their
transactions.

If you are solicited by a company that claims to trade foreign
currencies and asks you to commit funds for those purposes, you
should be very careful. Watch for the warning signs listed in the
following sections, and take the recommended precautions before
placing your funds with any currency trading company.


The Firm Promises a Free Lunch
Remember, there’s no such thing. If a scheme promises quick riches
with little effort, then be aware because it might be a fraud.
Investing has always attracted a criminal element that can ensnare
the unsuspecting or the naïve. This is especially true of inexperienced
people who have just received a windfall—from a retirement
or the sale of a home—and are eager to invest it somewhere. Some
telltale signs are firms that “guarantee” profits or a high return.

They’ll use lines like, “Whether the market moves up or down, in
the currency market you will make a profit,” or, “The main advantage
of the Forex markets is that there is no bear market.”
Remember, the investment pros on Wall Street are thrilled to beat
the markets by one or two percentage points—and even that
achievement is relatively rare and even they suffer down years.

Anyone who does not acknowledge this reality should not be handling
your money and you should never believe any firm that says,
“With a $10,000 deposit, the maximum you can lose is $200 to
$250 per day.”

The Trader Uses Terminology You Don’t Fully Understand
Do you remember the commercials that used to appear on television?
“It’s five o’clock. Do you know what your child is doing?”
An investor should be thinking, “Do I know what my money is
doing?” If you don’t, then you are far more likely to lose it. This
does not mean that you are necessarily being cheated. Many legitimate
investing strategies can put you at greater risk, but you must
be aware of it and be ready to accept the chance of greater losses. A
perfect example is margin trading. Currency traders may ask for
money from investors to trade on “margin.” As we explain else-

where in this book, margin allows a mere $1,000 to $5,000 to control
vastly larger sums on the Forex markets. It increases the size of
the reward but also increases the size of the pain if the market goes
against you. Consequently, an investor may give a relatively small
amount to a trader and find himself or herself facing far greater
losses. This goes for any other trading strategy or vocabulary. If
your trader is using terminology that you don’t fully grasp, then
you should not be risking your money.

The Firm Claims To Trade in the “Interbank Market”
Some firms or companies will say that they have access to the
“interbank market” and can therefore trade at better prices on
your behalf. This is a sign of possible fraud and you should remember
our first warning sign—someone is offering you a free lunch.
The interbank market is dominated by large institutions—banks,
corporations, and financial powerhouses. Anyone who claims to
have that kind of access should be closely questioned.

The Firm is Using the Hard Sell via the Internet
The Internet, as we have noted, has greatly increased the individual’s
ability to access financial information and trade relatively
quickly and at low prices. The downside of this is that it has also
made it easier (and cheaper) to use fraudulent and misleading
pitches to reach investors and take their money from them. Be careful
of a hard sell that is followed with pressure to transfer funds
quickly over the Internet. In many cases, sending money can be as
easy as clicking a button, but getting it back can be almost impossible.

Be especially aware of firms that do not conspicuously list their
addresses. If they are not located in the U.S., then your money
could be sent to a foreign firm, and it may be virtually impossible
to recover.


The Firm is Vague and Little Information is Available
The good news is that a certain measure of due diligence can protect
you from most scams. If you are considering sending your money
to a firm, get as much information about the firm as possible—
especially about their track record with other clients. If the firm is
vague or is unwilling to send you this information, this should be
your first warning sign. However, even if they do send you a packet
of information that appears professional, be careful that it is not fraudulent.

Another way to ensure that a firm is legitimate is to do background
checks on the people running it. A simple Internet search
can yield enormous amounts of information. Use this to confirm
that the firm’s statements are true. Do not rely on what the company
tells or promises you. Above all, if you feel any suspicion
about the firm, trust it. There are plenty of legitimate Forex firms
that will give you the trading opportunities you seek.
Read More: Avoiding Fraud and Safe Yourself In Trading World

You Should Avoid Boredom!!

I was interviewed in Technical Analysis of Stocks & Commodities magazine
a number of years ago. One answer that I gave surprised them. They
asked me what my biggest problem as a trader was.
I told them boredom!

They were shocked; nobody had ever suggested that. Everybody else
thought that trading was exciting.
In the mid-1990s I had the opportunity to train some traders from a
Korean bank. I had six traders for six months, then a second group of six
traders for six months, and a final group of six traders for six months. For
the first group, I brought in guest lecturers to give the students a strong
grounding in all aspects of trading. One guest lecturer was a very experienced
trader using Elliott Wave analysis. For those of you who are not
familiar with Elliott Wave, the basic concept is that the market moves in a
five-wave pattern with, in a bullish configuration, the first, third, and fifth
waves going up and the second and fourth waves declining. The third wave
is the biggest and most powerful wave of them all. So the Holy Grail for

Elliotticians is to try to buy the bottom of the second wave looking to ride
the huge third wave up.

I let my guest lecturer do his lecture with my students and came back
into the room after his lecture. I asked a series of pointed questions to make
sure that the students had gotten a good idea of Elliott Wave. At one point,
I asked him if he was a profitable trader. Imagine my surprise and shock
when he said that he wasn’t. Further, he said that he was never really a
profitable trader. I was partially shocked because I thought that he had
been profitable all these years that I had known him.

But then he burst out, “Well, at least what I’m doing isn’t boring like
the way Courtney trades!”
Turns out that he loved the feeling of catching that Wave Two dip and
watching the Wave Three bull move. Problem was that he couldn’t do that
very often and was a losing trader.

I plead guilty to the fact that following the ideas in this book is not
exciting. I’ll go farther and say that most of you will find my way of trading
boring. I make no excuses. I want trading to be boring, but profitable.
I want trading to be something you do for 15 minutes a day and then go on
with your life.

If trading is exciting, then you are likely to get excited, and getting
excited is usually a recipe for losing money. Think of the casino owner.
Does he get excited when you sit down at the blackjack table? No, he is
bored. He already knows the outcome of the exercise. Contrast this with
the gambler. The gambler is there to get excited. Gamblers know that they
are likely to lose money but they are there to get excited. They have a
chance of winning and the process of gambling is exciting. But who wins?
The guy who is bored or the guy who is excited?
Boredom is one of my personal issues with trading. Here is how I have
overcome it.

One advantage that I have is that I am a scientific person. So what
I have done is created a structure that turns my boredom into increasing
profits. What I do is to take a technique that I am using and then try to
create an enhancement to it. Let’s say that I take channel breakouts and
then come up with an enhancement that says that I will only take trades
in months with blue moons. I then turn on my scientific brain. I now have
a control method, channel breakouts, and an experimental method, Blue
Moon Channel Breakouts.

I now put on both trades from both methods. I flawlessly execute both
methods. I am excited every day to see which method is “winning” the
battle. Which method will be more profitable and/or has less risk. I keep
this comparison up until I have a fair sample of trades. I will look for at
least 30 trades. This might take six months or more to get a good sample of
trades of both methods. I find this comparison trading to be very interesting.
It is certainly not boring to me.


And guess what? I actually constantly find improvements in my
methods using this technique. I beat my boredom and make more
money!

Look, boredom is a problem. But it is a problem for only 15 minutes a
day or you can even use it as the impetus to make more money like I do!
I think boredom comes partially as a result of discipline. It takes discipline
to execute flawlessly. It is boring to be disciplined. I’ve had students
tell me that they wanted to be creative traders. Great! Unfortunately, it is
almost impossible to be profitable and creative at the same time.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life 

BROKER QUALIFICATIONS— DID YOUR BROKER GO TO COLLEGE?

Brokers, like other professionals such as doctors, certified
public accountants (CPAs), and lawyers, are required to have licenses
to conduct their jobs. The qualifications required to obtain
a broker’s license, though, are significantly fewer than in other
professions.

Being a medical doctor requires a person to concentrate his
undergraduate years in the sciences followed by many years of more
specialized and expensive schooling. After schooling comes the residency
program that culminates in a rigorous licensing agenda.

Becoming a lawyer requires three years of law school. Law
school is neither easy to get into nor cheap to attend. Then there
is the dreaded and grueling bar exam, which may have to be passed
in more than one state, depending on where the lawyer intends
to practice.

For CPAs, almost all states require a college degree plus a number
of years of experience depending on whether the degree was in
accounting. And, of course, state licensing is also demanding.

In Chapter 13, we discuss what traits and business practices
make a good stockbroker from the customer’s point of view. But
for now, let’s discuss what qualifications are needed to become a
stockbroker.

Unlike doctors, lawyers, and CPAs, stockbrokers need have no
special schooling or training to be hired by a brokerage firm, other
than acquiring the NASD Series 7 license. Being a stockbroker requires
no formal education at all. A high school dropout could be
a stockbroker! Seriously, you would probably be surprised at how
many stockbrokers have never attended college. In addition, an
NASD rule prohibits persons convicted of financial-related crimes
from being stockbrokers, but only if the conviction occurred within
the last ten years.2 There is no special area of expertise that brokers
are required to have other than being a good salesperson.


The following is a list of qualifications that brokerage firms
look for when hiring someone who has not previously worked as a
stockbroker:
• The ability to sell
• The ability to sell
• The ability to sell

To a brokerage firm branch manager or sales manager, who
many times conducts the initial interview, the ability to sell is the
primary qualification. Although some firms have much stricter standards
than others when it comes to new hires, virtually every trait
or attribute that is examined by the brokerage firm relates back to
the question, Will this attribute enable the applicant to sell? With
that in mind, we finish the list of qualifications firms seek:
• A proven track record of selling (not necessary but a big plus)
• A great communicator, which means the ability to talk on the phone
• Confident, slick, vocal, gutsy—call it what you will. It is
the ability to call a total stranger in the middle of her dinner
and convince her to invest thousands of dollars in a
company she has never heard of.

It was 1980 and as the rest of Dallas settled in for their favorite
television show on a Tuesday night, Douglas sat in a brightly lit office
with a handful of applicants in a closed and darkened Merrill
Lynch office in north Dallas. He and the others had made it through
the initial interview process at Merrill and now were being put
through “the sales test” to become a Merrill Lynch stockbroker. Each
applicant was given a desk, an investment to peddle, and a card that
contained a limited amount of information on the prospects they
were about to call. Merrill was measuring Douglas’s ability to sell intangibles
to strangers. It’s funny to think that not much has
changed over time. Twenty years later, the identical sales process
was depicted in the movie Boiler Room. That criticism aside, Merrill
Lynch has an excellent training system in place.

What qualifications or traits are not important to the brokerage
industry when reviewing stockbroker applicants? They are:

• Appearance (The majority of stockbrokers never see their
customers.)
• Intelligence (The major wirehouses create and promote the
products and investments they want their brokers to sell;
thinking and researching only limits the time the broker
could be selling.)
• Knowledge of finance or investments (Likewise, brokerage
firms provide this information to the broker, figuring that if
the broker can pass his Series 7 exam, that’s good enough.)
• Level of education or education emphasis
• Previous employment unless sales related

The qualifications change dramatically if a broker is going
from one brokerage firm to another. Then the following list of qualifications
would be important:
• Total number of accounts
• Total assets in dollars in those accounts
• Record of opening new accounts
• Total commissions generated in the previous year
• Ability to promise the world to his new manager
• Ability to sell

You may note one critically important item missing from this
last list: how much money the broker made for his customers. This
computation is not performed when brokerage firms evaluate stockbrokers.
Behind the walls of Wall Street, in fact, this calculation is
rarely, if ever, performed.

What we have illustrated is that there is little in the hiring
practices of brokerage firms or in the desired qualifications for stockbrokers
that relates to the best interest of investors.
Source: Brokerage Fraud: What Wall Street Doesn't Want You to Know

Effect of the Business Climate In Price Valuation

The same forces that affect the value of a business have an
impact on the price of currencies. In fundamental terms, a
company is valued on the basis of its balance sheet and current
or future income as well as intangible factors that will
affect that future income, including business model and plan,
management and leadership, competitive advantage, and
adherence to laws and regulations. External factors that affect
a company’s value include the valuation of the industry in
which it competes, the company’s rank or market share in that
industry, interest rates, and current or pending legislation that
will affect regulation of the industry. If a company’s products
or services are selling at a profit and are expected to continue
doing that and if other market conditions are favorable, that
company’s value, or stock, should go up. It is said that the

company is fundamentally sound in those circumstances, and
the market reflects that value. If sales slow, expenses are
higher than expected, or external factors affecting profitability
change in a negative direction, the stock price should go
down. If sales are steady and the company makes no appreciable
gains, the stock may go sideways.

Similar concepts apply to countries and geographic unions. In
very simplified terms, if the companies and citizens in a country
are producing more than they spend and taxes are sufficient to
cover expenses, increased income in the form of tax receipts flows
into government coffers. Because most businesses continually
seek to improve, there is increased competition for money, or
funding, as individuals and businesses borrow money to expand.
An increased rate of borrowing money leads to increases in interest
rates, which will attract capital from investors seeking a
higher yield for their savings and investments and thus cause an
increase in tax receipts. Job growth is healthy when businesses
are spending money to stay competitive. In a healthy worldwide
environment, the stronger an individual country’s economy is,
the more demand there is for stocks and other investments
denominated in that currency, the more pressure there is for
higher interest rates, and the stronger the currency is. Conversely,
the slower the economy is, the more pressure it puts on stock
prices as investors exit investments in search of higher yields and
on central bankers to lower interest rates, further decreasing the
return on investments valued in that country’s currency; in that
case, the country’s currency becomes weaker.

To generalize about the impact of a positive global business
climate, it can be said that higher interest rates mean a stronger
currency and that a weaker currency leads to lower interest

rates. The most direct link between interest rates and currency
values is the level of business activity. If business activity is
growing, there is room for higher interest rates created by
demand for more money and thus a stronger currency. If business
activity is contracting, higher interest rates are a threat to
commerce and interest rates may have to be lowered, with the
effect being a weaker currency.

In times of global economic uncertainty and recession, however,
traders and investors favor lower-yielding currencies
because governments and businesses in those countries will be
relatively less handicapped by lower borrowing costs (interest
rates) in a slowing economic environment. In summer 2008 we
saw a good example of this as global stock markets turned lower,
erasing the gains of the previous two years. Investors around the
world went from thinking about the return on their investments
to being concerned about the return of their investments. With
governments, businesses, and individuals all trying to exit their
previously higher-yielding investments at the same time, currencies
with higher-yielding interest rates fell sharply as money
poured out of the British, European, Canadian, Australian, and
New Zealand currencies and into the lower-yielding U.S. dollar
and Japanese yen. The sharp reevaluation of currencies in the
third and fourth quarters of 2008 also pointed out the fact that
the currency market is a self-correcting mechanism. What
strengthens a currency initially also can weaken it as interest
rates become too high and currency valuations become too
inflated relative to those of competing countries and unions.

Although Canadian citizens felt proud as their currency rose
from 0.60 to 0.80 against that of their U.S. neighbors, Canadian
businesspeople felt concern and then fear as the looney kept

on strengthening from 0.80 to 1.00 against, or on par with, the
U.S. currency. This 40 percent increase in the looney made it
very easy for American farmers and manufacturers to take
business from their Canadian counterparts because the cost of
American feed and products was so much lower compared
with the Canadian than it had been just three or four years earlier.

As business shifted away from Canada, the looney turned
and was sold off, and the Canadian government cut interest
rates accordingly. Like a pendulum that has swung too far, it
can be said that the weight of a stronger currency can cause its
value to swing lower. It is this characteristic of a free enterprise
system with floating currency values that ideally ensures that
the best products and services at the most competitive prices
are what will set economic standards going forward, not political
or nationalistic considerations.
Source: Mastering the Currency Market: Forex Strategies for High and Low Volatility Markets

WHAT ARE STOCHASTICS?

Stochastics are a form of oscillator. An oscillator measures the rate of change of prices. The simplest oscillator takes the current price and subtracts the price some number of days ago. For example, suppose EUR/USD closed today at 1.2050 and closed 10 days ago at 1.2000. The oscillator value would be 0.0050. This process would be repeated each day and plotted on a graph. The common wisdom is that oscillators will signal the turn in a market ahead of the actual turn in price because changes in momentum lead changes in the actual price. This idea follows the analogy of physics.

The rate of change of an object will show decreasing momentum until the object actually changes direction.
The big criticism of oscillators is that they sometimes give a trading signal but the market is in such a strong trending mode that the signal is false. The common wisdom is that oscillators do well in nontrending markets
and poorly in trending markets.

The simpler the oscillator, the more sensitive it is to current market price action. For example, a simple oscillator based on the 10-day rate of change will be more sensitive to current price action than an oscillator

based on the 30-day rate of change.

Many analysts got beat up badly using the simple oscillators so they tried to find ways to improve them. Welles Wilder’s relative strength index (RSI) and stochastics are the two most popular and famous improvements on the basic oscillator. Larry Williams’s %R is actually the same as stochastics except not smoothed and the scale is turned upside down. Stochastics are reasonably easy to calculate. There is a three-step process to calculate the two components of stochastics: %K and %D.

First calculate the raw stochastic number:
K = (C − L)/(H − L) ∗ 100

Where C is the close of the last x number of days, H is the high for the last x number of days, and L is the low for the last x number of days. Typically, x is the last 14 days, though 9 days is also very popular.
%K is a three-day MA of K, and %D is a three-day MA of %K

Fortunately, you won’t need to know the math unless you want to fiddle with it to see if you can improve it. Virtually all chart services, quote systems, and software packages have stochastics built in. However, they
sometimes fiddle with the parameters. I suggest using the parameters I just outlined. The software packages and quote systems often allow you to change the parameters.

The one important question that must be addressed is the term of the stochastics. How many days will you use in your calculation? The classic answer is 14 days, which many people claim is about half of the normal
cycle of forex prices. Other people use nine days, though I have never heard a justification for this number except that it is more sensitive than the usual 14 days. I have never seen any proof of the claim that the average price cycle is 28 days. Further, I have never seen any argument that you should, therefore, use a half cycle as your length in using stochastics. Nonetheless, fewer days in your calculations will lead to a more sensitive stochastic.

Could the length of stochastics be optimized? (By this I mean testing different parameters to find the most profitable one over a given test over past data.) Yes, but first you have to determine how you are going to use
them. Are you going to use them as an overbought/oversold indicator? Are you going to use them as a trend indicator? Each use of stochastics will likely lead to a different optimization.

I won’t get into the pros and cons of optimization here, so I suggest you read Bob Pardo’s book on trading systems. See the Appendix for more information.


Unless otherwise stated, I will use 14 days as the length of the stochastics. Why? Well, I came up with all these profitable techniques when everything had to be done by hand and 14-day stochastics were all we had to use when testing. In the meantime, I have seen that these techniques work so I am loath to change them. I leave it to my superintelligent readers to optimize them!

A second reason to use 14 days for the length is that readers can easily use the indicators because they are the most common in available software packages. There is no need to fiddle with your software package to figure out how to change the parameters.

The techniques outlined in this chapter work similarly on both 9- and 14-day time frames. This is an important suggestion that stochastics are a robust indicator. However, the main difference between the 9- and 14-day
stochastics is that the 9-day is more sensitive and gives more indications or signals. A key consideration in determining which length to use is your particular trading style. A longer length will give fewer signals and later
signals but will filter out some whipsaws. A shorter length will give more signals and earlier signals but will be whipsawed more often.

Stochastics are essentially a measure of the close as related to the high and low. The stochastic measures the percent distance of the close to the range. Thus, a reading of 50 percent means that the close is halfway between the high and low. A reading of 75 percent means that the close was at the 75 percent level between the high and low. In other words, it was at the 75 percent level of the day’s range or nearer to the high than the low.

This means that you can only see a stochastic reading of 100 percent if a market closes on its high every day in the study. The underlying concept is that it is bullish if the market is tending to close in the upper half of the
day’s range and bearish if the converse is true.

Stochastics are used to trade all time frames, including day trading. Obviously, the most popular time frame is daily, using daily bars. However, I know a number of people who use them on shorter-term bars, such as
five-minute and 60-minute bars. George Lane, the inventor of stochastics, used to use stochastics on three-minute bars in the S&P 500 futures.
Source: How to Make a Living Trading Foreign Exchange: A Guaranteed Income for Life (Wiley Trading)

BUY THE RUMOR, SELL THE NEWS . . . OR BUY THE NEWS?

Another of those well-worn Wall Street adages and one that has a good
pedigree goes, “Buy the rumor, sell the news.” Stocks often enjoy a good
upward run based on chatter among market professionals regarding forthcoming
news, such as strong quarterly numbers. Often the so-called “whisper
number” circulating among the professionals is higher than the number
that stock analysts have arrived at in consensus based on guidance from senior
executives at the company. Once the actual numbers are announced,
should they come in below the whisper number, then this news hits the
Street as if the chief executive had just announced the CFO had disappeared
after embezzling all the company’s cash—the stock swoons. It does
not matter if these numbers are essentially sound or even good.


Interestingly, even if the whisper number is reached, the stock often
still falls back sharply as those who had bought into it now sell and take
their profits. In both cases, such a drop in a stock’s price inspired by an
announcement (which hits the stock out of the gate at the opening bell,
should the results have been announced the previous evening or that morning
before the bell), can take several dollars off the stock price and bring
it to a level that puts it squarely in buy territory under our trading technique,
so in such cases we are buyers of the news. Typically, following the
initial sharp drop, the stock tends to come back during the rest of the day
as value-oriented investors and traders perceive value and buy. As the day
progresses, the stock often seesaws as traders come in at low prices, but
take profits each time there is an upswing. As a result, the ripple trader can
buy and sell several times in the same day and make a handsome profit.

One good example of this comes courtesy of Nike Inc. (NKE). We
bought and sold Nike twice on December 21, 2005, when it followed precisely
this pattern. Its quarterly earnings were above expectations, but a
relative weakness in future orders was perceived by analysts. The stock
fell $4.48 or around 5 percent at the open and we bought 100 shares for $84
even. It then climbed back up to $84.56 at which point we sold, only to buy
again shortly afterward for $84.31 with a final sale later that day at $84.98.
We made $103 with the stock on that day. Why were investors in such turmoil
over Nike? The quarterly profits announced were 15 cents higher than
the $1.03 consensus forecast. Go figure!
Read More : BUY THE RUMOR, SELL THE NEWS . . . OR BUY THE NEWS?

Types Of Stocks Calls

Long Stock
Long stock is the most common position among investors. After analyzing
the fundamentals of a company and deducing that the company's product,
its revenue model, and current market conditions reflect the likelihood
of positive growth, the retail investor purchases the stock as an
investment in that company: Over a period oftime, ifthe investor's analysis
proves correct, the stock value increases-rendering a profit. In this
case, the investor who purchases stock with his or her own capital is said
to be long stock.

Here is an example. An investor who has no position in XYZ purchases
100 shares ofXYZ at $50 per share. The investor is now long 100
shares ofXYZ. Figure 3-1 shows the profit and loss associated with the
outright ownership of stock.


The profit in this case is unlimited. This position will profit as the
stock increases in value. Each $1 increase in the market price ofthe stock
will result in $100 worth of profit.

The loss in this example is limited. This position will generate a loss
as the stock declines in price. The risk is limited only because the stock
can only decrease to zero. Each $1 decrease in the market price of the
stock will result in $100 worth ofloss.

Short Stock
Being long stock is a bullish strategy, meaning that you believe there will
be a rise in the market price. What if the stock is not performing positively;
however? What if it is declining in price? Or, what if the investor
believes that the stock is highly overvalued and is ready for a significant
price pullback? Is the investor simply out of luck?

Stock that is in a downward trend (decreasing in value) is referred to
as behaving bearishly. Similarly, an investor who has a pessimistic outlook
on a stock is referred to as being bearish. The bearish trader can take
advantage of an anticipated declining market by selling a stock short. In
other words, he or she will sell a stock that he or she does not currently
own. In this case, the brokerage firm lends the investor a certain number
of stock shares at a particular price under the condition that the investor
has capital in his or her account in order to cover the cost of the stock

being borrowed. With the stock in hand, the investor now has the ability
to capitalize off what he or she is speculating to be a downward move in
the stock. The investor sells the borrowed stock in the marketplace at its
existing price and waits until the price decreases. Once the stock price
declines, the investor buys the stock back in the open market at the lower
price. He or she is then able to return the stock to the brokerage firm
while capturing the profit. To be sure, by selling stock short, a retail
iIlvestor can take advantage of a declining market. There is always a risk
that the stock that has been sold short will increase in price, however.

This situation could force the investor to purchase the stock back at a
higher price, resulting in a loss. If the investor is correct, however, the
stock will decrease in price and he or she can buy the stock back from the
open market in order to capture profit.

Here is an example. An investor who has no position in XYZ borrows
100 shares from his broker and sells it for $50 per share. Figure 3-2 shows
the profits and losses associated with the short sale of a security. In this
case, the profit is limited to the amount collected for the stock and risk is
unlimited.

The profit in this situation is limited. This position will profit as the
stock declines in value. Each $1 decrease in the market price ofthe stock
will result in $100 worth of profit.

The loss in this case is unlimited. This position will lose money as the
stock rises in value. Each $1 increase in the market price ofthe stock will
result in $100 worth of loss. There is also the risk of stock being
demanded back by the brokerage firm.

Long Call
The buyer (holder) of a call has as much profit potential as the owner of
the underlying stock but has significantly limited the risk ofloss. Because
of the limited capital used in controlling a large interest, the long call
position is a leveraged position. The risk involved is the total amount paid
for the call.

A long call position is used when the trader is bullish on the underlying
security and is an alternative to long stock.
Here is an example. XYZ stock is trading at $50 per share, and the XYZ
July 50 call is trading at $2.An investor purchases one XYZ July 50 call for
$200. Figure 3-3 shows the profits and losses associated with ownership of
a call option. The profit potential to the upside is similar to that of long
stock, whereas the risk is limited to the purchase price ofthe option.

The profit in this case is unlimited. When measured upon expiration of
the option, each $1 increase in the price ofthe stock higher than $52 ($50
strike price ofthe option plus $2 paid for the option) results in $100 worth
ofprofit. The profit from a long call will always be less than the profit from
the same amount oflong stock as represented by the option because ofthe
time premium paid for the option. In this case, the profit from long stock
would be $200 higher than the profit derived from the option.

The loss in this situation is limited to the amount paid to purchase
the option. When measured upon expiration ofthe option, if the stock is
trading at $50 or lower, the option will expire worthless-and the entire

investment in the option will be lost. There will be a partial loss if the
stock is trading between $50 and $52 upon expiration of the option.

Short Calls
The seller (writer) of a short call has as much loss potential as the short
seller of stock but faces much less potential for gain. The retail investor
will need to meet capital requirements in order to transact this position.
He or she will also need to have cash in the account in order to cover the
short call position or to own the underlying securit)T. The short call is frequently
combined with long stock. This strategy is called a covered call or
a buy-write and is covered.

Here is an example. XYZ is trading at $50 per share, and the XYZ July
50 call is trading at $2. One XYZ July 50 call is sold for $200. Figure 3-4
illustrates the risks and losses associated with the sale of a call option.
The profit potential is limited to the amount collected for the sale of the
option and the risk is unlimited.

The profit in this situation is limited. The total profit to the option
seller is the $2, or $2 X 100 = $200. When measured upon expiration of
the option, if the stock is trading at $50 or lower, the option will expire
worthless and the entire premium received is retained. There will be a

lesser gain if the stock is trading between $50 and $52 upon expiration
of the option.

The loss here is unlimited. When measured upon expiration of the
option, each $1 increase in the price of the stock higher than $52 ($50
strike price ofthe option plus the $2 received for the option) will result in
$100 worth ofloss.

Long Put
A long put position is used when the trader is bearish on the underlying
securit)T. The buyer/holder of a put carries the profit potential of a short
stock position but has a significantly limited risk of loss. There are no
margin requirements for a long put position, and the risk is the total
amount purchased for the put. Also, for those who do not trade on margin,
selling stock short is not an available option. Therefore, a long put is the
exclusive vehicle for speculating on a decline in the price of the underlying
stock.

Here is an example. XYZ is trading at $50 per share, and the XYZ July
50 put is trading at $2. One XYZ July 50 put is purchased for $200. The
profit and loss associated with the purchase of a put.

The profit potential is considered to be unlimited, although the

underlying can only go to zero, and the loss is limited to the purchase
price of the option.

The profit in this instance is limited. The profit potential of the long
put is limited only because the value of the underlying stock can only
decline to zero. When measured upon expiration of the option, each $1
decrease in the price of the stock lower than $48 ($50 strike price of the
option minus the $2 paid for the option) will result in $100 worth ofprofit.

The profit from a long put will always be less than the profit that would
have been earned by selling the same amount of stock short, covered by
the option contract due to the time premium paid for the long put.
The loss here is limited to the amount paid in order to purchase the
option. When measured upon expiration of the option, if the stock is
trading at $50 or higher, the option will expire worthless-and the entire
investment in the option will be lost. There will be a smaller loss if the
stock is trading between $48 and $50 upon expiration of the option.

Short Put
The buyer (holder) of a put has much ofthe profit potential of a short
stock position but has significantly limited the risk ofloss. No margin is
required for this position. The risk is the total amount purchased for the
put.

The seller (writer) ofa put has as much ofthe same loss potential as a long
stock position but has much less potential for gain. The retail trader or
investor is required to meet capital requirements for this transaction (in
other words, he or she will need to have cash in the account as security
against the short put). This requirement is referred to as a cash-covered
put, which is similar to a covered call (discussed in the strategy section of
this book). Cash in the account covers the short put.

Here is an example. XYZ is trading at $50 per share, and the XYZ July
50 put is trading at $2. One XYZ July 50 put is sold for $200. Figure 3-6
illustrates the profits and losses associated with the sale ofa put. As with
the outright sale of any option, the profit potential is limited to the
amount collected for the sale of the option and the risk is unlimited, or in
this case limited as the underlying can only go to zero.

The profit here is limited to the amount received upon sale of the option.
When measured upon expiration of the option, if the stock is trading
at $50 or higher, the option will expire worthless and the entire premium
received will be retained. There will be a lesser gain if the stock is trading
between $48 and $50 upon expiration of the option.

The loss here is unlimited. When measured upon expiration of the
option, each $1 decrease in the price of the stock lower than $48 ($50
strike price of the option minus the $2 received for the option) will result

in $100 worth of loss. There will be a smaller loss if the stock is trading
between $48 and $50 upon expiration of the option.
Read More: Types Of Stocks Calls

How To Filtering False Breakouts

I usually do not trade a price breakout at the first attempt, unless there are other
reasons (technicals or market sentiment) to convince me to do so. While most
people are more afraid of losing out on a potentially great opportunity than losing
their money in a bad trade, I prefer to let the price breakout play out the scene first
before deciding on the next move. One way of doing that is to check if the currency
price will close beyond the breakout level on the hourly chart.

Focus on an hourly time frame that displays the price actions either in the candlestick
or bar format. Language-wise, I will refer to either the candlestick or bar as the
candle. If the candle closes beyond the breakout level on the hourly chart, you may
then place a short order at least 10 pips below that candle’s low for a downside
breakout. The opposite is true for an upside breakout – you may open a long position
when any subsequent candle exceeds more than 10 pips above that candle’s high.
This filtering technique only works if there is still more room left for
the currency pair to move before it reaches its average daily range.

If the price does go back to the breakout level, you will need to monitor the price
action even more attentively as its behaviour around that level could provide you
with important clues as to the next price movement. A false breakout is almost
certain if the price moves back into the pre-breakout range, but if it is repelled by
the breakout level, and does not penetrate past it, there is a higher chance of the
price moving in the direction of the breakout.


Remember that the success of a breakout relies on the second and subsequent
waves of traders joining in the breakout, sustaining the breakout like a selffulfilling
prophecy. Let’s say in a downside breakout, the price soon returns to the
breakout level after penetrating the support. For the breakout not to fail there must
be more selling interest from a second wave of traders who see that it is a good
opportunity to short at that breakout level in order to overcome the opposing buying
interest. This second wave of traders are selling in anticipation of lower currency
prices after seeing the bearish technical picture, thus pushing down the currency
price from the breakout level of support. The reverse applies to an upside breakout.

If you see that prices are bouncing off that breakout point on the rebound trip, you
could place your breakout trade with a limit or market entry order, with a stop placed
at least 20 pips on the other side of the breakout level or outside of the day’s price
range, depending on your risk tolerance. Once the price movement picks up speed in
the direction of the original breakout, and breaks below the low (high) of the
downside (upside) breakout candle, there is a high probability of the breakout being
successful since this new low (high) is another confirmation of a successful breakout.
This way of filtering a fleeting short-lived breakout offers some protection against
losses even though like all trading tactics it is not completely fail-proof.
Source: 7 Winning Strategies for Trading Forex: Real and Actionable Techniques for Profiting from the Currency Markets