The Power Of online Forex Trading
Few traders ever stop to consider the context that defines the foreign exchange marketplace, but all of them should. As forex matures in its role as a retail investment environment the rules – and the stakes – will only multiply.
ANALYSIS
• Who: The faces of forex that shape market action
• Why: Understand the nature of forex, and its inherent opportunity
• Where: Matching your objectives to the optimal dealer
• What: Choosing a trading vehicle based on your investment premise
• When: Time your trades for maximum efficiency
• How: Select a toolkit that actually improves your trading ability
ACTION
• Take an inventory of your personal trading plan
• Find solutions that can help you execute your plan, step by step
Analysis
For most traders, a comprehensive trading plan is an unmet ideal. In the foreign exchange markets in particular, the lure of easy money often distracts the trader from the reality of hard work. But as anyone who has had success trading can attest, trading is a discipline. It requires a plan informed by extensive knowledge of the markets and the ability to carefully, consistently apply that knowledge. The main ingredient of any trading plan is an understanding of the context that defines the trading environment.
THE SIX FORCES OF FOREX
Trading forex is like watching a school of fish move. One minute is total harmony, the next, complete chaos. As the observer of this school of fish, do you believe you can accurately predict the direction the school of fish will move each time? Would you bet on it?
What causes the fish to move the way they do? Why do they work together in one moment, moving with force and precision, and move in what seems to be an infinite number of directions the next? There’s no way to know unless you can sense what the fish sense each time they move. The fish have an instinct about the nature of their environment. They understand the context of all things around them – natively – and can react accordingly. Surely if you shared this understanding you’d be a much more accurate predictor of fish movement!
Trading forex is not much different - we need to develop that keen sense of what is happening around us. Will we ever be able to predict every move in the forex markets? Absolutely not. But we can use our understanding of the context of the market – the six forces of forex – to make better, more profitable trading choices.
Once we understand these forces, we can create and operate within a
comprehensive trading plan:
• Who trades forex? Understand who participates in the markets, why they are
successful, and how you can emulate them.
• Why trade forex? There are superior returns in forex, but not for all
investors. Are you one of them?
• Where should you trade? Choose to work with service providers who can
efficiently enable your style of trading.
• What should you trade? Select the currency pair, entry, exit and money
management methods that will maximize your returns.
• When should you trade? Trade when the environment is most likely to produce
the best conditions for executing your system.
• How should you trade? Trade using methods that maximize your ability to
emulate the proven winners.
Knowledge of these forces and how they work is a major determinant of your
success as a trader. Figure 1 shows these 6 forces, their relative rarity, and
their effect on profitability.
Finding a Broker
“Hey Joe! I need help finding a broker. I
notice that discount commission rates are pretty much the same. So how do I
choose?”
Commission is definitely not the most important factor in choosing a broker.
Most important in choosing a brokerage firm is the per trade slippage, the
difference between the stop order price and execution price.
Based o a study I saw some years back, ten orders were placed with five
commission houses. All orders were priced in the same market at the same price,
before the market opened. The difference in slippage from worst to best was
over $800. Slippage one year for Rosenthal-Collins trading one and two contracts
of the S&P, was over $20,000 per account. The floor broker for the majority
of those trades was Mario De Bartolo. All the fills were supposedly legal. One
order for 15 contracts was to sell at 45. The market took over two minutes to
fall in one-tick increments to even money, at 00, before an up tick. All 15
contracts were unbelievably filled at 00. Slippage on the order was $3,375. A
week later another order was slipped over $2,000, then all accounts were
closed. Coffee once had the daily high and low in the opening range. I was
filled on my buy stop and sell stop at the high and low of the day, 360 points
times three. Legalized theft. The broker could have taken both sides of the
orders. New York markets are notorious for their slippage, as is the Chicago
pork belly market.
Any broker who allows this kind of slippage to occur on his customer’s orders
is not worth having as a broker. There are brokerage firms that carefully
monitor the kinds of fills their customers are getting from the floor. If the
fills are bad, they will dump the bad floor broker and use another. Bad floor
brokers can be penalized that way. They lose the business. A good broker will
do battle for his/her customers. That’s why we use the broker we are currently
using. If you want a referral, let me know. I’ll be happy to give it.
Using Fibonacci to determinate market goals
Part I: Introduction
Leonardo Pisano, better know as Fibonacci, explained the
development of natural growing phenomenon through his famous numerical
sequence. He proved that this series was highly connected with the growing of
dynamics structures, and the most important use is relationated with its
ratios.
The objective of the present work is to demonstrate that
the application of these rules, have an important probability of success in
financial markets, and principally in FOREX.
We start with the premise that the human society is a dynamic system, and its behavior is represented in financial markets through prices.
That is the reason why we will try to prove that there is an important probability to predict the behavior of prices in Forex, joining Fibonacci numbers with Zig Zag Oscillator.
So, we will try to determine the objectives zones, or where the prices tend to go using Fibonacci. We will study the prices corrections against the major trend.
The Method: Fibonacci, and his legacy
In the beginning, we start using the most important
correction ratios discovered by Fibonacci. These ratios came from the famous
Sequence.
Many contributions were applied to mathematics science by Fibonacci, but the most relevant discover was denominated by the French mathematician, Edouard Lucas, as Fibonacci Sequence in the XIX Century.
The sequence. Properties and principal characteristics
This sequence is a rule that explain the development of
natural growing phenomenon. Formed by adding the last two numbers to get the
next one.
The formula is:
The Fibonacci Sequence is: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987, etc.…
Fibonacci proved that this sequence could be found in the evolution of many natural phenomenons. He used as example the rabbit reproduction process. He wanted to know how many rabbits will be born in a year, knowing that:
a. A couple of rabbits could birth since the fist month, but
the others couples just can do it since the second month.
b. Each labor brings two new rabbits as result.
If we suppose that any rabbit die, the process will be
the like this:
1. In the first month there will be born two rabbits. So, we
will have two couples.
2. During the second month, the initial couple will born
another couple, and then will be three pair of rabbits.
3. In the third month, the initial couple, and the second
one, will produce new couples. Then, there will be five couples.
Continuing with the present analysis, we could see in the
next table the results of the rabbit’s couples forming the Fibonacci Sequence.
Despite all this, we find the major utility of the sequence in these fundamentals properties:
Despite all this, we find the major utility of the sequence in these fundamentals properties:
1. If we divide two consecutives numbers, 1/1, 1/2, 2/3,
3/5, 5/8, 8/13, etc. We could find that the results tend to 0.618.
2. If we divided two non consecutive numbers from the
sequence, ½, 1/3, 2/5, 3/8, 5/13, 8/21, etc. We could see that the result
obtained tend to 0.382.
3. If we calculate the division between any numbers of the
sequence to the next lower, 21/13, 13/8, 8/5... the results tend to 1.618,
which is the opposite of 0.618.
4. If we calculate the division between any numbers of the
sequence to the higher low non consecutive, 21/8, 13/5, 8/3... the results tend
to 2.618, which is the opposite of 0.382.
E.g.; 144 /
233 = 0,618 144/89= 1.6179
The ratio 1.618, or the opposite 0,618 were denominated by the Old Greeks “Golden ratio” or “golden section”, and they are represented with the Greek letter phi, referenced by the greek author, Phidias. Chirstopher Carolan mentions in his book that Phidias was the author of the Athens statues in the Parthenon and The Zeus in Olympus. He considered very important the phi number in Art, and in nature.
This ratio, who’s opposite is the same number more the unit, characterize all the progressions of this kind, where ever it is the initial number.
The most important ratios are 0,618 and it’s opposite 1,618, but not the only ones. We can continue on the ratios derivation of the Sequence, just increasing or decreasing the distance between the Fibonacci numbers.
So, each number is relationated with the higher next trough the 0,382 ratio, and with the lower next with the opposite ratio, 2,618.
E.g.: 144/377=0,3819 144/55=2,618
In the same way, the division between a number and the
third next, bring as a result, 0,236, and the proportion between a number and
the third lower next is 4,236.
E.g.: 89/377=0.236 144/21=4,238
The same occurs with 0,618 and 1,618, these ratios are more exactly, when we use higher fibonacci numbers. The next table shows some examples:
Ratios de 1,618
|
Ratios de 0,618
|
1,618 2 = 2,618
|
0,618 2 = 0,382
|
1618 3 = 4,236
|
0,618 3 = 0,236
|
1,618 4 = 6,854
|
0,618 4 = 0,146
|
Carolan emphasized that the Fibonacci ratios
could be order as follows: 0,146, 0,236, 0,382, 0618, 1, 1,1618, 2,618, 4,236,
and 6,854. Then we could find and additive sequence with the properties of the
Fibonacci Sequence, because each number is the sum of the immediately two
before, and moreover, each number is 1,618 times the number before.
Pivot Points in Forex
Mapping Your Time Frame
It is useful to have a map and be able to see where the price is relative to previous market action. This way we can see how is the sentiment of traders and investors at any given moment, it also gives us a general idea of where the market is heading during the day. This information can help us decide which way to trade.
Pivot points, a technique developed by floor traders, help us see where the price is relative to previous market action.
As a definition, a pivot point is a turning point or condition. The
same applies to the Forex market, the pivot point is a level in which the
sentiment of the market changes from “bull” to “bear” or vice versa. If the
market breaks this level up, then the sentiment is said to be a bull market and
it is likely to continue its way up, on the other hand, if the market breaks
this level down, then the sentiment is bear, and it is expected to continue its
way down. Also at this level, the market is expected to have some kind of
support/resistance, and if price can’t break the pivot point, a possible bounce
from it is plausible.
Pivot points work best on highly liquid markets, like the spot currency
market, but they can also be used in other markets as well.
Pivot Points
In a few words, pivot point is a level in which the
sentiment of traders and investors changes from bull to bear or vice versa.
Why PP work?
They work simply because many individual traders and
investors use and trust them, as well as bank and institutional traders. It is
known to every trader that the pivot point is an important measure of strength
and weakness of any market.
Calculating pivot points
There are several ways to arrive to the Pivot point. The
method we found to have the most accurate results is calculated by taking the
average of the high, low and close of a previous period (or session).
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from the previous session:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is trading above 1.2439, Bulls are winning the battle pushing the prices higher. And if the market is trading below this 1.2439 the bears are winning the battle pulling prices lower. On both cases this condition is likely to sustain until the next session.
Since the Forex market is a 24hr market (no close or open from day to day) there is a eternal battle on deciding at white time we should take the open, close, high and low from each session. From our point of view, the times that produce more accurate predictions is taking the open at 00:00 GMT and the close at 23:59 GMT.
Besides the calculation of the PP, there are other support and resistance levels that are calculated taking the PP as a reference.
Support 1 (S1) = (PP * 2) – H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP – (R1 – S1)
Resistance 2 (R2) = PP + (R1 – S1)
Where, H is the High of the previous period and L is the low of the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
These levels are supposed to mark support and resistance levels for the current session.
On the example above, the PP was calculated using information of the previous session (previous day.) This way we could see possible intraday resistance and support levels. But it can also be calculated using the previous weekly or monthly data to determine such levels. By doing so we are able to see the sentiment over longer periods of time. Also we can see possible levels that might offer support and resistance throughout the week or month. Calculating the Pivot point in a weekly or monthly basis is mostly used by long term traders, but it can also be used by short time traders, it gives us a good idea about the longer term trend.
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from the previous session:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is trading above 1.2439, Bulls are winning the battle pushing the prices higher. And if the market is trading below this 1.2439 the bears are winning the battle pulling prices lower. On both cases this condition is likely to sustain until the next session.
Since the Forex market is a 24hr market (no close or open from day to day) there is a eternal battle on deciding at white time we should take the open, close, high and low from each session. From our point of view, the times that produce more accurate predictions is taking the open at 00:00 GMT and the close at 23:59 GMT.
Besides the calculation of the PP, there are other support and resistance levels that are calculated taking the PP as a reference.
Support 1 (S1) = (PP * 2) – H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP – (R1 – S1)
Resistance 2 (R2) = PP + (R1 – S1)
Where, H is the High of the previous period and L is the low of the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
These levels are supposed to mark support and resistance levels for the current session.
On the example above, the PP was calculated using information of the previous session (previous day.) This way we could see possible intraday resistance and support levels. But it can also be calculated using the previous weekly or monthly data to determine such levels. By doing so we are able to see the sentiment over longer periods of time. Also we can see possible levels that might offer support and resistance throughout the week or month. Calculating the Pivot point in a weekly or monthly basis is mostly used by long term traders, but it can also be used by short time traders, it gives us a good idea about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone is
a well-known technique and it works simply because many traders and investors
use and trust it. But what about the other support and resistance zones (S1,
S2, R1 and R2,) to forecast a support or resistance level with some
mathematical formula is somehow subjective. It is hard to rely on them blindly
just because the formula popped out that level. For this reason, we have
created an alternative way to map our time frame, simpler but more objective
and effective.
We calculate the pivot point as showed before. But our support and resistance levels are drawn in a different way. We take the previous session high and low, and draw those levels on today’s chart. The same is done with the session before the previous session. So, we will have our PP and four more important levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session.
PP, pivot point.
These levels will tell us the strength of the market at any given moment. If the market is trading above the PP, then the market is considered in a possible uptrend. If the market is trading above HOPS1 or HOPS2, then the market is in an uptrend, and we only take long positions. If the market is trading below the PP then the market is considered in a possible downtrend. If the market is trading below LOPS1 or LOPS2, then the market is in a downtrend, and we should only consider short trades.
The psychology behind this approach is simple. We know that for some reason the market stopped there from going higher/lower the previous session, or the session before that. We don’t know the reason, and we don’t need to know it. We only know the fact: the market reversed at that level. We also know that traders and investors have memories, they do remember that the price stopped there before, and the odds are that the market reverses from there again (maybe because the same reason, and maybe not) or at least find some support or resistance at these levels.
What is important about his approach is that support and resistance levels are measured objectively; they aren’t just a level derived from a mathematical formula, the price reversed there before so these levels have a higher probability of being effective.
Our mapping method works on both market conditions, when trending and on sideways conditions. In a trending market, it helps us determine the strength of the trend and combined with price behavior helps us trade off important levels. On sideways markets it shows us possible reversal levels. It also helps us to set the Risk Reward ratio based on where is the market relative to previous market action.
We calculate the pivot point as showed before. But our support and resistance levels are drawn in a different way. We take the previous session high and low, and draw those levels on today’s chart. The same is done with the session before the previous session. So, we will have our PP and four more important levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session.
PP, pivot point.
These levels will tell us the strength of the market at any given moment. If the market is trading above the PP, then the market is considered in a possible uptrend. If the market is trading above HOPS1 or HOPS2, then the market is in an uptrend, and we only take long positions. If the market is trading below the PP then the market is considered in a possible downtrend. If the market is trading below LOPS1 or LOPS2, then the market is in a downtrend, and we should only consider short trades.
The psychology behind this approach is simple. We know that for some reason the market stopped there from going higher/lower the previous session, or the session before that. We don’t know the reason, and we don’t need to know it. We only know the fact: the market reversed at that level. We also know that traders and investors have memories, they do remember that the price stopped there before, and the odds are that the market reverses from there again (maybe because the same reason, and maybe not) or at least find some support or resistance at these levels.
What is important about his approach is that support and resistance levels are measured objectively; they aren’t just a level derived from a mathematical formula, the price reversed there before so these levels have a higher probability of being effective.
Our mapping method works on both market conditions, when trending and on sideways conditions. In a trending market, it helps us determine the strength of the trend and combined with price behavior helps us trade off important levels. On sideways markets it shows us possible reversal levels. It also helps us to set the Risk Reward ratio based on where is the market relative to previous market action.
Trade the News
Fri, 18 Aug 2006 09:58:54 GMT
by Scott Owens
by Scott Owens
Most
traders intuitively know that major news events drive FX price action, but few
trade the news proactively. In fact, most traders avoid news events simply
because they lack the tools and information needed to trade the news
effectively. Now, the introduction of a toolkit specifically designed to trade
the news makes a new, compelling method of trading available to FX traders for
the first time.
Analysis
·
Understanding the
drivers of price action
·
Context: the most
critical element of any trading system
·
Targeting news event
driven price action
·
Automation as the key
element of any news trading approach
·
Why trading the news
is actually a conservative strategy
·
See recent sample
trades with charts
Action
·
Trade the news with FX
Engines!
·
Get familiar with the
FX Engines Trade the News Toolkit
Related material
Test-drive
FX Engines for free online at www.fxengines.com to see the power of trading the
news first hand.
About this report
The
Forex Report is a periodic publication that investigates strategies for
superior trading performance in the foreign exchange markets. These reports
utilize advanced statistical and econometric modeling techniques to create new
insight into the trading strategy of the average trader. This report, Trade the
News, is a general report intended for all audiences, including those new to
the forex market.
Analysis
All
traders want an edge. In pursuit of that extra advantage, traders will pay
thousands in training, subscribe to black-box signal services, and build
trading systems using signals they barely understand. The desired end result is
a system that can be used repeatedly for profits beyond those offered by
traditional investment alternatives. Most traders fail.
To
find out why, we dissected price data from the past five years and emerged with
a single conviction: forex price action is driven by news events.
We
learned that the systems most people use are fundamentally flawed, and we
learned that most traders avoid the very thing that could lead to their success
because of a lack of tools. This report exposes the reality of trading the
news: the empirical, analytical support for the concept and the introduction of
a new set of tools from FX Engines specifically designed to extract profits
from these amazing price moves.
Drivers of price action
From
a distance, market action in the forex markets represents pure chaos. One minute
the market can be completely flat while another can witness 10-pip tics in both
directions. Prices can trade in a range for months, then suddenly jump out into
a major trend lasting equally long. What drives it?
To
understand the drivers of price action one must understand the participants in
the market. The world’s daily FX volume is created by a myriad of constituents:
governments, banks, corporations, investors, traders, et al. Each of these
constituents brings with it certain goals for their participation, and each
brings a transaction volume. The sum of these goals and their corresponding
volume is the price action seen each day in the markets.
At
the most basic level, foreign exchange rates are derived from long term
economic fundamentals. These variables measure and weigh the value of one
currency vs. another. Think of these economic fundamentals as the tide, ebbing
and flowing over time. Indeed, these macro-factors can lead to the very long
term trends we see in weekly and monthly charts.
Go a
little closer to the surface and you will see a variety of price action driven
by governments protecting their currency, corporations and banks transacting
true currency swaps, and traders speculating according to differing timelines
and investment goals. Each of these constituents can cause price action that
goes with the tide or against it, depending on their market power at the time
of their transactions.
At
the very surface level we have a constant hunt for equilibrium. The market
wishes to always have a complete, correct value for the exchange rate for two
currencies, but it does not always have complete, correct information. The
passing of inflection points and, more importantly, major economic news events,
gives the market the information it needs to re-evaluate exchange rates and
make instant changes.
When
the market receives this information, it quickly discerns the equilibrium gap
and moves to correct it. This movement can be instantaneous and violent, moving
100 pips in minutes, or in a steady march of 40 pips to equilibrium.
Because
these events are instantly reacted to by market participants with very large
transactional power, these news events actually move the markets. Our Event
Reports for the major economic news events demonstrate this emphatically: news
is the driver of the forex markets in the short term.
This
realization is important not only because it paves the way for a new kind of
trading, but also because it shows why most trading systems used now are likely
to fail.
In order to read the full report download the PDF file
below.
Managing Option Directional Trades
Tue, 13 Jun 2006 15:56:46 GMT
by John Forman
by John Forman
Options provide great position management and risk control potential when using them to trade the market directionally. This goes beyond the simple fact that a long position in a call or put option has an absolute maximum risk equal to the cost of the option (plus commissions, of course). That, in and of itself, is a very useful thing. What this article discusses, however, are a couple of handy little things one can do while holding an option position to maximize the return and keep the risk well constrained.
Roll Up/Down
Most traders are familiar with the concept of a trailing
stop whereby one moves their protective exit as the market moves in favor of
the trade. This is used to lock in profits. The same thing can be accomplished
when one is trading options rather than the underlying. This is done by rolling
one's position up or down strike prices depending on whether the trade is a
long using calls or short employing put options.
Here's a recent example from the author's own trading.
A long position in Seagate Technology (STX) was initiated when the stock was trading at around 21.50 using the March 22.50 call options. They were purchased for $0.80. The market rallied over the next few weeks, eventually moving up above $24. At that point, a roll-up was executed by selling the March 22.50 calls at $2.60 and purchasing the March 25 calls at $1.40. This action served two purposes. The first is that it took $1.20 off the table, reducing the portfolio exposure and freeing up cash for use elsewhere. It also locked in a profit of $0.40 ($2.60 sales price minus the $0.80 purchase price for the 22.50 calls minus the $1.40 purchase price for the new 25 calls). At the same time, it had no effect on the remaining upside potential for the trade. The two strikes would probably profit about the same from any further appreciation in the price of STX shares.
If the portfolio exposure was deemed acceptable at $2.60, an alternate course of action would have been to sell the March 22.50 calls and not take any money out, but rather roll it all in to the March 25 calls. For example, if the position was 10 options, selling the 22.50s would net $2600. That cash could have been used to purchase 18 of the 25 calls ($2600/$140 = 18.57). By doing so, one actually increases the upside potential for the trade substantially. Of course, the full position is at risk, meaning one could theoretically lose the whole $2600 invested, which is more than could have been lost when the trade was first initiated.
Here's a recent example from the author's own trading.
A long position in Seagate Technology (STX) was initiated when the stock was trading at around 21.50 using the March 22.50 call options. They were purchased for $0.80. The market rallied over the next few weeks, eventually moving up above $24. At that point, a roll-up was executed by selling the March 22.50 calls at $2.60 and purchasing the March 25 calls at $1.40. This action served two purposes. The first is that it took $1.20 off the table, reducing the portfolio exposure and freeing up cash for use elsewhere. It also locked in a profit of $0.40 ($2.60 sales price minus the $0.80 purchase price for the 22.50 calls minus the $1.40 purchase price for the new 25 calls). At the same time, it had no effect on the remaining upside potential for the trade. The two strikes would probably profit about the same from any further appreciation in the price of STX shares.
If the portfolio exposure was deemed acceptable at $2.60, an alternate course of action would have been to sell the March 22.50 calls and not take any money out, but rather roll it all in to the March 25 calls. For example, if the position was 10 options, selling the 22.50s would net $2600. That cash could have been used to purchase 18 of the 25 calls ($2600/$140 = 18.57). By doing so, one actually increases the upside potential for the trade substantially. Of course, the full position is at risk, meaning one could theoretically lose the whole $2600 invested, which is more than could have been lost when the trade was first initiated.
Roll Forward
One of the issues with options is the
limited duration they provide for holding trades. If one is an intermediate to
longer-term trader, this can be an important hurdle. That said, however, in a
manner similar to the roll up/down, if one wants to extend the holding period
of a position it can be done by rolling forward the expiration month.
Continuing with the STX example, we can look at rolling forward. That would be accomplished by going from the March contract to the June one. As of this writing, the March 25s are trading at $2.40 and the June 25s are at $3.60. There's the rub, though. Because of the longer time to expiration, the June contract is priced significantly higher. That is why a roll forward is often best accomplished with a roll up/down.
Consider the earlier roll-up in STX from the 22.50 call to the 25 call. If we were still in the former, and wanted to both roll forward and up, we could jump to the June 25 call. The current price on the 22.50 option is $4.10. With the June 25 at $3.60, we could accomplish both the roll up and roll forward and take $0.50 off the table. That is not quite as much as we accomplished with the roll up, but it does extend the time we could hold the position by three months. Whether that is worth the trade-off depends on the anticipated holding period for the trade.
The rolling of strike prices and expiration is something easily accomplished. The transaction costs for options trades have come down substantially for the individual trader in recent years. That opens up a great many possibilities for playing the market directionally and managing positions efficiently.
Continuing with the STX example, we can look at rolling forward. That would be accomplished by going from the March contract to the June one. As of this writing, the March 25s are trading at $2.40 and the June 25s are at $3.60. There's the rub, though. Because of the longer time to expiration, the June contract is priced significantly higher. That is why a roll forward is often best accomplished with a roll up/down.
Consider the earlier roll-up in STX from the 22.50 call to the 25 call. If we were still in the former, and wanted to both roll forward and up, we could jump to the June 25 call. The current price on the 22.50 option is $4.10. With the June 25 at $3.60, we could accomplish both the roll up and roll forward and take $0.50 off the table. That is not quite as much as we accomplished with the roll up, but it does extend the time we could hold the position by three months. Whether that is worth the trade-off depends on the anticipated holding period for the trade.
The rolling of strike prices and expiration is something easily accomplished. The transaction costs for options trades have come down substantially for the individual trader in recent years. That opens up a great many possibilities for playing the market directionally and managing positions efficiently.
Money Management
There are some common mistakes I’ve seen traders make in the area of money management. First, let’s understand what money management is all about.
Money management overlaps with risk, trade, business, and personal management, yet it has many aspects that make it unique, distinctly different from all of the other areas of management. In this chapter we want to examine some areas of money management that seem to involve mental quirks leading to costly mistakes.
LISTENING TO OPINION
Kim has entered a short position in crude oil after carefully studying as many factors as she could reasonably include while making her decision to trade. She has entered the trade because her study of the underlying fundamentals has her convinced that crude oil prices must soon begin to fall. Then Kim turns on her television set and begins to watch one of the financial news stations. An “expert” in crude oil is being interviewed. He begins to talk about how crude oil inventories are almost certain to drop this year because oil companies are not doing as much exploration as they have in previous years. Kim listens intently to what he has to say and then begins to doubt her decision about the trade she has entered. The more she thinks about it, the more panicky she becomes. She considers abandoning her position even though she will end up with a loss. The fact that an “expert” has decided something else completely shakes her confidence. She exits the trade intraday and takes a $400 loss. Prices have not come near her protective stop, which was $700 away from her entry. The market never moves sufficiently far to have taken out her stop. By the end of the day, her crude oil futures have made a new high, and in the following days explodes into a genuine bull market. Instead of a magnificent win, Kim has a loss. The loss is more than money, she has lost confidence in herself.
What should be done?
You should set your own trading guidelines and trade what you see. Forget about opinion, your own and especially that of others. Unless you are one of a very rare breed whose opinions are sufficiently good for trading, do not trade on them.
Make an evaluation based on the facts you have and then go with the trade. Just be sure you have a strategy for extricating yourself before losses become big. Had Kim stayed with her original strategy and stop placement, she would have ended up a happy winner instead of a regretful loser.
TAKING TOO BIG A BITE
Biting off more than can be chewed is a weakness of many traders. This form of over trading derives from greed and failing to have clearly defined trading objectives. Trading only to “make money” is not sufficient.
Pete has sold short T-Bonds and is now ahead by a full point. He notes that he is making money on his trade. Feeling very confident and thinking it would be smart to be diversified, he enters a long position in silver futures, and also sells short Call options of wheat which he is sure is headed down. Almost as soon he is in the market, wheat prices explode upward and his Calls are in trouble. Pete buys back the losing short Calls and sells additional Calls on a two-for-one basis at a higher strike price. At the end of the day he looks at other positions. Silver had an intraday reversal leaving a spiked bottom as they close at the high of the day. The T-Bonds have made an inside day, but to Pete they suddenly look weak, he is down a few ticks. At the end of the day, he finds that most of the money he had made on his short T-Bonds was used to buy back the short wheat Call options. He covered those and now has additional premium in his account, but he also has additional risk, and is short Calls in a rising market – not an enviable position. Moreover, he is now worried about his long silver futures based on the fact that silver closed at its lows on what seems to be a genuine reversal. To further aggravate the situation, he has lost confidence in himself. What was once a happy, simple, winning silver long, has now become an ugly, confusing mess, and Pete has a good chance of ending up a loser on all three trades. If Pete keeps over-trading in this fashion, he could end up like the poor fellow in the picture.
What should be done?
Break every trade into definitive goals. Make sure you achieve those goals before adding other positions. Even with a single short sale of the T-Bonds, Pete could have set himself a goal for the trade. One or two full points might have been all he needed to satisfactorily retire that trade as a winner. Then he could have made his trading decision for an additional position. There are very few traders who can successfully manage multiple positions in a variety of markets.
OVERCONFIDENCE
Overconfidence is a particular kind of trap that springs shut when people have or think they have special information or personal experience, no matter how limited. That's why small traders get hurt trading on no more information than “hot-tips.”
Tim is a farmer. He raises hogs and purchases huge amounts of feed to provide for his hogs. Tim has a large farming operation which is quite profitable. He takes 250 hogs a week to market. Because of a steady flow of hogs from his operation to the market, Tim has no need to hedge his hog business because he is able to dollar average the prices he gets for them. But Tim does want to indirectly reduce the cost of the feed he has to buy, so he purchases soy meal futures. Tim listens to weather and farm reports all day long. He attends meetings of other farmers, and tries to gather all the information he can that might help him be more profitable. But Tim has a major problem, called tunnel vision. When he looks out at the grain fields in the area where he lives, whatever he sees there he extrapolates to the whole world.
In other words, if Tim sees that the surrounding fields are dry, he suspects that all fields everywhere must also be dry. One year Tim witnessed a local drought. He checked with all the local farmers and they said they were truly experiencing drought conditions. He looked at the news on his data feed, and sure enough it said that there was a drought in his area. In fact, the entire state where Tim raises his hogs was undergoing drought.
Tim wasn’t too concerned about his own feed bins. He had plenty of it in his silos from previous bumper crop years. Tim decided to be piggish and speculate on what he considered to be inside information. He called his broker and bought heavily into soy meal futures. Tim was confident. He was sure that soy meal prices would explode upward some time soon, and that he was going to make himself a small fortune. Tim's greed may have turned him into a hog. However, the futures he purchased started moving down and the value of his investment began to shrink markedly. What Tim failed to do was to have a broader perspective. Everywhere else that grains were grown, farmers were experiencing rain in due season. The drought was localized almost entirely within the state in which Tim did his hog raising. Tim lost because he was confident in the limited knowledge he had.
What should be done?
We all need to broaden our horizons. We need a humble attitude relative to the markets. We can never afford to wallow in overconfidence in what we perceive as special knowledge. A trader can never afford to let his guard down. Tim thought he knew something that others hadn’t yet caught onto. In so doing, Tim made another mistake as well. He heard only what he wanted to hear.
HEARING WHAT YOU WANT TO HEAR – SEEING WHAT YOU WANT TO SEE
Marketers call this preferential bias. Preferential bias exists among traders. Once they develop a preference for a trade, they often distort additional information to support their view. This is why an otherwise conscientious trader may choose to ignore what the market is really doing. We've seen traders convince themselves that a market was going up when, in fact, it was in an established downtrend. We’ve seen traders poll their friends and brokers until they obtained an opinion that agreed with their own, and then enter a trade based upon that opinion.
A student of ours, Fran and her husband, John, decided they wanted to go to live in the Missouri Ozarks. Everyone told them that there was no way for them to make a living there.
Everyone they asked
advised them not to do it.
Finally, a minister in the Church they proposed to attend told them that they were to serve there. Out of twenty or thirty people they asked, that minister was the only one who told them to come. Of course, it was exactly what they wanted to hear. They sold their home and most of their possessions accumulated over a lifetime. They moved to the Ozarks and went broke within a year. They had to leave and begin all over again. John, who had been semi-retired, now had to find a job. So did Fran. She had to give up a promising start as a trader to go out to put food on the table.
What should be done?
Look at each trade objectively. Do not allow yourself to become married to your opinion. Learn to recognize the difference between what you see, what you feel, and what you think. Then, throw out what you think. Lock out the input of others once you have made up your mind. Don't let your broker tell you what you want to hear. Never ask your broker, your friends, or your relatives for an opinion. Turn off your TV or radio, you don't need to see or hear what they have to say. Take all indicators off your chart and just look at the price bars. If you still see a trade there, then go for it.
FEARING LOSSES
There is a huge difference between being risk averse and fearing losses. You must hate to lose. In fact, you can program your brain to find ways to not lose. But not losing is a logical thought-out process, rather than an emotion-based reaction.
Two human-based tendencies come into play. The first is the sunk-cost fallacy and the second is the exaggerated-loss syndrome.
Sunk-cost fallacy: You are in a trade that begins to go against you. You reason that you have already spent a commission, so you have costs to make up for. Moreover, you have spent time and effort researching and planning this trade. You reckon that time and effort as cost. You have waited for just such an opportunity and you are afraid that now that it has come you will have to miss this trade. The time spent waiting for opportunity is something you also count as cost. You don't want to waste all these costs, so you decide to give the trade a little more room. By the time you realize what you’ve done, the pain is almost overwhelming. Finally, you have to take your loss which is now much larger than it might have been. The size of the loss adds to your fear of ever losing again. The end result is brain lock and inability to pull the trigger on a trade.
Exaggerated-loss syndrome: You give the importance of losing on a trade two to three times the weight of winning on a trade. In your mind, losses have greater significance than wins. In reality, neither is more or less important than the other. In fact, wins do not have to be as numerous as losses as long as the wins are significantly larger in size than the losses. Of course, best is to have more wins than losses with the wins greater in size than the losses.
What should be done?
Evaluate your trades solely on their potential for future loss or gain. Ask yourself, “what do I stand to gain from this trade, and what do I stand to lose from this trade?” Think the matter through. “What is the worst thing that can happen to me if I take this trade, and do I have a plan and a strategy for extricating myself long before it happens?” “If I begin to lose, is there a way I can turn things around and come out a winner?” Learn to look at the costs of a trade as part of your business overhead. Try to have a mind set that you will not throw good money after bad. When you give a trade more room, you are doing just that – often throwing away money.
VALUING INVESTED MONEY MORE THAN WON MONEY
Traders have a tendency to be more careless with money they’ve won than with money they’ve invested. Just because you won money on good trades doesn’t mean you should gamble with that money. People are more willing to take chances with money they perceive as winnings as though it were found money. They forget that money is money. Valuing money depending on where it comes from can lead to unfortunate consequences for a trader. The tendency to take greater risk with money made from trades than with money invested as capital makes no sense. Yet traders will take risks with money won in the markets that they would never dream about with money from their savings account.
What should be done?
Wait awhile before placing at risk money won on trades. Keep your trading account at a constant level. Strip your winnings from your account and put them in a safe conservative place. The longer you hold on to money, the more likely you are to consider it your own.
FORGETTING ABOUT MARGIN INFLATION
Before the crash of 1987, S&P 500 stock index futures carried an exchange minimum margin of about $12,000 . Immediately after the crash, margins required by some brokers rose to $36,000 and higher.
A trader we know, called Willie, figured that if prices on an index he was short went down, he would continually add to his position whenever prices first pulled back and then broke out to new lows. The index he was trading became very volatile, and his broker raised margins to by 1/3rd. Willie was trading a small account, and when he tried to sell short additional contracts onto his already short position, his broker would not allow him to do so. Willie complained bitterly, but the broker was adamant in his refusal. The broker would not allow Willie to use unrealized paper profits to cover the additional margin required for adding on. He explained to Willie that to do so would in effect allow Willie to build a pyramid position and that was not going to be allowed by the broker's firm.
The mistake Willie was making was what some call the “money illusion.” Willie assumed that because his position was moving in his favor that he had more selling power and more margin. His broker quickly brought Willie face to face with reality. While some brokers may allow it, unrealized paper profits do not truly constitute additional funds that may be used for margin. Willie’s dream of fabulous profits from this trade were just that, a dream. Willie should be thankful that his broker did not allow him to get in trouble. Pyramiding with unearned paper profits is not the way to succeed as a futures trader.
What should be done?
You should realize that each so-called “add-on” to an open position is really a whole new position. Each add-on carries all new risk, and each add-on brings you closer to the add-on trade which will fail and become a loser. When planning a trade, be aware that if the market becomes volatile, margin requirements may go up, thereby defeating any strategy for adding on to your position. There is nothing wrong with building a position one leg at time as prices ascend or descend, but when volatility dictates an increase in margin requirements, beware of trying to add on and be aware that you may not be able to add on.
Option sellers can quickly get into similarly difficult positions. As they roll out to new strikes to defend a threatened short options position, they can find themselves not only facing the need for a larger position, but also facing increased margins in creating that larger position. They may discover that they no longer have sufficient margin to defend a particular position and thus have to eat a sizable loss.
MORE KEY MISTAKES
Throughout our courses we mention some key mistakes commonly made by traders. Here are a few more:
Error: Confusing trading with investing. Many traders justify taking trades because they think they have to keep their money working. While this may be true of money with which you invest, it is not at all true concerning money with which you speculate. Unless you own the underlying commodity, for instance, selling short is speculation, and speculation is not investment. Although it is possible, you generally do not invest in futures. A trader does not have to be concerned with making his money work for him. A trader’s concern is making a wise and timely speculation, keeping his losses small by being quick to get out, and maximizing profits by not staying in too long, i.e., to a point where he is giving back more than a small percent of what he has already gained.
Error: Copying other people’s trading strategies. A floor trader I know tells about the time he tried to copy the actions of one of the bigger, more experienced floor traders. While the floor trader won, my friend lost. Trading copycats rarely come out ahead. You may have a different set of goals than the person you are copying. You may not be able to mentally or emotionally tolerate the losses his strategy will encounter. You may not have the depth of trading capital the person you are copying has. This is why following a futures trading (not investing) advisory while at the same time not using your own good judgment seldom works in the long run. Some of the best traders have had advisories, but their subscribers usually fail. Trading futures is so personalized that it is almost impossible for two people to trade the same way.
Error: Ignoring the downside of a trade. Most traders, when entering a trade, look only at the money they think they will make by taking the trade. They rarely consider that the trade may go against them and that they could lose. The reality is that whenever someone buys a futures contract, someone else is selling that same futures contract. The buyer is convinced that the market will go up. The seller is convinced that the market has finished going up. If you look at your trades that way, you will become a more conservative and realistic trader.
Error: Expecting each trade to be the one that will make you rich. When we tell people that trading is speculative, they argue that they must trade because the next trade they take may be the one that will make them a ton of money. What people forget is that to be a winner, you can't wait for the big trade that comes along every now and then to make you rich. Even when it does come along, there is no guarantee that you will be in that particular trade. You will earn more and be able to keep more if you trade with objectives and are satisfied with regular small to medium size wins. A trader makes his money by getting his share of the day-to-day price action of the markets. That doesn't mean you have to trade every day. It means that when you do trade, be quick to get out if the trade doesn’t go your way within a period of time that you set beforehand. If the trade does go your way, protect it with a stop and hang on for the ride.
Error: Having profit expectations that are too high. The greatest disappointments come when expectations are unrealistically high. Many traders get into trouble by anticipating greater than reasonable profits from their trading. They will often get into a trade and, when it goes their way and they are winning, they will mentally start spending their winnings, and may even borrow against their anticipated winnings to take on additional risk. Reality is that you seldom make all of the money available in a trade. I cannot count the times that I had for the taking hundreds or thousands of dollars in unrealized paper profits only to see most of those profits melt away before I was able to or had the good sense to get out. One trader I know had $700 per contract profits in a short eurodollar trade. The next day his position literally imploded on news of a 50 basis point cut in interest rates. He was lucky to get out with $350 per contract. The money from trading often doesn’t come in as fast or as plentifully as you have expected or been led to believe, but the overhead costs of trading arrive right on schedule. False profit expectations have caused aspiring traders to leave their job before they were really successful. The same false hope causes them to lose the money of friends and family. False hope causes them to borrow against their home and other fixed assets. Too high expectations are dangerous to the well-being of every trader and those around him.
Error: Not reviewing your financial goals. Before you make a position trading decision, or before you begin a day of day trading, review your motives and your goals.
• Why are you trading today?
• Why are you taking this trade?
• How will it move your closer to your goals and objectives?
Error: Taking a trade because it seems like the right thing to do now. Some of the saddest calls we get come from traders who do not know how to manage a trade. By the time they call, they are deep in trouble. They have entered a trade because, in their opinion or someone else’s opinion, it was the right thing to do. They thought that following the dictates of opinion was shrewd. They haven’t planned the trade, and worse, they haven’t planned their actions in the event the trade went against them. Just because a market is hot and making a major move is no reason for you to enter a trade. Sometimes, when you don’t fully understand what is happening, the wisest choice is to do nothing at all. There will always be another trading opportunity. You do NOT have to trade.
Error: Taking too much risk. With all the warnings about risk contained in the forms with which you open your account, and with all the required warnings in books, magazines, and many other forms of literature you receive as a trader, why is it so hard to believe that trading carries with it a tremendous amount of risk? It’s as though you know on an intellectual basis that trading futures is risky, but you don’t really take it to heart and live it until you find yourself caught up in the sheer terror of a major losing trade. Greed drives traders to accept too much risk. They get into too many trades. They put their stop too far away. They trade with too little capital. We’re not advising you to avoid trading futures. What we’re saying is that you should embark on a sound, disciplined trading plan based on knowledge of the futures markets in which you trade, coupled with good common sense.
Forex Trade: Main Drawbacks of a Forex Trader
Why is it that very few traders succeed in the Forex trading environment while the grand majority of traders fail to achieve success? Although there is no hard answer to this question, there are a few things that will put you one step ahead and will definitely put the odds in your favor.
The main purpose of this article is to guide you through some important aspects of Forex trading. But in a different way, instead of telling you what to do or the best way to do it, it will tell you what to avoid. Sometimes it is better to identify the main drawbacks on a discipline and then isolate them so we have the best results at a certain level of development.
The search for the Holy Grail
Many traders spend years and years trying to find the
Holy Grail of trading. That magic indicator or set of indicators, only known by
a few traders, that will make them rich in a short period of time.
Fact: Well, there is no magic indicator, nor a set of indicators that will make anyone rich in a short period of time. The main reason of this is because market changes, every single moment is unique. Every Forex trading system will fail from time to time. Our work here is to find a Forex trading system that fits our personality as traders, otherwise the trader will find it hard to follow it.
Fact: Well, there is no magic indicator, nor a set of indicators that will make anyone rich in a short period of time. The main reason of this is because market changes, every single moment is unique. Every Forex trading system will fail from time to time. Our work here is to find a Forex trading system that fits our personality as traders, otherwise the trader will find it hard to follow it.
Looking for Easy Money
Unfortunately most traders are attracted to the Forex
market for this reason. Mainly because of the publicity showing or rather
trying to show how easy is to trade and make money in the Forex market.
Fact: Yes, it is very easy to trade, anyone can do it. It is as hard as one click. But the second part of it isn’t that easy. Making money or achieving consistent profitable results is hard. It requires lots of education, patience, discipline, commitment, and this list could go to infinite. In a few words, it is possible to have consistent profitable results, but definitely it is not easy.
Fact: Yes, it is very easy to trade, anyone can do it. It is as hard as one click. But the second part of it isn’t that easy. Making money or achieving consistent profitable results is hard. It requires lots of education, patience, discipline, commitment, and this list could go to infinite. In a few words, it is possible to have consistent profitable results, but definitely it is not easy.
Looking for Excitement
Some other traders are attracted to the Forex market or
any other financial market because they think it is exciting to be a trader.
Fact: Yes, it is very exciting to trade the Forex market. But if this is the main reason you are still trading the Forex market, sooner or later you will discover the most expensive adventure you have ever known. Do some thinking on it.
Fact: Yes, it is very exciting to trade the Forex market. But if this is the main reason you are still trading the Forex market, sooner or later you will discover the most expensive adventure you have ever known. Do some thinking on it.
Not Using Money Management
Most traders forget about this important aspect of
trading. They think they shouldn’t be using money management until they achieve
consistent profitable results. They totally forget about the risk side of
trading.
Fact: Money management allows your profits to increase geometrically, but also limits your risk on every single trade. Money management tells you how much to risk on each trade. Using money management is a must if you want to achieve your trading goals. By using money management you make sure you are going to be able to trade tomorrow, the next week, month and the following years.
Fact: Money management allows your profits to increase geometrically, but also limits your risk on every single trade. Money management tells you how much to risk on each trade. Using money management is a must if you want to achieve your trading goals. By using money management you make sure you are going to be able to trade tomorrow, the next week, month and the following years.
Not Being Psychology Tuned
This is one of the most underestimated subjects when it
comes to trading. One of the main principles of financial markets is that the
price of each instrument is based on the perception of each individual
participant “the crowd.” In other words the price of each instrument is
determined by the fear, greed, ego and hope of all traders.
Fact: Being aware of all psychological issues that affect the decisions made by traders will definitely put the odds in your favor
Fact: Being aware of all psychological issues that affect the decisions made by traders will definitely put the odds in your favor
Lack of Education
Education is the base of knowledge on every
discipline. As lawyers and doctors require several years of college until they
get their degree, Forex traders also require long years of study. It is better
to have someone experienced to guide you through your trading, since some
information could take you in the wrong path.
Fact: The market teaches us invaluable lessons on every single trade made. The process of education for a Forex trader could take for ever. That’s right, we never stop learning. We should be humble about the markets and our knowledge; otherwise the market will prove us wrong.
These are some of the most important barriers every trader faces when trying to trade successfully.
Trading successfully the Forex markets is no easy task, it requires a lot of hard work to do it right, but with the right education, you will put yourself closer to your trading goals.
Fact: The market teaches us invaluable lessons on every single trade made. The process of education for a Forex trader could take for ever. That’s right, we never stop learning. We should be humble about the markets and our knowledge; otherwise the market will prove us wrong.
These are some of the most important barriers every trader faces when trying to trade successfully.
Trading successfully the Forex markets is no easy task, it requires a lot of hard work to do it right, but with the right education, you will put yourself closer to your trading goals.
