Basic knowledge and Skills Useful for Forex Trading


Basic Skills for Forex Trading

Forex trading is a peculiar endeavor, where no single magic bullet type of solutions exist. Some methods for trading forex are better than others, but no perfect way exists. Some traders use ultra analytical methods, analyzing and measuring everything, while others use simple indicators and allow for a margin for error. The truth is, profitable trading needs to be based on loose, flexible rules and not on rigid rules and perfect discipline. Forex traders need to know basic arithmetic, how to handle and add negative and positive numbers, and how to multiply numbers. This can done with a calculator, there’s no need to do it all in the head. The goal is to be able to calculate risk margins, margin requirements, interest rate charges, and the value of a pip. Pip value is a function of the exchange rate itself, for any given currency pair. At the time of writing this article, in an account with 100:1 leverage, a EURUSD pip is worth $10, but a USDCAD pip is worth $7.8. So you need to know about these key differences, and how to measure your market exposure. A trader for example may decide to combine spot forex trading with binary options hedging, so as to make money in a directional trade, on a currency pair, while hedge the risk with a binary option, such as One Touch type of binary options. But the trader needs to know that EURUSD is more valuable than USDCAD in pip terms, in other words, a EURUSD trade would require a large binary option to hedge the risk.

Traders Need to Focus on Limiting Risks

Most traders lose money not because they fail to predict markets, but because they get out of winning trades too soon, and they stay in losing trades for far too long. There’s an old tip that says cut losses short and let profits run, but this is useless to modern traders. Because they have no way of knowing beforehand which trade will be a winner, and which will be a loser. Then there’s the brokerage industry which does a good job, facilitating trading and offering very good services to their clients. But they won’t help you much in dealing with risk. They offer stop loss orders and other contingent orders, which are useful and nice to have. But traders need to calculate where to place these stop loss orders, and avoid all the hype out there. There are many myths out there that you need to have very low risk-reward ratios, so as to risk $1 to make $2 or $3 of profit. It sounds very nice and romantic, but it doesn’t work in the real world. In the real world, market volatility is such, that the market will run through your stop loss very fast, and the only way to avoid this is to use larger stop loss size. In reality, you will see that most profitable trades require a stop loss of 300pips, and they make a profit of 150-400pips. That’s the way it is, in the real world. Traders can limit risks further, by applying imaginary stop loss orders, in the time domain. So apart from your real, large size stop loss, which may be 300 or 500 pips, you will have to use this imaginary time limit, this is something the forex industry doesn’t offer yet, but it’s a concept well known to floor stock traders and even more so to binary option traders. For every trade there is a natural time limit, past which the probability of success becomes zero. Or simply put, if a certain amount of hours, or days elapse, and an open trade has not made progress, the it’s very likely that this trade will become a loser, in the following hours, or days. And it’s wise to get out of this trade, even though its physical 300-500pip stop loss has not been triggered. More often than not, you will see that this method will allow you to get out of losing trades very early, while still at breakeven levels.

As far as classic stop loss orders go, you need to forget about fixed size stops, and consider the dynamic nature of the forex market. The Parabolic SAR (Stop and Reverse) indicator, is one tool you can use to help you find best levels for placing stops. Your stop needs to be where the red dots are. It works well on the daily chart too, and if combined with the time limit concept, it can save you many losing trades.

Other Important Tips

Traders need to realize that the trends in the forex market tend to be rather solid, perhaps more solid than those found in the stock market. The daily trend of EURUSD, or USDCAD or GBPUSD cannot change in any single day, no matter what the news or market factors are. Rather, the trend only changes after significant changes have already occurred. And this happens over many days. In practical terms, you can detect this through technical analysis, the market may breach some 200 period moving average, may form a flag pattern, or breach a channel formation. These are patterns that hint possible trend reversals. Just remember not to panic about what happens during a single trading session, the market can move in the opposite direction too much, only to come back tomorrow, and the daily trend will have not changed. Many traders, even highly experienced traders sometimes fall into this trap, and think that the market is always right, but in fact, the market is not always right. This is because market price can deviate from fair valuation, and this deviation can last several hours. The market is only right, on average, and on the daily chart, over many days, but in a single day it can be wrong.

Some Classic Tips are Wrong

Remember that some classic tips on financial trading are actually wrong, or at least incomplete. Such as the one on cutting losses short and letting profits run, it’s so incomplete and useless, that is not worth paying attention. Another classic tip that is called into question is that of always using stops. In today’s forex trading it is possible to fully hedge risk, on a spot forex trade, through 2-4 binary options. So that either the spot trade makes money, or it loses money, but all losses are offset 100% by the binaries. The only real cost in this case, is that a buffer (breakeven) zone is established, so the combination of all these trades, both binaries and one spot trade, will either make money, or you will get your money back. But to make money, the market has to move more than 100-150 pips. That’s the buffer or breakeven price range. Any movement less than that will not result in a profit. And that’s the price you pay for a fully hedged trade, as opposed to a naked spot trade where you make profit from the first pip. Hedging is interesting and slightly complicated, but it’s worth looking into. Because classic trading tips no longer apply to the market, especially when one is hedging their trades.

Another classic trading tip which is wrong, at least for the most part, is that of having discipline. Discipline sounds like a good habit to have, but in real life it has been proven that the more disciplined you are, and the tighter your plans are, the more likely you are to face something totally unexpected. And the disciplined type of people lack the initiative to think originally and take quick action. The profitability of wise traders is based on various skills, and little discipline. Discipline alone cannot win over markets, because total discipline is all about mechanical, rigid thought and trading, whereas markets are dynamic and slightly changing every day, they are not rigid. So remember to always question old tips and tricks, no matter where they come from.

Popular indicators, for the most part are useless too! Most classic indicators are useless, except powerful indicators such as LSS price pivots, and even that is not really an indicator of market direction but rather one of momentum. Indicators such as MACD, RSI and many more, have limited predictive power, so limited that may not be worth using them at all. Moreover, all these indicators and oscillators take a second place, since they all can be overridden by chart patterns. All chart patterns are more powerful than oscillators. So if you see a bullish flag on EURUSD, while also seeing a bearish MACD reading, the flag formation instantly overpowers the MACD. So you simply need to ignore the MACD reading and pay attention to the flag. Many other classic indicators are misleading and poor, and you will be better off without them. It has been found that these indicators work no better than a coin flip. People still use them because they always find few fitting signals, and out of their need to believe in them. As far as good trading is concerned, you don’t need to use much more than LSS pivots and Parabolic SAR.

Ignore All News!

News based forex trading is a trap. This is what proponents of day trading push for, and while day trading is actually possible, we are against news based day trading. In fact all news trading is wrong and fundamentally flawed. It’s not possible to predict market direction based on the news. The news can only help predict market volatility, and that’s about as useful as it can be. Beyond that, market price will always go where it’s prepared to go. It can go up on bad news days, and it can go down on good news days. It’s not possible to profit from the forex news, and traders attempting to do so end up losing all their money. But you can do better, and trade differently, just by ignoring the hype and using news only as a volatility indicator.

Crude oil is one interesting commodity, it’s a very technical market, and it trades almost completely inversely of USDCAD. So if you trade USDCAD you may find useful signals on the crude oil charts. Sometimes, it may be the other way around. But for the most part the energy market itself provides most clues, and finally impacts USDCAD as a result. So there is no need to watch the news on crude oil, on energy, or news on USDCAD. Simply by studying these charts you can figure out many more things. On the above chart the Parabolic SAR indicator is used, as a way to gauge possible reversals, the indicator is not very useful for identifying market direction as it can be wrong. Other tools, such as LSS pivots can help identify daily and weekly levels where momentum may be stopped or unleashed further. If you do decide to start trading with commodity currency pairs, then USDCAD is one of the best pairs you can choose. Another pair is AUDUSD, which tends to correlate to the price of Gold, not perfectly but for most of the time.

Commodities have something unique, in that they have limited supply and sure demand. In the longer term, it is possible to identify tops and bottoms in crude oil and gold, and trade the related currency pairs accordingly. We know for example that crude oil cannot fall much below $30, and even if does it won’t stay there for too long. This would ultimately put pressure on USDCAD and would result in a long term down trend in USDCAD. And you don’t need to watch the news to figure this out. We simply know that crude oil cannot be sustained at $30, the insurance costs alone for transporting a single barrel of oil is so high, that makes a $30 price unrealistic. And producing more oil means more risk for an oil spill accident, therefore insurance costs will go up. Crude oil is not some kind of product where more demand will simply drive prices lower to near zero, and in this case especially, we see $30 as a bottom price, which cannot even last too long. To the forex trader, a dip down to $30 in oil prices, means that USDCAD is topping out.