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Basic Forex Trading Guide : eTORO

About this guide If this is your first time coming across the online Forex market, then you’ve come to the right place. This guide will provide you with the basic knowledge, tools and techniques a novice Forex trader should have as you take your first steps in the fascinating world of Forex. Many of the trading concepts introduced here are explained in greater detail in later chapters of the guide. If you are unclear about any Forex term you come across here, be sure to refer to the glossary of terms Basic Forex Trading Guide.

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Coaching Yourself for Self-Control: Lesson From The Daily Trading Coach

Some good news this week: The Daily Trading Coach is now shipping from Amazon and a contract has already been signed for a Japanese language edition.

The book, unlike my first two, is explicitly structured as a self-help book for traders, focusing on 101 lessons for changing patterns of thought, emotion, and behavior. It also includes ideas for managing a trading business and using Excel to identify historical patterns in markets. My thanks to the many excellent trader/bloggers who contributed their original coaching ideas to the book.

Here is a segment from Lesson 53:

"Suppose someone hijacked your computer as you were trading and suddenly switched the screen from your markets other some other, random ones? Suppose your mouse was taken out of your control and clicked on trades that you didn't want? I guarantee, if that happened to you, you'd become very upset. You would not tolerate someone controlling your computer or your mouse. You would do everything in your power to regain control of your equipment. That has to become your attitude toward the hijacking of your mind [by negative thought patterns]."

Keeping cognitive journals, performing experiential exercises to challenge your self-talk, reframing automatic, negative thought patterns: there are many techniques for shifting how you perceive yourself and your markets.

Are your ways of thinking helping or hindering your performance? Are you actively framing and reframing your views of markets, or are impulses, needs, and fears hijacking the ways in which you think? My goal with the book is to provide tools that enable you to become your own coach and psychologist, so that you are controlling your trading--not the reverse.

Recognizing When You're Wrong In A Trade

Sometimes we're just wrong. We're interpreting price and indicator action one way and the market smacks us the other way. Key to trading survival is getting out of the trade quickly when it goes sour. Key to trading success is using the failed trade to revise your view and formulate new, promising trade ideas.

So let's look at Friday's market. No question about it, I was leaning the wrong way in the late morning as I watched the market between phone calls with traders. If you click on the top chart (ES, 3 minute), you'll see where the X's are that I was looking at a rounding bottom process. The TICK (middle chart) hit its low point between 10:00 AM and 10:30 AM CT, and by the time we approached that 11:00 AM period, it seemed that selling was drying up and we were making a higher low, just beneath the 20-period volume-weighted moving average.

So things were good on the long side: we moved smartly above that moving average, and TICK made a new high on the move between 11:00 and 11:30 AM. We should be able to take out those highs from between 9 and 9:30 AM and stay above our moving average if this idea is solid.

Well, look just one bar later at the bottom chart. We get vicious selling on twice the recent volume and greatly expanded volatility, propelling us below the moving average. What next?

The phrase that goes through my head at these times is "This shouldn't be happening." In other words, if we're picking up buying interest (rising TICK, staying above the moving average), there's no way we should get an influx of sellers and for the market to move down so readily in the face of selling pressure. Indeed, one of the things I liked about the long side was that the little market dip prior to 11:30 AM stayed above the moving average. The selling shortly thereafter ripped below that low and violated something I liked about the trade.

I've learned that the "This shouldn't be happening" thought running through my head is usually a good point to get out of a trade. Instead of gaining confidence in the idea, I'm losing it. I need to fight that "shouldn't be happening" feeling to rationalize staying in the trade. Those rationalizations are almost always losers.

Could it be a temporary whipsaw? It's possible, but what has a trader lost by getting scared out? If a good upmove is to follow, the trader can play an upside break of the 780 level (from which the selling started). By that time, the trader could be looking to test the AM highs and would still have a good risk/reward trade.

But when volume and volatility are going against your trade and violating your levels, more often than not, you want to acknowledge that the market proved your idea wrong and then try to learn from that. Learning to make friends with being wrong is key to long-term success.

Indeed, exiting the long trade with an open mind would prove helpful several bars later, when the downside volume and volatility continued and thrust us below the morning lows in a breakout move. And even if you did not catch that breakout, there was plenty of time to see that bounces were feeble and make money on the downside. But only if you first were able to exit your trade, accept being wrong, and use the trade as information for the next one.

Let's see if some intraday Twitter posts can identify, not only some market ideas, but some points where those ideas prove wrong. Those, we see, can also be times of opportunity. The intraday market posts via Twitter will appear on the blog page under "Twitter Trader" (last five tweets), or you can subscribe to the posts free of charge via RSS.

Learning When to Not Trade

The previous post emphasized managing the psychological risks of trading as a key challenge for those learning to trade. An astute reader commented on the post, noting that limiting daily losses and taking time outs are important trading practices.

I could not agree more heartily. Many times traders press too hard to make money, leading to overtrading. Instead of trading for logical reasons (their edge), they trade for psychological reasons. That trader with the 55% win rate suddenly becomes a trader with a 45% win rate when overtrading. Without limits on daily losses and a process for taking a time out, that trader can blow up in a short amount of time.

The other reason it's important to limit daily losses and take those times away from trading is that markets themselves go through shifts. Adapting to changing market conditions is a challenge even for the most experienced and successful traders. When hedge funds and CTAs experienced redemptions from investors, their trading patterns changed; that has made 2009 a very different environment from 2008 across a range of markets. Similarly, when computerized trading began to dominate market making, many of the profitable ways of scalping markets dried up.

Because market conditions change periodically, one's edge in trading is never fixed. We go through periods of greater or lesser edge. For that reason, a central skill to long-term success is recognizing when your edge is eroding and pulling back from risk taking.

I saw this first hand at proprietary trading firms during the low volatility markets of 2005 and 2006. Traders who did not adapt to those conditions and reduce their profit expectations (per trade, as well as per week and per year) fought the slow, choppy markets and did not last to see far better conditions in late 2007 and 2008. Similarly, many daytraders who raked in money during the tech boom of the late 1990s did not pull in their horns after early 2000 and lost their money and their trading careers.

The takeaway message is that successful traders are always students of markets, always learning, and always adapting. They have periods of feast and famine, and they learn to keep themselves afloat during the lean times so that they can participate when things get better. In that context, learning when to not trade is a crucial component of trading success.

Learning How to Trade: Managing the Psychological Risks

A couple of years ago, I posted an article (now available as a PDF) on managing the psychological risks of trading. I encourage you to review that article; it offers an important perspective for those learning how to trade.

The financial risks of trading are fairly well known: If we size positions too large or incur too many runs of losing trades, our capital will become depleted. Lose half your money and suddenly you have to double your remaining capital just to return to breakeven. If you trade every day and average 55% winning trades, you'll incur runs of four consecutive losing trades roughly every month. Size those trades too large and you'll be looking for a new vocation or avocation.

(Another article in PDF worth reviewing is Henry Carstens' Introduction to Testing Trading Ideas. Even if you're a discretionary trader, knowing your typical win ratio, average loss size, average drawdown, etc. helps you gauge your financial risks).

When you are learning to trade, those financial risks turn into psychological ones quite quickly. We might have a 55% win ratio, but we don't know how that 55% will be distributed over time. Consider Henry's P/L forecaster illustrated above. We have a small trader with a $33,000 account who has an average win equal to their average loss ($1000 per week after commissions) and a 55% winning percentage. The above chart shows one possible path for their two-year (100 week) P/L.

Overall, the trader is quite successful. The two-year return on capital is 33%, enough to support a career in the portfolio management world. But note that the first 15 weeks are spent in the red. Moreover, there is a drawdown late in the period in which nearly one-third of profits are lost. These adverse events--entirely expectable and having nothing to do with altered or poor trading--create many of the psychological risks of trading.

Most new traders, facing 15 weeks in the red, will change what they do, abandoning profitable trading methods. Many more, facing a profit drawdown, will shut down or change their methods, again drifting from their strengths. The resilient trader learns to expect these setbacks as a normal part of doing business. No matter how good you are--and I work with some very good traders--you will have extended periods in the red. The psychological risk for those learning to trade is not that you'll lose your money--proper position sizing and risk management can prevent that-- but that you'll lose your nerve. Just because you have an edge doesn't mean it won't feel at times like you're on the ledge.

Catching the Breakout Trade: Recognizing Rejection of a Key Price Level

Here we see today's S&P 500 e-mini (ES) futures market (blue line) plotted against the day's volume-weighted average price (VWAP; pink line) and the previous day's support level drawn in red.

Notice that we traded around that resistance level for much of the morning in a range trade, but could not sustain rallies above VWAP and largely remained below the day's opening price.

As noted in the Twitter post just prior to the noon CT hour, selling picked up along with volume and volatility, as we rejected both the resistance level and the current VWAP as an estimate of value. This breakout from the morning's range led to a significant downmove that took us near the S2 support level.

Differentiating moves with normal volume and volatility that meander around an average price from moves away from that price that are accompanied by expanding volume and volatility is key to recognizing breakout trades.

Tells that I did not emphasize in my Twitter posts that deserved greater attention were the inability of the market to trade above its opening price and the consequent downward slope of VWAP. Even with extensive preparation, there are always things we miss; things we need to work on. That's one of the things that keeps the trading game endlessly challenging.
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Morning Preparation for Trading

One of the most valuable trading practices, I've found, takes place before markets actually open. It's the practice of framing "what-if" scenarios for the day, so that you're prepared to act when your market hits crucial price levels. Note that I emphasize scenarios in the plural; the idea is to be prepared for a variety of situations, not to get locked into any single one. The goal is to promote mental and behavioral flexibility, not to pull out a crystal ball that will entice your confirmation bias.

A trader I work with called me yesterday and shared how he profited nicely from the Fed announcement. I was initially surprised, because--going into the announcement--he was leaning the wrong way. He had played out the scenarios in his head, however, and was prepared for an announcement that the Fed would be buying Treasuries. Very shortly after the news came out, he flipped his positions and, from that point forward, made a very nice profit.

The combination of an open mind and an ability to quickly and decisively act upon fresh developments is something I've found in successful traders. Much underperformance comes from the inability to keep the mind open and the inability to be decisive when markets shift.

Above we see a snapshot of an hourly chart of the ES futures just before 7 AM CT. Recall from my Twitter posting yesterday afternoon that 778 was important intraday support. An attempted rally from that point failed late in the day, and we moved lower. Observe also that this support area roughly corresponds to the level at which we launched the upmove following the Fed announcement.

During pre-opening trade, we have moved smartly above that 778 level (blue line), placing us back in the prior day's range. (Green line is 20-period volume-weighted moving average). I am going to be watching that level closely in early trading. If early selling cannot take us below 778, I'm going to expect a bounce well into the previous day's range, with the day's pivot as an initial target. I'll be watching the distribution of NYSE TICK and the advance-decline ratio ($ADD) for confirmation that buyers have the upper hand before committing to the long side.

Conversely, should we fail to hold 778 and we see distinct signs of weakness among those indicators, I'll be thinking about selling bounces for a move toward S1. Should we see weak volume and choppy trade on this expiration Friday, I'll be thinking range market and will look to fade moves away from VWAP and the market open. Most of all, I'll chill in the early minutes of the morning trade to let the market tell me what it's doing.

Going back to the Twitter posts, I have the profit targets set (see 6:30 AM tweet) and written down in front of me; I have the lines drawn on my chart; and I have scenarios laid out. All well before an hour is left before the open, when I can relax, exercise, scope out correlated markets, and update my views.

Whether in sports or trading, so much of the game is won before the initial tipoff, kickoff, or faceoff. Preparation is a powerful psychological tool, because it primes us to act on our perceptions.

Do you have what it takes to become a successful Forex Trader?

Forex trading, or any trading for that matter, is an occupation that requires experience and the accumulation of proficiency not unlike any other highly skilled profession. Whether you are a leading executive at a major publically traded company, a professional golfer or trading from your kitchen table, there are 5 key ingredients that one must possess in order to become successful.

1. You must be Passionate about what you do.

As Forex traders we all face one unique set of circumstances that does not exist in any other profession. We get rewarded for when we succeed and equally punished when we don’t! Could you image a corporate worker one quarter receiving a significant accomplishment bonus and the next quarter actually getting money taken from their paycheck for missing performance targets? Not on your life!

We do as Forex traders and that is why passion for what you do will carry you through the tough times that are part of your trading business. Asked yourself why you trade currencies and would you still do it if Forex were not potentially lucrative? Your answers will be quite revealing. You’ve got to feel your passion for trading!

2. You have to Apply Yourself and work hard at it.

I talk to so many people that enter into Forex trading with the aspiration of getting rich quick. Without putting the time and energy into really getting good at trading I see them jump from strategy to strategy looking for the goose that will lay the golden egg and eventually quitting while blaming everything else, except the true cause.

I got news for you – you are the goose and your Forex education is the golden egg. The magic has always resided with the magician and not some strategy. Work hard at trading and the rewards will eventually come your way. Remember what Tiger Woods said, “Funny, the harder I work the luckier I get.” Apply yourself as a trader and it will be no accident when your account begins to blossom.

3. You must Focus to really get good at what you do.

Now here is the hurdle most Forex traders struggle to get over. You have the passion and you are applying yourself to your trade, now focus and really get good at just at what you are doing. Be the expert to the experts at just that one thing. Become the master of a strategy or risk management methodologies. Really focus on getting good at it.

Stop jumping around or getting pulled from the last “latest and greatest” into the next “latest and greatest” and focus on one aspect of Forex trading and know it inside out. Know it strengths and weakness. Set your sights on becoming expert on just one aspect of trading and watch it spill over in all other aspects for your currency trading. This is the time to fail forward fast, use every setback as a learning opportunity that will propel you 3-steps ahead!

4. You must Push Yourself beyond the point everyone else might have quite.

In Forex Trading this is simple. Assume there is someone on the other side of your trade that is pushing themselves and sharpening their edge. To be successful you must you must do the same thing. Now is the time to examine your mental edge. Do you know the single most critical factor in any currency trade? It is you, the trader! Sharpening you mental edge is the most difficult aspect of trading, but also the most rewarding.

Start with your Forex education and gain the self-awareness necessary to maximize your strengths and suppress your weaknesses. Any expert will tell you that trading is 80% mental. It’s time to sharpen your trading to the razor’s edge and you do this through Forex education. A constant and never ending process that will become the cornerstone of your Forex experience.

5. You must, without wavering, be Determined and Persist to your objective.

You will fail. I can state that emphatically. However, you will not be defeated unless you allow your failures to control your trading. It is the old adage; failure is not falling of your horse, failure is refusing to get back on. Your success depends on your ability to dismiss the criticism, rejection, self-doubt and pressures associated with Forex trading.

Defining what is a winning trade, losing trade and bad trade will go a long way into developing you as a successful trader. Without the determination and persistence in all aspects of your trading life, obstacle will definitely appear closer and larger than they actually are.

Take a moment and assess yourself and your trading. Do you have the key elements to succeed? Which areas are presents development opportunities? When conducting a self-evaluation it is critical to be totally upfront and honest with yourself. After all, you will only be dishonest with yourself. One of the most interesting observations you can make is that all key success factors are interwoven. One factor supports the other. This is why your Forex education is a continuous journey of forex strategy, money management and self-mastery. Set these factors as your Forex education goals and take your currency trading to new heights.

Happy Trading!!

Identification of Foreign Exchange Exposures

Foreign exchange exposures arise from many different activities. A traveller going to visit another country has the risk that if that country's currency appreciates against their own their trip will be more expensive.An exporter who sells its product in foreign currency has the risk that if the value of that foreign currency falls then the revenues in the exporter's home currency will be lower.An importer who buys goods priced in foreign currency has the risk that the foreign currency will appreciate thereby making the local currency cost greater than expected.Fund Managers and companies who own foreign assets are exposed to falls in the currencies where they own the assets. This is because if they were to sell (repatriate) those assets their exchange rate would have a negative effect on the home currency value.Other foreign exchange exposures are less obvious and relate to the exporting and importing in ones local currency but where the negotiated price is being effected by exchange rate movements.Generally the aim of foreign exchange risk management is to stabilise the cash flows and reduce uncertainty from financial forecasts. Fortunately there are a range of hedging instruments that achieve exactly that.

Forex Currency

The ratio calculated of one currency with respect to the other currency is termed as foreign currency. For example, let's take the process and perspectives of currency trading occurring at inter bank levels. Say that the bank A inquires regarding the price of the particular currency from Bank B. In response the Bank B will state the quote of the currency and also specify the bank's standing state. If the quote is acceptable to Bank A, then both the banks would enter into an agreement. In the same process, the other details like the purchased amount, amount and the price will also be revealed. Thus, after the terms and conditions are specified, the settlement takes place. The bank A releases the specific amount of rupees which are thereby converted to the respective dollar amount by the Bank B. In this process of forex trading, if the value of rupees increases in the forex trading, the Bank makes the profit.In forex trading, 2 way quotes are given by the currency traders. The two quotes are basically the rate at which the currency will be purchased and the respective value on which the currency will be sold. These two respective quoted prices are differentiated through the incorporation of hyphen. The price mentioned on the left is the amount on which the forex trader will buy the quotes of the currency and accordingly, the price mentioned on the right side is the price at which the trader has to sell the currency. The spread, basically the bid and ask one specifies the difference between the two quotes which will be applicable for the forex traders. But at the same time, the traders do anticipate a bit of changes in the values of the purchase and the sale rates. Similarly, the trader also sells the purchased currency quote at the determined value, with a slight margin added in the deal. Thus this margin creates the profit or loss for the trader.The profit which is earned by the forex trader depends on size, position and respective variations in the rates of exchange. Moreover, there are other strict and mandatory rules implemented by the government because of which long time speculations of the forex market can be prevented, thereby reducing the occurrence of the money embezzlement.The forex currency trading systems are of below mentioned types:Crossbow Swiss system of trading: This trading system encourages the advent of traders into the long on dips and selling the short ones so that the craved profits can be attained in spite of not returning the distinct open profits made. This particular system is meant for grabbing the sudden investment and intermediate swings.The Piranaha system: This system is strictly focused on the current interest rates. Due to this system, the forex traders can predict whether they should invest in short or in long. The main fundamental of this trading is that the entry and the exit should be very smooth.

Forex Overview

What is Forex? Forex is an abbreviation of Foreign Exchange (also referred to as FX) and it is the largest financial market in the world. The Forex market is the place where currencies are traded (currencies are money that is used as an exchange medium). In other words, it is the place where currencies are being sold and bought. In the Forex market all currencies are traded in real time. Trading with currencies always means that there are two simultaneous transactions taking place. If a currency is being bought, it is also being sold. To better understand this notion, think of currencies as both the goods you are buying AND the method with which you're paying for the goods. Since the Forex market is the place where currencies are traded in real time, people may trade one currency for another and make a profit off of this transaction. Profits are made when one is able to determine which currency's value will increase by the end of a pre-determined time period (such time periods may be short or long). The Forex market is open 24 hours a day, five days a week and it is based in four major cities: New York, London, Sydney, and Tokyo. The Forex market is open to individuals over the age of eighteen. While Forex trading may sound daunting, it really isn’t. It can be easily comprehended and understood without prior experience in finance or economy. It is challenging and exciting, thought provoking and manageable, stimulating and filled with opportunities. Some Forex Basics: The first currency listed in a currency pair is called the "base currency". The “base currency” is usually the U.S. Dollar. Traders will generally trade the U.S. Dollar against another currency, which is called the “counter currency”. Currencies are quoted in pairs. For example: The pair U.S. Dollar and JPY will be quoted in the following way: USD/JPY equals to 2.5 (This means that 1 U.S. Dollar can buy 2.5 JPY). When a quote increases, it means that the “base currency” has risen in value and the “counter currency” has weakened in value. For example: If the USD/JPY quote used to be equal to 2.5 but is now equal to 2.6, then this means that the dollar has strengthened (because 1 U.S. Dollar can now buy 2.6 JPY as opposed to the mere 2.5 JPY it could buy beforehand.) Now that you know a thing or two about the Foreign Exchange market, we invite you to explore eToro—the Revolutionary Forex Trading Platform. You too can make your mark in the Foreign Exchange market. Use eToro as your gateway to the ever-growing world of Forex trading.