Forex Trading Secrets: Trading Strategies for the Forex Market

FOREX TRADING SECRETS

TRADING STRATEGIES

FOR THE FOREX MARKET

JAMES DICKS

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.

ISBN: 978-0-07-174709-7

MHID: 0-07-174709-5

The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-166422-6, MHID: 0-07-166422-X.

All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefit of the trademark owner, with no intention of infringement of the trademark. Where such designations appear in this book, they have been printed with initial caps.

McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. To contact a representative please e-mail us at bulksales@mcgraw-hill.com.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

—From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers.

TERMS OF USE

This is a copyrighted work and The McGraw-Hill Companies, Inc. (McGraw-Hill) and its licensors reserve all rights in and to the work. Use of this work is subject to these terms. Except as permitted under the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may not decompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon, transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGraw-Hill’s prior consent. You may use the work for your own noncommercial and personal use; any other use of the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply with these terms.

THE WORK IS PROVIDED AS IS. McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OF OR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE, AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. McGraw-Hill and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted or error free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom. McGraw-Hill has no responsibility for the content of any information accessed through the work. Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise.

To be successful you have to have a mentor. Someone who can inspire you, someone that will listen to you, someone that will give you sound advice whether you want to hear it or not. If you don’t have a mentor, that someone to help you get to the top, then keep looking. For me it’s My Uncle Jack. I know there were many times that he felt I was not listening but I always was. Thanks for everything you do, this book is dedicated you.

Contents

Preface

Acknowledgments

Disclaimer

Introduction

Part 1 The Basics

1 What You Must Know to Get Started

Back to the Basics: A History of the FOREX

FOREX versus Stocks

FOREX versus Futures

2 Major Currencies and Pairs

The U.S. Dollar

The Euro

The Australian Dollar

The Canadian Dollar

The British Pound

The Swiss Franc

The Japanese Yen

The New Zealand Dollar

The Dollar Index

The Dow Jones Industrial Average (DJIA)

Gold CFDs

Crude Oil

Cross-Rate Currency Pairs

Exotic Currency Pairs

Chinese Yuan or Renminbi

Swedish Krona

Norwegian Krone

The Iraqi Dinar

3 Anyone Can Learn the FOREX

FOREX 101

Opening a Position

Trading on Margin

Managing a Position

Closing a Position

Pips and Lots

The Lot

Order Types

Where Is the Market Going?

Stops and Targets

Spreads and Swaps

Technical versus Fundamental

4 Preparing Yourself Adequately before Jumping into the Market

FOREX Trading Accounts

Choosing a Broker

Tools

Who Trades the FOREX?

What Kind of Trader Am I?

Trading Techniques

The Trader’s Levels of Ascension

Part 2 Money Management

5 The Secret to Making Money

Are You Really Fit to Trade in the FOREX Market?

Trading Plans

Rules and Discipline

How the Market Works

Rules for Working with the Market

Paper Trading

6 How to Keep Your Profits

Money Management

Managing Risk

Leverage and True Leverage

Overtrading and Overconfidence

Overleveraging

Trade Expectations

Part 3 Trading Psychology

7 Mastering Emotions

Trading Psychology

Emotions of Trading

How to Get Out of a Bad Trade

Become a Pro

8 Mind over Matter for Huge Profits

Affirmations

Power of Networking

Part 4 Fundamental Analysis

9 Economics

What Does Economic Release Mean?

Fundamental Analysis

Dow Theory

Fundamental Indicators

Japan’s Monetary Policy

FOREX Currency Carry Trade

Interventions

Gross Domestic Product (GDP)

Trading the News

What Are Contrarian Indicators?

Part 5 Technical Analysis

10 Technical Indicators

Technical Analysis

Types of Charts Showing Price Action

Trend Indicators

Market and Volatility Indicators

Understanding Oscillators

A Unique Indicator: Ichimoku Kinko Hyo

Divergences

11 Technical Patterns

Candlesticks

Chartism Patterns

Reversal Patterns

Continuation Patterns

Elliott Waves

Harmonic Price Patterns

Fractals

Trading Naked (Only Price Action)

12 Support and Resistance

Support

Resistance

Trendlines

Moving Average

Other Indicators

Entering Positions

Exiting Positions

Pivot Points: Do They Work?

Psychological Levels

Using Multiple Time Frames

Trend Is Your Friend

13 Automated Trading

Expert Advisors and Automatic Programming Interfaces (APIs)

Advanced Robots: Neural Networks in the FOREX

Part 6 Building Your Portfolio

14 Secrets to FOREX Diversification

FOREX Options

Spot FOREX Options

FOREX Futures

FOREX Exchange-Traded Funds (ETFs)

Contracts for Difference (CFDs)

Commodities

Indices (Securities)

15 My Favorite Ways to Trade

Breakouts

Channeling

Hedging

Basic Oscillator-Based Strategy

Basic Moving-Average Crosses

Trading Gaps

Daily High-Low

CONCLUSION

APPENDIX

GLOSSARY

BIBLIOGRAPHY

INDEX

Preface

There are many books on the market that cover the subject of FOREX trading. But I believe that until now, there has never been a book on this unique topic that has so vividly described the subject of the FOREX—a universe completely of its own. The FOREX market is an anonymous entity that bears many faces, and each individual who participates in it leaves a footprint that just might change the course of their personal circumstances based on their individual hopes and dreams for success.

This book was written with several purposes in mind. First of all, this book is designed to inform and educate the potential FOREX trader about a field that is growing exponentially around the world and is reaching millions of individuals from all walks of life. It is a market that was reserved for a select few just a decade ago but now is in the hands of anyone, even those without a formal financial education. For this reason, it is very important to include a qualified point of view from a real trader’s perspective, a trader who has already traveled through all the steps and experienced numerous pitfalls but now wants to share this information with you to help you avoid or, at the very least, minimize any potential negative impact through education and solid money management techniques.

This book also is intended to provide an overview of all the fundamentals involved in the FOREX and of the trading process so that any new trader can easily obtain all the tools needed to ensure a quick start. It is also aimed at the intermediate trader who has already started the process but could use some guidance and additional tools, with an emphasis on the importance of a solid money management program and the right mind-set to develop a successful trading career.

Written from the insider’s perspective of an experienced FOREX trader who has gone through every step until reaching a stable and consistent success, this book is focused on pointing out the potential hazards that every trader will encounter at some point. In the beginning, it will offer solutions to help you understand how to mitigate many of the risks involved by centering on dedicated attention to the preliminary preparation, education, and training needed to become a true professional in this field.

The overview includes a history of the FOREX and its basics, as well as a thorough description of all the fundamental, technical, and psychological aspects and how they merge and interact in the market’s behavior.

Finally, some of the preferred trading systems are described in detail and discussed as additional elements to help you practice and build your trading toolbox.

I hope that you will enjoy this book and its concepts. May it bring you a step closer to becoming a consistent winner and an educated and confident FOREX trader.

Acknowledgments

As you so often read on the acknowledgments page, the author takes a few brief lines to say thanks. A page of appreciation is in nearly every book and this one is no different; primarily because a project like this is just impossible to successfully complete without the combined effort of an entire team. For me I must give thanks first.

I can do everything through Him who gives me strength. — Philippians 4:13

We cannot do it on our own. It is the strength that comes through Jesus Christ that allows us to master the difficult situations of life and to succeed where all human wisdom sees only failure.

I was reading through my first book’s acknowledgments (FOREX Made Easy: Six Ways to Trade the Dollar) and noticed that some of my same team is still with me and assisted on this project, so thanks to all. I also noticed that my family is now even bigger; I would not have been able to complete this book if it were not for my absolute significant other, my beautiful wife of more than 10 years. Thanks, Deb, for all the trust and confidence you gave me each and every day. In my last book, I was able to get my son James’ name in the book, so I better add my daughter Jacqueline to this one; I love you both dearly.

I, of course, will simply not be able to thank everyone individually for their help, but for the handful of constant contributors I will try.

When working to get a book such as this completed it takes lots of reading by lots of people. Jack Lott has been there every step of the way. Thanks Jack for being such a great friend and team member. I know you have read through this book a few hundred times and everyone reading it will appreciate your effort, as I do. I am already looking forward to the next project. Michael Thomas has done his fair share of reading of this book and his specific attention to the FOREX strategies will have the reader’s appreciation and understanding. Thanks for all your help and friendship. I would like to give a special thanks to Caroline for her help in getting this project moving and off the ground.

Finally and certainly not least, thanks to my publisher McGraw-Hill and the entire team for their dedication of getting this book to you.

Disclaimer

The information in this book is for educational purposes only. I am not giving advice or specific financial recommendations. You must seek guidance from your personal advisors before acting on this information. Trading can result in losses. I accept no responsibility for any losses you may incur. Do not invest more than you can afford to lose.

NFA-AND CFTC-REQUIRED DISCLAIMERS

Trading in the Foreign Exchange (FOREX) market is a challenging opportunity where above-average returns are available for educated and experienced investors who are willing to take above-average risk. However, before deciding to participate in FOREX trading, you should carefully consider your investment objectives, level of experience, and risk appetite. Do not invest money you cannot afford to lose.

FOREX futures and options trading have large potential rewards but also large potential risk. You must be aware of the individual risks and be willing to accept them to invest in FOREX futures and options markets. Don’t trade with money you can’t afford to lose. This book is neither a solicitation nor an offer to buy/sell FOREX futures or options. No representation is being made that any account will or is likely to achieve profits or losses similar to those discussed in this book. The past performance of any trading system or methodology is not necessarily indicative of future results.

There is considerable exposure to risk in any foreign exchange transaction. Any transaction involving currencies involves risks, including, but not limited to, the potential for changing political and/or economic conditions that may substantially affect the price or liquidity of a currency.

Moreover, the leveraged nature of foreign exchange trading means that any market movement will have an equally proportional effect on your deposited funds. This may work against you as well as for you. The possibility exists that you could sustain a total loss of your initial margin funds and be required to deposit additional funds to maintain your position. If you fail to meet any margin call within the time prescribed, your position will be liquidated, and you will be responsible for any resulting losses. Investors may lower their exposure to risk by employing risk-reducing strategies such as stop-loss and limit orders.

CFTC RULE 4.41

Hypothetical or simulated performance results have certain limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not been executed, the results may have under- or overcompensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profit or losses similar to those shown.

Introduction

What is FOREX? FOREX (also known as FX) is the contracted name of FOReign EXchange, an international trading market where banks, businesses, and public and private investors of all the countries in the world can obtain and exchange their respective currencies so as to perform commercial transactions or simply speculate. This market functions in a different way from the stock market; the stock exchange has a fixed daily schedule for opening and closing, whereas the FOREX is open 24 hours a day, five days a week nonstop. FOREX activities start on Sunday afternoon at 5 p.m. Eastern Time (ET) and close on Friday at 4 p.m. ET. This continuous activity is possible because there are always open markets around the world, and today there is no need for the traders to be physically present at the exchange location because the funds can be traded electronically from any country.

The main markets involved in the FOREX are New Zealand, Sydney, Tokyo, China, Frankfurt, London, Zurich, and New York. The FOREX market is the largest in the world, where more than $3.2 trillion is being transacted every day (traditional daily turnover was reported to be over US $3.2 trillion in April 2007 by the Bank for International Settlements. Source: Triennial Central Bank Survey, BIS, December 2007), which is many times larger than the combined volume of all U.S. equities and futures markets, and thus the FOREX is also the market that possesses the greatest liquidity. Late in 2008, with all the uncertainty in the equities markets, the FOREX daily turnover surpassed US $6.5 trillion in a day. This market will continue to attract more and more investors.

Currency trading used to be an exclusive activity reserved to government central banks and commercial and investment banks. In recent years, the market has opened up and become available to smaller investors and speculators, thanks to computers and the Internet.

There is a broad electronic network that allows central banks from all over the world to share their quotes and actual currency rates. This is known as the Interbank. In this way, central banks are able to exchange and convert their currencies one into another in real time. The currencies that are traded most commonly are the U.S. dollar, the Japanese yen, the euro, the British pound, the Swiss franc, the Canadian dollar, and the Australian dollar. The Interbank’s activity being continuous, and thanks to decentralization from any physical location or exchange, access to real quotes and the speed at which transactions can be performed are greatly increased.

When you are transacting on the FOREX market, you are simultaneously buying one currency and selling another. Currencies are always traded in pairs, for example, pound sterling/U.S. dollar (GBP/USD) or U.S. dollar/Canadian dollar (USD/CAD).

You would be executing a trade when there is an expectation that the currency you are buying increases in respect to the one you are selling. If the value of the currency you have bought effectively increases, you then would sell the position and take a profit. Currency pairs are composed of a base currency, which is the first on the quote, and a counter currency (also called the quote or payment currency), which appears as second on the quote. When the U.S. dollar is the base currency, quotes are given in $1 USD per counter currency, for example USD/CAD or USD/JPY.

The role of the FOREX in the world economy is very important because there is always an increasing need of currency exchange owing to the development of technology, communications, and general international commerce. Countries need the FOREX market to be able to sell their products to other countries and receive payment in their own currency or pay for their imported goods to the foreign producer in its own currency.

In addition to commercial turnover, though, plenty of money is used for speculation, and thus the great liquidity of the FOREX allows traders to profit at any moment, provided they are using the right techniques and strategies.

Over the last few years, the FOREX market has gained significant ground in the U.S. retail marketplace. Through my many Web sites, such as the James Dicks FOREX Network (www.JamesDicks.com), educational tools and services, I have introduced millions of individual investors to the retail FOREX marketplace.

The CNBC Million-Dollar Portfolio Challenge is well known among retail investors. To see firsthand how exciting, how popular, and how big the FOREX market is getting, just check out the results of the past challenges. The winner and top investors all dominated the challenge, trading the FOREX.

PART 1

THE BASICS

CHAPTER 1

WHAT YOU MUST KNOW TO GET STARTED

BACK TO THE BASICS: A HISTORY OF THE FOREX

The FOREX (i.e., FOReign EXchange) market is an international market where the money (currency) of every country is sold and bought freely. It was launched in the 1970s at the moment of introduction of free exchange rates, and the price of one currency against another that occurs from supply and demand is determined only by market participants.

There is no external control, and competition is free because all the participants can decide to transact or not. In this respect, the FOREX is a perfect market because it can’t be controlled or monopolized by any of its participants. The enormous number of transactions executed day after day in a continuous activity make it the biggest liquid financial market. According to various assessments, money masses in the market constitute up to US $4.5 trillion a day.

This market has seen recent turnover as high as US $6 trillion in a day, and the average most recently has been hovering at around US $3 trillion a day. The exact figure can’t be determined because the transactions are not centralized on a single exchange.

Trading is conducted all over the world through telecommunications and electronic networks 24 hours a day, 5 days a week starting from 00:00 Greenwich Mean Time (GMT) on Monday (some starting a little earlier) to 10:00 p.m. GMT on Friday (some closing a little later). There are dealers quoting currencies in every time zone through the main central markets: Frankfurt, London, New York, Tokyo, Hong Kong, Australia, New Zealand, etc.

To get a better understanding of FOREX quotes, you just have to know that one unit of the base currency is equivalent to the exchange rate in the quote currency. For example, if EUR/USD is trading at 1.2762, the price of 1 euro (base currency) in dollars (quote currency) will be 1.2762 dollars.

FOREX trading is conducted through individual contracts. The standard contract size (also called a lot) is usually 100,000 units. This means that for every standard contract you acquire, you are controlling 100,000 units of the base currency. For this contract size, each pip (the smallest price increment) is worth $10. Many companies offer mini accounts in which you can trade units of 10,000, where the pip value is $1 or even smaller.

In comparison with other markets, trading the FOREX market allows very low margin requirements because of leverage. In FOREX, you don’t need to obligatorily buy a currency first in order to sell it later. It is possible to open positions for buying and selling any currency without actually having it at hand: For a standard account size, usually Internet brokers establish a minimum deposit such as $2000 for trading in the FOREX market and grant a leverage of 1:100. That is, opening the position at $100,000, a trader invests $1000 and receives $99,000 as a credit.

For those wishing to get started at a smaller investment size, many brokers offer a mini account. The FOREX mini account offers smaller contract sizes controlling $10,000 units. The usual account minimum to start a mini account is about $250.

With a mini account, you only need $50 as a margin deposit requirement per every $10,000 lot traded. The leverage is usually 200:1 (10,000 ÷ 50 = 200), and in some cases it can rise to 400 or 500:1 (you then would need even less margin to operate). Thus, with $250, you could trade a maximum of 5 minilots; with $500, a maximum of 10; with $1000, a maximum of 20; etc.

This leverage is 50 times greater than for stocks (stock day trading provides a 4:1 intraday leverage for traders who have $25,000 or more in an account by U.S. law). Using a high degree of leverage is not always appropriate because it can be very risky, but it provides the trader with a higher degree of flexibility for the execution of different trading strategies.

Even further, now some brokers are offering a micro account. I personally would not recommend these because the leverage is really high, but a micro account may be a good way to get your feet wet, so to speak, by trading real money before moving on to a more standard size account. Micro accounts require as little as $25 to open and be able to control $1000 units. The pip values, on average, are about $0.10 (10 cents).

You can always go to www.JamesDicks.com to see what brokers I use.

The FOREX is able to maintain its objectivity and avoid being controlled or manipulated by one or few of its participants because the volume transacted is so high that if any of them would want to do so, by changing prices at will, they would have to operate with tens of billions of dollars. This is the reason why the FOREX can’t be influenced by any single participant, and even though there are situations where a huge transaction can seem to take control of the market for a few moments, the balance is established again almost immediately because of the great liquidity involved. This also allows traders to get a profit by opening and closing positions within a few seconds.

The FOREX market is always moving. You can chose to maintain a position for a very short time or for longer periods, even years; it will depend only on your own trading strategies.

In the FOREX, it is possible to perform speculative activities without the need for a real money supply. This is referred to as marginal trading. The amount required as a guarantee for the transaction is low, thus providing an opportunity to open positions with a small account in U.S. dollars (some local brokers also accept some of the main currencies, such as the euro, pound sterling, Japanese yen, etc.) and buy or sell a lot of other different currencies.

Transactions can be conducted very quickly and yield a profit while the exchange rates go up or down. Marginal trading implies operating with borrowed capital, where you need only a small percentage of the total sum of the transaction.

For example, you have analyzed the situation in the market and have come to the conclusion that the euro will go up against the dollar. You open 1 lot for buying the euro (EUR) with a margin of 1 percent (1:100 leverage) at the price of 1.2750 dollars per euro (the margin needed will be $1275) and wait for the exchange rate to go up. Sometime later, you see that your analysis was right. You close the position at 1.2827 and earn 77 pips ($770).

Most currencies have a daily range of fluctuation of about 100 to 150 pips on average, some even more. This gives FOREX traders the opportunity to make money on these changes.

There are several tools that allow the trader to be able to understand and make decisions on the market, grouped basically under fundamental or technical analysis. There is a constant exchange of political and economic information going on, and it is important to be informed on this because this will have an impact on the overall behavior of the market and will show market reaction as price changes. This is called fundamental analysis, an overview on all this information and how it affects a particular country and currency value. Fundamental analysis takes account of rumors, political events, and the local and international economy, such as, for example, the rates of inflation and unemployment, taxes, and interest rates. The political stability of a particular country and unexpected events also have great influence on the fluctuations of that country’s currency.

Sometimes, especially in the case of economic forecasts, this information can become a self-fulfilling prophecy in that a certain outcome is expected, so the market reacts before the fact, thus starting a movement in prices that can be seen as an early move, and if the forecast is confirmed, the prices suddenly can start going in the opposite direction from the real move because the predicted result has already occurred, and traders are now closing their positions. This can lead to market reactions that seem completely opposite to what the economic releases are implying for the currency, although there are also many details that could be modifying the outcome because all the currencies are moving in unison, and their respective interaction will affect all the others. Thus the fundamental details sometimes can be too big to grasp completely. Only the big banks and financial institutions, which employ professional economic analysts, can have access to a more precise and wide array of information with timely accuracy.

Technical analysis affirms, on the contrary, that all this information is already priced in and that the resulting reactions are visible on charts. It is based essentially on prices, time, and volume: What are the lowest and highest prices that a currency has reached in how much time or during what period, and how many transactions were performed?

Technical analysis also assumes the repetitiveness of the market, which it most probably will perform again in the future as it has already performed in the past. It analyzes past quotes and predicts the prices to come based on statistical and mathematical calculations.

Both technical and fundamental analyses complement each other. A professional trader should consider both sides at any moment because