A Hitch-hikers Guide to the Forex Market

By www.thetradersclub.com
Contents: Key #1: Preparation Key #2: Tools Key #3: Mentoring Key #4: Market price movement Key #5: Risk and Randomness Key #6: Probability Key #7: Price Action Key #8: Risk exposure Key #9: Patience Key #10: Enjoy your Trading! Many people I meet seem fascinated when I tell them that I trade currencies for a living. I imagine they fantasize about huge sums of money being made and lost during frantic moments of trading where lightening quick reactions and a roll of the dice determine the outcome of todays bet, and possibly the size of my next car. Nothing could be further from the truth. I have been trading Forex for over 8 years now as a full time occupation. I have had successes and I have had failures, but above all, I have grown as a trader and as a person. In this little Ebook, I want to take you through the basics of trading Forex, which are completely opposite to the picture I have just painted. When you reach the end, you will see why. The big question is If so many people fail at trading (I have been told around 95%) then how can I beat the crowd and succeed Well, hopefully this little book will help to answer that question for you and give you some of the keys for success. I say keys because I truly believe thats what they are, and if you use them properly, you can unlock the door to success. The problem with keys, unfortunately, is that few people are prepared to use them properly. Using keys requires several qualities which many people simply do not possess or are unwilling to use; qualities such as hard work, perseverance, enthusiasm, determination, study, and so on.

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I will assume that you possess some or all of these qualities and now lead you through the steps (keys) which I firmly believe can turn you into a profitable trader and a master technician. Learn the bank Forex system yourself click here Key number 1: Preparation This is going to sound terribly boring to some readers, but the first step in any business is to learn from the experts. Pilots dont try to fly a plane without going to flight school. Builders dont try to build a house without studying building management, and Engineers dont try to fix a machine without studying engineering. I am firmly of the belief that you should not take a single trade with real money until you have read and studied the basics of technical analysis. I am a technical trader, so I am recommending technical analysis. Other traders will rely more on fundamentals and that is quite fine with me. I know that technical trading works, and works well, so that is what I use. What are the basics? Well there are hundreds of books on the market on the subject of Forex and trading, but there are a few which I highly recommend. That is not to say that you should only read these books, but you should start with them and make sure you have read each one several times before trading a single cent of real money. They are listed in order of reading so you can start with the first one on the list and continue through the list: The books are listed at www.thetradersclub.com/read.htm and, although we highly recommend all the books in the list, the books on technical charting and probability and statistics are the ones I highly recommend you read first. Please take this advice seriously. Yes, it costs money to buy books, but the books I have recommended to you are key reading material and they will give you an excellent foundation in your trading. I also recommend the E-book called G7 Forex which can be downloaded instantly at www.thetradersclub.com How do I know? Because I wrote the G7 system and the book follows the concepts in this E-book, and is the basis for the way I trade and make money every month from Forex! If you dont invest in knowledge, you wont succeed in anything

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Learn the bank Forex system yourself click here Key number 2: Tools There are several things you need to trade currencies online. Firstly you need a good computer and internet connection, secondly you need good technical charts and thirdly you need a good broker (market maker). I am not going to suggest which tools you should be using, but I can tell you that if any of those three items are not working properly, you will have problems. Make sure that you have a good enough computer and internet connection, which will not let you down in critical moments. This might sound basic, but trading is only about money and timing. A poor computer setup could well lose you money if it fails during a trade or during a time when you need to enter a trade. Use good charts. In the following sections you will see that the key to good analysis is to have good charts which can display what you need in a clear visual format without you having to click on icons to bring up information or having to page between windows to find the information you need. Once again, there are several good chart providers on the market find the one which is right for you. Make sure you use a safe, honest broker. About 50% of the online brokers out there are probably neither safe or honest, so do your homework. Particularly watch for brokers who are not insured, do not have any credentials, have low or zero spreads, use gorilla marketing tactics etc etc. If possible, use a broker which is part of a listed company, where you know your money is at least part of a bigger, safer pool. Learn the bank Forex system yourself click here Key number 3: Mentoring We highly recommend that traders get a good mentor when they start out. The problem is are there any genuine mentors? A lot of the mentors advertising their service online are simply charlatans and losers. Try to find someone you know is highly recommended and is REALLY a trader. Its no good trying to learn from the multitude of so-called trainers who have never managed to turn a profit in a live trading account. The classic blind leading the blind scenario! Ok lets move onto the meaty stuff stuff to do with trading and charting. I will try to aim the rest of this E-book at the right level, but I am aware as I write this, that there are more and less experienced traders reading at this point, so I will have to walk a delicately fine line. I am going to divide the rest of the book into

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the following sections, and hope that we can somehow muddle through these topics in a comprehensive, yet clear and interesting manner. Market price movement Risk/Randomness Probability Price action (PAPA principle) Risk Exposure Profit Goals Learn the bank Forex system yourself click here Key number 4: Market price movement As trading the Forex market, or any other market for that matter, is all about price movement, it is essential that every trader gets a feel for how this happens. We all know that the price moves up and down, but we need to get to know how it moves and when it moves. For example, I know that the price of the EUR/USD is likely to move 80-100 pips per day on average, with extreme days moving possibly 200-300 pips. I know that after a strong move, the price is likely to retrace to a predictable level. I know that the price moves strongly during the European session and especially during the news releases in the NY session, but can drift quietly during the Asian session. I know that price tends to stall at certain levels, such as round numbers and at the 20 and 80 price levels on any currency chart. And so on.There are many more insights and little gems I have picked up over the years. How have I picked them up? Simply from watching the charts and observing for myself. This takes time and concentration, but it has paid off! I suggest that you do the same, and try to recognize patterns which you can come to rely on in future trades. Spend time watching the charts and how the price moves at certain times of the day and you will be surprised at how much you will pick up. There are several price movement patterns which I want to point out to you and which will form the basis of the keys in this book. 1. The market never moves in one direction for too long it always retraces or corrects at some stage. We can trade towards the correction or after the correction. 2. The corrections begin when the probability for continued price movement in the same direction drops 3. The corrections often stop at predictable levels 4. Reversals are heralded by reversal patterns These are the principles which will help you to become a profitable trader. Lets leave them for now, as they will permeate through the rest of the chapters of this book.

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Learn the bank Forex system yourself click here Key number 5: Risk and Randomness Put this in your pipe and smoke it: The market is not predictable and the market is always at risk of extremely unexpected movement. The sooner you accept these principles the better. If you do not accept them, eventually you will no longer be trading Forex and you will be back in your day job. Probably sooner rather than later! These are probably the two biggest killers for traders: They feel that they can predict the market (WRONG!) And they feel that even if they get it wrong, the price will come back the other way at some stage (WRONG!) The end result? Getting the direction wrong, and receiving a margin call when the price is 1000 pips on the wrong side of your entry level. How can we combat these problems? Well its actually very easy. Firstly we must accept that the market is not predictable and that we are likely to get our trades wrong somewhere between 50% and 20% of the time (depending on your ability). Getting stopped out of a trade does not mean bad analysis or bad trading. Accept the loss and wait for the next trade. Secondly we accept that huge adverse price movements are quite possible and we remember to keep reasonable stop losses to make it easy to recover. Dont keep moving your stop or averaging down into the adverse price movement. JUST DONT DO IT! Get caught into this trap and you WILL eventually loose your whole account, even if the first few times it works out for you. Stops should generally be between 20 and 60 pips for the major currencies.

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Learn the bank Forex system yourself click here Key number 6: Probability I was going to suggest that this is THE most important of all they keys, but thats not true they are all equally important. The probability key has got to do with what I have called the PAPA principle. PAPA stands for Probability And Price Action and the idea behind this is very simple and should govern every single trade you make. This principle will help you determine: Which direction to trade in Which price level to enter at What trigger to use to determine the timing of the entry

Now I dont have to tell you that if you have these three pieces of information, you have everything you need for a successful trade! But remember we are dealing with probability in this chapter, and not certainty. We are looking for clues to give us a high probability of winning and we are not expecting a certainty. OK how does PAPA work? Well, firstly, we want to only enter the market when we know that the probability is in our favour. It amazes me how many traders are prepared to enter a trade without knowing the first thing about the likelihood of winning. In fact, many traders enter the market most times in what I term nomans land These are zones on the chart where there is no reason to enter the trade at all. So how do we know when the probability is in our favour? Think back to key number 4: The market never moves in one direction for ever it always retraces or corrects at some stage. We can trade towards the correction or after the correction. The corrections begin when the probability for continued price movement in the same direction drops The corrections often stop at predictable levels Reversals are heralded by reversal patterns

The probability of the price reversing increases the further it goes in one direction. We can determine these probabilities by using simple charting tools, such as overbought/oversold indicators. I also have my own system of determining probability using mathematical and statistical calculations.

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Anyway to cut a long story short, here is how you can apply the PAPA principle: 1. Try to go with the current trend on daily/weekly charts, but find a point where you can determine the trend has reversed. When this point is breached, stop trading in the trend direction, and stand aside. There are always more opportunities to make money, but dont keep trying to pick a top or bottom. 2. Trade mostly in the direction of that trend, but be prepared to trade against the trend on occasion as well 3. If you are going with the trend (for example up) then wait for the price to come down to a high probability area, determined by: a. A key chart level (I use Fibonacci and horizontal levels extensively) b. An oversold condition (Try some of the standard indicators) c. A high probability of reversal from a statistical perspective (this is not easy for everyone to determine, but it certainly helps) 4. If going against the trend, make sure that point 3 above is in place, but also look for a major daily level to trade off. 5. Wait for a trigger before trading (see the next chapter) Learn the bank Forex system yourself click here In summary, price action is governed to a certain extent by probability. It can never be predicted with certainty, but we CAN determine probabilities. Each trade is taken on the basis that we have say 65% chance of winning (in reality this will be between 50% and 75% for experienced traders. I average around 70%) The knowledge that each trade is only a gamble based on the probability is refreshing. It relieves the pain of losing a trade (expect to lose 30-50%) and it prevents us from taking too much risk. We will talk about risk in a later chapter. Learn the bank Forex system yourself click here Key number 7: Price action We have determined that trades should only be entered when the probability for an entry is high enough, which is determined by, for example, particular retracement levels (eg; Fibonacci), overbought/sold indicators and perhaps a mathematical calculation as well. We have determined that we should try to go with the trend, but that countertrend trading is also acceptable, if the conditions are right.

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We also said that, if everything else is in place, we still need a trigger to encourage us to enter the trade. Actually, the trigger plays another role in assisting with risk exposure determination as well, and we will come to that later. One of the keys to successful trading is to wait for a trigger before entering a trade. There are many different ways to find and use a trigger, such as using short term charts (for example 5 or 15 minute charts) and technical triggers such as moving average crosses, stochastic crosses, breakouts, MACD and a variety of others. However, all of these triggers are created by what we call lagging indicators which only give the trigger signal well after the actual price movement has occurred. The quickest and most reliable triggers are those related to the actual price action itself. I use candlestick patterns as my trigger to enter each trade. In a nutshell, I wait for a reversal pattern to form on the one hour charts using candlestick analysis. Candlestick charting has been around for hundreds of years and was first used by the Japanese to determine optimal entries into the rice market, and this technique still exists today, still being highly reliable and very quick to show when the charts are likely to change direction. This is why I recommended purchasing the book on candlestick charting by Steve Nison earlier in this book. So how does it exactly work? Well its as simple as this: Once I have decided the direction of my trade, Which levels I am interested in trading from, And when the probabilities are in my favour, I simply wait for a reversal pattern on the hourly charts to trigger my entry. Reversal patterns using candlesticks can be spotted on any time frame of charts, from 1 minute to 1 week charts, but the smaller time frame you choose, the less reliable the patterns become. A reversal pattern on the weekly chart is much more significant than a reversal pattern on a 1 minute chart, for example. Reversal patterns can take many shapes and forms, but they can be summarized down into probably 3-4 particular patterns which occur most frequently, are the easiest to spot and are the most reliable. I like to use the following patterns: Spikes, such as Dojis, shooting stars, and hammers Engulfing candles, both bullish and bearish Dark cloud covers Piercing patterns Evening and morning stars Outside candles

Unless you understand candle patterns, have read a good book on the subject and observed these formations on real time charts, you will not understand what

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this is all about. Read the book I have recommended and it will all become clear. Its not as mystical as it sounds at all, and these patterns are actually easy-tospot natural occurrences due to normal price action in all markets.

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Some of the common patterns I have mentioned are included in the diagrams below:
Piercing Line - This is a bullish pattern. The first candle is a long bear candle followed by a long bull candle. The bull candle opens lower than the bears low but closes more than halfway above the middle of the bear candles body.

Hammer - The hammer is a bullish pattern if it occurs after a significant downtrend. If the line occurs after a significant uptrend, it is called a hanging man. A small body and a long wick identify a hammer. The body can be clear or filled in.

Morning Star - This is a bullish pattern signifying a potential bottom. The star indicates a possible reversal and the bullish (blue) candle confirms this. The star can be a bullish (blue) or a bearish (red) candle.

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Bullish Engulfing Lines - This pattern is strongly bullish if it occurs after a significant downtrend (it may serve as a reversal pattern). It occurs when a small bearish (red) candle is engulfed by a large bullish (blue) candle.

Dark Cloud Cover - This is a bearish pattern. The pattern is more significant if the second candles body is below the center of the previous candles body.

Bearish Engulfing Lines - This pattern is strongly bearish if it occurs after a significant uptrend (it may serve as a reversal pattern). It occurs when a small bullish (blue) candle is engulfed by a large bearish (red) candle.

Hanging Man - This pattern is bearish if it occurs after a significant uptrend. If this pattern occurs after a significant downtrend, it is called a hammer. A hanging man is identified by small candle bodies and a long wick below the bodies (can be either blue or red).

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Evening Star - This is a bearish pattern signifying a potential top. The star indicates a possible reversal and the bearish (red) candle confirms this. The star can be a bullish (blue) candle or a bearish (red) candle.

Doji Star - This star indicates a reversal and a doji indicates indecision. Thus, this pattern usually indicates a reversal following an indecisive period. One should wait for a confirmation (like an evening star) before trading a doji star.

Spinning Tops - This is a neutral pattern that occurs when the distance between the high and low, and the distance between the open and close, are relatively small.

Doji - This candle implies indecision. The open and close are the same.

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Learn the bank Forex system yourself click here Key number 8: Risk exposure Many traders expose themselves to far too much risk, and that almost always ends in disaster. If you want to last as a trader, you have to be extremely disciplined when it comes to risk. This means suppressing the emotions and relying on probability, logic and common sense, none of which comes naturally to the human mind. I guess there are five rules which should be applied on this subject, and if you can manage to apply these rules every single time you trade, there should be no reason for you to fail (as long as you have even a half decent trading system) Risk Rule number 1 keep tight stop losses. This is easier said than done, purely due to the emotional tendency to increase stop losses when a loss is imminent, or to add extra positions to an already losing trade. As we have stressed before JUST DONT DO IT! You can always re-enter the market once you have been stopped out for a small loss, but it is much harder to recover after a huge loss, when your account is down by a significant percentage. When using candlestick reversal patterns as the entry trigger, simple place the stop loss 5-10 pips below the low of the reversal candle if buying, or 5-10 pips above the reversal candle if selling. This will, in most cases, allow you to use a stop loss of between 20 and 50 pips, with no more than 60 pips as a rule. Risk Rule number 2 Do not leverage your account more than required. Whilst we cannot recommend the right leverage for your own trading, we suggest a leverage of no more than 10:1 and preferably 5:1 or lower. This means you should not trade more than 10k for each 1k in your trading account, preferably no more than 5k per 1k in your account. If you stick to rules 1 and 2, you will never be exposing more than about 2% of your account in a losing trade. Risk Rule number 3 enter one currency at a time to start with. If you feel that there is a BUY signal on the Euro, the Pound and the Yen all at the same time, rather enter only one currency to start with. For example, enter only the Euro and see how the trade goes. If you win the trade, you didnt need the other two currencies, but if you lose the trade, you didnt lose too much, and you then have a chance to re-enter the same currency and another at a better entry price. In other words, if your direction is short the Dollar, start shorting with one pair only, and then work your way into the other pairs later on if you lose the first trade. This discipline will help you to minimize risk, but maximize opportunities when they come along.

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Risk Rule number 4 - Aim for at profits at least twice the size of your stop loss. In other words, if your stop is 30 pips on a trade, be sure to aim for at least 60 pips if the trade is a winner. It is not always possible to do this, but at least have it as a goal. If you are able to stick to this discipline, you can win only 50% of your trades and yet still make a healthy monthly profit. Risk Rule number 5 When you have reached your weekly or monthly target, STOP TRADING! I generally aim for 300-400 pips per month (60-100 per week) and stop trading when I have reached those targets. Doing so has several benefits: You protect your profits You avoid over-trading You take advantage of the cyclical nature of most trading models You get a well earned rest on occasion Your results become more consistent

An example of a perfect PAPA based trade entry using our system

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The trade entry above, taken in July 2006, is an example of the high probability, low risk trading possible, using the principles in the E-book. This trade was initiated using the G7 trading system (available at www.thetradersclub.com and based on the concepts in this book). The green arrow points out the entry level and reversal candle which triggered the trade, from a pre-defined level and probability area. As you can see, the trade had a maximum risk of 30 pips and went on to generate over 100 pips of profit. This is not uncommon using the G7 system, which has a winning ratio of well over 70%. Learn the bank Forex system yourself click here Key number 9: PATIENCE!! Part of the art of trading is patience. Sometimes it is harder to wait for a good trade setup than it is to enter the market in impatience. Good trades are not always available and our job is simply to wait for them to come along, no matter how long it takes I am quite prepared to wait for several days, even a week before taking the next trade. This way, we keep losses minimal and we only enter high probability setups. ALL THAT MATTERS IS THE END RESULT. We simply want to end each month with 200-400 pips (even a 100 will do just fine), whether it takes 30 trades or 1 trade. I am writing this because I know that some of you have itchy trigger fingers and you simply cant wait for the next setup. BE PATIENT. The goal IS NOT to trade frequently - the goal is to end each month safely with a profit. Learn the bank Forex system yourself click here Key number 10: Enjoy your trading! Trading the Forex market can be one of the most wonderful careers there is. But, like anything, you must enjoy it and be passionate about it to get the most benefit from it. Trading is not for everyone, and if you have started out in trading but find that you cannot deal with the various stresses involved walk away from it now. However, if you are passionate, enthusiastic and excited about trading and you have had a taste of success, there is no reason why you should not go on to make a fantastic living from this dynamic and rewarding career. I hope you have enjoyed my small E-book and that it has given you some food for thought. Obviously, I couldnt fit all I want to say into this small space, but if you want to know more about the principles I have outlined here, please visit my professional services at: www.thetradersclub.com

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or email me on admin@thetradersclub.com with any questions you have on this topic or my services. Regards, James.

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