acfx ebook for newbies
DESCRIPTION
Introduction to Forex trading and forex marlets.TRANSCRIPT
1www.acfx.com
2 www.acfx.com
3www.acfx.com
CHAPTER 1
CHAPTER 2
CHAPTER 3
CHAPTER 4
CHAPTER 4
TABLE OF CONTENTS
FOREX PRIMER
THE BASICS
FUNDAMENTAL ANALYSIS
TECHNICAL ANALYSIS
THE PSYCHOLOGY OF TRADING
pg. 5
pg. 17
pg. 23
pg. 31
pg. 47
Risk Warning: CFD’s and Foreign Exchange (FX) traded on margin carry a high degree of risk. As such they may not be suit-able for all investors. Investors should ensure they fully understand the risks associated with leveraged CFD and FX trading before deciding to trade because you can lose some or all invested capital. Investors may choose to seek independent
advice and should not risk more than they are prepared to lose.
4 www.acfx.com
5www.acfx.com
CHAPTER 1FOREX PRIMER
6 www.acfx.com
The Forex Market is the giant of Global Financial Markets and by far the biggest, with it out stripping the Bond, Equity and Com-modity Markets. This is due to the incredible scale of the Forex Market with over US$ 4 trillion traded on a daily basis.
Most tourists would have come across the word ‘foreign ex-change’ when they dealt with a bank or bureau de exchange. Or entrepreneurs who are involved in international commerce could be active in the Forex Market as part of their normal pro-cess of importing and exporting goods and services.
Although both tourism and commercial based transactions ac-count for a large amount of foreign exchange transactions the largest percentage by far relates to speculative business. In fact some 90% of all foreign exchange (also known as FX) business is speculative. What we mean by this is that an individual or a busi-ness will open and close a FX position with a view of generating a profitable outcome.
However this is not always the case and on occasions loss will occur. In both cases wins and losses are represented as debits and credits on an investor’s online account. As an investor who owns an online trading account Forex Trader never needs to take physical delivery of currency or remit foreign currency. The reason for this is that an investor will never take possession of the actual physical currency.
The Forex Market is not traded on any global exchange but is de-scribed as an over the counter market or in short (OTC). An OTC market has one major characteristic, that being all transactions take place directly between two parties.
An OTC market lends perfectly adapts to advances in modern technology and is well suited to the internet age. Investors are therefore able to access this large, dynamic and exciting market from wherever there is reliable internet access.
THE FOREX MARKET
7www.acfx.com
LIQUIDITY - Due to the enormous scale of the Forex Market and the volumes that are traded on a daily basis a great deal of liquid-ity is created. Liquidity is a trader’s best friend in any market. The reason is that, every person or organisation willing to sell a currency has to have a counter-partner looking to purchase that same currency. High levels of liquidity ensures that buyers and sellers in most cases can find the appropriate match.
ACCESS TO ALL - At ACFX it is easy and free to open a live trading account. ACFX accepts all respectable payment providers and a new client can be underway and trading in no time at all.
LEVERAGE - An investor uses leverage to amplify the effect of an open position. This is achieved by borrowing funds from their broker so as to increase the open exposure. The majority of equity markets make available leverage levels of 1:2. Forex Brokers however can typical offer levels of leverage in excess of 1:100 and in some cases 1:500. The scale of this leverage allows an in-vestor to capitalize on both small and large moves in the Forex Market. There is a flip side being that high levels of leverage can also magnify the size of an investor’s loss.
COMMISSION FREE - On our entry point market making account ACFX will not charge its clients any transaction commission. A cli-ent will see an all in price where cost of doing business is charged as a spread. The spread is the difference between the price an investor would sell at and the price an investor would buy at. This is also known as the bid and offer price. There may be a case where an investor is charged a small fee for hold a position overnight. This is known as the Swap and relates to interest charged for leveraged positions held overnight.
RISK MANAGEMENT - At times the forex market can become overly volatile such as the 2015 Swiss Franc event. An investor is able to manage this risk by placing both automated stop and profit targets. Furthermore ACFX has taken the bold move to guaran-tee that an investor’s negative open position will never exceed the value of the account equity on deposit.
THE FOREX MARKET NEVER SLEEPS - The Forex market being off exchange can be traded around the clock. Apart from weekends, 25th December and the 1St January one can trade the Forex Markets day or night. Daily news releases such as the United States Non-Farm Payrolls, Australian Monetary Policy Meeting Minutes or the German ZEW data will add volatility to the mar-ket. As these major news events are continuously and consistently happening every day or night one could realistically never leave their trading terminal.
WHAT MAKES THE FOREX MARKET UNIQUE?THERE ARE SEVERAL KEY FEATURES OF THE FOREX MARKET THAT GIVES IT INHERENT ADVANTAGES OVER OTHER FINANCIAL MARKETS SUCH AS EQUITIES AND BONDS.
8 www.acfx.com
The trading of Cross Currency’s is also very popular. A Cross Cur-rency pair is a trading instrument that does not include a US Dol-lar component. For example EURGBP, AUDNZD and CADJPY.
The movement’s in cross currency exchange rates can give an active trader valuable insights on the strength and weaknesses of underlying moves in currency majors. For example if the Euro is weakening against the Pound Sterling, Swiss Franc, Australian Dollar and New Zealand Dollar then there is a good chance that weakness will be found in the EURUSD currency pairing.
The ACFX Metatrader 4 (MT4) platform offers more than just the currency majors. Exotic instruments such as PLNJPY, NOKSEK and USDCNH are also available to clients.
Furthermore the ACFX MT4 platform does not exclusively offer Forex products. Our clients are able to trade well known and highly traded equity CFD’s, Commodities, Metals and Indices.
ACFX is proud to be one of very few MT4 brokers to offer this highly traded instrument to its clients.
WHAT TO TRADE?
AN OVERVIEW: THE FOREX MARKET IS DOMINATED BY FOUR MAJOR CURRENCY TRADING PAIRS. THESE ARE EURUSD, GBPUSD, USDJPY AND USDCHF. OTHER MAJOR PAIRS INCLUDE AUDUSD, NZDUSD AND USDCAD.
9www.acfx.com
IT ALWAYS NEEDS TWO PARTIES TO MAKE A MARKET. THIS WILL INCLUDE A BUYER AND A SELLER. THERE IS NO DIFFERENCE IN THE FOREX MARKET.
In the Forex Market the buyers and sellers could be individuals, businesses, investment banks, hedge funds, multi-national corpora-tions and government organizations such as Central Banks.
ACFX operates and offers their clients two distinct business models under one roof. This allows the client the freedom to choose a business model that is appropriate and most suitable to a client’s needs. These well-known business models are the:
WHO ACTUALLY TRADES IN THE FOREX MARKET?
BUSINESS MODELS
MARKET MAKING BUSINESS MODEL - In the case of the Retail Forex Market one side of the trade is the investor and the other is ACFX being broker of choice.
ACFX provides the pricing required to allow the investor to participate in Forex Market activity. Additionally, ACFX oper-ates as a market maker by providing bid and ask pricing to the investors to trade from.
STRAIGHT THROUGH PROCESSING MODEL - In this case ACFX pro-vides pricing direct through a well-respected selection of global liquidity providers. The STP model is also known as the Agency model. In the STP model, the investor acts as the client through the ACFX MT4 trading terminal, and is able to transact on prices quoted directly from our liquidity providers. In return for acting as the link to the liquidity providers ACFX charges a brokerage fee that is calculated on the volume transacted.
10 www.acfx.com
WHEN CAN I TRADE IN THE FOREX MARKET? THE FOREX MARKET NEVER SLEEPS: The Forex Market is the only mar-ket that it is kept open 24 hours a day and 5 days a week.
As the London and European trading sessions close, the New York session is already in full swing; as trader’s switch off their computers in the United States the Asian and Australian Markets get into gear.
TRADING SESSIONS: The business day in all financial sectors be it London, Tokyo or New York is usually based on the 8 hour shift.
However as the Forex Market is not traded on any particular ex-change, a market participant who resides in London has no legal, physical or regulatory obstacle stopping him/herfrom trading into the New York and even Tokyo sessions.
This is especially advantageous to European Forex Traders who are keen to trade the afternoon volatility that is created by Unit-ed States data releases such as the all-important Federal Reserve Open Market Committee (FOMC) events and the Non-Farm Pay roll (NFP) numbers.
Most global banks operate full branches in all the major finan-cial centres of the world. Before the advent of automated trade management systems investors need a method to manage open positions and handle pending orders.
In today’s computerized world this task is easier to accom-plish as trade management software will automatically look after the currency position, limit the size of the potential loss, set profit targets and execute new positions.
Therefore it became a necessity and standard practice over the years for banks to pass on executional trading orders across the world and across time zones. In this way a Cable Trader who is sweating on an open position of GBPUSD can pass on sell and buy orders to his colleagues in New York. If the Market did not trade through these levels during New York trading hours then the order would be passed onto To-kyo. From there would move onto Hong Kong, Singapore, the Gulf and then back to Europe.
However the trading hours of a London Dealing Desk had to accommodate the ending of the Asian trading session. Therefore a Forex Trader could not work the standard and well known 9 am to 5 pm day but had to shift their morning so that it overlapped the Asian session.
FOREX MARKET CENTER TIME ZONE OPENS (GMT) CLOSES (GMT) STATUSFrakfurt Germany Europe / Berlin 07:00 AM
18 - March - 201503:00 PM
18 - March - 2015Open
London - UK Europe / London 08:00 AM18 - March - 2015
04:00 PM18 - March - 2015
Open
New York - USA America / New York 12:00 PM18 - March - 2015
08:00 PM18 - March - 2015
Open
Sydney - Australia Australia / Sydney 09:00 PM18 - March - 2015
05:00 AM19 - March - 2015
Closed
Tokyo - Japan Asia / Tokyo 11:00 PM18 - March - 2015
07:00 AM19 - March - 2015
Closed
11www.acfx.com
NOT ALL SESSIONS ARE CREATED EQUAL - The London Session is by far the largest market in terms of Forex Volumes accounting for some 37% of the global trading volumes. Whilst trading in the New York session accounts for around 18% of global volume.
Not only does the London session dominate the Forex Market in terms of global volumes, but also experiences much larger price movements and daily ranges than its counterparts in New York and Tokyo.
The extent of large price movements during this session has been a turning point for many trading strategies which are based around the London Open. These strategies attempt to take ad-vantage of large congestion break out trades that follow the close of the Asian session and the London open.
London 41.00%
New York 19.00%
Singapore 5.70%
Japan 5.60%
Hong Kong 4.10%
PAIR TOKYO LONDON NEW YORKEUR/USD 76 114 92
GBP/USD 92 127 99
USD/JPY 51 66 59
AUD/USD 77 83 81
NZD/USD 62 72 70
USD/CAD 57 96 96
USD/CHF 67 102 83
EUR/JPY 102 129 107
GBP/JPY 118 151 132
AUD/JPY 98 107 103
EUR/GBP 78 61 47
EUR/CHF 79 109 84
12 www.acfx.com
13www.acfx.com
MARKET ACCESS THROUGH A CLICK OF AN IN-VESTOR’S MOUSE
HOW DOES ACFX MANAGE CLIENT PROFITS AND LOSSES?
OPENING POSITION
CLOSING POSITION
HOW CAN I PROFIT FROM TRADING IN THE FOREX MARKET?
The internet revolution has transformed the world of invest-ing and trading, it has brought the markets to the masses. The days when investor have to call a broker to place a trade are long gone. With respect to the Forex Markets the chang-es enforsed over the years have been extraordinary.
In the mid 1990’s the Forex Markets was the preserve of in-vestment banks, business and rich individuals. However with the introduction of internet to the general public, scores of companies around the world came into existence offering internet based trading platforms.
With no need to go to an office, exchange or dealing floor; today’s traders can now trade from their own home office or even from their mobile phones. With ACFX, the world of trading has become so accessible investor can trade any-where, anytime.
To take this scenario a little further, an investor has £1000 of equity in his/her bank account. Assuming that, other than the spread there are no other transaction costs at that very moment, the investor decides to pull the trigger and buy £1000 of the ACFX GBPUSD CFD at 1.4700 at leverage of 1 to 1. A few hours later and with much happiness the investor exits the trade at 1.4950.
In terms of profit and loss position let’s do
The investor buys GBPUSD @ 1.4700
The investor purchases £1000 @ 1.4700 and agrees to transfer USD 1,470.00.
The investor sells GBPUSD @ 1.4950
The investor sells £1000 @ 1.4950 and agrees to receive USD 1,495.00.
The investor can see the net movement in the Base Currency and in this case the British Pound equates to zero.
However the net movement in US Dollar terms is:
The net US Dollar difference USD 25.00 will be credited to investors trading account.
A currency pair is split into two different components. These are simply called the Base Currency and the Counter Cur-rency.
The Base Currency always relates to the first currency and the counter currency to the second in a pairing. A little confused? If investor chooses to trade GBPUSD the Base Currency is GBP (Pound Sterling) and the Counter Currency is USD (United States Dollar).
If for example, after analysing charts an investor comes to the decision that the British Pound looks cheap where as the US Dollar is rather expensive; and to take advantage of the po-tential benefit of an appreciation in the Pound, the investor would buy the GBPUSD currency instrument.
USD 1,495.00 – 1,470.00 = USD 25.00
14 www.acfx.com
ACFX MT4 OFFERS ITS CLIENTS TIGHTER PRICING
WHY DO FOREX MARKET EXCHANGE RATES MOVE?
ISN’T TRADING RISKY?It is generally accepted that the standard Forex Pip value is set at four decimal places. However some pairs such as USDJPY are limited to two places.
ACFX strives to give tighter pricing and therefore the ACFX MT4 quotes all prices in terms of five and three decimal places.
FOR EXAMPLE the current EURUSD rate is 1.06105 and the USDJPY is quoted at 121.117.
We live in a world where interest, inflation and growth rates vary from country to country. Big cartels such as the ‘‘Organiza-tion of the Petroleum Exporting Countries, (OPEC) dictate the supply and therefore the price of Oil. Geo-political issues affect the markets (e.g. the Ukrainian crisis, or a general election in the UK or Germany). Maybe bad weather destroyed the wheat harvest, and this results to a spike in the price of bread.
Additionally, prices move because global events are always in a state of flux. This has a direct impact not only on demand and supply but more importantly our expectations.
Trading the Forex Markets could be risky but so is crossing a busy road with eyes closed whilst listening to music on the MP3 player. With ACFX we always make sure we provide our clients full support, education, tools and a demo account to prepare them prepare for their trading journey.
This includes learning how to use a trading platform and be-ing familiar with all order types. Additionally, there is educa-tion and training that can be undertaken before one decides to trade on a live account. ACFX brings to all its clients a demo platform where an investor can simulate opening and closing positions and testing strategies without risking their capital.
GUARANTEED STOP LOSS
Also available to the traders are methods to limit the size of the loss that will negatively impact their trading account, by setting physical stop loss levels. ACFX protects an investors trading account by using automated margin stops, which stop a trading account from going into negative territory if a cer-tain level is hit. Furthermore ACFX offers all clients negative balance protection. This is useful in the unlikely event that market volatility is so great the liquidity dries up and the price slashes like a knife through investors stop and margin level without being automatically triggered. Such an event occured when the Swiss National Bank decided to no longer support the Euro with no warning.
ACFX offers our clients the ability to trade nonstandard mini and micro lots which limit losses and allow investors to experi-ence a realistic trading experience without taking the risk of losing a significant amount of capital.
15www.acfx.com
16 www.acfx.com
17www.acfx.com
CHAPTER 2THE BASICS
18 www.acfx.com
ACCOUNT OPENINGOpening a trading account with ACFX has never been easier. By visiting our website and selecting the START TRADING button an investor is only a few clicks away from gaining access to the dynamic world of Forex.
The application form is unobtrusive and is in line with all the modern guidelines of our European Union regulator.
An investor can invest funds into a wide range of base currencies. Deposits are accepted from a wide variety of glob-ally accepted and respected payment providers.
In the unlikely event that an investor has difficulty in completing the account opening process ACFX offers all our clients LIVE 24/5 CUSTOMER SUPPORT through our LIVE CHAT function. Alternatively an email can be sent to our support team at [email protected] .
WHAT IS A PIP?
WHAT IS THE SPREAD?
The pip can be described as the smallest incremental movement for a currency, which is usually the fourth decimal place (It can sometimes though be the second).
The spread is the cost of doing business. The provision of advanced charting and complex trade management sys-tems to clients is an extremely expensive undertaking. If one then adds in the cost of employing skilled and highly educated technicians to run the platform, investors can imagine that running a Forex brokerage firm is a very seri-ous and expensive business.
As with all tradable markets there is a cost to buy and sell a given financial instrument. Most markets quote this price as a spread.
In simple terms the bid is the price a counterparty is willing to buy a financial instrument from an investor. Whereas an offer is the price a counterparty is willing to sell a financial instrument to an investor.
It is only logical that the counterparty is going to aim to purchase the instrument at a lower price than it would want to sell it.
This difference in bid/sell and offer/buy is called the spread.
EXAMPLE:
If EURUSD is quoted at 1.0615 and then moves to 1.0616 that means that the EURUSD exchange rate increased by 1 pip.
19www.acfx.com
TRADING TERMS – LONG AND SHORTThe Forex Market allows market participants to either purchase or sell a currency pair. When a trader for example buys GBPUSD, the Pound (GBP) can be described as LONG United States Dollar (USD) can be described as SHORT.
The act of going long, would imply that the investor wishes that the Base Currency appreciates in value and the Counter Cur-rency depreciates. Investors are therefore effectively taking a financial bet that the Counter Currency will lose value.
To GO FLAT means that the size of the long positions equals the size of short positions. This leaves the investor perfectly hedged but does run the risk of building up considerable swap fees if positions are not liquidated.
FLAT HOWEVER CAN ALSO MEAN THAT INVESTOR HAVE NO OPEN LONG OR SHORT POSITIONS.
EXAMPLE:
An investor decides to buy GBPUSD and open a position of UK£1,000.00 at a rate of 1.4750. By entering into this transaction the investor has obliged him/herself to purchase UK£1,000.00 and sell USD 1,475.00.
If subsequently the exchange rate rises to 1.4800, the result for the investor would be that now he/she can receive more US Dollars for every 1 Pound Sterling. In simple mathematic terms:
OPENING POSITION
The investor buys GBP 1,000.00 and sells 1,475.00 @1.4750.
CLOSING POSITION
The investor sells GBP 1,000.00 and buys 1,480.00 @ 1.4800.
This produces a profit of USD 5.00.
To go short would imply that the investor believes that the Base Currency is overpriced and the Counter currency is under-priced.
For example an investor takes a view to short GBPUSD
OPENING POSITION
The investor sells GBP 1,000.00 and buys 1,475.00 @1.4750.
CLOSING POSITION
The investor buys GBP 1,000.00 and sells 1,470.00 @ 1.4700.
This produces a profit of USD 5.00.
20 www.acfx.com
WHAT IS MARGIN AND LEVERAGE?LEVERAGE
By means of leverage an investor is able to control a much larger position than their equity balance would allow. This is possible because brokers such ACFX offer beneficial leverage terms.
SO WHAT IS LEVERAGE? Leverage is a powerful tool that al-lows traders to take the maximum benefit from price moves in the Forex Market.
Leverage is effectively a loan made to a trader by the Forex Broker. This loan is automatically activated by the MT4 Trade Manager as soon as an investor opens position an open. ACFX offers their customers a leverage of up to 1:500.
SO WHY DO INVESTORS NEED LEVERAGE?
MARGIN
You can think of margin as a loan from your brokerage. Mar-gin trading allows you to buy more than you would be able to normally buy.
BACK TO OUR PREVIOUS EXAMPLE
To open a position of 1 Lot of GBPUSD at a leverage level if 1:100 requires a GBP 1,000.00.
The Margin calculation being:
Position size = 1 Lot valued at GBP 100,000.00Leverage = 1:100
Margin = GBP 1000 or (GBP 100,000 / 100)
LET’S RECALL A PREVIOUS EXAMPLE
An investor buys GBP 1,000.00 and sells 1,475.00 @1.4750.
A standard lot of has a value of 100,000. Therefore without leverage the investor would need GBP 100,000 to open a posi-tion of 1 Lot in GBPUSD.
However with a leverage level of 1:100 and account bal-ance of GBP 1,000.00 allows the investor is able to open and control a position of GBP 100,000.00.
A move from 1.4750 to 1.4800 equals to 50 pips, which gener-ate a return of just USD 500.
This sounds all good, but leverage is a double edged sword. It will magnify the size of one’s profit but also ones loss.
MARGIN CALCULATION = POSITION / LEVERAGE
21www.acfx.com
PROFIT AND LOSS
TRADING TIME FRAMES
ORDER TYPESSTOP LOSS
The ACFX MT4 PLATFORM allows a market participant to decide, before entering the trade, where the exit level should be placed.
This is a key component it the management and mitiga-tion of risk. It consequently limits the potential for excessive losses being generated. The stop loss order would auto-matically action a trading order that flattens a position and crystalizes the loss.
MARKET ORDER
A market order or instant execution, allows the investor to open a Forex Market position at the next best available price. This order type is used if the investor wants to gain immedi-ate access to the Forex Market.
TAKE PROFIT
At times, markets can move in a slow pace. Other times, ex-treme market volatility could take an open position into the the price target area only for the move to fade eventually.
A take profit order can be placed at a certain price level, it will then be automatically trigerred by the MT4 platform. This takes out the stress of trying to manually flatten a posi-tion in a fast moving market.
Knowing that a stop loss order protects the investor from exaggerated losses and a take profit has predetermined a level to crystalize profits, the investor can in theory walk away from their trading terminal.
LIMIT ORDER
A limit order is an order to buy or sell at a specific price or bet-ter. A buy limit order can be only executed at the limit price or lower, and a sell limit order can be only executed at the limit price or higher.
This means that if the investor is of the opinion that the cur-rent buy level maybe higher than where they wish to enter-then they can use a limit order to open the position at a level that offers better value for the investor.
STOP ORDER
A stop loss order is not just used as a means to limit ones downside risk. A buy stop can be placed above the current price and a sell stop beneath the current price.
The question most inexperienced traders will ask is:
WHY WOULD I WANT TO BUY SOMETHING AT A HIGHER PRICE AND SELL IT AT A LOWER PRICE?
The answer is simple market dynamics. Traders are always looking for clues on where the price action will head to. Sometimes these clues give a positive result and sometimes create a loss. In trading, the key to making money is being patient. Therefore it is sometimes better for the price action to confirm trader’s hunch by the price action moving higher or lower before investor decides to enter a trade.
By adopting such a strategy, the investor is able to avoid some of the pitfalls of false breakouts and fake breakdowns.
There is not one type of trader and not all traders have the same profit or time thresholds. Some traders use advance algorith-mic models that enter and exit the markets automatically at a fraction of a second as they attempt to take small bites out of the bid and offer spread.
Other traders are scalpers who look to trade off both momentum and key support and resistance areas to generate profits. These trades can last for the period of seconds to a couple of hours.
There are also Swing Traders who look to try to take chunks out of the prevailing trend or position traders who look to fade moves to key daily, weekly and monthly levels. These trades could last a few hours or could be rolled daily and last weeks.
Some investors are end day closing data such as hedge funds and the longer term money managers who look to take positions that could last from days to months.
The Forex Market has lots of different market participants who all have different trading styles and time horizons. However all these different traders interact with one another. The ultimate shared goal ofcourse is to effectively make profit.
22 www.acfx.com
23www.acfx.com
CHAPTER 3FUNDAMENTAL ANALYSISAS AN INVESTOR CAN USE A VARIETY OF METHODS TO COME TO AN INVESTMENT DECISION. THE TWO MOST WIDELY USED AND POPULAR METHODOLOGIES IS FUNDAMENTAL AND TECHNICAL ANALYSIS.
LET’S TAKE A LOOK AT THIS FIRST BY STARTING WITH FUNDAMENTAL ANALYSIS.
24 www.acfx.com
FUNDAMENTAL ANALYSISA trader or investor who takes a Fundamental approach to active investing, will focus on economic numbers.
A trader who uses fundamental approach to trading, could take a short term view by following today’s or the last few sets of data.
The trader can have a longer term view by taking in a broad picture of macro-economic, geo-political, legislative and regulatory news and data.
As a participant in the Forex Market, a trader should not limit themselves to focussing on the events of one country. The Forex Market is the leading indicator of Global money flow and as such what may seem an inconsequential piece of news from one part of the planet could have huge global ramifications.
This was the case in 2013 when the Cyprus government took a political and budgetary decisions to liquidate its small holding of Gold. Due to the financial crisis the markets took the Cyprus government’s decision to sell its entire Gold position as a signal that the same would follow from the Italian and Portuguese governments who hold substantial positions of Gold.
The study of Fundamental Analysis is to focus on the macro-economic indicators which allows investors to build a picture of the state of a nation’s economic wellbeing. By understanding the trend in the data and being able to take a longer term views, investors are able to gain a perspective of what the future could hold.
Fundamental analysis is however not just a case of collection lists of data samples. There is a need to and requirement to be able to read through the news and between the lines of statements made by prominent Central Bankers, politicians and business leaders.
WHICH DATA IS IMPORTANT?
All data is important, some data though gain greater importance at certain times. In recognition of the above ACFX employs a team of highly skilled and experienced market analysts who will alert our client’s focus to what they need to know.
There are however some consistently important news and events which are repeated on a weekly, monthly, quarterly and yearly basis.
There is a whole list of data sets which come out on a daily basis. ACFX as an aid to our clients provides a free to access economic calendar which lists forthcoming releases and provides data on prior releases.
LET’S EXPLORE WHAT DATA THE MARKET WILL GIVE US!
25www.acfx.com
NON-FARM PAYROLLS
The king of the data sets we previously mentioned is the Non-Farm Payrolls number, or more commonly known as the NFP.
The NFP number is released monthly on the first Friday of a new month. The NFP accounts for the total number of Paid US Workers of any business.
The NFP has an overbearing impact on the market and can cause large amounts of volatility in all liquid asset classes and the forex market.
The NFP ,being released early in the month, gives traders and investors an early warning of economic changes and as such is a valuable tool in helping one decide if new risk should be taken or if current exposure management should be changed.
The NFP is an important barometer on the current positioin of the United States economy and is a leading indicator on possible changes to consumer spending.
FOR EXAMPLE
If the market consensus expects 241K new vacancies to have been filled in December, whilst the November num-ber is 235K, this means that the market is expecting an im-provement in the outlook for Jobs.
If the actual release was for instance 230K then the market will be disappointed as the actual release missed the con-sensus target and the prior month’s number.
The above scenario would also disappoint the Federal Open Market Committee (FOMC) which is the body managing the United States interest rate policy. A jobs number that shows contraction could lead to a decision to reduce interest rates or put into discussion the possibility of an interest rate cut.The very idea that the FOMC could be contemplating a cut in interest rates would add a great deal of volatility into global markets. Thinking of the Forex Market, the above would result in the US Dollar will declining as investors will exchange the Green Back for currencies that have higher interest rate yields.
There are other important data sets and news release such as the Federal Open Market Committee Statement also known as the FOMC. The unemployment rate is also closely watched, as is inflation date such as the Core CPI.
INFLATION
Inflation in an economic context occurs when underlying data indicate that the trend in prices for goods and services experi-ences a sustained increase over a predefined time period.
Governments, Central Banks, business, traders and investors monitor data releases for the Consumer Price Index (CPI) and the Producer Price Index (PPI), which are released regularly, on a monthly and quarterly basis.
Inflation is viewed negatively by the general public as it lim-its their purchasing power. The reason being that it erodes the value of a given currency. However some inflation is needed to ensure that an economy grows at a consistent and sustainable level.
During periods when the inflation rate is rising at a decreas-ing speed or when prices are actually falling, can have a detri-mental effect on the growth and therefore impact on the Gross Domestic Product.
The reason being that during periods of falling or negative in-flation (also known as deflation) both the general public and businesses could put off the purchase of goods and services. The resulting drop off in demand could lead to a reduction in the rate of economic growth.
In recent years the Central Banks of developed nations such as the United States Federal Reserve, the Bank of England and the European Central Bank have managed inflation targets of between 2-3%. If the rate of inflation data begins to indicate that increasing prices are above and beyond this threshold, the Central Bank will raise interest rates. The action of raising interest rates has the effect of reducing the money supply in the economy. This under normal circumstances should lead to some of the heat being taken out of an economy that is grow-ing too quickly. In turn the drop off in demand causes the infla-tion rate to fall back into target levels.
The rate of interest has a direct link to the value of a currency. An increase in interest rates will make a currency more attrac-tive to invest in. This is due to the higher interest yield an inves-tor will receive for a deposit if compared to a currency that has a lower rate of interest.
Traders and investors therefore attempt to anticipate increases in the rate of interest before it happens. By doing this a trader will benefit from the appreciation in the value of the affected currency.
GROSS DOMESTIC PRODUCT (GDP)
The GDP is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, the GDP is calculated on an annual basis.
The GDP is a barometer of a countries health. The reason being that rising numbers would indicate that a country is producing more and more goods and services.
A productive and healthy economy is an attractive economy to both investors who would like to inject fresh capital into the economy, as well as the Forex Market where traders will flock to purchase a sought after currency.
There is also a flip side of course, where declining growth num-bers indicate that the country is going through a slowdown. A slowdown which could be due to some cyclical or structural problems of the country’s economy. There is another problem called runaway growth where economic bubbles are created and eventually collapse; such as in the US subprime crises which created a growth expansion that was fuelled by a lax rules on credit.
26 www.acfx.com
UNEMPLOYMENT RATE
Economic data that is derived from readings of the labour market has a huge impact on the financial markets. The most important data sets originate from the United States with the Non-Farm Payrolls (NFP) data dominating all other releases. These other releases being the Unemployment Claims and Average Earnings data.
The labour data are hugely important as they can be directly linked to the health of an economy. As such a buoyant labour market is an indication that an economy is growing with the labour force being economically productive and contribut-ing to a countries economic activity.Whereas increasing and high levels of unemployment is a strong indicator that the economy is suffering from a drop off in demand and then associated with a fall in growth levels.
In times of rising or full employment the Central Bank will seek to curb a tendency for inflation to get out of control by increasing interest rates and reducing the money supply.
Whereas at times when the labour market is shrinking and the economy is experiencing a contraction the Central Bank will reduce the interest rates as a means to increase the mon-ey supply and stimulate the economy through an expansion of credit.
CONSUMER DATA
Demand and sentiment based data releases give important and significant insights on the health of an economy. Con-sumer led demand has an overbearing hold on economic ac-tivity. Through employment and the income that is received for production,s citizens contribute by purchasing goods and services.
When consumer based data and sentiment indicators begin to trend lower or higher the Central Bank is alerted so that it can bring the economy back into balance through means of implementing effective interest rate policy. The Central Bank will of course also simultaneously monitor other important economic indications such as GDP growth, the labour mar-ket and inflation.
Traders therefore wil be in anticipation of changes in mon-etary policy monitoring important economic data releases such as, Retail Sales, Durable Goods Orders, Consumer Con-fidence, Consumer Sentiment and the German ZEW and iFO.
DO NEWS RELEASES MATTER TO TECHNICAL TRADERS?
The subject of Technical Analysis will be greatly expanded upon in a dedicated chapter of its own. However this trading method warrants a mention here due to the impact of funda-mental news flow on the price action.
Through the application of Technical Analysis a trader is able, with a degree of certainty, to predict the possible direction of the price action or the market conditions that will follow. A technical trader can do this by monitoring historical price ac-tion and then by employing Technical Analysis to expand his view into the future.
This can happen through the identification of certain relevant price points such as support and resistance levels. Or the for-mulation of a trading plan around certain well known and identifiable market patterns such as double tops, double
STATEMENTS, SPEECHES, SUMMITS, CONFERENCES AND THE MIN-UTES OF PRIOR MEETINGS
In recent years some of the most important and influential fig-ures in the global economy are the governors and senior board members of the Central Banks.
THE MAJOR CENTRAL BANKS ARE THE:
BALANCE OF TRADE
The Balance of trade is a very simple calculation which mea-sures the difference between the value of all the goods and services that a country will import against those that are ex-ported.
A country is said to have a surplus if the value of its exports surpasses the value of its imports. On the other hand a coun-try is said to be in deficit if the value of its imports surpasses the value of its exports.
The trade balance numbers are made available on monthly basis. Traders not only look for the absolute number in the monthly Balance of Trade number but are also interested in the trend of the numbers, and ofcourse if the latest release is higher or lower than market expectations.
A positive trade balance is a reflection of good economic health as a surplus would bring external revenues to the economy, which will further bolster company earnings which In turn feeds through to the labour force through salary increases.
Statements and speeches by the managers and key members of these Central Banks can have a large and immediate impact on the financial markets. The reasons being that this key indi-viduals are the decision makers who are able to influence and change monetary policies.
The financial markets use the terms dovish and hawkish or Doves and Hawks with respect to the intentions of the inten-tions of key Central Banks with respect to monetary policy.
A Central Banker who is a Dove is inclined to want a relaxation of monetary policy and a reduction of interest rates. Whereas a Central Banker who is a Hawk is inclined to want a tightening of monetary policy and an increase of interest rates.
UNITED STATES FEDERAL OPEN MARKET COMMITTEE (FOMC)EUROPEAN CENTRAL BANK (ECB)BANK OF ENGLAND (BOE)BANK OF JAPAN (BOJ)BANK OF CANADA (BOC)SWISS NATIONAL BANK, (SNB)RESERVE BANK OF AUSTRALIA (RBA)RESERVE BANK OF NEW ZEALAND (RBNZ)
27www.acfx.com
SENTIMENT INDICATORS AND THEIR MARKET IMPACT
The global market cannot be neatly separated into Forex, Equi-ties, Commodities, Bonds and Metals. There are relationships and coloration’s between all these markets. At some points in time these relationships become stronger and at other times the relationships become detached.
As a trader, it is important to view the markets as a living or-ganism that has mood swings that shift from depression to eu-phoria in a short space of time. These market mood swings can be termed as market sentiment.
It is important for traders to understand the inter market rela-tions and from these deduce the best way to manage, take on or reduce risk.
CORRELATIONS
Many traders are happy to trade one currency pair or financial instrument without being concerned with the implications that are happening around them in the wider market. Many of these traders are very skilled at following and trading one financial instrument and are able to enjoy a profitable career by being so extremely specialized and focussed.
However one financial instrument does not move indepen-dently from the broader global financial market. As any sea-soned market professional knows, many financial instruments move in parallel with the other. A bullish day for USDJPY will usually lead to a bullish day for USDCHF. In fact if one was to compare the two charts side by side it would be hard to differ-entiate between USDJPY and USDCHF.
This similarity in the price activity of different financial instru-ments is often referred to a correlation. The definition of a cor-relation is the relationship between two variables that can be measured through statistical analysis.
Some financial instruments such as USDJPY and USDCHF are positively correlated. That is to say that a move in one direc-tion for USDJPY will be confirmed by a similar move in USD-CHF. Inversely a negative correlation describes a relationship between two financial instruments which move in opposite directions. A good example of this the US Dollar Index ($dxy) and EURUSD. On a statistical basis if $dxy moves higher then consequently the EURUSD will move lower.
The degree of correlations however will vary. USDJPY and US-DCHF will not experience the exact same percentage moves over a given period of time and $dxy and EURUSD will not ex-perience in percentage terms a move that is equal and oppo-site. However the correlation will be derived over a set period of time and will produce a data output of between 1.00 and -1.00. A result of 0.80 to 1.00 would be considered highly cor-related and -0.80 to -1.00 to be highly negatively correlated.Currencies and other financial instruments are correlated be-cause prices are ultimately moved by a multitude of factors. This can be economic factors such as growth, employment, in-flation or interest rates. There are also political, legislative and geopolitical factors. International trade plays an important role in driving global financial markets. Countries which are exposed and reliant on cross border trade will have their cur-rencies affected by the demand and supply of these resources. For example Canada is recognized as a major producer of en-ergy commodities and most notably Crude Oil. Therefore there is a high degree correlation between the price of Oil and the value of USDCAD.
Understanding that correlations exist between different finan-cial instruments is important as it allows an active trader to have an insight of the true direction the money is flowing. As Oil is getting weaker is it that wise to be selling USDCAD at an area of resistance?
bottoms, converging triangles, head and shoulders patterns. The techniques that can be applied to technical trading are endless with individual traders constantly looking for an edge; hoping that this will give them a winning strategy. However all technical studies, no matter how robust, cannot stand in the way of strong market news that can drive the market in one direction or another.
FOR EXAMPLE
A trader may have a technical view to sell EURUSD on pull backs to the 8 period daily moving averages. This method maybe profitable however on a given Friday once a month the Bureau of Labor Statistics announce the monthly United State Non-Farm Payrolls Number. If in this instance the NFP num-ber falls below expectations the US Dollar would weaken and therefore invalidate a shorting strategy for EURUSD.
Ultimately the price action may send EURUSD lower. However market volatility during news releases can cause problems when entering the market.
For this reason it is only logical that a technical trader would be aware of pending news releases and would consequently prepare a trading plan in such a way to allow for the resulting market volatility.
ACFX understands the need for its clients to always be in-formed. To this end ACFX offers to all its clients, an economic calendar, live news feeds, forex calculators and up to date mar-ket analysis.
The very action of falling or rising prices in different currency pairings or across different markets will give rise to negative or positive sentiment. It is for investors to gauge through market sentiment the validity and the strengths in the market.
FOR EXAMPLE
Would a EURUSD Trader be more inclined or less inclined to go long with the Euro if EURGBP was falling? Probably not enough data is available to make a fair assessment. However if an inves-tor noticed that the price movement was also in a downward direction in say EURAUD, EURCAD then he or she would prob-ably think twice about placing that long trade.
28 www.acfx.com
THE AUSTRALIAN DOLLAR
Australia is the third largest producer of precious metals and one of the biggest producers of Gold. Therefore it should not be a surprise that correlation between AUDUSD and Gold is usually above 0.80.
Gold is recognized as a safe haven asset. This usually means that in time of crisis due to economic or politically instability investors seek out the shelter that Gold gives. Commodities and metals such as Gold act as a store of wealth that have the longev-ity to outlast these times of uncertainty.
Investing in Gold has one big drawback; although like other financial instruments Gold has the potential to appreciate in value, unlike currencies, Gold cannot be deposited at a bank for the purpose of receiving interest. Therefore if an investor wishes to benefit from the safe haven quality of Gold and at the same benefit from an interest rate yield they could chose to purchase the Australian Dollar instead.
JAPANESE YEN AND CANADIAN DOLLAR
Japan is one the largest global importers of Oil. On the other hand Canada is one the largest producers and exporters of Oil.
As the price of Oil increases and decreases the fates of the Japanese and Canadian economies also changes. Japan which is heavily reliant on Oil imports will experi-ence a direct economic benefit from a reduction in the price of Oil. This is because the Japanese economy is heavily reliant on export driven manufacturing economy. Lower Oil prices will mean that Japanese manufacturers will pay less for energy. This in turn will result in a lower cost of production and more competitive export prices.
On the other hand an increase in the price of energy commodities will benefit ex-porters of crude oil. Therefore an increase in the price of Oil will act as a boost to the Canadian economy and therefore the Canadian Dollar.
OTHER NOTABLE CORRELATIONS
29www.acfx.com
30 www.acfx.com
31www.acfx.com
CHAPTER 4TECHNICAL ANALYSIS
32 www.acfx.com
TECHNICAL ANALYSISAn approach to trading that solely relies on the historical research of price movements is defined as Technical Analysis. Through the analysis of price movements a trader or investor aims to identify key price patterns, important price points and other important relation-ships. It is through the correct application of technical analysis that a trader or investor can make assumptions and predictions on the possible future price action.
CHARTS
CHARTS HAVE BECOME A MAJOR COMPONENT AND TOOL IN THE STUDY OF TECHNICAL ANALYSIS.
A chart is a graphical representation of the price action. Charts are useful to traders as they give the price action a visual order that is easier to interpret. Further visual representation allows a trader to identify relationships between certain price points through the application of trend lines, horizontal support and resistance levels, moving average and more complicated market studies such as Stochastics’, Bollinger Bands, MACD and RSI.
CHART TYPES
ACFX OFFERS TO OUR CLIENTS THE OPTION TO USE THREE WELL KNOWN AND POPULAR CHART STUDIES. THESE BEING:
CANDLESTICK CHARTS BAR CHARTS LINE CHARTS
All chart options allow our clients to choose a range of standard time frames from 1 minute to monthly. The ACFX Metatrader4 chart package also allows our clients to further customize their charts by choosing different colour schemes and back ground designs.
33www.acfx.com
LINE CHART
Also known as Line on Close is probably one of the least used method of chart types. The reason for is that its graphical rep-resentation of the price action as a sequence of closing prices gives the least information. However this very simplicity does give it a big advantage over other chart types. This being that the lack of noise that a Line chart produces takes away some of the psychological pressure a trader or investor experiences. Furthermore this simple graphical representation does make it much easier for the eye to identify price patterns which could be lost in the noise of other chart types.
CANDLESTICK CHARTS
Candlestick Charts are by far the most popular chart study. Al-though very similar to Bar Charts, Candlesticks give a trader an additional visual clue on how the last period closed. It does this by creating what is called a body between the opening and closing price. If the closing price posted a higher value than the opening price for the period the body will be shaded green. If conversely the closing price posted a value that is lower than the opening price the body will be shaded red. The prices that fall outside the candle body are called the wicks. The top of the wick represents the highest price the instrument traded to during a predetermined time scale and the bottom of the wick being the lowest price.
BAR CHART
Bar Charts have been popular for many years within the West and as such are the second popular chart type in use. A Bar Chart gives a trader four important price points over a specific period of time. These being the open, high, low and close.
Traders and investors look at the structures created by bar chart patterns for a means to predict the future direction of prices.
34 www.acfx.com
WHAT TIME FRAMES SHOULD I TRADE?
This is a question which is depended on how much time an investor has available to trade. A short term trader could choose 1, 5, 15 and 30 minute time frames from ultra-fast tick charts. Whereas longer term traders could decide to concentrate on 1 hour, 4 hour, Daily, Weekly and Monthly times frames.
Many traders choose to adopt a top down approach. This approach allows, through the implementation of multiple time frame analysis, the trader to choose one or two time frames to ascertain the most likely direction for future price action. The entry and stop targets are then taken off a lower time frame. Popular techniques, amongst others, would be the adoption of a daily and 4 hour time frame, a 4 hour and 1 hour or a 1 hour and 5 minute time frame.
The possibilities and options are numerous and can be customized to an investors individual trading style, risk appetite and time they have available to trade.
SUPPORT AND RESISTANCE, WHAT THEY ARE AND HOW TO USE THEM
Imagine an investor stood in the middle of an alley surounded by tall brick walls. If one was to throw a tennis ball at one of the walls with sufficient power it would not be a surprising if the ball was to bounce back and forth between each wall. In this case the two walls offer a solid boundary that repels the tennis ball.
On a chart, support and resistance have a similar effect to price action. In this case however, instead of two horizontal walls a trader will look for an area to place a price floor and and a price ceiling. Support and resistance both act as boundaries against the current price level. Support being the boundary floor and resistance being the boundary ceiling.
Unlike two solid brick walls horizontal support and resistance act as areas where the price may struggle to trade above or be-neath. Traders tend to observe the price action around the key support and resistance levels. They want to examine whether the price action can sustain a move and therefore close above or below these key levels; or whether the price action be pulled back into the prior range.
By understanding the relationship of support and resistance levels to the current price structure, a trader is able to make in-formed decisions and plan their trading. A trader could for instance create a plan where they buy at support or sells at resistance. Alternatively a trader may create a plan which buys breakouts above resistance and sells break downs beneath support.
35www.acfx.com
TREND LINES. WHAT ARE THEY AND HOW TO USE THEM?
If a trader studies a chart long enough, they will notice that price action tends to rise and fall along a consistent line. An uptrend can be defined as a series of higher highs and higher lows, there is a certain degree of predictability to identifying key turning points that the price action will follow. The same can be said of a down trend. When the price action is trending lower a trader would expect to see a series of lower lows and lower highs. Once again a trader could probably gauge by eye when a corrective rally will lose its momentum and begin to move back in the direction of the dominant trend.
The flow of market action during the trend cycle can be defined by visual means through the use of the most basic yet one of the most effective chart studies. The trend line. A trend line is a simple process of connecting two swing points during and up trend and then extending this line into the future. The same process can occur during the down trend, where the investor would connect two consecutive high swings. In both cases if the price action is trending in one direction then the investor should see a rising trend line that connects rising lows during an uptrend, and a falling trend line that connects lower highs.
As if by financial alchemy, the investor can now with some predictability work out through visual means, where the price action should naturally pullback to. This type of price movement is especially useful to swing traders whose aim it is to participate in moves by buying into weakness during an uptrend and selling into strength during a down trend.
Trend lines do not always give investors the exact point of entry on the third pullback. This is because other traders are aware that swing traders will look to add positions at these levels and try to hunt for their stops. Therefore an investor may see some volatil-ity around the third intersection of price and trend line support, and resistance with a series fake outs and false moves that could keep investor the investor guessing.
A trend line break could also give the investor an early clue that a trend is about to change. A break beneath an uptrend line can be viewed as bearish if the price action on the first pull back fails to break above or sustain a move above the uptrend line. Alter-natively a break above a down trend line can be viewed as bullish if the price action on the first pull back fails to break beneath or sustains a move below the downtrend line.
The understanding of how a financial instrument reacts to a move to or through a trend line is a difficult task as it requires a de-tailed understanding of short term price patterns and price exhaustion or continuation analysis. Investors must also be able to master the correct placement of stops around these levels, to ensure that the market volatility does not prematurely take them out of a profitable trade.
BULL POSITION
A bull or long position seeks to profit from rising prices in certain securities. When prices rise, a bull position becomes profitable. If prices fall, the bull position is not profitable. A bull or long posi-tion is the most well-known type of position and is what is typi-cally used in “buy and hold” investing.
BEAR POSITION
A bear position attempts to profit in a market by betting that prices will fall for certain securities. The short seller borrows securities in the hopes that prices will decline. When the price drops, the investor makes a profit on the price change. When the price rises, the investor loses money.
36 www.acfx.com
TRADING WITH INDICATORS
For some time now the use of technical indicators has been very popular amongst traders and financial analysts. The ACFX Meta-trader 4 platform, offers a wide variety of indicators to our clients. Indicators are useful as they enable chart users, through the ap-plication of both simple and complicated programs to gain a mar-ket view that side steps the perceived complexity of price action analysis.
The use of indicators has both positive and negative aspects. From a positive view point, the user of this chart functions
interpret the price action very quickly and through these tools gath-er a picture of how the instrument could move over the coming pe-riods. Furthermore the simplicity of the data outputs allow a trader to build a standardize strategy around these technical indicators.
From a negative aspect these indicators are all derived from price and therefore lagging. A skilled technical trader who applies pure price action analysis should be quick in entering the trade and nim-ble in managing the position.
MOVING AVERAGES
A moving average is a technical indicator which is used to take away some of the volatility of raw price action. This is achieved by calculating the average closing price over a set amount of periods. This process is repeated over subsequent periods, with the net result being a line that shadows the price action. Moving averages cannot be used to predict future price actions as they are a lagging indicator.
The most common use of a moving average, is for reasons of quick visual identification of a trend. For example if an instrument is trading above a 100 period moving average, over a set period, then it can be said that the price action is positive.
If a trader now adds the 50 period moving average to the chart, a variety of scenarios can be created based on the interaction of the price action and both averages.
If the shorter 50 period moving average crosses above the 100 period moving average then it is said to be bullish and is defined as a Golden Cross. As moving averages are lagging indicators, the price action will almost certainly be above the 100 period aver-age at the time the cross over takes place.
If the shorter 50 period moving average crosses below the 100 period moving average, then it is said to be bearish and is defined as a Black Cross. As moving averages are lagging indicator the price action will almost certainly be below the 100 period average at the time the cross over takes place.
CONTINUES ON TO PAGE 36
37www.acfx.com
TYPES OF MOVING AVERAGES
THE ACFX METATRADER 4 PLATFORM OFFERS A VARIETY OF FEATURES AND CHART STUDIES. THIS NOT ONLY INCLUDES THE STANDARD SIMPLE AVERAGE BUT ALSO OTHER MORE EXOTIC VERSIONS SUCH AS THE EXPONENTIAL, SMOOTHED AND LINEAR WEIGHTED AVERAGES.
A moving average can act as a leash that a dog walker will use to control his pet. As the dog gets over excited it will pull at the leash as it moves away from the owner. At the point where the leash tightens as the dog struggles to move too far away the walker pulls the dog back towards him.
Price action that trades away and becomes increasingly extended from the moving average is very much like the over excited dog. Whereas the moving average is the leash that brings the price action back to a place where it feels most comfortable.If for example the price action is trending higher, extended from the 50 period and 100 period moving averages, there is a ten-dency for upward momentum to lose energy. Eventually either the price action trades back down to meet the average, or in a sideways fashion that allows the average to catch up with the price action.
SIMPLE MOVING AVERAGE
The Simple Moving Average (SMA) uses a very straightforward method to calculate the average line. This calculation being the simple average calculated over X periods. For example the SMA for 20 periods of closing prices is just that. Take the clos-ing price for the last consecutive periods, add them together and then divide by 20.
EXPONENTIAL MOVING AVERAGE
The Exponential Moving Average (EMA) are viewed by many traders and investors as being more reliable than a Simple Moving Average. However both average types are very popu-lar, the benefits of using one average over the other though has yet to be proven.
The reason why EMA’s are deemed as being more reliable is
because greater weight is given to more recent price data out-puts. The more recent the data, the more relevant and there-fore more useful. The sum of weighting should always equal to 100. An SMA on the other hand gives all values the same weighting.
SMA are deemed to have a problem which is referred to as ‘‘barking twice’’. This is used when the SMA react at the start of the moving average period when a new data output is in-cluded in the equation, and once at the end when this same data output falls out of the equation.
An EMA slope can be recognized with greater ease. This is be-cause the slope EMA should point up when the price closes above the average and down when the price closes below the average. This tendency usually follows the most recent price closely, which means that the EMA is much quicker to react when compared to an SMA and the nature of the price action.
38 www.acfx.com
SMOOTHED MOVING AVERAGE
The Smoothed Moving Average (SMMA) similar to the EMA is a weighted average. It is also very similar to the SMA. The differ-ence between the SMMA and the SMA is how it treats the old-est data output. With the SMA, the oldest data output is simply subtracted from the SMA calculation. However in the case of the SMMA the previous smoothed average value is subtracted.
LINEAR WEIGHTED MOVING AVERAGE
The Linear Weighted Moving Average (LWMA) gives higher weighting to more recent data outputs. A data output is ob-tained by multiplying the closing prices by the position occu-pied in the data set. The data output is then added together and then divided by the sum of the number of time periods.
39www.acfx.com
BOLLINGER BANDS
The Bollinger Band chart overlay was created by John Bollinger. Bollinger Bands work in conjunction with the moving average. Bol-linger Bands are designed to act as volatility bands which envelope a moving average above and below. Bollinger Bands are calcu-lated by the use of a standard deviation. The Bollinger Bands will expand as volatility increases and contract as volatility decreases.
The Bollinger Band overlay that can be found on the ACFX Metatrader 4 platform consists of three components. A Simple 20 period moving average of closing prices. An upper and lower band that uses a standard deviation of 2. The bands use the same look back period of the average.
Bollinger Bands can also be used to provide trading signals in the form of double tops and double bottoms. Furthermore Bollinger Band contraction can be used as a warning signal of a potential break out or break down.
PARABOLIC SAR
The Parabolic SAR (PSAR) system was created by Welles Wilder. He referred to it as the “Parabolic Time/Price System.” SAR means “stop and reverse”. Wilder is a well-respected writer on technical trading and wrote about the Parabolic SAR indicator in his book “New Concepts in Technical Trading Systems”, that was published in 1978. This book also introduced other well-known technical indicators such as the RSI, ATR and Directional Movement Index.
The indicator is actually a trading system. The indicator is designed to plot SAR points under the price action during an uptrend and above the price action during a down trend.
A signal to stop and reverse will be given if the current candle breaks below or above the Parabolic SAR indicator. When this occurs a new SAR point will be painted in the opposite direction of what was the prevailing trend.
As the SAR follows the price action it is considered a trend following indicator. The SAR comes into its own as an indicator that allows a trader to stay in a trade during strong trending markets. Without the PSAR indicator a trader maybe influenced to cut a trade early, due to psychological stress caused by normal market volatility.
TECHNICAL OVERLAYS
CONTINUES ON TO PAGE 40
40 www.acfx.com
The PSAR will continually rise during an uptrend and continually fall during a down trend. Furthermore the PSAR will act as a trailing stop which stops a trader from increasing the stop value.
41www.acfx.com
Simple pivot point levels are calculated by taking the previous day’s high, low and close and by use of a simple arithmetic equation which helps create predictive levels for the day ahead.
The calculation is shown below:
• PIVOT POINT (P) = (HIGH + LOW + CLOSE)/3
• SUPPORT 1 (S1) = (P X 2) - HIGH
• SUPPORT 2 (S2) = P - (HIGH - LOW)
• RESISTANCE 1 (R1) = (P X 2) - LOW
• RESISTANCE 2 (R2) = P + (HIGH - LOW)
As the Pivot Point is based on the previous day’s data, the levels created are set in place for the whole days trading. A day trader would look to buy a financial instrument and keep the position up to R1.
At R1 the day trader has three decisions to take:
1. CLOSE LONG POSITIONS AND BOOK PROFITS.2. CLOSE LONG POSITIONS AND ENTER A SHORT AGAIN R1.3. ALLOW THE PRICE ACTION TO BREAK ABOVE R1 AND HOLD THE POSITION UNTIL IT TESTS R2.
Shorts will mirror longs with the trader looking for tests and fades of S1 and S2.
THERE ARE OTHER MORE EXOTIC VERSIONS OF THE PIVOT POINT. THESE INCLUDE THE FOLLOWING.
PIVOT POINTS
PIVOTS POINTS AND PIVOT POINT ANALYSIS IS A POPULAR AND WELL KNOWN TECHNICAL TRADING TOOL. THE USE OF PIVOT LEVELS WAS FIRST USED AT EX-CHANGES BY PIT TRADERS. TRADING ON THE FLOORS OF MAJOR EXCHANGES IS TYPICALLY VERY FAST PACED. TRADERS ON THE FLOORS DID NOT HAVE THE USE OF TECHNICAL CHARTS AND MODERN COMPUTER SYSTEMS. THEREFORE THERE WAS A REQUIREMENT TO CREATE A LEADING INDICATOR THAT WOULD MAP OUT THE KEY DAILY LEVELS FOR THE FLOOR TRADERS.
SIMPLE PIVOT POINTS
42 www.acfx.com
FIBONACCI PIVOT POINTS
Fibonacci Pivot Points are similar to Simple Pivot Points. The Fibonacci Pivots use the same high, low and close levels; however they include a Fibonacci element into the calculation.
THE CALCULATION IS SHOWN BELOW:
• PIVOT POINT (P) = (HIGH + LOW + CLOSE)/3
• SUPPORT 1 (S1) = P - {.382 * (HIGH - LOW)}
• SUPPORT 2 (S2) = P - {.618 * (HIGH - LOW)}
• SUPPORT 3 (S3) = P - {1 * (HIGH - LOW)}
• RESISTANCE 1 (R1) = P + {.382 * (HIGH - LOW)}
• RESISTANCE 2 (R2) = P + {.618 * (HIGH - LOW)}
• RESISTANCE 3 (R3) = P + {1 * (HIGH - LOW)}
MOVING AVERAGE CONVERGENCE DIVERGENCE
The Moving Average Convergence Divergence (MACD) was created by Gerald Appel in the late 1970s. The MACD is a very simple but at the same time one of the most useful indicators that is available to traders.
The MACD makes use of two trend following Moving Averages and creates a momentum indicator, by simply subtracting one aver-age from the other. The end product of creating the MACD oscillator is an indicator that can be used for both trend following and momentum analysis.
The MACD oscillates around a zero line with the moving averages converging, crossing or diverging around this level.
THE CALCULATION OF THE MACD IS AS FOLLOWS:
• MACD LINE: (12-DAY EMA - 26-DAY EMA)
• SIGNAL LINE: 9-DAY EMA OF MACD LINE
• MACD HISTOGRAM: MACD LINE - SIGNAL LINE
HOW TO INTERPRET THE MACD
As the name implies the MACD highlights the degree of convergence and divergence between moving averages. According to Ap-pel’s interpretation of the MACD, convergence happens as the two averages move closer together. Conversely divergence occurs as the two averages move apart from each other. The shorter length moving average is more responsive than the longer period moving average.
CENTRE LINE CROSS OVERS
The centerline is placed at the zero value. The MACD will oscillate above the centerline. Crossovers of the centreline will also indicate that the short length average is above or beneath the longer average. If the MACD crosses above the zero line, then the short mov-ing average should be above the long moving average. If the MACD crosses below the zero line, then the short moving average should be below the long moving average.
Positive and negative crossovers will also give an indication of the current trend; a positive cross indicating an uptrend and a nega-tive cross indicating a down trend. Furthermore the separation of the moving averages from each other, can be interpreted as an increase in positive or negative momentum depending on the direction the crossover took place.
SIGNAL LINE CROSSOVERS
Signal line crossover occurs when the fast EMA crosses the slow EMA. A positive cross over happens when the short length moving average crosses the long length moving average from below. A negative crossover occurs when the short length moving average crosses the long length moving average from above.
43www.acfx.com
DIVERGENCES
Divergences typically occur when both moving averages con-verge with each other. The convergence signifies a decrease of positive or negative directional momentum. Whereas the di-vergence signifies a lack of commitment to push prices higher or lower.
During an uptrend one would expect to see the MACD in step with the price action. As the financial instrument pro-ceeds to print new highs, the MACD will also reach higher levels. However during the exhaustion phase of the trend, the MACD could come out of gear with the underlying price action and consequently stop printing higher values.
This is a warning sign that the trend is reaching levels of exhaustion which could lead to a corrective pullback.
A similar scenario could occur during a down trend. As the financial instrument proceeds to print new lows the MACD will also reach lower levels. However during the exhaustion phase of the trend, the MACD could come out of gear with the underlying price action and stop printing lower values.
This is a warning sign that the down trend is reaching lev-els of exhaustion which could lead to a corrective pullback.
44 www.acfx.com
The Relative Strength Index (RSI) was developed by J. Welles Wilder. The RSI is classed as a momentum oscillator. Its function is to measure the speed and change in price movements.
The RSI has a range of 0 to 100. Traditionally and according to Wilder levels above 70 are considered overbought and levels beneath 30 oversold. However these levels can be adapted to suit the investors trading strategy.
THE CALCULATION OF THE RSI IS:
INTERPRETATION
The RSI can print multiple false signals during very strong trending markets. There can also be times when the RSI remains in over-bought and oversold areas for a considerable time. This phenomenon can occur when the momentum oscillator becomes embed-ded in extreme areas during strong trending markets.
The use of RSI divergences are extremely useful when used as a filter to identify valid and non-valid overbought and oversold trade set ups. As discussed in the section that focussed on MACD divergences, very similar set ups occur when using the RSI.
Furthermore although RSI could signal profitable trade sets off extreme overbought and oversold levels, divergences on the whole can offer safe trade set ups that lead to much larger corrective moves in the price action.
As with all indicator based trading, the paramount importance is once the oscillator moves into an extreme area; entry should only be taken if the price action begins to show signs of exhaustion.
THE RELATIVE STRENGTH INDEX
RSI = 100 -
RS = AVERAGE GAIN / AVERAGE LOSS
100__________
1 + RS
45www.acfx.com
46 www.acfx.com
47www.acfx.com
CHAPTER 5THE PSYCHOLOGY OF TRADING
48 www.acfx.com
THE PSYCHOLOGY OF TRADINGThe path to become a master of trading requires the student to become well versed in the subjects of both fundamental and technical analysis. Furthermore a great deal of awareness is required to both the current trading environment and market sentiment. It is only possible to come to a conclusion regarding through a thorough understanding of the current market conditions that it is possible to come to a conclusion regarding the direction the price action will move in during the period of interest.
However , having a good understanding of the mechanics that give the market its form and catalysts is not enough to master trading. The reason is that humans are emotional machines and trading can be a very stressful occupation that brings these emotions to the forefront. For example a day trader who employs a high volume scalping strategy, could have feelings of euphoria and depression in a short space of time. Much like a football player who scores an equalizing goal for his team but only to see the opponents snatch a winner in the dying moments of the match; emotions of joy and despair are amplified.
For a trader to be successful there is a need to conquer ones emotions, especially because a trader might suffer many confidence sapping losses. In fact some trading strategies have been created with a goal to accept many tiny losses which are wiped out by a smaller amount of large wins. An emotional person who will trade on such a system would soon begin to question their ability and their strategy.All traders need to hurdle what has been described as a wall of fear and greed. In fact an old Wall Street phrase about the market, sais that the market has two emotions. “Fear and greed”. Although this sounds as a very simple way to describe the market participants state of mind, the inability to conquer these emotions will have a negative effect on an investor’s equity position.
49www.acfx.com
GREED, FEAR AND HOPE
The catch phrase during the years of the well respected and now retired head of the Federal Reserve Mr. Alan Greenspan was irrational exuberance. Traders feel the need to make huge profits in the shortest period of time possible. The sharp mar-ket operators sense that a big move is about to happen, they therefore minimize their risk and book profits according to a well thought out plan.
Less experienced traders, do not always anticipate moves tlike that. Fearing that they have missed a great opportunity they jump onto the trade. Soon, the find themselves into the black as their unrealized profit begins to rise. However this trader did not have an entry plan and certainly did not have an exit plan. The possible outcome to such a trade is therefore in a state of flux. This trader may get lucky and close the position for the maximum profit available. It is however more likely that the greed takes hold as this trader gets excited and feels an emo-tional high as his unrealized profit increases dramatically.
The market then begins to fluctuate. The trader reinforces the positive feeling about this trade by telling himself, “don’t worry, it’s just another consolidation.” Then the price slips lower so the trader sets an imaginary stop under the current price ac-tion. The trader anxiously watches the market as the price ac-tion ticks down ever so closer to his soft stop. His stop is then breached. He tells himself “the market is wrong, this is just a minor correction” but the market moves lower.
The trader now places another soft stop just above the entry price. The price action inevitably heads lower and before he has time to contemplate what is happening, a profitable trade is now in debit.
With his position now underwater a sense of fear and hope takes control of what should be a rational trader. This trader now is hoping that the selloff has run its course. He tells him-self that if the position goes back into profit he will close the trade with a small win. Then he thinks about the opportunity he missed in booking a large profit and that next time he will not repeat the same mistake.
However a simple transaction of buying low and selling higher has turned into an emotional roller coaster and a story that has an unscripted ending.
ALL THIS COULD HAVE BEEN AVOIDED IF OUR TRADER HAD A TRADING PLAN IN PLACE, WHICH WOULD PREDEFINE THE STRATEGY, ENTRY, TAKE PROFIT AND STOP LOSS. IT IS ONLY THROUGH A TRADING PLAN THAT A TRADER CAN CONQUER HIS EMOTIONS.
THE TRADING PLAN
A well written and detailed trading plan will go a long way to easing the anxiety that a trader will feel about trading. Further-more a strategy that is logical, robust and that has been tested, will give the trader a chance to pull the trigger and enter the trade when the trade set up presents itself.
HAVE A DISCIPLINED APPROACH TO TRADING
Formulating a great trading strategy will not be enough if a trader does not have the discipline to follow the trading rules. The market will always give a trader another opportunity; therefore chasing a moving market or trying to second guess the market and ignoring the rules of the strategy lead to the traders equity balance to be damaged or exposed to greater risk.
Furthermore ignoring rules such as tampering with margin or stop loss and take profit levels during the trade will lead to un-certainty and inconsistence results.
Trading requires the discipline to enter and manage the trade according to predefined rules.
DEFINE THE TRADING STRATEGY
Consistent profits can only occur through the consistent appli-cation of a proven and well thought out trading strategy. Trad-ing off hunches and estimates might work on occasion but in the long run will surely grind down the value of an investors equity.
A trading strategy must be thoroughly researched, be based on logic and well thought out. How the execution of the strat-egy must be clearly stated and documented in a step by step process.
All the components that are used to create a trading strat-egy must be of value. Integrating indicators and components which make the strategy unnecessarily complicated will slow down and cloud a trader’s decision process.
The strategy ultimately is written to allow a trader to benefit from their knowledge. This can only be achieved if the trading strategy clear states:
To be a successful in the financial markets a trader will need to:
DEFINE THEIR TRADING STRATEGY.
HAVE A DISCIPLINED APPROACH TO TRADING.
HAVE ACHIEVABLE EXPECTATIONS
BE PATIENT
USE TESTED MONEY & TRADE MANAGEMENT TECHNIQUES
WHAT EVENT OR EVENTS WILL TRIGGER THE TRADER INTO TAKING ACTION?
WHAT IS THE EXACT ENTRY LEVEL?
WHAT IS THE STOP LOSS LEVEL?
WHEN DOES A TRADER TAKE PROFIT?
50 www.acfx.com
AIM FOR ACHIEVABLE EXPECTATIONS
Trading is a race between knowledge and capital. During the learning period it is the goal of a new trader to learn as much as he/she can. This may require reading books, attending seminars and training, practicing on demo accounts, formulating trading strategies and test strategies on demo account.
However a learning process has no value if a new trader does not test these ideas on the market with a live account. A trader can only sharpen his or her knowledge through live trading.
This leads to a race between knowledge and equity. The more knowledgeable and experienced a trader becomes the less likely that losses will be incurred and the more likely that profits will be booked. At some point in time a new trader will cross that magi-cal line where the trading knowledge and experience leads to profits being booked on a regular basis as well as a consistent trading style.
A traders expectations should also be in line with what the mar-ket will give back to the investor. Traders need to be able to place both stops and take profits which are in line with underlying mar-ket volatility.
FOR EXAMPLE
Placing a 10 pip stop on a trade, when trying to trade a daily swing, would probably lead to a loss. This is due to the fact that daily market volatility has a tendency to move through the stop. A stop needs to be placed at a relevant level which allows the trade to develop.
Furthermore a trader who aims to take 120 pips on daily positions whilst the average range is 80 pips will lead to disappointment.
IT IS THE DUTY OF THE TRADER TO UNDERSTAND THE FINANCIAL INSTRUMENT AND HOW IT TYPICALLY MOVES.
MANAGE RISK
Trading is all about managing risk. The management of risk sets a trader apart from a gambler playing roulette at a casino.Trade position sizes should be limited to the amount a trader is willing to lose. The idea being that one trade should not be suf-ficient to wipe out an equity balance.
A trader needs to aim to incur acceptable losses and consistent gains. The risk to reward ratio should preferably be biased to booking profits that are larger than losses.
In terms of hard and fast rules, how much a trader should risk on any given trade is very much down to their risk appetite and ex-perience. However stop loss levels could vary between 0.5 – 5% however many professional trades will risk at the most no more than 2%.
Risking more could mean that a trader is over leveraged or has misread the market. Sitting on a position that is 5% underwater does beggar the question of how wrong must to a trader be to be right?
51www.acfx.com
IN CONCLUSION
TO BECOME A SUCCESSFUL TRADER ONE REQUIRES TO TAKE A LONG JOURNEY THAT TAKES COMMITMENT, DEDICATION AND DISCIPLINE. THE MARKET WILL NOT ALWAYS GIVE THE TRADER WHAT HE/SHE WISHES FOR. THERE WILL BE TIMES WHEN EUPHORIA IS FOLLOWED BY FEELING OF REGRET, FRUSTRATION AND PAIN.
A TRADER NEEDS TO BE ABLE TO MANAGE EMOTIONS AND TRADE TO A PLAN. A FAILURE TO FOLLOW THE RULES WILL ULTIMATELY LEAD TO A PROMISING TRADING CAREER ENDING PREMATURELY.
THIS EBOOK HAS BEEN WRITTEN TO GIVE TRADERS WHO ARE NEW TO THE MARKET AS MUCH INFORMATION AS POSSIBLE IN THE SHORT-EST SPACE OF TIME.
READING THIS EBOOK SHOULD GIVE A TRADER THAT IS NEW TO THE MARKET THE BASIC GUIDELINES TO APPROACHING WHAT CAN BE A VERY EXCITING AND REWARDING PROFESSION.
HOWEVER IT IS UP TO THE TRADER TO GO OUT AND FIND AS MUCH INFORMATION AS POSSIBLE ON TRADING. BE IT BOOKS, ONLINE VIDEO’S, CHAT ROOMS OR BY SUBSCRIBING TO THE DETAILED NEWS LETTERS SENT OUT TWICE DAILY FOR FREE TO ALL OUR CLIENTS.
THERE IS ALSO A WEALTH OF KNOWLEDGE TO BE FOUND ON THE ACFX ACADEMY WEBSITE. FURTHERMORE OUR INVESTMENT RESEARCH DEPARTMENT IS ALWAYS AVAILABLE TO ASSIST OUR CLIENTS WHERE POSSIBLE.
SO WHAT IS HOLDING YOU BACK?
WITH ACFX YOU CAN.
52 www.acfx.com