In the world of forex trading and speculating there are many facets of the daily price action that are either poorly understood or simply ignored by most traders. Few traders rarely take the time to learn the basic mechanisms involved in the forex market. So many traders fail simply through a lack of knowledge about how the forex markets really work, and what they need to understand before they open their first position.
Because of this lack of basic education many traders have two fundamental misconceptions of how forex markets operate.
- The first is that currencies move in isolation, unconnected from other markets
- Trading in the currency markets is simple and straight forward.
Forex traders who believe this almost always fail. The currency markets do not move in isolation. They are influenced heavily by the money flow in the stock market, the bond market, and the commodities market. It is these relational linkages between the markets that give us vital clues and signals as to the flow of money from one to another. Without being aware of this a trader is trading with one hand tied behind their back. The bottom line is that to trade successfully, consistently, and not rely on luck ( which is essentially gambling), then you need some knowledge of the markets. That’s what this section of the web site is about. It’s about giving you the knowledge you need to trade intelligently, so that you are not gambling, but you are making trading decisions like a professional, which of course , means that you have a great chance of becoming consistently profitable.
I have been trading successfully for over 16 years and during that time I have traded every market and every instrument As well as trading currencies full time, I also write for a wide variety of publications, both on line and off line, such as FXstreet, ForexPros, Seeking Alpha and many more. I have been interviewed by both the BBC and City AM in the UK, and appear regularly as a guest contributor for the CME in the US, along with the Money Show.
My formula for a successful trade
If I had to sum up in one word what trading the markets is all about I would say it is about risk. Let me explain. Every decision by every investor or trader, in every financial market anywhere in the world is about money. Nothing else – just money. Market price movements are as a result of the combined decision making by investors and speculators across all markets, all of whom have one objective in mind – to increase their wealth or the wealth of their clients. When a market participant buys, they are placing money into the market relinquishing liquidity in return for some future gain. When a market participant sells, they are recouping liquidity and relinquishing the prospect of a future gain. So all markets and prices move for one reason, and one reason only, and it’s called risk. If market participants are risk averse and fearful, then safe haven asset classes and currencies will perform well, as investors and speculators seek a safe haven for their money, with funds flowing into safe haven asset classes such as bonds, precious metals, and certain currencies. Alternatively if investors are prepared to take on more risk then high risk currencies will perform well, with the flow of money moving from bonds and into equities and commodities.
A risk analogy
Take your house purchase as a simple example. If you are feeling positive about the future, have a good job, and feel generally secure then you are more likely to move house, buy something bigger perhaps, and take on a bigger loan to fund the purchase. You feel confident, and are therefore prepared to take on more risk, in return for a future gain on the value of your property. If you are feeling pessimistic about the future, perhaps less secure, you may look to move to a smaller house, or perhaps even sell and move to a rental property whilst you wait for better times. You are risk averse and are looking to reduce your risk or have no risk at all and convert your major assets into cash. This simple analogy sums up the decision making which is replicated millions of times every day by investors and speculators around the world and spread across all the capital markets.
The big question
If risk lies at the heart of every decision, and every move that the markets make, the big question is how do we begin to analyse and forecast these price moves which appear both complex and apparently random? The answer is using a technique that I refer to as three dimensional trading.
Three dimensional trading
Most forex traders are familiar with the terms, fundamental and technical, which consider the markets as two dimensional models encompassing economic data on the one hand, and a technical approach with a price chart on the other ( if you are not familiar with that terminology, don’t worry, I will explain that too). The majority traders either use a one dimensional approach to the markets, by just using charts, or at best they use a two dimensional approach by considering the fundamental data alongside the charts. I use a three dimensional approach which includes an additional factor called relational analysis. The relational aspect considers the linkages between one market and another which provide very strong signals, not only in terms of the money flow, but also in terms of potential growth, risk appetite, inflation and ultimately interest rates which are so important in the longer term.
Example of relational analysis
One such simple relationship is that between gold and the US dollar, both of which are considered to be safe havens and which epitomize the two extremes of money. Gold is classed as a hard asset, and the US dollar is regarded as a soft asset. The relationship between them is vital to understand as a forex trader for two reasons. Commodities provide many clues as to future inflation (or deflation) which has such a major impact on longer term interest rates, and therefore currencies. Gold, the purest and most significant of all commodities, provides the bridge between money and all the other markets. The US dollar is the most used and traded currency in the world. It follows that the relationship between the two will give a clue as to where the currencies are headed. They have a direct relationship where a trend change in one, will have a direct and immediate trend change in the other, so as the dollar weakens gold will rise, and as the US dollar strengthens then the price of gold will fall. In summary, you need to understand the technical, fundamental and relational factors involved in the currency markets if you want to make good consistent profits. Whilst the 3D approach to market analysis (technical, fundamental and relational) is key to understanding how the markets work, understanding yourself is equally important, and an area that is generally ignored by most forex traders.
Feel the fear
All trading is a mind game, and perhaps forex even more so, given the volatile nature of the markets, and the speculative nature of trading. As forex traders we are constantly facing the prospect of dealing with fear, of which there are three key elements.
- Fear of a loss.
- Fear of losing a profit.
- Fear of missing a profitable trade
What happens in our brains to trigger this fear response, and how can we manage this potentially damaging response when we trade? To answer that, let’s have a brief look at what fear really is. In simple terms, fear is a natural response to danger, and is the ‘’flight or fight’’ trigger that has been programmed into our DNA to protect us. It is the brain’s natural response in reacting to any threat. What happens is that we go into a stress response and adrenalin is released. Once adrenalin has been released we become agitated and are unable to react logically or calmly. This is simply the body telling us whether to stay and fight or to run (hence the well known ‘’fight or flight’’ phrase used to describe it). This stress response happens many times every day…even when we don’t notice it. It is not just the times when we feel very stressed. So it plays a big part in how we trade…or at least, it can do if we don’t do something to neutralise it. Neutralise the fear and make professional trading decisions.
A typical stress response will last up to ten minutes as the adrenalin flows, and there are two simple ways to deal with this situation. Prevention of course is always better than a cure and the simplest and easiest way to prevent the adrenalin rush, which is so dangerous to us as forex traders, is to write a trading plan. Ninety-five percent (95%) of traders never, ever have a trading plan, and whilst we are all familiar with the old adages – ‘plan the trade and trade the plan’, or ‘no one plans to fail, but everyone fails to plan’, few forex traders ever bother, and yet this is the one key aspects of trading which virtually guarantees longer term survival and success. Do you think it is just a coincidence that 5% of traders are consistently successful and make a living from trading, whereas 95% make a loss over the long term? If you have a trading plan, which has been developed well away from the emotion of the market, and which you follow on each and every trade, then your trading will become clinical and mechanical, avoiding stress, and the damaging release of adrenalin we outlined above.
This is why soldiers are trained to react to a plan, which is practiced and repeated until it becomes second nature, so that once they are subjected to the real battlefield situation, they react accordingly. Their training keeps them safe and they react to each situation using a rehearsed plan. A trading plan is one of the fundamental building blocks of your trading success in the forex market. Have a plan which you follow on each trade, and you will be elevated to the top 5% of traders. Trade without a plan and you will descend into the crowd and eventually fail. Even with a trading plan there will be very occasional moments of stress and fear when you are trading. Before making a trading decision (whether that is to get in, stay in, or get out) you need to get rid of any adrenalin. To do so, simply move away from the screen, and take a short walk, before returning. It may sound a little corny, but it works for me and many professional city traders I know.
The final piece of the forex education jigsaw is learning the mechanics of trading . I will teach you to understand the mechanics of how to trade, with all that this entails, from money and risk management, to understanding trading terminology, leverage, margin, and all the other aspects of a opening, managing and closing positions using our broker platforms.
Leverage is the key
One of the biggest mistakes forex traders make is in failing to understand the implications of leverage, and what this means in terms of their money management and position sizing as a result. With brokers offering leveraged accounts from 1:50 up to and eye watering 1:400, this issue is unlikely to disappear soon. However, the authorities are now starting to take action, with the US CFTC having recently introduced a ban on forex brokers offering leverage in excess of 1:50. There are ways around this restriction of course, but it is a move in the right direction, and hopefully one that will be gather momentum around the world. Leverage is a double edged sword – it will magnify your profits, but will also magnify your losses, and if you fail to understand the implications, then your account will be wiped out quickly. I always advises my students to leverage at a maximum of 1:50 and less if possible. To put this into context, managed forex accounts ( the ones I handle for clients) are generally based on 1:1 – in other words NO leverage! If leverage is relatively new to you, rest easy. I explain more about it in the trading mechanics section.
Putting it all together
If you are new to forex trading and perhaps a little overwhelmed, this is perfectly natural, but I hope in the remaining sections of this site, you will find a host of simple tips and explanations which will demystify the market, and help you to get started on your own road to personal freedom and financial success. With my own trading experience coupled with my free training rooms, you have a winning combination, and remember, in my forecasts I also tell you where I believe currencies are heading next, so you can simply follow my market analysis and trade along with me. Let’s start putting some meat on the bones as I explain the key headings in your forex education journey.