TradeSphereFX

Short Side Basics

Short selling in FOREX means to sell a currency with the expectation that the price will drop and you can buy it back at a profit. But if the price increases, you will be forced to buy or cover the position at a higher price, incurring a loss. In each currency pair transaction, you will be buying one currency and selling the other half of the currency pair.

The Risks of Short Selling

Short sellers theoretically face unlimited risk because there is no limit to how high a currency’s price can go. For example, if you short or sell the EUR/USD @ 1.2025 and the price rises by 10 pips ( a pip is the smallest tradable increment in FOREX), you will lose 10 points per contract. Because of the additional risk of the short sale as opposed to the long trade, you must be extremely disciplined about selling short and decisive about cutting losses when a short position goes against you. Protect your trades at all times by using stop-loss targets. Never leave a trade unattended, and never execute a trade without a plan. Your plan is your lifeline to survival. Trading is a business, and all successful businesses are based on well-defined plans.

Benefits of Short Selling

Short selling adds consistency to trading by giving traders the potential to profit in down markets. There are always currencies that are falling, even when the market is bullish. However, very few currencies rise to any great degree when the market is bearish. Whether it's profit-taking in a bull market or liquidation in a bear market, short sellers can always find opportunities to sell short for a profit.

One aspect of price behavior to consider when looking for short selling opportunities is the differences between up moves and down moves in the market. When a pair rises, it often increases slowly due to incremental profit taking throughout the rise. By contrast, when a pair declines, it often does so very quickly and sharply. As a short seller, you want to be positioned to take advantage of a drop in the price.

This contrast between upward and downward price movement can be compared to a car going up a hill, over the top and down the other side: It moves up rather slowly, requiring a great deal of power to make the ascent. As it moves down the other side after reaching the peak, it does so, picking up speed and momentum much more easily than during the up hill climb.

Similarly, price will often rally gradually, with increasing volume providing the "power" to make the upside move. As price begins to reach a plateau, look for the volume to begin to decrease. This is often where short traders will attempt to execute the short trade, looking for the reversal of trend to begin to occur.

When the price reverses to the downside, it will often do so with much more momentum and force than the up move. As the price sell offs, particularly in panic selling, volume will increase until the selling begins to subside. At this point, buyers begin to move back in and short traders take their profits. Volume speaks volumes

Volume is one of the most useful indicators to determine trend strength and warn of potential reversals, and whether traders are buying on weakness and supporting price or selling into strength and limiting price. Volume has a direct relationship to price. The more buyers (increasing volume) the higher the price goes. The fewer buyers, the better the chance for market makers to lower the price. There are six simple rules to learn to interpret price and volume movements:

1. Increasing volume on increasing price indicates increasing buying pressure and a possible price advance.
2. Increasing volume on decreasing price indicates increasing selling pressure and a possible price decrease.
3. Decreasing volume on increasing price indicates easing buying pressure and a possible price plateau or reversal.
4. Decreasing volume on decreasing price indicates a slowing of selling pressure and a possible price plateau or reversal.
5. Higher-than-normal volume (spikes) at price highs indicates selling into strength and a price ceiling.
6. Higher than normal volume (spikes) at price lows indicates buying on weakness and price support.

Burn these into your brain--they are the most reliable measures you can use to determine an instrument’s strength and direction and can potentially give you several minutes advantage over other traders to enter your short sell order and maximize your returns. For the short seller looking to position near the top of a rally, a progressive decrease in volume as price continues to rise will be the first indicator of a potential trend reversal. It will occur before any other indicator begins to suggest an impending price reversal.

Short Selling at Resistance

Many currencies tend to move within trading ranges during the day, or during specific times of the day, bouncing off support at low points and retreating from resistance at high points. When you recognize that a pair is fluctuating within a trading range, you can place short limit orders at or just under the resistance level of the range to take advantage of the pair’s profit taking off that resistance; you can cover at the support level. Make sure the volume has been decreasing as the price nears the established resistance level. If the volume remains constant, or begins to increase, a potential move through the resistance level could occur. Breakouts above resistance levels (or below support levels) are often explosive and accompanied by high volume. Think of support and resistance levels as floodgates that are closed tight. When they open, they release an extreme amount of pressure.

Market Movement

In the course of the market transactions, there are really only two types of transactions. The first is a positive transaction and the second is a negative transaction. Without it appearing that this article is trying to over simplify market activity and the various movements of the market, when the market is really examined, there are really only two types of transactions. In other words, there are successful transactions and then there are those that are not successful. If you have ever thought about it, I am sure you have asked the question what did that trade work or not work. What could have been done to make it successful?

Obviously placing the trade in the opposite direction would have worked. But seriously, what is it in your decision making process that could have been done differently to have made a positive outcome of the trade? One area could have been with regard to trader psychology It is a known fact that better than 98% of traders lose money. So, since 98%+ lose money, there must be something about where they are placing the trades that is the issue.

The component of the trade must be taken into consideration. The components are two primary items: 1) Entry Price and 2) Protective Stop Price. It can be reasonable to say that since 98%+ traders lose money, it can also be reasonable to expect that better than 98%+ of all trades are stopped out. Thus by conclusion, it seems to be a high probability that the market moves based on stops, thus the market moves to where the stops are located.

History is a wonderful event. Charting is simply an expose’ of History and it can read like a road map, showing exactly where it has been, but more important, the natural areas of human reaction. Let me explain: The market moves up to a certain price point level, stops and reverses and moves the opposite direction for a short time period, then stops and reverses again. In this example, does the market have buying pressure or selling pressure? Is the market in an up trend or down trend? Not sure? Well you’re not alone. Most of the traders in the above example were confused also. Initially when the traders placed their “Long side” trade, they took a position and then placed Sell Stops to protect their position. The market moves downward in the opposite direction of the position triggering the stops. Once all the stops were cleared out, the market lost momentum and reverses. So, now everyone who was initially long has been closed out of their positions. Now for those traders fortunate enough to have been short, begin to cover their positions and take profits, which also begin to trigger the buy stops of those traders who are short when the market reverses to the upside. This process is a constantly repeating cycle. Market moves in the wrong direction, triggering stops. The market then reverses when the stops have dried up and begins to trigger stops in the opposite direction. This is the basis of the saying, “The Market moves to where the stops are located.” Co-incidentally, major swing points or major reversal price points are used as major placements for stop positions. Next time you look at a chart, consider looking at it from this point of view, ie. “ Where are the stops located?.”. You just may begin to look at charts and what they represent in a bit of a different light.

MTI North America

I am honored to share my thoughts on our methodologies, focusing on the current technical movements and conditions of the FOREX Markets, i.e. USD traded against the major world currencies such as the EUR, JPY, GBP. Let me ask this question. In your opinion, what drives the markets first ... Fundamental conditions or technical movements?

I am sure you all have an opinion. Perhaps you have never even though about it. My belief is and what I have found that what works for me is the reliability of the technicals out performs the reliability of the fundamentals. Even though I strongly recommend, every trader must be aware of fundamental announcements, i.e. Governmental reports, Central bank decisions, interest rate changes etc. as best they can before they trade. My methodologies and rules for trading as well as risk management are based off of the technical movements (technical analysis) in the market.

If a trader wants to play this game and find long-term success, the best thing they could do for themselves is create a trading plan with a checklist of criteria for entry, and exiting positions. Creating a trading plan before entry plays a large part in avoiding emotional decisions and staying structured in your trading. After all, the worst time to check your fuel as a pilot is after the plane has taken off. The reason there are less accidents in the air, verses the ground, is due to well thought out flight plans by pilots, who create several alternative scenarios should things go wrong. I have come to the realization that, not only does Murphy's Law apply to trading in the markets, Murphy's primary residence is found in the trading charts. If any thing can and will go wrong, It will go wrong.

Trading is not a game of chance or luck. It is a solid means of creating income. It can be like playing a game of chess. At all times, there are several scenarios that can take place. The expected move of the market is usually not in the direction we thought and the out come is like playing chess with an expert. They have a habit of blindsiding you as you play with the out come of the game ending unfavorable and a lot earlier than you anticipated. Income comes to those who approach the market with knowledge and a serious level of disciplines. Safety and longevity in trading comes from properly educating yourself on how the markets work first and then knowing how to manage your risk.

Having said that let me get started with our approach in trading on the FOREX.

I don't care how you look at the market. It can only move up, down and sideways. The question is, on what time frame?

Every day the market is filled with traders who have different opinions of which way the market is moving. I have learned that one of the reasons they think and feel so differently is based on the charts and time frame they are looking at. A trader who looks at daily charts may think the market is trending up, while a trader who looks at a 60 minute chart may think the market is trending down. The fact is, they may both be right.

The question is, how are they both right? What were the signs or analysis that made them both right? It comes down to understanding technical analysis and whether your trading style is that of a day trader / scalper or long-term position trader. We have created a trading methodology that includes 4 major aspects of Technical Decision making:

1. Candlestick Formations
2. Fibonacci Corrections / Retracements and Extensions
3. Financial Breakouts
4. Trading in the direction of the trend using Trend lines

• Download PDF to read the full manual

ForexYard

Forex Trading with FOREXYARD

Receive up to $1,000 cashback on deposit, reliable analysis & high level of client support. Register today for a Demo

As the online Forex trading market becomes increasingly saturated and the choice of brokers becomes wider, the decision of which broker to run with becomes increasingly important for the trader. Although the majority of brokers provide the same basic trading platform, there can be a vast difference in what they offer their clients, both in terms of trading conditions as well as customer support. By simply visiting a company's homepage it may be hard to separate the second-rate firms from the professionals, therefore this article will examine the main parameters that should be taken into consideration before creating an account and depositing.

Account type

The decision of which type of account to open will most likely depend on the amount of capital you have to invest. Most brokerages offer two main account types: a "Mini" ($100-$200 minimum deposit) and a "standard" account ($1,000-$2,000 minimum deposit). Mini accounts are best suited to new or amateur traders looking to gain market experience and confidence with a smaller investment, and offer higher leverage, which you’ll need in order to make money with such a small amount of initial capital. "Standard" account holders can expect to enjoy a wider variety of leverage options, but will have to invest a greater sum of money for the privilege. Although not as commonly advertised, many brokers provide a premium service for large investors (perhaps $100,000 - $250,000+), including additional VIP services, such as a dedicated fund manager and tailor made conditions.

Common to nearly all online brokers is the offer of a demo account, which allows users to get a feel for the software and gain trading experience without the risk of market exposure. Such simulations are undoubtedly beneficial to potential clients wishing to test the waters, but caveat emptor: they are not always representative of real-market, real-platform conditions, despite claims of full functionality. Do not be afraid to question a brokerage on this matter - an honest, reliable broker will admit the downfalls of a demo account.

Software Considerations

The foreign currency market can move at a fast pace and will often require you to make quick decisions and executions, regardless of where you happen to be. Depending on your level and frequency of trading as well as travel habits, it may be wise to choose a brokerage that offers a web-based Java trading platform, which requires no download and enables you to trade from any location worldwide.

Payment Options

Look for brokers that allow you to pay with credit card, as this is the easiest option by far and does not involve the necessity of transferring funds from online e-account. Other payment options typically offered include wire transfer, which is equally as secure as credit card, but expect to wait a number of days for it to clear and to have access to your funds.

Support

Perhaps one of the most crucial considerations and one that may potentially have a significant effect on your trading success is the issue of customer support. Whether you are a first time forex amateur or a FX vet, having the support and advice of a reliable, dedicated customer service team is undoubtedly invaluable, so it would prudent to do your homework on this one. The only way to gauge the quality of a support team is to contact them and see how they deal with your inquiries: are they fast, do they give reliable technical and market advice; do you get the sense that they know the industry well enough to advise others, or are they simply good sales people? This might not be so easy to find out, but as the only point of contact between yourself and the brokerage, it is important to do so. As with any business, pre-sale service might be more satisfactory than post-sale, so again, try to judge whether or not you are being helped or simply pitched.

Platform, Tools & Analysis

In the present online market place it is rare to find a company which does not offer real-time tools such as charting and price updates, but predictably the quality and availability of such applications will vary from broker to broker. Ideally you should have access to a wide range of tools, enabling you to assess the market 24 hours a day, making your trading decisions accordingly, and in addition your broker should also provide you with daily market reports, prepared in-house by professional analysts. These reports should cover the basics: economic news relevant to the major currencies, technical movements and general commentary. The better known, more reputable analysts have their reports published on a number of the larger online forex portals and forums, which is an indication that their data is considered accurate and reliable, which in turn tells you a little more about the reliability of the brokerage itself.

As previously mentioned, many trading platforms offer the same basic functions, but not all brokers cover all areas of the forex market, so before committing make sure your chosen platform will let you trade the currency pairs you require.

Spreads

Spreads are an important factor to consider before investment and will certainly require some shopping around in order to find the best offer to suit your trading habits. The spread is the difference between the price at which currency can be bought and the price at which it can be sold at any given point in time. FX brokers don't charge "commissions", so this difference is how they make their money; therefore, the lower the spread, the lower the commission, and unlike stocks, currencies are not traded through a central exchange, so the spread may differ from broker to broker. Spreads differ according to account type, with mini accounts offering spreads between 1.5-2 times higher than those offered for Standard accounts, which in turn are higher than those offered to large volume traders with VIP status.

"Fixed" spreads remain the same day or night, and despite market conditions, and although they are usually somewhat wider than the narrowest of variable spreads, they can be safer over the long term by providing a slightly higher level of predictability and a slightly lower level of risk. "Variable" spreads change according to market conditions (which may initially be attractive during a calm period, but once the market becomes busy, they are likely to widen considerably, meaning that the market will then have to move significantly in your favor before a profit is turned).

Leverage

Unless you intend to invest a six-figure sum of capital, the use of leverage will be essential in order to make decent profits in forex. Generally speaking, the sum of money made during a successful trade amounts to just fractions of a single cent per unit, so if you are buying lots worth just a few thousand dollars or less, your profits will be minimal. This is where leverage comes into play: in effect by "borrowing" your broker's funds temporarily you will be able to make larger trades, which, if all goes according to plan, will lead to larger profits. Obviously, this practice involves an inherent risk: if the market takes a turn for the worse you risk losing a substantial sum of money, depending on the amount of leverage taken. For this reason it is advisable to do some further reading on leverage and margins prior to using leverage, so that you are fully informed before exposing yourself to the open market. Under normal market conditions, some common currency pairs are generally less volatile, and may warrant a higher level of risk taking, while more exotic currencies may not be predictable enough and traders would be advised to use less leverage when getting involved with such pairs. Mini accounts provide the highest levels of leverage, with some brokers offering up to x 400.

Education

While practicing on a demo account may help you improve somewhat and trading with real money might teach you some hard-learned lessons, the best way to improve your trading ability and provide yourself with a solid knowledge base is to educate yourself. To this effect, more and more online brokers are offering trading courses or tutorials, ranging from free five minute "introductions to forex" to curricula covering the smallest of details and costing thousands of dollars. Well established educational centers, such as the Online Trading Academy (OTA), with years of technical training experience are your best bet, providing solid instruction that will not only teach you the basics of the market, but also the technical side of the business (advanced technical analysis, charting, chart reading, Fibonacci calculations etc.). Some brokerages produce their own courses in conjunction with such trading centers, such as the course offered by Forexyard.com. Without educating oneself, the vast majority of built in market tools offered by trading platforms will be wasted on the amateur forex trader.

In summary, there are numerous factors to consider before choosing the right online forex broker, all of which should be researched to ensure that your trading account and broker will allow you to get the most from your investment. You must be aware that some brokers do not have your best interests at heart, but do not despair, as there are many reputable and reliable companies eager and capable of providing a professional service. As part of your research, be sure to visit the many online trader forums, where you can discuss any of the issues raised in this article with other traders, many of whom will already have been through the process of choosing a broker and will be able to advise you from their own experiences.

ForexHit

What is Money Management System?

Money management system is the subsystem of the forex trading plan which controls how much you risk when you get an entry signal from your forex trading system. One of the best money management methods used by many professional forex traders is to always risk a fixed percentage of your equity (e.g. 3%) per position. By using this method a trader gradually increases the size of his trades while he is winning and decreases the size of his trades when he is losing. Increasing the size of bets during a winning streak allows for a geometric growth of the trader's account (also known as profit compounding). Decreasing the size of bets during a losing streak minimizes the damage to the trader's equity. You can view interactive demonstration of this technique by opening the forex trading simulator (Please note: The size of this page is 0,6 Mbs and it requires that you have Flash installed and Javascript enabled in your browser).

Trading on forex allows to multiply your account over time - or to make it grow geometrically. Geometric capital growth is produced when the profits are reinvested into the trading which leads to progressively larger positions being taken and, consequently, to bigger profits and losses. The pace at which the account grows is controlled by the size of the profits and by their frequency (which should always be remembered by forex trading system developers). While the geometric equity growth can and should be smooth (i.e. consistent), some traders try to accelerate it by artificially inflating the size of their profits by risking very high percentages of their account. Because the actual sequence of the winning and the losing trades can never be predicted in advance, such practice results in very erratic trading performance (i.e. sharp equity fluctuations). Among other things this practice betrays the trader's lack of confidence in his or her trading system's long-term profit potential. As long as the trader is confident about his trading system he can risk small percentages (%1 to 3%) of his account on every trade and simply watch the system realize its potential. It should be noted that only the geometric capital growth allows to make regular profit withdrawals from an account (as a certain percent of the equity) without seriously affecting a trading system's money making ability. This contrasts sharply with the fixed-dollar-bet money management system (e.g. always risk $500 per trade) whose profits grow arithmetically and where each withdrawal from the account puts the system a fixed number of profitable trades back in time.

Both proper money management and sound trading system are required for a smooth geometric capital growth. The speed (i.e. "geometricity") and the smoothness of the account's growth depend on how much you risk per trade (as set by the money management system) and on the trading system's accuracy and the payoff ratio parameters (trading system's mathematical expectation). Apart from the controlling equity fluctuations by setting a fixed percentage of the capital to be risked on any trade, money management system can also reduce equity swings through diversification (splitting your risk capital among unrelated currency pairs/trading systems).

Quote: "..analysis is the door to fabulous riches, while money management is the key that opens that door.", Robert Balan, in his book, "Elliott wave principle applied to the foreign exchange markets".

How Much to Risk?

Quote: "There is no return without risk", the 1st rule of the 9 Rules of Risk Management, by RiskMetrics.

Trading on the forex market can be a very profitable business. Armed with this fact some traders start determined to make huge sums of money in as little time as possible - by risking too much. In other words, they are aiming for fast geometric growth of their accounts with no regard for the smoothness of the equity curve. Doing so invariably results in severe drawdowns or complete wipe-outs as can be easily seen if you enter values larger than 10 as the “Percent Risked” in the forex trading simulator (Please note: The size of this page is 0,6 Mbs and it requires that you have Flash installed and Javascript enabled in your browser) and model a few equity scenarios with this setting. Risking high percentage of your account might indeed have dramatic effect on the geometric growth of your account balance in the very short-term. However, winning streaks (however long) are always followed by losing streaks (however short) and much of what was “given” by the high percentages is very likely to be “taken away” by the same percentages.

For example, if you risk 25% of your account balance per trade with the system accuracy of 50% and the payoff ratio of 2 you can expect to double your account in 6 trades (as you can see from the "Exp # of trades to TR" cell on the forex trading simulator when you use such settings). You can also expect to give away most or all of these profits in the next few traders – as the same percentages will now cut deep into your profits when your trading system generates losing signals. Now try to imagine how you would feel if your car accelerates to a 500 miles per hour in a few seconds then suddenly reverses and flies back at the same speed. You would achieve similar effect on your feelings or your investors' if you got your account up to 100% in a few trades and then lost all of the profits in the very next few trades.

It certainly pays to keep the speed (percent risked) of your car (forex trading system) within reason so that you can reach your destination (e.g. doubling you account balance) without submitting your emotional and financial well-being to excessive risks - as both your financial and emotional strength tends to be limited. At lower percentages of equity risked a winning or a losing streak simply does not have as spectacular impact on the equity curve which results in smoother capital appreciation (and much less stress for the trader or for the investor). This is because when you risk small fractions of your equity (up to 3%) each trade is given less "power" to affect the shape of your equity curve which leads to smaller drawdowns and consequently greater ability to capitalize on the winning signals in the future. In other words, the size of drawdowns is directly proportional to the percent risked. You can see this if you enter progressively larger values in the "Percent Risked" filed in the forex trading simulator and then compare the resultant maximum drawdowns (in "Max DrawDown in %" field) for each of percent values that you entered. In addition to being directly proportional to the % risked, drawdowns are inversely proportional to both the accuracy and the payoff ratio (average win/average loss) of a trading system (as you can see if you enter different accuracy and payoff ratio values in the forex trading simulator). This relationship can be clearly seen with the help of the three 3D charts shown below which plot the combined effect of the payoff ratio and the accuracy of a trading system on the maximum percent drawdown, as seen during 15,000 trading scenarios modelled on the forex trading simulator (5,000 for each of the three different "perecent risked" settings which were tested - 1%, 3% and 5%).

Quote: "..the final return is only a function of how well you would like to sleep at night", Thomas Stridsman, in his book "Trading Systems That Work: Building and Evaluating Effective Trading Systems".

A drawdown is the distance from the lowest point between two consecutive equity highs to the first of these highs. For example, if your account increases from $10,000 to $15,000 (first equity high) then drops to 12,000 (lowest point between equity highs) and then rises again to $20,000 (second equity high) your drawdown will be $3,000 ($15,000-$12,000) or 20% ($3,000/$15,000). When deciding on the percent to be risked on each trade you should keep in mind that as the drawdown grows arithmetically, the profits (and psychological fortitude to stick to the system) required to get out of it increase geometrically (as you can see from the chart below). You can also use the following calculator to model the effect of a losing streak on the equity and the profit required to recoup the loss. The "%" stands for the percent of the equity risked per trade. The "#" stands for the number of consecutive losses. The "loss" column calculates the cumulative damage to the equity in percentage terms. The "recoup" column shows how much profit is required to return to the breakeven. Alternatively, you can just enter the value of loss into the cell below the "Loss" heading to calculate the size of the profit necessary to recoup it.

As can be readily seen from the above calculator it takes only a few trades to severely damage your prospects as a currency trader - if you risk too much in your trading. With this information in mind it is best to always risk a maximum of 1% of the equity if you are managing other people's money and a maximum of 3% of the equity if you are trading with your own funds. As a general rule the higher the accuracy of a trading system AND the higher its payoff ratio the safer it is to risk more per trade. This principle is the basis for the money management calculator (Please note: This calculator requires that Javascript is enabled in your browser) located in the trade forex section of the site.

Note: It is best not to rely too much on the theoretical probability of a large number of losing trades happening in a row. In other words, because the probability of a few losses happening in a row is very low it doesn't mean this cannot happen in your trading. Suppose you trade a system which generates 60 winning trades out of 100 on average. The probability of a profitable trade is always 60%, while the probability of a losing trade is always 40% with such a system. The chances of 5 consecutive losses can be calculated by multiplying 0,4 five times by itself or 0,4*0,4*0,4*0,4*0,4 which results in 1,02%. Even if the probability of roughly one percent does look very remote this is not a zero probability and quite likely to happen in real trading - as you will quickly see if you model just a few equity scenarios in the forex trading simulator with system accuracy set to 60% (be sure to check the "Max. Consec.Losses" cell). Moreover, given that the outcome of any single trade can be considered random there is nothing in the world that can guarantee that your system's next five trades will not be all losses or all profits, for that matter. Therefore, it is best to be prepared for such an outcome in advance by risking less of your account per each trade. Closely related to this is the idea of luck in trading, which can be defined as the clustering of large number of profitable trades in narrow periods of time. For example, you can easily generate a string of 12 winning trades on the forex trading simulator with the system accuracy set to 60%. The probability of such an event is equal to 0,6 raised to the 12'th power or 0,2% or 1 in 500. Despite such a low probability you can expect to see 12 or more successive winners in your trading (be sure to check the "Max. Consec.Wins" cell on the forex trading simulator as you perform the above simulation) when you trade long enough with a system that has success rate equal to %60. Even if the short-term effect on the equity (and trader morale) of such a long series of successful trades can be quite dramatic, it plays little role in the long-term success as a currency trader. In other words, the fact that your trading system has just generated a long run of profitable trades doesn't say very much about its long-term profit potential, which should instead be measured by its mathematical expectation.

Money management system is similar to the forex trading system in that sticking to it is vital to the long-term success in currency trading. Once you decide on the percentage of equity that you will risk per position you should never deviate from this number and try to stay as close to it as possible - no matter how bad or good your system performance is. This question becomes especially important when you decide on the type of account that you open - if it will be a mini or a standard trading account. As you can see from the allocation efficiency calculator (Please note: This calculator requires that Javascript is enabled in your browser) mini accounts are vastly superior to the standard accounts (especially with account balances less than $50,000) when it comes to meeting the constraints of both your money management system (% risked) and your trading system (size of the stop-loss).

Note: When you select the account type you should pay close attention to the level of the leverage offered by your forex broker. Even if high leverage (from 1:100 and up) allows to trade multiple lots with very little money of your own, it can be dangerous when it forces you to overtrade - to assume positions which risk more than the percentage value set by your money management system. For example, you might be compelled to risk $400 (40 pip stop-loss) on a very attractive EUR/USD trade while on a standard account with the maximum allowable risk per trade set at 3% of $10,000 or $300. The only way to stick to your money management system would be to bypass this trade and therefore undermine your system's profitability (and your morale). You wouldn't need to avoid this signal or use smaller stop-loss than the one suggested by your system if you traded at half the leverage (which would mean only $200 risk per trade) or if you traded on a mini account altogether - as is shown by the allocation efficiency calculator.

Mathematical Expectation of a Forex Trading System

Mathematical expectation of a forex trading system is how much of the risked capital you can expect to earn per trade on average. You can calculate the mathematical expectation of a system by the following formula:

Mathematical Exectation= (1+average win/average loss)*(system accuracy) -1

This formula requires that you take into account both the success rate (percent of winning signals) and the payoff ratio (average win/average loss) of any trading system when estimating its long-term profit potential. For example, a system with 50% accuracy and the 2 to 1 payoff ratio has the expectancy equal to +0,5. This means you can expect to earn 50% of the amount that you risk per trade on average. If you risk 2% of your capital per trade you can expect to earn 1% per trade (50% of 2%) on average with such a system. Negative mathematical expectation (e.g. casino roulette) means you will lose your money over the long-term no matter how small or big your positions are. Zero expectation means you can expect your account to fluctuate around breakeven for ever.

Quote:"The difference between a negative expectation and a positive one is the difference between life and death. It doesn't matter so much how positive or how negative your expectation is; what matters is whether it is positive or negative." Ralph Vince in his book "The Mathematics of Money Management: Risk Analysis Techniques for Traders".

You can model various equity development scenarios under the positive, the negative or the zero mathematical expectations by entering the following accuracy and the payoff values in the system controls on the forex trading simulator:

This table demonstrates the value of letting your profits run and cutting your losses short when you start to trade and don’t yet have a reliable currency trading system to follow. When you begin to trade your accuracy tends to be low. To compensate for the larger number of losses you absolutely have to let your profits run and keep you losses small. This will ensure that the profits from the few winners that you are able to capture will more than cover the total loss from all the losses that you take. Not allowing your profits to run at the start of your trading career would simply be "suicidal". This boils down to selecting the trades only with high reward/risk ratios. This will help to improve your payoff ratio and, therefore, your profit potential.

As you can also see from the table above, systems with different accuracy and payoff ratios can have identical mathematical expectations. This means, for example, that in the long run the profit that you can achieve with the system that is the first in the table will be equal to the profit that you will make using the second system - even if the second system is twice as accurate as the first one. You can compare how the equities develop for both of these systems by using the currency diversification simulator (Please note: The size of this page is 0,7 Mbs and it requires that you have Flash installed and Javascript enabled in your browser). Enter 40 in "past accuracy" field for system A and 80 for system B. Payoff ratio should be set to 3 for A and to 1 for B and set the "Percent Risked" to 1. If you wish to compare B with a more dissimilar trading system you can enter 20 as the accuracy and 7 as the payoff ratio on the A's control panel.

The closer the simulated equity performance (shown in the "Actual Accuracy" field) is to the past accuracy of each of the systems the clearer you will see that both systems tend to converge at the same final equity level. Because geometric capital growth is highly dependent on the frequency of the profits - when you increase the Percent Risked - a system with substantially higher accuracy will outperform a less accurate system even if both of them have identical mathematical expectations. This is one of the reasons to strive for the highest possible rate of accuracy in your trading. The other reason is that drawdown duration and size (in both absolute and percentage terms) tend to be much larger with the lower accuracy systems which leads to lower reward-to-risk ratios - as you can quickly see if you check the ""Drawdown time", the "Max Drawdown" and the "Max % Drawdown" fields in the diversification simulator when you do the simulation described above. As a third reason, it is always necessary to give a trading system some "room for error" in real-life trading - or excpect it to trade with accuracy lower than the past accuracy. Very low accuracy and high payoff ratio systems simply do not offer this - which means you should be prepared to sit through very long losing streaks before you see any profit. In contrast, higher accuracy forex trading systems make the currency trading less stressful by ensuring that you take smaller yet much more regular profits.

It stands to reason that the higher the mathematical expectation of a trading system the faster your account will grow. Very good trading systems have mathematical expectation close to 0,8. Common definition of an excellent trading system is that its payoff ratio is one point better than the payoff ratio of a breakeven system with the accuracy of 10 percent less. For example, the payoff ratio for a breakeven system with 40% success rate is 1,5, therefore an optimal system with 50% accuracy will have 1,5+1 = 2,5 payoff ratio. The following calculator allows you to compute the payoff ratio for a breakeven system and an optimal system:

Quote: "The first part of your system design should focus on building the highest possible expectancy into your system" by Van K. Tharp in his "Special Report on Money Management".

Note: You can get the most reliable measure of mechanical expectation of a trading system when you can translate it into computer code. One example of a simple trading system which can be readily backtested to calculate its expectancy is the moving average crossover system. Most of the advanced forex charting packages (e.g. FXtrek IntelliChart™ Copyright 2001-2007 FXtrek.com, Inc.) allow to construct wholly mechanical trading systems and to backtest them over historical price data. If you are using interpretive technical analysis tools in your trading (like price patterns, trendlines) you can only generate the statistics required for the calculation of your system's expectation by using the information from your trading log (where you enter individual trade results when you test-trade your trading system on a demo account). However, since these statistics are generated using interpretive analysis methods their validity will stay the same only if you continue to interpret price formations in exactly the same manner as you did before. Because signals of mechanical trading systems are never open to conflicting interpretation, their mathematical expectation is more reliable measure of future system performance than the expectation of interpretive trading systems.

Diversification in Currency Trading

Diversification is the distribution of the risk capital across unrelated currency pairs and/or trading systems for the purpose of increasing the consistency of trading performance. For example, if you trade one system on two unrelated currency pairs you can protect yourself against long losing streaks that any of these pairs can go through on its own. When you get a losing signal on the first pair, the second pair might generate a winning trade which will cover the loss of the first pair or vice versa. By splitting the risk capital (% of your equity) among two pairs you can be sure that when both pairs generate losing trades at the same time your total risk will not exceed the maximum value set by your money management system. This way you can achieve smoother capital appreciation than you would be able to do if you traded only one pair. For an interactive demonstration this concept please visit the currency diversification simulator. It should be noted that this calculator assumes zero correlation between the pairs or systems (more on correlation below).

Be sure to compare the values in the "Consistency" cells for each of the pairs when they are traded separately with the value of consistency achieved when trading them together (in the "Trading A&B" column). The combined consistency will almost always exceed the consistency of either of the pairs when they are traded individually.

The more unrelated pairs or systems you add to your portfolio the better protection you can have against the risk. For example, when trading one trading system on two absolutely uncorrelated currency pairs you decrease the probability of a losing trade (two pairs generating a losing trade simultaneously) by the percentage value equal to the system's accuracy. Suppose your system has the success rate of %60, therefore the probability of a losing trade for each pair is %40. The probability that both pairs will generate a losing signal is calculated by multiplying %40 by itself - which results in %16. This is the %60 decrease (24/40=0,6) in the probability of a losing trade achieved when you trade both pairs simultaneously. If your system has %70 success rate you can reduce the probability of a loss by %70 if you trade two unrelated pairs instead of one. The probability of a losing trade occurring for both pairs at the same time is %9 (%30*%30) which is a %70 decrease in the likelihood of a loss if you traded only one pair (21/30=0,7). I will note that even if you diversify into two or more weakly correlated currencies/trading systems, this won't eliminate the drawdowns completely. However weak is the correlation between the pairs or trading systems, they are likely to go through the losing streak all at once, at some point in the trading. You can see this by modelling the performance of two similar trading systems with the help of the currency diversification simulator (e.g. set accuracy to 40 and payoff ratio to 2 for both A and B) and checking if the yellow curve on the DRADOWN chart is moving in sync with the other two curves.

There is a weak relationship between two pairs if the absolute value of their correlation coefficient (usually denoted by r) doesn't exceed 0,3 (i.e. it can be anything from -0,3 to +0,3). A medium strength relationship exists when the absolute value of the coefficient is greater than 0,3 but less than 0,5. There is a strong relationship between two pairs if r is greater than 0.5 in absolute terms (i.e. bigger than 0.5 or less than –0.5). Currencies are said to be highly correlated if the absolute value of their correlation coefficient is equal to or bigger than 0,8. You can visualize these concepts with the help of the interactive correlation simulator. (Please note: This calculator requires that you have Flash installed and Javascript enabled in your browser)

Suppose you trade two currency pairs which are highly positively correlated like the EUR/USD and the GBP/USD (daily r is equal to 0,8 on average). When you get a sell signal for EUR/USD your system is likely to generate the same signal for the GBP/USD. If the first signal results in a loss this increases the probability that the second signal will not be profitable either. The same holds if you are trading very negatively correlated pairs with the same system - like EUR/USD and USD/CHF (daily r is equal to -0,9 on average). Selling one lot of EUR/USD and buying one lot of USD/CHF at the same time (e.g. on the break of a trendline which usually is simply a mirror image of the trendline visible on the other pair's chart - e.g. set "Target Correlation" to -0,9 on the correlation simulator and notice how similar are the imaginary trendlines for A and B) amounts roughly to selling 2 lots of EUR/USD or buying 2 lots of USD/CHF individually - with no reduction in risk whatsoever.

Quote:"Through bitter experience, I have learned that a mistake in position correlation is the root of some of the most serious problems in trading. If you have eight highly correlated positions, then you are really trading one position that is eight times as large." Bruce Kovner in Jack D. Schwager's book "Market Wizards: Interviews with Top Traders ".

In contrast, when you trade two uncorrelated or loosely correlated pairs you can expect your system to perform differently on each pair which should result in smoother overall trading performance. As an example you can buy a touch of a uptrendline on one pair (e.g. USD/JPY) and sell the top of the range on another unrelated pair (e.g. GBP/CHF, which has an average r of 0,3 with USD/JPY) without having to worry that price developments in USD/JPY might "spill over" into GBP/CHF (or the other way round) and by doing so spoil your whole trading setup. As the next best alternative, you can reduce the risk by opening opposing trades in the positively correlated pairs or same direction trades in the negatively correlated pairs - by using a different system for each of the pairs, as is described below. Yet another way you can use correlation is to select among highly correlated pairs that pair which offers the highest reward potential under the current market conditions and trade only it.

You can monitor the correlations between the currency pairs that you trade by using the information on the currency correlations page (which contains most up-to-date correlation data for the commonly traded currency pairs). I will note that it is best to keep the number of the currency pairs in your portfolio to a minimum because the number of the correlations to be tracked and the time required for this rises geometrically with the addition of each new pair. The formula for calculating the number of correlations between n number of pairs is [n*(n-1)]/2. You can start with one currency pair and gradually increase to a maximum of four pairs (with 6 correlations to monitor) as your experience grows.

When you diversify into different trading systems you should look for a combination of systems which results in the lowest possible correlation between their returns. Ideally you would trade only two systems which are perfectly negatively correlated (r=-1). This means that whenever one system generated a losing signal the other would produce a winning signal and vice versa. Examples of this possible combination are a mean-reversion system (e.g. RSI) and a trending system (e.g. Moving average) - for more examples please consult Richard L. Weissman's book "Mechanical Trading Systems: Pairing Trader Psychology with Technical Analysis". If you could find such a perfect combination of systems you would not see a single loss (as their net result) because the loss of one system would always be covered by the profit of the other. You can see how this works if you enter minus one into "Target Correlation" cell on the system correlation simulator (Please note: The size of this page is 0,7 Mbs and it requires that you have Flash installed and Javascript enabled in your browser). In practice, it is extremely hard to find perfectly negatively correlated systems. Nevertheless, even if systems traded are only mildly negatively correlated the trader can expect to benefit from the risk reduction offered by the diversification.

Quote: "The correlations of the different market systems can have a profound effect on a portfolio. It is important that you realize that a portfolio can be greater than the sum of its parts (if the correlations of its component parts are low enough). It is also possible that a portfolio may be less than the sum of its parts (if the correlations are too high)." Ralph Vince in his book "The Mathematics of Money Management: Risk Analysis Techniques for Traders".

Note: You can create and autotrade your own portfolio of loosely related trading systems created by the top forex signal providers with the help of the firms listed in the invest in forex section of our site.

Mastering Money Management in Forex Trading

The key to mastering money management is shifting your attention from the dollar value of your profits and losses to their percentage value of your account balance. Once you have trained yourself to think of your profits and losses exclusively in percentage terms it will be a simple mathematical task to stick to your money management system (e.g. just enter your constraints into the money management calculator and it will give you the number of lots to trade). As you account grows this practice will help you to avoid the hesitation in placing the trades when the absolute value of the dollars risked becomes very large - since you will know at that moment that you are still risking no more than amount dictated by your money management system (which will have played a major role in getting your account to that level in the first place).

You should also remember that the outcome of any single trade is almost always random. It is, therefore, not practical to attach yourself too strongly - either emotionally or financially (by risking too much)- to the result of any one trade or a series of trades. This concept of randomness is incorporated into all the trading simulators on this site which use random number generators to determine if any single trade is profitable or not.

As with the forex trading system, you can receive protection from your own destructive tendencies by closely following your money management system. It will protect you from greed and pride (which always demand that you overtrade) when your system generates unusually large number of winning signals in a row. It will also protect you from trader paralysis (inability to open new positions) when your system goes through a losing streak because you will know that, as long as you risk a small fraction of your equity per each trade (as is set by your money management system) and use a currency trading system with positive mathematical expectation, no string of losses can wipe out your trading account.

This article is taken from the Forex Journal, a special edition by Trader’s Journal magazine in Nov 2007.

The author is Daniel M. Gramza. He is President of Gramza Capital Management, Inc. He is a trader, consultant to domestic and international clients. He is completing Trading in the Eye of the Storm and The Handbook of Japanese Candle Trading Strategies. Mr. Gramza develops and presents worldwide public and private courses on trading strategies.

• Daniel Gramza provides a detailed outline of questions that a trader must answer before embarking on a trading career. Many novice traders believe that all they have to do is sit down behind a computer and begin trading. Nothing could be further from the truth:

The accessibility of screen based trading has transformed the trading industry. Many novice traders believe that all they have to do is sit down behind a computer and begin trading. Nothing could be further from the truth.

• Read the whole article

This article is taken from the Forex Journal, a special edition by Trader’s Journal magazine in Nov 2007.

The author is Dar Wong. He has 18 year of trading experience in global futures and Forex markets. His past employment as a floor trader involved Bank of America, Bankers Trust, Barclays ZW and S.B. Shearson Citigroup. Now, he is serving as a hedge advisor, coach and also trading on his personal account, besides writing as a Forex columnist for newspapers.

• Dar Wong discusses trading Forex as a business opportunity. First, he discusses the terms and nuances of trading Forex currency pairs and then shares the personal tools that need to be developed to become a successful currency trader

Since the turn of the new millennium, ‘Globalization’ has come to affect most commercial enterprises. Businesses face stiffer competition from faster communications, but reach a wider consumer base for this same reason! As a result, only those who are productive, fast and efficient will survive in their trades.

The new modern economy has reached a turning point. Today, many businesses can be operated profitably from home. Many businesses can also be highly profitable with low capitalization and scarce labor! In other words, one does not need to toil and sweat for long hours to achieve the linear results by investing the same amount of effort.

• Read the whole article

LearningMarkets.com

Over a trillion dollars per day is exchanged on the foreign currency market. The Forex market is used by smart traders for speculation, hedging and long-term profit taking.

You can trade in the foreign currency market. It is available to anyone and everyone.

Take our Forex Essentials course and follow our analysis to get started in this exciting market.

Overview: Learning the Forex with us

There are a couple things you need to know about this course and our educational philosophy. We believe you will learn best when there is a mix of media in a course. That's why every lesson you'll find in Forex Essentials contains the following:

• Written Text
  
• Video Demonstration
  
• Examples

The combination of these items will provide for you a rich learning experience where the principles will be learned, re-inforced and tested, meaning you really learn the stuff.

This course is also meant to be used as a reference guide. You can come back to it and re-read. Watch the videos again after you've started applying a principle. You will find the video demonstrations to be even more valuable as you have a better understanding, and some experience in the market.

A note to more experienced traders: You will likely still find great benefit in this course. The way PFX approaches and teaches the forex is very different from anything you've seen. We also invite you to submit feedback and offer suggestions for future courses. Simply email feedback@learningmarkets.com

What every forex trader needs to know

There are a lot of things that a new trader needs to know about the forex. This section is a summary of some of this information and a preview of the things you will learn through the rest of the course. Feeling comfortable with this information is important before you begin trading and in most cases it isn’t difficult to understand. If you are properly armed and willing to hold realistic expectations and put in some work you can find yourself Profiting With Forex in no time.

You can trade in the foreign currency market. It is available to anyone and everyone.

You don’t have to be a mathematical genius to trade in the forex market.

You don’t have to be an economist to trade in the forex market.

You simply have to learn what trading signals to watch for and how to respond when you see those signals.

First, you have to learn and understand the basics so you have a strong foundation to stand on in your trading.

While learning and understanding this material and building a strong foundation is important, you must remember that this is only your first step. You can only learn so much from this material. To truly become a successful forex trader, you need to take what you learn here and start applying it in the live market.

Think of this part of the course as Driver’s Ed. When you learn to drive, you go to class to learn about traffic rules, how your car works and what you are supposed to do as a driver. That is the first step you take when learning how to drive. However, there are two more steps you have to take before you can get your driver’s license: driving on the range and driving on the street with an instructor.

Trading in a forex demo account (a working practice account that is funded with paper, or pretend, money) is the equivalent of driving on the range when you are learning how to drive. You are in the car and you have to make live decisions, but you are operating in a controlled environment.

Trading in a live forex account is the equivalent of driving on the street when you are learning to drive.

We will be there along side of you to give you pointers and help you make decisions when you are driving on the range (trading in your demo account) and driving on the street (trading in your live account), but you will be behind the wheel. You will be making the decisions and seeing how those decisions play out in real life.

Once you’ve taken these three steps, you are ready to go out and trade on your own.

Learn how the market works and you can trade it

The first thing you need to learn about as a forex trader is your trading environment. Whether you are a brand new trader or you have had experience trading in other markets—like the stock market—you need to understand the unique characteristics of the forex market so you can be properly equipped for success.

You have access to leverage in the forex market. Leverage gives you the ability to trade a position larger than the amount of money in your account. For example, using leverage, you could place a $100,000 trade by only using $1,000 of your own money in your account.

Word of caution: leverage is a tremendous tool for traders. It allows you to make more money on trades than you normally would if you were using only your own money. However, it also allows you to lose more money on trades than you normally would if you were using only your own money.

When you trade with leverage, you have to post margin. Margin is the amount of money you have to set aside in your account when you enter a trade. For example, if you are using 100:1 leverage and you buy 1 mini lot—which is worth $10,000—you must set aside $100 as margin ($10,000 ÷ 100 = $100).

Currencies are grouped in pairs for trading.

When you trade in the stock market, you buy or sell the stock of one company. When you trade in the forex market, you buy or sell a currency pair (two currencies put together).

Exotic pairs:

(These are some other lesser-traded pairs that contain the USD and a currency from a small and/or emerging economy)

USD/SEK (U.S. dollar / Swedish krone)

USD/NOK (U.S. dollar / Norwegian krone)

USD/DKK (U.S. dollar / Danish krone)

USD/HKD (U.S. dollar / Hong Kong dollar)

USD/ZAR (U.S. dollar / South African rand)

USD/THB (U.S. dollar / Thai baht)

USD/SGD (U.S. dollar / Singapore dollar)

USD/MXN (U.S. dollar / Mexican peso)

As you begin investing in the forex market, you should focus on the major pairs and some of the crosses. Spreads (the difference between the price you can buy and the price you can sell the currency for) are tighter, liquidity is higher and information is more readily available for the major pairs—which makes it easier for you to be profitable trading them. As you progress, you can consider investing in some of the exotic pairs.

Imagine each pairing as a tug-o-war, the stronger currency pulls the price of the currency pair in its direction.

One thing causes currency pairs to become stronger or weaker: people (buyers and sellers). Remember that it is ultimately people who move this market.

What are these people watching?

You should watch the same things.

Final Thoughts

You have to be willing to take what the market gives you. If you try to fight the market, you will lose every time.

Currency pairs can move up, down or sideways. You should be prepared to know how to respond in each scenario.

The past cannot tell you what will happen in the future. However, you can find recurring patterns that can put you in position to benefit from future movements. This course will help you start doing that.

Forex Essentials Course - 21 lessons:

1. What is the forex
2. Supply and Demand
3. How Trading Works - Interbank and the Forex
4. Choosing a Dealer
5. Forex Pairs - Characteristics and Qualities
6. Earning Interest in the Forex
7. Margin and Leverage
8. Short Term vs. Long Term Trading
9. Forex Futures vs. Spot Forex Accounts
10. Fundamental Analysis in the Forex
11. The Calendar and Economic News
12. Introduction to Charting and Technical Analysis
13. Support and Resistance
14. Fibonacci Analysis
15. Price Patterns
16. Continuation Patterns
17. Reversal Patterns
18. Technical Indicators
19. Portfolio management – Diversification
20. Portfolio Management - Position Sizing and Stop Losses
21. Introduction for Forex Options