What is forex?

The foreign exchange market is a financial market which are freely traded currencies. Most major currencies were already traded in the 70s but at the time, this market was only available to institutional investors. It is the rise of the Internet that has actually allowed individual investors to access the forex with a capital as low as 100 euros.

It is the most liquid financial market in the world with in excess of one trillion dollars traded daily, this is far greater than any other financial market. One can not be sure of the exact numbers as unlike futures, stocks and so there is no centralized exchange. The market is traded from midnight on Monday (GMT) to midnight on Friday.

The Forex market has a very wide spectrum of traders from the very small to the very broad including central banks, banks, corporations, hedge funds, portfolio managers and small speculators. The forex market is often used by big business' to hedge their currency risks are theirs imports and exports

This is a good simple strategy. I have traded it myself on a demo account with great success. It involved looking at the daily charts and drawing trend lines. A trend line must connect to at least two points. It is important that the trend line doesn’t have any breaks between the two points it connects to. Here is an example:

As trend lines are often used as support and resistance points, the market often bounces and sometimes even reverses at them. The way we can use this to our advantage is by placing buy or sell orders at the trend lines. We can place a stop just below the trend line, but ensure you leave enough room for volatility. If the trend line holds you can either set a TP at a support or resistance point or use a trailing stop. I like trailing stops personally. If the trend line breaks you take a small loss, but if it holds as they so often do you have a good chance of a winning trade that greatly exceeds the risk you took. You can see how this happened around the 11th May on the chart above. If you had placed a sell order at this point, it would have been a very nice, low risk trade.

• Having a concrete trading plan
• Always stay true to his trading plan
• Never trade too much
• Do not believe the predictions of "experts"
• Do not believe the news, only the price movement
• Always use a money management strategy
• Follow trends in the foreign exchange market
• Ensure that your strategy is profitable once you have paid the spread
• Ensure that your trading strategy can survive a bad trade
• Choose your broker wisely
• Put aside your emotions when trading
• Check twice the orders you place
• Never believe that there is a foolproof strategy
• Never insure in real unless you're completely safe
• Never assume that trade is easy
• Do not waste your money buying strategies of other
• Be cautious towards training trading, most are often useless.
• Take time to inform you on the forums dedicated to Forex, they are often an important source of information

In recent years, many traders invested in the foreign exchange market by focusing primarily on economic news. At first glance, trader based news seems pretty easy but it's not really the case. Indeed, this strategy requires trading, like technical analysis, a lot of patience and discipline involves having implemented a sound money management strategy.

There are many statistics or new businesses which have an impact on the Forex. Here are a few:

• Index of Consumer Prices
• Trade Balance
• Retail Sales
• Index of producer prices
• Interest Rate
• GDP

These statistics often have a significant impact on the foreign exchange market. If the published figures correspond to the expectations of investors, in general, the market hardly moves, but this is not always the case.

Forex News Trading Strategies

If you were trading in January 2007 you may remember the Bank of England shocked the vast majority of traders by hiking rates by 25bp. Let’s look what happened to the pound:

The pound shot up by a staggering 150 pips or so in the first minute. The move was so big because there was such an element of surprise amongst most traders. The traders who managed to get in before the big initial spike will have done extremely well. This is a common strategy for news trading. Waiting for a surprise event to occur, then trying to beat the spike. This is certainly not as easy as it might sound. There are two major obstacles for most traders; 1) Getting the numbers before the market moves 2) Finding a broker that will execute your order before the market moves. There are services out there that try to get the numbers to you quickly for less than $50 per month but often all but the very expensive ones fail. I believe the bloomberg terminal to be about the quickest, but it is around $1600 per month, out of the question for many small traders.

There are many different strategies for trading the news. Another is a “fade”. This is where you speculate that the market will move in the opposite direction after a spike. You can see on the chart above how price moved down in the short term after the spike. This often happens, but not always. Finding the top is not easy and does require a lot of discipline and practice.

Conclusion

While the prospect of news trading may be very appealing due to the low time commitment, like other forms of trading does require a lot of patience and discipline and certainly is not as easy as it may initially sound. However, with a lot of practice it is possible to make some very nice returns on your money.

Risk Management Forex

Forex Risk management is a term often used with FX trading. It is perhaps one of the biggest factors that separates the winning traders from the losers. Experienced traders know they must use extreme discipline at all times when trading if they have any chance of succeeding. The inexperienced trader may find this part of their trading the single most difficult thing to master. With FX trading it is always essential to have the long term picture in mind. One day here or there really has very little impact on the big picture. It is important that the amount risked on each trade reflects this view. For example there is no point risking 1% of your account per trade for 3 months, then risking 20% on one trade because it is a “sure thing”. This kind of behavior islittle more than gambling and that is not we want. We want the long term odds in our favour. It also potentially undoes all the hard work you did for those 3 months.

Let’s say we have a $10,000 account balance and have developed an intraday strategy and would like to risk 1% of our account balance on each trade:

Now let’s say our strategy is telling us to buy GBP/USD and there is major support 20 pips below price and we want to risk 30 pips.

1% of our account is $100. So we need to select the position size with this in mind.

If we divide the amount we would be prepared to risk with the number of pips we are prepared to risk, it will tell us the price per pip we wish to trade. Let’s do this simple math

$100 / 33 = $3.33.

The pip values of one minilot on GBP/USD are one $1 per pip. So our position size would need to be 3.3 minilots. Many brokers do not allow us to trade fractional minilots so we will round it down to $3. So our position size will be 3 minilots for this trade.

So the worst that can happen on this trade would be an approximately 1% loss. As no trader can win 100% of the time, and will inevitably go through a bad run at some point, it is essential to ensure when this does occur, it is a minor bump along the road and not a complete disaster to your account. Remember, always think of the big picture. Forex Risk Management is so important!

Let’s take a quick look at what would happen if you used too much risk on your trades and hit a bad run. Most strategies do at some point. Say you were trading with 1% risk per trade your account was -10% at the end of the month, you would need around 11% to get back to break even. If however you had exposed yourself to a much higher risk, say 5% per trade and were -50% at the end of the month, you would need to make 100% just to get back to breakeven, this would be disastrous. Compounding can work nicely for you, but it can also work againstyou.

It can be very difficult at first for new traders to consistently use good risk management as it’s easy to let your emotion dictate your trading. These are some of the emotions and thoughts I experienced at first:
“Nevermind, This trade lost, I will just trade will double next time to make it back”
“I’m carrying a large floating loss, the market will move back in my favour”
“I’m bored I don’t have a signal but I want to be in the market and I price will continue to move up”
“A hedge fund manager on bloomberg expects the pound to appreciate so I will use high leverage and go long”

and many more..

These kind of emotions are very common amongst new traders and they really are an almost certain way to be a losing trader. It with this in mind that it is very important that new traders trade on a demo account for many months prior to trading live. It is true, that the vast majority of new traders lose all their money in a very short time frame and the vast majority of traders end up losing money in the long term, even many of the big institutional traders. With this in mind it is essential that you are fully knowledgeable and prepared for trading and have got over the emotions that come it.

Carry Trading

Carry trading is one of the popular trades in the FX market. This potentially lucrative form of trading involves selling a currency with a low interest rate and buying a currency with a higher interest rate and earning from the interest rate differentials. This can be traded using as much or as little leverage as the trader feels suits his risk appetite. For many years now, carry trades involving selling the Japanese Yen have been very popular due to Japan having a low central bank rate for many many years. Infact, Japan had 0% interest rates between 2000-2006 to try and help their poorly performing economy, this of course was highly attractive for carry traders. Today they are at 0.5%, still very attractive when we look at the central bank rates of many other countries:

• New Zealand 8.25%
• Australia 6.5%
• United Kingdom 5.75%
• United States 5.25%
• Canada 4.5%
• Eurozone 4%
• Japan 0.5%

Currently, the New Zealand Dollar (NZD) really stands out. If we wanted to do a carry trade that involved buying New Zealand Dollars and selling Japanese Yens there would be a 7.75% interest rate differential (8.25%-0.5%). This mean if we bought NZ$10,000 and sold the equivalent number of yens, the trade would earn NZ$775 over a year. However, In reality we don’t get this exact rate, the brokers take a slight cut and there are other factors too. I am sure some people find 7.75% per year attractive whilst other people may seek much higher returns in a trade off for greater risk. This is where leverage comes in. Many FX brokers nowadays allow very high amounts of leverage, I have seen upto 500:1. I will start writing about the risk factors involved in the carry trade before I go into detail about leverage, it will become clear why if you read on.

As with all FX trading there is considerable risk in the carry trades. When we buy our New Zealand Dollars and sell our Yens we are taking the risk on the currency pair NZD/JPY. Historically this pair has been on a strong up trend until July 2007, so your carry trades would have earn the income from the interest rate differentials as well as the appreciation of value of your New Zealand Dollars against the Yen. However, with carry trades, there is always the risk of a major carry unwind. This where a huge number of carry trades are closed and the money goes back into Japan. Historically, there have been a number of very major carry trade unwinds. The most obvious recent one was in July 2007. On the 22nd July 2007 the NZD/JPY rate was around 97. On the 17th August the rate hit 74.25. A huge drop. If had invested those NZ$10,000 at the top, they would only be worth around NZ$7600 at the bottom. A huge loss. The chart below illustrates this:

This sudden move was caused by the global stock market concerns relating to the US sub prime mortgage problems.

On a more Positive note, If we look at the long term chart for this pair, We can see how it has appreciated considerably in the long term.

Now you have seen the charts, I can talk about leverage. Trading the Carry Trade using leverage can be highly profitable. For example if you traded the NZD/JPY carry trade with 4:1 leverage, you would earn 4 times the income from the interest rate differentials, which would equate to around 30% in a year. However, the currency movements would affect you 4 times as much, both up and down. For example if price went from 60-90 during your carry trade. That would be a 50% gain. However, if 4:1 leverage was used it would be four times that, 200%. Now let’s look at the recent occurrence where the NZD/JPY carry trade went from 97 to around 74.25 in a very short time. This is around a 24% loss, multiply this by 4 and it equates to a 96% loss. This would probably result in a margin call from your broker resulting in most of your account being lost. It is very important to fully understand the potential risks and rewards before acting live carry trades.

Some people prefer to trade GBP/JPY or EUR/JPY instead, the differential is currently smaller but swings tend to be considerably less in percentage terms.

On a final note, most FX brokers pay the interest differentials on a daily basis. If you use an MT4 broker, there is a SWAP section in your terming showing your open positions, this is the interest you have earned. If you open a position with negative interest rate differentials (e.g. A short NZD/JPY) you will have to pay the interest rather than receive it.

Conclusion

The carry trade is a potentially lucrative way of trading/investing, however it is not without considerable risks, especially when traded with large amount of leverage. There are strategies that traders use to trade to hedge to offset some of the risk in carry trades. You can look at some of these in the strategies section. If you do seek to carry trade, I wish you all the best.