Indicators – Technical Vs. Fundamental
If you’re planning on short-term trading for quick profits, technical trading is not the way to go.
Technical analysis is the study of the history of price and volume movement over time, of securities such as futures, stocks, currencies, etc. The most common of them being Fibonacci, ADX, MACD, Stochastics, RSI and Bollinger Bands. Technical analysis is also a fad, marketed sublimely by the market makers. Any trader who relies solely on technical analysis is bound to fail for the simple reason – the forex market is not mechanical/technical. While past behaviour is a good predictor for future behaviour, it is just that – a prediction. In my experience I’ve found that a prime example for a trading career blunder, is to try to pinpoint exact entry and exit points using technical indicators. It doesn’t work that way. If it did, we would be millionaires.
Understanding The Forex Market
The forex market is made up of investors - buyers and sellers. Many of these investors perform market affecting trades unconsciously, e.g. exchanging currencies for a holiday or moving abroad, purchasing goods or online products from a different country, etc. And these investors are people, not machines! So how can one base trading decisions on a mechanical method of trading? The movement of the forex market is largely affected by the ‘big-boys’ of the financial world, which includes government central banks, billion-dollar corporations and the like. In turn, their decisions on where to invest their capital is based on current world affairs such as political standing and economic data such as interest rate differentials, CPI (Consumer Price Index), PPI (Production Price Index), IP (Industrial Production), etc. Which is where economic indicators play an important role.
Economic Indicators
After every major financial announcement, you might notice that the market experiences a brief period of high volatility. This has got nothing to do with Fibonacci, a mathematician (not day trader) who’s been dead for ages. Monitoring the financial news is your first step to bettering your trading system. Learn all you can about the macroeconomics side of things. The market never repeats itself in exactly he same way because the market is unique – investors/people are unique. But, monitoring current financial affairs can aid in capitalizing on certain certainties, such as human emotion. The ‘unconscious investor’ bases his decisions on emotion, the largest being fear. If the CEO of the Fed makes an announcement, investors listen with bated breath. Say its Bad news, investors then sell, and the result is an enormous immediate fluctuation on the market, which could well directly oppose everything that your technical indicators are telling you. This is the flaw in basing all your decisions on technical analysis.
The Victor
Fundamentals! While there are advantages to technical analysis, they have to be used in conjunction with a proper trading system and that system has to be created by an individual. Nobody can copy somebody else’s trading system and make it their own, simply because everyone is unique. Your trading reflects your personality (I will touch on this at a later date). The best traders in the world don’t rely solely on technical analysis, even the creators of these techniques. Go research them for yourself if you don’t believe me. So get financial newspaper and start reading!
Friday, 2 March 2007
Sunday, 18 February 2007
The Truth About Leverage
The main reason so many amateur forex traders fail is because they are consumed by the glamour of leverage. "Get rich quickly with just a few thousand dollars! Low margin! Leverage up to 400:1...", claim the market makers so intently. But what is the truth about leverage and does it help or hinder forex traders?
What is leverage?
Leverage/trading on margin, is a way of boosting your potential profits (as well as your losses) by means of a marginal balance as collateral. Basically, if you only have $1000, you can trade a $100 000 lot by using leverage, the $1000 being your margin. So in this instance, your leverage is 100:1 and your margin is 1% of the currency lot that you're purchasing. It's as if the market maker is lending you the money in order to help you add a couple of zeros to your profits. So what's in it for the market maker? Well, they're encouraging you to make more trades and the more trades you make, the more money they make because they take a small cut of every trade that you enter into. Therefore when you enter into a trade, you'll immediately open with a negative unrealized profit/loss balance.
The leverage set is dependent on the market maker, ranging anywhere from 50:1 up to an astonishing 400:1. Because the forex market is not as volatile as say the stock market, market makers can afford to make this loan to its traders at no risk to themselves. In any case, the market maker automatically liquidates any open positions you may have, in the event of your margin balance depleting beneath their required level.
The Beauty Of Leverage
This is an example of the power of leverage:
If you decide that the dollar is trading higher than usual to the franc, you might then decide to sell dollars, purchasing francs. If you have $10 000 and the market is trading at USD/CHF 1.3200, your trade would look like this:
$1000 x 1.3200 = 1 320 CHF
Assuming you're trading over a mid-term period (suggested - I will touch on longer term trading at a later date), if the market moves lower as you predicted, to say 1.2700, and you repurchase your dollars, it would look like this:
1320 CHF / 1.2700 = $1 039.37
So your profit in dollars would be $1039.37 - $1000 = $39.37
Now if you had used 100:1 leverage (sold $100 000) it would look like this:
$100 000 x 1.3200 = 132 000 CHF
The market moves to 1.2700, and you repurchase your dollars:
132 000 CHF / 1.2700 = $103 937
So your profit in dollars would be $103 937 - $100 000 = $3 937
In summation, if you had used leverage, you would have made $3 897.63 more profit than if you had just used the money that you had. That's an enormous difference, and this attraction is what the market makers focus on in their marketing campaigns. What they don't stress is that leverage works both ways.
The Dark Side Of Leverage
There are two sides to the coin of leverage. If you flip it on the right side, a cash flow problem would be the least of your worries. But flip it on the wrong side, even just once in some cases, and that could well mark the end of your trading career. Leverage is one of the pivotal reasons why 90% of all day traders fail. While leverage is an excellent way of magnifying your profits, first off, you have to know how to make profitable trades. And unless you have a degree in macroeconomics or are thoroughly acquainted with the forex market and its players, chances are, your failure is imminent. By the way, you may be a Fibonacci fanatic, but honestly, technical trading alone will not save you (I will touch on this as well). In any case, technical indicators were originally created to trade stocks and the like on centralized exchanges, not the exchange of foreign currency. It is indeed in a good trader's interest to make sensible, low geared trades. I would suggest that you do not exceed a leverage of 4:1.
Let me show you the results of steady, low geared trading, if every trade you made was a loss.
As shown above, with low gearing, 14 losing trades were required to reach a 50% deficit of your initial margin as opposed to 4 trades when using high gearing.
Don't Gamble
Respect the power of leverage. Ignore the dazzling advertisements. Do not consistently enter trades with high leverage, or your trading career will undoubtedly be over before it's begun. I can guarantee that the experienced, successful trader does not use high leverage, I certainly do not. If you're in doubt, read Roger Lowenstein's 'When Genius Failed'. This non-fictional story perfectly illustrates the overwhelming effects of high gearing, even when used by the most brilliant minds in the forex world. If you have $10 000 and are thinking of using high leverage, rather take that money to a casino - you will have as much chance of making money there as you do on the forex market.
What is leverage?
Leverage/trading on margin, is a way of boosting your potential profits (as well as your losses) by means of a marginal balance as collateral. Basically, if you only have $1000, you can trade a $100 000 lot by using leverage, the $1000 being your margin. So in this instance, your leverage is 100:1 and your margin is 1% of the currency lot that you're purchasing. It's as if the market maker is lending you the money in order to help you add a couple of zeros to your profits. So what's in it for the market maker? Well, they're encouraging you to make more trades and the more trades you make, the more money they make because they take a small cut of every trade that you enter into. Therefore when you enter into a trade, you'll immediately open with a negative unrealized profit/loss balance.
The leverage set is dependent on the market maker, ranging anywhere from 50:1 up to an astonishing 400:1. Because the forex market is not as volatile as say the stock market, market makers can afford to make this loan to its traders at no risk to themselves. In any case, the market maker automatically liquidates any open positions you may have, in the event of your margin balance depleting beneath their required level.
The Beauty Of Leverage
This is an example of the power of leverage:
If you decide that the dollar is trading higher than usual to the franc, you might then decide to sell dollars, purchasing francs. If you have $10 000 and the market is trading at USD/CHF 1.3200, your trade would look like this:
$1000 x 1.3200 = 1 320 CHF
Assuming you're trading over a mid-term period (suggested - I will touch on longer term trading at a later date), if the market moves lower as you predicted, to say 1.2700, and you repurchase your dollars, it would look like this:
1320 CHF / 1.2700 = $1 039.37
So your profit in dollars would be $1039.37 - $1000 = $39.37
Now if you had used 100:1 leverage (sold $100 000) it would look like this:
$100 000 x 1.3200 = 132 000 CHF
The market moves to 1.2700, and you repurchase your dollars:
132 000 CHF / 1.2700 = $103 937
So your profit in dollars would be $103 937 - $100 000 = $3 937
In summation, if you had used leverage, you would have made $3 897.63 more profit than if you had just used the money that you had. That's an enormous difference, and this attraction is what the market makers focus on in their marketing campaigns. What they don't stress is that leverage works both ways.
The Dark Side Of Leverage
There are two sides to the coin of leverage. If you flip it on the right side, a cash flow problem would be the least of your worries. But flip it on the wrong side, even just once in some cases, and that could well mark the end of your trading career. Leverage is one of the pivotal reasons why 90% of all day traders fail. While leverage is an excellent way of magnifying your profits, first off, you have to know how to make profitable trades. And unless you have a degree in macroeconomics or are thoroughly acquainted with the forex market and its players, chances are, your failure is imminent. By the way, you may be a Fibonacci fanatic, but honestly, technical trading alone will not save you (I will touch on this as well). In any case, technical indicators were originally created to trade stocks and the like on centralized exchanges, not the exchange of foreign currency. It is indeed in a good trader's interest to make sensible, low geared trades. I would suggest that you do not exceed a leverage of 4:1.
Let me show you the results of steady, low geared trading, if every trade you made was a loss.
As shown above, with low gearing, 14 losing trades were required to reach a 50% deficit of your initial margin as opposed to 4 trades when using high gearing.
Don't Gamble
Respect the power of leverage. Ignore the dazzling advertisements. Do not consistently enter trades with high leverage, or your trading career will undoubtedly be over before it's begun. I can guarantee that the experienced, successful trader does not use high leverage, I certainly do not. If you're in doubt, read Roger Lowenstein's 'When Genius Failed'. This non-fictional story perfectly illustrates the overwhelming effects of high gearing, even when used by the most brilliant minds in the forex world. If you have $10 000 and are thinking of using high leverage, rather take that money to a casino - you will have as much chance of making money there as you do on the forex market.
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