Forex for the Rest of Us
Back again to trading money around. Currency markets affects every corporation that has operations overseas, but it also provides opportunities for traders to make some profit. There are a few ways to go about trading here, and many of these ways rely on something called technical analysis or price action. This is a type of analysis that textbooks don’t typically teach. College courses for this don’t typically exist. Like many other soft sciences, technical analysis isn’t perfect. The goal is to tell you whether to buy or sell a market using price charts and patterns. Technical analysis recognizes that is isn’t perfect, but also that fundamental analysis isn’t perfect either.
There have been many times throughout history where markets should have behaved rationally but didn’t. When traders use fundamental analysis only, they are forgetting that “markets can remain irrational longer than you can remain solvent” and that’s one way people quickly get into trouble.
In the future, I’ll be talking more about technical analysis, but for now we’ll start by applying it to the currency markets. When people try to develop trading strategies for markets that work technically (most markets do), they look at three important concepts.
- Position Sizing
- Risk Management
- Entry and Exit of a Trade
The toughest part of coming up with these strategies is that they don’t work all the time and they don’t work the same for everybody. Each strategy plays on different concepts that resonate with different people. This may take some experimentation, as does building your own portfolio for more investment oriented people. Another important part of technical trading is the price chart to look at. it’s important to look at something called candlestick charts. We’ll get more into candlesticks in the future as we go deeper into technical analysis.
Getting into the nitty gritty, there are a few different things to consider when building your strategy. Time frames are the first thing that you’re going to want to consider for Forex. Are you thinking longer term or do you want to be doing this throughout the day? There are four types of trading that fit into different time frames.
These are quick intra-day trades that focus on quick price movements. Scalpers do not hold positions overnight, and often won’t hold positions for more than ten minutes. The goal is to profit from quick dislocations in the market.
This is what gets the most press. Day trading sounds magical, right? Sitting in your house all day making trades predicting where the market is going and – hopefully – making a bunch of money while you’re doing it. These traders will usually hold their positions throughout the day but they will never hold positions overnight. You will typically be looking at ten to fifteen-minute candle sticks.
Swing traders will typically hold positions for a few days or weeks. The goal here is to catch an uptrend of a breakout in the market. I’ll explain what these words mean in the next article, but for now it’s important to just focus on the time frames here.
This is a longer-term strategy where a trader will maintain a portfolio of stocks for months. The trader believes that these stocks are in a long term up trend.
Now, depending on how you approach trading, you may be using different strategies. For instance, scalping requires different indicators than positional trading would. A huge dip or expansion may be something that scalpers are watching, but a swing trader may be focused on more long-term trends. Now applying this to Forex specifically, there are some things to note. Forex trading occurs all day long because markets open and close as day and night rolls across the Earth. Here’s a good place to check which markets are open and when the next market will open. The tricky thing is that when a new market opens, the price for currencies tend to get volatile. This is because traders in Japan could have vastly different ideas about the prospects of one currency than the traders in the United States have set through the price.
Most Forex technical strategies focus on the idea of support and resistance. This is a concept that is near and dear to every technical trader. The idea is that at certain prices, the stock experiences either support and resistance.
It’s not always easy to see, but the idea is that the currency pair won’t pass below a certain level. The above chart is of the stock price for the company Paychex, but this concept applies just as well to the currency markets. Resistance works the same way in the other direction. The trick is that when a currency pair goes above a resistance line, this tends to mean that the pair is going to continue to appreciate. This is called a breakout, and that’s when most traders hop on board. This is a self-fulfilling prophecy because this is a well agreed upon signal to buy so the traders jump on and only appreciate the pair further. The flip-side is that if a pair falls below the support level, the base currency is likely to depreciate even further.
In my next article, I’ll dig a little deeper into technical analysis because it can be extremely useful for traders, but more importantly it provides a greater framework with which to view the market from. Most professionals in the finance industry agree that technical analysis is useful, but colleges don’t typically teach it. Good luck trading and keep your eyes out for more articles on this topic!