Test Your Forex IQ

The following questions test the knowledge you’ve acquired by reading this book.
You are able to take this quiz, place your responses, and find the answers,
as well as new questions IQ. E-mail Abe Cofnas with any questions you may have. Good luck!
1. What is the index that tracks U.S. dollar as an instrument for trading?
2. Which currency pairs are closely related to movements in gold, and which commodities
are closely related to movements in the U.S. dollar?
3. Can you name the heads of the world’s key central banks?
4. Which time interval is the best for entering a trade?
5. What is the technical basis for locating a stop loss?
6. What are the four strategies for trading a sideways pattern?
7. What information does a candlestick pattern provide that is not in a bar chart?
8. How do you measure sentiment in forex?
9. What is the best time of the day to trade?
10. When is countertrend trading less risky?
11. Which Fibonacci level is the most important?
12. What is the most important report that affects trading the yen, and when does it
come out?
13. When the Federal Reserve Open Market Committee meets, what does it decide?
14. What is the name of the Chinese currency?

15. What is the gross national product of the United States versus Europe versus Japan?
16. What is the current interest rate difference between the 10-year U.S. Treasury note
and the 3-month Treasury note?
17. Which currency pair allows you to trade the British pound against the euro?
18. When trading forex, what is the cost of the trade when there is no commission?
19. What are the two basic trading strategies for buying or selling that apply to any time
frame?
20. If forex prices surge or plunge in response to news, how long should you wait to
enter a trade?
21. What’s the major problem with using moving averages?
22. What is the average duration of a profitable trade generating 20 pips?
23. When you see a parabolic pattern, what does it predict about the imminent movement
of the market?
24. What is the most important fundamental piece of information to track before you
decide to trade a currency pair?
25. How do you obtain free and professional advice?
26. How is a cross-pair different than the majors?
27. What pattern always precedes a break of support or resistance?
28. What is the definition of a “false” breakout?
29. What is the best way to spot a trend reversal?
30. If oil prices surge, which currency pair is the most affected?
31. If the Chinese economy slows down or enters a “hard landing,” which currency pair
is the most affected?
32. Which indicator compares the performance of two different trading systems?
33. Which indicator effectively confirms a reversal?
34. What pattern indicates volatility exhaustion?
35. Which economic calendar release is the most important?
36. How do G7 and G20 meetings affect your forex trading?
37. If gold goes into a downtrend, how do you use gold patterns to determine which
currency pair to buy?
38. Which key moving average period should be watched to indicate a trend reversal?
39. When are technical indicators totally useless in determining your next trade?
40. If you are looking at three different time frames, which ones should they be?
41. Which pattern is almost always a reliable predictor of the next move in a currency?

42. Which indicator is the most leading regarding price direction?
43. Which six currencies comprise the U.S. Dollar Index?
44. The index that shows a currency’s strength in terms of the country’s trading relationship
is called −−−−−−−−−−−.
45. What is the formula for pivot points?
46. Which chart type leaves out time and volume?
47. Which pattern is usually a prelude to a breakout?
48. Name an indicator that shows volatility besides Bollinger bands.
49. The Chinese currency is called the renminbi yuan. What is its value against the U.S.
dollar?
50. A trader is losing 70 percent of his trades but claims he is as good as a trader
having a win-loss ratio of 60 percent winners. What are their comparable win-loss
ratios?
51. If an economic data release is coming out on the British economy and a trader
wants to trade it both ways, he will buy the GBPUSD and what other pair?
52. What economic data release report is the most important one issued by the Bank of
Japan?
53. What report provides data on foreign owners of U.S. Treasury securities?
54. Who is Japan’s biggest trading partner?
55. What is the next number of the following Fibonacci sequence: 0, 1, 2, 3, 5, 8, 13, 21,
34, 55, 89, 144, 233, −−−−−−−−−−−.
56. What is the ratio between any two Fibonacci numbers?
57. In a recent equity market sell-off, the Dow Jones Index went down, the dollar
against the yen fell sharply, and gold fell also. Why?
58. Regarding currencies, what futures industry report provides a clue to where the
smart money is?
59. If you wanted to have a 99 percent confidence that the price is between two
Bollinger bands, how many standard deviations would it be set at?
60. If the USDX broke support and the trade-weighted USDX did not, which would you
use to put on your next trade?
61. What is the difference between a slow stochastic and a fast stochastic?
62. Which is a more aggressive trade: (a) selling before support, anticipating a move
down; or (b) selling on the break of support?
63. Which developed country (not third world) has the highest interest rates in the
world?

64. If the EURUSD is priced at 1.3150 and a European goes to Disney world in Orlando,
how many dollars will he be able to get (assuming no exchange costs)?
65. What does repatriation refer to within the context of the Japanese yen?
66. What technical indicators are leading?
67. If housing starts in the United States showed a surprise increase, what would you
expect the EURUSD to do in reaction to this release?
68. If China unexpectedly increased interest rates, which direction would you expect
the USDJPY to go?
69. If a trader is using two moving averages, the Simple MA 21 and the simple MA 8,
and the SMA 8 rises above the SMA21, is this a signal to go long?
70. If a currency pair closes above the 38.2 percent day fib line, is it more likely to reach
the next fib line at 50 percent?
71. If a currency pair reaches the 20-period moving average in the middle of a Bollinger
band, and crosses it, is this a signal to sell?
72. If a trader missed a news release and saw the price surge, how many minutes should
he wait to enter a trade?
73. If the amount of foreign owners of U.S. Treasury securities significantly declined,
what would likely happen to U.S. interest rates?
74. What happens to the value of the average true range when one moves from a 5-
minute chart to a 30-minute chart?
75. If the United States increases the rate of exports, what happens to the trade deficit?
76. If a triangle formation forms and it is equilateral, in which direction is the price
most likely to break out?
77. If a price is probing a four-hour resistance, does this represent stronger resistance
than a price probing a five-minute resistance?
78. If a doji pattern appears at the top of a Bollinger band, is it indicating a reversal?
79. Which has a greater interest rate differential the USCHF pair or the EURCHF pair?
80. If a trader was able to save one pip per trade on the spread and traded five times
a day for 100 days, what would the value of the saving be if he were trading the
AUDUSD only?
81. Which equity market opens up first, the Tokyo or London?
82. When it is 8:30 A.M. Eastern Standard Time and the nonfarm payroll report is released,
what time is it Greenwich Mean Time?
83. Joe put on a sell limit order for the GBPUSD at 1.9205 and he saw on his chart that
the price hit limit. He didn’t get it, though. Did the forex firm make a mistake?

84. What is slippage?
85. When three or more multiple moving averages compress in a pancake pattern, what
does this signify?
86. The default setting on MACD is 12, 26, 9. What do these numbers represent?
87. John came up with his own moving average crossover of 95 and five simple moving
averages. He decided to back test it over three years and the result came out quite
positive. What is wrong with his approach?
88. Bob signed up to get a news trading report that provides a few seconds’ more release
of the embargoed economic data on a news release. Will this make a difference
in the trading results?
89. Why is holding a position over a weekend very risky?
90. If the yen suddenly sells off and gets weaker, what is gold likely to do and why?
91. A change in the demand for copper affects which currency the most?
92. The ZEW sentiment indicator represents what kind of sentiment?
93. If the Indian rupee starts floating, what is the major risk to their currency reserves?
94. If China increases its value of the renminbi, what would the impact be on Wal-Mart
shares?
95. If the EURJPY reaches historical highs, who would be more pleased, European car
manufacturers or Japanese car manufacturers?
96. New Zealand has had the second highest interest rates in the world, at 7.25 percent.
If they lowered the rate, what would happen to the yen?
97. Jim is trading at an account that is offering 200-to-1 leverage. He has $1000 in his
account. How much can he trade with this 1000 without getting a margin call?
98. If crude oil prices collapsed, which country would benefit the most?
99. Tom went long the EURUSD at 1.305 and the price moved to 1.3015. Where would
the break even point be if Tom wanted to put a stop there?
100. If the setting for a renko chart was moved from one pips to two pips, and the action
was very choppy, what would be the result on the chart?




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GAUGING PERFORMANCE: KNOW THYSELF

Central bank of New Zealand The path to success in forex trading is not measured by
profitability alone. Those traders who become profitable have the challenge of consistency.
Can they do it over a sustained period of time? The duration of successful trading
also requires adaptability. Conditions change in the geopolitical world and its global
economic cycles that significantly impact forex. Those who are successful during periods
of global growth may not be able to use the same strategies during periods of
global stagnation. The key skill of identifying macro conditions comes into play to provide
early warnings to reassess trading strategies or choose different currency pairs. If
China enters into a slowdown, the forex trader will be very careful about going long on
the Australian dollar. If oil is trending up toward the $75+ level, the experienced trader
may start including the strategy of going long the Canadian dollar. If the trader observes
that Japan’s economic performance is showing growth and inflationary tendencies, those favoring carry trades will significantly lighten their leverage or turn to other pairs to avoid
equity volatility.
Becoming more successful in forex trading is also about being efficient. Two traders
may have the same performance record of profitability, but they are not equal in success.
The trader who has achieved the pip accumulation with less time is more efficient. Consider
two traders who have the same profitability but different win-loss ratios. One trader
wins 60 percent of the time, and the other wins 40 percent of the time. Which one is more
successful? By measure of profitability, they are equal. But there are huge distinctions in
other qualities associated with the trade. The 60/40 trader has a much wider freedom of
trading action than the 40/60 trader. The later has to win big and lose small—almost all
the time.
One thing that is critical on the path to success in forex trading is what happens
after the trade. Being able to evaluate trading performance and apply the new knowledge
gained about yourself will be essential to improving. The ability to improve depends on
the ability to evaluate.
Performance evaluation needs to avoid being overloaded with information that
doesn’t lead to improvements. Here are some performance evaluation measures that
traders should be able to have regarding their own trading history.
Measuring Performance
To help gauge your performance, the following objective measures should be used:
Win-loss ratio, standard
Win-loss ratio, adjusted
Average win
Average loss
Average duration of the winning trade
Average duration of the losing trade
Average stop loss distance from entry
Average profit limit
Measuring Emotional Intelligence
While it is conventional wisdom that emotions are not beneficial to trading, the fact is
that they are used by all traders. We are—in the words of Marvin Minsky, one of the
founders of the artificial intelligence field—an emotional machine. The profitable trader
is using emotions to his advantage. The new trader needs to obtain a high level of confidence
about how he or she trades. This is, in fact, a use of emotional intelligence. We
reviewed how to rank your trades by confidence level. The goal is to determine what kind of emotional trader you are. Are your winning trades hunch trades, or are they trades that
are taken on excellent setup conditions? The effective hunch trader is a very rare species
because hunches are hard to replicate. So it becomes important to know the following:
Distribution of wining trades by level of confidence
Distribution of losing trades by level of confidence
Compare your first 50 trades against your second 50 trades in terms of how confident
you were when you put on the trades. There is a natural shift in percentage of winning
trades being highly ranked setups versus hunch trades.
Measuring Performance with the Learn4x Trading Pad
Learn4x has created its own trading pad (Figures 18.1 and 18.2) that provides the ability
to have real-time trades in a simulated account. The pad, which can be downloaded at
www.learn4x.com/tradingpad, uniquely offers built-in analytics on trader performance,
allowing the trader to track the key performance results. The Learn4x trading pad is
independent of any Forex brokerage firm and receives the real-time prices from its own
feed supplied by Tenfore Systems, a world feed provider.

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FACTORS IN CHOOSING A FIRM

While strategies and tactics are important, ultimately, the trades are placed at a forex
firm. The industry is growing rapidly, and forex firms are available throughout the world.
Selecting the right broker can make a difference. While there are essential features at
most firms, the most important criteria for selection for a trader include the pip spread,
dealing desk, customer service, and trading resources.
Pip spreads are rapidly becoming much narrower. Just a few years ago, five-pip
spreads were the standard. Today two-pip spreads are available. Remember, if the spread
is two pips, then the forex firm is still making money. They are offering you the currency
pair with a built-in profit.
The industry is also evolving its dealing desk structure. Firms that have automatic
dealing desks are becoming more common, allowing better spreads. But there is no free lunch. Remember, the firms make money on your trades. Customer service is critical.
When the net freezes or you have a question about a trade, the ability to call someone on
a 24-hour basis is important. Equally important is the ability to communicate. Some firms
offer 24-hour service, but the trader connects to a barely competent English speaker.
Tech support could be in a third world country. But trading resources is a major tipping
point in choosing a firm. Most trading platforms have basic charting. The trader has to go
to third-party providers to obtain charts such as three-line break and renko. Firms offering
advanced charting packages and discounts on their cost is one criterion for choosing,
particularly when accounts are traded with larger capital. Essentially, a good trader can
trade profitably at any firm, but an average trader can improve his trading when choosing
a better firm in terms of the total services he receives.
The trading environment used by the trader is more important than is usually recognized.
Getting started the right way requires having a trading environment that serves
the needs of the trade. Having two screens is a minimum suggested configuration. One
screen should provide access to charts, and the second screen should enable access
to Internet-based information and other activity. Having more than two is not unusual
among more serious traders. The forex trader beginning today can use any new computer
due to the advances in computer speed and capability. The most important aspect
of organizing your own trading room is whether it is dedicated to the trader. The trading
room should be isolated from family interference. Trading with kids running around is
too distractive. Today’s Internet connections provide easy access via high-speed links
(DSL, digital cable, etc.). Trading through a dial-up should be avoided, but it can be used
as a backup.




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The Path to Success in Forex Trading

Ultimately, the knowledge gained in this book and in training in general needs to
be applied to the real world. This involves taking practical steps and choosing a
brokerage firm to trade with. Competitive pressures in the industry are narrowing
the difference between firms in terms of pip spread, platform, and technology offered the
trader. The really important determinants of success will involve how well traders are
prepared before they start real trading, and whether the trading itself follows a sound
action plan.




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LEVEL 5: THE $100,000 TRADING CHALLENGE

There are several challenges here within this level of account size that will enable a trader
to prepare for full-time and professional trading. This level should be used if traders have
achieved at least a 55-to-45 win-loss ratio. At this level, the trader has evolved to handle
the pressures of trades that can result in gains or losses of $1000 per trade. For example,
a 50-pip loss on a two-big-lot trade results in a $1000 loss. At a level of $100,000 in the
account, such a size loss is 1 percent of the total. If the risk per day is 2 percent, the
trader has to be very careful on the trades that follow.
1. Scan all majors and cross-pairs.
2. Use standard lot sizes, with a six-lot maximum.
3. For the first 25-trade sequence, have the goal of trading 7 trades in a row correctly,
with a minimum pip gain of 10 pips; if this goal is achieved, repeat the goal of the
next 25 trades.
4. For a sequence of 25 trades, put on trades only with the goal of 20 pips per trade.
5. Use a 2 percent risk per day for all trades.
6. Learn to optimize your trading setups by back-testing.




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LEVEL 4: THE $50,000 75-TRADE CHALLENGE

A $50,000 account provides a serious capability to generate results that could provide
a path to professional trading. The steps required to meet the challenges of a $50,000
account focus more on being able to handle the psychological pressures that emerge
when more money is at stake. Many beginning traders put on too much leverage without
first testing their skills in handling the larger risks per trade.
1. Scan all majors and cross-pairs to select to trade.
2. Raise your lot size to maximum of 30 mini lots (two standard-size lots).
3. For the first 25 trades, reduce risk per day to 2 percent.
4. For the first 25 trades, put on multiple lots but leave profit limits open on half of the
lots.




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LEVEL 3: THE $25,000 FIRST-50-TRADE CHALLENGE

This level of capital presents new opportunities and new challenges. A $25,000 account
offers the opportunity to trade a combination of more pairs, larger sizes, and longer durations.
More sophisticated strategies can be put to the test. The trader at this level of
capital can trade more than one strategy. Therefore, we divide the trade challenge into
two phases.
1. Phase 1: Intraday Trading
a. Select two currency pairs to start trading.
b. Raise your lot size to maximum of five lots. Remember to use five lots only when
you have a high confidence level in the setup observed.
c. Leave your risk per day at 3 percent.
d. Set the goal to achieve an average pip gain of 10 pips for one pair and 20 pips for
the second pair, per trade, for a 25-trade sequence.
e. When using multiple lots, use an all-in and legging-out strategy.
2. Phase 2: Multiple-Day Positions
a. Take the next 25 trades and focus on opportunities for 50-pip or more gains. This
involves using the 4-hour chart to identify large trading ranges.




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LEVEL 2: THE $10,000 FIRST-50-TRADE CHALLENGE

Whether one starts with a $10,000 account or grows to that level, one gets the ability to
test and train with more strategies than at $5000. The biggest difference is to trade with
two currency pairs at a time. The $10,000 account should still trade with mini lot sizes,
but we increase the lot level to a maximum of three lots. The strategy for effectively
phasing into a $10,000 account requires that you first select the currency pair or pairs
you will trade. An important consideration is formulating a pip profit target that you
want to achieve each day. Determining your risk tolerance is a critical task. Let’s take a
step-by-step look:
1. Select two currency pairs to start your trading. One is a currency pair you like as your
favorite, and the other is a pair that your scan of the markets suggests is presenting
good conditions to trade.
2. Set a goal to achieve an average pip gain of 10 pips for the first 25 trades on one pair
and 20 pips on the second pair.
3. The maximum risk per day should drop down to 3 percent risk per day, or $300.
4. When using multiple lots, use an all-in and all-out strategy.
The Trader Log of Ross, A Real Beginner
Following is a real-world example of getting started. Ross, a beginning trader in London,
takes a controlled approach. After learning how to trade at Learn4x.com, Ross opened
a real account with approximately $10,000. A careful examination of his actual trades
(Table 1) shows a remarkable discipline. The initial trades were put on with small
sums to test his skills. Greater amounts per trade were slowly put on.

This trader had good initial strengths such as being able to have consecutive wins. A
key weakness is not putting on a limit order, and therefore getting out too early. Ross is
building key psychological skills in handling more money and facing the pressures that
this entails.




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LEVEL 1: THE $5000 FIRST-100-TRADE CHALLENGE

In beginning to trade forex, the account size should not be less than $5000. At $5000,
one has the ability to put on trades and strategies that can be used in any size account.
In a $5000 account, one should put on a standard lot amount ($100,000) only when they
recognize a very high probability setup. A 20-pip loss in such a trade would represent a
$200 decline, which is a 4 percent decline. In the early stages of trading experience, a
sequence of losses with big lots could wipe out the account.
The best approach for a $5000 account size is to trade at $1 per pip and the most $2
per pip. This means placing $10,000 trades and $20,000 trades. The objective at this stage
is to achieve a measure of competence, not a measure of profitability.
A $5000 account size should be viewed as a training account to get one into shape for
the marathon of forex trading. With that view in mind, there are warm-up exercises and
strategies to test out for your first 100 trades. Each strategy should apply to a sequence of 10 trades to allow for a reasonable ability to quantify performance and learn from that
analysis. Think of the trading as a series of challenges:
1. Select one currency pair to start your trade.
2. Set a goal to achieve an average pip win of 10 pips for your first 25 trades.
3. For your next series of 25 trades, set an average pip win of 15 pips.
4. For the third and fourth sequence of 25 trades each, select a different currency pair
with the same profit targets of 10 pips and then 15 pips.
5. Set a risk per day of 4 percent of equity ($200) to allow for the expectation of being
frequently wrong during your first 100 trades.
6. Don’t do any trades using less than 5-minute candles.




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Strategies and Challenges for Different Account Sizes

The experience of trading can be greatly affected by the size of an account. Traders
starting with relatively large amounts of money often have the belief that more
money in the account leads great success. Often, the opposite is true. Having a
large account before you have acquired proven skills is an invitation to simply losing
more money. Yet, size does matter in trading forex because alternative account sizes
generate different combinations of strategies and tactics. In a sense, each account size
could be seen as presenting different challenges that should be mastered. Let’s explore
some of them.


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PREPARING TO TRADE

Preparing to trade is not a linear process; you’re always preparing to trade. But we are
focusing here on key steps to take that promote a winning mind-set. These steps are
effective because they are rituals of behavior that reinforce practices:
1. Scan yourself. The most important scan to undertake is a self-scan. When you wake
up in the morning or right before you come to the screen after a break, observe your
own state of being.
2. Take a walk and clear your thoughts.
3. Read the Financial Times while you’re having a cup of coffee or your favorite morning
beverage.
4. Turn your cell phone off.
5. Scan fundamentals and select the currency-pair’s predominant direction of your next
trade.
6. Scan monthly, weekly, and daily charts for key areas of support and resistance.
7. Check the trade-weighted index charts for each currency pair (www.iboxx.com).

The result of following these steps is more than formulating an evaluation of market
conditions. The process generates greater confidence in taking on the trades that follow
and the trader mind-set is ready for the challenges ahead.
Following are 10 key principles to guide the beginning experiences of forex trading:
1. Trading in simulation is effective as a learning tool only if it is guided by a sound
methodology.
2. Training to trade needs to approximate the actual level of capital intended to trade.
3. The first 50 real trades are all test trades.
4. The first 100 real trades should be at no more than 2-to-1 leverage.
5. Losing trades are as valuable as winning trades: Don’t fear losses—learn from them.
6. A trading plan won’t work if it’s somebody else’s.
7. Success in trading is more than just profitability—it is repeatability.
8. There is no best time to trade there are only best patterns to trade.
9. Analyze the market by yourself before you read someone else’s analysis.
10. Don’t waste time looking for better trading platforms; focus on better trading.




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HOW TO USE A SIMULATED ACCOUNT

Even if the critique of simulated trading is correct, the benefits far outweigh the costs.
Let’s proceed with how to use the simulated or virtual account.

1. Set the account size to the level anticipated for opening an account.
2. Apply the sequence of trading challenges that are outlined in the previous chapter
and test them in the virtual account.
3. Test yourself in the following challenges:
a. Sequential wins. Try to get 9 sequential wins in a row of 10 pips or more.
b. Stop loss test. Place an extra lot on each trade and place a stop loss of 50 pips on
the second lot. Compare whether you improve the percentage of being stopped
out.
c. Profit-limit test. Place an extra lot on each trade, and place a profit limit on one
with your average pip goal, and on the other leave it open.
4. Select a currency pair you have never traded and put on 20 trades on that pair in
simulation before you try it in real time.
5. When trading a real account, place the identical trade in a simulated account and
vary the stops, limits, or lot sizes to compare performance.
One of the greater challenges that the simulated account offers an opportunity to
test is that of discipline. If one can’t follow a trading strategy and rules in a simulated
account, it may be a prelude to the lack of discipline in a real account.


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WHEN SIMULATION DOESN’T WORK

The major weakness cited in relationship to simulated accounts is that they cannot reproduce
the emotions associated with trading real money. The fear and pain of loss, the
anxiety of anticipation, and the joy of winning are not produced by the simulated account.
The simulated account may be a clone of real trading, without a soul. Yet, this is
a narrow view and, in fact, misunderstands even the drawbacks of simulation. Not being
able to reproduce the emotions associated with the trading situation may be simulating
the best psychological state of them all—no emotions. Having practiced trades seriously,
without the emotional angst of each trade, the trader has in fact reproduced an advanced
state of trading.


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WHY SIMULATION WORKS

Training and simulation, when applied correctly under a well-planned sequence of instruction,
work very well. It is inconceivable for airline pilots to fly jets without extensive
simulation. Simulation allows for testing one’s strategies and tactics to discover weaknesses
and does not have discovering strengths as a priority. War games are designed
to discover the strategic vulnerabilities of the battle strategies, not to predict a particular
battle. It is essential, in preparing for forex, to correctly use a simulated account to
test-drive your skills. The question arises: What is the best way?
We have already provided the hints of an answer. The best way to use a simulated
forex trading account is to use it to simulate strategies and tactics that are intended to
be used. Trading $100,000 in a simulated account when the real account will be $5,000
is misapplying the concept of simulation. Putting on two lots instead of one to test your
skills in multiple-lot trading is an excellent way to use simulation to stretch your boundary
of experience. The test-drive of forex skills in a simulated account should be seen
as an opportunity to identify what you know and don’t know about your own level of
competence. Of course, the results are hypothetical, but if trades are put on as realistically
as possible, then the results will have preparative value in moving ahead to real
trading.




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The Right Way to Use Simulation Accounts

One of the most useful tools to prepare for forex trading is the demo or simulated
account. All firms provide these accounts. They enable a person to practice trading
without the risk of loss. The trades go through an identical platform that
would be used in real trades, but they do not execute. Instead, the profit and loss are
hypothetical but tracked in the account history. The demo accounts are viewed and used
by the forex firms as marketing tools for converting prospects into customer accounts.
They are not designed to train people on trading. The result is that many people have observed
the experience in going from simulated accounts, where they were making large
profits, to real accounts with sudden and large losses.
Their conclusion has been that simulated accounts are not a valid way to prepare
for trading. That is a wrong conclusion. While the real test of one’s capability is in trading
real dollars, testing one’s strategies and tactics through simulation can be very useful
if done under a plan of action that follows rules. The idea that one can start trading
forex effectively by simply opening an account and beginning to trade invites too
many pitfalls. Trading for the sake of trading is learning by trial and error. The risks
of major drawdowns are too great. Getting started in forex trading begins before one
trades. It begins with building fundamental and technical knowledge, testing skills without
risk, and then applying those skills in real accounts with varying amounts of risk and
capital.


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Putting It Together

At some point in time, you need to transition from observing the market and acquiring
knowledge to applying that knowledge in putting on real trades. Some accelerate
the process by quickly opening a forex account and beginning to trade. Many
start a demo or virtual account and then proceed to trade. Both approaches are deeply
flawed. Immediately starting a real-dollar account provides the realism of facing emotions
in real trading, but the result is usually large and quick drawdowns. Those using
demo accounts often experience beginner’s exuberance by putting on trades with large
lots, only to see their real trading totally disconnected from the successes in simulation.
The point is not that it is wrong to go and trade with a real account as soon as possible,
nor that it is wrong to simulate trades. The common flaw is that of inadequate
preparation. One does not go into war without training, and one should not start trading
forex without appropriate training. The shift into live trading should follow several milestones
of phases that enable a constant cycle of learning, pattern recognition, and risk
management. Even the best traders never stop learning.
How to get ready to trade is the overall theme of this section. There are many ways
to start and many ways to start wrong. Many traders start with too much money and too
much leverage and quickly get caught in major drawdowns.
There is a better way that persons with various degrees of available trading capital
can use. This section provides guidance on the essential ways of getting started and
achieving adequate preparation.




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MULTILOT TRADING

Putting on more than one lot is a milestone in the evolution of the trader. Multiple-lot
trading provides enormous efficiency for the same effort. But it comes at a price.
The risk of quick and large drawdowns is proportionally greater. Multilot trading becomes
a double-edged sword. The new trader needs to learn how and when to put on
multiple lots.
The first rule of multiple-lot trading is the rule of three. Each trading decision can be
broken down into three components:
1. Financial
2. Technical
3. Psychological
All three converge to trigger a trade. The trader makes a financial decision on how
much to risk. At the same time, there is a technical decision on quality of the setup. Finally,
there is an unquantifiable factor on whether the trade feels good. It is very difficult
to quantify how each component contributes to the final trigger of the trade. Because it
is impossible to separate these three factors, the best approach by a trader is to think of
three lots as the best way to trade multiple trades. Each lot, in a sense, serves a different
master. The first lot calibrates with the financial objective of the trade and would get a
limit of the average goal per trade of 15 pips. The second lot would be aligned with the
technical aspects of the trade and get a limit that is related to the range. It would be more
than the first and would be designed to capture more profits. In other words, if the range
is 50 pips, the first lot is always set at 15 pips, and a second lot is set at 40 pips (just short
of the other side). The last lot becomes the wild card—it serves the psychological needs
of the trader. You can decide to have a very large limit, such as 70 pips or more, or even
leave it totally open. The effect of this approach is that when three lots are put on, the
trader will be able to manage the trade without overreacting to the market. The fear of
missing a big move is eliminated.
The challenge becomes identifying when to put on multiple lots. When do you put
on more than one lot. How do you differentiate between conditions that justify two lots from those that justify three lots? The multilot decision should not be an arbitrary one.
While there is no rule set in stone on this issue, an effective approach that has worked
very well is the confidence indicator. The purpose of the confidence indicator is to be
able to determine when to put on multiple lots. Each trader should develop his or her
own confidence indicator. It is not difficult, but it becomes a powerful way to improve
trading.
The process is straightforward. For each trade setup that the trader is using, the
trader should assign a number from 1 to 5 (5 being the highest rank). If the trader sees
a setup that has many elements of confirmation, then it gets a 5. An example would be a
setup that has Fibonacci levels at resistance or support, the price is probing the Bollinger
band, there is alignment with the trend, and so on. The 15-minute and 5-minute setups
are similar and supportive of the trade. This deserves a 5. If the trade setup generates
a feeling of high confidence with good features, but not the best, it gets a 4. A 3-ranked
setup is one that the trader has a “hunch” about. Maybe it will work. It may be a guess. A
2 ranking is one where there is divergence and the situation appears to be not tradable.
It may be a narrow range, or the price may be in the middle of a range. A 1 is the lowest
ranking. A ranking of 1 represents conditions that experience shows are very dubious for
a successful trade. A ranking of 1 results when the trade is countertrend and when the
indicators are not agreeing with the trade, showing divergence.
The idea is that, over time, by ranking each trade that is about to happen, the trader
will be able to have a strong correlation of the confidence index with profitable trades.
As traders become more experienced, more of the profitable trades should consist of
higher-ranking setups such as a 4 and a 5. In the beginning, during your first 50 trades,
many of the trades are hunches. So the distribution of winners should, over time, be with
highly ranked trade setups. During the first 50 trades, many losing trades would consist
of high-ranking setups, which is an indicator that the trader is misevaluating the trading
setups. If a large number of the winning trades are ranked 3 as hunches, consider yourself
an intuitive trader and keep doing what you’re doing!
Using your own confidence indicator ranking system provides a powerful tool for
self-improvement. Traders who experience a series of losses and then go back and review
the trades in terms of their rankings will more quickly perceive what the nature of
the error was. Having an archive of your trades ranked by confidence levels becomes
the equivalent of having a snapshot of your thinking right before a trade. A key tool is
to take an image of the chart when you put on the trade and place the ranking on it.
Using the “print screen” function achieves this capture. A very good and popular software
tool to do this is SnagIt (available at www.techsmith.com). Take a snapshot of your
next trade, and rank it right after you put on the trade. Then evaluate your own ranking.
Did it deserve the number you gave it? Over time, your ranking criteria will also
improve.

Here’s an example: Early on the morning of February 28, at the opening of the
London session, a high-confidence setup was observed (see Figure 15.1). Evaluate this
setup. We see the price probing an upper band. We see the Williams %R indicator pointing
down, and we see a reversal in the renko blocks. This was a nice 4 rating (in my mind)
and it fit the criteria for a multilot trade worthy of two lots of USDJPY for a Sell@118.57.
Placing a stop order for 118. 36 (not quite twice ATR) and one limit of 20 pips for the first
lot, the second lot would have a limit of 30 pips. Both objectives were met within a short
amount of time.

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PROFIT LIMITS

Profit limits are orders that are designed to close a position with a profit. Technically, if
the ongoing trade was to buy, for example, the EURUSD at 1.3200, then the profit-limit
trade would be a sell limit at 1.3220 if a 20-pip profit was desired. The price would have
to go through it to execute the trade. The limit order guarantees that price or better, but
not worse. But the price has to go through the position. Many new traders see the price
hit the limit and think it should have been executed. The question arises of how to form
profit targets. This is the other side of the stop loss issue.
The major difference between being able to formulate a stop loss risk-control strategy
and being able to formulate a profit-limit strategy is that one has total control over
stop losses. Where to set them is up to the trader. But achieving profit targets is not under
the control of the trader. Market conditions vary and setups vary, with the potential
for small profits, from 5 pips to bigger moves of 50 pips and more. The best approach is
to become proficient in getting small moves. A good medium ground for setting a profit
target is 15 pips on the trade. This target falls within the ranges offered by the market
under even small time frames. It is achievable, and coming close to it is acceptable. The goal of the trader should be to become competent in achieving an average 15 pips per
trade. Once this is achieved, gaining more pips can be accomplished by adding more lots
and by becoming skilled in managing the trade. This brings us to the issue of multiple-lot
trading.




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TRAILING STOPS

The question of trailing stops is always a topic of controversy. Should one have trailing
stops? Where should a trailing stop be placed? There are a variety of approaches that
provide different answers. First, the trader is new to trading and has not accumulated
many trades, and putting on a trailing stop could be detrimental to improvement in performance.
This may not seem obvious. However, a trailing stop is a predetermined pip
increment that is distant from the price. If the price moves further by 10 pips, a trailing
stop set for a 10-pip trail would adjust further. The problem with this approach is that it
is delegating to the market the decision to get out of the position. The trader should be
watching the position, and putting on a trailing stop may be an incentive not to watch. Additionally,
an arbitrary trailing stop such as 10 pips may be an invitation to being stopped
out because the natural noise and vibration of the market could easily exceed that trailing stop (remember the ATR discussion). Finally, when traders are trading for relatively
small targets such as 15 to 20 pips, it’s important to get good at achieving those
targets and not focus on pushing the profits further. Keeping in a position after it reaches
one’s goals may not be as productive as simply adding another lot to the original position.
It is easier to get a 40-pip total profit from two lots than to use a trailing stop to try to get
another 40 pips.
Rather than trailing stops, a valid approach is to move a position to break even when
possible. If the target has been reached and the trader wants to stay in, moving the stop
to a breakeven point results in a free ride on the trade. A good rule of thumb would be
if you sold a currency pair, the breakeven stop loss would be 5 pips above your entry.
If you bought the currency pair, the position of the breakeven stop loss would be 5 pips
below the purchase. In multilot trading, where a trader can capture profits on some of
the lots, it makes sense to move the stops down to a breakeven location.
Finally, mental stops are very popular and very dangerous. A mental stop is one that
can easily be changed with the onset of an emotional whim. Mental stops violate the
cardinal principle that all trades should have three components: the entry order, a stop
loss order, and a profit order.
For those traders interested in avoiding stops, using options instead of stops is an
area worth pursuing once they have experience in trading.




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STRATEGIES FOR STOP LOSSES AND PROFIT LIMITS—ESSENTIAL COMPONENTS OF RISK CONTROL

Even if you mastered all of the elements of fundamental and technical analysis, trading
success would still require risk control. The most frequent question asked is: Where
should I put my stops? There is no definitive method for stops, but the most important
first step is to determine the risk per day that a person wants to tolerate. For example, if you have a $10,000 account, and the risk per day is 2 percent, this means that the trader
will tolerate a loss up to a limit of $200.
Any level of risk has the consequence of providing a boundary for the trading. Unless
you have an unlimited ATM machine to replenish your account, risk discipline is a critical
factor. The consequence of having $200 risk per day is that the trader needs to decide
how much risk a particular trade is worth. Is the next trade worth the entire risk of the
day? A $200 risk must also be translated into pips. Trading at standard size amounts
of $100,000, the value of each pip move is $10. This means that putting on a trade that
results in a 20-pip loss would result in using all of the risk for that day. The trader in this
situation would be foolish to risk a whole day’s trading capital on one trade unless it was
a fantastic setup. The trader should make room for several trades by choosing smaller
amounts to trade. Mini lots that involve putting on $10,000 would mean that the value of
a loss of 20 pips would be only $20. There is room for 10 more losing trades that day!
The concept of a risk per day can be better understood as having two accounts. The
first account is your real account with the capital in it. But the second account is the risk
capital account. Ask yourself how many pips you are willing to lose per day. By putting
on trades of $10,000 on a currency pair, many more trades can be taken. Yes, it does limit
the gains, but during the critical formative period where beginning traders are learning
trading, staying alive is more important than the magnitude of profits.
After selecting the level of risk per day, locating a stop loss becomes a choice of the
geometry of the price action. The first approximation for a stop loss location should be
the answer to where you would get out if the market moved against you. In other words,
if you were to buy a currency pair, then the stop loss would be where one would sell
it—and vice versa. The trader will look to the trend line and support and resistance lines
to find the location. But it’s not that simple in forex. Remember, there is noise in the
forex market. There is no precise location for the price, since it is a bid-ask market. One
of the most frequent sources of losses for beginning traders is being stopped out very
quickly. They place the stop close to the entry. In forex, the noise may take up three to
five pips easily.
The response to this situation is to allow the prices to vibrate through its range.
Here is where looking at larger time frames is important. You may trade off a 5-minute
chart, but remember the price pattern of the 5 minutes provides a close look. Zoom out
to the 15-minute and 30-minute charts to find more secure levels of resistance or support.
This translates into putting one’s stop loss above or below the 15-minute support
or resistance, or above or below the 30-minute support or resistance. If you’re trading
off a 4-hour chart, then day support or resistance is an appropriate level for locating
a stop.
Another method for finding an optimal location for a stop is the level of volatility.
Putting a stop above the extreme Bollinger band is one solution because that would
recognize that the price would have to go to new extremes to get stopped out.



Another tool for locating the stop is the average true range (ATR) indicator. The ATR
provides a measure of the “reaching” ability of the price in terms of its lows and highs.
Remember that the range is defined as the difference between support and resistance.
The ATR compares the range’s behavior to previous closes, highs, and lows. The ATR is
the greatest of the following three values:
1. The difference between the current maximum and minimum (high and low)
2. The difference between the previous closing price and the current maximum
3. The difference between the previous closing price and the current minimum
The ATR becomes a smoothing indicator of the true range over the periods selected.
How do we apply it to stops?
When the trader chooses to trade off a specific time interval, such as the 5-minute
chart, the range of that time interval is expected to be less than the range of the 15-minute
chart. Generally, the larger the time frame, the larger the distance between support and
resistance. By watching the ATR, the trader can get a sense of whether the candles themselves
are increasing in volatility.
Table 15.1 gives an example of two currency pairs and their associated ATRs for
different time periods. If the ATR with a period 14 indicates a level of 9 pips, let’s say
on a 15-minute chart, this means that the lows and highs could have been 9 pips higher
or lower on the average for the previous 15 candles. A good way to understand this is to
visualize any candle to stretch beyond its highs and lows 9 pips either way. So if the trader
places the stop near or at the ATR level, it is inviting being stopped out by the natural
tendency of the market to swing in the plus or minus 9 pip range around a candle. Here
is how to use this: A good rule of thumb is to use two times the ATR for your stop. If
one is trading on the 15-minute chart, then two times the ATR of the 15-minute candles
provides room to breath.
Alternatively, one can use the 30-minute ATR as the stop distance, even if one is
trading off the 5-minute or 15-minute chart. By doing so, the trader is acknowledging the
natural vibrations of the price. Try to test this application out by putting on two trades in
your simulation account. Place a stop on one of the trades based on your own selection criteria, but for the second lot, put the stop on two times the ATR of the 15-minute chart.
See how your frequency of being stopped out is reduced. In Table 15.1, we see that the
ATR of the British pound–U.S. dollar (GBPUSD) pair was 9 and that the ATR of the
euro–U.S. dollar (EURUSD) was 5. Using the rule of two times ATR, traders looking to
put on a trade in the GBPUSD would be sure to have a stop above 18 pips. Those looking
to trade the EURUSD could place the stop above 10 pips, since the ATR was lower in
value.
Very often, the question arises: Should the stop loss be a ratio of the profit? In other
words, if the trader were going for a 20-pip move, should the stop be 60 pips? The idea
of a positive ratio of reward to risk is at the surface a good one. Having bigger winners
than losers is critical to profitability. But having an arbitrary ratio between a profit target
and a stop loss is just that—arbitrary. It does not reflect the reality of the dynamics of the
price movements and actual conditions facing the trader. It does not take into account
whether there have been increases in volatility in the range. Additionally, if a trader is
achieving a very good win-loss ratio, then it is possible to be profitable even if there are
more losers than winners.
Consider the situation where a trader has a ratio of 60 percent wins. If the trader had
a risk of 20 pips per trade and a profit of 20 pips per trade, the result would be (6 wins
× 20) – (4 losers × 20), or +40 pips. In contrast, a trader with a ratio of 40 percent wins
and an average profit of 40 pips with an average loss of 20 pips would result in a net of
(4 wins × 40) – (6 losers × 20), or the same 40 pips. In other words, the reward-to-risk
ratio depends on the performance results. A very good trader can, in fact, have a high
negative ratio and still be profitable.




By ABE COFNAS

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Alternative Setups and Trading Strategies

This book is designed to provide traders new to forex knowledge that helps shape
trades. This knowledge includes fundamentals, charting analysis, technical indicators,
and market psychology—to name just a few. The act of trading becomes
the application of these areas of knowledge with the forex trading mixing-and-matching
techniques and tactics. The setups used will vary along with the trader.
Charting companies such as eSignal, VisualCharts, TradeSignal, and Prorealtime are
examples of current excellent forex chart providers. These providers often offer many
indicators, including some that may not be relevant to forex trading. For example, indicators
that show volume cannot be used for spot forex. Some companies include experimental
indicators that are developed by traders but have not been proven. This chapter
examines alternative setups and compares them with traditional setups that use more
common indicators. Which is better? That will depend on the skills of the trader. Forex
trading success is not a process of instant creation but a process of evolution. You should
try different setups and determine which mix is best for you.




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POST-NEWS RETRACEMENT TRADER

This strategy is by far the most consistently productive and should be part of the initial
set of strategies used by beginning traders. The idea is that after the break of the news,
there will be retracement—the price will move from a high to a low, or from a low to a
high and then retrace. The trader waits for the retracement failure and looks to enter a
trade on the direction of the original break. The retracement failure point is most likely to be a Fibonacci-based pattern. After a news release, there is the initial move, but there
can be many retracement attempts and therefore many opportunities to trade.
An aggressive version of this is to wait for the move after the release of the news, and
then when it stops and reverses, put on a reversal trade. This strategy of fading the move
adds a scalping tactic and provides more opportunity. But the far greater percentage
payoff is on trading post-news retracement. If the price does retrace to a Fib point, then
the trade can employ the setups that work in other times.
SUMMARY
Which economic data release should you trade? Every currency pair has economic news
that affects that pair. It’s hard to know in advance which ones will be important. The key
factor is whether the market is surprised. Check your economic calendar and highlight
key news releases. Focus on those releases that will report on inflation, job growth, and
housing data. Initially, be sure to use low leverage or test your skills in simulation.




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NEWS TRADER

The news trader focuses on trading economic news releases. A great advantage is that
the strategy offers effective trading in a short period of time. News trades should be
considered seriously by those who cannot do forex trading on a full-time basis.

The market patterns relating to the news trade display three distance phases. First, the price patterns go into a sideways pattern. This is because there is hesitation
about the outcome. Then the news release occurs. A surprise result causes a sharp
move in one direction or the other through the formed support or resistance levels. After
the initial impulse, the market will sell off and try to retrace. It may succeed in returning
to the original sideways range, or simply go to a point of retracement and then pause and
resume the move in the direction of the break. These phases are part of every economic
news release responses by the market.
Tactics for News Trading
There are three essential tactics traders can use:
1. The Hedger. Put on a hedge trade by buying and selling the currency pair at the same
time right before the news. When the news is released, the trader gets out of the
losing position and stays with the winner.

2. The Bull Ride. Trade on the break of the news by entering the market in the direction
of the break and trying to ride out the move.
3. Post-News Retracement. Wait for the economic data to be released and allow the
market to move and complete its first wave. Once the move is over, the trader
will wait for a post-news Fibonacci retracement and enter the trade after this
retracement.
Each tactic has its advantages and disadvantages. Trading the news is a very efficient
way to trade forex because the trader knows in advance that the market will move. Let’s
look at the strategies in greater detail.
Riding the Bull or Bear—Anticipating Results (Most Aggressive Strategy)
The trader has an intuitive feeling (a hunch) for the outcome of the economic data. It is
not a wise strategy to put on a trade before an economic news announcement. But if the
trader has an informed point of view, putting on the trade before the news announcement
is an aggressive play that can be very profitable if correct. The key risk of being wrong
and having the price move against you is important to minimize.
Tactics for the aggressive strategy are as follows: About 15 minutes before the economic
data release, locate the 5-minute or 15-minute chart. Locate support and resistance
levels. Use the average true range (ATR) at the default setting of 14 periods. Place a market
order in the direction you desire. Place a stop loss order at 2 times the ATR. Should
you put on a limit order? In trading the news, the idea is to be ready for a big move But
we don’t know if a big move will come. So a small limit order targeting 10 to 15 pips
would be like eating cake with artificial sweeteners. If you’re going to trade the news,
focus on controlling the risk. The idea is to take a ride on the bull or bear, get on before
the break of the news, and then try to stay on to get the most out of the move. So I don’t
recommend a small limit. You might want to put on a larger limit of 75 pips.
Getting off the trade in a news event requires a high level of skills in identifying shifts
in sentiment. Renko charts are a powerful tool for this. Remember, riding a bull or bear
represents high risk. But if you want to try it out, do it with small lots on and test your
skills.
Trading on the Break (the Bull Ride) In this version of the news trade, the idea
is to get into the trade as soon as the data release breaks. The trader needs to have the
ticket ready to go and jump in. The risk here is of a whipsaw, where the price reverses.
This risk is not as high as people think because when the news breaks, there is maximum
energy and the market will respond. The risk of no surprise does occur and that results
in a small move, causing the risk of smaller losses than a whipsaw because essentially
the price doesn’t move beyond a previous range and there is little room for profits. But if you’re on the bull or bear trade and it is a big move, you have the same challenge of
when to get out. The advantage is that you are not immediately wrong.
Playing Both Sides at the Same Time (the Hedger) In this strategy, the
trader wants to participate in the news breakout but doesn’t want the risk of prediction
and the costs of waiting to decide direction. This strategy means you are buying
and selling the currency pair at the same time. As soon as the news breaks out, a decision
has to be made as to which side to get out of. Should it be the winning or the
losing side?
The first tactic is to get immediately out of the losing side. This may cost you 20 pips
or more on a strong move, but it also means you’re in on the winning side. So the price
for the ride depends on how quickly you can get out. Getting out of the loser first follows
the logic that at the break of the trade there is maximum momentum, and being in at this
point is, in fact, the best time to be in. This strategy works well when there is a big move.
Figure 14.12 shows a classic breakout in response to positive dollar nonfarm payroll
news release. The hedge strategy would have worked out, with the loss of about 20 pips
on buying the EURUSD, offset by a gain of up to 60 pips with buying the USDCHF. Few
traders could get the maximum gain out of this kind of move and would more probably
achieve a 15- to 25-pip move in about a 15-minute period.
Getting out of the winner first is a variation of this strategy. In other words, keep
the loser and get out of the winner because the first minute is when there is maximum
energy. Then manage the losing side. The idea is to wait for a retracement on
the loser. This strategy can backfire; if there is a small move on the news, both sides
can lose.
News trades can occur on any currency pair because all countries have key economic
data releases. There are many hedge combinations for trading news that affect
currency pairs. The same principle of going long and short at the same time applies (see
Table 14.2). Some forex firms now allow hedging in the same account. Other firms allow
the creation of a subaccount. For example, one can buy EURUSD in one account and
sell the EURUSD in the other account. But when this is not permitted, there are other
ways to employ a hedge strategy. If one is doing the EURUSD news and buying also the
USDCHF, there is a pip differential. The EURUSD moves $10 per pip (per $100,000), and
the USDCHF will vary. To obtain an actual hedge, one needs to rebalance the trade. For
example, if a trade were put on when the USDCHF was at 1.22, it would move $8.20 per
pip. So a trader doing a hedge would trade 10,000 for the EURUSD and 12,500 for the
USDCHF to balance out the move.
The trader will find that the implementation of these news trading strategies may
vary, based on the forex firm involved. One should test them out to determine if a great
deal of slippage occurs at the firm you are considering.


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CARRY TRADER

The carry trader is interested in playing the interest rate differentials for receiving income
by buying the pairs that pay income to the account. The goal of a carry trade account is to get a superior return on the equity through interest. The carry trade will
almost always be part of forex as long as interest rates around the world differ. Money
tends to flow where it is perceived to get the best return. The most famous of the carry
trade pairs is buying the New Zealand dollar–Japanese yen (NZDJPY). The NZD offers
8.0 percent interest, while the JPY offers 0.50 percent. This means that the gap between
them is 6.75 percent paid to the trader if done right. Another part of any carry
trade portfolio has been the AUDJPY playing off the 6.25 percent interest rates behind
the aussie. A third pair common to carry traders has been the British pound–Japanese
yen (GBPJPY) using the high rates of the pound at 5.75 percent. Carry trades have
been the domain of very large institutional trading, but they are available to new
traders.
Carry trading has become extremely popular. A sure sign that the success of that
strategy was coming to an end was a taxi driver’s asking about carry trades. The risks
of carry trades need to be recognized. The risks of large drawdowns while one waits for
interest to be paid is substantial. Let’s first take a closer look at the mechanics of the
carry trade for the retail trader.
The first concept that needs to be learned is how a carry trade account works differently
from a regular forex account. The account is the same, but the trader has two
important focuses. The first is the balance of the account. As interest payments come
in, the balance totals will increase. The second is the equity of the account. This is the
liquid value of the account if everything was sold. There will be volatility in the equity
because the value of the pair bought will vary. The concept is that even though there
is risk of losing equity, ultimately, if you hold on, the interest rate will reimburse the
account. This is a tricky trade because there can be substantial volatility in the equity
values.
Figure 14.10 shows the weekly NZDJPY and GBPJPY. These are the two major carry
trade currency pairs. We can see that for a substantial period of time those buying these
pairs and holding them not only got high interest rates but also benefited from the fall
of the yen. But as interest rates in Japan increase, the carry trade becomes less attractive
and holds greater risk of losses as the yen rises against the other pairs. A carry
trade portfolio looks to capture interest rates, but the equity value of the account will be
volatile.
A real-world example shows this very well. The trader trading a $30,000 account
had on a mix of pairs. Until a major sell-off of the yen on February 27, this account performed
approximately 5 percent per month. But it incurred a loss of equity of $6000, or 20
percent, in one day. Those who held on to the carry trade positions the week after February
27 suffered further losses. But the carry trade was not eliminated. The difference in
interest rates in the carry trade pairs continued to appeal, and the prices recovered weeks
later. It’s important to keep leverage low in carry trade accounts to enable sudden large moves to be sustained. Jes Black, a forex trader and money manager at Black Flag Capital,
observed that:
Typically, the carry trade is leveraged. With a $10,000 account, and trading minis,
you should not exceed 10 times leverage. If you have more trading capital,
you should look to diversify the various carry trades to reduce your risk. You could
also look to do hedging strategies whereby you equalize your U.S. dollar exposure
to net zero. Example: long USDCHF and short USDMEX. Both collect a carry, and
you have effectively brought your dollar exposure to zero, much like a long/short
equity manager attempts to do.




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SET-AND-FORGET TRADER

The set-and-forget trader is playing fundamental direction and is seeking very large
moves of 150 to 300 pips. This trader doesn’t want to sit and watch the screen but
play the longer moves and forces behind forex. This requires trading off 4-hour, daily,
and even weekly charts and setting with risk control to target a 3-to-1 ratio of pip
profits over losses. Trading cross-pairs such as the euro–Japanese yen (EURJPY), Australian dollar–Japanese yen (AUDJPY), and euro–Canadian dollar (EURCAD) provide
wide ranges. One disadvantage is psychological. Set-and-forget trades are slow and
take a long time to complete. In contrast, an advantage is that all it takes is three out of
seven wins to be profitable.
The trader wants to enter on the side of the predominant trend, put on the trade with
proper limits and targets. Channel patterns fit this style. In Figure 14.9, we can see the
EURUSD day chart was in an upward channel, and sentiment for the strengthening EUR
is confirmed by the bull sentiment histogram, especially when it turned positive.


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SCALPER

The scalper has the goal of a quick trade for small but leveraged profits. The scalper
prefers to trade frequently for small moves instead of working for larger moves. The
scalper focuses on the goal of taking profits quickly from the market and trades in a
very limited time frame. Scalpers focus on the most recent price action and on small
time intervals, from 10-minute candles to 1-minute candles. The trader seeing a high
probable trade can decide to put on multiple lots and then attempt to obtain 5 to
10 pips or more. Parabolic patterns are excellent conditions for a scalp. After a parabolic
move up, the probability of a fading of the sentiment is great. The scalper has to minimize
the risk of a whipsaw. There is no perfect strategy, but the use of renko blocks will clarify more precisely than candlesticks when to get in and out of a scalp. Figure
14.6 shows the situation facing the euro–U.S. dollar (EURUSD). There was a parabolic
move up, indicating a potential reversal. The question was when to get in and out for
a scalp.
Let’s see how a renko scenario would have worked. Mr. Ashkan Balour is a professional
forex scalper trader who focuses on capturing moves like a hawk looking for prey.
It takes experience in pattern recognition, but Ash is an example that forex trading can
become a profitable endeavor. Figure 14.7 is an example of one trade he did; his own
description of it follows. Ash is quite a good trader and was able to pick off 15 pips without
1-minute candles. Compare his candlestick view with renko. The newcomer to forex
scalping should use renko to help out.

I just finished this trade. The dollar has been weak all day. It came down from the
top of about 1.9673. It did one wave down to around 1.9645, then started to form
a pendant and went lower. I was looking to go long the whole time. I waited till it
did a three-wave sequence down under the pendant. On the third wave, it entered
an area of support in the 1.9630 area. I read a comment that there were buyers
here around 1.9630, which is not my reason to trade this area but gives you some
confidence. On the first up candle I was long, 1.9636; I waited until the first red
candle and bagged 15 pips easily. Most trades aren’t this quick and easy.


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TREND TRADER

The trend trader (slide or hug trader) isn’t looking for reversals but wants to go along
with the crowd. When a pattern confirms trend continuation, this trader enters into the
trade. Many times, one hardly needs any indicators at all to recognize that a trend continuation
pattern is intact. This occurred in a classic way on February 27, when the USDJPY
pair proceeded to enter into a downtrend with increasing momentum (Figure 14.2). The chart reveals several shifts in the trend line, creating a fan of outer to inner trend. Trend
patterns such as this one are irresistible, and entering into the trend is a high probable
trade provided stops are placed above the trend lines.
The pattern shows crowd behavior, as there are very few corrective moves up. This
usually occurs when the price is sliding down the Bollinger band or hugging the band on
an upward move. The major technical tactic is using the trend line to confirm where the
trend reversal would occur. Also, determine if an oscillator is appropriately aligned in
the direction of the trend (see Figure 14.3).
Let’s look at how the trader would use renko blocks to determine whether to get
out after going into a slide trade. We see a very clear hugging-the-band situation in the
USDJPY 15-minute chart (Figure 14.4). Assume the trade was put on at 8:00 after seeing
the price stick right on the band. The question is: Should the trader get out? By using trend lines and renko blocks, the trader gets the answer. If the trader sees that the renko
blocks are staying in a selling sentiment (red), as we see in Figure 14.5 and also that the
price is below the trend line, it is a good idea to stay in for the ride and not get out on
small countermoves up.


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BOUNCE TRADER

The bounce trader waits for prices to enter into sideways ranges. The price could be
coming from an uptrend or a downtrend, but there are likely to be pauses along the way.
The bounce trader will select a direction to trade and then wait for either the failure of
the price to penetrate resistance or support. The price could in fact close above resistance
or support but then proceed to fall back. Using a setup to confirm the reversal the
bounce trader is looking for a 15+ pip move. In the U.S. dollar–Japanese yen (USDJPY)
15-minute chart shown in Figure 14.1, we see a set up with standard Bollinger bands, slow
stochastics (5, 3, 3) and moving average convergence divergence (MACD) histogram or
Forest version. These indicators are all lined up and provide a high confidence that the
setup for the trade is reasonable. The setup aligned itself for several bounces off the top
and bottom trades. Important to note in the setup is the convergence of the upper channel
line with the upper Bollinger band. The range is about 40 pips. This means the trade
has to conserve slippage and trade off the top or bottom.

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Trading Styles and Setups

One of the major reasons that forex trading has such a wide appeal is the presence
of different trading styles that can be applied. Those traders looking for very quick
moves can adapt scalping strategies and tactics. A great portion of forex traders
put on trades that have moderate-size intraday durations that allow the currency pair to
move through a range. These traders go for 10 to 30 pip moves. Multiple day trades allow
for larger profit objectives of 100 pips or more. Forex trading can also include the goal
of trading for income. This goal is featured in carry trades and is a dominant strategy
of large hedge funds and institutions. But carry trades are also possible for the average
retail trader.
The beginning trader should explore many of these styles and strategies by creating
trading setups that use a combination of technical indicators, and chart patterns to pinpoint
conditions for a trade. Table 14.1 provides a matrix for grouping the strategies and
the appropriate technical analysis tools to implement them.
As we can see, there is no single style of trading, nor any one technical indicator
or methodology that will be sufficient. Successful trading of forex is a combination of
fundamental knowledge, technical tactics, and experience in pattern recognition. While
there are many paths to success once you choose a particular style, there are setups that
have proven successful for each style as summarized in the matrix above. Let’s discuss
each one with some illustrations of their application. The order of these styles does not
reflect any priority. All the styles are valid for use in forex trading.


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TIME AS A TOOL OF ANALYSIS: MULTIPLE TIME FRAMES

Once you become familiar with trading setups, using time as a variable of analysis
is appropriate. In a real sense, the forex trader is a time traveler moving from the intrahour chart worlds to the outer reaches of weekly and monthly charts. The question
often arises: Which time interval frame is the best to use to put on the trade?
The answer is that each time interval generates trade-offs that the trader has to
consider. A short time interval such as a 5-minute or 15-minute chart provides less
risk exposure to wider moves, but also involves the risk that the pattern traded is not
reliable and has more noise than information in it. A longer time frame such as a 4-
hour or day chart generates a much wider price range and great potential for larger
pip profits.
At the same time, it is also associated with risk of larger losses since a wider range
increases volatility. The proper way to utilize time is to compare and align different time
frames. This allows time itself to be a confirming indicator, increasing confidence in the
decision made by the trader to put on the trade.

SUMMARY
Technical analysis, when applied to trading forex, must also include recognition of price
patterns. When forex prices form patterns, they represent a variety of emotions. Understanding
patterns and whether they are stable is a key milestone in evolving into a
knowledgeable and skilled trader.




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FRUSTRATION IN THE CHARTS

When sentiment can’t find a release, the price compresses and waits for a break. The
signature of such compression, frustration, and impending explosion of a breakout are
the triangles. Triangles can be equilateral where the angles are all equal or shaped in an
ascending or descending pattern. Figure 13.6 shows an ascending pattern because the
largest side is trending up. The range is getting narrower, and there is no room for the
energy to go. There must be a break. The strength of the break is not known in advance.
But the trader seeing a triangle can anticipate that a break will occur.
In the EURCAD cross-pair, an equilateral triangle is spotted, providing an anticipation
of a breakout .



STABILITY: THE CHANNEL PATTERN


Patterns that endure over time through 20 or more candles demonstrate sentiment stability.
The best visualization of this is the channel pattern. Channels can be sideways or
tilted downward or upward. It is called a channel pattern because the patterns are similar
to a river channel, and, in fact, the geometry and energy flow of water in a river channel
is very similar to the movements prices make when forming a channel pattern. Channel
patterns in forex trading are examples of traders using the language of another field of
science as a metaphor to describe what they see the price doing (see Figures 13.8 and
13.9). The trader perceiving a channel can decide on several ways of trading it.
The first strategy is to trade in the direction of the channel and, in a downward channel,
wait for the price to retest the upper bank. For an upward channel, the best location
of the next trade is for the price to sell off and bounce off the lower channel. Channel
trading permits countertrend trading because the market is showing persistence in the
pattern. The width of the channel should permit trading. This means that the trader needs
room for entry off the top or bottom, and assuming that such a cushion requires about 10
pips each, it is reasonable to assume that channels of 30 pips or more are the best size.
Four-hour charts provide a very good source of channels.
The channel formation occurs in almost every time interval. Its robustness can express
itself even at the most micro levels of price movement. The 1-minute pattern can
show a channel and therefore reveal the inherent stability of the sentiment as we see in
the 1-minute U.S. dollar–Japanese yen (USDJPY) chart channel in Figure 13.10.
Most recently, as the EURUSD pair reached historic levels, it formed a clearly identifiable
channel pattern .




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SURPRISE, GREED, AND EXHAUSTION

When you see prices follow a parabolic path, trades will follow. The parabolic path is a
general phenomenon of energy transfer. Figure 13.3 shows the general equation for what
is called a “cubical parabolic hyperbola.” This equation closely models the path often
taken by forex prices. This should not be a surprise because parabolic patterns are about
energy flow and its subsequent loss. When you throw a ball, it follows a parabolic path
as it loses energy.
Parabolic paths of forex prices are patterns that show many emotions. First is surprise
when the price has a quick and big move. Then there is greed as traders rush in
to take a ride on the move and take the path to altitudes approaching 90 degrees. It is
unsustainable. At the apex, the trader can anticipate a sell-off. The parabolic is not necessarily
a reversal indicator, but it is an indicator of exhaustion. Often, the sell-off works
within the Fibonacci levels and the prepared trader can look to trade in the direction of
the original move—after the price stops at the Fib level. Look what happened in Figure
13.4 to the euro–U.S. dollar (EURUSD) parabolic and Fib combination.

Figure 13.5 shows a U.S. dollar–Canadian dollar (USDCAD) 90-minute chart with a
classic parabolic followed by a sideways sell-off and then a downward parabolic.


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