There are a lot of fraud and scams from the direction of intermediaries such as brokers and dealers in Forex business. The United States Commodity Futures Trading Commission (CFTC) is the federal agency that regulates the trading of Forex currency, commodity futures and options contracts in the United States and takes action against firms suspected of illegally or fraudulently selling Forex currency, commodity futures and options. Off-exchange trading of Forex, foreign currency futures and options contracts with retail customers by a counterparty that is not a regulated financial entity as set forth in the CFMA is unlawful and may be a fraud or scam.
There are some forex broker's or dealer's strategies sometimes not honest and respectable.
If you become a victim of such a broker you may put your broker's review.
Using the "kitchen" method, management of the dealing center is based on the assumption, that the majority of players (clients) will lose the money sooner or later. It is promoted by a lot of the reasons. The cores are the lowest vocational training of the client, excessive aggression and practically absolute ignorance of foreign language. Such clients are very often completely out of the basic information streams.
Brokerage is the overlapping of absolutely all client transactions (positions) during their performance. "Brokerage" can be profitable only at a great deal of clients and their activity at transactions' performance. Broker can earn money "moving" of the market against the client. It is possible to shift the market in the various ways. Since any client transaction passes through dealer of dealing center, the dealer forms the quotation, giving to the client.
Basis of this broker strategy is the following thesis: dealing center doesn't use brokerage as the basic technology, a basis of profit are the client's losses. The client transactions completed in current of one day, as a rule, do not bring to dealing center neither greater profits, nor heavy losses. In a total sum these transactions make small profit. The basic money appears when positions open in current of several bank days and lead the client to greater, significant losses.
At "pseudo-brokerage" any position has moments during which client is incured losses, accordingly, dealing center has some profit on this position (provided that this position is not blocked at the foreign broker).
Some dealers guarantee that you will not lose more than you invest, which includes both the initial deposit and any subsequent deposits to keep the position open. There are two significant differences between buying off-exchange Forex currency options and buying options on futures contracts. First, when you exercise an option on an exchange-traded futures contract, you receive the underlying exchange-traded futures contract. When you exercise an off-exchange Forex currency option, you will probably receive either a cash payment or a position in the underlying currency. Second, NFA’s options brochure only discusses American-style options, which can be exercised at any time before they expire. Many Forex options are European-style options, which can be exercised only on or near the expiration date. You should understand which type of option you are purchasing.
Retail off-exchange Forex currency trades are not guaranteed by a clearing organization and are the most sustainable to fraud and scams. Furthermore, funds that you have deposited to trade Forex currency contracts are not insured and do not receive a priority in bankruptcy. Even customer funds deposited by a dealer in an FDIC-insured bank account are not protected if the dealer goes bankrupt. There is no central marketplace unlike regulated futures exchanges in the retail off-exchange. Forex currency market there is no central marketplace with many buyers and sellers. The Forex currency dealer determines the execution price, so you are relying on the dealer’s integrity for a fair price.
You should ask the dealer how it is regulated and check with the dealer’s regulator about the dealer’s registration status. You should also ask the dealer if its regulator has adopted rules to regulate its retail Forex activities.
Unlike Forex dealers, firms and individuals that solicit retail accounts for Forex currency dealers and manage those accounts do not have to be regulated or affiliated with a regulated firm. Therefore, you should find out if the person’s Forex activities are regulated and by whom.
Warning Signs of Fraud
Watch for the warning signs listed below, and take the following precautions before placing your funds with any currency trading company.
* 1. Stay Away From Opportunities That Sound Too Good to Be True
* 2. Avoid Any Company that Predicts or Guarantees Large Profits
* 3. Stay Away From Companies That Promise Little or No Financial Risk
* 4. Don't Trade on Margin Unless You Understand What It Means
* 5. Question Firms That Claim To Trade in the "Interbank Market"
* 6. Be Wary of Sending or Transferring Cash on the Internet, By Mail or Otherwise
* 7. Currency Scams Often Target Members of Ethnic Minorities
* 8. Be Sure You Get the Company's Performance Track Record
* 9. Don't Deal With Anyone Who Won't Give You Their Background
* 10. Warning Signs Of Commodity "Come-Ons"
Most Forex fraud and commodity fraud is committed by either firms located in South Florida (Boca Raton was voted by CNBC the telemarketing fraud capital of the world in 2000), Southern California or outside the United States. Never make a check or bank wire payable to ANYONE other that a FCM registered with the NFA. In the majority of cases Forex fraud is perpetrated by firms located in the United States and the principals and brokers of the firm and were at one time registered with the National Futures Association (800) 621-3570 and have had their licenses revoked.
Tuesday, November 27, 2007
Deadly Forex Mistakes That Assure Failure
Before venturing into your trading journey there are some things you need to be aware of, otherwise you could succeed on your trading adventure, and we don't want that to happen, do we? This Forex training guide will help you track the most costly mistakes Forex traders do.
First of all, make sure you don't have a trading system. Having a trading system might increase the odds of your success. If you have a system, you will have an objective way to get in and out the market. When traders create their trading systems they think objectively since there is no position to be taken at the moment. If there is no position to be taken, there is also no money at risk, if there is no money at risk, we do think objectively and are open to every possibility, thus we are able to find low risk trading opportunities. So make sure you don't have a system and trade based on a randomly approach.
If you have already created your system, then don't follow it, be undisciplined. If you follow your system, there is a possibility that you can profit from the Forex market based on the trading opportunities you have found. If you want to fail on your trading, be sure to be undisciplined.
Don't get educated. Most successful traders are very well educated in the market they trade (stocks, Forex, futures, etc.) If you get educated, you might acquire the knowledge and experience you require to master the Forex market. Don't read about the Forex market, don't enroll into Forex training programs and don't even look at historical charts.
Don't use any money management technique. The purpose of money management is to avoid the risk of ruin, but at the same time it helps you boost your profits, allowing them to grow geometrically. For instance, by using no money management techniques, there is a possibility that in loosing 10 trades in a row you could empty your trading account. On the other hand, by applying simple money management techniques you can avoid it. So make sure, if you want to fail, don't even consider money management.
Forget about psychological issues. You need to get every trade to win. Successful traders know that they don't need to win every trade in order to profit from the market. This is one characteristic that is hard to understand and really apply. Why? Because we are taught, since kids, that any number below 70% is a bad number. In the Forex trading environment, this is not true.
Don't even consider using a Risk-reward (RR) ratio greater than 1-1. If you use a RR ratio of 1-2 (willing to make twice the amount risked in one trade) then you only need a system that is right around 50% to make money. If you use a RR ratio of 1-3 (willing to make three times the amount risked in one trade) then you will need a system that is right around 40% of the time to make money. So make sure to use a RR ratio below 1-1.
First of all, make sure you don't have a trading system. Having a trading system might increase the odds of your success. If you have a system, you will have an objective way to get in and out the market. When traders create their trading systems they think objectively since there is no position to be taken at the moment. If there is no position to be taken, there is also no money at risk, if there is no money at risk, we do think objectively and are open to every possibility, thus we are able to find low risk trading opportunities. So make sure you don't have a system and trade based on a randomly approach.
If you have already created your system, then don't follow it, be undisciplined. If you follow your system, there is a possibility that you can profit from the Forex market based on the trading opportunities you have found. If you want to fail on your trading, be sure to be undisciplined.
Don't get educated. Most successful traders are very well educated in the market they trade (stocks, Forex, futures, etc.) If you get educated, you might acquire the knowledge and experience you require to master the Forex market. Don't read about the Forex market, don't enroll into Forex training programs and don't even look at historical charts.
Don't use any money management technique. The purpose of money management is to avoid the risk of ruin, but at the same time it helps you boost your profits, allowing them to grow geometrically. For instance, by using no money management techniques, there is a possibility that in loosing 10 trades in a row you could empty your trading account. On the other hand, by applying simple money management techniques you can avoid it. So make sure, if you want to fail, don't even consider money management.
Forget about psychological issues. You need to get every trade to win. Successful traders know that they don't need to win every trade in order to profit from the market. This is one characteristic that is hard to understand and really apply. Why? Because we are taught, since kids, that any number below 70% is a bad number. In the Forex trading environment, this is not true.
Don't even consider using a Risk-reward (RR) ratio greater than 1-1. If you use a RR ratio of 1-2 (willing to make twice the amount risked in one trade) then you only need a system that is right around 50% to make money. If you use a RR ratio of 1-3 (willing to make three times the amount risked in one trade) then you will need a system that is right around 40% of the time to make money. So make sure to use a RR ratio below 1-1.
A Quick Forex Guide for Traders
In this Forex course we will review some steps you need to take care before you venture into your trading journey. Most traders venture into the Forex market with little or no experience in the Forex market. This results in painful experiences like loosing most of the risk capital, frustration because it seemed so easy to make money, etc.
The first thing you need to realize is that, it is not easy to make money. As every other endeavor in life, where important rewards are to come after mastering it, you need to work hard. You need to get very well educated and experienced before having the possibility to receive important rewards on it. The key on mastering the Forex market relies on commitment, patience and discipline.
Ok, you have decided you are going to trade the Forex market, you have seen several advertisings featuring how easy is to make money in the Forex market. You might think this is your opportunity to reach your financial freedom, right away, time is money, why waiting any longer if you have the opportunity to make money now. I know, I've been there, but you have a chance now, I didn't, no body told me what I am going to tell you.
We, Forex traders, make transactions based on a set of rules. These sets of rules are what we call a Trading System. Our systems tell us the exact time where we need to get in the market and out the market in order to make a profit (i.e. buy low sell high.)
Creating a system is the first big step you need to take care first. Why is this so important? Because you need to build a system that suits your personality, otherwise you are going to find hard to follow it, thus hard to profit from.
A system can be based on technical indicators or what we called a mechanical system or based on experience and intuition or what we call discretionary systems. I highly recommend using and trying first a mechanical system, because discretionary systems are dangerous during the early stages of a Forex trader (can lead to indiscipline.) With experience, on later stages, you will find out which signals work better and which ones to avoid.
The next step in this Forex course is to try your system on a demo account. Most Forex brokers offer a demo account, an account with virtual money. This is an excellent choice to test your trading system as there is no money at risk. In this step you will figure out if the strategy works for you. If you feel comfortable trading it, then it is most likely to produce good results. How much time should you stay in this step? It varies, but you shouldn't go one step further until your system gets consistent profitable results over a period of time. It can take many months, but remember, you need to be patient.
You must be honest to yourself; you need to take every single signal generated by your system, not only the signals you thought were going to work, otherwise, you are going to have problems in the next two steps.
Ok, by know you had consistent profitable results on your demo account. You might think its time to go full. Nope, nope, nope. There is a big difference between trading a demo and a real account. The most important difference lies on emotions (fear, greed, anger, etc.) These are psychological barriers that affect every single decision made by traders regardless of what he/she is trading (stocks, bonds, Forex, futures, grains, etc.) These emotional factors, in my opinion, are the most determinant factor that separates profitable traders from the others.
The next step in this Forex course is specially designed to deal with emotions and to confirm the results obtained in the prior step (consistent results in a demo account.) At this step you need to trade in a real account with limited funds. Some brokers offer fractional lot trading. Meaning you are able to trade any desired amount (even cents.) The important thing here is that these emotions we've been talking about are present only when there is real money at risk. At this stage, you are going to see if you are really comfortable trading your system and if you are able to trade with such system, remember different systems produce different emotions. If you are able to produce similar results than those obtained in a demo account, then ready for the next step. If you didn't, then you might need to create another system, there is chance your system never fit you. If you created consistent profitable results on this stage, you have a chance to produce similar results in the next one, on the other hand, if you didn't produce good results in this stage, you will not be able to make on the next stage. Remember, you need to do things right, and be honest to yourself.
The last stage is trading in a real account with sufficient funds. If you are at this stage, and have passed successfully every prior stage, then you have a chance to make it, go ahead and try it, you need to be confident in yourself and in your system, your strategy have already produced consistent profitable results, there are reasons to believe you are going to make it. Very few traders fail at this stage (if passed successfully prior stages.
The first thing you need to realize is that, it is not easy to make money. As every other endeavor in life, where important rewards are to come after mastering it, you need to work hard. You need to get very well educated and experienced before having the possibility to receive important rewards on it. The key on mastering the Forex market relies on commitment, patience and discipline.
Ok, you have decided you are going to trade the Forex market, you have seen several advertisings featuring how easy is to make money in the Forex market. You might think this is your opportunity to reach your financial freedom, right away, time is money, why waiting any longer if you have the opportunity to make money now. I know, I've been there, but you have a chance now, I didn't, no body told me what I am going to tell you.
We, Forex traders, make transactions based on a set of rules. These sets of rules are what we call a Trading System. Our systems tell us the exact time where we need to get in the market and out the market in order to make a profit (i.e. buy low sell high.)
Creating a system is the first big step you need to take care first. Why is this so important? Because you need to build a system that suits your personality, otherwise you are going to find hard to follow it, thus hard to profit from.
A system can be based on technical indicators or what we called a mechanical system or based on experience and intuition or what we call discretionary systems. I highly recommend using and trying first a mechanical system, because discretionary systems are dangerous during the early stages of a Forex trader (can lead to indiscipline.) With experience, on later stages, you will find out which signals work better and which ones to avoid.
The next step in this Forex course is to try your system on a demo account. Most Forex brokers offer a demo account, an account with virtual money. This is an excellent choice to test your trading system as there is no money at risk. In this step you will figure out if the strategy works for you. If you feel comfortable trading it, then it is most likely to produce good results. How much time should you stay in this step? It varies, but you shouldn't go one step further until your system gets consistent profitable results over a period of time. It can take many months, but remember, you need to be patient.
You must be honest to yourself; you need to take every single signal generated by your system, not only the signals you thought were going to work, otherwise, you are going to have problems in the next two steps.
Ok, by know you had consistent profitable results on your demo account. You might think its time to go full. Nope, nope, nope. There is a big difference between trading a demo and a real account. The most important difference lies on emotions (fear, greed, anger, etc.) These are psychological barriers that affect every single decision made by traders regardless of what he/she is trading (stocks, bonds, Forex, futures, grains, etc.) These emotional factors, in my opinion, are the most determinant factor that separates profitable traders from the others.
The next step in this Forex course is specially designed to deal with emotions and to confirm the results obtained in the prior step (consistent results in a demo account.) At this step you need to trade in a real account with limited funds. Some brokers offer fractional lot trading. Meaning you are able to trade any desired amount (even cents.) The important thing here is that these emotions we've been talking about are present only when there is real money at risk. At this stage, you are going to see if you are really comfortable trading your system and if you are able to trade with such system, remember different systems produce different emotions. If you are able to produce similar results than those obtained in a demo account, then ready for the next step. If you didn't, then you might need to create another system, there is chance your system never fit you. If you created consistent profitable results on this stage, you have a chance to produce similar results in the next one, on the other hand, if you didn't produce good results in this stage, you will not be able to make on the next stage. Remember, you need to do things right, and be honest to yourself.
The last stage is trading in a real account with sufficient funds. If you are at this stage, and have passed successfully every prior stage, then you have a chance to make it, go ahead and try it, you need to be confident in yourself and in your system, your strategy have already produced consistent profitable results, there are reasons to believe you are going to make it. Very few traders fail at this stage (if passed successfully prior stages.
Things You Should Know About Forex Trading
How difficult is it to make money trading the Forex market? How much time does it take to actually be able to make a living trading the Forex market? These and other important aspects of trading are to be discussed in this article.
Trading the Forex market has many benefits over other financial markets, among the most important are: superior liquidity, 24hrs market, better execution, and others. Traders and investor see the Forex market as a new speculation or diversifying opportunity because of these benefits. Does this mean that it is easy to make money trading the Forex Market? Not at all.
Forex brokers agree that 90% of traders end up losing money, 5% of traders end up at break even and only 5% of them achieve consistent profitable results. With these statistics shown, I don't consider trading to be an easy task. But, is it harder to master any other endeavor? I don't think so, consider musicians, writers, or even other businesses, the success rates are about the same, there are a whole bunch of them who never got to the top.
Now that we know it is not easy to achieve consistent profitable results, a must question would be, Why is it that some traders succeed while others fail to trade successfully in the Forex market? There is no hard answer to this question, or a recipe to follow to achieve consistent profitable results. What we do know is that traders that reach the top think different. That's right, they don't follow the crowd, they are an independent part of the crowd.
A few things that separate the top traders from the rest are:
Education: They are very well educated in the matter; they have chosen to learn every single and important aspect of trading. The best traders know that every trade is a learning experience. They approach the Forex market with humility, otherwise the market will prove them wrong.
Forex trading system: Top traders have a Forex trading system. They have the discipline to follow it rigorously, because they know that only the trades that are signaled by their system have a greater rate of success.
Price behavior: They have incorporated price behavior into their trading systems. They know price action has the last word.
Money management: Avoiding the risk of ruin is a primary subject to the best traders. After all, you cannot succeed without funds in your trading account.
Trading psychology: They are aware of every psychological issue that affects the decisions made by traders. They have accepted the fact that every individual trade has two probable outcomes, not just the winning side.
These are, among others, the most important factors that influence the success rate of Forex traders.
We know now that it is not easy to make money trading the Forex market, but it is possible. We also discussed the most important factors that influence the rate of success of Forex traders. But, how much time does it take to have consistent profitable results? It is different from trader to trader. For some, it could take a life time, and still don't get the desired results, for some others, a few years are enough to get consistent profitable results. The answer to this question may vary, but what I want to make clear here is that trading successfully is a process, it's not something you can do in a short period of time.
Trading the Forex market has many benefits over other financial markets, among the most important are: superior liquidity, 24hrs market, better execution, and others. Traders and investor see the Forex market as a new speculation or diversifying opportunity because of these benefits. Does this mean that it is easy to make money trading the Forex Market? Not at all.
Forex brokers agree that 90% of traders end up losing money, 5% of traders end up at break even and only 5% of them achieve consistent profitable results. With these statistics shown, I don't consider trading to be an easy task. But, is it harder to master any other endeavor? I don't think so, consider musicians, writers, or even other businesses, the success rates are about the same, there are a whole bunch of them who never got to the top.
Now that we know it is not easy to achieve consistent profitable results, a must question would be, Why is it that some traders succeed while others fail to trade successfully in the Forex market? There is no hard answer to this question, or a recipe to follow to achieve consistent profitable results. What we do know is that traders that reach the top think different. That's right, they don't follow the crowd, they are an independent part of the crowd.
A few things that separate the top traders from the rest are:
Education: They are very well educated in the matter; they have chosen to learn every single and important aspect of trading. The best traders know that every trade is a learning experience. They approach the Forex market with humility, otherwise the market will prove them wrong.
Forex trading system: Top traders have a Forex trading system. They have the discipline to follow it rigorously, because they know that only the trades that are signaled by their system have a greater rate of success.
Price behavior: They have incorporated price behavior into their trading systems. They know price action has the last word.
Money management: Avoiding the risk of ruin is a primary subject to the best traders. After all, you cannot succeed without funds in your trading account.
Trading psychology: They are aware of every psychological issue that affects the decisions made by traders. They have accepted the fact that every individual trade has two probable outcomes, not just the winning side.
These are, among others, the most important factors that influence the success rate of Forex traders.
We know now that it is not easy to make money trading the Forex market, but it is possible. We also discussed the most important factors that influence the rate of success of Forex traders. But, how much time does it take to have consistent profitable results? It is different from trader to trader. For some, it could take a life time, and still don't get the desired results, for some others, a few years are enough to get consistent profitable results. The answer to this question may vary, but what I want to make clear here is that trading successfully is a process, it's not something you can do in a short period of time.
Forex Pivot Points: Mapping Your Time Frame
It is useful to have a map and be able to see where the price is relative to previous market action. This way we can see how is the sentiment of traders and investors at any given moment, it also gives us a general idea of where the market is heading during the day. This information can help us decide which way to trade.
Pivot points, a technique developed by floor traders, help us see where the price is relative to previous market action.
As a definition, a pivot point is a turning point or condition. The same applies to the Forex market, the pivot point is a level in which the sentiment of the market changes from “bull” to “bear” or vice versa. If the market breaks this level up, then the sentiment is said to be a bull market and it is likely to continue its way up, on the other hand, if the market breaks this level down, then the sentiment is bear, and it is expected to continue its way down. Also at this level, the market is expected to have some kind of support/resistance, and if price can't break the pivot point, a possible bounce from it is plausible.
Pivot points work best on highly liquid markets, like the spot currency market, but they can also be used in other markets as well.
Forex Pivot Points
In a few words, pivot point is a level in which the sentiment of traders and investors changes from bull to bear or vice versa.
Why PP work?
They work simply because many individual traders and investors use and trust them, as well as bank and institutional traders. It is known to every trader that the pivot point is an important measure of strength and weakness of any market.
Calculating pivot points
There are several ways to arrive to the Pivot point. The method we found to have the most accurate results is calculated by taking the average of the high, low and close of a previous period (or session).
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from the previous session:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is trading above 1.2439, Bulls are winning the battle pushing the prices higher. And if the market is trading below this 1.2439 the bears are winning the battle pulling prices lower. On both cases this condition is likely to sustain until the next session.
Since the Forex market is a 24hr market (no close or open from day to day) there is a eternal battle on deciding at white time we should take the open, close, high and low from each session. From our point of view, the times that produce more accurate predictions is taking the open at 00:00 GMT and the close at 23:59 GMT .
Besides the calculation of the PP, there are other support and resistance levels that are calculated taking the PP as a reference.
Support 1 (S1) = (PP * 2) – H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP – (R1 – S1)
Resistance 2 (R2) = PP + (R1 – S1)
Where , H is the High of the previous period and L is the low of the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
These levels are supposed to mark support and resistance levels for the current session.
On the example above, the PP was calculated using information of the previous session (previous day.) This way we could see possible intraday resistance and support levels. But it can also be calculated using the previous weekly or monthly data to determine such levels. By doing so we are able to see the sentiment over longer periods of time. Also we can see possible levels that might offer support and resistance throughout the week or month. Calculating the Pivot point in a weekly or monthly basis is mostly used by long term traders, but it can also be used by short time traders, it gives us a good idea about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone is a well-known technique and it works simply because many traders and investors use and trust it. But what about the other support and resistance zones (S1, S2, R1 and R2,) to forecast a support or resistance level with some mathematical formula is somehow subjective. It is hard to rely on them blindly just because the formula popped out that level. For this reason, we have created an alternative way to map our time frame, simpler but more objective and effective.
We calculate the pivot point as showed before. But our support and resistance levels are drawn in a different way. We take the previous session high and low, and draw those levels on today's chart. The same is done with the session before the previous session. So, we will have our PP and four more important levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session.
PP, pivot point.
These levels will tell us the strength of the market at any given moment. If the market is trading above the PP, then the market is considered in a possible uptrend. If the market is trading above HOPS1 or HOPS2, then the market is in an uptrend, and we only take long positions. If the market is trading below the PP then the market is considered in a possible downtrend. If the market is trading below LOPS1 or LOPS2, then the market is in a downtrend, and we should only consider short trades.
The psychology behind this approach is simple. We know that for some reason the market stopped there from going higher/lower the previous session, or the session before that. We don't know the reason, and we don't need to know it. We only know the fact: the market reversed at that level. We also know that traders and investors have memories, they do remember that the price stopped there before, and the odds are that the market reverses from there again (maybe because the same reason, and maybe not) or at least find some support or resistance at these levels.
What is important about his approach is that support and resistance levels are measured objectively; they aren't just a level derived from a mathematical formula, the price reversed there before so these levels have a higher probability of being effective.
Our mapping method works on both market conditions, when trending and on sideways conditions. In a trending market, it helps us determine the strength of the trend and trade off important levels. On sideways markets it shows us possible reversal levels.
Pivot points, a technique developed by floor traders, help us see where the price is relative to previous market action.
As a definition, a pivot point is a turning point or condition. The same applies to the Forex market, the pivot point is a level in which the sentiment of the market changes from “bull” to “bear” or vice versa. If the market breaks this level up, then the sentiment is said to be a bull market and it is likely to continue its way up, on the other hand, if the market breaks this level down, then the sentiment is bear, and it is expected to continue its way down. Also at this level, the market is expected to have some kind of support/resistance, and if price can't break the pivot point, a possible bounce from it is plausible.
Pivot points work best on highly liquid markets, like the spot currency market, but they can also be used in other markets as well.
Forex Pivot Points
In a few words, pivot point is a level in which the sentiment of traders and investors changes from bull to bear or vice versa.
Why PP work?
They work simply because many individual traders and investors use and trust them, as well as bank and institutional traders. It is known to every trader that the pivot point is an important measure of strength and weakness of any market.
Calculating pivot points
There are several ways to arrive to the Pivot point. The method we found to have the most accurate results is calculated by taking the average of the high, low and close of a previous period (or session).
Pivot point (PP) = (High + Low + Close) / 3
Take for instance the following EUR/USD information from the previous session:
Open: 1.2386
High: 1.2474
Low: 1.2376
Close: 1.2458
The PP would be,
PP = (1.2474 + 1.2376 + 1.2458) / 3 = 1.2439
What does this number tell us?
It simply tells us that if the market is trading above 1.2439, Bulls are winning the battle pushing the prices higher. And if the market is trading below this 1.2439 the bears are winning the battle pulling prices lower. On both cases this condition is likely to sustain until the next session.
Since the Forex market is a 24hr market (no close or open from day to day) there is a eternal battle on deciding at white time we should take the open, close, high and low from each session. From our point of view, the times that produce more accurate predictions is taking the open at 00:00 GMT and the close at 23:59 GMT .
Besides the calculation of the PP, there are other support and resistance levels that are calculated taking the PP as a reference.
Support 1 (S1) = (PP * 2) – H
Resistance 1 (R1) = (PP * 2) - L
Support 2 (S2) = PP – (R1 – S1)
Resistance 2 (R2) = PP + (R1 – S1)
Where , H is the High of the previous period and L is the low of the previous period
Continuing with the example above, PP = 1.2439
S1 = (1.2439 * 2) - 1.2474 = 1.2404
R1 = (1.2439 * 2) – 1.2376 = 1.2502
R2 = 1.2439 + (1.2636 – 1.2537) = 1.2537
S2 = 1.2439 – (1.2636 – 1.2537) = 1.2537
These levels are supposed to mark support and resistance levels for the current session.
On the example above, the PP was calculated using information of the previous session (previous day.) This way we could see possible intraday resistance and support levels. But it can also be calculated using the previous weekly or monthly data to determine such levels. By doing so we are able to see the sentiment over longer periods of time. Also we can see possible levels that might offer support and resistance throughout the week or month. Calculating the Pivot point in a weekly or monthly basis is mostly used by long term traders, but it can also be used by short time traders, it gives us a good idea about the longer term trend.
S1, S2, R1 AND R2...? An Objective Alternative
As already stated, the pivot point zone is a well-known technique and it works simply because many traders and investors use and trust it. But what about the other support and resistance zones (S1, S2, R1 and R2,) to forecast a support or resistance level with some mathematical formula is somehow subjective. It is hard to rely on them blindly just because the formula popped out that level. For this reason, we have created an alternative way to map our time frame, simpler but more objective and effective.
We calculate the pivot point as showed before. But our support and resistance levels are drawn in a different way. We take the previous session high and low, and draw those levels on today's chart. The same is done with the session before the previous session. So, we will have our PP and four more important levels drawn in our chart.
LOPS1, low of the previous session.
HOPS1, high of the previous session.
LOPS2, low of the session before the previous session.
HOPS2, high of the session before the previous session.
PP, pivot point.
These levels will tell us the strength of the market at any given moment. If the market is trading above the PP, then the market is considered in a possible uptrend. If the market is trading above HOPS1 or HOPS2, then the market is in an uptrend, and we only take long positions. If the market is trading below the PP then the market is considered in a possible downtrend. If the market is trading below LOPS1 or LOPS2, then the market is in a downtrend, and we should only consider short trades.
The psychology behind this approach is simple. We know that for some reason the market stopped there from going higher/lower the previous session, or the session before that. We don't know the reason, and we don't need to know it. We only know the fact: the market reversed at that level. We also know that traders and investors have memories, they do remember that the price stopped there before, and the odds are that the market reverses from there again (maybe because the same reason, and maybe not) or at least find some support or resistance at these levels.
What is important about his approach is that support and resistance levels are measured objectively; they aren't just a level derived from a mathematical formula, the price reversed there before so these levels have a higher probability of being effective.
Our mapping method works on both market conditions, when trending and on sideways conditions. In a trending market, it helps us determine the strength of the trend and trade off important levels. On sideways markets it shows us possible reversal levels.
Using Bollinger Band "Bands" To Gauge Trends
Access Boris' Exclusive FREE Report The 5 Things That Move The Market
Bollinger bands are one of the most popular technical indicators for traders in any financial market - stocks, bonds or foreign exchange (FX). Many traders use them primarily to determine overbought and oversold levels, selling when price touches the upper Bollinger band and buying when it hits the lower Bollinger band. In range-bound markets, this technique works well, as prices travel between the two bands like balls bouncing off the walls of a racquetball court.
Yet as John Bollinger was first to acknowledge, "tags of the bands are just that - tags, not signals. A tag of the upper Bollinger band is not in and of itself a sell signal. A tag of the lower Bollinger band is not in and of itself a buy signal". Price often can and does "walk the band". In those markets, traders who continuously try to "sell the top" or "buy the bottom" are faced with an excruciating series of stop-outs or worse, an ever-mounting floating loss as price moves further and further away from the original entry.
Perhaps a more useful way to trade with Bollinger bands is to use them to gauge trends. To understand why Bollinger bands may be a good tool for this task we first need to ask - what is a trend?
Trend as Deviance
One standard cliché in trading is that prices range 80% of the time. Like many clichés this one contains a good amount of truth since markets mostly consolidate as bulls and bears battle for supremacy. Market trends are rare, which is why trading them is not nearly as easy as it seems. Looking at price this way we can then define trend as deviation from the norm (range).
The Bollinger band formula consists of the following:
BOLU = Upper Bollinger Band
BOLD = Lower Bollinger Band
n = Smoothing Period
m = Number of Standard Deviations (SD)
SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3
BOLU = MA(TP, n) + m * SD[TP, n]
BOLD = MA(TP, n) - m * SD[TP, n]
At the core, Bollinger bands measure deviation. This is the reason why they can be very helpful in diagnosing trend. By generating two sets of Bollinger bands - one set using the parameter of "1 standard deviation" and the other using the typical setting of "2 standard deviation" - we can look at price in a whole new way.
In the chart below we see that whenever price channels between the upper Bollinger bands +1 SD and +2 SD away from mean, the trend is up; therefore, we can define that channel as the "buy zone". Conversely, if price channels within Bollinger bands –1 SD and –2 SD, it is in the "sell zone". Finally, if price meanders between +1 SD band and –1 SD band, it is essentially in a neutral state, and we can say that it's in "no man's land".
One of the other great advantages of Bollinger bands is that they adapt dynamically to price expanding and contracting as volatility increases and decreases. Therefore, the bands naturally widen and narrow in sync with price action, creating a very accurate trending envelope.
A Tool for Trend Traders and Faders
Having established the basic rules for Bollinger band "bands", we can now demonstrate how this technical tool can be used by both trend traders who seek to exploit momentum and fade traders who like to profit from trend exhaustion. Returning back to the AUD/USD chart just above, we can see how trend traders would position long once price entered the "buy zone". They would then be able to stay in trend as the Bollinger band "bands" encapsulate most of the price action of the massive up-move.
What would be a logical stop-out point? The answer is different for each individual trader, but one reasonable possibility would be to close the long trade if the candle turned red and more than 75% of its body were below the "buy zone". Using the 75% rule is obvious since at that point price clearly falls out of trend, but why insist that the candle be red? The reason for the second condition is to prevent the trend trader from being "wiggled out" of a trend by a quick probative move to the downside that snaps back to the "buy zone" at the end of the trading period. Note how in the following chart the trader is able to stay with the move for most of the uptrend, exiting only when price starts to consolidate at the top of the new range.
Bollinger band "bands" can also be a valuable tool for traders who like to exploit trend exhaustion by picking the turn in price. Note, however, that counter-trend trading requires far larger margins of error as trends will often make several attempts at continuation before capitulating.
n the chart below, we see that a fade trader using Bollinger band "bands" will be able to diagnose quickly the first hint of trend weakness. Having seen prices fall out of the trend channel, the fader may decide to make classic use of Bollinger bands by shorting the next tag of the upper Bollinger band. But where to place the stop? Putting it just above the swing high will practically assure the trader of a stop-out as price will often make many probative forays to the top of the range, with buyers trying to extend the trend. Here is where the volatility property of Bollinger bands becomes an enormous benefit to the trader. By measuring the width of the "no man's land" area, which is simply the range of +1 to –1 SD from the mean, the trader can create a quick and very effective projection zone which will prevent him or her from being stopped out on market noise and yet protect his or her capital if trend truly regains its momentum.
Conclusion
As one the most popular technical-analysis indicators, Bollinger bands have become crucial to many technically oriented traders. By extending their functionality through the use of Bollinger band "bands", traders can achieve a greater level of analytical sophistication using this simple and elegant tool for both trending and fading strategies.
By Boris Schlossberg, Senior Currency Strategist, FXCM
Access Boris' Exclusive FREE Report The 5 Things That Move The Market
Boris Schlossberg is the Senior Currency Strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book "Technical Analysis of the Currency Market", published by John Wiley and Sons, is available on Amazon, where he also hosts a blog on all things trading.
Bollinger bands are one of the most popular technical indicators for traders in any financial market - stocks, bonds or foreign exchange (FX). Many traders use them primarily to determine overbought and oversold levels, selling when price touches the upper Bollinger band and buying when it hits the lower Bollinger band. In range-bound markets, this technique works well, as prices travel between the two bands like balls bouncing off the walls of a racquetball court.
Yet as John Bollinger was first to acknowledge, "tags of the bands are just that - tags, not signals. A tag of the upper Bollinger band is not in and of itself a sell signal. A tag of the lower Bollinger band is not in and of itself a buy signal". Price often can and does "walk the band". In those markets, traders who continuously try to "sell the top" or "buy the bottom" are faced with an excruciating series of stop-outs or worse, an ever-mounting floating loss as price moves further and further away from the original entry.
Perhaps a more useful way to trade with Bollinger bands is to use them to gauge trends. To understand why Bollinger bands may be a good tool for this task we first need to ask - what is a trend?
Trend as Deviance
One standard cliché in trading is that prices range 80% of the time. Like many clichés this one contains a good amount of truth since markets mostly consolidate as bulls and bears battle for supremacy. Market trends are rare, which is why trading them is not nearly as easy as it seems. Looking at price this way we can then define trend as deviation from the norm (range).
The Bollinger band formula consists of the following:
BOLU = Upper Bollinger Band
BOLD = Lower Bollinger Band
n = Smoothing Period
m = Number of Standard Deviations (SD)
SD = Standard Deviation over Last n Periods Typical Price (TP) = (HI + LO + CL) / 3
BOLU = MA(TP, n) + m * SD[TP, n]
BOLD = MA(TP, n) - m * SD[TP, n]
At the core, Bollinger bands measure deviation. This is the reason why they can be very helpful in diagnosing trend. By generating two sets of Bollinger bands - one set using the parameter of "1 standard deviation" and the other using the typical setting of "2 standard deviation" - we can look at price in a whole new way.
In the chart below we see that whenever price channels between the upper Bollinger bands +1 SD and +2 SD away from mean, the trend is up; therefore, we can define that channel as the "buy zone". Conversely, if price channels within Bollinger bands –1 SD and –2 SD, it is in the "sell zone". Finally, if price meanders between +1 SD band and –1 SD band, it is essentially in a neutral state, and we can say that it's in "no man's land".
One of the other great advantages of Bollinger bands is that they adapt dynamically to price expanding and contracting as volatility increases and decreases. Therefore, the bands naturally widen and narrow in sync with price action, creating a very accurate trending envelope.
A Tool for Trend Traders and Faders
Having established the basic rules for Bollinger band "bands", we can now demonstrate how this technical tool can be used by both trend traders who seek to exploit momentum and fade traders who like to profit from trend exhaustion. Returning back to the AUD/USD chart just above, we can see how trend traders would position long once price entered the "buy zone". They would then be able to stay in trend as the Bollinger band "bands" encapsulate most of the price action of the massive up-move.
What would be a logical stop-out point? The answer is different for each individual trader, but one reasonable possibility would be to close the long trade if the candle turned red and more than 75% of its body were below the "buy zone". Using the 75% rule is obvious since at that point price clearly falls out of trend, but why insist that the candle be red? The reason for the second condition is to prevent the trend trader from being "wiggled out" of a trend by a quick probative move to the downside that snaps back to the "buy zone" at the end of the trading period. Note how in the following chart the trader is able to stay with the move for most of the uptrend, exiting only when price starts to consolidate at the top of the new range.
Bollinger band "bands" can also be a valuable tool for traders who like to exploit trend exhaustion by picking the turn in price. Note, however, that counter-trend trading requires far larger margins of error as trends will often make several attempts at continuation before capitulating.
n the chart below, we see that a fade trader using Bollinger band "bands" will be able to diagnose quickly the first hint of trend weakness. Having seen prices fall out of the trend channel, the fader may decide to make classic use of Bollinger bands by shorting the next tag of the upper Bollinger band. But where to place the stop? Putting it just above the swing high will practically assure the trader of a stop-out as price will often make many probative forays to the top of the range, with buyers trying to extend the trend. Here is where the volatility property of Bollinger bands becomes an enormous benefit to the trader. By measuring the width of the "no man's land" area, which is simply the range of +1 to –1 SD from the mean, the trader can create a quick and very effective projection zone which will prevent him or her from being stopped out on market noise and yet protect his or her capital if trend truly regains its momentum.
Conclusion
As one the most popular technical-analysis indicators, Bollinger bands have become crucial to many technically oriented traders. By extending their functionality through the use of Bollinger band "bands", traders can achieve a greater level of analytical sophistication using this simple and elegant tool for both trending and fading strategies.
By Boris Schlossberg, Senior Currency Strategist, FXCM
Access Boris' Exclusive FREE Report The 5 Things That Move The Market
Boris Schlossberg is the Senior Currency Strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book "Technical Analysis of the Currency Market", published by John Wiley and Sons, is available on Amazon, where he also hosts a blog on all things trading.
A Primer On The Forex Market
With the increasingly widespread availability of electronic trading networks, trading on the currency exchanges is now more accessible than ever. The foreign exchange market, or forex, is notoriously the domain of government central banks and commercial and investment banks, not to mention hedge funds and massive international corporations. At first glance, the presence of such heavyweight entities may appear rather daunting to the individual investor. But the presence of such powerful groups and such a massive international market can also work to the benefit of the individual trader. The forex offers trading 24-hours a day, five days a week, and the daily dollar volume of currencies traded in the currency market exceeds $1.4 trillion, making it the largest and most liquid market in the world.
Trading Opportunities
The sheer number of currencies traded serves to ensure a rather extreme level of volatility on a day-to-day basis. There will always be currencies that are moving rapidly up or down, offering opportunities for profit (and commensurate risk) to astute traders. Yet, like the equity markets, forex offers plenty of instruments to mitigate risk and allows the individual to profit in both rising and falling markets. Forex also allows highly leveraged trading with low margin requirements relative to its equity counterparts. Perhaps best of all, forex charges zero dealing commissions!
Many of the instruments utilized in forex - such as forwards and futures, options, spread betting, contracts for difference and the spot market - will appear similar to those used in the equity markets. Since the instruments on the forex often maintain minimum trade sizes in terms of the base currencies (the spot market, for example, requires a minimum trade size of 100,000 units of the base currency), the use of margin is absolutely essential for the person trading these instruments.
Buying and Selling Currencies
Regarding the specifics of buying and selling on forex, it is important to note that currencies are always priced in pairs. All trades result in the simultaneous purchase of one currency and the sale of another. This necessitates a slightly different mode of thinking than what you might be used to. While trading on the forex, you would execute a trade only at a time when you expect the currency you are buying to increase in value relative to the one you are selling. If the currency you are buying does increase in value, you must sell the other currency back in order to lock in a profit. An open trade (or open position), therefore, is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.
Base and Counter Currencies and Quotes
Currency traders must become familiar also with the way currencies are quoted. The first currency in the pair is considered the base currency; and the second is the counter or quote currency. Most of the time, U.S. dollar is considered the base currency, and quotes are expressed in units of US$1 per counter currency (for example, USD/JPY or USD/CAD). The only exceptions to this convention are quotes in relation to the euro, the pound sterling and the Australian dollar - these three are quoted as dollars per foreign currency.
Forex quotes always include a bid and an ask price. The bid is the price at which the market maker is willing to buy the base currency in exchange for the counter currency. The ask price is the price at which the market maker is willing to sell the base currency in exchange for the counter currency. The difference between the bid and the ask prices is referred to as the spread.
The cost of establishing a position is determined by the spread, and prices are always quoted using five numbers (for example, 134.85), the final digit of which is referred to as a point or a pip. For example, if USD/JPY was quoted with a bid of 134.85 and an ask of 134.90, the five-pip spread is the cost of trading this position. From the very start, therefore, the trader must recover the five-pip cost from his or her profits, necessitating a favorable move in the position in order simply to break even.
More about Margin
Trading in the currency markets requires a trader to think in a slightly different way also about margin. Margin on the forex is not a down payment on a future purchase of equity but a deposit to the trader's account that will cover against any currency-trading losses in the future. A typical currency trading system will allow for a very high degree of leverage in its margin requirements, up to 100:1. The system will automatically calculate the funds necessary for current positions and will check for margin availability before executing any trade.
Rollover
In the spot forex market, trades must be settled within two business days. For example, if a trader sells a certain number of currency units on Wednesday, he or she must deliver an equivalent number of units on Friday. But currency trading systems may allow for a "rollover", with which open positions can be swapped forward to the next settlement date (giving an extension of two additional business days). The interest rate for such a swap is predetermined, and, in fact, these swaps are actually financial instruments that can also be traded on the currency market.
In any spot rollover transaction the difference between the interest rates of the base and counter currencies is reflected as an overnight loan. If the trader holds a long position in the currency with the higher interest rate, he or she would gain on the spot rollover. The amount of such a gain would fluctuate day-to-day according to the precise interest-rate differential between the base and the counter currency. Such rollover rates are quoted in dollars and are shown in the interest column of the forex trading system. Rollovers, however, will not affect traders who never hold a position overnight since the rollover is exclusively a day-to-day phenomenon.
Conclusion
As one can immediately see, trading in forex requires a slightly different way of thinking than the way required by equity markets. Yet, for its extreme liquidity, multitude of opportunities for large profits due to strong trends and high levels of available leverage, the currency market are hard to resist for the advanced trader. With such potential, however, comes significant risk, and traders should quickly establish an intimate familiarity with methods of risk management.
Trading Opportunities
The sheer number of currencies traded serves to ensure a rather extreme level of volatility on a day-to-day basis. There will always be currencies that are moving rapidly up or down, offering opportunities for profit (and commensurate risk) to astute traders. Yet, like the equity markets, forex offers plenty of instruments to mitigate risk and allows the individual to profit in both rising and falling markets. Forex also allows highly leveraged trading with low margin requirements relative to its equity counterparts. Perhaps best of all, forex charges zero dealing commissions!
Many of the instruments utilized in forex - such as forwards and futures, options, spread betting, contracts for difference and the spot market - will appear similar to those used in the equity markets. Since the instruments on the forex often maintain minimum trade sizes in terms of the base currencies (the spot market, for example, requires a minimum trade size of 100,000 units of the base currency), the use of margin is absolutely essential for the person trading these instruments.
Buying and Selling Currencies
Regarding the specifics of buying and selling on forex, it is important to note that currencies are always priced in pairs. All trades result in the simultaneous purchase of one currency and the sale of another. This necessitates a slightly different mode of thinking than what you might be used to. While trading on the forex, you would execute a trade only at a time when you expect the currency you are buying to increase in value relative to the one you are selling. If the currency you are buying does increase in value, you must sell the other currency back in order to lock in a profit. An open trade (or open position), therefore, is a trade in which a trader has bought or sold a particular currency pair and has not yet sold or bought back the equivalent amount to close the position.
Base and Counter Currencies and Quotes
Currency traders must become familiar also with the way currencies are quoted. The first currency in the pair is considered the base currency; and the second is the counter or quote currency. Most of the time, U.S. dollar is considered the base currency, and quotes are expressed in units of US$1 per counter currency (for example, USD/JPY or USD/CAD). The only exceptions to this convention are quotes in relation to the euro, the pound sterling and the Australian dollar - these three are quoted as dollars per foreign currency.
Forex quotes always include a bid and an ask price. The bid is the price at which the market maker is willing to buy the base currency in exchange for the counter currency. The ask price is the price at which the market maker is willing to sell the base currency in exchange for the counter currency. The difference between the bid and the ask prices is referred to as the spread.
The cost of establishing a position is determined by the spread, and prices are always quoted using five numbers (for example, 134.85), the final digit of which is referred to as a point or a pip. For example, if USD/JPY was quoted with a bid of 134.85 and an ask of 134.90, the five-pip spread is the cost of trading this position. From the very start, therefore, the trader must recover the five-pip cost from his or her profits, necessitating a favorable move in the position in order simply to break even.
More about Margin
Trading in the currency markets requires a trader to think in a slightly different way also about margin. Margin on the forex is not a down payment on a future purchase of equity but a deposit to the trader's account that will cover against any currency-trading losses in the future. A typical currency trading system will allow for a very high degree of leverage in its margin requirements, up to 100:1. The system will automatically calculate the funds necessary for current positions and will check for margin availability before executing any trade.
Rollover
In the spot forex market, trades must be settled within two business days. For example, if a trader sells a certain number of currency units on Wednesday, he or she must deliver an equivalent number of units on Friday. But currency trading systems may allow for a "rollover", with which open positions can be swapped forward to the next settlement date (giving an extension of two additional business days). The interest rate for such a swap is predetermined, and, in fact, these swaps are actually financial instruments that can also be traded on the currency market.
In any spot rollover transaction the difference between the interest rates of the base and counter currencies is reflected as an overnight loan. If the trader holds a long position in the currency with the higher interest rate, he or she would gain on the spot rollover. The amount of such a gain would fluctuate day-to-day according to the precise interest-rate differential between the base and the counter currency. Such rollover rates are quoted in dollars and are shown in the interest column of the forex trading system. Rollovers, however, will not affect traders who never hold a position overnight since the rollover is exclusively a day-to-day phenomenon.
Conclusion
As one can immediately see, trading in forex requires a slightly different way of thinking than the way required by equity markets. Yet, for its extreme liquidity, multitude of opportunities for large profits due to strong trends and high levels of available leverage, the currency market are hard to resist for the advanced trader. With such potential, however, comes significant risk, and traders should quickly establish an intimate familiarity with methods of risk management.
Profiting on Interventions in Forex Markets
How would you like to make US$1,287 in 10 minutes? Well, if you had purchased a $100,000 lot of US dollar/Japanese yen on Dec 10, 2003 at 107.40 and sold 10 minutes later at 108.80, you could have!
1. Bought $100,000 and sold 10,740,000 yen (100,000*107.40)
2. Ten minutes later, the USD/JPY increases to 108.80
3. Sell $100,000 to buy 10,880,000 yen to realize a gain of 140,000 yen
4. In dollar terms, the gain would be 140,000/108.8 = $1,286.76 USD
So, who was on the other end of the trade taking the huge losses? Believe it or not, it was the central Bank of Japan! And why would they do this? The act is known as an intervention, but before we discover why they do it, let's quickly review the economics of the currency markets.
A Brief Economics Lesson
The entire foreign-exchange market (forex) revolves around currencies and their valuations relative to one another. These valuations play a large role in domestic and global economics. They determine many things, most notably the prices of imports and exports.
Valuation and the Central Banks
In order to understand why interventions occur, we must first establish how currencies are valuated. This can happen in two ways: by the market through supply and demand or by governments (ie: central banks). Subjecting a currency to valuation by the markets is known as floating the currency. Conversely, currency rates set by governments is known as fixing the currency, meaning a country’s currency is pegged to a major world currency (usually the U.S. dollar). Thus, in order for a central bank to maintain or stabilize the local exchange rate, it will implement monetary policy by adjusting interest rates or by buying and selling its own currency on the foreign-exchange market in return for the currency to which it is pegged, called intervention.
Instability and Intervention
Since currencies always trade in pairs (relative to one another), a significant movement in one directly impacts the other. When a country's currency becomes unstable for any reason (speculation, growing deficits, national tragedy, etc), other countries experience the aftereffect. Normally, this occurs over a long period of time, which allows for the market and/or central banks to effectively deal with any revaluation needs.
There becomes a problem, however, when there is a sudden and rapid and sustainable movement in a currency's valuation, which makes it impractical or even impossible for a central bank to immediately respond via interest rates, used to quickly correct the movement. These are times in which interventions take place.
Take the USD/JPY currency pair, for example. Between 2000 and 2003, the Bank of Japan intervened several times to keep the yen valued lower than the dollar as they were afraid of a increase in the value of the yen, making exports relatively more expensive than imports and hindering an economic recovery at that time. In 2001, Japan intervened and spent more than $28 billion to halt the yen from appreciating and in 2002, they spent a record $33 billion to keep the yen down.
Trading & Interventions
Interventions present an interesting opportunity for traders. If there is some significant negative catalyst (such as national debt or tragedy), this can indicate to traders that a currency they are targeting should be fundamentally valued lower. For example, the U.S. budget deficit caused the dollar to fall rapidly in relation to the yen, whose value, in turn, rose rapidly. In such circumstances, traders can speculate on the likelihood of an intervention, which would result in sharp price movements in the short term. This creates an opportunity for traders to profit handsomely by taking a position before the intervention and exiting the position after the effects of the intervention takes place. It is important to realize, however, that trading against a fast-moving trend (looking for an intervention) can be very risky and should be reserved for speculation traders.Furthermore, trading against a trend, especially when leveraged, can be extremely dangerous as large amounts of capital can be lost in short periods of time.
The Intervention
Now, let's take a look at what the intervention looks like on the charts:
Here we can see that between 2000 and 2003, the Bank of Japan intervened several times. Please note that there may have been more or less interventions than shown here since these interventions are not always made public. It is usually easy to spot them when they occur, however, because of the large short-term price movement, such as the one mentioned in the beginning of this article.
Trading
Knowing when interventions may occur is more of an art than a science; but, that doesn't mean there aren't clear indicators to help you. Here are some basic principles to follow:
1. Interventions usually occur around the same price level as previous interventions. In the case of the USD/JPY, this level was 115.00 – notice in the chart above that the interventions pushed the value of the dollar above that point for quite some time. But keep in mind that this may not always be true; interventions may cease if the central bank deems it unnecessary (i.e. too costly). This is also apparent where we see the value drop below 115.00.
2. Sometimes there are verbal clues prior to interventions. Japan’s former finance minister Kiichi Miyazawa was infamous for threatening to intervene on multiple occasions. Similarly, the European Union has given clues as to their possible intervention in the future. Sometimes these words alone are enough to move the markets. Keep in mind, however, that the more often traders hear these threats with no action, the less impact these threats will have on the market.
3. Analysts also often give good estimates of intervention levels. Keep an eye on foreign exchange analysts from popular banks and investment firms for a good idea of when to expect them.
Knowing these can help you determine when an intervention is likely to occur. Here is some advice for trading when an intervention is occurring:
1. Gauge the expected price levels by locating previous intervention movements. Again, we can see that most of the major interventions in the USD/JPY pair amounted to 125.00 or so, before resuming a downward course again.
2. Always keep a stop-loss point and a take-profit point to lock in gains, and limit losses. Make sure to set your stop-loss at a reasonable level, but leave enough room for the downside before an intervention occurs. Take-profit points should be set at levels previously attained by interventions.
3. Use as little margin as possible. Although this lowers you potential profit, it also reduces the risk of getting a margin call. And, since you are trading against the long-term trend, margin calls become a significant risk if an intervention doesn't occur during the time you plan.
Conclusion
Interventions occur as a result of central banks intervening by using their reserves in order to stabilize the value of their currency. Although they can be extremely profitable, trading them is mostly for speculators. There are several ways to try and gauge when an intervention is likely to occur, but it is always a good idea to be prepared by using low (if any) leverage, and smart money management (stop-loss/take-profit). All in all, they present an interesting opportunity for any forex traders looking for ideas to profit.
1. Bought $100,000 and sold 10,740,000 yen (100,000*107.40)
2. Ten minutes later, the USD/JPY increases to 108.80
3. Sell $100,000 to buy 10,880,000 yen to realize a gain of 140,000 yen
4. In dollar terms, the gain would be 140,000/108.8 = $1,286.76 USD
So, who was on the other end of the trade taking the huge losses? Believe it or not, it was the central Bank of Japan! And why would they do this? The act is known as an intervention, but before we discover why they do it, let's quickly review the economics of the currency markets.
A Brief Economics Lesson
The entire foreign-exchange market (forex) revolves around currencies and their valuations relative to one another. These valuations play a large role in domestic and global economics. They determine many things, most notably the prices of imports and exports.
Valuation and the Central Banks
In order to understand why interventions occur, we must first establish how currencies are valuated. This can happen in two ways: by the market through supply and demand or by governments (ie: central banks). Subjecting a currency to valuation by the markets is known as floating the currency. Conversely, currency rates set by governments is known as fixing the currency, meaning a country’s currency is pegged to a major world currency (usually the U.S. dollar). Thus, in order for a central bank to maintain or stabilize the local exchange rate, it will implement monetary policy by adjusting interest rates or by buying and selling its own currency on the foreign-exchange market in return for the currency to which it is pegged, called intervention.
Instability and Intervention
Since currencies always trade in pairs (relative to one another), a significant movement in one directly impacts the other. When a country's currency becomes unstable for any reason (speculation, growing deficits, national tragedy, etc), other countries experience the aftereffect. Normally, this occurs over a long period of time, which allows for the market and/or central banks to effectively deal with any revaluation needs.
There becomes a problem, however, when there is a sudden and rapid and sustainable movement in a currency's valuation, which makes it impractical or even impossible for a central bank to immediately respond via interest rates, used to quickly correct the movement. These are times in which interventions take place.
Take the USD/JPY currency pair, for example. Between 2000 and 2003, the Bank of Japan intervened several times to keep the yen valued lower than the dollar as they were afraid of a increase in the value of the yen, making exports relatively more expensive than imports and hindering an economic recovery at that time. In 2001, Japan intervened and spent more than $28 billion to halt the yen from appreciating and in 2002, they spent a record $33 billion to keep the yen down.
Trading & Interventions
Interventions present an interesting opportunity for traders. If there is some significant negative catalyst (such as national debt or tragedy), this can indicate to traders that a currency they are targeting should be fundamentally valued lower. For example, the U.S. budget deficit caused the dollar to fall rapidly in relation to the yen, whose value, in turn, rose rapidly. In such circumstances, traders can speculate on the likelihood of an intervention, which would result in sharp price movements in the short term. This creates an opportunity for traders to profit handsomely by taking a position before the intervention and exiting the position after the effects of the intervention takes place. It is important to realize, however, that trading against a fast-moving trend (looking for an intervention) can be very risky and should be reserved for speculation traders.Furthermore, trading against a trend, especially when leveraged, can be extremely dangerous as large amounts of capital can be lost in short periods of time.
The Intervention
Now, let's take a look at what the intervention looks like on the charts:
Here we can see that between 2000 and 2003, the Bank of Japan intervened several times. Please note that there may have been more or less interventions than shown here since these interventions are not always made public. It is usually easy to spot them when they occur, however, because of the large short-term price movement, such as the one mentioned in the beginning of this article.
Trading
Knowing when interventions may occur is more of an art than a science; but, that doesn't mean there aren't clear indicators to help you. Here are some basic principles to follow:
1. Interventions usually occur around the same price level as previous interventions. In the case of the USD/JPY, this level was 115.00 – notice in the chart above that the interventions pushed the value of the dollar above that point for quite some time. But keep in mind that this may not always be true; interventions may cease if the central bank deems it unnecessary (i.e. too costly). This is also apparent where we see the value drop below 115.00.
2. Sometimes there are verbal clues prior to interventions. Japan’s former finance minister Kiichi Miyazawa was infamous for threatening to intervene on multiple occasions. Similarly, the European Union has given clues as to their possible intervention in the future. Sometimes these words alone are enough to move the markets. Keep in mind, however, that the more often traders hear these threats with no action, the less impact these threats will have on the market.
3. Analysts also often give good estimates of intervention levels. Keep an eye on foreign exchange analysts from popular banks and investment firms for a good idea of when to expect them.
Knowing these can help you determine when an intervention is likely to occur. Here is some advice for trading when an intervention is occurring:
1. Gauge the expected price levels by locating previous intervention movements. Again, we can see that most of the major interventions in the USD/JPY pair amounted to 125.00 or so, before resuming a downward course again.
2. Always keep a stop-loss point and a take-profit point to lock in gains, and limit losses. Make sure to set your stop-loss at a reasonable level, but leave enough room for the downside before an intervention occurs. Take-profit points should be set at levels previously attained by interventions.
3. Use as little margin as possible. Although this lowers you potential profit, it also reduces the risk of getting a margin call. And, since you are trading against the long-term trend, margin calls become a significant risk if an intervention doesn't occur during the time you plan.
Conclusion
Interventions occur as a result of central banks intervening by using their reserves in order to stabilize the value of their currency. Although they can be extremely profitable, trading them is mostly for speculators. There are several ways to try and gauge when an intervention is likely to occur, but it is always a good idea to be prepared by using low (if any) leverage, and smart money management (stop-loss/take-profit). All in all, they present an interesting opportunity for any forex traders looking for ideas to profit.
Floating And Fixed Exchange Rate
Did you know that the foreign exchange market (also known as FX or forex) is the largest market in the world? In fact, over $1 trillion is traded in the currency markets on a daily basis. This article is certainly not a primer for currency trading, but it will help you understand exchange rates and why some fluctuate while others do not.
What Is an Exchange Rate?
An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of another country's currency compared to that of your own. If you are traveling to another country, you need to "buy" the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency. If you are traveling to Egypt, for example, and the exchange rate for USD 1.00 is EGP 5.50, this means that for every U.S. dollar, you can buy five and a half Egyptian pounds. Theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.
Fixed
There are two ways the price of a currency can be determined against another. A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged.
If, for example, it is determined that the value of a single unit of local currency is equal to USD 3.00, the central bank will have to ensure that it can supply the market with those dollars. In order to maintain the rate, the central bank must keep a high level of foreign reserves. This is a reserved amount of foreign currency held by the central bank which it can use to release (or absorb) extra funds into (or out of) the market. This ensures an appropriate money supply, appropriate fluctuations in the market (inflation/deflation), and ultimately, the exchange rate. The central bank can also adjust the official exchange rate when necessary.
Floating
Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting", as any differences in supply and demand will automatically be corrected in the market. Take a look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and thus stimulating demand for local goods and services. This in turn will generate more jobs, and hence an auto-correction would occur in the market. A floating exchange rate is constantly changing.
In reality, no currency is wholly fixed or floating. In a fixed regime, market pressures can also influence changes in the exchange rate. Sometimes, when a local currency does reflect its true value against its pegged currency, a "black market" which is more reflective of actual supply and demand may develop. A central bank will often then be forced to revalue or devalue the official rate so that the rate is in line with the unofficial one, thereby halting the activity of the black market.
In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation; however, it is less often that the central bank of a floating regime will interfere.
The World Once Pegged
Between 1870 and 1914, there was a global fixed exchange rate. Currencies were linked to gold, meaning that the value of a local currency was fixed at a set exchange rate to gold ounces. This was known as the gold standard. This allowed for unrestricted capital mobility as well as global stability in currencies and trade; however, with the start of World War I, the gold standard was abandoned.
At the end of World War II, the conference at Bretton Woods, in an effort to generate global economic stability and increased volumes of global trade, established the basic rules and regulations governing international exchange. As such, an international monetary system, embodied in the International Monetary Fund (IMF), was established to promote foreign trade and to maintain the monetary stability of countries and therefore that of the global economy.
It was agreed that currencies would once again be fixed, or pegged, but this time to the U.S. dollar, which in turn was pegged to gold at USD 35/ounce. What this meant was that the value of a currency was directly linked with the value of the U.S. dollar. So if you needed to buy Japanese yen, the value of the yen would be expressed in U.S. dollars, whose value in turn was determined in the value of gold. If a country needed to readjust the value of its currency, it could approach the IMF to adjust the pegged value of its currency. The peg was maintained until 1971, when the U.S. dollar could no longer hold the value of the pegged rate of USD 35/ounce of gold.
From then on, major governments adopted a floating system, and all attempts to move back to a global peg were eventually abandoned in 1985. Since then, no major economies have gone back to a peg, and the use of gold as a peg has been completely abandoned.
Why Peg?
The reasons to peg a currency are linked to stability. Especially in today's developing nations, a country may decide to peg its currency to create a stable atmosphere for foreign investment. With a peg the investor will always know what his/her investment value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.
Fixed regimes, however, can often lead to severe financial crises since a peg is difficult to maintain in the long run. This was seen in the Mexican (1995), Asian and Russian (1997) financial crises: an attempt to maintain a high value of the local currency to the peg resulted in the currencies eventually becoming overvalued. This meant that the governments could no longer meet the demands to convert the local currency into the foreign currency at the pegged rate. With speculation and panic, investors scrambled to get out their money and convert it into foreign currency before the local currency was devalued against the peg; foreign reserve supplies eventually became depleted. In Mexico's case, the government was forced to devalue the peso by 30%. In Thailand, the government eventually had to allow the currency to float, and by the end of 1997, the bhat had lost its value by 50% as the market's demand and supply readjusted the value of the local currency.
Countries with pegs are often associated with having unsophisticated capital markets and weak regulating institutions. The peg is therefore there to help create stability in such an environment. It takes a stronger system as well as a mature market to maintain a float. When a country is forced to devalue its currency, it is also required to proceed with some form of economic reform, like implementing greater transparency, in an effort to strengthen its financial institutions.
Some governments may choose to have a "floating," or "crawling" peg, whereby the government reassesses the value of the peg periodically and then changes the peg rate accordingly. Usually the change is devaluation, but one that is controlled so that market panic is avoided. This method is often used in the transition from a peg to a floating regime, and it allows the government to "save face" by not being forced to devalue in an uncontrollable crisis.
What Is an Exchange Rate?
An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of another country's currency compared to that of your own. If you are traveling to another country, you need to "buy" the local currency. Just like the price of any asset, the exchange rate is the price at which you can buy that currency. If you are traveling to Egypt, for example, and the exchange rate for USD 1.00 is EGP 5.50, this means that for every U.S. dollar, you can buy five and a half Egyptian pounds. Theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.
Fixed
There are two ways the price of a currency can be determined against another. A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged.
If, for example, it is determined that the value of a single unit of local currency is equal to USD 3.00, the central bank will have to ensure that it can supply the market with those dollars. In order to maintain the rate, the central bank must keep a high level of foreign reserves. This is a reserved amount of foreign currency held by the central bank which it can use to release (or absorb) extra funds into (or out of) the market. This ensures an appropriate money supply, appropriate fluctuations in the market (inflation/deflation), and ultimately, the exchange rate. The central bank can also adjust the official exchange rate when necessary.
Floating
Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting", as any differences in supply and demand will automatically be corrected in the market. Take a look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and thus stimulating demand for local goods and services. This in turn will generate more jobs, and hence an auto-correction would occur in the market. A floating exchange rate is constantly changing.
In reality, no currency is wholly fixed or floating. In a fixed regime, market pressures can also influence changes in the exchange rate. Sometimes, when a local currency does reflect its true value against its pegged currency, a "black market" which is more reflective of actual supply and demand may develop. A central bank will often then be forced to revalue or devalue the official rate so that the rate is in line with the unofficial one, thereby halting the activity of the black market.
In a floating regime, the central bank may also intervene when it is necessary to ensure stability and to avoid inflation; however, it is less often that the central bank of a floating regime will interfere.
The World Once Pegged
Between 1870 and 1914, there was a global fixed exchange rate. Currencies were linked to gold, meaning that the value of a local currency was fixed at a set exchange rate to gold ounces. This was known as the gold standard. This allowed for unrestricted capital mobility as well as global stability in currencies and trade; however, with the start of World War I, the gold standard was abandoned.
At the end of World War II, the conference at Bretton Woods, in an effort to generate global economic stability and increased volumes of global trade, established the basic rules and regulations governing international exchange. As such, an international monetary system, embodied in the International Monetary Fund (IMF), was established to promote foreign trade and to maintain the monetary stability of countries and therefore that of the global economy.
It was agreed that currencies would once again be fixed, or pegged, but this time to the U.S. dollar, which in turn was pegged to gold at USD 35/ounce. What this meant was that the value of a currency was directly linked with the value of the U.S. dollar. So if you needed to buy Japanese yen, the value of the yen would be expressed in U.S. dollars, whose value in turn was determined in the value of gold. If a country needed to readjust the value of its currency, it could approach the IMF to adjust the pegged value of its currency. The peg was maintained until 1971, when the U.S. dollar could no longer hold the value of the pegged rate of USD 35/ounce of gold.
From then on, major governments adopted a floating system, and all attempts to move back to a global peg were eventually abandoned in 1985. Since then, no major economies have gone back to a peg, and the use of gold as a peg has been completely abandoned.
Why Peg?
The reasons to peg a currency are linked to stability. Especially in today's developing nations, a country may decide to peg its currency to create a stable atmosphere for foreign investment. With a peg the investor will always know what his/her investment value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.
Fixed regimes, however, can often lead to severe financial crises since a peg is difficult to maintain in the long run. This was seen in the Mexican (1995), Asian and Russian (1997) financial crises: an attempt to maintain a high value of the local currency to the peg resulted in the currencies eventually becoming overvalued. This meant that the governments could no longer meet the demands to convert the local currency into the foreign currency at the pegged rate. With speculation and panic, investors scrambled to get out their money and convert it into foreign currency before the local currency was devalued against the peg; foreign reserve supplies eventually became depleted. In Mexico's case, the government was forced to devalue the peso by 30%. In Thailand, the government eventually had to allow the currency to float, and by the end of 1997, the bhat had lost its value by 50% as the market's demand and supply readjusted the value of the local currency.
Countries with pegs are often associated with having unsophisticated capital markets and weak regulating institutions. The peg is therefore there to help create stability in such an environment. It takes a stronger system as well as a mature market to maintain a float. When a country is forced to devalue its currency, it is also required to proceed with some form of economic reform, like implementing greater transparency, in an effort to strengthen its financial institutions.
Some governments may choose to have a "floating," or "crawling" peg, whereby the government reassesses the value of the peg periodically and then changes the peg rate accordingly. Usually the change is devaluation, but one that is controlled so that market panic is avoided. This method is often used in the transition from a peg to a floating regime, and it allows the government to "save face" by not being forced to devalue in an uncontrollable crisis.
The Fundamentals Of Forex Fundamentals
Those trading in the foreign-exchange market (forex) rely on the same two basic forms of analysis that are used in the stock market: fundamental analysis and technical analysis. The uses of technical analysis in forex are much the same: price is assumed to reflect all news, and the charts are the objects of analysis. But unlike companies, countries have no balance sheets, so how can fundamental analysis be conducted on a currency?
Since fundamental analysis is about looking at the intrinsic value of an investment, its application in forex entails looking at the economic conditions that affect the valuation of a nation's currency. Here we look at some of the major fundamental factors that play a role in the movement of a currency.
Economic Indicators
Economic indicators are reports released by the government or a private organization that detail a country's economic performance. Economic reports are the means by which a country's economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation's economic performance.
These reports are released at scheduled times, providing the market with an indication of whether a nation's economy has improved or declined. The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities. In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.
You may recognize some of these economic reports, such as the unemployment numbers, which are well publicized. Others, like housing stats, receive little coverage. However, each indicator serves a particular purpose, and can be useful. Here we outline four major reports, some of which are comparable to particular fundamental indicators used by equity investors:
The Gross Domestic Product (GDP)
The GDP is considered the broadest measure of a country's economy, and it represents the total market value of all goods and services produced in a country during a given year. Since the GDP figure itself is often considered a lagging indicator, most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the gross profit margin of a publicly traded company in that they are both measures of internal growth.
Retail Sales
The retail-sales report measures the total receipts of all retail stores in a given country. This measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful because it is a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company.
Industrial Production
This report shows the change in the production of factories, mines and utilities within a nation. It also reports their 'capacity utilizations', the degree to which the capacity of each of these factories is being used. It is ideal for a nation to see an increase of production while being at its maximum or near maximum capacity utilization.
Traders using this indicator are usually concerned with utility production, which can be extremely volatile since the utilities industry, and in turn the trading of and demand for energy, is heavily affected by changes in weather. Significant revisions between reports can be caused by weather changes, which in turn, can cause volatility in the nation's currency.
Consumer Price Index (CPI)
The CPI is a measure of the change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation's exports, can be used to see if a country is making or losing money on its products and services. Be careful, however, to monitor the exports - it is a focus that is popular with many traders because the prices of exports often change relative to a currency's strength or weakness.
Some of the other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI), and housing starts. And don't forget the many privately issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these provide a valuable resource to traders, if used properly.
So, How Are These Used?
Since economic indicators gauge a country's economic state, changes in the conditions reported will therefore directly affect the price and volume of a country's currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency's price. There are third-party reports, technical factors, and many other things that also can drastically affect a currency's valuation. Here are a few useful tips that may help you when conducting fundamental analysis in the foreign exchange market:
* Keep an economic calendar on hand that lists the indicators and when they are due to be released. Also, keep an eye on the future; often markets will move in anticipation of a certain indicator or report due to be released at a later time.
* Be informed about the economic indicators that are capturing most of the market's attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
* Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.
* Don't react too quickly to the news. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.
Conclusion
There are many economic indicators, and even more private reports that can be used to evaluate the fundamentals of forex. It's important to take the time to not only look at the numbers, but also understand what they mean and how they affect a nation's economy. When properly used, these indicators can be an invaluable resource for any currency trader.
Since fundamental analysis is about looking at the intrinsic value of an investment, its application in forex entails looking at the economic conditions that affect the valuation of a nation's currency. Here we look at some of the major fundamental factors that play a role in the movement of a currency.
Economic Indicators
Economic indicators are reports released by the government or a private organization that detail a country's economic performance. Economic reports are the means by which a country's economic health is directly measured, but do remember that a great deal of factors and policies will affect a nation's economic performance.
These reports are released at scheduled times, providing the market with an indication of whether a nation's economy has improved or declined. The effects of these reports are comparable to how earnings reports, SEC filings and other releases may affect securities. In forex, as in the stock market, any deviation from the norm can cause large price and volume movements.
You may recognize some of these economic reports, such as the unemployment numbers, which are well publicized. Others, like housing stats, receive little coverage. However, each indicator serves a particular purpose, and can be useful. Here we outline four major reports, some of which are comparable to particular fundamental indicators used by equity investors:
The Gross Domestic Product (GDP)
The GDP is considered the broadest measure of a country's economy, and it represents the total market value of all goods and services produced in a country during a given year. Since the GDP figure itself is often considered a lagging indicator, most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the gross profit margin of a publicly traded company in that they are both measures of internal growth.
Retail Sales
The retail-sales report measures the total receipts of all retail stores in a given country. This measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful because it is a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company.
Industrial Production
This report shows the change in the production of factories, mines and utilities within a nation. It also reports their 'capacity utilizations', the degree to which the capacity of each of these factories is being used. It is ideal for a nation to see an increase of production while being at its maximum or near maximum capacity utilization.
Traders using this indicator are usually concerned with utility production, which can be extremely volatile since the utilities industry, and in turn the trading of and demand for energy, is heavily affected by changes in weather. Significant revisions between reports can be caused by weather changes, which in turn, can cause volatility in the nation's currency.
Consumer Price Index (CPI)
The CPI is a measure of the change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation's exports, can be used to see if a country is making or losing money on its products and services. Be careful, however, to monitor the exports - it is a focus that is popular with many traders because the prices of exports often change relative to a currency's strength or weakness.
Some of the other major indicators include the purchasing managers index (PMI), producer price index (PPI), durable goods report, employment cost index (ECI), and housing starts. And don't forget the many privately issued reports, the most famous of which is the Michigan Consumer Confidence Survey. All of these provide a valuable resource to traders, if used properly.
So, How Are These Used?
Since economic indicators gauge a country's economic state, changes in the conditions reported will therefore directly affect the price and volume of a country's currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency's price. There are third-party reports, technical factors, and many other things that also can drastically affect a currency's valuation. Here are a few useful tips that may help you when conducting fundamental analysis in the foreign exchange market:
* Keep an economic calendar on hand that lists the indicators and when they are due to be released. Also, keep an eye on the future; often markets will move in anticipation of a certain indicator or report due to be released at a later time.
* Be informed about the economic indicators that are capturing most of the market's attention at any given time. Such indicators are catalysts for the largest price and volume movements. For example, when the U.S. dollar is weak, inflation is often one of the most watched indicators.
* Know the market expectations for the data, and then pay attention to whether or not the expectations are met. That is far more important than the data itself. Occasionally, there is a drastic difference between the expectations and actual results and, if there is, be aware of the possible justifications for this difference.
* Don't react too quickly to the news. Oftentimes, numbers are released and then revised, and things can change quickly. Pay attention to these revisions, as they may be a useful tool for seeing the trends and reacting more accurately to future reports.
Conclusion
There are many economic indicators, and even more private reports that can be used to evaluate the fundamentals of forex. It's important to take the time to not only look at the numbers, but also understand what they mean and how they affect a nation's economy. When properly used, these indicators can be an invaluable resource for any currency trader.
Getting Started In Forex Options
Many people think of the stock market when they think of options; however, the foreign exchange market also offers the opportunity to trade these unique derivatives. Options give retail traders many opportunities to limit risk and increase profit. Here we discuss what options are, how they are used, and which strategies you can use to profit.
Types of Forex Options
There are two primary types of options available to retail FOREX traders. The most common is the traditional call/put option, which works much like the respective stock option. The other alternative is single payment option trading--or SPOT--which gives traders more flexibility.
Traditional Options
Traditional options allow the buyer the right but not the obligation to purchase something from the option seller at a set price and time. For example, a trader might purchase an option to buy two lots of EUR/USD at 1.3000 in one month; such a contract is known as a "EUR call/USD put." (Keep in mind that, in the options market, when you buy a call, you buy a put simultaneously--just as in the cash market you buy one currency and simultaneously sell another.) If the price of EUR/USD is below 1.3000, the option expires worthless, and the buyer loses only the premium. On the other hand, if EUR/USD skyrockets to 1.4000, then the buyer can exercise the option and gain two lots for only 1.3000, which can then be sold for profit.
Since FOREX options are traded over-the-counter (OTC), traders can choose the price and date on which the option is to be valid and then receive a quote stating the premium they must pay to obtain the option.
There are two types of traditional options offered by brokers:
* American-style – This type of option can be exercised at any point up until expiration.
* European-style – This type of option can be exercised only at the time of expiration.
One advantage of traditional options is that they have lower premiums than SPOT options. Also, because (American) traditional options can be bought and sold before expiration, they allow for more flexibility. On the other hand, traditional options are more difficult to set and execute than SPOT options. (For a detailed introduction to options, see Options Basics Tutorial.)
Single Payment Options Trading (SPOT)
Here is how SPOT options work: the trader inputs a scenario (for example, "EUR/USD will break 1.3000 in 12 days"), obtains a premium (option cost) quote, and then receives a payout if the scenario takes place. Essentially, SPOT automatically converts your option to cash when your option trade is successful, giving you a payout.
Many traders enjoy the additional choices (listed below) that SPOT options give traders. Also, SPOT options are easy to trade: it's a matter of entering the scenario and letting it play out. If you are correct, you receive cash into your account. If you are not correct, your loss is your premium. Another advantage is that SPOT options offer a choice of many different scenarios, allowing the trader to choose exactly what he or she thinks is going to happen.
A disadvantage of SPOT options, however, is their higher premiums. On average, SPOT option premiums cost more than standard options.
Why Trade Options?
There are several reasons why options in general appeal to many traders:
* Your downside risk is limited to the option premium (the amount you paid to purchase the option).
* You have unlimited profit potential.
* You pay less money up front than for a spot (cash) FOREX position.
* You get to set the price and expiration date. (These are not predefined like those of options on futures.)
* Options can be used to hedge against open spot (cash) positions in order to limit risk.
* Without risking a lot of capital, you can use options to trade on predictions of market movements before fundamental events take place (such as economic reports or meetings).
* SPOT options allow you many choices:
o Standard options.
o One-touch SPOT – You receive a payout if the price touches a certain level.
o No-touch SPOT – You receive a payout if the price doesn't touch a certain level.
o Digital SPOT – You receive a payout if the price is above or below a certain level.
o Double one-touch SPOT – You receive a payout if the price touches one of two set levels.
o Double no-touch SPOT – You receive a payout if the price doesn't touch any of the two set levels.
So, why isn't everyone using options? Well, there also are a few downsides to using them:
* The premium varies according to the strike price and date of the option, so the risk/reward ratio varies.
* SPOT options cannot be traded: once you buy one, you can't change your mind and then sell it.
* It can be hard to predict the exact time period and price at which movements in the market may occur.
* You may be going against the odds. (See the article Do Option Sellers Have A Trading Edge?)
Options Prices
Options have several factors that collectively determine their value:
* Intrinsic value - This is how much the option would be worth if it were to be exercised right now. The position of the current price in relation to the strike price can be described in one of three ways:
o "In the money" - This means the strike price is higher than the current market price.
o "Out of the money" – This means the strike price is lower than the current market price.
o "At the money" – This means the strike price is at the current market price.
* The time value - This represents the uncertainty of the price over time. Generally, the longer the time, the higher premium you pay because the time value is greater.
* Interest rate differential - A change in interest rates affects the relationship between the strike of the option and the current market rate. This effect is often factored into the premium as a function of the time value.
* Volatility - Higher volatility increases the likelihood of the market price hitting the strike price within a limited time period. Volatility is factored into the time value. Typically, more volatile currencies have higher options premiums.
How It Works – A Scenario
Say it's January 2, 2004, and you think that the EUR/USD (euro vs. dollar) pair, which is currently at 1.3000, is headed downward due to positive U.S. numbers; however, there are some major reports coming out soon that could cause significant volatility. You suspect this volatility will occur within the next two months, but you don't want to risk a cash position, so you decide to use options.
You then go to your broker and put in a request to buy a EUR put/USD call, commonly referred to as a "EUR put option," set at a strike price of 1.2900 and an expiry of March 2, 2004. The broker informs you that this option will cost 10 pips, so you gladly decide to buy.
This order would look something like this:
Buy: EUR put/USD call
Strike price: 1.2900
Expiration: 2 March 2004
Premium: 10 USD pips
Cash (spot) reference: 1.3000
Say the new reports come out and the EUR/USD pair falls to 1.2850--you decide to exercise your option, and the result gives you 40 USD pips profit (1.2900 – 1.2850 – 0.0010).
Option Strategies
Options can be used in a variety of ways, but they are usually used for one of two purposes: (1) to capture profit or (2) to hedge against existing positions.
Profit Motivated Strategies
Options are a good way to profit while keeping the risk down--after all, you can lose no more than the premium! Many FOREX traders like to use options around the times of important reports or events, when the spreads and risk increase in the cash FOREX markets. Other profit-driven FOREX traders simply use options instead of cash because options are cheaper. An options position can make a lot more money than a cash position in the same amount.
Hedging Strategies
Options are a great way to hedge against your existing positions to decrease risk. Some traders even use options instead of or together with stop-loss points. The primary advantage of using options together with stops is that you have an unlimited profit potential if the price continues to move against your position.
Conclusion
Although they can be difficult to use, options represent yet another valuable tool that traders can use to profit or lower risk. Options in FOREX are especially prevalent during important economic reports or events that cause significant volatility (when cash markets have high spreads and uncertainty). Below are some brokers that offer options services:
Resources
FOREX Options Broker: Saxobank.com
FOREX SPOT Option Broker: RefcoSPOT.com
Types of Forex Options
There are two primary types of options available to retail FOREX traders. The most common is the traditional call/put option, which works much like the respective stock option. The other alternative is single payment option trading--or SPOT--which gives traders more flexibility.
Traditional Options
Traditional options allow the buyer the right but not the obligation to purchase something from the option seller at a set price and time. For example, a trader might purchase an option to buy two lots of EUR/USD at 1.3000 in one month; such a contract is known as a "EUR call/USD put." (Keep in mind that, in the options market, when you buy a call, you buy a put simultaneously--just as in the cash market you buy one currency and simultaneously sell another.) If the price of EUR/USD is below 1.3000, the option expires worthless, and the buyer loses only the premium. On the other hand, if EUR/USD skyrockets to 1.4000, then the buyer can exercise the option and gain two lots for only 1.3000, which can then be sold for profit.
Since FOREX options are traded over-the-counter (OTC), traders can choose the price and date on which the option is to be valid and then receive a quote stating the premium they must pay to obtain the option.
There are two types of traditional options offered by brokers:
* American-style – This type of option can be exercised at any point up until expiration.
* European-style – This type of option can be exercised only at the time of expiration.
One advantage of traditional options is that they have lower premiums than SPOT options. Also, because (American) traditional options can be bought and sold before expiration, they allow for more flexibility. On the other hand, traditional options are more difficult to set and execute than SPOT options. (For a detailed introduction to options, see Options Basics Tutorial.)
Single Payment Options Trading (SPOT)
Here is how SPOT options work: the trader inputs a scenario (for example, "EUR/USD will break 1.3000 in 12 days"), obtains a premium (option cost) quote, and then receives a payout if the scenario takes place. Essentially, SPOT automatically converts your option to cash when your option trade is successful, giving you a payout.
Many traders enjoy the additional choices (listed below) that SPOT options give traders. Also, SPOT options are easy to trade: it's a matter of entering the scenario and letting it play out. If you are correct, you receive cash into your account. If you are not correct, your loss is your premium. Another advantage is that SPOT options offer a choice of many different scenarios, allowing the trader to choose exactly what he or she thinks is going to happen.
A disadvantage of SPOT options, however, is their higher premiums. On average, SPOT option premiums cost more than standard options.
Why Trade Options?
There are several reasons why options in general appeal to many traders:
* Your downside risk is limited to the option premium (the amount you paid to purchase the option).
* You have unlimited profit potential.
* You pay less money up front than for a spot (cash) FOREX position.
* You get to set the price and expiration date. (These are not predefined like those of options on futures.)
* Options can be used to hedge against open spot (cash) positions in order to limit risk.
* Without risking a lot of capital, you can use options to trade on predictions of market movements before fundamental events take place (such as economic reports or meetings).
* SPOT options allow you many choices:
o Standard options.
o One-touch SPOT – You receive a payout if the price touches a certain level.
o No-touch SPOT – You receive a payout if the price doesn't touch a certain level.
o Digital SPOT – You receive a payout if the price is above or below a certain level.
o Double one-touch SPOT – You receive a payout if the price touches one of two set levels.
o Double no-touch SPOT – You receive a payout if the price doesn't touch any of the two set levels.
So, why isn't everyone using options? Well, there also are a few downsides to using them:
* The premium varies according to the strike price and date of the option, so the risk/reward ratio varies.
* SPOT options cannot be traded: once you buy one, you can't change your mind and then sell it.
* It can be hard to predict the exact time period and price at which movements in the market may occur.
* You may be going against the odds. (See the article Do Option Sellers Have A Trading Edge?)
Options Prices
Options have several factors that collectively determine their value:
* Intrinsic value - This is how much the option would be worth if it were to be exercised right now. The position of the current price in relation to the strike price can be described in one of three ways:
o "In the money" - This means the strike price is higher than the current market price.
o "Out of the money" – This means the strike price is lower than the current market price.
o "At the money" – This means the strike price is at the current market price.
* The time value - This represents the uncertainty of the price over time. Generally, the longer the time, the higher premium you pay because the time value is greater.
* Interest rate differential - A change in interest rates affects the relationship between the strike of the option and the current market rate. This effect is often factored into the premium as a function of the time value.
* Volatility - Higher volatility increases the likelihood of the market price hitting the strike price within a limited time period. Volatility is factored into the time value. Typically, more volatile currencies have higher options premiums.
How It Works – A Scenario
Say it's January 2, 2004, and you think that the EUR/USD (euro vs. dollar) pair, which is currently at 1.3000, is headed downward due to positive U.S. numbers; however, there are some major reports coming out soon that could cause significant volatility. You suspect this volatility will occur within the next two months, but you don't want to risk a cash position, so you decide to use options.
You then go to your broker and put in a request to buy a EUR put/USD call, commonly referred to as a "EUR put option," set at a strike price of 1.2900 and an expiry of March 2, 2004. The broker informs you that this option will cost 10 pips, so you gladly decide to buy.
This order would look something like this:
Buy: EUR put/USD call
Strike price: 1.2900
Expiration: 2 March 2004
Premium: 10 USD pips
Cash (spot) reference: 1.3000
Say the new reports come out and the EUR/USD pair falls to 1.2850--you decide to exercise your option, and the result gives you 40 USD pips profit (1.2900 – 1.2850 – 0.0010).
Option Strategies
Options can be used in a variety of ways, but they are usually used for one of two purposes: (1) to capture profit or (2) to hedge against existing positions.
Profit Motivated Strategies
Options are a good way to profit while keeping the risk down--after all, you can lose no more than the premium! Many FOREX traders like to use options around the times of important reports or events, when the spreads and risk increase in the cash FOREX markets. Other profit-driven FOREX traders simply use options instead of cash because options are cheaper. An options position can make a lot more money than a cash position in the same amount.
Hedging Strategies
Options are a great way to hedge against your existing positions to decrease risk. Some traders even use options instead of or together with stop-loss points. The primary advantage of using options together with stops is that you have an unlimited profit potential if the price continues to move against your position.
Conclusion
Although they can be difficult to use, options represent yet another valuable tool that traders can use to profit or lower risk. Options in FOREX are especially prevalent during important economic reports or events that cause significant volatility (when cash markets have high spreads and uncertainty). Below are some brokers that offer options services:
Resources
FOREX Options Broker: Saxobank.com
FOREX SPOT Option Broker: RefcoSPOT.com
Using Pivot Points In FX
Trading requires reference points (support and resistance), which are used to determine when to enter the market, place stops and take profits. However, many beginning traders divert too much attention to technical indicators such as moving average convergence divergence (MACD) and relative strength index (RSI) (to name a few) and fail to identify a point that defines risk. Unknown risk can lead to margin calls, but calculated risk significantly improves the odds of success over the long haul.
One tool that actually provides potential support and resistance and helps minimize risk is the pivot point and its derivatives. In this article, we'll argue why a combination of pivot points and traditional technical tools is far more powerful than technical tools alone and show how this combination can be used effectively in the FX market.
Pivot Points 101
Originally employed by floor traders on equity and futures exchanges, pivot point have proved exceptionally useful in the FX market. In fact, the projected support and resistance generated by pivot points tends to work better in FX (especially with the most liquid pairs) because the large size of the market guards against market manipulation. In essence, the FX market adheres to technical principles such as support and resistance better than less liquid markets. (For related reading, see Using Pivot Points For Predictions and Pivot Strategies: A Handy Tool.)
Calculating Pivots
Pivot points can be calculated for any time frame. That is, the previous day's prices are used to calculate the pivot point for the current trading day.
Pivot Point for Current = High (previous) + Low (previous) + Close (previous)
3
The pivot point can then be used to calculate estimated support and resistance for the current trading day.
Resistance 1 = (2 x Pivot Point) – Low (previous period)
Support 1 = (2 x Pivot Point) – High (previous period)
Resistance 2 = (Pivot Point – Support 1) + Resistance 1
Support 2 = Pivot Point – (Resistance 1 – Support 1)
Resistance 3 = (Pivot Point – Support 2) + Resistance 2
Support 3 = Pivot Point – (Resistance 2 – Support 2)
To get a full understanding of how well pivot points can work, compile statistics for the EUR/USD on how distant each high and low has been from each calculated resistance (R1, R2, R3) and support level (S1, S2, S3).
To do the calculation yourself:
* Calculate the pivot points, support levels and resistance levels for x number of days.
* Subtract the support pivot points from the actual low of the day (Low – S1, Low – S2, Low – S3).
* Subtract the resistance pivot points from the actual high of the day (High – R1, High – R2, High – R3).
* Calculate the average for each difference.
The results since the inception of the euro (January 1, 1999, with the first trading day on January 4, 1999):
* The actual low is, on average, 1 pip below Support 1
* The actual high is, on average, 1 pip below Resistance 1
* The actual low is, on average, 53 pips above Support 2
* The actual high is, on average, 53 pips below Resistance 2
* The actual low is, on average, 158 pips above Support 3
* The actual high is, on average, 159 pips below Resistance 3
Judging Probabilities
The statistics indicate that the calculated pivot points of S1 and R1 are a decent gauge for the actual high and low of the trading day.
Going a step farther, we calculated the number of days that the low was lower than each S1, S2 and S3 and the number of days that the high was higher than the each R1, R2 and R3.
The result: there have been 2,026 trading days since the inception of the euro as of October 12, 2006.
* The actual low has been lower than S1 892 times, or 44% of the time
* The actual high has been higher than R1 853 times, or 42% of the time
* The actual low has been lower than S2 342 times, or 17% of the time
* The actual high has been higher than R2 354 times, or 17% of the time
* The actual low has been lower than S3 63 times, or 3% of the time
* The actual high has been higher than R3 52 times, or 3% of the time
This information is useful to a trader; if you know that the pair slips below S1 44% of the time, you can place a stop below S1 with confidence, understanding that probability is on your side. Additionally, you may want to take profits just below R1 because you know that the high for the day exceeds R1 only 42% of the time. Again, the probabilities are with you.
It is important to understand, however, that theses are probabilities and not certainties. On average, the high is 1 pip below R1 and exceeds R1 42% of the time. This neither means that the high will exceed R1 four days out of the next 10, nor that the high is always going to be 1 pip below R1. The power in this information lies in the fact that you can confidently gauge potential support and resistance ahead of time, have reference points to place stops and limits and, most importantly, limit risk while putting yourself in a position to profit.
Using the Information
The pivot point and its derivatives are potential support and resistance. The examples below show a setup using pivot point in conjunction with the popular RSI oscillator. (For more insight, see Momentum And The Relative Strength Index and Getting To Know Oscillators - Part 2: RSI.)
RSI Divergence at Pivot Resistance/Support
This is typically a high reward-to-risk trade. The risk is well-defined due to the recent high (or low for a buy).The pivot points in the above examples are calculated using weekly data. The above example shows that from August 16 to 17, R1 held as solid resistance (first circle) at 1.2854 and the RSI divergence suggested that the upside was limited. This suggests that there is an opportunity to go short on a break below R1 with a stop at the recent high and a limit at the pivot point, which is now a support:
* Sell Short at 1.2853.
* Stop at the recent high at 1.2885.
* Limit at the pivot point at 1.2784.
This first trade netted a 69 pip profit with 32 pips of risk. The reward to risk ratio was 2.16.
The next week produced nearly the exact same setup. The week began with a rally to and just above R1 at 1.2908, which was also accompanied by bearish divergence. The short signal is generated on the decline back below R1 at which point we can sell short with a stop at the recent high and a limit at the pivot point (which is now support):
* Sell short at 1.2907.
* Stop at the recent high at 1.2939.
* Limit at the pivot point at 1.2802.
This trade netted a 105 pip profit with just 32 pips of risk. The reward to risk ratio was 3.28.
The rules for the setup are simple:
For shorts:
1. Identify bearish divergence at the pivot point, either R1, R2 or R3 (most common at R1).
2. When price declines back below the reference point (it could be the pivot point, R1, R2, R3), initiate a short position with a stop at the recent swing high.
3. Place a limit (take profit) order at the next level. If you sold at R2, your first target would be R1. In this case, former resistance becomes support and vice versa.
For longs:
1. Identify bullish divergence at the pivot point, either S1, S2 or S3 (most common at S1).
2. When price rallies back above the reference point (it could be the pivot point, S1, S2, S3), initiate a long position with a stop at the recent swing low.
3. Place a limit (take profit) order at the next level (if you bought at S2, your first target would be S1 … former support becomes resistance and vice versa).
Summary
A day trader can use daily data to calculate the pivot points each day, a swing trader can use weekly data to calculate the pivot points for each week and a position trader can use monthly data to calculate the pivot points at the beginning of each month. Investors can even use yearly data to approximate significant levels for the coming year. The trading philosophy remains the same regardless of the time frame. That is, the calculated pivot points give the trader an idea of where support and resistance is for the coming period, but the trader - because nothing in trading is more important than preparedness - must always be prepared to act.
One tool that actually provides potential support and resistance and helps minimize risk is the pivot point and its derivatives. In this article, we'll argue why a combination of pivot points and traditional technical tools is far more powerful than technical tools alone and show how this combination can be used effectively in the FX market.
Pivot Points 101
Originally employed by floor traders on equity and futures exchanges, pivot point have proved exceptionally useful in the FX market. In fact, the projected support and resistance generated by pivot points tends to work better in FX (especially with the most liquid pairs) because the large size of the market guards against market manipulation. In essence, the FX market adheres to technical principles such as support and resistance better than less liquid markets. (For related reading, see Using Pivot Points For Predictions and Pivot Strategies: A Handy Tool.)
Calculating Pivots
Pivot points can be calculated for any time frame. That is, the previous day's prices are used to calculate the pivot point for the current trading day.
Pivot Point for Current = High (previous) + Low (previous) + Close (previous)
3
The pivot point can then be used to calculate estimated support and resistance for the current trading day.
Resistance 1 = (2 x Pivot Point) – Low (previous period)
Support 1 = (2 x Pivot Point) – High (previous period)
Resistance 2 = (Pivot Point – Support 1) + Resistance 1
Support 2 = Pivot Point – (Resistance 1 – Support 1)
Resistance 3 = (Pivot Point – Support 2) + Resistance 2
Support 3 = Pivot Point – (Resistance 2 – Support 2)
To get a full understanding of how well pivot points can work, compile statistics for the EUR/USD on how distant each high and low has been from each calculated resistance (R1, R2, R3) and support level (S1, S2, S3).
To do the calculation yourself:
* Calculate the pivot points, support levels and resistance levels for x number of days.
* Subtract the support pivot points from the actual low of the day (Low – S1, Low – S2, Low – S3).
* Subtract the resistance pivot points from the actual high of the day (High – R1, High – R2, High – R3).
* Calculate the average for each difference.
The results since the inception of the euro (January 1, 1999, with the first trading day on January 4, 1999):
* The actual low is, on average, 1 pip below Support 1
* The actual high is, on average, 1 pip below Resistance 1
* The actual low is, on average, 53 pips above Support 2
* The actual high is, on average, 53 pips below Resistance 2
* The actual low is, on average, 158 pips above Support 3
* The actual high is, on average, 159 pips below Resistance 3
Judging Probabilities
The statistics indicate that the calculated pivot points of S1 and R1 are a decent gauge for the actual high and low of the trading day.
Going a step farther, we calculated the number of days that the low was lower than each S1, S2 and S3 and the number of days that the high was higher than the each R1, R2 and R3.
The result: there have been 2,026 trading days since the inception of the euro as of October 12, 2006.
* The actual low has been lower than S1 892 times, or 44% of the time
* The actual high has been higher than R1 853 times, or 42% of the time
* The actual low has been lower than S2 342 times, or 17% of the time
* The actual high has been higher than R2 354 times, or 17% of the time
* The actual low has been lower than S3 63 times, or 3% of the time
* The actual high has been higher than R3 52 times, or 3% of the time
This information is useful to a trader; if you know that the pair slips below S1 44% of the time, you can place a stop below S1 with confidence, understanding that probability is on your side. Additionally, you may want to take profits just below R1 because you know that the high for the day exceeds R1 only 42% of the time. Again, the probabilities are with you.
It is important to understand, however, that theses are probabilities and not certainties. On average, the high is 1 pip below R1 and exceeds R1 42% of the time. This neither means that the high will exceed R1 four days out of the next 10, nor that the high is always going to be 1 pip below R1. The power in this information lies in the fact that you can confidently gauge potential support and resistance ahead of time, have reference points to place stops and limits and, most importantly, limit risk while putting yourself in a position to profit.
Using the Information
The pivot point and its derivatives are potential support and resistance. The examples below show a setup using pivot point in conjunction with the popular RSI oscillator. (For more insight, see Momentum And The Relative Strength Index and Getting To Know Oscillators - Part 2: RSI.)
RSI Divergence at Pivot Resistance/Support
This is typically a high reward-to-risk trade. The risk is well-defined due to the recent high (or low for a buy).The pivot points in the above examples are calculated using weekly data. The above example shows that from August 16 to 17, R1 held as solid resistance (first circle) at 1.2854 and the RSI divergence suggested that the upside was limited. This suggests that there is an opportunity to go short on a break below R1 with a stop at the recent high and a limit at the pivot point, which is now a support:
* Sell Short at 1.2853.
* Stop at the recent high at 1.2885.
* Limit at the pivot point at 1.2784.
This first trade netted a 69 pip profit with 32 pips of risk. The reward to risk ratio was 2.16.
The next week produced nearly the exact same setup. The week began with a rally to and just above R1 at 1.2908, which was also accompanied by bearish divergence. The short signal is generated on the decline back below R1 at which point we can sell short with a stop at the recent high and a limit at the pivot point (which is now support):
* Sell short at 1.2907.
* Stop at the recent high at 1.2939.
* Limit at the pivot point at 1.2802.
This trade netted a 105 pip profit with just 32 pips of risk. The reward to risk ratio was 3.28.
The rules for the setup are simple:
For shorts:
1. Identify bearish divergence at the pivot point, either R1, R2 or R3 (most common at R1).
2. When price declines back below the reference point (it could be the pivot point, R1, R2, R3), initiate a short position with a stop at the recent swing high.
3. Place a limit (take profit) order at the next level. If you sold at R2, your first target would be R1. In this case, former resistance becomes support and vice versa.
For longs:
1. Identify bullish divergence at the pivot point, either S1, S2 or S3 (most common at S1).
2. When price rallies back above the reference point (it could be the pivot point, S1, S2, S3), initiate a long position with a stop at the recent swing low.
3. Place a limit (take profit) order at the next level (if you bought at S2, your first target would be S1 … former support becomes resistance and vice versa).
Summary
A day trader can use daily data to calculate the pivot points each day, a swing trader can use weekly data to calculate the pivot points for each week and a position trader can use monthly data to calculate the pivot points at the beginning of each month. Investors can even use yearly data to approximate significant levels for the coming year. The trading philosophy remains the same regardless of the time frame. That is, the calculated pivot points give the trader an idea of where support and resistance is for the coming period, but the trader - because nothing in trading is more important than preparedness - must always be prepared to act.
Subscribe to:
Posts (Atom)