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With average volume in foreign exchange exceeding $1.5 trillion
per day, foreign exchange (Forex) is truly a global marketplace
displaying the crucial attributes of liquidity and low cost of
execution. For traders, this high volume can be advantageous, as
transactions can be executed speedily and with minimal
slippage.* Indeed traders and investors alike are discovering
that Forex is the underlying asset class that might fulfill
nearly all of their trade strategy requirements. *Under normal
market conditions.
This market has long
held these benefits for market participants, so why now should
this be the moment that Forex has come of age for the individual
trader?
In fact, it is the coinciding of two key factors; firstly,
rarely has there been so much focus on the foreign exchange
markets as in the last 18 months, leading to continued and
consistent trading opportunities. And secondly, the technology
revolution that enables individuals to trade effectively on a
'level playing field' with the institutions is now a reality.
Hardly surprising
then that the largest, most liquid market in the world, is
drawing increased interest from both active and retail investors
alike.
Market accessibility is the key component that enables
individual traders the opportunity of participation, and now
more than ever before, brokers, software providers and financial
institutions have both the ability and presence of mind to offer
effective market access.
 Medium-term traders
are finding that institutions are ever increasing the range of
currency-dominated products, such as funds, baskets and other
investment vehicles. Even investors with long-term portfolio
planning tactics who have previously been used to Dollar
stability must now include an element of currency hedging within
their strategy.
But, it is active
traders who are benefiting most from the aggressive rise in
accessibility of the electronic foreign exchange markets. New
software, providing lightning speed of execution, variable
order-type, and improved software applications all go toward
making daytrading more effective.
Couple this with increased Internet speed, the availability of
timely market news and quality analysis and it is clear to see
that the active trader can now access the very 'heart of the
market'.
The trend is set to
continue with an increased appetite amongst the brokerage
community to offer global currency markets alongside their
existing product offering. This is leading to the launch of
successive products from specialist brokers, as well as
spread-betting companies, all offering market access to everyone
with an online trading account.
Dealing services like
that of easy2forex (see figure 1) incorporate multi-screen
capabilities, including real-time news, data, charting and
dealing functionality, displayed in an intuitive format. The
result is that a market once dominated solely by banking
institutions has now truly become accessible to all. With more
and more traders gravitating towards this compelling market
place, whether in conjunction with an existing trade schedule or
as an entire switch.
As an asset class,
foreign exchange is probably the least understood by retail
investors and active traders alike. Knowledge is still limited,
especially when compared to products such as equities, bonds and
futures. Indeed, European traders have some catching up to do
compared with their US counterpart with regard to the widespread
inclusion of Forex trading. However, the trend is in place and
over the next few years the currency markets promise to become a
widely used underlying instrument for daytraders, swing-traders,
and even private investors.
The following
paragraphs briefly examine market background, key information
including contract terminology and specification, as well as
outlining some of the most effective techniques used to trade
the foreign exchange markets.
History and background
Looking back to the origins of currency trading, coins have been
around since ancient Egyptian times and currency notes were
introduced in the Middle Ages to make commercial trading an
easier process. This use of bills as opposed to coins helped
regional economies flourish. These currency markets, from their
origins right through to the mid 1940's and the end of the
Second World War, were relatively stable and were never
perceived as instruments for speculation.
All this changed as
the post-war economies became extremely volatile, resulting in a
dramatic increase in currency volatility. Market volatility
began to attract speculators and traders, whose numbers were few
given the potential gains from such volatility. At this time,
the British Pound was the benchmark for global currencies,
however, the inevitable post war turmoil led to the US Dollar
taking it's place and has remained the benchmark and safe haven
ever since. The Bretton Woods Accord, formed in 1944 between the
US, UK, and France as an attempt to stabilise the global
economies, essentially limited currency movement to just 1%
against the Dollar. This pegging of currencies to the US Dollar
lasted until the early 1970's.
More recently, the
European Monetary System, which was introduced in 1978 as an
attempt to gain independence from the US Dollar, failed in a
spectacular fashion in 1993, following the exit of the British
Pound in 1992.
Since 1993, the major global currencies have been freely trading
with no structured boundaries. This free movement of the major
currencies catalysed an influx of mainly institutional
speculators including banks, brokerage houses and hedge funds.
The increase in speculative interest has now filtered down to
private individuals who are also able to trade Forex.
Until relatively
recently, Japan had long been a country with an interest rate
differential to the rest of the world so large that made holding
the Yen a punitive gamble. This world differential is now far
smaller, meaning that even the Yen is on the table to traders
with a broader appetite.
The largest and most
recent impact to foreign exchange trading occurred with the
incorporation of the Euro. The new single currency is no longer
the fledgling underdog that it started life as. The Euro has
risen in importance and increased its weighting in the global
economy, gaining its current status as the second most liquid
currency in the world. The result is that the major currencies
now holding speculators interest are the US Dollar, the Japanese
Yen and the Euro, with as much as 90% of all transactions
involving the Dollar.
Volatility and change
is something that the Forex market has become accustomed to, and
with recent aggressive Dollar depreciation, once again the
spotlight is firmly fixed on foreign exchange trading
opportunities. This time however, its not just the banks who
can take advantage of the market, as changes in market
accessibility mean that everyone from day-traders to swing
traders to long term portfolio hedgers, can access this global
market place.
An efficient market place
Worldwide focus together with factors touched upon in previous
paragraphs all contribute to the adoption of currency markets
amongst private traders. However, there are additional and
important market characteristics that also enhance trading
opportunities and explain why Forex is rapidly gaining
popularity.
24/7
Forex markets are open for business every hour of every day.
They in effect "follow the sun" around the globe in a market
that rarely experiences periods of illiquidity. The market for
major currencies never closes; in fact at every moment someone
somewhere is trading the principal markets.
This means that any
trader in any time zone can trade Forex day and night. In
contrast to just about every other asset class, a Forex trader
never has to wait for the market to open when perhaps news has
already hit newswires. The result is the virtual eradication of'
overnight risk,' as a stop-loss order can be executed at any
time. It also allows Forex traders the added flexibility and
continuous market opportunities that just aren't available in
most other markets.
The three main
economic world zones ensure continuous execution availability.
For instance, when the Pacific Rim markets such as Japan and
Singapore begin to slow, the European markets of England,
Switzerland and Germany take over, followed by the North
American markets of the United States, Canada and Mexico. As the
North American markets begin to slow down for the evening, the
Pacific Rim starts their trading day and so on.
Super-liquidity
A perpetual trading environment attracts volume, in turn
attracting additional volume, creating a market with
super-liquidity. This makes it extremely difficult for large
'players' to manipulate the market during periods of low volume,
thus resulting in an even more attractive market place. The true
24-hour nature of the Forex markets, mean that traders enjoy
unparalleled liquidity. With liquidity comes tight spreads,
reducing trade slippage as well as improving price fills on both
entry and exit orders.
In
contrast to many futures markets where overnight access is to a
large extent "window dressing," currency markets offer full-time
genuine liquidity, allowing greater control over position
management.
Minimal execution fees and high leverage
Whether trading currency futures or SPOT, Forex execution
typically offers some of the lowest commission levels available
in any market place. Instead, brokers are compensated by the
spread between the bid and ask prices.
However, the high degree of leverage can work both for or
against a trader. Increasing leverage increases both potential
gains or losses
 A trending market
Forex markets provide some of the smoothest trends available in
any market. Whereas equity and futures markets often trade with
gaps and spikes, currency markets may offer smoother and less
erratic trading conditions, better for traders who dislike
trading 'choppy markets.'
In fact, foreign
exchange markets are widely accepted as the best trending
markets in the world. Proof, if needed of this fact, is that
Forex is traded technically and systematically by all major
hedge funds. ManFinacial, the FTSE100 Company, has over recent
years grown assets under management to over $30 billion,
trading, to a great extent, systematically.
This last and
important feature is the premise on which a vast majority of
traders build their trading strategy. Trending markets offer
traders incredible opportunities, allowing price data analysis
to form the foundation to a trading system over many varying
time frames.
Strategy - fundamental or technical?
As with any other market in the world, there are two high-level
trading strategies used to identify trading opportunities in the
Forex market. The first strategy is technical or systematic
analysis using charts, mathematical analysis, support and
resistance and so on. The second is fundamental analysis which
uses financial, political and economic information to make
trading decisions.
Beneath these primary headings lie hundreds of different
strategies to choose from. Add this to the fact that many of the
most successful traders use a combined approach, and it becomes
clear that there are numerous valid Forex strategies.
The strategy that traders adopt as their own must be dependent
on what works best in the traders experience and is most
comfortable for them. If choosing fundamental analysis
exclusively, a trader must follow current breaking news,
indicators, as well as current political trends in order to
increase the chances of making money. Using fundamental analysis
for trading decisions requires deep understanding of how the
markets work and of how the markets will react to news.
Econometric tools can
aid the analysis of fundamental information, some of which are
provided by brokers and financial web sites. A trader choosing
to use technical analysis will also have to learn techniques
that best suit their individual trading style. There are
hundreds of technical trading techniques to choose from,
encompassing the use of standard charts, mathematical formulae
and quantitative methodology.
In fact, this vast
range of technical techniques often overwhelms traders,
effectively negating any potential opportunities with 'analysis
paralysis,' or analysis overload. The result is that too many
traders feel cornered into a strategy that they have either read
about or been lectured about. Trader should use studies that
work for them, remembering that within any given market, at any
given time, a vast array of traders using hugely varying trading
strategies can all simultaneously profit or lose.
Technical analysis
For a trader entering the forex market for the first time,
technical analysis has major advantages when compared to
fundamental methods, not least the fact that it is a directly
transferable skill-set. Techniques learned and fine tuned over
many years of trading are just as valid when trading foreign
exchange contracts as they were with previously traded
instruments. From an active trader's perspective, this effectively means that existing
expertise may be directly transferable to the currency markets.
Technical analysis
also has the advantage of assisting short term intra-day
trading, as opposed to fundamental techniques, which are largely
applied to mid- and long-term position taking. In addition to
this, trading using technical analysis has the benefit of being
rule-based or systematical. This makes strategy testing using
historical data comparably easy. By mastering any degree of
systematic approach, traders are able to measure both current
and past performance, enabling them to tweak their
system-criteria attempting to maximize their performance. It also provides the
benefit of helping eliminate stress, reducing individual trade
anxiety and improving overall time management.
The following paragraphs examine the utilization of these
techniques when constructing an initial Forex trading strategy.
 Strategy construction
A trader undertaking foreign exchange trading while continuing
to trade in other markets must determine two important factors.
Firstly, how much time can productively be spent trading the
Forex markets, and secondly, which time frame to trade within.
Clearly, for a trader
who is unable to focus entire attention on one market, a
sensible approach is to trade from a medium-term perspective,
perhaps initially trading only several times per week or even
less. Forex markets are ideally suited to this approach to
trading as they typically trend extremely well.
So, when considering which technical trading strategy to
implement, the most reasonable starting point is to utilise
trend following and continuation techniques.
Supporting this
theory is the fact that one of the most common causes of losing
trades is from trying to pick the top or bottom of the market.
Often, as a result of a 'gut feeling', the exchange rate is
overdone and traders attempt to pre-empt the trend reversal.
Foreign exchange
trends are typically long and often overshoot perceived value
areas; there is no better example of this than that of the Euro
since launch. It was, and still is widely considered by most
institutional analysts that "fair-value" for the Dollar versus
Euro is between 1.20 and 1.22 Dollars to the Euro.
However, following
launch it traded as low as 0.80, overshooting within the
long-term trend. Now the reverse is true, and markets are
witnessing considerable Dollar weakness. In Forex, the trend is
your friend.
Clear trend patterns can be identified using simple but
effective continuation and breakout techniques, once again
emphasising just how valuable technical analysis is for traders.
A trading strategy
An initial trading strategy for a trader entering the Forex
markets, in addition to his existing trade activities should
include the following attributes:
Trend following technical analysis - use existing techniques
that work for you
Medium-term position trading - initially just a few trades per
week
Monitoring system - traders must have the ability to evaluate
precisely where they are making and losing money
Start small - test performance with inconsequential trade size
Keep it simple! - Start with basics and then add one system
constituent at a time
Stick to your rules: discipline, discipline, discipline
Traders should utilise existing techniques that have been well-tested, however the most widely used technical
analysis techniques in the Forex markets are:
Support and resistance
Channel trends
Moving average
Fibonacci
Relative Strength Index
An initial trading strategy should aim to trade with the long or
medium term trend, from the position of the trend. So if the
Dollar is in a long- or medium-term depreciation trend as is
currently the case, opening trades even if relatively
short-term, should be from the short Dollar side. This is
particularly important if a trader's attention is divided
between several markets.
Traders often suffer losses when they feel under pressure to
trade, forcing trade decisions that perhaps do not meet all
trade entry or exit criteria. By trading less frequently as
outlined above, traders might be more successful than
anticipated due to their ability to follow a newly developed
trading strategy with reduced trade pressure.
Currency trading
patterns are apparent over a whole range of different time
frames, from yearly to monthly, to daily and intra-day trends.
With this in mind, a trader has the ability to scale-in trade
frequency and activity. The fact that Forex markets consistently
trend is the crucial reason why many independent currency
traders choose to utilise technical analysis. Indeed, even when
combined with some broad fundamental studies, technical analysis
can form the cornerstone of an active traders rule set.
Conclusion
Catalysed by world events and then fuelled by the incredible
appreciation of the fledgling European currency, interest in
Forex trading is now penetrating even the retail investor
market. Headline grabbing news of the Dollar's decline to levels
not seen for over a decade, coupled with global market
volatility, has turned the spotlight on the emerging
opportunities available to market participants.
From an active trader's perspective, identifiable trading
patterns as well as comparatively low margin requirements and
cheap execution costs have created potentially favourable
trading conditions. Whether in conjunction with an existing
trading approach or as an entirely new undertaking, Forex
markets may lend themselves to traders following price data
using technical analysis. Indeed,
many traders previously trading futures on bonds or even
equities have switched entirely to the currency markets.
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