Complex Trading Systems - Part II

The basic advantages of this approach are:

1. There is no human factor, i.e. a trader, as a person, will be free from excessive emotions. Nerves are kept (relatively) intact!

2. The trader will have more free time. Traders should not be constantly "chained" to the computer screen.

The basic disadvantages of this approach:

1. As all these systems are executed by the client’s computer (within the trading terminal or platform), instead of on the brokerage’s server, it can create a different sort of force majeure situation such as: problems with your РС (computer lock-ups, etc.), power failures or internet connection problems.

2. There is more chance of missing unexpected fundamental news.

The given approach has advantages and also disadvantages – ultimately it is up to you.

Trading Systems offered by financial companies

As has been mentioned before, there are many companies offering “ready for trading” trade recommendations or instant trade alerts (for intraday trading). Charges for these facilities can be monthly, quarterly or annual. These services can be in the form of “ready for use” software, e-mail mail alerts or notifications via instant messenger services.

The cost for such services can be quite high: around $200 per month for trading alerts and more.

Software can be even more expensive. I know of companies offering software for generating trading signals/alerts that costs over $9,000!

In fairness, these services can be very useful for people who are very busy and just unable to watch the markets all the time.

Complex Trading Systems - Part I

Trading Systems created by advanced traders

As a rule, “beginner” traders search for literature devoted to trading financial markets. They study market basics and as they begin to understand how they function, they study the technical and fundamental analysis.

While continuing with their studies, they open a virtual trading account and start to practice their theoretical knowledge.

Of course, it takes time.

Once they start to earn “income” using virtual money, they open the real trading account, fund it with real money and start trading with the intention of receiving a real money profit. A trader looks at various indicators, trying to define which are best suited to their style of trading. In parallel, a trader can use the free and paid services giving trading recommendations.

In due course, step by step, a trader begins to form their own approach to trading based on certain rules for using those particular indicators or other trading tools (a set of carefully chosen indicators, with certain parameters, for example).

Eventually, the trader forms their own unique approach to trading; their trading strategy or trading system.

Put simply, a system consists of identifying a set of events or situations which arise in the market and confirming these as good (or bad) by comparing them with a known set of parameters and technical indicators. When all or most of these events occur at any one time, it is a signal to buy (or sell).

It is important for the systems developed by a trader to be computerized at the earliest opportunity. This will allow their automatic execution without the trader having to be directly involved.

Many trading platforms such as МТ4 allow the user to program algorithms (a procedure or formula for solving a problem, created in the form of a script that is run on your computer) and build them into a trading system. This makes it possible for trade positions to be opened and closed automatically when certain conditions occur.

Technical analysis

Technical analysis

Technical analysis is research of market dynamics done mainly with the help of charts, and for the purpose of forecasting future price movement.

Technical analysis comprises several approaches to the study of price movement which are interconnected within the framework of one harmonious theory.

This type of analysis studies the price movement in the market by analyzing three market factors: price, volume, and in the case of futures contracts, the number of open positions.

Of these three factors, the primary one for technical analysis is that of price. Changes in other factors are studied, mainly in order to confirm the correctness of the identified price trend. This technical theory, just like any theory, has its core postulates.

Technical analysts base their research on three axioms:

􀂉 Market movement considers everything

This is the most important postulate of technical analysis. It is crucial to understand it in order to grasp the procedures of analysis. Put simply, any factor that influences the price of securities, whether economic, political, or psychological, has already been taken into account and reflected in the price chart.

In other words, every price change is accompanied by a change in external factors. The main inference of this premise is the necessity to follow closely the price movements and analyze them. By means of analyzing price charts and multiple other indicators, a technical analyst reaches the point that the market, itself, shows him/her the trend it will most likely follow.

This premise is in conflict with fundamental analysis where the attention is primarily paid to the study of factors, and later on, after the analysis of the factors, conclusions as to the market trends are made.

Thus, if the demand is higher than the supply, a fundamental analyst will come to the conclusion that the price will increase. A technical analyst, however, makes his/her conclusions in the opposite sequence: since the price has increased, it means the demand is higher than the supply.

􀂉 Prices move with the trend

This assumption is the basis for all methods of technical analysis, as a market that moves in accordance with trends can be analyzed, unlike a chaotic market.

The postulate that the price movement is a result of a trend has two effects: The first implies that the current trend will most likely continue and will not reverse itself, thus, excluding disorderly chaotic movement of the market. The second implies that the current trend will go on until the opposite trend sets in.

􀂉 History repeats itself

Technical analysis and study of market dynamics are closely related to the study of human psychology. Thus, the graphical price models identified and classified within the last hundred years depict core characteristics of the psychological state of the market.

Primarily, they show the moods currently prevailing in the market, whether bullish or bearish. Since these models worked in the past, we have reason to suppose that they will work in the future, for they are based on human psychology which remains almost unchanged over the years.

We can reword the last postulate — history repeats itself — in a slightly different way: the key to understanding the future lies in the study of the past.

IMPORTANCE OF THE ECONOMIC DATA

1  The announcement of a given result is not expected to influence a currency and, most likely, its publication will be little more than a statistical fact

2  The announcement of a given result is expected to influence a currency for the current session at most

3  The announcement of a given result is expected to influence a currency for a day, a week or even a month

POSSIBLE INFLUENCE ON AN EXCHANGE RATE 32

→  The output of the economic indicator (presumably) does not render action on an exchange rate

↑  The output of the economic indicator will (presumably) cause growth of an exchange rate

↓  The output of the economic indicator will (presumably) cause a decline of an exchange rate

↓↓  The output of the economic indicator will (presumably) cause strong (very strong) decline of an exchange rate

↑↑  The output of the economic indicator will (presumably) cause strong (very strong) growth of an exchange rate

?  It is very difficult to predict movement of the currency after the publication of the data (more often it happens before publication of carryovers from sessions of central banks, statements of large political figures, publications of economic reports (the Beige book (USA), Tankan (Japan), etc.)

As you can see, brokerages will try their best to help you with all kinds of trading information. In time, you’ll be able to understand everything very clearly.

Common detailed Fundamental Analysis for an index:

Fundamental Analysis: ISM services index

The last value on the chart above shows predicted data

Analysis: This index was in an uptrend from the end of 2001. During 2002 it stayed above 50, signifying that the service sector was increasing. From the middle of 2003 this index stabilized within the indicated range. Its decrease in September was triggered by the hurricane and, though it recovered in October, it is still quite low.

Conclusion: This index signifies some weakness in the mid-term perspective. ISM services index for March may be more positive than forecast.

2nd example of Fundamental Analysis for a day

Notes: Above the forecast – the actual value is mathematically larger than the forecast value (for example, 5% > 4.3% and -49 > -51).

Below the forecast – the actual value is mathematically smaller than the forecast value (for example, 4.1% <>

Fundamental analysis does not provide absolute indication in market analysis and will always consist of a complex of possible tendencies.

The level of importance of each economic indicator can be deduced by studying the influence that indicator exerted on an exchange rate over a period of several years.

The level of importance of a given indicator can be over or underestimated depending on the market conditions at the time and the degree of expectancy by a market of the announced result.

How to Forecast Market Behavior

Can we forecast the future?

Why yes, of course! Any financial market can be analyzed and forecast in some way.

Through the medium of specialized sciences we call technical and fundamental analysis we can assess the probabilities of a market’s direction in the future.

Fundamental Analysis

Fundamental analysis is an analysis of a country’s national qualities (macroeconomics). Fundamental analysis is more pivotal in its power to move the markets with the whims of its daily, weekly, monthly, etc. economical news releases.

Any kind of breaking news, such as some unexpected event of national importance, can break any market prediction that is based on technical analysis alone. We will discuss technical analysis much more in the next section.

The most important macroeconomic indicators are:

1. Factors influencing the market include: Consumer Price Index (CPI), Orders for durable goods, Employment data, Gross National Product (GNP), new house construction, international trade balances, personal income and outlay, Producer Price Index, retail sales, etc.

2. Other important indicators: Beige book, Consumer confidence, Current account, session of the Federal Open Market Committee (FOMC Meeting), Leading Indicators, initial requirements of unemployment benefits (Jobless claims)

3. Reports of heads of the governments, heads of the central banks, outstanding economists concerning a situation in the market 

4. Changing monetary and credit policy

5. Sessions of the big seven - the trading and economic unions

There is no real need to worry about “surprise” results. These macroeconomic indicator reports are published at known times of the year and rarely contain unexpected results.

Here is a typical example for one day:

As you can see, the right hand part of the table (above) consists of three columns: Prior, Forecast and Actual.

"Prior" means that a previously defined index had some value in the past for a defined period of time (week, month, quarter).

"Forecast" means economists and professional traders, based on specific calculations, are waiting for this index value for the week, month or quarter.

"Actual" means the real value of the index is unknown (or, at least, unpublished) so far.

Of course, if you are a beginner, then these aspects can be difficult to understand.

Don’t worry! Help is at hand.

Most brokerages offer a service providing this information to their clients free of charge.

Speed of Order Execution

Speed of execution for an order is a very important aspect of any on-line trade operation.

Whilst speed is naturally important for managers of large funds and for traders who trade on a long-term basis, it is extremely important to us – traders whose profit depends on seconds or even fractions of a second.

Not long ago, orders could only be conducted by telephone. Today, some brokerage companies still insist that trades above a certain size, e.g. $1,000,000 for single trading position, are placed by telephone.

Nowadays, most companies have switched to so-called “instant execution” of orders. This means that the time taken for the operation (the period between when you issue an order to the broker to open or close a trade position and the actual opening or closing of the trade) is typically 2-5 seconds, though this time period depends very much on the quality of your Internet connection.

So, we’ve looked at almost all aspects required for trading and now we need to move on to learn about forecasting market behaviour.

Why forecast? Well, you certainly wouldn’t drive your car while blindfolded so why would you think about trading that way?

What We Need To Access the Market and Trade It - Part V

There are four types of pending orders available on the terminal:

Buy Limit - Buy provided the future "ASK" price is equal to the pre-defined value. The current price level is higher than the value of the placed order. Orders of this type are usually placed in anticipation that the security price, having fallen to a certain level, will increase.

Buy Stop - Buy provided the future "ASK" price is equal to the pre-defined value. The current price level is lower than the value of the placed order. Orders of this type are usually placed in anticipation that the security price, having reached a certain level, will continue to increase.

Sell Limit - Sell provided the future "BID" price is equal to the pre-defined value. The current price level is lower than the value of the placed order. Orders of this type are usually placed in anticipation of that the security price, having increased to a certain level, will fall.

Sell Stop - Sell provided the future "BID" price is equal to the pre-defined value. The current price level is higher than the value of the placed order. Orders of this type are usually placed in anticipation of that the security price, having reached a certain level, will continue to fall. Stop Loss and/or Take Profit orders can be attached to a pending order. After a pending order has triggered, its Stop Loss and/or Take Profit levels will be attached to the newly opened position automatically.

Stop Loss - A Stop Loss order is used to minimize losses if the security price has started to move in an unprofitable direction. If the security price reaches this level, the position will be closed automatically.

Such orders are always connected to an open position or a pending order.

The brokerage company can place them together only with a market or a pending order. The terminal compares long positions against the ASK price and short positions against the BID price.

There is also an automated Stop Loss order called a Trailing Stop which continuously adjusts its position to a fixed distance from the current price while a trade is increasing in profit but holds its position if the current price starts to move against the trade, thus locking in profits.

Take Profit

The Take Profit order is intended for automatically exiting with a profit when the security price has reached a certain level. Execution of this order results in closing of the position.

It is always connected to an open position or a pending order.

The order can be requested together only with a market or a pending order. The terminal compares long positions against the ASK price and short positions against the BID price.

Important: Execution prices for all trade operations are defined by the broker; Stop Loss and Take Profit orders can only be executed for an open position but not for pending orders.

What We Need To Access the Market and Trade It - Part IV

Types of Orders

There are many different types of orders, some of which are specific to stock trading. Fortunately, it is not necessary for us to learn all of them.

In my opinion, it is enough to examine only those orders which are used in MetaTrader 4 – this will encompass the types of orders which are most commonly used in the FOREX market.

Client terminals allow the preparation of requests to the broker for execution of trading operations. Moreover, a terminal allows control and management of open positions. To achieve this, several types of trading orders are used.

An order is a client's commitment to a brokerage company to perform a trade operation.

The types of orders we will be using are:

Market Order

A Market Order is a commitment to the brokerage company to buy or sell a security at the current price. Execution of this order results in opening of a trade position.

Securities are bought at the ASK price and sold at the BID price.

Stop Loss and Take Profit (I will explain what is it in the next post) orders can be attached to a market order.

The Execution mode of market orders depends on the type of security traded.

Pending Order

Pending order is the client's commitment to the brokerage company to buy or sell a security at a pre-defined price in the future. This type of orders is used for the opening of a trade position provided the future price quotes reach the pre-defined level.

What We Need To Access the Market and Trade It - Part III

We Need Specialized Software to Access the Market

As you will realize, we need specialized software, but what do we actually require and what would be best?

Types of software for working in financial markets

Brokerages with on-line market access and other services offer different types of programs free of charge.

Some companies offer purely trading platforms without any market analysis functions.

Others offer both trading platforms and market analysis software. These usually consist of separate applications, which is a little inconvenient because you have to launch one program for trading and the other for analysis.

There are even brokerages which only provide a trading platform and advise clients to purchase additional software for market analysis & forecasting. As a general rule, stand-alone software is rather expensive and may require a one-time payment, a monthly/annual charge or both.

Therefore, the best choice is a stand-alone application that integrates both market analysis and the ability to execute trades.

My software of choice is MetaTrader 4. This trade terminal allows you to analyze markets and, at the same time, execute trades directly from the charts.

What We Need To Access the Market and Trade It - Part II

We Need a Brokerage

There are many brokerage offices offering access to the FOREX market.

Use the following criteria for choosing a brokerage who will give you the best level of service:

1. Reliability.

• It is necessary to find out how many years the given company has been working in this sphere of business and how many clients it has.

• The longer it has worked in this sphere of business, and the more clients it has, the better

2. Quantity and quality of services:

• Technical support service

• Facilities for funding and withdrawing from a trading account, etc. to meet your personal requirements

3. Number of available currency pairs for trading

4. Most important:

• pay attention to the size of their spreads (each brokerage is free to set their own) and the speed & quality of order executions

• consider the functionality of the trading terminal offered. Download it, install it and study the documentation until you are totally comfortable with it.

You should know your trading terminal so well that you can instantly find any tool or feature when required.

Most importantly, you should understand the various orders and the rules relating to their execution – for example: the multiplication table.

In this post we have briefly touched on the subject of software for giving us access to the market. In the following posts we shall consider in more detail the types of applications available for working in the financial markets.

What We Need To Access the Market and Trade It - Part I

We Need an Internet Connection

Actually, transactions can be carried out by telephone. Some brokerages insist on carrying out transactions by telephone if the volume of transactions exceeds certain limits.

Also, as you know, neither software nor internet access can be guaranteed to operate 100% of the time. In these situations, transactions can be opened or cancelled by telephone.

Of course, it is to your advantage when you can work via the Internet as it allows continuous communication with the market and high speed execution of orders.

For our purposes, the best option is high-speed Internet. Either DSL or Cable is perfectly adequate and a dial-up connection for emergency use is a good idea. Remember that dial-up is for unforeseen situations - I would not recommend it for normal use.

For added safety, I strongly suggest purchasing a good Uninterruptible Power Supply (UPS) in case of a local power failure.

Ok! We have discussed what is required and or prudent for us to connect with the brokerage and we have protected ourselves against various unforeseen situations. Now we need to choose a brokerage or Dealing Center through which we can access the market and place our trades.

 

 

Mini-FOREX – FOREX Trading With $100 Deposit

InterBankFX provides its clients with the ability to trade mini-FOREX contracts where margin requirements start at just $100 because the contract sizes are smaller than standard contracts.

This means that the average person can trade currencies alongside those with $100,000+ trading accounts and earn proportionally the same returns.

To trade mini-FOREX, a trader simply specifies a smaller lot size, i.e. 0.1, 0.2, etc. (at any rate, less than 1.0 lot).

Until 2003, there was a difference in trading conditions between mini-FOREX and standard FOREX and a commission of $3.00 was charged for each mini-FOREX contract. In mid-2003, this practice ceased and there is now no difference between mini-FOREX and standard FOREX: there are no longer any commission charges, only the spread.

Keep these things in mind:

The FOREX market is an inter-bank market with a minimum trade size of $1,000,000. How then do $10,000 trades, representing mini-FOREX contracts, get represented in an inter-bank market?

For small deals, clients require a partner, i.e. a brokerage. If the brokerage has a large number of clients trading mini-FOREX then it is conceivable that they could combine those orders to create an inter-bank market contract.

On the other hand, a brokerage with just a few clients would never reach minimum contract requirements to place a trade into the market.

In these circumstances, a brokerage might decide to assume any potential liability in the hope that the majority of their clients would hold losing positions, i.e. the brokerage takes opposing positions to their own clients. If the client wins then the brokerage loses and vice-versa.

A brokerage in this situation may try to tip the balance in their favor by shifting the quotation when closing trades, etc. to create unplanned losses for their clients.

Of course, if the brokerage has been in existence for some time then they have most likely amassed a large client-bank of active traders so combining contracts to take actual positions in the inter-bank market would not be an issue for them.

In such a scenario, the brokerage is not interested in whether a client wins or loses as they will be earning the 1-2 pip spread in either case

In practice, the brokerage does care whether their clients win because winning traders become more confident, active and more profitable for the brokerage.

The Main Concepts of the FOREX Market

In banking practice there are special code abbreviations: for example, the exchange rate for the US Dollar against the Japanese Yen is referred to as USD/JPY and the British Pound against the US Dollar is referred to as GBP/USD.

The first currency is known as the base currency and the second as the quote currency:

This notation specifies how much you have to pay in the quote currency to obtain one unit of the base currency (in this example, 120.25 Japanese Yen for one US Dollar). The minimum rate fluctuation is called a point or pip.

Most currencies (except USD/JPY, EUR/JPY and GBP/JPY, where a pip is 0.01) use 4 decimal places, i.e. 0.0001.

The currency pairs on FOREX are quoted as bid and ask (or offer) prices:

Bid

Bid is the rate at which you can sell the base currency, in our case it is the US Dollar, and buy the quote currency, i.e. Japanese Yen.

Ask (or offer)

Ask (or offer) is the rate at which you can buy the base currency, in our case US Dollars, and sell the quote currency, i.e. Japanese Yen.

Spread

Spread is the difference between the 'bid' and 'ask' prices.

Margin trading

Margin trading assumes that FOREX dealing is based on the margin, the collateral, and the provided leverage.

Such credits are provided by the brokerage companies, in addition to their informational services, and make it possible for a trader to enter into positions larger than his/her account balance. This collateral is typically referred to as margin.

Margin

Margin is the sum of a guarantee pledge under which leverage is provided.

Leverage

Leverage is the term used to describe margin requirements. It is expressed as the ratio between the collateral and borrowed funds, i.e. 1:20, 1:40, 1:50, 1:100.

Leverage of 1:100 means that when you wish to open a new position you need just 1/100th of the contract size in available capital. 

Currency Rate

Currency Rate is the ratio of one currency valued against another. It depends on the demand and supply within a free market or a market restricted by a government or central bank.

Lot

Lot is a fixed standard amount of a given currency for the purpose of trading. Sometimes it is known as the contract size. The monetary value of 1.0 lot for each currency pair is listed in Table 2.

Storage

Storage is the charge to rollover (hold) a position overnight. It can be either positive (credited) or negative (debited) to your account balance depending on the interest rates in the countries of the currencies you are trading.

The Main Market Participants - Part III

Currency exchanges

Among some countries with transitive economies, there are currency exchanges which are there to both arrange exchanges and to formulate a market’s rate of exchange. Their Governments usually regulate the level of rate of exchange.

Currency brokerages

Their function is to introduce a buyer to a foreign currency seller and effect a loan-deposit  transaction. For this service, brokerage firms ask for a commission - usually as a percentage of the deal amount.

Private persons

Individuals arrange a wide spectrum of non-trade operations in the areas of foreign tourism, wages, pensions, fee transactions, buying/selling of cash currency, etc.

In 1983, with the creation of margined trades, the ability to invest spare funds in the FOREX market for profit became a viable option for individuals.

The majority of FOREX transactions (90-95%) are arranged by international commercial banks; their own transactions as well as those of their clients.

Advancements in computer technology within the financial sphere has opened the way for private and small investors as more brokerage firms and banks allow access for private investors to FOREX via the Internet.

The Main Market Participants - Part II

Companies making foreign investments

These are those companies involved with Investment Funds, Money Market Funds and International Corporations.

These companies show constant demand for foreign currency (as importers) and offer foreign currency (as exporters). Also, they place spare funds on short-term deposit.

At the same time, companies with direct access to the currency market do not, as a rule, effect conversion and deposit operations through commercial banks.

These companies, represented by various international investment funds, operate a portfolio strategy for investment of assets, arranging funds in securities of the Governments of different countries. In dealers’ slang they are referred to as funds, the most well-known of which are G. Soros’ “Quantum”, for successful currency speculations, and “Dean Witter”.

Other types of companies that belong in this category are the great international corporations, creating foreign production investments: the creation of offices, combined business, etc. such as Xerox, Nestle, General Motors, British Petroleum and others.

Central banks

Their main task is currency regulation of their internal market - staving off sudden jumps in rate of a national currency to avoid economical crisis, maintaining a balance of import-export, etc.

Central banks have an influence on the currency market. Their influence could be direct – in the case of currency intervention, or indirect – through regulating the volume of money supply and bank rates.

They are not to be confused with bulls or bears, as their role involves the resolution of international financial issues being faced at a given moment.

A central bank could affect the market independently, to influence its national currency or, in co-ordination with other central banks to arrange a combined currency policy with the international market.

The banks with the most influence on world currency markets are: The United States (the US Federal Reserve or FED), Germany (Deutsche Bundesbank) and Great Britain (the Bank of England, the so-called ‘Old Lady’).