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"Actual" means the real value of the index is unknown (or, at least, unpublished) so far.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

The Main Market Participants - Part I

The main currency market participants are:

Commercial banks

They hold the primary capacity of currency operations. Other market participants hold accounts with banks and use them to realize their required conversion and deposit-credit operations.

A bank accumulates (through its operations with clients) the combined market needs in terms of currency conversions and effects them with the help of other banks.

Besides fulfilling clients’ requests, banks can also effect transactions on their own behalf. The result is a currency market made up of inter-bank deals.

In the world currency markets, prominent international banks create the main influence as the value of their everyday operations is huge. These banks are Deutsche Bank, Barclays Bank, Union Bank of Switzerland, Citibank, Chase Manhattan Bank, Standard Chartered Bank, etc.

Their main criterion is the prominent volume of their deals which can cause important changes in quotations or in the price of a currency.

Usually, these major players are subdivided into “bulls” and “bears”.

Bulls are interested in increasing the price of a currency while bears are interested in lowering the price.

Usually, the market is in a relatively balanced condition between bulls and bears where the difference in currency quotation changes within rather tight limits.

When imbalance allows bulls or bears to dominate a currency, quotations change much faster.

Classification Features of the FOREX Market

The FOREX market can be classified by its different features:

By the type of operations:

There is a World Market of conversion operations (consisting, for example, of conversion markets like US Dollar/Japanese Yen or US Dollar/Canadian Dollar, and so on).

By the territorial feature:

The International Currency Market (FOREX) is a system of markets associated with the assistance of modern technologies.

The most significant ones would be the Asiatic (Tokyo, Singapore, Hong Kong), European (London, Frankfurt on Maine, Zurich) and American (New York, Chicago, Los Angeles) markets.

It’s also possible to indicate national currency markets (i.e. Russian currency market) with a wide complex of currency operations.

Due to the location of world regional markets in different time zones it’s correct to say that the International Currency Market works around the clock.

It begins in the Far East, New Zealand (Wellington), passing time zones in Sidney, Tokyo, Hong Kong, Singapore, Moscow, Frankfurt on Maine, London and finishes the day in New York and Los Angeles.

The Reasons for the Popularity of FOREX

In today’s financial markets, whether you are a small or large investor, the Foreign Exchange Market (FOREX) is the most profitable sector for your investments.

Unlike other financial markets, the FOREX market has no physical location, like a stock exchange for example. It operates through the electronic network of banks, computer terminals or just by telephone.

The lack of any physical exchange enables the FOREX market to operate on a 24-hour basis, spanning from one time zone to another across the major financial centers (Sydney, Tokyo, Hong Kong, Frankfurt, London, New York, etc).

In every financial center there are a lot of dealers who buy and sell currencies 24 hours a day during the whole business week.

The trading session starts in the Far East, in New Zealand (Wellington), then Sydney, Tokyo, Hong Kong, Singapore, Moscow, Frankfurt-on-Maine, London and ends in New York and Los Angeles. Below are approximated trading hours for regional markets (New York Time):

Now, let’s look at the most important reasons why FOREX is so popular today:

Liquidity

FOREX is the largest financial market in the world, with the equivalent of $3-4 trillion changing hands daily whereas the volume of the stock markets is only around $500 billion.

Flexibility

Because of 24-hour trading, participants of the Foreign Exchange Market do not have to wait for a reaction to certain external events in the same way as other daily markets (stock or futures markets, for example).

In these other markets, it is normal for prices at the “open” of the next day to “gap” up or down from the previous day’s closing prices because, by morning of whatever time zone you are in, the opening price will have already factored in the impact of any relevant overnight events.

Depending upon your position, this may or may not be desirable so, generally speaking, you should aim to trade markets in your time zone to avoid the situation. That is where the 24-hour nature of FOREX is a great advantage.

Lower transaction costs

Traditionally, the FOREX market has no commissions (other than the spread - the difference between bid and ask prices).

Price stability

High liquidity helps ensure price stability when unlimited contract sizes can be executed at a fair price. It helps avoid the problem of instability, as happens in the stock market and other exchangetraded markets because of the lower trade volumes where, at any given price, only a limited number of contracts can be executed.

Margin

Margin size for trading on FOREX is defined in the contract entered between a client and a bank or a brokerage company, which provides opportunity for individuals to enter the market - usually with a capital requirement of just 1% of the contract value.

So, collateral of 1000 US dollars allows a trader to enter trades of $100,000. Such high leverage, combined with the rapid rate fluctuations make this market extremely profitable but at the same time extremely risky.

How a Transaction Is Carried Out

So, you speculate that EUR/USD is moving higher and you buy 10,000 EUR and sell 12,509 USD.

Assuming that you are right and EUR/USD reaches 1.2599/1.2603, you close the open position with an opposing one.

In our example, you close the long (buy) position with a short (sell) position, i.e. you sell 10,000 EUR (0.1 lot * 1.0 lot size for EUR/USD) and buy 12,509 USD: 

You get a profit of 90 pips = $90 in this case. Importantly, you didn't require 10,000 EUR ($12,509) to make the trade, just $125.

A Pip or point is the minimum rate fluctuation. For EUR/USD, 1 pip is 0.0001 of the price (see Table 2). Our profit is 1.2599 - 1.2509 = 0.0090, i.e. 90 pips.

So, you invested $125 and made a profit of $90.

The time period to achieve this could be anywhere between a few seconds and several days. Assuming that it actually took a few hours, a profit of $90 for an investment of $125 and no actual “work” isn't a bad return at all.

However, you must be aware that leverage can also work against you and magnify your losses.

Only money management will help you to minimize the risks, ideally reduce them to zero, and increase the return from your funds to 10%, 20%, 30%, or higher each month.

One question is left: what is the broker's charge for the leverage they provide?

If you open and close a position before 23:00 GMT, brokers provide the leverage for free. If you leave your position open, they adjust your account with a storage charge for the overnight position. It can be either positive (credited to your account) or negative (debited to your account) depending upon the interest rates in those countries.

For example: ECB interest rate is 4.25%, FED interest rate is 3.5%. Assume you have a short position on EUR/USD of 1.0 lot so you have sold 100,000 EUR. This means you have borrowed them at 4.25% per annum.

You sold Euros and bought Dollars, which can be deposited at 3.5% per annum. As a result, the costs are (4.25% - 3.50%) per annum or $937.50 per year (if the EUR/USD rate is 1.2500), or $2.57 per day.

This means that your account will be debited with $2.57 every day for each lot if you have a short (selling) position on EUR/USD and credited with $2.57 if you have a long (buying) position.

In practice, the debited amount is a little higher than 2.57% and the credited amount is a bit lower. The difference goes to a broker as a payment for the rollover.

Swaps

Note: the storage charge for the rollover from Wednesday to Thursday is three times higher than for a position held over any other night.

This is because in the spot currency market, the funds ordered when you open a position are not received until 2 business days after the position is opened and by the same token, if you close a position, the funds are not returned for 2 business days.

For positions opened on Wednesday and closed on Thursday, that would mean receipt on Friday and, therefore, rollover would be for Friday, Saturday and Sunday nights before being returned on Monday. Sorry if that seemed overly complicated – it probably was!

The main thing you need to remember is that you will see a much larger rollover charge if you hold a position over Wednesday night.

What is FOREX?

FOREX (FOReign EXchange Market)

The Foreign Exchange Market is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. The FOREX market was formed in the mid ‘70s, when international trade was changed from a system of fixed rates to a system of free-floating rates of exchange.

In fact, every country’s currency is considered merchandise, like wheat or sugar; it is the same medium of exchange, like gold and silver. Since the world changes faster and faster every year, the economic conditions of every country (e.g. labor productivity, inflation, unemployment, etc.) are ever more dependant upon the level of development of other countries, and this, in turn, impacts the value of a country’s currency in relation to the currencies of other countries. This is the main reason why there are rate fluctuations.

Currency Symbols:

Table 1

Currency Exchange Rate

Currency exchange rates are simply the ratio of one currency valued against another. For example, "EUR/USD exchange rate is 1.2505" means that one euro is traded for 1.2505 dollars.

The exchange rate of any currency is usually given as a bid price (left) and an ask price (right).

The bid price represents what has to be obtained in the quote currency (US Dollar, in our example) when selling one unit of the base currency (Euro, in our example).

The ask price represents what has to be paid in the quote currency (US Dollar, in our example) to obtain one unit of the base currency (Euro, in our example).

The difference between the bid and the ask price is referred to as the spread.

Table 2

Let's assume the exchange rate for EUR/USD is: 1.2505/1.2509. You may have done some market analysis and decide the EUR/USD rate is moving higher (at least to 1.2600) so you buy 0.1 lot (minimum contract size) of EUR/USD at the 1.2509 ask price.

Table 1 will help you define what the contract size is, i.e. 1.0 lot for EUR/USD is 100,000 EUR so 0.1 lot (our contract size) is 10,000 EUR.

This means you bought 10,000 EUR and sold 10,000 * 1.2509 = 12,509 USD.

Now, in order to make a trade, you don't need to have the total amount of $12,509. You actually require just 1/100th of that amount ($125.09) as the rest of the money (in our example, $12,383.91) is leveraged to you by a broker (a company you entered the contract with to enter the market).

Leverage

Leverage is the term used to describe margin requirements - the ratio between the collateral and borrowed funds i.e. 1:20, 1:40, 1:50, 1:100. Leverage 1:100 means that when you wish to open a new position, you only deposit 1/100th of the contract size.