Attacking Currency Trends

How to Anticipate and Trade Big Moves in the Forex Market

Greg Michalowski

• Publisher: Wiley
• Year: 2011
• Print ISBN: 9780470874387
• eBook ISBN: 9781118023518
• Edition: 1
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

The guide for reading long-term trends in the foreign currency market

To thrive in the marketplace traders must anticipate, enter, and stay with trends in the foreign exchange market.

In this much-needed guide top forex, expert Greg Michalowski clearly explains the attributes of successful traders, and shows how traders can set themselves up for success by drafting an explicit mission statement and game plan. The book also contains the tools and techniques traders need to read the markets and identify when a market is in a trend. Michalowski shows traders how to enter an emerging trend, how to manage the position, and how to exit the position most effectively.

• Includes the technical tools needed to invest in the foreign exchange market: moving averages, trendlines, and Fibonacci levels
• Shows how to identify a trend and stick with the trend through its duration
• Written by Greg Michalowski who was cited by SmartMoney magazine as a "go to" source for making money moves

With this book, Michalowski offers an important resource for identifying and riding out long-term trends in the volatile foreign currency.

Part I

The Foundation for Success

A house needs to be built on a strong foundation. Otherwise, there is a risk that the house will fall down in a storm. A successful trader has a strong trading foundation. Otherwise, the risk is the trader's account will blow up in a volatile market.

The currency market is characterized—rightly or wrongly—by volatility. I think what people might mean when they say this is that currencies can go up and they can go down. The evening news will say, “The dollar is strong” or “The dollar is weak.” That may sound volatile to a stock investor who is used to buying and holding because over time stocks go higher. However, is that theory still necessarily true, especially in a country like the United States, which has seen stock prices move up and down over the last 10 or so years? If you listen now, the stock market is characterized as being “more volatile” as well.

To me, volatility means that the price can trend one way and then trend the other way. Those trend changes can wreak havoc if a trader does not have a firm foundation for the risk. It is not good enough to buy and hold, because the reversals in trends can be storms that cause total failure. Many traders blame the failures from large losses on volatility. They may blame them on the institutional traders or “big boys” whom they believe cause that volatility, that change in trend. I like to think the blame lies with a faulty trading foundation. A foundation that is not strong enough to weather the trend storms.

Part I of this book builds that foundation for your currency trading so you have a chance during the storms. In fact, if the foundation is truly solid, the storms should not have an effect at all. You should be able to stand strong, just like the big boys.

Chapter 1 is an introduction to the characteristics of the retail currency trader and will address why trend trading is so difficult for most traders. Just because it is difficult does not mean you cannot do it. It means you may have to change, though. So be prepared for some soul searching in that chapter. In Chapter 2, I discuss those attributes that are needed to be a successful currency trader. There are six of them, and they build on each other. If you skip one, you will most likely fail; your foundation will crumble. From there, I progress to the trader's mission statement in Chapter 3. When I ask retail traders whether they have a mission statement, 99 percent of them say no. Do you have one? You need one. Without one, that storm will knock you out. I will give you a mission statement in Chapter 3. Chapter 4 outlines the game plan for satisfying our mission statement. What do you have to focus on to win the game—to satisfy the mission? If there is a game plan, that implies a game of some sorts. All games have rules that provide control. Successful traders need to follow rules so they too can have better control over their trading. Those rules are outlined in Chapter 5. Finally, Part I ends with a look at the tools needed in the trader's toolbox. Not just any tool is allowed; some tools can be counterproductive. They do more harm than good. I will warn you of what tools are not welcomed, but more importantly tell you which ones will help you with your mission and game plan.

I have the opportunity to talk to many retail traders. Many times the story starts with “I blew up and . . .” What they really often mean to say is that their foundation wasn't in place, a storm came along, and the account blew up. Don't ignore the storm warnings. A storm is indeed approaching. So firm up that foundation before it is too late.

Chapter 1

Stereotyping the Retail Currency Trader

Stereotyping people is something I do not feel comfortable doing. It mainly comes from being wrong in the past about people whom I bucketed as being one way, only to find out they were not at all what I thought.

My biggest blunder occurred when I was offered a job at Citibank in London in 1991. I remember my wife and I being warned that the British were hard to get to know. They liked to keep to themselves. We would be better off living in an expatriate community and for our young sons to go to the American school.

When my wife and I went over to look for a place to live, we were sure we should live where the American school was located and settle in what we thought was our comfort zone—in a place where we would be happiest.

We arrived in London in early February 1991 and faced something we were very accustomed to—snow. It was the blizzard of 1991, and although the eight or so inches did not approach the snowfalls we experienced in the northeast United States, it crippled the city. Despite the distractions from shoveling out the family car, going sledding with their children, and stocking up on supplies, my new work colleagues made a special effort to immediately welcome me.

My wife and I both realized our preconceived thoughts about the people we would meet in our new home—our new country—bore no resemblance to the people we met. It was then we realized we did not want to live overseas in an American enclave. We wanted to do the total opposite and embrace living with the British people, sending our young children to British schools and respecting and learning about their customs and traditions. We wanted to call cookies biscuits and french fries chips, do without American football and learn about British football, and figure out what a cricket score really meant.

We spent four years in the U.K. and met many wonderful British people. I wonder what it would have been like if we had kept our misguided stereotypical thoughts and moved into the American community. I am sure the experience would have been less memorable and rewarding.

Since that experience, my family and I have always welcomed a new adventure where the idea of change takes you forward—not backward. We may now be back to calling chips fries and biscuits cookies, but I still say “Cheers.” I realized that introspection and change can often be a good thing.

So with my confession out of the way, it is with some apprehension that I have to stereotype retail currency traders. However, it is also done with more than 10 years of knowledge from monitoring retail currency traders, and from my share of trading blunders, that I try to right some of the wrongs before they send you down trading paths that will cost you money.

For some of you, the characteristics may strike a chord after your own self-analysis. I hope it helps force a change. For others, you may have already come to the realization and changed. For still others, you may look to stay the same. For those who may be reluctant, I only ask that you take a serious look at yourself and consider a change. You might like what you eventually see.

THEY THINK TRADING CURRENCIES IS EASY

I often have retail traders come to me at trade shows or other events, put a chart in front of me, and say, “All I have to do is flip a coin. If the flip says ‘buy,’ either I will be right, and the price will go up, or I will be wrong, and the price will go down. I am willing to take that bet.”

I have to stop them and tell them if it were so easy, this room would be empty, and everyone would be trading rather than looking for the next answer to the age-old question of how to trade successfully.

Nevertheless, on the surface it does seem easy. There is a price for the euro versus the U.S. dollar (conventionally displayed as EURUSD), say 1.3512, and that price is either going up or going down. If the event of the next price movement were isolated, and not dependent on any outside forces like fundamental analysis or technical analysis, a trader could flip a coin to determine whether he or she should be bullish and buy, or be bearish and sell.

Currency pairs like the EURUSD, GBPUSD, USDJPY, USDCHF, USDCAD, AUDUSD, and NZDUSD are quoted in the market in terms of how much of the base currency it would take to buy one unit of the counter currency. The base currency is the first currency in the currency pair, and is represented by a universally derived three character “name.” EUR is short for the euro, USD is short for the U.S. dollar, GBP is short for the British pound, JPY is short for the Japanese yen, CHF is short for the Swiss franc, CAD is short for the Canadian dollar, AUD is short for the Australian dollar, and NZD is short for the New Zealand dollar. These currencies make up the major currencies. The combinations of any one of the major currencies to the U.S. dollar make up the major currency pairs.

The major currency pairs are quoted for trading in a consistent, universally accepted convention. For example, the EURUSD currency pair has the euro as the base currency and the U.S. dollar as the counter currency. The convention is that the value of the base currency remains constant at 1.0000. The value of the counter currency is floating. As a result, a price of 1.3512 would imply that 1.3512 U.S. dollars are equivalent to 1.0000 euro. If a trader thought the euro was going to appreciate versus the U.S. dollar, he would buy the EURUSD. If the price of the EURUSD went higher, say to 1.3525, he could sell the 1.0000 euro for that higher value of 1.3525 U.S. dollars. When this happens, the euro is said to be strengthening and the dollar is said to be weakening. Note that one currency in a currency pair is always getting stronger while the other currency is getting weaker. If another trader thought the euro was going to depreciate versus the U.S. dollar, she would sell the EURUSD. If the EURUSD did fall to 1.3500, the trader could buy back the euros she sold at the cheaper price of 1.3500 U.S. dollars for the same 1.0000 euro.

The pricing convention versus the U.S. dollar is the same for the EUR, GBP, AUD, and NZD. That is, it is in terms of how many dollars it would take to equal 1.0000 units of the foreign currency.

The JPY, CHF, and CAD pricing conventions are reversed versus the U.S. dollar. For these currency pairs, the USD is the base currency (i.e., USDJPY, USDCAD, and USDCHF) and the foreign currency is the counter currency. As a result, the price of the currency pair is in terms of how many foreign currency units it would take to buy or sell 1.0000 U.S. dollar.

If, for example, the USDCHF was at 1.0112, it would take 1.0112 Swiss francs to buy (or sell) 1.0000 U.S. dollars. If the USDCHF went up, the dollar would have said to strengthen. If the price went down, the dollar would have weakened.

However, what is important to realize is that the 50-50 probability of the price moving higher or lower is for the next price change only, which is typically a one-pip move (a pip is the minimum a currency pair can fluctuate). That is, if the price is at 1.3512, there is a 50-50 chance the next price move will tick up to 1.3513 or down to 1.3511.

If there were no bid-to-ask spread, the 50-50 probability of making a pip or losing a pip from a standing start would be correct (all things being equal). However, in currency trading (and all trading for that matter), there is a bid-to-ask spread that skews the odds for success slightly against the trader. This spread is the property of the market makers or brokers who quote the market prices 24 hours a day, 5 days a week.

For example, the EURUSD, which is the most liquid currency pair, tends to trade at around a two-pip bid-to-ask spread. Assume the current price in the market is 1.3510 Bid/1.3512 Ask (see Table 1.1). If a trader flips a coin that has “buy” written on one side and “sell” on the other, and the random flip says to “buy,” the trader would need to buy at the ask price of 1.3512.

TABLE 1.1 Bid-to-Ask Spread Matters

Buy Price −	Sell Price =	Loss on Trade
1.31512 –	1.3510 =	– 2 pips

If the deal were immediately liquidated, the best the trader could do would be to sell at the bid price of 1.3510. If this were done, the trader would incur a two-pip loss on his long position.

Taking a two-pip loss is not the definition of successful trading. A trader needs to make a profit to be successful. So where would his long position be profitable?

To make a profit of one pip, the trader would need the bid price to move up to 1.3513. This would be the minimum price that would guarantee the trader a profit. If the market bid-to-ask price is 1.3510/1.3512 when the trade is initiated, three successive price moves up would be needed to make a profit (see Table 1.2). That is not as easy as a 50-50 proposition from a standing start. Table 1.2 outlines those moves.

TABLE 1.2 EURUSD P/L Profile for a Three-Pip Move in the Trade's Favor

Bid	Ask	Profit/Loss
1.3510	1.3512	–2-pip loss
1.3511	1.3513	–1-pip loss
1.3512	1.3514	0-pip loss
1.3513	1.3515	+1-pip gain

What about the Trading Losses?

Let's take this example a step further. Assume the trader flips the coin and has a rule that as soon as he makes a one-pip profit, he closes the position. We have seen the trader has to have the price move three pips to make that one-pip profit.

What about the stop loss? The same trader cannot just flip the coin, go long or buy, and if the price goes down, not have a stop loss price that limits the loss by squaring the position.

So let's assume that if the profit requires a three-pip move in the direction of the trade to take a profit, the trader will tolerate a similar three-pip move in the opposite direction of the trade before stopping the position out. Since there is a bid-to-ask spread in currency pair prices, and traders need to buy at the ask price and sell at the bid, the three-pip move in the opposite direction would create the loss profile shown in Table 1.3, assuming a purchase at 1.3512.

TABLE 1.3 EURUSD P/L Profile for a Three-Pip Move against the Trade

Bid	Ask	Profit/Loss
1.3510	1.3512	–2-pip loss
1.3509	1.3511	–3-pip loss
1.3508	1.3510	–4-pip loss
1.3507	1.3509	–5-pip loss

Initially, as soon as the trade is executed, the trader can sell at 1.3510 and incur a two-pip loss. Should the price move down one pip, it would bring the price down to 1.3509. A two-pip decline moves the price to 1.3508, and a three-pip move results in ...

Table of contents

• Cover
• Series
• Title Page
• Copyright
• Dedication
• Acknowledgments
• Introduction
• Part I: The Foundation for Success
• Part II: Tools and Strategies
• About the Author
• Index