THE SIX FORCES OF FOREX

Trading forex is like watching a school of fish move. One minute is total harmony, the next, complete chaos. As the observer of this school of fish, do you believe you can accurately predict the direction the school of fish will move each time? Would you bet on it?

What causes the fish to move the way they do? Why do they work together in one moment, moving with force and precision, and move in what seems to be an infinite number of directions the next? There’s no way to know unless you can sense what the fish sense each time they move. The fish have an instinct about the nature of their environment. They understand the context of all things around them – natively – and can react accordingly. Surely if you shared this understanding you’d be a much more accurate predictor of fish movement!

Trading forex is not much different - we need to develop that keen sense of what is happening around us. Will we ever be able to predict every move in the forex markets? Absolutely not. But we can use our understanding of the context of the market – the six forces of forex – to make better, more profitable trading choices.

Once we understand these forces, we can create and operate within a comprehensive trading plan:

• Who trades forex? Understand who participates in the markets, why they are successful, and how you can emulate them.
• Why trade forex? There are superior returns in forex, but not for all investors. Are you one of them?
• Where should you trade? Choose to work with service providers who can efficiently enable your style of trading.
• What should you trade? Select the currency pair, entry, exit and money management methods that will maximize your returns.
• When should you trade? Trade when the environment is most likely to produce the best conditions for executing your system.
• How should you trade? Trade using methods that maximize your ability to emulate the proven winners.

Knowledge of these forces and how they work is a major determinant of your success as a trader.

PIVOT POINT ANALYSIS

As you know there are to ways of analyzing the forex market: Technical and Fundamental Analysis.

Personally, I think that for short term trading the Technical Analysis is very useful and the Pivot Points are indicators used in this theory.

Pivot points are based on a mathematical formula originally developed by Henry Wheeler Chase in the 1930s. Chester W. Keltner used part of the formula to develop the Keltner Bands as described in his book - How to Make Money in Commodities (Keltner Statistical Service, 1960).

However, it was really Larry Williams who was credited with repopularizing the analysis in his book - How I Made One Million Dollars Last Year Trading Commodities (Windsor Books, 1979). Don Lambert, the creator of the Commodity Channel Indicator (CCI) uses the pivot point formula
that makes the CCI work.

You can make develop your own trading methods using pivot point analysis combined with candlestick patterns, including the advantage of trading using multiple time frames, or what is know as a confluence of various target levels based on different time periods.

This topic will highlight those techniques as well as explain how to incorporate the pivot point as a moving average trading system and how to filter out and narrow the field of the respective support and resistance numbers and will divulge various formulas that are popular today.

Pivot points are a mathematical formula designed to determine the next time period’s range based on the previous time period’s data, which includes, the high, the low, and the close or settlement price

Using these variables from a given time period’s range is that will reflect all market participants’ collective perception of value for that time period. The range, which is the high and the low of a given time period, accurately reflects all market participants’ exuberant bullishness and pessimistic bearishness for that trading session. The high and the low of a given period are certainly important, as they mirror human emotional behavior. Also, the high is a reference point for those who bought out of greed, thinking that they were missing an opportunity. They certainly won’t forget how much they lost and how the market reacted as it declined from that level.

The opposite is true for those who sold the low of a given session out of fear they would lose more by staying in a long trade; they certainly will respect that price the next time the market trades back at that level, too. So the high and the low are important reference points. With that said, the pivot point calculations incorporate the three most important elements of the previous time period: the high (H), the low (L), and, of course, the close © of a given trading session. First, let me give you the actual mathematical calculations, and then I will go over what each level represents.


Pivot point
the sum of the high, the low, and the close divided by three.
P = (H + L + C)/3

Resistance 2 (R-2)
pivot point number plus the high minus the low.
R-2 = P + H – L

Resistance 1 (R-1)
pivot point number times two minus the low.
R-1 = (P × 2) – L

Support 1 (S-1)
pivot point number times two minus the high.
S-1 = (P × 2) – H

Support 2 (S-2)
pivot point number minus the high plus the low.
S-2 = P – H + L

Some analysts are adding a third level to their pivot calculations to help target extreme price swings that have occurred on certain occasions, such as a price shock resulting from a news event. You can notice that the spot forex currency markets tend to experience a double dose of price shocks because they are exposed to foreign economic developments and U.S. economic developments that pertain to a specific country’s currency.

This tends to make wide trading ranges. Therefore, a third level of projected support and resistance was calculated.

Resistance 3 (R-3)
the high plus two times (the pivot minus the low)
R-3 = H + 2 × (P – L)

Support 3
the low minus two times (the high minus the pivot)
S-3 = L – 2 × (H – P)

or

R-3 = P – S-2 + R-1
S-3 = P – R-2 – S-1

There are other variations that include adding the opening range, which, in this case, would involve simply taking the sum of the high, the low, and the open, and the close and dividing by four to derive the actual pivot point.

P = (O + H + L + C) /4

Since there is no formal closing and opening range, forex traders can use the N.Y. bank settlement as the close at 5 P.M. (EST) and assign the next
day’s session open as 5:05 P.M. (EST).

The following list shows what these numbers represent, how price action reacts with these projected target levels, how the numbers would break down by order, what typically occurs, and how the market can behave at these levels. Keep in mind that this is a general description, and we will learn what to look for at these price points to spot reversals in order to make money. I must stress that it is important to look at the progressively higher time period’s price support or resistance projections; for example, from the daily numbers, look at the weekly figures; and then from the weekly numbers, look at the monthly numbers. The longer the time frame, the more important or significant are the data. Also, it is rare that the daily numbers trade beyond the extreme R-2 or S-2 numbers; and when the market does, it is generally in a strong trending condition. In this case, we have methods to follow the market’s flow, and we will cover them in more detail in the next few chapters. Remember, pivot point analysis is used as a guide; these numbers are not the holy grail. By focusing on just a few select numbers and learning how to filter out excess information, I eliminate the analysis paralysis from information overload.

Resistance Level 3
This is the extreme bullish market condition generally created by news-driven price shocks. The market is at an overbought condition and may offer a day trader a quick reversal scalp trade.

Resistance Level 2
This is the bullish market price objective or target high number for a trading session. It generally establishes the high of a given time period. The market often sees significant resistance at this price level and will provide an exit target for long positions.

Resistance Level 1
This is the mild bullish to bearish projected high target number. In low-volume or light-volatility sessions or in consolidating trading periods, this often acts as the high of a given session. In a bearish market condition, prices will try to come close to this level but most times will fail.

Pivot Point
This is the focal price level or the mean, which is derived from the collective market data from the prior session’s high, low, and close. It is the strongest of the support and resistance numbers. Prices normally trade above or below this area before breaking in one direction or the other. As a general guideline, if the market opens above the primary pivot be a buyer on dips. If the market opens below this level, look to sell rallies.

Support Level 1
This is the mild bearish to bullish projected low target number in light-volume or low-volatility sessions or in consolidating trading periods. Prices tend to reverse at or near this level in bullish market conditions but most times fall short of hitting this number.

Support Level 2
This is the bearish market price objective or targeted low number. The market often sees significant support at or near this level in a bearish market condition. This level is a likely target level to cover shorts.

Support Level 3
In an extremely bearish market condition, this level will act as the projected target low or support area. A price decline to this level is generally created by news-driven price shocks. This is where a market is at an oversold condition and may offer a day trader a quick reversal scalp trade.

Weekly and monthly time frames can and should be utilized as well as the daily numbers you may be used to or have heard about in the past. To
understand how price moves within the pivots, begin by breaking down the time frames from longer term to shorter term. As traders, we should begin with a monthly time frame, where there is a price range or an established high or low for a given period. This range, with its price points, is what we
as traders should be looking for. Here is how I utilize the range in my research.

There are approximately 22 business days, or about 4 weeks, in each month. Every month there will be an established range - a high and a
low. There are typically five trading days in a week. Now consider that in one day of one week in one month, a high and a low will be made. It is likely that this high and low may be made in a minute or within one hour of a given day of a given week of that month. That is why longer-term time
frames, such as monthly or weekly, should be included in your market analysis. In the world of 24-hour trading, the most popular question I get from those studying and using pivot points is, “What are the times that you derive the high-low-close information?” There are many different people telling many different stories. Here is what I do and what seems to work the best for me. For starters, just keep things simple, and apply some good oldfashioned common sense. If the exchanges and the banking system use a specific time to settle a market, then that is the time period that should be
considered for a “close.” They should know those are the rules that make money move. I want to follow the money flow and be on the same time schedule as the banks and institutions, so here are a few pointers:

- Use the 5 P.M. (EST), New York bank settlement close to determine pivots.

- For the weekly calculations, take the open from Sunday night’s session and use the close on Friday.

- For the monthly calculations, take the opening of the first day of the month and the close from the last day of the month.

Tope Ten Mistakes in Forex Trading

Let's say that you are ready. You’ve done your homework. You have read the all right trading books, watched all the right professional trading videos and attended a few of the right live seminars presented by big-name professional traders. You’ve researched your brokers, did your trials of various electronic trading platforms, and have your trading account ready to go. It’s day one of your new career—hopefully the one that will finally send you down the road to financial freedom.

Congratulations, you are now a FOREX Trader.

But the odds are against you. You know that. You’ve read the statistics and heard the critics; but you are confident you won’t be the one to fail. You have the best trading system and you have planned for every contingency you can think of. Your charts, analysis and research are up-tothe- minute and instantly ready for every market you are going to trade. It’s go time. You take a deep breath and click the mouse…your first trade is LIVE; you’re in the game.

Fast forward six months. Your account balance is lower than when you started. Sure—you had some great trades and looking back, your analysis of most of the markets you traded was correct; but where is the profit you could have had? How did this happen? How do you get back on track?

I’ll tell you how it happened—because it happened to me; more than once. It happened because the real world of trading and the textbook world of trading are two completely different things. You need to be ready for that reality or you run a very big risk of being the one who makes part
of the statistics.

If you want to read the whole story of how I got to be a professional FOREX and Futures trader pick up a copy of The Art of the Trade (Wiley & Sons publishing August 2008). I think you will be surprised to learn what is really required to be successful. In fact, I bet you are downright shocked to discover what is required.

If you would rather not read another book and simply want to get down to making your fortune, then I would encourage you to at least take the next few pages very seriously. Find a way to keep the thoughts you find here at your fingertips and consider them equally or more important than all your pre-trade preparation and analysis. If you seriously want to avoid the worst that could happen; then take some advice from someone who knows.

Before we get to The Top Ten Mistakes FOREX Traders Make, I want to give you some
perspective. I started my career at a time when the markets were only just beginning to see the
growth and public interest that they have today. The technology you and I take for granted today hadn’t even been invented yet. It took me years to learn what I needed to learn to be successful, without any of the help you have available FOR FREE anytime you want. You need to accept one very critical thing: the most important part of lasting trading success has nothing to do with the markets. It’s all in your head. All this FREE stuff is not going to offer you an easy road.

If you are willing to consider that the human element—the way you think and how you behave —is the REAL variable to lasting trading success; then I think you will get where you want to go a lot faster and with a lot less headache. If you are ready to get serious about your personal trader psychology then please come to my twice daily FOREX training sessions. If you really want to avoid the disasters you have read about then take my advice; don’t make these mistakes.

So let’s get’s started…

MISTAKE # 10
PAPER TRADING TOO LONG
Paper trading is hypothetical trading. If you have never traded anything before, you will probably do some paper trading. The benefit of paper trading is that it will help the new trader become acquainted with the basics of interfacing with the markets. This is often a “demo” account with a broker or clearing firm that provides real-time market data but provides a hypothetical balance.

You are allowed to buy and sell as much as you want, just like in a “live” or “real” account. Your hypothetical gains and losses are accrued against your hypothetical account balance over time. As time goes on, most traders find that they can gain quite a surprising amount of paper-profits in a very short period of time. These traders are now completely convinced that they can easily duplicate those hypothetical results in real time with real money. They open their real trading account and POW! Within about three to four weeks they are down usually more than 50% of their equity. This is not my opinion—this is actual fact. Ask any broker in the industry what happens to “paper-traders” who open a real account. The ratio of “paper-traders” to “winning traders” is about one in ninety.

Why does this happen?
Because there was never any real risk to the trader.

Let me illustrate by telling you a story:
I am a private pilot. I soloed on my 17th birthday. In 1979 I was an Air Force academy appointee. I have flown a T-38 Jet fighter in extreme conditions. Just knowing that, I think most people would agree that I probably have a certain amount of experience flying airplanes. Here in the suburbs outside of Chicago there is a small airport that has a “Fighter Pilot for a Day” program. This is where you fly co-pilot with a retired military pilot in high-performance aircraft. You are allowed to fly the aircraft (with the real pilot’s hands on the controls) in an attempt to “shoot down” an “enemy” fighter; which is another co-pilot flying another airplane with HIS retired military pilot. You are awarded a “kill” if your laser guns hit your opponent. It’s like a very expensive high-stakes game of laser-tag.

I went for a day to have some fun. As it turned out, I was flying against a complete novice. Of course, I didn’t tell him I had some Air Force training. I asked my adversary what kind of training he had. He very confidently told me that he was the top scoring “ace” from his on-line club and various other national methods of playing of high-tech video games. He told me that he could “out-fly” almost anyone in the Microsoft Flight Simulator in both the F-16 Falcon and F-15 Eagle.

I agreed that his credentials were very impressive and proceeded to blow him out of the sky no less than six times in 20 minutes. To start with, this novice had never flown in aerobatic conditions so he spent most of his time trying not to throw-up. He stalled and spun most of the other time. If he wasn’t flying with someone he’d be dead. In the end he had to quit early because he simply couldn’t take the physical punishment. To add insult to injury, I have never played Microsoft Flight Simulator (ever). I do the real thing. BIG DIFFERENCE between the two as you can see.

Do you see the point I’m getting at? PRETENDING to do something is never the same as actually doing it. Yes, it is helpful up to a certain point to simulate certain things but that can only take you so far. In the case of air-to-air combat, PRETENDING to be a fighter pilot will likely get you killed if you ACTUALLY go up against a trained fighter pilot. In fact, the US Army Air Corps learned this the hard way back in WWI. They sent young men into combat with oftentimes less than 10 hours of actual flying time. Imagine how fast those men were killed when they went man-to-man with Richthofen, Boelke and Immelmann. Everyone concluded flying was “dangerous” when in fact it was the lack of training that was “dangerous” I’m not trying to impress you with my flying skills. I’m trying to impress on you that paper-trading is exactly like playing Microsoft Flight Simulator. It is pretending to be something you are not while convincing you that you know what you are doing. Paper trading hides from you the need for real skills.

Paper-trading will get you killed because when you go up against real traders with real money it’s not a game anymore. If you make the wrong move you lose equity. There is no “do over” button. If you stall your F-16 in the simulator, you get another chance; stall your F-16 in combat and you die. Lose money in your paper-trading account; just sign up for another trial account. Lose money in your real account and you go home broke.

Paper-trading is a waste of time because paper-trading will never give you the real skills you need to trade. All paper-trading can do is help you learn how to use the functions of your trading platform. In fact, that is a good thing. But once you learn the functions of your platform and your account is ready to trade, everything you learned paper-trading goes out the window because NOW IT IS DO OR DIE. There are no second chances.

Don’t make mistake #1; don’t think you know what you are doing because you pretended to trade without taking any real risk.

HOW TO MAKE THIS MISTAKE WORSE: Continue paper-trading for more than 30 days and/or go back to paper-trading if you have lost money in your first real account. SOLUTION: Open the absolute smallest account your broker will allow and trade for 90 days the absolute smallest size possible. If you are ahead, increase your equity size and your trade size by a factor of 20%. If you are losing, stay with the real thing; it’s the only way to learn.

MISTAKE # 9
NOT HAVING A TRADING PLAN

Suppose you called your 401K manager this afternoon. Suppose you asked him “What is your plan for the next six months?” Suppose he told you “Oh—whatever. I just try to get on the right side and if I don’t I just get out”

How long would that guy be managing your retirement money if you had any say in the matter? Many traders take the same attitude with their daily work habit and many don’t even know they do it. Not having a clear and concise plan for your daily trading presence is a serious mistake and you need to address it. The best way to describe a sound plan is to let you read one from a professional full-time trader. This is an actual trade plan form a friend of mine who is an E-mini trader:

My goal is to earn 100% on my trading equity before the end of the year. To maintain my focus I will set a near term goal every quarter to be at a 25% gain and I will plot my equity daily. If I reach my quarterly goal ahead of the last trading day of the quarter I will take a two-day break. I will hold any open positions that are at a profit but any open trade losses I will close at that point before I take a break.

If my open trade gains continue into the new quarter I will add to those winning positions by a factor of 25%. I will move my protective stops up to reduce my exposure on the entire position.
If I am behind on my trade goal for the quarter, I will take a five-day break. I will re-evaluate my trade system and ask the question: “Has my market quality changed to something my system is not able to perform at best?”
During the year I will not trade more than three markets. I have learned I cannot focus well on more than three markets at a time.
If I have more than four losing trades in a row in any of my three markets I will take a trading break for five days. Again, I will leave open position winners alone in the other markets but close all losing positions. I will again roll protective stops to reduce my risk.
When I take a trading break, I will enter resting limit orders in the open trade winners to take the objective profit should I be unavailable and the market gets to those levels during my break.
If I am ahead of my plan for the year at any point I will take a break. I will take 30% of the new equity out of my account and place that into a secure place. If I am behind I will not add equity under any circumstances. If I reach a 40% drawdown from my high equity I will quit for the year.
I will record my daily trade activity in my trading log and review this weekly. I will know my ratios and results; I will look to improve them by 5% each week.
I will trade only from the bull side because my analysis tells me that all three of the markets I have selected have more than a year of solid bullish fundamentals. I will learn how to use options this year because I see from last year I could have protected more trades if I had a solid grasp of when to use options and when not to. I will invest two-hours a week on option knowledge.
My son is leaving for Europe in May. I will not trade the week before he leaves or the week after. I plan to join him in the fall for Oktoberfest for one week and will not trade the three days before I leave or when I get back. I know I suffer from jet-lag so the week after I am back I am not at my best. I have blocked out these times on my trade calendar so I will not be tempted to trade anyway.
If you read between the lines you will notice that his trade plan included all the things that were in his control—NOT things outside of his control; like the markets.

HOW TO MAKE THIS MISTAKE WORSE: Base your trading plan on hypothetical profits or on how well you did paper-trading, Ignore your personal emotional needs when compiling a plan, Ignore your family while making a plan, keep thinking you can trade everyday or all the time, average your potential over a period of time and think results will equal a daily amount.

SOLUTION: Ask a professional trader to show you his daily/weekly/monthly or annual trading
plan. Ask yourself if you can make a plan that addresses similar things. If the professional you have selected can’t show you or won’t show you his plan then ignore what he has to say. If he isn’t using a plan then he is likely unable to assist you in building wealth. There are resources for writing trade plans on my site; please use them.

MISTAKE # 8
TRADING TOO LARGE FOR YOUR ACCOUNT

The fastest way to go broke is to bet it all—all the time. Most traders don’t learn this lesson until they have had at least one blow-out; by that I mean they have lost all their equity quickly and have had to start over.

For some reason, there is a tendency for traders of all age and experience levels to trade too large for the actual cash in their account. This is a symptom of a larger problem and unless you are willing to consider that you personally might have this problem already you most likely will be trading too large for your account right now today.

What is this larger problem?
GREED, BABY—GREED

It is unrealistic for you to believe you are going to make a killing on THIS ONE TRADE RIGHT NOW. Sure, you might be on the right side of a large move but that will take time and evidence to see. For this moment, any trade you have on has the potential to run the other way against you and if you are trading too large, your potential to lose a lot on only a few trades is huge. No matter your age, education, skill or experience level you are not going to make 100% winning trades. Therefore a certain percentage of your trades will simply not work. Those trades cannot be so large that you lose a significant portion of your equity in the process.

To beat the greed habit you need to make a few changes to both your equity management and more importantly to your thinking. First, trading is a business. You need to treat it like one. There are certain things every business needs to run effectively and the first thing is liquidity. Simply put, if you run out of cash to play you can’t remain open.

Second, if you had a reasonable plan in place already then it is a good guess that your plan calls for only a reasonable amount of percent gain on your equity regularly. If you were to use some basic mathematics while creating a sound trading approach one of the things you would be looking for was a realistic “risk-to-reward” ratio. That means for every dollar you lose you expect to make a certain number of dollars and out of every 100 trades a certain percent will be winners and some will be losers.

If you put this all together and asked the “what-if?” questions you get this base-line number that statistically will be a winning set of results: 42% winning trades out of 100 taken Two dollars out for every dollar you give back
This is not my opinion, this is the Probability of Ruin Matrix and you can research it yourself if you have time. Of course, if you have higher percentages of winners and take more out on those winners you make money a lot faster but the point is if your results are at least this good consistently you are on your way to success.
It’s great to be on the high side of the matrix but most of us didn’t start there and that is why you have to TRADE SMALL at first. To protect yourself from being greedy about your trading and to help you stay focused on long-term success it is important to make your trade size small enough so that it won’t leave you in a position of not being able to play at all should you have a string of losses all at once. I found that limiting your risk/reward ratio to a factor of about 1.5% on any one trade is a great way to stay focused and not get greedy.
This means that for any one trade you take, no matter how you think of the trade or how certain you are of a win; you will not risk more than 1.5% of your account balance at any one time. This means that if you are trading so that your average loss is 3-5% of your account balance at any one time—you are trading TWO to THREE TIMES TOO LARGE for your account size. In that case, the Probability of Ruin Matrix will work against you and you will likely run out of capital before you make money with your approach.
If you are the greedy trader right now and you are guilty of making this mistake; If this means you have to drop your trading size down a few notches then you had better call your broker today and fix it—because if you don’t you are an accident waiting to happen. It only takes making this mistake THREE TIMES IN A ROW to drop your account balance 15% or more in a heartbeat; especially if you are day trading!

HOW TO MAKE THIS MISTAKE WORSE: Convince yourself you are so good at trading that this couldn’t possibly happen to you, convince yourself that your analysis is good enough to help you find 80-90% winning trades all the time, trade without a stop-loss order “just this once”, double-up on the next trade after taking a large loss.

SOLUTION: Immediately reduce your account balance; take 20-30% of your cash home. Trade position sizes that are no more than 300% as valuable as your account balance. In other words, if your account size is $10,000, don’t trade anything that has a total contract value larger than around $30,000. If that means trading mini’s instead of big-board you had better do it.

We hope you’ve enjoyed the first few mistakes that traders make, and that it opens up your
eyes to the Forex markets a little more!