2Bull Forex Blog

Are you new to trading? Perhaps you wonder what the difference is between trading Stocks and trading Futures. Often when I meet someone new who inquires as to what I do, I get a response of “that’s like trading stocks, isn’t it?”

In some ways they are similar, but only minutely so. So let’s consider some of the major differences between the two.

Most individuals have likely traded stocks at one time or another. Usually, it is to buy in order to ‘own’ a percentage of a particular company or to liquidate such partial ownership. They pick up a phone to call a broker or go online to purchase or sell. The order is facilitated through an ‘exchange’, such as the New York Stock Exchange for example.

Buying and selling Futures is similar in this respect. You can call a broker or go online to buy or sell Futures contracts. The order is then facilitated througha commodity exchange, such as the Chicago Merchatile Exchange for example. Yet while buying a stock gives you part ownership in a company or portfolio of companies (as in a fund), buying a Futures contract does not give you ownership of a commodity or product. Rather, you are simply entering into a contract to purchase the underlying commodity at a certain price at a future time, noted by the contract. For example, buying one May Wheat at 3.00 simply creates a contract between you and the seller (whom you need not know as this is taken care of via the exchange) that come May you will take delivery of 5000 bushels of Wheat at $3 per bushel, regardless of what the price of Wheat at market happens to be come May. As a speculator simply trading to make a profit from trading itself and with no interest in actually taking delivery of product, you will simply sell your contract prior to delivery at the going market price and the difference between your buy price and sell price is either your profit or loss.

When you buy a stock, you are part owner of a company. When you buy a Futures contract, you simply are entering a contract. With stocks, you will pay for the stock at the time of your purchase plus broker commissions. When buying a futures contract, you are simply entering the buy side of a contract and no monies is paid other than commissions to your broker.

Stock exchanges and commodity exchanges are both membership organizations established to act as middlemen between the buys and sells of all types of traders, from business entities to the individual small trader. The stock exchange act to bring capital from investors to the businesses that need that capital. They facilitate the transfer of property rights (ownership in the various companies offering stock).The commodity exchange act to bring people willing to assume risk for the opportunity to make a substantial amount of money for taking such risk. This helps transfer the price risk associated with ownership of various commodities, such as Soybeans, or a service, like interest rates, from producers.

To buy stocks, you only need enough money in your account to purchase the stock outright plus commissions. Once you make the purchase, the money is removed immediately to make the purchase. With trading futures, since you are not actually purchasing anything but simply entering a contract to do so at a later time (which you will exit prior to avoid delivery), the broker will require a certain amount of margin (good faith deposit to cover any possible losses) in what is called a ‘margin account’. Each commodity has a different minimum margin requirement depending on several factors. Your broker may use the exchange calculated margin or require a different margin of their own. If the value of the commodity were to decrease and you are on the buy side of the contract, then your contract has lost value and your broker will notify you if your unrealized losses exceeds have gone beyond your minimum margin requirement. This is called a ‘margin call’. Naturally you would want to have more capital than simply the margin amount when trading futures to avoid these broker calls. The broker has the right (and likely will) liquidate your position if you are getting too close to not having enough to cover the losses in order to protect themselves.

With buying stocks outright, there is no potential for a margin call. You simply own the stock outright. So perhaps you may be wondering why anyone would bother buying futures contracts rather than stocks. The major answer is: LEVERAGE.

Leverage gives the trader the ability to control a large amount of money (or commodity worth a lot of money) with very little money. For example, if Live Cattle futures requires a minimum margin of $800 to trade a single contract, and a single contract represents 40,000 lbs at the current market price of say 75, you would be controlling $30,000 worth for a leverage of over 35:1. This is appealing to many traders and justifies the risk. What is that risk? Just as leverage can work in your favor, it can work against you at the very same ratio. Known as a ‘two-edged sword’.

You can increase the leverage of trading stocks if you trade with a margin account. This usually allows you to purchase stocks on margin at the usual rate of 50%. So for every dollar you have you can purchase $2 worth of stock. The leverage is 2:1. How this works is that the broker is actually ‘lending’ you the other 50%. Of course by purchasing stock with margin you can lose more than you have due to the leverage. And in this case you can end up getting a ‘margin call’ from your broker if your stock losses too much value. But trading stocks comes no where close to the kind of leverage you get trading Futures.

When you look at these two trading vehicles, the bottom line comes to MARGIN and LEVERAGE.

The foreign-exchange (”forex” or “FX”) market is the place where currencies are traded. The forex market is the largest, most liquid market in the world with an average traded value that exceeds $1.8 trillion per day.

The forex market is open 24 hours a day, five days a week, with currencies being traded worldwide among the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - spanning most time zones. There is no central marketplace for currency exchange. Trade is conducted over-the-counter.

The forex has been the domain of government central banks, as well as commercial and investment banks. It has also been used for hedge funds by large international corporations. The rules were revised during the 1980s to allow smaller investors to participate using margin accounts. It is because of these margin accounts that forex trading has become so popular. When you consider that a 100:1 margin account allows you to control $100,000 of currency for just $1000, this has created an excellent opportunity for making a great deal of money. Of course, such leverage is also a recipe for losing a great deal if you are not properly prepared. Naturally this course is designed to help you become prepared.

FOREX traders usually require a broker to handle transactions. Most brokers are reputable and are associated with large financial institutions such as banks.

Like anything else, you should shop around for the best bang for the buck when looking for a broker. Here are some things you should look for when considering a broker:

A Respectable Quality Institution - Forex brokers are usually associated with lending institutions or large banks. The reason for this is that such institutions have the large amount of capital needed in order to provide the leverage needed. Look for brokers that are registered with the Futures Commission Merchant (FCM) and regulated by the Commodity Futures Trading Commission (CFTC). This information should be provided on the broker’s webpage or its parent company page.

Lowest Spreads - Forex brokers do not charge a commission such as Futures brokers do. They make their money from the spread, which is calculated in “pips”. The difference between what you can buy the currency for and what you can sell it for is the spread. PIP stands for Price Interest Point. It is the increment in which the currency pair will trade. For example, if you buy the EUR/USD for 1.2015 and it goes up to 1.2016, it has gone up 1 pip. When looking for a forex broker, find one that offers you the lowest spread for the currency pairs you plan on trading.

Types of Accounts - No two traders are alike. Some have a vast amount of money while others have smaller accounts in which to trade. Look for a forex broker that provides you with some account choices. For example, traders with small accounts or just learning how to trade in the forex should look for what many brokers call the “Mini Account”. This type of account requires a small minimum to open, say, $250. This account allows for a high amount of leverage that you will need in order to trade with so little amount of money. In such an account, you can trade with a $1 pip, as opposed to $10 or higher pip value. Standard accounts have higher minimum balance requirements and allow for trading at different leverages. Read carefully the different types of accounts being offered.

Available Leverages - Leverage is important in forex because the price deviations (how you make your money) are merely fractions of a cent. Leverage is the ratio between the capital that is available and actual capital. The leverage depends on what the broker is willing to lend you. For instance, 100:1 ratio means that for every 1 dollar of your money (actual capital) the broker will lend you $100 (available capital). Some brokers offer 250:1 and even 300:1 ratios. The higher the ratio, the more leverage (bang for the buck) you will have. Keep in mind that a high ratio not only gives you more bang for your dollar but it also increases your risk of a margin call. Lower ratio will lower your risk of a margin call, but it will also lower the power of your dollar.

Extra Goodies (Tools, Research) - To get your business brokers provide various free tools and information resources to their customers. You will want to find a broker that will provide you with free real-time price charts as well as an excellent online trading platform. One very popular platform and the one I currently use is FX Trading Station. But shop around and see what is being offered.

The best thing you can do is to ask around on various trading forums where forex traders haunt. This is because there does not exist any blacklist for those brokers that may commit acts of sniping or hunting, which is prematurely buying or selling near preset price points in order to increase profits. Also, make sure that they are happy with the broker’s margin rules. Some may be too strict and get you out when the market moves against you although you still have enough capital to hold the position. The position may turn out in your favor had you not been exited by the broker. This can be costly. So ask around!

What is a Price Wave? In simplest terms, a Price Wave is a simple symmetrical oscillation or fluctuation that moves from peak to trough and back again indefinitely. Just one interval of this wave (from top to bottom back to top again) is called a ‘cycle’.

All freely traded markets are made up of these Price Waves. That is the common element of all markets. It is theorized that all price movements of all stocks and commodities consist of the same type and number of these price waves providing a degree of predictability of when the market is going to reverse. Once you have come to understand these price waves you will gain a better understanding of how they produce the resultant peaks and troughs (tops and bottoms).

Because these price waves repeat indefinitely, cycle after cycle, once you have identified the wave pattern itself you can determine its value at any point in the past or future. This characteristic of price waves is what gives it a degree of predictability.

Take any price chart, such as Cotton, Soybeans or the SP500, and it is possible to look at it and note a wave-like motion. You can apply a moving average, a Stochastic or some other oscillation indicator and these wave-like moves become even more evident. But more is needed than just noting these waves in order to arrive at an estimate of what the market will do next.

There are questions that every trader asks when looking at a price chart. Should I buy or sell? Should I wait? How high up will the market go? How much should I risk? If I exited now would I be leaving too much on the table?

The purpose of the above discussion on price waves is to set the stage toward your understanding of what makes up what you see on a price chart and that by knowing the price waves involved that you can obtain answers to the questions asked in the previous paragraph.

But understanding of price waves cannot be achieved by simply reading a single article like this alone. More research and extensive study is required, and how far you go in your ability to forecast market price action will be directly tied to the amount of time and effort you are willing to put forth.

I present you with this article in order to help you get started. If you are impressed with the fact that cyclic concepts can provide you with a lot of information as to the probable direction of market prices, then perhaps you’ll be strongly motivated to go to the next level.

Suppose you are looking at a chart of the SP500 and by way of cyclic analysis you note that price has been in a downward swing. Noting that the ebb and flow of all the price waves that make up this market pattern show strong evidence that it is ready to start on its up swing. Without even knowing precise details there are things you can determine from this information.

1. Now would not be the best time to short.
2. Prices are likely to stop dropping any time now.

From this you can decide to tighten your trailing-stops, not initiate any more sells, and prehaps prepare for possible trend change. This is just the basics. With a proper cyclic analysis, you can determine the best place to enter your trades, where to put your risk stops, and where to anticipate your profit objective price points. From this you can determine your risk-to-reward ratios and determine whether conditions are favorable for a trade.

If this appeals to you, then all you need now is to know what direction to go to learn. For this I would suggest that you do a search on the Internet on Cycle Analysis and use the names Edward Dewey and J.M. Hurst. I would provide you with the exact publications if it were not for the fluid nature of the Internet and pages changing all the time. By doing a search on the above terms and names, you’ll find what you need to get started in making a cycle analysis.

Yesterday I sent out to my free newsletter subscribers a lesson I had written a couple years ago dealing with what I call the PAUSE formation. The reason for this was that a market that I had been sharing future cycle turn dates on had formed the early warning sign for a PAUSE formation and may present an opportunity for a trade. At the very least, it should help those looking to learn more about cycle turns, swings, pivots and other associated phenomena to cycles. The more you understand a tool or indicator the better you can exploit it.

The PAUSE formation is very simple to identify. But what I want to discuss first is what to look for in order to determine a POTENTIAL PAUSE formation. Unless you have some advanced warning, who cares what the formation is after-the-fact?

Let’s start from the basics. In dealing with market cycles, it has to be understood that market patterns are the result of the cumulative effect of several cycles. But to make it really simple, let’s just call each time frame a single cycle that has its own frequency and magnitude. Yes, this is extremely simplified, but should help those new to cycles altogether.

If you look on a MONTHLY price chart, that being a price chart where each price bar represents a complete month of trading, you are looking at a LONG-TERM view of the market in question. We’ll call the market GOLD.

If we look at the MONTHLY chart of GOLD, you can see that prices have just been moving higher each month. So you could say the LONG-TERM cycle is moving up right now. Simple to view, right?

If we look at the WEEKLY chart of GOLD, where each price bar represents a complete week of trading, we can see that each week is making new highs. So let’s say the INTERMEDIATE-TERM cycle is moving up also.

On the DAILY chart, where each price bar represents a single day of trading, we can see that price has been pulling back (down) from the recent top high on 1/20/06. A very small pullback, mind you, but the direction is still down. So we could say that the SHORT-TERM cycle is going through a down swing.

Can you visualize this? It really helps if you can.

Now consider that the LONG-TERM cycle has more power than the INTERMEDIATE-TERM cycle. And the INTERMEDIATE-TERM cycle has more power than the SHORT-TERM cycle. And all of these are working and doing their thing at the SAME TIME.

If the LONG-TERM cycle happens to be moving up, and the INTERMEDIATE-TERM cycle is moving up, what chance do you think the SHORT-TERM cycle is going to have when it wants to start down again? Quick answer: Just take a look at your daily chart of Gold and look at the 12/29/05, 1/5/06, 1/18/06 price bars. Each of these made a new daily low and then were quickly overruled by the stronger upward moving cycles. Now we see 1/24/06 making a lower low than 1/23/06. What are the odds it can continue in this direction for several days? It has longer-term cycles working against it.

Now cycles are more complex than this. But hopefully you can get an idea as to what I’m trying to get across. Cycles can support or oppose each other. If you can visualize the monthly chart making new highs, but currently the weekly chart is making a new lower weekly price bar low, what you have is an intermediate-term cycle in its downward swing (cycles swing up and then down and start over again) while the longer-term cycle is still in its up swing. You have opposing powers that will tend to cancel each other out at various points in time. And riding on these is the short-term cycle that as far as the longer-term cycles are concern is just noise. Yet, when the larger cycles are canceling each other out, the ‘noise’ or short-term cycle will become more visible and you will see nice swings as the market is moving more sideways on the lower time-frame charts.

It is during strong trends either up or down that have a washout effect on short-term cycle turns. As you can see with the daily chart of Gold, the swings are there but start and conclude quickly in order to continue in the strong upward trending direction.

Now that you have a better understanding of cycles, we can now cover the PAUSE formation in a clearer light.

While long-term and intermediate-term cycles help those of us who analyze charts for such cycles to determine the longer-term direction of prices, it is the short-term daily chart and lower-time frames that are used to ‘fine-tune’ our trade entry. The idea is to keep risk low and catch a new move as early as possible.

With GOLD, for example, we can see the long-term and intermediate-term direction has been up. So the power behind higher prices on the lower time-frame daily prices is strong. This suggests that as we determine where the daily turns are likely to occur using daily cycle turn dates (based on short-term cycles), we are going to want to catch the swing bottoms they produce rather than try to short the swing tops that precede them. As the saying goes, TRADE WITH THE TREND! No wonder this has passed the test of time.

The PAUSE formation is when you have a short-term cycle that is due to oppose the strong longer-term cycles and makes an attempt, only to fail to complete the swing (confirm). A good example is the 1/9/06 price bar in Gold. Note how this price bar made a higher high and then is followed by a price bar that does not move above it. Although the next price bar did not make a higher high, it also did not make a lower low. This is called an INSIDE bar.

The short-term cycle was actually topping and trying to correct (down) at this time. Yet the longer-term cycles were just too strong to allow the lower time-frame cycle to complete its swing with a full confirmation. Confirmation requires that a following price bar make a lower low in comparison to the prior price bar (for swing tops. Bottoms are the opposite). So in the case of the 1/9 new high, had any price bar formed later with a lower low than the price bar prior to it, then the 1/9 high would have confirmed as a swing top (assuming this lower low occurs prior to price eventually exceeding the 1/9 high).

The 1/9 price high turned out to be a PAUSE formation top. As stated earlier, it is an attempt to form a swing that is cut short of confirmation.

At the beginning of this article I stated that such a situation can be anticipated in advance. Can you see how based on what you have learned so far? You start off first expecting the swing based on a cycle turn date (when a cycle is due to turn). In the case of rising prices, you see a new high occur when the cycle is due to turn. The next trading day does not make a higher high, yet it does not make a lower low either (inside bar). This is called a POTENTIAL PAUSE formation. In a strong up trend market, this potential becomes very strong and likely. Since you have resolved not to oppose the longer-term cycles that are moving up, you do not attempt to sell suspected swing tops on the daily chart. And with the potential for a PAUSE top situation, you are even more resolved not to sell. However, the PAUSE now gives you an opportunity to go with the trend on the buy side. How? When price decides not to confirm the swing top but rather ‘breakout’ above the high (of the pause high bar) that preceded the inside bar, you can use that as an entry signal.

It has been my experience that these breakouts, when a counter-swing was originally expected due to a cycle date calculated, provides excellent trading opportunities. Many times these breakout moves are strong ones. When you consider the fact that the market was strong enough to resist the short-term cycle from completing a confirmed counter-trend swing, these are clues to hop on board the train.

There is an old saying about ‘not seeing the trees from the forest’. When it comes to deciding whether to buy or sell a Futures, Commodity or Forex contract, this can actually be a good thing in the beginning. At the level where the trees are, the lower time-frame such as the daily price chart, you witness the market (Futures, Commodity or Forex) trending up, down and sideways. In fact, it often can appear quite ‘noisy’ to the untrained eye. Deciding whether to buy or sell based solely on what you see on this lower time-frame can be quite a challenge. However, approaching this problem from a ‘higher’ view can be a great help in smoothing out the overall view of the market in question. This would be looking at the ‘forest’ first before focusing on the ‘trees’.

Often you can get away with just going one time-frame above that which you trade from. For example, if you often allow your trades to continue overnite for one or more days, then it is likely that you use the ‘daily’ price chart to make your final entry decisions. Therefore, one time-frame higher would be the ‘weekly’ price chart, where each price bar represents a whole trading week (5 days). If you are a day trader, one who does not normally leave a position on overnite, and you use the 5 minute chart for your final timing decisions, the 10-min, 30-min, 1 hour and daily charts are higher time-frames in respects to your preferred time-frame for timing trades. For the rest of this article, we’ll assume you normally use the daily chart to make your Futures, Commodity or Forex trade decisions. Thus, the next time-frame higher (our forest) would be the weekly chart.

Start by taking out your weekly price chart of the market you wish to analyze. What you want to look for is whether the overall weekly trend is up or down. Basically, a bull trend is one that forms higher swing bottoms and higher swing tops, and a bear trend forms lower swing bottoms and lower swing tops. There are exceptions to this general rule. However, an indepth discussion on trends is beyond the scope of this article. I invite you to visit my repository of articles and lessons at the ProfitMax Trading, Inc. website for more information on this subject and others.

If your examination of the weekly chart reveals that it is bullish, then you’ll want to focus on looking for buying opportunities off your daily Futures, Commodity or Forex price charts. When looking to buy off the daily chart, entering as close to retracement bottoms will provide you with the lowest risk and highest profit potential trades. If you determined the weekly trend to be bearish, then you’ll be looking for shorting (selling) opportunities, selling off of rally tops. If the weekly trend is narrow sideways, find another market to trade unless you like to trade channel swings (hopefully you are aware of channel breakouts - be prepared). Wide sideway trends on the weekly charts would suggest you simply trade in the direction of the current weekly direction. If the weekly trend is currently moving up, buying off the daily chart on those retracement (dips) pivot bottoms will provide you with the better trades.

Whenever I plan a trade, I look at the larger picture. I want to get a good idea which way the market wants to go. If you look at any higher time-frame chart, such as the weekly or monthly price chart, you will see that when the market is bullish for example that the daily chart will be bullish for a very, very long time. Momentum is a very powerful attribute in the Futures, Commodity and Forex markets, and the trend of the higher time-frames will often tell you what that momentum is on the daily chart (the lower time-frame that you are basing your final buy/sell trading decision from.)

Be aware that even weekly and monthly trends can change at anytime. Yes, you can go to the next level up, monthly charts, and note which way it is moving to get an idea of likely, weekly direction. But be careful not to lose your perspective. Although trends take a long time to change, someday it will. At that point you will need to be prepared.

Using this ‘downward approach’ to Futures, Commodity and Forex trading, you are getting the ‘big picture’ first. You are looking at the ‘forest’ before getting down and looking closer at the ‘trees’. Once you have done this and have a good idea what the longer-term picture looks like for prices, you can then focus on your timing technique to ‘fine-tune’ your trade timing decisions. As many successful traders know, TIMING IS EVERYTHING! As a market analyst and trader, my preference for timing is based on market cycles and their cumulative affects, that which causes market tops and bottoms.

Always remember that it is the ‘law of probability’ that you want on your side of every trade. You want the odds in your favor. You do not want to risk too much or be overly exposed. You want to buy low and sell high. All this depends on you seeing the ‘big picture’ as we have just discussed, and a method of precision timing to get the best price possible for the lowest risk exposure.