2Bull Forex Blog

Most traders who engage in currency trading have no idea how prices really move. They then base their forex trading strategy on incorrect logic and lose their money. To win in currency trading you must understand the following equation.

This is the formula for currency market movement:

Fundamentals (supply and demand) + Human Perception of Facts = Market Price

Sounds simple?

It is, but if you think about it you will come to some compelling conclusions and they are:

- Currency markets are impossible to predict
- Following news stories won’t help you
- Technical analysis is not scientific

Let’s examine these points in more detail.

Currency Markets are Impossible to Predict

This is obvious and the reason is, the price is made up of millions of individuals, all governed by emotions who don’t think logically. You therefore can never predict in advance what they are going to do.

Following News Stories won’t help you

We have better news sources than ever today but they won’t help you win.

There stories and viewpoints and just reflect what the crowd thinks or has thought and the crowd always losses.

Furthermore, these stories are instantly discounted and you have the additional problem that - we all see the facts however were not logical beings so we all see them differently!

Technical Analysis is Not Scientific

This really leads on from predicting markets.

You can’t as you never know what the vast mass of traders who contribute to the price is going to do. There is the view that human nature repeats and it does - but not to a scientific theory.

If markets were scientific we would all know the price in advance and there would be no market!

Those who trade thinking the above lose.

Well that sounds daunting - How do I make money trading forex?

THE GOOD NEWS IS:

You can calculate the odds in trading and while you won’t win every trade just like the successful blackjack player if you know how to calculate the odds you will win more than you lose and can enjoy currency trading success over the long term.

So how do you calculate the odds?

The best way is to use forex charts and simply follow and act on the reality of price change.

With forex technical analysis, you simply assume all the fundamental news is reflected instantly in the price. It’s a question of where humans as a mass move prices thats important and they all see the news differently.

Prices may not move scientifically but human nature is constant and they will always push prices too far to quickly up or down based on the emotions of greed and fear. These short term price spikes are easy to see on forex charts and you can trade them for profit.

You are not going to predict in advance, you are going to react to the reality of price change and go with it. If you look at any forex chart you will trends and you want to make money from them - you’re not interested in why or how they develop - You just want to make money from them when they do.

Trade the Odds For Big Consistent Profits!

If you understand the equation we gave you at the start of this essay, you will understand that trading is a game of odds - NOT certainties but that doesn’t mean you can make a lot of money.

If you trade currency markets and use a simple technical forex trading system which simply reacts to price change, you can make a lot of money and enjoy currency trading success.

Forex trading systems are popular just switch them on and turn your computer into a regular money making machine. That’s the theory, the reality is 95% or more lose due to curve fitting and if you don’t know what it is then you should.

Curve fitting is when a forex trading system is bent (curve fitted) to price data to make a profit.

A trader I once knew likened this to shooting at a barn door with a gun and then afterwards going and drawing a circle around each shot, to make it look like a bulls-eye.

Vendors when testing their forex trading systems on past data, find that it doesn’t work or doesn’t work well enough, so they bend or curve fit the system, until it does.

A curve fitted trading system will never work in real time trading.

Why?

Because the data sequence will never re produce exactly again.

Clues to curve fitted systems are:

- Lots of rules and parameters.
- Different rules for different currencies or trading conditions.
- Extraordinary profit and low or little drawdown.

Generally, a good trading system should consist of a few rules and parameters and work the same in all market conditions and in all currencies.

While many traders make genuine attempts and curve fit by accident, most don’t - they simply make up the track records and curve fit to make a track record look good. How many systems do you see sold for a few hundred bucks that promise you 1,000% per annum $10,000 bucks a month etc - The answer is loads.

These vendors are NOT traders, their marketing companies and they know they can put out any track record they like so long as the disclaimer has the words “done in hindsight” “simulated” Of course we can all make a profit going backwards - but the problem is we have to trade not knowing the future and that’s a little more difficult.

The internet means you see them all the time and while most traders pass them by on the basis that, “if it looks to good to be true it probably is”, many others let greed, naivety or both get the better of them and buy them.

If you want to buy a forex trading system, your best option is to get one that’s got a real time track record, to show it’s based on sound logic.

After all, if the vendor does not have the confidence to trade it why should you?

If you buy a simulated one, then it should be one with very few rules which work on all currencies, in all markets and you should understand how and why it will works.

So when you see that track record promising you untold riches - think curve fitting and think losses rather than profits.

Shop Around For The Good Ones

You can make money with a forex trading system but you need to be careful in your selection.

If you are then your time will have been well spent and you could enjoy long term currency trading success with it.

Using the internet to trade stocks provides you with the freedom to trade which in the past was not accessible to amateur traders not that long ago. The idea has gotten extremely accepted and numerous variables have been critical in promoting the popularity of online trading. Let us look at some of the advantages of doing online stock trading.

Probably the most intense variation has been lower brokerage commissions. People really like the fact that that online stock investing provides a broker commission rate that is considerably lower than the traditional method of equity investing. Moreover, there are several online brokers who offer a fixed amount for each transaction irrespective of how many stocks are traded. So you can bring down your cost if you buy and sell stocks in larger volumes.

Another gain is that you get to play in real time stock trading. Online trading gives you the opportunity to invest in stocks in real time. You can trade stocks with simply a few mouse clicks. Your stock orders will be executed in real time and you will be able to immediately verify the changes in your account. So online stock trading is undoubtedly transparent and you are the master of your own.

Another advantage is that there are no middlemen. When you trade stocks online, there is no middleman taking part in the process so you can do everything by yourself. buying or holding your stocks are completely your decision. You initiate the commands on the terminal and do the trading. There is no broker and middleman caught up in the process so your trades are much more simpler.

One other benefit with trading online is that there is less paper work. Paper work is not required when you trade stocks online. Everything is done immediately, a few mouse clicks are are all you need to do to process a trade.

You have access to a wider range of investment choices such as stock options with this sort of investing. It doesn’t matter if you do day trading or make long-term investments, online brokers will provide a wide range of trading stock options. Online brokers feature many options for trading, they exist in more stock exchanges and you have plenty of options when it comes to initiating an account for online stock trading. All you have to do is log in to any broker website and select the option that satisfies your objectives.

You also have access to stock analysis and consultancy. Most of these online stock brokers provide in depth stock consideration and research, and they create scheduled tips and recommendations for investing. These services are valuable for those who are not capable of keeping track of the stock market everyday. The consultancy services help them choose the right stocks that will get them maximum profit. Therefore, when you choose your online stock broker, please make sure they will provide you with the consultancy service and do it without charging you anything. To get this benefit and to make the most out of your stock investment, you have to find our trustworthy and knowledgeable online stock broker.

There are numerous online stockbrokers offering really great solutions with appealing brokerage rates. All you need to do is to select one and open an account and start to make your online stock market trading.

Back in 2003, (October and November ‘03), the giant biotech Amgen (AMGN) came under some intense pressure, trading down about $12.00 before it found what appeared to be a decent level of support, and began to consolidate. At this level, anyone interested in going long Amgen at a discounted price would be advised to do so. Implied volatility was high coming off this precipitous drop, which caused premiums in the options to increase considerably.

This scenario can be a very attractive for covered call sellers or buy-writers. On Tuesday, December 2, 2003, Amgen was trading at $58.90, the December 60 call was trading at $1.30, and there were only two weeks left until expiration.

Let’s assume that you wanted to take advantage of this opportunity but you would be unable to participate in it due to capital requirements. The stock was trading at $58.90 and you did not have sufficient funds to support buying the stock at that price. After all, the purchase of just 1000 shares would cost $58,900.00.

This is the time to consider using a strategy called stock replacement. In many instances, an insufficient amount of funds in the investors account can mean the loss of a golden opportunity when dealing with high dollar priced stocks.

So, an alternative to purchasing the stock outright is to find a way to replace the actual stock with something else which is not as expensive. In this case, a deep in-the-money call would do just that.

When a call is deep in-the-money, meaning that the strike price of the call is much lower than the stock price, the delta of the call approaches 100. This means that there is close to a 100% chance that this option will finish in-the-money.

Because of this, the option will trade just like the stock; penny for penny, dollar for dollar (in a theoretical 100 delta scenario.) If you recall, the term delta was mentioned when describing the option in question. Delta is the first derivative of the stock and it has a three pronged definition. The first is percentage change.

The delta is given as a percentage change, meaning how much in percentage terms the option price will change with a movement in the stock. A 50 delta option will move 50% the amount the stock does. If the stock moves $1.00, than the option moves $.50. A 30 delta option moves $.30 on a $1.00 movement in the stock, and so on.

Delta can also be defined as percent chance. This is used to describe the percentage chance that the option will end up in-the-money. A 90 delta option has a 90% chance of finishing in-the-money.

Finally, delta can also be defined as hedge ratio which is the amount of deltas needed to properly hedge a position. These concepts will be discussed in more detail in future Options University courses, but for now it is sufficient to just understand these basic concepts.

It was important to explain the meaning of delta to understand that the deep in-the-money call would perform and act just like the stock. One way to determine if the call you will select is in-the-money enough for your purpose is the delta. A delta in the mid or high 90’s is an ideal candidate.

The selection of the proper in-the-money call to use is a critical element in the success of this strategy. In order to obtain an accurate delta of all options under consideration for stock replacement use, you can go to any number of web sites or consult your broker. If all else fails, there is a little trick of the trade that can be used to aid in selecting a call that is deep enough in-the-money to suit the stock replacement criteria.

To do this, check the quote of the corresponding put (i.e. the December 47.5 put if you are looking at the December 47.5 call for stock replacement). If there is no bid quoted for the put, then the call is deep enough in the money to consider it for a stock surrogate. There are several reasons for this being an effective strategy, which we wont cover here, but for the purposes of this discussion, it is enough to know that this method does work.

So, with the stock at $58.90, the December 47.5 calls met the criteria for stock replacement. This call had a mid to high 90’s delta and its corresponding put had no bid. The December 47.5 call was trading at $11.45 or $.05 over parity. By purchasing this option, you would be equivalently buying the stock at $58.95 (the strike price plus the option price).

Let’s say that you bought the December 47.5 call for $11.45. If a total of 10 calls were purchased (an equivalent of 1000 shares), you would lay out a total of $11,450 to fulfill your stock requirement on this buy-write. If you had purchased the stock outright, you would have spent $58,900. The difference between the capital needed to purchase the stock outright ($58,900) and the capital needed to buy the in-the-money call ($11,450) is the key to this trade.

Now that you have your stock (via the calls you bought above), it is time to sell covered calls against this position, which would be the December 60 calls for $1.30. If the stock stays at its present level, you would then capture the $1.30 premium that you sold the December 60 calls for because they finished out-of-the-money at expiration.

The $1,300 profit in this scenario represents an 11.35% return in only two weeks. This well out-performs the return garnished on a $58,900 investment which would only be a 2.21% return in the two weeks, if you purchased the actual stock.

As we know, the maximum profit of $2.35 will be attained if the stock reaches $60.00 or above. This return comes from the $1.30 you received in the premium for the sale of the now worthless December 60 call plus a $1.05 profit from the December 47.5 call you purchased. With the stock now at $60.00, the December 47.5 call is worth parity, which is $12.50.

You purchased the call for $11.45 thus you received a $1.05 capital gain in the option. This profit of $2350.00 represents a 20.5% return in two weeks verses a 3.98% return in two weeks, if you had purchased the actual stock.

As you can see, you are getting the same overall dollar return on much less money - which creates a much higher percentage rate of return. This is one of the positive leverage effects that the proper usage of options can provide. When you initiate this trade, you are buying and selling two different options simultaneously which is known as a spread. A spread is a trade which involves the buying of one option against the sale of a different option simultaneously and will be covered briefly in the next section.

By buying the December 47.5 calls for $11.45 and then selling the December 60 calls at $1.30, you are buying the December 47.5 December 60 call spread for $10.15. This type of spread is known as a vertical spread.

One of the hardest things about stock trading is self-discipline. You have a set of rules you use for trading, whether you realize it or not. The hard part is sticking to those rules. For example, you may tell yourself that you will never buy a penny stock. Then one day you get a spam email that is boasting about “the next big thing” in the stock market and you go ahead and buy that penny stock. One day later, you have lost 50% of your investment and you are mad at yourself for violating your own rules!

A good solution to the self-discipline problem is to write out your rules on a piece of paper. Better yet, make many copies of this paper with checkboxes next to each rule. Before you place a trade, make sure the stock fits within each of your rules and put a check next to them. That will help you stay on track! It may sound silly, but it is actually quite helpful. After all, we are human, and humans like to break rules!

In fact, one of your rules might even say, “There are no rules.” There will be times when it’s okay to break one or two of your rules because of a special scenario. You may find a stock that is a “sure thing” and you just have to ignore those couple rules that it violates. Of course if you get burned on the trade you will know why! Remember, there are no sure things in the stock market! There are no stocks that can guarantee a profit or a dividend. They can always drop in price or go bankrupt. So stick to those rules as much as you can!

Here are my rules:

1. Never put more than 1/3 of your money into one stock.
2. If no opportunities are found, stay out!
3. Avoid trading on Mondays. They have big drops sometimes.
4. Look at charts of the Dow to see how the market is doing.
5. Keep track of economic news schedules, such as Fed meetings.
6. After a huge loss, take a week off.
7. Research your holdings once a week.
8. Never short-sell more than 50% of your account.

Here are some stock-picking rules used by other people:

1. Predictable growth in free cash flow
2. Rich in assets, with little or no debt
3. Low multiple of price to free cash flow
4. Generous returns on equity, coupled with a reasonable cash flow multiple
5. Insider ownership and shareholder-friendly management
6. Insider buying, especially by executive officers
7. Leadership of an important niche

Feel free to use these rules or modify them to suit your trading style. There should also be different rules for day trading, short-term trading, long-term trading, and so on. Also, getting an accountability partner will help you stay on track. Show them your trades, when you bought them, why you bought them, and when you plan to sell.

There’s a popular saying on Wall Street that goes, “Plan Your Trade and Trade Your Plan.” That simply means, decide when you’re going to buy and under what conditions you will sell, and then stick to your plans!