5 Forex Day Trading Mistakes To Avoid

Posted: Aug 3, 2011 | Email Print

FILED UNDER DAY TRADING FOREX FOREX TRADING STRATEGIES FOREX-BEGINNER SWING TRADING VOLATILITY

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Cory Mitchell
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These five potentially devastating mistakes can be avoided. Holding losing positions costs time and money.

In the high leverage game of retail forex day trading, there are certain practices that, if used regularly, are likely to lose a trader all he has. There are five common mistakes that day traders often make in an attempt to ramp up returns, but that end up resulting in lower returns. These five potentially devastating mistakes can be avoided with knowledge, discipline and an alternative approach. (For more strategies that you can use, check out Strategies For Part-Time Forex Traders.) TUTORIAL: Forex

Averaging Down Traders often stumble across averaging down. It is not something they intended to do when they began trading, but most traders have ended up doing it. There are several problems with averaging down. The main problem is that a losing position is being held - not only potentially sacrificing money, but also time. This time and money could be placed in something else that is proving itself to be a better position. Also, for capital that is lost, a larger return is needed on remaining capital to get it back. If a trader loses 50% of her capital, it will take a 100% return to bring her back to the original capital level. Losing large chunks of money on single trades or on single days of trading can cripple capital growth for long periods of time. While it may work a few times, averaging down will inevitably lead to a large loss or margin call, as a trend can sustain itself longer than a trader can stay liquid - especially if more capital is being added as the position moves further out of the money. Day traders are especially sensitive to these issues. The short time frame for trades means opportunities must be capitalized on when they occur and bad trades must be exited quickly. (To learn more on averaging down, check out Buying Stocks When The Price Goes Down: Big Mistake?) Pre-Positioning for News Traders know the news events that will move the market, yet the direction is not known in advance. A trader may even be fairly confident what a news announcement may be for instance that the Federal Reserve will or will not raise interest rates - but even so cannot predict how the market will react to this expected news. Often there are additional statements, figures or forward looking indications provided by news announcements that can make movements extremely illogical. There is also the simple fact that as volatility surges and all sorts of orders hit the market, stops are triggered on both sides of the market. This often results in whip-saw like action before a trend emerges (if one emerges in the near term at all). For all these reasons, taking a position before a news announcement can seriously jeopardize a trader's chances of success. There is no easy money here; those who believe there is may face larger than usual losses.

Trading Right after News A news headline hits the markets and then the market starts to move aggressively. It seems like easy money to hop on board and grab some pips. If this is done in a nonregimented and untested way without a solid trading plan behind it, it can be just as devastating as placing a gamble before the news comes out. News announcements often cause whipsaw-like action because of a lack of liquidity and hair-pin turns in the market assessment of the report. Even a trade that is in the money can turn quickly, bringing large losses as large swings occur back and forth. Stops during these times are dependent on liquidity that may not be there, which means losses could potentially be much more than calculated. Day traders should wait for volatility to subside and for a definitive trend to develop after news announcements. By doing so there is likely to be fewer liquidity concerns, risk can be managed more effectively and a more stable price direction is likely. (For more on trading with news releases, read How To Trade Forex On News Releases.) Risking More Than 1% of Capital Excessive risk does not equal excessive returns. Almost all traders who risk large amounts of capital on single trades will eventually lose in the long run. A common rule is that a trader should risk (in terms of the difference between entry and stop price) no more than 1% of capital on any single trade. Professional traders will often risk far less than 1% of capital. Day trading also deserves some extra attention in this area. A daily risk maximum should also be implemented. This daily risk maximum can be 1% (or less) of capital, or equivalent to the average daily profit over a 30 day period. For example, a trader with a $50,000 account (leverage not included) could lose a maximum of $500 per day. Alternatively, this number could be altered so it is more in line with the average daily gain - if a trader makes $100 on positive days, she keeps losing days close to $100 or less. The purpose of this method is to make sure no single trade or single day of trading hurts the traders account significantly. By adopting a risk maximum that is equivalent to the average daily gain over a 30 day period, the trader knows that he will not lose more in a single trade/day than he can make back on another. (To understand the risks involved in the forex market, see Forex Leverage: A Double-Edged Sword.) Unrealistic Expectations Unrealistic expectations come from many sources, but often result in all of the above

problems. Our own trading expectations are often imposed on the market, leaving us expecting it to act according our desires and trade direction. The market doesn't care what you want. Traders must accept that the market can be illogical. It can be choppy, volatile and trending all in short, medium and long-term cycles. Isolating each move and profiting from it is not possible, and believing so will result in frustration and errors in judgment. The best way to avoid unrealistic expectations is formulate a trading plan and then trade it. If it yields steady results, then don't change it - with forex leverage, even a small gain can become large. Accept this as what the market gives you. As capital grows over time, the position size can be increased to bring in higher dollar returns. Also, new strategies can be implemented and tested with minimal capital at first. Then, if positive results are seen, more capital can be put into the strategy. Intra-day, a trader must also accept what the market provides at different parts of the day. Near the open, the markets are more volatile. Specific strategies can be used during the market open that may not work later in the day. As the day progresses, it may become quieter and a different strategy can be used. Towards the close, there may be a pickup in action and yet another strategy can be used. Accept what is given at each point in the day and don't expect more from a system than what it is providing. Bottom Line Traders get trapped in five common forex day trading mistakes. These must be avoided at all costs by developing an alternative approach. For averaging down, traders must not add to positions but rather exit losers quickly with a pre-planned exit strategy. Traders should sit back and watch news announcements until the volatility has subsided. Risk must be kept in check, with no single trade or day losing more than what can be easily made back on another. Expectations must be managed, and what the market gives must be accepted. By understanding the pitfalls and how to avoid to them, traders are more likely to find success in trading. (To help you become successful in the forex market, check out 10 Ways To Avoid Losing Money In Forex.)
by Cory Mitchell Cory Mitchell is an independent trader specializing in short- to medium-term technical strategies. He is the founder of www.vantagepointtrading.com, a website dedicated to free trader education and discussion. After graduating with a business degree, Mitchell has spent the last five years trading multiple markets and educating traders. He has been widely published and is a member of the Canadian Society of Technical Analysts and the Market Technicians Association.

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The Canadian Dollar: What Every Forex Trader Needs To Know

Posted: Jun 29, 2011 | Email Print
FILED UNDER CURRENCIES FOREX FOREX FUNDAMENTALS FOREX THEORY INTERNATIONAL MARKETS

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Stephen D. Simpson, CFA

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The Canadian dollar is the sixth-most held currency as a reserve. In terms of GDP (measured in U.S. dollars), Canada is the 10th-largest economy. The Canadian dollar is uniquely tied to the health of the U.S. economy.

Foreign exchange, or forex, trading is an increasingly popular option for speculators. Ads boast of "commission-free" trading, 24-hour market access and huge potential gains, and it is easy to set up simulated trading accounts to allow people to practice their trading techniques. TUTORIAL: The Ultimate Forex Guide

With that easy access comes risk. It is true that forex trading is a huge market, but it also true that every single wannabe forex trader is going up against thousands of professions working for major banks and funds. The foreign exchange market is a 24-hour market and there is no exchange trades take place between individual banks, brokers, fund managers, and other market participants but 10 firms dominate nearly 75% of the volume. It is not a market for the unprepared, and investors would do well to do their homework beforehand. In particular, would-be traders need to understand the economic underpinnings of the major currencies in the market and the special or unique drivers that influence their value. Introduction to the Canadian Dollar Just seven currencies account for over 80% of the volume of the forex market, and the Canadian dollar (often called the "loonie" because of the appearance of a loon on the back of the C$1 coin) is one of these major currencies and is the sixth-most held currency as a reserve. (Whether you're puzzled by pips or curious about carry trades, your queries are answered here. For more, see Top 7 Questions About Currency Trading Answered.) This is somewhat of an anomaly, as Canada's economy (in terms of U.S. dollars of GDP) is actually number 10 in the world. Canada is also relatively low on the list of major economies in terms of population, but it does stand at ninth in the world in terms of its dollar-value exports. Anomalies are somewhat par for the course with the loonie, though. The Canadian dollar was not part of the original Bretton Woods system, and so it floated freely until 1962 when extensive depreciation toppled a government and Canada went with a fixed rate until 1970 when high inflation prompted the government to move back to a floating system. All of the major currencies in the forex market have central banks behind them. In the case of the Canadian dollar it is the Bank of Canada. Like all central banks, the Bank of Canada tries to find a balance between policies that will promote employment and economic growth while containing inflation. Despite the significance of foreign trade to Canada's economy (and the influence that currency can have on that), the Bank of Canada does not intervene in the currency the last intervention was in 1998, when the government decided that intervention was ineffective and pointless. (For more, see Get To Know The Major Central Banks.) The Economy Behind the Canadian Dollar In terms of GDP (measured in U.S. dollars), Canada is the 10th-largest economy. Canada

has enjoyed relatively strong growth over the last 20 years, with two relatively brief periods of recession in the early 1990s and 2009. Canada had persistently high inflation rates, but better fiscal policy and an improved current account balance have led to lower budget deficits, lower inflation and lower inflation rates. In analyzing the economic situation in Canada, it is also important to consider Canada's exposure to commodities. Canada is a meaningful producer of petroleum, minerals, wood products and grains, and the trade flows from those exports (nearly 60% of the country's total exports) can influence investor sentiment regarding the loonie. As is the case for virtually all developed economies, this data can be readily found on the internet through sources like the Agriculture and Agri-Food Canada website. (For related reading, see Economic Factors That Affect The Forex Market.) Although the average age of Canada's population is high relative to global standards, Canada is relatively younger than most other developed economies. Canada has a relatively liberal immigration policy, though, and Canada's demographics are not especially troubling for the long-term economic outlook. Because of the tight trading relationship between Canada and the United States (they both make up over half of the other's import/export market), traders of the Canadian dollar have to keep an eye on events in the United States as well. While Canada has pursued very different economic policies, the reality is that conditions in the U.S. inevitably spill over into Canada to some extent. (It also influences other economic phenomena such as inflation. For more, see How The U.S. Government Formulates Monetary Policy.) What is particularly interesting about that relationship is how conditions can diverge. The structure of Canada's financial market helped the country avoid many of the problems with bad mortgages that affected the U.S. On the other hand, the lesser significance of technology companies to Canada's economy led to relative weakness in the Canadian dollar during the tech boom in the U.S. in the 1990s. On the other hand, the commodity boom of the 2000s (particularly in oil) led to outperformance for the loonie. (For more, see 5 Steps Of A Bubble.) Drivers Of The Canadian Dollar Economic models designed to calculate the "right" foreign currency exchange rates are notoriously inaccurate when compared to real market rates, due in part to the fact that economic models are typically based on a very small number of economic variables (sometimes just a single variable like interest rates). Traders, however, incorporate a

much larger range of economic data into their trading decisions and their speculative outlooks can themselves move rates just as investor optimism or pessimism can move a stock above or below the value its fundamentals suggest. (For more, see 4 Ways To Forecast Currency Changes.) Major economic data includes the release of GDP, retail sales, industrial production, inflation, and trade balances. These come out at regular intervals and many brokers, as well as many financial information sources like the Wall Street Journal and Bloomberg, make this information freely available. Investors should also take note of information on employment, interest rates (including scheduled meetings of the central bank), and the daily news flow natural disasters, elections, and new government policies can all have significant impacts on exchange rates. As is often the case with countries that rely on commodities for a sizable portion of their exports, performance of the Canadian dollar is often related to the movement of commodity prices. In the case of Canada, the price of oil seems to be especially significant in currency moves and it generally seems to pay off to go long loonies and short oil importers (like Japan, for instance) when oil prices are moving up. Along similar lines, there is some impact on the loonie from fiscal and trade policy in countries like China countries that are major importers of Canadian materials. (For more, see Canada's Commodity Currency: Oil And The Loonie.) Capital inflows can also drive action in the loonie. During periods of higher commodity prices there is often increased interest in investing in Canadian assets, and that influx of capital can impact exchange rates. That said, the carry trade is usually not so significant for the Canadian dollar. Unique Factors for the Canadian Dollar Given the relative economic health of Canada, the country has a relatively high interest rate among developed economies. Canada also enjoys a relatively newly-won reputation for balanced fiscal management and finding a workable middle path between a statedominated economy and a more hands-off approach. That can become more relevant during periods of global economic uncertainty though not a reserve currency like the U.S. dollar, the Canadian dollar is seen as something of a global safe haven. (For more, see The U.S. Dollar's Unofficial Status as World Currency.) In point of fact, though, while the Canadian dollar is not a reserve currency like the U.S. dollar, that is changing. Canada is now the sixth most commonly held reserve currency and those holdings are increasing.

The Canadian dollar is also uniquely tied to the health of the U.S. economy. Though it would be a mistake for traders to assume a one-to-one relationship, the U.S. is a huge trade partner for Canada and U.S. policies can have significant influence over the course of trading in the Canadian dollar. The Bottom Line Currency rates are notoriously difficult to predict, and most models seldom work for more than brief periods of time. While economics-based models are seldom useful to short-term traders, economic conditions do shape long-term trends. Though Canada is not an especially large country and is not among the very largest exporters of manufactured goods, the country's economic vitals are stable and the country has found a good balance between profiting from its natural resource wealth and risking "Dutch disease" from over-reliance on these goods. As Canada becomes an increasingly viable alternative to the U.S. dollar, traders should not be surprised to see the loonie become more important in the forex market. (For related reading, see 3 Factors That Drive The U.S. Dollar.)
by Stephen D. Simpson, CFA Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates theKratisto Investing blog, and can be reached there.

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How gold affect currencies?

Posted: Jun 30, 2011 | Email Print
FILED UNDER CURRENCIES ECONOMICS FOREX FOREX THEORY

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Kalen Smith
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Gold was once used to back up fiat currencies. Gold is used to hedge against inflation. Gold purchases tend to reduce the value of the currency used to purchase it.

Gold is one of the most widely discussed metals due to its prominent role in both the investment and consumer world. Even though gold is no longer used as a primary form of currency in developed nations, it continues to have a strong impact on the value of those currencies. Moreover, there is a strong correlation between its value and the strength of currencies trading on foreign exchanges. (For related reading, see Gold: The Other Currency.) TUTORIAL: Commodities Introduction

To help illustrate this relationship between gold and foreign exchange trading, consider these five important aspects: 1. Gold was once used to back up fiat currencies. As early as the Byzantine Empire, gold was used to support fiat currencies, or the various currencies considered legal tender in their nation of origin. Gold was also used as the world reserve currency up through most of the 20th century; the United States used the gold standard until 1971 when President Nixon discontinued it. (For more, see The Gold Standard Revisited.) One of the reasons for its use is that it limited the amount of money nations were allowed to print. This is because, then as now, countries had limited gold supplies on hand. Until the gold standard was abandoned, countries couldn't simply print their fiat currencies ad nauseum unless they possessed an equal amount of gold. Although the gold standard is no longer used in the developed world, some economists feel we should return to it due to the volatility of the U.S. dollar and other currencies. 2. Gold is used to hedge against inflation. Investors typically buy large quantities of gold when their country is experiencing high levels of inflation. The demand for gold increases during inflationary times due to its inherent value and limited supply. As it cannot be diluted, gold is able to retain value much better than other forms of currency. (For related reading, see The Great Inflation Of The 1970s.) For example, in April 2011, investors feared declining values of fiat currency and the price of gold was driven to a staggering $1,500 an ounce. This indicates there was little confidence in the currencies on the world market and that expectations of future economic stability were grim. 3. The price of gold affects countries that import and export it. The value of a nation's currency is strongly tied to the value of its imports and exports. When a country imports more than it exports, the value of its currency will decline. On the other hand, the value of its currency will increase when a country is a net exporter. Thus, a country that exports gold or has access to gold reserves will see an increase in the strength of its currency when gold prices increase, since this increases the value of the country's total exports. (For related reading, see What Is Wrong With Gold?) In other words, an increase in the price of gold can create a trade surplus or help offset a trade deficit. Conversely, countries that are large importers of gold will inevitably end up having a weaker currency when the price of gold rises. For example, countries that

specialize in producing products made with gold, but lack their own gold reserves, will be large importers of gold. Thus, they will be particularly susceptible to increases in the price of gold. 4. Gold purchases tend to reduce the value of the currency used to purchase it. When central banks purchase gold, it affects the supply and demand of the domestic currency and may result in inflation. This is largely due to the fact that banks rely on printing more money to buy gold, and thereby create an excess supply of the fiat currency. (This metal's rich history stems from its ability to maintain value over the long term. For more, see 8 Reasons To Own Gold.) 5. Gold prices are often used to measure the value of a local currency, but there are exceptions. Many people mistakenly use gold as a definitive proxy for valuing a country's currency. Although there is undoubtedly a relationship between gold prices and the value of a fiat currency, it is not always an inverse relationship as many people assume. For example, if there is high demand from an industry that requires gold for production, this will cause gold prices to rise. But this will say nothing about the local currency, which may very well be highly valued at the same time. Thus, while the price of gold can often be used as a reflection of the value of the U.S. dollar, conditions need to be analyzed to determine if an inverse relationship is indeed appropriate. The Bottom Line Gold has a profound impact on the value of world currencies. Even though the gold standard has been abandoned, gold as a commodity can act as a substitute for fiat currencies and be used as an effective hedge against inflation. There is no doubt that gold will continue to play an integral role in the foreign exchange markets. Therefore, it is an important metal to follow and analyze for its unique ability to represent the health of both local and international economies. (This article explores the past, present and future of gold. For more, see The Midas Touch For Gold Investors.)
by Kalen Smith Kalen Smith is a frequent contributor to the Money Crashers personal finance blog and writes about financial topics like investing in the stock market, insurance options, saving for retirement, and behavioral finance theory. Kalen holds an Master of Business Administration degree in finance from Clark University in Worcester, Mass.

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