The essence of the FX2u Forex strategy is that it does not have any Forex trading system but could forecast the market trend accurately.
Every set of Forex trading system available has its disadvantages. The market trend could not be forecasted. If the market could be forecasted, by depending on the RSI, PAR, MOM analysis techniques and some other theories, Forex traders could easily make a fortune.
Many Forex traders could not obtain the anticipated outcome by using these analysis tools, and suffer huge losses. The main reason is relying on some imperfect tools to forecast the unpredictable market trend is just a waste of effort. Therefore the FX2u Forex strategy spirit is to abolish the entire subjective analysis tool.
To survive in the market is to follow the market trend, following the market trend is the essence of the FX2u Forex strategy. By using the opposite theory to enter the market, will only lead to lost. The reason is that if the market rises, it may continue to rise. If the market drops, it may continue to drop. No one is able to forecast when the market trend will stop.
By following the market trend, the market risk could be reduce to the lowest, the FX2u Forex strategy will advance the following the ten principles:
fully understand the how market function and the market trend, else don’t trade
After entering the market, the Forex trader MUST immediately put a market stop.
If the stop order has been hit it MUST be executed immediately, NEVER make changes by lowering the stop order price.
If the forecast is wrong, Forex traders should leave the market immediately, then analyze again.
If the forecast is wrong, Forex traders should stop loss and should not increase trading.
Forex traders should admit mistakes, do not continuously make mistakes.
All analysis tools are imperfect, mistakes could always occur.
If the market rises Forex traders should buy, if the market drops Forex traders should sell, always follow the market trend.
Forex traders should not forecast the market price because such forecast will not be as easy as forecasting the market trend.
If the forecast is wrong, once the loss reach 10%, Forex traders must stop loss immediately, do not let it surpasses 10%, otherwise it would be difficult to recoup the capital again.
Saturday, November 1, 2008
How Do Other Countries Devalue Their Currencies?
Countries devalue their currencies only when they have no other way to correct past economic mistakes - whether their own or mistakes committed by their predecessors.
The ills of a devaluation are still at least equal to its advantages.
True, it does encourage exports and discourage imports to some extents and for a limited period of time. As the devaluation is manifested in a higher inflation, even this temporary relief is eroded. In a previous article in this paper I described WHY governments resort to such a drastic measure. This article will deal with HOW they do it.
A government can be forced into a devaluation by an ominous trade deficit. Thailand, Mexico, the Czech Republic - all devalued strongly, willingly or unwillingly, after their trade deficits exceeded 8% of the GDP. It can decide to devalue as part of an economic package of measures which is likely to include a freeze on wages, on government expenses and on fees charged by the government for the provision of public services. This, partly, has been the case in Macedonia. In extreme cases and when the government refuses to respond to market signals of economic distress - it may be forced into devaluation. International and local speculators will buy foreign exchange from the government until its reserves are depleted and it has no money even to import basic staples and other necessities.
Thus coerced, the government has no choice but to devalue and buy back dearly the foreign exchange that it has sold to the speculators cheaply.
In general, there are two known exchange rate systems: the floating and the fixed.
In the floating system, the local currency is allowed to fluctuate freely against other currencies and its exchange rate is determined by market forces within a loosely regulated foreign exchange domestic (or international) market. Such currencies need not necessarily be fully convertible but some measure of free convertibility is a sine qua non.
In the fixed system, the rates are centrally determined (usually by the Central Bank or by the Currency Board where it supplants this function of the Central Bank). The rates are determined periodically (normally, daily) and revolve around a "peg" with very tiny variations.
Life being more complicated than any economic system, there are no "pure cases".
Even in floating rate systems, Central banks intervene to protect their currencies or to move them to an exchange rate deemed favourable (to the country's economy) or "fair". The market's invisible hand is often handcuffed by "We-Know-Better" Central Bankers. This usually leads to disastrous (and breathtakingly costly) consequences. Suffice it to mention the Pound Sterling debacle in 1992 and the billion dollars made overnight by the arbitrageur-speculator Soros - both a direct result of such misguided policy and hubris.
Floating rates are considered a protection against deteriorating terms of trade.
If export prices fall or import prices surge - the exchange rate will adjust itself to reflect the new flows of currencies. The resulting devaluation will restore the equilibrium.
Floating rates are also good as a protection against "hot" (speculative) foreign capital looking to make a quick killing and vanish. As they buy the currency, speculators will have to pay more expensively, due to an upward adjustment in the exchange rates. Conversely, when they will try to cash their profits, they will be penalized by a new exchange rate.
So, floating rates are ideal for countries with volatile export prices and speculative capital flows. This characterizes most of the emerging economies (also known as the Third World).
It looks surprising that only a very small minority of these states has them until one recalls their high rates of inflation. Nothing like a fixed rate (coupled with consistent and prudent economic policies) to quell inflationary expectations. Pegged rates also help maintain a constant level of foreign exchange reserves, at least as long as the government does not stray from sound macro-economic management. It is impossible to over-estimate the importance of the stability and predictability which are a result of fixed rates: investors, businessmen and traders can plan ahead, protect themselves by hedging and concentrate on long term growth.
It is not that a fixed exchange rate is forever. Currencies - in all types of rate determination systems - move against one another to reflect new economic realities or expectations regarding such realities. Only the pace of changing the exchange rates is different.
Countries have invented numerous mechanisms to deal with exchange rates fluctuations.
Many countries (Argentina, Bulgaria) have currency boards. This mechanism ensures that all the local currency in circulation is covered by foreign exchange reserves in the coffers of the Central bank. All, government, and Central Bank alike - cannot print money and must operate within the straitjacket.
Other countries peg their currency to a basket of currencies. The composition of this basket is supposed to reflect the composition of the country's international trade. Unfortunately, it rarely does and when it does, it is rarely updated (as is the case in Israel). Most countries peg their currencies to arbitrary baskets of currencies in which the dominant currency is a "hard, reputable" currency such as the US dollar. This is the case with the Thai baht.
In Slovakia the basket is made up of two currencies only (40% dollar and 60% DEM) and the Slovak crown is free to move 7% up and down, around the basket-peg.
Some countries have a "crawling peg". This is an exchange rate, linked to other currencies, which is fractionally changed daily. The currency is devalued at a rate set in advance and made known to the public (transparent). A close variant is the "crawling band" (used in Israel and in some countries in South America). The exchange rate is allowed to move within a band, above and below a central peg which, in itself depreciates daily at a preset rate.
This pre-determined rate reflects a planned real devaluation over and above the inflation rate.
It denotes the country's intention to encourage its exports without rocking the whole monetary boat. It also signals to the markets that the government is bent on taming inflation.
So, there is no agreement among economists. It is clear that fixed rate systems have cut down inflation almost miraculously. The example of Argentina is prominent: from 27% a month (1991) to 1% a year (1997)!!!
The problem is that this system creates a growing disparity between the stable exchange rate - and the level of inflation which goes down slowly. This, in effect, is the opposite of devaluation - the local currency appreciates, becomes stronger. Real exchange rates strengthen by 42% (the Czech Republic), 26% (Brazil), even 50% (Israel until lately, despite the fact that the exchange rate system there is hardly fixed). This has a disastrous effect on the trade deficit: it balloons and consumes 4-10% of the GDP.
This phenomenon does not happen in non-fixed systems. Especially benign are the crawling peg and the crawling band systems which keep apace with inflation and do not let the currency appreciate against the currencies of major trading partners. Even then, the important question is the composition of the pegging basket. If the exchange rate is linked to one major currency - the local currency will appreciate and depreciate together with that major currency. In a way the inflation of the major currency is thus imported through the foreign exchange mechanism. This is what happened in Thailand when the dollar got stronger in the world markets.
In other words, the design of the pegging and exchange rate system is the crucial element.
In a crawling band system - the wider the band, the less the volatility of the exchange rate. This European Monetary System (EMS - ERM), known as "The Snake", had to realign itself a few times during the 1990s and each time the solution was to widen the bands within which the exchange rates were allowed to fluctuate. Israel had to do it twice. On June 18th, the band was doubled and the Shekel can go up and down by 10% in each direction.
But fixed exchange rates offer other problems. The strengthening real exchange rate attracts foreign capital. This is not the kind of foreign capital that countries are looking for. It is not Foreign Direct Investment (FDI). It is speculative, hot money in pursuit of ever higher returns. It aims to benefit from the stability of the exchange rate - and from the high interest rates paid on deposits in local currency.
Let us study an example: if a foreign investor were to convert 100,000 DEM to Israeli Shekels last year and invest them in a liquid deposit with an Israeli bank - he will have ended up earning an interest rate of 12% annually. The exchange rate did not change appreciably - so he would have needed the same amount of Shekels to buy his DEM back. On his Shekel deposit he would have earned between 12-16%, all net, tax free profit.
No wonder that Israel's foreign exchange reserves doubled themselves in the preceding 18 months. This phenomenon happened all over the globe, from Mexico to Thailand.
This kind of foreign capital expands the money supply (it is converted to local currency) and - when it suddenly evaporates - prices and wages collapse. Thus it tends to exacerbate the natural inflationary-deflationary cycles in emerging economies. Measures like control on capital inflows, taxing them are useless in a global economy with global capital markets.
They also deter foreign investors and distort the allocation of economic resources.
The other option is "sterilization": selling government bonds and thus absorbing the monetary overflow or maintaining high interest rates to prevent a capital drain. Both measures have adverse economic effects, tend to corrupt and destroy the banking and financial infrastructure and are expensive while bringing only temporary relief.
Where floating rate systems are applied, wages and prices can move freely. The market mechanisms are trusted to adjust the exchange rates. In fixed rate systems, taxes move freely. The state, having voluntarily given up one of the tools used in fine tuning the economy (the exchange rate) - must resort to fiscal rigor, tightening fiscal policy (=collect more taxes) to absorb liquidity and rein in demand when foreign capital comes flowing in.
In the absence of fiscal discipline, a fixed exchange rate will explode in the face of the decision makers either in the form of forced devaluation or in the form of massive capital outflows.
After all, what is wrong with volatile exchange rates? Why must they be fixed, save for psychological reasons? The West has never prospered as it does nowadays, in the era of floating rates. Trade, investment - all the areas of economic activity which were supposed to be influenced by exchange rate volatility - are experiencing a continuous big bang. That daily small fluctuations (even in a devaluation trend) are better than a big one time devaluation in restoring investor and business confidence is an axiom. That there is no such thing as a pure floating rate system (Central Banks always intervene to limit what they regard as excessive fluctuations) - is also agreed on all economists.
That exchange rate management is no substitute for sound macro- and micro-economic practices and policies - is the most important lesson. After all, a currency is the reflection of the country in which it is legal tender. It stores all the data about that country and their appraisal. A currency is a unique package of past and future with serious implications on the present.
The ills of a devaluation are still at least equal to its advantages.
True, it does encourage exports and discourage imports to some extents and for a limited period of time. As the devaluation is manifested in a higher inflation, even this temporary relief is eroded. In a previous article in this paper I described WHY governments resort to such a drastic measure. This article will deal with HOW they do it.
A government can be forced into a devaluation by an ominous trade deficit. Thailand, Mexico, the Czech Republic - all devalued strongly, willingly or unwillingly, after their trade deficits exceeded 8% of the GDP. It can decide to devalue as part of an economic package of measures which is likely to include a freeze on wages, on government expenses and on fees charged by the government for the provision of public services. This, partly, has been the case in Macedonia. In extreme cases and when the government refuses to respond to market signals of economic distress - it may be forced into devaluation. International and local speculators will buy foreign exchange from the government until its reserves are depleted and it has no money even to import basic staples and other necessities.
Thus coerced, the government has no choice but to devalue and buy back dearly the foreign exchange that it has sold to the speculators cheaply.
In general, there are two known exchange rate systems: the floating and the fixed.
In the floating system, the local currency is allowed to fluctuate freely against other currencies and its exchange rate is determined by market forces within a loosely regulated foreign exchange domestic (or international) market. Such currencies need not necessarily be fully convertible but some measure of free convertibility is a sine qua non.
In the fixed system, the rates are centrally determined (usually by the Central Bank or by the Currency Board where it supplants this function of the Central Bank). The rates are determined periodically (normally, daily) and revolve around a "peg" with very tiny variations.
Life being more complicated than any economic system, there are no "pure cases".
Even in floating rate systems, Central banks intervene to protect their currencies or to move them to an exchange rate deemed favourable (to the country's economy) or "fair". The market's invisible hand is often handcuffed by "We-Know-Better" Central Bankers. This usually leads to disastrous (and breathtakingly costly) consequences. Suffice it to mention the Pound Sterling debacle in 1992 and the billion dollars made overnight by the arbitrageur-speculator Soros - both a direct result of such misguided policy and hubris.
Floating rates are considered a protection against deteriorating terms of trade.
If export prices fall or import prices surge - the exchange rate will adjust itself to reflect the new flows of currencies. The resulting devaluation will restore the equilibrium.
Floating rates are also good as a protection against "hot" (speculative) foreign capital looking to make a quick killing and vanish. As they buy the currency, speculators will have to pay more expensively, due to an upward adjustment in the exchange rates. Conversely, when they will try to cash their profits, they will be penalized by a new exchange rate.
So, floating rates are ideal for countries with volatile export prices and speculative capital flows. This characterizes most of the emerging economies (also known as the Third World).
It looks surprising that only a very small minority of these states has them until one recalls their high rates of inflation. Nothing like a fixed rate (coupled with consistent and prudent economic policies) to quell inflationary expectations. Pegged rates also help maintain a constant level of foreign exchange reserves, at least as long as the government does not stray from sound macro-economic management. It is impossible to over-estimate the importance of the stability and predictability which are a result of fixed rates: investors, businessmen and traders can plan ahead, protect themselves by hedging and concentrate on long term growth.
It is not that a fixed exchange rate is forever. Currencies - in all types of rate determination systems - move against one another to reflect new economic realities or expectations regarding such realities. Only the pace of changing the exchange rates is different.
Countries have invented numerous mechanisms to deal with exchange rates fluctuations.
Many countries (Argentina, Bulgaria) have currency boards. This mechanism ensures that all the local currency in circulation is covered by foreign exchange reserves in the coffers of the Central bank. All, government, and Central Bank alike - cannot print money and must operate within the straitjacket.
Other countries peg their currency to a basket of currencies. The composition of this basket is supposed to reflect the composition of the country's international trade. Unfortunately, it rarely does and when it does, it is rarely updated (as is the case in Israel). Most countries peg their currencies to arbitrary baskets of currencies in which the dominant currency is a "hard, reputable" currency such as the US dollar. This is the case with the Thai baht.
In Slovakia the basket is made up of two currencies only (40% dollar and 60% DEM) and the Slovak crown is free to move 7% up and down, around the basket-peg.
Some countries have a "crawling peg". This is an exchange rate, linked to other currencies, which is fractionally changed daily. The currency is devalued at a rate set in advance and made known to the public (transparent). A close variant is the "crawling band" (used in Israel and in some countries in South America). The exchange rate is allowed to move within a band, above and below a central peg which, in itself depreciates daily at a preset rate.
This pre-determined rate reflects a planned real devaluation over and above the inflation rate.
It denotes the country's intention to encourage its exports without rocking the whole monetary boat. It also signals to the markets that the government is bent on taming inflation.
So, there is no agreement among economists. It is clear that fixed rate systems have cut down inflation almost miraculously. The example of Argentina is prominent: from 27% a month (1991) to 1% a year (1997)!!!
The problem is that this system creates a growing disparity between the stable exchange rate - and the level of inflation which goes down slowly. This, in effect, is the opposite of devaluation - the local currency appreciates, becomes stronger. Real exchange rates strengthen by 42% (the Czech Republic), 26% (Brazil), even 50% (Israel until lately, despite the fact that the exchange rate system there is hardly fixed). This has a disastrous effect on the trade deficit: it balloons and consumes 4-10% of the GDP.
This phenomenon does not happen in non-fixed systems. Especially benign are the crawling peg and the crawling band systems which keep apace with inflation and do not let the currency appreciate against the currencies of major trading partners. Even then, the important question is the composition of the pegging basket. If the exchange rate is linked to one major currency - the local currency will appreciate and depreciate together with that major currency. In a way the inflation of the major currency is thus imported through the foreign exchange mechanism. This is what happened in Thailand when the dollar got stronger in the world markets.
In other words, the design of the pegging and exchange rate system is the crucial element.
In a crawling band system - the wider the band, the less the volatility of the exchange rate. This European Monetary System (EMS - ERM), known as "The Snake", had to realign itself a few times during the 1990s and each time the solution was to widen the bands within which the exchange rates were allowed to fluctuate. Israel had to do it twice. On June 18th, the band was doubled and the Shekel can go up and down by 10% in each direction.
But fixed exchange rates offer other problems. The strengthening real exchange rate attracts foreign capital. This is not the kind of foreign capital that countries are looking for. It is not Foreign Direct Investment (FDI). It is speculative, hot money in pursuit of ever higher returns. It aims to benefit from the stability of the exchange rate - and from the high interest rates paid on deposits in local currency.
Let us study an example: if a foreign investor were to convert 100,000 DEM to Israeli Shekels last year and invest them in a liquid deposit with an Israeli bank - he will have ended up earning an interest rate of 12% annually. The exchange rate did not change appreciably - so he would have needed the same amount of Shekels to buy his DEM back. On his Shekel deposit he would have earned between 12-16%, all net, tax free profit.
No wonder that Israel's foreign exchange reserves doubled themselves in the preceding 18 months. This phenomenon happened all over the globe, from Mexico to Thailand.
This kind of foreign capital expands the money supply (it is converted to local currency) and - when it suddenly evaporates - prices and wages collapse. Thus it tends to exacerbate the natural inflationary-deflationary cycles in emerging economies. Measures like control on capital inflows, taxing them are useless in a global economy with global capital markets.
They also deter foreign investors and distort the allocation of economic resources.
The other option is "sterilization": selling government bonds and thus absorbing the monetary overflow or maintaining high interest rates to prevent a capital drain. Both measures have adverse economic effects, tend to corrupt and destroy the banking and financial infrastructure and are expensive while bringing only temporary relief.
Where floating rate systems are applied, wages and prices can move freely. The market mechanisms are trusted to adjust the exchange rates. In fixed rate systems, taxes move freely. The state, having voluntarily given up one of the tools used in fine tuning the economy (the exchange rate) - must resort to fiscal rigor, tightening fiscal policy (=collect more taxes) to absorb liquidity and rein in demand when foreign capital comes flowing in.
In the absence of fiscal discipline, a fixed exchange rate will explode in the face of the decision makers either in the form of forced devaluation or in the form of massive capital outflows.
After all, what is wrong with volatile exchange rates? Why must they be fixed, save for psychological reasons? The West has never prospered as it does nowadays, in the era of floating rates. Trade, investment - all the areas of economic activity which were supposed to be influenced by exchange rate volatility - are experiencing a continuous big bang. That daily small fluctuations (even in a devaluation trend) are better than a big one time devaluation in restoring investor and business confidence is an axiom. That there is no such thing as a pure floating rate system (Central Banks always intervene to limit what they regard as excessive fluctuations) - is also agreed on all economists.
That exchange rate management is no substitute for sound macro- and micro-economic practices and policies - is the most important lesson. After all, a currency is the reflection of the country in which it is legal tender. It stores all the data about that country and their appraisal. A currency is a unique package of past and future with serious implications on the present.
Forex Options Market Overview
The forex options market started as an over-the-counter (OTC) financial vehicle for large banks, financial institutions and large international corporations to hedge against foreign currency exposure. Like the forex spot market, the forex options market is considered an "interbank" market. However, with the plethora of real-time financial data and forex option trading software available to most investors through the internet, today's forex option market now includes an increasingly large number of individuals and corporations who are speculating and/or hedging foreign currency exposure via telephone or online forex trading platforms.
Forex option trading has emerged as an alternative investment vehicle for many traders and investors. As an investment tool, forex option trading provides both large and small investors with greater flexibility when determining the appropriate forex trading and hedging strategies to implement.
Most forex options trading is conducted via telephone as there are only a few forex brokers offering online forex option trading platforms.
Forex Option Defined - A forex option is a financial currency contract giving the forex option buyer the right, but not the obligation, to purchase or sell a specific forex spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the forex option buyer pays to the forex option seller for the forex option contract rights is called the forex option "premium."
The Forex Option Buyer - The buyer, or holder, of a foreign currency option has the choice to either sell the foreign currency option contract prior to expiration, or he or she can choose to hold the foreign currency options contract until expiration and exercise his or her right to take a position in the underlying spot foreign currency. The act of exercising the foreign currency option and taking the subsequent underlying position in the foreign currency spot market is known as "assignment" or being "assigned" a spot position.
The only initial financial obligation of the foreign currency option buyer is to pay the premium to the seller up front when the foreign currency option is initially purchased. Once the premium is paid, the foreign currency option holder has no other financial obligation (no margin is required) until the foreign currency option is either offset or expires.
On the expiration date, the call buyer can exercise his or her right to buy the underlying foreign currency spot position at the foreign currency option's strike price, and a put holder can exercise his or her right to sell the underlying foreign currency spot position at the foreign currency option's strike price. Most foreign currency options are not exercised by the buyer, but instead are offset in the market before expiration.
Foreign currency options expires worthless if, at the time the foreign currency option expires, the strike price is "out-of-the-money." In simplest terms, a foreign currency option is "out-of-the-money" if the underlying foreign currency spot price is lower than a foreign currency call option's strike price, or the underlying foreign currency spot price is higher than a put option's strike price. Once a foreign currency option has expired worthless, the foreign currency option contract itself expires and neither the buyer nor the seller have any further obligation to the other party.
The Forex Option Seller - The foreign currency option seller may also be called the "writer" or "grantor" of a foreign currency option contract. The seller of a foreign currency option is contractually obligated to take the opposite underlying foreign currency spot position if the buyer exercises his right. In return for the premium paid by the buyer, the seller assumes the risk of taking a possible adverse position at a later point in time in the foreign currency spot market.
Initially, the foreign currency option seller collects the premium paid by the foreign currency option buyer (the buyer's funds will immediately be transferred into the seller's foreign currency trading account). The foreign currency option seller must have the funds in his or her account to cover the initial margin requirement. If the markets move in a favorable direction for the seller, the seller will not have to post any more funds for his foreign currency options other than the initial margin requirement. However, if the markets move in an unfavorable direction for the foreign currency options seller, the seller may have to post additional funds to his or her foreign currency trading account to keep the balance in the foreign currency trading account above the maintenance margin requirement.
Just like the buyer, the foreign currency option seller has the choice to either offset (buy back) the foreign currency option contract in the options market prior to expiration, or the seller can choose to hold the foreign currency option contract until expiration. If the foreign currency options seller holds the contract until expiration, one of two scenarios will occur: (1) the seller will take the opposite underlying foreign currency spot position if the buyer exercises the option or (2) the seller will simply let the foreign currency option expire worthless (keeping the entire premium) if the strike price is out-of-the-money.
Please note that "puts" and "calls" are separate foreign currency options contracts and are NOT the opposite side of the same transaction. For every put buyer there is a put seller, and for every call buyer there is a call seller. The foreign currency options buyer pays a premium to the foreign currency options seller in every option transaction.
Forex Call Option - A foreign exchange call option gives the foreign exchange options buyer the right, but not the obligation, to purchase a specific foreign exchange spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the foreign exchange option buyer pays to the foreign exchange option seller for the foreign exchange option contract rights is called the option "premium."
Please note that "puts" and "calls" are separate foreign exchange options contracts and are NOT the opposite side of the same transaction. For every foreign exchange put buyer there is a foreign exchange put seller, and for every foreign exchange call buyer there is a foreign exchange call seller. The foreign exchange options buyer pays a premium to the foreign exchange options seller in every option transaction.
The Forex Put Option - A foreign exchange put option gives the foreign exchange options buyer the right, but not the obligation, to sell a specific foreign exchange spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the foreign exchange option buyer pays to the foreign exchange option seller for the foreign exchange option contract rights is called the option "premium."
Please note that "puts" and "calls" are separate foreign exchange options contracts and are NOT the opposite side of the same transaction. For every foreign exchange put buyer there is a foreign exchange put seller, and for every foreign exchange call buyer there is a foreign exchange call seller. The foreign exchange options buyer pays a premium to the foreign exchange options seller in every option transaction.
Plain Vanilla Forex Options - Plain vanilla options generally refer to standard put and call option contracts traded through an exchange (however, in the case of forex option trading, plain vanilla options would refer to the standard, generic forex option contracts that are traded through an over-the-counter (OTC) forex options dealer or clearinghouse). In simplest terms, vanilla forex options would be defined as the buying or selling of a standard forex call option contract or a forex put option contract.
Exotic Forex Options - To understand what makes an exotic forex option "exotic," you must first understand what makes a forex option "non-vanilla." Plain vanilla forex options have a definitive expiration structure, payout structure and payout amount. Exotic forex option contracts may have a change in one or all of the above features of a vanilla forex option. It is important to note that exotic options, since they are often tailored to a specific's investor's needs by an exotic forex options broker, are generally not very liquid, if at all.
Intrinsic & Extrinsic Value - The price of an FX option is calculated into two separate parts, the intrinsic value and the extrinsic (time) value.
The intrinsic value of an FX option is defined as the difference between the strike price and the underlying FX spot contract rate (American Style Options) or the FX forward rate (European Style Options). The intrinsic value represents the actual value of the FX option if exercised. Please note that the intrinsic value must be zero (0) or above - if an FX option has no intrinsic value, then the FX option is simply referred to as having no (or zero) intrinsic value (the intrinsic value is never represented as a negative number). An FX option with no intrinsic value is considered "out-of-the-money," an FX option having intrinsic value is considered "in-the-money," and an FX option with a strike price at, or very close to, the underlying FX spot rate is considered "at-the-money."
The extrinsic value of an FX option is commonly referred to as the "time" value and is defined as the value of an FX option beyond the intrinsic value. A number of factors contribute to the calculation of the extrinsic value including, but not limited to, the volatility of the two spot currencies involved, the time left until expiration, the riskless interest rate of both currencies, the spot price of both currencies and the strike price of the FX option. It is important to note that the extrinsic value of FX options erodes as its expiration nears. An FX option with 60 days left to expiration will be worth more than the same FX option that has only 30 days left to expiration. Because there is more time for the underlying FX spot price to possibly move in a favorable direction, FX options sellers demand (and FX options buyers are willing to pay) a larger premium for the extra amount of time.
Volatility - Volatility is considered the most important factor when pricing forex options and it measures movements in the price of the underlying. High volatility increases the probability that the forex option could expire in-the-money and increases the risk to the forex option seller who, in turn, can demand a larger premium. An increase in volatility causes an increase in the price of both call and put options.
Delta - The delta of a forex option is defined as the change in price of a forex option relative to a change in the underlying forex spot rate. A change in a forex option's delta can be influenced by a change in the underlying forex spot rate, a change in volatility, a change in the riskless interest rate of the underlying spot currencies or simply by the passage of time (nearing of the expiration date).
The delta must always be calculated in a range of zero to one (0-1.0). Generally, the delta of a deep out-of-the-money forex option will be closer to zero, the delta of an at-the-money forex option will be near .5 (the probability of exercise is near 50%) and the delta of deep in-the-money forex options will be closer to 1.0. In simplest terms, the closer a forex option's strike price is relative to the underlying spot forex rate, the higher the delta because it is more sensitive to a change in the underlying rate.
Forex option trading has emerged as an alternative investment vehicle for many traders and investors. As an investment tool, forex option trading provides both large and small investors with greater flexibility when determining the appropriate forex trading and hedging strategies to implement.
Most forex options trading is conducted via telephone as there are only a few forex brokers offering online forex option trading platforms.
Forex Option Defined - A forex option is a financial currency contract giving the forex option buyer the right, but not the obligation, to purchase or sell a specific forex spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the forex option buyer pays to the forex option seller for the forex option contract rights is called the forex option "premium."
The Forex Option Buyer - The buyer, or holder, of a foreign currency option has the choice to either sell the foreign currency option contract prior to expiration, or he or she can choose to hold the foreign currency options contract until expiration and exercise his or her right to take a position in the underlying spot foreign currency. The act of exercising the foreign currency option and taking the subsequent underlying position in the foreign currency spot market is known as "assignment" or being "assigned" a spot position.
The only initial financial obligation of the foreign currency option buyer is to pay the premium to the seller up front when the foreign currency option is initially purchased. Once the premium is paid, the foreign currency option holder has no other financial obligation (no margin is required) until the foreign currency option is either offset or expires.
On the expiration date, the call buyer can exercise his or her right to buy the underlying foreign currency spot position at the foreign currency option's strike price, and a put holder can exercise his or her right to sell the underlying foreign currency spot position at the foreign currency option's strike price. Most foreign currency options are not exercised by the buyer, but instead are offset in the market before expiration.
Foreign currency options expires worthless if, at the time the foreign currency option expires, the strike price is "out-of-the-money." In simplest terms, a foreign currency option is "out-of-the-money" if the underlying foreign currency spot price is lower than a foreign currency call option's strike price, or the underlying foreign currency spot price is higher than a put option's strike price. Once a foreign currency option has expired worthless, the foreign currency option contract itself expires and neither the buyer nor the seller have any further obligation to the other party.
The Forex Option Seller - The foreign currency option seller may also be called the "writer" or "grantor" of a foreign currency option contract. The seller of a foreign currency option is contractually obligated to take the opposite underlying foreign currency spot position if the buyer exercises his right. In return for the premium paid by the buyer, the seller assumes the risk of taking a possible adverse position at a later point in time in the foreign currency spot market.
Initially, the foreign currency option seller collects the premium paid by the foreign currency option buyer (the buyer's funds will immediately be transferred into the seller's foreign currency trading account). The foreign currency option seller must have the funds in his or her account to cover the initial margin requirement. If the markets move in a favorable direction for the seller, the seller will not have to post any more funds for his foreign currency options other than the initial margin requirement. However, if the markets move in an unfavorable direction for the foreign currency options seller, the seller may have to post additional funds to his or her foreign currency trading account to keep the balance in the foreign currency trading account above the maintenance margin requirement.
Just like the buyer, the foreign currency option seller has the choice to either offset (buy back) the foreign currency option contract in the options market prior to expiration, or the seller can choose to hold the foreign currency option contract until expiration. If the foreign currency options seller holds the contract until expiration, one of two scenarios will occur: (1) the seller will take the opposite underlying foreign currency spot position if the buyer exercises the option or (2) the seller will simply let the foreign currency option expire worthless (keeping the entire premium) if the strike price is out-of-the-money.
Please note that "puts" and "calls" are separate foreign currency options contracts and are NOT the opposite side of the same transaction. For every put buyer there is a put seller, and for every call buyer there is a call seller. The foreign currency options buyer pays a premium to the foreign currency options seller in every option transaction.
Forex Call Option - A foreign exchange call option gives the foreign exchange options buyer the right, but not the obligation, to purchase a specific foreign exchange spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the foreign exchange option buyer pays to the foreign exchange option seller for the foreign exchange option contract rights is called the option "premium."
Please note that "puts" and "calls" are separate foreign exchange options contracts and are NOT the opposite side of the same transaction. For every foreign exchange put buyer there is a foreign exchange put seller, and for every foreign exchange call buyer there is a foreign exchange call seller. The foreign exchange options buyer pays a premium to the foreign exchange options seller in every option transaction.
The Forex Put Option - A foreign exchange put option gives the foreign exchange options buyer the right, but not the obligation, to sell a specific foreign exchange spot contract (the underlying) at a specific price (the strike price) on or before a specific date (the expiration date). The amount the foreign exchange option buyer pays to the foreign exchange option seller for the foreign exchange option contract rights is called the option "premium."
Please note that "puts" and "calls" are separate foreign exchange options contracts and are NOT the opposite side of the same transaction. For every foreign exchange put buyer there is a foreign exchange put seller, and for every foreign exchange call buyer there is a foreign exchange call seller. The foreign exchange options buyer pays a premium to the foreign exchange options seller in every option transaction.
Plain Vanilla Forex Options - Plain vanilla options generally refer to standard put and call option contracts traded through an exchange (however, in the case of forex option trading, plain vanilla options would refer to the standard, generic forex option contracts that are traded through an over-the-counter (OTC) forex options dealer or clearinghouse). In simplest terms, vanilla forex options would be defined as the buying or selling of a standard forex call option contract or a forex put option contract.
Exotic Forex Options - To understand what makes an exotic forex option "exotic," you must first understand what makes a forex option "non-vanilla." Plain vanilla forex options have a definitive expiration structure, payout structure and payout amount. Exotic forex option contracts may have a change in one or all of the above features of a vanilla forex option. It is important to note that exotic options, since they are often tailored to a specific's investor's needs by an exotic forex options broker, are generally not very liquid, if at all.
Intrinsic & Extrinsic Value - The price of an FX option is calculated into two separate parts, the intrinsic value and the extrinsic (time) value.
The intrinsic value of an FX option is defined as the difference between the strike price and the underlying FX spot contract rate (American Style Options) or the FX forward rate (European Style Options). The intrinsic value represents the actual value of the FX option if exercised. Please note that the intrinsic value must be zero (0) or above - if an FX option has no intrinsic value, then the FX option is simply referred to as having no (or zero) intrinsic value (the intrinsic value is never represented as a negative number). An FX option with no intrinsic value is considered "out-of-the-money," an FX option having intrinsic value is considered "in-the-money," and an FX option with a strike price at, or very close to, the underlying FX spot rate is considered "at-the-money."
The extrinsic value of an FX option is commonly referred to as the "time" value and is defined as the value of an FX option beyond the intrinsic value. A number of factors contribute to the calculation of the extrinsic value including, but not limited to, the volatility of the two spot currencies involved, the time left until expiration, the riskless interest rate of both currencies, the spot price of both currencies and the strike price of the FX option. It is important to note that the extrinsic value of FX options erodes as its expiration nears. An FX option with 60 days left to expiration will be worth more than the same FX option that has only 30 days left to expiration. Because there is more time for the underlying FX spot price to possibly move in a favorable direction, FX options sellers demand (and FX options buyers are willing to pay) a larger premium for the extra amount of time.
Volatility - Volatility is considered the most important factor when pricing forex options and it measures movements in the price of the underlying. High volatility increases the probability that the forex option could expire in-the-money and increases the risk to the forex option seller who, in turn, can demand a larger premium. An increase in volatility causes an increase in the price of both call and put options.
Delta - The delta of a forex option is defined as the change in price of a forex option relative to a change in the underlying forex spot rate. A change in a forex option's delta can be influenced by a change in the underlying forex spot rate, a change in volatility, a change in the riskless interest rate of the underlying spot currencies or simply by the passage of time (nearing of the expiration date).
The delta must always be calculated in a range of zero to one (0-1.0). Generally, the delta of a deep out-of-the-money forex option will be closer to zero, the delta of an at-the-money forex option will be near .5 (the probability of exercise is near 50%) and the delta of deep in-the-money forex options will be closer to 1.0. In simplest terms, the closer a forex option's strike price is relative to the underlying spot forex rate, the higher the delta because it is more sensitive to a change in the underlying rate.
Advantages of Trading FOREX Over Stocks and Commodities
There are many advantages to Trading FOREX as your main income generator. Let’s start by something that may be worrying you already.
“Do I need a Diploma or some kind of Certification to trade FOREX?” The answer is this:
When attempting to make more profit than losses on the fluctuation of exchange rates between major currencies (i.e., Trading the FOREX), nobody is going to ask you for a diploma, a formal license or verify the amount of hours you've spent studying the Foreign exchange market and banking industry. All you need is the proper training.
But this is not the only advantage you get when trading FOREX, compared to other ways of investment and speculation; i.e. Stocks and Commodities. You have a whole bunch of advantages over these other options that will be enumerated in the following paragraphs.
The Main Benefits of Trading the FX Spot Market:
1): FOREX is the largest financial market in the world.
With a daily trading volume of over $1.5 trillion, the spot FOREX market can absorb trading sizes that dwarf the capacity of any other market. In fact, when compared with the $50 billion daily market for equities or the $30 billion futures market, it becomes quickly apparent this gives you, and millions of other FOREX traders, almost infinite trading liquidity and flexibility.
2): FOREX is a TRUE 24-hour market.
The FOREX Market never sleeps. Trading positions can be entered and exited at any moment - around the globe, around the clock, six days a week. There is no waiting for an opening bell as in the case of trading stocks. It is a 24- hour, continuous electronic (ONLINE) currency exchange that never closes. This is very desirable for you if you want to trade on a part-time basis, because you can choose when you want to trade: morning, noon or night.
3): There is never a Bear Market in FOREX.
You can have access to a seamless, mutually-inclusive (two- way) exchange of currencies. Meaning, because currencies trade in "pairs" (for example, US dollar vs. yen or US dollar vs. Swiss franc), one side of every currency pair (for example, USD/JPY - JPY = YEN) is constantly moving in relation to the other. Thus, when you buy a particular currency, you are actually simultaneously selling the other currency in that particular pair. As the market moves, one of the currencies will increase in value versus the other. Of course, it is up to you to choose the correct currency to be long or short. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market. This means you have equal potential to profit in both a rising or falling market.
4): High Leverage - up to 200:1 Leverage.
You are permitted to trade foreign currencies on a highly leveraged basis - up to 200 times your investment with some brokers. This is primarily attributed to the higher levels of liquidity within the currency markets. Standard 100,000- unit currency lots can be traded with as little as 1% margin, or $1,000. Mini FX accounts are permitted to trade with just 0.5% margin -- in other words, just $50 allows you to control a 10,000-unit currency position. Futures traders, who are accustomed to margin requirements generally equal to 5%-8% of the contract value, will immediately recognize that the FOREX market provides much greater leverage, and for stock traders, who must post at least 50% margin, there’s no comparison. If you are looking for an efficient use of trading capital, this is it!
5): Price Movements Are Highly Predictable.
Although currency prices in the FX market may be volatile, they generally repeat themselves in relatively predictable cycles, creating trends. The strong trends that foreign currencies develop are a significant advantage for traders who use the correct "technical" methods.
Unlike stocks, currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. Over 80% of volume is speculative in nature and, as a result, the market frequently overshoots and then corrects itself. As a technically-trained trader, you can easily identify new trends and breakouts, which provide for multiple opportunities to enter and exit positions.
6:) Commission-free Trading and Low Transaction Cost
When you trade FOREX, through one of our recommended brokers (this info is in our private resources section), you'll do it totally commission-free! These brokers don't charge commissions to trade or to maintain an account, and that goes for all clients trading the FOREX through them, regardless of your account balance or trading volume. Even Mini FX traders can buy and sell currencies online, commission-free.
What about trading fees? There are none of the usual fees to which futures and equity traders are accustomed -- no exchange or clearing fees, no N_F_A or S_E_C fees. Because currencies trade over-the-counter (OTC), via a global electronic network -- in FOREX, what you see is what you get, allowing you to make quick decisions on your trades without having to worry or account for fees that may affect your profit/loss or slippage.
In the equities markets, you must pay both a commission and exchange fees. The over-the-counter structure of the FX market eliminates exchange and clearing fees, which in turn lowers transaction costs.
So, if FOREX broker don't charge commissions, how do they make money? Like all traded financial products, over-the- counter currency trading involves a bid/ask spread, which represents the prices at which your counterparty is willing to trade. Because the currency market offers round-the-clock liquidity, you receive tight, competitive spreads both intra-day and night. Stock traders can be more vulnerable to liquidity risk and typically receive wider trading spreads, especially during after-hours trading.
7): Instantaneous Order Execution and Market Transparency.
Market transparency is highly desired in any trading environment. The greater the market transparency, the more efficient the market becomes. Unlike other markets where transparency is compromised (like in the Enron scandal), FOREX markets are highly transparent (i.e., analyzing countries, and having access to real-time research / news, is easier than companies).
Because of this transparency, as an FX trader, you will be able to exercise risk management strategies in accordance to the fundamental and technical indicators we teach at RapidForex.com
The FX market offers the highest level of market transparency out of all the financial markets. Because of this, order execution and fill confirmation usually occur in just 1-2 seconds. Markets that do not offer executable prices and force traders to absorb slippage obviously compromise the trader's profit potential considerably.
In the forex world, order execution is all-electronic and because you'll be trading via an Internet-based platform, instantaneous execution is routine. There are no exchanges, no traditional open-outcry pits, no floor brokers, and consequently, no delays.
“Do I need a Diploma or some kind of Certification to trade FOREX?” The answer is this:
When attempting to make more profit than losses on the fluctuation of exchange rates between major currencies (i.e., Trading the FOREX), nobody is going to ask you for a diploma, a formal license or verify the amount of hours you've spent studying the Foreign exchange market and banking industry. All you need is the proper training.
But this is not the only advantage you get when trading FOREX, compared to other ways of investment and speculation; i.e. Stocks and Commodities. You have a whole bunch of advantages over these other options that will be enumerated in the following paragraphs.
The Main Benefits of Trading the FX Spot Market:
1): FOREX is the largest financial market in the world.
With a daily trading volume of over $1.5 trillion, the spot FOREX market can absorb trading sizes that dwarf the capacity of any other market. In fact, when compared with the $50 billion daily market for equities or the $30 billion futures market, it becomes quickly apparent this gives you, and millions of other FOREX traders, almost infinite trading liquidity and flexibility.
2): FOREX is a TRUE 24-hour market.
The FOREX Market never sleeps. Trading positions can be entered and exited at any moment - around the globe, around the clock, six days a week. There is no waiting for an opening bell as in the case of trading stocks. It is a 24- hour, continuous electronic (ONLINE) currency exchange that never closes. This is very desirable for you if you want to trade on a part-time basis, because you can choose when you want to trade: morning, noon or night.
3): There is never a Bear Market in FOREX.
You can have access to a seamless, mutually-inclusive (two- way) exchange of currencies. Meaning, because currencies trade in "pairs" (for example, US dollar vs. yen or US dollar vs. Swiss franc), one side of every currency pair (for example, USD/JPY - JPY = YEN) is constantly moving in relation to the other. Thus, when you buy a particular currency, you are actually simultaneously selling the other currency in that particular pair. As the market moves, one of the currencies will increase in value versus the other. Of course, it is up to you to choose the correct currency to be long or short. Since currency trading always involves buying one currency and selling another, there is no structural bias to the market. This means you have equal potential to profit in both a rising or falling market.
4): High Leverage - up to 200:1 Leverage.
You are permitted to trade foreign currencies on a highly leveraged basis - up to 200 times your investment with some brokers. This is primarily attributed to the higher levels of liquidity within the currency markets. Standard 100,000- unit currency lots can be traded with as little as 1% margin, or $1,000. Mini FX accounts are permitted to trade with just 0.5% margin -- in other words, just $50 allows you to control a 10,000-unit currency position. Futures traders, who are accustomed to margin requirements generally equal to 5%-8% of the contract value, will immediately recognize that the FOREX market provides much greater leverage, and for stock traders, who must post at least 50% margin, there’s no comparison. If you are looking for an efficient use of trading capital, this is it!
5): Price Movements Are Highly Predictable.
Although currency prices in the FX market may be volatile, they generally repeat themselves in relatively predictable cycles, creating trends. The strong trends that foreign currencies develop are a significant advantage for traders who use the correct "technical" methods.
Unlike stocks, currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends. Over 80% of volume is speculative in nature and, as a result, the market frequently overshoots and then corrects itself. As a technically-trained trader, you can easily identify new trends and breakouts, which provide for multiple opportunities to enter and exit positions.
6:) Commission-free Trading and Low Transaction Cost
When you trade FOREX, through one of our recommended brokers (this info is in our private resources section), you'll do it totally commission-free! These brokers don't charge commissions to trade or to maintain an account, and that goes for all clients trading the FOREX through them, regardless of your account balance or trading volume. Even Mini FX traders can buy and sell currencies online, commission-free.
What about trading fees? There are none of the usual fees to which futures and equity traders are accustomed -- no exchange or clearing fees, no N_F_A or S_E_C fees. Because currencies trade over-the-counter (OTC), via a global electronic network -- in FOREX, what you see is what you get, allowing you to make quick decisions on your trades without having to worry or account for fees that may affect your profit/loss or slippage.
In the equities markets, you must pay both a commission and exchange fees. The over-the-counter structure of the FX market eliminates exchange and clearing fees, which in turn lowers transaction costs.
So, if FOREX broker don't charge commissions, how do they make money? Like all traded financial products, over-the- counter currency trading involves a bid/ask spread, which represents the prices at which your counterparty is willing to trade. Because the currency market offers round-the-clock liquidity, you receive tight, competitive spreads both intra-day and night. Stock traders can be more vulnerable to liquidity risk and typically receive wider trading spreads, especially during after-hours trading.
7): Instantaneous Order Execution and Market Transparency.
Market transparency is highly desired in any trading environment. The greater the market transparency, the more efficient the market becomes. Unlike other markets where transparency is compromised (like in the Enron scandal), FOREX markets are highly transparent (i.e., analyzing countries, and having access to real-time research / news, is easier than companies).
Because of this transparency, as an FX trader, you will be able to exercise risk management strategies in accordance to the fundamental and technical indicators we teach at RapidForex.com
The FX market offers the highest level of market transparency out of all the financial markets. Because of this, order execution and fill confirmation usually occur in just 1-2 seconds. Markets that do not offer executable prices and force traders to absorb slippage obviously compromise the trader's profit potential considerably.
In the forex world, order execution is all-electronic and because you'll be trading via an Internet-based platform, instantaneous execution is routine. There are no exchanges, no traditional open-outcry pits, no floor brokers, and consequently, no delays.
Why Demo Account Performance Is Often Better Than Real Account Performance
Over the past several years, the popularity of online currency trading has grown substantially. Each day, online FX brokerage firms attract new investors - each of them lining up with a glint in their eye, lured in by promises of easy money. Most of these companies allow you to sign up for a free demo account which lets you place mock trades using their trading platform to get a feel for the excitement of currency trading. In the casual world of free demo accounts - many young traders find they are able to garner impressive profits without a significant amount of effort. It almost seems too good to be true. But transferring this success from a demo account to a real account is far less common. Why is this? The actual trading platform behaves the exact same way, the market doesn't care whether you're a demo or real trader - so what is different? It's you who has changed. Not your personality, not even your trading style - but the factors that affect you are different.
What is the key factor to trading success?
The search for the "Holy Grail" of trading has been a common theme throughout the history of markets. There are a variety of different techniques. Those whom are inclined towards number crunching and pattern recognition may prefer technical analysis, whereas those more focused on the big picture, logical macro perspective prefer fundamental analysis. Then there are specific methodologies like swing trading, trend following or even more esoteric ideas like the Elliot Wave theory. Which one is best? There are examples of very successful traders using each methodology.
Since most new traders lose money - perhaps the more appropriate question to ask is, "What is the key factor to trading failure?"
Greed and Fear
Trading is an atmosphere rich in the porous emotions of greed and fear. The current price of a given security or financial instrument at any point in time can be thought of as the confluence of greed (bulls) and fear (bears). These two emotions make up the core of humanity itself. When market information is released, trading can be a high intensity experience. Sensing danger, your body releases adrenaline that acts to accentuate both your greed (fight) and your fear (flight). Because these emotions are so strong, they can cause you to act irrationally, ignore your system, stated set of rules or trading plan and to act upon impulse. Indeed, this is a genetically programmed response - but it is often also the trader's downfall, especially when he's playing with much better capitalized, more sophisticated and experienced foes that know how to manipulate those emotions.
When you are a trader - you are always under the influence of at least one of these two emotions, even if you don't have any trades on.
Impact of fear and greed on your trading
If the market's going up and you're in - greed is telling you to buy more and fear is telling you to take your profits while you still can. If it's going down, fear of being wrong makes you hold onto a losing position - and then greed sometimes convinces you to "average down" your position (and buy more) so it'll be easier for you to come back.
If the market's going up and you're not invested - fear is telling you that you're missing out on easy money but it's your greed that causes you to get in just after the greatest increase (just when its about to reverse course). If the market's going down and you're not invested - greed is telling you to get in as the price is cheap, while fear reminds you that you'll miss out on this opportunity if you don't act quickly.
Perhaps if we just felt greed, or just felt fear we would be able to control our emotions a little better. But when both of these little devils whisper into our ears at the same time - it is often impossible not to listen.
The Thrill of Greed
The first time you try FX trading - you will feel the thrill of greed. It is an ecstatic experience, your brain flush with neurotransmitters and your mind giddy with visions of untold riches about to be reaped. Greed is bold, aggressive and incredibly exciting. It can take hold of you both mentally and physically. Just imagine the possibilities!
This greed is what draws us into FX trading in the first place - the dream of easy money and 100:1 or 200:1 margin rates. It inspires us and causes us to forego rational thinking in favour of reckless abandon.
In the movie Wall Street, Gordon Gecko says, "Greed is good", but it is also very dangerous - especially if you are unable to recognize when greed is the one doing the talking. Greed is also one of the most common techniques used to manipulate people. Every get rich quick scheme, promising untold riches for no money down takes advantage of your natural predisposition to throw all logic and sense out the window when greed pays a visit. The argument starts to appear very compelling and you ignore what would otherwise be clear warning signs. Like drunk goggles, greed can mislead you and when you eventually wake up you are often in a very precarious position.
The Fear of Losing
Fear can be equally as dangerous. The most potent and easily manipulated form of fear is your fear of admitting that you are wrong. Fear of having your precious ego bruised. This fear can cause people to do incredibly stupid things. The funny thing about this world is that everyone thinks that they are right. Most people would rather lose thousands of dollars than admit they are wrong. It is easy to feel ashamed of trading losses and live in denial but this is self-destructive behaviour. By denying the problem exists, you fail to take steps address it and only ensure that it will continue in the future.
Demo Trading
Demo trading is a great way to get started in foreign exchange trading. It is identical to real trading, except that you're using "pretend" money. Demo trading allows you to get a taste for what type of events move markets and how they move. It encourages you to learn more about geopolitics, macroeconomics and global finance and these are all incredibly positive things.
Demo trading also introduces you to the rapture of greed. Trading is a means to one of the purest, most raw and potent forms of greed. The whole point of trading is to make money and the more money you make - the stronger the pull of your greed becomes. It is intoxicating and can take complete control of you.
But demo trading does not introduce you to fear. There is no fear when you are demo trading. It is like you have a perpetual get out of jail free card. If you start losing badly on a demo account - simply start a new one. There is no accountability for your trading failures and only recognition of your trading success.
So your demo account does not teach you how to handle the emotion of fear. This emotion is most likely going to lead to your downfall. Greed may get you overextended, but fear will stop you from cutting your losses. You may think that fear of losing money would cause you to cut your losses, but the stronger emotion is fear of being wrong and that causes you to hold on to your losing position - until it's all gone.
There is also the issue of account size. Many demo accounts give you $50,000 to play with. This type of capitalization allows you to buy 5 lots (500K) of EURUSD pretty easily. If goes up 20 pips you've made $1000. Nice one. But when you open your real account - it's more likely that you put $5000 or $10000 in there to begin with. Now you're dealing with a 50K lot, which means you'll take $100 out of a 20-pip movement. But mentally you are used to getting $1000 for that movement so you usually end up risking more. Next thing you know - your 200K position has turned against you 50 pips and you've lost $1000. That's real money you just lost. You can't just start another account.
The capitalization of the demo account is sufficient to sustain losses and still come out on top. But your real account is likely to be undercapitalized and if you're trying to achieve returns similar to what you got on your demo account - you are going to blow up very quickly.
Being honest with yourself
Ultimately, while providing an excellent introduction to FX trading - demo accounts do not accurately predict whether you'll be successful trading real money. Markets are dominated by psychology and often go against what fundamental logic or technical indicators suggest should happen. The single most critical factor in your trading success will be your ability to control your emotions of greed and fear. These emotions cloud your judgment and cause you to trade recklessly. Demo accounts introduce you to the emotion of greed, but by their very nature they are risk free and therefore there is no fear involved. They are also likely to be better capitalized than your real money account, which misleads you with respect to the amount of returns you can expect to earn.
For all of these reasons, demo accounts allow you to avoid being honest with yourself and this is perhaps the most important factor of all. You need to know your edge and your limits and in order to know these - you must be honest with yourself.
This being said, demo accounts are still very entertaining and educational and I highly recommend opening one to anyone who's interested in getting a taste of the exciting world of FX trading. It's a great way to learn more about economics, global politics and yourself.
What is the key factor to trading success?
The search for the "Holy Grail" of trading has been a common theme throughout the history of markets. There are a variety of different techniques. Those whom are inclined towards number crunching and pattern recognition may prefer technical analysis, whereas those more focused on the big picture, logical macro perspective prefer fundamental analysis. Then there are specific methodologies like swing trading, trend following or even more esoteric ideas like the Elliot Wave theory. Which one is best? There are examples of very successful traders using each methodology.
Since most new traders lose money - perhaps the more appropriate question to ask is, "What is the key factor to trading failure?"
Greed and Fear
Trading is an atmosphere rich in the porous emotions of greed and fear. The current price of a given security or financial instrument at any point in time can be thought of as the confluence of greed (bulls) and fear (bears). These two emotions make up the core of humanity itself. When market information is released, trading can be a high intensity experience. Sensing danger, your body releases adrenaline that acts to accentuate both your greed (fight) and your fear (flight). Because these emotions are so strong, they can cause you to act irrationally, ignore your system, stated set of rules or trading plan and to act upon impulse. Indeed, this is a genetically programmed response - but it is often also the trader's downfall, especially when he's playing with much better capitalized, more sophisticated and experienced foes that know how to manipulate those emotions.
When you are a trader - you are always under the influence of at least one of these two emotions, even if you don't have any trades on.
Impact of fear and greed on your trading
If the market's going up and you're in - greed is telling you to buy more and fear is telling you to take your profits while you still can. If it's going down, fear of being wrong makes you hold onto a losing position - and then greed sometimes convinces you to "average down" your position (and buy more) so it'll be easier for you to come back.
If the market's going up and you're not invested - fear is telling you that you're missing out on easy money but it's your greed that causes you to get in just after the greatest increase (just when its about to reverse course). If the market's going down and you're not invested - greed is telling you to get in as the price is cheap, while fear reminds you that you'll miss out on this opportunity if you don't act quickly.
Perhaps if we just felt greed, or just felt fear we would be able to control our emotions a little better. But when both of these little devils whisper into our ears at the same time - it is often impossible not to listen.
The Thrill of Greed
The first time you try FX trading - you will feel the thrill of greed. It is an ecstatic experience, your brain flush with neurotransmitters and your mind giddy with visions of untold riches about to be reaped. Greed is bold, aggressive and incredibly exciting. It can take hold of you both mentally and physically. Just imagine the possibilities!
This greed is what draws us into FX trading in the first place - the dream of easy money and 100:1 or 200:1 margin rates. It inspires us and causes us to forego rational thinking in favour of reckless abandon.
In the movie Wall Street, Gordon Gecko says, "Greed is good", but it is also very dangerous - especially if you are unable to recognize when greed is the one doing the talking. Greed is also one of the most common techniques used to manipulate people. Every get rich quick scheme, promising untold riches for no money down takes advantage of your natural predisposition to throw all logic and sense out the window when greed pays a visit. The argument starts to appear very compelling and you ignore what would otherwise be clear warning signs. Like drunk goggles, greed can mislead you and when you eventually wake up you are often in a very precarious position.
The Fear of Losing
Fear can be equally as dangerous. The most potent and easily manipulated form of fear is your fear of admitting that you are wrong. Fear of having your precious ego bruised. This fear can cause people to do incredibly stupid things. The funny thing about this world is that everyone thinks that they are right. Most people would rather lose thousands of dollars than admit they are wrong. It is easy to feel ashamed of trading losses and live in denial but this is self-destructive behaviour. By denying the problem exists, you fail to take steps address it and only ensure that it will continue in the future.
Demo Trading
Demo trading is a great way to get started in foreign exchange trading. It is identical to real trading, except that you're using "pretend" money. Demo trading allows you to get a taste for what type of events move markets and how they move. It encourages you to learn more about geopolitics, macroeconomics and global finance and these are all incredibly positive things.
Demo trading also introduces you to the rapture of greed. Trading is a means to one of the purest, most raw and potent forms of greed. The whole point of trading is to make money and the more money you make - the stronger the pull of your greed becomes. It is intoxicating and can take complete control of you.
But demo trading does not introduce you to fear. There is no fear when you are demo trading. It is like you have a perpetual get out of jail free card. If you start losing badly on a demo account - simply start a new one. There is no accountability for your trading failures and only recognition of your trading success.
So your demo account does not teach you how to handle the emotion of fear. This emotion is most likely going to lead to your downfall. Greed may get you overextended, but fear will stop you from cutting your losses. You may think that fear of losing money would cause you to cut your losses, but the stronger emotion is fear of being wrong and that causes you to hold on to your losing position - until it's all gone.
There is also the issue of account size. Many demo accounts give you $50,000 to play with. This type of capitalization allows you to buy 5 lots (500K) of EURUSD pretty easily. If goes up 20 pips you've made $1000. Nice one. But when you open your real account - it's more likely that you put $5000 or $10000 in there to begin with. Now you're dealing with a 50K lot, which means you'll take $100 out of a 20-pip movement. But mentally you are used to getting $1000 for that movement so you usually end up risking more. Next thing you know - your 200K position has turned against you 50 pips and you've lost $1000. That's real money you just lost. You can't just start another account.
The capitalization of the demo account is sufficient to sustain losses and still come out on top. But your real account is likely to be undercapitalized and if you're trying to achieve returns similar to what you got on your demo account - you are going to blow up very quickly.
Being honest with yourself
Ultimately, while providing an excellent introduction to FX trading - demo accounts do not accurately predict whether you'll be successful trading real money. Markets are dominated by psychology and often go against what fundamental logic or technical indicators suggest should happen. The single most critical factor in your trading success will be your ability to control your emotions of greed and fear. These emotions cloud your judgment and cause you to trade recklessly. Demo accounts introduce you to the emotion of greed, but by their very nature they are risk free and therefore there is no fear involved. They are also likely to be better capitalized than your real money account, which misleads you with respect to the amount of returns you can expect to earn.
For all of these reasons, demo accounts allow you to avoid being honest with yourself and this is perhaps the most important factor of all. You need to know your edge and your limits and in order to know these - you must be honest with yourself.
This being said, demo accounts are still very entertaining and educational and I highly recommend opening one to anyone who's interested in getting a taste of the exciting world of FX trading. It's a great way to learn more about economics, global politics and yourself.
Sunday, October 26, 2008
Forex Trading - Anyone Can Learn to Win But 95% of Traders Lose Why?
Forex trading is simple to understand and easy to learn yet, 95% of traders lose. There are two main reasons for this and we will look at both here...
First let's start with a fact to make you think:
30 years ago 95% of traders lost and 95% lose today despite the huge advances in communications, speed of data, quality of news and the power of computers and there testing power - the same ratio lose, so all the advances haven't helped.
You can't beat Forex with technology and the fact is simple systems work best and always have, as they have fewer elements to break than complicated ones.
So if you work hard or try and be clever it doesn't guarantee you success.
You may now well be asking...
If it only takes a simple system to win, anyone can do that and yes they can - but they must learn to apply it with discipline.
Discipline is the key!
Most traders can never trade in a disciplined fashion and the reasons they can't are they require that, not only do you need a good forex education but you are fighting your emotions when you trade and let them get the better of you and you will lose.
Normal behaviour we take for granted in society is fatal in forex markets. Let's look at some examples to illustrate this:
- You need to trade in isolation, away from the herd and this is hard, as we are like to be with the majority and not feel on our own.
- You cannot consult an expert, as trading success comes from within - your knowledge and the confidence you have in it and an expert can never give you that.
- There are no set rules in the market, you make your own, trust them and survive by them.
- We all hate losing, it wounds our ego but unless you learn to lose and keep your losses small you will never win.
Now all the above make trading a unique challenge.
Sure you can become disciplined - but don't let anyone tell you its easy - it isn't.
Of course, you wouldn't expect it to be, with the rewards on offer - but if you are disciplined and you have a sound logical method, applying it with discipline can bring you rewards which can change your financial future forever.
The choice is yours:
You can learn Forex trading the right way, or you can listen to the so called gurus and experts, who tell you it's a walk in the park and lose.
Make an effort - invest in a sound Forex education and you will have confidence and discipline and win - it's as simple as that. You can do it if you want to and the choice is yours.
Avoid Forex Gambling - Proper Money Management
A mentor of mine once taught me, "the difference between gambling and investing is education". In Forex, possibly more than anything else, this statement stands true. I would like to add one aspect to that statement though. The difference between Forex Trading and Forex Gambling is not only education, but proper a money management plan.
So what do I mean when I say "a proper money management plan you may ask? Well, learning how to trade Forex is more than just studying technical analysis, creating a Forex trading system, and trading that system. Even the best Forex trading system will lose with out proper money management. A money management plan is a plan for how the total account balance will be affected but each individual trade in a trading system. Your money management plan gets you through the losing periods and back to winning.
A money management plan should include several key components.- What percent of my overall account balance will I risk on every trade? This number can vary depending on the system and signal types. It should however be consistent across every trade. For instance, lets say you have a moving average system that takes trades off of both a one hour chart and a day chart. Your day signals may be higher probability signals but come less often. Your money management rules may call for risking 1% of the total account balance on every daily signal and 1/2% of the total balance on the hourly signals.
- What is my maximum daily and overall maximum drawdown? Some plans look at what a system's maximum drawdown has been over the last few years as well as the average daily maximum drawdown. The plan then could include a rule that states I will stop trading today if my account balance draws down 2%. If the system as a whole draws down more than 25% at anytime I will stop trading. This is your maximum risk threshold. A daily maximum helps you stop trading when emotions may get the best of you and the overall maximum drawdown helps you determine at what point I may need to reassess the effectiveness of my system.
- At what intervals will I withdraw profits from my account? I am not talking about taking profit on individual trades. I am talking about actually pulling profits from your trading account. Pulling profits must be balanced with compounding profits. There is a delicate balance between the rule as to when profits should be withdrawn depends on the investor and his/her trading strategy. My Forex money management plan calls for withdrawing 50% of profits on a quarterly basis. Some may take profits on a monthly basis and others yearly.
- What is my maximum Margin level? This refers to over trading. Some traders may think, I have all this available margin, why not use it? This can be a dangerous mentality though. Every dollar margined puts at risk the overall balance of the account. You may make money faster but you WILL lose it faster. Using too much of your available margin puts you in the realm of gambling. Markets can move quickly and even if you have a stop-loss that is suppose to keep you from losing more than a small percent of your account balance, drastic news could move a currency far past your stop-loss resulting in a much larger loss than your money management plan had anticipated. Keep at least 50% of your margin available for use. Never trade less than $1000 with a micro account, $10000 with a mini account, and $100,000 with a standard account. Your money management plan should have rules in place in the event margin falls below certain levels.
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