Technical Analysis of the Forex Market

Along with fundamental analysis, technical analysis is one of the two main methods of informing oneself and building a stronger position to profit from the Forex market. While fundamental analysis allows you to predict the movement of a currency by looking at the political and economic position of a country, technical analysis has more to do with looking at collected market data and using it to predict future movement. This is an approach that is very commonly used on the stock market, for example, where historic data is the single most important part of predicting future performance.

While a fundamental analysis will look at the reasons for market movement – allowing us to know why something happened – the technical analysis of the same market will tell us exactly what happened. That is to say that it will give us the raw data. Fundamental analysis requires an extremely broad view and, for those who are disinterested in politics, can be overly time-consuming. If these people are strong technical analysts, they can usually learn enough from the movements themselves. Whatever the reason for a movement, the fact is that currency prices follow trends.

Regardless of anything else, people know that patterns have emerged in how foreign currencies behave, patterns which have held true for more than a century. These patterns mirror human behavior – one of the few constant things in the world – and therefore are an excellent way of predicting the future. You may not know who the President of a certain country is, but if you know how its currency performs over a period of time you are well within your rights to not care.

Analyzing the market to your advantage

It has been said by many experienced traders that Forex is a more volatile market than any of the available options. The theory goes that it is difficult enough to judge a single company’s value at a given time and in the future, just imagine how hard it is to do the same thing with a whole country. This philosophy takes the point of view that analyzing the Forex market relies on careful reading over a period of time. Some knowledge of world affairs is also advantageous, as it allows you to be aware in advance of the timing of important announcements which can cause market volatility.

Others will treat the Forex market exactly like they would treat any other stock market, and take a more technical approach to analyzing their next step. This is not as simple a process in Forex as it is in the stock market, as the Forex is a 24-hour market, and the data-gathering systems require some modification to work effectively on Forex. Nonetheless, where these methods of technical analysis have been correctly applied, they have proved to be an effective way of making a profit on the Forex market just as their original forms proved on other markets.

While the first method is more of a global, evidence-based approach and the second tends towards techniques and patterns, both have been proven to be successful if correctly applied. It is highly advisable, though, to recognise which one to apply at a given time, as confusion can easily arise around what exactly the data tells you. Pick the method that you require and use the other to supplement it. That is the only way you can confidently operate in the long term.

What New Traders Need to Learn

Kudos to John Forman, who has assembled an edited volume specific to the questions most asked by developing traders. A variety of experienced traders and market bloggers have participated in the volume, offering a mix of viewpoints. It is often quite difficult for new traders to obtain impartial guidance in starting their careers, so such resources are quite valuable. The topics for the questions range from trading mechanics and trading psychology to market analysis and trading careers. Good stuff!

In general, I would highlight three areas of learning that I would want to have if I were looking to start out as a trader today:

1) Macroeconomics – I would want to have a grasp of intermarket relationships and how monetary policy affects interest rates, currencies, and economic growth. This information may not determine the trade over the next half-hour, but it does govern the market’s longer time frame picture and help determine market trends. A lack of understanding of macroeconomics and intermarket relationships has been a major reason many short-term traders have lost money fighting the market over the last few months.

2) A Trading Theory – A trader needs a framework for thinking about price movement and making sense out of the steady stream of price changes across markets. I’m not sure that it matters greatly whether traders subscribe to one theory or another, but I am certain that having an explanatory framework is better than not having one. Personally, I have found Market Profile theory to be an especially useful way of conceptualizing market action across time frames. Other people find Elliott Wave theory or any of a variety of technical analysis frameworks to be useful.

3) Observation – Hands down, the smartest thing I ever did when learning how to trade was to watch markets for a long time before trying to trade them. I collected charts of intraday action and, each day, looked for the best trading opportunities. Over time, I started to see repetitive patterns among those opportunities and those became important to my subsequent trading. Watching not only price, but volume, sector behavior, intermarket action, and such measures as NYSE TICK help you recognize the dynamics of breakouts, reversals, and trends.

Knowing what I know today, if I were starting out as a trader or advising a beginning trader, I would advocate at least a full year of learning, observation, and practice trading before putting money at risk. I strongly believe that a major reason new traders don’t succeed is that they fail to put in the necessary time to learn markets and acquire skills.

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Catching Up on Midweek Reading

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Support and Resistance – the two key words

To really understand the behavior of a currency on the Forex market it is important to see how it has behaved over a period of time. Taken over the course of a very short space of time, it is possible to make data mean just about anything. This, in turn, means that the data will be almost worthless. Over a longer period of time, however, patterns always seem to assert themselves, and establish a firm basis for predicting the future behavior of a currency price. Among the most important figures that appear in a pattern are the support and resistance points.

The point of “support” for any currency is the price level beneath which a currency never trades – effectively its market “bottom”. Whenever the price reaches this level, it almost always bounces back upwards, and for this reason many people will invest when a currency hits that point. Conversely, the “resistance” point is the traditional high point of a currency price, above which it never trades. If you are looking to cash out, this is a good reference point.

Of course, the old saying “there’s a first time for everything” exists for a reason. There will come a time when a currency breaks its support or resistance levels, and this is seen as hugely important. When a currency does this it will be expected to continue this trend, possibly for an extended period of time. It is therefore a good time to get “in” if it is rising or “out” if it is falling.

End of the Week Readings

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Core Ideas in Trading Psychology: Solution-Focused Change

One of the key themes running through the TraderFeed blog, as well as the books that I’ve written on trading psychology, is that effective change comes from building on positive patterns of thoughts and behavior. We can think of these as “solution patterns”, as opposed to the “problem patterns” that typically become the focus of coaching and counseling efforts.

The essence of the solution-focused approach is that we can often find the answers to our problems by looking at instances in which those problems are not occurring. For instance, if a trader who is troubled by a problem of overtrading exercises good restraint on a particular day, we would try to find out how he accomplished that. We would examine his preparation for the market day, his efforts to guide his decision-making with rules, his thought process while positions were on, etc. Out of this examination, we can figure out what he did right: what works for him. By crystallizing those positive actions into solution patterns, we can do more of what works and begin to build new, positive habit patterns.

The value of the solution focused method is that it does not impose answers from the outside: it builds upon the existing strengths of the trader. The key idea is that, in some ways, at some times, we trade well: we do not fall into problem patterns and instead enact the skills that define who we are when we are at our best. This requires a major mind shift for many traders: they are so focused on their problem patterns that they never note their strengths. And if they aren’t aware of what they are doing right and how they’re doing it, how can they hope to build on those competencies?

This is why it is valuable, in keeping trading journals, to identify clearly what you are doing well as well as what you need to improve. By turning positive trading behaviors into forward-looking goals, we build on strengths and move ourselves closer to our ideals.

For more on solution-focused methods, check out The Daily Trading Coach and the posts on Focusing on Trading Solutions and this post (and its links) on Becoming Solution Focused.
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Core Ideas in Trading Psychology: Creating Change Through Mirrors and Corrective Emotional Experiences

When people find themselves locked into repetitive patterns of thought, feeling, and/or behavior that interfere with their lives, how do they escape? As all too many dieters are aware, we can know our problems and want to change them, but sustaining change can still be challenging.

A core idea in the Psychology of Trading book is that we tend to operate within a relatively narrow bandwidth of consciousness. If we imagine our possible states of mind and body as arrayed along a radio dial, we are generally stuck with a few presets on that dial. Life events can shift us from one state to another without our awareness, triggering patterns of thought and behavior specific to that state. That is how we can be wholly determined to quit smoking in one frame of mind, only to lapse into a smoke when we are bored or after we eat and drink.

The most effective techniques utilized by psychologists are those that enable people to become aware of those state shifts and reprogram the triggers unique to particular states. If, for instance, frustration in reaching my goals tends to trigger negative patterns of self-talk for me and those lead me to withdraw and feel depressed, I can use visualization and real life experience to place myself in frustrating situations and rehearse alternative modes of self-talk and behavior. With sufficient repetition, we internalize those new modes and reprogram our radio dials.

It is not simply the act of talking with a therapist that creates change: it is the act of doing things differently and generating new experiences that eventually become part of our selves. Alexander and French referred to these as “corrective emotional experiences”. They recognized that insight into problems, in itself, is not enough: change is accelerated and cemented through powerful emotional experience. Ironically, we know that powerful emotional experience can generate sudden, substantial life changes when it comes in the form of psychological trauma. Less acknowledged is that positive, powerful emotional experience can also catalyze major shifts in our life course.

From this vantage point, then, we can see that the problem of being stuck on the radio dial really boils down to having too few powerful and constructive life experiences. Every relationship, every activity, every day at work potentially provides us with new ways of experiencing our selves. Every aspect of our environment becomes a mirror, reflecting to us who we are. Trading is one of those mirrors: it can reflect experiences of mastery and pride of accomplishment or frustration and failure. Romantic relationships are another mirror; who we are with helps shape our experience of our selves.

To create change, therefore, we must become architects of our own experience. That means carefully creating our life mirrors, particularly selecting mirrors that take us out of our comfort zones on the radio dial to generate fresh experiences of the self. If we stay in life routines, we will live out the same routines in life; change cannot occur. Implemented properly, trading journals are not only tools for reflecting on our performance; they provide blueprints for our life’s architecture.

For more on psychological techniques for achieving corrective emotional experiences, see the Daily Trading Coach book; for more on the role of mirroring in trading development, see Enhancing Trader Performance. Posts relevant to creating life mirrors include The Devon Principle, my Theory of Romantic Relationships, and How to Change Yourself.
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Readings to Kick Off the New Week

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What Competent Traders Need Most

I’ve written quite a few posts to attempt to guide beginning traders. But what if you’re a trader who has reached the stage of competence? Now you can consistently cover costs and sustain modest profits. How do you get to the next stage of expertise, where you can make a solid living from your trading?

What many competent traders do is try to magnify their modest profits by trading more instead of by trading larger. Because they have modest account sizes, they cannot size their trades significantly, so they try to put on more trades. Such overtrading takes them out of their niches of competence and leads them to lose money.

Those traders don’t recognize that they may already have the skills to become excellent traders. After all, a trader who can make $200/day trading 5 lots in the ES futures could be making $2000 a day trading 50 lots, not a bad six figure income. Given the liquidity of the market, the trades that work with 5 lots by and large will work with 50 lots. It’s just a matter of growing into that size. The actual trading doesn’t have to change significantly.

Probably, this issue occurs in other areas of business. The successful local restaurant might have all the makings of a powerhouse chain of eateries, but without access to capital and a managerial talent pool, that growth never happens.

That is why access to capital is key for the competent trader: either capital one has saved up or that one can access through trading for deep-pocketed firms.

The second thing that competent traders need is access to expert traders. A beginning trader, like a Little League ball player, can benefit from coaching from a more experienced person. It doesn’t take an expert to coach a rookie. But once athletes becomes college stars, they require hands-on mentoring from coaches and mentors with expertise. It is not too unusual to see self-made competent golf players, traders, or singers. It’s rare to see expertise develop in relative isolation.

That is because expert coaches and mentors help to mold and accelerate learning curves, to make the most of a person’s talent. If you’ve reached a stage of competence, it is vital to use online resources, personal networking, and/or access to trading firms to learn from pros. Look at the history of great achievers in business, the arts, sciences, and sports: even the self-made greats stood on the shoulders of giants.

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