forex

Courage Under Stressful Conditions When the Outcome is Uncertain
All the foreign exchange trading knowledge in the world is not going to
help, unless you have the nerve to buy and sell currencies and put
your money at risk. As with the lottery “You gotta be in it to win it”.
Trust me when I say that the simple task of hitting the buy or sell key
is extremely difficult to do when your own real money is put at risk.
You will feel anxiety, even fear. Here lies the moment of truth. Do you
have the courage to be afraid and act anyway? When a fireman runs into
a burning building I assume he is afraid but he does it anyway and
achieves the desired result. Unless you can overcome or accept your fear
and do it anyway, you will not be a successful trader.
However, once you learn to control your fear, it gets easier and easier
and in time there is no fear. The opposite reaction can become an
issue – you’re overconfident and not focused enough on the risk you're
taking.
Start by analyzing yourself. Are you the type of person that can
control their emotions and flawlessly execute trades, oftentimes under
extremely stressful conditions? Are you the type of person who’s
overconfident and prone to take more risk than they should? Before your first real
trade you need to look inside yourself and get the answers. We can
correct any deficiencies before they result in paralysis (not pulling the
trigger) or a huge loss (overconfidence). A huge loss can prematurely
end your trading career, or prolong your success until you can raise
additional capital.
Both the inability to initiate a trade, or close a losing trade can
create serious psychological issues for a trader going forward. By calling
attention to these potential stumbling blocks beforehand, you can
properly prepare prior to your first real trade and develop good trading
habits from day one.
The difficulty doesn’t end with “pulling the trigger”. In fact what
comes next is equally or perhaps more difficult. Once you are in the trade
the next hurdle is staying in the trade. When trading foreign exchange
you exit the trade as soon as possible after entry when it is not
working. Most people who have been successful in non-trading ventures find
this concept difficult to implement.
For example, real estate tycoons make their fortune riding out the bad
times and selling during the boom periods. The problem with trying to
adapt a 'hold on until it comes back' strategy in foreign exchange is
that most of the time the currencies are in long-term persistent,
directional trends and your equity will be wiped out before the currency comes
back.
The other side of the coin is staying in a trade that is working. The
most common pitfall is closing out a winning position without a valid
reason. Once again, fear is the culprit. Your subconscious demons will be
scaring you non-stop with questions like “what if news comes out and
you wind up with a loss”. The reality is if news comes out in a currency
that is going up, the news has a higher probability of being positive
than negative (more on why that is so in a later article).
So your fear is just a baseless annoyance. Don’t try and fight the
fear. Accept it. Have a laugh about it and then move on to the task at
hand, which is determining an exit strategy based on actual price movement.
As Garth says in Waynesworld “Live in the now man”. Worrying about
what could be is irrational. Studying your chart and determining an
objective exit point is reality based and rational.
Another common pitfall is closing a winning position because you are
bored with it; its not moving. In Football, after a star running back
breaks free for a 50-yard gain, he comes out of the game temporarily for a
breather. When he reenters the game he is a serious threat to gain
more yards – this is indisputable. So when your position takes a breather
after a winning move, the next likely event is further gains – so why
close it?
If you can be courageous under fire and strategically patient, foreign
exchange trading may be for you. If you’re a natural gunslinger and
reckless you will need to tone your act down a notch or two and we can
help you make the necessary adjustments. If putting your money at risk
makes you a nervous wreck its because you lack the knowledge base to be
confident in your decision making.
Patience to Gain Knowledge through Study and Focus
Many new traders believe all you need to profitably trade foreign
currencies are charts, technical indicators and a small bankroll. Most of
them blow up (lose all their money) within a few weeks or months; some
are initially successful and it takes as long as a year before they blow
up. A tiny minority with good money management skills, patience, and a
market niche go on to be successful traders. Armed with charts,
technical indicators, and a small bankroll, the chance of succeeding is
probably 500 to 1.
To increase your chances of success to near certainty requires
knowledge; acquiring knowledge takes hard work, study, dedication and focus.
Compile your knowledge base without taking any shortcuts, thereby
assuring a solid foundation to build upon.
s you may already know, foreign exchange (Forex/FX) is an unregulated
market that is not traded on an exchange, which means that prices you
see and get from one broker could vary from those of another broker.
There are mainly two types of brokers. One type is an ECN (Electronic
Communications Network) and another a Market-Maker.
Market-makers "make" or set the prices on their systems based on what
they think is best for themselves as the counter-party. This is because
every time you sell, they must buy, and when you buy, they must sell to
you. This is why they can give you a fixed spread since they are
setting both the bid and the ask price. Many of them will then try to
"hedge" or "cover" your order by passing it on to someone else; however, some
may decide to hold your order, and thus trade against you. This can
result in a conflict of interest between the retail trader (you) and the
market-maker.
ECNs, on the other hand, pass on prices from several banks and
market-makers, as well as from the other traders in the ECN, and display the
best bid/ask prices based on these input. This is why sometimes you can
get no spread on ECNs, especially in very liquid currency pairs. How do
ECNs make money then? They do so by charging you a fixed commission for
each transaction.
I want to explain to you how so-called News Trading is the latest
method devised by the marketing wizards to take your money.
The more subtle marketing wizards package it very scientifically. They
use impressive looking historical statistics to show how price action
unfolded immediately after certain economic data releases. See the
pattern, they trumpet, and make money from it.
The less subtle approach explains how to beat the gun with proprietary
data feeds on supposedly important data releases. In reality, most of
these data releases have never had any significant impact on the forex
market before, but despite this, the marketing wizards invite you to
join them in the shoot-out by paying a monthly subscription in the belief
that this will help you beat the market makers.
Before I go any further in showing you how to really lose your money,
your mind and your interest in this most lucrative market, let me just
tell you why I think you can pay attention to what I have to say on the
topic. Apart from the fact that I describe in my book, Bird Watching in
Lion Country – Retail Forex Trading Explained (BWILC), the absolute
necessity of real-time analysis and the folly of basing a trading
strategy for the long-term on very short-term technical analysis indicators -
or other illusionary patterns - I also explain a term which I coined:
“relational analysis”. This simply means that, if you are trading forex,
you have to relate three things all the time: price, time and events.
News trading as a concept has mainly to do with “events” and
specifically with those anticipated events that cause prices to move more than
usual, but only briefly - brief even in terms of short-term trading. News
trading as offered by the marketing wizards takes this concept and
then distorts it to rob you of your money.
Non-farm payrolls: March 1998
My mentor is an institutional bond trader who has a simple view on
technical analysis: “if the prices are high, it may be time to sell and if
the prices are low it may be a time to buy”. (He amusingly referred to
traders’ screens filled with every conceivable squiggle, line and
indicator as Playboys – dirty pictures.)
The point he was making is that trading decisions were not made based
on technical analysis other than for the basic positioning it could give
you as regards where the price is now, relative to where it has been
recently. If you are closely monitoring the market you will have a feel
for this anyway, but charts are helpful for a quick snapshot picture.
Noting and being acutely aware of upcoming economic data releases was
one of the main elements of his analysis and approach to understanding
the market and price action. This is what he based his trading decisions
on. At the time I started trading in 1998 I was only vaguely aware of
things like CPI, PPI, trade balance, money supply, and unemployment –
all the things that give economists and analysts that warm and fuzzy
feeling – but I quickly acquired an interest, figured out what each of
them meant and started using the Sunday papers’ business section to
monitor releases and follow the comments.
At this stage I was trading bonds on margin here in South Africa.
I had no live real-time price feed, nor a charting service. After a few
months I got a pager-based informational price feed which was about as
real-time as you could get. In addition to price changes it also
informed me of economic data releases. If you saw a price change occour that
made you to want to trade, you used the phone to call the broker - who
wasn’t in the primary business of fielding these sorts of calls - and
so, if you were lucky you got through to someone who was willing to
help, and that help usually took the form of discussing how stupid your
anticipated trade was.
My dumbest trading idea ever
Now, you have to understand, there is a psychological element to all of
this. Big price moves are exciting – and they lure traders. If you
could figure out how the prices would react to the data releases you might
just have it made, I thought. But my mentor explained to me why this
was about my dumbest idea. Of course I knew everything, and disagreed.
“Look”, I said “Here are all the examples, I have this cracked.” But I
didn’t. And he explained to me why. Let me first give you some
background.
One of the things that I realized when looking into the phenomenon of
News Trading (2006 retail FX version) was that it was brand new in the
forex market (you’ll see how new below.) I have been watching economic
data and its effect on short-term forex pricing since I started in forex
in 2000/1. I did this because this is the genetic code of the forex
market. Very early on I bought a book by Brian Kettell, “What drives the
Currency Markets”? This book contains a dedicated chapter on the
phenomenon of expected economic data releases and the academic research on
their impact on the US dollar, in the very short term and also in the
longer run. With the right perspective of the market all data releases
make sense, as do price action around these data releases. (I am not
talking about the on-the-release spikes.)
When I decided to write this newsletter, something prompted me to go to
my 1999 diary in which I did some initial, and to me, important
research on price behaviour and relating different markets’ influences on the
market I was involved in (the South African government bond market).
And then I almost fell on my back. What did I see?
On Friday 5 March 1999 at 15:30 local time I wrote:
“US Employment as expected. 14.16% à 14.11% !!!!”
I was referring to the non-farm payrolls report. My note indicated that
it had come out as expected and my exclamation marks indicated that it
had triggered a relatively big price move on the South African bond
market.
Consciously or unconsciously, relating price, event and time has been a
part of my trading from the very beginning and a constant feature of
my analysis. It has become the genetic code of my 4 X 1 strategy and
relational analysis. I watched the effect of the non-farm payrolls for
probably 5 to 6 years before many so-called forex gurus caught on. In
fact, many of them mechanically recited the mantra “don’t trade on a
Friday, play golf” until quite recently.
If repetition is the mother of all learning, my news watching
experience may have been behind what I said to my clients in my Daily Briefing
(GMT 06:00) on non-farm payrolls (GMT 12:30) October 6, 2006:
You can also rest assured that the new bread of news traders will have
an increasing tussle with their clearinghouses - a fight the news
traders will lose and due to the historical sentiment that the jobs report
is the big one, the day that April / May 2003/4 - can't exactly remember
which one - will be repeated and the blood will be flowing is nearing.
Someone is going to get sick of it and run the market and shake out
every trade straddle and news trader trick in a million mile radius ...
The following is a visual representation of what happened with that
release:
Fig 1: Shoot-out on FX Street
The last 30 minute candle gives the picture. In the bottom right corner
the time is indicated as 08:40:29. The data release was at 08:30 and
the pre-release price was 1.2670 (EURUSD). The action during these ten
minutes dwarfs the preceding price action of more than 60 hours.
According to News Trading 2006, the spike from 1.2670 to 1.2710 should have
had follow-through as the increase in non-farm payrolls was only 50,000
whereas 125,000 was expected. Even a significant adjustment to the
previous month simply negated the impact of the 50,000 and brought the
month’s net adjustment in line with the three month average. (This
supposedly should have resulted in a “no trade” due to no volatility. Big
revisions to previous jobs reports are a standard feature and part of the
expectations.)
My dumbest trading idea ever - reborn: Class of 2006 News Traders
The idea of doing something on News Trading came to me after I had
launched my Bird Watching Newsletter in August 2006. The first two
newsletters covered the topic of leverage. I didn’t know what I was going to do
for the third. And then it came to me as a flash-back to my days as an
early bond trader, how I was going to beat the market. Dumb idea, the
dumbest I have ever had. That was then, now it is 2006, but history is
repeating itself. There are a lot of newbies thinking they are sitting
on the best idea since sliced bread, but as they’ll find out, they are
just being plain dumb.
I cottoned on to the revival of the “dumbest trading idea ever” (2006
version) when one of my clients who was trading a live account contacted
me on the Instant Messenger, with an ominous “what’s happening here?”
“Here” was the market and a recent data release, and “what was
happening” was basically nothing. Yet my client was bothered. Why? (As
background I should perhaps just mention that my main source of real-time
information and analysis is CNBC Europe. All economic data releases are
discussed beforehand, flashed instantaneously, and analysed afterwards. My
television is near me, either with the sound on (not very often), or
with the sound way down, which allows me to see the ticker and news
flashes.)
So for a moment I was taken aback by the client’s question because as
far as I knew nothing had happened and, the way I had anticipated it,
nothing was supposed to happen. It was some minor data release in the US
of no real consequence for forex and the release was basically as
expected. However, zooming in on my very short-term charts I saw there had
been a flurry of price action around this mundane data release and a
relatively significant spike and then a reversal but, all said, no big
deal, yet my client was anxious. Why?
And then the penny dropped. News Trading had become the big new thing.
I should have picked it up, the signs were all around me. Marketing
wizards were punting it. Bird Watching affiliates had become big on “News
Trading” recently. I checked and sure enough, there had been a number
of recent referrals from those sites. New clients increasingly had “News
Trading” in their vocabulary. I should have seen it earlier, but there
it was, the new manifestation of my old dearest and dumbest trading
idea ever, the News Traders of 2006.
And where News Trading is present, sorrow, loss and confusion is never
far behind. It was all so familiar. Of course it was much sexier now
with instant information, many different feeds to choose from, analysts
by the dozen, gurus by the bagful, and those exhilarating 1 minute and 5
minute tick charts tracking the rising and falling account equity of 1
minute-a-day News Trading “millionaires”, but the results were the
same: people losing money.
Hop-a-long Cassidy and the Forex Kid
At school I read cowboy books. The only author I can remember now is
the legendary Louis L’Amour.
Crossfire Trail; Showdown at Yellow Butte; Last Stand at Papago Wells;
The First Fast Draw; The Quick and the Dead; The Sacketts; Hanging
Woman’s Creek and many more.
If you haven’t read the books I am sure you would have at least seen a
traditional western movie. The plot is pretty simple. There are cowboys
and there are crooks. The crooks come to town and cause havoc. In ride
the cowboys and you know the shooting is about to start. All the
decent folk get out of the way, mothers grab children off the street, stores
close, windows are boarded, old people get off the boardwalk, someone
peeks from behind a curtain. There is danger in the air, and before you
can say “shoot-out”, Main Street is cleared. The action starts, guns
blaze, the bad guys turn tail. And sometimes there is an interesting
sub-plot - some testosterone driven wannabe Kid with a gun joins in. He’s
been told beforehand not to, but he can’t be dissuaded. He reckons he’s
slick with a fast draw but he’s just an amateur. He comes up against
the pros and the result is a dead Kid.
One of L’Amour’s books is called The Daybreakers … sounds a bit like
The Day Traders.
The Class of 2006 News Traders know when there will be a shoot-out,
they know it is going to be ugly, but they can’t be talked out of it.
They’re the wannabe Kid. Don’t join the shoot-out, the greybeards tell
them, but no, they know better.
The problem with shoot-outs is that so much can happen and there is a
lot that can go wrong. For instance, the other guy can be faster on the
draw. But he can also have a back-up man somewhere behind you, just in
case. Crooks come in pairs (as do currencies). Shoot-outs are
unpredictable, lead flying in all directions, and the only guy who benefits is
the funeral parlour owner (the forex broker?).
News Trading 2006 version
As far as I can see there are two main strategies used by the Class of
2006 News Traders.
Strategy 1 – The fast draw
This dumb strategy asserts that by being quicker than the broker who
gives you the prices to trade on, you can actually make money on a
variety of data releases.
This can’t be done consistently, but people fool themselves into
thinking it can with one or two text book examples, and using the perfect
science of hindsight.
Strategy 2 – follow the leader
This strategy, equally unsuccessful, believes that if the prices go in
one direction after the news release they will in the vast majority of
cases continue to do so. This, despite good evidence that price action
following data release is pretty much a random walk. Of course, this is
not enough to deter Hop-a-long Cassidy and the Forex Kid, and they
will grimly hang in there until the last bit of life blood is drained from
their account.
Slick marketing wizardry shows technicolour examples of fantastic big
directional moves on news releases according to the classic News Trading
models, ie, the straight forward shootout. Recently however the
reviews of their trades are punctuated, with “classical reversals” (being
shot in the back?), exceptions to the rule, and other qualifications -
only the traders using the professional services offered at a price (like
opening and funding a live trading account) are privy to this “inside
info”. In other words, simplistic marketing is used to lure Forex Kid to
the shoot-out and the moment he arrives he is caught in a deadly
crossfire. Doesn’t this sound ominously like the intra-day technical
analysis models touted by the self-same forex marketing wizards?
Why do Hop-a-long Cassidy and Forex Kid keep ending up in the mortuary?
It is simply a fact, based on statistical probabilities, that when
there is more than a certain amount of lead flying about, you will be hit.
When the shoot-out of data releases starts, the wise old men of Forex
Town, sitting on the veranda’s day in and day out watching the daily
lives of Forex Town’s folks, vacate Main Street. That is why they are old
– remember the adage: there are old traders and there are bold traders
but there are no old bold traders.
Many readers (at least all those who have read Bird Watching in Lion
Country) know that one of the major delusions of retail forex created by
the marketing wizards is that the forex market is ideal for technical
analysis. Every marketing wizard trick was initially built on this
illusion. People with a deep understanding of technical analysis, which most
starry-eyed newbies in the forex market don’t have, know that one of
the pillars of technical analysis is accurate volume information. If a
move occours on high volume it is much more meaningful than a move on
low volume (because a move supported by volume is likely to continue and
not peter out in a false break).
Where’s the volume control?
In the spot forex market there is no reliable real-time volume
information available, particularly on the retail level. Notwithstanding this,
extreme importance is given to technical analysis by the marketing
wizards and volume was simply substituted by fast price moves, which, I
might tell you, is a wholly inadequate replacement. In other words, a
relatively large / fast intra-day price move is seen as extremely important
- it must have been on large volume, the argument goes. This, however,
is bogus. A large, fast move in the forex market can be caused by
almost anything.
Believing it is volume just because the price is moving fast and far,
will cost you dearly.
On an intra-day level, fast and relatively large price moves are
usually caused by a lack of liquidity. In fact it is a situation of lower,
not higher volume and the pros actually don’t like trading if they feel
the liquidity is thin and they are not getting the prices they want.
Volume in the currency market can come from two sources: either very
large single transactions by a single or handful of participants with the
same objectives, or many participants with smaller transactions with
the same objectives at any given time. If you for one moment think a
number of rational, professional money managers, traders or executing
agents will use an erratic data release to do large transactions, you will
seriously have to rethink even your most basic assumptions about the
forex market. Since 2001 there has been an explosion in general forex
market volumes and a large portion of this increase was due to the growth
in the numbers of hedge funds and smaller money managers like Commodity
Trading Advisors (CTA). It is certainly fair to assume that this large
increase in the number of participants contributed to both better
liquidity and larger volatility across all time frames in the FX market.
Nobody in his right mind, with his business or bonus at stake, is going
to do highly leveraged trades and take undue risks when price
movements are random. You have to understand that this is simply not how
professional investors or traders, responsible for other people’s money,
trade. Highly leveraged gambles on intra-day events are just not part of
their repertoire. These guys are pros, and if it is not part of their
repertoire, it should not be part of yours.
Don’t trust your mother, but trust your forex counter party
Because the forex market is not a centralized exchange regulated by
exchange rules which assure participants that their transaction will be
honoured, you have to trust your counter party. What makes this dynamic
so interesting is that your counter party also has to trust you and that
if this mutual trust is violated someone is going to come short.
Unfortunately retail traders are prone to seek opportunities to exploit
the perceived faults in their counter parties’ armour. The moment that
this threatens the sustained profitability of the counter party these
schemes fall flat – they always have and they always will.
Scalper arbitrage was probably the first of these schemes. As marketing
wizards competed to lure more clients, they decreased spreads and
margin requirements which opened opportunities for arbitrage pip scalpers
to enter the fray using a variety of tricks at the expense of their
counter party – the market maker. The pip scalpers had fantastic demo
account track records. Things changed the moment the market makers’ (real)
money was on the table. This was probably the first fight that the
retail traders (the pip scalpers) lost hands down against the market makers,
who simply instructed their dealers to identify the pip scalpers who
didn’t heed the warnings, and take them out. Problem solved.
The second one was straddling news releases. The thing the retail
traders tried to exploit was marketing wizards luring clients with
guaranteed fixed spreads and guaranteed stops. It was basically just the US
non-farm payrolls that really attracted this group a few years ago. They
would place entry orders on both sides of the market just before the data
release. Apparently a win-win scenario. So what did the market makers
do? They refused to guarantee that they would execute your price on the
level you had entered it. As a result they could enter you at a bad
price and then take you out on the stop on the retracement and even if
you then made money on the other leg of the straddle, it was hardly
enough for you to cover your loss on the first stopped-out leg.
However, systemic risk for the market maker remained a problem. If a
few hundred or thousand retail traders take 100:1 and 200:1 bets on a
data release, the market maker became seriously exposed. Market makers are
there to make money, not to run the risk of blowing up on one economic
data release.
The problem was that they had to cover themselves against the positions
taken by the non-farm payroll straddlers by hedging their exposure at
their own clearing houses. Now you try to convince a big bank dealer to
take a huge position one minute before non-farm payrolls release. He
will send you packing. So the market makers couldn’t off-set their risk
and thus had to carry the risk of huge and highly leveraged positions
themselves. One bit of bad luck and a whole month’s profits could be
wiped out.
The market maker makes the rules
There was a particular non-farm payrolls day a few years ago during
which, just before the release, the market was run up about 60 or 70
points and on the data release it was run down about 150 points. Blood
flowed on “Forex Street”. The shoot-out was rigged. Rumours abounded that a
large futures company caused this outrageous price movement. The market
makers had had enough and changed the rules of the game to restore
order and prevent news release straddles that could harm them.
How did they do this? Well, they made adjustments to their business
practices and their contractual arrangements with clients. Spreads are
fixed under normal market conditions and so stops will be honoured under
normal market conditions, but not under abnormal market conditions –
market makers were free to widen their spreads and thereby pass the risk
on to the trader. Sometimes they simply wouldn’t allow traders from
entering orders shortly before keenly watched data releases. And the
decision as to what constitutes normal and abnormal market conditions rests
exclusively with the retail forex market maker. Problem solved.
The Class of 2006 News Traders vs Market Makers
Straddling is no longer an option, so News Traders do the next best
thing. They try to beat the gun by guessing the direction of the market’s
first move, and then they try to benefit with highly leveraged
positions.
There are a few challenges, however:
Being fastest on the draw. This means you need to get a good price
close to the pre-release price and before your market maker removes the
arbitrage opportunity (initial price spike according to News Trading
theory) in an instant.
Being fastest on the draw also means you have to draw faster than the
rest of the mob trying the same thing. The risk of them jumping the gun
enters the equation.
Before you can actually start drawing to shoot, you have to decide what
this data release actually means and how all those who react after
you, will react to the data release. What will have the main and immediate
affect, the headline or the details?
In other words you must take a guess if this data release will indeed
cause a large enough move for you to risk taking the highly leveraged
position and secondly, you have to guess correctly the direction of this
move vis-à-vis the US dollar.
Opportunists who can see what is going on don’t try to jump the gun but
jump in counter the first spike, causing more erratic price movements.
Here is a challenge for anybody who thinks he is going to make a living
by consistently beating the odds in a well-publicised shootout with
the ever-evolving dynamics I have described above.
Let’s assume you will be able to beat the gun and regularly get an
extremely good fill on your news trade. All you will be dependent on then
is to analyse the market correctly to understand if the first spike will
be up or down (let’s look at it from a USD perspective).
How do you determine that? Well that’s the question, and it doesn’t
have a simple answer, despite what the News Trading gurus, analysts and TV
talking heads say. There are simply too many factors playing a role:
the history of this particular data release, expectations, how far
expectations are off or might be off, the actual figures of the data
release, the expectations’ reaction to its own expectations, the expectations
reaction to the data, it just goes on and on until the final result is
just another bout of randomness.
If you don’t believe me try tossing a coin over a period long enough to
get a representative sample and then compare your results with that of
your guru’s.
News Traders – architects of their own demise.
Let’s look at the dynamic the Class of 2006 News Traders cause in the
FX market:
They don’t straddle the market beforehand. They jump in the market on
the data release mostly in the same direction (there aren’t many gurus
promoting this loony method to lose money). What happens? They cause a
sudden great demand for a currency, let’s say euro. As a result euro’s
price spikes up - I am talking a few seconds. Our news traders’ orders
get filled usually at a worse price than they had hoped for but
nevertheless they are in the market and then two things happen – this is before
most professionals, still looking at the details of the release, even
paid attention to the immediate price action. First this sudden demand
just vanishes, so there is no upwards momentum to cause the
follow-through the news traders hope will give them their measly pip target on
their highly leveraged position. Secondly the weak “highly leveraged”
hands with a few pips profit decide to get out, and in a wink there is
suddenly euro supply and a turnaround materialises.
During all of this you have a market maker trying to make a decent
market for decent clients and now having to manage this crazy action in a
traditionally illiquid market. It took a very prominent forex market
maker specialist - in fact the one currently with the highest net capital
according to the CFTC reporting - about two months to figure out that
they have a bunch of hooligan traders on their hands that could cause
them serious damage. Their response, as I mentioned above, was to start
fooling around with the spreads in order to discourage and chase away
News Traders.
Fixed and floating spreads are a topic of a future newsletter, but
understand this: widening spreads, thus increasing the cost and the risk to
deal, is a basic protection mechanism of the forex market. In the week
following 9/11 the New York Stock Exchange was closed as a protective
measure against market meltdown. The forex market increased the spreads
to 30 - 40 pips on the most popular pairs and 80 – 100 pips on the
less liquid pairs.
News Trading is fundamentally an arbitrage opportunity, but like all
arbitrage opportunities it will vanish very quickly if the market catches
on. There is already evidence that this is happening and this evidence
is clear from the reporting of the sudden change in fortunes of some
of the gurus now selling this as a subscription opportunity. Whereas
past records are reportedly flawless, recent records are certainly not.
In this case, just as with the initial pip scalpers, the arbitrage is
basically a duel between the mob of retail traders and their market
maker. There will only be one winner.
The death knell for News Trading as a popular strategy
Why do people latch on to News Trading? Because they buy the pitch sold
to them by marketing wizards that News Trading is the new way to
become a consistent winner. There is no other reason. Unfortunately
marketing wizards have already realized that News Trading can make good money
for them (but not for you). Here is the proof:
One of the biggest forex marketing wizard companies is behind the
popularisation of the 2006 News Trading fad. You must understand that News
Trading only makes sense if it is done highly leveraged and very
regularly. According to this specific crowd you must push the leverage and you
must, wait for this, “place close stops”, because “it will be suicide
to use the high leverage without close stops”. (And this is true, but
it is only a half-truth, and as with all half-truths it is the other
half that kills you.) If this strategy were to be put forward by an
individual he would appear foolish. But touted and encouraged by a market
maker and their introducing brokers it appears legitimate and savvy.
I downloaded a free report some two years ago from a company. The
report gave statistical evidence regarding very short-term price behaviour
and supports my contention that it is basically random and that there is
no edge to be derived from searching for repetitive linear patterns in
these very short-time frames. This company has now changed its view on
the randomness of short-term price behaviour. Needless to say they now
push News Trading. Unlike some outfits who ask subscription fees for
their services (guessing which way the market will go after data
releases) everything is free, but you must open a trading account to use their
automated News Trading service at the big marketing wizards mentioned
above. Even documentation prepared by the big marketing wizards above
is provided by this company.
It is pretty clear who sits behind the current popularisation of News
Trading. The beneficiaries of regular highly-leveraged-tight-stop
trading strategies are the market makers and their marketing agents who
promote the viability of this kind of hair-brained trading.
(I again want to point out that while professionals may even play along
and have a punt on some data releases it will never be a consistent
feature of their professional strategy to expose themselves to any great
degree. Yet this is what you are encouraged do: take all your trading
capital, gear it up like crazy and take a punt on what is essentially an
event with a 50 / 50 probability of satisfying your highly leveraged
bet. The placement of a close stop practically ensures that in every
instance you do not make money, the market maker gets a nice pay out in
addition to whatever he made on the spread.)
And that is why I say you can bet your bottom dollar that most fools
who try News Trading will lose. Different game, but the same people are
selling it. Here is an example of why you should be very afraid.
A prominent and respected analyst at one of the largest market makers
(and marketing wizards) wrote an article on News Trading in which the
technical analysis approach to intra-day trading is debunked. Now this
should make your ears prick up because they were (and still are) the very
ones punting it – to take your money. Ever innovative, they have come
up with News Trading as the big new thing, though in this research
article news trading in the spot forex market is discouraged.
So what is the solution – can retail traders win?
Yes they can win. They can win if they first of all do not fall for the
tricks of marketing wizards. In order to be able to do that you must
understand the market very well. Secondly you need to have a strategy
that is, or has aspects of it, used by professionals. Thirdly, and this
is very important - you must not catch the unwanted attention of a
market maker. Do not violate the trust relationship that is supposed to
exist by trying to exploit weaknesses in the system and create a scenario
where your market maker can only lose. He holds the aces because he can
change the rules of the game. If you have a strategy that offers a
winning edge, you will be able to negotiate this market and make money
without resorting to any fundamentally flawed concepts and tactics which
attract the sort of attention from your counter party that will end up
costing you money.
There is more than one way to make money trading any market and there
are a myriad of factors playing a role in being successful, including
having a scientific edge, being a master of relevant analysis and working
through the constant changes in the markets. Success as a trader does
not come cheaply, it does not come overnight and it does not come from
running after every fad touted by marketing wizards. Success is hard
earned, requiring application of, and dedication to, sound trading and
business principles. Bird Watching in Lion Country – Retail Forex Trading
Explained is a thorough introduction to what you need in this regard
and it explains in sufficient details my strategy and methodology that
have served me and my clients well.
Here are some of the pros and cons of ECNs and market-makers:
Market-Makers
Pros:
Usually give free charting software and news feed
Prices can be "smoother" and less volatile than ECN prices (this can be
a con if you are scalping or trading very short term)
Often have a more user-friendly trading and analysis interface
Cons:
They may trade against you. In that case, there will be a conflict of
interest between you and them
The price they offer you may be worse than what you could get on an ECN
It is possible that they may trigger stops or not let your trade reach
your profit target levels by manipulating prices
During news, there will usually be a large amount of slippage; their
systems may also lock up or not allow order placing during times of high
volatility
Many of them discourage scalping and put scalpers on "manual execution"
which means their orders may not get filled at the price they want
Examples of some market-makers:
http://www.goforex.net/forex-broker-list.htm#MM
ECNs
Pros:
You can usually get better bid/ask prices since they come from several
sources
Variable spreads between bid and ask may give no spread or tiny spreads
at times
If they are a true ECN, they will not be trading against you but will
pass on your orders to a bank or another customer on the other end of
the transaction.
You will be able to offer a price between the bid and ask with a chance
of it getting filled
If they support Stop-Limit orders, you can prevent slippage during news
by making sure that your order either gets filled at the price you
want or not at all
Prices may be more volatile which will be better for scalping
Cons:
Many do not offer integrated charting
Many do not offer integrated news
Many of the trading platforms are less user-friendly
Because of variable spreads (between bid and ask,) it may be more
difficult to calculate stop loss and profit target in pips beforehand.
Examples of some ECNs:
http://www.goforex.net/forex-broker-list.htm#ECN
Summary
It is important that you carefully look into the pros and cons of each
broker before choosing the one which best suits your needs. You may
also wish to have several broker accounts to mitigate the risks, and so
that you can compare bid/ask prices and trade on the broker with the best
prices for the direction you wish to trade. Because of the unregulated
nature of forex, US brokers are not required to keep your money in an
untouchable account that only you can have access to if they were to
collapse. As customers of Refco (was one of the world's largest brokers)
found out, their unprotected accounts made them unsecured creditors,
and thus are less likely to get their money back than those who had given
secured loans to Refco. What this means is that the customers' money
was used to pay other creditors.
The moral of the story is this:
Deposit as little money with your broker as you need for trading, and
withdraw your profits when they exceed a certain amount. Keep the rest
of your trading capital in your own bank accounts which are probably
government-insured.