Know Your Trading Environment

Mechanics of Trading Forex

Know your Trading Environment

What does it mean to know your trading environment? The trading environment is the action around a currency pair's price movement.

Like Knowing the Weather

Just like knowing the weather in a city that you are visiting, you should know how the currency pairs are moving before you enter a trade. Another similarity to the weather is that the price movement of a currency pair provides clues and information that can help you determine the trading environment. Just like high pressure forecasts clear skies and dark clouds precede a storm, indicators forecast certain price movements. But the similarities end here. There can be lots of different types of weather: rain, shine, snow, etc., while the Forex trading environment is limited to two types of price movements: range-bound or trending. Let’s take a look of each type of trading environment.

Range-bound Trading Environment

In a range-bound trading environment, the currency pair stays within a tight trading zone. The high and low prices of the currency pair move within fairly constant and distinct parameters. The currency pair price will remain within these parameters and often bounce off the “walls” of the range. Many traders find range-bound trading quite difficult and frustrating since there is no definable trend to help in anticipating price movement.

Look to the Charts

Chartists are often able to determine whether a currency pair is trading within a range simply by looking at the chart. This type of visual information requires the eye of an experienced trader to obtain accurate results. However, there are other, more reliable, ways to determine if a currency pair is trading within a range.

Three Range-bound Trading Signals

A Low ADX level

The ADX (average directional index) measures the strength of a trend. ADX is one of the primary indicators used to determine the strength of a trend. When a currency pair is trading within a range, the ADX level will decline. Conversely, when a currency pair is trending, the ADX level will rise.

An ADX level below 20 is considered low. It is a strong indicator of a currency trading within a range. When the ADX is at 25, the strength of a trend is growing, but still may not be strong enough yet to break out of the range.

Decreasing Volatility

Volatility refers to the price movement of a currency pair. When volatility is high, currency prices are moving (or trending) strongly. When volatility is low, prices are staying with a tight range.

Bollinger Bands

Bollinger Bands are one of the best indicators of volatility and price movement. A range-bound currency is indicated when the Bollinger Bands grow together. They can begin to squeeze the currency pair. Bollinger Bands are a great visual tool for determining volatility and trading environments. For range-bound trading, we are looking for Bollinger Bands that are close and tight, leaving only a narrow tunnel in which the currency pair can move.

Trending Environment

A trading environment is trending when the currency pair is moving in a strong direction. You have probably heard the phrase saying “the trend is your friend.” In a trending environment, the currency pair is moving decisively in a particular direction—usually up or down. (A sideways trend is more indicative of a range-bound trading environment.) A trend can be visually identified on a chart. However, other tools are available that can help the trader to identify a trend.

A trend is considered long-term when it continues for a year or more. A short-term trend usually lasts less than a month. A medium-term trend is the time between a month and a year. Most traders will focus short-term trends for quick trades, but will look for confirmation from the long-term trend.

Of course, the long- and short-term trends can move in opposite directions. For example, a currency pair may move in a bullish trend for a year (long-term trend) and, during that year, experience several week-long bearish price movements (short-term trends).

Two Trending Trading Signals

High ADX level (25+)

Remember the ADX is the average directional index, which measures the strength of a trend. When the number was below 20 as in the previous example, the trend was weak or nonexistent, which indicates the currency is range-bound. A trending environment will usually have an ADX level that is above 25 and continuing to rise.

Momentum Indicators Confirm Trend

Traders need to know that movement is consistent in the direction of the trend. What are momentum indicators? As the name suggests, they are indicators that gauge momentum. Examples of momentum indicators are RSI (relative strength index), Stochastics, and the moving average converging divergence (or MACD) line. Of course, visually reviewing charts is one of the best ways to establish the trend, its strength, and its momentum.

Trading Tools

* ADX : Determine if it is a high number (trending) or a low number (range-bound).
* Bollinger Bands: Determine if they are flaring (trending) or tight (range-bound).
* RSI: Determine if it is a rising number (trending) or a declining number (range-bound).
* MACD: Determine if the line is rising (trending) or declining (range-bound).

Determining the trading environment is the first step toward successful trading. Taking the time to determine the environment can help you to know if you are trading in the right “weather”. Knowing your time horizon and managing your risk are the next steps in the mechanics of trading Forex.

Could a World Currency Replace the Dollar?

Last month, China suggested that the IMF develop a single global currency to replace the dollar as the world's reserve currency. China is concerned the value of its holdings in dollars will decline as a result of U.S. deficit spending. However, any attempt to replace the dollar would be a massive, complicated undertaking. The dollar is used for 43% of all cross-border transactions, and 66% the world's central bank foreign currency reserves are in dollars. (See Power of the U.S. Dollar)
What It Means to You
Since so many transactions are already done in dollars, the impact of a switch to a single world currency would not have as much immediate impact on U.S. citizens. Other countries' economies would be more severely affected, as they attempted to set economic policy to compensate for U.S. policy. Flexible exchange rates between countries with different economies reduces risk, since the countries can set policy to benefit their needs. Eliminating flexible exchange rates would introduce more risk to the global financial system.

The most direct impact would be the elimination of the international forex trading system. This was over $3 trillion per day in 2007, the most recent estimate. This would affect all corporations that use this market to hedge foreign exchange risk. It would also affect day traders and other individuals who have switched to the forex markets from stocks, real estate and commodities.

Currency Predictions for 2009

I took some time and sat down with Miss Bonnie, who is an Astrologer and Clairvoyant Medium. She had a few things to say about what is in store for 2009.

John Russell: Miss Bonnie, for starters do countries have astrological charts and if so, how are they developed?

Miss Bonnie: Astrologers have a sort of bible called an ephemeris. It tells us the positions of all the planets and any given time or place, past, present, and future with exact degrees. Like a science. Every chart has 12 houses and each house carries a flavor or aspect of our lives. If we want to focus on finances and the future, we look to the second and eighth houses in the chart. If we know where the planets are and what kinds of impacts they have on the houses, then we can layout future trends.

JR:So what do you see charted for the US in 2009?

MB: The birth chart for the US is based on July 4th, 1776.

The second house represents personal finance. It would refer to America’s budget and how it gets spent. The eighth house represents loans and money that is returned or comes back into the coffers.

There is a moving away from deceptive spending in the second house. Much of the deceptions will already be front page news even as the year begins. Everyone will become aware of many well kept secrets and these will continue to be exposed.

For the eighth house things look to be improving on the side of loans being paid back and loans being made available. Banks are strongly emphasized here with much potential growth and controversial management shakeups with secrets coming out. By April we should see some real progress as Jupiter moves into Aquarius and we all start to get along better. Some of the pessimism needs to be wrung out of everyone and people need to hang together.

JR: What does the future look like for the markets?

MB: Keep in mind the stars don’t compel, they impel. The choice is always up to us. If we like what we see, we keep doing what we’re doing in the market. If we don’t like it, we have to adjust or we will surely be adjusted.

JR: What are the strengths for 2009?

MB: America will be returning to her old values and old ways. Truly coming full circle and back to the time where our forefathers worked as a team. This doesn’t mean that there won’t be conflict. But things with be done with more honor and integrity and egos will be placed aside for the higher good.

The US will experience a resurgence of respect and come into full empowerment as master or mistress of her own destiny as a world power.

Nuclear power will serve as an energy source rather than as a weapon.

JR: Can you summarize in a nutshell where we are going in 2009?

MB: America will return to her motherhood mode and begin to take care of her own home and children and place them above the rest.
End of Interview Forex Translation

My take on this information is that if things are really heading this way for the US, it means a continuation of the return of the US dollar strength against everything. It’s hard to imagine this coming true so easily after terrible mismanagement by the US government and all of the borrowing that has taken place in 2008. Economically, someone has to pay for that, and it won’t be pretty. However, the US dollar seems to be heading up anyway. If Miss Bonnie is right, it looks like that will be the trend to play for 2009

Currency Futures Are Shrinking

The CME Group has recently introduced micro size currency futures for some of its most popular currency futures markets. The CME Group already offered full size and small size currency futures, but with the availability of the micro size versions, the currency futures are shrinking even further.

The new micro size currency futures markets are as follows:

• M6E - Euro to US Dollar
• M6B - British Pound to US Dollar
• M6S - US Dollar to Swiss Franc
• M6A - Australian Dollar to US Dollar
• M6J - US Dollar to Japanese Yen
• M6C - US Dollar to Canadian Dollar

The micro size currency futures are very small, with tick values of less than $1 in some cases. An example of the contract specifications for the micro size currency futures are as follows, for the M6E (EUR to USD) and M6B (GBP to USD):

• Symbol: M6E
• Expiration Date: June 15th 2009 (the second business day before the third Wednesday of every third month)
• Exchange: GLOBEX
• Currency: USD
• Contract Value / Multiplier: $12,500
• Tick Size: 0.0001
• Tick Value: $1.25

• Symbol: M6B
• Expiration Date: June 15th 2009 (the second business day before the third Wednesday of every third month)
• Exchange: GLOBEX
• Currency: USD
• Contract Value / Multiplier: $6,250
• Tick Size: 0.0001
• Tick Value: $0.625

The margin requirements for the micro size currency futures are low (as would be expected for such a low tick value), and this will make the micro size currency futures attractive to traders without much trading capital. However, the commission for a complete trade on the micro size currency futures is approximately $4.80. With a tick value of only $0.625, approximately eight ticks of profit would be used just to pay the commission, or conversely, an additional eight ticks of loss would be incurred, and this could make the micro size currency futures untradeable.

Currency Markets Back in Full Swing

The currency markets are back in full swing and they started off the new year with a roar. The US Dollar rallied hard on this first Monday of 2009. It seems that trading desk are once again full staffed and the first vote of the year for currencies seems to be in favor of the US Dollar.

It’s interesting to see the dollar rally after all the bailout news that happened just before the holidays hit full swing in the US. Amidst dismal news about retail and auto sales for the past few months, the dollar seems to rally in the face of everything, specifically bad news. Perhaps traders feel like the worst is out of the way.

On the US Dollar Index, the dollar seems to be approaching a strong resistance point on the 4 hour chart. It will be interesting to see if the dollar clears that hurdle and truly makes it’s way upward for 2009. The inauguration is 2 and a half weeks away, bailouts are slowly fading from the news (since there is no one left to bailout except the taxpayer), this could get very interesting in the next few weeks. Stay tuned.

Currency Futures

Currency futures are futures markets where the underlying commodity is a currency exchange rate, such as the Euro to US Dollar exchange rate, or the British Pound to US Dollar exchange rate. Currency futures are essentially the same as all other futures markets (index and commodity futures markets), and are traded in exactly the same way.

Futures based upon currencies are similar to the actual currency markets (often known as Forex), but there are some significant differences. For example, currency futures are traded via exchanges, such as the CME (Chicago Mercantile Exchange), but the currency markets are traded via currency brokers, and are therefore not as controlled as the currency futures. Some day traders prefer the currency markets, and some day traders prefer the currency futures. I recommend the currency futures as they do not suffer from some of the problems that currency markets suffer from, such as currency brokers trading against their clients, and non centralized pricing.
Settlement and Delivery

As currency futures are based upon the exchange rates of two currencies, they are settled in cash, in the underlying currency. For example, the EUR futures market is based upon the Euro to US Dollar exchange rate, and has the Euro as its underlying currency. When a EUR futures contract expires, the holder receives delivery of $125,000 worth of Euros in cash. Note that this only happens when the contract expires, and as day traders do not usually hold futures contracts until they expire, they should not be involved in the settlement, and will not receive delivery of the underlying currency.
Popular Currency Futures

Many of the most popular futures markets that are based upon currencies are offered by the CME (Chicago Mercantile Exchange), including the following :

* EUR - The Euro to US Dollar currency future
* GBP - The British Pound to US Dollar currency future
* CHF - The Swiss Franc to US Dollar currency future
* AUD - The Australian Dollar to US Dollar currency future
* CAD - The Canadian Dollar to US Dollar currency future
* RP - The Euro to British Pound currency future
* RF - The Euro to Swiss Franc currency future

Forex or Currency Futures?

Currencies are the money of different countries, and currency trading is the buying and selling of these currencies. There are almost as many different currencies as there are countries, but the most popular currencies for trading are the US Dollar, the Euro, the British Pound (Sterling), and the Japanese Yen. The currency markets are some of the most popular day trading markets, and they therefore have some of the highest volume (number of contracts) and liquidity. This high volume and liquidity makes the currency markets attractive to all types of traders, including individual day traders, trading companies, financial and non financial companies, banks, and governments.

There are several different ways of trading currencies, and even non traders are familiar with one form of currency trading. When people go on holiday to a different country they often need to exchange their local currency for the currency of the destination country. For example, a tourist from the US would need to exchange their US Dollars for Mexican Pesos if they went to Mexico on holiday. This exchange would be processed via a currency broker (such as a bank), and the transaction would become part of the currency markets. This type of currency trading is not suitable for professional traders, so two other forms of currency trading are used by day traders.
Forex (FOReign EXchange)

Forex trading is one of the most popular ways of trading the currency markets. Forex markets trade the actual exchange rate between two currencies. For example, the most popular Forex market is the Euro to US Dollar exchange rate (EUR to USD), which trades the value of 1 Euro in US Dollars. There are Forex markets for most of the major currencies, including the following :

* EUR -> USD - The Euro to US Dollar exchange rate
* GBP -> USD - The British Pound (Sterling) to US Dollar exchange rate
* EUR -> GBP - The Euro to British Pound exchange rate
* CAD -> USD - The Canadian Dollar to US Dollar exchange rate
* AUD -> USD - The Australian Dollar to US Dollar exchange rate
* EUR -> CHF - The Euro to Swiss Franc exchange rate

As the Forex markets are global markets, they trade 24 hours per day from Monday morning in New Zealand (Sunday night in the US) until Friday night in Asia (also Friday night in the US). Forex markets are different from most day trading markets in that they are not provided by an exchange. Forex markets are decentralized markets, where all trades are directly between two traders (or a trader and a Forex broker). This means that there could be several different exchange rates for the same currencies, depending upon factors such as the location of the traders, and the brokers being used.

Forex markets trade the currencies directly (rather than trading contracts), and the minimum amount that can be traded is known as a lot. The size of a lot is dependant upon the Forex broker being used, but is commonly at least $25,000. This amount is usually margined, so individual traders do not need to have anywhere near the lot size in their trading account, and will borrow most of the lot size from their Forex broker instead.
Currency Futures

Currency futures are futures markets that are based upon the currency markets. Currency futures markets trade futures contracts that reflect the exchange rates of two currencies. For example, the most popular currency futures market is the EUR futures market, which is based upon the Euro to US Dollar exchange rate. The most popular currency futures are provided by the CME Group (formerly the Chicago Mercantile Exchange), and include the following futures markets :

* EUR - The Euro to US Dollar futures market
* GBP - The British Pound (Sterling) to US Dollar futures market
* CAD - The Canadian Dollar to US Dollar futures market
* CHF - The Swiss Franc to US Dollar futures market

As they are futures markets, currency futures are provided by an exchange. This means that they have centralized pricing (and clearing), so the market price is the same regardless of the brokerage being used. Currency futures markets also trade 24 hours per day from Sunday night until Friday night in the US, so they are accessible to traders worldwide, even though all of the trades go through the same exchange.

Currency futures trade futures contracts that are worth a specific amount of the underlying currency. For example, the EUR futures contract is worth $125,000. The contract specifications for each currency futures market specifies the contract value, and other trading information such as the minimum price change (tick size) and the price change value (tick value).
Forex or Futures

Even though both the Forex markets and the currency futures markets are based upon the same underlying financial markets, there are some significant differences that make one or the other the best choice for day trading. The Forex markets have very large liquidity (amount of money traded) so they can absorb very large trades (millions of dollars) without the market being affected, whereas the currency futures can only absorb a certain number of contracts (usually less than 100) before the market becomes affected by the trade. On the other hand, the currency futures markets are regulated markets, so they are not susceptible to price fixing (also known as market making).

Unless you have several million dollars that you want to trade with, or you want to convert one currency to another indefintely (i.e. not convert it back again), the currency futures markets are the best choice for individual day traders. The two most popular currency futures markets are the EUR (Euro to US Dollar futures market), and the GBP (British Pound to US Dollar futures market), and complete information about these (and other) markets (including their contract specifications) can be found in their market profiles.

What are Currencies?

Currency markets (also known as forex markets) are the largest day trading markets (in terms of volume and amount of money), trading approximately $2 trillion per day. Currency markets are the markets where one currency is traded for another currency, such as trading the Euro for the US Dollar. The majority of currency trading is between central banks, commercial banks, and large companies, with the largest currency trader currently being Deutsche Bank in Europe, but the currency markets are also traded by individual day traders.

Currency markets are unique in that they are not traded at exchanges, but are traded directly between traders instead. There are several large currency trading centers, with London in Europe, New York in the US, and Tokyo in Japan, being the largest.
Popular Currency Markets

Some of the most popular currency markets are the following :

* EUR / USD - The Euro to US Dollar exchange rate
* GBP / USD - The British Pound to US Dollar exchange rate (also known as cable)
* USD / JPY - The US Dollar to Japanese Yen exchange rate
* CHF / USD - The Swiss Franc to US Dollar exchange rate
* EUR / GBP - The Euro to British Pound exchange rate
* AUD / USD - The Australian Dollar to US Dollar exchange rate
* CAD / USD - The Canadian Dollar to US Dollar exchange rate
* EUR / CHF - The Euro to Swiss Franc exchange rate

Exchange Rate Spreads

Most people are familiar with the difference (or spread) between the buying and selling exchange rates that they get when they exchange foreign currencies at a bank (e.g. when they go on holiday). For example, using the EUR / USD exchange rate, the difference would be several percentage points, which in real prices could be from 1.2500 to 1.2800, which in currency trading terms would be 300 pips (calculated as (1.2800 - 1.2500) / 0.0001). Day trading spreads are much lower, and would be more like a fraction of a percentage point, or 1.2500 to 1.2503, or only 3 pips (calculated as (1.2503 - 1.2500) / 0.0001). Some traders are attracted to the currency markets by the difference between the retail and trading spreads, but note that the currency futures markets have an even lower spread (usually the equivalent of 1 pip).
Currency Brokers

Day traders can access the currency markets via the same direct access brokerages that they use for other markets, but should be aware that their trades are not being processed by an exchange, but by a currency broker instead. These currency brokers are allowed to make their own markets, which means that traders using one currency broker will not necessarily see the same prices as those traders using a different currency broker. In addition, some of the more unscrupulous currency brokers actively trade against their traders, and will prevent their traders from getting the best possible price, while taking the extra profit for themselves. It is common for currency brokers to not charge commissions for currency trades, as they will take some of the spread as their commission instead.
Symbols and Tick Values

Currency market trading symbols are constructed using the two currencies that are being traded. For example, the trading symbol for the Euro to US Dollar market would be EUR/USD. Each currency market has a minimum price change (tick size), and a minimum trading amount, with which the value per minimum price change can be calculated. Continuing with the EUR/USD currency market, the minimum price change is 0.0001, and the minimum trading amount is approximately $25,000 (this varies depending upon the currency broker), so the value per minimum price change is calculated as 0.0001 X $ 25000 = $2.50. This means that for every 0.0001 in price change, a trade's profit or loss would change by $2.50. Even though the minimum trading amount is $25,000 or more, the currency markets are traded using leverage, so an individual day trader only needs to have a fraction of that amount in their trading account.
Trading Recommendation

While the currency markets can be day traded, they have some features that make them a less preferred day trading market. If you want to trade the currency markets purely for day trading purposes, then the futures markets offer enough markets based upon currencies, that you should trade the futures markets instead. If however, you want to trade currencies to actually hold the other currency (i.e. if you want to keep some money in Euros), then the currency markets are the markets to trade.