Main Three Lines Forecasting Forex Price Action
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Three Lines Forecasting Forex Price Action

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Overview: "Three Lines" is a practical guide to foreign exchange trading that offers a simple strategy for forecasting future price movements based on the fundamental economic mechanism of demand and supply. Just a few years ago, it was nearly impossible for the average investor to trade in the forex market online. What was once the domain of corporations, large financial institutions, central banks, hedge funds, and very wealthy individuals is now open to just about anyone with an Internet connection. Today, the forex is one of the largest financial markets in the world. The forex market is driven by demand and supply. The primary purpose of this book is to show how a trader can effectively predict the next price move, once he knows how to spot demand and supply imbalance points on what are known as candlestick charts.
Year:
2016
Language:
english
File:
EPUB, 4.26 MB
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Chapter Two

AN ANALYSIS OF THE FOREX MARKET

In Forex, traders use mainly two kinds of analysis to predict future price movements. They are fundamental and technical analysis. Fundamental analysis is most similar to the way traders in the stock market evaluate a company; they look at the company’s earnings, expenses, assets, liabilities, and statements by operating officers and the board to determine its health. People buy stock in anticipation that it will rise in value in the future. In Forex, it is very important to do research on individual countries, just as if they were companies. On the other hand, technical analysis involves pattern recognition on a price chart in order to predict future prices. In the share market, traders analyze the prices of the volume of the shares traded on the stock exchange. If prices are moving higher on increasing volume, traders will see the demand for shares of that company’s stock rise. Forex traders use also a similar kind of technical analysis, and they apply the same kind of technical tools, too. A technical trader in Forex will look at price action, trends, and other empirical factors to make decisions about buying and selling a particular currency pair.

Fundamental analysis suggests that in order to invest intelligently, it is very important to do research on countries themselves. This theory holds that if a country is fundamentally strong, it will be worth investing in (McDonald 2007). Several theories have been developed to explain this in relation to financial markets. Efficient market hypothesis is a theory that says instruments trade at fair value. Random walk hypothesis says a past price cannot be used to predict future price and the theory of rational expectations suggests that past experience can help to predict the future. These theories are either biased toward fundamental or toward technical analysis. In general, fundamental analysis is based on the overall financial condition of the economy, whereas technical analysis is based on price action and hum; an emotions, as revealed by the charts.

FUNDAMENTAL ANALYSIS



In the equities market, fundamental analysis measures everything that could affect a security’s value. This includes financial stability, management, the economy, and the condition of an industry. To some extent, fundamental analysis also involves studying the economic situation of countries in order to trade currencies more effectively. Fundamental analysis is therefore the study of geopolitical and socioeconomic factors that influence a country’s currency. Currencies react to fundamental factors such as interest rates, economic growth, and speeches made by the directors of central banks. Looking at an economic calendar is another way to speculate on forecast verses actual values to predict currency movements upward or downward. Free sites such as forexfactory.com, screenshot shown in Figure 3, and fxstreet.com provide information about forecast verses actual values in real time. Other sources are available too, such as television stations Bloomberg, CNBC, and CNNMoney; financial magazines and newspapers like the Wall Street Journal and Financial Times; and Internet sites Marketwatch, CNNMoney, and Yahoo Finance. Other lists of fundamental indicators include oil prices, gold prices, US dollar sentiments, gross domestic products (GDP), consumer sentiments, imports, and exports.

[image: ]

Figure 3: Actual vs. Forecast Data (source: Forex Factory)

Intermarket analysis is also a part of fundamental analysis. A good trader is always aware of stocks, bond yields, commodities, and US dollar sentiments. The dollar is the leading currency in the world not only because the United States is an economic powerhouse, but because it is the preferred reserve currency in the world. Asia alone holds $4.96 trillion in reserve (Arunachalam 2010). Global commodities such as oil, copper, and gold also play a large role in the flow of global capital and international trade. The changes in demand and supply for commodities impact currencies. For example, if we look at gold prices we’ll see that a falling price results in the weakening of currencies from countries that are correlated with gold, like Switzerland. The Canadian and Australian dollars are also closely related to commodity price movements. New currencies emerging in the global market must also be taken into account. China has become second-largest economy in the world, for example, but its currency has lagged behind in international stakes (Zhou 2015). Between 1989 and 2015, the annual growth rate (AGR) in China averaged 9.06% (Trading Economics, n.d.). Such strong growth requires consumption of global resources such as copper, wheat, cement, etc. Hence, a stronger Chinese currency benefits its commodities trading partners, such as Australia.

Many additional, smaller or more unpredictable factors also influence currency movements. These include inflation, rate of interest, account balances, political stability, employment data, microeconomics, geopolitical events, and economic performance. (P. Patel 2014; N. Patel 2014; & S. Patel 2014). These can be more generally categorized into two categories, however: economic and political. Economic factors are composed of general macroeconomic policies and general economic conditions as revealed in market surveys and other reports. They are also based on economic indicators and economic policies including fiscal and the monetary policies. Fiscal policy is related to budget and government spending, whereas monetary policy is related to central bank activities—these influence money supplies and interest rates.

Political events profoundly impact how currencies behave. These impacts can either be from internal, regional, or international political conditions. Exchange rate markets as well as Forex market trading are deeply impacted by political conditions as well as the policies of parties in power. For example, political incidents between radical Islamic groups and the Egyptian state led to fewer domestic assets being in demand and replacement of foreign currency deposits. Various measures were taken in response to political instability, including economic policy interventions (Fielding & Shortland, n.d.), but ultimately any political upheaval will generally cause investors to withdraw money from a country. The currency market, like any other, has long-term trends. Currencies do not grow, nor can they be mined like physical commodities, so business cycles do have a measurable impact on currency values. Cycle analysis helps an investor look at a long-term price trend that may arise from an economic or political trend. It’s not surprising that economic numbers certainly reflect economic policies, but some numbers create what seem to be a strangely disproportionate effect where a number itself becomes important and has an immediate effect on short-term market moves.

Governments also affect Forex trading in various ways. They can do so directly, by instituting policies that have effects on portfolio investments as well as money supply. Regulations, taxation, and subsidies will all impact macroeconomics and will thus have a spillover impact on the performance of Forex market trading. Governments now often have to choose between traditional methods of intervention and market-based approaches. A central bank’s policy on interest rates, for example, will also impact the economy and hence the Forex. Many investors and analysts argue that the market is efficient, but fundamental analysis says that publicly available information alone cannot be used consistently to earn an enhanced return on investment (Kevin 2006).

TECHNICAL ANALYSIS



The credibility of technical analysis goes to Charles Dow [journalist and coinventor of stock market index Dow Jones & Company in 1884). His series of articles for his fledgling Wall Street Journal popularized Dow Theory, which evolved into what we now call technical analysis. Technical analysis is basically the recognition of price action in combination with volume. It seeks to find patterns of support and resistance that indicate whether a price is likely to go up or down. The technical analysis approach has not gained significant credibility in academic circles, interestingly. This might be one of the reasons why the efficient market hypothesis has become so popular. Explained and surveyed by fame, it claims that price cannot be predicted based on behavior, that it follows random directions (Loganantharaj 2000). However, the supporters of the technical analysis technique argue that past performance shows a trend that can easily point to the future price of a security. Significant academic research reports show that you can indeed predict future market prices based on historical data. A considerable body of work exists in academic literature concerning the validation and verification of expert systems (surveyed in Weiss and Kulikowski) (Loganantharaj 2000). A survey reported in a research paper by Menkhoff and Taylor (2006), from the University of Warwick, mentioned that when asked about the statement “almost all foreign exchange professionals use technical analysis as a tool in decision making at least some degree,” almost 90 percent of those surveyed responded positively.

Neely and Weller (2011) define technical analysis as the use of price behavior in the past to help make decisions about future plans. Historical data is used to make future decisions by overlaying rules on the data. Technical analysis is simply the study of price movements, activity, and price relationships for market analysis. According to Plummer (1993), price patterns of a historical nature can be used for current trading. According to Murphy (1999), practitioners extensively use technical analysis. Technical analysis is used to find a sort of geometry in prices, such as support and resistance and other basic patterns. Sentiments such as trends, surprise events, and emotions such as momentum and exhaustion all influence pricing. Technical analysis relies on charting price activity. Chart patterns are the result of reactions to other people’s actions. Graphs that show trends of previous prices are studied so that positive movements can be predicted by the observation of key variables. According to surveys by Menkhoff (2010), Allen and Taylor (1992), and Cheung & Chinn (1999), the use of technical analysis has grown (Menkhoff & Taylor 2006).

In conclusion, there are two common types of analysis: fundamental and technical. Many traders use a combination of both when making their trading decisions about what currency to trade, when to enter, and when to exit.

TRADING STYLES



Trade styles are defined by how a trader enters a trade and how he or she manages that trade. There are basically four types of trading styles: scalping, day-trading, swing, and position trading. However, a trader can of course switch from one style to another depending on need or circumstances.

Scalpers use the shortest time frame in trading; these are individuals who are satisfied to come away with small gains and who may enter and exit many times in a continued trend. Scalpers think quickly and have excellent eye-hand coordination for the quickest trade execution. Since scalpers use short turnarounds—seconds to minutes—they look for few pips from the trade. To be a scalper, you must not mind being attached to trading charts for several hours at a time, you must like to analyze, you must be impatient, and you need to be able to change your mind frequently in regards to trends or directions. If you get stressed easily, do not like taking longer periods to analyze charts, or you want to make fewer trades and bigger long-term profits, scalping is not a good fit for your personality (Cheng 2007).

The name itself tells us that a day trader enters and exits a position within a day. This is one of the more popular trading strategies in Forex trading. Day traders do not like to hold a position overnight because of added risk, and of not knowing whether prices will change significantly while they’re away from the trading screen. Day-trading is best for traders who have sufficient time to analyze, execute, and monitor trades. Typically, a day trader takes less than an hour to analyze a chart about whether to enter and exit a trade. Once the overall trend is identified, the trader moves from bigger time frames to smaller in order to look for trading opportunities. If a trader decides to follow a trend, it is known as trend-trading. If a trader identifies that a trend is going to end, he or she might make a trade in the opposite direction, which is called counter trend-trading. Breakout traders look for opportunity by waiting to see if a price moves outside a defined resistance or support level—with increased volume. Day traders tend to wait for good opportunities to enter the trade for long periods, in contrast to scalpers (Cheng 2007).

Swing trading attempts to capture gains by holding positions for several days; hence it is a longer-term trading strategy. Early identification of trends is one of the main objectives of swing trading. This type of trader looks for fundamental indicators as well as for price action, trends, and patterns. They will not buy into highs or short into the lows. This kind of trading suits people who are willing to make fewer trades, are patient enough to look for distinct trends and stick with them until reversal, and who are capable of making measured pullbacks in an uptrend and bounces in downturns. Mostly they set profit goals by using support and resistance or trend lines. This strategy will not be attractive to the trader who likes to jump in and out frequently, who is impatient, or who cannot spend time analyzing charts (Cheng 2007).

Position trading is a longer-term approach, and is based on overall trends, sentiments, and technical analysis. Positions can last from several months to years. They set high profit targets, and need to be alert to major, fundamental changes in the market. Such a strategy will be suitable for the trader who can effectively incorporate fundamental foresight into predictions about how it might affect particular instruments over the long run (Cheng 2007). However, if the traders get easily influenced by market news, do not understand how the fundamentals affect the market over the long term, are impatient, do not have sufficient starting capital, or who are looking for quick results, the trader does not fit with the position trading strategy. Usually, portfolio managers and hedge fund managers engage in position trading.

CHAPTER SUMMARY



We have learned that there are two basic types of analysis: fundamental and technical. Traders incorporate the principles of one or both into their decision-making routines. These also help them decide whether to enter, hold, or exit a trade. The next thing we will look at is the basis of all technical analysis—charts. Traders mainly use three kinds of charts in order to predict future prices in technical analysis. They are A-line, bar, and candlestick charts. We will look at all three in detail in the third chapter.


Chapter Seven

CANDLESTICK AS DEMAND AND SUPPLY

Now that we have pretty good idea about demand and supply strategy and how confluence factors may help in providing additional confirmations about trades, let’s take an in-depth look at how a candlestick chart could be used to identify demand and supply imbalances that yield high-reward and low-risk trades. We can actually draw demand and supply zones in Forex trading.

Demand and supply strategy falls under technical analysis in Forex trading. Technical analysis is the study of past price action in order to predict the future. Candlestick charts not only show the price of an instrument, but they reflect all items that have influenced a price, such as economic reports, geopolitical issues, technical indicators, emotions, thoughts, and so on. This information can be plotted as “time” on the horizontal axis and “price” on the vertical axis. Candles are the results of the battles between sellers and buyers. If the buyers win a battle, it’s represented by a bull candle (most trading platforms represent these in blue or green colors). If sellers win a battle, it’s represented by a bear candle (most trading platforms represent these in red or black colors). They form different shapes. A no win/no lose situation can be represented as a doji. Traders use technical indicators as tools to analyze charts. These tools are nothing more than the mathematical calculation of price, for example: a simple moving average (SMA) or a relative strength index (RSI).

Good businesses always have a plan regarding return on investment. Fast-food restaurants such as McDonald’s introduce many new products each and every year, but also keep products on the menu that have proven to be profitable in the past. Some products they inevitably discontinue at a loss. Similarly, traders need to analyze past information ahead of making investments in order to take advantage of the future. Finding demand and supply is the processes of predicting what looks likely to happen in the future. There are three elements to every trade: entry, stop, and target. Low-risk and high-profit targets should be the focus of all trades. There are as many kinds of strategies available in the market as there are traders. Some enjoy riding out trends. However, calculating demand and supply is a strategy for entering a market before a trend starts. It scans the places where trades have the highest probability of success. It is a trend-setting or a trend-reversal strategy. Stops are used to minimize cost. Like in the above example, McDonald’s discontinues products that are not performing well. In trading, the decision of where to place stop losses is important. One of the reason amateurs start to lose significant amounts of money if often because they do not know where to place stop losses. Letting profit run is a good idea, but how far is the critical question to answer. Professional traders know where to exit, because they keep in mind that the price of any given instrument cannot continue to go in one direction forever.

Traders can open long or short positions in the Forex market. Long positions are opened at low prices, with the intention to sell at higher prices. Short positions are opened at higher prices, with the intention to close at low prices. As soon as a trader takes an action to buy or sell, only one of two things can happen: profit or loss. Occasionally a situation arises where there is no profit or loss, but that is not the purpose of trading. The reward is a measure of what happens between entry and target, and risk is a measurement of what happens between entry and stop loss.

In Chapter 3, we saw how candlestick charts can be used to identify demand and supply imbalances for high reward and low risk trades. A demand and supply imbalance occurs when demand exceeds supply or supply exceeds demand. A series of same-color candles in one direction indicates a significant imbalance. When the price moves quickly up from the equilibrium zone, one thing is confirmed: there were no available sellers at that moment in time. If there had been sellers at that point, the price would not have moved up. All the supplies were absorbed, therefore the price started to go up. This type of move is created by an institution trading at high volume. Individuals or speculators then started to join in the move, which created a series of bull (blue) candles. This imbalance point can be taken as a market turning point for high possible reward and low-risk entry points. Similarly, when price moves quickly down from the equilibrium zone, one thing is confirmed: there were no available buyers. Had there been buyers at that moment, the price would not have moved down. At that moment in time, all the buyers were absorbed, therefore the price started to fall. This imbalance point can also be taken as a market turning points for high possible reward and low-risk entry points (Seiden 2011).

In Figure 44, the price quickly dropped after point A, creating a series of red candles. Two things can be derived from this data: a) the market moved quickly from the equilibrium because there were no demands available, and b) not all the sellers’ positions were triggered at that moment, and some were left behind (Seiden 2009).

[image: ]

Figure 44: Demand and Supply Imbalance

Institutional and professional traders do not chase prices—they wait. They know for certain that a price does not move in only one direction. People who entered at point A will need to take their profit at a certain point, and should do so when the next demand is available—before point B. We will be targeting the location where imbalance occurred (point A), and try to anticipate when the price will approach that level again, so we can sell the position along with leftover sellers. To do this, we draw two horizontal lines at the origin of the imbalance. The lower line (blue) in Figure 42 near point A indicates trade “entry” (this line can be moved up or down based on a trader’s own risk-taking criteria) and upper line (red) is the “stop loss” in case we guess wrong. The red line is static, and cannot be moved. The bigger the yellow zone between these two lines, the more chance we have to get the trade filled, but it correlates with a higher amount of risk. A small zone has less risk, but also a lower chance that the trade will be triggered.

As shown in Figure 44, while prices travel from point A to B, we do nothing. We wait for the price come to point C before we sell. There are three types of possible entry at point C: market entry, limit entry order, and stop entry order. Limit entry order and stop entry orders are often called pending orders. Stop losses will be placed a few pips up from the stop line. Profit targets will be a few pips above the next demand level (or opposing area), just above point D. While prices travel from point A to B, we also watch to see whether there will be any demand created for future buying opportunities. If B is a buying opportunity, when the price reaches D we will buy the instrument. At point A, the difference between the entry to and the stop loss is called risk, which is 16 pips. Reward (entry to target, i.e., point A to point B) is the distance between the opposing areas where demand was created, which is 60 pips. In this case, the ratio of reward to risk is 3.75:1.

As discussed in previous chapters, there are four types of zone: drop-base-drop, rally-base-drop, rally-base-rally, and rally-base-drop. A zone is simply the place where supply and demand fell out of balance. There are two types of zones: demand zones and supply zones. These zones provide a) low-risk trades, which are an important factor for minimizing loss, b) high profit potential, and c) most important, rule-based trading, which is an important aspect of professional trading. Rule-based trading not only helps a trader to be systematic, but helps to overcome any impulse a person may have to act emotionally.

Based on the quality of the zone, traders can decide whether to place an entry or not, and should establish predefined stop losses and targets. Supply zones are always located above the current price and demand zones are always located below the current price.

There are three steps to finding supply zones:

        •Start with the current price,

        •Without cutting through any candles, look left on the chart until you find a strong drop due to an imbalance (it will be higher than the current price),

        •Mark two horizontal lines at the origin of the imbalance.

Similarly, there are three steps to finding out demand zones:

        •Start from the current price,

        •Without cutting through any candles, look left on the chart until you find a strong drop due to an imbalance (it will be lower than the current price),

        •Mark two horizontal lines at the origin of the imbalance.

To identify the quality of these zones, we should take into account the reward-to-risk ratio. Additional factors, such as the distance to the zone, the freshness of the zone, and time spent at a given level are vital, too.

TRADE ENTRY TYPES



There are three types of entry available on the MetaTrader 4 platform. These are: market order, limit entry order, and stop entry order.

A market order is an order to sell or buy at the best available price. For example, for the EUR/USD pair, say the bid price is currently at 1.1110 and the ask price is at 1.1112. If trader decides to go long, the long position will be executed instantly at the ask price, which is 1.1112. The main drawback is that you will pay a little more, but this may be acceptable when trading volume is thin or there has been high volatility due to a news announcement, etc.

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Figure 45: Limit entries

A limit entry order is placed to with an indication to either buy below the current market price or to sell above the current market price. For example, see Figure 45, say at the moment, EUR/USD is trading at 1.0863. We traders want to take a short position when the price reaches 1.0940. There are two possibilities: we can either watch until the price reaches 1.0940, or we can place a sell limit order at 1.0940. When price reaches 1.0940, it will be automatically executed. The disadvantages of this method is that order filling takes some time, and there is the possibility that the higher price may never be reach and therefore entire order may not be filled.

Stop entry orders are orders placed to sell below the current price or to buy above the market price, where a specified price is arranged (OTA 2010). For example, see Figure 46, say the current trading price of EUR/USD is 1.0863, and we traders would like to take a buy position when the price reaches 1.0940. There are two possibilities: we can either watch until price reaches 1.0940, or we can place a buy stop entry at 1.0940. When price reaches 1.0940, it will be automatically executed. The disadvantage of this method is that order filling takes some time, and there is the possibility that the price may never reach that level and therefore the entire order may not be filled.

Buy and sell stops and buy and sell limits are called pending orders.

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Figure 46: Buy and Sell stop entries

CHAPTER SUMMARY



When a price moves quickly upward or downward, creating a series of similar-colored candles, the origin of the move can be considered an imbalance between demand and supply. That imbalance point is a potential entry point for buy and sell instruments. Traders can choose to place an order with different entry styles for pending entries. In the next chapter, we will look at money management and its importance.


Appendix

SAMPLE TRADING PLAN

A trading plan is a written set of rules that defines how and when to place trades. It can be simple and short, or long and complex; this is based on personal preferences, personality, and style. The purpose of a trading plan is to keep you relaxed, to remove emotions, and to make you to follow a rule-based approach. If the strategy/plan is working fine, there is no need to modify it; however, it can be modified based on assessment (from journals, logs, etc.) every three months, six months, or annually. A trading plan should not be modified as regularly as on a daily or weekly basis.

POSSIBLE OBJECTIVES



        •Not to lose more than 50% of initial capital after six months (novice traders)

        •To make a 60% return on investment in one year (experienced traders)

        •To generate the same income from trading as from a salary ($10,000/month) so you can leave your current job in three years

        •Contribute to social causes or not-for-profits

        •To pay for a family trip to Paris

PERSONAL STRENGTHS



        •“I worked as an office manager for a very organized company; this helped me to be extremely organized at work and home. I am confident that this will help me to keep journals, logs, and be organized in my new work—Forex trading.”

        •“I worked as crime controller, which helped me develop powerful skills for looking at evidence from different angles. This skill will help me to analyze charts from various angles as well—essential for Forex trading.”

PERSONAL WEAKNESSES



        •“I am a very impatient person, and I cannot wait long for anything. I know this could be destructive if I cannot wait to enter and exit a trade. Therefore, I will set up only trades that use pending orders, with a set-and-forget strategy.”

        •“Most of the decisions in my life that I have made based solely on emotions resulted in negative effects. In trading, if I make decisions based on emotion, it could lead to failure in a trading career. Trading is ultimate thing I would like to do. In order to overcome this problem, I will use only set-and-forget strategies.”

TRADING SCHEDULES



        •Best trading days: Tuesday to Thursday.

        •Fundamental analysis time (GMT): 8:00 a.m. to 9:00 a.m., to look over news and economic calendars.

        •Technical analysis time (GMT): 9:00 a.m. to 11:00 a.m., to analyze charts, find demand and supply levels, select trades, and place pending orders.

        •Trading times for day trades (GMT): 2:00 p.m. to 5:30 p.m.

        •Meditation/break time (GMT): 3:30 p.m. to 4:00 p.m.

        •Documentation time (GMT): 5:30 p.m. to 6:00 p.m., to record journal logs, etc.

TRADING STYLE: DAY TRADER







	ITEM
	DESCRIPTION












	Chart types

	Daily: to discover daily demand and supply and daily highs and lows; 60 min: for trend analysis and profit targets; and 5 min/15 min: for trade entry



	Currency pairs

	EUR/USD, GBP/USD, AUD/USD (only one pair at a time, since all are trading against USD) USD/JPY, EUR/JPY and GBP/JPY (one pair at a time, since all pairs are trading against JPY)



	Main Strategy

	Buy in demand zones and sell in supply zones based on 5-to-15-minute candle charts. Zones will be valid ONLY if less than 40 pips



	Entry Type

	
1. Pending order with set-and-forget strategy, if daily demand and hourly demand are in the same zone.

2. Buy/Sell: STOP entry if the demand and supply zones are in only hourly zones.

3. Confirm entry if the zone exists only in 5-min chart.

4. No market execution!



	News trading

	No trading during the news, however, pending orders (if any) will not be removed even if price is very close to my level. After 15 min, trading opportunities will be looked at for trends



	Number

	The level will be increased or decreased toward 00 and 50; however, in any case there must be less than 40 pips at risk.



	Min lot to open

	2



	Max lot to open

	2



	Maximum stop loss

	50 pips (Maximum stop loss with allowance)



	Minimum Stop loss

	20 pips



	Maximum pending order

	5 positions



	Removing pending order

	After 10 days, when pending order is placed, or
 if the price has moved away 300 pips from the level



	Risk amount

	3% of capital per trade. If there are open positions also, 3% of the balance will be used for new positions



	Reword to risk ratio

	1:1 for first target
 3:1 for second target



	Technical stop loss

	No



	Money management

	Once first target is achieved, stop loss will be moved to entry; however, for the first target, hit-or-kill method



	Trading Log

	Before placing a trade, all the entry and exit criteria must be written into log file. Trades will be ignored if the price comes into zone while writing it. Trading log will be analyzed on a weekly basis and monthly basis. The strategy will be modified on a quarterly basis if required.







LOG SAMPLE



Traders can make their own log files based on their own preferences and personalities. However, maintaining at least these parameters, could help to analyze trades on a monthly basis. Traders can add more parameters such as date of chart analysis, pending order selection date, date when a pending order was actually placed on terminal, etc.


Chapter Three

THE BASIS OF TECHNICAL ANALYSIS

Technical analysis is all about forecasting future financial price movements based on an examination of past price movements. Past data is usually examined in the form of a chart. Technical analysis works mainly on the following principles, founded by Charles Dow:

        •Price discounts everything

        •Price movements are not random

        •Price is set by ongoing demand and supply phenomena

Let’s look in more detail at the first point: price discounts everything. Technical analysts believe that all influences on price are reflected in the price. At any moment, thousands of events of different types could have occurred—announcements by the Federal Reserve, employment news, crises, terrorist attacks—and all of these lead traders’ thoughts and perceptions to two actions: buy or sell. Because all circumstantial information is already reflected in the price, the price represents the fair value of a currency, and should form the basis for analysis of its performance. Therefore, technical analysis utilizes the information inherent in the price to understand what the market is saying with the purpose of forming a view to the future. The second principle is that price movements are not random. This simply means it is possible to identify patterns of trade based on a trend. There are various kinds of trends, including upward, downward, and sideways. The third principle explains how technical analysis provides a direct approach to data. It says that a price is set by the ongoing forces of demand and supply. Demand for a currency gets higher when there are fewer sellers, and demand for a currency gets lower when there are more sellers. This is a simple principle of economics!

Charts are at the core of technical analysis, and a technical analysis is virtually impossible to perform without charts. Technical analysts study price actions, patterns, and volume. They believe that influences from factors such as economics, political forces, geopolitical forces, crises, bank announcements, etc. are either positives or negatives for an instrument—in our case, a currency. This leads to different approaches and perceptions among traders, who take action based on their analysis of these forces’ influence on price to either buy or sell currencies. Historic buy and sell actions are clearly documented and available in a chart form. Hence, as a technical trader, the decision to enter or exit should be based on technical analysis rather than fundamental analysis!

CHART TYPES



There are three main types of charts used in technical analysis:

        •Line charts

        •Bar charts

        •Candlestick charts

Line charts: The most basic type of chart is a line chart.

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Figure 4: EUR/USD Line Chart

This chart also displays the least amount of data. It is very simple—it just plots closing prices and connects them. This is for traders do not need to know the price movements of an instrument such as the opening, high, and low prices. Figure 4 shows a line chart of EUR/USD over the time frame of one day. The x-axis represents date and time; the y-axis represents the price.


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Figure 5: OHLC Chart




Bar charts: These are more complex than line charts. In addition to closing price, they shows high, low, and opening prices, too. Figure 6 shows a bar chart of EUR/USD over a one-day time frame. That means each individual bar was created over a one-day time frame. The vertical lines show trading range, and the two horizontal bars connected to each vertical line show the opening and closing prices of currency pairs; the opening price is on the left, and the closing price is on the right. These charts are sometimes called “OHLC” charts, for “open-high-low-close.” They provide a more detailed picture of the price movements of a particular currency pair than a line chart can. A closer look at a bar chart that indicates both a bull OHLC and a bear OHLC is given above, in Figure 5.

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Figure 6: EUR/USD Bar Chart

Candlestick charts: These are the preferred chart type for technical analysis. Candlestick charts (originally developed in Japan) display the greatest amount of detail about the price movement of a currency pair. The construction of a candlestick chart is shown below, in Figure 7. Different colors represent when the opening is higher than the closing, and vice versa, in addition to bars displaying the open, high, low, and close prices.

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Figure 7: Bull Candle (Left), Bear Candle (Right)

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Figure 8: Candlestick Chart (Source: Meta Trader 4)

The wide area on each vertical line is called the “real body,” and the thin area on each vertical lines above and below the body are called “shadows” or “wicks.” The shadow represents the highest and lowest price that occurred during a trading session (of a specific time frame). The upper wick represents the difference between the highest price and top of the real body of that period, and the lower wick represents the difference between the real body and the lowest price of that period.

Bullish candle forms—indicating when the price closes higher than it opened—are shown with blue, and bearish candle forms—when a price closes lower than it opened—are shown in red color. The top and bottom of the candle is called the “range” of the candle.

A closer look at a candlestick chart, with bull and bear periods labeled, is given above in Figure 8. Please note that different colors can be used for bull and bear candles based on customer preferences, however the market standard is blue for bull and red for bear.

Candlestick charts allow for a quicker analysis and a more efficient analysis than the previous two types of charts. Bearish and bullish candles can be identified easily, since the areas between the opening and closing prices are colored and boxed. Also, various formations of candlesticks can act as a signal to traders to take quick action, as we’ll see below. The limitation of candlestick charts is they are not perfect—like any other technical analysis tool. They also take up a lot of space on screen once you enlarge them enough to get useful detail. Since they create different kinds of forms, with colorful names like hanging man, doji, shooting star, and hammer, each of which point different types of reversal or continuation patterns, it can be time-consuming and hard to analyze authentic charts.

CONCEPTS OF CANDLESTICK FORMATION



The Forex market is driven by a supply and demand principle. Candlestick charts simply show supply and demand for specific currency pairs. The demand for a particular currency increases when it is considered more valuable as compared to the second currency in a pair; similarly, the demand of particular currency decreases when it is considered less valuable as compared to the second currency in a pair.

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Figure 9: Bull Candlestick Formation

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Figure 10: Bear Candlestick Formation

Another way of looking at it is that a base currency will be more valuable than a quote currency when the demand for the base currency increases, and less valuable when demand for the base currency decreases. The magic behind being a successful currency trader lies in being able to identify supply and demand trends in the market. If traders can determine these, they will be well on the way to making significant income in the Forex trading market (Hansen 2006).

Candlestick charts show supply and demand imbalance in a colorful way. Traders can take advantage of candlestick formation to identify supply and demand on a chart. When buyers take control over suppliers in a particular time frame a candle is represented in blue, and similarly, when sellers take control over buyers, it is represented in red, as shown in Figure 9 and 10.

Looking again at Figure 9, suppose the EUR/USD is currently trading at 1.1000. If there are no willing buyers or sellers available, the price will be constant. Candlestick formation would look like a dot. Since Forex represents one of the most liquid markets in financial trading, therefore, buyers and sellers are present at all times. Assume at the price of 1.1000 there are 1,000 buyers available to buy EUR and 500 willing sellers, thus, the demand of 500 buyers will be fulfilled by the existing 500 sellers. However, there are still more willing buyers, but the sellers have run out. In this scenario, the price starts to move up. When buyers take control over sellers, the candlestick formation will be blue/bull candle. When the demand is very strong, the formation of the blue candle will be longer. Therefore, the size of the candlestick represents the strength of a buyer-seller imbalance at any given point. In the opposite scenario, where at the price of 1.1000 there are 500 buyers available to buy EUR and 1,000 willing sellers, all sellers cannot offload their currency. In this scenario, the price starts to move down. When sellers take control over buyers, the candlestick formation will red/bear candle, indicating a bear market. Strong supply is denoted by larger red candles.

CONCEPTS OF SUPPLY AND DEMAND IN FX



Traders use various kinds of strategies to govern when to enter and exit trades. Some traders are happy to trade in a sideways market or a ranging market, whereas some like to trade in a trending market. When the pair has been frequently trading between the same level of resistance and the same level of support for a period of time, the market is said to be moving “sideways” whereas trending market is one in which price is generally moving in one direction. It establishes new highs or lows. The demand and supply strategy tends to identify moves in advance, in order for a trader to be a trend setter. Early entry can provide great profit potential, but it could be risky because you will be going against a previous trend.

Technical analysis is all about using historical prices overlaid with a set of rules to predict future prices. They use technical indicators as a weapon for decision making. Studies show that support and resistance strategy is one of the most widely used methods in the financial industry. Research done by Osler (2000) and major exchange firms shows what provided some technical assistance to clients in order to help predict future price movements, and most of the useful data provided support and resistance levels. Support is a price when demand is greater than supply; buyers have control over supply in this scenario, so prices stop falling. Resistance is a price when demand is less than the supply; buyers cannot take control over supply, hence the price stops rising (Osier 2000).

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A: Such kind of formation appears when market can not make new highs or lows (Sideways)

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B: Price makes new highs and new higher lows during the uptrend.

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C: Price makes new lows and new lower highs during the downtrend

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Figure 11: Support and Resistance Formation

There are many ways to identify support and resistance trends. Figure 11 (A) shows support and resistance indicators as lines during a sideways market.

Figure 11 (B) and (C) show support and resistance in a channel format. The most common ways to show support and resistance levels are these two. In Figure 11 (A), lines indicate where a price touched a high and low point multiple times. In Figure 11 (B) and (C), recent highs are connected by one line and recent lows are connected by another to form a channel (Osler 2000). When a price touches a resistance or support line without breaking it, that data indicates the strength of that level, or price. However, the more time a line is touched, the weaker that price becomes (Wagner 2011). It is easiest to identify support and resistance trending in a sideways market. Many traders use support and resistance to enter a trade or to create profit targets. In a sideways market, neither the bears nor the bulls take control of prices, so neither an uptrend nor a downtrend happens. In sideways markets, price activity oscillates between narrow ranges without forming any distinct trends (Waring 2007).

Each pip movement in foreign exchange data shows the game between buyers and sellers. They create two opposing forces, which results in price movements. Sellers are looking to sell high, whereas buyers like to buy at a cheap price. This tension is recorded by candlestick charts. At support and resistance areas, traders consider their positions in order to buy or sell particular instruments at a higher volume. These levels are not the result of market participants agreeing to buy and sell an instrument at a given price; support and resistance levels simply indicate that traders think that the exchange rate is either too high or low. This is also due to memory of market phenomena, which tell when certain price levels have been important in the past, indicating that they may have some impact on price movements in the future (Seiden 2009).

When the price reaches a new high and then falls considerably, both the sellers who bought at that high and the ones who lost the opportunity to sell will be willing to enter short when the price reaches that level again. The same thing will happen when the price reaches a new low and then rises considerably; both the sellers who sold at that high and the ones who lost the chance to buy will be willing to go long when the price arrives at that level again. This dance happens until there is balance between buyers and sellers. But many other variables affect the market in the meantime; therefore, a new variable can change the general actions of traders, resulting in weakening support or resistance and breakdowns (Frankel, n.d.).

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Figure 12: Imbalance Points (Support Broken)

In Figure 12, at point A, indicating support, have been broken at a certain point (shown by the black price). The reason is either that there were no more buyers left, or that the point was not attractive enough for buyers to buy again, therefore, the support lines could not hold. Similarly, in Figure 13, at point A, which indicate resistance, have also been broken at a certain point (shown by the black price). The reason is either that there were no more sellers left or that the point was not attractive enough for sellers to sell again, therefore, the line could not hold (fxstreet, n.d.).

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Figure 13: Imbalance Points (Resistance Broken)

In Forex, there are no defined rules about whether trade can be categorized by buyer or seller. Buyers can turn to sellers and sellers can turn to buyers. For example, when you have a long position, you are considered a buyer. At some point, though, you need to close the position for profit. Your action in seeking profit turns you into a seller; hence, Forex is a double-direction market (fxstreet, n.d.).

Traders/investors use support and resistance levels in conjunction with demand and supply as the basic function of economics to make decisions. Like other markets, the Forex market is driven by the supply and demand principle. The demand for a particular currency increases when it is considered more valuable compared to the other currency in a pair; similarly, demand for a particular currency decreases when it is considered less valuable compared to the other currency in a pair. Another way to say this is that a base currency will be more valuable than a quote currency when the demand of the base currency is increased and less valuable when demand of the base currency is decreased. The magic of being a successful currency trader lies in being able to find supply and demand trends in the market. If traders can determine that, they are well on the way to making significant income in the Forex trading market (Hansen 2006).

In the financial marketplace, the price of an instrument has significant impact on demand and supply. The supply and demand principle tends to work best when market conditions stay steady. The effect of minor fundamental influences are minimal, thus the market does not behave drastically by showing changes in price. However, major fundamental news could affect things such as interest rates, which could cause formerly stable support and resistance lines to break (Stanley 2012). Volume also plays a significant role in demand and supply. The demand and supply level becomes valid only when there is sufficient volume (Evens 2009).

In Forex, people are essentially trading the economies of one country against another. Strong economies tend to have strong currency, and weaker economics tend to have weaker currencies. Thus, demand and supply of a particular currency depends on the economy today as well as in the future. This of course involves making an emotional decision. However, trading is all about making rule-based decisions rather than relying on emotions or luck. The market operates on three principles: in a free market, supply and demand is an ongoing process of price actions; all price influence factors are already reflected in price; and changes in price movements happen when one of the sides (supply or demand) approaches null (Seiden 2011).

Let’s look at the first principle: in a free market, supply and demand is an ongoing process of price actions. In the Forex market, the price is determined by ongoing actions between sellers and buyers of particular instruments. If there is greater demand, it pushes prices higher and creates a pivot high. Similarly, when there is greater supply, it creates higher lows and creates a pivot low. All these are reported on the charts we have seen above. However, in equilibrium states, buyers and sellers are almost equal (indicated on the chart by where the majority of candles are) and the price movement cannot be driven in one direction or another. The market cannot stay forever in a state of equilibrium—various factors will eventually move the price. However, the market will eventually again move toward equilibrium (Seiden 2011).

To examine the second principle: all price influence factors are already reflected in the price. This means that at any given moment, thousands of pieces of information, such as economic reports, speeches by key figures, political issues, etc. can emerge and fade away. This information is translated into thoughts and beliefs by traders. Thoughts can be translated into action—either selling or buying an instrument at a specific price. Therefore, only price matters.

The last principle: changes in price movements happens when one of the sides (supply or demand) approaches null. This can be illustrated using a simple example. Say there are 100 buyers and 50 sellers at the price of 1.1000. The price will be in equilibrium until all 50 sellers have sold. After that, the price will start to move upward because no sellers are available but demand is present. The price will move upward until it finds another equilibrium point. In this example, the movement started when the sellers approached null (Seiden 2011).

So, as a trader, opportunities arise by seeking out these imbalance points of supply and demand. Doing so not only helps to maximize profit potential, but creates better chances for trading success while limiting risk.

CHAPTER SUMMARY



In this chapter, we learned about the three types of chart: line, bar, and candlestick. The most preferred among these three is the candlestick, which provides a huge amount of information to traders and allows them to make better decisions during a trade. It can be a very powerful tool for learning to understand quickly what has happened in the battle between buyers and sellers during a particular time period. In addition, we’ve learned how the demand and supply concept applies to Forex trading. In the next chapter, we are going to look about some theories about trends, and examine the most popular chart patters to find out about trends and multiple time frame analysis.


Chapter Nine

TRADING PLANS

Identifying supply and demand imbalance points as possible entry points is a method of predicting market behavior before it happens. These imbalance points are considered market turning points. The sell zones are always located above the current market price, and buy zones are located below the market price. The beauties of this trading strategy include the following benefits:

        •The entry, exit, and targets are predetermined before a trade is initiated. Traders can identify reward-to-risk ratios in advance. That includes predicting how much money a trader will make in the case of a successful trade. Similarly, how much money a trader stands to lose in the case of an unsuccessful trade. This is helpful to the traders in making decisions, such as whether to take a trade or not. Does the risk level satisfy the trader’s trading plan criteria, or not?

        •Second, the trader has a clear plan of why he wants to take trades on at demand and supply imbalance points. This gives confidence to the trader.

        •Consistency is key to being a successful trader. Trading plans also help develop good habits—essential to any trading career. With demand and supply strategy, it helps to be consistent in the way a trader approaches the actions of buying and selling currencies.

        •Trades must follow a rule-based trading approach to be successful. It is one of the vital ingredients for a trading career. Opening positions randomly or applying multiple strategies may lead to confusion and frustration. Rule-based trading helps traders to overcome fear and greed (Curtis 2003). Besides that, keeping journals and logs of transactions based on a rule-based approach could help to modify strategies, and by extension, to help traders mature for better performance.

        •This strategy is based on a straightforward approach; it is quite simple, and has only a few rules to remember.

WHAT IS A TRADING PLAN?



The Forex dictionary defines a trading plan as “a formal document that summarizes a Forex strategy of the trader, including a trading system, money and risk management, trading rules, and other details.” It is a primary document that helps traders track feedback. A written plan also helps traders to compare his/her different actions, which could lead to performance improvement in the near future. A plan also helps during a trade itself, when emotions threaten to lead traders into making to bad trades or poor decisions.

Most professional traders undoubtedly emphasize trading plans heavily. They consider them must-have documents. Trading plans are to traders what business plans are to entrepreneurs. It is a roadmap for a trading business that outlines a goal. Business dictionaries define business plans as a written document prepared by a company to summarize its operational and financial objectives for the near future, and details how it plans to achieve those goals. The business plan can be continually modified as conditions change and new opportunities and/or threats emerge. The same basic principles apply for trading plans, too.

A trading plan is a written set of rules that defines why, how, and when a trader will place trades, and how a trader will manage them. Although there are some differences between business plans and trading plans, the end goal is almost same: to earn profit in the long term (ignoring charitable or special-purpose businesses!).

The main aim of a trading plan is to eliminate ill-advised or emotional decisions, to help a trader stick to the rules, and to overcome the pull of greed and fear. Sticking with a trading plan will also give a trader the opportunity to learn from past mistakes, and to modify the plan based on new opportunities and threats as the market conditions change and/or as a trader updates him or herself on the market changes.

TRADING TIME AND DAY



While developing trading plan, it is important to consider days and timing. This will help to plan better in your daily life, too. Although technically there is always round-the-clock liquidity in Forex, not all periods are exciting to trade in. There are some periods where the market does not move much, called muted time. Therefore, the trader should always look to trade during the time when the market is most active.

Stock market opening and closing hours of the three major world markets—New York, Tokyo, and London—drive Forex movements significantly. Until recently, London was known as the trading capital of the world. The opening of the stock market in London always creates significant movements in currency trading. New York plays an important role as well, since the USD is the king of currencies. Movements in the New York Stock Exchange can have an immediate and powerful effect on the US dollar. Actions taken by the American Federal Reserve are therefore also key, because they result in stock market movements, and these movements are directly and instantly correlated with the value of dollar’s gain or loss. Similarly, Tokyo is considered the main trading hub for all Asia.

The geography of the earth is so beautiful. As it rotates to create twenty-four hours a day, one or more of these stock market’s trading hours always overlap, This creates a much higher volume of trading than if just one were open at a time. This means more trading opportunities. The best trading hours are considered to be when volume and volatility levels are high. London and New York alone have the capacity to move currency pairs significantly. The time when they overlap is the most important time for many traders.

The movements of currency are expected to be lower when one or more important industrialized countries has a holiday or weekend. Mostly, liquidity reaches its lowest levels on Friday after the NYSE has closed, and on Sunday as well. Traders consider Tuesday, Wednesday, and Thursday to be the best trading days because of liquidity and volatility. Similarly, liquidity drops sharply between mid-December and mid-January.

Considering all these different sources of information helps traders to plan daily, weekly, and monthly targets.

TRADER TYPES



Another aspect you should consider while developing a trading plan is simply what kind of trader you are. Generally, traders fall into four categories: scalping, day, swing, and position. These groups define how a trader enters a trade and how he or she manages it. The scalper uses shortest time frame in trading, is an individual who looks for small gains, and may enter and exit many times in one continued trend. Day traders enter and exit a position within a day. Swing traders attempt to capture gains by holding positions for several days or weeks. Position traders are the longest-term traders, they base their entry on overall trends, sentiment, and technical analysis. Therefore, it is important to know what kind of trader you are. Do you like to trade many positions in a day, or just once a week?

TRADING GOALS



Every trader who likes to trade must have a goal. The more specific and focused a goal, the better the chance you have of encouraging yourself to achieve it. A trading plan without cannot be imagined or put into action without a goal. Earning money is the most common goal—but not the only one. Goal setting provides you a reason to work hard, motivates you to achieve the goal, and gives you a sense of confidence and accomplishment once you achieve it. Trading goals can be formulated by answering questions such as: What do I expect to achieve from trading? Where I want to be in five years? What do I want to achieve for my wife and kids? And so on.

Goals should be realistic and achievable. Depositing $100 in a Forex trading account and setting a goal to be a millionaire in a year is not a realistic goal. If you are a novice trader, trying not to lose your initial capital during your first six months in the market might be a better goal. If you achieve your first goal, you will be much more confident about trying to achieve the next one. Once your goals are identified, it will help you to budget, to set monetary targets, perhaps even on a daily, weekly, monthly, or yearly basis.

TRADE RISK MANAGEMENT



A trading plan should include a clear trade risk management plan. This is a plan about how to manage an individual trade. There is no doubt that risk management is one of the most important aspects of becoming a successful trader. It focuses on the risk of each trade, the risk-reward ratio, the winning probability, and position sizing. Depending on your account, the pair of currency, and the risk you will accept per trade, you should be able to calculate the exact size of the position you should use for the trade.

MONEY MANAGEMENT



Money management is a crucial element in trading, particularly in times of high volatility. It is a defensive concept that protects your capital. Not all days are the same, and some days traders make bad decisions due to various factors. There will always be another day to trade. No one in the world makes a good trade every time. Money management helps you to have more staying power in the market. Besides that, you’ll always know that there is a sufficient amount in your trading account to achieve your goals. Money management focuses on initial lot sizing in relation to account size, and how it increases and decreases as the account grows or falls.

TRADING STRATEGY



This book is all about how to develop the most effective and powerful demand and supply trading strategy. The core of the plan is a trading strategy, which consists of trade entry, stop, and exit rules. Once the predefined conditions are met, trades take action. Trading strategies also include aspects of money management, order types, etc. A trading strategy must be quantifiable. Most strategies fall into three groups: trends, retracements, and reversals.

JOURNALS/TRADE REVIEWS



There are various benefits to keeping a trading journal. As a trader, you should be consistent about continuing to improve. If you consistently apply your entry and exit rules for trades, journals will help you detect errors made on your previous trades—this way, you’re less likely to make the same mistake again. Besides that, it will help to fine-tune your strategy. For example, you might ask yourself whether you need to increase or decrease your risk-to-reward ratio in sixty-minute time frames. Do you need to slightly increase or decrease GBP/JPY allowance for better result? Journals and logs help you to keep track of your past behaviors in order to recognize mistakes and avoid them in the future.

CHAPTER SUMMARY



Trading is one of the most competitive businesses in the world. Being an owner or employee of a trading company requires a proper plan, discipline, and an effective rule-based approach. Every action taken by the owner directly affects the employees, and vice versa. In the case of accountability—it is ONLY you. Developing a trading plan and following it, is necessary if you want to be a professional trader. In the next chapter, we will discussing about features of the popular MetaTrader 4 platform in order to show how demand and supply strategy can be applied with it.


Chapter Four

TRENDS IN FOREX MARKETS

Market trends in Forex trading show the direction of a price for a particular currency pair. When identified early, a trader can be profitable in the market by positioning his trades in advance (Chande 2001). Equally, a trader can avoid huge losses from aborting unfavorable existing trades. Forecasting the market is important for all sizes of companies, individual investors, and financial institutions. Effective technical forecasting methods will help keep investors from losing capital easily in the market, and will help them residing for longer periods of time in the market and to be profitable as well.

DOW THEORY



Charles Dow is considered the inventor of technical analysis. He founded Dow Jones & Company, which created the Wall Street Journal. Around 1900, after analyzing how the Dow Jones Industrial Average and the Dow Jones Transportation Index moved, he concluded that markets tend to move in similar fashion over time. Later, this basic statement evolved into Dow Theory. The theory is quite old now, but interestingly still relevant for many financial instruments (Waring 2007).

There are six assumptions that must hold for the theory to function. 1. Price discounts everything. 2. New information is disseminated immediately; when it arrives in investors’ hands, prices are adjusted accordingly. 3. There are three trends in the market (uptrend, downtrend, and correction) and each trend has three phases (accumulation, public participation, and excess). These forces include primary, secondary, and minor trends. The primary trend is likely to last for a long time (more than one year). Intermediate trends last for a few months. Minor trends last for a very short time (between three and twenty-one days) (Spaulding 2014). 4. Averages must conform to each other. 5. Volume confirms the trend. 6. A trend is considered to remain intact until it gives a definite reversal signal.

Let’s look for a moment at Dow’s third condition, regarding trends. An uptrend is defined as a movement when the price makes higher highs (HH) and higher lows (HL) than the previous highs and lows in a given period of time (shown in Figure 14). Down trends are when the price makes lower lows (LL) and lower highs (LH) (shown in Figure 15). When the market moves sharply in one direction, a correction is required in order to get it to move in the same direction again (shown in Figure 16).

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Figure 14: Uptrend

Let’s look for a moment at Dow’s third assumption—that a primary trend has three phases. During the first phase (accumulation), investors buy in plenty as they begin to enter the market. When conditions improve in the second phase (participation), investors accumulate the instrument due to improved market conditions. During the third phase (excess phase), more instrument is bought, but smart investors start to exit their positions in order to gain profit (Waring 2007).

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Figure 15: Downtrend

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Figure 16: Correction

An instrument’s movement will be upward if there is an upswing in the market and downward if the market is on the downward swing. Two indexes developed for measuring overall market movement are the Dow Jones Industrial Average and the Dow Jones Transportation Average (only industrial and transportation instruments are included in Dow Theory) (Siegel, Shim, Qureshi, & Brauchler 2000). Investors in the market use this theory in determining whether there is a trend emerging and, if so, what its direction is likely to be. The theory is criticized for failing to give a maximum length and magnitude to the primary, minor, or secondary trends. It is also viewed as indicating the beginnings or endings of market movement very late. At times, it may also give inaccurate results. People are generally advised to buy if the market moves high and sell if it moves low (Siegel, Shim, Qureshi, & Brauchler 2000).

A trend is used to represent a consistent change in prices. The market for an instrument cannot move in a straight line. Decisions in trading can be made through support (traders may buy the instruments, causing sellers to be overpowered by the buyers) and resistance (traders may sell the instruments, causing prices to be pushed up and sellers to overpower the buyers) analysis. In support mode, a price tries to find support as it goes down. A resistance level indicates that the price goes up until it finds resistance. There is a shift in supply and demand once the trend lines (used for connecting points that are significant to resistance, as we saw above) are broken. Support may turn into resistance, or resistance may turn into support. Analysis of support and resistance is very crucial, as it helps in the process of making trade decisions and in identifying trends that may be reversing. Through the use of Dow Theory, price patterns can be determined. The operation of support and resistance can be well understood if there is an understanding of how Dow Theory can be applied to trading instruments (Thomsett 2003).

ELLIOTT WAVE THEORY



R. N. Elliott first developed Elliott Theory in the early 1930s, but it was published by Charles Collins in 1938. Waves in this theory refer to patterns of movement of prices in the financial markets (Ginneken, n.d). The price moves in five steps, and support or resistance is found after every step. When this specific repeating pattern of waves is observed and identified, prediction of market movement can be made. Fibonacci ratios are mainly used to find support and resistance levels, and mathematical foundations for this theory are provided by Fibonacci numbers. The time and magnitude of future market movements can be predicted by using Fibonacci numbers and counting waves. For the theory to make correct predictions, however, wave count must be accurate. It can be challenging to determine the starting or ending points of a wave.

A study by Dash and Patil (2009) was conducted in the stock market in India to find support for Elliott Wave Theory. Statistical data on the closing prices between the 2001 and 2008 indexes were used. The National Stock Exchange website served as a source of secondary data. Twenty-five companies were sampled in the study, drawn from the telecommunication, banking, information technology, energy, and automobile industries. The method used to identify the wave was careful observation. In their sample, the researchers selected scripts that were used in trading for the whole period under study. The study used two patterns (Pattern 1 and Pattern 2). Pattern 1 (a four-day pattern) had alternating signs that signified either gains (+) or losses (-). Pattern 2 (a seven-day pattern) was also used. The results of the study showed that the market does exhibit significant patterns. Pattern 1 was found to be missing in some scripts, but Pattern 2 was found to be present in all the scripts. Trends were found to be of short length in several scripts. An Elliott Wave was present in various scripts. The Elliott Wave Theory is hence supported by this study (Dash and Patil 2009).

The Elliott Wave principle states that the psychology of investors and the momentum of the prices changes results in the movement of markets. There is movement from positivity to negativity in crowd psychology, hence the progress of some market trends in being forecasted. This principle is mainly applied in stock markets (Talreja 2007). There are five waves (impulse) that exist on the upside and three (corrective waves) on the downside of an Elliott wave. Major waves determine major trends and minor waves determine minor trends in the financial market. Impulse waves must be analyzed before a trader can predict or act on a prediction. In Figure 17, Wave 1 is caused by a small number of various reasons—that instrument is cheap and there is time to buy it. Wave 2 is where profit-taking happens, but the prices does not make it to a lower low than when the move started. Wave 3 occurs when an instrument gets the attention of traders and it creates a higher high. Profit-taking happens again in Wave 4, but again the price does not make a lower low than the original price from Wave 3. When it reaches Wave 5, people believe that the instrument is extremely overbought (Babypips 2011).

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Figure 17: Impulse and Corrective Waves

In summary, understanding trends is one of the vital factors in Forex trading. When you look at charts, you can figure out the general direction a currency pair is headed. In some cases, the trend is easily identified; however, there are some cases where the trend is much more difficult to identify. There are commonly used rules for identifying trends. The first is that trends tend to move in a series of gradually moving highs and lows. Thus, an uptrend is a series of ascending highs and lows, while a downtrend is a series of descending lows and highs. It takes at least two higher highs and higher lows to establish the uptrend and two lower lows and lower highs to establish a downtrend. Besides uptrends and downtrends, though, many instruments experience sideways trends too, which are created by roughly equal highs and equal lows.

The main purpose of this book is to teach investors to trade using demand and support strategies, not by relying on chart patterns. However, these chart patters can provide additional confirmation to the likely success of a trade. Therefore, we should investigate some details about four often-encountered chart patterns.

DOUBLE TOP AND DOUBLE BOTTOM



Double top is a powerful reversal chart pattern. Shown in Figure 18, this kind of pattern forms two consecutive peaks. Double top appears during an uptrend where price creates a new high to the resistance level. It falls quickly, though, because sellers take control over buyers. Since the overall trend is still on the upswing however, buyers make another attempt to purchase, and this pushes prices higher. Buyers fail to make a higher high, however, due to selling pressure. Finally, the price starts to fall back to the support level (called the neckline). Once the support level is broken more sellers step in, which marks the beginning of a downtrend.

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Figure 18: Double Top (Left), Double Bottom (Right)

Another way to say this is that, at the resistance level, supply surpasses the demand, which results in falling prices. It is quite difficult to see volume in Forex due to the fact that it is a decentralized market, so in the normal trading process, traders watch closely for declining volume in the second peak of a double top.

Another common chart pattern is a double bottom. This is also a reversal pattern, and is the mirror image of a double top. Double bottoms appear during a downtrend, where price creates a new low at the support level. It rises quickly up because buyers take control over sellers. Since the overall trend is still downward, however, sellers make another attempt to push price lower, and this causes the second low. However, sellers fail to make a lower low due to buying pressure from bulls. Finally, the price starts rising back to the resistance level. Once the resistance level (neckline) is broken, more buyers step in, which makes the beginning of an uptrend again.

Simply put, at the support level, demand surpasses supply, which results in rising prices. It is quite difficult to see volume in Forex due to the decentralized market, so in the normal process, traders watch closely for declining volume in the second peak of a double bottom.

HEAD-AND-SHOULDERS AND INVERSE H&S



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Figure 19: Head-and-shoulders

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Figure 20: Inverse head-and-shoulders

The head-and-shoulders (H&S) pattern is another common chart pattern to encounter. This is trend-reversal pattern and occurs during an uptrend. The formation structure follows the name itself, and it looks like a head with two shoulders (shown in Figure 19). A head-and-shoulders pattern forms when the price makes one peak (the left shoulder), followed by a higher peak (the head), which is then followed by a lower peak (the right shoulder), and finally breaks below the support level (neckline). As we can see from Figure 19, buyers pushed the price higher three separate times before the sellers finally took control. The chart pattern gets validation when the neckline is broken. Traders pay special attention to this, but the neckline is synonymous with the support line.

An inverse head-and-shoulders pattern is mirror image of a head-and-shoulders pattern. This is also trend-reversal pattern, but it occurs during a downtrend. An inverse head-and-shoulders pattern forms when the price makes a new low (the left shoulder), followed by a lower low (the head), which is then followed by a higher low (the right shoulder), and finally the price breaks below the resistance level.

As we can see from Figure 20, sellers pushed the price lower three times before buyers took control. The chart pattern gets validation when the neckline is broken, and traders pay special attention to it. The neckline is synonymous with the resistance line.

MULTIPLE TIME FRAME



A multiple time frame chart is one of the tools we can use to analyze the same instrument over several different time frames, for trend analysis. This enables the trader to find out whether an instrument is experiencing an overall trend. If there is a trending market, smaller trends occur before larger trends, which means trends exist within trends (Money 2012). For example, if we look at a weekly chart of AUD/USD, the trend may seem to be toward a downturn; however, on a four-hours chart, the trend may be up. A sixty-minute chart of the same pair may appear to be no trend (see Figure 21)

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Figure 21: Multiple Time Frame

Most traders use three time frame analyses, but this depends on an individual’s trading style. For example, swing traders may look at a weekly chart for bigger-picture analysis, trend identification in a daily chart, and a 240-minute chart to determine entry. Traders such as day traders—who want to get in and out of a trade on the same day—might look at 240 minutes as their “big picture” chart, a sixty-minute chart for intermediate analysis, and a fifteen-minute chart to determine entry. As described earlier in the Dow and Elliott theories discussion, in case of an uptrend, a price reaches new higher highs and new higher lows, and in a downtrend, a price is creates new lower lows and new higher lows. Traders see opportunity once the smallest time frames have completed a retracement and a price starts to travel in the direction of the longest time frame’s chart trend. If we take the example of three-time-frame analysis for swing trading, the best entry point would be when the 240-minute trend chart begins to align with the daily chart and daily chart begins to align with the weekly chart (Money 2012).

CHAPTER SUMMARY



Many traders use Dow and Elliott wave theory to identify trends, in combination with other tools. Double top, double bottom, head-and-shoulders and inverse head-and-shoulders are often-seen reversal patterns. It is very important to be able to understand and identify trends in order to trade with a trend for profit maximization. Trend identification also helps traders to avoid losing money by acting counter to trends. Demand and supply directs trends or trend reversal strategy, which will be explained in greater detail in Chapter Five.


Chapter One

AN INTRODUCTION TO THE

FOREIGN EXCHANGE (FOREX)

Worldwide, the importance of trading is increasing in the financial market. The basic concept of trading is an exchange of goods or services for other goods or services. When money emerged as a medium for commerce, trading became much simpler than traditional bartering. In financial markets, instruments such as stocks, bonds, currencies, and derivatives are exchanged or traded. A market where sellers and buyer exchange shares is called a stock market. Bonds are another kind of investment, and buyers and sellers engage in the exchange of debt securities—arrangements where one party promises to return the invested money with interest at fixed intervals. Usually, a contract is signed by both parties to formalize a trade. The predictive market is another type of exchange, where the exchange of goods or services is arranged to take place in the future. Foreign exchange (Forex) is a type of financial market where people exchange currencies to conduct business internationally.

Forex is an unregulated and decentralized network of currency trading between banks, public and private institutions, retailers, and speculators. It is one of the most liquid and the single largest financial market in the world. In the year 2013, Forex traded at an average volume of $5.3 trillion per day—much more than the largest stock exchange. The New York Stock Exchange (NYSE) trades at an average of $22.4 billion a day (EV 2014).

In 1944, with the aim of stabilizing the global economy after World War II, the Bretton Woods Agreement was developed. This agreement fixed other nations’ currencies against the price of gold, but eventually the US dollar was identified as a reserve currency linked to the price of gold. Gold was set at $35 per ounce. In 1971, the modern foreign currency exchange was created and the Bretton Woods Agreement was discontinued (Viterbo 2012), and it was agreed that the US dollar would no longer be exchangeable for gold. In late 1971 and 1972, two more attempts were made to redefine how exchange rates related to the US dollar. These agreements were called the Smithsonian Agreement and The European Joint Float. By 1973, the price of a foreign currency was determined by supply and demand, which was mainly controlled by industrialized countries. The birth of computer and Internet technology encouraged currency trading to rise from $70 billion a day in the 1980s to $1.86 trillion a day twenty-five years later (Bailey 2006). In 1999, the European Union introduced the Euro (EUR), and it became the first single currency to be able to rival historic leader currencies such as the United States Dollar (USD), British Pound (GBP), and the Japanese Yen (JPY). Today, the Euro (EUR) is considered the second most important currency in the world (Martinez 2007).

In Forex, a transaction between traders occurs on the spot, using decentralized computer networks. Therefore it is called the spot market. Traditionally, foreign exchange trading has been a domain of large financial institutions, corporations, hedge funds, central banks, and very wealthy individuals. However, trading became much easier with the advent of modern Internet technology and other financial trading platforms; average individual investors can now speculate on the foreign exchange market. The attraction to Forex trading is also growing rapidly. This is mainly because it provides enormous opportunities to traders. It is open twenty-four hours a day, five and a half days a week; it has the highest leverage of any financial industry; liquidity around the clock; no commission; and it’s relatively easy to open an account even with a small initial deposit.

FOREX TRADING ESSENTIALS



Forex is the abbreviation for foreign exchange. This is where one country’s currency is traded with another country’s currency (sometimes, a currency can represent the economies of multiple countries, as is the case with the Euro). Since a currency represents a country, its value depends on that country’s economic health. The trading between currencies happens in real time, on the spot, for whatever price it costs at any given moment, therefore, it is called the spot market, too (Martinez 2007). In Forex trading, there are only two possible actions: the buying or selling of currencies. Because of the nature of the exchange, currencies must always be bought or sold in pairs. For example: Euro vs. United States Dollar (EUR/USD), or British Pound vs. Japanese Yen (GBP/JPY). The first currency listed in an exchange, EUR and GBP in these two examples, are called base currencies and the second currency listed, the USD and JPY in these examples, are called quote currencies. The base currencies are the basis for any currency being bought or sold.

Let’s look at an example of EUR/USD to discover how traders earn money by buying and selling a currency pair. Below, in Table 1, we see the process of buying a base currency (EUR) in respect to a quote currency (USD). In Table 2, we see the process of selling a base currency (EUR) in respect to a quote currency (USD).

Currencies are mainly divided into three categories: major, minor, and exotic. Major currencies include the United States Dollar (USD), Euro (EUR), Swiss Franc (CHF), Australian Dollar (AUD), British Pound (GBP), Japanese Yen (JPY), Canadian Dollar (CAD), and the New Zealand Dollar (NZD). When these currencies are traded with USD, they are called major pairs, for example, EUR/USD, GBP/USD, USD/JPY. When any of the major currencies are traded with each other, but not with USD, they are called a minor currency pair. For example, EUR/GBP, GBP/CAD. If there are no major currencies traded with another currency, it is called an exotic currency pair. for example, Omani Rial (OMR) vs. Egyptian Pound (EGP), so OMR/EGP. These currencies are less liquid, lack market depth, and trade at low volumes (Taylor 2003).

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Table 1: An example of EUR/USD buying

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Table 2: An example of EUR/USD selling

In Forex trading, all currencies are quoted in two ways: with a bid price and an ask price. In general, the bid price will always be lower than the ask price. The bid is the price at which market is willing to buy the base currency in exchange for the quote currency (Arkolakis 2014). This is the price at which traders buy the base currency.

Below, in Figure 1, we see a EUR/USD pair. The bid price is 1.1043, which means the trader can sell 1 EUR for 1.1043 USD. The ask is the price at which market sells the base currency in exchange for the quote currency. In this EUR/USD pair, the ask price is 1.1046, which means the trader can buy 1 EUR for 1.1046 USD. The difference between the bid and the ask price is called the spread, which is 0.0003 pips. Normally, the spread is what a trader would pay a broker as a commission charge. A pip is short for a “price interest point,” or the amount of change in the exchange rate of a currency pair. A pip is the smallest unit of currency value. This is also the smallest measure of change in a given currency pair. All currency pairs are displayed to four decimal places, and one pip is equal to 0.0001. The only exception to this is Yen-based currency pairs; they are displayed in two decimal places (0.01). Some Forex brokers offer smaller denotations of pips, up to 1/10 of a pip.

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Figure 1: BID and ASK Prices

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Figure 2: BID and ASK Prices. Meta Trader 4 Live Chart.

Traders have various nicknames for approaches to buying currencies, such as “going long,” “long,” or taking a “long position.” These are for when they think that the base currency will rise in value; then they buy it in order to sell it back later at a higher price. Similarly, if they think that the base currency will fall in value, they sell it in order to buy it back at a lower price. This is often called taking a “short position” or “short,” or “sell position.”

There are three types of lot size available in Forex trading: standard lots, mini lots, and micro lots. The standard lot is made of 100,000 units. The average pip size for a standard lot is approximately USD 10/pip. One pip changes the base currency value relative to the quote currency, with a result of USD 10 positive or negative value in a standard lot. A mini lot is a 10,000 unit lot, and the average pip size for a mini lot is approximately USD 1/pip. One pip changes the base currency value relative to quote currency, with a result USD 1 positive or negative. The micro lot the smallest lot, 1,000 units. The average pip size for micro lot is noted in cents (i.e., approximately USD 0.10/pip). That means one pip changes the base currency value relative to quote currency, with a result 10 cents positive or negative.

Traders (individual or institutional) must open an account with a Forex broker in order to trade Forex. Based on the broker’s capabilities, traders can open an account in various currencies, such as USD, EUR, JPY, or others. A broker also provides the investor with a trading platform—software that allows traders to carry out online buying and selling activities. One of the most common trading platforms is MetaTrader; however, some brokers have developed their own platforms for clients. An open account comes with leverage, agreed between the client and the Forex broker. Leverage is expressed as a ratio and is based on the margin requirements imposed by your Forex broker. In order to hold an open position, a margin is required—it is collateral. The term “margin” is probably best explained with the word “bailout”. Margin is defined as the amount of money required in your account to maintain your market positions using leverage. For example, if you are in an open position for $20,000 using a 100:1 margin, then your account balance should be no less than 1% of that amount. This is because you can usually trade up to 100 times the money you actually have. Similarly, if your broker require a 2% margin, you have a 50:1 leverage. The calculation for leverage is:

Leverage = 100 / Margin Percentage

Account balance and margin balance are different. The trader can have a balance in his or her account, but he or she can also have a shortage of margin, which may trigger the broker to close all open positions. Leverage allows a trader to trade without putting up the full amount, however, some margin amount is required to be in the trading account. For example, 100:1 leverage means $1,000 of equity is required to purchase an order worth $100,000. Traders need to keep a careful eye on margins. If there is not a sufficient marginal amount or the account falls below the liquidation margin level, trade will be immediately liquidated, which is called margin closeout. This mainly happens when open positions are in the negative.

Traders can conduct just two actions: buying and selling a base currency. An entry is when a trader decides to open a position, either to buy or sell. Traders have the option to close a position as well, either in a state of profit, loss, or no gain or loss. When a trader decides to close open positions for either a profit or a loss, or for no gain or loss, it’s is called an exit. A stop loss is the amount or value a trader is willing to lose in case of a bad decision. Stop loss can also be used to secure profit, if the trade is already profitable. The distance between entry and stop is called risk, whereas the distance between target and entry is called a reward (Seiden 2011). Target is a price that, if accomplished, would result in a trader recognizing the best possible outcome. This is the price at which the trader would like to exit his or her existing position.

Liquidity in the Forex market is due to the presence of many participants. This enables traders to get in and out anytime, and at a variety of prices. This level of activity and interest reduces trading risk to traders. The seven major currencies—EUR, CHF, GBP, CAD, AUD, JPY and NZD—are the most liquid currencies in the Forex market when traded against the USD (Karnaukh, Ranaldo, & Söderlind 2013). Major international banks play an important role in providing liquidity in the Forex market (BIS 2014).

CHAPTER SUMMARY



Now we have had a general introduction to Forex and we have learned the basic terms associated with Forex trading. The next thing we will look at is how to analyze the Forex market.


INTRODUCTION

Just a few years ago, it was almost impossible for the average investor to trade in the foreign exchange market (Forex) online. It was the domain of corporations, large financial institutions, hedge funds, central banks, and very wealthy individuals. However, with the advent of Internet access to brokerage houses, it became easier to integrate financial trading platforms worldwide; thus today almost anyone can trade on foreign exchanges.

The Bank for International Settlements Triennial Central Bank Survey report on global foreign exchange market activity of 2013 showed that the daily turnover of Forex is about $5.3 trillion. It is one of the largest financial markets in the world. Generally speaking, in Forex there are two actions, BUYING and SELLING, which lead people to either EARN money or to LOSE money. The end result a trader can expect is either financial success or financial loss.

Taking action to either buy or sell using a computer platform is very simple—almost everyone could do that. However, making money in Forex is not easy. The market does not move in a logical fashion. Emotions, greed, and wariness move the market. Therefore, you need to change your habits and have discipline to be consistently profitable over the long term. This book provides information in detail on how you can be successful in a Forex trading career. This book contains all the skills you will need to become a successful Forex trader.

This book will give you a clear idea of when to buy or sell, how protect yourself in case you make a bad decision, and to give you tips on when to get out. These parameters must be learned before you make your first trade. This book will help you to be a rule-based trader, not one overcome by greed or fear. I have tested this strategy on myself for almost five and a half years, and I am very happy with the result—and I have decided to share the approach in this book.

Before going into further details, I would like to mention that this book is for those “who like to trade using technical analysis.” Analysis of the foreign exchange market falls into two broad methods: technical and fundamental. Fundamental analysis looks at the price of a currency in respect to many factors that may affect it, including political stability, economic performance, interest rates, and a market development. On the other hand, in technical analysis, an investor studies the behavior of different indicators, such as momentum indicators, support and resistance levels, price indicators, statistical price, and oscillator indicators in order to predict a future price. These days, technical analysis is growing in popularity due to its accuracy and simplicity. I am not saying that a technical trader should ignore all fundamental analysis indicators, but any decision should be made based on a technical point of view rather than a fundamental one. In short, as a technical trader, a trader should be aware of fundamental factors, but act based on technical analysis.

WHY TRADE FOREX?



The objective of buying and selling currencies is to get profit in order to fulfill desires—whether they are personal or for social causes. I have met a fifty-three-year-old woman, for example, who was trading Forex to support a nonprofit company. Forex offers numerous of benefits, such as:

        •The market is open twenty-four hours a day, five days a week. This means traders can make trades any time of the day or night.

        •There are two ways of earning money—in many financial markets, going short may cause difficulties. In Forex there is no restriction on either buying or selling. Both ways, traders can earn money.

        •Excellent liquidity. Liquidity makes it easier to get in and out of a trade at any time (if the market is not liquid, the trader may stock up to buy or sell instruments when they want). Forex is one of the most liquid financial markets in the world.

        •High leverage. Leverage allows someone with a small amount of capital to control large amounts of money. Which means gains can be maximized.

        •Low trading cost. Nothing is free in the financial market—every transaction costs money. Any person who decides to open a trade must pay fees to brokers as spread (you open an account with a broker for a Forex trading account). Spread is just the difference between the bid and ask (I will explain more about these terms in a later section).

Anyone who has Internet access, a personal computer or laptop, who knows how to use a computer, and who has this book can trade. In the beginning, you do not even need real money to get experience in trading. Large numbers of Forex brokers offer demo accounts. There is no difference between demo and real account platforms, except that you will trade without emotions! Real accounts can be opened for as little as twenty-five dollars (not recommended).

Forex trading can be done without leaving your current job, too; however, you need to develop a strategy that fits your lifestyle. In general, traders are categorized into four types: scalping, day, swing, and momentum. Scalping and day-trading styles consume more time, whereas swing and momentum trading requires very little time.

This book is divided into three broad sections:

        •Enriching your knowledge about Forex trading

        •Introducing a great strategy for buying and selling currency pairs

        •A sample trading plan, journal, and money management tips

The method for trading on almost any Forex platform is similar, however, we will show a step-by-step process with clear pictures using the MetaTrader 4 platform (a free Forex trading platform for all) and most for Forex brokers provide this platform for clients, too.


AUTHOR BIOGRAPHY

R. Rana is an MBA graduate from the Netherlands who currently lives in Germany. After working as project manager in multinational companies for more than ten years, he left the corporate world in 2011. He has been trading on the foreign exchange market since 2008, and one of his major research areas is forex technical analysis.

He enjoys meditation, travel, and keeping up with economic news.


Chapter Ten

TRADING USING METATRADER 4/5

The MetaTrader 4/5 (MT4) trading platform was developed by MetaQuotes Software for online Forex trading (although some brokers use it to trade other instruments such as stock, commodities, etc. as well). It is a free Forex trading platform. Traders can download the program directly from the MetaQuotes website at metaquotes.net, or through a Forex brokers for free. The platform can be used to trade in live or demo accounts. It provides many tools for analyzing charts, making automated trades, and various kinds of entry and exit methods for risk management. It is considered one of the most powerful Forex trading platforms.

INSTALLATION PROCESS



MT4 can be downloaded from most Forex brokers. It takes only a couple of minutes to install. Read the licensing agreement, then click “Next” to begin the installation. A new window will appear, giving you the option to create a new folder for the program or to allow the program to default install where it chooses. Click “Next” and “Next” without changing anything for default setting. This will create a shortcut on your desktop.

OPENING A DEMO ACCOUNT



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Figure 50: MT4 Demo Account Registration Form

Once the MT4 installation is completed, open the program by clicking the desktop shortcut. Some brokers give the option of opening a demo account right away, as shown in Figure 50. Fill in the required fields for name, country, state, city, zip code, address, phone, and e-mail. Select the account type, currency, desired leverage, and hypothetical deposit from the drop-down menus.


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Figure 51: MT4 demo account opening



Click “Next” and the demo account will be opened. Your user-name and password may appear on the terminal, and some brokers send these to your e-mail address, too.

If there is no option to open a demo account right away, you should be able to as shown in Figure 51, by navigating to “Open an Account” under the “File” menu. This process can also be undertaken even if you already have live account and would like to open a demo account.

In the demo account, traders can practice Forex trading without risking real money. Once you log in to your demo or live MT4 account the first time, the terminal screen will look like Figure 52.

This is not a great appearance for technical analysis. The good news is that it can be formatted with custom colors. You can change the colors of candlesticks or the background, and windows/terminals can be removed or added.

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Figure 52: MT4 Terminal at First Time

OPTIMIZING MT4 FOR DEMAND AND SUPPLY



In general, all MT4 platforms are similar, across brokers. However, some brokers offer a few features more than others. For example: some brokers do not offer the “partial close” feature. Partial close means, for example, that a trader might have opened one position of 0.5 mini lot of EUR/USD, and after making a profit or loss he/she would like to close 0.3 of the mini lot and to keep 0.2 mini lot open in the market. However, tools and indicators are almost the same across all Forex brokers who offer an MT4 trading platform to their clients.

Clean screens with white backgrounds, like Figure 53, are the most helpful for interpreting demand and supply zones and for drawing lines. In a later section, we will be discussing in more detail how to make clean screens with red and blue candles and how to draw demand and support lines after analyzing charts for trade entry viability.

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Figure 53: Clean MT4 Chart

STEP 1: Remove All Windows

If you like to work with a clear screen like Figure 53, just close all windows by clicking “X” on the right top of each of them. Windows can be removed and brought back by clicking icons on the toolbar, too. For example, if you would like to close a market watch window, just click one time on the market watch icon. If you would like to bring it back, click the market watch icon again. Other windows can be removed from the main screen by clicking the icons. These include the data window, the navigator, a terminal, and a strategy tester icon.

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Figure 54: Creating Multiple Profiles

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Figure 55: Profiles

STEP 2: Create Multiple Profiles

Creating multiple profiles will help you switch to a particular currency pair with one click. Within each profile, traders can create multiple windows of the same currencies, or different instruments. For example, you can create a dollar index chart and four EUR/USD charts, or a gold chart and three USD/CHF charts, etc.

In the MT4 terminal, click “Default” (located on the center-bottom of terminal, on the terminal window). A screen will appear. Click “Save Profile As,” type GBPUSD (as shown in Figure 54) and click “OK.” Now GBP/USD will appear instead of the default currency.

You can create any currency pairs you like, for example EUR/USD, AUD/USD or USD/JPY by repeating above process. Once you have created a profile for each currency pair you’re interesting in trading, it is ver