Thanks to the Internet and the relatively recent availability of online forex brokers, just about anyone with a computer and an Internet connection can open a demo forex account and trade forex with virtual money.
This feature allows newcomers to forex trading to get a better idea about what trading forex involves and also helps them improve their education about the huge largely-unregulated forex market.
Demo Trading Results Can Differ
Nevertheless, new traders need to be aware that the results they might achieve when trading in a forex demo trading account may be quite different from the results seen in a live forex trading account.
Even if a person performs extremely well trading a demo account, their results in a live account often differ considerably. In general, this phenomenon tends to arise because when your own funds are at risk, a different trading mindset often ensues than when trading with virtual money.
This key distinction tends to affect traders in different ways, depending on their psychological makeup.
Other Reasons Why Demo Trading Gives Different Results
Not only does the difference in a demo trading environment involve the psychological aspect, but the general market environment can also differ substantially.
Although a price is easily guaranteed by a broker for a demo trade when no funds change hands, getting that price for a live trade may be an entirely different matter when trading a live account. This can be especially true during a volatile or fast market when slippage often occurs in the execution of orders.
In addition, because of the lack of financial commitment, traders tend to overtrade and deviate from their set trading plans when trading demo accounts.
If you really want optimal results trading a live account, then it would be wise to trade in the demo account as closely and in the amounts that you will most likely trade once you fund an account.
Alternatively, you can just trade small amounts using a micro account to get a feel for a live trading environment before moving up to a standard account and dealing sizes.
Demo Trading Benefits
Trading virtual money removes the psychological element from trading, so for this reason, it cannot accurately assess a person's trading abilities. Nevertheless, virtual trading can have great benefits when testing the performance of a trade plan and also for trader education purposes.
When used as an educational tool, a forex demo account gives novices a risk-free start to trading in the forex market. In addition, strategies can be put to the test without assuming any risk, all in real time trading situations.
Also, live trading involves inherent risks that can affect the trader emotionally, while trading in a demo account tends to limit a person's emotional involvement in trading. In addition, considerably larger positions can usually be taken in a demo account that may lead to what seems like higher profitability, when in fact, the risk-adjusted returns are actually quite low.
Overall, trading in a demo account offers a great service to novices that would otherwise have to learn using, and probably losing, real money. While the emotional rush of risking real money while trading may be lacking in demo trading, trading a demo account allows you to learn to watch the market closely and can help you get a better feel for how the forex market operates without putting any real cash on the line.
Day Trading can offer a very exciting and lucrative way of trading the forex market for those who take the time to prepare appropriately for the endeavor. As the name implies, the basic idea behind day trading is that all transactions happen during the trader's normal business hours. Also, all day-trading positions are typically closed out before the end of the business day.
Advantages and Disadvantages of Day Trading
Day trading has the primary advantage that at the end of the day, the trader goes home with no positions and no overnight market risk. Another advantage of day trading is that the trader tends to be alert and can more easily focus on and take advantage of intra-day market movements.
Nevertheless, people with heart conditions or those overly-sensitive to stress may want to trade other strategies that are not as intensive and short-term in nature. Also, since the big moves in foreign exchange generally happen when the market trends over weeks or even months, day trading strategies may not give you the same sort of returns as successful trend-following trading systems.
Developing a Day Trading Strategy
If you think you might like to try your hand at day trading, the first thing you will need to do is come up with a successful day trading system. You can start this process by reviewing literature and online resources for information that can help you develop an objective trade plan.
The main idea behind having an objective trading plan involves minimizing any emotional interference that might sabotage your forex trading. Also remember to keep your trading system relatively simple and easy to follow so that you can do so quickly and with confidence.
One especially important consideration with day trading strategies is the risk/reward ratio of the strategy employed. For example, a day trader might set a goal of 30 pips of profit per day with a risk level of 20 pips to begin with. As their trading success improves and the equity in their trading account rises, they can also increase the amounts traded.
Many commercial automated trading robots risk hundreds of pips to make just a few and so they seem to trade well for a while before eventually blowing up on a serious adverse move. You will want to make sure that your day trading system avoids this potential pitfall and uses a risk/reward ratio that is conducive to long-term success.
Testing Your Day Trading System
The next step is to test your trading plan. Many day traders opt to first test their day trading strategy over historical data to find a system that has suitable profitability and draw down characteristics that suit their trading goals.
Then, they will want to trade their system on live data to gain experience and confidence in putting the strategy into practice. This process can also suggest refinements to the day trading strategy that can make it more successful.
Using a Forex Broker for Day Trading
Once an aspiring forex day trader has developed a day trading strategy and practiced implementing it, they can usually open up a free forex demo account with a forex broker without risking any money initially.
Doing so can give a trader a good idea of whether the actual work and returns involved in day trading in the forex market might be suitable for them. You can then usually upgrade and fund your account when you feel confident in your ability to day trade profitably on a consistent basis.
Fundamental analysis examines the reasons behind the price action. The analyst uses economic indicators and news flows to decide on the causes behind price movements. Since one cannot determine the cause of something which has not yet happened, the causal relationships demonstrated by fundamental analysis are always about present market behavior. Nonetheless, economic events move slower than market developments, and this is the real cause of the great predictive and interpretative power of fundamental analysis.
Technical analysis is a relatively new phenomenon. It has been developed mostly in the last century, for the most part by US-based traders, for providing some clarity to short term price actions. Fundamental analysis, on the other hand, has been with us for many centuries. The ancient speculator of the Peloponnesian War in Classical Greece used news flow (hearsay, public meetings) and economic data on supply and demand (starvation, poor harvest) for stockpiling resources and for deciding when to sell them. The ancient Chinese classic Shiji, which records the lives and exploits of important personages two millennia before our time, reports on successful traders and speculators who traded wartime shortages, or the needs of warlords for massive profits. Some of these people were middlemen who exploited the inefficiencies of ancient markets, others were producers themselves with good insight into macro-scale developments, and patience allowed them to successfully utilize their analytical capabilities. But all of them used news and analysis to profit from fundamental developments, without any tool other than common sense to help them.
During the Middle Ages there were the Fugger and the Medici families who took advantage of their good relationships with royalty and governments to stay one step ahead of the markets. The Rotschild family of the 18th-19th centuries also used fundamental imbalances created by warfare to undertake contracts with sovereigns states and for maximizing profits. The twentieth century, of course, has had more than its fair share of traders and speculators capitalizing on market distortions, imbalances and bubbles for very large profits. But at the basic level, the tools of the successful investor, trader or speculator are the same: a good understanding of fundamental data, deaf ears to hyperbole, euphoria and panic, and the strength of will to act when the time is right.
Human life and natural phenomena move on causal relationships. Causality is a major principle of scientific study. And, given how our brains function, it is not possible to make any meaningful decision, judgment or choice without backing it with sensible causes. This is also where the power of fundamental analysis originates. The charts of the technical analyst may give all kinds of profit alerts, signals and alarms, but there’s little in the charts that tell us why a group of people make the choices that create the price patterns. Ultimately, most transactions in the financial markets have reasons that are independent of technical values in the long-term. If a stock goes down in response to a temporary bout of panic among traders, the price will rebound once the dust settles; or, if a currency pair plummets in value because of a false rumor or a temporary squeeze of capital, the situation will inevitably be corrected once a stream of concrete data establishes the false nature of the fears.
Fundamental analysis allows us to decide on the value of an asset. We are unable to be certain about the future value of an asset, and past value is never a good indicator for future prices. But, by all means, we posses the faculties and resources necessary for deciding if the price of an asset is expensive or not, and that is the basis on which the fundamental analyst bases his choices. We can establish the causes behind a trend, we can establish if they are ongoing, and we can exploit that knowledge to bring us profits.
There are many traders who successfully used fundamental analysis to obtain great wealth, but the exploits of George Soros, and his Quantum Hedge Fund have made them household names in our era, particularly after the notorious Black Wednesday on which Britain was forced to drop out of the European exchange rate mechanism. In the rest of this article we will examine this interesting event to drive home the great power of fundamental analysis and how accurate and profitable its predictions can be.
Most traders today know that the British pound is not a part of the Eurosystem. It is an independent currency managed by its own central bank. While some may attribute this fact to the insular mentality of the British and their typical desire for independence from continental customs and habits, this is not the real cause of the existence of the pound today. The real reasons are to be found in the developments of September 16th 1992, and the events leading up to them.
Before it was launched, the nations which today share the Euro as their national currency had to abide by an agreement known as the European Exchange rate mechanism (ERM) which was the precursor to the eventual unification of currencies. The ERM stipulated a fixed currency exchange rate between each national currency and the ECU (the European currency unit, which would eventually be called the Euro), but bilateral currency values were allowed to float within a margin of 2.25 of the the fixed rate. The ERM was created in 1979, and Britain was one of the later members of the EU to join the mechanism in 1990.
At the time Britain joined, the government of Margaret Thatcher was lost in intrigues and disputes about the benefits and the need for ERM. With inflation at 15 percent, to restrain the expansionism of the previous era, the British government had for a while been mirroring the Bundesbank’s policy rates. The decision to join was partly taken to formalize this policy of copying the central bank rates of Western Germany, and also as a result of an argument between the chancellor of the exchequer (the equivalent of the Treasury secretary), Nigel Lawson and the prime minister’s economic advisor, which resulted in the resignation of Lawson. He was replaced by the future prime minister John Major, who in turn finalized the entry of Britain into the ERM in 1990 at a rate of 2.95DM to the pound, with commitment to intervene at 2.778.
As we just mentioned, at the time of Britain’s entry inflation was quite high, due to the expansionist policies of Nigel Lawson. The easy money policy had created a period of boom at the end of the 80’s, but it had also created a property bubble and high inflation which had to be restrained by higher interest rates and a period of economic downturn. Thus, when the crisis struck two years after UK’s adoption of the ERM, economic conditions were already far from being ideal. Unfortunately for the British, this was also a time when German interest rates were even higher than the British rates, as the Bundesbank tried to control the inflationary impact of reunification-related spending.
Mr. Soros, who enters the scene at about this point, had established his Quantum Fund in the early 1970s in partnership with the equally famous Jim Rogers, his initial capital being provided by a number of wealthy acquaintances including the aforementioned Rotschild family. Before his rise to notoriety through his role in the British debacle, he had already made massive profits in trading the collapse of currency pegs and economic deregulation of the 70s. He and his analysts had impressive skills in analyzing the fundamental factors that drive the international economy. Indeed, apart from being a rich financier, Mr. Soros has books published on philosophy and politics, and he is equally well-known as a philanthropist and for his contributions to liberal movements around the world.
Upon analyzing the fundamental situation of the British economy and the increasing gap between the performance of the British and German economies at the time of Britain’s adoption of the ERM, Mr. Soros was increasingly convinced that the British would drop out of the system regardless of the choices they made. The fundamental health of the UK economy was incapable of coping with the demands of matching Germany at the time. Thus, he began shorting the pound as early as spring 1992, in anticipation that high interest rates would eventually deepen the recession in the UK economy, and the resulting fall of asset prices would prove unpalatable to the government authorities. It is thought that he accumulated short positions reaching 6.5 billion pounds (about 10 billion USD), at a leverage of 1:10.
Meanwhile, the situation of Britain continued to deteriorate as the USD kept depreciating, making British exports less competitive on a global basis. The breaking point came, as it often happens, through political turmoil. When in spring 1992 the Danes refused to join the ERM, and it was decided that France would have a referendum on the issue as well, the resulting nervous atmosphere reached climax in a general distrust of the currency pegs of nations that were suffering the worst of the ERM.
On Wednesday, 16th September 1992, as speculators kept selling the pound, the British cabinet held meeting after meeting on how to defend the nation’s currency. They first raised the main rate to 10, then to 12, eventually promised to raise to 15 percent in order to convince the speculators that they were facing the full determination and might of the UK government. The government also bought billions of pounds to prop up the currency, but all that was in vain. Heedless monetary expansionism of the Lawson Boom had created massive imbalances in the British financial system, and the British economy would never be able to function under such a high interest rate burden. Speculators like George Soros had already made their calculations and had discovered the untenable nature of the British peg a long time ago through fundamental analysis, and they would not be cowed into submission by the frantic, but ultimately futile endeavors of the John Major Government.
By 19:00 it was already clear that the peg couldn’t be defended, and the Chancellor of the Exchequer had to declare that the government would leave the ERM framework, and the main interest rate would remain at 12 percent. The credibility of the British government was destroyed in a few hours, the speculators left for new hunts, and George Soros pocketed an estimated 1 billion USD in the process. As the person who took the largest bet, he was instantly notorious across the globe, and to this day he’s known as "the man who broke the Bank of England".
Later, it was also admitted that the 15 percent promise was just a ruse created to calm the markets, and as many speculators believed, the government had no intention of holding the rates at such a high level given the difficulties the British economy were going through.
It is an exciting story, but the sensational value of the events has no use for our trading practices. What are the lessons that we gain from this disaster for the UK economy?
- Fundamental analysis is always right. Imbalances will always be corrected. But it takes time and patience to exploit them successfully. Mr. Soros held his position for months before market developments confirmed his expectations.
- Neither government authorities, nor company heads are immune to the temptation of lying, or “bluffing” as it’s sometimes called. If you’re a speculator, nobody will have any sympathy for you if you lose money, and the only person you can blame is yourself. So be careful about your leverage, your risk and who you believe.
- Macroeconomic events are often triggered by political developments. Political events rarely cause major economic shocks by themselves alone, but accumulated imbalances are usually balanced as a result of political shocks.
- The payback time of expansion fueled by monetary expansionism is exceptionally destructive in any economy. If the economic leadership of a nation is constrained by political obstacles when the payback time arrives, the results are doubly disastrous.
If you intend to use fundamental analysis in the way George Soros used it, you will need a good understanding of both politics and economics. Achieving such a skill is not that hard, provided you have the commitment and the patience to complete your task.
Technical strategies aim to predict future prices on the basis of past developments. All that the technical analyst is interested in is the price, and news, or data have no bearing on his decisions. In this article we will examine some of the basic concepts behind technical strategies, and will attempt to summarize the main tools used by technical traders in braking down price patterns.
As we noted technical analysis chooses to ignore everything except the price in its decisions. A technical strategy will usually involve several phases, each clarifying some aspect of the price action, until a credible entry or exit point is determined. The phases for this are.
1. Identify the type of the market and the type of the trade..
Needless to say, the first step in technical analysis must be the identification of the market with which the trader is interacting. After that he must determine the time period of the trade he will enter. What kind of charts will the trader use for his trade? Will it be a monthly trade, or an hourly one? If it’s a monthly trade, there’s no need to worry about the hourly changes in the price, provided that the strategy regards the present value as an acceptable monthly entry or exit point. Conversely, if the trade is for the short term, the trader may desire to examine charts of longer periods to gain an understanding of the bigger picture which may guide him with respect to his stop loss or take profit orders.
The trader will use trend lines, oscillators, and visual identification to determine the type of market that the price action is presenting. Strategies in a flat, ranging, or trending market are bound to contrast strongly with each other, and it is not possible to identify a useful strategy without first filtering the tools on the basis of the market’s character. Once this is done, and the time frame of the trade is determined, the second stage is -
2. Picking the technical tools
On the basis of the criteria discussed in the previous item, we must pick the appropriate technical tools for the chart we examine. If the market is trending, there’s little point to using the RSI. If it’s ranging, the moving averages are unlikely to be of much use. If the underlying currency pair is strongly cyclical (for example, if the currency is issued by a commodity exporting nation) the commodity channel index could be a good choice. If it is highly volatile, smoothing out the fluctuations with moving average crossovers could be very beneficial for identifying the trend.
Of course the list can be extended. The trader must refine his approach to trade over time by deciding on the kind of indicators which he understands best, and then combining them later to form a simple and concise method.
3. Refine the periods, and other inputs
Upon deciding on the technical tools, the analyst must decide on the periods, and ranges for which values must be supplied to the software. Today’s traders have many advantages over those in the past, but diligence and patience may not be one of those. As we’re so used to having everything automated and performed by the computer with no questions asked, many don’t even bother to tinker with the minutiae that can in fact be all the difference between success and failure for the trader’s analysis.
Thus, before going any further, the trader must check which periods, which values provide the pattern that is most fitting for the price action on the chart. For example, for the RSI, will we pick a period of 14, 10, or 7 for the chart we examine? Or what will be the periods of the moving averages that constitute the MACD indicator? These can only be answered through trial and error, and for each price pattern, a different value may be necessary.
4. Seek the signals
Once the technical tools are setup, we must now seek the signals that will show us the trade opportunities created by investor sentiment and temporary imbalances in the supply and demand for a currency pair. The signals that we seek are the ones created by the interaction between a number of indicators, such as that between moving averages, various oscillators, or between the price and the indicator. Our purpose is to confirm our ideas with various aspects of technical analysis. If there’s an oversold or overbough level, we will confirm it with a divergence/convergence. If there’s a breakout, we will seek to ascertain it with studies of crossovers.
We will examine the signals in greater detail a bit later, but in summary they are channels, crossovers, divergence or convergences, breakouts, consolidation patterns, the various price patterns like triangles, flags, and head and shoulders. We will keep our indicators simple, but we will make sure that the signals generated by them are examined and exploited to the full, allowing us to draw a complete picture of the price action.
5. Perform the analysis
After deciding on the signals and their meaning, we will perform our analysis by identifying actionable signals, and deciding on capital allocation in light of proper money management techniques. When analyzing the data we must make our utmost exertion to ensure that we focus on signals relevant to our selected period and trading plan. This stage of analysis will involve the separation of wheat from chaff, and data from noise.
6. Compare the results, execute the trade
After examining the various scenarios presented by the charts, and determining on which of them are actionable, the trader will compare them in terms of credibility and profit potential (for example, how extreme are the indicator values, how much profit or loss will be generated in case a take- profit or stop-loss order is realized?) Once that is done, he will pick the trade that offers the highest returns with the lowest risk on the basis of the technical scenario that is the most contrarian.
What the above implies is that, when a trend follower trades, he will wait for the corrections, acting on a contrarian basis to the short term movement, while conforming to the main trend. When he desires to bet against the trend, he will await the most extreme valuations generated by the trend, and when the momentum is highest, he will make a contrarian bet at the first credible reversal.
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A forex trading strategy is created by using many different types of price phenomena that are manifested on many different kinds of indicators. We will examine strategies later, but at this stage let us examine the signal types that are used to create them.
1. Channels
Channels are two parallel trend lines that constrain the price action in opposite directions. The upper line prevents bullish breakouts, while the lower line checks the bearish ones. A channel is a very regular formation, and offers great potential for realizing a profitable trade, but it’s also relatively rare.
Channels are used to generate signals that help us identify breakout points. If the indicator used to analyze the channel stayed above or below a certain level for a long period of time, a breakout can be confirmed by excessive values. But given how regular and controlled the price movement must be while inside a channel, the trader can devise many other ways of trading it, and some of his methods can be based on fundamental analysis too.
The existence of a channel will allow the trader to use other tools, such as overbought, oversold indicators, to generate additional signals. A channel also signals that market participants are expecting a major development to decide the direction of the trend, and that the trader must be alert about potential 
2. Crossovers
Crossovers occur when one indicator’s value suddenly rises or falls below that of another one which is used as a signal line. Crossovers signal momentum change in the market, and are often used to generate trade signals that are more reliable than those indicated by single indicators.
In the hourly chart of AUD/USD we see the 14-day moving average shown by the yellow line falling below the 100- day moving average shown by red, and we notice that the price later made a major move in the same direction. Crossovers are not limited to one type of indicator, and of course, the trader can use them in many different situations for analyzing price patterns.
The disadvantage with crossovers is born of the fact that they’re fairly common, and thus prone to generate conflicting and false signals. Unless confirmed by other, more reliable phenomena like divergence/convergence, the trader should be cautious about regarding the crossover as an actionable signal. 
3. Breakthroughs, breakouts
This signal is generated when a range or a consolidation pattern breaks down, allowing the price to move violently and rapidly in the direction of the breakout. Potential breakouts are identified first by direct visual examination (for instance, an uptrend is fluctuating around a price level for a prolonged period ), and then confirmed by the behavior of indicators (a very calm MACD registering strong values, or an moving average crossover).
A consolidation occurs when a trend fluctuates around a value for a relatively long period without jeopardizing its strength. A breakout is when a range pattern breaks down, and the price action is no longer constrained. A breakthrough is the situation where a previously strong resistance level is breached by an ongoing trend.
Consolidation, breakout and breakthrough may all occur on the price chart, or on the indicators themselves. The interpretation will differ depending on the significance of the levels breached (for example, the price breaking through a multi-year resistance line is more important than the RSI reaching a previously unbreached level.)
False breakouts are relatively common in the markets, and many traders try to avoid them by getting into the trade when the breakout is going through its correction phase. Deciding on the nature of a breakout will of course depend on probability analysis. Experience, and proper money management methods are our best friends.
4. Divergence/convergence
The tendency of all indicators to create false signals is well-known among technical traders, and to overcome this problem, traders have been looking at divergences between indicators, or between an indicator and the price for quite some time. Convergence occurs when successive values of two indicators are closer to each other with the passage of time. Divergence occurs when the values are farther apart as time passes. In both cases, the principle behind convergence/divergence dictates that the indicators make movements in opposing directions, and the phenomenon is used to signal that the ongoing trend is getting weaker.
In the above example of AUD/USD, we see that the MACD is making lower values even as the price keeps getting higher. In other words, the price action is not only comfirmed, but contradicted by the indicator. Traders seek these signals to decide on opportunities that offer a greater risk-reward potential. 
5. Price patterns
Price patterns, such as triangles, head and shoulders, pennants, flags can all be used to identify a potential trade, or at least be used to signify an emerging opportunity. These patterns all have different ways of being interpreted, but the seasoned analyst is unlikely to move on any of them without receiving a confirmation from a secondary source, such as an indicator. We will examine the patterns in detail later.
Conclusion
Technical strategies are created by the combination of the above signals and patterns. It is a good idea to combine signals of indicators with price patterns to receive more reliable indications on a potential trade. For example, an MACD crossover after a major counter-trend move can be much more reliable as a trade signal than any value of the MACD, however extreme it may be. In a major triangle movement, a divergence or convergence between the RSI and the price can be far more reliable than the extremes registered on the indicator.
In short, instead of absolute values, the technical analyst will choose to focus on the rarer phenomena which we just discussed. In following chapters of this section, we will discuss technical strategies in greater detail.
Trend following is perhaps the most popular long-term strategy in all financial markets. It is exceedingly effective and profitable when the conditions are favorable, is quite straightforward in its methodology, and there are many individuals, past and present, famous or obscure, who have used this strategy to success and riches. We should note that the technical aspect of trend following is in fact quite simple, but also that it requires, before everything else, discipline, sound money management, and patience from the trader. Trend following is not a short-term method, and patience and determination are as important as correct analysis as a result.
Trends are created by powerful underlying economic factors which may not be all that clear to those who are not very familiar with fundamental analysis. But the simple patterns created by the price action in response to the economic events can often be identified through methods that are easy to learn and apply. Thus, the retail trader has as much potential of success as the most experienced analyst if he can control his emotions and behave logically.
To apply this strategy we must first be aware of the existence of a trend. Without identifying a trend we would be gambling, and that’s not the purpose of trading forex. Both fundamental and technical analysis can be employed for identifying a trend, and both of them have their advantages and drawbacks. It is in general a good idea to use a combination of them for deciding on the trend’s character, and deciding on our entry and exit points.
From here, let us use the dialogue between the successful trader and the beginner in order to explain the principles in an easier way.
B: I want to use the trend following method. How do I do it?
ST: You must first choose whether you want to employ technical or fundamental analysis for your method, or a combination of both.
B: Is there a difference between these methods?
ST: Yes. Fundamental analysis can provide you with information which can predict the strength and length of a trend., while technical analysis can show you how it develops. It is possible to base your strategy on one of these to the exclusion of the other, and it is still possible to turn a profit if you are lucky enough, but our principle has always been to reduce the role of luck to as little as possible. Fundamental analysis is more reliable than technical analysis in defining a trend that has long term potential, but without technical analysis it would be extremely difficult to decide when or how to trade. Technical analysis can suggest the beginning of a trend, but it’s unlikely to tell much about the length or strength of the same. Thus, I suggest that you use both technical and fundamental methods for your trend following strategy, with fundamental factors eliminating the false signals of technical analysis, and technical tools providing you with a time-price frame for deciding on entry points.
B: How do I decide on the existence of a trend?
ST: There are many technical tools that can signal the phenomenon, but there are an equal number of false signals generated by them. Remember that there are only three kinds of trends that can exist at any time: flat, up or down, and it is possible to speak of trends between any two points on a price chart. Simply take two random points on a chart, draw a moving average on it, and the pattern that arises can be analyzed as a trend. Thus it is always necessary to have at least a basic of understanding of the economic factors that can create trends, before deciding on the validity of a chart pattern.
B: And how do I do that?
ST: Familiarize yourself with the big picture; understand what drives market participants; recognize the stage of the business cycle.
B: What kind of price pattern will create a trend?
ST: The trend that we seek to trade is different from random fluctuations, range patterns and similar price movements in that the price itself, in the absence of any technical indicator, can still be recognized as showing a trend. In other words, there is some driving conviction behind the price action which allows the trader to easily identify it visually. Depending on the type of the trend (that is, an up- or downtrend), successive highs and lows should constitute a rising or falling pattern, with relatively few irregularities. But such a case is often a rarity, and the trader will have to back his technical patterns with conviction that can perhaps only be gained through fundamental analysis.
B: If the trend can be identified visually, why use technical tools?
ST: Even though we can notice the existence of a trend, we still need technical tools to trade it, and time it.
B: So will you try time the market? I’m told that never works.
ST: Market timing never works when one is trying to predict reversal points on a technical basis. However market timing in the context of a trend, with the purpose of picking the counter-trend extremes, and using them to enter a trade, is necessary and profitable. And there lies the main principle of a trend following strategy: recognize the trend, identify counter-trend moves, and use them to enter a trade in the direction of the trend.
B: In a sense, then, you’re behaving as a contrarian of short scale moves, and the follower of the long-term trend
ST: Yes. Indeed, there lies the soul and spirit of all trading. To utilize short-term irrational behaviors of the market in order to enter into long-term positions in positive alignment with fundamentals (or, sometimes just the trend), is the core of all successful trading.
B: How long should the trend follower maintain his position?
ST: Forever, or to be exact, for as long as the fundamental reasons that back the trend are dominant. If the trader cannot identify those reasons, if he’s unwilling to do so, or if he doesn’t believe, for some unfathomable reason, that they are useful, he can use technical patterns to time his exit point. Even if the trader is aware of the fundamental factors, and is able to evaluate them correctly, technical analysis can still provide him with a very useful early warning system. If the price action is suggesting strongly that there’s some error in the trader’s fundamental outlook, he can use the technical signals as an occasion to reevaluate and reexamine his fundamental picture.
B: How do I time my trade with technical analysis?
ST: The best tools for trend following are supplied by moving averages and simple price charts. Bar charts, candlesticks and many others can be equally useful if employed with moving averages. For example, between October 2007 and April-May 2008, the price action of USD/SGD always remained below the 100-day moving average. When the pattern broke down, in June of the same year, the trend had also broken down, and the price went on to break the 200-day average, and a medium-term upward trend was established. It is also possible to use moving average crossovers, and myriad other methods, but whichever you choose to use, you should ensure that you do not complicate the main aspect of your strategy, which is trend following.
B: Which time frame do you recommend for the moving average?
ST: If you want to trade on a weekly or daily basis, the 100-day MA will probably be able to capture most of the important trends for you. Anything with a longer period is likely to be meaningless because of too much data discarded , and any time frame that is too much below the 100-day period may be too sensitive to price action. But as usual, one can use other timeframes below 100, provided that he doesn’t clutter his screen with lots of indicators, charts, tools.
B: When trend following, where should I place my stop-losses and take profit orders?
ST: This partly depends on the term and nature of your trend following method. A stop-loss order can be placed a short distance above or below the trend line, whether it is provided by the moving average, or a simple line drawn on the chart. In our opinion, the trend follower should not realize his profits until he has a good reason to do so. The purpose of this strategy is to focus on underlying price dynamics by stripping out volatility and short term movements, and there is little logic to realizing profits in response to fluctuations which are irrelevant to the main action of the trend.
B: But I still have to take profit at some point. Where should I do that?
ST: Go as far as the trend goes, then stop. There you can take profits.
B: How do I know how far it goes?
ST: As we just explained, you can use the MAs to decide on that, but it’s far better to identify the fundamental causes behind a trend, and then to exit the trade once those causes are eliminated.
To sum it up, we can repeat that trend following is the easiest and most straightforward way of making money in the forex market. But successful trading requires the foresight provided by analysis and the patience that only comes with confidence. Those of us who prefer quick profits and instant ratification will find the method uninspiring, but it is reliable and will work wonders if you give it the chance.
