Taking Profits

So much time is spent on entering a trade. Today I want to focus on some exit strategies. This is not a full Fibonacci course, so if you don't understand the basics I suggest that you visit my website for help with those aspects.

Human nature makes trading very challenging. Sometimes you want to exit a trade too quickly when it goes against you, and to cling on to a winner too long. Too often a winning trade will reverse, taking back most of your profits, or even going into a loss. On the other hand if you exit too soon, you risk missing some big profits. You may find that you're sitting on the sidelines while the market continues well beyond your exit.

In this lesson I'll show you how to bank those profits before they turn against you.

First look at this FOREX chart (JPY hourly chart).



Let's imagine that you were clever (or lucky) enough to enter long near point "A". You're feeling pretty good when price reaches "B". So good that you don't want to exit, because the up-thrust just before "B" give the impression that this market wants to go further.

Before you know it, the market reverses and heads towards "C". Right at "C" you get scared and bail out with a little profit. Not much profit compared to exiting at point "D" or even at "F".

You exit near "C", and feel relieved until you see the market heading (thrusting) up to point "D". You stop kicking yourself long enough to enter when it breaks above "B", just a little before the high at "D".

Soon after your entry near "D", the market retraces to "E", and on the way breaks below the high of "B". Breaking below the high of "B" feels scary because you're thinking this chart could be back at "A" in a flash. So you exit at "E" licking your wounds with a loss in this trade.

You start to notice more frustration now, when you enter somewhere between "E" and "F". You're feeling good near "F", but then the chart dives to "G" and you're stunned! This is a losing day for your account, and it's beginning to hurt.

By this time you feel like the whole market is watching your trades, and they're doing exactly the opposite of what you are doing. You start thinking that they wait for you to enter before they slam you and empty your account..

You have wasted your emotional capital, you don't want to trade any more. You don't have the stomach to consider shorting the rally after "G" to take profits at "H".

There must be a better way!

Banking those profits.

You should seriously consider using profit targets to improve your trading performance. There are several ways to do this, my preference is to use Fibonacci techniques.

On the following chart, I have added a Fibonacci expansion using points "A, B, C". This provides us with three profit targets. They are at 116.52, 116.93, and 117.59, see the blue arrows.



If I add another Fibonacci expansion using points "C, D, E", then two more profit targets are added, at 116.87 and at 117.22 . I have not added those studies to the chart, in order to keep things simple for now. You will notice the 116.87 target is quite close to the profit target at 116.93 in the above paragraph. And the 117.22 target is remarkably close to the swing high at 117.32 which is between E and F. We'll ignore those for simplicity, just remember that Fibonacci is excellent at predicting probable turning points.

The trick with Fibonacci is that the market sometimes blows right through a profit target. So what do you do then? Simple - you stay in the trade! But sometimes the market reverses shortly after a profit target.

Sometimes the market respects a certain Fibonacci level, sometimes not. Some Fibonacci levels are "stronger" than others. Advanced Fibonacci techniques are able to help determine which have more validity, but that is beyond the scope of this lesson. What mechanism could you use to exit the trade?

One practical method of timing a trade is to use an oscillator. Another is to use a moving average. When an oscillator shows a decline of momentum, or when price crosses a moving average, you could exit the trade. Let's explore the "oscillator" option in the following chart.



In that chart, I have removed the Fibonacci studies (less clutter), leaving the blue arrows for profit targets. At the bottom I have added the default Stochastic per E*Signal charting software. I have added a red vertical line whenever the Stochastic "fast" blue line crosses the "slow" red line just after price rises above the Fibonacci target. If you exited when price reached those vertical red lines, you'd be a happy trader!

Already you can see the potential of using profit targets with an exit trigger.

You may want to research the following:

Possibly exiting a partial position at each profit target.
Consider entering long again on the dips, when the chart begins to rally again.
Consider using multiple time-frames, perhaps Fibonacci studies on the hourly chart, and exit triggers on 5 minute charts.
If you would like to become an expert at trading with Fibonacci, see my trading seminars at my website.

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High Probability Trading

Even traders with limited experience start to realize that we are not trying to capture every market move. We want to improve our odds and reduce our frustration by filtering, for high-probability trades.

The combination of trend and Fibonacci techniques can provide powerful signals for higher probability trading. We already know that trend-lines have some validity, and so do Fibonacci levels. Combine the two, to improve your chances.

The following charts are the USD/British Pound GBP. First, the daily chart as of October 5th 2005. I have drawn a red down-sloping trend-line joining the two recent swing highs.



The chart has moved down since early September , making a down-trend of consecutive "waves" with lower swing highs and lower swing lows. There were several opportunities to take advantage of the down-move. In this tutorial we will focus on the October 6th opportunity.

In a down-trend we want to short those swing highs, and take profits on swing lows. We don't want to short every time we **think** we have a swing high. If you have tried that, you know about whipsaw and fake-outs already haha. We only want the best trades, those which are more likely to succeed. So how do we choose an optimum entry point?

Our odds are improved if we have a swing high near a down-sloping trend-line (in red on the chart). Markets tend to reverse at Fibonacci levels. So if we have a significant resistance level near a trend-line we have an even better chance of success.

The next chart shows the GBP with Fibonacci resistance levels. Notice the "SK Resistance" level. This represents an area of significant resistance, with a higher probability of a reversal.

If you are new to Fibonacci, those studies look like a confusing series of colored lines. Learning how to use these Fibonacci studies, and which of them are stronger (higher probability), is really easy! I have made two video seminars that explain this. FibMaster.



That "SK Resistance" level, coinciding with a trend-line is an optimum shorting zone. If the market reaches that area (we can't be sure it will), and if the market resists there, we want to take a short position. Once the resistance materializes, it will be difficult for the market to move against us.

Most of us are not trading the daily chart, but we can use the longer-term charts to find **powerful** trends and Fibonacci levels. The next chart is a 60-minute chart. I choose 60-minutes because it clearly shows when resistance has materialized. You may prefer a 30 minute or 5 minute chart.

The following 60-minute chart shows how the Pound rallied to the SK resistance level, and the trend-line. It rallied over those, tested them briefly, then retreated. There are several ways to determine whether resistance has materialized. I have some very powerful techniques for that purpose. However we want this tutorial to focus on some basics. So for now we will use the obvious breaking of the rising trend as our trigger.



During that rally upward, the 60-minute chart has a series of higher swing highs and higher swing lows. Once we broke the highest swing low (see the last bar on the above chart), we know that up-trend has expired. So we want to start shorting rallies and take profits on dips as shown on the next chart (60-minute chart).



Notice how the market broke down, and never looked back! That is what happens when you combine trend-lines with Fibonacci techniques. The best trades go your way and keep on going. That is a characteristic of higher-probability trading.

If this tutorial makes sense, you are ready for my Fibonacci Trading videos! My two introductory videos are inexpensive, and they receive glowing reviews almost daily. You can take your trading to the next level, bring these powerful techniques to your trading just by watching my video seminars. FibMaster.

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Forex Money Management

Put two rookie traders in front of the screen, provide them with your best high-probability set-up, and for good measure, have each one take the opposite side of the trade. More than likely, both will wind up losing money. However, if you take two pros and have them trade in the opposite direction of each other, quite frequently both traders will wind up making money - despite the seeming contradiction of the premise. What's the difference? What is the most important factor separating the seasoned traders from the amateurs? The answer is money management.

Like dieting and working out, money management is something that most traders pay lip service to, but few practice in real life. The reason is simple: just like eating healthy and staying fit, money management can seem like a burdensome, unpleasant activity. It forces traders to constantly monitor their positions and to take necessary losses, and few people like to do that. However, as Figure 1 proves, loss-taking is crucial to long-term trading success.

Amount of Equity Lost Amount of Return Necessary to Restore to Original Equity Value
25% 33%
50% 100%
75% 400%
90% 1000%


Figure 1 - This table shows just how difficult it is to recover from a debilitating loss.

Note that a trader would have to earn 100% on his or her capital - a feat accomplished by less than 1% of traders worldwide - just to break even on an account with a 50% loss. At 75% drawdown, the trader must quadruple his or her account just to bring it back to its original equity - truly a Herculean task!

The Big One
Although most traders are familiar with the figures above, they are inevitably ignored. Trading books are littered with stories of traders losing one, two, even five years' worth of profits in a single trade gone terribly wrong. Typically, the runaway loss is a result of sloppy money management, with no hard stops and lots of average downs into the longs and average ups into the shorts. Above all, the runaway loss is due simply to a loss of discipline.

Most traders begin their trading career, whether consciously or subconsciously, visualizing "The Big One" - the one trade that will make them millions and allow them to retire young and live carefree for the rest of their lives. In FX, this fantasy is further reinforced by the folklore of the markets. Who can forget the time that George Soros "broke the Bank of England" by shorting the pound and walked away with a cool $1-billion profit in a single day? But the cold hard truth for most retail traders is that, instead of experiencing the "Big Win", most traders fall victim to just one "Big Loss" that can knock them out of the game forever.

Learning Tough Lessons
Traders can avoid this fate by controlling their risks through stop losses. In Jack Schwager's famous book "Market Wizards" (1989), day trader and trend follower Larry Hite offers this practical advice: "Never risk more than 1% of total equity on any trade. By only risking 1%, I am indifferent to any individual trade." This is a very good approach. A trader can be wrong 20 times in a row and still have 80% of his or her equity left.

The reality is that very few traders have the discipline to practice this method consistently. Not unlike a child who learns not to touch a hot stove only after being burned once or twice, most traders can only absorb the lessons of risk discipline through the harsh experience of monetary loss. This is the most important reason why traders should use only their speculative capital when first entering the forex market. When novices ask how much money they should begin trading with, one seasoned trader says: "Choose a number that will not materially impact your life if you were to lose it completely. Now subdivide that number by five because your first few attempts at trading will most likely end up in blow out." This too is very sage advice, and it is well worth following for anyone considering trading FX.

Money Management Styles
Generally speaking, there are two ways to practice successful money management. A trader can take many frequent small stops and try to harvest profits from the few large winning trades, or a trader can choose to go for many small squirrel-like gains and take infrequent but large stops in the hope the many small profits will outweigh the few large losses. The first method generates many minor instances of psychological pain, but it produces a few major moments of ecstasy. On the other hand, the second strategy offers many minor instances of joy, but at the expense of experiencing a few very nasty psychological hits. With this wide-stop approach, it is not unusual to lose a week or even a month's worth of profits in one or two trades. (For further reading, see Introduction To Types Of Trading: Swing Trades.)

To a large extent, the method you choose depends on your personality; it is part of the process of discovery for each trader. One of the great benefits of the FX market is that it can accommodate both styles equally, without any additional cost to the retail trader. Since FX is a spread-based market, the cost of each transaction is the same, regardless of the size of any given trader's position.

For example, in EUR/USD, most traders would encounter a 3 pip spread equal to the cost of 3/100th of 1% of the underlying position. This cost will be uniform, in percentage terms, whether the trader wants to deal in 100-unit lots or one million-unit lots of the currency. For example, if the trader wanted to use 10,000-unit lots, the spread would amount to $3, but for the same trade using only 100-unit lots, the spread would be a mere $0.03. Contrast that with the stock market where, for example, a commission on 100 shares or 1,000 shares of a $20 stock may be fixed at $40, making the effective cost of transaction 2% in the case of 100 shares, but only 0.2% in the case of 1,000 shares. This type of variability makes it very hard for smaller traders in the equity market to scale into positions, as commissions heavily skew costs against them. However, FX traders have the benefit of uniform pricing and can practice any style of money management they choose without concern about variable transaction costs.

Four Types of Stops
Once you are ready to trade with a serious approach to money management and the proper amount of capital is allocated to your account, there are four types of stops you may consider.

1. Equity Stop
This is the simplest of all stops. The trader risks only a predetermined amount of his or her account on a single trade. A common metric is to risk 2% of the account on any given trade. On a hypothetical $10,000 trading account, a trader could risk $200, or about 200 points, on one mini lot (10,000 units) of EUR/USD, or only 20 points on a standard 100,000-unit lot. Aggressive traders may consider using 5% equity stops, but note that this amount is generally considered to be the upper limit of prudent money management because 10 consecutive wrong trades would draw down the account by 50%.
One strong criticism of the equity stop is that it places an arbitrary exit point on a trader's position. The trade is liquidated not as a result of a logical response to the price action of the marketplace, but rather to satisfy the trader's internal risk controls.

2. Chart Stop
Technical analysis can generate thousands of possible stops, driven by the price action of the charts or by various technical indicator signals. Technically oriented traders like to combine these exit points with standard equity stop rules to formulate charts stops. A classic example of a chart stop is the swing high/low point. In Figure 2 a trader with our hypothetical $10,000 account using the chart stop could sell one mini lot risking 150 points, or about 1.5% of the account.


3. Volatility Stop
A more sophisticated version of the chart stop uses volatility instead of price action to set risk parameters. The idea is that in a high volatility environment, when prices traverse wide ranges, the trader needs to adapt to the present conditions and allow the position more room for risk to avoid being stopped out by intra-market noise. The opposite holds true for a low volatility environment, in which risk parameters would need to be compressed.
One easy way to measure volatility is through the use of Bollinger bands, which employ standard deviation to measure variance in price. Figures 3 and 4 show a high volatility and a low volatility stop with Bollinger bands. In Figure 3 the volatility stop also allows the trader to use a scale-in approach to achieve a better "blended" price and a faster breakeven point. Note that the total risk exposure of the position should not exceed 2% of the account; therefore, it is critical that the trader use smaller lots to properly size his or her cumulative risk in the trade.

4. Margin Stop
This is perhaps the most unorthodox of all money management strategies, but it can be an effective method in FX, if used judiciously. Unlike exchange-based markets, FX markets operate 24 hours a day. Therefore, FX dealers can liquidate their customer positions almost as soon as they trigger a margin call. For this reason, FX customers are rarely in danger of generating a negative balance in their account, since computers automatically close out all positions.
This money management strategy requires the trader to subdivide his or her capital into 10 equal parts. In our original $10,000 example, the trader would open the account with an FX dealer but only wire $1,000 instead of $10,000, leaving the other $9,000 in his or her bank account. Most FX dealers offer 100:1 leverage, so a $1,000 deposit would allow the trader to control one standard 100,000-unit lot. However, even a 1 point move against the trader would trigger a margin call (since $1,000 is the minimum that the dealer requires). So, depending on the trader's risk tolerance, he or she may choose to trade a 50,000-unit lot position, which allows him or her room for almost 100 points (on a 50,000 lot the dealer requires $500 margin, so $1,000 – 100-point loss* 50,000 lot = $500). Regardless of how much leverage the trader assumed, this controlled parsing of his or her speculative capital would prevent the trader from blowing up his or her account in just one trade and would allow him or her to take many swings at a potentially profitable set-up without the worry or care of setting manual stops. For those traders who like to practice the "have a bunch, bet a bunch" style, this approach may be quite interesting.

Conclusion
As you can see, money management in FX is as flexible and as varied as the market itself. The only universal rule is that all traders in this market must practice some form of it in order to succeed.

By Boris Schlossberg, Senior Currency Strategist, FXCM

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TRADING: A MIND GAME

You must change your mental attitude first from a normal person to that of a speculator. Almost all traders I have met, except a few successful ones who really made millions and billions trading in the market, simply waste all their time trying to learn the easiest part in perfection, like about how to read data and charts, and trying to perfect entry and exit skills, etc. Trading is a mind game and without having a right frame of mind, it is a losing game even before it starts. Training a trader?s mind is the first step for any successful trader but almost all new traders neglect that part and that explains why more than 95% of traders are a failure in the long run.

Acquiring the knowledge of the market is not difficult for anyone with average intelligence after a few years of hard study in the market. But it is neither the level of intelligence nor the knowledge that decides the outcome of the market operations of a trader. It is the decision making process that is so hard for most traders to overcome and that is the main reason for a success or a failure for all the traders. Some find it easy to make decisions and stick to it and most find it so hard to make decisions and stick to it. Unfortunately, any decision making process in trading is a pain-taking process and humans tend to avoid pains and go for pleasures even if for temporary ones. Assuming one has acquired enough market knowledge and acquired one?s proven trading system (this is the second most important element of success in trading, in fact. An edge in any system is based on the quality of info one has, charts being only an info of secondary quality not the best one)

Through studies and research, a trader faces the task of making decisions to put this knowledge and system into practice. Then, how many traders can honestly say they can commit their ranch when the trade is suggested by their own system (given that trading is just a chance game) and let the profit run for weeks and months when their system tells them, and how many can manage to cut the loss as a routine process when the situation arise. It all sounds so easy when saying it but so difficult when doing it affecting real money in the market. I still do not sleep well when I am running position because even if the profits are running into a few hundred dollars and the system is telling you to carry on, there is no guarantee that the profit will turn into a yard or two in a month time, and it may even turn into a loss in a day or two when something unexpected happens. A painstaking process in real sense. The pain is not knowing what will happen in the future and in fear of losing. So at the end of the day, assuming one has decent trading system and market knowledge and decent info, it is ultimately how disciplined and how well that trader can take the pain of making right decisions at the right time that decides the outcome of the trades. Hence I call trading a mind game. When I interview prospective young traders, I always look for disciplined and strong-willed person as my first priority as long as one has decent education, but strangely in many cases, it is some kind of genius or half-genius with lots of brains with no disciplines who turn up for an interview thinking only bright people can make good traders.

In fact, I always try to pyramid while position trading medium-term once I am convinced of a new medium-term trend emerging. Like in USD/JPY position trading 135-132 as an initial position, adding in 132 and 129 areas. Same for AUD/USD and EUR/USD with similar strategies. But sitting on positions and watching the counter-rallies costing truck load of money is not easy job to do and causes lots of pain all the time. Most traders even among experienced ones cannot bear that pain and give up too early. But there is no other way to make a big money and we have to bite the bullet and "sit and accumulate" as long as the medium-term trend is intact. That is why I always believe psychological aspects of trading is far more important than anything else in successful trading. A mind game like those bluffing game of poker.

Entries and exits can never be "irrelevant" for any trader for any purpose. It is just that psychological aspects of trading are much more important than entries and exits, and decisive for the success or failure of a trader in the long run. Perhaps exits are more important than entries because any perfect or near-perfect entries are possible only in hindsight.



BC?s WORDS OF WISDOM
Any market, be it real estate market or forex market, is all about transferring money from the masses to a few lucky ones in the long run. In most real property speculation cases, the masses make money ,a lot of money, but the money stays as paper profit and evaporate before they realize their paper profit into real hard cash. In most forex speculation cases, the masses barely survive a few years thanks to lack of knowledge of the market and the deadly leverage. But both types of speculators all serve their useful purposes in investment food chain contributing their hard earned money to the market in exchange for a dream.

For any prospective traders, hope this is not in anyway a discouragement. Trading is a hard mind game and not everyone is suitable to be engaged in such a hard game. Most have neither frame of mind nor mental fortitude to survive in this hard game. Mastering TAs or numbers or options business are at best a first tentative step into the right direction with no guarantee to any success. Training a right frame of mind is the most difficult but absolutely necessary part for success and most are simply not ready to go through that hard stage of the learning process because it is a very painful process. Trading is essentially about pain-taking-process in the end although most do not realize it. The process of overcoming fear, greed and mastering tranquility of mind in this hard school of speculation. Fwiw.

Every trader should find his/her method/system which suits his/her own situation and personality. And that system/method must be the one that has proven to be able to make some money through trials. So, if Tom, the medium-term trader, revealed his money making method of last three decades, it may not have the same effect for Dick and Harry, the day traders, and vice versa. Agree that most fail for lack of system/method and/or lack of discipline to follow through.

Trading success is all about making as much as one can when one is right and losing as little as possible when one is wrong. That is the essence of this business. So, any theory or system which looks after the above is a good one.

System is a weapon of a soldier in this market. You must have one as soon as possible. Otherwise, it will be like fighting well-armed Forex robbers with a handbag. Best one is a self-made one because you can never feel comfy in borrowed shoes although borrowing good ideas from others is a good idea. Good luck.

One cannot make a dime unless follow the herd or trend most of the time. It is just that one has to be cautious when overbought/oversold region is approaching and know how to turn at inflection point for the opposite trend. Following herd needs average intelligence and courage but identifying inflection points and taking a necessary action needs not only intelligence but also a lot of courage. Again, fortune favors the brave.

Money management is where most traders go wrong in almost all cases leaving only a few as the winner at the end of the day. Money management and discipline of mind is what makes or brakes a trader at the end of the day, not the elementary entry and exit method.

Forex/Currency Trading: It is a sentiment game w/ a crowd mentality where even the best players w/ the best forecasts are tricked out of good positions by the magic of price action.



TREND TRADING: Accumulation and Distribution
Forex market like any other market works in a very simple way. It accumulates in a certain area for awhile, and once the accumulation is over, it advances to a certain distance until distribution starts, and accumulation happens again and advances to a certain distance again, and repeat and repeat. Day trading may not yield the best results while the accumulation and distribution work out itself, being double-murdered by zig-zag moves, while the market starts advancing out of accumulation area, day trading is a sure way of cutting profit short. In general, day trading is not the best form of yielding the most profits in my experience contrary to what some writers who never made real money in this game try to say.

The safe and better way in making some money must be wait for "accumulation" to be over and ride the whole length of advance until "distribution" starts and reverse as the market dictates as a short-term trade for 2-10 days, as the case may be.

Please study 8 hour or 4 hour line charts or candle charts, especially the patterns and 20 MA inside the charts for a few months everyday, and you will discover what I mean by accumulation and distribution for short-term trades in Forex market. Forex market always needs this process, so you can decide what tactics you will use at a given stage. Imho. Good luck.



TECHNICALS and CHARTING
Why day trade once you get a good seat and the market is going your way. It is always more profitable to ride even the short wave for 2-10 days by adding up. In general, you must day trade only when you are losing. To find a buy entry seat for short-term trades, you can study the "accumulation and distribution patterns and 20 MA" in 8, 4 hourlies or 30 min "Line Charts" (or Candle Charts), together with MACD "overbought and oversold indicators" with its Patterns. If you study them for awhile you will understand when it the best entry point. The remainder is for money management and discipline and of course, experience. Good trades?

On technical side of the trading, the first thing to do is to find out the trend in one?s trading time frame and the proper trading strategy for that trend. Some ride positions for months, while some ride positions for less than an hour or a day and their views of the trend obviously differ. For a trader who is running a position for months, a daily fluctuation may be just a meaningless noise while for a daytrader or an hour trader, a daily fluctuation could be a monstrous tsunami. Having a precise definition and a technique of identifying a trend and the turn of a trend in a trader?s time frame, and adopting the right strategies for that trend is the first elementary step in a hard school of trading. Imho.

I keep my technical side on any pair as simple as possible largely relying on other?s moves to see how I can take advantage of the situation. So for me the strategy is to "range trade". Please always give stop order per your risk profile when you open any new position. Medium-term reversals can be confirmed only in monthly, weekly and daily charts. Chart reading is not to predict the tops or bottoms of any move, but to confirm the change of trend as soon as they are made and adopt right strategies in that new trend. Good trades.

Each cycle is different from the last one and that is the beauty of the market. It is extremely important to look at the big picture from the distance rather than studying the minute and hourly charts with a microscope. And repeat the whole show again and again ?til it shows the sign of turning in daily or weekly chart. And flip. Good trades to you.

I use very primitive charting methods. Please read 8 hour charts of EUR/GBP with 20 and 40 MA, and read round figures and breakout (from consolidations, then you will realize the method cannot be more primitive than that, but still deadly effective). Buy on dips towards the support and add up on breakout of that consolidation treating the two as one trade with same stop loss and "keep them" as long as the market moves in your way. Good trades.

As a rule of thumb, 20 MAs in 8 hour, day, week and month are useful for its directional tendency and as a resistance and support point. Not sure how much it is useful in daytrading though.

Please have a look at Eur/Usd and Usd/Jpy weekly 10 RSI and Aud/Usd monthly 10 RSI "patterns", not levels. Then you will find out primitive things work better when coupled with even simpler MAs. And RSI is useful "only in these weekly and monthly time scale" as far as I can see. You can ignore RSI in short-term scales as the inventor of RSI, Wilder, told us long ago.

Good afternoon. Agree with your observation. Once Soros of Quantum Fund hit the nail on the head with his theory of reflexivity in the market and that is exactly how these players work in the market. That rather romantic tool of daily candlestick chart is useful because whenever some players start positioning to start or stop short-term moves in Yen market, say several hundred pips, for whatever reasons, it reveals their intention to the market, more often than not. It sounds so weird to say tens of yards are spent relying on indicators so primitive like hand-drawn candlestick charts, but that is the truth in Yen market. Same as millions of soldiers risking their lives depending on how their generals draw up the battle plan with their cheap red and blue pencils in their operation room desk. Crazy world, I would say, but that is the fact. And as you say, battle is a battle and those ones who make their first move with their candlestick may not always win either. I happen to believe if a child can learn to trade with some simple signals he will do better than most traders, most of the time, making a good living. But then again, movin market is more than just following the signals. Good trades to you.

I guess if you are a daytrader, 30 minute and 15 minute candle charts and line charts in combination with MACD and MA could be more useful than hourly charts or even daily charts. Especially watch out for the down-sign and up-sign with long tails in candle charts and confirmation of the change of short-term trend in line charts breaking accumulation area in these charts. If you are a nimble trader, even a candle-sign is enough to start moving in with stops above or below the long tail end. For dollar/yen trade, read swiss/yen, pound/yen and euro/yen together to confirm the top or bottom. For Eurodollar or dollar/swiss trade, read pound/swiss and euro/pound together to confirm the same. If you are a daytrader, what matters is the flow of that particular day, not the bull or bear bias, so, 30 Min and 15 Min Candle Charts and Line charts are not bad tools to follow these flows. Good trades.



USING CROSSES AND GOLD
EUR/GBP and GBP/JPY have a value as the leading indicators of EUR/USD and USD/JPY moves. EUR/CHF is similar to EUR/GBP in forecasting value but stopped trading and looking at it a long ago after experiencing difficulties in running good sized positions there.

In short, EUR/GBP and GBP/CHF are leading indicators for EUR/USD and USD/CHF, and GBP/JPY, EUR/JPY and CHF/JPY are leading indicators for USD/JPY. EUR/JPY plays a very important role in EUR/JPY direction too, while GBP/JPY plays the same role for GBP/USD. For example, yesterday?s EUR/USD weakness largely started from EUR/JPY sales keeping EUR/USD and USD/JPY downwards. As a rule of thumb, if EUR/USD does not move but EUR/GBP moves first, it is a good indicator that someone is maneuvering in EUR/USD front in the same direction later, and when EUR/USD moves but EUR/GBP does not move first or in tandem, then it is highly likely EUR/USD move is countered by its opponent and the opposite move is highly likely soon. Same applies in USD/JPY and EUR/JPY, GBP/JPY front in the same fashion. Imho. Good trades.

Good morning. EUR/USD, EUR/GBP, EUR/JPY and GBP/CHF all have correlation to a certain degree affecting each other. It simply shows how the money moves around in these pairs. For daily candle studies, it is more accurate to read them all to see where the flow is going, and same for 4 hourly or hourly or even 10 minute charts. In fact, GBP/CHF and EUR/GBP in many cases move a day or two before EUR/USD. Even by watching GBP/CHF and EUR/GBP charts, short term or long-term as above, you can manage to move in front of EUR/USD moves in many cases. Same goes for GBP/JPY and EUR/JPY charts for USD/JPY moves. More study on these pairs moves will reveal some more interesting things too. Good trades.

I have been using USD index and Eur/Gbp (or Gbp/Chf) as my guide dogs since late 70?s with reasonable accuracy for medium-term trend. Never lost money on medium-term bet relying on those guide dogs in fact. But that cross does not work when Pound is deliberately devalued.

AUD/JPY is one of the important pairs influencing AUD after Dollar, Euro and Pound. Usually falling AUD/JPY is good for Yen Bulls as well.

Good evening. Gold is the mirror of Dollar for hedging purposes and the co-relation is excellent. Sometimes, when I am tired of double checking too many "inside infos" rushing in every hour, I just watch Gold to confirm and go ahead with the moves. Gold chart is one of the top charts you must always watch in forex trading. Eur/Gbp chart, along with the Eur/Jpy chart, is an excellent mirror for Eur/Usd directions most of the time too. Gold, Eur/Gbp and Eur/Jpy charts will tell most of the market story most of the time with Gold and Eur/Gbp leading Forex world most of the time. Good luck.



USING STOPS
Please always give stop order per your risk profile when you open any new position. Medium-term reversals can be confirmed only in monthly, weekly and daily charts. Chart reading is not to predict the tops or bottoms of any move, but to confirm the change of trend as soon as they are made and adopt right strategies in that new trend. Good trades.

For position traders, the basic bias of the market in his trading time frame, the liquidity situation of the market in that time frame, and the size of trading positions must be all taken into account when exercising stops, be it based on tech levels or a certain sum of money or a percentage of a total equity. It is a must but also it is form of art like trading itself. And every trader must develop his own unique style of using stops. But unfortunately, all this can be learned only by paying a certain amount of tuition fee to the market.

Yes, but as a position trader I never use tight stops. Same goes for trailing stops. All very far away from the market not to be taken out by meaningless market noises. Initial stop is always 1% of my total equity, and never commit the whole position at a go but always scale in and scale out.

Good morning. You can avoid your problem in most cases by leaving the market always by trailing stops, i.e., do not set the profit target. So, any winning trade must be held as long as market does not tell you to leave by hitting your trailing stops. When you enter the market by market signals and leave by stops or trailing stops, it solves the most difficult part of decision making process rather easier for traders. Good trades.



USD/JPY HINTS
One of the silly rules of thumb in USD/JPY trading is it rarely moves 700-800 pips in a row without 200 pips or more correction in the middle and it almost always retraces back to 350 pips advance point from the start of its 700-800 pips move. All because of liquidity problem in Yen market.

The real battle of bulls and bears for medium-term trend is always around 20 day MA line in Yen market. Daily option activities here and there are of no relevance as far as medium-term trend is concerned.

Yen position traders sit on their positions gunning for several hundred pips at one go. For day trades, much more nimble approach is required. As Yen position trader, please never buy anything below falling daily 20 MA and never sell anything above rising daily 20 MA, no matter how attractive they look. So start buying only when daily 20 MA starts rising, from whatever level, is not only safe but also proven way of making money although it sounds so simple. Imho. Good trades.

You can read how Yen traders make intraday moves by watching 30 min USD/JPY candlestick chart or line chart if you are not familiar with candle nuance. 4, 8 hourlies are for positional moves. Good trades.

The Tokyo Fix is where the FX rate is established for the day by the banks for their customers. So even though the FX rate may change during the day the customer gets the rate at the time of the fix. There is a fix in Tokyo, London and Toronto (more I am sure). Importers generally settle their accounts on the 5th, 10th, 15th, etc, of the month before and up until the fix ():50 GMT). Sometimes, if there is an "excess" dollar demand $/JPY will continue to climb slightly after the fix. $Bulls will also use this as a staging for extending a rally. $Bears (Yen Bulls) will use this to establish better shorts.



REACTING TO NEWS
News or data are always read by the market along the prevailing market bias. Data can provide a good reading for the state of the market. If the data is bad but the price is still rising or not affected, it must be a bull market which means buy on dip strategy is a better one. Conversely, if the data is good but the price is not rising or even falling, it must be a bear market which means sell on bounce strategy is a better one. The inflexion point must be when bad news or good news. no longer affect the prices as they have done before. Medium/long-term bias changes are usually accompanied by such reactions to the news. Fwiw.

It is not the numbers that counts but how the market reacts to the numbers that counts. That gives some comfort to those who are not privy to the numbers already



FAIR VALUE
Good evening. The concept of fair value in any currency is largely that of CBers and economists and not much about trading ..Almost always currencies overshoot from the fair value areas some 20-30% in their medium-term trend and what makes all hard currencies range in reasonable areas overtime since we had this floating regime in 1971 must the ability of relevant CBs to control the currency ranges and their real economy's weakness or strength to support those ranges. ECB folks were not joking when they said Eur/usd was some 25% undervalued from the fair value when Eur/Usd was below parity levels two years ago. Same goes for BOJ when they were saying Yen was some 10-20% overvalued when it was trading around 100 some three years ago too. That is how these folks view the markets and try to guide the market. Of course, when US Treasury folks say "Dollar is still strong" when it is falling, they are begging the market to sell more Dollars.



DIFFERENT CENTERS
The first hour after opening in Tokyo tend to provide the best liquidity of the day and that is when most heavyweight players try to position their way without having much difficulty for the day. Sydney open is more often used as an ambush hour by certain players using the time window till Tokyo open. One rule of thumb is when Yen jumps at Tokyo open the chances are it will continue throughout the day and a few more days. On different point, learn to position trade Yen or any other currency if one is really going to make a big money one day. Fwiw.

One hour from Tokyo open, London open and NY open are the times where most liquidity of the market exist. And that is where market makers are busy setting the trend for the session or even the day. Your observation has a merit because most of the session or daily moves are started either in London open or Tokyo open or NY open. Especially London Open. Other markets are too thin for any good sized traders to make their market views felt. Good luck.

London is just a market place where all sorts of Forex folks flock to buy and sell. It does not have to be London folks. It could be anyone from anywhere in the world with deep pockets who start setting the market direction on a given day. Same goes for NY and Tokyo sessions markets. In any case, Tokyo and NY still relatively small markets when compared to London as far as Forex goes.



A WORD FOR NEW TRADERS
Traders that try to pick the tops and bottoms of the market throughout the day end up with mostly misery because inexperienced fellows in Forex departments even in first division clubs try to pick the tops and bottoms believing that is where the real big money is. And ego demonstration and bonus consideration comes into play too for smart college graduates. The first thing I do when facing new recruits is, do my best to destroy their ego and fear in the market first. Once their ego and fear are reasonably cured, they become dutiful followers of the market like Pavolv?s hounds and they can survive. And once they can survive, they can be taught on how to put temporary tops and bottoms to the market at much higher level of speculation school. Then, that may take at least a decade of training too.



QUIPS FROM BC
Forex is all about how to hit the next ball correctly rather than worrying about something of a distant future. The next ball may be for 2 pips or 20 pips or 200 pips or 500 pips depending on a trader?s style.

Anything is possible in Forex.

I am useless as a daytrader. Corrections may take days or longer to complete.

Good quality info is everything in this game.

Bottom picking in the Usd/Jpy is the Mother of all risky trades.

We learn how to trade till we stop trading and we learn from each other everyday. That is the beauty of trading and life in general.

Do not worry about what market will do. Just worry about what you will do when market reaches your "pain point" or "happy point". You will have an easier life as a trader that way.

Forex players can operate quietly, but they cannot hide their moves in those charts.

Good morning. Yes, no liquidity and no conviction by players make the market look like a vagrant loitering in his usual area. Good forecasts and trades.

Good sleep is essential for good trading but most of the traders I know of seem to sleep with one eye open.

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Trading Styles

Currency traders make decisions by analyzing technical factors and economic fundamentals. Traders must decide which style and/or combination of analysis works best for them.

Technical Traders
Technical traders make their decisions using two primary tools:

Charting tools (trend lines, support and resistance levels, etc,)
Quantitive Trading Models (mathematical analysis to identify trading opportunities).
The goal of a technical analysis is to study historical data or past behavior of the market in order to predict future market movements. Traders may using their own charts and/or models, or use those developed by third-party providers.

The FXTrade interface provides a variety of forex graphing features.

Fundamental Traders
Fundamental traders analyze key economic data, including news and government reports, to evaluate trading opportunities. They believe that currency exchange rates are affected primarily by economic and political conditions, and occasionally by central banks intervening in the currency markets in an attempt to influence the value of their currencies.

Some of the key figures tracked by fundamental traders include interest rates, inflation, trade balance, GDP (Gross Domestic Product), CPI (Consumer Price Index), PPI (Producer Price Index), capacity utilization, factory orders, durable goods orders, inventories, and employment statistics. They are also constantly evaluating the potential impact of military conflicts, natural disasters, and changes in political leadership.

Another factor that often influences trading decisions is market sentiment. Traders often read news, analyst reports, and Web site bulletin boards to get a sense of the general market sentiment and then trade either with or against that sentiment.

OANDA provides various news sources for the fundamental trader:

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Benefits of Currency Trading vs. Equity Trading

Historically, currency trading has been a “closed” market, reserved primarily for major banks, multi-national corporations, and other large organizations. These institutions trade in large transaction sizes and high volumes and it has been next to impossible for smaller-scale, individual investors to participate in an equal and competitive manner.


This all changed however, as new technologies such as OANDA's proprietary FXTrade platform have made it possible for smaller investors to participate directly in the forex market. By lowering these traditional barriers, the forex marketplace is now open to a new group of forex investors.

Forex trading is rapidly winning favour as an alternative investment opportunity thanks not only to new trading tools pioneered by OANDA, but also because forex trading has several inherent benefits when compared to equity trading. This page lists some of these benefits.

Continuous, 24-hour trading
The currency exchange market is a true 24-hour market, operating five days a week. Equity trading, on the other hand, is restricted to the operating hours of the various equity exchanges. While after-hours trading for equities has become available to a limited degree through some electronic communication networks (ECNs), there are no guarantees that liquidity will be maintained after-hours or that trades can executed at true “market prices”.

High liquidity and greater efficiency
Key to any efficient market is high liquidity. After all, as a trader, you want to know that you have an active market with plenty of buyers and sellers looking to participate. Trading volumes in the currency market can be one hundred times larger than that of the New York Stock Exchange, and daily dollar amounts traded in foreign currency approaches $3 trillion compared to less than $100 billion for the NYSE. High volumes and “round-the-clock” trading ensures an active market for currency traders and greater liquidity.


The incredible volumes traded in the FX market also contribute to the integrity of the market—it is virtually impossible for an individual or group to manipulate prices. Compare this to the equity markets, where large price movements can be triggered with no warning should a major holder of a stock suddenly decide to reduce their holdings.

Intra-day volatility
FX trading is centered around a handful of currency pairs referred to colloquially as the big seven. The high volume and liquidity combined with fewer active instruments generates greater intra-day volatility than the equity markets where hundreds of stocks are actively traded. It is this volatility that can be profitability exploited by forex traders.

Low spreads
Currency trading offers spreads that are much lower than what can be obtained when buying or selling equities, especially during after-hours trading. Although exceptionally tight currency spreads were previously reserved for transactions involving $1 million or more, a shift towards tighter spreads for smaller transactions is gaining traction. Again, OANDA's FXTrade is an industry leader in offering tight spreads regardless of the size of the trade.

Margin-based leverage
Leverage—or margin based trading—makes it possible for FX market participants to submit trades valued considerably higher than the deposits in their trading accounts. Typically, margin ratios for trading currencies are higher than those permitted for equities, and this is primarily attributable to the higher level of liquidity within the currency markets.

To illustrate the power of leverage provided through the use of margin, consider a margin ratio of 20:1 coupled with a trading account containing $10,000. This means that you could trade amounts up to $200,000! Trading in larger volumes allows you to take better advantage of even small price movements (but can also dramatically increases your risk). Read about OANDA's margin policy.

Profit potential regardless of market direction
By definition, an investor with an open forex position is long one currency and short another. If you determine that a currency is about to fall in value, then you can sell that currency short and go long with another currency. No matter whether you buy or sell a currency pair, however, every trade you make involves the buying of one currency and the selling of another. Therefore, potential exists in the FX market regardless of whether the market is moving up or down.


Short-selling is much less common in the equity markets and there are many rules and regulations that you must abide by when shorting stock. This can make it difficult for you to take advantage of a declining share price or market trend. These same restrictions do not apply to the FX market, thereby allowing you to gain no matter which direction the market heads.

No commissions or transaction costs
A currency transaction typically incurs no commission or transaction fee outside of the quoted spread. This is in stark contrast to the equity market, where commissions for stock trades can range anywhere from $8 to $70 per trade, in addition to the quoted spread.

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Who Uses Forex?

Individuals and organizations require forex at various times.


Consumers and Travelers
Consumers typically come into contact with currency exchange when they travel or purchase items from foreign vendors.

Travelers must go to a bank or currency exchange bureau to convert one currency (typically, their "home currency") into another (i.e., the currency of the country they intend to travel to) so they can pay for goods and services in the foreign country. Travellers need to be aware of exchange rates to ensure they receive a fair deal. OANDA.com provides various conversion tools to help them.

Consumers may purchase goods in a foreign country or via the Internet with their credit card, in which case they will find that the amount they paid in the foreign currency will have been converted to their home currency on their credit card statement.

Although each consumer currency exchange is a relatively small transaction, the aggregate of all such transactions is significant.


Businesses
Businesses typically need to convert currencies when they conduct business outside their home country. For example, if they export goods to another country and receive payment in the currency of that foreign country, then the payment must typically be converted back to the home currency. Similarly, if they have to import goods or services, then businesses will often have to pay in a foreign currency, requiring them to first convert their home currency into the foreign currency.

Large companies convert huge amounts of currency; for example, a company such as General Electric (GE) converts tens of billions of dollars each year. The timing of when they convert can have a large affect on their balance sheet and "bottom line, and many businesses use hedging strategies to ensure they do not incur losses over time due to currency market volatility.


Investors and Speculators
Investors and speculators require currency exchange whenever they trade in any foreign investment, be it equities, bonds, bank deposits, or real estate. For example, when a Swedish investor buys shares in Sun Microsystems on the NASDAQ, she will have to pay for the shares in U.S. Dollars and likely have to convert Swedish Krona to U.S. Dollars. Similarly, a Japanese real estate investor who sells a New York property may want to convert the proceeds of the sale in U.S. Dollars to Japanese Yen.

Investors and speculators also trade currencies directly in order to benefit from movements in the currency exchange markets. For example, if an American investor believes that the Japanese economy is strengthening and as a result expects the Japanese Yen to appreciate in value (i.e., go up relative to other currencies), then she may want to buy Japanese Yen and take what is referred to as a long position. Similarly, if an American investor believes that the Euro will go down over time, then she may want to sell Euro to take a short position. Interestingly, investors and speculators can profit equally from currencies becoming stronger (by taking a long position) or from currencies becoming weaker (by taking a short position).

Speculators are often day traders, trying to take advantage of market movements in very short time periods; buying a currency and then selling it again within hours or even minutes. They are attracted to currency trading for numerous reasons, including (i) the size and daily volatility of the market, which provides some individuals with an unparalleled level of excitement, (ii) the almost perfect liquidity of the currency exchange market, (iii) the fact that the currency exchange market is "open" 24 hours a day, and (vi) the fact that currencies can be traded with no brokerage charges.


Commercial and Investment Banks
Commercial and investment banks trade currencies as a service for their commercial banking, deposit and lending customers. These institutions also generally participate in the currency market for hedging and proprietary trading purposes.


Governments and Central Banks
Governments and central banks trade currencies to improve trading conditions or to intervene in an attempt to adjust economic or financial imbalances. Although they do not trade for speculative reasons—they are non-profit organizations—they often tend to be profitable, since they generally trade on a long-term basis.

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Choosing a Forex Broker

As you may already know, foreign exchange (Forex/FX) is an unregulated market that is not traded on an exchange, which means that prices you see and get from one broker could vary from those of another broker. There are mainly two types of brokers. One type is an ECN (Electronic Communications Network) and another a Market-Maker.

Market-makers "make" or set the prices on their systems based on what they think is best for themselves as the counter-party. This is because every time you sell, they must buy, and when you buy, they must sell to you. This is why they can give you a fixed spread since they are setting both the bid and the ask price. Many of them will then try to "hedge" or "cover" your order by passing it on to someone else; however, some may decide to hold your order, and thus trade against you. This can result in a conflict of interest between the retail trader (you) and the market-maker.

ECNs, on the other hand, pass on prices from several banks and market-makers, as well as from the other traders in the ECN, and display the best bid/ask prices based on these input. This is why sometimes you can get no spread on ECNs, especially in very liquid currency pairs. How do ECNs make money then? They do so by charging you a fixed commission for each transaction.

Here are some of the pros and cons of ECNs and market-makers:

Market-Makers

Pros:


Usually give free charting software and news feed
Prices can be "smoother" and less volatile than ECN prices (this can be a con if you are scalping or trading very short term)
Often have a more user-friendly trading and analysis interface
Cons:


They may trade against you. In that case, there will be a conflict of interest between you and them
The price they offer you may be worse than what you could get on an ECN
It is possible that they may trigger stops or not let your trade reach your profit target levels by manipulating prices
During news, there will usually be a large amount of slippage; their systems may also lock up or not allow order placing during times of high volatility
Many of them discourage scalping and put scalpers on "manual execution" which means their orders may not get filled at the price they want

ECNs

Pros:
You can usually get better bid/ask prices since they come from several sources
Variable spreads between bid and ask may give no spread or tiny spreads at times
If they are a true ECN, they will not be trading against you but will pass on your orders to a bank or another customer on the other end of the transaction.
You will be able to offer a price between the bid and ask with a chance of it getting filled
If they support Stop-Limit orders, you can prevent slippage during news by making sure that your order either gets filled at the price you want or not at all
Prices may be more volatile which will be better for scalping
Cons:
Many do not offer integrated charting
Many do not offer integrated news
Many of the trading platforms are less user-friendly
Because of variable spreads (between bid and ask,) it may be more difficult to calculate stop loss and profit target in pips beforehand.

Summary

It is important that you carefully look into the pros and cons of each broker before choosing the one which best suits your needs. You may also wish to have several broker accounts to mitigate the risks, and so that you can compare bid/ask prices and trade on the broker with the best prices for the direction you wish to trade. Because of the unregulated nature of forex, US brokers are not required to keep your money in an untouchable account that only you can have access to if they were to collapse. As customers of Refco (was one of the world's largest brokers) found out, their unprotected accounts made them unsecured creditors, and thus are less likely to get their money back than those who had given secured loans to Refco. What this means is that the customers' money was used to pay other creditors.

The moral of the story is this:

Deposit as little money with your broker as you need for trading, and withdraw your profits when they exceed a certain amount. Keep the rest of your trading capital in your own bank accounts which are probably government-insured.

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Forex Broker Guide

Introduction

The following is a list of questions you may like to consider before opening an account. You can use this checklist to narrow down your selection of companies that fit your requirements. You may also wish to refer to the forex broker ratings page on this site to read about traders unique experiences with particular brokers.

The following links will also give you some background information on U.S. FCM's (Futures Commission Merchants).

Selected Financial Data for FCM's
NFA Background Affiliation Status
1. Word of Mouth

What do other traders say about the broker?
What is their customer service like?
2. Customer Protection

Is the broker regulated?
What regulatory organisation are they registered with and what protections does it afford you?
Are client funds insured against fraud?
Are client funds insured against bankruptcy?
3. Execution

What business model do they operate? i.e. Are they a Market Maker[?], ECN[?] or no-dealing desk broker[?]?
How fast is their order execution?
Are orders manually or automatically executed? [?]
What is the maximum trade size before you have to request a quote?
Are all clients trades offset?
4. Spread [?]

How tight is the spread?
Is it fixed or variable?
5. Slippage [?]

How much slippage can be expected in normal and fast moving markets?
6. Margin [?]

What is the margin requirement? e.g. 0.25% margin = max 400:1 leverage [?]), 0.5% margin = max 200:1 leverage, 1% margin = max 100:1 leverage, 2% margin = max 50:1 leverage, etc.
Does the margin requirement change for different currency pairs or days of the week?
At what point will the broker issue a margin call?
Is it the same for standard and mini accounts? [?]
7. Commissions

Do they charge commissions? (Most market makers' commissions are built into the spread)
8. Rollover Policy [?]

Is there a minimum margin requirement in order to earn rollover interest?
What are the swap rates like for going long or short in a particular currency pair?
Are there any other conditions for earning rollover interest?
9. Trading Platform

How intuitive and functional is it to use?
Are there many disconnections during trading hours?
How reliable is it during fast moving markets and news announcements?
How many different currency pairs can you trade?
Do they offer an Application Programming Interface (API) to allow you to automate your trading system?
Does it offer any other special features? (e.g. One click dealing, trading from the chart, trailing stops, mobile trading etc.)
10. Trading Account

What is the minimum balance required to open an account?
What is the minimum trade size?
Can you adjust the standard lot size traded? [?]
Can you earn interest on the unused margin balance in your account?

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Understanding Leverage Pt II

Leverage is not even a double-edged sword, it’s a guillotine - and your head is on the block – PART 2


Dr Forex says - Let me explain to you once and for all
why and how leverage destructs trading accounts.
I am very pleased with the reaction I received on my “Leverage Part 1” newsletter. I get the impression that it helped to clear up a number of issues for forex traders “out there”.

I hope that this newsletter will help you to change your position from being “out there” to “in here”.

“Out there” is a maze, mostly the blind leading the blind, and all spell-bound by the illusions created by the marketing wizards of forex. Forex forums are popular – they have become sites where the uninformed can meet with the unsure and concoct theories that are unsustainable. Would-be traders who don’t know what they are looking for tend to frequent these forums and as Yogi Berra, the famous baseball player said "You've got to be very careful if you don't know where you're going, because you might not get there."

“In here”, with me, you will know where you are going and together we will reach the destination of consistent and profitable trading.

This testimonial arrived in my inbox from one of my existing clients and it supports my belief that we are on the right route.


Congratulations on a stellar start with your newsletter.
Indispensable! I am glad I bought a lifetime BWILC mentoring subscription because you will become so much in demand your tuition price will probably go way up.
It is noteworthy that I only began consistently making any money in forex when I switched to the BWILC way. Even more noteworthy is that I'm making money in ever-increasing amounts as the BWILC techniques gradually become second nature.
Thanks for rescuing me from my former dead-end efforts.



To re-cap
Last time I said that with leverage we must clearly distinguish between what’s available (100:1, 200:1, 400:1, 500:1) and what you can choose to use. I showed you how the marketing wizards trick people into trading with very high leverage, convincing them that it is a good thing. These people are often unaware of the devastating effect of leverage on their account. It’s like speeding on a mountain pass but thinking you are on the flats. It can only end in one way … disaster.

We concluded that:



What is usually referred to as leverage is actually the margin required expressed as a ratio if you use all the borrowing power the broker will allow you to.



Real leverage is determined by dividing your capital into the value of your positions.



Real leverage can differ from trade to trade and increases with multiple simultaneous trades (open positions).



Margin required has no influence on your risk if you trade properly with modest leverage within your means and margin is not to be used as a risk calculating principle.

I also want to re-cap on the most basic issue regarding leverage, that is, its proper calculation.

Leverage is about borrowing money. To calculate leverage you must first know how much you have and then you must divide that into how much you are going to trade with (the size of the lot you are going to buy, or in effect, borrow).

Let’s say you have €20,000 and you do a trade (buy EURUSD of 100,000). Your leverage is 100,000/20,000 = 5:1. For every €1.00 you actually have you trade with €5.00.

Now I specifically used euro as an example as I want to make sure you understand the difference between “Trader’s leverage” and “Professor’s leverage”. I did refer to this in the Part 1, but only in passing and because this is important I want to make very sure you understand what I mean.

I guess many readers of BWILC (the book) skipped Part 3 – “All that Jazz”, or flipped quickly through it and missed the part where I explain leverage. They may also have missed the very important little paragraph on base currencies and currency quoting conventions. For real money dealers in banking dealing rooms these things are of paramount importance and it is second nature to them, but for some reason retail forex speculators see it as of minor importance and thus they make crucial mistakes in calculating their risk.

You see, if you look at a leveraged transaction in the futures market or the stock market the calculation is really simply - as in the example above. If you live in India and you do a leveraged transaction on the Indian stock exchange you have rupees and your borrow rupees and you trade some listed stock on the stock exchange. It is a very straightforward calculation: divide what you have into the value of your deal. But matters are not so simple in the forex market.

The first minor complication is making sure you know what you have. In other words, in what currency is your account? Let’s assume it is US dollar. (I think many more US traders should diversify their trading account to other currencies as a way of mitigating the risk of having all their eggs in one basket.)

The problem with leverage calculations in foreign exchange is that you have to divide apples into apples. Consequently you must express the base currency of the currency pair you trade in the currency of your account.

So we are back to basics. What the heck is a base currency? It is not the currency of your account. The base currency is the currency named first in the currency quotation. When we say EURUSD, euro is the base currency. When we say USDJPY, US dollar is the base currency.

When we say the price of EURUSD is 1.2755/8, then we mean for each euro you will have to pay 1.2758 US dollars if you buy euro and if you sell euro you will receive 1.2755 US dollars. Let’s say that with our $10,000 US dollar denominated trading account we buy one “standard lot” of (€100,000) EURUSD. The value of the transaction in US dollar terms is $127, 580. We have $10,000 and therefore our leverage is 127,580 / 10,000 = 12.75:1. For each one dollar we trade $12.75 - we have leveraged or geared our account 12.75 times. (There is no difference between “leverage” and “gearing”.)

But it became commonplace in the retail forex world to simply express such a transaction as having leverage of 10:1. Doing this ignores the fact that we are dealing with both apples and pears and just divide the 10K into 100K. It is an interesting question why this has become the normal practice, and I would like to spend some time explaining why I think it has.

Some history

In December 2003 the US regulator, the CFCT, which in terms of the Commodity Futures Modernization Act (2000) started to oversee OTC (over the counter) forex, issued new margin requirement rules. It seems to me that until then the marketing wizards advertised 100:1 or 200:1 leverage (or 1% margin requirement) without understanding that whichever is the base currency of a specific transaction has an important impact on the margin they require. They simply didn’t care. All accounts were in US dollar and they simply charged 1% of the number 100,000 currency units as if it was always US dollars. At the time the most traded currency pair - EURUSD - was valued less than one dollar per euro, and so this didn’t have an impact because the margin was actually more than 1% of the contract value. For example, while EURUSD traded at 0.9250 the contract was worth $92,500 and $1,000 was more than 1% of that ($925).

This changed when the euro increased substantially in value to more than $1.00 per euro, and suddenly the margin they charged was less than 1%. The CFTC also issued rules during 2003 that the margin requirements of retail OTC (OTC vs exchange traded) forex brokers must be brought in line with those of the exchange traded forex futures. This caused an uproar because the margins needed to be up to 4% - 8% and the marketing wizards objected that they would lose money to unregulated companies.

Their objections worked (as we all know by now) because margin requirements are still from as little as 0.25% based on transaction sizes, with the most common at around 1%. What the regulator did achieve is to force the correct (accurate) calculation of margin as a percentage of the base currency contract amount.

Understanding the exact amount that you trade should be pretty important, one would think. One would also think that retail traders that pay good money for trading advice, or training, from an e-book to a classroom course or home study course, will receive correct guidance in this regard. Unfortunately this is rarely the case.

How too high leverage kills potentially promising trading careers
Leverage amplifies the volatility in the market in the leveraged trading account by the factor of the leverage.

I am going to explain this problem with a story of two friends, Frank Marks and Buck Sterling.

Frank is a teacher in history and doing his PhD on ancient civilizations and Buck is a computer programmer. For his yearly vacation Frank decides to visit Stonehenge in the UK and he consults Buck who has recently started exploration in currency trading, assisted by an e-book “Forex Trading for Idiots”.

They went to a free seminar but Frank decided it was not for him. Buck however forked out the $1,500 for a weekend course, with free prices, free graphs, free this, free that, and a system to leverage his $3,000 to make $1,500 a day trading the British pound around the “London open”.

Buck initially struggled but recently he got the hang of it and made no less than $70,000 demo dollars. Slightly in awe Frank enquired of Buck how he was doing it and what the essence of the system was. Bucks reply? “Leverage buddy, leverage”. (Let me also add that Buck had $50,000 demo money.)

So Frank, mindful of his pending trip to the UK asks Buck to let him know when the best moment would be to exchange his money for Pounds Sterling and Buck obliges, showing him on 5 minute, 15 minute and 60 minute charts when the moment has come to buy GBP - the stochastix screams ”buy” and the fantastix promises wealth. At the top of the hour Frank rushes over to the Bureaux de Exchange and pays 1.88 US dollar for each of his 5,000 GBP. Altogether he pays $9,400. Buck, who has now written a programme on his Easy Money forex software, has just made 15,000 pounds worth of demo money overnight. Frank is becoming envious.

Buck explains to Frank that the Alligator has hoisted the white flag upside down with a Doji dangling from the Hangman’s noose yesterday; the Resistance is throwing away their guns while the Support is building a new base closer to the action on the daily charts; and your lucky star is in the right quadrant because the Paralytic Tsar made a handbrake turn on the dot. Translated, says Buck to Frank, it means that if Frank buys another 5,000 GBP while he is at it he is going to make a tidy profit because, “‘the GBP trend is up and the trend is your friend”, says Buck paging through Forex Trading for Idiots.

Frank rushes off to the Bureaux de Exchange and buys another 5,000 GBP. Buck was correct; today Frank paid 1.89 dollars per pound Sterling. Total expense: $18,850 for GBP 10,000. By the time Frank is on the plane, Buck is launching his trading career with real money, funding his commission free, two pip spread on majors, 200:1 leveraged trading account at Money-for-Jam Capital Partners with a $20,000.00 deposit.

The next few weeks Frank has a wonderful time in the UK and decides a week before his return to visit the Arlington racecourse and play the horses. The GBP is now trading at 1.95. Of course Frank thinks that Buck is rolling in money – the trend is one’s friend. Frank’s luck holds and he wins GBP 10,000 with the Pick Six after Long Shot wins the 6th race by a wet nose.

At home a few days later he exchanges it (his 10,000 GBP) for USD at the airport for a rate of 1.92. Frank receives $19,200. He has made $350 after being on vacation. Not bad. Buck, however, should be a millionaire by now!

First day back on the job Frank finds Buck deeply engrossed in a computer program. His two trading screens are blank.

“You were right”, says Frank with admiration. “The trend is your friend.” He places a souvenir from Arlington on Mark’s desk. “I had a great holiday and afterwards I was in the black, thanks to you. You’re a genius. What’s the pound trading at now?”

“No idea”, says Buck his head down.

A little taken aback Frank asks about the Paralytic Tsar, whether the Resistance is still building bases, and if the Hangman has been busy. “No idea”, says Buck, “I am not interested.” He looks wretched. The penny drops for Frank.

“How much did you lose Buckey?”
“Twenty K”. Shocked Frank presses Buck for an answer.
“Leverage buddy, leverage”.

Later the two talk in more detail and the sad story unfolds. Says Buck:

“The problem was that initially I was a bit too conservative. I made a few good trades with 50:1 leverage. In other words I made $100.00 per pip. By the time the GBP hit 1.9500, I was up to $40,000. So I decided to increase the stakes a bit and I leveraged the 40K 80:1, in other words I would make $320.00 per pip. I had to place the stops a bit closer, because that is how Idiot Money Management works. So I placed the Idiot stops 15 pips away, initially. What happens? I get taken out 3 times in a row, same day, $14,400 down the tube. What happens then? The market turns around and heads off in my direction just after having stopped me out. In fact, my third stop was taken out on a downward spike and 20 minutes latter two of my trades would have been in the money.”

“Well the next day the trend was back and I bought another 80:1 now with 30K, so $240.00 per pip. I realized this GBP is a bit volatile – and so I kept the stop, this time at 30 pips. Well call me the stop-out king. I was taken out by only 5 pips. That was $7200 down the drain. I realized it made a double top at 1.95 and got the signal that the trend has changed - 15 minute Parabolic SAR was crystal clear. I sold big time ….. $200 per pip.

So what happened next? I am not too sure, at some stage I was 50 points up and then all hell broke loose and well, I had my stop well out of the way. That was $6,000 gone and from there it was pretty much all over. I had to use tight stops because I didn’t have much left in my account and the same thing kept happening over and over. I started realising that volatility with real money is a bit different from volatility with demo money. I can’t explain it, it just seems bigger. My stops seemed like magnets drawing the market. Ping! Stopped out, market reverses and goes in my direction. Well, two days later I had 3K left. Money-for-Jam Capital Partners has the rest.

Let me tell you something Frank, leverage is not a double-edged sword - it’s a bloody guillotine and my head was on the block”.

Buck had to deal with the variance in his account created by market volatility and amplified by leverage. It would seem that Frank had a punt, and Buck lost money in an adverse market. In fact they were both gambling, the only difference being that Frank knew his win on the horses was a matter of luck. It is part of our psychology that when we do well we ascribe it to our talent and when we do poorly we ascribe it to bad luck. Often it is just randomness, nothing more and nothing less.

The cost of leverage
This story, with different shades but the same central theme, is repeated every day as aspiring forex traders burn out accounts.

In addition to the fact that high leverage forces you to place close stops - the bread-and-butter revenue for the forex broker - and dramatically increases the chances of you becoming a victim of the very short-term randomness of the forex market, it is also costs you a whack.

Many traders think there is no cost in trading because the spread is not seen separate from either the pips they lose or the pips they make. This is wrong because a transaction consists of two parts. The cost, and then the profit or loss. The cost is the amount debited to your account equity if you closed a trade you have opened immediately, without a change in market price.

Let’s say you get a GBPUSD quote 1.8650/55. You buy at 55 and if you sell immediately you would sell at 50. Your cost to deal is 5 pips. You broker sold to you at 55 and bought from you at 50. We can say the real market is already 5 pips against your position. You can’t claim the spread, unless you make a winning trade – if the market moves in your direction you reclaim the spread. But if you make a losing trade there is a 5 pip cost in addition to what you have lost due to an adverse price movement. The higher you are leveraged the more the spread costs you, bleeding money from your account

Let me give you a practical example. Highly leveraged retail forex speculators would jump at the chance of using a trading system that is wrong 35% of the time but because it cuts losses and runs profits, they are confident they would come out ahead. They would be wrong.

If you are un-leveraged, the only way in which you can lose all your money is if the currency you hold loses all its value.

From a cost point of view Frank Marks, when he bought his GBP probably paid a 15 pip spread at the Bureaux de Exchange. For him to lose all his money something would have had to happen to GBP to make it lose all its value – a meteor from the heavens obliterates the UK. Unlikely. And so, the GBP value Frank holds is relatively stable. But the moment you add leverage it amplifies in your account, creating instability, as the story of Frank and Buck illustrated.

But what I really want to get to is this: If you take an active highly leveraged trader who does, say, 40 trades in a month leveraged at 20:1, the real cost of his trading before profit or losses due to price fluctuation starts playing a role. The maths looks like this: 40 trades X 5 pips x 20 (mini) lots = $4,000. If he is using the trading system that is wrong 35% of the time (he is getting stopped out because of short stops) the cost that he can’t recoup is $1,400 or 14% of his capital. That is a direct cost to your trading business, and it is this cost that I am attacking – it is a highly questionable “overhead” if you consider that trading is a business.

If a trader using this trading system breaks even he is a very good trader. But in the long run he will eventually lose because the leverage, besides whatever else it does, is draining his account.

If you understand randomness you will know that those 35% of losing trades can come at any time. They can be the first 14 trades of the month. The effect of the highly leveraged losses on a trader’s equity, only once, with a really bad run, can be devastating to his account. In order to maintain his “system” he has to drop his transaction size, particularly after a bad run. Therefore it is going to take him a lot longer to make up the losses. In the process, even though his transaction size is smaller, his leverage is still the same (and too high) because his margin is dwindling.

If you really want to work out your return then you should work out your return, not expressed as a percentage of your margin but as a percentage of the total value and cost of your transactions. >/p>

Leverage amplifies everything in your account – at the same time not much has changed in the markets.
Another consequence of leverage is that it amplifies the variance in your account equity. And this (variance) has nothing to do with sustained profitable trading.

In the short term, days, weeks, months, (some will even say a few years) if you look at the result of your trading, there is a good probability that all you are seeing is random variance cloaked by the pretence of an intelligent trading system. There simply isn’t enough data to establish that what you see is the result of any edge or skill that you have.

It would be completely insane for Frank, after his visit to Arlington, to start a career as a bookmaker. But in the same way it was just a little bit less naïve for Buck to think that he had cracked it based on a few weeks of positive variance in his demo account.

If you know anything about probabilities you will know that the chances are very high that a series of coin tosses will end 50 / 50, either heads or tails. But did you know that if you take a series of 100 coin tosses the range of 50 / 50 will mainly be between 38 / 62 with very few lying outside these parameters.

Unfortunately it seems to be part of human nature (behavioural psychology has proved this) that we tend to see patterns or series where they don’t exist. And we usually do this based on insufficient data. Novice traders who so dearly want to do well are especially prone to reading into a short profit series that they have some edge and that they are on the brink of a long-term successful career in trading. Once they open their live accounts, probability rears up and bites them.

I want to make this very practical.

Let’s say you use 20:1 leverage to do all your demo trades and you hit a good run of luck and end positive, making 20% that month. Remove the leverage and thus the amplified variance in your account equity and your return may have been 2% - and that was during a good short run. What is going to happen if you have a longer period of say four months with three “bad” ones? You are nowhere. If you maintain the high leverage you will have losses during the bad runs that probably exceed the profits during the good runs.

By deciding at the end of a good high leverage stint you are now ready for real trading is exactly the type of thing that Money-for-Jam Capital Partners would want you to do, because they know they are going to get money for jam – from you.

What I am talking about is how variance in your account forces upon you a changed and negative mindset. You cannot concentrate on the market, which is what a trader should always be doing. Instead you are obsessed with the chaos in your account. What is the price out there, what are the factors you should be aware of? You don’t know. Your energies are being utilised in completely the wrong place. In short, you have lost the sort of perspective you need in order to trade successfully.

You find yourself in a situation where you can’t even handle the natural swings and retracements that occour in a trending market.

Variance of this magnitude due to leverage not only robs your account of money; it robs you of the ability to trade sensibly. Simply put, to be able to buy low and sell high you need to have an idea of what’s low and what’s high in the market. But it is exactly this perspective that you lose, paralysed with fear of further losses in your account as opposed to “further losses” in the currency market.

Can you make money with low-leveraged trading?
Good and well some will say, with your low-leveraged system you can’t lose too much, but can you actually make money? Is it worth your while? I believe you can, and in addition to the track record in BWILC where I show how I made 74% in two months on a trading account with low leverage, I can show you how others are doing it. To make money your forex trading strategy must be based on a genuine edge to beat the basic 50 / 50 odds of any trade.

I have developed a strategy that provides an edge. I call it my 4X1 strategy: one currency, one direction, one lot and one percent. This is my E=mc2 and just like Einstein’s formula turned a few things that were taken for granted upside down, this formula turns upside down the sort of orthodoxy and accepted wisdom peddled in books such as Forex Trading for Idiots.

Here is a fascinating true story from one of my clients. When he started out with my mentoring programme his answer to the question - Assuming that you have struggled until now, what would you ascribe this to? – was:

Most of my struggles have been believing what I have read on trading systems. Biggest problem has been placing stops too close to random price movements in order to limit my % of risk on the overall account. You are the first to expose this folly to me. However, I’m now concerned on just how to make any “real” money with so little gearing.

That was in January 2006. In March 2006 he funded a live trading account of $5,000 and by end of August 2006 his account was well up. After 5 months of trading, using the above formula and appropriate low leverage he was looking at an annualized return of 278%. His actual return was 129% - in anyone’s book that should count as “real” money.

Oh, and his trade accuracy is 90% (ie 10% losing trades), the typical losing trade is larger than the typical profitable trade and the largest single profit was 4% of initial trading capital, which shows that there is a real edge, not a one-night stand on a single big trade that convinces you of your own new-found “brilliance”.

Have a look at the details here: 129% in first five months


(Scroll down and click on the “Free” button next to the “PREMIUM” button. Then scroll down about half-way down until you find “Non-premium user. Please enter…” with a code. Enter the code and it will take you to the page.)

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Understanding Leverage

Leverage is not even a double-edged sword, it’s a guillotine - and your head is on the block – PART 1
Dr Forex says - Let me explain to you once and for all that leverage is not what brokers allow you to use, it is what you decide to use.
At long last I am at the point where my Bird Watching in Lion Country Newsletter is ready for publication. If you haven’t received one before, don’t start searching amongst your spam filter emails. This is the first newsletter.
Choice of topic is a difficult matter but “leverage” was always high on the priority list for the first issue. Recently I once again realized clearly how misunderstood this vital concept was to all aspects of forex. In my mind there is no doubt that most of the trouble that forex traders have starts with leverage.
I will dedicate this first newsletter then to this concept – leverage and its destructive power in the retail forex trading world.
A few facts
Personally I have not seen one wiped out trading account that wasn’t leveraged too high.
I have also no record of any sustained profitable trading account based on high leveraged, short-stop trading.
I ask my mentoring clients early on what they believe are the reasons for previous losses. Most answers include something to do with leverage, not understanding it at all, or only partially, or underestimating it once they have understood it.
Leverage then, is …?
I get many questions, like the one below:
I'm reading your book and I'm really enjoying it. Can you provide me with the information where I can get 1:1 leverage with the company you mention on page 108 of your book? I'm using a demo with only $1500 in the account with 200:1 leverage and I'm a bit worried about this even on 1 mini contract with one currency.
Or:
I contacted the broker you suggested where I could trade with less than $10,000 with low leverage, but they only offer 50:1 leverage and not 3:1 like you suggest.
It is very clear that leverage is misunderstood and this misunderstanding is a root cause of forex trading losses and the futile attempts to overcome these losses without addressing the root cause.
Regulatory warnings that leverage is a double-edged sword that can work for or against you go completely unheeded, just as the warning “past performance is no indication of future performance” is flatly ignored.
Leverage is largely misunderstood because the marketing wizards of forex (your friendly forex broker) have done a slight-of-hand trick that shifted the focus from the very important fact of how much the trader levers his trading capital to how much the forex marketing wizard is prepared to lend the trader.
Everything you read about leverage has to do with the maximum leverage you can achieve and very little about the prudent application of leverage in a forex trading system. In other words, the broker is telling you how much he will allow you to leverage, if you want to, not how much you should leverage, if you know better.
Warren Buffet said – “Risk is not knowing what you are doing”.
People speak about 100:1 leverage – “I trade with 100:1”, without knowing what it means. I will show below how you are your greatest enemy by being ignorant about this vital concept. I hope many of you will get a very important “AHA” experience from the newsletter.
Definition of leverage
This is a general definition:
The mechanical power or advantage gained through using a lever.
A definition found at www.investorwords.com says leverage is:
The degree to which an investor or business is utilizing borrowed money.
Closer to forex trading: www.thefreedictionary.com
The use of credit or borrowed funds to improve one's speculative capacity and increase the rate of return from an investment, as in buying securities on margin.
Enter the concept of “margin”. Let’s make sure we understand what margin is:
Definition of margin
The amount of collateral a customer deposits with a broker when borrowing from the broker to buy securities.
This is exactly what you do if you open a forex trading account. You deposit collateral in order to be able to borrow currencies to trade currencies. Actually you don’t have to borrow, but you can if you want to.
The moment that borrowing comes into play it is common knowledge that the amount that the lender will be prepared to lend has certain limitations. Obviously you can’t lend indefinite amounts.
The thing that stumps most traders is the fact that the marketing wizards use the terms “leverage” and “margin” very loosely and interchangeably. This causes a lot of confusion. I believe this is done deliberately because it is in the forex broker’s interest that traders do not see high leverage as a destructive problem but as an opportunity.
Let’s make sure we understand first “leverage” and then “margin”.
To understand leverage properly for trading purposes, let’s use a well-known concept. You want to buy a house, you don’t have the capital available, but you have a salary and can pay instalments on a regular basis, so you go to the bank and borrow money to pay for the house. So you are leveraging your income / salary. There are limitations based on, amongst others, your income which means the amount you can borrow based on your income will be limited. There is a maximum you can borrow. Obvious, yes, but a very important concept for the lender – the maximum he should lend you in order to get the maximum return on his capital without overexposing himself to risk of default on your side.
(Just a thought from the sideline. If trading forex is mostly with borrowed funds why don’t the brokers ask interest? Think about that …. )
Remember this: The lender is focused on maximums whereas the borrower should be concerned with minimums - borrowing as little as he can but still getting bang for his buck.
Now we turn to your trading account: you want to increase your speculative capacity by leveraging your investment, therefore you borrow money to trade with from your broker.
Before your broker will lend you money you have to put down margin, which you wish to lever. Your broker, being a prudent businessman has calculated his risk beforehand and is quick to tell you what the maximum is he will allow you to borrow from him. In forex it is typically one hundred times your capital but it can also be two hundred times your capital or even four hundred times your capital. This is one part of the equation:
“Dear valued customer, you will be able to leverage your money 100:1, (200:1, 400;1). We hope we can have a long and mutually beneficial relationship.”
The other side of the equation is how much of this available borrowing you want to utilize in your speculative endeavours.
How much leverage you apply is your own decision and not something the broker can force on to you.
Here is proof:
We are going to start with a stock market example.
You open a trading account with a stockbroker, with say, $10,000. You can buy stocks to the value of $10,000. Let’s say you did. Did you leverage your funds?
No. You didn’t borrow a cent from the broker. You have $10,000 and the value of your stocks when you purchased them was $10,000 (ignore costs for the moment).
How do you calculate your leverage?
You divide your capital into the value of your transaction and express it as a ratio of “value of transaction” : “capital”.
In the above example you divide $10,000 / $10,000 = 1:1
Well, your friendly online stockbroker one day sends you a message that they now allow margined trading and you can borrow funds to purchase stock up to the value of your current stocks. For simplicity sake we say the value of your stocks is still $10,000. In other words you can now buy another $10,000 worth of stocks while your capital input remains $10,000.
You do this after you just received a hot tip and now you have a transaction value of 2 X $10,000 = $20,000 divided by your capital of $10,000 = leverage of 2:1. Or you can choose not to, it depends on you.
Vital for the broker: Maximum leverage allowed
The maximum leverage you can apply (as opposed to how much you want to apply) is your broker’s decision:
The important thing you have to note in the above example is that you have utilized all the leverage you were allowed by the broker. This is vital. The broker takes a huge risk to lend you money and therefore they have certain rules which you must adhere to. There is a limit to what you can borrow from them. In the above example the limit is leverage of 2:1 or seen from another viewpoint margin of 50%. You must have at least half the value of your total transaction available in margin (in other words collateral in case you aren’t as hot a trader as you thought).
Margin is usually expressed as a percentage, while leverage is expressed as a ratio.
The marketing wizards of forex realized that the fact that they can offer very high leverage will be to their advantage to lure online investors from the traditional markets. Furthermore, many online investors’ portfolios were devastated by the 2000 crash and losses of up to 90% of formerly lucrative stock portfolios became commonplace – much of this leveraged through stock option schemes.
As a result they started to tout from the rooftops that leverage of 100:1, 200:1, and with the introduction of mini accounts, even 400:1 and 500:1 was available.
Terms like “trade with 100:1” leverage became the order of the day.
An unsuspecting and clueless online trading public swallowed this hook, line and sinker and were trading with “100:1 and 200:1 leverage”, not understanding what they are doing.
In reality the broker simply said “we will allow you to lever your margin up to 100:1, 200:1 or 400:1 at the absolute maximum, if you utilized all your borrowing power with us.”
But you must remember leverage is a double-edged sword. It can work for you and against you. And so a race started amongst the forex losers out there: where were the highest leverage, lowest margin and narrowest spreads being offered? As if this lethal combination would contribute to success...
So if you go to your friendly broker who offers both 100K lots and 10K mini lots you will find that on 100K lots you usually have a maximum of 100:1 leverage and on mini accounts 200:1 or 400:1.
So that is from the angle of the forex broker: They will allow maximum leverage of 100:1, 200:1, 400:1.
Vital for the trader: Minimum leverage needed
How does leverage look from your (the trader’s) side?
The question from your side is: How much margin do I need to trade a transaction of a certain value? The answer is simple, if they offer that I can lever my funds 100 times, then it is 1 / 100 = 1%, 1 /200 = 0.5%, 1/ 400 = 0.25%.
If we return to the stock market example the question of minimum leverage doesn’t play a role because if you have limited funds it would be prudent to buy low priced stocks in order to be able to invest in a basket of stocks.
But in the forex market where the minimum transaction values were initially 100K or 10K and a shell-shocked online trading public were lured to utilize the “advantages” of the high leverage with accounts of just $2,000 - $3,000 or mini accounts of $200 - $300, the minimum leverage certainly played a role.
To make all of this stick better I am going to use a real example:
A few years ago a now defunct tip service company did a survey on the typical forex trading account trading with 100K lots. The average sized account was an account of $6,000.
There is no question that the average trader will have to borrow money from the broker, ie leverage his funds. The question is “how much”? To do a minimum transaction of 100,000 you divide the 100,000 by 6,000 and there is the answer: 100,000 / 6,000 = 16.67.
In other words, he must borrow 16.67 times his money to do a minimum transaction and thus utilize a minimum leverage of 16.67:1. Just to do one silly trade.
Trading successfully: Know your real leverage
I am not going to be too technical about the exact leverage in these examples.
In reality if you have a US dollar account you should express the transaction value in US dollars before you calculate the exact leverage. So if you trade 100,000 GBPUSD, you actually trade dollars to the value of £100,000 which is at time of writing about $190,000. There is a big difference between $100,000 and $190,000. (As Warren Buffet said: Risk is not knowing what you are doing …)
With the flexibility offered by mini lots (10K), micro lots (1K) and variable lots (any size the trader defines) it is easier these days to determine one’s real leverage because you operate within the extremes of minimum leverage and maximum leverage.
Let’s return to the questions above:
Can you provide me with the information where I can get 1:1 leverage with the company you mention on page 108 of your book? I'm using a demo with only $1500 in the account with 200:1 leverage and I'm a bit worried about this even on 1 mini contract with one currency.
“Can you provide me with the information where I can get 1:1 leverage?”
Considering that leverage is transaction value divided by capital the important aspect is your capital and the minimum position size because to be in a position to trade 1:1 you must have at least the same capital as the minimum transaction. In your case you will have to trade with a broker that offers variable lots or micro lots not larger than 1,500 units.
“I'm using a demo with only $1500 in the account with 200:1 leverage”
You refer here to the maximum leverage or the maximum amount they will allow you to borrow. This is a fixed amount (percentage) applicable to all transactions and it does not affect your transactions at all, as long as you stay within this limit.
“I'm a bit worried about this even on 1 mini contract with one currency.”
First of all there is no need to worry about the “200;1 leverage”. It simply means it is the maximum you are allowed to trade, not what you are forced to trade (it’s your choice!). To trade the maximum would really be silly. Your real leverage if you trade one mini contract with $1,500 will be in the region of 6:1 or 7:1. (10,000 / 1,500).
It is interesting that you mention one currency also, because you must know that if you simultaneously trade 2 or 3 currencies your leverage increases. Say you trade one mini lot EURUSD, GBPUSD and USDCHF, the total value of units = 30,000 (3 mini lots) and your capital is still $1,500.
Your leverage is thus 30,000 / 1,500 = 20:1. That’s high. You borrow 20 times what you have.
To trade forex profitably you need a $3.00 calculator not $300.00 a month charting service.
Here is the proof:
Let’s talk about the 200:1 “leverage”.
I hope by now you understand that this refers to the maximum the marketing wizard will allow you to borrow and that you can borrow much less to keep your leverage sane and your account afloat. But if you go to that extreme you must be really desperate or stupid and for all practical purposes you are already on the way out.
So what the forex marketing wizards call “leverage” is actually the margin requirement expressed as a ratio instead of as a percentage, which makes more sense and has absolutely no impact on your trading, unless you are already basically wiped out or about to be.
Let’s say a trader has $10,000 and trades at a broker which offers “flexible leverage”.
You can choose your “leverage”, 400:1, 200:1, 100:1 or 50:1. What they mean is you can choose your margin requirement (which will define the maximum you can borrow from them) to be 0.25%, 0.5%, 1% or 2% of the transaction value.
Trader decides to buy 5 mini lots EURUSD, ie €50,000 transaction value and the value of one pip on this transaction is $5.00. Let’s say he makes 100 pips profit which is $500 or 5% of his capital.
Does the flexible margin requirement, generally called “leverage” affect this outcome?
The answer is “no”.
Leverage = 400:1 = 0.25% = $25 X 5 = $125. After 100 pips move the Trader makes $500.
Leverage = 200:1 = 0.50% = $50 X 5 = $250. After 100 pips move the Trader makes $500.
Leverage = 100:1 = 1.00% = $100 X 5 = $500. After 100 pips move the Trader makes $500.
Leverage = 50:1 = 2.00% = $200 X 5 = $1000. After 100 pips move the Trader makes $500.
It is vitally important that you grasp this:
The only variable in this whole trading exercise is the real leverage, not the margin requirement.
In the example above the market moved 100 pips irrespective of the margin required.
The only differentiating factor is how much the trader borrows out of what is available. Depending on how much trader borrows he will have a different outcome.
In the example he borrowed 5 times his capital, was levered 5:1 and made $500.00. If he borrowed ten times his capital and was levered 10:1, he would have made on the same market move $1,000 or 10% of his capital. If he borrowed two times his capital 2:1, 2% and so on.
Margin – Leverage - Risk
People incorrectly think the risk they take has to do with the margin requirement, forex marketing wizard’s “leverage”.
How many times have you come across money management or risk management systems that say you must not risk more than x% of your capital on a trade?
Let’s say our Trader used this technique and he doesn’t “risk more than 10% of his capital” on a trade.
In the example above in the case of 2% margin (50:1 “leverage”) the Trader “uses” 10% of his capital (as margin). (Hopefully you now realize that in reality he risks his capital 10 times!)
So if the approach is that the risk is determined in terms of the margin that is being “put up” on a per trade basis the following applies: Out with the calculators!
Trader has $10,000 and is prepared to "risk 10%"
Leverage = 400:1 = 0.25% 10 / .25 = 40. That is, 10% “risk” will be 40 lots or 400K. Real leverage = 400 / 10,000 = 40:1. Pip value = $40.00.
Leverage = 200:1 = 0.50% 10 / .50 = 20. That is, 10% “risk” will be 20 lots or 200K. Real leverage = 200 / 10,000 = 20:1. Pip value = $20.00
Leverage = 100:1 = 1.00% 10 / 1.00 = 10. That is, 10% “risk” will be 10 lots or 100K. Real leverage = 100 / 10,000 = 10:1. Pip value = $10.00
Leverage = 50:1 = 2.00% 10 / 2.00 = 5. That is, 10% “risk” will be 5 lots or 50K. Real leverage = 50 / 10,000 = 5:1. Pip value = $5.00
This same risk management strategy then usually says, don’t risk more than x% of your capital in potential losses, therefore calculate your stop-loss point beforehand as a percentage of capital. So a stop-loss is typically set at 2% or 3% of capital.
In this case, if 2%, the maximum loss value will be $200 (2% of capital of $10,000). But as you have seen now, the first part incorrectly calculates pip value based on a bogus principle (for the leveraged trader), while the trader supposedly “risks” 10% of his capital in all four cases.
Leverage = 400:1, Pip value = $40.00, “risk 10%”. The stop-loss of 2% must be 5 pips.
Leverage = 200:1, Pip value = $20.00, “risk 10%”. The stop-loss of 2% must be 10 pips.
Leverage = 100:1, Pip value = $10.00, “risk 10%”. The stop-loss of 2% must be 20 pips.
Leverage = 50:1, Pip value = $5.00, “risk 10%”. The stop-loss of 2% must be 40 pips.
The above clearly demonstrates that a misunderstanding of leverage can be devastating to your chances of success.
It also demonstrates that many so-called money management systems are absolutely bogus - spreadsheet theory - and have nothing to do with real profitable trading.
Suffice it to say that while the “400:1 and 200:1” options aren’t utilized that much you will be tempted by the 100:1 and 50:1 options as suggested by almost all the experts out there, accompanied by the necessary 20, 30 and 40 pip stops that are hit all the time (followed by the inevitable market movement in your initial anticipated direction).
Summary
What is usually referred to as leverage is actually the margin required expressed as a ratio if you use all the borrowing power the broker will allow.
Real leverage is determined by dividing your capital into the value of your positions.
Real leverage can differ from trade to trade and increases with multiple simultaneous trades.
Margin required has no influence on your risk if you trade properly with modest leverage within your means and is not to be used as a risk calculating principle.

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