Currency Trading For Dummies (3rd Edition) PDF

Currency Trading 3rd Edition Currency Trading 3rd Edition by Kathleen Brooks and Brian Dolan Currency Trading For Dummies®, 3rd Edition Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com Copyright © 2015 by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. 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Library of Congress Control Number: 2014950596 ISBN 978-1-118-98980-7 (pbk); ISBN 978-1-118-98981-4 (ebk); ISBN 978-1-118-98983-8 (ebk) Manufactured in the United States of America 10 9 8 7 6 5 4 3 2 1 Contents at a Glance Introduction................................................................. 1 Part I: Getting Started with Currency Trading................. 5 Chapter 1: Currency Trading 101...................................................................................... 7 Chapter 2: What Is the Forex Market?............................................................................ 17 Chapter 3: Who Trades Currencies? Meet the Players................................................ 33 Chapter 4: The Mechanics of Currency Trading........................................................... 47 Part II: Driving Forces behind Currencies...................... 71 Chapter 5: Looking at the Big Picture............................................................................ 73 Chapter 6: Understanding and Applying Market News and Information.......................... 99 Chapter 7: Getting Down and Dirty with Fundamental Data..................................... 115 Chapter 8: Getting to Know the Major Currency Pairs.............................................. 139 Chapter 9: Minor Currency Pairs and Cross-Currency Trading............................... 163 Part III: Developing a Trading Plan............................ 179 Chapter 10: Training and Preparing for Battle............................................................ 181 Chapter 11: Cutting the Fog with Technical Analysis................................................ 201 Chapter 12: Identifying Trade Opportunities.............................................................. 229 Chapter 13: Risk-Management Considerations........................................................... 249 Part IV: Executing a Trading Plan.............................. 267 Chapter 14: Pulling the Trigger..................................................................................... 269 Chapter 15: Managing the Trade................................................................................... 283 Chapter 16: Closing the Position and Evaluating Your Results................................ 295 Part V: The Part of Tens............................................ 305 Chapter 17: Ten Habits of Successful Currency Traders........................................... 307 Chapter 18: Ten Rules of Risk Management................................................................ 313 Chapter 19: Ten Great Resources................................................................................. 317 Appendix: Trading Strategies..................................... 321 Index....................................................................... 343 Table of Contents Introduction.................................................................. 1 About This Book............................................................................................... 1 Foolish Assumptions........................................................................................ 3 Icons Used in This Book.................................................................................. 3 Beyond the Book.............................................................................................. 4 Where to Go from Here.................................................................................... 4 Part I: Getting Started with Currency Trading.................. 5 Chapter 1: Currency Trading 101.................................. 7 What Is Currency Trading?.............................................................................. 7 Speculating as an enterprise................................................................. 8 Currencies as the trading vehicle......................................................... 8 What Affects Currency Rates?...................................................................... 10 Fundamentals drive the currency market......................................... 10 Unless it’s the technicals that are driving the currency market....... 11 Or it may be something else................................................................ 11 Developing a Trading Plan............................................................................ 12 Finding your trading style.................................................................... 12 Planning the trade................................................................................ 13 Executing the Trading Plan from Start to Finish........................................ 14 Chapter 2: What Is the Forex Market?............................ 17 Getting Inside the Numbers.......................................................................... 19 Trading for spot.................................................................................... 19 Speculating in the currency market................................................... 19 Getting liquid without getting soaked................................................ 20 Around the World in a Trading Day............................................................. 21 The opening of the trading week........................................................ 21 Trading in the Asia-Pacific session..................................................... 22 Trading in the European/London session......................................... 23 Trading in the North American session............................................. 24 Key daily times and events.................................................................. 25 The U.S. dollar index............................................................................ 26 Currencies and Other Financial Markets..................................................... 28 Gold........................................................................................................ 28 Oil............................................................................................................ 29 Stocks..................................................................................................... 29 Bonds...................................................................................................... 30 Getting Started with a Practice Account..................................................... 31 viii Currency Trading For Dummies, 3rd Edition Chapter 3: Who Trades Currencies? Meet the Players............. 33 The Interbank Market Is “The Market”........................................................ 33 Getting inside the interbank market................................................... 34 Bank to bank and beyond.................................................................... 35 Hedgers and Financial Investors.................................................................. 37 Hedging your bets................................................................................. 37 Global investment flows....................................................................... 39 Speculators...................................................................................................... 40 Hedge funds........................................................................................... 41 Day traders, big and small................................................................... 43 Governments and Central Banks.................................................................. 44 Currency reserve management........................................................... 44 The Bank for International Settlements............................................. 45 The Group of Twenty........................................................................... 46 Chapter 4: The Mechanics of Currency Trading................... 47 Buying and Selling Simultaneously............................................................... 47 Currencies come in pairs..................................................................... 48 The long and the short of it................................................................. 52 Profit and Loss................................................................................................ 53 Margin balances and liquidations....................................................... 53 Unrealized and realized profit and loss............................................. 54 Calculating profit and loss with pips.................................................. 54 Factoring profit and loss into margin calculations.......................... 55 Understanding Rollovers and Interest Rates.............................................. 56 Currency is money, after all................................................................ 56 Value dates and trade settlement....................................................... 57 Market holidays and value dates........................................................ 58 Applying rollovers................................................................................ 59 Understanding Currency Prices................................................................... 61 Bids and offers...................................................................................... 61 Spreads................................................................................................... 62 Executing a Trade........................................................................................... 62 Trading online....................................................................................... 62 Orders.................................................................................................... 65 Part II: Driving Forces behind Currencies...................... 71 Chapter 5: Looking at the Big Picture............................ 73 Currencies and Interest Rates....................................................................... 74 The future is now: Interest rate expectations................................... 75 Relative interest rates.......................................................................... 76 Monetary Policy 101....................................................................................... 77 Looking at benchmark interest rates................................................. 78 Easy money, tight money..................................................................... 78 Unconventional easing......................................................................... 80 Table of Contents ix Watching the central bankers............................................................. 81 Interpreting monetary policy communications................................ 82 Official Currency Policies and Rhetoric....................................................... 84 Currency policy or currency stance?................................................. 84 Calling the shots on currencies.......................................................... 85 Taking a closer look at currency market intervention..................... 88 Financial stability.................................................................................. 91 Debts, deficits, and growth.................................................................. 91 Gauging credit risk................................................................................ 92 Geopolitical Risks and Events....................................................................... 94 Gauging risk sentiment........................................................................ 95 Risk on or risk off?................................................................................ 95 Chapter 6: Understanding and Applying Market News and Information.................................................. 99 Sourcing Market Information...................................................................... 100 The art of boarding a moving train.................................................. 100 Taking the pulse of the market......................................................... 101 Rumors: Where there’s smoke, there’s fire..................................... 103 Putting Market Information into Perspective: Focusing on Themes..........104 Driving fundamental themes............................................................. 104 Analyzing technical themes............................................................... 108 Reality Check: Expectations versus Actual............................................... 110 The role of consensus expectations................................................. 111 Pricing in and pricing out forecasts................................................. 112 When good expectations go bad...................................................... 112 Anticipating alternative outcome scenarios................................... 113 Chapter 7: Getting Down and Dirty with Fundamental Data........ 115 Finding the Data............................................................................................ 116 Economics 101 for Currency Traders: Making Sense of Economic Data.......................................................................................... 116 The labor market................................................................................ 117 The consumer..................................................................................... 118 The business sector........................................................................... 118 The structural..................................................................................... 119 Assessing Economic Data Reports from a Trading Perspective............ 120 Understanding and revising data history........................................ 120 Getting to the core.............................................................................. 121 Market-Moving Economic Data Reports from the United States............ 122 Labor-market reports......................................................................... 122 Consumer-level data reports............................................................. 125 Business-level data reports............................................................... 128 Structural data reports...................................................................... 130 Major International Data Reports............................................................... 133 Eurozone.............................................................................................. 133 Japan.................................................................................................... 134 x Currency Trading For Dummies, 3rd Edition United Kingdom.................................................................................. 135 Canada.................................................................................................. 136 Australia............................................................................................... 136 New Zealand........................................................................................ 137 China..................................................................................................... 137 Chapter 8: Getting to Know the Major Currency Pairs............. 139 The Big Dollar: EUR/USD.............................................................................. 140 Trading fundamentals of EUR/USD................................................... 140 Trading behavior of EUR/USD........................................................... 143 Tactical trading considerations in EUR/USD................................... 146 East Meets West: USD/JPY........................................................................... 147 Trading fundamentals of USD/JPY.................................................... 148 Price action behavior of USD/JPY..................................................... 152 Tactical trading considerations in USD/JPY.................................... 154 The Other Majors: Sterling and Aussie...................................................... 155 The British pound: GBP/USD............................................................. 155 The new kid in town: Trading the Aussie........................................ 157 Understanding Forex Positioning Data...................................................... 159 How to interpret the data.................................................................. 159 The FX fix............................................................................................. 160 Forex and regulation.......................................................................... 160 Chapter 9: Minor Currency Pairs and Cross-Currency Trading..... 163 Trading the Minor Pairs............................................................................... 163 Trading fundamentals of USD/CAD................................................... 165 Trading fundamentals of NZD/USD................................................... 167 Tactical trading considerations in USD/CAD, AUD/USD, and NZD/USD................................................................. 169 Trading the Scandies: SEK, NOK, and DKK............................................... 171 Swedish krona — “Stocky”............................................................... 172 Norwegian krone — “Nokkie”........................................................... 172 Danish krone — “Copey”.................................................................. 173 Cross-Currency Pairs................................................................................... 173 Why trade the crosses?...................................................................... 174 Stretching the legs.............................................................................. 175 Trading the JPY crosses.................................................................... 176 Trading the EUR crosses.................................................................... 177 Part III: Developing a Trading Plan............................. 179 Chapter 10: Training and Preparing for Battle.................... 181 Finding the Right Trading Style for You.................................................... 181 Real-world and lifestyle considerations........................................... 182 Making time for market analysis....................................................... 183 Technical versus fundamental analysis........................................... 183 Table of Contents xi Different Strokes for Different Folks........................................................... 184 Short-term, high-frequency day trading.......................................... 185 Medium-term directional trading..................................................... 187 Long-term macroeconomic trading.................................................. 189 Trading on Auto-Pilot................................................................................... 192 Potential inputs to drive an EA system............................................ 192 Caveat emptor on models.................................................................. 193 Using social media for trading: The power of the crowd.............. 194 Developing Trading Discipline.................................................................... 195 Taking the emotion out of trading.................................................... 196 Managing your expectations............................................................. 197 Keeping your ammunition dry.......................................................... 198 Chapter 11: Cutting the Fog with Technical Analysis............. 201 The Philosophy of Technical Analysis....................................................... 202 What is technical analysis?................................................................ 202 What technical analysis is not.......................................................... 203 Forms of technical analysis............................................................... 203 Finding support and resistance........................................................ 204 Waiting for confirmation.................................................................... 206 The Art of Technical Analysis..................................................................... 207 Bar charts and candlestick charts.................................................... 207 Drawing trend lines............................................................................ 209 Recognizing chart formations........................................................... 210 Fibonacci retracements..................................................................... 220 The Science of Technical Analysis............................................................. 221 Momentum oscillators and studies.................................................. 221 Trend-identifying indicators.............................................................. 225 Trading with clouds — Ichimoku charts......................................... 227 Chapter 12: Identifying Trade Opportunities..................... 229 Developing a Routine for Market Analysis................................................ 229 Performing Multiple-Time-Frame Technical Analysis.............................. 230 Identifying Support and Resistance Levels............................................... 234 Trend lines........................................................................................... 235 Highs and lows.................................................................................... 236 Congestion zones................................................................................ 236 Fibonacci retracements..................................................................... 237 Ichimoku levels................................................................................... 237 Looking for Symmetry with Channels........................................................ 238 Drawing price channels..................................................................... 238 Listening to Momentum............................................................................... 239 Factoring momentum analysis into your routine........................... 240 Looking at momentum in multiple time frames.............................. 241 Trading on divergences between price and momentum............... 241 Using momentum for timing entry and exit.................................... 243 Trading on Candlestick Patterns................................................................ 243 Building a Trade Strategy from Start to Finish......................................... 244 xii Currency Trading For Dummies, 3rd Edition Chapter 13: Risk-Management Considerations................... 249 Managing Risk Is More Than Avoiding Losses.......................................... 249 Leverage amplifies gains and losses — and expectations............. 250 Knowing your margin requirements................................................ 251 Market liquidity, volatility, and gap risk.......................................... 252 We have a winner here! Protecting your profits............................. 255 Placing your orders effectively......................................................... 256 Applying Risk Management to the Trade.................................................. 259 Analyzing the trade setup to determine position size................... 259 Doing the math to put the risk in cash terms................................. 260 Devising the trading plan in terms of risk....................................... 261 Choosing Your Trading Broker................................................................... 263 Different business models of brokers.............................................. 263 Financial risks of brokers................................................................... 265 Technology Issues and Contingency Planning......................................... 265 Part IV: Executing a Trading Plan............................... 267 Chapter 14: Pulling the Trigger................................. 269 Getting into the Position.............................................................................. 269 Buying and selling at the current market........................................ 270 Averaging into a position................................................................... 271 Trading breakouts.............................................................................. 275 Making the Trade Correctly........................................................................ 279 Buying and selling online................................................................... 280 Placing your orders............................................................................ 281 Chapter 15: Managing the Trade............................... 283 Monitoring the Market while Your Trade Is Active.................................. 284 Following the market with rate alerts.............................................. 284 Staying alert for news and data developments............................... 285 Keeping an eye on other financial markets..................................... 286 Updating Your Trade Plan as Time Marches On...................................... 288 Trend lines move over time.............................................................. 289 Impending events may require trade plan adjustments................ 290 Updating Order Levels as Prices Progress................................................ 291 Increasing take-profit targets............................................................ 292 Tightening stop-loss orders to protect profits............................... 293 Chapter 16: Closing the Position and Evaluating Your Results...... 295 Closing Out the Trade.................................................................................. 296 Taking profit and stopping out......................................................... 296 Setting it and forgetting it: Letting the market trigger your order........................................................................... 299 Table of Contents xiii Squaring up after events have happened........................................ 299 Exiting at the right time..................................................................... 300 Getting out when the price is right................................................... 301 Assessing Your Trading Strategy............................................................... 301 Identifying what you did right and wrong....................................... 302 Updating your trading record........................................................... 302 Part V: The Part of Tens............................................. 305 Chapter 17: Ten Habits of Successful Currency Traders........... 307 Trading with a Plan...................................................................................... 307 Anticipating Event Outcomes..................................................................... 308 Staying Flexible............................................................................................. 308 Being Prepared for Trading......................................................................... 308 Keeping Technically Alert........................................................................... 309 Going with the Flow/Trading the Range.................................................... 309 Focusing on a Few Pairs............................................................................... 310 Protecting Profits.......................................................................................... 310 Trading with Stop Losses............................................................................ 310 Watching Other Markets.............................................................................. 311 Chapter 18: Ten Rules of Risk Management...................... 313 Trade with Stop-Loss Orders...................................................................... 313 Leverage to a Minimum............................................................................... 314 Trade with a Plan.......................................................................................... 314 Stay on Top of the Market........................................................................... 314 Trade with an Edge....................................................................................... 314 Step Back from the Market.......................................................................... 315 Take Profit Regularly.................................................................................... 315 Understand Currency-Pair Selection.......................................................... 315 Double-Check for Accuracy......................................................................... 316 Take Money out of Your Trading Account................................................ 316 Chapter 19: Ten Great Resources............................... 317 Technical Analysis of the Financial Markets............................................. 317 Japanese Candlestick Charting Techniques............................................. 318 Elliott Wave Principle................................................................................... 318 Technical Analysis For Dummies............................................................... 318 The Book of Five Rings................................................................................. 318 Market Wizards: Interviews with Top Traders......................................... 319 Come into My Trading Room...................................................................... 319 Zero Hedge.................................................................................................... 319 BabyPips.com............................................................................................... 320 Forex Factory................................................................................................ 320 xiv Currency Trading For Dummies, 3rd Edition Appendix: Trading Strategies...................................... 321 What’s Your Sign? Determining Your Trader Type.................................. 321 Looking at Trading Strategies Based on Trader Type............................. 322 Strategies for the scalper................................................................... 322 Strategies for the swing trader.......................................................... 329 Strategies for the position trader..................................................... 340 Index........................................................................ 343 Introduction T oday, millions of individual traders and investors all over the world are discovering the excitement and challenges of trading in the forex market. You don’t even have to be at your desk to trade — these days, you can trade on the go using a smartphone or other handheld device. No question about it, the forex market can be one of the fastest and most volatile financial markets to trade. Money can be made or lost in a matter of seconds or minutes. At the same time, currencies can display significant trends lasting several days to weeks and even years. Most important, forex markets are always moving, providing an accessible and target-rich trading environment. In contrast to stock markets, which are more familiar and relatively intuitive to most investors, the forex market somehow remains more elusive and seemingly complicated to newcomers. In this book, we show you how the forex market really works, what moves it, and how you can actively trade it. We also provide you with the tools you need to develop a structured game plan for trading in the forex market without losing your shirt. We cover the following: ✓ Getting a handle on the forces that drive currency movements ✓ Understanding forex market trading conventions and strategies ✓ Interpreting economic data and official statements ✓ Finding sources of data and market intelligence ✓ Gauging market psychology, sentiment, and positioning ✓ Identifying key traits of individual currency pairs ✓ Utilizing technical analysis to spot trade opportunities ✓ Developing a regimented and disciplined approach to trading currencies ✓ Focusing on risk management to minimize losses and keep more of your gains About This Book If you’re an active trader looking for alternatives to trading stocks or futures, the forex market is hard to beat due to its sheer size (more than $5 trillion turnover per day at last count) and the depth of the market. 2 Currency Trading For Dummies, 3rd Edition But as an individual trader, gaining access to the forex market is only the beginning. Just because you’ve got the keys to a Formula One race car doesn’t mean you’re ready to compete in a Grand Prix. First, you have to understand how the car works. Then you have to figure out some of the tactics and strategies the pros use. And then you have to get behind the wheel and practice, developing your skills, instincts, and tactics as you go. To succeed in the forex market, you’ll have to do the same. This book gives you the no-nonsense information you need, with the perspective, experience, and insight of two forex market veterans. Whether you’re an experienced trader in other markets looking to expand into currencies, or a total newcomer to trading looking to start out in currencies, this book has what you need. Best of all, it’s presented in the easy-to-use For Dummies format. Divided into easy-to-follow parts, this book can serve as both your reference and troubleshooting guide. Note: Trading foreign currencies is a challenging and potentially profitable opportunity for educated and experienced investors. However, before decid- ing to participate in the forex market, you should carefully consider your investment objectives, level of experience, and risk appetite. Most important, don’t invest money you can’t afford to lose. The leveraged nature of forex trading means that any market movement will have an equally proportional effect on your deposited funds; this may work against you as well as for you. (To manage exposure, employ risk-reducing strategies such as stop-loss or limit orders.) Any off-exchange foreign exchange transaction involves considerable exposure to risk, including, but not limited to, leverage, credit worthiness, limited regulatory protection, and market volatility that may sub- stantially affect the price or liquidity of a currency or currency pair. Using the Internet to trade also involves its own risks, including, but not limited to, the failure of hardware, software, and Internet connection. Finally, this book is a reference. You don’t have to read it from beginning to end, in order; instead, you can use the table of contents and index to find the information you need right now. Sidebars (text in gray boxes) and anything marked with the Technical Stuff icon are skippable — they’re interesting but not essential to your understanding of the topic at hand. Also, within this book, you may note that some web addresses break across two lines of text. If you’re reading this book in print and you want to visit one of these web pages, simply key in the web address exactly as it’s noted in the text, pretending as though the line break doesn’t exist. If you’re reading this as an e-book, you’ve got it easy — just click the web address to be taken directly to the web page. Introduction 3 Foolish Assumptions Making assumptions is always a risky business, but knowing where we’re coming from may help put you at ease. Obviously, not all these assumptions will apply to you, but at least we’ll have it all out in the open. In writing this book, we assume the following: ✓ You’ve heard about currency trading, and you’re looking to find out more about what’s involved before you try it. ✓ You’re intrigued by the international dimensions of the forex market, and you want to find out how to profit from currency movements. ✓ You’re seeking to diversify your trading activities or hedge your investments. ✓ You want to discover more about technical analysis and how it can be used to improve trading results. ✓ You understand that trading currencies carries the risk of losses. ✓ You’re prepared to devote the time and resources necessary to understand what’s involved in currency trading. ✓ You have the financial resources to pursue margin trading, meaning that you’ll never risk more than you can afford to lose without affecting your lifestyle. ✓ You aren’t gullible enough to believe the infomercials that promise easy money by trading currencies. ✓ You understand that there is a big difference between gambling and speculating. These assumptions should serve as a healthy reality check for you before you decide to jump into currency trading actively. A lot of it is similar to being a weekend golfer and being disappointed when your play doesn’t reach pro-level scores. But when you think about it, why should it? The pros are out there practicing and playing all day, every day — it’s their full-time job. Most people can only hope to get a round in on the weekend or get to the driving range for a few hours a week. Keep your perspective about what’s realistic for you, and you’ll be in a much better position to profit from actively trading. Icons Used in This Book Throughout this book, you see icons in the margins, highlighting certain paragraphs. Here are the icons we use and what they mean: 4 Currency Trading For Dummies, 3rd Edition Theories are fine, but anything marked with a Tip icon tells you what currency traders really think and respond to. These are the tricks of the trade. Paragraphs marked with the Remember icon contain the key takeaways from this book and the essence of each subject’s coverage. Achtung, baby! The Warning icon highlights potential errors and misconcep- tions that can cost you money, your sanity, or both. You can skip anything marked by the Technical Stuff icon without missing out on the main message, but you may find the information useful for a deeper understanding of the subject. Beyond the Book In addition to the material in the print or e-book you’re reading right now, this product also comes with some access-anywhere goodies on the web. Check out the free Cheat Sheet at www.dummies.com/cheatsheet/ currencytrading for tips on choosing a broker for currency trading, the fundamentals of currency rates, and more. You can find articles on trading forex with other asset classes, determining what kind of trader you are, and more at www.dummies.com/extras/ currencytrading. Where to Go from Here This book is set up so you can jump right into the topics that are of greatest interest to you. If you’re an absolute newcomer to trading in general and currencies in particular, we recommend reading Parts I and II to build a founda- tion for the other topics. If you have more experience with trading, use the table of contents and index to find the subject you have questions about right now. This book is a reference — keep it by your computer, and turn to it whenever you have a question about currency trading. Part I Getting Started with Currency Trading For Dummies can help you get started with lots of subjects. Visit www.dummies.com to learn more and do more with For Dummies. In this part... ✓ Get a comprehensive overview of the forex market and how it works. ✓ Find out what moves currencies. ✓ Get acquainted with the main players in the forex market. ✓ Understand the motivations behind trading decisions and simple strategies to get started. ✓ Find out why the world’s biggest market is the most fascinating market. ✓ Get an introduction to trading plans. Chapter 1 Currency Trading 101 In This Chapter ▶ Looking at currency trading as a business ▶ Getting a sense of what moves currencies ▶ Developing trading strategies to exploit opportunities ▶ Implementing the trading plan T he forex market has exploded onto the scene and is the hot new financial market. It’s been around for years, but advances in electronic trading have now made it available to individual traders on a scale unimaginable just a few years ago. We’ve spent our professional careers in the forex market and we can’t think of a better traders’ market. In our opinion, nothing quite compares to the speed and exhilaration of the forex market or the intellectual and psychologi- cal challenges of trading in it. We’ve always looked at our work as essentially doing the same thing every day, but no two days are ever the same in the forex market. Not many people can say that about their day jobs and we wouldn’t trade it for the world, no pun intended. What Is Currency Trading? At its heart, currency trading is about speculating on the value of one currency versus another. The key words in that last sentence are speculating and currency. We think that looking at currency trading from those two angles — or two dimensions, if you allow us to get a little philosophical — is essential. On the one hand, it’s speculation, pure and simple, just like buying an individual stock, or any other financial security, in the hope that it will make a profitable return. On the other hand, the securities you’re speculating with are the currencies of various countries. Viewed separately, that means that currency trading is both about the dynamics of market speculation, or trading, and the factors that affect the value of currencies. Put them together and you’ve got the largest, most dynamic and exciting financial market in the world. 8 Part I: Getting Started with Currency Trading Throughout this book, we approach currency trading from those two per- spectives, looking at them separately and blending them together to give you the information you need to trade in the forex market. Speculating as an enterprise Speculating is all about taking on financial risk in the hope of making a profit. But it’s not gambling and it’s not investing. Gambling is about playing with money even when you know the odds are stacked against you. Investing is about minimizing risk and maximizing return, usually over a long time period. Speculating, or active trading, is about taking calculated financial risks to attempt to realize a profitable return, usually over a very short time horizon. To be a successful trader in any market requires ✓ Dedication (in terms of both time and energy) ✓ Resources (technological and financial) ✓ Discipline (emotional and financial) ✓ Decisiveness ✓ Perseverance ✓ Knowledge But even if you have all those traits, there’s no substitute for developing a comprehensive trading plan (see Chapters 11, 12, and 13). You wouldn’t open up a business enterprise without first developing a business plan (at least we hope not!). So you shouldn’t expect any success in trading if you don’t develop a realistic trading plan and stick to it. Think of trading as if it were your own business, and approach it as you would a business enterprise, because that’s what it is. Above all, try not to take your trading results too personally. Financial markets are prone to seemingly irrational movements on a regular basis, and the market doesn’t know or care who you are and what your trade idea is. Currencies as the trading vehicle If you’ve heard anything at all about the forex market, it’s probably that it’s the largest financial market in the world, at least in terms of daily trading volumes. To be sure, the forex market is unique in many respects. The volumes are, indeed, huge, which means that liquidity is ever present. It also operates Chapter 1: Currency Trading 101 9 around the clock six days a week, giving traders access to the market any time they need it. (In Chapter 2, we give you a sense of the scale of the forex market and how it operates on a daily basis. In Chapter 3, we look at who the major forex players are.) Few trading restrictions exist — no daily trading limits up or down, no restrictions on position sizes, and no requirements on selling a currency pair short. (We cover all the mechanics and conventions of currency trading in Chapter 4.) Selling a currency pair short means you’re expecting the price to decline. Because of the way currencies are quoted and because currency rates move up and down all the time, going short is as common as being long. Most of the action takes place in the major currency pairs, which pit the U.S. dollar (USD) against the currencies of the Eurozone (the European countries that have adopted the euro as their currency), Japan, Great Britain, and Switzerland. There’s also plenty of trading opportunities in the minor pairs, which see the U.S. dollar traded against the Canadian, Australian, and New Zealand dollars. On top of that, there’s cross-currency trading, which directly pits two non-USD currencies against each other, such as the Swiss franc against the Japanese yen. Altogether, there are anywhere from 15 to 20 different major currency pairs, depending on which forex brokerage you deal with. (See Chapters 5 and 6 for a look at the fundamental and market factors that affect the most widely traded currency pairs.) Most individual traders trade currencies via the Internet — on a desktop, tablet, or even smartphone — through a brokerage firm. Online currency trading is typically done on a margin basis, which allows individual traders to trade in larger amounts by leveraging the amount of margin on deposit. One of the key features of the forex market is trading with leverage. The leverage, or margin trading ratios, can be very high, sometimes as much as 200:1 or greater, meaning a margin deposit of $1,000 could control a position size of $200,000. (Note: Margin rules can vary by country.) Trading on margin is the backdrop against which all your trading will take place. It has benefits, but it carries its own rules and requirements as well. Leverage is a two-edged sword, amplifying gains and losses equally, which makes risk management the key to any successful trading strategy (see Chapter 13). Before you ever start trading, in any market, make sure you’re only risking money that you can afford to lose, what’s commonly called risk capital. Risk management is the key to any successful trading plan. Without a risk-aware strategy, margin trading can be an extremely short-lived endeavor. With a proper risk plan in place, you stand a much better chance of surviving losing trades and making winning ones. (We incorporate risk management throughout this book, but especially in Chapters 11, 13, and 19.) 10 Part I: Getting Started with Currency Trading Downturns don’t affect the forex market as they do other financial markets. Selling a currency pair is normal in the forex market. This is different from other markets — for example, stock markets, where retail investors rarely sell physical stocks due to the financial risks involved. Because selling is so common in the forex market, the forex market is fairly immune to downturns. You trade one currency against another, so something is always going up, even in times of financial crisis. (We talk more about risk on and risk off and what this means for currencies in Chapter 2.) What Affects Currency Rates? In a word — information. Information is what drives every financial market, but the forex market has its own unique roster of information inputs. Many different cross-currents are at play in the currency market at any given moment. After all, the forex market is setting the value of one currency relative to another, so at the minimum, you’re looking at the themes affecting two major international economies. Add in half a dozen or more other national economies, and you’ve got a serious amount of information flowing through the market. Fundamentals drive the currency market Fundamentals are the broad grouping of news and information that reflects the macroeconomic and political fortunes of the countries whose currencies are traded. (We look at those inputs in depth in Chapters 7 and 9.) Most of the time, when you hear someone talking about the fundamentals of a currency, she’s referring to the economic fundamentals. Economic fundamentals are based on: ✓ Economic data reports ✓ Interest rate levels ✓ Monetary policy ✓ International trade flows ✓ International investment flows There are also political and geopolitical fundamentals (see Chapter 7). An essential element of any currency’s value is the faith or confidence that the market places in the value of the currency. If political events, such as an election, a war, or a scandal, are seen to be undermining the confidence in a nation’s leadership, the value of its currency may be negatively affected. Chapter 1: Currency Trading 101 11 Gathering and interpreting all this information is just part of a currency trader’s daily routine, which is one reason why we put dedication at the top of our list of successful trader attributes (see “Speculating as an enterprise,” earlier in this chapter). Unless it’s the technicals that are driving the currency market The term technicals refers to technical analysis, a form of market analysis most commonly involving chart analysis, trend-line analysis, and mathemati- cal studies of price behavior, such as momentum or moving averages, to men- tion just a couple (see Chapter 10). We don’t know of too many currency traders who don’t follow some form of technical analysis in their trading. Even the stereotypical seat-of-the-pants, trade-your-gut traders are likely to at least be aware of technical price levels identified by others. If you’ve been an active trader in other financial markets, chances are, you’ve engaged in some technical analysis or at least heard of it. If you’re not aware of technical analysis, but you want to trade actively, we strongly recommend that you familiarize yourself with some of its basics (see Chapter 10). Don’t be scared off by the name. Technical analysis is just a tool, like an electric saw — you don’t need to know the circuitry of the saw to know how to use it. But you do need to know how to use it properly to avoid injury. Technical analysis is especially important in the forex market because of the amount of fundamental information hitting the market at any given time. Currency traders regularly apply various forms of technical analysis to define and refine their trading strategies, with many people trading based on technical indicators alone. (See Chapters 14, 15, and 16 for how traders really use technicals.) Or it may be something else We’re not trying to be funny here. Honest. What we are trying to do is get across the idea of the many cross-currents that are at play in the forex market at any given time. Earlier in this chapter, we note that currency trading is just one form of market speculation, and that speculative trading involves an inherent market dynamic (see “What Is Currency Trading?” earlier in this chapter). 12 Part I: Getting Started with Currency Trading Call it what you like — trader’s instinct, market psychology, sentiment, position adjustment, or more buyers than sellers. The reality is that the forex market is made up of hundreds of thousands of different traders, each with a different view of the market and each expressing his view by buying or selling different currencies at various times and price levels. That means that in addition to understanding the currency-specific fundamentals, and familiarizing yourself with technical analysis, you also need to have an appreciation of the market dynamic (see Chapter 8). And that’s where trading with a plan comes in (see the following section). Developing a Trading Plan If your email inbox is anything like ours, you probably get inundated with random penny-stock tips or the next great Chinese stock initial public offer- ing (IPO). (If you’re not, please send us your spam filter.) Those are about the only times you’re going to get a message telling you how to trade. The rest of the time you’re going to be on your own. But isn’t that what speculative trading is all about, anyway? Don’t get us wrong, we’re not trying to scare you off. We’re just trying to make it clear that you’re the only one who knows your risk appetite and your own trading style. And very likely, you may not have even settled on a trading style yet. Finding your trading style Before you can develop a trading plan, settling on a trading style is essential. (See Chapter 10 for more on trading styles.) Different trading styles generally call for variations on trading plans, though there are plenty of overarching trading rules that apply to all styles. What do we mean by a trading style? Basically, it boils down to how you approach currency trading in terms of ✓ Trade time frame: How long will you hold a position? Are you looking at short-term trade opportunities (day trading), trying to capture more- significant shifts in currency prices over days or weeks, or something in between? Chapter 1: Currency Trading 101 13 ✓ Currency pair selection: Are you interested in trading in all the different currency pairs, or are you inclined to specialize in only one or two? ✓ Trade rationale: Are you fundamentally or technically inclined? Are you considering creating a systematic trading model? What strategy will you follow? Are you a trend follower or a breakout trader? ✓ Risk appetite: How much are you prepared to risk and what are your return expectations? We don’t expect you to have answers to any or all of those questions, and that’s exactly the point. As you read this book, we hope you’ll be thinking about what trading style you’d like to pursue. Feel free to experiment with different styles and strategies — that’s what practice accounts, or demo accounts, are for. (See Chapter 2 for the best way to utilize practice accounts.) At the end of the day, though, zeroing in on a trading style that you feel com- fortable with and that you can pursue on a consistent basis helps. Your own individual circumstances (including work, family, free time, finances, temper- ament, and discipline) will be the key variables, and you’re the only one who knows what they are. Planning the trade Whatever trading style you ultimately choose to follow, you won’t get very far if you don’t establish a concrete trading plan and stick to it (see Chapter 10). Trading plans are what keep small, bad trades from becoming big, bad trades and what can turn small winners into bigger winners. More than anything, though, they’re your road map, helping you to navigate the market after the adrenaline and emotions start pumping, no matter what the market throws your way. We’re not telling you that currency trading is any easier than any other financial market speculation. But we can tell you that trading with a plan will greatly improve your chances of being successful in the forex market over time. Most important, we want to caution you that trading without a plan is a surefire recipe for disaster. You may survive a few close calls, but a day of reckoning comes for any trader without a plan — it’s just what happens in markets. The starting point of any trading plan is to identify a trading opportunity (see Chapter 12). No one is going to give you a call or shoot you an email telling you what and when to trade. You have to devote the effort and gray cells to spotting viable trading opportunities yourself. 14 Part I: Getting Started with Currency Trading Throughout this book, we offer our own observations on how the forex market behaves in various market conditions. We think there are plenty of kernels for spotting trade opportunities in those observations. (In Chapter 12, in particular, we show you a number of concrete ways to look at the market with a view to spotting trade opportunities.) Above all, be patient and wait for the market to show its hand, which it always does, one way or the other. Executing the Trading Plan from Start to Finish The start of any trade comes when you step into the market and open up a position. How you enter your position, how you execute the first step of your trading plan, can be as important as the trade opportunity itself. (More on getting into a position in Chapter 14.) After all, if you never enter the position, the trade opportunity will never be exploited. And probably nothing is more frustrating as a trader than having pinpointed a trade opportunity, having it go the way you expected, but having nothing to show for it because you never put the trade on. The effort and resources you invest in researching, monitoring, and analyzing the market come to a concrete result when you open a trade. This process is made easier by formulating a personal trading system, with trigger points and setups to help you enter the trade. Placing the trade is just the beginning. Just because you have a trading plan doesn’t mean the market is necessarily going to play ball. You need to be actively engaged in managing your position to make the most of it if it’s a winner and to minimize the damage if the market is not going in your favor (see Chapter 15). Active trade management is also critical to keeping more of what you make in a trade. In our experience, making money in the forex market is not necessarily the hard part. More often than not, keeping what you’ve made is the really hard part. You need to stay on your toes, and keep thinking about and monitoring the market while your trade is still active. The market will always be moving, sometimes faster than at other times, and new information will still be coming into the market. In Chapter 15, we look at several different ways you can monitor the market while your trade is open, as well as how and when you should adjust your trade strategy depending on events and time. Chapter 1: Currency Trading 101 15 Exiting each trade is the culmination of the entire process and you’re either going to be pleased with a profit or disappointed with a loss. Every trade ends in either a profit or a loss (unless you get out at the entry price); it’s just the way the market works. While your trade is still active, however, you’re still in control and you can choose to exit the trade at any time. In Chapter 16, we look at important tactical considerations to keep in mind when it’s time to close out the trade. Even after you’ve exited the position, your work is not done. If you’re serious about currency trading as an enterprise, you need to review your prior trade for what it tells you about your overall trading style and trade execution. Keeping a record of your trading history is how you stay focused, learn from your mistakes, and avoid lapses in discipline that could hurt you on your next trade. Only then is it time to move on to the next trading opportunity. 16 Part I: Getting Started with Currency Trading Chapter 2 What Is the Forex Market? In This Chapter ▶ Getting inside the forex market ▶ Understanding that speculating is the name of the game ▶ Trading currencies around the world ▶ Linking other financial markets to currencies ▶ Getting a feel for currency trading with a practice account W e like to think of it as the Big Kahuna of financial markets. The foreign exchange market — most often called the forex market, or simply the FX market — is the largest and most liquid of all international financial markets. (See the “Getting liquid without getting soaked” section, later in this chapter, for our discussion of liquidity.) The forex market is the crossroads for international capital, the intersection through which global commercial and investment flows have to move. Interna tional trade flows, such as when a Swiss electronics company purchases Japanese-made components, were the original basis for the development of the forex markets. Today, however, global financial and investment flows dominate trade as the primary nonspeculative source of forex market volume. Whether it’s an Australian pension fund investing in U.S. Treasury bonds, or a British insurer allocating assets to the Japanese equity market, or a German conglomerate purchasing a Canadian manufacturing facility, each cross-border transaction passes through the forex market at some stage. The forex market is the ultimate traders’ market. It’s a market that’s open around the clock six days a week, enabling traders to act on news and events as they happen. It’s a market where half-billion-dollar trades can be executed in a matter of seconds and may not even move prices noticeably. That is what’s unique about forex — try buying or selling a half-billion of anything in another market and see how prices react. 18 Part I: Getting Started with Currency Trading The rise of electronic currency trading The forex markets have had a limited form of At the same time, retail forex brokers intro- electronic trading since the mid-1980s. At that duced online trading platforms designed for time, the primary means of electronic trading individual traders. Online currency trading relied on an advanced communication system allows for smaller trade sizes instead of the developed by Reuters, known as Reuters 1 million base currency units that are standard Dealing. It was a closed-network, real-time in the interbank market, such as $1 million or chat system well before the Internet ever hit £1 million. Forex markets trade in such large, the scene. The Reuters system enabled banks notional amounts because the price fluctua- to contact each other electronically for price tions are in tiny increments, commonly known quotes in so-called direct dealing. This system as pips, usually 0.0001. functioned alongside a global network of bro- Remember: When retail currency trading broke kerage firms that relied on telephone connec- into the mainstream, most online currency plat- tions to currency trading desks and broadcast forms offered trade sizes in amounts commonly running price quotes, making them known as known as lots, with a standard-size lot equal to voice brokers. 100,000 base currency units and mini-lots equal The modern form of electronic currency trading to 10,000 base currency units. However, as the debuted in the forex market in the early to mid- retail market has evolved, brokers have started 1990s, eventually supplanting much of the voice to act on demand for the ability to place smaller brokers’ share of trading volume. The two main trades. Most brokers now have an option to versions of electronic matching systems were trade in micro 1,000 lots, which require a lot less developed by Reuters and EBS for the institu- capital than a mini or standard lot. This means tional “interbank” forex market. Both systems that traders can enter the forex market with a allowed banks to enter bids and offers into the lot less capital at risk. system and trade on eligible prices from other In addition to multiple lot sizes, online broker- banks, based on prescreened credit limits. The ages offer generally high levels of margin, systems would match buyers and sellers, and ranging from 50:1 to 200:1 and sometimes the prices dealt in these systems became the higher, depending on the regulations of the benchmarks for currency price data, such as country that you trade in. This allows individ- highs and lows. ual traders to make larger trades based on the Advances in trading software saw the develop- amount of margin on deposit. For example, at ment by major international banks of their own 100:1 leverage, a $2,000 margin deposit would individualized trading platforms. These platforms enable an individual trader to control a posi- allowed banks and their institutional clients, like tion as large as $200,000. Retail forex broker- corporations and hedge funds, to trade directly ages offer leverage to allow individual traders on live streaming prices fed over the banks’ trad- to trade in larger amounts relative to the small ing platforms. These systems function alongside size of pips. the matching systems, which remain the primary sources of market liquidity. Chapter 2: What Is the Forex Market? 19 Firms such as FOREX.com, Saxo Bank, Oanada, CMC Markets, and IG Group have made the forex market accessible to individual traders and investors. You can now trade the same forex market as the big banks and hedge funds. Getting Inside the Numbers Average daily currency trading volumes exceed $5 trillion per day. That’s a mind-boggling number, isn’t it? $5,000,000,000,000 — that’s a lot of zeros, no matter how you slice it. To give you some perspective on that size, it’s about 10 to 15 times the size of daily trading volume on all the world’s stock markets combined. That $5-trillion-a-day number, which you may’ve seen in the financial press or other books on currency trading, actually overstates the size of what the forex market is all about — spot currency trading. Trading for spot Spot refers to the price where you can buy or sell currencies now, as in “on the spot.” If you’re familiar with stock trading, the price you can trade at is essentially a spot price. The term is primarily meant to differentiate spot, or cash, trading from futures trading, or trading for some future delivery date. The spot currency market is normally traded for settlement in two business days. Unless otherwise specified, the spot price is most likely to be what you buy and sell at with your currency broker. Speculating in the currency market While commercial and financial transactions in the currency markets represent huge nominal sums, they still pale in comparison to amounts based on speculation. By far the vast majority of currency trading volume is based on speculation — traders buying and selling for short-term gains based on minute-to-minute, hour-to-hour, and day-to-day price fluctuations. Estimates are that upwards of 90 percent of daily trading volume is derived from speculation (meaning, commercial or investment-based FX trades account for less than 10 percent of daily global volume). The depth and breadth of the speculative market means that the liquidity of the overall forex market is unparalleled among global financial markets. 20 Part I: Getting Started with Currency Trading The bulk of spot currency trading, about 75 percent by volume, takes place in the so-called “major currencies,” which represent the world’s largest and most developed economies. Trading in the major currencies is largely free from government regulation and takes place outside the authority of any national or international body or exchange. Additionally, activity in the forex market frequently functions on a regional “currency bloc” basis, where the bulk of trading takes place between the USD bloc, JPY bloc, and EUR bloc, representing the three largest global economic regions. Trading in the currencies of smaller, less-developed economies, such as Thailand or Chile, is often referred to as emerging market or exotic currency trading. Although trading in emerging markets has grown significantly in recent years, in terms of volume it remains some way behind the developed currencies. Due to some internal factors (such as local restrictions on currency transactions by foreigners), and some external factors (such as geopolitical crises and the financial market crash, which can make emerging market currencies tricky to trade), the emerging-market forex space can be illiquid, which can be a turnoff for a small investor. Getting liquid without getting soaked Liquidity refers to the level of market interest — the level of buying and selling volume — available at any given moment for a particular asset or security. The higher the liquidity, or the deeper the market, the faster and easier it is to buy or sell a security. From a trading perspective, liquidity is a critical consideration because it determines how quickly prices move between trades and over time. A highly liquid market like forex can see large trading volumes transacted with relatively minor price changes. An illiquid, or thin, market will tend to see prices move more rapidly on relatively lower trading volumes. A market that only trades during certain hours (futures contracts, for example) also represents a less liquid, thinner market. We refer to liquidity, liquidity considerations, and market interest throughout this book because they’re among the most important factors affecting how prices move, or price action. It’s important to understand that, although the forex market offers exception- ally high liquidity on an overall basis, liquidity levels vary throughout the trading day and across various currency pairs. For individual traders, though, variations in liquidity are more of a strategic consideration rather than a tactical issue. For example, if a large hedge fund needs to make a trade worth Chapter 2: What Is the Forex Market? 21 several hundred million dollars, it needs to be concerned about the tactical levels of liquidity, such as how much its trade is likely to move market prices depending on when the trade is executed. For individuals, who generally trade in smaller sizes, the amounts are not an issue, but the strategic levels of liquidity are an important factor in the timing of when and how prices are likely to move. In the next section, we examine how liquidity and market interest changes throughout the global trading day with an eye to what it means for trading in particular currency pairs. (We look at individual currency pairs in greater detail in Chapters 8 and 9.) Around the World in a Trading Day The forex market is open and active 24 hours a day from the start of business hours on Monday morning in the Asia-Pacific time zone straight through to the Friday close of business hours in New York. At any given moment, depending on the time zone, dozens of global financial centers — such as Sydney, Tokyo, or London — are open, and currency trading desks in those financial centers are active in the market. In addition to the major global financial centers, many financial institutions operate 24-hour-a-day currency trading desks, providing an ever-present source of market interest. Currency trading doesn’t even stop for holidays when other financial markets, like stocks or futures exchanges, may be closed. Even though it’s a holiday in Japan, for example, Sydney, Singapore, and Hong Kong may still be open. It might be the Fourth of July in the United States, but if it’s a business day, Tokyo, London, Toronto, and other financial centers will still be trading currencies. About the only holiday in common around the world is New Year’s Day, and even that depends on what day of the week it falls on. The opening of the trading week There is no officially designated starting time to the trading day or week, but for all intents the market action kicks off when Wellington, New Zealand, the first financial center west of the international dateline, opens on Monday morning local time. Depending on whether daylight saving time is in effect in your own time zone, it roughly corresponds to early Sunday afternoon in North America, Sunday evening in Europe, and very early Monday morning in Asia. 22 Part I: Getting Started with Currency Trading The Sunday open represents the starting point where currency markets resume trading after the Friday close of trading in North America (5 p.m. eastern time [ET]). This is the first chance for the forex market to react to news and events that may have happened over the weekend. Prices may have closed New York trading at one level, but depending on the circumstances, they may start trading at different levels at the Sunday open. The risk that currency prices open at different levels on Sunday versus their close on Friday is referred to as the weekend gap risk or the Sunday open gap risk. A gap is a change in price levels where no prices are tradable in between. As a strategic trading consideration, individual traders need to be aware of the weekend gap risk and know what events are scheduled over the weekend. There’s no fixed set of potential events and there’s never any way of ruling out what may transpire, such as a terror attack, a geopolitical conflict, or a natural disaster. You just need to be aware that the risk exists and factor it into your trading strategy. Of typical scheduled weekend events, the most common are quarterly Group of Twenty (G20) meetings (see Chapter 3 for more on the G20) and national elections or referenda. Just be sure you’re aware of any major events that are scheduled. During the height of the Eurozone sovereign debt crisis, a lot of last-minute bailout decisions were made over the course of a weekend, which had major implications for the markets when they opened. On most Sunday opens, prices generally pick up where they left off on Friday afternoon. The opening price spreads in the interbank market will be much wider than normal, because only Wellington and 24-hour trading desks are active at the time. Opening price spreads of 10 to 30 points in the major currency pairs are not uncommon in the initial hours of trading. When banks in Sydney, Australia, and other early Asian centers enter the market over the next few hours, liquidity begins to improve and price spreads begin to narrow to more normal levels. Because of the wider price spreads in the initial hours of the Sunday open, most online trading platforms do not begin trading until 5 p.m. ET on Sundays, when sufficient liquidity enables the platforms to offer their normal price quotes. Make sure you’re aware of your broker’s trading policies with regard to the Sunday open, especially in terms of order executions. Trading in the Asia-Pacific session Currency trading volumes in the Asia-Pacific session account for about 21 percent of total daily global volume, according to the 2004 BIS survey. The principal financial trading centers are Wellington, New Zealand; Sydney, Australia; Tokyo, Japan; Hong Kong, and Singapore. Chapter 2: What Is the Forex Market? 23 News and data reports from New Zealand, Australia, and Japan are going to be hitting the market during this session. New Zealand and Australian data reports are typically released in the early morning local time, which corresponds to early evening hours in North America. Japanese data is typically released just before 9 a.m. Tokyo time, which equates to roughly 7 or 8 p.m. ET. Some Japanese data reports and events also take place in the Tokyo afternoon, which equates to roughly midnight to 4 a.m. ET. The overall trading direction for the NZD, AUD, and JPY can be set for the entire session depending on what news and data reports are released and what they indicate. In addition, news from China, such as economic data, interest rate changes and official comments or currency policy adjustments, may also be released. Occasionally as well, late speakers from the United States, such as Federal Reserve officials speaking on the West Coast of the United States, may offer remarks on the U.S. economy or the direction of U.S. interest rates that affect the value of the U.S. dollar against other major currencies. Because of the size of the Japanese market and the importance of Japanese data to the market, much of the action during the Asia-Pacific session is focused on the Japanese yen currency pairs, such as USD/JPY and the JPY crosses, like EUR/JPY and AUD/JPY. Of course, Japanese financial institutions are also most active during this session, so you can frequently get a sense of what the Japanese market is doing based on price movements. For individual traders, overall liquidity in the major currency pairs is more than sufficient, with generally orderly price movements. In some less liquid, non-regional currencies, like GBP/USD or USD/CAD, price movements may be more erratic or nonexistent, depending on the environment. With no Canadian news out for the next 12 hours, for example, there may be little reason or interest to move that pair. But if a large market participant needs to make a transaction in that pair, the price movement could be larger than normal. Trading in the European/London session About midway through the Asian trading day, European financial centers begin to open up and the market gets into its full swing. European financial centers and London account for over 50 percent of total daily global trading volume, with London alone accounting for about one-third of total daily global volume, according to the 2004 BIS survey. The European session overlaps with half of the Asian trading day and half of the North American trading session, which means that market interest and liquidity is at its absolute peak during this session. 24 Part I: Getting Started with Currency Trading News and data events from the Eurozone (and individual countries like Germany and France), Switzerland, and the United Kingdom are typically released in the early-morning hours of the European session. As a result, some of the biggest moves and most active trading takes place in the European currencies (EUR, GBP, and CHF) and the euro cross-currency pairs (EUR/CHF and EUR/GBP). Asian trading centers begin to wind down in the late-morning hours of the European session, and North American financial centers come in a few hours later, around 7 a.m. ET. Trading in the North American session Because of the overlap between North American and European trading ses- sions, the trading volumes are much more significant. Some of the biggest and most meaningful directional price movements take place during this crossover period. On its own, however, the North American trading session accounts for roughly the same share of global trading volume as the Asia- Pacific market, or about 22 percent of global daily trading volume. The North American morning is when key U.S. economic data is released and the forex market makes many of its most significant decisions on the value of the U.S. dollar. Most U.S. data reports are released at 8:30 a.m. ET, with others coming out later (between 9 and 10 a.m. ET). Canadian data reports are also released in the morning, usually between 7 and 9 a.m. ET. There are also a few U.S. economic reports that variously come out at noon or 2 p.m. ET, livening up the New York afternoon market. (See Chapter 9 for more details on individual economic data reports.) London and the European financial centers begin to wind down their daily trading operations around noon eastern time (ET) each day. The London, or European close, as it’s known, can frequently generate volatile flurries of activity. A directional move that occurred earlier in European trading or the New York session may be reversed if enough traders decide to take profit (selling out or exiting long positions) or cover shorts (buying back short positions). Or the directional move may extend farther, as more traders jump onboard before the end of the trading day. There’s no set recipe for how the European close plays out, but significant flurries of activity frequently occur around this time. On most days, market liquidity and interest fall off significantly in the New York afternoon, which can make for challenging trading conditions. On quiet days, the generally lower market interest typically leads to stagnating price action. On more active days, where prices may have moved more significantly, Chapter 2: What Is the Forex Market? 25 the lower liquidity can spark additional outsized price movements, as fewer traders scramble to get similarly fewer prices and liquidity. Just as with the London close, there’s never a set way in which a New York afternoon market move will play out, so traders just need to be aware that lower liquidity conditions tend to prevail, and adapt accordingly. Lower liquidity and the potential for increased volatility is most evident in the least-liquid major-currency pairs, especially USD/CHF and GBP/USD. North American trading interest and volume generally continue to wind down as the trading day moves toward the 5 p.m. New York close, which also sees the change in value dates take place. (See Chapter 4 for more on rollovers and value dates.) But during the late New York afternoon, Wellington and Sydney have reopened and a new trading day has begun. As you can see, in terms of volume, London is the center of the forex world, but plenty of opportunities exist during the New York and Asia Pacific ses- sions. As a general rule, if you trade during the Asian session and no major data releases or events have taken place, the themes from the U.S. session the day before tend to prevail. When the European session comes around, there are usually a few meaty events to move the markets and create new themes; likewise during the U.S. trading session. Key daily times and events In addition to the ebb and flow of liquidity and market interest during the global currency trading day, you need to be aware of the following daily events, which tend to occur around the same times each day. Expiring options Currency options are typically set to expire either at the Tokyo expiry (3 p.m. Tokyo time) or the New York expiry (10 a.m. ET). The New York option expiry is the more significant one, because it tends to capture both European and North American option market interest. When an option expires, the under- lying option ceases to exist. Any hedging in the spot market that was done based on the option being alive suddenly needs to be unwound, which can trigger significant price changes in the hours leading up to and just after the option expiry time. The amount and variety of currency option interest is just too large to suggest any single way that spot prices will always react around the expiry (there may not even be any significant option interest expiring on many days), but if you do notice some volatility around 10 a.m. ET, it could be due to the expiry of some currency options. 26 Part I: Getting Started with Currency Trading Setting the rate at currency fixings There are several daily currency fixings in various financial centers, but the two most important are the 8:55 a.m. Tokyo time and the 4 p.m. London time fixings. A currency fixing is a set time each day when the prices of currencies for commercial transactions are set, or fixed. (See Chapter 3 for more on fixings.) From a trading standpoint, these fixings may see a flurry of trading in a particular currency pair in the run-up (generally 15 to 30 minutes) to the fixing time that abruptly ends exactly at the fixing time. A sharp rally in a specific currency pair on fixing-related buying, for example, may suddenly come to an end at the fixing time and see the price quickly drop back to where it

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