handbook on forex trading

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Handbook On

T R A D I N GFOREX

Nicholas Tan

An Easy Guide To Profitable Currency Trading

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First Published May 2007

Reprinted June 2008

Reprinted June 2009

Published and distributed by:

Rank Books

Blk 1002 Toa Payoh Ind Pk

#07-1423 Singapore 319074

Tel: 65-62508180 Fax: 65-62506191

Website: www.rankbooks.com

Email: [email protected]

ISBN 978-981-05-7936-4

Cover Design and Typeset: Nathania Fransiska Susilo

All Rights Reserved. No part of this publication may be reproduced or copied in any form or by any means - graphic, electronic or mechanical, including photocopying, recording, taping or information retrieval systems - without written permission of Rank Books.

Conditions of Sale: This book is sold subject to the condition that it shall not, by way of trade or otherwise, be lent, resold, hired out or otherwise circulated without the publisher’s prior consent in any form of binding or cover other than that in which it is published and without a similar condition including this condition being imposed on the subsequent purchaser.

While every reasonable care is taken to ensure the accuracy of information printed, no responsibility can be accepted for any loss or inconvenience caused by any error or omission. The ideas, suggestions, general principles, examples and other information presented here are for reference and educational purposes only. This book is not in anyway intended to give investment advice or recommendations to trade. The author or publisher shall have no liability for any loss or expense whatsoever relating to investment decisions made by the reader.

Acknowledgement: Special thanks to OANDA Corporation for granting the publisher the right to reproduce the charts which appeared in this book.

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This book is dedicated to

all my students, past and present,

who have given me

the confidence and inspiration

to write this handbook.

Dedication

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Nicholas Tan has more than 13 years of experience in the

treasury departments of major banks. Armed with a degree

in business administration from the National University of

Singapore in 1989, he started as an assistant dealer. Working

his way up to Vice President, he made millions for the banks

he worked for. Since 2002, Nicholas has been trading his

own account and has coached numerous individuals on forex

trading. With five years of personal trading and 13 years trading

for banks in Singapore, Nicholas has a wealth of experience

and knowledge in forex trading.

About the Author

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The forex market may be the biggest market in the world, but

not many people know of it or even trade it as compared to

the stock market. Forex trading is an exciting alternative to the

stock market. This market was once confined to banks and

high net worth individuals but with the advent of the internet

and broadband, retail forex trading is now within the reach of

many individuals. With a deposit of less than US$3000, which

enables you to trade an amount of US$200,000, and online

brokers providing 100 times leverage on the margin deposit

in many cases, forex trading has become the playground of

many small time retail players.

The aim of this book, Handbook on Forex Trading, is to provide

you with the knowledge and skills while guiding you through

forex trading. You will learn how the forex market works, the

basics of charting, how to trade, and when the best time to

trade is. By explaining to you the FX terms and basics involved

and guiding you through opening an online trading account,

teaching you various useful chart patterns and technical

indicators and infusing you with money management and

trading discipline, this book is an invaluable help in shortening

your learning curve and giving you a jumpstart on your road to

forex trading.

This book will cover the following and more:

1. Introductiontotheforexmarket

This will give you an understanding of what forex is, as

Preface

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well as the main players involved in this forex market. To

get you started in FX trading, you will be introduced to

FX basics and terms, as well as the fundamentals and

news that move forex rates.

2.Howtounderstandbasicchartpatternsandtechnical

indicators

Condensed into three chapters in this section is heaps

of information on chart patterns and candlestick patterns

useful for forex trading. An additional chapter will guide

you on the technical indicators the majority of FX traders use.

3.Whenthebesttimetotradeis

In this section, you will put your new knowledge into a

practical plan. You will learn to combine chart patterns

with technical indicators to eke out synergies. You will

learn about the various currency pair characteristics and

when is the best time to trade these currency pairs.

4.Gettingstartedinforextrading

Here’s where you can get help and tips on choosing

and opening an online forex trading account, be it a

standard account or a mini account. In another section,

you will learn to use the various types of forex orders.

Free sources of information and their websites will be

provided to get you started as well.

5.Howtomanageriskandincreaseyourprofit

Learn how to increase your winning percentage in forex

trading and about the importance of discipline in forex

trading.

Filled with real charts and proven trading techniques, this

practical handbook will show you how to trade profitably.

Master these techniques of trading and enjoy the great

rewards that await you in the forex market!.

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Chapter 1 Introduction to Foreign Exchange

Chapter 2 Understanding FX Basics

Chapter 3 What Moves FX Rates?

Chapter 4 Basics of Charting

Chapter 5 Chart Patterns

Chapter 6 Using Technical Indicators in FX Trading

Chapter 7 Putting It All Together

Chapter 8 When Is the Best Time to Trade?

Chapter 9 Choosing an Online Broker

Chapter 10 Money Management

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13

23

35

49

77

101

113

135

149

Contents

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INTRODUCTION TO FOREIGN EXCHANGE

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chapter 01introduction to foreign exchange

HANDBOOK ON FOREX TRADING

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inside this chapter:- What is forex?- The FX marketplace- Main players in the FX market- What are the attractions of trading FX?- Is FX suitable for you?


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chapter01introduction to

foreign exchange

What is Forex?

Foreign Exchange, or FX as it is commonly referred to,

involves the simultaneous buying of one currency and

the selling of another. Currencies are traded in pairs,

for example US Dollar/Japanese Yen (USD/JPY). When

you buy US dollars, you are selling Japanese Yen in

exchange for the US dollars. You can buy your currency

from the moneychangers or go to the banks. This is the

FX marketplace you are familiar with. For the majority

of us, our knowledge of FX extends only to changing

currency when we need it or when we want to go to

another country. By changing currency, you are playing

a part in this market. However, FX is much more than

this, and it is a huge marketplace of which we only know

a fraction. Hopefully, by the end of this book, you will

know enough of FX to trade in it.


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The FX Marketplace

At the core of the FX market, there is a network of banks,

which trade against one another. This is known as the

interbank market. This interbank market accounts for

the bulk of daily FX volume, which amounts to US$3.2

trillion daily. The banks trade directly among themselves

through a network of dealing stations. Each bank has

a unique code through which other banks can make

contact and connect directly with to carry out their

trades. They can conduct their trading through an

electronic broker called the Electronic Broking System

(EBS). Banks will conduct their buying and selling by

placing their buy orders and sell orders in the electronic

broking system, where buy and sell orders of the same

price are matched. If prices cannot be matched, they

will be put in the queue. Prices will remain in the queue

till they are matched or withdrawn.

RetailTrader B

RetailTrader A

RetailTrader C

OnlineBroker

HedgeFund B

MoneyChanger

Bank C

Bank A

Bank D Bank B HedgeFund A

EBS

Fig 1.1 The FX marketplace and its participants.


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In the interbank market, this buying and selling of currency

continues 24 hours a day from Monday to Friday. In

a week, starting from Monday, the market will open

with Australia and move on to Asia, when Tokyo, Hong

Kong, and Singapore come in. When Europe comes in,

activities will move over to Europe as Asia calls it a day.

New York will join in when it opens, and when New York

officially closes at 5 p.m. New York time, it is the end of

a day in foreign exchange. After the close of New York,

it is back to Australia again to start another day cycle.

This continues till New York closes on Friday evening at

5 p.m. This will end a week in FX. If we were to convert

all these into Singapore time, the FX market would have

started at 6 a.m. Singapore time on Monday, with trading

continuing through till 6 a.m. of Saturday morning. When

there is daylight savings in Europe and USA, the hours

will be from Singapore 5 a.m. on Monday morning to

5 a.m. of Saturday morning. Daylight savings starts in

March and ends in October.

Fig 1.2 A daily cycle in the FX.

Sydney/Aust

0500 0700050003000100230021001900170015001300110009000700

Tokyo/HK/Singapore

Europe/London

New York

Day 1 Day 2

SINGAPORE TIME


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This goes on for 363 days a year. There are only two

holidays a year for the FX market. They are New Year’s

Day and Christmas Day. For these two holidays, the

majority of trading centres in the world are closed so

there is no trading. At other times, when there is a holiday

in one country, it may not be the case with another

country. FX trading in the world will continue as usual

with other trading centres. If there is a public holiday

in Tokyo, there is still the FX market in Hong Kong and

Singapore to make up the numbers. Just in case you

might wonder, if the United States is closed for a holiday,

Canadian centres like Montreal and Toronto will still be

opened to trade. Liquidity, of course, would be lower

without Uncle Sam.

Main Players in the FX Market

Banks and Central Banks

The main players in this big FX market are the banks.

Banks employ many traders to trade on the banks’

proprietary accounts. These proprietary traders trade

currency to generate profit for the bank. Banks also act

on their customers’ orders to buy one currency against

another for commercial and trading purposes.

Governments and their central banks also buy and sell

currency to hold as reserves. For example, when one

central bank decides to reduce their US dollar holding

and wants to increase their Japanese yen holding, the

central bank will sell US dollars against the Japanese yen.


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In this way, the central bank increases its holding of yen

and reduces its US dollar holding. They might want to do

this if they think the US dollar will weaken. What they are

trying to do is to protect the country’s reserves.

Another reason why central banks are active in the FX

market is to moderate the strength or weakness of their

country’s currency. The Monetary Authority of Singapore

(MAS), which is the central bank of Singapore, tries to

intervene in the FX market when they think the Singapore

dollar movement is excessive. Similarly, the People’s

Bank of China will try to sell the yuan when the yuan

appreciates too much against the US dollar.

Investment Funds and Hedge Funds

In the FX market, there are hedge funds speculating

in currency value. They will buy or sell a currency if

they think it will appreciate or depreciate in value over

time. One of the most famous of this hedge funds is

the Quantum fund, whose major shareholder is George

Soros. Mr Soros made his name in the 1990s, with the

most famous example being his bet against the Bank

of England. He made a cool USD two billion out of

speculating on the Sterling pound depreciation. Most

big hedge funds will, to a certain extent, speculate

in currency. FX is the biggest market in the world in

terms of volume turnover. The FX market is able to

accommodate their large trading size, which may not

be possible in the equity market or futures market.


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Companies

Companies have a part to play in the FX market. Let’s

consider the example of Singapore Airlines: SIA will need

to pay for the cost of purchasing Boeing airplanes. SIA

would have to buy US dollars from a bank to pay for

their airplane purchase unless Boeing agrees to accept

payment in Singapore dollars. But if Boeing were to

accept payment in Singapore dollars, they will still need

to convert the money to US dollars. Boeing will need to

pay their US workers in US dollars. Similarly, an exporter

in Singapore will receive their payment either in US

dollars or Singapore dollars. If they were to receive their

payment in US dollars, they will need to convert it to

Singapore dollars.

Retail Trader

Not least of all, there is the small retail trader, who is

out to make some money from FX trading. Not too long

ago, FX was out of access to the small retail trader. It

was the arena of the banks and other big participants.

However, with the rise of the Internet and fast and

cheap broadband, the scenario has changed. The small

retail player is now able to participate in this FX market

without handicap compared to the big players. Brokers

are able to provide this continuous price feed to small

retail players at a low and affordable cost. Brokers have

gone online with their own trading platforms. These

sophisticated online trading platforms are able to offer

quick access to prices and information. This has brought


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FX trading to the small retail trader in the late 1990s.

The number of brokers has mushroomed in recent

years. As a result of this, costs have decreased for the

small retail FX trader. Today, most online brokers offer

commission free trading for their clients. The spread

has also narrowed to two to three pips for the major

currency while in the past it used to be five to seven

pips. There is no better time to get started in FX trading.

(more explanation of pips in page 19).

What are the Attractions of Trading FX?

There are many reasons for you to get hooked on FX

trading.

1. The market is open 24 hours a day. As the market

is opened 24 hours a day, you will be able to find

a time window to trade. When you are free, after

all your work has been done, you can switch on

the computer, login to your online trading platform

and start trading. It could be in the evening for the

busy office worker. From 8 p.m. to 11 p.m. there

will be opportunities to make some money. Unlike

the stock market, when the office worker would

have to juggle his office duty and watch the stock

prices during office hours, FX allows him to watch

and trade the market without distraction during his

free time. For a housewife out to make some extra

income, FX is another alternative besides the stock

market when their children are in school.


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2. The daily volume for the FX market totals USD 1.7

trillion a day. That is more than the volume of NYSE,

NASDAQ, and the London equity market combined.

There is no reason for you to worry about a lack of

liquidity.

3. Unlike stocks, the four major currency pairs

account for a substantial amount (70%) of the FX

volume. You just have to concentrate on the four

major currency pairs. Time spent on analysis will

be confined to the four major currency pairs. You

do not have to waste time analysing countless

companies.

4. There is a good daily range to keep you happy as

well. The usual daily range for Euro/USD is close

to 100 pips. Only on a few days a month will the

daily range be less than 100 pips. Even when the

daily range falls below 100 pips, it will have at least

80 pips.

5. Unlike Singapore stocks, where short selling is

prohibited, in FX there is equal opportunity in both

long and short. There is no restriction on short

selling. You can short a currency pair and hold it

for as long as you want so long as your margin is

able to support it.


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6. Small capital with great leverage is provided. Most

FX trading platforms provide great leverage for

you to trade currency. Most platforms need you to

put up only a 2% margin deposit. That is as good

as 50 times leverage. Many brokers will provide

100 times leverage. At this ratio, you only need a

margin of USD 1,000 to short USD 100,000 against

the Japanese yen.

7. When using online trading platforms, your trade

execution is almost instantaneous. Once you

submit your buy or sell market order, the platform

will report back to you in a second or two on your

order execution. Your broker’s platform is likely to

provide news information and charting as well. You

do not need to incur additional monetary cost to

subscribe to news and charting software. By just

putting up a margin deposit with your broker, you

will be ready to start trading.

Is Forex Suitable for You?

Unlike the stock market, forex has higher risks to the

new investor. To a new forex investor, the product itself

is new. His knowledge of forex is next to nothing. Little

is reported in the newspapers daily except when there

is a major event.


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There are few or no rumours in the market for the trader

to depend on. Even if there are any rumours, the forex

market would be very fast to factor in these rumours.

Passed down rumours would not be fast enough for

those further down the line to profit from it. Real trading

skill is needed. Charting skill and knowledge would come

in handy.

The forex rate movement is fast and at time furious

and as a result, stress level is higher than that in the

stock market. It is certainly not for the faint-hearted. As

forex trading involves leverage, profits and losses are

magnified. One would have to be disciplined to control

losses and not let losses ruined his financial standing.

UNDERSTANDING FX BASICS

13

chapter 02understanding FX basics


14

inside this chapter:- The spot FX market- Transaction and settlement date- Rollover- Currency pairs- Reference and quote currency- Pips- Bid and offer- Spread- Profit and loss


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chapter02understanding

FX basics

The Spot FX Market

When we trade the FX, it is usually the spot market that

we are involved in. The rate that we see changing almost

every second on our broker’s online trading platform is

the spot price. It is also referred to as the cash rate.

Transaction Day and Settlement Date

When we purchase or sell a currency pair at the rate we

see and trade, there is an exchange date or settlement

date. The day you trade is the transaction day. The day

of settlement is two trading days after the transaction

day. Taking the example of the USD/JPY, if we purchase

USD/JPY on 3 Jan 2007 (Wed), the settlement will be

on the 5 Jan 2007 (Fri), which is two trading days later.

Saturday and Sunday are not trading days, so if the


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transaction date is on a Friday, the settlement date will

be on a Tuesday.

Rollover

After your transaction, if you do not close or square

your position on that same day, but instead choose to

close your position one day later, there will be a different

settlement date. Your opening position’s settlement

date would not be the same as your closing position

settlement date. Your broker will roll over your opening

position settlement date to the next day so that both

your opening and closing position settlement date is the

same. You will either have to pay interest or earn interest

depending on your position. If you bought a currency

that pays a higher interest rate than the currency you

sold, you will earn interest. If you are holding a currency

that has a lower interest than the one you sold, you will

have to pay interest.

Currency Pairs

The four majors

Currencies always trade in pairs. You buy one currency

and sell the other currency in the pair. There are many

pairs of currencies, but these pairs are the most highly

traded. (See Table 2.1). These four majors alone account

for 70% of the USD 1.7 trillion daily volume.


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The Four Major Currency Pairs Symbols

1. Euro Currency/US Dollar EUR/USD

2. Great Britain Pound/US Dollar GBP/USD

3. US Dollar/Swiss Francs USD/CHF

4. US Dollar/ Japanese Yen USD/JPY

Other currency pairs

Besides the four majors, there are many other currency

pairs. They are sometimes referred to as the minor

currency pairs. Here are some examples:

Asian Currency Symbols

1. Australian Dollar/US Dollar AUD/USD

2. US Dollar/Singapore Dollar USD/SGD

3. US Dollar/Korean Won USD/KWR

4. US Dollar/China Yuan USD/CNY*

* Some brokers use CNY, while some brokers use RMB

Others Symbols

1. US Dollar/South African Rand USD/ZAR

2. US Dollar/Mexico Peso USD/MXN

3. US Dollar/Swedish Krona USD/SEK

Table 2.1 Highly traded currency pairs.

Table 2.2 Minor currency pairs.


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Cross currency pairs

Cross currency pairs are currency pairs that do not

involve the USD. Some examples are:

Euro Cross Currency Pairs Symbols

1. Euro Currency/Japanese Yen EUR/JPY

2. Euro Currency/Swiss Francs EUR/CHF

3. Euro Currency/Great Britain Pound EUR/GBP

Other Cross Currency Pairs Symbols

1. Malaysian Ringgit/Singapore Dollar MYR/SGD

2. Singapore Dollar/Thai Baht SGD/THB

3. Australian Dollar/NZ Dollar AUD/NZD

4. Great Britain Pound/Japanese Yen GBP/JPY

Reference and Quote Currency

USD/JPY

Sell

USD

Buy

USD68 70

reference currency quote currency

bid price ask price

119.68/70

Fig 2.1 USD/JPY example.

Table 2.3 Cross currency pairs.


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In the example on the USD/JPY, the USD is called the

reference currency while the JPY is called the quoted

currency. The reference currency is the first of the two

currencies while the quoted currency is the second

currency of the pair. Profit or loss is always in the quoted

currency. The transaction amount is usually denominated

in the reference currency. Example: USD 100,000/

Japanese Yen 11,970,000. The transaction amount is

USD 100,000. Profit and loss would be in Yen amount.

Pips

The smallest movement is one pip. In EUR/USD terms,

one pip is equivalent to 0.0001. In most currency pairs, it

is the fourth decimal placing. However, in USD/JPY, one

pip is equivalent to 0.01. For Yen related currency pairs,

one pip is the second decimal placing.

Bid and Offer

Your online broker will quote you a price. E.g. 119.68/70.

When you want to buy USD/JPY, you will have to buy at

the asking price or the ask price. This would be 119.70.

When you want to sell, it will be at the bid or buying

price. This would be 119.68.


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Spread

The difference between the bid and ask price is the

spread. In the above example 119.68/70, the spread

would be two pips. The spread is the price you pay to

your online broker. Most online brokers do not charge

any commission on FX trading. Instead, they earn their

money from the spread when you trade. Thus, when

choosing any online broker, it would be an important

consideration to look at the spread. The narrower the

spread, the more you would save and also the faster for

you to breakeven on your trade.

Profit and Loss

Unrealized/Realized Profit and Loss

If your position is still open and losing money, it is

considered as unrealized loss. If your position is making

money, it is considered as an unrealized profit.

Once you close your position, there will be a profit or

loss; this is called the realized profit or loss.

Using the EUR/USD as an example:

Buy EUR/USD @ 1.3101 Buy EUR 10,000 Sell USD 13,101

Sell EUR/USD @ 1.3102 Sell EUR 10,000 Buy USD 13,102

Difference 0 USD 1 Profit


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When you are trading on a size of EUR 10,000, the profit

and loss for every pip would be USD 1. If you are trading

on a size of EUR 100,000, every movement in pip would

cost you USD 10.

Below is another example on the USD/JPY:

Buy USD/JPY @ 118.01 Buy USD 10,000 JPY 1,180,100

Sell USD/JPY @ 118.02 Sell USD 10,000 JPY 1,180,200

Difference 0 JPY 100 Profit

In the above two examples, I have used the difference

of one pip to illustrate what one pip would mean to your

bottom line; your profit and loss. However, in trading, due

to the spread quoted and earned by the online broker,

you would need more than one pip to make a profit. If

your online broker quotes you a spread of two pips for

EUR/USD, you would only make a profit if the EUR/USD

were to advance more than two pips.

In fact every time you enter into a position, you will notice

that you are making a loss on your entry position. This

is due to the spread. The trading software will calculate

your profit and loss in real time. Assuming you close the

position immediately and the rate remains unchanged,

you would lose two pips when you sell out. If you refer

back to the section on spread, when the spread of USD/

JPY is two pips, 119.68/70, you need to buy at 119.70. If


22

you want to sell immediately, assuming that USD/JPY

rate remains unchanged, you would have to sell at

119.68. That is why you always start your position with an

unrealized loss. That unrealized loss is equivalent to the

spread of the currency pair. In this case, the unrealized

loss would be two pips.

handbook on forex trading

Documents

retail forex trading

years trading

years of personal trading

authorvthe forex market

stock market

biggest market

way of trade

years of experience