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The lucrative world of FX revealed in all its risk and rewards

by Helen Castell

Fingers burned in equities? Spooked by commodities’ crazy swings? Trading FX could be the answer. Vast depth, slick liquidity and paper-thin pricing are helping retail FX trading become finance’s fastest growing playground. Throw in some juicy volatility, add an arsenal of risk-management tools, and it’s easy to understand the attraction.

But what is the best way for investors to get in on the act? What moves the market, what data does is vital to understand, and why do so many traders tap into technical analysis? Do the rewards of currency trades rack up well against the risk, what strategies work best in which conditions, and how can traders know when to change tack? This FX supplement, produced in association with Interbank FX, provides all the answers.

Why forex - Blowing the market wide open

Vast, liquid and with just the right amount of volatility, FX is the world’s biggest and fastest-growing market. The trading is 24 hour, the pricing is as tight as you will find and high leverage means that if you get it right, a little money can earn you a lot. No wonder retail investors are piling in.

‘The access to the market has been blown right open,’ says Russell LaScala, managing director – head of North American foreign exchange trading at Deutsche Bank.

Retail trade in FX has ballooned from $10 billion turnover six years ago to $110 billion today, he says. It is also the fastest growing segment of the foreign exchange market, currently accounting for 7% to 9% of total daily spot turnover.

FX is more ‘democratic’ than many other markets, and herein lies its appeal, says Marilyn McDonald, marketing manager at IBFX. ‘It has low barriers to entry and most people, regardless of trading experience and disposable income, have the ability to trade in this market.’

Meanwhile, round-the-clock trading, five and a half days a week, ‘means that you can work your full-time job, make dinner, take care of the kids and still have a few hours left over for trading,’ she says. ‘The forex market is not the exclusive club of bankers and brokers. Now the housewife in the suburbs can control a portion of the market from her home office.’

Starting small

Leverage also means that investors can start accessing the market from a relatively small margin account, McDonald continues. ‘The standard lot size in forex is $100,000. Since most brokers offer 100-to-1 leverage, that means that the average guy can control a standard contract with $1,000 in his margin account.’

Most brokers also offer ‘mini contracts’ or ‘mini accounts’ on $10,000 contracts, she adds. Since most mini accounts carry higher leverage – typically 200-to-1 – investors can control a mini contract for $50.

And more are even offering ‘micro mini contracts’ – essentially 0.01% of a mini contract. ‘This means that newer traders can learn by trading cents,’ she says. ‘It is much easier to be down a few pence on your first trade as opposed to £50.’

Technological innovations are driving FX’s growth, says Kelly Quintanilla, spokesperson at GFT. ‘Individuals can access the world’s largest market from their home or from anywhere with an internet connection.

‘GFT for example provides a secure mobile trading application, which lets investors trade from their mobile phone,’ she adds. ‘This kind of access would have been unimaginable a decade ago.’

And for the nervous novice, it is good to remember that retail investors often know more about FX than they think. ‘Retail clients normally have a vague idea where certain FX rates are and certainly if they are going on vacation they tend to keep an eye on the rates – if only the tourist rates,’ says Tom Nagle, senior manager, institutional sales at Saxo Bank.

‘Most people also have some kind of a view on what they consider value – for example a UK resident will think that $2 to the pound is good value and e1.25 to the pound is bad value, so by default they have a view on euro-dollar. Probably as a natural extension of this, retail investors find it less intimidating to trade in one of the four major currency pairs than in one of the thousands of share prices that are available globally,’ Nagle adds.

Finely tuned

Ultimately, the best thing about FX is that it’s a fine piece of machinery. As Sandy Jadeja, chief currency strategist at ODL Securities, says: ‘It is one of the best mechanical markets out there – it just works.’

FX markets are not, however, without their risks, with volatility at the top of the list. Even on a quiet day, they can move 60 to 100 points, and on choppy days they can range 400. This, though, is how traders like it.

In the first few weeks of March, cable traded in almost a 700-point range, creating juicy opportunities for ambitious investors, says David Jones, chief market strategist at IG Index. ‘What traders want ultimately is not a market that just sits there dead in the water – they want a market that moves around.

‘You have the opportunity to make more profits, and of course the opportunity to incur bigger losses,’ he adds. ‘It is a double-edged sword.’

Currency markets are typically more volatile than other asset classes, and this is good news for FX investors, especially those using spread bets to trade, says James Hughes, market analyst at CMC Markets.

‘If you are a spread bettor you tend to be a short-term trader, and if you’re a short-term trader you tend to be looking for volatility,’ he says. ‘You need the volatility to hopefully make some money out of short-term moves.’

‘A lot of the trading strategies that people use in FX really depend on volatility,’ says Drew Niv, CEO at FXCM. And the good news is that unlike in commodities and fixed income, rising volatility has barely hiked FX spreads yet, he adds.

Access all areas

Transparency of price is one of the biggest drivers behind FX markets’ growth, says Deutsche’s LaScala. Ten or 15 years ago, retail investors had virtually no access to the institutional-type spreads and liquidity – and hence minimal transaction costs – available on FX, he notes. With online FX platforms ‘that has all changed’.

Spreads are much tighter than ten years ago, agrees Jones. ‘The cost of doing business in FX is very low compared to traditional shares. You have companies like us offering institutional-sized spreads for really small trades. The FX market is more open today than it has ever been for private investors.’

And despite FX markets’ current volatility, traders have never been shut out, says LaScala. ‘There has been no time where you couldn’t get in or out of positions.’

FX’s unmatched liquidity also provides multi-directional trading opportunities, notes GFT’s Quintanilla. ‘Traders can just as easily buy as they can sell, resulting in potential profit opportunities in either up or downtrending markets.’

When the chips are down...

The ongoing credit crisis has shaken up many equity investors’ belief systems that investing in a solid company always makes sense, says Niv. Many retail investors get trapped in the mentality of only looking for cheap times to buy, and multi-directional FX gives them a chance to change tack, he says.

‘If we are heading in a major stock market decline, and people are worried about bear markets, then at least we’re going to get movements both from the upside and downside in the FX markets,’ says Jadeja. ‘And that’s great for a beginner to get involved in, because they can learn both sides very quickly.’

Including currency markets in an investor’s trading portfolio is, meanwhile, a good risk diversifier, and their correlation with certain other asset classes makes them doubly attractive, says Saxo Bank’s Nagle.

Currency markets also allow investors to take a punt on a specific country, LaScala adds. ‘If you have a view that New Zealand is going to enter a recession, you can express that by selling its currency,’ he says. ‘You can’t really do that in equities as some companies may actually benefit from the slower growth.’

‘A lot of the recent interest in forex trading may be due to the recent fluctuations in the US dollar,’ says Quintanilla. ‘This currency, which used to be very strong compared to many other world currencies, has been steadily dropping in value.

‘Because the declining US economy has been such a newsworthy topic around the globe, many individuals are seeing the opportunities that can be found in trading the dollar, or a variety of other currencies,’ she adds.

A lot of the growth in FX is due to the dollar’s current big break-out, says Phil Sisca, director of foreign exchange at E*Trade. ‘It’s created a very sustainable trend, and traders love trends,’ he says.

‘Trends tend to persist longer in FX,’ with the US dollar’s downward slide one example, says IG Index’s Jones. ‘We have seen persistent weakness year in, year out,’ he notes.

Euro-dollar has moved 8.5% this year alone, and 18% year-on-year, notes LaScala – although this trend could be set to change.

‘We have had a six-and-a-half to seven-year downtrend in the dollar, and if you look back throughout history you can see that cycles tend to last about seven years.’

‘It’s tricky now to pick a bottom in the dollar… but we could be approaching the end of the downward trend,’ he adds. ‘I think some time in the next six to nine months there will be evidence that the dollar has turned. Once we have evidence the Fed is in a neutral policy stance, the dollar could reverse.’

Which means for retail investors, the very next FX opportunity could be just around the corner.

What moves the market? - The fundamentals of FX

Interest rates, oil prices and non-farm payroll – few markets are as sensitive to big macro themes as FX. And staying on top of so many variables can be tough. But exactly what data do FX traders need to watch, which fundamentals really rock the euro and why do technical analysts so fiercely champion the chart?

‘Generally [FX] moves are caused by interest rates, fundamentals and technicals,’ says Deutsche Bank’s Russell LaScala.

But what is unique about FX is the political factor, he says. Big moves in a currency can trigger political pressure on a central bank to intervene. This does not happen with stocks, bonds or commodities, he notes.

‘The FX market is moved by the difference between expectation and reality,’ says Saxo Bank’s Tom Nagle. ‘Players within the market have their expectations on how economies will grow, and there are various assumptions surrounding these expectations, mainly based on central bank actions and rhetoric.

‘If the central bank actions are perceived to be out of kilter with the market’s view then the market will move.’

Watch with interest

The fundamentals which most affect FX are interest rates, perceptions of whether individual corporate bonds are ahead or behind the curve, rates of unemployment, manufacturing data and retail sales, he says.

Certain things also come in and out of vogue, he adds. For example the oil price, the perception of equity markets, non-farm payrolls – especially between 2003 and 2006 – and the credit squeeze, as seen currently.

‘Investors in FX need to have an awareness of many things, including data releases due in today’s session, which ones are deemed to be the market movers and the implications if the data are far away from the consensus view,’ Nagle says.

‘They should have a general technical picture in their mind about the markets they’re trading in, whether the market is bullish or bearing and what would be required to change that scenario. Also, knowledge of the previous session is very helpful.’

Some currencies – for example the Australian, Canadian and New Zealand dollars – are particularly sensitive to commodity prices. ‘But outside of those currencies, interest rates are most important – that is the number one thing that people should be looking at,’ says Drew Niv at FXCM. ‘If you can predict interest rates correctly, you can predict FX.’

‘The biggest driver or motivation for why people trade FX is interest rates,’ says LaScala. ‘Currently we are in a very low US interest-rate environment, with a higher interest-rate environment in Europe, which accounts for the rise in the euro-dollar.’

Investors also need to be aware of what’s happening to share prices, argues E*Trade’s Phil Sisca. ‘In general, if equities start to fall, we see a movement back into the low-yielding currencies – the yen and the Swiss franc, and then everyone wants to sell the high-yielding currencies against them.’

Compared with trading individual equities, tracking the fundamentals that affect FX involves a lot of work, which is part of the reason behind technical analysis’ popularity, he adds.

Time to get technical

Technicals take some of the complication out of trading FX, agrees CMC Markets’ James Hughes. An investor trading cable on fundamentals for example needs to factor in everything that’s going on in the US – from equity markets to monetary policy and recession fears. ‘And then you have to think about everything that’s going on in the UK as well. You have to double the fundamental data up.’

‘Technical analysis is a way of assessing crowd psychology and taking advantage of it,’ says Nagle. ‘It can show you where the crowd sees value, and which direction they are likely to move.’

Most traders use technical analyses of some type, but approach it in varying ways, he says. ‘Some will only use it as a timing tool to enter trades which they have pre-selected on a fundamental basis while others will trade 100% off the technical indicators.

‘I use technicals almost 100% of the time,’ Nagle adds. ‘I don’t have any time for those who talk about self-fulfilling prophesies. Technical analysis works, full stop. Even the old-school traders who have scorned it in the past cannot expect to survive without it, even if they will not admit to using it.’

Technical analysis helps in controlling a trader’s risk, in pre-planning their parameters and also acts as a road map, says Sisca. ‘The charts are your maps – they guide you and tell you what to expect,’ he says. ‘If you’re new in a place and you don’t have a map with you, you’re at a disadvantage. Technical analysis defines your entry and exit points for you,’ he adds. ‘You have general opinions – what the dollar’s going to do, or long-term prospects for the dollar – but in order to get in and out, and time your trades properly you need to have your technical analysis tools.’

Within technicals, FX traders tend to use moving averages, range highs/lows, momentum indicators, retracement levels, trend lines and channel break-outs. Some traders use Bollinger Bands, Linear Regression or more complex approaches such as Ichimoku and Elliott Wave Theory, ‘but simplicity goes a long way in my opinion,’ Nagle says.

Technical analysis tends to work better with FX than with any other asset class, and this again comes down to its volatility, says Hughes. ‘Because you get the bigger moves, you tend to get clearer buy-sell signals.’

The fact that FX markets tend to trend also makes technicals work well, argues IG Index’s David Jones. And with so many traders relying on technicals for FX, the system is given extra momentum. ‘If a big level breaks on a chart, there are more people watching that level on currency markets than other markets. So it will have more of an impact.’

The removal of an extra layer of unknowns makes FX better suited to technical analysis than are equities, says Niv. ‘They are less prone to things like a CEO committing fraud,’ he says. ‘It doesn’t have those things that charts can’t predict.’

Tooled up

Ultimately though, there is no easy answer to investing in FX – and few traders would step into the market without solid fundamental research plus a taste for technicals.

‘Does FX move with fundamentals or technicals? Well it’s both,’ says Sandy Jadeja at ODL Securities. ‘For the longer-term approach, fundamentals are key. But for the short-term approach to intermediate term, technicals win hands down.’

Retail investors need to decide first whether they’re approaching the market from short- or long-term perspective, which means they also have to decide whether they’re playing the spot market or the futures market, he adds.

‘The spots will be very short-term traders, and the forwards would be trading everything from a couple of days to maybe even a couple of months.’

While technicals work well for short-term and momentum trades, fundamentals rule for longer-term plays, agrees Jones.

‘The vast majority of decisions in financial markets are not being made off charts,’ he says. ‘Certainly, technicals play a part. But ultimately, what makes FX a good market to trade is the fact that everything affects it.’

Risk & reward - Volatility can bring home the bacon, but how can you manage the risks?

Fast-moving, multi-directional and ultra-sensitive, currencies experience the kind of intra-day swings that put equities to shame. But while volatility can help you stack up the cash, it also racks up the risk.

‘The FX market is the riskiest of all the financial markets. You can’t get crazier than this,’ says IBFX’s Marilyn McDonald. ‘It really is designed only for the most disposable of your income.’

With the right risk management tools though – as well as discipline and some self-knowledge – there is much a retail investor can do to secure himself a safer ride.

The high volatility in currencies can make for some potentially painful swings, says ODL Securities’ Sandy Jadeja. Beginners with an equity background may be used to 80-point daily moves on the FTSE – but with FX the shifts can be as wide as 200 to 400 points. ‘So if they don’t have the discipline to get out when they’re losing, they could really get hurt in this game.’

And if the relative volatility of FX markets increases their risk, so does the leverage afforded by online trading. ‘It’s more like futures in the way that the leverage can greatly amplify the risks – and the reward,’ says Phil Sisca at E*Trade. ‘People who are starting out doing this have to be very cognisant of that.’

‘While all markets have some aspect of risk, the risky part of the forex markets lies in the use of leverage,’ agrees GFT’s Kelly Quintanilla. ‘Because you can find 100-to-1 (or even up to 400-to-1) leverage, losses as well as gains are magnified.’

He who dares

FX is not for everyone, says McDonald. If approached properly though, FX need not be riskier than other asset classes, some brokers argue. When you approach trading from a technical perspective, most instruments carry essentially the same risk, says James Hughes at CMC Markets. ‘They will either go up or down, and you have to be caught on the right side of that.’

‘I think [the risk] is the same,’ agrees FXCM’s Drew Niv. ‘If you take a risk you suffer the consequences if it goes wrong.’

And in some ways, FX risk compares well with that of equities, says Deutsche Bank’s Russell LaScala. ‘If company news comes out, [shares] traders need to wait for the market to open in order to trade. Even when the market does open, that stock may have an “order imbalance” and experience a delayed opening,’ he notes.

‘In foreign exchange, the velocity of the moves may increase, but you will always have access to the prices 24 hours a day, five days a week.’

Many FX brokers also offer a debit balance guarantee, meaning investors never lose more than the principal in their account, Niv notes. ‘You can’t really offer that in futures or equities.’

‘A crucial part of any trading plan is the risk management, and fortunately, forex traders have a number of options to help manage risk,’ says Quintanilla.

Damage limitation

Stop orders can be set to help get out of the market at a specified price, while GFT also offers automated trailing stops, which traders can set to follow the market in real time, Quintanilla says. ‘This type of order can help limit losses as well as help maximise profits, as your stop order is automatically adjusted as the market moves in your direction.

‘We also offer guaranteed stops for an extra charge on selected markets, which allow you to exit the market at your specified price, even if a fast-moving market gaps past your stop price.’

Parent and contingent orders meanwhile allow a trader to set a stop and limit order to be triggered automatically. ‘This type of order allows a trader to set up an entire trade and leave it, including entry, exit and risk management,’ says Quintanilla. Orders are triggered automatically when the pricing conditions are met, meaning ‘they don’t have to sit at their desk and watch the

market.’

GFT also offers its customers an automatic risk-notification system, which tells customers when their account equity reaches 75% of their IM requirement, and again

at 50%.

And protecting your positions needn’t take much effort either, says Hughes. ‘People tend to over-complicate things.’ Most companies offer simple stop loss orders and using one on every position a trader takes on is the best risk management strategy around, he argues.

Stop losses don’t, however, offer quite the same protection in FX as in many other

markets, McDonald argues.

During times of heavy trading, for example with a fundamental news announcement, FX can enter what is described as a ‘fast market’. ‘Right before and right after the news announcements the major banks may stop trading. They may widen their spreads and wait to see what the market is doing before resuming trading activity,’ she explains.

‘What happens to the retail investor is everything gets converted to a market order and the customer sees slippage – even limit orders and stop losses,’ she says.

‘If the customer were in a trade on a non-farm payroll announcement and had a stop loss 20 pips away from their entry point and the market gapped 100 points on the announcement, the customer may get filled 80 points away from where they had originally intended to get filled, resulting in a larger loss than they expected, or the dreaded margin call. This is not the broker being bad, or the market stealing from the trade – this is how the market works.’

Stop it out

This is no excuse for not using stop losses though, most brokers say. Regardless of how good a trader’s technical or fundamental analysis is, ‘if you don’t put in the relevant risk and rewards strategies you might as well throw all that stuff out of the window,’ says Hughes.

‘Not using stop losses – that is a dangerous approach I think in any market, but particularly at the moment,’ adds David Jones at IG Index.

There are a range of ways that stop losses can be used – plus other more straightforward strategies for managing your risk.

‘Typically we read in text books that trades should only be entered if the perceived reward is at least three times as big as the perceived risk,’ says Saxo Bank’s Tom Nagle.

‘While it’s certainly advisable to look for larger rewards and smaller risks, I do not believe the three-to-one ratio should be seen as a hard rule. The problem is it can be difficult to gauge the likelihood of reaching the described levels. For example, just because your profit-target is 90 pips and your stop loss is 30 pips it may mean that the stop loss is three times as likely to get hit!

‘One approach is to back-test your trading strategy ensuring you have an initial fixed stop loss and to utilise a flexible approach to taking profits,’ Nagle adds. ‘That way you can allow the good trades to reach healthy profit levels and the bad trades to be stopped out as early as possible.

‘From a risk perspective, I believe it is good to move your stop loss to break-even at the earliest opportunity and after that it’s just a matter of managing your profit.’

Traders should also be careful not to abuse their leverage, warns Sisca. ‘If a company is giving you 50 times leverage on a deposit to trade FX, that doesn’t mean that you ramp up to 50 times on the first trade that you do. You’ve got to get into a comfort zone where you understand the risk – you understand the power of the leverage.’

Ultimately, however useful stop losses and such risk-control orders can be, the best risk control involves only putting on trades that you’re comfortable with – and getting out the moment they turn sour, he argues.

‘The best way to mitigate a loss is to cut it – there is no sense in hedging it with something else,’ he advises. Only play with as much money as you can afford to lose and devise a careful strategy, he advises.

‘The first move is generally the best move – just cut any losses as quickly as you can,’ he says. And never risk more than a certain percentage of your capital in any one strategy. ‘So that you can live for another day.’

Retail investors are ‘really quick to get in, but they’re really slow to get out,’ says Jadeja, and this is one of their biggest mistakes. It is ‘because their emotions are controlling their actions,’ rather than the other way round, he says.

Getting to know your own emotions can be the best risk-management strategy of all, says Niv. ‘Retail investors, primarily speaking, do not pick the wrong trades. They’re not inaccurate about the dollar,’ he says. They do, however, sometimes lie to themselves about why they’re trading and take bigger risks than they need to.

Get to understand your trading personality, pick currency pairs that suit it and tailor your trading accordingly, he advises. If you’re in it for your ego then open a separate trading account and play out your fantasies with small stakes – while your main account slowly brings in the big bucks.

Trading strategies - Matching how you trade to market conditions can make all the difference

Choosing a strategy can be the most interesting trading decision you make – but knowing when to change it is often more important. So what strategy works in each kind of market, what signals suggest that conditions could soon change, and what are the most common mistakes that retail traders make?

Long-term trend trading is one of the most profitable strategies around, but it is sadly under-used, says FXCM’s Drew Niv. Apart from 2006, it has worked well since 2002, ‘but a lot of retail investors don’t like the strategy, because it’s boring.

Cash and carry

Carry, meanwhile, is historically the most profitable FX trading strategy, although now is not the right time, he says.

The strategy involves selling a low interest-rate currency and using the money to buy a currency that yields a higher rate. If for example a trader sold a currency with a 1% interest rate and bought another with a 5% interest rate, he would earn 4%, as long as the exchange rate between the currencies did not change.

Carry worked flawlessly from early 2003 to the first half of 2007, but ‘has probably had its worst time ever over the last nine months,’ Niv says. And the people who have lost money are those who didn’t read the signs in August and get out fast. ‘They’ve worked so well that people are having a hard time letting go.’

Carry trade has very hard rules, where if you see option volatilities go higher, and risk reversals go negative, it’s time to unwind, he explains. So for investors who think the strategy might suit them, ‘all you have to do is watch those options volatilities, watch those risk reversals, and when they snap back to normal, you can get back in.’

‘The carry trade methodology has worked over time,’ says Deutsche Bank’s Russell LaScala. ‘It doesn’t work in a high-volatility environment, but I think if we see volatility come off – if we have a quiet summer – we’re going to see people come back.’

‘There has been a major shake-out in the carry trade theme, with most if not all of these positions being closed out in recent months,’ says Tom Nagle at Saxo Bank. ‘I think, over time, these carry trades could begin to re-emerge but it will take time for the market to regain confidence in it’

Home on the range

Range trading works best in quiet markets, as experienced in the four or five years prior to last summer, says Niv. Unfortunately, ‘it is probably the single most mis-used strategy by retail clients.’

With its reliance on selling tops and buying bottoms, ‘it seems the most logical to people who come from an equity-based background,’ but too many use it on volatile pairs, he says.

And in a highly leveraged arena like FX, this can be disastrous. Too often traders hang on to a trade even after a range has been broken, waiting for it to return. ‘This is the reason why a lot of people lose money, but it is actually a very successful strategy if people employ it in very quiet boring pairs.’

Time to break-out

Break-out trading, where key barriers are repeatedly touched then move swiftly in the same direction once broken, has worked well in current markets, says IG Index’s David Jones. ‘Investors watch for a break in these levels and look to trade in the direction of the break.’

The pound against the US dollar for example has struggled with the $2 level this year, approaching it in January and February but then being knocked back. ‘When it broke $2 at the beginning of March, it quickly moved 400 points higher.’

However, ‘where markets like that will tend to fall down is when a market just gets really choppy – goes sideways,’ Jones adds. And this is where stop losses become important.

The euro-dollar has been on an uptrend and could reach 1.70 in the longer term, notes Sandy Jadeja at ODL Securities. ‘One of the best ways that novice traders could have played that is to simply keep buying the pull-backs, or the break-outs – either one of those would have worked.’

‘Most people trade FX technically, and 80% of technical indicators are basically break-out trends,’ says Niv. Break-out trading only works well in volatile markets, meaning this strategy is hugely popular now, and have been the best strategies of the past nine months, says Niv, while for the two years prior to that they were ‘awful’.

One downside of break-out trades is the long losing streaks investors sometimes have to endure. ‘You must have tight stop losses and lose five or six times in a row to get a win. You’ve got to ride that winner.’

The strategy also demands strict discipline, he notes. ‘When the market goes quiet, people really need to stop using it. In 2006 you would have lost your shirt.’

Play for today

FX trading is currently dominated by short-term trading and day trading, says Nagle. ‘For this style of trading I think the old three-to-one rule of thumb for risk-reward is not entirely appropriate because many day traders will happily take profits between one and two times their initial risk.’

Day trading by its very nature involves quite a high turnover – or number of trades – and lower margins, meaning day traders tend to take their profits when they see them, and then start again, he adds.

‘This tendency towards day trading may unwind over the next six to 12 months when the overall economic climate improves and some trends begin to unfold in the FX majors,’ Nagle says.

‘It would be good to see a return to the FX markets of the ‘80s and early ‘90s when we saw wild swings throughout the year and daily FX movements of 3% to 5%, but it’s very unlikely.’

Ultimately, the only strategy that works is going to be one that suits you – that fits your lifestyle, complements your personality and meets your objectives. This means choosing a combination of all the above – rather than sticking to one rigidly – might just be your best bet, says Marilyn McDonald at IBFX.

Making the FX market work for you - Top tips from those in the know

• Develop a strategy and stay disciplined

‘Have a strategy for how to enter and exit your trades, and stick with the discipline which you have set out,’ says Saxo Bank’s Nagle.

‘Discipline simply means following the rules,’ adds Jadeja at ODL Securities. ‘If you think this is where your stop should be, don’t sit there and think “I’m going to get out” – physically put the stop loss in as an order.’

• Keep enough in your account…

While brokers like CMC Markets will allow you to open an FX spread betting account with as little as £200, the big shifts in currencies mean £1,000 is a more realistic starting point, says Hughes.

‘You will never go into a trade and the market will continuously move in your favour all the time – you will lose at some point and you need to have the money in your account to cover those losses.’

• …but play safe with small positions

Know how much of your capital you are putting at risk, and don’t go above a certain percentage, says E*Trade’s Sisca. ‘Think about the size of the trade that you’re putting on – too many people will put on a position that they’re not really comfortable with.’

• Get a ‘boss’…

Not having anyone to explain themselves to anyone can make retail investors more reckless, warns Niv. ‘If you look at professional investors, a lot of what differentiates them is that they have a boss. And that boss has rules. If they don’t follow those rules they get fired.’ Get a close friend on board and turn them into your trading partner, he advises. Sell your strategies to them in advance and get them to hold you to this.

• … and always keep a diary

‘We all have a skewed memory of how events occurred,’ and it is even easier to lie to yourself if you don’t write things down, says Niv.

So keep a trading diary, briefly recording every trade you make, what you were hoping to achieve and why you did what you did – and refer back to it to help you learn from your mistakes, he advises.

• Go for long-term returns…

The bigger – and more consistent – money is often made on longer-term plays, says Jones at IG Index. ‘Try to catch a move over days and weeks, rather than over seconds and minutes.’

Traders with an equity background often make the mistake of picking overly short time frames with FX, but would be better sticking to hourly or daily frames, says Niv. ‘Think of FX like an oil tanker. Stocks are more like speed boats. They turn faster and you can’t really predict which way the waves are going to take it.’

• … and don’t over trade

‘The job of a trader is not to trade – it’s to make money,’ and just because you have all the trading tools and data at your fingertips doesn’t mean that every day is the right time to use them, says Sisca.

‘The best traders that I’ve seen are the ones that are very selective in their position taking,’ he says. ‘When they see a good idea they will have the confidence to be really aggressive with it, rather than be tentative because of the cumulative effect of all these small losses they’ve taken when there’s nothing to do.’

• Stay away from data days…

‘Try not to trade around non-farm payroll day, the first Friday of each month,’ says Hughes. ‘That tends to absolutely cause havoc in the FX market. You will see massive moves all over the place.’

Trading on an economic report, ‘even if you have the strongest feeling in the world … is akin to gambling,’ says Sisca. ‘When the numbers come out, let the dust settle a bit.’

• … unless you’re an intra-day expert

‘If you’re trading intra-day, then the news announcements are key to trade that momentum,’ says Deutsche Bank’s LaScala.

And if you do want to put on a short-term play, watch a 15-minute price bar before the announcement you are trading off is made, and place an order on either side of the bar’s high and low, says Jadeja.

‘You are saying if it breaks the high I will buy it and put a stop at the low. If it breaks the low I will sell and put a buy on the top side,’ he says. ‘You can make really quick money – but you’ve got to be so quick to close the other order off.’

• Tailor your trading to your personality and lifestyle

‘Remember to trade in a way that suits your personality,’ says Nagle. ‘Not everyone has the ability to sit and watch a losing trade for extended periods, so tailor your trading strategy to accommodate your own personality traits.’

‘Whatever strategy traders pick, in FX more than anything else, it needs to work with their personality,’ agrees Niv. ‘If you are a person who needs to do tops and bottoms because you’re impatient and have to pick small profits, don’t get into currencies that move a lot.’

• Buck the trend

The minority always wins, says Niv. FXCM publishes a ‘short-term sentiment index’ measuring the mood of its customers, and regularly advises investors to trade against the general sentiment.

‘At least 50% of people have to lose, directionally. And so if 80% of the people think the market’s moving one way, then they have to lose,’ he says. ‘When sentiment turns extreme, and the majority thinks one way, you definitely have to go the other.’

I only give tips to waiters

The brass tacks of trading on the FX markets by Marilyn McDonald, marketing director of Interbank FX

Every trader has a list of tips and tricks up their sleeve. The longer someone has been a trader, the more comprehensive their list becomes. These tips aren’t necessarily scribbled down in a journal, instead they usually fill up a compartment in the trading brain and become a vital part of every decision that trader makes.

Some tips translate very well to other traders, and some are specific to the trader themselves. For instance, my husband is a terrific trader. However, most of his EUR/USD trades are disastrous if they are left open for longer than a couple of hours. So, one of my trader specific tips is ‘If I have taken a EUR/USD trade based on my husband’s analysis and it is open longer than an hour or two, tighten the stop loss right up and be prepared to lose a little on the trade.’

This doesn’t translate very well because your trading partner might be right on regarding the EUR/USD and be a disaster trading the GBP/JPY. With that in mind, I have compiled some of my trading tips that I hope do translate well. Remember though, this is not the FX trading bible. Don’t feel that you have to incorporate all of these tips. If you can take one or two and make yourself a better trader then you have done well.

Currency pairs

Choosing which currency pair to trade can be a challenge, particularly if you are newer to the FX market. Most brokers offer at least 19, some over 40. Just looking at the list of available pairs can be an education.

You should think of currency pairs as having personalities. Just like people, currency pairs will react in predictable ways under similar stresses. Once you understand the characteristics of your chosen currency pair you will know how to respond to any given situation.

Choosing the ideal currency pair should take into account your trading personality. Take a moment to quickly answer these questions:

• How much of a risk taker are you?

• How much time to you have to devote to trading?

• Can you sleep with a trade on?

Remember currency pairs, like people, have personalities. Some pairs are known for aggressively daily swings, while others are calmer and tend to trend. Your trading personality should tell what currency pair will suit you best.

Chart 1 shows the average daily range of 14 different currency pairs. You will see that the GBP/JPY is the pair with the highest range in this selection. That doesn’t necessarily make it the best pair to trade.

If you look at the same time period for the EUR/GBP, bar a few little price pushes, the chart looks a lot calmer.

When it comes to choosing a currency pair, my tip is to not choose the craziest pair (the risk of getting your account cleaned out in the first ten minutes is too high) nor should you choose the calmest (some heart pounding is what you sign up for when you trade in this market). Choose one in the middle. Take a look at the charts and understand what moves your currency pair. Once you have become comfortable with its behaviour you will gain confidence in your trading ability.

Choosing indicators

There is no shortage of technical indicators. In fact, sometimes I feel like they are breeding faster than rabbits. Don’t get sucked in by some super cool new indicator. I am fairly certain that Joe the super trader hasn’t created a brand new way of looking at the market.

How you ask? Because we are primarily looking at price data; simply the open, close, high and low for a given time period. That’s it. There isn’t any super new amazing data in the mix. Joe might have taken an existing set of indicators and changed their default settings and combined them but it is the same old indicators that are available for free everywhere.

The reality is, technical indicators have been around for centuries. It is more important to understand what kinds of indicators there are out there and choose indicators that measure different aspects of the market. I use the building analogy: you need a lot of tools to build a house but you aren’t going

to get very far if all you have is a bunch

of hammers.

Leading vs lagging

Indicators are either leading or lagging. A lagging indicator won’t tell you what is about to happen, it will simply tell you what is already going on. So using a lagging indicator on a currency pair that tends to react quickly and aggressively rather than sustaining trends is a bad idea. However, if you are following a trending currency pair a lagging indicator such as the MACD may help you measure the trend and keep you on the right side of the market. A leading indicator attempts to predict what will happen next. They typically try to measure whether the market is ‘overbought’ or ‘oversold’. Leading indicators can return some terrific signals but these are generated at the expense of much greater risk.

Momentum

Momentum indicators measure what the price is actually doing, velocity wise. These indicators are designed to track how quickly the price is changing. Momentum indicators may use slightly different data in their calculations, however, they are all attempting to measure the same thing. Momentum indicators include the RSI and the Stochastic.

Trend

A trend is defined as successively higher low prices or successively lower high prices. It basically just means that the market is moving in one direction or another rather that channelling or flattening out. I change my trading style, depending on whether my charts are trending or channelling. You may find it beneficial to do the same thing. Trend indicators include moving averages, linear regression and more.

Volatility

Volatility indicators measure the magnitude of the day-to-day changes in the price data. In certain currency pairs, changes in the volatility can lead to changes in prices. They can also be used to measure the strength of breakouts and trends. Volatility indicators include Chaikin’s Volatility, Average True Range, and standard deviation.

Volume

If you know the FX market, you will know that volume holds no water here. Because there is no central exchange there is no way to measure volume. If you have any volume based indicators in your quiver they are most likely using tick volume (the sheer number of ticks) and that really isn’t relevant. You might want to reconsider using any volume indicators in FX.

What time to trade?

I travel the world and talk to traders from London to Sydney. Every place I have gone I have heard that the best time to trade is 2am. It got me to thinking. How in the world can the best time to trade be 2am everywhere in the world? I asked my friends at autochartist to research the issue for me and am pleased to announce that 2am isn’t the best time everywhere. It does depend on your chosen currency pair, however. Since the EUR/USD tends to be heavily favoured we will look at that one.

As you can see from the Chart 2, the most volatile time of the day to trade the EUR/USD is between 8am and 10am Eastern. That means, for you in London, the most active time to trade this pair is on your lunch hour(s) and perhaps for an hour right after work. So if you work a full-time job and come home to trade a few hours in the evening, perhaps the EUR/USD isn’t the best pair for you.

Daily goals

I talk to traders everywhere and quite often people approach me and ask how much they can reasonably make per day. What is realistic? Well, I can’t answer that question in monetary terms, but I can attempt to narrow down the number of pips. Let’s say you can trade for three hours a day, we will use the chart above. You are going to trade the EUR/USD from 7pm–10pm (that equates to the 15–17 hours on the chart above). You can see that the average hourly movement for that time period is about 15 pips per hour. There is no way you are going to catch all 15. It just isn’t going to happen. But you may be able to catch five pips during that three-hour period. Remember the spread on the EUR/USD is two and you will have to cover the spread to take the trade. That leaves you with three pips. Is investing three hours of your life worth three pips a day? I wouldn’t think so and would advise you to choose a different currency pair that had a little more movement during the hours you could trade.

However, let’s change our perspective just a little and put together a hypothetical situation including some dollar figures. Let’s say you are trading a standard account. That means each pip is worth about $10. If you traded five lots (make sure you have enough in your account – you should only enter about 5-10% of your margin into any one trade) and made three pips it changes the scenario a little.

Three pips x $10 per pip = $30 x five lots = $150 for three hours of your life.

Not too shabby. Remember you aren’t going to catch all five days of the week so don’t be too hard on yourself if you have an off day. However, the goal is small consistent wins.

To wrap this all up, let me just remind you that these tips are primarily borne from tragic trading mistakes. Part of trading and developing yourself as a trader is making mistakes. What will truly define you as a trader is how you act and react after something tragic happens. I would urge you all to learn from others, and if you can’t do that at least jot down your own trading tips as you learn them the hard way.