Moving Averages: Lesson 3A.

Moving Averages

A moving average is simply a way to smooth out price action over time.  By “moving average”, I mean that you are taking the average closing price of a currency for the last ‘X’ number of periods. 

Like every indicator, it is used to help us forecast future prices.  By looking at the slope of the moving average you can make general predictions as to where the price will go. 

As I said, moving averages smooth out price action.  There are different types of moving averages, and each of them has their own level of “smoothness”.  Generally, the smoother the moving average, the slower it is to react to the price movement.  The choppier the moving average, the quicker it is to react to the price movement. 

I’ll explain the pros and cons of each type a little later, but for now let’s look at the different types of moving averages and how they are calculated.

Simple Moving Average (SMA)

A simple moving average is the simplest type of moving average (DUH!).  Basically, a simple moving average is calculated by adding up the last “X” period’s closing prices and then dividing that number by X.  Confused???  Allow me to clarify.  If you plotted a 5 period simple moving average on a 1 hour chart, you would add up the closing prices for the last 5 hours, and then divide that number by 5.  Voila!  You have your simple moving average.

If you were to plot a 5 period simple moving average on a 10 minute chart, you would add up the closing prices of the last 50 minutes and then divide that number by 5. 

If you were to plot a 5 period simple moving average on a 30 minute chart, you would add up the closing prices of the last 150 minutes and then divide that number by 5.

If you were to plot the 5 period simple moving average on a 4 hr. chart………………..OK, OK, I think you get the picture!  Let’s move on.

Most charting packages will do all the calculations for you.  The reason I just bored you (yawn!) with how to calculate a simple moving average is because it is important that you understand how the moving averages are calculated.  If you understand how each moving average is calculated, you can make your own decision as to which type is better for you.

Just like any indicator out there, moving averages operate with a delay.  Because you are taking the averages of the price, you are really only seeing a “forecast” of the future price and not a concrete view of the future.  Disclaimer: Moving averages will not turn you into Ms. Cleo the psychic!

Here is an example of how moving averages smooth out the price action.  On the chart above, you can see 3 different SMAs.  As you can see, the longer the SMA period is, the more it lags behind the price.  Notice how the 62 SMA is farther away from the current price than the 30 and 5 SMA.  This is because with the 62 SMA, you are adding up the closing prices of the last 62 periods and dividing it by 62.  The higher the number period you use, the slower it is to react to the price movement. 

The SMAs in this chart show you the overall sentiment of the market at this point in time.  Instead of just looking at the current price of the market, the moving averages give us a broader view, and we can now make a general prediction of its future price. 

Exponential Moving Average (EMA)

Although the simple moving average is a great tool, there is one major flaw associated with it.  Simple moving averages are very susceptible to spikes.  Let me show you an example of what I mean:

Let’s say we plot a 5 period SMA on the daily chart of the EUR/USD and the closing prices for the last 5 days are as follows:

Day 1: 1.2345
Day 2: 1.2350
Day 3: 1.2360
Day 4: 1.2365
Day 5: 1.2370

The simple moving average would be calculated as
(1.2345+1.2350+1.2360+1.2365+1.2370)/5= 1.2358

Simple enough right?  Well what if Day 2’s price was 1.2300?  The result of the simple moving average would be a lot lower and it would give you the notion that the price was actually going down, when in reality, Day 2 could have just been a one time event (maybe interest rates decreasing). 

The point I’m trying to make is that sometimes the simple moving average might be too simple.  If only there was a way that you could filter out these spikes so that you wouldn’t get the wrong idea.  Hmmmm… I wonder….Wait a minute……Yep, there is a way!    It’s called the Exponential Moving Average!

Exponential moving averages (EMA) give more weight to the most recent periods.  In our example above, the EMA would put more weight on Days 3-5, which means that the spike on Day 2 would be of lesser value and wouldn’t affect the moving average as much.  What this does is it puts more emphasis on what traders are doing NOW. 

When trading, it is far more important to see what traders are doing now rather than what they did last week or last month.

Moving Averages

Which is better:  Simple or Exponential?

First, let’s start with an exponential moving average. When you want a moving average that will respond to the price action rather quickly, then a short period EMA is the best way to go.  These can help you catch trends very early, which can result in higher profit. 

In fact, the earlier you catch a trend, the longer you can ride it and rake in those profits!  The downside to the choppy moving average is that you might get faked out.  Because the moving average responds so quickly to the price, you might think a trend is forming when in actuality; it could just be a price spike. 

With a simple moving average, the opposite is true. When you want a moving average that is smoother and slower to respond to price action, then a longer period SMA is the best way to go.  Although it is slow to respond to the price action, it will save you from many fake outs.  The downside is that it might delay you too long, and you might miss out on a good trade. 

SMA

EMA

Pros:

Displays a smooth chart, which eliminates most fake outs.

Quick moving, and is good at showing recent price swings.

Cons:

Slow moving, which may cause a lag in buying and selling signals?

More prone to cause fake outs and give errant signals.

So which one is better? It’s really up to you to decide.  Many traders plot several different moving averages to give them both sides of the story.  They might use a longer period simple moving average to find out what the overall trend is, and then use a shorter period exponential moving average to find a good time to enter a trade. 

In fact, many trading systems are built around what is called “Moving Average Crossovers”.  Later in this course, we will give you an example of how you can use moving averages as part of your trading system. 

Time for recess! Go find a chart and start playing with some moving averages. Try out different types and look at different periods. In time, you will find out which moving averages work best for you. Class dismissed!

Summary:

• A moving average is a way to smooth out price action.
• There are many types of moving averages.  The 2 most common types are: Simple Moving Average and Exponential Moving Average
• Simple moving averages are the simplest form of moving averages, but they are susceptible to spikes.
• Exponential moving averages put more weight to recent prices and therefore show us what traders are doing now. 
• It is much more important to know what traders are doing now, than what they did last week or last month.
• Simple moving averages are smoother than Exponential moving averages.
• Longer period moving averages are smoother than shorter period moving averages.
• Choppy moving averages are quicker to respond to price action and can catch trends early.  However, because of their quick reaction, they are susceptible to spikes and can fake you out.
• Smooth moving averages are slower to respond to price action but will save you from spikes and fake outs.  However, because of their slow reaction, they can delay you from taking a trade and may cause you to miss some good opportunities.
• The best way to use moving averages is to plot different types on a chart so that you can see both long term movement and short term movement. 

The only limits to the possibilities in your life tomorrow are the buts you use today. - Les Brown

Understanding Charts: Lesson Three

Reading Charts using Support and Resistance, Trend Lines, and Channels

Support and Resistance

Support and resistance is one of the most widely used concepts in trading. Strangely enough, everyone seems to have their own idea on how you should measure support and resistance.

Let’s just take a look at the basics first.

Look at the diagram above. As you can see, this zigzag pattern is making its way up (bull market). When the market moves up and then pulls back, the highest point reached before it pulled back is now resistance.

As the market continues up again, the lowest point reached before it started back is now support. In this way resistance and support are continually formed as the market oscillates over time. The reverse of course is true of the downtrend.

There are two interesting points to remember:

1. When the market passes through resistance, that resistance now becomes support.

2. The more often price tests a level of resistance or support without breaking it the stronger the area of resistance or support is.

Hence being able to know the zones will be of help in making you understand, when the market is preparing for a new trend hence making you gain the much desired pips.

Trend Lines

Trend lines are probably the most common form of technical analysis used today. They are probably one of the most underutilized as well.

If drawn correctly, they can be as accurate as any other method. Unfortunately, most traders don’t draw them correctly or they try to make the line fit the market instead of the other way around.

With a combination of resistance levels, trend lines and channels, the market sure does provide for us the much needed leverage to make bucks out of it. Thus permit me to say that the market beams the green light that we need to enter the market with, and the red light that we require to exit the market or stop our trade with.

When life gives you lemons, make lemonade.

- Origin Unknown

Fibonacci and Moving Averages

We will be using Fibonacci ratios a lot in our trading so you better learn it and love it like your mother. Fibonacci is a huge subject and there are many different studies of Fibonacci with weird names but we’re going to stick to two: retracement and extension.

Let me first start by introducing you to the Fib man himself…Leonard Fibonacci.

Leonardo Fibonacci was a famous Italian mathematician, also called a super duper uber geek, who had an “aha!” moment and discovered a simple series of numbers that created ratios describing the natural proportions of things in the universe

The ratios arise from the following number series: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144 ……

This series of numbers is derived by starting with 1 followed by 2 and then adding 1 + 2 to get 3, the third number. Then, adding 2 + 3 to get 5, the fourth number, and so on.

After the first few numbers in the sequence, if you measure the ratio of any number to that of the next higher number you get .618. For example, 34 divided by 55 equals 0.618.

If you measure the ratio between alternate numbers you get .382. For example, 34 divided by 89 = 0.382 and that’s as far as into the explanation as we’ll go.

These ratios are called the “golden mean.” Okay that’s enough mumbo jumbo. Even I’m about to fall asleep with all these numbers. I'll just cut to the chase; these are the ratios you have to know:

Fibonacci Retracement Levels
0.236, 0.382, 0.500, 0.618, 0.764

Fibonacci Extension Levels
0, 0.382, 0.618, 1.000, 1.382, 1.618

You won’t really need to know how to calculate all of this. Your charting software will do all the work for you. But it’s always good to be familiar with the basic theory behind the indicator so you’ll have knowledge to impress your date.

Traders use the Fibonacci retracement levels as support and resistance levels. Since so many traders watch these same levels and place buy and sell orders on them to enter trades or place stops, the support and resistance levels become a self-fulfilling expectation.

Traders use the Fibonacci extension levels as profit taking levels. Again, since so many traders are watching these levels and placing buy and sell orders to take profits, this tool usually works due self-fulfilling expectations.

Most charting software includes both Fibonacci retracement levels and extension level tools. In order to apply Fibonacci levels to your charts, you’ll need to identify Swing High and Swing Low points.

A Swing High is a candlestick with at least two lower highs on both the left and right of itself.

A Swing Low is a candlestick with at least two higher lows on both the left and right of itself.

Let's take a closer look at Fibonacci retracement levels...

Fibonacci Retracement Levels

In an uptrend, the general idea is to go long the market on a retracement to a Fibonacci support level. In order to find the retracement levels, you would click on a significant Swing Low and drag the cursor to the most recent Swing High. This will display each of the Retracement Levels showing both the ratio and corresponding price level. Let’s take a look at some examples of markets in an uptrend.

This is an hourly chart of USD/JPY. Here we plotted the Fibonacci Retracement Levels by clicking on the Swing Low at 110.78 on 07/12/05 and dragging the cursor to the Swing High at 112.27 on 07/13/05. You can see the levels plotted by the software. The Retracement Levels were 111.92 (0.236), 111.70 (0.382), 111.52 (0.500), and 111.35 (0.618). Now the expectation is that if USD/JPY retraces from this high, it will find support at one of the Fibonacci Levels because traders will be placing buy orders at these levels as the market pulls back.

Now let’s see how we would use Fibonacci Retracement Levels during a downtrend. This is an hourly chart for EUR/USD. As you can see, we found our Swing High at 1.3278 on 02/28/05 and our Swing Low at 1.3169 a couple hours later. The Retracement Levels were 1.3236 (0.618), 1.3224 (0.500), 1.3211 (0.382), and 1.3195 (.236). The expectation for a downtrend is if it retraces from this high, it will encounter resistance at one of the Fibonacci Levels because traders will be placing sell orders at these levels as the market attempts to rally.

Let’s check out what happened next. Now isn’t that a thing of beauty! The market did try to rally but it barely past the 0.382 level spiking to a high 1.3227 and it actually closed below it. After that bar, you can see that the rally reversed and the downward move continued. You would have made some nice dough selling at the 0.382 level.

Here’s another example. This is an hourly chart for GBP/USD. We had a Swing High of 1.7438 on 07/26/05 and a Swing Low of 1.7336 the next day. So our Retracement Levels are: 1.7399 (0.618), 1.7387 (0.500), 1.7375 (0.382), and 1.7360 (0.236). Looking at the chart, the market looks like it tried to break the 0.500 level on several occasions, but try as it may, it failed. So would putting a sell order at the 0.500 level be a good trade?

If you did, you would have lost some serious cheddar! Take a look at what happened. The Swing Low looked to be the bottom for this downtrend as the market rallied above the Swing High point.

You can see from these examples the market usually finds at least temporary support (during an uptrend) or resistance (during a downtrend) at the Fibonacci Retracements Levels. It’s apparent that there a few problems to deal with here. There’s no way of knowing which level will provide support. The 0.236 seems to provide the weakest support/resistance, while the other levels provide support/resistance at about the same frequency. Even though the charts above show the market usually only retracing to the 0.382 level, it doesn’t mean the price will hit that level every time and reverse. Sometimes it’ll hit the 0.500 and reverse, other times it’ll hit the 0.618 and reverse, and other times the price will totally ignore Mr. Fibonacci and blow past all the levels like similar to the way Allen Iverson blows past his defenders with his nasty first step. Remember, the market will not always resume its uptrend after finding temporary support, but instead continue to decline below the last Swing Low. It is the same for a downtrend. The market may instead decide to continue above the last Swing High.

The placement of stops is a challenge. It’s probably best to place stops below the last Swing Low (on an uptrend) or above the Swing High (on a downtrend), but this requires taking a high level of risk in proportion to the likely profit potential in the trade. This is called reward-to-risk ratio. In a later lesson, you will learn more money management and risk control and how you would only take trades with certain reward-to-risk ratios.

Another problem is determining which Swing Low and Swing High points to start from to create the Fibonacci Retracement Levels. People look at charts differently and so will have their own version of where the Swing High and Swing Low points should be. The point is, there is no one right away to do it, but the bad thing is sometimes it becomes a guessing game.

Fibonacci Price Extension Levels

The next use of Fibonacci you will be applying is that of targets. Let’s start with an example in an uptrend.

In an uptrend, the general idea is to take profits on a long trade at a Fibonacci Price Extension Level. You determine the Fibonacci extension levels by using three mouse clicks. First, click on a significant Swing Low, then drag your cursor and click on the most recent Swing High. Finally, drag your cursor back down and click on the retracement Swing Low. This will display each of the Price Extension Levels showing both the ratio and corresponding price levels.

On this 1-hour USD/CHF chart, we plotted the Fibonacci extension levels by clicking on the Swing Low at 1.2447 on 08/14/05 and dragged the cursor to the Swing High at 1.2593 on 08/15/15 and then down to the retracement Swing Low of 1.2541 on 08/15/05. The following Fibonacci extension levels created are 1.2597 (0.382), 1.2631 (0.618), 1.2687 (1.000), 1.2743 (1.382), 1.2760 (1.500), and 1.2777 (1.618).

Now let’s look at what actually happened after the retracement Swing Low occurred.

• The market rallied to the 0.500 level
• fell back to the retracement Swing Low
• then rallied back up to the 0.500 level
• fell back slightly
• rallied to the 0.618 level
• fell back to the 0.382 level which acted as support
• then rallied all the way to the 1.382 level
• consolidated a bit
• then rallied to the 1.500 level

You can see from these examples that the market often finds at least temporary resistance at the Fibonacci extension levels - not always, but often. As in the examples of the retracement levels, it should be apparent that there are a few problems to deal with here as well. First, there is no way of knowing which level will provide resistance. The 0.500 level was a good level to cover any long trades in the above example since the market retraced back to its original level, but if you didn’t get back in the trade, you would have left a lot of profits on the table.

Another problem is determining which Swing Low to start from in creating the Fibonacci Extension Levels. One way is from the last Swing Low as we did in the examples; another is from the lowest Swing Low of the past 30 bars. Again, the point is that there is no one right way to do it, and consequently it becomes a guessing game.

Alright, let’s see how Fibonacci extension levels can be used during a downtrend. In a downtrend, the general idea is to take profits on a short trade at a Fibonacci price extension level since the market often finds at least temporary support at these levels.

On this 1-hour EUR/USD chart, we plotted the Fibonacci extension levels by clicking on the Swing High at 1.21377 on 07/15/05 and dragged the cursor to the Swing Low at 1.2021 on 08/15/15 and then down to the retracement High of 1.2085. The following Fibonacci extension levels created are 1.2041 (0.382), 1.2027 (0.500), 1.2013 (0.618), 1.1969 (1.000), 1.1925 (1.382), 1.1911 (1.500), and 1.1897 (1.618).

Now let’s look at what actually happened after the retracement Swing Low occurred.

• The market fell down almost to the 0.382 level which for right now is acting as a support level
• The market then traded sideways between the retracement Swing High level and 0.382 level
• Finally, the market broke through the 0.382 and rested on the 0.500 level
• Then it broke the 0.500 level and fell all the way down to the 1.000 level

Alone, Fibonacci levels will not make you rich. However, Fibonacci levels are definitely useful as part of an effective trading method that includes other analysis and techniques. You see, the key to an effective trading system is to integrate a few indicators (not too many) that are applied in a way that is not obvious to most observers.

All successful traders know it’s how you use and integrate the indicators (including Fibonacci) that make the difference. The lesson learned here is that Fibonacci Levels can be a useful tool, but never enter or exit a trade based on Fibonacci Levels alone.

Summary:

• Fibonacce retracement levels are 0.236, 0.382, 0.500, 0.618, 0.764
• Fibonacci retracement levels are used as support and resistance levels.
• Fibonacci extension levels are 0, 0.382, 0.618, 1.000, 1.382, 1.618
• Fibonacci extension levels are used as profit taking levels.

Opportunity is missed by most people because it is dressed in overalls and looks like work.

- Thomas Edison

FX Lesson Two

Types of Charts

Let’s take a look at the three most popular types of charts:

1. Line chart

2. Bar chart

3. Candlestick chart

Line Charts

A simple line chart draws a line from one closing price to the next closing price. When strung together with a line, we can see the general price movement of a currency pair over a period of time.

Bar Charts

A bar chart also shows closing prices, while simultaneously showing opening prices, as well as the highs and lows. The bottom of the vertical bar indicates the lowest traded price for that time period, while the top of the bar indicates the highest price paid. So, the vertical bar indicates the currency pair’s trading range as a whole. The horizontal hash on the left side of the bar is the opening price, and the right-side horizontal hash is the closing price.

Bar charts are also called “OHLC” charts, because they indicate the Open, the High, the Low, and the Close for that particular currency. Here’s an example of a price bar:

Open: The little horizontal line on the left is the opening price
High: The top of the vertical line defines the highest price of the time period
Low: The bottom of the vertical line defines the lowest price of the time period
Close: The little horizontal line on the right is the closing price

NOTE: Throughout our lessons, you will see the word “bar” in reference to a single piece of data on a chart. A bar is simply one segment of time, whether it is one day, one week, or one hour. When you see the word ‘bar’ going forward, be sure to understand it.

Candle Stick Chart

Candlestick charts show the same information as a bar chart, but in a prettier graphic format. Candlestick bars still indicate the high-to-low range with a vertical line.

However, in candlestick charting, the larger block in the middle indicates the range between the opening and closing prices. Traditionally, if the block in the middle is filled or colored in, then the currency closed lower than it opened.

In the example below, the ‘filled colour’ is black. For our ‘filled’ blocks, the top of the block is the opening price, and the bottom of the block is the closing price. If the closing price is higher than the opening price, then the block in the middle will be “white” or hollow or unfilled.

We don’t like to use the traditional black and white candlesticks. We feel it’s easier to look at a chart that’s colored. A color television is much better than a black-and-white television, so why not in candlestick charts?

We simply substituted green instead of white, and red instead of black. This means that if the price closed higher than it opened, the candlestick would be green. If the price closed lower than it opened, the candlestick would be red. In our later lessons, you will see how using green and red candles will allow you to “see” things on the charts much quicker, such as uptrend/downtrends and possible reversal points. For now, just remember that we use red and green candlesticks instead of black and white and we will be using these colors for now on.

Above is an example of a candlestick. Isn’t it pretty?

The purpose of candlestick charting is strictly to serve as a visual aid, since the exact same information appears on an OHLC bar chart. The advantages of candlestick charting are:

• Candlesticks are easy to interpret and it's a good place for a beginner to start figuring out chart analysis
• Candlesticks are easy to use. Your eyes adapt almost immediately to the information in the bar notation.
• Candlesticks and candlestick patterns have cool names such as the shooting star, which helps you to remember what the pattern means.
• Candlesticks are good at identifying marketing turning points – reversals from an uptrend to a downtrend or a downtrend to an uptrend. You will learn more about this later. 

Now that you know why candlesticks are so cool, it’s time to let you know that we will be using candlestick charts for most, if not all of chart examples on this manual.

Summary:

• There are three types of charts:

1. Line charts

2. Bar charts

3. Candlestick charts

• We will be using candlesticks from now on

The best way to predict the future is to create it.

- Peter F. Drucker

Trading Japanese Candlesticks

While we briefly covered candlestick charts in the previous lesson, we’ll now dig in a little and discuss them more in detail. First let’s do a quick review.

What is a candlestick?

Back in the day when Godzilla was still a cute little lizard, the Japanese created their own old school version of technical analysis to trade rice. A westerner by the name of Steve Nison “discovered” this secret technique on how to read charts from a fellow Japanese broker and Japanese candlesticks lived happily ever after. Steve researched, studied, lived, breathed, ate candlesticks, began writing about it and slowly grew in popularity in 90s. To make a long story short, without Steve Nison, candle charts might have remained a buried secret. Steve Nison is Mr. Candlestick.

Okay so what the heck are candlesticks?

The best way to explain is by using a picture off course.

Candlesticks are formed using the open, high, low and close. 

If the close is above the open, then a hollow candlestick (usually displayed as white) is drawn.

If the close is below the open, then a filled candlestick (usually displayed as black) is drawn.

The hollow or filled section of the candlestick is called the “real body” or body.

The thin lines poking above and below the body display the high/low range and are called shadows.

The top of the upper shadow is the “high”.

The bottom of the lower shadow is the “low”.

Trading Japanese Candlesticks

Sexy Bodies
Just like humans, candlesticks have different body sizes. And when it comes to forex trading, there’s nothing naughtier than checking out the bodies of candlesticks!

Long bodies indicate strong buying or selling. The more buying or selling activity occurs, the longer the body becomes. 

Short bodies imply very little buying or selling activity. In street forex lingo, bulls mean buyers and bears mean sellers.

Long hollow candlesticks means lots of buying is going on. The longer the body, the father apart the close price is from the open price. This means bulls are being aggressive and are kicking the bears’ butts’ big time.

Long filled candlesticks means lots of selling are happening. The longer the body, the farther apart the close price is from the open price. This means that prices fell a great deal from the open. In other words, the bears were the aggressors this time and were grabbing the bulls by their horns and body slamming them. 

Mysterious Shadows

The upper and lower shadows on candlesticks provide important clues about the trading session.

Upper shadows signify the session high. Lower shadows signify the session low.

Candlesticks with long shadows show that trading action occurred well past the open and close.

Candlesticks with short shadows show that trading action was restricted near the open and close.

If a candlestick has a long upper shadow and short lower shadow, this means that buyers flexed their muscles bided prices higher, but for one reason or another, sellers came in and drove prices back down to end the session back near its open price.

If a candlestick has a long lower shadow and short upper shadow, this means that sellers flashed their washboard and forced price lower, but for one reason or another, buyers came in and drove prices back up to end the session back near its open price.

Trading Japanese Candlesticks

Basic Patterns

Spinning Tops
spinning tops are candlesticks with a long upper shadow, long lower shadow and small real bodies. The color of the real bodies is not very important. The pattern indicates the indecision between the buyers and sellers

The small real body (whether hollow or filled) shows little movement from open to close, and the shadows indicate that both buyers and sellers were fighting but nobody could gain the upper hand.

While the price opened and closed with little change, prices moved significantly higher and lower during the session.

If a spinning top forms during an uptrend, this usually means there aren’t many buyers left and a possible reversal in direction could occur. 

If a spinning top forms during a downtrend, this usually means there aren’t many sellers left and a possible reversal in direction could occur. 

Marubozu
Marubozu means there are no shadows from the bodies. Depending on whether the candlestick’s body is filled or hollow, the high and low are the same as it’s open or close. If you look at the picture below, there are two types of Marubozus.

A White Marubozu contains a long white body with no shadows. The open price equals the low price and the close price equals the high price. This is a very bullish candle as it shows that buyers were in control the whole entire session. It usually becomes the first part of a bullish continuation or a bullish reversal pattern.

A Black Marubozu contains a long black body with no shadows. The open equals the high and the close equals the low. This is a very bearish candle as it shows that sellers controlled the price action the whole entire session. It usually implies bearish continuation or bearish reversal.

Doji

Doji candlesticks have the same open and close price or at least their bodies are extremely short. The doji should have a very small body that appears as a thin line.

Doji suggest indecision or a struggle for turf positioning between buyers and sellers. Prices move above and below the open price during the session, but close at or very near the open price.

Neither buyers nor sellers were able to gain control and the result was essentially a draw.

There are four special types of Doji lines. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. The word "Doji" refers to both the singular and plural form.

When a doji forms on your chart, pay special attention to the preceding candlesticks.

If a doji forms after a series of candlesticks with long hollow bodies (like white marubozus), the doji signals that the buyers are becoming exhausted and weakening. In order for price to continue rising, more buyers are needed but there aren’t anymore! Sellers are licking their chops and are looking to come in and drive the price back down. 

Keep in mind that while the decline is sputtering due to lack of new sellers, further buying strength is required to confirm any reversal. Look for a white candlestick to close above the long black candlestick’s open.

Reversal Patterns

Prior Trend
For a pattern to qualify as a reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding downtrend and bearish reversals require a prior uptrend. The direction of the trend can be determined using trend lines, moving averages, or other aspects of technical analysis.

Hammer and Hanging Man
The hammer and hanging man look exactly alike but have totally different meaning depending on past price action. Both have cute little bodies (black or white), long lower shadows and short or absent upper shadows.

The hammer is a bullish reversal pattern that forms during a downtrend. It is named because the market is hammering out a bottom.

When price is falling, hammers signal that the bottom is near and price will start rising again. The long lower shadow indicates that sellers pushed prices lower, but buyers were able to overcome this selling pressure and closed near the open.

Word to the wise… just because you see a hammer form in a downtrend doesn’t mean you automatically place a buy order!  More bullish confirmation is needed before it’s safe to pull the trigger. A good confirmation example would be to wait for a white candlestick to close above the open of the candlestick on the left side of the hammer.

Recognition Criteria:

• The long shadow is about two or three times of the real body.
• Little or no upper shadow.
• The real body is at the upper end of the trading range.
• The color of the real body is not important.

The hanging man is a bearish reversal pattern that can also mark a top or strong resistance level. When price is rising, the formation of a hanging man indicates that sellers are beginning to outnumber buyers. The long lower shadow shows that sellers pushed prices lower during the session. Buyers were able to push the price back up some but only near the open. This should set off alarms since this tells us that there are no buyers left to provide the necessary momentum to keep raising the price. .

Recognition Criteria:

• A long lower shadow which is about two or three times of the real body.
• Little or no upper shadow.
• The real body is at the upper end of the trading range.
• The color of the body is not important, though a black body is more bearish than a white body.

Inverted Hammer and Shooting Star
The inverted hammer and shooting star also look identical. The only difference between them is whether you’re in a downtrend or uptrend. Both candlesticks have petite little bodies (filled or hollow), long upper shadows and small or absent lower shadows.

The inverted hammer occurs when price has been falling suggests the possibility of a reversal. Its long upper shadow shows that buyers tried to bid the price higher. However, sellers saw what the buyers were doing, said “oh hell no” and attempted to push the price back down. Fortunately, the buyers had eaten enough of their Wheaties for breakfast and still managed to close the session near the open. Since the sellers weren’t able to close the price any lower, this is a good indication that everybody who wants to sell has already sold. And if there’s no more sellers, who is left? Buyers are.

The shooting star is a bearish reversal pattern that looks identical to the inverted hammer but occurs when price has been rising. Its shape indicates that the price opened at its low, rallied, but pulled back to the bottom. This means that buyers attempted to push the price up, but sellers came in and overpowered them. A definite bearish sign since there are no more buyers left because they’ve all been murdered. 

Shoot for the moon. Even if you miss, you'll land among the stars.

- Les Brown

FX Lesson One

Forex Trading

If you want to trade forex you simply have to know somewhat certain terminologies like margin requirement, how margin call occurs and what does it affect. You also need to know why your forex broker will charge you interest or premium. While you chat with traders they will often use slang to express their thoughts in a shorter form: "what is going on with kiwi this morning? Meaning how is the Swiss dollar doing, if you have followed the glossary of terms that was on the concluding part of chapter 1.

The basic fundamental in FX is the currency pairs, which are usually what, are being traded always on this market.

Currency pairs that are usually traded include:

EUR/USD: Euro / US Dollar is often called Euro;

USD/JPY: US Dollar / Japanese Yen is often called Dollar Yen;

GBP/USD: British Pound / US Dollar is often called Cable;

USD/CHF: US Dollar / Swiss Franc is often called Dollar Swiss, or Swissy;

AUD/USD: Australian Dollar / US Dollar is often called Aussie Dollar;

EUR/GBP: Euro / British Pound is often called Euro Sterling;

EUR/JPY: Euro / Japanese Yen is often called Euro Yen;

EUR/CHF: Euro / Swiss Franc is often called Euro Swiss;

GBP/CHF: British Pound / Swiss Franc is often called Sterling Swiss;

GBP/JPY: British Pound / Japanese Yen is often called Sterling Yen;

CHF/JPY: Swiss Franc / Japanese Yen is often called Swiss Yen;

NZD/USD: New Zealand Dollar / US Dollar is often called New Zealand Dollar or Kiwi;

The first currency in the pair is referred to as the base currency, and the second currency is the counter or quote currency. The U.S Dollar is usually the base currency for quotes, and includes USD/JPY, USD/CHF, and USD/CAD. The exceptions are the Euro (EUR), Great Britain Pound (GBP), and Australian Dollar (AUD). As with all financial products, forex quotes include a "bid" and "ask", which is more often called "offer" in the forex market. The bid is the price at which a forex market maker is willing to buy (and you can sell) the base currency in exchange for the counter currency. The offer is the price at which a forex market maker will sell (and you can buy) the base currency in exchange for the counter currency. The difference between the bid and the offer price is referred to as the spread.

 

Criteria for a Competent Forex Broker & the Problem of Choice

They are lots to look at when settling down and trying to get a competent partner when it comes to online fx (forex) biz, but we will take you on a safe ride on knowing this. First and foremost, after Identifying a particular forex brokers, one has to go through their information on their website, these is probably your first contact with your partners.

Before trading Forex you need to set up an account with a Forex broker. What exactly is a broker? In simplest terms, a broker is an individual or a company that buys and sells orders according to the trader's decisions. Brokers earn money by charging a commission or a fee for their services.

You may feel overwhelmed by the number of brokers who offer their services online. Settling on one broker requires a little bit of research on your part, but the time spent will give you insight into the services that are available and fees charged by various brokers. When selecting a prospective Forex broker, find out with which regulatory agencies each dealer is registered. The Forex market is label as an “unregulated” market, and it basically is. Regulation is typically reactive, meaning only after you’ve been bamboozled out of your entire savings will something be done.

In the United States a broker should be registered as a Futures Commission Merchant (FCM) with the Commodity Futures Trading Commission (CFTC) and a NFA member. The CFTC and NFA is here to protect the public against fraud, manipulations, and abusive trade practices.

You can verify Commodity Futures Trading Commission (CFTC) registration and NFA membership status of a particular firm or individual and check their disciplinary history by phoning NFA at (800) 621-3570 or by checking the broker/firm information section (BASIC) of NFA's Web site at www.nfa.futures.org/basicnet/.

Among the registered firms, look for those with clean regulatory records and solid financials. Stay away from non-regulated firms! Forex is a 24-hour market, so 24-hour support is a must! Can you contact the firm by phone, email, chat, etc. Do the reps seem knowledgeable? The quality of support can vary drastically from broker to broker, so be sure to check it out before opening an account.

Here’s a good tip: choose several online brokers and contact their help desks. Seeing how quickly they respond to your questions can be key in gauging how they will respond to your needs. If you don't get a speedy reply and a satisfactory answer to your question you certainly wouldn't want to trust them with your business. Just be aware that as in other types of businesses, pre-sales service might be better than post-sales service. Most, if not all, Forex brokers allow you to trade over the Internet relatively easy. The backbone of any trading platform is, of course, the order entry and exit process. Trading software is very important. Get a feel for the options that are available by trying out a demo account at a few online brokers.

Closely examine the dealer’s screen layout. It should include the ability to view real-time currency quotes, an account summary showing your current account balance with realized and unrealized profit and loss, margin available, and any margin locked in open positions.

Most trading platforms are either Web-based, in Java, or a client-based program you can install on your computer. Which version you choose is your personal preference,

Web based software is housed on your brokers web site. You won’t have to install any software on your own computer and you’ll be able to log in from any computer that has an Internet connection.

A client-based software program or one that you download and install into your own computer will limit you to transactions only to that computer.

Usually, the "download and install" program runs faster, but most programs are operating system specific. For example, most brokers only offer their trading platform application to run on Microsoft Windows. If you are a Mac user, you won’t be able to install the application and will either have to use your dealer’s Web-based or Java-based trading platform. These two (the Web or Java-based) will run on any computer since they run through your browser.

Java-based software programs are preferred by most brokers who think they are more safe and reliable. Java-based software tends to be less vulnerable to attack from viruses and hackers during transmissions than "download and install" software.

Be sure to open a demo account or virtual accounts, which are of course accounts that offer you money to trade with, but you can’t withdraw them, they are use to test your trading capabilities hence the name virtual or demo and also test out the broker's platform before opening a real account, which will offer you the ability of withdrawing your monies after profit and at your convenience. The Forex market is a fast moving market and you will need up-to-the minute information to make informed transactions. Make sure you have a high speed Internet connection. If you don’t, you might as not even bother trading. Dial-up will absolutely not work for Forex! If you plan to trade online you will need a modern computer and high speed Internet connection. I can’t stress this enough! Any Forex broker worth his salt should offer you real-time quotes and allow you to quickly enter and exit the market. These are minimal requirements of any trading software. Upgraded software packages are usually offered at an extra monthly fee by brokers.

Most dealers now offer integrated charting and technical analysis packages with their trading platforms. These are definitely worth exploring if the charts or technical tools offered are of value to your method of trading. The level of integration with the trading platforms varies and is worth understanding carefully. Most dealers offer very small “mini-accounts” for as little as $300. Mini-accounts are a great way to get started and test your trading skills and gain experience.

Broker Policies

Before selecting an online Forex broker, you should closely examine their features and policies. These include:

• Available Currency Pairs
  you should confirm that the prospective broker offers the minimum of seven major currencies (AUD, CAD, CHF, EUR, GBP, JPY, and USD).
• Transaction Costs
  Transaction costs are calculated in pips. The lower the number of pips required per trade by the broker, the greater the profit that the trader makes. Comparing pip spreads of half dozen brokers will reveal different transaction costs. For example, the bid/ask spread for EUR/USD is usually 3 pips, but if you can find 2 pips, that’s even better.
• Margin Requirement
  The lower the margin requirement (meaning the higher the leverage), the greater the potential for higher profits and losses. Margin percentages vary from .25 and up.
  Low margin requirements are great when your trades are good, but not so great when you are wrong. Be realistic about margins and remember that they swing both ways.

· Minimum Trading Size Requirement
The size of one lot may differ from broker to broker, spanning 1,000, 10,000, and 100,000 units. These brokers usually offer a mini-lot, which is one-tenth of a lot. Some brokers even offer fractional unit sizes (called odd lots) which allow you create your own unit size.

• Rollover Charges
  Rollover charges are determined by the difference between the U.S. interest rates and the interest rates of the other country. The greater the interest rate differential between the two currencies in the currency pair, the greater the rollover charge will be. For example, if the British pound has the greater interest differential with the U.S. dollar, then the rollover charge for holding British pound positions would be the most expensive. On the other hand, if the Swiss Franc were to have the smallest interest differential to the U.S. dollar, then overnight charges for USD/CHF would be the least expensive of the currency pairs.
• Margin Account Interest Rate
  Most brokers pay interest on a trader’s margin account. The interest rates normally fluctuate with the prevailing national rates. If you decide to take an extended break from trading, the money in your margin account will be accruing interest
• Trading Hours
  Nearly all brokers align their hours of operation to coincide with the hours of operation of the global Forex market: 5:00 PM EST Sunday through 4:00 PM EST Friday.

Other Policies

Be sure to scrutinize a prospective broker’s “fine print” section to be fully aware of all the nuances that a specific broker may impose on a new trader.

Finding the right broker/dealer is a critical part of the process. It’s not easy and requires some real work on your part. Don’t pick the first one that looks good to you. Keep looking.

Summary

What to look for in an online Forex broker/dealer:

1. Low Spreads.
In Forex trading the ‘spread’ is the difference between the buy and sell price of any given currency pair. Lower spreads save you money.

2. Low minimum account openings.
For those that are new to Forex trading and for those that don’t have thousands of dollars in risk capital to trade, being able to open a mini trading account with only $300 is a great feature for new traders.

3. Instant automatic execution of your orders.
This is very important when choosing a Forex broker. You want what we call a WYSIWYG (wizeewig) broker! This means you want instant execution of your orders and the price you see and "click" is the price that you should get...What You See Is What You Get!
Don’t settle with a firm that re-quotes you when you click on a price or a firm that allows for price ‘slippage’. This is very important when trading for small profits.

4. Free charting and technical analysis
Choose a broker that gives you access to the best charting and technical analysis available to active traders. Look for a broker that provides free professional charting services and allows traders to trade directly on the charts.

5. Leverage
You don't want too much leverage. Firms offering excessively high leverage aren't looking out for the best interest of their customers. A good rule of thumb is to not use more than 100:1 leverage for Standard (100k) accounts and 200:1 for Mini (10k) accounts.

Types of Trading and Charts

By now you’ve learned some history about the Forex, how it works, what affects the prices, blah blah blah.  We know what you’re thinking…BORING!  SHOW ME HOW TO MAKE MONEY! Well, say no more my friend; here is where your journey as a forex trader begins…

This is your last chance to turn back.  Take the red pill, and we take you back to where you were and you will forget all about this.  You can go back to living your average life in your 9-5 job and work for someone else for the rest of your life.  

OR

You can take the green pill (green for money! yeah!) and learn how you can make money for yourself in the most active market in the world, simply by using a little brain power.  Just remember, your education will never stop.  Even after you graduate from our training you must constantly pursue as much knowledge as you can so that you can become a true FOREX MASTER!

Two Types of Trading

There are 2 types of analysis you can take when approaching the forex:  Fundamental analysis and Technical analysis.  There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know a little bit of both.  So let’s break each one down and then come back and put them together.

Ø Fundamental Analysis

Fundamental analysis is a way of looking at the market through economic, social and political forces that affect supply and demand.  (Yada yada yada.)  In other words, you look at whose economy is doing well, and whose economy sucks.  The idea behind this type of analysis is that whoever’s economy is doing well; their currency will also be doing well.  This is because the better a country’s economy is, the more trust other countries have in that currency.  For example, the U.S. dollar has been gaining strength because the U.S. economy is gaining strength.  As the U.S. interest rates keep increasing, the value of the dollar continues to increase.  And that is what we call fundamental analysis.  Later on in the course you will learn which specific news events drive currency prices the most.  For now, just know that the fundamental analysis of the forex is a way of analyzing a currency through the strength of that country’s economy. 

Ø Technical Analysis

Technical analysis is the study of price movement.  In one word, technical analysis=charts.  The idea is that a person can look at historical price movements, and based on the price action, can determine on some level where the price will go.  By looking at charts, you can identify trends and patterns which can help you find good trading opportunities. The most IMPORTANT thing you will ever learn in technical analysis is the trend!  Many people have a saying that goes, “The trend is your friend”.  The reason is that you are much more likely to make money when you can find a trend and trade in the same direction.  Technical analysis can help you identify these trends in its earliest stages and therefore (did I just say therefore?) provide you with very profitable trading opportunities. 

Now I know you’re thinking to yourself, “Geez, these guys are smart.  They use big words like “therefore”. Technical Analysis is probably the most common and successful method of making trading decisions and analyzing forex and commodities markets.

Technical analysis differs from fundamental analysis in that technical analysis is applied only to the price action of the market, ignoring fundamental factors. As fundamental data can often provide only a long-term or "delayed" forecast of exchange rate movements, technical analysis has become the primary tool with which to successfully trade shorter-term price movements, and to set stop loss and profit targets.

Technical analysis consists primarily of a variety of technical studies, each of which can be interpreted to generate buy and sell decisions or to predict market direction.

Ø Support and Resistance Levels

One use of technical analysis, apart from technical studies, is in deriving "support" and "resistance" levels. The concept here is that the market will tend to trade above its support levels and trade below its resistance levels. If a support or resistance level is broken, the market is then expected to follow through in that direction. These levels are determined by analyzing the chart and assessing where the market has encountered unbroken support or resistance in the past.

Ø Popular Technical Analysis Tools

Moving Averages (MA): Indicators used to smooth price fluctuations and identify trends. The most basic type of moving average, the simple moving average, is the average of the past x bars ending with the current bar;

Moving Average Convergence Divergence (MACD): Indicator that utilizes moving averages to identify possible trends and an oscillator to determine when a trend is overbought or oversold;

Bollinger Bands: Bands that are placed x moving average standard deviations above and below a simple MA line;

Fibonacci Retracement Levels: Indicator used to identify potential levels of support and resistance;

Directional Movement Index (DMI): A positive line (+DI) measuring buying and a negative line (-DI) measuring selling pressure;

Relative Strength Index (RSI): Momentum oscillator that is plotted on a vertical scale from 0 to 100;

Stochastic: Momentum oscillator that measure momentum by comparing the recent close to the absolute price range (high of the range minus the low of the range) over a period of x bars;

Trend lines: Straight line on a chart that connects consecutive tops or consecutive bottoms of prices and is utilized to identify levels of support and resistance;

I can never learn this stuff.”  Never fear my friend; you too will be just as hush…smart as us.  By the way, do you feel that green pill kicking in yet?  Bark like a dog!

So you're probably wondering which type is better.

Ø So which type of analysis is better?

I’m glad you asked that question.  The answer is neither.  You need both types of analysis to become a successful trader.  Here’s an example of how focusing only on one type of analysis can turn into a disaster. 

Let’s say that you’re looking at your charts and you find a good trading opportunity.  You get all excited thinking about the money that’s going to be raining down from the sky.  You say to yourself, “Man, I’ve never seen a more perfect trading opportunity.  I love my charts.” 

You then proceed to enter your trade with a big fat smile on your face (the kind where all your teeth are showing).  But wait!  All of a sudden the trade makes a 30 pip move in the OTHER DIRECTION!  Little did you know that there was an interest rate decrease for your currency and now everyone is trading in the opposite direction? 

Your big fat smile turns into mush and you start getting angry at your charts.  You throw your computer on the ground and begin to pulverize it.  You just lost a bunch of money, and now your computer is broken.  And it’s all because you completely ignored fundamental analysis. 

Ok, so the story was a little over dramatic, but you get the point. Just remember to incorporate both types of analysis before you trade. Or else.

Summary:

• There are 2 types of analysis: Fundamental and Technical
• Fundamental analysis is the analysis of a market through the strength of its economy.  (i.e. the dollar gets stronger because the US economy is getting stronger)
• Technical analysis is the analysis of price movements.  Technical analysis = charts.
• Technical analysis also helps us identify trends which can help us find profitable trading opportunities.
• To become a successful trader, you must always incorporate both types of analysis.

When the student is ready, the teacher will appear.

- Buddhist Proverb

Rogue Trader In Court

Jerome Kerviel, the trader accused of losing 4.9 billion euros ($7.2 billion) at Societe Generale SA through unauthorized dealing, will remain in custody for a further day as police question him.

``Kerviel's custody has been renewed for another 24 hours,'' Isabelle Montagne, a spokeswoman for the Paris prosecutor, said. Police now have a deadline of tomorrow afternoon to charge or release him.
Societe Generale, France's second-largest lender by market value, handed investigators information about Kerviel on the evening of Jan. 25 as part of the probe. The lender says the losses, the biggest in banking history, occurred when Kerviel set up positions in futures linked to European stock indexes and then hedged them with fictitious trades.
Societe Generale says the positions were in balance at midday on Friday Jan. 18. As European stock markets fell on average almost 2 percent that day, the positions were making losses of 1.4 billion euros by the evening, when Societe Generale managers first became aware of the fraud. As the bank moved to unload the positions Monday, a day when fears of a U.S. recession sent European stock markets down on average 7 percent, the losses ballooned to 4.9 billion euros.
The numbers were given by Societe Generale Chairman Daniel Bouton in an interview with Le Figaro and confirmed by the bank.


Financial Brigade



The Paris police's financial brigade began questioning Kerviel, 31, yesterday at their offices in the southeast of the city, Montagne said in a phone interview. Kerviel arrived at the brigade's headquarters in the 13th arrondissement at about 2 p.m. yesterday in a gray car, which drove through an underground garage entrance. Under French law, police can hold him for two consecutive periods before deciding whether to let him go or charge him.



Societe Generale on Jan. 24 filed a lawsuit with the Nanterre prosecutor against ``a 31-year-old person'' for creating fraudulent documents, using forged documents and making attacks on an automated system, according to a spokeswoman for the prosecutor.
The investigation was transferred to the Paris prosecutor on Jan. 25. That day police visited both Kerviel's apartment in the Paris suburb of Neuilly-sur-Seine and the bank's headquarters in the financial district of La Defense.
Societe Generale voluntarily turned over documents to the police, spokeswoman Stephanie Carson-Parker said by phone.



Bank Reorganization



Elisabeth Meyer, Kerviel's lawyer, wasn't available to comment. No one has answered the phone in her office throughout the weekend, and she hasn't responded to messages left with her offices since Jan. 25.



Meanwhile, the bank named four executives who will lose their jobs or be transferred as a result of the losses, which Societe Generale blames on fraud perpetuated by Kerviel. They are Luc Francois, co-head of global equities and derivatives solutions; Jean-Pierre Lessage, head of the resources division; and Marc Breillout and Gregoire Varenne, co-heads of fixed income, currencies and commodities.
The four will ``either leave the group or move to other positions,'' the bank said. Kerviel is in the process of being fired.



Kerviel built a virtual company within Societe Generale, bank officials said. He balanced each bet with a fictitious one for almost a year. He was caught because he exceeded the allowed limits with a counterparty whose limits, unknown to him, had recently been changed, a bank official who asked not to be named said. Bank officials worked throughout the weekend to uncover the extent of his montage.



Government Probe



French Prime Minister Francois Fillon has asked Finance Minister Christine Lagarde to deliver a report this week on how Societe Generale suffered the trading loss. The Bank of France is also carrying out an investigation.
Lagarde said her probe will focus on why the bank's internal checks failed and whether financial companies should be forced to impose more controls on their businesses.



The trader, whose father and grandfather were ironworkers, grew up in Pont l'Abbe, a town of 8,200 in Britanny, western France. Kerviel, a green-belt judoka, attended high school at the Lycee Laennec. He went to work in Societe Generale's back office in 2000 after completing a degree in market operations at the University of Lyon II.
Kerviel spent his childhood in a white house with a slate roof and a triangular, peaked front based on the traditional Breton style, with a small front yard. Jerome's father, Charles, built it about 30 years ago and then constructed his workshop attached to it, according to neighbors.
Breton Background



Charles, who died a couple of years ago, was an ironworker, making pieces for furniture and ships mainly. Jerome's grandfather, Charles's father Laurent, was in the same trade, making items for furniture and horseshoes, the neighbors said.
Tangi Hourmand, a 33-year-old childhood friend of Jerome, said Kerviel had always wanted to go into finance, describing him as ``very intelligent.'' ``He was a normal guy who liked to go out,'' Hourmand said.