Top Tips
We will use this space to provide you with useful hints and tips for successful Foreign Exchange trading. From pitfalls you should avoid to interesting observations and facts that Foreign Exchange markets respect. Do not trade before you have seen this page!
“Winning traders plan the trade and then trade the plan”
12 general rules for successful trading:
- Have written plans and rules for your trading. State from the start what you can lose, what you aim to make. Review this monthly/annually.
- Never trade without a reason. Punting for the sake of it will never be profitable. Go to a casino instead where at least you can have a good time while losing.
- Use a strategy/method that suits you. Off-the-shelf solutions for sale on the web that will make you rich in three days, while you do nothing, do not work. You should not spend money trying to disprove this.
- Understand your risk/reward profile and appetite, and the rationale behind your strategies.
- Know the market. There are so many resources at hand - from free information on the internet to economics and finance reports in the daily news. Read everything you can to improve your understanding and instincts about the market.
- Maintain consistent behaviour whether winning or losing in a trade. People are too patient with a losing trade “it will turn around” and too impatient with a winning one “I’d better take some profit now that I can”.
- Never ever add to a losing trade. Avoid changing the size of your position altogether if possible as it affects leverage ratios and your net position in ways that are tricky to understand and difficult to monitor.
- As a rule of thumb, you should be risking about 1% of your capital per trade, and never really more than 3%. If the minimum size and reasonable stop limit for a trade demands more % of capital at risk, you then either need more capital or a smaller trade.
- You should know all of your positions by heart, your strategy for each of them, all levels relating to them and where the market is. You should be able to recall and review this information at any time for short term trading, or at least 3 times per day for longer term. If you can’t do that, then you need to trade fewer positions until you can.
- Always set reasonable profit taking targets and stop losses for the trades. They should both allow enough leeway for the volatility of the time frame you are trading. If the right stop distance constrains the size of the position, then the latter should be reduced rather than the stop distance.
- Keep records and simple statistics of trade history, by trade date. Study them regularly. Be meticulous, it will pay off.
- Be adaptable. Your thinking, your strategy, your trades.
Other Important Topics:
Correlations
Currency markets correlate with other asset classes and between one another. These correlations, whilst not constant over time - in fact on occasion they reverse - are strength enough and last long enough for market participants to trade them.
Let’s take a look at some of them:
Commodities and currencies
Gold is a good starting point. Traditionally it has been negatively correlated with the USD. The idea behind being that in times of uncertainty investors sell fiat currencies (the USD as proxy by being the most liquid and secure) in favour of Gold, the traditional value storage element. Post the credit crisis of 2007-08, that relationship has weakened a bit as the USD in itself has been perceived as a run to safety asset.
The AUD is also a good correlator with Gold as well as with most of the hard commodities bloc as Australia is one of the biggest producers globally.
The CHF is well correlated with Gold. They are both perceived to be a safe haven and therefore correlate well. On the table below you can see a few key correlation levels between currencies that exhibit high correlation values and other assets.
Oil and the Canadian dollar (CAD) is another example. Canada, one of the top oil producers in the world exports around 2mio bpd to the US, thus creating a constant demand for CAD. When oil prices rise, it normally leads to a stronger CAD (USD/CAD lower).
Equities and currencies
Equity markets are also a key correlating factor for currencies. It makes sense as in order for an individual or institutional investor to be able to buy a country’s stocks, first they need the respective currencies. Thus, well performing/rising stock markets attract more investment, which needs more of the local currency, which pushes the local currency higher and vice versa.
Bond spreads and currencies
A bond spread is the difference between two countries’ bond yields in equivalent bonds (2Y, 5Y etc). The normal relationship is that when the bond spread between two economies widens, the country experiencing the higher yield would normally see their currency rise too. See for example the AUD/USD vs their equivalent bond spreads.
A word of caution here for day trading as bond market correlations tend to hold well enough in the long term, but could be impossible to trade on a daily basis.
The correlation between currency pairs
An important fact is that some currency pairs traditionally exhibit high (positive or negative) correlations whereas others have values close to zero. It is useful if not imperative for successful trading for someone to know key characteristics among different currency pairs if only for correct estimation and awareness of risk exposure. Below is a set of main currency pairs that exhibit noteworthy correlations, whether positive or negative. We have tabulated these in three timeframes: hourly, daily and weekly.
Hourly
| AUDUSD | EURJPY | EURUSD | GBPUSD | NZDUSD | USDCAD | USDCHF | USDJPY | |
|---|---|---|---|---|---|---|---|---|
| AUDUSD | 100 | 92.2 | 94.1 | 95.1 | 95.1 | -92.5 | -95.1 | 74.1 |
| EURJPY | 100 | 98.6 | 95 | 93.3 | -82.9 | -97.9 | 88.6 | |
| EURUSD | 100 | 94.8 | 94.7 | -87.9 | -98.9 | 81.2 | ||
| GBPUSD | 100 | 91.8 | -88.8 | -95.6 | 81.2 | |||
| NZDUSD | 100 | -91.7 | -94.4 | 74.4 | ||||
| USDCAD | 100 | 86.9 | -60.4 | |||||
| USDCHF | 100 | -77 | ||||||
| USDJPY | 100 |
Daily
| AUDUSD | EURJPY | EURUSD | GBPUSD | NZDUSD | USDCAD | USDCHF | USDJPY | |
|---|---|---|---|---|---|---|---|---|
| AUDUSD | 100 | 81.7 | 78.5 | 75.9 | 97.6 | -95.2 | -60.4 | 43.1 |
| EURJPY | 100 | 97.1 | 95.9 | 81.5 | -80.9 | -87.3 | 47.8 | |
| EURUSD | 100 | 96.4 | 78.9 | -77.7 | -86.2 | 25.5 | ||
| GBPUSD | 100 | 76.3 | -75.3 | -88.4 | 33.7 | |||
| NZDUSD | 100 | -97.7 | -65.7 | 41.1 | ||||
| USDCAD | 100 | 66.8 |
-43 |
|||||
| USDCHF | 100 | -36.6 | ||||||
| USDJPY | 100 |
Weekly
| AUDUSD | EURJPY | EURUSD | GBPUSD | NZDUSD | USDCAD | USDCHF | USDJPY | |
|---|---|---|---|---|---|---|---|---|
| AUDUSD | 100 | 48 | 83.4 | 71.6 | 78.2 | -84.8 | -77.2 | -34.1 |
| EURJPY | 100 | 64.1 | 66.4 | 3.4 | -66.2 | -5.7 | 50.7 | |
| EURUSD | 100 | 88.1 | 63.9 | -74.2 | -73.1 | -33.5 | ||
| GBPUSD | 100 | 49.3 | -71.8 | -56.6 | -16.8 | |||
| NZDUSD | 100 | -49.7 | -85 | -66.7 | ||||
| USDCAD | 100 | 52.6 | 1.2 | |||||
| USDCHF | 100 | 74.4 | ||||||
| USDJPY | 100 |
Note how the short term correlations values tend to be higher (positive or negative) compared to the longer term where the high correlation effects are diluted or even completely reversed in some cases. For example EURJPY with NZDUSD or AUDUSD with USDJPY.
As mentioned above, correlation levels could be fairly constant over a short period of time, but ultimately they do vary, and the tables above do change. Risk aversion and generic changes of risk appetite in the market are the key factors that move intra-correlation values over time.
Timing specific concerns
Timing in markets is a key concern and can prove to be a key hazard too. The FX market may be the most seamless, liquid and largest in the world, but there are many timing specific issues that regularly affect liquidity. Any aspiring day trader should be aware of basic irregularities that affect their market.
For the FX community, some key concerns are:
Special dates: These can be national holidays, bank holidays, UK or US school term weeks, general western calendar holiday periods like Christmas or August and generally any day that markets are off. The general observation around these dates is twofold; first that liquidity conditions and market participation tends to be limited or constrained, therefore potential market moves can appear exaggerated for no other reason than the lack of flow. Second, the period preceding the special date is often a period of position squaring and risk consolidation, i.e markets can sustain a move against the recent trend as people close down on open positions. The latter is especially true in longer term breaks, particularly during Christmas and summer holidays.
Calendar Flows: This refers to regular flows through the market that can be large enough to cause significant market moves. Typical examples are the institutional community's regular month end adjustment flows. These occur on the last trading day of every month and are a result of global bond and equity portfolio rebalancing according to their past month's performance. Another case is the flows that occur from M&A activity or regular large bond auctions.
A Final word: Risk management
This section deals with common misconceptions of amateur traders involved in the world of margin trading. It is by no means a complete guide, but nevertheless offers some good - we believe - pointers on the approach to yield generation, leverage, position sizing and term, stop losses etc.
Leverage is the key headline with anything concerning risk management. Most margin trading systems in FX, ourselves included, offer leverage to a degree of 100:1. Many go way above that to 200:1 or even 400:1. The marketing spiel behind it runs along the lines “large leverage equals large and quick profits”. What they do not mention that this is a two way street and that a 1% move in a currency pair - move that is often less that the daily average volatility of many pairs - even at a 50:1 leverage could yield a 50% return or 50% loss. Leverage to that extent is uncomfortably close to terms such as gambling rather than any form of “investment” and it should come as no surprise that the average speculator regularly using leverage levels of more than 10:1 has an average lifespan of a few weeks. In contrast, professional investors, fund managers and hedge funds, rarely use leverage levels of more than 4:1. Moreover, the leverage ratio in a position is not a constant variable. By the very nature of the industry, any position is Marked-to-Market (MTM) in real time. That means that as the position is increasing in value, its leverage factor decreases and vice versa.
For example:
Suppose that one goes long 100k GBP/USD with a funded account of GBP 5k. This is a position with leverage of 20:1. If that position goes up by, say 2%, it will have generated a profit of GBP 2k. The notional of the position remains at GBP 100k, but now the user’s account has GBP 7k in it. Leverage has thus gone from 20:1 to almost 14:1, a 30% change in leverage terms. Consider the opposite effect by the same numbers: The market has gone down by 2%, and the 100k position has now lost GBP 2k worth of value. The position is still on for a notional of GBP 100k, but the user’s account has only got GBP 3k left in it. Aside from the fact that a 2% move has caused a 40% loss of the user’s account, leverage has moved from 20:1 to 33:1. This is a 65% change in leverage terms. So the same move either side of the market has had a very different impact in leverage terms.
In fact, any standard market position using leverage implies that the leverage ratio is dynamic. The higher the leverage is to start with, the faster it changes. Leverage ratios increase with a losing position, and moreover the increase itself speeds up as the position moves further against us. Thus the same % increment of an adverse market move incurs ever increasing losses on capital and makes the way to claw back on the losses slower and more difficult.
This last point is very important and very much misunderstood and is the fundamental reason as to why one needs lower leverage levels in order to survive and be profitable.
A good rule of thumb on leverage levels is 1-3 for medium terms positions, 4-6 for shorter term with allowance for momentary allocations up to 10:1 or 15:1 in a winning run. Any long term positioning using leverage above these levels will pretty much end in guaranteed ruin.