What is forex? Why trade forex?

The foreign exchange market or forex for short is the buying and selling of currencies, and its one of the
fastest growing markets in the world. From 2007 to 2010, forex market activity increased by 20%, with
average daily turnover reaching nearly $4 trillion in April of 2010.

Forex trading works much like it does with stocks, you buy low and you sell high. The benefit of trading
forex is that you dont have to choose from thousands of companies or sectors. Plus, you can make things
even simpler than choosing which company to buy.
For example, most people, even those that are new to forex, have an opinion on the US dollar and the US
economy. They can easily take their opinions and translate them into a forex trade. Buying or selling US
Dollars as simple as they buying or selling a companys stock.
Also, another advantage of the FX market is that it doesnt begin at 9AM and end at 4PM. Trading takes
place 24 hours a day, 5 days a week. For most people 24 hour trading means they can trade before or after
work. Plus, you have the flexibility to make your trades online.

Plus, you can buy and sell at any time, in up trends (also called bull markets) and in down trends (also called
bear markets).
Its easy to get started. You can sign up for a free practice demo account to practice trading online.
The time to trade forex is now. Join the millions of traders around the world.

Each day, more and more traders find the ever expanding Forex market; making the shift from other asset
classes for a variety of reasons.
Around-the-clock trading availability, wide geographical dispersion, and pure unbridled opportunity have
contributed to the growth in this market, as average daily volume in the FX Market nears $4 trillion dollars
($3.98 Trillion per the Bank of International Settlements).
Thats nearly $4 Trillion, in one day.
The goal of this article is to explain the nuances of the Forex market, highlighting key similarities and
differences from other popular trading vehicles.
The FX Quote
The first thing that most new traders will notice is the FX quote. When trading stocks or futures, quotes can
generally be read easily, as they are one-sided; meaning when you read a quote on Google, you are looking
at the price at which traders can buy or sell Google. However when you want to trade a currency, such as the
Euro, you have quite a few options. If you want to trade the Euro, you can pick a variety of different ways of
doing so.
You can choose to pair the Euro with the US Dollar. This would be the EUR/USD currency pair, which is
the most common, liquid currency pair in the world.

Or perhaps you wanted to make a different type of play and choose to marry the Euro with another currency,
such as the Australian Dollar (abbreviated AUD), or the Japanese Yen (abbreviated JPY).
Traders can choose to trade the Euro in a wide variety of ways, based on their goals and prevailing
opportunities in the market.
This really isnt all that different than stocks.
Lets go back to our quote on Google. If GOOG is trading at $650.00, we can think of this in currency terms
as GOOG/USD at $650 (Google quoted in terms of US Dollars is trading at $650).
We can also quote Google in terms of Euros.
Lets say that the spot quote on EUR/USD was $1.50, meaning that each Euro was worth One Dollar and
Fifty Cents. We can then divide our $650.00 price on Google with the exchange rate of 1.5 Dollars for every
Euro (remember 1.50 is euros quoted in terms of dollars) to get the equation ($650/1.5 = $433.33). So
Google, quoted in terms of Euros with the above information would look like:
GOOG/EUR = $433.33
Just like any other asset class, as the trader I want to look to buy low and sell high. Or sell high, and buy
back to cover at a lower price for short positions.
When we sell a currency pair, we are selling it relative to another currency. Lets take our EUR/USD
example from above. If I were to sell the EUR/USD currency pair, I would be selling Euros. I would also
be buying dollars. My goal in this trade would be for Euros to weaken, the Dollar to strengthen, and price to
go lower so that I could cover my short position at a lower price.
Five Digit Pricing
Another key difference in the quote of an FX pair is the fact that prices are offered, in many cases, to five
digits. Most markets are denominated in a much more common sense manner, using prices that resemble
those which we see in our everyday lives, quoted to 2 decimal places. When I want to buy some flour at the
store, the price will be quoted 2 digits beyond the decimal place; like $4.56. If I want to buy a car, once
again, prices are quoted 2 places past the decimal with a price such as $54,367.31.
But in the FX Market, more precision is needed, and prices are quoted up to 5 digits beyond the decimal.
Lets look at a quote on EUR/USD for further examination.
Lets assume that the bid on EUR/USD is 1.27218.
The first three digits of this number are just like any other price that we will see. In this case the Euro is
worth One dollar, and 27 cents. The digits after help further define this quote.
The next 2 digits in this quote are called pips, which is short for percentage in point. In this quote, the
Euro is trading at 1 dollar, 27 cents, and 21 pips, or 21/100ths of a cent. Another way of saying this same
quote would be One dollar, 27 cents, and 21 pips.
The fifth digit of this quote is called a fractional pip, and some forex brokers do not offer this fifth digit.
The fifth digit further helps define price, and represents tenths of a pip. In the case of the above quote, it
can be read One dollar, 27 cents, 21 pips, and 8/10th of a pip.
Below is an example of another quote, with full annotation.

Many traders first entering FX wonder why such precision is needed with prices. That leads us into the next
unique aspect of the FX Market.
Leverage
The current average daily range (over the past 14 days) of the EUR/USD currency pair is approximately 115
pips. Using the EUR/USD current market price of (1.2726 as of this writing), the average range is
approximately .9%, or less than 1%.
This is much less volatility than many traders, including myself, are looking for.
In the FX market, leverage is available so that I can make these smaller moves work in the way that I want.
For most traders in the United States, up to 50X leverage is available. Meaning, I could lever up a .9% daily
move 50 times on my portfolio, theoretically allowing me to turn a .9% gain into a 45% gain at 50:1 leverage.
The thing that traders entering the FX Market have to keep in mind is that these excessive levels of leverage
can be counter-productive.
Most professional traders keep their leverage inside of 10:1. Meaning, if they have $10,000 on deposit with
their broker, they will keep their position sizes under $100,000. Or if they have $2,000 on deposit, they will
keep their positions under $20,000.
To find leverage, we can simply multiply the account deposit times the leverage factor (such as 10X or 5X)
to find the desired position size to stay inside of their desired leverage level.
Lets walk through a full example together.
Lets assume that our trader has $10,000 on deposit, and wanted to use a 2x leverage factor. This would allow
them to open a trade of up to $20,000.
Lets assume they wanted to speculate on the EUR/USD currency pair.
They could purchase (or sell) 2 standard lots (each standard lot is $10,000 of the base currency, or the second
currency in the quote), to arrive at a position size of $20K.
Traders deposit: $10,000
Leverage Factor: 2X
Position Size: $20,000 (or 2 standard lots, as each standard lot is $10,000 USD)

When money flows into a currency, it strengthens, and when money flows out of a currency, it weakens.
When we place a trade in the forex market, we are buying one currency and selling the other. This is why
forex is traded in currency pairs. As a visual example, we can reference the image below.
If we buy a currency pair, like the EUR/USD, we are buying euros and selling dollars. We place this trade
when we believe the EUR/USD exchange rate will rise and allow us to sell back our euros for a larger
amount of dollars at some point in the future.
But in the forex market, we can trade the other direction as well. So we could sell the EUR/USD, effectively
selling euros and buying dollars. With that trade, we would want the EUR/USD exchange rate to fall so we
can buy back the euros for less dollars than we originally sold them for.

So not only do we have a goal of buying low and later selling high, we have the option to sell high first, and
then buy low later. There are no restrictions on short selling and we do not need to own any euros prior to
selling the EUR/USD. This is what people refer to as a two-way market.

Trading currency in the Forex market centers around the basic concepts of buying and selling.
Let's take the idea of buying first. What if you bought something (it could literally be almost anything...a
house, a piece of jewelry or a stock) and it went up in value. If you sold it at that point, you would have
made a profit...the difference between what you paid originally and the greater value that the item is worth
now.
Currency trading is the same way...
Let's say you want to buy the AUDUSD currency pair. If the AUD goes up in value relative to the USD and
then you sell it, you will have made a profit. A trader in this example would be buying the AUD and selling
the USD at the same time.
For example if the AUDUSD pair was bought at 0.74975 and the pair moved up to 0.76466 at the time that
the trade was closed/exited, the profit on the trade would have been 149 pips. (See the chart below)

Created using IGs web trading platform

Had the pair moved down to 0.74805 before the trade was closed, the loss on the trade would have been 17
pips.
Also, it makes no difference which currency pair you are trading. If the price of the currency you are buying
goes up from the time you bought it, you will have made a profit.
Here is another example using the AUD. In this case we still want to buy the AUD but lets do this with the
EURAUD currency pair. In this instance we would sell the pair. We would be selling the EUR and buying
the AUD simultaneously. Should the AUD go up relative to the EUR we would profit as we bought the
AUD.
In this example if we sold the EURAUD pair at 1.2320 and the price moved down to 1.2250 when we closed
the position, we would have made a profit of 70 pips. Had the pair moved up instead and we closed out the
position at 1.2360 we would have had a loss of 40 pips on the trade.
Remember, we are always buying or selling the currency on the left side of the pair. If we buy the currency
on the left side, which is called the base currency, we are selling the one on the right side which is called the
cross or counter currency. The opposite would be true if we were selling the currency on the left side.
Now let's take a look at how a trader can make a profit by selling a currency pair. This concept is a little
trickier to understand than buying. It is based on the idea of selling something that you borrowed as opposed
to selling something that you own.
In the case of currency trading, when taking a sell position you would borrow the currency in the pair that
you were selling from your broker (this all takes place seamlessly within the trading station when the trade is
executed) and if the price went down, you would then sell it back to the broker at the lower price. The
difference between the price at which you borrowed it (the higher price) and the price at which you sold it
back to them (the lower price) would be your profit.
For example, lets say a trader believes that the USD will go down relative to the JPY. In this case the trader
would want to sell the USDJPY pair. They would be selling the USD and buying the JPY at the same time.
The trader would be borrowing the USD from their broker when they execute the trade. If the trade moved
in their favor the JPY would increase in value and the USD would decrease. At the point where they closed
out the trade, their profits from the JPY increasing in value would be used to pay back the broker for the
borrowed USD at the now lower price. After paying back the broker, the remainder would be their profit on
the trade.
For example, lets say the trader shorted the USDJPY pair at 122.761. If the pair did in fact move down and
the trader closed/exited the position at 121.401, the profit on the trade would be 136 pips.

On the other hand, if the pair was shorted at 122.761 and the pair did not move down but rather it moved up
to 122.951 when the position was closed, there would be a loss on the trade of 19 pips.
In a nutshell, this how you can make a profit from selling something that you do not own.
In wrapping up, if you buy a currency pair and it moves up, that trade would show a profit. If you sell a
currency pair and it moves down, that trade would show a profit.
Among the many things that make Forex so interesting are the underlying themes that drive the market
itself. When looking at it from a fundamental viewpoint, there are geopolitics, governments, societies,
macroeconomics, and the behavior of numerous participants who vary greatly in objectives and approach.
Throughout history, we have seen major events born from these themes that have greatly influenced
the Forex trading environment. Here are some highlights from five impactful events.
The Bretton Woods Accord
The first major transformation, the Bretton Woods Accord, occurred toward the end of World War II. The
United States, Great Britain, and France met at the United Nations Monetary and Financial Conference in
Bretton Woods, NH to design a new global economic order. The location was chosen because at the time,
the U.S. was the only country unscathed by war. Most of the major European countries were in shambles. In
fact, WWII vaulted the U.S. dollar from a failed currency after the stock market crash of 1929 to benchmark
currency by which most other international currencies were compared. The Bretton Woods Accord was
established to create a stable environment by which global economies could restore themselves. It also
established the pegging of currencies and the International Monetary Fund (IMF) in hopes of stabilizing the
global economic situation.Though the Bretton Woods Accord lasted until 1971, it ultimately failed but did
accomplish what its charter set out to do to re-establish economic stability in Europe and Japan.
The Beginning of the Free-floating System
After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971, which was
similar but allowed for a greater fluctuation band for the currencies. In 1972, the European community tried
to move away from its dependency on the dollar. The European Joint Float was then established by West
Germany, France, Italy, the Netherlands, Belgium, and Luxemburg. Both agreements made mistakes similar
to the Bretton Woods Accord and in 1973 collapsed. These failures resulted in an official switch to the free-
floating system.
The Plaza Accord
It did not take long for traders to realize the potential for profit in this new world of currency trading. Even
with government intervention, there still were strong degrees of fluctuation and where there is fluctuation,
there is profit. This became clear a little over a decade after the collapse of Bretton Woods. The U.S.
economy was booming but the dollar had risen too far, too fast. The weight of the U.S. dollar was crushing
third-world nations under debt and closing American factories because they could not compete with foreign
competitors. In 1985, the G-5, the most powerful economies in the world U.S., Great Britain, France, West
Germany, and Japan sent representatives to what was supposed to be a secret meeting at the Plaza Hotel in
New York City. News of the meeting leaked, forcing the G-5 to make a statement encouraging the
appreciation of non-dollar currencies. This became known as the Plaza Accord and its reverberations
caused a precipitous fall in the dollar.
Establishment of the Euro
After WWII, Europe forged many treaties designed to bring countries of the region closer together. None
were more prolific than the 1992 treaty referred to as the Maastricht Treaty, named for the Dutch city where
the conference was held. The treaty established the European Union (EU), the creation of the Euro currency,
and put together a cohesive whole that included initiatives on foreign policy and security. The treaty has
been amended several times but the formation of the Euro gave European banks and businesses the distinct
benefit of removing exchange risk in an ever-globalized economy.
Internet Trading
In the 1990s, the currency markets grew more sophisticated and faster than ever because money and how
people viewed and used it was changing. A person sitting alone at home could find, with the click of a
button, an accurate price that only a few years prior would have required an army of traders, brokers, and
telephones. These advances in communication came during a time when former divisions gave way to
capitalism and globalization (the fall of the Berlin Wall and the Soviet Union). For Forex, everything
changed. Currencies that were previously shut off in totalitarian political systems could be traded. Emerging
markets, such as those in Southeast Asia, flourished, attracting capital and currency speculation.
The history of Forex markets since 1944 presents a classic example of a free market in action. Competitive
forces have created a marketplace with unparalleled liquidity. Spreads have fallen dramatically with
increased online competition among trustworthy participants. Individuals trading large amounts now have
access to the same electronic communications networks used by international banks and merchants.
Talking Points
Foreign exchange rates are quoted in pairs
The Majors, refer to actively traded Forex currencies
Major Pairs reference major currencies coupled with the USD
By now you probably know that foreign exchange rates are quoted in pairs. While this is important, it is also
imperative to know exactly which currencies are being referenced in these pairs. Whether you are preparing
to place your first trade or are a seasoned pro analyzing extensive research having a firm grasp on which
currency is which will ultimately influence your decisions.
To help today we will review the Forex market Major Currencies and Pairs.
The Majors
When trading Forex, it is inevitable that traders will run across currencies known as The Majors. This
term is in reference to the most frequently traded currencies in the world, with the list normally including the
Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Great British Pound (GBP), Australian Dollar (AUD),
and Swiss Franc (CHF).See the graph below, and you will find a list of the Major currencies along with their
associated country and ISO symbol.
The Symbol is how you will know exactly which currency you are trading when referencing a Forex
Bid/Ask quote. However, it is also important to review each currencies nickname. These names will often
come up in research and will be handy when communicating with other Forex traders.

Major Currency Pairs

Next we will take a look at currencies pairs that are considered Major Pairs. The Major Pairs are a
reference to any of the major currencies listed above when paired with the USD. For example, the EURO is
considered a major currency, but when paired with the USD (EUR/USD) the quote becomes a reference to a
major pair.

Foreign exchange rates are quoted in pairs

Major Pairs reference major currencies coupled with the USD
Cross Pairs reference major currencies coupled with a non USD currency
Foreign exchange ratesare quoted using two currencies, which then are combined to create a currency
pair. The majority of these pairs are created using the G-8 currencies listed below which are then divided
into two classifications, Major Pairs and Cross Pairs.
Today we will continue our review by briefly explaining exactly is meant by a currency cross.
Currency Cross Pairs
Major Pairs are considered when any of the Major G8 currencies are coupled with the USD, such as
the EURUSD. A cross pair is one that does not include the USD. These currency cross pairs were created to
ease the process in which traders could exchange money. Not only were transactions simplified without first
having to convert to USD as a common medium, but now traders can also trade while avoiding USD
volatility.
The other major benefit to trading cross pairs is for their strong trending markets. One example of a currency
cross pair is the EURAUD. For the 2013 trading year the EURAUD moved a total of 3378 pips from low to
high. This is nearly 4x the movement of the EURUSD! The EURUSD major only managed a move 848
pips, measured from low to high for the 2013 trading year. Other cross pairs for the Euro includes
the EURGBP, EURAUD and EURJPY to name a few.So remember next time you open your platform there
are opportunities outside of the majors, and look for the currency crosses.

One of the oldest and most popular currency pairings in the world is the British Pound v/s the United States
Dollar.
Speaking directly to this quality, the name The Cable comes from the first transatlantic cable that was laid
across the floor of the Ocean for the United States and Great Britain to communicate with one another.
One of the primary pieces of information exchanged on this first transatlantic cable were currency quotes on
the two currencies.
A lot has changed since that first Trans-Atlantic cable was placed on the floor of the Ocean, but the
GBPUSD currency pair continues to remain a favorite to traders around the world.
This article will take a closer look at this pair, and how traders may want to build their approach in trading
The Cable. At the end of the article, well also enclose 2 strategies for trading in GBPUSD.
Characteristics of the GBPUSD
The reasons for GBPUSDs popularity are abundant. The United Kingdom and the United States represent
two of the oldest, modern economies in the world. Both economies feature a relative amount of safety, due
in large part to the sheer size that each represents to the overall global economy. Below is a listing of the
worlds 10 largest Independent economies (using 2011 IMF Statistics, in Millions of US Dollars):

Gross Domestic Product in 2011 per the International Monetary Fund

Perhaps a larger contributing factor to interest in the GBPUSD currency pair is the fact that London is often
considered to be the center of the Forex trading world.
Estimates approximate that 35% of volume traded in the FX Markets takes place through London. This is
the period just before the United States opens for business, leading to some of the most liquid trading times
of the day.
As we saw in the article Here is How to Trade Majors like the Euro During Active Hours, these market
periods can potentially see larger moves as major players in-and-around London enter the market as the UK
opens for business.
This can greatly affect the traders approach during the London Session, and more specifically in trading
the GBPUSD currency pair.
Strategies for Trading GBPUSD
Before deciding on the way that you want to trade The Cable, you should probably answer another
question first.
When are you planning on trading?
As we found in the DailyFX Traits of Successful Traders series, the different trading periods in the market
can exhibit markedly different tones.
The Asian Session(s) from Sydney and Tokyo have a propensity to be more accommodating for Range-
Trading approaches, as hourly moves are in general smaller than what we may see during the more
active London and US sessions.
Range-Trading approaches often look to buy when price is cheap and at support; and sell when price is
expensive, or at resistance. There are quite a few different ways of doing this. In the JW Ranger Strategy,
DailyFX Instructor Jeremy Wagner looks at trading ranges with the Commodity Channel Index, or CCI. In
How to Analyze and Trade Ranges with Price Action, I walked you through a way of trading ranges
without needing any indicators at all; using only price to point out pertinent areas of support and resistance
for building our approach.
For traders looking to trade GBPUSD during the more active times in the market, when liquidity is coming
from Europe and the United States, breakout trading may be more accommodating. With breakouts, traders
are watching support and resistance, much like in the Asian session. But differing from the Asian session,
support and resistance may be broken much more frequently as the onslaught of liquidity entering the
market can potentially push price in one-direction for an extended period of time.
Below is a picture of a breakout on the AUDUSD currency pair:
As you can see above, price resisted twice at a price just shy of .9880, but on its third attempt was able to
breakout and run for an extended period of time.
This is what traders speculating during the London and US sessions should be looking for.
Trading Breakouts on GBPUSD
For traders looking to trade breakouts on GBPUSD, there are, once again, quite a few ways of doing so. A
key component of trading breakouts is looking for strong risk-reward ratios, such as the trader risking 20
pips, but looking for 100 pips if correct. This could be classified as a 1-to-5 risk-to-reward ratio (20 pips at
risk 100 pips sought = 1:5 risk-to-reward).
With a risk-reward ratio so aggressively on the traders side, one would need to be right only 2 out of 5
times to gleam a net profit. If a trader was right 40% of the time with a 1-to-5 risk-to-reward ratio, they
could be looking at a handsome profit ( 2 winning trades at 100 pips each = 200 pips won, 3 losing trades at
20 pips each = 60 pips lost, net profit of 140 pips (200-60) not including commissions, slippage, etc).
In How to Identify Positive Risk-Reward Ratios with Price Action, we looked at mannerisms for finding
and calculating risk amounts. The same mechanism used in that article, identifying previous swing-highs
for short positions, or looking for previous swing-lows for long positions can be used to identify areas to
place stops in breakout strategies.
However, since traders are looking for new highs or new lows with breakout strategies limits or profit
targets can be calculated simply by looking for a multiple of the risk amount (i.e., Im risking 63 pips on this
trade, so I will look for 5 times my risk amount (or 315 pips (63 X 5)) for my profit target.
As for strategies to trade breakouts, traders can look to the Price Channel indicator, looking for breaks of the
highs and lows that were seen on the longer-term charts.
For traders looking to utilize Price Action in their Breakouts strategy, we looked at exactly that in the article
Price Action Breakouts.
Whatever your mechanism for identifying support and resistance; looking to trade breaks of these levels
during the active period(s) of the day while looking for price to respect these levels during the more quiet
periods will generally bring the trader more robust results, in GBPUSD or any of the other major currency
pairs.
The British Pound Japanese Yen currency pair is a volatile offering that presents traders with potentially
large moves in price relative to many other pairings. This currency pair is, at times, so volatile that it has
earned the nickname of The Dragon, as well as another well-coined term: The Widow-maker.
Whatever you call it, the fact remains the same: GBPJPY can really move.
Take, for instance, the initial throws of the Financial Collapse in 2008. While the EURUSD had, at one
point, gone down by ~3300 pips, the top-to-bottom move on GBPJPY was much larger: at one point a loss
of more than a staggering 7000 pips.
This volatility can be a good thing, or it can be a very bad thing; depending on how you trade.
DailyFX Traits of Successful Traders
Exhaustive research was performed by DailyFX Quantitative Strategist David Rodriguez, examining more
than 12 million trades placed by live traders. The goal of the research was to find out how traders were
speculating, what wasnt working, and what we, as an education and research group, could do to help.
The results of the research are shocking, and what was found was that the Number One Mistake that FX
Traders Make often revolves around risk-reward ratios; that is, how much is lost on losing trades against
how much is profited on winning trades.
From the research, David states:
Traders are right more than 50% of the time, but lose more money on losing trades than they win on
winning trades. Traders should use stops and limits to enforce a risk/reward ratio of 1:1 or higher.
GBPJPY is an extreme example of this fact.
From our research, we can see that traders are correct a whopping 66% of the time on GBPJPY!
Traders win, on average, 52 pips on GBPJPY trades when they are right; but when they are wrong, they lose
a monstrous 122 pips. From the above chart, GBPJPY is showing the lowest ratio of pips won v/s pips lost
(on average).
This type of risk-reward ratio puts traders in a precarious position; as to be profitable over the long-term one
would have to be right about 75% of the time (3 out of 4) to be able to hope for a net profit.
I dont know about you, but there are very few things in life I want to expect to be right 75% of the time
with; least of all anything that could cost me money when I am wrong.

Trading GBPJPY
Trading a currency pair like GBPJPY could be optimal for traders looking for volatility or large moves; but
it should be noted that those moves arent always very smooth; which is exactly why overall profitability
wasnt higher on the pair.
The first point of emphasis is that given the above points, trading in GBPJPY should always entail a
protective stop-loss order. Lack of doing so exposes the trader to significant risks as the pair may trend for
an extended period of time.
Due to this volatile nature, and given the fact that the pair could trade with very wide swings in either
direction, breakouts can be an attractive approach when trading GBPJPY. This will allow traders to
maximize profits on the large swings when they are right; while also allowing them to cut their losses short
as the big swings move against them.
With breakout strategies, traders are monitoring support and/or resistance; waiting for a break of the price
level with the expectation that once the break is made price will continue running in that direction,
allowing for the maximization of profits in instances when the trader is correct (which is yet another reason
stop losses are important, as those extended moves can cost significantly in instances when the trader is
incorrect).
In the article Price Action Breakouts, we looked at a mannerism for trading price-breaks without the
necessity of any indicators at all, using price alone to denote support and resistance levels.
In the article, Breakouts: How to Stay Away from Some Losing Trades, Jeremy Wagner introduces
another indicator, price channels aka Donchian Channels, to help monitor price levels that may warrant
future breakout opportunities.
For traders speculating in -denominated currency pairs, Ichimoku may also be a relevant manner of
analysis. Ichimoku is a popular technical system that was developed in Japan before World War II. Its
staying power as a popular mechanism for initiating trades has continued, as the system is still widely in use
today.
Ichimoku is often used as a trend-following system, but with a slight modification can be used to trade in
breakout-style scenarios.
A large part Ichimoku is The Cloud, which is a moving area of support or resistance plotted on the chart.
When price breaks through either side of the cloud, the trader can often look to trade breakouts by placing a
trade in that direction.
In this article, we are taking a closer look at Australian Dollar/US Dollar currency pair. After we
examine how The Aussie made its way to current price levels, well provide a framework for trading it.
The Australian Dollar, commonly called The Aussie is the national currency for the country and continent
of Australia, and one of the favorite vehicles of traders around the globe.

In 2012, AUDUSD became the 3rd most popular currency pair in the world, jumping up 2 places from only 2
years before. High interest rates from Australia coupling very strong long-term growth, a robust trading
relationship with China and large deposits and exports of natural resources combine to make this a favored
asset amongst traders.
One needs only to look at the trend put in by the pair over the past decade to see why:

Since 2001 The Aussie has enjoyed a rigorous up-trend that saw its only major test during the 2008
Financial Collapse. Outside of that period, there was most definitely a one-sided bias in the currency pair.
Something interesting is happening of late, as the up-trend appears to be congesting, but well get in the last
section of the article for Trading the Aussie.
Why Did the Aussie Trend so Hard for so Long?
A number of factors contributed to the gains in Australia, key of which were:
1. High Interest Rates set by the RBA to moderate the inflation that was created from strong growth
2. Strong growth brought upon by heavy natural resource and commodity deposits that were being
mined, and exported from Australia
3. Increasing commodity prices brought upon by even stronger growth from China and India; both of
which are key trading partners of Australia
4. The aforementioned stronger growth rates being seen in China and Australia only increased the
demand for the commodities that Australia was mining and exporting
The economy of Australia had a fairly bullish cycle of events working in its favor, and these are just some of
the reasons that traders flocked to the Aussie.
The fact that the RBA is one of the few large Central Banks that hasnt embarked on some form of
government intervention in the past 10 years also helps attract FX traders. Intervention efforts can amount to
a financial sucker-punch for traders; unexpectedly reversing strong trends with (or maybe even without)
announcements out of the blue.
Australia is one of the few large economies to retain the highest AAA Debt rating, speaking to the political
and economic stability that's been seen in the country and yet another contributing factor to the currencys
rising popularity amongst traders.
Trading the Aussie
Because of the high interest rate differential between Australia and the United States, the Aussie-dollar
remains a favorite of traders seeking volatility.
During bullish market environments, the AUDUSD can run up faster than many pairs due to its interest rate
differential.
During bearish market environments, AUDUSD can fall much faster than many pairs due to its interest rate
differential.
In many ways, the Aussie-dollar can offer characteristics similar to high-beta stocks, in which market
movements are exaggerated by additional volatility.
Due to the volatile nature of the currency pair, breakout strategies may work best during trending markets.
With breakout strategies, traders are monitoring support and/or resistance; waiting for a break of the price
level with the expectation that once the break is made price will continue running in that direction,
allowing for the maximization of profits in instances when the trader is correct.
The picture below will illustrate a breakout on the AUDUSD currency pair as it was initially attempting to
make its way over parity.
This is the same prescription for volatility that was suggested in the article How to Trade Forex Majors
During Active Hours, by David Rodriguez; which was part of the larger overall study of Traits of
Successful Traders by DailyFX.
Jeremy Wagner exhibited another mannerism of trading breakouts in the article How to Trade a Breakout
Strategy on the EURUSD, in which he investigated a breakout sell entry on EURUSD. Interesting to note
that price on the pair is now ~1500 pips lower since that article was published.
As we saw above, AUDUSD can be more volatile than EURUSD; and as Jeremy and David investigated
breakouts on EURUSD in the above references, Aussie can most certainly be used in the same mannerism;
as traders are looking for the bigger moves the market may bring while allowing those moves to continue in
their favor.

Gold (XAU/USD) has been used as a medium for exchange and a store of value for thousands of years.
Normally known as a slow moving asset, gold began the last leg of its rally during the 2008 financial crisis.
From the 2008 low, gold has rallied as much as 181% to its current all-time high at 1920.80. Price is
currently finding support at 1,522.50 after a 20% decline only a year after a peak was established.
With these sharp movements occurring in such a relatively short period of time, gold often leaves traders
with more questions than answers. Today we will be looking at the fundamental factors currently driving the
gold market.

Safe Haven Status

With a modern fiat currency system, Gold has lost much of its use for exchange and payments for goods.
That doesnt mean the asset doesnt have its uses. Gold is now seen as a safe haven investment and used as a
store of value. Traditionally investors have parked their funds in gold in order to retain their value and
purchasing power. During the financial collapse of 2008 many central banks around the world, such as the
Fed in the United States, stepped in to add liquidity (supply of Dollars) to financial markets to stimulate
lending and purchasing. This program known as quantitave easing, increased the assets on the Feds balance
sheet, and by default weakened the purchasing power of the Dollar. As the USD weakened commodities and
gold rallied.
Trading Gold
Trading a commodity like Gold it is always important to view the denomination that a commodity is traded
in. XAG/USD is based in the US Dollar, and is quoted in Dollars per oz. This means the price of gold is
directly impacted by the price of the USD. Below we see Gold compared to the USDollar. These two assets
are inversely correlated, meaning they will head in opposing directions. If the USDollar is heading up,
expect Gold to be trading down.
This information is very useful to traders that have a general fundamental view of the market. If you have an
opinion on Gold or the US Dollar this can be relayed into a trade idea. Often traders that are bullish on Gold
choose to trade the AUDUSD instead of the metal itself. The Aussie Dollar carries a 3.50% banking rate,
meaning traders can earn additional interest while executing a buy order on a positively correlated opinion
of Gold. If a trader is bearish on the AUDUSD currency pair, traders can in turn sell gold to avoid
accumulating interest on their trading balance.
Current Price
Bellow we can see the current price action on gold (XAUUSD) using a daily chart. The market can be seen
consolidating in a triangle pattern between support and resistance. The market has been effectively on hold
for the last 10 months neither making new highs or lows as we wait on new economic policy to influence
direction. Either a new federal easing program or a resumption ofUSD strength could push the asset out of
this pattern. Until this time, traders can elect to set entry orders waiting for a breakout or elect to trade the
interior of the triangle.

As we often see in the carry trade, investors acting rationally in normal market environments will follow
yield. Meaning, if all factors are equal and you are given a choice between an investment paying one percent
and an investment paying five percent most rational people will choose the five percent option.
This article will examine the whats and whys of the times when you might want to pick the one percent
investment instead.
One look at the AUDUSD chart from 2010, which saw lows of .8000 move up to 1.1000, the entire period of
which positive rollover was being accrued for holding long positions in the pair, will confirm the fact that,
typically, investors will follow yield.
 Created by James Stanley
But what happens when the market environment isnt normal?
Such as the 2008 Financial Collapse... or the Tech bust or the S&L crisis?
These are just three of the bigger and more recent examples, but you probably see where this is going: While
a five percent investment will often be more attractive than the one percent investment once the question
of losing your investment altogether comes into play, the safety of each option becomes all the more
important.
As a matter of fact, if you look at the above chart youll notice it wasnt all roses and daylight for The
Aussie in 2010. Ill post the chart below from a different angle than we had looked at previously:

Relative Safety
While the thought of an entire economy such as Europe, or Australia going bankrupt may seem ludicrous,
we have to realize that investors, in all of their fashions whether they are hedge fund traders or central
bankers all hate to lose money.
And through the tests of time, the United States Treasury Bill has proved to be one of the safest financial
instruments the world has ever seen.
In the article, How Treasuries Impact Forex Capital Flows we saw exactly that; how traders in panicking
markets will often choose return of capital, over return on capital.
The above chart illustrates this: If investors are fearful of a recession they will buy US Dollars despite the
fact that any potential returns may be minimal. They are instead choosing safety over profit potential.
They can then invest those US Dollars into Treasury Bills, and despite the fact that they may have smaller
profit potential there is also a far smaller risk of actually losing their investment.
Because if I can earn a rollover payment for holding the position at 5 Oclock today but the trade loses
more money than I make in rollover what is the point?
So if there is perceived economic weakness, investors may run to US Dollars in an attempt to avoid the
chaos. This is often called a flight-to-quality, or a safe-haven run.
A strengthening currency, much like what weve seen in Switzerland or the ravaged economy of Japan, can
rapidly change the balance of payments and cost a country greatly. But because of the sheer size of the
United States economy, investors continue to look for ways of safely parking money so that it may not be
exposed to principal risk.

Traders around the world are increasingly confounded as to how to trade the US Dollar. After multiple
scares and momentum shifts pertaining to debt limits, potential Quantitative Easing, and of course
sovereign debt downgrades, many folks are throwing up the white flag on the Greenback and instead
choosing to speculate on cross pairs such as EUR/AUD, GBP/NZD, or perhaps even EUR/CHF.
Focusing on cross pairs (that do not include the US Dollar) can be an extremely prudent strategy in markets
in which the US Dollar looks like this:

By avoiding the US Dollar, traders can potentially focus on strong trending moves that can be found in the
aforementioned cross pairs.
But what if the trader was adamant about trading the US Dollar? Perhaps its because of the liquidity behind
Dollars, or maybe the trader was welcoming the increased volatility that the Greenback is showing us?
To those traders formulation of strength analysis can add a large arrow in their trading quivers.
By noticing that the NZD/USD currency pair is in the process of formulating an all-time high (currently
sitting 70 pips from this level), traders can gleam that in the event of US Dollar weakness; being long the
Kiwi-Dollar might not be a bad place to be.
Now that can be great if the US Dollar is weakening; but as we saw in the first chart of this article the US
Dollar also has the propensity to strengthen. What pair can the trader look to in these events?
Once again, Im going to draw to the strength analysis that Ive performed. During a good portion of the US
Dollar volatility we looked at earlier, the Euro Zone faced quite a few hardships in regards to the sovereign-
debt of their nation-state constituents. As a matter of fact, when I perform my strength analysis, the Euro
consistently comes up towards the bottom of the list of my strong competitors.
Lets take this point a little further.
If the US Dollar is strengthening, what situations are we generally looking at as a trader? We know that rate
hikes out of the US are probably not coming any time soon (given recent verbiage from Bernanke). We also
know the fundamentals of the US economy dont look so bright (confirmed by speeches last week given by
Bernanke). So the primary situation in which we will probably be seeing US Dollar strength would be a
flight-to-quality, in which traders eschew higher rates of return instead for safety of principal. Those
are the panic situations we discuss in the DailyFX+ Trading Room.
In that situation I want to be short on Euros or short the economy with the highest potential for showing
us bad news. In these events, I want to look to short the EUR/USD currency pair to take part with my fellow
traders in this flight-to-quality.
Article Summary: China is the worlds second-largest economy and its economic growth far outpaces major
industrialized counterparts. Yet its domestic currency, the Chinese Yuan, is not a truly international
currency. Here is a guide on using the USDCNH to trade the uptrend in the Chinese Yuan.
China is the second largest economy in the world, while its currency Renmnibi is not yet a truly
international currency. Yet with the fast developments in Chinas financial system, more Chinese currency
products such as offshore futures have been and will be launched overseas. Investors are likely to be able to
trade in a new global currency competing with the dollar and the euro in the near future.
Get to Know the Key Terms
Before investing in this new opportunity, traders will want to understand some key concepts first.
China s currency is officially called the Renminbi, Peoples Currency literately. The Yuan is the unit of
account, similar to the dollar, so Chinas currency also can be called as the Chinese Yuan.
Renminbi, denoted RMB is the name for the currency traded both onshore and offshore.
If the RMB is traded onshore (in mainland China), it is referred to as CNYtraded as USD/CNY.
If the RMB is traded offshore (mainly in Hong Kong), the ticker will be USD/CNH. Thus, RMB is one
currency but trades at two different exchange rates depending on locations.
Current RMB Exchange Rate and Markets
Many investors may ignore this potential opportunity as they believe RMB is fixed to the US Dollar. It is
partly true. Unlike the U.S. dollar or the Euro, the RMB is not fully-pledged simply based on market supply
and demand; instead, the trading price of RMB is managed floating within a range of 0.5 percent around the
central parity published by the Peoples Bank of China. The central parity is determined by a basket of
foreign currency including the US dollar, Euro, Japanese Yen and other currencies.
The good news for traders is that despite of controlled volatility, the intrinsic value of RMB is indeed
affected by economic forces in the market. Both hedgers and speculators may take advantage of RMB
trading.
In the domestic RMB market, the main players are onshore exporters, who demand CNY and sell the US
dollar, and importers pay US dollar with CNY. On the other side, most speculators participate in the
offshore currency market via the USDCNH in Hong Kongs markets. As the demand for CNH usually
exceeds supply, which is suppressed by government regulation, the CNH is generally trading above the
value of CNY.
Regulator in Focus: Peoples Bank of China
The Central Bank of China plays the most important role on formulate policy on the RMB exchange rate and
also on the reforms to increase the role of Chinese Yuan on the world stage. Investors will want to keep an
eye on it to gauge any clues on fundamental changes and the timing for the Chinese Yuan to become a truly
global currency.
In order to keep currency volatility within the expected range, PBOC, the largest currency trader in China
with over $3 trillion foreign reserves, purchases or sells the US Dollar in the open market.
Historical Chart for Offshore RMB Exchange Rate versus US Dollar (USD/CNH )
Since the height of the global financial crisis in 2008, China has intensified efforts to promote the RMB as
an international currency. Yet more important questions to potential investors are when and how the process
will take place. In order to predict future, we first need to review history first in order to determine the
critical timing for changes in the Chinese Yuan.
The Renminbi was first issued on December 1, 1948 and soon pegged to the US dollar with USDCNY at
approximately2.46Yuan. At that time, China had little international trade so the setup of exchange system
remained in in relative infancy.
As imports and exports continued to increase sharply, China adopted a double currency system starting in
1981: regardless of the official exchange rate, a US Dollar at 2.80 Yuan was used for trade settlement.
From 1994, the Chinese government pegged the RMB to the greenback within a narrow range from 8.27
Yuan to 8.28 Yuan. The fixed exchange rate guaranteed a relatively stable financial market and helped
protect against external shocks as Chinas economy expanded at a fast pace.
On July 21, 2005, the Peoples Bank of China announced that it would lift the peg to the US dollar and
increased flexibility of RMB exchange rate. Following the release, RMB appreciated by 2 percent to 8.11
Yuan. As the use of Chinas currency expanded from trade settlement to offshore financial markets and
direct investment, RMB reform and internationalization has accelerated with a market-oriented focus.
Overall, the development of Chinas economy is the main driver to RMB globalization.

New traders entering markets are often comfortable with the concept of buying when opening a trade. After
all, from the time many of us are infants, we are told to buy low and sell high.
Its easy to imagine how we might be able to profit from this endeavor. If we are able to sell something at a
price higher than we had purchased it, we get to keep the difference.
But financial markets are populated with opportunists that dont want to wait around for a low price to find
potential profits; and with traders willing to buy and sell at many intervals, there is no reason to relegate
opportunities to ONLY buying.
This is where Short-Selling comes in to play.
The term Short-Selling, often confuses many new traders. After all, how can we sell something if we dont
own it?
This is a relationship that began in stock markets before Forex was even thought of. Traders that wanted to
speculate on the price of a stock going down created a fascinating mechanism by which they could do so.
Traders wanting to speculate on price moving down may not own the stock they want to bet against; but
likely, somebody else does. Brokers began to see this potential opportunity; in matching up their clients the
held this stock with other clients that wanted to sell it without owning it. The traders holding the stock long
can be doing so for any number of reasons. Perhaps they have a really low purchasing price and do not want
to enact a capital gains tax. Or perhaps the investor holding long believes the exact opposite of the trader
wanting to sell short?
Whatever the reason, an opportunity exists for the broker to play as a middle-man, in the transaction, and
make a fee for doing so.
The broker would go to the customer who had bought, and was holding a long position to borrow, the
shares.
You may have heard the term re-hypothecation, and thats where this comes into play. Traders that have
went on margin to buy the stock have often already signed a hypothecation agreement, that allows their
broker to use the shares purchased as collateral of the sale. With re-hypothecation, those same brokers can
use this collateral for their own purposes; such as letting other customers borrow the shares to sell (without
really owning).
The customer wishing to sell short could then borrow the shares from the broker, with the promise to buy
back to cover, at a later date and time. The hope of the trader is that they will be able to buy back at a lower
price, repay the loan with the exact number of shares that were borrowed, and pocket the difference in
prices.
If the trader is able to buy back the shares at a lower price, the difference between the price at which the
trader had initially sold the borrowed shares, and the new lower price the trader was able to purchase the
shares to cover the trade becomes the traders profit.
Short Selling in the Forex Market
In the FX Market, transactions are handled differently than stocks.
First of all, each currency quote is provided as a two-sided transaction.
This means that if you are selling the EUR/USD currency pair, you are not only selling Euros; but you are
buying dollars.
If you buy the GBP/JPY currency pair you are buying British Pounds and selling Japanese Yen.
If you sell the AUD/NZD currency pair you are selling Australian dollars and buying New Zealand
dollars.
Because of this, no borrowing, needs to take place to enable the short sale. As a matter of fact, quotes are
provided in a very easy-to-read format that makes short-selling more simplistic.
Want to sell the EUR/USD?
Easy. Just click on the side of the quote that says Sell.
After you have sold, to close the position, you would want to Buy, the same amount (hopefully at a lower
price allowing for profit on the trade).
You could also choose to close a partial portion of your trade. Lets walk through an example together.
Lets assume that we initiated a short position for 100k, and sold EUR/USD when price was at 1.29.
Let's assume the price has moved quite a bit lower. The trader, at this point, has the opportunity to realize a
profit on the trade. But lets assume for a moment that our trader expected further declines and did not want
to close the entire position.
Rather, they wanted to close half of the position in an attempt to bank profits, while still retaining the ability
to profit further on the remainder of the position.
The trader that is short 100k EUR/USD can then click on the Buy, side of the currency quote to begin the
trade closing process of 50k.
After clicking on Ok, our trader has bought 50k EUR/USD offsetting half of the 100k short position that
was previously held.
Our trader, at that point, would have realized the price difference on half of the trade (50k) from their 1.29
entry price to the lower price they were able to close on.
The remainder of the trade would continue in the market until the trader decided to buy another 50k in
EUR/USD to offset, the rest of the position.
At this point in our trading education, we should be aware of the fact that FX spreads are variable and can
widen to levels several times larger than their typical spreads. These spread increases are most often
seen during news releases and can affect our positions rapidly. But, what is the best way to weather the
storm during times of widening spreads?
How to Truly Protect Ourselves Against Widening Spreads
The only way to protect ourselves during times of widening spreads is to restrict the amount of leverage
used in our account (which in my opinion, should be less than 10x leverage). Spreads can only hurt us when
a trade is being opened or closed. If we arent opening or closing a trade during a news events, we wont be
affected. Prices will eventually go back to normal and at some point we will close on our own terms.
The only time the market can force our hand to liquidate our positions is with a margin call. If we reduce our
leverage, we reduce our chances of liquidation.
The Hedging Myth
Helping traders around the world means that I have seen many different methods to trade this market, both
good and bad. One of the most damaging methods Ive come across is the idea of hedging a Forex trade by
opening an opposing trade in the same currency pair and holding both long and short positions
simultaneously. This not only incurs greater trade cost (by paying additional spread) but does not protect
your position against additional losses.
Hedgers attempt to lock-in their profit or loss on a trade by opening an opposing trade, but if the spread
widens, this negatively affects both sides of the trade. If the trader is over leveraged on these trades, a wider
spread could incur a margin call and liquidate both positions. Worst of all, you would most likely be filled at
the widened spread prices, adding insult to injury.
So now we know, hedging is not the proper way to secure a profit or a loss. Only the closing of a position
can do that. Hedging also can be dangerous around widening spreads and can cause margin calls, so we need
to limit the amount of leverage we are using to 10x or less.

Leverage is a financial tool that allows an individual to increase their market exposure to a point that
exceeds their actual investment. For example, a trader goes long 10000 units of the USD/JPY, with $1,000
dollars of equity in their account.
The USD/JPY trade is equivalent to controlling $10,000. Because the trade is 10 times larger than the equity
in the traders account, the account is said to be leveraged 10 times or 10:1.

Had the trader bought 20,000 units of the USD/JPY, which is equivalent to $20,000, their account would
have been leveraged 20:1.

Leverage allows an individual to control larger trade sizes. Traders will use this tool as a way to magnify
their returns. Its imperative to stress, that losses are also magnified when leverage is used. Therefore, it is
important to understand that leverage needs to be controlled.

What is Margin?
Using margin in Forex trading is a new concept for many traders, and one that is often misunderstood. Margin
is a good faith deposit that a trader puts up for collateral to hold open a position. More often than not margin
gets confused as a fee to a trader. It is actually not a transaction cost, but a portion of your account equity set
aside and allocated as a margin deposit.
When trading with margin it is important to remember that the amount of margin needed to hold open a
position will ultimately be determined by trade size. As trade size increases your margin requirement will
increase as well.
What is leverage?
Leverage is a byproduct of margin and allows an individual to control larger trade sizes. Traders will use this
tool as a way to magnify their returns. Its imperative to stress, that losses are also magnified when leverage
is used. Therefore, it is important to understand that leverage needs to be controlled.
Lets assume a trader chooses to trade one mini lot of the USD/CAD. This trade would be the equivalent to
controlling $10,000. Because the trade is 10 times larger than the equity in the traders account, the account
is said to be leveraged 10 times or 10:1. Had the trader bought 20,000 units of the USD/CAD, which is
equivalent to $20,000, their account would have been leveraged 20:1.

Effects of leverage
Using leverages can have extreme effects on your accounts if it is not used properly. Trading larger lot sizes
through leverage can ratchet up your gains, but ultimately can lead to larger losses if a trade moves against
you. Below we can see this concept in action by viewing a hypothetical trading scenario. Lets assume both
Trader A and Trader B have starting balances of $10,000. Trader A used his account to lever his account up
to a 500,000 notional position using 50 to 1 leverage. Trader B traded a more conservative 5 to 1 leverage
taking a notional position of 50,000. So what are the results on each traders balance after a 100 pip stop loss?
Trader A would have sustained a loss of $5,000, loosing near half their account balance on one position!
Trader B on the other hand fared much better. Even though Trader B took a loss off 100 pips, the dollar value
was cut to a loss of $500. Through leverage management Trader B can continue to trade and potentially take
advantage of future winning moves. Typically traders have a greater chance of long-term success when using
a conservative amount of leverage. Keep this information in mind when looking to trade your next position
and keep effective leverage of 10 to 1 or less to maximize your trading.
Leverage gives traders the ability to open positions with trade sizes larger than their account equity. We
want to be careful when using leverage as this magnifies both our trades gains and losses, but how can
leverage be controlled? How do we determine the amount of leverage we are using at any given time? These
are the questions we will cover in todays article.
Margin Can Be a Distraction
Let's say a trader logs into their trading account and finds the amount of margin required to trade 10,000
units of USD/JPY is $200...which means $200 is set aside from my accounts equity. If we wanted to open a
100k trade, that would take $2000 to be set aside, etc.
At this exact moment, many traders begin to look at leverage the wrong way. We see the margin required,
we look at our accounts equity level and then figure out how much we can open. So a trader with a $2,500
account might feel comfortable opening a 100K USDJPY position because it only requires $2,000, but that
would be a terrible decision. Why? Because we would be leveraging our account 40 times!
How We Should Calculate Leverage
So where did we go wrong with our trade? We were so distracted by the margin requirement that we forgot
to look at what we were actually trading, $100,000 US Dollars against the Japanese Yen. $100,000 is 40
times our $2,500 equity that we deposited into our trading account. Using this amount of leverage is very
dangerous and actually decreases the chance we will be profitable traders in the long run.
To solve this problem, we need to first look at the actual trade size in relationship to how much equity we
have in our account. We need to calculate what each trades notional value is and make sure it is not too
large for our risk appetite. A good rule of thumb that I follow is never trade more than 10 times your
accounts equity across all of your open trades.
For example, our $2,500 account we would multiply $2,500 by 10 to get to $25,000. That means we could
open up a maximum of 2 mini lots in USD/JPY and be within the rule of 10. The best part is, as long as we
always keep our trades less than 10 times our equity, we dont need to worry about how much margin each
pair requires. The formula insures our account will be well capitalized for the positions we have open.

Talking Points:
All traders need to master Risk Management
Margin & Leverage can affect your total loss
Plan your stops using Risk / Reward ratios
A trader will learn many things in their career, but no lesson is as important to master as risk management.
Understanding and managing risk will ultimately affect how much we loose on any specific position in the
event that the market moves against an open order. In todays lesson we will being looking at some key
components to understand when it comes to managing risk.
Margin & Leverage
Margin and leverage are two important concepts every Forex trader must know. Forex is traded on margin
meaning money must be put aside to hold open your trade. As the margin requirement is smaller than the
actual trade size traders can leverage much larger position than what you may have on deposit in your
account balance. While leverage can increase your profits, It can also compound your losses!
Normally it is recommended to use no more than 10 to 1 effective leverage as shown below. To learn more
about this equation and how to manage margin and leverage read more at the FXCM University below.

Setting Stops
For most traders, the majority of the emphasis of a trading plan is set on the market entry. However, equal if
not more emphasis should be placed on setting stop orders. This order type is designed to execute in the
event that a position moves against you. Traders should familiarize themselves with this order and how to
place them.
Typically stops are set above a key line or resistance or below a key point of support. Once they are found
they can even be coupled with your trade size to extrapolate your total risk in absolute dollars!
Risk Reward Ratios
Risk reward ratios compare the amount a trader can potentially earn on a successful trade, relative to the risk
to do so. One easy way to find this value is to evaluate the difference between the stop and limit on a
specific trade setup. These values are important because regardless of the strategy used, traders should look
to capitalize on winning positions, while cutting their losses as quickly as possible
Knowing this, traders should always look to maximize their profit potential through the use of a positive risk
reward ratio. This will help traders avoid The Traders Number one Mistake.

Talking Points:
Where To Buy Is A Small Part Of the Puzzle
Learn How To Take Small Losses Early Is Key
Focus On Good Decisions More So Than Right / Wrong
Accepting losses is the most important single investment devise to insure safety of capital
-Gerald Loeb
Its natural for you to look profitable FX traders to see what type of trading methodology you should take
on. Because, you figure, if James Stanley is making money on the Finger Trap strategy, then thats
obviously the way to go right? But if hes doing well with such a short-term methodology, why is Jeremy
Wagner knocking out big moves with Elliott Wave & Donchian Channels? The answer to this question is
that the truth about trading lies less is where to buy and more in deciding where youre wrong and
should get out of the trade.
Where to Buy Is a Small Part of the Puzzle
Of course, you should have an idea where is a good time to enter into a trade. I consider this an edge, when
your entry has a better chance or probability of profit than a random entry. The most common of edges that
youll hear us address at DailyFX is trading with the trend and when reasonable fading the crowd bias with
our Sentiment Index. More importantly, its best to write down the key things that build your edge so that
before you can objectify your edge and not be swayed by emotions before jumping in a trade.
Learn Forex: My Checklist for Entering a Trade
With my objective edge checklist displayed on the AUDUSD chart above its important that you understand
that it doesnt hold the path to riches but it is important. The importance lies in that youre not being pulled
by the latest news headline or largest candle on the chart which could just be a few large orders going
through that doesnt break the overall trend. In fact, a great investor of the 20th century, Sir John Templeton,
used to keep a list of investments hed make if a price got to a certain price and give it to an associate to
enter orders so that he would not be dismayed by the news around that time and in effect keeping his buying
objective when it was easier to be subjective.
The Bottom Line: You need to have an objective way of identifying the edge but getting into the trade isnt
nearly as important as getting out of the trade at appropriate points.
Learn How to Take Small Losses Early Is Key
If you decided to set out and learn the investing secrets of the top traders in the world, youd likely end up
more confused than when you started. The reason for the confusion is that you may read the great Paul
Tudor Jones, who stated, I believe the very best money is made at the market turns. Everyone says you get
killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well
for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and
bottoms."That could easily get you excited about learning how to read market turns but just as quickly, you
may read Bernard Baruch stating, Don't try to buy at the bottom and sell at the top. It can't be done except
by liars. or I made my money by selling too soon, which was in context of catching the meat of a move.
Learn Forex: Decide Where Your Trade Is Wrong before Deciding Where Youre Right

Youll notice in the chart above that I dont know if EURUSD will go to 1.3200, 1.2400, or lower but I
know if EURUSD breaks above 1.3900 which is the trendline resistance that I do not belong in a short
trade. Deciding and honoring your exit point is a very tough but critical point in trading and why two
traders can be very successful but have completely different ways of entering into a trade. In other words, if
one guy is doing great picking tops and bottoms and another is doing great catching the meat of the move
then the common denominator of these professional traders is their ability to decide when they are wrong on
the trade as per their analysis for getting in in the first place.
The Bottom Line: There are many roads that lead to trading well but there is only one highway to trading
poorly and that is letting the market trade past your conviction point for getting into a trade. Make sure you
know at what price you should no longer have your capital at risk or else youre just gambling.
Focus on Good Decisions More Than If Youre Right / Wrong
Its easy to close a profitable trade and think that you were right on your call or close out a losing trade and
say you were wrong on the trade but that can be a harmful way of thinking. The harm comes from the fact
that when you entered the trade, you may have an objective edge as we discussed earlier but you obviously
didnt know whether youre trade would close at a profit or loss (or else, youd never enter a losing trade
again). Whats a more appropriate way to look at any trade is making sure that its based on good and
methodical decisions because a decision is based on collecting the present data and putting the best foot
(buy, sell, flat) forward, which is a fair definition of trading.
As you can imagine, in all of life, were always making decisions. When youve made a bad decision, in
trading as in most of life, youre best served in recognizing when the decision did not turn out as you hoped
and changing your course of action as soon as possible. What can be harmful, is when you tied every
decision you make to your ego so that you wait for the circumstances to hopefully turn so that youre
hopefully proven right and your ego is protected. This hope has cost many traders their career and I hope
this article prevents anyone from repeating this mental error in 2014.
Closing Thoughts
Adjust your thinking on trading so that you see loss control and objective decision making that protects your
capital as the cornerstone of your trading while see an entry price in less esteem as you may have earlier in
your career. That is the truth of trading.

There is a phenomenon that almost every trader struggles with at some point in their career. For some, it
even happens before they ever get started. For me, it was most prominent in my career when I was making
the switch to FX from trading stocks and options.
And that is the ever-present, but occasionally more prominent fear of failure.
Fear can stupefy traders into in-action; allowing their trading accounts to sit idly while their dreams dissipate
into the realities of indecision. Fear can affect us individually, and it can become a pervasive theme
throughout markets, wreaking havoc across the globe; 2008 is evidence how poisonous this emotion can
become.

In this article, Im going to share with you some of the best advice that Ive ever received on the topic of
fear; a short, sweet axiom that I can utter to myself whenever I have a question about whether or not I should
take that trade that instantly dissolves any fear that I may have.
Before we get to the quote, there is an important question that every trader needs to have the answer to at all
points throughout their trading day. The answer to this question will add perspective to our fear; it will show
us how insignificant this emotion can be and even more importantly it will encourage us to battle through
difficulties to get to the promise land. And that question is:
Why do you trade?
There isnt one right answer to this question The answer can be different for all of us.
Some of us just want to make a little extra money so that we can spend more time with our families, while
others have plans and hopes for full-on global financial domination. The answer to this question is your
driver. This is what can make the tough times easy.
Whatever the answer is, it needs to be important to you.
This is your goal. This should be posted on the top line of your trading plan as a reminder of what you hope
to get out of all your hard work. Its of vital importance to keep this in mind, because when we are trading,
there is a litany of factors to stay on top of. Our primary objective can easily become obscured, which can
lead to paralysis by analysis.

One Trade Wont Make Your Career, but It Sure Can Break it
This is how the conversation came about with my friend in which I ultimately found the error of my ways.
The friend, also a former stock trader, had moved into the FX market earlier than I had. He had adapted his
game before FX was the prominent asset class it is today. He has since retired and now spends his days on
the sunny shores of San Diego or Hawaii, wherever his mood takes him. He still trades FX, but primarily for
fun as he doesnt really need to earn another dollar for the rest of his life.
Coming from stocks and options, I was a patient trader. I would find a stock I liked and a reason I liked it
(usually a fundamental story of some kind such as a biotech company with a product up for FDA approval),
and I would then watch the technicals to find a comfortable way to play it. The inclusion of options,
essentially, gave me the opportunity to leverage my ideas. Trading in gaps was a near necessity if I wanted
to catch the bigger moves, and because of this I comfortably developed myself as a swing-trader.

The FX Market can be intimidating

Even after trading in stocks for over nine years at the time I had moved up to FX, the speed of the Forex
market was impressive. The fact that the market never closes was only partly as interesting to me as the
amount of liquidity behind each of the major currency pairs. The availability of 400 times leverage (which
has since been lowered to a maximum of 50 times leverage per Dodd-Frank in the United States), made
these moves seem even more threatening.
Just as I had done with stocks, I was patient. I waited. I looked for an opportunity, a theme with which I
could look to begin to build a position.
And when I finally found that theme, my first entry hit its stop.
I attempted to re-enter, thinking that my analysis was strong, and I now had an opportunity to enter at a
better price. That got stopped out as well.
I worked through this uncomfortable, awkward period of trading a stock-traders strategy in a Forex traders
market, and didnt see results resembling anything close to what I had put up trading stocks. For the first
time in a long time, I was looking at a negative profit line and I began to question whether I really wanted to
adapt to the FX market, or whether I wanted to go back to trading stocks and options.
A traders psychology is of the upmost importance, I knew that then as I know it now, and I realized that I
was starting to dig myself into the pit of despair that traders will occasionally find themselves languishing
within.
So, I talked to my friend. And he started the conversation by asking me the very same question that I began
this article with: Why do you trade?
I gave him my answer, and he then asked me
Do you honestly think you are going to achieve all of that with one trade?
To which I replied, well, no but. At which point he promptly cut me off.
He then went on a lot of people like to trade because of the feeling of being right [which was not the reason
I had provided him.] Its not all that different than the reason people will sit in front of a slot machine
throwing away their childrens inheritance one quarter at a time. They know that the odds are against them,
they just want to feel that emotion of winning. It's an easy trap for human beings, who innately desire to be
right, to fall into.
He continued: with your goal, you are going to need a heck of a lot more than one trade, arent you?
I looked at him like the wizard that he had just become to me, and nodded in agreement.
He went on to say, while you may need a lot more than one trade to get what you want, any one of those
trades can easily drain your account, and end your game pretty quickly.
You need to learn to be wrong more often because any trade you take is going to be but one of a
thousand insignificant little trades in your career.
One of a thousand insignificant, little trades

That line hit me like a freight train carrying a ton of bricks. It showed me where my perspective had become
skewed when moving from trading stocks to FX; the fact that all of this additional leverage I now had at my
disposal was not necessarily something that I had to use. It merely gave me more flexibility, which like
freedom, is best in abundance so that we can choose how or how not to impact our own fate.
More importantly that that this phrase puts into perspective the fact that any one trading idea you have is,
at its very best, a hypothesis. Nobody knows for certain what price will do next. There is risk in every single
trade that we place, and every single idea that we have.
Counter Fear with Planning

The best way to counter fear in the FX market is planning. After the conversation with my friend, I built risk
parameters into my trading plan that will not allow me to lose more than 5% in any given day, or more than
1% on any given trade idea. This is what allows me to look at every trade I place as insignificant in the
grand scope of my overall trading career; because the most that it can hurt me is 1/100th of my account
value.
Some ideas work out, others dont. But worse-case scenario, I come back to the game tomorrow with at least
95% of todays account equity, and a very real chance to move one step closer to my goal.
This part of my plan has truly made each trade I place but one of thousands of insignificant, little trades.
There is a big reason that this is important advice. Because if we are ever to attain our goals, there is but one
way to do it: By placing lots, and lots of trades. Fear is the enemy in that paradigm, and sitting on the
sidelines is only wasting time. Even if its a surreal market condition, trade it on a demo account until you
have a strategy that you feel is consistent enough to put real money to work.

Because the only thing you will never have the opportunity to gain more of in this world is time.
Time is the only asset available to you in a finite amount. You can make more money, you can buy
more stuff, and you can get more of anything else. But you cannot get more time.
Trading gives us the opportunity to make the most of this precious time. Use it wisely.

Article Summary: Forex liquidity is confusing to the new trader. How can a market be seemingly volatile
and liquid at the same time? This article will be a primer to understanding just that.
As one gets started in forex trading, one of the first benefits theyre likely to hear is how much liquidity the
FX Market offers over other markets. The latest figures are roughly $4 Trillion in daily volume as per the
Bank of International Settlements. But what does that mean to you and your trading?
Why Should You Care About Liquidity?

Ask anyone during the 2008 credit crisis who was trying to sell their home what are the benefits of liquidity?
Or maybe a stock trader who is on the wrong side of a trade when its been announced that the stock theyre
shorting is rumored to be acquired by a much larger company at a premium in afterhours trading. These
people were at a financial stronghold because they could not exit their trade when they wanted to and were
subject to illiquid conditions in the market.
Liquidity by definition is the ability of a valued item to be transferred into currency on demand. When
youre trading currencies or Foreign Exchange, youre trading a market that is by itself, liquid. However,
you are trading based on the available liquidity of financial institutions who get you in or out of the trade of
your choosing.
What are the Signs of Liquidity & Illiquidity?

From a traders point of view, an illiquid market will have chaotic moves or gaps because the level of
buying or selling volume at any one moment can vary greatly. A highly liquid market is also known as a
deep market or a smooth market and price action is also smooth. Most traders need and should require a
liquid market because it is very hard to manage risk if youre on the wrong side of a big move in an illiquid
market.
Learn Forex: Illiquid Vs. Liquid Market
FTSE 100 Index - Equity Markets Are Prone to Gaps

Forex Has Many Liquidity Providers Around The Clock

A market that trades 24 hours a day like the forex market is considered more liquid because you can enter or
exit a trade at your discretion. A market that only trades for a fraction of the day like the US Equity market
or Futures Exchange would be condensed a thinner market because price can jump at the open if overnight
news comes out against the crowds expectations.
Are There Gaps When Trading Forex?

Gaps in Forex vary compared to other markets. However, price gaps can occur in Forex if an interest rate
announcement or other high impact news announcement comes out against expectations. Also, gaps can
occur at the weeks opening on Sunday afternoon in the US if there is a news announcement over the
weekend but overall, gaps in Forex are usually less than a %0.50 of a currencys value and orders can be
sent in for execution whenever the market is open and youll be filled as soon as the liquidity provider has a
price for you.
Different Times of Day Offer Varying Amounts of Liquidity

If youre a short term trader or scalper, you should be aware of how liquidity in Forex varies through the
trading day. There are less active hours like the Asian Session that is often range bound and easier to
trade from a speculation point of view. The major moving market sessions such as the London session and
US session are more prone to breakouts and larger percentile moves on the day.
The time of day that youre likely to see the biggest moves are the US Morning Session because it overlaps
with the European / London Session which alone accounts for roughly 50 %+ of total daily global volume.
The US session alone accounts for around 20% and in the US Afternoon, you will often see a sharp drop off
in aggressive moves except for when the Federal Open Market Committee (FOMC) comes out with a
surprise announcement which is but a few times a month.
Closing Thoughts

If youre new to the forex market or maybe youre coming over from a less liquid market, youll be
pleasantly surprised by the liquidity. Youll be able to trade around the clock and the liquidity that provides
smooth price actions makes for good technical analysis. Whatever your back ground, building a trading
plan in this market can conform to you and your availability much better than most markets.
David Rodriguez, Jeremy Wagner, and I spent a lot of time this year sorting through a mountain of statistics.
These statistics were the combined anonymous trading data for over 12 million trades made by account
holders of a major FX broker. During this process, we were searching for one thing what is it that
separates successful traders from unsuccessful ones? What do they do differently? What are the traits or
habits of successful traders?
We found that it wasnt so much what successful traders did that made them successful, but what
they didnt do. I reading through all these statistics, we found some of the most common mistakes that
traders make. For example, many traders trade at the wrong time of day, use too much leverage, or use a
poor risk/reward ratio.
In our four-part Traits of Successful Traders series, we put together some of the common mistakes that the
data points out to us. We then analyze how forex traders can avoid these mistakes, and suggest ways to trade
more effectively. You can follow these articles as we publish them on DailyFX.com. We hope that you find
this research useful in your trading.
Part One: What is the Number One Mistake Forex Traders Make?
We found that traders are right more than 50% of the time, but often lose more money on losing trades than
they win on winning trades. Traders should use stops and limits to enforce a risk/reward ratio of 1:1 or
higher.
Part Two: When is the Best Time of Day to Trade Forex?
Most forex traders are range traders. The best time of day to range trade is Asian trading hours.
Part Three:Here is How to Trade Forex Majors Like the Euro During Active Hours
In Part Two, we made the case for why most traders should trade during Asian hours. We know that some
traders still feel the need to trade during North American trading hours. When trading this volatile time, it is
important to recognize that some strategies work better than others. In this report, we detail which types of
strategies we have found to work the best in the past, and our preferred approach.
Part Four:How Much Capital Should I Trade Forex With?
In Part One we looked at risk/reward. In Parts Two and Three we looked at using the appropriate strategy for
the time of day. In Part Four, we look at the third most common mistake: trading with loo much leverage.
We look at the data for account sizes and give traders guidelines for how to choose their trade size based on
their account size.
Summary: Traders are right more than 50% of the time, but lose more money on losing trades than they win
on winning trades. Traders should use stops and limits to enforce a risk/reward ratio of 1:1 or higher.
Big US Dollar moves against the Euro and other currencies have made forex trading more popular than ever,
but the influx of new traders has been matched by an outflow of existing traders.
Why do major currency moves bring increased trader losses? To find out, the DailyFX research team has
looked through amalgamated trading data on thousands of live accounts from a major FX broker. In this
article, we look at the biggest mistake that forex traders make, and a way to trade appropriately.
What Does the Average Forex Trader Do Wrong?
Many forex traders have significant experience trading in other markets, and their technical and fundamental
analysis is often quite good. In fact, in almost all of the most popular currency pairs that clients traded at this
major FX broker, traders are correct more than 50% of the time:

The above chart shows the results of a data set of over 12 million real trades conducted by clients from a
major FX broker worldwide in 2009 and 2010. It shows the 15 most popular currency pairs that clients trade.
The blue bar shows the percentage of trades that ended with a profit for the client. Red shows the percentage
of trades that ended in loss. For example, in EUR/USD, the most popular currency pair, clients a major FX
broker in the sample were profitable on 59% of their trades, and lost on 41% of their trades.
So if traders tend to be right more than half the time, what are they doing wrong?

The above chart says it all. In blue, it shows the average number of pips traders earned on profitable trades.
In red, it shows the average number of pips lost in losing trades. We can now clearly see why traders lose
money despite bring right more than half the time. They lose more money on their losing trades than they
make on their winning trades.
Lets use EUR/USD as an example. We know that EUR/USD trades were profitable 59% of the time, but
trader losses on EUR/USD were an average of 127 pips while profits were only an average of 65 pips. While
traders were correct more than half the time, they lost nearly twice as much on their losing trades as they
won on winning trades losing money overall.
The track record for the volatile GBP/JPY pair was even worse. Traders were right an impressive 66% of the
time in GBP/JPY thats twice as many successful trades as unsuccessful ones. However, traders overall
lost money in GBP/JPY because they made an average of only 52 pips on winning trades, while losing more
than twice that an average 122 pips on losing trades.
Cut Your Losses Early, Let Your Profits Run
Countless trading books advise traders to do this. When your trade goes against you, close it out. Take the
small loss and then try again later, if appropriate. It is better to take a small loss early than a big loss later.
Conversely, when a trade is going well, do not be afraid to let it continue working. You may be able to gain
more profits.
This may sound simple do more of what is working and less of what is not but it runs contrary to
human nature. We want to be right. We naturally want to hold on to losses, hoping that things will turn
around and that our trade will be right. Meanwhile, we want to take our profitable trades off the table
early, because we become afraid of losing the profits that weve already made. This is how you lose money
trading. When trading, it is more important to be profitable than to be right. So take your losses early, and let
your profits run.
How to Do It: Follow One Simple Rule
Avoiding the loss-making problem described above is pretty simple. When trading, always follow one
simple rule: always seek a bigger reward than the loss you are risking. This is a valuable piece of advice that
can be found in almost every trading book. Typically, this is called a risk/reward ratio. If you risk losing
the same number of pips as you hope to gain, then your risk/reward ratio is 1-to-1 (sometimes written 1:1).
If you target a profit of 80 pips with a risk of 40 pips, then you have a 1:2 risk/reward ratio. If you follow
this simple rule, you can be right on the direction of only half of your trades and still make money because
you will earn more profits on your winning trades than losses on your losing trades.
What ratio should you use? It depends on the type of trade you are making. You should always use a
minimum 1:1 ratio. That way, if you are right only half the time, you will at least break even. Generally,
with high probability trading strategies, such as range trading strategies, you will want to use a lower ratio,
perhaps between 1:1 and 1:2. For lower probability trades, such as trend trading strategies, a higher
risk/reward ratio is recommended, such as 1:2, 1:3, or even 1:4. Remember, the higher the risk/reward ratio
you choose, the less often you need to correctly predict market direction in order to make money trading.
Stick to Your Plan: Use Stops and Limits
Once you have a trading plan that uses a proper risk/reward ratio, the next challenge is to stick to the plan.
Remember, it is natural for humans to want to hold on to losses and take profits early, but it makes for bad
trading. We must overcome this natural tendency and remove our emotions from trading. The best way to
do this is to set up your trade with Stop-Loss and Limit orders from the beginning. This will allow you
to use the proper risk/reward ratio (1:1 or higher) from the outset, and to stick to it. Once you set them, dont
touch them (One exception: you can move your stop in your favor to lock in profits as the market moves in
your favor).
Managing your risk in this way is a part of what many traders call money management. Many of the
most successful forex traders are right about the markets direction less than half the time. Since they
practice good money management, they cut their losses quickly and let their profits run, so they are still
profitable in their overall trading.
Does This Rule Really Work?

Absolutely. There is a reason why so many traders advocate it. You can readily see the difference in the
chart below.

The 2 lines in the chart above show the hypothetical returns from a basic RSI trading strategy on USD/CHF
using a 60 minute chart. This system was developed to mimic the strategy followed by a very large number
of live clients, who tend to be range traders. The blue line shows the raw returns, if we run the system
without any stops or limits. The red line shows the results if we use stops and limits. The improved results
are plain to see.
Our raw system follows traders in another way it has a high win percentage, but still loses more money
on losing trades than it gains on winning ones. The raw systems trades are profitable an impressive 65%
of the time during the test period, but it lost an average $200 on losing trades, while only making an average
$121 on winning trades.
For our Stop and Limit settings in this model, we set the stop to a constant 115 pips, and the limit to 120
pips, giving us a risk/reward ratio of slightly higher than 1:1. Since this is an RSI Range Trading Strategy, a
lower risk/reward ratio gave us better results, because it is a high-probability strategy. 56% of trades in the
system were profitable.
In comparing these two results, you can see that not only are the overall results better with the stops and
limits, but positive results are more consistent. Drawdowns tend to be smaller, and the equity curve a bit
smoother.
Also, in general, a risk/reward of 1-to-1 or higher was more profitable than one that was lower. The
next chart shows a simulation for setting a stop to 110 pips on every trade. The system had the best overall
profit at around the 1-to-1 and 1-to-1.5 risk/reward level. In the chart below, the left axis shows you the
overall return generated over time by the system. The bottom axis shows the risk/reward ratios. You can see
the steep rise right at the 1:1 level. At higher risk/rewards levels, the results are broadly similar to the 1:1
level.
Again, we note that our model strategy in this case is a high probability range trading strategy, so a low
risk/reward ratio is likely to work well. With a trending strategy, we would expect better results at a higher
risk/reward, as trends can continue in your favor for far longer than a range-bound price move.
Game Plan: What Strategy Should I Use?
Trade forex with stops and limits set to a risk/reward ratio of 1:1 or higher
Whenever you place a trade, make sure that you use a stop-loss order. Always make sure that your profit
target is at least as far away from your entry price as your stop-loss is. You can certainly set your price
target higher, and probably should aim for 1:2 or more when trend trading. Then you can choose the
market direction correctly only half the time and still make money in your account.
The actual distance you place your stops and limits will depend on the conditions in the market at the time,
such as volatility, currency pair, and where you see support and resistance. You can apply the same
risk/reward ratio to any trade. If you have a stop level 40 pips away from entry, you should have a profit
target 40 pips or more away. If you have a stop level 500 pips away, your profit target should be at least 500
pips away.
Model Strategy:
For our models in this article, we simulated a typical trader using one of the most common and simple
intraday range trading strategies there is, following RSI on a 15 minute chart.
Entry Rule: When the 14-period RSI crosses above 30, buy at market on the open of the next bar. When
RSI crosses below 70, sell at market on the open of the next bar.
Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.
When adding in the stops and limits, the strategy can close out a trade before a stop or limit is hit, if the RSI
indicates that a position should be closed or flipped. When a Stop or Limit order is triggered, the position is
closed and the system waits to open its next position according to the Entry Rule.
Our research on forex seasonality showed that most traders could be well-served restricting their trading to
less-active trading hours, but what if you cant trade when its quiet? For traders who feel the need to be in
the market during the more volatile times, here is some advice about how to do it.

Our previous report on trading during certain hours of the day emphasized that most traders do poorly
during active markets. We looked through 12 million real trades conducted by retail traders, and the data we
found was quite revealing.
The chart above shows that average profitability varies significantly throughout different trading session.
The takeaway was fairly straightforward: for most traders, avoiding the most active trading sessions can
improve performance.
In our hypothetical results, the returns of a simple Relative Strength Index (RSI) trading
strategy improved dramatically when we limited its trading to the hours of 2:00 PM 6:00 AM Eastern
Time.
But limiting trading to those hours is impractical for some and unsatisfying for othersthere should be a
way to take advantage of stronger volatility. And thats exactly where we come upon breakout trading
strategies.
What Strategy Can We Use to Trade the US Daytime?
We believe most should avoid trading during volatile hours due to clear patterns in real trader performance,
but we also acknowledge that this may be impractical or undesirable for many. The reason is simple: most
retail traders use range trading strategies, which do poorly in volatile trading conditions. If trading during
active hours, we believe breakout strategies are more likely to succeed.
What is a Breakout?
A breakout is when a currency that has been trapped in a range breaks through support or resistance, escaping
the range. When this happens, the movement in prices can be very powerful and can create a trading
opportunity.
Here is an example where the US Dollar/Japanese Yen Daily chart held a narrow price channel for over 12
months. You can see that when this channel broke, the move was swift and powerful.
US Dollar/Japanese Yen Daily Chart Shows Major Breakout

Prepared by David Rodriguez

How Can We Trade Breakouts?
Trading breakouts is almost the exact opposite of range trading. Most traders instinctively buy a currency
pair when it has fallen and is near support and sell when price is expensive and near resistance. They do this
in anticipation that price will reverse and stick to broad trading rangesor range trade, for short.
Breakout trading strategies buy the currency pair when it rallies above resistance and sell it when it breaks
below support. These breakout trades work when price continues significantly higher or lower, and they
perform poorly when currencies stick to well-defined trading ranges. In other words, breakout trading will
often work when range trading does not. Lets use this to our advantage.
Sample Strategy: Donchian Channel Breakout
The Donchian Channel Breakout strategy is straightforward. The system draws a channel surrounding price
action, with the top of the channel set at the highest high and the bottom set at the lowest low of the past 20
bars.
In the chart below, you can see the top and bottom of the channel in blue. The blue vertical lines show breaks
above and below the Donchian channel. The dashed line shows profitable trades made by the system, while
the red dashed line shows losing trades made by the system.
Donchian Channel Breakout Strategy on a USDJPY 60-Minute Chart
Prepared by David Rodriguez
The strategy sells the currency pair if the price breaks below the channel bottom. If price quickly reverses,
it will be taken out of the trade at a loss. Yet if price continues lower, the strategy stands to see profits on the
continued moves. It likewise buys the currency pair if price breaks above the channel top.
Thus we can conceptualize that this trade system might work especially well during times of high volatility,
when channels tend to be broken. Lets test by looking at how well it has done on the Euro/US Dollar in the
past several years:
Channel Breakout Strategy on EURUSD Pair from 2001-2013, 60min Chart
The channel breakout system did reasonably well overall, and especially well during times of strong market
volatility in late 2009. Yet it has also had long stretches of underperformance and noteworthy losing
streaks. Since we know that breakout strategies tend to work better during times of higher volatility, how can
we instruct our system to trade only during those times?

When Can We Look to Trade Breakouts?

We publish Volatility Percentile figures on the DailyFX Technical Analysis page for reference. The
Volatility Percentile is derived from FX options prices.
The higher the number, the more volatile options traders expect the currency pair to be. We can use these
volatility percentages to judge when it may be best to use particular strategies. When volatility percentiles
are high, we look to trade breakout strategies. When they are low, we look to avoid them.
When looking at the Channel Breakout strategy above, our research shows that the strategy hypothetically
improved noticeably when we apply filters. We plot two hypothetical results below.
In one case, the strategy is allowed to trade whenever the EURUSD breaks above its 20-hour high or
below its 20-hour low. In the other, it is only allowed to take those trades when the EURUSD Volatility
Percentile is above 75%. As you can see in the chart below, the volatility-filtered result is hypothetically an
important improvement over the base strategy.

With the 75 percentile filter, the system can only trade roughly 25 percent of the time. Obviously this means
that were rarely tradinglikely frustrating at pointsbut we feel that the hypothetical improvement in
the strategys returns could justify the trade filter.
Game Plan: What Strategy Can We Use?

When volatility is above 75%, we may use a Channel Breakout trading strategy. Our data show that over
the past 10 years many individual currency traders have generally been unsuccessful trading in times of
high volatility. As we spoke about in our earlier article on real trader successes and failures, we
generally recommend trading European currencies during the Off Hours using a range trading strategy.
Such an approach has historically produced good results and best matches how most retail traders trade.
We believe that traders who feel the need to trade during times of high volatility should use a different
strategy and look to trade breakouts rather than ranges. Breakout trading has historically shown superior
risk-adjusted returns if limited to the most volatile trading days.
We can use the DailyFX Volatility Percentage to gauge what FX options traders expect for volatility in the
near future. When above 75%, breakouts are historically more likely than normal, so look for opportunities.
Model Strategy: Donchian Channel Breakout Trading on a 60 Minute Chart

For our models, we used one of the most common and simple breakout trading strategies there is, creating
channels on a 60 minute chart.
Entry Rule: When price crosses above the highest price of the last 20 bars, buy at market on the open of the
next bar. When price crosses below the lowest price of the last 20 bars, sell at market on the open of the next
bar.
Filter: Strategy can only enter new trades when the Volatility Percentage is above the specified level (such as
the 50% or 75% examples used above).
Exit Rule: Strategy will exit a trade and flip direction when the opposite signal is triggered.
As was shown earlier, in the EUR/USD this strategy has shown the best risk-adjusted returns in the EUR/USD
over the past 6 years when it was restricted to trade only when the Volatility Percentage was above 75%.
Talking Points:
Fundamental Analysis in the Currency markets centers around Macroeconomic data
Macroeconomic analysis can be simplified by focusing on interest rates (and expectations)
Traders can incorporate Price Action to make analysis even more simplistic
Fundamental Analysis in the stock market involves analyzing the inputs of a company in an effort to
forecast future growth potential. For an individual company, this can be a very logical way to look for
investment ideas. Fundamental Analysis of a company would involve investigating that companys financial
statements, to notice changes from one year to the next; or perhaps looking that the management of that
company, and their track record in order to determine how successful they might be towards accomplishing
their goals.
In the Forex market, many of those statistics dont exist, and were trading entire economies against one
another. In each of these economies, thousands of companies exist trying to maximize their profit potential,
so the analysis of a single companys management structure or market share doesnt really mean a whole lot.
Due to the nature of the market, many traders refer to technical analysis, and we showed you how
fundamental data events can be traded with technical analysis in the article The Potent Combination of
Fundamentals and Price Action. In this article, were going to go in-depth behind how fundamentals impact
prices in the FX market.
Why Currency Values Matter
Currency prices matter because of cross-border trade. We investigated this concept in-depth in The Nucleus
of the FX Market. In the article, we saw how the nation of Japan was absolutely ravaged by a strong yen; as
a stronger yen meant lower profits and margins for Japanese exporters.
The concept of Fundamental Analysis in the Forex Market can be all boiled down to one simple data point:
Interest Rates. If interest rates move higher, investors have a greater incentive to invest their capital; and if
interest rates move lower, that incentive is lessened. This relationship is at the heart and soul of
macroeconomics; and this is what allows Central Bankers to have tools to steward their respective
economies.

The decision to increase or decrease rates can bring impact to other economies as well. Lets say, for
instance, that you are an American with cash to invest. After having little incentive and extremely low rates
for a long time, you notice that The United Kingdom increases rates 25 basis points. This increase in interest
rates from the Bank of England can and should bring higher rates in other issues from The United Kingdom;
so you may not necessarily buy Gilts or a government bond, but investors can now look to invest in England
to get that higher rate of return.
Additional investors thinking the same thing rush into UK bonds, and eventually the price of the British
Pound will go up to reflect this additional demand. Now it becomes slightly more difficult for the UK to
export goods (similar to the problem Japan faced in The Nucleus of the FX Market).
A great example of this was in Australia from 2002 leading up to the Financial Collapse; as insatiable
demand from China drove growth throughout Australia, unemployment got very low and inflation moved
very high. The Reserve Bank of Australia (RBA) moved to increase interest rates, and currency prices
followed.
The Aussie more than doubled while RBA moved rates from 4.25% to 6.75%
This is an interest rate cycle, and it drives capital flows that are at the heart of the FX market.
How Interest Rate Cycles Drive Economies

It all goes back to the incentive to invest. If Central Bankers want to slow down their economy, they look to
raise rates. If they want to encourage more growth within an economy, they look to decrease rates.
Higher or lower rates bring a two-pronged impact on the economy.
The first and most obvious impact is the incentive to invest. If rates increase, that incentive to invest also
increases; and if rates decrease, so does the incentive to lock up ones money.
The second impact is what this does for capital expenditures. If rates decrease, the attractiveness of locking
up a long-term loan at the new lower rate is much higher than it was previously. The incentive to buy big-
ticket items like homes, and cars is now higher.
And when you buy a home or a car, the homebuilder or car maker has to turn around to pay for their
materials and workers. If the lower rates increase the number of homes or cars that are being purchased, this
amounts to growth. Homebuilders and car makers will eventually have to hire new workers to keep up with
the demand; and as demand for workers increases, so will the wages that are needed to attract qualified
candidates.
This is how lower interest rates can bring higher employment and inflation (often shown as CPI or
Consumer Price Index); and its at this point that Central Bankers are going to investigate increasing rates
in an effort to prevent the economy from over-heating.
If interest rates stay low, the effects of over-heating could be immense. Prices can continue inflating, and if
left unchecked could bring hyperinflation.
Imagine going to the store to buy a gallon of milk and seeing the price at 27 dollars. I dont know about you,
but Id freak out at seeing something like this. Then my mind would wander to other areas where costs
might be increasing. If a gallon of milk is 27 dollars, then how much will that new car cost me? How much
is milk going to cost tomorrow?
So, Central Banks want a moderate rate of inflation. This helps to keep growth within an economy; people
get pay increases, more people are working and paying taxes, and consumers have the confidence that they
can save their money for tomorrow because prices wont increase a hundred-fold overnight.
What do Central Bankers Watch?
Both Central Bankers and Forex Traders watch macroeconomic data prints with the goal of getting
something out of them; but their objectives are slightly different.
FX Traders are often interested in the price reaction of a data print. If CPI comes out higher than expected,
then traders may be looking for long positions to move higher.
FX Traders can price in new data quickly, creating volatile price movements
Central Bankers, however, take a much more broad view on such statistics.
Central Bankers want to watch the primary points of reference for an economy in an effort to make the
correct decision as to where to move rates.
Inflation and employment are chief amongst these statistics, as these are two of the primary pressure points
within an economy. If unemployment is high, the economy will likely struggle. As
employment/unemployment prints are released out of an economy, this new information is factored in fairly
quickly. FX Traders will begin pricing this in with the probability of an eventual rate hike or cut by Central
Bankers to factor this information in.
Same for inflation: As inflation (CPI) data prints are released in an economy, traders will act quickly to
incorporate this new information in to prices. Meanwhile, Central Bankers are watching cautiously to decide
if they want to do anything at their next meeting.
Increasing unemployment (decreasing employment) along with decreasing inflation are threats to an
economy that will usually see Central Bankers investigate rate cuts.
Decreasing unemployment (increasing employment), and increasing inflation are signs of a growing
economy, and this is when Central bankers will look at potential rate hikes.
But, Central Bankers and Forex traders alike are not happy to just sit around and wait for employment or
inflation numbers to show changes within an economy. This has brought to light numerous additional data
prints that traders and investors will look to in an effort to anticipate changes to inflation, unemployment and
interest rates.
Consumer statistics are extremely important in large economies like The United States, or Europe in which
consumer activity has a heightened level of importance for the global economy. In the article, The Lifeblood
of the US Economy, we looked at the major data releases that include this information. The Euro can get
extremely volatile around releases of Consumer Sentiment Numbers, and this is because consumer activity
in established economies is often looked at as a precursor to inflation, employment, and growth.
GDP, or Gross Domestic Product, is a direct expression of growth (or contraction) within an economy, and
this can also be a huge precursor to price movements; especially if the announced rate of growth is far away
from expectations. But, in and of itself, increases or decreases in GDP dont bring more jobs or higher
inflation, so this is often looked at as more of a lagging fundamental indicator.
Production numbers can be especially important in growing economies that are at a very industrialized stage
of the growth process. China is a phenomenal example; as each months PMI (Purchasing Managers Index),
will draw massive interest from numerous parties around the globe.
PMI is a survey thats recorded from producers gauging their sentiment on future orders. The thought behind
this statistic is that if producers are seeing growth, then that growth will eventually cycle through to
consumers; after all, if someone wants to buy a good, it has to be produced in the first place, right?
Bullish Data Bearish Data
Higher GDP Lower GDP
Higher Inflation Lower Inflation
Higher Employment Lower Employment
Lower Unemployment Higher Unemployment
Higher Consumer Lower Consumer
Confidence Confidence
Higher PMI Lower PMI
Regardless of the data print or release, the markets reaction always comes back to interest rate cycles, and
how that improvement or decline in measured activity might eventually amount to an interest rate increase
or decrease.

How to Trade Fundamentals

A line that I used in The Potent Combination of Fundamentals and Price Action is a line that I say quite a bit
in webinars and live events:
Not only do you not know what any given data print might be, but you arent entirely sure of how the
market might price it in.
This makes trading on fundamentals in the FX market dangerous; because you could guess that GDP is
going to come out better than expected, and you can trade it accordingly and still eat a stop. You can be
right, and still lose.
In stocks, trading on fundamentals makes a lot of sense. You can grade company A versus company B in
relevant markets. Youre trading one small part, of one economy, in the larger global macroeconomic
environment.
The market capitalization of any company that youre trading might be a few hundred billion, at most. The
currency market turns over north of $5,000,000,000,000 every day. Thats 5 trillion, and this is on the low-
side of estimates.
Youre trading entire economies against each other, and it can be much more difficult to use fundamental
points of reference in an effort to project future growth potential.
For this reason, many traders in the FX market incorporate or include Technical Analysis in their
fundamental trade ideas. This can bring quite a bit of benefit to the trader in helping to determine trends or
biases that may have been exhibited in a currency.
How Technical Analysis can improve your fundamental approach
Earlier in the article, we used the hypothetical example of the Bank of England increasing interest rates 25
basis points. When this happens, well generally see traders buying the British Pound to get this new, higher
rate.
But, its not only rate hikes that will see buying the Forex market; as traders dont want to wait around to see
a Central Bank do what they know that theyll probably do anyways.
So, as we see increasingly positive data coming from the UK; data that may eventually amount to an interest
rate increase, well see increased demand for the British Pound. This increased demand will show higher
prices.
So, this is a fundamental theme that is clear and apparent in the technical setup of the chart. If there is an
up-trend, prices are moving higher for a reason, right?
Prices can show biases and trends in fundamental data

Taken from The Potent Combination of Fundamentals and Price Action

Traders can incorporate price action to see where these trends may be existing, and to what degree they
might be traded. Then, traders can also use price action to buy up-trends cheaply, and sell down-trends
expensively; so that if that momentum continues, they can look to profit.
Over the past few months, weve published multiple articles on the topic of Price Action, which is the study
of one of the most pure indicators available to traders: Price.
With knowledge of price action, traders can perform a wide range of technical analysis functions without the
necessity of any indicators. Perhaps more importantly, price action can assist traders with the management
of risk; whether that management is setting up good risk-reward ratios on potential setups, or effectively
managing positions after the trade is opened.
This article is a capstone of all of price action studies that weve published thus far; teaching traders to
analyze and grade trends, enter trades in 6 different ways with various setups, and manage risk while
looking at support and/or resistance.
Before we get into the individual elements of price action, there are a few important points to establish.
Trend Analysis
The first area of analysis that traders will often want to focus on is diagnosing the trend (or lack thereof), to
see where any perceivable biases may exist or how sentiment is playing out at the time.
In Price Action Introduction we looked at how traders can notice higher-highs and higher-lows in currency
pairs to denote up-trends; or lower-lows, and lower-highs to qualify down-trends. The chart below will
illustrate in more detail:

Entering Trades
After the trend has been analyzed, and the Price Action trader has an idea for sentiment on the chart, and
trend in the currency pair its time to look for trades.
There are quite a few different ways of doing so, and weve published quite a few resources on the topic.
In Price Action Pin Bars, we examined one of the more popular candlestick setups available, which traders
will commonly call a Pin Bar. The Pin Bar is highlighted by the elongated wick that sticks out from price
action. The picture below will show a pin bar in greater detail:
We took this a step further in How to Trade Fake Pin Bars, as we looked at how traders can trade candles
that show long wicks that dont quite stick out from price action. This is where trend analysis can greatly
assist in the setting of initial risk (stops and limits). The following picture will show how a trader might want
to play a Fake Pin Bar.

Periods of congestion or consolidation can also be used by traders utilizing price action. In Trading Double-
Spikes, we looked at the double bottom or double top formation that is popular across markets. We
looked at two different ways of playing Double-Spikes, both of which weve outlined in the following 2
charts.
We looked at the Double-Spike breakout for instances in which traders are anticipating that the support (or
resistance) that has twice rebuked price may get broken with strength. The Double-Spike breakout is plotted
below:
And for situations in which traders are anticipating support or resistance continuing to be respected,
the Double-Spike Fade may be more accommodating:

On the topic of congestion, another very popular setup that we discussed was Trading Price Action
Triangles.
While there are different types of triangles, most traders look to trade these periods by anticipating a
breakout. Below is the Descending Triangle, in which price has respected a horizontal support level while
offering a down-ward sloping trend-line. Related is the ascending triangle that is highlighted with an upward
sloping trend-line. In both instances, traders are often looking to play breakouts of the horizontal support or
resistance level (this horizontal line is support for descending triangles, and resistance for ascending
triangles).

If no horizontal support or resistance exists, traders may be looking at a symmetrical triangle, which adds
an element of complication since there are no horizontal levels with which to look to play breakouts. The
following illustration shows a symmetrical triangle setup, along with how a trader may look to trade it:
And for periods in which the market is ranging the article How to Analyze and Trade Ranges with Price
Action went over the topic in detail.

Risk Management
In Price Action Swings we identified swing-highs and swing-lows with which traders could use to
identify comfortable areas of setting stops or limits.
And of course, in an up-trend:

We took this a step further in the article How to Identify Positive Risk-Reward Ratios with Price Action, so
that traders can analyze the relevant swings to decide whether or not the potential trade (given its
management parameters) would be warranted.

And of course, once we are in the trade, managing profits is a topic of key consideration. We looked at
exactly that in Trading Trends by Trailing Stops with Price Swings. The following picture will illustrate this
concept further:
The British Pound Japanese Yen currency pair is a volatile offering that presents traders with potentially
large moves in price relative to many other pairings. This currency pair is, at times, so volatile that it has
earned the nickname of The Dragon, as well as another well-coined term: The Widow-maker.
Whatever you call it, the fact remains the same: GBPJPY can really move.
Take, for instance, the initial throws of the Financial Collapse in 2008. While the EURUSD had, at one
point, gone down by ~3300 pips, the top-to-bottom move on GBPJPY was much larger: at one point a loss
of more than a staggering 7000 pips.

This volatility can be a good thing, or it can be a very bad thing; depending on how you trade.
DailyFX Traits of Successful Traders
Exhaustive research was performed by DailyFX Quantitative Strategist David Rodriguez, examining more
than 12 million trades placed by live traders. The goal of the research was to find out how traders were
speculating, what wasnt working, and what we, as an education and research group, could do to help.
The results of the research are shocking, and what was found was that the Number One Mistake that FX
Traders Make often revolves around risk-reward ratios; that is, how much is lost on losing trades against
how much is profited on winning trades.
From the research, David states:
Traders are right more than 50% of the time, but lose more money on losing trades than they win on
winning trades. Traders should use stops and limits to enforce a risk/reward ratio of 1:1 or higher.
GBPJPY is an extreme example of this fact.
From our research, we can see that traders are correct a whopping 66% of the time on GBPJPY!
But exactly as David had found in the research, this robust winning percentage didnt translate into profits;
as traders took far larger losses when they were wrong than profits when they were right:
Traders win, on average, 52 pips on GBPJPY trades when they are right; but when they are wrong, they lose
a monstrous 122 pips. From the above chart, GBPJPY is showing the lowest ratio of pips won v/s pips lost
(on average).
This type of risk-reward ratio puts traders in a precarious position; as to be profitable over the long-term one
would have to be right about 75% of the time (3 out of 4) to be able to hope for a net profit.
I dont know about you, but there are very few things in life I want to expect to be right 75% of the time
with; least of all anything that could cost me money when I am wrong.
Trading GBPJPY
Trading a currency pair like GBPJPY could be optimal for traders looking for volatility or large moves; but
it should be noted that those moves arent always very smooth; which is exactly why overall profitability
wasnt higher on the pair.
The first point of emphasis is that given the above points, trading in GBPJPY should always entail a
protective stop-loss order. Lack of doing so exposes the trader to significant risks as the pair may trend for
an extended period of time.
Due to this volatile nature, and given the fact that the pair could trade with very wide swings in either
direction, breakouts can be an attractive approach when trading GBPJPY. This will allow traders to
maximize profits on the large swings when they are right; while also allowing them to cut their losses short
as the big swings move against them.
With breakout strategies, traders are monitoring support and/or resistance; waiting for a break of the price
level with the expectation that once the break is made price will continue running in that direction,
allowing for the maximization of profits in instances when the trader is correct (which is yet another reason
stop losses are important, as those extended moves can cost significantly in instances when the trader is
incorrect).
In the article Price Action Breakouts, we looked at a mannerism for trading price-breaks without the
necessity of any indicators at all, using price alone to denote support and resistance levels.
In the article, Breakouts: How to Stay Away from Some Losing Trades, Jeremy Wagner introduces
another indicator, price channels aka Donchian Channels, to help monitor price levels that may warrant
future breakout opportunities.
For traders speculating in -denominated currency pairs, Ichimoku may also be a relevant manner of
analysis. Ichimoku is a popular technical system that was developed in Japan before World War II. Its
staying power as a popular mechanism for initiating trades has continued, as the system is still widely in use
today.
Ichimoku is often used as a trend-following system, but with a slight modification can be used to trade in
breakout-style scenarios.
A large part Ichimoku is The Cloud, which is a moving area of support or resistance plotted on the chart.
When price breaks through either side of the cloud, the trader can often look to trade breakouts by placing a
trade in that direction.

One of the oldest and most popular currency pairings in the world is the British Pound v/s the United States
Dollar.
Speaking directly to this quality, the name The Cable comes from the first transatlantic cable that was laid
across the floor of the Ocean for the United States and Great Britain to communicate with one another.
One of the primary pieces of information exchanged on this first transatlantic cable were currency quotes on
the two currencies.
A lot has changed since that first Trans-Atlantic cable was placed on the floor of the Ocean, but the
GBPUSD currency pair continues to remain a favorite to traders around the world.
This article will take a closer look at this pair, and how traders may want to build their approach in trading
The Cable. At the end of the article, well also enclose 2 strategies for trading in GBPUSD.
Characteristics of the GBPUSD
The reasons for GBPUSDs popularity are abundant. The United Kingdom and the United States represent
two of the oldest, modern economies in the world. Both economies feature a relative amount of safety, due
in large part to the sheer size that each represents to the overall global economy. Below is a listing of the
worlds 10 largest Independent economies (using 2011 IMF Statistics, in Millions of US Dollars):
Perhaps a larger contributing factor to interest in the GBPUSD currency pair is the fact that London is often
considered to be the center of the Forex trading world.
Estimates approximate that 35% of volume traded in the FX Markets takes place through London. This is
the period just before the United States opens for business, leading to some of the most liquid trading times
of the day.
This can greatly affect the traders approach during the London Session, and more specifically in trading
the GBPUSD currency pair.

Strategies for Trading GBPUSD

Before deciding on the way that you want to trade The Cable, you should probably answer another
question first.
When are you planning on trading?
As we found in the DailyFX Traits of Successful Traders series, the different trading periods in the market
can exhibit markedly different tones.
The Asian Session(s) from Sydney and Tokyo have a propensity to be more accommodating for Range-
Trading approaches, as hourly moves are in general smaller than what we may see during the more
active London and US sessions.
Range-Trading approaches often look to buy when price is cheap and at support; and sell when price is
expensive, or at resistance. There are quite a few different ways of doing this. In the JW Ranger Strategy,
DailyFX Instructor Jeremy Wagner looks at trading ranges with the Commodity Channel Index, or CCI. In
How to Analyze and Trade Ranges with Price Action, I walked you through a way of trading ranges
without needing any indicators at all; using only price to point out pertinent areas of support and resistance
for building our approach.
For traders looking to trade GBPUSD during the more active times in the market, when liquidity is coming
from Europe and the United States, breakout trading may be more accommodating. With breakouts, traders
are watching support and resistance, much like in the Asian session. But differing from the Asian session,
support and resistance may be broken much more frequently as the onslaught of liquidity entering the
market can potentially push price in one-direction for an extended period of time.
Trading Breakouts on GBPUSD
For traders looking to trade breakouts on GBPUSD, there are, once again, quite a few ways of doing so. A
key component of trading breakouts is looking for strong risk-reward ratios, such as the trader risking 20
pips, but looking for 100 pips if correct. This could be classified as a 1-to-5 risk-to-reward ratio (20 pips at
risk 100 pips sought = 1:5 risk-to-reward).
With a risk-reward ratio so aggressively on the traders side, one would need to be right only 2 out of 5
times to gleam a net profit. If a trader was right 40% of the time with a 1-to-5 risk-to-reward ratio, they
could be looking at a handsome profit ( 2 winning trades at 100 pips each = 200 pips won, 3 losing trades at
20 pips each = 60 pips lost, net profit of 140 pips (200-60) not including commissions, slippage, etc).
In How to Identify Positive Risk-Reward Ratios with Price Action, we looked at mannerisms for finding
and calculating risk amounts. The same mechanism used in that article, identifying previous swing-highs
for short positions, or looking for previous swing-lows for long positions can be used to identify areas to
place stops in breakout strategies.
However, since traders are looking for new highs or new lows with breakout strategies limits or profit
targets can be calculated simply by looking for a multiple of the risk amount (i.e., Im risking 63 pips on this
trade, so I will look for 5 times my risk amount (or 315 pips (63 X 5)) for my profit target.
As for strategies to trade breakouts, traders can look to the Price Channel indicator, looking for breaks of the
highs and lows that were seen on the longer-term charts.
For traders looking to utilize Price Action in their Breakouts strategy, we looked at exactly that in the article
Price Action Breakouts.
Whatever your mechanism for identifying support and resistance; looking to trade breaks of these levels
during the active period(s) of the day while looking for price to respect these levels during the more quiet
periods will generally bring the trader more robust results, in GBPUSD or any of the other major currency
pairs.

Article Summary: A simple Forex strategy used by traders is a price breakout strategy. Here are 4 easy to
follow steps to trade a price breakout and manage that risk.
You have probably heard the phrase buy low and sell high. This phrase permeates many different markets
from real estate to automobiles. However, there are times, when you actually want to buy higher while
selling lower. A breakout strategy does just that and it tends to work best during volatile market conditions
or in strong trends. Today, well discuss a 4 step strategy to trading breakouts in Forex.
Here are the 4 steps to identifying your Forex breakout trade.
1. Add the Donchian Channel indicator (DNC) to your chart
2. Identify the direction of trend
3. Enter on a break of the DNC using entry orders
4. Exit on a break of the opposing DNC using a stop loss
Lets unpack each step of the strategy further.
The Donchian Channel Indicator
Add the Donchian Channels indicator to your intraday chart (between 1hr and 4hr charts) with an input
setting of 55.
If you wish to utilize longer time frame charts such as a daily chart, then follow these steps in how to trade
Forex in your spare time. Trading from a daily chart will offer less trading signals and you will be in the
trades longer versus an intraday chart which offers more signals with some of those signals being less
reliable.
Identify Your Trend
As with any strategy, at DailyFX Education we recommend that you filter your trades solely in the direction
of the trend. There are many benefits to following trends. Two benefits of trend trading include being bailed
out of having an imperfect strategy and there are more pips available in the direction of the trend. Therefore,
trading with the Donchian Channels is no different and we want to incorporate a way to filter our trends and
bias our signals.
Add Your Entry Order
Once we have determined a trend bias, identify the entry price by incorporating the trend and Donchian
Channels together.
For example, in an uptrend, we want to buy 1 pip above the upper Donchian Channel. The best signal occurs
on the first occasion where the upper Donchian Channel is reached. Subsequent breaks of the upper channel
are ok, but the trend is a bit more mature and therefore, more likely to reverse.
In a downtrend, we want to sell 1 pip below the lower Donchian Channel. Again, the best signal occurs on
the first occasion where the lower Donchian Cchannel is reached.
Add Your Exit Order
Once you have determined where to get in, it is important to know where to exit the trade. This strategy
utilizes a manual trailing stop which is how many professionals manage their stops. For the purposes of this
strategy, the trailing stop is located at the same price as the opposing Donchian channel.

For example, if the trend is up, then we will use the lower Donchian channel as the stop loss. If you remain
in the trade long enough, then over time, the lower Donchian channel and your stop loss will begin to move
in your favor. The longer you are in the trade, the more favorable the trailing stop moves in your direction.
Conclusion
Many traders often ask if they can trade breakouts without having to use the Donchian channels indicator.
The answer is yes, of course. The basic elements of a Forex breakout strategy remain the same. Look for a
level of support and resistance, and play a price break of those levels.
As with any strategy, your entry and exit rules are just a couple pieces to the trading plan puzzle. Make sure
your risk is commensurate to the size of account you are trading. In our DailyFX EDU courses, we talk
about risking less than 5% of your account on all open trades.
 Ichimoku
There are 5 lines used with Ichimoku, and this article will explain each.
The Signal
At the heart of Ichimoku is a 9 and 26 period moving average built on average price. The 9 period Moving
Average is called Tenkan-Sen, while the 26 period moving average is called by Kijun-Sen.
Much of the action with the Ichimoku takes place with these two lines, so it is important to recognize their
function of each.
The 9 period moving average, or Tenkan-Sen, is the fastest moving average, and I call this the Trigger
Line. An easy way to remember this is T, for Tenkan-Sen, stands for Trigger.
The 26 period moving average, or Kijun-Sen, is the slower of the 2 averages, and I call this the Base
Line.
Like many crossover strategies, a bullish signal is generated when the fast moving average, or the Trigger
Line (Tenkan-Sen) crosses the Base Line (Kijun-Sen).

Conversely, a bearish signal is initiated when the fast moving average, or the trigger line, crosses down and
under the slower moving average, or the base line.
The crossovers taking place within Ichimoku are the heart of the system; but many traders already know that
moving average crossovers can be tricky. Not all will work out, and many signals will lag the market as
price reverses shortly after the crossover takes place.
This is where Ichimoku can shine, and well investigate that in the next portion of the indicator: Kumo.
Kumo
If there is one part of Ichimoku that sticks in traders minds, its The Cloud, or called Kumo, in Japanese.
The Cloud actually consists of 2 lines, with the area between the 2 lines shaded; offering traders a unique
addition to their charts.
To create Kumo, we can take 2 lines, known as Senkou Span A and Senkou Span B, and look to the area of
the chart between these two lines for potential support and/or resistance.
The Cloud is always plotted 26 periods in advance, and this is where the trader can receive assistance in
grading the strength of the signals taking place with the Trigger and Base Line Crossovers we looked at
above.
If Price Action is residing ABOVE Kumo, traders can consider that the posture of the pair is bullish. In this
case, Kumo is a variable area of support. The below picture will show this relationship. Notice the inflection
points at which prices were supported by the cloud:

If Price Action is below Kumo, the exact opposite is the case. Traders can grade the posture of the pair as
bearish, with Kumo functioning as Resistance.
Grading Signals
One of the primary benefits of being able to grade a currency pairs posture revolves around the traders
ability to grade the potential strength of the trigger/base line crossover signal.
Traders will often grade each signal accordingly depending on whether or not the direction of the signal
agrees with the posture of the pair at the time.
So, for example, in situations in which the direction of the signal and the posture of the pair agree traders
can grade that signal as strong. The longer-term trend direction of the pair and the shorter-term momentum
have aligned to give the trader the idea that they may be able to enter into the trade when the trend is strong.
The below picture illustrates a strong, crossover signal via Ichimoku.

If you look closely at the graphic above, youll probably notice that shortly before we received our strong,
signal with the bullish trigger/base crossover we had received another crossover. However, this was a short
crossover signal as the trigger crossed down and under the base line.
Perhaps more to the point this signal disagreed with the posture of the pair at the time. Because the pair
had Bullish posture, with a bearish signal that differed from the pairs posture, many traders would consider
this to be a weak, signal. As in, the signal that was generated does not agree with the longer-term trend of
the currency pair. The chart below will further illustrate the difference between strong and weak signals via
Ichimoku.
Crossovers that take place within the cloud can be looked at as neutral, as the pair is not displaying bearish
or bullish posture at the time.
The below chart will take a closer look to the signals the generated during an up-trend on the Aussie Dollar.
Weak signals are in red, while strong signals are circled in blue.

1. This bullish signal takes place while the pair is displaying weak posture. This signal does not agree with
the longer-term trend direction at the time, and as such many traders will choose to ignore this crossover
altogether.
However, for traders that are patient, there is a potential way of playing these signals which well discuss a
little later.
2 This bearish signal takes place after price action has crossed the cloud, now giving us bullish posture. This
signal also disagrees, and once again, many traders may choose to either A) wait for a strong signal that
offers agreement or B) not take a trade based on the signal at all.
3. Now we see a signal that offers agreement. This bullish signal takes place while price action is above the
cloud, and many traders look at this as a strong, signal. Notice how traders that may have elected not to
take signal 1, can now look to enter in the trend as this is a signal with agreement.
4. As the currency pair congests ahead of making new highs, traders see another weak crossover signal.
Notice the candle that had bounced off the top of Kumo shortly before this signal generated. This is a sign to
traders that other speculators might be looking at Kumo as an element of support. And shortly thereafter, we
receive signal 5.
5. On this signal, we have that agreement that traders are often looking for. This is another opportunity for
traders to enter in the trend. Notice the bullishness that follows as price continues to rise after this signal
takes place.
6. Another weak signal. Once again we have an inflection with the cloud. However, notice this time that
the penetration of the cloud was deeper than the previous touch we had before signal 4.
7. We receive yet another strong crossover; however this time price doesnt continue to accelerate to the
upside. As a matter of fact, price begins to trade closer to and within Kumo shortly after the generation of
this signal. This gives traders the idea that the trend may be waning. Remember posture is graded by price
actions relationship to Kumo. So, if price action is moving towards Kumo, many traders will have the idea
that the trend may potential reverse or congest.
8. Now weve received a short signal but this time we are seeing a signal inside the cloud. As we looked at
for signal 7, many traders will have the idea that the trend is waning at this point as price is trading closer to,
and within Kumo. Notice the strong breakout through the bottom-side of Kumo that follows this signal.
Playing weak signals
As we pointed out above, many traders will elect to ignore weak signals altogether; focusing solely on the
strong signals which offer agreement between the trigger/base crossover and the pairs posture but with all
of the available tools within this indicator there is quite a bit of room for creativity.
For example, perhaps traders wanted to play weak, signals but only if the posture ended up agreeing with
the signal.
So for example, a weak signal generates on a chart; and rather than just ignoring the signal and waiting for a
strong crossover the trader keeps a watchful eye on the chart waiting for the posture to change. The trader
can look to take breakout trades, using Kumo as support or resistance. The chart below illustrates this
potential play.

Risk Management
Because of Kumo, Ichimoku has a mechanism of built in risk management.
Remember, Ichimoku is a trend following system; and as we had looked at above, inflections with Kumo
give traders the idea that the trend may be breaking down or potentially reversing. So many traders will use
this as area as their stop under the presumption that if, and when price action came back to Kumo the
trend may be over and they want to get out of the trade.
Traders even have flexibility with this mechanism as they can choose conservative, or aggressive, stops
based on their individual risk profiles.
For traders that want to be aggressive, they can look to setting their stops to the nearest side of Kumo. In up-
trends, this would be the top side of Kumo; and in down-trends, the bottom side.
This way, as soon as price action threatens Kumo the trader is taken out of the trade.
However, for traders that want to be more conservative, they can look to the opposing side of the Cloud.
This gives those traders extra distance to their stop, which could allow them to stay in the trade, and
potentially the trend, even longer.
The chart below shows the difference between aggressive and conservative risk management via Ichimoku.
Notice from the above graphic, our conservative trader could have potentially stayed in the trade longer,
potentially capturing additional pips that were not available to our aggressive trader. But also notice the
additional strong signals that take place after the first long entry. Shortly after our aggressive trader gets
stopped out, another buying opportunity presents itself with a strong crossover. Our aggressive traders that
had gotten stopped out quickly could potentially re-enter.
Lets take a look at the above chart in a slightly different way.

In this chart, the trader takes the second signal and our aggressive traders see far different results than the
earlier chart we analyzed.
In the earlier chart, we saw that aggressive traders were stopped out very quickly, potentially amounting to a
loss on the trade. The conservative traders, however, were able to stay in the trade longer and generate more
pips.
In this chart, we see the exact opposite. Once again, the aggressive trader is stopped out much more quickly
but this time price action continues to fall and actually breaks the bottom of Kumo, giving us bearish
posture.
While price was falling, our conservative trader was giving up more of the gain that would have been
generated by this strong crossover signal.
Because the pair continues on its downward trajectory and breaks the bottom side of Kumo, stopping out our
conservative traders they see far less favorable results than our aggressive traders; and quite a bit of a
different scenario than the first chart we looked at.

Conservative v/s Aggressive

After examining the above charts, many traders may be wondering should I use aggressive or conservative
risk management with Ichimoku?
Unfortunately an answer to that question isnt so clear cut.
The fact of the matter is that regardless of what trading system we are using, price is unpredictable, and
nobody knows for certain where price will move in the future.
We looked at just two examples above; one that shows a situation in which a conservative risk profile works
for the best, and another in which an aggressive profile worked the best.
But these instances arent necessarily governed by conservative v/s aggressive risk management; it has more
to do with price. As we saw in the second example, price continued falling causing our conservative
traders to give up additional pips that our aggressive traders did not. However, had price not broken through
the bottom side or Kumo, and instead, moved higher re-affirming the bullish posture we had previously seen
(as we had seen in our first example) the conservative trader could have come out on top.
For traders that are new to Ichimoku, it is advisable to choose a risk profile that most closely resembles your
overall investing or trading risk profile. That way, management of trades is more comfortable based on your
individual risk tolerances, objectives, and goals.