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The Sensible Guide to Forex: Safer, Smarter Ways to Survive and Prosper from the Start

The Sensible Guide to Forex: Safer, Smarter Ways to Survive and Prosper from the Start

Cliff Wachtel

ISBN: 978-1-118-22605-6

Aug 2012

448 pages

$42.99

Description

FXstreet.Com’s 2013 Best Book Award!

The Sensible Guide to Forex: Safer, Smarter Ways to Survive and Prosper from the Start is written for the risk averse, mainstream retail investor or trader seeking a more effective way to tap forex markets to improve returns and hedge currency risk. As the most widely held currencies are being devalued, they're taking your portfolio down with them—unless you're prepared.

For traders, the book focuses on reducing the high risk, complexity, and time demands normally associated with forex trading.

For long-term investors, it concentrates on how to hedge currency risk by diversifying portfolios into the strongest currencies for lower risk and higher capital gains and income.

The usual forex materials don't provide practical answers for most retail traders or longer term investors. Virtually all forex trading materials focus on time-consuming, high-leverage, high-risk methods at which most traders fail. Materials about long-term investing in foreign assets rarely take into account the prospects of the related currency. A falling currency can turn an otherwise good investment into a bad one.

Throughout the book, the emphasis is on planning and executing only low risk, high potential yield trades or investments and avoiding serious losses at all costs. Packed with richly illustrated examples every step of the way and including additional appendices and references to online resources, the book is the ultimate guide to forex for retail traders and investors seeking to tap forex markets for better currency diversification and income.

  • Provides traders with safer, smarter, less complex and time-consuming ways to trade forex with higher odds of success. These include the use of such increasingly popular new instruments like forex binary options and social trading accounts that mimic expert traders.
  • Shows investors how to identify the currencies most likely to hold or increase their value, and provides a wealth of ideas about how to apply that knowledge to a long-term, low-maintenance portfolio for both income and capital appreciation.
  • Helps anyone seeking an asset class with low correlation to other markets by explaining how the very nature of forex markets means that regardless of market conditions there's always a playable trend somewhere, regardless of what other asset markets are doing, and how to find and exploit it for a short-term trade or a long-term investment in a currency pair, stock, bond, or other asset

The Sensible Guide to Forex is only book that teaches mainstream risk averse investors and traders how to build a portfolio that’s diversified by currency exposure as well as by asset class and sector, via a variety of safer, simpler methods to suit different needs, risk tolerances, and levels of expertise.

Written by Cliff Wachtel, a 30+ year financial market writer, advisor, and analyst, The Sensible Guide to Forex offers practical solutions to the above dilemmas faced by every serious, prudent investor.

A must own for any informed investor-but don’t take out word for it - see advanced reviews at: http://thesensibleguidetoforex.com/review/

Read This First xix

Currency Risk: Every Investor’s Dilemma xix

Currency Risk and How to Fight It xx

The Solution xx

Some Background xxi

Why Any Trader or Investor Needs This Book xxii

What This Book Offers xxiv

Why Listen to You, Cliff? xxv

Visit thesensibleguidetoforex.com for Additional

Online Content xxviii

Acknowledgments xxxi

CHAPTER 1 Three Must-Know Forex Facts 1

Fact 1: Everyone Needs Forex Diversification Even if You

Don’t Trade Actively 2

You’re Exposed: Cover Your Assets 2

Even Long-Term Buy-and-Hold Investors Need Forex Diversification 3

Fact 2: Potential for Better Risk-Adjusted Returns 4

Forex Markets Often Provide Advanced Warnings of Changes in Other Markets 4

Forex Needn’t Be Any Riskier Than Other Markets 4

No Uptick Rule: Just as Easy to Profit in a Falling Market as in a Rising One 5

Low Correlation to Other Financial Markets 7

The Most Flexible Hours 7

Forex Markets Offer the Best Liquidity 8

No Centralized Exchange with Specialists Holding Monopoly Power to Regulate Prices 9

Less Slippage 9

The Best Risk/Reward Potential 9

The Lowest Startup and Trading Costs 10

Fact 3: You Can Do This 11

How Can I Compete against the Pros and Big Institutions? 11

How David Beats Goliath: More on What This Book Will and Won’t Do 12

What’s the Catch? 14

Most Traders Fail within Their First Two Years 14

CHAPTER 2 Forex Basics 17

Basics of Currencies and Currency Pairs 17

Trade Only the Most Liquid Currencies 18

The Major Currencies 18

Risk versus Safe Haven Currencies: Definition and Ranking 19

Currencies Trade in Pairs and Why That Matters 20

Price Movements Are Always Relative to Another Currency 20

It’s Just as Easy to Profit in Bear Markets as in Bull Markets 21

How to Read a Forex Pair Price Quote 22

Summary of Currency Pair Basics 24

Why It’s Just as Easy to Profit from Falling Prices 25

Size Matters: Types of Currency Pairs 29

The Major Currency Pairs: The Most Liquid 29

More on Risk and Safe Haven Currencies 29

The Signs of the Crosses: Divine Revelations about Currency Strength 30

Walk on the Wild Side: The Exotics 32

Pips: The Universal Currency of Currencies 32

Calculating Pip Values 33

Three Ways to Limit Risk: Lot Size Usually the Easiest 33

Leverage and Margin: Their Relationship and Impact on Risk 35

Leverage: Greater Risk and Reward 35

Permitted Leverage Varies with Place and Time 35

How Margin, Lot Size, and Leverage Interact 36

The Importance of Adequate Capital 36

Margin Calls: Your account’s Circuit Breaker 37

Order Types 38

Exit Orders: Ways to Close a Position 42

The Three Facets of Risk and Risk Control 44

The Core Four: The Most Important Skills for Success 45

Trader Psychology 46

Risk and Money Management (RAMM) 48

Technical and Fundamental Analysis 48

CHAPTER 3 Technical Analysis (TA) Basics 49

Candle Chart Basics 50

Candle Anatomy and Meaning 50

Relationship between Body, Wick, and Its Significance 52

Support and Resistance (S/R) Basics 54

Candle Chart Time Frames: Length Matters 59

Different Time Frames, Different Trading Techniques, and Styles 59

Different Time Frames, Different Trends 60

Identifying Support and Resistance (S/R) to Buy Low, Sell

High, or Vice Versa 62

Definitions of S/R Are Reversed for Long and Short Positions 63

The General Rule for Identifying Low-Risk High-Yield Trades 64

Finding S/R Is Key to Identifying and Executing Low-Risk High-Yield Trades 64

Good Risk Management Requires Good TA 66

Think of S/R as Zones or Areas 66

So Stick to Trading Longer Time Frames—They’re Safer 67

Reasons to Consider Using Multiple Entry and Exit Points 68

Once Broken, Resistance Becomes Support and Vice Versa 68

Don’t “OD” on TA 69

Why Specialize in a Few Currency Pairs and Time Frames? 69

What Determines Whether a Currency Is a Risk or a Safe Haven? 70

CHAPTER 4 Technical Analysis: Types of Support and Resistance (S/R) 73

Price Levels 74

For Lowest Risk, Enter Near Strong Support 75

What Makes Some S/R Points Stronger Than Others? 76

Longer Time Frames Offer More Reliable S/R Indicators 77

Check Shorter Time Frames to Detect Interim S/R Levels 77

Trends and Trend Lines 80

Trends Vary with Time Frame 80

Defining Trends, and Constructing Trend Lines 80

Types of Trend Lines 81

Single Uptrend or Downtrend Lines 82

Channels: Better Than Single Trend Lines 83

Moving Averages (MAs) 87

Fibonacci Retracements (Fibs): These Fibs Don’t Lie 93

Applying Fibs to Your Charts 94

Fibs within Fibs 96

Bollinger Bands (BBs): Use as S/R in Range-Bound Markets 98

Support/Resistance (S/R) for Flat or Gently Sloping Trends: The Bollinger Bounce 99

Bollinger Bands Don’t Provide Meaningful S/R with Strong Trends 100

Introduction to Japanese Candle Chart Patterns 101

More Key Points about Japanese Candle Patterns 107

Context and Timing Matter 107

Introduction to Western Chart Patterns 108

Classic Western Reversal Patterns 108

Beware False Breakouts, Shake Outs, and Other Fake Outs 111

Other Reversal Patterns to Know 112

Classic Western Continuation Patterns 113

We Repeat: False Breakouts Happen 115

Other Continuation Patterns 116

Patterns That Can Be Continuation or Reversal 116

The Underlying Logic of Chart Patterns 116

The More S/R Indicators, the Better 119

Multiple Mutually Reinforcing S/R Indicators: An Example 119

CHAPTER 5 Trader Psychology and Risk and Money Management (RAMM) 123

RAMM: Preserving Capital Is Your Top Priority 124

The Inner Game: Trader Psychology Basics 125

Lesson 1: Seek Trading Styles and Methods That Fit You 126

Lesson 2: Basics of the Trader’s Mindset—Minimizing and Accepting Risk 128

Lesson 3: Dealing with Losing and Winning Streaks 129

Why Trade Longer Time Frames 130

Seek Safer Trading Styles 130

As with Driving, Speed Kills 131

A More Level Playing Field 132

More and Better Information Means Better Trade Decisions 134

Trends Are More Reliable in Longer Time Frames 134

Ideal Trends For Long-Term Investors 136

Other Technical Indicators Are Better in Longer Time Frames 137

Publicly Available Fundamental Data and Analysis Matters in Longer Time Frames 137

Lower Trading Costs 138

Start Out with Longer Duration Trades 138

Content Quality: The Sign of a Quality Broker 139

The Essence of Good RAMM 140

The Three Pillars of RAMM 141

Account Size and Affordable Loss per Trade 142

Setting Stop Losses: Basic Technique and Psychology 142

Where to Set Stop Losses: Two Criteria 142

More Capital Allows Wider Stop Losses and a Wider Choice of Low-Risk Trade Opportunities 143

Balancing Risk versus the Need to Win 144

Method 1: Recent Range 145

Method 2: Average True Range (ATR) 145

So How Much Capital Is Enough? 146

Leverage and Margin 147

Position Sizing 147

Avoid Having Too Many Open Positions 148

Entries Near Strong Support, Exits Near Strong Resistance 148

Entries 148

Exits: Use Trailing Stops to Protect and Maximize Gains 149

Entries and Exits: Single versus Multiple 149

Risk-Reward Ratios (RRRs) 150

Example: How 1:3 RRRs Make Winners Out of Losers 150

Example: How 1:2 Risk-Reward Ratios Make Winners Out of Losers 152

Applying 1:3 RRR: An Example 154

Acceptable RRR Can Vary with Market Conditions 155

More on Stop Loss Orders: An Example of Using ATR to Gauge Volatility and Place a Fixed or Trailing Stop Loss Order 156

If You Fail to Plan, You Plan to Fail 158

What’s Your Rationale for Taking This Trade? 158

No. 1: Plan Every Trade and Record It in a Journal 160

Sample Trade Rationale as Recorded in Journal 162

No. 2: Your Overall Business Plan 165

What Conditions Do You Need for Success? 166

Safety in Numbers: Build a Team 166

CHAPTER 6 Essentials of Fundamental Analysis 169

Using Fundamental Analysis (FA) and Technical Analysis (TA) Together 171

An Overview of FA: Main Fundamental Drivers of Forex Trends 175

Overall Risk Appetite 176

Short-Term Interest Rates 183

Macroeconomic Data and Indicators 189

Example: EURUSD Uptrend Reverses in Late 2009 as Data Show Europe Slows, U.S. Grows 189

Geopolitics 193

Capital and Trade Flows 193

Merger and Acquisition (M&A) Activity 194

Short-Term Illiquidity: A Lack of Buyers and Sellers 195

Government and Central Bank Special Interventions in Times of Crisis 196

News Trading: Day Trading Based on Short-Term Fundamentals 197

What News Traders Watch 197

FA Basics: Easy to Understand and Hard to Apply 199

Therefore, Get Thee to an Analyst 200

Combining FA and TA: An Example 200

CHAPTER 7 Pulling It All Together with Trade Examples 205

Identifying and Executing Low-Risk, High Potential

Yield Trades 205

Begin Your Search On Longer Time Frame Charts, Then Zoom In 205

Consider the Fundamental Context 206

Initial Screening on Longer Time Frame Charts 206

Second Screening 208

Third Screening to Monitor Trade Progress 209

Types of Trades 210

Trade Example 1: A Swing Trade 211

Initial Screening 211

Second Screening 213

RRR Evaluation 214

Conclusion: We Take the Trade 216

Trade Postmortem: What Happened 217

Trade Example 2: A Breakout Trade 218

First Screening 218

Second Screening 220

RRR Evaluation 221

Conclusion: Know When to Walk Away 222

Trade Postmortem: Was I Right? 223

More Key Trader Psychology: Distinguishing between Good Trades and Winning Trades 224

CHAPTER 8 Technical Analysis: Basic Momentum Indicators 227

Double Bollinger Bands (DBBs )—Use as Momentum Indicators 229

DBB Basics 231

The Four Rules for Using Double Bollinger Bands 232

Combine DBBs with a Leading Indicator 236

DBBs: Conclusion and Summary 237

Moving Average Crossovers 237

Price Crosses Over or Under a Moving Average 238

The More Indicators in Our Favor, the Better 239

How Many Indicators Should You Use? 240

But RAMM Is Key 240

Moving Averages Cross Each Other 241

Examples of Simple Trading Systems Using MA Crossovers 242

Welcome to Back Testing 244

Oscillators 244

How They’re Used to Generate Buy/Sell Signals 246

When to Use Oscillators 248

Other Oscillators to Consider 248

Designer Genes 249

Moving Average Layering Indicates Trend Strength 249

The Stronger the Trend, the Clearer the MA Layering 249

CHAPTER 9 Technical Analysis: Future Study 255

Catch a Wave: Timing or Cycle Indicators 255

Meet the Fibonaccis 256

. . . And the Ganns 256

Catch the Most Popular Wave: Elliott Wave Theory and More 256

Combining Technical Indicators: Which Ones and How Many? 257

Your Tool Kit Needs a Gang of Four 258

Apply Indicators to Each Time Frame When Screening Trades 259

Back Testing: Learning from the Past 260

Back Testing Software: Play It Again, Sam 260

A Manual Back Testing Example 261

Back Testing Is a Tool, Not a Solution 265

Intermarket Analysis: Reading Intermarket Correlations and Divergences 265

Background 266

Currencies versus Equities: The S&P 500 as Forex Indicator 267

Risk Currencies versus Safe Haven Currencies 268

Why These Relationships Matter 268

They Give You a Fast, Big Picture 269

Divergences from Normal Correlations Can Be Significant 269

The USD versus Equities 271

The USD and Stocks: Correlation, but Not Causation 272

Currencies versus Currencies: How They Correlate 273

Warning: The U.S. Dollar Index Isn’t a Substitute for Studying Charts 275

Currencies versus Commodities 277

Gold as a Barometer of the USD or EUR 277

Other Currency versus Commodity Correlations 282

Thinking Like a Pro, One Step Beyond Technical Analysis 284

Mind Games 284

Learn to Think Like These Pros 285

CHAPTER 10 Alternatives to Traditional Methods 287

Auto-Trading Systems: Welcome to the Machine 287

Currency Funds: Forex ETFs, ETNs, and More 289

Managed Accounts: Should You Seek Professional Help? 291

CHAPTER 11 Newer, Smarter Methods 295

Follow the Leaders: Forex Social Networks and Trading 295

What Are Forex Social Networks? 296

What Is Social Trading? 297

How It Works: The Highest Form of Flattery 297

Risks of Social Trading 298

Rewards of Social Trading 305

The Growth of Social Trading 307

How eToro and Currensee Compare 307

Great Tool, but Requires Skill to Use 311

An Auspicious Start 312

Do Your Homework Before You Decide Which to Use 312

Consider Market Conditions in Choosing Strategy and Risk Tolerance 313

Binary Options: Trading Made Easier 316

Background 318

How They Work 319

Pros and Cons 320

CHAPTER 12 Forex for Income: The Smartest Oxymoron 323

Ride Long-Term Forex Trends for Lower Risk, Higher Income 324

Why Income Investors Neglect Currency Diversification 325

Long-Term Trends for Long-Term Investors 327

Case Study: Canada 2000–2011: Applying Forex Trends to Equities Investing 328

The USD versus the CAD: Guess Which Has No Debt/GDP Problem 328

Equities: Canada Is Not Japan 329

Be Aware of Tax Withholdings and Credits 332

For Further Investigation: Online Resources 332

The Carry Trade: Using Direct Forex Trades as an Income Vehicle 333

Differences between Forex Carry Trade and Traditional Long-Term Buy-and-Hold Instruments 334

The Key to Carry Trading 336

Carry Trade Steps 338

CHAPTER 13 Now What? Next Steps 341

Where You’ve Been 341

Where You’re Going 342

APPENDIX A Recommended Free Online

Resources 347

Forex Sites 347

Thesensibleguidetoforex.com 347

BabyPips.com 347

DailyForex.com 348

DailyFX.com 348

Forex.com 349

ForexCrunch.com 350

ForexFactory.com 350

ForexMagnates.com 350

Forexpros.com 350

FXstreet.com 350

Bkassetmanagement.com 351

Other Favorite Financial Sites 351

BusinessInsider.com 351

Investopedia.com 351

SeekingAlpha.com 352

Wall Street Sector Selector (wallstreetsectorselector.com) 353

Individual Analysts 353

Fundamental Analysis 353

Technical Analysis 354

APPENDIX B How to Calculate Pip Values and Examples 355

Definition 355

Calculation 355

Example: EURUSD 356

Handy Rule of Tens 357

Example USDCAD 357

Example USDJPY: Rule of Tens Doesn’t Apply with the JPY 358

APPENDIX C Forex Trading Time Zones, Liquidity, and Why These Matter 359

Three Major Trading Sessions and Why They Matter 359

Markets Tend to Follow Each Other 362

What Stops the Follow-Through? 363

1. News or How It’s Interpreted 363

2. Technical Resistance: The News Is Already Priced In 363

The Prior Session Is Most Influential 363

Beware Holiday Catch-Up Sessions 364

APPENDIX D More on Leverage and Margin 365

APPENDIX E How the Mathematics of Loss Demands Keeping Losses Per Trade Low 367

APPENDIX F Choosing a Forex Broker 371

Suggested Search Terms to Find Broker Reviews 371

Criteria to Consider 371

APPENDIX G Low Correlations to Other Markets via Social Trading Means There’s Always a Bull Market Somewhere 375

Trade Leader Noncorrelations to the Markets 376

Market Correlations 376

Looking at the Trade Leaders 377

Diversification of Approach 378

Notes 379

About the Author 385

Index 387