Foreign Exchange Currency Trading or Forex Trading is the “Fast and the Furious” of high-level finance. You can go from 0 to 100 in one favorable “tick”. At the same token, you can also go from 100 to 0 in one unfavorable tick. It is an investment where you can get rich quick or lose your shirt in a heartbeat. If you want to win big, you must first learn how to invest in Forex.

I was a SEC licensed Forex Trader from 1991 to 1993. Prior to trading currencies, I was managing accounts in commodities. If Forex Trading is an Aston Martin, Commodities Futures Trading is a Fiat. As a leveraged investment, commodities present a measure of risk but many products particularly seasonal ones such as coffee hardly move.

Because the volume of transactions is thin, it is difficult to get out of commodities. There are no assured buyers for every order to sell. This is why if your account is in a losing position, it will be difficult to get your money out intact.

Forex is a whole new, different world. I’ve seen accounts brought back from the dead by some talented traders and I’ve seen accounts incinerated by careless traders in one ill-advised move.

One of the accounts I was handling was down to 88,000 pesos from its original balance of 150,000 pesos. When I traded it under the advice of my mentor in technical analysis, the account grew to 440,000 in two weeks!

As a trader, it was one of the most stressful times of my life. Many first time investors only focus on the potential rewards. They don’t realize the risks until they lose out in the market.

The most difficult aspect of the job was explaining to a client exactly what happened to their trade. 9 out of 10 investors did not believe they could lose everything in one day.

Thus, before you learn how to invest in Forex, you should develop an understanding of how the Forex market works.

Understanding the Forex Market

The Forex Market involves a network of activities whereby participants buy one currency while simultaneously selling another. The usual analogy is that of a community marketplace where buyers and sellers meet except that there is no real marketplace. All exchanges are done bank-to-bank via electronic transfer.

Currencies are regularly traded around the world to transact. If you’re in Switzerland, you cannot use Philippine Pesos to buy merchandise; you have to exchange or sell the equivalent amount of Pesos per Swiss Franc.

In the large scale Forex Market, these transactions total an estimated US$ 4 to 5 Trillion US Dollars a day! Compare that with the global stock market which averages US$2 Billion a day. Remember that global businesses are transacting on a daily basis; money is regularly changing hands.

High volume makes Forex a very liquid market; it is easy to get in and easy to get out. However, high volume and high liquidity make Forex a very volatile market. Unlike the stock market, market movement in Forex could mean sharp climbs or steep drops.

If you’re in the wrong position without any risk management tools in place, you could end up losing everything within a few minutes. Forex markets move very fast and react to news quickly.

Making the Decision to Invest

In any investment, it always pays to focus on the risk factors. You have to develop a keen understanding on which factors could go adversely on your position in the market. Because of its magnitude, the Forex market is subject to fundamental and technical factors.

Fundamental refers to economic, political and social factors that influence buying and selling decisions. Technical refers to the underlying behavior of the market; analysts often call this market psychology. Using charts, computer programs, and principles of behavioral market theory, technical analysts can identify general trends and corrections in the market. These trends will give analysts an idea of the market’s general sentiment.

The availability of these tools and processes disqualify Forex trading as a form of gambling as some people attest. Tools and techniques give you the means to create a system for trading, but the level of risk remains high.

In a volatile investment, it should go without saying that you should limit your exposure to risk. Traders would often callously advise clients to “invest what you can afford to lose.”

If you have an Investment Pyramid, 2% to 6% of the investible funds can be allocated for high-risk, high-reward investments like Forex Trading. Another approach is to find a reputable Fund Manager and ask for advice.

Keep in mind, that while these Fund Managers are highly qualified, they still want your money. Take their advice to heart but review your finances closely.

Once you have identified the amount you are willing to risk, the next step is to commit to the value of discipline. The people who have lost the most money are those who lost their sense of discipline.

They become emotional when they lose and put in more money so they can start winning. To this, I want you to remember the Golden Rule of High Stakes Trading:

No single man or entity regardless of the amount of money he has to invest can influence the market to do his bidding.

In short, no one can control the market. Not Warren Buffet or even the collective fortunes of Bill Gates and the Walton Family. If you keep putting money in a losing position, it would be like pouring gasoline on a raging fire.

Stay disciplined. If your trading plan has been verified by concrete analyses as erroneous, cut your losses, assess your position then develop a new strategy.

As I’ve stated, the Forex market is vast, large, fast-moving and highly liquid. There will always be opportunities to enter the market and recover losses.

Learning the Basic Terminologies in Forex

It is important to learn and understand the basic terminologies in Forex trading so you can have better communication with your trader. Here is a shortlist of important terms used in Forex Trading:

  • Calling Bank. In a transaction, the calling bank is the institution that asks for the prevailing rate of currency.
  • Quoting Bank. This is the bank that issues a quote on a requested currency.
  • Base Currency. The currency you wish to sell.
  • Quote Currency. The currency you wish to buy.
  • Exchange Rate. The prevailing value of a currency vis-à-vis another currency.
  • Long Position. To enter a “Buy” position in the market.
  • Short Position. To enter a “Sell” position in the market.
  • Bid Price. The price the trader is willing to buy base currency in exchange for quote currency.
  • Offer Price. The price the trader is willing to sell base currency in exchange for quote currency.
  • The difference between the Bid Price and the Offer Price.
  • Cut or Stop Loss. An instruction that is entered into the market in order to limit the amount of loss.
  • Cut or Stop Profit. An instruction that is entered into the market to hit a pre-determined profit objective.

Forex has many other terms that you will come across as you trade more frequently. If possible, conduct more research and learn what you can about the market.

Finding Your Forex Trader

I have not traded currencies in more than 20 years. I am not sure if the Forex brokerage houses that proliferated in the early 1990’s are still around. One of the reasons I resigned was many fly-by-night companies were operating as Forex houses.

The industry was deeply tarnished; there was regular television coverage of broker houses being raided. The SEC moved to clamp down on these illegal brokerage firms.

But today there are online brokerage houses that you can connect with. When searching online consider the following:

  • Make sure the brokerage firm is registered with the SEC and subject to other regulating bodies such as CySEC or Cyprus Securities and Exchange Commission, which is part of the Markets in Financial Instruments Directive or MiFID.
  • The broker should be in business for at least ten years.
  • The larger the number of instruments traded, the larger the client base and the more reputable the broker.
  • Conduct due diligence; look for online reviews.
  • Visit their website. If the design, functionality and content look like it was haphazardly done, stay away.
  • Compare transaction costs, bank charges, availability of customer support and transparency in details.

You should ask for recommendations from friends who have traded in Forex.

When you trade in Forex, you are doing margin trading. This means you can still engage in the big trades with a little money. Think of margin trading as a gigantic pie with several slices. The size of your slice will depend on the amount you invest.

But this is also why Forex Trading is risky. Gains are magnified; but so are the losses. If we assume the pie is worth US$100,000, and you invested US$1,000, your slice is worth 1% of the amount of the pie. If the pie loses 25% of its value, your US$1,000 will only be worth US$750 and much less once you deduct commissions and other fees.

If the pie loses 50% of its value, you could end up losing more than you originally invested. This is when your trader would advise you of a “Margin Call.” Margin Call is additional capital infusion so you can trade again. Many Forex and Commodities investors wind up losing more money because of continued capital infusion.

Thus, finding a credible trader is important for the success of your trading. He or she should show greater concern for protecting your interest. Personally, I would not contract traders who recommend day trading.

This is the practice of going in and out of the market multiple times in the market. Traders will tell you they are taking small profits out but what they are doing is increasing your risk and making money at your expense. Traders get paid a commission whenever they exit the market.

Trading is subject to probabilities. The more frequent you enter the market, the greater the probability of hitting a losing trade.

A Position Trader takes a more conservative approach. His purpose is to run profits and cuts losses. When he enters the market, he has a profit objective and has included stop loss orders to make sure risks are limited.

Ask your prospective trader what his preferred approach is for trading. If he prefers Day Trading, take it from me and look for another trader.

How to Analyze the Forex Market

Market analysis is a crucial aspect of having profitable trades in Forex. When choosing your trader, you have to make sure he or she has a system for designing trading plans.

Regardless of what traders tell you, no trading plan will guarantee you a 100% success rate every time. If a trader tells you that, take your business elsewhere. Every trader has their approach to trading, but there is no perfect system.

Ask the trader to give you an overview of his/her system and to present his portfolio. If he/she does not want to present any evidence of performance, again, take your business elsewhere.

Given the high-risk levels of Forex, you should take some time to study the two most popular methods of market analysis:

1. Fundamental Analysis

As stated earlier, this refers to economic, social and political factors that could influence buying and selling decisions. A big part of my morning routine as a trader was to read wire reports from Telerate and Bloomberg. I looked for data and information that could affect currency movements particularly the US Dollar. These includes:

  • Federal Reserve policies, i.e. rate cuts or hikes, currency depreciation
  • Economic Data: unemployment, housing sales, payroll data, manufacturing data, retail sales, oil price hikes/declines.
  • Political News: Wars, election-related items.
  • Social Developments: incidents of unrest

Fundamental analysts use these types of information for positioning. From my experience fundamentals are only good for sales presentations and explaining the market to clients. Using fundamentals as your primary trading tool will get your client killed in the market.

2. Technical Analysis

This is the approach of using charts, graphs, and technical indicators to study the market. The purpose of Technical Analysis is to determine the underlying sentiment of the market.

An experienced Technical Analyst uses technical trading tools to paint a picture of the market. He gets a better idea of the trend, establishes profit and risk levels then pinpoints entry and exit points.

Every Technical Analyst starts out by learning Dow Theory, which uses chart patterns to determine market sentiment. From Dow Theory, the trader can proceed to learn other techniques such as:

  • Elliott Wave Theory
  • Fibonacci Ratios
  • Relative Strength Index
  • Oscillators
  • Moving Averages

My most successful trades came from technical analysis. I was fortunate to have had an amazing boss who took me under his wing and trains me in Elliott Wave and Fibonacci.

We used Elliott Wave to determine the market structure and find out trends and corrective movements. My boss always told me to have a primary reading and a secondary reading. The primary reading would be the most likely of all possible scenarios. Elliott Wave chief proponent Robert Prechter would say, “If you eliminate all the improbable scenarios, then what is left would most like be the most probable scenario.”

Once we are confident of our market structure, we would apply Fibonacci Ratios to determine profit objectives and cut-loss points. These numbers would be the basis for the cut loss instruction that would accompany buy or sell entry orders.

After the structure, profit and cut loss points have been established, it would be time to find the entry point. The much vilified Relative Strength Index or RSI was valuable in finding the entry point. The key was to find a divergent point. This is the level whereby continued declines in price would not deter RSI levels from rising above the 20% or the oversold zone.

We would also use RSI to confirm an exit point by looking for a convergent point. This is the level whereby a continued ascent in price would not deter RSI levels from falling below the 80% or overbought zone. RSI calibrated on an hourly basis was particularly powerful. If the divergence or convergence occurred within a period of 9 hours, you had a high probability of getting the best entry and exit points.

Succeed and win big in the Forex market

If you want to succeed and win big in the Forex market, take the time to learn technical analysis. In fact, I would strongly suggest learning 3-4 technical trading tools and modalities and do 2-3 months of mock trading.

I genuinely believe technical analysis is the best way to approach Forex trading. The news and information you read is available to everyone participating in the market and is subject to different analysis. If you trade using fundamental analysis, you will become a victim of your biases.

In economics, we have been taught that if a Central Bank cuts rates, money will flow out of that currency and move to another with better returns. In theory, this is correct, but the question is, “When will the market react?”

In the case of 3 May 2016, when the Reserve Bank of Australia cut its cash rate by 25 basis points, the market had already been anticipating the reduction. The Australian Dollar was already losing in value.

An analogy I like to use to differentiate fundamental analysis from the technical analysis is the martial arts. If you study forms-heavy martial arts, the instructor will teach you how to block and counter a strike “when it is delivered this way.”

In reality, when you get into a fight, a strike will not be “delivered this way” or that way. It could come in a variety of ways, and if you do not have the means to counter the number of strikes, you will get knocked out.

On the other hand, if you adopt a “fighting philosophy” of being able to adapt to different conditions, the chances of being beaten are less because you will be more prepared and have more skills available to counter different styles and situations.

Fundamental analysis is “forms-heavy martial arts” while technical analysis is the free flowing “fighting philosophy”. In a volatile market, you need to adopt less rigid strategies and utilize more flexible strategies.

Developing a Trading Plan

Before you enter the Forex market, you must always have a trading plan. While the trading plan is the responsibility of your trader, it should have your inputs. To a trader, a chart is like a work of art. The lines, points, angles and shapes that are found in the chart are a matter of individual interpretation. A good trader will not rush a trading plan.

Take as much time as you want. You should be comfortable with the decision to enter. If you miss an opportunity because you hesitated, remember that the Forex market’s high volume will always present opportunities.

Here are a few things to keep in mind when developing a trading plan:

  • Validate the reason for your choice of currency. This is perhaps the only other value of fundamentals. Read up on the economic, political and social conditions of the currency. Identify potential developments in the future that may affect currency movements.
  • Determine the amount of money you plan to risk. Always start out small. You can always increase your placement if you are on a winning trend.
  • Conduct different time studies on the currency. An experienced trader takes time to study the historical trend of the currency and its underlying movement.

They use charts of a lesser degree to validate the movements of a chart of a higher degree. This simply means using a daily chart to validate a monthly chart, an hourly chart to validate a daily chart and a tick-by-tick chart to validate an hourly chart.

  • Apply your analytical tools. If you have found your preferred tools of the trade, apply them consistently. Try not to use other tools into the mix as it may only serve to detract from your analysis.
  • Come up with contingency plans. You should always keep the worst case scenario in mind and develop contingency plans.

Finally, implement Risk Management strategies.

The biggest reason people lose their investment in Forex is the absence of risk management strategies. Put simply; risk management strategies limit the amount of capital at risk in the investment.

Not having risk management strategies in place is like being Mr. Mega Bucks Hollywood Star and marrying the starlet you met during a Tequila-infused night on a beach in Cabo Wabo, Mexico. If you don’t have a prenup agreement in place, and things turn sour, she could legally run off with half of your money by next Tuesday.

When I do a trading plan, the cut loss points have to be established. I’m a very conservative trader. I follow the “2% Rule” in trading which states:

“Never risk more than 2% of your trading capital in any one stock.”

Thus, when I place a position in the market even after the cut loss points have been identified, I adjust it to comply with the 2% Rule.

If we get the right position, and the market moves according to our trading plan, I re-compute the 2% risk based on my client’s effective margin and adjust it upward. If the market moves against our position and the cut loss point gets hit, my client would still come out of the market with more money. In effect, my client would not lose more than 2% of his money.

Because 2% presents a narrow margin of error, it is possible that we could be taken out frequently even if our long term position is the right one. Again, I will have to validate the market studies and re-assess our entry point. If we are confident of our position, we could expand the risk to 6% of his trading capital.

Forex Trading is high-stakes trading; high-risk but high-reward. If you want to invest in Forex, approach it with a conservative mindset. Establish realistic profit objectives; do not be greedy.

If you attain the profit objective, cut your position so you can recover your initial trading capital plus some profit then ride the rest of the wave. But always remember to have risk management strategies in place even if you are trading on pure profit.

It is possible to win big in volatile markets if you know how to invest in Forex and manage with your mind and not your heart.