As a retail trader, your orders will hardly have any influence on the overall market prices. However, when large investors such as commercial traders or professional traders place their orders, they will likely define where prices are heading. Therefore, it’s of extreme importance to find what these large traders are doing and to be on their side. In this article, we intend to explain how you can spot what the big players are doing, i.e., tracking the “smart money”, and take advantage of their actions.
What is the “Smart Money”?
So, what exactly is the “Smart money”? It’s the name we use to describe professional and large traders with a big amount of capital. In this category, we may find both institutional investors, investment banks and hedge/mutual funds. Not all funds can be considered professional since some of them lack the expertise or the size to truly impact markets. Besides, small funds usually do not have enough capital to place orders capable of influencing prices.
Besides being the traders with the largest amount of capital, these are also the traders with access to more information and knowledge about the markets. Note that both hedge funds and investment banks have huge teams of researchers continuously analyzing the market. They also spend large sums to have access to the latest news before the rest of the market. As such, the odds are that professional traders will spot some opportunities faster than the “average trader”. This is why it’s extremely important to know what they are doing. Due to the size of the organized actions of these traders, they are usually behind biggest price movements. Therefore, knowing what they are doing should be one of the first objectives of any trader.
Tracking the Smart Money
The most direct and efficient method to understand when these players act in simply by looking at a price-volume chart. Due to the large size of their orders, these traders are not able to hide their actions. There is a myth that says that because of dark pools, they are able to hide their actions. Some institutional traders do use dark pools, but they can only hide their orders during execution, which can be a matter of milliseconds. After the order is executed, there’s no way to hide it, as exchanges (and consequently Forex liquidity providers) will report it in the volume.
1- Interpret the direction of their trading
You’ll need to look at prices and volumes to know this. Our article about volume trading explains some ways to observe this. The important thing here is to see where there is a general and organized action, and various funds are buying or selling a currency consistently. You can see this in lower timeframes, like 1 minute, as well as in daily/weekly timeframes.
There are many supply/demand patterns, which our VSA indicator shows, and one of the most prominent SUPPLY ones is a wide range bar, closing on the lows, with volume above the average. The demand ones close on the highs instead. Even though these are wide range bars, many times the prices will continue trending, as you can see in the chart below.
General buying/selling pressure leading fast price movements
Buying pressure marked by high volumes that move prices upwards.
2- Take a look at fundamentals
In long-term trading (daily timeframe and above), good fundamentals make it more likely for big traders to have an interest in a given currency. Traders should be aware when talking about “fundamentals” given that some economic measures like the GDP growth or the interest rate hikes, although important, are not a leading indicator. We frequently see these variables changing only after price corrections in the value of the currency. Traders are better off by looking to the increase of the spread of the interest rates or the movement of a related commodity. These variables are usually a good proxy for the fundamentals that drive currencies and often are leading indicators. In the image below, for instance, we can see how correlated are the AUD with the price of Gold. If the price of gold increases, large traders know that this will benefit the AUD and start buying the currency.
AUD/USD – Gold (Source: Bloomberg)
3- Sentiment
“Listen to what the market is saying about others, not what others are saying about the market.”
-Richard Wyckoff
- Sentiment indicators such as COT report and SSI index will give you secondary information. Although it has its usefulness, COT report shows the actions of ALL large traders, even the ones that aren’t so good. Traders should, therefore, pay special attention to their analysis, because the report may have some lag in what comes to be a market turn. Traders should use the COT report mainly as a confirmation, or as a search mechanism for extreme values between large investors and hedgers. The image below presents some examples when the large spread was linked with a market turn
COT report
- On the other hand, the SSI shows the actions of small retail traders, which are usually wrong and in the opposite direction of smart money. In this indicator, look for historically high % of long positions to look for a short, and vice-versa for long positions. You can combine both information to be more confident about the right direction you should trade.
SSI Index
Conclusion
If you aren’t using volumes in your analysis, you are missing a big part of the picture. By showing the market’s activity, volume together with prices shows what the big traders are doing. Only these traders are capable of placing orders large enough, and in an organized manner, to sustain market trends, so you should look closely at what they are doing. By tracking the smart money, you can follow their actions and be on the right side of the price movement.
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“How much money can I make in Forex?” This is probably the first question a beginner makes, and it’s a completely valid question. Why invest my time and money into something, if I have no idea what the returns will be?
The truth is that Forex is an enormous market, with many interests behind. It’s usual to see brokers trying to “sell” the maximum they can as if it was like a gold mine, where you can get fast and easy results. In fact, beginners may have some trouble in finding viable resources. It’s easy to fall in the many traps in this business, and develop incorrect expectations since the start.
Returns and Risk is the Key
The returns you make, vs the risk you take, is really the key point. Even though it’s possible to have a 1000% return in one year, that would mean incurring in a lot of risks. To have this kind of returns, a trader would need to risk almost all of his account into one single trade. The problem of this way of trading is that it would be very difficult to survive over the long-run.
In the table below we present the bankruptcy probability or risk of ruin. On the top row it’s the win-rate and in the left column the risk/reward ratio per trade. As you can see, the key to winning in this game is to have a higher risk reward ratio. This will assure that, even if you have a low winning ratio, you won’t go broke in the long run.
Bankruptcy Probability
So, for instance, a trader with a win-rate of 30% and a risk/reward of 1:1 has absolutely no chance of succeeding for long. However, if we keep this same win-rate but increase the risk/reward ratio to 3:1, the probability of bankruptcy drastically drops to 27%. Of course, the risk of going bankrupt decreases with an increase in the win-rate and in the risk/reward rate.
Given that the win-rate of an average trader is somewhere around 50%, a risk reward ratio of around 1.5 is sufficient to almost eliminate the risk of ruin. However, the best is to always aim for the best risk/reward ratio, to keep the odds on your side.
How Much Do The “Big Guys” Make?
To get a sense of what you should expect is to know how much the best in this industry make. The list presented below shows the annual return as from 2014 of top performing Forex Hedge Funds.
Top performing Forex Hedge Funds returns in 2014
And how does Forex compare to other markets? The next image shows equities, commodities and other markets hedge funds returns between 2014 and 2016:
Hedge Funds Returns 2014-2016
Some claim that it’s easier to make money trading Forex because of high leverage, which allows to take more out of a movement. But as you can see, the annual returns between top hedge funds are similar between different markets. This goes to show that it’s all about return vs risk: while leverage offers more potential return, it increases the risk in the same proportion, which makes it a meaningless factor to judge the results.
How much should you expect?
A realistic return for a solo trader is around 20-40%/year, on average. A trader can sometimes get 100%+ or more in a given year, but unless you are a full-time trading expert, you shouldn’t expect to get this type of returns on average. And if you think about it for a moment, even if you start with a small amount, with a 20-40% return per year, you can build a small fortune after a few years. This is because of the compounding effect.
The image below shows, using this calculator, how you can easily simulate how much will your account grow in the future.
For example, starting with $5000, and with a 40% return per year, your account will be worth $35.000 in 5 years, for a total return of 700%!
Now let’s assume that you even start with a more modest bankroll, such as $500, and you add $200 each month, with a 30% annual return. After 5 years, your account would be $30.000! Add more years and more money into the equation, and you can see how the compounding effect makes good traders become rich, even without having absurd yearly returns.
Taking a Look at a Scenario…
Now that you know how much is possible to get, on average, let’s take a look at a simple example.
Assume a scenario in which a trader has a $1,000 account and an average win-rate of 50%. An acceptable risk per trade is usually between 2-5% of your account in one trade. In this case, this trader would risk a maximum of $30 per trade. A 1.2:1 risk/reward ratio means the trader would place the target price at 1.2x the distance from the entry price of the stop-loss. If the stop-loss is placed 5 pips below the entry price, the target price has to be placed 6 pips above the entry price. This assures winners will be bigger than losers since the reward on each trade is 1.2 times greater than the risk.
With a limit of 2% per trade, this trader will only risk a maximum of 20$ per trade. This means he will lose $20 each time prices hit the Stop-Loss. On the other hand, he wins $24 if prices hit the Take-Profit.
15*$24=$360
15*($20)=-$300
Without commissions, growth profit would be $60 per month.
This is a 6% rate in a month, which can be considered very good. If we take into account compounding, a 6% rate per month means a 100% return per year! Of course, this is not a completely realistic return, as this example didn’t take into spreads and variability in each trade’s outcome. However, it gives an idea of the importance of having a higher risk/reward ratio. By doing this, any trader can aspire to have an expected return of 2-3 digits per year.
What Does It Take To Get Good Results In Forex Trading?
We’ve seen already how much is on the line if you have a good strategy. But what do you need to be successful in this game and achieve higher results? We consider these 4 points to be fundamental:
- Good market knowledge: It is essential to know how prices and volumes work, as well as which are the different players and what relations exist between markets. This will allow you to always be conscious of everything that’s happening around you and make you open the right positions.
- Have a probabilistic mindset: Trading is an unknown activity when it comes to the future. You can have several months with bad results but that doesn’t mean your strategy is failing. You need to keep developing your strategy to achieve better results in the future.
- Don’t think of trading like gambling: Forex is a business like any other. If you make good investments, you should expect a good return. If your attitude towards trading is to gamble like in a casino, the chances are, that you’ll end up blowing up your account!
- Consistency: Once you develop a good strategy, take advantage of it to be consistent with your results. A good strategy enables to achieve consistent returns over time.
The Bottom Line
Wrong expectations about returns usually lead to taking a lot of risks, which translates into a higher probability of losing the whole account. All traders, especially beginners, should be aware of how much they can get and what are their limitations. A trader who claims to have returns of 300%+/year on a consistent basis by trading Forex can only be a genius or a liar, and there are very few geniuses! The very best traders who are able to have outstanding returns for a long period of time usually have returns that don’t even match 100% per year.
The final takeaway is on the importance of establishing a strategy with a higher risk/reward ratio. A higher ratio allows you to lose more trades than you win and still earn money. This will give you an advantage over time.
Volumes are one of the most important aspects to look for in trading, even though it’s one of the most overlooked ones. Most traders don’t use volume, and most of the ones who do, don’t know all the ways volumes can help them. Volumes can tell you what you can’t find in prices, such as the relative number of traders that are selling or buying. In this article, we will see what differences between volumes exist and how volume trading can help you in better understanding market trends.
What Are The Differences Between Volumes?
There are two main types of trading volumes: trade volume and tick volume. But what are the differences between them?
Trade volume
This is the most common type of volumes. It is widely used to refer to the total amount contracts/shares traded in a given period.
Volume tells investors about the market’s activity and liquidity. Higher trade volume means higher liquidity, which leads to a better order execution.
Tick volume
In the Forex market, as it is a decentralized market, it’s impossible to keep track of the size and amount of all contracts traded in a given period. In this sense, as an alternative to trade volume, traders look for tick volume. Tick volume is the number of price changes in a time interval. The main difference is that tick volumes represent how many times the price changed in a given period, and not the real bid/ask volume. We assume that, if prices change 100 times in only 5 minutes, there’s higher activity than if prices only change 50 times.
In decentralized markets like Forex, tick volumes act as a good proxy for the real amount traded. Usually, the most price changes in a given period, the larger the number of transactions that exist. This would imply a higher volume. We made a study on the relationship between volumes vs. tick volumes, and turns out they are quite closely correlated. Check more here.
What Information Do Volumes Give Us?
Volume trading is a strategy that can be very useful since volumes can lead or confirm major price movements. Before opening a position, you may want to look at trading volume to see where the money is flowing to. Volume levels can also help traders decide what are the best times for a making a transaction.
High volume during a large price movement may signal the strength of the trend. Volumes may act as a leading or a laggard indicator. When there’s high supply volume during an uptrend or high demand volume during a downtrend, this may signal a trend reversal before the reversal actually occurs. On the other hand, high volume can also show strength and confirms price movements – it’s all about the context.
Volumes usually indicate what large traders are doing, namely if they are buying or selling. Large traders, as explained in this article, are the ones capable of moving prices. Therefore, the best is to be on their side and benefit from their actions. By looking at volumes alongside price action, you can identify if there’s higher demand or supply at certain points.
Volumes also allow identifying key levels of accumulation and distribution and congestion zones. These are zones where there are a lot of demand and supply and traders may face above-normal resistance. Price By Volume Indicator, which we explain below, can help traders looking for these key levels
How to Use Volume in Trading?
1. Trend Reversion
Many times we see volume spikes preceding price. A decreasing volume in an uptrend is usually a sign that it may be coming to a reversal. Traders should wait for a confirmation of prices to close positions or go short.
In the chart below you can observe how major moves in prices or price reversions were always accompanied by volumes higher than normal. An analysis of volume in this situation would help traders identify these movements of prices.
High volume during major market movements
2. High volume with little price movement
This is another pattern that usually shows in the market when there is professional distribution going on. This action means that even though there is buying pressure from weak or hedging traders, there are professional traders selling, and thus they keep the price in a tight range. Many great bull markets in history ended up with this kind of pattern, which is most reliable when the market is at new highs.
Narrow range and high volume means heavy supply (gold futures weekly chart)
3. Confirmation of a price movement
A rising market usually sees rising volume. Higher volume is a sign that the trend is healthy and likely to continue. Increasing price and decreasing volume shows a lack of interest and may warn a potential reversal. Traders may use this information to decide if they are going to open a position during an uptrend or if they prefer to wait given the low levels of volume.
Strong volume confirms a successful breakout. If the breakout occurs under high volume, this is a confirmation that traders are bullish/bearish and the price movement is likely to continue. If the breakout happens under low volume, this may signal a lack of interest and a higher probability of being a false breakout. Before opening a position, traders should look to volumes to understand if the breakout will be successful or if the buying/selling pressure is not strong enough.
Successful breakout confirmed by high volume
Useful Indicators
Price By Volume
Trade volumes appear at the bottom of the chart. However, Price By Volume (PBV), also called Market Profile, is an indicator plotted on the vertical axis. The indicator shows how much is the trading volume in a certain price range. This information helps traders understanding where are the major congestion zones, as well as resistances/supports. This indicator is mostly useful in very short-term time frames, such as 1 minute. We already wrote an explanative article about this indicator, which you can read here.
The chart below shows the price ranges with higher volume. Traders should expect some resistance/support or congestion areas near these levels.
Market Profile
You can download this indicator here.
Go Further with VSA
These are only some well-known indicators used in volume trading. However, they do not give you important information like if there’s buying or selling pressure. By looking only at these indicators, you only have an idea of generic levels to pay attention to. A complete volume spread analysis implies looking at demand/supply patterns, to identify the best time to buy and sell. By knowing if there are many traders selling/buying, you can anticipate important price movements.
The Bottom Line
Volume is a powerful tool to analyze the market and predict where prices are likely to go. Traders should use volumes to see what large traders are doing and follow their lead since that usually is where the money goes. However, volume only provides insights and traders should not use it right away as trade signals. Prices ultimately confirm what volumes already said and vice-versa. Traders should always wait for a price/volume confirmation and only then open positions.
“Should I trade Forex?” This is a question a lot of traders may have already asked themselves. Although there’s no right answer, there are many pros and cons to bear in mind. In this article, we are going to talk about benefits and disadvantages of trading. You can find which are the main advantages of turning Forex trading a source of income and the drawbacks of doing it.
Pros
Choose when to trade
It’s you who decide when to enter and exit the market. This is an important advantage since you can choose to trade only when the odds are in your favor. When the market is too volatile and there is a lot of uncertainty about the future, you can simply withdraw from trading. Besides, if you trade during your free time, you can easily adapt to changes in your working hours. Since Forex market is open 24 hours during weekdays, you can trade even if the trading session from your region is already closed or didn’t open yet.
No need to rely on someone else
A major advantage of trading for a living instead of having a usual job position is that you don’t need to rely on another’s work to perform well. Many times, you may find yourself dependent on what your colleagues do and that may lower your performance. In trading, you are only dependent on yourself. You can easily create your own strategy and test in your own way. Of course, you can and should share your thoughts with other traders to exchange points of view. However, ultimately, you can always disagree with what others say and do it your own way.
You don’t have a boss
Besides not having to rely on what others do, you also don’t need to answer to anyone. Have you already thought about not having to listen to your boss asking what you have already done? What about your annoying colleague which is always telling you to do things differently? With trading, all these problems disappear. Suddenly, you’re on your own. You trade when you want in the way you want and no one will control your actions. There’s a feeling of freedom which cannot be found in a regular job.
The fact that there’s no such thing as an “authority” also means there’s no outside pressure. We all know how stressful it can be to always have your colleagues or your boss pressuring you to perform better. Fortunately, none of these happen in trading. The only pressure that exists is the one you put on yourself.
Market and trading opportunities will always be there
There are more than 100 pairs which you can trade 24h a day. Opportunities will always exist independently of the trading session. You can choose the session you prefer to trade in and be sure there’ll be a chance to make money. Besides, you will always have a second chance. If you have a bad trade or miss a good trading opportunity, the market will provide you another chance to perform better. If you have a bad day, the market will always be there tomorrow and opportunities will come for you to recover.
Entry cost is low
All you need to trade is a small amount of money and to open an account in a bank or brokerage house. You may have to pay a small execution fee and the spread but no more than that. This is a great advantage of forex trading over stock trading since commissions are usually higher when trading stocks. Besides, commissions are not fixed like in stocks and futures. As commissions are in percentage, this does not negatively impact accounts with a small capital.
There is of course expensive equipment and software that you can buy to help you in trading. However, it’s possible to trade using simple strategies and achieve good results without a significant investment.
Access to free information
In stocks and futures, where exchanges are centralized and controlled by big companies, you’ll have to pay for any extra you may need. Whether you need intraday data, fundamental news, depth of market, in other markets, it always comes with an associated cost. But in Forex, you can easily have free access to this kind of data in any timeframe, for the last dozens of years. The main problem is not accessing information, but filtering what’s important or not.
This easy access to a lot of information is also relevant if you want to test a strategy. Some platforms like Metatrader offer you a tester in which you can backtest a new strategy and see what are the results.
Cons
We already discussed some major advantages of Forex trading. However, there are also some major cons for you to keep in mind.
There’s no fixed salary
One of them is not earning a fixed income per month. The money you earn will depend solely on your performance during that month. This means you can earn a lot in one month, not earn nothing at all or even lose money. If you prefer to earn a fixed income in spite of how well you perform, it may be better to not depend only on trading to pay your bills!
It’s a risky activity
The market is constantly changing, and your performance will depend directly on how well you adapt to this changes. So, if you’re risk averse, trading may not be right activity for you. You need to be constantly attentive to what’s happening in the market to not be caught off guard. It’s very important to know how to deal with uncertainty and be able to manage your account having that into consideration. Improving your knowledge by knowing what are the Intermarket relationships or what money management strategies exist to protect your capital can help you to overcome this problem.
It can become stressful
The amount of uncertainty and the pace at which prices change may become very stressful. It’s very important to keep calm even when the market is going against you, otherwise, you may end up taking wrong decisions. Being able to withstand high levels of stress is one of the major requirements to be a successful trader.
This may be particularly evident in scalping. Since scalpers try to get profit from small changes in prices, they need to act really fast to catch the beginning of the movement. This may become very stressful since they need to be very attentive to open and exit their positions really fast.
The Bottom Line
Overall, it will always come down to your own personality and interests. If you’re the kind of person which can handle stress easily and even like a bit of uncertainty, maybe Forex trading is the right activity for you. If you’re tired of your job, you may even think about trading for a living, if you’ve been consistently successful in the past.
However, if you prefer not to be dependent on uncertainty and like to be sure that you’ll have a fixed amount of income at the end of the month, maybe trading is not for you, at least for a living. You may want to trade more conservatively in your free time. This way, you can do something you like without being too exposed.
In yesterday’s post, we analyzed 3 pairs that could be headed to take a hit: USD/CHF, EUR/GBP, EUR/JPY. However, both EUR/GBP and EUR/JPY dried up on volumes, and they didn’t reach the target levels. The confirmation as a break of a low volume bar / SR level is especially important when the background is neutral/adverse.
In USD/CHF, we were looking for a possible LONG position reaching the trendline/support at 0.969.
In the chart we can see that there were low volumes near the support, giving a confirmation for a LONG trade during the London session. And why? This is because there is plenty of buying at this level, so any low volume bar is showing lack of supply in a critical zone.
As the New York trading session closes, we found 3 potential trading opportunities to follow and possibly trade during the Tokyo session or tomorrow’s London. These opportunities are in USD/CHF, EUR/GBP, and EUR/JPY. Below you can check the current market background, short-term trend and nearest supports/resistances for each pair. As always, we are using VSA, and associated indicators, for a supply/demand view of the market.
Read the 25/May Update here: https://www.analyticaltrader.com/market-update-final-remark-on-ny-closing-session/
USD/CHF M30
Background: Weak
Short-term trend: Down
Support: 0.9691
Resistance: 0.98243
This is a pair to observe in case it rebounds after touching the upwards trendline. The market is currently in a downward sloping trend with low volume, showing a lack of supply to further continue the trend. If the trend rebounds and breaks the previous bar high near the 0.9705 level on high volume, we may be heading for a rally in the late Tokyo/early London session. Traders should look for low volume near the trendline and a fast price movement as prices break the already mentioned level.
EUR/GBP M30
Background: Neutral
Short-term trend: Down
Resistance: 0.86743
In this case, we see a short-term uptrend that seems now to be starting a reversion. There were already many weak VSA signals in the current and above timeframes and the trend is now down. If it breaks the most recent trendline, may look for a SHORT position on high volume showing strong supply. This may constitute a good trading opportunity to open a short position since there is no strong support nearby.
EUR/JPY M30
Background: Neutral
Short-term trend: Down
Resistance: 125.288
Support: 124.552
EUR/JPY may be a good trading opportunity even before the opening of the Tokyo Session. The trend failed to break the near resistance and bounced back. We’re now at a crucial zone where the market has been trading sideways. If prices continue the downward trend, there may be room for a SHORT position with a take-profit near the mid-term support. There has been distribution recently and the high volume bar denotes supply near the resistance
The ultimate goal in trading is to have the highest return for the minimum level of risk. Money management is the calculation of risk and reward in any trade, to maximize efficiency. In this article, we explain why money management in Forex trading is truly important to improve your results and what strategies you can adopt. Find out why it’s important to know your risk profile and how you can manage risk vs reward accordingly.
Money Management – The Basics
Every trader is different. As such, the way different traders manage their accounts will vary a lot. However, independently of the type of trader, there are some common principles of money management in Forex trading that apply in every situation.
- Determine how risky is the trade – This one is especially important for risk-averse traders, but also apply to others. Before opening a position, you should always evaluate what are the risks involved. You don’t want to lose all your account in just one trade, so always evaluate the worst case scenario first. There are some trades which are simply not worth the risk since the expected return is relatively low. These trades should be avoided.
- Determine how much risk are you willing to take – Once you assessed the risks of the trade, it’s time to decide if you are willing to take that risk. Some traders prefer to take larger risks in exchange for a higher return. Others prefer to have smaller but safer profits. Understand what type of trader you are, and develop a strategy according to that.
- Check the relation between risk and reward – Finally, after deciding if you are willing or not to bear a higher risk, you should see what’s the expected return for that level of risk. It’s not worth it to trade a pair which has the same reward as another pair but is riskier. Always choose the trade that offers the best risk-reward relationship.
Risk Profile
Many traders fail because they do not create a strategy according to their risk profile. When a risk-averse trader tries to use a more aggressive strategy, he will probably let his emotions control his actions. As explained in our article about trader’s mentality, this is because some traders are less willing to bear major drawdowns. They will probably end up closing their positions at the wrong time, which will make the strategy ineffective.
According to your risk profile, you should set up a maximum amount to each trade. In order to protect your capital, it’s highly recommended not to use more than 5% of your account in one single trade. This simple rule can be very helpful in case the trade goes against you. By risking only a maximum of 5%, you can be sure you’re not going to blow off your account in one single trade. Although the 5% is a standard measure, some traders may find it better to establish a lower percentage, like 1% or 2%, which is also fine.
To calculate these values, you can use the FXPro’s calculator. In Stop Loss Take Profit Amount, you can select the pair you want to trade and place the respective levels of Stop-Loss and Take-Profit. The calculator will automatically give you the Drawdown and the Profit according to the lot size.
Managing Risk and Reward
As already mentioned, an efficient trade is the one that maximizes reward to a certain level of risk. But how can you do this? In fact, there are some strategies worth noting to manage risk against reward.
Risk/Reward ratio
This is a widely known and used ratio to evaluate the relationship between the risk of a trade and its expected return. If you’re trading a pair which is at 0.9 and you place a stop-loss in 0.85, you’re risking 0.05. On the other hand, if you believe the pair is going to 1, your expected return would be 0.1. In this case, the risk/reward ratio is 0.05:0.1 = 1:2. This means that you can make a profit even if just you win more than 33% of the times!
Define your stop-loss before opening a position
Stop-losses are important to set a limit to your losses. The location of your stop-loss may vary according to the amount you’re willing to lose if the trade goes wrong. However, there are some simple techniques to define its location. Generally, stop-losses should be placed a little bit under the closer support. This will guarantee that it will only be triggered if there’s a breakout. If the trend touches the support and rebound, you will benefit from this reversion. You can also know more about the support/resistances indicator here and download it here.
Moving Stop-Loss
As mentioned above, it’s recommended to define a stop-loss before opening a position. However, to protect your capital while the trade is open, move the Stop-Loss as the trade goes on. If you already have a profit from an open trade, don’t risk to lose it all if the trend reverses. As the trend goes up, establish new SL levels closer to the current price, below the most recent short-term support. In this way, you won’t lose everything in case there is an abrupt reversion.
The Bottom Line
Any successful trader should be aware of how money management in Forex trading is essential to get better results. Traders should know what is their risk profile and define a strategy according to it. Compare the risk of a trade against the return to check its efficiency and guarantee the best reward. Ratios like the Risk/Reward are very useful to do this, as well as defining a Stop-Loss and move it during the trade.
The NFP is due in some hours, and we found 3 potential trading opportunities before and after the release, in NZD/USD, GBP/USD and USD/JPY. Below you can check the current market background, short-term trend and nearest supports/resistances for each pair. As always, we are using VSA, and associated indicators, for a supply/demand view of the market.
NZD/USD M15
Background: Strong
Short-term trend: Down
Support: 0.68500
NZD/USD may be a solid trading opportunity for a late Tokyo Session or early London. We’re approaching a major news announcement and, if NZD/USD retraces after the announcement, it may be a good buying opportunity near the long-term support at 0.68500. If prices touch the resistance and bounce back, traders may open a long position, which will be reinforced in case there are demand signals. Low volume bars during a downtrend near a resistance may also anticipate a trend reversion.
GBP/USD 1H
Background: Weak
Short-term trend: Neutral
Resistance: 1.29648
Support: 1.28631
In this case, we see a long-term downtrend and prices near the upper bound. After the news, in the case of GBP/USD appreciates and touches the trendline, it may be a good opportunity to short. This is because there was distribution before, and if NFP doesn’t change things radically, it could give a shot to trade GBP/USD.
USD/JPY 1H
Background: Strong
Short-term trend: Up
There are no supports, neither resistances nearby. However, we saw an uptrend that was broken with high volumes during the US session. News about US employment are due in a few hours and it will bring some volatility. In case prices approach the trend line from below, it may become a short opportunity. Look for low volume bars approaching the trendline.
The NFP will dictate what happens next, but by being alert to what’s happening now, we can better plan our trades.
Very few traders realize it, but bond spreads have an immense value when trading Forex on a daily/weekly basis. In this guide, we’ll show how you can use this technique to improve your Forex trading.
Firstly, let’s see what ‘spread’ means in this context. Usually, in Forex, the spread is the difference between the bid and ask prices. However, here we are concerned with a different kind of spread: the bonds yields spread. For example, if US 10y bonds yield is 2%, and UK 10y bond yield is 1.5%, the spread would be 0.5 percentual points. Higher spreads suggest that interest rates are higher in a country relative to another. As we will see, these spreads can be valuable in trading.
How do Bonds Spreads affect the Forex market?
Now that we know what the bonds spread is, it’s important to understand how spreads influence the Forex market. This relation depends on one main factor – interest rates. Interest rates are the basis of any bond, and higher interest rates will mean higher bond yields. Interest rates can affect the Forex market because of 2 main reasons:
1. Institutional and Private Investors
Yields are dependent on the interest rate defined by Central Banks. If the Fed or the ECB decide to increase interest rates, bond yields from the respective companies will also increase. This happens because bonds are dependent on the interest rate from the country where they are issued. A rise in interest rates means bonds will pay a higher interest, i.e., have a higher yield. Investors will, therefore, get higher returns.
When interest rates are higher in country A relative to country B, bonds from country A are more attractive. Investors will prefer to put their money in these bonds since they pay higher coupons.
To buy bonds, investors will need to exchange their currency for the currency in which bonds are traded. So, the currency with higher yield bonds will have a higher demand.
2. Central Banks
As already said, the price of bonds depends on the interest rates defined by central banks. According to their monetary policies, central banks buy or sell bonds in order to achieve the desired interest rate. To raise the interest rate, central banks sell bonds, increasing supply and reducing bonds prices. Bond yields and their prices go in opposite directions so, when central banks raise interest rates, prices fall and yields rise. In this sense, when central banks sell bonds, they are withdrawing money out of the economy. This will make the currency appreciate. The reduction of money in circulation makes each unit to worth more.
Both arguments explain the positive correlation between bonds spreads and forex. From one side, higher interest rates will attract more investors. These investors will increase the demand for the currency in which the bond is traded. On the other hand, higher interest rates mean Central Banks are selling bonds, which reduces the supply of money in the economy. The two will contribute to an appreciation of the domestic currency.
Simply put, between two countries, the currency of the country with higher interest rates tends to appreciate.
Looking at some examples…
Traders can expect an appreciation in the domestic currency after a rise in interest rates. We can see this positive correlation between bond spreads and forex in the following charts.
Although the correlation between bonds and spreads is positive in the overall picture, there are periods where both diverge from each other. Those divergence periods are annotated in red.
USD/JPY vs US 10Y / JP 10Y Yield Spreads
In this chart, it’s possible to see a very close correlation between US bonds and Japanese bonds spreads and USD/JPY. However, there are two main periods we want to highlight:
Divergence (in red): During the period from December 2011 to April 2016, there was only one period in which the positive correlation did not stand. The period signaled in red shows a high volatility in bond spreads while the pair traded relatively flat. This is a divergence.
Spreads leading USDJPY (in yellow): we see how the major increase in spreads that happened in August 2013 only affected the forex market one year later. Actually, it’s very common to see this lag correlation, usually with spreads usually leading the pair between 2 and 10 months.
GBP/USD vs UK 10Y / US 10Y Yield Spreads
Spreads leading Pair (in yellow): We can see yet again, in this chart, how a major drop in the forex market follows a major drop in spreads only months later. Both charts show how, very often, spreads movements lead the Forex pair’s movement.
Divergences (in red): In 1 and 3, GBP/USD rose while bonds went down, while in 2 and 4, the contrary happened.
How can traders benefit from this relationship?
Traders may profit from the above-mentioned correlation in two main ways:
1. Through carry trade. It involves borrowing in the country that has a lower interest rate and buying a bond in the country with the highest. As long as the exchange rate remains the same, the bond spread is the profit. However, this strategy can be risky, since the movements in the Forex pair will ultimately compensate for that differential. In practice, this has to be implemented within a hedging strategy.
2. Divergences between spreads and the Forex pair. We know that spreads usually lead the Forex pair by some months, so when they diverge, we know that the pair’s movement is nearly ending. For example, if GBP/USD is rising, but the bonds spreads are falling for some months already, you should be getting ready to short GBP/USD.
Resources
All the data collected for the research was extracted from www.investing.com.
Conclusion
The relationship between bonds spreads and forex is a very useful analysis to forecast movements in certain pairs. However, traders should do a more broad analysis of the market before entering a position. In the article Intermarket Relationships in Forex, we explain how other factors such as the price of commodities and stocks also affect the Forex market.
To be successful in trading, you should aim to develop a true trader mentality. That means to have the capacity and attitude that allows doing the right calls in trading.
Control your emotions
For instance, how do you react after losing 5 trades in a row? How do you react when your stop-loss is nearly getting hit? Perhaps the most difficult in trading is to accept losses and go ahead to the next trade. This is a difficult decision in your trading, but you need to understand that if you had a loss it doesn’t mean you failed or you were wrong. If you were following your strategy rules, you were doing the right thing. Always following the rules of your (winning) strategy is the necessary attitude to be developed.
When it comes to trading, your emotions are a big part of the equation, primarily when you’re losing. The way you face your losses is crucial to develop a correct trading mentality and achieve better results in the future. Successful traders are the ones able to better control themselves and always act to what they have planned. They also know that losing is part of the game, and the focus should be on improving the strategy, not avoiding losses. Below you can find some key elements that are part of winning and losing mentalities. You can also find out more about how to succeed in trading here.
Winning mentality vs Losing mentality
Probably, the most important thing in trading is to learn from your own mistakes. At the beginning, it’s usual to lose more than you win. The first losses are crucial to understanding what went wrong and improve your strategy. Since it isn’t possible to control the market, it’s important to understand how it works and how you can profit from movements of prices.
It’s impossible to win every trade. The focus should be to maximize profits and minimize losses so that you can have a positive overall result even if you lose more trades than you win. The successful trader is the one who has a higher profit/loss ratio, not a higher win/loss ratio. You can do this by focusing on letting your profitable trades run, and accept small losses. A newbie trader does exactly the opposite – he takes many quick wins, which surely results in a fantastic win-rate. But when he’s losing, he just hopes and prays that the market turns. Of course, this inevitably results in high losses. This is the wrong attitude, one that will make you lose money.
Finally, it’s fundamental to know that you’re the only one responsible for your wins and losses. You shouldn’t trade just because of some tip or an analyst’s opinion. Reading others opinions can, of course, expand your horizons, but try and check if what you were told really works or not. Create your own strategy and always act according to it. If you don’t have a plan, it’s easier to lose control of your trading.
Let’s take a look at 2 common types of traders, to see what are the most usual differences between a successful and losing trader.
Trader A
1. Doesn’t expect to win every trade, but expects positive results
2. Accepts the responsibility of trading
3. Learns from own mistakes
Trader B
1. Thinks the market targets him and hunts his stop losses
2. Blames the broker, platform, and even the market, for losses
3. Doesn’t admit own mistakes, and so, doesn’t learn from them
These are two fundamentally different ways of looking at the markets. Trader A accepts his losses and tries to learn from them, while trader B will blame everyone and everything for his losses. Trader A knows trading is a responsibility, whereas trader B looks at trading as gambling. Over time, these differences will make these traders go different ways: trader A will strive to become a better trader, and will likely get there. Trader B will hardly learn anything, and if he doesn’t have a lucky shot, he will eventually lose all of his money.
Practical mental configuration
- Your path to successful trading might be frustrating, not because it’s hard, but because there is a lot to learn and you will make mistakes, as everyone does.
- If you’re paying for your mistakes, then learn from them!
- Any person can reach better results in trading if they place their effort on it. That includes believing in yourself.
A good way to apply these 3 points is through trading in a demo account. Most brokers offer it for free, and it’s the best way to test strategies, improve your trading and control your emotions during trades. Once you start playing in a real account, your money is at risk, so you better know what you’re doing if you don’t want to lose it.
So, what type of trader do you want to become? Which of traders above would you trust your money? Definitely, the answer will be Trader A, right? Then start working on these 3 points, and achieve a true trader mentality.
