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Trading Fundamentals

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Chapter 2

Trading Fundamentals

 

2.1 Chart Types & Frames

Chart is displayed by plotting time on the horizontal axis and pair price on the vertical axis.

Line chart

Line chart is plotted connecting single prices for a selected time period. Although any point in the day can be plotted, most traders emphasis is on the closing price for the day. But the main problem with the daily line chart is that it is difficult to see the price activity for the balance of the period as well as gaps.

(Sourced from www.Tradingview.com)

 

 

 

 

Bar Chart

For the Bar chart, the opening price usually is marked with a small-sized horizontal line to the left of the bar and the closing price is marked with a small-sized horizontal line to the right of the bar. Bar charts have the advantage of displaying the currency range for the period selected. An advantage of this chart is that, unlike line charts, the bar chart is able to plot price gaps

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

Candlestick chart

The candlestick chart is similar to the bar chart.

Each candle shows 4 important prices high, low, open, and close. Opening and closing price is the body of the candle whereas high and low price each is drawn as line extended out of body up or down respectively and called wick or shadow.

Its most famous chart as it gives a unique description of the prices over the period.

It still does not provide detailed price movement within the time period. You have to move to a lower time frame and make an overlay of 2 time frames if needed.

We will be using candlestick charts for discussion in this book.

Note- The charts are sourced from www.tradingview.com unless explicitly stated somewhere.

(Sourced from www.Tradingview.com)

 

 

Time Frames-

 

Time Frame means the time period of the chart you are analyzing. So it is framing the price in a specific period means open, close, high & low values of prices & charting the candles.

 

Time frames could be 1 year or more down to 1 minute. For example, you can analyze price movement from 1 year, 1 month, 1 day, 4 hours, 30 minutes, 15 minutes, 5 minutes and 1 minute. Higher time frame candles are made up of summation of price movements of respective lower time frame candles for example prices (open, close, high & low) on 1 “one year” candle will depict price movements of total of 12 “one month” candles, 1 “Four Hour” candle will depict price movements of total of 4 “one Hour” candles, etc. These days many charting software even allows users to read custom time frames.

 

There are 2 schools of thoughts. First is that lower time frame candles follow higher time frames & another one is that higher time frames are build-up of independent lower time frame candles.

 

Both thoughts are right depending on your trading style and trade entry approach. It's important to view prices on different time frames from reading/analyzing perspective and of course to make decisions to place orders depending on how much risk one can take.

 

The candle @ 1pm 4HR Chart, (below Fig A), for 2nd Aug 2018 displays the prices movements within 1pm to 5PM; which is combination of 4 “one Hour” candles starting @ 1pm on 1HR Chart, (below Fig B), on 2nd Aug 2018 displays the prices movements in these 4 candles in 4 hours within 1pm to 5pm.

 

 

Fig A

 

Fig B

(Sourced from www.Tradingview.com)

2.2 Trader Types

 

When to buy when to sell, what time frame to use what are your risk management rules you want to follow; all these label you a specific type of trader. In general type of trader is also referenced as your trading style.

So you fall into either of these 4 types of categories.

2.3 Scalpers

Traders keep the trade open for a very short period of time ranging from few seconds to few minutes.

Personally not a choice for trading, but it is a style of trading & rather well adopted by many traders.

Intent is to open the trade, grab a few pips and close the trade; hopefully with some profit.

There are 2 kinds of scalpers

  1. Knee jerk scalpers

 

You believe more in your gut feelings than a set strategy. Scalpers enter into a trade without any current market analysis or strategy. Such traders enter into the market based on speculation and hope to win a few Pips. You should prefer not to be a knee jerk scalper.

 

  1. Position trading scalpers

 

This is a comparatively better scalper. This kind of scalper trades after basic analysis and has a straightforward exit strategy for profit or loss with hope to get a few Pips. Few active position trading scalpers even go a step further by taking positions in the middle of their existing trades, (called Stacking or Pyramiding), thus having higher chances of winning few Pips.

 

 

2.4 Day Traders

These traders look for short term trades, these traders keep the position open for few hours to max one day. The open position sometimes does extend up to 2-3 days but rarely goes beyond this.

2.5 Swing Traders

Swing Trading as a short-term trading lasts for 2 days to 6 weeks. Trading stocks, options or even currencies to close positions in 3-6 weeks as a swing trader.

Short Term Swing Trading- refers to the time duration between opening and closing a position is a few days to a few weeks.

2.6 Position Traders

These traders trade on 4H / Daily or even weekly time frame & Long term swing traders hold positions for few weeks to up to a few months.

 

2.7 Investors

Investors traditionally hold positions for long terms. Short term investors hold any particular investment for less than one year. Whereas long term investors hold positions for many years up to or sometimes even more than a decade.

They hold the position to gradually build wealth over time.

The time frame used is daily, weekly or even monthly.

 

Bottom line is that either you trade or you invest, but you have to be decisive before entering the market & not after the fact when either you are happy that market is with you or you are struggling to get out of market that it has turned against you.

 

 

 

 

2.8 Brokers & Platforms

 

  1. Brokers

 

Usually, you trade any asset class because you are comfortable and interested in that asset class. So you may or may not need a broker depending on your interest.

 

You can trade without a broker. For example, you can take your Dollars to bank and exchange it to Euros or Yens or whatever currency you want and then exchange it back into the currency.

 

I consider trading with a broker is an easier operation than direct trading. There may be some cons such as commission, margin requirements, etc. but lots of pros e.g. leverage, trading platform, anytime trading access in 24hrs x 5days, etc.

 

To trade in the forex market (also called retail market) with a broker you have to have an account with your broker & on its platform.

 

You prefer to choose a broker that operates locally in your country & you shall ensure the broker is regulated under local laws for securities & currencies trading. Though allowed by some courtiers, you should still conduct research before choosing an international broker that follows local laws of your country.

 

 

 

 

 

All this is not difficult to do online search these days & make decision, maybe in a day or so.

 

 

A broker is chosen based on many factors; major factors are—

  1. Leverage
  2. Margin
  3. Spread of execution
  4. Total Commission
  5. Minimum deposit
  6. Payment methods
  7. Withdrawal convenience

 

 

  1. Platforms

 

If you are trading by yourself then you need a platform to trade on. Usually, the platform that is provided by your broker. Platform facilitates including charting and trades management features.

 

Because of advanced charting features capabilities, some traders like to use 3rd party trading platform integrated to broker platform/broker account.

 

Many renowned European and North American brokers have there own trading platforms those make charting certainly much easier than on MT4 and have basic versions free to use as well. More or less MT4 is the most commonly used trading platform by traders. But I encourage you to explore other platforms by integrating your MT4 broker account with other platforms.

 

 

 

 

 

2.9 Leverage & Margin Continued

 

The reason that Leverage and Margin is explained here in detail, instead of chapter 1, is to explain these 2 important terms to their fullest.

 

As explained earlier Leverage is called borrowing to invest. When you take a loan for investment to make potentially higher profits; its called leveraging.

 

Now how it works; leverage is usually established when you open the account with broker & certainly you can change it anytime with your broker depending on max leverage provided by your broker under local regulations.

 

Let’s build this from bottoms up..

 

In simple terms, the broker has to pitch in based on decided leverage, when you open a trade. For leverage of 1:100 your broker will supplement your trade with leverage times pledged amount.

 

 

A simple description of lot type and lot size—

Lot Type

Lot size

Lot description

PIP Value

Standard

100,000

1 Lot

$10

Mini

10,000

0.1 Lot

$1

Micro

1,000

0.01 Lot

$0.01

 

 

So for standard lot, you shall be investing $100,000 of the base currency.

 

And don’t have these funds with you,

 

No problem so you make use of leverage, let’s say 1:100

 

This means you need $1000 to open a position with standard lot; with this, you successfully open trade or you get message insufficient funds.

Also, in other words, you need $100 to open a position with mini lot for leverage 1:100

And you need $10 to open a position with micro-lot for leverage 1:100

 

Margin / Margin Trading

 

As explained earlier Margin in forex is concept started after a global market crash of 2008-2009. So Margin is an initial deposit you put for trade or in other words your broker holds this amount for collateral. So Margin is pledged as security for repayment of a leverage, to be forfeited in the event of a default/loss exceeding funds in the account under the trade.

 

When you use leverage to trade then you are margin trading. Please note that every broker has margin call requirements. If your margin drops below specific % say 50% then the position will be closed this is called margin call, a call that no one wants to take. Means, in other words, the requirement is that margin must be maintained for the live trades to continue.

 

Let’ s take an example of a margin call. Let say John’s initial deposit is US$5,000 and on Jun 23 2016 all financial gurus & forex coaches are speculating that the pair will break resistance of 1.1396, in excitement he decided to go long next day & starts on EURUSD at 1.1388 with 3 standard lots.

 

So this 3 x 1 standard lot position is worth 3 x US$113,880 = US$341,640

At the leverage of 1:100; maintenance margin would be John’s money x 100 = US$341,640

Or John’s money as maintenance margin = $341,640 / 100 = US$3,416.40

 

 

So balance is what is left for John to back her losses up $5,000 - $3,416.40 = $1583.60

 

 

Needless to say market went against John on Jun 24 2016 and EURUSD fell like a rock. Now Margin call calculation becomes simple. Isn’t it? A 53 pip fall in EURUSD to support loss, would need funds that should be present in account = 53 pip x 3 Lot x $10 (per std. lot) = $1590. So as the account will touch the limit of US$1583.60 all open positions will be closed.

 

Margin call is the call you don’t want to take so I encourage you to understand this concept before you get into trading forex demo or live.

 

2.10 Take Profit (TP), Stop Loss (SL) & Trailing SL

 

Take Profit (TP) or Stop Loss (SL) is a Stop Order, either for stopping the loss or for taking the profit thus existing out of the order. These are limit orders hat cancels the original order when executed.

If you are trading long, then your stop-loss order must be below the entry / current market price.

If you are trading short, then your stop-loss order must be above the entry / current market price.

If you are trading long, then your Take Profit order must be sitting above the entry / current market price.

If you are trading Short, then your Take Profit order must be sitting below the entry / current market price.

Take it as advice or instruction-- DO NOT TRADE WITHOUT A STOP LOSS ORDER IN PLACE.

 

Trailing SL is a future stop order intended to move a step forward to the stated number of pips after the market moves in your favor. Trailing stop loss works well in trending markets to seal profit that pair has already reached.

 

 

 

2.11 Risk Management

 

Risk management is the key to success in Forex trading. Risk is the other side of the coin of reward in forex. There is no trader who will have 100% of winning trades. Even the best of the best known to the trading world are not having 70% winning trades.

 

Winners are having anywhere between 40% to 60% winning trades to be profitable.

 

It's advisable to always keep your risk to rewards ratio at least 1:2

 

Full details on this in section “Risk Management” in Chapter 9 “Trading Habits and Success”

Watch this Surplus Forex video to understand forex terms you need to know.

This is how far you have read and hopefully grasped the basics of forex.

Now move on to next steps to ensure you understood the forex trading relevamt aspects of these fundamentals

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