<s> IntroductionChapter 1Chapter 2Chapter 3
Disclaimer
Contents
What is Forex Trading? ------------------------------Japanese Candlesticks — ------------------------------
Chart Patterns www ween nn nnn nee - eee - ee
1Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwide
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22
49Introduction
Over the last 9 years we have put in thousands of hours of research and development to refine our tradingmethods. Our trading methods have been tried and are functioning successfully. They work for us but wecannot guarantee they will work for you. There are many trading systems available in the market, most ofthem are mechanical and are based only on a combination of indicators, and although they make moneyfor traders, the number of successful trades varies between 35 and 75 percent. By understanding themarket sentiment and by using chart and candlestick patterns, losses can be minimized. What we attemptto do in this book is to take trading methodologies to a higher level by using a combination of chart andcandlestick patterns with technical indicators. There is no single strategy that works successfully everytime. You need to use the strategy appropriate for the market conditions. The majority of the technicalindicators tell traders what has happened and are considered lagging indicators while chart andcandlestick patterns predict what will happen in the immediate future and can be considered as leadingindicators.
Trading is approximately 20% technical and 80% psychological. With the psychological side of trading,it is important that you understand the sentiment of the market and have good money management skills.To teach this would take hundreds of hours, this can only be successfully gained by hard work on yourpart.
The main aim of this ebook is to go through the basics of forex trading and to share with you our tradingexperience and knowledge in the hope that you can use it for your own success. We cover the “BigPicture” and go through the building blocks, finally putting it all together.
In this ebook we focus mainly on the use of candlesticks as the trend is towards the use of candlesticksover the use of conventional bars. More and more chartists are moving over to using candlestick charts asthey are easier to read and candlesticks in combinations provide critical information on what the market isgoing to do. When the traditional candlestick patterns are combined with Western analysis, they add anextra dimension to conventional chart analysis.
2Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideChapter 1What is Forex Trading?
Forex or Foreign Exchange is the simultaneous buying of one currency and the selling of another.Currencies are traded in pairs.
The Forex Market has more buyers and sellers and daily volume than any other market in the world andtakes place in major financial institutions across the globe. The forex market is open 24 hours a day fivedays a week
Buying/Selling
In the forex market, currencies are always priced in pairs and all trades result in the simultaneous buyingof one currency and the selling of another. The objective of currency trading is to buy the currency thatincreases in value relative to the one you sold. If you have bought a currency and the price appreciates invalue, then you must sell the currency back in order to lock in the profit.
Quoting Conventions
Currencies are quoted in pairs. The first listed currency is known as the base currency and the second iscalled the counter or quote currency.
Currencies are quoted using five significant numbers, with the last placeholder called a point or a pipFor example a EUR/USD quote = 1.1345/1.1350
Like all financial products, forex quotes include a "bid" and "ask" or a “sell” and a “buy” price.
By quoting both the bid and ask in real time, brokers ensure that traders always receive a fair price on alltransactions. As in any traded instrument, there is an immediate cost in establishing a position. This costwill vary between the different brokers and is sometimes called “spread”.
For example, USD/JPY may bid at 131.40 and ask at 131.45, this five-pip spread defines the trader’s cost,which can be recovered with a favourable currency move in the market.
3Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideMargin
The margin is a performance bond, or good faith deposit, to ensure against the total loss of your account.Trade stations have margin management capabilities. In the event that funds in the account fall belowmargin requirements, the broker’s dealing desk will close all open positions. This prevents clients'accounts from falling into a negative balance, even in a highly volatile, fast moving market.
The new NFA rule requires a minimum 1% margin at all time to maintain an open trade. (Note this maychange from time to time so although we use 1% as the example at some stage in the future the marginmaybe different. However using similar calculations one can easily calculate the new margins)
Some deal stations automatically calculate this according to the formula and hence the marginrequirements are continually varying.
Based on a 1% margin requirement
Example 1: GBP/USD
rate: 1.7442/1.7447account type: 100 000/lot account1% leverage: 100 000x0.01 (1%) =1000units
When you are long (buy) GBP/USD, the margin required is:
1.7447 (GBP/USD) x1000 (units of base currency GBP) = USD1744 for each lot.Some brokers require $1,800 margin for GBP pairs.
Example 2: EUR/USD
rate: 1.2326/1.2331account type: 100 000/lot account1% leverage: 100 000x0.01 (1%) =1000units
When you are long (buy) EUR/USD, the margin required is:1.2331 (EUR/USD) x1000 (units of base currency EUR) = USD1233 for each lot.
Some brokers require $1,300 per lot in margin for EUR based pairs. In general, a margin of $1,300allows you to control a $100,000 spot currency position. This is an efficient use of trading capital as theleverage in futures and stock markets is much less.
Example 3: | Where the USD is the BASE currency, the margin requirement is USD1000(ie 1% of 100 000)
When you are long (buy) USD/CAD, USD/CHF etc the margin required is: = USD1000 foreach lot.
4Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideForex Market and Locations
The forex market is a seamless 24 hour market and is open 5 days a week.
At 5 pm Sunday, New York time, trading begins as markets open in Sydney and Singapore.At 7 pm the Tokyo market opens, followed by London at 2 am,
and finally New York at 8 am. (Time is based on New York time)
As a trader, this allows you to react to favourable/unfavourable news by trading immediately.
The trading of forex takes place all over the world and is not located in any one central location.Deals are done between a variety of traders, from banks to managed funds to individual traders
Size of the Forex Market
Forex trades approximately US$1.85 trillion a day and is by far the most liquid market in the world. Ittakes the NY Stock Exchange THREE MONTHS to trade the same USD value as the forex trades eachand every day making it the largest and most liquid market in the world. This market can absorb tradingvolume and transaction sizes that dwarf the capacity of any other market. If you compare this to theUS$30 billion per day futures market, it becomes clear that the futures markets provide only limitedliquidity. The forex market is always liquid, meaning positions can be liquidated and stop orders executedwithout slippage.
Brokers and Market Makers
Market Maker - One that consistently makes two way prices, providing both a bid and an offer. Unlikebrokers, market makers trade their capital
Broker - An individual who matches buy and sell orders in return for a commission. The bid and offerprices are those of the market participants and not of the broker.
Currency Pairs
Traders can trade a variety of currency pairs, limited only by which pairs each broker provides.Major currency pairs are typically the USD pairs for exampleEURUSDGBPUSDAUDUSDUSDJPYUSDCHFCross currency pairs are pairs which do not involve the USD for exampleEURGBPEURJPYGBPJPYEURCHFEUR= Euro, GBP= Pound, CHF= Swiss Franc, JPY=Yen, AUD= Aussie $
5Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwidePoint/Pip Values
Point/Pip values is the US$ value for each Point/Pip (these are typical values and can vary between thedifferent Brokers and Market Makers)
. Regular MiniEuro = $10 ($1)Pound = $10 ($1)Australian Dollar = $10 ($1)Swiss Franc CHF = $7.60 ($0.76)Canadian Dollar CAD = $7.30 ($0.73)Japanese Yen = $8.45 ($0.85)
Major Market Participants
Traders includeGovernments,Reserve Banks,Large Mutual Funds,Banks,
Companies,
Hedge Funds,Individual Traders.
Fundamental or Technical
The two basic approaches to analysing the currency market are Fundamental Analysis and TechnicalAnalysis. The fundamental analyst concentrates on the underlying causes of price movements, while thetechnical analyst studies the price movements themselves.
Fundamental AnalysisFundamental analysis focuses on the
economic
social
politicalgeopolitical forces
These drive supply and demand.Fundamental analysts look at various macroeconomic indicators such as
economic growth rates,interest rates,
inflation,unemployment, etc.
6Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideHowever, there is no single set of beliefs that guide fundamental analysis. There are several theories as tohow currencies should be valued. Do not try and analyse the fundamentals unless you are a financialexpert. Let the experts do this and follow their lead by reading the charts.
Be aware when announcements are due.Sometimes the experts are wrong and get caught by unpredictable actions.Technical Analysis
Technical analysis focuses on the study of price movements. Historical currency data is used to forecastthe direction of future prices. The premise of technical analysis is that all current market information isalready reflected in the price of that currency, therefore, studying price action is all that is required tomake informed trading decisions.
The primary tools of the technical analyst are charts. Charts are used to identify trends and patterns inorder to find profit opportunities. The most basic concept of technical analysis is that markets have atendency to trend. Being able to identify trends in their earliest stage of development is the key totechnical analysis.
7Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideSoftware Tools
Deal Station (Also know as Trade Station or Trading Terminal)
Deal Stations are used to access the currency pairs for placing your trades. The provide all youraccount details such as
Dealing Rates
Open Trades
Entry Orders
Account Balances
News providers
Sometimes Deal Stations come with combined charting packages
Recommended Deal Station FXCM Wwww.fxcm.com or www.interbankfx.comBase currencies other than USD www.fxcm.co.uk
Charts
There are many different types of charts complete with sets of technical indicators, and they come in amultiple of different timeframes
1, 5, 10, 15, 30,minutes, | hour, 4 hour, Daily, Weekly, Monthly timeframes
Different traders use the different timeframes depending on their strategies
Recommended free charts = www.interbankfx.com
Uses MetaTrader. Free charts account (demo) needs to be renewed every 30 days.
Computer RequirementsComputer
Fast as possible — Pentium 3 or greater.
Dual monitors an advantage but are not essential.
Monitor size — at least 15” flat screen (19” preferable)
Minimum RAM 256Mb
The average computer will cope but sometimes you may experience lack of RAM problems whichwill slow the computer
Internet
Broadband / ADSL and cable preferred
Good dial up modem is typically adequate
Unlimited download and time plans
Broadband — minimum speed is ok — need at least 3Gb downloadSession times — plans with 2-4 hr session times are frustrating
Software
Windows 2000 Pro or XPTrading software supplied by the brokers
8Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideDeal StationsWhat to look for in a forex broker.
Honesty
Reliability
Security of data and information
Easy to use software
Fast accurate order execution
Minimum slippage
Charting packages incorporated with Deal StationFinancial strength and stability
9
Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideChapter 2
Japanese Candlesticks
Introduction - Repeatable Japanese Candlestick Patterns to Exploit
Japanese candlesticks offer a better visual perspective to predict future market action than bars. Intraday
charts with clear Japanese candlestick patterns are invaluable for entry and exit strategies. Below is acomparison between a candlestick chart and a bar chart
 
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10Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideComparison between Candlesticks and Bars.
Bullish CandleHighCloseOpenLowBullish BarHighCloseOpenLow
Bearish Candle
High
Open
Close
Low
Bearish Bar
High
Open
Close
Low
Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideCandlestick patterns are reliable on all timeframes. Some patterns such as morning stars, evening starsand haramis are rarely seen in intraday trading because they require a gap between the close of one candleand the opening and another. With electronic forex trading and fluid price movements, gaps rarely occurbetween intraday candlesticks. Gaps are found where the OPEN of the following candle does not equalthe CLOSE of the preceding candle.
No GaiP : : Gap
However, we can still use morning stars and evening stars without the gaps. This is where we use “poeticlicense” (where POETIC LICENSE is the justifiable departure from conventional rules of form). Theexamples we will show in the next section depict ideal Candlestick patterns, but in reality there we do notalways get ideal patterns. For example, we define the following patterns as the same.
Bearish Engulfing Bullish Engulfing
Departure from the ideal formation is often caused by sudden price movements as the chart is updatingfrom one time period to the next. Ideally the close of the previous candle should line up exactly with theopen of the following candle.
Using candlestick signals creates tremendous profit making advantages because it allows a trader to makea quick decision. Combined with chart patterns and suitable indicators, we have found candlestickpatterns provide reliable entry and exit points.
12Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideDoji
The doji is a reversal signal. The opening and closing prices are at or near the same price. The lack of areal body means the bulls and the bears are fighting and the balance of power may be shifting. The doji isa warning sign of a pending reversal. Proceed with caution. The doji needs a confirmation candlestickbefore you act on it, and when found with in other candle patterns the doji candle adds strength andreliability to the formation. If there is a doji in an up trend, we need a close below the close of the doji asconfirmation that the trend has changed.
Dragonfly Doji (Bullish)This doji is sometimes seen at the bottom of a move. The open and close prices are the same. The Long
wick (shadow) below indicates a reversal.This pattern is more bullish than a hammer.
Hammer
Gravestone Doji (Bearish)
The gravestone doji is often seen at tops. The open and close prices are the same. There is a tall wick(shadow). This pattern is more bearish than a shooting star. Technically, it should not have a body.
Shooting Star
13Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideSpinning Top
The spinning top can be a very good reversal signal and can be any colour. The smaller the real body, theless the direction the market has.
Bullish Engulfing Pattern
The market must be in a clearly definable downtrend, not in sideways consolidation.
The first candle is the colour of the short term trend (down) or a doji. The second candle is the colour ofthe reversal (up). The second candle body engulfs the previous body. Ignore the wicks (shadows).
An even stronger signal occurs when a candle body engulfs the bodies of 2 or 3 previous candles.
Bearish Engulfing pattern
The market must be in a clearly definable trend. The first candle is the colour of the short term trend (up)or a doji. The second candle is the colour of the reversal (down). The second candle body engulfs theprevious candle body. Ignore the wicks (shadows).The size of the candle body being engulfed does notmatter. A stronger signal occurs when 2 or more candle bodies are engulfed by one candle body.
Bearish Engulfing Bullish Engulfing
14Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideTweezer Bottom
Two or more candlesticks with matching bottoms. They can be composed of real bodies, wicks (shadows)and/or dojis.
Tweezer Top
Two or more candlesticks with matching tops. They can be composed of real bodies, wicks (shadows)and/or dojis. These occur on consecutive or nearby candles.
Tweezer Bottom Tweezer Top
a
Tweezer Top and Bottom candlestick patterns are good reversal signals. The wicks or bodies must be atthe same level. Look for the 2 types of tweezer bottoms and 2 types of tweezer tops.
SIL 7
15Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideMorning Star Bullish reversal sign
A morning star is a bullish three candle pattern. The first candle is a tall red real body, the second is smallreal body (red or green) that gaps below the first real body and the third is a tall green candle that closesat least 50% into the red body. However, if there is no gap because intraday forex candles don’t gap
often, still count it as a morning star.
Bullish Morning Star Bullish Morning Doji Star
I
Evening Star Bearish Reversal signal
A three candle pattern in an upward price swing. The first candle is a tall green real body. The second is asmall real body (red or green) that gaps above the previous real body, and the third is a tall red candle thatcloses at least 50% into the first candle’s real body.
Bearish Evening Star Bearish Evening Doji StarHammer Bullish after a significant downturn
A reversal signal. The long lower shadow must be at least twice the length of the real body. The real bodycan be any colour. The hammer needs a confirmation candle before we can act on it. We need to see aclose above the close.
Mi
16Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideInverted Hammer Bullish at bottom of trend
Wait for a bullish verification candle before acting
it A
Shooting star Bearish at top of trendA shooting star can mark a top and is often retested. It is a reversal indicator after an up trend (long upper
shadow is bearish as higher prices are rejected.).
Shooting Star (Shooting Star is the top candle) (Inverted Hammer)
Sometimes a pattern with four candlesticks occurs. They consist of an extra candle such as a doji orspinning top. When this occurs the pattern gets added strength and is more reliable. Also where a hammeroccurs in conjunction with a spinning top or doji, the result is stronger and more reliable.
Shooting Star with Spinning Top Hammer and Spinning Top
i
17Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideBullish and Bearish Rejection PatternsThe Bullish and Bearish Rejection patterns are reversal patterns and occur in conjunction with supportand resistance lines. When the currency pair attempts to breach the support or resistance line and fails it
has been rejected at that level and reverses.
Bearish Rejection Bullish Rejection
Resistance Line
There are many more combinations of Candlestick patterns. We have only selected a few that work wellfor us and limited the number to keep things simple.
Support Line
Following this section are a number of charts which show the candlestick patterns in their different forms.
18Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwide 
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 Chapter 3CHART PATTERNS
Chart Patterns are patterns which occur in trading charts that help traders predict the probable directionthe currency pair is likely to move. Chart patterns may form over any timeframe from a couple of hoursto even years. Japanese Candlestick patterns also provide a reliable insight as to where the immediate
direction of the currency pair may head. Firstly, we will look at chart patterns then candlestick patterns.Sketches have been provided to illustrate the patterns and in a following section a number of real forex
charts have been included.
Patterns can be divided into two main categories (a) Reversal Patterns where the market reverses itsdirection and (b) Continuation Patterns where the market continues in the same direction after a period of
consolidation or retracement.
 
Reversal Patterns
Continuation Patterns
 
 
 
Head and Shoulders Channels / RectanglesAscending and Descending Wedges Flags and Pennants123, Higher Lows, Lower Highs Triangles
 
Double Tops and Bottoms
1234s, Higher Lows, Lower Highs
 
Trendlines, Support and Resistance Lines
 
Pivots
 
 
 
 
Japanese Candlestick Patterns
 
REVERSAL PATTERNSHead and Shoulders
Head and Shoulder Patterns can be normal or inverted. The normal head and shoulders consists of threepeaks where the center peak is the highest while the Inverted Head and shoulders consists of three lowswith the center low the lowest. A neckline is drawn through the lowest points either side of the head. Abreak through the neckline provides a “sell opportunity” With the Inverted Head and shoulders theneckline is drawn through the top of the two peaks either side of the head. A break through the necklineprovides a “buy opportunity”.
Head Right
Left Shoulder
Shoulder Neckline
Neckline
RightLeft Shoulder
22 Shoulder Head
Copyright © 2003 Forex Systeius neseaicu CompanyAll rights reserved worldwideUSDJPY A hous LastBid 110.82 Time= 14:60:64 ET
 
          
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Created with Interbank FX Trader, © 2002-2003 MetaQuotes Sofware Corp.Ascending and Descending WedgesAscending Wedge in an uptrend-bearish
This pattern occurs when the slope of price candles’ highs and lows join at a point forming an incliningwedge. The slope of both lines is up with the lower line being steeper than the higher one. Place an orderto breakdown and out of the wedge. The drop out of the wedge can be very dramatic.
Descending Wedge in a downtrend -bullish
This formation occurs when the slope of the price candle high and lows join at a point forming adeclining wedge. The slope of both lines is down with the upper line being steeper than the lower one. Totrade this pattern, place an order on a break up and out of the wedge.
24Copyright © 2003 Forex Systems Research CompanyAll rights reserved worldwideECT = lai!Fic View Chart Indicetors Tools Window Help | MMS. Strategieer ©) PullData Mode “alel>d[Ci eo oe lS @ NP te ll e SHIR KX EAA YAK T | [6 Arle) ® [ie Oe oe
 
 
 
 
 
    
 
 
 
   
 
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