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FOREXMADE EASY6 Ways to Trade the Dollar
James Dicks
McGraw-HillNew York Chicago San Francisco Lisbon LondonMadrid Mexico City Milan New DelhiSan Juan Seoul SingaporeSydney Toronto
—From a Declaration of Principles jointly adopted by a Committee of theAmerican Bar Association and a Committee of Publishers.
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. Manufactured in theUnited States of America. Except as permitted under the United States Copyright Act of 1976, no partof this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher.0-07-144597-8The material in this eBook also appears in the print version of this title: 0-07-143894-7.All trademarks are trademarks of their respective owners. Rather than put a trademark symbol afterevery occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefitof the trademark owner, with no intention of infringement of the trademark. Where such designationsappear in this book, they have been printed with initial caps.McGraw-Hill eBooks are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. For more information, please contact George Hoare,Special Sales, at george_hoare@mcgraw-hill.com or (212) 904-4069.TERMS OF USEThis is a copyrighted work and The McGraw-Hill Companies, Inc. (“McGraw-Hill”) and its licensorsreserve all rights in and to the work. Use of this work is subject to these terms. Except as permittedunder the Copyright Act of 1976 and the right to store and retrieve one copy of the work, you may notdecompile, disassemble, reverse engineer, reproduce, modify, create derivative works based upon,transmit, distribute, disseminate, sell, publish or sublicense the work or any part of it without McGrawHill’s prior consent. You may use the work for your own noncommercial and personal use; any other useof the work is strictly prohibited. Your right to use the work may be terminated if you fail to comply withthese terms.THE WORK IS PROVIDED “AS IS.” McGRAW-HILL AND ITS LICENSORS MAKE NO GUARANTEES OR WARRANTIES AS TO THE ACCURACY, ADEQUACY OR COMPLETENESS OFOR RESULTS TO BE OBTAINED FROM USING THE WORK, INCLUDING ANY INFORMATION THAT CAN BE ACCESSED THROUGH THE WORK VIA HYPERLINK OR OTHERWISE,AND EXPRESSLY DISCLAIM ANY WARRANTY, EXPRESS OR IMPLIED, INCLUDING BUTNOT LIMITED TO IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR APARTICULAR PURPOSE. McGraw-Hill and its licensors do not warrant or guarantee that the functions contained in the work will meet your requirements or that its operation will be uninterrupted orerror free. Neither McGraw-Hill nor its licensors shall be liable to you or anyone else for any inaccuracy, error or omission, regardless of cause, in the work or for any damages resulting therefrom.McGraw-Hill has no responsibility for the content of any information accessed through the work.Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental,special, punitive, consequential or similar damages that result from the use of or inability to use thework, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tortor otherwise.DOI:10.1036/0071445978
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HIS BOOK IS DEDICATED to my wife Deb. As I learned so well in
T
the Marine Corps, there is no “I” in Team. It takes a team effortto make things happen. Deb is the team member that has beenthere through thick and thin. The long nights and the days awayfrom home are hard. Deb has always had nothing but motivation, encouragement and love along the way, and with her love anything ispossible. I love you dear.
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Contents
Preface xiiiAcknowledgments xvii1
What Is the FOREX? 1Introduction
1
FOREX Defined
12
A Brief History of the FOREX
13
Free-Floating FOREX Market
13
Major FOREX Participants2
14
More FOREX 15Currency Pairs
15
Recommended Currency PairsWhy Trade the FOREX
19
Volume in the FOREX
19
Analyzing the FOREX
23
How Profits Are Made
23
16
The FOREX as a Two-Way Market3
25
Forecasting the Market 29Fundamental AnalysisTechnical Analysis
2932
Fundamental versus Technical Analysis
33
CONTENTS
viii
4
Currency Options 35Currency Options IntroductionOptions Pricing
36
Advantages of Trading Options
37
European and American Options
37
Exotic Options
38
Lock in Profits
40
Accelerate Your Profits5
35
41
Creating a Workstation for Trading 43Workstation Location
43
Trading Computer and AccessoriesInternet Connection
45
Trading Software ProgramsContinuing Education6
44
45
48
Fundamentals of Trading 51Introduction to Trading TheoryTrends DefinedTrend Cycles
52
5353
High-Probability Trading
55
Sideways, Nontrend Strategy: Wait for Strong TrendsUptrend Trading Strategy: Buy at Dip Bottoms
55
Downtrend Trading Strategy: Sell at Rally Tops
58
Symmetrical Triangle
58
Ascending Triangle: A Bullish Continuation PatternDescending Triangle
55
65
The Falling Broadening Formation
67
Support Breakdown or Resistance Breakout
67
63
CONTENTS
ix
The Double Bottom
68
Head and Shoulders (Crown)7
70
Economic Fundamentals 73Introduction
73
Economic Indicators
74
Inflation Indicators
76
Employment Indicators
78
Consumer Spending IndicatorsLeading Indicators8
78
79
Introduction to Technical Analysis 81Technical Analysis Defined
81
Technical Analysis AssumptionsBar and Candlestick ChartsTechnical Analysis Terms
82
8386
Market Patterns: Uptrends, Downtrends,and Sideways Trends
87
Support and Resistance
95
Moving Averages9
95
Advanced Trading Charts and Indicators 103Tools for Technical AnalysisBollinger Bands
104
104
Directional Movement Index (DMI)Stochastic Indicator
107
107
Moving Averages (Simple, Weighted, and Exponential)Moving Average Convergence/Divergence (MAC/D)
110116
CONTENTS
x
Momentum
119
Relative Strength Index (RSI)Rate of Change (ROC)Volume10
119
122
122
Fibonacci Numerical Sequences and Elliot Waves 125Introduction
125
Fibonacci Rectangles and Shell SpiralsFibonacci RetracementsFibonacci ExtensionsFibonacci Time
11
128128
129
Fibonacci CirclesElliot Waves
127
130
135
Money Management Principles 139Trade with Sufficient CapitalExercise Discipline
140
140
Be Patient and Persistent
141
Employ Risk-to-Reward RatiosFollow Trading RulesAccept Losses
141
143
144
Always, Always Use Stops
144
When In Doubt, Stay Out
145
Never Overleverage Your Account
145
Make Realistic Goals That Can Be Achieved within ReasonAlways Trade with Money You Can Afford to LoseProtecting Your ProfitsKeep a Trading Log
147147
147
146
CONTENTS
12
xi
Six Steps to Success 149Identify Current Long- and Short-Term Trendsand Which Trend to Trade
149
Check News and Market AnnouncementsIdentify Support and Resistance Levels
150151
Use Studies and Indicators for Entry
151
Buy at Dip Bottoms (Uptrends) or Sell on RallyTops (Downtrends) 151Use Proper Money Management13
152
Getting Started with a Trading Station 155Access the PremiereTrade Web Site
156
Install and Run the Dealing Software
156
Open a Demo Trading AccountDealing Rates Window
157
Open Positions Window
159
Accounts Window
161
Multiple-Accounts WindowOrders Window
156
163
163
Placing a Market Order
164
Placing a Stop/Limit on an Open Position
167
Change Price on a Stop/Limit (Open Position)Delete Stop/Limit (Open Position)Close an Open Position
169
Placing an Entry Order
170
Change an Entry Order
171
Canceling an Entry OrderReports
173
173
168
168
CONTENTS
xii
Customizing the Trading ScreenTrading Station Options14
173
175
Corporations in the FOREX 179Introduction
179
Forward Transactions
180
Examples of Strategies
181
Portfolio Management and Currency Risk15
183
The Business of Trading 185Staring your BusinessThe Tax Code
185
186
How to Become a Trader
187
What If I Don’t Make Enough Money to UseThose Deductions? 188How to Make the Win/Win Better
188
What Kind of Corporation Should You Use?Let’s Take a Look at Some Examples
189
190
Appendix: Bretton Woods System and Post–BrettonWoods System 193Glossary
199
Bibliography
207
Charts, Figures and CreditsIndex
209
207
Preface
ELCOME TO A NEW and exciting opportunity. It is calledthe foreign currency market (or the FOREX). My nameis James Dicks, and I have been trading for more than 13years. I have traded through many different market conditions and have seen first hand what such conditionscan do to individual investors’ portfolios.I have spent most of my adult life and all of my younger years with myfather and uncles as my mentors. My father is a very successful real estateinvestor, both commercially and residentially. My uncles, Jack and John,both attorneys and entrepreneurs, looked at me as their personal challengein life, and I don’t think I let them down.Let me start from the beginning. I want to build a foundation so thatyou understand and know that I am no different than you are. Some of youmay be older and wiser than I am, but I know one thing with which you cannot disagree: There is no reason for you to make the same mistakes I did,and if you have already made those same mistakes, I hope that you canlearn from the solutions that I have found.My family has always been one to think outside the box. We have verystrong genes when it comes to the entrepreneur spirit. I grew up in the hotelbusiness, as my father had several. As I got older, I began to think a littledifferently. Interestingly, everything I thought of was directly related to thefinancial industry.I went to work for my uncles in the late 1980s, and I learned about personal finance and investing; it was soon after that I got my first securitieslicense and became a stockbroker. I watched as my firm educated investorson alternative investments such as oil and gas limited partnerships—a greatalternative to the stock market. As things frequently seem, it appeared to begreener on the other side.The stock market took off, and most of the investors who invested inthese limited partnerships were very unhappy that they were only making 8
W
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xiv
PREFACE
percent on their money; they wanted all their money in the stock market,especially the technology sector. What do you think happened? You’re right.The market went down like the Titanic, and so did investors’ portfolios.I was on a plane recently sitting next to a gentleman, and we were talking about investing. I was sharing with him my knowledge of the FOREX,and come to find out, he had invested in one of our limited partnerships. Hetold me how he could not have been happier that he did this. He told me thathe would have been completely wiped out if he had not simply diversifiedhis portfolio, not to mention that he was really quite happy to be getting hismonthly check annualized out at 8 percent for the last 2 years.My message—one of diversification and good money management—without a doubt can help you in your quest for financial freedom.After years of being a stockbroker, I took a little time off, traded formyself, invested in real estate, opened a retail store, and just tried to dowhat everyone wants to do—become financially independent. I made somereal good money with my retail stores. I opened a few and sold them,invested in some real estate, and decided that I had to accomplish one ofthe goals on my lifetime list, so I joined the Marine Corps, volunteered forinfantry, went to Parris Islands—not exactly a time share location, either—and then on to my military occupational school.Respect for the Marines Corps runs very deep in my blood. I think Iwas a born Marine. I love the Corp, and I definitely got a very good education on discipline, something all traders must have. After getting out of theMarine Corps, I continued my real estate investing, and I was still tradingin the stock market, although it was starting to get a little harder than justbuying a technology stock.I ultimately bought about $20 million in real estate, with a very sizableamount in equity. I started living the good life but soon learned one lessonthat applies to trading—money management, something I didn’t knowmuch about. I ultimately lost everything I had. I overleveraged my portfolio. One of the things you will learn in this book is how to avoid overleveraging your account, a strategy that you will need to learn as a FOREXtrader. Well, back to square one again for me. The good news is I was ableto avoid ever having to file for any type of bankruptcy. I simply facedadversity, and as the Marines taught me, I overcame and adapted.After all that, I decided to go back to what I knew most—trading. Iwas working with my Uncle Jack again and got together with a softwarecompany that claimed to make trading as easy as 1-2-3, red light–greenlight. Now, all of sudden, there is all this software out there to simplifysome of the more complicated ways to trade, and the software in the case
PREFACE
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of the red light–green light that I am sure some of you are familiar withwas Wizetrade.I became very good friends with the owners of the company and evenwent out teaching the software because I believed in it so much. The problem came when the market continued to go down. I was not happy tradingthe stock market. Too many scandals were happening. The news wasbecoming absolutely ridiculous, and the market makers were out of control.It was hard enough to trade the market without all that going on. Ifinally got so frustrated that I stopped trading the market altogether. I stillto this day use the stock market for diversification. While looking for analternative to the stock market, a friend of mine told me about the FOREX,and I was interested.It seemed that this market had all the benefits I was looking for. I couldtrade 24 hours a day, 6 days a week, with no commissions and no gaps up ordown. So I started learning about it. Just after the Commodities and FuturesModernization Act was passed in October 2000, I worked on my firstFOREX training in Vancouver, Canada. This was the beginning of 2001. Itwas real slow going, and I couldn’t convince anyone to listen to me. Can youbelieve that this market is bigger in volume daily than all the markets of theworld combined for 3 weeks, the same market that big banks, institutions,and corporations of the world used to diversify their portfolios?Over the years, I had spoken to and taught tens of thousands of peopleall types of investing, and I was really getting tired of hearing horror storiesabout people’s portfolios. The technology market was crashing, and peoplewere losing upwards of 90 percent of their portfolios. Some stocks weregoing from $300 to $1. And all the while, investors were riding them all theway down. Worse yet, some investors were adding to their positions, costaveraging down.In most cases such actions are all mistakes. You have to have a plan andtrade the plan. You have to avoid trading emotionally, and you have to usediversification and good money management. You have heard, “Don’t putall your eggs in one basket.” Diversification doesn’t mean that you shouldhave your money spread out over a bunch of stocks. Or maybe several sectors. It means using multiple opportunities that spread your potential risk ofloss.In this book I have put together what I feel to be a very investorfriendly understanding of the FOREX and how to trade it. There are plentyof ways to make this more complicated, but there is no reason. This book isnot for the investor who wishes to be an economist. This book is for theeveryday investor who is looking for an alternative to the stock market forbetter portfolio diversification.
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Acknowledgments
FEEL LIKE I AM AT ONE of those big award shows and I just receivedan award. Now I have to make a quick speech and try to thank everyone that has been involved in this project without forgetting anyone.First and foremost I would like to just say thank you to my family. My wife Deb, my son James and my daughter Jacqueline. I amthe luckiest man on the planet to have such a loving family.My uncle Jack goes without saying. He has spent the last 14 years teaching me lesson after lesson. Some of those lessons I learned quickly andsome not so quickly. Now my uncle Jack is also my partner and I have neverhad more fun working, than working with him. I also thank my Uncle Johnfor his many years of that one little extra lesson. Thanks for taking the timeto make sure I learned something and always believing in me. Thanks Momfor always being there for me and the love that you have given. I also thankmy Dad for giving me the burning desire to succeed and all of the other family members that have helped me through the years. Can’t forget the MarineCorps for teaching me never to quit and that anything is possible. Semper fi!I give a special thanks to Mike Krajewski, Ari Paget, and Mike Stewartfor all their help with this project. Couldn’t have done it without you.Thanks guys!Thank you all.
I
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FOREXMADE EASY
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C
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1
A
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E
R
WHAT IS THEFOREX?●
Introduction
●
FOREX Defined
●
A Brief History of FOREX
●
Free-Floating FOREX Market
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Major FOREX Participants
INTRODUCTIONThere are more than 48 million household traders in the United States andmore than 11 million are online with one purpose—to make profits fromtheir investments and to take control of their retirement funds.What is the purpose of investing? To make money, right! I have alwayssaid that the single greatest source for wealth is the stock market. It alwayshas been and always will be. Well, this has been obscured somewhat overthe last couple of years.I have spent a great deal of time traveling across this great country ofours teaching people (investors) how to take control of their financiallives. I have spoken to many individual investors who have come up to me
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FOREX MADE EASY
and told me their trading nightmares—told me that their portfolios havelost upwards of 90 percent of their value.That in itself is a real tragedy, but what makes it worse is that many ofthese individual investors are approaching retirement; they do not have theluxury or the time to start rebuilding their retirement nest eggs. They arefaced with some very harsh decisions. Well, let me tell you: It is never toolate—you have to take action. If you don’t, you will lose.One of my favorite sayings is, “If you always do what you have alwaysdone, then you will always get what you have always gotten.” Let’s changethis. I will teach you how you can start to make a difference just by increasing your awareness of and education about an alternative to the stock market, opening up opportunities that have long been available to Fortune 1000companies, big banks, and institutions.As a foundation to what I am going to be talking about, let’s look at thebiggest mistakes investors make, regardless of what market or what instrument they are trading.
MISTAKE 1: TRADE AGAINST THE TRENDThis is the number one mistake that investors make today. They tradeagainst the trend of their positions. Remember, “The trend is your friend.”Let’s look at a perfect example of this: Do you remember the companywhose stock prices are depicted in Figure 1-1?Yes, it’s Enron, and what has become known as the Enron debacle is aperfect example of investors trading against the trend. How about one ofthe biggest companies on Wall Street? Do you think that such a companywould be a good investment for you portfolio? Probably so.Look at Figure 1-1. Notice how the stock price is going down. Thelong-term trend on this is down—straight down. However, I want to pointout a few things. First, there were a lot of Enron employees who loved thecompany. Most of the employees even took parts of their salaries as stocksand options.Did you know that during the entire plunge of this stock, there was notone sell recommendation from a Wall Street analyst? Notice that as thestock went down from the $90 range, it had several retracements; that is, asthe stock price was going down, it rallied and went back up a bit beforegoing down again. As it was going down, what do you think investors weredoing? They were buying. Why not—it was one of the biggest companieson Wall Street.When the Enron stock price got to around the $65 mark, investorswere somewhat relieved. They probably were saying, “Okay, it is now
3
FIGURE 1-1 Enron 2002–2003
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finally going back up.” Not so fast—the stock just retraced a little andstarted going back down again. Enron stock did this two more times, at$50 and $35, before falling off the map, so to speak. All the while, inventors were buying more.
MISTAKE 2: LISTING TO SO-CALLED EXPERTSLook again at Figure 1-1. The entire way down, Enron stock had buy orhold recommendations from Wall Street analysts, never a sell. This is onereason why legislation was being discussed on Capitol Hill to solve thistype of problem. The problem certainly was not limited to Enron. Therewas so much conflict of interest among analysts that most investors had ahard time keeping up with what was going on.How many investors watch CNBC? Many, right? Well, where do youthink the novice investors are getting their trading information? They get itfrom TV, newspapers, friends, and so on. The problem with this is that mostof the information they are trading on is old, sometimes weeks old. You seethis kind of thing happen all the time.Let me give you an example. Let’s say that ABC Company justannounced that it has the greatest new computer in the world and that it willrevolutionize the industry. What do you think is going to happen to thestock? It will go up, sometimes very quickly. However, usually the stock willturn around and go back down just as quickly when the volume dies down.You see, in the world of stocks, there are market makers. These individuals have one objective in mind, and this is to make a fair and orderlymarket for a specific security. In the stock market, the reason a stock goesup is because there are more buyers than sellers, and the reason a stockgoes down is because there are more sellers than buyers.While the stock market is hard enough to trade with all the variables tokeep in mind, the problem with the so-called experts is conflict of interest.The companies these experts work for are also market makers and ownstocks. The opinions of these experts cannot be considered without considering their ulterior motives (see Figure 1-2).Investor confidence is at an all-time low and has dropped dramaticallyas major investment firms are getting fined millions of dollars after recommending stocks to the public and yet at the same time sending internalmemos and e-mails describing the lack of profit potential these samestocks actually had (see Figures 1-3 and 1-4).I won’t mention the firm I am referring to, but the improprieties continue. However, here is some good news. As I commented earlier, there
CHAPTER 1
WHAT IS THE FOREX?
FIGURE 1-2 James Dicks Buy Sell Hold
5
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FIGURE 1-3 James Dicks Buy Sell Hold
is a lot of legislation being introduced, if not passed, on Capitol Hill tohelp clear up some of these problems.The New York Stock Exchange (NYSE), as a self-regulating body, hastaken on the task of changing the way it operates and has also taken the lead incleaning up these problems. All the proposed and forthcoming changes willmake a difference and ultimately allow for a better trading environment.Next, there is a common falsehood among traders that for every buyer,there is a seller. This is not true. That is what the market makers are for. If thereis not enough buying in a stock, then the market maker will come in and lowerthe price until there is more interest. The same holds true for selling. If thereis not enough selling, then the market maker will start raising the price untilthere is more selling interest. This cycle repeats many times and is the basis ofwhat is known as support and resistance. I will talk more about these conceptslater.
MISTAKE 3: UNWILLINGNESS TO SELLYou have to be willing to cut your losers. There is no reason to ride a loserall the way down. You have to let your winners outpace your losers. You
CHAPTER 1
WHAT IS THE FOREX?
7
FIGURE 1-4 James Dicks Buy Sell Hold
will learn a lot more about this when I get into good money management.I have heard investors tell me that they can’t sell right now because theydon’t want to take a loss. “It is only a loss on paper.” Okay, try spendingit. It is a loss if you can’t spend it, such as the Enron example. It nevercame back.You would have been better off having a stop loss on your trade and having gotten out with a 25 percent loss to trade another day. I will cover stoplosses as a way to use money management in your trading later. On the otherhand, I have had investors say such things to me as, “If I sell it, I will have topay taxes.” Okay, if you have to pay taxes, why? Profit probably. As long asyou have a plan for your taxes, don’t be afraid to take your gains as well.
MISTAKE 4: EMOTIONALLY INVOLVEDThis is my favorite. Let’s look at Cisco Systems, a favorite story of mine totell. I have personally experienced these changes in my portfolio, and mybrother-in-law is a big salesman with the company.The stock had split several times, and I bought some. It went back to$80, and I had dreams of retiring one day from trading this stock. A great
FOREX MADE EASY
8
many investors made millions on Cisco as it went to $80 and split severaltimes, so surely I could do the same thing.After hitting the $80 range in mid-2000, the trend reversed, and it wasan excellent opportunity to short the stock if you had a crystal ball. However, I, like many individual investors out there, loved the company.As the stock went down, I said to my self, “Hey, Cisco at $60. Wow,now that’s a good buy.” So guess what? I bought more. As it continued togo down, I started saying, “Well, it’s got to go back up. It’s a good company.” It then dropped to $40. This is as low as it has been in a long time.The last time it was at $40, it went back to $80 several times (from thesplits). This is the time to buy more.Then Cisco went to $20. Now I again, like many other investors, said,“Wow! Well, I guess it is a good time to cost average down.” This is what theprofessionals were saying. It had to be right. Then low and behold, the stockkept going lower, all the way down to about $11. Now here I am saying, “Well,I guess it can’t go much lower.” So I bought some more. Ultimately, it lost 85percent from its high, and most investors bought more as it went down—buying into and adding to these positions. Why? Because of emotions.Emotions and investing do not go hand and hand. Look at the Ciscochart for the time period I was referring to (Figure 1-5), and you will seehow it had a few up trends (retracements). This is where all the investorswere buying more.Emotions—Here are a few things that I have said in the past whileinvesting, and I am sure I was not alone:“It will come back.”“It’s a good company.”“It can’t go any lower.”“I can’t sell it now.”“I have a feeling about this one.”You might ask, then, “What can I do to invest wiser?” The answer isproper diversification. My grandmother told me so many times: “Don’t putall your eggs in one basket.” Guess what? I didn’t listen until it was too late.There is no difference with investing; your portfolio is your basket, sowhy would you invest all your money in the stock market or, worse yet, allin one sector of the market.At my training classes, I have had investors come up to me and say, “Iam diversified. I have my money in mutual funds.” Sorry, that is still thestock market. Or, “I have my money in about 10 different tech stocks.”Sorry, that is all one sector.
9
FIGURE 1-5 Cisco Weekly Chart 2002–2003
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True diversification means just that. Put a portion of your portfolio indifferent areas, such as bonds, mutual funds, stock, real estate, options, annuities, and the FOREX. This is what the Fortune 1000 companies, big banks,and institutions do,