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Getting Started in
FOREX TRADINGSTRATEGIESS E V E N T H
E D I T I O N
Michael Duane Archer
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Getting Started in
FOREX TRADINGSTRATEGIES
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The Getting Started In SeriesGetting Started in Online Day Trading by Kassandra BentleyGetting Started in Investment Clubs by Marsha BertrandGetting Started in Asset Allocation by Bill Bresnan and Eric P. GelbGetting Started in Online Investing by David L. Brown andKassandra BentleyGetting Started in Online Brokers by Kristine DeForgeGetting Started in Internet Auctions by Alan ElliottGetting Started in Stocks by Alvin D. HallGetting Started in Mutual Funds by Alvin D. HallGetting Started in Estate Planning by Kerry HannonGetting Started in Online Personal Finance by Brad HillGetting Started in 401(k) Investing by Paul KatzeffGetting Started in Internet Investing by Paul KatzeffGetting Started in Security Analysis by Peter J. KleinGetting Started in Global Investing by Robert P. KreitlerGetting Started in Futures by Todd LoftonGetting Started in Project Management by Paula Martin andKaren TateGetting Started in Financial Information by Daniel Moreau andTracey LongoGetting Started in Emerging Markets by Christopher PoillonGetting Started in Technical Analysis by Jack D. SchwagerGetting Started in Hedge Funds by Daniel A. StrachmanGetting Started in Options by Michael C. ThomsettGetting Started in Six Sigma by Michael C. ThomsettGetting Started in Real Estate Investing by Michael C. Thomsett andJean Freestone ThomsettGetting Started in Tax-Savvy Investing by Andrew Westham andDon KornGetting Started in Annuities by Gordon M. WilliamsonGetting Started in Bonds by Sharon Saltzgiver WrightGetting Started in Retirement Planning by Ronald M. Yolles andMurray YollesGetting Started in Currency Trading by Michael D. Archer andJim L. BickfordGetting Started in Rental Income by Michael C. ThomsettGetting Started in Exchange Traded Funds by Todd LoftonGetting Started in Fundamental Analysis by Michael C. ThomsettGetting Started in REITS by Richard ImperialeGetting Started in Swing Trading by Michael C. ThomsettGetting Started in Property Flipping by Michael C. Thomsett
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FOREX TRADINGSTRATEGIESS E V E N T H
E D I T I O N
Michael Duane Archer
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Copyright © 2007 by Michael Archer. All rights reserved.Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.Wiley Bicentennial Logo: Richard J. Pacifico.No part of this publication may be reproduced, stored in a retrieval system, or transmitted inany form or by any means, electronic, mechanical, photocopying, recording, scanning, orotherwise, except as permitted under Section 107 or 108 of the 1976 United States CopyrightAct, without either the prior written permission of the Publisher, or authorization throughpayment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web atwww.copyright.com. Requests to the Publisher for permission should be addressed to thePermissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030,(201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their bestefforts in preparing this book, they make no representations or warranties with respect to theaccuracy or completeness of the contents of this book and specifically disclaim any impliedwarranties of merchantability or fitness for a particular purpose. No warranty may be created orextended by sales representatives or written sales materials. The advice and strategies containedherein may not be suitable for your situation. You should consult with a professional whereappropriate. Neither the publisher nor author shall be liable for any loss of profit or any othercommercial damages, including but not limited to special, incidental, consequential, or otherdamages.For general information on our other products and services or for technical support, pleasecontact our Customer Care Department within the United States at (800) 762-2974, outsidethe United States at (317) 572-3993 or fax (317) 572-4002.Wiley also publishes its books in a variety of electronic formats. Some content that appears inprint may not be available in electronic formats. For more information about Wiley products,visit our Web site at www.wiley.com.Library of Congress Cataloging-in-Publication Data:Archer, Michael D. (Michael Duane)Getting started in Forex trading strategies / Michael D. Archer.p. cm. — (The getting started in series)ISBN 978-0-470-07392-6 (pbk.)1. Foreign exchange market. 2. Foreign exchange futures. 3. Speculation. I. Title.HG3851.A7392 2007332.4'5—dc222007023236Printed in the United States of America10 9 8 7 6 5 4 3 2 1
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To My Wife, Elaine
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Contents
Introduction
1PART 1
Traditional Elements of FOREX StrategyChapter 1Trading Techniques
13
Chapter 2The Soft Elements of Style
39
Chapter 3Money Management
49PART 2
Developing a Trading CodexChapter 4The Codex Notebook
59
Chapter 5The Codex Toolbox
65
Chapter 6Style
98
Chapter 7Making Money Management Decisions
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CONTENTS
Chapter 8Setting Up Your Trading Platform
113
PART 3
The Codex Method of Trading FOREXChapter 9Tracking Markets
123
Chapter 10Selecting Markets
129
Chapter 11Making a Trade
133
Chapter 12Monitoring a Trade
137
Chapter 13Exiting a Trade
142PART 4
The Complete FOREX TraderChapter 14Postmortem and Record Keeping
147
Chapter 15Options and Options
152
Chapter 16The Dreams of Reason—To Be or Not to Be a FOREX TraderAppendix AVisual Basic Source Code
160
165
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Appendix BHow the FOREX Game Is Played
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Glossary
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Index
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Do something different, even if it’s wrong.—Charles B. Goodman
Getting Started in FOREX TradingStrategiesGetting Started in FOREX Trading Strategies is intended as a sequel to GettingStarted in Currency Trading (GSICT), although it may certainly be used independently. One comment readers often make after reading the latter is, “Great, now Iknow the mechanics of FOREX. But what do I do next?” This book addressesthat question. However, it does assume some basic knowledge of FOREX.If you are new to currency trading, I suggest you pick up a copy of Getting Started in Currency Trading and read and study the material before startingthis volume.Readers’ expectations vary enormously. Most thought “getting started”truly meant getting started, but some assumed the book would carry themthrough more advanced training. A few were disappointed not to find a $19.95black-box system leading to great wealth without effort. There is no get-richquick method in FOREX or any other market. Getting Started in FOREX Trading Strategies (GSIFTS) is meant to give you an initial perspective on variousmethods and a simple method on which to build.
Traditional StrategiesTo most traders, strategy is synonymous with trading techniques—one or more ofthe many flavors of price charts or indicators such as oscillators and moving averages. In GSIFTS, strategy refers to the three primary elements that define a trader:trading techniques, money management, and the soft elements of market selection, trader profile, tactics, and psychology. Together they compose a trader’s style.
1
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A traditional trading strategy includes a charting technique such as pointand figure or candlestick charts, a number of technical indicators, and perhapsa few other tools the trader has found useful in previous trading. Money management is typically an ad hoc set of rules for limiting losses, maximizing gains,and entering and exiting a trade. Most traditional strategies rarely considerstyle, or soft elements, in any depth.Traditional strategies represent a linear approach to trading. Each strategic element is separate from the other. The elements don’t communicate verywell, if at all, with each other. The codex approach, introduced herein, applies aprocess paradigm to the elements and to trading.Trading Strategies: The Elements• Trading tools (“toolbox”)• Money management• Soft elements• Style• Psychology and attitude
There is nothing inherently wrong with traditional strategies and the elements approach. Some traders are very successful with them. A plethora ofprint and online material currently exists for the traditional trader. But let’slook at the facts. The FOREX market is not unlike other highly leveraged markets, such as options or futures. The statistics are not pretty; nearly 90 percentof new traders lose their initial account deposit in less than six months—mostof them using traditional strategies.I recently attended a FOREX convention in Las Vegas. I observed someone lecturing on chart support and resistance points. Useful information, to besure, but probably not in the way the lecturer intended. The vast majority oftraditional currency traders will be looking for the same or nearly the same support and resistance points. The market never cooperates with the majority; if itdid, everyone would be a winner and it would soon cease to exist. To the codextrader, the traditional support and resistance points are useful only to see whatother traders are thinking. The codex trader will seek to find the market’s truestopping and turning points.
The Codex ProcessThe codex approach introduced in Getting Started in FOREX Trading Strategiesattempts to meld the three elements into a trading process. Changes to one
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element, such as trading technique, will reverberate to the other elements. Instead of looking at the elements individually, a personal trading codex foldsthem into a process beginning with finding good trading candidates and concluding with a short postmortem of each completed trade.An analysis of each completed trade allows the trader to adjust his tradingcodex in an evolutionary, rather than revolutionary, manner. The specific codexmethod I use is named FxCodex in this book. Codex refers generally to theprocess method of trading; FxCodex refers to the specific elements I use to tradecurrencies as a process.
Trading Strategies: Codex• Tracking• Selecting• Entry• Monitoring• Exit
Steps to Strategic SuccessA codex is very personal and will differ with each trader. The FxCodex methodis my personal way of trading. GSIFTS will use it to explore the codex philosophy but offer individual choices for traders who want to go in a different direction. The key is developing a trading codex leading to a process rather than anelements trading approach.
Principles of Codex and FxCodex• Codex is a process.• Each step in a process is based on previous steps.• Steps talk to each other.• A change in one step of the process requires other steps to beadjusted.• Process changes should be evolutionary rather than revolutionary.• FxCodex is the name given my speciﬁc codex.
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Developing any personal trading codex requires the trader to make anumber of initial decisions. These decisions will define your initial tradingcodex. You can begin with a simple, basic structure and add to it as your experiences in the market dictate. This is just one of the advantages of the codex approach.These decision steps are the transition required to move from a traditionalelements approach to a codex-process approach to trading. Too many traders begin without having made these decisions and then make sharp revolutionarychanges in strategies as they go along. It is far better to have a codex defined before making any trades and make small, evolutionary adjustments thereafter.The traditional strategies give heavy emphasis to trading tools, often ignoring money management and soft elements such as style, market selection,psychology, and tactics. The codex approach gives equal emphasis to all ofthem and places them in a process paradigm. See Figure I.1.The trader may move back and forth between these steps before havingfully built a codex. You may find, for example, that you have selected currencypairs inappropriate for your trading style. If so, you may want to go back andconsider the selection of currency pairs vis-à-vis that information. The codexapproach allows you to weave back and forth without major disruption to youroverall trading method.ToolsYour first step is to decide the trading tools or techniques you will use. Thenumber of technical analysis tools is legend. There are dozens of chartingtechniques, indicators by the hundreds, and a myriad of methods, systems,techniques, and black boxes. It would be neither practical nor possible to assignall of them to the codex tool box.In my opinion (after 30 years in the markets), systems and black boxesdon’t work consistently over different market environments and for long periods of time. If you find one that does, call me. Making money in the marketsrequires real work and constant diligence.The most important factors in selecting codex tools are transparency andsimplicity. If you cannot understand how a tool works and what it really does,Trading Strategies: Steps→ Tracking → ← Selecting → ← Entry → ← Monitoring → ← Exit →←←←←←←←←←←←←←←←←←←←←←←←←
FIGURE I.1 Trading Strategies: Steps.
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don’t use it. Making evolutionary adjustments to your codex requires you to beable to understand the tools you use for trading.The trading technique backbone of the FxCodex method is charting.Most charts are simple, transparent, and visual. You can see what they mean.Indicators are often opaque; what are they really measuring? If you don’t knowwhat a tool does, how can you make adjustments when things go bad?If you carefully examine many of the indicators available—typically atype of moving average or oscillator—you will discover the following: (1) Theindicators are curve-fit to a specific market environment, and (2) they are reallyonly variations of the slope-intercept formula you learned in eighth-grade algebra. They measure the slope of the price changes in a market. You can see thatbetter and faster by simply eyeballing a chart.Which charting technique should you use for your codex? Bar charts?Point and figure charts? Candlesticks? Swing charts? In fact, any will work justfine! Whatever charting tool you are most comfortable with, use it. I use barcharts primarily for finding trade candidates and then switch to swing chartsfor market entry and exit. This book gives examples using all of them.Of course, you must interpret whatever charts you select. Traditionaltraders use such methods as support and resistance levels. They can be effective,but too many people are using them for the market to cooperate, in my opinion.How can all these traders be successful? In fact, we know they are not and cannot be. Don’t be afraid to be in the minority; only a minority of traders is eversuccessful.Charles B. Goodman was a commodities grain trader from Eads, Colorado. He became my mentor shortly after I began trading in 1973. Charlieentrusted to me many of his trading methods, the most significant of which Ihave introduced in this book as the Goodman Swing Count System, theGoodman Cycle Count System, and Market Environments. Perhaps even moreuseful was his astute money management approach to trading, which I havealso shared with the reader.The Goodman Swing Count System (GSCS) has stood me well for myentire trading career spanning more than 30 years. It’s an excellent way to geta quick fix on any market and for determining entry and exit points. It’s agood method for beginners or near beginners. You may use it effectively rightaway to trade and then plumb its more advanced features as your comfortlevel and trading experience increase. Such things as support and resistancewill usually not be in the same places as they are using traditional chart interpretation concepts.I rely on GSCS heavily in this book. It is the cornerstone of the FxCodexmethod. Remember, the FxCodex method is used primarily to show you howto develop and apply your own personal trading codex. What works for me
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may not work for you. The important idea is to develop a comprehensive andconsistent codex for trading.I have never been a fan of technical indicators. It is difficult to see whatthey actually do, or measure. Most of them require a curve-fit to some specificmarket environment, and when the environment changes, the indicator flops.Moving averages work well in trending markets but fall apart in trading markets. Oscillators work great in trading markets but fail in trending markets.Nonetheless I’ve included two that are simpler, that provide information noteasily visible with any chart, and that can be adjusted to different codex tradingbuilds.Market filters, typically statistical, are easy to implement and they provide great value for all traders. Strategy may find you the pot of gold, but it isoften tactics that allow you to bring it home. Filters assist you in decidingwhat markets to avoid and on what markets to focus your valuable andlimited time. Most of the market filters detailed in this book derive from theFOREX Companion series of books, written by this author and JamesBickford.MarketsYour second step is to select which currency pairs and crosses you want to atleast begin trading. You may want to add or subtract pairs as you go along, butsuch swaps should be facilitated in an evolutionary, not revolutionary, fashion.This book lists five pairs and five crosses to meet a wide range of trading interests and propensities. The codex method allows you to keep more pairs andcrosses on a monitor status and easily bring them into your trading if certaincriteria are met.The most popular markets are those including either the euro (EUR) orthe U.S. dollar (USD). Five of the seven markets include one or both of these.The so-called exotics may offer exceptional opportunity, but they also command exceptional risk.Currency pairs have different personalities and generally evolve slowly.The trader wants very much to select pairs for which his codex is a good fit. Ifyou have an aggressive trading codex, select high-volatility pairs. If you are avery conservative trader, select low-volatility pairs. There are several other currency selection criteria that I discuss in GSIFTS.Money Management and the Soft ElementsYour third step is to define yourself as a trader. This is a critical step and onemost traders accomplish only by default. You will save a great deal of time andavoid much frustration by working through this process as early as possible in
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your trading career. Too many traders overemphasize the specific tools neededfor trading and fail to apply the “know thyself ” rule as traders.What markets do you like to trade? Probably the ones in which you enjoythe greatest success. Analyze those for the characteristics that make them work,and stick to markets with those characteristics.What are your personality traits as they relate to trading? Are you a calmor nervous sort of person, for example? Are you conservative or aggressive?What are your financial means and goals? Will you be trading an account of$3,000 or $30,000? How much are you really comfortable risking in toto andon any specific trade?What money management ideas are best for you and for the tools inyour codex? Are your selections realistic, and do they complement eachother? Money management is not about how much money you can make. It’sabout avoiding losses. If you stay in the game long enough, you will makemoney. But if you lose your grubstake, you will not be in the game for thatbig payoff day.My mentor, Charles B. Goodman, emphasized this over and over to me. Icall it the Belgian Dentist approach. In Europe, Belgian dentists are consideredthe most conservative of traders. Trade the long term to break even; always consider risk above reward. I know, that doesn’t sound very sexy. But if you breakeven over and over again, you will eventually win.The primary money management parameters for all traders are the following:• Aggregate account drawdown or risk.• Win-to-loss percentage for specific trades.• Aggregate percentage of wins to losses.Different traders will modulate these parameters in different proportions,but it is important to set your standards up front, be realistic about them, andconfirm that they are in agreement with the rest of your codex.
Getting Started in FOREX TradingStrategies—Sections in SummaryThe following summary outlines the sections that make up GSIFTS.Traditional Elements of FOREX StrategyThis comprises a brief overview of the traditional elements—trading techniques, money management, and style. A basic knowledge of the elements is
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important to the topic of developing the codex. The brief discussions are intended to get you thinking about your own personal likes, dislikes, successes,failures, and propensities as a trader.Developing a Trading CodexThis section describes the important transition from traditional element strategies to the process codex strategy. The reader should spend as much time hereas possible, taking pen to paper and pouring out his own thoughts on every aspect of trading.The FxCodex MethodFxCodex is my personal codex. It is used in Getting Started in FOREX TradingStrategies to show you how to implement a codex of your own.The key to the FxCodex approach is transparency. As a trader, you willgradually zero in on high-percentage opportunities using simple and understandable trading techniques. You will apply consistent money managementrules consistent with your trading style and the soft elements.No matter how good a trader you are, things do not always go as planned.The FxCodex method allows for on-the-fly diagnostics. Traditional traders toooften redefine themselves and their strategies when things go awry. This is notgood; evolution is more effective than revolution. Do your codex due diligencebefore you risk a dime in the markets.This section also offers the reader some alternative codex selections forthose who want to go their own way. Several trading campaigns hopefullybring home the codex approach to trading and its differences from traditionalstrategies.The Complete FOREX TraderThe successful trader never ceases to explore and evolve! But the key is to makechanges in harmony with your codex in an evolutionary rather than revolutionary manner. Record keeping is a vital resource for such activities. Written accounts of your trades and daily and weekly summaries not only allow you toaccurately monitor your progress but also provide a feedback loop for improvements and codex quality control.The Layout of GSIFTSA final note about the layout of GSIFTS: This book is highly visual. Text is keptto a minimum and much information is provided in the charts, diagrams,
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tables, and explanations. Boxes provide a different perspective on especiallydifficult or important concepts, or provide ideas for independent study. I am abig fan of the visual approach to both studying and trading FOREX.Building BlocksThe book attempts a building-block approach to developing the codexmethod. Part 1 introduces the elements, Part 2 details them in the context ofthe codex approach, and Part Three shows them in application. The same information may appear to be repeated, but the context is important and the repetition is useful to fully mastering the ideas.As a writer and a trader I am always interested in comments, suggestions,and questions. No matter the vast reservoir of information available to us,we each can see the trading world only through our own eyes. Sometimes theview from another perspective can be enlightening. You may write to me atDuane@FxPraxis.com.If you would like to keep abreast of the codex trading approach in generaland the FxCodex method in particular, please visit www.fxpraxis.com.Good trading!
AcknowledgmentsA special thank you to Intellicharts for the use of their outstanding FOREXcharts from their online service, FxTrek, www.fxtrek.com, and to Dawn Borrisfor her many suggestions, editing assistance and moral support.
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Trading TechniquesThere are enough ideas for beating the markets to make you very rich—or very poor.—Charles B. Goodman
ost traders consider trading techniques—the actual tools they use tomake trading decisions—as the most important element of trading.The proof is in the pudding; just consider the corpus of informationboth in print and online that deals with trading techniques. The sheer amountis staggering.As the FOREX market matures, some literature on money managementand the soft elements is becoming available, but it is still dwarfed by information available about trading techniques. The demand continues to be for information on trading techniques. That is unfortunate given the importance of theother two elements.
M
Systems and Black BoxesBefore considering some of the most popular trading techniques or tools, letme briefly discuss systems and black boxes.A system is a self-contained way to make trades. Systems generate specificbuy and sell signals. Many FOREX trading systems are available either frombroker/dealers or from third-party vendors. They are intended to be completein and of themselves, although many traders still use them in conjunction withother trading techniques.
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Systems typically show outstanding results over historic data, or theywould not sell. But the historic data is very often curve fit. This means that thesystem was developed to fit the data and not the other way around. If that datarelated to some specific types of markets, such as volatile markets, trading markets, or trending markets, when the music changes the system is bound to fail.Systems have always been popular in all the markets—stocks, options,futures, and now FOREX. Not all systems are bad, but they are all opaque andthat is always a warning sign. See Figure 1.1.Opaque and TransparentIf a trading tool is opaque, it is difﬁcult or impossible to fully analyzewhat it measures. If a trading tool is transparent, what it measures iseither obvious or easy to comprehend.Indicators are generally opaque. Charts are transparent.
If you insist on using a system in your trading, be sure you understandwhich type of market it was build for or around—and use it only in those markets. However, determining which type of market the system was built for canbe difficult. Many systems provide limited information regarding how theywere developed. The best process is to look at charts of the markets vis-à-vis thesystem’s performance. In which markets did it perform best—trading, trending, fast, slow? If the system vendor does not provide at least enough information to do this analysis, beware.Black boxes are systems for which no information is available. You don’tknow how they were built, how they work, or what type of data they were builtaround. My recommendation regarding black box systems is to stay away fromthem. The less transparent the tool, the more difficult it is to make adjustmentswhen things go wrong. A black box is the most opaque tool of all.Robots have become popular in the FOREX markets. Usually, these areprograms that automatically execute a trading system. In fast-moving marketsthey are very useful, especially to the professional money manager overseeingdozens or even hundreds of separate accounts. If your available time for tradingis limited, you may want to consider using robots.But if you have so little time to trade that a robot appeals to you, I recommend that you consider a professional money manager to trade your account. There are many money managers with excellent track records, but adiscussion is beyond the scope of this book. Seek out a manager who has
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FIGURE 1.1 Curve-Fit Data.The moving average is curve-ﬁt to the data. A ﬁve-day average was selectedon previous market performance. There is no guarantee that the futuremarket performance will work with this value.Source: FXtrek IntellichartTM. Copyright 2001–2007 FXtrek.com, Inc.
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performed well in a variety of markets. It is more important that the manager has done well in a spectrum of market types than in specific pairs orcrosses.
Technical versus Fundamental AnalysisMost traders today use technical analysis to trade. This refers to techniquesbased on price and other objective data that result from market action. Thetechnician’s credo is “Everything is in the market price.”The factors examined in fundamental analysis, such as a country’s income,gross national product, and interest rates certainly drive currency prices in thelong run. The problem for the currency trader is, as Keynes said, “