10 Essential Lessons

for Successful Forex Trading

Getting started in todays largest global financial market

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Table of Contents

Risk Warning Introduction Lesson 1 Fundamentals - What Moves the Currency Markets Lesson 2 Pips, Lots, Leverage & Margins Lesson 3 Placing Orders Lesson 4 Technical Analysis: An Introduction to Chart Reading Lesson 5 Support, Resistance, and Moving Averages Lesson 6 Trends & Trendlines Lesson 7 Indicators, part I: The Trend Followers Lesson 8 Indicators, part II: The Oscillators Lesson 9 Trading Psychology - Greed & Fear Lesson 10 Money Management and Building Your System Going Further

3 4 5 7 10 13 16 19 22 26 30 33 35

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Risk Warning
Trading in the foreign exchange (FX) market on margin carries a high level of risk, and may not be suitable for all investors. Before deciding to trade foreign exchange you should carefully consider your monetary objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your deposited funds and therefore you should not speculate with capital that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent advisor if you have any doubts. Knight Media Group and its affiliates assume no responsibility for errors, inaccuracies or omissions in these materials. They do not warrant the accuracy or completeness of the information, text, graphics, links or other items contained within these materials. Knight Media Group and its affiliates shall not be liable for any special, indirect, incidental, or consequential damages, including without limitation losses, lost revenues, or lost profits that may result from these materials. This eBook is not a solicitation to buy or sell currency or any other investment instrument. Please review our Risk Warning and Terms of Use.

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Introduction
Forex, or the foreign exchange, is the worlds largest financial market, with over $3Trillion changing hands on a daily basis thats more than all of the worlds stock markets put together. Currency traders speculate on the fortunes of entire countries, much in the same way that other traders analyze and attempt to predict the future value of companies and commodities. Unlike these other investments, however, the forex market is much larger, and much harder for any individual party to manipulate or trade on insider information. Thanks to the power of leverage and the availability of real-time data, todays currency trader is no longer at a severe disadvantage to the large financial institutions. The markets are open 24 hours per day, and you can easily trade in both directions, up or down. Through currency trading, Ive been able to fulfill some of my personal goals and dreams. Now it is my desire to give back to the trading community, and to help others achieve new levels of success and abundance in their lives as well. Good hunting! -=Andrei Knight

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Lesson 1

Fundamentals - What Moves the Currency Markets

Welcome to global financial markets! Just as a trader or investor can buy stock in a company, the foreign exchange (or forex for short) allows you to buy or sell currencies, which is in a way like owning a piece of the future rise or decline of an entire countrys economy. Supply and Demand To determine where a particular countrys economy may be headed next, traders turn to a variety of data, including: gross domestic product (GDP), imports, exports, employment, unemployment, growth, debt, and many other factors. Collectively, these are often referred to as the fundamentals. Like any other market, the value of currencies responds to changes in supply and demand. When the world needs more Dollars, for example, the Dollar becomes worth more. When too many Dollars are available on the market, or the need for them declines for some reason, then the Dollar drops in value. Currency Pairs The worlds currencies trade in pairs - one currencys value either or rises or drops in comparison to another. Each currency has a 3-letter abbreviation, and the trailing currency of any pair is considered the base currency. The price at any given time tells you how much of the base currency is needed to equal exactly one unit of the leading currency. For example, when the EUR/USD pair is priced at 1.5000, this means that it takes 1.5 US Dollars to exchange for 1 Euro. If the Euro rises in value, then the EUR/USD price will also rise, as more US Dollars are needed to buy each Euro. Likewise, if the Euro drops in value, then the price of the EUR/USD pair will also drop, as now you need less US Dollars to equal each Euro. The value of the leading currency is not the only factor in the value of a particular pair. Any change in the value of the base currency obviously also affects this relationship. So, in the same example, if the US Dollar now rises in value, then the EUR/USD pair would drop, as now you need less Dollars to buy each Euro. And if the US Dollar drops in value, then the EUR/USD price would rise, as you need more of those US Dollars to equal each Euro. -5Copyright 2006 Knight Media Group. All rights reserved.

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Therefore, it can be said that each currency pair goes up and down in value proportionately to the rise or drop in value of its leading currency. Likewise, the same currency pair also moves up and down in an inverse relationship to the increases or drops in value of its base currency. So if a trader expects that the US economy will go up, and the value of the US Dollar with it, then they may wish to sell the EUR/USD pair, since it will most likely go down in price in such a scenario. If the trader believes that the European economy will go up, bringing up the value of the Euro, then they would buy the EUR/USD pair instead. Interest Rates Another key factor which has an influence upon the value of a given currency is the interest rate that the central bank of a particular country charges for the use of its money. These interest rates are always changing, so it is wise to keep track of them. For example, if the Federal Reserve in the United States (commonly referred to as the Fed) lowers its interest rate, then typically the value of the US Dollar will drop as well, causing the EUR/USD pair to rise. If the Fed raises rates, then the US Dollar will typically go up as well, causing the EUR/USD to drop. The Feds counterpart in the European Union is the European Central Bank (the ECB). If they raise their interest rate, then usually the value of the Euro will go up as well, causing the EUR/USD to rise. If they lower their interest rate, then typically the Euro will drop in value as well, causing the EUR/USD to fall. Central banks are always caught in a delicate balancing act. If a countrys currency rises too far, its exports become too expensive and other countries may look elsewhere. Interest rates are sometimes also cut in an attempt to stimulate the economy, but if they get too low then inflation can set in. Then it is time to start raising them again in order to slow growth. Higher interest rates also tend to attract more foreign investments (which is why the currency of that country frequently goes up in step with the interest rates), meanwhile cheaper interest rates tend to stimulate lending inside the country and therefore economic growth.

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Lesson 2

Pips, Lots, Leverage & Margins

The forex world is filled with its own unique terms and concepts. Here are some of the most common you need to know: Pips A pip is similar to a tick or point in stocks, futures, or other markets. It stands for percentage interest point and is the smallest individual unit of trading in forex. The pip is always the right-most digit of any forex price quote. Exactly how much an individual pip is worth depends upon the currency being traded. The Euro is measured out to four decimal places, thus each pip is equals 1/100th of a cent. The Yen, on the other hand, is measured out to two decimal places, thus one pip is one cent. Thats not to say that each pip is worth 1/100th of a cent in profit to calculate this, we need to introduce two other terms, lots and leverage. Lots Banks and other liquidity providers trade currency in lots. A standard lot is 100,000 (100K) units of the currency being traded, while a mini lot is 10,000 (10K). Since those amounts would make trading prohibitive for the average trader, brokers introduced a concept called leverage. Leverage Leverage allows you to control more currency in a trade than you have deposited in your account. This is where the real power of forex trading lies, but one needs to be careful as leverage is also very much a double-edged sword. It can work against you just as easily as it works for you. With 100:1 leverage, you need 1 unit of currency to control 100 units in the market. Thus, it would only take 100 units to control 1 mini lot (10K) in the market, or 1000 units to control 1 standard lot (100K). With 200:1 leverage, you would need 50 units to control 1 mini lot, and 500 units to control 1 standard lot. -7Copyright 2006 Knight Media Group. All rights reserved.

Euro

Yen

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Profit, therefore, is a factor of your leverage x the amount and size of lots being traded x the amount of pips price moves in your favor. Loss, likewise, is calculated in the same way when price moves against you. In the simplest example, if you buy 1 mini lot of the EUR/USD currency pair (see lesson 1 for an explanation of pairs), your account equity would increase or decrease by $1 for each pip of movement. If you buy 1 standard lot, then your account would increase or decrease $10 with each pip of price movement. It is a good idea to spend some time trading on a demo account and experiment with different lot sizes on different currency pairs in order to get an idea of the movements and their resulting gain or loss on your account balance. Trading on Margin The margin is the amount of collateral required to maintain your open positions. Unlike stocks and commodities, there are no margin calls in forex (when a broker requires you to deposit additional funds in order to cover losses on open positions if there are sudden and unexpected price movements) this can be both good and bad. On one hand, your account is protected from losing more than you originally deposited, as all open positions will be automatically closed if your account falls below the required margin requirements. On the other hand, all open positions will be automatically closed if your account falls below the required margin requirements. Therefore, it is always a good idea to keep track of how much margin is required to maintain each open position, as well as the sum total margin required by all currently open positions. Luckily, your trading software tracks these amounts for you automatically. In the above example, if you buy 1 mini lot of the EUR/USD pair for 1.50 at 100:1 leverage, then you will need $150 of your account in margin to maintain that open position. If price moves against you by 1 pip, you will need $151. And if price moves against you by 10 pips, you will need $160. If, on the other hand, you buy 1 standard lot of the EUR/USD pair for 1.50 at 100:1 leverage, then you will need $1500 of your account in margin to maintain that open position. If price moves against you by 1 pip, then you will need $1510. And if price moves against you by 10 pips, you will need $1600. As with calculating profit, it is a good idea to try out different amounts on different currency pairs in a demo setting first in order to get a feeling for how -8Copyright 2006 Knight Media Group. All rights reserved.

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margin moves with price, and how it can affect the open and available balances of your account.

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Lesson 3

Placing Orders
The price buyers are willing to pay is called the bid. The price sellers are asking is called the ask. And the distance between the two is called the spread. If you believe the price is going to go up, you would buy a long position, and then look to close it by selling when the higher price is reached. If instead you think the price will go down, you would sell and enter into a short position. The idea then is to cover your position by buying back at a lower price. Order Types When you want to enter into a position immediately, at the best available price at that time, you would place a market order. The downside to a market order is that if markets are moving fast, there is sometimes the chance that your order will get filled at a price different than what you wanted. The difference is called slippage. If instead you are more concerned with getting the right price, and are willing to wait and enter the market when those conditions are met, then you would place a pending order. There are several different kinds of pending orders: Buy Limit This order is placed when the trader believes the price will begin to rise after first dropping to a certain level. It is executed when the asking price becomes equal to the pending order. Buy Stop A trader would place this order if they believe the price will continue to rise after it breaks above a certain level. This type of pending order is also executed at the ask price. Sell Limit This order is placed when the trader believes that the price will begin to fall after it reaches a certain level. It is executed when the bid price is equal to the pending order. Sell Stop A trader would place this order if they believe that the price will continue to fall if can break below a certain level. This type of pending order is also executed at the bid price.

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Stops Another type of pending order is designed to stop your losses by automatically closing your position in the event that price moves in a direction different than what you expected. It is called a stop loss, or simply a stop for short. If you are buying a long position, you would set your stop somewhere underneath your entry in order to protect you from a sudden drop. If you are selling a short position, then your stop would be placed somewhere above it, just in case there is an unexpected rally. A stop can also follow the price once it moves in your favor in this case it is called a trailing stop.

Stop Protecting Long Position

Stop Protecting Short Position

A stop under a long position automatically closes if it is touched by the bid price, meanwhile a stop placed over a short position executed when it is touched by the ask price. Take Profit Another order which can close your position automatically for you is called a take profit order (sometimes abbreviated TP). Just like a stop is intended to protect your position in the event something unexpected happens, a take profit order assures you that your position will be closed should your target price be reached while you are away from the computer, or in a fast moving market where price may touch the target too quickly to react. It is generally a good idea to have both a stop and a target when entering new positions. A target would normally be set above the current price if you are in a long position, and below the current price if you are in a short position. For long positions, the take profit order would be executed when the bid price becomes equal to the amount you set, and for short positions the ask price must equal the take profit amount.

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Take Profit on a Long

Take Profit on a Short

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Lesson 4

Technical Analysis: An Introduction to Chart Reading

The markets represent the struggle between two opposing forces the bulls, who want to push the price higher, and the bears, who wish to push it lower. As each side tries to overpower the other, they leave footprints behind. Technical analysis is the art and science of reading a price chart in order to determine who is stronger, and who is winning the struggle at any given moment. Chart Types There are three types of charts commonly used in technical analysis:

Line Chart

Bar Chart

Candlestick Chart

The line chart is the simplest form of charting. For any given time period, it shows you what the closing price was. It does not, however, tell you very much about at which price the time period opened, or how big the struggle itself was. For this, we turn to the bar chart. Here the vertical bar shows us the extremes, the highest and lowest price reached during that particular period, while the short ticks on the sides show us where that period opened and closed. The bigger the bar, the wider the range of the struggle, and the smaller it is the more agreement and consensus there was on the price. You can also see if the open and the close of the period in question occurred closer to the lowest price, the highest, or somewhere closer to the middle. Candlestick charts were first used in Japan in the 12th century, in an attempt to predict rice prices, and yielded remarkable accuracy. Like a bar chart, they show you the open, the close, the high, and the low of any given period. Besides just answering the question who is winning?, at a glance they can also tell you who is stronger? This is due to some easily recognizable characteristics such as the size of their bodies, the length of their wicks, and their overall coloring. Candlesticks on charts have wicks at both ends. The wick shows us the extremes, the highest and lowest prices seen during that period. The candle - 13 Copyright 2006 Knight Media Group. All rights reserved.

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body shows us where the opening and closing prices were. Additionally, the color of the candle shows you who ultimately won. Green candles represent a higher close than open, while red candles represent a decline in the closing price from the open. In the example on the right, you can see that the most recent candle opened at 1.4830, then dropped as low as 1.4820, went on to rise as high as 1.4860, before finally settling at the present closing price of 1.4850; 20 pips above where it started its journey. In this manner, each candlestick tells us a complete story of what happened in the power struggle between bulls and bears during that particular period of time, and gives us clues as to who is growing stronger and who is weakening. There is also a special kind of candle called a doji this is a candle where the open and closing price were the same, leaving the candle without a body at all. These candles look like a + and represent a moment of consensus an agreement between buyers and sellers in the market, but also moment of indecision as to the next direction. In the chart to the left, you can see the bulls gradually losing strength as the rally comes to an end at the top, as evidenced by the shrinking candle body. Then a doji prints and we begin to see the bears slowly overpower the bulls as price begins to move back downward. Timeframes Each candle or bar on a chart represents a specific period of time. This can be a minute, 5 minutes, 15 minutes, 30 minutes, an hour, 4 hours, even a day, week, or an entire month. The timeframe refers to the amount of time it takes to print one candlestick on your chart. Both of the charts on the right show the same period of time, and the same price move from 1.4710 up 1.4840 The first chart is a longer timeframe, where each candle takes 1 hour to form. The second chart is a lower timeframe, which shows the same move but in 5minute increments. - 14 Copyright 2006 Knight Media Group. All rights reserved.

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The timeframe you choose to use depends on what sort of trade you are looking for. A long-term trend follower is likely to use a longer timeframe, a swing trader something in the middle, and a day trader or scalper might choose one of the lower timeframes. Trading with Multiple Timeframes One strategy for trading might be to use multiple timeframes. First, identify the best chart to use for your particular style of trading. This will be your lower time frame. Now pick another to be the higher one - the goal is to pick two that are far enough apart (a factor of 5 or as close to that as possible). A long-term trader who uses a daily chart as the lower timeframe, for example, may occasionally glance up at a weekly chart as the higher one (since there are 5 days in 1 week). A day trader who uses a 5-minute chart as the lower timeframe would most likely use a 30-minute chart for the higher one (since a 15minute chart is only a factor of 3, and may not provide a different enough perspective). On the higher timeframe, you can decide if you wish to be a bull or a bear in regards to that particular currency pair (or you can also decide to stand aside and look for another pair if the market is sideways and showing no clear direction). Then you can switch to the lower timeframe and take entry signals as normal, but only in the direction you decided upon in the higher timeframe. A bull would be looking for long signals in order to buy, while disregarding any short signals, while a bear would be looking to sell short and would disregard any long signals. Trends do change direction eventually, but generally they tend to do so gradually. You are allowed to change your mind and choose a different direction, but only on the higher timeframe, not on the lower one. The idea behind multiple timeframe analysis is to reduce the number of false trades, and to avoid the temptation to trade randomly in both directions at once.

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Lesson 5

Support, Resistance, and Moving Averages

As price moves up and down on our charts, it encounters barriers along the way. If this barrier acts like a floor, keeping price from dropping any lower, it is known in trading terminology as support. When it acts more as a ceiling and stands in the way of upward moves, it is called resistance. What is interesting to note is that if a certain price level acts as resistance on the way up (such as the doji candle which highlights a moment of market indecision on the way up at 1.4848 in the example on the right), then it also has a high probability of acting as support on the way back down (and viceversa). What Causes Support & Resistance When price is moving up, it means that more people are buying than selling. These bulls eventually need to take their profits. Likewise bears, who are waiting in the wings and looking for an opportunity to enter short, are more likely to do so the higher the price gets. When the amount of sellers eventually overpowers the buyers, a resistance level is formed (as shown in the illustration above when price reached 1.4862). Similarly, when price is moving down, there are more sellers than buyers. The sellers will eventually need to cover their short positions and take profit. Likewise, if there are bulls waiting to buy, then the lower the price goes the more tempting it becomes for them to enter into new long positions. Eventually the number of buyers will overpower the sellers, creating a support level. Since many traders use pending orders set at a specific level, the same level is likely to act as support or resistance multiple times until it finally breaks (as seen in the example above as we approach 1.4848 for the second time, now to test it as support). There can me many different support and resistance levels at any given time, and the wise trader tries to be aware of as many of them as possible so as not to be caught by a surprise reversal. As price approaches each of these levels it will either break it and go on to the next, or it will bounce. - 16 Copyright 2006 Knight Media Group. All rights reserved.

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A good technique may be to zoom out to the longer time frames and draw horizontal lines at key levels where you observe price stalling or reversing. Then, as you zoom in to find your trades, you will have reminders of these important levels. Moving Averages Additional levels of likely support and resistance can be identified by drawing moving averages. A moving average is simply a line chart which shows the average value of a series of periods.

There are several different kinds of moving averages. Most are an average of the closing price, though there are cases when they can be calculated also on the high or the low of the periods being averaged. When the value being plotted is a straight average with no modifications, we refer to it as a simple moving average. The blue line in the chart above represents a 21-period simple moving average (21 SMA) at any given time its value reflects an average of the closing prices of the previous 21 candles. Since the blue line is an average, it is by its very nature slow to respond to sudden movements in price. The red line in the chart above is an exponential moving average for the same 21 periods (21 EMA). Here there is more value placed upon the most recent candles. And, as you can see, it responds a bit faster to both the sudden drop in price, as well as the rally which follows. Both kinds can have advantages and disadvantages, depending on the situation. - 17 Copyright 2006 Knight Media Group. All rights reserved.

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As you can see in the above example, moving averages can act as both support and resistance when price approaches them. But unlike regular support and resistance levels, they do not remain at one stationary level and can also move on your chart. Common MA Strategies People use moving averages in many different ways. Traders will often check to see whether price is trading above or below its moving average in order to decide if they are a bull or a bear (especially on a longer time frame). As price gets closer to the moving average, traders look closely to see whether it will bounce back away from it or break that barrier, just as with any other support and resistance level. And, as price moves further away from its moving average, the trade becomes ever more risky as price is thought to be out at an extreme (since the moving average is still an average, logic suggests that eventually it and price will meet again at the same level). Some people even use crosses of various different moving averages back and forth over one another to signal entries and exits. Going Further Advanced tools which can help us identify other likely support and resistance levels include pivot points and Fibonacci retracements and extensions. The common factor among all support and resistance levels is their likelihood to either break or bounce when price reaches them, which is why it pays to be aware of them.

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Lesson 6

Trends & Trendlines

A trend can do one of 3 things: it can go up, go down, or it can go sideways. An up trend is defined as having higher highs, and higher lows. Similarly, a down trend is defined as having lower highs and lower lows. When a trend is moving sideways, price is said to be in a range.

Range Up Trend Trendlines Lines can be drawn connecting the tops of support levels, as well as the lows or resistance levels to form trendlines. Typically, when drawing trendlines, people use the candle bodies as opposed to the wicks, as shown below: Down Trend

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Connecting the prior tops and extending the line gives traders an idea where resistance is likely to be in the future. Connecting the prior lows gives an idea of future support levels. As long as price continues obeying these levels, we can continue to trade inside of the range as long as we also stay aware of the other support and resistance levels which may be found inside of it (see Lesson 5). The trendlines themselves become additional support and resistance levels. When price breaks past the support or resistance levels defined by a trendline, we look to take a trade in the same direction as the breakout. One needs to be cautious, however, as 81% of all breakouts end up being false breakouts so therefore an additional step is needed in order to confirm them. Avoiding False Breakouts: the Re-test When price breaks below a trendline which has been acting as support, typically it will come back up to test that same level again but this time as resistance. The best short entries are taken not on the initial break, but rather on the second move downwards, following this re-test of the level in question. A successful re-test is defined as a candle body closing outside that level. In the example below, we can see that price broke below support, failed the first retest as resistance, but went on to successfully pass on the second attempt:

This is a pattern also known as the good-bye kiss. The same scenario can be reversed when price breaks above a trendline which has previously been acting as resistance. Then we look for that same trendline to be re-tested as support prior to taking a long position. The Trendline Break System

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One of the simplest trading systems can be formed simply by using trendlines. In an up trend, we connect the bottoms (as shown on the left). We then look to enter short as soon as price breaks this trendline to the downside. Similarly, in a down trend, we connect the tops of the candle bodies (as shown to the right). If we are short from before, we look to exit our trade as soon as price breaks to the upside. If we are not yet in a trade, we may consider taking a long position at this point.

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Lesson 7

Indicators, part I: The Trend Followers

An indicator (sometimes also called a study) is a tool which helps you analyze price movements. There are two groups which most indicators fall into trendfollowing indicators are the most useful when price is trending in one direction or the other, meanwhile oscillating indicators can be helpful when price is consolidating into a range. It is important to know which group the indicator you are using falls into, and to choose the correct indicator for each situation. Some common trend-following indicators include: ADX The Average Directional Index is a special type of trend follower which can also help you decide whether a trend follower is, in fact, the best tool for the job at that particular moment. Trend-following indicators will function best when the ADX is over 30. When it is below 30, then an oscillating indicator may be a better choice. When the ADX is rising, this indicates that the trend is gaining in strength, and when it begins declining it is a sign that the trend is losing steam and a trading range may soon develop. Likewise, when ADX begins rising again it indicates that price is breaking out of its range and a new trend may emerge. The ADX does not, however show which direction the trend is going (up or down), only its strength. In the example below, note how the ADX starts off low as price is trading within a range near the left side of the chart. Then, as price begins dropping, the ADX rises above 30 to indicate a trend is in progress. The ADX also confirms that the trend is over by beginning to decline once again. And when it finally drops below 30 we find ourselves trading once again in a tight range.

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MACD Moving Average Convergence Divergence measures the difference between a short-term and longer-term moving average. When the red line crosses above the blue line it indicates an up trend, and when the red crosses below the blue it indicates a down trend. Additionally, the green bars (called the MACD histogram) give us an indication of the trends strength or weakness. And, unlike the ADX, they also show us the overall direction of the trend. Longer bars indicate increasing strength, and shorter bars indicate decreasing strength. In the following example, we see the red MACD line fall below the blue one as price begins its move downward. The green bars in the histogram are increasing in length as well, indicating that the down-trend is gaining momentum. When price reverses momentarily to head up, the histogram reflects a loss of downward strength. Downward strength resumes as the next long red candle posts on the chart. However it is important to note that while price made a lower low, the histogram did not make it quite as far down. This is known as a bullish divergence, and indicates that the trend will soon end and be followed by a reversal.

Momentum

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The momentum indicator measures the rate of change in closing prices, and functions very similarly to the MACD histogram. It is often useful in identifying likely reversal points due to its ability to detect trend weakness. In the example below, the moment indicator perfectly identifies the point at which the down trend ends and the new up trend emerges. As we near the end of the down trend, the momentum indicator begins tracing a bullish divergence. When momentum is below zero and turns sharply upwards following a bullish divergence, it can signal a long entry. Similarly, when it is above zero and turns sharply downwards following a bearish divergence, it can indicate a potential short entry. As we near the right edge of the chart, we see that momentum is indicating that the up trend is nearing an end and a reversal may be imminent.

Linear Regression Linear regression is a special kind of moving average which is more responsive to price changes and with less delay. When price makes an extreme move away from its linear regression line (the red line in the chart below), a quick countertrend trade can sometimes be taken as price snaps back to normal with the same linear regression line acting also as the target for taking profits.

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Lesson 8

Indicators, part II: The Oscillators

Oscillating indicators get their name due to their tendency to oscillate within a range of values. They can signal when price is at extreme levels and due for a reversal. Stochastics Stochastics consist of a fast line and a slow line, and oscillate between 0 and 100. Levels above 80 are said to be over-bought and levels below 20 are referred to as over-sold. When the red line crosses above the blue we know that the bulls are overpowering the bears. When the red line crosses below the blue, on the other hand, we know that the bears are beginning to overpower the bulls. It is best to enter long positions when stochastics first cross above 20, returning from over-sold conditions. This indicates the greatest amount of room left for an upward move. As stochastics near 80, we know that we are closer to the end of the move rather than the beginning of it, and may consider staying out of the trade if not already in it from before. As the stochastics begin to turn and cross, we are given a signal to close any remaining long positions. As they cross back below 80 and return from over-bought conditions, we may look to enter short. If the stochastics are closer to 20 than to 80, we may wish to think twice about entering into any new short positions. Once they cross, we would also look to close any short positions already open from before. Then, as the stochastics break above 20, the cycle repeats and we begin looking to enter long once again.

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RSI The Relative Strength Index is similar in its function to stochastics, except it uses 30 to indicate over-sold conditions and 70 to indicate over-bought. RSI signals a potential long when it breaks above 30, and a potential short if it comes from above and breaks below 70. In addition, levels above 50 confirm an up trend, while levels below 50 indicate a down trend.

CCI The Commodity Channel Index is another oscillator, but unlike the others it has 0 in the middle, and ranges from -300 to +300. Levels above +200 are thought to be over-bought; meanwhile levels below -200 are considered over-sold. One can consider entering long when the CCI hooks up from any level -200 or below, or going short when it hooks down from +200 or above. In addition, if the CCI drops towards 0 but bounces back up from it instead of crossing below, then look to enter long. Likewise, if CCI is rising up towards 0 from underneath it and then bounces back down without crossing above, that usually signals a potential short. These are known as continuation patterns.

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Fractals and the Alligator Indicator Fractals are simple markers which highlight candles which are extremes that is candles which make a new high but have lower ones on either side, or candles which make a new low, but have higher candles surrounding them. Fractals indicate likely reversal points, and are even more powerful when filtered with the alligator indicator. The alligator is made up of three lines, forming its mouth and tongue. When the alligator opens its mouth, a new trend is emerging, and we can continue to trade this trend until we see signs that the alligators jaw is about to snap shut. After the alligator eats, he sleeps but the longer he sleeps the hungrier he gets again. It is because of this sleep and hunger cycle that the alligator indicator is sometimes considered part of the oscillator family. Longs should be kept open if a fractal appears but is below the alligators tongue, and short positions can remain open if the fractal is higher than the alligators tongue.

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Lesson 9

Trading Psychology - Greed & Fear

Besides all of the fundamental and technical factors a trader must keep track of in order to be successful, there is another area which is often overlooked themselves. No matter how good your strategy is, the other factor which will always influence your outcomes are your own emotions. After all, it is emotions that move the markets. Emotions are what most of our indicators are designed to give us a measurement of. And in order to be able to profit on market movements created by the emotions of others, you must first learn how to read the mood behind the move, and also how recognize and control your own. Greed As prices rise, they naturally attract more attention. As more and more people jump onboard the rally, its climb accelerates. But in all the excitement, there is a tendency to confuse account balance (the amount actually on your account) with account equity (the total value including the sum of your open positions). People begin to treat their potential profits as if they were already realized. This expectation can sometimes cause basic reversal signals to be overlooked. Additionally, those who missed out on the opportunity early on, when the trend was still young, are becoming hypnotized by the length and size of the rally. Jumping onboard late is a risky game, however, as those who got in early will eventually need to take their profits. There is also a bit of the greater fool factor, as anyone who is still buying is now buying at a higher price, and from a seller who has reason to believe the move may soon be over. The idea then is that hopefully someone will keep on buying after you, at an even higher price, when you eventually decide to become a seller yourself. Fear When prices start falling, they awaken fear and panic. Fear is one of our most primal emotions, which explains why prices often fall faster than they rise. People holding longs run for the door trying to sell as quickly as possible, and short sellers motivated by the falling prices add their own orders to the mix as well. When those short orders are eventually covered in order to realize profit, there are temporary rallies which can give false hopes. - 30 Copyright 2006 Knight Media Group. All rights reserved.

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This crowd mentality frequently creates moments of market imbalance which can be capitalized upon, once one can learn to recognize the signs and interpret them correctly. Above all else, the key to developing this skill is practice. How Emotions Manifest on Charts One of the key measurements of market sentiment is support and resistance. If resistance breaks, there are more bulls in the market at that time than bears. If it bounces, we know the bears have overpowered the bulls. Likewise, if a support level holds, we know that any drops in price were most likely caused by routine profit-taking. If it breaks, on the other hand, we know we have short sellers entering the market along with longs starting to close their positions. Another indicator that mood and sentiment in the market may be beginning to change is momentum. Declines in follow-through on moves can often signal a drop in enthusiasm and increased likelihood of a pending reversal. Both trendfollowing and oscillating indicators can give us some clues and insights in this regard, especially as divergences begin to appear on the chart. Lastly, there is volume. Often overlooked on forex charts due to the lack of a centralized exchange (though still worth paying attention to even if it is only the volume from your own broker), volume should typically increase as trends accelerate in either direction. If volume suddenly starts to drop off, it can signal an impending end to the trend in question, or at least some turbulent times ahead. Learning to Control Your Own Emotions The first step to becoming a more disciplined trader and having control over your emotions is becoming aware of them. If your results are not consistent, take a close look to see if you are indeed following the strategy you outlined for yourself. Are you entering and exiting positions due to a well-defined signal, or was there some other reason? Here are some of the most common symptoms to watch out for, especially if you see the pattern occurring with some regularity: Getting out of positions too early, only to see them continue on in the direction you were hoping they would go is a sign of fear. Staying in positions too long and watching the markets take back some of your profits is often a sign of greed.

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Closing a position for a loss, only to see it reverse and go back above break-even moments later is a sign of fear. Not closing a losing position, and letting small losses become larger ones in the hope of a reversal that never comes can often be a sign of greed. Jumping into a trend late, after much of it has already happened without you, can stem from a fear of missing out on the move. And jumping in too early, before the markets given clear evidence of a direction, can be driven by greed.

It is important to take a step back and really have a close look at what is driving us into and out of the markets. Is it really the strategy and signals we have outlined for ourselves (which should be easy to verify), or is it something else? Our progress in the markets can only be as good as the records we keep, and the time we spend reviewing them. And when we hear news in the markets, it is important to do a quick reality check to make certain were giving both positive and negative news the same weight in our evaluations, and not allowing our biases towards a position interfere. By far the absolute best time to set both targets and stops is before you enter the position. Once the hopes and stresses of the market become your own, we can rely less and less on clear and sound judgment.

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Lesson 10

Money Management and Building Your System

The final, and by far one of the most important factors to your success is money management (sometimes also referred to as position-sizing). To illustrate just how important it is to your final results, there has actually been a mathematical study which confirms that even completely random entries, based upon a coin toss and yielding only a 35% win ratio, can produce steady profits when combined with proper money management formulas. As a matter of fact, to break it down by level of importance and influence, it can be said that money management accounts for up to 50% of the final result. Approximately 40% can be attributed to psychology, 8% to exits (including targets, stops, and position management), which leaves 2% for entries at best. And, yet, when most people believe they have a system, what they really mean is they have a set of signals for entry. The Components of a Good System Every system should include the following components: Criteria for entering trades Indicators to confirm entry signals Criteria for exiting trades (or staying in them) Rules for setting stops Rules for setting targets A method to size positions relative to risk A way to look back and evaluate trades

A Simple Money Management Formula

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A good rule of thumb for sizing positions is to risk no more than 2% of your account equity in any one position. Thats 2% assuming worst-case scenario of a stop loss being triggered. Therefore it should be easy to calculate how much is being risked based upon the total size of the account, and the distance in pips to the stop you have in mind for any given position. If you are trading a strategy which requires you to use wider stops in order to be effective, then you will have to consider using smaller lots. Conversely, if you find yourself trading with smaller amounts than you like, you will have to seek out a strategy which uses tighter stops (and therefore closer targets and perhaps smaller timeframes). It is far better to make small, yet consistent profits than it is to have one or two big wins, followed by an equally big loss which creates irreparable damage to your account. By far the biggest mistakes made by new traders are over-trading (due to greed and fear see lesson 9) and trading with positions too large relative to their account size. Keep in mind larger positions are also more uncomfortable to hold if the market is moving against you, making it that much more likely that you will exit early, not giving the markets enough time to move in your favor. It should be noted also that 2% is the maximum for positions you feel really strongly about. It is also quite acceptable (and recommended) to use less. Additionally, there should never me more than 6% of your account balance exposed at any one time as a sum of all open positions. Risk vs. Reward The other critical factor is a healthy risk-to-reward ratio. Simply put, what is the distance from your entry price to your stop vs. the distance to your target? Trades with a ratio of 1:1 should be avoided you should strive for a minimum ratio of 1:2 (that is, your target distance is twice as big as your stop). This does not mean arbitrarily tightening stops or widening targets the rules of your strategy must still be obeyed it just means passing on trades which do not satisfy this requirement. Of course, once you become good at identifying trades with risk-to-reward ratios of 1:3, 1:5 or even better, you will see your overall percentage gain improve dramatically. When combined with proper money management, these two keys become the final pillar of your trading system.

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Going Further
Dont let this be the end of your trading education, it is merely the beginning! Like any worthwhile skill, it will take you lots of practice to begin achieving consistent results. Be patient with yourself, and spend plenty of time on demo before risking real money. Trading is not get rich quick by any means, but if you put in the time and effort now, the results you will get will reflect it. You can do it I did.

fxKnight.com
Weve developed a website to help traders on their path to profitability and success. Many of the resources on it are completely free, including: Live chat room Trading forum Streaming news Market insights newsletter

Pro Training
To help speed the journey, weve created a live coaching program which has won praise from traders the world over, 5-star reviews, and multiple awards. Start and end each trading day looking at live charts together with me and some of my top traders. Preview each day ahead, identify key levels and likely scenarios, and plan your trading strategy. Then well meet again at the end of the day to review the results. Theres even a session each week with a medical board-licensed psychiatrist, to make sure youre mentally at the top of your game as well. Through constant hands-on practice and real-time feedback you will soon develop confidence in your trading and consistency in your results. And, as a reader of this eBook, well also give you 10% off. Please join us for a free sample class today! For those unable to attend live, we also have pre-recorded online workshops which you can watch at your convenience. The results of our students speak for themselves. You can be among them. - 35 Copyright 2006 Knight Media Group. All rights reserved.

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- 36 Copyright 2006 Knight Media Group. All rights reserved.