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4 Big Forex Questions Answered
01/12/2012 6:00 am EST
Those looking to assess and improve their trading in the New Year can begin by reviewing these in-depth answers to common but important questions facing currency traders in today’s markets.
First, let me begin this article by wishing MoneyShow.com readers a very happy and prosperous New Year for 2012. For some, this is a little bit of a downbeat time, as the blues creep in after the festive celebrations. But if you are anything like me, I am always invigorated and fired up for the challenges of the year ahead.
With this in mind, I believe that the holiday season and start of each and every New Year is one of the very best times for traders of all levels to take stock, revisit their trading plan, and make sure that they are doing everything that they should be doing in their speculative activities.
Maybe even going over that all-important trading plan could be a good idea, or just setting up a few new rules to keep you on the straight and narrow.
Whatever you decide you need to work on, just make sure that you take the time to do it as thoroughly as you can. Don't do for the sake of doing it, but rather, because you need to do it to improve your overall trading results.
Now, with this topic in mind, I thought that this would be an ideal time to publicly answer some of the most important and frequent forex trading questions I have been sent recently.
“I have often read about or heard about risk management and how important it is in forex trading. Is this just to do with setting a stop loss, or is there more to it than that?”
For me and my students of Online Trading Academy, risk management skills are probably the most important and fundamental of the tools applicable to consistently profitable trading. If you can't hope to protect your account, then how can you ever hope to grow it, as this obviously takes money in the first place, and if you wipe out your cash, then what do you have left to trade with?
As you rightly say, setting a stop loss is vital during trading, as this will protect your account from damaging losses and the order will limit the loss to just a small pre-determined percentage of your account balance.
However, risk management also extends to when and where you take a trade. I like to look for only the best trades the market has to offer with the lowest risks and the highest potential rewards on the table.
See related: Tough Talk About Risk Management
We can also include the actual currency pair we trade as part of our risk parameters. A little tip I give to my students is to keep an eye on the spread of various currency pairs. The greater the spread, the greater the level of volatility (most of the time), so this will give traders an objective idea of what to expect before they even enter a trade.
US Dollar Index
“What would you say is the simplest and most practical use of the dollar index, and why is it important to FX traders?”
I think that if used correctly, the US dollar index can be one of the most powerful tools in the complete trader's toolkit. Firstly, we should understand that the dollar index is basically a measure of the overall strength of the US dollar against a basket of other currencies, namely, the euro (EUR), British pound (GBP), Japanese yen (JPY), Canadian dollar (CAD), Swiss Franc (CHF), and Swedish krona (SEK).
See related: FX Basics: Trading the US Dollar Index
I like to look at it as a chart just like any other currency pair or tradable asset.
As we can see from the above chart of the dollar index, it looks like any other price chart, and we can plot areas of support (demand) and resistance (supply) like anything else. Knowing that this chart is, in its simplest form, just a chart of overall dollar strength or weakness, we can use this to help us to select an ideal currency pair to trade.
For example, if the dollar index is reaching a level of support (or demand), then this is telling us that it would be a low-risk buying opportunity for the US dollar. We could then look to short the weakest currency against the buck to stack the odds further in our favor, or trade one of the other majors like the EUR/USD, USD/CAD, AUD/USD, or GBP/USD.
In our forex trading, we always look to the dollar index before checking out any other currency pairs of trades, so as to get a good feel for the kind of opportunities we will find on other currency markets. It is a key part of the trading routine.
Trend vs. Countertrend Trading
“I have read time and time again that the highest-probability trades we can find are those that follow the overall trend, yet I have seen many examples where trades you have shown look like countertrend trades. How do you define the difference?”
I have been asked this question by so many traders that I have pretty much forgotten how many times it has been asked! To keep things simple in my answer, I would clearly say that I am always looking to trade with the trend one of two ways: with the current trend I can see before me, or when I am trying to take a low-risk entry into the market in anticipation of the next trend about to develop.
I accept that as a trader, I will never know exactly when a trend is likely to end or change direction, but I can use a simple set of objective, analytical trading rules to read my price charts and make a decision based on logic.
My advice when trading is to look to the chart and ask yourself the following questions: Is there a trend, and if so, how do you define it?
See related: Spot Trends Easily with Bollinger Bands
If there is a trend, then how long does it potentially have left to run? Is it showing strength (higher highs and higher lows) or weakness (lower lows and lower highs)?
If it’s looking strong, then go with it, and if it’s looking weak, then look for the reversal trade with a good quality supply or demand level. Never just take a countertrend move for the sake of it, however; always have a reason for taking any kind of action in the market and follow your rules for execution and risk management at all times.
Best Hours for Forex Trading
“I understand that one of the single biggest advantages of forex trading is the fact that the markets are open 24 hours a day. I like this because it means that I can trade around my full-time job. What would you say is the best time for me to trade FX during the day, as I am based on the west coast of America?”
I would agree that one of the most attractive aspects of the FX market is the fact that it is open for so long throughout the week, pretty much from the Sunday open through to the Friday close. I would suggest in the early days of your trading to avoid holding trades over the weekend close, as this is when major gaps in the market can happen, and for a newer trader, this can be potentially damaging if they are unaware of the risks involved.
However, if the plan is to do a little intraday trading, then it is about picking the most active and liquid sessions to trade. While the hours may not be ideal to you considering the fact that you are on the Pacific coast, the overlap between the Tokyo close and the European market open is a great time to trade, which works out to around midnight to 3 am PST or 3 am to 6 am EST (8 am to 11 am GMT).
See related: Peak Hours for Forex Traders
The quietest hours are typically around the US market close until the aforementioned open of Europe. Liquidity usually dries up, offering few decent trading opportunities and low volatility.
Once again, I would like to thank you all for you questions, and I try to answer as many as time allows. Thanks as always for your continued support and good luck in your trades.
By Sam Evans, instructor, Online Trading Academy
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