Chapter two: Overview of Professional Trading in Financial Market
(Please, you may grab a book and pen to take notes). This is the shortest chapter
Table of Contents:
A. Types of Market Analysis
- Fundamental Analysis
- Sentimental Analysis
- Technical Analysis
B. Types of Trends
C. Fundamental Factors
- Retail Sales
- ISM/PMI Reports
- Business and Consumer Confidence
- Housing Data
- Gross Domestic Product (GDP)
- Interest Rate
- Trade Balance
A. Types of Market Analysis
In fast-emerging global financial market, to make consistent income, and to become a professional trader, it is essential to understand types of market analysis and it volatility in the first place.
There are three basic types of Market analysis: Fundamental, Sentimental and Technical.
If you like analyzing social, economic, and political factors that affect supply and demand, fundamental analysis is for you! As a new trader, you may look at the economic calendar every morning before you start trading. There are news that move the market and some do not move the market. You may observe your chart when a new is released to see how it works. Nowaday, if you click on the detail of the news, you will find an explanation of the new and how to interpret it. U.S. news affect the pairs with the USD. European countries’ news have an impact on the pairs with the EUR. Japanese news have an impact on the pairs with JPY. Canadian news have an impact on the pairs with CAD. And so on with all others countries. In the chapter three, I will explain how to trade the news with RSI indicator.
Sometimes it is not about the numbers, but how you feel…how do you figure out and trade Forex off of that? I recommend you to read books about how to control your emotions, Psychology of Traders, and other books of Mind-set. It will help you! But me I do not like to read, so I subscribe to podcasts and play it.
Technical Analysis is the framework in which traders study price movement. To have full comprehension in trading financial market, it is important to start with Technical analysis. The theory is that a person can look at historical price movement and determine the current trading conditions and potential price movement.
The main evidence for using technical analysis is that, theoretically, all current market information is reflected in price. If price reflects all the information that is out there, then price action is all one would really need to make trade.
Now, have you ever heard the saying, “History tends to repeat itself ” ?
Well, that is basically what technical analysis is all about! If the price level held as a key support or resistance in the past, traders will keep an eye out for it and base their trades around that historical price level.
Technical analysts look for similar patterns that have formed in the past, and will form trade ideas believing that price will act the same way that it did before.
In the world of currency trading, when someone says technical analysis, the first thing that comes to mind is a chart. Technical analysts use charts because they are the easiest way to visualize historical data!
You can look at past data to help you spot trends and patterns which could help you find some great trading opportunities.
What’s more is that with all the traders who rely on technical analysis out there, these price patterns and indicator signals tend to become self-fulfilling.
As more and more Forex Traders look for certain price levels and chart patterns, the more likely that these patterns will manifest themselves in the markets.
NB: DO NOT USE LOW TIME FRAMES TO DO YOUR TECHNICAL ANALYSIS. EACH MORNING USE D1 AND H4 TO DRAW YOUR LINES AND THEN USE H1 AND M30 TO LOOK FOR ENTRY POINTS.
B. Types of Trends
There are two basic sorts of opportunity to make profit from trading Financial Market such as:
- Trend: trend is usually categorized into two, Uptrend and Downtrend.
- Range: Support and Resistance Lines.
Uptrend is identified as prices having a series of Higher Highs and Higher Lows. The highs are the peaks that prices reach irregularly. Lows are the valleys that prices fall to before heading up again. Thus, an uptrend is formed when there is a series of Highs going higher and a series of Lows going higher. Figure 1.0 shows below an example of price movement in uptrend.
Downtrend has prices moving in a series of lower highs and lows, figure 1.1 shows an example of a chart moving in a downtrend.
Traders use a trending strategy when the market is moving in an Uptrend or a Downtrend. When the market is in an Uptrend, we would place long position at the Higher Lows and when the market is moving in downtrend, we would place a short position at the Lower Highs.
WHY SHOULD I DRAW TREND LINES?
Trend lines are lines that are drawn to show prevailing direction of prices. They are visual indication to provide us insight into where prices could go next.
In an Uptrend, it is easy to summarize that prices could increase because there are more buyers than sellers. But this is not real case. In the financial market, trading Foreign Exchange, the number of contracts bought always equals the number of contracts sold. For example, if you want to buy 5 lots of USD/JPY currency, the contract must be available from someone who wants to sell it. Thus, the number of long and short positions in the financial market is always equal.
The reason lies in the intensity of emotions between the buyers and the sellers. In an uptrend, the buyers are in control because they are willing to pay higher price. They buy high because they expect prices to rise even higher. Sellers are nervous in an uptrend and the agree to sell only at higher price. The price moves up because the intensity of buyers’ greed overpowers the fear and anxiety of the sellers. The uptrend starts to fail only when buyers refuses to buy at higher prices.
RANGE: SUPPORT AND RESISTANCE
The bottom and the top of trade channels are named as Support and Resistance correspondingly. Resistance is a level at which the selling pressure exceeds the purchasing pressure. Support is a level at which the purchasing pressure exceeds to the selling presure.
The more prices bounce off the support and resistance, the stronger these levels become. But these levels will be broken through sooner or later, once a strong support is broken, that level is likely to turn into a strong resistance. It is important for the trader to consider these levels of conversion as it can assist in finding best zones to place your stop loss or profit target.
The figure 2.0 below shows an example of a ranging chart.
HOW DO I TRADE A SUPPORT AND RESISTANCE?
In order to place best entries and exits through support and resistance, it is important to spot the start and end of support and resistance zones.
Long trade is placed when a bull candle bounces of support level and closes above the support level. Then it is good to place a stop loss below the bottom of the support level as it is expected that chances of prices fall below that level is unlikely. The take profit target may be placed about 80% of the range measured from the support level. It means that if the distance between support and resistance is 100 pis, the profit target is placed 80 pips away from the support. The risk and reward ratio is taken 1:1. Thus the distance between the entry price and the profit target is 50 pips, stop loss should be 50 pips from the entry price. Likewise, if the distance between the entry price of long position and target profit is 100 pips, the stop loss should be 100 pips from the entry of long position.
The main purpose of exiting before the price reaches the top of the range is because the Resistance level is easily spotted by both retail and institutional traders alike. It pays to exit earlier since it is not known how the price will react once iit reaches the Resistance level.
See Figure 2.1 and Figure 2.2 below:
Short trade is placed when a bear candle bounces of the resistance level and closes below the resistance level. Then it is good to place a stop loss above the top of the resistance level as it is expected that chances of prices rise above that level is unlikely. The take profit target may be placed about 80% of the range measured from the resistance level. It means that if the distance between support and resistance is 100 pips, the profit target is placed 80 pips away from the resistance. The risk and reward ratio is taken 1:1. Thus the distance between the entry price and profit target is 50 pips, stop loss should be 50 pips from the entry price. Likewise, if the distance between the entry price of the short position and target profit is 100 pips, the stop loss should be 100 pips from the entry of long position.
The main purpose of exiting before the price reaches the bottom of the range is because the support level is easily spotted by both retail and institutional traders alike. It pays to exit earlier since it is not known how the price will react once it reaches the support level
That’s just an example, your target profit and stop loss may be placed according to what the market will show you when you start trading.
C. Fundamental Factors
Those trading in the Foreign Exchange Market (Forex) rely on the same two basic forms of analysis that are used in the Stock Market: Fundamental Analysis and Technical Analysis. The uses of technical analysis in Forex are much the same: price is assumed to reflect all news, and the charts are the objects of analysis. But unlike companies, countries have no balance sheets, so how can fundamental analysis be conducted on a currency?
Since fundamental analysis is about looking at the intrinsic value of an investment, its application in Forex entails looking at the economic conditions that affect the valuation of a nation’s currency. Here we look at some of the major fundamental factors that play a role in a currency’s movement.
Economic indicators are reports released by the government or a private organization that detail a country’s economic performance. Economic reports are the means by which a country’s economic health is directly measured, but remember that a great deal of factors and policies will affect a nation’s economic performance.
So, how are they used?
Since economic indicators gauge a country’s economic state, changes in the conditions reported will therefore directly affect the price and volume of a country’s currency. It is important to keep in mind, however, that the indicators discussed above are not the only things that affect a currency’s price. Third-party reports, technical factors and many other things also can drastically affect a currency’s valuation.
Costs of Inflation: Inflation has a bad rap, but it is just misunderstood. Inflation affects different people in different ways. A major factor in how inflation is viewed is whether inflation is anticipated orunanticipated. If the inflation rate is in line with what most people are expecting (anticipated inflation), then we can compensate and the cost is not high. For example, banks can vary their interest rates and businesses can price their products accordingly.
Causes of Inflation: Although the causes of inflation are greatly debated, there are at least two theories that are generally accepted:
a) Demand-Pull Inflation: this theory can be summarized as “too much money chasing too few goods”. In other words, if demand is growing faster than supply, prices will increase. This usually occurs in growing economies.
b) Cost-Push Inflation: when business’ costs go up, they need to increase prices to maintain their profit margins. Increased costs can include things such as wages, taxes, or increased costs of imports.
Consumer Price Index (CPI): a measure of price changes in consumer goods and services such as gasoline, food, clothing and automobiles. The CPI measures price change from the perspective of the purchaser. U.S. CPI data can be found at the Bureau of Labor Statistics.
Producer Price Indexes (PPI): a family of indexes that measure the average change over time in selling prices by domestic producers of goods and services. PPis measure price change from the perspective of the seller. U.S. PPI data can be found at the bureau of Labor Statistics.
It may be easier to think of these price indexes as large surveys. Every month, the U.S. Bureau of Labor Statistics contacts thousands of retail stores, service establishments, rental units and professional offices to acquire price information on thousands of items used to track and measure price changes in the CPI. They record the prices of about 80,000 items month, which represent a scientifically selected sample of the prices paid by consumers for goods and services purchased.
Non-Farm Payrolls (NFP) are the name given to the data that pertains to the number of people who are employed within the US economy, and it is released the first Friday of every month by the Bureau of Labor Statistics. Strong decreases in employment indicate a contracting economy, while strong increases are perceived indicators of a prosperous economy. Evey first Friday of a new month please observe USD/JPY during the NFP releasing to see the movement (if the month starts on a Friday, then it happens on the next Friday. The time of release will be seen on the economic calendar). In chapter three I will explain how to trade economic news.
- RETAIL SALES
The retail-sales report measures the total receipts of all retail stores in a given country. this measurement is derived from a diverse sample of retail stores throughout a nation. The report is particularly useful as a timely indicator of broad consumer spending patterns that is adjusted for seasonal variables. It can be used to predict the performance of more important lagging indicators, and to assess the immediate direction of an economy. Revisions to advanced reports of retail sales can cause significant volatility. The retail sales report can be compared to the sales activity of a publicly traded company.
- ISM/PMI REPORTS
Industrial Production: this report change in the production of factories, mines and utilities within a nation. It also reports their “capacity utilizations”, the degree to which each factory’s capacity is being used. It is the deal for a nation to see a production increase while being at its maximun or near maximum capacity utilization.
Traders using this indicator are usually concerned with utility production, which can be extremely volatile since the utilities industry, and in turn trading of and demand for energy, is heavily affected by changes in weather. Significant revisions between reports can be caused by weather changes, which in turn can cause volatility in the nation’s currency.
- BUSINESS AND CONSUMER CONFIDENCE
Consumer Price Index (CPI): the CPI measures change in the prices of consumer goods across over 200 different categories. This report, when compared to a nation’s exports, can be used to see if a country is making or losing money on its products and services. Be careful, however, to monitor the exports, it is a popular focus with many traders, because the prices of exports often change relative to a currency’s strengh or weakness.
- HOUSING DATA
The Existing Home Sales Report is a monthly release covering the number of existing homes that were closed during the survey month along with average sales prices by geographic region. The “closed” distinction is important because most closing periods are anywhere from six to eight weeks, so values listed are likely to relate to sales made about two months prior. The data is collected and released by the National Association of Realtors.
There are three important metrics in this report; in addition to the aggregate number of existing homes sold and median selling prices, inventory levels are provided through the “months” supply figure, a number that represents the lenght of time in months required to burn through all of the existing inventory measured during the period.
Data is provided raw and with seasonal adjustments. This is because weather is a big factor in deteermining month-to-month demand. As with the Housing Starts Report, the data is also broken down by geographic region (Northeast, Midwest, South and West). Price data wil show percentage chages from the year-over-year period and the prior month.
- GROSS DOMESTIC PRODUCT (GDP)
GDP is considered the broadest measure of a country’s economy, and it represents the total market value of all goods and services produced in a country during a given year. Since the GDP figure itself is often considered a lagging indicator, most traders focus on the two reports that are issued in the months before the final GDP figures: the advance report and the preliminary report. Significant revisions between these reports can cause considerable volatility. The GDP is somewhat analogous to the gross profit margin of a publicly traded company in that they are both measures of internal growth.
- INTEREST RATE
The higher Interest Rates that can be earned tend to attract foreign investment, increasing the demand for and value of the home country’s currency. Conversly, lower interst rates tend to be unattractive for foreign investment and decrease the currency’s relative value. Simply put, interest rates make the Forex world go ’round! In other worlds, the Forex Market is ruled by interest rates. A currency’s interest rate is probably the biggest factor in determining the perceived value of a currency. So, knowing how a country’s central bank sets its monetary policy, such as interest rate decisions, is a crucial thing to wrap your head around.
One of the biggest influences on a central bank’s interest rate decision is price stability, or “Inflation”. Inflation is a steady increase in the prices of goods and services.
Inflation is the reason why your parents or your parents’ parents paid a nickel for a soda pop in the 1920’s, but now people pay twenty times more for the same product.
It’s generally accepted that moderate inflation comes with economic growth. However, too much inflation can harm an economy and that’s why central banks are always keeping a watchful eye on inflation-related economic indicators, such as the CPI and PCE.
- TRADE BALANCE
Trade balance measures the ratio of exports to imports for a given country’s economy. If exports are higher than imports (a trade surplus), the trade balance will be positive. If the imports are higher than exports (a trade deficit), the trade balance will be negative.
Knowing the exchange rate is obviously critical for any foreign exchange trader, but information on the net exports in a country can help to predict future trends in inflation and foreign investment, and thus can give clues to the future behavior of any given currency market.
Trade balance is derived primarily from three factors: The price of goods in a country; Tax and tariff levies on imported or exported goods; and The exchange rate between two currencies.
This last factor is fundamental to foreign exchange trading. Since the trade balance depends so heavily on the currentt state of exchange rates between two countries, trade balance is a key coincident indicator for the state of a foreign exchange asset market.
There are a number of measures for trade balance, but one of the chief sources of information on the state of trade in the US is the International Trade report released monthly by the Cenus Bureau and the Bureau of Economic Analysis. This report is released around the third week of every month and details the performance of several exported goods and services in various sectors of the economy.