The art of currency trading a professionals guide to the foreign exchange market (wiley trading)

Table of Contents COVER FOREWORD ACKNOWLEDGMENTS CHAPTER 1: Introduction Why I Wrote This Book PART I: Understand the Foreign Exchange Market (FX 101) CHAPTER 2: A Very Brief History of FX A Very Brief History of Currency Markets A Short History of Currency Trading The Telex Era (1971 to 1981) The Direct Dealing Era (1981 to 1992) The Electronic Era (1992 to 2001) The Algo Era (2001 to Present) Notes CHAPTER 3: Currency Trading Basics What It Means to Be Long and Short Currencies Understand the Different Currency Pairs Highly Liquid Pairs Less Liquid Pairs Common Crosses Illiquid Pairs Quotes, Spreads, Market Structure, and Order Types Order Types Understand Profit and Loss How to Calculate P&L on an FX Trade Notes CHAPTER 4: Understand Market Structure The Players Different Currencies Have Different Personalities Understand Volatility and Liquidity Volatility and Liquidity Vary by Regime Volatility and Liquidity Vary by Time of Day Understand Time of Day Understand Jump Risk Notes PART II: Trade the Foreign Exchange Market CHAPTER 5: Understand Fundamental Analysis Long Run Determinants of Currency Values FX Fundamentals Can Be Domestic or Global Domestic Drivers Understand Intervention and Reserve Recycling Understand US Economic Data Releases Understand Global Economic Releases Notes CHAPTER 6: Understand Technical Analysis I Introduction Technical Analysis: Does It Work? The Need to Know of Technical Analysis Choosing Indicators Basic Indicators Using Support and Resistance in Your Trading Identify the Regime Reversal Patterns Further Reading Notes CHAPTER 7: Understand Technical Analysis II (The Seven Deadly Setups) Introduction Slingshot Reversal Shooting Stars and Hammers Extreme Deviation from a Moving Average (AKA the Deviation) Volume Spike at a Price Extreme Broken Triangles Double and Triple Top Sunday Gaps Combo Setups Notes CHAPTER 8: Understand Correlation and Intermarket Relationships Introduction Understand Correlation Correlation of One Currency Pair versus Another Currency Pair Correlation of One Currency Pair versus Commodities Correlation of One Currency Pair versus an Equity Index Correlation of a Currency Pair versus Single Name Equities or ETFs Trading the Correlations January 2012 The Result Understand the Regime and Relevant Correlations A Note on Stop Losses and Discipline FAQ about Correlation Trading February 2016 Notes CHAPTER 9: Understand Behavioral Finance Introduction Positioning and Sentiment Cognitive Bias Conclusion The Skyscraper Indicator The Cheer Hedge The WTF Indicator The IPO Indicator Further Reading Notes CHAPTER 10: Trading the News Introduction Trade the Extreme Data Beat the Algos! Going the Other Way after Economic Data Reversal for a Good Reason (Headline and Details Do Not Match) Reversal for No Reason Understand Central Banks Central Bank Meetings Positioning into a Central Bank Meeting Trading the Outcome of a Central Bank Meeting Central Bank Speeches Other Headlines and News Events Notes PART III: Understand Risk Management CHAPTER 11: Understand Free Capital Set Goals Track and Analyze Your P&L Daily P&L Create a Chart of Your Daily and YTD Data Month to Date P&L Year to Date P&L Win% Average Gain/Loss Sharpe Ratio Fat Tails and Risk of Ruin Rolling Drawdown P&L by Time of Day Keep a Trading Journal Note CHAPTER 12: Understand Position Sizing Position Size as a Percentage of Capital Another Simple and Effective Way for Short Term Traders to Determine Risk Determine Position Size Common Errors in Position Sizing Positions Are Too Big Positions Are Too Small A Third Mistake Is Always Trading the Same Size of Position Stop Losses Take Profits Establish a Clear, Rule Based Risk Management Approach Process versus Outcome Further Reading Notes PART IV: Understand Yourself CHAPTER 13: Characteristics of a Successful Trader Finds the Balance between Risky Behavior and Discipline Thinks Independently Knows Their Edge Trades One Time Horizon Controls Emotion/Acts Like a Robot/Self Aware Implements a Consistent Daily Routine Happy to Be Flat Understands Tight/Aggressive Self Understanding and Metacognition Loves Trading Learns and Adapts Gut versus Head: Two Very Different Decision Making Systems Further Reading CHAPTER 14: Common Weaknesses in Trading Poor Risk Management, Bad Discipline, and Negative Risk/Reward Trading for the Wrong Reasons To Feel Smarter Than Anyone Else FOMO (Fear of Missing Out) To Lose Money Waiting for the Perfect Trade Invincibility/Overconfidence Woulda, Coulda, Shoulda Syndrome Directional Bias Further Reading Note CHAPTER 15: The Voice of Experience Don't Let Random Trades Bleed You How to Avoid Overtrading Trading Slumps Tips for a Happy Life Get Some Perspective Don't Constantly Check the Market Turn off Your Phone at Night Read Nonfinancial Books Eat Properly and Exercise Have Fun Further Reading Note CHAPTER 16: Conclusion Note APPENDIX: Brent Donnelly's 25 Rules of FX Trading ABOUT THE AUTHOR INDEX END USER LICENSE AGREEMENT List of Illustrations Chapter Figure 2.1 Figure 2.2 Legendary voice broker Micky Roberts doing his thing in 1983 Chapter Figure 3.3 The decentralized structure of the currency trading market Figure 3.4 P&L of various position sizes in FX Chapter Figure 4.5 Daily AUDJPY 2005 to 2007 Figure 4.6 Daily AUDJPY 2005 to Q1 2009 Figure 4.7 The dollar smile Figure 4.8 Venn diagram of relationships between major global currencies Figure 4.10 The relationship between volatility and liquidity for the Top 15 cu Figure 4.11 Currency volatility, 2002–2018 Figure 4.12 Currency volatility vs equity volatility, 2002–2018 Figure 4.13 Average hourly volumes in EURUSD by time of day (GMT) February–Apri Figure 4.14 Average intraday volumes in USDJPY during London hours 7:00AM LDN t Figure 4.15 Key times of day for G10 FX Figure 4.16 Average intraday volumes in USDJPY by time of day (times in GMT) Figure 4.17 (a) Ranking currencies by daily range compared to spread In other Figure 4.18 minute AUDUSD after a strong Australian jobs number, December 9, Figure 4.19 CADMXN (black bars) vs USDMXN (thin dotted line) and USDCAD (thick Figure 4.20 AUDCAD (black bars) vs AUDUSD (thin dotted line) and USDCAD (thick Chapter Figure 5.1 How domestic and global factors feed into currency markets Figure 5.2 Daily AUDNZD with key RBNZ (NZ central bank) meetings marked June 20 Figure 5.3 Two theoretical yield curves, one positively sloped (gray) and the o Figure 5.4 Daily EURCHF April 2011 to January 2014 Figure 5.5 Global central bank reserve holdings, by currency Figure 5.6 US Nonfarm Payrolls (actual vs expected, 2010–2018) Figure 5.7 Initial Claims (GRAY) vs US Unemployment Rate (WHITE) Figure 5.8 Consumer Confidence (WHITE) vs S&P 500 Index (GRAY), 2010– 2018 Figure 5.9 Monthly Durable Goods releases 1960–2014 Chapter Figure 6.1 The same hourly EURUSD chart presented two ways: candlesticks above Figure 6.2 Hourly EURUSD, broken support lets the downtrend resume, July– August Figure 6.3 Hourly EURUSD, August 14 to 29, 2014 Figure 6.4 Hourly USDJPY, July 16 to September 4, 2014 Figure 6.5 Hourly USDJPY with RSI and MACD, June 29 to September 7, 2014 Figure 6.6 Hourly USDJPY with Parabolic SAR, August 24 to September 4, 2014 Figure 6.7 Standard up and down candlesticks Figure 6.8 Three consecutive dojis on a candlestick chart Figure 6.9 Daily S&P 500 (with a doji on March 8, 2009), December 2008 Figure 6.10 Gravestone doji Figure 6.11 Hammer candle formations Figure 6.12 Daily USDCAD with a bull hammer reversal, August to November 2013 Figure 6.13 Hourly AUDUSD, August 29 to September 9, 2014 Figure 6.14 Hourly USDJPY with ichimoku cloud, August 18 to September 18, 2014 Figure 6.15 EURUSD Market Profile, July to July 10, 2013 Figure 6.16 Daily EURUSD with Fibonacci retracements marked, October 2008 to Ja Figure 6.17 Daily USDJPY, January 2014 to August 2014 Figure 6.18 USDCAD with the 100 day MA and the 200 day MA, June 2014 to April Figure 6.19 Daily CADJPY, a successful bull flag breakout, May to June 2014 Figure 6.20 Daily USDJPY, a pennant and trend continuation, July 2012 to Septem Figure 6.21 Hourly EURUSD, a triangle and trend continuation, December 2013 to Figure 6.22 Hourly USDJPY, November 15 to November 28, 2016 Figure 6.23 Daily GBPUSD triple top, February 2012 to February 2013 Chapter Figure 7.1 Daily USDJPY with a Slingshot Reversal marked, March 2017 to April Figure 7.2 Daily Dollar Index, August 2013 to May 2014 Figure 7.3 Daily Dollar Index with a hammer bottom, August 2013 to May 2014) Figure 7.4 Daily Dollar Index with a hammer bottom, September 2013 to October Figure 7.5 Hourly USDCAD with 100 hour MA and deviation from the 100 hour movin Figure 7.6 30 minute USDJPY candle chart with volume bars below (in gray), Sept Figure 7.7 Daily USDJPY with triangle consolidation, January 2013 to January 20 Figure 7.8 Daily AUDUSD with triangle breakout, November 2010 to March 2011 Figure 7.9 Daily AUDUSD with failed triangle reversal, December 2010 to May 201 Figure 7.10 Hourly USDCAD, December 11 to December 21, 2015 Figure 7.11 Daily USDCAD with dotcom bubble marked 1971 to 2014; USDCAD has tro Figure 7.12 Tick chart of EURUSD the Friday before and Sunday after the Greek r Figure 7.13 Tick chart of USDTRY around the August 10, 2018 weekend gap Chapter Figure 8.1 Wholesale rabbit meat prices vs Citi Economic Surprises for the US, Figure 8.2 Annual data for “Letters in winning word of Scripps National Spellin Figure 8.3 minute AUDUSD through an unexpected RBA rate hike, November 1–3, Figure 8.4 Daily AUDUSD vs Australia/US 10 year interest rate differential (gr Figure 8.5 Daily NZDUSD vs Dairy futures prices (gray line), October 2006 to F Figure 8.6 Daily NASDAQ vs AUDUSD (gray line), January 1996 to December 1999 Figure 8.7 Daily NASDAQ vs AUDUSD (gray line), February 2007 to June 2010 Figure 8.8 Daily USDJPY vs Nikkei futures (gray line), 2006 to 2016 Figure 8.10 Hourly USDJPY vs Nikkei futures (gray line) (2 months of data), De Figure 8.11 Hourly USDCAD vs Crude oil (inverted, gray line), December 21, 201 Figure 8.12 Hourly EURUSD vs DAX/DJI ratio (gray): Chart 1, November 8, 2011, Figure 8.13 Hourly EURUSD vs DAX/DJI ratio (gray): Chart 2, November 8, 2011, Figure 8.14 Hourly USDCAD vs Crude Oil (inverted, in gray), September 29, 2011 Figure 8.15 USDCAD vs June 2012 Canadian BAs (gray), September 29, 2011, to Ja Figure 8.16 Daily DXY: Note multiple tops around 81.50 in late 2010, April 2009 Figure 8.17 Daily Shanghai Composite: Was that the bottom? September 2011 to Ja Quantitative easing (QE), 276 increase, 256 programs, 224 Quarter Kelly sizing, 329 Quotes, 23–25 Random trades, impact, 369 Rangebound markets, 380 trading difficulty, 142, 144 Real money, market player, 39 Recency bias, 230–234 Recession, inverted yield curves (impact), 83 Regime identification, 141–151 understanding, 211 variation (See Liquidity) Relative strength index (RSI), usage, 121–123, 122f Relative value (RV) trade, usage, 213–214 trading, skill, 213 Reserve Bank of Australia (RBA), 190 cut rates, 283 inflation focus, 281 market expectation, 188 meeting, noise, 283 rate hike, 188f Reserve Bank of New Zealand (RBNZ), 80, 87 bias, tightening, 80 inflation reversal, 288 rates, cut, 257 statements, evolution, 80 Reserve recycling, 87–90 Resistance existence, explanations, 113–115 trader usage, 113 usage, 115–141 Retail platforms, price competition, 24 Retail Sales, 101–102 Retracements, 137 Reuters, reaction, 269 Reversal patterns, 152–154 reason, absence, 270–277 result, 273 setup, 271 reason, presence, 269–270 setup/result, 270 Risk discipline, balance, 353 diversification, 39 jump risk, 64–69 reduction, 298 reset, 297 short term trader determination, 326–330 tail risk, 304 Risk aversion, 75 fluctuations, 77 Risk management, quality, problem, 361 rule based risk management approach, establishment, 344–345 spreadsheet, sample, 327f system, 326–328 Risk of ruin See Ruin Risk On, Risk Off (RORO) regime, 193 Risk price, 26–28 trade, 27 Risk/reward, 339–343 negative risk/reward, 361 Robotic actions, 355 Rolling drawdown, 315 Rollover (carry), 34–35 Round number, 115 bias, 228, 237–238 Routine, implementation, 355–356 R squared, 191 Ruin, risk, 304–310, 323 avoidance, 306 Rule based risk management approach, establishment, 344–345 Rumor, purchase, 260–264 Scottish Referendum, impact, 262f Scripps National Spelling Bee letters, venomous spider deaths (contrast), 183 Sears Tower (skyscraper example), 247 Second tier provider, 25 Self awareness, 355 Self fulfilling prophecy, 113 Self understanding, 356–357 Sentiment, 222–228, 243 theme, 223 Seven Deadly Setups, 2, 154–156, 177 Sharpe ratio, 302–304 Shiller, Robert, 363 Shooting stars/hammers, 155, 159, 177 Short term fair value, 184 Short term momentum, opposition, 269 Short term traders, bias infection, 237 Short term trades, 214, 354 Short term trading, currencies (selection), 62 Signaling, 87 Simple moving average (SMA), 117–121 Single name equities/ETFs, currency pair correlation (contrast), 197 Single print, 135 Size, betting, 323 Skandies, 41–42 Skew, presence, 300 Sklansky, David, 348 Skyscraper Indicator, 247–249 Slingshot Reversal, 155–158, 169 marking, 157f occurrence, 176–177 trading, simplicity, 158 Smartness, 363 Smile See US Dollar Smith, Adam, 255 Sovereign credit ratings, 89 Sovereign debt, increase, 90 Sovereign wealth funds (SWFs), operation, 40 S&P 500 (Business Week cover), 244f S&P 500 Index (SPX) CCI, contrast, 97f daily SPX, transports (contrast), 216f dojis, presence, 127f hourly SPX, Dow transports (contrast), 218f low level, 126 S&P 500 puts, sale, 303 Spot transactions, forward transactions (contrast), 17 Spreads, 23–25 crossing, 49 pip expression, 23 tight spreads, 24–25 Stagflation, 247 Sterling flash event, 312 Stock returns, distribution (comparison), 108 Stop enter, 29 Stop losses, 211–212, 297, 337–343 level, stability, 342 location, 338–339 movement, reasons, 342 orders, 28, 140, 156 process, automation, 342 recordation, 341–342 selection, 330 slippage, 343 tension, 117 trade journal entry, 341–342 trailing stop losses, 339 Stop sell order, trigger, 158 Stops, setting (criteria), 337–338 Storage arbitrage, usage, 231 Streaming prices, bank provision, 25 Strong currency, central bank preference, 78 Sub zero interest rates, impact, 277 Sunday Gaps, 156, 174–176, 177 Sunday open, 60 Support, 138 existence, explanations, 113–115 trader usage, 113 usage, 115–141 Sweden, economic releases, 105 Swiss franc (CHF) currency float, 47 sale, promise, 85 stimulation, SNB failure, 87 Swiss National Bank (SNB), 314 EURCHF currency floor announcement, 304 EURCHF floor drop, 343 floor, loss, 306 Switzerland, economic releases, 105 Sympathy plays, 289–290 Systematic funds competition, 109 market player, 38–39 Tails fat tails, 241, 304–310 fattening, 310–315 options/trades, overpayment, 239 risk, 304 Take profit, finding, 158 Technical analysis, 107, 155, 176–177 application, 338 branches, 111–112 knowledge, 111–112 risk management/tactical tool, 113 success, discussion, 107–111 usage, 73 value, limitation, 110 Technical convergence, 317 Technical indicator, 163 Technicals, 324 trading, 73 Telexes, usage, 12–13 Theory of Moral Sentiments, The (Smith), 255 Theory of Poker (Sklansky), 348 Thiel, Peter, 222, 353 Third tier provider, 25 Three Star trades, 321, 329 Tight/aggressive wins, 356 Tight spreads, 24–25 Time horizon, 159, 163, 222 knowledge, 355 scaling, fitting, 214 trading, 354–355 Time of day, 55–64 analysis, 315–316, 316f importance, 61–62 variation, 52–54 Times, representation/observation, 53 Time weighted average price (TWAP), 30–31 Tokyo fix, 58–59 Tomorrow/next, 34–35 Trade balance, 78, 90 breakouts, 146–148 footprint, 27 ideas, pullbacks, 144, 146 random trades, impact, 369 risk, 376 terms, 77 Traders, characteristics, 353 Trading breakouts, advantage, 146 flexibility, 364–365 love, 357 perspective, 375–376 process, outcome (contrast), 346 psychology, reasons, problems, 361–363 signals, 227 slumps, 371–373 handling, 373–374 support/resistance, usage, 115–141 time horizon, 159, 163 weaknesses, 361 Trading journal Excel trading journal, entry (sample), 317f usage, 316–319 Trailing stop losses, 339 Transports daily SPX, transports (contrast), 216f indices, 215 Trend continuation, 149f, 150f following, 15, 152 Trending markets, trading ease, 144–152 Triangles breakout, 170f consolidation, 168f continuation, 150f pennants, comparison, 148 Triple tops, 156, 169–174, 177 daily GBPUSD triple top, 153f usage, 152 Trump, Donald NAFTA withdrawal threat, 261 presidential election, 4–6 Turkey, lira (crisis), 175–176 Tversky, Amos, 236–237 Twilight Zone, 61 Twitter, reaction, 269 Two way quotes, spreads, 29 United Kingdom, economic releases, 103 University of Michigan Consumer Sentiment Index Thomson Reuters, 98–99 University of Michigan Surveys of Consumers, 98–99 US Census Bureau, Manufacturers' Shipments, Inventories, and Orders (M3) survey, 99 USDCAD minute USDCAD, 286f 10 minute USDCAD, CPI number release (impact), 274f 30 minute USDCAD, CPI release (impact), 275f 100 day MA/200 day MA, 145f 100 hour MA, 164f AUDCAD, contrast, 69f CADMXN, contrast, 68f Canadian BAs, contrast, 207f crude oil, divergence, 211–212 currency pair, 163 daily USDCAD bull hammer reversal, 130f dotcom bubble, marking, 173f decline, 271 hourly USDCAD, 172f interest, 82–83 intraday USDCAD, 286f strategy, 144 USDJPY minute USDJPY, 266, 267f 30 minute USDJPY candle chart, volume bars (inclusion), 167f average intraday volumes, 54f, 59f bars, 166 bearishness, 121, 123, 364 daily USDJPY, 143f daily USDJPY, triangle consolidation, 168f hourly USDJPY, 119f, 122f, 124f, 151f ichimoku cloud, presence, 133f ichimoku, 132 intraday volumes, 54 purchase, 264 rally, 233 spike, sale, 269 spot, forecast (contrast), 234f USDMXN minute USDMXN, US/Mexico trade pact news (impact), 263f CADMXN, contrast, 68f decline, 261 US Dollar (USD) 100 day rolling median daily range, 312f G7 currencies, contrast, 310, 311f shortage drive, fears, 47 smile, 46–47, 46f usage, 47 USDTRY closing, 175 tick chart, 176f US economic data, 56 releases, 90–102 US nonfarm payrolls, comparison, 93f US Retail Sales 12 month cumulative miss, 265f economist forecasts, distribution, 242f release, 224, 241 US unemployment rate, Initial Claims (contrast), 94f Value at Risk (VAR), 48 Venomous spider deaths, Scripps National Spelling Bee letters (contrast), 183f VIX futures, Sharpe ratio, 303 level, 330 Voice brokers, 13 Volatility, 48–51 currency variation, 50–51 importance, 49 liquidity, relationship, 50f profiles, 323–324 regime variation, 51–52 time of day variation, 52–54 Volcker, Paul, 10 Volume bars, inclusion, 167f indexing, 53 liquidity, relationship, 49–50 spike, price extreme, 156, 177 Volume at Price, 132 Volume weighted average prices (VWAP), 30–31 Weak currency, central bank preference, 78 Weekends, jump risk example, 64 “Whatever It Takes” speech (Draghi), 89 Whipsaws, creation, 123 Wilder, Jr., J Welles, 123 Win percentage (win%), 301 WMR benchmark fix, 56–58 WMR fix, 54 FX usage, 57 World Bank, formation, 10 World Trade Center (skyscraper example), 247 Would, coulda, shoulda syndrome, 367 WTF indicator, 250–251 Yards, 24 Year to date P&L, 301 Yield curves example, 83f inverted yield curves, impact, 83 Yield, reference, 43 Yield to date (YTD) data, chart (creation), 299–301 Yield to date (YTD), impact, 297 Zero to One (Thiel), 222, 353 WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley’s ebook EULA ... much the market will move Market making: Algos show a bid and an offer in the market and attempt to earn a spread and profit from intraday noise Correlation: Algos watch other markets and trade... one of the evidence based investing people and they will bury you under an avalanche of data and charts Thing is, the data and charts are contradicted by the market within a matter of days, and... Understand Risk Management CHAPTER 11: Understand Free Capital Set Goals Track and Analyze Your P&L Daily P&L Create a Chart of Your Daily and YTD Data Month to Date P&L Year to Date P&L Win% Average