Almost every field has its principles that provide a foundation for performance and prediction. One of the most famous is Isaac Newton’s Philosophiae Naturalis
Principia Mathematica (Mathematical Principles of Natural Philosophy), commonly known as the Principia. It codified and revolutionized the study of physics. As for forex traders we can only dream about having laws that guide the markets as surely as those that explain the physical world. This book has discussed many dimensions to forex trading and we can conclude that there are some generally accepted principles that can make your trading less painful.
Almost every field has its principles that provide a foundation for performance and prediction. One of the most famous is Isaac Newton’s Philosophiae Naturalis
Principia Mathematica (Mathematical Principles of Natural Philosophy), commonly known as the Principia. It codified and revolutionized the study of physics. As for forex traders we can only dream about having laws that guide the markets as surely as those that explain the physical world. This book has discussed many dimensions to forex trading and we can conclude that there are some generally accepted principles that can make your trading less painful.
Almost every field has its principles that provide a foundation for performance and prediction. One of the most famous is Isaac Newton’s Philosophiae Naturalis
Principia Mathematica (Mathematical Principles of Natural Philosophy), commonly known as the Principia. It codified and revolutionized the study of physics. As for forex traders we can only dream about having laws that guide the markets as surely as those that explain the physical world. This book has discussed many dimensions to forex trading and we can conclude that there are some generally accepted principles that can make your trading less painful.
1-Assymetrical Information – In other markets, such as equities and futures, there is a democracy in the distribution of information. By looking at a chart, prices in these markets reflect all available information that is relevant to determining whether the market is pricing the instrument logically. Also, these markets have options that ensure the ability of the trader to evaluate sentiment on future values of prices. There is no centralized, accessible option market on spot forex. Options trading is available to the “big boys” who have an advantage by knowing where the calls and puts are concentrated. This represents an asymmetry of information. The average forex trader who believes that everything is in the chart is ignoring a core feature of how forex works. This creates the need to look at longer time frames of monthly and weekly charts that provide more perspective of support and resistance ranges that the market has registered.
The forex trader needs to look beyond the chart for other sources of information to project direction. This leads to the role of fundamental forces.
2-Fundamentals Cannot Be Ignored – Currencies reflect the status of the world economy. Knowing which countries are in recession, inflation, or stagnation creates the context for long term currency trends.
3-News Drives Forex – The word news in everyday usage means surprise. Something you already know is not news. This is true for all markets. But in forex trading, news is always potentially big and reflects global events. Forex traders should know when and how to trade the news.
Straddle trades work well for scheduled news announcements. Many traders wait for news to occur, causing price to go into periods of consolidation. The forex trader knows that the market will move out of this pattern and can prepare for this. This is why mechanical systems have an inherent flaw. They fail to incorporate news and fundamentals. When news shocks occur the signals are not reliable and will fail.
4-Prices Reflect Mass Psychology-The value of a currency pair is the cumulative reflection of millions of decisions made by traders around the world. Prices are psychological signatures of sentiment. Traders who understand market psychology will realize that prices and opportunities cluster. For example, if the euro is breaking out, then the Swiss franc and pound will tend to provide similar patterns. One currency pair may take the lead, but others will follow and momentum toward a trend direction emerges.
Accepting the role of psychology reflected in chart patterns is a better understanding of what a “price signal” is. A price signal is a break or failure to break a key pattern or parameter. The task of the trader is to find the multiple parameters that provide evidence that a price signal is being generated.
5-Trading Involves Emotions and the Use of Emotional Knowledge
The concept of trading forex mechanically has a major flaw. It presumes that the forex market can be predicted and modeled. Mechanical systems cannot effectively factor in the news or reflect the complexities of the global economy. But the trader has a more powerful computer, the human brain. The ability to recognize patterns and assess changes in sentiment in the market will significantly improve trading. Successful trading also requires the ability to tap emotional knowledge; the sense of opportunity by using emotions should not be ignored.
6-Rule of Three – The number three is significant for all traders.
A good example is the use of multiple time horizons. While trading, place your trade in the context of three time intervals. Some use four-hour, 30-minute and five-minute charts. There is no set rule for which three time intervals should be used but using three different charts with large, medium, and small time period is a key habit of successful traders. Another important expression of the rule of three is multiple confirmations. When prices break through a key resistance or support line, expect the third breakout to be the defining one. Also, when identifying a trend line, use the rule of three as the criteria that three consecutive candles can compose a trend. In charts such as point and figure and three-line break, three is a key reversal factor. In pivot point analysis, the number three is used to generate the key levels: (Pivot Point = (H + L + O)/3). In placing your trade, you have three components: an entry, stop-loss and profit-limit. Even managing the trade entails three parts: a cash or pip profit objective, a technical reason for entry or exit, and an emotional judgement on when to get in or out.
7-Projection Not Prediction – Forex trading requires a projection of the price patterns, not a prediction. Projection works well because forex prices form patterns as sentiment aggregates together.
8-Scalability- Forex price patterns often repeat themselves in different time periods. This is also known as a fractal basis of price movements.
9-Multiple Time Comparison – Integrating the big picture with moments of opportunity is a principle of trading in forex that provides one of the most powerful technical tools. When a trend direction of the day is discerned and the trend direction of a smaller time frame like the 15 minute pattern is aligned, then the principle of multiple time comparison is being applied.
10-Price Signals are Bounces or Breaks of Patterns
This principle focuses on the nature of price action. Bounces are more stable then breaks, because prices tend to stay in patterns, trends, and ranges, etc., more often the prices will in fact be testing the boundaries of those patterns, creating bounce trades. Prices breaking through a pattern will try to return to the previous pattern. This is known commonly as retracement.
11- Trading Is a Business
Of all the principles of forex trading, the concept that forex trading is a business gets the most neglect. Trading is about choices and costs. The role of the trader is to perceive the huge number of trading possibilities and then possibly participate in the trades. Not trading is also a rational choice. The more a trader knows why a trade was made and why a trade may have been avoided, the potential for improving trading skills over time will increase. Forex trading, like a business, has built-in costs. Commission-free trading is misleading because the cost of the trade is embedded in the spread charged to the customer. When the forex trader sees each trade as an input with profits or losses as outputs, he is operating his business with the goal of making money.
These principles can help shape the forex trader develop strategies and tactics for trading.
Yet, no matter how many principles are developed, trading forex will always be a combination of technique, art, emotion and luck.
