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Michael Duane Archer has been an active commodity futures and FOREX trader for over thirty years. He has worked in various advisory capacities, notably as a commodity trading advisor and an SEC-registered investment advisor. Archer operates www.fxpraxis.com and is a professional FOREX money manager. He is also the coauthor of Getting Started in Currency Trading, The Forex Chartist Companion, and Charting the Major Forex Pairs, which are all published by Wiley.

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<p>A Highly Visual Guide To Developing A Personal Forex Trading Strategy</p> <p>Getting Started In Forex Trading Strategies</p> <p>"A great next step to read for the beginning trader. It contains practical advice and resources on trading FOREX that only come with experience."<br /> —Derek Ching, President, Hawaii Forex</p> <p>"We have members from over 125 countries on our Web site and plan to make Getting Started in ForexTrading Strategies a 'must read' for those looking to trade the FOREX market. It is good to see a book that emphasizes the importance of other elements, such as money management, which are crucial to master if one is to stay in this game. Well done!"</p> <p>—Jay Meisler, cofounder, Global-View.com</p> <p>Written in a straightforward and accessible style, Getting Started in Forex Trading Strategies is a highly visual guide to foreign exchange trading that introduces you to the Codex Method—a proven process that allows you to tailor a trading strategy to your own personal preferences.</p> <p>Divided into four comprehensive parts, this reliable resource opens with a brief overview of traditional FOREX strategies. From here, author Michael Duane Archer outlines his own personal codex—as he guides you through the process of developing yours—and reveals how to use this approach to make, monitor, and exit a trade. Along the way, Archer reveals the best ways to implement your strategy and discusses the importance of consistently keeping trading records.</p> <p>In his previous book, Getting Started in Currency Trading, Archer set a solid foundation for trading the currency market by illustrating how it operated. Now, with Getting Started in Forex Trading Strategies, Archer goes a step further by showing you how to cultivate a personal trading strategy that will allow you to succeed within this dynamic environment.</p>

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A Highly Visual Guide To Developing A Personal Forex Trading Strategy

Getting Started In Forex Trading Strategies

A great next step to read for the beginning trader. It contains practical advice and resources on trading FOREX that only come with experience.
--Derek Ching, President, Hawaii Forex

We have members from over 125 countries on our Web site and plan to make Getting Started in ForexTrading Strategies a 'must read' for those looking to trade the FOREX market. It is good to see a book that emphasizes the importance of other elements, such as money management, which are crucial to master if one is to stay in this game. Well done!

--Jay Meisler, cofounder, Global-View.com

Written in a straightforward and accessible style, Getting Started in Forex Trading Strategies is a highly visual guide to foreign exchange trading that introduces you to the Codex Method--a proven process that allows you to tailor a trading strategy to your own personal preferences.

Divided into four comprehensive parts, this reliable resource opens with a brief overview of traditional FOREX strategies. From here, author Michael Duane Archer outlines his own personal codex--as he guides you through the process of developing yours--and reveals how to use this approach to make, monitor, and exit a trade. Along the way, Archer reveals the best ways to implement your strategy and discusses the importance of consistently keeping trading records.

In his previous book, Getting Started in Currency Trading, Archer set a solid foundation for trading the currency market by illustrating how it operated. Now, with Getting Started in Forex Trading Strategies, Archer goes a step further by showing you how to cultivate a personal trading strategy that will allow you to succeed within this dynamic environment.

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Getting Started in Forex Trading Strategies

John Wiley & Sons

Chapter One

There are enough ideas for beating the markets to make you very rich-or very poor. -Charles B. Goodman

Most traders consider trading techniques-the actual tools they use to make trading decisions-as the most important element of trading. The proof is in the pudding; just consider the corpus of information both in print and online that deals with trading techniques. The sheer amount is staggering.

As the FOREX market matures, some literature on money management and the soft elements is becoming available, but it is still dwarfed by information available about trading techniques. The demand continues to be for information on trading techniques. That is unfortunate given the importance of the other two elements.

Systems and Black Boxes

Before considering some of the most popular trading techniques or tools, let me briefly discuss systems and black boxes.

A system is a self-contained way to make trades. Systems generate specific buy and sell signals. Many FOREX trading systems are available either from broker/dealers or from third-party vendors. They are intended to be complete in and of themselves, although many traders still use them in conjunction with other trading techniques.

Systems typically show outstanding results over historic data, or they would not sell. But the historic data is very often curve fit. This means that the system was developed to fit the data and not the other way around. If that data related to some specific types of markets, such as volatile markets, trading markets, or trending markets, when the music changes the system is bound to fail.

Systems have always been popular in all the markets-stocks, options, futures, and now FOREX. Not all systems are bad, but they are all opaque and that is always a warning sign. See Figure 1.1.

If you insist on using a system in your trading, be sure you understand which type of market it was build for or around-and use it only in those markets. However, determining which type of market the system was built for can be difficult. Many systems provide limited information regarding how they were developed. The best process is to look at charts of the markets vis--vis the system's performance. In which markets did it perform best-trading, trending, fast, slow? If the system vendor does not provide at least enough information to do this analysis, beware.

Black boxes are systems for which no information is available. You don't know how they were built, how they work, or what type of data they were built around. My recommendation regarding black box systems is to stay away from them. The less transparent the tool, the more difficult it is to make adjustments when things go wrong. A black box is the most opaque tool of all.

Robots have become popular in the FOREX markets. Usually, these are programs that automatically execute a trading system. In fast-moving markets they are very useful, especially to the professional money manager overseeing dozens or even hundreds of separate accounts. If your available time for trading is limited, you may want to consider using robots.

But if you have so little time to trade that a robot appeals to you, I recommend that you consider a professional money manager to trade your account. There are many money managers with excellent track records, but a discussion is beyond the scope of this book. Seek out a manager who has performed well in a variety of markets. It is more important that the manager has done well in a spectrum of market types than in specific pairs or crosses.

Technical versus Fundamental Analysis

Most traders today use technical analysis to trade. This refers to techniques based on price and other objective data that result from market action. The technician's credo is "Everything is in the market price."

The factors examined in fundamental analysis, such as a country's income, gross national product, and interest rates certainly drive currency prices in the long run. The problem for the currency trader is, as Keynes said, "In the long run we are all dead." The FOREX markets are highly leveraged; this is one of their main attractions. You can be correct about a currency pair in the long run, but the leverage may cause a price movement more than ample in degree to take you out of the market before you can profit from being correct about the fundamentals. It is discouraging to be correct in your determination of long-term trend direction-for example, "Interest rates will drive the U.S. dollar lower against the euro"-but lose money because volatility and leverage cause so many short-term fluctuations that you are never able to board the long-term trend successfully.

No one denies that fundamentals such as money supply, labor statistics, political events, and many others drive the currency markets. The problem-and why most traders use technical analysis-is how to interpret them, especially in the short term.

Most fundamental information is quantitative but much is not. For example, how does a trader convert an unemployment statistic to a price value? To further complicate matters, there are hundreds of fundamentals that impact prices, and the matrix of possibilities is astronomical. And some fundamentals, such as geopolitical events, are not even quantifiable.

The prices in Figure 1.2-tracked hourly for 30 days on EUR/USD-were ultimately driven by a wide range of fundamentals. But how does the trader discern them in advance?

Technical analysis allows you to zoom in as close to the markets as you want. In fact, an advantage of technical analysis is the ability to visualize the markets at multiple price levels simultaneously. See Figures 1.3 through 1.5.

There is no perfect world, of course. Fundamentalists will counter that the prices you use to do technical analysis are already history by the time you do your calculations, and they have no rational effect on the future prices.

But a simple example will show this concept to be incorrect, at least in theory. It is true that after I enter my order to buy or sell, I have had all the impact on prices that I will have until I enter the opposite order to exit the market. Yet every trader has a propensity to exit the market, once entered, on variable factors of price and time. At what price will I take a profit? At what price will I take a loss? How long am I willing to stay in a trade? These propensities vary from trader to trader, but the aggregate of all propensities creates a push and pull on the market that should, again in theory, be measurable. See Table 1.1.

All traders have access to market prices; the same cannot be said of fundamentals. There are literally millions of fundamental factors in any given currency, and the relationships among them are in the billions. Someone will almost certainly know a piece of fundamental information before you do. And how do you translate a fundamental like gross domestic product (GDP) to a specific market value or even a specific entry price? To add gasoline to the fire, remember that these relationships are almost certainly nonlinear and are changing rapidly all the time.

Fundamental traders conclude that prices have no memory and that only raw fundamental information drives the markets. The following is only a partial list of potential fundamentals for the U.S. dollar (USD). Other countries will have similar lists. Now, don't you really want to be a technical trader!

ABC/Money magazine Consumer Comfort Index.

Aggregate hours worked.

Atlanta Fed index.

Average hourly earnings.

Average weekly earnings.

Average workweek.

Balance of trade.

Federal Reserve Bank's Beige Book.

Bridge/Commodity Research Bureau (CRB) indexes.

BTM-UBSW Chain-Store Sales Index.

Building permits.

Business inventories.

Capacity utilization.

Capital flows, per Treasury International Capital System (TIC).

Confederation of British Industry (CBI) report.

Challenger, Gray, and Christmas layoff announcements.

Chicago Purchasing Managers Index (PMI).

Chicago Purchasing Managers Survey.

Chartered Institute of Purchasing and Supply (CIPS) report.

Composite Index of Leading Economic Indicators.

Consumer confidence.

Consumer installment credit.

Consumer price index (CPI).

Consumer sentiment.

Consumer spending.

Corporate profits.

Current account (balance of payments).

Durable goods orders.

Employment cost index.

Employment report.

Employment situation.

Existing home sales.

Export prices.

Factory orders.

Federal budget.

Federal government finances.

Federal Reserve Policy disclosures.

Financial account balance.

Federal Open Market Committee (FOMC) minutes and transcripts.

Foreign trade.

GDP.

GDP advance.

GDP deflator.

GDP final.

GDP provisional (revised).

GNP indicators.

Goldman Sachs Commodity Index.

Goldman Sachs Retail Index for Same-Store Sales.

Help-wanted index.

House prices.

Housing starts.

Humphrey-Hawkins testimony.

German IFO index.

Import prices.

Industrial production.

Industrial Production and Capacity Utilization report from Federal Reserve Board.

Initial claims.

International trade.

Institute for Supply Management (ISM) Manufacturing Index.

ISM Nonmanufacturing Survey.

ISM Services Index.

Jobless claims.

Kansas City Federal Reserve Bank manufacturing survey.

Lynch, Jones & Ryan (LJR) Redbook report.

Manufacturers' shipments, inventories, and orders.

Manufacturing and trade inventories.

Michigan Consumer Sentiment Index (MCSI).

Monetary base.

Money supply figures (M1, M2, M3) released monthly by Federal Reserve Economic Data (FRED).

Mortgage Bankers Association weekly survey.

National Association of Purchasing Managers (NAPM) index.

National Association of Home Builders (NAHB) survey.

New home sales.

Nonfarm payrolls.

New York's Empire State Index.

Orders, sectoral production, and inventories.

Payroll employment.

Personal consumption expenditures.

Personal income.

Philadelphia Fed index.

Philadelphia Federal Reserve Bank Business Outlook Survey.

Prices, wages, and productivity.

Producer price index (PPI).

Productivity.

Purchasing Managers Index (PMI).

Real earnings (real average weekly earnings).

Real GDP.

Redbook Index.

Residential construction spending.

Retail sales.

Richmond Federal Reserve Bank Survey.

Trade balance.

Tankan report.

Unemployment insurance claims.

Unemployment rate.

Unit auto and Ttuck sales.

Unit labor cost.

U.S. Treasury Borrowing Schedule.

Wholesale inventories.

List courtesy of www.FOREXrealm.com

Why Technical Analysis?

Pay your money; take your pick. Technical analysis, despite its faults, has attracted more traders than fundamental analysis has, for the following reasons:

Technical analysis input (primarily prices in FOREX) is objective, transparent, and available to everyone.

Technical analysis offers a nearly infinite number of possibilities for manipulation and application. Despite the millions of hours of effort expended on technical analysis, the field is wide open. Who knows what you might discover?

Technical analysis allows traders to see the markets at many different price levels-of their choosing-at the same time.

Technical analysis lets traders easily time their entries and exits as well as monitor their trades while they are open and active.

If you are right using technical analysis, you will probably make money on a trade. If you are right using fundamental analysis, the leverage inherent in the market may well cause you to get stopped out or exit the trade before you can collect on your judgment.

Despite the fundamentalists' concept that prices used in technical analysis are "instant history," the technical market paradigm infers that actions in the market of buying and selling obviously have reactions in the markets of selling and buying. Past prices contain information about future prices. Whether this information can be usefully deciphered is an issue for the theorists.

Charting

Price charts of market behavior have been around for centuries, probably almost as long as markets have existed in both the East and West. The most important types of charts used today are bar charts, candlestick charts, point and figure charts, and swing charts.

All charts share the primary characteristic of visually depicting price behavior over some period of time. They differ as to their secondary characteristics and type and degree of visual impact.

Bar Charts

Bar charts are the most popular and enduring for all trading, whether stocks, options, futures, or FOREX. They are time-specific, meaning that they are scaled according to time increments. For FOREX this can be ticks: 5-second, 10-second, 30-second, 1-minute, 5-minute, 10-minute, 30-minute, 1-hour, 12-hour, daily, or weekly. See Figure 1.6.

Candlestick Charts

Candlestick charts, a charting idea from the East, are especially popular in FOREX. Candlestick chart patterns emphasize the technical analysis paradigm-that past prices carry information about future prices. Candlesticks are also time-specific.

I used candlestick charts in the 1980s to trade cocoon futures on the Japanese commodity exchange. When in Rome, do as the Romans do! See Figure 1.7.

Point and Figure Charts

Point and figure (P&F) charts have fallen from favor over the past 20 years. Perhaps this is a good reason to give them some extra consideration now. Point and figure charts are price-specific. Instead of scaling as a function of time, P&F charts are scaled as a function of price. In the end, it is a half-dozen of one and six of the other. Prices occur over time, and time is relevant only as it depicts changing prices.

It is said P&F charts were the "secret" of many of the robber barons of the nineteenth century who often raided railroad stocks using a tool no one else used. I don't know how true that is, but it rings true to me. Trading tools invariably are most effective when they are not widely used. After a technique becomes popular, it loses much of its effectiveness. The theory is this: The market, never interested in cooperating with traders, essentially immunizes itself against overly popular techniques to prevent the masses from making money.

To understand the market's ability to discount and immunize itself, we need only to consider the commodity spread relationships in grain futures. Useful and effective in the 1950s and 1960s, they have shifted so dramatically as to be worthless today. See Figure 1.8.

Swing Charts

Swing charts can be either time-specific or price-specific, although most of them are price-specific in the manner of P&F charts. I like swing charts very much for my close-up view of markets when I am looking to enter or exit. They are also, obviously, useful for detecting swings in the market. When I discuss the FxCodex method of trading, you will see how important the information derived from swing charts can be to trading currencies. See Figure 1.9.

There is no best chart technique. Many traders use more than one for studying the markets. I use bar charts and swing charts and occasionally refer to point and figure charts. If you haven't selected a primary chart tool, look at the same market over the identical period of time with each type. Which one speaks to you? If you have already selected a charting technique, feel free to use it to develop your personal codex.

I strongly encourage a charting method as your primary tool both for watching the markets and for deriving buy and sell signals.

Indicators

Indicators are popular with traders. The classification and sheer variety of indicators is vast, and a full discussion of them is beyond the scope of this work. Because most of us aren't math and statistics experts, anything that uses dazzling displays of mathematical pyrotechnics often seems somehow magical and infallible to us.

Many traders use an indicator battery (IB), which is a selection of perhaps a dozen or more indicators covering all the technical bases. If you use an IB, you need to have ad hoc rules (or a meta-indicator or indicators) to determine what all of its components mean and how to apply them in actually executing a trade.

Charts offer traders a transparent one-to-one correspondence with market prices; indicators do not, and that is the primary problem with them. Indicators are second-level techniques. They use the primary market data such as prices but manipulate it to attain a new level, hopefully, of understanding.

Information theory tells us that such translations or manipulations are fraught with some risk and danger. Without being 100 percent certain how the indicator relates to the underlying data, we can be easily misled. Markets move in prices, and using indicators requires that we constantly shift levels to make trading decisions. Each shift can cause an error, and because the markets move very swiftly, errors compound quickly.

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Excerpted from Getting Started in Forex Trading Strategiesby Michael D. Archer Copyright © 2007 by Michael D. Archer. Excerpted by permission.
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