TradingMarkets.com
6 Facts That Give Forex Traders An Edge
Friday August 29, 9:01 am ET
By TradingMarkets Research


Austin Passamonte is a full-time professional trader who specializes in E-mini stock index futures and commodity markets. Mr. Passamonte's trading approach uses proprietary chart patterns found on an intraday basis. Austin trades privately in the Finger Lakes region of New York. More work by Passamonte can be found at CoiledMarkets.com.

Over the past few years, FX markets have exploded in popularity amongst retail traders. Hard to say if that was due to heavy promotional efforts from the industry itself, or whether the continual pumping of FX trading is a result of increased interest and demand. In any event, there are a lot of misconceptions and mistruths floating out there that need to be addressed. Most of the myths involve spot currency aka "FX" markets but some include currency futures, too.

Currency Markets Are Totally Random

Not at all... nothing could be further from the truth. An individual's stock price movement can be pushed up, down or sideways by an endless procession of factors. Part may be economic, part fundamentals to specific company, industry or sector. Another part of stock market action is pure emotion. Someone makes or sells a widget with perceived value higher than what turns out to be economic reality. Doesn't matter... stock prices can remain pumped on pure emotion longer than rational people can comprehend.

Currency markets aren't like that. They are purely supply and demand, a commodity if you will. Each currency is weighted on economic conditions for that specific denomination versus any or all others in the marketplace. Price value of currencies is nothing more than a reflection of where that denomination's economy ranks as weak or strong relative to others. There is no sentimental or emotional impact on a currency. No one buys the British Pound to unreasonable heights because they like the color scheme of those bills. No one sells the USD/CHF because that country has great skiing in the winter; therefore it's a "play" to profit from guesswork of increased tourism. If the Swiss economy is weak or strong, it'll be amply reflected in the CHF pairs accordingly. Same holds true for all currency pairs accordingly.

Technically Pure

FX markets are technically purer than stock markets. By that we mean price action reacts more strongly to resistance and support levels on a chart much better than equity markets do. FX traders and dealers only have supply and demand to make their buy/sell decisions from. It's all based on price levels, which is reflected in the charts. FX markets react better than stocks when it comes to Fibonacci tools, pivot points, trendlines, prior resistance - support levels, etc.

Stock market traders often struggle when a switch is made to currencies because there are no sentiment (another name for emotional) indicators to read. No advance/decline, TICK or TRIN, Level II/III and no volume studies in the spot market FX. Currency markets do react sharply to economic news and reports... anything affecting interest rate changes is a direct correlation to FX. Other than that, currency markets are immune to the emotional vagaries that often slap stock prices around. Stocks reflect a company or sector of companies while currencies are commodities. Pure supply and demand pressures equate to purer price movement in reflection of technical analysis in FX markets.

FX Is A Scam

Spot forex markets are sometimes said to be a collusion of major banks and dealers where price action is unstructured and vague. In a nutshell, currency market spot or exchange price modeling is fluid and dynamic. The process of finding "fair value" for a currency pair includes a lot of factors. Currency futures markets are a derivative based on actual underlying... which we could say is the "spot" pricing or cash FX. The fact that no central marketplace exists for global pricing of currency spot values at every moment in time does make it a somewhat moving target. Nearest we can come to centralized pricing is dealer data provided by actual broker/dealers or most major chart-service providers. In the past, I've monitored FX pricing from three different major sources of FX data with nil difference between any of them.

Now, that doesn't mean unscrupulous dealers are a myth. FX is the least regulated of all financial markets, in some cases totally unregulated. That coupled with the human greed aspect of get rich quick lends to all kinds of scams and illegal schemes duping the public. However, just because one portion of FX trading falls into a wild-west description does not mean blanket coverage applies. It's a simple matter of sticking with the big broker/dealers for discretionary trading. Avoid offers of wild riches without risk, mechanical systems that never lose and any other ads which wave red flags at 40 mph speeds. FX trading requires the same factors as any other marketplace: patience, discipline, structured approach to create favorable risk/reward parameters, tolerance for loss as part of an overall profitable approach. There is no substitute for time, study and experience to create success. Any ads or offers that appeal otherwise are blatant lies to be avoided. Sensible traders will, while the willingly gullible will continue to fall prey as usual.

FX Broker/Dealers Purposely Trade Against Their Clients

This myth is repeated all the time. FX brokers with dealers? desks purposely target traders with profitable accounts to "take them down". Any FX trader turning a profit is doing so at the expense of the FX broker, and therefore the broker does whatever possible to thwart that trader(s) success.

In reality, FX broker/dealer trading desks exist to trade against their "book", aka the collective sum of all clients as an aggregate. FX broker/dealers serve a similar role as anyone hosting a poker game, or we could say a casino "house". The reality is, a majority of traders in any financial market will naturally lose, no matter what. A dealer desk merely exists to take the other side of majority aggregate trades to hedge off risk. That makes the collection of bid/ask pip spread one profitable stream of income. Successful dealer desk trading against the sum total of their collective book may be another.

That being the case, no reputable broker/dealer is concerned about individual success stories amongst their aggregate clientele. The fact remains that most traders lose money, FX or otherwise. A dealer desk is focused on outperforming the natural, predictable results of a sum total with no regard to individuals. No major, reputable FX broker is going to look through their book, see that Johnny Smith is making +100% annual turning 10-lots and set their sights on him. What exactly can the dealer desk do? Move the entire GBP/USD pair 30 pips away from fair value just to take out his well-placed stop? Wouldn't that concentrated effort likewise move the market likewise in favor of nine otherwise losing traders into a profit zone? If the belief that nine out of ten traders (any market) are net losers, that scenario would be counter-productive for the dealer. They'd be making nine traders right (on average) just to make one trader wrong.

Major broker/dealers cannot individually move entire currency pair markets away from fair value far enough to consistently or repeatedly target individual traders and their stops. The concept is ludicrous and illogical when you stop and think about it. Just another one of those pervasive myths generated by people with an agenda against spot FX markets, some of which are currency futures brokers competing for clientele and commissions generated.

A retail FX trader is not pitted against the broker/dealer for success. Simply a matter of being on the correct side of enough trades to be net profitable overall... something a majority in collective group fashion will fail to do. Individual success will stand on its own, unfettered by a legitimate broker/dealer.

Currency Futures Are Superior To Spot Currency Markets

Like most other aspects of trading, there is no black and white objectiveness here. The choice to trade spot FX versus currency futures markets depends on personal preferences more than anything else. Each has strengths and limitations, features and benefits.

Currency futures markets are transparent. Traders can see volume and bid/ask, there is one standard pricing value across the board. The futures contracts are also traded through the same broker that other contracts listed on CME clear thru. No need for a second broker, different set of charts, more trading platforms or software, etc. Traders who focus on other futures markets to begin with OR traders who opt to work the currency futures markets alone, while content with their current brokerage = software setup, need do nothing more than flip symbols on their screen to be in business.

That said, currency futures are thinly traded in off-hours while spot FX dealers offer guaranteed stops to limit or eliminate slippage on stops during most situations between Sunday evening and the following Friday afternoon unbroken stretch of trading hours. That is a considerable advantage for spot over the futures when traders hold swing trades open beyond pit-session hours for the futures. Unexpected news events, regional or global can send currency markets soaring or tanking to extremes. There is a chance of painful slippage or outright missed fills on resting stop orders for any futures market. Some FX broker/dealers guarantee stops being filled in most situations (examine details specific to any such offer) guaranteed.

FX Markets Have Bigger Trade Costs Than Futures

Spot currency markets have a bid/ask spread structure as a profit incentive for broker/dealers that makes a retail market available to traders. If it weren't for the bid/ask spread as a revenue stream, who would create or offer a spot market for trading to begin with? With the FX major broker/dealers, there is no other per-trade commission cost involved. Trades held overnight in the spot currency market are subject to interest-rate carry charge adjustments, but that's a negligible cost relative to commissions and bid/ask spreads.

Currency futures traders have a charged per-trade cost debited from their account on every round-turn. Winning trades, scratched trades and losing trades all incur the same cost of commission and exchange fee alike. There is a fixed per-trade cost in currency futures on each and every trade without exception. Take a trade, get charged a commission fee regardless of that trade's outcome.

By comparison, spot currency FX transactions have no real trade costs. Think about that for minute. Let's say you take the same currency futures trades and spot FX trade side by side. You are working equal contracts in the EUR/USD futures and spot FX with a futures broker and FX dealer alike. The futures contract has a 1-pip bid/ask spread valued at $12.50 while the FX contract has a 2-pip spread valued at $20. On its face, the futures contract seems "cheaper" to trade. But is it? Each futures trade includes a -$4 commission cost per contract, win, lose or draw. The FX trade does not.

Assume three of your simultaneous currency futures and FX trades result in the following:

Trade #1: stopped out for -250 per contract loss

Trade #2: stopped out at original entry for par

Trade #3: exited on a trailed stop for +$500 per contract gain

The debited and credited results to each account would look like this:

Trade #1: -$250 and -$5 commission in futures/-$250 in FX

Trade #2: $0 and -$5 commission in futures/-$0 in FX

Trade #3: +$500 and -$5 commission in futures/$500 in FX

See the difference? Each currency trade incurred the normal commission cost. There was no per-trade cost in FX. A bid/ask spread in either case is never actually "paid" by any individual. The whole concept of a bid/ask spread is creating profits between two offset parties. Neither individual parties (in this case traders) actually pay the bid/ask spread out of pocket. In all reality it gets absorbed inside the trade with distance between trade fill and exit.

Traders set stops with either $$ values risked or technical strategy of where the stop-loss protection should go. The actual "cost" of a bid/ask spread is reflected in the distance between actual fill and initial stop... which is wider or narrower in true value relative to the width of spread. A trader doesn't pay a debit charge out of account for stopped-out trades in FX. You could say the cost of losing trades (not applicable to winners) was a smaller stop hit due to width of bid/ask spread. But no actual cost is charged as a debit in cash removed from an FX account.

On the winning trade side of this equation, the bid/ask spread is absorbed by price action moving beyond an FX trade's exit. In other words, if an FX trade is exited at +$500 per contract inside of a price move that goes +$840 per contract from entry to peak before reversal, where did the bid/ask spread truly go? It was absorbed out the back-end of that profitable trade moving five miles beyond the exit. What would it matter if someone was long GBP/USD from 1995 or 2000 if price went to 2175 peak high? Looking for a +$500 per contract exit would have each FX trade out at 2045 or 2050 respectively. The net profit result in each case would be +$500 credited to the account with no commission cost incurred. The bid/ask spread could be 10-pips wide and would not matter one whit if the trade worked in favor from entry to targeted profit exit.

The only way a bid/ask spread would become a real cost is if the fictitious concept of exiting EVERY trade at peak high for longs or peak low for shorts were possible. Then and only then would the bid/ask spread become a true incurred cost. Otherwise, it is merely absorbed inside of normal price movement for winning and losing trades alike.

Summation

Trading currency markets is an excellent alternative for many reasons. Any region or time zone on earth has some FX pair available to trade during normal waking hours. There is almost always something moving somewhere in currency charts, which are semi-correlated to equity markets. Be it currency futures or spot market FX, don't let pervasive myths steer you away from the true benefits both offer.