Chartists have long held the belief that patterns can predict future price movement. These assumptions are largely based on the interpretative analysis of the trader or technician that happens to be looking at it. Often times, two traders can be looking at the same chart and have two entirely different opinions.

It’s this sort of subjective, opinion based analysis that can easily lead to a bad trading decision. However, there are a number of patterns that have been identified and catalogued for many years by chart readers. These patterns have withstood the test of time and by virtue of their lengthy history can provide us with sufficient statistical data for traders to base their assumptions on.

These well known patterns, despite the fact that they are used by thousands of traders every day, will always work within the confines of any well planned strategy. Some will argue that their very appearance creates a sort of self professed strategy, and to some degree there may be some truth to that.

However, once you learn the underlying reasons for their formation, you’ll begin to understand the very foundation upon which chartists base their belief in a price pattern’s predictive powers. The reason for this is because a good chart pattern’s very formation is born out of two conditions that will never change.

The first condition is psychological. The human condition will always possess varying degrees of fear, greed and uncertainty, even, and especially when it comes to trading! We all know that money can have a big effect on the behaviors exhibited by most people. As you will see by the examples below, chart patterns do an excellent job of revealing these behaviors.

The second condition is the natural presence of supply and demand. Buying and selling also has a story to tell as it prints it’s data onto your screen. When you start studying these charts you’ll begin to see the very logical reasons for some of these formations and how to interpret them. Once you are able to recognize the convergence of psychology with supply and demand in one of these patterns… now you’ve really got something to begin building a trading system around.

Double Top or Double Bottom Formations

Currency pairs that have been in a long term up trend will often see a double or triple top formation occur before the trend reverses direction and begins trading lower. Conversely, down trending currency pairs will often show a double or triple bottom before changing direction and trading higher. Multiple tops and bottoms are classic reversal patterns.

As the predominant trend weakens, buyers and sellers begin to do battle resulting in what initially appears as a classic pullback and continuation pattern. However, with any multiple top formation, if the buyers become fearful and choose to take profits once price has reached the previous high… then a sell off ensues sending the chart into a new downward trend. The reverse of this is true with a multiple bottom formation.

Bull And Bear Flags

Flag formations are considered trend continuation patterns and are among the most reliable of all patterns to trade. A bull flag forms when the currency pair has been in a strong uptrend and price then trades in a range bound sideways pattern. The resulting pattern looks like a flag at the top of a flag pole.

Traders that recognize this set up will place a buy order just above the previous high of the flag with the expectation that the trend will continue. The reverse is true when a bear flag formation occurs.

With this pattern we see a dramatic increase in price (the pole) with some normal and expected profit taking (the flag). However, demand (in the case of a bull flag) is greater then supply despite the profit taking which has created this temporary sideways action. High demand, combined with confidence by traders causes price to break out of it’s consolidation and the trend resumes.

Triangles

The triangle pattern is another very reliable charting formation and is considered a consolidation pattern. Triangles begin with a fairly wide yet defined sideways movement in price that over time tends to have lower highs and higher lows until the price points are trading within a very narrow range. This gradual narrowing of highs and lows creates an apex with the resulting pattern looking like a triangle.

What sets triangles apart from other side ways patterns is that once a break out occurs beyond the crudely drawn lines of the triangular shape, these break outs can often be explosive and the beginning of a new trend. This occurs because we can see very little conviction from buyers or sellers as price drifts slowly sideways into the point of the apex. However, at the beginning of this consolidation, the triangle’s wide point proves the potential and likely magnitude of price once it is a confirmed break out or break down.

Psychology + (Buyers and Sellers)= Profitable Patterns

Double tops, double bottoms, bull and bear flags, and triangle formations are among the most heavily watched  and traded patterns in the world. They are, and always will be extremely reliable because they represent the merging of human behavior, supply and demand in a way that is identifiable and logical.

The descriptions of each pattern in this article are very basic. There are many other considerations  required before attempting to trade them. The point in all of this is so that as you become a student of technical analysis, and chart patterns in particular, that you will understand the importance of being able to visualize the fear, greed, uncertainty, and confidence that causes many of the buyers to sell and the sellers to buy.

This knowledge is what will set you apart from the whimsical amateur  who thinks that patterns are magical ATM machines to be followed blindly. It also is what sets apart the charted results from a coin flip versus a currency pair that involves human beings and real money.

Successful forex traders use a variety of methods in which to base their directional bias before placing a trade. Chart formations, or patterns, have been used as a foundational basis for many trading systems dating back to the ancient Japanese rice traders who would use hand drawn candlestick charts as a way of interpreting supply and demand.

Many chartists believe that the formations of specific patterns can reveal to the trained technician what will unfold in the future, providing them with an analytical edge over the rest of the uninformed crowd.         Although there may very well be some predictive qualities to these emerging patterns of price action, it should also be noted that a charted record of daily temperatures, or the results of a coin flip will yield similar patterns.

The anti-chartists will use this example as proof that patterns on a chart are nothing more then squiggles and squaggles of lines on a computer screen. They will shout from the roof tops that chart reading is a fools game not worthy of consideration by a professional. But in truth, they would be wrong, just as any glassy eyed chartist would be wrong to boldly claim a chart pattern’s infallibility.

Chart patterns are not the holy grail, but when interpreted correctly, they do have a story to tell. When used in conjunction with price action from buyers and sellers, predictable patterns do begin to emerge that are logical and make sense. These patterns can provide the astute trader with a better understanding of who is winning the battle of supply and demand. Chart patterns provide the technician with price points that can identify reversals, break-outs, or continuations of trends, and much more.

Statistically, these predictions of future price are not always right. Percentages of accuracy will vary from pattern to pattern. However, they provide an edge of probability as well as boundaries that are defined and  mandatory for any profitable trading system. Once you understand the logic behind a pattern and why it is occurring, you can the take this information and place an order with a reasonable anticipation of where prices will go… and even more importantly, you will know when you are wrong and when to get out.

Price patterns can vary in the length of time they take to unfold. Some patterns can take months to develop, others can print in one day. Of course, this is assuming that we are looking at a daily or weekly chart. When traders use charts with lower time frames, such as a 2 minute or 15 minute intra-day chart then these patterns will adjust in length accordingly.

These patterns are also used by forex traders to help define the possibilities of certain market characteristics as well. Most chart patterns fall into the following categories… reversals, continuations, and consolidations. Let’s take a look at all three of these for a better understanding.

Reversals

Reversal patterns indicate the possibility of an extreme change in directional trend rather then a short term pullback or consolidation in price. True reversal patterns, also known as tops and bottoms, are very reliable when forecasting trend change.

Continuations

Continuation patterns help traders identify temporary pullbacks or consolidations in price. These minor sell-offs or sideways movements represent that the currency pair may be experiencing some normal profit taking before resuming it’s current trend once again.

Consolidations

These patterns show the trader that a deliberate, well defined side ways movement in price may be reaching an end and that a break out in price with a new trend may be about to happen. Often times these patterns are non-directional, meaning that price could break in either direction.

What Chart Patterns Are The Most Reliable

Despite the talk from the random market theorists, chart patterns work. There are hundreds of formations that have been catalogued, with new ones popping up almost every day. But when it comes to reliability in so much as the historical probability can allow, there are a handful that are widely used and will always provide a good picture of what may unfold as supply and demand go back and forth.

In Part 2 of this report we’ll take a close look at the more popular and reliable patterns within each category described above. I encourage you to research these and other chart patterns on your own so that you can begin to see the correlation between buying and selling and what it means to you as a speculator in the currency markets.

For investors and traders, the internet has created an environment that allows anyone to participate in forex trading online. What makes this so different from other markets is the fact that currency trading, despite it’s huge global volume was only available to huge banks and international monetary funds who had the ability and capital to trade in large numbers. The little guy was precluded from participating in this market for many years. Once the internet and several other factors all came together, forex trading on-line became accessible to anyone and everyone. This created a new and exciting era for retail currency traders.

With the volatility and manipulation that can take place in other trading instruments around the world, small individual traders are coming over to the foreign exchange as their preferred market to trade. The purpose of this article is to introduce the basics to anyone first looking into this exciting, fast paced world of currency trading. We’ll take a quick look at some of the most common questions first asked by anyone looking into forex trading online for the first time.

What is Forex and Why Trade It?

Forex stands for the Foreign Exchange and has been around since 1970 when President Richard Nixon signed legislation removing the gold backed standard from the US dollar. This changed the value of the US currency from being historically backed by gold inventories, to being backed by the “full credit and ability” of the US government.

However, this market was not opened to retail traders until the 1990′s and it wasn’t until 2000 that we began to see brokers who could provide a platform for the average person to participate in forex trading online. Once these brokers began to do business, it opened up the trading of world wide currencies to anyone that had an internet connection and an account. Being the most heavily traded market in the world, the small retail trader can enjoy the tighter spreads, reduced volatility and investment opportunities that not too long ago were not available.

Understanding Currency Pairs

In the forex market, all currencies are traded in pairs. A currency pair is simply the simultaneous purchase of one currency and the selling of another currency. The value of each currency is determined by the exchange rate. The currency pairs value is based on the corresponding value of one currency in relation to another. In other words, the Euro may be strong when compared to one currency, but it could also be weak when compared to another one. Money is made or lost on a currency pair dependent upon the speculator’s analysis of how one currency will perform when compared to another one.

What in the world is a PIP?

A “pip” is a unit of measurement that is used to determine the value of a given currency pair. Similar in concept to the decimal or fractional increments used in a stock quote, the pip is a bit different because the pip measurement is unique to each currency pair. Understanding a pip’s value and knowing how to calculate this value are mandatory before you ever consider forex trading online. Yes, at first it will seem like you’re having to do mathematical gymnastics… and yes, you’ll also need to ask your broker to explain fractional pips and lots. But don’t worry, If I can learn it anyone can, and with a little practice you’ll have it down as well.

Forex versus Stocks

As with any tradeable instrument, there are advantages and there are disadvantages. However, the differences between trading currency pairs and stocks are worth noting, and in my opinion, prove quite easily that stocks simply cannot compete with the advantages offered in the foreign exchange.

The forex markets have tremendous liquidity which makes it easy to enter and exit the market at a fair price. Forex markets are open 24 hours a day, allowing traders from anywhere in the world to participate at the time that best suits their schedule. Information that affects the pricing of currencies is relatively limited and somewhat predictable. With stocks, the investor has so much more to study, analyze and in the end… worry about. No market is without risk, but trading currency pairs removes much of this volatility that stock traders must endure.

What’s the Next Step to Trading Forex Online?

The first step for anyone wanting to become a forex trader is really quite simple. Find a reputable, well capitalized broker that can provide you with excellent support, a large community of fellow traders, and a platform for trading a simulated account (paper trading). Commit to your education and become knowledgable in your new craft by studying and learning before committing real money trading forex online.

Achieving success in any business venture can be a difficult and challenging task. I recently read in a business review journal that most small business’s fail because they are undercapitalized. Which means, in very simplistic terms, that they ran out of money before the company’s profits could cash-flow the  company’s operating expenses.

Now, let’s think about this for just a moment. No one would intentionally go into business if they knew that they would fail. Seems like a reasonable statement, doesn’t it? And if most business’s that fail would have survived provided they had enough money, why then didn’t the new business owner know this in the beginning? The reason for this is because of a poorly researched business plan, or in many cases no business plan at all.

I can assure you, that if any of these entrepreneurs knew ahead of time that they were going to fail with their new business they would either wait until they had enough capital or they would make operational changes within their business model so as to allow for success. This proves then, that bankruptcy and business failures could be dramatically reduced with better research and better planning. This logical premise could apply to start-ups as well as business’s already in existence.

Your trading business, whether full time or part time is also a business and should be treated no differently with regards to its need for a well researched plan than any other business venture. Traders that are successful will always have a trading plan that serves as their road map to how they operate. Successful trading demands discipline and the adherence to a set of predetermined rules. Traders that shoot from the hip are like a drunk staggering down a street. There is very little control over the outcome and success will largely be due to luck.

Taking the time to write out your own trading plan will force you to look at all the components that make up the anatomy of a trade and the rules with which you will live by in order to be successful. In this article, we’ll go through some of the important categories that should be considered and included in your trading plan.

• Personal Reasons For Trading

Though not specific to the rules of your system, this will help you to define your personal goals set for yourself as they pertain to your desired income or lifestyle that your forex trading will give you.

• Your Office And Equipment

Take the time to know what your currency trading office set up will require. List computer hardware, software, printers, internet access, phone systems, office supplies and back up plans in place in the event of power or internet problems. Be sure to research the requirements for the platform and charting software you’ll be using. Online currency trading requires the right technology and your business operations need to remain organized.

• Select A Forex Broker And Trading Platform

Do your due diligence on the broker and the trading platform they provide you. You need to be proficient with placing orders and managing your account. Place all relevant phone numbers and other information within your plan.

• Hours To Trade

Establish your schedule and define how you are to be contacted during trading hours.

• General Money Management Rules

These rules for money management pertain to your overall account, it’s size and certain rules you will establish for yourself outside of the money management rules that are specifically within your trading system.

• Currency Pairs To Trade

Identify what instruments you plan to trade and why.

• Trading Strategies

Notice that I listed strategy’s as plural…. this is if you intend to trade more then one method. However, each strategy will require it’s own set of very specific rules that very clearly define all the inputs and perimeters that make up that particular strategy. From position sizing, entries, exits, targets, stops etc… everything that is required of a good trading strategy will go here.

Some Final Thoughts

This list of categories and sections should give you some ideas as to the type of research and thought that needs to go into your forex trading plan if you intend to be successful. If you can develop the discipline to write a detailed trading plan you will probably have the discipline and the guidance to stick with the rules required of your system. By remembering to plan your trade and trade your plan, your odds of creating wealth as a currency speculator will be quite good.

The trading public, the new aspiring currency trading person, and the curious observer of the forex all seem to think that the secret to creating wealth in the markets is to have some sort of magic indicator or system that few people know about. It’s this kind of thinking that keeps the trading system gurus in business and new traders from becoming old traders.

Unfortunately, very few traders learn, until it’s too late, that the principles and formulas behind money management is where their initial focus should have been from the beginning. The creation of wealth and the preservation of trading capital begins when a trader understands how to properly manage his or her money. Until this becomes an integrated part of your trading plan, you remain destined to be just another wide-eyed amateur, skipping from one trade to another with no idea at all how these wins and losses will ultimately affect the size of your account.

Money management is one of the least sought after topics by most currency traders. Courses and books usually will have the money management discussions tucked away in the last few chapters. Try listening in on anyone talking forex trading and it’s always about a new indicator, the strategy du jour, or some new fangled piece of software. At first glance, the idea of money management doesn’t seem very sexy. In fact it’s down right boring to most traders, which is why most traders lose money.

Most Forex Traders Are Too Random With Their Approach

Money is made by successful traders when they learn that each segment of their trading plan requires an advantage. We select a particular set-up or strategy because it gives us an edge. We establish a stop-loss or length of time designated to remain in a trade because it provides us with an edge. We use a certain broker because his trade executions or fees, once again, give us an edge in our trading. Money management does the same thing as we decide how best to direct our funds for each trade.

A smart trader understands the need to analyze, optimize, and implement every statistical advantage he or she can within the blueprint of their trading plan. The proper marshaling of funds, once understood,  is even more important than coming up with the hottest, super, “Can’t Lose Double Thrust Buy On A Down Close” trading system.

Could You Make Money From A Coin Flip

Many of you won’t believe me, and I can almost see you snickering, but consider this… what if I could show you a money management system that allowed you to be profitable with a method that selected currency pairs with a coin-flip? How powerful would this information be if you could insure a profit using what seems to be such a random method for determining a directional bias?

Wow… this is good stuff. Suddenly, when you begin to consider the possibilities of what a well thought out money management formula can do for your trading, it starts to get kinda sexy doesn’t it? Gamblers and casinos have been using these types of algorithm’s for years. And although the “coin-flip” analogy is a bit simplistic, these formulas do indeed exist. However, a detailed explanation on gambling algorithms would be extensive and are beyond the scope of this  article.

Finding A Formula That Works For You

There are many different approaches, techniques and formulas to money management. Some key considerations would be the size of your account, your personal risk tolerance, and the system you are trading. Using back-tested data from your system (be careful not to use curve fitted, overly optimized results), you can select a money management formula that will factor in  expected profits, drawdowns, maximum loss per trade, etc.

This data forms a set of inputs for the formula known as “expectations”. From this we can put together a sensible allocation of our funds for each trade, while automatically increasing our trade size as profits grow. This creates a logical method for increased position sizing while still managing exposure and risk. By using a proper money management system, we can now begin to create real wealth within our account instead of focusing on winning or losing trades individually.

As a new student of the markets, I hope this information has opened your eyes to the importance of money management. Finding the right method for you will take some research, but by doing so, you will be on the road to trading like a professional.

A good trading system is invaluable to the professional trader and should be an integral part of any trading plan. A good system provides an objective, statistically logical and responsible way to speculate in the forex markets. They are always rule based and they can be automated (like a robot) or they can be used only when the trader is in front of their screen.  However, selecting a good trading system and knowing the potential pit-falls go way beyond whether or not the systems report shows a profit or not.

In this report, I’m going to provide you with a check list for identifying a robust system from an unprofitable or an untradeable one. This check list is not a complete one. The science of system evaluation is vast and covers many variables. But this list will help you tremendously in deciding how viable the system is you may be considering, and it is my hope that it will open your eyes to the many components that must be reviewed before putting real money on the line

It Must Be Mechanical

A good trading system must be 100% mechanical in nature, devoid of any human overrides as it scans the markets. If a system requires inputs or data during the course of a trading day, then the profitability and all other pertinent data are not reliable.

It Must Be Transparent

Every rule, assumption and input that make up your system must be transparent, fully disclosed and understandable. Forget any black box systems or robots that do not provide full disclosure. Look carefully at the conditions that make up the trading rules and be sure that you can understand the indicators used. If a fast stochastic is used in conjunction with donchian channels then it’s important that you know what they are and how they work. Oh, and one more thing…proprietary formula is code for black box.

Works With All Currency Pairs

Well, almost… the system needs to have profitable and acceptable results in any market with similar liquidity. Most one trick ponies have been overly optimized and curve fitted.

Maximum Drawdowns

A maximum drawdown is the total drop in value of an account during a specified time frame. In other words, if a system shows at the end of  2010 that it profited 40% for the year that seems pretty good doesn’t it? But, if the max drawdown was 70% during the same year, could you trade that system? This part of the report reveals that even though the system rallied to earn a profit… the account first had to endure a 70% drop in value. This, in my opinion makes this system untradeable despite its glowing year end profit.

Total Consecutive Losses

This statistic is equally important and is somewhat similar to our max drawdown example. Again, if the system you are trading has had historically 7 consecutive losses before hitting a winning trade, could you stick with it? Maybe you could, maybe you couldn’t… but the point is that you need to know and be prepared.

Statistical Validity

All good systems will have enough data to satisfy normal standards for statistical validity. Here’s what I mean, if you flip a coin 4 times, and 3 of those times it lands heads. According to this report, a coin flip produces 75% heads and 25% tails. Would you consider that to be statistically valid? No, I certainly wouldn’t, look for at least 40 trades, as a minimum, spread out over several macro-economic eras.

Not Always In The Market

A well designed system will not always be in the market. A good system knows and identifies when conditions exist for a set up to occur. Robust systems are never “Jack Of All Trades”…

Never Misses It’s Intended Move

This requirement is really geared towards trending systems only, but I wanted to include it because trending systems can often be the most profitable of all systems out there because they are designed to always catch the big move. They might be wrong a lot… but as long as the drawdowns are acceptable, when a good trending system catches a big move… they make a lot of money.

Consider These Before Trading Any System

An interesting point to consider is that an incredibly profitable trading system might have only 33% winners, while a terrible system could have 75% winners. Take this information and be sure to apply it next time you’re considering how viable a trading system is.

Wow, seems like an awfully bold statement doesn’t it? We’ve heard time and time again that the Holy Grail System is a fantasy, that perfection only exists in the outrageous claims of currency trading charlatans with promises of easy profits if you’ll just buy their system!

I can assure you, that in my trading career, I’ve looked for that holy grail. I was desperate to find the previously unnoticed method that I could secretly exploit and soon be fabulously rich. The truth is that traders who are constantly looking for a strategy or system as the primary mechanism to becoming profitable find that this quest is like trying to find a pot of gold at the end of a rainbow. The closer you get… the farther away it becomes.

When you look carefully at the majority of the systems being sold, or the courses being taught… by an overwhelming margin, they all claim very high percentages of winners versus losers. How many times do you see an ad for a strategy that says, “75% winners”, or “23 consecutive winning trades”! And, of course, every one of these are substantiated by being so-called back-tested over 12 years of data… blah, blah, blah!

The reason for this is because 99% of all currency traders have a comfort level with winning and they cannot come to terms with losing. The predominant mind set is that if I can just find a strategy with a high percentage of winning trades, I’ll be successful and my account will grow. At the face of this argument, it really does make sense doesn’t it? Of course if we win more then we lose, we’ll have this forex trading thing figured out and we will soon be trading full time for a living.

Here’s where this thought process gets us in trouble… first, forget about the fact that often times the most profitable systems have a winning trade percentage under 50%. You can also disregard the notion that maybe there is merit to a low probability / high reward set-up in this discussion. Even though both of those statements are absolutely true, that is not where I am going with this.

The point I’m trying to make is that being a profitable trader means becoming a good loser. It is imperative that losing must become an expected, almost welcome occurrence. Why would a trader welcome a losing trade? Because a good trader knows and has confidence in his system. This allows him or her to look at a loss as a stepping stone, rather then as a stumbling block. The new and aspiring forex trader who focuses on a high win ratio also fears the inevitable losses that are bound to happen. This fear then grips the trader into an unpleasant yet predictable pattern that begins with hope, then fear, then devastation, and ends in total surrender.

So if all of these assumptions are true, how can we as forex traders learn to deal effectively and professionally with losses? And, how in the world can you trade without ever having a bad trade? The answer, though logical and incredibly easy to follow is very rarely done, but here it is…

The secret to never having a bad trade is by planning your trade and then trading your plan. Look, no one would ever consider opening a business without a proper business plan. Your trading business should be no different. If you have properly back-tested your strategy and you know that as long as you follow your rules without hesitation, then win or lose, that trade is a good trade. By knowing and having confidence in your trading plan, then your definition of a good trade will not be based on whether it made money.

It will be based on the fact that you traded your plan according to the rules of your system, and you understand that the profits are what you have in your account at the end of the month, not on each and every trade you place.

Technical trading systems are used by currency traders to provide clear entries and exits for trades based on a set of rules. By adhering to a very specific set of rules that govern your trading decisions, you have the foundation in place for most robust forex trading systems.

In previous articles we discussed the differences between a discretionary trader and a mechanical trader. A mechanical currency trader will always trade forex trading systems where price action, money management, and any other necessary data are put into a clear and well defined set of rules that will constitute the entire anatomy of the trade.

Currency traders that do not use forex trading systems as part of their trading plan are generally not profitable. Trading a system provides a road map, a blueprint for the trader with a set of rules and a solid trading plan to live by.

What is the difference between a Black Box, A Robot, and An Automated Trading System?

A black box trading system is a trading system with proprietary rules, conditions and indicators for generating trades on an automated basis where the system developer will not make the system’s methodologies known to the user, hence the term, “Black Box”.

A robot is an automated trading system that scans the forex charts 24 hours a day placing trades for the owner of the account. If the Robot does not have a fully disclosed set of rules defining it’s methodology, then it is also considered a black box trading system.

An automated trading system, provided its rules and conditions are transparent allows the forex trader to place trades automatically when the systems criteria are met. Similar to a robot, the differences are that you may opt to run this system only when you are at the screen if you like, versus just trading 24/7 which is the normal intended function of a robot.

What Works and What Doesn’t?

So, as a new trader to the forex markets, how do you make sense out of all this? What works and what doesn’t? There are literally thousands of forex trading systems out there… and I think the important thing to remember is that when it comes to trading, there is no such thing as the holy grail. If the holy grail of trading did in fact exist…. then every one would be getting rich because so many of these systems are sold every day.

The truth is that you, as a trader, need to have enough fundamental knowledge to be able to look at the trading criteria and rules for any strategy or system and at least understand the logic behind it. You then need to be able to take this system and back test it your self over multiple markets and time frames before even thinking about trading real money with it.

Essentially, by doing this… you can see the absolute folly in considering a black box system where you are asked to trade completely in the dark. Besides, the developers of these systems are quite proficient at the art of curve fitting results and over optimization. These deceptive results may show an eye-popping profit, but quite honestly, you could do the same thing with the data from a coin flip too.

The important take away from all of this, is to only trade a system that you fully understand and where all the conditions, stops, indicators, and filters are transparent and fully disclosed.

What Defines Good Forex Trading Systems?

The simplest and most basic definition of a good trading system would be one that provides a statistical edge. A good trading system will take this statistical advantage and combine it with all of the other parts that make up the entire structure of a trade from beginning to end. This would include, at the very least, inputs that will define the maximum loss allowed per trade, total size of the position, an expected profit target, trailing stops, money management, and potentially many other factors as well.

A good trading system is able to take all of the above conditions, and over time be profitable. We are just scratching the surface in our discussion of what good forex trading systems are, but the point being made is that the synergistic combination of many inputs and conditions must show statistical validity that the system is both tradable and profitable.

More importantly, the trader needs to have complete confidence in the systems long term performance. This is absolutely crucial to becoming a profitable currency trader.

As an example, if you know that historically your system remains profitable despite 6 losses in a row,  you will have the confidence to place the next trade in that situation because it is a known and expected part of the data that is used to  develop and select  good forex trading systems to begin with.

Light years ago, in a galaxy far, far away…. financial institutions, banks and international monetary funds were the only participants in the trading of foreign exchange instruments.

Thats a fancy way of saying forex!

Forex brokers at the retail level did not exist because these institutions monopolized the foreign exchange due to their abilities to have access to information and data that allowed them to hedge their interests and profit from the monetary policy that the average investor could not get to very easily. This, combined with government regulations and the huge volume required in trades to maintain adequate liquidity,  prohibited the small speculator from participating.

Access to the currency markets changed however, first with the invention of the internet… this new and exciting information super highway opened the doors to allow anyone virtually instant access to the same macro-economic events, news and data that the large world banking institutions had previously dominated. Combine this new fangled world wide web with legislation by the CFTC and we soon found ourselves with a retail market for individual traders to have the same abilities to trade currencies as the big boys.

What Are The Differences Between Brokers?

In order to access the forex as a retail trader, we need brokers to provide us with a platform to trade from, liquidity and reliable execution of our trades. Much like a stock broker, the forex broker acts as  an intermediary for these ( relatively speaking) small trades, and they also can assist in advice, recommendations etc. Each brokerage house can have different commission rates, minimum balances and account requirements that make it essential for any forex trader to research and become familiar with before opening an account.

Before selecting a brokerage firm, it’s important to understand the basic differences from one to the other, and also to have a good understanding of what your choices are. Forex brokers, for the most part, fall into one of two categories. There are Market Makers, also referred to as “Dealing Desks” and there are Straight Through Processing Brokers (STP), also referred to as “Non Dealing Desks”.

Market makers provide the liquidity for a given currency market themselves, and they make their money off of the spreads, (the difference between the bid and the ask) and by placing hedges, or bets against their customers. In other words, when you place a trade with a Market Maker, more then likely, they will be taking the other side of that trade in the expectation that you will lose. So…. the market maker earns money through both the spread and by hedging your bet. It seems a bit counterintuitive doesn’t it? But this is how it works… your trades are commission free, but the spreads tend to be a little wider.

Straight through processing brokers, or non dealing desks, do not create their own markets… meaning that they do not take the other side of your trade. Your order is sent straight to the recipient on the other side of your position. These brokers however, do charge commissions for each trade you place with the advantage to you being a tighter spread.

Do Your Research First

Which type of broker you choose is dependent on what type of trading you do. If you are a day trader and a scalper, then it will probably be better for you to enjoy tighter spreads and just pay the transaction fee because you are attempting to make a profit with a smaller expected move by virtue of the very short time frame with this style of trading.

Conversely, if you are a swing or a position trader, holding onto a position for days, weeks or maybe even months, then the spread is of less consequence to you because your expected move will easily overcome this.

Knowing what type of trading you will be doing is a big part of choosing which type of brokerage house is best for you, but it’s most certainly not the only research you need to do when looking at different forex brokers. You also need to be aware of fraudulent enterprises know as “bucket shops”. Bucket shops are essentially fake brokers that work out of boiler rooms acting as legitimate forex brokers. They man the phones… take your orders and then promptly drop it in a bucket, hence the name. Simply being aware that these types of scams exist should be enough to insure that you do proper research and due diligence before transferring funds to anyone.

For a currency trader, nothing creates a better or more valuable picture of price data then a price chart. This visual representation is the primary tool used by traders to develop directional opinions and to forecast future movements in price. Understanding forex charts and how to use them properly is an important step in the educational process of any new trader. Elaborate theories and complex algorithms, despite their potential for being profitable often lose their perspective to even the most astute trader. Yet their predictive theory can often be better understood through the use of a simple chart to look at.

Price Charts are a Picture of the Past

Price charts can allow us at a glance to identify trends, possible reversals, points of entry and times to exit. As technical traders, we can also use forex charts to tell us when we are wrong, or at what price point we should expect a profit target to be reached. The picture that a forex chart provides us can be used to establish many, or in some cases all of our trading decisions, with objectivity… making it a worthy skill to develop for any student of the markets.

Technical analysis, or chart reading can be broken down into 3 specific categories; Market Structure, Indicators, and Pattern Recognition. By understanding these 3 areas you can begin  to understand and formulate for yourself how to begin combining all or some of these into a logical, cohesive trading strategy. Let’s talk about each of these categories now!

Market Structure

Many traders tend to focus on specific indicators or chart patterns without remembering the most basic and important purpose of a price chart. Charts are primarily designed to show traders the highs and the lows within the charted time frame. Identifying these highs and lows are extremely important to understanding turning points and whether these turning points are reversals, pull backs, or reflecting a range bound market. To do this, we must first identify the highest high and the lowest low on the chart. These are easy to identify because we are looking for an absolute high and an absolute low, within a specified period of time as reflected on the chart.

For example purposes, we will identify these as  the “long term high” and the “long term low”. However, between the long term high and the long term low you will generally find “intermediate term highs” and “intermediate term lows”. These represent turning points that are contained within the previously identified price points. OK… drilling down we can now begin looking for highs and lows that are contained within the intermediate turning points as well. By forcing yourself to look for and identify these swings in price, you can begin to understand the market structure and how to begin establishing some simple but effective strategies for buying and selling.

Indicators

Indicators are best described as mathematical calculations of data `points used as tools to help forecast future price action. As complicated as that may sound, most indicators are easy to understand once you look at the so-called fancy math behind them. For instance, a 20 day, simple moving average can be calculated by taking 20 days of price data and dividing it by 20. This final number represents the average price over 20 days and can be used to provide a better visual understanding of trend direction for the currency pair you are trading. For instance, if todays price is above the 20 day moving average, and todays moving average is greater then yesterdays moving average, most analysts would interpret that as bullish.

Other indicators can be used to determine the velocity or momentum of price action, such as stochastic , momentum, and/or relative strength indicators. These indicators, often referred to as oscillators help traders gauge the strength of a currency pairs trend and can also show possible turning points or exhaustion of that trend.

Although each of these represent a more complicated mathematical formula then the moving average example, a basic understanding of their purpose and how the formula uses the data to plot it’s calculation are still within the reach of  mathematically  challenged people like me! Indicators are an important part of your trading arsenal, they are the truth serum in chart reading and can be used in a variety of combinations.

Pattern Recognition

Chart patterns represent another method for traders to forecast price. Developing a keen eye for these is also important to understanding forex charts. Chart patterns can be used to identify periods of sideways movements, known as consolidations, reversals, break-outs, break-downs, pull-backs, support / resistance, tops / bottoms, and continuations of trend. Some patterns represent only 1 day of price data, while others can take months to unfold.

As an example, a “key reversal” or a “doji” (2 different patterns) encompass one day (or time period) of price action, while the classic “cup and handle” (a continuation pattern), or the well known “head and shoulders” (a reversal pattern), can take weeks or months before it is considered valid. Pattern recognition can also provide the technician with profit targets by measuring the length between 2 price points, as well as the expected time frame by analyzing the amount of time certain patterns take to unfold.

Chart patterns can also provide the forex trader with a visual of where support and resistance levels are, they assist us in drawing trend lines or by identifying key areas for consideration when determining where to place our stops, when to enter, and of course, when to get out.

Putting It All Together

As you can see, by understanding the overall market structure, a handful of indicators, and developing your pattern recognition skills you will be giving yourself a tremendous advantage over most speculators.  These skills will provide the foundation a trader needs to begin developing there own trading plan and also to be able to look at the currency pair you are trading and know what is going on and why. At first, much of this will appear as Greek… but I assure you that as you continue to study, these concepts will eventually become English and you will find yourself, one day, understanding forex charts better then 99% of the population.