4.
TTABLEABLE OFOF CCONTENTSONTENTS
Chapter 1: Definition of Forex MarketChapter 1: Definition of Forex MarketChapter 1: Definition of Forex Market..................................................................................................................................................................................................................................................................... 111
A Brief History of Foreign ExchangeA Brief History of Foreign ExchangeA Brief History of Foreign Exchange..........................................................................................................................................................................................................................................111
The Bretton Woods AccordThe Bretton Woods AccordThe Bretton Woods Accord.......................................................................................................................................................................................................................................................................................111
Formation of the Group of Ten (G10)Formation of the Group of Ten (G10)Formation of the Group of Ten (G10).......................................................................................................................................................................................................................................222
Smithsonian AgreementSmithsonian AgreementSmithsonian Agreement......................................................................................................................................................................................................................................................................................................222
European Joint FloatEuropean Joint FloatEuropean Joint Float ..................................................................................................................................................................................................................................................................................................................222
To Peg or Not to PegTo Peg or Not to PegTo Peg or Not to Peg........................................................................................................................................................................................................................................................................................................................333
FOREX Currency TradingFOREX Currency TradingFOREX Currency Trading.............................................................................................................................................................................................................................................................................................444
Major Names in FOREX NewsMajor Names in FOREX NewsMajor Names in FOREX News...........................................................................................................................................................................................................................................................................555
Advantages to Trading FOREXAdvantages to Trading FOREXAdvantages to Trading FOREX ..................................................................................................................................................................................................................................................................666
RegulationsRegulationsRegulations..................................................................................................................................................................................................................................................................................................................................................................777
Industry FeedbackIndustry FeedbackIndustry Feedback .................................................................................................................................................................................................................................................................................................................................777
Market HoursMarket HoursMarket Hours.........................................................................................................................................................................................................................................................................................................................................................777
Correlation of 24Correlation of 24Correlation of 24---Hour Clock to 12Hour Clock to 12Hour Clock to 12---Hour ClockHour ClockHour Clock.................................................................................................................................................................................888
Chapter 2: What Moves The MarketChapter 2: What Moves The MarketChapter 2: What Moves The Market..............................................................................................................................................................................................................................................................................999
Fundamental AnalysisFundamental AnalysisFundamental Analysis...............................................................................................................................................................................................................................................................................................................999
Capital FlowsCapital FlowsCapital Flows.........................................................................................................................................................................................................................................................................................................................................................999
Physical FlowsPhysical FlowsPhysical Flows................................................................................................................................................................................................................................................................................................................................................101010
Portfolio FlowsPortfolio FlowsPortfolio Flows.............................................................................................................................................................................................................................................................................................................................................101010
Equity MarketsEquity MarketsEquity Markets.........................................................................................................................................................................................................................................................................................................101010
Fixed Income MarketsFixed Income MarketsFixed Income Markets.....................................................................................................................................................................................................................................................................101010
i
5.
Trade Flows: Measuring Exports vs. ImportsTrade Flows: Measuring Exports vs. ImportsTrade Flows: Measuring Exports vs. Imports...................................................................................................................................................................................................111111
Technical AnalysisTechnical AnalysisTechnical Analysis ............................................................................................................................................................................................................................................................................................................................................................111111
Technicals vs. FundamentalsTechnicals vs. FundamentalsTechnicals vs. Fundamentals...........................................................................................................................................................................................................................................................................111111
Important Technical Concepts in FOREXImportant Technical Concepts in FOREXImportant Technical Concepts in FOREX ...............................................................................................................................................................................................................131313
Fibonacci Retracement LevelsFibonacci Retracement LevelsFibonacci Retracement Levels ..............................................................................................................................................................................................................................131313
Moving AveragesMoving AveragesMoving Averages..........................................................................................................................................................................................................................................................................................141414
Simple Moving Average (SMA)Simple Moving Average (SMA)Simple Moving Average (SMA)....................................................................................................................................................................................141414
Exponentially Smoothed Moving Average (EMA)Exponentially Smoothed Moving Average (EMA)Exponentially Smoothed Moving Average (EMA)..........................................................................................151515
OscillatorsOscillatorsOscillators..........................................................................................................................................................................................................................................................................................151515
Moving Average Convergence Divergence (MACD)Moving Average Convergence Divergence (MACD)Moving Average Convergence Divergence (MACD) ...........................................................................151515
Candlestick AnalysisCandlestick AnalysisCandlestick Analysis...............................................................................................................................................................................................................................................................................................................151515
Bollinger BandsBollinger BandsBollinger Bands......................................................................................................................................................................................................................................................................................................161616
Relative Strength Index (RSI)Relative Strength Index (RSI)Relative Strength Index (RSI) .................................................................................................................................................................................................................................161616
RSI UsesRSI UsesRSI Uses......................................................................................................................................................................................................................................................................................................161616
Overbought/OversoldOverbought/OversoldOverbought/Oversold ..........................................................................................................................................................................................161616
DivergencesDivergencesDivergences .............................................................................................................................................................................................................................................171717
Centerline CrossoverCenterline CrossoverCenterline Crossover ................................................................................................................................................................................................171717
CandlesticksCandlesticksCandlesticks ....................................................................................................................................................................................................................................................................................................................................................................................171717
Candlestick AnalysisCandlestick AnalysisCandlestick Analysis ............................................................................................................................................................................................................................................................................................................171717
HistoryHistoryHistory .............................................................................................................................................................................................................................................................................................................................................171717
FormationFormationFormation.................................................................................................................................................................................................................................................................................................................................181818
Long vs. Short BodiesLong vs. Short BodiesLong vs. Short Bodies...........................................................................................................................................................................................................................................................................181818
Long vs. Short ShadowsLong vs. Short ShadowsLong vs. Short Shadows ............................................................................................................................................................................................................................................................191919
ii
6.
DojiDojiDoji...............................................................................................................................................................................................................................................................................................................................................................202020
Doji and TrendDoji and TrendDoji and Trend .........................................................................................................................................................................................................................................................................................................212121
LongLongLong---legged Dojilegged Dojilegged Doji .............................................................................................................................................................................................................................................................................................222222
Dragon Fly DojiDragon Fly DojiDragon Fly Doji......................................................................................................................................................................................................................................................................................................222222
Gravestone DojiGravestone DojiGravestone Doji...................................................................................................................................................................................................................................................................................................222222
Prior TrendPrior TrendPrior Trend ................................................................................................................................................................................................................................................................................................................................................232323
Candlestick PositioningCandlestick PositioningCandlestick Positioning.......................................................................................................................................................................................................................................................................................................................................242424
Star PositionStar PositionStar Position ................................................................................................................................................................................................................................................................................................................................................242424
Harami PositionHarami PositionHarami Position.......................................................................................................................................................................................................................................................................................................................................242424
Long Shadow ReversalsLong Shadow ReversalsLong Shadow Reversals ................................................................................................................................................................................................................................................................................................252525
Hammer and Hanging ManHammer and Hanging ManHammer and Hanging Man ..............................................................................................................................................................................................................................................................................252525
Inverted Hammer and Shooting StarInverted Hammer and Shooting StarInverted Hammer and Shooting Star....................................................................................................................................................................................................................................262626
Blending CandlesticksBlending CandlesticksBlending Candlesticks .........................................................................................................................................................................................................................................................................................................272727
Bulls vs. BearsBulls vs. BearsBulls vs. Bears ................................................................................................................................................................................................................................................................................................................................................282828
What Candlesticks Don't ShowWhat Candlesticks Don't ShowWhat Candlesticks Don't Show...............................................................................................................................................................................................................................................................292929
Chapter 3: Making Money with FOREXChapter 3: Making Money with FOREXChapter 3: Making Money with FOREX.........................................................................................................................................................................................................................................................303030
How To Predict A TrendHow To Predict A TrendHow To Predict A Trend................................................................................................................................................................................................................................................................................................313131
Time PeriodTime PeriodTime Period ........................................................................................................................................................................................................................................................................................................................313131
Starting To TradeStarting To TradeStarting To Trade ..............................................................................................................................................................................................................................................................................................................................333333
Which Currencies To Trade?Which Currencies To Trade?Which Currencies To Trade?...........................................................................................................................................................................................................................................................................333333
Timing Is EverythingTiming Is EverythingTiming Is Everything ..................................................................................................................................................................................................................................................................................................................343434
Beating the MarketBeating the MarketBeating the Market .....................................................................................................................................................................................................................................................................................................................353535
iii
7.
Finding OrderFinding OrderFinding Order ................................................................................................................................................................................................................................................................................................................................................353535
Mental PreparationMental PreparationMental Preparation ..................................................................................................................................................................................................................................................................................................................363636
Analyzing TradesAnalyzing TradesAnalyzing Trades ...........................................................................................................................................................................................................................................................................................................................373737
How To Use A Demo AccountHow To Use A Demo AccountHow To Use A Demo Account .....................................................................................................................................................................................................................................................................373737
Buy & Sell Signals & StrategiesBuy & Sell Signals & StrategiesBuy & Sell Signals & Strategies ......................................................................................................................................................................................................................................................................................................383838
Strategy 1: Daily Charts SystemStrategy 1: Daily Charts SystemStrategy 1: Daily Charts System ......................................................................................................................................................................................................................................................383838
How To Set Up the SignalHow To Set Up the SignalHow To Set Up the Signal ...................................................................................................................................................................................................................................................393939
UptrendUptrendUptrend ...................................................................................................................................................................................................................................................................................................404040
DowntrendDowntrendDowntrend ....................................................................................................................................................................................................................................................................................414141
Strategy 2:. FourStrategy 2:. FourStrategy 2:. Four---Hour Charts TradingHour Charts TradingHour Charts Trading ........................................................................................................................................................................................................................424242
Four Hour vs. DailyFour Hour vs. DailyFour Hour vs. Daily ....................................................................................................................................................................................................................................................................................434343
StopStopStop---Losses for FourLosses for FourLosses for Four---Hour TradingHour TradingHour Trading.........................................................................................................................................................................................................434343
Strategy3: FiveStrategy3: FiveStrategy3: Five---Minute Trading StrategyMinute Trading StrategyMinute Trading Strategy ............................................................................................................................................................................................................434343
Stop Loss for FiveStop Loss for FiveStop Loss for Five---Minute TradingMinute TradingMinute Trading ............................................................................................................................................................................................................444444
Daily Rollover InterestDaily Rollover InterestDaily Rollover Interest ......................................................................................................................................................................................................................................................................................................454545
Money ManagementMoney ManagementMoney Management ................................................................................................................................................................................................................................................................................................................................................464646
Stop lossStop lossStop loss ...........................................................................................................................................................................................................................................................................................................................................................................474747
Examples of Placing a Stop LossExamples of Placing a Stop LossExamples of Placing a Stop Loss .....................................................................................................................................................................................................................474747
Chapter 4: Influential Factors Affecting Cross Pair CurrenciesChapter 4: Influential Factors Affecting Cross Pair CurrenciesChapter 4: Influential Factors Affecting Cross Pair Currencies..........................................................................................................................................494949
Key Fundamentals Impacting the U.S. DollarKey Fundamentals Impacting the U.S. DollarKey Fundamentals Impacting the U.S. Dollar .............................................................................................................................................................................................505050
iv
8.
Factors Affecting EUR/USDFactors Affecting EUR/USDFactors Affecting EUR/USD ..............................................................................................................................................................................................................................................................................525252
Factors Affecting USD/JPYFactors Affecting USD/JPYFactors Affecting USD/JPY ..............................................................................................................................................................................................................................................................................555555
Factors Affecting GBP/USDFactors Affecting GBP/USDFactors Affecting GBP/USD ..............................................................................................................................................................................................................................................................................565656
Factors Affecting USD/CHFFactors Affecting USD/CHFFactors Affecting USD/CHF ...........................................................................................................................................................................................................................................................................585858
Factors Affecting USD/CADFactors Affecting USD/CADFactors Affecting USD/CAD ........................................................................................................................................................................................................................................................................606060
Special Report: 20 Most Influential People in ForexSpecial Report: 20 Most Influential People in ForexSpecial Report: 20 Most Influential People in Forex ................................................................................................................................................................................................626262
The AmericansThe AmericansThe Americans.............................................................................................................................................................................................................................................................................................................................................636363
The EuropeansThe EuropeansThe Europeans .............................................................................................................................................................................................................................................................................................................................................656565
The JapaneseThe JapaneseThe Japanese ................................................................................................................................................................................................................................................................................................................................................676767
The BritishThe BritishThe British ..................................................................................................................................................................................................................................................................................................................................................................686868
The SwissThe SwissThe Swiss........................................................................................................................................................................................................................................................................................................................................................................696969
Commodity CurrenciesCommodity CurrenciesCommodity Currencies......................................................................................................................................................................................................................................................................................................707070
GlossaryGlossaryGlossary...............................................................................................................................................................................................................................................................................................................................................................................................................717171
v
Notes on usage:Notes on usage:Notes on usage:
Personal pronouns: Unless specifically referring to a named male individual, the term “he” re-
fers to individuals who may be male or female. This form is used in place of “he or she” to
economize on the use of language yielding text that is easier to read. No gender bias is intend-
ed in the use of this traditionally male pronoun.
Candlestick Colors: Traditionally, red or black candlesticks indicate downtrend, while green,
white or blue indicate uptrends. In this publication downtrends are indicated by red exclu-
sively; uptrends by blue exclusively.
9. 1
CCHAPTERHAPTER 11
DDDEFINITIONEFINITIONEFINITION OFOFOF FFFOREXOREXOREX MMMARKETARKETARKET
FOREX is an acronym for foreign exchange, the marketplace where one country's cur-
rency is exchanged for that of another. FOREX is the world's largest and most liquid
financial market, where the average DAILY volume is estimated to range between $1.5
TRILLION AND $2 TRILLION per day. Compare this to the total average value of ALL equity trad-
ing world wide at $25 billion daily.
FOREX is not a market in the traditional sense, as there is no central exchange. Instead, the
entire market is run electronically through a floating exchange-rate system within a network of
foreign exchange banks. This market operates 24 hours a day, five days per week, opening Sunday
at 5pm (EST) and closing Friday afternoon at 4:30pm (EST).
A BA BA BRIEFRIEFRIEF HHHISTORYISTORYISTORY OFOFOF FFFOREIGNOREIGNOREIGN EEEXCHANGEXCHANGEXCHANGE
The practice of exchanging currencies among different issuing bodies dates back to ancient
times when traders first began trading coins from different countries and groups. However, as an
organized entity, FOREX itself is the newest financial market.
The Bretton Woods AccordThe Bretton Woods AccordThe Bretton Woods Accord
FOREX has undergone dramatic transformations in the last half century. In 1944, the postwar
foreign exchange system was established as a result of a multinational conference held at Bretton
Woods, New Hampshire and culminated in the adoption of the Bretton Woods Accord, which
served as the operating blueprint for foreign exchange for the next three decades.
At this conference, representatives from 45 nations met to discuss the future exchange sys-
tem. The conference established the International Bank for Reconstruction (now called the
World Bank) and the International Monetary Fund (IMF). It also produced an agreement that
fixed currencies in an exchange-rate system which would tolerate currency fluctuations of one per-
cent compared to gold values, or to the U.S. Dollar, which was established previously as the "gold
standard." The system of connecting the currency's value to gold or the U.S. Dollar was called
PEGGING.
10. 2
Although it succeeded in achieving its original goal — returning economic stability to post-war
Japan and Europe — the Bretton Woods Accord collapsed in 1971, the result of dramatically un-
controllable currency rate fluctuations. This started a chain of events and regulatory reactions in-
tended to control international currency fluctuations. Among the more noteworthy of these were
the Smithsonian Agreement the European Joint Float.
Formation of the Group of Ten (G10).Formation of the Group of Ten (G10).Formation of the Group of Ten (G10).
A subset of the International Monetary Fund, the G10 includes the United States, Japan, the
United Kingdom, Germany, France, Belgium, the Netherlands, Italy, Sweden, and Canada — the
ten largest trading member of the IMF. Switzerland, although not the eleventh largest IMF mem-
ber, is an adjunct member of the G10. The Group of Ten is an ad hoc body, meeting only when
required. It participates in the allocation of major loans from the IMF, and functions as a mediat-
ing body of the Bank for International Settlements.
Smithsonian AgreementSmithsonian AgreementSmithsonian Agreement
In December 1971, after when it had become
clear that the Bretton Woods Accord’s system of
fixed exchange rates was no longer effective, the
Group of Ten met at the Smithsonian Institution in
Washington, D.C. The Smithsonian agreement was
similar to the Bretton Woods Accord, but allowed
for greater deviation in currency values. The most
significant outcome of the Agreement was the deci-
sion by the G10 to devalue the US dollar against
gold and against most other currencies.
But devaluation of the US dollar brought only
short-lived corrections. In took only a matter of
months for a number of nations to decide to aban-
don fixed exchange rates, allowing their currencies to
float.
European Joint FloatEuropean Joint FloatEuropean Joint Float
In 1972, in an effort to reduce its dependency on
the dollar, several members of the European commu-
nity met to form an accord beyond the scope of
Smithsonian Agreement . This resulted in the crea-
tion of European Joint Float by Belgium, France,
Foreign Exchange Chronology
1944
Bretton Woods Accord is established
to stabilize global economy after
World War II.
1971
Bretton Woods Accord breaks down
under market pressures. Smithsonian
Agreement allows for greater ex-
change fluctuations.
1972
European Joint Float attempts to
break European dependency on U.S.
dollar.
1973
Smithsonian Agreement and Europe-
an Joint Float fail; market forces drive
toward free-floating system .
1978
European Monetary System attempts
to allow greater independence from
the U.S. dollar.
1978
Free-floating system mandated by
IMF
1993
European Monetary System aban-
doned; market forces drive switch to
world-wide free-floating system.
1998
Forex market trading available to
average investor.
11. 3
Germany, Italy, the Netherlands, and Luxemburg. Like the Smithsonian Agreement, the Europe-
an Joint Float attempted to bring stability to foreign exchange, but did so by simply allowing a
greater range of fluctuation in currency values. In 1973, the gold standard for the U.S. dollar was
abandoned under U.S. President Richard Nixon’s administration.
The Bretton Woods Accord, the Smithsonian Agreement, and the European Joint Float were
all based on what are today known as the uncontrollable forces of supply and demand. Ultimate-
ly, market forces will preside, and, in 1973 Smithsonian Agreement and the European Joint Float
collapsed, just as the Bretton Woods Accord did in 1971. Currency market forces drove the
world’s economies to switch to a free-floating system. This happened by the natural forces of eco-
nomics; no new agreements set currencies to freely float against each other. In 1978, the free-
floating system was officially mandated. Each nation was now were free to peg, semipeg, or free-
float their currencies
To Peg or Not to PegTo Peg or Not to PegTo Peg or Not to Peg
PEGGED: Some smaller economies have attached their currencies to larger economies with
which they hold close economic liaisons. For instance, many Caribbean nations, such as Jamaica,
have pegged their currencies to the U.S. Dollar.
SEMIPEGGED: Semipegged currencies have disappeared since 1993. A perfect example of semi-
pegging would be the currencies of the European Monetary System (EMS). Those currencies
would only be allowed to fluctuate within 2.25 percent or, exceptionally, within 6 percent inter-
vention bands. Following the foreign exchange crisis of 1993, the new EMS intervention rates
were expanded to 15 percent. Semipegging would have a slowing-down effect on currencies when
they were reaching the extreme values allowed within the range. Since 1999, the semipegged cur-
rencies of the EMS were switched to fully pegged values that form the Euro.
FREE-FLOATING: When the major currencies are free-floating, such as the U.S. Dollar, they
move independently of other currencies. The value of the currency is determined purely by sup-
ply and demand, which has no specific intervention point that has to be observed, and can be
traded by anybody so inclined. Free-floating currencies are in the heaviest trading demand.
The FOREX market became available to the average investor in 1998. It is now one of the fast-
est growing markets in the world, with daily volumes nearly 100 times that of all the world’s stock
markets combined.
12. 4
FOREX CFOREX CFOREX CURRENCYURRENCYURRENCY TTTRADINGRADINGRADING
The FOREX trades currency pairs, which offers equal risk for short and long positions due to
one of the currencies always having a bull side. For example, entering a long position on EUR/
USD means going long on the Euro (EUR) and short on the US Dollar (USD), and it works the
same way entering a short position on EUR/USD, which means actually going short on the Euro
and long on the US Dollar.
In the currency pair, the first currency symbol is known as the Base Currency – this is always
the dominant of the two symbols, and drives the direction of a trade. The second symbol is called
the Cross Currency – which fluctuates in exchange rate value compared to the Base Currency.
For example, with the EUR/USD pair, the Euro is the Base Currency and the US Dollar is
the Cross Currency. If the Base Currency is stronger in value than the Cross Currency, the trade
will have an upward trend for a specific time interval. Conversely, a downward trend would be
indicated if the Base Currency is weaker than the Cross Currency.
There are six major currency pairs, and trading in these pairs accounts for more than eighty
percent of all FOREX transactions:
€ EUR/USD Euro vs. US Dollar $US
$US USD/CHF US Dollar vs. Swiss Franc CH₣
£ GBP/USD British Pound vs. US Dollar $US
$US USD/JPY US Dollar vs. Japanese Yen ¥
$US USD/CAD US Dollar vs. Canadian Dollar $CAD
$AUD AUD/USD Australian Dollar vs. US Dollar $US
13. 5
MMMAJORAJORAJOR NNNAMESAMESAMES INININ FOREX NFOREX NFOREX NEWSEWSEWS
Major FOREX participants include commercial and investment banks and central banks.
Other participants include corporations, hedge funds, and millions of traders worldwide. The top
seven banks that provide liquidity in this market include Bank of America, Credit Suisse, First
Boston, Goldman Sachs, HSBC, J.P. Morgan, Morgan Stanley, Dean Witter, and UBS Warburg.
Bank of America reported in its 2002 annual report a $530 million profit
from foreign exchange trading revenue under "Global Investment Income".
Meanwhile, it reported only a $384 million profit from trading stocks, and an $86 million profit
from commodities trading.
It is not uncommon for a large bank to trade billions of dollars daily. Some of this trading
activity is done on behalf of corporate customers, however bank dealers are performing a large
amount of trading to make the bank profits. The financial statements of a majority of banks
throughout the U.S. will denote income received from foreign exchange trading.
The commercial companies' international trade exposure is the backbone of the foreign ex-
change market. Companies such as Siemens, Nestle, Toyota, BP Amoco, Volkswagen, Intel, Dell
Computers, Dow Chemicals, Monsanto, Merck Pharmaceuticals, Smith-Kline, Beckman,
Lufthansa, Caterpillar, Union Carbide and Kodak have traded or continue to trade heavily in
foreign currencies. Most of these companies established in-house trading facilities or subsidiaries
to manage their currency trading.
Caterpillar established its special currency management group back in 1986, when
it reported a $100 million profit on foreign exchange that turned its $24 million
operating loss into a $76 million profit for that year.
DaimlerChrysler threw itself into major investment headlines in late 2003 when it
acknowledged that more than half of its 2Q 2003 operating profit was generated by
currency trades - making more money on foreign exchange than in sell-
ing cars. The car maker reported quarterly operating profit of €641 million ($1 bil-
lion), beating some analysts estimates. The company says approximately €350 million
of this profit was generated in foreign exchange.
In a recent interview, Warren Buffet, perhaps the most suc-
cessful investor in history and Chairman of Berkshire Hatha-
way, Inc., stated "Through the spring of 2002, I had lived nearly 72 years without purchasing a
foreign currency. Since then Berkshire has made significant investments in — and today holds —
several currencies."
14. 6
George Soros, the hedge-fund manager who made trading history in
1992 by trading successfully against the British pound, disclosed in
2003 that he had taken a short position against the dollar, betting that
it would decline in value against the Euro, Canadian Dollar and Aus-
tralian Dollar. His statement would have made a huge impact ten years
ago, when hedge funds had the potential to significantly influence the
value of important international currencies. In fact, in 1992 Soros
made an estimated $1 billion profit by helping push the British pound
out of the European Exchange Rate Mechanism, earning him the
name "the man who broke the bank of England."
The foreign currency exchange is a much different animal today, as economies are far more
interconnected and currency markets are far more liquid and active. The estimated $2 trillion
traded daily currently is several times the size of the daily trade in 1993. These days, “exchange
rates are effectively set by American Backpackers, or Italian tourists getting dollars at Disneyland, or Nokia
selling phone equipment to China Telecom, or Coca-Cola selling syrup to a South African bottler, or Daimler
buying Chrysler, or Intel paying firms to construct a facility in Taiwan – in fact by the interaction of all
these forces. The unfathomably immense number of cross-border transactions, investments, and exchanges
now affects currencies far more than any single trader can.” — Daniel Gross, as written in his
“Moneybox” column.
AAADVANTAGESDVANTAGESDVANTAGES TOTOTO TTTRADINGRADINGRADING FFFOREXOREXOREX
The spot market, unlike the futures market, does not have time value associated with it; there-
fore, there are no deltas, thetas or intrinsic value to consider. The leverage is very attractive to
many investors as it is generally 50:1, although there are some FOREX brokers who offer 100:1.
Commissions are eliminated in most cases, as the investor trades directly with dealers. Many
brokers in foreign exchange will make money on the spread between the bid and ask, rather than
charging direct commissions.
Because the FOREX market is open continuously, 24 hours a day — from Sunday evening to
Friday afternoon, it doesn't see the gaps up or down that are typically seen at the open or close of
the stock market; investors don't have to worry about their stop limits being skipped.
And, unlike stock markets, FOREX trading is not concerned with the possibility of companies
posting false information, or money managers or so-called experts offering biased, self-serving
opinions. Such activities simply will not have a material impact on a country's currency.
Of course, a trader can suffer losses should the market turn against him. This is a key reason
why money management skills are taught as part of the FXGW training system.
15. 7
RRREGULATIONSEGULATIONSEGULATIONS
After the FOREX market opened to the public as an investment option and as its popularity
began to increase, the Commodity Futures Trading Commission (CFTC) and National Futures
Association (NFA) stepped in to monitor the FOREX market. The CFTC and NFA increased
registration requirements and provide a high degree of regulation, adding stability to the market
and giving investors more confidence in trading FOREX.
IIINDUSTRYNDUSTRYNDUSTRY FFFEEDBACKEEDBACKEEDBACK
Since FOREX is a highly liquid investment and it is a viable option to the scandal-ridden
stock market, more individual investors take up trading FOREX every day. With the advent of
software tools and proper training, these investors are making independent and highly empow-
ered trading decisions.
FOREX trading firms are increasing their emphasis on customer service and offering educa-
tional seminars, chat sessions and new technologies such as wireless trading. Plus, firms are con-
tinually enhancing their software and user interfaces to meet the changing needs of traders as
they become more sophisticated. The best FOREX trading software has all the bells and whistles
of a good direct-access equity-trading platform. The FOREX industry is growing, and growth is
the engine of innovation.
MMMARKETARKETARKET HHHOURSOURSOURS
The FOREX market is not only global, it is an around
the clock market. A major currency exchange is trading
somewhere in the world 24 hours a, five days per week.
16. 8
Most of the world uses a 24 hour clock (also called military time). The United States is the
major exception. Below is a chart correlating 12-hour (AM/PM) to 24 hour time.
TIME ZONE US (EST) LONDON TOKYO GMT
Tokyo Open 1900 0000 0900 0000
Tokyo Close 0400 0900 1800 0900
London Open 0300 0800 1700 0800
London Close 1200 1700 1400 1700
NY Open 0800 1300 2200 1300
NY Close 1700 2200 0700 2200
12-HOUR CLOCK 24-HOUR CLOCK
12:00 Midnight 0000
1:00 A.M. 0100
2:00 A.M. 0200
3:00 A.M. 0300
4:00 A.M. 0400
5:00 A.M. 0500
6:00 A.M. 0600
7:00 A.M. 0700
8:00 A.M. 0800
9:00 A.M. 0900
10:00 A.M. 1000
11:00 A.M. 1100
12-HOUR CLOCK 24-HOUR CLOCK
12:00 Noon 1200
1:00 P.M. 1300
2:00 P.M. 1400
3:00 P.M. 1500
4:00 P.M. 1600
5:00 P.M. 1700
6:00 P.M. 1800
7:00 P.M. 1900
8:00 P.M. 2000
9:00 P.M. 2100
10:00 P.M. 2200
11:00 P.M. 2300
17. 9
WWWHATHATHAT MMMOVESOVESOVES TTTHEHEHE MMMARKETARKETARKET
There are two major ways to analyze financial markets: fundamental analysis and tech-
nical analysis. Fundamental analysis is based upon underlying economic conditions,
while technical analysis uses historical prices to predict future movements. There is
an ongoing debate as to which methodology is more successful. Short-term traders prefer to use
technical analysis, focusing their strategies primarily on price action, while fundamental traders
focus their efforts on determining a currency's proper valuation, as well as future valuation.
It is important to take into consideration both strategies, as fundamental analysis can explain
technical analysis movements such as breakouts or trend reversals. Technical analysis can explain
fundamental analysis, especially in quiet markets, causing resistance in trends or unexplainable
movements.
Fundamental AnalysisFundamental AnalysisFundamental Analysis
There are two main factors that impact exchange rate movement from a fundamental perspec-
tive: capital flows and trade flows. Both of these components constitute a country's balance of
payments. The balance of payments quantifies the amount of demand for a currency over a given
period of time.
Capital FlowsCapital FlowsCapital Flows
Capital flows measure the net amount of a currency that is being purchased or sold due to
capital investments. A positive capital flow balance implies that foreign inflows of physical or
portfolio investments into a country exceed outflows. A negative capital flow balance indicates
that there are more physical or portfolio investments bought by domestic investors than foreign
investors.
Capital flows can be classified into two categories - Physical Flows and Portfolio Flows:
CCHAPTERHAPTER 22
18. 10
Physical FlowsPhysical FlowsPhysical Flows
Physical flows of capital typically fall into one of three categories:
Foreign direct investment - constitutes an entirely new foreign investment
Joint ventures - a partnership between a foreign and a domestic entity
Third party licensing agreements - the purchase of patented software applications, busi-
ness processes, and brand names.
Physical flows are important to watch, as they represent the underlying changes in actual phys-
ical investment activity. These flows shift in response to changes in each country's financial health
and growth opportunities. Changes in local laws that encourage foreign investment also serve to
promote physical flows.
Portfolio FlowsPortfolio FlowsPortfolio Flows
Equity MarketsEquity MarketsEquity Markets
As technology enables greater ease with respect to the transfer of capital, investing in global
equities markets has become far more feasible. Accordingly, a rallying stock market in any part of
the world serves as an ideal opportunity for all investors, regardless of geographic location. As a
result, a strong correlation has developed between a country's equity markets and its currency. If
the equity market is rising, investment dollars are coming in to seize the opportunity. Alternative-
ly, falling equity markets will have domestic investors selling their shares of local publicly traded
firms only to seize investment opportunities abroad.
In terms of relative strength, historical evidence shows that the stronger the performance of a
country's equity market, the stronger its currency appreciation. A Relative Strength Index (not to
be confused with the Welles Wilder RSI – technical indicator) is just a numerical way see which
equity markets have performed the best over a given period time. A high RS (80-100) denotes
strong relative performance.
The attraction of the equities markets over fixed income markets has increased over the years.
Since the early 1990s, the ratio of foreign transactions in US government bonds relative to US
equities has declined from 10:1 to 2:1. As a result, currency traders closely follow the global equi-
ty markets to predict short and intermediate term equity based capital flows. The most commonly
watched stock indices are the Dow Jones Industrial Index (Dow), S&P 500, NASDAQ, NIKKEI,
DAX and FTSE.
Fixed Income MarketsFixed Income MarketsFixed Income Markets
Just as the equity market is correlated to exchange rate movement, the same holds true for the
fixed income market. In times of global uncertainty, fixed income investments can become partic-
19. 11
ularly appealing, due to the inherent safety they provide. As a result, economies boasting the most
valuable fixed income opportunities will attract a greater share of foreign investment and natural-
ly this will first require the purchase of the country's respective currency.
A good gauge of fixed income capital flows are the short and long-term yields of international
government bonds. It is important to monitor the spread differential between the yield on the 10-
year US Treasury note and that on foreign bonds. The logic behind this is that international in-
vestors tend to place their funds in countries with the highest yielding assets. Therefore, if US
assets have one of the highest yields, this would encourage more investments in US financial in-
struments, hence benefiting the USD. Investors can also use short-term yields such as the spreads
on 2-year government notes to gauge the short-term flow of international funds.
Trade Flows: Measuring Exports vs. ImportsTrade Flows: Measuring Exports vs. ImportsTrade Flows: Measuring Exports vs. Imports
Trade flow is the foundation of all international transactions. Just as the investment environ-
ment of any given economy determines its currency valuation, trade flows represent a country's
net trade balance. Countries that are net exporters, meaning they export more to international
clients than they import from international producers, will experience a net trade surplus. Coun-
tries with a net trade surplus are more likely to have their currency rise in value, since their cur-
rency is being bought more than it is sold due to a strong inherent demand for the currency for
trade purposes.
Countries that are net importers - meaning they make more international purchases than in-
ternational sales - experience what is known as a trade deficit, which has the potential to drive the
value of the currency down. In order to engage in international trade, importers must sell their
currency to purchase goods or services. Clearly a change in the balance of payments has a direct
effect on currency levels. Therefore, it is important for traders to keep abreast of economic data
relating to this balance and understand the implications of changes in the balance of payments.
TTTECHNICALECHNICALECHNICAL AAANALYSISNALYSISNALYSIS
Technicals vs. FundamentalsTechnicals vs. FundamentalsTechnicals vs. Fundamentals
FXGW believes that technical trading is preferred to fundamental trading when beginning
one’s currency trading experience. There are a number of reasons for this:
Technical trading can be taught and learned in a relatively short period of time. Once the
basic concept of technical trading are understood, the new trader can start practicing to use the
various technical indicators and applying them to his own specific trading system. Since the
FXGW system deals with numbers, the technical indicators deliver objective data. These data are
not based on emotion or personal feelings, but cold hard facts. Because these are dispassionate
20. 12
numerical data, those technical indicators which do not suit an individual trader’s style and per-
sonality can be abandoned. Further, a trader can change the parameters of his individual indica-
tors to work within the time frame he has chosen to trade.
Fundamental trading is another story. Naturally one cannot expect to learn, and more im-
portantly, to understand the fundamentals that move the market. Yes, there is always a funda-
mental reason which moves the market in a certain direction, but the timing of such moves is far
more difficult to predict. Fundamentalists and students of economics (namely macroeconomics)
study these principles for years; a new trader cannot be expected to grasp this amount of
knowledge in the time it takes to understand technical indicators and how to apply them. Even if
one has studied economics and has the theoretical knowledge of basic economic theory such as
interest rates, CPI (consumer price index), GDP (gross domestic product) this will not necessarily
help in the timing of a trade. It is not enough to know that raising interest rates should strength-
en a currency – it may well be that the “strengthening” expected has been discounted into that
particular currency’s price prior to the announcement . Again, timing is everything.
This is not to say that master traders like George Soros and Warren Buffet do not use their
fundamental skills to profit in their trading, but one must be realistic. These traders have so many
years of knowledge and experience behind them (to say nothing of extensive supporting staffs)
that it would be foolish to expect a novice trader to understand fundamentals in the same way. It
is simply unrealistic for a novice trader to learn and understand and apply the theoretical con-
struct of a technical indicator like “exponential moving averages” correctly. But it is reasonable to
expect the novice trader to be able to use an indicator like exponential moving averages to time a
trade. Just as one need not know or understand microwave theory to know that when the buzzer
sounds on a microwave oven it’s time to take the food out, one need not know how an indicator
is derived in order to use it to profit in FOREX.
When so-called experts give their predictions — whether based on fundamental or technical
analysis — it begs the question: “With all this knowledge, why are they not trading themselves?”
The answer to this should give the new trader a lot of comfort. It is not simply enough to
have theoretical knowledge. Trading is a psychological business; that is why it is difficult to be a
profitable trader. Having knowledge is very important. In fact, it is imperative. Yet theoretical
knowledge is not enough. Money management, risk tolerance and the psychology of trading is
what separates traders who profit from those who lose.
Fundamentals Give Us the WHYFundamentals Give Us the WHYFundamentals Give Us the WHY
Technicals Give Us the WHENTechnicals Give Us the WHENTechnicals Give Us the WHEN
21. 13
This is why the novice trader must be selective in choosing from whom he will learn his craft.
The knowledge required to be either a fundamental or technical trader is not proprietary infor-
mation. This information is generally in the public domain and freely available to any potential
trader.
Bearing this in mind, the novice trader should be extremely cautious of currency training
companies whose sole income is derived from teaching people to trade as opposed to earning
money from their own trading. FXGW is an example of the new paradigm: a firm whose primary
income is from its own trading and offers personalized training conducted by real traders trading
real money.
Mass psychology, fueled by the human emotions of fear and greed, is a main driver of curren-
cy price fluctuations. For the trader looking to take advantage of this volatility, perception is reali-
ty and technical analysis is really the only viable form of analysis reflecting this. Technical analysis
in its simplest form allows traders to integrate the psychology of past price action into current
analysis. Technical analysis allows speculators to get a better handle on the emotional extremes of
buyers and sellers and accurately directs them to levels where greed and fear are at their strongest.
Understanding how to spot these extremes through pattern recognition and indicator analysis
equips traders with a valuable edge that cannot be matched by any other methodology. Thus all
traders looking to profit from short term movements must develop a solid understanding and feel
for important technical concepts if they are to succeed as a short term forex trader.
Technical analysis examines past price performance to help determine potential price move-
ments. Technical analysis focuses primarily on the formation of charts and indicators to capture
major and minor trends, identify buying/selling opportunities, and assess the extent of market
reversals. Depending upon time horizon, traders can use technical analysis on an intraday (5-
minute, 15 minute, hourly), daily, weekly or monthly basis.
Important Technical Concepts in ForexImportant Technical Concepts in ForexImportant Technical Concepts in Forex
Different markets such as equities and futures tend to focus and place importance on very
different technical indicators. FOREX is no different and places more validity in a select group of
concepts. Some of the most widely used indicators in FOREX are:
Fibonacci Retracement LevelsFibonacci Retracement LevelsFibonacci Retracement Levels
This is a popular retracement series based on mathematical ratios arising from natural and
man-made phenomena. The Fibonacci series is series of numbers; each consisting of the sum of
the two preceding numbers. It begins: 1,1,2,3,5,8,13,21,34, (etc). The relationship between these
numbers occurs repeatedly. The ratio of two number which follow each other is always 0.618.
This is called the "golden ratio". If ratios are calculated using alternative numbers in the series,
the ratio will approach 0.382.
22. 14
These relationships are used to derive how far a price has rebounded or backtracked from its
underlying trend. This ability to predict swing areas in the market operates under the premise
that humans adopt a "herd mentality" and will react in a predictable manner, regardless of trend
direction and speculation of where the index should be. The most important retracement levels
are: 38.2%, 50% and 61.8%. For example, in technical analysis, a 38.2% retracement level is of-
ten interpreted as a continuation of a trend whereas a 61.8 % retracement may imply that a trend
change is occurring.
Moving AveragesMoving AveragesMoving Averages
For the trader who believes in the "trend-is-your-friend" tenet of technical analysis, moving
averages are very helpful. Moving averages tell the average price in a given point of time over a
defined period of time. They are called moving because they reflect the latest average, while ad-
hering to the same time measure.
The moving average however is a lagging indictor, so it does not necessarily signal a change in
trends. To address this issue, using a shorter period, such as five- or 10-day moving average, would
be more reflective of the recent price action than the 40 or 200-day moving averages.
Alternatively, moving averages may be used by combining two averages of distinct time-
frames. Whether using five- and 20-day MA, or 40 and 200-day MA, buy signals are usually detect-
ed when the shorter-term average crosses above the longer-term average. Conversely, sell signals
are suggested when the shorter average falls below the longer one.
One popular method of interpreting a moving average is to compare the relationship between
a moving average of the currency's exchange rate with the currency’s current price. A buy signal is
generated when the exchange rate rises above its moving average and a sell signal is generated
when the exchange rate falls below its moving average. This type of moving average trading system
is not intended to get the trader in at the exact bottom nor out at the exact top. Rather, it is de-
signed to keep the trader in line with the exchange rate trend by buying shortly after the exchange
rate bottoms and selling shortly after it tops.
There are three kinds of mathematically distinct moving averages: Simple MA; Linearly
Weighted MA; and Exponentially Smoothed MA .
Simple Moving Average (SMA)Simple Moving Average (SMA)Simple Moving Average (SMA)
A simple, or arithmetic, moving average is calculated as the sum of a predetermined number
of prices for a number of time periods, divided by the number of time periods. The result is the
average price over the time period. Simple moving averages apply equal weight to the prices.
23. 15
Exponentially Smoothed Moving Average (EMA)Exponentially Smoothed Moving Average (EMA)Exponentially Smoothed Moving Average (EMA)
An exponential (or exponentially weighted) moving average is calculated by applying a per-
centage of today's closing price to yesterday's moving average value. It is the preferred one because
it assigns greater weight for the most recent data, and considers data in the entire life of the in-
strument. Naturally the older the price becomes, the less weight it is assigned.
OscillatorsOscillatorsOscillators
As the market gyrates, prices tend to overshoot, or overextend. Oscillators are derived from
the underlying currency to provide signals regarding these overbought and oversold conditions.
They are very useful especially during trading ranges or at the beginning of new trends.
THE THREE MOST IMPORTANT RULES WHEN APPLYING OSCILLATORS INCLUDE:
The signals are most useful at the extremes of their scales.
Crossings of the equilibrium line and crossings between oscillator lines usually generate
direction signals
Warnings and/or signals are triggered when a divergence occurs between the price of the
underlying currency and the oscillator.
Moving Average Convergence DivergenceMoving Average Convergence DivergenceMoving Average Convergence Divergence
Moving Average Convergence Divergence (MACD) uses moving averages, defined previously
as lagging indicators, but converts moving averages into momentum oscillators by plotting the
difference between longer moving averages and shorter moving averages. The resulting candle-
stick oscillates above and below zero.
With MACD, shorter term moving averages will produce faster responding indicators. Con-
versely, longer-term MAs produce slower indicators.
Since MACD charts the difference between two moving averages — a fast one and a slow one
— a positive MACD indicates that faster EMA is trading above the slower EMA. A negative
MACD indicates that the faster EMA is trading below the slower EMA. If MACD is positive and
rising, then the difference between the faster EMA and the slower one is expanding. In this case,
the faster moving average is changing at a faster rate than the slow one, which would indicate pos-
itive (bullish) momentum. A negative MACD that continues to decline indicates that the negative
gap between the faster MA and the slower one is expanding, indicating negative (bearish) momen-
tum. MACD centerline crossovers occur when the faster MA crosses the slower MA.
Candlestick AnalysisCandlestick AnalysisCandlestick Analysis
Candlestick trading's primary purpose is to determine current market psychology through the
use of pattern recognition. Candlestick traders believe that candlestick's easy to read color depic-
24. 16
tion of price action gives traders a better explanation into market psychology and price action and
thus make it a better indicator in determining short-term market fluctuations. Candlestick bars
are composed of a currency pair's open, high, low and close. The body of the candlestick repre-
sents the difference between the open and the close and will be shaded blue if price closed up
and red if price closed down. Wicks depict the high and low of the respective time period.
Bollinger BandsBollinger BandsBollinger Bands
A volatility based indicator using moving average envelopes, which incorporate a stastical
component. The statistical side of the indicator incorporates two standard deviations, which in
statistical theory implies that 95% of price movement should be contained within the two bands.
This also makes the bands self-adjusting to changing market conditions. The indicator is most
commonly displayed with two bands (at standard deviation levels) and a 20 period moving aver-
age over the underlying currency pair but it is not unusual to see it on a chart as a stand alone
indicator.
Relative Strength Index (RSI)Relative Strength Index (RSI)Relative Strength Index (RSI)
Developed by J. Welles Wilder and introduced in his 1978 book, New Concepts in Technical
Trading Systems, the Relative Strength Index (RSI) is an extremely useful and popular momentum
oscillator. The RSI compares the magnitude of recent gains to the magnitude of recent losses
and turns that information into a number that ranges from 0 to 100. It takes a single parameter,
the number of time periods to use in the calculation. In his book, Wilder recommends using 14
periods.
The RSI's full name is actually rather unfortunate as it is easily confused with other forms of
Relative Strength analysis such as John Murphy's "Relative Strength" charts and IBD's "Relative
Strength" rankings. Most other kinds of "Relative Strength" stuff involve using more than one
stock in the calculation. Like most true indicators, the RSI only needs one stock to be computed.
In order to avoid confusion, many people avoid using the RSI's full name and just call it “the
RSI.”
RSI UsesRSI UsesRSI Uses
Overbought/OversoldOverbought/OversoldOverbought/Oversold
Wilder recommended using 70 and 30 and overbought and oversold levels respectively. Gen-
erally, if the RSI rises above 30 it is considered bullish for the underlying stock. Conversely, if the
RSI falls below 70, it is a bearish signal. Some traders identify the long-term trend and then use
extreme readings for entry points. If the long-term trend is bullish, then oversold readings could
mark potential entry points.
25. 17
DivergencesDivergencesDivergences
Buy and sell signals can also be generated by looking for positive and negative divergences be-
tween the RSI and the underlying price of the currency. For example, consider a falling price
whose RSI rises from a low point of (for example) 15 back up to say, 55. Because of how the RSI
is constructed, the underlying currency will often reverse its direction soon after such a diver-
gence. As in that example, divergences that occur after an overbought or oversold reading usually
provide more reliable signals.
Centerline CrossoverCenterline CrossoverCenterline Crossover
The centerline for RSI is 50. Readings above and below can give the indicator a bullish or
bearish tilt. On the whole, a reading above 50 indicates that average gains are higher than average
losses and a reading below 50 indicates that losses are winning the battle. Some traders look for a
move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.
CCCANDLESTICKSANDLESTICKSANDLESTICKS
Candlestick AnalysisCandlestick AnalysisCandlestick Analysis
Candlestick trading’s primary purpose is to determine current market psychology through the
use of pattern recognition. Candlesticks’ easy-to-read color depiction of price movement gives
traders better explanation into market psychology and price action, making candlesticks an effi-
cient indicator for determining short-term market fluctuations. Candlestick bars are composed of
a currency pair's open, high, low and close. The body of the candlestick represents the difference
between the open and the close and will be shaded blue or green if its price closed up and red or
black if its price closed down. Wicks depict the high and low of the respective time period.
HistoryHistoryHistory
The Japanese began using technical analysis to trade rice in the 17th century. While this early
version of technical analysis may have been different from the US version initiated by Charles
Dow around 1900, many of the guiding principles were very similar.
The "what" (price action) is more important than the "why" (news, earnings, and so on).
All known information is reflected in the price.
Buyers and sellers move markets based on expectations and emotions (fear and greed).
Markets fluctuate.
The actual price may not reflect the underlying value.
According to Steve Nison, candlestick charting came later and probably began sometime after
1850. Much of the credit for candlestick development and charting goes to Homma, a legendary
26. 18
rice trader from Sakata. Even though it is not exactly clear "who" created candlesticks, Nison
notes that they likely resulted from a collective effort developed over many years of trading.
FormationFormationFormation
Candlesticks are formed using the open, high, low and close. Without opening prices, candle-
stick charts are impossible to draw. If the close is above the open, then a hollow candlestick
(usually displayed as blue) is drawn. If the close is below the open, then a filled candlestick
(usually displayed as red) is drawn. The hollow or filled portion of the candlestick is called the
body (also referred to as the "real body"). The long thin lines above and below the body represent
the high/low range and are called shadows (also referred to as wicks and tails). The high is
marked by the top of the upper shadow and the low by the bottom of the lower shadow.
Compared to traditional bar charts, many traders consider candlestick charts more visually
appealing and easier to interpret. Each candlestick provides an easy-to-decipher picture of price
action. Immediately a trader can see the relation-
ship between the open and close as well as the
high and low. The relationship between the open
and close is considered vital information and
forms the essence of candlesticks. Blue candle-
sticks, where the close is greater than the open,
indicate buying pressure. Red candlesticks, where
the close is less than the open, indicate selling
pressure.
Long vs. Short BodiesLong vs. Short BodiesLong vs. Short Bodies
Generally speaking, the longer the body is, the
more intense the buying or selling pressure. Conversely, short candlesticks indicate little price
movement and represent consolidation.
Long blue candlesticks show strong buying
pressure. The longer the blue candlestick is, the
further the close is above the open. This indicates
that prices advanced significantly from open to
close and buyers were aggressive. While long blue
candlesticks are generally bullish, much depends
on their position within the broader technical pic-
ture. After extended declines, long blue candle-
sticks can mark a potential turning point or sup-
port level. If buying gets too aggressive after a long
advance, it can lead to excessive bullishness.
Anatomy of a Candlestick
Open
Close
Open
Close
High
Low
Long vs. Short
27. 19
Long red candlesticks show strong selling pressure. The longer the red candlestick is, the fur-
ther the close is below the open. This indicates that prices declined significantly from the open
and sellers were aggressive. After a long advance, a long red candlestick can foreshadow a turning
point or mark a future resistance level. After a long decline a long red candlestick can indicate
panic or capitulation
Even more potent long candlesticks are the Marubozu brothers, red and blue. Marubozu do
not have upper or lower shadows and the high and low are represented by the open or close. A
blue Marubozu forms when the open equals the low and the close equals the high. This indicates
that buyers controlled the price action from the first trade to the last trade. Red Marubozu form
when the open equals the high and the close equals the low. This indicates that sellers controlled
the price action from the first trade to the last
trade.
Long vs. Short ShadowsLong vs. Short ShadowsLong vs. Short Shadows
The upper and lower shadows on candlesticks can
provide valuable information about the trading
session. Upper shadows represent the session high
and lower shadows the session low. Candlesticks
with short shadows indicate that most of the trad-
ing action was confined near the open and close.
Candlestick with long shadows show that trading
extended well past the open and close.
Candlesticks with a long upper shadow and short
lower shadow indicate that buyers dominated dur-
ing the session and bid prices higher. However,
sellers later forced prices down off of their highs
and the weak close created a long upper shadow.
Conversely, candlesticks with long lower shadows
and short upper shadows indicate that sellers
dominated during the session and drove prices
lower. However, buyers later resurfaced to bid
prices higher by the end of the session and the
strong close created a long lower shadow.
Candlesticks’ color depiction gives traders insight into market psychologyCandlesticks’ color depiction gives traders insight into market psychologyCandlesticks’ color depiction gives traders insight into market psychology
and price action helping to determine shortand price action helping to determine shortand price action helping to determine short---term market fluctuations.term market fluctuations.term market fluctuations.
Long Shadows
Long Upper
Shadow
Long Lower
Shadow
Morubozu
28. 20
Candlesticks with a long upper shadow,
long lower shadow and small real body are
called spinning tops. One long shadow repre-
sents a reversal of sorts; spinning tops represent
indecision. The small real body (whether hollow
or filled) shows little movement from open to
close, and the shadows indicate that both bulls
and bears were active during the session. Even
though the session opened and closed with little
change, prices moved significantly higher and
lower in the mean time. Neither buyers nor
sellers could gain the upper hand and the result
was a standoff. After a long advance or long
blue candlestick, a spinning top indicates weak-
ness among the bulls and a potential change or
interruption in trend. After a long decline or
long red candlestick, a spinning top indicates
weakness among the bears and a potential
change or interruption in trend.
DojiDojiDoji
Doji are important candlesticks that provide
information on their own and also feature in a
number of important patterns. Doji form when
a pairs open and close are virtually equal. The
length of the upper and lower shadows can vary
and the resulting candlestick looks like a cross,
inverted cross or plus sign. Alone, doji are neu-
tral patterns. Any bullish or bearish bias is
based on preceding price action and future con-
firmation. The word "Doji" refers to both the
singular and plural form. Ideally, but not neces-
sarily, the open and close should be equal.
While a doji with an equal open and close
would be considered more robust, it is more
important to capture the essence of the candle-
stick. Doji convey a sense of indecision or tug-of
-war between buyers and sellers. Prices move
Spinning Tops
Doji
Doji
29. 21
above and below the opening level during the session, but close at or near the opening level. The
result is a standoff. Neither bulls nor bears were able to gain control and a turning point could be
developing.
Determining the robustness of the doji will depend on the price, recent volatility and previ-
ous candlesticks. Relative to previous candlesticks, the doji should have a very small body that
appears as a thin line. Steven Nison notes that a doji that forms among other candlesticks with
small real bodies would not be considered important. However, a doji that forms among candle-
sticks with long real bodies would be deemed significant.
Doji and TrendDoji and TrendDoji and Trend
The relevance of a doji depends on the preceding trend or preceding candlesticks. After an
advance, or long blue candlestick, a doji signals that the buying pressure is starting to weaken.
After a decline, or long red candlestick, a doji signals that selling pressure is starting to diminish.
Doji indicate that the forces of supply and demand are becoming more evenly matched and a
change in trend may be near. Doji alone are not enough to mark a reversal and further confirma-
tion may be warranted.
After an advance or long blue candlestick, a doji
signals that buying pressure may be diminishing and
the uptrend could be nearing an end. Therefore, a
doji may be more significant after an uptrend or
long blue candlestick. Even after the doji forms, fur-
ther downside is required for bearish confirmation.
This may come as a gap down, long red candlestick,
or decline below the long blue candlestick's open.
After a long blue candlestick and doji, traders
should be on the alert for a potential evening doji
star.
After a decline or long red candlestick, a doji indi-
cates that selling pressure may be diminishing and
the downtrend could be nearing an end. Even
though the bears are starting to lose control of the
decline, further strength is required to confirm any
reversal. Bullish confirmation could come from a
gap up, long blue candlestick or advance above the
long red candlestick's open. After a long red candle-
stick and doji, traders should be on the alert for a
potential morning doji star.
Long Red Candle Plus Doji
Long Blue Candle Plus Doji
30. 22
LongLongLong---legged Dojilegged Dojilegged Doji
Long-legged doji have long upper and lower
shadows that are almost equal in length. These doji
reflect a great amount of indecision in the market.
Long-legged doji indicate that prices traded well
above and below the session's opening level, but
closed virtually even with the open. After a whole lot
of yelling and screaming, the end result showed little
change from the initial open.
Dragon Fly DojiDragon Fly DojiDragon Fly Doji
Dragon fly doji form when the open, high and close are equal and the low creates a long low-
er shadow. The resulting candlestick looks like a "T" with a long lower shadow and no upper
shadow. Dragon fly doji indicate that sellers dominated trading and drove prices lower during the
session. By the end of the session, buyers resurfaced
and pushed prices back to the opening level and the
session high.
The reversal implications of a dragon fly doji de-
pend on previous price action and future confirma-
tion. The long lower shadow provides evidence of
buying pressure, but the low indicates that plenty of
sellers still loom. After a long downtrend, long red
candlestick or at support, a dragon fly doji could sig-
nal a potential bullish reversal or bottom. After a
long uptrend, long blue candlestick or at resistance,
the long lower shadow could foreshadow a potential
bearish reversal or top. Bearish or bullish confirma-
tion is required for both situations.
Gravestone DojiGravestone DojiGravestone Doji
Gravestone doji form when the open, low and
close are equal and the high creates a long upper
shadow. The resulting candlestick looks like an up-
side down "T" with a long upper shadow and no low-
er shadow. Gravestone doji indicate that buyers
dominated trading and drove prices higher during
Long-Legged Doji
Dragon Fly Doji
Gravestone Doji
31. 23
the session. However, by the end of the session, sellers resurfaced and pushed prices back to the
opening level and the session low.
As with the dragon fly doji and other candlesticks, the reversal implications of gravestone doji
depend on previous price action and future confirmation. Even though the long upper shadow
indicates a failed rally, the intraday high provides evidence of some buying pressure. After a long
downtrend, long red candlestick or at support, focus turns to the evidence of buying pressure and
a potential bullish reversal. After a long uptrend, long blue candlestick or at resistance, focus
turns to the failed rally and a potential bearish reversal. Bearish or bullish confirmation is re-
quired for both situations.
Before turning to the single and multiple candlestick patterns, there are a few general guide-
lines to cover.
Prior TrendPrior TrendPrior Trend
In his book, Candlestick Charting Explained, Greg Morris notes that for a pattern to qualify as a
reversal pattern, there should be a prior trend to reverse. Bullish reversals require a preceding
downtrend and bearish reversals require a prior uptrend. The direction of the trend can be deter-
mined using trend lines, moving averages, peak/trough analysis or other aspects of technical anal-
ysis. A downtrend might exist as long as the pair was trading below its down trend line, below its
previous reaction high or below a specific moving average. The length and duration will depend
on individual preferences. However, because candlesticks are short-term in nature, it is usually
best to consider the last 1-4 weeks of price action.
32. 24
Star PositionStar PositionStar Position
A candlestick that gaps away from the previ-
ous candlestick is said to be in star position.
The first candlestick usually has a large real
body, but not always, and the second candle-
stick in star position has a small real body. De-
pending on the previous candlestick, the star
position candlestick gaps up or down and ap-
pears isolated from previous price action. The
two candlesticks can be any combination of
blue and red. Doji, hammers, shooting stars
and spinning tops have small real bodies and
can form in the star position.
Harami PositionHarami PositionHarami Position
A candlestick that forms within the real
body of the previous candlestick is in Harami
position. Harami means pregnant in Japanese
and the second candlestick is nestled inside the
first. The first candlestick usually has a large real
body and the second a smaller real body than
the first. The shadows (high/low) of the second
candlestick do not have to be contained within
the first, though it's preferable if they are. Doji
and spinning tops have small real bodies and
can form in the Harami position as well.
CCCANDLESTICKANDLESTICKANDLESTICK PPPOSITIONINGOSITIONINGOSITIONING
Star Position
Harami Position
33. 25
Long Shadow ReversalsLong Shadow ReversalsLong Shadow Reversals
There are two pair of single candlestick reversal patterns made up of a small real body, one
long shadow and one short or non-existent shadow. Generally, the long shadow should be at least
twice the length of the real body, which can be either red or blue. The location of the long shad-
ow and preceding price action determine the classification.
The first pair, hammer and hanging man, are identical with small bodies and long lower shad-
ows. The second pair, shooting star and inverted hammer, are also identical with small bodies
and long upper shadows. Only preceding price action and further confirmation determine the
bullish or bearish nature of these candlesticks. The hammer and inverted hammer form after a
decline and are bullish reversal patterns, while the shooting star and hanging man form after an
advance and are bearish reversal patterns.
Hammer and Hanging ManHammer and Hanging ManHammer and Hanging Man
The hammer and hanging man look exactly alike,
but have different implications based on the pre-
ceding price action. Both have small real bodies
(red or blue), long lower shadows and short or
non-existent upper shadows. As with most single
and double candlestick formations, the hammer
and hanging man require confirmation before
action.
The hammer is a bullish reversal pattern that
forms after a decline. In addition to a potential
trend reversal, hammers can mark bottoms or sup-
port levels. After a decline, hammers signal a bull-
ish revival. The low of the long lower shadow im-
plies that sellers drove prices lower during the ses-
sion. However, the strong finish indicates that
buyers regained their footing and the session end-
ed strong. While this may seem like enough to act
on, hammers require further bullish confirma-
tion. The low of the hammer shows that plenty of
sellers remain. Further buying pressure, and pref-
erably on expanding volume, is needed before act-
ing. Such confirmation could come from a gap up
or long blue candlestick. Hammers are similar to
Hammer
Hanging ManHammer
34. 26
selling climaxes and heavy volume can serve to
reinforce the validity of the reversal.
The hanging man is a bearish reversal pattern
that can also mark a top or resistance level. Form-
ing after an advance, a hanging man signals that
selling pressure is starting to increase. The low of
the long lower shadow confirms that sellers
pushed prices lower during the session. Even
though the bulls regained their footing and drove
prices higher by the finish, the appearance of sell-
ing pressure raises the yellow flag. As with the
hammer, a hanging man requires bearish confir-
mation before action. Such confirmation can
come as a gap down or long red candlestick on
heavy volume.
Inverted Hammer and Shooting StarInverted Hammer and Shooting StarInverted Hammer and Shooting Star
The inverted hammer and shooting star look
exactly alike, but have different implications based
on previous price action. Both candlesticks have
small real bodies (red or blue), long upper shad-
ows and small or non-existent lower shadows.
These candlesticks mark potential trend reversals,
but require confirmation before action.
The shooting star is a bearish reversal pattern
that forms after an advance and in the star posi-
tion, hence its name. A shooting star can mark a
potential trend reversal or resistance level. The
candlestick forms when prices gap higher on the
open, advance during the session and close well
off their highs. The resulting candlestick has a
long upper shadow and small red or blue body.
After a large advance (the upper shadow), the abil-
ity of the bears to force prices down raises the yel-
low flag. To indicate a substantial reversal, the up-
per shadow should relatively long and at least 2
times the length of the body. Bearish confirma-
Hanging Man
Inverted
Hammer
Shooting Star
Inverted Hammer
35. 27
tion is required after the shooting star and can
take the form of a gap down or long red can-
dlestick on heavy volume.
The inverted hammer looks exactly like a
shooting star, but forms after a decline or
downtrend. Inverted hammers represent a
potential trend reversal or support levels. Af-
ter a decline, the long upper shadow indicates
buying pressure during the session. However,
the bulls were not able to sustain this buying
pressure and prices closed well off of their
highs to create the long upper shadow. Be-
cause of this failure, bullish confirmation is
required before action. An inverted hammer
followed by a gap up or long blue candlestick
with heavy volume could act as bullish confir-
mation.
Blending CandlesticksBlending CandlesticksBlending Candlesticks
Candlestick patterns are made up of one or
more candlesticks and these can be blended
together to form one candlestick. This blend-
ed candlestick captures the essence of the pat-
tern and can be formed using the following:
The open of first candlestick
The close of the last candlestick
The high and low of the pattern
By using the open of the first candlestick,
close of the second candlestick and high/low
of the pattern, a bullish engulfing or piercing
pattern blends into a hammer. The long lower
shadow of the hammer signals a potential
bullish reversal. As with the hammer, both the
bullish engulfing and piercing pattern require
bullish confirmation.
Shooting Star
Blending Candles
Bullish
Engulfing
+ =
Hammer
Bearish
Engulfing
Shooting
Star
+ =
Piercing
Pattern
+ =
Hammer
Blending Candles
Dark Cloud
Cover
Shooting
Star
=+
36. 28
Blending the candlesticks of a bearish en-
gulfing or dark cloud pattern creates a shoot-
ing star. The long upper shadow of the shoot-
ing star indicates a potential bearish reversal.
As with the shooting star, bearish engulfing
and dark cloud cover patterns require bearish
confirmation.
More than two candlesticks can be blend-
ed using the same guidelines: open from the
first, close from the last and high/low of the
pattern. Blending three blue soldiers creates a
long blue candlestick and blending three red
crows creates a long red candlestick.
Bulls vs. BearsBulls vs. BearsBulls vs. Bears
A candlestick depicts the battle between
Bulls (buyers) and Bears (sellers) over a given
period of time. An analogy to this battle can
be made between two football teams, which
can also be called the Bulls and the Bears. The
bottom (intra-session low) of the candlestick
represents a touchdown for the Bears and the top (intra-session high) a touchdown for the Bulls.
The closer the close is to the high, the closer the Bulls are to a touchdown. The closer the close is
to the low, the closer the Bears are to a touchdown. While there are many variations, below are
the six most common games or candlesticks:
1.Long blue candlesticks indicate that Bulls controlled the ball for most of the game.
2.Long red candlesticks indicate that Bears controlled the ball for most of the game.
3.Small candlesticks indicate that neither team could move the ball and prices finished about
where they started.
4.A long lower shadow indicates that the Bears controlled the ball for part of the game, but
lost control by the end and the Bulls made an impressive comeback.
5.A long upper shadow indicates that the Bulls controlled the ball for part of the game, but
lost control by the end and the Bears made an impressive comeback.
6.A long upper and lower shadow indicates that the both the Bears and the Bulls had their
moments during the game, but neither could put the other away, resulting in a standoff.
Blending Candles
Three
Short Reds
Long Red
Candle
=
Three Short
Blues
Long Blue
Candle
=
1 2 3 4 5 6
37. 29
What Candlesticks Don't ShowWhat Candlesticks Don't ShowWhat Candlesticks Don't Show
Candlesticks do not reflect the sequence of
events between the open and close, only the rela-
tionship between the open and the close. The
high and the low are obvious and indisputable,
but candlesticks (and bar charts) cannot tell us
which came first.
With a long blue candlestick, the assumption
is that prices advanced most of the session. However, based on the high/low sequence, the ses-
sion could have been more volatile. The example above depicts two possible high/low sequences
that would form the same candlestick. The first sequence shows two small moves and one large
move: a small decline off the open to form the low, a sharp advance to form the high and a small
decline to form the close. The second sequence shows three rather sharp moves: a sharp advance
off the open to form the high, a sharp decline to form the low and a sharp advance to form the
close. The first sequence portrays strong sustained buying pressure and would be considered more
bullish. The second sequence reflects more volatility and some selling pressure. These are just two
examples and there are hundreds of potential combinations that could result in the same candle-
stick. Candlesticks still offer valuable information on the relative positions of the open, high, low
and close. However, the trading activity that forms a particular candlestick can vary.
Open
Close
1
2
High-Low Sequence
Close
Open
High
Low
1
2
Open
Close
