Develop your trading strategy based on an edge
A trading strategy is a set of rules that help a trader make decisions in the market. It takes away subjective judgement and guessing. A strategy is based on an edge and the rules identify when that edge in the market is present.
A trading strategy answers the following questions:
What are the best conditions in order to enter the market?
What are the best conditions in order to exit the market, i.e. where are your stop losses and profit targets?
The basis of a strategy therefore consists of the following elements: an entry, a profit target and a stop loss.
First you find an edge in the markets
Observing the markets over time will help you understand that market behaviour repeats itself.
Let’s say you have identified a price level where the price seems to reverse back to the upside. In other words, at this price buyers are entering the markets.
If the price seems to reverse back to the upside at this level, then you have identified a market condition where something seems to happen. You have identified an edge – a level where there is a higher probability of the price reversing. This price level is known as a support level.
There is always the possibility that the price may not reverse and that it could break through the support level. Most of the time, however, it does not – the probability of the price reversing back to the upside is higher and this presents an opportunity to buy. This is illustrated by the chart below:
Note that in the chart above, the price does eventually break through the support level. This illustrates that even though a condition has been identified where the price reverses, it is only a higher probability that this will happen, as sometimes it does not.
You develop the rules of the strategy based on an edge
You can use a similar basis to exit the trade. For example, you may have also identified a price level where selling takes place and the price starts to reverse to the downside. This is known as a resistance level. This is illustrated by the chart below:
You have identified a set of conditions: a price level where the price reverses to the upside and a price level where the price reverses to the downside. There are multiple levels at which the price will reverse the other way, in other words, there will be other support and resistance levels.
If you then buy at support levels and take your profit at resistance levels, you now have a rule for an entry and a rule for an exit.
If you buy at a support level and place your stop loss below the support level, in the event that the price does not reverse to the upside, then you have a rule for placing your stop loss too. You now have the basis of a strategy: an entry at support levels, an exit at resistance levels and a stop loss below the support levels.
Elements of a trading strategy
To recap, a trading strategy consists of the following elements: an entry, a profit target and a stop loss.
So to use the support and resistance level example above, the basis of a strategy would be as follows:
- Entry: Buy at the support level.
- Exit: Take profit at the next resistance level up.
- Stop loss: Place your stop loss just below the support level.
The entry and exits are not the entire strategy. You need to incorporate money management for example. However you have identified a set of markets conditions on which you can develop a set of rules and build a trading strategy on.
The difference with random entries
Let’s take a different approach. Say you enter into the markets randomly. The price may go up or down, however, you have no basis for why you entered and so you do not have a reason to exit either. This leaves you with the following questions:
- Even if the trade has gone straight into profit, at what point do you take your profit?
- What happens if the profitable trade then starts to reverse and go against you?
- How much of the profit do you give back to the market until you decide to take what is left?
- Do you let your trade run into a loss?
- What if the trade goes straight into a loss?
- How much of a loss do you take?
Without a reason to enter or exit the trade, you are simply buying or selling something with the hope that your trade will somehow end up in profit. Then, even if your trade does go into profit, you will still not know when or how much to take of your profit.
Developing a trading strategy allows you to enter and exit the market in the right conditions and you know exactly where you will take your profit and loss.
- Will your pension provision meet your requirements? The long-term upward trend of property prices provides welcome income for many people in their retirement years.
- Many people, feeling disappointed with the poor performance of equities and a volatile stock market, diversify into property for sustained growth, and with PGI’s help, accelerated growth.
- Global real estate will be the only major asset class that could deliver double digit returns over the next 5 years.
- Property is one of the most solid investment opportunities. Although the market may suffer short term ups and downs, if you are willing to hold on to an investment property for a long period of time, it will almost certainly be profitable
- At the end of 2005 the FTSE 100 was 10% below its 1999 level, whereas house prices were more than twice as high
- Property prices typically double in value every 7 years.
- 50% of the names mentioned in The Sunday Times rich list made their money through property investment.
- No other type of investment today offers the stability, simplicity and excellent returns offered by property investment.
- No other type of investment allows you to purchase with other peoples' money (the banks') and pay this back with other peoples' money (the rental income from tenants).
- A buy to let investment can produce a reliable rental income whilst the property investment benefits from capital appreciation;
The forex market, unlike other exchange-driven markets, has a unique feature that many market makers use to entice traders. They promise no exchange fees or regulatory fees, no data fees and, best of all, no commissions. To the new trader just wanting to break into the trading business, this sounds too good to be true. Trading without transaction costs is clearly an advantage. However, what might sound like a bargain to inexperienced traders may not be the best deal available - or even a deal at all. Here we'll show you how to evaluate forex broker fee/commission structures and find the one that will work best for you.
Commission Structures
Three forms of commission are used by brokers in forex. Some firms offer a fixed spread, others offer a variable spread and still others charge a commission based on a percentage of the spread. So which is the best choice? At first glance, it seems that the fixed spread may be the right choice, because then you would know exactly what to expect. However, before you jump in and choose one, you need to consider a few things.
The spread is the difference between the price the market maker is prepared to pay you for buying the currency (the bid price), versus the price at which he is prepared to sell you the currency (the ask price). Suppose you see the following quotes on your screen: "EURUSD - 1.4952 - 1.4955." This represents a spread of three pips, the difference between the bid price of 1.4952 and the ask price of 1.4955. If you are dealing with a market maker who is offering a fixed spread of three pips instead of a variable spread, the difference will always be three pips, regardless of market volatility.
In the case of a broker who offers a variable spread, you can expect a spread that will, at times, be as low as 1.5 pips or as high as five pips, depending on the currency pair being traded and the market volatility level.
Some brokers may also charge a very small commission, perhaps two-tenths of one pip, and then will pass the order flow received from you on to a large market maker with whom he or she has a relationship. In such an arrangement, you can receive a very tight spread that only larger traders could otherwise access.
Different Brokers, Different Service Levels
So what is each type of commission's bottom line effect on your trading? Given that all brokers are not created equal, this is a difficult question to answer. The reason is that there are other factors to take into account when weighing what is most advantageous for your trading account.
For example, not all brokers are able to make a market equally. The forex market is an over-the-counter market, which means that banks, the primary market makers, have relationships with other banks and price aggregators (retail online brokers), based on the capitalization and creditworthiness of each organization. There are no guarantors or exchanges involved, just the credit agreement between each player. So, when it comes to an online market maker, for example, your broker's effectiveness will depend on his or her relationship with banks, and how much volume the broker does with them. Usually, the higher-volume forex players are quoted tighter spreads.
If your market maker has a strong relationship with a line of banks and can aggregate, say, 12 banks' price quotes, then the brokerage firm will be able to pass the average bid and ask prices on to its retail customers. Even after slightly widening the spread to account for profit, the dealer can pass a more competitive spread on to you than competitors that are not well capitalized.
If you are dealing with a broker that can offer guaranteed liquidity at attractive spreads, this may be what you should look for. On the other hand, you might want to pay a fixed pip spread if you know you are getting at-the-money executions every time you trade. Slippage, which occurs when your trade is executed away from the price you were offered, is a cost that you do not want to bear.
In the case of a commission broker, whether you should pay a small commission depends on what else the broker is offering. For example, suppose your broker charges you a small commission, usually in the order of two-tenths of one pip, or about $2.50 to $3 per 100,000 unit trade, but in exchange offers you access to a proprietary software platform that is superior to most online brokers' platforms, or some other benefit. In this case, it may be worth paying the small commission for this additional service.
Choosing a Forex Broker
As a trader, you should always consider the total package when deciding on a broker, in addition to the type of spreads the broker offers. For example, some brokers may offer excellent spreads, but their platforms may not have all the bells and whistles offered by competitors. When choosing a brokerage firm, you should check out the following:
- How well capitalized is the firm?
- How long has it been in business?
- Who manages the firm and how much experience does this person have?
- Which and how many banks does the firm have relationships with?
- How much volume does it transact each month?
- What are its liquidity guarantees in terms of order size?
What is its margin policy?
- What is its rollover policy in case you want to hold your positions overnight?
- Does the firm pass through the positive carry, if there is one?
- Does the firm add a spread to the rollover interest rates?
- What kind of platform does it offer?
- Does it have multiple order types, such as "order cancels order" or "order sends order"?
- Does it guarantee to execute your stop losses at the order price?
- Does the firm have a dealing desk?
- What do you do if your internet connection is lost and you have an open position?
- Does the firm provide all the back-end office functions, such as P&L, in real time?
Even though you might think you are getting a deal when paying a variable spread, you may be sacrificing other benefits. But one thing is certain: As a trader, you always pay the spread and your broker always earns it. To get the best deal possible, choose a reputable broker who is well capitalized and has strong relationships with the large foreign-exchange banks. Examine the spreads on the most popular currencies. Very often, they will be as little as 1.5 pips. If this is the case, a variable spread may work out to be cheaper than a fixed spread. Some brokers even offer you the choice of either a fixed spread or a variable one. In the end, the cheapest way to trade is with a very reputable market maker who can provide the liquidity you need to trade well.
Better understand and learn how to invest in mutual funds with these informative tips.
1. What exactly is a mutual fund?
A mutual fund pools money from hundreds and thousands of investors to construct a portfolio of stocks, bonds, real estate, or other securities, according to its charter. Each investor in the fund gets a slice of the total pie.
2. Mutual funds make it easy to diversify.
Most funds require only moderate minimum investments, from a few hundred to a few thousand dollars, enabling investors to construct a diversified portfolio much more cheaply than they could on their own.
3. There are many kinds of stock funds.
The number of categories is dizzying. Some examples: growth funds, which buy shares of burgeoning companies; sector funds, which buy shares of companies in a particular sector, such as technology or health care; and index funds, which buy shares of every stock in a particular index, such as the S&P 500.
4. Bond funds come in many different flavors too.
There are bond funds for every taste. If you want safe investments, consider government bond funds; if you're willing to gamble on high-risk investments, try high-yield bond funds; and if you want to keep down your tax bill, try municipal bond funds.
5. Returns aren't everything - also consider the risk taken to achieve those returns.
Before buying a fund, look at how risky its investments are. Can you tolerate big market swings for a shot at higher returns? If not, stick with low-risk funds. To assess risk level, check these three factors: the fund's biggest quarterly loss, which will help you brace for the worst; its beta, which measures a fund's volatility against the S&P 500; and the standard deviation, which shows how much a fund bounces around its average returns.
6. Low expenses are crucial.
In order to cover their expenses - and to make a profit - funds charge a percentage of total assets. At no more than a few percentage points a year, expenses may not sound substantial, but they create a serious drag on performance over time.
7. Taxes take a big bite out of performance.
Even if you don't sell your fund shares, you could still end up stuck with a big tax bite. If a fund owns dividend-paying stocks, or if a fund manager sells some big winners, shareholders will owe their share of Uncle Sam's bill. Investors are often surprised to learn they owe taxes - both for dividends and for capital gains - even for funds that have declined in value. Tax-efficient funds avoid rapid trading (and high short-term capital gains taxes) and match winning trades with losing trades.
8. Don't chase winners.
Funds that rank very highly over one period rarely finish on top in later ones. When choosing a fund, look for consistent long-term results.
9. Index funds should be a core component of your portfolio.
Index funds track the performance of market benchmarks, such as the S&P 500. Such "passive" funds offer a number of advantages over "active" funds: Index funds tend to charge lower expenses and be more tax efficient, and there's no risk the fund manager will make sudden changes that throw off your portfolio's allocation. What's more, most active mutual funds underperform the S&P index.
10. Don't be too quick to dump a fund.
Any fund can - and probably will - have an off year. Though you may be tempted to sell a losing fund, first check to see whether it has trailed comparable funds for more than two years. If it hasn't, sit tight. But if earnings have been consistently below par, it may be time to move on.
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What currency is traded in the Forex market?
The item traded by Forex traders and investors are currency pairs. A currency pair is the exchange rate of one currency over another. The most popular currency pairs are:
USD/CHF: Swiss franc
GBP/USD: Pound
USD/CAD: Canadian dollar
USD/JPY: Yen
AUD/USD: Aussie
EUR/USD: Euro
The first currency of each currency pair is referred as the base currency, while second currency is referred as the counter or quote currency.
All currency pairs are quoted with a bid and ask price. The bid (always lower than the ask) is the price your broker is willing to buy at, thus the trader should sell at this price.
When dealing in Forex you will frequently hear the term pip. A pip is the minimum move a currency pair can make. Pip means price interest point. A move in the EUR/USD from 1.2545 to 1.2554 equals 9 pips.
The purpose of trading is to buy low and sell high. The foreign currency market FOREX is no different. The product traded are rates of currencies of different countries.
FOREX is a really unusual market for a variety of reasons. First, it is one of the few markets that it is free of any outside controls and that it cannot be manipulated. It is also the largest liquid financial market, with trade reaching between 1 and 1.7 trillion US dollars a day.
When this amount of money moves this fast, you can easily understand why a few investors would find it almost impossible to radically increase or decrease the price of a major currency.
The liquidity of the market means that unlike some stocks, traders are able to open and close positions within a few seconds as there are many buyers and sellers.
Margin Trading:
Margin trading refers to the leverage dollars given to the traders in the market.
One of the best features in Forex trading is that traders are able to trade foreign currencies with high margin.
In Forex, normal trade margins are 100:1 and 150:1, or even 200:1 trade margins. You get 1:1 margin for stock exchanges, 2:1 margin for equity trading, 15:1 margin for futures market. You can easily see how much more attractive Forex Trading is for the average trader.
This very attractive feature can also be dangerous. Traders should be very aware of the margin call and should always avoid them at all cost.
The typical broker will require a minimum account size, also known as account margin or initial margin. Once you have deposited your money you will then be able to trade. The broker will also specify how much they require per position (lot) traded.
There are many automatic trading systems available. Do your research!
What is the cost of trading forex?
The cost of trading is the overall expense that a forex trader has to incur in order to run their trading business. There are optional costs for things that the trader may wish to purchase, such as news services, custom technical analysis services and faster connections, and compulsory costs, which are expenses that every trader must pay.
For every trade that you place, you will have to pay a certain amount in costs or commissions for each trade that you place with a broker. These costs vary from broker to broker, but they are usually a relatively low amount. These are usually the only cost of trading that you are likely to incur.
This may sound like a simple enough process, but many traders overlook these costs of trading and thus underestimate the challenges to generate a long-term profit.
For many forex traders, failure to make a profit is not always down to not being able to trade well – sometimes a mismanagement or underestimation of the costs involved can lead to failure when the trading results should, in theory, lead to success.
By taking a look at the main costs of trading, a trader can be more prepared to manage their capital.
Forex spreads and commissions
The most common costs associated with trading are the spread and commission fees charged by the broker for each trade placed. These costs are incurred by the trader regardless of how successful those trades are.
What does the term “spread” actually mean?
The easiest way to understand the term spread is by thinking of it as the fee your broker charges you to trade. Your broker will quote or give you two prices for every currency pair that they offer you on their trading platform: a price to buy at (the bid price) and a price to sell at (the ask price).
The spread is the difference between these two prices and what the broker charges you. This is how they make their money and stay in business.
To illustrate, let's say you want to make a long (buy) trade on the EUR/USD and your price chart shows a price of 1.2000.
The broker, however, will quote two prices, 1.2002 and 1.2000. When you click the buy button, you will be entered into a long position with a fill at 1.2002. This means that you have been charged 2 pips for the spread (the difference between the price 1.2002 and 1.2000).
Now say you want to make a short (sell) trade and again, the price chart shows a price of 1.2000. The broker will fill your trade at 1.2000, however, when you exit the trade – in other words buying back the short position – you will still pay the spread. This is because whatever the price shows at the time you want to exit your trade, you will be filled two pips above that price. For example, if you wanted to exit at 1.9980, you will in fact exit your trade at 1.9982.
Therefore, the spread is a cost of trading to you and a way of paying the broker. The bid price is the highest price the broker will pay to purchase the instrument from you and the ask price is the lowest price the broker will pay to sell the instrument to you.
In order for a trader to make a profit or avoid making a loss on a trade, the price must move enough to make up for the cost of the spread.
Variable rate spreads
It is also worth noting that the spread you pay can be dependent on market volatility and the currency pair that is traded. These variable spread fees are commonplace in markets where there is higher volatility.
or example, if a market is quiet, i.e. there is not much market activity and the volatility is low, the broker may charge a +2 pip spread. But if volatility increases or liquidity decreases, the broker/spread dealer may change that to incorporate the additional risk of the faster, thinner market and so they may increase the spread.
Some brokers also charge a commission for handling and executing the trade. In these circumstances the broker may only increase the spread by a fraction or not at all, because they make their money mainly from the commission.
What is commission and how is it calculated?
A commission is similar to the spread in that it is charged to the trader on every trade placed. The trade must then attain profit in order to cover the cost of the commission.
Forex commissions can come in two main forms:
- Fixed fee – using this model, the broker charges a fixed sum regardless of the size and volume of the trade being placed. For example: With a fixed fee, a broker may charge a $1 commission per executed transaction, regardless of the size involved.
- Relative fee – the most common way for commission to be calculated. The amount a trader is charged is based on trade size; for example, the broker may charge “$x per $million in traded volume”. In other words, the higher the trading volume, the higher the cash value of the commissions being charged.
With a relative fee, a broker may charge $1 per $100,000 of a currency pairing that is bought or sold. If a trader buys $1,000,000 EUR/USD, the broker receives $10 as a commission. If a trader buys $10,000,000 the broker receives $100 as a commission.
Note: The relative fee is, in some cases, variable and based on the amount that is bought or sold.
For example, a broker may charge $1 commission per $1,000,000 of a currency pairing bought or sold up to a transaction limit of $10,000,000.
If a trader buys $10,000,000 EUR/USD, the broker receives $10 as a fee. However, if a trader buys more than $10,000,000 EUR/USD, they will become subject to the new fee. Usually the commission is on a sliding scale to encourage larger trades, however, there are different permutations from broker to broker.
Additional fees to consider
There are also hidden fees with some brokerages. Some of the fees you should look out for include inactivity fees, monthly or quarterly minimums, margin costs and the fees associated with calling a broker on the phone.
Before making a judgement on which commission model is the most cost-effective, a trader must consider their own trading habits. For example, traders who trade at high volumes may prefer to pay only a fixed fee in order to keep costs down. While smaller traders, who trade relatively low volumes, may tend to prefer a commission based on trade size option as this results in smaller relative fees for their trading activity.
Leverage
Leverage is a tool that traders use as way to increase returns on their initial investment. One reason that the forex markets are so popular amongst investors is because of the easy access to leverage. However, when factoring in spreads and commissions, traders must be careful of their use of leverage because this can inflate the costs of each trade to unmanageable levels.
Overnight positions
When trades are held overnight there is another cost that should be factored in by the trader holding the position.
This cost is mainly centred on the forex market and is called the overnight rollover.
Every currency you buy and sell comes with its own overnight interest rate attached. The difference between the two interest rates of the currencies you are trading will give you the cost of holding the position overnight. These rates are not determined by your broker, but at the Interbank level.
For example, if you buy the GBP/USD, then the rollover will depend on the difference between the interest rates of the UK and the USA.
If the UK had an interest rate of 5% and the USA had a rate of 4%, the trader would receive a payment of 1% on their position because they were buying the currency from the nation with the higher interest rate – if they were selling this currency, then they would be charged 1% instead.
Data feeds
Aside from the transactional costs of trading, extra costs should be factored in by traders when calculating their overall profitability.
Data feeds help the trader see what is happening in the markets at any given time in the form of news and price action analysis.
This data is then used by the trader to make important decisions:
- When to enter and exit the market
- How to manage any open positions
- Where to set stop losses
This data is therefore directly linked to the performance of the trader; good efficient data is vital in order to maintain a constant edge in the markets.
These costs are usually a fixed price charged monthly. The costs vary between providers, as does the quality and nature of their data feeds. It is important that traders determine which kind of feed they feel most comfortable and confident using before committing money to any feed provider.
Other additional costs to a trader may include subscriptions to magazines or cable television packages, which enable access to non-stop financial news channels. The cost of attending exhibitions, shows or tutorials may also need to be considered if you are a novice trader.
Aside from this are the obvious necessary costs of owning a reliable PC or laptop, and cupboards stocked with plenty of coffee!
The first step is to learn how to buy a stock. Many investors jump right in learning investment strategies and adopting techniques that worked for others, before learning the simple steps to buying a stock. Without a good understanding of the rules of buying a stock, it becomes impossible to make the strategies work.
The strategies do work but only when the investor chooses the right stocks for their own portfolios. The strategies do not tell investors what to buy and when to sell. They are only meant to tell investors how to manage their stocks. First, the investor must buy some stocks.
Step #1: Read the Wall Street Journal
The Wall Street Journal is not the only paper that can help investors. The business section of your local paper can often offer tips that will never make it into the Wall Street Journal. However, The Journal can teach new investors the lingo, and the basics of the markets. The more you read, the more familiar the markets become, and the easier it is to research stocks.
Step #2: Pick Industries
No one expects an investor to build a portfolio with a few stocks from mining, a couple from manufacturing, a drug developing company, a foreign natural resource harvester, and a marine biology firm. This is foolish investing. Instead, investors should focus on one or two industries and learn everything they can about that industry.
There are many places to research. Sometimes a simple place like finance.yahoo.com or Morningstar.com can provide all the resources needed to find an industry you will not tire of.
Step #3: Decide How Much to Invest
This is one of the hardest parts of investing. Many people have a set amount to invest. They experience some success and hit 'pay load.' Then the temptation sets in. If they had invested $10 000 instead of $1 000, their payoff would have been 10x higher. What if they had of invested $100 000? This type of thinking is dangerous.
Never invest more than you can lose is a nice mantra, but in the real world, resisting temptation is much harder. As the years past, some investors start counting up the intangible money they 'may have' earned if they invested more. This leads to frustration instead of joy when a stock does well.
Eventually, they start investing more than they can afford to lose. Then, they lose it.
Step #4: Avoid the Crowd
Some new investors believe the best way to buy a stock is buy whatever is 'hot' at the moment. They skip through websites and financial papers until they find something that is 'hot.' Unfortunately for them, they have not yet met the Bull or the Bear.
Buying hot stocks is only for people who are able to determine why that particular stock is hot at the moment. Buying on an impulse or gut feeling is just as dangerous. By the time a stock is hot, the 'real' investors have already bailed, having made their money, and are leaving before the crash.
These four steps will help a new investor buy a stock which should perform well, instead of buying a stock that bottoms out within a few weeks.
