Thursday, March 16, 2006

Forex: Know the Market You're Trading!

My recent article in Trading Markets emphasized the importance of the fit between the personality of a market--its degree of volatility and trending--and the trading style of the trader. Quite a few readers wrote to me, asking about which market would be best for them. Many asked specifically about currency (forex) trading, since instruments such as the Euro are known to be trending and volatile.

My next article for Trading Markets will examine whether the Euro truly is a superior trading instrument. I think you'll be surprised by the findings. Without giving away too many punch lines here, allow me to mention one important finding: I find no evidence of trending in the currency market on either a 30 minute or daily basis. In fact, up periods are modestly more likely to be followed by down periods (and vice versa) than by continuation.

Many brokerage houses specializing in currency trading--especially those going after retail customers--stress what wonderful trending markets currencies are. They also emphasize commission-free trading with "only" a three-pip spread and possible leverage of several hundred to one on your money.

Well, each pip in the Euro emini is like a tick in the S&P emini: worth $12.50. So the highly leveraged trader in a market he thinks is trending, buys a volatile period and what happens? He is down three ticks on size already even if he scratches the trade. But when the market reverses with high volatility, he quickly is in the red by a substantial amount.

I spoke with a very well placed industry insider who revealed to me that the average length of time from the opening of a trading account to the closing of that account was seven months. This was not because the trader was dissatisfied with the firm; rather, that was how long it took the average customer to blow through their capital.

Yale Hirsch says, "Investigate before you invest." That's wisdom that applies equally to traders.