Forex Trader Mentor
Newsletter # 11
1st December 2005
Welcome to the latest Forex Trader Mentor Newsletter. In this issue, I will discuss the dollar and where I think it may be heading in the New Year, the relaunch of the TraderMetrics forex simulation and there is an article from a guest writer, Mark Hughes, the Fib Master.
Factors affecting the U.S. and where they may lead us.
As always, there are several factors affecting the king pin of all currencies, the U.S. Dollar. We have had a year where the Greenback has rallied significantly. This time last year, analysts were predicting a EUR/USD rate of 1.40 or higher, but since then we have come all the way down from the 1.35 level. What has been the driving factor?
Homeland Investment Act
The Homeland Investment Act is legislation in the US designed to induce firms to repatriate foreign profits. For this, they will pay a lower tax rate of 5.25% on the 'above normal' level of dollars brought back home. This is instead of paying 35% tax (less any taxes paid abroad). This tax break expires at the end of 2005. So far, it is estimated that $300 billion has been repatriated so far. In addition, it is estimated that $320 is riding on dollar-based 'carry trades', where the dollar is the high-yielding currency.
Can these be the main cause of dollar strength at the moment? What happens when the HIA expires? Will the U.S. Government extend the deadline? Will the dollar start to sell off?
Chinese Revaluation Pressure
At the same time, there is still tension between the U.S. and China over the reluctance of the Chinese to further revalue, or indeed float the Yuan. Perhaps it is a realization that the Chinese forex and money market cannot be established in a day or the need for the U.S. to have China mediate in talks with N. Korea that stops this escalating. In any case there is a delicate balance. The Chinese have to sustain the growth rate of the economy at around 10% to be able to employ all the people migrating to the cities. Otherwise, there is a risk of social unrest.
They will do this by exporting, largely to the U.S. The dollars have to be reinvested back into the U.S. and so far, so good; however, the U.S. Consumer appears to be borrowing on the back of rising equity in homes to purchase goods from abroad. If the circle is broken, by higher interest rates, a collapse in property prices or a revaluation of the Yen, there could be disaster. So what is the only thing that can 'give'? The dollar.
Therefore, I think that we may be heading back to where we were at the beginning of 2005, if not higher.
Trichet and the Euro.
The European Central Bank President, Jean Claude Trichet, really painted himself into a corner recently. He had already said that the ECB was going to tighten several weeks ago. He tried to back-pedal at a conference 2 weeks ago and finally, raised rates 25 basis points. Why? Because the credibility of the ECB was a stake and '311 million Europeans want price stability'. Well, I can tell you that at least 40 million Europeans would like a job!
In my opinion, Europe needs a rate rise like it needs bird flu. Germany has announce tax increases in 2007 and a rate increase will not help recovery. In fact, it may kill it stone dead. The new German government did not want to hear this. Trichet said that the Bundesbank had never had interest rates so low (2%) in its history. I would say that if the Deutschmark was still the German currency, the Bundesbank would have had interest rates at 1.5% or lower. Why? Because Germany is in the same situation as Japan. Great export numbers, but no domestic demand. Therefore, a weak Deutschemark would have been a good solution.
But no, we are probably going to see a strong Euro. Trichet tried to appease critics by saying that this was not a new cycle of tightening and it was only to ward off inflationary pressures caused by high oil prices. This rate rise is supposed to stop wage inflation, but European workers have a habit of wanting higher wages and lower working hours. Ha ha, I hear you say in other parts of the world. but, alas, this is the sad truth here in Europe.
In the 1990's I had a company that trained Interbank traders using a forex simulation called TraderMetrics. It was an accurate replication of the market and was used by many banks and institution. I sold my company in 2000. The buyers spent a lot of money further developing the system, but never realised the potential as they decided to concentrate on their core business, which was and is portfolio management systems.
After getting several enquiries recently, they decided to offer me the rights back, which I gladly said 'yes' to.
Therefore, it is with great pleasure that I can offer TraderMetrics once more.
What is TraderMetrics?
It is a fully-functioning model of the spot forex market,which can be driven by actual market rates, scenarios (canned rates), or in network mode, a pure supply and demand driven market. There is an interbank trader interface but also a margin trading interface.
There are two main versions: A stand-alone version, which allows the user to trade against the computer and a network version which allows users to trade against each other.
Why would I need this when I can get a demo account?
Because demo accounts do not train you sufficiently well. For instance, you cannot go through a scenario to see if you are good at picking up trade signals and executing entries and exits correctly. Think how frustrating it is to sit and wait for a pattern to emerge with live rates, and then if you got it right, the additional frustration knowing you could have earned some cash.
Brokers are gaining notoriety in looking at demo account patterns to eventually send a particular price feed to the unwary client. For example, if they know you set 15 point stop losses, don't be surprised if there are some 20 point spikes in the price when you trade! Also, I have evidence that brokers use the demo accounts to infect users' computers with 'Trojans' and other nasty things. Why would you want to do this?
Why will this help my education?
It is clear that ex-Interbank traders have the advantage. Many of them now sit in hedge funds and are very successful. Why? Because they have understood the importance of 'flows' to price development. The best way to learn this is by being a 'market maker'. Unfortunately, it is not possible for even the current generation of Interbank traders to really experience this, becuase of the electronification and consolidation in the market. Think of the analogy with pilots in commercial aircraft. The previous generation of pilots learnt how to fly in planes that did not have automatic systems - 'seat of the pants'. Nowadays, pilots- like bank traders - are 'system managers' with near-disastrous consequences. Only recentlys, an Scandinavian Airlines plane was seriously damaged on take off in Shanghai, because the wrong weight numbers had been tapped in. An 'old' pilot would have sensed something was wrong. So is it with trading today.
The most graphic demonstration of this is in the network trading. Here, we can create a 'virtual market' where imaginary customer trades are automatically transacted with traders on the network. The traders have to anticipate these orders and being market makers, also anticipate what positions the other traders have. This is because they must always be ready to quote a price. You get a real feel for what is going on. If you are a true market maker, quoting close prices, you will generally be the first to spot that there is some big buying and selling going on. This is 100 times more graphic than looking at charts, and is guaranteed to increase your knowledge of how markets work!
Live Rates vs. Canned Rates
After working with TraderMetrics for many years, I learned that short term, the market is indeed a 'random walk'. There are simply to many actors doing their business in the market for it to be otherwise. Having said that, there is an optimal time period where trends can be seen to develop. Technical analysts will tell you that there are patterns that repeat themselves, but I believe that they are just as random as the market moves. I can demonstrate that here:
Which one is the actual live market?
The bottom one is a randomly generated rate set (this generator is a part of the software package). This means that exactly the same patterns of price movements can be generated randomly as the market itself produces.
There is a rate feed out for TraderMetrics and we have developed a spreadsheet that allows further price studies. For example, how to practice trading using candlesticks or Fibonacci retracements.
Getting a live rate feed.
The ultimate live feed is the EBS (Electronic Broker System) ticker. Unfortunately, this is only available to banks, but it is the real 'nitty-gritty'. Reuters is the next preference, if you have the money to take a feed from them! Out choice is FXTrek's Intellichart Desktop, which has a feed that comes from FXCM or Comstock.
Downloading and installing
TraderMetrics Evaluation version is available free. All you have to do is register and then download the software. This will give you full functionality and 30 minutes of canned rates. If you decided to purchase one of the full versions, please go to the purchase page here. You will receive access to the comprehensive help system and some interesting tutorials.
TraderMetrics has been applauded as a masterpiece of programming and comes as close as it gets to the actual market, albeit with an Interbank bias. I am sure that you will most certainly benefit and what is more, have a lot of fun.
We are planning network sessions, a forum and a newsletter. We are also negotiating to be able to offer TraderMetrics Network as a 'trader game' where you can win cash prizes by demonstrating your trading skill.
Read more, see screen shots, register and download TraderMetrics www.forextradermentor.com/tmsignup.html.
This tutorial is provided by Neal Hughes "FibMaster" .
Even traders with limited experience start to realize that we are not trying to capture every market move. We want to improve our odds and reduce our frustration by filtering, for high-probability trades.
The combination of trend and Fibonacci techniques can provide powerful signals for higher probability trading. We already know that trend-lines have some validity, and so do Fibonacci levels. Combine the two, to improve your chances.
The following charts are the USD/British Pound GBP. First, the daily chart as of October 5th 2005. I have drawn a red down-sloping trend-line joining the two recent swing highs.
The chart has moved down since early September , making a down-trend of consecutive "waves" with lower swing highs and lower swing lows. There were several opportunities to take advantage of the down-move. In this tutorial we will focus on the October 6th opportunity.
In a down-trend we want to short those swing highs, and take profits on swing lows. We don't want to short every time we **think** we have a swing high. If you have tried that, you know about whipsaw and fake-outs already haha. We only want the best trades, those which are more likely to succeed. So how do we choose an optimum entry point?
Our odds are improved if we have a swing high near a down-sloping trend-line (in red on the chart). Markets tend to reverse at Fibonacci levels. So if we have a significant resistance level near a trend-line we have an even better chance of success.
The next chart shows the GBP with Fibonacci resistance levels. Notice the "SK Resistance" level. This represents an area of significant resistance, with a higher probability of a reversal.
If you are new to Fibonacci, those studies look like a confusing series of colored lines. Learning how to use these Fibonacci studies, and which of them are stronger (higher probability), is really easy! I have made two video seminars that explain this.
That "SK Resistance" level, coinciding with a trend-line is an optimum shorting zone. If the market reaches that area (we can't be sure it will), and if the market resists there, we want to take a short position. Once the resistance materializes, it will be difficult for the market to move against us.
Most of us are not trading the daily chart, but we can use the longer-term charts to find **powerful** trends and Fibonacci levels. The next chart is a 60-minute chart. I choose 60-minutes because it clearly shows when resistance has materialized. You may prefer a 30 minute of 5 minute chart.
The following 60-minute chart shows how the Pound rallied to the SK resistance level, and the trend-line. It rallied over those, tested them briefly, then retreated. There are several ways to determine whether resistance has materialized. I have some very powerful techniques for that purpose. However we want this tutorial to focus on some basics. So for now we will use the obvious breaking of the rising trend as our trigger.
During that rally upward, the 60-minute chart has a series of higher swing highs and higher swing lows. Once we broke the highest swing low (see the last bar on the above chart), we know that up-trend has expired. So we want to start shorting rallies and take profits on dips as shown on the next chart (60-minute chart).
Notice how the market broke down, and never looked back! That is what happens when you combine trend-lines with Fibonacci techniques. The best trades go your way and keep on going. That is a characteristic of higher-probability trading.
If this tutorial makes sense, you are ready for my Fibonacci Trading videos! My two introductory videos are inexpensive, and they receive glowing reviews almost daily. You can take your trading to the next level, bring these powerful techniques to your trading just by watching my video seminars.
Archive: Find the previous issues here
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