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Mr Market’s Ultimate
Trading Guide
Mr Market’s Ultimate Trading Guide
Edition 1.0
© 2020 by 16 Spencer Street Ltd. ("Mr Market”)
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FOREWORD
This is an impressive project because it tackles a complex topic and distills

years of professional experience into a highly readable and approachable
book.
It captures the classic education that someone would receive when joining
an investment bank or hedge fund trading desk, preparing to take
discretionary risk.
All the major topics are dealt with - risk management, fundamental and
technical analysis, psychology - and the guidance is simple, realistic and
helpful.
This is a beginners’ book for serious traders, written by a professional in

the industry. For those interested in trading and without an investment
banking or hedge fund background, it would be an excellent place to start.
Peter Welsby, former Equity Derivatives Trader at a top 10 investment bank and Senior
Trader at a multi-asset systematic hedge fund with peak assets under management of
$5 billion
CHAPTERS
1 INTRODUCTION ....................................................................................1
2 THE HISTORY OF TRADING .............................................................11
3 TRADING 101: THE BASICS OF TRADING FOREX, CRYPTO
AND INDICES ..........................................................................................20
4 FOREX FOR ABSOLUTE BEGINNERS ..............................................40
5 CRYPTO FOR ABSOLUTE BEGINNERS ...........................................66
6 THE A-Z GUIDE TO EQUITIES, INDICES AND OPTIONS ..........92
7 CORE CONCEPTS OF TECHNICAL ANALYSIS ..........................115
8 RISK MANAGEMENT FOR TRADERS ...........................................160
9 TRADING PSYCHOLOGY ................................................................200
10 THE MAGIC OF FACTORS .............................................................217
11 FUNDAMENTAL TRADING IN FOREX ......................................231
12 FUNDAMENTAL ANALYSIS IN CRYPTO MARKETS ..............259
13 TRADING STOCKS ON FUNDAMENTALS ................................274
14 INTERMARKET RELATIONSHIPS AND ADVANCED
CHARTING .............................................................................................298
15 NEWS TRADING AND SECOND-ORDER THINKING.............334
16 ADDITIONAL TOPICS IN TECHNICAL ANALYSIS .................356
17 ELEVEN TRADES: EIGHT LOSERS AND ONE WINNER ........383
18 CHOOSING A BROKER ...................................................................407

www.getmrmarket.com | Mr Market’s Ultimate Trading Guide
1 INTRODUCTION
If you have bought this book it is probably because you are looking to
learn about or improve at trading. Most likely in forex or indices or crypto
or single stocks. That’s great. However, we have to get one thing out of
the way first. Trading is not a get rich quick scheme.
If you have seen an Instagram post, promoting the idea that you can ‘get
rich quick’ with zero effort, then I’m afraid that is simply not true. Things
that are too good to be true … usually are not true.
Despite some of the rubbish you see online, trading is not a license to
print money with little or no work required. Trading can be enormously
interesting and intellectually stimulating. Trading can be a great full-time
career. Many folks have become extremely well off (even billionaires)
from trading. However, trading is not easy.
Like any game of skill, trading requires mastery and that takes time and
effort. To be clear: do not start trading if you think it is a get-rich-quick
scheme. With this crucial health warning out of the way let’s look at why
we wrote this guide and what you can hope to get out of it.
The difference between amateur and professional results
The difference between how trading is conducted by the pros and the
retail trader is simply huge. It shows in the results. The overwhelming
majority of retail traders lose money.
1
FIGURE 1
Source: data from regulatory filings analysed by Finance Magnates
This is not the case for professionals. Bank traders’ true PNL is masked
because they have client franchises. However, currency funds do report
their PNL and it is generally pretty good. The below is from EurekaHedge
and shows the performance of their index of 20 FX hedge funds.
2
FIGURE 2
Source: data from EurekaHedge website
The reason for the difference in performance is not that the pros are much
smarter than the average retail trader. It is because they have been trained
to take disciplined, logical approaches to trading. They use specific tools
and techniques to help them achieve this.
I should know. My first graduate job was trading FX at an investment

bank that was then the third-largest currency trader in the world.
Like any new trader, I had a steep learning curve and plenty of
challenges. However, I had the huge benefit of being trained by some of
the best in the market. Each day I saw how professionals with long track
records of successful PNL approached this business. I picked up things
mainly by getting it wrong and asking questions.
During this course, you are going to learn the tools and techniques I
learned.
3
The jigsaw method
You can see the full course outline below.
I want to be clear about one thing. No one - this book included - can teach
you a system or method that you can copy out-of-the-box and will
produce instant results.
It does not work that way. If it was that easy everyone would do it. You
have to experiment and find what works for you. Find what suits your
personality and trading style.
The best approach is to have a broad appreciation of all the key topics that
have been learned the hard way over decades of other people’s trading
experience. Other traders had to sweat and lose money to find out this
stuff. The smart thing we can all do is learn from collective experience.
With full knowledge of these tools and techniques, you can then focus on
the specific techniques that work for your style and personality. This book
advocates the ‘jigsaw method': learn about everything, try a little bit of
everything, and then double-down on whatever works for you -
combining techniques and tools from different disciplines.
By the end of this course you will have a decent grounding in all the
topics this book considers key to a trader’s education. You will know
more than 99% of retail traders I have met. However you will still be
learning with each trade because the hardest thing in trading is not
knowledge but psychology.
It is extremely tough to evolve your emotional reactions and thinking

process. Staying rational on a trade to which you are emotionally
4
attached. Taking a loss with the same level of emotion as you do a winner.
You can know exactly what to do and it still is not easy to do it.
What we’ll cover
Let’s look at the topics we are going to cover together.
The basics
The first two chapters are introductions.
First we are going to learn a little bit about market history. How the forex,
equities and crypto markets grew into what they are today.
Next we are going to examine some trading 101. We are going to look at
topics you may have heard of like ‘liquidity’ and explain simply what all
the jargon like ‘pip’ and ‘spread’ and ‘bullish’ and ‘bearish’ mean in
simple terms.
This article is jam-packed full of examples so you can follow along in your
own time. You’ll learn how to calculate PNL as well as how all the order
types work like ‘stop loss’ and ‘take profit’. You’ll also learn about two
crucial topics for retail-trading: margin and leverage.
The markets
After this we’ll take a walk through the big speculative markets - forex,
crypto, equities - and consider the role of various players. How do hedge
funds, commercial banks, central banks interact with the market? How
about the retail trading community?
5
Knowing who else is out there and how they use the market is crucial to
trading survival. We are going to cover all the various instruments. Each
trading instrument has a different ‘personality’ - even currencies like AUD
and EUR behave and trade differently, let alone compared with a stock
like Tesla or Bitcoin.
FIGURE 3
An illustration of a mobile trading app, which is a popular way to access the markets
nowadays
Chart wizards
Now that we know a bit about each market it is time to look at how to
study price charts. This is a big chapter: technical analysis. This is the
most common trade entry toolkit for retail traders. Technical analysis is
very important but only one of several tools. We will cover the key topics
such as support and resistance, moving averages, candlesticks. Everything
6
will be explained clearly with visuals and examples so you can follow
along - even if this is completely new to you.
Risk management
After that we will learn about risk management: position sizing,

correlation, stop losses and risk-reward ratios amongst many other tools.
This is probably the single most important part of the entire course and
what really separates professionals from amateurs.
FIGURE 4
The concept of risk-reward will become second-nature
The mind game
Behavioural finance is next on our list. This is a fashionable subject these

days! We are going to look at cognitive biases such as loss aversion,
anchoring, confirmation bias and examine how they affect us all as
humans and as traders. We will look at ways to help protect ourselves
from emotions and natural bias, including writing a trading journal. We
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will also examine two crucial inputs to trading decisions: market

positioning and market sentiment.
Connecting multiple markets
Intermarket trade ideas are another tool used extensively by the pros but
rarely, if at all, by retail traders. We are going to look at the lead-lag
relationship between instruments like oil and Canadian dollar. You are
going to start to think about trades in terms of relative value and this will
open up many more high conviction trading opportunities. We will also
run through some advanced charting techniques with examples so you
can follow along.
News trading
Next up we will cover the economic calendar. We’ll go through an

example of how to read it as well as highlighting some of the biggest
events. We will look for the first time at trade entry ideas and how to use
news and the economic calendar to generate trade ideas. You will learn
about second-order thinking and start to think critically about what is
priced into markets rather than simply reacting to news as it arrives.
The magic of factors
Factor-based trade ideas are our next idea generation chapter. You will
explore the concept of momentum - probably the most famous of all
trading concepts and the backbone of most technical analysis techniques.
We will also look at another famous factor, which is the ‘carry’ factor that
is so extensively used to trade the Japanese Yen.
8
The fundamentals of trading
It will then be time to cover the fundamentals of currencies, crypto and

equity markets. This stuff is almost entirely ignored by retail traders but
absolutely crucial for professional traders. Even if you do not trade
fundamentally you need to have a basic understanding of the drivers of
each market because the biggest players in the market trade off
fundamentals and their trading activity will affect everyone’s market
price. This is where the big trends can be spotted early.
Real-world trading
In the next chapter we’ll put everything we’ve learned into practice. We
will look at eleven trades (some winning and some losing) and see what
went right and wrong in each case. The idea is to help you learn from
your trading journal and give you the toolkit to analyse past trades -
either by yourself or with a friend or mentor.
More chart wizardry
Finally, some more technical analysis. There was simply too much to fit
into a single chapter. We will look at popular methods like Bollinger
Bands, MACD and Elliott Wave Theory.
9
FIGURE 5
You will learn about Elliott Wave Theory and other exotic-sounding techniques within
technical analysis
10
2 THE HISTORY OF TRADING
In one form or another people have traded since the earliest

civilisations. However we are not interested in barter agreements. We are
interested in the business of speculative trading. Buying something
because you believe the market is going up.
In this chapter we'll walk you through how three major markets came into
being. On one level a lot has changed. There were no mobiles in 15th
Century Florence! However, in many respects, nothing has really
changed.
The emotions that a Florentine merchant - or a 1930s American

stockbroker - felt when watching his position in the market were surely
no different to what we all feel today. Trading was then and remains now
a battle of wits. An exciting intellectual challenge.
Forex
Forex is one of the oldest markets because it is necessary for all sorts of
real-world trade. When the Medici banking family were buying and
selling textiles across the world in the 15th century they were also trading
Florins. Florins being gold coins used in the European trading hub of
Florence.
Gold remained important in the development of currencies. In the early

1800s countries like England and United States adopted a gold standard.
This means that anyone bearing the US dollar or British pound had the
right to convert these currencies into a fixed amount of gold.
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This creates high confidence in the currency. You might recognise the
concept in USD-pegged crypto stablecoins today.
In 1971 Richard Nixon addressed the nation, announcing the end of the
gold standard. This meant the US dollar’s value could ‘float’ i.e. go up
and down based on demand. By 1973 most other major currencies had
followed suit and forex trading as we know it began.
Now currencies could go up or down against one another based on the

market’s view of their relative strength. Fast forward to the 1980s and the
interdealer era. This will seem completely ‘old school’ to you but this is
the first time the markets vaguely resembled their current form.
Trading occurred between banks on the phone. It was hectic. Banks would
employ teams of traders to do ‘call outs’. Imagine a big hedge-fund buys
100 million Dollar-Mark (the precursor to EURUSD). The bank’s chief
dealer would tell ten of his traders to each call a bank and get a price in 10
million. When all the prices are in they would shout “mine” to signify that
they’d bought the 10 million from each bank.
This was a chaotic and exciting time. Traders smoked in the dealing room
whilst working. Here is a great documentary that gives you a flavour of
what it was like.
Hedge funds and banks could speculate on the direction of each pair but
the market was not readily accessible to the average person.
The next major shift was when the markets became electronic in the early
2000s. The two major FX trading markets – Reuters and EBS – permitted
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computers to plug into their venues. For the first time computers could
trade with humans … or other computers.
FIGURE 6
BIS data capture the migration to electronic trading
Banks began to offer their clients sponsored access to these venues. All of
a sudden other players could join in. This democratised access and today
the vast majority of forex trading is electronic as you can see from below.
As markets became electronic, early retail pioneers such as Saxo Bank and
IG Markets were able to plug into the market (via dealer banks) and offer
their clients fully automated execution.
Nowadays it is trivial for an average Joe to trade EURUSD from his couch
or chart the price of Chinese Yuan vs the US dollar with a click. In fact
almost half of all retail trading occurs on a mobile, according to the annual
reports of various retail brokers.
13
The nature of the market has changed hugely from Renaissance Florence.
However the merchants of the day were doing something not totally
unlike you.
Crypto
Crypto is of course the newest of these three asset classes. The mother
of all cryptocurrencies, Bitcoin, was created in 2009 by the anonymous
Satoshi Nakamoto. Satoshi authored this whitepaper: https://
bitcoin.org/bitcoin.pdf
Many people have claimed to be Satoshi but no one really knows who he
or she is. It seems highly unlikely that Satoshi intended Bitcoin to be a
speculative instrument. Instead he seems interested in technical
challenges of cryptography.
A common feature of a cryptocurrency is that it is decentralised. This

means it relies on cryptography rather than a trusted intermediary to
police and process all the transactions. The early Bitcoin movement was
often motivated by goals of freedom. Freedom from government
interference since governments control the supply of fiat currencies like
the US dollar via their central banks.
Despite this slightly hippy original vibe, in 2017 Bitcoin-mania happened.

The price rose from around $1,000 to a peak of nearly $20,000. Millionaires
were created overnight. Some billionaires, even. It was not uncommon to
see Bitcoin trading adverts on public transport and other mainstream
places. Almost everyone seemed to trade crypto.
14
FIGURE 7
Crypto’s speculative bubble drew in many first-time traders and has been a wild ride
A flurry of alt-coins cropped up. Some of them were serious efforts

designed to address limitations in the Bitcoin protocol that would allow
the instrument to be more flexible or handle more throughput, which is
necessary if you actually wish to use it to pay for things. Credit cards
wouldn't be popular if they took ten minutes to process a payment at the
counter.
Etherium was one such major project. Designed by Vitalik Buterin it

ushered in the era of ‘smart contracts’. This simply means that you can set
rules that have to be met before an exchange happens. Let's imagine that
you will send me payment but only once I deliver you a game download;
Etherium can automate that so you are certain you get the game and I am
certain I get the payment if I send the download link.
15
Other projects were pretty ridiculous. Dogecoin was seemingly a parody

rather than a serious project. Yet it reached a market cap of $1bn in 2018.
Here’s what its dismayed founder had to say.
I think it says a lot about the state of the cryptocurrency space in

general that a currency with a dog on it which hasn’t released a
software update in over 2 years has a $1B+ market cap.
Dogecoin founder
Major institutional exchange groups like the CME – the home of oil
futures trading – clamoured to participate and launched Bitcoin contracts.
Needless to say it all ended in tears and the price crashed. Many true
believers chose to stay invested whilst others saw their savings
evaporate.
Way back in 2013, a misspelled post on a Bitcoin Forum message board “I

AM HODLING” created a new term: HODL. Redefined after the late 2017
crash as “hold on for dear life” this became a common mantra for staying
invested in cryptos, regardless of price.
Crypto has quietened down a little since but a lot of the infrastructure
around it is growing up. It feels like an asset class that is here to stay.
Major trading firms – including Wall Street banks – have built up trading
capabilities. This is allowing traditional asset managers to invest in the
asset class.
A lot of crypto enthusiasts compare crypto to gold. Gold is a pretty

useless substance by itself – other than jewellery and a few industrial uses
one cannot do much with it. Gold is only valuable because people believe
it is valuable.
Gold is often used as a hedge to mainstream portfolios of stocks and

bonds: if you do not trust what governments will do to fiat currencies you
16
might buy gold. Unlike the US Dollar its value cannot be diminished by
printing more of it as one simply cannot print gold. Crypto enthusiasts
believe that cryptocurrencies can play a similar role in portfolios. They
point out that they offer uncorrelated returns to traditional asset classes.
One attraction of cryptos for speculative traders is their volatility. Simply

put, they move a lot more than other instruments each day. These moves
create opportunities to trade and make a profit or loss. Bitcoin typically
fluctuates by around 3.5% per day – far more on certain days – whereas
the largest currency pair, EURUSD, typically moves by under 0.5% per
day.
Today cryptos can be traded on a mobile phone with ease, just like other
currencies. One major difference is that crypto markets are open 24/7
whereas forex shuts for the weekend.
Equities
Trading shares in companies goes back a long way. The Amsterdam

Stock Exchange, depicted below, was the first stock exchange to launch
continuous trading. Trading had long since been occurring in the famous
Amsterdam coffee shops.
It took a long time for America to catch up. In 1792 the historic
‘Buttonwood Agreement’ was commenced. It is said that the 24
stockbrokers agreed some rules of trading outside 68 Wall Street and this
was the predecessor to the New York Stock Exchange.
When you think of the New York Stock Exchange you will doubtless be
imagining the opening or closing bell as seen on CNBC and other
business channels. However, trading is nearly all electronic and not all of
it takes place on exchanges. This is more like a movie set nowadays.
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The single best book on trading ever written was Reminiscences of a Stock
Operator. I highly recommend you purchase it on Amazon. Written in 1923
it tells the story of a ‘plunger’. That is a man who plays the stock market.
He makes a fortune, loses it and makes it back. He bets on important

companies of the time such as the railways and often uses trading tactics
that would be illegal today. However the core concepts of greed and fear
and reading the prices and trends have not changed one bit.
Originally all trading took place against ‘specialists’. Specialists were

traders, members of the Stock Exchange, who provided prices for others
to buy and sell an instrument. Each specialist would cover five or ten
stocks and had a little monopoly on these. There were many complaints
about the specialists. They were said to have abused their position of
power. In 1984 NASDAQ launched the SOES (Small Order Execution
System). This forced the specialists to display their quotes electronically
and more importantly honour them in up to 1,000 shares.
That meant retail investors could suddenly see and access the real
orderbook. This system was exploited by what came to be known as the
SOES bandits.
SOES bandits would monitor the stock prices on various systems,

understanding that one might update to incorporate some news before a
specialist could update his or her terminal. If a price was off then they
would whack it! Soon SOES bandits became responsible for 13% of overall
order execution.
Wall Street professionals hated this of course. However, it provided the

impetus for developing the fully electronic trading that we see today.
18
FIGURE 8
‘FANG’ tech stocks have captured the imagination of investors in the last decade
Today a retail investor can trade shares at a click of a button. Often at

better prices than are available on the public markets and in recent years
with zero commissions.
This is made possible because the market makers who provide prices
really like the small-size retail flow and will pay retail brokers to send it to
them. Instead of hedging it on the market they will sit on this risk and
wait for another retail trade to take the other side and flatten them out.
As trading equities has become cheap and easy, volumes have exploded
and companies have been born. Robinhood was founded only in 2013 but
was the first widely available app where users could trade stocks
commission free and is today worth almost $10 billion.
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3 TRADING 101: THE BASICS OF TRADING

FOREX, CRYPTO AND INDICES
Before we go any further we need to run through the mechanics of

trading.
There’s so much jargon involved it can seem confusing at first. But it

really is not difficult. In fact lots of the concepts are extremely simple and
familiar. We must simply learn some industry words.
Reading quotes
If we are trading something we need to know what the current price

is. Obviously, I hear you say!
When trading forex you will see pricing tiles like this.
FIGURE 9
You can sell at 1.32049 or buy at 1.32058
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The pair is GBPUSD. When you see rates in GBPUSD it simply means
“how many USD does one GBP get me?” If you saw EURGBP it would
mean “how many GBP does one EUR get me?” and so on.So the pricing
tile above tells us “how many USD does one GBP get me?” The answer to
that is the rate displayed. But there are two rates displayed, you say!
1.32049 and 1.32058.
The left-hand rate is referred to as the “bid” and the right-hand rate is
referred to as the “offer”. So the bid is 1.32049 and the offer is 1.32058.
Selling AKA "giving the bid"
If you wish to sell GBP and buy USD you will do so by giving the bid. We
can see that for every 1 GBP we sell we receive 1.32049 USD in return.
You would sell GBPUSD if you think the GBPUSD rate will go down. If
you think the GBP will lose value versus the USD. This is often referred to
as being “short” GBPUSD. Short GBP and long USD.
Buying AKA "paying the offer"
If you wish to buy GBP and sell USD you will do so by paying the offer.
We can see that for each GBP we buy we must provide 1.32058 USD in
return.
You would buy GBPUSD if you think the GBPUSD rate will go up. If you
think the GBP will gain value versus the USD. This is often referred to as
being “long” GBPUSD. Long GBP and short USD.
21
Reading a crypto quote
Reading a crypto quote or CFD quote works in exactly the same way.
Let’s say we want to go long Bitcoin. That means we will buy BTC and
sell USD.
FIGURE 10
You can buy at 9,434.37 - it works exactly the same way as we saw previously
We are paying the offer. So that means we must give the broker $9,434.37
in exchange for one Bitcoin.
That’s it. You’ve understood everything there is to know about reading a

quote. Told you it was simpler than it sounds.
The spread
Why is there a difference between the bid and offer prices? Well, that is
the spread that market makers charge.
If you wish to buy, say 1,200 GBPUSD, it is unlikely that another trader
wishes to sell 1,200 GBPUSD at that exact time! Up step the market
22
makers with a streaming two-way quote, allowing you to trade either

side whenever you like.
When you buy GBP and sell USD to them, they will wait for another
trader to sell GBP and buy USD from them to flatten their book. In the
mean-time the market for GBPUSD may move higher or lower and so
they charge a small spread to compensate for this risk and the cost of
running their business.
That is perfectly reasonable but as a trader you will always want the
smallest spread possible. The cost of the spread affects you as a trader
because you must “cross the spread”.
Let’s look again at our crypto example. What would happen if you bought
one Bitcoin and immediately sold it?
FIGURE 11
The spread is the difference between the buy price (offer) and sell price (bid) so in this
case it is 36.01
You would buy a Bitcoin for $9,434.37 and then sell it for $9.398.36.
That means a loss of $36.01. So BTCUSD has to move at least $36 in your
chosen direction before you recoup the spread cost.
23
Spreads are very small in some instruments and very large in others and
this will affect how you trade each instrument. We’ll look at that in a later
article. For now it is enough to simply understand what the spread is and
why it matters.
A smaller spread is a good thing as it means your cost of trading is lower.
Bullish and bearish
You may wonder what on earth it means when people say “I’m
bullish” or “the market is bearish.”
You hear it all the time - especially on CNBC and Bloomberg TV. If you
visit the actual Wall Street in New York you will even see statues of each
of these beasts.
The answer is simple.
Bullish means you are optimistic about something’s prospects. If you are
bullish GBPUSD you think that the price of GBPUSD will move higher.
Bearish means the exact opposite. You are pessimistic about something’s
prospects. If you are bearish gold you think that the price of gold will go
lower.
There are many supposed explanations for why these terms came to be
used. My favourite is that the terms derive from the way in which each
animal attacks its opponents. A bull will thrust its horns UP into the air. A
bear will swipe DOWN.
Many people like to imagine the market as millions of individually bullish

and bearish speculators battling it out to see who is right.
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Types of orders
So now we have an understanding of how to read a quote and describe

our feelings on an instrument.
We are going to look next at the various order types that can be used to
trade.
Market orders
The simplest and most popular is a market order.
Remember our example earlier where we decided to buy GBPUSD? A

market order just means clicking on buy and doing so at the market price
of 1.32058. That simple.
FIGURE 12
A market order would be as simple as clicking buy or sell
25
Limit entry orders
But sometimes you only want to buy at a certain price. For example you
might say “I’d like to buy GBPUSD but only if it gets a little cheaper and
hits 1.32000.” That’s fine. You can use a limit order.
FIGURE 13
A limit order to buy if the price drops to 1.25
A limit order simply means you enter a price and amount. For example
Buy 10,000 GBPUSD when the price gets to 1.32000.
The price always has to be below current market if you’re buying or

above current market if you’re selling. Otherwise obviously you’d just do
an at market order and trade at the current price.
For example you could leave a limit order to buy at 1.25 on the above. If
the price goes down to 1.25 you’ll get filled. But you couldn’t leave one at
1.35 because the current price of roughly 1.32 is better than that so you’d
just trade at market immediately.
Limit orders are really useful.
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Take profit limit orders
This works in exactly the same way. The only difference is that you
already have a position, instead of looking to enter a position.
Let’s say you had gone long i.e. bought GBPUSD at 1.25. You could enter
a take profit order to sell at 1.35. All that means is close the position, by
selling GBPUSD, if the price reaches 1.35.
FIGURE 14
A limit order to sell if the price rises to 1.35
You got the direction right, it hit your target, so now you’ll close the trade.
That’s why it is called “take profit” - being exactly what this order does.
Stop loss
A stop loss is the opposite of a take profit order.
Let’s say you had gone long i.e. bought GBPUSD at 1.30. You could enter
a stop loss order to sell at 1.25.
27
All that means is close the position, by selling GBPUSD, if the price
reaches 1.25. You got the direction wrong, it hit your exit point, so now
you’ll close the trade.
FIGURE 15
A stop loss order to sell if the price drops to 1.25
That’s why it is called “stop loss” - being exactly what this order does.
We are going to look at how to use these effectively in a later article.
Trailing stop loss
A trailing stop loss is a really interesting order type.
It works exactly like a stop loss above in many ways.You have an existing
position and you need to set an exit price at which the pain is too much
and you want to close it out.
However, a trailing stop loss allows you to ‘lock in’ wins.
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FIGURE 16
A trailing stop loss order ratchets up as the trade moves in the money
Let’s say you were bullish and had bought at 1.30. You put your trailing
stop loss at 1.25 with an offset of 0.1. Since then the market went up. Nice
trade.
What a trailing stop loss does is ratchets up the stop level as the price
moves in your favour. Every time the price goes up 0.1 so does the stop
loss. For example it raises itself first to 1.26 and then 1.27 and so on for as
long as the price moves up.
It never adjusts itself lower. For example, once it is 1.27 if the price goes
down to 1.27 it'll sell and close out your position.
As soon as the stop loss gets above your buy price of 1.30 you know you
have made money on the trade. Clearly this order does not “stop a loss”
strictly speaking as you may be locking in a profit. But if the market
reverses and drops through its level at any point you’ll safely cut out of
the trade.
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Stop entry
By now you are probably seeing some similarities.
Like a limit entry order a stop entry is about entering a position you don’t
have.
The difference is that limit entry orders say “trade if the price gets more
favourable than now i.e. lower if I’m buying.” Stop entry orders say
“trade if the price gets worse than now i.e. higher if I’m buying.”
Okay, that sounds like madness. But consider this example. We are
looking at GBPUSD again. You might have a view that it should go higher
but keeps topping out around that 1.35 area. So you could enter a stop
entry: if the price gets above the 1.35 area then get me long! It is going to
the moon.
If the price remains below 1.35 you do not trade. You need confirmation
the previous high has been successfully broken before you are willing to
take a long position.
FIGURE 17
A stop entry to buy but only if/when the market trades through 1.35
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That’s a stop entry.
OCO
An OCO order stands for “One cancels the other”.
It is a very simple concept: you have gone long GBPUSD at 1.30 and you
have both a stop loss (1.25) and a take profit (1.35).
If either one of those is filled the other order should cancel since you no
longer have a position. You either made money and hit the take profit so
no longer need the stop loss ; or you lost money and hit the stop loss so no
longer need the take profit.
Kind of obvious once you know all the terms!
If done
If done is a contingent order. It saves you having to manually enter

orders.
For example, you could leave an If done limit entry order to buy GBPUSD
at 1.20. If that order is "done" i.e. if the price goes down to 1.20, a new
OCO order is created with a SL at 1.10 and a TP at 1.30.
The idea is just that you can enter this all into the system to prepare for a
price move and not have to sit there watching the market constantly.
I promise these orders will become second-nature really soon. Just

remember:
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• You can trade at the current market price with a market order.
• If you do not have a position already you’ll use a stop entry (buy when
the price is higher) or limit entry order (buy when the price is lower).
• If you do have a position already you’ll use a stop loss and take profit
and these will be set so that one cancels the other.
• You can combine all of this with an if done order. Your instructions
will be ready to implement in every circumstance.
Leverage and margin
Leverage and margin are a key topic. Again - nothing complicated but
it is important.
Let us imagine we are trading EURUSD and have a one-day trade

horizon. This pair fluctuates on average less than 1% a day.
With an account of £100, I am only likely to make or lose 1% i.e. £1. That is
very small. However, leverage allows traders to amplify these moves.
Here’s how it works.
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FIGURE 18
Leverage magnifies winnings and losses and needs to be used carefully
Leverage of 50:1 works like this:
• I deposit £100 into my account.

• This £100 is known as the margin.
• With 50:1 leverage the broker then gives me a tradeable balance of
£50,000 i.e. 50x my margin amount. That’s where 50:1 comes from.
• Now, when I buy EURUSD and it moves 1%, I can do so on an account
of £50,000 so a 1% move becomes £50 instead of the £1 before.
Relative to my margin balance of £100, I have now made (or lost) 50% on
an instrument that only moved 1%.
When you combine ignorance and leverage, you get some pretty
interesting results
Warren Buffett
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Leverage is a powerful tool but a double-edged sword. It amplifies not

only profits but also losses.
Sometimes brokers explain leverage in percentage terms.
If you see a margin requirement of 5% that means you must put down 5%
of the amount you want to trade which is the same as 20:1 leverage.
If you see a margin requirement of 1% that means you must put down 1%
of the amount you wish to trade which is 100:1 leverage.
Broker terminology
We need to understand a few terms:
• Margin requirement
• Account balance
• Used margin
• Free/unused margin
• Margin call
Let’s do it with an example.
We are trading gold and the broker’s margin requirement is 2%. This means
if we wish to take a position of $100,000 worth we must deposit 2% i.e.
$2,000.
For every 100 we trade we must deposit 2. They have offered us 50:1
leverage. We deposit our margin requirement for this trade of $2,000. We
now have an account balance of $2,000.
Now let’s say the trade moves in our favour and our position of $100,000
goes up 1%. We’ve made $1,000 in unrealised P&L. We say it is unrealised
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since that’s just the value of our holdings if we closed at current market
prices - we didn’t actually close the trade yet.
So our new account balance is $3,000. Very nice.
We have an account balance of $3,000 with $2,000 in used margin (for our
gold position) and $1,000 in free or unused margin.
We could use that $1,000 to add a new position, if we like, but the $2,000 is
reserved for our existing position.
Now let’s say that the gold price takes a turn for the worse. It retraces 1%.
Then it moves down another 2%.
Our account balance is now approaching zero. We gave back the $1,000 we
made. And we have lost the $2,000 we deposited.
At this point the broker will likely contact you with a margin call. If you
want to continue to hold the trade you’ll need to add more money since
your initial margin has all been used up with the drop in gold price.
If you do not top up your deposit, the broker may liquidate i.e. close the
trade on your behalf. This will crystalise your loss of $2,000. This is
known as a liquidation or stop out level.
Normally brokers will contact and warn you ahead of time with a margin
call when things get close but before it actually reaches the stop out level.
This gives you a chance to stay in the trade. However, the exact policies of
each broker vary.
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PNL calculation
Let’s do a trade from start to scratch. We are looking at Tesla CFDs and
we decide to buy.
Our broker asks for a 20% margin requirement. We know this is 5:1
leverage. We want to take a position of $10,000 so we deposit $2,000.
The market moves up 10% over the next week. We have made 10% of
$10,000 i.e. $1,000.
Relative to our deposit we are up not just 10% but 50%. That is because
we were leveraged 5:1.
Our PNL is $1,000. Our account balance is $2,000. We made a return of

50% on a 10% move.
It works exactly the same way in FX and everything else. We decide to sell
GBPUSD.
FIGURE 19
We sell GBPUSD at 1.32049
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Our broker asks us for a 4% margin requirement. We know this is 25:1

leverage.
We deposit £1,000. This allows us to take a position of up to £25,000 worth

of GBPUSD.
Unfortunately the price moves against us. Instead of going down as we’d
hoped, GBPUSD goes up from 1.32049 to 1.33049. That’s a price difference
of 0.01 since it is 1.32 to 1.33.
We have lost 0.01 * £25,000 which is £250.
So our account balance is now £750. This time the 25:1 leverage magnified
a loss, rather than a win.
If we had only traded a position of £1,000 we would only have lost 0.01 *
£1,000 on the move which is £10.
Demo trading
So now you know all the key trading concepts and are probably
thinking about how to practice them safely.
Enter … the demo account.
Almost every single broker offers a demo account. It looks and feels just
like a live account except you are playing with paper money. Anything
you make or lose on trades is just for fun, there’s no actual money at
stake.
Demo accounts are a great way to familiarise yourself with these concepts:
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• Leave order types and make sure they operate as you expect them to.
• Perform trades and watch the impact on margin.
• Understand how the amount of leverage you use affects the PNL that
is displayed in the platform.
This is great stuff as you can make sure you understand everything in this
article without actually risking any money.
If you wish to trade definitely start off by learning the basics of operating
a trading platform with a demo account.
However, demo accounts are of limited use when it comes to knowing

how real trading will be.
Imagine you are learning to drive a race car. Sure, playing a driving game
will give you a better operational understanding of steering and how
gears and breaks work. However, it won’t actually help you drive the car!
The two things are quite different. In a driving game it doesn’t matter
much if you skid off and crash. In real life it does and so obviously your
behaviour will be totally different.
It is the same with demo accounts.
They are great for getting you familiar with a platform and basic
operational concepts. They don’t really help you learn about trading.
The reason is that if you lose money on a demo account it can be topped
up (without any real money of course) and you never feel the emotional
attachment to trades that you do in real life. Furthermore the price data on
demo accounts may not match the real price data on live accounts.
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Once you have mastered the operations on a demo account, you may
wish to progress to real trading. But as a newbie you don’t want to risk
much. What you should do is fund a real account with a tiny amount of
money.
Now trade like you really would but in tiny sizes - the smallest available
increments. You may use no leverage (1:1) and if you only take a position
size of $10 then a 1% move is only going to make or lose 10c.
This will give you a far more realistic sense of how trading would be in
larger size than any demo account.
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4 FOREX FOR ABSOLUTE BEGINNERS
The forex market is the market in which you can exchange one
currency for another. You have likely used it without even noticing.
Say Bob from the UK goes on holiday to the US and buys a T-shirt for 20
USD. Bob’s UK bank now needs to convert this 20 USD into the correct
amount of GBP and remove that sum from Bob’s bank account.
On Bob’s behalf, his bank will go into the forex market to buy USD and
sell the equivalent amount of GBP. A tiny order of GBPUSD has been
traded!
This example is about transactional FX. This article will focus on trading
i.e. speculative trading in currency markets. However, both take place in
the same forex market. The example serves to show how commonplace
and huge the currency markets are.
The market size
The first thing to realise is that the forex market is huge. Ridiculously
huge. Every day nearly two trillion USD (1.65 to be precise!) of spot FX is
traded, according to the Bank for International Settlements.
This is many, many times larger than the global equity markets. For
example, summing up all activity across every single stock on every
single European stock exchange provides a daily turnover of just 50
billion USD. That 50 billion USD is barely 3% of the global spot FX
market.
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The FX market is simply huge, which means it is said to have great

‘liquidity’. Another bit of trading jargon. What traders mean by “great
liquidity” is that you can buy or sell at almost any time of day and the
cost of doing these transactions is incredibly cheap - more on that later.
Something that is “illiquid” would be hard to sell / buy immediately and
would involve large transaction costs. A house, for example.
However, despite the huge size of this market, there are far fewer
currencies traded than stocks. For example, whereas a major hedge fund
might trade in the region of 7,000 stocks it will likely trade fewer than 20
currencies. There are tens of thousands of stocks trading globally whereas
in currencies just nine currencies account for the majority of activity. In
fact, just three currencies — USD, EUR, JPY — account for over 70% of all
activity.
FX is always traded as pairs of currencies. You buy one currency and sell
the other. For example EURUSD means EUR versus USD. Here, again,
activity is highly concentrated. Look at the chart on the next page and
note that EURUSD alone accounts for almost one in five of all forex
trades.
So the FX market is huge and activity is concentrated in a handful of

major pairs, which makes it a very accessible market for retail traders. The
equities market by comparison requires monitoring thousands of stocks,
each of which has far less daily trading volume and is less
‘liquid’ (meaning more expensive to trade) than a typical currency pair.
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FIGURE 20
Currency market volumes are highly concentrated and EURUSD is the biggest of all,
data sourced from publicly reporting interbank ECN venues
Top pairs
Now we are going to look at some of the top pairs you’ll trade.As you
start to trade more you’ll soon realise that each pair has its own
‘personality’ and traders will affectionately refer to them by their
nicknames. Bizarre-sounding names like cable, the loonie, and the
widowmaker will become second-nature to you. We promise!
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Relative value
One thing to remember is the bullish / bearish terminology we covered

before. A trader is bullish an asset if they believe it will go up. She is
bearish if she believes it will go down.
So “I’m bearish EURUSD” means that EURUSD is expected to go lower.

That means, EUR is expected to drop in value versus the USD.
In equities and commodities it is very simple. If you are bullish oil you
think oil will go up. But in forex everything is expressed as one currency
versus another. Something goes up relative to something else.
Sometimes it is easier to think of a quote like EURUSD as EUR v USD. If

EUR goes up by the exact same amount as USD then the EURUSD price
wouldn’t have changed. If EUR goes up by more than USD then the
EURUSD price would go up.
But now consider USDCAD or USD v CAD. USDCAD goes up when USD
rises versus CAD. It goes down if USD drops versus CAD.
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FIGURE 21
It can take a while to get used to forex because we are always buying one currency and
selling another
If you are bullish on CAD (you think CAD will rise) that actually means
you are bearishUSDCAD. Imagine USD doesn’t move but CAD goes up -
well, the amount of CAD per USD (which is what USDCAD is) would go
down.
This relative value stuff can take a bit of getting used to so just keep it in
mind. Again, it will soon become second-nature.
EURUSD
EURUSD is by far and away the most popular and heavily traded forex
pair.
Because it is so heavily traded liquidity i.e. the ability to buy and sell
instantly is abundant. Spreads are typically under a single pip or 0.01% of
notional price, meaning you could buy and instantly sell and you would
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lose ‘only’ 0.02% in transaction costs.The daily range at time of writing

was 44 pips or 0.4%.
Of course EURUSD in the literal sense is a bet on the relative strength of

the European and US currencies. This means that negative news for the
Eurozone will tend to make EURUSD trade lower (EUR lower vs USD)
whilst negative news for the US will tend to make EURUSD trade higher
(USD lower vs the EUR).
However, EURUSD is one of the 'bellweather' products for financial

markets and is often traded as a proxy for 'risk on/risk off'. When the
outlook is good for the global economy EURUSD will generally react by
trading higher and when the outlook is bad EURUSD will generally trade
lower, even if this outlook or feeling of risk is not at all specific to the
Eurozone.
XAUUSD (gold)
Gold is by far the most favoured metal for retail traders, especially in
countries where physical gold has a strong historic tie to wealth such as
India and China.
Typically traded as USD per oz of gold, the pair is relatively liquid - far
more so than silver - with spreads of between 10-20 cents. Typical daily
range at time of writing was $9 or 0.7%.
Gold is seen as a safe-haven: when participants lose trust in governments

they buy gold as a long-term store of wealth since there is a fixed supply
of gold and governments cannot print more of it - unlike they can with
their own currencies.
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GBPUSD (Cable)
A top three FX pair, GBPUSD (and the various GBP crosses such as
GBPJPY, EURGBP) is very popular with retail traders.
Named "cable" after the transatlantic under-sea wire that transports

trading data between London and New York, this pair can be quite
volatile and spreads are wider than EURUSD - typically around two pips.
The daily range at time of writing was 0.6% or 78 pips.
AUDUSD (aussie-dollar)
Spreads are tight at 1-2 pips and daily range at time of writing was 0.5%
or 37 pips.
The Australian dollar belongs to the commodity currency group and

traders will often note its correlation to industrial metals like copper.
Because of its proximity to China and close trading relationship,
AUDUSD also moves in sympathy with Chinese economic data.
Of course AUDUSD is also a relative bet on the Australian currency

versus the US currency and domestic developments can also drive price
action.
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USDJPY (the widowmaker)
USDJPY is the second largest currency pair and, like EURUSD, trades
with a very tight spread - typically around a single pip. Trading ranges at
time of writing were 0.5% or 49 pips.
Nicknamed "the widowmaker" because it doesn't move much ... until it

gaps hugely! This can often catch out traders.
USDJPY is the most technically traded market. It is estimated that ~20% of

all USDJPY activity derives from retail traders (far larger than other pairs)
and these retail traders are often using chart-based signals. Even if you do
not believe in these signals it is important to be aware of them so that you
can predict what the crowd will do as these indicators can become a self-
fulfilling prophecy.
Because interest rates have been extremely low in JPY for a long time JPY
is often traded as a funding currency in carry trades. ZARJPY, TRYJPY,
AUDJPY are all popular expressions of this trade. We’ll look at carry
trades in more detail, later.
USDCAD (the loonie)
The "loonie", named after the bird on Canada's one dollar coin, is typically
a rather volatile pair but has been subdued in recent years. It generally
costs two pips to trade and has a current daily range of 0.4% or 52 pips.
Again there is a commodity link: Canada is a major oil producer and

supplies a large amount of oil to the US. Therefore USDCAD prices will
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reflect developments in the oil market as well as the relative outlooks for
the Canadian and US currencies.
DXY (Dexy or dollar index)
DXY is the USD index. That means the value of the US dollar vs a basket
of other currencies, which includes Euro, Japanese yen, British pound,
Canadian dollar, Swedish krona and the Swiss franc.
The USD is by far the most important currency. Sometimes you will want
to express a view on it broadly. If you would trade EURUSD for example
the price is also affected by specific developments in EUR. If you trade
DXY you are taking a broader bet on the USD normalised against multiple
currencies.
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FIGURE 22
The USD index is made up of a basket of currencies per above
Even if you do not trade DXY directly you should always keep an eye on
it for a quick feeling of USD strength or weakness.
There is an interesting story of ‘USD smile’. Basically USD will do well

when the US economy is strong but also when the world economy is weak
- because USD is seen as a flight to safety currency that folks like to hold
when they are nervous.
Currency groups
We have looked at some of the main currency pairs but now let’s
consider some of the common currency groups.
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The first common way to group currencies is majors and exotics.
Majors:
• EURUSD
• USDJPY
• GBPUSD
• AUDUSD
• USDCHF
• USDCAD
• USDCNH
• Gold
Exotics:
• USDTRY
• USDZAR
• USDSEK
• USDNOK
• USDMXN
• Silver
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The above is not an exhaustive list but gives you an idea. Really the
difference between the two is in the liquidity of each currency. The
spreads in majors should be much tighter than in exotics. Therefore if you
are trading in and out frequently you’ll likely focus on majors as the
spread costs would be too high in something like USDTRY.
The next common grouping is commodity currencies. These countries’

economies are often considered to be highly influenced by the price of
raw commodities.
AUD CAD NZD NOK
Copper, gold, Oil Dairy Oil

iron ore
For example almost one fifth of Australia’s exports are linked to iron ore
so the price clearly affects the Aussie dollar. Similarly almost one quarter
of Canada’s exports to the rest of the world (and thus a source of demand
for Canadian dollars to pay for the goods) are in energy products.
Sometimes you will hear people talk about EM (emerging markets) and
DM (developed markets). No grouping is perfect but you can probably
agree that Canada, Australia and the UK have more in common with each
other than they do Turkey and South Africa. More stable governments
and open economies and typically lower rates of inflation.
Finally you may see people refer to high-yielding and funding (low-
yielding) pairs. This is linked to the carry trade, which we’ll explore in a
later note.
Here are some low-yielding major pairs. Note that some of the rates are
negative! That’s right: you get negative interest from the central bank if
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you save Swiss francs. One year later you will have less in your account
than today. Madness.
EUR USD CHF JPY
0% 1.75% -0.75% -0.1%
Here are some high-yielding pairs.
ZAR TRY MXN
6.5% 11.25% 7.5%
This looks a lot like the DM vs EM grouping, you’ll notice.
The players
The FX market contains many diverse participants. Two crucial things

to note is that they do not all have the same objective when trading and
there is no central marketplace where all activity takes place. There are 4-5
major 'interbank' venues (known as ECNs) but activity across these
accounts for less than 10% of overall FX market volumes.
Most activity occurs bilaterally. The market resembles a spider's web of

connections between participants with the banks acting as connecting
nodes. Whilst FX prices are very transparent (you can Google them in
real-time) there is, for example, no single definitive EURUSD price in the
market. So choosing who you trade with is important in getting a fair rate.
Different brokers will offer you slightly different prices.
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Now we'll look at some of the major participant types in the FX markets.
Natural hedgers
There are of course the hedgers. This is non speculative activity, where the
end-user is simply trying to facilitate global trade rather than bet on the
direction of currencies. A very simple hedging example would be a
European corporate who produces a product in Europe but sells it in the
US and has to sell those USD to convert them back to EUR. These hedgers
conduct their activity via banks who go to the interbank market on their
behalf.
Banks
Banks are huge players in the forex market and sit in the middle of all the
other participants. Banks can speculate for themselves but the majority of
their business is based around providing liquidity to their clients. This
means allowing large clients who trade in minimum clips of one million
USD to buy and sell to them and then the bank hedging that risk with
other interbank participants in the interbank ECN venues.
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Central Banks
There are also Central Banks, who may intervene in the FX markets if they
think their currency is priced too high or low for their economic policy
goals. They are not seeking to profit but they are not hedging, either. For
example, if a local currency is high vs the USD, it makes it challenging for
domestic companies to export as their goods seem expensive to the
international market and the central bank may intervene by selling its
own currency in the interbank. Central Banks may also purchase foreign
currencies to build up their national reserves.
Speculators
Finally, there are speculators, who are trading forex to make a profit.
These range from retail traders, trading from their mobile phone, to multi-
billion dollar hedge-funds. These speculators only wish to bet on the
direction of the price so will only trade when they have reason to believe
they have an edge.
What’s a pip?
A lot of folks get confused about pips but they're really simple.
A pip is simply the historical unit in which prices fluctuated on the

interbank market. Over the years, as computers have replaced human
traders, spreads have tightened and now prices are often quoted to more
precision - hence the micro pips.
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In GBPUSD (and most pairs) the 4th decimal place is one pip. For
example the difference between 1.28485 and 1.28495 is one pip. In
USDJPY, however, a pip is defined as the second decimal place. For
example 110.225 to 110.235 is one pip.
FIGURE 23
The same GBPUSD quote as before
Let's try an example. If you sold below at 1.32049 and the price moved
down to 1.32000 you would have made 4.9 pips. The digit after the full
pip is sometimes known as a pipette.
The only reason you care about pips is so you can communicate with
other traders easily. Don't get stressed about it.
Often traders will refer to spreads in pips "the spread is half a pip wide"
or will talk about trading ranges "USDCAD traded in a 50-pip range
today" and this is all you have to know to understand what they mean. It
becomes intuitive very quickly as you look at these prices more often.
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What’s a lot or a unit?
Unit are really simple. If you have 100,000 units of EURUSD you have a
position of literally 100,000 EURUSD. 100,000 Euros’ worth of the
position.
Sometimes though you’ll see people refer to lots. This is just a shorthand
way of describing common trade sizes.
A standard lot means you have a 100,000 position whilst a mini lot is
10,000 and so on. Here's our handy cheat sheet.
Lot Unit
Standard 100,000
Mini 10,000
Micro 1,000
Nano 100
Yup. That's pretty much it.
The value of a pip
It is often useful to know the value of a pip. For example, you may
want to know “If my position moves 50 pips to my take profit, how much
will i have made?”
Calculating it can be a little tricky as you need to convert back into your
account balance. Happily we have built a simple calculator to help you.
You can find it at www.getmarket.com/calculator.
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FIGURE 24
The pip value of a position of 100,000 EURUSD is $10
In the above example someone has a position of 100,000 EURUSD. Each

pip is worth 10 USD. A move of 10 pips would result in a profit or loss of
10 USD.
Clearly if the position size were bigger the pip value would increase too.
Instead of one standard lot (100,000 units) let’s look at a three-lot (300,000
units) position.
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FIGURE 25
Dead simple - the pip value increases 3x because our position size increased by 3x
Pip value increased by 3x as the position is 3x bigger. Makes sense.
Volatility
It is really important to understand the different volatility of different

forex pairs.
Volatility simply means: how much does it move each day? If you look at
something crazy like Tesla shares for example they’ll sometimes move up
or down by 10% in a day. If you look at a major FX pair like EURUSD a
daily move up or down of 1% would be considered relatively large. Tesla
is more volatile than EURUSD.
This has implications for how you trade obviously. We’ll look at position
sizing in more detail in a later article but let’s say you have a risk appetite
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of making or losing 10% on your portfolio each day. Well, you would
Tesla without any leverage whereas you’d take a 10:1 leveraged position
in EURUSD to scale up that volatility.
Even in FX land, say you typically trade EURUSD in standard lots of 100k
units. If you start trading the more volatile exotics like USDTRY you
might only take a mini lot position of 10k units.
One nice way to think about volatility is in relation to spreads. Remember

earlier for EURUSD we learned that spreads are typically under a single
pip or 0.01% of notional price, meaning you could buy and instantly sell
and you would lose ‘only’ 0.02% in transaction costs.The daily range at
time of writing was 44 pips or 0.4%.
That seems kinda fair. If something only moves 40-50 pips you don’t want
to pay more than 1-2 pips to enter and exit a position.
The spreads are wider in exotic pairs but then again they tend to move
more. This is the typical relationship between volatility and spread: the
more a currency pair moves on average each day, the wider its spread.
If you are trading in and out often then stick to low volatility pairs with
tight spreads. If you are taking a longer-term view and happy to hold
onto a position for days or weeks then you have more freedom to trade
the exotic currencies with wider spreads because the spread itself will be a
small % of the overall move.
We will see in the next session that prices move most in the liquid part of
the day. This is when the major moves happen because this is when most
traders are active.
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Markets also move in cycles. Some years are just more volatile than
others. Deutsche Bank has created an index called the CVIX for currency
volatility. As you can see we are currently in a very sleepy, boring market
compared to the past. The CVIX provides you with a good high level
overview of currency volatility.
Timezones: when do people trade forex?
Unlike equities exchanges which have defined hours of trading, the

forex market is a ‘follow the sun’ market. This means it is open 24 hours a
day, 5.5 days a week. Weekends are not traded. Interbank venues shut on
Friday afternoon in NY and open again for the new week on Sunday
evening in New Zealand.
Traders often refer to three sessions throughout the day: the Asia open;
the London session; the New York close. Most trading activity occurs
during London hours as they cross-over with both the Asia market in
London morning and the US market in London afternoon.
FIGURE 26
For many, the best time to trade is the London-New York crossover hours
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This pattern of activity is representative for most major pairs. It is worth

noting that peak activity hours can and do shift for regionally-focused
pairs. For example, the Chinese currency (CNH) is most liquid during the
Asia-London crossover hours, as you might expect.
Having an idea of peak trading hours is important because the cost of

trading — we'll cover that in the next article — is lowest in the most active
hours.
Also, prices tend to move the most in the busiest sessions so these
timezones tend to provide the most trading opportunities.
The ‘always open’ nature of the forex markets seems to appeal to retail
traders who can fit trading in around their daily lives. We’ll cover this
later but there are tools that automatically monitor the market and trade
on your behalf, if for example the price reaches a target level, so you need
not worry about losing sleep!
There are two other times to mark in your calendar.
3PM London
“Options Expiry”. This is when options, which are often the main
instrument that hedge funds use to trade currencies, expire. For example a
hedge-fund may have bought an option a month ago to sell EURUSD at
1.10. If EURUSD is above 1.10 they will exercise it. If it is below 1.10 they
will let the option expire worthless.
For reasons we will not go into now you tend to find the spot market is
pulled towards the options expiry prices around 3pm. It has a
gravitational effect. So if you observe the price being very sticky in the run
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up to 3pm around a certain price, be prepared for it to move afterwards as

the options expiry completes and the effect disappears.
4PM London
The “FIX”. Big asset managers still leave orders to buy or sell currencies at
the WMR FIX. These orders are especially large at the end of the month
when they hedge the FX movements related to other portfolios like bonds
or stocks.
Banks will have billions of FX to trade in just a five-minute window. Be

aware that the price may be pushed around a lot during this window and
do not try to fight it because the sums involved are huge and pure supply
and demand will win.
Jump risk or weekend gap risk is another thing to be aware of. Say you
have a position in USDCAD and, over the weekend the Canadian
government declares a national state of emergency. Well, CAD is gonna
drop and USDCAD is gonna rocket. It will not happen immediately as the
market is shut but where will it open?
There is little you can do about this kind of thing. Sometimes it will work
for you and sometimes against. Some traders do not like the risk and
decide to close all positions before going into the weekend. That is a
perfectly reasonable approach.
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Why do people trade forex?
There are several reasons commonly given for why trading FX is so

popular.
Number 1: intellectual thrill
One reason is that it can be exciting and an intellectual challenge to

speculate on global financial markets. This is true not only of forex but of
many financial markets.
You have to be willing to make mistakes regularly; it’s about

making your best judgment, being wrong, making your next best
judgment, being wrong, making your third best judgment, and
then doubling your money.
Bruce Kovner
Number 2: edge givers
Another reason is that the forex market is unlike, say, equities in that there
are a number of non speculative traders (such as hedgers) whose non
directional activity provides an edge for those looking instead to trade
opportunistically for profit.
For example, imagine an Aussie corporate does a huge amount of

hedging, not because it believes the price is going lower but because it has
just sold a subsidiary. This hedging activity temporarily drives the
AUDUSD price down to a day’s low, buying the dip after they finish and
betting on the market mean-reverting to its old price might allow a day-
trader to take some profit out of the market by making it more efficient.
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Number 3: Low barriers to entry
The entry requirements are also low in FX. All that is really needed other
than education and some time is the internet. Accounts can be opened
with relatively small account balances — sometimes as low as $100 — and
trading is generally commission-free and available in fractional ‘micro lot’
sizes to accommodate smaller accounts. It is common to trade 'on the go'
via mobile apps. Finally leverage is easy to come by.
Number 4: Concentrated activity
Traders can focus on just 5-10 key pairs, rather than having to monitor
thousands of stocks each with highly specific company stories. Since retail
traders do not have teams of economists and analysts working for them -
unlike hedge funds - they may feel that focusing on 5-10 pairs is more
realistic than thousands of equities.
Number 5: 24-hour markets
The market also trades 24 hours which may appeal to traders who have
day jobs that constrain their availability.
Number 6: Huge, liquid market
The forex market is huge, which means that liquidity is plentiful — one
can buy or sell a given pair relatively easily throughout the day without
paying too much to do so. Furthermore even really big players cannot
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easily corner (control) the direction of the market for any length of time in
such a big market, which may be reassuring to smaller retail investors.
Number 7: Popularity
Popularity begets popularity. There is a big ecosystem of apps and tools

that has grown up around FX and CFD trading and there are large online
communities of fellow traders with whom new traders can talk and
bounce off ideas.
A lot of people like to compare forex vs equities vs crypto. Here is a

round-up table that compares the characteristics of each.
FIGURE 27
Author’s own experience
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5 CRYPTO FOR ABSOLUTE BEGINNERS
You’ll remember from the first article we looked at the history of

cryptocurrency markets. They are new, exciting, and have captured the
attention of the world’s retail traders.
Thousands of companies and people have begun to get involved in the

cryptocurrency world. A lot has happened in a short time. On the next
page is just a high level overview of developments.
The Bitcoin price increased from $1,000 in early 2017 to a peak of almost
$20,000 in just over a year. Crypto went from being a small subculture
thing in 2011 to a public mania in 2017 and 2018. It has been a very wild,
speculative ride.
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FIGURE 28
Some major developments in crypto markets
Major coins
There are hundreds of coins but only a handful that trade actively.
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CoinMarketCap is an excellent website for seeing the market cap of each

coin. Market cap simply means the total value of all the coins in existence.
For example if there were 10 coins with a value of $10 each the market cap
would be $100. It also shows the price of each coin and traded volume
over the last 24 hours.
FIGURE 29
Coin Market Cap is a website that lists one measure of each project’s size
Whilst this ranking is useful to get a sense of the most popular coins,
some people believe that the overall volumes on this site are wildly
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inflated. They make a very strong argument. For a more conservative and
probably realistic indication of daily volumes see https://
www.bitcointradevolume.com/.
You’ll notice that crypto volumes aren’t even 1% of global FX volumes.

That gives you some sense of how much more liquid FX is than crypto. As
we’ll see later that has a big effect on spreads and how much the price
moves each day.
Bitcoin (BTC)
In every respect Bitcoin (BTC) is the king of crypto currencies.
It has six times the market cap of the next biggest project and was the coin
that started the whole movement.
Other coins tend to be influenced by the BTC price and it acts as a kind of
bellwether for crypto markets in general.
The spreads in BTC are 0.5% (for crypto pretty tight but much wider than
FX pairs) but it has a huge daily range of 3.4% which makes FX look
puny! 1% would be a big day in FX. That is just an average, too. BTC can
move 10% in a day, which can be a little scary.
We will look at what drives the BTC price in a later article.
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Ether (ETH)
The Etherium network and its instrument of payment, named Ether

and often written as ETH, came after Bitcoin and introduced the idea of
smart contracts.
This means a contract that will automatically pay out when a condition is
met. The interesting thing is that it all takes place on the blockchain
without the need for any third party involvement. All the contract’s
conditions are embedded in code.
or example, imagine the ownership record of a car is put onto the

Blockchain as a token and the owner agrees to sell her car in return for
two Bitcoins. A smart contract could be created which automatically
transfers the ownership token to the buyer, upon him sending the two
Bitcoin. Neither side needs to trust one another i.e. no one has to ‘go first’
as the contract only completes when the conditions are met.
Ether is smaller than Bitcoin but still pretty huge. The spreads are slightly
wider than BTC at roughly 075% but its daily range is even larger than
BTC at nearly 5%.
Ripple (XRP)
XRP is the payment token used by the Ripple network.
Ripple aims to be a modern replacement for SWIFT - the system that

underpins global cross-border payments. Ripple wants to be the network
that banks use to send money to one another across borders.
The benefits of Ripple are clear: rather than taking days for a payment to
arrive, payments via Ripple can arrive in seconds. It also reduces the
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number of intermediaries between sender and receiver so should be

cheaper, too.
Whenever there are signs that the Ripple network is taking off the price of
XRP goes up. For example a bullish event would be a major bank using it
and publicly backing the network.
XRP is highly volatile and many traders trade it purely using technical
analysis.
Bitcoin Cash
Bitcoin Cash (BCH) is a fork of Bitcoin. Don’t worry we’ll cover what a
fork is later. All it really means is that Bitcoin cash started out as Bitcoin
and then a bunch of participants decided to branch out and do their own
network.
Bitcoin Cash came about when a number of Bitcoin developers grew

frustrated with the limitations of Bitcoin. They wanted to change the
network to make it easier for BTC to be used as a medium of payment in
everyday life.
They were mainly focused on reducing transaction costs and speeding up

the transaction times and increasing capacity.
You would never use BTC to buy a sandwich if it costs $10 per transaction
and takes ten minutes to complete. Hence the launch of Bitcoin Cash.
Bitcoin Cash has less brand name recognition than Bitcoin and trades at a
discount. There are 20 BCH to one BTC at time of writing. The big
question is whether that gap will narrow.
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Litecoin
Litecoin (LTC) and the Lightning Network came after Bitcoin but work
in similar ways.
Like BCH, Litecoin uses a different technical infrastructure to reduce some

limitations of the Bitcoin network that make it challenging to use for real-
world payments.
As a result, Litecoin transactions are faster and cheaper than Bitcoin

transactions.
Again, once you are outside ETH and BTC the crypto currencies tend to
be very volatile and exhibit wide spreads. This is true of Litecoin.
Tether
Tether is different to all the other crypto currencies above in that it is a

‘stable coin’.
It aims to be a tokenised USD. Its price is ‘pegged’ to $1. In theory it

should never vary much from that level because each Tether should be
redeemable for a USD upon receipt.
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FIGURE 30
Stablecoins are said to be ‘pegged’ to another asset like the US Dollar or gold
In practice it can decouple a little, based on the market’s trust in the

system.
However, Tether is not typically traded in the same way as BTC, ETH,
XRP, BCH, LTC given it is designed not to budge vs the USD.
Fiat and crypto
When you recall what you know about currency markets where one
currency is traded against another e.g. EUR v USD you might wonder
how that works in crypto currencies.
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First we have to understand what is meant by a fiat currency. All that

means is a currency whose value is backed or guaranteed by a
government. USD is an example. GBP is another.
The Great British Pound is an imaginary concept, really, it doesn’t entitle

you to a fixed amount of gold or any commodity. People are happy to
hold GBP or receive it as payment because everyone believes the British
Government will honour its debts and manage the stability and value of
its currency.
This is different to crypto currencies whose value isn’t backed by any

government. Instead their value derives from the market’s trust in the
network itself. We'll look at why in a bit.
Bitcoin for example is often quoted in USD. BTCUSD means “How many
USD is one BTC worth?” And this is the most common way to trade
cryptos.
But you can also trade crypto to crypto. For example, ETHBTC. And why
not? Perhaps you think Bitcoin goes down relative to Ether. Why use the
intermediary USD - especially if you are a hardcore crypto believer?
When trading minor coins - often known as ‘alt coins’ - you will typically
have to trade them versus crypto rather than fiat. Here you might have to
convert USD into BTC and then use the BTC to buy the alt coins.
There’s nothing new to learn here in terms of the quotes as it just works
exactly the same as with forex.
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FIGURE 31
Crypto quotes work just like any other quotes
The quote is for ETHBTC. If you sell you are selling ETH and buying BTC.
If you buy it is the other way around.
Physical, CFD and futures
People tend to make this overly confusing but it is pretty simple.
Physical just means you actually own the asset. If you buy a BTC you’ll
have a transaction on the Blockchain and use a wallet to store your BTC. It
is yours.
A CFD on crypto is exactly the same as a CFD on forex or stocks. You have
a contract open with the broker that will pay you out (normally in USD)
when you close the position. You do not physically own any Bitcoin, say,
you have simply taken a speculative position on its value.
Bitcoin futures got everyone excited when the CME (Chicago Mercantile
Exchange) launched them in December 2017. The CME is one of the
world’s largest exchanges, where futures on oil and US government debt
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are traded, and this was thought to help open up crypto to institutional
investors.
CME futures allow you to buy or sell BTCUSD for delivery at a set point
in the future. CME futures are cash settled and like a CFD the owner is
speculating on the price without actually holding the underlying crypto
currency. Retail traders do not access the CME typically but may trade
crypto futures on venues such as Bitmex.
FIGURE 32
A comparison of different trading instruments
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The really crucial thing to understand with futures is the settlement

mechanism. Say you bought a future that expires in one month, what
happens at the end of that month? The exchange will detail this in its
contract specification. Typically they will look at some physical exchanges
and take an average price for that day and call that the closing price.
So what are the advantages of trading each type?
The truth is that most traders will use CFDs or futures. If you are buying
with a view to holding for years or simply want to experience how the
network itself works then you might prefer physical.
OTC and exchanges
This is more relevant for physical transactions.
You can either trade on an exchange or OTC, which means over the
counter.For most people trading in reasonably small sizes the exchanges
will be fine.
For the whales who want to trade say 1,000 BTC at a time they might
obtain a better price by asking a market maker privately for the full
amount.
Exchanges are transparent and each tiny transaction is shown to

everyone. This is great in general but the amount you can buy or sell in
one go is quite small. Imagine trying to sell 1,000 BTC in small clips of 1-2
BTC each time on an exchange where everyone can see this activity. The
market would soon spot you as a seller and move the price against you,
which makes your sale price worse.
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FIGURE 33
An illustrative exchange
An OTC market maker will instead try to find someone on the other side
and match them. Or they may take the risk onto their own book. This is
sometimes called a block trade.
When you trade a CFD you are trading OTC. It is just a contract between
you and the broker. You trust the broker to provide you with any profits
you may make when you close the position.
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Accordingly you need to choose your broker extremely carefully and

trade with a sound company whose financials and compliance procedures
you trust.
All about wallets
Wallets are just the name given to places to store your crypto
currencies.
Crypto is a bearer asset, meaning whoever holds it owns it. If someone

can move crypto out of your wallet into theirs it becomes theirs. Now you
can see why it is important.
Public and private keys
The first thing to understand is public and private keys. Each wallet
has both a public and private key. A key is just a sequence of numbers. As
the name suggests the public number can be known by everyone with no
issue but the private one must remain private to you. This private key is
what proves you own and control the wallet.
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FIGURE 34
Public-private encryption
Think about a public key as a postage box’s address. It tells people where
to send your mail. The private key is the key that unlocks that box.
This is a highly simplified explanation of how the Bitcoin network’s
encryption works.
The crucial point is you must keep your private key secret. Unfortunately
it is a 256-bit long number so it is not something that is easy to remember.
Hence we have wallets.
Hot and cold wallets
A wallet is a convenient way to store your public and more importantly

private keys. Remember this is all there is to show that you own the
Bitcoin and you’ll need these to send Bitcoin to anyone else.
Wallets are often described as either ‘hot’ or ‘cold’. A ‘cold’ wallet is a

wallet that is not connected to the internet. An example might be a paper
certificate. Or it could be physical hardware - a USB drive device.
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The benefits of these cold storage devices is that they are extremely
secure. As long as no one has physical access to them, no one can see your
private key.
A hot wallet is a wallet that’s connected to the internet. Anything that is

connected to the internet could in theory be hacked. Different wallet
providers provide different levels of security but no one can guarantee
100% security.
On the other hand if you are frequently using the crypto then it is super
inconvenient to not have an online wallet. Imagine having to look up and
type in your private key every time you wished to make a transaction.
There’s a clear trade-off between convenience and security.
Exchange wallets
Sometimes when you trade on exchange, all that happens is the crypto
is sent to your account at the exchange. That means on the exchange’s
own wallet. Given exchanges are trading constantly they will have large
sections of their wallet that must be kept hot and therefore are vulnerable.
If you are trading in and out, it might make sense to leave your assets on
the exchange wallet.
However, there is a risk in doing so and you should consider moving it

into your own wallet if you plan on keeping the position for a period of
time. Of course if you just trade CFDs you can avoid all of this.
The mining process
Bitcoin mining sounds more exciting than it is. Miners are basically
auditors.
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One big issue with cryptocurrencies vs physical cash is the “double

spending problem”. Say I agree to send you a Bitcoin and I also agree to
send your friend one. If I have only one Bitcoin then you need to ensure i
don’t just try to send you both the same Bitcoin. With a $10 note clearly
we do not have the same problem as it physically cannot be in two places
at once.
There are two common ways of auditing a blockchain and we’ll look at
both.
Proof of work
Here’s where miners step up. Bitcoin operates a “Proof of work”

consensus scheme. Miners are simply farms of computers who perform
computational tasks on “blocks” of transactions. They validate each of the
transactions contained within the block. For example if there’s an alleged
transaction in which Bob sends Mary two Bitcoin, it’ll check that Bob has
actually signed the transaction with his private key and everything is
cryptographically legit.
Miners also have to find a number called a “hash” in order to process a

block. This hash itself is pretty useless - the point is just that it requires a
lot of brute-force computing power to solve it. This stops people
spamming the network because they have to invest significant computing
power.
When the hash is found, a new “block” comes into existence and the
transactions on it are processed. This means the Bitcoin arrives at its
destination and ownership has changed. The record is now stored in the
Blockchain, which is a history of all transactions. Multiple individual
nodes on the blockchain network will verify the latest block is valid so a
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miner cannot simply solve the hash and input fraudulent transactions to
benefit themselves. Such a block would be ignored by other nodes.
So why do the miners bother? Miners are rewarded for this effort with
newly minted Bitcoins. So the business model for them is to earn more
Bitcoin than it costs to run their computer network. It is a competitive
game. Multiple miners are competing simultaneously to complete the
transactions and only the first correct solution wins the Bitcoin.
Accordingly you get a lot of mining pools where miners club together to
increase computing power. The most sophisticated miners are based in
places where electricity is cheap such as Iceland. Over time the rewards
from mining Bitcoin halve - after every 210,000 blocks to be precise and
this makes Bitcoin more expensive to produce. We’ll look at that in a later
article.
The main thing to know is that these miners earn Bitcoin for powering the
audit and verification process for all the transactions.
Proof of stake
Whilst the design is very elegant, the thing that sucks about the proof
of work method is the effect on the environment. Bitcoin consumes more
electricity than the whole of Switzerland to solve hash problems that have
no real-world use.
With proof of stake, instead of miners there are validators. Would-be

validators lock up some of their Ether and the odds that they will be
chosen to perform the validation is in proportion to the amount they have
put aside.
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The validator who has been chosen then checks if the transactions are
valid and if so signs the block and adds it to the blockchain. They get a
transaction fee as a reward. If they performed the validations
fraudulently, their locked up Ether can be taken from them so they have
an incentive to act honestly - they would lose more than they would gain.
There are in-depth debates about which method is more secure or
decentralised but everyone can agree that proof of stake is more energy-
efficient.
FIGURE 35
Proof of work vs proof of stake
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The players
Retail
A huge segment of the market is individual retail traders. Team HODL.

There’s a nice story about HODL. It originally appeared in 2013 on a
forum from a - perhaps drunk - crypto trader who misspelled “hold”.
Ever since it has become part of crytpo culture with many now suggesting
it stands for “Hold on for dear life!”
Many of these retail traders are trading for the first time. We are not aware
of any reliable statistics but anecdotally the crypto market has the highest
percentage of retail traders.
Brokers
Brokers get flow from retail traders. They will try to hold some of the
risk but when it gets too big they’ll go onto an exchange to hedge their
exposure. Most of these brokers have their own trading desks, who
behave much like the professional end of retail traders. They are
experienced and have reasonably large position limits. One advantage
they have is being able to see the order flow from their clients and
knowing if the short-term pressure side is to buy or sell.
Whales
Whales are the one animal you don’t want to run up against. A whale is
just a huge holder of Bitcoin (or any crypto really). Often these are the
people who got in really early and are sitting on thousands of Bitcoins.
Occasionally they’ll enter the market and the changes in supply and
demand that their orders cause can be huge. Don’t forget the market is
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tiny compared to FX and very illiquid so a large order can send the
market up or down. Mostly these guys trade OTC but sometimes you’ll
see their footprints on the exchanges.
Funds
Funds are a bit like whales. They are professional firms focused on
trading crypto with investors’ money. The strategies can vary from fully
discretionary to systematic and each fund will have different time
horizons - some look to enter and exit a trade within an hour whilst others
may buy and hold for months.
Miners
Miners we already spoke about. When they get paid in Bitcoin they
will sometimes want to sell it so they can take out cash in USD or
diversify into other cryptos. Therefore miners selling tends to act as a
downward force.
Market makers
Market makers are the final big group and they work just like they do
in FX even though the firms who do this are not always the same across
both markets. Market makers aren’t taking long-term positions and will
flip from long to short throughout the day. They just want to get flow
from their customers - miners, funds, whales - and hedge it on the
exchanges or with other clients before the price moves too much and their
spread has disappeared.
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Volatility
Volatility in Bitcoin has calmed down relative to its past but it is still
absolutely crazy compared to FX. It just moves so much. Minor coins
move even more than Bitcoin.
Bitmex produces a volatility index for Bitcoin, which is calls BVOL. This
is very much like the CVIX we saw in FX. This aims to record an
annualised volatility rate for Bitcoin and typically sits around 50%.
Just like CVIX, monitoring changes in BVOL can give you a sense of the
market conditions as they shift through cycles of low and high volatility.
All the same stuff we learned in FX applies. As volatility rises you see
transaction costs / spreads increase. Position sizing, which we’ll look at in
a later article, becomes really crucial with extremely volatile instruments
like crypto if you want your trades to survive.
Trading hours
When people say crypto is 24/7 they mean it. This market is literally
never shut. Weekend trading is perfectly normal. This is unlike any other
asset class - even FX does not come close.
However it is of course the case that certain times are more or less liquid
than others. The day doesn’t map as clearly into the Asia , London , NY
session as it does in FX. Volumes seem to be driven mainly by price
moves, rather than having predictable profiles throughout the day.
Weekends do tend to be quieter than weekdays on average so there is

some ‘seasonality’ effect. However, occasionally huge moves happen over
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the weekend and volumes predictably spike with price moves - whether it
is a weekend or not.
There are some excellent and free resources such as https://

tradeblock.com/. This website is full of real-time analytics that allow you
to track volumes across the market at different times.
Forks
A fork is simply when a change in the underlying protocol of a crypto

network occurs. Think of Bitcoin Cash for example. Often this is when
groups of developers on a project have different views on how the project
should continue. Forks are typically split into soft and hard categories.
A soft fork means it remains compatible with the existing protocol. No

new crypto currency is created. A soft fork is considered complete once
the majority of the computers in the network have updated their software
to its version. If they do not do so, the minority group behind the fork
may give up. As such traders rarely notice soft forks.
Hard forks are much more disruptive. They result in the creation of a new
network and a new crypto currency. There have been many Bitcoin forks
and most of them have failed and are ignored but some, like Bitcoin Cash,
have acquired importance. A fork can be a big event for traders.
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FIGURE 36
An illustrative example of a fork
What do you need to do as a trader? Nothing to keep your existing coins.

You will still keep your old Bitcoins if there is a hard fork. No one can take
them. However, you may wish to claim your right to the equivalent coins
on the new network. There are some nuances to this and we'll cover them
in a future note.
Why trade crypto?
There are lots of reasons that people like to trade crypto.
Volatility
Firstly, there’s no doubt it is due to the volatility. Not many products can
move up 10% one day and down 10% the next. These big price swings are
of course a source of danger but with proper position sizing plenty of
traders will argue that it means there are more trading opportunities for
them.
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Non correlated asset
Crypto is also … different. It is relatively uncorrelated with most global

markets. This can be attractive for traders with portfolios who like to
diversify from a small group of global drivers. We will look at the drivers
for crypto later but it is safe to say that many - not all - of them bear
absolutely no relation to the stuff that drives EURUSD or US equities.
24/7 trading
Crypto trades 24/7. For intraday traders who are limited to trading over
weekends because they have a day job this ‘always on’ nature of the
market may prove convenient.
Retail edge-givers
Crypto has lots of uninformed participants who are trading for the first
time. The key is not to be one yourself. The big institutional hedge funds
by and large do not trade in crypto in the same way they do in developed
products like equities. The argument goes that there’s more opportunity
for the more experienced retail traders as a result as the space is less
crowded.
Exciting ecosystem
It is genuinely exciting. The whole crypto ecosystem is on fire. There are

plenty of charlatans and frauds, no doubt. However there are also some
really smart people doing genuinely interesting things. There’s a lot of
innovation. It is easy to understand why people find following the crypto
ecosystem exciting compared to the relatively dry subject matter of, say,
government bonds.
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Marketing and popularity
Lastly, it is aggressively marketed and popular. It seems like everyone

knows someone who made (or lost) a fortune trading crypto. There’s a
huge community out there on social media. Fuelling this are the adverts
that the brokers place in taxis and airports and online. We haven’t seen
this level of sustained marketing effort for retail trading for any other
product. Is that good or bad? It definitely works.
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6 THE A-Z GUIDE TO EQUITIES, INDICES

AND OPTIONS
If you ask the man on the street about trading, their mind will almost
certainly turn to equities. Speculating on the fortune of companies has
enthralled people for hundreds of years.
There is something compelling about the ‘story’ of an individual stock. A

feeling that - unlike forex or crypto - there’s a fundamental narrative to
the company that you can learn. How strong are its product lines and
management team? Does the market misunderstand its prospects?
In the last few years there has been a revolution in the access to the
market for retail investors. Commission-free trading (as we’ll explore
later) is now commonplace and the quality of trading apps has caught up
with the crypto and forex markets.
Trading basics are the same
You will be relieved to know that much of what you’ve already learned
about forex works the same way in crypto and equities. A lot of the
trading basics are the same. For example, let’s look at a quote for TESLA.
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FIGURE 37
A quote for Tesla stock
If you are bullish Tesla it means you think it’ll go up. So you want to buy.
You do so by paying the offer at 667.77. Exactly the same as forex and
crypto.
Leverage works exactly the same way, too. If you do not recall the lesson
it is worth going back and reviewing it.
Leverage allows you to amplify your bet: this can increase the size of
winnings but also losses. We will look at this in more detail in a later
section but traders tend to use less leverage on stocks compared to forex
because the stocks themselves are a lot more volatile.
The global equities markets
Unsurprisingly retail traders tend to focus a lot on their local markets

because these contain the companies with which they are familiar and
tend to be more interesting as a result.
A Polish trader is unlikely to trade German stocks and vice versa. The
exception is the US tech stocks. Things like Apple and Tesla capture the
imagination of traders worldwide and so these tend to be widely traded.
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Just for some guide you can see how big each of the markets are. EU
contains a number of separate markets like Germany, France and UK. The
US alone accounts for almost 40% of all equity wealth.
FIGURE 38
Data from SIFMA demonstrate how large the US market is
This is measured by market capitalisation. This simply means the total

value of the company, implied by the share price: take all the shares in
existence and times them by the current market price of each share.
Free stock trading
Retail traders tend not to access the direct exchanges. In some cases
they do but for the majority of orders wholesaler brokers will trade with
retail traders and hedge with market makers, who then offset this risk
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onto exchanges. There are two potential benefits of this approach,

although it has its critics.
Firstly, retail flow tends to be very nice. The orders are small and less
aggressive than the institutional flow on the exchanges. As a result, retail
traders can often trade inside Exchange Best Bid Offer. This means they
may get a tighter spread than the exchange would show. The high
frequency traders will show a tighter spread to win the flow and then sit
on the risk, waiting for another retail trader to send offsetting flow and
close the position. This process is known as internalisation but the result
of it is that retail traders can get very tight spreads.
FIGURE 39
A stylised route to market for retail equity flow
The second thing is commissions. Exchanges are businesses and charge

fees for trading activity. By avoiding trading directly on exchange the
wholesale brokers can offer their clients commission free trading.
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Robinhood was the first broker to aggressively market commission free

trading. Now it has become popular all over the world. You would
generally not expect to pay a commission these days when trading stocks.
This can really add up for traders who go in and out of positions often as
commissions used to be in the region of $5-10 per trade.
Stock indices
Traders don’t only trade ‘single name’ company stocks.They also trade
stock indices. A stock index is a basket of shares.
An example is the DAX or “GER 30”. This is an index which tracks 30 of

the biggest publicly traded companies on the Frankfurt Stock Exchange,
including well known brands such as Adidas and BMW.When you buy
the DAX you are buying all of these stocks in a basket.
Other common indices include the FTSE100 (UK); Nikkei 225 (Japan);
CAC 40 (France); Dow Jones or “Wall Street” (30 US stocks); Nasdaq or
“US Tech 100” (100 US Stocks); and the biggest of all the S&P or “US
500” (500 US stocks).
We will look at these in a bit more detail later. For now it is enough to
know you can use a stock index to take a position on the wider market in
each country, as well as trading individual names for a more specific story.
Top stocks and indices
There are thousands of stocks that you can trade. The universe is
absolutely huge compared to forex or crypto and can be quite daunting.
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However, the truth is that the vast majority of retail traders focus on only
15-20 instruments.
These will comprise the major indices that we discussed above; the top
global tech companies; any companies that are in the news a lot at that
particular moment; and some local companies that are of particular
interest to people in that country.
Let’s look at some of the top instruments.
GER 30 (DAX)
The DAX is often treated as a stock equivalent of EURUSD, although it is

a lot more volatile and has far greater moves each day. This can provide
opportunities but can be dangerous, too!
Spreads from €1 (0.01%) and a daily range of $177 or 1% (around
double EURUSD). This is very much a 'risk on' product that tends to do
well when market participants feel optimistic and gets sold when they
feel gloomy.
AAPL (Apple)
Apple is one of the most traded stocks in the world. Therefore spreads are
reasonably tight at 4 cents (0.02%). As with all single stocks price action is
volatile with a typical daily range of 1.7% or $3.
As with all stocks, the price action is driven by both macroeconomic and
stock-specific factors.
• Macroeconomic factors include the overall health of the economy and
the future view of interest rates: low interest rates tend to result in
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higher stock prices whereas anything that made interest rates more
likely to hike (increase) would tend to weigh on stock prices.
• Stock-specific factors simply represent all the things that analysts
believe affect the prospects of a company: its balance sheet, its product
pipeline, its leadership and strategy.
Prices tend to be especially volatile around major events such as quarterly

earnings releases when the company releases data on its progress and
outlook.
UK 100 (FTSE)
This is a bet on the UK's top 100 blue-chip stocks. Spread of ~£2 (0.03%)
and a daily range of £94 or 1.3%.
As with all stock indices it tends to act as a 'risk on' asset and represents a
proxy for how investors think the performance and cash flows of major
companies listed in the UK will look like in future.
US 500 (S&P)
The S&P 500 is, like EURUSD, one of the bellweather market products.
Spread of 4 cents (0.01%) and a daily range of $39 or 1.4%.
It is an index that tracks the stocks of 500 blue-chip public US companies

across multiple sectors including tech, financials, health care, industrials
and others. When people talk about the US stock market as a whole the
S&P is typically the benchmark index they have in mind.
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Wall Street (Dow Jones)
The Dow Jones Industrial Average is the oldest of the indices. It began life
at a price of 100 in February of 1885. Its nominal (i.e. without adjusting for
inflation) price at time of writing – some 134 years later – is $24,805
reflecting the long-term gains of the wider stock market.
Spreads from $2 (0.01%) and a range of 1.1% or $272 in dollar terms.
Relative to the S&P 500, the Dow Jones is much more concentrated and
covers only 30 stocks.
US Tech 100 (Nasdaq)
The youngest of the indices, the Nasdaq covers 100 stocks so sits in
between the DJIA and S&P 500 in terms of coverage breadth.
Spread of $1.7 (0.02%) and the highest daily range of any stock index at
1.6% of $111 in dollar terms.
It is considered the most tech-heavy of the indices and because of its

concentration in riskier, high growth companies such as the FANGs
(Facebook, Apple, Netflix, Google) it tends to be the most volatile.
Hours
The hours in stocks tend to be much more rigid than forex or crypto
because they are set by the underlying exchanges.
For example British stocks trade on the LSE and that is only open 08:00 to
16:30 UK time. You cannot trade outside this window and - even if
someone will let you - it is not advisable to do so as the core market is
shut.
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The stock market opens with something named an ‘auction’. Given a lot
may have happened after 16:30 UK time when it opens at 08:00 the next
morning the price is unlikely to be the same. This opening auction sets the
new price.
Similarly a lot of volume - some say up to 20% of the day’s activity -

happens in the closing auction. Before the market closes a lot of
institutional orders are released, targeting a ‘closing price’, and so there’s a
flurry of activity.
This can be seen below. Note how this is specific to equities - it doesn’t
happen in forex or crypto.
FIGURE 40
Analysis using public exchange data
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CFD vs physical stocks
Just like we saw in crypto there’s a difference between trading the

physical asset and a CFD on it. Both might give you the same kind of
exposure - profiting if it moves in your direction but losing if it goes in the
other way - but they do so differently.
The first thing to note is that with a CFD you do not own the physical
stock. You instead have a contract with a broker that will mimic the stock
price. If the broker goes bankrupt you have nothing, unlike when you
own the share certificate and it sits with you regardless of what happens
to your broker.
Trading via CFD means you wouldn’t get some of the benefits of owning
a share. You could not attend or vote for example at a company’s annual
shareholder meeting.
Economic benefits and corporate actions are replicated. For example if the
stock pays a dividend payment to its shareholders or $5 per share, this
would be credited to your account by the CFD provider. Equally,
sometimes companies will do share splits which means halving the price
but giving each shareholder twice the shares they own. For example if you
owned ten shares at $100 each you’d now own twenty at $50. CFDs will
replicate all this, too.
There are some benefits of CFDs.
For one thing you can get leverage on them, allowing you to trade
without having to put down a lot of margin. This is typically not available
on physical stocks.
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You can also short stocks via CFDs which is a feature rarely available
using physical shares. Physical shares accounts tend to be long only. If
you think for example Tesla is overhyped and due a correction, you can
express that view via CFDs.
Finally you may find the tax treatment is favourable on CFDs. It will
depend on your circumstances and jurisdiction but often stamp tax duty
is not charged on CFD trades but is charge on physical shares.
In general traders who enter and exit positions frequently will use CFDs
whereas long-term investors will use physical shares.
Spreadbetting
Spread betting is popular in the UK because in certain circumstances

the proceeds may not be subject to capital gains tax.
In many respects it is similar to a CFD but rather than taking a position in

the normal way you bet a fixed amount per point. For example, $10 per
DAX point. If DAX goes up 10 points you’ve made 10 x $10 = $100. If it
moves down 5 points you’ve lost 5 x $10 = $50.
The other difference to CFDs is that all spread bets have an expiry date by
when the date ends. You can always close the spread bet earlier, if you
wish to do so, but there’s always an end date unlike CFD positions which
can be held as long as you like.
Volatility
Volatility in stocks can be wild! Compared to forex, individual stocks

and even indices move a lot. Although a bit less than crypto which is truly
the wild west of trading.
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As we saw with the CVIX in FX, we can get an idea of the overall equities
regime by looking at a volatility index. This is called the VIX. Some media
articles refer to it as the “fear index” because a high VIX normally
indicates that the market is scared.
Tesla’s (TSLA) wild stock ride began Monday with a whopping

20% increase to $780 per share. That was followed by a 17% price
spike Tuesday, sending prices near the $1000 dollar mark. Year-to-
date that’s a 170% increase in Tesla’s share price, and a
quadrupling since its low of $178 in June 2019.
Forbes article
That is utterly crazy price action. With such a volatile stock it makes sense
to be very careful with leverage.
The cause of volatility for stocks will depend on the stock in question. For
example, when tensions run high in the China-US trade war you will see
US companies who rely on importing/exporting to China affected whilst
others are not. However there are some predictable times of high
volatility for all stocks.
Earnings are one such time. This is when the market gets an update from
management on business progress. Typically there is an instant move on
headline numbers (key metrics like revenue etc.) where the market
compares the actual results with what it had expected. Check out our
news trading article for more on that. Then afterwards there’s a Q&A with
executives and wall street analysts in which more detail emerges and the
price can bounce around during this call, too.
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If you are following a stock closely you will hear in the news that its
quarterly earnings are due soon. Yahoo also has a neat tool that lists all the
earnings results for each day.
FIGURE 41
Screengrab of the Yahoo earnings calendar
Options
Options are not specific to stocks - there are forex options, too - but
retail traders tend to use stock options more than any other type. The two
building block options are puts and calls.
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Puts
A put would be used if you are bearish. Say Netflix is trading at $369 /
$370.
FIGURE 42
The cost of buying a March $355 put is $15.59 in this example. This is known as the
“premium”
Buying a $355 March 6th put would mean you have the right but not the
obligation to sell Tesla at $355 on March 6th. The cost of buying this option
is $15.59.
Now, if Tesla’s price stays around $370 you are clearly not going to
exercise or use that option. Why would you sell something for $355 when
the cash price is higher? Your worst case outcome is that you have lost
your premium of $15.59.
However, imagine you were correct in your bearish outlook. By March 6th
Tesla is actually trading at $300. Now your option lets you sell at $355,
locking in a $55 profit. Well, more like $40 since you paid $15.59 for the
option.
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The benefit of the option is that you can express a bearish view with a
fixed maximum loss of $15.59. Even if Netflix rockets up to $600 you only
lose the $15.59. No one forces you to sell at $355 - you simply choose not
to do so. With highly volatile stocks that are scary to short, you may find
options help you ride out the volatility.
Calls
A call is the opposite of a put. It means you have the right but not the
obligation to buy at a certain price.
FIGURE 43
The cost of buying a March $625 call is $94.11 in this example. This is known as the
“premium”
For example above - you would pay $94.11 for a $625 March 6th call
option on Tesla. The strike price is $625 and expiry date is March 6th.
If Tesla’s price is above $625 on March 6th you’ll obviously exercise your
right to buy the shares cheaply via the option. You can then sell them back
in cash and lock in a profit.
If Tesla’s price is below $625 on March 6th you simply won’t use the
option. You’ll have lost your premium of $94.11.
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Again - this can be a useful tool if you like the stock higher but are
worried about a big drop and your ability to hold onto the position
meanwhile.
In and out the money
This stuff can be hard to wrap your head around so take a moment to re-
read.
• Call is bullish.
• Put is bearish.
• If you own the option you have the right but not the obligation to trade
at the strike level at expiry.
• When buying an option the most you can lose is your premium.
You can of course trade options just like anything else. You do not need to
hold them till they expire. If the stock moves in your chosen direction and
the option price goes up you can sell it and close your position.
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FIGURE 44
PNL pay-off when you own an option … you start off losing money (premium paid) and
then make money if the market goes above your strike and covers the initial premium
outlay
Selling options is way more risky. If you sell a call option on Tesla you will
collect $84.50 upfront in premium. But if Tesla now rallies 20% higher you
will be forced to sell the shares at a big loss to the option holder.
Selling options is incredibly risky as you may have uncapped losses - the
stock can keep going up and up - and it is hard to see how doing so could
make sense for the average retail trader.
This is a left-skew strategy. On most days you will earn a small return but
sooner or later you expect a huge loss that may wipeout your entire
account. Think very, very carefully before even considering selling
options. You would be exposing yourself to potentially unlimited losses.
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Like leverage, options are powerful tools but can be very dangerous if
used carelessly.
Analysts
Analysts are employed to do research on stocks and write

recommendations. Often attaching price targets to the stock and a buy /
sell / hold view on each report. Sometimes you will see famous analysts
on CNBC debating the market.
We are going to cover some common valuation methods in our equities

fundamentals article.
Retail investors do not get access to investment banking analyst reports.

However they can access articles online on sites such as Seeking Alpha.
The quality of such reports varies - take note of who has written it and try
to judge whether they are an objective and credible voice.
Tesla is a good example of analysts being a completely useless signal.

Here’s an analyst quote from mid 2019. In the subsequent year Tesla
traded as high as $690.
Barclays says Tesla is ‘stalling as a niche automaker’ and cuts its

price target to $150
CNBC Headline
Today there are analysts who claim it will reach $1,000 and those who
believe it is worth $200. That’s such a wide range it is not very helpful.
Nonetheless, reading analysts reports can help you see how others view
the stock - whether you have the opposite or same view as them on its
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direction. A healthy diet of both bulls and bears will help you form your
own, informed opinion.
This is helpful information as you know what they consider to be the

main drivers and how they may react if certain things occur. They may
also force you to consider a scenario or fact you had missed.
The players
The stock markets are a key investment asset class for all sorts of
people.
There are retail traders who take positions. This is especially common in
the US and Asia and a little less so in Europe.
The largest players are asset managers - hedge funds and pension funds.
These whales will trade in large size but with completely different
investment styles. Mostly they’ll be holding the position for days if not
weeks or months.
The key thing to notice is that everyone is trying to earn a return and beat
the market. Unlike FX there is very little transactional real-world activity.
People are buying because they think it goes up!
One set of major players who act a little differently are the passive tracker
funds. You have surely heard the noise about Vanguard. Its low cost index
trackers are often used as part of people’s pension portfolios.
Rather than pay a wealth adviser 1.5% a year, simply pay 0.2% to
Vanguard and it’ll invest your pension pot across stock market indices,
without trying to beat the market, just replicating its overall returns and
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diversifying across multiple indices. That’s something like how the pitch
goes.The strategy is popular and AUM have ballooned.
FIGURE 45
Figures compiled by the FT show that the AUM of tracker funds has become huge
These index trackers must buy additional shares as new investors give
them money and their AUM increases. Because these funds don’t try and
beat the market they’ll buy regardless of a company’s prospects - they just
need to buy whatever is in their index.
Corporates also trade in the market because they will sometimes do share
buybacks of their own stock. This is when they have excess profits that
cannot be reinvested in the business. They may choose to pay out a
dividend to shareholders or they may choose to buy back their shares.
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They will tend to do so when they think the current price is cheap relative
to long-term prospects.
Market makers are active like in forex and crypto. However, they do not
tend to hold positions for the long term. They just act as temporary risk
buffers, earning spread in exchange for giving the other players an
immediately available price at which to buy and sell.
Why do people trade stocks, indices and options?
Stocks are one of the world’s biggest asset classes so it is totally natural
that investors and traders will get involved. The below shows the S&P
index over the last few decades. Investing in stocks - rather than trading
in and out of them - has been a huge wealth generator for many people.
And this ignores the dividends!
FIGURE 46
The stock market has been kind to long-term investors
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There is an intellectual thrill in learning what makes a company tick and

trying to predict its fortunes. This can be hugely interesting and exciting.
One of the advantages (and disadvantages!) of stocks is that there are so

many of them. Compared to 20 currency pairs you can trade maybe
10,000+ stocks. This gives you plenty of opportunities to find over or
under-valued companies or express themes that you like.
Volatility is another factor in why people like stocks. They really move!
These moves can be dangerous so you have to size your positions
accordingly but a stock that moves a lot clearly offers more trading
opportunities than a product that doesn’t. Options may prove attractive
for managing this volatility - being able to buy a call and pay a premium
to know that you can hold onto that bullish view, without getting
destroyed if the stock gaps 20% in the wrong direction short-term.
Popularity is another reason people like trading stocks. Lots of people

from all walks of life trade stocks and there’s a wealth of commentary and
analysis (not all of it good!) on TV and the internet. There are huge
communities online of other traders willing to discuss ideas.
As well as single stocks, indices are a convenient and popular way to

express a view on multiple companies across a whole country. With a
single trade you can gain exposure to all the US tech companies, for
example.
Finally, now that stocks are commission free, trading them has become
much more frictionless. It is possible to trade from a mobile phone and
with no fees. The concept of fractional share ownership has also helped. It
means you can own $50 worth of Apple shares, even if a single share costs
$300. The barriers to entering the stock market are far lower for regular
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people than they were previously and that has boosted retail trader
engagement.
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7 CORE CONCEPTS OF TECHNICAL

ANALYSIS
Technical analysis is a huge subject. It is comfortably the most popular

form of analysis amongst retail traders. There are all sorts of self-
proclaimed gurus and funky names like “shooting stars” and “bull
hammers”. But let’s start with the basics.
The idea behind technical analysis is that there are clues visible in price
charts. These signs offer clues as to the market’s future direction. The
future echoes the past.
Higher or lower prices happen because traders choose to buy or sell.

These traders - as with all humans - behave in predictable ways when
confronted with certain situations. They panic. They are greedy. This
predictable behaviour creates patterns that technical analysts can exploit -
if they know where to look.
Having clear patterns on a chart is reassuring when making sense of a

market with so much noise. Feeling good for example that you have
identified a clear stop loss level on the charts - “at this point i’m wrong” -
may give you the confidence you need to enter trades. In the face of
uncertainty we humans love a clear process we can follow.
There are however problems with technical analysis. For one, it is more of
an art than a science. Two people applying the same method on the same
chart would not necessarily arrive at the exact same conclusion.
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FIGURE 47
If you draw enough lines, one of them will be right! This is not the way to do it
Also - it can be incredibly noisy. Amateur traders often create monstrosity

charts like the above. If you add 100 indicators onto a chart then surely
one of them will seem like it worked when you review it afterwards. That
does not help you at the time.
More experienced traders often embrace a rule of “the simpler, the better”
for technical analysis. This article will give you an overview of the most
common tools and methods widely used in the market. We are not going
to cover every single pattern but rather the broad strokes of this
discipline.
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Chart types
To detect a pattern you need to chart the prices visually. We will focus
on the three most common chart types: bars, lines, candlesticks.
Bar charts are sometimes called OHLC charts. They look like this.
FIGURE 48
A simple bar chart, sometimes known as OHLC charts
Each bar tells you the key information about that session. It shows the
opening price, the high price, the low price and the closing price of its
period. Periods can be a minute, a day, a week - whatever you choose.
Open, high, low, close - hence OHLC. Green means the price went up in
that period i.e. close was higher than the open. Red means the opposite.
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FIGURE 49
How to read a bar chart
The advantage of bar charts is that they are a visually simple way to
capture a lot of information. You can see if a market has been trending.
Equally well you can inspect individually daily bars and see which days
had big or small ranges and which days were up or down.
Line charts are even simpler. They are just a simple line. Unlike the bar
chart which contained high, low, open, close there is only one data point
per time unit. Commonly this is the closing price.
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FIGURE 50
Compare this line chart to the bar chart on the previous page
Be aware that a lot of information has been lost. If you look at a line chart
to find the low of the last year it may only show you the low closing price.
The closing price is likely not the low of that day. Therefore traders tend
not to use line charts other than for a quick glance to see the day’s price
action.
Candlesticks contain the exact same information as bar charts. However,

many folks find them easier to read. Candlesticks are so popular we are
going to come back to them later.
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FIGURE 51
Candlesticks are similar to bars but a more popular form of chart with traders
Timeframes
There are two choices: tick and clock-time.
Tick charts show every single price move, rather than sampling the price
once per second or once per minute. In some busy minutes a price may
move or ‘tick’ one hundred times whereas in others only once. The tick
charts capture more information but are unreadable at any longer term
horizons and thus rarely used outside high frequency strategies.
For clock-time charts we can set our chart to different timeframes -

minute, hourly, daily and so on. This will determine what length of time is
captured in each candlestick. For example if we click 1D below each
candlestick on that chart will represent one day.
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FIGURE 52
Changing the timescale on a chart allows you to investigate both short and long-term
trends
If you prefer you can also select a range for the chart. Perhaps 1Y for one
year. In that case the chart will automatically adjust the candlesticks to the
appropriate period (in this case one day) and show you the price chart
over the last year. It is very simple.
You can try it by visiting www.tradingview.com which is a popular (and

free) charting tool. Try both methods of updating the chart till you are
comfortable with how easy it is.
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FIGURE 53
This is a chart of Apple stock - AAPL. You can see we have chosen a candlestick chart.
Next to the stock we see "D" meaning we have daily candlesticks. Try clicking on that to
change it. Alternatively you can choose the range, at the bottom. Right now "1Y" is
selected so you can see the chart covers the last year of trading. Chart from TradingView
Choosing the right time horizon
Different trading styles will lend themselves to different time horizons.

If you are a long-term trend follower then it makes no sense to look at the
minute charts. Instead you're more likely to look at charts where each
candlestick represents a whole day.
A lot of newbie forex traders want to get rich quick so they’ll look at very
short time-frames like one minute. Of course there are many more
patterns at such a micro level but also way more noise. Often these traders
will get chopped to pieces and frustrated.
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Looking at the one-hour chart reduces the noise but also means it takes
longer to find a trade setup. The daily chart even more so. As with so
much of trading, the time horizon that works for you will depend on your
personality.
If you are a big picture trader who likes to ride a small number of long-
term trends and not constantly check the market you may look at 1Y
charts with 1D candlesticks. If you are a markets junkie who likes to
follow every tick and make hundreds of tiny trades a day you may look at
the five or fifteen minute candlesticks.
A bit of experimentation is required to find what works for you. Just be

aware that you need to be consistent and not go cycling through time
horizons until you finally find a pattern that confirms what you already
wanted to see! That is known as confirmation bias.
You can also use a combination of longer and shorter term charts.
Long term charts are good for analyzing the big picture and to get
a broad perspective of the historical price action. Once the big
picture has been analyzed, a daily chart can be used to zoom in on
the latest few days or weeks.
Ashwani Gujral
Some advanced traders will use multiple time-horizons to help them get a
sense of the short-term and long-term trend. For example, you may be
trading the hourly charts and you use those to identify that the trend is
higher. So you want to buy and get long. However, you may zoom in to
the 15-min chart to get a sense of the short-term trend to help you enter
into your long position at a good price. Maybe you can buy cheaply by
waiting for a little pullback in the trend.
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Equally, you may zoom out to the daily charts to see if the hourly trend is
confirmed by the daily trend. In general traders trust a trend more the
longer it has lasted. so a daily pattern is more important than the same
pattern on an hourly chart and so on.
Price scales
The typical price scale used by traders is the arithmetic or linear scale.
99% of charts are of this type. It is the type of chart we are all used to.
However, when the price has moved hugely in a short period of time
(think of crypto) some traders will use a log scale. This keeps the gaps on
the chart as a constant percentage. The charts look slightly different and
so any trend lines you draw onto the chart come in at different levels, too.
FIGURE 54
The Bitcoin price chart looks very different on a linear scale (left) to how it looks on a
logarithmic scale (right)
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Log scale is generally used when prices have had huge fluctuations and
on longer-run charts. For short-term trading where you are only
comparing the prices across a few days at most almost everyone uses
arithmetic scale charts.
Support
This is one of the key concepts of technical analysis and even the most
hardcore fundamentals-driven traders will observe it.
Support is a level which - as it sounds - is supporting the price. The most

common support is a previous low. Imagine for example we approach the
previous year’s low in a stock.
Well, anyone who wanted to buy the stock is going to think “hey, it’s great
value down here because last time it bounced” and leave limit orders.
These resting buy orders have the effect of supporting the price and
making it go higher if the support zone is reached.
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FIGURE 55
A previous low is a classic support zone
There are other classic support levels, too.
One is just simple round numbers. Yep, it’s a thing. USDCHF took ages to
break the 1.0 level. This may sound odd but maybe it is simply a self-
fulfilling prophecy. If traders in the market believe that other traders in
the market care about round numbers then all of a sudden trading
behaviour is influenced by them.
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Resistance
Resistance is the flip side of support. It is a level at which the price is

expected to meet resistance.
No surprise for you: the most common resistance is a previous high.

Imagine we approach the last year’s high in Bitcoin and all the bears will
think “this is a great place to sell, last time it couldn’t punch through
here.” These resting sell orders will have the effect of making it hard for
the price to push through them.
Again, round numbers and trend lines and moving averages are all
common methods to identify resistance levels.
For both support and resistance try to think of zones rather than exact
numbers. This is because prices often have a stab at going through
resistance and whilst an exact number might break the rough zone holds.
We’ll look at this in more detail when we look at stop losses.
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FIGURE 56
Here we see a previous resistance level (red zone) become a support level (green zone),
after the price has broken through the resistance
There is also a very clear phenomenon where an old resistance that has
been broken becomes a new support and vice versa. Consider above - the
market breaks the old resistance at X and then this acts as a future
support. This makes sense as it was a significant price zone for traders
and they will have a significant reaction to it in future. This phenomenon
is extremely common.
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Trending and ranging markets
When we zoom right out we can see that markets operate in different
regimes. For years a market might be range-bound with no real trends.
FIGURE 57
A range-bound market can be frustrating for traders
This environment can be very tiring and expensive for traders. They try to
identify a trend and get chopped up in the noise with lots of false
breakouts. The trick here is to simply sell at resistance levels and buy at
support levels and sit on your hands when it is in the middle.
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That is easier said than done. Range bound markets are obvious after the
fact but at the time you are always thinking it might break out and a new
trend might emerge. As the price goes higher and reaches the old high the
market is most optimistic. The fundamentals and news will seem bullish!
You may get a number of fake breakouts - we’ll cover those in a bit.
FIGURE 58
A trending market. Trending markets are where most traders make their money. A
trending market feels easy to trade for most people. You buy and the price goes higher -
you get confirmation, which humans love. It is far harder to be contrarian and go against
the trend
The key with trending markets is to identify the trend and stick with it.
Ignore noise. Here’s a story from the greatest trading book of all time.
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The customers, who were all eager to be shoved and forced into
doing things so as to lay the blame for failure on others, used to go
to old Partridge and tell him what some friend of a friend of an
insider had advised them to do in a certain stock. They would tell
him what they had not done with the tip so he would tell them
what they ought to do. But whether the tip they had was to buy or
sell, the old chap’s answer was always the same. The customer
would finish the tale of his perplexity and then ask: “What do you
think i ought to do?” Old Turkey would cock his head to one side,
contemplate his fellow customer with a fatherly smile, and finally
he would say very impressively, “You know, it’s a bull market!”
Edwin Lefevre "Reminiscences of a stock operator”
The point being made is that the majority of PNL comes from being on the
right side of the big-picture trend, not picking highs and lows of
individual days.
One way to play trending markets is to take advantage of pull backs.

These are often called retracements. If you know that the market is in a
bull trend then whenever there’s a temporary wobble lower you can add
to your position. Using the moving average can be a helpful method here
and we’ll look at that in a bit.
Traders also look for ‘continuation patterns’. One such pattern is the flag.
The above flag pattern shows a market consolidating around the new
price zone, after a rally higher. Once the flag is broken to the upside it
indicates a new rally may occur.
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FIGURE 59
This is a flag pattern. After a big trend the market takes a breather and consolidates in a
sideways range. Once that flag is broken to the upside the trend resumes full-steam
ahead
When trading ranges one must always be alert for reversals. This means a
signal the trend has run out of steam and will change direction. We will
look at some of these signs later on in this article.
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Trend lines, channels and wedges
Trend lines can be very simple.

Here’s a support trend line showing an upward trend with the price
bouncing off the trend line. Obviously the more times it has held the
better - five bounces off the line indicates a more robust trend line than
two bounces.
FIGURE 60
A simple trend-line support
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Trend lines can sometimes result in channels. Here traders will try and
buy and sell within the channel. They might be core long but flip briefly to
short at channel highs, for example, before going back long.
FIGURE 61
Here we see a channel. In this case it holds nicely
Other traders will try to play break-outs. A common strategy is to wait

until a support (or resistance) has been broken and then trade with the
momentum. For example if it breaks a previous high then go long and
add a stop below the previous high, which will now act as a support.
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Unfortunately there are lots of false breakouts - these are sometimes called
fakeouts. This strategy only risks a small amount, provided you leave a
tight stop loss, but you can get burned multiple times in a row. Even if the
loss each time is small it can hurt your confidence to lose multiple times in
a row. Hence why traders tend to prefer trending markets rather than
range-bound environments.
If the two lines do not form a channel but rather point towards each other
that’s known as a wedge formation. At the end of the wedge the market
has a choice to make: higher or lower! We will look at wedge patterns in
some more detail in a later chapter.
FIGURE 62
This is an ascending wedge, meaning it is angled upwards
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Moving averages
Moving averages are an incredibly powerful tool. So simple but scarily

powerful. In trending markets they keep you on the right side of the
trend. That is key.
There are two main flavours: simple moving average (SMA) and
exponential moving average (EMA). The simple moving average is just a
weighted average of all the last prices. Say a 30-day moving average. It
looks at the average price of the last 30 days, recalculated each day.
Therefore it only updates by one day at a time and is quite slow to react.
This gives us a nice smooth trendline.
FIGURE 63
Simple Moving Averages on a chart. Note how the shorter periods are "faster" or more
reactive than the "smoother" longer periods
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Of course the periods you choose makes a difference, too. The longer the
period the more observations. That results in a smoother trendline but
means it is slower to react.
An EMA on the other hand weights the most recent days more highly.
This means it is faster to update. If the price is changing direction the
EMA will capture this trend pretty fast.
FIGURE 64
Note that the EMA is "faster" than the SMA for the same period
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On the other hand it will be noisy and provide false signals that the
slower SMA does not. Imagine you are long EURUSD and there’s a tiny
pull back: the EMA may suggest you sell out of your position whilst the
SMA keeps you in it.
Neither approach is necessarily better than the other. It is just a case of

using the right tool for the job. Trying plotting SMA and EMA on your
time scale and seeing which you think better captures the trend. Do you
prefer the faster but noisier EMA signal or the smoother but slower SMA?
A common way to use moving averages is as a support or resistance line.

We talked earlier about buying pullbacks on a bullish trend. One way to
do that is to pick a moving average and add to the position whenever the
price pulls back to that level. In that case it is being used as a support
level. However moving averages can also work in exactly the same way
as a resistance level.
FIGURE 65
Moving average resistance line capping the price
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Of course the exact level doesn’t always hold. Sometimes you may use the
zone of two SMAs of different speeds as a stop zone.
FIGURE 66
Here we have a moving average resistance zone, made from two moving averages lines
Clearly the timeframe that you pick will affect your moving average.
Many people will use multiple moving averages - short and long-term - to
define trends.This gives rise to a technique called the moving average
crossover.
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FIGURE 67
Look how beautifully the moving average crossover catches first the downtrend then the
uptrend
When the faster moving average crosses the slower average it generates a
signal because it indicates a new trend is forming. For example you might
buy when the 5 SMA cuts above the 30 SMA. Here the faster average
signals the trend has turned. If at some point in future the 5 SMA then
crosses below the 30 SMA you would close your position and flip short.
Momentum indicators
We are going to look at momentum in detail in our factors article. For

now you can think of momentum as the pace and energy of the trend.
The Relative Strength Index (RSI) is a common oscillator that was

introduced in 1978. It measures the magnitude of recent moves versus
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moves in the recent past. The RSI gives readings of 0-100 and the values
oscillate within this range. How they oscillate can provide some clues.
Many traders will consider a reading above 70 as overbought. They feel

that any uptrend is likely to fade. Equally many traders will consider a
reading below 30 as oversold. They feel that any downtrend is likely to
reverse.
FIGURE 68
The RSI indicator is an oscillator, whose values swing up and down
However, it is not that simple. What traders really look for is a stretched
RSI that is already beginning to turn.
Of course these 30 and 70 are just whole numbers - there is nothing
hugely different about a reading of 29 or 31 so you don’t think of these as
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hard rules. Over or underbought indications are just giving you one piece
of the overall picture.
FIGURE 69
Here the RSI nails the turning points: as it indicates overbought the trend reverses and
sells off and then the oversold signal captures the bottom of the trend. Chart from
TradingView
A trend is often at its strongest just before it turns - so always wait for
confirmation before fighting the trend.
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In fact - just to make the point - often these same values are sometimes
interpreted in almost the opposite way. There is a concept called
divergence, which is when the RSI points in a different direction to the
price. Followers of divergence believe that the oscillator will override the
price signal and that price will follow the oscillator.
Divergence is when the price makes lower lows but the oscillator does
not. Or when the price makes higher highs but the oscillator does not.
Typically this is interpreted as a sign that the current price trend may stop
or reverse. It is a reversal sign.
Hidden divergence is when the price makes higher lows but the oscillator
does not. Or when the price makes lower highs but the oscillator does not.
Typically this is interpreted as a sign that the current price trend will
consolidate and continue. It is a continuation sign.
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FIGURE 70
Divergence and hidden divergence are another way to use the RSI indicator
It is a little inconsistent that some traders will flip bearish because an RSI
reading is too high and thus “oversold” (above 70) whereas at other times
they’ll consider a new high on the RSI to be confirming the new high they
can see in the price.
Again, all these indicators are just little clues that help give you a clearer
overall picture. RSI is not something on which to base a mechanical
trading rule - just another part of the overall puzzle. Always remember
the old advice of not fighting the trend. The RSI may alert you something
is at extreme levels and should be on your radar but you can wait for it to
actually turn before jumping on the trade.
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Leading and lagging indicators
There is a trade-off between leading and lagging indicators.
Of course a leading indicator that tells you what the price is going to
do before it happens is amazing. However, bear in mind these indicators
are less certain and more noisy. The RSI is an example.
Let’s look at the RSI oscillator above … it screams oversold … but the
price still moves higher. If anything the trend gets stronger. In fact this is
pretty common: a large part of the overall move happens in the final,
gasping stages of a bull or bear run. Being too early is just as bad for your
PNL as being wrong!
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FIGURE 71
RSI indicates overbought yet the market bull trend continues for some time. Chart from
TradingView
A lagging indicator may provide more certainty that the directional trend
is established but at a cost: you only learn about the trend after it is
underway. A slower, long period SMA is a good example of this - the
trend is clearly established but you missed the start of the move.
Both leading and lagging indicators help fill in part of the overall picture.
It is simply important to understand the difference and limitations of
both.
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Candlestick patterns
Candlesticks are the most popular type of trading chart. There are
even certain names for particular types of candlesticks.
Do not read too much into them. It is not the case that if you see a certain
type of candle the price is certain to go up or down: if you look closely at
charts you’ll notice that these patterns often give you a false signal.
Trading is a game of odds and this is just one more factor that may tip the
trade in your favour - if you see a certain pattern, it aligns with other
technical indicators, you like the fundamentals already then that’s when
you go for it. Trading off simple patterns by themselves is not a magic
bullet.
The best way to think about this is that a certain style of candlestick
characterises a type of trading day. For example a day in which bulls and
bears battled, going higher and lower, but ultimately closing where it
started produces a specific candlestick pattern.
A spinning top for example is a marker of great indecision where the open
and close end up very close to one another, but during the session the
market tried to go both higher and lower. This shows the market is unsure
of the future direction and was unable to close much lower or higher.
Some believe these markers of indecision are inflection points. They see
them as signals the market is about to reverse its current trend.
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FIGURE 72
A spinning top candle is often seen as a sign of uncertainty that might mark a turning
point in the trend
To keep a bull trend going you need continued buying pressure. What the
spinning top captures is that the market opened, tried to go higher, tried
to go lower, and ended up much where it started. Neither the bulls nor
bears prevailed. This could be sign that the bull trend is running out of
stream.
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FIGURE 73
This spinning top is often found at a key trend reversal moment when the downtrend
turns into a bull trend
Doji are similar to spinning tops but the open and close price are even
closer together or even the same. Seeing a doji after a strong run up or
down in the price may indicate that the trend followers are exhausted as
they fail to push the market in their direction. Accordingly many also
view them as a warning of a potential reversal in trend.
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FIGURE 74
Some popular "types" of doji candlesticks
Hammers are another important type of candlestick. They are called

hammers because they … look like hammers.
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FIGURE 75
Here's an example of a hammer candle "hammering out a bottom" of a downtrend
Where a hammer is seen after a downtrend it may indicate a reversal.

Here we see the sellers tried to force the price lower but buyers fought
back and the session closed near the open. This may indicate fatigue on
behalf of the sellers and thus a good entry point for those looking to play
the reversal of the trend.
Hammers can be very useful for people who try to go against the trend
because they help you time your entry to when participants riding the
trend are exhausted.
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The colour of the hammer may be either bullish (higher close than open)
or bearish (lower close than open). Traders will generally prefer that the
colour aligns with the view: for example, if it indicates a reversal of a bear
trend a green hammer is even better than a red one.
The hanging man candlestick looks exactly like a hammer. The only
difference is that it is seen after an uptrend rather than a downtrend.
Again, in combination with other signals, this may signal a reversal in the
trend. Buyers were unable to push the price higher and the market even
tried to go lower.
FIGURE 76
A hanging man candle signals the end of the uptrend
Well, what about an upside down hammer? Or an upside down hanging

man?
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These have different names but operate the exact same way:
• An upside down hammer is known as an inverted hammer and might
indicate a downtrend is about to reverse.
• An upside down hanging man is known as a shooting star and might
indicate an uptrend is about to reverse.
FIGURE 77
Inverted hammer and shooting stars
Again it is worth repeating that seeing such a pattern by itself is a weak

indicator. Most traders would expect to see such a candle in conjunction
with other aspects that make them wish to trade.
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Equally many traders would wait for confirmation that the trend has
reversed. For example if you see an inverted hammer which may indicate
the downtrend is over you will wait for a close higher in the next candle
before entering a position.
There is a saying in trading that it is “hard to catch a falling knife”. What

this means is that you can get burned trying to pick the absolute high or
low and get in at the very start of a reversal. Better to give up a few pips
but not fight market momentum and join in when the trend appears to be
confirmed.
Patterns and the learning journey
We’ll now look at two common patterns. There are many hundreds of
patterns used by traders and we’ll cover others later. For now two will
suffice to show you how to learn and use new patterns.
The first peak is caused when the price makes a new high and stalls. It
comes a bit lower before having another go and failing around the same
zone again, creating the second peak. The final peak is a repeat of this
failed attempt to make new highs.
The triple top is confirmed when the price breaks through the retracement
level of each peak. Commonly traders will then cut longs and perhaps
even enter shorts, using an equal gap lower as their price target or take
profit level. They would leave a stop above the retracement level.
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FIGURE 78
A triple top pattern
Head and shoulders is another classic pattern. It indicates that a bull trend
is about to reverse.
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FIGURE 79
A head and shoulders pattern
As always the pattern is just telling us about the war between bulls and
bears and who is flagging. We can can see the price trying to go higher
and failing. It then makes a lower high (right shoulder). As the shoulder
line is broken the bearish trend is confirmed. The bulls are losing to the
sellers and the trend is expected to continue lower.
And really we are just getting started. There are hundreds of patterns - we
have just covered some of the most popular. There are exotic techniques
like Elliott Wave theory and Fibonacci retracements. Even relatively
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simple and popular techniques like swing trading and pivot points. We
will cover all of those later.
For now the key thing is just to be aware there’s a lot out there and focus
on intuitively understanding the basics before you move on to
progressively more niche techniques.
The reality is that bank and hedge fund traders do use simple and
intuitive technical analysis like support, resistance, trend lines and
moving averages to help them time entry and exit points … the more
exotic stuff is used far less.
Does it work?
Tech analysis is extremely attractive to new traders. They love the idea
of finding a system that can beat the market. No need to focus on
complicated fundamentals, simply refine a system and follow it.
Unfortunately … that doesn’t work. Think about all these people selling
systems - if it was really so great why bother selling it? Just trade and
enjoy the winnings.
Equally, do not forget there are incredibly well resourced quantitative

funds who trade these markets professionally and use complex
algorithms to detect any patterns and exploit them in milliseconds. Way
before a retail trader can trade. If a simple moving average system or
pattern works so well does it really pass the sniff test?
We humans are biased to seek out patterns. Even where they do not exist.
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FIGURE 80
Do you see the smiling face? We are wired to see patterns, even when they don’t exist
Beware of this when looking into the charts. It is really easy to confirm a
bias you already had and find a pattern that suggests the next move will
be up/down when there are so many patterns to choose from.
Indeed most tech analysts I’ve met are always chasing the rainbow,
convinced that one final refinement to their system will bring them the
results they desire ... but never quite getting there.
Most professional traders do not enter trades purely based on tech

analysis. That is not to say it is not useful. Almost all traders will know
and use the basic techniques in this article. Again - most will not trade
purely because of a simple pattern but it might be one additional
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argument in favour of adding a trade. Or it might help time entry and exit
levels on the trade.
If you see two or three things line up in a cluster of bullish or bearish
signals then you have higher conviction. You just broke a major resistance,
the moving average is supportive and you like the fundamentals -
brilliant.
Many successful traders use technical analysis to help them time entry
and exit of trades whose direction they like for other reasons. It is a
fantastic risk management tool and provides very clear stop and take
profit levels which you can use to implement your directional view. You
don’t have to love it but ignore it at your peril.
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8 RISK MANAGEMENT FOR TRADERS
The first rule of making money through trading is to not lose money. Look
at any serious hedge fund’s website and they’ll talk about their first
priority being “preservation of investor capital.” You have to keep it
before you grow it.
Strangely, if you look at retail trading websites, for every one article on
risk management there are probably fifty on trade selection. This is
completely the wrong way around. The great news is that this stuff is
pretty simple and process-driven.
Anyone can learn and follow best practices. To my mind, this is one of the
most important chapters in this book so please take time to read it
carefully and think about its contents.
Capital and position sizing
The first thing you have to know is how much capital you are working
with. Let’s say you have $100,000 deposited. This is your maximum
trading capital. Your trading capital is not the leveraged amount. It is the
amount of money you have deposited and can withdraw or lose.
Position sizing is what ensures that a losing streak does not take you out
of the market.
A commonly cited rule of thumb is that one should risk no more than 2%
of one’s account balance on an individual trade and no more than 8% of
one’s account balance on a specific theme. We’ll look at why that’s a rule
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of thumb later in this chapter. For now let’s just accept those numbers and
look at examples.
Let’s say we have $100,000 in our account. We wish to buy EURUSD. We

should therefore not be risking more than 2%, which is $2,000.
We look at a technical chart and decide to leave a stop below the monthly
low, which is 55 pips below market. We’ll come back to this in a bit.
Knowing all these details, what should our position size be? We go to the
calculator page, select Position Size and enter our details.
FIGURE 81
You can find this tool online at www.getmrmarket.com/calculator or you can find many
other position size calculators online, all free to use
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So the appropriate size is a buy position of 363,636 EURUSD. If it reaches

our stop level we know we’ll lose precisely $2,000 or 2% of our capital.
You should be using this calculator (or something similar) on every single
trade so that you know your risk.
Now imagine that we have similar bets on EURJPY and EURGBP, which
have also broken above moving averages. Clearly this EUR-momentum is
a theme. If it works all three bets are likely to pay off. But if it goes wrong
we are likely to lose on all three at once. We are going to look at this
concept of correlation in more detail later.
The total amount of risk in our portfolio - if all of the trades on this EUR-
momentum theme were to hit their stops - should not exceed $8,000 or 8%
of total capital. This allows us to go big on themes we like without going
bust when the theme does not work.
As we’ll see later, many traders only win on 40-60% of trades. So you have
to accept losing trades will be common and ensure you size trades so they
cannot ruin you.
Similarly, like poker players, we should risk more on trades we feel

confident about and less on trades that seem less compelling. However,
this should always be subject to overall position sizing constraints.
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FIGURE 82
Size your bets according to how strongly you feel about them (the exact % will vary for
each trader)
For example before you put on each trade you might rate the strength of
your conviction in the trade and allocate a position size accordingly.
To keep yourself disciplined you should try to ensure that no more than
one in twenty trades are graded exceptional and allocated 5% of account
balance risk. It really should be a rare moment when all the stars align for
you.
Notice that the nice thing about dealing in percentages is that it scales. Say
you start out with $100,000 but end the year up 50% at $150,000. Now a
1% bet will risk $1,500 rather than $1,000. That makes sense as your
capital has grown.
It is extremely common for retail accounts to blow-up by making only 4-5

losing trades because they are leveraged at 50:1 and have taken on far too
large a position, relative to their account balance.
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Consider that GBPUSD tends to move 1% each day. If you have an

account balance of $10k then it would be crazy to take a position of $500k
(50:1 leveraged). A 1% move on $500k is $5k. Two perfectly regular down
days in a row — or a single day’s move of 2% — and you will receive a
margin call from the broker, have the account closed out, and have lost all
your money.
Do not let this happen to you. Use position sizing discipline to protect
yourself.
The Kelly Criterion
If you’re wondering - why “about 2%” per trade? - that’s a fair

question. Why not 0.5% or 10% or any other number? The Kelly Criterion
is a formula that was adapted for use in casinos. If you know the odds of
winning and the expected pay-off, it tells you how much you should bet
in each round.
This is harder than it sounds. Let’s say you could bet on a weighted coin
flip, where it lands on heads 60% of the time and tails 40% of the time. The
payout is $2 per $1 bet.
Well, absolutely you should bet. The odds are in your favour. But if you
have, say, $100 it is less obvious how much you should bet to avoid ruin.
Say you bet $50, the odds that it could land on tails twice in a row are
16%. You could easily be out after the first two flips.
Equally, betting $1 is not going to maximise your advantage. The odds are
60/40 in your favour so only betting $1 is likely too conservative. The
Kelly Criterion is a formula that produces the long-run optimal bet size,
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given the odds.
Applying the formula to forex trading looks like this:
Position size % = Winning Trade % - (1 - Winning trade %) /

Risk Reward Ratio
If you have recorded hundreds of trades in your journal - see next chapter
- you can calculate what this outputs for you specifically.
If you don't have hundreds of trades then let’s assume some realistic
defaults of Winning Trade % being 30% and Risk Reward Ratio being 3. The
3 implies your TP is 3x the distance of your stop from entry e.g. 300 pips
take profit and 100 pips stop loss.
So that’s 0.3 - (1 - 0.3) / 3 = 6.6%.
Hold on a second. 6.6% of your account probably feels like a LOT to risk
per trade.
This is the main observation people have on Kelly: whilst it may optimise
the long-run results it doesn’t take into account the pain of drawdowns. It
is better thought of as the rational maximum limit. You needn’t go right
up to the limit!
With a 30% winning trade ratio, the odds of you losing on four trades in a
row is nearly one in four. That would result in a drawdown of nearly a
quarter of your starting account balance. Could you really stomach that
and put on the fifth trade, cool as ice? Most of us could not.
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Accordingly people tend to reduce the bet size. For example, let’s say you
know you would feel emotionally affected by losing 25% of your account.
Well, the simplest way is to divide the Kelly output by four. You have
effectively hidden 75% of your account balance from Kelly and it is now
optimised to avoid a total wipeout of just the 25% it can see.
This gives 6.6% / 4 = 1.65%. Of course different trading styles and

different risk appetites will result in different optimal bet sizes but as a
rule of thumb something between 1-2% is appropriate for the style and
risk appetite of a typical retail trader.
Incidentally be very wary of systems or traders who claim high winning

trade % like 80%. Invariably these don’t pass a basic sense-check:
• How many live trades have you done? Often they’ll have done only a
handful of real trades and the rest are simulated backtests, which are
overfitted. The model will soon die.
• What is your risk-reward ratio on each trade? If you have a take profit
$3 away and a stop loss $100 away, of course most trades will be
winners. You will not be making money, however!
• Is there some left-skew risk on the trade where you make a small
amount most days but there’s a small chance of a huge blow-up (like
selling a lottery ticket)?
In general most traders should trade smaller position sizes and less
frequently than they do. If you are going to bias one way or the other, far
better to start off too small.
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How to use stop losses sensibly
Stop losses have a bad reputation amongst the retail community but are
absolutely essential to risk management. No serious discretionary trader
can operate without them.
A stop loss is a resting order, left with the broker, to automatically close
your position if it reaches a certain price. For a recap on the various order
types visit this chapter.
The valid concern with stop losses is that disreputable brokers look for a
concentration of stops and then, when the market is close, whipsaw the
price through the stop levels so that the clients ‘stop out’ and sell to the
broker at a low rate before the market naturally comes back higher. This is
referred to as ‘stop hunting’. This would be extremely immoral behaviour
and the way to guard against it is to use a highly reputable top-tier broker
in a well regulated region such as the UK.
Why are stop losses so important? Well, there is no other way to manage
risk with certainty. You should always have a pre-determined stop loss
before you put on a trade. Not having one is a recipe for disaster: you will
find yourself emotionally attached to the trade as it goes against you and
it will be extremely hard to cut the loss. This is a well known behavioural
bias that we’ll explore in a later chapter.
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Learning to take a loss and move on rationally is a key lesson for new
traders.
A common mistake is to think of the market as a personal nemesis.

The market, of course, is totally impersonal; it doesn’t care whether
you make money or not
Bruce Kovner
There is an old saying amongst bank traders which is “losers average

losers”. It is tempting, having bought EURUSD and seeing it go lower, to
buy more. Your average price will improve if you keep buying as it goes
lower. If it was cheap before it must be a bargain now, right? Wrong.
Where does that end? Always have a pre-determined cut-off point which
limits your risk. A level where you know the reason for the trade was
proved ‘wrong’ ... and stick to it strictly. If you trade using discretion, use
stops.
Picking a clear level
Where you leave your stop loss is key.
Typically traders will leave them at big technical levels such as recent
highs or lows. For example if EURUSD is trading at 1.1250 and the recent
month’s low is 1.1205 then leaving it just below at 1.1200 seems sensible.
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FIGURE 83
Previous highs or lows are a popular choice for stops and take profits
You want to give it a bit of breathing room as we know support zones

often get challenged before the price rallies. This is because lots of traders
identify the same zones. You won’t be the only one selling around 1.1200.
The “weak hands” who leave their sell stop order at exactly the level are
likely to get taken out as the market tests the support. Those who leave it
ten or fifteen pips below the level have more breathing room and will
survive a quick test of the level before a resumed run-up.
Your timeframe and trading style clearly play a part. Here’s a candlestick
chart (one candle is one day) for GBPUSD.
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FIGURE 84
GBPUSD daily chart
If you are putting on a trend-following trade you expect to hold for weeks
then you need to have a stop loss that can withstand the daily noise. Look
at the downtrend on the chart. There were plenty of days in which the
price rallied 60 pips or more during the wider downtrend.
So having a really tight stop of, say, 25 pips that gets chopped up in noisy
short-term moves is not going to work for this kind of trade. You need to
use a wider stop and take a smaller position size, determined by the stop
level.
There are several tools you can use to help you estimate what is a safe
distance and we’ll look at those in the next section.
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There are of course exceptions. For example, if you are doing range-break
style trading you might have a really tight stop, set just below the
previous range high.
FIGURE 85
On a breakout chart you might leave a tight stop just below the previous resistance zone
Clearly then where you set stops will depend on your trading style as
well as your holding horizons and the volatility of each instrument.
Here are some guidelines that can help:
• Use technical analysis to pick important levels (support, resistance,

previous high/lows, moving averages etc.) as these provide clear exit
and entry points on a trade.
• Ensure that the stop gives your trade enough room to breathe and
reflects your timeframe and typical volatility of each pair. See next
section.
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• Always pick your stop level first. Then use a calculator to determine
the appropriate lot size for the position, based on the % of your
account balance you wish to risk on the trade.
So far we have talked about price-based stops. There is another sort which
is more of a fundamental stop, used alongside - not instead of - price
stops. If either breaks you’re out.
For example if you stop understanding why a product is going up or

down and your fundamental thesis has been confirmed wrong, get out.
Let’s say you are long because you think the central bank is turning
hawkish and AUDUSD is going to play catch up with rates … then you
hear dovish noises from the central bank and the bond yields retrace
lower and back in line with the currency - close your AUDUSD position.
You already know your thesis was wrong. No need to give away more
money to the market.
Letting stops breathe
We talked earlier about giving a position enough room to breathe so it

is not stopped out in day-to-day noise.
Let’s consider the chart below and imagine you had a trailing stop. It
would be super painful to miss out on the wider move just because you
left a stop that was too tight.
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FIGURE 86
Imagine being long and stopped out on a meaningless retracement ... ouch!
One simple technique is simply to look at your chosen chart - let’s say
daily bars. And then look at previous trends and use the measuring tool.
Those generally look something like this and then you just click and drag
to measure.
For example if we wanted to bet on a downtrend on the chart above we

might look at the biggest retracement on the previous uptrend. That max
drawdown was about 100 pips or just under 1%. So you’d want your stop
to be able to withstand at least that.
If market conditions have changed - for example if CVIX has risen - and
daily ranges are now higher you should incorporate that. If you know a
big event is coming up you might think about that, too. The human brain
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is a remarkable tool and the power of the eye-ball method is not to be

dismissed. This is how most discretionary traders do it.
There are also more analytical approaches.
Some look at the Average True Range (ATR). This attempts to capture the
volatility of a pair, typically averaged over a number of sessions. It looks
at three separate measures and takes the largest reading. Think of this as a
moving average of how much a pair moves.
FIGURE 87
The ATR indicator is available on charting systems such as TradingView
For example, below shows the daily move in EURUSD was around 60
pips before spiking to 140 pips in March. Conditions were clearly far more
volatile in March. Accordingly, you would need to leave your stop further
away in March and take a correspondingly smaller position size.
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Professional traders tend to use standard deviation as a measure of

volatility instead of ATR. There are advantages and disadvantages to
both.
Once you have chosen a measure of volatility, stop distance can then be
back-tested and optimised. For example does 2x ATR work best or 5x ATR
for a given style and time horizon?
Discretionary traders may still eye-ball the ATR or standard deviation to

get a feeling for how it has changed over time and what ‘normal’ feels like
for a chosen study period - daily, weekly, monthly etc.
Reasons to change a stop
As a general rule you should be disciplined and not change your stops.
Remember - losers average losers. This is really hard at first and we’re
going to look at that in more detail later.
There are some good reasons to modify stops but they are rare.
One reason is if another risk management process demands you stop

trading and close positions. We’ll look at this later. In that case just close
out your positions at market and take the loss/gains as they are.
Another is event risk. If you have some big upcoming data like Non Farm
Payrolls that you know can move the market +/- 150 pips and you have
no edge going into the release then many traders will take off or scale
down their positions. They’ll go back into the positions when the data is
out and the market has quietened down after fifteen minutes or so. This is
a matter of some debate - many traders consider it a coin toss and argue
you win some and lose some and it all averages out.
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Trailing stops can also be used to ‘lock in’ profits. We looked at those
before. As the trade moves in your favour (say up if you are long) the stop
loss ratchets with it. This means you may well end up ‘stopping out’ at a
profit - as per the below example.
FIGURE 88
Trailing stop losses are a powerful tool
It is perfectly reasonable to have your stop loss move in the direction of

PNL. This is not exposing you to more risk than you originally were
comfortable with. It is taking less and less risk as the trade moves in your
favour.
One final question traders ask is what they should do if they get stopped
out but still like the trade. Should they try the same trade again a day later
for the same reasons? Nope. Look for a different trade rather than getting
emotionally wed to the original idea.
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Let’s say a particular stock looked cheap based on valuation metrics

yesterday, you bought, it went down and you got stopped out. Well, it is
going to look even better on those same metrics today. Maybe the market
just doesn’t respect value at the moment and is driven by momentum.
Wait it out.
Otherwise, why even have a stop in the first place?
Entering and exiting winning positions
If you don’t recall take profits, take a quick look at chapter three.
Take profits are the opposite of stop losses. They are also resting orders,
left with the broker, to automatically close your position if it reaches a
certain price.
Imagine I’m long EURUSD at 1.1250. If it hits a previous high of 1.1400

(150 pips higher) I will leave a sell order to take profit and close the
position.
The rookie mistake on take profits is to take profit too early. One should
start from the assumption that you will win on no more than half of your
trades. Therefore you will need to ensure that you win more on the ones
that work than you lose on those that don’t.
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FIGURE 89
Unfortunately incredibly common: retail traders often take profits way too early
This is going to be the exact opposite of what your emotions want you to
do. We are going to look at that in the next section.
Remember: let winners run. Just like stops you need to know in advance
the level where you will close out at a profit. Then let the trade happen.
Don’t override yourself and let emotions force you to take a small profit.
A classic mistake to avoid.
The trader puts on a trade and it almost stops out before rebounding. As
soon as it is slightly in the money they spook and cut out, instead of
letting it run to their original take profit. Do not do this.
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Entering positions with limit orders
That covers exiting a position but how about getting into one?
Take profits can also be left speculatively to enter a position. Sometimes

referred to as “bids” (buy orders) or “offers” (sell orders). Imagine the
price is 1.1250 and the recent low is 1.1205.
You might wish to leave a bid around 1.2010 to enter a long position, if the
market reaches that price. This way you don’t need to sit at the computer
and wait.
Again, typically traders will use tech analysis to identify attractive levels.
Again - other traders will cluster with your orders. Just like the stop loss
we need to bake that in.
So this time if we know everyone is going to buy around the recent low of
1.1205 we might leave the take profit bit a little bit above there at 1.1210 to
ensure it gets done. Sure it costs 5 more pips but how mad would you be
if the low was 1.1207 and then it rallied a hundred points and you didn’t
have the trade on?!
There are two more methods that traders often use for entering a position.
Scaling in is one such technique. Let’s imagine that you think we are in a
long-term bulltrend for AUDUSD but experiencing a brief retracement.
You want to take a total position of 500,000 AUD and don’t have a strong
view on the current price action.
You might therefore leave a series of five bids of 100,000. As the price
moves lower each one gets hit. The nice thing about scaling in is it reduces
pressure on you to pick the perfect level. Of course the risk is that not all
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your orders get hit before the price moves higher and you have to trade
at-market.
Pyramiding is the second technique. Pyramiding is for take profits what a

trailing stop loss is to regular stops. It is especially common for
momentum traders.
FIGURE 90
Pyramiding into a position means buying more as it goes in your favour
Again let’s imagine we’re bullish AUDUSD and want to take a position of
500,000 AUD.
Here we add 100,000 when our first signal is reached. Then we add
subsequent clips of 100,000 when the trade moves in our favour. We are
waiting for confirmation that the move is correct.
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Obviously this is quite nice as we humans love trading when it goes in

our direction. However, the drawback is obvious: we haven’t had the full
amount of risk on from the start of the trend.
You can see the attractions and drawbacks of both approaches. It is best to
experiment and choose techniques that work for your own personal
psychology as these will be the easiest for you to stick with and build a
disciplined process around.
Risk:reward and win ratios
Be extremely skeptical of people who claim to win on 80% of trades.

Most traders will win on roughly 50% of trades and lose on 50% of trades.
Once you start keeping a trading journal you’ll be able to see how the
win/loss ratio looks for you. Until then, assume you’re typical and that
every other trade will lose money.
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FIGURE 91
A combination of win % and risk:reward ratio determine if you are profitable
If that is the case then you need to be sure you make more on the wins
than you lose on the losses. You can see the effect of this below.
A typical rule of thumb is that a ratio of 1:3 works well for most traders.
That is, if you are prepared to risk 100 pips on your stop you should be
setting a take profit at a level that would return you 300 pips.
One needn’t be religious about these numbers - 11 pips and 28 pips would
be perfectly fine - but they are a guideline.
Again - you should still use technical analysis to find meaningful chart
levels for both the stop and take profit. Don’t just blindly take your stop
distance and do 3x the pips on the other side as your take profit. Use the
ratio to set approximate targets and then look for a relevant resistance or
support level in that kind of region.
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Risk-adjusted returns
Not all returns are equal. Suppose you are examining the track record
of two traders. Now, both have produced a return of 14% over the year.
Not bad!
FIGURE 92
Would you rather have the first trading record or the second?
The first trader, however, made hundreds of small bets throughout the
year and his cumulative PNL looked like the left image below.
The second trader made just one bet — he sold CADJPY at the start of the
year — and his PNL looked like the right image below with lots of large
drawdowns and volatility.
If you were investing money and betting on who would do well next year
which would you choose? Of course all sensible people would choose the
first trader. Yet if you look only at returns one cannot distinguish between
the two. Both are up 14% at that point in time. This is where the Sharpe
ratio helps .
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A high Sharpe ratio indicates that a portfolio has better risk-adjusted

performance. One cannot sensibly compare returns without considering
the risk taken to earn that return.
If I can earn 80% of the return of another investor at only 50% of the risk
then a rational investor should simply leverage me at 2x and enjoy 160%
of the return at the same level of risk.
This is very important in the context of Execution Advisor algorithms

(EAs) that are popular in the retail community. You must evaluate historic
performance by its risk-adjusted return — not just the nominal
return. Otherwise an EA developer could produce two EAs: the first
simply buys at 1000:1 leverage on January 1st ; and the second sells in the
same manner. At the end of the year, one of them will be discarded and
the other will look incredible. Its risk-adjusted return, however, would be
abysmal and the odds of repeated success are similarly poor.
Sharpe ratio
The Sharpe ratio works like this:
• It takes the average returns of your strategy;

• It deducts from these the risk-free rate of return i.e. the rate anyone
could have got by investing in US government bonds with very little
risk;
• It then divides this total return by its own volatility - the more smooth
the return the higher and better the Sharpe, the more volatile the lower
and worse the Sharpe.
For example, say the return last year was 15% with a volatility of 10% and
US bonds are trading at 2%. That gives (15-2)/10 or a Sharpe ratio of 1.3.
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As a rule of thumb a Sharpe ratio of above 0.5 would be considered decent

for a discretionary retail trader. Above 1 is excellent.
You don’t really need to know how to calculate Sharpe ratios. Good
trading software will do this for you. It will either be available in the
system by default or you can add a plug-in.
VAR
VAR is another useful measure to help with drawdowns. It stands for

Value at Risk. Normally people will use 99% VAR (conservative) or 95%
VAR (aggressive). Let’s say you’re long EURUSD and using 95% VAR.
The system will look at the historic movement of EURUSD. It might spit
out a number of -1.2%.
FIGURE 93
A 5% VAR of -1.2% tells you you should expect to lose 1.2% on 5% of days, whilst 95% of
days should be better than that
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This means it is expected that on 5 days out of 100 (hence the 95%) the
portfolio will lose 1.2% or more. This can help you manage your capital
by taking appropriately sized positions. Typically you would look at VAR
across your portfolio of trades rather than trade by trade.
Sharpe ratios and VAR don’t give you the whole picture, though.
Legendary fund manager, Howard Marks of Oaktree, notes that, while
tools like VAR and Sharpe ratios are helpful and absolutely necessary, the
best investors will also overlay their own judgment.
Investors can calculate risk metrics like VaR and Sharpe ratios (we
use them at Oaktree; they’re the best tools we have), but they
shouldn’t put too much faith in them. The bottom line for me is
that risk management should be the responsibility of every
participant in the investment process, applying experience,
judgment and knowledge of the underlying investments.
Howard Marks
What he’s saying is don’t misplace your common sense. Do use these
tools as they are helpful. However, you cannot fully rely on them. Both
assume a normal distribution of returns. Whereas in real life you get
“black swans” - events that should supposedly happen only once every
thousand years but which actually seem to happen fairly often.
These outlier events are often referred to as “tail risk”. Don’t make the
mistake of saying “well, the model said…” - overlay what the model is
telling you with your own common sense and good judgment.
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Squeezes and other risks
We are going to cover three common risks that traders face: events;
squeezes, asymmetric bets.
Events
Economic releases can cause large short-term volatility. The most

famous is Non Farm Payrolls, which is the most widely watched measure
of US employment levels and affects the price of many instruments.
On an NFP announcement currencies like EURUSD might jump (or drop)

a 100 pips no problem.
This is fine and there are trading strategies that one may employ around
this but the key thing is to be aware of these releases. You can find
economic calendars all over the internet - including on this site - and you
need only check if there are any major releases each day or week.
For example, if you are trading off some intraday chart and scalping a few
pips here and there it would be highly sensible to go into a known data
release flat as it is pure coin-toss and not the reason for your trading. It
only takes five minutes each day to plan for the day ahead so do not get
caught out by this. Many retail traders get stopped out on such events
when price volatility is at its peak.
Squeezes
Short squeezes bring a lot of danger and perhaps some opportunity.

The story of VW and Porsche is the best short squeeze ever. A short
squeeze is when a participant ends up in a short position they are forced
to cover. Especially when the rest of the market knows that this
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participant can be bullied into stopping out at terrible levels, provided the
market can briefly drive the price higher.
Hedge funds had been shorting VW stock. However the amount of VW

stock available was actually quite limited. The local government owned a
chunk and Porsche itself had bought and locked away around 30%.
Neither of these would sell to the hedge-funds so a good amount of the
stock was un-buyable at any price.
If you sell or short a stock you must be prepared to buy it back to go flat at
some point. To cut a long story short, Porsche bought a lot of call options
on VW stock. These options gave them the right to purchase VW stock
from banks at slightly above market price.
Eventually the banks who had sold these options realised there was no
VW stock to go out and buy since the German government wouldn’t sell
its allocation and Porsche wouldn’t either. If Porsche called in the options
the banks were in trouble.
Porsche called in the options which forced the shorts to buy stock - at
whatever price they could get it. The price squeezed higher as those that
were short got massively squeezed and stopped out. For one short
moment in 2008, VW was the world’s most valuable company. Shorts
were burned hard.
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FIGURE 94
The story of the time Porsche cornered the market in VW is simply incredible because it
was so unexpected - car companies don’t usually behave like hedge funds
Porsche made $11.5 billion on the trade. BBC described Porsche as “a

hedge fund with a carmaker attached.” VW executives complained about
“the tail wagging the dog.”
If this all seems exotic then know that the same thing happens in FX all
the time. If everyone in the market is talking about a key level in EURUSD
being 1.2050 then you can bet the market will try to push through 1.2050
just to take out any short stops at that level. Whether it then rallies higher
or fails and trades back lower is a different matter entirely.
This brings us on to the matter of crowded trades. We will look at

positioning in more detail in the next section. Crowded trades are
dangerous for PNL. If everyone believes EURUSD is going down and has
already sold EURUSD then you run the risk of a short squeeze.
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For additional selling to take place you need a very good reason for
people to add to their position whereas a move in the other direction
could force mass buying to cover their shorts.
A trading mentor when I worked at an investment bank once told me the

following:
Always think about which move would cause the maximum

number of traders the maximum pain. Prepare for the market to
trade that way.
EURUSD Spot FX trader
Asymmetric losses
Also known as picking up pennies in front of a steamroller. This risk

has caught out many retail trader. Sometimes it is referred to as negative
skew.
Ideally what you are looking for is asymmetric risk trade set-ups: that is
where the downside is clearly defined and smaller than the upside. What
you want to avoid is the opposite.
A famous example of this going wrong, which destroyed the accounts of

many a retail trader, was the Swiss National Bank de-peg in 2012.
The SNB had said they would defend the price of EURCHF so that it did
not go below 1.2. Many people believed it could never go below 1.2 due to
this. Many retail traders therefore opted for a strategy that some describe
as ‘picking up pennies in front of a steam-roller’.
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They would would buy EURCHF above the peg level and hope for a tiny
rally of several pips before selling them back and keep doing this
repeatedly. Often they were highly leveraged at 100:1 so that they could
amplify the profit of the tiny 5-10 pip rally.
The SNB then did the unthinkable. They stopped defending the price.
CHF jumped and so EURCHF (the number of CHF per 1 EUR) dropped to
new lows very fast. Clearly, this trade had horrific risk : reward
asymmetry: you risked 30% to make 0.05%.
Other strategies like naively selling options have the same result. You win
a small amount of money each day and then spectacularly blow up at
some point down the line.
Market positioning
We have talked about short squeezes. But how do you know what the
market position is? And should you care?
Let’s start with the first. You definitely should care.

Let’s imagine the entire market is exceptionally long EURUSD and
positioning reaches extreme levels. This makes EURUSD very vulnerable.
To keep the price going higher EURUSD needs to attract fresh buy orders.
If everyone is already long and has no room to add, what can incentivise
people to keep buying? The news flow might be good. They may believe
EURUSD goes higher. But they have already bought and have their
maximum position on.
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On the flip side, if there’s an unexpected event and EURUSD gaps lower
you will have the entire market trying to exit the position at the same
time. Like a herd of cows running through a single doorway. Messy.
We are going to look at this in more detail in a later chapter, where we

discuss ‘carry’ trades. For now this TRYJPY chart might provide some
idea of what a rush to the exits of a crowded position looks like.
FIGURE 95
Carry trades can blow up spectacularly and it happens fast
Knowing if the market is at extreme levels of long or short can therefore

be helpful.
The CFTC makes available a weekly report, which details the overall
positions of speculative traders “Non Commercial Traders” in some of the
major futures products. This includes futures tied to deliverable FX pairs
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such as EURUSD as well as products such as gold. The report is called

“CFTC Commitments of Traders”.
This is a great benchmark. It is far more representative of the overall

market than the proprietary ones offered by retail brokers as it covers a far
larger cross-section of the market.
Generally market participants will not pay a lot of attention to commercial

hedgers, which are also detailed in the report. This data is worth tracking
but these folks are simply hedging real-world transactions rather than
speculating so their activity is far less revealing and far more noisy.
It is available for free on their website but the format is rather difficult to
process. However, many websites will chart this for you free of charge
and you may find it more convenient to look at it that way. Just google
“CFTC positioning charts”.
FIGURE 96
An illustrative CFTC speculative positioning chart
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You can visually spot extreme positioning. It is extremely powerful.

Bear in mind the reports come out Friday afternoon US time and the
report is a snapshot up to the prior Tuesday. That means it is a lagged
report - by the time it is released it is a few days out of date. For longer
term trades this is of course still pretty helpful information.
As well as the absolute level (is the speculative market net long or short)
you can also use this to pick up on changes in positioning.
For example if bad news comes out how much does the net short
increase? If good news comes out, the market may remain net short but
how much did they buy back?
A lot of traders ask themselves “Does the market have this trade on?” The
positioning data is a good method for answering this. It provides a good
finger on the pulse of the wider market sentiment and activity.
For example you might say: “There was lots of noise about the good
employment numbers in the US. However, there wasn’t actually a lot of
position change on the back of it. Maybe everyone who wants to buy
already has. What would happen now if bad news came out?”
In general traders will be wary of entering a crowded position because it

will be hard to attract additional buyers or sellers and there could be an
aggressive exit. If you want to enter a trade that is showing extreme levels
of positioning you must think carefully about this dynamic.
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Bet correlation
Retail traders often drastically underestimate how correlated their bets

are.
Through bitter experience, I have learned that a mistake in position

correlation is the root of some of the most serious problems in
trading. If you have eight highly correlated positions, then you are
really trading one position that is eight times as large.
Bruce Kovner
For example, if you are trading a bunch of pairs against the USD you will
end up with a simply huge USD exposure. A single USD-trigger can ruin
all your bets. Your ideal scenario — and it isn’t always possible — would
be to have a highly diversified portfolio of bets that do not move in
tandem.
Look at this chart. Inverted USD index (DXY) is green. AUDUSD is

orange. EURUSD is blue.
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FIGURE 97
Are all your bets actually a single huge bet? Chart from TradingView
So the whole thing is just one big USD trade! If you are long AUDUSD,
long EURUSD, and short DXY you have three anti USD bets that are all
likely to work or fail together.
The more diversified your portfolio of bets are, the more risk you can take
on each. There’s a really good (free) video, explaining the benefits of
diversification from Ray Dalio, who runs one of the world’s most
successful hedge-funds.
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A systematic fund with access to an investable universe of 10,000

instruments has more opportunity to make a better risk-adjusted return
than a trader who only focuses on three symbols. Diversification really is
the closest thing to a free lunch in finance.
But let’s be pragmatic and realistic. Human retail traders don’t have
capacity to run even one hundred bets at a time. More realistic would be
an average of 2-5 trades on simultaneously. So what can be done?
For example:
• You might diversify across time horizons by having a mix of short-

term and long-term trades.
• You might diversify across asset classes - trading some FX but also
crypto and equities.
• You might diversify your trade generation approach with a mix of
fundamental and technically-inspired trades.
• You might diversify your exposure to the market regime by having
some trades that assume a trend will continue (momentum) and some
that assume we will be range-bound (carry).
• And so on.
Basically you want to scan your portfolio of trades and make sure you are
not putting all your eggs in one basket. If some trades underperform
others will perform - assuming the bets are not correlated - and that way
you can ensure your overall portfolio takes less risk per unit of return.
The key thing is to start thinking about a portfolio of bets and what each
new trade offers to your existing portfolio of risk. Will it diversify or
amplify a current exposure?
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Crap trades, timeouts and monthly limits
One common mistake is to get bored and restless and put on crap
trades. This just means trades in which you have low conviction.
It is perfectly fine not to trade. If you feel like you do not understand the
market at a particular point, simply choose not to trade. Flat is a position.
Do not waste your bullets on rubbish trades. Only enter a trade when you
have carefully considered it from all angles and feel good about the risk.
This will make it far easier to hold onto the trade if it moves against you
at any point.
Equally, you need to set monthly limits. A standard limit might be a 10%
stop per month. At that point you close all your positions immediately
and stop trading till next month.
Let’s assume you started the year with $100k and made 5% in January so
enter Feb with $105k balance. Your stop is therefore 10% of $105k or
$10.5k . If your account balance dips to $94.5k ($105k-$10.5k) then you
stop yourself out and don’t resume trading till March the first.
Having monthly calendar breaks is nice for another reason. Say you made
a load of money in January. You don’t want to start February feeling you
are up 5% or it is too tempting to avoid trading all month and protect the
existing win. Each month and each year should feel like a clean slate and
an independent period.
Everyone has trading slumps. It is perfectly normal. It will definitely

happen to you at some stage. The trick is to take a break and refocus.
Conserve your capital by not trading a lot whilst you are on a losing
streak. This period will be much harder for you emotionally and you’ll
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end up making suboptimal decisions. An enforced break will help you see
the bigger picture.
Put in place a process before you start trading and then it’ll be easy to
follow and will feel much less emotional. Remember: the market doesn’t
care if you win or lose, it is nothing personal. When your head has cooled
and you feel calm you return the next month and begin the task of
building back your account balance.
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9 TRADING PSYCHOLOGY
We humans are not robots. As much as we’d like to believe we are calm
and rational trading machines, our decisions are massively influenced by
our emotions.
There are several well known behavioural biases to be aware of and guard
against. In this chapter we’ll look at some of the most common. We’ll
explain each one and then discuss how it can affect trading.
Thankfully there are ways to protect your PNL from emotions and human
biases. We will look at some methods that help before examining some
rookie mistakes. Once you know about them you can avoid them.
Loss aversion
Loss aversion tells us that people prefer avoiding losses to acquiring

equivalent gains. For example: it feels better not to lose $100 than it does
to make $100.
Nobel-prize winning psychologists Daniel Kahneman and Amos Tversky

captured this part of human nature with a neat experiment.
We toss a coin. If it’s tails you lose $10. How much would you have to
gain on winning in order for this gamble to be acceptable to you?
Most people want more than $20 before it’s acceptable. Of course in truth
even $11 would be a winning result: there’s a 50% chance of winning or
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losing and you have an ‘edge’ of $1. But losing is painful for people so
they avoid it, irrationally.
FIGURE 98
Loss aversion explains a lot of market dynamics
This loss aversion has several effects in trading.
For example it can be recognised in people’s unwillingness to crystallise

losses by stopping out of a trade. This means they try to avoid the loss
and end up and hanging on to losing positions for far too long. When they
eventually are forced to stop out they lose far more than they would have,
had they taken a small loss early on. This is why the discipline of
predetermined stop losses is so important.
It also explains why traders commonly take profit on winners too early.
They fear losing the small gains they’ve already made. Because they're
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scared of losing the little gain they've got they miss out on a bigger prize.
If they would only let winning positions run they might end up making
far more money.
Recency/availability bias
People tend to place more decision-making weight on recent events

than historic ones.
Imagine that for the last few months, volatility is very low compared to
the historic average. This lulls traders into a false sense of calm and can
result in them taking outsized risk with too much leverage.
If volatility increases suddenly they need to re-assess what "normal"
means and not simply assume it'll soon go back to how it was.
Or imagine that the market has been trending for a year. That is no
guarantee it will continue! We might be about to enter a two-year period
of range-bound, choppy markets. The techniques that worked reliably
before are going to stop working.
Conditions could rapidly change. That would prove very expensive for
traders who relied too much on evidence from recent periods. These
"regime changes" often catch out traders due to the recency bias.
Hindsight bias
Hindsight bias is the natural human tendency to perceive events that

already occurred as being more predictable or obvious than they were at
the time.
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Imagine, for example, you have put on a short GBPUSD position. A few
weeks into the trade a major political breakthrough occurs in the Brexit
process, GBPUSD rallies higher and you are stopped out.
After the fact, surrounded by news reports, you can rationalise this and it
feels obvious that this was a risk. However, this makes the past look more
predictable than it was.
Equally well the Brexit process may have faltered and this could have
helped your position; there would have been no way to have predicted
the outcome. You should instead evaluate the quality of trades based on
the information available at the time and not fall into the trap of
rationalising events post hoc.
Recording the reasons for your trade entry in a trading journal can help
produce a more honest account. We’ll look at that in a bit.
Confirmation bias
Confirmation bias is seen in everyday human life: we have pre-existing

beliefs and when confronted with evidence that argues against them we
discount this evidence whereas, when we encounter evidence that
supports our belief, we amplify it.
A classic example is a feeling that, say, EURUSD should be going up. You
scan through multiple timeframes on the charts. You disregard all of them
until you find one that confirms what you knew all along!
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FIGURE 99
Confirmation bias is a biggie
Looking at multiple factors when putting together a trade can help

provide a more balanced picture.
If you talk to other traders, try not to only focus on ones who use the same
styles and share the same views as you. Diverse opinions can help you
stress-test your own ideas far better than groupthink chat rooms.
Overconfidence
If you did a poll of all the men in the world, how many of them would
consider themself an ‘above average’ driver?
Let us always remember that 70% of retail traders lose money. Be humble
when you put on positions. The risk management techniques in the
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previous chapter, especially position sizing, help guard against the natural
overconfidence of human traders.
Anchoring bias
Ever noticed how software always has the most expensive plan next to
the most popular?
FIGURE 100
$14.99 seems cheap next to $299! Anchoring bias at work
This is because the expensive plan anchors your reaction. “Oh wow,
$14.99 looks really cheap.”
You cannot help it even when you know the number is irrelevant. Tversky
and Kahneman did another experiment in which they asked people to
estimate what percentage of African countries were part of the United
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Nations. Before they answered they span a wheel with numbers 0-100.
The wheel was rigged to land on either 10 or 65.
People whose wheel landed on 10 guessed 25% of African countries.

People whose wheel landed on 65 guessed 45% of countries. Crazy!
In trading this happens all the time. You get hooked on what the “fair”
value of something is.
Imagine you buy gold at $1,520. It drifts a tiny bit lower to $1,517 but
suddenly your fundamental reason for buying changes. You should cut
the position. You’ll be really reluctant to sell below where you bought. If
the price was $1,521 you wouldn’t hesitate!
Longshot bias
Humans love longshots. This is why lottery tickets are so popular. We

know they are not good value but we love the tiny chance of winning big.
In trading you will often see ‘hero’ trades such as trying to call the
absolute top or bottom of a market or trend. When the market is in freefall
this is sometimes referred to as ‘catching a falling knife’ and rarely works.
Having a disciplined system that waits for confirmation of a trend before

jumping on can help guard against this bias. Remember: do not fight the
trend!
Herd behaviour
We humans feel most comfortable when others agree with us.
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Ever been for dinner and changed the dish you had in mind based on
what others ordered?
It feels hard to fight the consensus. If everyone else believes EURUSD is

going up it is easy to be part of the trade. However, this brings the
extremely real risk of crowded positions that we looked at in the last
chapter.
Keeping an eye on positioning data can help you avoid getting sucked
into herd behaviour trades at extreme levels.
Greed
When we have dollar signs in our eyes, we tend to ignore risk and
suspend rational thought.
A prime example in trading is the managed accounts and robots. Often

these will promise a return that you know deep down cannot make sense
in return for a small upfront deposit and fee.
Double your money each week with our simple forex robot system
No serious person ever
These scams really shouldn’t work. Sadly they do.
Always remember that if these folks were really that good they wouldn’t
need your deposit. They would be working in a professional hedge fund.
Or sitting on their private island, counting their money.
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Do not let greed cloud your good judgment. If something sounds too
good to be true, it probably is.
Trading plan and analysis
One really effective way to learn what does and does not work for you
is to use a trading plan. Having a clear process also helps take some of the
emotion out of the activity and makes it easier to stick to your system.
A trading plan is just a simple set of details that you fill out before you put
on a trade. You can make one in Google Sheets or just use pen and paper
if you prefer.
This takes only five minutes to set up and will make you far more
disciplined.
FIGURE 101
Having a trading plan on each trade (see later chapter) is one way to help keep yourself
disciplined and avoid emotional bias
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First of all it’ll ensure you follow the basics of risk management. You
position size appropriately and pick sensible TP and SL levels.
Secondly it’ll force you to really think about why you’re entering the trade
and to review those reasons later. Because of hindsight bias we
inaccurately recall our thought process back when we put the position on.
If you commit to simply filling out a simple trade journal for each trade
you’ll be setting yourself up far better than the average trader and it only
takes a few minutes.
This also allows you to do some analysis.
One common thing you might look at is your win to loss ratio. Is this
50/50 or 40/60 etc.?
You might also look at your experience in each pair. Are you doing great
in liquid stuff like EURUSD and USDJPY but terribly in gold and illiquid
pairs like USDTRY? There might be a reason that you need to drill into. At
least you’ll have narrowed down the problem.
You can also look at the reasons you put on the trades and see what
techniques are working for you. Maybe momentum trades are killing you
but your carry trades are working out great? If that’s the case then maybe
it is down to the wider environment - perhaps the market is range bound
and simply not trending. You might want to reduce the position size of
your momentum trades until they start working for you again.
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FIGURE 102
Analysing your results can help shed light on bad behaviours you can fix
This is all analysis you can perform on your own. However, many folks
find it helpful to discuss with a mentor. Sometimes this is because the
mentor is experienced and has seen it all before so can offer valuable
perspective. Other times this is because it simply helps to talk to a neutral
person who is not emotionally involved in the trades: they can help you
see things more objectively.
If you do decide to go that route you will get a lot more out of it if you’ve
kept a precise trading journal as you can discuss specifics rather than
anecdotes.
It can also be very interesting to monitor your daily PNL and look at the
results:
• Are your up days bigger than the down days?

• What’s the maximum drawdown (loss) day you have seen in the last
year?
• How likely are you to have a losing day vs a losing week vs a losing
month vs a losing year?
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As you build a trading career and get to know these numbers it can help
you feel more in control.
Making trading more systematic
The more you turn trading into a process-based activity, the more you
guard against emotional decisions.
Beware that there is not one simple system that will work for all styles
and personalities. If you are happy to take drawdowns of 10% you will
not be comfortable using the same system as someone who is fine with a
50% drawdown, for example.
Here are some sample questions you can ask yourself and think about
when designing a framework and set of rules that work for you.
What is my max drawdown before it hurts too much?

15% of total capital
Monthly limits and timeouts?

Stop trading if I lose more than four trades in a row or 8% per calendar
month
How many products can I follow and properly understand?

Gold, silver, DAX, Wall Street, EURUSD, USDJPY, GBPUSD, AUDUSD,
Bitcoin, Ripple
How many trades will I have on average?

Maximum allowed is three trades at a time with an average of one or two
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How do I rate conviction of trade?

• Good - I want to trade this for at least two reasons and the 1:3 risk/
reward level is clear on the charts
• Great - This trade thesis is supported by multiple fundamentals and
technicals, the 1:3 risk/reward level is clear on the charts
• Exceptional - This is an absolute slam dunk (no more than 1 in 20
trades can be rated exceptional)
What risk % do I give each level of conviction?

• Good - 1%
• Great - 1.5%
• Exceptional - 4%
What ratio of SL:TP do I use?

Never less than 1:2 and generally 1:3
What win:loss ratio do I expect?

I expect to win on 40% of trades
How long do I hold positions?

On average 6-7 weeks
Which chart timeframes are my main focus?

Daily candles
How do I make sure stops have enough space?

I use a rule of approximately 4x ATR from where I enter and look for a
key technical level around there; then i use a trailing stop
When am I allowed to re-try a trade after being stopped out?
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Only after the direction flips (if i wanted to buy i now want to sell) or a
calendar month has passed
How do I enter orders?

I pyramid into the position in three steps
How do I avoid crowded trades?

Reduce trade size by half if the CFTC positioning is within 25% of the
extremes of the last year. Do not take a position if the positioning is
making a new high or low
How do I avoid asymmetric risks?

Before entering, always think through and list what could make this trade
go wrong and what would the price be if that happened? If I can think of
an example that is heavily asymmetric, pass on the trade
How do I manage event risk?

Even if there is a large event I just ignore it and do not adjust the position
- some will work for me and some against, my stop is large enough to
withstand the noise
How do I ensure I do not have overly correlated bets?

I plot the correlation of each new bet vs my existing positions in my
charting system. If it is over 0.5 I reduce the most recent bet’s position size
by half.
The above is not necessarily a model set of answers. Yours may differ. The
rules will depend on your own personality and risk tolerance and trading
style. However, asking yourself these questions and formulating your
own trading rules as a result will help you be more disciplined.
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Having a clear process to follow makes trading less of an emotional

rollercoaster and protects you from irrational human behaviour.
Ten rookie mistakes
This is like the greatest hits of this chapter and the last one on risk
management.
You can see how the two are linked. A lot of the risk management
techniques are designed to prevent our natural human biases from
hurting ourselves.
Taking too large a position
You should be on the assumption that you have no more than a 50%
chance of winning. If we just flipped a coin, losing (or winning) the first
three trades in a row will happen to one in ten people on average.
Do not let a losing streak clean out your balance. Use the position sizing
techniques.
Not having good risk:reward ratios
You should be looking to risk X to gain 3X, in general. Wait until the trade
set ups appear and don’t go for low quality risk:reward trades.
Not using a trading plan
Without a plan it is hard for beginners to be disciplined. A plan forces you

to consider all the necessary risk management measures and allows you
to review what you were thinking at the time you put the trade om.
Rather than looking at it with the benefit of the world’s greatest trader,
Harry Hindsight.
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Not using stops
Good risk management requires a stop loss. You have to be able to cap
your downside and know when you put on the trade the price at which
you should get out.
Do not risk getting emotionally wed to your trade and having it move
drastically against you, whilst the original motivations for the trade have
long since been invalidated.
Taking poor asymmetric risks
Don’t pick up pennies in front of the steam-roller. If something looks like

“free money” remember there is no such thing. The small return you’re
earning is downpayment for a lottery ticket you have sold.
Taking proﬁt too early
Although it is tempting, do not take profit on the good trades too early.
Let them run. You are looking for that 1:3 ratio. It is working as you had
hoped. If you feel comfortable with the risk, you might even consider
adding.
Not understanding bets are correlated
Selling EURGBP, DAX, EURUSD, and EURJPY is basically a huge bet on

the Euro area. Be aware of this. One idiosyncratic factor could destroy
your entire portfolio. Limit your exposure to any one theme to no more
than 8% of your balance.
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Looking at returns without considering what risks have been taken
Smooth PNL profiles without huge drawdowns are easier to live with
than violently volatile ones with big daily drawdowns.
Remember that there could have been many other outcomes: a huge
naked directional bet on a single product says nothing about an investors’
long-term prospects unlike a track record of many smaller bets.
Over-trading
If there are no good trades then just don’t trade.
Warren Buffet once compared investing to baseball, noting that a baseball

player has to swing and run after three pitches whereas he could look at
trades all day everyday and only go for the ones he thought were home
runs.
Overtrading will deplete your account balance - you’ll pay a lot in spread
and you’ll be entering low quality trades. Be patient.
Not accounting for cognitive biases
Everyone has them but acknowledging the effect of these biases on your
decision making will help you avoid the worst effects:
• Is the herd instinct stopping you from buying an unloved stock that
nonetheless provides good value?
• If GBPUSD has been very quiet and not moved much this year does
that mean it never will in future?
No one can fully control these biases - it is part of being human. However,
there is no excuse for not being aware of them and the common ways they
negatively influence trading decisions.
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10 THE MAGIC OF FACTORS
Factor investing is all about identifying overarching characteristics

(“style factors”) that offer investors more returns than you’d expect for the
risk taken.
An example could be as simple as “owning instruments that pay high

interest beats owning instruments that pay low interest.” That is basically
the carry factor in a nutshell.
For a factor to be widely accepted, it generally has to work across multiple

asset classes over a long period of time. We are talking decades so it
covers a variety of market conditions.
Factor investors are looking for some kind of universal investing truth.
Generally its existence can be explained by human psychology.
There are three widely accepted factors: momentum; value; and carry. We
are going to look at each in detail.
We are also going to look at some of the more disputed factors such as
size, quality and volatility.
Momentum
Once you understand the momentum factor, you’ll be able to see that a
lot of technical analysis is simply trying to harness this underlying
phenomenon.
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Here’s how Factor King Cliff Asness of AQR defines momentum.
Momentum is the phenomenon that securities which have

performed well relative to peers (winners) on average continue to
outperform, and securities that have performed relatively poorly
(losers) tend to continue to underperform.
Cliff Asness
That sounds a bit … weird. Can something so simple really be true?

However, there has been a lot of study of momentum and strong evidence
it has existed since basically forever in all products - bonds, stocks, FX,
commodities.
FIGURE 103
Think of momentum as a boulder rolling down a hill … sure it will stop eventually but
at any given point it seems more likely to continue
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Think of it this way:
• We look at the top 10 percentage gain stocks over the last month and
call this “winner group”.
• We look at the bottom 10 percentage loss stocks over the last month
and call this “loser group”.
• We buy the winners and sell the losers.
• After six months we close the positions across the portfolio.
Momentum expects on average, over the long run you’ll make money
doing this kind of thing.
When you hear phrases like “The trend is your friend” or “Don’t fight the
market” now you know why. But why does this happen?
Some argue that investors underreact to information arriving in small bits.

Like a frog in a pot of water that is slowly brought to the boil. As good or
bad news arrives they become more bullish or bearish only slowly and
this results in a trending price.
Others argue that the human preference for herding is the reason. As
trades become more popular others are tempted to join in, pushing the
price further.
The number of funds using the momentum factor to trade surely plays
some part. It has become a self-fulfilling prophecy. Many players buy
winners because they have learned that buying winners pays. This itself
drives the winners higher.
If trading momentum is so easy and well known, how come it still exists?
As you’ll recall from the trading psychology chapter, most investors like
to let losers run whilst taking profit early on winners: you need to do the
exact opposite here. That is not easy.
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It is also true that trend-following (yep, that’s what momentum is) returns
can have very sharp drawdowns. Many human investors do not have the
capacity to take a big paper loss and keep going without closing the
position and cementing the loss. It is natural that investors should receive
some premium for accepting this risk of a temporary loss.
This is one of the few areas where the retail trader has a big advantage
over professional funds. Retail traders can often access guaranteed stops
and trade in small enough size that they can trade in one clip and not
move the market. Big funds often cannot close a portfolio without selling
for multiple days and their own selling activity moving the market
against them.
AQR has some fantastic papers on momentum available on their website,

if you would like to go into further detail.
Value
Warren Buffett was inspired by Benjamin Graham, who quite literally

wrote the book on value investing. It is called The Intelligent Investor, if
you are interested.
The idea is simple: buy things only when they are good value.
The value factor says that relatively cheap assets will outperform
relatively expensive ones.
In equities you might look at metrics like the Price/Earnings ratio. Or you
might look to find companies that have a big Growth of Earnings that
isn’t reflected in their Price/Earnings ratio.
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Or you might look at the Price/Dividends ratio. If a company pays you

5% a year in dividends then you know it is worth something. After
enough years it’ll have paid for itself.
You will remember a lot of these ratios from the value section in our
equities fundamental trading chapter. If you want to recap them, just click
here.
Amazingly enough, every now and then, companies are valued at below
Tangible Book Value. That means if you shut down the company and sold
all its assets and added up all the cash in the bank, it’d be worth more
than you bought it for.
There are many screening methods for value and we’ll leave those for
another time. Yahoo has a great tool. That sounds simple enough. But who
on earth would sell something that appears to be valuable on the cheap?
In the short run, the market is like a voting machine - tallying up

which firms are popular and unpopular. But in the long run, the
market is like a weighing machine - assessing the substance of each
company.
Benjamin Graham
What Graham is saying is that if you are patient enough the market will
offer you an opportunity. Stocks that pay good dividends might be boring
stories that escape the market’s focus. Or the market might collectively
panic and sell indiscriminately, allowing you to pick up some bargains.
At this point you are probably thinking: Hmmm this seems to clash with
momentum. You are exactly right. Imagine a momentum investor chasing
up the price of a stock. It could get well beyond what its intrinsic value
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suggests it should be. Eventually it will pop and mean-revert lower. Who
was right?
This is why trend-followers will often reverse a signal and flip long to
short. Value investors are patient and wait for opportunities to buy
undervalued assets and perhaps sell overvalued assets. We are going to
look at how to combine factors later.
This is why trend-followers will often reverse a signal and flip long to
short. Value investors are patient and wait for opportunities to buy
undervalued assets and perhaps sell overvalued assets. We are going to
look at how to combine factors later.
Carry
Carry is the return an asset gives you, assuming its price stays the
same.
Let’s consider our FX example again. Say interest rates in Turkey are 7%
and 1% in the US. If you sell USD and buy TRY you therefore get a 6%
annualised interest return. Now, assuming USDTRY doesn’t go up by
more than 6% you are in the money.
Carry in bonds is equally simple: you just look at the interest rate. In
stocks you might look at the dividend yield to see how much cash owning
the stock is likely to give you each year.
What they carry factor says is that there’s a tendency for higher yielding
assets to provide higher returns than lower yielding assets.
But how might you pick the best ones?
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You might plot the “carry” vs previous 12 months' price move.
FIGURE 104
In the carry trade your PNL is the carry + the spot move ... if you earn 100 pips carry but
spot moves against you 120 pips you lost money ... so generally it makes sense to look at
carry vs the last 12 months' spot move. USDZAR looks much more attractive than
USDTRY in this illustrative example, despite both having roughly the same carry
Or you might plot the “carry” vs the ATR to get an idea of volatility.
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FIGURE 105
The more volatile a currency, typically the more carry a trader receives for being long: in
this illustrative case EURZAR stands out a great long because it offers lots of carry
without as much volatility as you'd expect
Carry trades work well in low volatility times when the market is risk-on.
They can explode when the market becomes volatile or risk-off and
everyone scrambles in a flight to safety. Normally this means selling the
emerging market currencies which have the highest yields and buying
pairs like the USD.
In the Global Financial Crises of 2008 for example AUDJPY dropped 45%.
Yes, 45%. That is an extreme example of how bad a carry trade can go.
Any position must be sized accordingly.
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Other factors
There are other factors, too. We’ll look at some of them briefly but there
are questions over how real they are.
Size factor is the idea that small and mid-cap stocks tend to outperform
large-cap stocks. At first glance this is not surprising since the smaller
stocks are more volatile. Surely you are just getting more return for the
extra risk you are taking? Advocates believe it generates superior returns
on a risk-adjusted basis.
Quality factor is a bit looser. What does a high quality instrument mean
exactly? Typically folks will look at things in stocks like high margins, low
earnings volatility, a strong balance sheet. However, the definition of
quality can vary from one person to another. This makes it hard to
evaluate.
Volatility factor suggests that instruments that have been the least volatile
tend to outperform the higher volatility instruments on a risk-adjusted
basis. This is very surprising: you’d expect the owners of more volatile
assets to get rewarded for the extra risk since not everyone is comfortable
holding something that moves up and down sharply.
There are hundreds of claimed factors and you can spend all day googling
and learning about them.
However, beware that very few have been robustly tested and found to
work over the long-term in multiple asset classes and different market
conditions. Momentum, value, and carry are the key ones.
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Combining factors
We saw earlier how different factors might clash. A value investor

wouldn’t chase a high priced stock. Whereas a momentum investor might
buy it because it is high priced. So who is right?
Well, different factors perform well in different market conditions.

Investors typically combine different factors to build a diversified
portfolio.
FIGURE 106
Look at the diversification in action! That's what a multi-factor portfolio aims to do. With
a more stable return series you can add more leverage and achieve a better risk-adjusted
return
You can see when Momentum does great in 2014-2016 the Carry trades
stop working. However, by combining all three strategies - with the
226
appropriate sizes - the investor can end up with a more stable P&L. This
is known as a multi-factor portfolio.
Using a combination of all three styles can help diversify your PNL and
open you up to more trading opportunities. Back-testing strategies is a
great way to get an idea of how they interact but that’s an important topic
for another time.
Timing factors
There’s an old saying amongst traders: Timing is everything
It is perfectly true. If you say that Bitcoin will go up … or down … you

will likely be correct at some point. It depends on your time range.
But can you time factors?
There is a lot of debate about this. Given that factors like value and
momentum are not highly correlated, it would be amazing if you could
know in advance when to use each one.
It is not that easy. You might conclude from historic performance that FX
carry will do well in bullish risk markets with low volatility. If you had a
screaming view that volatility was about to explode and markets would
crash then, sure, you would be unlikely to add carry risk to your portfolio.
You might conclude from historic performance that when carry does
poorly a moving average momentum strategy will compensate by doing
well.
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However, how confident are you that you can accurately forecast the
overall market regime? Not too confident, I hope, after having read the
trading psychology chapter.
So if you cannot time factors what’s the point? Diversification. By adding

exposure to carry and value and not having all your eggs in e.g. the
momentum basket, you have a better chance of achieving a superior risk-
adjusted return. Not to mention you should find the drawdowns smaller
and easier to live with.
Investing or trading
The difference between investing and trading is mainly one of time

horizons. Both types are trying to earn profit from taking risk in the
market.
People who hold trades for less than one year would not typically
consider themselves traders but rather investors.
For example swing trading, holding positions for several weeks, is clearly
not the same thing as Warren Buffett’s long-term investing. No doubt he
has held some stocks for decades.
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FIGURE 107
Some typical trading techniques for expressing each factor
Factors tend to be associated with investing and longer time frames. So

why look at them? However, let’s admit that a lot of the technical analysis
indicators used by traders are trying to capture a form of momentum.
Also notice that understanding the carry dynamics can help you explain
the huge short squeezes we sometimes observe in emerging market
crosses like TRYJPY.
Finally, it is crucial for traders to understand and anticipate the behaviour

of big investors. These folks are the marginal supply and demand that
push the price around and create the trends. Traders should always try to
understand the behaviour of big players in their market. And guess what:
these firms use factor investing.
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FIGURE 108
This paper from the BIS attempts to identify the techniques used by FX hedge funds ...
recognise any of those? https://www.bis.org/publ/bppdf/bispap58j.pdf
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11 FUNDAMENTAL TRADING IN FOREX
This is not going to be a chapter that everyone will like. However it is

important to read. People think fundamentals seem like too much hard
work. Wait till you finish the final section of this chapter before you make
your mind up on that as you might be pleasantly surprised. There are
some ways to make this a lot easier.
Fundamentals are the foundation of trading. The overwhelming majority

of professional traders, like hedge funds, trade based on fundamental
analysis. Almost none of them trade purely based on technical analysis. If
technical analysis really worked reliably then they would do so. Think
about that!
At extremely short time horizons you might get away without factoring in
the fundamentals into trades. However, if you are holding trades for days,
weeks, months you cannot afford to ignore them.
Fundamentals are like the foundation of a house. You can spot trends
through technical analysis but only after they’ve been around for some
time. Fundamentals cause the mega trends. They end them, too. So
understanding the drivers can help you predict the future market prices.
Think of fundamental investing as “try to predict trends before they
happen” and “try to understand what drives the current trend and predict
when it will end.”
Imagine you bet on football. You might use the last 20 games
(win;draw;lose) to help predict the club’s next ten games. Great. What if a
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billionaire buys the club and signs superstar players?

Something fundamental has changed.
But what do fundamentals mean in the context of a currency? In a stock

(which we’ll look at in the next article) it is more intuitive. You can look at
the products, sales, management strategy and so on.
In currencies it is more about the underlying economic conditions in each

country. A lot of current affairs. Yep, afraid it is pretty dry stuff. But bear
with us - it is worthwhile.
The Economist produces a Big Mac Index, which shows the price of a Big
Mac meal in sixteen major currencies. They then convert these prices into
US Dollar and compare against the local Big Mac price in the US. At one
point Switzerland’s Big Mac cost almost $7 while in the UK it was under
$4 (in line with the US price). Accordingly on this real-world measure the
Swiss Franc was heavily overvalued.
This is a simple form of Purchasing Power Parity models that attempts to

value currencies on fundamentals. However, these metrics are almost
useless for traders who focus on trades lasting days, weeks, or months.
Currencies can stay out of line with PPP models for years on end. In the
next sections we are going to cover some common fundamental currency
drivers that, unlike PPP, actually nudge prices up or down in the short
and medium-term.
Now, having said that understanding fundamentals are crucial for

successful trading, there’s some bad news. Doing this analysis properly is
hard for at-home retail traders.
For one thing you simply don’t have enough time. This is a full-time job
for teams of trained economists and that is exactly what hedge funds have
- don’t think you can just skim some headlines and gain an edge.
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Secondly, you don’t have access to enough economic data. The bare
minimum involves a Bloomberg terminal and those start at $24,000 per
year.
Fundamentals in a macro product FX, which are driven by the currents of

the global economy, are way more complicated than in micro products
like stocks, which are driven by things specific to that company.
FIGURE 109
Forex is a very big picture, current affairs type market
So fundamentals are important but hard for retail traders. This perhaps
explains why the average retail trader ignores them totally and only uses
technical analysis. That in turn perhaps explains some of the reason the
average retail trader loses money.
In this article we’re going to sketch some of the techniques that

professionals use to analyse currency fundamentals and then provide
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some realistic approaches that might help retail traders benefit from this
information. Without having to re-train as economists…
Macro top-down approach
Global macro is a popular approach in professional currency trading. It

is a “top down” approach in which you try to form a big picture world
view and think about what that means for individual currencies.
Understanding the current regime and where each country is in the

business cycle is helpful if you want to ride multi-year trends. Ray Dalio
has done some great stuff here.
FIGURE 110
Boom and bust! Analysing the business cycle is a macro tool
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Wait, is that an … oscillator? Yep, it sure looks like it. Investors also
believe in debt cycles. There are good underlying reasons for these cycles
as Dalio explains:
There are always big unsustainable forces that drive the paradigm.
They go on long enough for people to believe that they will never
end even though they obviously must end. A classic one of those is
an unsustainable rate of debt growth that supports the buying of
investment assets; it drives asset prices up, which leads people to
believe that borrowing and buying those investment assets is a
good thing to do. But it can’t go on forever because the entities
borrowing and buying those assets will run out of borrowing
capacity while the debt service costs rise relative to their incomes
by amounts that squeeze their cash flows. When these things
happen, there is a paradigm shift. Debtors get squeezed and credit
problems emerge, so there is a retrenchment of lending and
spending on goods, services, and investment assets so they go
down in a self-reinforcing dynamic that looks more opposite than
similar to the prior paradigm. This continues until it’s also
overdone, which reverses...
Ray Dalio
So the stage of each country in the economic cycle is the biggest of big
picture views. Accurately understanding the stage in the cycle can also
help you predict what will happen to major drivers of FX prices like
domestic interest rates and economic growth. These drivers are tracked
closely by investors, as we’ll discuss later.
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Some big picture indicators may seem incredibly odd. For example,
investors look at the Baltic Dry Index, which tracks the price of moving
major raw materials by sea. Turns out this captures global economic
growth and trade nicely. How many retail traders follow that? You can see
how it could be a leading indicator, I hope!
FIGURE 111
The Baltic Dry Index captures the cost of shipping goods around the world
Investors are also constantly judging general market risk appetite: is the
market feeling greedy or fearful? This is described as a “risk on, risk off”
mentality. This mood will affect investment decisions. For example
moderately bad news in a fearful market may move prices more than the
same news in a greedy market, which is willing to shrug off risks. We’ll
look in a bit at some indicators to track the mood.
Geopolitics is another key area of focus. You might immediately think of

currency trade wars - as we have seen from the US recently. Another
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driver might be civil unrest that disrupts energy pipelines and causes oil
prices (and currencies of oil-exporting nations like CAD or NOK) to spike.
Investors are constantly trying to think about where the next global shock
might arrive from that the market has not fully priced in.
Economic policy is another key driver of currencies. Perhaps the most

important one. Macro investors are always on the lookout for diverging
approaches between countries - and diverging reactions from asset classes
- as this can lead to trading opportunities. We’ll look at the precise role of
central banks and governments, shortly.
Now it is time to drill into some more concrete examples of what

investors look at.
Central banks and rates
If you had to pick a single driver for currencies, the local interest rates
would probably be the best choice.
This relationship is not that hard to explain. If interest rates are much
higher for US bonds (say 3%) than British bonds (say 1%) investors will,
all things equal, prefer to buy US bonds. There’s an interest rate
differential of 2% in favour of the USD, in our made-up example.
I mean - if you had one bank account paying 1% interest and another 3%
where would you put your money? To buy the US bonds you need USD.
So the relationship between interest rates and FX is very real. As a general
rule a high interest rate will result in a high currency. This is known as
carry and is one of the core trading approaches in FX - we’ll look at it in
detail in a later chapter.
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FIGURE 112
We will look at this in more detail in a later chapter but interest rates and currencies are
tightly linked
Understanding central banks, who are the people who set interest rates,
helps you understand and predict their behaviour. Each bank has slightly
different objectives but they tend to focus on three things. It is no secret
and each central bank publishes their mandate.
The first common objective is price stability. Consumers like to know that
e.g. a loaf of bread costs roughly £1. They don’t want it to cost £2 the next
week (inflation) and 50p the next month (deflation). Central banks
therefore monitor measures of inflation and adjust rates. For example if
inflation is too high (prices are growing too much) they might ‘cool’ the
economy by raising interest rates. This tends to reduce the purchasing
power of consumers and this reduced demand means the prices (inflation)
stop growing so fast. Typically developed countries will focus on keeping
inflation between 1-3% per year.
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FIGURE 113
Keeping inflation within the target zone so that consumer prices do not swing too much
is a core aim of almost all central banks
The second common objective is employment. Governments like to see

full employment because then citizens are happy and they get voted back
into office. Central banks carefully monitor employment. If they feel the
economy is softening and employment is low they may for example
reduce interest rates and loosen economic conditions. This makes it
cheaper for companies to borrow and invest in hiring more employees, for
example.
The third common objective is economic growth. This can be measured in

different ways but GDP is the most common. All governments want
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growth so they ensure part of the mandate of central banks is to adjust the
interest rate to achieve it.
Now you can see why people look at the economic indicators. They can
provide a leading indicator on what the central bank will do with interest
rates.
Some things to note. Central banks are (in the vast majority of countries)
independent from government. Central banks set the interest rate.
Governments cannot set the rate themselves or order them to set it to a
certain level. However, the government does typically appoint the head of
the central bank and also sets the mandate of the central bank. There’s a
clear linkage but a clear distance, too.
All the stuff central banks do is called ‘monetary policy’. It mainly boils
down to setting interest rates but there are other levers, as well. A central
bank who is open to higher interest rates is often called ‘dovish’ and a
central bank who is open to lower interest rates is often called ‘hawkish’.
That is really all those fancy terms mean.
Governments can also have an effect on the economy. They can stimulate
the economy by reducing taxes, for example, so companies and people
have more money to spend. They can issue debt and borrow.
Governments can spend money and employ people or build
infrastructure. This stuff is collectively called ‘fiscal policy’. Reading the
tea leaves on fiscal policy requires a deep understanding of politics in
each country as well as the personalities of key figures.
Central banks can also have a dramatic effect by intervening directly in FX

markets. The SNB for example once caused a circa 30% move in Swiss
Franc by abandoning a price target.
But why would a central bank care about FX? Well, the price of the
currency affects the economy’s ability to export or import. If the Swiss
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Franc were too high it would be hard for Swiss manufacturers to export
products and services to other countries, for example. Most times the
central bankers will just say publicly if they care about the exchange rate
and, if so, whether they find it too high or too low. It is common
knowledge for anyone who pays attention.
Investors will carefully monitor official central bank meeting minutes

(typically released monthly) and quotes from central bankers. These key
central bank figures also give speeches at universities and other places
between their monthly interest policy meetings. Because they are human
they leak certain clues as to their thinking when they speak. These
minutes by the way are really short, simple and easy to read.
For example, they may use certain words like “weak conditions”
repetitively and when they subtly change them to “relatively weak
conditions” this marks a change in their thinking. Investors are looking to
understand the central bankers’ reaction function. That means to
understand things like “If employment data turned really bad, would they
cut rates?” That way when the data arrives the market has an idea if it
will likely affect the all-important interest rates or not.
At different times different economic indicators are important: for

example, housing data may be important in one environment but
irrelevant in another. Listening to what the officials say helps investors
understand their likely response.
There is a silly but somewhat serious meme in the investment community:

Shhh the bond market is telling me something.
The idea being simple. The traders who trade the interest rate markets like
bonds pay super close attention to all these speeches and data because
that’s literally their entire job. If you see a move in the price of bonds it
may well appear there before the same move turns up in equities and FX,
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where the market is focused on other things as well and not paying as
close attention to expectations of future interest rates.
Interest rates are one of the main FX drivers. The best way to track them is
to look at the price of rates differentials vs the FX pairs and to read the
monthly “minutes” from central banks, explaining their economic outlook
for the country. We will cover the charting bit in a later note.
Commodities
Commodity prices are clearly linked to economic health. The more

economies are growing and trading with one another, the more raw
materials like copper or iron ore are in demand so the price goes up. Just
like we saw with the shipping index.
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FIGURE 114
“Dr Copper” is so-called because the copper market is often jokingly understood to have
a PhD in macroeconomics and a tendency to be a leading indicator for the overall
economy. It is also correlated with certain pairs such as AUDUSD
Commodities can also drive economic fundamentals. Oil is important for

so much stuff in today’s world: not only energy but the production of
plastics and much more. So when the price of oil goes up, it becomes more
expensive to produce many common goods. Therefore inflation (the price
of goods) goes up. When oil goes down it has the opposite effect. Central
bankers definitely watch the oil price so it has an effect on rates, which in
turn affect FX.
All the markets are linked! However, not all traders trade across all the
markets so they move at different paces and in different ways. Therefore
looking for clues in one area of the market (e.g. oil or rates) may help you
realise that another area of the market (e.g. Norwegian Krone) is out-of-
line with the wider story and likely to play catch-up.
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Investors will therefore closely follow commodity prices. In some cases,

where a large part of the economy is based on oil, the oil price will have a
clear effect. You might think of Canadian Dollar, Russian Rouble,
Norwegian Krone. Oil accounts for 60% of Canadian exports so of course
there’s a relationship between the oil price and CAD.
Traders will often plot these two next to each other. We will look at inter-
market correlations in a later chapter. Clearly, though, understanding
what drives the commodity markets can also help you understand certain
currencies.
Investors also look at ratios. For example the gold:oil ratio. How many
barrels of oil does it take to buy a one ounce gold bar? You could be
forgiven for wondering what that should mean.
You see, oil prices tend to go up when the economy is humming and
people are buying more stuff. Gold prices tend to go up when the
economy is doing badly and investors are scared. So the ratio between
them tells you something about global risk appetite. We’ll cover that in
more detail later.
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FIGURE 115
Gold:oil is just one of many indicators that fundamental traders use to get clues on the
economy
A ratio of around 15 is totally average. Above 20 signals a scared market.

Below 10 signals a relaxed market. Just one more piece of the puzzle.
Economic data
To form a thesis about, say, Australian growth or the stage in the

economic cycle investors will look at a variety of economic indicators.
These are published throughout the month and together help build up a
picture of the domestic economy. Below is an illustrative example for a
single currency - AUD.
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FIGURE 116
The key drivers of Aussie dollar
Imagine keeping that all in your head! And that’s just for a single
currency.
The sort of things fundamental FX investors will look at include:
• Trade balances (are countries net exporting or importing?) as this

affects demand for the currency
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• Employment and productivity (is it strong or weak?) as this can affect

a country’s growth
• Gross Domestic Product (is the economy growing or shrinking?)
• Inflation (e.g. how many $ does it take to buy the same basket of goods
this year vs the previous year?) as this may affect interest rate
decisions
• Surveys and indices (are consumers confident? are manufacturers

producing more or less than last month?) as this can affect a country’s
growth.
And there is much more, too. We’ll look at some of the key releases in a
later note on trading the economic calendar.
You can make this easier though by simply keeping up-to-date with the
economy by reading the paper each day. You’ll soon get a feeling for how
each country is doing.
Trading Economics (website) is a great resource for historic economic data

and totally free. As you can see from charting things such as
unemployment rates - it is not only prices that trend but economic
indicators, too. This momentum relationship makes sense: people feel
more confident so they hire people, the economy grows, people feel more
confident, they hire more people etc.
You can also get a snapshot of all the major indicators for each country
and forecasts, too, so you can quickly compare and see the shape of the
economy in each country.
It is a bit unrealistic to expect retail traders to monitor and process all of

these indicators for all of the currency pairs. Simply read each central
bank’s comments (“minutes”) when they set rates each month and that’ll
give you a big picture summary of how the economy is developing.
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Big hedge funds will employ teams of economists who produce ‘nowcasts’
- leading indicators of what the economic releases are likely to show. The
economists often worked at central banks previously. The models are
extremely sophisticated and can be tweaked to incorporate new dynamics
faster than the models whose forecasts are publicly reported.
Let’s say the market has forecast the US labour market adding 27,000 jobs
but the hedge fund sees some other effect and its model believes it’ll be
165,000. They can trade this data release with an edge. Assuming their
model is indeed more accurate and the jobs are more like 165,000 than
27,000 they have an opportunity to make money.
As well as scheduled data releases that provide clues as to how the

economy is doing, investors will also carefully read speeches from
important government officials and central bankers to try and gain clues
about their current thinking
One-off events
Clearly one-off events influence economies. By their nature they’re hard

to predict.
An example could be an election. Who is likely to win? What is their

economic policy? Investors have to rapidly become political experts at
such times.
Another less predictable example might be the tragic example of

Covid-19. This pandemic disease caused havoc in global markets and
drove the price action for months in almost every asset. Overnight
investors had to learn all about epidemiology and learn to interpret all
sorts of new information. Some of the leading indicators were very niche.
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For example traders were watching charts that show the level of travel
between cities in China. Such charts were completely irrelevant for
markets prior to the disease but presumably it was considered a leading
indicator of the disease’s spread and magnitude and therefore a clue to
help investors navigate the markets.
This highlights the point that fundamental investors have to study and
learn new things continually because what drives economic factors can
change, even if the economic factors themselves can be understood
relatively clearly.
Risk appetite
Risk appetite is another absolutely crucial part of the fundamental

investment toolkit. Often it is the main driver of daily swings.
Like we wrote before: investors react to the same news differently based
on their risk appetite. Are they greedy or fearful? Famous economist, John
Maynard Keynes, called this “animal spirits”.
When investors are scared there’s something called a “flight to safety” or a

“flight to quality”.
In FX terms this means a flight to the most liquid currency in the world,
the USD. When markets are in “risk off” mode, the USD will tend to do
well against “risk” currencies such as emerging markets pairs like Turkish
Lira or even pairs such as AUD or GBP.
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Risk on Risk off
EUR, GBP, AUD, MXN, TRY, ZAR USD, CHF, JPY
Copper, oil Gold
Equities and indices Government bonds
We have already mentioned the VIX index from equities - sometimes

referred to as the fear gauge. When the VIX is elevated investors know the
market is spooked.
FIGURE 117
The KCJ index is a measure of how much different instruments are moving in sync and
when it is high that normally indicates a strong "risk off" mood in markets
Another measure is correlations between asset prices. When markets are

normal, different products will behave differently. For example equities
250
may go up whilst gold may go down when the market feels relaxed and
bullish. In times of extreme panic and stress (when VIX is high) there is a
maxim that “all correlations go to one.” The strength of correlation is
visible in this index from CBOE, the producers of the VIX.
The media focuses less on this complementary metric than they do the
VIX. However it is very useful. The reason that assets which normally
trade in opposite directions move in the same direction is simple. In times
of stress some investors are forced to sell assets indiscriminately to
produce cash.
For example, a hedge fund may suffer redemptions from its underlying
investors and have to pay them their money. To do so it has to close its
positions - even where it makes no sense. This leads to a “sell everything”
mood. The first thing that can be sold is the most liquid asset and these
are often the ones who do best in stressed environments. Selling them
doesn’t make sense but some people have to find cash immediately.
Therefore they sell the things they can sell; not the things they want to
sell.
Technical factors
Technical factors are part of the macro investor toolkit in currencies.

This stuff is unfortunately near impossible for retail investors as the
information is hard to come by without being connected to other
institutional traders. We’ll mention just a couple of examples so you
understand the general idea but won’t dwell on them long as this stuff is
inaccessible for the retail trader.
One example would be the portfolio liquidation i.e. the forced selling we
discussed just above. Big investors have a good understanding of how
this works and will hear whispers of such flows from their market
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contacts, allowing them to anticipate such moves. Often these moves will
reverse once the immediate panic selling has finished.
Another example is predicting big market flows. One well-known

example of this is month-end rebalancing flows. Equity funds for example
might invest in diverse equity markets of multiple countries but pay out
performance to underlying investors in a local currency like the US Dollar.
So if Australian equities go up a lot in one month, the fund is likely to sell
AUDUSD and hedge. This is so that, say, 5% Australian equity
performance converts cleanly into 5% USD performance when the
investor comes to withdraw. Otherwise an investor’s actual return in USD
will depend entirely on the AUDUSD rate at the time of withdrawal,
which could be many years later.
There are many such nuances, which broadly depend on understanding

in detail the mechanical processes of other investors and what will cause
them to buy or sell large quantities of currency - without regard to price
or value - at certain times.
The past as a guide
The old saying that the past doesn’t repeat but it rhymes is embraced
by fundamental traders. They often look into economic history to see
what happened last time similar conditions were in place.
Often this is expressed through charts like in the below commentary,

freely available on LinkedIn, from Raoul Pal, a former CIO at a large
macro hedge-fund.
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FIGURE 118
Excerpt of Raoul Pal analysis from LinkedIn
253
The past can provide a playbook for the current situation. When
something similar happened ten years ago, which assets went up and
which went down? How far did they go? How long did it take for the
stock market to recover after the last time it lost 25%? And so on.
However, this is not blind technical analysis. Fundamental investors will
interrogate the relationship and see whether it actually makes sense.
Are interest rates high or low in both periods? What is fiscal policy like?
Were the drivers then the same as now? They will study all aspects of
economic history when similar events occur to try and glean some clues
as to what may happen this time around. This provides a framework for
taking risk.
Putting together a trade
Although the inputs to forming a fundamental view are complicated

the trade logic is pretty simple.
A trade might be formed via a multi level view like below.
On fundamentals:
• US economic fundamentals have momentum and the economic picture

seems healthy
• Brexit is driving the UK economy and despite the seemingly positive

Brexit headlines recently I strongly believe nothing is actually going to
happen soon and the market has become far too optimistic about
progress
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On policy:
• The US central bank (Fed) seems unconcerned about USD strength and
isn’t going to touch rates anytime soon
• Based on their recent minutes, I feel the UK central bank (Bank of

England) has become quite dovish
On price and technicals:
• Bond prices already moved to reflect this dovish stance but GBPUSD
has not yet followed
• We are approaching a triple top resistance in GBPUSD that held nicely

before
So there’s a fundamental bias to go short GBPUSD. Then when she sees

the right level on the charts there’s an attractive entry point.
The trade is made for fundamental reasons. But the trader still waits for a
good entry point on the chart that sets up a good risk-reward
opportunity.
How to incorporate fundamentals
So what on earth is a retail trader to do?
Firstly, don’t try to beat the professionals when the odds are stacked
against you. You cannot possibly know more about central banker biases
or build economic models that outperform those used by hedge-funds.
Equally, don’t just ignore fundamentals completely because they’re hard.

That’s like closing your eyes, rolling down the window, and driving
purely based on what you can hear. Hearing is part of the overall picture
at best!
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It would be mad to go long GBPUSD based on some technical indicator if

the central bank is actively talking about the currency being too strong, for
example.
Part of the reason fundamentals are effective is because many other

traders cannot be bothered to do the work. They do not use them and lose
to those who do incorporate this extra information.
Reading this article is a start. At least you have an idea of the general
approach. Even merely reading the Economist and/or FT regularly helps
build a worldview. Then make sure to read the central bank minutes each
month for every currency you like to trade.
You can also sign up to some really high quality resources where macro
traders with actual track records (big banks, major funds) share ideas and
commentary. The nice thing about this stuff is that it is relatively slow-
moving - you don’t need to put the trade on in five minutes. They’re
helping you build a big picture macro framework. You’ll pick it up
through exposure.
You are now ahead of 99% of retail traders. Here are some additional
resources with high quality, free content:
• Raoul Pal on LinkedIn/Twitter/Realvision
• Mohammed El-Erian on LinkedIn/Twitter
• Ray Dalio on LinkedIn
• Macro Ops Monday chart pack
• ING Bank FX research (see their website)
There’s so much good stuff on Twitter and LinkedIn, in particular. The

nice stuff is that this big picture view tends to be pretty slow moving. For
example it might be "the world economy is worse than everyone realises
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and you have to buy USD on every opportunity". There you have a nice
theme and you can look for good trading opportunities to express it in
various pairs.
This is what most fundamental traders are doing. They have a medium-
term investment theme and trade tactically around that, waiting for
opportunities to take the right side in each pair.
In each of these cases, just read everything you can find and google any
parts you didn’t understand. After a few months (yep, not overnight) it’ll
start to make sense. You may need to google a few economic concepts
because these folks write for a professional audience and assume their
readers are familiar with linkages across the economic system. To get
familiar with some key FX data releases you can check out our piece on
the economic calendar.
Whenever you see big daily moves, read the daily commentary and see
whether the explanations given actually make sense. Is the price reaction
reasonable relative to the fundamental change? Does it fit the longer term
picture of the economy? Does it match the price action in other related
assets?
For each medium-term (days to months) trade you want to enter, ensure
you are familiar with the fundamentals and story behind the pair.
Spend thirty minutes asking yourself simple questions like:
• Has either central bank shown indications they are concerned about
the FX rate or likely to intervene?
• What’s the interest rate differential between the currencies and is this
differential (“carry”) for or against my trade?
• Are the central banks of each pair changing and becoming dovish or
hawkish in their minutes?
257
• What newsflow or concern is driving the pair at the moment (e.g.

Brexit)?
• Do I have a view on that driver?
• Is the wider market in a risk-on or risk-off regime? Is it likely to stay

like this?
• Is this currency reacting to the overall economic environment as you’d

expect relative to other assets (commodities, rates etc.) and the wider
framework?
• What’s fundamentally changed that the market hasn’t already priced

in and means I should be long or short this currency right now?
There’s no doubt that fundamentals in FX require some effort but they

become second nature after a while and ignoring them means you’re
flying blind.
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12 FUNDAMENTAL ANALYSIS IN CRYPTO

MARKETS
You could be forgiven for thinking that fundamental analysis and

crypto don’t belong in the same sentence.
Many people believe crypto is a speculative bubble like Tulipmania.

Tulipmania is the story of the first recorded financial bubble. In the 17th
century investors began to madly purchase tulips. The average price of a
single tulip exceeded the annual income of a skilled worker at one point.
Before the bubble burst and tulips were valued as … tulips.
However, there are some ways to think about a fundamental value of

crypto. It is mistaken to say there is no intellectual underpinning. Even if
you disagree with the valuation, it is important to know what methods
others in the market are using to reach investment decisions.
We’ll look at some of the common fundamental approaches in this

chapter.
It could be zero
It would be misleading not to start with this view.
There are some real heavyweights out there who think that the
fundamental value of crypto might well be zero. Jamie Dimon is CEO of
JP Morgan and amongst the world’s most important financiers. He once
described Bitcoin as a “fraud” that governments would “crush”.
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The majority of serious asset managers still do not allocate any of their
portfolio to crypto assets. A handful do, but the vast majority do not.
Typically the view amongst conventional finance types is that the

blockchain concept holds some promise but cryptocurrencies themselves
are not interesting.
As a method of payment, crypto has some way to go to catch up with

established methods like VISA. As things stand it is true that crypto is
more expensive per transaction, less widely accepted, slower to process
transactions.
As a store of value - like a currency - detractors point out that most crypto
currencies are far too volatile. No one would want to hold USD from a
supplier if the USD fluctuated 10% a day against other currencies.
Finally, you have the government argument. The argument is that major
governments simply will not allow a method payment that is fully
anonymous and outside their control. Think about the negative uses like
funding terrorism. Governments could use KYC regulation to ensure that
fiat-crypto processors give them the data. Or they could tell internet
service providers to take down access to certain sites. They have the
power.
So that’s the bear case. These are some pretty powerful arguments, to my
mind, and need to be taken into consideration.
Public engagement
There is no doubt that public engagement is linked to the price of

crypto.
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The relationship seems to be that when Bitcoin price moves a lot, people
start to google it. These people then rush to join the trade, creating more
momentum. Fear and Greed in action! Certainly there’s an argument that
for crypto to succeed it needs to capture public attention. One way to
measure public engagement is growth in Google searches.
FIGURE 119
Original chart from Peter Tchir
Digital gold
A serious argument in favour of crypto - and especially Bitcoin - is the

idea it can act like a digital gold.
Gold is intrinsically pretty worthless. You cannot do much with it. It does
not pay interest. However, it is scarce. Supplies are limited. People believe
it is a store of value and, when they’re scared, they buy it. It is a safe
haven for money in times of stress.
They also buy gold when they fear governments will mess around with
their money: printing more of it and inflating its value lower.
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The argument goes that Bitcoin is the modern equivalent. Governments

cannot print more Bitcoin. The world is moving online so why hold
physical gold in a vault? Enter Bitcoin.
There is no fundamental reason BTCUSD should be correlated to major

assets like the stock market. If stocks drop Bitcoin may therefore remain
unscathed. Therefore institutional investors could diversify their portfolio
by holding, say, 1% in Bitcoin.
There are not enough Bitcoins in the world to cover even 0.2% of all
institutional assets under management. So such demand would massively
raise prices. Figures based on BCG estimates of institutional AUM in 2019
and publicly available Bitcoin market capitalisation figures.
The problem with this argument is that BTCUSD has shown correlation
with the stock market in times of stress.
FIGURE 120
This correlation was a blow (although not terminal) to the digital gold theory. Chart from
TradingView
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For example when the S&P sold off 30% during the Coronavirus episode
this happened. S&P in green and BTCUSD in red.
Whereas gold worked far better as a diversifier. Again, S&P in green and
this time gold in red.
FIGURE 121
Gold on the other hand acted as a nice diversifier. Chart from TradingView
It remains to be seen what happens. However, for this argument to play

out you would want to see BTCUSD correlations to major stock indices
drop. Especially at times when the stock markets are selling off.
If that becomes true institutional investors may not be able to ignore it for
much longer. Even individual high net wealth individuals vastly
outnumber Bitcoin supply.
There are 46.8m millionaires in the world but there will only ever be 21m
Bitcoins. That is only 0.45 Bitcoin per millionaire. Meaning an allocation of
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just $3,300 for each millionaire at today’s prices. That is before you take
into account that many of the 21m Bitcoins are in lost wallets or otherwise
not for sale. It is clear to see how a demand spike could happen.
Institutional adoption
As we noted before, there is not enough Bitcoin in existence to satisfy

even a 0.2% holding of institutional assets under management.
FIGURE 122
If institutional investors do get a taste for Bitcoin, there ain't a lot to go around
Signs of institutional adoption are therefore another fundamental driver.

Is the newsflow good or bad?
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We saw some promising developments. A major institutional exchange -

the CME - has built a Bitcoin product. Investors are already connected to
this exchange. Tracking volumes on there and seeing further products
develop might be considered bullish signs. Will it be possible to trade
ETH on there? Will they launch options products?
We know that some institutional managers like Rentech and Fidelity are
gearing up to trade crypto. Hearing others publicly commit would be a
bullish sign.
We have seen major sell-side players get involved. Goldman Sachs is

rumoured to have built a crypto team in preparation of servicing their
institutional clients. Again, will other banks commit?
On the other hand, when you see public hacks, this damages the
perception of this asset class. It sets back institutional adoption.
The same goes for regulation. Clear supportive statements from major
regulators like the CFTC and SEC would re-assure institutional investors
that this is a safe asset class to enter. Negative statements do just the
opposite.
If your thesis is that institutional demand will eventually overwhelm

available supply and drive the price of Bitcoin up, you need to carefully
follow two things.
Firstly, does the necessary trading infrastructure and regulatory clarity

exist to allow such investors to get involved using their normal channels?
Secondly, is there a compelling reason to do so? Investors will want to see

that crypto can diversify them against drops in value of their traditional
asset classes such as bonds, stocks, property. It also helps if it goes up in
value: everyone chases returns to some degree.
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Flows
Flows can move the price of an illiquid asset a lot.
Some players focus on trying to anticipate upcoming flows of major

participants. These could be early-investor whales, for example. They
could also be exchanges or miners who need to sell crypto to hedge.
Perhaps there are patterns you can pick up on and anticipate pockets of
supply and demand.
For example, you might look at the way taxes work in each jurisdiction. It
might be the case that certain whales open or close positions in order to
shuffle their portfolio and be tax-efficient. Or they may just sell some to
cover the tax bills from a gain in the crypto price over the year.
Trying to model structural in and out-flows of crypto by major

participants is a classic piece of fundamental analysis.
Stock to flow
Stock-to-flow models are a measure of scarcity. You take the total

amount of a resource and divide it by the amount of new resources
produced annually.
Typically you’d do this with raw materials. However, it is often used for
Bitcoin.
The interesting thing about Bitcoin is that there are only 21m Bitcoins that
can be mined in total. Around 18m have already been mined.
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FIGURE 123
In a world of governments printing money, Bitcoin's fixed supply is extremely interesting
The fixed supply contrasts with fiat currencies where governments may
print money. Printing more money i.e. increasing supply is likely to cause
inflation in these currencies.
The other interesting thing is that the reward for processing a block goes
down over time. This is called “halving” or “halvening”. When Bitcoin
first started miners would get 50 Bitcoins per block. Right now it stands at
6.25 coins per block.
So the level of inflation in Bitcoin gets smaller and smaller until 21m exist.
At that point inflation is not possible and the supply is fixed. Accordingly
Bitcoin may prove attractive to investors in a high inflation environment.
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In any case, stock-to-flow models capture this dynamic. A popular live

chart for crypto is by Digitalik. Just Google “Digitalik stock to flow”. They
take the total amount of Bitcoin and divide it by the amount of new
Bitcoins produced annually. Since fewer and fewer Bitcoins are being
mined each year it stands to reason the stock-to-flow is bullish and
predicts a higher BTCUSD price.
Marginal production cost
There’s an argument that some fundamental value of Bitcoin must be

determined by how much miners are willing to pay to produce one
Bitcoin.
If a Bitcoin isn’t worth anything, why would they pay for all those
computers and electricity bills?
This production cost is another model borrowed from commodities. When

the price of copper drops below production cost for a large percentage of
mines, they stop mining. Eventually this lack of supply drives up the
price.
Over on Tradingview someone has helpfully set up an indicator called

“Bitcoin production cost”. We have not checked its methodology for
accuracy. As you can see it seems that the marginal cost of production has
acted as support to the price at times. Note we use log scale.
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FIGURE 124
Over on Tradingview someone has helpfully set up an indicator called “Bitcoin
production cost”
The hash rate is another number worth tracking. You can do that
here: https://www.blockchain.com/charts/hash-rate. The hash rate is a
measure of the computational power of the Bitcoin network. The higher it
is the stronger the network.
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FIGURE 125
You can think of the hash rate as the difficulty of mining
If this is going up, it means mining for Bitcoin has become harder. It
seems hard to square that people would continue to dedicate expensive
computational resource to something they believe has no fundamental
value.
Payments
Some folks argue that the value of crypto is connected with its utility as
a payment network.
Any newsflow which suggests it is being more widely adopted is thus

bullish. Equally, measuring the number of actual transactions might
provide some indication.
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A dose of realism, however. Cryptos have a long way to go to catch up

with “old fashioned” payment rails in terms of how many transactions
they can process.
Furthermore the energy efficiency of Bitcoin as a payment network is

awful. Robeco estimates that the energy involved in processing one
Bitcoin transaction is equivalent to 330,000 credit card transactions. Then
you have the cost of each transaction. You can track Bitcoin transaction
fees here: https://bitinfocharts.com/comparison/bitcoin-
transactionfees.html#6m.
FIGURE 126
Who would pay $4 in transaction fees per purchase?
It is important to note that people will disagree with the exact numbers
and assumptions above but the overall picture remains true. Regular
Bitcoin is a useless payment network for everyday transactions. That’s
why new coins have sprung up to address these limitations.
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Ripple is the network, which has made the most progress in this regard. It
has signed up major players and is trying to replace SWIFT - the current
cross-border payments architecture.
If you believe the fundamental value comes from utility as a payment

mechanism, you will need to follow adoption. To disrupt incumbents
you’d want to see 10x features like “instant settlement” and costs per
transaction that beat existing methods.
Owning the network for cross-border payments would undoubtedly be

valuable. However, it is not clear that the actual crypto token being used
should be of value. Any number of stable-coins could do the job.
No yield but no rolls either
Crypto does not pay interest. This is a bad thing - all things being
equal, you’d rather own things that make you money when the price
doesn’t move.
On the other hand, crypto does not incur roll costs. It doesn’t need to be
insured and stored in a vault like gold. This all costs money. In today’s
Zero Interest Rate environment when central banks are in some cases
charging people to deposit money, that might make crypto attractive.
Imagine the US central bank set rates to -1%. Stable-coins, pegged to the
USD value, should surely go up. They are pegged to the price of 1 USD
but don’t cost you 1% each year to hold.
In general lower rates should be supportive of higher crypto prices for

this reason. The opportunity cost of holding a non yielding product like
crypto drops with low rates being paid on competing assets.
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Reflexivity
There is no doubt that crypto exhibits what George Soros calls

reflexivity. This means a feedback loop.
For example, investors get bullish about crypto. The price goes up. The
price rise attracts lots of attention. More developers get involved. They
build cool stuff. People see this. They become more bullish. The price goes
up more.
This happens in all asset classes but seems particularly pronounced in

crypto. Understanding the feedback loops and reaction function in detail
can help investors predict mini surges in demand and supply.
FIGURE 127
Reflexivity at work in crypto
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13 TRADING STOCKS ON FUNDAMENTALS
Equity fundamentals is a huge topic. People have been trying to beat

the stock market since it existed. If only it were that easy. In this article
we’ll walk through the basics.
Macro and the market mood
You’ll remember how we said before that all markets are linked?
Especially if you are trading equity indices like GER 30 you will want to
consider top-down macro factors and positioning data.
If you expect the economy to boom and interest rates to stay low, you are
likely to want to be long the index. If you feel rates are going to rise or the
economy is going to stumble, you will likely want to short the index.
We won’t spend long on this now. You can read FX fundamentals to get an
idea of market ‘risk on’ and ‘risk off’ regimes. Just be aware equities are
definitely a ‘risk on’ product.
Even if you buy the best stock, with a great outlook and story, you might
find it drops in line with the wider index in a ‘risk off’ market mood
swing.
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FIGURE 128
Stocks are broadly considered a "risk on" product so the overall sentiment affects day to
day moves
Value investing
Probably the most famous equity investor today is Warren Buffet. He is

definitely not a trader. He holds stocks for years if not decades. Seems to
have worked for him.
By the way he writes brilliant notes and shares a lot of wisdom in his
interviews. Well worth checking out.
Buffet is a proponent of what’s known as ‘value investing’. Value

investing in a nutshell means staying patient and disciplined and buying
stocks only when they’re cheap.
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That sounds simple enough. But who on earth would sell you something
that appears to be valuable on the cheap Yet recall what Buffet’s mentor
said.
In the short run, the market is like a voting machine - tallying up

which firms are popular and unpopular. But in the long run, the
market is like a weighing machine - assessing the substance of each
company.
Benjamin Graham
What Graham is saying is that if you are patient enough the market will
offer you an opportunity.
Stocks that pay good dividends might be boring stories that escape the
market’s focus. A lot of people prefer to chase after media darling stocks
with the rest of the herd.
Or the market might get spooked in a crisis and, caught up by the panic,
sell particular companies for less than they are really worth.
But how do you know what a company is really worth? Great question.
Ratios
The idea of value investing is to buy companies that offer good value
and a margin of safety. If you buy something for $80 that is intrinsically
worth $100, you have a $20 margin of safety. We are going to look at a
bunch of commonly used ratios to value a company.
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Price to earnings (P/E)
The P/E ratio is simple: it is the company’s stock price divided by its
profit. For example, if the company had a market cap of $100m and an
annual profit of $10m it would have a P/E of 10.
Now, that seems pretty good. You could buy a share and within ten years
(ignoring inflation) the profits would have covered the purchase. After
that it is a freebie.
A low P/E is one indication you are buying earnings on the cheap and the
stock is good value. For example you can screen for all US stocks, ranked
by P/E or similar.
FIGURE 129
A stock's P/E ratio is a measure of how much the market charges you for that company's
earnings over time ... think about that a moment. This is normalised by how much the
company earns at each time. Sometimes it is cheaper to buy the exact same amount of
earnings at the exact same company than other times
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You will see that different stocks have very different P/E ratios. This
reflects the market’s view on growth. Perhaps the stock makes very little
earnings now but is expected to grow those earnings over time.
You will also notice that the P/E ratio for the same stock changes a lot
over time. Value investing argues you should wait till earnings are on
sale, rather than buy them at full price.
Price to book ratio
Book value is a measure of the net wealth of a company.
Imagine you wound down the company and sold all of its assets - stock,
real estate, intellectual property, cash in the bank etc.
You can often buy companies below this value.
That presents you with a margin of safety. The devil is in the details. You
have to think what the assets are really worth.
Have their accountants bundled a lot of intangible stuff into a ‘goodwill’

category on the balance sheet? If they had to sell all their inventory fast,
could they realistically do so at full price?
Price to Book ratio is exactly this. If the book value is $100m and the
market cap of the company is $80m you have a Price to Book ratio of 0.8.
If you believe the book value is calculated accurately (this is where you
need to do your work) then you are buying a dollar for 80c.
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Dividend yield
Stocks pay dividends to their shareholders. In some cases, quite

handsome ones.
Imagine a stock trades at a price of $100 per share. Historically it has paid
one dividend per year of $5.
That’s pretty good: you get a 5% return, even if the stock stays flat. In that
case the dividend yield would be 5%. Obviously, the higher the better.
Now - some fantastic stocks may not pay dividends.
They may feel they’re better off reinvesting excess cash back into their
business. Maybe they have demand for new products and want to scale
up their factories to meet the demand. Using cash for this instead of
dividends is perfectly reasonable. That’s fine, too, but in that case you’d
want to see the stock price go up.
Yahoo screener tool and the importance of context
There are hundreds of these value metrics. By now, however, you are
probably getting a good idea of how they work. You are ready to do your
own research.
Yahoo has a great tool where you can filter stocks based on many metrics.
For example, we might look for all large-cap stocks with high Dividend
Yield and a low Price to Book.
Now, several words of warning.
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You cannot blindly follow these metrics. Maybe the stock is cheap simply
because it is a dog with no future. Its accountants might have inflated its
book value, for example, by making unrealistic assumptions. Or it might
be at risk of serious disruption from a competitor. The metrics are only
approximations: to really dig into a company’s prospects you need to
understand the company at a deeper level.
Metrics are just a convenient starting point for a fundamental

investigation. They are simply an alert that tells us “Hmmm, these stocks
are worth looking at in more detail.”
Equally, value investing is not about short-term trading. Stocks can

remain cheap on value metrics for years or even decades. What drives the
price in the short term is the story, momentum, shifts in market mood -
not intrinsic value.
However, you cannot seriously do fundamental research without

understanding and being aware of these value concepts and the big
investors who use them. Even though, as we will see next, you might
choose to look through them when trading shorter horizons.
Trading the story: Tesla case study
Tesla is such a great example of the ‘story’ that drives stocks.
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FIGURE 130
Hard to say something was bad value when it goes up tenfold
Tesla is a horrible stock on any value metric. It has never paid a dividend.
It rarely makes a profit so the P/E is awful. But here’s how it traded.
Would a dollar invested in 2013 have been ‘bad' value?
In stocks the market is driven by ‘the story’ of each company. The story
with Tesla is that it is going to be the iPhone of transport, a huge segment
of the economy.
Elon Musk is a visionary guy, who has sent rockets to space and re-
invented what cars will be like. The old-fashioned car makers will end up
like Kodak and never catch up once consumers move to electric vehicles.
Self-driving vehicles are going to change the way we live and Tesla is
years ahead of anyone else. And so on.
Now the bear case is that Elon Musk is an irresponsible egomaniac, unfit
to run a company. The economics of Tesla don’t add up. BMW and VW
are going to move into electric and crush them.
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There are wars on Twitter every single day. Try searching #teslaq. The Q
refers to the bankruptcy code in the US.
TESLAQ-ers are convinced Tesla is a horrible company and a great short.

They go to incredible lengths to do on-the-ground research. Even flying
over parking lots to count the number of vehicles being produced!
The point is. Both sides cannot be right. There are people who think Tesla
should be worth $10,000 and others who think it is worth $0. That is what
makes a market.
Tesla is the most dramatic example but each stock has this bull/bear
tension. The key is to really focus on what is important and think clearly.
If you had a fundamental understanding back in 2007 that the iPhone

would change everything and smartphones would ride the internet wave,
you would have found it easy to buy Apple stock even at pretty high P/E
multiples. After all - you know the current earnings numbers are going to
grow 100x as the world buys their products. The market simply hasn’t
appreciated that this new product will change everything.
There’s no simple guide on critical thinking. It is a difficult skill. However,

many find this deep dive into the ‘story’ of a stock fascinating.
One tip is to read both bull and bear cases and make a list of their
strongest arguments. Try to avoid “straw man” caricatures of the opposite
side’s arguments, where you view them in their most fragile form.
Construct what Peter Thiel calls “iron man” versions of each side’s core
arguments for yourself: make them as strong as the facts can support.
Now you need to evaluate these as well as best you can. Ray Dalio argues
the best way to get to the truth is seek out the smartest people who
disagree with you and discuss the topic with them.
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Twitter and Seeking Alpha are both decent sources of information. As a

trader or investor it is your job to find examples where you believe the
market has got the fundamental ‘story’ wrong.
Short selling
Everyone knows you can buy stocks. You can short them, too, if you
think they’ll go down.
Bear in mind this is more risky. If you buy a stock at $50 the most you can
lose is $50. If you short it at $50 and it goes up to $150 you lose $100. The
losses are unlimited.
Also, over the long run, stocks tend to go up. You are betting against the
tide. There is also a “borrow cost” that you must pay daily when going
short and this can add up.
Shorting is a very risky discipline and tends to be done by specialists. A

lot of the time they are looking for outright fraud. Stocks that should be
worth zero when everyone realises.
Because of the unlimited losses, shorting involves a very specific risk

management approach. It also requires careful trade entry discipline.
After all, if you think the stock is a fraud you are going to want to sell at
any price.
Enron was a famous fraud. Say you realised and sold. The market still
doubled in the next year.
So most short sellers will build a thesis but only enter the trade when the
market has already begun to turn. A classic case of combining
fundamental and technical analysis.
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Some famous short sellers include Carson Block and Marc Cohodes. There
are some great video interviews freely available online in which they
explain their process.
Sectors and the market mood
You’ll often see sector specialists in stock trading. For example, former
medical researchers who focus solely on pharmaceutical stocks where
they have some edge in interpreting drug trials.
Often traders monitor the flows in and out each sector as an indicator of
the market mood.
For example you have defensive sectors like Utilities. These are mature
stocks, generally with stable earnings and dividends. An example might
be an electricity company. In an economic downturn these stocks are
expected to weather the storm.
On the other hand the Technology sector tends to house more exciting,
growth stocks like Netflix. These stocks roar in good times but have
further to fall in an economic crash.
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FIGURE 131
The stock market sectors are typically divided along the lines above
So the flows in and out of various sectors can be some guide as to market
sentiment. Fidelity offers a neat live overview of sector performance on its
website.
Trading IPOs
IPOs can be extremely interesting. IPO stands for Initial Public

Offering. This is when a private company lists its stock on the open
market.
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The way it works is that investment bankers go around big investors on a

roadshow and tout the company. They hold a series of private auctions to
try and find a fair price at which there are enough investors to buy all the
shares on offer.
At some point the company IPOs and the shares can be traded.
The interesting thing is that there’s an effect called the “IPO pop”. A lot of
the time the price will jump when the secondary market is allowed to
access the shares.
FIGURE 132
Source Jay Ritter, University of Florida, first seen on CNBC
Venture capitalists hate this. They feel like they (and the companies who
IPO) are getting ripped off by IPOing at a price that is below the price the
open market will pay. Look at what Bill Gurley has to say on the matter.
Anyhow, the strategy here is obvious. It is not without risk. Not all IPOs
pop. Uber did not.
You need to carefully read the IPO prospectus (just google “Company IPO
prospectus”) and see if this is a company you think is worth owning.
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Pay especially careful attention to the section named “Risk Factors”. This
sets out things that could go wrong and weaknesses in the business. You
may also find it helpful to compare against similar companies, which are
already public.
Trading earnings
Trading earnings is just like trading the economic calendar. We are

going to look at that in more detail in the later chapter on news trading.
Make sure you have fully digested concepts like second-level thinking
and the idea of knowing what is priced in by the market.
Earnings announcements tend to cause extreme volatility because a lot of

important new information is released to the market.
You need to prepare.
Companies do not all report at the same time. What helpful clues can you
find from other similar companies who have already reported? Does the
stock price look like it incorporated that information already?
Equally, you might want to look for companies whose earnings analysts
get wrong often. Generally these are smaller companies, where there’s less
focus.
It costs money but there are services like Zacks which filter these stocks
out for you.
The earnings calendar is freely available in loads of places. Bloomberg

does a nice one. Seeking Alpha often has analysis on each stock.
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Pairs trading
Pairs trading is a strategy where you identify two stocks that are
similar. You buy one and sell the other.
Now, you might feel that JP Morgan has far better prospects than
Goldman Sachs. Or vice versa.
FIGURE 133
Goldman vs JP Morgan
The nice thing about the pairs trade is that you are taking some of the
wider market noise out of the trade.
Say you buy JP Morgan and sell Goldman Sachs. If the wider market
drops 40% for reasons unrelated to either stock specifically, you are more
protected than if you had just gone long JP Morgan.
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The relationship between a specific stock and the wider market is known
as “beta”. For example a Google search reveals that the group that owns
Hilton Hotels (HLT) has a beta to the S&P of 1.37 currently.
That means if the S&P index as a whole goes up 1%, HLT is expected to go
up 1.37%. If the S&P goes down 10% HLT is expected to go down 13.7%.
These betas aren’t stable of course. They change over time. However they
give some idea of your net market exposure when pairs trading. It is
unlikely to be exactly zero unless you specifically ratio your trade sizes in
each stock to achieve that. However you should be far less exposed than if
you took a single directional position.
Often pairs traders will plot the premium of one stock over another.
This is easy to do in TradingView: simply enter JP Morgan in the

instrument panel. Then left-click it and select the “-” button and type
Goldman Sachs and hit enter.
Next we look at JP Morgan stock price - Goldman Sachs stock price over
the last five years.
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FIGURE 134
Can you spot a likely double bottom support level? Chart from TradingView
This provides some context for whether the pairs trade is at extreme levels
relative to the past or not.
You might imagine that you’d find buying interest around that $150-$160
level where the spread recovered historically, for example.
Merger arbitrage
Merger arbitrage is a hedge fund strategy that has become popular

with individual traders. Let’s look at an example.
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In November 2019, LVMH Group announced it had successfully agreed a

takeover of Tiffany & Co. for a price of $135 per share in cash.
The price of Tiffany was around $125 per share at this point, having risen
from around $90 before talk of the merger.
Obviously if you had some insight and could predict likely take-over
targets before they happened, based on your industry knowledge, an
amazing trade would have been to buy at $90.
However, let’s forget that for now, and just focus on trading after the deal
is announced.
FIGURE 135
Arbitrage is never quite "free money" - there are risks, maybe you just don't see them at
first
LVMH is going to buy the stock for $135 when the deal goes through …
but the stock is still only trading at $125. That seems like a free $10? Just
buy it at $125 and wait six months till the deal concludes to sell at $135.
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This is merger arbitrage. Of course it isn’t that simple. The deal may not
go through. At that point Tiffany stock might drop back down to $90.
There are all sorts of reasons the deal might not go through: the business
environment could change or a regulator might not approve the deal etc.
According to McKinsey there are around 450 M&A deals each year and
about 10 percent are cancelled.
Therefore merger arbitrage involves monitoring the spread (the current

price vs acquisition price) and making a detailed judgment call on
whether the deal is likely to go through or not.
There is also an upside scenario. It might be that a second acquirer comes

in for Tiffany & Co. and bids up the purchase price beyond $135.
Insider purchases
One of the long-time favourite indicators has been insider buying or

selling. After all, who knows the firm’s forward prospects better than the
management company?
A word of caution: selling is not always a negative indicator. Sometimes

CEOs just need liquidity. They might simply be diversifying their wealth
or need cash to buy an asset like a house. Buying, on the other hand, is a
wonderful sign. They are putting their money where their mouth is.
Again, this is all captured in regulatory forms. SEC Forms 3,4,5. These
guys do a great job of tracking insider purchases in a visual table: https://
www.gurufocus.com/insider/summary.
If you think a little harder there are ways to calibrate how bullish a signal
this is. A CEO who gets paid $10m a year and buys $50k of stock is not all-
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in. A CEO who gets paid $1m a year and buys $1.5m of stock is clearly
extremely bullish.
Like most useful signals, you will need to do a bit of extra work to
establish a CEO’s approximate income or net wealth. Not everyone will
bother to do so.
Seasonality
Stocks seem to exhibit some seasonality. The old saying is “Sell in May
and go away.” The idea being why waste summer staring at the screens
when stocks are not going to do much.
FIGURE 136
Seasonality is a weak signal but something to consider
However, this is a pretty weak alpha and often doesn’t work at all. Look at
2019 for example versus the last few decades.
The most compelling argument for why stocks would exhibit seasonality
is things like tax years or funds which measure performance annually.
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Imagine a fund is up 8% in November. They are biased to take off risk and
ride out the profit and get a year’s good track record.
In January they need to start all over again so load up on stocks, moving
prices higher.
You can get similar behavioural nuances around tax periods, depending
on stock performance.
The term is called “tax harvesting”. Imagine you have twenty stocks in the
portfolio and made a gain on 15 and loss on five. It might be beneficial to
close the five to crystallise a loss that you can offset against other gains for
tax purposes. A day later, we are in a new tax year and the position may
get reinstated.
Buying or selling blindly based on seasonality is not a smart idea.

However seasonality it is one market undercurrent of which you should
be aware.
Activist investors and whale holdings
Activism is a form of investing where investors influence the running

of the company.
This sounds like it would be the default method. Why wouldn’t the owner
give the CEO their input? In reality most investors are passive and have
little direct interaction with management.
Examples include Bill Ackman or Dan Loeb, who writes funny poison pen
letters to target company CEOs who writes public letters to CEOs with
barbs like “It is time for you to step down from your role as CEO and
director so that you can do what you do best: retreat to your waterfront
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mansion in the Hamptons, where you can play tennis and hobnob with
your fellow socialites.” Ouch.
Both Ackman, Carl Icahn and Loeb became billionaires through this
strategy and routinely publish detailed letters to their investors about
their current thoughts and tactics. You can simply do a quick Google
search to find these letters. Reading them is a free education.
Typically activist investors will look to replace board members and give
the management team in underperforming companies a sense of urgency.
This may involve selling non performing assets, rebranding and
refocusing the business.
Activism is not a strategy available to the home investor. You do not have
the firepower to buy 5% of outstanding Sony shares. However, you can
ride on the coat-tails of these guys. They have to declare their holdings in
each company and you can see who they own.
The turnaround process generally takes months to years before they sell
so, even with some delay you can jump on the same trade - if you believe
in their thesis and track record.
For example you can see Pershing Square (Bill Ackman’s) top holdings for
free here: https://www.bloomberg.com/quote/PSH:NA.
If you don’t like the Bloomberg page you can just google “Fund name SEC
Form 13F” or “Fund name top holdings” and it’ll usually come up.
There’s a delay of course because these are a quarterly snapshot of the

fund’s regulatory filings. However, this stuff is pretty slow-moving and
monitoring what the whales hold can be interesting.
These funds normally charge 2% management fee per year plus 20% of
the profits they make. However, these filings are publicly available and
free.
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Alternative data
We looked at earnings data earlier. Now, if you knew that Walmart was
going to publish way better-than-expected earnings, you could get long
the stock.
However, there’s no way to know for sure. The company can give
guidance and clues in its public statements. It will be careful to only
disclose information in accordance with all rules and regulations,
naturally.
This is where alternative data comes in to offer an edge. Hedge funds

might use satellite imagery to see if Walmart car parks are more or less
full versus the same time last year.
FIGURE 137
How busy are the car parks? Perhaps this provides an early indication of how earnings
will look
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Or they may use sentiment analysis models to try and detect subtle clues
from the language the CEO uses on earnings calls.
This is not really a strategy you can easily replicate at home. However,
you should be aware of it.
Whenever information comes out to the market you have to think: if I had
access to all this alternative data, would this really be news to me?
FIGURE 138
If you saw the satellite data and has reason to believe earnings would be good before
they were released, you might see the stock do this
It is said to be a major contributor to the buy the rumour, sell the fact
trade. All the smart money already knows earnings are going to be a big
beat.
When it comes in that way, rather than buy they actually take profit and
sell their longs.
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14 INTERMARKET RELATIONSHIPS AND

ADVANCED CHARTING
Markets are fundamentally linked. Let’s look at an example. When FX

prices change this affects the profits of global companies and so equity
prices may change. When equities drop, consumer confidence drops so
people spend less. This affects interest rates. These in turn affect FX. This
is just one example amongst hundreds of links across major markets.
Once you understand that markets are linked, you realise there are some
interesting opportunities that arise. Not all participants trade all markets.
Not all participants even look at all markets.
When a fundamental change happens in the world - say, a US election -

each market may react somewhat differently.
In this chapter we are going to look at some common linkages across

markets so you can spot divergences and build a framework for using
them to inform trades. This is primarily a chart-based activity. So we will
also run through how to build the charts on each example.
Intuitive links vs co-incidences
If you look at enough charts you’ll find some seemingly linked things
that are actually just a pure co-incidence.
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FIGURE 139
Tyler Vigen's brilliant "Spurious correlations" website has many crazy co-incidence charts
No one would seriously believe cheese and bedsheets are in some way
linked. To belabour the point, here's another example.
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FIGURE 140
Tyler Vigen's brilliant "Spurious correlations" website has many crazy co-incidence charts
So we have to be careful. When we spot a linkage we should always ask

“is this intuitive?” We need to know that there’s a good reason that the
two things are linked and can be expected to stay linked.
It is not enough that they appear linked on the charts. That is required.
But we also need to know there’s a real fundamental relationship that we
can explain. Otherwise we have no idea if the linkage will suddenly stop.
We also need to think about whether the seeming correlation we see is

due to a third variable. Imagine we plot for each city the number of
swimming pools and number of violent crimes and see a correlation.
That seems weird? Swimming pools and violent crime do not really go
together. But it is rock-solid and works in every country and every year.
Should we shut down all the pools and expect to see crime drop?
The answer can be explained by a third variable: population. Cities with

big populations have more swimming pools. They also have more violent
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crimes. In this case there’s no real link between swimming pools and
violent crime, even though the chart looked very real.
Single product comparisons
This is a pretty easy one. Some countries have highly interlinked

economies and their currencies tend to move together. Here’s AUDUSD vs
NZDUSD for example.
FIGURE 141
AUDUSD vs NZDUSD. Chart from TradingView
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You might do gold vs silver. Or DAX vs S&P.
FIGURE 142
Gold vs silver. Chart from TradingView
There are many examples like this that spring to mind. Or let us look at
two USD-Emerging Market pairs. The Russian Ruble and the South
African Rand.
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FIGURE 143
USDRUB vs USDZAR. Chart from TradingView
But how do we plot these? Well, first we head over to the chart on
www.tradingview.com and we enter our first pair. The first thing we have
to do is switch from candles to line chart. It is too messy otherwise
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FIGURE 144
Change the type from Candles to Line. Chart from TradingView
Our next step is to click Compare and add our second instrument. Now
we should have something that looks like this.
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FIGURE 145
USDRUB vs USDZAR. Chart from TradingView
The final step is to use different colours. Right-click one of the lines.
Choose Settings. Now choose a colour for the line. I like blue and orange.
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FIGURE 146
The final product. Chart from TradingView
That’s it. Now you may wish to save your chart layout to make things
easier in future.
FX vs rates
We spent some time discussing this in the fundamentals of FX chapter

so for a recap please check that out. The relationship between FX and rates
is very real. There are two types of charts you might look at here.
The first is the currency pair vs domestic interest rates. We’ll use GBPUSD.
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FIGURE 147
GBPUSD vs 2-year British bond yields. Chart from TradingView
Building the chart is exactly the same process as FX vs FX. However, we

simply choose the country’s 2-year bond yield as the second instrument.
For the UK this is “GB02Y”. For Australia it is “AU02Y”. For Italy we use
“IT02Y”. You get the picture.
Now you can see something interesting in the chart above. Bond yields
moved sharply lower in late February. GBPUSD followed them but only a
couple of weeks later. What a signal! We will cover this in a bit.
You can also look at bond yields of different maturities - 10Y for example.
However, I find that the shorter-term bonds are better for FX. Have a look
and see what you think.
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The second signal from rates markets is the interest rate differential. This
is a little harder to chart.
Let’s stick with GBPUSD. Here I want to see the price of GBPUSD vs the
interest rate differential between UK 2-year bond yields and US 2-year
bond yields.
First we type in the formula. Literally just GB02Y - US02Y. Then press
enter.
FIGURE 148
Type in the formula ... for GBPUSD it is GB - US as you want to see the difference in bond
yields in the UK vs the US. Chart from TradingView
Okay. Not bad.
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FIGURE 149
Generally US bonds yielded more than UK bonds since the chart is below 0% most of the
time. Chart from TradingView
This chart shows that generally US bonds yielded more than UK bonds.
The US central bank paid higher interest than the UK central bank. But
there’s been a change in trend. The gap has narrowed.
Now let’s add GBPUSD by clicking Compare.
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FIGURE 150
GBPUSD vs GB-US bond yield differential. Chart from TradingView
Hmmmm. Kinda weird. Interest rate differential moved in the UK’s

favour. But GBPUSD went down. You would expect GBP to go up relative
to USD.
Actually we know the reason for this one. The chart was taken at a time of
extreme market panic ("risk off") during the Covid-19 crisis when
everyone rushed to buy USD.
Even a very real and steady correlation has temporarily broken down.
This is an important example. We have to understand that correlations
aren’t perfect. They go through periods of working and not working.
External events - like a USD buying panic - can knock markets out of line
from fundamental fair value.
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Of course this might just be the mother of all GBPUSD buying

opportunities! Eventually FX is likely to move back in line with rates
differentials.
FIGURE 151
Multi-year view of GBPUSD vs bond yield differentials. Chart from TradingView
One helpful way to see the stickiness of the correlation is to zoom out.
Change the timescale. This helps give you perspective on how often it
works and how far out of line it has been in the past.
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Commodities vs FX and stocks
We spent some time discussing this in the fundamentals of FX chapter

so for a recap please check that out.
We know for example that a large part of Canadian exports are linked
to oil. So if we plot USDCAD vs oil we would expect to see a clear pattern.
FIGURE 152
USDCAD vs oil. Chart from TradingView
We do see a pattern. It is an inverse pattern. USDCAD goes up when oil

goes down. This makes sense. CAD gets weaker when the oil price goes
down. Yes, Canada and oil are linked. So if CAD gets weaker USDCAD
goes up.
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Inverse patterns are a bit harder to visualise. At least for me. So there’s a
trick. You can flip oil upside down. This is easy. Just click on the top where
we enter oil and select the 1/ icon and press enter.
FIGURE 153
Inverting one line can make the charts easier to follow. Chart from TradingView
Much nicer.
FIGURE 154
USDCAD vs inverted oil. Chart from TradingView
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You’ll recall the following linkages between FX and commodities from a

previous chapter. Try plotting them and see what you find. AUDUSD and
copper is a good one to start with. Or you might do oil vs an energy stock
like Shell.
FIGURE 155
Oil vs Shell stock. Chart from TradingView
Or even versus a wider index like DAX. Both oil and equity index are risk
assets. This chart captures the risk-on and risk-off mood of the markets.
This is a bit like the swimming pool and crime rate, example. Here the
third variable is global risk appetite.
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FIGURE 156
Oil vs DAX - risk asset linkages. Chart from TradingView
FX vs indices
Equity indices are another interesting comparison. Not as reliable as

rates or commodities but useful sometimes.
There are two real reasons.
• If the local equity market is doing well, money should flow into the
country. This money will need to be converted into local currency in
order to buy the local equities.
• The other reason is that certain currencies are considered ‘risk’ assets.
Emerging markets, GBP, EUR, AUD, NZD, CAD whilst other
currencies are considered ‘safety’ assets such as USD, CHF, JPY.
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When the market is in ‘risk on’ mood both risk currencies and equities are
likely to do well. They are likely to both do poorly when the market is in
‘risk off’ mood.
FIGURE 157
AUDUSD vs DAX. Chart from TradingView
The above shows this relationship clearly. It is AUDUSD vs the German

DAX stock index. Clearly these are two countries on the opposite side of
the world. Both have been driven by global risk appetite. When the
market is bullish it buys DAX and risk currencies like Aussie. AUDJPY in
particular is often considered a proxy for 'risk on' equity markets.
Let’s look back at domestic comparisons for a moment. Here we have the
Nikkei 225 vs USDJPY. Not bad.
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FIGURE 158
USDJPY vs Nikkei 225. Chart from TradingView
Over the last year it certainly seems a decent a barometer of risk. Are local
equity market players buying the dip or not? Has FX over-reacted? And
so on.
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FIGURE 159
Longer term USDJPY vs Nikkei 225. Chart from TradingView
But recall what we said about zooming out? Longer term, it seems, it is a
bit of a mess. Extremely noisy. Typically when people are scared or
uncertain you'll see these correlations increase as they look to other
markets to validate their direction.
Even more relationships
There are some other really interesting relationships but TradingView

unfortunately does not have the right data.
One relationship is to compare a currency pair vs its country’s CDS. A

CDS is a credit default swap. It is the cost of insuring against that country
not paying its debts. When the country does badly its currency tends to
drop and its CDS (insurance against its debt) becomes more expensive.
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Another interesting relationship is to compare a currency pair vs options

pricing - in particular something called a ‘risk reversal’. A risk reversal
tells us how much more the market will pay for bullish options than
bearish options. It is a measure of sentiment about the future price.
Tradingview also does not allow you to compare economic indicator

releases vs market prices. This is annoying. Being able to look for example
at consumer sentiment indices vs the stock market price can present very
interesting relationships and trading opportunities.
You can do all this stuff in Bloomberg. But Bloomberg is $2,000 a month.
Market regime
We saw an interesting example earlier where a correlation broke down.

Interest rates moved in the favour of the UK. Yet GBP went down in
relation to the USD.
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FIGURE 160
The correlation between GBPUSD and bond differentials broke down. Chart from
TradingView
Now this was explained as the market being in total panic. When the
market is scared of risk it buys USD. You might remember the 'risk on,
risk off' table from the forex fundamentals chapter.
Here’s the VIX index at that time. VIX is equity market volatility, often
known as the "fear index".
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FIGURE 161
VIX rocketed - the market was in a panic. Chart from TradingView
Wow. That is real panic.
So you might say that GBPUSD will go up and this presents a buying
opportunity. However, right now fear is overriding fundamental value.
This is why you have to understand the fundamentals behind each trade -
you couldn’t have predicted that from the first chart alone.
So we look at correlations and see that they are stable for long periods
then don’t work then go back to working again. Let’s think about the
market regime.
• Are we in an equities bull market?
• Or a bear market?
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• Is the market fearful?
• Or greedy?
You will notice that some correlations work well in bull markets but not in
bear markets and so on.
Eventually you will expect the two assets to normalise but you may have
to wait a helluva long time. Beware of the old joke about the trader who
waits ten years for his trade to turn positive: What do you call a trade that
went wrong? An investment.
Market focus
The chart below speaks for itself really.
FIGURE 162
Bitcoin price vs Google searches for "Bitcoin"
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Sometimes the market is just obsessed with a particular story and risk
appetite trades on the back of it.
It is not hard to spot such times: papers like the FT will be jammed full of
articles on the topic.
Let’s say, the market is focused on a trade war between the US and China.
Any comments relating to this will send risk assets up or down. Economic
indicators, related to trade, which are usually ignored move entire
markets.
The point to remember is that the thing that drives risk appetite will often
change. Reading the papers helps you identify what the market is trading.
Sometimes these things can be charted nicely against price.
Additional charting tricks
One neat trick is to rebase instruments to 100 for a specific period in

time.
For example, let’s say we had a massive market crash. It might be

interesting to plot DAX (GER30) vs S&P (US500).
We first do the normal thing: add DAX and S&P on a chart.
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FIGURE 163
DAX vs S&P. Chart from TradingView
Next step we right-click the right axis and select indexed to 100
FIGURE 164
Now we select "Indexed to 100". Chart from TradingView
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Now we do the same on the left axis. Finally we right-click either axis and
choose Merge All Scales into One > On the left.
FIGURE 165
DAX vs S&P indexed to start date. Chart from TradingView
Beautiful. Now we have normalised both of them. At the start of the chart
they were each 100. And we can see that the blue DAX has undershot the
orange S&P.
This is particularly useful if you think one market is unloved by the

market versus its peers and especially good for plotting a before/after
chart around major market events.
We spoke about logarithmic charts in the technical analysis article.
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FIGURE 166
XRP vs log XRP. Chart from TradingView
Above is XRP. Below is also XRP but this time on a log scale.
To do this we click Compare. Then write XRP but uncheck the Overlay the
main chart box.
FIGURE 167
Don't check the box. Chart from TradingView
Now we simply right-click the axis on the bottom and select Logarithmic.
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FIGURE 168
Check "Logarithmic". Chart from TradingView
Indicators
Maybe we want to add some moving averages.We select our

instrument first of all - let’s go with Apple. Now we click the Indicators
button.
FIGURE 169
All the indicators are available from here. Chart from TradingView
We are going to choose Moving Average Exponential.
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FIGURE 170
Here we can choose our indicators. Chart from TradingView
We will repeat this step again as we want two moving averages. Now
hover over the first EMA on the chart and click the cog icon. It'll look like
this.
FIGURE 171
Click the cog icon to adjust the settings of each indicator. Chart from TradingView
Click Inputs and choose Length of 15.
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FIGURE 172
Click the cog icon to adjust the settings of each indicator. Chart from TradingView
I also Tend to click Style and change the colour and line thickness so it is
easy to read.
Now we repeat the process but using a Length of 60 on the second EMA.
Here we go. A lovely chart. The faster moving average in yellow and the
slower moving average in orange.
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FIGURE 173
Apple stock and two moving averages - a fast and slow. Chart from TradingView
Was it a decent signal? You decide.
Adding something like RSI is exactly the same process. Just click
Indicators and pick your poison.
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FIGURE 174
RSI and other common indicators are available. Chart from TradingView
The catch-up trade and which markets to trust
The point of looking at these charts is to find trading opportunities.We

had a great example earlier when the UK bond yields (blue) moved a
couple of weeks before the currency (orange). This is a classic catch-up
trade.
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FIGURE 175
Bond yields in blue signalled the leg lower before GBPUSD caught up. Chart from
TradingView
But how do you know in advance which one was right? Couldn’t it have
been the case that GBPUSD stayed higher and the bond move retraced?
Yes. This is where some detective work comes in.
Say you are trading GBPUSD and you see the above.
The next thing is you might flip to look at UK equity markets. Did they
move, too? How about other risk assets like oil or global equities? Are
they all moving in line with bond yields?
If they are neutral that’s okay but the trade feels less solid. If they point in
the other direction then selling GBPUSD is probably something to avoid.
If everything is supporting the GBPUSD lower idea you have to think: Do

the fundamentals support such a drop? How is the market positioned? If
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the market is currently very long GBPUSD and the fundamentals are
indeed getting worse this could be a really exciting trade opportunity. All
these longs might be forced to sell in a crowded market as the currency
catches up with fundamentals.
FIGURE 176
When all the stars align you go big on a trade; if they all point in different directions you
might pass on it
In general look for confirmation in other areas (positioning, fundamentals,

other assets) to see which side is right. You may also find that the market
with the bigger move and more momentum has more information.
For example - it would be one thing if GBPUSD ripped higher at the time
that bond yields sharply dropped. Both sides need to be confident to
move a lot. Instead GBPUSD just sat there doing nothing. That looks like a
market that’s asleep to something the other market knows.
Those are the times when knowing how to trade using intermarket
relationships can really pay off.
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15 NEWS TRADING AND SECOND-ORDER

THINKING
Knowing how to use and benefit from the economic calendar is key for
all traders - not just news traders.
In this chapter we are going to take a practical look at how to use the
economic calendar. We are also going to look at how to interpret news
using second order thinking.
The key concept is learning what has already been ‘priced in’ by the
market so we can estimate how the market price might react to the new
information.
Why use the economic calendar
The economic calendar contains all the scheduled economic releases for
that day and week. Even if you purely trade based on technical analysis,
you still must know what is in store.
Why? Three main reasons.
Firstly, releases can help provide direction. They create trends. For
example if GBPUSD has been fluctuating aimlessly within a range and
suddenly the Bank of England starts raising rates you better believe the
British Pound will start to move. Big news events often start long-term
trends which you can trade around.
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FIGURE 177
News came out and the trend changed as the market absorbed the new information
Secondly, a lot of the volatility occurs around these events. This is because
these events give the market new information. Prior to a big scheduled
release like the US Non Farm Payrolls you might find no one wants to
take a big position. After it is released the market may move violently and
potentially not just in a single direction - often prices may overshoot and
come back down. Even without a trend this volatility provides lots of
trading opportunities for the day trader.
Finally, these releases can change trends. Going into a huge release because
of a technical indicator makes little sense. Everything could reverse and
stop you out in a moment. You need to be aware of which events are
likely to influence the positions you have on so you can decide whether to
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keep the positions or flatten exposure before the binary event for which
you have no edge.
Most traders will therefore ‘scan’ the calendar for the week ahead, noting
what the big events are and when they will occur. Then you can focus on
each day at a time.
Reading the economic calendar
Our calendar shows events cut by trading day. Helpfully it adjusts the
time of each release to your own timezone. For example we can see that
the Bank of Japan Interest Rate decision is happening at 4am local time for
this particular London-based trader.
FIGURE 178
Our trading calendar, available on www.getmrmarket.com
Note that some events do not happen at a specific time. Think of a Central
Banker’s speech for example - this can go on for an hour. It is not like an
economic statistic that gets released at a precise time. Clicking the finger
emoji will open up additional information on each event.
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Event importance
How do you define importance? Well, some events are always

unimportant. With the greatest of respect to Italian farmers, nobody cares
about mundane releases like Italian farm productivity figures.
Other events always seem to be important. That means, markets

consistently react to them and prices move. Interest rate decisions are an
example of consistently high importance events.
So the Medium and High can be thought of as guides to how much each
event typically affects markets. They are not perfect guides, however, as
different events are more or less important depending on the
circumstances.
For example, imagine the UK economy was undergoing a consumer-led

recovery. The Central Bank has said it would raise interest rates (making
GBPUSD move higher) if they feel the consumer is confident.
Consumer confidence data would suddenly become an extremely

important event. At other times, when the Central Bank has not said it is
focused on the consumer, this release might be near irrelevant.
Knowing what’s priced in
Next to each piece of economic data you can normally see three figures.
Actual, Forecast, and Previous.
• Actual refers to the number as it is released.
• Forecast refers to the consensus estimate from analysts.
• Previous is what it was last time.
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We are going to look at this in a bit more detail later but what you care
about is when numbers are better or worse than expected. Whether a
number is ‘good’ or ‘bad’ really does not matter much. Yes, really.
FIGURE 179
Once you understand that markets move based on the news vs expectations, you will be
less confused by price action around events
This is a common misunderstanding. Say everyone is expecting ‘great’

economic data and it comes out as ‘good’. Does the price go up?
You might think it should. After all, the economic data was good.
However, everyone expected it to be great and it was just … good. The
great release was ‘priced in’ by the market already. Most likely the price
will be disappointed and go down.
By priced in we simply mean that the market expected it and already

bought or sold. The information was already in the price before the
announcement.
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For example, let’s say the market is focused on the number of Tesla
deliveries. Analysts think it’ll be 100,000 this quarter. But Elon Musk
tweets something that hints he’s really, really, really looking forward to
the analyst call. Tesla’s price ticks higher after the tweet as traders put on
positions, reflecting the sentiment that Tesla is likely to massively beat the
100,000. (This example is not a real one - it just serves to illustrate the
concept.)
FIGURE 180
Tesla deliveries are up hugely vs last quarter ... but they are disappointing vs market
expectations ... what do you think will happen to the stock?
On the day it turns out Tesla hit 101,000. A better than the officially
forecasted result - sure - but only marginally. Way below what readers of
Musk's twitter account might have thought. Disappointed traders may
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sell their longs and close out the positions. The stock might go down on
‘good’ results because the market had priced in something even better.
(This example is not a real one - it just serves to illustrate the concept.)
Trader surveys
It can be a little hard to know what the market really expects. Often the
published forecasts are stale and do not reflect what actual traders and
investors are looking for.
One of the most effective ways is a simple survey of investors. Something

like a Twitter poll is freely available and not a bad barometer. Often CNBC
will do one before Non Farm Payrolls for example.
Interest rates decisions
For major interest rate decisions there’s a great tool on the CME’s
website that you can use.
FIGURE 181
The CME's Fed Watch tool
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This gives you a % probability of each interest rate level, implied by

traded prices in the bond futures market. For example, in the case above
the market thinks there’s a 20% chance the Fed will cut rates to 75-100bp.
Always try to estimate what the market has priced in. That way you have
some context for whether the release really was better or worse than
expected.
Second-order thinking
You have to know what the market expects to try and guess how it’ll
react. This is referred to by Howard Marks of Oaktree as second-level
thinking.
First-level thinking is simplistic and superficial, and just about

everyone can do it (a bad sign for anything involving an attempt
at superiority). All the first-level thinker needs is an opinion about
the future, as in “The outlook for the company is favorable,
meaning the stock will go up.” Second-level thinking is deep,
complex and convoluted.
Howard Marks
He explains first-level thinking.
The first-level thinker simply looks for the highest quality

company, the best product, the fastest earnings growth or the
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lowest p/e ratio. He’s ignorant of the very existence of a second

level at which to think, and of the need to pursue it.
Howard Marks
The above describes the guy who sees a 101,000 result and buys Tesla
stock because - hey, this beat expectations. Marks goes on to describe
second-level thinking.
The second-level thinker goes through a much more complex

process when thinking about buying an asset. Is it good? Do
others think it’s as good as I think it is? Is it really as good as I
think it is? Is it as good as others think it is? Is it as good as others
think others think it is? How will it change? How do others think
it will change? How is it priced given: its current condition; how
do I think its conditions will change; how others think it will
change; and how others think others think it will change? And
that’s just the beginning. No, this isn’t easy.
Howard Marks
In this version of events you are always thinking about the market’s
response to Tesla results.
What do you think they’ll announce? What has the market priced in? Is
Musk reliable? Are the people who bought because of his tweet likely to
hold on if he disappoints or exit immediately? If it goes up at which price
will they take profit? How big a number is now considered ‘wow’ by the
market?
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As Marks says: not easy. However, you need to start getting into the habit
of thinking like this if you want to beat the market. You can make
gameplans in advance for various scenarios.
Here are some examples from Marks to illustrate the difference between
first order and second order thinking.
FIGURE 182
First and second-level thinking
Preparing for quantitative and qualitative releases
The majority of releases are quantitative. All that means is there’s some
number. Like unemployment figures or GDP.
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Historic results provide interesting context. We are looking below the

Australian unemployment rate which is released monthly. If you plot it
out a few years back you can see a clear trend. Knowing this trend gives
you additional information when the figure is released. In the same way
prices can trend so do economic data.
FIGURE 183
Trading Economics is a great website with lots of free charts and data
This makes sense: if for example things are getting steadily better in the
economy you’d expect to see unemployment steadily going down.
Knowing the trend and how much noise there is in the data gives you an
informational edge over lazy traders.
For example, when we see the spike above 6% on the above you’d
instantly know it was crazy and a huge trading opportunity since a) the
fluctuations month on month are normally tiny and b) it is a huge reversal
of the long-term trend.
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Would all the other AUDUSD traders know and react proportionately? If
not and yet they still trade, their laziness may be an opportunity for more
informed traders to make some money.
There are also qualitative events. Normally these are speeches by Central
Bankers. There are whole blogs dedicated to closely reading such texts
and looking for subtle changes in direction or opinion on the economy.
Stuff like how often does the phrase "in a good place" come up when the
Chair of the Fed speaks. It is pretty dry stuff. Yet these are leading
indicators of how each member may vote to set interest rates. Ed
Yardeni is the go-to guy on central banks.
Data surprise index
The other thing you might look at is something investment banks

produce for their customers. A data surprise index.
You’ll remember we talked about data not being good or bad of itself but
good or bad relative to what was expected. These indices measure this
difference.
If results are consistently better than analysts expect then you’ll see a
positive number. If they are consistently worse than analysts expect a
negative number. You can see they tend to swing from positive to negative
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FIGURE 184
Mean reversion at its best! Data surprise indices measure how much better or worse data
came in vs forecast
There are many theories for this but in general people consider that
analysts herd around the consensus. They are scared to be outliers and
look ‘wrong’ or ‘stupid’ so they instead place estimates close to the pack of
their peers.
When economic conditions change they may therefore be slow to update.

When they are wrong consistently - say too bearish - they eventually flip
the other way and become too bullish.
These charts can be interesting to give you an idea of how the recent data
releases have been versus market expectations. You may try to spot the
turning points in macroeconomic data that drive long term currency
prices and trends.
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Using recent events to predict future reactions
The market reaction function is the most important thing on an

economic calendar in many ways. It means: what will happen to the price
if the data is better or worse than the market expects?
You’ll remember we talked about data not being good or bad of itself but
That seems easy to answer but it is not.
Consider the example of consumer confidence we had earlier.
• Many times the market will shrug and ignore it.
• But when the economic recovery is predicated on a strong consumer it

may move markets a lot.
Or consider the S&P index of US stocks (Wall Street).
• If you get good economic data that beats analyst estimates surely it
should go up? Well, sometimes that is certainly the case.
• But good economic data might result in the US Central Bank raising
interest rates. Raising interest rates will generally make the stock
market go down!
So better than expected data could make the S&P go up (“the economy is
great”) or down (“the Fed is more likely to raise rates”). It depends. The
market can interpret the same data totally differently at different times.
One clue is to look at what happened to the price of risk assets at the last
event. For example, let’s say we looked at unemployment and it came in a
lot worse than forecast last month. What happened to the S&P back then?
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FIGURE 185
2% drop last time on a 'worse than expected' number ... so it it is 'better than expected'
best guess is we rally 2% higher
So this tells us that - at least for our most recent event - the S&P moved 2%
lower on a far worse than expected number. This gives us some guidance
as to what it might do next time and the direction. Bad number = lower
S&P. For a huge surprise 2% is the size of move we’d expect.
Buy the rumour, sell the fact
A final example of an unpredictable reaction relates to the old rule of

‘Buy the rumour, sell the fact.’ This captures the tendency for markets to
anticipate events and then reverse when they occur.
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FIGURE 186
Buy the rumour, sell the fact
In short: people take profit and close their positions when what they
expected to happen is confirmed.
So we have to decide which driver is most important to the market at any

point in time. You obviously cannot ask every participant. The best way to
do it is to look at what happened recently. Look at the price action during
recent releases and you will get a feel for how much the market moves
and in which direction.
Trimming or taking off positions
One thing to note is that events sometimes give smart participants

information about positioning. This is because many traders take off or
reduce positions ahead of big news events for risk management purposes.
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Imagine we see GBPUSD dips in the hour before GDP release. That
probably indicates the market is long and has taken off positions.
FIGURE 187
The price action before an event can tell you about speculative positioning
If GDP is merely in line with expectations those same people are likely to
add back their positions. They avoided a potential banana skin. This is
why sometimes the market moves on an event that seemingly was bang
on consensus.
But you have learned something. The speculative market is short and
vulnerable to a squeeze.
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Two kinds of reversals
Fairly often you’ll see the market move in one direction on a release
then turn around and go the other way. These are known as reversals.
Traders will often ‘fade’ a move, meaning bet against it and expect it to
reverse.
Logical reversals
Sometimes this happens when the data looks good at first glance but the
details don’t support it.
For example, say the headline is very bullish on German manufacturing

numbers but then a minute later it becomes clear the company who
releases the data has changed methodology or believes the number is
driven by a one-off event. Or maybe the headline number is positive but
buried in the detail there is a very negative revision to previous numbers.
Fading the initial spike is one way to trade news. Try looking at what the
price action is one minute after the event and thirty minutes afterwards
on historic releases.
Crazy reversals
Sometimes a reversal happens for seemingly no fundamental reason. Say

you get clearly positive news that is better than anyone expects. There are
no caveats to the positive number. Yet the price briefly spikes up and then
falls hard. What on earth?
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FIGURE 188
Some reversals don't make sense
This is a pure supply and demand thing. Even on bullish news the market
cannot sustain a rally. The market is telling you it wants to sell this asset.
Try not to get in its way.
Some key releases
As we have already discussed, different releases are important at

different times. However, we’ll look at some consistently important ones
in this final section.
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Interest rates decisions
These can sometimes be unscheduled. However, normally the decisions

are announced monthly. The exact process varies for each central bank.
Typically there’s a headline decision e.g. maintain 0.75% rate.
You may also see “minutes” of the meeting in which the decision was
reached and a vote tally e.g. 7 for maintain, 2 for lower rates. These are
always top-tier data releases and have capacity to move the currency a lot.
A hawkish central bank (higher rates) will tend to move a currency higher
whilst a dovish central bank (lower rates) will tend to move a currency
lower.
Non farm payrolls
These are released once per month. This is another top-tier release that
will move all USD pairs as well as equities.
There are three numbers:

• The headline number of jobs created (bigger is better)
• The unemployment rate (smaller is better)
• Average hourly earnings (depends)
Bear in mind these headline numbers are often off by around 75,000. If a
report comes in +/- 25,000 of the forecast, that is probably a non event.
In general a positive response should move the USD higher but check
recent price action.
Other countries each have their own unemployment data releases but this
is the single most important release.
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Surveys
There are various types of surveys: consumer confidence; house price

expectations; purchasing managers index etc.
Each one basically asks a group of people if they expect to make more
purchases or activity in their area of expertise to rise. There are so many
we won’t go into each one here.
A really useful tool is the tradingeconomics.com economic indicators for

each country. You can see all the major indicators and an explanation of
each plus the historic results.
GDP
Gross Domestic Product is another big release. It is a measure of how

much a country’s economy is growing.
In general the market focuses more on ‘advance’ GDP forecasts more than
‘final’ numbers, which are often released at the same time.
This is because the final figures are accurate but by the time they come
around the market has already seen all the inputs. The advance figure
tends to be less accurate but incorporates new information that the market
may not have known before the release.
In general a strong GDP number is good for the domestic currency.
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Inflation
Countries tend to release measures of inflation (increase in prices) each

month. These releases are important mainly because they may influence
the future decisions of the central bank, when setting the interest rate.
See the FX fundamentals section for more details.
Industrial data
Things like factory orders or or inventory levels. These can provide a

leading indicator of the strength of the economy.
These numbers can be extremely volatile. This is because a one-off large
order can drive the numbers well outside usual levels.
Pay careful attention to previous releases so you have a sense of how

noisy each release is and what kind of moves might be expected.
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16 ADDITIONAL TOPICS IN TECHNICAL

ANALYSIS
In this chapter we’ll look at some additional technical analysis tools.

These are not necessarily more advanced or complicated than the first
bunch. It is just that we couldn’t fit everything into one chapter.
Between these two chapters we’ll have covered the vast majority of
popular techniques.
Bollinger bands
Bollinger bands are very attractive to many traders because they take a
lot of complex data and display it very simply.
But what are Bollinger bands? The bands consist of three lines.
FIGURE 189
A zoomed in image of a Bollinger band
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The middle band is an Exponential Moving Average. As you’ll recall from

the first chapter, these trend lines capture the broad trend and are
reasonably fast to react.
The upper and lower bands are standard deviations of price. As you’ll
recall from the first chapter, the standard deviation is a measure of
volatility.
The really nice thing about using standard deviations is that they
normalise the analysis for different instruments. Say EURUSD barely
moves each day but TESLA jumps around +/- 5%, a standard deviation is
just a measure of “how much of a move is normal” for each individual
instrument. So you can use the same technique to analyse totally different
instruments.
The idea is basically this: markets often trend over the long-term but the
day-to-day noise looks fairly random. Rather than go up or down in a
straight line markets zig-zag a little on the way. The middle line helps
capture the trends and the standard deviations bracket the noise. Let’s
look at an example of how traders might use Bollinger bands. The green
line is the stock’s price.
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FIGURE 190
How a Bollinger band might look with a green price line
So we can see this stock moved sideways and then was in a downtrend,
where the price was consistently below the EMA line.
The upper and lower Bollinger bands provide an indication of a likely
range whilst the EMA shows the overall trend direction This is a bet that
the day-to-day noise will mean-revert in the direction of the overall trend.
Now you’ll probably be thinking: doesn’t the period of the EMA and the
number of standard deviations make a difference? Dead right.
A typical set-up might be a 20-period EMA and 2 standard deviations. Of

course you can vary this. The shorter the EMA the noiser the trendline but
the faster it reacts. The larger the standard deviations the further away
your bands will be, meaning they allow for more day-to-day noise.
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Average Directional Index (ADX)
The ADX is a measure of trend strength. It originated in the commodity

markets but is now used in forex and equities and cryptos.
The ADX is generally plotted below a chart.
FIGURE 191
An ADX index might look like this
The idea is that it tells you the strength of a trend. Not the direction. The
scores range from 0 to 100. Anything above 25 is considered to be a trend.
Higher numbers indicate a stronger trend.
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As a rule of thumb, you can interpret ADX readings like this:

• Below 20 means no trend
• Above 25 means a weak trend
• Above 50 means a strong trend
• Above 75 means an exceptionally strong trend
Traders will often look at the ADX alongside other trending indicators to
get a feel for the evolution of the trend itself. Is the trend strength gaining
momentum? This is what we see in our chart image above where the ADX
is getting higher. Or is the trend running out of steam? In this case the
ADX would be moving lower.
MACD
The MACD indicator stands for Moving Average Convergence

Divergence. It is often misunderstood. The aim of the MACD is to help
you identify trends.
FIGURE 192
An MACD chart
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The MACD has three outputs. The first and second outputs are the blue
line (“MACD”) and orange line (“signal”). This is where people often get
confused. Let’s look at the chart again.
FIGURE 193
An MACD chart
The blue MACD line is just a simple combination of a slow and fast EMA.
• When the blue MACD line is above zero it means the fast EMA is
above the slow EMA (bull trend).
• When the blue MACD line is below zero it means the fast EMA is
below the slow EMA (bear trend).
The orange signal line is an Exponential Moving Average of the MACD

line itself. It is detecting if the MACD is trending up or down.
This brings us to the third output: that histogram oscillator. This is simply
capturing the difference between the MACD and signal lines.
• It is green (positive) when MACD is above the signal line.
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• It is red (negative) when the MACD is below the signal line.
So how do traders use MACD?
The first thing is do not fight the trend.

• If the blue MACD line is above zero it is indicating a bull trend. Don’t
sell.
• If the blue MACD line is below zero it is indicating a bear trend. Don’t
buy.
The second thing is to look for MACD crossovers.

• You can think of the orange signal line as a “slow” trend and the blue
MACD line as a “fast” trend.
• So when MACD crosses signal, it might be an indication to trade.
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FIGURE 194
Note how the MACD helped capture both the initial downtrend and subsequent uptrend
In this example it captures the beginning of down and uptrends

nicely. Although note that it completely violated the first rule about not
fighting the trend! The blue MACD line was well above zero at the point
of the MACD crossover.
The absolute best set up for many traders is when MACD crossover
happens in the direction of the trend. For example if the blue MACD line
is above zero and the MACD line crosses above the signal line. This is
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often seen as an indication that a retracement of a wider trend is over and

the trend is about to resume.
Another way in which traders might use the MACD is to look at the
histogram. It provides a really quick and visual indication of how strong a
trend is and whether it is gaining or losing momentum. This is easier for
us humans than subtracting two lines in our head.
Similarly to what we saw in the previous chapter, some traders may look
to see if the oscillator agrees (converges) or disagrees (diverges) with the
price trend. We’ll leave that for its own note.
You can adjust the settings on MACD.

• The default is typically 12, 26, 9.
• The 12 is the fast EMA and the 26 is the slow EMA and the comparison
of these two produces the MACD.
• The 9 is the EMA period used on the MACD line itself to create the
signal line.
Stochastic oscillator
The stochastic indicator uses one piece of wisdom:

• in a bull trend, each price will tend to be higher than the previous
price
• In a bear trend, each price will tend to be lower than the previous
price
The stochastic oscillator has two lines, much like the MACD.
• Above 80 the instrument is considered “overbought”. Traders would
typically look for the trend to run out of steam and the price to move
lower.
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• Below 20 the instrument is considered “oversold”. Traders would

typically look for the trend to run out of steam and the price to move
higher.
FIGURE 195
Stochastic oscillator alongside a price chart
As we can see it seemed to call one turning point nicely. However, it is

very noisy! There are lots of “false signals”. By this we mean times that we
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would have generated a buy or sell trade incorrectly, based on the

indicator.
Because of its noisiness, traders tend to use the stochastic oscillator only
as one input into their view - its conclusions would have to be confirmed
by many others.
Bear in mind that as a bull trend gains momentum and makes

increasingly higher highs, the stochastic will enter overbought territory
due to how it is calculated. It may stay overbought for some time as often
the largest gains are made during the final portion of a trend.
Selling naively just because the stochastic goes above 80 would be fighting
the trend. Accordingly traders will often look for momentum to turn and
for the stochastic itself to begin moving lower and dip back below 80
before entering a sell trade.
Williams % R
Williams Percent Range (often written as Williams % R) is very similar

to the stochastic oscillator. Again it is all about current prices relative to
recent highs or lows.
This time it is measured from 0 to -100:

• A rating of -80 to -100 means oversold
• A rating of 0 to -20 means overbought
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FIGURE 196
Williams R shows overbought during the uptrend
As we can see during the uptrend the Williams % R remained

“overbought” throughout.
Just because it is “overbought” doesn’t simply mean you should naively

sell. It is just a helpful alert so that you start to follow this particular price
chart and look for signs of a downtrend. Remember what we looked at
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just now with the stochastic: it is about seeing when the oscillator trend
itself changes.
You can see Williams % R remained steady throughout the bull price run.
This means that each day was generating new highs with the same
momentum as before and the trend was not running out of steam.
However, eventually the Williams $ R does move lower, dipping below

-20. At this point the price trend reverses sharply as the oscillator drops
from “overbought” all the way down to “oversold”.
Fibonacci retracements
You might remember the Fibonacci sequence from school: 0, 1, 1, 2, 3, 5,

8 etc. This is where to find the next number you simply add the most
recent two. For example the next number in the sequence is 5 + 8 = 13.
Each number ends up being 1.618 times bigger than the previous one. The
1.618 constant is called the “golden ratio”. This mathematical
phenomenon turns up in all areas of nature. For example it describes the
number of petals on flowers or the shape of a snail’s shell.
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FIGURE 197
The Fibonacci sequence is pretty beautiful
People also use it in trading. The typical way is to translate the golden
ratio into five levels:
• 100%
• 61.8%
• 50%
• 38.2%
• 23.6%
• 0%
You’ll notice that we wrote five but actually displayed six. This is because
many traders include the 50% level, despite it having nothing to do with
Fibonacci. Now how do you use it?
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The way to use it is to select a Fibonacci indicator on your charting

platform. Then you drag it so that the high price on the chart matches
100% and the low point on the chart 0%. Now you will have a chart that
looks something like the below. I find TradingView’s default view far too
noisy so you can play with the settings to make the colours simpler.
FIGURE 198
Fibonacci retracements
The idea now is that each Fibonacci retracement level might act as a
support or resistance. For example you can see the price repeatedly
topped out around that 61.8% Fibonacci resistance quite nicely for a
period.
A word of caution. If you draw a lot of Fibonacci retracements on a lot of

charts over a lot of time horizons, you’re bound to eventually find some
that work. It does not seem to be a particularly reliable indicator as you
can see from the chart above.
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However, a lot of people do swear by these - especially the 61.8%

retracement - and it pays to know what other market participants are
watching. You will often hear things like “it stopped just where it should,
around the 61.8% Fibo.” This is all people mean by that.
Simply because they may use them as support or resistance and it

becomes a self-fulfilling prophecy by generating its own pockets of
supply or demand.
Pivot points
Pivot points are sometimes considered to be similar to Fibonacci

retracements because they calculate support and resistance levels.
However, there’s a big difference: pivot points are a simple calculation

based on high, low, open prices. That is different to the Fibonacci
retracement, which relies on the trader to select the 100 and 0 points on
the chart. The lack of human input makes pivot points more objective:
everyone using them would see the same levels.
Anyway, the typical pivot point calculator or charting indicator will spit
out five values:
• Pivot point
• S1 or first support level
• S2 or second support level
• R1 or first resistance level
• R2 or second resistance level
Range bound trading
Let’s look at an example.
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FIGURE 199
Pivot points in action
We can see the Pivot Point line (purple) acted nicely as a support for a
while. In this case the trader bets on the level holding and buys as the
price approaches the pivot point. She leaves a stop just below the pivot
point support level. If it goes through here she was wrong and will want
to cut out of the trade.
Next up the price rallies and the R1 level works perfectly as a resistance.
This was of course a natural place for her to leave her take profit.
One of the biggest complaints of pivot points is that, with hindsight, it is
easy to spot examples that did work … but much harder to tell at the time.
Sometimes these levels hold but sometimes they do not. How do you
know in advance?
Traders therefore will tend to focus on pivot point levels that have already
held several times. For example if the price has bounced off R1 four times
in a row you might feel more confident it is a real resistance level than you
would if it had never been tested.
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Breakout trading
Now, it will sometimes break through. This is what our second trade
shows. Finally the pivot point support is broken.
FIGURE 200
Pivot points in action
A breakout trader may therefore sell on the breakout, leaving a stop above
the pivot point support line. This line has now become a resistance zone
as often happens when a support level is broken.
The natural place to leave a take profit is above the first chart level of S1.
Indeed this support level is soon hit and the trader closes her short at a
profit.
That is pretty much all there is to standard pivot points. There are
variations on pivot points, such as Camarilla pivots which simply use a
slightly different formula to calculate the points. We’ll look at those in a
separate article.
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Wedges
We briefly touched on wedge patterns when we looked at channels.

Wedges are really simple. When a channel is narrowing the market has to
go up or down.
FIGURE 201
The two kinds of wedge patterns
You may see rising wedges. Also known as ascending wedges. You may
also see falling wedges. Also known as descending wedges.
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Traders will trade this in two ways. The idea is just like channels: the top
of the wedge acts as resistance whilst the bottom of the wedge acts as
support.
• Traders might buy when the price approaches the support level with a
stop just below the support line.
• Equally traders might sell when the price approaches the resistance
level with a stop just above the resistance line.
FIGURE 202
Range trades and breakout trades on wedge patterns
If the price breaks out of the wedge that is known as a break-out. For
example if it breaks through resistance. Traders would buy the instrument
and the old resistance becomes the new support area.
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Triangles
Triangles are basically just like wedges, except that one of the lines is
straight. Therefore it forms a triangle shape.
Again you can get ascending triangles and descending triangles.
FIGURE 203
Ascending triangles point up whilst descending triangles point down
Just like wedges, you can use the lines of the triangle as support and
resistance. This means you can trade ranges or breakouts.
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FIGURE 204
Ranges and breakouts - just like with the wedge pattern
Double tops and bottoms
We looked before at triple tops and triple bottoms. Well, double top
and bottoms are the exact same thing except there are two points, rather
than three. Here for example is a double top, acting as resistance.
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FIGURE 205
Double top acting as a resistance level
In general the more observations, the stronger the resistance or support

level. So a triple top is likely to be harder to break through than a double
top.
Generally traders will bet on the previous level holding. So they might
sell as the price approaches a double top. They would then leave a stop
loss just above the double top resistance area.
If the double top is broken then we have a breakout. In this case traders
will follow the price action and buy, using the old double top resistance
zone as the new support area.
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Elliott wave
The Elliott wave topic is simply huge and divisive. Many claim it is an
elegant idea but does not work in practice. Others swear by it.
The basic principle comes from Ralph Elliott, who analysed stocks in the
1930s.Like many other analysts, Elliott observed that price movements
were linked to the psychology of traders. He came to believe that swings
in psychology generated predictable “wave” patterns in prices.
The typical Elliott wave formation is made of two parts. The “impulse” or
“motive” wave and the “corrective wave”.
FIGURE 206
The impulse or motive wave in green and the corrective wave in red
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The (green) impulse wave consists of five points: 1, 2, 3, 4, 5. It moves in

the direction of the general trend. In this example that happens to be up.
The (red) corrective wave consists of three points: A, B, C. It moves
counter to the trend. In this example it happens to be a downward
retracement.
These patterns can be formed in uptrends and downtrends. The above is

an uptrend or “impulse wave pattern”. In a down trend the shape is
simply reversed and the overall pattern is known as a “corrective wave
pattern”.
FIGURE 207
A corrective wave pattern is the mirror image but a downtrend
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However, drawing the waves is subject to three strict rules:

• Wave 2 can never go beyond the start of wave 1
• Wave 3 can never be shorter than wave 1 or wave 5
• Wave 4 can never enter the same price territory as wave 1
There are other rules - less strictly followed - and many different types of
Elliott wave patterns, determined by the particular length and shape of
each mini wave.
Because of the complex rules and the difficulty of finding these patterns,
traders often subscribe to newsletters or blogs that are dedicated
specifically to Elliott wave theory. Typically these charge fees. The most
famous is https://www.Elliotttwave.com/ although we have never used
their services and cannot recommend them. Nor do we have anything
negative to say: we simply have not used their services.
Elliott also believed in cycles. He identified nine time horizons, ranging

from “Grand supercycle” (multi century) down to sub-minuette (minutes).
The idea is that Elliott waves can be found across all of these time
horizons.
Followers of Elliot wave theory believe the patterns to be fractal. This

means that they are self-repeating i.e. there are mini Elliott waves within
each Elliott wave.
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FIGURE 208
Waves within a wave
Now, the way that most people trade Elliott waves is to wait for the mini
waves 1,2,3,4 to appear clearly on a chart. At that point they’ll jump on
board to ride from 4 to 5.
As a turning point appears to kick-in, they’ll flip sides and ride the
corrective wave trend in the opposite direction.
Now you have a basic overview of Elliott wave theory and how traders
use it. One warning: this is a BIG topic and you’ll need to do a lot of extra
research to see if it is something that you find interesting or useful. Years
later some traders are still not sure!
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17 ELEVEN TRADES: EIGHT LOSERS AND

ONE WINNER
We already discussed how important it is to keep a trading journal so

you can record your thinking and learn from your experiences.
It only takes five minutes but is a really useful discipline. It helps you
learn from mistakes and become a better trader. It also makes you less
likely to over-trade.
This is especially useful if you have a mentor with whom to discuss your
trades. Just like with learning a sport or instrument, having a mentor can
help.
You may wish to hire an experienced trader to act as your mentor or you
may simply buddy-up with someone else on a trading forum.
The point is that it’s easier to spot things in other people’s trades than
your own. Simply because you are too emotionally involved. It is hard to
be objective about yourself.
We are going to look now at ten illustrative trades and review them after
the fact, as a mentor might, to try and learn some lessons.
We’ll look at it from the perspective of someone with a $100,000 account.
383
A losing but smart GBPUSD trade
FIGURE 209
The details of our Cable trade
So we went long Sterling but it turns out the market went lower and we
got taken out. Looking through the entry, however, it looks pretty good.
• Sure it was a decent sized chunk (5%) to lose in one go but the reasons
for putting on a trade look solid: technicals, fundamentals and other
intermarket analysis all seemed supportive.
• The time horizon seems reasonable and the stop has plenty of room to
breathe.
• The ratio is attractive.
384
FIGURE 210
It ended up being a losing trade but the process was good and some sensible trades will
end up losing, that's just a reality of this game
The lesson here is that you can control the process but not the outcome.
Some perfectly reasonable trades will end up losing. That’s fine. Do not
get too upset about it. This is the nature of the market and why we control
our position sizes on each bet.
This trade was pretty reasonable and the process was solid.
385
A losing Ripple trade with two lessons
FIGURE 211
Our Ripple trade details in the journal
This trade looks a lot more flimsy.

• The ratio of 1:5 looks incredible but on inspection this is just a random
level chosen to make a nice-looking ratio: neither the SL or TP
correspond to any meaningful tech levels.
• The reason for entry is also very weak. A single candlestick pattern?!?
That is not a high conviction trade. Especially on a short timeframe
chart.
• There is no consideration of longer time horizon trends, fundamentals,
or anything else.
386
FIGURE 212
What a flimsy bet! Rubbish trade to throw away money on
The main lesson here is to be patient and trade only when a good trade
arrives with multiple reasons for entry.
A second lesson is to ensure the TP and SL levels are at meaningful chart

areas: don’t force them to be stuck in no-man’s land just to get a nice ratio.
387
A winning GER 30 trade that should have made more
FIGURE 213
Our GER 30 trade entry
The logic for this trade looks very nice.

• A good combination of technical and fundamental factors.
• The stop loss is nice, too: enough room to breathe and a sensible
technical level to pick.
• However, the ratio is horrible. Why take profit at 9,000? Why even
choose 9,000? It is not a clear level on the charts, just like we saw with
the last trade.
388
FIGURE 214
Letting profits run is one of the hardest things for new traders
This trade was technically a win but we should have made far more, if
we’d held onto the winning position for longer. The ratio should be more
like 1 : 3 and the exact area of the TP should be chosen by looking for
meaningful chart levels that roughly correspond to the 1 : 3 guideline
zone.
Again, this reminds us to focus on the process not the outcome. We

shouldn’t be too pleased with this win. We did a great job on calling the
direction and a terrible job of making money from that insight.
389
A losing Apple trade with a dumb stop loss level
FIGURE 215
Our Apple trade entry in the journal
Can you spot the rookie error?
There’s a long-term fundamental reason for holding the stock. Yet the stop
loss is way, way too close. The trade may be right over a one-year time
horizon but it got stopped out in meaningless day-to-day noise.
390
FIGURE 216
Stopped out in meaningless noise but calling the long-term move = super frustrating
The key here is to think about the time horizon of your reasoning and
look at the instrument on that chart. On an annual chart a move of +/- 5 is
pure noise for AAPL.
Remember to give stops room to breathe. Even the eye-ball method will
prevent this kind of error.
There’s nothing more frustrating than being right on the direction but
losing on the trade. Ensure your SL and TP levels are consistent with the
time horizon of your reasons for the trade.
391
A losing silver trade that was way too big
FIGURE 217
Our silver trade details
At first glance this looks like a nice trade. There’s a combination of

momentum, fundamentals, and intermarket signals.
But wait ……. There’s no calculation of risk taken? So how on earth did he
come up with that stop level?
Let's do some quick calculations:
• At a price of 15 USD per oz, 10,000 oz is equivalent to $150,000

notional trade size.
• We risked 200 pips (entry at 15.000, stop at 13.000).
• Now as a percentage that’s 2,000/15,000 or 13.3%.
• So our total risk was $150,000 * 13.3% or $19,950.
392
• $19,950 if we stop out. Oh wow. 20% of our total account on a single

trade. Way too much.
FIGURE 218
Use a position size calculator to help you choose an appropriate size position, based on
your risk tolerance and SL level
Also the stop loss is at such a random level. If it had been slightly lower
we could have left it at a nice double bottom level.
The way to do this is to first pick a stop loss based on the chart. Only after
you know the stop level, use a position calculator to figure out an
appropriate size of position. That size of position should be far lower than
20% or you run the risk of blowing up your account fast.
For a reminder on ways to think about position sizing systems see the
previous risk management chapter.
393
A winning USDJPY trade that should have made more
FIGURE 219
The USDJPY trade details in our journal
A similar error to what we’ve seen before. Taking profit way too early. If
you find yourself making the same mistakes multiple times, you need to
take time out to reflect before going back.
Should have let this play out and the profit would be far bigger. Aiming
for a ratio of around 1: 3 on SL: TP helps guard against the natural
tendency to ‘lock in’ wins and let losers ‘run’.
This was a winner but should have been bigger. Another example of good
outcome but bad process.
394
A losing oil trade which reminds us not to play hero
FIGURE 220
This trade was a particularly expensive mistake because we risked 5% on a high
conviction idea
Now this looks like a no-brainer. Oil has been at $100 a barrel in recent
history. How can it possibly be worth less than $10?
Then this happened.
395
FIGURE 221
Oil cannot go below zero ... right? Wrong
There are a couple of lessons to learn here.
Firstly, don’t try to “catch a falling knife”. This is a classic “hero” trade
where a trader attempts to pick the absolute bottom and ride it all the way
up. Experienced traders do not fight the market. If you have reason to
believe $10 is too cheap then that’s fine but wait. Wait until the short-term
trend reverses and the market has some upward momentum before
pulling the trigger.
Secondly, overconfidence. We looked at that in the cognitive biases

chapter. The answer to risks to trade is never “none”. This just means you
haven’t understood some dynamic. Please do not assume that there are
any free lunches.
396
This is a perfect chance to discuss your idea with someone else, who you
consider smart, and try to find people who will disagree with you. That’s
how you stress-test a trade idea.
There's a saying that there are old traders and brave traders ... but no old,
brave traders. The point is that with experience you learn not to take
stupid risks. If you never learn that, you are forced to stop trading
because you lose so much money.
A losing EURUSD trade with conflicting time horizons
FIGURE 222
The trade entry
This is a really short-term trade and the stop loss looks too tight.
• The stop loss is only 60 pips which EURUSD can easily move in a day.
• Especially when a big data release is coming up like Non Farm
Payrolls, you can easily get stopped out of this trade just due to that.
397
Another trick is to zoom out to a wider timeframe. Here we were looking

at the hourly chart.
FIGURE 223
Kinda bullish price action...
The pattern looks less bullish if we zoom out to the daily chart.
398
FIGURE 224
Not so bullish when seen in the longer term context
A couple of lessons, then.

• Make sure if you are trading short horizons that the pattern is not
clashing with the longer horizon charts.
• Also, for intraday trades, where you have a tight stop loss, ensure
there are not upcoming economic calendar releases that can whipsaw
the market and stop you out.
399
A winning gold trade that is frankly a thing of beauty
FIGURE 225
Lovely trade idea
What a beauty!
This is an example of process and outcome both coming off perfectly. The
trailing stop is really nice … it allows you to lock-in a profit, although in
this case the take profit was hit first.
400
FIGURE 226
Trailing stop losses are loved by trend followers
401
A losing Tesla trade which bit us twice
FIGURE 227
Going short without a predetermined stop loss is madness
Oh wow. No stop at all. This is so dumb.
What happened? The trade immediately went against us by $100. Then

we decided to double-down on this. If it was overpriced at $700 then
selling at $800 is a total bargain, right?
Wrong.
402
FIGURE 228
Oh, the pain - losing twice on one trade
Eventually we stopped out at $1,000. We had way too much risk on. We
got emotionally attached and added to a losing position. This means we
lose twice on the same idea.
Takeaways are “losers average losers”. Never double-down. If you want to

enter the trade gradually (pyramiding or scaling) then that’s fine.
However, you plan in advance and do so in smaller chunks so the overall
position is reasonable.
Never get sucked into throwing good money after bad money. Set your
stop level before you add the trade and stick with it. We are all human. It
is damn hard to be disciplined and unemotional without a risk
management process.
403
A losing AUDUSD trade where we ignored positioning
FIGURE 229
Not a bad looking trade idea
This trade looks pretty nice on the face of it.

• Decent reasons for trading.
• A nice ratio and SL and TP level.
• Position size is sensible.
But there’s one factor we missed. Positioning. It was extremely short.
And a short squeeze was enough to take us through the stop level, before
the market eventually sold-off to our target TP price.
404
FIGURE 230
Extreme positioning at the time of entering the short trade
The lesson here is to be patient. This could have been a great trade. But
the key was to wait for the short squeeze and enter at that point.
After the weak hands have been taken out, the trade is less crowded and
thus less risky and you would have got an extra 300 pips.
Conclusions
There’s no new information in here that you couldn’t find in the

previous chapters. Especially the risk management chapter.
405
However, it is really hard to learn a theory lesson and apply that in a

practical setting. Watching guitar lesson videos doesn’t mean you will be
able to pick up and play a guitar.
It is only when you start to trade and have some successes and failures
that you’ll start to really internalise these concepts. After a while, they’ll
become second-nature.
Using a trade journal may help you avoid the classic rookie mistakes
because you are more likely to pick up on them as you fill it out. It is also
great for reflection and learning lessons or discussing with other traders.
The key thing is to always be learning. Even a losing trade is an

opportunity.
You’ll also have noticed that winning trades can (luckily) occur from a bad
process. Losing trades can (unluckily) occur from a good process.
So don’t be totally hung up on winning and losing. You cannot control the
outcomes. Nobody can. Focus on improving the process and the idea is
that outcomes will follow.
Remember the first thing that professional funds focus on: do not lose
investors’ money. Eliminating clear trading process errors helps with that
goal.
Discussing trades with other people can be really helpful. Either before or
after you put on the trade. You get a more objective perspective and you
can see how other people in the market might think about things. They
may well have noticed something you have missed.
406
18 CHOOSING A BROKER
Choosing a broker to trade with is a really important decision.
In this chapter we’ll look at what we think are the key areas to consider.
There are five crucial areas where you should make zero compromises.
After that there are several 'nice to have' aspects. These are the exact same
things we consider in the in-depth reviews we publish.
You can find an example here or just search for a broker by name on our
reviews page and it’ll bring up a button, if we’ve written an in-depth
review for them.
A lot of stuff is unfortunately tricky to figure out for yourself without

signing up first.
• How good is customer service?
• Are they quick to refund your deposit into your account?
• Does their app crash or have bugs?
• Till you try them, you simply don’t know a lot of this stuff.
In that case just read one of our reviews on www.getmrmarket.com. We
did the work for you.
However, some of you might prefer to do your own research. If so, what
follows are the things we’d recommend looking at.
407
Regulation
I can see your eye-roll. But this absolutely is the first thing to check.
You wouldn’t open a savings account with a bank that isn’t well
regulated. Nor should you deposit a large sum of money with a broker
that isn’t well regulated.
Being in a top-tier regulatory jurisdiction offers you protection. These

regulators have more stringent requirements on brokers.
For example, they may dictate that client money (i.e. your deposits) are
ring-fenced and cannot be used for operational expenditure. Or they may
dictate that advertising has to be fair and not misleading. Or they may
dictate that clients may not lose more than they deposit.
This is all seriously good stuff.
The top-tier regulators that you’d like to see are:

• US - NFA, CFTC, SEC
• UK - FCA
• Australia - ASIC
• Japan - JFSA
• Germany - BaFIN
• Canada - IIROC
Seeing that a broker is regulated by one of these is a very reassuring first
step.
Other reasonable regulators include:

• Swiss - SFBC
• NZ - FMA
• Israel - ISA
408
• Hong Kong - SFC

• South Africa - FSB
• Cyprus - CySec
• Malta - FSA Malta
These are serious jurisdictions, however in some cases they are clearly
more relaxed than the top-tier names. For example, CySec has been
criticised many times for being too lax with the huge number of
brokerages that base themselves in Cyprus.
Then we have offshore locations:

• Belize - IFSC
• BVI - FSC
• St Vincent & Grenadines - SVG GSA
• Vanuatu - VFSC
• Seychelles - SFSA
• Mauritius - FSC
• Domenica - FSU
I would question whether the level of consumer protection you enjoy is

comparable in these places. Why exactly has the broker chosen to be
regulated offshore and is that in yourinterests? In general I would stick
with brokers that are regulated by a top-tier jurisdiction. There's plenty of
choice in that group. Why take the risk?
Many brokers have multiple entities and licenses. For example they may
offer CySec and FCA. Always sign up with the entity that has the most
stringent regulator so you get the maximum protection. If you ever have
issues with the broker down the line, you’ll be pleased you did.
409
Company history
Just choosing a well regulated broker is not enough. You need to do a

bit of research on the company.
How long has it been around? What is the management team like? Does it
have a public annual report? If so, do the strategy and balance sheet look
fine? Is there any adverse news?
For example, a company that has an audited annual report and trades on
a stock market is likely to have a lot of scrutiny and a competent
management team.
Trading with them is likely to be a better experience than a bucket shop of

three people with a fancy website but working out of an apartment in
Belize.
Each company is different but looking at the calibre of the management

team and the length of time the firm has been in business should give you
a fair idea. If they have audited public reporting, you’ll get an even clearer
picture of what the firm is like.
Customer reviews
Well, naturally reading what other customers have written is super

helpful.
You need to apply some caution here, however. Reviews tend to be a bit
skewed towards unhappy customers. For example, imagine you read
reviews on a mobile phone company:
• No one bothers to fill out a review on Vodafone when stuff works.
410
• They only fill it out when there’s a service issue and they’re annoyed
with the customer service.
• So you get negative skewed results.
• The majority of "reasonably happy" customers never bother to fill out a
review ... but a minority of "angry broadband warriors" write one as a
form of complaint.
It is the same with brokers. So absolutely take on board what people have
said but know that you are more likely to be reading unhappy customers
than happy ones.
We tried to address this in our site by normalising it:

• Individual reviews (1-5 stars) are presented exactly as they were
completed but we also give each broker an overall score.
• The overall score calculates its average reviews across all the
customers and then ranks the overall score versus all the other
brokers.
• This helps address the issue of negatively or positively skewed
reviews.
You can use the overall scores to compare apples with apples:
• You know that a broker with a score of 88% gets better reviews than
88% of all the brokers in our database. That’s really quite good.
• A broker with a score of 50% gets better reviews than 50% of the
brokers in our database. That means they’re middle of the pack.
• A broker with a 10% score means they’re in the bottom 10% of all
brokers in the database. That is not a good sign.
You can see it in action here: www.getmrmarket.com/reviews.
411
Product offering
How broad is it? Does it cover:

• FX
• Commodities (gold, oil etc.)
• Single stocks (Apple, Facebook etc.)
• Equity indices (GER30 etc.)
• Options
• Crypto CFD
• Crypto physical
Then we’ll look individually within these categories.
Some brokers make a real effort to offer neat stuff like the USD index
(DXY). Some put effort into bringing out new products as the market
starts focusing on them like a Cannabis stock index. Some have a huge
spectrum of cryptos. Others may offer just the basic FX pairs and top 3
cryptos.
This is a pretty simple thing you can find out from each broker’s website
as they normally list the products. Obviously, the more choice you have
the better.
Account opening and funding methods
These days we are used to nice account opening experiences with apps.
We don’t want to have to spend five hours filling out forms that crash and
lose all our data. Or processes that require a human to verify, which takes
24 hours. You definitely don’t want sales-people calling you up and
hassling you.
This is kind of impossible to review for yourself, without wasting hours

opening multiple accounts. Kind of defeats the purpose.
412
There’s a balance. You want account opening to be smooth, easy, and

fast. However, you want the broker to be selling products that are
appropriate and doing the necessary KYC checks. We look at this balance
in our reviews.
FIGURE 231
Paying money in and especially taking profits out is a key part of the experience: how
easy and fast is it?
Funding methods tend to be the same everywhere. You can use a card,
bank transfer or things like Paypal. Points are scored for processing the
payment fast.
We also check the way out.
413
• How fast and easy is it to remove cash from your account?

• How long does that take?
• Are there unnecessary steps?
• Does the broker try to hold onto it?
In an ideal world this would just not be an issue but unfortunately the
results vary by broker.
Web platform
Most brokers offer the ubiquitous MT4 and MT5 platforms.

Not all offer both, however. If you use those you will want to be sure
that they offer the one you are familiar with, especially if you have EAs
who only work on MT4.
However, many brokers also offer proprietary platforms.
FIGURE 232
How could you not care about the user experience when trading? Some are better than
others
414
This is a piece of kit you are going to use a lot. So it makes sense to pick
one you like. It could be as simple as the colour scheme. If you are
someone who likes dark mode, you won’t want to stare at a bright white
screen for hours on end.
The sort of questions you might ask are:

• How intuitive is it to use?
• Does it work well in all browsers?
• Is it cluttered or light?
• What kind of value-add features have they added?
• What gets annoying once you use it for a week?
• What do you wish they’d change?
• How good is the charting?
There’s a whole list of stuff you can look at and ultimately this is
somewhat subjective. When you read a review on a computer game you
may not share the reviewer’s tastes on everything but the idea is that you
should get a good sense of the game, as if you’d played it yourself for a
few days.
It is the same with web platform reviews. Realistically the platform is a

big part of how enjoyable your experience is going to be.
Mobile platform
Some brokers do more than half of their business on mobile.However,

not all the mobile apps are as good as the desktop versions.
• Is the font readable?
• How do they use the screen space?
• Are charts useful?
• Is it easy to click the wrong thing?
415
• What’s navigation like?
FIGURE 233
If you are trading mainly on mobile, the quality of app is important
You can really tell when a broker has designed a mobile app from the
ground-up vs when they have ‘translated’ an existing desktop platform
onto mobile.
Again - why accept a crappy app? These days it is unacceptable not to

offer a good user experience on mobile.
416
Tools
Not all brokers offer tools but many do.
These can range from economic calendars to things like text notifications
when certain prices have been reached. Some of the best ones offer
advanced technical analysis tools, which alert you when certain patterns
are formed.
Others will offer proprietary positioning data and MT4/MT5 indicators

that they have built for their clients. Taking a detailed look at what each
broker offers gives you an idea of whether there’s anything you’d find
particularly useful. It is also a good sign that the brokers care about
creating some value for their customers and have a client-focused
approach.
Content and analysis
The bigger brokers write their own market commentary for clients. A
mix of technical analysis and fundamental economics. Videos and e-mails
and live streams.
The quality of this analysis varies a lot.

• Is what they’ve said accurate?
• Do they provide actionable insight that helps generate trade ideas …
or are they just recapping what already happened?
• Is it well presented and timely?
Some traders don’t care at all about this and prefer to get their analysis
from neutral sources. Fair enough. Others find it helpful and a way of
understanding what the wider market is thinking. There is a big variety in
417
what is offered by each broker (many offer nothing) and the quality of
what is offered.
Equally, some brokers will offer education content. In general - although,

hey, we’re biased - I’d suggest you get it from a neutral, non-trading
source like us. However, I still appreciate it when brokers make an effort
to use their reach for good and educate clients. Especially brand new
traders.
It again hints that they actually care about the well-being of their clients
rather than just seeing them as a dollar sign.
Demo
All decent brokers should offer a demo.
A good broker will offer a demo that takes seconds from sign up to entry.
There’s no KYC required for paper-trading so why make it hard?
A great demo will work exactly the same as the real trading system. That
means you are totally familiar with how everything works before you risk
any real money. That also means that they use the same prices in demo as
they do real-life trading so conditions are the same.
418
FIGURE 234
A common problem ... it all seemed so easy in the demo!
A superb demo will let you specify your account balance. Most do not.
This is crucial.
The problem with demo trading is that you are not making or losing real
money. Therefore you will not have the same emotional reaction. Just lost
$2,000 on a trade? Whatever. Let’s go again! In real life it won’t feel so
easy.
Giving you a starting balance of $100,000 if you would in real life deposit
$2,000 gets you used to trading sizes that would bankrupt you if you did
it in real life. It is like playing with Monopoly money. Far better than you
set the demo to $2,000 and experience what it would really be like. If you
lose $2,000 that’s it - game over! Very different to being at $98,000.
419
Spreads
How much do the brokers charge to trade?
Spreads are normally variable and so they will change with market
conditions. They might be tighter in the London timezone and wider in
Asia, for example. Some brokers quote all-in spreads. Others quote tight
spreads but then add a commission on top.
It is confusing.
For traders who are very active i.e. multiple trades per week these entry/
exit costs can add up. It is hard to compare. Broker 1 may be great in
crypto in Asia hours whereas Broker 2 might be great in EURUSD in
London hours.
Certain brokers livestream spreads on their website. Some disreputable

brokers show fake spreads on their website “Ultra-tight spreads from 0.0
pips” - don’t be fooled. Maybe 0.1% of the time they’re 0 pips and then it’s
1.2 pips the rest of the day.
Spreads are an important metric but you should not overweight this. For
example, never trade with a broker who promises tight spreads but is
disreputable or not well regulated.
Customer support
There is nothing more annoying than being placed on hold. For an

hour.
The first thing we look for is the contact options:

• Phone is necessary for urgent queries.
420
• Whatsapp or live chat is great - this way you can ask questions
without having to stop whatever you are doing. Surprisingly few
brokers offer this.
• E-mail/contact form is terrible. Why should you have to wait hours or
days because they haven’t bothered to invest in a proper customer
service function?
FIGURE 235
Great customer support is an important factor for many traders
Then we look at the quality of response.

• Is the customer service agent friendly and polite?
• Are they knowledgeable?
• We try asking them some basic questions and then some more
complicated calculations to see how they get on.
• Again - customer support is one of those areas that's hard for you to
road-test without signing up in advance but we cover it in our
reviews.
421
THE END
Thank you so much for your time.
If you enjoyed this book, please visit www.getmrmarket.com for further

in-depth articles and interviews with traders.
422

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Mr Market’s Ultimate

© 2020 by 16 Spencer Street Ltd. ("Mr Market”)

The scary but important stuff (please read)

All rights reserved; no part of this publication may be reproduced or transmitted

No responsibility for loss occasioned to any person or corporate body acting or

This is an impressive project because it tackles a complex topic and distills

This is a beginners’ book for serious traders, written by a professional in

2 THE HISTORY OF TRADING .............................................................11

3 TRADING 101: THE BASICS OF TRADING FOREX, CRYPTO

AND INDICES ..........................................................................................20

4 FOREX FOR ABSOLUTE BEGINNERS ..............................................40

5 CRYPTO FOR ABSOLUTE BEGINNERS ...........................................66

6 THE A-Z GUIDE TO EQUITIES, INDICES AND OPTIONS ..........92

7 CORE CONCEPTS OF TECHNICAL ANALYSIS ..........................115

8 RISK MANAGEMENT FOR TRADERS ...........................................160

9 TRADING PSYCHOLOGY ................................................................200

10 THE MAGIC OF FACTORS .............................................................217

11 FUNDAMENTAL TRADING IN FOREX ......................................231

12 FUNDAMENTAL ANALYSIS IN CRYPTO MARKETS ..............259

13 TRADING STOCKS ON FUNDAMENTALS ................................274

14 INTERMARKET RELATIONSHIPS AND ADVANCED

15 NEWS TRADING AND SECOND-ORDER THINKING.............334

16 ADDITIONAL TOPICS IN TECHNICAL ANALYSIS .................356

17 ELEVEN TRADES: EIGHT LOSERS AND ONE WINNER ........383

18 CHOOSING A BROKER ...................................................................407

The difference between amateur and professional results

I should know. My first graduate job was trading FX at an investment

The jigsaw method

You can see the full course outline below.

It is extremely tough to evolve your emotional reactions and thinking

What we’ll cover

Let’s look at the topics we are going to cover together.

The first two chapters are introductions.

After that we will learn about risk management: position sizing,

The mind game

Behavioural finance is next on our list. This is a fashionable subject these

will also examine two crucial inputs to trading decisions: market

Connecting multiple markets

Next up we will cover the economic calendar. We’ll go through an

The magic of factors

The fundamentals of trading

It will then be time to cover the fundamentals of currencies, crypto and

More chart wizardry

2 THE HISTORY OF TRADING

In one form or another people have traded since the earliest

The emotions that a Florentine merchant - or a 1930s American

Gold remained important in the development of currencies. In the early

Now currencies could go up or down against one another based on the

A common feature of a cryptocurrency is that it is decentralised. This

Despite this slightly hippy original vibe, in 2017 Bitcoin-mania happened.

A flurry of alt-coins cropped up. Some of them were serious efforts

Etherium was one such major project. Designed by Vitalik Buterin it

Other projects were pretty ridiculous. Dogecoin was seemingly a parody

I think it says a lot about the state of the cryptocurrency space in

Way back in 2013, a misspelled post on a Bitcoin Forum message board “I

A lot of crypto enthusiasts compare crypto to gold. Gold is a pretty

Gold is often used as a hedge to mainstream portfolios of stocks and

One attraction of cryptos for speculative traders is their volatility. Simply

Trading shares in companies goes back a long way. The Amsterdam

He makes a fortune, loses it and makes it back. He bets on important