Forex Q&A with Ed Ponsi

Forex Q&A with Ed Ponsi

We have some great questions from our readers this week; please keep them coming! Most of these relate to our recent discussion on volume, starting with a star pupil from Canada who is now managing money professionally. Here we go!

Q) I was reading your articles on the volume in Forex and I would have to say that the numbers are actually not as increased as people think they are. Correct me if I am wrong, the actual daily dollar value is up, but the true value of a US dollar is actually less today than it was a few years back. So the daily dollar value is greater but people must also take into consideration that a buck is less today than what it used to be.

By the way, how are things with you? Keep up the good work, and I know I have said it before but thanks for the great course; it really set me in the correct direction and gave me the foundation to build on.

Ed Ponsi) The student has become the master! Just kidding, as usual you are always asking the right questions and making astute observations. It's a pleasure to have students like you in the class, and you deserve 100% credit for your success. You are absolutely correct – since the U.S. Dollar has taken such a beating over the past seven years, we must consider that the increase in Forex volume would have been less (as measured in USD) if the greenback had maintained its value. Still, Forex as a retail instrument is growing at an incredible rate - so much so that some of the world's biggest banks are finally entering the retail market. Expect volume figures to explode in the coming years if this trend continues, as major financial institutions begin to offer Forex trading to their clients alongside other services. With the biggest names in trading and investment just now entering the field, retail Forex trading might become as commonplace and mainstream as stock trading.

Q) Thanks Ed, as always good stuff. So if key times have volume significance, would it be safe to say then that a breakout occurring at 5 pm Eastern time should fail at a major support or resistance level, and one appearing at a key time like 3 am Eastern time should plow through most support and resistance levels? Also are the prints a valid tool in Forex trading like stocks? Would we see tremendous velocity at the key times on them to gauge which direction to take a trade?

Ed Ponsi) Thank you for your email, you're definitely on the right track. Not only do breakouts that occur at or around 5 pm Eastern time tend to fail, they usually fizzle out before they reach any significant support or resistance levels. Because of this, moves that occur at this time of day make excellent candidates for "fade" techniques, which is a type of trade that goes against a breakout because of the assumption that the move will not follow through. On the other hand, moves that occur after 3 am Eastern time have a better chance of success. In cases such as this, an opening range breakout strategy would be more appropriate. It's not unusual to see strong breakouts early in the London session, due to an increase in volume and the increased possibility of major economic news releases, so a fade strategy would be less likely to work at that time.

It would be difficult to discern any meaningful information from time and sales, or prints, in the Forex market, because not every trade would be included; this is due to the vast size of the currency markets. Since there is no central location where all Forex trades are processed, no individual or entity would have the ability to tally all of these trades and put them together. Because of this, whatever prints you are viewing show only a partial snapshot of what is really happening in the overall market, a snapshot that may or may not be representative of what is really going on. Because of this, it would be dangerous to read too much into prints on the Forex market.

Q) Hi Ed, I was wondering if you would do the honor of providing a brief description - maybe 2 or 3 paragraphs - describing your primary approach to foreign exchange trading from a strategy perspective.

Ed Ponsi) Thank you for your question. Regarding technique, I'm primarily a trend trader. I look for situations where the technicals mesh with the fundamentals - if there is a clear trend in place, and if the fundamentals confirm what I see on the chart, I'm going to try to grab a chunk of that trend. One thing I'm very cautious about is trading the breakout - if the trend is moving upwards, I want to go long but I don't want to buy into a currency as it's hitting new highs. Because there are so many false breakouts in Forex trading, my strategy is to try to catch the pullbacks. That way, even if the currency pair fails to break through, there is still some potential for profit when the pair reaches resistance.

One of my favorite situations is a false breakout that moves against the trend. These types of breakouts have a high failure rate, and they also set the stage for a "slingshot" trade in the opposite direction. It's a great setup, and I'm constantly looking for it. If the trend is strong enough, I might not use a target at all; instead, I'll trail a stop. I like to trail stops manually, moving them strategically instead of automatically. That way, I can keep my stop beneath a trend line or a moving average, instead of moving it to an arbitrary location - which is often exactly what happens when we use automatic trailing stops.

Q) I am nearing the end of my enlistment in the Army and my goal is to become a professional trader. Do you have any advice that I might solicit on starting out? I would highly value any suggestions and experiences you could share with me.

Ed Ponsi) Thank you for your question. When I started out, I traded for a few years on my own, and then went to work for a firm on Wall Street...that's where it all came together. By working as an employee at a trading firm, I learned a lot of the finer points of trading that I write about in this column.

My best advice would be to build a track record of at least six months of profitable trading, and then try to parlay that into a job as a trader. Trading jobs exist in various places all over the US, although there are higher concentrations in certain areas like New York and Chicago. Your military background is a plus; it indicates that you can follow a structured system of rules. The ability to maintain discipline while trading is one of the main ingredients to a successful career.

Finally, if you are really serious about this, there is nothing that can stop you. Some firms might have requirements that are difficult to satisfy; for example, some quant firms require a degree in mathematics. But others are only interested in one thing - can you trade successfully? If you can prove that you can, you will eventually knock on a door that will be opened to you. Good luck!

The Dollar Continues to Roll

The Dollar Continues to Roll

In last week's article, I mentioned that the sharp move lower in the Euro – U.S. Dollar currency pair (EUR/USD) still had room to run, and that "Euro has a very good chance to break this new support level" (near 1.4950) based on the velocity of the move. You could also add to that the fact that the weekly candle closed near its low, signifying that shorts were unwilling to take profits going into the weekend. Well, here we are one week later, and the EUR/USD currency pair is now nearly 300 pips lower than it was at last week's close. Not only that, but once again the weekly EUR/USD candle closed near its lows, once again indicating that shorts remain reluctant to take profits, and sellers may have still more inventory of Euros to unload (see figure 1).

Figure 1: EUR/USD continues to fall hard on the weekly chart. Source: Saxo Bank

The next major support levels appear to be 1.4500 (psychological) and 1.4350 (old support from late 2007 – early 2008). The velocity of the move shows near panic on the part of sellers, some of whom are trying to protect the huge profits they made buying Euros on the way up. As you can see from the weekly chart in figure 1, many Euro longs may still be holding on to profitable positions despite the vicious pullback of the past two weeks. This just goes to show how long and persistent trends in the Forex market can be.

Question of the Week

Q) Hi Ed, I read your articles every week and I always learn something new, thank you so much! In last week's article, you mentioned that Forex volume is so high that it would be impossible to count all of it, yet in the same article you mentioned that the daily average volume in the Forex market is $3.1 trillion USD per day. Forgive me if I'm missing something, but if the volume is so high that nobody can keep track of it all, where does that $3.1 trillion figure come from?

Ed Ponsi) Thank you for your kind comments and for your question. It's true that Forex volume is so high that accurate volume figures are not available, but every three years, the Bank of International Settlements (BIS) surveys major Forex market participants and then creates a volume estimate based on the information gathered. The most recent BIS survey, completed in 2007, yielded the estimated volume figure that I reported last week as $3.1 trillion (turns out it's actually closer to $3.2 trillion), a figure that is widely quoted and accepted. This figure represents an increase in volume of about 70% from the 2004 survey. According to the BIS, the $3.2 trillion average daily volume is equivalent to:

The survey even breaks down volume figures by geographic location. The United Kingdom continues to dominate the Forex markets, as it is home to many large banks and funds that are prominent players in the world of currencies. These stats only serve to reinforce London's reputation as the world's capital of Forex trading (see figure 2):

Figure 2: Breakdown of daily volume figures by location. Source: BIS Triennial Survey 2007

Finally, the Bank of International Settlements offers a volume breakdown by currency pair. Note that EUR/USD has the greatest volume by far; it's not a coincidence that this currency pair has the tightest spread on nearly every Forex trading platform. Generally speaking, high volume leads to tight spreads in the Forex market (see figure 3).

Figure 3: Breakdown of daily volume figures by currency pair. Source: BIS Triennial Survey 2007

Question of the Week, Part ll

Q) Regarding finding good volume information, you recently wrote:"...If a breakout occurs during a time of day when volume is known to be high, it would be reasonable to assume that the breakout is occurring on high volume; if it occurs during a time of day when volume is known to be low, the opposite would be true." What are those "known" times of day? Opening of markets, etc.?

Ed Ponsi) Thank you for your question. As you mentioned, the opening of markets, in other words morning in any given geographic location, is the time of day when the bulk of trading is done. For example, referring to the image in figure 2, more volume is generated in the U.K. than in any other location. So, it stands to reason that when it is morning in London, volume tends to be high. You could also say the same thing about the U.S., which is second only to the U.K. in Forex trading volume. Since morning in New York coincides with lunchtime in London, it is reasonable to assume that just as things are settling down a bit in the U.K., traders in the U.S. wake up and start trading. Also, most economic indicators are released in the morning, so this creates added volatility and can also attract added attention from traders. So, if a breakout occurs when it is morning in the U.S. and/or the U.K. – anywhere from 3 a.m. to noon New York time - then I would assume that the volume is likely to be high.

On the other hand, what if a breakout occurs at 5 pm U.S. East coast time? Well, that is a pretty quiet time of day in the U.S., as most New York traders are on their way home or having dinner. When it is 5 pm in New York, it is 10 pm in London, so I wouldn't expect too much activity from traders in the U.K. Also, when it is 5 pm in New York, it is only 5 am in Singapore and 6 am in Tokyo, too early for any meaningful activity from these Asian trading capitals. Taking all of this into account, I would assume that a breakout that occurs at 5 pm New York time is occurring on low volume and has a high likelihood of failure.

The Homer Simpson Breakout

Last week saw a breakout of historic proportions, as the U.S. Dollar got up off of the mat and roared higher across the board, crushing everything in its path. Here we see the Euro – U.S. Dollar currency pair (EUR/USD) crashing back to earth on the weekly chart after hitting a new lifetime high above 1.6000 just a few weeks ago. The pair has found support at a former level of resistance from late last year (see figure 1).

Figure 1: EUR/USD plunges from a failed ascending triangle. Source: Saxo Bank

Looking at the chart, I'd have to say the Euro has a very good chance to break this new support level and continue lower, just based on the sheer velocity of the move. An awful lot of people made an awful lot of money on the Euro uptrend, and now it's time for them to ring the register.

If you are a regular reader, you know that this is a bittersweet moment; as an American, I'm happy to see my currency strengthening, as I've been constantly railing against the weak USD in articles such as this one, titled The US Dollar and the Thief in the Night. Because of that piece I was invited onto Larry Kudlow's show on CNBC. But is the greenback really doing all that well, or is this just a case of the Euro and other currencies doing poorly? To find out, let's look at the hourly chart and pinpoint the genesis of this move. The Euro began to fall in earnest around 9:00 am New York time on August 7, right at the time when European Central Bank chief Jean Claude Trichet said that European economic growth would be "particularly weak" through the third quarter (see figure 2).

Figure 2: Trichet speech ignites the USD rally as the Euro gets crushed. Source: Saxo Bank

So last week's big move is not a vote of confidence in the U.S Dollar; instead, it shows a lack of confidence in the Euro. Still, the tide has turned at least for now, so don't try to fight this move. Also, don't feel too bad for traders who were short the greenback for most of this year, myself included. The weak USD trend has been my friend for quite a while, and it's sad to say goodbye to that friend for now. Until now, this year has been one of the best in memory for USD shorts. Right now it is too early to tell, but if a new trend of USD strength emerges, you can bet trend traders will be riding it.

Why the Euro REALLY Fell…

A one euro coin has turned up in Spain bearing the face of Homer Simpson instead of that of the country's king, a sweetshop owner told Reuters on Friday. Jose Martinez was counting the cash in his till in the city of Aviles, northern Spain, when he came across the coin where Homer's bald head, big eyes and big nose had replaced the serious features of King Juan Carlos. "The coin must have been done by a professional, the work is impressive," he told Reuters. "I've been offered 20 Euros for it."

The Learning Curve

The Learning Curve

Hola from Mexico City! I have another great question from a reader this week. Hopefully the answer will help prevent some of you from making the same mistakes I made when I got started in trading. Read on!

Question of the Week

Q) Mr. Ponsi, I found your response to the automated system very interesting. I am in the process of training myself for the Forex....hopefully in the correct way. I realize as well (having worked with a demo account) that you can be "punished" if you do not know what you are doing!

I would like to know how YOU got to be where you are. Did you have struggles? How long was it before the "light bulb" went off in your head? I consider myself an intelligent person; I am a physician and have had extensive training, 12 years beyond college. How long was it before you felt comfortable with what you were doing? I have heard some say six months. Of course no one can truly predict where the market will go after you get in and I have heard statistics that even the best Forex traders are correct 50-70% of the time. Do you feel bad when your trades go the wrong way or have you disciplined yourself to extract from the emotion?

Ed Ponsi) Thank you for your question. I started out as a part time stock trader in the mid nineties, and I freely admit that at that time I had no idea what I was doing. Luckily for me, I began my trading career at the beginning of the biggest bull market in history – at a time when all you had to do to make money was buy tech stocks and watch them skyrocket. There was a popular saying at the time, "don't confuse brains with a bull market". After making money on my own for a few years, I realized that I was not yet a good trader, just fortunate to be in the right place at the right time. If I wanted to make a career out of trading, I was going to have to learn how to do it properly.

Determined to succeed, I went about the task of getting hired on Wall Street. After months of emailing my resume and trading record to every Wall Street firm that I could find, I finally got an interview, and I was hired. Let me tell you, it wasn't Goldman Sachs. I was hired by what is called a "boutique" trading firm, based on my trading record for the previous two years, and because of my determination. Part of that determination was my willingness to travel over 100 miles each way, every day, to get to work.

The beautiful thing was, this firm was a meritocracy – you rose or fell based on your performance. Unfortunately, most of us fell. I was one of a group of 20 that was hired. What I didn't know at the time was the firm expected most of us to fail, they were just hoping that one or two of us would pan out. The next month, there would be 20 more new hires, and 20 more the month after that. Out of all of these new hires, only a handful of us were expected to survive.

And so I began. I was confident, having done very well for myself in the two prior years, despite my lack of real trading knowledge. My new employers gave me a blueprint for success and put restrictions on my trading, using good risk management rules. I had never even heard of risk management up to that point, and I soon learned that it would be the key to success. My instructions were simple; I was to have no large losses, period. This was a big change from my prior freewheeling style, but I was trading their money and I wanted to do it right, so I set about taking small losses.

The next two months were psychological torture, as I could not seem to reconcile my old style of trading to the new, stringent risk rules that were imposed upon me. During that time, I couldn't sleep and I could barely eat. It really bothered me that I was losing, and it bothered me even more that I was losing someone else's money. After surviving the dreaded "learning curve", I finally began to win and I never looked back.

Why did the firm stick with me during this difficult time? Because they monitored my actions closely, they could see that I never took a large loss – no matter what. They knew that the ability to avoid large losses is the most important skill in trading. Since I already knew how to lose like a professional, it was only a matter of time until I learned how to win like one. Once I learned how to hang on to my winners, the account balance began to rise, and I never looked back. It was a long two months, but life was never the same after that.

Do I still feel bad when trades go the wrong way? A little, but I understand that my feelings don't matter, and that losing is a part of winning. I'm not going to change my tactics if I have a few losses, because those techniques have worked for me for many years. Small losses lead to large gains, as I learned long ago; in fact, small losses are a necessary ingredient to winning. If I see someone who is not taking small losses, or a trader who never seems to lose, I know that person is setting himself up for a big loss.

It's true that markets are unpredictable, and that's why we have to use a stop on every trade, without exception. One of the things that I learned on Wall Street is that nobody is right all of the time; that is just fantasy. The beautiful part of trading is you don't have to have a crystal ball or the ability to see the future in order to make money as a trader. You create your analysis, put on your best trade, and if you're wrong, get out. On the other hand, if you're right, know how to maximize the gain. If you use this philosophy, win-loss percentage becomes meaningless. There are many successful traders who have unimpressive win-loss percentages, but it is not our job as traders to be right. Our job is to lose small when we're wrong, and win big when we're right