TOKYO INFO SOLUTIONS (P) LTD

BASIC EDUCATION IN TRADING FOREIGN EXCHANGE

TABLE OF CONTENTS

CHAPTER 1

INTRODUCING FOREX MARKET

CHAPTER 2

TECHNICAL ANALYSIS

CHAPTER 3

FUNDAMENTAL ANALYSIS

CHAPTER 4

RISK MANAGEMENT

CHAPTER 5

TRADING FOREX WITH MT4

CHAPTER 1 INTRODUCING FOREX TRADING

I. THE MARKET
The currency trading (foreign exchange, FX) market is the biggest and fastest growing market on earth. Its daily turnover is more than 2.5 trillion dollars. The participants in this market are central and commercial banks, corporations, institutional investors, hedge funds, and private individuals like you.

II. WHAT HAPPENS IN THE MARKET?

Markets are places where goods are traded, and the same goes with Foreign exchange. In Foreign exchange markets, the "goods" are the currencies of various countries (as well as gold and silver). For example, you might buy euro with US dollars, or you might sell Japanese Yen for Canadian dollars. It's as basic as trading one currency for another. Of course, you don't have to purchase or sell actual, physical currency: you trade and work with your own base currency, and deal with any currency pair you wish to.

III. FX MARKET PARTICIPANTS

A. Banks The inter bank market caters for both the majority of commercial turnover as well as enormous amounts of speculative trading every day. It is not uncommon for a large bank to trade billions of dollars on a daily basis. Some of this trading activity is undertaken on behalf of customers, but a large amount of trading is also conducted by proprietary desks, where dealers trade to make the bank profits. The inter bank market has become increasingly competitive in the last couple of years and the god-like status of top foreign exchange traders has suffered as the equity guys are back in charge again. A large part of the inter bank trading takes place on electronic broking systems that have negatively affected the traditional foreign exchange brokers. 3

B. Inter bank Brokers Until recently, foreign exchange brokers were doing large amounts of business, facilitating Inter bank trading and matching anonymous counterparts for comparatively small fees. Today, however, a lot of this business is moving onto more efficient electronic systems which function as a closed circuit for banks only. Still, the broker box providing the opportunity to listen in on the ongoing inter bank trading is seen in most trading rooms, but turnover is noticeably smaller than just a year or two ago. C. Customer Brokers For many commercial and private clients, there is a need to receive specialized foreign exchange services. There are a fair number of nonbanks offering dealing services, analysis and strategic advice to such clients. Many banks do not undertake trading for private clients at all, and do not have the necessary resources or inclination to support medium sized commercial clients adequately. The services of such brokers are more similar in nature to other investment brokers and typically provide a service-oriented approach to their clients. D. Central Banks The national central banks play an important role in the foreign exchange markets. Ultimately, the central banks seek to control money supply and often have official or unofficial target rates for their currencies. As many central banks have very substantial foreign exchange reserves, the intervention power is significant. Among the most important responsibilities of a central bank is the restoration of an orderly market in times of excessive exchange rate volatility and the control of the inflationary impact of a weakening currency. Frequently, the mere expectation of central bank intervention is sufficient to stabilize a currency, but in the event of aggressive intervention the actual impact on the short term supply/demand balance can lead to the desired moves in exchange rates. Central banks do not always achieve their objectives, however. If the market participants really want to take on a central bank, the combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992-93 ERM collapse and in more recent times in South East Asia.

E. Hedge Funds Hedge funds have gained a reputation for aggressive currency speculation in recent years. There is no doubt that with the increasing amount of money some of these investment vehicles have under management, the size and liquidity of foreign exchange markets is very appealing. The leverage available in these markets allow such funds to speculate with tens of billions of dollars at a time, and the herd instinct typical in hedge fund circles means that having Solos and friends on your back is less than pleasant for a weak currency and economy. It is unlikely, however, that such investments would be successful if the underlying investment strategy was not sound and therefore it is argued that hedge funds actually perform a beneficial service by exploiting and exposing unsustainable financial weaknesses, forcing realignment to more realistic levels. F. Commercial Companies The international trade exposure of commercial companies is the backbone of foreign exchange markets. Protection against unfavorable moves is an important reason why these markets are in existence, although it sometimes appears to be a chicken and egg situation? Commercial companies often trade in sizes that are insignificant to short-term market move; however, as the main currency markets can quite easily absorb hundreds of millions of dollars without any big impact. But it also clear that one of the decisive factors determining the long-term direction of a currency's exchange rate is the overall trade flow. Some multinational companies can have an unpredictable impact when very large positions are covered however due to exposures that are not commonly known to the majority of market participants. G. Investors and Speculators As in all other efficient markets, the speculator performs an important role taking over the risks that commercial participants do not wish to be exposed to. The boundaries of speculation are unclear, however, as many of the above-mentioned participants also have speculative interests, even some of the central banks. The foreign exchange markets are popular with investors due to the large amount of leverage that can be obtained and the ease with which positions can be entered and exited 24 hours a day. Trading in a currency might be the "purest" way of taking a view on an overall local market expectation, much simpler than investing in illiquid emerging stock markets. Taking advantage of interest rate differentials is another 5

popular strategy that can be efficiently undertaken in a market with high leverage.

The investor's goal in Foreign exchange trading is to profit from foreign currency movements. More than 95% of all Foreign exchange trading performed today is for speculative purposes (e.g. to profit from currency movements). The rest belongs to hedging (managing business exposures to various currencies) and other activities. Foreign exchange trades (trading onboard internet platforms) are non-delivery trades: currencies are not physically traded, but rather there are currency contracts which are agreed upon and performed. Both parties to such contracts (the trader and the trading platform) undertake to fulfill their obligations: one side undertakes to sell the amount specified, and the other undertakes to buy it. As mentioned, over 95% of the market activity is for speculative purposes, so there is no intention on either side to actually perform the contract (the physical delivery of the currencies). Thus, the contract ends by offsetting it against an opposite position, resulting in the profit and loss of the parties involved.

IV. COMPONENTS OF A FOREX TRADE

A Foreign exchange deal is a contract agreed upon between the trader and the market-maker (i.e. the Trading Platform). The contract is comprised of the following components: The currency pairs (which currency to buy; which currency to sell) The principal amount (or "face", or "nominal": the amount of currency involved in the deal) The rate (the agreed exchange rate between the two currencies).

Time frame is also a factor in some deals, but this chapter focuses on DayTrading (similar to "Spot" or "Current Time" trading), in which deals have a lifespan of no more than a single full day. Thus, time frame does not play into the equation. Note, however, that deals can be renewed ("rolled-over") to the next day for a limited period of time. The Foreign exchange deal, in this context, is therefore an obligation to buy and sell a specified amount of a particular pair of currencies at a predetermined exchange rate. Foreign exchange trading is always done in currency pairs. For example, imagine that the exchange rate of EUR/USD (euros to US dollars) on a certain day is 1.1999 (this number is also referred to as a "spot rate", or just "rate", for short). If an investor had bought 1,000 euros on that date, he would have paid 1,199.00 US dollars. If one year later, the Foreign exchange rate was 1.2222; the value of the euro has increased in relation to the US dollar. The investor could now sell the 1,000 euros in order to receive 1222.00 US dollars. The investor would then 6

have USD 23.00 more than when he started a year earlier.

Trade only when you expect the currency you are buying to increase in value relative to the currency you are selling. If the currency you are buying does increase in value, you must sell back that currency in order to lock in the profit. An open trade (also called an "open position") is one in which a trader has bought or sold a particular currency pair, and has not yet sold or bought back the equivalent amount to complete the deal. It is estimated that around 95% of the FX market is speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. A. Exchange rate Because currencies are traded in pairs and exchanged one against the other when traded, the rate at which they are exchanged is called the exchange rate. The majority of currencies are traded against the US dollar (USD), which is traded more than any other currency. The four currencies traded most frequently after the US dollar are the euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). These five currencies make up the majority of the market and are called the major currencies or "the Majors". Some sources also include the Australian dollar (AUD) within the group of major currencies. The first currency in the exchange pair is referred to as the base currency. The second currency is the counter currency or quote currency. The counter or quote currency is thus the numerator in the ratio, and the base currency is the denominator. The exchange rate tells a buyer how much of the counter or quote currency must be paid to obtain one unit of the base currency. The exchange rate also tells a seller how much is received in the counter or quote currency when selling one unit of the base currency. For example, an exchange rate for EUR/USD of 1.2083 specifies to the buyer of euros that 1.2083 USD must be paid to obtain 1 euro. B. Spreads It is the difference between BUY and SELL, or BID and ASK. In other words, this is the difference between the market maker's "selling" price (to its clients) and the price the market maker "buys" it from its clients. If an investor buys a currency and immediately sells it (and thus there is no change in the rate of exchange), the investor will lose money. The reason for this is "the spread". At any given moment, the amount that will be received in the counter currency when selling a unit of base currency will be lower than the amount of counter currency which is required to purchase a unit of base 7

currency. For instance, the EUR/USD bid/ask currency rates at your bank may be 1.2015/1.3015, representing a spread of 1,000 pips (percentage in points; one pip = 0.0001). Such a rate is much higher than the bid/ask currency rates that online Foreign exchange investors commonly encounter, such as 1.2014/1.2017, with a spread of 3 pips. In general, smaller spreads are better for Foreign exchange investors since they require a smaller movement in exchange rates in order to profit from a trade. C. Prices, Quotes and Indications The price of a currency (in terms of the counter currency), is called "Quote". There are two kinds of quotes in the Foreign exchange market: Direct Quote: the price for 1 US dollar in terms of the other currency, e.g. Japanese Yen, Canadian dollar, etc. Indirect Quote: the price of 1 unit of a currency in terms of US dollars, e.g. British pound, euro. The market maker provides the investor with a quote. The quote is the price the market maker will honor when the deal is executed. This is unlike an "indication" by the market maker, which informs the trader about the market price level, but is not the final rate for a deal. Cross rates: any quote which is not against the US dollar is called "cross". For example, GBP/JPY is a cross rate, since it is calculated via the US dollar. Here is how the GBP/JPY rate is calculated: GBP/USD = 1.7464; USD/JPY = 112.29; Therefore: GBP/JPY = 112.29 x 1.7464 = 196.10. D. Margin Banks and/or online trading providers need collateral to ensure that the investor can pay in the event of a loss. The collateral is called the "margin" is also known as minimum security in Foreign exchange markets. In practice, it is a deposit to the trader's account that is intended to cover any currency trading losses in the future. Margin enables private investors to trade in markets that have high minimum units of trading, by allowing traders to hold a much larger position than their account value. Margin trading also enhances the rate of profit, but similarly enhances the rate of loss, beyond that taken without leveraging. E. Leverage Leveraged financing is a common practice in Foreign exchange trading, and allows traders to use credit, such as a trade purchased on margin, to maximize returns. Collateral for the loan/leverage in the margined 8

account is provided by the initial deposit. This can create opportunity to control USD 100,000 for as little as USD 1,000.

the

There are five ways private investors can trade in Foreign exchange, directly or indirectly: The spot market Forwards and futures Options Contracts for difference Spread betting

Please note that this book focuses on the most common way of trading in the Foreign exchange market, "Day-Trading" (related to "Spot"). Please refer to the glossary for explanations of each of the five ways investors can trade in Foreign exchange. F. Interest Rate Differentials Different currencies pay different interest rates. This is one of the main driving forces behind foreign exchange trends. It is inherently attractive to be a buyer of a currency that pays a high interest rate while being short a currency that has a low interest rate. Although such interest rate differentials may not appear very large, the significance is much greater in a highly leveraged position. But it is by no means a certainty that the currency with the higher interest rate will be strongest. If the reason for the high interest rate is runaway inflation, this may undermine confidence in the currency even more than the benefits perceived from the high interest rate.

V. HOW DOES ONE EXCHANGE MARKET?

PROFIT

IN

THE

FOREIGN

Obviously, buy low and sell high! The profit potential comes from the fluctuations (changes) in the currency exchange market. Unlike the stock market, where share are purchased, Foreign exchange trading does not require physical purchase of the currencies, but rather involves contracts for amount and exchange rate of currency pairs. The advantageous thing about the Foreign exchange market is that regular daily fluctuations - in the regular currency exchange markets, often around 1% - are multiplied by 100.

Formula : EUR / USD, GBP / USD , AUD / USD Profit / Loss = (Selling Price Buy Price) x Contract Size x Amount of Lot Formula : USD / JPY and USD / CHF Profit / Loss = (Selling Price Buy Price) x Contract Size x Amount of Lot Liquidation Price

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Foreign exchange Trading Scenario

Scenario 1 Trading the Rising Price

Action

You buy British Pound

You believe the British Pound will strengthen against the US dollar. It is a long term view, so he takes a small position to allow for wider swings in the rate: We quote GBPUSD at Bid 1.7750 and Ask 1.7754, which means that you can sell 1 British Pound for 1.7750 USD or buy 1 British Pound for 1.7754 USD. In this example you buy British Pound 100,000, at the quote price of 1.7754 (ask price) per British Pound.

The market turns

Later the market turns in flavor of the British Pound and the GBPUSD is now quoted at Bid 1.7824 and Ask 1.7827. Now you want to sell your You sell British Pound at a Bid price of British Pound and get the1.7824. profit The profit is calculated asSell price-buy price x size of trade follows: (1.7824 minus 1.7754 ) multiplied by 100.000 = $700 Profit

Scenario 2 - Trading the Falling Price

Action

You sell British Pound

On the other hand, you believe that the British Pound will weaken against the dollar, you'll want to sell GBPUSD. You believe the British Pound will strengthen against the US dollar. It is a long term view, so he takes a small position to allow for wider swings in the rate: We quote GBPUSD at Bid 1.7750 and Ask 1.7754, which means that you can sell 1 British Pound for 1.7750 USD or buy 1 British Pound for 1.7754 USD.

In this example you sell British Pound 100,000, at the quote price of 1.7750 (bid price) per British Pound. The market turns Later the market turns in favour of the British Pound and the GBPUSD is now quoted at Bid 1.7629 and Ask 1.7632 Now you want to Buy yourYou buy British Pound at a Bid price of 1.7632. British Pound and get the profit The profit is calculated asSell price-buy price x size of trade

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Please take note that trading GBP 100,000 as we have done in our examples, does not mean that you have to put up British Pound 100,000 yourself. It means that you have to deposit 1.0% on a 1:100 leverage of British Pound 100,000, which is 1,000 GBP. Since StarPac's base currency is USD, so you only need 1,000 USD on margin as a guarantee for the future performance of your position. Maintenance Margin Most trading platforms require a "maintenance margin" be deposited by the trader parallel to the margins deposited for actual trades. The main reason for this is to ensure the necessary amount is available in the event of a "gap" or "slippage" in rates. Maintenance margins are also used to cover administrative costs. When a trader sets a Stop-Loss rate, most market makers cannot guarantee that the stop-loss will actually be used. For example, if the market for a particular counter currency had a vertical fall from 1.1850 to 1.1900 between the close and opening of the market, and the trader had a stop-loss of 1.1875, at which rate would the deal be closed? No matter how the rate slippage is accounted for, the trader would probably be required to add-up on his initial margin to finalize the automatically closed transaction. The funds from the maintenance margin might be used for this purpose. Stop-loss discipline As you can see from the description above, there are significant opportunities and risks in foreign exchange markets. Aggressive traders might experience profit/loss swings of 20-30% daily. This calls for strict stop-loss policies in positions that are moving against you. Luckily, there are no daily limits on foreign exchange trading and no restrictions on trading hours other than the weekend. This means that there will nearly always be an opportunity to react to moves in the main currency markets and a low risk of getting caught without the opportunity of getting out. Of course, the market can move very fast and a stop-loss order is by no means a guarantee of getting out at the desired level. But the main risk is really an event over the weekend, where all markets are closed. This happens from time to time as many important political events, such as G7 meetings, are normally scheduled for weekends. But for speculative trading, we would always recommend the placement of protective stop-losses. With StarPac Trader Internet Trading you can easily place and change such orders while watching development graphically on your computer screen - which we believe is a unique feature in on-line trading today. 12

VI. HOW A FOREIGN OPERATES IN REAL TIME

EXCHANGE

SYSTEM

Online foreign exchange trading occurs in real time. Exchange rates are constantly changing, in intervals of seconds. Quotes are accurate for the time they are displayed only. At any moment, a different rate may be quoted. When a trader locks in a rate and executes a transaction, that transaction is immediately processed; the trade has been executed. A . U p-to- da te exch an ge ra tes As rates change so rapidly, any Foreign exchange software must display the most up-to-date rates. To accomplish this, the Foreign exchange software is con tin uously communicating with a remote server that provides the most current exchange rates. The rates quoted, unlike traditional bank exchange rates, are actual tradable rates. A trader may choose to "lock in" to a rate (called the "f reeze rate") only as long as it is displayed. Foreign exchange on the Internet: In general, the individual Foreign exchange trader is required to fulfill two steps prior to trading: Register at the trading platform Deposit funds to facilitate trading

Requirements vary with each trading platform, but these steps bear further discussion: B. Registering Registration is done online by the individual trader. There are various forms used in the industry. Some are quite simple, where others are longer and more time-consuming. In part, this can be attributed to governmental or other authorities' requirements, though some Foreign exchange platforms require more information than is actually needed. Some even require a face-toface meeting, or to obtain hard copies of required documents such as a passport, or driver's license. The key requirements for registration are the trader's full name, telephone, email address, residence, and sometimes also the trader's yearly income or capital (equity) and an ID number (passport / driver's license / SSN / etc.). Typically, the Foreign exchange platform is not required to run a thorough check, but rely on the registrant to be truthful. Nevertheless, each Foreign exchange platform conducts certain routines, in order to check and verify the authenticity of the details provided. Registrants are required to declare that funds used for trading are not in question, and are not the result of any criminal act or money laundering activity. This is mandatory as part of a global anti-money laundering effort. 13

C. Depositing funds New registrants must deposit funds to facilitate trading. However, the majority of the Foreign exchange platforms today require that, in addition to funds used for actual trading, an additional amount be deposited. Often called "maintenance margin" or "activity collateral", its purpose is for the platform to have an additional guaranteeing. Some of the platforms that require an additional deposit do pay interest on the collateral, which is "frozen" under the trader's name. StarPac Trader Trading Platform does NOT require any additional guarantee, and allows trading with 100% of the amount deposited. StarPac Trader is able to provide these advantages because it assures "guaranteed rates and Stop-Loss". That means that there will never be any additional requirement for funds as a result of a "gap" that causes you to surpass the Stop-Loss.

CHAPTER 2 TECHNICAL ANALYSIS

I. OVERVIEW
Technical Analysis is the study of past price and activity history in order to predict future price movements. The basic premise of technical analysis is that the price discounts all information available in the market and that pattern in price movements tend to repeat themselves. Another important foundation of technical analysis is that price movements are not random, but tend to trend in some direction most of the time. Although this seems an obvious fact to anybody that has ever looked at a chart, it is in fact a hotly disputed idea in certain academic circles. But then again, maybe that is why they are academics rather than traders... The best practical introduction you can have to technical analysis is via the StarPac Internet Trader, where the system allows you interaction over the Internet with state-of-the-art technical analysis resources. In 14

addition, our daily analysis, freely available to members, describes the most recent technical levels seen in the main currency markets. A. TECHNICAL ANALYSIS IS BASED ON THREE BELIEFS: 1. ACTION IN THE MARKET This means that the actual price is a reflection of everything that is known to the market that could affect it, for example, supply and demand, political factors and market sentiment. The pure technical analyst is only concerned with price movements, not with the reasons for any changes. 2. PRICE MOVE IN TRENDS Prices can move in one of three directions, up, down or sideways. Once a trend in any of these directions is in effect it usually will persist. The market trend is simply the direction of market prices, a concept which is absolutely essential to the success of technical analysis. Identifying trends is quite simple; a price chart will usually indicate the prevailing trend as characterized by a series of waves with obvious peaks and troughs. It is the direction of these peaks and troughs that constitutes the market trend. 3. HISTORY TENDS TO REPEAT ITSELF To a technical analyst, the human characteristics of the market might be irrational but nonetheless they exist. Because investors' attitudes often repeat, investors' actions in the marketplace often repeat as well. I.e., patterns of price movement will develop on a chart that a technical analyst believes have predictive qualities. Technical analysis is always primarily concerned with price trends. Anything that can influence the price trend is of interest to a technical analyst. As an example, many technical analysts monitor surveys of investor enthusiasm. These surveys attempt to gauge the general attitude of the investment community to determine whether investors are bearish or bullish. A number of technical indicators have been used in StarPac Trader 4. When analyzing the indicators, one can come to the conclusion about further movements of the quoted products for a more detailed description of the indicators, analyzing price charts and volumes of trading. B. SUPPLY AND DEMAND There is nothing mysterious about support and resistance: it is classic supply and demand. Remembering 'Econ 101' class, supply/demand lines show what the supply and demand will be at a given price. 15

The supply line shows the quantity (i.e., the number of shares) that sellers are willing to supply at a given price. When prices increase, the quantity of sellers also increases as more investors are willing to sell at these higher prices. The demand line shows the number of shares that buyers are willing to buy at a given price, when prices increase, the quantity of buyers decreases as fewer investors are willing to buy at higher prices. At any given price, a supply/demand chart shows how many buyers and sellers there are. In a free market, these lines are continually changing. Investor's expectations change, and so do the prices buyers and sellers feel are acceptable. A breakout above a resistance level is evidence of an upward shift in the demand line as more buyers become willing to buy at higher prices. Similarly, the failure of a support level shows that the supply line has shifted downward. The foundation of most technical analysis tools is rooted in the concept of supply and demand. Charts of prices for financial instruments give us a superb view of these forces in action.

C . TRADERS' REMORSE Following the penetration of a support/resistance level, it is common for traders to question the new price levels. For example, after a breakout above a resistance level, buyers and sellers may both question the validity of the new price and may decide to sell. This creates phenomena I refer to as "traders' remorse" where prices return to a support/resistance level following a price breakout. The price action following this remorseful period is crucial. One of two things can happen. Either the consensus of expectations will be that the new price is not warranted, in which case prices will move back to their previous level; or investors will accept the new price, in which case prices will continue to move in the direction of the penetration. If, following traders' remorse, the consensus of expectations is that a new higher price is not warranted, a classic "bull trap" (or "false breakout") is created. Similar sentiment creates a bear trap. Prices drop below a support level long enough to get the bears to sell (or sell short) and then bounce back above the support level leaving the bears out of the market. A good way to quantify expectations following a breakout is with volume associated with the price breakout. If prices break through support/resistance level with a large increase in volume and traders' remorse period is on relatively low volume, it implies that new expectations will rule (a minority of investors are remorseful). the the the the 16

Conversely, if the breakout is on moderate volume and the "remorseful" period is on increased volume, it implies that very few investor expectations have changed and a return to the original expectations (i.e., original prices) is warranted. Resistance becomes support, when a resistance level is successfully penetrated, that level becomes a support level.

II. CHARTS AND DIAGRAMS

Foreign exchange charts are based on market action involving price. Charts are major tools in Foreign exchange trading. There are many kinds of charts, each of which helps to visually analyze market conditions, assess and create forecasts, and identify behavior patterns. Most charts present the behavior of currency exchange rates over time. Rates (prices) are measured on the vertical axis and time is shown of the horizontal axis.

Charts are used by both technical and fundamental analysts. The technical analyst analyzes the "micro" movements, trying to match the actual occurrence with known patterns. The fundamental analyst tries to find correlation between the trend seen on the chart and "macro" events occurring parallel to that (political and others). WHAT IS AN APPROPRIATE TIME SCALE TO USE ON A CHART? It depends on the trader's strategy. The short-range investor would probably select a day chart (units of hours, minutes), where the medium and long-range investor would use the weekly or monthly charts. High resolution charts (e.g. minutes and seconds) may show "noise", meaning that with fine details in view, it is sometimes harder to see the overall trend. The major types of charts:

A. BAR CHART
His chart shows three rates for each time unit selected: the High, the Low, the Closing (HLC). There are also bar charts including f o u r r a t e s ( O H L C , wh i c h i n c l u d e s t h e Opening rate for the time in terval). Th is chart provides clearly, v i s i b l e i n f or ma t i on about trading prices range during the time period (per unit) selected.
High Upper shado Close High open

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Open

close Lower shado Low low

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B. CANDLESTICK CHART
This kind of chart is based on an ancient Japanese method. The chart represents prices at their opening, high, low and closing rates, in a form of candles, for each time unit selected. The empty (transparent) candles show increase, while the dark (full) ones show decrease. The length of the body shows the range between opening and closing, while the whole candle (including top and bottom wicks) show the whole range of trading prices for the selected time un

H ig h Upper dow ha C lo se R e a l B od y

H ig h O pen

O pen L o w e r sh a do w Low Low

C lo s e

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PATTERN RECOGNITION IN CANDLESTICK CHARTS Pattern recognition is a field within the area of "machine learning". Alternatively, it can be defined as "the act of taking in raw data and taking an action based on the category of the data". As such, it is a collection of methods for "supervised learning". A complete pattern recognition system consists of a sensor that gathers the observations to be classified or described; a feature extraction mechanism that computes numeric or symbolic information from the observations; and a classification or description scheme that does the actual job of classifying or describing observations, relying on the extracted features. In general, the market uses the following patterns in candlestick charts: Bullish patterns: hammer, inverted hammer, engulfing, harami, harami cross, doji star, piercing line, morning star, morning doji star. Close

Open Bearish patterns: shooting star , hanging man, engulfing, harami, harami cross, doji star, dark cloud cover, evening star, evening doji open

Close

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Shooting Star

Hanging man

Engulfing line

Engulfing line

Hammer

Doji

BEARISH TYPE SHOOTING STAR BEAR

HOW TO IDENTIFY

1. An uptrend is under way 2. The first day is a white day 3.Prices gap open on second day with a small real body at the lower end of the trading range 4. Upper shadow usually at least twice as long as the real body 5. No lower shadow

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The Shooting Star bear pattern occurs during an uptrend and indicates an end to the upward move. The Shooting Star pattern looks exactly the same as the Inverted Hammer bull. The difference of course is the preceding days candlestick and that the Shooting Star bear occurs at market tops. The market gaps open above the previous day's close, rallies to a new high then loses strength and closes near its low for the day. This action, following a gap up, can only be considered as bearish. The length of the shadow will help determine its strength. Certainly, it would cause some concern to any bulls that have profits. Confirmation of the trend reversal would by an opening below the body of the Shooting Star bear, a black candlestick, and a large gap down or by a lower close on the next trading day. The Shooting Star bear pattern is very similar to the Gravestone Doji bear. With the Gravestone Doji bear the open and close are identical whereas the Shooting Star bear has a small real body at the upper end of the trading range. The Gravestone Doji bear has a higher reliability associated with it than a Shooting Star bear. SELL SIGNAL

HANGING MAN BEAR

HOW TO IDENTIFY

1. Occurs at the top or during an uptrend 2. Small real body at the upper end of the trading range and should be above the trend. 3. Lower shadow at least three times as long as the real body 4. No (or almost no) upper shadow A Hanging Man bear occurs at the top of a trend or during an uptrend. The market is considered bullish because of the uptrend. In order for the Hanging Man bear to appear, the price action for the day must trade much lower as in a sharp sell off, than where it opened, then rallies to close at or near its high for the day. This signifies the potential for further sell-offs. This is what causes the long lower shadow which shows how the market just might begin a sell off or further sell offs. If the market opens lower the next day, there would be many participants with long positions that would want to look for an opportunity to sell. Since the reliability for a Hanging Man bear pattern is low, a black candlestick or a large down gap can confirm the trend reversal on the next trading day and by a lower close.

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The Hanging Man bear is a single candlestick pattern and is very similar to the Dragonfly Doji bear. With the Dragonfly Doji bear the open and close are identical whereas the Hanging Man bear has a small real body at the upper end of the trading range. The Dragonfly Doji bear is considered more bearish than a Hanging Man bear and has a higher reliability associated with it than a Hanging Man bear. SELL SIGNAL

ENGULFING BEAR
How to identify

1. An uptrend is under way 2. A long white day occurs 3.The second day is a black day that completely engulfs the real body of the first day With the Engulfing bear pattern an uptrend is in place when a small white body day occurs with not much volume. The next day, prices open at new highs and then quickly sell off. The sell-off is sustained by high volume and finally closes below the open of the previous day. Emotionally, the uptrend has been damaged. If the next (third) day's prices remain lower, a major reversal of the uptrend has occurred. Confirmation of the trend reversal would be with a black candlestick, a large gap down or by a lower close on the next trading day would confirm the trend reversal. The Engulfing bear pattern is also the first two days of the Three outside Down bear pattern. Because of this, the Engulfing bear pattern is not considered as reliable as the Three Outside Down bear pattern. SELL SIGNAL

HARAMI BEAR
How to identify 23

1. An uptrend is under way 2. A long white day occurs 3. The second day is a black day where the real body is Completely engulfed by the real body of the first day 4. The tops or bottoms of the real bodies can be equal, but Both tops and both bottoms cannot be equal For a Harami bear, an uptrend is in place and is perpetuated with a long white day and high volume. The next day prices open lower and stay in a small range throughout the day, closing even lower creating a black candlestick but still within the previous day's body. This is a signal that the current uptrend is losing strength. In view of this sudden deterioration of trend, traders should become concerned about the strength of this market, especially if volume is light. It certainly appears that the trend is about to change. Confirmation on the third day would be a lower close. The Harami bear pattern is also the first two days of the Three inside down bear pattern. SELL SIGNAL

DOJI STAR BEAR

How to identify

1. An uptrend is under way 2. First day is a long white day 3. Second day is a Doji that gaps in the direction of the previous trend 4. The shadows of the Doji should not be excessively long A Doji Star bear is a warning that a trend is about to change. It is a long white real body that should reflect the previous trend. In an uptrend, the market builds strength on a long white day and gaps open on the second day. However, the second day trades within a small range and closes at or near its open. This

24

scenario generally shows erosion of confidence in the current trend. Confirmation of the trend reversal would be with a black candlestick, a large gap down or by a lower close on the next trading day would confirm the trend reversal. The Doji Star bear pattern is also the first two days of the Evening Doji Star bear pattern. SELL SIGNAL

DARK CLOUD COVER BEAR

How to identify

1. An uptrend is under way 2. The first day is a long white body which is continuing the uptrend 3. The second day is black body day with an open above the high of the previous day (that's the high not the close) 4. The second black day closes within and below the midpoint of the previous white body The Dark Cloud Cover bear is a reversal pattern and the counterpart of the Piercing Line bull pattern. The Dark Cloud Cover bear pattern only occurs in an uptrend. Typical in an uptrend, a long white candlestick is formed. The next day the market gaps higher on the opening however that is all that is remaining to the uptrend. The day after the market drops to close well into the body of the white day, in fact, below its midpoint. Anyone who was bullish would certainly have to rethink their strategy with this type of action. Like the Piercing Line bull a significant reversal of trend has occurred. SELL SIGNAL

EVENING STAR BEAR

How to identify

25

1. An uptrend is under way 2. First day is a long white day 3. Second day is a small day that gaps in the direction of the previous trend 4. The third day is a black day and gaps down 5. It appears after or during an uptrend The Evening Star bear takes place after or during an uptrend and is assisted by a long white candlestick. The next day prices gap higher on the open, trade within a small range and close near their open. This small body shows the beginning of indecision and lack of confidence in the current trend. This scenario generally shows the potential for a sell off, as many positions have been changed. The next day the prices gap lower on the open and then close still lower. A significant reversal of trend has occurred. Confirmation of the trend reversal is the black third day. SELL SIGNAL

EVENING DOJI STAR BEAR

How to identify

1. 2. 3. 4.

An uptrend is under way First day is a long white day Second day is a Doji that gaps in the direction of the previous trend The third day is a black day

With an Evening Doji Star bear, the market is in an uptrend and the market builds strength on a long white day and gaps open on the second day. The second day however trades within a small range and closes at or near its open creating a Doji. This scenario generally shows erosion of confidence in the current trend. Confirmation of the trend reversal is the black third day. The Evening Doji Star bear pattern is the third day to the fully developed Doji Star bear pattern.

26

The psychology behind this pattern is similar to that of the Evening Star bear, except that the Evening Doji Star bear is more of a shock to the previous trend and therefore is more significant because of the Doji. The evening Doji Star bear has also been referred to as the Southern Cross bear. SELL SIGNAL

BULLISH TYPE
DOJI STAR BULL HOW TO IDENTIFY

1. 2. 3. 4.

A downtrend is under way First day is a long black day Second day is a Doji that gaps in the direction of the previous trend The shadows of the Doji should not be excessively long

A Doji Star bull is a warning that the trend is about to change. The first day is a long black real body that should reflect the previous trend. In a downtrend the market continues to lose strength on a long black day and gaps open on the second day. The second day trades within a small range and closes at or near its open. This scenario generally shows the potential for a rally, as many positions have been changed. Confirmation of the trend reversal would be with a white candlestick, a large gap up or by a higher close on the next trading day would confirm the trend reversal. The Doji Star bull pattern is also the first two days of the Morning Doji Star bull pattern. BUY SIGNAL

HAMMER BULL
How to identify

27

1. 2. 3. 4.

Occurs during a downtrend Small real body at the upper end of the trading range Lower shadow at least twice as long as the real body No (or almost no) upper shadow

The Hammer bull occurs at the bottom of a trend or during a downtrend and is so named because it is hammering out a bottom. The market is considered bearish because of the downtrend. The market opens and then sells off sharply. However, the sell-off is abated and the markets returns to, or near, its high for the day which causes the long lower shadow. The failure of the market to continue the selling reduces the bearish sentiment, and most traders will be uneasy with any bearish positions they might have especially if the real body is white. If the close is above the open, causing a white body, the situation is even better for the bulls. Since the reliability for a Hammer bull pattern is low, a white candlestick or a large gap up can confirm the trend reversal on the next trading day and by a higher close.

The Hammer bull is a single candlestick pattern and is very similar to the Dragonfly Doji bull. With the Dragonfly Doji bull the open and close are identical whereas the Hammer bull has a small real body at the upper end of the trading range. The Dragonfly Doji bull is considered more bullish than a Hammer bull and has a higher reliability associated with it than a Hammer bull. BUY SIGNAL

DRAGONFLY DOJI BULL

How to identify

28

1. 2. 3. 4.

A downtrend is in place A Doji at the upper end of the trading range Lower shadow extremely long No upper shadow

The Dragonfly Doji bull is very similar to the Hammer bull. With the Dragonfly Doji bull the open and close are identical whereas the Hammer bull has a small real body at the upper end of the trading range. The Dragonfly Doji bull is considered more bullish than a Hammer bull and has a higher reliability associated with it than a Hammer bull. The Dragonfly Doji bull is a single candlestick pattern and occurs at the bottom of a trend or during a downtrend and is so named because it is hammering out a bottom. The market is considered bearish because of the downtrend. The market opens and then sells off sharply. However, the sell-off is abated and the market returns to or near, its high for the day which causes the long lower shadow. The failure of the market to continue the selling reduces the bearish sentiment, and most traders will be uneasy with any bearish positions they might have. If the market opens higher the next day, there would be many participants with short positions that would want to look for an opportunity cover these positions. Confirmation of the trend reversal would be with a white candlestick, a large gap up or by a higher close on the next trading day would confirm the trend reversal. BUY SIGNAL

III. SUPPORT & RESISTANCE

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Think of prices for financial instruments as a result of a head-to-head battle between a bull (the buyer) and a bear (the seller). Bulls push prices higher, and bears lower them. The direction prices actually move shows who win the battle.

SUPPORT - A price level below the current market price, at which buying interest should be able to overcome selling pressure and thus keep the price from going any lower RESISTANCE - A price level above the current market price, at which selling pressure should be strong enough to overcome buying pressure and thus keep the price from going any higher. When investor expectations change, they often do so abruptly. Note too, that the breakout above the resistance level was accompanied with a significant increase in volume. The development of support and resistance levels is probably the most noticeable and reoccurring event on price charts. The penetration of support/resistance levels can be triggered by fundamental changes that are above or below investor expectations (e.g., changes in earnings, management, competition, etc.) or by self-fulfilling prophecy ( Investors buy as they see prices rise). 30

The cause is not as significant as the effect--new expectations lead to new price levels.

IV. TREND LINES

The concept of trend is absolutely essential to the technical approach to market analysis. All the tools used by chartist support and resistance levels, price pattern, moving averages and trend lines and etc have the sole purpose of helping to measure the trend of the market for the purpose of participating in that trend.

TREND HAS THREE DIRECTIONS Most people tend to think of markets as being always in either an uptrend or a downtrend. The fact of the matter is that market move in three directions: up, down and sideways. It is important if this distinction because for at least a third of the time, a price moves in flat or sideways. This type of sideways action reflects a period of equilibrium in the price level where forces of supply and demand are in a state of relative balance. We define sideways trend as trend less market. These type of changes is often not constant, news and rumor based. Such changes may create a trap in a bull or bear market.

31

There are 3 decisions confronting the trader? Whether to go long, short or do nothing with the market. When a market is rising, the buying strategy is preferable. When it is falling, the second approach would be correct. However, when the market is moving sideways, the third choice? Stay out of the market - it is usually the wisest. You can see that, by changing the number of days or weeks as a time frame, the chartist can better determine the direction and duration of the trend. Markets are made up of several different kinds of trends, and it is the recognition of these trends that will largely determine the success or failure of your long and short-term investing.

Down trend Up trend

LINE STUDIES In technical analysis, lines and various geometric figures to be plotted in price charts or in indicator charts are called line studies. Those include the Support/Resistance Lines and Trend Lines described above, along with:

Side ways

V. FIBONACCI INSTRUMENTS
Leonardo Fibonacci was an important mathematician who was born in Italy around the year 1170. It is rumored that Fibonacci discovered the relationship of what are now referred to as Fibonacci numbers while studying the Great Pyramid of Gaza in Egypt. Fibonacci numbers are a sequence of numbers in which each successive number is the sum of the two previous numbers: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, etc. These numbers possess an intriguing number of interrelationships, such as the fact that any given number is approximately 1.618 times the preceding number and any given number is approximately 0.618 times the following number.

32

These numbers are interrelated with a series of curious correlations. For example, each number in the series is approximately 1.618 times more than the previous one, and each preceding one makes approximately 0.618 of the consequent one. There are several widespread instruments of technical analysis based on Fibonacci Numbers. The general interpretation principle of these instruments consists in the fact that, when the price approximates to lines built with their help, the changes in trend development should be expected. FIBONACCI RETRENCHMENTS Fibonacci Retrenchments are displayed by first drawing a trend line between two extreme points, for example, a trough and opposing peak. A series of nine horizontal lines are drawn intersecting the trend line at the Fibonacci levels of 0.0%, 23.6%, 38.2%, 50%, 61.8%, 100%, 161.8%, 261.8%, and 423.6%. (Some of the lines will probably not be visible because they will be off the scale.) After a significant price move (either up or down), prices will often retrace a significant portion (if not all) of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retrenchment levels.

Technical Indicator

33

A technical indicator is a series of data points that are derived by applying a formula to the price data of a security. Price data includes any combination of the open, high, low or close over a period of time. Some indicators may use only the closing prices, while others incorporate volume and open interest into their formulas.

VI. MOVING AVERAGE - MA

A Moving Average is an indicator that shows the average value of a security's price over a period of time. When calculating a moving average, a mathematical analysis of the security's average value over a predetermined time period is made. As the security's price changes, its average price moves up or down. There are five popular types of moving averages: simple (also referred to as arithmetic), exponential, triangular, variable, and weighted. Moving averages can be calculated on any data series including a security's open, high, low, close, volume, or another indicator. A moving average of another moving average is also common. The only significant difference between the various types of moving averages is the weight assigned to the most recent data. Simple moving averages apply equal weight to the prices. Exponential and weighted averages apply more weight to recent prices. Triangular averages apply more weight to prices in the middle of the time period. And variable moving averages change the weighting based on the volatility of prices The most popular method of interpreting a moving average is to compare the relationship between a moving average of the security's price with the security's price itself. A buy signal is generated when the security's price rises above its moving average and a sell signal is generated when the security's price falls below its moving average.

34

This type of moving average trading system is not intended to get you in at the exact bottom nor out at the exact top. Rather, it is designed to keep you in line with the security's price trend by buying shortly after the security's price bottoms and selling shortly after it tops. The critical element in a moving average is the number of time periods used in calculating the average. When using hindsight, you can always find a moving average that would have been profitable (using a computer, I found that the optimum number of months in the preceding chart would have been 43). The key is to find a moving average that will be consistently profitable. The most popular moving average is the 39-week (or 200-day) moving average. This moving average has an excellent track record in timing the major (long-term) market cycles. The length of a moving average should fit the market cycle you wish to follow. For example if you determine that a security has a 40-day peak to peak cycle, the ideal moving average length would be 21 days calculated using the following formula:

You can convert a daily moving average quantity into a weekly moving average quantity by dividing the number of days by 5 (e.g., a 200-day moving average is almost identical to a 40-week moving average). To convert a daily moving average 35

quantity into a monthly quantity, divide the number of days by 21 (e.g., a 200-day moving average is very similar to a 9-month moving average, because there are approximately 21 trading days in a month). Moving averages can also be calculated and plotted on indicators. The interpretation of an indicator's moving average is similar to the interpretation of a security's moving average: when the indicator rises above its moving average, it signifies a continued upward movement by the indicator; when the indicator falls below its moving average, it signifies a continued downward movement by the indicator. Indicators which are especially well-suited for use with moving average penetration systems include the MACD, Price ROC, Momentum, and Stochastic. Some indicators, such as short-term Stochastic, fluctuate so erratically that it is difficult to tell what their trend really is. By erasing the indicator and then plotting a moving average of the indicator, you can see the general trend of the indicator rather than its day-to-day fluctuations. Whipsaws can be reduced, at the expense of slightly later signals, by plotting a short-term moving average (e.g., 2-10 day) of oscillating indicators such as the 12-day ROC, Stochastic, or the RSI. For example, rather than selling when the Stochastic Oscillator falls below 80, you might sell only when a 5-period moving average of the Stochastic Oscillator falls below 80. Calculation: SIMPLE A simple, or arithmetic, moving average is calculated by adding the closing price of the security for a number of time periods (e.g., 12 days) and then dividing this total by the number of time periods. The result is the average price of the security over the time period. Simple moving averages give equal weight to each daily price.

Where:

36

EXPONENTIAL An exponential (or exponentially weighted) moving average is calculated by applying a percentage of today's closing price to yesterday's moving average value. Exponential moving averages place more weight on recent prices.

Because most investors feel more comfortable working with time periods, rather than with percentages, the exponential percentage can be converted into an approximate number of days. For example, a 9% moving average is equal to a 21.2 time period (rounded to 21) exponential moving average. The formula for converting exponential percentages to time periods is:

You can use the above formula to determine that a 9% moving average is equivalent to a 21-day exponential moving average:

The formula for converting time periods to exponential percentages is:

You can use the above formula to determine that a 21-day exponential moving average is actually a 9% moving average:

TRIANGULAR Triangular moving averages place the majority of the weight on the middle portion of the price series. They are actually double-smoothed simple moving averages. The periods used in the simple moving averages varies depending on if you specify an odd or even number of time periods. The following steps explain how to calculate a 12-period triangular moving average. 37

1. Add 1 to the number of periods in the moving average (e.g., 12 plus 1 is 13). 2. Divide the sum from Step #1 by 2 (e.g., 13 divided by 2 is 6.5). 3. If the result of Step #2 contains a fractional portion, round the result up to the nearest integer (e.g., round 6.5 up to 7). 4. Using the value from Step #3 (i.e., 7), calculate a simple moving average of the closing prices (i.e., a 7-period simple moving average). 5 Again using the value from Step #3 (i.e., 7) calculate a simple moving average of the moving average calculated in Step #4 (i.e., a moving average of a moving average). VARIABLE A variable moving average is an exponential moving average that automatically adjusts the smoothing percentage based on the volatility of the data series. The more volatile the data, the more sensitive the smoothing constant used in the moving average calculation. Sensitivity is increased by giving more weight given to the current data. Most moving average calculation methods are unable to compensate for trading range versus trending markets. During trading ranges (when prices move sideways in a narrow range) shorter term moving averages tend to produce numerous false signals. In trending markets (when prices move up or down over an extended period) longer term moving averages are slow to react to reversals in trend. By automatically adjusting the smoothing constant, a variable moving average is able to adjust its sensitivity, allowing it to perform better in both types of markets. A variable moving average is calculated as follows:

Where:

The variable moving average was defined by Tushar Chande in an article that appeared in Technical Analysis of Stocks and Commodities in March, 1992. WEIGHTED A weighted moving average is designed to put more weight on recent data and less weight on past data. A weighted moving average is calculated by multiplying each of the previous day's data by a weight. The following table shows the calculation of a 5-day weighted moving average.

38

The weight is based on the number of days in the moving average. In the above example, the weight on the first day is 1.0 while the value on the most recent day is 5.0. This gives five times more weight to today's price than the price five days ago.

VII. RELATIVE STRENGTH INDEX RSI

The Relative Strength Index ("RSI") is a popular oscillator. It was first introduced by Wiles Wilder in an article in Commodities (now known as Futures) Magazine in June, 1978. Step-by-step instructions on calculating and interpreting the RSI are also provided in Mr. Wilder's book, New Concepts in Technical Trading Systems. The name "Relative Strength Index" is slightly misleading as the RSI does not compare the relative strength of two securities, but rather the internal strength of a single security. A more appropriate name might be "Internal Strength Index." Relative strength charts that compare two market indices, which are often referred to as Comparative Relative Strength. When Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-day RSI have also gained popularity. Because you can vary the number of time periods in the RSI calculation, I suggest that you experiment to find the period that works best for you. (The fewer days used to calculate the RSI, the more volatile the indicator.) The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the RSI then turns down and falls below its most recent trough, it is said to have completed a "failure swing." The failure swing is considered a confirmation of the impending reversal.

In Mr. Wilder's book, he discusses five uses of the RSI in analyzing commodity charts. These methods can be applied to other security types as well.

Tops and Bottoms.

The RSI usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart.

Chart Formations.

39

The RSI often forms chart patterns such as head and shoulders or triangles that may or may not be visible on the price chart.

Failure Swings

(also known as support or resistance penetrations or breakouts). This is where the RSI surpasses a previous high (peak) or falls below a recent low (trough).

Support and Resistance.

The RSI shows, sometimes more clearly than price themselves, levels of support and resistance.

Divergences.

As discussed above, divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction of the RSI. For additional information on the RSI, refer to Mr. Wielders book.

Calculation

40

The RSI is a fairly simple formula, but is difficult to explain without pages of examples. Refer to Wilder's book for additional calculation information. The basic formula is:

Where:

VIII. STOCHASTIC OSCILLATOR

The Stochastic Oscillator is displayed as two lines. The main line is called "%K." The second line, called "%D," is a moving average of %K. The %K line is usually displayed as a solid line and the %D line is usually displayed as a dotted line. There are several ways to interpret a Stochastic Oscillator. Three popular methods include: 1. Buy when the Oscillator (either %K or %D) falls below a specific level (e.g., 20) and then rises above that level. Sell when the Oscillator rises above a specific level (e.g., 80) and then falls below that level. 2. Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line. 3. Look for divergences. For example, where prices are making a series of new highs and the Stochastic Oscillator is failing to surpass its previous highs.

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Calculation The Stochastic Oscillator has four variables: 1. %K Periods. This is the number of time periods used in the stochastic calculation. 2. %K Slowing Periods. This value controls the internal smoothing of %K. A value of 1 is Considered a fast stochastic; a value of 3 is considered a slow stochastic. 3. %D Periods. This is the number of time periods used when calculating a moving average of %K. The moving average is called "%D" and is usually displayed as a dotted line on top of %K. 4. %D Method. The method (i.e., Exponential, Simple, Time Series, Triangular, 42

Variable, or Weighted) that is used to calculate %D. The formula for %K is:

For example, to calculate a 10-day %K, first find the security's highest-high and lowest-low over the last 10 days. As an example, let's assume that during the last 10 days the highest-high was 46 and the lowest-low was 38--a range of 8 points. If today's closing price was 41, %K would be calculated as:

The 37.5% in this example shows that today's close was at the level of 37.5% relative to the security's trading range over the last 10 days. If today's close was 42, the Stochastic Oscillator would be 50%. This would mean that that the security closed today at 50%, or the mid-point, of its 10-day trading range. The above example used a %K Slowing Period of 1-day (no slowing). If you use a value greater than one, you average the highest-high and the lowest-low over the number of %K Slowing Periods before performing the division. A moving average of %K is then calculated using the number of time periods specified in the %D periods. This moving average is called %D. The Stochastic Oscillator always ranges between 0% and 100%. A reading of 0% shows that the security's close was the lowest price that the security has traded during the preceding x-time periods. A reading of 100% shows that the security's close was the highest price that the security has traded during the preceding xtime periods.

IX. GAPS
Gaps are spaces left on the bar chart where no trading has taken place. Gaps can be created by factors such as regular buying or selling pressure, earnings announcements, a change in an analyst's outlook or any other type of news release.

43

Gap

An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day. A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness. A breakaway gap is a price gap that forms on the completion of an important price pattern. It usually signals the beginning of an important price move. A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap. An exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.

CHAPTER 3 FUNDAMENTAL ANALYSIS

Fundamental analysis deals with the factual influences on the market and the trader will aim to predict economic developments and the impact on the direction of foreign exchange rates. Frequently, there is an almost hostile atmosphere between technical and fundamental traders, disrespecting the other's approach. This is clearly wrong, as there are merits to both approaches and the combination of the two will often give 44

excellent results. The great advantage of technical analysis is the ability to finetune and accurately time market entries and exits, while the fundamental approach will deal better with the longer term directional views. Many aspects are taken into consideration when applying fundamental analysis. Many of the monthly and quarterly economic statistics give good indications of the strength of the economy. This indicates probable future changes in short and longterm interest rates that are of great significance to foreign exchange trends. Generally, high short-term interest rates will be supportive for a currency, unless confidence is undermined by fears of strong inflationary pressures. International trade and investment flows are followed closely to assess the implications for the relative strength of buying and selling for commercial and cash transactions. Political events, such as elections or cabinet appointments can often have significant impact on foreign exchange markets, depending on the perceived policy impact on the economy. Monetary policy is also followed very closely, including the indicators shaping such policy decisions. Money supply, central bank interventions and short-term interest rates are all significant factors for fundamental analysts. Trading currencies is probably the purest way of taking a view of a country's overall economic situation. Events in South East Asia in the second half of 1997 clearly showed the consequences when confidence in a local economy collapses and the most efficient way to profit from such expectations is shorting the currency involved. The overall stronger economic situation in the US compared to Continental Europe likewise resulted in a substantial appreciation in the US currency during 1997. But, to return to the Fundamental vs. Technical argument, the rally in the US dollar also resulted in clearly bullish technical, underlining the fact that the two approaches are by no means contradictory. ECONOMICAL TERMS Gross Domestic Product: GDP Equals the total income of everyone in the economy and the total expenditure on the economy's output of goods and services. Initial Jobless Claims: Weekly initial jobless claims are the amount of people who have put in claims for unemployment.

45

Consumer Price Index: The change in consumer prices determined monthly by the U.S. Bureau of Labor Statistics, often cited as a general measure of inflation. Business Inventories: The change in business inventories determined monthly by the U.S. Bureau of Census. Personal Income Source: is the income received by persons from all sources, that is, from participation in production, from both government and business transfer payments, and from government interest. Industrial Production: The Industrial Index is compiled by 2 sub groups, Products and Materials. Products include Final Products and Intermediate Products. Materials include Durable, Nondurable and Energy indices. US Unemployment Rates: The unemployment rate represents the number unemployed as a percent of the labor force. Durable Goods New Orders: Durable Goods manufacturers shipments and orders - seasonally adjusted millions of dollars.

National Association of Purchasing Managers Index NAPM: The NAPM Indices compare the changes in various market areas on a month-tomonth basis. Chicago Purchasing Managers Index NAPM: The Chicago Purchasing Managers Index is a monthly index of regional (Midwestern) manufacturing activity. Compiled by the Purchasing Managers Association of Chicago, the index is released on the last day of every month for that month. An index reading higher than 50 means manufacturers reporting improved business outnumbered those reporting deteriorating conditions. PPI Producer Price Index: Producer Price Index (PPI) Measure average changes in prices received. Consumer Confidence: A commonly accepted measure of consumer sentiment published monthly by the Conference Board.

46

Retail Sales: Adjusted Estimated Monthly Retail and Food Services Sales by Kinds of Business. Leading Economic Indicators: An index measuring the percent change in 10 factors, such as average manufacturing weekly hours, and money supply. Employment Cost Index: An index measuring the change in cost of labor free from the influence of employment shifts among occupations and industries. U.S. Non-farm productivity: An index measuring the percent change in U.S. non-farm productivity of the current quarter over the previous quarter. U.S. Trade Balance: An index measuring the balance of payments for US goods, or total trade balance.

CAPACITY UTILIZATION: Calculated for the manufacturing, mining and electric and gas utilities industries. For a given industry, the utilization rate is equal to an output index divided by a capacity index. Output is measured by seasonally adjusted indexes of industrial production. The capacity indexes attempt to capture the concept of sustainable practical capacity, which is defined as the greatest level of output that a plant can maintain within the framework of a realistic work schedule, taking account of normal downtime, and assuming sufficient availability of inputs to operate the machinery and equipment in place.

TREASURY BILL, BOND, NOTE Negotiable debt obligations issued by the U.S. government and backed by its full faith and credit. Treasury bills are short-term securities with maturities of one year or less. Treasury notes are intermediate-term securities with maturities of 1 to 10 years. Treasury bonds are long-term securities with maturities of 10 years longer. 47

FEDERAL RESERVE SYSTEM The central bank of the United States which has regulated credit in the economy since its inception in 1913, Includes the Federal Reserve Bank, 14 district banks and the member banks of the Federal Reserve. Note: Every Based on the below opposite in condition translates in opposite of $ US E.g: Condition is UP - $ US is UP then Condition is DOWN - $ US is DOWN Condition is DOWN - $US is UP then Condition is UP - $ US is DOWN

INDICATORS ECONOMIC
No 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. Indicators Average Earning Balance of Payment Budget Deficit Business Inventories Capacity Utilization Car Sales Chicago PMI (Purchasing Management Index) Construction Spending Consumer Price Index (CPI) Consumer Credit Consumer Confident Index Consumer Spending Cost Of Living Current Account Deflasi Discount Rate Durable Goods Orders Economic Monetary System (EMS) Condition Up Up Down Down Up Up Up Up Down Up Up Down Up Up Up Up Up Up $ US Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up

48

19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33 34. 35. 36. 37. 38. 39. 40 41. 42.

Factory Orders Federal Budget Federal Reserve Fund Gross Domestic Product Gross National Product Housing Start Industrial Production Jobless Claims Leading indicators Money Supply(M1,M2,M3,M4) National Association purchasing Manager ( NAPM) Non Farm Payroll Personal Expenditure Personal Income Prime Rate Producer Price Index (PPI) Public Sector Dept Repayment Retail Sales Trade Balance Trade Deficit Unemployment Rate Unit Labor Cost Value Added Tax Whole Sale Price Index

Up Up Up Up Up Up Up Down Up Up Up Up Up Up Up Down Up Up Up Down Down Down Down Up

Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up Up

CHAPTER 4 RISKS MANAGEMENT

Although Foreign exchange trading can lead to very profitable results, there are substantial risks involved: exchange rate risks, interest rate risks, credit risks and event risks. Approximately 80% of all currency transactions last a period of seven days or less, with more than 40% lasting fewer than two days. Given the extremely short lifespan of the typical trade, technical indicators heavily influence entry, exit and order placement decisions. There are some ways of risk management:

I. CUT LOSS

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Example: Open Sell GBPUSD at 1.9900 and then the Price Move up and Running at 1.9930. We take Cut Loss by closing the position at 1.9930, so we get Loss of 30 points.

II. HEDGING
Example: Open Buy GBPUSD at 1.9900 and then the Price Move Up and running at 1.9930. We take Hedging Position by Open New Position with Sell GBPUSD at 1.9930, so we get 2 different position that is 1 Buy GBPUSD and 1 Sell GBPUSD.

III. AVERAGING
Example: Open Sell GBPUSD at 1.9900 and then the Price Move Up and running at 2.0000. We take Averaging by Open New Position Sell GBPUSD at 2.0000, so we have 2 same positions that is Sell GBPUSD at 1.9900 and Sell GBPUSD at 2.0000.

CHAPTER 5 TRADING FOREIGN EXCHANGE WITH META TRADER 4

Trading online The trading platform operates 24 hours a day just as the global Foreign exchange market runs around the clock. However, many online Foreign exchange market makers require the download and installation of software specific to their own trading platform. Consequently, accessibility is limited to those terminals that have the software. Since Foreign exchange trading is borderless, and may be performed at any given time, it is obviously advantageous to have access to trading from as many locations as possible. StarPac Trader Trading Platform is a fully web-based

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system, which means trading can be conducted from any computer connected to the internet. Traders are only required to log-in, ensure they have available funds to trade, or make new deposits, and commence trading. The Trading Platform: real-time software The main feature of any Foreign exchange trading platform is real time access to exchange rates, to deal and order making, to deposits and withdrawals, and to monitoring the status of positions and one's account. The StarPac Trader Trading Platform system uses web services to continuously fetch the most current exchange rates. The most recent data displays without the need for a page refresh. This includes account status screens such as "Trade", which updates continually to reflect changes in rates and other real time elements. Transaction processing and storage As soon as a transaction is executed, the relevant data is processed securely and sent to the data server where it is stored. A backup is created on a different server farm, to ensure data integrity and continuity. All of this happens in real time, with no human intervention.

HOW TO OPEN NEW POSITION

Click for new position

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Click here for put limit order

HOW TO PUT LIMIT ORDER

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Click here to set limit or stop order

HOW TO OPEN DEMO ACCOUNT

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HOW TO MAKE CHART

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