I want to explore a question that is asked of colleagues and me time and time again. It is a good question, such that it warrants a deeper look and further understanding. Let’s face it, most individuals think about how to invest in the stock market when they first become interested in the financial markets; and this is very different to what we at the Online Trading Academy would classify as actual “trading.” In a nutshell, when we invest in the markets we tend to buy shares or stock in companies and hold them for a long term duration as part of our portfolio. This portfolio is then cashed in at the age of retirement. Whether or not this is a good strategy is a discussion for another time. For now I just want us to be clear on the terms and what they mean.
When we trade we actually define specific entry and exit points ahead of time, waiting for the very best time to get in and get out. We not only buy the market but we also sell short when we can and trades can be held for various durations of time, anywhere from minutes to hours to days or maybe a few months. However, each decision is made ahead of time with a plan and rules that prepare us to get out when we are wrong to limit our financial losses so we can get out when we are right for a gain.
Once people get their head around stock trading in the market they tend to gain an interest in other financial asset classes, like Options, Futures and, of course, Forex. This is mainly due to the advantages that these other asset classes offer such as smaller accounts, various trading times and attractive leverage, with FX being the most economical of them all. So the question is; can we take the same trading approach to the world of Forex trading as we use for stocks? Well, the answer is both yes and no! Let’s take a deeper look into it.
As you may already know, our core strategy recognizes institutional Supply and Demand on a price chart. It highlights the areas of unfilled orders and imbalances across all markets. Be it stocks, futures or currency, these rules stay the same: the lowest risk and highest reward trades with the odds in our favor can be found by buying at demand and selling at supply. This remains the same no matter what you are trading, in my humble opinion. If there are more willing buyers than sellers at any given price level in any given market, prices must rally or fall to correct this lack of equilibrium. This does not change whether trading stocks or FX. Sure, there are some specific characteristics we must be aware of that are different in each market and can help with putting the odds in our favor, but when this is taken care of the rest remains pretty much the same.
With this in mind though, we do need to manage our expectations in respect to market behavior when looking at the ways we need to approach our FX trading as opposed to stocks. To explain this, let’s take a look at a monthly chart of the Dow Jones Index:
As we can clearly see, the overall equity market has been rising for 35 years now; in fact it has gone up ever since it started trading. You can see why investors like to “Buy and Hold.” The market has had its corrections too, the last major one being the Credit Crunch in 2007/08, but it has still risen over time. If we look to the Weekly chart, we can see levels of Demand which would have been low risk entry points in the latest Bull run:
There have been some great Supply levels which have pushed prices lower too that a trader would make good use of these but overall, the upside has worked better than the downside as is often the case with stocks. Using this approach to “upside bias” is not quite so practical in the FX markets though, as we can see when we take a look at the weekly charts for the GBPUSD:
This weekly chart is nowhere near as clean as our Dow Jones is it? Notice the longer-term sideways price action on the currency pair? If we were to take a longer term directional bias on this chart over the last 5 years by either buying or selling the pair, we would be right back to where we would have started. Now, I’m not suggesting this means we can’t take longer term positions in the currency market at all. Personally, I love to take Swing and Position trades whenever I can in FX but we do need to rethink our approach to what exactly is long term in this arena of FX. What it means is that we have to be open to the idea that the average currency pair is likely to go through bigger swings and changes in longer term direction more so than stock would, which we can see clearly on this monthly chart of GBPUSD:
In this chart example we can see that levels of Supply and Demand work just like they do in stocks but the pair is in a range in the longer term. Ranges like this are very common in FX due to the fact that there are 2 currencies in each pairing and it is highly unlikely that either will go to zero resulting in the above price action on the bigger picture, unlike a stock which could go to zero more easily in theory.
So in conclusion, we can see that it is perfectly ok to use the same trading techniques when trading FX or stocks, as long as we remain open to the fact that prices do not trade in one directional trend for too long. In 2 weeks I would like to continue this discussion further with a look into various ways to embrace the FX markets for longer term wealth but with a respect for price directional change.
Until next time take care,