Saturday, May 14, 2011

Learn How to Make Big Profits in the World of Forex

Once dominated by global banks, hedge funds, and multinational corporations, the foreign exchange market, or forex, is now easily accessible to traders and investors around the world. But in order to make the most of your time in this market, you need to have a firm understanding of how it works.

Written by forex expert Kathy Lien, The Little Book of Currency Trading shows you how to effectively trade and invest in today’s biggest market. Page by page, she describes the multitude of opportunities possible in the forex market, from short-term price swings to long-term trends, and details the practical products that can help you achieve success.

Along the way, Lien skillfully explains the forces that drive currencies and provides strategies to profit from them; reveals how you can use various currencies to reduce risk; and take advantage of global trends, and examines what you can do to make money without the stress of monitoring the market every day.
At the core of this book is the use of a well-known trading technique

The Little Book series by Wiley, one of the finest efforts at introducing investment ideas to the masses, has now run into 17 books (onlyMoneylife has reviewed every single one of them). The series has gone into every aspect of trading and investing; but the latest book on currency trading is a disappointment. It is really a few pages of technical analysis masquerading as a book-length offering of trading techniques and advice on how to trade currencies.

Currencies, like stocks, are driven by fundamental economic factors. But, unlike stocks, dabbling in currencies is a matter of pure speculation. While you can buy shares of blue-chip stocks and hold them for the long term, enjoying dividends and capital appreciation, you cannot do that forcurrencies.

Currency trades are done through leverage—sometimes as high as a 50:1. In that situation, a 2% move will wipe out your capital. It is the playground for some of the biggest traders. In 1992, George Soros bet $10 billion on the pound and encashed $2 billion. Soros worked his economic and monetary theory and bet a large sum of money (he has not reaped that kind of payoff since). You cannot do that. So what is the secret of making ‘big profits in the world of forex’, as Kathy Lien promises? It is applying a technical indicator called ‘Bollinger Band’, named after John Bollinger. The bands trace out the area that falls with two standard deviations from the mean (usually the 20-day average). As those who understand elementary statistics, know that 95% of data should fall in this range, for a normally distributed series. Lien takes this a step forward. She applies a second Bollinger Band which is one standard deviation from the mean.

The author writes: “Of the hundreds of technical indicators out there, the Double Bollinger Bands are hands down my favourite… they provide a wealth of actionable information. They tell me whether a currency pair is in a trend or range, the direction of the trend, and when the trend has exhausted. More importantly, Bollinger Bands also identify entry points and proper places to put a stop.”

I have several problems with this view. One, this is the core of the book and, yet, Lien deals with it in just a few pages. Her rules are not clearly articulated because they don’t take into account all situations. Two, she provides no back-tested results and a comparison of how using Double Bollinger Bands gave better results than other techniques. Three, traders use the bands in any market and, so, why write a book on forex trading if using the bands was all there is to it? But Lien is a successful trader and one can only assume that she has tested hundreds of indicators and is offering something that she has seen to work best. All technical indicators work well at times and fail at others. It is impossible to know in advance what to use and when. This is why for technically-guided trades, profits come from using exits intelligently (and that too stop loss) rather than mechanically following an entry. Lien makes this point as well. Once you know that you are reading a book on trading and not on forex, it looks more useful. A chapter titled “Top Ten Mistakes” is one of the very best set of guides for traders I have come across. Read the book not to trade in forexbut to improve your trading technique for any market.

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