The Six Forces of Forex

ABOUT THIS REPORT 
The Forex Report is a periodic publication that investigates advanced strategies 
for superior trading performance in the foreign exchange markets.  These 
reports utilize advanced statistical and econometric modeling techniques to 
create new insight into the trading strategy of the average trader.  This report, 
The Six Forces of Forex, is a more general report intended for all audiences, 
including those new to the forex market. 

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THE SIX FORCES OF FOREX 
Trading forex is like watching a school of fish move.  One minute is total 
harmony, the next, complete chaos.  As the observer of this school of fish, 
do you believe you can accurately predict the direction the school of fish 
will move each time?  Would you bet on it? 

What causes the fish to move the way they do?  Why do they work together 
in one moment, moving with force and precision, and move in what seems 
to be an infinite number of directions the next?  There’s no way to know 
unless you can sense what the fish sense each time they move.  The fish 
have an instinct about the nature of their environment.  They understand 
the context of all things around them – natively – and can react 
accordingly.  Surely if you shared this understanding you’d be a much 
more accurate predictor of fish movement! 

Trading forex is not much different - we need to develop that keen sense of 
what is happening around us.  Will we ever be able to predict every move 
in the forex markets?  Absolutely not.  But we can use our understanding 
of the context of the market – the six forces of forex – to make better, 
more profitable trading choices.  Once we understand these forces, we can 
create and operate within a comprehensive trading plan: 

ƒ  Who trades forex?  Understand who participates in the markets, 
why they are successful, and how you can emulate them. 

ƒ  Why trade forex?  There are superior returns in forex, but not for 
all investors.  Are you one of them? 

MINIMIZING THE RISKS

MINIMIZING THE RISKS
There is no way around the risks inherent in trading counter to the prevailing market action. All we can do is reduce
the risks as much as possible by using the tools available. Happily, there are ways to do this.
First, always be aware of the longer-term picture. If the market you are planning to trade is in the middle of a strong
trend, going against that action is probably one of the quickest ways to lose money. Wait until the momentum starts
to ease; this will reduce your chances of getting caught on the wrong side of a breakout.
Further, this is a good time to mention a candlestick caveat: Beware of reversal patterns signaled by candlesticks in a
trending market. The bond market is especially notorious for throwing out countertrend candlestick signals during
major trends, and I've seen the same in other markets as well. Never look at candles in a vacuum.
So what should we look at in conjunction with candlesticks to lower our risk in the countertrend trades I am
suggesting? For one, there's John Bollinger's band width indicator (BWI) as a trend indicator, which can be used by
monitoring the area between the upper and lower bands. (I outlined this technique in the November 1994 STOCKS
& COMMODITIES.) I like to use the BWI as an indicator of a weakening trend; I want to jump in when the slope of
the BWI line starts to decrease. This is the first signal that the trend is petering out, and that at this point countertrend
trades are reasonably safe.
There are, of course, other technicals that you can use. Bollinger bands themselves can be helpful, among others.
Select the tool or tools that make you most comfortable.
More important than any additional indicator you could use, however, is your money management strategy. There
are many ways you could trade using this methodology, and each has its own advantages and limitations. Cash or
futures trading exposes you to the potential for theoretically unlimited risk, requiring tight stops and quick
executions. Options could limit your risk, but probably at the cost of requiring larger moves to make them
worthwhile. Of course, you may be able to tailor a combination of instruments to suit your needs.
An important factor in determining your risk exposure, and as a result how you trade, is the point at which you cut
your losses. Often, there is no second support or resistance level nearby to provide a good stop-loss point, which
means you'll have to use your own instinct as a guide. I find it useful to use whatever candlestick shadows there are
as a rough guide to how far the market might go against me, thus letting me set reasonably good stops.
One last thing to consider: Where you're going to get out. I use a combination of techniques. Fibonacci retracement
levels work fairly well, as do moving averages. I prefer to determine another support or resistance point using real
bodies. Unfortunately, there are times when a significant level is not available nearby, forcing me to use other
techniques.

Forex

What is the forex ? The Foreign Exchange market, also referred to as the "Forex" or FX market, is the largest financial market in the world, with a daily average turnover of well over US$1 trillion -- 30 times larger than the combined volume of all U.S. equity markets. Unlike other financial markets, the forex market has no physical location or central exchange. It is an over-the-counter market where buyers and sellers including banks, corporations, and private investors conduct business. A true 24-hour market, currency trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York.the unmatched liquidity and around-the-clock global activity make forex the ideal market for active traders.