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3 Top Currency Trading Secrets

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3 Top Currency Trading Secrets

Post by Sean on Sun Sep 07, 2008 5:29 pm

By Sean Hyman

Happy Weekend, Currency Traders! Very Happy

With my tenure trading currencies, I can tell you hands down that there are a few things your Forex broker doesn’t want you to know. Or I should say there are a few things your “dealing desk” Forex broker hopes you don’t find out.

I say “dealing desk broker” because honestly, only dealing desk brokers care how market savvy you are. Regular non-dealing desk brokers couldn’t care less. They don’t care how (or if) you make money on your trades. They get their standard fee spread either way.

But dealing-desk brokers…well, that’s a whole other story.

Let me explain: A “dealing desk” brokerage firm actually has traders sitting at a desk, who make their living betting against their clients’ trades. In other words, they follow a trading model that ensures they win when you lose.

And vice versa. When you’re congratulating yourself over that last winning trade, your dealing desk broker is sitting on a loss.
Secret #3: Buy, Hold and Rake in “Daily” Interest!
The last secret is you should always trade “with” the carry interest when possible. Carry interest involves buying a currency from a “higher interest” country that is outperforming a currency from a lower interest country. You’ll give yourself an advantage if you invest in the higher interest currency, and then hold it for a while to pick up the daily interest.

By the way, make sure you compare interest rates between potential brokers. In theory, they should all pay you the same interest. However, in practice many brokers won’t pay as much interest as they should. Interest adds up, so check this out before you open up your account.

Tip: It’s best to go with a “no-dealing desk” broker that pays out favorable “rollover interest” (aka carry interest).

Now, here’s the word of caution with these “carry trades.” (Remember carry trades? They involve borrowing a low-yielding currency and using those funds to invest in a higher-yielding currency.)

Just because you’re invested in a “high interest” currency, does not mean that currency will stay on top forever. Eventually the higher interest country will start to slump. That country’s central bank will start cutting rates. If you see rate cuts coming, don’t bother buying a currency just because it pays higher interest.

ONLY take the longer term carry trades when the higher interest country (compared to the lower interest country) is expanding more favorably. You’re looking for a high-yielding country that has higher inflation than the lower interest country. Then, in those times, you have fundamental support for these trades.

Case in point, many traders like to buy GBP/JPY because it pays out good “daily interest.” However, right now, the U.K. economy is crumbling and headed for a recession. This means the Bank of England will soon have to cut rates.

In times like that, you don’t want to buy that pair. Instead, wait for the fundamentals to turn around and the central banker starts to report a more favorable outlook. Once that happens, then you can resume “carry trading” for a longer term position.

The Golden Rules of Trading Forex
To recap: Buy ONLY the country in the pair that has the more favorable fundamentals and make sure you pair that strong country with a poor country with eroding fundamentals. This gives you the edge over the house which is the market maker or what many refer to as “brokers.”

Then even when trading in the right fundamental direction, make sure to limit your leverage. I prefer mini-lots. If you’re trading mini-lots, I suggest using US$5,000 or more in your account (per 1-2 mini lots traded).

This means you’ll be able to trade with a well-funded account for quite some time. Also, your dealing desk broker will hate you because you don’t trade as often.

Then finally, when the fundamentals are working in your favor, buy the higher yielding currency against the lower yielding currency. Hold onto that pair with a low leveraged position and collect the “daily interest.”

Again, this will frustrate your broker, but it gives you one more way to become profitable on the trade. It also gives you the edge and takes the advantage away from the “house,” (aka your brokerage firm).

Even if you ultimately choose a no-dealing desk broker, still follow these same rules because they will help you be successful on your trades in the long run.

So keep in mind these “secrets” that I’ve learned from all my years of “being on the inside.” This way, you’ll have the natural advantage – instead of your broker.

Best Regards,
Sean




Why is this profitable for a brokerage house? Because most Forex traders are novices. These beginners try to trade on their own, so they often rack up the losses. This gives “dealing desk brokers” a natural advantage.

Of course, it’s not difficult to give yourself the advantage. In fact, it’s pretty easy. But you have to know a few “Forex secrets” that your FX dealing desk broker definitely won’t tell you. In fact, he’s betting you don’t know these tricks.

So let’s shake things up a bit and take a look at the top three secrets your broker doesn’t want you to know.

Secret #1: It’s All About the Fundamentals
Firstly, you need to trade on the side of the fundamentals and never against it. So pay attention to what central bankers are saying about their economies. This is important. They may not always give you all the facts, but you can usually get at least an idea of what they will do next from their statements.

Central bankers will give you their thoughts on their respective economies. And if they don’t tell you outright, you can tell by their actions. For example, when central bankers raise rates, it means they’re fighting inflation. That’s usually a good sign for the country’s currency. However, if inflation is shrinking or if the central bank is in “rate cut” mode, then it’s bad for the currency.

If the economy is growing (according to its GDP numbers), then that’s another plus for a country and its currency. On the other hand, a falling GDP either means a country is slowing or the economy is shrinking rather than expanding. Either way, that’s a bad thing for the their currency.

So to find the perfect currency pair to trade, you need to play “matchmaker.” Match up the best-looking country with high inflation and rising interest rates to the ugliest country with the worst fundamentals (lower inflation and slashed interest rates). Once you have your “best-of” and “worst-of” currencies, simply trade the good country vs. the bad country.

For example, let’s say you decided the U.S. dollar was the “ugliest” currency in the world because the U.S. is slowing and the Fed just cut rates. You also decided that the euro was the best-looking currency. In this instance, you would buy the EUR/USD pair.

Your dealing desk broker doesn’t want you to trade with the proper fundamental direction. They’d prefer you “trade against the trend” of the economic fundamentals. These greedy brokers want you to “pick tops” and “pick bottoms” (and ultimately fail) because you’re fighting the trend. You do that, and your dealing-desk Forex broker wins.

Secret #2: Trade Less Than Your Broker Wants You To
The second secret is how much leverage to use. Trust me: Your dealing-desk broker would love you to pour on the leverage (a.k.a. trade more “lots” per trade).

Why? The bigger the lot size you use, the more fees you have to pay them in the short-term (because you pay the spread as your fee, and higher leverage means a greater number of lots which also means more spreads for them). On the other hand, if you use a smaller lot size, and use less leverage per trade, then you pay your broker fewer spreads, at least in the short-term.

So if you use a ton of lots and trade very, very frequently, then you’re actually helping out your broker (not necessarily yourself). Your dealing desk broker will love you because your over-trading is “good for business.” You’re also making a ton of money – only for your broker, not yourself. That’s why they’ll always encourage active trading.

However, you’ll build up your trading account over the long-term if you trade a lower number of lots in proportion to your account size. Also, if you trade less frequently and hold trades longer, you’ll help yourself and your trading account rather than your broker.

Sean

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