Benefits of Contracts for Differences

CFDs allow forex traders to take long or short exposure using leverage and settle the transaction with cash, rather than delivery of physical assets.  These instruments differ from buying or selling the underlying asset because the contract holder doesn’t need to post 100% of capital and does not own the asset. CFDs are not allowed in the United States.

The CFD trading stake only needs to cover the net change from the entry price to the exit price. Compare this to a forex broker who requires a higher percentage of capital in the account to buy or sell currency pairs. CFDs can be used to trade directionally, or you can buy one CFD and simultaneously sell another CFD, capturing the relative change in value in a ‘pairs trade’.

KEY POINTS

  • Contracts-for-difference are derivative instruments that track many assets.
  • CFDs provide leverage based on the buy and sell price, rather than the underlying assets.
  • CFDs support greater total exposure than forex cash markets.
  • EU rules limit the margin on forex CFDs to 30:1 on major pairs and 20:1 on minor pairs.
  • Limit CFD exposure on a single trade to a small percentage of total capital.

Do CFDs Provide Leverage?

The contract for difference has an embedded leverage feature that differs from broker to broker, and asset to asset. Leverage increases both trading profits and trading losses, allowing the market participant to take an exposure with borrowed capital. Current European Union regulations limit leverage on major currency pairs to 30: 1 and minor currency pairs to 20: 1. In addition, those rules provide negative balance protection so the trading account never goes below zero.

Forex contracts for difference are bought or sold in standard, mini, or micro ‘lots’, or unit sizes, that correspond with $100,000, $10,000, or $1,000 of the underlying forex pair, respectively.  So, for example, a broker following EU rules will allow the trader to purchase three EUR/USD CFD mini lots ($30,000) while posting collateral (free account capital) of just $1,000.

It’s important to understand how leverage will impact your trading returns, positively and negatively.  For example, if you purchase $30,000 of EUR/USD using 30: 1 leverage in a $1,000 account, it will take just a 3.33% ($30,000 * .0333) move to either double your money or wipe out your capital. So, while leverage is an attractive tool, it’s also a double-edged sword.

To use leverage, the trader needs to open a ‘margin’ account as opposed to a ‘cash’ account. Each broker has different criteria for opening a margin account but most require a higher minimum stake than a cash account. In addition, the applicant may need to answer questions about trading experience and investment knowledge.

After opening a margin account, the trader needs to maintain a specific amount of capital. Each position requires the account holder to post a specific amount of funds from this capital pool, referred to as ‘initial margin’.  This is the money needed to cover the loss if the trade doesn’t work out as expected.

The broker will ensure the account holder has funds to cover potential losses or positions will be closed automatically to cover the deficit. As the market moves, the amount of margin needed to maintain the trade will change. If the value of the position decreases, the broker will take a ‘maintenance margin’ to cover losses in addition to the initial margin. If the value of the position increases, the initial margin will remain unchanged, but the maintenance margin will decline.

The margin calculation is in real-time, telling the broker the minimum amount of capital required for the account holder to maintain the trade.  If the position moves against the trader and account capital isn’t increased, the broker has the right to liquidate the position.  It’s vital that new forex traders understand the written margin agreement and the broker’s rights to liquidate positions before starting to trade CFDs.

Managing Your Risk

Trading CFDs can be risky, especially if you use leverage, so a written trading plan (trading rules) must be in place before entering a position (see ‘Psychology and Trading’). Limit the amount of individual trade exposure to a small percentage of the total account size, providing a measure of safety as your trading skills grow.  Place stops on all trades, cut your losses and, if the market moves in your favor, adjust the stop and lock in some profits.

Summary

Contracts for difference (CFDs) are financial derivatives that allow market participants to trade the forex market without purchasing or selling currency pairs. CFD pricing tracks underlying assets and provides leverage to enhance returns. Trading CFDs requires opening a margin account at a CFD broker. Leverage can significantly enhance forex trading returns but will also generate damaging losses, especially when applied incorrectly. A well-constructed risk management plan is needed to trade CFDs for consistent profits.

Walt Disney Near Two-Year Low Ahead of Report

Dow component Walt Disney Co. (DIS) reports Q2 2022 results next week, with analysts looking for a profit of $1.19 per-share on $20.04 billion in revenue. If met, earnings-per-share (EPS) will mark a 51% profit increase compared to the same quarter last year, when renewed Covid restrictions delayed reopening plans. The stock rallied to 157 after beating Q1 estimates in February but that buying spike marked the highest high in the last three months, ahead of a major decline that’s relinquished 25% of its value.

Politics vs. Profits

The Mouse has lost nearly 45% in two months since posting an all-time high above 200 in March, close to repeating 2020’s 49% somersault. Worse yet, the company is entangled in hot-button social justice issues, practically ensuring that half of its diverse customer base is angry with its actions. That’s no way to protect an American brand that’s defined wholesome family entertainment since “Steamboat Willie” was released in 1928.

Disney rallied in 2020 on the rapid growth of its streaming service but recent subscriber numbers have been mixed, for the same reason that Netflix Inc. (NFLX) recently warned about subscriber losses in the second quarter. Many who were stuck at home with kids in the first year of the pandemic subscribed to Disney+ to keep them engaged between Zoom school sessions. That phenomenon ’pulled forward’ future sales, generating a classic saturated market for streamers.

Wall Street and Technical Outlook

Wall Street has been asleep at the wheel during the Disney decline, generating an ‘Overweight’ consensus based upon 21 ‘Buy’, 2 ‘Overweight’, and 8 ‘Hold’ recommendations. Worse yet, price targets currently range between a low of $130 and a Street-high $229 but the stock will trade on Friday more than $20 below the low target. This huge disconnect highlights the failure of analysts to measure the financial impact of the Netflix warning and social justice controversy.

Walt Disney finally cleared 2015 resistance at 122 in December 2020, entering a brief uptrend that hit an all-time high at 203.02 in March 2021. The subsequent decline sliced through the 2019 high in January 2022, signaling a failed breakout that’s dropped the stock to levels first struck in April 2015. Disney pays no dividend so that horrific performance translates into a zero seven-year return, making it one of the Dow’s worst performers.  Accumulation has dropped to a 10-year low at the same time, further darkening the long-term outlook.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Cleveland-Cliffs Could Rally to 40

Flat roll steel producer Cleveland-Cliffs Inc. (CLF) is pulling back after doubling in price in less than two months, nearing support that could offer a low risk buying opportunity. Spot steel prices fell from $1,700 in Q4 2021 to $1,200 in Q1 2022 but CLF’s specialized products commanded higher prices, highlighting a market edge that could persist for many years. Ukraine and record inflation are acting as tailwinds in this phenomenon, predicting that CLF will trade at much higher levels in coming months.

Top Dollar for Flat Rolled Steel

The company is expected to generate record 2022 cash flow, lifting from $2.1 billion in 2021 to around $2.9 billion this year. The stock trades at just five times free cash flow and five times estimated 2022 earnings-per-share (EPS), making it a far cheaper bet than mid-sized tech stocks crashing to earth this year. Better yet, Cleveland-Cliffs’ current price-to-earnings ratio (P/E) is lower than the 7x average of the last few years, limiting secular risk.

CEO Lourenco Goncalves touted record first quarter results after the April report, trying to ease chronic investor skepticism. As he notes “Our first-quarter results are a clear indication of the success we have been able to achieve as we renewed our fixed-price contracts last year. Despite the decline in spot prices for steel from Q4 to Q1 and its lagged impact on our results, we were able to continue to deliver strong profitability.”

Wall Street and Technical Outlook

Wall Street consensus stands at an ‘Overweight’ rating based upon 6 ‘Buy’ and 5 ‘Hold’ recommendations. The lack of analyst coverage illustrates long-term apathy for the steel sector after a multi-decade downturn. Price targets currently range from a low of $23.50 to a Street-high $47 while the stock is set to open Thursday’s session just $3 above the low target. This modest placement, taken together with the excellent technical outlook, suggests significant upside in coming quarters.

Cleveland-Cliffs fell to a 29-year low in 2016 and turned higher, entering an uptrend that stalled in the lower teens in 2017. It posted a higher low in March 2020, ahead of a breakout that settled in the mid-20s in the summer of 2021. The stock rallied above resistance in March 2022, reaching a 9-year high at 34.04 before entering a pullback that’s now approaching breakout support. Weekly Stochastics has reached the oversold level while the monthly indicator remains in a buy cycle, setting up an ideal combination for buy-the-dip strategy, ahead of new upside.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

 

Marriott Bookings Near Pre-Pandemic Levels

Marriott International Inc. (MAR) is trading higher by 2% in Wednesday’s pre-market after beating Q1 2022 profit estimates by a wide margin and reinstating its dividend after suspending the payout in February 2020. The company reported earnings of $1.25 per-share, $0.33 higher than expectations, while revenue rose a healthy 81.3% year-over-year to $4.2 billion, just below consensus. Occupancy rose from 45% in January to 64% in March, less than 10% below pre-pandemic levels.

Business Travel Returning to Normal

The lodging giant reported the largest surge in global demand since the start of the pandemic, with massive immunity generated by vaccines and natural infection dropping hospitalization rates. The end of most government mandates has encouraged businesses to reinstate physical travel, finally walking away from the virtual meeting place, hopefully for the last time. Even so, travel costs are soaring due to rising fuel prices, causing some companies to retain cheaper alternatives.

Marriott also reported a strong quarter in February but Omicron kept many investors on the sidelines. The company is faring better than many rivals, with Hilton Worldwide Holdings Inc. (HLT) missing revenue estimates and issuing downside guidance on Tuesday. That stock is now trading at a three-week low after posting an all-time high in April. Technically speaking, Hyatt Hotels Inc. (H) is the weakness of the three majors, still oscillating near February 2020 resistance ahead of May 10th earnings.

Wall Street and Technical Outlook

Wall Street consensus stands at a mediocre ‘Hold’ rating based upon 7 ‘Buy’, 1 ‘Overweight’, 14 ‘Hold’, and 1 ‘Underweight’ recommendation. No analysts are recommending that shareholders close positions. Price targets currently range from a low of $164 to a Street-high $210 while the stock is set to open Wednesday’s session about $3 below the median $179 target. This modest placement bodes well for an uptick reaching the all-time high at 196, posted just two weeks ago.

Marriott topped out near 150 in 2018 when President Trump started the trade war with China. It tested that price level in February 2020 and sold off to a 6-year low during March’s pandemic decline. The subsequent rally reached resistance in March 2021, ahead of a September breakout that eased into a rising channel pattern. That bullish formation is still in place, suggesting the stock is engaged in a long-term uptrend that reaches 200 as the next short-term target.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

AMD Could Bottom Out in the Low 70s

Advanced Micro Devices Inc. (AMD) reports Q1 2022 results after Tuesday’s closing bell, with analysts forecasting a profit of $0.92 per-share on $5.58 billion in revenue. If met, earnings-per-share (EPS) will mark a 75% increase on profit compared to the same quarter last year. The stock rose more than 5% in February after beating Q4 2021 top and bottom line estimates but rolled over quickly and has lost more than 30% of its value in the last three months.

Bearish Sentiment Limits Upside

AMD’s innovative pipeline features the new Genoa server chip, which should compete forcefully with Dow component Intel Corp. (INTC) and Taiwan Semiconductor (TSM). However, PHLX Semiconductor Index has lost more than 26% this year, highlighting a painful deterioration in sentiment. Worse yet, chip stocks are showing no signs of bottoming out, with Intel nearing a breakdown and industry leader NVIDIA Corp (NVDA) trading at a 9-month low.

But not everyone is bearish on AMD’s outlook. Raymond James analyst Chris Caso upgraded the stock to ‘Strong Buy’ last week, insisted the company is well-positioned to thrive in a tough semi environment. As he notes “we have become more concerned about cycle risks given potential for slowing consumer demand and elevated inventory levels at customers, (but) we favor those semi companies with strong secular drivers, more muted cyclical exposure and attractive valuations, for which AMD appears well positioned.”

Wall Street and Technical Outlook

Wall Street consensus stands at an ‘Overweight’ rating based upon 20 ‘Buy’, 4 ‘Overweight’, 14 ‘Hold’, and 1 ‘Sell’ recommendation. Price targets currently range from a low of $100 to a Street-high $185 while the stock is set to open Monday’s session nearly $15 below the low target. This dismal placement highlights the failure of analysts to properly evaluate the financial and psychological impact of rising inflation, war in Eastern Europe, and chronic supply chain disruptions.

Advanced Micro broke out above 20-year resistance at 48.50 at the start of 2020, entering a powerful uptrend that stair-stepped to an all-time high at 164.46 in November 2021. The stock has been cut in half since that time, giving up nearly two-thirds of the gains posted since the March 2020 low. It broke through support at 100 in April and is now targeting the May 2021 low in the low 70s.  An active monthly sell cycle should keep pressure on price in the second quarter, favoring downside into that support zone.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Intel Struggling at Support after Q2 Warning

Dow component Intel Corp. (INTC) is trading lower by more than 4% after meeting Q1 2022 estimates and guiding Q2 results below consensus. The chip giant posted a profit of $0.87 per-share during the quarter while revenue fell 6.6% year-over-year to $18.4 billion. The company reaffirmed fiscal year 2022 numbers but the mixed outlook didn’t sit well, with rising inflation, chronic supply chain issues, and long-term instability in Eastern Europe weighing on sentiment.

Bad Year for Chip Stocks

The chip sector has struggled so far in 2022, posting year-to-date losses across the board. PHLX Semiconductor Index is down 23% and showing no signs of stabilization, with sector leaders that include Advanced Micro Devices Inc. (AMD) and NVIDIA Corp. (NVDA) sitting at 9-month lows. Intel is outperforming the sector with a 10% loss but has lost a stomach-churning 35% since April 2021 while accumulation has dropped to a 9-year low.

CEO Pat Gelsinger chatted up the mixed report, insisting that Q1 “was a strong start to the year, exceeding expectations on both the top- and bottom-line. With a $1 trillion market opportunity ahead of us, we remain laser focused on our IDM 2.0 strategy. We executed well against that strategy in Q1, delivering key product and technology milestones and announcing plans to expand our manufacturing capacity in both the US and Europe to meet the continued demand for semiconductors and drive a more balanced, resilient global supply chain.”

Wall Street and Technical Outlook

Wall Street consensus stands at an apathetic ‘Hold’ rating based upon 7 ‘Buy’, 2 ‘Overweight’, 22 ‘Hold’, and 3 ‘Underweight’ recommendations. In addition, six analysts now recommend that shareholders close positions and move to the sidelines. Price targets currently range from a low of $40 to a Street-high $75 while the stock is set to open Friday’s session more than $5 below the median $50 target. Further downgrades at this point could trigger a rapid decline into the low target.

Intel sold off from 75.81 to 12.06 between 2000 and 2009 and has traded within those boundaries for the last 13 years. A slow motion uptick reversed at the .786 Fibonacci selloff retracement level in January 2020 while an April 2021 test triggered a reversal that’s relinquished more than 23 points into Friday’s opening bell. The stock is now sitting on horizontal support that’s been tested multiple times since 2017, with each occurrence raising odds for an historic breakdown.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Mixed Signals Ahead of Apple Report

Dow component Apple Inc. (AAPL) reports Q2 2022 results after Thursday’s closing bell, with analysts forecasting a profit of $1.43 per share on $94.0 billion in revenue. If met, earnings-per-share (EPS) will mark a slight improvement compared to the $1.40 earned in the same quarter last year. The stock rose 7.0% in January after beating Q1 estimates but is now trading more than ten points lower, highlighting a major rotation out of big tech growth stocks.

EU Regulators Take Aim at Big Tech

Europe has emerged as a trouble spot, with headwinds going well beyond the Russia – Ukraine conflict. The European Union has just approved rules to police big tech platforms, demanding they introduce adequate safeguards to fight disinformation. The regulation may also force iPhone and Mac to open up to third party vendors, outside the tightly controlled and highly profitable Apple Store. In addition, anti-competitive behavior will now expose American giants to steep fines and possible divestitures.

JP Morgan analyst Samik Chatterjee lowered his 2022 iPhone estimate to 245 million from 250 million earlier this month, citing the drag of recently introduced low priced models. As he notes “our estimates for iPhone 13 remain largely intact as we expect the combination of recent color variant launches as well as a higher than typical inventory level in the channel against the backdrop of existing supply chain constraints to provide offsets to lower customer spending.”

Wall Street and Technical Outlook

Wall Street consensus now stands at a mixed ‘Overweight’ rating based upon 26 ‘Buy’, 6 ‘Overweight’, 10 ‘Hold’, and 1 ‘Underweight’ recommendation. Boutique firm Global Equities posted the sole ‘Sell’ rating this week, but many publications are hiding this bearish call. Price targets currently range from that firm’s $95 target to a Street-high $215 while the stock is set to open Thursday’s session more than $30 below the median $191 target.

Apple mounted the February 2020 peak at 81.81 in June, entering a strong uptrend that eased into a rising channel in September. This pattern has contained price action for 20 months, reaching channel support for the fifth time this week. Weekly and monthly Stochastics are engaged in sell cycles, slightly raising odds for a breakdown, but accumulation is holding up while the stock has held support in lower time frames. This provides bulls with a mild advantage, heading into the report, but there are no guarantees in this volatile spring market.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Alphabet Downside Appears Limited After Mixed Quarter

Alphabet Inc. (GOOG) is trading lower by more than 4% in Wednesday’s pre-market after posting a Q1 2022 profit of $24.62 per-share, missing estimates by $0.92, while revenue increased 23% year-over-year to $68.0 billion, slightly higher than consensus. Advertising income rose a healthy 22%, with Chrome and Android OS less impacted by Apple Inc. (AAPL) privacy code that’s wreaking havoc in the social media space. The Board eased the pain of the mixed quarter by authorizing an additional $70 billion in Class A and C share repurchases.

Second Quarter Headwinds

YouTube ad income rose 15% year-over-year to $6.9 billion, now comprising just 12% of total revenue. Executives warned that advertising revenue will face tough comps in the second quarter, with the Russia – Ukraine war falling within that time slot. Alphabet suspended commercial activities in Russia following the outbreak in February. The company is scheduled to split 20-for-1 after the market close on Friday, July 15th.

CEO Sundar Pichai did his best to talk up the report despite the shortfall, noting that “Q1 saw strong growth in Search and Cloud, in particular, which are both helping people and businesses as the digital transformation continues. We’ll keep investing in great products and services, and creating opportunities for partners and local communities around the world.” The lack of major bullet points reinforced anxiety about the tough environment for high valuation growth stocks.

Wall Street and Technical Outlook

Wall Street consensus hasn’t budged in 2022, standing at an ecstatic ‘Buy’ rating based upon 42 ‘Buy’, 7 ‘Overweight’, and 1 ‘Hold’ recommendation. No analysts are recommending that shareholders close positions and move to the sidelines. Price targets currently range from a low of $2,900 to a Street-high $4,183 while the stock is set to open Wednesday’s session more than $600 below the low target. This horrific placement highlights the failure of analysts to see past their blind obsession with tech stocks.

Alphabet mounted the pre-pandemic peak in November 2020, entering a strong uptrend that posted exceptional gains into November 2021’s all-time high at 3,032. A selloff through the 200-day moving average got bought in January 2022, yielding a bounce to range resistance, followed by a secondary decline that also ended at range support. The stock broke down last week, confirming new resistance at the moving average and could now find support at .382 Fibonacci rally retracement at 2,260.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Mixed Signals Ahead of Microsoft Report

Dow component Microsoft Corp. (MSFT) reports fiscal Q3 2022 results after Tuesday’s closing bell, with analysts looking for a profit of $2.20 per-share on $49.05 billion in revenue. If met, earnings-per-share (EPS) will mark a 13% improvement over the $1.95 reported in the same quarter last year. The stock rose 2.9% in January after beating consensus and raising guidance, but the rally failed, yielding narrow rangebound action that’s still in place ahead of the news.

Growth Stocks Under Pressure

Mr. Softee faces the same issue as other tech giants, i.e. ultra-high valuation in a rising rate environment that rarely favors growth plays. However, Microsoft is clearly ‘best-in-class’, with unbeatable cloud computing growth and broad diversification that evens out revenue peaks and valleys. Even so, it’s just lost a large market due to the Russia – Ukraine war while red flags, like the broad slowdown in video game revenue, raises the prospect of a missed quarter.

Rosenblatt Securities analyst Blair Abernathy posted a bullish commentary ahead of the news, reiterating a ‘Buy’ rating and $349 price target. As he notes, “we believe enterprise IT spending, digital transformation project activity, and shift to the cloud trend remained strong in the March quarter.” On the flip side, Piper Sandler analyst Brent Bracelin had a more cautious take, maintaining an ‘Overweight’ rating while admitting there is “little margin for error” due to increasing global headwinds.

Wall Street and Technical Outlook

Wall Street consensus has been pristine for years, maintaining a ‘Buy’ rating based upon 36 ‘Buy’, 6 ‘Overweight’, and 2 ‘Hold’ recommendations. No analysts are recommending that shareholders close positions. Price targets currently range from a low of $307 to a Street-high $410 while the stock is set to open Tuesday’s session more than $25 below the low target. This dismal placement highlights the failure of analysts to measure the impact of rising rates on investor risk appetites.

Microsoft posted exceptional returns into the current decade and barely skipped a beat during the pandemic, breaking out to a new high in June 2020. It continued to gain ground into November 2021’s all-time high at 349.67 and turned tail, breaking down from a small triple top pattern in January. The stock fell quickly into the 270s and has tested that support level three times into Monday’s close. Mixed signals in longer time frames suggest this range will hold, for now.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

UPS Profit Margins Under Pressure

United Parcel Service Inc. (UPS) reports Q1 2022 results in Tuesday’s pre-market session, with analysts looking for a profit of $2.88 per-share on $23.8 billion in revenue. If met, earnings-per-share (EPS) will mark a modest improvement compared to the $2.77 booked in the same quarter last year. Rival FedEx Corp. (FDX) fell 4.0% in March after missing fiscal Q3 earnings estimates and reaffirming guidance, generating a cautious tone ahead of the news.

Freight and Fuel Pressuring Margins

The stock fell ten sessions in a row at the start of April, signaling a major shareholder exodus, ahead of this week’s closely-watched confessional. A Bank of America downgrade after the seventh day added insult to injury, dumping price to the lowest low since October. Slumping freight prices explain most of the downside, with additional capacity putting pressure on profit margins, further aggravated by fuel costs hitting their highest highs in more than a decade.

BofA Securities analyst Ken Hoexter downgraded UPS to ‘Hold’ from ‘Buy’ on Apr. 15, lowering the firm’s price target to $204. JPMorgan analyst Brian Ossenbeck followed suit, cutting the price target to $229 while citing “the fragile balance of capacity additions in an overheated freight market.”  It’s instructive to note that freight rates across the board have dropped since those downgrades but it’s too early to declare a change in trend.

Wall Street and Technical Outlook

Wall Street consensus has deteriorated in the last three months, dropping to an ‘Overweight’ rating based upon 14 ‘Buy’, 3 ‘Overweight’, 11 ‘Hold’, 1 ‘Underweight’, and 1 ‘Sell’ recommendation. Price targets currently range from a low of $150 to a Street-high $275 while the stock is set to open Monday’s session more than $55 below the median $245 target. This low placement suggests firms are doing a bad job informing clients about systemic risks in the transportation sector.

United Parcel Service broke out above the 2018 peak at 135.53 in August 2020, entering a powerful uptrend that stalled near 220 in May 2021. November and February breakout attempts failed, yielding a selling wave that dropped the stock within six points of October range support at 181. It’s been grinding sideways at that level for the last two weeks while accumulation has dropped to a six-month low. Bull and bear odds are equally weighted after the news but a long-term sell cycle could yield lower prices through most of the quarter.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Psychology and Trading

Unfortunately, new participants get punished with this naive mentality, shocked to discover that ‘winning’ trades aren’t enough to become successful in the forex market.

Trading is a head game and it’s not the market you need to beat … it’s yourself. Psychological habits built up over years or decades affect our trading decisions and stand in the way of long-term profitability. Psychology is the study of the mind, behavior, and behavior patterns. It’s what makes us do the things we do and how we overcome obstacles that are holding us back.


KEY POINTS

  • Discipline is the key to long-term market survival.
  • New traders need to write down trading rules and follow them.
  • Greed and fear control the buy and sell decisions of losing traders.
  • Most folks have trouble taking losses, which is a required skill for profitable trading.
  • Control emotions by limiting individual trade risk to a small percentage of total capital.

Trading Discipline: The Foundation to Profits

Trading discipline is the foundation to profits because it provides a set of rules to follow that lower the frequency of self-inflicted losses. We’re all human, prone to mistakes and miscalculations that no discipline can eradicate, but rules optimize this behavior so it doesn’t drive us insane. Even so, it won’t extinguish all greed and fear, the two strongest trading emotions and hardest ones to overcome.

Write down a set of trading rules to follow religiously to lower the impact of greed and fear. It’s harder to follow those rules than to put them on paper due to the destructive habits we’re trying to overcome. Rules can be as simple as trading just once per day or as complex and multi-leveled as entering a trade only when an instrument, for example, (1) bounces from support (2) after a bullish breakout, (3) confirmed by a bullish crossover in MACD and (4) rising RSI.

The forex market can evoke intense anger and frustration when it doesn’t do what you expect. Grudge trading, revenge trading, and trying to ‘get back at the market’ with wild bets are all deadly and real ways to lose your trading capital. Rules are intended to keep you from making trades based on blindness, triggered by these dark emotions, and the most important step you can take on the road to profitability.

List of Simple Rules

Here is a list of simple rules for speculative forex traders.

  • “I will risk no more than 2% of capital on a trade”. (Using a percentage instead of a fixed amount allows the trade size to grow or shrink, depending on account balance, in order to maximize profits and minimize losses).
  • “I will always trade with the trend. I will determine trends by price action, trendlines, moving averages, and momentum indicators”.
  • “I will only enter on confirmed long and short entry signals. My signals are bullish or bearish crossovers in relative strength and momentum indicators, confirmed by a breakout or breakdown of the 50-period moving average”.
  • “I will not enter if price action is within 3% of resistance for a buy trade or 3% of support for a sell (short) trade”.
  • “I will use support and resistance as exit targets. If the price reaches a target, I will exit to take profits”. (Some profits are better than no profits and infinitely more satisfying than losses).
  • “I won’t have more than one trade open on one asset at a time”.
  • “I won’t have more than five trades open at the same time, or risk more than 5% of account capital at one time”.
  • “I will always follow my rules”.

The last rule is the most important rule of all. It doesn’t make sense to have rules if you don’t follow them.

Negative Psychological Factors

The following list identifies the biggest reasons that traders lose money. These often-unconscious emotions generate bad decisions and must be addressed with specific rules to reduce negative fallout. When you take emotions out of the equation, better decisions, more consistent wins, and capital preservation will naturally follow.

  • Fear: one of the market’s most vicious emotions. Fear can keep you from making a good trade, or keep you from taking a timely profit. Fear of losing money will keep you awake at night but don’t let that stop you from trading. The solution: keep trade size small so one loss can’t hurt too badly and you still have the capital to trade.

Scared Trader

  • Greed: is as damaging as fear but the positive feelings make it harder to recognize. Greed is the other face of fear. Greed is the fear of losing profits you don’t have, or the desire to make big trades and take even bigger profits. Greed rears its ugly head when we’re doing well, taking most of us by surprise. In its most common form, profits build confidence beyond the current experience level, invoking greed that encourages over-aggressive trades and excessive leverage.

Greedy man

  • Ambition: a required trait for long-term success but a noose around the trader’s neck when it isn’t controlled.  Admittedly, it takes a ton of raw desire (and adrenaline) to succeed in the financial markets but ambition becomes dangerous to survival when it triggers bad decisions. Comparing results to another trader’s performance and letting that influence your decisions offers a perfect example of runaway ambition.
  • Loss: an inevitable part of trading that can be managed through rules and discipline. The goal is to take ‘appropriate’ losses while avoiding catastrophic career-ending losses. Position sizing is the key to loss management (2% rule), and not getting blinded by greed or fear and throwing away money. Walk away if you get frustrated from a string of losses.
  • Hope: turns against you when the ‘ticker tape’ turns against you. It makes sense to hope that your hard work pays off but the train goes off the tracks when ‘hoping’ a trade pays off the mortgage, buys a vacation, or saves a marriage. That’s ‘gambling’ not trading, a perfect way to lose your trading stake and wash out of the forex market.

Summary

Negative psychological traits and their impact on trade decisions need to be studied and mastered to succeed in the forex market. Putting it bluntly, emotions need to be removed from forex decision-making to be profitable in the long term. That requires specific rules, the discipline to follow them, and the ability to walk away when things go haywire.

Gap Headed Back Into Single Digits

The Gap Inc. (GPS) is trading lower by 17% on Friday morning after reducing Q1sales guidance for the Old Navy division, which accounts for more than half of total sales. Old Navy CEO Nancy Green stepped down at the same time, continuing a melodrama that started in 2019 when the apparel chain decided to spin off the division into a separate entity. It reversed the initiative in 2020 but a chronic sales slump has continued, as illustrated by the closure of 81 stores in the United Kingdom in July 2021.

Failing to Innovate

The company has failed to innovate for newer generations, encouraging long-time customers to shift their apparel purchases online, or to brick and mortar competitors. Global sales fell 16% in the first year of the pandemic and have bounced back, but are still trailing meager 2019 levels by a wide margin. The Old Navy division has mildly outperformed, posting flat three-year growth, while flagship Gap store sales have declined by a painful 3%. Supply chain disruptions have added to growth woes, with many products manufactured in Asian countries.

A Morgan Stanley upgrade ahead of the warning was poorly timed but Barclays analyst Adrienne Yih hit a home run, downgrading the stock to ‘Underweight’ while ticking off headwinds that include “1) negative sales to inventory spread and increasing weeks of supply safety stock, 2) increasing promotional activity at Gap and Old Navy, 3) lack of significant brand loyalty at Gap and Old Navy given the value-oriented pricing, and 4) increasing need for advertising spend to reinvigorate Gap”.

Wall Street and Technical Outlook

Wall Street consensus now stands at a mediocre ‘Hold’ rating based upon 3 ‘Buy’, 17 ‘Hold’, 2 ‘Underweight’, and 1 ‘Sell’ recommendation. Price targets currently range from a low of $12 to a Street-high $20 while the stock has opened Friday’s session more than 30 cents below the low target. This depressed placement suggests that analysts have allowed post-pandemic recovery optimism to overrule an impartial review of the troubled balance sheet.

Gap hit an all-time high at 53.75 in 2000 and settled into a multi-decade trading range, with support between 8.50 and 9.50. It fell to a 25-year low at 5.26 in April 2020, ahead of a bounce that reinstated range support in June. The uptick ended out near 2018 resistance in the mid-30s in May 2021, giving way to a decline that sliced through the .786 Fibonacci rally retracement at 12.25 overnight. The failure to remount this price will sharply raise odds for a selloff into the 2020 low.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Buyers’ Strike Ahead of Snap Report

Snap Inc. (SNAP) reports Q1 2022 results after Thursday’s closing bell, with analysts forecasting a profit of $0.01 per-share on $1.07 billion in revenue. If met, earnings-per-share (EPS) will mark a slight improvement compared to the $0.00 reported in the same quarter last year. The stock rallied 58.2% in February after beating Q4 expectations and raising Q1 guidance but the uptick followed a one-day 24% plunge to a 16-month low. Price action has made no progress since the buying spike, grinding sideways in the 30s.

 User Growth Outside the States

Some analysts see “compelling pockets of user growth opportunity” outside of the United States, where a saturated social media market and iOS privacy changes have weighed on profit margins. Piper Sandler’s Thomas Champion is looking to Japan, Mexico, Brazil, and Italy for growth, tapping into an estimated 800+ million addressable monthly users in the top 15 GDP countries. As he sees it, Snap has 2% to 31% penetration in those targeted nations, offering fresh eyeballs to build market share.

Bullish fervor is growing ahead of the report, even though the stock has fallen 22% in the last two weeks. Citigroup, Rosenblatt, Benchmark, and Deutsche Bank have all issued ‘Buy’ ratings since March while legendary hedge fund manager Stanley Druckenmiller bought 1.4 million shares in February. Even so, accumulation remains stuck near an 18-month low, reflecting risk aversion for social media stocks after Meta Platform Inc.’s (FB) 50% haircut since September.

Wall Street and Technical Outlook

Wall Street consensus stands at an ‘Overweight’ rating based upon 29 ‘Buy’, 3 ‘Overweight’, and 10 ‘Hold’ recommendations. No analysts are recommending that shareholders close positions. Price targets currently range from a low of $39 to a Street-high $88 while the stock will open the session nearly $8 below the low target. This dismal placement highlights a major disconnect with Main Street investors, who incurred major losses when Snap gapped down and sold off nearly 70% in reaction to the disastrous Q3 2021 report.

Snap broke out above 2017 resistance in the mid-20s in October 2020, entering a strong uptrend that hit an all-time high at 83.34 in September 2021. It completed a bearish island reversal in October, entering a painful decline that wiped out more than 50 points into the February 2022 low. A post earnings bounce failed three attempts to mount 50-day moving average resistance, yielding sideways action that could easily test February support following an earnings shortfall.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Tesla Margins Bigger Deal Than Shanghai

Tesla Inc. (TSLA) reports Q1 2022 results after Wednesday’s closing bell, with analysts looking for a profit of $2.27 per-share on $17.84 billion in revenue. If met, earnings-per-share (EPS) will mark a 244% profit increase compared to the same quarter last year. The stock fell 5.9% in January despite better-than-expected Q4 sales and earnings, but is now trading about 150 points higher. Accumulation has soared since March, lifting technical readings back to all-time highs.

Soaring Raw Material Prices

Analysts are squarely focused on the Shanghai shutdown and its impact to deliveries in the second quarter. However, raw material prices could pose a more destructive obstacle, with the average price for metals needed to produce EV batteries rising 74% in the first quarter. Credit Suisse analyst Dan Levy summarized this headwind in a recent outlook, warning that “Margins remain a key focus amid cost inflation. Any commentary on risk to margins could be a negative for the stock.”

On the flip side, Wedbush analyst Dan Ives pounded the tables ahead of the report, raising his price target to $1400 while noting challenges that could negate his bullishness. As he argues “All eyes are on the company’s brutal production issues in China, with Giga Shanghai having a three-week shutdown due to the zero Covid policy in the region. The main question is just how bad the China production issues are and what that means for deliveries in 2Q and the rest of the year.”

Wall Street and Technical Outlook

Wall Street consensus hasn’t budged since Tesla reported 310,000 first quarter deliveries earlier this month, lower than 325,000 expectations. The combined outlook stands at an ‘Overweight’ rating based upon 18 ‘Buy’, 4 ‘Overweight’, 10 ‘Hold’, and 3 ‘Underweight’ recommendations. In addition, six analysts now recommend that shareholders close positions. Price targets currently range from a low of just $67, which is obviously stale, to a Street-high $1,580.  The stock is set to open Wednesday’s session about $70 below the median $1,103 target.

Tesla broke out above the February 2020 peak at 194 in July of that year, entering a powerful uptrend that topped out at 901 in January 2021. An October breakout posted an all-time high at 1,243 in November, ahead of sideways action that’s tested new support for the last five months. Accumulation readings look excellent, favoring a bullish outcome, but conflicting cycles suggests more pattern building before substantially higher or lower prices.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Seven Common Trading Mistakes

In many cases, these folks just made dumb mistakes that could easily have been avoided, given the proper guidance and discipline.


KEY POINTS

  • Common mistakes force the majority of forex traders to ‘wash out’ and leave the markets.
  • Poor trend recognition is a major reason why traders fail.
  • Leverage is deadly to new traders, encouraging unskilled participants to risk too much capital.
  • The chosen market interface (platform) has to meet the trader’s specific needs.
  • Stop losses keep traders ‘in the game’ long enough to develop important skills.

Here are the most common mistakes made by new forex traders.

1. Choosing the Wrong Platform

A robust platform is essential if you want to trade the forex market. The ‘right‘ platform will provide solid educational resources, access to news, a dependable real-time feed, an easy-to-read trading interface, and a variety of trading signals. The software should also include access to major currency and cross-currency pairs, as well as minor and exotic pairs you find of interest.

2. Risking Too Much

Newcomers let the fear of missing out (FOMO) take control, encouraging excessive risk. This is a classic mind-cramp that starts when new traders see missed opportunities and wonder how much they would have gained while forgetting much they could have lost. Say you lose 50% of your capital on a single trade. You now need to double your money on the next trade, just to break even. That isn’t sustainable, especially if you’re just getting started in the forex market.

Only trade what you can afford to lose. A good rule of thumb: risk no more than 2% of capital on a single position, or a combination of correlated positions (pairs that move together). The percentage might seem small but it’s an effective methodology to stay in the game long enough to develop profitable skills.

Another advantage: you’ll stay calm and not lose your cool the next time you’re stuck in a losing trade. It will also discourage closing out good trades too early out of panic because you’re now willing to lose up to the percentage limit.

3. Ignoring Longer Time Frames

The longer the trend higher or lower, the stronger and more durable it will be. Many traders walk into the forex market with a day trading mentality, getting sucked repeatedly into 1-minute to 15-minute chart signals. However, trends on hourly, daily, and weekly time frames exert much greater control, causing the majority of contrary short-term signals to fail. For example, a dip on a 15-minute chart means nothing without a review of higher time frames.

4. Trading with Poor Risk-to-Reward Ratio

The act of trading releases adrenaline and focuses attention, generating addictive sensations that aren’t impacted by profits or losses. This bad chemistry induces the new trader to take positions with poor profit potential and excessive risk, just for the thrill of ‘being in the market’. Rigid discipline and unbiased reward-to-risk analysis is needed before taking a trade to overcome this common flaw. In most cases, stick to opportunities that generate profits of at least three times expected losses if trades turn against you.

5. Not Using a Stop Loss

Placing a stop loss at the right price marks the difference between prosperity, survival, and losing everything. The forex market becomes enormously volatile at times, carving near-violent price swings with little or no warning. Add in excessive leverage and the new trader faces a potentially catastrophic loss in just a few minutes. Even walking downstairs and making a sandwich can trigger career-ending losses so it’s vital to place a stop after entering a new position.

6. Trading Difficult and Unclear Patterns

Take only the most promising profit opportunities and walk away from everything else. Do your homework no matter how long it takes, looking for nearly-perfect technical patterns or fundamental set-ups. Beware of form-fitting when doing your research. An untrained eye can easily block out aspects of a chart that don’t fit the pre-established bullish or bearish bias. When in doubt, rely on cross-verification that looks for confirmation through three, four or even five different types of indicators or analytical methods before taking the trade.

unclear pattern

7. Losing Control of Your Emotions

A profitable trading career requires the same level of mental discipline as building a successful marriage or raising children. If you lose control of your emotions in other aspects of your life, expect the same thing to happen when a trade goes against you. Tobacco, alcohol, THC, and gluttony all contribute to a trader’s emotional state so it’s a good idea to start the journey by developing good health habits, getting a good night’s sleep, and doing a little meditation.

Frustration

Summary

New traders come into the forex game hoping to ‘score big’ and take home a quick fortune. Then reality bites, generating unexpected losses that lower confidence and generate waves of bad decision-making. Survivors eventually learn that profitable trading is a lifetime pursuit, in which the practitioner controls his or her emotions and lets numbers and signals decide buy and sell decisions, rather than greed or fear.

Low Expectations Could Stoke IBM Upside

The new slimmed-down International Business Machines Corp. (IBM) reports its first full quarter since the Kyndryl Holdings Inc. (KD) spin-off after the close, with analysts forecasting a profit of $1.39 per-share on $13.85 billion in revenue. Neither stock has performed well since the Nov. 4 split-up, with KD cut in half while IBM is trading less than two points from the Nov. 3 close. Buying interest has been non-existent during this period, highlighting continued investor apathy.

Safe Haven in Tough Times?

However, IBM could outperform in a slowing economy or deep recession. Hardware budgets will decline but just 20% of the balance sheet is hardware-related after the spin-off while half of all revenues are recurring, through contracts and service agreements. Even the old tech behemoth was considered a good bet in tough times, historically trending in the opposite direction of the Purchasing Managers Index (PMI), a leading indicator for economic strength and weakness.

Morgan Stanley analyst Erik Woodring posted a $150 price target while upgrading the stock to ‘Overweight’ last week, noting the “result is a stronger long-term growth outlook, though investors still question whether mid-single-digit long-term revenue growth is achievable. However, we do see green shoots of improving customer sentiment and spending plans …While it is too early to call a clear inflection, these data points bear watching.”

Wall Street and Technical Outlook

Wall Street consensus stands at an apathetic ‘Hold’ rating based upon 7 ‘Buy’, 9 ‘Overweight’, and 11 ‘Hold’ recommendations. In addition, two analysts recommend that shareholders close positions and move to the sidelines. Price targets currently range from a low of $115 to a Street-high $185 while the stock is set to open Tuesday’s session about $19 below the median $145 target. Sadly, these dismal ratings have barely budged in the last seven or eight years, perfectly in line with the multiyear downtrend.

IBM topped out in 2013 and entered a severe decline that has carved nine years of lower highs and lower lows. It hit an 11-year low in March 2020 and bounced, reversing at an 8-year down trendline in June 2021. The stock has traded near the midpoint of the 2020 trading range since that time while accumulation continues to slump near 2018 levels. The good news for bulls at this point: no one expects the company to beat earnings and raise guidance, improving odds for a pleasant surprise.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Sellers Lock and Load Ahead of Netflix Report

Netflix Inc. (NFLX) reports Q1 2022 results after Tuesday’s closing bell, with analysts projecting a profit of $2.92 per-share on $7.95 billion in revenue. If met, earnings-per-share (EPS) will mark a 21% profit decline compared to the same quarter in 2021, when pandemic restrictions added to subscriber growth. The stock collapsed in January, posting a 21% sell gap after lowering Q1 guidance to just 2.5 million new subscriber additions.

Is Slow Growth Permanent?

Analysts have raised guidance to 2.8 million during the quarter, well below previous estimates of 5.7 million. That number could be over-optimistic, given price hikes, industry saturation, loss of some international markets, and broad macro headwinds that have impacted consumer buying decisions.  Adding to risk, Q2 marks the streaming giant’s historically weakest quarter, with the onset of spring encouraging folks to engage in more outside activities.

Monness Crespi Hardt analyst Brian White offered a somber preview of the report, noting that “Although the content on Netflix has been exceptional over the past couple of years, nefarious forces appear to be lurking beneath the surface of Netflix’s post-lockdown recovery, either in the form of a slower-than-expected healing process after the pandemic-driven pull forward, a weaker-than-expected global economy, or a platform that has simply hit a near-term growth wall.”

Wall Street and Technical Outlook

Wall Street consensus stands at an ‘Overweight’ rating based upon 21 ‘Buy’, 3 ‘Overweight’, 16 ‘Hold’, and 2 ‘Underweight’ recommendations. In addition, two analysts recommend that shareholders close positions and move to the sidelines. Price targets currently range from a low of $330 to a Street-high $700 while the stock is set to open Monday’s session just $10 above the low target. It pays to be skeptical about these ratings, given the chronic failure of analysts to accurately predict slowing subscriber growth.

Netflix broke out above 2018 resistance near 400 in April 2020, entering an uptrend that stalled above 575 in July. It cleared that barrier in September 2021, posting an all-time high at 700.99 in November, ahead of a downturn that failed the breakout about two weeks before January’s horrific Q4 report. The stock bounced after falling to a two-year low in March, but the uptick failed to end the string of lower highs and lower lows. In turn, this bearish price action exposes additional downside through the 300 level.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication. 

Basics of Forex Trading – Part 2

As a trader, you’ll have access to all or some of these venues, depending on the services provided by your broker. In addition, let’s introduce the three types of trading styles you can choose, depending on your account size, willingness to watch the forex market in ‘real-time’, and long-term goals.


KEY POINTS

  • Currencies can be traded through spot, forwards, and futures markets.
  • Forex traders can take positions lasting from a few seconds to a few months or years.
  • The majority of forex trading strategies follow the trend, higher or lower.
  • Trends and counter-trends can be subdivided into much longer and shorter time frames.
  • Charles Dow’s work on trends more than 100 years ago is still used every day by forex traders.

Spot Market and the Forwards & Futures Markets

Market participants can take risks in three types of forex markets: spot market, forwards market, and futures market:

  • Spot Market: the most popular of the three, with traders worldwide exchanging ‘real assets’ through an electronic communications network, broker dealing desk, contracts for difference, or direct interbank system. Prices on the spot market are based on supply and demand.

Spot market

  • Forwards Market:  a more sophisticated venue, accessed by international companies and large investors seeking to hedge currency risk. For example, McDonald’s might enter into forwards contracts to lower the risk of exchange rate fluctuations and price shocks in other parts of the world. The parties to a forwards contract choose agreed-upon pricing, which can differ greatly from interbank or futures quotes.

Forward Market

  • Futures Market: the most popular forex venue prior to the advent of retail forex brokers. Futures contracts are based upon a standard size and settlement dates on the Chicago Mercantile Exchange (CME) in the United States and regulated by the National Futures Association. Smaller exchanges in other countries also offer currency futures contracts. Minimum price increments, delivery, and settlement dates are determined by the contract and the exchange is the counter-party in all cases.

Different Trading Styles

The majority of retail forex traders follow one or more of three main strategies and methodologies:

  • Day trading
  • Scalping
  • Swing (position) trading

Day trading and scalping are two of the most aggressive and active trading styles. In both cases, positions will be closed before the end of the active session. However, these styles differ in trade frequency and holding period.

Scalping techniques take advantage of very small movements, often buying and selling within a few seconds or minutes. Scalpers analyze very short-term charts, looking at 1-minute to 5-minute price action for clues to directional impulses. High transaction costs eat up returns with this high volume trading strategy, requiring a high win-to-loss ratio to book consistent profits.

Day trading techniques focus exposure on 5-minute to hourly charts, looking for directional impulses lasting from one to six hours, as a general rule. Occasionally, day traders will ‘take-home’ a position, holding it overnight while seeking greater profits or an important move at the start of the next session.

Swing trading techniques are longer-term, with positions held for days or weeks. A sizable minority of swing traders also review long-term signals and hold positions for several months.  The chosen method determines which price charts to follow, looking for buying or selling signals on hourly, daily, and even weekly charts.

Forex traders use different types of entry and exit orders, depending on their trading styles. For example, scalpers use market orders more often than swing traders because it lets them enter or exit positions instantly. Limit orders are more useful for day traders and swing traders because positions can be taken at pre-determined prices. In addition, it’s important to use stops on all, day and swing trades to limit losses, in case the market decides you’re wrong.

The Importance of the Trend in Forex Trading

Forex traders follow interest rates and the world economy but most rely on technical analysis to evaluate major trends and make trading decisions. This classic approach depends upon three basic assumptions:

  • Prices discount everything.
  • History tends to repeat itself.
  • Prices move in trends.

The majority of newcomers think prices only go up or down but Dow Theory asserts there are actually three trends in the market: up, down, and ‘sideways’ or rangebound. According to Charles Dow’s work, 100 years ago, investors and traders need to look at the sequence of highs and lows to determine a trend’s long and short-term direction.

Downtrend

uptreng

Sideways

Specifically, his theory states an uptrend is generated by higher highs and higher lows while a downtrend is generated by lower highs and lower lows. In addition, when neither buyers nor sellers have control of the market, prices evolve within a lateral consolidation, also called a ‘trading range’.

ups and downs

The theory categorizes relationships between trends in different time frames, which may converge with each other or diverge from each other. According to Dow, each trend is formed by three other trends: ‘primary’, ‘secondary’, and ‘minor’.

A primary trend lasts more than a year and signals a bull or bear market. Within a primary trend, a secondary trend goes in the other direction, carving a pullback lasting between three weeks and three months. Finally, minor price action is common within the secondary trend, lasting less than 3 weeks.

Traders and technicians have refined Dow’s brilliant trend observations over the last century. We now understand, in our fast-moving modern electronic markets, that primary, secondary, and minor trends can evolve over days or weeks, rather than months or years. Even scalpers apply Dow’s work when flipping positions in the 21st century, using 1-minute to 5-minute charts to determine the primary trend.

Summary

Market participants can take forex exposure through a variety of cash and derivatives markets but most trade in a cash market through a forex or contracts-for-difference broker. Most forex traders speculate on currency prices through time-based trend-following strategies that include scalping, day trading, swing trading, and long-term investment. The majority of forex trading falls in-between these extremes, with positions open for a few hours to a few days.

Basics of Forex Trading – Part 1

What is the forex market? Why is it a great market to trade? What is a currency pair and how it is read? What are the major terms and concepts that forex traders need to learn? These are some of the questions you will find answers to at the end of this series.

Forex trading can be an exciting and lucrative activity, but it can also be tough, especially for beginners. New market participants underestimate the importance of financial education, lack risk management skills, tend to have unrealistic expectations, and fail to control their emotions, pushing them to act irrationally and impair their performance. In addition, traders in all markets have to accept drawdowns and losses because the best strategies only work part of the time.


KEY POINTS

  • The forex market is the largest and most liquid financial market in the world.
  • Traders speculate on the foreign exchange through currency pairs.
  • A variety of factors affect the price of a currency in relation to a second currency.
  • The trader opens and closes positions through buy, sell, stop, and limit orders.
  • Traders use margin and leverage to increase reward and risk.

What is the Forex Market?

The foreign exchange market, also called ‘forex’ or the ‘FX market’, is a global decentralized venue where the world’s money is exchanged through the buying and selling (short) of different currencies. This trading takes place through transactions at brokerages, over-the-counter (OTC) markets, or via the interbank system, rather than centralized exchanges.

Many types of market participants trade the forex market, including private individuals (retail traders) working from home on personal computers or on the road through mobile devices. Thousands of professionals also trade forex through funds, institutions, central banks, and commercial banks, among others.

Forex has grown into the world’s most liquid market for the following reasons:

  • Its Enormous size, with trillions of dollars in daily transactions
  • 24-hour access between Monday and Friday
  • Wide variety of currencies and currency pairs
  • All levels of volatility, from quiet price action to historic uptrends and downtrends
  • Low account minimums
  • Low transaction costs (commissions, spreads, fees, and interest)

Forex trading is conducted through cash-based spot markets, as well as derivatives markets that provide sophisticated access to forwards, futures, options, and currency swaps. Private individuals generally trade forex to speculate on higher or lower prices, making a profit or loss on each closed position. On the other hand, most institutional forex activity is geared towards hedging against currency and interest rate risk or to diversify large portfolios.

New traders open accounts at forex or contracts for difference (CFD) brokers, taking exposure when they speculate on currency pairs, like the Euro vs. U.S. Dollar (EUR/USD) or U.S. Dollar vs. Japanese Yen (USD/JPY). At a typical forex broker, the participant opens a buy or sell (short) position in a decentralized market and books a profit or incurs a loss on the difference between the opening and closing prices.

Exposure at a CFD broker is taken between the trader and broker, establishing a legal obligation to exchange the difference between the entry and exit price of the asset, which can be a currency pair or other financial instrument that includes stocks, bonds, and futures. Forex lot sizes are uniform regardless of currency pair while CFDs have greater size flexibility. This advantage translates into greater risk control and customization of a trader’s experience level and market strategy.

What Moves the Forex Market?

Many factors move the forex market on a daily basis. Forex traders keep 24-hour economic calendars close at hand because regularly-scheduled data releases generate the majority of currency pair rallies and declines, especially when numbers fall outside expectations projected by experts. Global shock events and political developments move currency markets as well, with an election, skirmish, or natural disaster translating into highly-volatile price action.

Economic Calendar

Reading a Forex Quote

Foreign exchange is always quoted in pairs. For example, in the EUR/USD currency pair, the Euro (EUR) is the ‘base’ currency while the U.S. Dollar (USD) is the ‘quoted’ currency. The quoted currency is always the equivalent of one base currency, so if the EUR/USD exchange rate is worth 1.1222, you will get $1.12 for €1.00.

Note how the EUR/USD currency pair has four decimals. This is typical of most currency pairs, except those including the Japanese Yen (JPY), which displays only two decimals. When a currency pair moves up or down, the change is measured in ‘Pips’, which is a one-digit movement in the last decimal of a currency pair. So, for example, when the EUR/USD rallies from $1.1222 to $1.1223, the EUR/USD has increased by one Pip.

Forex Quote

The broker’s trading platform will display two prices in a currency pair quotation: a SELL price on the left (BID price) and a BUY price on the right (ASK price). The difference between these prices is called the ‘spread’. The spread is pocketed by the broker and is one of the main ways in which the company makes money.

A buy order that’s filled above the quoted ask or sell order that’s filled below the quoted bid incurs ‘slippage’, one of the biggest obstacles to profitable forex trading. Slippage occurs most often in volatile or active currency pairs when placing a market order.

Forex Spread

The average daily trading volume of the forex market now exceeds 5 trillion U.S. Dollars, making it the most liquid market in the world. Liquidity refers to how easy it is for market participants to open and close positions without affecting the price of the underlying asset.

The concept of liquidity also works hand-in-hand with volatility, which measures the speed and velocity of changing buy and sell prices. The majority of forex traders love volatile markets because they provide greater opportunities to profit, especially with short-term strategies like scalping and day trading.

Forex Trading Risks

Most forex traders lose money over time. Lack of preparation, bad leveraging, weak skill sets, and emotional fatigue all take their toll, triggering losses that eventually force the trader to ‘wash out’, leaving the forex game to the next participant.  The profitable minority learns how to overcome these headwinds, often spending hours building skillsets, doing research, and testing new systems and strategies.

In addition, banks around the world seek to manage sovereign and credit risk through bid and ask prices on the interbank quoting system, triggering frequent supply and demand disruptions unrelated to market-moving events or economic releases. These pose a major risk for the typical newcomer who grows complacent between scheduled market movers, failing to place stop losses, or taking too much short-term exposure for their experience level.

Ironically, the new trader’s biggest risk comes from the broker they choose. The vast interbank system is a hodgepodge of ‘regulated brokers’, offering unbiased market access, and ‘unregulated brokers’ who take advantage of customers’ lack of sophistication. These companies are easy to spot because most are domiciled (headquartered) in off-shore tax havens, rather than in the U.S., U.K., E.U., or Australia, which heavily regulate currency trading.

Unregulated brokers do the most damage when they operate a ‘dealing desk’ that takes the other side of a customer’s position and manipulate price through ‘requoting’ to trigger stops and force unexpected losses, especially in the off-hours when most active traders are asleep. It can also be difficult to get your money back when you choose to close an account at an unregulated broker.

Key Forex Trading Terms

Currency Pair: Currency pairs consist of two currencies, the base currency on the left (top) and the quoted currency on the right (bottom). EUR/USD is an example of a currency pair. When buying this pair, the trader buys the Euro and sells the U.S. Dollar. Alternatively, when selling this pair, the trader sells the Euro and buys the U.S. Dollar.

Major Pairs: Currency pairs can be sub-divided into major, cross, minor, and exotic pairs. Major pairs include the U.S. Dollar as the base or counter-currency, coupled with one of seven major currencies: EUR, CAD, GBP, CHF, JPY, AUD, and NZD.  New traders focus on major pairs because they’re highly liquid and carry lower transaction costs through tighter spreads, limiting slippage.

Cross Pairs: Cross pairs consist of any two major currencies, except the U.S. Dollar. Unlike major pairs, cross pairs have higher transaction costs, higher volatility, and lower liquidity, increasing potential slippage. Examples of cross pairs include EUR/GBP, EUR/CHF, and AUD/NZD.

Exchange Rate:  Exchange rate shows the price of a base currency, expressed in terms of a counter-currency (quoted currency). For example, if the EUR/USD exchange rate is 1.2500, €1.00 will cost $1.25. A rising exchange rate indicates the base currency is appreciating against the counter-currency while a falling exchange rate indicates the base currency is depreciating against the counter-currency.

Bid/Ask: Currency pairs have two exchange rates: the bid price and the ask price. The bid price identifies the current price that market participants can sell (short), while the ask price identifies the current price that market participants can buy. The bid price is always lower than the ask price and the difference between the two is called the spread.

Spread: The difference between the bid price and ask price. The spread marks one type of transaction cost for a trade and a profit source for the broker. This cost can greatly reduce profits or increase losses when engaged in high-frequency trading strategies, like scalping.

Pip:  Pip refers to ‘percentage in point’, or the smallest increment that a currency pair can rise or fall in price. One pip is equal to the fourth decimal of most currency pairs. For example, if the EUR/USD ask price is quoted at 1.2542 and rallies to 1.2548, the change is equal to six pips.

Hedge: A hedge marks a forex transaction intended to offset or protect another position from positive or negative exchange rate risk. Traders, investors, and institutions apply hedging techniques to enhance profits, limit losses, or protect investments.

Margin: Brokers lend money up to a multiple of account capital, called margin, so traders can take leveraged positions. Borrowed funds incur transaction costs through overnight lending rates. For example, a 30: 1 margin allows exposure up to 30 times higher than account capital.  Leveraged positions need to build profits in excess of borrowing costs or they lose money.

Leverage: Leverage allows traders to take positions in excess of account capital through broker margin lending. Taking substantial leverage is risky for new forex traders but an appropriate and required strategy for experienced forex traders.

Major Order Types

The forex trader opens a position through a buy or sell order, specifying whether to take the position ‘at the market’, or at a specified price. A market order will execute immediately at the current ask price for a buy or the current bid price for a sell. Both orders can incur slippage when prices are moving quickly, triggering trade executions at much higher or lower price levels.

A limit order can be used in place of a market order, specifying the price at which a) the limit order turns into a market order or b) the exact price of the entry. The order will be filled when the price is hit with the first technique, potentially incurring slippage, but the price can ‘skip over’ order with the second technique and never get filled. Similar limit order types, including stop and stop-loss orders, are used to open, manage, and close outstanding positions.

In summary:

  • Buy Stop: open a long position at the price higher than the current price or close a short position at the price lower than the current price.
  • Sell Stop: open a short position at the price lower than the current price or close a long position at the price higher than the current price.
  • Buy Limit: open a long position at the price lower than the current price or close a short position at the price higher than the current price.
  • Sell Limit: open a short position at the price higher than the current price or close a long position at the price lower than the current price.

Summary

The forex market has grown hugely popular with new traders and has never been easier to access. Learning the basics of forex trading isn’t overly complicated but choosing the right way to trade requires self-examination, with a realistic view of personality traits, available time, long-term goals, and current income. It’s a rewarding endeavor that benefits from dedication, patience, emotional control, and a willingness to build multiple skillsets and strategies over time.

Wells Fargo Under Pressure After Mixed Quarter

Wells Fargo & Co. (WFC) is trading lower by more than 6% in Thursday session after beating Q1 2022 earnings-per-share estimates (EPS) by $0.08 and coming up short on revenue. The banking giant posted a profit of $0.88 per-share on a 5.2% year-over-year decline in revenue to $17.52 billion, more than $200 million below $17.82 billion expectations. The company noted lower income from government stimulus programs, just like JP Morgan Chase and Co. (JPM) on Wednesday.

Geopolitical Headwinds and the Fed

Citigroup analyst Keith Horowitz shot blanks when he upgraded the stock to ‘Buy’ ahead of the report, noting “a very strong deposit base and excess liquidity”. Horowitz also insisted that Wells Fargo was “best positioned for higher rates and we see 8% EPS upside in 2023, with limited credit risk”. Unfortunately, the mixed report featured little of the optimism expressed by the analyst, with executives outlining major obstacles to 2022 profitability

Wells Fargo CEO Charlie Scharf looked for scapegoats to explain the 5% year-over-year revenue decline after the release, noting “Our internal indicators continue to point towards the strength of our customers’ financial position, but the Federal Reserve has made it clear that it will take actions necessary to reduce inflation and this will certainly reduce economic growth. In addition, the war in Ukraine adds additional risk to the downside.”

Wall Street and Technical Outlook

Wall Street consensus stands at an ‘Overweight’ rating based upon 16 ‘Buy’, 7 ‘Overweight’, and 5 ‘Hold’ recommendations. No analysts are recommending that shareholders close positions and move to the sidelines. Price targets currently range from a low of $53 to a Street-high $71 while the stock is set to open Thursday’s session more than $6 below the low target. This dismal placement highlights the failure of analysts to properly evaluate Wells’ 2022 growth outlook.

Wells Fargo hit an all-time high at 66.31 in 2018 and plunged to an 11-year low in October 2020. The subsequent uptick reversed at the .786 Fibonacci selloff retracement level in January 2022, yielding a short-lived breakout, followed by a failure swing that undercut 200-day moving average support in March. The stock has been testing that critical level for the last six weeks and could break down in the second quarter, exposing downside into the upper 30s.

Catch up on the latest price action with our new ETF performance breakdown.

Disclosure: the author held no positions in aforementioned securities at the time of publication.