Forex Investment and Currency Trading

A system is a self-contained way to make trades. Systems generate specific buy and sell signals. Many FOREX trading systems are available either from broker/dealers or from third-party vendors. They are intended to be complete in and of themselves, although many traders still use them in conjunction with other trading techniques.

Systems typically show outstanding results over historic data, or they would not sell. But the historic data is very often curve fit. This means that the system was developed to fit the data and not the other way around. if that data related to some specific types of markets, such as volatile markets, trading market, or trending markets, when the music changes the system is bound to fail.

Systems have always been popular in all the markets – stocks, options, futures, and now FOREX. Not all systems are bad, buy they are all opaque and that is always a warning sign.

Opaque and Transparent

If a trading tool is opaque, it is difficult or impossible to bully analyze what it measures. If a trading tool is transparent, what it measures is either obvious or easy to comprehend.

Indicators are generally opaque. Charts are transparent.

If you insist on using a system in your trading, be sure you understand which type of market it was built for or around – and use it only in those markets. However, determining which type of market the system was built for can be difficult. Many systems provide limited information regarding how they were developed. The best process is to look at charts of the markets via the system’s performance. In which markets did it perform best – trading, trending, fast, slow? If the system vendor does not provide at least enough information to do this analysis, beware.

Black boxes are systems for which no information is available. You don’t know how they were built, how they work, or what type of data they were built around. my recommendation regarding black box systems is to stay away from them. The less transparent the tool, the more difficult it is to make adjustments when things go wrong. A black box is the most opaque tool of all.

Robots have become popular in the FOREX markets. Usually, these are programs that automatically execute a trading system. In fast-moving markets they are very useful, especially to the professional money manager overseeing dozens or even hundreds of separate accounts. If your available time for trading is limited, you may want to consider using robots.

But if you have so little time to trade that a robot appeals to you, I recommend that you consider a professional money manager to trade your account. There are many money managers with excellent trade records. Seek out a manager who has performed well in a variety of markets. It is more important that the manager has done well in a spectrum of market types than in specific pairs of crosses.

Technical versus fundamental analysis

Most traders today use technical analysis to trade. This refers to techniques based on price and other objective data that result from market action. The technician’s credo is “Everything is in the market price”.

The factors examined in fundamental analysis, such as a country’s income, gross national product, and interest rates certainly drive currency prices in the long run. The problem for the currency trader is, “In the long run we are all dead”. The FOREX markets are highly leveraged; this is one of their main attractions. You can be correct about a currency pair in the long run, but the leverage may cause a price movement more than ample in degree to take you out of the market before you can profit from being correct about the fundamentals. It is discouraging to be correct in your determination of long-term trend direction – for example, “Interest rates will drive the U.S. dollar lower against the euro” – but lose money because volatility and leverage cause so many short-term fluctuations that you are never able to board the long-term trend successfully.

No one denies that fundamentals such as money supply, labor statistics, political events, and may others drive the currency markets. The problem – and why most traders use technical analysis – is how to interpret them, especially in the short term.

Most fundamental information is quantitative but much is not. For example, how does a trader convert an unemployment statistic to a price value? To further complicate matters, there are hundreds of fundamentals that impact prices, and the matrix of possibilities is astronomical. And some fundamentals, such as geopolitical events, are not even quantifiable.

Technical analysis allows you to zoom in as close to the markets as you want. In fact, an advantage of technical analysis is the ability to visualize the markets at multiple price levels simultaneously.

There is no perfect world, of course. Fundamentalists will counter that the prices you use to do technical analysis are already history by the time you do your calculations, and they have no rational effect on the future prices.

But a simple example will show this concept toe incorrect, at least in theory. It is true that after I enter my order to buy or sell, I have had all the impact on prices that I will have until I enter the opposite order to exit the market. Yet every trader has a propensity to exit the market, once entered, on variable factors of price and time. At what price will I take a profit? At what price will I take a loss? How long am I wiling to stay in a trade? These propensities vary from trader to trader, but the aggregate of all propensities creates a push and pull on the market that should, again in theory, be measurable.

All traders have access to market prices; the same cannot be said of fundamentals. There are literally millions of fundamental factors in any given currency, and the relationships among them are in the billions. Someone will almost certainly know a piece of fundamental information before you do. And how do you translate a fundamental like gross domestic product (GDP) to a specific market value or even a specific entry price? To add gasoline to the fire, remember that these relationships are almost certainly nonlinear and are changing rapidly all the time.