Dennis Jones is a Jamaican-born international economist, who has lived most of the time in the UK and USA, and latterly in Guinea, west Africa. He moved back to the Caribbean in 2007. This blog contains his observations on life on this small eastern Caribbean island, as well as views on life and issues on a broader landscape, especially the Caribbean and Africa.







**You may contact me by e-mail at livinginbarbados[at]gmail[dot]com**

Tuesday, October 23, 2007

So you want to do online foreign exchange trading?

A month ago I started dealing foreign exchange online. I am an economist but am not a professional foreign currency dealer, and it shows! I have taken the plunge and opened a live trading account after a period with a practice account. I can say frankly that I opened and used the live account too soon, and learning by doing can be very expensive in this venture.

I am not going to try to teach as if I know what I am doing, because I do not. But I have picked up on some basic rules, and have found that if you do not stick to them you will lose and lose badly. Here are a few:

1. Plan the trade and trade the plan; follow the trends: Decide what you are going to do (with analysis beforehand, if you can), set it up and then stick with it. Tinkering tends to mean that emotions are getting involved and nervousness usually means ending deals too early before full gains can materialize. Dealing the plan also means accepting fully the potential loss that you have set in the deal. I have found that with the practice accounts I am more relaxed about dealing, having less of a care, and I have let deals run with the result that gains and losses have evened out. Also, trying to go against the market is doomed to failure: you cannot judge the momentum but if you try to get in its way you will be run over. The art of deal making is to get the entry points right so that the gains can be maximized and losses minimized. There are techniques for working that out and they are very helpful and can be powerful in association with other indicators. But if the sentiment is "buy" or "sell" go with it, if you want to deal; going against the sentiment wont work, though the sentiment will often change. This week has seen enormous volatility, which means potential large gains or losses, or both.

2. Be careful how much of your capital you put at risk. If you are cautious you naturally start with a small amount to play with, but once you put a large portion of that at stake, then losses mean you have less to play with. As many have said you have to be at the party to dance. Remembering that this kind of dealing works on margins, meaning that your stake allows you to trade with an amount many times larger, and the gains and losses from that larger amount are yours to savour or lament. So, between US$35-100 approximately allows you to deal one lot 100 times that size, or of US$10,000. If you do not have margin to support your position your deals get closed out automatically.

3. Monitor your positions and trade only when you have time to do that. I have only once left my live account trading "desk" unattended when I had deals in place, and that was today, when I needed to make a hospital visit with my father. What I did was set my loss limit and then set my potential gain very high to try to capture as much of the gains that could occur during the day. I came back 10 hours later to find that despite all the ups and downs during the day that I was well in the hunt and ahead; I had missed out on a good sized gain during the day with one trade, but I was still in the hunt and looking at positive territory. Another deal was near its top and I decided to take a good sized profit. I had accepted how much I could lose from my loss limits so had put that out of my mind. I was happy with the outcome but it in not an advisable way to approach dealing. If you can lock in some profit ahead of leaving the position you can at least be assured of a gain, though the deal may close out too early, or you may miss a top lower than the upper limit set.

4. Only make deals with good ratios of risk-to-rewards. This is hard to assess without analysis. But at least set the limits of loss to potential gains at a ratio of 1-to-2.

5. Follow the rules you set. I have said to myself many times that I will not deal on Day x, and ending up placing a deal and not been happy with the red ink. Dealing at any time is alright and feeling the right entry levels will mean that more deals succeed at least to some degree. You should buy weakness and sell strength, so in watching the ups and downs, getting in to buy near a relatively low price or selling at a relatively high price is likely to generate more gains.

6. Make sure that your internet connection is working well. It sounds basic but I went through a period several days ago when my internet connection was unreliable: it would be up for long periods, down for long periods, be up and down repeatedly in an hour. I traded despite that (which should be against a rule) and of course lived on my nerves' edge. Last night after I got back to see the outcome of the positions I had left running all day, one reason for taking the profits as I saw them was to avoid a possible reversal. About half an hour later, we had a long power cut and were in the dark for an hour, and of course no internet. But I was calm as my deals had been safely set up.

7. Monitor positions and make sure that stop losses/gain limits are set properly: whatever deal you set up, you need to have a counter order set to close it. (Some told me of people who don't do this, fall asleep and wake up to a horror.) If you close the deal manually you need to cancel the counter deal manually. Some programs give a prompt to do this but sometimes it gets missed. I failed to do this once with the practice account and after seeing the deal move to 70 points against me and a loss of some US$2700 on the account, I had to say "Wow!". Also remember that if the stop loss limit is too tight the deal may cancel too early; similarly if the potential gain is set too tight early cancellation of the deal erases the potential profit that was out there.

8. Try to trade less rather than more. Given that every start position is at a loss (because of the difference between buy-sell prices), you always need movement to at least get even. Every deal therefore starts as a loss, and the more you deal the more the chance that these losses get worse. Small amount traders have to deal with wider buy-sell spreads than those who trade larger amounts; I face spreads of say 4.5 for Pounds:US dollar, but larger dealers can face spreads of only 1.0. So big money finds it easier to make money.

9. Try not to do follow-up repeat deals. Your position gets closed too early and you are immediately tempted to get back into the market to get the rest of the gains you foresee. Remember point 8, you may also be too late, the gains are no more and the losses will start mounting.

10. There is potential for gains and losses every trading day. If you miss out in the morning there will be opportunities later in the day. If you miss out today there is always tomorrow. You can gain from price rises (by buying low and selling higher) or from price falls (by selling at high points and buying back at lower prices). Of course the possibility for losses are also there every day.

Large movements are what makes trading potentially lucrative, and it takes a certain disposition to see prices move a long way in your favour then move a long way against you, before moving back again for you...and so on. But these waves are in the nature of the beast. Sometimes a large unrealised profit evaporates and becomes a real loss. Other times, a long period of no movement is followed by a huge shift in seconds: like that when it' s in your favour and dread it when it's against you.

Assessment of "fundamental" economic of financial situations wont explain much on a daily basis. That is a salutary lesson for an economist. Also, statements of support can often be followed by movements that go against the support. Over the past weekend, the G7 Ministers said nothing about the weak position of the dollar, which was followed by the rates for several major currencies going to new highs. But almost in a flash were followed by huge falls: reports today indicate that this reflected a lot of long term holders taking their profits, and the market's reversed today to get back to positions near to where rates were last Friday.

It is an wonderful feeling to see money being gained as the rate ticker changes. It is a sickening feeling to see unrealised losses mount and then become real. Dealing is not for everyone and is risky. There are many more lessons to learn and these are just a few that have struck me after my short "apprenticeship".

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