How to Transition to FX from Stock Trading
Almost half of the NEW traders in the FX market have at least 2 years of experience trading other markets, most commonly the stock market. This article will identify how a trader can use their current fundamental and technical analytical methods to transition into forex trading.
- Fundamentals and FX
- Technical Trading
- Tying it All Together
Fundamentals and FX
There are many reasons why traders buy stock in a particular company. These reasons typically include items such as an exciting new product the firm has released, explosive earnings or revenue growth, a strongly improved balance sheet, or strategic acquisition of another firm to create synergy. In essence, the stock has a fundamental story to tell and it is compelling.
We have similar fundamentals to analyze in FX. One may argue the fundamental analysis in FX is simpler because it boils down to interest rates and their anticipated movements. You see, in FX, rather than trading a specific company’s earnings, revenue, and balance sheet projections, you are trading whole economies. The whole economy can be summarized through their central bank target interest rate.
If the economy is doing well, then the inflation (money chasing after goods and services) will likely be high and rising. Therefore, the central bank will be under pressure to increase the target interest rate to keep the economy from overheating.
If we are near the beginning of a growth cycle for that country, the central bank may increase rates several times over several years without any negative impact on the job growth or Gross Domestic Product (GDP) growth. This type of action tends to be bullish the currency as traders buy the high yielding currency to earn a higher interest rate. If we catch a country in the early stages of economic expansion, then it is similar to finding a stock that is about to experience growth in earnings and revenue due to a new product.
However, at some point in time, the increase in interest rates begins to weigh on the local economy. The cost of money becomes too much and the economy slows down. This will pressure the central bank to reduce the target interest rate as inflation concerns have subsided. This reduction in interest rates will send investors looking for either safety or higher returns in other countries and the currency sells off.
So high and rising rates tends to be bullish for the currency while low and lowering rates tend to be bearish. The big exception to these tendencies is during times of risk aversion when high yielding currencies are sold while safe haven currencies such as USD are bought.
You can find the current central bank target rates at forex research sites like www.dailyfx.com.
“Patience is the key to success not speed.” – Jesse Livermore
Nearly 100 years ago, Mr. Livermore describes patience and how there is a right place and a right time to make trades. Technical analysis is a method on how we can determine that right place and time. Technical analysis is essentially determining recurring patterns from price charts that offer a precise entry and exit point for a higher probability trade.
For equity traders, patterns may include price and volume of shares traded on the exchange. When trading stocks, I rely on volume as my crutch for making trading decisions. Rising volume on increasing price is indicative of a bullish move for the stock. Volume provides me with a clue about future potential market movements.
One of the biggest challenges I endured on my transition to FX was finding a crutch other than volume of shares traded. As many of you may already know, intraday volume figures in FX is not reliable because there is not a centralized exchange where currencies are traded.
However, foreign exchange has an advantage over the markets that helps bring stability to technical studies…its size. FX trades nearly $4 trillion each day which is about 85 times larger than the NYSE. Besides that, the FX market is growing in volume which means many traders are discovering this market as a means to trade.
The size of FX means that trends and chart patterns tend to be a bit cleaner because there is so much liquidity behind the pattern. After all, the patterns like triangles, flags, double bottoms, etc. are a culmination of greed and fear in the market. When these patterns appear in a $4 trillion per day market, the pattern is going to be more stable.
Trend lines, pivot points, and horizontal levels of support and resistance can help us identify higher probability turning points. Candle patterns such as dojis, morning/evening/shooting stars, engulfing, and hammers also provide us clues about levels of support and resistance in the market. FX traders will use these price zones on a chart to identify potential buying and selling opportunities.
Tying it All Together
Due to the 24 hour nature of trading foreign exchange, traders look towards fundamental analysis to help them identify which currency pairs to trade. They invariably match up and buy a strong currency while simultaneously selling a weak currency. This generally leads to a strong trend in the currency pair.
The trader will then use technical analysis to find the right time to enter and exit the trade creating a higher probability trade. Many of the same types of strategies that traders use in stocks can be transferred into FX like a moving average cross over strategy or a breakout strategy.
Once traders have identified their entry and exit points of the trades, it is important to trade with conservative amounts of effective leverage. We have found through our profitability statistics that traders who implement conservative amounts of effective leverage tend to be more profitable then traders who are more aggressive with their leverage.
Since stock margin trading accounts offer 2 times leverage, consider starting your forex trading with no greater than 2 times effective leverage. You can always change it in the future but this way you are planting risk controls in your account.
In closing, identify the market you wish to trade your strategy, and then utilize a conservative amount of leverage.
---Written by Jeremy Wagner, Lead Trading Instructor, DailyFX Education
To contact Jeremy, email email@example.com. Follow me on Twitter at @JWagnerFXTrader.
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