Friday, March 31, 2006

Weekly Forex Market Outlook

THE WEEK AHEAD IN THE FOREX MARKETS

U.S. Dollar
With the highly anticipated rate hike and Fed commentary behind them, US market participants will remain in the same mode they were prior to the release - digesting economic releases while trying to decipher on monetary policy officials’ stopping point. Looking ahead to the upcoming releases, there will be plenty for interest rate speculators to shift their positions on during the course of the week. First on the wire will be the simultaneous release of personal income, spending and the personal consumption expenditure deflator all for February. Both spending and income are expected to have cooled over February as sentiment dropped with the temperature resulting in a consensus of no change in purchasing habits. Earnings’ growth is expected to continue its expansion by 0.4 percent as employers are confronted with growing demand for goods, shrinking capacity and the jobless rate hovering around four year lows. This should heighten inflationary concerns as higher wages create price increases, dollar bullish. Subsequently, the deflator will act as the prominent inflation read for the market over the week. Considered one of the most reliable measures of price growth, the PCE deflator is expected to edged lower to 2.9 percent on an annual basis. Also scheduled for release the same day is the University of Michigan confidence number, Chicago Purchasing Manger index and monthly factory orders. A final release of consumer confidence for March is expected to read 86.9, little changed from the month before, with earnings and employment still relatively strong in the shoppers’ eyes. Separately, February’s bookings at factories are expected to rise 1.3 percent as companies look to restock depleted inventories. Manufacturing in the Chicago area is expected to rebound from February’s over-two-year low in line with improvements in other regions. Moving beyond this first day, pending home sales, ISM manufacturing and ISM prices paid will provide market volatility. After sales of new homes dropped to a nine year low in February, pending home sales are expected to fall a relatively reserved 0.5 percent. The overall ISM manufacturing read for March is forecasted to nudge higher to 57.6 while the price pressure is expected to ease once again to 61.4. The remaining indicators will be lost on the market’s short attention span with the exception of ISM services in March due Wednesday. Comprising the bulk of the US’s economy, the service sector is expected to slim to 59.0 from 60.1 the previous month.

Majors
On the non-U.S. agenda, there will be plenty of releases that could potentially counter or accelerate greenback sentiment. Friday’s action will be dictated by Germany’s March IFO business climate and February retail sales. While there is no market consensus on business sentiment for the month, sales at retailers are expected to have fallen 0.3 percent from January, a small pullback in a nascent and stronger trend. Subsequently, Germany, on Thursday will release its February factory orders figures, but it will be overlooked in favor of the ECB’s rate decision. If the central bank continues its new regime of tighter monetary policy, the Euro will continue to scale the US dollar’s advantage while shedding its status as one of the premier shorts on a carry trade. Monday, Tankan measures of manufacturing and service industry current conditions and outlooks will be market movers especially on the Japanese yen. Should a higher reading be obtained, the survey should add to suggestions the BoJ will finally raise rates sometime in the coming months. British pound traders will weigh in on the CIPS March manufacturing numbers, which continues to lag Euro-region factory activity. Another CIPS figure will flash on traders screen on Wednesday with health in services as well as February industrial production. Services accelerated to 58.9, its highest level since April 2004, in February against expectations of moderation. Industrial production has similarly showed promise with three consecutive months of growth. This weekly health gauge for factory activity is likely to play into Thursday’s Bank of England rate decision, which is unanimously predicted to hold steady once again; however a change in sentiment form policy officials will be welcome.

TECHNICAL OUTLOOK

EUR/USD

Market Recap. Euro continued to range trade as pair remained above the psychologically important 1.2000 handle, a level defended by the combination of the 38.2 Fib of the 1.2588-1.1642 USD rally, a 20-day, 50-day and 200-day SMA’s.

Short-Term. As single currency remains in a trading range, the next move to the downside will most likely see EUR/USD once again test the bids around the psychologically important 1.2000 handle, a level defended by the 38.2 Fib of the 1.2588-1.1642 USD rally and if further reinforced by the 20-day SMA. A confirmed breakdown will most likely see the pair head below the 1.1900 figure and test bids around 1.1861, a level created by the 23.6 Fib of the 1.2588-1.1642 USD rally. However in case single currency longs manage to push the pair above 1.2112, a level marked by the 50.0 Fib of the 1.2588-1.1642 USD rally, a further move to the upside will most likely see the pair extend its gains toward 1.2224, a level marked by the 61.8 Fib of the 1.2588-1.1642 USD rally. Stochastic is neutral at 49.07. ATR remains low as volatility dropped. A positive momentum indicator is treading above the zero line and favors the Euro longs.

Long-Term. A downside scenario points to a move toward 1.1861, a level marked by the 23.6 Fib of the 1.2588-1.1642 USD rally. An upside scenario points to a move toward 1.2224, a level established by the 61.8 Fib of the 1.2588-1.1642 USD rally.

EUR/USD WEEKLY CHART

Weekly Forex Chart

GBP/USD

Market Recap. GBP/USD continued to trade around 1.7453, a level defended by the 20-day SMA after failing to gain downside momentum below 1.7388, a level marked 23.6 Fib of the 1.8500-1.7056 USD rally.

Short-Term. British pound longs failed to keep the pair above the psychologically important 1.7500 handle and once again retreated toward 1.7388, a level defended by the 23.6 Fib of the 1.8500-1.7056 USD rally. A further move to the downside will most likely see the pair test sterling bids around 1.7231, a March swing low. However in case starling longs manage to push the pair above the psychologically important 1.7500 handle, a level marked by the 50-day SMA at 1.7509, a further move to the upside will most likely see GBP/USD target offers around 1.7605, a 38.2 Fib of the 1.8500-1.7056 USD rally. Stochastic is neutral at 51.28. ATR remains low as volatility dropped. A momentum indicator is treading along the zero line pointing to a lack of momentum in the market.

Long-Term. A downside scenario will most likely see the pair head below 1.7231, a March swing low and target 1.7131, a level marked by the December 28 daily low. An upside scenario will most likely see the pair head above .7605, a 38.2 Fib of the 1.8500-1.7056 USD rally and target 1.7776, a 50.0 Fib of the 1.8500-1.7056 USD rally.

GBP/USD WEEKLY CHART

Weekly Forex Chart

USD/JPY

Market Recap. Japanese Yen continues to trade within a narrow 116.00-119.0 trading range that confined the price action since December.

Short-Term. Japanese Yen remains trading range and with the pair remaining above 116.57, a level marked by the 38.2 Fib of the 108.76-121.39 USD rally. A further move to the upside will most likely see the greenback longs target yen offers around 118.41, a level defended by the 23.6 Fib of the 108.76-121.39 USD rally. However a move below 116.57 will most likely see the pair head toward the psychologically important 115.00 handle, a level defended by the 50.0 Fib of the 108.76-121.39 USD rally and 200-day SMA. Stochastic is neutral at 50.54. ATR is indicating a sharp rise in volatility. Momentum indicator is along the zero line pointing to a lack of momentum in the market.

Long-Term. An upside scenario will most likely see the pair head above psychologically important 120.00 handle. A downside scenario will most likely see USD/JPY head lower and target 113.53, a level marked by the key 61.8 Fib of the 108.76-121.39 USD rally.

USD/JPY WEEKLY CHART

Weekly Forex Chart

USD/CHF

Market Recap. Swiss Franc remains confined to a trading range that dominated the price action since September of last year with the latest price action seeing the pair testing bids around 1.3040, a 23.6 Fib of the 1.2240-1.3287 USD rally.

Short-Term. Swiss Franc remains confined to a trading range that dominated the price action since September of last year with the latest price action seeing the pair head above the psychologically important 1.3000 handle. As price action remains volatile, a move above 1.3100 figure will most likely see the pair head higher and target the Swissie offers around 1.3201, a level marked by the December 30 daily high However a move below 1.3040, a 23.6 Fib of the 1.2240-1.3287 USD rally will most likely see the pair extend its decline below 1.2996, a 50-day SMA and with further move to the downside seeing the pair test bids around 1.2887, a combination of the 200-day SMA and 38.2 Fib of the 1.2240-1.3287 USD rally. Stochastic is neutral at 60.11. ATR remains low as volatility dropped. A momentum indicator is treading below the zero line thus favoring Swiss Franc bulls.

Long-Term. An upside scenario will most likely see the pair test 1.3285, a level marked by the 2005 High. A downside scenario will most likely see USD/CHF head toward 1.2764, a level defended by the 61.8 Fib of the 1.2240-1.3287 USD rally.

USD/CHF WEEKLY CHART

Weekly Forex Chart

Thursday, March 30, 2006

Options Trading - Part 1 of 3

Lets start with talking about purchasing "call" and "put" options. What is paid for the option is called "premium." This is a debit transaction. That means you are taking your hard earned dollars and betting that the underlying stock will either go up of down. It's no different than Las Vegas.

When you combine that with the fact that about 80% of options expire worthless, you have to question someone's sanity who bet's on a stock moving in a particular direction. Later, I will teach you option strategies in which you can make money regardless whether the stock moves up or down or stays the same. But, for now, let's get back to the basics.

When you purchase an option (put or call), essentially, what you are doing is buying time - during which you hope the stock will perform the way you want. The more time you buy, the more premium you pay. You can buy one month, two months, three months, six months - even up to 2 1/2 years of time (on certain stocks).

Disappearing Premium

Options are wasting assets. They're like an ice cube. They melt away a little at a time -- until their value completely disappears by expiration. Why? Because you're buying TIME. Every day that goes by, there is less time until the expiration of that option. The less time that remains, the lower the value of the option.

An option with four weeks to go to expiration may have a value of $2.50. Assuming the stock doesn't move, the same option with three weeks to expiration may be worth only $2.00. With only two weeks to expiration, it may only be worth $1.25. The third week, it may go down $.65 (from $1.25 to $.60). By the time the last week rolls around, the value is a mere $.60 - heading to zero in a big hurry.

Important Concept: Option premium erodes SLOWLY during the EARLY part of the life of the option. As time goes by, the rate of erosion INCREASES more RAPIDLY.

Strike Prices

All optionable stocks will have a choice of strike prices. Option traders have a choice of strike prices to trade - usually relatively close to where the stock is trading. If a stock is trading at $50, you'll likely be able to trade the $35, $40, $45, $50, $55, $60, and $65 options. The prices of the options will vary depending on the strike prices. Your choice of which option to trade will have a large affect on the success or failure of your trade.

Strike Price Increments

The increments between strike prices will vary depending on where the stock is trading.

Strike prices below $25 are in $2.50 strike price increments: $5.00, $7.50, $10.00, $12.50, $15.00, $17.50, $20.00, and $22.50.

Strike prices above $25 are in $5.00 strike price increments: $25.00, $30.00, $35.00, $40.00, $45.00, and $50.00, etc.

Strike prices stay at $5.00 increments all the way up to $200, when they become $10 increments: $200, $210, $220, and $230 etc.

There are exceptions to these rules of thumb. Some very liquid lower priced stocks will have $1.00 strike price increments. The market makers feel that there is sufficient demand for the options that they open up additional strikes. The same holds true with very liquid stocks that trade in the $30 to $50 range. Many are likely to have $2.50 increments.

Another exception is when a stock undergoes a stock split. A stock that is trading at $100 might split 3-for-1. That will create a new strike price of $33.33. For every one $100 option contract owned, the purchaser will now own three $33.33 option contracts. There is no gain or loss of value - just some unusual strike prices. The same is true for a 2-for-1 stock split. An $80 call option on a stock that is trading $80 before the split will turn into two $40 call options after the split. Again, the value hasn't changed - just redistributed to two options instead of one.

Option Trading Hours

Stock options stop trading at 4 p.m. each trading day (except for a few holidays here and there when the market is only open a 1/2 day). On the other hand, many index options continue to trade until 4:15 p.m. Why is there a difference? Hell if I know.

Option Expiration

Options expire every month, but "options expiration" is a little different. Options don't expire at the end of a calendar month as one might expect. Stock options cease trading on the third Friday of each month.

If you look at a calendar for March, 2006, you'll see that the third Friday in March falls on the 17th. The March option cycle consisted of four weeks.

Some option cycles will be five weeks long. It happens four times a year. As a result, the premiums will be higher because you're buying an additional week of time. Case in point, look at the April, 2006 calendar. The third Friday in April falls on April 21st. There are five Fridays between March 17th and April.

Two Styles Of Options

There are two kinds of options - American and European. When trading options on stocks, you will be trading the American style of options. The European style of options are primarily on indexes. That's a subject we'll get into more thoroughly in future columns. For now, we're going to focus on the American style options.

Option Chains

Here is where you will get the guts of the information you will need to trade options. We will spend a lot of time going over option chains in Options Trading Part 2 & 3 in the following week. Stay tuned.

Tuesday, March 28, 2006

Fed Raises Rates to 4.75%, Hawkish Comments Signal 2 More Rate Hikes

By Kathy Lien FXCM Chief Strategist

The US Federal Reserve raised interest rates for the fifteenth time by a quarter of a point today to 4.75 percent, the highest level in 5 years. The FOMC statement was much more bullish than the market was expecting. With Fed Fund futures originally showing only a small minority favoring 5.25 percent rates, the positive outlook on growth and concerns for rising inflation pressures has 5.25 percent the more likely top. The US Federal Reserve raised interest rates for the fifteenth time by a quarter of a point today to 4.75 percent, the highest level in 5 years. The FOMC statement was much more bullish than the market was expecting. Newly installed Fed Chairman Ben Bernanke made his mark at today's meeting by changing the entire middle paragraph, or the meat of the statement. The committee now believes that the weaker numbers that we saw in the fourth quarter of last year were due to temporary or special factors. We will be fascinated to hear what these "special factors" are since most of the talk of the slowdown was due to higher interest rates crimping the housing market. The Fed sees current growth as strong but expect it to moderate to a more sustainable pace. However in contrast to Greenspan's more concise comments on inflation, in true Bernanke style, the updated comments on inflation were far more clearer. The Fed said that even though the "run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures."

Bottomline: The dollar is rallying on the more hawkish nature of the comments. Two more rate hikes seem to be the most likely scenario now, however with a great deal of economic data still due for release this week and five central bankers scheduled to speak, we expect a lot more volatility in the days to come. A vertical rally in the dollar here on forward is far from certain.

Monday, March 27, 2006

Weekly Market Outlook

Nasdaq Outlook

Despite the 12.67 point gain on Friday, the NASDAQ Composite only managed a 6.34 point (+0.27%) gain for the week. It closed at 2312.82, which was above all the key moving averages. However, it's just shy of the new 52-week high level that has been a sore spot for a few weeks now. That mark is at 2333, and we've brushed it a couple of times since January. That remains our ultimate bullish line in the sand.

There's really not a lot to add about the composite. Support has been at 2240 since January, just like resistance at 2333. We've been waiting for a move - any move - outside that box to signal the beginning of a real trend. And, we're still waiting. As it appears now, the support we recently saw at the 10 and 20 day lines would suggest that the chart is more likely to move higher than lower, but that support has been inconsistent all year long. We'd still recommend waiting for a breakout move if you're looking for a bigger-point trade.

Full Size Chart

S&P 500 Outlook

The S&P 500 squeeked out a 1.3 point gain on Friday to end the week at 1302.95. However, it still took a 4.3 point loss from the previous Friday (-0.33%). It was the only index to take a loss for the week, although the other two indices weren't exactly through the roof. However, we still saw a new 52-week high, and we still saw support at the short-term averages. So, the bulls are still winning most of the battles, even if in lackluster fashion.

On the other hand, we failed to see any follow through on the new highs hit late two weeks ago and early last week. True, the 10 day line acted as support during the most recent dip, but that support has been tested for three days straight now. Plus, we're stochastically overbought now. Sometimes that can be bullish, but as we saw in early January and mid-February, that can also be an ideal time to take some profits. That's one of the key worries we see right now.

What's most interesting here, though, is the VIX. Over the past week, we've seen a series of lower highs, steered mostly by the falling 10 day average. At the same time, we've seen the VIX make the same basic low for the entire week (11.17 or 11.11). In terms of a trend, the falling VIX is technically bullish for stocks. However, we also recognize that everything has a limit. We've seen the VIX lower than this, so it could certainly continue to head downward while stocks rise. However, we've also seen the VIX turn on a dime several times this year. With it hovering as low as it is right now (and not leaving a lot more room for that downward trend), the VIX is a bit dubious as a bullish indicator. That's the other key worry we see for the bulls right now.

Full Size Chart

Dow Jones Industrial Average Outlook

The Dow's 10 point gain on Friday was only a relative drop in the bucket (+0.1%), but still left the blue chip index at 11,280. For the week, though, the Dow registered a big goose egg.....nothing gained or lost. We did see a higher high and higher low though. In fact, the high of 11,364 (Tuesday) was a new multi-year high. The problem was, there was just no follow through.

Why no follow through? Well, as trite as it is to say 'not enough buyers', that really is the answer. The Chaikin line rolled over early last week following a super-surge in buying volume on the Friday before that. Well so far, that seems to be the case with the fourth instance we've seen in the last twelve months.

In any case, the likely landing spot for any dip is ultimately going to be around 11,000. That's where the 50 day line is now, and that's where a major support line (dashed) is going to be soon. As for resistance, the only thing that we'll get us thinking like bulls again is a break above the recent 52-week high of 11.364.

Note that the 10 day line really isn't doing all that great of a job of holding as support.

Full Size Chart

Friday, March 24, 2006

Weekly Forex Market Report

THE WEEK AHEAD IN THE FOREX MARKETS

With mounting speculation surrounding the upcoming Federal Reserve meeting, traders will be scrutinizing each piece of data in conjunction with earlier statements by policy makers. The Federal Reserve is predicted to raise interest rates by a quarter of a point and as usual, the wild card rests with the FOMC statement. The Fed is nearing the end of their tightening cycle and traders will be looking for more subtle shifts in tone for a sign of when the Fed will be done. Consumer prices released over the past week came out mixed, but still highlighted inflationary pressures. Durable goods orders due out Friday add to the positive outlook as orders are estimated to reverse the 10.2 percent decline in the previous month. Should the report be higher, confirmation of consumption would be obtained leading to dollar strength heading into the Monday meeting. Subsequently, it would coincide with the factory orders report next Friday as orders are additionally expected to rise 1.1 percent, above the decline of 4.5 percent witnessed in January. Evidence of growth and expansion in the world’s largest economy is also anticipated to be confirmed through the finalized gross domestic product figures for the fourth quarter. Rising only 1.1 percent in earlier estimates, expansion looks to have rebounded late in the year to a 1.7 percent annualized pace. Coupled with higher manufacturing activity and sustained consumer confidence for the month of March, dollar strength looks to continue in the week as policy makers apparently have ample evidence to raise rates for the fifteenth time. Remaining preemptive on inflation, policy makers are sure to leave further decisions dependant economic reports, lending to no real directional bias.

TECHNICAL OUTLOOK

USD/JPY

Market Recap. Japanese Yen continues to trade within a narrow 116.00-119.0 trading range that confined the price action since December

Short-Term. Japanese Yen remains trading range and with the latest swing to the upside breaking above 116.57, a level marked by the 38.2 Fib of the 108.76-121.39 USD rally and is further reinforced by the 50-day SMA. At 117.12 A further move to the upside will most likely see the greenback longs target yen offers around 118.41, a level defended by the 50.0 Fib of the 108.76-121.39 USD rally. Stochastic is neutral at 36.21. ATR is indicating a sharp rise in volatility. Momentum indicator is above the zero line adding support to the dollar bulls.

Long-Term. A move above 118.40 will most likely see the pair test offers around the psychologically important 120.00 handle and with a further move to the upside most likely seeing the pair extend its advance toward 121.42, a 2005 High.

USD/JPY Weekly Chart



EUR/USD

Market Recap. Euro continued to range trade as pair remained above the psychologically important 1.2000 handle, a level defended by the 38.2 Fib of the 1.2588-1.1642 USD rally and 20-day SMA.

Short-Term. As single currency remains in a trading range, the next move to the downside will most likely see EUR/USD once again test the bids around the psychologically important 1.2000 handle, a level defended by the 38.2 Fib of the 1.2588-1.1642 USD rally and if further reinforced by the 20-day SMA. A confirmed breakdown will most likely see the pair head below the 1.1900 figure and test bids around 1.1861, a level created by the 23.6 Fib of the 1.2588-1.1642 USD rally. Stochastic is overbought at 81.79. ATR remains low as volatility dropped. A positive momentum indicator is treading above the zero line and favors the Euro longs.

Long-Term. A downside momentum will most likely see the dollar bulls push the pair below the 1.1700 figure and with further move on the part of the greenback longs seeing EUR/USD target bids around 1.1636, a level established by the 2005 Low.

EUR/USD Weekly Chart



GBP/USD

Market Recap. Dollar traders managed to push the pair below the 1.7453, a level defended by the 20-day SMA and took aim toward 1.7388, a level marked 23.6 Fib of the 1.8500-1.7056 USD rally.

Short-Term. British pound longs failed to keep the pair above the psychologically important 1.7500 handle and once again retreated toward 1.7388, a level defended by the 23.6 Fib of the 1.8500-1.7056 USD rally. A further move to the downside will most likely see the pair test sterling bids around 1.7231, a March swing low, breaking of which will most likely see the GBP/USD extend its decline toward December lows at 1.7131. Stochastic is neutral at 71.20. ATR remains low as volatility dropped. A momentum indicator is treading along the zero line pointing to a lack of momentum in the market.

Long-Term. A break below the 1.7131, a level marked by the December 28 daily low will most likely see the pair head lower and test the bids around 1.7039, a level defended by the 2005 Low.

GBP/USD Weekly Chart



USD/CHF

Market Recap. Swiss Franc remains confined to a trading range that dominated the price action since September of last year with the latest price action seeing the pair head above the psychologically important 1.3000 handle.

Short-Term. Swiss Franc remains confined to a trading range that dominated the price action since September of last year with the latest price action seeing the pair head above the psychologically important 1.3000 handle. As price action remains in of favor dollar longs, a move above 1.3100 figure will most likely see the pair head higher and target the Swissie offers around 1.3201, a level marked by the December 30 daily high. A further move to the upside will most likely see the pair test 1.3285, a level marked by the 2005 High. Stochastic is neutral at 22.49. ATR remains low as volatility dropped. A momentum indicator is treading above the zero line thus favoring greenback bulls

Long-Term. A break above the 1.3285, a level marked by the 2005 High will most likely see the pair head higher and target the Swiss Franc offers around the psychologically important 1.3500 handle, a level defended by the October 17, 2003 daily high.

USD/CHF Weekly Chart



Key Events from Last Week

Student Riots – Not Worrisome Yet for the Euro
Dollar Rallies Ahead of FOMC as US Inflation Data Confuses
Japan – Making it Clear that Ending QE Does not Equal Ending ZIRP
Student Riots – Not Worrisome Yet for the Euro

Strikes are heating up in France and many traders are wondering how this could impact the Euro. So far, the Euro has sold off, but few have made the link between the strikes with Euro weakness. Instead, the sell-off in the EUR/USD has been attributed more to dollar strength. Unlike the riots back in November, where there was a great deal of cars being torched and we saw night after night of violence, the “riots” that we are seeing now are really nothing more than protests with very small scale car fires. In addition, the protests are mostly from college students, since the change to the labor law affects them directly. Given their higher level of education and probably more of a concern for being arrested than those who rioted back in November, there is a far lower likelihood that the latest strikes would erupt into the same scale of violence that we saw late last year. The law that the Prime Minister tried to institute would give employers the option to terminate the contract of workers under 26 years of age without an explanation or prior warning by effectively putting them on a two year trial period instead of the typical 1-3 months. The original concept of the law was to make it easier for businesses to hire and fire. Given that the students are striking in hopes of being able to hold onto their jobs longer, we reiterate that they are probably less compelled to do any large scale rioting that could put them in jail. Therefore, the main driver for the EUR/USD at the moment is still interest rates.

Dollar Rallies Ahead of FOMC as US Inflation Data Confuses

Over the past week, inflation data has been mixed. Consumer prices released on Thursday were far from encouraging with only a modest 0.1 percent rise for both headline and core prices. Producer prices fell a whopping 1.4 percent, the biggest drop in close to three years, but core prices rose a more than expected 0.3 percent. This goes to show that even though energy prices have been falling, taking the pressure off food and fuel costs, second round inflation effects are clearly emerging. With PPI rising, the Fed still has a solid reason to raise rates at the end of the month, but should weaker headline inflation filter into core prices over the next few months, the case for 5 and 5.25 percent rates will weaken. Last week the US dollar sold off significantly with CPI falling short of expectations and the Treasury International Capital flow report coming in below the trade deficit for the same month. Even though the dollar has recuperated much of the TIC related losses, if we get one more month of funding deficiency, the deficit could become a major issue.

Japan – Making it Clear that Ending QE Does not Equal Ending ZIRP

Even though Japan has ended their quantitative easing policy, they have recently made it quite clear that just because they have done so, doesn’t mean that they are moving far away from their zero interest rate policy. Speaking to a parliamentary committee last week in Tokyo, Fukui stated that if central bankers can “judge that inflationary pressures are restrained and the economy can achieve balanced growth, we can keep interest rates at very low levels.” The comments spoke to traders who previously were awaiting a decision as early as next month and now have to cope with uncertainty. However, although directly affecting markets in the overnight, the comments look to simply be further jawboning by policy makers in attempts to quell discrepancies with previous government sentiment. The statements come on the heels of yesterday’s call by Finance Minister Sadakazu Tanigaki for the Bank of Japan to ensure the stabilization of markets on the ultimate decision. As a result, with further rhetoric surely to follow from both parties, market participants are keeping in mind consecutive quarters of growth and rising, although incremental, consumer prices in fueling downside for the currency pair.

Monday, March 20, 2006

Trading Fear? Knowledge > Goals > Plan > Action > Success



CONQUER TRADING FEARS

Merriam-Webster's dictionary defines fear as "an unpleasant, often strong emotion caused by anticipation or awareness of danger, going on to explain that fear...implies anxiety and usually the loss of courage." This definition of fear is useful in helping define the issues that traders face when coping with fear. The reality is that all traders feel fear at some level, but the key is how we prepare to address our concerns related to taking on risk as a trader. In this article I will review four major fears experienced by traders, and I'll take it a step further by noting how the outcomes of these fears create undesirable trading behaviors. Basically, my aim is to have you walk away with an understanding of these dangers so you can and implement strategies that will address your fears and let you get on with your trading plan.

Mark Douglas, an expert in trading psychology, noted in his book, Trading in the Zone, that most investors believe they know what is going to happen next. This causes traders to put too much weight on the outcome of the current trade, while not assessing their performance as "a probability game" that they are playing over time. This manifests itself in investors getting too high and too low and causes them to react emotionally, with excessive fear or greed after a series of losses or wins. As the importance of an individual trade increases in the trader's mind, the fear level tends to increase as well. A trader becomes more hesitant and cautious, seeking to avoid a mistake. The risk of choking under pressure increases as the trader feels the pressure build.

All traders have fear, but winning traders manage their fear while losers are controlled by it. When faced with a potentially dangerous situation, the instinctive tendency is to revert to the "fight or flight" response. We can either prepare to do battle against the perceived threat, or we can flee from this danger. When an investor interprets a state of arousal negatively as fear or stress, performance is likely to be impaired. A trader will tend to ?freeze.? In contrast, when a trader feels the surge of adrenaline but interprets this as excitement or a state of greater alertness before placing a trade, then performance will tend to improve. Many great live performers talk of feeling butterflies just before they go on stage, and how they interpret this as a wake-up call to go out and perform at their highest level. That's clearly a more empowering response than someone who might interpret these butterflies as a reason to run back to his dressing room to get sick! Winners take positive action in spite of fear. Read below for tips to conquer the four major fears in trading.

1. Fear of Loss

The fear of losing when making a trade often has several consequences. Fear of loss tends to make a trader hesitant to execute his trading plan. This can often lead to an inability to pull the trigger on new entries as well as on new exits. As a trader, you know that you need to be decisive in taking action when your approach dictates a new entry or exit, so when fear of loss holds you back from taking action, you also lose confidence in your ability to execute your trading plan. This causes a lack of trust in your method or, more importantly, in your own ability to execute future trades.

Thus, you can see how fear can set in place a vicious cycle of recurring doubt and, in turn, reinforce a traders' lack of confidence in executing new positions. For example, if you doubt you will actually be able to exit your position when your method tells you to get the heck out, then as a self-preservation mechanism you will also choose not to get into new trades. Thus begins the analysis paralysis, where you are merely looking at new trades but not getting the proper reinforcement to pull the trigger. In fact, the reinforcement is negative and actually pulls you away from making a move.

Looking deeper at why a trader cannot pull the trigger, I believe the root stems from a lack of confidence about the trading plan, which then causes the trader to believe that by not trading, he is moving away from potential pain as opposed to moving toward future gain. No one likes losses, but the reality is, of course, that even the best professionals will lose. The key is that they will lose much less, which allows them to remain in the game both financially and psychologically. The longer you can remain in the trading game with a sound method, the more likely you will start to experience a better run of trades that will take you out of any temporary trading slumps.

When you're having trouble pulling the trigger, realize that you are worrying too much about results and are not focused on your execution process. Make sure your have a written plan and then practice executing your plan.

Start with paper trades if you prefer, or consider trading smaller positions to get the fear of losing out of your system and get yourself focused on execution. When in the heat of battle and realizing you need to get in or out of a trade, consider using market orders, especially on the exit. That way you can't beat yourself up for not pulling the trigger on your trade.

Many traders may get too cute with a trade and try to work out of a position at a limit price better than the current market price, hoping they can squeeze more out of a trade. But as famed trader Jesse Livermore advised in the classic book Reminiscences of a Stock Operator by Edwin Lefevre, "give up trying to catch the last eighth." Keep it simple with a market order to exit allows you to bring closure when you need it, which reinforces the confidence-building feelings that come from following your trading plan. In the past when my indicators noted it was time to exit, I have experienced firsthand the pain of not getting filled at my limit, watching the option drop and then placing a new limit back where I should have exited at the market in the first place! Then I have realized I was not going to get filled there either, so I again kept lowering my limit until, in frustration, I placed a market order to exit much lower than I could have closed the position initially. Not only can you feel the pain of loss financially but more importantly, you can chip away at your internal state of confidence and create frustration by not getting filled.

You should be more concerned about avoiding big losses and less concerned about taking small losses. If you can't bear to take a small loss, you will never give yourself an opportunity to be around when a big winning idea comes along, as every trade you enter has the risk of first turning against you for a loss. You must execute by knowing what your risk is in each trade, and define parameters to make sure you can ride favorable trends correctly as well so that your winners will be larger than you losers. And never get stuck in the mindset of hoping a loser will come back to "breakeven," as that is one of the trader's most deadly mental fantasies. Billions of dollars have been lost by technology investors hoping their stocks would bounce back in recent years to allow them to escape the downtrend. That only led to even greater losses in most cases. That's how a short-term trader can become a long-term investor unintentionally, and that is a position in which you never want to put yourself.

Ask how well you trust yourself to execute your trading plan. You want to judge your effectiveness based on how well you get in and out of the market when your method gives entry and exit signals. You'll need to be decisive, not hesitant, know in your heart that your method is well tested and that your risk is low compared to your likely reward. In other words, you must be fully prepared before you go into the heat of battle during a trading day. You need to know where you will enter and where you will exit if you are a discretionary trader. Or you need to know what system you are following and be prepared to enter and exit as the system dictates. This keeps you disciplined and focused on following a process that can generate favorable results over time.

2. Fear of Missing Out

Every trend always has its doubters, but I often notice that many skeptics of a trend will slowly become converts due to the fear of missing out on profits or the pain of losses in betting against that trend. The fear of missing out can also be characterized as greed of a sorts, for an investor is not acting based on some desire to own the security - other than the fact that it is going up without him on board. This fear is often fueled during runaway booms like the technology bubble of the late-1990s, as investors heard their friends talking about newfound riches. The fear of missing out came into play for those who wanted to experience the same type of euphoria.

When you think about it, this is a very dangerous situation, as at this stage investors tend essentially to say, "Get me in at any price - I must participate in this hot trend!? The effect of the fear of missing out is a blindness to any potential downside risk, as it seems clear to the investor that there can only be gains ahead from such a "promising" and "obviously beneficial" trend. But there's nothing obvious about it.

We remember the stories of the Internet and how it would revolutionize the way business was done. While the Internet has indeed had a significant impact on our lives, the hype and frenzy for these stocks ramped up supply of every possible technology stock that could be brought public and created a situation where the incredibly high expectations could not possibly be met in reality. It is expectation gaps like this that often create serious risks for those who have piled into a trend late, once it has been widely broadcast in the media to all investors.

3. Fear of Letting a Profit Turn into a Loss

I get many more questions from subscribers asking if it is time to take a profit than I do subscribers asking when they should take their loss. This represents the fact that most traders do the opposite of the "let profits run, cut losses short" motto: they instead like to take quick profits while letting losers get out of control. Why would a trader do this? Too many traders tend to equate their net worth with their self-worth. They want to lock in a quick profit to guarantee that they feel like a winner.

How should you take profits? Should you utilize a fixed target profit objective, or should you only trail your stop on a winning trade until the trend breaks?

Those who can accept more risk should consider trailing a stop on their trending position, while more conservative traders may be more comfortable taking profits at their target objective. There is another alternative as well, which is to merge the two concepts by taking some profits off the table while seeking to ride the trend with a trailing stop on the remaining portion of the position.

When I trade options, I usually recommend taking half of the position off at a double or more, and then following the half position still open with a trailing stop. This allows you to have the opportunity to ride my best trading ideas further, as these are the trades where I am mostly likely to continue being right. Yet, I am also able to get the initial capital at risk back in my pocket, which frees me from worrying about letting a profit turn into a loss; I am guaranteed a breakeven even if the other half position were to go to nothing overnight. My general rule for the remaining half position is to exit if it reaches my trailing stop of half its maximum profit on an end-of-day closing basis, or scale out of the remaining half position every time it doubles again.

I'm also a big fan of moving your stop up to breakeven relatively quickly once the position starts to move in your favor, by about five percent on a stock or by roughly 25 percent on the option. It is also critical to recognize the impact of time spent waiting for a position to move. If you are not losing but not yet winning after several trading days, there are likely better opportunities elsewhere. This is known as a "time stop," and it will get your capital out of non-performers and free it up for fresher trading ideas.

4. Fear of Not Being Right

Too many traders care too much about being proven right in their analysis on each trade, as opposed to looking at trading as a probability game in which they will be both right and wrong on individual trades. In other words, their overall method will create positive results.

The desire to focus on being right instead of making money is a function of the individual's ego, and to be successful you must trade without ego at all costs. Ego leads to equating the trader's net worth with his self-worth, which results in the desire to take winners too quickly and sit on losers in often-misguided hopes of exiting at a breakeven.

Trading results are often a mirror for where you are in your life. If you feel any sort of conflict internally with making money or feel the need to be perfect in everything you do, you will experience cognitive dissonance as you trade. This means that your brain will be insisting that you cannot exit a trade at a loss because it ruins your self-image of perfection. Or if you grew up and feel guilty about having money, your mind and ego will find a way to give up gains and take losses in the markets. The ego's need to protect its version of the self must be let go in order to rid ourselves of the potential for self-sabotage.

If you have a perfectionist mentality when trading, you are really setting yourself up for failure, because it is a given that you will experience losses along the way in trading. Again, you have to think of trading as a probability game. You can't be a perfectionist and expect to be a great trader. If you cannot take a loss when it is small because of the need to be perfect, then the loss will often times grow to a much larger loss, causing further pain for the perfectionist. The objective should be excellence in trading, not perfection.

In addition, you should strive for excellence over a sustained period, as opposed to judging that each trade must be excellent. The great traders make mistakes too, but they are able to keep the impact of those mistakes small, while really riding their best ideas fully.

For the trader who is dealing with excessive ego challenges (yet, who wants to admit it?), this is one of the strongest arguments for mechanical systems, as you grade yourself not on whether your trade analysis was right or wrong. Instead you judge yourself based on how effectively you executed your system's entry and exit signals. This is much easier for those traders who want to leave their egos at the door when they start to trade. Additionally, because we are raised in a highly competitive culture, the perception of a contest or competition will also bring out your ego's desire to win and beat others.

You will be better off seeing trading as a series of opportunities that will become apparent to you, and your task is to create a plan that finds opportunities with potential rewards that are several times greater than the risks you incur.

Be sure you are writing down your reasons for entering each trade, as the ego will play tricks and come up with new reasons to hang on to losing positions once the original reasons have evaporated. One of our survival mechanisms is remembering the good and omitting the bad in our minds, but this is dangerous in trading. You must acknowledge the risk and use a stop on every trade to admit when the analysis is no longer timely. This helps prevent undesirable situations where you get stuck in a position because you did not adhere to your original stop. This is a bad use of capital being tied up in an under-performing position, when there are likely to be many better opportunities elsewhere. Trading without stops is an ego-driven approach that hopes to avoid accountability for a losing trading idea. This is an unacceptable behavior to the successful trader, who knows he must limit risk with stops to stay in the game for the next trading opportunity.

In summary, your trading plan must account for the emotions you will be prone to experience, particularly those related to managing fear. As a trade, you must move from a fearful mindset to mental state of confidence. You have to believe in your ability as well as the effectiveness of your plan to take profits that are larger than the manageable losses. This builds the confidence of knowing that you are on the right track. It also makes it easier to continue to execute new trades after a string of losing positions. Psychologically, that's the critical point where many individuals will pull the plug, because they are too reactive to emotions as opposed to the longer-term mechanics of their plan. If you're not sure if you can make this leap, know that you can if you start small.

Too many investors have an "all-or-none" mentality. They're either going to get rich quick or blow out trying. You want to take the opposite mentality - one that signals that you are in this for the longer haul. This gives you "permission" to slowly get comfortable and to keep refining your plan as you go. As you focus on execution while managing fear, you realize that giving up is the only way you can truly lose. You will win as you conquer the four major fears, to gain confidence in your trading method and, ultimately, you will gain even more confidence in yourself.

Monday, March 13, 2006

More Trading Rules To Live By.


NEVER ADD TO A LOSING POSITION

R U L E # 1. Never, ever, under any circumstance, should one add to a losing position ... not EVER! Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

R U L E # 2. Never, ever, under any circumstance, should one add to a losing position ... not EVER! We trust our point is made. If "location, location, location" are the first three rules of investing in real estate, then the first two rules of trading equities, debt, commodities, currencies, and so on are these: never add to a losing position.

INVEST ON THE SIDE THAT IS WINNING

R U L E # 3. Learn to trade like a mercenary guerrilla. The great Jesse Livermore once said that it is not our duty to trade upon the bullish side, nor the bearish side, but upon the winning side. This is brilliance of the first order. We must indeed learn to fight/invest on the winning side, and we must be willing to change sides immediately when one side has gained the upper hand.

Once, when Lord Keynes was appearing at a conference he had spoken to the year previous, at which he had suggested an investment in a particular stock that he was now suggesting should be shorted, a gentleman in the audience took him to task for having changed his view. This gentleman wondered how it was possible that Lord Keynes could shift in this manner and thought that Keynes was a charlatan for having changed his opinion. Lord Keynes responded in a wonderfully prescient manner when he said, " Sir, the facts have changed regarding this company, and when the facts change, I change. What do you do, Sir?" Lord Keynes understood the rationality of trading as a mercenary guerrilla, choosing to invest/fight upon the winning side. When the facts change, we must change. It is illogical to do otherwise.

DON'T HOLD ON TO LOSING POSITIONS

R U L E # 4. Capital is in two varieties: Mental and Real, and, of the two, the mental capital is the most important. Holding on to losing positions costs real capital as one's account balance is depleted, but it can exhaust one's mental capital even more seriously as one holds to the losing trade, becoming more and more fearful with each passing minute, day and week, avoiding potentially profitable trades while one nurtures the losing position.

GO WHERE THE STRENGTH IS

R U L E # 5. The objective of what we are after is not to buy low and to sell high, but to buy high and to sell higher, or to sell short low and to buy lower. We can never know what price is really "low," nor what price is really "high." We can, however, have a modest chance at knowing what the trend is and acting on that trend. We can buy higher and we can sell higher still if the trend is up. Conversely, we can sell short at low prices and we can cover at lower prices if the trend is still down. However, we've no idea how high high is, nor how low low is.

Nortel went from approximately the split-adjusted price of $1 share back in the early 1980s, to just under $90/share in early 2000 and back to near $1 share by 2002 (where it has hovered ever since). On the way up, it looked expensive at $20, at $30, at $70, and at $85, and on the way down it may have looked inexpensive at $70, and $30, and $20--and even at $10 and $5. The lesson here is that we really cannot tell what is high and/or what is low, but when the trend becomes established, it can run far farther than the most optimistic or most pessimistic among us can foresee.

R U L E # 6. Sell markets that show the greatest weakness; buy markets that show the greatest strength. Metaphorically, when bearish we need to throw our rocks into the wettest paper sack for it will break the most readily, while in bull markets we need to ride the strongest wind for it shall carry us farther than others.

Those in the women's apparel business understand this rule better than others, for when they carry an inventory of various dresses and designers they watch which designer's work moves off the shelf most readily and which do not. They instinctively mark down the work of those designers who sell poorly, recovering what capital then can as swiftly as they can, and use that capital to buy more works by the successful designer. To do otherwise is counterintuitive. They instinctively buy the "strongest" designers and sell the "weakest." Investors in stocks all too often and by contrast, watch their portfolio shift over time and sell out the best stocks, often deploying this capital into the shares that have lagged. They are, in essence, selling the best designers while buying more of the worst. A clothing shop owner would never do this; stock investors do it all the time and think they are wise for doing so!

MAKING "LOGICAL" PLAYS IS COSTLY

R U L E # 7. In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral. In a Bull Market we can only be long or neutral; in a bear market we can only be bearish or neutral. Rule 6 addresses what might seem like a logical play: selling out of a long position after a sharp rush higher or covering a short position after a sharp break lower--and then trying to play the market from the other direction, hoping to profit from the supposedly inevitable correction, only to see the market continue on in the original direction that we had gotten ourselves exposed to. At this point, we are not only losing real capital, we are losing mental capital at an explosive rate, and we are bound to make more and more errors of judgment along the way.

Actually, in a bull market we can be neutral, modestly long, or aggressively long--getting into the last position after a protracted bull run into which we've added to our winning position all along the way. Conversely, in a bear market we can be neutral, modestly short, or aggressively short, but never, ever can we--or should we--be the opposite way even so slightly.

While standing on the top step of the CBOT bond-trading pit, a trader was looking down into the tumult below in awe. When asked what he thought, the trader replied, "I'm flat ... and I'm nervous." That, we think, says it all . . . that the markets are often so terrifying that no position is a position of consequence.

R U L E # 8. As Lord Keynes said, "Markets can remain illogical far longer than you or I can remain solvent." The markets are illogical at times, and they can remain illogical far longer than you or I can remain solvent." The University of Chicago "boys" have argued for decades that the markets are rational, but we in the markets every day know otherwise. We must learn to accept that irrationality, deal with it, and move on. There is not much else one can say.

R U L E # 9. Trading runs in cycles; some are good, some are bad, and there is nothing we can do about that other than accept it and act accordingly. The academics will never understand this, but those of us who trade for a living know that there are times when every trade we make (even the errors) is profitable and there is nothing we can do to change that. Conversely, there are times that no matter what we do--no matter how wise and considered are our insights; no matter how sophisticated our analysis--our trades will surrender nothing other than losses. Thus, when things are going well, trade often, trade large, and try to maximize the good fortune that is being bestowed upon you. However, when trading poorly, trade infrequently, trade very small, and continue to get steadily smaller until the winds have changed and the trading "gods" have chosen to smile upon you once again. The latter usually happens when we begin following the rules of trading again. Funny how that happens!

THINK LIKE A FUNDAMENTALIST > TRADE LIKE A TECHNICIAN

R U L E # 10. To trade/invest successfully, think like a fundamentalist and trade like a technician. It is obviously imperative that we understand the economic fundamentals that will drive a market higher or lower, but we must understand the technicals as well. When we do, then and only then can we, or should we, trade. If the market fundamentals as we understand them are bullish and the trend is down, it is illogical to buy; conversely, if the fundamentals as we understand them are bearish but the market's trend is up, it is illogical to sell that market short. Ah, but if we understand the market's fundamentals to be bullish and if the trend is up, it is even more illogical not to trade bullishly.

R U L E # 11. Keep your technical systems simple. Over the years we have listened to inordinately bright young men and women explain the most complicated and clearly sophisticated trading systems. These are systems that they have labored over; nurtured; expended huge sums of money and time upon, but our history has shown that they rarely make money for those employing them. Complexity breeds confusion; simplicity breeds an ability to make decisions swiftly, and to admit error when wrong. Simplicity breeds elegance.

The greatest traders/investors we've had the honor to know over the years continue to employ the simplest trading schemes. They draw simple trend lines, they see and act on simple technical signals, they react swiftly, and they attribute it to their knowledge gained over the years that complexity is the home of the young and untested.

UNDERSTAND THE ENVIRONMENT

R U L E # 12. In trading/investing, an understanding of mass psychology is often more important than an understanding of economics. Markets are, as we like to say, the sum total of the wisdom and stupidity of all who trade in them, and they are collectively given over to the most basic components of the collective psychology. The dot-com bubble was indeed a bubble, but it grew from a small group to a larger group to the largest group, collectively fed by mass mania, until it ended. The economists among us missed the bull-run entirely, but that proves only that markets can indeed remain irrational, and that economic fundamentals may eventually hold the day but in the interim, psychology holds the moment. And finally the most important rule of all.

THE RULE THAT SUMS UP THE REST

R U L E # 13. Do more of that which is working and do less of that which is not. This is a simple rule in writing; this is a difficult rule to act upon. However, it synthesizes all the modest wisdom we've accumulated over thirty years of watching and trading in markets. Adding to a winning trade while cutting back on losing trades is the one true rule that holds--and it holds in life as well as in trading/investing.

If you would go to the golf course to play a tournament and find at the practice tee that you are hitting the ball with a slight "left-to-right" tendency that day, it would be best to take that notion out to the course rather than attempt to re-work your swing. Doing more of what is working works on the golf course, and it works in investing.

If you find that writing thank you notes, following the niceties of life that are extended to you, gets you more niceties in the future, you should write more thank you notes. If you find that being pleasant to those around you elicits more pleasantness, then be more pleasant. And if you find that cutting losses while letting profits run--or even more directly, that cutting losses and adding to winning trades works best of all--then that is the course of action you must take when trading/investing. Here in our offices, as we trade for our own account, we constantly ask each other, "What's working today, and what's not?" Then we try to the very best of our ability "to do more of that which is working and less of that which is not." We've no set rule on how much more or how much less we are to do, we know only that we are to do "some" more of the former and "some" less of the latter. If our long positions are up, we look at which of those long positions is doing us the most good and we do more of that. If short positions are also up, we cut back on that which is doing us the most ill.

Our process is simple. We are certain that great--even vast--holes can and will be proven in our rules by doctoral candidates in business and economics, but we care not a whit, for they work. They've proven so through time and under pressure. We try our best to adhere to them.

This is what I have learned about the world of investing in almost two decades. I try each day to stand by my rules. I fail miserably at times, for I break them often, and when I do I lose money and mental capital, until such time as I return to my rules and try my very best to hold strongly to them. The losses incurred are the inevitable tithe I must make to the markets to atone for my trading sins. I accept them, and I move on, but only after vowing that "I'll never do that again."

Monday, March 06, 2006

Demo Accounts & Paper Trading - Real World Trading?

Paper trading or trading without real money can be the biggest mistake new traders can make. This can be counterproductive and a destructive way to learn how to trade any market correctly. Paper trading is based on zero emotions because theres no real money at stake, which is not reality in the real trading market. Paper trading is based on zero risk which is totally the opposite of real trading risk with real money. Its true that the greater the risk, the greater the reward. Money and risk management are very important factors in trading. Before a trader asks how much can be profited from a trade, the trader first asks what can be the loss if wrong. Learning to trade with zero risk can be financially devastating in real money trading. As a new trader, if you do choose to paper trade, make a diligent continous effort to adhere to trading rules and trading plans with a defined risk amount that is as realistic as possible. Then take it as serious as possible like it's your real money. Keep a trading diary to constantly review your good and bad trades to refine trading for success. Being disciplined in the market is the difference between trading another day or cooking your trading account to nothing left to trade the next day.

To trade correctly, trader must have 100% technical skills, but they only need to apply 20% of these skills while trading. The other 80% of trading is keeping emotions under control.

First determine how much money real or not to risk during learning to trade. This will make learning trading productive and educational. Do not risk all your capital on any one trade to make sure you are emotionally trading the markets. As traders, every trader has different financial goals, and each trader will have a specific comfort zone where a certain amount of money at risk triggers a specific amount of emotion. The key is to find your emotional risk level and trade within it until you become a successfull and better trader.

The secret to educational and profitable trading is to closely monitor your emotional risk level and change your actions as required to be a successfull trader in the long term. Lowering risk capital as a new trader is very important when trading with real money. The key is to survive the market to trade another day. If you risk everything and are wrong, you won't be trading very long.

For new traders, paper trading can be helpful when learning the trading platform. Its not wise to trade real money while first learning the trading platform. The following are some guidelines while paper trading a demo account.

1. Whatever the intended size of your real money trading account, try to make the demo account that amount of starting trading capital. Ask the online broker your working with to adjust your demo account for an amount you will actually be starting a real money account with. Some brokers are able to adjust and some are not.

2. Trade share or lot sizes that meet your emotional risk level.

3. Ignore unrealistic order fills that overpay for each trade. Demo trading accounts often fill orders at a price that many times may not happen in real world trading. Learn how and when to use buy sell limits, and better yet buy sell stops for entry. Professional traders rarely use market orders to make entry into a position.

4. Create real emotions while paper trading. Find someone or a group to compete against while demo trading. Create a trading game amongst your trading friends or group where for each point earned or lost theres real money being won and lost. To keep it realistic, put a cap to the total amount won and lost. Create your trading game as realistic as possible to mimick real market trading conditions. When there's real money at stake, even its just a little between friends, this will create real emotional trading conditions to correctly learn trading.

As soon as you are comfortable with the trading platform. stop paper trading, and start trading live with real money. Make sure you trade withing your lower limits of emotional risk for the first week or two or longer if required. You will become a successfull trader faster trading live with your real money than in with a demo account. Continous paper trading will decrease the odds of becoming a successfull real money trader because after doing something repetitive, then it can become instinct. Trading a demo account unrealistically will teach and provide you with instincts that are useless, counterproductive, and financially devasting to your trading account. When trading live with real money, you will be trading at a level below others with no experience. Before you can advance as a trader, you will have to shed all of your bad habits.

In summary, seriously trading a demo account based on realistic condistions and circumstances can be a very educational experience. Not taking it seriously while demo trading will in most odds will teach you to be a unsuccessfull trader.