Leonardo of Pisa, aka the mathematician “Fibonacci”, published his Fibonacci sequence in 1202. Fibonacci came upon his now very famous sequence of numbers when he was trying to breed rabbits and figure out how many pairs of rabbits he would have at the end of one year based upon their breeding behavior. This is just the kind of no-nonsense approach that Forex traders are into.
Mistakenly many individuals consider mathematical abstraction as frivolous; however it is rooted into real world mathematical applications. The Fibonacci sequence is useful for making us aware of and then explaining those hidden patterns around us daily.
How can this be applied to investing? Very astute investors understand that there are hidden patterns in the stock market–based on the mass of investors’ behavior. “Buy low and sell high” and “The best time to buy is when there’s blood in the streets” are but two investment aphorisms that not only work, but also come from understanding hidden patterns of the investment markets.
The reason that investment market patterns are so well hidden is because “up close” they cannot be seen. Day to day, hour to hour fluctuations in the investment markets cannot be predicted with any accuracy. But certain overall trends that extend over longer periods of time definitely can be. And savvy investors, including Forex traders, have successfully been using Fibonacci’s number sequence to take advantage and make big profits.
Using the Fibonacci sequence involves a series of numbers. Each following number is the sum of the two numbers before it. It progresses like this 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, and into infinity. There are numeral interrelationships within these numerals. For example, take any number; it is roughly 1.618 times the number before it. Anciently the Greeks found number 1.618 reprehensive of the golden ratio which is the supreme essence of balance. This balance is the fundamental strategy of profitable investing
The most common applications of the Fibonacci sequence for investment purposes are retracements and arcs.
Fibonacci charts are created through a technique comprising three curved lines that are drawn for the purpose of anticipating key resistance and support levels as well as areas of ranging. First, an invisible trendline is drawn between two points (typically these are the high and low for a given time period). Then, three curves are drawn so as to intersect this trendline at the key Fibonacci levels of 38.2%, 50%, and 61.8%. Transaction decisions are made at the point where the price of the asset crosses through these key levels.
Next is the retracement – this is when the movement of a stock or other traded commodity reverses direction; this is a reversal which is stronger than the prevailing trend of the stock’s movement. Retracement patterns are looked at closely by investors; a Fibonacci retracement can be used to analyze the odds of a commodity’s price having a larger than average retracement before continuing back on the direction it had before reversal. The trendline is typically drawn between two extremes and is divided vertically by the Fibonacci ratios of 23.6%, 38.2%, 50%, 61.8% and 100%.
The Fibonacci retracement is widely used by sophisticated traders to find: strategic places for transactions to be placed; target prices; and stop-losses. Other technical tools including Tirone levels, Gartley patterns, and Elliott Wave theory all make use of retracement.
The reason that the Fibonacci sequence is used in investing is simple: it works! Forex traders in particular in particular seem to find it useful in making profitable trades.
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The traditional definition of a forex broker is one who puts buyers and sellers together for a commission or fee. Many forex brokers make their money by charging you a spread, the difference between the buying and selling prices for a currency pair.
Spreads greatly impact your forex returns and vary depending on the type of account you open. As buying low and transacting high is the trader’s goal, a wider spread means you have to pay more when you buy and wind up with less when you sell. In some cases, your broker gets the difference, which is added onto the price of the trade. Spreads often narrow or widen depending on market liquidity and other factors. You can learn a lot by watching the video tutorial on spreads located on our forex guide page. I have worked with many different types of forex brokers and have witnessed the haphazard ways in which clients’ investments were distributed. In many cases, the trading transaction would go into a ‘bucket’, and never actually execute. My heart would go out to the scores of clients who had quit their day jobs, anticipating income from trading forex, only to learn their profits had disappeared due to some alleged violation. In reality, there was no profit to deliver since the buy/sell trade never happened and the broker had to come up with an excuse. These types of brokers operate in what’s commonly known in the forex industry as a “bucket shop.”
From Electronic Communication Networks (ECNs) to retail forex companies, the type of forex broker chosen is a factor in the timeliness and return on your investment. ECNs do not trade against you and act as an Interbank broker in the free market by connecting the major banks and brokerages with individual forex traders. The spreads may be smaller but you know upfront what you’re paying for the service – either a flat fee or commission.
Retail forex companies are glorified bucket shops and are often referred to as market makers, since they essentially create their own trading markets. Spreads are arbitrarily decided, trades are made against you, and profits are distributed at the broker’s discretion. Retail forex companies are attractive to newcomers and those short on cash because they don’t require large investments. If you don’t mind running the risk of having your profits disappear on a whim, then retail forex companies are a good place to learn the ins and outs of forex trading. They allow you to demo trade on their platforms until you know what you’re doing and give you unusually high leverage.
Of the two types of brokers, a forex ECN broker is the more legitimate. They provide a place where banks, traders, and multiple market makers can enter competing bids and offers around the spread amount. Unlike a dealing desk, bank quotes are consolidated and orders are matched to the best bid/offer price on which traders are permitted to trade. Although minimum trade requirements are often higher and leverage is lower, prices are not manipulated, profits can be more stable, and trades are passed to a real trader, the Interbank.
When honestly executed, forex spreads can be a valid indicator of what’s happening with your trade. After years of mistakes and believing everything I was told, I now know to look for the red flags, such as reverse pips, rejected transactions, tight spreads, and delayed executions. These are common strategies used to deceive many forex traders.
The best advice I can give you when selecting a forex broker is to read forex reviews . Learn what others are saying about forex brokers before you make a decision.
When I woke up this morning to trade the NY session and started catching up on the price action of the Forex, equities, and commodities markets I got that gut feeling that said, "don't take a trade, you'll lose". It's been awhile since I sat through an entire NY session without taking a single trade but I'm glad I listened because I probably would have lost on trades today as the markets were very disjointed, choppy, and erratic to kick off the third quarter. My hat's off to all those traders who did make a profit today...
I can't put my finger on one exact thing that caused the markets to become disjointed but it was more a combo of central bank, fundamental, and geo-political factors. The erratic price action really started last evening in the Asian session with Fed Yellen's strong anti-dollar rhetoric. On the prospect of the Fed leaving their interest rate near zero for the next several years, Yellen said:
"It is not outside the realm of possibility; we have a very serious recession, we have a 9.4% unemployment rate, and inflation possibly falling further below the Fed's preferred level; we should want to do more. If we were not at zero, we would be lowering the funds rate"
That kind of central bank rhetoric is about as anti-dollar as it gets and the almost immediate response from the market was to drive the euro higher against the dollar. The reason why market participants sent their money-flows into the euro is because the euro is still yielding a minimum of 75bps higher than the dollar and when compared to the pound sterling, the euro yields a better rate against the dollar, so the euro was one of the main beneficiaries of Yellen's anti-dollar comments.
From a fundamental standpoint, it was mostly a mixed bag of somewhat-bad and not-so-bad data... the data that the S&P 500 and Dow Jones enjoyed most was the ISM report and specifically the ISM Price Index. ISM Manufacturing is still well below the 50 level but as I looked at the various components it's easy to see what the markets got excited about. The production and employment components were both up by over 6% and best of all, the prices component was up by 6.5%.
Remember, higher prices are good for higher-risk, higher-yielding markets, it's what these markets need... any price related components in this type of data that are not deflationary is just another reason to buy. Whenever a piece of fundamental data that is connected to price inflation prints hot or better than expected I've seen a clear pattern for equities to rise and the dollar to fall and this pattern played out again today.
And finally from a geo-political standpoint, the dollar was hammered by more comments from China. At 1158 EST, just as London was closing, these comments from a Chinese finance minister hit the news wires:
"China has asked the G8 Italy summit to discuss issue of new global reserve currency; China requests reserve currency debate at G8"
Within seconds of these anti-dollar comments hitting the wires the EUR/USD jumped up over 60-pips, took out stops at the 1.4200 level and then fell right back down to the point of lift-off after NY closed this afternoon. I'm not exactly sure why the Chinese are talking the dollar down but all I can think of is that they are strategizing way in the future and not so much in the past or present.
The argument that the Chinese shouldn't talk the dollar down no longer holds any water because they have shown a pattern of using verbal rhetoric to depreciate the dollar in recent months. I believe the Chinese are thinking ahead by about 10-years and whatever their ulterior economic and social agendas dictate for the future probably includes the dollar being dethroned as the world's reserve currency.
All in all, it was a weird start to Q3 and it will probably stay weird as the markets deal with a tag-team NFP/ECB event tomorrow morning and Friday's US bank holiday...
NFP and unemployment rate event:
I'm going to get this out of the way now -- do not trade NFP tomorrow. You saw how wild last month's NFP event was and I expect no different tomorrow. The best way to properly manage your risk is to sit on the sidelines, let the market do its thing, and either trade after the dust settles or wait until next week.
Last month's NFP printed way better than expected but I believe that number will be revised lower tomorrow. Last month's unemployment rate will not likely be revised lower but possibly revised higher. As far as the actual market forecasts are currently running, this is what the bank traders are forecasting:
Non-farm payrolls consensus range: -435K to -225K
Unemployment rate consensus range: 9.7% to 9.5%
My NFP forecast: -378K to -414K
My unemployment rate forecast: 9.7%
The ADP NFP report came in much worse than expected at -473K but I do not think tomorrow's government report will breach that level. What Wall St. and the higher-risk, higher-yielders want to see is an NFP print that comes in as it did last month because they are still looking for any news-driven reason to keep buying and to keep prices supported.
The thing to remember is, this employment data from the BLS is hardly reliable and purely manipulated. If the markets are looking for a reason to go up, they will find it within the data... if the profit-takers want a reason to square their books ahead of the holiday weekend, they will find a reason within the data... if big money movers want to push the dollar and USD Index lower, they will find a reason in the data...
ECB interest rate event:
As important as tomorrow's NFP even is, the ECB interest rate policy and Trichet press conference is even more important and should likely have greater affect over the value of the EUR/USD. Monetary policy always trumps a single fundamental event and you can be sure all eyes will be on Trichet at 0830 EST tomorrow morning and looking for any sign or signal to either sell or buy the euro against the dollar.
That's what tomorrow's event is really all about... what to do with the euro... the Eurozone's dismal fundamentals have kept the euro's gains somewhat capped against the dollar and it's been the ECB's verbal rhetoric along with the euro's correlation to equities and commodities which has kept it from breaking below the 1.3750 level. If Trichet and his ECB comrades decide they want to continue their pro-euro stance this should be made clear at the press conference. Conversely, if Trichet wants to help support a Eurozone recovery by depreciating the euro, like the Swiss are doing with the franc, he will talk it down tomorrow.
As far as the ECB interest rate is concerned I see no change and for rates to be held at 1.00%. Trichet said he's not dropping rates this month and I'm going on his word. Obviously if Trichet was playing games with the markets and does decide to drop rates this would be a shock and unexpected move and the euro would sell-off against the dollar.
Central bankers like Trichet and Bernanke have been fairly trustworthy trade indicators in recent weeks, they've been telling the markets exactly what they want their respective currencies to do. So, as you're watching Trichet's press conference tomorrow and you're looking for signs he wants the euro to stay supported, he will say things like:
•ECB interest rates have reached their lowest levels
•ECB interest rates may rise in the near-term
•The ECB is more concerned with inflation and price stability compared to deflation
•Deflation is not at all an issue in the Eurozone
•ECB forecasts show an end to the growth contraction in Europe and signs of a growth recovery are present
•European credit markets are stabilizing and money and credit is expanding
•The European banking system is sound
•The ECB will not monetize any sovereign or commercial debt beyond their already existing program
•The ECB expects German exports to rebound in the near-term
•The employment situation in Europe is improving
•The worst of the financial crisis is over and recovery is right around the corner
If Trichet wants the euro to depreciate he will make comments like this:
•ECB interest rates have not reached their lowest threshold and may come lower in the near-term
•The ECB is open and ready to use more non-standard measures
•The ECB will monetize more sovereign or commercial debt
•The ECB is concerned with deflation/disinflation
•Consumer and producer inflation rates are expected to remain negative in the near-term
•The European banking system remains at risk
•Eurozone growth will contract beyond what the ECB has estimated
•Unemployment will continue rising
•The consumer will remain weak for a longer period of time than anticipated
The points on those two lists are the main things Trichet would say to either appreciate or depreciate the euro tomorrow. I can't predict which Trichet we'll get but I'm leaning towards him making more comments that are supportive of the euro compared to negative comments. The biggest risks for the euro obviously would be an announcement of interest rates being lowered and or more debt being monetized.
Even if you do not trade the EUR/USD you will be well served to watch Trichet's press conference because it's a great learning lesson for how central bank monetary policy and geo-politics drive price action of currencies and how these guys use verbal rhetoric to manipulate the Forex market. You can watch the press conference here.
Manage your risk:
On a scale of 1-10 tomorrow's trading risk is an 11. I really encourage all retail FX traders to practice some patience and good money management by sitting on the sidelines. I usually trade every NFP and ECB event but at this point I'm leaning towards sitting on the sidelines as well. The other risk factor beside these fundamental events is the fact the markets are severely ill-liquid right now. That means it takes far less money to move the market as opposed to what it may take under normal trading conditions when the level of market participation is higher.
The price swings could be very sharp tomorrow and not something you want to find yourself on the wrong side of... you could be on the right side of a market move and 30-seconds later find yourself on the wrong side of a price swing... that's the potential risk for tomorrow. If you can't help yourself from trading I suggest using at least half of your normal entry size. I always recommend for traders to use just half of one percent used margin entries so you may want to cut that in half for tomorrow and Friday.
Finally, a great Jesse Livermore quote to consider:
"After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting"
-David
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