Sound complex? It really isn’t.

The Basics of the Basket

To create a forex basket, investors seek out reliable trading pairs that are predictable and offer very little volatility. For all practical purposes, basket traders want nothing to do with high flying currency pairs and would rather a pair sit and do nothing than rise and fall quickly.

One common combination in a basket is the AUDUSD and the NZDUSD. The Australian Dollar and the New Zealand Dollar tend to range together due to their geographical, economical, and political similarities. However, one currency yields more to hold it than the other costs to borrow it.

During the recent recovery from the 2008 financial crisis, the USD (US Dollar) became the premier currency to short. The USD made excellent carry trade pairs because it:

• Was inexpensive to borrow
• Was from an established, politically sound country
• Wasn’t likely to appreciate, nor lead the world in economic growth.

As such, investors sold the USD against high yielding currencies like the AUD (Australian Dollar.) You can see how this trade played out excellently; as rates were increased in Australia, rates were cut in the United States. Thus, more and more traders piled in, and early-movers enjoyed a cash flowing carry trade combined with rising AUD values:

The AUDUSD's rise after the 2008 financial crisis happened largely as a result of rising rates in Australia and falling rates in the United States

The Process of Basket Trading

Using the AUDUSD and NZDUSD as an example, a trader would long (buy) one currency pair, and sell the other. The hope here is that the two pairs will rise and fall together. So if the AUDUSD that was shorted fell 1% and the NZDUSD that was bought rose 1%, the basket would neither lose nor gain any value.

Making a carry trade basket allows a trader to limit the downside, thus providing a higher, risk-adjusted return. However, as you can see from the chart above, the trader who opted not to create a basket would have higher capital gains on a rise in AUD. They would, though, also have greater risks to the downside, as well as lower cash flow from the carry trade.

Where the Money is

Earlier in this article we mentioned that the profits in forex basket trading come from the carry interest, or the interest that is either paid or earned for borrowing or lending currency. If one shorted currency par, say the AUDUSD costs .5% to borrow, and the other currency pair, the NZDUSD pays 5% to lend, a basket trader would earn 4.5% per year divided by two currency pairs. The effective return on the dollar would be 2.25%.

Unleveraged, 2.25% per year is nothing to write home about. However, with forex brokers offering leverage as high as 400:1 (US-based traders can access these pairs at 30:1, which is still plenty high), there is an incredible amount of money to be made with basket trading. $1000 invested at 20:1 in the example above would generate an annual income of $450 per year. On a $1000 investment that is a 45% return. Of course, that kind of performance would require your basket creates a perfect hedge.

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Backtesting a forex trading system isn’t particularly hard. With the advent of online trading, and desktop based trading platforms, most traders should be able to backtest any simple strategy and get a concrete look at its effectiveness. Backtested strategies are typically scored on the following criteria:

Profit/Loss – How much did you make or lose.

Maximum Drawdown – What was the greatest dip from the peak on a chart. For example, an account that went from $150 to $125 would have a maximum drawdown of 16.6%. (16.6% is really good).

Win/Loss Ratio – What percentage of trades were winners or losers. This is important for strategies that use differing values for stop loss and take profit orders.

The most important number of the above mentioned is the maximum drawdown number. This number will tell you how risky you can get with the strategy, and how to squeeze more profits from the same account. With a maximum draw down of only 16.6% as exemplified above, a trader could realistically increase position sizes by 5 times over and have a maximum drawdown of 83%.

83% is a large paper loss to be holding, however, if the strategy is profitable then short term losses don’t really matter anyway. Besides, the strategy with a draw down of 83% with all things being equal would be more profitable than the strategy with only 16% drawdown.

The Hardest Part of Forex Backtesting

The number one issue traders run into when backtesting a forex strategy is how to do it. You could do it all by hand, spend hours with a calculator and a pen or you could code it, program it, and plug it into a trading platform. If you’re not familiar with backtesting or coding forex systems and automated trading programs, you mgiht be best doing it by hand, or paying someone (yes, companies do exist for this purpose) to code the system for you.

If you did, you were thinking about averaging down on a position. That is, buying more of a trade after your first order has already shed some value.

Averaging Down Example

You’re trading cable (GBPUSD) long term with a 1 lot position that you purchased at 1.55. Over the next few weeks, the pair falls 1000 pips to 1.45. You’re down $10,000, but you still think this trade is it, the pair will rebound and if you buy more (average down) you’ll bring in the bank on the uptick.

At 1.45, 1000 pips off your first entry, you average down with a 10 lot order. In doing so, you now have 10 times more exposure than you originally had, at an average price of 1.4590. Once the pair moves over 1.4590, your trade is profitable, instead of the 1.55 price it originally had to rise to.

Averaging Down Mathematics

From the example above:

1 trade of 1 lot at 1.55

1 trade of 10 lots at 1.45

Equals

11 lots at an average price of 1.4590

The Downside to Averaging Down

The concept of averaging down on a losing position is controversial. Some see it as an excellent way to get a trade you like for cheaper, but with more exposure. Others see it as pure suicide…why would you put more into a losing trade?

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Breaking it Down

When I say that foreign exchange markets are boring, I mean that at the basis they’re actually lacking in volatility. Sure, you may hear about traders doubling their cash or losing it all in one day, but you’re also hearing about cases where traders have used highly leveraged accounts. Without leverage, the foreign exchange market would be one of the least profitable.

Consider this: A 250 pip move in the GBPUSD would be considered a highly, highly volatile day. That bar would stand out on any chart, regardless of perspective and timeframe. However, that 250 pip move is a 1.6% move. And that is a crazy day!

Compare those kind of numbers to, say, the stock market, which can move 2-3% without making headlines and you’ll see why I say foreign exchange is boring without leverage.

So How Much Buying Power Can I Get

Retail foreign exchange traders have more access to increased buying power than do professionals, and can generally leverage up as high as 400:1. Typical leverage amounts are anywhere from 10:1 (for long term investors) to 200:1 (short term day traders) to 400:1 (gambling addicts).

At 400:1, a trader could own as much as $100,000 worth of currency with a $250 deposit and make or lose $10 with every pip move in a USD denominated pair. That is, if a USD pair were to move just 5 pips, a move that happens every few minutes

Nearly all brokers have a minimum account balance, and only one (that I know of), Oanda, requires no account balance at all. Most account balance minimums are in the neighborhood of $500 to $1000, which should be more than sufficient for most traders, and strategies, especially in accounts that allow you to trade mini lots (one-tenth the size of whole lots) or units (units are a single piece of currency).

What to Make of an Account Balance

A larger account balance is better for more “rigid” brokers, those that allow trading only in lots or mini lots. A mini lot account, for example, that is funded with $250 will disappear or double with the change of 250 pips in a single currency pair.

A forex brokerage account with no minimums and unit based transactions will allow the most flexibility. An investor could pony up as little as $50 and trade even 1 unit of GBP/USD for example, exposing them to just $1.60 worth of trades. Of course, this isn’t going to make you rich, but its not going to make you poor either. For most people, I recommend this route over a forex demo account.

Account Size and Leverage

Foreign exchange account sizes should also vary by the amount of leverage (buying power) a trader will use. For example, a $250 account at 400:1 is worth just as much as a $2,000 account at 50:1. So this is just one more variable to consider before making a deposit for investment.

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Foreign exchange trading is probably the most technical of any type of trading. From stocks to bonds to options and futures, no market has as much participation from technical analysts than the forex market. However, just because the majority are technical traders doesn’t mean there isn’t plenty of room for fundamentalists.

No Indicators Forex Trading

Trading without indicators means you’ll likely rely more on the fundamentals like trade balances, national debt loads, central bank actions and many other non-chart indicators.

Here is a list of the items often covered by fundamental traders:

• Currency Interest Yields
• Central Bank (Monetary) Policy
• Fiscal (Government Spending) Policy
• Trade balances or imbalances
• Employment (Non-Farm Payroll Report in the United States)
• And many more

For the Long Term

Most fundamental traders perform best with a long term trading horizon usually multiple times longer than technical traders who are frequently day or swing traders. George Soros, arguably the best fundamental (no indicator) trader, made more than $1 billion in just a few months betting against his own country (England’s) currency.

If you’d like to avoid indicators clogging up your computer real estate, long term forex trading may just be your cup of tea. Maintaining a long term investment perspective allows you to ride out the ups and downs made by the short term trends made by technical traders, and realize profits on the long term movements caused by underlying economic trends.

For example, China, which has a strong economy and an excellent trade balance should see higher currency prices in the future. However, in the next 15 minutes, their currency may easily drop .25-.5% before rising several percentage points over the course of years. While technical traders would grab the small pips, no indicator traders would have the several percentage point move in the bag, netting an excellent profit.

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Forex Scalping Techniques

There are a few techniques that will make your trading easier. The first technique, although not so much a technique in itself, is to open an account at a forex broker that has thin spreads. When it comes to making money scalping the foreign exchange market, low pip spreads are preferred.

Scalping Forex with Moving Averages

Moving averages are the most popular indicators with forex scalpers. One well-known technique is to use a short term and long term MA and buy/sell when the two cross. Common choices are the 10, 15, 20, 25, 50, 75, 100, and 200 moving average either calculated in simple form, or exponentially.

What Makes Good Technique?

Each trader needs to find their own niche, their own techniques, but there are some important pieces of information all traders need to know. First and foremost, you need a solid plan with good entry and exit practices. Also, you need to be quick on your feet, and ready to dump a position when it runs out of favor. Finally, you need to be yourself, adapt your techniques around your own trading style and time you have to trade each day.

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Making a Living with forex

Making a living with forex may seem to be just a pipe dream, but many, many people are using the foreign exchange market as a way to provide for themselves and family. However, we can’t get too caught up in making millions, as very few traders ever make enough with forex to make a living.

One of the most notable forex traders to ever make a living trading currencies might just be George Soros. Then the manager of the famous Quantum fund—Soros managed annual compounded returns of 30% annually while at the helm—Soros famously bet $10 billion against the Great British Pound in 1992. In just one day, Soros was rewarded with a profit of $1 billion. By the time he closed the trade, Soros had earned more than $2 billion for himself and his fund.

Another opportunity emerged for Soros in 1997. Thailand’s currency, the Baht, was under stress as the central bank had hoped to artificially inflate its value. Sensing that the available supply of foreign currencies were low—the central bank traded foreign currencies for Baht at prices above the market level to inflate the currency’s value—Soros again bet big.

This bet eventually spawned what was known as the Asian Financial Crisis, and once again Soros made billions on a single bet. Since that time, Soros has been quiet in the currency markets, choosing instead to speculate on the gold market, which he described as “the ultimate bubble.” Soros closed that trade in May 2011, after making hundreds of millions on his wager. To say that Soros makes a living trading forex might be an understatement.

Trading Forex Odds

Of all the traders that try to make millions with currencies, very few succeed and the majority fail miserably. Statistics prove that of all the traders who will set out to make a living with forex, only a small fraction will, while 90% of traders will lose everything in their first year.

Where to Start Trading For a Living

To make a living trading forex, you’ll need to be well educated about the ins and outs of the foreign exchange market. Certainly, you wouldn’t try to make a living as a surgeon if you hadn’t yet completed medical school, and you can’t expect the same results with forex. Making money takes time, patience, and the ability to learn.

The only place where you can begin trading forex for a living are:

Prop firms – Proprietary trading firms love the currency markets because their traders can generate massive ROIs using highly-levered currency trades. Of course, entry to such a firm costs as much as $25,000, and requires that you dedicate the time to learn about the firm’s proprietary trading techniques.

Trading yourself – At home traders compromise the fastest growing segment of the foreign exchange market. Learning how to trade the markets to a point at which you become qualified enough to churn consistent income equal to the average American income may be years off, but the good news is that you’ve come to the right place. We can teach you how to trade successfully, though it won’t be as easy as joining a proprietary trading desk.

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Free Forex Trading Simulator

The most popular free forex trading simulator is one which is produced by forex company Oanda. The company, one of the few no-minimum brokers worth your business, also has one of the easiest to use platforms. No software is required to use their free practice accounts, also known as demo accounts, and their data is acquired directly from market makers.

Oanda’s free simulator is powered by real-time data from the foreign exchange market, meaning that a profit or loss in a simulator is the same as if you were using real money. Of course, any trades you place in a simulator are made with fake money, but the actual changes in currency values do correspond with market movements in the simulator.

Why Use a Forex Simulator

Unfortunately, nearly 95% of all traders who trade real money in the currency markets fail within a year. Usually, this is the result of poor trading form but can also be due to other factors including not enough time with a free forex simulator. You would try flying a plane, or doing a brain surgery without studying up, so why would you start trading real money without any understanding of the forex market?

There are few opportunities in life to learn by doing, and even fewer opportunities that let you learn for free. If you’re not using a free forex trading simulator to learn to trade then you’re either throwing your money away for a paid simulator, or you’re sure to watch your account balance dwindle thanks to your inability to learn, or both. If only for the safety of your money, please spend the time to practice your trading abilities with a free simulator–we’re sure you’ll be glad you did!

Reasons to Avoid Forex Simulators

Forex trading simulators can be deceiving as much as they are helpful. A minute difference in terminology often makes the difference between the best forex simulators, and the worst.

Trading simulators can use both real-time, accurate forex data derived from the foreign exchange market, or data that is simulated. Simulated data–forex feeds that are made up–will not make you a better trader, as you’re testing your abilities against a fake market feed.

On the other hand, demo accounts almost always use real market data. When deciding which trading simulator to use, opt for a demo account that uses a real data feed. All MetaTrader 4 platforms use real data from broker servers, and thus your simulated trades are actually measured against changes in the real forex market.

Forex Hedge Funds

Because the foreign-exchange market (forex) is an over-the-counter marketplace, the barriers for entry into this exciting field are very easy to break through. The market is globalized, thus there are no central regulating authorities. As such, forex hedge fund managers can launch their own funds simply by meeting the regulation of the country in which the hedge fund wishes to operate.

Best Fund Countries

The best countries to release a forex hedge fund are those that have a significant flow of capital (to attract investors) as well as limited regulation and oversight. Unfortunately, from the perspective of the hedge fund manager, the United States is unlikely the best place to start. Expensive barriers to entry as well as complicated accounting regulations make it impossibly expensive for upstart forex hedge funds.

Forex Hedge Fund Fees

Hedge funds are some of the most expensive, albeit some of the most profitable, investments for wealthy clients. Ordinary, a hedge fund manager receives as much as 15-20% of the profits each year as well as a 1-2% fee on all accounts at the fund. If the forex hedge fund were to produce returns of 30% on a $100 million portfolio, the hedge fund manager would receive his annual 1-2% cut ($1-2 million) as well as a 20% bonus on the hedge fund’s returns ($6 million at 20%).

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