The Ultimate New Trader Guide Part Two

In part one of The Ultimate New Trader Guide, we looked at how to approach Forex and CFD trading in the right way, including the mindset needed to become a master.

Here, in part two, we'll concern ourselves with types of analysis used, and touch on the best markets to trade, timeframes and finally talk a little about mechanical and discretionary methods.

Much of what I say in these guides is true for all types of trading, but at Tradeneophytes, my goal is to help you become a short-term swing trader and so everything I advise has that one aim in mind.

My thoughts on Technical Analysis

First off, if you're not yet familiar with what Technical Analysis is, you should read here before continuing.

Over the years, I've tried most traditional charting techniques, and being honest, most didn't work - for me.

A big part of that was down to my erratic trading psychology and general newbiness at the time (a very long time in fact).

But I do have a good nose for smelling a rat, and quite frankly, many of the traditional techniques espoused in all the books and on all the courses, are not good enough timing tools when for Forex or CFDs.

What do I mean by that?

It's not that the chart patterns, indicators, trendlines, support and resistance don't work on leveraged trading instruments, it's that the use of leverage brings with it a new set of problems.

With margin trading, every pip move against you cuts deep psychologically.

The longer you wait for a trade to 'come good', the more open you are for emotional hijackings.

The indicators, moving average crossovers, trendline techniques, and all the other 'usual suspects' are just not good enough at market timing for my liking.

Trading Tip: Take special care when choosing the trading methods you use when with leverage.

Approaches I'd avoid

With many traditional techniques, you are entering either when the price has already moved a lot, or are entering against the prevailing short-term price trend.

Such as trying to catch a market bottom (or top), as with all the methods below.

  • Elliot wave
  • Momentum & price indicators
  • Fibonacci ratios
  • Buying at support, selling at resistance

Beginners don't know the dangers of trying to buy at a bottom or short at a top.

To seems to make perfect sense.

In the 'real world' we all want to buy something on the cheap or sell something at a high value.

So newbies choose these type of methodologies thinking it's the right thing to do.

But, markets are not the 'real world'. Much of what works in the world of trading, is opposite to what works in everyday life.

Trading Tip: Stay away from any method that tries to catch a top or bottom in a market.

 

Momentum must be on your side

Momentum must be on your side

With experience, traders figure out buying at bottoms is a bad idea.

It leads to catching a falling knife, or if shorting at a top, being squeezed.

Neither is pleasant, throw leverage into the mix, it can be very painful emotionally.

When I say that momentum should be on your side, I'm not talking about using some RSI, MACD type divergence either.

I'm mean, the price must have already started moving upwards (or down).

I'm not saying you should buy a market that's already had a very large move, that's just silly.

But you need to jump on board as prices start moving, not a moment before.

There's a specific point in the market when the short-term trend changes, and it's here where you step in.

Trading Tip: Find a specific trigger point in the market where prices clearly become favourable for the direction you wish to trade.

 

Breakouts Strategies

One of the best ways to do this is with breakout strategies.

Breakouts tend to get a bad rep.

A market fails to break out to new highs and suddenly traders start complaining breakouts 'no longer work'.

But this isn't the way to look at breakouts.

Markets break out all the time and on all timeframes.

They break out on 10-minute charts, in the first 30-mins of trading, and after tight consolidations.

Ways to catch breakouts include the following:

  • Tom Demark trendlines
  • Bill Williams fractals
  • Bollinger band strategies
  • Inside Bar breakouts
  • Chart patterns - coils, springs, triangles, wedges

You can still lose money with breakouts (as you can with any system) but because momentum's on your side, there's less chance of catching a falling knife or being short squeezed.

Plus, with an effective breakout strategy, you know quickly if you're right or wrong, which means you waste time worrying over it.

There are many sub-disciplines within the area of Technical Analysis, some more useful than others.

By concentrating your efforts on a select few that are suitable with leveraged you'll save time and a world of pain.

Trading Tip: Get a book or two about short-term trading techniques, breakout trading or volatility breakouts. Master them. And forget everything else.

 

Fundamental Analysis

Fundamentals are interesting.

You can debate forever with your 401K stock buddy what's going on at the Federal Reserve; if PE ratios are expanding or contracting; or how the trade deficit is affecting Uncle Buck.

With fundamentals, you get to express an opinion, and who of us doesn't like to do that?

The problem is often, our opinions are dead wrong, and we are rarely in possession of all the facts.

I've seen long-term investors who rely on fundamentals make decent returns. But it's always in the long-term.

Have you noticed how fundamentalists are fond of saying, 'you can't time the market'?

What they mean is, they can't. Not surprising if you're relying on fundamentals as a timing method.

As mentioned previously, you need superior timing tools when trading with leverage to avoid the psychological pitfalls of Forex or CFDs.

On balance then, it's just not worth going too deep in studying the fundamentals.

That said, it's not good being totally ignorant of them either.

I personally keep abreast of the most important macro and geopolitical events making the headlines.

And in terms of specific data, I follow these:

  • Gold/Silver ratio
  • Gold/Oil ratio
  • Yield curve
  • Dow/Gold ratio
  • Ted spread

Real financial shocks are rare, but it's important to know if one's around the corner.

The bond market is usually the first to cotton on.

An inverted yield curve is a pre-cursor to impending financial crisis, as is the Ted spread.

The bond market (smart money) figures out the economy is going to hell in a handbasket and start buying short-dated bonds while selling long-dated ones.

Meanwhile, other players are buying Gold (an insurance policy), and selling Silver or Copper (industrial commodities).

All the above, highlight what the smart money's up to.

Taken together, they can be telling as to any future financial shocks.

Trading Tip: Follow the fundamentals through smart money ratios.

 

The Commitment of Traders Report

Another smart money indicator is the COT report.

It reports the aggregate positions of the largest traders required to report to the CFTC.

By largest traders, I mean trading funds, multi-nationals using commodities in business ops, swap dealers, banks and speculators.

The COT is a futures report. It has nothing to do with spot Forex or the stock market.

But the futures market can be used to trade the GBP, USD, Yen and Euro, which is where many astute players reside.

Knowing how the smartest (and dumbest) are positioned is enlightening (and rewarding).

The smart money knows all fundamentals you and I are clueless of.

They've boots on the ground.

They know what's going on in Iraq and how it affects Oil supply.

Or, how impending strikes in Chile will affect the price of Copper.

They'll know if the weather's going to cause problems in the agricultural sector.

And in Foreign Exchange, they're better at weighing up the economic data than any stay at home retail traders could ever do.

So, it makes perfect sense to keep an eye on what they're up to via the COT report.

Trading Tip: Follow the extremes in swap dealer positioning as a leading indicator.

 

Choice of markets

I personally think the best markets to trade are Indices.

They've got a natural bias to the upside which, believe me, is no small thing.

They've less intraday volatility, meaning they don't mess with your emotions in the same way as the hyper volatile FX market can.

It's unfortunate in the United States that Index CFDs aren't available.

Another market that can trade well is Gold. Certain setups just seem to work smoothly over in that market, ditto Copper and Oil.

When Gold moves it really moves, catch one of its parabolic trends and it can make your entire year!

IMO more traders would be successful if they'd concentrate on Indexes rather than Forex.

But, if Forex is the only option, or you feel destined to be an FX trader, its advisable to stick to the major pairs, GBP/USD, USD/CHF, USD/JPY and EUR/USD.

At least while you're new to trading.

Trading Tip: Each market has its own volatility profile, choose markets suitable for your experience.

 

What timeframes are best?

What time frames are best?

My bias is for 8-hour and daily charts.

Everything on this blog is written with those in mind.

8-hour charts are particularly nice.

Not all brokers platforms provide them but if yours does, they're worthy of consideration.

They're long enough for Simple Pattern Trading strategies to work well, but short enough for the trader to feel he is actually 'day trading' or 'working for a living'.

The quicker the timeframe, the more erratic the technical picture becomes.

Very few TA tools are going to work with accuracy on anything less than 4-hour charts.

Daily charts are the best for me, especially on Forex.

The hardest part of trading on a daily chart is to refrain from actually doing anything during the course of the day.

You just have to learn to relax, trust the system and the markets, and let your market edge work out.

Losses are much easier to accept the longer they take to occur. You're not so prone to hijack yourself.

Trading Tip: Losses on smaller timeframes can lead to revenge trading.

Day Trading

There's nothing more appealing to the newbie than the idea of making $100 a day, $3000 a day, even $50 a day.

There is something psychologically comforting about pulling out money from the market on a daily basis. It feels like you're at a 'real' job.

And, it's certainly possible to make impressive returns within any one day.

But, it's just not possible to do it consistently day after day.

Often, the best intraday trades, if kept longer, would go on to make multiples of what's they do in day trading.

You have to ask yourself the question, do you want to make money or do you want to satisfy your need to be trading every day?

Day trading is akin to playing a slot machine; one decent win and you think you can do it constantly. In reality, you're going broke slowly.

Small intraday timeframes should be left to the shoot 'em up gamers and poker players who thrive during intense situations.

If this doesn't describe you, then better not to start trading the lower timeframes.

You are up against two problems when intraday trading:

  1. Most systems just aren't accurate enough
  2. You can lose money at a fast clip which leads to revenge trading

As a successful trader on an 8-hour or daily chart, the leap to successful day trader isn't so great.

But for a total beginner, it's like trying to leap a giant chasm.

Trading Tip: Day trading wins often work out much bigger if held over days.

 

Long-term position trading

While I advise beginners against day-trading I also advise them against longer-term or trend trading.

You'd think this timeframe would be ideal for beginners, but it's not.

And here's why.

Trend traders use wide stops and there's little worse for a newbie trying to make his or her first profits than seeing those profits going up in smoke.

You'll give back many profitable trades, all in an attempt to land that one big fish.

This is enough to a mess with a newbies head, which then sets off a cascade of related emotional issues.

Which is why I advocate short-term trading for the beginner.

Trading Tip: Using wide stops can work against you psychologically if you give profits back regularly.

 

Mechanical or Discretionary approach?

Mechanical systems involve following a strict methodology, (usually technical) on a consistent basis.

A discretionary system, on the other hand, involves a 'weight of the evidence' approach.

Discretion is often based on fundamentals, but also many technical traders use discretion based on what they think the charts are saying at the time.

I'll let you into a secret, I never know what the charts are saying at any time.

The best I can do is do what they are telling me to do.

I have no trust whatsoever in my own discretionary ability to make that call.

That sits with me fine though, I follow a mechanical system and implement it, regardless of what my 'gut' is telling me.

I usually find my system's right, and my own thoughts are wrong.

One of my primary goals as a trader is simplicity and that should be yours too.

So why add layer after layer of thought to the process of trading, when a mechanical system works equally well if not better?

There are two problems with discretion.

  1. There are far too many moving parts to make an informed choice
  2. Once you've made the call, and if wrong, it's easy to spend days beating yourself up afterwards

Discretionary systems are also extremely difficult to backtest with any degree of accuracy

A mechanical system's much simpler.

Backtesting is an important part of being a professional mechanical based short-term trader, and next time, in part three of The Ultimate New Trader Guide I'll tell you why.

Trading Tip: Beginners should opt for simple mechanical strategies testable either in Excel or with backtesting software.

 

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John Scott
John Scott has been trading CFDs and FX since 2003. His favourite markets are the Dow 30, Gold and the GBP/USD. John believes short-term price action trading is the best approach for beginners to trade. Tradeneophytes is his humble attempt at helping new traders reduce the learning curve to trading success.
Posted in Beginner Trading Guides.

John Scott has been trading CFDs and FX since 2003. His favourite markets are the Dow 30, Gold and the GBP/USD. John believes short-term price action trading is the best approach for beginners to trade. Tradeneophytes is his humble attempt at helping new traders reduce the learning curve to trading success.

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Leandro GUimaraes
Leandro GUimaraes
3 months ago

Great guide, John. Keep it up.
Just to let you know that there’s one link for “short-term trading” on this page which is not working.
Looking forward to Part 3.
Many thanks!!!