At face value, foreign exchange (forex) and share trading have lots in common. Whether it’s shares or currency, the aim is to buy when it weakens in the hope of selling when it goes up in value. But as trader Steve Matthews discovered that’s where the similarities end.
What Matthews learnt about forex trading was how simple maths (or money-management principles) can offset the extreme unpredictability of analysing forex using fundamentals. His biggest epiphany was the realisation that he could side-step daily news and commentary and – by trusting the ‘technicals’ (the charts) – he could use one currency pair to de-risk his exposure to another currency pair.
It’s something that few forex ‘how-to’ books properly explain, but some currency pairs move in opposite directions to each other. Typically, if the €/USD and £/USD are trading up, there’s a strong likelihood the USD/Yen and the USD/CHF will be trading down.
Admittedly, some people do try and trade key events. But with the markets quick to price in the news, Matthews says it’s extremely difficult to make money this way. “Fundamental news will have more impact within the current economic climate, but the technicals will win out in the end,” says Matthews who’s been a full-time forex trader for 18 months.
Matthews started trading back in March 2007 with GFT after six months paper-trading a demo account. Since then he has grown his initial account by 300 per cent.
The trading strategy that Matthews operates allows him to make money by mathematically cancelling out the USD (against the USD). “By trading one currency pair against another, I’m hedging myself from a protection viewpoint,” he states.
While no trader wants to jump into a loss position, Matthews says it’s the maths around the trading dynamics of two currency pairs that delivers the net return. “It doesn’t matter which of the two currency pairs goes up (or down), I still make money.”
Here’s an example of a recent trade:
Matthews bought the following pairs: €/USD and USD/CHF – on $50,000 leveraged at 200 to one.
He margined out at 10 per cent – in other words by using 10 per cent of his ($50,000) account he was able to put $1 million in leverage into these trades.
This strategy saw him buy: €448,085, and USD 331,914
The net affect: While these trades are still open, he has currently lost money on the USD (which was intentional) and the differential between the two represents an overall net return of 34 per cent.
Matthews trades every week of the year. He places two to four trades during any daily session, and mostly against the USD and another key currency, notably the € or CHF.
And while he says that he is not permanently glued to the screen, there are times when he stays up all night watching markets play out.
Given that there are three primary forex exchanges globally (Sydney, London and New York) Matthews can literally trade around the clock. He says the best trading opportunities are often at the start of the European market (6.pm Eastern) or the overlap between one market opening and another closing.
While he occasionally trades from five-minute charts, most of his trades are based on daily charts. Sometimes he has let his trades run (up to two months) to collect the ‘carry position’ – the interest rate differential between the USD at 1.5 per cent and 6 per cent against the AUD. “The longer your trading period, the more accurate your positions tend to be,” says Matthews. “You can get phenomenal leverage with forex trading and be paid interest on the leveraged position.”
So how does Matthews protect his money? To ensure he is not overexposed, Matthew usually trades on a 200 to one margin leverage, and never risks more than 10 per cent of his account on any trade. By keeping his trades open (longer than most) he manages to make money on around 80 per cent of his trades.
Sadly, he says most forex traders don’t achieve these success ratios because their emotions overrule the technical data. By matching their stop-loss to their risk profile instead of what the charts indicate, he says most forex traders pull out too soon. “It’s not uncommon for forex traders to take a loss position, only to see it take off in the direction they thought it would,” advises Matthews. “The danger is trying to base a stop-loss on a percentage or dollar value rather than what the technicals tell you.”
While there’s no bell signaling when to lock-in gains, he typically closes-out his trades when the charts suggest a change in direction. And while Matthews hasn’t endured too many meltdowns, he has lost as much as 35 per cent (around $70,000 in a night), which took up to six weeks to recover.
And his advice for other forex traders: “Once you’ve got a trading system, stick with it and follow what the charts tell you. Above all, never trade against the trend.”
Tips for forex traders
– Paper-trade first.
– Develop a game-plan around times, markets & trade length.
– Take the emotion out of stop-losses.
– Understand what the charts indicate.
– Master the basics before increasing your leverage.
– Never commit over 10% of your account to one trade.
– Only trade what you’re prepared to lose.
– Don’t agonise over losses.
– Calculate the losses you’re comfortable with.
– Develop a solid money-management strategy.