Forex Secrets: Successful Scalping Strategies from the Dark Side

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Introduction

If money is your hope for independence you will never have it. The only real security that a man will have in this world is a reserve of knowledge, experience, and ability.

Henry Ford

This book is designed for people who already have a basic knowledge of technical analysis, as well as some background in fundamental analysis and economics. It assumes that you have experience with charting basics and economic dissemination, and that you have done some investing. Forex Secrets goes into practical depth on many issues that relate to scalping and trading. You will benefit more if you have some trading experience, either in a real or demonstration environment, paper trading, or demo account with exposure to technical analysis. The concepts of scalping require a deep understanding of how the currency markets work in relation to global economics and technical analysis. This does not mean that the material covered in this book cannot be learned without that experience; it just means you may need to spend extra time learning some of the more difficult concepts. You will not learn it all overnight. If it were that easy, everyone would be scalping successfully.

Also, as an introduction, I want to emphasize that while this book is designed to teach you many scalping concepts as they relate to the Forex markets, the concepts can be used in just about any market that has volatility. Examples in the book will refer to the Forex markets, and most of our discussions will be on Forex, but the principles can be applied to any volatile market.

The book should be considered nothing more than education. I am not here advocating any kind of personal recommendations or stating this is the Holy Grail of trading. You can use everything in this book literally word for word, or you may incorporate certain parts into your current trading plan. It is not meant as a learn-all, do-all, guru-type of trading system. This is a book that teaches about scalping the markets through a set of proven processes.

There are no shortcuts to successful trading. Forex Secrets is detailed and does not provide one easy answer. It is a culmination of my experiences and trading style that has been laid out for you to use.

The principles that I discuss in Forex Secrets are ones that I have developed over many years and have employed in various trading programs in real life. They have worked well for me over the years, but they are constantly being tweaked. Even though I have been trading for over twenty years, these principles change, the markets change, situations change, and I learn new things, so nothing is carved in stone. What works well for me now may need to be tweaked next year or may not work well for your personality.

Some of these concepts may be difficult to grasp, and because of that, I will repeat them several different ways. Average adults need to hear or see a concept five to seven times before they fully remember and can apply the knowledge. There will be times when you read something in this book and think it makes sense, but then it will be repeated in a different way, and that is when the light bulb goes on and you get that aha moment. All of a sudden it becomes more than intellect; it becomes clear and usable. At that moment the knowledge has become a powerful tool for you to implement in your trading.

Tools for Success and Scalping Preparation

There are a few items we need to touch on before we get into the real meat of scalping. We need to talk about certain fundamental items and market conditions. When we need to fix a physical item, we may reach for a hammer or screwdriver. If we have to write a letter or analyze lots of data, we may use a computer. All of these are tools that make the task successful. Everything we discuss in this book is nothing more than a tool to utilize to become a successful scalper.

Cycles, or waves, play a big role in the markets, and it is these market waves that can help us become more accurate traders. When we look at a chart, we can see patterns. If we look at the chart in a bigger or longer time frame, we will see even more patterns or waves. It is these market waves that are not all that prevalent unless we are looking for them. They are just another tool for us to use to be successful.

Some of you may have studied theories like Elliott Waves, Fibonacci, or Gann numbers. These all have a lot to do with cycles or patterns in the markets. There is some truth to these theories, and they do play a significant role in trading. Learning to recognize cycles or waves can increase the odds in our favor. They can cause a direction change in the market. Cycle times can last for very short or very long periods. We have top points and bottom points in cycles and waves. It is these up and down, top points and bottom points that we are concerned with. On longer-term trends the points in between those high and low spots are significant, as they determine tradable trends.

As markets change direction, cycles change; this can also be considered a visual for a change in sentiment. Sometimes sentiment changes within hours. Sometimes it takes years. The market sentiment, or the tone of the market, can be set by many events. Sometimes they are technical in nature, but more than likely it is because of fundamental events. It is fundamental events such as economic reports, political events, or various unexpected disasters that can change the sentiment of a market. Sentiment can sometimes change very quickly, and it can change on a short-term or long-term basis.

Let’s think of the markets from a psychological standpoint. Many times the markets are moving in one direction, and all the market players feel comfortable with that direction. The market is moving up and everybody feels confident; everybody is buying, so the market continues to move higher. Buyers are willing to pay a higher price than sellers are asking. As sentiment increases there comes an almost frenzied buying. Then all of a sudden something happens that changes market sentiment. An economic report comes out. We have hundreds of them every day, all over the world. Maybe retail sales in Japan, maybe unemployment in Europe, or maybe a rate decision in Brazil. We have become a global economy. What happens in Indonesia influences markets in Vancouver, Canada. We cannot avoid the globalization of our economy; we can only accept it. We have to learn how all this information influences everything else, especially when we are trading currencies.

Market sentiment is an interesting concept, and many times it seems almost unpredictable. When the market has been going up, everybody has been on board, believing the good times will never end. Then an economic report is released, and all of a sudden everybody starts thinking that this is not such a good market to be in at this time. They may say, I’m not going to buy anymore. As a matter of fact, I may sell some of my positions because the world doesn’t look so good right now. Thus, a change in sentiment has just occurred. The market now starts to go down. There are more sellers than buyers. The tone of the market has changed. The cycle has peaked; direction has changed. There has been an event that has switched the thinking of market participants.

Market Construction

Here is a trick question. What makes up markets? All markets are made up of human participants. It is the psychological factors of all these human participants that make markets move either up or down. Market participants are humans, and humans are fickle. They are going to change their minds many times in an hour, many times in a day, many times in a year, based on information that is fed to them. It is similar to computers. We type information into them, and they change. The difference is that humans are reactionary. Computers are non-emotional. Humans react to the information, and it is this reaction that creates markets and makes them move. We may think, Things are not as good as they were an hour ago, and I no longer want to hold this particular investment - stock, futures, currency cross, whatever it may be. There are a lot of psychological events that drive markets. If we can understand this psychology, not necessarily understand why, but understand that it happens, and understand when perceptions are going to change, then we will be able to be more successful in our entries. There may be a cycle top, which is a timing event as well as a measurable distance on a chart. Because time is distance we can almost plan where that market will be next, regardless of any report. It may not be that bad a report, but, again, markets are driven by human emotions. So when the market peaks in a wave or cycle, it is telling us that at that particular moment the psychology of the market is vulnerable to a reversal. We are going to talk a little more in depth about fundamental events in the coming chapters, and then we are going to learn to apply solutions in our trading to neutralize the risk of these events. It really is very important, and many traders, especially amateurs, do not want to deal with all these factors because it is complicated, convoluted, and abstract. But the more we understand about human emotions, the more we understand the driving forces behind the markets, and the better traders we are going to become.

There are many scheduled news items that are released within a day, and they all have certain expected outcomes. It is these expectations compared to the actual news release that affects markets. Scheduled events may be simple economic reports or major political events. These types of news items are released, and everyone is prepared with a consensus of expectations. What they are unprepared for is when the actual event is different from the expectations. The true market movers are the unexpected news events - life-changing events such as an earthquake or tsunami like we experienced in 2011 in Japan or terrorist attacks in New York and Washington in 2001 - that surprise markets to switch direction or to make exceptionally large moves in an unexpected direction. These events have profound effects on markets. It is these types of events we cannot predict; it is these events that throw the markets into turmoil. In August 2001 I spoke with an associate who said to me, Something big is going happen. I said, You know, I can sense that too. We could not possibly even think of what was actually going to happen on September 11. That was the furthest thing from our minds. But we knew something was going to happen. How did we know? Cycle change; we were hitting a cycle top economically and in various industrial sectors. The general feel of the market, the tone of the market, was at an extreme. The tone of society was at an extreme. This was, if you remember, the time of the dot coms. We had gotten to a point in the markets where everything was starting to collapse. There was so much euphoria for so long, and then the dot coms collapsed.

People are the driving forces behind market actions; they set market tone. Understanding this tone is most commonly referred to as reading the tape. Sometimes it is obvious, but we just cannot put our finger on it. It takes time to develop this sixth sense. As we work through this book, we will talk about how to better recognize these events. We are going to talk about market sentiment and recognizing the tone of the market, as well as how we can best use that information to our advantage.

In 2001 when my friend and I felt something was going to happen our surprise was not at the event but at the magnitude. On September 12, the day after the terrorist attacks, he called me, and all he said was, Wow. He didn’t say hello or give any other greeting. All he said was Wow. I said, You know, we both felt it, but we couldn’t imagine what just happened. The markets were shut down. How can you possibly imagine anything like that? How can you prepare for something like that? What we are really talking about is risk.

Markets many times get to these extreme points and news items come out, or there is some catalyst that changes the cycle, or changes the tone of the market, but it may not be such a catastrophic event. It may be just a small event. Small events at cycle tops or bottoms can significantly move the markets. If, on the other hand, there are large, unexpected events such as terrorist attacks, an earthquake, or a tsunami at market tops or market bottoms (cycle tops, cycle bottoms), then those events can have a profound impact on markets.

Market risk dictates when we should be in or out of the market. Timing those in or out periods comes only from a well-thought-out money management plan with an accurate risk profile. We will examine the best ways to achieve these while maintaining our focus on short term scalping strategies.

Chapter 1

History and Concept of Scalping

Wide diversification is only required when investors do not understand what they are doing.

Warren Buffett

Some of us may feel that a history lesson is not necessary for learning how to scalp; however, I argue that the more we understand about the basics, the more successful we will be in the longer term. Knowledge is power, and the more knowledge we have about the reasons why can benefit us greatly. While those people who start out on the ground floor of a new entity or business have the benefit of knowledge gained from trial and error, the rest of us have to learn it through our experiences. Which way is better is a matter of opinion. In either event, reading this chapter can only help.

Scalping started out on the exchange floors, where traders buy and sell very quickly. Floor traders are the ones who can buy at the bid and sell at the offer. On the trading floor it was common for a trader to make thousands of trades in a day.

The Bid/Offer

In any type of market transaction there is a bid and an offer. Exchanges are an auction place, and within the auction place you can buy and sell any particular item that is listed. In the case of Forex, there really is no formal centralized exchange or trading floor. Forex is a set of interconnected banks and financial institutions. This interconnection, or network, is all done electronically between the banks forming sort of an electronic exchange. Because there is no centralized exchange, there are no rules and no guarantees.

Forex, because of the wants and needs of the various institutions, sets up a competitive auction. This competition creates the required bid/offer as in any auction market place. The financial institutions within the network are the ones that can buy at the bid and sell at the offer, just like a floor trader. Individuals or any non-Forex network players who wish to get into the game will need to go through one of the financial institutions that are connected to the Forex network.

The bid is the lower price, and the offer is the higher price. Financial institutions buy at the bid and sell at the offer, and their profit is the spread in-between. They receive this profit for making the market; hence the term market makers. In order for us to trade, we need to go through an institution that is either connected to a market maker or is a market maker. This forces us to buy at the offer (higher price) and sell at the bid (lower price). So we are buying at a high price and selling at a low price, which means there is an inherent risk as soon as we get in, as soon as the trade is initiated. That is true in stocks, bonds, and futures, as well as in Forex. The spread is what the market maker receives for their work. In addition to the spread, some financial institutions may charge a fee or commission for executing a trade. This practice is not as prevalent as it once was, as competition has eaten away at duality of commissions and spreads. The Financial services industry used to be extremely profitable. It still is, but the margins have dropped considerably, and volumes have increased, balancing out overall brokerage firm profits.

Scalping Concept

Scalping is looking for small multiple achievements. Floor traders were the ones who really originated scalping because they were buying at the bid, the lower price, and selling at the offer, the higher price, or vice versa. On the floor traders are either considered locals (locals trade for themselves) or trade paper. If traders trade paper for a brokerage house, then they execute orders for retail clients. Locals are the ones who are the true scalpers because they are the ones taking those small amounts of profit on each trade. There are also many floor traders who will take position trades or swing