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Inside Scoop

by Michelle Gebhardt, Executive Editor

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VOLUME

10,

NO. 9

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SEPTEMBER

2011

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CONTENTS

18

By Brian dolan

RISKY

BUSINESS

gauge fx trades using risk sentiment

28

HOT CURRENCIES TO WATCH

By Paul J. Kavanaugh, CTA

32

THE FX WORLD: EXPAND YOUR BOUNDARIES

By Greg Michalowski

38

7 OPTIONS DAY TRADING TIPS

By Gregory Brown

departments

>

Tech Support

8

>

Technical Strategy

9

>

Ask Dr. Duke

11

>

Eye on Futures

14

>

Trade of the Month

16

Trading

46

With add

{

attention deficit disorder

}

By Kenneth Reid, Ph.D.

PUBLISHER
PUBLISHER

Wasendorf & Associates Inc. Russell R. Wasendorf Sr., Chairman and CEO Karris Golden, President and COO P.O. Box 849 • Cedar Falls, IA 50613

EDITORIAL EXECUTIVE EDITOR: Michelle Gebhardt MANAGING EDITOR: Kira McCaffrey Brecht

CONTRIBUTING WRITERS

PRODUCTION CREATIVE DIRECTOR: Sara Kies DESIGNER: Sarah Judisch DESIGNER: Samantha Schmiesing WEB DEVELOPER: Jeff Kennedy

CONTACT SFO Customer Service: 800.590.0919

SUBSCRIBE TO SFO

ADVERTISE WITH SFO ads@sfomag.com

800.590.0919

Copyright 2011 by Wasendorf & Associates Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form by any means, electronic or mechanical including photocopying, recording or by any informative storage and retrieval system without the written permission of Wasendorf & Associates Inc.’s president.

This publication is strictly the opinion and conjecture of its writers and is intended solely for informative and educational purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. This publication is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Information is obtained from sources believed to be reliable, but is in no way guaranteed. Further, there is no guarantee of any kind that is implied or possible where projections of future conditions are attempted. The publisher is not liable for typographical errors.

Commodity futures, securities, options and forex trading involve risk and are not suitable investments for everyone. Any investment should be carefully considered in light of an investor’s personal financial objectives and risk tolerance.

Articles and/or advertisements contained herein may provide hypothetical or simulated performance results. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, because the trades have not actually been executed, the results may have over- or undercompensated for the impact, if any, of certain market factors such as the lack of liquidity. Simulated trading programs are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. Further, past performance does not guarantee future results.

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TECH SUPPORT

LEARN TO USE STOCKTWITS

By Phil Pearlman

StockTwits offers high-quality trading ideas for stocks, options and futures as news is breaking. Members research as- sets using ticker pages that stream what other traders are thinking and doing while taking the trade. If there is uncommon volatility or vol- ume in a name, StockTwits’ ticker pages will have infor- mation (and color) on it as it is happening. StockTwits members can follow specific stocks and other members in their Home stream. Members share ideas in real time and receive feedback from the community by en- tering it in the message box. StockTwits’ streams pick up messages where the dollar sign precedes the ticker name — $AMZN. The StockTwits Chartly plat- form is a humongous chart sharing platform that allows members to filter charts post- ed by other members by asset or sentiment. It is also a live

ed by other members by asset or sentiment. It is also a live Phil Pearlman walks

Phil Pearlman walks you through the StockTwits website.

pattern recognition resource for those learning technical analysis. It’s free to set up an account and tap into the power of the StockTwits stream. A search box at the top of the site allows members to follow stocks by visiting the ticker page.The StockTwits Discovery Tool highlights members with similar interests. The StockTwits Suggested Stream features the most knowl- edgeable StockTwits members.

Each week, StockTwits pub-
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Each week, StockTwits pub-

which shows the best stocks with the best setups. It’s a great place to begin
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which shows the best stocks with the best setups. It’s a great place to begin your research as you prepare for the week.

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Phil Pearlman is the executive editor of StockTwits and an investor in the company.
Phil Pearlman is the executive editor of StockTwits and an investor in the company.
Phil Pearlman is the executive editor of StockTwits and an investor in the company.

Phil Pearlman is the executive editor of StockTwits and an investor in the company.

Phil Pearlman is the executive editor of StockTwits and an investor in the company.
as you prepare for the week. Phil Pearlman is the executive editor of StockTwits and an
as you prepare for the week. Phil Pearlman is the executive editor of StockTwits and an
as you prepare for the week. Phil Pearlman is the executive editor of StockTwits and an
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Source: data—Bloomberg

TECHNICAL STRATEGY

THE LIQUIDITY GAUGE

By John Kicklighter

The euro/dollar (EUR/USD) exchange rate is the forex market’s most liquid pair. In fact, according to the Bank

of International Settlements (the

central bank to the world’s

central banks) Triennial Survey,

the pair accounts for 28% of the average daily turnover on a $4 trillion-a-day market. What moves the exchange rate of such a prolific asset? A currency represents the value of all the fundamental and financial nuances of its economy.That role is further complicated when we mea- sure its value against another currency. However, lucky for us, there are only a few major catalysts that can move a mar- ket this deep — and EUR/USD in particular is a special case.

BULLISH FLOWS

In fundamental circles, FX trad- ers consider the U.S. dollar a safe haven currency.Though, rather than acting as a magnet for capital whenever market

1.5300 8 EUR/USD and EUR/USD Implied Vol (1mth) 9 1.4800 10 1.4300 11 12 1.3800
1.5300
8
EUR/USD and EUR/USD Implied Vol (1mth)
9
1.4800
10
1.4300
11
12
1.3800
13
1.3300
14
15
1.2800
16
1.2300
EURUSD
17
EURUSD Imp Vol (Inv)
1.1800
18
1/1/10
2/1/10
3/1/10
4/1/10
5/1/10
6/1/10
7/1/10
8/1/10
9/1/10
10/1/10
11/1/10
12/1/10
1/1/11
2/1/11
3/1/11
4/1/11
5/1/11
6/1/11
7/1/11
1.5300 0 EUR/USD and US FRA/OIS (3mth) 10 1.4800 20 1.4300 30 1.3800 40 1.3300
1.5300
0
EUR/USD and US FRA/OIS (3mth)
10
1.4800
20
1.4300
30
1.3800
40
1.3300
50
1.2800
60
1.2300
EURUSD
70
US FRA/OIS (Inv)
1.1800
80
FIGURE 1: Euro/Dollar and U.S. FRA/OIS (3 month)
1/1/11
2/1/11
3/1/11
4/1/11
5/1/11
6/1/11
7/1/11
1/1/10
2/1/10
3/1/10
4/1/10
5/1/10
6/1/10
7/1/10
8/1/10
9/1/10
10/1/10
11/1/10
12/1/10
1/1/11
2/1/11
3/1/11
4/1/11
5/1/11
6/1/11
7/1/11

participants are looking to transfer funds away from risky investments, the dollar really shines when liquidity is at a premium.The U.S. markets (spe- cifically the Treasury and money markets) are the deepest in the world, and this imbues the cur- rency with a special safe haven appeal.And given that the EUR/ USD is the most liquid asset in

the world, it is particularly adept at following the need for capital.

MEASURE LIQUIDITY

Therefore, when we want to verify a strong and lasting trend for the U.S. dollar (bearish EUR/ USD move), an indicator of fear and liquidity can help act as a gauge of conviction. Rather than attempting to intuit these

conditions, a great indicator of liquidity demand is the spread

between U.S. Forward Rate Agreements (FRA) and Over- night Index Swaps (OIS).

In Figure 1, we set the EUR/ USD price action (blue line) against the liquidity spread (red line).The spread actually is inverted, because the dol- lar is the second currency in the pair. As we can see, when liquidity is tight (the red line is low), the momentum behind the U.S. dollar builds, and the currency generates a greater level of strength.

It works best to confirm medium-term, dollar bull trends as a signal to take profit.

ENTRY SIGNAL

For entry, I typically use basic technical analysis (I prefer

using trendlines and moving

averages) and fundamental analysis to enter on a bearish EUR/USD (dollar bull) trend. From there, I use the liquidity gauge to assess its strength in terms of momentum and pace. If the liquidity measure is rising very aggressively, it typically supports a lasting and equally

strong rally for the dollar. When momentum on the liquidity measure flags, it is a strong sign that the dollar’s run will soon come to an end. Alternatively, when trading a EUR/USD bear trend that does not develop alongside a notable rise in liquidity, I plan for a much shorter trend by setting my profit targets and stop closer.

John Kicklighter is senior cur- rency strategist at DailyFX.com.

trend by setting my profit targets and stop closer. John Kicklighter is senior cur- rency strategist
trend by setting my profit targets and stop closer. John Kicklighter is senior cur- rency strategist
trend by setting my profit targets and stop closer. John Kicklighter is senior cur- rency strategist
trend by setting my profit targets and stop closer. John Kicklighter is senior cur- rency strategist
risk = reward What’s next for the Stock Market,Bonds,Interest Rates, Currencies and other Commodities? John
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Trading in futures and options involves a high degree of risk and may not be suitable for everyone.

ASK DR. DUKE

DEAR DR. DUKE,

I have an S&P 500 Index (SPX) August iron condor with strikes 1150/1160/1380/1390. I opened 10 contracts for a credit of $2. My planned adjustment strategy is the long hedge that you recommend. However, I am pondering the pros and cons of adjusting with a bull call spread instead. Under the long hedge adjust- ment scenario, I will buy one 1380 September call. On the other hand, I may adjust with an August 1370/1380 bull call spread. I can buy 10 of these spreads for $2 each.

ment. It allows me to hold the position longer to give it a chance to recover, while keep- ing losses to a minimum. — Alex; Richland, WA

DEAR ALEX,

I would not consider buying the 1370/1380 call spreads to be a viable adjustment. We are trading the iron condor on SPX as a classic delta neutral income generation trade. Our first objective is to mini- mize our price risk due to the

index price trending strongly in one way or the other. We monitor that price risk by keeping delta reasonably small or delta neutral.

Our second objec- tive is to maintain a steady rate of profit

I am always wary of putting more capital at risk in a losing trade.

This will consume all my initial credit, but it will make my max loss (above 1160) extremely small. I can hold the position until expiration with very little downside risk. Should the posi- tion recover at any point? I can sell the bull call spread and make a small profit. At first glance, it looks like the bull call spread is a better adjust-

generation via time decay. We monitor our profit potential by keeping our posi- tion theta large and positive. We are minimizing our price risk. I am always wary of putting more capital at risk in a losing trade. It’s often best to close the trade.The proposed call spreads would require an ad- ditional $2,350.The result will be a position that is essentially

Q&A

delta neutral, but the position’s theta will have turned nega- tive. We are no longer making money from time decay. We have locked in a minimal loss if the market continues upward, but we also have tied up more capital, and time works against us. By contrast, you could buy a September $1,380 call for about $1,100.This adjustment requires less money, but it reduces your delta risk substantially. More im- portant,theta remains positive. Alternatively,you could close the position today for a small loss. It would be much better to either close the position now or adjust with the September call. Buying the call spreads puts more capital at risk and transi- tions our trade into a negative theta position,one that loses money with the passage of time.

Kerry W. Given, Ph.D. (aka Dr. Duke) is the founder and manag- ing director of Parkwood Capital LLC and the author of No Hype Options Trading . Parkwood Capital LLC and the author of No Hype Options Trading.

Dr. Duke) is the founder and manag- ing director of Parkwood Capital LLC and the author
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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

EYE ON FUTURES

ABOUT RISK

By Curt Wagaman

Many successful traders will tell you that most of their ef- forts are focused on managing risk rather than making profits. This is exactly the opposite of how many traders think. Consider the following:You’ve crafted a technical trading strategy that trades exclusively in one market.You back tested it to death, being careful not to over-optimize.You concluded that the strategy has performed well in the past and meets your criteria to move forward. You begin to paper trade the strategy and have found that if you adhere to the rules set forth in your trading plan, then you achieve very similar results as those obtained from back testing. For the sake of discussion, let’s say that your strategy has a 65% winning percentage and achieves a risk/reward ratio of 2:1.

Enough testing has been done to deduce these num- bers as statistically significant. For our purposes, the specific numbers aren’t all that im- portant. What we will assume from these numbers is that if everything is conducted exact- ly the same in a live account and market conditions remain the same as those tested in, then we should have a winner on our hands.

NOT SO FAST

First, ceteris paribus rarely ex- ists in trading. Second, sticking to your trad- ing plan in the face of adver- sity and psychological factors isn’t easy. Third, a 2:1 risk/reward ratio sounds nice. However, pose this question to yourself: What percentage of your account are you risking per trade? Many traders have an opinion on the optimal risk per trade, but the point is you cannot afford to risk too much.

Sticking to your trading plan in the face of adversity and psychological factors isn’t easy.

Think about professional trad- ers, CTAs and others who have experienced prolonged success. Even the elite have losing trades, losing streaks and subsequent drawdowns in their accounts.

DRAWDOWNS

 

Risk of ruin illustrates how in- evitable losing streaks can wipe out an account. It’s calculated by looking at the probability of win- ning, the probability of losing and how much is at risk each trade. Flip a coin thousands of times, and you’ll find streaks where one side appears many times in a row.This is the los- ing streak. Even with a coin weighted 65/35 in favor of suc- cess, you will still undoubtedly experience bad spells. If you consistently risk too much per trade and trade long enough, you’ll go bust. Bottom line — expect the best, but always plan for the worst and manage risk accordingly.

Curt Wagaman is an instructor and professional trading mentor for the futures training division of PFGBEST.

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TRADE OF THE

LOOKING FOR A BREAKOUT

By Casey Stubbs

As of mid-August, the euro/ dollar (EUR/USD) is in a tight consolidation range. Traditionally, EUR/USD is a

trending pair, which is why it is

a favorite among traders. How-

ever, now traders are confused as to which way is best to

trade it.The good thing about the current tight range is that

it creates an opportunity for a breakout.The breakout could

MONTH

be quite significant and travel for some time. Figure 1 shows a pattern you should be looking for if the eventual breakout is a down- ward movement. Notice how it tests the trendline and the key resistance level before making a strong break to the south. A breakout in the upward direc- tion involves the same princi- ples as the downward breakout in terms of testing the trendline and the key resistance area. Keep in mind that we need to take an entry based on price action and what the market is

doing, not our bias on which di- rection we feel that it may go.A strong breakout from a channel is a very high-probability trade, and traders can risk a relatively small amount of capital for the chance to have huge gains.

THE TRADE

 

Buy price would be: 1.4700 Target would be: 1.5200 Stop loss would be: 1.4600

Casey Stubbs is the founder of

Winners Edge Trading.

 
1.4700 Target would be: 1.5200 Stop loss would be: 1.4600 Casey Stubbs is the founder of
1.4700 Target would be: 1.5200 Stop loss would be: 1.4600 Casey Stubbs is the founder of
1.4700 Target would be: 1.5200 Stop loss would be: 1.4600 Casey Stubbs is the founder of
1.4700 Target would be: 1.5200 Stop loss would be: 1.4600 Casey Stubbs is the founder of
1.4700 Target would be: 1.5200 Stop loss would be: 1.4600 Casey Stubbs is the founder of
Source: Tradestation chart from FXCM 1.503 1.492 EUR/USD Daily Chart 1.481 1.470 1.459 1.448 1.437
Source: Tradestation chart from FXCM
1.503
1.492
EUR/USD Daily Chart
1.481
1.470
1.459
1.448
1.437
1.426
1.415
1.404
1.393
The current price range on the EUR/USD
lasted for 5 months as breakout is coming
in the near future
1.382
1.371
If this level gets broken, then we could see 1.3300
1.349
1.337
1.326

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RISKY BUSINESS?

RISK SENTIMENT

GAUGE FX TRADES USING RISK SENTIMENT

Even if you’re not active- ly trading forex, paying attention to what’s hap- pening to FX risk assets can provide important signals for other major financial markets. For traders crossing over to forex markets from stocks or commodities, the flow of market news and data in currencies can be overwhelming. Avoid paralysis by analysis by using risk sentiment to

form short-term FX trad- ing strategies.

RISK SENTIMENT Risk sentiment (aka risk appetite) is a relatively new market term used to express investors' atti- tudes. Bullish and bear- ish describe stocks, but risk sentiment applies to a broader swath of finan- cial markets. If investors are confi- dent in the economic out-

look and news and data are supportive, they’re seeking risk. They have an appetite for risk. The risk is said to be "on," typically sending stocks and commodities higher and safe assets lower. If bad news on the economy is dominant or data is disappointing, sentiment shifts toward risk aversion, or "risk- off" mode. Investors typically dump so-called

Source: Bloomberg, FOREX.com 1 weak/no correlation 0.8 0.6 0.4 0.2 strong positive correlation 0 -0.2
Source: Bloomberg, FOREX.com
1
weak/no correlation
0.8
0.6
0.4
0.2
strong positive correlation
0
-0.2
start of Great Financial Crisis
-0.4
Jul-01
Dec-01
May-02
Oct-02
Mar-03
Aug-03
Jan-04
Jun-04
Nov-04
Apr-05
Sep-05
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Mar-08
Aug-08
Jan-09
Jun-09
Nov-09
Apr-10
Sep-10
Feb-11
Jul-11

FIGURE 1: S&P 500 and AUD/JPY 60-Day Correlation

Figure 1 plots the 60-day rolling correlation over the last decade between AUD/JPY and the S&P 500, to use two examples of risk assets. Note that prior to 2006, the relationship was nonexistent, fluctuating between negative and positive and never reaching statistically significant levels of correlation one way or the other. With the bursting of the U.S. housing bubble and the Great Financial Crisis of 2007-09 (GFC), a strong positive correlation materialized. What’s behind that? And more important, how long will it persist?

risk assets and seek shel- ter in safe haven assets.

RISK OFF CURRENCIES In currencies, the Swiss franc (CHF) and the Japanese yen (JPY) are the primary havens when risk is off. Part of this is due to short- covering. Both are low- yielding currencies that are typically sold when risk is on as part of the carry trade strategy. If the market environment deteriorates, short-JPY and -CHF positions need to be covered. The Swiss franc his- torically has functioned as an insulated alterna- tive to major currencies. The JPY benefits from Japan’s traditional trade surplus and vast pool of domestic savings. It’s not reliant on foreign lenders (95% of Japanese government debt is do- mestically owned). The USD can be two- faced as a safe haven, weakening in a risk on environment as safe haven demand for U.S. Treasuries fades, pos- sibly even on the back of

TAKING A RISK

Risk assets — markets that expose investors to greater potential risks and rewards (typically stocks and commodities). In the forex space, risk assets are long carry trade pairs (long higher yielding/short lower yield- ing currency), like long Australian/Japan (AUD/ JPY) or New Zealand/Japan (NZD/JPY) currently, and long commodity currencies, such as Aus- tralian dollar (AUD), New Zealand dollar (NZD), Canadian dollar (CAD) and the Norwegian krone (NOK) against safe haven currencies. Long emerging market currencies like the Mexi- can peso (MXN), South African rand (ZAR) and the Turkish lira (TRY) also function as risk assets in the currency world.

PLAYING IT SAFE

Safe haven assets — popular during times of mar- ket turmoil or extreme uncertainty. Among major financial markets, government bonds of highly rated nations are the preferred refuge — U.S. Trea- suries, German bunds and Japanese government bonds (JGB’s). Precious metals, such as silver and gold, also have acted as safe haven plays, especially with plights in the euro (EUR) and U.S. dollar (USD). At other times, the metals may tend to follow overall commodity trends.

upbeat U.S. data (which is good for risk appetite), but then strengthen- ing if markets turn risk averse, potentially after worse-than-expected U.S. data (bad for risk

sentiment). As you can see, the USD reaction to U.S. data frequently can be counter-intuitive but viewed through the lens of risk sentiment. It makes more sense.

CHANGING TIMES Risk sentiment has been a dominant driver of market moves. In terms of risk senti- ment, investors clearly fell into the abyss follow- ing the Great Financial Crisis but also have re- surfaced to find a vastly altered landscape. As major central banks cut rates to near zero, inves- tors have been forced to chase yield more than ever. Decent returns in traditionally safe assets (i.e. bonds) are scarce, so they are forced into more

risky assets. Traditional asset managers (pension funds and endowments) have plunged headlong into commodities. Another reinforcing element is the increased prevalence of algorithmic trading programs (algos), both on the institutional and retail level. Many rely on inter-market sta- tistical relationships as key drivers. In terms of the outlook, the anemic recoveries in the major economies suggest rates will remain low through 2012 and likely into 2013,

while algos will continue to proliferate, suggest- ing the risk on/risk off dynamic will remain a viable trading approach for several years.

MEASURING RISK SENTIMENT Gauging sentiment is always a questionable proposition, whether its consumer confidence or risk appetite, but forex markets provide an easy- to-read guide of if risk is on or off. Examine carry trades, especially the JPY- and

but forex markets provide an easy- to-read guide of if risk is on or off. Examine

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

CHF-crosses. If they’re down or falling, risk is off, and the low-yielding JPY and CHF are be- ing bought — both on short-covering and flight to safety. If the envi- ronment is especially severe and markets are in a panic, the USD may see additional strength against currencies oth- er than JPY and CHF, likely propelling those crosses even lower. In one risk off sce- nario, the USD might be bought against EUR (sending EUR/USD lower), while the JPY is bought against the USD (sending USD/JPY low- er), amplifying the move down in EUR/JPY. For more concrete measures of risk sen- timent, I focus on op- tions volatility of major currency pairs and the Volatile Index in stocks. Rising volatility sug- gests heightened risk aversion and vice versa. U.S. Treasury bond yields are another way to gauge risk appetite (yields down, risk off/ yields up, risk on) and

 

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an intraday move of more than five basis points in the 10-year gets my attention.

TRADING ON RISK SENTIMENT There are two ways to approach this topic:

For active forex traders, trading on risk sentiment involves waiting on sig- nificant data. If you want to trade FX on risk senti- ment and news hits, ask:

Is the outlook bright- ening or darkening? Is this good or bad for risk sentiment? And degree does matter. You need to judge the magnitude of the news to estimate the extent of the market reaction. Is it a little bad, really bad or downright atro- cious? If you’re unsure or looking for confirma- tion, just watch the FX risk pairs (JPY and CHF crosses and commodity currencies) and the other gauges outlined above. Then it’s a simple mat- ter of going with the risk sentiment result in the FX risk assets.

For those actively trading forex

For those trading other markets, say, stocks or commodities Keep in mind that my views are based on the current state of inter- market correlations, which invariably will break down in some cases. That’s why it’s important to maintain a healthy sense of daily data and news on the major currencies, indi- vidual stocks and com- modities, as well as the longer-term drivers.

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to the Option Seller Newsletter Today! Click here! One caveat is to re- member currency pair

One caveat is to re- member currency pair selection and be mind- ful of recent individual currency developments. For example, risk may be off on a disappoint-

ing U.S. data report, and you may be tempted to sell a JPY-cross, say AUD/JPY. But if the Re- serve Bank of Australia (RBA) is hiking or Aus- sie data recently bright-

ened, you might consider alternative JPY-crosses. At the beginning of July, FX risk pairs plunged, indicating rising risk aversion, and yet stocks remained buoyant for a period, only to sub- sequently move lower. FX risk remained de- pressed in the middle of July, but stocks diverged again and rallied to near prior highs. That final bearish divergence played out into the end of the month, with FX risk plunging again and shares following suit.

IMPORTANT BAROMETER For traders not active in FX, keeping an eye on FX risk barometers can provide clues to market direction in other mar- kets. See Figure 2 for a recent example. FX is the largest market in the world and the crossroads of international capital flows, so I always look at FX as the dog that wags the tail. Major financial mar- kets have exhibited a degree of interconnect- edness in recent years

104 104 102 102 100 100 98 98 96 96 94 94 Source: Bloomberg, FOREX.com
104
104
102
102
100
100
98
98
96
96
94
94
Source: Bloomberg, FOREX.com
FX shows sharp rise
in risk aversion
FX indicates
92
92
risk aversion
remains, but
stocks diverge
90
90
bearishly
FX shows sharp rise in risk aversion
88
88
1-Jun-11
8-Jun-11
15-Jun-11
22-Jun-11
29-Jun-11
6-Jul-11
13-Jul-11
20-Ju1-11
27-Ju1-11
S&P 500
ERU/JPY
EUR/CHF

FIGURE 2: Using FX Risk Assets To Gauge Sentiment

Figure 2 shows the S&P 500, EUR/CHF and EUR/JPY over June and July 2011, normalized to start at 100 to highlight relative movements. Note the multiple divergences between FX risk assets and stocks. In June, the FX risk pairs were above stocks, suggesting the S&P was too bearish, and stocks eventually rallied into the end of June.

that needs to be factored into trading strategies, no matter which market you’re trading. The com- mon denominator is risk sentiment, and many recent market moves can best be explained by asking if risk is on or off. Risk sentiment can be used as the basis for trading strategies in forex and for spotting directional shifts or di-

vergences in other major markets. Understanding risk ba- rometers helps you gauge risk appetite and cut through the fog of funda- mental analysis.

Brian Dolan is the chief currency strategist at FOREX.com. Foreign Exchange and other leveraged products involve significant risk of loss and are not suitable for

all investors. The charts, data, information, reference to any events or trends and opinions in this report are for general information use or illustrative purposes only and are not in- tended as an offer or solicitation to any product offered. There is no guarantee that any event or trend is likely to be repeated or that profits will be or are likely to be achieved.

is no guarantee that any event or trend is likely to be repeated or that profits

HOT

Currencies to Watch

By Paul J. Kavanaugh, CTA

Knowing the key fundamental factors likely to drive price movement is an essential starting point for trading in the forex futures markets.

September 2001

THE U.S. DOLLAR

Since its peak of 12,129 in September 2001, the U.S. dollar index fell by more than 40% to its March 2008 low of 7,080. Then as the financial meltdown of 2008

developed, we saw a 25% move higher as global cur- rency speculators lost their appetite for risk and sought out the relative safety and security of the U.S. dollar. See Figure 1.

121,290 120,000 115,000 110,000 The U.S. dollar declined by 40% 2001-2008 105,000 100,000 95,000 90,000
121,290
120,000
115,000
110,000
The U.S. dollar declined
by 40% 2001-2008
105,000
100,000
95,000
90,000
85,000
80,000
75,000
70,805
$50,485.00
70,000
41.62%
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Source: CQG

FIGURE 1: Semiannual U.S. Dollar Index Chart

March 2009

By March 2009, the U.S. dollar was once again above 8,800 for the first time since April 2006. Then the Fed began its first round of quan- titative easing (QE1). The dollar resumed its down- trend, slipping 17% to 7,421 by November 2009, when sovereign debt concerns took center stage in the global news. See Figure 2.

92,500 Flight to QE1 quality rally 90,000 QE2 87,500 85,000 82,500 80,000 77,500 U.S. dollar
92,500
Flight to
QE1
quality rally
90,000
QE2
87,500
85,000
82,500
80,000
77,500
U.S. dollar in May 2011
lowest since July 2008
75,000
72,500
2005
2006
2007
2008
2009
2010
2011
Source: CQG

FIGURE 2: Monthly Continuation U.S. Dollar Index Chart

June 2010

Once again currency speculators ran to the U.S. dollar for safety. By June 2010, the green- back was nearly 20% higher again above 8,800. Subsequently the dol- lar declined again as the Fed announced and then

implemented another round of fiscal stimulus that came to be known as QE2. By May 2011, the U.S. dollar had declined once again to the lowest levels since July 2008,

when the financial crisis

took hold.

COMMODITY CURRENCIES

During the 2001-2011 decade, the Austra- lian dollar moved up 130% from its April 2001 low of 0.4774 to its July 2011 high of 1.1005. Similarly, the Canadian dollar moved up 78% from its January 2002 low

of 0.6170 to its Novem- ber 2007 high of 1.1043. Over the same period of time, the continuous

commodity index (CCI), which consists of (or tracks) 17 commodity fu- tures markets, increased by 278% from its October 2001 low of 18,283 to its April 2011 high of 69,109. FX futures traders often refer to these currencies as commodity currencies, because the economies of Australia and Canada are significantly dependent on

Kavanaugh’s interview teaches the basics to trading forex futures

   

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s e

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commodity exports of gold for the Aus- tralian currency and crude oil for the Canadian dollar.

4Q TRADING OPPORTUNITIES

 

One of the best approaches to forex trad- ing in the fourth quarter may be trading risk appetite versus risk aversion us- ing the U.S., Australian and Canadian dollar FX futures. Risk aversion is best described as the preference for certainty versus uncertainty. When traders seek safety, they often move assets to the U.S. dollar, causing it to move higher. Conversely, when traders are hungry for better returns, they may look to be long Australian and Canadian dollars. In addition, the sovereign debt concerns over the eurozone nations likely will re-take center stage in the global me- dia as the structural problems plaguing the single currency remain unsolved. Therefore, we could see the euro under significant pressure in the fourth quar- ter and potentially a test of the 1.2000- 1.2500 level against the U.S. dollar.

Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency report.

against the U.S. dollar. Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency
against the U.S. dollar. Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency
against the U.S. dollar. Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency
against the U.S. dollar. Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency
against the U.S. dollar. Paul Kavanaugh is senior currency markets analyst at PFGBEST. Download his currency
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The FX World::

Expand

Your Boundaries

By Greg Michalowski

You only trade equities, but you notice the foreign exchange market has gotten lots of attention in recent years. Neverthe- less, you are a tradition- alist, and trading forex seems — for lack of a bet- ter term — foreign. By using basic techni- cal analysis and tools, you may find that trading forex is very similar to your equity trading. Liquidity ($4 trillion/day) is a key benefit of the forex market. There are several traders, both retail and institutional, who trade off prices that are transpar-

ent (i.e. virtually the same for all). The advantage is all traders are looking at the same (or very similar) charts. Since the charts are the same, technical traders can apply visual technical tools that determine key support or resistance.

DEFINING RISK If everyone can draw the same upward sloping trendline, then trading entry levels can be defined for the risk-conscience traders at those points. If the price moves above the trendline, the bias turns bullish (i.e. buy). If

the price dips below that trendline, the bias turns bearish (i.e. sell). As a result, energy is often found at these levels. The energy either stops/slows the market's directional move and reverses the price action or leads to a move through the level with momentum continu- ing through the break.

LEVEL THE PLAYING FIELD This helps level the playing field among in- stitutional traders with power to move the mar- ket and retail traders who cannot. Retail trad-

Source: Bigcharts.com 7/01/11 SPX Daily SMA (100) SPX Daily 1,375 1,350 1,325 1,300 1,275 1,250
Source: Bigcharts.com
7/01/11
SPX Daily
SMA (100)
SPX Daily
1,375
1,350
1,325
1,300
1,275
1,250
1,225
1,200
1,175
1,150
1,125
1,100
1,075
1,050
1,025
1,000
Aug
Sep
Oct
Nov
Dec
11
Feb
Mar
Apr
May
Jun

ers need only trust that the visual technical lev- els mean something to the market. If true, there should be price move- ment at these energy points. In other words, follow the technical lev- els and don’t worry what the institutional traders may be doing.

TECHNICALS WORK ON ALL CHARTS If you were to look at the S&P 500 index and apply the same visual technical tools like trendlines and moving averages, there is similar energy at the key levels. After all, there are a lot of traders who trade the S&P index, and the price is transparent to all traders. Like forex, retail traders need only trust the visual technical levels derived from the tools.

VISUAL CLUES Figure 1 shows a daily chart of the S&P 500 in- dex. As a technician, I focus on simple and visual tools like trendlines and moving averages. I like the 100 and 200 bar simple moving averages (SMA).

I drew key trendlines and

applied the moving aver- ages on the chart (green arrow is 100 day SMA, blue line is the 200 day SMA). Take a look at the price action near the SMA levels (the white numbered circles 1-6). At the white circle 1, the price held below the 100 day SMA, and the price fell. At white circle 2, the price broke above the 100 day SMA, and this started a trend move higher. More recently at white circle 5, the price bounced very nicely off the 200 day SMA twice. At each point, the trader can define risk and ex- ecute trades as per the bias (price moves above or holds the SMA — buy; price moves below or holds — sell).

USING CHANNELS

Looking at the trendlines, the black numbered circles outline the uptrend and channel trendlines. The gold square boxes defined

a narrower channel within

a channel. In March 2011,

at black circle 5, the trend- line going back to Septem-

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ber 2010 was broken, and the price fell sharply. Like the SMAs, the trendlines are risk-defining levels that traders focus on for trade clues.

SAME IN FOREX Figure 2 shows the euro/ dollar (EUR/USD) with the same 100 and 200 day SMAs and the ma-

jor trendlines/channels drawn. Like the S&P chart, if you follow the 100 and 200 day SMAs, you can see levels where moves were initiated. At the start, the price is consolidating sideways after a trend moves lower. The price moves above and below the moving averages, but most of the

action occurs between the two moving averages. When the price breaks above or below the SMAs and fails, note how the price heads to the other extreme. Traders can use the failed breaks to their advantage, too.

BUY SIGNAL SEEN At white circle 4, the price moves above the 200 bar SMA, giving a buy signal. A short time later at white circle 5, 6 and later at 7, the price finds support against the 100 day SMA. The price moves higher. More

Source: FXDD 1.49570 1.47650 1.45670 1.43750 1.41830 1.39910 1.37990 1.36010 1.34090 1.32170 1.30250 D
Source: FXDD
1.49570
1.47650
1.45670
1.43750
1.41830
1.39910
1.37990
1.36010
1.34090
1.32170
1.30250
D
1.28330
3 Nov 2010
25 Nov 2010 17 Dec 2010 10 Jan 2011 1 Feb 2011
23 Feb 2011 17 Mar 2011 8 Apr 2011
2 May 2011
24 May 2011 15 Jun 2011
Greg Michalowski explains what to look for so you can get started in the forex
Greg Michalowski explains what to look for so you can get started in the forex
Greg Michalowski
explains what to
look for so you
can get started in
the forex market.

recently, at white circle 8, the price bounced nicely off the 100 day SMA, and rallied more than 700 pips over the next 12 trading days. It is this energy that forex trad- ers look for at these key visual levels. Like in the S&P, the visual trendlines/chan- nels also do their job in defining risk and creat- ing energy in the forex market. Did you notice the number of times the price touches the chan- nel trendlines on the top and bottom of the major

upward channel (defined by the black circles)? At each level, traders are able to define risk and trade against the level. Near the high, the price breaks above the top channel trendline indica- tive of an acceleration of the bullish momentum. In May 2011, the price moves back into the channel at black circle 6, and the failed up- side break starts a large corrective move that takes the price 800 pips through the trendline started in February 2011.

FINDING OPPORTUNITIES Trading the S&P and foreign exchange may be more similar than you may think. In markets like the S&P and the EUR/USD that are trans- parent and have lots of liquidity, the visual tech- nical tools give trading opportunities with clearly defined risk. It’s a matter of seeing them.

Greg Michalowski is chief currency analyst at FXDD.

 
with clearly defined risk. It’s a matter of seeing them. Greg Michalowski is chief currency analyst
with clearly defined risk. It’s a matter of seeing them. Greg Michalowski is chief currency analyst
with clearly defined risk. It’s a matter of seeing them. Greg Michalowski is chief currency analyst
with clearly defined risk. It’s a matter of seeing them. Greg Michalowski is chief currency analyst
with clearly defined risk. It’s a matter of seeing them. Greg Michalowski is chief currency analyst

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

7

6

3

2

45

OPTIONS

DAY TRADING TIPS

With so many tips to day trading, I had to break them down using text, video and a webinar. >>>

By Gregory Brown

We Speak greek!

Come Chat With uS!

get Your Free pass to the options room today!

The Options Room is a chat room for traders and anyone who wants to learn as much as possible about options. Your participation in The Options Room will increase your knowledge about options in all of their forms. Each session offers unique information and options “all stars” are lined up each month!

Check out this month’s all-star line up:

up each month! Check out this month’s all-star line up: Finding trades with optionVue “LIVE” software

Finding trades with optionVue

“LIVE” software event featuring Steve Lentz, Director of Educa- tion For DiscoverOptions.com.

STEVE

Steve will give an overview of the OptionVue 6 software and show how OptionVue 6 can help you make better, more profitable trading decisions.

LENTz

Find, analyze and manage options trades with greater success

Back test strategies before you trade

Track your entire portfolio’s risk

Benefit from the program’s many features.

ThuRSday SEPT 8Th 3:15 – 4:15

program’s many features. ThuRSday SEPT 8Th 3:15 – 4:15 an introduc- tion to Binary options Dan

an introduc- tion to Binary options

Dan Cook, Director of Business development

DaN COOk

at Nadex discusses retail use of binary options. He will cover the following topics:

Who is Nadex

What are Binary options

Why use PFGBEST

TuESday SEPT 13Th 3:15 – 4:15

options • Why use PFGBEST TuESday SEPT 13Th 3:15 – 4:15 What’s New with BeStDirect Jeff

What’s New with BeStDirect

Jeff Lewandowski, Director of The Options Division, gives an overview of the

JEFF

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New Bollinger Studies: %b and bandwidth

ThuRSday SEPT 29Th 3:15 - 4:15

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

1

1. EXPIRATION DRAWINGS

Don't trade options based on expiration drawings. Before you pull the trigger on an option trade, you must know when the option expires. Don’t think you always need to take the options all the way to expiration. For the most actively traded markets, there will be too much movement in between your opening trade and ex- piration. Taking all your options to expiration usually means your profit/loss will fluctuate more then you want. Trading options close to expiration should only be done by seasoned professionals. If your plan is based on option expiration, you are tying up capital that can be used for other trades. If you want to be involved in the market, you should think in terms of how to get out of an option trade if you are right on market direction and have a profit.

2

2. FINDING

BALANCE

You risk getting margin calls the longer you hold

a position. This can happen even if you're right

on the market, but it certainly will if your options start netting a loss. Be careful how you balance your option play. How much your option moves versus the under-

lying futures contract is called the delta. It will be

a number between -1 and 1. If the delta is .25, your option will move the same direction as the futures but only 25% as

far. If the futures move four ticks, your option

will move one.

>>>

Learn to trade options with pauL forchione!

“Knowledge is a trader’s most valuable tool.”

as a commodity trading advisor and options strategist with pfGBest, paul specializes in nondirectional, volatility-based trading.

Paul is the author of The ACE Program - Encyclopedia of Options Trading Strategies, the Strategy Series of instructional CDs, and Trading Options Visually, a highly acclaimed book that presents a graphical and mathematical approach for trading options. Paul writes the PFGBEST Weekly Options Report, and is also a frequent presenter of webinars and seminars throughout the country and abroad.

of webinars and seminars throughout the country and abroad. don’t Miss this free offer! For a

don’t Miss this free offer!

For a limited time, register for a 90-day FREE trial of PFGBEST’s Weekly Options Report and receive Paul Forchione’s How to Structure Powerful Options Trades eBook absolutely FREE!

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products. Past performance is not indicative of future results.

SPREADS:

Strangles

Straddles

Ratio Spreads

Butterflies

(RANKED BY MOST TO LEAST RISK)

If your delta is -.25, the

option will move one tick

to four but in the opposite

direction as the futures

contract. Know your deltas.

A lot of retail option traders

like to balance the amount

Get Paul’s eBOOKs & save!

of money it takes to buy an option by selling other options that add up to ap- proximately the same dollar amount. This can lead

to identical deltas, in which case your position is no longer bullish or bearish. It’s perfectly hedged! The delta of the whole position equals all the op- tion deltas added together. Example:

Buy two 100 calls

Sell four 120 calls

The delta for a 100 call is .50, and the delta for a 120 is -.25.

One side adds up to +1.00 and the other to -1.00, which is a perfect hedge. Also, the more naked options that are part of the combination, the more risk/reward. If you buy three options and sell four as part of a spread strategy, you are naked one option. A 3:4 spread ratio is less risky then 2:4 or 1:4, etc.

The longer you hold open positions, the more the inherent risk that markets will do something completely new and unexpected.

markets will do something completely new and unexpected. Order Paul Forchione’s latest titles from the Traders

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3

Gregory Brown offers the next four tips in the video below! To get even more tips from Brown, attend his FREE WEBINAR!

<< REGISTER NOW! >>

3. LEARN WHEN TO TAKE PROFITS

Professional traders are always ready to take a winning trade and put the profits on the books. Too many traders look at the graphs of how an option spread or strategy will settle at expiration. However, this has little to do with what the mar- ket is doing right now. Futures have expiration dates, just like options. Do you trade a September futures contract think- ing about taking the position to expiration? The longer you hold open positions, the more the inherent risk that markets will do something completely new and unexpected. Commodity fu- tures have a way of turning on a dime. The call or put you bought or sold can decrease in value just as fast as it went up in value.

Gregory Brown is president of Sequence Trading Group LLC.

in value just as fast as it went up in value. Gregory Brown is president of

4

5 6

7

in value just as fast as it went up in value. Gregory Brown is president of
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If you are an active trader who struggles with issues of discipline, impulsivity and consistency, you may have a neurological con- dition known as attention deficit disorder (ADD). Don’t let the term deficit fool you. Only one of the six types of ADD identi- fied by Dr. Daniel Amen is inattentive; the others often involve hyperfocus. I was diagnosed with adult ADD in 2006, while struggling to complete my doctorate in clini- cal psychology. Finish- ing the dissertation was

a big challenge, but it pales in comparison to the challenges of trading with ADD.

PREVALENCE ADD, along with its hy- peractive variant ADHD, is the most widely diag- nosed neurobehavioral disorder among school- age children, affecting almost 10% of individuals in the U.S. between the ages of 3 and 17. Psychologists believe the cause is partly ge- netic and partly environ- mental. Close relatives

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products.
Past performance is not indicative of future results.

of children with ADD have a five times greater chance of having the dis- order, and boys tend to be diagnosed three times as often as girls. Adult ADD is much less commonly diagnosed than the childhood con- dition, largely because adults find ways to com- pensate for their orga- nizational shortcomings (delegate it!). There is no opportunity to delegate in trading, so ADD trad- ers eventually face their perplexing mind.

SYMPTOMS ADD is known by its symptoms; the causes are still obscure. The disorder impairs one’s ability to organize in- formation and con- sistently follow rules, even when one wants to. Therefore, for ADD traders, author Mark

Douglas’ simple advice is, quite frankly, impos- sible to implement. Although individuals with ADD are often un- derachievers in the trad- ing world, they typically have been successful in

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previous entrepreneur- ial ventures, where they tend to be the creative force. Unfortunately, business skills do not translate well into the trading world. Traders with ADD, who often have high IQs, seem to constantly outsmart themselves. A

highly intuitive mindset driven by compulsive creativity causes them to miss the obvious or sabotage good trades. Among the other com- mon symptoms, ADD traders report:

• Impulsivity

• Excessive multitasking

• Acts of irresponsible risk taking

• Inability to follow a trading plan

• Overtrading to the point of addiction

• Hyperfocus on moment- to-moment price action

• Tendency to be-

come overstimulated (tranced-out) by infor- mational input Traders with adult ADD often feel like their worst enemy, because it gets worse when they try harder.

AdultAdult ADDADD TestTest

SCORING

RESULTS

If you answered yes to:

0 or 1 question: You appear to have few symptoms of adult ADD. Most likely, you are already a profitable trader.

2-5 questions: You have some of the symptoms of adult ADD I have noticed in traders. I suspect you are a break-even trader.

Free test

Get a free, extensive self-test and other information on ADD and trading.

More than 5: You have many of the symptoms of ADD that I have noticed in traders. You are likely to have a boom-bust or steadily declining equity curve.

ADD & YOUR BRAIN

ADD is a brain condition.

There are two aspects

of brain function affected

by ADD: metabolism in the

prefrontal region and cer-

tain neurotransmitter levels.

The prefrontal cortex (PFC) is the area of the brain responsible for executive function, i.e. reflective and organiza- tional tasks. Adult ADD shows up in a single-pho- ton emission computer- ized tomography SPECT scans as areas of low me- tabolism in the PFC. In order to compensate, in-

dividuals with ADD seek stimulation. This is why prescription stimulants may help some people. For traders, risk-taking is the preferred stimulant. However, in trading, the need for stimulation and the need for self-discipline work against each other. Additionally, low levels of the neurotransmitters do- pamine and norepineph- rine also have been associ- ated with adult ADD.

NEXT STEPS ADD treatment needs to be individualized. Some

people will respond well to stimulants, but for others, stimulants make the symp- toms worse. The standard prescription drugs did not work for me, so I sought alternative approaches.

Dr. Kenneth Reid holds a Ph.D. in clinical psychology. He has been an independent trader since 1996 and a trading coach since 2002.

This article is for educational purposes only. Consult with a physician or men- tal health professional in your area for a diagnosis and/or treatment.

purposes only. Consult with a physician or men- tal health professional in your area for a
purposes only. Consult with a physician or men- tal health professional in your area for a
purposes only. Consult with a physician or men- tal health professional in your area for a
purposes only. Consult with a physician or men- tal health professional in your area for a
purposes only. Consult with a physician or men- tal health professional in your area for a
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Gregory Brown’s tips on options day trading gives you a taste of what you can
Gregory Brown’s tips on options day trading gives you a taste of what you can
Gregory Brown’s tips on options day trading gives you a taste of what you can

Gregory Brown’s tips on options day trading gives you a taste of what you can get in October’s SFO. Make sure you sign up for his free webinar to get the final three (and most important) tips. We move from this month’s forex theme to day trading next month. Learn about an analytical tool that will help ease your decision-making pro- cess. Get more information on trading future spreads. Do you understand the single in/scale out method? You have a chance to get the information you need next month. We are getting close to harvest season. Tim Hannagan of PFGBEST will be look- ing at grains in his feature story. You read him each week in SFO’s free newsletter, but options writer Jeff Augen will contribute a longer, more in-depth story about the changing statistics of the market in the monthly magazine, too. You will be able to get a discount on his books, including one that is reviewed next month. Augen’s books will not be the only discounts available. So, be looking for great deals next month if you are looking to add to your library.

SFO will have its usual columns:

Trade of the Month

Tech Strategy

Eye on Futures

Contributing authors next month:

Jeff Augen (and webinar host)

Ross Beck (and webinar host)

Jim Dalton

Kerry Given

Tim Hannagan

Donna Heidkamp

Tech Support

Dr. Duke

Mark Hodge (and webinar host)

Steven L. Miller

John Sarkett

Quint Tatro

Curt Wagaman

Find this and more at SFOMAG.COM

webinar host) • Steven L. Miller • John Sarkett • Quint Tatro • Curt Wagaman Find