How much do you need to know before you take a step into trading a market?
While I don’t consider myself to have an abnormally small brain … I do quickly feel its limits when I get an information overload.
Supplied with too much information, human beings tend to shut down, and move towards the ‘eyes closed, pin on a chart’ technique for making decisions.
This would happen pretty quickly if we thought, “I want to start trading AUDUSD, so I’m going to Google as much information about this market as I can” … financial pundits are great at waffling on about liquidity … volatility … effects of x, y, z … But which of these factors do we listen to? And what can we shut out?
Here I’ve pinned down the 5 key facts you should know about any market you’re trading. There’s nothing involved or technical here – it’s just about being conscious of the context you’re trading in …
5 questions to ask before you get involved with a market (and how to understand the answers)
Which is the best market to trade?
Forex … indices … commodities … crypto currencies …
Most people have some idea of what they’re looking for in the ‘perfect’ market – a goldilocks zone of volatility, cost and profit potential.
But how closely do we really look at markets before we jump into what’s being hyped up as the next big thing? Probably not very closely at all.
You don’t need to be an expert in financial markets, or a follow the financial news to have a solid understanding of what you can expect from any financial market. It just takes a quick look under the hood at a few key facts …
1. Volatility & Range
One of the most important things to know about a market is how it moves.
Past behaviour is no guarantee of future behaviour, but it is an indicator of it, and one of the best you’ll find.
Before you enter a market, you should have a good idea of how much that market usually moves each day, and how much it usually moves in the timeframe you’re trading. If you expect to be in and out of your trade in an hour … how much does it usually move in an hour? If you expect to be in the market for the next 2 weeks … how much does it usually move in a 2-week period?
If you don’t know these answers, then your stop distance and profit target will be arbitrary – and you can’t judge how likely it is that your target or stop will be hit.
If you’re not sure how to do this, the first thing is to familiarize yourself with old charts – get a feel for how it moves, where it turns, and how big daily moves tend to be.
Then, add an ATR indicator to your chart.
Here’s a USDCAD daily chart, with the Average True Range indicator added …
This shows an average daily range of around 80 pips (the default setting for ATR is 14 periods, so this shows the average over the previous 14 candles).
Trading times & costs
What time does your market open and close each day? Is it open on a Sunday night?
Is the market you’re trading 24 hour? If so, do you know what time your broker ‘rolls’ from one day to the next? And what are the busy and quiet periods?
Do you know how much you’re paying in spread costs, and do those costs change if you trade out of hours?
If you’re unsure about any of these points, you should be able to find the information on your trading platform. Most brokers include an ‘information’ button next to each instrument which will tell you trading times and costs …
Here’s the information for trading AUDUSD from one broker …
Note that the market is closed for 5 minutes at 10pm each evening. The spread cost at the time of checking is 0.8 pips.
On other brokers, the information will be presented slightly differently. Here’s an example for the German DAX …
In this example, the spread cost is 1 point, and the exact times are shown when you can access the market, including what time the rolling charge is applied to your trade (if you’re holding a position at 16.30).
If you’re trading more than one instrument, you should have an awareness of how they could be correlated to each other.
Technical traders have no end of correlation tools they can use, which will give you precise measurements of how two instruments are moving against each other, but, once you’ve found out that your two markets have a +71 correlation on a 10-minute chart … what do you do with that information?
Too much information is what drives traders to bury their heads in the sand about correlations.
You just need to be aware that some markets have a tendency to move together.
Consider the possible scenarios … a market crash? An interest rate announcement? A recession? High inflation? What would these do to your investments? Will they all move the same way?
If the answer is yes, then you need to look at a rebalance.
4. Long-term trend & levels
With any short or medium-term trading strategy, it’s easy to lose track of the bigger picture. Are we shorting a rising market? Are we about to hit a key long-term level?
To know this, we need to pull back and look at a long-term chart.
In the chart below, I’ve pulled out a long view on a daily GBPUSD chart, showing that we’re in a clear up trend, having just run into resistance at the 1.4000 level, with the next major resistance at 1.4680 and 1.5000 …
5. Who’s pulling the strings?
This can be trickier to work out than just checking a chart, but some instruments are more open to ‘free market dynamics’ than others.
For example, the oil price has many external factors influencing it, that are difficult to judge without a good knowledge of the fundamentals. If you don’t know which pipelines are coming online … or what the latest Opec meeting is expected to say … you’re likely to be surprised by sudden jumps and swings (while other traders are ahead of the curve).
Another example of this is trading the Japanese Yen, which is often influenced by the monetary policy of the Bank of Japan.
I’m not saying that you can’t trade these instruments – but, if you do, be aware of which fundamentals could be affecting them, and – if necessary – sit out of the markets when ‘news’ is due. (A quick look at www.forexfactory.com will tell you exactly when major central bank announcements and meetings are due.)
Obviously, there’s a lot more we can know about instruments than the five points above, but sometimes, knowing more just fogs up the picture.
If you have an idea of how much it moves, how much it costs, what a long-term chart looks like, and what external factors could influence it … then you’ve the crucial information to start making trading decisions on any market.