Forex: Gauging Forex Market Sentiment With Open Interest

Market sentiment is the most important factor that drives the currency market, and assessing market sentiment is one aspect of trading that is often overlooked by traders. While there are quite a few ways of gauging what the majority of market participants are thinking or feeling about the market, in this article, we'll take a look at how to do this using interest analysis.

Open Interest in Forex
Open interest analysis is not uncommon among those who trade futures, but it is a different story for those who trade spot forex.One of the most important points to note about the spot forex market is that information pertaining to open interest and volume is not available because transactions are carried out over-the-counter, and not through exchanges. As a result, there is no record of all the transactions that have taken place or are taking place in all the "back alleys". Without open interest and volume as vital indicators of the strength of spot price moves, the next best thing would be to examine the open interest data on currency futures. (For related reading, see Getting Started In Foreign Exchange Futures.)

Spot FX Vs. FX Futures
Open interest and volume data on currency futures allow you to gauge market sentiment in the currency futures market, which also influences, and is influenced by, the spot forex market. Currency futures are basically spot prices, which are adjusted by the forward swaps (derived by interest rate differentials) to arrive at a future delivery price. Unlike spot forex, which does not have a centralized exchange, currency futures are cleared at exchanges, such as the Chicago Mercantile Exchange (CME), which is the world's largest market for exchange-traded currency futures. Currency ffutures are generally based on standard contract sizes, with typical durations of three months. Spot forex, on the other hand, involves a two-day cash delivery transaction. (To learn more, see Futures Fundamentals.)

One of the many differences between spot forex and currency futures lies in their quoting convention. In the currency futures market, currency futures are mostly quoted as the foreign currency directly against the U.S. dollar. For example, Swiss francs are quoted versus the U.S. dollar in futures (CHF/USD), unlike the USD/CHF notation in the spot forex market. Therefore, if the Swiss franc depreciates in value against the U.S. dollar, USD/CHF will rise, and the Swiss franc futures will decline. On the other hand, EUR/USD in spot forex is quoted in the same manner as euro futures, so if the euro appreciates in value, euro futures will rise as the EUR/USD goes up. (For more insight, see The Forex Market.)

The spot and futures prices of a currency (not currency pair) tend to move in tandem; when either the spot or futures price of a currency rises, the other also tends to rise, and when either falls, the other also tends to fall. For example, if the GBP futures price goes up, spot GBP/USD goes up (because GBP gains in strength). However, if the CHF futures price goes up, spot USD/CHF goes down (because CHF gains in strength), as both the spot and futures prices of CHF move in tandem.

What Is Open Interest?
Many people tend to get open interest mixed up with volume. Open interest refers to the total number of contracts entered into, but not yet offset, by a transaction or delivery. In other words, these contracts are still outstanding or "open". Open interest that is held by a trader can be referred to as that trader's position. When a new buyer wants to establish a new long position and buys a contract, and the seller on the opposite side is also opening a new short position, the open interest is increased by one contract.

It is important to note that if this new buyer buys from another old buyer who intends to sell, the open interest does not increase because no new contracts have been created. Open interest is reduced when traders offset their positions. If you add up all the long open interest, you will find that the aggregate number is equal to all of the short open interest. This reflects the fact that for every buyer, there is a seller on the opposite side of transaction.

Relationship Between Open Interest and Price Trend
Overall, open interest tends to increase when new money is poured into the market, meaning that speculators are betting more aggressively on the current market direction. Thus, an increase in total open interest is generally supportive of the current trend, and tends to point to a continuation of the trend, unless sentiment changes based on an influx of new information.

Conversely, overall open interest tends to decrease when speculators are pulling money out of the market, showing a change in sentiment, especially if open interest has been rising before.

In a steady uptrend or downtrend, open interest should (ideally) increase. This implies that longs are in control during an uptrend, or shorts are dominating in a downtrend. Decreasing open interest serves as a potential warning sign that the current price trend may be lacking real power, as no significant amount of money has entered the market.

Therefore, as a general rule of thumb, rising open interest should point to a continuation of the current price move, whether in an uptrend or downtrend. Declining or flat open interest signals that the trend is waning and is probably near its end. (To read more, check out Discovering Open Interest - Part 1 and Part 2.)

Putting it Together when Trading Forex
Take, for example, the period between October and November 2004, when the euro futures (in candlesticks) embarked on a trend of higher highs and higher lows (as seen in Figure 1 below). As depicted in the upper chart window, there were several opportunities to go long on euro, whether by trading breakouts of resistance levels or by trading bounces off the daily up trendline. You can see in the lower window that open interest of euro futures had been increasing gradually as the euro went up against the US dollar. Note that the price movements of spot EUR/USD (seen as blue line) moved in tandem with euro futures (candlesticks). In this case, the rising open interest accompanied the existing medium-term trend, hence, it would have given you a signal that the trend is backed by new money.

Figure 1: composite daily chart of euro futures (candlesticks) overlay with spot EUR/USD prices (dark blue line).

Source: Esignal.com

However, sometimes you may get a strong clue that a trend is of a suspect nature. This clue usually comes in the form of falling open interest that accompanies a trend, whether it is an uptrend or downtrend. In Figure 2, you can see that the Sterling futures (in candlesticks) trended south between September and October 2006 (as did spot GBP/USD, seen as dark blue line). During this same period, open interest fell, signifying that people were not shorting more contracts; therefore, the overall sentiment is not bearish at all. The trend then promptly reversed, and open interest started increasing.

Figure 2: A composite daily chart of Sterling futures (candlesticks) overlay with spot GBP/USD prices (dark blue line).

Source: Esignal.com

Conclusion
Whether you are trading currency futures or spot forex, you can make use of the futures open interest to gauge the overall market sentiment. Open interest analysis can help you confirm the strength or weakness of a current trend and also to confirm your trade.
by Grace Cheng,See Grace's Forex blog at www.gracecheng.com (Contact Author | Biography)

Grace Cheng is a forex trader, creator of the PowerFX Course and author of "7 Winning Strategies for Trading Forex" (2007, Harriman House). This revealing book explains how traders can use various market conditions to their advantage by tailoring a strategy to suit each one. The book is a perfect complement to the PowerFX Course. The PowerFX Course, designed for both new and current traders, teaches tools and trading approaches that combine technicals, fundamentals and the psychology of trading forex. It also includes Grace's proprietary tips and tricks. Grace's works have been published in The Trader's Journal, Technical Analysis of Stocks & Commodities, Smart Investor and other leading trading/investment publications.

Capture Profits Using Bands And Channels

Widely known for their ability to incorporate volatility and capture price action, Bollinger bands have been a favorite staple of traders in the FX market. However, there are other technical options that traders in the currency markets can apply to capture profitable opportunities in swing action. Lesser-known band indicators such as Donchian channels, Keltner channels and STARC bands are all used to isolate such opportunities. Also used in the futures and options markets, these technical indicators have a lot to offer given the vast liquidity and technical nature of the FX forum. Differing in underlying calculations and interpretations, each study is unique because it highlights different components of the price action. Here we explain how Donchian channels, Keltner channels and STARC bands work and how you can use them to your advantage in the FX market.

Donchian Channels
Donchian channels are price channel studies that are available on most charting packages and can be profitably applied by both novice and expert traders. Although the application was intended mostly for the commodity futures market, these channels can also be widely used in the FX market to capture short-term bursts or longer-term trends. Created by Richard Donchian, considered to be the father of successful trend following, the study contains the underlying currency fluctuations and aims to place profitable entries upon the start of a new trend through penetration of either the lower or upper band. Based on a 20-period moving average (and thus sometimes referred to as a moving average indicator), the application additionally establishes bands that plot the highest high and lowest low. As a result, the following signals are produced:

• A buy, or long, signal is created when the price action breaks through and closes above the upper band.
• A sell, or short, signal is created when the price action breaks through and closes below the lower band.

The theory behind the signals may seem a little confusing at first, as most traders assume that a break of the upper or lower boundary signals a reversal, but it is actually quite simple. If the current price action is able to surpass the range's high (provided enough momentum exists), then a new high will be established because an uptrend is ensuing. Conversely, if the price action can crash through the range's low, a new downtrend may be in the works. Let's look at a prime example of how this theory works in the FX markets.

Figure 1: A typical example of the effectiveness of Donchian channels

Source: FXtrek Intellicharts

In Figure 1, we see the short, one hour time-framed euro/U.S. dollar currency pair chart. We can see that, prior to December 8, the price action is contained in tight consolidation within the parameters of the bands. Then, at 2am on December 8, the price of the euro makes a run on the session and closes above the band at Point A. This is a signal for the trader to enter a long position and liquidate short positions in the market. If entered correctly, the trader will gain almost 100 pips in the short intraday burst.

Keltner Channels
Another great channel study that is used in multiple markets by all types of traders is the Keltner channel. The application was introduced by Chester W. Keltner (in his book "How To Make Money In Commodities" (1960)) and later modified by famed futures trader Linda B. Raschke. Raschke altered the application to take into account average true range calculation over 10 periods. As a result, the volatility-based technical indicator bears many similarities to Bollinger bands. The difference between the two studies is simply that Keltner's channels represent volatility using the high and low prices, while Bollinger's studies rely on the standard deviation. Nonetheless, the two studies share similar interpretations and tradable signals in the currency markets. Like Bollinger bands, Keltner channel signals are produced when the price action breaks above or below the channel bands. Here, however, as the price action breaks above or below the top and bottom barriers, a continuation is favored over a retracement back to the median or opposite barrier. (To learn more, see Discovering Keltner Channels And The Chaikin Oscillator and The Basics Of Bollinger Bands.)

• If the price action breaks above the band, the trader should consider initiating long positions while liquidating short positions.
• If the price action breaks below the band, the trader should consider initiating short positions while exiting long, or buy, positions.

Let's dive further into the application by looking at the example below.

Figure 2: Three profitable opportunities are presented to the trader through Keltner.

Source: FXtrek Intellicharts

By applying the Keltner study to a daily charted British pound/Japanese yen currency cross pair we can see that the price action breaks above the upper barrier, signaling for the trader to initiate long positions. Placing effective entries, the FX trader will have the opportunity to effectively capture profitable swings higher and at the same time exit efficiently, maximizing profits. No other example is more visually stunning than the initial break above the upper barrier. Here, the trader can initiate above the close of the initial session burst above at Point A on July 17. After the initial entry is placed above the close of the session, the trader is able to capture approximately 300 pips before the price action pulls back to retest support. Subsequently, another position can be initiated at Point B, where momentum once again takes the position approximately 350 pips higher

STARC Bands
Also similar to the Bollinger band technical indicator, STARC (or Stoller Average Range Channels) bands are calculated to incorporate market volatility. Developed by Manning Stoller in the 1980s, the bands will contract and expand depending on the fluctuations in the average true range component. The main difference between the two interpretations is that STARC bands help to determine the higher probability trade rather than standard deviations containing the price action. Simply put, the bands will allow the trader to consider higher or lower risk opportunities rather than a return to a median.

• Price action that rises to the upper band offers a lower risk sell opportunity and a high-risk buy situation.
• Price action that declines to the lower band offers a lower risk buy opportunity and a high-risk sell situation.

This is not to say that the price action won't go against the newly initiated position; however, STARC bands do act in the trader's favor by displaying the best opportunities. If this indicator is coupled with disciplined money management, the FX enthusiast will be able to profit by taking on lower risk initiatives and minimizing losses. Let's take a look at an opportunity in the New Zealand dollar/U.S. dollar currency pair.

Figure 3: A great risk to reward is presented through this STARC bands example in the NZD/USD.

Source: FXtrek Intellicharts

Looking at New Zealand dollar/U.S. dollar currency pair presented in Figure 3, we see that the price action has been mounting a bullish rise over the course of November, and the currency pair looks ripe for a retracement of sorts. Here, the trader can apply the STARC indicator as well as a price oscillator (Stochastic, in this case) to confirm the trade. After overlaying the STARC bands, the trader can see a low-risk sell opportunity as we approach the upper band at Point A. Waiting for the second candle in the textbook evening star formation to close, the individual can take advantage by placing an entry below the close of the session. Confirming with the downside cross in the Stochastic oscillator, Point X, the trader will be able to profit almost 150 pips in the day's session as the currency plummets from 0.7150 to an even 0.7000 figure. Notice that the price action touches the lower band at that point, signaling a low-risk buy opportunity or a potential reversal in the short-term trend.

Putting It All Together
Now that we've examined trading opportunities using channel-based technical indicators, it's time to take a detailed look at two more examples and to explain how to capture such profit windfalls.

In Figure 4 we see a great short-term opportunity in the British pound/Swiss franc currency cross pair. We'll put the Donchian technical indicator to work and go through the process step by step.

Figure 4: Applying the Donchian channel study, we see a couple of extremely profitable opportunities in the short time frame of a one-hour chart.

Source: FXtrek Intellicharts

These are the steps to follow:

1. Apply the Donchian channel study on the price action. Once the indicator is applied, the opportunities should be clearly visible, as you are looking to isolate periods where the price action breaks above or below the study's bands.

2. Wait for the close of the session that is potentially above or below the band. A close is needed for the setup as the pending action could very well revert back within the band's parameters, ultimately nullifying the trade.

3. Place the entry at slightly above or below the close. Once momentum has taken over, the directional bias should push the price past the close.

4. Always use stop management. Once the entry has been executed, the stop should always be considered, as in any other situation.

Applying the Donchian study in Figure 4, we find that there have been several profitable opportunities in the short time span. Point A is a prime example: here, the session closes below the bottom channel, lending to a downside trend. As a result, the entry is placed at the low of the session after the close, at 2.2777. The subsequent stop will be placed slightly above the high of the session, at 2.2847. Once you are in the market, you can either liquidate your short position on the first leg down or hold on to the sell. Ideally, the position would be held in retaining a legitimate risk to reward ratio. However, in the event the position is closed, you may consider a re-initiation at Point B. Ultimately, the trade will profit over 120 pips, justifying the high stop.

Defining a Keltner Opportunity
It's not just Donchians that are used to capture profitable opportunities - Keltner applications can be used as well. Taking the step-by-step approach, let's define a Keltner opportunity:

1. Overlay the Keltner channel indicator onto the price action. As with the Donchian example, the opportunities should be clearly visible, as you are looking for penetration of the upper or lower bands.

2. Establish a session close of the candle that is the closest or within the channel's parameters.

3. Place the entry four to five points below the high or low of the session's candle.

4. Money management is applied by placing a stop slightly below the session's low or above the session's high price.

Let's apply these steps to the British pound/U.S. dollar example below.

Figure 5: A tricky but profitable catch using the Keltner channel

Source: FXtrek Intellicharts

In Figure 5, we see a very profitable opportunity in the British pound/U.S. dollar major currency pair on the daily time frame. Already testing the upper barrier twice in recent weeks, the trader can see a third attempt as the price action rises on July 27 at Point A. What needs to be obtained at this point is a definitive close above the barrier, constituting a break above and signaling the initiation of a long position. Once the chartist receives the clear break and closes above the barrier, the entry will be placed five points above the high of the closed session (entry). This will ensure that momentum is on the side of the trade and the advance will continue. The notion will place our entry precisely at 1.8671. Subsequently, our stop will be placed below the low price by one to two points, or in this case at 1.8535. The trade pays off as the price action moves higher in the following weeks with our profits maximized at the move's high of 1.9128. Giving us a profit of over 400 pips in less than a month, the risk reward is maximized at more than a 3:1 ratio.

Conclusion
Although Bollinger bands are more widely known, Donchian channels, Keltner channels and STARC bands have proved to offer comparably profitable opportunities. By diversifying your knowledge and experience in different band-based indicators, you'll be able to seek a multitude of other opportunities in the FX market. These lesser-known bands can add to the repertoire of both the novice and the seasoned trader.

Dual And Multiple Exchange Rates 101

When faced with a sudden shock to its economy, a country can opt to implement a dual or multiple foreign-exchange rate system.With this type of system, a country has more than one rate at which its currencies are exchanged. So, unlike a fixed or floating system the dual and multiple systems consist of different rates, fixed and floating, that are used for the same currency during the same period of time. (to learn more about these, see Floating And Fixed Exchange Rates),

In a dual exchange rate system, there are both fixed and floating exchange rates in the market. The fixed rate is only applied to certain segments of the market, such as "essential" imports and exports and/or current account transactions. In the meantime, the price of capital account transactions is determined by a market driven exchange rate (so as not to hinder transactions in this market, which are crucial to providing foreign reserves for a country).

In a multiple exchange rate system, the concept is the same, except the market is divided into many different segments, each with its own foreign exchange rate, whether fixed or floating. Thus, importers of certain goods "essential" to an economy may have a preferential exchange rate while importers of "non-essential" or luxury goods may have a discouraging exchange rate. Capital account transactions could, again, be left to the floating exchange rate.

Why More Than One?
A multiple system is usually transitional in nature and is used as a means to alleviate excess pressure on foreign reserves when a shock hits an economy and causes investors to panic and pull out. It is also a way to subdue local inflation and importers' demand on foreign currency. Most of all, in times of economic turmoil, it is a mechanism by which governments can quickly implement control over foreign currency transactions. Such a system can buy some extra time for the governments in their attempts to fix the inherent problem in their balance of payments. This extra time is particularly important for fixed currency regimes, which may be forced to completely devalue their currency and turn to foreign institutions for help.

How Does It Work?
Instead of depleting precious foreign reserves, the government diverts the heavy demand for foreign currency to the free-floating exchange rate market. Changes in the free floating rate will reflect demand and supply.

The use of multiple exchange rates has been seen as an implicit means of imposing tariffs or taxes. For example, a low exchange rate applied to food imports functions like a subsidy, while the high exchange rate on luxury imports works to "tax" people importing goods which, in a time of crisis, are perceived as non-essential. On a similar note, a higher exchange rate in a specific export industry can function as a tax on profits. (For mroe insight, see The Basics Of Tariffs And Trade Barriers.)

Is It the Best Solution?
While multiple exchange rates are easier to implement, most economists agree that the actual implementation of tariffs and taxes would be a more effective and transparent solution: the underlying problem in the balance of payments could thus be addressed directly.

While the system of multiple exchange rates may sound like a viable quick-fix solution, it does have negative consequences. More often than not, because the market segments are not functioning under the same conditions, a multiple exchange rate results in a distortion of the economy and a misallocation of resources. For example, if a certain industry in the export market is given a favorable foreign exchange rate, it will develop under artificial conditions. Resources allocated to the industry will not necessarily reflect its actual need because its performance has been unnaturally inflated. Profits are thus not accurately reflective of performance, quality, or supply and demand. Participants of this favored sector are (unduly) rewarded better than other export market participants. An optimal allocation of resources within the economy can thus not be achieved.

A multiple exchange rate system can also lead to economic rents for factors of production benefiting from implicit protection. This effect can also open up doors for increased corruption because people gaining may lobby to try and keep the rates in place. This, in turn, prolongs an already inefficient system.

Finally, multiple exchange rates result in problems with the central bank and the federal budget. The different exchange rates likely result in losses in foreign currency transactions, in which case the central bank must print more money to make up for the loss. This, in turn, can lead to inflation.

Conclusion
An initially more painful, but eventually more efficient mechanism for dealing with economic shock and inflation is to float a currency if it is pegged. If the currency is already floating, another alternative is allowing a full depreciation (as opposed to introducing a fixed rate alongside the floating rate). This can eventually bring equilibrium to the foreign exchange market. On the other hand, while floating a currency or allowing depreciation may both seem like logical steps, many developing nations are faced with political constraints that do not allow them to devalue or float a currency across the board: the "strategic" industries of a nation's livelihood, such as food imports, must remain protected. This is why multiple exchange rates are introduced - despite their unfortunate capacity to skew an industry, the foreign exchange market, and the economy as a whole.

Trading Multiple Time Frames In FX

Most technical traders in the foreign exchange market, whether they are novices or seasoned pros, have come across the concept of multiple time frame analysis in their market educations. However, this well-founded means of reading charts and developing strategies is often the first level of analysis to be forgotten when a trader pursues an edge over the market.

In specializing as a day trader, momentum trader, breakout trader or event risk trader, among other styles, many market participants lose sight of the larger trend, miss clear levels of support and resistance and overlook high probability entry and stop levels. In this article, we will describe what multiple time frame analysis is and how to choose the various periods and how to put it all together. (For related reading, see Multiple Time Frames Can Multiply Returns.)

What Is Multiple Time-Frame Analysis?
Multiple time-frame analysis involves monitoring the same currency pair across different frequencies (or time compressions). While there is no real limit as to how many frequencies can be monitored or which specific ones to choose, there are general guidelines that most practitioners will follow.

Typically, using three different periods gives a broad enough reading on the market - using fewer than this can result in a considerable loss of data, while using more typically provides redundant analysis. When choosing the three time frequencies, a simple strategy can be to follow a "rule of four." This means that a medium-term period should first be determined and it should represent a standard as to how long the average trade is held. From there, a shorter term time frame should be chosen and it should be at least one-fourth the intermediate period (for example, a 15-minute chart for the short-term time frame and 60-minute chart for the medium or intermediate time frame). Through the same calculation, the long-term time frame should be at least four times greater than the intermediate one (so, keeping with the previous example, the 240-minute, or four-hour, chart would round out the three time frequencies).

It is imperative to select the correct time frame when choosing the range of the three periods. Clearly, a long-term trader who holds positions for months will find little use for a 15-minute, 60-minute and 240-minute combination. At the same time, a day trader who holds positions for hours and rarely longer than a day would find little advantage in daily, weekly and monthly arrangements. This is not to say that the long-term trader would not benefit from keeping an eye on the 240-minute chart or the short-term trader from keeping a daily chart in the repertoire, but these should come at the extremes rather than anchoring the entire range.

Long-Term Time Frame
Equipped with the groundwork for describing multiple time frame analysis, it is now time to apply it to the forex market. With this method of studying charts, it is generally the best policy to start with the long-term time frame and work down to the more granular frequencies. By looking at the long-term time frame, the dominant trend is established. It is best to remember the most overused adage in trading for this frequency - "The trend is your friend." (For more on this topic, read Trading Trend Or Range?)

Positions should not be executed on this wide angled chart, but the trades that are taken should be in the same direction as this frequency's trend is heading. This doesn't mean that trades can't be taken against the larger trend, but that those that are will likely have a lower probability of success and the profit target should be smaller than if it was heading in the direction of the overall trend.

In the currency markets, when the long-term time frame has a daily, weekly or monthly periodicity, fundamentals tend to have a significant impact on direction. Therefore, a trader should monitor the major economic trends when following the general trend on this time frame. Whether the primary economic concern is current account deficits, consumer spending, business investment or any other number of influences, these developments should be monitored to better understand the direction in price action. At the same time, such dynamics tend to change infrequently, just as the trend in price on this time frame, so they need only be checked occasionally. (For related reading, see Fundamental Analysis For Traders.)

Another consideration for a higher time frame in this range is the interest rate. Partially a reflection of an economy's health, the interest rate is a basic component in pricing exchange rates. Under most circumstances, capital will flow toward the currency with the higher rate in a pair as this equates to greater returns on investments.

Medium-Term Time Frame
Increasing the granularity of the same chart to the intermediate time frame, smaller moves within the broader trend become visible. This is the most versatile of the three frequencies because a sense of both the short-term and longer-term time frames can be obtained from this level. As we said above, the expected holding period for an average trade should define this anchor for the time frame range. In fact, this level should be the most frequently followed chart when planning a trade while the trade is on and as the position nears either its profit target or stop loss. (To learn more, check out Devising A Medium-Term Forex Trading System.)

Short-Term Time Frame
Finally, trades should be executed on the short-term time frame. As the smaller fluctuations in price action become clearer, a trader is better able to pick an attractive entry for a position whose direction has already been defined by the higher frequency charts.

Another consideration for this period is that fundamentals once again hold a heavy influence over price action in these charts, although in a very different way than they do for the higher time frame. Fundamental trends are no longer discernible when charts are below a four-hour frequency. Instead, the short-term time frame will respond with increased volatility to those indicators dubbed market moving. The more granular this lower time frame is, the bigger the reaction to economic indicators will seem. Often, these sharp moves last for a very short time and, as such, are sometimes described as noise. However, a trader will often avoid taking poor trades on these temporary imbalances as they monitor the progression of the other time frames. (Learn more about dealing with market noise, read Trading Without Noise.)

Putting It All Together
When all three time frames are combined to evaluate a currency pair, a trader will easily improve the odds of success for a trade, regardless of the other rules applied for a strategy. Performing the top-down analysis encourages trading with the larger trend. This alone lowers risk as there is a higher probability that price action will eventually continue on the longer trend. Applying this theory, the confidence level in a trade should be measured by how the time frames line up. For example, if the larger trend is to the upside but the medium- and short-term trends are heading lower, cautious shorts should be taken with reasonable profit targets and stops. Alternatively, a trader may wait until a bearish wave runs its course on the lower frequency charts and look to go long at a good level when the three time frames line up once again. (To learn more, read A Top-Down Approach To Investing.)

Another clear benefit from incorporating multiple time frames into analyzing trades is the ability to identify support and resistance readings as well as strong entry and exit levels. A trade's chance of success improves when it is followed on a short-term chart because of the ability for a trader to avoid poor entry prices, ill-placed stops, and/or unreasonable targets.

Example
To put this theory into action, we will analyze the EUR/USD.

Source: StockCharts.com

Figure 1: Monthly frequency over a long-term (10-year) time frame.

In Figure 1 a monthly frequency was chosen for the long-term time frame. It is clear from this chart that EUR/USD has been in an uptrend for a number of years. More precisely, the pair has formed a rather consistent rising trendline from a swing low in late 2005. Over a few months, the spot pulled away from this trendline.

Source: StockCharts.com

Figure 2: A daily frequency over a medium-term time frame (one year).

Moving down to the medium-term time frame, the general uptrend seen in the monthly chart is still identifiable. However, it is now evident that the spot price has broken a different, yet notable, rising trendline on this period and a correction back to the bigger trend may be underway. Taking this into consideration, a trade can be fleshed out. For the best chance at profit, a long position should only be considered when the price pulls back to the trendline on the long-term time frame. Another possible trade is to short the break of this medium-term trendline and set the profit target above the monthly chart's technical level.

Source: StockCharts.com

Figure 3: A short-term frequency (four hours) over a shorter time frame (40 days).

Depending on what direction we take from the higher period charts, the lower time frame can better frame entry for a short or monitor the decline toward the major trendline. On the four-hour chart shown in Figure 3, a support level at 1.4525 has just recently fallen. Often, former support turns into new resistance (and vice versa) so a short limit entry order can be set just below this technical level and a stop can be placed above 1.4750 to ensure the trade's integrity should spot move up to test the new, short-term falling trend.

Conclusion
Using multiple time-frame analysis can drastically improve the odds of making a successful trade. Unfortunately, many traders ignore the usefulness of this technique once they start to find a specialized niche. As we've shown in this article, it may be time for many novice traders to revisit this method because it is a simple way to ensure that a position benefits from the direction of the underlying trend.

Forex: The Memory Of Price Strategy

Is there anything more annoying than getting stopped out of a short trade on the absolute top tick of the move or being taken out of a long trade on the lowest possible bottom tick, only to have prices reverse and then ultimately move in your direction for profit? Anyone who has ever traded currencies has experienced that unpleasant reality more than once. The memory of price setup is specifically designed to take advantage of these spike moves in currencies by carefully scaling into the trade in anticipation of a reversal. Read on to find out how to use it in your next trade.

The Strategy
The memory of price setup should appeal to traders who despise taking frequent stops and like to bank consistent, small profits. However, anyone who trades this setup must understand that while it misses infrequently, when it does miss, the losses can be very large. Therefore, it is absolutely critical to honor the stops in this setup because when it fails it can morph into a relentless runaway move that could blow up your entire account if you continue to fade it. (For background reading, see Place Forex Orders Properly.)

This setup rests on the assumption that the support and resistance points of double tops and double bottoms exert an influence on price action even after they are broken. They act almost like magnetic fields, attracting price action back to those points after the majority of the stops have been cleared. The thesis behind this setup is that it takes an enormous amount of buying power to exceed the value of the prior range of the double top breakout, and vice versa for the double bottom breakdown. In the case of a double top, for example, breaking above a previous top requires that buyers not only expend capital and power to overcome the topside resistance, but also retain enough additional momentum to fuel the rally further. By that time, much of the momentum has been expended on the challenge to the double top, and it is unlikely that we will see a move of the same amplitude as the one that created the first top. (To learn more, read Trading Double Tops and Double Bottoms.)

Determining Risk
We use a symmetrical approach to determine risk. Using our double-top example, we measure the amplitude of the retrace in the double top and then add that value to the swing high to create our zone of resistance.

Figure 1: The memory of price, EUR/USD

Source: FXtrek Intellichart

In Figure 1 the price pushes higher above the initial swing high of 1.2060, but cannot extend the up move by the full amplitude of the initial retracement. We see this happen quite often on the hourly charts as well as daily charts. On the dailies, the setup will suffer fewer failures because the range extensions will be much larger, but it will also generate larger losses. Therefore, traders must weigh the advantages and disadvantages of each approach and adapt their risk parameters accordingly.

Rules for the Short Trade

1. Look for an established uptrend that is making consistently higher lows.
2. Note when this up move makes a retrace on the daily or hourly charts.
3. Make sure that this retrace is at least 38.2% of the original move.
4. Enter short half the position (position No.1) when the price rallies to the swing high, making a double top.
5. Measure the amplitude of the retrace segment.
6. Add the value of the amplitude to the swing high and make that your ultimate stop.
7. Target 50% of the retrace segment as your profit. So, if the retrace segment is 100, target 50 points as your profit.
8. If the position moves against you, add the second half of the position (position No. 2) at the 50% point between the swing high and the ultimate stop.
9. Keep the stop on both units at the ultimate stop value.
10. If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.

Rules for the Long Trade

1. Look for an established downtrend that is making consistently lower highs.
2. Note when this down move makes a retrace on the daily or hourly charts.
3. Make sure that this retrace is at least 38.2% of the original move.
4. Enter long half the position (position No.1) when the price falls to the swing low making a double bottom.
5. Measure the amplitude of the retrace segment.
6. Add the value of the amplitude to the swing low and make that your ultimate stop.
7. Target 50% of the retrace segment as your profit. If the retrace segment is 100, target 50 points as your profit.
8. If the position moves against you, add the second half of the position (position No.2) at the 50% point between the swing low and the ultimate stop.
9. Keep the stop on both units at the ultimate stop value.
10. If position No.2 moves back to the entry price of position No.1, take profit on position No.2, move the stop to breakeven and continue holding position No.1 for the initial target.

Short Trades
Let's see how this setup works on both the long and short time frames.

Figure 2: The memory of price, GBP/USD

Source: FXtrek Intellichart

Let's look at a long setup in GBP/USD, which begins to form on November 12, 2005. Notice that prices first rally but then begin to drop, setting up for a possible double bottom. According to the rules of our setup, we take half our position at 1.7386, expecting prices to bounce back up. When this setup is traded on the daily charts, the stops can be enormous. In the case of this long setup, the stop is more than 500 points large. The amplitude of the counter-move up is 1.7907-1.7386 = 521 points.

A wide stop is necessary because a trader should never risk more that 2% per trade. On a hypothetical $10,000 account, the trader should never trade more than two mini lots, which are 10,000 units where a one-point move is worth $1. This will already violate our "no more than 2% risk per trade" rule because the total drawdown will exceed 7.5% if the setup fails (521 points + 260 points =$780 or 7.8% on a $10,000 account). You can compensate for this risk by toning down the leverage if you are trading the memory of price strategy, although the high probability nature of the setup allows us to be more liberal with risk control. Nevertheless, the bottom line is that on the dailies, leverage should be extremely conservative, not exceeding a factor of two. This means that for a hypothetical $10,000 account the trader should not assume a position larger than $20,000 in size.

As the trade proceeds, we see that the support at 1.7386 fails; we therefore place a second buy order at 1.7126, halfway below our ultimate stop of 1.6865. We now have a full position on and wait for market action to respond. Sure enough, having expended so much effort on the downside move, prices begin to stall way ahead of our ultimate stop. As the price bounces back, we sell the one lot, which we purchased at 1.7126, back at 1.7386, our initial entry point in the trade, banking 260 points for our efforts. We then immediately move our stop on the remaining lot to 1.7126, ensuring that the trade will lose us no capital should the price fail to rally to our second profit target. However, on November 23, 2005, the price does reach our second target of 1.7646, generating a gain of another 260 points for a total profit on the trade of 521 points. Therefore, what could wind up as a loss under most standard setups because support was broken by a material amount turns into a profitable, high probability trade.

Now let's take a look at the setup on a shorter time frame using the hourly charts. In this example, the GBP/USD traces out a countertrend move of 177 points that lasts from 1.7313 to 1.7490. The move starts at approximately 9am EST on March 29, 2006, and lasts until 2pm EST the following day. As the price trades back down to 1.7313, we place a buy order and set our stop 177 points lower at 1.7136. In this case, the price does not retreat much more, leaving us with only the first half of the position as it creates a very shallow fake out double bottom.

We take our profits at 50% of risk, exiting at 1.7402 at 8pm EST on April 3, 2006. The trade lasts approximately four days, with very little drawdown, and produces a healthy profit in the process. On the shorter time frames, the risk of this setup is considerably less than the daily version, with the ultimate stop only 177 points away from entry, versus the prior example where the stops were 521 points away.

Figure 3: The memory of price, GBP/USD

Source: FXtrek Intellichart

Short Trades
Turning now to the short side, we look at the daily chart in the EUR/USD trading a relatively small retrace at the beginning of 2006 from 1.2181 to 1.2004. As price once again approaches the 1.2181 level on January 23, 2006, we go short with half of the total position, placing a stop at 1.2358. Prices then verticalize, and at this point the strategy of the setup really comes into play as we short the second half at 1.2278.

Prices push higher, beyond even our second entry, but the move exhausts before hitting our stop. We exit half of the trade as prices come back to 1.2181 and move our stop to breakeven on the whole position. Prices then proceed to collapse even further as we cover the second half at 1.2092, banking the full profit on the trade.

Figure 4: The memory of price, EUR/USD

Source: FXtrek Intellichart

In another short example of this setup, we look at the hourly chart in the USD/JPY as it forms a retrace between 8am EST March 29, 2006, and 8am EST March 30, 2006. The amplitude of that range is 118.22 to 117.08, or 116 points. We then add 116 points to the swing high of 118.22 to establish our ultimate stop of 119.36. As it trades back up to 118.22 on April 3, 2006, we short half of our position size and then short the rest of the position at 118.78. Prices do not trade much higher and by 10am EST the next day we are able to cover half of our short at 118.22. Just 10 hours later, at 8 pm EST, we are able to close out the rest of the position for profit.

Figure 5: The memory of price, USD/JPY

Source: FXtrek Intellichart

This example illustrates once again the power of this setup on the shorter time frames. The small risk parameters and the relatively short time frames allow nimble forex traders to take advantage of the natural daily ebb and flow of the markets. Clearly this setup works best in range-bound markets, which occurs a majority of the time.

When This Trade Fails
The gravest danger to the memory of price setup is a one-way market during which prices do not retrace. This is why keeping disciplined stops is so essential to the strategy because one runaway trade could blow up a trader's entire portfolio.

Figure 6: The memory of price, USD/JPY

Source: FXtrek Intellichart

In the preceding example, we saw how the daily trend on the USD/JPY pair during the fourth quarter of 2006 reached such powerful momentum that traders had no chance to recoup their losses, and shorts were simply steamrolled. Starting with the initial entry on September 20, 2005, off the countertrend move at 111.78, we proceeded to short the pair at half position value, adding yet another half position seven days later on September 27, 2005, at 113.33. Unfortunately, prices did not pause in their ascent, and the whole trade was stopped out at 114.88 on October 13, 2005, for a total loss of 465 points ((114.88-111.78) + (114.88-113.33) = 465).

Conclusion
The memory of price strategy works well for traders who don't like to take frequent stops and prefer to bank small profits along the way. Although losses can be large when the strategy does miss, it can prevent traders from being stopped out of a short trade on the top tick or a long trade on the lowest possible bottom tick right before prices reverse and move in the trader's favor.

The Foreign Exchange Interbank Market

According to an April 2007 report by the Bank for International Settlements, the foreign exchange market has an average daily volume of close to $3 trillion, making it the largest market in the world. Unlike most other exchanges such as the New York Stock Exchange or the Chicago Board of Trade, the FX market is not a centralized market. In a centralized market, each transaction is recorded by price dealt and volume traded. There is usually one central place back to which all trades can be traced and there is often one specialist or market maker. The currency market, however, is a decentralized market. There isn't one "exchange" where every trade is recorded. Instead, each market maker records his or her own transactions and keeps it as proprietary information. The primary market makers who make bid and ask spreads in the currency market are the largest banks in the world. They deal with each other constantly either on behalf of themselves or their customers. This is why the market on which banks conduct transactions is called the interbank market.

The competition between banks ensures tight spreads and fair pricing. For individual investors, this is the source of price quotes and is where forex brokers offset their positions. Most individuals are unable to access the pricing available on the interbank market because the customers at the interbank desks tend to include the largest mutual and hedge funds in the world as well as large multinational corporations who have millions (if not billions) of dollars. Despite this, it is important for individual investors to understand how the interbank market works because it is one the best ways to understand how retail spreads are priced, and to decide whether you are getting fair pricing from your broker. Read on to find out how this market works and how its inner workings can affect your investments.

Who makes the prices?
Trading in a decentralized market has its advantages and disadvantages. In a centralized market, you have the benefit of seeing volume in the market as a whole but at the same time, prices can easily be skewed to accommodate the interests of the specialist and not the trader. The international nature of the interbank market can make it difficult to regulate, however, with such important players in the market, self-regulation is sometimes even more effective than government regulations. For the individual investor, a forex broker must be registered with the Commodity Futures Trading Commission as a futures commission merchant and be a member of the National Futures Association (NFA). The CFTC regulates the broker and ensures that he or she meets strict financial standards. (For more insight on determining whether you're getting a fair price from your broker, read Is Your Forex Broker A Scam? and Price Shading In The Forex Markets.)

Most of the total forex volume is transacted through about 10 banks. These banks are the brand names that we all know well, including Deutsche Bank (NYSE:DB), UBS (NYSE:UBS), Citigroup (NYSE:C) and HSBC (NYSE:HBC). Each bank is structured differently but most banks will have a separate group known as the Foreign Exchange Sales and Trading Department. This group is responsible for making prices for the bank's clients and for offsetting that risk with other banks. Within the foreign exchange group, there is a sales and a trading desk. The sales desk is generally responsible for taking the orders from the client, getting a quote from the spot trader and relaying the quote to the client to see if they want to deal on it. This three-step process is quite common because even though online foreign exchange trading is available, many of the large clients who deal anywhere from $10 million to $100 million at a time (cash on cash), believe that they can get better pricing dealing over the phone than over the trading platform. This is because most platforms offered by banks will have a trading size limit because the dealer wants to make sure that it is able to offset the risk.

On a foreign exchange spot trading desk, there are generally one or two market makers responsible for each currency pair. That is, for the EUR/USD, there is only one primary dealer that will give quotes on the currency. He or she may have a secondary dealer that gives quotes on a smaller transaction size. This setup is mostly true for the four majors where the dealers see a lot of activity. For the commodity currencies, there may be one dealer responsible for all three commodity currencies or, depending upon how much volume the bank sees, there may be two dealers.

This is important because the bank wants to make sure that each dealer knows its currency well and understands the behavior of the other players in the market. Usually, the Australian dollar dealer is also responsible for the New Zealand dollar and there is often a separate dealer making quotes for the Canadian dollar. There usually isn't a "crosses" dealer - the primary dealer responsible for the more liquid currency will make the quote. For example, the Japanese yen trader will make quotes on all yen crosses. Finally, there is one additional dealer that is responsible for the exotic currencies such as the Mexican peso and the South African rand. This setup is usually mimicked across three trading centers - London, New York and Tokyo. Each center passes the client orders and positions to another trading center at the end of the day to ensure that client orders are watched 24 hours a day. (To continue reading about currency crosses, see Make The Currency Cross Your Boss and Identifying Trending & Range-Bound Currencies.)

How do banks determine the price?
Bank dealers will determine their prices based upon a variety of factors including, the current market rate, how much volume is available at the current price level, their views on where the currency pair is headed and their inventory positions. If they think that the euro is headed higher, they may be willing to offer a more competitive rate for clients who want to sell euros because they believe that once they are given the euros, they can hold onto them for a few pips and offset at a better price. On the flip side, if they think that the euro is headed lower and the client is giving them euros, they may offer a lower price because they are not sure if they can sell the euro back to the market at the same level at which it was given to them. This is something that is unique to market makers that do not offer a fixed spread.

How does a bank offset risk?
Similar to the way we see prices on an electronic forex broker's platform, there are two primary platforms that interbank traders use: one is offered by Reuters Dealing and the other is offered by the Electronic Brokerage Service (EBS). The interbank market is a credit-approved system in which banks trade based solely on the credit relationships they have established with one another. All of the banks can see the best market rates currently available; however, each bank must have a specific credit relationship with another bank in order to trade at the rates being offered. The bigger the banks, the more credit relationships they can have and the better pricing they will be able access. The same is true for clients such as retail forex brokers. The larger the retail forex broker in terms of capital available, the more favorable pricing it can get from the interbank market. If a client or even a bank is small, it is restricted to dealing with only a select number of larger banks and tends to get less favorable pricing.


Both the EBS and Reuters Dealing systems offer trading in the major currency pairs, but certain currency pairs are more liquid and are traded more frequently over either EBS or Reuters Dealing. These two companies are continually trying to capture each other's market shares, but as a guide, the following is the breakdown where each currency pair is primarily traded:

EBS	Reuters
EUR/USD	GBP/USD
USD/JPY	EUR/GBP
EUR/JPY	USD/CAD
EUR/CHF	AUD/USD
USD/CHF	NZD/USD

Cross currency pairs are generally not quoted on either platform, but are calculated based on the rates of the major currency pairs and then offset through the legs. For example, if an interbank trader had a client who wanted to go long EUR/CAD, the trader would most likely buy EUR/USD over the EBS system and buy USD/CAD over the Reuters platform. The trader then would multiply these rates and provide the client with the respective EUR/CAD rate. The two-currency-pair transaction is the reason why the spread for currency crosses, such as the EUR/CAD, tends to be wider than the spread for the EUR/USD.

The minimum transaction size of each unit that can be dealt on either platform tends to one million of the base currency. The average one-ticket transaction size tends to five million of the base currency. This is why individual investors can't access the interbank market - what would be an extremely large trading amount (remember this is unleveraged) is the bare minimum quote that banks are willing to give - and this is only for clients that trade between $10 million and $100 million and just need to clear up some loose change on their books. (To learn more, see Wading Into The Currency Market.)

Conclusion
Individual clients then rely on online market makers for pricing. The forex brokers use their own capital to gain credit with the banks that trade on the interbank market. The more well capitalized the market makers, the more credit relationships they can establish and the more competitive pricing they can access for themselves as well as their clients. This also means that when markets are volatile, the banks are more obligated to give their good clients continuously competitive pricing. Therefore, if a forex retail broker is not well capitalized, how they can access more competitive pricing than a well capitalized market maker remains questionable. The structure of the market makes it extremely difficult for this to be the case. As a result, it is extremely important for individual investors to do extensive due diligence on the forex broker with which they choose to trade.

Forex: FX Trading The Martingale Way

Forex: FX Trading The Martingale Way
Imagine a trading strategy that is practically 100% profitable - would you be interested? Most traders will probably reply with a resounding "Yes", especially since such a strategy does exist and dates all the way back to the 18th century. This strategy is based on probability theory and if your pockets are deep enough, it has a near 100% success rate.

Known in the trading world as the martingale, this strategy was most commonly practiced in the gambling halls of Las Vegas casinos and is the main reason why casinos now have betting minimums and maximums and why the roulette wheel has two green markers (0 and 00) in addition to the odd or even bets. The problem with this strategy is that in order to achieve 100% profitability, you need to have very deep pockets - in some cases, they must be infinitely deep. Unfortunately, no one has infinite wealth, but with a theory that relies on mean reversion, one missed trade can bankrupt an entire account. Also, the amount risked on the trade is far greater than the potential gain. Despite these drawbacks, there are ways to improve the martingale strategy. In this article, we'll explore the ways you can improve your chances of succeeding at this very high risk and difficult strategy.

What is Martingale Strategy?
Popularized in the 18th century, the martingale was introduced by a French mathematician by the name of Paul Pierre Levy. The martingale was originally a type of betting style that was based on the premise of "doubling down". Interestingly enough, a lot of the work done on the martingale was by an American mathematician named Joseph Leo Doob, who sought to disprove the possibility of a 100% profitable betting strategy.

The mechanics of the system naturally involve an initial bet; however, each time the bet becomes a loser, the wager is doubled such that, given enough time, one winning trade will make up all of the previous losses. The introduction of the 0 and 00 on the roulette wheel was used to break the mechanics of the martingale by giving the game more than two possible outcomes other than the odd vs. even or red vs. black. This made the long-run profit expectancy of using the martingale in roulette negative and thus destroyed any incentive for using it.

To understand the basics behind the martingale strategy, let's take a look at a simple example. Suppose that we had a coin and engaged in a betting game of either head or tails with a starting wager of $1. There is an equal probability that the coin will land on a head or tails and each flip is independent, meaning that the previous flip does not impact the outcome of the next flip. As long as you stick with the same directional view each time, you would eventually, given an infinite amount of money, see the coin land on heads and regain all of your losses plus $1. The strategy is based on the premise that only one trade is needed to turn your account around.

Examples
Scenario No.1 (Head or Tails 50/50 Chance):

Your Bet	Wager	Flip Results	Profit/Loss	Account Equity
Heads	$ 1	Heads	$ 1	$11
Heads	$ 1	Tails	$ (1)	$10
Heads	$ 2	Tails	$(2)	$8
Heads	$ 4	Heads	$ 4	$12

Assume that you have a total of $10 to wager, starting with a first wager of $1. You bet on heads, the coin flips that way and you win $1, bringing your equity up to $11. Each time you are successful, you keep on betting the same $1 until you lose. The next flip is a loser and you bring your account equity back to $10. On the next bet, you wager $2 in the hope that if the coin lands on heads, you will recoup your previous losses and bring your net profit and loss to zero. Unfortunately, it lands on tails again and you lose another $2, bringing your total equity down to $8. So, according to martingale strategy, on the next bet you wager double the prior amount (or $4). Thankfully, you hit a winner and gain $4, bringing your total equity back up to $12. As you can see, all you needed was one winner to get back all of your previous losses.

However, let's consider what happens when you hit a losing streak like in scenario No.2:

Your Bet	Wager	Flip Results	Profit/Loss	Account Equity
Heads	$1	Tails	$ (1)	$9
Heads	$2	Tails	$ (2)	$7
Heads	$4	Tails	$ (4)	$3
Heads	$3	Tails	$ (3)	ZERO

Once again, you have $10 to wager with a starting bet of $1. In this scenario, you immediately lose on the first bet and bring your balance down $9. You double your bet on the next wager, lose again and end up with $7. On the third bet, your wager is up to $4, your losing streak continues and now you are down to $3. You do not have enough money to double down and the best you can do is bet it all. If you lose, you are down to zero and even if you win, you are still far from your initial $10 starting capital.

Trading Application
You may think that the long string of losses such as in the above example would represent unusually bad luck, but when you trade currencies, they tend to trend and trends can last for a very long time if you are caught in the wrong direction. However, the key with martingale when applied to trading is that by "doubling down" you in essentially lower your average entry price. In the example below, at two lots, you need the EUR/USD to rally from 1.2630 to 1.2640 to break even. As the price moves lower and you add four lots, you only need it to rally to 1.2625 instead of 1.2640 to break even. The more lots you add, the lower your average entry price. Even though you may lose 100 pips on the first lot of the EUR/USD if the price hits 1.2550, you only need the currency pair to rally to 1.2569 to break even on your entire holdings. This is also a clear example of why deep pockets are needed. If you only have $5,000 to trade, you would be bankrupt before you were even able to see the EUR/USD reach 1.2550. The currency may eventually turn, but with the martingale strategy, there are many cases when you may not have enough money to keep you in the market long enough to see that end. (To learn more, see Common Questions About Currency Trading.)

EURUSD	Lots	Average or Breakeven Price	Accumulated Loss	Break-Even Move
1.2650	1	1.2650	$0	0 pips
1.2630	2	1.2640	-$200	+10 pips
1.2610	4	1.2625	-$600	+15 pips
1.2590	8	1.2605	-$1,400	+17 pips
1.2570	16	1.2588	-$3,000	+18 pips
1.2550	32	1.2569	-$6,200	+19 pips

Why Martingale Works Better With FX
One of the reasons why the martingale strategy is so popular in the currency market is because unlike stocks, currencies rarely go to zero. Although companies easily can go bankrupt, countries cannot. There will be times when a currency is devalued, but even in cases where there is a sharp slide, the currency's value never reaches zero. It's not impossible, but what it would take for this to happen is too scary to even consider.

The FX market also offers one unique advantage that makes it more attractive for traders who have the capital to follow the martingale strategy. The ability to earn interest allows traders to offset a portion of their losses with interest income. This means that an astute martingale trader may want to only trade the strategy on currency pairs in the direction of positive carry. This means that he or she would buy a currency with a high interest rate and earn that interest while, at the same time, selling a currency with a low interest rate.With a large amount of lots, interest income can be very substantial and could work to reduce your average entry price. (For related reading, see Trading The Odds With Arbitrage.)

Minding the Risk
As attractive as the martingale strategy may sound to some traders, we stress that grave caution is needed for those who attempt to practice this style of trading. The main problem with this strategy is that oftentimes, that sure-fire trade may blow up your account before you can turn a profit - or even recoup your losses. In the end, traders must question whether they are willing to lose most of their account equity on a single trade. Given that they must do this to average much smaller profits, many feel that the martingale trading strategy is entirely too risky for their tastes.