Pattern Recognition

Historically, technical analysis in the futures markets has focused on the six price fields available during any given period of time: open, high, low, close, volume, and open interest. Since the Forex market has no central exchange, it is very difficult to esti¬mate the latter two fields, volume and open interest. In this section, therefore, we will limit our analysis to the first four price fields.

In this section, the technical analysis methods have been cate-gorized not only be the underlying techniques used but also by the type of output that each category generates. We will begin this summary with pattern recognition, probably the most popular and easiest to use technique within the technical analysis family. This method involves scanning a raw open-high-low-close (OHLC) chart (such as a vertical bar chart or a candlestick chart) from left to right searching for identifiable price formations.
Technical analysis consists primarily of a variety of technical studies, each of which can be interpreted to predict market direction or to generate buy and sell signals. Many technical stud¬ies share one common important tool: a price-time chart that emphasizes selected characteristics in the price motion of the underlying security. One great advantage of technical analysis is its “visualness.”

IDENTIFYING PRICE FORMATIONS 

Proper identification of an ongoing trend can be a tremendous asset to a trader. However, the trader also must learn to recognize recurring chart patterns that disrupt the continuity of trend lines. Broadly speaking, these chart patterns can be categorized as reversal patterns and continuation patterns. 

REVERSAL PATTERNS 

Reversal patterns are important because they inform the trader that a market entry point is unfolding or that it may be time to liq¬uidate an open position. Figures 3-1 through 3-4 display the most common reversal patterns. 

CONTINUATION PATTERNS 

A continuation pattern implies that while a visible trend was in progress, it was interrupted temporarily and then continued in the 

Currency Future

FUTURES CONTRACTS
A futures contract is an agreement between two parties: a short position, the party who agrees to deliver a commodity, and a long position, the party who agrees to receive a commodity. For exam-ple, a grain farmer would be the holder of the short position (agreeing to sell the grain), whereas the bakery would be the holder of the long position (agreeing to buy the grain).
In every futures contract, everything is specified precisely: the quantity and quality of the underlying commodity, the specific price per unit, and the date and method of delivery. The price of a futures contract is represented by the agreed-on price of the underlying commodity or financial instrument that will be deliv¬ered in the future. For example, in the preceding scenario, the price of the contract is 5,000 bushels of grain at a price of $4 per bushel, and the delivery date may be the third Wednesday in September of the current year.
The Forex market is essentially a cash or spot market in which over 90 percent of the trades are liquidated within 48 hours. Currency trades held longer than this normally are routed through an authorized commodity futures exchange such as the International Monetary Market (IMM). IMM was founded in 1972 and is a division of the Chicago Mercantile Exchange (CME) that specializes in currency futures, interest-rate futures, and stock index futures, as well as options on futures. Clearinghouses (the futures exchange) and introducing brokers are subject to more stringent regulations from the Securities and Exchange Commission (SEC), Commodity Futures Trading Commission (CFTC), and National Futures Association (NFA) than the Forex spot market.
It also should be noted that Forex traders are charged only a single transaction cost per trade, which is simply the difference between the current bid and ask prices. Currency futures traders are charged a round-turn commission that varies from brokerage house to brokerage house. In addition, margin requirements for futures contracts usually are slightly higher than the requirements for the Forex spot market.

Spot Currencies

Forex swaps are transactions involving the exchange of two cur-rency amounts on a specific date and a reverse exchange of the same amounts at a later date. Their purpose is to manage liquid¬ity and currency risk by executing foreign exchange transactions at the most appropriate moment. Effectively, the underlying amount is borrowed and lent simultaneously in two currencies, for example, by selling U.S. dollars for the Euro for spot value and agreeing to reverse the deal at a later date.
Since currency risk is replaced by credit risk, such transactions are different conceptually from Forex spot transactions. They are, however, closely linked because Forex swaps often are initiated to move the delivery date of a foreign currency originating from spot or outright forward transactions to a more optimal moment in time. By keeping maturities to less than a week and renewing swaps continuously, market participants maximize their flexibility in reacting to market events. For this reason, swaps tend to have shorter maturities than outright forwards. Swaps with maturities of up to one week account for 71 percent of deals, compared with 53 percent for outright forwards.

Ask & Pay

ASK PRICE
This ask is the price at which the market is prepared to sell a specific currency pair in the Forex market. At this price, the trader can buy the base currency. The ask price is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/32, the ask price is 1.4532, meaning that you can buy one
U.S. dollar for 1.4532 Swiss francs. The ask price is also called the
offer price.
BID/ASK SPREAD
The difference between the bid price and ask price is called the spread. The big-figure quote is a dealer expression referring to the first few digits of an exchange rate. These digits often are omitted in dealer quotes. For example, a USD/JPY rate might be 117.30/117.35 but would be quoted verbally without the first three digits as 30/35.
The critical characteristic of the bid/ask spread is that it is also the transaction cost for a round-turn trade. Round turn means both a buy (or sell) trade and an offsetting sell (or buy) trade of the same size in the same currency pair. In the case of the EUR/USD rate above, the transaction cost is 3 pips (Figure 1-2).
FORWARDS AND SWAPS
Outright forwards are structurally similar to spot transactions in that once the exchange rate for a forward deal has been agreed, the confirmation and settlement procedures are the same as in the cash market. Forwards are spot transactions that have been held over 48 hours but less than 180 days when they mature and are liquidated at the prevailing spot price.
Transaction Cost  = Ask Price – Bid Price

Two Trades

Two trades. (Occasionally, the term tick is also used as a synonym for pip.) When trading the most active currency pairs (such as EUR/USD and USD/JPY) during peak trading periods, multiple ticks may (and will) occur within the span of one second. When trading a low-activity minor cross-pair (such as the Mexican peso and the Singapore dollar), a tick may occur only once every two or three hours (Figure 1-1).
Ticks, therefore, do not occur at uniform intervals of time. Fortunately, most historical data vendors will group sequences of streaming data and calculate the open, high, low, and close over reg¬ular time intervals (1, 5, and 30 minutes, 1 hour, daily, and so forth).
BID PRICE
The bid is the price at which the market is prepared to buy a spe-cific currency pair in the Forex market. At this price, the trader can sell the base currency. The bid price is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/32, the bid price is 1.4527, meaning that you can sell one U.S. dollar for 1.4527 Swiss francs.

Currency Markets

Foreign exchange is the simultaneous buying of one currency and sell¬ing of another. Currencies are traded through a broker or dealer and are executed in pairs, for example, the Euro and the U.S. dollar (EUR/USD) or the British pound and the Japanese yen (GBP/JPY).
The foreign exchange market (Forex) is the largest financial mar¬ket in the world, with a volume of over $2 trillion daily. This is more than three times the total amount of the stocks, options, and futures markets combined.
Unlike other financial markets, the Forex spot market has no physical location, nor a central exchange. It operates through an electronic network of banks, corporations, and individuals trading one currency for another. The lack of a physical exchange enables the Forex to operate on a 24-hour basis, spanning from one time zone to another across the major financial centers. This fact has a number of ramifications that we will discuss throughout this book.
A spot market is any market that deals in the current price of a financial instrument. Futures markets, such as the Chicago Board of Trade (CBOT), offer commodity contracts whose delivery date may span several months into the future. Settlement of Forex spot transactions usually occurs within two business days.

CURRENCY PAIRS
Every Forex trade involves the simultaneous buying of one cur-rency and the selling of another currency. These two currencies are always referred to as the currency pair in a trade.
BASE CURRENCY
The base currency is the first currency in any currency pair. It shows how much the base currency is worth, as measured against the second currency. For example, if the USD/CHF rate is 1.6215, then one U.S. dollar is worth 1.6215 Swiss francs. In the Forex markets, the U.S. dollar normally is considered the base currency for quotes, meaning that quotes are expressed as a unit of US$1 per the other currency quoted in the pair. The primary exceptions to this rule are the British pound, the Euro, and the Australian dollar.
QUOTE CURRENCY
The quote currency is the second currency in any currency pair. This is frequently called the pip currency, and any unrealized profit or loss is expressed in this currency.
PIPS AND TICKS
A pip is the smallest unit of price for any foreign currency. Nearly all currency pairs consist of five significant digits, and most pairs have the decimal point immediately after the first digit; that is, EUR/USD equals 1.2812. In this instance, a single pip equals the smallest change in the fourth decimal place, that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equals 1/100 of a cent.
One notable exception is the USD/JPY pair, where a pip equals US$0.01 (one U.S. dollar equals approximately 107.19 Japanese yen). Pips sometimes are called points.
Just as a pip is the smallest price movement (the y axis), a tick is the smallest interval of time along the x axis that occurs between

DISCRETIONARY TRADING

Purely discretionary traders rely on their experience, gut feeling, and reading of the price action to make trading decisions. and for FX traders this means coming to grips with what makes the market tick. Intra-day FX prices are shaped by Haws, and as we know these flows may be the speculative bets of a large hedge fund or they may simply be the hedging activity of an exporter. Either way, supply and demand is what sets short-term prices, which is why we say that in FX there is no such thing as a fair price. Even if the macro backdrop favors a dollar decline, a large buy order will disrupt prices in the short run and drive the dollar higher until the demand is satisfied. For the intra-day trader the thinking behind these flows is not important; price is all that matters.

Getting a proper "feel" for the market comes down to understanding the price action. Price action is that magical thing that scares traders oU{ of their positions and lures them into traps. Watching the bids and the offers get hit is the equivalent of the old-(jme tape reading made famous by Jesse Livermore and other "punters", who used to read the ticker tape attentively in an effort to gauge short-term price trends according to price and volume. Price action reflects the tug-of-war that is constantly going on between the buyers and the sellers in the market, and to the experienced trader it can also be a window into the market's footing.

Since shol1-term price movements are largely dictated by the maneuvering of the "big boys" in the market, it is in the interest of every small speculator to closely rol­low the price action in order 10 find the "footprints" that all large players inevitably leave behind. Needless to say, reading price action is easier in exchange-traded markets, where volume information is available and institutional block orders are more easily detected, but in FX those with no flow information can still glean the market's intentions by looking at the order How information lefl behind in (he form of chart patterns and noting how prices react near important pivot points. Correctly reading price action is not something that can easily be taught. and over lime traders find that it is more of an art form than a science