Wednesday, December 29, 2010

Lien, The Little Book of Currency Trading

I am not a forex trader, nor do I aspire to become one. Nonetheless, I am interested in currencies, so I decided to read Kathy Lien’s The Little Book of Currency Trading: How to Make Big Profits in the World of Forex (Wiley, 2011). This is the sixteenth volume in Wiley’s “little book” series.

Lien covers a lot of ground, from the basics of forex trading to one of her favorite trade setups, from trade management to identifying scams, from having a trading plan and a contingency plan to the top ten mistakes traders make (including, my personal favorite, becoming a demo billionaire). Often she proceeds by way of analogy. For instance, she highlights the difference between a trader and an investor by analyzing the behavior of those New York City taxi cab drivers who pay medallion owners a fixed sum per week for the right to drive a 12-hour night shift: some speed down city streets looking for as many “lower value” fares as possible, others wait patiently at JFK for the few “higher value” fares.

Since readers are always searching for ways to make outsized gains in the markets, I’m going to accommodate today. Well, that’s a gross overstatement. More accurately, I am going to share two practical suggestions that Lien makes on “how to make big profits in the world of forex.”

First, she describes her Double Bollinger Band Method, where the bands are set to one and two standard deviations above and below the 20-period moving average. These double bands, Lien argues, “can be used for identifying whether the currency is in a range or trend, if and when a trend has exhausted, where to find value within the trend, and how to get into a new trend.” (p. 108) I’m not going to steal her thunder. I assume that anyone who is savvy in technical analysis can hypothesize the outline of some of her tactics, if not their details.

Second, she disputes the common claim that traders must maintain at least a 2 to 1 reward to risk ratio. “An overly ideal risk to reward ratio encourages traders to try and take more from the market than is being offered and may encourage scalpers to use excessively tight stops.” (p. 100) Instead, she advocates trading with a negative edge, entering with a double lot and scaling out in two steps. Why adopt a mathematically inferior strategy which needs to be successful at least 60 to 70 percent of the time? Because, she writes, “it is psychologically more palatable, and trading at its core is always more psychological than it is logical.” (p. 103)

The Little Book of Currency Trading emphasizes the practical over the theoretical. Although it’s written for forex traders and investors, much of it is applicable to traders and investors in other markets as well. It’s a quick, lively read; it’s informative and concrete. It may not be a classic, but it’s definitely worth a look.

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