The 3 Pillars of Trading Success

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in the Forex Markets

By Corvin Codirla, PhD FXMasterCourse.com

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DISCLAIMER:
Futures, stocks, and spot currency trading have large potential rewards,
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but also large potential risk. You must be aware of the risks and be willing
to accept them in order to invest in futures, stocks & FX markets. Don't
trade with money you can't afford to lose. This communication is neither
a solicitation nor an offer to Buy/Sell futures, stocks or FX. No
representation is made that any account will or is likely to achieve profits
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or losses similar to those discussed on this her. Past performance of
indicators or methodology are not necessarily indicative of future results.
CFTC RULE 4.41-HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS
HAVE CERTAIN LIMITATIONS.UNLIKE AN ACTUAL PERFORMANCE
RECORD,SIMULATED RESULTS DO NOT REPRESENT ACTUAL
TRADING.ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED THE
RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT
OF MARKET FACTORS SUCH AS LACK OF LIQUIDITY.
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© 2016 Corvin Codirla
The material in this guide may include information, products or services
by third parties. Third Party Materials comprise of the products and
opinions expressed by their owners. As such, I do not assume
responsibility or liability for any Third Party material or opinions.
The publication of such Third Party Materials does not constitute my
guarantee of any information, instruction, opinion, products or services
contained within the Third Party Material. Publication of such Third Part
Material is simply a recommendation and an expression of my own
opinion of that material.
No part of this publication shall be reproduced, transmitted, or sold in
whole or in part in any form, without the prior written consent of the
author. Al trademarks and registered trademarks appearing in this guide
are the property of their respective owners.
 Table of Contents

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 Introduction

 Pillar 1: Know Thy Self

o The Rule-Based Coin Flip Exercise

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o How to keep a Trade Log
o Measure Your Performance like a Hedge Fund Manager

 Pillar 2: Develop a System that works

o What is a good system?
o Long-term Biases in FX
o Pattern based trading

 Pillar 3: Money Management and Risk Control

o Where do I put my Stops and Take Profits?
o What is the right leverage to use?


R o Is it possible to make 100% a year?

Final Words
Introduction

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Hello!

My name is Corvin Codirla and I run the FX Master Course blog.

Thanks so much for buying this E-Book!

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You’ve probably arrived at this website and downloaded the book to up
your trading skills to the next level: to start to become consistently
profitable.

If you’re like me you probably believe that it is possible to make money

out of the Forex market. Well is it? One way to answer the question is to
look at what the professionals are up to.

Similarly to equity indices (like the S&P 500 or the FTSE 100), which track
the performance of the equity markets, there are indices out there which
track only FX hedge fund managers.

One such index is the BarclayHedge Currency Manager Index made up of

82 managers. As you can see they’ve been making money consistently!
R And then you have my own hedge fund performance, which is also part of
the index above. My fund, CCFX (not the most imaginative name!), was
awarded the Recognition Award for Excellence TOP 10 by BarclayHedge.
 Just like you, I started out trading to gain freedom. I didn’t want to work
a 9 to 5 job answering to other people’s requests or working towards

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other people’s dreams.

And let’s face it, in our society the markets are the only place with the
shortest time between idea and profit. So if you love a good puzzle, the
possibility of riches as rewards, and being absolutely and solely in control
and responsible for your future there is no other better place to try your

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hand!

I’ve been asked by many people how they could reach similar
consistency. After many interviews, and comparing notes with my own
progress I’ve compiled these three pillars that are the foundation for your
future performance.

I am also passionate about teaching (and was voted one of the best tutors
by the undergraduates at Cambridge University when I was researching
Cosmology there). I love seeing the AHA moment in people’s eyes,
because I know how difficult it is to get to that stage, and how amazing
that sensation is.

Follow the exercises set out in this book and you will start to belong to
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So given the industry, and my own experience, the answer is a
resounding YES.
the 10% of successful traders out there.

It was a long journey to get to consistent profitability with many pitfalls.

And lastly (and most importantly) trading can be a very solitary
enterprise, so I want to welcome you to the FXMasterCourse community,

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whose aim is to provide a vibrant, solid, intellectually curious, and
ultimately profitable home for our tribe of FX traders.

Let’s plunge in!

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Corvin

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The 3 Pillars of Trading Success

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in the Forex Markets

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 their account in 90 days. (A statistic that is fairly accurate and one that I
ONE have seen in the stats of several retail brokers).

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So what is the one thing that is common across the other 10% of the
γνῶθι σεαυτόν - “Know thyself”, one of the Delphic Maxims retail trader population? The one thing that will help you belong to the
inscribed on the forecourt of the Temple of Apollo at Delphi 10% of winners.

It is: “Know Thyself.”

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What is Trading? That sounds very much like pop-psychology. And, no, you don’t need to
wear a loin-cloth, grow a beard, and sit in a cave up in the Himalayas for
People hold certain beliefs about trading: ten years.
1) It will provide them with the five basic freedoms of life: What you need to do is understand your emotional reaction to loss,
a. Financial Freedom regardless if you are a discretionary-macro, or a systematic rule-based
b. Freedom of Time trader.
c. Freedom of Location
Let me give you an experience that many retail traders have recounted to
d. Freedom of Association
me.
e. Freedom of Purpose
They all start out with small accounts, let’s assume nano-lots (where 1 pip
2) It will provide them with the three factors that contribute to = 1 cent). So what’s the worst that can happen? A trade goes against you
our happiness: by 100 pips, or maybe even 200pips. So what’s the worst loss that you
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a. Autonomy: a desire to feel free and in control
b. Mastery: a desire to better ourselves
might incur? Let’s say you went wild and leveraged yourself 10x. So 200
pips x 0.01 dollars per pip x 10 times leverage = a 20 dollar loss.
c. Purpose: a desire for our actions to have meaning That’s not much. People are very happy to spend that much on a
Trading does indeed provide all of this. sandwich, a coffee, and a cupcake down at the local Starbucks. Or maybe
spend that much on a book, or a couple of cinema tickets, without batting
But trading, unlike any other enterprise, is also the fastest route to failure an eye-lid.
and in the end loss. It’s the old 90/90/90 rule: 90% of traders lose 90% of
But in this situation. Oh no! In this situation, with that $20 loss, they will Let me introduce you to following exercise:
beat themselves up. They will start to believe they are useless. Doomed
The Rule-based Coin-Flip Exercise

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to failure. Incapable of making any money whatsoever. The amount of
self-hate that you hear people come up with for those $20 is amazing. As
if it were all the money in the world.
That is the reason they belong to the 90%.
You see, nobody can foretell the outcome of a trade. So being right is the
For starters choose three currency pairs, which are liquid, have a tight
spread, and you can easily get in and out of. I suggest you choose out of
the following: EUR/USD, GBP/USD, USD/JPY, AUD/USD, NZD/USD,
USD/CHF, though you should check leverage requirements on the last
one, since many brokers have become more stringent after the January

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last thing you want to have on your mind. All you can determine is if the 2015 SNB event.
decision you are taking right now is the best decision you can make.
Also, this exercise needs to be carried out while you’re at the computer,
Because if it is, out of 100 decisions you take you’ll come ahead on
average. It’s the collection of 100 trades that will make you rich. Not the at least for the first five minutes, so make sure you have the time. And
decision on one trade. The moment you stop wanting to be right on one try to trade during an active period, preferably during the active London
trade, on being concerned about one trade that will be the moment you or NY sessions.
will become successful. Now you are set, here are the rules:
Why? 1) Flip a coin
2) It it’s heads go long, if it’s tails go short
Because all these detrimental behaviours fall to the way-side:
3) In both cases put an initial stop of 20 pips on the trade
1) Over-trading 4) If the trade is showing a loss after 5 minutes, close it out.
2)
3)
4)
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Revenge-trading
Over-leverage
Letting losses run
5) If the trade is showing a gain after 5 minutes, let it run with a
trailing stop of 20 pips.
6) If the trade is still in profit by the end of the week, close it out on
5) Changing systems on a frequent basis a Friday afternoon
6) Chasing the holy grail 7) Keep an accurate log (more on that later)
8) Stick to these rules without exception
In a nut-shell: inconsistency.

So how do we get to know ourselves, and overcome these behaviours?

I urge you to do this exercise. And the most important rule is number (8).
Let me clarify one the most burning questions you might have. I can
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already hear you shouting it: “Trade on a random flip of a coin?! I might
as well be throwing money out the window.”
Well I will answer with a quote from one of my subscribers Michele, who
nailed it completely:
“Really glad to be doing this exercise. Feels like the
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trades are getting less emotional or less chemical
inducing. It’s odd to see how with just a flip of the coin
you can make a “winning trade decision” instead of
doing hours of analysis. Somehow this takes a bit of
sting out of the idea of being wrong. People say the
market will do what it will do and no system is going to
be right all the time and no person is going to call it
right all the time. This statement feels more real after
doing 10 of these trades.”
Jonney had following remarks to make:
“Behavioural: When I lost on trades I did feel an urge to
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be aggressive. But then realised that the quantum of loss
is not big and that was strange as I would waste pounds
daily on other stuff but in trading the idea of loss was
somehow equivalent to defeat. But I controlled and
didn’t give in - thought of it as a profession, so kept
emotions out.
Non-Behavioural - Seems prediction of direction of market is
irrelevant. It’s more systematic i.e. you lose you get out you win
let it run (as you said earlier) trailing stops (now I hope I will use
them the way they should be used). So I can see your point now
that this is definitely a net positive sum game but over time not in
a day or month”
Do this exercise and then email me with the results you found! I’d be
happy to hear how it is improving your trades.
But stick to the rules. 5 minutes means five minutes. If it shows a loss cut
it. It doesn’t matter if it’s just a 0.1 pip loss, or if your gut is telling you it
will come back in the next two minutes. GET OUT!
To make the trailing stop easier, you can download following MT4 script
from my website: http://www.fxmastercourse.com/wpdm-package/mt4-
trailing-stop-expert-advisor/.
To sum it up: if you stick to nano / micro lot size, and stick to the rules,
your downside is limited. However, the lessons viscerally learned will be
substantial and can be captured by this feedback:
With Flip Coin trades $6.00 loss for the week. Feel I got more than $6.00
worth of learning.
and
I feel less internal pressure to make trades to try to make up this week’s
losses. Right now I feel less focused on the Account Balance and more
focused on understanding why the trades didn’t work and developing a
system that I feel better about.
How to Keep a Trade Log Let me give you an excerpt of a couple of trades from such a trade-log,
and in the next section we will cover what you can deduce about these
Oh no! Another log, another diary, I hear you grown.

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numbers!
Well in this section I’ll show you exactly what you need. And if you’re Open Time B/S Symbol Open Close Time Close Pips MAE in MFE in
using MT4 here is a script that will make your life tremendously easier: Price Price pips pips
http://www.fxmastercourse.com/wpdm-package/mt4-tradelog- 12/10/2015 Sell EURGBP 0.74005 13/10/2015 0.74675 -67 -74 0
14:05:35 11:56:25
extractor/. 12/10/2015 Sell EURGBP 0.74005 13/10/2015 0.74728 -72.3 -74 0
14:05:35 12:09:26

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A trade-log needs to capture for each trade: 12/10/2015 buy AUDNZD 1.09714 13/10/2015 1.08916 -79.8 -80 0
23:39:47 12:09:13
1) What you traded 13/10/2015 sell AUDCAD 0.95255 13/10/2015 0.95384 -12.9 -13 0
10:24:06 12:09:53
2) What time you traded it 13/10/2015 sell EURUSD 1.13598 22/10/2015 1.11556 204.2 -140 204
3) What time you closed the trade out 16:28:25 17:35:40
4) Your profit 13/10/2015 buy GBPUSD 1.5224 14/10/2015 1.53624 138.4 0 138
16:59:06 11:07:42
5) The maximum loss incurred in that trade 14/10/2015 buy GBPUSD 1.535 14/10/2015 1.54614 111.4 0 111
6) The maximum profit incurred in that trade 10:55:50 19:55:27
14/10/2015 sell EURGBP 0.74348 15/10/2015 0.74157 19.1 0 35
Points (5) and (6) are incredibly important. Without them you are 11:40:46 02:32:52
14/10/2015 buy GBPUSD 1.54057 15/10/2015 1.54736 67.9 0 88
essentially flying blind. 14:41:48 02:33:11
14/10/2015 sell AUDUSD 0.72914 22/10/2015 0.72076 83.8 -72 111
The MT4 script won’t provide you with (5) and (6), however you can 14:51:27 08:32:54
always go back at the end of every week and fill those details in from your 14/10/2015 sell EURUSD 1.14399 16/10/2015 1.13467 93.2 -60 107
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trading screen, as well as taking a screenshot.

Some traders recommend keeping a log of the reason you traded. That’s
15:38:13
15/10/2015
22:55:39
sell EURGBP 0.7346
11:58:44
16/10/2015
11:55:50
0.73436 2.4 -34 2

a nice-to-have. Let me tell you, the screenshot will definitely tell you your
reasoning, and almost always highlight which trades were ‘impulse
trades.'
The majority of these trades were “Range” trades, in that the currency
was traded against one of its extreme boundaries that had been in place
for some time (months in fact). The highlighted row shows an example of
bad discipline. It’s a trade that went beyond the maximum loss of most
other trades, each which easily fit under 100 pips. So what kind of
deductions can we make from such information?
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For starters it allows you to go back to the charts, and realize that for
several of these trades the profits should have been kept running!
I can tell you that letting profits run is one of the main challenges I have
found in myself and most others.
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These numbers also allow you to work out weekly statistics so you can
see how well you are on track.
The statistics which you will find most useful are:
Hit Rate: this is defined as the percentage of times you had a winning
trade. In the above it is 66%.
Average Profit:90 pips per trade
Average Loss: 60 pips per trade
Win/Loss Ratio: 1.5
Average Pips per trade: 40 pips
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The Hit Rate is important, but it isn’t the end-all and be-all of trading.
And you should always be wary of high hit rates (especially those
advertised at 70% and above)! When market conditions change, a high
hit rate can easily become a very low hit rate. And if your profitability
depended upon a high hit rate, you’ll be losing money fast.
So let’s say that the hit rate actually changed to 40%. What would
happen now? We can re-work the average pips per trade (assuming that
the average profits and losses stay the same, since we haven’t changed
our Stop Losses or Take Profits).
So: 40%*90 + 60%*(-40) = -20 pips. So we would be losing money.
How could we protect against this? If you were to pull up a chart for the
trade log above you would see that many trades could have
i) Be traded closer to existing ranges
ii) Trades could have been run for longer.
These are important insights to gain, because it will change the way you
trade in the future, and allow you to understand how to improve your
approach, and continue to stay positive on your Profit / Loss, even if your
hit-rate goes down.
Keep a trade log!
And keep a track of your statistics.
For scalpers this is especially important, since your average pips per
trade, needs to be larger than the bid/ask spread and commission for you
to survive.
This brings us to a really important point: it’s not the Hit Rate that is of
ultimate importance but your Average Pips per trade. This is called
EXPECTANCY. And in the end it’s one of the few things that counts. It
combines hit rate with your average losses and gains. So you could still
have a very low hit rate, but if your average gains outweigh your average
losses massively, you have nothing to worry about: you’re making money
even when trading badly! What else do you want? And the primary way
to achieve this is to cut losses and let profits run.
Measure Your Performance Like a Hedge Fund Manager The drawdown is defined as the biggest fall in profits from the most
recent peak.
Surely the way to measure your performance is by looking at the Profit

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and Loss (P&L) statement at the end of the day?

Well, that’s one of the ways to do it.

But let me ask you this. Which Hedge Fund Manager would you prefer to
give your money to:

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A) The Hedge Fund Manager who finished the year $1million up
B) The Hedge Fund Manager who finished the year $4million up

I hear you already: “B of course!”

What if I told you that manager A’s P&L went steadily up throughout the
year and that his biggest drawdown from his peak Equity Balance was
never more than $100,000? On the other hand manager’s B peak This is what the P&L chart looks from the table above. We’ve made 500
performance that year was up $10million. pips that week, and the biggest drop was 200. So the ratio is roughly 2.5.
That is a very good ratio. However, it’s only for one week.
Would you still go with B? The guy who managed to give back more than
half his P&L, a grand total of $6 million. Keep a log of this ratio as well, since it will allow you to gain an insight
into your losing streaks. Nobody ever complains about winning streaks,
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Probably not. With this new information you’d probably choose A.

So would I. And so would all those investors that invested in the past
with my fund, and so would all those due-diligence advisors (like Mercer).
but when they lose, they usually don’t know why. Keeping a track of your
losing streaks on a per trade basis, allows you to determine in the future
if your trading has completely gone out of kilter.

So if it’s not the final outcome that matters what does?
If you’re keeping a trade log, then the ultimate measure will be: weekly
return divided by the maximum drawdown you’ve ever experienced.
There are other measures, such as Sharpe and Sortino ratio, which are
used by institutional investors, but these usually tend to hide the
drawdowns. From a trading perspective the drawdown is the knife that
will end your career, so I usually tend to focus on how much I can expect
to make given the worst string of losses I’ve experienced.
 Long Term Biases in Forex Markets
TWO At last we’ve gotten to the markets. And it took some time. Since no

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matter what system you apply, if you haven’t worked on yourself, you
Develop a System that Works won’t have the stamina to keep to a system, nor that adaptability to
survive constantly changing market conditions.
“What is a system that works?” This is the first question anybody coming
to trading will ask. Well it turns out that FX markets, just like any other markets have
fundamental economic factors that drive them.

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This is also the part that was missing in the Random Coin-Flip Exercise.
To make it clear what I mean, let me quickly cover the other asset classes:
Remember, I asked you to flip a coin and based on the outcome to go
long or short? 1) Equities: you participate in the profits of a company
2) Bonds: you are betting that governments will repay you back
Well this time round, what would happen if instead of a random input
their debt
you could garner all the information available to make a well educated
3) Commodities and Real-Estate: you are betting on cycles in
guess, which would give you an edge?
consumption
Presumably you’d start seeing this edge pay-off after 100 trades.
All these are tangible objects. You can touch a company (in any case its
Now that’s a good system. factories). You can touch the stuff a government buys with the money
you’ve lent it by buying bonds. You can see the commodities floating in
So what makes a good system? Following are the factors: your cereal bowl you had for breakfast this morning.
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1) It shows you the long term bias in the asset you are trading
2) It provides a framework that adapts to the market conditions
3) It has “nice” risk properties as we discussed in section One
So what about FX?

FX is the most macro of macro vehicles. It doesn’t relate to the goods in

one country, but is a statement of the relative value of goods and
monetary conditions between two countries. In some sense you can’t
touch it. But you have an intuitive sense that you could definitely bet on
“relative” value between two countries.
The Three Factors Driving FX So here is how it works. We’ll cover each of the factors in turn.

So here are the three factors that drive FX

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1) Interest rates Factor 1: Interest Rates
2) Value
By interest rates I mean the interest rate you will earn by depositing your
3) Momentum
money with a bank.
Is it really that simple? Well look at what happens if you use these three

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factors to trade the G10 currencies1 against each other. From your perspective you can see that accumulate in the “Swap” column
in your MT4 trade terminal.

Let’s say you go long NZD/CHF. This trade means you bought New
Zealand Dollars by using Swiss Francs. In essence you received New
Zealand Dollars and in return you paid with Swiss Francs. Phrased
differently New Zealand Dollars arrived in your deposit account, and you
paid with Swiss Francs which you borrowed from a bank. Each day your
P&L gets settled between you and the counterparty, and on top you earn
interest on the New Zealand Dollars you deposited, and you have to pay
interest on the Swiss Francs you borrowed.

So your P&L = pip move in spot on NZD/CHF + interest on notional of NZD

– interest on CHF notional.
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which you keep open past the 22:00 GMT cut-off time for FX trades.

Which is also the chart on my website: So even if the price of NZD/CHF does not move you will still make money,
http://www.fxmastercourse.com/trading-approach/. because the interest rate differential is big.

Let’s work it out by looking at the prevailing rates in the market, and then
1
comparing to the Swap rates on my MT4 broker screen.
By G10 I mean: USD, EUR, GBP,JPY, CHF, AUD, NZD, CAD, SEK, and NOK
Bingo! With this information you should be able to see that we chose NZD/CHF
for this example as it yields the highest “Swap” into your account.
You have just stumbled across the carry trade.

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The theory is quite intricate, but the principle is simple: money chases
high rates and runs away from low rates. Why? Well that’s the nature of
the “rational” economic agent.
Let’s work it out by looking at the prevailing rates in the market, and then
Here’s how it works: NZD yields 1.09% on an annualized basis for a three
month deposit and CHF yields -0.75% on annualized basis for a three
month deposit. We are assuming here that interest rates on deposits of
less than a three month duration are roughly the same, which tends to be
true.

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comparing to the Swap rates on my MT4 broker screen. Now let’s assume that you have traded one standard lot of NZDCHF, that
The rates on the G10 currencies: (these are three month rates as of the is NZD 100,000 versus CHF 65,500, which is the prevailing rate of 0.655.
5th February, 2016) The NZD 100,000 earn in interest in one day 100,000 * 2.665%/365 = NZD
CCY Rate Source 7.30. On the CHF loan (since we are short CHF as we are long NZDCHF)
CHF -0.751% Golbal-Rates we have to pay 65,500 * -0.75%/365 = -CHF1.35. Since we are paying a
SEK -0.355% NASDAQ OMX negative amount we actually receive on this loan a total of CHF 1.35.
EUR -0.188% Golbal-Rates
JPY 0.031% Golbal-Rates Converting the NZD 7.30 to Swiss francs(by multiplying by the prevailing
CAD 0.450% BoC exchange rate of 0.655) we get CHF4.78. So in one day we receive a total
GBP 0.591% Golbal-Rates of CHF6.12 on a 1 standard lot trade. This is the same as a 0.6 pip
USD 0.620% Golbal-Rates fluctuation on a standard lot trade.
NOK 1.090% Oslo Bors
AUD
NZD
R 2.285%
2.665%
AFMA
NZFMA
Now bear with me for a second since this last number we got 0.6 (which
was obtained by taking 6.12 and dividing by 10, since a 1pip move = CHF
10 profit and loss on a 100,000 NZDCHF trade), can actually be found in
your MT4 terminal!

If you go to the Symbols window, right-click and select Specifciation, you

It’s pretty amazing to see so many countries with negative rates, and an
will see the Swap Long value equals 5.8. Now it’s not exactly the 6.12 we
indication of the times we live in.
obtained, but close enough.
So holding a NZDCHF long generates a profit of 0.58 pips in one day. The
5.8 in the Symbol specification window comes from the fact that the

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broker is a 5-digit broker, and hence 1 conventional market pip = 10
broker pips. Another extra detail to bear in mind.

And these 0.58 pips are earned per day, including weekends. Of course
this value will change as interest rates change. But assuming they don’t
over the course of a year, or that they stay pretty much near this value,

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the number of pips earned in year = 0.58 *365 = 212 pips! Just by holding
this position long. Taking the current prevailing exchange rate of 0.655
this produces a return of 0.0212/0.655 = 3.23% which roughly equals the
difference in rates between NZD and CHF 2.67% - (-0.75%) = 3.4%.

Now, you might say, that’s not an interesting return. However, the way
to play the carry game, is to leverage, as well as understand the price
action of the currency you are trading. On the leverage side, if you were
This is just an example of how you can use the information on interest
to leverage 3x you already get a 10% return, which is miles more than any
rates to make an appropriate trading choice.
bank account will provide you with.
Following is the performance of trading the Carry Strategy in isolation
And if you take a look at NZDCHF, it’s close to its lower range.
with only one currency pair:
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Of course you can create more sophisticated portfolios which take risk Central Bank Mandate
and hedging into account.2 And remember this is only one of the factors The Fed Price stability and sustainable growth. Inflation target

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of affecting currencies. Just like value stocks underperform during of 2%
extended periods of time, so you will find the carry strategy lagging from ECB Price stability and sustainable growth. Inflation target
of 2%
time to time, however, the power lies in combining it with the other
BoE To maintain monetary and financial stability. Inflation
factors. target of 2%
BoJ Price stability and stability of financial system.
Inflation focus

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Interest Rates –Central Banks and Trading the News SNB Ensure price stability while taking economic situation
into account
Since Interest Rates are such an important component in determining the BoC Maintaining integrity and value of currency. Inflation
target of 1-3%.
flow of cash around the globe, you should immediately be asking: who
RBA Currency stability, maintenance of full employment
sets them? How and why? and economic welfare of Australians. Inflation target
of 2-3%.
In this subsection I’m going to take a detour and introduce you to the
RBNZ Price stability and avoid instability in output, interest
institutions that set them: the Central Banks, as well as their mandates rates and currency. Inflation target of1.5%
and how to trade their announcements. Norges Bank Promote economic and price stability. Inflation target
of 2.5%
Let’s have a look at the Central Banks of the G10 currencies and see what Sveriges Price stability. Inflation target of 2%
their mandates are: Riksbank
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And it also turns out that these Central Banks use a rule based approach
to setting interest rates.

The rule is called the Taylor Rule. It relies on fundamental economic

factors, such as GDP growth, unemployment, inflation, etc.
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I developed such a portfolio at a big Investment Bank back in 2006, which sold
like hot cakes, and later traded it at a big hedge fund.
That’s the reason why currency traders watch news announcements so Simple. The initial knee-jerk reaction was a big US Dollar sell-off. But
keenly. then within the first 5 to 10 mintues, after people digested the

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components, they realized that the unemployment rate was at its best in
You see, Central Bankers are just humans, like you and me. Which means years, and that the wage growth had a bumper month. This kind of wage
they tend to get things wrong (Greenspan for instance is blamed for the
growth is what leads ultimately to inflation. And that means the Fed will
housing bubble as he kept interest rates too low for far too long in the
take action, regardless. The US Dollar therefore rallied.
2000s).
But, hang on. What if you don’t have the experience or you don’t have
And just like other humans, they tend to shift their perspective and

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the time to watch for news announcements what then?
change their minds and opinions.
Well this is what I call the
Well, when they do, it means that they’ll change interest rates in ways
the market hasn’t expected.

These changes lead to market shocks. Why? Because now everybody is
re-balancing their books in anticipation of the changes the new Central
Bank policy will cause in the markets. For instance bigger interest rates
will imply expensive capital. This will probably reduce company’s desire
to invest, which reduces output, and therefore earnings, and probably
will lead to lower share prices. Therefore traders sell shares now in
anticipation of this new outcome.
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Does this mean you have to become an expert at understanding these
numbers? It certainly will help your trading. For instance you’d need to
understand that the non-farm payrolls are made up of more than just the
Central Bank Exercise
And again it is the type of exercise that will set you in the 10% of winning
traders out there.
This exercise will show you how to trade Central Bank announcements in
a stress-free way, without the hassle of delving into too much economic
analysis. You will let the market do all the talking!
This requires some time, but the results and your insight will be
invaluable.

headline number, and that understanding the scenarios the various
components imply gives you an edge. Just look at the bad number which
came out on the 5th February. This might lead you initially to expect the
Fed to keep its tightening cycle on hold, and hence be US Dollar bearish.
However, the US Dollar rallied by the end of the day. Why?
Start by taking your favourite currency pair. In this case I will choose the
ubiquitous EUR/USD, which makes up a significant fraction of the daily
Foreign Exchange volume.
Now let’s plot it. Preferably in your case, print it out as well!
The next step is to pull out the Central Bank announcement days.

And now superimpose these meetings on the chart.

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To give you a flavour of what this looks like for EUR/USD (and only for the
ECB meetings, I’ll have you mark the FOMC meetings) here’s a chart I’ve
prepared earlier:

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I’ll leave it up to you to extend the exercise to include the FOMC
meetings, as well as think of better ways to manage the trade.

Factor 2: Value

The second factor in our list at the start of the section is referred to as
I urge you to go even further and conduct this exercise for all the Value. It’s called Value since it refers to the value of the underlying goods
currency pairs you are likely to trade, plotting the corresponding Central
which cash can purchase.
Bank meetings. Do yourself this favour!
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I’ll also leave the conclusions up to you, though here is one thing you
could do with the ECB meetings for EURUSD. After the day of the
Let’s assume that the water company Evian sells an identical bottle of
water both in the UK and in the US. These two bottles are identical.
Same water, same glass bottle, same label, same everything. In essence a
meeting itself place stop orders either side of the day’s high and low (in tourist from the US could come to the UK and exchange one bottle for
the style of a breakout trading strategy). The version I’m suggesting here
another without anybody disagreeing to value!
is very naïve in that you will close the trades out at the close of the day
following the ECB meeting. Here is a backtest over the last seven years: Now let’s say that the US price of 1 bottle is $1.30, and let’s say that the
price of one bottle in the UK is £1.00. So the actual exchange rate
GBP/USD according to these equivalent bottles is 1.30 (the US price
divided by the UK price).

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Now let’s go into the market. The exchange rate is 1.45 for GBPUSD (as
of the time of this writing).

Why aren’t the two values the same? In both cases, by exchanging two
identical bottles from two countries or exchanging cash, I should come up
with the same exchange rate!

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No!

There are various reasons: for instance, Evian is a French company, and so
maybe transportation costs to the US and the UK are different, which
factors into the mismatch of the hypothetical exchange rate. So how do we determine the values of these currencies?

Regardless, there is still a value mismatch. And just like in equities where
people have the notion of a value stock and a value trade, the value trade
in this example is to short GBP/USD until it hits its value of 1.30 as
determined by the real goods in the real economy. The exchange rate
price of GBP/USD is a market aberration.
The way to trade this across the universe of currencies is to establish the
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value of each currency and then on a monthly basis figure out which
currencies to buy and which currencies to sell.
For most of 2015 the value trade has been short CHF versus long JPY.
That trade took right off in the second week of January after the SNB
removed the EURCHF floor, however throughout 2015, timing the price
action right, would have milked the trade several times over.
For starters these Value exchange rates are called Purchasing Power
Parity values (PPP). And they tend to be quoted against the US Dollar, as
it is the ubiquitous currency, and US is the biggest importer of goods.
Several international organizations calculate these PPP values. We will
use the numbers from the OECD. These numbers get published at the
start of every calendar year. Since they are only published once a year,
does it mean that these don’t change throughout the year? Well since
they represent the values of goods, and the prices of goods change due to
inflation, we would need to adjust these numbers by the relative inflation
rate of the two countries forming the currency pair.
However, inflation rates are currently at historic lows, and so these
adjustments won’t make much of a difference (at least for now!).

This is the 2015 CHFJPY chart:

The link to the PPP numbers on the OECD website is: OECD-PPP. We list Here’s a recent chart of this currency pair:
the newest values and the actual market rates (as of 8th February 2016).

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Note that all values are quoted with the USD as base currency (for
instance USDEUR rather than EURUSD):

By taking the ratio of the PPP rate versus the market exchange rate we
obtain the Real Exchange Rate (RER), which should equal to one if the
market rate equalled the PPP value. A RER that is above 1 means the

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currency is overvalued. A RER value that is below 1 means that the
currency is undervalued. Ordering them according to the RER we obtain
following table:

Currency PPP Market Value (with USD as RER

One possible way of trading the Value factor dynamically is to repeat the
base)
ranking process of the various currencies on a monthly basis.
USDEUR 0.760845 0.892851 0.852146
USDCAD 1.219516 1.392 0.876089 Obviously the PPP values will remain unchanged throughout the year.
USDJPY 106.0434 115.7 0.916537 However the exchange rates will oscillate. This is due to the vagaries of
USDNZD 1.420758 1.508296 0.941963
Mr. Market as Warren Buffett likes saying. Therefore the rankings will
USDGBP 0.700296 0.693001 1.010527
change from month to month as well.
USDAUD 1.444425 1.410437 1.024097
USDSEK 9.026982 8.44 1.069548
And so each month we put on another value trade, buying the cheapest
USDNOK 9.169112 8.57 1.069908
USDCHF
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and selling the most expensive currency.

Also, similarly to the Carry Portfolio we can construct portfolios which are
more sophisticated, taking risk and hedging into account.
So the cheapest currency is the EUR and the most expensive is the CHF.
So the value-trade would be long EURCHF. That is we sell the most
expensive and go long the cheapest currency.
The historical performance of this strategy is shown in this chart: The way to trade momentum is to identify those currencies with positive
momentum and trade those versus the ones with negative momentum.

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Again since currencies come in pairs, we will use the US Dollar as the base
currency. This is more by convention, but you can go ahead and try other
base currencies if you wish.

In this calculation we will restrict ourselves to all the majors versus the US
Dollar, which essentially creates a universe of 9 currency pairs: EURUSD,

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GPBUSD, USDCHF, USDJPY, AUDUSD, NZDUSD, USDCAD, USDSEK, and
USDNOK. And we will use the quote convention of CCYUSD, even for
those where it’s the other way around. It just makes it easier to compare
them against each other.
Factor 3 – Momentum
For each of these you measure the percentage movement over the last 3
The third factor on our list is Momentum. It has been known for a long months.
time that momentum plays an important component in the markets. This
Currency 1st Feb 1st Nov Return
can be associated with order flow, herd behaviour, and other behavioural
GBPUSD 1.4235 1.5446 -7.8%
finance explanations. CADUSD 0.7151 0.7648 -6.5%
CHFUSD 0.9769 1.0153 -3.8%
Unlike Carry and Value, Momentum is more less founded in tangible NZDUSD 0.6463 0.6732 -4.0%
economics and more in behavioural finance, and crowd psychology.
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Nonetheless it is present all over the place: in the commodities markets,
in the equities markets, in the bond markets, as well as in the currency
markets.
NOKUSD
EURUSD
JPYUSD
AUDUSD
0.1152
1.0829
0.0082
0.7062
0.118
1.103
0.0083
0.7115
-2.4%
-1.8%
-0.8%
-0.7%
SEKUSD 0.1165 0.1177 -1.0%
So how do we go about defining momentum, and trade it?

It turns out that this is the easiest factor to trade, since you just need the The momentum trade is to go long the ones with positive performance
underlying price history of each currency pair, which you can easily access and short the ones with negative performance.
in your trade terminal, e.g. MetaTrader 4 or 5.
In this particular case all currencies have declined against the US Dollar
over the last three months, and so the trade for February would be short
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a basket of currencies against the US dollar.
As before, you can re-calculate the trade on a monthly basis, and re-
balance, in that way maintaining a dynamic portfolio.
You can also add or drop currency pairs you might not be comfortable
with. For instance I wouldn’t recommend undercapitalized novices at the
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markets to trade the Scandie currencies (USDNOK and USDSEK).
If you have followed the above, your first reaction might be why 3-
months? The reason is that 3-months tend to work the best, though you
can use other time-frames if you wish, as long as it is larger than 3
months. Mean-reversion tends to dominate over the shorter time
horizon.
The long-term performance of the momentum factor (since 1994) looks
like:
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Its beauty is that it acts as an insurance against turbulent times. Look at
the returns during the GFC (Great Financial Crisis) period.
The Result of the 3 Factors
If you were to perform the calculations for the above three factors on a
monthly basis and put the trades on as indicated you will find that you
can replicate the performance of the chart at the start of this section.
As we described at the start of this section the first important step
towards creating a good system was to determine the long-term biases.
We have done this by using the three factors that drive currencies: Carry,
Value and Momentum. You can now start to trade and manage this
portfolio.
So how do these factors qualify as long-term biases in the currency
market?
Well we have just created something that is totally missing in the
currency world: a Foreign Exchange benchmark.
against the S&P500
The whole point of the S&P500 is that it allows people to invest in
companies and track the long-term economic growth policy of the
government.
Similarly the currency benchmark provides a framework which captures
the relative economic and monetary policy between countries, as
captured by relative value of goods, the relative value of cash, and the
flow of capital between countries.
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These factors have (since the major currencies became freely floating in
1974) provided long-term growth, as is evident by the index. As such it
provides a framework that adapts to market conditions, and will continue
to provide value.
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Other Factors
There are other factors which can be used. For instance currencies are
known to be mean-reverting over short term time-frames and over very
long-term time frames. You can combine these two together with the
above as well.
The justification for the mean-reversion over short term time-frames
tends to be the continuous to-and-fro of flows and the stabilization
mechanisms of various big institutions.
Mean-reversion over the long-term (3 years or more) tends to be
predominantly driven by the economic stability of the G10 countries. By
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that I mean that the UK for instance isn’t going to take off like Yahoo did
relative to the Euro Area. Note that I’m not making this statement for EM
currencies like ZAR or TRY!
Pattern Based Trading
At this point many will ask about ‘technical’ approaches to markets.
About trendlines, head and shoulders, moving averages.
In this section I want to briefly cover this subject and give some
foundational principles.
The problem with technical indicators is that they rely solely on past price
history. In the factors above we look at the current economic
environment to get a feel for future currency flows.
Technical analysis makes the assumption that the past repeats itself.
However, unlike with the economic factors, we don’t really know why.
Why should a moving average work? I can understand why interest rate
differentials work: because people chase returns, we’re wired that way.
Because of this lack of underlying explanatory power it becomes difficult
to really look for a holy grail of indicator systems.
This does not mean that I don’t believe they can be built, but they have to
be monitored incredibly closely, to ensure that they continue working.
The ones that I believe work the best are breakout strategies, especially
ones that look for natural support and resistance in the market.
Another feature that rarely gets taken into account is the realized
volatility of the market.
By that I mean the Average True Range (which you can find as an
indicator in the MT4 platform) or the “height” of the recent N bar range
(you can use following indicator form my site, Expanding and Contracting
Ranges)

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Why? Because support and resistance levels proxy the orders that big
players have put into the market, and naturally show where the price
preference lies. Volatility will tell you the type of trading you should
engage in: mean-reversion or trend following.

Being able to tell the directionality of the market, as well as the market

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conditions, is fundamental to applying the right ‘technical’ or
‘quantitative’ approach. Get this right everything else is easy.

A good reference for breakout systems is: Foreign Exchange Breakout

Systems, which is a book I published some time ago, updated for 2015,
and includes my personal experiences and approaches with breakout
strategies, and various betting approaches to them.
A Simple Pattern Based Approach
One of the easiest pattern based approaches is known as the Inside Day.
Following is a pictorial definition of what an inside day looks like:
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The underlying idea is that a state of price equilibrium, given the
multitude of different market participants, is unstable, and at some point
the asset must re-price. The hi and low of the inside day are the
boundaries set for the current equilibrium value, and once price moves
outside these boundaries, it is a signal that the market now perceives the
new price to exist at a different level.
You therefore use the hi and lo of the inside day as the upper and lower
levels for the breakout trade and trade the price in the direction of the

This approach is well known, and still works across many markets.

THREE
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Money Management and Risk Control
Two of the most frequent questions I get asked are:
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1) Where do I put my stop and take-profit targets?
2) What leverage do I use?
The second question is of course motivated by:
3) How much money can I make?
And rarely do people aim for conservative answers here.
You have all the tools in place to answer these questions now.
You’ve got a trade-log, and you have a workable system.
In this section I will show you how you can go about answering the
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questions above and apply them to your system, using the results from
your trade-log.
The first thing I’m going to do is to assume that you’ve split your trade-log
into subsections of trades.
For instance if you are trading a discretionary strategy as well as a system,
keep the records separately. Otherwise you will end-up combining apples
and oranges.
The next thing is to just keep a track of your pips, not dollar earnings. The
reason is to assume that each position was traded with the same size.
Why? Because we need a base-line case. The point of this exercise is to
figure out the right bet size!
And the final step to prepare your data is to work out every day’s Profit
and Loss which you can get from your broker statements.
You see, the question “How much money can I make?” is hiding a very
important factor: the factor of time. By splitting your Profit and Loss
statements by days, you will be answering the question “IN HOW MANY
DAYS could I double my money?” which is much more significant, than
asking after how many trades. Especially if your trades come from a rule-
based system.
Once you have all that we can proceed down the line of using Kelly
Betting to find your right trade size.
For starters Kelly Betting is known to produce the optimal leverage, if
your question is to create the fastest growth of wealth you could hope to
achieve.
To figure out the leverage we first off have to define some concepts, and
then I’ll show you how you can figure them out for the S&P500 and then
the Benchmark index. You can then use that to figure out your own
optimal leverage from your trade log.
Right up front I have to highlight, that this method has little to do with
the fixed-odds betting Kelly method, since in this scenario our losses and
gains are fixed in size, which is not the case when you trade. Therefore
from a trading perspective the formulas will look slightly different.
You can do this exercise along my side so that you get a feel for what’s 2) You then need the annualized returns. You can easily calculate
happening. these as the average daily returns times 252. We are assuming

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252 business days here!
Let’s start out with S&P500. To get tradeable reliable data we’ll 3) Next you need the annual swing in returns, or the annualized
download the Yahoo Finance data for SPY, which is the ETF on the back of standard deviation. This is just the STDEV function in Excel
the S&P500 benchmark index. applied to the daily returns. To annualize this daily number you
Here’s an excerpt of the data: need to multiply by √252, the square root of the number of
business days in a year, which we assume to be 252. The reason

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This screenshot of the excel spreadsheet shows the necessary formulas
you need to calculate. Let’s start out:
1) You need the daily returns as percentage returns. So if you
assume $100 as investment capital, and your return is $1, then
you have 1% return.
for the square root can be described by the fact that returns
come in swings, and don’t happen consistently in one direction.
So it can’t grow linearly, i.e. multiplying by 252. It turns out that a
smaller growth over a year of the average swing can be induced
by using the square root. (Don’t worry over this technicality, just
keep in mind that you are multiplying the daily standard deviation
by roughly 16!)
4) Now you can calculate the Sharpe Ratio = Annual Return / Annual
PL Swing (which is the Annualized Standard Deviation). In our
case for the S&P 500 = 10.1% / 18.9% = 0.53. In essence for every
dollar risked you stand to make 50 cents back.
Now to figure out the leverage you divide the Sharpe Ratio by the
annualized swing. So Kelly Leverage = 0.53 / 18.9% = 0.53 / 0.189 = 2.82.
So in essence you have to trade every day on the open with twice the
amount of capital you have at your disposal.
So if you start out with $100, you would trade a position size which
equates to utilize $282! I.e. a leverage of 2.82x.
So how does this affect the cumulative return over the period we are This is the way Kelly is constructed. But here is the hook: it constructed
investigating? Following chart shows the difference in performance: form historically estimated numbers. And as we know the future can and

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does change, it does not perfectly repeat the past.

This can well mean that the future can turn out worse, in which case the
Kelly leverage will end up to bankruptcy.

To prevent this, investors usually use a fraction of Kelly as leverage. A

preference tends to be half-Kelly:

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The end result is tremendous. Rather than having obtained a 577%
return over the time period 1993->2016, we have obtained 2519% return.
This equates to improving the original 8.6% annualized return on the
S&P500 to 15.2%. It also shows what the miracle of compound growth
can do.
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But for everything there is a price. Firstly notice the swings! The
S&P500’s worst drawdown in this time period was 55.2%. Our leveraged
version had a drawdown of 95%. The Kelly leverage is intended to
The worst drawdown is now 69%, however the return over this time
period is 1068%. This seems a more acceptable version, and the returns
are still very appealing.
optimize growth rate. Since on each day / trade, you take a fixed
percentage of your new wealth as your risk, it means that at the Kelly So how does this apply the FX Benchmark index we have presented
leverage you might deplete your capital, but won’t actually hit zero. above. If we look at the Sharpe Ratio and Annualized Standard deviation
we obtain the half-Kelly leverage as: 1.22/4.15%/2 = 3.2
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.
The return over this period is 1623% rather than 151%.
Remember: money management is designed to increase your
compounded returns to the max. Risk control is in charge of lowering
your downside. But ultimately the purpose of Risk Control is to feed into
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your ability to leverage up.
As George Soros put it: “It takes courage to be a pig. It takes courage to
ride a profit with huge leverage.”
Do Hedge Funds apply this technique? The answer is a resounding yes.
One of the best examples is the Turtle Approach to trading futures. (For
those who haven’t come across the Turtles a very good overview can be
found in The Way of the Turtle by Curtis Faith).
which provided a 36% annualized return.
If this has been a bit of a whirl-wind approach to figuring out the right
Kelly Leverage, there is another way of doing this. It’s a rough
approximation, and based on the approach Kelly originally took from
fixed outcome betting, such as Horse Races.
From Section One you saw how to calculate your average Winners (in
pips!) and your average Losers, as well as the your hit-rate for your
Winners, which is nothing else than the probability of Winning.
You can now plug these numbers into following formula:
𝑏𝑝−𝑞
𝐹= ,
𝑏
where F is the fraction of your account you should risk per trade. b here
stands for your Win/Loss ratio, p is your hit-rate, and q is your loss-rate,
which is nothing more than 1-p.
I’ll give you an example:

Let’s say you make 100 pips on average when you win and lose 50 pips

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when you lose. The ratio is 2:1, so b equals to 2 in the formula. P is the
percent of total trades that are winners and q is simply 1 minus p.
Assuming that p is 45% the formula gives F = 18.5%. So Kelly tells us to
put on position size so that the average loss on the portfolio equals to
18.5%.

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So if you have worked out your average loss to be 50 pips, and your
account size is $10,000, then you should trade a lot size of $10,000 x
18.5% / 50 / 10 = 3.7 standard lots. Which is the same as a 37x leverage.

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FOUR Thanks so much for your support of FX Master Course.

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Final Words from Corvin To continue the conversation, come and join the community …

Well done for making it to the end!  Facebook: http://facebook.com/FXMasterC

 Twitter: @FXMasterCourse
I hope you found this guide useful, and that you’ve enjoyed reading it as

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much as I’ve enjoyed writing it for you. You now have the basic three
pillars under your belt to start trading successfully in the markets:
All the best, and all power to you!!!
1) A good understanding the right trading approach
2) A sound understanding for what drives the markets (the kind of
information hedge funds and investment banks use) Corvin
3) A handle on how to control risk and maximize returns
4) A framework which allows you to adapt to ever-changing market
conditions

As you’ve seen, and probably can think of yourself, there are infinite
possibilities of implementing various strategies and approaches with the
information above.
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You can now choose which topic or section you want to dig in deeper,
knowing that if you at least stick the foundation, you have a long term
growth benchmark, like the old buy-and-hold S&P 500 in equities. And
you’ve also seen how you can outperform using the same old buy-and-
hold technique, simply by employing the right Kelly leverage factor.

Take away this information, start monitoring your trades, monitoring

Central Banks, and the data that they look at, dig and do your research,
and let me know how it goes!