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Trading 101

Trading 101: Intro to Forex Trading

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Forex trading

When you are first getting introduced to the world of forex trading, things can seem a bit overwhelming. There is so much information available online, but very little of it is aimed at beginners who may not be familiar with the terms and concepts they refer to. In this article we will cover the basics of forex trading, explain the most important terminology, and tell you how you can get started trading forex for yourself.

Forex jargon

To start off, let’s define some terms. Forex stands for “Foreign exchange” and is the name often used for this market where traders can buy one currency by paying with another currency. Other names used for this is the “FX market” or the “currency market.”

A pip, often referred to as “point in price”, is simply the smallest price move that is possible in a given currency, also known as a basis point. Forex traders often talk about their gains and losses in terms of pips instead of percentages or monetary values.

Long/short are confusing terms that often get tossed around by forex traders as well as other traders. To put it simply, long means that you are buying an asset and will make a profit if that asset goes up in price. Short, on the other hand, means that you are trying to make a profit from declining prices. The way it works is that you sell an asset that is borrowed from another market participant. After the price has dropped, you can then buy back the asset in the market for a lower price than you sold it for, and thus make a profit.

Stop-loss is the level a trader decides on where he would like to exit his trade if it is not working out for him. In other words, it is the maximum loss the trader is willing to take on one particular trade. Alternatively, a stop-loss order can be used to secure a profit on a profitable trade in case the market turns.

Leverage is the practice of taking a larger position in the market than your trading account size would otherwise allow. Basically you are borrowing money from your broker in order to boost your buying power in the market. Leverage offered in the forex market is often in the range of 200-400:1

Spread, also known as bid-ask spread, is the difference between the buying and selling price of an asset in the market. The broker will offer you to buy a currency at a slightly higher price than they will let you sell that currency. This is where brokers make most of their money, and it is important to compare spreads when choosing a forex broker.

Currency pairs

Since the forex market works by participants buying one currency with another currency, the price of a currency must always be quoted in another currency. For example, when you see that EUR/USD is trading at 1.20, it means that you need 1.20 US dollar to buy 1 euro.

The worlds largest market

The forex market is known as the largest of the world’s financial markets. Approximately $5 trillion changes hands in the forex market every day, far surpassing the global stock markets and commodities markets.

It is important to understand that the trading activity that retail traders (traders like you and me) account for is just a small, but rapidly growing, share of the total activity in the forex market.

Fundamental or Technical Analysis

When you are deciding to become a trader, you also need to decide on what type of trader you want to be. Broadly speaking, there are three types of traders; fundamental traders, technical traders, or a combination of the two.

Fundamentals take into account news, valuation, interest rates, etc. when trying to determine what price a currency pair “should” be trading at.

Technicals, on the other hand, focus strictly on what the price of the currency pair is doing. Technical traders study and analyze price charts to try to determine the future direction of the price.

Majors and Minors

Forex traders often talk about majors and minors when referring to currencies. Majors is a list of the most actively traded currency pairs in the world, and it consists of these pairs:

  • EUR/USD: The euro and the US dollar.
  • USD/JPY: The US dollar and the Japanese yen.
  • GBP/USD: The British pound and the US dollar.
  • USD/CHF: The US dollar and the Swiss franc.

Forex majors often have the lowest spreads in the forex market and they are also among the most liquid instruments you can trade in the financial markets.

Forex minors is a list of the next most actively traded currencies. This list includes currencies such as the British pound (GBP), Canadian dollar (CAD, aka “Loonie”), Australian dollar (AUD, aka “Aussie”), and New Zealand dollar (NZD, aka “Kiwi”).

Lastly, there are the exotic currency pairs. These include the remaining currencies from European countries outside the Eurozone (NOK, SEK, DKK) and smaller yet important Asian currencies like the Singapore dollar (SGD) and Hong Kong dollar (HKD). The exotics have less trading activity and the spreads are usually higher than for the majors and minors.

Benefits of Forex Trading vs. Stock Trading

A benefit of trading in the forex market rather than the stock market is that the forex market is trading 24 hours a day, from Monday morning in Australia until Friday evening in North America. The great thing about the market being open 24 hours is that there are no overnight “gaps” like you can find in the stock market.

A gap simply means that the market opens at another price in the morning than it closed the night before. For traders, gaps are considered a big risk, since the trader cannot control what is happening with his trade while the market is closed.

A market that is open 24/5, like the forex market is, opens up great opportunities for medium-term traders (swing traders) to for example take positions during the beginning of the week and exit those same positions before the week is over. That way, the trader takes no risk over the weekend when the market is closed.

Additionally, the forex market is much more liquid than most stocks, and it’s easy to find technical and fundamental analysis of this market everywhere on the Internet.

Choose a Forex Broker

Once you have decided to give forex trading a try, you need to choose a good broker that you trust with your money. This is the first, but still a critical step, on your way to become a successful trader. Pay particularly close attention to regulation, withdrawal policies, spreads, and trading platforms offered when choosing your broker. Fore more on this, read our earlier article on how to choose a forex broker.

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Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 34 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Trading 101: Determining and Trading Trend Strength

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Trend-following trading remains the most popular approach to trading in the retail segment, both in crypto and other markets. However, before taking positions in the direction of a trend, it is crucial to determine if the trend is gaining or losing strength. As trend traders, we need to make sure we are only taking trades in trends that are building up, and not those that are fading.

While we have covered the basics of trend-following trading in the past, and also revealed several trend-following strategies, we will here focus on how you can determine if a trend is worth trading, using both systematic and discretionary tools.

Trend waves and pullbacks

Studying trend waves and pullbacks during a trend forms the basis of a discretionary approach to determining trend strength.

In a trending market, small pullbacks signal strength in the trend. If each pullback is getting increasingly smaller as the trend continues, we can say that the trend is picking up momentum. Another thing we often see in strong bullish trends in that the pullback is not really a pullback, but rather a sideways consolidation of the price. This indicates that bulls are strongly in control of the market, buying up even the smallest dip in prices.

On the other hand, as pullbacks get larger and occur more frequently, we can take it as a sign that the trend is losing momentum and the price may reverse into the opposite direction soon.

Moving Averages

Moving Averages are probably some of the best-known tools for trend traders, and for good reason. They are incredibly simple to use, and can provide powerful signals in almost all markets.

The most common way to determine trend strength with Moving Averages is to apply two Moving Average lines to the chart; one slower and one faster. For example, combining the 20 and 50 period Moving Averages is a common strategy among swing traders in both forex, stocks, and crypto (the lower the period setting of the Moving Average is, the faster it reacts to changes in the price).

In a strong uptrend, we should have the faster moving average staying consistently above the slower Moving Average. If the distance between the two moving average lines grows, it means that the trend is gaining momentum, and if the distance between them shrinks, the trend is losing momentum.

If the two lines cross over each other, this is often taken as a sign that the trend is about to reverse. Many successful trend-following strategies follow the simple logic of buying an asset when the faster Moving Average crosses over the slower one, and selling an asset when the slower Moving Average crosses over the faster one.

Price rejection

What we call rejection of higher or lower prices in technical analysis is most easily spotted using traditional candlestick charts and looking for long wicks sticking out either above or below the “body” of the candles, as in the screenshot below.

Price rejection

In this chart, we can clearly see that we had a strong bullish trend and that the price attempted to extent the trend further, but repeatedly got rejected by the market. After four attempts at going higher, this market lost all bullishness and went into an extended downtrend.

Relative Strength Index (RSI)

As the name implies, RSI is an indicator that measures strength. In just the same way as we define an uptrend in price as a series of higher lows and higher highs, the RSI line should also make higher lows and higher highs when the market is trending up. In non-trending (range-bound) markets, the RSI generally moves sideways and stays between readings of 30 and 70.

As trends come to an end, we sometimes see divergences between the trend of the RSI and the price itself. For example, price may be making a new higher high, while the RSI line fails at making a new high, or even makes a new lower high, as we have two examples of in the screenshot below:

RSI divergence

Average Directional Index (ADX)

This is the classic trend indicator that many traders still use. The indicator consists of a red line and a green line and it basically says that a green line above a red line means we are in an uptrend. In the opposite case, a red line above a green line would mean that we are in a downtrend. If the two lines are close together it means that the market is not clearly trending, but rather stuck in a range.

Trend-following strategies sometimes make use of the ADX indicator in combination with Moving Averages to find strong price trends to ride. The ADX could then help determine the strength of the trend while for example cross-overs of two Moving Averages could serve as entry and exit points.

Which one should you use?

Perhaps unfortunately, which specific indicator to use in your trend-following trading really comes down to personal preferences. There is no right or wrong indicator to use, nor is there any right or wrong way to combine indicators and create your own trading strategy.

That said, most traders try to avoid combining indicators that are measuring the same thing. For example, ADX, Moving Averages and MACD are all considered trend indicators, while RSI and Stochastic are considered momentum indicators. In other words, you could combine Moving Averages and RSI, but should avoid combining Moving Averages and ADX with each other.

Experimentation is also fine, but instead of trying to learn how to use lots of different indicators, a better strategy is generally to use a few and become an expert at them. They are all powerful in their own way, it just comes down to the trader to master them.

Featured image from Pixabay.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.3 stars on average, based on 34 rated postsFredrik Vold is an entrepreneur, financial writer, and technical analysis enthusiast. He has been working and traveling in Asia for several years, and is currently based out of Beijing, China. He closely follows stocks, forex and cryptocurrencies, and is always looking for the next great alternative investment opportunity.




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Trading 101

Trading 101 and Beyond: The Head and Shoulders Pattern and Why You Should Never Ignore it

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The “Head and Shoulders” pattern (H&S henceforth) is perhaps one of the most widely used and misused technical patterns out there. Figure 1 depicts an example of a H&S pattern (tops – white ellipses; neckline – bright blue trendline).

Figure 1. REGN Daily Chart

It is without a doubt the pattern’s name that makes people smirk when they hear market commentators referring to it. After all, why would anyone invest/trade their hard-earned money using a pattern that has the same name as the most popular anti-dandruff shampoo? I am personally never thrilled to discuss the pattern. Imagine advising a portfolio manager, who relies entirely on fundamental analysis, that they should immediately sell one of their favourite names because the stock has broken its “neckline”… Patterns such as the double/triple top seem to be never questioned, whereas the H&S pattern gets ridiculed left, right and center, even though their implications are not that much different.

The former takes into consideration that the same level has served as resistance on more than one occasion (i.e. market participants realize that a security is too “expensive” at a certain price and a horizontal resistance is formed). Double/triple tops have an implied target of the distance between the “resistance” level (marked by the double or triple top) and the interim low (the lowest level within the pattern) projected down from the interim low (see Figure 2; double top – violet horizontal trendline; interim low – bright blue horizontal trendline; target – yellow vertical line).

Figure 2. MRK Daily Chart.

Hypothetically, if the stock had bounced up one more time before moving lower, a H&S would have been observed (tops – white ellipses; neckline – bright blue trendline; target – yellow vertical line in Figure 3). The only difference between the two is the slight change in the implied target, which is simply dictated by the slope of the neckline. That is, had the neckline been flat, the target from the H&S would have been identical to the one obtained from the double top.

Figure 3. MRK Hypothetical Daily Chart

While double/triple tops seem to be understood by most market participants, the H&S pattern is often disregarded. In the next section, I discuss why, on the contrary, the pattern should never be ignored.

The H&S Pattern

A textbook H&S pattern occurs in an uptrend and has three peaks, with the middle one being the highest. The neckline connects the two interim lows (i.e. the lows on each side of the “head”) and is used as the trigger to sell. Similarly, an inverse H&S transpires in a downtrend and has three troughs, with the middle one being the lowest. The neckline connects the interim highs and is used as the trigger to initiate long positions. So what makes this pattern so important? Two things.

Note, at a first glance the two don’t have much to do with the pattern so just bear with me.

  1. Prices tend to trend, and the trend should be considered active until there have been definite signals that a reversal has occurred. Yes, this is one of the six tenets of Dow Theory. A quick glance at S&P 500’s monthly chart reveals that the tenet could very well hold true (Figure 4). With the exception of 2016, the index always appeared to trend for extended periods. That is, the index was either posting higher highs and higher lows (uptrend) or lower highs and lower lows (downtrend) until eventually reversing. So how is this related to the H&S pattern? Let’s recall that a H&S pattern occurs in an uptrend and, by definition, includes one lower high – the right “shoulder”. So unless the neckline has a very steep slope, a break below it, in most cases, would lead to a lower low. A lower high (the right “shoulder”) and a lower low (the subsequent move below the neckline) implies a downtrend. But as the chart depicts, there were a total of only three periods where the index posted lower highs and lower lows (i.e. the dot-com bust, the “Great Recession”, and the sideways move in 2016). Therefore, the H&S pattern should not occur frequently on charts of “trending” securities, similar to that of S&P 500. Of course, unless prices are indeed reversing. We will return to this chart shortly to examine the pattern’s track record.

Figure 4. S&P 500 Monthly Chart

  1. Stock prices are significantly more volatile than their underlying drivers. This proposition has been a topic of discussion for many years, with Robert Schiller pointing out to this phenomenon in his papers “Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends” in 1980 and “The Volatility of Stock Market Prices” 7 years later. He concludes that stock prices deviate significantly more than the expected changes in real dividends. For more details on the subject, you can refer to Shiller’s texts. Market volatility, particularly since the “Great Recession”, is indicative of markets exhibiting bouts of extreme volatility, which cannot be explained by fundamental drivers. The “Flash Crashes” of 2010 and 2015, and the several late-day selloffs during the February and mid-March corrections in 2018 are only some of the examples of such volatility. In the context of H&S patterns, as market volatility exacerbates each move during a trend, a change in trend (i.e. a completed H&S pattern) should be followed by a swift move in the direction of the new trend.

All in all, the combined implication from the above two points is that market participants can profit tremendously by initiating positions at the onset of a new trend (i.e. when a trend reversal occurs) because 1) markets will move in the direction of the new trend for a prolonged period (as markets tend to trend), and 2) each move during the new trend will be of large magnitude (as markets are significantly more volatile than their underlying drivers).

Going back to the monthly S&P 500’s chart, it is evident that nearly all major trends had terminated with a H&S pattern (tops and bottoms – white ellipses; necklines – bright blue trendlines in Figure 5).

Figure 5. S&P 500 Monthly Chart

Of course, the pattern has also given false signals. Zooming in (Figure 6 –S&P 500 weekly chart), two such occasions catch the eye – the 2016 consolidation (already visible on the monthly chart, Figure 5) and earlier in 2010. On both occasions, the index broke below the neckline of a H&S pattern (neckline – yellow trendlines, break below necklines – yellow arrows) but did not subsequently trend in the opposite direction (i.e. a trend reversal did not lead to a prolonged movement in the opposite direction).

Figure 6. S&P 500 Weekly Chart

However, had one gone short upon both signals, they would have had an opportunity to reverse and go back long shortly after. Not surprisingly, it was inverse H&S patterns that gave clues that the topping patterns in Figure 6 are giving false signals (lows – bright blue ellipses; necklines – bright blue trendlines in Figure 7).

Figure 7. S&P 500 Weekly Chart (same period as in Figure 6 – 2009 to May 22, 2018)

Overall, using the pattern would have led to catching practically all major tops and bottoms over the last 20 years, and being whipsawed on two occasions. Not a bad track record given how quickly one could have been able to close and reverse in both 2010 and 2016.

Formation of the Pattern

So how exactly does a H&S pattern form? Imagine a prolonged uptrend where each subsequent rally takes prices to a new high and each subsequent pullback terminates at a higher level. As prices tend to trend (point #1 above), prices are expected to move way past fundamental values before they reverse. Market volatility (point #2) only exacerbates the extent of each move. It is only after prices have reached extreme levels, in relation to their true drivers, that they are unable to make a new high (yellow trendline in Figure 8).

Figure 8. Hypothetical Uptrend with One Lower High 

This is not a reversal as of yet. A reversal of a trend requires not only a lower high but also a lower low. For example, if the subsequent low terminates at a higher level, followed by a new high, the uptrend will be considered intact (Figure 9).

Figure 9. Hypothetical Uptrend Continuation

However, had the subsequent down-move terminated at a lower level, the security would be considered in a downtrend (Figure 10).

Figure 10. Hypothetical Uptrend Reversal

As seen in Figure 5, in most cases, once markets eventually reverse, they start trending in the opposite direction. That is, markets trend higher to reach extreme “expensive” readings before they reverse and trend downwards until they become extremely “cheap”.

Unfortunately, most of the technical analysis literature on the subject describes the pattern with a very stringent set of rules. Those rules, while aiming to make interpretation of the pattern objective, may lead to untimely entry & exit, and ultimately to unprofitable trading.

Traditional & Alternative Interpretations of the H&S Pattern

Traditional Interpretation #1: The H&S pattern is a reversal pattern (i.e. H&S can only point to falling prices and inverse H&S – to rising prices). This is perhaps one of the two greatest myths about the pattern. Most traditional texts discuss the action of prices breaking through the “head” of the pattern as simply one of the three ways to negate the pattern’s original reversal signal (the other two being -1) breaking back above the neckline, and 2) breaking above the right shoulder). This completely ignores the fact that a “failed” H&S pattern may often give a continuation signal that is more potent than a reversal signal generated by a “completed” H&S pattern. Given that markets trend for extended periods, there are various examples of “failed” H&S patterns pointing to a continuation of the ongoing trend before the eventual reversal takes place. Let’s look at a few examples. First, Figure 11 depicts Aphria’s (APH.TO) price action since mid- 2016. The stock formed a “tentative” H&S pattern from November 2016 to August 2017 (tops – white ellipses, neckline – green trendline). APH never broke below the neckline, and instead broke through the head in late 2017, giving one of its most potent buy signals, with the stock tripling over the next few months.

Figure 11. APH.TO Daily Chart

More recently, a client of mine requested a technical overview of New Flyer Industries (NFI.TO). Over the last 3 years, the stock had formed several tentative H&S patterns (tops – white ellipses; necklines – green trendlines in Figure 12). Similar to Aphria, the necklines were never broken, and the subsequent breaks above the “heads” of the pattern resulted in major buy signals.

Figure 12. NFI.TO 2-Day Chart

Going back to the S&P 500’s weekly chart, the index formed a tentative H&S pattern in 2012 (tops – white ellipses, neckline – green trendline in Figure 13), but instead of breaking the neckline, it broke the head and continued its advance.

Figure 13. S&P 500 Weekly Chart

Credit for this alternative interpretation goes to Fregal Walsh, who had published a paper on the subject in the 2015 IFTA Annual Journal.

Traditional Interpretation #2:  The first counter move after the pattern is completed should terminate at the neckline. In other words, after the break of the neckline and the initial move in the opposite direction of the prior trend, prices are expected to reverse and halt at the neckline before reversing again in the direction of the breakout (first counter move after pattern completion terminates at the neckline – yellow trendline in Figure 14).

Figure 14. Traditional Theory for First Counter-move after a H&S Completion

While this certainly is the case for most broken trendlines (i.e. support turns into resistance and vice versa), this is yet another stringent guideline in the context of the H&S pattern , which can certainly lead to missed opportunities. On one hand, prices may never retrace back to the neckline, meaning one may never enter in the direction of the breakout if they were to wait for a retest. On the other hand, prices would often not only retrace back to the neckline, but would also move back above/below it before eventually reversing in the direction of the breakout. Using the same monthly chart of S&P 500, it is evident that out of the 5 major H&S patterns, on 4 occasions (patterns 1, 2, 3 & 4 in Figure 15), the index never retested the neckline after breaking it. Notice that this was the case irrespective of the direction or the slope of the neckline.

Figure 15. S&P 500 Monthly Chart

In the last inverse H&S pattern (#5), the index reached the neckline but before bouncing higher it broke below it (Figure 16).

Figure 16. S&P 500 2-day Chart

I am certainly not implying that subsequent retests of the neckline are insignificant. Often enough, if the specific technical backdrop of a security warrants it, I use the neckline as either a potential entry or a negation level. Rather, I am suggesting that if one is certain of a trend reversal, they should not religiously wait for a retest of the neckline. Also, sometimes, the neckline could be broken back (i.e. the security moves back within the pattern) but this not necessarily mean that one should close all positions. Figure 17 shows one of many such examples, where a stock (ATD.B.TO) moved back above the neckline of the H&S pattern (green trendline) for a week before plummeting over the next few months.

Figure 17. ATD.B.TO Daily Chart

Entry

Traditional technical analysis theory suggests that one should wait for the neckline to be broken before initiating a trade. To a large degree, entering upon a close below/above the neckline is a reasonable entry strategy. After all, as we saw in Figures 11, 12 & 13, the pattern could very well be consolidating before breaking the “head” of the pattern and continuing its prior trend. In that case, a premature entry in the expectation that the neckline will be broken will result in an unprofitable trade. Thus, on a systematic basis (and without considering any other technical developments), waiting for a close beyond the neckline is advised (H&S tops – white ellipses;  neckline – blue trendline; target – vertical blue line; entry – blue arrow in Figure 18).

Figure 18. WMT Daily Chart

Unfortunately, this entry often leads to trades with a very unfavourable risk-reward profile, as by the time the neckline is broken on a closing basis the stock may have already moved significantly away from the top of the pattern (i.e. from the negation level which determines the risk of the trade). One way to tackle this is to wait for a corrective move in the opposite direction of the breakout before initiating a trade. This scenario was already covered in the previous section, where it was shown that the first corrective move after the break of the neckline may terminate 1) prior to retesting the neckline, 2) at the neckline, or 3) beyond the neckline (yellow lines in Figure 19 indicating possible scenarios for the first counter-move after the neckline is broken; eventual move in the direction of the breakdown – red line).

Figure 19. Possible Scenarios for First Counter-move after a H&S Completion

Having done extensive work on “price gaps”, I had found that if a gap transpires during the formation of the head or the right shoulder, or upon breaking out of the pattern (i.e. breaking the neckline), a probable scenario is that price will pull back to pre-gap levels, giving a K-Divergence signal. See my primer on gaps for more details on how to trade the gap phenomenon and my “K-Divergence” paper in the 2018 IFTA Annual Journal for details on the specific H&S trading application.

Exit

Naturally, one exit strategy is to close positions once the pattern reaches its implied target (i.e. the distance from the head to the neckline projected from the neckline break – see Figures 3 & 18 for examples). It is noteworthy that the suggested target is considered to be a “minimum” projection from the point of pattern completion. Simply looking at S&P 500’s monthly chart, it is evident that the minimum target was exceeded on every occasion (target – purple vertical lines in Figure 20).

Figure 20. S&P 500 Monthly Chart

Not surprisingly, as index’s constituents are more volatile than the index itself, they form the pattern much more frequently. When it comes to individual stocks, the minimum target can be used to close at least half of the position. WMT’s chart (Figure 18 above) shows just that – an S&P 500 constituent completing a H&S pattern (and meeting its minimum downside target in May) without the index completing a topping pattern during the same period.

Conclusion 

Hopefully, the above discussion has at the very least made you just a little bit less skeptical about the infamous Head and Shoulders pattern. If you have any questions or if you would like to see a more thorough description/explanation for any of the sections in this article, feel free to do so in the comment section below.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 15 rated postsPublished author of technical research. In his work on price “gaps”, published in the 2018 International Federation of Technical Analysts’ Annual Journal, he developed a new technical tool for analyzing and trading the “gap” phenomenon – the “K-Divergence” (http://ifta.org/public/files/journal/d_ifta_journal_18). Besides obtaining a Master in Financial Technical Analysis, he has completed a BBA and an MBA from the Schulich School of Business in Toronto and has completed all exams for the CFA, CMT and CFTe designations. Currently, providing research to investment management and financial advisory firms. http://www.linkedin.com/in/konstantindimov




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Trading 101

Managing the Safety of Your Cryptocurrency

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The fact that Coinbase and other companies have made it possible for nearly anyone to invest in cryptocurrencies is almost unilaterally a good thing, but it has led to many people buying cryptocurrencies without understanding the ecosystem. Bitcoin and other cryptocurrencies are only seen as risky investments because of their future worth, when there is also the risk of theft in the present.

Many investors focus their time on the idea of maximizing the returns on their investments, but protection against downside is equally important. We’ve all heard the oft-cited thought experiment where when you lose 50% of your investment, you now need 100% returns to get back to even. Avoiding negative returns is an equal priority to achieving high ones.

There are some steps a newbie cryptocurrency investor can take to make sure they are as protected as they can be. From wallets to basic security and diversification, the points below are a few quick changes you can make that will maximize your security.

The Basics

The two most basic steps are not keeping your money in an exchange wallet, and using a 2-factor authentication application. Many people new to the ecosystem will go with the path of least resistance, and that results in only having a password protecting their assets.

Exchanges are considered to be secure, but there have been many breaches in the past, so it is not impossible your funds could be compromised in the future. In the case of a hack, hopefully your exchange would cover you, but the best thing you can do is move your funds into an offline wallet (e.g. desktop, mobile, or hardware). By splitting your money off from the giant “honeypot” that exchanges serve as, the incentive for hackers is greatly reduced.

Additionally, by enabling 2-factor authentication and using an application, you mitigate for the risk that your password or phone number are compromised. This may sound crazy, but it is possible for a SIM card to get hijacked and a hacker to use your phone number to gain access to your funds. Authly and Google Authenticator make it possible to prevent that from happening.

Wallet Management

Once you have made sure your money is on a wallet, there are still risks you need to understand. At this point, the biggest risk is that you might forget the passcode or PIN to your wallet. Or you could lose the device with the private keys on it. Both of these situations can be handled easily by taking careful note of your memetic passcode and backing up your wallets onto a second device.

It might help to back up a bit for a second. Your private key is what verifies your ownership of a public key, which can be thought of as being similar to a bank account. When you moved your coins into an offline wallet, you “took ownership” of your private keys. This is an essential part of forming a decentralized network, because if you hadn’t done that, all the keys would still be managed by a centralized source. Another way to look at it as if you are making sure no one else knows your ATM code.

Something fewer people in the ecosystem realize is they are not assigned a single set of keys, but actually many pairs. These pairs of keys are generated from a “seed root”, which is a 16 word sequence of seemingly random words (see this list for more about this). By having this seed root, you are can prove you are the rightful owner of the cryptocurrency in question. It is considered to be the password of passwords, and should be guarded as such.

Knowing all of this, the best way for you to carry on with your security is to write down your 16-word seed root, file it away in a separate area from your wallet, and then back up the data onto an offline hard drive that can be recovered in the case of emergency. All of this may sound like a paranoid hassle now, but the small time investment will make the difference.

Protect Your Crypto

By learning to manage your money well, you will be able to increase the protection of your cryptocurrency. The final thing you should consider is spreading out your funds between several different wallets. There is always the risk that a company gets compromised, and by diversifying where you hold your securities, you can reduce the effect this may have.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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