Once dominated by global banks, hedge funds, and multinational corporations, the foreign exchange market, or forex, is now easily accessible to traders and investors around the world. But in order to make the most of your time in this market, you need to have a firm understanding of how it works.

Written by forex expert Kathy Lien, The Little Book of Currency Trading shows you how to effectively trade and invest in today's biggest market. Page by page, she describes the multitude of opportunities possible in the forex market, from short-term price swings to long-term trends, and details the practical products that can help you achieve success.

Along the way, Lien skillfully explains the forces that drive currencies and provides strategies to profit from them; reveals how you can use various currencies to reduce risk and take advantage of global trends; and examines what you can do to make money without the stress of monitoring the market every day. Other issues addressed include:

• Getting started in forex and finding the right approach for you
• The most commonly made forex mistakes
• Making the most of slow and steady investing as well as learning the fast and furious approach to forex
• Avoiding popular forex scams
• And much more

Filled with in-depth insights and practical advice, The Little Book of Currency Trading opens the world of currency trading and investing to anyone interested in entering this dynamic arena.

KATHY LIEN is the Director of Currency Research for Global Forex Trading (GFT), a Division of Global Futures & Forex, Ltd. She also runs an FX signal service, BKForex Advisor, with Boris Schlossberg. Prior to joining GFT, Lien was the chief strategist of DailyFX.com and an associate at JPMorgan Chase, where she worked in cross-markets and foreign exchange trading. As an internationally renowned currency strategist, Lien specializes in combining fundamental and technical analysis. With more than ten years of currency trading experience, Lien is a frequent guest host of CNBC Asia and Sky Business News and has appeared on CNBC (U.S. and Europe), Bloomberg, Fox Business, and Reuters. She is a regulator contributor to Active Trader, Futures, and SFO magazines and is quoted by financial publications around the world. Lien is also the author of the two editions of Day Trading and Swing Trading the Currency Market as well as Millionaire Traders, which are published by Wiley.

The Little Book of Currency Trading

How to Make Big Profits in the World of ForexBy Kathy Lien

John Wiley & Sons

Copyright © 2011 John Wiley & Sons, Ltd
All right reserved.
ISBN: 978-0-470-77035-1

Chapter One

When Lightning Strikes

Financial Crises and the Rise of Currency Trading

Do you know someone who's been struck by lightning? What about someone who's been struck by lightning twice? According to the National Weather Service, the odds of someone being struck by lightning in a given year are 1 in 750,000. That makes it extremely unlikely that a person will be struck by lightning once, much less twice. However, because lightning aims for the tallest object in a given area, it's not at all uncommon for it to hit the same place more than once. For that reason, lightning rods are placed atop city skyscrapers to attract the bolts and absorb the hit.

Lightning rods attract lightning just like financial markets attract greed, which inevitably brews disaster. Given the right conditions, disasters in the financial markets—like lightning—can hit more than once and investors must be prepared.

Back in 2007, Nassim Nicholas Taleb wrote what became a very famous book called The Black Swan: The Impact of the Highly Improbable. Taleb describes a Black Swan as an extremely rare event that catches people by surprise, has a major impact, and is then rationalized as if it had been expected to happen all along. Unfortunately, as we've all seen, Black Swan events have become much more common in recent years. As bubbles in the economy begin to reach their breaking points, it is important for investors to identify ways to deflect risk and possibly capitalize on those events because fortunes are at stake. In fact, two of the world's most famous global investors made their fortunes when other people were panicking and running for the exit.

In 1992, at the ripe young age of 62, George Soros gambled that the U.K. would not be able to maintain high interest rates necessary to keep the British pound within the tight currency band mandated by Exchange Rate Mechanism (ERM). Soros believed the weak economy and high unemployment would force the U.K. to abandon the ERM and cut rates. He turned his speculation into action by establishing a massive $10 billion short position in the British pound through the use of as many different instruments as he could find. Of course, Soros was not the only one selling the pound. As speculation grew about the U.K. abandoning the ERM, no one wanted to hold pounds. What separated Soros from other investors was that when most people were on the defensive, selling pounds and squaring their exposures into the madness, Soros was on the offensive, attacking the pound until the Bank of England cried uncle. A month later, Soros's Quantum Fund cashed in and banked approximately $2 billion in profit.

The second financial legend is Sir John Templeton, who took a very different approach from that of George Soros. Founder of the world's largest equity fund, the Templeton Growth Fund, Templeton was a deeply religious man and a contrarian at heart. He loved to buy the crashes and come in during what he called times of "maximum pessimism." For example, Templeton swooped into Ford when the automaker appeared to be headed for bankruptcy in 1978 and poured money into Peru when it was awash with communists in the 1980s. However, he was not always a buyer. In 2000, when everyone else was buying technology stocks, he shorted dozens of technology companies. Templeton liked to get in when the underlying fundamentals were extremely out of line with the perceptions of the reality. Those opportunities don't come along every day, but when they do, they can present enormous opportunities.

The Worst Decade Ever

Time magazine labeled the first 10 years of the twenty-first century as the worst decade ever. Apart from wars and environmental catastrophes, there were two market crashes: the dot-com bubble at the beginning of the decade and the global financial crisis at the end. The global financial crisis wiped out the savings of families around the world, plunged millions of people into unemployment, and claimed a number of Wall Street's oldest institutions including Lehman Brothers, Merrill Lynch, and Bear Stearns. Most people did not imagine that a company like Lehman, that was established in 1850 and survived two World Wars and the Great Depression, could be pushed into bankruptcy during our lifetime. There are countless stories of individual investors who lost 50 to 90 percent of their retirement funds. The debacle in one way or another affected the lives of every American. Yet, believe it or not, a handful of savvy investors profited handsomely during this period when most were losing their shirts.

The subprime crisis that began in 2007 eventually morphed into the global financial crisis. The origin of the crisis was the popping of the technology bubble, which led Alan Greenspan, the Federal Reserve chairman at the time, to stimulate the economy by cutting interest rates aggressively. Unfortunately, he left interest rates too low for too long, creating housing and credit bubbles. Money was flowing into the U.S. economy from spigots as the Dow Jones Industrial Average raced from 8,000 in 2003 to a high 14,000 by 2007. The low cost of borrowing encouraged Americans to refinance their current homes, trade up, or buy investment property—and in some cases, all of the above.

Many of you may have participated or at least had ringside seats to the hysteria—even if it was only watching TV shows like Flip This House on A&E or Flip That House on the Discovery Channel. At the time, everyone from your local barber to taxi drivers was dabbling in real estate and believed to the core that in the long term, you could never lose money on housing. Boy, were they wrong. By 2005, real estate had accounted for 70 percent of the rise in net household wealth and an astounding 50 percent of overall growth in the U.S. economy in the first half of that year. Between 2001 and 2005, more than half of the private sector payroll jobs created were in housing related sectors. Who could blame the average American when house prices in places like Phoenix, Arizona, were rising as much as 45 percent a quarter. But when things got bad, they became very bad very quickly. When the housing bubble burst, prices in some states fell nearly 50 percent from their peak levels in 2006. Between the middle of 2007 and the beginning of 2009, U.S. stocks also dropped more than 50 percent. By March 2009, Americans lost more than $15 trillion in total net worth. The housing market bubble is exactly what Sir John Templeton would have called "maximum optimism."

In retrospect, many of us would wonder, how could we have not seen the warnings signs. With banks willing to lend to almost anyone, and average Americans overloading on debt, how could it have gone on forever? At the time, the bursting of the technology bubble was still in recent memory, which should have reminded us about the consequences of excesses. Although the subprime crisis created the largest housing bubble ever, it was certainly not the only one in recent history.

In the past 40 years alone, there were two housing bubbles in the United States, one that peaked in 1979 and another in 1989. Between 1987 and 1991, the housing bubble in Japan also collapsed, pushing the country into a long period of zero growth...