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The Warren Buffet Way of Trading Forex by Kathy Lien

With the outlook for the global economy brightening, the one lesson that the past few years have taught us is the need for diversification. For most people, investing means only one thing - picking which shares to buy.

However, in recent years currency trading has exploded and if you are eager to find out what the excitement is all about, you will be surprised to see that what moves currencies is not all that different from what moves shares. The best way to get started is to trade what you know - at least, that is what legendary investor Warren Buffett would do.

For example, if you are trading shares, you probably already have an opinion on the outlook for the Australian economy. Therefore, it shouldn't be a surprise that the price action of the Australian dollar also reflects the country's economic outlook.

For technical traders, the transition is even easier. Since currencies trade 24 hours a day, 5.5 days a week, there are a lot of data points, increasing the accuracy of technical analysis. You can employ the same technical toolkit you use to trade shares. In fact, you may find that the forex market is even more suitable for these strategies because of its unparalleled liquidity.

In his 2008 letter to shareholders, Warren Buffett said only four things really count when making an investment - which can also be applied to currency trading:

1. A business you understand = A currency trade you understand

Make sure you have a reason for every currency trade that you take - and it's not just because your mate thinks it is a good idea.

Your reasoning should be firmly based in fundamentals, technicals or both. Imagine that we were back in the first quarter of 2009; definitely a scary time, but one ripe with opportunities. The Australian dollar was being relentlessly hammered due to the unwinding of everything in sight and an all out push into safe haven assets. But what many global traders failed to realise was that Australia was more immune to the turmoil because of its relationship with China.

The country did not fall into a recession, avoiding much of the financial plague. If you believed in the strength and resilience of the economy at that time, and believed that the trading universe would eventually realise the disparity, you could have bought Aussies after prices consolidated in early March through forex or CFDs. The key is to understand the trade and to truly believe in it.

2. Favourable long term economics = Is the trend in your favour?

Whether you are using technicals or fundamentals, try to make sure that the trend is in your favour, because trends in the currency market can last for weeks, months and even years.

When trading currencies you are trading the outlook of a country, which usually does not turn on a dime. It typically gets progressively better or progressively worse - rarely will it get better/worse/better/worse, which explains why currencies can trade for weeks, months and in some cases even years.

Take the Australian dollar, for example. Between May and July of 2013, the currency was on a one-way downtrend against the U.S. dollar with only brief relief rallies. The uptrend in the GBP/USD between July 2013 and February 2014 lasted even longer and took the pair from a low of 1.48 to a high of 1.68.  Although you may have been able to capture profits fighting those trends, you would have saved a lot of sleepless nights, been more relaxed and yielded better results if you followed the trend.

3. Able and trustworthy management = Do you have a reliable broker to execute the trade?

The most important part about trading is being able to get in and out of the trade easily. Make sure you trade with a broker that is regulated by local agencies.

It is important to trade with a trustworthy broker, because you never want to be exposed to counterparty risk. Find one that is licensed and well reviewed by trade magazines.

4. Sensible price tag = Are you paying up or coming in at value?

Since trends are so dominant, try to look for value opportunities rather than paying up and chasing a trade.

Warren Buffett always likes to find a bargain. It is important to follow this guideline as well, since trends can be very powerful and paying up would create a poor risk-to-reward ratio. Technical analysis tools could be particularly useful in helping to identify value points.

With these four rules in hand, you are on your way to exploring life outside of shares!

Kathy Lien
Kathy Lien

KATHY LIEN is Managing Director and Founding Partner of BKForex Trading Signals and BK Asset Management. Having graduated New York University 4 years early, Kathy started working on Wall St at the age of 18.

Her career started at JPMorgan Chase where she worked on the interbank FX trading desk making markets in foreign exchange and later in the cross markets proprietary trading group where she traded FX spot, options, interest rate derivatives, bonds, equities, and futures. In 2003, Kathy joined FXCM and started DailyFX.com, a leading online foreign exchange research portal. As Chief Strategist, she managed a team of analysts dedicated to providing research and commentary on the foreign exchange market. In 2008, Kathy joined Global Futures & Forex Ltd as Director of Currency Research and in 2012, she decided to branch out on her own with Boris Schlossberg to start BK Asset Management.

As an expert on G20 currencies, Kathy is often quoted in financial newspapers worldwide and appears regularly on CNBC. Kathy is an internationally published author of Day Trading & Swing Trading the Currency Market, The Little Book of Currency Trading and Millionaire Traders: How Everyday People Beat Wall Street at its Own Game.