Scott BarkleyTrader Interview: Scott Barkley on How Banks Trade

Pod Chats: Scott Barkley on How Banks Trade

Two Blokes Trading

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Scott Barkley is an award-winning Forex trainer and co-founder of Pro Act Traders. Along with his forex mentoring - which has seen several of his students go on to become professional fund managers - he is also an analyst for a number of high-profile FX websites, including Investing.com and FXStreet.com.

In this discussion on the Two Blokes Trading podcast, Scott talks to Brandon and Tom about trading's "big boys" - the professional bankers and institutional traders. He discusses what they're doing and why, including the two reasons bankers move the market and why he says price action is not random.

Check out some highlights from his chat below, or listen to the full interview in Episode 93 of Two Blokes Trading podcast here...

The market is being manipulated for two reasons: filling orders, and creating a structure that all professional traders and other banks know.Scott Barkley

On his trading epiphany...

My first mentor I spent 5,000 bucks to get trained by them and then I opened up an account. I had asked my wife for five grand to fund my account and three weeks later I had to ask for another five grand because I’d already blown up my account. So you know, that sounds pretty normal for most people, but I did learn to trade and started trading, I learnt a scalping method and moving average cross over method.

The market was trending back in the day, I started in 2001, and really I’m a grandfather in the FX business. The market trended really well, we got up every day and bought the GBP/USD and sold it a little later and always made money and things were wonderful until the market changed. Then we found out that all the little indicators and all the things we had been doing, they didn’t work anymore.

I had been successful; in fact at one time I traded 78 trades in a row without a loss. I was trading 5-8 pips, I looked at my account and realised I made 78 trades, I risked 30-40 pips each time and I made 5-8 pips, I said there is something wrong with this, I risked so much money for almost no return. And that’s what turned the corner for me, I realised I could be successful. I just said to myself "when are you going to be so in sync with the market that you are going to trade 78 trades in a row?" and my answer to myself was "never again". It took a paradigm shift at the time and I began the process of looking for how the market actually worked.

On forming Pro Act Trading...

I’m one of those guys who was very fortunate, I was in front of the right mentor at the right time. People say "when the student's ready, the teacher will appear", and that literally happened to me. Every turn on the way there was a guy there, a bank trader who told me how it worked. So I was very fortunate that that learning curve for me was pretty short because of having the right people in my life at that time. I ended up becoming a consultant with FXDD, and I travelled for them for three years, teaching trading to their clients, wherever they happened to go.

As I did that I travelled with a guy, Greg Michalowski. Greg is a good friend of mine and he was a bank trader in London. So with three years hanging out with him I learnt a whole lot about what the market actually does, as opposed to what people think it does. So that led me on this little quest and by that time we had started a little trading club. We rented a second floor, about 12-14 of us got together every night to trade the London session and all kinds of stuff. We quickly found some things that worked, I had my partner, who was my old boss when I got fired by the way, he is a mathematical genius and he said I can program that.

So we began the process of creating some charts. Our whole goal was to create charts for ourselves, but we ended up letting our friends use the charts and next thing you know we had 100 people in there, so we created a club. The next thing we had 200 people in there, we needed redundant servers, we needed tech support, and what ended up happening was we got dragged kicking and screaming into the charting business.

On how the 'big boys' trade...

The first thing we have to do is analyse and figure out what the ‘big boys’ are doing today and then we ask the question "why are they doing that?". Because they are constantly manipulating the market, but they have several other factors that are going on. They get paid to fill orders; there are about $400 billion worth of money in the retail market every single day. With about 200,000 retail traders. Those orders have to get filled. The bank gets paid to fill those orders. They always look at where the orders are stacked - people don’t realise that they’ve got a big old dashboard in front of them and they get to see all the traders with stacked up limit orders at a certain price point. Their job is to go and fix those orders; they drive the market to get those orders.

Now professional traders all know where those levels are, so they are looking to put their positions on there. For instance in a down move, dumb money will sell at the bottom, a professional trader will never sell at the bottom, he will only ever sell at the top. So what happens is traders see the market going down, they enter a trade and it goes against them, they go "ah the broker stopped me out again". Well they ran out of orders and they’re going back up to find the sellers. Those levels are known levels on the charts, bankers are technical traders, they trade the known levels and they manipulate the market for two reasons.

One of them is they have an agenda; their agenda may be to go down to a certain place. A lot of that had to do with that they’re trading the option market at the same time. What retail traders don’t realise is that the market is $5.3 trillion a day (an estimate), but we trade the Spot part of it, which is only $2.8 trillion a day. The rest of it is option contracts and swaps etc and of course commercial clients where they need to swap money from one country to another. We’re trading that part of the market but it’s not all of the market. All of those factors really drive the currencies.

On creating an agenda to direct the market...

For instance, HSBC can’t call up BoA and say "we’ve got this nice trend we’ve created and we’re trying to get down to a certain number, will you help us out?". Well they can’t do that because that’s called price fixing, so how do they get them to do it? They do it in the charts. So they create this market that is not random at all, every candle can be random, but the market structure is not random at all. The 'big boys', tier one bankers, are creating a market structure to get that agenda taken care of.

That happens day in and day out and that’s why you consistently see patterns over and over again in the market. If they were just random things in the market, they would be just that, they would be random, but they’re not. We have bull flags, bear flags, head and shoulders, rising wedges, falling wedges on and on and on. Well those things are created by bankers to continue movements. Apart from double and triple tops, there are only really four reversal patterns. A head and shoulders, an inverse head and shoulders, a rising wedge and a falling wedge. Every other pattern you see in the market is a continuation pattern. I say continuation because they are trying to continue a move that they have built. With an agenda and objective at mind.

On sideways markets...

Then of course we have the sideways market, everyone thinks the market is trending. But the reality is the market only trends 30% of the time, 70% of the time it’s going sideways. Sideways markets for bankers are heaven. Because it’s very simplistic and it’s easily go to the targets. Now the targets become the Fibonacci values inside that sideways market, previous support and resistance, the trend line, all those factors come into play and it’s all part of the structure. The structure of the market is dictating what kind of continuation pattern we need to keep in play so our agenda is met by all the bankers.

There are 15 major bankers in the world that control 78% of all market volume - 78% of everything you see on a chart is created by a ‘big boy’. We’re significant, retail traders, we’re $400 billion a day and we’re trading with stops, and they love to go get us. They’re not really hunting stops per say, they don’t really care about your two lot mini, they’re only interested in filling orders and in the process traders who are on the wrong side of the order flow get stopped out.

For instance they put in what we call a flag, you and I would call that consolidation. They don’t call that consolidation, they call that accumulation, they are accumulating positions and when the breakout occurs, they are going to own all those positions, including all the ones that lose. It’s a great opportunity for them.

On the markets not being random...

Any candle can be random right. I mean you look at a freeway, or the M1 over in the UK. It's rush hour, it looks like a parking lot, well every single truck, car, SUV is random, but that freeway is not random, that freeway is the structure and they’re all going in the same direction. That’s a way of looking at it when looking at a trend on the chart. You have a sideways market, all those candles are not random at all, you can call them random but 78% of everything you see is caused by a ‘big boy’.

I’ll give you an example, when I was at FXDD I was down in the pits one day with those guys and I said "what does the average winning trader take for profit?". Now FXDD at the time was the second largest broker in the world and they said the average winning trader makes 5-8 pips. Wow, ok. Then I said "how much money does it take to move this currency?". Well on average it takes $35 million to move the EUR Dollar one half of a pip in the New York session. That will give you an idea; try to wrap your head around those numbers. So how much money does it take to move it 20 pips? You’re talking billions of dollars. That’s why it’s a $5.3 trillion a day market. How do all those people decide to be a buyer at the same time, the only ones that count are the ‘big boys’. We could take all the money we’ve got, all of us click the candle at exactly the same time and we wouldn’t even put a shadow on a wick. But they can move it, because they’re moving big big amounts of money.

On front running the market...

They do other things, such as front running. The trader will come and realise that Sony is going to have a big order this afternoon at the London fix or the New York fix. And for 50-60 billion where they need exchange money from GBP to JPY, so on the Pound Yen there is going to be an order placed at a known time. Well the banker who is going to execute that order knows about it so he front runs it. In other words he’s placing bank positions prior to that so when he puts the $50 billion in, all of a sudden it jumps it up 20-30 pips and he makes all that profit. They’re doing stuff behind the scenes that retail traders aren’t actually aware of at all.

On market structure...

Structure is something like; can I find a trend, what are the rules of finding a trend? How many points do I need, do I need higher highs, higher lows, those kinds of things. There are rules on every single thing on there, Fibs, trends, previous support and resistance etc. But the two major ones are trend or no trend and Fibonacci ratios. The market does not turn in the middle of nowhere. All you’ve got to do is put a Fib on any major move and watch as the move goes to the pip, to each one of those Fib values. Those are the targets for the next moves.

Bankers go back in the past, find out what they did in the past and then they do it again; they’re mathematicians. That’s what they want, conservative type people who are not willing to take great risks. Bankers don’t lose because they don’t take great risks, doesn’t mean they don’t take risks, their job is to take risk, but they take structured risk.

You can’t trade Forex, at least based on structure, without knowing where the Fibonaccis are. You can’t do that. Jesse Livermore stated it very well, "the game doesn’t change because human nature doesn’t change." They didn’t know about Fibonacci until this rice farmer in the 1800’s decided to do a Fibonacci sequence on rice futures and he found out that they’re going right to the point of that Fibonacci. He made millions and nobody could figure out what he was doing and all he was doing was running Fib numbers because the market would turn just because human nature would make a turn there. It happens to be measurable. That’s our edge.

Bankers have learnt to use those and they don’t turn (price) in the middle of nowhere. You don’t see a candle in the middle of nowhere that all of a sudden everybody in the world decided to exit their trade here. Remember that the big bankers are 78% of everything you see. How did they know how to do that? They knew where the target was. And that’s exactly what target trading is. It’s finding those values based on structure and waiting for the market to make a move to accomplish that agenda.

Want to listen to Scott Barkley's full interview with Two Blokes Trading? Listen here to Episode 93