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THE ELLIOT WAVE THEORY

ELLIOT WAVE THEORY

- The –

Elliott

Wave

Theory

Written by

Kingsley

(Head of EWEB)

Contents

1. Introduction

2. Dow Theory

3. Directions of Trend

4. Five Waves

5. Markets do not Move in a Straight Line

6. A Complete Elliott Cycle

7. Repetitive Structure

8. Wave Degrees

9. End of the Trend and Beginning of Another

10. Phases

11. Rules and Guidelines

12. Wave 2 Never Moves beyond the Beginning of Wave 1

13. Wave 3 is Never the Shortest

14. Wave 3 Always Travels beyond the End of Wave 1

15. Wave 4 Never Enters the Territory of Wave 1

16. The Principle of Alternation

17. Extensions (and Counting Waves)

18. Corrective Waves

19. Zigzag Corrective Wave

20. Flats – Corrective Waves

21. Irregular Flats – Corrective Waves

22. Inverted Irregular Flats – Corrective Waves

23. Triangles – Corrective Waves

24. Symmetrical Triangle – Corrective Wave

25. Descending Triangle – Corrective Wave

26. Ascending Triangle – Corrective Wave

27. Running Triangle – Corrective Wave

28. Expanding Triangle – Corrective Wave

29. Triangles – Minimum Price Target (Measuring Technique I)

30. Triangles – Minimum Price Target (Measuring Technique II)

31. Double Three Combinations – Corrective Waves

32. Triple Threes Combinations – Corrective Waves

33. Wave Fibonacci Relationships – Extended Wave

34. Minimum Length of Wave 3

35. Wave 5 Maximum Price Target

36. Wave 5 Minimum Price Target

37. Extended Wave 5 Price Target

38. Zigzag Wave Relationships

39. Correction or Reversal

40. Crowd Psychology

41. Channeling

42. Time Factor

43. How to Trade Wave 3

44. How to Enter in Wave 3 Even Faster

45. How to Trade Wave 5

46. Trading the ABC Reversal

47. Final Thoughts

 

Introduction

As Head of Education at EWEB, I have trained thousands of traders, both beginners and advanced, on different concepts and theories on trading the financial markets. People are very enthusiastic to learn new strategies, tools and concepts, but what I came to realize is that every trader’s dream is to master the Elliott Wave Principle and Fibonacci ratios. They are fascinated by the recurring structure and cyclic model that the wave principle suggests. In this book, I will present both the Elliott Wave Theory and Fibonacci ratios from a trader’s point of view.

About the Author

EWEB’s Head of Education, Kingsley, is a respected FX educator and Certified Technical Analyst. He is a recognised authority in the forex industry, and renowned for his expertise in algorithmic trading. After years of consulting with EWEB on a number of key projects, Kingsley officially joined the company in June 2016 and is the principal driver and architect of EWEB’s extensive educational programme. His department’s international seminars and workshops provide clients across the world with on-location support, while his webinars, e-books, educational articles and videos form the cornerstone of EWEB’s multilingual, open access training resources. The training is tailored to traders’ needs by region and experience level.

kingsley has played a key role in the development of forex education within the industry, training tens of thousands of traders and forex professionals around the world. Traders of all levels value his seminars and workshops for both content and his passionate and lively presentations. As Head of Education, Kingsley also plays a pivotal role in EWEB’s research and development team. In this capacity, he led the development of the EWEB Trading Signals and EWEB Pivot Points Strategy tools, which are designed to help traders spot potential trading opportunities across various trading instruments.    

kingsley has been awarded a number of international professional certificates including: MSTA by the Society of Technical Analysts (UK) and CFTe and MFTA by the International Federation of Technical Analysts (USA) – the highest qualifications in the technical analysis community. He also holds a BSc and MSc in Computer Science from University of Louisiana at Lafayette and Bowie State University, respectively.

2. Dow Theory

There is no way to start talking about technical analysis and the important concept of the trend without mentioning Charles Dow. I consider Charles Dow to be the “father” of technical analysis. What intrigues me about the theory is the tenet on trends: a trend will continue to move in the same direction until a definite signal suggests that it has come to an end. This reminds me of Newton’s first law of motion —which states that a body in motion will continue to move in the same direction at the same speed until an external force acts upon it. Naturally, one will ask what is a trend? Well, according to technical analysis, a trend is defined as the direction of successive tops and bottoms – either up or down.

3. Directions of Trend

Successively higher tops and higher bottoms define an uptrend, while successively lower tops and lower bottoms define a downtrend. Of course, there are times that prices do not follow an uptrend nor a downtrend — but instead, they are “trapped” in a range known as a sideways market. A range is defined as an area on the chart where prices are confined by the upper and lower boundaries. In hindsight, it looks very tempting to trade; in reality, it is more complex than it looks, as it takes different shapes and patterns such as a rectangle, triangle or combination of patterns.

4. Five Waves

Ralph Nelson Elliott, who also studied the Dow Theory, suggested that markets unfold in five waves. More specifically, during his empirical observations and after analyzing 75 years of the market’s historical prices and stock market behavior, he concluded that five waves are required to have a structured progression in the market. Three waves in the direction of the trend and two waves in the opposite direction. This is the 5-wave pattern:

5. Markets do not Move in a Straight Line

This is what every trader should learn and understand in the early steps of studying the financial markets. Prices do not move in a straight line, but rather they follow a zigzag path. A good way to comprehend it is to observe the 5-wave structure. Waves 1, 3 and 5 move in the direction of the trend, whereas waves 2 and 4 form a pause in the development of the trend.

6. A Complete Elliott Cycle

Additionally, Elliott noted that a corrective pattern denoted by the letters A, B, C moves in the opposite direction of waves 1, 2, 3, 4 and 5. So, a complete Elliott cycle consists of 8 waves — 5 waves in the direction of the trend, also known as motive waves, and 3 waves countertrend, also known as corrective waves. Interestingly enough, Elliott mentioned that the 8-wave structure is repetitive.

7. Repetitive Structure

Each wave subdivides into smaller waves of one lesser degree. For example, waves 1, 3 and 5 consist of 5 smaller waves, whereas each corrective wave such as 2 and 4 consists of a 3-wave structure A-B-C. So, wave  1  subdivides into smaller waves (1), (2), (3), (4) and (5). Similarly, wave   2   subdivides into waves (a), (b) and (c). Additionally, waves (a) and (c) subdivide into 5 smaller waves, as do waves (1), (3) and (5) - which are also known as impulse waves. Conversely, waves (2), (4) and (b) subdivide into 3 corrective waves. In a nutshell, each wave is part of a wave of a higher degree and at the same time, it subdivides into waves of a lesser degree.of a lesser degree.

8. Wave Degrees

Elliott identified nine degrees, ranging from minutes to decades and even centuries. The naming conventions are as follows, but the most important thing to remember is that the basic 8-wave structure is present at every degree. Each wave subdivides into waves of one smaller degree and each wave is part of the wave of one higher degree.

Grand Super Cycle: ((I))  ((II))  ((III))  ((IV))  ((V))  ((a))  ((b))  ((c))              

Super cycle: (I)  (II)  (III)  (IV)  (V)  (a)  (b)  (c)

Cycle: I  II  III  IV  V  a  b  c

Primary: ((1))  ((2))  ((3))  ((4))  ((5))  ((A))  ((B))  ((C))

Intermediate:  (1)  (2)  (3)  (4)  (5)  (A)  (B)  (C)

Minor:  1  2  3  4  5  A  B  C 

Minute:  ((i))  ((ii))  ((iii))  ((iv))  ((v))  ((a))  ((b))  ((c))

Minuette:  (i)  (ii)  (iii)  (iv)  (v)  (a)  (b)  (c)

Subminuette:  I  ii  iii  iv  v  a  b  c

 

 

9. End of the Trend and Beginning                                                                                                                              of Another Waves that move in the same direction as the wave of a higher degree subdivide into 5 smaller waves. On the other hand, waves that move in the opposite direction subdivide into 3 waves. So, it makes sense that after identifying a 5-wave structure that there is more correction to come! That is true for both upward and downward movements. More specifically, after identifying wave 1, which consists of 5 waves of a lesser degree, one can expect more rally to come. This is also true for wave 3 as well. The only exception is the fifth of the fifth wave. This will signal the completion of wave 1 of a higher degree. Usually, Oscillators will be at the extremely overbought area. Similarly, waves A and C will also consist of 5 waves as they move in the direction of the wave of a higher degree, wave 2. Conversely, waves 2, 4 and B consist of 3 waves as they move in the opposite direction of the wave of a higher degree.

10. Phases

A complete Elliott Wave cycle consists of the motive and corrective phase. This includes the waves of the prevailing trend, these being 1, 2, 3, 4 and 5. On the other hand, the corrective phase includes waves a, b and c.

Waves 1, 3 and 5 are called impulse waves, whereas waves 2 and 4 are called corrective waves.

11. Rules and Guidelines

The Elliott Waves follow certain rules and guidelines as observed by Ralph Nelson Elliott. If any of the rules are violated, then the counting of waves is invalidated. So, the following rules must be present at all times:

•    Wave 2 never retraces 100% of wave 1

•     Wave 3 is never the shortest wave among the impulse waves 1, 3 and 5

•    Wave 3 always travels beyond the end of wave 1

•    Wave 4 never enters the territory of wave 1

Also, the following guidelines may be observed as tendencies rather than rules:

•    Alternation. If wave 2 is sharp, then expect wave 4 to be sideways and vice versa

•    If one of the impulse waves 1, 3 and 5 are extended, then the other two will tend to be equal or a Fibonacci ratio.

12. Wave 2 Never Moves beyond the Beginning of   Wave 1

 Most traders who follow Elliott Waves count the waves in an attempt to identify profitable setups and forecast the price direction. In counting the waves, one has to observe certain rules or the counting is invalid. For example, wave 2 should never retrace or fall below the beginning of wave 1. Similarly, in a bearish market, wave 2 should never retrace or exceed above the beginning of wave 1.

13. Wave 3 is Never the Shortest

This is a very important rule which hints at the preferred wave to trade. As wave 3 is never the shortest among the impulse waves 1, 3 and 5, it makes sense that if we had to choose one wave to trade, then wave 3 would be on the top of the list.

14. Wave 3 Always Travels beyond  the End of Wave 1

It makes sense! After all, progress is achieved when prices exceed the previous highs. This is the point at which market participants will enter the market as sentiment and traders’ psychology rises and economic news improves. Crowd psychology and peer pressure draw traders to enter the market, as the temptation to conform to the majority is hard to resist.

15. Wave 4 Never Enters the Territory of Wave 1

 More specifically, the end of wave 4 never enters the territory of wave 1. This is true in many other popular technical analysis concepts  and theories. For example, once price penetrates a top that acts as resistance, it changes the role and it becomes support. This is very common in observing support and resistance. Of course, almost every rule has an exception or two and this is also true for wave 4. At times when the wave 4 correction is a triangle, it might overlap with wave 1 — but the rule states that it should end out of the territory of wave 1.

16. The Principle of Alternation: If corrective wave 2 is sharp, then expect wave 4 to be sideways. Similarly, if wave 2 is a sideways correction, then expect wave 4 to be sharp.

17.  Extensions (and Counting Waves)

One of the impulse waves 1, 3 and 5 will be extended. The other two will tend to be equal or a Fibonacci ratio. Empirically, wave 3 is usually the one to be extended. Extensions may increase potential profits if the trade taken is in the right direction, but at the same time may hinder counting waves.

18. Corrective Waves:

Corrective waves come in four broad categories:

• Zigzags

• Flats

• Triangles

• Combinations

The complexity and the wide range of combinations make corrective waves risky and almost unpredictable.

19. Zigzag Corrective Wave:

 The Zigzag, or sharp correction as it also is known, is perhaps the simplest form of corrective waves. It is an ABC corrective wave, where wave A moves in the opposite direction of the motive 5-wave structure. Wave A subdivides into 5 smaller waves. Similarly, Wave B moves in the opposite direction of A and it subdivides into 3 smaller waves. The terminal wave of the ABC structure, wave C, extends well beyond the beginning of wave B.

20. Flats – Corrective Waves:

 If the corrective wave is not sharp, then it is expected to be a sideways correction. Sideways corrections come in different shapes and  “flavours”. One of them is the flat (regular) correction, which consists of 3 waves, referred to as ABC. It is considered a "shallow" correction, as the price movement is not as sharp as that of the Zigzag. More specifically, wave B usually terminates close to the beginning of wave A, whereas wave C usually concludes close to the beginning of wave B. Flat corrective waves follow the 3-3-5 structure. It consists of 3-3-5.

21. Irregular Flats – Corrective   Waves:

 A variation of the Flat correction is the Irregular Flat, whereby waves B and C extend beyond the beginning of wave A and B respectively. It is also known as an Expanded Flat.

22. Inverted Irregular Flats – Corrective Waves:

 On the other hand, if wave C falls short and doesn’t extend beyond the beginning of wave B, then this variation is called Running Flat or Inverted Irregular.

23. Triangles – Corrective Waves:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets.

24. Symmetrical Triangle –Corrective Wave:

 Geometry teaches us that a symmetrical triangle is made up of two equal sides. A symmetrical triangle follows a structure of 3-3-3-3-3. Symmetrical triangles are also known in the bibliography as Contracting or Coil. When the price eventually breaks out of the triangle, it will most probably follow the direction of the established trend. How far will it travel? That can be estimated with the same measuring techniques that are applied to all triangles.

25. Descending Triangle – Corrective Wave:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets.

The only difference with a descending triangle is that one of the sides is flat and is on the bottom. It still follows a 3-3-3-3-3 structure and the measuring techniques are the same. During an uptrend, the price will usually break out of the inclined side, not the “flat” side, in the direction of the prevailing trend. On the other hand, the price will usually break out of the flat side during a decline. An estimation of the minimum price target after the breakout will follow the same principles of the triangle measuring techniques.

26. Ascending Triangle –Corrective Wave:

 An ascending triangle also has a flat side, but this time it is on the top. The price will break out of the flat side during a rally in the direction of the prevailing trend. Similarly, during a downtrend price will break out of the inclined side, not the flat. As expected, it shares the identical structure of 3-3-3-3-3 and the same measuring techniques.

27.  Running Triangle – Corrective Wave:

 Another type of sideways correction is the triangle. There are four types of corrective triangles: Ascending, Descending, Symmetrical, and Broadening (or “Megaphone”). They follow a 3-3-3-3-3 structure and, of course, are considered a continuation pattern. At least four points are needed to draw a triangle: 2 points for each side. Remember that we need at least two points to draw a straight line. The opening between the two sides is called the base, and the point where the two sides meet is called the apex. Triangles boast a unique feature of calculating minimum price targets. A running triangle is very similar to a symmetrical triangle, with the exception that Point B exceeds the beginning of wave A. It also follows the 3-3-3-3-3 structure and the same measuring techniques.

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IF YOU WISH TO BE A SUCCESSFUL TRADER I THINK YOU NEED TO TAKE THIS ACTS AND HAVE THEM AS A HABIT 

50 SUCCESSFUL TRADERS HABIT

Reach your trading potential

SUCCESSFUL

TRADERS’ HABITS

Written by:

Kingsley

 (EWEB Head of Education)

 

Kingsley

(BSc, MSc, MSTA, CFTe, MFTA)

EWEB’s Head of Education is one of the world most respected FX educators and Certified Technical Analysts. Kingsley is known for being an authority in algorithmic trading and for developing hundreds of automated systems, indicators and trading tools used today. His passion for educating traders and Forex industry professionals has made him a Guru of the industry with his tutorials being welcomed across the globe by thousands of attendees on a regular basis. Kingsley's seminars are instilled with a lively atmosphere and renowned for being enthusiastic and exceptionally informative with outstanding attendance on every occasion. kingsley's seminars and workshops are tailored to all experience levels, where both beginner and advanced traders gain thorough understanding of the financial markets and a deep knowledge of market analysis. His seminars particularly emphasis the importance of trend and risk management in order to maximize earning potential. With his extensive knowledge, Kingsley has been revolutionising forex education for years and was awarded with the international professional certificate, MSTA by the Society of Technical Analysts (UK), CFTE and MFTA by the International Federation of Technical Analysts (USA). In addition, his latest research thesis is entitled “Anatomy of a living trend: Swing charts, High Points and Low Points, Peaks and Troughs and how their underlying structure may define their forecasting strength.”

INTRODUCTION

The purpose of this book is to provide you with useful tips and tools to ensure that you become an educated investor. EWEB has a team of highly-experienced trainers who develop materials for all levels of trader. Whether you are just starting out, or consider yourself an advanced trader, you will find material that will enhance your skills. This book represents a small fraction of our educational suite, which includes seminars, webinars, videos, articles and eBooks. These resources are free to use, to help you sharpen your skills on the way to becoming a successful investor.

01

Invest in yourself before you invest in the markets

In any business endeavor, a good understanding of the business, an identification of opportunities, thorough risk assessment and a sound strategy are imperative to success.

Knowledge of the foreign exchange market is a must before you start investing. Successful traders know that very well, that’s why they continually invest in their knowledge. And that’s why we at EWEB offer professional training sessions, seminars, webinars and tools so that you the trader can learn as much as possible. EWEB offers continuous training programs with our team of highly experienced trainers, covering all levels of trading knowledge, including beginner, intermediate and advanced. The best thing about investing in your education with EWEB is that we provide these learning tools for free so that you can invest your time and money wisely.

02

Learn the rules of the game

Knowing the rules of the game before you play it is essential. Would you get behind the wheel of a car and start to drive before you knew the rules?

Of course not. You need to learn how to turn, when to stop and how to safely accelerate before you put yourself and others at risk on the road. Forex trading is a little more complex than driving a car, but the basic principle remains the same. You need to learn and understand the rules before you start to trade. Understanding the details of your trading account, such as your account currency, spread, leverage, margin requirements, execution type, margin call and contract specifications  just to name a few are vital if you are going to succeed. With the right tools, safety measures and professional support, FXTM sends you on the open road fully equipped to make the right decisions when you trade.

03

Practice, Practice, Practice

Practice makes perfect!

This also applies to trading the markets. After mastering the theory, rules and trading techniques, a time comes to put all that knowledge into practice under real conditions, but with virtual money! At FXTM we believe that it is important to feel confident when you are trading with your hard- earned money, so we provide free demo accounts until you feel truly ready to make educated decisions. With a demo account, you can test out the markets, trade under different market conditions and practice your trading strategies with virtual money. Even the best traders in the world use a demo account from time to time to test out new methods and strategies. At FXTM we offer free demo accounts that can be used at any time, no questions asked.

04

Start small with a real account

Whilst practicing on a demo account is a good beginning, successful traders know that trading psychology, discipline and emotions are very different when real money is involved.

The fear of losing, the greed of a big win and the panic you may feel if a trade goes against you are all common emotions you will need to learn to control in order to become successful. FXTM encourages new traders to start small and take trading at their own pace. We want you to experience live trading in a comfortable environment where you are not risking more than you can afford to lose. By opening a live account with FXTM, you will experience real trading emotions in a safe and supportive environment. Open an account with FXTM and start trading to see for yourself.

05

Do not expect to become a millionaire with a $100 deposit

One of the major reasons foreign exchange has expanded all over the world, and enjoys high

popularity amongst traders, is undoubtedly leverage.

It is true that leverage attracts the attention of many traders and especially those who make small deposits. Many beginners rush into trading with a low deposit, expecting to make huge profits. More often than not, their false expectations lead to poor decisions and disappointment. Understanding leverage, strategy and money management are key to extending the power of your deposit, so reset your expectations and learn how to invest your time wisely. Successful traders know very well that their potential profits correspond to their risk.

06

Have realistic expectations

Successful traders have realistic expectations, which is directly linked to understanding the risk to reward ratio.

How much are you willing to risk?

How much are you able to deposit?

How many hours can you dedicate to your trading? Your answers to these questions will ultimately define your potential profits! Successful traders have detailed plans for their trading and their expectations are grounded in reality which makes them less likely to go off the rails. Learning the rules and having realistic expectations means knowing when to enter a trade and, ultimately, when to exit. Follow our seminars and master your risk management to reach your trading potential.

07

Learn to identify the trend 

The trend is your friend. We have all heard that phrase so many times, but many traders don’t follow the wisdom behind the words.

Well, successful traders do! Their success depends on identifying the trend early on, following it and understanding how to maximize its benefits. This can be daunting for new traders because they are not trained on identifying trends in the early stages of development. Learning how to spot the small signs of a trending financial instrument is a key technique for success which every great trader uses. A trending financial instrument is more likely to continue in the direction of the prevailing trend rather than reversing, so it is a great source of guidance for traders. The center of our teachings at FXTM is the trend, and we provide hands-on training sessions to help you spot it.

08

Learn to identify trend reversals

A trend reversal marks the end of an existing trend and the beginning of a new one, and it’s the fastest way to “jump” on a new trade.

This can happen in any timeframe and it can make the difference between a big win, a break even or a loss. Successful traders understand that very well and use it to their advantage every single day. Being able to effectively read your trading charts and understand the crowd’s trails is essential  at FXTM we can teach you exactly how to identify trend reversals.

09

Develop a trading system based on trend following & trend reversal

There are thousands of trading strategies out there, which may be confusing for a beginner.

Don’t worry, though, as most strategies are trend following. This is not a coincidence because trending markets are more likely to continue than to reverse. If you need to learn one strategy it’s trend following & trend reversal. FXTM will teach you how to identify the prevailing trend and how to enter the market when a new trend starts afresh. It would be a good idea to develop your own trading system based on trends. Learn to identify the prevailing trend. Spot the reversal. Know your entry to the market. Under- stand the exit. Follow it.

10

Test your system

As a beginner, you may be wondering, ‘why do I need a trading system?’

What could possibly be the reason for wanting to follow a trading strategy? Having a system is easy. The hardest part is following it. A fully tested system allows you to trust it and act with machinelike accuracy as to when it may be best to enter the market, take your profit or even cut your losses short. Once you’ve found a comfortable mixture of indictors and risk management rules, it comes time to test… test…test! Only by testing your strategy will you know if it is profitable and worth repeating. Take your time and build up trust in your system so that you’re ready to follow it and take advantage of the opportunities the market certainly has in store for you.

11

Revise your system to achieve low Drawdown

Many traders in the early stages of their trading career look for a trading system that boasts a high percentage of winning profits, largely ignoring one of the most important parameters of evaluating a trading system: draw down! A drawdown is the peak to trough decline during a specifically recorded period of an investment, and it is closely linked with risk management which is imperative for a successful trading system. Successful traders follow strict risk management rules and make sure that their trading account enjoys low drawdown. You can learn drawdown basics with FXTM’s free training webinars, seminars and helpful videos.

12

Revise your system to boost your potential winning trades

A lot of papers and articles have been written about this vital topic in trading the markets. Some may argue that less winning trades over losing trades is not a big deal as long as the winnings outweigh the losses. The bottom line, they say, is to have more profits than losses. No problem! What about the trader’s psychology, though? How does a trader feel when he or she loses? Not very pleasant, for sure! When emotions take over, a trader’s mind goes blurry. A blurry mind is a recipe for unpredictable outcomes such as a lack of discipline. Successful traders know that very well and make sure that their strategy has more winning. trades than losing trades. After all, trader’s psychology is invaluable in trading the markets successfully.  At FXTM our team of experts has plenty of tips to help you boost your potential wins and minimize your losses.

13

Lock small profits                                   

A lot of economists and fundamentalists will argue that financial markets are unpredictable.

This is only partially true! When markets enter a consolidation phase they are usually trendless, lacking a direction. But when a breakout of the accumulation or the distribution phase occurs, markets do trend and that is manifested on the price charts. Obviously, a trending market is a dream come true for all trend followers out there. This is the phase where money may be made. But what about volatility? What about unexpected events? A single price movement in the opposite direction is enough to turn a winning trade into a losing trade. Make sure you get what you deserve and lock potential profits as the trend is being unfolded on the price chart. FXTM provides you with trading features that can protect your potential profits by locking small profits! Find out more by speaking with our experienced team.

14

Incorporate risk management rules

Imagine that you are a captain of a boat entering stormy seas. Wouldn’t you feel better if you had a host of safety tools onboard such as a compass, life jacket, emergency radio and inflatable raft? The same is true when trading the markets. We may not want to think about the worst case scenario, but it is entirely necessary to do so. One of the most important elements of a successful trading strategy is undoubtedly the existence of risk management rules. These rules define initial protective stop loss, trailing stops, take profit levels, reward to risk ratio and last (but not least), position sizing. In our educational events we address all these topics and we make sure that you understand their importance. Successful traders do!

15

Go easy on leverage. It’s risky

One of the most lucrative aspects of trading is leverage.

Leverage is the reason that traders with a small deposit are able to make large amount of profits. Great right? Well, yes, but at the same time, leverage is to blame for big losses because whilst profits can happen quickly, losses can too! Leverage is a financial tool to enhance a trader’s potential to be able to earn more profits with less money. Unfortunately, in the same way that leverage multiplies profits it also multiplies losses and can quickly wipe out a poorly managed trading account. Use it sensibly.

16

Calculate your position size every

time you open a position

Many traders believe that risk management only comes into play when a trade is going against them, so novice traders often enter the market impulsively without any risk management rules in place. Large drawdowns, stress, lack of discipline and of course the inevitable margin call and stop out can be catastrophic to a trader’s psychology and trading account! It is imperative that traders understand their risks before entering the market or opening a position. How much money might you lose if the market doesn’t follow the direction you expected? Is your protective stop loss in place? What is your margin? Taking your time to calculate your position before every trade may save you a lot of heartache in the long run.

17

Always place a protective stop loss

Here’s a scenario. If you were walking a tightrope between two buildings, would you prefer to have the glory of doing it without any safety tools or would you be happier knowing that there was a safety net halfway down to catch you if you fall? The safety net won’t interfere with your task it is simply there to protect you if the worst happens. This is the essence of a protective stop loss yet many traders don’t use them. This is usually because in trading there is plenty of ego to go around! Who wants to admit that they were wrong or that their trade went wrong? That’s really painful and that’s why human beings rarely admit that they are wrong. Let go of your ego, be humble and understand that even the best traders use stop losses. They are a part of trading. Learn to accept them and place a stop loss to protect your capital!

18

Trail the stop loss to protect profits

In a quest to find the perfect entry, traders usually ignore the fact that entering a position is just one element of trading the financial markets.

Many other parameters also exist that are equally as important to trade successfully. The trailing stop is one of them. A trailing stop is designed to protect gains by enabling a trade to remain open and profits to run as long as the price is moving in the right direction, but closing the trade once the price changes direction. In periods of success, where traders let their profits run, it is wise to protect profits with a trailing stop loss. As profits grow, successful traders move the trailing stop loss closer to the current price just in case the unexpected happens. Tools such as this make it possible for you to trade with more discipline.

19

Be wary of Trading news events

Trading news events, especially the high impact ones like NFP (non-farm payroll) is an adrenaline rush for most traders.

The anticipation, the market buzz, the announcement and the high volatility that surrounds the event is so appealing that most traders overlook the dangers and risks. Re-quotes, slippage, lack of direction and the resulting frustration are just a few consequences. The abrupt bidirectional price movement also doesn’t leave a lot of room to maneuver, especially on lower timeframes where most novice traders are trading. At FXTM we offer controlled training during real life market events so that you can understand the way the market reacts. You may find the lure of trading news events too much to resist but you also need to understand the risks involved and be wary.

20

Define the trading hours

One of the most appealing characteristics of the foreign exchange market is undoubtedly the trading hours. Twenty-four hours per day, five days a week. Yes, twenty four hours each and every working day. Obviously, this schedule can accommodate any trader any- where in the world but be cautious! Before you start trading, choose the hours that are most suitable to your lifestyle, trading profile and character. Study the characteristics of these hours. Learn about session overlaps. How do currencies and other financial instruments behave during those trading hours? Is price action volatile or dormant? Do prices usually move in a narrow range or do they usually trend? Before you decide on your trading hours do some research and be realistic about your commitments.

21

Master the art of discipline

Having a professional trading system and risk management rules are not enough.

Discipline is a prerequisite for all successful traders but the good news is that it can be mastered all that’s required is some willpower from your part. Just as an athlete will rise at 5am each day to train, so you must acquire a strictly disciplined regime for your trading. This involves studying the markets (especially the ones you will be trading), paying close attention to relevant news announcements and mastering your self-control. Discipline cannot be taught, however there are plenty of ways to master it. You just need to find the one that works for you. Successful traders take the time to perfect their discipline and so can you.

22

If you cannot stick to your system, then have an EA developed for you

Expert Advisor trading systems (EAs) are developed through the use of empirical observations combined with statistical findings and back testing on historical data, as well as forward testing on live prices.Sounds complicated right? Well for most traders it probably is but that’s why we use them… to take some of the calculations and stress out of everyday trading. Sometimes, the development phase requires visual inspection of the price charts, expertise, hard work, tweaking of parameters and long hours during the day and night. Why all that trouble? Well the answer is quite simple. To have a road map for trading the markets. Precise entry points, precise profit level

BASICS OF FOREX

BASIC CONCEPTS OF FOREX TRADING

BASICS OF FOREX

 

You have been hearing about forex trading and you want to know what exactly is this forex trading that people talk about?  how those it work?. Now on this page we are going to tell you all the basic things you need to know about forex trading.

First of all what is forex: Forex or FX simply means foreign exchange, what exactly are we exchanging? Exchanging one currency for the other. Sometimes we involve in forex trading in our day to day activity without knowing, you don’t necessary need to be a trader to participate in the foreign exchange market. For instance when you travel to a different country that does not use your currency and landing on the airport you were very hungry and need to eat something but, you can’t buy any food or snacks to eat because you are still with your country’s currency so you need to exchange it with your new country’s currency. Now going to the airport’s foreign exchange desk and exchange your country’s currency to the new country’s currency, doing this you have simply participated in forex trading.

What does forex trade: in the forex market we trade currencies, (i.e we buy and sell currencies ). And you may even earn a profit, according to which currency pair you exchanged. This is why we call it foreign exchange. Depending on the currency rates and market movements, you can make profit it all depends on how alert and how economies change. Remember do not confuse forex trading with physical trading- it’s all online! You buy a currency online, sell another online, and you make your profit online. If you have a forex trading account all your profit (money) will always be available there, you can withdraw your profit to your personal bank account at anytime and finally cash it out if you want.

In forex we trade currencies in pairs and we use symbols to represent them. How does currency pairs work? Trading always consist of buying one currency and selling another. Together these currencies make up a currency pair. Imagine choosing the USD/JPY pair. You expect the USD to increase in value as compared to JPY. So you buy USD and sell JPY. Remember in other to buy one currency you have to sell another. If the USD rises against the JPY, you close the position and take your profit. Why is forex trading done in currency pairs? Imagine that the first currency in any currency pair (in our example USD) in a potato. So in order to buy a potato, you need to buy some certain amount of the second currency (in our example JPY). There are two categories of: major, minor, exotic.

Majors: major currency pairs are traded most frequently, and they contain major currency pairs are traded most frequently, and they contain the US dollar (USD).

Minors: minor currency pairs don’t contain the USD. The most active ones contain EUR, JPY, and GBP.

Exotics: exotic currency pairs contains one major currency as the base currency, paired with any non-major currency, such as South African rand, Mexican peso, or Danish krone. Exotic pairs are not so widely traded.

Trading styles: the beauty of forex among other trading is that you can do it anywhere, anytime and you are free to choose your own trading style and trade according to your own knowledge and risk tolerance. There are four trading style which is Intraday trading, Swing trading, position trading and Scalping.

Intraday trading is when you hold positions for a short time (from minutes to hours), make many trades a day, and usually enter and close your trades on the same day.

Swing trading: swing trading is similar to intraday treading but it has a longer trading horizon between hours to few days.

Position trading:  this means when you hold position for a long time (from weeks to years). It’s the opposite of intraday trading because you are more interested in long-time investment than in short-time price change.

Scalping: is very short-time trading. You try to make many small profits during a single trading day.

FOREX TERMINOLOGIES

Learning a foreign language starts with the alphabet, and so does forex. Forex has its own terms that serve as its language making it easy for traders to interact with the market.

Currency Pair: this is the quotation of one currency unit against another currency unit. For example the EUR/USD, and in this currency pair there is what we call the base and the quote currency, the first currency in the pair is the base currency while the second currency is the quote currency

Exchange Rate: this is the rate at which you exchange one currency to another. The exchange rate shows you how much of the quote currency you need if you want to buy unit of the base currency. Example EUR/USD=1.3119 this means that 1 euro is equal to 1.3119 US dollars.

Quote: it is a market price that always consist of two figures: the first figure is the bid/selling price, and the second the ask/buying price. (e.g  1.23458/1.12347)

Ask Price: also known as the offer price, the ask price is the price visible at the right hand side of a quote. This is the price at which you can by the base currency. While the Bid price is the price at which you can sell a currency pair. Bid is always lower than ask. And the difference between ask and bid is the spread.

Spread: it is the difference in pips between the ask price and the bid price. The spread represents the brokerage service costs and replaces transaction fees. There are fixed and variable spreads. Fixed spreads maintain the same number of pips between the ask price and the bid price, and are not affected by market changes. While variable spreads increase and decrease according to the liquidity of the market.

Account currency: this is the currency you choose when you open a trading account with any broker, it can be your local currency and your profits and losses will be converted into that particular currency.

Pip: a pip is the smallest price change of a given exchange rate. Example if the currency pair EUR/USD moves from 1.2550 to 1.2551, that’s a 1 pip movement; or a move from 1.2550 to 1.2555 is a 5 pip movement. And as you can see, the pip is the last decimal point. All currency pairs have 4 decimal point except the Japanese yen (JPY) which has only 2 decimal points.

Lot: forex is traded in amounts called lots. One standard lot has 100,000 units of the base currency, while a micro lot has 1,000 units. For example if you buy 1 standard lot of EUR/USD at 1.3125, you buuy 100,00 Euros and sell 131,250 US dollars. Similarly, when you sell 1 micro lot of EUR/USD at 1.3120, you sell 1,000 Euros and you buy 1,312 US dollars.

Pip Value: the pip value show how much 1 pip is worth. The pip value changes in parallel with market movements. So it is good to keep an eye on the currency pairs you are trading and how the market changes. Now let’s reflect on what you have learnt about pips! To benefit from pips and see significant an increase/decrease in profit, you will need to trade larger amounts. Suppose you account currency is USD and you choose to trade 1 standard lot of USD/JPY. How much is one pip worth per $100,000 on the USD/JPY currency pair? The calculation formula is as follows: amount x 1 pip= 100,000x0.01 JPY = JPY 1,000 if USD/JPY = 130.46, then JPY 1,000 – 1,000/130.46= USD 7.7 therefore, the value of 1 pip in USD/JPY is equal to: (1 pip, with proper decimal placement x amount/exchange rate)

Margin: margin is the minimum amount of funds, expressed as percentage that you will need if you want to open a position and keep your position open. If you trade on 1% margin, for what instance, for any USD 100 that you trade, you need to put down a deposit of USD 1. And so, in order to buy one standard lot (i.e 100,000 of USD/CHF), if you need to maintain only 1% of traded amount in your account i.e USD 1,000 but how can you buy 100,000 USD/JPY with only USD 1,000? Basically, margin trading involves a loan from the forex broker to the trader. When USD 1,000 but how can you buy 100,000 USD/JPY with only USD 1,000? Basically, margin trading involves a loan from the forex broker to the trader. When you carry out a forex transaction, you don’t actually buy all the currency and deposit it into you trading account. Practically speaking what you do is speculate on the exchange rate. In order words, you estimate how the exchange rate will move, and you made a contract based agreement with your broker that he will pay  you or you pay him depending on whether you estimation has proved to be correct or wrong. If you purchase a USD/JPY standard lot, you don’t need to put down 100,000USD as the full value of your trade. Instead, you will have to put down a deposit that we call margin. This is why margin trading is trading with borrowed capital. In order words, you can trade with a loan from your broker, and that loan amount depends on the amount you initially deposited.

Leverage: strictly speaking, through leverage the broker lends you money so that you can trade bigger lots: leverage depends on the broker and flexibility. At the same time, Leverage varies: it can be 100:1, 200:1 or even 500:1. Remember that with leverage you can use $1,000 to trade $100,000 (1,000x100) or $200,000 (1,000x200) etc. this sounds great, but how does it actually work? I open a trading account and I get a loan from my broker as simple as that?

How does this works? You open a trading account that has a leverage of 1:100. You want to trade a position worth $500,000 but you only have $5,000 in your account. No worries, your broker will lend you the remaining $495,000 and sets aside $5,000 as your good faith deposit. The profits that you make by trading will be added to your account balance or if there are losses, they will be deducted. Leverage increases your buying power and can multiply both your gains and losses.

Equity: it is the total amount of money in your trading account, including your profits and losses. For instance,  if you deposited USD1,000 in your account and also made a profit of USD3,000 your euity is amount to USD 13,000

Used Margin: it is the amount of money kept aside by your broker so that your current trading positions can be kept open and you don’t end up with a negative balance.

Free Margin: it is the amount of money in your trading account with which you can open new positions. Free margin = equity-used margin. This means that if your equity is $13,000 and your open positions require $2,000 margin (used margin), you are left with $11,000 (free margin) available to open new positions.

Margin Call: margin call are major part of risk management: as soon as your equity drops to a percentage of the margin used, your forex broker will notify you that you need to deposit more money if you want to maintain your position.

Position: it is a trade that you hold open during a certain period of time. There is two types of position, long and short position. Long position is to buy a base currency while short position is to sell a base currency.

Close Position: if you enter a long (buy) position and the base currency rate has gone up, you want to get you profit. To do so, you must close the position.

Order Types: market order/entry order it is an order to buy o sell currency instantly at the current price.

Open Order: it is an order to buy or sell a financial instrument (e.g forex, stocks or commodities like oil, gold etc) that will stay open until you close, or have your broker close it for you

Limit Order: it is an order placed away from the current market price assuming that EUR/USD is traded at 1.34. you want to go short (place a sell order on this currency pair) if the price reaches 1.35, so you place an order for the price 1.35. this order is called limit order. So your order is placed when the price reaches the limit of 1.35. A buy limit order is always set below the current price whereas a sell limit order is always set above the current price.

Stop-entry order: it is an order that you give to buy above the current price or an order to sell below the current price when you think the price will continue in the same direction. It is the opposite of limit order.

Take Profit (TP): it is an order that closes your trade as soon as it has reached a certain level of profit

Stop-Loss Order (SL):top-Loss Order (SL): it is an order to close your trade as soon as it reaches a certain level of loss. With this strategy, you can minimize your loss and avoid losing all your capital.

Execution: it is the process of completing an order. When you place an order, it will be sent to your broker, who decides whether to fill it, reject it, or re-quote it. Once your order if filled, you will receive a confirmation from your broker.

 

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We provide you with quality forex teachers, not just teachers but also well trained experienced expert traders  who  know 99% of forex market. Just obey and apply the rules and one day you will surely be even more  higher than them in terms of forex trading.

 

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CRYPTO EXINITY EBOOK

CRYPTO EXINITY EBOOK

CRYPTOCURRENCIES BITCOIN

Written by

Kingsley

(HEAD of EWEB)

Contents

Satoshi Nakamoto

Decentralisation & The Peer-to-Peer (P2P) Network

Public and Private Keys vs. Public Address

Trust

Proof-of-work

Financial Institutions

Blockchain technology

Cryptography

Double spending

Bitcoin vs. bitcoin

Mining

Block Reward

Digital Signature

Distributed System

Byzantine Generals Problem

The Future of Bitcoin

Trading bitcoin

Altcoins

Regulation

Transaction Fees

About the Author

Satoshi Nakamoto

Emerging from the world of cryptography in the mid-2000s, the mysterious Satoshi Nakamoto is credited as the mastermind creator behind bitcoin the currency, and Bitcoin the network. Is that his real name? Is he Japanese? American? Is he or she, in fact, a lot of people merged under one pseudonym? To this day, no one knows.

As a direct response to the financial crisis of 2008, Satoshi Nakamoto envisioned a new and decentralised digital currency system he called bitcoin. In October 2008, Nakamoto published a paper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System” which detailed a payment system based on chains of data blocks (later to become known as blockchain) and the removal of third parties between transactions. It came at a perfect time, of course, because a lot of people had lost trust in traditional financial institutions due to the crisis.

Nakamoto’s proposal detailed how the new system would function without financial institutions, how a peer-to-peer network would resolve the issue of double spending and what this new system would mean for transactional privacy.

A few years after his proposal, Satoshi Nakamoto stopped being involved in the development of bitcoin and completely disappeared from all public forums.

 

Decentralisation & The Peer-to-Peer (P2P) Network

The core principle of decentralisation is the removal of a central, controlling body, whether that be an entity in the form of a financial institution (i.e. a bank), a “trusted third party” in the form of a payment provider, or an individual middle-man between the sender and the receiver of a transaction.

One type of decentralised system like this has existed for many decades. Known as peer-to-peer – P2P for short – this network consists of, in its most simplified definition, two or more computers connected to one another and sharing all types of data. Torrent file-sharing, which is widespread and allows users to download music, movies, documents and other types of files, is based on a P2P network.

P2P technology has a long history. As a fault-tolerant network, P2P was initially designed for the purpose of transmitting military messages without any vulnerability to human fatality, natural phenomena or technical malfunction. Its primary feature is its autonomy – in other words, its inherent decentralised nature.

A P2P network has no centralised authority or regulatory entity that monitors, facilitates or controls any of the data that is shared between the two peers.      

 

Public and Private Keys vs. Public Address

To understand bitcoin and its intricate structure, you need to know the difference between three terms whose definitions are often, easily (and mistakenly), interchanged.

Private Keys

In their purest form, private keys are 256-bit numbers that are generated randomly and used to authorise the spending of bitcoins. ‘Bit’ is short for binary digit and always represented by one of the two binary figures: a 0 or a 1.   

Since the number of possible 256-bit combinations is extremely large, a simpler system has been created to represent the private key. A 64-character hexadecimal system using letters a-f and numbers 1-9, like so:

ef235aacf90d9f4aadd8c92e4b2562e1d9eb97f0df9ba3b508258739cb013db2 Public Keys

Derived from the mathematical theory of elliptic curve multiplication, public keys are created from private keys. They are used to confirm that the data sent in the blockchain is authentic; in other words that it comes from the owner of the specific private key.

5Thanks to the public key, the private key takes the shape of a digital signature, without ever being publicly revealed. The receiver, or any peer in the network, will only see the digital signature and public key.

Example of a Public Key:

030589ee559348bd6a7325994f9c8eff12bd5d73cc683142bd0dd1a17abc99b0dc Public Address

Also known as the bitcoin address, the public address is also a major identifier for a transaction and it’s derived from the public key. In fact, this is the information that people need to input if they wish to send you bitcoin.

Each bitcoin transaction carries with it a unique public address, generated by applying the public key into a cryptographic algorithm called Secure Hash Algorithm (SHA).

Example of a Public Address: 1J7mdgA5rbQyUHE2NYd5x39WVBWK7AfsLpEo6XZy

 

Trust

You’ve heard the term “trusted third party” before, right? Traditionally speaking, this third party is the mediator between any customer and any merchant. Banks and financial institutions or online payment processors are conventional third parties that help facilitate transactions.

Naturally, any transactions that involve people’s money must be built on trust. After the 2008 financial crisis, this core principle was shaken as the concepts of fraud and disputes became more prominent.

Traditional trust constitutes good faith towards the middle man; should any disputes or claims of fraud arise, it is up to this intermediary to settle them. The system works relatively well, but merchants end up incurring costs, customers are asked for more information, and transactional fees increase.

Coupled with the fact that the traditional trust system took a hit after 2008, Satoshi Nakamoto came up with the Bitcoin Network as a new kind of trust system, based on the P2P network.  

 

Proof-of-work

Integral to the mechanics of Bitcoin, proof-of-work (or POW) is Satoshi Nakamoto’s ingenious workaround for confirming the blocks of transactions. The trust that is traditionally extended to financial institutions is transferred to the decentralised nodes (or computers) on the P2P Bitcoin network.

These nodes validate and group transactions into blocks. In order to include the block in the ledger (blockchain), these nodes need to solve a “cryptographic puzzle”. This is done by hashing the information in the block to satisfy specific conditions. For example, one such condition is that the resulting cryptographic hash has to be less than a specified number. Since this type of proof-of-work involves a lot of trial and error, the approach is called bruteforce - meaning all possible solutions are exhausted until the correct one is found.

The idea behind POW first emerged in the early 90s. By 1999, the first appearance of the official term was documented, and while appearing in various forms, it became increasingly popular when Satoshi Nakamoto integrated it into Bitcoin, amending it to include the decentralised node verification system.

 

Financial Institutions

Financial Institutions, in the context of Bitcoin, are the conventional or traditional entities or companies that deal with monetary transactions within the overall sphere of financial services.

Banks, for example, are the most readily recognisable and referred-to financial institutions. They store clients’ financial data and records, apply their own fees for various transactions, and generally act as the middle man (or “trusted third party”) between a buyer and a seller or, indeed, any two parties (whether individual or group) who enter into some form of financial agreement between each other.  

After the 2008 financial crisis, terms like “bail-in” and “bailout” became popular and threw a very negative light on all standard and regulated financial institutions, especially banks. A popular investment bank famously collapsed in September 2008, prompting a massive banking crisis. With the enactment of the Emergency Economic Stabilization Act of 2008, it has been reported that the US government supplied up to $700 billion to banks in order to bail them out of the crisis.

Nakamoto developed bitcoin as an “antidote” to this loss of collective trust in financial institutions.

 

Blockchain technology

Blockchain technology is at the centre of what makes the entire cryptocurrency system function, including, of course, bitcoin.

As the name suggests, a blockchain is essentially a chain of blocks that contain transactions and other data. In the case of bitcoin, this data is an encrypted form of digital currency. However, the blocks contain more than just the transactions themselves.

Besides the transactions (i.e. the amount for transfer), the blocks also contain the following information:

• A timestamp indicating when the block was created

• A digital signature that is unique to its contents

• A code that links it to the previous block.

To get more detailed, the block header – which is the key identifier of any given block within the blockchain – contains even more data. This includes, but is not limited to, the version of the blockchain, an encrypted summary of transactions, and a number that correctly calculates the digital signature of the block header.

Once a block is included in the blockchain, it becomes permanent and irreversible. Looked at in its entirety, a blockchain consists of every transaction that occurred since the beginning of bitcoin, starting with the very first block known as Genesis.

 

Cryptography

Cryptography has a long history, dating back thousands of years. At its heart, the principle definition has remained the same even while technological advances have radically modernised cryptography.

It is the discipline or science of keeping data and messages secure (or secret) while communicating and/or transmitting them over an insecure route or through a vulnerable medium.

Historically speaking, the use of cryptography heavily influenced the course of action in both World War I and World War II. Since then, cryptography has made huge advances into the digital space. The Bitcoin network uses cryptography as its primary security measure.

While transacting bitcoin, cryptography comes into play when describing the role of the Secure Hash Algorithm (SHA). This is a cryptographic algorithm designed by the National Security Agency (NSA). In order for a user to obtain his or her public keys, the corresponding private key is fed into SHA-256. This generates the public key, which is then fed back into the SHA-256 to generate the public address. The SHA- 256 algorithm takes a string of data of any length and transforms it into exactly 256 bits – that is, a series of 256 1s and 0s.

Another innovation of Satoshi Nakamoto is the digital signature, which is actually not only unique to every block but also contains links to the previous blocks that make its transactions irreversible. Digital signatures are another example of the kind of cryptography used in the Bitcoin network.

 

Double spending

Even though a form of P2P technology has been available since the 1960s, it has proven very difficult for an independent online payment system such as bitcoin to appear. The reason for this can be summed up in two words: double spending.

The best way to explain what double spending is to imagine a bitcoin transaction as a text file:

Imagine that each text file represents €10.

A customer only has €10 to his name and needs to buy a product online that is worth €20.

If he takes the text file, and copies it 10 times, all of a sudden he has €100.  

If the customer buys 5 products with these €100, he would be double spending. In the bitcoin world, if someone were to copy a digital file that represents €10, and send €10 to two different merchants at the same time, this would be an act of double spending.

Nakamoto figured out a workaround for double spending, by registering each bitcoin in a public ledger (i.e. the blockchain) and ensuring that once a bitcoin is spent, it would be marked as spent, and would not be usable for more spending.

 

Bitcoin vs. bitcoin

One of the most common misconceptions when talking about the most popular digital cryptocurrency is the differentiation between Bitcoin and bitcoin.

Bitcoin (written with a capital B) defines the entire network upon which the cryptocurrency system is built. When referring to Bitcoin, it’s the blockchain technology that is being referenced, the system that makes use of all of the necessary confirmations needed for new blocks to be added to the chain (i.e. the public ledger). The other bitcoin (always written with a lower-case ‘b’) refers to the actual currency, which runs on the Bitcoin network.

 

Mining

To mine bitcoin you need software and a computer built for the specific purpose of mining. The goal of the miner is to figure out a hash of the block that is equal to or less than a specific target. If all information in the block header remains constant, the result of SHA-256 will always be the same – see the section on Cryptography to get a refresher on the SHA.

In cryptography, a nonce is an arbitrary number that can only be used once. That’s why it is included in the header – every time the calculated hash of the block header fails to meet the targeted range, the nonce is increased and the hash is re-calculated until it ultimately reaches its target.

Miners with the most powerful computing devices will have an advantage – the total number of possible answers is close to 1077, which requires a lot of power and speed. Since there is no logic when calculating the winning hash, bruteforce should be followed.

Once the winning targeted hash is calculated, the block is included in the blockchain and the reward is granted to the victorious miner. Currently, a block is included in the blockchain every 10 or so minutes and a single block may contain approximately 1,000 transactions.

 

Block Reward

As nodes need to solve cryptographic puzzles on a P2P network through the use of bruteforce, and the number of possible combinations is about 1077, Satoshi Nakamoto decided to include an incentive in the Bitcoin system to make up for all these great efforts.

The first node to solve the puzzle will be awarded with a reward, which is known as the “block reward”. The first ever reward was set at 50 bitcoins. In reality, every time a new block is included in the blockchain, it generates a corresponding reward anew. Nakamoto also figured out a way to control the creation of new bitcoins, by setting a limit of up to around 10 minutes between new blocks being included in the blockchain. Looking at it this way, you can say a cryptographic puzzle is solved every 10 or so minutes. That means 144 blocks per day or 52560 per year. As more nodes and more powerful computers join the network, puzzles will be solved much faster. To avoid any inflationary trends, Nakamoto also included a parameter called ‘Difficulty’ in the protocol. This increases the number of leading zeros in the resulting hash when a node tries to solve the puzzle. In addition to this, the block reward is halved every 210,000 blocks (which is approximately every 4 years). The last reward will be awarded in the year 2140.

 

Digital Signature

The digital signature is the result of a mathematical formula (or, cryptographic hash algorithm), known as SHA-256 (refer to ‘Cryptography’ for more information on the SHA).

A file of data is accepted and scanned through this cryptographic algorithm, generating an output of 64 alphanumeric characters. This output is known as the digital signature. Keep in mind that the length of this alphanumeric code will always be 64 characters, regardless of the length of the received data file, and that every digital signature always begins with 4 zeroes.

To make things even more secure, the system is designed so that if just one character is changed in the data, the SHA-256 algorithm will generate an entirely different signature.

If a user was attempting to trick the system by changing the amount of bitcoins he received from the sender, the corresponding digital signature would change as well, including all the previous signatures since the beginning of time. This makes it impossible for users to trick the system, which creates another layer of security.

 

Distributed System

In computer networks there are mainly two architectures: client server and peer-to-peer.

We have already covered P2P, which is the main foundation for Nakamoto’s Bitcoin network – and it was clear from the start that Bitcoin will not be based on a client- server protocol, as that is a centralised environment where the applications, files and other resources are stored on a central computer, the server. So, what did Nakamoto do to replace the second main architect model? He came up with a relatively innovative alternative: the distributed system.

The Bitcoin network follows this distributed application model, wherein the work load is spread among the participated nodes (or computers) – without a central server. In order to maintain reliability in the network, a consensus must be reached among the participating computers. Although 100% consensus is ideal, it is not feasible every time.

When “digging” into computer networks, one will come across the Byzantine Generals Problem – the subject of our next topic.

 

Byzantine Generals Problem

A group of generals have surrounded an enemy city. They have to attack or retreat, but must wait to see what their commanding officer will order them to do.

In order for the mission to succeed, it is imperative that a consensus exists among all the generals. Correspondence between the commanding officer and the generals is done through insecure and vulnerable mediums. What’s more, a number of generals or perhaps even the commanding officer could turn out to be traitors.

As long as the commander remains loyal, and the number of traitors is less than 1/3 of all the generals, then consensus may be reached to attack or retreat.

Naturally, a loyal general would receive contradictory messages from the commander and from a general who happens to be a traitor. In this scenario, it is not possible to achieve more than 50% consensus.

The reason it’s important to understand the Byzantine Generals Problem is because the Bitcoin system faces a similar issue as it also transmits information through an insecure medium (i.e. the internet). This is why Nakamoto introduced the proof-of-work concept, in order to bypass it. When sending a message, the message is hashed and a nonce is sent to all nodes to verify the proof-of-work. Unlike the Byzantine example, the transmission of transactions or blocks (i.e. the “correspondence”) is therefore done through more secure and near-invulnerable methods. Every message (that is, every block) is chained; as a result it is almost impossible to tamper with it.

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