How to Create a "Trading Edge": Know the Strong and the Weak Currencies
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In our live Trading Webinars we often refer to finding out which currencies are the strongest and which are the weakest. By making that determination we can pair the currencies so that we have a strong versus a weak or a weak versus a strong. By doing that we are creating a “trading edge” for ourselves. If we trade a currency pair in which both currencies are fairly equal in strength, we give up the edge because either currency can “take control” since they are of equal strength.
By matching up a strong with a weak, however, we can have a bit more confidence in knowing the direction of the likely move. Then, if we match the direction of that potential move with the direction of the trend on the Daily chart, we have a clear trading edge.
For example, currently the USDCHF pair is in a downtrend on the Daily chart. Based on a strong/weak analysis we see that the USD is weak and the CHF is strong. So selling that pair in the direction of the Daily trend is a higher probability trade.
How to do it?
Briefly, here is how I go about doing a strong/weak analysis…
I use a 4 hour chart with a 200 SMA (Simple moving average) on it. On a sheet of paper, a legal pad or an Excel spreadsheet, I list the currencies (not the pairs but the currencies themselves) in a vertical column. For example, EUR, USD, CHF, etc.
Now, let’s say the pair in question on the 4 hour chart is the EURUSD. If it is trading above the 200 SMA that means that the EUR is stronger than the USD at that point in time. I make a note of that next to the EUR and the USD in the vertical column…EUR gets an up arrow and the USD gets a down arrow. Then I go to the next currency and go through the same process. (All in all I bring up about 25 pairs on the charts each day before the open of the New York session and it takes less than 15 minutes.)
When I am done with the above process, I tally all the “up arrows ” and “down arrows” for the EUR against the other currencies and then I can tell where the EUR ranks strength-wise relative to each of them. For example, if the EUR has 5 up arrows and 2 down arrows and the JPY has 3 up arrows and 4 down arrows, that means that the EUR, overall, is stronger than the JPY. (It doesn’t get much more simple than that!) When I have all the currencies in which I am interested evaluated in this way, I then have an overview of how they all relate to each other based on strength/weakness.
Next, I match the strongest with the weakest and go to the charts and look for a technical reason, such as a break of support or resistance, to enter the trade in the direction of the trend. A pair that has a strong currency paired against a weak currency would be a candidate for a buy in a Daily uptrend. On the other hand, a weak paired against a strong would be a candidate for a sell in a Daily downtrend.
The process is very basic, straightforward and quite boring…but it works.
As a side benefit, while I am going through the process of checking the 4 hour chart on each pair, I really get a sense for what is going on in the market at the time. And that information serves me well as the trading day progresses.
Frequently Asked Questions (FAQS)
Is this the only trading strategy?
No, there are countless other trading strategies. You must find a trading strategy that suites your trading style. However, most successful trading strategies are similar in how they manage risk and leverage. Managing risk, using positive risk-reward ratios, and limiting leverage, have been shown to increase a traders success.
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.