Which Currency Pairs to Trade?

During the 1-day course by Ed Ponsi, he touched on the criteria to decide which currency pairs to trade. I thought I will just put things in perspective and provide some links as to where to look for the information that we need.

Spread

Spread is like the commission that we have to pay for our trades in forex. It is part of our business cost in trading. Different brokers offer different spreads for the various currency pairs. Let's take CMS Forex currency spreads as a guide (quite indicative for spread across different brokers). Spreads could range from as low as 2 pips for EUR/USD to 8 pips for GBP/JPY. As a rule of thumb, currency pairs with the smaller spreads is certainly more attractive. However, one should also look at the price movement range (the average true range or ATR is a good guide)  for his trading timeframe (if it could cover the spread easliy). Those trading daily timeframe charts can look at currency pairs with larger spreads because the spreads would be relatively small compared to the profit potential.

Correlation

Ed Ponsi suggested to not open positions in correlated currency pairs at the same time. For instance, EUR/USD and USD/CHF are known to have very strong negative correlation (ie, when EUR/USD moves up, there is almost 90% chance that USD/CHF will move down). So when one go long on EUR/USD and short USD/CHF at the same time, he is almost like having positions on a single currency pair! If the trade goes against him, it is almost certain that he will lose on both currency pairs.

Metaf.net provides a good tool for determine the correlation between the different currency pairs. The bigger the number in the table would mean the 2 currency pairs are highly correlated with each other. If there is a '-' sign in front of the number, it just means that the 2 currency pairs are negatively correlated, like the case for EUR/USD and USD/CHF.

From this data, I actually found 1 currency pair to be least correlated with the other major currency pairs (based on daily data). Want to know which one? Leave me a comment with your email :-P

Currency Strength

Ed Ponsi mentioned during the seminar that during this period, he will not trade with USD/JPY. During times of recession like this, USD and JPY are traditionally the strongest currencies. USD because traders are buying US treasury bonds as a safe haven. JPY because of traders no longer wish to be in carry trades. When 2 strong currencies are paired up together, it will be tough to determine who will win the tug-of-war. Ed Ponsi prefers to look at currency pairs that are made up of a strong currency and a weak currency so that there will be long periods of trends. Trends are forex traders' best friends! Ed Ponsi also mentioned his favourite currency pair to be GBP/JPY at this point in time.

ForexPeaceArmy offers a calculator that calculates the relative strengths of the major currencies based on their price movements. I find this is a good gauge to find out which currencies are stronger and which are weaker.

Rollover

Every currency has an interest rate tied to it (as dictated by the individual central banks). FX Street has a good table on worldwide interest rates.

The basics of rollover (aka swap) in forex trading can be best explained with an example:

AUD interest rate is at 4.25% and JPY interest rate is at 0.3% at the moment

Let's say we are long AUD/JPY. We will receive positive rollover as we are long the currency with the higher interest rate (ie, the AUD). The idea is we will receive money for the position that we are holding (for the duration of time that the position is opened). The amount that we will receive is broker-dependant however.

Do not underrestimate this rollover amount. We may be able to pay for the spread with that! Hence, alleviating the cost of opening and closing our trades!

Now we have a better idea of how to choose which currency pairs to trade 8-)

Trading Short Timeframes Vs Long Timeframes

In my last post, I discussed about how can one know that he/she is trading a unsuitable timeframe. And I found 2 other articles that supported my claim:

• Glen De Vadder wrote about how can one determine which chart timeframe is suitable. He broke down chart timeframes to 3 main types, namely, intraday, swing/position and long-term. In summary, aspiring traders will a job should go for swing/position or long-term timeframes - hourly charts and above.


• The team from PFX is more for trading long timeframes. They mentioned about the spread - yes, trading short timeframes incur more trading cost in terms of the spread because more trades are taken and of course, the emotional stress that comes along with short term trading.

One interesting point to note. Both articles mentioned about rollover, but from a different standpoint. In my interpretation, rollover is a double-edge sword. Whether you collect or is charged a rollover depends on the position and the currency pairs that you are trading. So we will have to take note of this if we are holding our positions overnight.

One point that is still not addressed any where is: whether trading short timeframes or  trading long timeframes is more profitable?

I would think they are equally profitable. Let's see if we can convince ourselves.

From the USD/JPY daily chart, the 60-day average true range (ATR) is around 90 pips to 200 pips

The 60-day ATR for a 5 min USD/JPY chart is around 15 pips to 5 pips.

So when trading the daily charts, my stop loss would have to be at least 200 pips while my stop loss for the 5 min charts would just have to be at least 15 pips.

Let's say I have a strategy that gives me 1:1 risk-reward ratio with a success rate of 60%. In addition, let's say the strategy, when applied on the daily chart, takes 3 days to close with a winner and makes 200 pips. In order for me to make 200 pips in 3 days on the 5 min chart, I would need to make 200/15 = 14 winners. But all in all I have to make 24 trades since 60% of my trades are usually winners.

So I would need roughly 8 trades per day on the 5 min charts to match a win on the daily charts. So which is more profitable? In my opinion, once I made 200 pips on the daily charts, it is a done deal. Imagine I have to make 24 trades on the 5 min charts to make that same profits...

Signs To Tell That You Are Trading A Unsuitable Timeframe

Trading 5 min charts has more money-making opportunities?

You can be trained to trade in any timeframe?

Think again. I also went through what most aspiring traders went through. I used to think trading the 5 min timeframe was suitable for me because of the adrenaline rush, as there were more entry opportunities. Most men like this type of adrenaline rush :-P However, I still feel that trading the shorter timeframe is good for brushing up trading skills. After trading the 5 min timeframe for a period of time, my observations tell me that the 5 min timeframe may not be suitable for me. Let me share my observations with you.

I have a full-time nine-to-five job. Most aspiring traders do (some own businesses of course). I realized I have been missing out on many good trade setups because they happen during the time when I am working! Good trades are hard to come by. Missing out on good trades really takes a  toll on my psychology.

I did try to force myself to trade while working. I adjusted my work schedule and tasks such that I would be able to monitor the charts as frequent as I can. You think this helped? NO! It made things worse. On one hand, I felt stress from my job. On the other hand, because it wasn't easy for me to find time to monitor the charts, somehow my brain started to see things. I saw trade setups that were not there! As a result, my trade quality took a hit.

You think I am able to trade after work? Ya, ya...forex is a 24-hour market right? Bad news. In my part of the world, by the time I reach home after work, it is almost close to the US market opening hours. Prior to the US market opening and even during the US market hours, there are often market-moving economic news announcement that cause the forex market to behave haphazardly. We are often taught not to trade around high impact economic news announcements right?

Well, I can trade into the wee hours of the night right? Sad to say, the forex 5 min charts typically quietens down after around 10:30 EST. There may be some movement around 12:00 EST when the London market closes. After which, I had to wait all the way till 16:00 EST (around 4 am local time) for possible movements on the 5 min charts. Imagine you are home after a tiring day at work and got to stare hard at the computer screen all the while. Stressful isn't it? Both physically and psychologically.

A fellow trading course mate also showed me the evidence that a suitable timeframe is crucial to one's trading success. We learnt the same 5 min chart trading strategies but he had much greater successes! Upon probing, I learnt that his working hours are totally opposite of mine! He works in the night only and has all morning and afternoon to trade.

Unfortunately, there is no one magic formula to determine which timeframe is the most suitable for you. The only way is to try trading the timeframe and evaluate yourself. Everyone's working hours is different, isn't it? :-P

Types of Expert Advisors

Based on my knowledge of experts advisors, I was trying to categorize them. It turns out that I cannot categorized them distinctly. Let's look at the various categories first:

Non-directional vs directional

Expert advisors that adopts non-directional strategies are usually based on hedging or non-directional trading models such as one based on the mean reversion theory. Directional expert advisors trade news, breakout, trend, range etc.

Indicator-based vs price action-based

Indicator-based expert advisors use one or more indicators in determining trade entries whereas price action-based expert advisors merely use price action, which can even be candlestick patterns or chart patterns.

Single currency vs multi currency

Some expert advisors trade with only 1 currency while others, especially hedging expert advisors, require trading with more than 1 currencies. The PID expert advisor (defunct now) needs to trade with 13 different currencies at a go!

Rule-based vs self learning

Rule-based expert advisors trade exactly in the manner that their programmers want them to trade. A breed of self learning expert advisors make use of machine learning techniques to learn about the market and adjust themselves to trade accordingly. An example of such an expert advisor is the Bogie. The Bogies uses neural networks to "improve perceptive intelligence on order entries".

Fully automated vs semi automated

There are some expert advisors that can (or they claim they can) run on their own 24-by-7 without human intervention. Of course that is the ideal case. Most fully automated expert advisors require optimization regularly so as to stay in tune with the current market conditions. Some expert advisors, on the other hand, are developed for the purpose of semi-automation. For some expert advisors, one may need to analyze the market and only deploy the expert advisor only if the conditions are right. In some cases,  the level of automation may just merely be to adjust stop loss to trail for profits.

Regular position sizing vs special position sizing

Position sizing is how an expert advisor determine how many lots to enter. Actually, I ran of ideas to term this properly. Let me describe what I mean and perhaps you can help to propose a good terminology :-P

Regular position sizing is determining how many lots to enter based on traditional position sizing techniques. For instance, the position sizing rule may be: the amount to risk for every trade is 5% of total account balance. And this is a hard and fast rule. The number of lots to enter only increases if the account balance increases.

Special position sizing adopts techniques such as Martingale or anti-Martingale (may or not may be on top of regular position sizing). For certain Martingale expert advisors, the number of lots to enter for the next trade doubles after every losing trade!

It is good to know more about your expert advisor and understand how your expert advisor works.

Help in Trading

I have to leverage on technology to make part-time trading work. Can you imagine reaching home after day job  and coaching the kids in their studies and after all that, got to work through 30 charts?

Time to tap on my long lost programming skills to help me with the charts. Ok now, there is that programming book?

Apple Leading the Collapse?

Picture from http://etfdailynews.com/2012/03/30/apple-inc-nasdaqaapl-7-reasons-apples-stock-could-be-the-short-of-a-lifetime/

Happen to coincide with what was predicted in the my last article.

Market Peaking in Late April?

Picture from http://www.businessweek.com/articles/2012-03-30/stocks-yet-another-spring-slide

Picture tells a thousand words. Getting your money ready anyone?