Trader Resources

Making use of seasonal patterns in forex

As those who have followed my work over the last several years are aware, I have done some research into so-called “seasonal” patterns in the foreign exchange market. This was motivated by observing a tradeable pattern in one of my favorite pairs and using it to make a fair bit of money. Out of curiosity, I did a review of other pairs to see if there were any other patterns worth trading. I really didn’t expect to find anything, so it was quite a surprise when I found them all over the place.

That initial research ended up going into a report I published in 2006 titled Opportunities in Forex Calendar Trading Patterns. Over the years since I have expanded and updated that report a handful of times. Recently, I brought it up to date with data through the end of 2013. If you’re interested, you can get a copy or learn more about it at

I recently had someone ask me why I don’t just trade the information, and presumably horde the knowledge for myself. This is akin to one of the questions myself and others addressed in Trading FAQs. It also assumes there is only one way to trade using this sort of information. That is most definitely not the case!

Seasonal patterns in forex operate in different time frames, just like traders. As a result, there are opportunities to apply the knowledge of such patterns in multiple ways, depending on how you trade the markets.

Trading News

Forex Trading – Volatility, Regulation, and Survivorship

There’s been considerable talk over the last few years about whether US regulators are killing (intentionally or otherwise) the retail forex business in the States. The latest round comes on the heels of word going around that the National Futures Association (NFA), the industry overseer of most US forex brokers, is looking to ban the use of credit cards (directly or indirectly via the likes of PayPal) for funding accounts [I’d love to hear your thoughts on that, by the way. Feel free to leave a comment on Facebook or Twitter @RhodyTrader]. Retail traders have been screaming about overly active regulators since at least 2009 when word came down that “hedge” accounting would no longer be permitted for US accounts and that FIFO accounting would be required (see No More “Hedging” for Forex Traders).

Here’s the thing, though. The figures actually don’t back up any “death of…” scenarios, at least from a regulatory perspective. The US brokers didn’t start reporting active trader accounts to the CFTC until Q3 2010 (with data retroactive to Q4 2009), so we don’t have good figures for the Q2 2009 period when the “no hedging” rules kicked-in, or for the quarter immediately thereafter. There is a dip in active accounts between Q4 2009 and Q1 2010, which may be attributable in some way to the subsequent 100:1 leverage restriction put in place at the end of November 2009 (see New NFA Retail Forex Leverage Restrictions), but that seems highly unlikely given that when the Commodity Futures Trading Commission (CFTC) lowered that leverage cap to 50:1 a year later (see New CFTC Rules for Retail Forex Trading) there was no noticeable impact on active accounts as we can see in this table:

Notice how the number of active US-broker accounts held quite level during the year from Q4 2010 when the lowered permissible leverage went into effect through Q3 2011 (figures derived from the quarterly reports compiled by Forex Magnates). The sharp drop in active accounts doesn’t come until Q4 2011, though there wasn’t any particular catalyst (Forex Magnates suggested the cumulative effect of increase regulation, but that seems unlikely given the sharp 1-quarter move) and the fall was across brokers.

What is really interesting to note in the table, though, is how stable the number of profitable accounts has been since about Q4 2010. It’s only twice dipped below 30k. This comes as we’ve seen persistent weakness in the number of active accounts, which could be attributable to reduced volatility in the forex market for the last year or so. We can see that in the Average True Range (ATR) reading in the weekly USD Index chart below.

Interestingly, the number of active accounts is now back down into the area it was in during late 2009 and early 2010 when volatility was also on the low end before it ramped up again as 2010 progressed, which is when we saw the jump in accounts. That may not be cause/effect, but if we see volatility rise and the active account numbers increase again we’ll know that it’s the markets (and increased competition, no doubt) which has put the US retail forex business under pressure, not regulation.

Getting back to the stable number of profitable accounts, though, we’ve got indications of survivorship in them. That means profitable traders are staying active (though as I noted a couple weeks ago, there is considerable turnover in the accounts making money each quarter) and unprofitable ones are dropping out, which is what you’d expect to see in any case. It’s just that these days we’re not seeing an influx of new accounts to replace the dropouts.

Trading Tips

More evidence of wrong-way retail

At the request of my PhD supervisor, I’ve been working on a document that will no doubt be part of my overall dissertation. It’s meant to explain retail spot forex in an academic manner (meaning multisyllabic words and copious formulas), with an eye toward setting the stage for my research into individual trader performance from a Behavioral Finance perspective.

In developing the area of the document which discusses market participants I came across a telling graph. Below is a 1-year look-back at the positioning of OANDA customers in EUR/USD, which I pulled from the broker’s website.

The black line is the EUR/USD exchange rate, while the histogram shows the overall net position of all OANDA customers (blue being net long, yellow net short). In many ways this is comparable to the Commitment of Traders (COT) report, which I’ve written about in this blog on several previous occasions (see Commitment of Traders – A Weekly Report Worth Viewing as a starting point).

What I want you to make particular notice of is how often in the chart above the market is rising when traders are positioned short and falling when they are long. This supports the often-expressed view that retail traders are usually on the wrong side of the market, and suggests in general terms that they trade in a counter-trend fashion.

Trading News

Margins on forex hedges

There’s a story on Forex Magnates about how FXCM has decided to require margin for forex “hedge” positions.

That’s right. Even though these positions have no directional risk whatsoever (in as much as they represent complete offsets), the broker is going to require that margin be posted. Specifically, they will require the margin that would be needed if only one leg of the trade was open. So basically, the margin requirement will be the same as if you there was no “hedge” at all.

Why is FXCM doing this? Here’s what their representative had to say:

Under the current system where no margin is required, some traders have inadvertently opened positions that were disproportionately large compared to the size of their account. In some cases clients have received margin calls when closing one side of the position (which would then trigger an added margin requirement for the remaining un-hedged side).

So basically, what is happening is that some traders are building up “hedges” which are much too large, then getting burned by margin calls when they unwind them (the Forex Magnates author suggest they are closing out the profitable legs and leaving the losing legs open, not realizing the losing position’s margin requirement). This whole thing, to my mind, is just another example of how traders can get themselves totally deluded by doing these “hedges”, and why I have long argued against the practice (the No More “Hedging” for Forex Traders article is the single most commented on post in this blog).

The “inadvertently” part of the above statement, to my mind, really speaks volumes to the whole hedging discussion. It implies either these traders are clueless about trade sizes, or they are horribly off-base in terms of risk management and/or margin requirements. Hedging is thus masking serious trading deficiencies.

FXCM is actually doing traders a favor by putting these margin requirements in place, helping the foolish avoid blowing themselves up. It would be better if they just scrapped “hedge” accounting (and really “hedging” is just about a different way of accounting for gains and losses).

Trading Tips

On Safe Havens and Currency Pair Correlations

I usually think the stuff put out by OANDA is pretty solid, but a post on their blog yesterday definitely fell short of that standard. Using their correlation matrix – which I do think is very useful and which I posted about on Facebook and Twitter not long ago – the author looked to make the case that USD/CHF is the best safe haven current pair.

First of all, currency pairs are not safe havens. That only works with individual currencies. At various points in recent years the USD, the CHF, and even the JPY have been tagged as safe haven currencies. This is an indication of where global capital is likely to move during times of stress. The result is that when the markets are risk-off, money will flow from risk currencies (currently the likes of the EUR and AUD) into safe haven currencies, and that will reverse with the markets go risk-on. This tends to make the pairs which join up safe haven and risk currencies (AUD/USD, for example) particularly volatile in times of shifting market psychology.

Shifting to the OANDA blog author’s argument, though, we get into the area of correlation. The point made is that USD/CHF is almost perfectly negatively correlated to EUR/USD in nearly all time frames. Let’s think about what those causes are:

1) The USD positions in the two pairs are opposing
Any two currency pairs which have the USD in them are going to be fairly strongly correlated most of the time. Whether that is negative or positive depends on whether the USD is in opposing positions in the pairs (base in one, quote in the other) or in the same position (base in both or quote in both). In the case of EUR/USD and USD/CHF we have the dollar as quote currency in one and base currency in the other, so we have a natural negative correlation.

2) The EUR and CHF tend to be influenced by common factors
This means both the euro and franc have a long history of seeing their values rise or fall on the basis of the same news and fundamental information. As a result, they tend to move in the same direction most of the time, though the amplitudes of the moves does vary (which is the cause for movement in EUR/CHF). Because EUR/USD and USD/CHF have the two currencies in opposing positions (as noted with the dollar above), there is a natural negative correlation between the pairs.

3) The Swiss National Bank has put a floor under EUR/CHF at 1.20
Because of the persistent issues in the Eurozone and the perception of the franc as a safe haven (meaning flows out of the EUR and into the CHF), this has effectively mean EUR/CHF has been pegged at or near 1.20 for long period of time of late. That means the euro and franc have traded in near lockstep. Going back to the relationship between EUR/USD and USD/CHF noted in 2) above, this is the strongest case of all for a very strongly negative (near -1) correlation between the two pairs.

Put all this together and you get the reason for USD/CHF trading at a near perfect negative correlation to EUR/USD being that the EUR and CHF are virtually the same currency these days, and both pairs feature the same opposing currency (USD) on the other side. Of course they are going to be strongly negatively correlated!

Because of the strong negative correlation between EUR/USD and USD/CHF, hedgers may look at the two as presenting an opportunity. I would note, however, that being long EUR/USD (for example) and hedging with a long USD/CHF position would only serve in creating a synthetic (and overly expensive) EUR/CHF long position.

The bottom line with the correlation stuff, which seems to get everyone very excited these days for some reason, is that it’s important to know why two markets are correlated (or uncorrelated). If you don’t, then you may find yourself in a nasty position where the correlation breaks down and catches you out because you weren’t prepared for it based on an understanding of the market dynamics at work.

And getting back to the idea of USD/CHF being the best safe haven currency pair… I’m sorry, but just looking at the correlation to EUR/USD alone is a far cry from sufficient evidence to make such a claim. You’d have to do a full analysis to see which pair or pairs is most reactive to safe haven capital flows before making any claims. Correlation analysis doesn’t get you there.

Trading Tips

Responding to a Forex Rant

What you are about to read below came from a comment that someone left. The spam filter caught it, and likely with good reason given the lack of a real name associated with it. Basically, it’s a rant against trading forex. There are some legitimate points made, but also so errors. I figure it represents some common thinking about the forex market, so I thought it worth addressing.

Playing Forex can appear alluring, but the majority of people who try it lose money. All you have to do is do a web search on the words Forex and lose to see this is the consensus.Forex is what we call a zero sum game. You are making a bet with someone else about whether a currency will rise or fall. For every winner there has to be a loser. If you are smarter than the average player, you may make money. If you are dumber than the average player, you are likely to lose money. Most of the people making the bets in Forex are highly trained professionals at banks and other institutions. You are unlikely to beat them at this game.Actually Forex is not quite a zero sum game. It’s a slightly negative sum game as the Forex broker takes a small percentage each time in the spread. It’s a small amount but over a hundred trades, it ends up being a considerable amount of money. So the average player is likely to lose money, and remember the average player is a highly trained professional and probably smarter than you.There is a lot of luck in Forex, and if you play it, you will have some periods of time where you make money. This is usually because you are having a lucky streak, not because you have suddenly become an expert Forex player. However, most people are unwilling to admit their success is due to luck. They become convinced they have a system that works, and lose a lot of money trying to refine it.

There’s more to the original, but I think the point is made with what’s above. Let me address the main ideas.

Yes, forex is a zero sum market – negative sum when factoring in the bid/ask spread and commissions (where applicable). I’ve addressed forex as a zero sum game before, so I won’t delve into that again here.

No, it is not true that most forex traders are highly trained professionals. The latest US forex broker profitability figures indicate that there are something approaching 100,000 active trading accounts (meaning did at least one trade in the last 3 months). There is absolutely no way you can claim most of those folks are pros. In fact, it is unlikely more than a very small percentage of them could be considered professional. Most of those accounts are individual non-professional types. The pros generally don’t trade through retail brokerage accounts.

That said, it is definitely true that most traders lose money. The figures generally show that only about 1 in 3 traders are profitable in a given three month period. In a lot of ways, forex trading can be looked at in a similar way as a game like poker. In the short run chance plays a big part in the outcome, but over the long run those with a higher level of skill will take money from those with less skill.

Trading News

Battling HFT in the forex markets

I just had something come across my desk that is really interesting and ties in with the stuff in the book Broken Markets which I posted a review for the other day. One of the issues brought up by the authors of that book is the impact of decimalization on the stock market since its introduction and how we’re now seeing sub-decimalization being used by high frequency trading (HFT) systems to scalp. One of the big inter-bank dealing platforms is being pressured by its customers to fight back against a similar thing happening in forex.

EBS is also looking at addressing so-called quote stuffing, which involves putting in orders and pulling them out quickly in an effort to sense market liquidity, etc.

The pippette change is something which could have an impact on pricing in the retail forex market. The quote stuffing thing may as well, but in a less direct fashion most likely.

Here’s the full story from the Dow Jones wire.

UPDATE: EBS To Change Way It Quotes Currencies on Trading System – Sources
06/26/12 09:36
Electronic inter-dealer currencies-trading platform EBS plans to scrap the fifth decimal place on its currency quotes and introduce so-called half-pip pricing ahead of major changes to the system, people familiar with the matter told Dow Jones Newswires Tuesday.

EBS, owned by ICAP PLC (IAP.LN), has been considering a range of options that will change the way investors are allowed to trade on the system in a bid to repair relations with its core banking customer base. EBS shares a dominant position in currency markets with Thomson Reuters (TRI), but it has come under fire from its core bank clients for allowing trading behavior that seemingly favors so-called high-frequency traders in recent years. Now it is seeking to redress that balance.

“We have been engaged in a wide-ranging dialog with key customers and other market participants, reviewing all aspects of the EBS system. This includes a review of the EBS dealing rules. The review is still ongoing and we expect to complete it and share the agreed proposal during the summer,” a spokesman for EBS said in an emailed statement.

In late 2010, EBS added a fifth decimal place to its prices, allowing trades at $1.23456, for example, rather than the old-fashioned $1.2345. That last number will now be available only in increments of five, removing most of the finer price points that work best for high-speed computer-based traders.
The move is designed to increase liquidity at the available price points and takes away some ability for high-speed traders to anticipate where the market will move next, one person familiar with the matter said.

“It’s a massive turnaround,” this person said.

Other changes being considered include so-called fill ratios, which would require a certain percentage of orders sent to the platform to be traded, addressing bank traders’ concerns that many high-speed trade requests are speculative steps to judge where the market might move next, rather than genuine requests to trade. Minimum trading sizes and cancellation times are also under review, according to people familiar with the firm’s plans.
The rethink in strategy comes after the shift to decimal pricing in late 2010 caused relations between EBS and traditional customers to sour. Although most electronic trading platforms currently quote foreign exchange prices up to a fifth decimal place, banks felt the move on EBS favored high-speed funds too much.

Earlier this year EBS announced a raft of senior management changes that saw Gil Mandelzis replacing David Rutter at the helm of the trading system. Since the appointment of Mandelzis, EBS said it would review its trading rules to “eliminate certain types of behaviors” from the system. Mandelzis added that EBS isn’t seeking to become a bank-only platform.

The changes in strategy come after some of the biggest currency-trading banks announced the formation of traFXpure, a rival trading system that is set to launch toward the end of this year. The project was announced after more than 18 months of planning and includes Deutsche Bank (DB), the world’s biggest foreign-exchange trading bank by volume.

Write to Eva Szalay at

(END) Dow Jones Newswires
June 26, 2012 09:36 ET (13:36 GMT)
Copyright (c) 2012 Dow Jones & Company, Inc.