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Trading Tips

Is forex more predictable than other markets?

prices

In a recent post at Zero Hedge, the following assertion was made:

“But the currency markets are easier to trade from a predictability standpoint compared to many other markets once one learns the relationships.”

The whole piece is essentially one long sales pitch in favor of trading forex over other markets, so it is perhaps no surprise to see a comment of this sort. I’m not here to agree or disagree with that general sentiment. The bottom line is that each trader should pick the market or markets which best suit them and their particular situation.

What I will challenge, however, is the above quote.

I don’t know if anyone has done any tests of market predictability, but if I were to hazard a guess as to which one tops the list I’d have to say stocks. Just look at any major index and the trend it’s had going back multiple decades. Just to be clear, I’m not talking individual stocks here, but rather the market as a whole.

Now, one might say something like, “But who trades in that kind of time frame?”

It’s true. Thinking in terms of decades is the realm of the investors, not traders. That brings me to the main point I want to make with respect to predictability.

The author of the statement above makes a valid point about central banks, etc. signaling their intentions. What they fails to consider, however, is the time frame variation involved.

The vast majority of retail (individual) forex traders operate in the hours to days range. They are day or swing traders, for the most part. The central bank signaling is something which works over significantly longer periods.

While it may be true that the BOJ wanting the JPY to be weaker results in a general down trend in the yen exchange rates, that path is anything but straight and smooth when considering normal trader time frames. Along the way toward yen devaluation there are any number of market influences at work in the shorter time scales.

To my mind, in the shorter term where traders tend to operate, no market really has a long-term predictability advantage.

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Reader Questions Answered

Which range target should I use?

A reader asked me the following:

I am a Forex Trader at the beginning and my question is about range trading. I have attached a Screenshot of USD/CAD 4H chart and make some notes about targets and profitability. I want you know what do you think about target 1,2,3 pro and cons.

Here’s that screenshot.

Range Trading
Click for full-sized version

For me the selection of target in a case like this depends on the broader market pattern. If the general trend is positive, then going with a very conservative objective (Target 1) risks leaving considerable profits on the table. I would personally go with something higher, maybe all the way up to Target 3 in expectation that if the market is generally bullish it should reach the upper bounds of the range. If not, then you have a sign of potential weakness.

If, however, the market is in a generally negative condition then I would definitely use the closer target. In that case I would then watch to see how price moved in the range change to gauge whether it was continuing to show weakness (in which case I’d be less inclined to make long trades) or whether it started to show strength.

 

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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 www.forexseasonals.com.

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.

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Trading Book Reviews

Book Review: The Secrets of Economic Indicators by Bernard Baumohl

[easyazon-link asin=”B008O7V05U”][/easyazon-link]It’s taken me about a year, but I’ve finally gotten around to having a look through the 3rd edition of Bernard Baumohl’s book [easyazon-link asin=”B008O7V05U”]The Secrets of Economic Indicators[/easyazon-link]. Now that I’ve done so, I really which I’d dug in sooner.

This book answers the question a lot of new and developing traders have in terms of what economic indicators are important and where to go to get information about them. It comprises only 6 chapters, despite being over 400 pages long in print format. They are as follows:

Chapter 1 – The Lock-Up, which looks at how indicators are released and lays the groundwork for what’s to come.

Chapter 2 – A Beginner’s Guide: Understanding the Lingo, which is a brief look at what does into economic data and the interpretation of releases.

Chapter 3 – The Most Influential US Economic Indicators is the bulk of the book (over 300 pages). It goes through each of the major releases (and not so major) with a quite thorough discussion. That starts with a quick reference on

  • Market Sensitivity
  • What Is It?
  • Most Current News Release on the Internet
  • Home Web Address
  • Release Time
  • Frequency
  • Source
  • Revisions

That is then followed by discussion sections

  • Why Is it Important?
  • How Is It Computed?
  • The Tables: Clues on What’s Ahead for the Economy
  • Market Impact

Lots of information here, for sure.

Chapter 4 – International Economic Indicators: Why Are They So Important? follows a similar pattern to Chapter 3 in looking at the major non-US data releases.

Chapter 5 – Best Websites for U.S. Economic Indicators is several pages worth of useful websites to find fundamental information and news.

Chapter 6 – Best Websites for International Economic Indicators is the same as with Chapter 5 for international data.

I can’t imagine a better, more complete resource on the subject of economic indicators. If you’re looking at using fundamentals in your trading, you’ll definitely want to give [easyazon-link asin=”B008O7V05U”]The Secrets of Economic Indicators[/easyazon-link] a look.

Make sure to check out all my trading book reviews.

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Reader Questions Answered

Technical analysis in manipulated markets

This originally went up on the Currensee blog, but I think it’s something that this audience will find interesting as well.

I threw the question of what I should write about this week to a former manager of mine who was a forex dealer back in his younger years and now makes a living telling folks what’s happening in the markets. He tossed back a surprisingly good question:

How can technicals be relevant when central banks are trying to manipulate the market- BOJ with USD/JPY and SNB with EUR/CHF?

I’m sure this is something that others have pondered as well.

Here’s my view on it – speaking as someone who is very much a practicing technical analyst.

Currency intervention by a central bank or other monetary authority (in the US intervention is directed by the Treasury, though it’s executed by the NY Federal Reserve Bank) is just another news item or event that influences exchange rates. Those of us who’ve been around the markets for a while have seen a great many dramatic market reactions to all kinds of developments. Some of them have been triggered by data releases. Some have been driven by news events. Some have been caused by speakers. And some have been the result of intervention action. Heck, some of the moves have come just from the suggestion of intervention without it actually happening.

In other words, intervention is just one more thing that is reflected in the price action we see on the charts. Furthermore, it’s also something that is incorporated into the market’s expectation of the future as part of the price action we’re seeing now. The more market participants anticipate intervention, the more they will factor that into their trading and by extension the more it will influence the price action we see. It works in the same way that stock traders will price in anticipated share buybacks or weak earnings. All markets are discounting mechanisms in some fashion or another, and we can analyze the patterns that are developed in the price action through that process.

So, from my perspective, I don’t view technicals as any less useful in a market where intervention may happen. I use the same methods I would in any other case.

Now, having said that, intervention certainly presents the potential for a major volatility spike on the event (or even the hint of it). If your trading strategy or market analysis is ill-suited to that kind of thing, then while that risk is in the markets you may be best advised to either change the pair(s) you trade or to lengthen your trading time frame out to one where sharp intraday moves aren’t so much of a concern. Alternatively, you could adjust your risk so that you have less exposure for trades going against the likely direction of intervention (like when going short USD/JPY if you think the Bank of Japan is going to sell yen). The analysis doesn’t change, but how you then use it does.

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Reader Questions Answered

Picking the right indicator(s)

This question came in the other day from a developing trader on the subject of technical indicators.

Dear Mr. Forman,

I’m a subscriber to your trading e-newsletter. I have a market question that I’d like to ask you. I often see it written on different market websites where they say that traders should use some kind of Technical Indicators on their charts to help determine the strength on a trend. I’m strickly a retail day trader (amateur lol), and mostly on using a 50 day moving avg on my charts and drawing my SR lines. I’ve tried lagging indicators like the RSI and MACD but they only seem to confuse me. I’m wondering which Indicators you think would be the most helpful to use for the shorter time frames that day traders trade in. Thank you so much and I look forward to your answer.

Germain

The first thing I’d point out is that all indicators are lagging in some fashion. Germain mentions RSI and MACD, but anything that uses historical data – and that’s all of them – has a built in lag effect to it. The further the look-back period, the greater the lag.

Now, certain indicators are meant to filter out the noise. Moving averages are in that category. They are meant to smooth out the ups and downs to indicate overall market direction. Longer moving averages will smooth out more volatility, but will be less responsive to market change, while the opposite will be the case with shorter averages.

RSI and other oscillator type of indicators basically tell you where the market is in reference to where it’s been. The idea there is that if it moves too far in one direction it will be overbought or oversold. The problem is that doesn’t work so well in a trending market.

To my mind, the best indicator of trend is the chart. Which way is it sloping? Stepping up a time interval from the one you’re trading to a higher one to look at the bigger trend can be very helpful. Again, you’re looking at history, so you there’s always a lag effect in your analysis (a trend will change before that change can be seen on the charts), but that’s just what we have to deal with.

No matter what I say, though, indicators (or the lack thereof) are an individual choice. We all have to pick things to look at that give us the specific information we require – and preferably no more than that. Decide how you want to trade and pick the things which help you identify trading opportunities or analyze the markets based on that approach.

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Reader Questions Answered

CANSLIM and market trend

I received the following query from a Trade2Win member the other day.

I was just re-reading the example strategy part of your book. I know you said it is inspired from CANSLIM. O’Neill generally advises staying out of the market if it is in a bear trend. Do you generally find this affects your strategy. Do you have to leave it for another or do you find it still works fine possibly with less candidates?

My personal experience with stock trading in general, and CANSLIM-related strategies in specific, is that the overall trend of the market is a major influence on the performance of most individual stocks. I think most experienced traders would back me up on this. Also, there’s been a lot of talk lately about how much more correlated individual stocks have become to the indices of late, so it would seem these days the O’Neill suggestion should be taken even more seriously.

While it’s certainly true that strong stocks will tend to outperform the market no matter the overall conditions, there’s an aspect to CANSLIM which needs to be accounted for here. The stocks identified tend to be high beta names, meaning they tend move move more aggressively than the overall market. That’s great when the market is rallying, but it can be a killer when the market’s moving the other way.