We shall explore the concept of "theme" in another article, so here we'll just give it a breif introduction. Let's take it from a microsctructure point of view: who are we up against in this ball park?
- Hedge Funds
- Mutual Funds
- Specs (Leveraged money)
- Central Banks
- Fellow traders with experience
- Would-be traders
And what do they base their decisions on? What makes the “big players” pull up a chair and maybe call their prime broker? It's a fact that the key players in FX don't formulate their ideas off a double top or a 20 moving average or an RSI. The would-be traders jump into the ring armed only with their great technical skills – which is like having one arm tied behind your back.
The big players instead formulate their trades by analyzing the most recent economic news and geopolitical developments, which of course can be related to the short term (like a FOMC meeting) or medium term (like the tensions in Iraq which kept the markets alert in summer 2014, or like the Scottish independence vote that influenced Gbp for over 3 weeks at the beginning of 2015). So before even looking at charts and setups (i know, we're all chart junkies up to a certain extent but we need to stay calm), we need to find out what's going on in the World.
Source: futuresmag.com
So what is the main practical takeaway here? The markets cannot be focused on too many things at once. So there will only be a handful of sentiment drivers “active” at any given moment. Those “themes” will have the most impact on certain currencies. For example:
- the Scottish independence vote will affect Sterling (Gbp) first and foremost;
- the FOMC rate decisions will affect the greenback (USD) and YM/ES/NQ first and foremost;
- the Global Dairy Trade Auctions affect first and foremost the Kiwi (NZD);
etc.
So as a trader, you don't have to focus on everything in the FX universe! Just focus on things that are “in play” and attracting attention to themselves.
2. Momentum: relative strength vs. absolute strength
So once the themes are clear in our mind, we need to shift to charts, and look for entries in line with momentum. Momentum, in FX, can have different meanings depending on price behaviour. My description is very similar to what Gary Antonacci speaks about in his "Dual Momentum" studies.
- relative momentum: the Gbp might be feeling the uncertainty regarding the Scottish vote but it only looks “weak” vs. the Greenback.
- absolute momentum: the Gbp might be feeling the uncertainty regarding the Scottish vote and it looks “weak” against all it's main counterparts (GbpUsd, GbpJpy, EurGbp, GbpChf).
Of course, we would ideally like to get ourselves into situations that show absolute momentum rather than relative momentum. So we need a way to systematically identify strength or weakness, and how widespread or local it is. In essence, a solution might be:
1. Check DXY: is it moving/doing anything that interests me?
2. Check strongest or weakest currency vs. USD: what is doing on the crosses?
3. If nothing evident is popping up, look to the crosses directly (it's not always about the Dollar!)
We are always hunting for value vs. risk, in order to make our life easy. We're basically looking for evidently trending candidates (strong momentum), without exluding anything.
Usd going one way, everything else going the other way. Sure, there will also be local drivers but it's evident that the major story is one of Dollar strength across the board (absolute value). Find the weakest currencies vs. DXY, find what's driving their sentiment and milk it until it ends!
Source: Finviz.com
3. A note on Time Frames
So what constitutes a trending candidate? For how long does a currency have to be in the spotlight (from a sentiment perspective) and unidirectional (from a trend perspective) before it can be considered a good candidate? Here are some good places to start:
1 Week relative strength chart
Source: Finviz.com
This first image answers the question: who was the biggest winner and the biggest loser this week?
1 Month relative strength chart
Source: Finviz.com
This second image tells you who the biggest winner and loser were for the past month.
Now comes the question – I know you're going to ask it: so all we have to do is pull up the relative value charts and pair up strong vs. weak? Is it that easy?
Of course not! Those snapshots show “static” values, when the market is instead a very dynamic creature. That's why we always need to look at the current chart, and where price is relative to
- the week's open
- the month's open
because the best performer last week could very well lose it's shine this week. Why? For a number of reasons, but evidently there has been a shift of sentiment away from that particular asset. That's why trading is so difficult: things happen in real time, and all the market cares about is what is happening today! Not what happened yesterday or what will happen tomorrow.
We need a plan, on order to avoid getting spit out penniless
Source: deathandtaxesmag.com
Many traders seem to think that focusing on weekly and/or monthly performance is too large of a window for their day-to-day endeavours. So they go and focus on the 1 hour charts or even the 30 minute charts. But in order to correctly respond to such short-sightedness, we must recall what exactly drives prices in the first place: expectations revolving around themes.
And market themes don't flip on a dime (except maybe during Central Bank announcements and during NFP). Themes can last for a while, so even if the currency pair starts to retrace and chop around for a bit, so long as the sentiment drier is still present, it's only a matter of time before things click into place again.
In & out of fashion: the theme has always been present since May 2014 (ECB QE possibility/weak EU data) so the fact that the Euro has seen periods of consolidation (therefore slipping out of trend mode and getting short sighted traders confused) is to be seen only as a pause. Just wait until something brings the theme back under the spotlight and milk it more!
Source: FXCM Marketscope
To sum up: finding good value in the world of Forex trading is not as easy as it seems. We need to stack the odds in our favour, and we can do this by using current themes to identify possible candidates, and then by identifying where there could be some absolute or relative strength to exploit. The markets are dynamic by nature, so we cannot work off of last week's data if we want to trade this week's markets. That's why the Skype Trading Room exists in the first place! To show realtime analysis and trades in live market conditions. If you do not continuously stack up the strong vs. the weak each week and verify things each day then the FX market can quickly leave you penniless.
Good Luck!
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