See relative strength, pick winning forex trade from an overlay
What do you do when you have a question in your head like 'I want to short JPY but I don't know which JPY cross is the best trade?' To pick the winning forex pair that will give you the best performance for your trade idea, one way is to build an overlay, choose pairs based on relative strength/ relative performance.
In this post, I share how you can analyse relative strength between currency pairs by building an overlaid chart using free charting platforms. In case you are not comfortable with this method or you think it is exceeds your needs, I offer an alternative 'off-the-shelf' solution.
Picking a winner is a major challenge
And one of the most common mistakes made by new forex traders. Even if you get the trend of a currency right, you could be a 'loser' if you do not pick the currency pair that delivers you the best performance.
Let's look at the recent trend of JPY weakening. JPY has been weakening against major currencies since November 2016 (see chart below↓; also visit my post '2016 performance of USD to forex majors in 4 sentences').
Many traders could have gotten the trend right by going short the JPY. There are many ways to do so but seven common JPY crosses are USDJPY, GBPJPY, CADJPY, EURJPY, AUDJPY, NZDJPY and SGDJPY. Short JPY by going long these 7 currency pairs.
Getting the trend right is the first step but choosing the right pair is where many traders stumble. Consider this second chart which is an overlay of those seven JPY crosses from 08 November 2016.
There are several features in this chart:
- Going long these pairs to short JPY was the right trade because all of them made money.
- When put together, the overlay instantly shows the winner and 'losers'. The overlay is a picture of relative strength.
- In this example, the winners and losers can be distinctly separated into two groups (see red dashed line in the middle) - a group of CADJPY, USDJPY and GBPJPY that consistently outperformed and a group consisting SGDJPY, EURJPY, AUDJPY and NZDJPY that consistently underperformed.
- Choosing the right pair is obviously critical. CADJPY is the strongest performer till date. Long CADJPY delivered double the performance of pairs at the bottom.
- Some pairs move very closely from time to time such as AUDJPY/NZDJPY and AUDJPY/EURJPY. There would be no point to pick one pair over another when they are 'stuck' because the performance is the same.
Two common mistakes made by traders
- A trader who chose to go long AUDJPY, EURJPY and NZDJPY this entire duration would be underperforming CADJPY by half. Yet this underperformance and mistake was visible since the second half of November and could have been easily corrected.
- Instead of identifying the best performer, some traders pick up a few - then end up with a whole handful of trades hugging the bottom.
Moral of the story - 1) one could be a 'poor' winner if one picks the wrong pair 2) there has to be a systematic way to spot the winning trade.
Pick your winning trade by building an overlay
Build an overlay, inspect relative strength visually like what I did in Chart #2↑.
1. Use Tradingview.com or Investing.com. Both of them are browser based charting platforms that are free to use. Importantly they both have a 'Compare' feature in the toolbar that lets you compare different trades in a top-bottom arrangement (multiple panels) or even multiple trades overlaid in a single chart.
Both use a charting engine based on Tradingview so both of them work the same way. Their difference is data feed from different sources so some markets may be available in one platform but not the other.
Take note some contracts are identified by different tickers on each platform because of different data providers.
2. The starting date on the x-axis of your chart should be personalised according to your analysis. To look at short term ideas like this JPY example, I built the JPY overlay starting from 08 November 2016 because I believe that was a major turning point.
A good way to decide your starting date is to frame your analysis into a question such as 'what is the 10-year performance of holding on to EURUSD versus GBPUSD'? The starting date should be based on the time horizon that interests you most. Your chart could also start from high impact days such as 'Brexit', 'Black Monday' or even recurring days like RBA rate decisions, FOMC meetings and so on. High impact trading news often turn out to be turning points for price.
3. Finally make sure you have a common price denominator. If you want to see how USDSGD performs against GBPUSD visually over a period of time, make sure you have an apple to apple comparison. Your overlay should be built with USDSGD and USDGBP or you can also choose SGDUSD versus GBPUSD.
Websites like Finviz.com and Barchart.com provide existing solutions. They take less effort to use and are good solutions for busy traders.
Finviz.com has a 'Forex Performance' feature. You can personalise your analysis switching period settings between day, week, month, month to date, quarter, half year, year and year to date. These are short term settings that are sufficient.
Barchart.com has 'Forex Performance Leaders' feature. The period settings are similar to Finviz.com. Both of them lack the full customisation offered by Tradingview.com and Investing.com.
- When you make a decision to follow a trade based on past performance, you also submit that the trend is likely to continue. It might, it might not but there has to be a starting point.
- The overlay technique is powerful because you can really see price action in a visual way. Many times I build an overlay to look at the aftermath/outcome of a major event such as the US Presidential Election last year. This helps me form my own opinion instead of following others.
- I wrote a piece 'Simple method to select trending currencies for trading' back in 2014. There is some overlap in content but really addresses different needs.