apart from the discussion about the best analytical tool for forecasting forex quotes - mainly technical vs fundamental analysis - i believe that there should be a lot more discussion on WHICH PAIR(s) to trade and WHAT TRADING STYLE to employ.
let’s start out with chosing the pair(s).
decision nr1: major pairs or side pairs? on first glance this question doesn’t seem to be an issue since forex is forex but when checking correlation data (FOREX correlation tables can be downloaded at many websites) between various currency pairs it becomes obvious that choosing the “right” pair is very important and crucial for your trading results no matter which forecasting method you prefer. due to the fact that we’re at the moment faced with very uncertain and erratic fx markets all over the globe as a result of various economic crisis situations the major pairs are extremely news driven and incredibly hard to forecasts. politicians, bankers, economists, rating agencies etc… they all influence quotes in an unforeseeable way 24h a day and destroy “systematic” development.
in my opinion an extremely bad environment for technical analysis. usable patterns either don’t show up at all or come in a very unstable fashion since they can be broken by news at any time. various technical methods can be successful or turn out to be completely useless from one moment to another. a situation in which i wouldn’t bet money on any technical analysis available. but betting money is exactly what you do when trading forex.
fundamental analysis might be a bit more useful in this crisis situation but only if the forecaster is capable of coping with the huge volume of data to process and with the complicated and sometimes very surprising mechanisms turning up in the market. (ie budget crisis in the US and falling!!! gold prices). a task which only a few companies can cope with. and not even they are always successful.
my conclusion is that traders should either focus on one single major pair and perfect their expertise in trading this pair exclusively or look for independent side pairs as long as the worldwide economic situation remains unstable. we employed an extremely successful trading model from 2000 to 2007 in trading EURUSD - doesn’t work at all anymore. market mechanisms and pattern development have changed completely. ALWAYS be aware of traps like this one and stay flexible in every aspect of your trading behaviour and decisions.
this leads us to side pairs. there are side pairs that show surprisingly low correlation to even very erratic development of EUR, USD, GBP and Yen. we picked AUDNZD for various reasons but there are many other tradable and liquid pairs out there, too. AUDNZD has the advantage of huge trading volumes - both currencies are among the top 10 most traded worldwide - and stable political situations in both countries. this pair can be traded at every broker you chose. since quote development is not heavily biased by outside influences pattern recognition systems like technical analysis should be more successful here than with the majors. we at neuralfx.eu use neural nets and feed and train them with tech data of AUDNZD, tech data of the majors vs AUD and NZD (AUDUSD, AUDYEN etc…) and even quotes of gold and copper. the neural variable selection algorithm decides which input variables and data fields are best suited for predicting the direction of quote development.
decision nr2: once you’ve decided which pair to trade, you have to determine HOW to trade it. this is basically a matter of finding
- the right time frame
- right lot size
- stop loss
- exit levels
these decisions largely depend on your prediction method, trading goal (high risk trading, moderate additional income etc.) and personal situation (professional trader, time zone, time at the computer). lot sizes, s/l levels and exits are essential risk management tools. many traders argue that for managing risk when trading FOREX you need to diversify and trade multiple pairs. this is a common mistake and simply not true for the FOREX market. this idea stems from trading stocks and definitely does make sense there. companies can go broke, might become the victim of bad management decisions and all your money would be gone. diversification is important there!
when trading FOREX you’ll be never be able to acquire the best expertise possible for every pair in your basket. not when you’re a single person. but the basket doesn’t even make too much sense when we talk about a FOREX trading company. the company can also be seen as one entity and would be able to gain more expertise in one pair than in a basket. i know that this is a very unpopular approach but from the logical point of view it seems right under the assumption of limited ressources a trader has as regards time and knowledge.
when (test or demo) trading a basket for a certain time period - no matter if the trader is an individual or a company - there will be statistics and records available on the individual performance of each pair. the logical question is: why don’t you trade the best pair only? see my point? risk management is handled via leverage, stop loss and exit strategy. it’s even handled by improving your own trading psychology - never underestimate this aspect - but NOT by trading multiple pairs. (i wrote an article on this, too. in case you’re interested just send me an email to the address in my profile) diversification will REDUCE your profit! trading your best pair only will MAXIMIZE them.
one IMPORTANT thing: i’m not saying that you shouldn’t investigate multiple pairs as far as trading and making profit goes. doing so is an absolute must to stay flexible and be able to react to new trading conditions. you might change the pair you trade at any time when you think that you’ve found a better one or when performance on your traded pair deteriorates. as i mentioned this happened to us when trading EURUSD. we threw the pair away after 3 months of negative overall results.
let’s now turn to the right time frame for trading your pair: the time frame depends on your forecasting method and maybe the time zone you live in if your method requires you to be in front of the computer. carefully check average pip ranges per trading hour (incredible differences in AUDNZD!), average daily open/close, open/high, open/low differences etcetc… these stats will help you set the best stop loss and exit levels. beware that optimal values for s/l and exit limits might change over time depending on volatility of the pair. run trading simulations, do backtest, set up trial accounts and practice trading. experiment with varyinng stop losses, different exits, trailing stops and so on. get every experience possible. all this will help taking your profits higher or your losses lower no matter which forecasting method you use. it’s all up to you to detect interesting stuff in quote development of your pair. be innovative in creating your own parameters and indicators. don’t only stick to the well known ones. THAT’s the way to manage risk and develop your final strategy! published trading stats from brokers show that around 60% of trade entries yield positive results but that far more than 60% of clients lose money. so it’s not only the forecasts that make you win or lose.
please keep in mind that all these necessary measures are independent of your forecasting and decision model. this is general stuff every trader should see as a necessity when developing a trading plan. you might sum it up as “position management”. i perfectly well know that many people will maybe disagree with my statements but this article is not meant to produce the ultimate trading wisdom and tell people what’s right. the intention is to build awareness for trading essentials apart from your forecasting method.
looking forward to your feedback.
cheers juergen
neuralfx.eu