This guide on trading profitably is meant for experienced forex traders who already know the basics of trading and market analysis. If you’re completely new to forex trading, you may want to go through my guide on “Getting started in Forex” first.
At the beginning of his book, “New Market Wizards,” Jack Schwager notes that, “There are a million ways to make money in the markets. The irony is that they are all very difficult to find.”
I’d like you to take two things from this. First, my way of making money in the forex market is by no means the only way. It works for me, but it may not suit the style and/or temperament of other traders. Secondly, you’re not going to find a profitable trading method among the common techniques that you find discussed everywhere; chart patterns, technical indicators, and so on. These ready-made pat solutions are not difficult to find, and if they worked, the vast majority of traders would be getting rich using them.
One path to profits is through rigorous statistical research and disciplined analysis. That’s the path I followed to develop the method that I use in my own trading operations. It’s not the only path, but it’s the one I’m familiar with and the one I use every day. So that’s the method I’ll be describing in this guide.
To summarize, I conducted three research projects, described in the three reports available here on the site. Each of these resulted in a unique market indicator, the values of which I calculate weekly. I use these values to rank the eight major currencies each week, from most bullish to most bearish, and adjust my account positions accordingly.
All of these calculations that I do each week can be tedious and time consuming, but the good news is that you don’t have to do all that work. I publish the results of my analysis along with my own weekly trading activity in the CapTraderPro dashboard. I update and publish it each weekend prior to the opening of the Asian session.
So that’s where my directional edge comes from. In the first three parts of this guide, I’ll discuss the indicators, the dashboard, and how I use them to trade. However, you need more than just an edge to be profitable. You also need to understand and apply the correct trading tactics; money management, risk control, and trade management. So in the fourth part of the guide, “Trading tactics,” we’ll concentrate on those.
I use three indicators; one based on a fundamental analysis concept, one based purely on price action, and one based on a combination of price action and tick volume. I calculate the values of the indicators each week for eight major currencies; USD, EUR, GBP, JPY, CAD, CHF, AUD, and NZD.
Each indicator allows me to rank these currencies on a normalized scale ranging from -100 to +100. The most bullish currency has a score of +100, the most bearish has a score of -100, and the other six have values somewhere between these two extremes. This gives me 3 different currency rankings each week, one based on each indicator.
I average the values from these three rankings to arrive at a final ranking list, which is what I use to make my trading decisions. Here is a summary of each indicator.
Buying Power Reversal Potential (BPRP): I describe the calculations and research behind this indicator in “Beyond The Big Mac.” BPRP is based on the fundamental analysis concept of Purchasing Price Parity (PPP), as popularized in Economy Magazine’s “Big Mac Index.” As the most accurate predictor of future price direction, this is my flagship indicator. BPRP is a long-term contrarian indicator which identifies over-extended moves in currency prices. It calculates the 13-week change in the buying power of each currency in terms of a basket of commodities, and is based on the idea that policy makers and economic forces will combine to eventually reverse an extended movement in either direction.
Weekly Reversal Potential (WRP): I describe the calculations and research behind this indicator in “Weekly Price Action Statistics.” WRP is a technical indicator based purely on the price action of a single weekly bar. Like BPRP, this is also a contrarian indicator, but much shorter-term. It is based on the idea that traders will take note of certain price action events indicating that a currency pair has gotten too far out of line in one direction or the other. This is the least accurate of the three indicators, but is the easiest to use in isolation. This is because the important price action events identified in the report are easily seen on a price chart.
Tick Density (TD): I describe the calculations and research behind this indicator in “Forex Tick Density.” Unlike the other two indicators, this is a momentum based indicator, not a contrarian one. That was a research driven decision, not one based on the model behind the indicator. The model is based on the idea that a large concentration of trades in a given price range indicates that there is big money becoming interested in the pair. The research indicated that this high concentration, combined with certain price action events, often indicates a sharp continuation of the current move. So TD is a technical momentum indicator based on a combination of price action and tick-volume.
Every weekend, I use each of the three indicators that I described above to score the eight major currencies from most bullish to most bearish. I then average the three scores for each currency to arrive at a combined currency ranking. Below is the part of the CapTraderPro dashboard from 7/1/2017 showing these four sets of scores.
The first set of scores uses the BPRP indicator only, the second uses only the WRP indicator, and the third uses just the TD indicator. The ranking on the far right is the average of all three.
While I use the average scores for my own trading operations, other traders may prefer to use the individual indicator rankings either in isolation or in some other combination than the one I use. That’s why I provide the individual rankings as well as the average. Traders can tailor this information to their own individual needs.
For those traders who are particularly partial to the Tick Density indicator, I also include a breakdown of which specific pairs had tick density signals during the prior week. Occasionally, there aren’t any at all, but there are usually at least a couple of pairs that flash signals each week. Sometimes there are quite a few. During the week ended 7/1/2017, there was only one tick density signal; a moderately bullish signal on NZD/USD as shown below.
For fundamental analysis purists, the CapTraderPro dashboard also includes a chart showing the current “Pure Fundamental Pick.” This is the pair formed by taking the most bullish and most bearish currencies based on the BPRP indicator. For the week ended 7/1/2017, this was a short EUR/JPY position as shown in the chart below. The green plot is the price of the pair, and the red plot is the value of the BPRP indicator. This chart shows how responsive the pair has been to the BPRP indicator in the past. In this case, the correlation is pretty good. The BPRP tends to peak when the price is near a low and vice versa. Not all pairs are so well behaved though, so use caution!
Finally, the dashboard includes a recap of my trading activity for the past week. This is organized by currency pair and broken down daily as shown below.
Green or red backgrounds indicate an open long or short position in the pair. PO and PC stand for “pending open” and “pending close,” while the color of the text indicates the direction of the pending trade. For instance, I was holding a short position in NZD/CAD, but was planning to close it (by buying the pair, thus the green text).
Open positions show the open profit or loss as a percentage of the account balance in the Friday block. So there’s an open 16.18% loss on that short EUR/JPY position (more on why my stops are so wide in the “Trading tactics” section below). Happily, there’s also an open 16.84% profit on that short NZD/CAD position that’s pending closure. When I exit a position during the week, the background changes back to gray, and I post the closed profit or loss on the closing day. So that short GBP/AUD trade closed on Tuesday for a profit of 2.50% of the account balance.
Let’s look at a step by step description of how I use the information on the dashboard to make my trading decisions each week. I’ll go through an actual example using the dashboard from the week ended 7/1/2017, so you can refer back to the excerpts shown above.
1. I use the currency ranking based on the average rankings from the individual indicators. That’s the one in the rightmost column in the first illustration above. So on Saturday, 7/1/2017, I would have been most bullish on JPY, then USD. I would have been most bearish on EUR, then GBP, then CAD, and so forth.
2. One of my risk management principles is not to be overly exposed to any single currency, so I try not to hold the same currency in more than one position. With only eight major currencies, I’m limited to a maximum of four pairs at any given time. The only exception is when I’m planning to exit an existing position with a trailing stop. While I’m waiting for the stop to hit, I may enter a position in another pair which includes one of the same currencies. In that case I may be temporarily holding the same currency in two positions at the same time.
3. The first thing I do is review my open positions to see if my directional outlook has changed. If so, I mark that position as a pending closure. In this case, I had two short positions; one in EUR/JPY and one in NZD/CAD. Based on my average currency rankings in the top illustration, I still wanted to be short EUR/JPY. However, notice that NZD is now more bullish than CAD in the average rankings. This meant that my bearish outlook on NZD/CAD is no longer valid, and I should be looking to get out of that short position. That’s why it’s marked as a pending close. In practice, I don’t just close the position at market. I move the stop loss closer to the price and trail it aggressively until it gets hit. More on that in the “Trading tactics” section below.
4. Once I figure out which of my positions I’m planning to close, and which I’m planning to keep, I know which currencies are “covered” in my account. In other words, any currencies in positions that I’m planning to keep are off limits to new trades, because I’ve already got a position in them. In this case, I’m keeping my short EUR/JPY position, so EUR and JPY are covered.
5. Now it’s time to choose my new entries. I start by looking for the most bullish and most bearish currencies that aren’t yet covered in the account. EUR and JPY are covered, so I ignore those; I already have my position in those two. So the next most bullish currency is USD, while the next most bearish is GBP. Thus, I want a new short position in GBP/USD. The next most bullish is AUD and the next most bearish is CAD, so I also want to be long AUD/CAD. Notice that I’ve got a position currently in NZD/CAD, but that it’s marked for pending closure. This is one of those exceptions that I described above. If my long AUD/CAD trade fills before I’m out of the NZD/CAD trade, I’ll have two positions involving CAD, but that’s OK. Finally I want to be long NZD/CHF, which is another example of the excpetion. Note that these are the three pending opens shown on the trading activity illustration for 7/1/2017.
So this is how I use the information in the dashboard to choose my pending entries and exits each week. In the next section we’ll look at the actual techniques I use to enter and exit trades, how I determine position sizing, and how I scale into winning trades.
This section is just comprised of links to a series of posts I wrote on trading tactics. At the end of each post in the series, there’s a link to the next one, so you don’t have to keep coming back to this page. Just follow the yellow brick road of “Next” links in each post!
Start with this post on Money Management.
Then read this other post on Money Management, because I still had more to say!
Next, let’s move on to Risk Management.
Finally, see how I handle the issues of Trade Management
Once you’ve finished all this, head over to the CapTraderPro page and join now! This will give you access to all the tools you need to…keep pipping up!