Salve a tutti,
in my previous post I started talking about how to trade Forex pairs using the spread (or pair) trading system.
In this post we’ll go more in depth and I’ll talk about how to “normalize” lot sizes once we have a entry signal.
We said that we use two directly (or inversely) correlated pairs. And once we know that one is becoming stronger than the other we go long the first (the stronger) and short the other (the weaker).
You should be already familiar about the concept of strength and weakness and so you should already guess how we’ll calculate which one is stronger/weaker.
What we need now is to “balance” the lot size we use.
Why that? Let’s say that we decide to use EURUSD and EURGBP. Those two pairs are generally directly correlated. Let’s say that we have a signal saying that EURGBP is becoming stronger than EURUSD, so we have to go long EURGBP and short EURUSD.
Let’s say that we decide to use a lot size of 0.1 lots (1 minilot).
To make a balanced trade we have to take into account also what’s called the “Average Daily Range”.
The ADR (Average Daily Range), not to be confused with the ATR indicator, tells you how wide in pips is the average spread between the daily high and low for a particular currency. In simple words it tells how “volatile” is a specific pair.
Actually the ADR for EURUSD is about 160 pips, while the ADR for EURGBP is about 70 pips. It means that the EURUSD moves 2.3 times (160 / 70 = 2.3) more than the EURGBP, on a daily basis.
It should be clear now that going long 0.1 lots on EURGBP is not the same as going long 0.1 lots on EURUSD. To make a really balanced trade we shoul multiply the EURGBP lot size by 2.3.
So we should go long 0.23 lots on EURGBP and short 0.1 lots on EURUSD.
This is what I mean when saying “normalize” the lot size. And it’s a crucial step for spread trading.
Here’s a screenshot of the actual EURUSD/EURGBP spread trade:
We entered 9 days ago and we are in total profit of 280 pips keeping the risk very very low.
That’s Forex Spread Trading
We’ll release the indicator in a short time (as you can see in the picture its original name was Statarb, but we’re going to release it under a different name). And after a few more weeks the EA trading the above strategy will be ready. As usual the Expert Advisor will require “its” underlying indicator in order to work.