Salve a tutti,
There are a couple of concepts that are the base of my automatic and manual Forex trading: currencies strength/weakness and currencies correlations.
Last year I coded the “Forex Cruscotto” indicator (Crescendo’s users can download it for free from the download area).
Cruscotto shows you the strength/weakness of the 8 major currencies on 5 timeframes. It is meant to make it easier to pick the best trading opportunities by choosing the cross between the strongest currency and the weakest one.
Based on the timeframe you are analyzing you can expect to have bigger or smaller profit targets.
How to calculate the “currency score”?
First of all let’s define what is the score. We want to evaluate how strong EUR(o), for example, is against all the other 7 major currencies (AUD, CAD, CHF, GBP, JPY, NZD and USD). If we see that EUR is gaining against all the other currencies and USD is losing against all the others, we have a very good opportunity for buying EURUSD.
The calculation can be made in many ways. Continuing the example of the EUR, the first thing that we have to do is to analyze the crosses between EUR and other currencies. At least the 7 crosses involving the other major currencies: EURAUD, EURCAD, EURCHF, EURGBP, EURJPY, EURNZD and EURUSD.
You can read also read Paolo’s previous post for more details: http://pimpmyea.com/may-the-strength-be-with-you/
What do we calculate?
Some calculate the number of pips gained/lost in a specific period of time and sum up all the values together. But we all know that currency pairs have different average daily ranges (“ADR” – the average difference in pips between the high and the low of each day). We know for example that EURJPY has a ADR that is about twice as big as the one of EURGBP. So a pip difference shouldn’t “weigh” the same for all the 7 pairs.
We need to find a way to “normalize” the evaluation among all pairs. And what’s better than an “oscillator” that is made to have a fixed range of values? Think about the RSI for example. It can go from 0 to 100 (the same applies to most of oscillators). That way we have a way to evaluate each currency pair using a normalized value that doesn’t depend on the ADR.
By calculating the average oscillator value among all the 7 crosses we can have our final “score”. By doing that calc for all the 8 major currencies we can have the big picture of currencies strengths and weaknesses.
To do so, we need to analyze at least 28 pairs (8 currencies x 7 possible crosses / 2 as we have just one possible cross between each couple of currencies). In real time.
I won’t tell you exactly the “oscillator” formula I use and the period value of it for each timeframe but that’s the basic concept behind my Cruscotto indicator. I’m about to release a new version of it that is much more powerful and useful for trading.
Independently from the indicator used, we need to learn to “read” it. The easiest way to do so is to trade the “crosses” between currencies’ scores.
Here’s a picture of the new version of my currency score indicator.
As you can see, each line shows the score of a currency. You have a line for each of the 8 major ones: AUD, CAD, CHF, EUR, GBP, JPY, NZD and USD. You can view all of them or enable only a subset of them. You may enable only the two currencies relative to you current chart (as an example EUR and USD if you apply Cruscotto to a EURUSD chart).
A cross of two currency lines tell you that the strength/weakness balance between the two currencies has changed and that gives you a first signal for entering a trade.
In my opinion, the analysis of the “balance” between the currencies is the first analysis that you should perform before entering a trade, both using a manual or automatic trading system.
Also, as you may have noticed, when in “big picture” mode the indicator also gives you information about the single currencies’ correlations.
In the next post I’ll explain you how the correlation value is calculated, what does it tell you and how crucial it is to be really profitable with that trading strategy.