The NFP is due in some hours, and we found 3 potential trading opportunities before and after the release, in NZD/USD, GBP/USD and USD/JPY. Below you can check the current market background, short-term trend and nearest supports/resistances for each pair. As always, we are using VSA, and associated indicators, for a supply/demand view of the market.
Short-term trend: Down
NZD/USD may be a solid trading opportunity for a late Tokyo Session or early London. We’re approaching a major news announcement and, if NZD/USD retraces after the announcement, it may be a good buying opportunity near the long-term support at 0.68500. If prices touch the resistance and bounce back, traders may open a long position, which will be reinforced in case there are demand signals. Low volume bars during a downtrend near a resistance may also anticipate a trend reversion.
Short-term trend: Neutral
In this case, we see a long-term downtrend and prices near the upper bound. After the news, in the case of GBP/USD appreciates and touches the trendline, it may be a good opportunity to short. This is because there was distribution before, and if NFP doesn’t change things radically, it could give a shot to trade GBP/USD.
Short-term trend: Up
There are no supports, neither resistances nearby. However, we saw an uptrend that was broken with high volumes during the US session. News about US employment are due in a few hours and it will bring some volatility. In case prices approach the trend line from below, it may become a short opportunity. Look for low volume bars approaching the trendline.
The NFP will dictate what happens next, but by being alert to what’s happening now, we can better plan our trades.
Very few traders realize it, but bond spreads have an immense value when trading Forex on a daily/weekly basis. In this guide, we’ll show how you can use this technique to improve your Forex trading.
Firstly, let’s see what ‘spread’ means in this context. Usually, in Forex, the spread is the difference between the bid and ask prices. However, here we are concerned with a different kind of spread: the bonds yields spread. For example, if US 10y bonds yield is 2%, and UK 10y bond yield is 1.5%, the spread would be 0.5 percentual points. Higher spreads suggest that interest rates are higher in a country relative to another. As we will see, these spreads can be valuable in trading.
How do Bonds Spreads affect the Forex market?
Now that we know what the bonds spread is, it’s important to understand how spreads influence the Forex market. This relation depends on one main factor – interest rates. Interest rates are the basis of any bond, and higher interest rates will mean higher bond yields. Interest rates can affect the Forex market because of 2 main reasons:
1. Institutional and Private Investors
Yields are dependent on the interest rate defined by Central Banks. If the Fed or the ECB decide to increase interest rates, bond yields from the respective companies will also increase. This happens because bonds are dependent on the interest rate from the country where they are issued. A rise in interest rates means bonds will pay a higher interest, i.e., have a higher yield. Investors will, therefore, get higher returns.
When interest rates are higher in country A relative to country B, bonds from country A are more attractive. Investors will prefer to put their money in these bonds since they pay higher coupons.
To buy bonds, investors will need to exchange their currency for the currency in which bonds are traded. So, the currency with higher yield bonds will have a higher demand.
2. Central Banks
As already said, the price of bonds depends on the interest rates defined by central banks. According to their monetary policies, central banks buy or sell bonds in order to achieve the desired interest rate. To raise the interest rate, central banks sell bonds, increasing supply and reducing bonds prices. Bond yields and their prices go in opposite directions so, when central banks raise interest rates, prices fall and yields rise. In this sense, when central banks sell bonds, they are withdrawing money out of the economy. This will make the currency appreciate. The reduction of money in circulation makes each unit to worth more.
Both arguments explain the positive correlation between bonds spreads and forex. From one side, higher interest rates will attract more investors. These investors will increase the demand for the currency in which the bond is traded. On the other hand, higher interest rates mean Central Banks are selling bonds, which reduces the supply of money in the economy. The two will contribute to an appreciation of the domestic currency.
Simply put, between two countries, the currency of the country with higher interest rates tends to appreciate.
Looking at some examples…
Traders can expect an appreciation in the domestic currency after a rise in interest rates. We can see this positive correlation between bond spreads and forex in the following charts.
Although the correlation between bonds and spreads is positive in the overall picture, there are periods where both diverge from each other. Those divergence periods are annotated in red.
USD/JPY vs US 10Y / JP 10Y Yield Spreads
In this chart, it’s possible to see a very close correlation between US bonds and Japanese bonds spreads and USD/JPY. However, there are two main periods we want to highlight:
Divergence (in red): During the period from December 2011 to April 2016, there was only one period in which the positive correlation did not stand. The period signaled in red shows a high volatility in bond spreads while the pair traded relatively flat. This is a divergence.
Spreads leading USDJPY (in yellow): we see how the major increase in spreads that happened in August 2013 only affected the forex market one year later. Actually, it’s very common to see this lag correlation, usually with spreads usually leading the pair between 2 and 10 months.
GBP/USD vs UK 10Y / US 10Y Yield Spreads
Spreads leading Pair (in yellow): We can see yet again, in this chart, how a major drop in the forex market follows a major drop in spreads only months later. Both charts show how, very often, spreads movements lead the Forex pair’s movement.
Divergences (in red): In 1 and 3, GBP/USD rose while bonds went down, while in 2 and 4, the contrary happened.
How can traders benefit from this relationship?
Traders may profit from the above-mentioned correlation in two main ways:
1. Through carry trade. It involves borrowing in the country that has a lower interest rate and buying a bond in the country with the highest. As long as the exchange rate remains the same, the bond spread is the profit. However, this strategy can be risky, since the movements in the Forex pair will ultimately compensate for that differential. In practice, this has to be implemented within a hedging strategy.
2. Divergences between spreads and the Forex pair. We know that spreads usually lead the Forex pair by some months, so when they diverge, we know that the pair’s movement is nearly ending. For example, if GBP/USD is rising, but the bonds spreads are falling for some months already, you should be getting ready to short GBP/USD.
All the data collected for the research was extracted from www.investing.com.
The relationship between bonds spreads and forex is a very useful analysis to forecast movements in certain pairs. However, traders should do a more broad analysis of the market before entering a position. In the article Intermarket Relationships in Forex, we explain how other factors such as the price of commodities and stocks also affect the Forex market.
To be successful in trading, you should aim to develop a true trader mentality. That means to have the capacity and attitude that allows doing the right calls in trading.
Control your emotions
For instance, how do you react after losing 5 trades in a row? How do you react when your stop-loss is nearly getting hit? Perhaps the most difficult in trading is to accept losses and go ahead to the next trade. This is a difficult decision in your trading, but you need to understand that if you had a loss it doesn’t mean you failed or you were wrong. If you were following your strategy rules, you were doing the right thing. Always following the rules of your (winning) strategy is the necessary attitude to be developed.
When it comes to trading, your emotions are a big part of the equation, primarily when you’re losing. The way you face your losses is crucial to develop a correct trading mentality and achieve better results in the future. Successful traders are the ones able to better control themselves and always act to what they have planned. They also know that losing is part of the game, and the focus should be on improving the strategy, not avoiding losses. Below you can find some key elements that are part of winning and losing mentalities. You can also find out more about how to succeed in trading here.
Winning mentality vs Losing mentality
Probably, the most important thing in trading is to learn from your own mistakes. At the beginning, it’s usual to lose more than you win. The first losses are crucial to understanding what went wrong and improve your strategy. Since it isn’t possible to control the market, it’s important to understand how it works and how you can profit from movements of prices.
It’s impossible to win every trade. The focus should be to maximize profits and minimize losses so that you can have a positive overall result even if you lose more trades than you win. The successful trader is the one who has a higher profit/loss ratio, not a higher win/loss ratio. You can do this by focusing on letting your profitable trades run, and accept small losses. A newbie trader does exactly the opposite – he takes many quick wins, which surely results in a fantastic win-rate. But when he’s losing, he just hopes and prays that the market turns. Of course, this inevitably results in high losses. This is the wrong attitude, one that will make you lose money.
Finally, it’s fundamental to know that you’re the only one responsible for your wins and losses. You shouldn’t trade just because of some tip or an analyst’s opinion. Reading others opinions can, of course, expand your horizons, but try and check if what you were told really works or not. Create your own strategy and always act according to it. If you don’t have a plan, it’s easier to lose control of your trading.
Let’s take a look at 2 common types of traders, to see what are the most usual differences between a successful and losing trader.
1. Doesn’t expect to win every trade, but expects positive results
2. Accepts the responsibility of trading
3. Learns from own mistakes
1. Thinks the market targets him and hunts his stop losses
2. Blames the broker, platform, and even the market, for losses
3. Doesn’t admit own mistakes, and so, doesn’t learn from them
These are two fundamentally different ways of looking at the markets. Trader A accepts his losses and tries to learn from them, while trader B will blame everyone and everything for his losses. Trader A knows trading is a responsibility, whereas trader B looks at trading as gambling. Over time, these differences will make these traders go different ways: trader A will strive to become a better trader, and will likely get there. Trader B will hardly learn anything, and if he doesn’t have a lucky shot, he will eventually lose all of his money.
Practical mental configuration
- Your path to successful trading might be frustrating, not because it’s hard, but because there is a lot to learn and you will make mistakes, as everyone does.
- If you’re paying for your mistakes, then learn from them!
- Any person can reach better results in trading if they place their effort on it. That includes believing in yourself.
A good way to apply these 3 points is through trading in a demo account. Most brokers offer it for free, and it’s the best way to test strategies, improve your trading and control your emotions during trades. Once you start playing in a real account, your money is at risk, so you better know what you’re doing if you don’t want to lose it.
So, what type of trader do you want to become? Which of traders above would you trust your money? Definitely, the answer will be Trader A, right? Then start working on these 3 points, and achieve a true trader mentality.
In today’s Tokyo’s session I found 2 potential opportunities for the next session, on 2 of the major pairs: GBP/USD, and USD/JPY.
GBP/USD 30 MINUTES
Short-term Trend: Down
- At this point, we can see distribution (many supply signals on sideways movement)
- Based on this weakness behind, wait for a short BREAKOUT alert from Alert System.
The next news important news (Retail Sales m/m) is in roughly 8 hours, so, be sure to look for a breakout afterward. Depending on the news result, there could be a reversal near the 1.27 support – let’s wait and see what VSA shows at that area.
USD/JPY 1 HOUR
Short-term Trend: Down
- Prices broke out the 109.213 resistance with high volume in today’s US session. There is latent supply shown by VSA supply signals
Although there was a breakout, the background is still neutral due to the recent supply signals. Still, if no more supply shows at these prices, I am still bullish, and looking for a long position, on a low volume down bar, above 109.213. The Alert System is also likely to alert if prices get nearer.
Have you wondered how to succeed in trading and become successful in your trading? One of the most interesting areas of study developed in psychology is research on the concept of success. What makes certain people more successful than others? This is one of the central themes for dealing with traders’ psychology. This article will address the issue of how to become successful in your trading and give you a roadmap to achieve success.
Indeed, achieving success in trading seems to have a formula. In an interesting study, and after 500 interviews and a much elaborated theoretical effort, Richard St. John helped to clarify which ingredients are part of this formula. He emphasizes 7.
First of all, one of the most important ingredients is passion. Passion requires a clear awareness of what motivates us, what moves us when we do something. What’s the reason and the strongest motive driving us to become traders?
This source of inspiration must always be present and should be the basis on which our day to day life should run. In difficult times, it’s this passion we must resort to finding our way forward.
It is especially important to be passionate about trading because of the amount of effort you’ll have to put in if you want to succeed. Trading evolves spending a lot of time looking at the markets and testing strategies until you find the right one for you. In this sense, it’s crucial that you like what you’re doing, otherwise, it’ll be really difficult to spend all this time until results start appearing.
2. See it as a Job
Dedication and work seem to be another important ingredient in achieving success. Not just work, but hard and dedicated work. No results are achieved without a hard and dedicated effort.
There are professional traders who do this as a job. However, even for small traders, this activity is able to proportionate good profits if the strategy is the right one.
Trading may be considered a source of income like any other job, and so it’s important to see it as such. Even if it’s done as a part-time, real money is at stake. As such, the intensity of work should be same as put in a job, only proportional to the time spent in this part-time.
A 3rd element, closely associated with the former, is the necessity to practice. Nothing in life comes for free, and so it’s crucial to practice, practice and practice again, in order to achieve results. We are creatures of habit striving to achieve something. Without practice and routines, our brain does not assimilate information.
A lot of brokers and platforms offer the possibility of opening an account without a minimum deposit and only use demo accounts. This may be a good way to start practicing and testing strategies. It is impossible to learn how to trading by just reading about it. As such, the best option to gain insights and understand how markets work is really by being involved.
The 4th ingredient for success is focus. Our brain performs better if we are doing only one thing. Concentration on a specific idea or strategy is essential to achieve a better result in that particular task. When trading, traders should only focus on the markets. Poor attention may result in missing major market moves or entering in the wrong ones.
Nowadays it’s very common to hear about multitasking. In trading, this may not be advisable. It’s an activity that requires a lot of attention to be able to spot possible reversions of the trend, breakouts, etc. To succeed in trading, a lot of factors must be taken into consideration. The only way to be completely aware of what’s happening is through complete focus.
By effort is meant not so much dedication but endeavor. Success requires constant commitment and being able to fight “against everything and against all”. Spending hours and hours unceasingly pulling old boundaries to reach new ones. This sense of commitment and endeavor characterizes many of the personality traits that have been successful in the markets.
As already said, trading requires a lot of hours invested until results start appearing. As a result, a lot of traders give up at half way, because they don’t understand the level of commitment necessary for success. Only be working more and putting more effort into something, you’ll be better than the guy next door.
Having the capacity to persist and the effort to achieve results is another ingredient to success. Persistence is a concept that, above all, requires building barriers against negativity. Barriers against failure, criticism, pressure and rejection.
In trading, it will be at least as common to lose than it is to win. Traders must be able to overcome all their losses and learn from them. Only with this mindset should you be able to reach a level of profitability. We wrote about how to work out this mentality in our Trader’s Mentality article.
It’s important to fall and learn from that. Don’t quit and improve more at each step. It may take more or less persistence, but time will come when things start being the way you thought.
7. Family Support/Team Spirit
To conclude, success is also more easily achieved when we have a network of affections around us. Once again, through this network of affection and understanding, we are able to overcome adversities with greater ease.
Working in a team can also be helpful. Although it’s only needed one person to trade, having a team of traders discussing their views about the market is valuable. Support and teamwork help fighting against our own limitations.
What is successful trading? How to succeed in trading? These questions pop up in traders’ heads when they start trading. The answer is that we must start by understanding what the word success means and how we can achieve it. Studies in the field of psychology came to detect patterns common to all those who have succeeded. The 7 aspects presented above are the main ones if you wish to become a successful trader.
In last April 5th there was some volatility caused by major news like the PMI in Europe, UK, and the US. The US also released the Crude Oil Inventories and the Fed Minutes. Despite this, the Alert System was able to catch some major moves outside of the news’ release. Below you can find some trades made throughout the session, with explanatory comments.
1. USD/CAD 15 Minutes – VSA SHORT Alert
Here we had a weak VSA signal with above the average volume showing supply. 3 bars after the short, the trend rebounded and volume started showing demand. Closed 1/2 when it hit TP1 and position was closed near the break-even level.
- Short on weak VSA signal (sell stop order). Placed the Stop-Loss and Take-Profit at the suggested levels.
- Close 1/2 trade at the blue dot level, +8 pips.
- Close trade when trend rebounded, a little above the opening price. Nearly break-even.
2. GBP/JPY 15 Minutes – Dynamic Trend LONG Alert
This was a case in which the Dynamic Trend Alert was able to indicate a major and fast move in GBP during the session. Because the signal was strong and the volume above the average, it was secure to close the whole trade at the final TP level.
- Long on dynamic trend alert (buy market order). Placed Stop-Loss and Take-Profit at the suggested levels.
- Hit take-profit 45 minutes later, +43 pips.
3. CAD/JPY 15 Minutes – Dynamic Trend buy signal
- Long on dynamic trend alert (buy market order). Placed Stop-Loss and Take-Profit at suggested levels.
- Close 1/2 trade, +10 pips.
- Hit take-profit 4 hours later, right before a major demand volume, +24 pips.
As the trend remained strong, the suggested TP could be canceled. Instead, you could wait for some signals of weakness to close the position and let the profits run.
4. AUD/USD 15 Minutes – INVALID VSA Signal
This VSA signal was invalid and wasn’t taken because:
- There was a resistance below the take-profit levels.
- The signal occurred after a very wide demand bar. When the volatility is too high, wait for a correction + low volume bar to go long instead.
This is a case in which the signal and respective buy stop order appeared too late to catch the main rally. Traders should not enter the market at this point, with a resistance nearby.
There are various relationships between different financial markets. These intermarket relationships are important in Forex trading because, by understanding the different correlations, you’ll be able to take advantage of them to capitalize gains and hedge positions. In this guide, we will focus on the securities related to the various Forex pairs.
Correlation measures the relatedness between securities. I.e., if one rises when the other drops, if they rise at the same time, etc. A perfect correlation is equal to 100% – both securities increase or decrease by the same proportion. The higher the correlation, the stronger the relation between two assets.
Gold and USD
Gold is one of the most traded commodities in the world. Because this precious metal has an intrinsic value, it’s considered to be a “safe haven” in times of uncertainty and bearishness. Gold relates to three major currencies – the USD, the AUD and the CHF.
Firstly, let’s see the relationship between gold and USD. As the commodity’s price is in US dollars, a rise in the dollar makes it more expensive for non-US investors to buy gold. If, say, a European investor wants to buy gold, he/she should first exchange his euros for dollars. If the dollar appreciated against the euro, more euros would be necessary to buy gold. In this sense, this investor will see the price of gold become relatively more expensive as dollar appreciates.
So, the USD index/GOLD relationship is an inverse relation – when one rises, the other decreases. An increase in USD makes gold more expensive, which, according to microeconomics, reduces demand for the commodity. The decrease in gold’s demand drives down the price per ounce – this is called a negative correlation. In the graph below it is possible to see that to a lower dollar value corresponds a higher price of gold and vice-versa.
Furthermore, IMF estimates nearly 50% of the changes in gold prices are due to movements of the US dollar.
GOLD-AUD & GOLD-CHF
The correlation between gold and AUD is positive. This is because Australia is one of the major exporters of gold and so, if the price of gold increases, Australian exports increase, contributing to the expansion the economy. The expansion of the economy contributes to an increase in foreign investment in Australia, which means the demand for Aussie dollars will increase.
Historically, AUD has an 80% correlation with gold.
Gold and CHF also have a positive correlation. One reason for this is that both assets are inflation-hedging safe-havens, which means they both appreciate with a rise in inflation. In times of uncertainty and selloff of currencies like the dollar, investors usually put their money into these assets. Besides having the same status as “safe-havens,” nearly 25% of Switzerland money is backed by gold reserves, the reason why CHF rises when gold appreciates.
Oil and CAD, NOK
Oil correlates positively with CAD and NOK because Canada and Norway are two major oil producers.
Canada, besides being one of the major oil producers, is the biggest exporter to the US, with around 85% of its exports going to its down south neighbor. As oil is priced in US dollars, oil exports have a major impact on the foreign exchange earnings in Canada. When oil prices increase, the amount of US dollars earned by Canada through exports will be higher, and therefore the supply of US dollars will be high relative to the supply of Canadian dollars. This results in an increase in the value of the CAD against USD.
You can take advantage of this relation by buying CAD/USD when oil price is rising or, instead, short the pair when it is falling. On a daily basis, the correlation can be less evident, but over the long-term, the value of CAD has shown to be sensitive to the price of oil. Below it is possible to see this close correlation. Notice that oil (green/red line) moves in the same direction as CAD/USD (blue line) most of the times, but usually the volatility of oil is much larger than of the currency.
The positive correlation between oil and CAD/USD was about 80% over the past 10 years.
Norway is also one of the major oil exporters worldwide, even bigger than Canada. This means that, when oil prices go up, the foreign exchanges inflow in Norway will increase, increasing the supply of foreign currencies relative to NOK. The higher supply of foreign currencies relative to the supply of NOK drives up its price. However, although there are times which NOK/OIL correlation may surpass 90%, in other times it is less than 20%. This makes NOK not such a good proxy for oil prices as CAD. If Forex traders want to take advantage of a change in oil’s price, the best currency to look for should be the Canadian dollar.
Commodities and NZD
One particular currency that benefits from the rise in general commodities prices is the New Zealand Dollar. This happens because New Zealand has many natural resources and a large agricultural sector. In this sense, a lot of New Zealand exports’ revenues come from commodities’ sales. When prices of commodities rise, the exports (and, consequently, revenues) rise and the economy gets a boost, therefore increasing the value of NZD.
The proximity of New Zealand to Australia also makes New Zealand’s economy closely tied to Australia’s. This means that there is also a positive correlation between gold and NZD. When gold prices rise, Australia’s economy expands, and this influences its neighbor’s economy. And so, both AUD and NZD appreciate with the rise in the price of gold. AUD and NZD are closely correlated – an appreciation of NZD often matches in AUD.
In the chart below we can see a comparison between the CRB index (an index that measures the overall direction of commodities) and NZD/USD. Notice how the NZD/USD is positively related to the CRB Index – one increases when the other increases and vice versa.
Other Intermarket Relations in Forex
Some of the exotic currencies are also related to commodities. Below you can find out about some of these relationships.
Oil/Natural Gas and RUB
Russia is one of the largest oil producers and has the largest natural gas reserves in the world, so its economy is very dependent on the price of the two commodities. Valuation in prices of oil or natural gas is very often linked with an appreciation of the Russian ruble. Below it is possible to see the positive correlation between oil and RUB/USD.
Precious Metals and ZAR
South Africa is a big exporter of several precious metals. It’s the 11th largest exporter of gold in the world, the 2nd in palladium and the 1st in platinum. This makes the country’s currency, ZAR, too dependent on the price of these precious metals in the markets. An increase of their prices will give increase South Africa’s exports and give ZAR a boost. Hence, there is a positive correlation between ZAR and these precious metals.
African/South American Currencies and Agricultural Commodities
Plenty of agricultural commodities’ exports come from African or South American countries. The currencies’ of these countries are, therefore, highly exposed to fluctuations in commodities prices like soybeans (large exporters are Argentina and Brazil), wheat (Argentina), cocoa (Côte d’Ivoire and Ghana), corn (Brazil and Argentina) or sugar (Brazil). Despite some currencies showing a positive correlation with a particular commodity, major fluctuations in valuations are usually due to changes in commodities general prices.
How Currencies React to the Bond Market
The price of bonds depends on the current interest rates established by the central banks. To keep interest rates constant, central banks need to buy or sell bonds until reaching the desired interest rate. If a central bank wants to raise an interest rate, it simply sells bonds to increase the supply and lower the price of each bond. As bonds’ prices and interest rates have an inverse relationship, when bonds prices decrease, interest rates increase.
This buying and selling of bonds have a great impact in the Forex market. When a central bond is buying bonds, it’s injecting money into the economy, increasing the supply of the currency. On the other hand, when the central bank is selling bonds, it’s withdrawing money out of the markets. This is why the domestic currency appreciates when interest rates are raised. The reduction of money in circulation makes each unit of the currency to be worth more.
Traders can profit from different levels of interest rates in the various countries through carry trade. Carry trade involves borrowing in the country that has a lower interest rate and buying a bond in a country that has a higher interest rate. As long as the exchange rate between the two countries remains the same, the profit comes from the difference between interest rates (also called bond spreads). The relationship between bond spreads and the Forex market will be discussed in another article.
Stock Market and Domestic Currency
The relationship between the stock market and its domestic currency may be less intuitive to understand since different factors should be weighed.
- On the one hand, we can observe a positive correlation between the stock market of a country and its currency. This is because when the stock market is rising, more foreign investors want to invest in that stock market, therefore increasing the demand for the respective currency. This will contribute to the appreciation of the domestic currency.
The following chart shows the relation between EUR/USD and the Eurostoxx 50 in the last month. It’s visible the positive relationship between both assets – they go in the same direction.
- On the other hand, an expansionary monetary policy may have a positive impact in the stock market. In this case, the central bank will decrease interest rates and buy sovereign bonds, injecting money into the economy to stimulate investment. Injecting money means increasing the supply of money, which will devalue the currency. In this case, the stock market is rising, but the value of the currency is falling – negative correlation.
The following chart presents the same assets but in a different timeframe. It is possible to observe how, on the right side, the EUR/USD (orange) decrease while the Eurostoxx50 (blue) rise – we have a negative correlation.
The Bottom Line
Before trading a pair, the trader should observe what the monetary policies of both countries are and how is the bond market. Don’t go long on a currency when the respective central bank is lowering interest rates or buying bonds. This policy increases the supply of money in the economy, depreciating its value. Inversely, the stock market rises with these expansionary policies because investors will prefer to invest in stocks instead of having lower returns from bonds.
Taking Advantage from Intermarket Relationships in Forex
To profit from these correlations, we look for confirmations and divergences. A confirmation happens when two related assets are moving in the same direction, while a divergence happens when they are moving in opposite directions.
Confirmation Example – Gold and AUD/USD
The next two charts show how gold prices preceded a breakout in the AUD/USD. Gold broke a medium-term support on 11th of November while AUD/USD only broke a support on the 17th of November. If you had spotted the depreciation of gold prices, you could have placed a sell order for AUD/USD near the support and profit from the breakout.
This is a clear case in which gold lead the AUD/USD movement. There was a confirmation when AUD/USD went in the same direction of gold and broke a medium term support.
As we could see from the above example, currencies don’t react to movements in other markets instantaneously. These correlations are usually stronger in the daily and upper timeframes.
Traders can also benefit from correlations by hedging their positions. But what is hedging exactly?
Let’s imagine a trader who is currently long OIL. If this trader doesn’t have any other position, he’s fully exposed to oil’s variations. If he wants to decrease his level of risk, he may short CAD/USD. This way, if the price of oil increases, CAD will most likely appreciate. As CAD and OIL aren’t fully correlated (their correlation is not 100%), oil will probably appreciate more than CAD. This trader will, in this way, profit from the position in OIL and have a loss from his position in CAD/USD, but his profit will be bigger than his loss. That position leaves him relatively less exposed to oil’s fluctuations. A large drop in oil’s price will not hurt him so much since he is backed up by his position in the Forex market, that will give him a profit. The overall loss will be smaller.
Summing up, traders should not use intermarket relationships just to capitalize gains but also to hedge positions. Diversifying and managing risk are strategies that perform better over the long run. The correlations mentioned above can be used to reduce drawdowns and benefit from gains across markets, allowing traders to achieve higher returns with less risk.
Traders can find and analyze all these relations between markets in ProRealTime and Bloomberg. Both platforms offer a broad range of tools that allow to make comparisons between markets and to understand their dynamic.
Yesterday there weren’t any particularly important news events, but in the 5 minutes timeframe it was still possible to catch a few moves with the Alert System. Below you can find the session’s resume, with the comments on why each trade was taken, and why they were closed.
EUR/USD 5 Minutes – Dynamic Trend SHORT Alert
- Short on dynamic trend alert (sell market order). Placed the SL and TP at the suggested levels.
- Closed 1/2 trade at the blue dot level
- It hit take-profit about 1 hour later, for +15 pips
USD/CAD 5 Minutes – INVALID VSA Signal Alert
This VSA signal was invalid and wasn’t taken due to:
- Mixed supply/demand signs at this price level. When this happens, avoid taking long or short trades
- Long-term resistance just above
AUD/USD 5 Minutes – VSA Signal SHORT Alert
This short trade was taken at the suggested execution price, and the stop-loss and take-profit set at the suggested levels. The alert was valid, but soon the market started to show strength.
- Short as sell stop-order at the execution price
- There was a churn bar, which is a demand sign in this context (during downtrend). 1st sign of strength
- Low volume bars on a 2nd attempted movement. CLOSE trade here, on the 2nd sign of strength. The trade closed barely BREAK-EVEN
EUR/JPY 5 Minutes – VSA Signal LONG Alert
- Long as buy stop-order at the execution price
- Close on the TAKE-PROFIT for +10 pips
If you have read the VSA user guide before, you might have noticed that there is actually distribution by the end of the Tokyo’s session, before this alert took place. So shouldn’t we avoid taking long trades? To go long after distribution, you want to see signs that there is no more supply to take prices lower, and that’s exactly what happened in EUR/JPY. The market went lower on low volume, and the VSA signal was actually a supply test which was successful. The alert was still valid because of that reason.
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To do sentiment analysis in Forex, the Speculative Sentiment Index (SSI) is a tool that can be used to understand how different traders are positioning themselves in the market. Continuing with the articles already published on the role that the Commitment of Traders (COT) Report plays in the market, on the analysis of Market Profile and the assessment made of the Money Flow Index, this text will address the interesting topic of sentiment analysis, with a focus in Forex. It will do so mainly by understanding what it is and how traders can read it.
What is the Sentiment?
Sentiment is about spotting traders’ positions, to ultimately understand how they are thinking, and how to take advantage of it. The most used indicator that can be used to understand where retail traders are positioned in the market is SSI. It comes in different forms and formats, but the main idea that traders need to understand when they are using it is that its main purpose is to capture potential opportunities for contrarian trading. And this is so because it allows us to identify where the herd is.
The herd is a pejorative term normally used to describe retail traders. As was explained in our previous analysis of the COT Report, there are mainly three types of players in the market: hedgers, big institutions and small institutions and retail traders. As was also explained, by understanding where retail traders have their positions, new opportunities for contrarian trading open themselves.
Supporting the SSI is, therefore, the way that the markets function from a psychological standpoint. Small and inexperienced retail traders tend to be driven much more intensely by greed and fear. They let their emotions get in the way much more often when compared to professional traders.
The reasoning behind the way these traders operate is very simple, therefore. When the market is clearly on the way up they buy. When the market is clearly on the way down they sell. Greed gets in the way of their reasoning.
The SSI allows us to understand where these traders are – and as more experienced traders to benefit from this knowledge.
How to Use the SSI for Sentiment Analysis?
SSI is the prime indicator to do sentiment analysis (although there are others such as the COT report, for long-term trading), but acquiring the SSI in the form of an indicator, for Forex, does not come cheap. Unfortunately we cannot have access to it via MT4 and so traders can’t always see whether they apply to their trading style unless they actually sign up for one of these platforms that provide this service.
One such broker is FXCM and in this last section we will use their indicator as the starting point to explain how to read the SSI. The indicator can easily be accessed on this website:
It shows the positions of retail traders in different financial instruments. From the difference between the number of traders holding long positions and those holding short positions, it establishes a percentage. When this number is above 0 it means that retail buyers with long positions prevail over the same type of traders with short positions. The same happens in reverse – when below 0 short retail traders are prominent.
So what can be extracted from this particular conclusion: when disparities between these two positions are higher, traders should be on alert for a potential reversal in the market.
How useful is this information? Well, we need to be aware that as with any other indicator the SSI is not the holy grail for trading. Here at ANALYTICAL TRADER, we consider it a relevant indicator but certainly not the most relevant one.
Nonetheless, the SSI is one of the most relevant indicators to understand where retail traders are in the market. And just because of this it certainly deserves our attention.
Continuing with the analysis that sentiment and volume play in the financial markets, in this article we saw how to do sentiment analysis using SSI. This indicator provides a very efficient way to understand where the herd is. When values are above 0 it means that there are more retail buyers in that particular position, and vice versa. In another article we will suggest different ways to trade using the SSI.
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