Sunday, November 27, 2011

Forex Trading Strategy

I’m changing my approach to tracking and trading forex in order to allow greater concentration pairs I am likely to trade. I think the alternations will help me make better trading decisions.

Truth is, the "everything but the kitchen sink" approach I've used the past few months has been quite paralyzing, a sort of information overload that makes decisions difficult and trades impossible to enter with any confidence.

So, to the changes...

First, I’m shrinking my coverage to, at most, 25 currency pairs, and fewer if possible. These will be the top-volume pairs, for the most part, although I shall from time to time add other pairs of that are of interest.

And the corollary is that I shall subtract pairs, no matter how liquid, if I feel they are no longer interesting.

Secondly, I’m moving to a longer term strategy. I’ll be drawing price trend channels on weekly charts. Afterward, I'll switch to the daily charts, using both the Wilder Relative Strength Index (RSI) and the position of the price within the channel, to determine entry and exit points.

(Read more about the RSI in Wikipedia and Stockcharts.)

Most minor-league private forex speculators -- that's my league -- play the short-term trades, with charts having granularity of an hour or less and certainly no more than a day.

This has two drawbacks: 1) Short-term moves tend to be less consistent than those in the longer term, and 2) hourly trading encourages the trader to stay glued to the charts day and night, especially when London is trading.

What the two points have in common is that they lead to bad trading decisions, be it due to fatigue or false signals. I'm looking for a more measured approach.

When institutions trade currencies long-term, they most often look at the reports of the governments and central banks of the issuing countries, and on those bases make a fundamental assessment of direction.

I lack the time and resources, and perhaps the knowledge, to follow such a course. So I'll stay with the charts, which have always been the basis of my trading.

In practical application, here's what I plan to do:

1) I'll draw a price channel on the weekly chart, tracking the current price trend. At that level of granularity the trend will generally be something that began three to six months prior, although in my current analysis I have one pair, USD/JPY, that has been trending since 2009.

2) For bearish entry, I'm looking for a situation on the daily chart where the current price has rebounded from the top of the sideways or descending channel and the RSI has moved to 65% or below. The price must be high in the channel.

3) For bullish entry, the current price must have rebounded from the bottom of the sideways or ascending channel and the RSI must have moved to 35% or above. The price must be low in the channel.

Clearly, this is not an auto-trading strategy. I mean, what does "high" and "low" mean? What constitutes a proper "bounce"? And since channels are pretty wide on a weekly chart, why the insistence that the trend channel be aligned with the direction of the trade?

The Holy Grail of trading is a scientific system that makes the profits roll in. That's a quest I no longer believe in.

Trading in truth is an application of the psychological art. It is an art because I am making decisions based on appearance, on the look-and-feel of the chart, and it is psychological because the goal is ensure that I'm confident about opening the trade.

The alternative is automatic trading decisions that cause me to stumble out a few days later because I've been spooked by a whipsaw.

As an art, the strategy I've described can, and should, accommodate the trader's level of caution or courage by ignoring the direction of the channel (as in swing trading), bringing the RSI level nearer the 30% or 70% baseline, and defining "high" and "low" in the channel as being nearer the middle.

As always, it's up to us, as traders, to make the decisions, and to happily see our trades live or die by the choices we make. We define the game by our actions, not by our rules.

I've put together a new version of my daily Forex report, which generally moves shortly after trading opens in New York, that shows how I'll be tracking the pairs I'm following day by day.

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