Have you ever been caught on the wrong side of a trade, when what appeared to be the beginning of break-out turned into a break-out failure? If you trade session opens like the London open then you more than likely have. In this post I’ll have a closer look at this topic and look at one of the primary reasons break-out trades turn into break-out failures.
Trading the session opens such as the London open can be a very good way to ride on the back of the giants. This is often the time of day when the flow of orders is building with great momentum, as this is often when the big institutions begin filling the orders in their books. One’s ability to successfully identify a nice divergence in the strength of two currencies at the time these orders are being filled, can be a great way to ride these sudden bursts of momentum. This is when currency strength analysis plays a very crucial role, as it enables one to identify the currencies being bought and those being sold the most aggressively. So to sum it up, you simply buy strength and sell weakness at the right time. Sounds easy doesn’t it?
So you’re saying that you simply pair a strong currency with a weak, and buy strength and sell weakness?
If only it were that simple. In a thin market, even relatively small orders can cause shifts in momentum sufficient enough to cause a sudden changes in price, but it doesn’t necessarily mean that such price changes will continue for long.
So how do you know when to trade a divergence in currency strength?
This is when you need to pay attention to the time of day, which is a game changer when applied correctly. It isn’t a coincidence that so many trading strategies are based on certain times of the day.
Let’s have a closer look.
Time of day
What is the first thing most people do when they get to work? Some go for a wee, and on their way back to their desks, they swing by the coffee machine for their first cup of a warm beverage. I can only speak from experience but this is how the early stages of my mornings normally unfold. So let’s assume that you get to work at 08:00, do you expect to be moving at full capacity at 08:01? Probably not. If this is valid for you and I, then why would it not be for institutional traders? Let’s have a look at a hypothetical example of an institutional traders morning routine:
- 07:40: Find parking spot for car/bike and start walking towards the main entrance
- 07:46: Walk through the reception and up the stairs
- 07:51: Dump gear at desk, hand up coat and have a chat with a colleague about a cool YouTube video you recently watched
- 08:00: Need a wee, head for the toilet
- 08:04: walk back to desk via the coffee machine
- 08:08: Back at desk. Skim through order book whilst sipping drink
- 08:10: Sit down and begin looking for liquidity to fill orders
Institutional traders get to their desks and have orders on the books, which need filling. Depending on the client, they will need to find the liquidity to fill the order, which may be spot interbank or they may even clear it in-house. In other words, this is the time of day a thinner market begins to accumulate liquidity, which often results in shifts in momentum.
What does the morning routine tell us about the price of currencies?
As mentioned previously, in a thin market, what appears to be a big move may only be a big move relative to the volume of liquidity available. Consider a bathtub for a moment. When does the water in the tub move the most, when water is added when empty or when water is added once full? Continuing with the bathtub analogy, when water is added to an empty/almost empty tub (a thin market) the sudden shift in the amount of water (liquidity) causes bigger waves and more turbulence to occur than compared to when the tub is full, as a full tub will simply absorb the added water (orders). When big orders are filled at the London open, they must find liquidity, which will drive price in the direction of the thinnest liquidity (empty tub) faster than when compared to the more liquid side of the market (full tub), as there will be enough liquidity (water) available to absorb the orders. The beauty of performing a currency strength analysis at the open of a session open such as the London open is that you know that the orders being filled are likely institutional orders, which are often big enough to give price a big push, big enough to make a profit. Additionally, when organisations open their doors and begin doing business, this is when money begins to flow into and out of different countries/currencies.
Remember that in the retail FX market there are no accurate volume readings available so you will never know how much of a currency is being bought or sold. The only way of knowing when volume will be high or increasing is by paying attention to the time of day. In other words, when the London session is fully active then you have a pretty good idea that the FX market is moving at full throttle.
Generally speaking, there are the following three trading sessions:
- Asia (e.g. Sydney, Tokyo: 21:00 – 08:00)
- European (e.g. Frankfurt, London: 07:00 – 16:00)
- North American (e.g. New York: 12:00 – 21:00)
Having the active session visible on your charts will help you remember when the different sessions open and close, and also enable you to follow along when each session begins to pick up in trading volume. In the example below, the grey box is drawn at the London open and extends into the future until the North American session opens. The time of the vertical line is 10:15, as my broker’s server time is currently two hours later than local time in London.
An example of this might resemble the following:
The image above illustrates how momentum picks up at the London open. The grey box shows when the currently active session opens and closes and also the high and the low of the first 15 minutes of trading. The vertical line is fifteen minutes into the session. As I mentioned in the previous section, Time of day, when a session opens, traders need to get to their desks before they can begin filling orders. I did some research on this topic and have found that when there is a clear divergence in the strength of two currencies as is the case above, price will often begin moving 15 to 30 minutes into the session, which is why the vertical line is so important to have on the chart. During my research, I found that the most common time for price to leave the session box was on the 22nd minute into the session.
Lets have a look at another example, which also occurred at the London open. This trade is beautiful, as the anatomy of price before the move lower supported this trade very nicely. Price had just finished testing a lovely area of resistance prior to the release of price at the open of the session, and the strong divergence in the strength of the Euro (EUR) and the Kiwi (NZD) made for an almost perfect trade. If you have a closer look at the currency strength readings, you can see how the EUR and the NZD were both located around the zero line prior to the move lower, which is a clear sign of an impending break-out. If only all trades were like this one.
Some trades are not as clear as the two examples above and when this is the case, experience is what counts. Trades likes these, as well as the other less attractive trades are similar at the moment price chooses a side, which is why close attention to the structure of price on a higher time-frame is so important. If price has already moved e.g. 60 pips and looks to continue, taking the trade before 15 minutes into the session will often get you into trouble, as price may very well rebalance before it decides to choose a direction. When you see this it’s best to look for another more attractive trade. Before taking any trades, ensure that you’ve had a good look at the hourly chart so you’re not met with any surprises.
Paying close attention to the time of day is very important for reasons we have touched upon in this article. I have spent much time trying to figure out when institutional order flows begin to pick up and can conclude that this generally happens after 15 minutes into the session. When I began incorporating this rule into my trading, my results improved radically and if you’re also trading session opens, doing your own research on this topic may be to your advantage.
If you have any questions or comments regarding this article or topic, please to write to me via the contact form.