Currency strength is a brilliant tool if you know how to use it. A quick Internet search will introduce you to two handfuls of ways to trade currency strength with tools, which often leave the user feeling overwhelmed and confused. In this post I present the new Pipnotic Currency Strength Histogram, which is the most simplified version of our currency strength software to date, resulting in a much simplified and intuitive way to use currency strength information.
Just to recap why one might consider using currency strength in the first place, let us reiterate our reasoning (excerpt taken from a previous article):
If you trade currency pairs and base your trading decisions exclusively on what you see in a given currency pair’s price chart, you’re only seeing a fraction of the big picture. If on the other hand, you trade stocks and base your trading decisions on what you see in the stock’s price chart, you’re seeing the big picture. A currency pair chart will show you only what the two currencies are doing, relative to one another, it will not show you what the two currencies are doing in their entirety. So if the EURUSD currency pair is going up, does this mean that the Euro is strong and the Dollar is weak? Not necessarily, it means that the Euro is strong, relative to the Dollar.
Despite the fact that it makes perfect sense to use currency strength for currency trading, why do so few incorporate this tool to their advantage? I think the obvious answer is that it is simply too confusing. One currency is strong and another is weak, I get it. I buy the strong one and sell the weak one, that’s fine. But, it’s simply not that easy.
Because the traditional tools available simply don’t show us when to enter in a game where timing is everything. Yes, this pair should be moving higher according to currency strength data but has the move already occurred? have I missed it? Should I simply click in now and expect that the pair will continue as suggested by currency strength readings? The short answer is that it depends.
It depends on what?
You need to get the timing right, even though, theoretically speaking, the most obvious thing to do would be buy strength and sell weakness. After three years of building algorithmic traders based on currency strength that simply buy strength and sell weakness, a look back a hundreds if not thousands of trades tells me one thing in particular: the algorithmic trader times it wrong almost every time, but deals with this issue by using wider stops. As discretionary traders, exposing ourselves to greater pip risks requires price to move much further in order to reach our targets, which sometimes doesn’t even happen, which in turn exposes us to more risk and a less than optimal trading model. What we need is a way to visualise currency strength data to show us not only what to buy/sell but also when.
What a great question. This is why currency strength combined with supply and demand is the golden answer. Using supply and demand, you can see where you need to buy and sell but you can’t always be certain that these levels will hold, despite the fact that you will almost always see price react at these levels. This is when the use of currency strength comes into play, as it answers the when. The best way to illustrate this is via a couple of screen-shots.
In this screen-shot you can see what happens when you combine supply and demand with the new currency strength histogram, and how very powerful this combination actually is. We have two examples of the histogram being used to indicate whether or not the daily area of demand (red box) is likely to hold by paying attention to the way the strength between the two currency changes when price feeds into, in this case, demand.
Here, we are seeing lower price swings on the four hour chart, which may lead one to believe that price is going to continue moving lower, but, as is clearly illustrated by the histogram, the strength of the AUD in relation to the USD is increasing, which tells us that these lower swings are simply price looking for the required liquidity to move price higher. In the later example of the two, we can see the same thing happening. We may ask ourselves that despite the fact that this is the second time back to this daily demand, can we take the trade? Again, looking at price, we can clearly see that the relative strengths of the Australian and American dollar are diverging at the daily demand, signifying that it is highly probable that the area of demand will be sufficient to hold price for the short term.
Does it always work like this?
It can never always work like this, as unexpected news may enter the market and cause liquidity to dry up and price to do anything. When the market is moving at a time of the day when you know the liquidity is high, price is very likely to respect the examples we just had a look at. it isn’t magic, it’s just simple yet clever. Another very important point to make here is that these trades are not just taken when there is currency strength divergence, but are taken at supply or demand. This is absolutely paramount.
The indicator looks like the MACD. What’s that all about?
Yes, it does – and in fact, it can be used in the same way. You can use it to see if a market is trending, and to spot divergence trades like those we just discussed. I even went the extra mile and removed the two currency lines to make interpreting the indicator even easier because if it isn’t simple and easy to use and understand, then it isn’t going to provide any value, at all!
You see, currency strength, when presented in a way that is both simple and easy to interpret, is useful, especially when you combine it with a study of price such as supply and demand, as we did in out examples.
I hope you found the information provided in this post as interesting to read and it was to write. The combination of supply and demand with currency strength is truly a divine combination, if ever one existed in trading, as they compliment each other in just the right way. Together they are able to tell you what to trade and when, which should get you in the right trades and keep you our of the wrong ones.
As always, thank you .