Momentum Trading Strategy: USD Pairs Part 2

Earlier this month, I published the first part of this series, which explained how trading a “time series”momentum strategy restricted to USD and EUR currency pairs and crosses has historically performed far better that implementing a “best of” momentum strategy across a universe of currencies, at least over recent years.
In this second part, I will get into the details of the results of the back test I conducted, and show the differences in performance between the EUR pairs and the USD pairs, as well as examining how overall performance can differ with the application of certain filters.

USD vs EUR Currency Pairs & Crosses

I wrote in Part 1 that “Over a period of 6 years – from April 2009 to April 2015 – if you looked at the 28 most important currency pairs and went long or short of each every week depending upon its look-back periods of 13 or 26 weeks, the only currencies producing positive results were the EUR and the USD. Both currencies would have produced a return of 110% each based upon the 26 week look-back period (corresponding to 6 months). Using the look-back period of 13 weeks (corresponding to 3 months) produced a positive result of 161% for the USD and 82% for the EUR.”
Let’s take a closer look at these results, by conducting a 13 year back test on USD and EUR currency pairs and crosses (concluding in 2015), and working though the numbers.

4 Week Period

The first look back period was 4 weeks (corresponding to 1 month). The results are shown below:
The USD pairs achieved profitability, but would have been in a draw down for more than three years to date. The EUR pairs and crosses were quite consistently unprofitable. Overall, the combined result was very slightly positive over the period, by 19.46%. This period is really too short to use, although it seems capable of providing some profit over the long term.

13 Week Period


The results for 13 weeks (corresponding to 3 months) look much better, although it has to be noted that both sets were under a draw down for more than one third of the period. The USD pairs performed better, at 328.44%. The combined return for both was 485.58%. This looks like a good time period to use as a look-back.

26 Week Period


The results for 26 weeks (corresponding to 6 months) also look good, and possibly even better than the 13 week results. The USD result in particular looks excellent, with a fairly consistently rising equity curve, and a shallower draw-down during the earlier part of the back test compared to the 13 week results. The USD pairs performed better, at 317.43%. The combined return for both was 388.19%. This also looks like a good time period to use as a look-back.

52 Week Period


The results for 52 weeks (corresponding to 1 year) do not appear to look very good, although the results are considerably better than the 4 week results. The EUR result in particular looks interesting, with return of 196.83%. The USD pairs performed much worse, at only 49.89%. The combined return for both was 246.72%.

Analysis of Results

Time Period USD Performance EUR Performance TOTAL Performance Maximum Drawdown Longest Drawdown
One further consideration has to be accounted for: the transaction cost. There would be approximately 3,000 trades taken, which might account for a deducted of about 30% from the overall profit, and would increase somewhat the size of the maximum drawdowns and lengthen the longest drawdown.
Taking this into account, we can draw a few conclusions:
1. The results for the USD pairs look better than the results for the EUR pairs and crosses.
2. The form of the USD results look more logical, with each time period showing a profit, which seems to form a bell curve, peaking around 13 to 26 weeks.
3. It appears likely that this strategy can suffer an approximately 4 year drawdown, even with an excellent long-term performance.
4. The obvious ways the back test might be improved would be by sticking to USD pairs only, and perhaps taking only the trades that qualify under both the 13 and 26 week time period look backs, as a type of “multiple time frame trading” filter. The results for this variation are shown below.
The USD performance was 310.90%, comparable to the USD results for both the 13 and 26 weeks as standalone periods.
However the maximum drawdown was considerably lower at only -54.51%.
The longest drawdown was 237 weeks, which is quite comparable to the earlier results.
The methodology also lowered the total number of trades, thus producing a greater return per trade and lessening transaction costs.
Adding the EUR pairs and crosses does not improve the drawdown results.
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Ten Psychological Trading Tips to Win

It is said that the psychological challenge makes up 90% of the struggle in achieving consistent success as a Forex trader. Can this really be true?

Yes and no. Many great traders that have written about their experiences have talked about how their own inner psychological struggles have caused them losses, even when they “knew” that whatever it was they were doing was wrong. There can be no doubt that psychological factors are of huge importance in the game of trading Forex or speculating in anything.

Mastering your trading psychology won’t make you money in itself, but if you are not aware of the tricks your own mind is trying to play on itself, you will probably find yourself losing even if you are a good trader and are basically right in your trading decisions. There are a hundred ways that a trader can quietly sabotage him or herself. There is a “physical” aspect to trading.

Hopefully it will help you in your trading journey to be aware of several tricks traders often get themselves caught up in psychologically. Sometimes you just have to experience something yourself in order to learn from it: nothing teaches like direct experience. Hopefully some of these points will either give you a new understanding of trading mistakes you have already made, or will warn you in advance of mistakes you have not yet made. Try not to blame yourself when you make a trading mistake: get your “revenge” instead by learning your lesson and not making that mistake again.

Common Mental Trading Mistakes

Not Believing in your Methodology
It is surprising how many people trade without being convinced they can make money, or at least sure that they have a good chance of it. Even if you think you do believe in what you are doing, are you sure you don’t have big doubts hiding just beneath the surface? The answer to this problem is to test your methodology. For example, if you follow trends, take the time to back test on a lot of historical data. Does it show good results most of the time? Is it based on a solid concept, like mean reversion, or momentum? If the answer to these questions is yes, you should believe in what you are doing and don’t forget that you believe in it either.

Not Making a Plan and Sticking to It
This one sounds very obvious. It is not just about making a plan, it is about having several plans and leaving some flexibility there too. For example, if you are day trading, you should have a method you use to decide each day which currency pair or pairs you are going to trade. However if the pair you select goes nowhere, while another pair takes off, you might want to be able to reconsider your decision instead of just “sticking to the plan”, say by allowing yourself the option to change your mind every 1 hour. This is a “plan”, but a plan can include some structured flexibility too.

Not Appreciating the Difference between Planning Something and Living It
It is quite easy to make a plan that works on paper, but it can be something different entirely to live that plan in real time. A good example is making a plan to take hundreds of trades over a year or so, and expect your account to be in a drawdown of -20% as you go through a run of 20 consecutive losing trades. You might work through this back test in a day or so and decide such losses are acceptable. You are likely to feel very different when you spend weeks or even months losing real money again and again while watching your account balance shrink. There is no good answer to this dilemma, you just have to be aware that running through months of time in an hour or so is not necessarily good practice psychologically for bad trading times.

Being Afraid to Take a Trade or Too Eager to Take a Trade
These are the opposite sides of the same problem. The best way to overcome this is to tell yourself every day that you are prepared to take either several trades or no trades at all, and that what you do will depend entirely upon the condition of the market instead of the condition of your wallet or your mood. There will be days with no action and days with plenty of action. You have to adapt to the circumstances.

Making “Deals” with the Market
Telling yourself that if the price goes up another 10 pips you will get out of the trade, or if doesn’t go up in the next hour you will exit the trade. This is just your mind running with its anxiety and talking nonsense. Ignore it, hold firm, and only exit trades according to your plan.

Itching to Take a Profit
You see a profit on the table and think how nice it would be to just take it and stop trading for the day and bask in the glow of a profitable trading day. This is laziness and self-indulgence and has to be fought. The only reason for taking a profit should be because you have a real reason to believe it is probably not going to go much further in the desired direction. Let that market demonstrate that to you: don’t anticipate.

Bailing Out on a Loss Too Early
This is really the same as itching to take a profit. It might be that you need to reconsider your risk management strategy.

Letting Losers Run
There is a simple way to avoid this: always use a hard stop loss and do not ever widen it.

Not Taking Responsibility for Your Trading
It is so easy to make excuses. If I hadn’t missed the bus / been distracted / been in a bad mood then I would have handled that trade better and made money instead of losing. It is your job to make sure that you don’t miss the bus or get distracted or fall into a bad mood. Once you take responsibility for all your trading, your mood can lift as you see there is a way for you to make things better. It is a marathon journey, not a sprint.

Endless Chase for the “Holy Grail”
You do some testing and devise a strategy that makes 20% per year on average. But wait! You try something else and find it makes even more, say 25%. Is there something better out there? Maybe, but this searching and testing process can take a long time. Consider this: if you spend 6 months testing instead of trading in a committed way to find a way to make 25% instead of 20%, you just lost 10% and it will take you another year to make it up! By all means continue searching, but don’t let it affect your trading. As long as you have a fairly solid methodology, it doesn’t have to be perfect!
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How to Build a Winning Trading Plan

You have probably heard it before: every trader should have a winning trading plan, and they should follow it. I am saying it here, again, but I am going to explain how to go about actually making the plan, and how exactly to follow it. Many traders make the mistake of just trying to get something down on paper as a guide. This is an admirable intention, but the true reason why a winning trading plan (which is always a written trading plan) is useful is because it is the very act of making a personalized plan that burns into a traders mind the “why” and not just the “how”. Knowing “why” you are doing what you are doing, instead of just knowing how, is the key to avoiding common trading mistakes.

Some people think that it is only day traders that need written trading plans. In fact every style of trader needs it.

It is really important to emphasize that many traders get to a point where their analysis is pretty good: good enough to know what they should be trading and in what direction. The problem is that although you would expect this to be enough, it is not enough to make money – at least not for most people, because they fall down on execution. It is in overcoming that final hurdle of executing trade entries and exits that a written trading plan is really most helpful.

Initial Questions to Answer
1. What is your “edge” that you are going to try to use to make money? Do you believe that the direction of the Forex market can be predicted? If so, how? Will you use trend following, mean reversion, or some combination of the two? Will you use fundamental and sentiment analysis or just pure numbers?

2. How much money can you both want and afford to risk trading Forex in your trading plan?

3. Which is the best Forex broker for your account size, country of residence/citizenship and trading style?

4. What is your risk management strategy going to be? What will your stop loss be based upon?

5. Make some kind of back test covering many years and calculate best case, worst case, and average case scenarios for your trading account. Can you handle the worst case?

Size Your Risk Per Trade Based Upon a Worse than Worst Case From these Results

6. Which currency pairs are you going to trade? How many trades will you have open at any one time maximum?

7. How much discretion are you going to allow yourself in picking currency pairs, opening trades and exiting trades? This is very important. How much will be based upon hard and fast rules?

8. Will you manage open trades? If so, how?

9. How much of your time will you devote to trading? Will you be a day trader, swing trader, position trader or some combination of these?

Once you have thought about and answered these questions – and you should give them considerable thought and work – you should be in a position to begin writing your winning trading plan, which must be completely comprehensive and have a good, well-reasoned answer to every possible question.

Writing Your Trading Plan

Your trading plan must cover everything and be in writing. A winning trading plan must contain the following:

1. How you will decide which pairs to trade.

2. The maximum positions at risk you can have at open at any time.

3. Any daily, weekly, or monthly loss limits you have decided to apply (e.g. once 0.50% of account equity is lost in a trading day, stop trading for the rest of that day).

4. Trade entry strategy, including position size and stop loss.

5. Whether you will manage open trades actively or not.

6. Trade exit strategy.

7. Where you are going to use your own discretion, which prices are going to make you do what – i.e. if price trades above 1.1000 for an hour, you will consider exiting from half of the position size, but if it does not, you will keep the trade open as normal.

8. How often you will review your trading and review your trading plan (this is very important). No plan should be static.

Reviewing Your Trading Plan
At the end of every trading session if you are a day trader, or otherwise at the end of every week, you should take notes, focusing on how well you were able to stick to the plan, and whether the “winning trading plan” covered everything that happened. Were there moments where you were not sure what to do, as in really confused and not just indecisive? If so, then your trading plan needs to be changed to allow for these eventualities. Also, you may find that parts of your plan sounded OK in theory, but where just too difficult or emotionally painful to implement in real time with real money. Think hard about whether there is an easier way to do things. Losses are inevitable in Forex trading, but they can be managed to some extent.

Secondly, you should keep an eye on your profits or losses. Are they much worse or better than your back testing suggested? If so, why do you think that is? Work on fixing the problem. A winning trading plan is one that wins over the long term, after all.

It is vital that traders constantly work on reviewing and improving their trading. It is a crucial habit of all consistently successful Forex traders.
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Forex Seasonality & the "Year-End Effect"

Forex seasonality is the term used for the tendencies that certain currencies might have exhibited to move in particular directions at certain times of the calendar year. Are there any seasonal patterns that have influenced Forex markets? For example, if the U.S. dollar shows a tendency statistically to increase in value during the month of March across a sample of many years, then we could say it has a seasonal tendency. Many studies have been done investigating Forex seasonality, although you might wonder whether it is worth it. In this article I am going to look into whether there has been any seasonal behavior of currencies exhibited from a study of the last 36 years of historical data, and explain what any such tendencies might plausibly be caused by. I will conclude by explaining the weaknesses of such studies and question whether these results are valuable and if so, how they might best be utilized by Forex traders as a seasonal forecast in order to make a profit.

Seasonal Forex Tendencies

If we look at a fairly large sample of data, we may be able to identify some seasonal currency behavior. The largest data range available to me was looking at the US Dollar Index and the more major other global currencies against the U.S. Dollar over a period greater than 35 years. Several seasonal tendencies could be identified quite clearly.
The U.S. Dollar Index tends to perform strongly in January, and falls in a pronounced manner during the final quarter of the year, in fact from September.
The Euro, British Pound and Swiss Franc behave in a nearly identical manner, and in the mirror image of the U.S. Dollar Index: they perform poorly in January, then rise from September through until the end of the calendar year.
The Japanese Yen rises from August to October. It tends to perform most poorly in January and best in September.
The Canadian Dollar is more erratic, performing most poorly during the months of July and November, and most strongly during June.

Interpreting Forex Seasonal Tendencies

What stands out the most from this review is a “year-end” effect that could be used in a seasonal forecast: the USD falls as the year end approaches, then takes off in January as a new calendar year starts, with the other currencies mostly mirroring this move. Is there a plausible explanation as to why this seasonality should happen? There is, as the end of the calendar year provides an “anchoring bias”, as well as being a key deadline for taxation and reporting. Funds and money managers usually report performance by calendar year, meaning that losers will be trying very hard to win and winners will be trying very hard not to lose more and more as the year end approaches. This could provide fuel for strong trends, and there is an old traders’ saying the December is usually either an awful or wonderful month to make profit in the markets.
Taxation issues should not be ignored, as taxation on profits and losses are levied in the U.S.A. and in many other countries on a calendar year basis. As many tax systems allow losses to be written off against profits from a previous year, there can even be a good reason for holders of losing positions to liquidate those positions before the end of December, and then buy them back once January begins, in spite of the transaction cost.
The next area to examine should be whether there is are any seasonal factors that drive the economies of any of the currencies’ countries. Of the currencies reviewed, the only “commodity currency” is the Canadian dollar, which is quite positively correlated with the price of crude oil. However industrial use of crude oil dwarfs any personal consumption, so we could not expect winter to have any seasonality effect, and in fact it does not anyway. I do not see any evidence based upon this study of particular seasonal behavior of currencies.

Methodological Weaknesses

Before getting too excited at the potential advantages of the seasonal effects we have identified in this study, we should question whether or not what we have here is convincing enough to use within a seasonal forecast with confidence. There are a two areas in particular that should concern us:
1. The currencies measured, with the exception of the U.S. Dollar Index, have been measured only against the USD, and not as fully weighted baskets against a range of currencies.
2. Although we have looked at more than 35 years of data, it is questionable whether that is enough to give a truly representative and meaningful sample. Most financial statisticians would argue that at least 200 samples are required, and we only have about 35.

Utilizing Seasonality

Seasonality should not be the basis of any trading strategy and I would never make a “seasonal” forecast. However, there is evidence that the end of the calendar year has a tendency to produce directional movement, while the summer months tend towards an absence of such movement. Trend traders can utilize seasonality by putting greater weight on trend trades that occur towards the end of the calendar year, and conversely, putting less size into such trades during the summer months. This can be done without holding to dubious forecasts of exchange rate seasonality.
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Momentum Trading Strategy: USD Pairs Part 3

A few weeks ago, I wrote an article explaining how the best Forex momentum trading strategy of recent years has been trading USD currency pairs in the direction of the 3 and 6 month trends when they both agree. I did not get into the specifics of how this could be traded, but just used a back test to show how simple opening a position at the beginning of each week, hypothetically, could have made great returns over a recent 14 year period.
Of course, most traders would find this an impractical method to trade: although it is very easy, the absence of a stop loss or any other kind of optimization can make it a psychologically uncomfortable trading experience. In this article, I am going to explain what I believe is the best way to execute this kind of trend trading.

Multiple Time Frames & Moving Averages

We have already established that the best way to successfully trend trade Forex is to trade non-exotic USD currency pairs long when the price is above where it was both 6 months and 3 months ago, and short when the situation is reversed. So this is rule number 1: every day, mark where the price was 3 months and 6 months ago, and only enter a new trade when the price is above or below both of these levels.
The second rule is to enter a trade only when a fast exponential moving average crosses a slower simple moving average in the direction of the trend. I like to use the 3 period exponential moving average as a fast moving average, and a 10 period simple moving average as the slower moving average, as I find it works well.
The third rule is to use the 1 hour time frame for entries, but to make sure that the 10 period simple moving average is working as a filter on the other higher time frames. You can achieve this by just using an H1 chart and putting simple moving averages of 40 periods (representing the 4 hour time frame), 240 periods (representing the 1 day time frame), and 1200 periods (representing the 1 week time frame). If the price at the moment of a cross of the 3 period exponential moving average above the 10 period simple moving average on the 1 hour time frame is not above all of these other moving averages, for example, there would be no trade.

Additional Entry Rules

I am just going to quickly mention here two additional entry rules on the side, so to speak, because I want to continue with our train of thought.
First of all you should probably use a stop loss, even though this strategy calls for time-based trade exits, and even though I will go into the details of a back test which shows this is a very profitable method overall even without a stop loss. This is simply to try to protect you from any very large losses. Another thing you really must do is make sure that you do not trade any currency pairs where one or both of the currencies is pegged by its central bank to another currency. Please remember that the Swiss Franc rose in value by more than 10% and your stop loss was worthless with every broker. So consider that your loss on a single long trade there would have been your entire account at leverage of 10 to 1 and more than that at any higher amount of leverage!
A stop loss equal to the 20 day average true range of the currency pair you are trading should work perfectly well.
Another thing you can do if you have the time is make sure all the lower time frames are in agreement before entering upon a cross on the 1 hour time frame. This should keep you out of a few bad trades, but if you do not have the time, do not worry about it too much.
Of course, most traders would find this an impractical method to trade: although it is very easy, the absence of a stop loss or any other kind of optimization can make it a psychologically uncomfortable trading experience. In this article, I am going to explain what I believe is the best way to execute this kind of trend trading.
Finally, position sizing is up to your own tolerance for draw-downs, but professional trend traders often recommend risking about 0.20% of equity per trade.

Special Trade Exit Rules

Traditionally, trend traders aim for fixed profit targets, or exit a trade when it starts to turn against the desired direction. There are drawbacks with both of these methods. I believe that far better results can be achieved in trend trading Forex by using time-based exits of 5 hours and 48 hours.
After entering a trade, forget about it for 5 hours, then check on its progress. The amount of 5 hours was chosen based upon the old trading maxim that a candlestick’s effect in the market only lasts for the next 5 hours. If the trade is not in profit, then close it right away at its loss. If the trade is in profit, then leave it for another 43 hours to complete the 48 hour cycle. When the 48 hours is complete, just close the trade whether it is at profit or loss.
It is surprising that such a simple and seemingly crude method for exiting trades can work so well, but unless you are a really good and very experienced trader, picking exits manually is very likely to get you much worse results. This method can take all the stress out of trade management. It is actually more profitable overall to just leave all the trades for 48 hours regardless of how they are doing after 5 hours, but adding this 5 hour rule tends to help most people psychologically, and prevent a strong of large losses.
You might not want to open more than one trade per day per currency pair, as sometimes there can be a cross backwards and forwards more than once per day, although these multiple trades are included in the back test results.

Back Test Results

This strategy was applied to three major USD currency pairs over a very recent 13 year period, without the 5 hour filter, and without stop losses. The results are shown below.
Trading strategies 2
trading strategies 1
During this entire period, the maximum number of consecutive losing trades was 19 trades, and the largest draw down was about 40 units, compared to a total profit of 1,000 units.
It is an easy strategy to master so why not get practicing by opening a demo account? Feel free to comment here with any questions and feedback.
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