Forex traders searching for a profitable trading method usually look at candlestick analysis, fundamental economics, trends, and overbought or oversold indicators as guidelines for when to enter and exit trades. There is another factor that is often overlooked, but which can be a surprisingly powerful element within a trading strategy: the time of day in Forex trading.
Volume and Time of Day in Forex Trading
It is well known that the majority of Forex trading by volume occurs during the London and New York sessions with the peak period occurring during the overlap between the two. For this reason, many traders – especially day traders – prefer to trade between 8am London time and 5pm New York time. Traders that live in time zones which render these hours inconvenient face a dilemma which they often try to resolve by trading only longer-term time frames such as the daily chart or perhaps a 4 hour chart, or maybe by focusing on Asian currencies which are assumed to be more active during Asian business hours than non-Asian currency pairs.
This two-pronged approach can use time of day in Forex trading determine which currency pairs should be traded and at which times of the day. Some analysts like to measure average volatilities of various pairs during the different time zones, and conclude that the best thing to do is trade a currency pair during the times when it is statistically most volatile. This may be oversimplifying things, however, because volatility does not necessarily equate with direction. In other words, just because the average range of a session is 80 pips for EUR/USD, for example, does not mean that it is 80 pips in one direction.
Session Opens and Closes
Extra power can be derived by seeking to enter trades very close to the beginning or end of a major financial center’s business hours. This is because it is at these times that major reversals in price occur disproportionately often, so these are the times where getting in early just as a reversal takes place can really pay off.
I constructed a case study with a large sample size in an attempt to prove my points about the time of day in Forex trading by means of a comprehensive back test.
I took the USD against the 7 other major global currencies, creating a total of 7 Forex currency pairs. The time range of the back test was from 2002 until the end of 2015.
Trade entries were made in line with both the 3 and 6 month trends. Entries were triggered from a 4 hour chart where a candlestick made a lower low than the previous four candlesticks and then broke to the upside within the next candle (for long entries), with the stop loss being placed just the other side of the candle. For short entries, the method was simply reversed.
The 4 hour time period was chosen fixed to London time, as the opens and closes of these candles mark some crucial times of day:
* Midnight London time is often used as a benchmark for daily trades.
* 8am is the traditional start of the London session and is close to the end of the Tokyo session.
* Noon time is close to the New York open.
* 4pm and 8pm overlap with the New York session.
Back Test Results
A total of 6,482 hypothetical trades were taken over a 14 year period. The method used was profitable no matter what take profit targets were used. The chart below show the expectancies of the strategy based upon multiples of risk, e.g. if the stop loss in a trade was 80 pips, a ratio of 1 to 1 would be a take profit at 80 pips, a ratio of 2 to 1 would be a take profit of 160 pips, etc.
The headline row in the table below shows the overall results, while the rows below that show the results for entries taken during the 4 hour period commencing at the London time on the left. The cells that are highlighted in yellow show those times where results superior to the overall results were achieved.
Firstly, starting with the leftmost column showing frequency of entries, we can see that about half of all the trades occurred at either Noon or 16:00 London time. Secondly, we can see that entries taken between Noon and Midnight London time were quite clearly the most profitable times to trade USD pairs overall. Can it be that the New York session is actually more important than the London session? Thirdly, note how the results in general improve the higher the profit target, up to a reward to risk ratio of about 50 to 1.
One question remains: are there significant differences between the seven currency pairs regarding the time of day in Forex trading?
The EUR/USD and GBP/USD currency pairs were more profitable at 4am and 8am than the general sample, and the USD/CHF pair was more profitable at 4am. This suggests that when the USD is paired with European currencies, entries near the start of European business hours become more significant. The table below shows results for EUR/USD, GBP/USD and USD/CHF:
The USD/CAD currency pair was much more profitable during the entries corresponding to New York business hours than the general sample:
The three remaining currency pairs which were composed of Asian currencies paired with the USD – AUD/USD, NZD/USD and USD/JPY – were uniquely profitable at Midnight, and also put in a very good performance at 4am, and again at 8pm, corresponding quite closely to Asian business hours:
Conclusion
There is no doubt that reversals could be traded with best results during the local business hours of either of the currencies within the currency pair. Note how the best overall results correspond to trade entries taken during New York business hours, as the common currency of all the 7 pairs tested is the USD. The time of day in Forex trading is a more important variable than most traders think.
