The forex market operates around the clock, thus not only does one need to be concerned with price movements, but they also need to know the importance of the time at which they are trading. By utilizing certain trading strategies at certain times, traders have a better chance of realizing profits. Different currency pairs are prone to somewhat more consistent movements at differing times of the day.
TUTORIAL: The Forex Market
The following day trading strategy takes advantage of price change patterns but couples the pattern with a time frame that makes the pattern more reliable than if traded at a random time. (Knowing the relationships between pairs can help control risk exposure and maximize profits. See Using Currency Correlations To Your Advantage.)
The following strategy is for the GBP/USD currency pair. We are looking for movement on both sides of the Frankfurt opening price. Trading begins in Frankfurt around 7am GMT. This is the bar we will use for our opening price.
The strategy is as follows
- A 25 to 40-pip move or more above (or below) the opening price at 7am GMT.
- Then a 25 to 40-pip move or more below (or above) the opening price.
- This creates a range of movement on both sides of the opening price. We enter a trade when either the high or low of this range is broken. Ideally, we want to see low, high, low breakout, or high, low, high breakout, although this does not need to be the case.
- Initial stop is 40 pips.
- Take profits on half of the position when showing a 40-pip profit. Trail the rest of the position with a 40-pip trailing stop, or alternatively create a second profit target. This can be done by calculating the difference between the morning high and morning low. Then add that difference to the breakout point, this is the profit target (covered in example below).
- Avoid patterns where initial moves in each direction are larger than 40 pips. Moves such as this create large opening ranges that are tradable themselves.
Because we are going to wait for at least a 25-pip movement above and below the open price, it is common to wait an hour or more for a tradable breakout. Until the breakout occurs, we do not enter into a trade using this strategy.
Why the GBP/USD Pair?
The GBP/USD exchange rate is often referred to as the "Cable." The cable is not heavily traded before the Frankfurt open. This is because the only market open right before Frankfurt and London is the Tokyo market. The cable is lightly traded on the Tokyo exchange and because of this, there is more volatility when traders enter the market around the Frankfurt opening time, which is followed shortly by the London open. Some other currency pairs are more evenly traded throughout the day and thus this strategy is not as effective.
Also, the GBP/USD is a volatile currency pair. It has large swinging moves that create excellent profit opportunities. Where there are large swings and profit potential, there is also the probability of being stopped out. We wait for the market to move both directions before entering a trade so we can reduce the likelihood of being stopped out of our trade. After these initial price movements have taken place, the next move – our breakout - is more likely to have conviction behind it because all the weak positions were shaken out of the market in initial rate swings. (To learn more about other strategies, refer to Confirm Forex Momentum With Heikin Ashi.)
Logic Behind the Strategy
Traders often put stops just outside ranges. When the market opens, and a direction has not been definitively established, these tight stops are triggered by the increased volatility of the open. Stops on one side of the opening price are triggered, pushing rates out of the range and giving the illusion of a breakout. Once all the stops and weak positions (traders not completely dedicated to this first move after the open) have been cleared out, the initial move slows and often reverses. The same thing happens on the other side of the opening price. All tight stops around the open price have been triggered and now the market is ready to make its first real move. This move is more likely to have strong traders and positions behind it and be based on more solid fundamental and technical criteria than the initial weak moves triggered simply by increased volatility.
We enter a trade after this noise and stop triggering has subsided and the market is making its first strong move and triggering a breakout of the either the high or low of the range established after 7am GMT. The morning session does not always play out in this fashion; patience is required in finding the pattern.
The example in Figure 1 shows how the strategy works. The blue vertical line is when trading begins at 7am GMT. The two blue horizontal lines mark the high (32 pips above open) and low (33 pips below open) made after our open of 1.4862. The market moves down, setting the low, then rallies to set the high and then breaks below the low again. We enter one pip below the old low at 1.4828 (first circle). A stop of 40 pips is set. When the market moves down 40 pips (or the equivalent of our stop), we close out half the position and change our stop order to a trailing stop of 40 pips.
At 1.4788, we lock in our 40-pip profit (second circle). The remainder of the position has a 40-pip trailing stop. The market in this example continued to move down to 1.4758. At this point it began to rebound and the remainder of our position was exited at 1.4798 (third circle) for a 30-pip profit. Sometimes the market will run and we will make more on the second half of the position, other times it will stall and reverse resulting in a smaller gain than on the first half the position.
Alternatively, we can use a second profit target by calculating the height of the opening range and then adding/subtracting it from the breakout point. In this example, the opening range is 65 pips. Therefore, we subtract 65 pips from our breakout point at 1.4828, giving us a target of 1.4763 which was also hit in this example (not marked on chart).
|Figure 1: GBP/USD, Feb 10, 2009. 5 Minute Chart. All times in GMT.|
Figure 2 looks at an alternative setup. The market moves lower, then higher, pulls back slightly, then continues higher, breaking above the opening range at 1.5842 and continuing over 120 pips higher. The open, low and high of the morning range are marked by horizontal lines. (Learn this simple momentum strategy and its profit protecting exit rules. Check out The 5-Minute Forex "Momo" Trade.)
|Figure 2: GBP/USD, Oct 28, 2010. 15 Minute Chart. All times in GMT.|
As with any strategy, there is a potential downside. It is possible that the market will continue to range, resulting in several false breakouts and, as a result, losses. In other words, the market may make multiple new swing highs or lows then quickly reverse before finally making a large move. It is also quite possible our entry criteria will not be met and thus we miss out on a large move because the market starts moving in one direction and continues in that direction. For this reason, we will not get trade signals everyday from this strategy.
The Bottom Line
This strategy takes advantage of increased volatility in the GBP/USD pair near the beginning of the Frankfurt, and then London, sessions. Trades are made after a swing high, then a swing low is made, both 25 to 40 pips from the open, and our trade is entered when a new high is reached (or swing low, then high and a break lower). The strategy does have a few downsides, but it can also be profitable, and it controls risk. The strategy is easy to implement and takes advantage of patterns seen around the open of a market. (Trading forex can make for a confusing time organizing your taxes. But there are simple steps to keep everything straight. To learn more, read Forex Taxation Basics.)
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