Trade Forex Fundamentally

Trade forex strength and weakness

When you look at a chart and see a nice uptrend in the currency pair, say the EUR/USD, how do you know whether that uptrend is due to Euro strength or Dollar weakness? Wouldn’t you like to know what currencies the so called “big dogs,” with the ability to influence prices, are buying and selling so that you can align your direction and currency pair selection with this deal flow? After finishing this forex trading tutorial you should be able to identify where the big buying and selling (a.k.a. “deal flow”) is happening by identifying a strengthening currency and a weakening currency and trading them against each other to make money trading forex.

The problem with most trend-following systems using technical analysis is, you’re not really following a strong up-trend if only one of the currencies in the pair is actually strong, and the other is neutral or also strong. Your goal when trading currencies is to buy strong currencies and sell weak currencies. Remember, in forex, all trades are done in pairs– you can’t buy USD without selling another currency to exchange value.

The objective of this forex trading tutorial is to objectively select a direction that is aligned with sentiment so that you have a powerful driving force supporting your trade.

Is the EUR/USD going up in this picture due to Euro strength or Dollar weakness? (Click to enlarge)

With some math and computer processing, we can graphically determine which currencies are strong and which are weak, and their individual trends. The best way to do this is by downloading a currency strength indicator that can be opened in free Metatrader forex charting software. The only indicator of importance is “CCFP,” which is displayed in the bottom window of the above forex chart snapshot (On the download page it is available at the links almost at the very bottom).

How the currency strength indicator works:

Each color line corresponds to an individual major currency. When that line is above the zero level (the center of the window), the currency is strong. When it’s below, it’s weak. The more it climbs, the stronger it gets. The more it falls the weaker it gets. If we re-examine the chart of the EUR/USD pair above, the price increase at the beginning of the chart was apparently caused by USD weakness. We can tell this because the green line (in the currency strength indicator window below the chart) representing the USD had been falling from the zero line (getting weaker), while the dark blue line representing the Euro remained flat near the zero line. Over this period, the EUR climbed above the zero line and got higher, making it an ideal candidate as a buying currency, while selling the USD. This translates to a trend of big money buying the EUR/USD pair.

Know your forex blocs

Currencies move in groups, or “blocs.” So called, “Commodity currencies”such as AUD, CAD, and NOK often move together in one bloc. “Risk off” currencies such as JPY and USD, because of their low interest rates in the industrial world at the time of writing, often move together in a correlated bloc. Why is this important? If you look at the currency strength indicator window and see 1-2 currencies that are normally in a bloc together start to shift direction, be ready for the other to also shift direction. Furthermore, as sentiment shifts, you will ideally want to buy a currency from one bloc and sell one in another. Since money often flows from one bloc to another when sentiment shifts, it’s not always a great idea to pair two currencies in the same bloc. As we established in an earlier post, currencies follow the ebs and flows of sentiment, rather than simply technicals and fundamentals. You want to be able to track these sentiment flows.

Remember, when setting out to make money trading forex your goal is to 1. select the right pair and 2. select the right direction based on forex sentiment. We’ve covered other indicators of sentiment such as COT and price reaction to news events that you can combine with the currency strength indicator to maximize the odds in your favor.