Counter-Trend strategy

July 28, 2006

By Mark Prosser, Chief Marketing Officer, Forex Capital Markets

As in the equity and futures markets, technical analysis is very popular in the currency market. Its popularity stems from the tremendous amount of liquidity created by the market’s round-the-clock trading and $1.4 trillion in daily volume. The many participants and significant amount of money that flows through the market on a daily basis mean that currencies rarely spend much time in tight trading ranges and have the tendency to develop strong trends.

Furthermore, more than 80 percent of volume is speculative in nature and, as a result, the market frequently overshoots and then corrects itself. New trends and breakout opportunities occur frequently and provide multiple opportunities for a technically trained trader to enter and exit positions. The opportunities are not limited to trend trading; range trading opportunities also exist fairly frequently, allowing traders ample opportunity to play the tops and bottoms of the ranges.

We have identified a technically based strategy that works particularly well in the currency market. The strategy seeks to fade, or trade against, an intraday trend and is intended to capture counter-trend moves off even, round numbers, which are also known as "figures" in the currency market. The strategy attempts to capitalize on the tendency of many market participants to place conditional
orders at or near large round numbers.

A natural psychological tendency makes round numbers particularly attractive to speculators while larger players or corporations who engage in foreign exchange trading for hedging purposes may prefer round numbers for accounting purposes. Regardless, short-term, counter-trend moves off round numbers occur frequently. Here are the rules to the strategy.

Long:

Locate a currency pair that is trading well below its intraday, 20-period simple moving average. This could      be on a 5 10 or 15-minute chart.
Go long the currency pair several pips below the figure.
Place an initial protective stop no more than 15 pips below your entry price.
When your position is profitable relative to the amount you risked, close half the position and move your       stop on the &remaining portion of the trade to break even. Trail your stop as the price moves in your favor.

Short:

Locate a currency pair that is trading well above its intraday, 20-period simple moving average. This could      be on a 5 10 or 15-minute chart.
Short the currency pair several pips above the figure.
Place an initial protective stop no more than 15 pips above your entry price.
When your position is profitable relative to the amount you risked, close half the position and move your       stop on the remaining portion of the trade to break even. Trail your stop as the price moves in your favor.
 
This strategy essentially puts you on the same side as inter-bank players with access to order flow. The strategy has an even higher probability of success when other important support or resistance levels, such as Simple Moving Averages, Fibonacci levels or Bollingers, converge at the figure.
The 24-hour nature of the market, which is unique to currency trading, provides an additional advantage for technical traders. Seasoned traders will learn that, during certain times of the day, specific pairs have a higher probability of range trading or a higher likelihood of breaking out of a period of intraday consolidation. For example, the British pound tends to trade more actively during the European / London trading session but keeps a tighter trading range during the Asian and U.S. session. A common intraday trading strategy in the British pound would then be to position for a breakout of an intraday consolidation in the pound ahead of the London open.
The transparency and round-the-clock trading characteristic of the currency market makes it articularly conducive to trading based on technical analysis strategies. Technical analysis is very popular within the currency markets and is used by the entire spectrum of participants, from hedge funds to day raders.

Marc rosser, Chief Marketing Officer, Forex Capital Markets
Email: marc@fxcm.com
 

Real-time Chart exmaple of Counter-Trend Strategy

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