Using Currency Strength Meters for Trading: A Comprehensive Guide
Understanding Bond Yield Spreads
A frequent question we receive is about our use of strength meters to gauge currency strength against overall market sentiment. In this article, we’ll delve into our approach and tools, with a specific focus on the Zenith platform and alternative free resources.
Our Preferred Tool: The Zenith Platform
To measure currency strength, we primarily use the Zenith platform. Here’s how we set it up:
- Commodities and ETFs: Below the primary strength meter, we also monitor commodities and ETFs.
- Bond Yields: We incorporate bond yields to provide additional market context.
- Currency Strength Meter: Positioned on the right side, our currency strength meter is designed with the base currency always in view. The currencies we focus on include:
- Australian Dollar (AUD)
- Canadian Dollar (CAD)
- New Zealand Dollar (NZD)
- Swiss Franc (CHF)
- Japanese Yen (JPY)
- Euro (EUR)
- British Pound (GBP)
- US Dollar (USD)
This setup allows us to clearly see which currencies are leading in strength or weakness. For example, at a glance, we might see weakness across AUD, CAD, NZD, and EUR, and strength in CHF, JPY, GBP, and USD.
Free Alternatives: Investing.com and Finviz.com
While Zenith is our primary tool, there are free alternatives that can provide similar insights:
Investing.com
- Setting Up a Currency Portfolio: On Investing.com, you can create a currency portfolio similar to our setup on Zenith. This involves comparing base currencies with quote currencies to gauge overall strength.
- Visual Indicators: Like Zenith, you can observe currency strength and weakness. For instance, you might see AUD, CAD, NZD weakness and strength in CHF, GBP, and USD.
Finviz.com
- Forex Section: Finviz offers a one-day relative performance measure in their Forex section.
- Comparison with Zenith: By comparing Finviz’s data with Zenith, you can validate trends. For instance, if Zenith shows AUD leading to the downside and GBP to the upside, Finviz should reflect similar trends.
How We Use Strength Meters
Our preferred way to use strength meters is to pair the strongest and weakest currencies, which we then use for news trading. Here’s our approach:
- Confirmation Tool: We never use strength meters alone to generate trade ideas. They serve as a confirmation tool.
- Sentiment and Fundamentals: We ensure that there is a fundamental or sentiment-driven reason for a currency’s strength or weakness. For instance, if AUD is strong and CHF is weak, we need a fundamental basis for this trend before considering any trades.
Once we’ve paired the strongest and weakest currencies, we then implement our trade plan.
Trading Strategy for CPI Print
While Zenith is our primary tool, there are free alternatives that can provide similar insights:
Step 1: Analyze Federal Reserve Priorities
The first step is to understand what data points the Federal Reserve is currently focused on. If the Fed is focused on this piece of data, it will generate significant volatility because the Fed bases its interest rate decisions on such data releases. To quickly determine the Fed’s current focus, you can use our Professional Economic Calendar, which includes a fundamental guide. This resource helps traders stay updated on the data points that matter most to the Fed, providing a strategic advantage.
Step 2: Use High-Low Expectation Forecasts
Professional traders rely on high-low forecasts to gauge market expectations accurately. Here’s a more detailed look at why these forecasts are crucial:
- Institutional Forecasts: Professional economic calendars include high and low estimates from top institutions. This broader range of expectations offers a more comprehensive picture of potential outcomes.
- Market Shocks: When a report exceeds the high estimate or falls below the low estimate, it’s a huge shock to markets because no analyst expected it. Such deviations often result in sharp market movements.
- Lightning Bolt Feature: This tool immediately signals a deviation above the high or below the low of analyst expectations. When a deviation occurs, the lightning bolt feature alerts traders instantly, allowing them to act without delay. The quick reaction to unexpected data can be the difference between a profitable trade and a missed opportunity.
Understanding High-Low Forecasts
Economic forecasts are derived from surveys of credible institutions, each providing their best estimate on upcoming data points. Retail calendars typically present the median of these estimates, which can be misleading. The median forecast doesn’t reveal the full range of expectations and, therefore, doesn’t indicate how surprising an actual data release is compared to the extremes of analysts’ projections.
In contrast, professional economic calendars include both high and low estimates. This additional information shows the analysts’ expectations at the extreme ends of their projections. Great trading opportunities arise when data releases fall outside these high and low estimates, creating market shocks that move prices significantly.
Step 3: Choosing the Most Volatile Instrument to Trade
Using insights from institutional reports, traders can select the most responsive currency pairs. For example, if USD/JPY is particularly sensitive to economic data as outlined by the City Economic Surprise Index and a CPI print shows a significant deviation, this pair could be an ideal target for trading.
- City Economic Surprise Index: This report identifies currency pairs that react strongly to economic surprises. It highlights pairs that are sensitive to data deviations, helping traders focus on the most responsive markets.
- Risk-Reversal Report: This report shows market positioning, revealing a buildup of call or put options on certain currency pairs. Understanding these positions helps traders choose a pair that may have orders susceptible to liquidation upon the release of an economic data point.
- CFTC Report: This report details hedge funds' positions. For instance, if many big players are long EUR/USD but data comes out in favor of USD, some of those funds might have to unwind their positions, leading to an outsized move.
Trading Strategy for CPI Print
- Confirm Fed Focus: Ensure the Federal Reserve is currently emphasizing CPI data. If inflation is a primary focus, the CPI report will have a higher likelihood of moving the market.
- If the central bank is focused on the data point, it’s because they are using that data point to make decisions on rates. This focus causes volatility. Sometimes the central bank is focused on a specific data point within a larger report, such as average hourly earnings within the Non-Farm Payroll report.
- Check Forecast Ranges: Before the data release, review the high and low forecast expectations. Plan to trade only if the actual data significantly exceeds the high estimate or falls below the low estimate. This strategy ensures you act on genuinely surprising data, likely leading to a follow-through reaction.
- Monitor Revisions: Check for any conflicting revisions in the data, as these can alter the initial market reaction. Make sure the primary release and any revisions align to support your trade.
- Enter Trade Promptly: Once you confirm the deviation, act quickly to enter your trade within the first 30 seconds. Speed is crucial, as market reactions to significant data surprises happen rapidly.
- Set Stop and Take Profit:
- Stop-Loss: Place your stop-loss below the low of the initial spike candle to protect against adverse movements.
- Take Profit: Aim for 15-30 pips for tier 1 events like CPI, adjusting based on market conditions and volatility.
Managing the Trade
- After the Initial Run: Look for a shallow pullback around a 23% Fibonacci retracement or near support/resistance levels. This initial pullback can provide an opportunity to enter the trade again after you’ve taken a few points off the table.
- Break Even: Move your stop-loss to break even as soon as possible to protect your gains. Generally, the stronger the release, the shallower the pullback. If the market should want to buy off your S&R level and continue to the highs of the one-minute candle and break. If that doesn’t happen, something could be off.
- Reentries: If your initial position is stopped out at break even, consider reentering at deeper retracements, such as the 38% or 50% Fibonacci levels. Use nearby support and resistance levels to guide your reentry points.
Conclusion
While the CPI print may not always lead to significant market movements, understanding its nuances and using a professional trading strategy can help you capitalize on unexpected deviations. If you don’t have the tools mentioned above, try out our Professional Economic Calendar Package and use institutional tools to level the playing field. By following these steps, you’ll be well-prepared to trade the CPI report effectively, leveraging the same strategies that professional traders use to profit from this economic data release.
Questions?
If you have any other questions or need further clarification, feel free to reach out. We’re here to help!