What is the best way to pick Forex trades? It’s a simple question with a simple answer.
I’ve been trading Forex for exactly 17 years and together with my colleague Boris Schlossberg, we have over 40 years of market experience.
Naturally lot has changed in our personal and professional lives through these years but the one thing that has not changed is the way we select our Forex trades.
And that says a lot when we’ve been using the same technique today as we were in 1999. Of course, we’ve refined our tactics with experience, but the foundation of the way we select our trades remain the same.
We’ve always taken a top down approach to analyzing the Forex market. We start with the big stories, establish a bias for a specific currency and decide which currency to buy or sell again. Then we take a look at the charts to identify our entries and exits. In other words, every single trade we take is a fusion of fundamental and technical analysis.
We know that chartists scoff at the news, saying everything is baked into the price, while fundamental traders argue the charts show history, which cannot determine the future. But in actually, both approaches are by themselves incomplete.
For example, fundamental traders could say the U.S. dollar is the strongest currency and will appreciate against all other currencies because the Federal Reserve is the only central bank raising interest rates.
Yet blindly buying dollars is a risky move because if a currency becomes overbought, it can reverse quickly and aggressively. Conversely, a technician could sell a major technical level only to be completely stopped out in a strong trend.
The general rule of thumb is that fundamentals tend to have a stronger impact on longer-term trades, while technicals are more important in the short term. So the way we fuse these two techniques is by letting fundamentals determine our trade and using technicals to select entries and exits.
Here’s an example – in the current environment we know that the Federal Reserve is preparing to raise interest rates. As a result, the U.S. dollar should perform particularly well against the Japanese Yen because of Japan’s weak economy and their central bank’s need to keep monetary policy easily.
However, this has been the story for months – not just in September and October but the following chart shows USD/JPY falling for most of September.
In this scenario, a simple way to fuse fundamentals with technicals is to overlay a 20 period moving average on the daily chart as we have done below. Rather than arbitrarily picking a bottom, it may be smarter to wait for USD/JPY to rise above the 20-SMA in a meaningful way, showing that a bottom is in place before buying.
In this case you won’t be buying the ultimate bottom but at least you would have avoided USD/JPY’s drop from 102.50 to 99.90 in September (a period when the Fed was hawkish and the Bank of Japan was dovish).
Until next time,
Ms. Kathy Lien is the Managing Director and Founding Partner of BKForex’s strategies and creator of the new course The ULTIMATE Forex Trading Course produced in conjunction with Weiss Educational Services.Kathy, a leading currency and Forex expert, started the #1 Forex news site DailyFX.com, is a regular contributor to CNBC Squawk Box and is a former host of CNBC’s Forex show, Money in Motion. She is also an internationally-published author of the best-selling book, “Day Trading and Swing Trading the Currency Market” (now in its third edition) and “The Little Book of Currency Trading.”