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What's Working Now
Trading is a lot like driving. Think of it this way, when you are driving, do you use only one technique when you're behind the wheel, regardless of the situation? I know that when I'm driving through mid-town Manhattan, I use a very different style of driving than I would use when driving on the New Jersey Turnpike. In gridlocked midtown Manhattan, I move very slowly and must be ready to stop frequently, while on a major highway like the Turnpike, I hit the gas and hope New Jersey's Finest don't notice or care that I'm going fast enough to escape the earth's gravitational pull (hint – always be sure that there is at least one car in your vicinity going faster than you are).
I've been getting questions from several readers and also from former students who are confused about trending and non-trending trading techniques, so I'd like to clear the air on this important topic. In particular, I've gotten several emails from traders who are having difficulty using trending techniques in recent weeks. For example, please take a look at the chart of EUR/USD below and see if you can determine why trending techniques used on the daily chart may not be appropriate for this currency pair right now (see figure 1).
Figure 1: Daily chart of EUR/USD trapped in a 700 pip range since late October. Source: Saxo Bank
If you guessed that the above chart resembles "stop and go traffic", you're correct. This is an indication that the current EUR/USD is in a consolidation. Notice how nicely the pair was trending on the left side of the chart; obviously, something has changed. To me, a trending market is just like that highway; it's fairly easy to drive, and when the price reaches my entry point I just floor it and trail a stop. If the trend is unusually strong, I don't even use targets, and instead I depend on my stop to take me out of the trade. This results in an occasional big winner, and can make up for many small losses. Trending markets can continue moving in one direction for a long time, so the techniques used at this time are designed to keep one in the trade. Conversely, if the market is trapped in a range, I can't expect such smooth sailing, and I would have to use a completely different set of tactics. Since a market that is trendless and consolidating offers little follow-through, I'd have to be prepared to get in and out more quickly, and the techniques that I use would have to reflect that. Sideways or trendless markets tend to reverse and come back toward your entry point (and beyond), so you have to be less aggressive with your targets and more nimble with your exits.
As traders, it is our job to determine "what is working right now". This is because markets are not static; they go through trending phases and consolidation (non-trending) phases. It seems that the best traders are the ones who can quickly adapt from a trending market to a non-trending market (and vice versa). If the market has ceased trending and you are still using trending techniques, this will almost certainly lead to trouble. To continue with our driving analogy, this would be just like driving through midtown Manhattan as if you were on the New Jersey Turnpike - the results wouldn't be pretty.
For example, the shorter moving averages on the daily charts are useless right now, because they tend to work in strongly trending markets, while most currency pairs are currently in consolidation mode. But I have noticed that some of the moving averages that are longer in duration are actually working quite well. While the 10-day moving average is not worth using right now, check out the 20-week exponential moving average on EUR/USD, which has acted as support numerous times in recent weeks (see figure 2).
Figure 2: Weekly EUR/USD charts shows frequent support on the 20-week EMA. Source: Saxo Bank
In a sense, you could say that by switching to the weekly chart, I'm playing the bigger trend. That's fine with me; I like to use wide stops and targets, as I feel that you can neutralize the spread by making the playing field bigger. Just be sure that if you set up the trade in one time frame, don't change time frames randomly to suit your analysis. In other words, since this is not a multiple time frame setup, and I have entered based on the weekly chart, then I must keep the trade on the weekly charts, regardless of any personal feelings that I might have about what might happen. As long as the price remains above the 20 week exponential moving average, I'm going to remain long and trail the stop. How long will I hold this trade? I have no idea, but I hope that it will be for a long, long time.
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Questions of the Week
Q) Hi Ed, It seems as though on the shorter time frames that most of the pairs that had a positive or negative correlation, the exact opposite is true now. When I first started trading you could look at the direction of one pair and know what pairs would be doing the same thing like the GBP/USD and the EUR/USD or the opposite like the GBP/USD and the USD/CHF. I find now that most of the pairs have a mind of their own and just do what they wish. Any comments?
Ed Ponsi) You're right; many of the correlations that currency traders depend upon have fallen apart this year, while inter-market correlations (for example EUR/JPY and the S&P 500) have taken center stage. It could be a temporary situation, or may be a sign of something bigger, but I no longer count on the EUR/USD and the USD/CHF currency pairs to correlate negatively. Even EUR/USD and GBP/USD are moving in opposite directions, which is rare but has been going on for months. I think this is all due to fundamentals; usually, EUR and GBP share a similar track but the central banks are not in sync; the Bank of England is cutting rates while the European Central Bank is holding steady. The one sure proof of the failure of the EUR/GBP correlation is to take a look at the EUR/GBP currency pair, which is normally flat as a pancake and about as much fun as watching paint dry. This pair broke out into a wicked trend from November through mid January - something that is extremely rare for this currency pair - before falling back into consolidation mode (see figure 3).
Figure 3: EUR/GBP trend during Nov-Jan. was unusual, as the pair tends to lie flat. Source: Saxo Bank
When will the old correlations come back into focus? Probably when the central banks get back into sync. Most analysts believe that the European Central Bank will have to start cutting rates later this year, which should bring us into a more normal environment and acknowledge that all of these economies will be affected negatively by the US slowdown. Already we are seeing a flattening of the EUR/GBP pair (from mid-January until the present), which tells me the market might be getting ready to settle back into its usual patterns.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through