We certainly have seen powerful movements in currency pairs in the first half of 2009. Some of these moves have been in the thousands of pips. Of course, looking back is easy and the challenge to the forex trader is to participate in similar moves for the remainder of the year. Few traders stay for months in a currency pair, and as a result bypass the large swings that accompany larger moves. However, a great deal of information about currency pair strength and direction can be gained from a more detailed examination of currency rankings. It’s useful to examine more carefully total returns per month. They tell us a great deal. For example, the ruble is down for the first half of the year, but it has the seventh highest return among currencies in May, returning 6.76%. The EUR/USD was nearly break-even year-to-date, but also showed a strong May, up 6.60%. What strategies can the forex trader derive from these data?
One useful trading tool is to use leaderboard ranking as a leading indicator or alert about a currency pair’s direction (see “Follow the leader”). This is analogous to a moving average crossover strategy, where a short moving average crosses a longer moving average. In this case, if the latest monthly rankings change or reverse a several month trend, we get a signal of a change in the strength of the direction. The currency pairs that occupy the top leaderboard slots are not there by accident. Fundamental forces provide the cause of their strength. It is no accident that the top three performers in May were the world’s commodity currencies (NZD, AUD, and CAD). They occupy the top rankings on the leaderboard of total returns for the month because global sentiment shifted towards expectations of a recovery and the commodity markets significantly improved.
Another potential strategy is “leaderboard reversal,” where the trader goes long the currency pair that is at the bottom of the leaderboard and/or goes short the pair that is at the top of the leaderboard. This is analogous to selling a parabolic price move based on the expectation that duration at the top is very limited. The trader has a reasonable expectation for any currency pair that occupies the top slot to be knocked out of that spot.
Finally, we can construct a contrarian or reversion to the mean spread strategy. Using a contrarian approach, a trader would at the end of each month select the top ranking currency pair and the bottom ranking currency pair. For example, on May 1, the USD/CAD produced the top total return for April and the USD/NZD produced the bottom return for April. A trader would go short CAD/NZD at 1.4822 on May 1 based on this strategy and hold the position to the close on May 29 at 1.4334. This would have produced a profit of 488 pips or $4,880 per $100,000 position. In real trading, the results would vary based on the exact entry and exit points. The May 1 high was 1.4850 and the May 29 low was 1.4258, so profits could have been greater and the trade would have been even more profitable if held into June.
The strategy of selling the top-ranked currency pair and buying the bottom-ranked pair is just one way forex traders can utilize the leaderboard of currency total returns as an indicator. The leaderboard is more than a simple ranking, it is a signature of multiple forces acting on each currency and all of them simultaneously. It is a rich resource for developing new trading strategies.
Abe Cofnas is the author of “The Forex Trading Course” and “The Forex Options Trading Course” (Wiley). Reach him at firstname.lastname@example.org