Categories
Forex Course

161. Learning To Trade Interest Rate Differentials

Introduction

In forex trading, every trader anticipates the upcoming price of a currency pair in several ways. Traders and analysts use market analysis tools like capital flows or price action to predict the currency pair’s future direction. However, some use interest rate differentials to predict the upcoming price movement of a currency pair.

What is the Interest Rate Differential?

In trading a currency pair, buying towards the currency with a higher interest rate and selling the currency with a lower interest rate is a way to make money from the forex market, which is known as interest rate differential or price appreciation.

The interest rate differential makes the forward point that makes up a forward currency rate. The forward rate is created by adding or subtracting the current exchange rate and making a new rate. At that rate, traders can buy or sell a currency pair in the future. Let’s have a look at the example of interest rate differential.

If we want to sell the USDJPY 10 year in the future, we have to make a payment to the buyer. The amount should be based on the difference between the US interest rate and the Japanese interest rate. Later on, we will make payment to the buyer at the current spot rate plus interest rate differential between the US interest rate and the Japanese interest rate.

How to Make Profit from Interest Rate Differential

The higher interest rate of a country has a higher demand for holding currencies than the country with a lower interest rate. The main reason behind the differential is that it costs a trader to hold on to a currency that has a lower interest rate.

Using this concept, we can predict the future price of a currency pair. If the US interest rate goes higher or the Japanese interest rate goes lower, the USDJPY price will move towards the direction of interest rate differential. Similarly, if the US interest rate goes lower or the Japanese interest rate increases, the USDJPY price will likely move lower.

Conclusion

In forex trading, we take trading decisions based on probabilities, and interest rate differential is one of these probabilities. Traders can take the ultimate trading decision by considering this element besides the fundamental and technical analysis.

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Categories
Forex Basic Strategies

Reliable Way To Make 30-Pips A Day In The Forex Market

Introduction

The 30 pips a day is a trading strategy that is based on market continuation pattern. This strategy is very profitable and has a long history of providing a substantial gain. Therefore, if you can implement this strategy well, you can make a decent profit from the forex market. This strategy is focused on a quick gain from the market; therefore, the currency pair that usually make a fast move is recommended for this strategy.

In this trading strategy, we will use the following elements:

  • 10 EMA and 26 EMA to identify the market direction. The main reason for using the Exponential Moving average over the simple moving average is that it provides the most reliable result in a short timeframe.
  • We will use 5-minute timeframe for trading as our focus is to make a quick gain from a short move.
  • We will implement the strategy in GBPJPY pair as it provides fast move in a short timeframe.

30 Pips a Day Trading System

In this trading strategy, we will consider the trend as an uptrend if the 10 EMA crosses the 26 EMA. Similarly, we will consider the trend as a downtrend if the 10 EMA crosses the 26 EMA. The reason for choosing the GBPJPY pair is that it has a higher daily movement compared to the other major currencies. GBPJPY pair can move 100-200 pips a day while most of the major currency pairs can move 60-100 pips a day.

However, our aim is not to catch every move during the day. Instead, we will focus on a little part of it, like 30 pips. That’s why the name of this trading strategy is 30 pips a day. In this trading strategy, the Potential Trading Zone is significant.

What is the Potential Trading Zone?

It is the zone where we will make trades based on our trading element. It is usually the reversal zone from where the price is likely to reverse from the current direction. Therefore, we will make the buying and selling decision at this zone depending on the current market trend.

In the above example, we can see that the major trend of the currency pair down. Despite the downtrend, the price will move up with a corrective speed, which is a minor counter-trend rally. In the 30 pips a day trading strategy, we will focus on the minor trend reversal movement and wait for the price to return to the major trend.

We can find the same market movement in the uptrend where the price will come down with a corrective speed. Later on, we will focus on the price zone from where the price is likely to resume its major trend.

Sell Setup Using the 30 Pips a Day Trading Strategy

  • Identify the major trend. If the primary trend is down, we will focus on sell trades only.
  • Find the location of price where 10 EMA crosses down the 26 EMA.
  • Do not sell immediately after the crossover. Wait for the price to make a retracement.
  • Enter the sell as soon as the candle crosses the potential trading zone halfway between the 10 and 26 EMA.
  • Stop-loss should be 15-20 pips.
  • Take profit should be 30 pips.

Example of 30 Pips a Day Sell Setup

In the above image, we can see that the 10 EMA crossed below the 26 EMA and moved up. The crossover is the first indication of sell entry. Later on, the trade setup comes as soon as price creates a bearish candle after a bullish rejection.

Buy Setup Using the 30 Pips a Day Trading Strategy

  • Identify the major trend. If the major trend is bullish, we will focus on buy trades only.
  • Find the location of price where 10 EMA crosses above the 26 EMA.
  • Do not buy immediately after the crossover. Wait for the price to make a retracement.
  • Enter the buy as soon as the candle crosses the potential trading zone halfway between the 10 and 26 EMA.
  • Stop-loss should be 15-20 pips.
  • Take profit should be 30 pips.

Example of 30 Pips a Day Buy Setup

In the above image, we can see that the 10 EMA crossed above the 26 EMA and moved down. The crossover is the first indication of buy entry. Later on, the trade setup comes as soon as price creates a bullish candle after a bearish rejection.

Alternative Trading Entry for 30 Pips a Day

  • If you don’t have enough time to manage your trade, you can simply use a pending order.
  • Once the candlestick comes back after the primary crossover, wait for a reversal candle to appear. Later on, place a buy stop or sell stop above or below the reversal candlestick.
  • You can place the stop loss above or below the candle high or low with some buffer. However, you can use the nearest swing points as a stop loss level also. Moreover, to take profit, you can set it to 30 pips.

Pros and Cons of 30 Pips a Day Trading Strategy

Like other trading strategies, 30 pips a day trading strategy has both strength and weakness.

Pros

  • As the GBPJPY pair is very volatile, it is straightforward to make 30 pips daily.
  • In a trending market, this strategy works well.
  • This strategy works well in Asian and London Session.

Cons

Summary

Let’s summarize the 30 pips a day trading strategy:

  • Identify the trending market in the GBPJPY pair.
  • Move to the 5-minute chart and identify a market where 10 EMA crosses the 26 EMA.
  • Wait for correction and enter the trade as soon as market rejects from the potential trading zone.
  • Set stop loss at 15-20 pips and take profit at 30 pips.

In every trading strategy, trade management is an important part. In the forex market, we anticipate the movement of various currency pairs and every pair moves in a different way. Therefore, if you face some consecutive losses, it is better to take a break from trading and enter the trade again as soon as the market starts to move as you expect.

Categories
Forex Daily Topic Forex Fundamental Analysis

How Important Is ‘Corporate Profits’ Economic Indicator In Determining A Nation’s Economy?

What is Corporate Profit?

Corporate profit is the money left after the company pays all its expenses and taxes. The money that is collected by the company after selling all products and services during the specified period is considered as line revenue. From this revenue, various deductions happen in the form of tax and salaries, to name a few. Money left over after all the expenses are paid considered to be the company’s profit. The profit earned by the company is an important parameter when it comes to the fundamental analysis of a company.

How is Corporate Profit measured?

The corporate profit economic indicator calculates the net income of a company that is measured by considering the following factors:

Profits from present production – This type of profit is gained from two components. First, the income that is gained after inventory replacement is included in this, and secondly, the income statement depreciation is considered. This type of profit is also known as operating or economic profit.

Profit on books – The profit earned from net income minus inventory and depreciation adjustment is known as book profits.

Profit after-tax – Book profit after the tax deduction is called profit after-tax. This type of profit is believed to be the most relevant number when calculating corporate profit.

Real Corporate Profit

Corporate profits are one of the most studied data of a company. It also plays a major role in other financial measures of the country. Profit is not a measure of the amount of cash a company earned in a given period. We need to understand the income statement that includes non-cash expenses as well. It is also important to understand the changes in accounting methods that have influenced the profit margins.

These are some hidden charges that are directly deducted from the net profit. Therefore, it is often more appropriate to consider profit as a percentage of sales when comparing one company to another. Remember, a comparison between companies should be made among companies within the same industry, and the net profit should be seen in this context.

Analyzing corporate profits

Corporate profit is nothing but a company’s income and the one that is directly reflected in the official statement. Hence, they are one of the most important things to consider when investing in the shares of a company. Increasing corporate profits means either increasing corporate spending, growth in retained earnings, or increasing dividend payments to shareholders. All of these are positive steps taken by a company indicating growth.

The corporate profits data is most useful for an investor rather than a trader. It involves buying the shares of a company and holding them for a minimum of 3 months. An investor may also use this number to do performance analysis. If an individual notices an increase in the profit of a particular company while the overall corporate profits are declining, it could signal company strength. Alternatively, if an investor notices that the company’s profits are declining while overall profits are increasing, i.e., of the sector, a structural problem may exist in the company.

Economic reports

Corporate profits are through statistical reports that are published by the Bureau of Economic Analysis (BEA). It is a comprehensive report comprising of the company’s net revenue, earnings before tax, earnings after tax, corporate profits, expenditure, etc. Finally, the report summarises the net income of corporations in the National Income and Product Accounts (NIPA). One thing we have to make a note of here is that the corporate profit numbers derived from the NIPA, which is dependent on the GDP growth, are different from the profit statements released by the companies. So, while analyzing the data, we need to be cautious by looking at both the numbers and rely on the ones where the difference is not huge.

Impact on Currency

There might not be a direct relationship between corporate profits and the value of a currency as the former is more company-specific and represents a very small portion of the economy. However, an overall corporate profit that is a collective data of all companies affects the stock market. If the data is good, it means the manufacturing is growing and that domestic companies are generating profits. This, in turn, has a positive impact on the currency and leads to an appreciation of the domestic currency. However, if the collective data is negative, it can lead to depreciation of the currency in the long term.

Sources of information on Corporate Profits

Corporate tax data is released by the Bureau of Economic Analysis (BEA) quarterly on the official website. Another reliable source of information on corporate profits is the press release by the respective companies. The press releases can be found on the website of the stock exchange. Links to Corporate Profits sources

GBP (Sterling) – https://tradingeconomics.com/united-kingdom/corporate-profits

AUD – https://tradingeconomics.com/australia/corporate-profits

USD – https://tradingeconomics.com/united-states/corporate-profits

CAD – https://tradingeconomics.com/canada/corporate-profits

EUR – https://tradingeconomics.com/germany/corporate-profits

JPY – https://tradingeconomics.com/japan/corporate-profits

Corporate profits are a closely watched economic indicator by institutional investors. Profitability provides a summary of the company’s financial health and serves as an essential indicator of economic performance. Profits are retained earnings, providing much of the capital for investing in productive capacity. The estimates of profits and related measures are used to evaluate the effects on corporations of changes in economic policy and the financial condition of the country.

Impact of the ‘Corporate Profits’ news release on the Forex market

Corporate profit, also called net income, is the amount remaining within the company after all costs such as interests, taxes, and other expenses are deducted from total sales. It is also referred to as net profit or net earnings. A high cumulative corporate profit generally indicates that a company is running efficiently, providing value to its shareholders, and contributing towards the growth of the manufacturing sector.

It is significant because it shows how well the company has managed its costs. The corporate profit data is not that important for traders as it does not have a direct impact on the value of a currency. Hence, we should not expect high volatility in the currency after the news announcement.

In the following section of the article, we will be analyzing the impact of Corporate Profit on various currency pairs and analyze the change in volatility due to the news release. The below image shows the latest quarter’s corporate profit in Canada that was released in June. We see a major drop in profits compared to the previous quarter, which means companies were unable to make huge profits in this quarter. Let us find out the reaction of the market to this data.

USD/CAD | Before the announcement

We will first examine the USD/CAD currency pair to observe the impact of corporate profit on the Canadian dollar. The above image shows the state of the chart before the news announcement. We see that the pair is in a strong uptrend, and recently the price seems to be retracing. Our approach should be to ‘buy’ the currency pair as the major trend is up, but the price needs to retrace to an important technical level before we can buy. Let us see that if ‘news’ gives us that opportunity.

USD/CAD | After the announcement

After the news announcement, the price goes lower, and volatility increases to the downside. Even though the Corporate Profit data was awful for the economy, traders went ‘long’ in the Canadian dollar by selling U.S. dollars. The bearish news candle shows that the news candle did not have any adverse effect on the currency. Few hours after the news announcement, volatility continues to increase on the downside, and we witness large selling pressure in the market.

GBP/CAD | Before the announcement

GBP/CAD | After the announcement

The above images represent the GBP/CAD currency pair, where we see that before the news, the market is moving in a ‘range,’ and recently, the price has moved higher after reacting from the support. Since the impact of corporate profits is least on the currency, traders shouldn’t be scared of the news release and can take a position in the market according to their strategy.

After the news announcement, the market slightly moves lower, or even one could argue that the news release had a major impact on the currency. The corporate profit data had a minor impact on the currency pair, which lasted for a few minutes. Traders should analyze the pair technically and not be worried about news data.

CAD/CHF | Before the announcement

CAD/CHF | After the announcement

The above images are that of CAD/CHF currency pair, where we see that the market in a strong downtrend with some minor price retracement at the moment. We should be looking to go ‘short’ in the currency pair after the occurrence of the price continuation pattern in the market. However, if the price continues to move higher, the sell trade is off the table. Conservative traders can wait for the news release and then take a position based on the impact of the news.

After the news announcement, the price moves higher, and volatility expands on the upside. The small up move gets completely retraced by the immediate next candle, and the market continues to move lower. Hence, it is evident that the news has a negligible impact on the currency pair, where the overall trend of the market dominates the move after the announcement.

We hope you understood this Fundamental Indicator and its relative impact on the Forex price charts. All the best!

Categories
Forex Educational Library

Let Profits Run

Introduction

Aspiring traders and the majority of people think that if they had a crystal ball telling them the right entry point or the perfect stock to pick, that would be the key to succeed in the financial markets and become filthily rich. Nothing could be further from the truth.

Of course, entries are important, but no entry would save the investor or trader from market volatility. Novice investors and traders without the knowledge about how and when to exit will be wiped from their perfect purchases at the worst moment for them.

Most people focus on a frequentist way of looking at trading. Van K. Tharp calls it “the need to be right.” This need to be right pushes the investor to cut gains short and let losses run in the hope of a reversal that doesn’t always happen.

Daniel Kahneman in his book “Judgment Under Uncertainty: Heuristics and Biases” says that giving a choice of experiencing a string of small losses or one single huge loss, people prefer the second one. It also happens that what people enjoy most are frequent, although modest, gains; a lethal combination that transforms any winning system into a loser.

1.    The mathematics of profitability

What you’ll read just below is the best-kept secret in the trading industry. The real holy grail of trading that explains the importance of letting profits run (achieving high Reward to risk ratios)

The critical feature of a good system isn’t the percentage of gainers, but its expectancy (expected value E).

Expectancy is the expected value of gainers (E+) less the expected value of losers (E-)

(E+) = Sum(G)/(n+) * %Gainers

(E-) = Sum(L)/(n-) * %Losers

Sum(G) is the total dollar gain in our sample history

Sum(L) is the total dollar loss in our sample history

n+ is the number of positive trades(Gainers)

n- is the number of negative trades(Losers)

The expectancy E then is:

E = (E+) – (E-)

If E is positive, the system is good. The higher E the better the system. If E is zero or negative, the system is a loser, even if the percentage of gainers were more than 80%.

There is another angle to this. If we switch our good-old brain to the right way a good trader should think -let profits run and cut losses short- we would be rewarded with high Reward to Risk ratios.

That is the right way to make our system resilient to a decrease in its percent of gainers.

For instance, a 2:1 RR sets the break-even point at 33.33 percent gainers.

Right! We need only one winner out of every three trades to break even.  A 2.5:1 RR will bring the BE point down to 28.5% and a 3:1 RR will get it to 25%: Just one winner out of four trades.

There is no need to struggle with being right! We just need to make sure we follow our system, cut our losses short and let profits run! We can be blind chickens searching for corn grains!

Letting profits run requires patient and discipline. Jack Schwager recalls a sentence by Jesse Livermore: “it was never my thinking that made the big money for me. It was my sitting”. According to Schwager, “that’s a very appropriate comment. It means that you don’t have to be a genius, you don’t have to be smarter than anybody else, but you do need the patience to stay in the correct position.

The “letting profits run” stuff seems to be aimed at long-term traders and nothing to do with short-term ones, but it’s false. Letting profits run is a way of thinking.

You may be an intra-day trader, but at least you’ll need a strategy or trading plan that uses some entry method and some profit target. In this context, letting profits run means allowing your trade develop until your profit target is reached (or close to it) and not letting your fears of losing trigger a premature exit compromising the Reward-to-risk of your system.

2.    Trailing the trend

The usual way to let profits run is using trailing stops, and there are different methods on where to put a trailing stop.

There are systems not using any explicit trail stop. On those, the close of a position is marked by the system’s indicators. A reverse signal marks the close of the previous position.

1.- Trailing stops

The usual way to follow a trend is by trailing it with a stop at some level below the price action in long trades or above it in shorts.

The use of very tight stops at the beginning of a trade, until it proves itself, may lower the risk at the expense of being caught early. In this case, a re-entry plan should be considered.

You should be aware that to catch big trends you’re going to give back 25-35% of the profits at least once in that move. One way to deal with this is to break the position into three different chunks and set different stops and targets for each.

The use of stops based on price and pattern are common. Price movement has to do with levels. Once a level is surpassed there is a good chance it’ll continue to the next level. If price takes out a level and then flips back, like a false breakout, it’s a definite sign to close.

2.- Volatility stops

Volatility stops are located to avoid the “noise” of the market, by putting them below the recent volatility. For example, a trailing stop below the level marked by 1.5 times the 14-period average true range (ATR) keeps us in the trend most of the time.

3.- Trailing stops based on chart patterns.

Some traders use trail stops based on the latest pullback. They use the distance of that pullback as his stop distance. We may also use a pattern of higher highs and lows to put stops just below the recent low (or high if short).

When a market is moving up vertically a very reliable strategy would be a stop below the low of two to three days back (the same strategy on highs apply to down-moving markets).

4.- Trail stops and profit targets

Let’s say we started with a $500 money management stop let’s call this risk R. We should have defined a logical target at least 2R.  As our trade develops in out favor we should consider moving our stop when we reach 1R: At that point, we are left with 1R potential profit, so we should at least move the stop to break-even.

As the price approaches our target, we must consider if the price momentum is improving or stalling, If the latter happens we should tight our stop to a level consistent with the principle of 2:1 reward to risk. For example, if what’s left is 0.5R, it’s unreasonable to risk 1R. The idea is to reassess the reward to risk ratio of what we think remains as open profit.

7.- Multiple methods

Two interesting methods are mentioned in Bruce Babcock’s book “The four cardinal principles of traders”:

Steve Briese, one of the traders, interviewed by the author, states that every trader should have a price objective. The objective shall be set based on the length of the trend. An oscillator of half the length of the trend can be used for this. When it becomes overbought on a long trade it’s advisable to exit a portion of the position, letting the rest ride the trend using a trailing stop.

Jake Bernstein spoke about a channel method to generate entries, which says, it will keep the trader on the right side of a trend.

That indicator consists of a moving average channel composed of a 10-bar MA of highs and an 8-bar MA of lows. The trend turns up when two successive bars are entirely above the top MA. It remains up until two consecutive price bars are below the bottom MA. The trade is kept until the indicator reverses.

Another way to lock profits would be, he says, to buy insurance in the form of options in the other direction (puts on longs, calls on shorts).

3.    key points

  • Let profits run is a crucial ability for a successful trader
  • We should pursue Reward to risk ratios (RR) greater than two rather than high frequency of gainers at the expense of high RR.
  • The use of trail stops is a standard method to let profits run, but an exit can be triggered, also, by a reversal signal or volatility in the opposite direction.
  • Trails come in different flavors: recent retracement point, latest higher low or high, the crossing of a moving average or the price moving out of the channel in the other direction.
  • It’s ok to set targets based on the price action, but the trailing stop must be moved to where RR is within the 2:1 concept. It doesn’t make sense to risk 2 to get just 1.
  • It is advisable to computer-test our idea of trailing to optimize it.

2.    conclusions and criticism

The concept of let profits run is nice, but a short-term currency trader must adapt it and test it, through back and forward tests, and make it his own system like a suit.

The use of trails stops must be carefully tested against fixed stops and targets, but the concept of Reward to risk ratios is Key.

A system with 2.5 – 3 :1 and 40% gainers is preferable than another one with a 1:1 ratio and 65% gainers because in real markets it’s usual that a system underperforms its back-tested values.  We see that the system with 2.5:1 RR has a lot of room to allow for underperformance and, still, being profitable.

The only drawback of low percentage gainers is longer losing streaks, but, as we said, we must train our mind to be committed to the plan, and accept losing streaks. To achieve the right state of mind, we should trade small at the beginning and let the system prove itself.

 


3.    appendix

Python code to play with Reward to risk and Percent gainers

The code takes % gainers (PG) and Reward to risk ratio(RR) as inputs and computes the expectancy(E). A Break-even point between % gainers and RR happens when E approaches zero.

appendix

The figure above shows the break-even (E=0) for a 3 to 1 reward to risk ratio that is at 25% gainers.

You could work the other way around and find the percentage needed for a Reward to risk ratio less than 1. (Below the one required for RR=0.5: PG=66.6% or 2 out of 3 winning trades shall be winners to BE, as is to be expected)

reward to risk game - forex academy

 

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