Inflation in Forex Trading

Inflation or the CPI (Consumer Price Index) is one of the most important economic releases. If not the most important one.

inflation

During a trading month, the economic calendar is filled with data. Traders use the data to interpret an economy.

Next, based on the economic differences between two economies, they sell or buy a currency pair. For example, if the U.S. data comes out stronger than expected, traders will buy the dollar.

But, there is so much economic data to be released on a monthly basis, that traders get confused. What matters the most for a market?

The answer to this question comes from knowing what matters for a central bank. Knowing what a central bank targets helps traders filtering the economic data.

A Central Bank’s Mandate

Central banks around the world have a clear mandate. Most of the times, it relates to inflation.

As such, a central bank’s goal is to create inflation. However, not by all means. Moreover, not any kind of inflation is desired.

For an economy to grow at a normal rate, inflation must sit around 2%. So, central banks in major economies around the world target the 2% level.

A normal central bank’s mandate looks to bring inflation below or close to 2%. Any move lower will be met with easing policies. Any move higher, with tightening ones.

The more inflation deviates from the target, the more aggressive the central bank’s actions will be. Recently, inflation declined on a global scale.

Oil and Inflation Expectations

A major source of inflation is the oil price. As a rule of thumb, when oil falls, inflation declines all over the world.

And, the other way around is true as well. When the price of oil rises, inflationary pressures pick up too.

The recent years showed the oil price moving aggressively lower. From values above $100 to around $30. In a matter of months, inflation fell in major economies around the world.

So dramatic the move lower was, that it reached negative levels in most economies. In the Eurozone, for example, deflation (when inflation moves below zero) appeared.

A central bank has only one way to respond to such conditions. To cut rates and ease monetary policy.

So, the ECB did just that. It cut rates all the way down to negative territory. And, it eased the monetary policy by starting a bond-buying program.

Even to this day, the program still runs. While inflation picked up a bit, it still rests well below the ECB target (below or close to two percent).

Why Do Forex Traders Care?

Traders always look for clues about what the central bank will do next. That’s what matters in Forex trading: the interest rate level and the monetary policy changes.

Inflation, or the CPI, is the one release that tells what the central bank will do with the rates. As such, traders expect the CPI data and position for the central bank’s decision.

That’s fundamental analysis in Forex trading. And inflation is the most important economic news to watch.

Conclusion

Forex traders mark the CPI releases on the economic calendar. When CPI gets out in UK, Eurozone, Japan, the United States, Australia or New Zealand, volatility is on the rise.

The more important the economy, the bigger the expected volatility is. The more the actual release differs from the expected one, the bigger the volatility.

All in all, when Forex traders look for clues about future interest rates, they look at the CPI level. That’s all that matters for most central banks.

Morning and Evening Stars in Forex Trading

Technical analysis as we know it today changed dramatically. Personal computers are responsible for it.

However, some patterns stand the test of time. No matter the market and the changes in execution, some patterns survived. Japanese candlestick techniques are such patterns.

Before discussing one of the most popular Japanese patterns, it is worth mentioning that, mostly, they are reversal ones.

As such, they form at the end of a trend. Either a bullish or a bearish trend, at the end of it, the market will form some sort of a Japanese reversal.

The Japanese candlestick patterns are made of a single candle or a group of candles. Their power is proportional with the time frame they appear on.

Stars are powerful reversal patterns. The bigger the time frame they appear on, the more powerful the signal is.

Trading Forex with Morning and Evening Stars

A star is a group of three candles. The name of the star comes from its implied future direction.

Having said that, a morning star is a bullish pattern. Hence, it forms at the end of a bearish trend. Remember? It shows a reversal.

On the other hand, an evening star is a bearish pattern. It appears at the end of a bullish trend and shows weakness.

However, both morning and evening stars will have a difficult time to reverse a trend. Typically, after a Japanese reversal, the ones that trade in the direction of the underlying trend will try to take the highs (in an evening star) or the lows (in a morning one).

This happens from time to time. But it doesn’t mean traders should disregard the patterns.

The secret is to integrate the morning and evening stars trading with a proper risk-reward ratio. It means at least 2 or 2.5 for every pip risked.

In doing that, discipline takes control over the trading process. As a result, Forex traders have more chances to survive in the long run.

How to Trade a Morning or an Evening Star

As mentioned earlier, the pattern has three candles. The first one is a strong candle in the direction of the original trend. It has a strong green body (in an evening star) or a strong red one (in a morning star) and a very short shadow.

The candle in the middle is either a hammer or a doji. In both cases, it shows reversal conditions. Or, at least hesitation.

The last candle moves in the opposite direction when compared to the original trend. It has a strong body, at least like the first candle has.

evening star

Above there’s an evening star that respects all the rules described. There’s a strong, bullish trend, and at the end of it, a group of three candles that form the evening star.

The market reaction speaks for itself. Unfortunately, look at the time frame. It is the hourly chart.

As such, chances for the pattern to survive are slim. Moreover, there’s no retracement after the third candle.

Typically, traders look for bulls to put up a stiff fight and retrace at least fifty percent of the pattern. That’s a great place to go short. However, this pattern here lacks that retracement.

Yet, the market retraced and, for the hourly time frame, it still offers a nice risk-reward ratio.

Conclusion

Japanese candlestick techniques are great reversal patterns. They work great, especially on the bigger time frames.

But the secret comes not from one’s ability to spot them. There are clear rules for that.

The key is to integrate the patterns in a strong money management system. That’s the only way to profitable Forex trading.

Trading Forex with the Ichimoku Indicator

Part of the Japanese approach to technical analysis, the Ichimoku Kinko Hyo indicator is extremely popular with retail traders.

It has plenty of reasons for that:

  • It is visible. The cloud offers a clue about the main trend (bullish or bearish).
  • The Kinjun/Tenkan cross signals possible reversals.
  • The cloud also projects future support and resistance levels.

According to the Japanese, the Ichimoku indicator offers a state of equilibrium. It shows a balance between the past and future prices.

As such, the cloud projects future support and resistance levels on the right side of the chart. Or, twenty-six periods forward.

Of course, traders can change these settings. But it is not a good idea, as the Ichimoku is supposed to give the best results with the original ones.

Describing the Indicator

This is no one simple line on a chart. Some trading platforms list the indicator as a trend one. Others list it as an oscillator.

The truth is that it has a bit of both. Judging by the fact that the trading platforms apply it on the actual chart, it looks like a trend indicator.

If we consider the strong support and resistance levels at the cloud area, it looks like an oscillator, with overbought and oversold levels.

In any case, the Ichimoku indicator is a complex one. It has no less than five lines:

  • The Tenkan line – this is the yellow-brown line on the chart below.
  • The Kinjun line – the blue line from the same chart.
  • The Chinkou line – the purple line.
  • The Senkou A and Senkou B lines.

The last ones are the ones that give the cloud, or the Kumo, as it is also called. In fact, they are the edges of the cloud.

When Senkou A crosses above Senkou B, the Kumo turns bullish. Or, green.

When the opposite happens, the Kumo turns read, or bearish.

forex with Ichimoku

Trading with the Ichimoku

Trading with this indicator is straight forward. There are several steps to consider.

Firstly, check the cloud’s color. On a green color, traders want to buy. On red, they want to sell.

Hence, there’s always a bias regarding the next trade. In the example above, the bias is bullish.

Secondly, look to buy at support. Support is given by the cloud (when the price hits the cloud) or by the other elements (lines) that make the Ichimoku.

However, not all trends are the same. Some are stronger than the other, and, of course, trends reverse.

As such, look to take only the first trades. Or, the first touch of those elements.

Finally, the two entries are shown above. One time when the price hits the cloud, and another one when the dip hits the Kinjun and Tenkan lines.

As for the take profit, traders use Chinkou’s highest value. When this comes, they exit.

Conclusion

This is just one way to use this wonderful indicator. There are plenty other ones.

Some traders use the future support and resistance levels to forecast the shape of the future price action.

Others look at the moment the Tenkan and Kinjun lines cross. And so on.

In any case, this is one of the most powerful indicators the Japanese brought to the technical analysis branch. Westerners embraced it quickly.

How To Do Forex Trading Without Charts

There are various reasons why traders buy or sell a currency pair. Some do it for a fundamental reason. They suspect an economic news, like the GDP (Gross Domestic Product), or Retail Sales, or Jobs Data, will disappoint. Or, beat expectations.

Others do it because of macroeconomic differences. They believe an economy goes in the wrong direction. Or, it outpaces another one.

However, retail traders should look at both technical and fundamental factors before buying or selling a currency. But, statistic says something else.

Trading a Currency Pair Without Looking at a Chart

Retail traders come to the trading table with unrealistic expectations. They want to get reach fast. And, if possible, with not much of an effort.

Because of that, they end up taking unnecessary risks. They overtrade the account.

Those who understand the long run aspect of trading will always end up as technical analysts. They’ll buy or sell currency pairs based on technical analysis setups.

But this comes after a clear understanding or markets and how markets function and move. When reaching that point, correlations become obvious.

Two Majors and One Cross

The U.S. Dollar is the central piece in the Forex world. This should come as no surprise.

Our financial system is built on it. Since Bretton Woods, the dollar took the major role of the world’s reserve currency.

Many argue this is a burden for the U.S. economy. Others say it is a privilege. No matter your position, the role of the dollar becomes obvious on the Forex dashboard. It splits the currency pairs into two main categories: majors and crosses.

A major pair always has the U.S. Dollar in its componence. On the other hand, a cross doesn’t.

For every two major pairs, there’s one cross. Just look at the Forex dashboard and pick to currency pairs that have the U.S. Dollar in their componence.

Let’s say, USDCAD and GBPUSD. These are two major pairs. What is the name of the corresponding cross? You guessed: the GBPCAD cross.

The thing is that any one of these three currency pairs can be traded without looking at a chart. The only condition is to have an idea about where the other two go.

For example, if you have a bullish setup on both USDCAD and GBPUSD, guess where the GBPCAD will go? Hint: not to the downside!

Different Correlations to Consider

There are plenty of examples here. Financial products move in a correlated fashion.

The most notorious one is the CAD and oil correlation. This is a direct correlation, in the sense that they move in the same direction.

It is no wonder. The Canadian economy is a highly energy-driven one. As such, what happens in the oil market, moves the CAD currency.

As a rule of thumb, when oil falls, CAD falls too. Hence, the USDCAD pair, the most important currency pair, will rise.

Other correlations to consider: JPY pairs and global equities, USDJPY and DJIA, gold and AUDUSD, and so on.

Conclusion

Whenever someone tells you it’s not possible to open a trade without looking at a chart, remind them of the correlated nature of some products that make the financial markets.

Because of electronic trading and the way the financial system interconnects, a market (like a currency pair) moves based on the imbalances between the other two pairs that affect its liquidity.

 

 

 

How to Hedge a Forex Account

Forex traders buy or sell a currency pair for various reasons. This comes either because of their technical analysis, or of interpreting an economic news. Or, simply they don’t like a currency pair and they don’t want to own it.

For example, when the Euro was introduced, a lot of skeptics gave no chances to the European project. After all, history was on their side: never a monetary union survived the test of time.

Retail traders face some other challenges. They are short-term traders. This means they will scalp their way into a trade, trying to get as fast as possible out of a trade with as big a win as the market allows.

At best, they are swing traders. But no investors. Having said that, at times, the market forces them to make difficult choices.

What do you do, as a retail trader, when you trade the same strategy on different timeframes? One timeframe may give a long signal, another one a sell signal…on the same currency pair. The answer is hedging.

Hedging in Forex Trading

Hedging means going long and short the same currency pair on the same account. If the volume is the same, the account is fully hedged.

For example, if you buy one lot EURUSD and sell one lot EURUSD, the result is a fully hedged account. From this moment on, the balance of your trading account is frozen.

However, the equity will change. One of your trades will end up costing you some money. This cost is the negative swap paid daily.

These days, being short EURUSD pays a positive swap, while being long costs you a negative swap. As a rule of thumb, the negative swap is always bigger. Otherwise, everyone will hedge and make money on the interest rate differential. This in not happening in the real world.

So, the idea is to temporary hedge your account when required. You can be short EURUSD on the hourly chart and long on the four-hour time frame. After a while, the take profit or stop loss on the hourly trade will be reached and the trade closed. The hedge functioned.

Partial Hedging

If the volume of the two opposite trades differs, the account is partially hedged. In other words, the balance will change based on the difference in volume.

Partial hedging takes place for various reasons. One would be to release some margin. You see, when you hedge a position, fully or partially, some of the initial margin blocked will be released.

Therefore, you can use it for other trades. People that must respect strict money management rules sometimes use this small trick.

Hedging in the United States

Due to strict regulations, in the United States, one cannot hedge in a trading account. That’s the regulation.

However, this can be “bent”. Either open multiple accounts with the same broker or a different account with some other broker and follow the same principle.

Trading Correlated Pairs

The best way to hedge a trading account or a portfolio, as a matter of fact, is to trade correlated pairs.

Some correlations in the Forex market are simply amazing. Take the EURUSD and USDCHF pairs. When the EURCHF was pegged to the 1.20 level, the two majors moved in opposite ways, almost identical.

Even now that the SNB (Swiss National Bank) dropped the peg, there’s still a strong, inverse, correlation between the two. Therefore, one can avoid the limitations in a trading account and can hedge a trade via a correlated pair.

For example, if you are long EURUSD, instead of selling EURUSD you can simply buy USDCHF. The result is the equivalent of hedging your position.

Other correlations work too: gold and AUDUSD, USDCAD and oil, USDJPY and Dow Jones…and the list can go on.

Conclusion

All in all, hedging is a great money management tool. Even though in some parts of the world it is forbidden, smart traders know other ways to benefit from it.

Its advantages cannot be ignored. If anything, it represents just another way to diversify the resources in a trading account and to protect it ahead of unexpected swings.