Alan's Forex Blog

How to Secretly Spy on the Market and Determine What Currencies Money is Flowing to for Maximal Forex Profits

Posted: 17 Jul 2010 05:16 PM PDT

Guest blog by Kris Matthews (http://tradeforexfundamentally.com)

What you see is not what you get

When you pull up a chart of the GBP/USD pair and notice that there has been an uptrend, how do you know whether that's due to GBP strength or USD weakness? The answer is, you don't (at least just by looking at the chart). The danger of just looking at a trend on a chart and buying dips or breakouts is that you don't know if the trend is sustainable. In an uptrend, it could be that the GBP is actually weak, but the Dollar is even weaker so the currency pair trends up, but if the Dollar gains any strength whatsoever, you can kiss your long position goodbye. There is simply not enough information in the chart that you see in front of you.

So what to do? You know the basic rule of making money trading forex is to buy low and sell high, right? Either said than done, but it's much easier if we take it one step further and buy strengthening currencies and sell weakening currencies, because money flows from weak currencies to strong currencies, and that's what produces profitable long term trends in forex.

How a currency meter reveals true trends

So how do you buy strong currencies and sell weak ones? By using a currency strength meter. Currency strength meters basically take one individual currency (e.g. USD) and compare its relative performance to all other major currencies (EUR, GBP,CAD,etc.), then they take another individual currency (e.g. EUR) and compare it to all other currencies, and so on, until the performance of each individual currency is recorded. The net result is an indication of which currencies are weak and which are strong in relation to all other currencies.

The chart below shows a currency meter in action (this currency meter is called the "CCFp Cluster Indicator" and is available for free in the MQL4 code database and works with the MetaTrader charting platform). The various colored curves represent the strengths of each of the major currencies with time, and the bold black line represents the zero line. All currencies below that line are considered weak and all above are considered strong. Notice how the red line representing GBP is above the zero line and the USD line in green is below, leading to a Pound rally. It would've made sense to buy the GBP because it was strong and to sell the USD because it was weak during this period.

How do you know a trend will continue?

Notice how the AUD/USD (in the chart below) and the GBP/USD (above) are both making new highs before the violet colored line representing a certain time. If you were just looking at a chart, both looked a good buy at the time. However, if you look at the currency meter, the GBP went below the zero line and became a weak currency while the pair was at its highs, and the pair ranged and soon declined. The AUD stayed strongly positive after this period and as you can see would've been very profitable for bullish traders who stuck around after watching the currency meter.

An effective strategy for winning consistent pips

If you want to use this tool successfully and spot forex profits do the following:

Spot a weak currency and a strong currency on a higher time frame than what you're trading. For example, if you normally trade on the 1-hour time frame, look to buy a strong currency and sell a weak currency as viewed on the currency meter on the 4-hour time frame.
Go back to the lower time frame and make an entry in the direction of buying the strong currency and selling the weak currency based on your entry criteria (e.g. breakout or support/resistance level)
Set your limit order for taking profit to be much greater than the stop loss size (1:2 risk/reward at least) and ride the trend caused by the flow of money from the weak currency to the strong one!

As you can see, forex currency meters are useful tools to see beyond what charts are telling you and allow you to ride trends produced by large flows of money.

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