Fundamental and Sentiment Trading Strategies

Utilizing Fundamental and Sentiment based trading strategies in the Forex market is not typically how retail traders start out their trading career. However, many retail traders who do discover these types of strategies will tell you that this is when they had their "Breakthrough" from being an "inconsistent breakeven trader" to becoming a "consistently profitable trader." We developed this Wiki with the hope that more of our fellow retail traders will have their "Breakthrough".

This Wiki is for informational purposes only. Any financial gain or loss from utilizing this information is at the discretion of the person using it. We are not responsible for any outcome you have from using this information.

Before diving into this Wiki, it is important that you have a good grasp of Fundamental Analysis, Sentiment Analysis and Central banks because many of the strategies and ideas presented here assume that you are aware of these concepts because they work together. Please refer to those very important Wikis if you have not already.

This Wiki is a part of our Essential Forex Trading Guide. Be sure to check that out HERE.

Fundamental and Sentiment Trading Strategies

Let’s now have a look at some examples of strategies that fundamental and sentiment traders use to trade the markets. Specifically, we will show you how you can get to grips with these strategies, learn how to apply them and figure out the ones that fit your personality best.

As with the entire principle behind all our Wikis, our goal is not to spoon-feed you a method that will work 10% of the time that you can blindly trade. This is because as much as that would be lovely that is not how the markets work. What will make you a skilled trader is knowing when to apply a certain strategy and when to stay out of the market. Being in or out of the market should be based on the prevailing sentiment and market conditions which can only be developed through practice and experience trading the markets in real-time.

It’s very important to set your expectations correctly because your trading skills will improve over time with dedicated practice. You should not expect to read this Wiki and be managing millions a few weeks later. It simply does not work like this because your skills will develop over months and years rather than days and weeks... Sorry, but it's the truth. This is no different than any other profession that requires advanced skills. However, by learning successful strategies that are proven you will shorten the learning curve substantially and reduce your development to just the time it takes to practice what you have learned in live market situations.

It’s important to understand that your strategy is not the major thing that will make your trading business a success or failure. The absolute best way for you to learn the process of finding trades and identifying the best currencies will be trading the current session by following along with the news feeds and information sources we have discussed in previous Wikis such as the Trading Tools Wiki. If it was as easy as blindly following a mechanical strategy then 95% of retail traders would be profitable instead of the opposite reality that 95% of retail traders lose money.

Note: All strategies are employed only after the analysis phase is complete. Don’t think that because you have a system you can cut out any of the 4 phases of the trading routine because they are relevant no matter how you execute your trades or what you base your trades on.

How to Trade Risk Events

Day trading is a very good way to find consistent trades that have a high probability and that require smaller stop losses. However, the downside is that you have to be at your trading desk most of the day to find them. This can get very tiring very quickly.

There are other day trading strategies that you can use to find better opportunities days and sometimes weeks in advance. This is the concept of trading risk events.

A risk event is basically any economic release or announcement that is scheduled on the economic calendar that has the potential to be a high impact event. Not all risk events are created equal and some do not move the market even 1 pip while others have the entire trading world in anticipation for days on end leading up to them.

This strategy relies on knowing which risk events to trade which will come through experience but you can shortcut this by following along with the daily analysis that some of the more premium news feeds offer. In that analysis, one of the biggest points is to highlight the tradeable risk events that you should be focusing on. You will also notice that a huge part of the news feed revolves around planning these risk events each day.

What is the process for trading risk events?

There are two main ways to trade a risk event:

1. Trading into a Risk Event

We trade into risk events because this is generally how institutional traders trade them. Many people imagine risk events to be chaos and visualize trading floors in utter panic with everyone running around trying to react to the headline number as it's released with huge amounts of money being made or lost. On some trading floors, this does happen but only on huge and particular events such as the hotly anticipated NFP figure or a surprise interest rate move by a central bank. Generally, risk events are traded in a much more controlled manner with careful planning and pinpoint accuracy regarding entries and exits.

Let’s understand exactly how this works by looking at some examples of how these risk events play out.

First of all, traders will look at the economic calendar and the expected forecasts for the following week on Friday afternoon. This allows them to see what risk events are planned and most importantly how the economists and experts anticipate the results of the releases. Some show a better reading than the previous release, others show a worse reading, and some forecast no change at all. Traders will then use that information to tie it in with the bigger picture.

For example, if we have UK average earnings next Wednesday and it is expected to be much better than the prior reading, and we also know that the BOE have made average earnings one of their key focuses in deciding whether or not to hike their interest rates, it is likely that the market will start buying the Pound into that risk event because it’s expected positive and this makes it more likely that the BOE will hike their interest rate sooner.

The big picture is very important when deciding to trade into a risk event and the general rule is that we need to have market expectations match the overall picture for that currency. For example, if the event is expected to come out better than the previous one and the currency is bullish with the long-term fundamentals then this is a decent reason to trade into a risk event. If the event is expected to be negative or worse than the previous one and the currency is bullish in the long run then there is no real reason to trade into the event and should be left alone under most circumstances.

Once you have the expectation and you know the big picture fundamentals your next step is to try and find as many analyst reports as possible. Analysts are experts at putting all of the information together, creating different scenarios, and trying to figure out the likelihood of something happening or not. They will write interesting articles on what to expect from the upcoming risk event and why they feel a particular outcome is likely. This gives you a final round-up of how the market is viewing the event overall.

Once we have a risk event that we are confident to trade the next step is actually entering the market. As with day trading the news feed the important thing is not so much where you get in but rather that you are in at some point before the day of the risk event itself. If you are correct in your analysis the markets will start moving in the expected direction in the run-up to the event and you can actually book your profits before the event is even released.

As a general rule, the closer to the release you enter the market the fewer pips you should look to make. The goal of trading into risk events is that you should take your profits before the event is actually released so that you save yourself any of the risk associated with holding through a volatile news release.

Of course, if you want to hold on to your trade for extra pips that is fine too. However, if you are only getting in on the morning of the release then you may consider holding through the event because you will not likely have many pips on the table. If you do that then you should always have a day trading size stop in place and if the price is closer to your target than it is to your entry you should make sure that you do not lose pips on that trade. If the risk event comes out as expected then you will likely get a reaction in your trade direction but if it comes out opposite as to what you and the markets were expecting then the price will quickly reverse the entire move that led up to the risk event.

The quickest way to get good at trading risk events is, of course, to practice trading them in real time.

Let’s do a recap on how to trade into a risk event.

• First, you need the forecasts and expectations for something that matches the overall fundamental view for that currency either positive or negative.
• Next you research and check what other analysts are saying to give you extra views and preparation.
• Finally, you need to get into the position as early as possible at the best possible price. Technicals could help with this but you could also use a position splitting technique if you are unsure about getting in at the market or waiting for a pullback. If the trade plays out you should look to exit sometime before the event so that you are not exposed to any more risk.

2. Trading out of a Risk Event

Sometimes there will be no clear expectations for a risk event that we can trade into despite the fact that the event is viewed as important and potentially a high-impact event. In this scenario, we keep a close eye on the event and try to trade out of it instead. This is generally viewed as safer because we know very quickly whether we were right or wrong with our expectations. If we didn’t have any expectations then waiting for the risk event to be released will tell us how to trade it based on the deviation in the number from the expectation.

How can we trade out of a risk event event?

The process of trading out of a risk event is very simple. First, we highlight the events that could potentially impact the markets then we do the same kind of research and determine how anticipated the event is by the markets and analysts. Next, we identify what is a possible deviation from the expected figure that could potentially impact the price significantly.

For example, if an unemployment figure is expected to show a reading of 5.8% then a reading over 6.0% would be considered much worse and potentially worth trading short. Conversely, if a reading of 5.5% came out this would be considered good and worth trading in the long direction.

This does not mean that you want to be trading every risk event whenever there is a deviation. Rather, it’s best to line up deviations with the overall fundamental picture. For example, we want to be waiting for an event just in case there is a positive deviation because this lines up with the overall positive fundamentals that is driving the currency right now. The opposite is true for currencies with a negative view on them; we would be looking for negative deviations on high-impact events.

While you are learning it will pay dividends to really make sure that you are getting as much analysis from the premium news feeds as you can because they will walk through the plan of each risk event each day. The news feed will contain detailed plans and research for every major event that you can use to help with your trading. This makes it very important to get a trial of some of the various news feeds and consider factoring in the cost of this to your business plan.

The general rule for trading out of risk events is taking advantage of unexpected deviations from what the market is expecting. Of course, you cannot plan these because they are unexpected but it is certainly worth being at your desk when the releases come out so that you are ready to take advantage when this type of event does occur.

Now that we have a collection of short-term strategies the next thing to do is to start zooming out a little bit and look at ways to trade the markets without being tied to your desk if that is the path that you wish to go. It’s worth having a good understanding of how to trade in this way for when you potentially manage much larger funds that requires more careful trade management.

How to Trade Upcoming Risk Events

After you have your assessment of the fundamentals look for an economic event that is expected to be better than the previous number to be released. If the fundamentals are not looking so great then you would be looking for the economic event to come out worse than the previous.

As long as the number is expected to come out in line with the fundamentals traders can place a trade before the figure comes out in line with the fundamental outlook. If we are looking at a positive fundamental situation and the economic number comes out in line or better than expected the pair will likely rally in the direction of the fundamentals. However, if the number misses expectations we will probably see a decline against the big picture.

The point is that the big players in the market are placing their trades in accordance with the long-term fundamental outlook. One figure that is counter to this outlook will not change anything in a series of many figures in line with the fundamentals. All this deviation will do is simply provide a better place for the professional traders to get back into the market at a better price. In this case, we should expect the market to continue back in line with the fundamentals shortly after the figure is released if the figure was not in line with the fundamentals.

In essence, you potentially profit by getting in before the event even if the event does not come out as expected. In this case, you will have to sit through some drawdown but the idea is that if the fundamentals remain intact then this drawdown will be temporary and price will eventually come back. This also gives you an opportunity to add to the trade when it has pulled back against you. However, you should not already have a full risk amount on the position if you are planning on adding to your position if the price goes against you. Your trading plan should detail this.

The goal is to get in at the best possible price so adding intelligently to a position at a better price isn’t a bad idea. Of course, solid money management should be used and this type of trade should only be employed by traders that have plenty of experience in the markets.

How to Trade with Central Banks

The big traders in the Forex market are all trading around the Central Banks of individual countries. The market will react every time a central bank takes action by implementing a policy or mandate or even when they say something in or out of tune from their normal rhetoric. It could be as simple as a member speaking more hawkish or dovish than they normally do.

If a central bank has recently changed its tone, just the mere mention of something such as inflation, could completely change the overall trend of that currency.

The primary role of the central bank is to control the money supply for the country in which it sits and maintain economic order. To do this the central bank will have targets which usually revolve around inflation and growth, both of which are usually around 2%.

Central Banks will typically offer forward guidance to the markets for 2 reasons:

• To prevent unnecessary market crashes or panics about what the bank might do, which is caused by speculation in the market.
• To ensure that their actions and policies have a desired effect. For example, if they are deliberately trying to weaken their currency then they will make it explicitly clear to the market and outline how they intend to do this, followed by expressing their determination to do this no matter what happens.

The key rule of central bank tools is that everything revolves around interest rates. A large part of the time all the markets are thinking is "How will this new information impact interest rates?" The answer to that question is what drives prices up or down.

Process for monitoring central banks:

1. Follow the news feeds and look out for articles written right after any major central bank statements that give an insight into how the markets are reacting to this information, and how you might best trade it.
2. Central banks release all of their policy actions and plans via specially planned statements. You will find when these statements will be released on the economic calendar weeks in advance, so you will need to be noting the dates and then monitor all related news articles to get an idea of what traders are expecting and how analysts expect these events to move the currencies.
3. Place your trades in line with expectations and existing market reactions. Do not become scared out of your positions by the short term volatility. Closely monitor the fundamental situation and make sure that your expectations and previous reasons for entering any positions are still valid on a session-by-session basis.

How to Trade Central Bank Statements

Trading central bank statements can produce large price moves in the market and be extremely profitable if you know how to catch the move.

There are 2 main ways to trade a central bank statement:

1. Analyse the market expectations and position yourself before the event:

By entering before the statement you have a much higher profit potential but the risk is higher if it does not play out as expected. The key is to have a very firm expectation regarding the upcoming statement. If there is a firm reason to think that the central bank will announce some type of action with regard to its monetary policy or if they change their tone of language then this will almost certainly move the market if it happens.

2. Wait for the central bank to confirm the market's expectations and then trade the aftermath

This is where you look to trade the pullback after the news rather than getting in before the event. The key to this strategy is to be patient and wait for price to pullback to an attractive level.

How to Trade Upcoming Economic Figures

Trading the calendar can be very profitable and the key is utilizing and understanding the information and the expectations available well ahead of the figure or event being released.

When deciding whether or not to trade an economic figure, traders need a deep understanding of the ongoing fundamentals, the current sentiment, and what the market is expecting from the figure.

For example, if the fundamentals are extremely bullish for the currency and the figure is expected to come out worse than the previous one, this would generally be a trade to avoid, because there is a contradiction between the fundamentals and the news event.

What we want to see is the figure to have expectations that are in line with the fundamentals. We want the figure to be better than the previous one if the fundamentals are bullish. In this situation, there is a good chance it will happen and the market will look for excuses to keep buying the currency in line with the buying that has already taken place.

If the figure doesn’t meet expectations it will likely pull back. The fundamentals will still remain intact because one bad figure in a long-standing series of positive figures doesn’t change the long-term outlook for that currency. The counter-trend move will most likely be temporary and the price will soon recover, likely sending the trade into profit anyway. This is the kind of situation that gives us a nice pullback to get in on and make some pips. This will be the case unless the deviation was so large that we have no choice but to reevaluate the fundamentals. This works in the same fashion for weak currencies. We would simply look to sell or go short instead.

Positioning yourself directly ahead of these events is more risky, but as long as you only trade in line with the fundamentals, drawdowns will likely be temporary. Waiting for the figure to pullback is another way to get in this trade but can be trickier and requires a higher level of skill and patience. Sometimes the price doesn’t come back if the deviation on the figure is big enough to force market participants to rethink their game plan.

How to Trade the Previous Session

There are 3 main sessions that we have already learned about in a previous Wiki where you can find all the details HERE. They are:

• The Asian Session
• The London Session
• The New York session

This cycle repeats for the entire 5-day trading week making it a 24 hour market.

What you are looking for is what has happened in the previous session that has moved the markets. Sometimes nothing happens but oftentimes a country has released an economic figure that affected the currency that it belongs to in the previous session.

What often happens is that traders from the new session will trade the continuation of the move from the previous session.

One strategy is to enter in the direction of the move from the previous session slightly before the next session is in full swing. In this way the trader can catch any potential move before or as it starts to continue.

This strategy is simple and mainly a sentiment based strategy where traders look for anything that has moved the price of a particular currency in the previous trading session to continue moving it into the current and possibly following sessions.

The trade begins with a thorough assessment of what has happened in the previous session, which news has been released, how it impacted the market, and which currencies were affected. Tradersthen determine whether or not to anticipate this move to continue in the new session based on what has already taken place.

For example, if some key Australian data was released during the Asian session but the AUD currency was unaffected then it’s very unlikely that traders will look to get in on a trade with the Australian dollar in the following session. On the other hand, if the event came out and showed a large deviation and the price of the AUD moved heavily, then we can expect traders in the next session to get in on the move too.

This strategy relies on having a real-time news feed that updates the market sentiment instantly. With both entry methods, it is important to keep your eye on the news feeds for any events that could change the sentiment and send price moving in the opposite direction.

There are 2 ways to trade this type of event:

1. Trade the Breakout: This can be done with a Market Profile Trade because it may be that price is close to the highs or lows. This allows you to enter the move should it simply continue into the next session with little or no pullback. The Market Profile Trade can be found in the Technical Trading Strategies Wiki.
2. Trade the Pullback: Often times the market will take a break between sessions and the price will pull back against the move as profit taking happens. This can provide some great trading opportunities from levels of support and resistance, but patience is required to wait for the correct pullbacks.

Trading Surprise Data and News

Another strategy that you can use is one that has a high probability of success and is also simple. The caveat is that it can only be used when there is an extreme deviation or surprise that the markets absolutely did not see coming.

The easiest way to see whether or not this has occurred is to research each risk event and find out what the market is expecting so that if the opposite happens you know that it will cause a large sustained reaction. The key word here is sustained because lots of minor deviations cause reactions but these are typically quickly retraced and within a few hours things are all back to normal as if nothing happened at all with the exception of a spike on the charts. Lots of new and retail traders get sucked into those moves and end up buying the top or selling the bottom only to watch the market move against them and stop them out.

An example of a time that we can apply this trade is when a central bank announces a rate adjustment when the market was expecting no change. In these circumstances, it’s hard to see a trade ever losing but these instances are also rare. However, you must act quickly because you can't sit and watch the move take off or else you will miss a good portion of the price extention.

Another example is if something really unexpected happens completely out of the blue. For example, if a central bank member was giving a speech and then said something totally unexpected and out of character this would also get the market moving in a sustained manner. This is because if a central bank member deviates way out of line then there must be something happening in the background that we have not been made aware of yet and this deviation is the first indication of new things to come.

This trade setup should not be used on small data points that have a deviation from the expected figure because it is better to trade those on pullbacks.

We also need the sentiment at the time in the right order to get any kind of tradeable move such as positive sentiment that is suddenly and instantly changed to negative from whatever the news was. As long as the event was extremely unexpected and had a direct impact on the expectations of the market for the central bank's monetary policy then you are probably good to consider this type of trade setup.

There are a few methods for taking advantage of this. One simple technical setup is entering the market right before or at the close of the first 5 minute candle after this surprise event has taken place. Stops can be placed either at the halfway point of the candle or just above or below the 5 minute candle away from your entry. This will be something that you perfect over time with practice with this type of trade.

You can also test out if using a 1 minute, 3 minute or any other timeframe has better odds of success with your entry and stop loss placement. With anything you need to test out what works best for you. We are simply offering general ideas here.

Targets should be based on normal things such as old highs or lows and the average daily range of the pair. You can also hold for longer if there is a strong fundamental reason supporting the move and the market has a clear expectation of where the price of the pair could get to in the long run. The main point is that you should be getting in within at least 5 minutes of the initial event to ensure that you make some pips from it. This requires you to watch and listen to the news feeds intensely but when you get a few trades like this each month it will be worth it.

Trading with the News Feed

Most traders working at professional firms become day traders because this is a good combination of regular trading activity while keeping risks limited. The news feeds are the main source of all our information and trading opportunities. Without these feeds you would be effectively trading blind so we will now look at finding trades that come from the news feeds each day.

Day trading the news feeds is actually fairly simple and is one of the best ways to find high quality trading setups. Day trading is not as precise as trading and scalping key levels because the main thing behind a successful trade is not the place that you enter but rather the reasons for the move.

Let’s walk through a typical day of scanning the news feed to get an idea of the type of things we are looking for.

Your analysis starts an hour or two before the session opens as you are reading the overnight or pre-session news and you are looking for core items that traders getting to their desks are likely to react to. This does take practice to master but the golden rule of sentiment is that the more something is known the less of an impact it will have on the market.

You are looking for surprises or changes in the tone from central banks or even breaking news that could change the markets view on a specific currency or how the central bank may approach its interest rate adjustments in the future. If you see something of note then the next step is to plan your trade.

At this point, you may have found a trade and you can either jump straight into at the current market price or try to wait for the price to pullback to a nearby level of support or resistance. The risk of jumping in is that the price might pullback first and you could potentially be sitting in drawdown which means you will need a larger stop loss to accommodate for this. The risk of waiting for a pullback is that you might miss the move simply because there may not be a pullback given a clear reason to trade it from the open.

How do you decide what to do in this scenario? The best way to know how to react to the details of market information is simply practice and experience... Sorry, but that is simply what any profitable trading strategy is going to come down to; Practice and Experience. For example, the first time you see a safe haven flow you may think that the market has gone too far too fast but it then continues for several hundred more pips before thinking about pulling back. We can sit here and tell you all about how aggressive proper safe haven flows tend to be but until you have actually seen one in full force in live market action you won’t fully understand the concept.

Remember, you are now past the training stage and as soon as you start placing trades on your practice account you will be at the skill building stage which is where you will develop your experience. One of the best ways to build your skills is to practice them in the live markets as much as possible.

Trading Tip:

One tip to help your trading in the early stages is to split your position into two pieces. You can enter one at market and enter the other at your proposed area of support or resistance should the pair pullback to that level. This gives you two chances to jump into a trade but only risking one full unit of risk. If the trade takes off straight away then you get to at least make a half profit and if it pulls back you average your positions at a slightly worse price than the area of support or resistance would have offered but you still are only risking one unit of risk on the account.

This is only a starting technique to assist you in the early months because after a while you will start to see a pattern in your trading that will give you a natural confidence of when to trade and place your orders. This will give you a nice day trade that you can hold as the session plays out. Because you are tracking every trade this will also give you lots of data to look back over to see if over the long run if it would be more profitable for you to jump straight in or wait for the pullback.

Obviously, you will need to have a stop loss in place and a take profit in mind. Generally, you want your stop loss orders to be between 25-50% of the average daily range away from your entry and your target should be where the market has reacted from in the most recent sessions. It’s generally not effective to try and day trade past an established high or low because this will result in losses and not cashing in on good trades at the appropriate times. The best technique is to take your trade off just before the top or bottom of these levels. It is never wise to think the market will make a new reaction high or low unless there is something extreme happening at that time.

What happens if you do not see a trade at the open of the session?

You keep watching the news feed and switch to a mode where you are looking for surprises or comments that the markets are not expecting but will view as fresh reasons to trade a pair in a certain direction. These come through as headlines and there are no set standards of news or phrases we can list but the golden rules of sentiment are key here.

Generally, we are looking for an announcement from a central banker or comments from someone else closely related. For example, look for things like a dove commenting that rate hikes should be coming sooner or a hawk stating that there is a strong reason for rate cuts. These are things that can be perceived as out of line with their traditional stance.

Typically, the premium news feeds will have a list of the current hawks and doves for each central bank as part of their service. However, you can get a list by doing a Google search just as easily.

This is something that you will get better at over time so we suggest that you make this one of your staple strategies and start practicing it straight away. By keeping your eyes on the feed for these types of comments or for breaking news that could cause the markets to panic and buy safe haven currencies you will start to see trade opportunities almost daily as the headlines appear and the prices react.

As you can see, day trading the news feed does not always apply to some of the technical concepts we have talked about in other Wikis. The main focus is on the fundamental or sentiment reason for the trade rather than where you should specifically get in or get out. It is very important to understand that trading with the fundamentals or sentiment is not something that can be turned into a mechanical system or method that you do blindly over and over again. Rather, it is something that you will get better and better at over time by applying the correct concepts and then practicing and learning from each trade you take.

To get a good feel for how this plays out let's go to the feed and look at the kind of things that we could use to find a possible trade opportunity to give you a good starting point.

How to Scalp Using Real Time News Feeds

The concept of scalping the real time news feeds is that you intensely monitor the news feeds for any information that could change the current market sentiment and drive the price of a currency over a short period of time within the trading session.

The kind of news that you want to look out for are:

• Comments from central bank members that have a different tone from how that specific member usually talks. For example; dovish comments from a central bank member that is known to be hawkish.
• Another would be a geopolitical event like war.
• Debt ceiling issues.
• Political leaders saying things that can change the amount of money withing the economy such as new bills or legislation.
• Pandemic concerns.

The key here is the market needs to have its expectations abruptly changed in the short term. These news trades are short term trades looking for 10-40 pips depending on how large the average daily range for the pair is. The larger the range of the pair then the more potential pips there could be in a scalp trade. The smaller the average daily range of the pair then the fewer potential pips there might be in a scalp trade.

In order to trade these you simply need to know what is normal to the market and what is not normal and that means you need to be in tune with the market. This will take time and experience in watching how these real time news events play out.

Trading Fundamental Pullbacks

Trading fundamental pullbacks is probably the simplest strategy of all and basically involves patiently waiting for the short or medium term sentiment to change the flow of the price away from the overall fundamental trend.

A classic example of this can be taken from the example we used earlier when in 2013 the BOJ’s decision to launch its QE program. This had the effect of the severe weakening of the Yen as the BOJ printed trillions worth of Japanese Yen every month in an attempt to get inflation up to its target range. At the same time, the Federal Reserve in the US was about to stop their own QE program and start the long march towards raising interest rates and normalizing monetary policy. This gave the perfect divergence between two central banks both moving in completely opposite directions with their monetary policies. One central bank was starting and the other was stopping QE. When this happens there can only be one way that the USDJPY will go which is up provided all else remains equal.

As traders, we would buy dollars and sell Japanese Yen. However, it’s not as simple as the pair moving up every single day. There are short term events that will cause the pair to drop and sometimes quite heavily. Let’s look at one example of this and how it affected the pair during this time.

At the beginning of 2014 we had a crisis in emerging markets as traders started panicking about the fact that the Fed was ending its flow of cheap money via QE. They reasoned that this meant that emerging markets would suffer as the investment from that cheap money would dry up. The equity markets went into a chaotic freefall and everyone headed for the traditional safety of the Japanese Yen.

Despite overall fundamentals being in place the short term move saw the USDJPY drop over 450 pips as highlighted by the blue box on the chart below. This was quite a large move given how strong the central bank divergence was at the time. However, when the market is fearful it will react strongly. The USDJPY eventually recovered and reached over 125.00.

Other Yen pairs such as the GBPJPY fell as much as 1,000 pips as everyone bought the Yen as a temporary safe haven. Many traders also panicked out of their long term fundamental positions but other traders had been waiting for this type of event. The reason was that they now had a really cheap price at which to enter the trade and ride up the move as the markets calmed down and regained their rational thinking and returning to the central bank divergence trade.

This type of trading requires patience and focussed research but can yield fantastic returns if you can keep a cool head when the rest of the market gets sucked into some temporary story that will not last longer than a few weeks.

If you are already in a long term fundamental position you should have your stops in place because you never know how far the market will move against you as not many people can stomach 10-20% drawdowns especially if they are managing client accounts. At the same time make sure to plan ahead. Perhaps you could identify a few key price levels that look good to get back in if the market gives you a chance.

The Yen pairs are generally more volatile than most because of the safe haven element but these types of pullbacks will happen across all currencies for reasons as simple as traders exiting their trades and taking profits.

The best way to approach this type of trading is to do your daily research as normal and then relate this to where the prices of various pairs have been trading over recent days or weeks. You will naturally notice that some pairs are just not where they should be trading and in the completely opposite direction based on the policies of the two central banks. When you see this it’s time to zoom in on the pair and find out exactly why it has been moving as it has using the research and news feeds. If it is due to some temporary event then you can consider this an opportunity to enter the pair. Splitting your entries could be used to enter which is a perfectly valid method for your trading as a whole.

What questions you should be asking when investigating an opportunity?

When the short term sentiment is over will the fundamental divergence between the two central banks still be in place?

If the answer is yes then you need to start planning your entry and identify the best time to start getting involved in the market. There is no perfect time because anything can happen at any time which is why we go to great lengths at making risk management a large part of everything we do. This way, whatever happens in the markets we are protected.

If you are day trading then you will naturally see these opportunities as well but please do not feel that you should only be trading a specific strategy for your system. Remember, trading is about finding opportunities. If you find gold in your garden you wouldn’t leave it in the ground because selling gold is not your method of making money, you would seize the opportunity and make the extra money. The same is going to be true of your career as a trader. Your job is to seek opportunities to make money and everything that you have learned here will help you spot these opportunities like a professional. As you trade and practice these skills the amount of money you make will gradually increase over time.

Trading Pullbacks against the Long Term Fundamental Trend

Once you have determined which currencies should be moving in which direction you then wait for these currencies to move in the opposite direction that they should be moving. Essentially you are waiting for a pullback to happen against the overall big picture.

Pullbacks against the long term fundamental picture can happen for a variety of sentiment reasons that we have already looked at in our previous Wiki on Sentiment Analysis. Some of the more common reasons are profit taking, risk on risk off, safe haven flows, etc.

Marking key levels of support and resistance can give you great ideas and potential entry points of where to get in when price is running against the fundamentals.

As long as the move counter to the fundamentals has not changed the overall fundamentals and is just short term sentiment or profit taking move then the trade in the direction of the overall fundamentals is still valid.

This style of trading takes a lot of conviction to hold against the current market move. Traders will need to have a lot of patience to wait for the right moment to enter.

Positioning Yourself with Medium Term Sentiment

Positioning yourself with medium-term sentiment is basically using any reason that we could have to hold a position over a period of one to a few weeks. A classic example of this is when we have an upcoming event that the market is hotly debating and really excited about.

If we imagine that there has been an article written by a respected FED watcher that indicates that the FED may be about to cut interest rates at their next meeting and the reason he has given makes sense and matches up with the recent data pretty well. If the market has taken this seriously it will very quickly appear as a headline in most of the major news feeds and will gain traction as a market moving story.

In cases like this what will tend to happen is that the currency will move in line with what the FED watcher said right up until the next meeting as outlined in the article. The caveat is that the market must believe this information and the more traction the story gets in the news the more likely that the market is to trade it.

This is just a simple example but there are many other things that can sway short and medium-term sentiment in the Forex market. This can be anything from a global financial crisis, a military conflict between major nations causing safe haven flows, to something like a set of data points causing economists to downgrade their assessment of an economy and calling for the central bank to act. The point is that we have some very solid reasons that the rest of the market is also paying attention to.

Remember, in order for us to make money on our trades we need the price to move in our direction after we have entered and this requires the rest of the markets to be on board with that trade. We don’t want to be the only person looking at a piece of information and doing so will not give us an edge. We need the large players to be in the same trade so that we can take advantage of them pushing price in our direction.

A good way to get trade ideas for medium-term sentiment is following the news feeds and looking out for trade alerts from major investment banks, brokers, or analysts because they almost always trade medium term sentiment. This type of trading allows plenty of time for analysis and trade entry but does require larger stop losses than for day trading which could potentially be 100% or greater of the average daily range for the pair. At the same time, it can be a much less stressful way of trading that stops you from getting sucked into the intraday noise associated with scalping or short term trading.

Trading medium term moves requires a lot of discipline because if you are going to be sitting at your desk anyways then this has the potential of getting in the way of you objectively monitoring the overall picture and could potentially impact your performance. It’s worth thinking this through before trying to integrate medium term sentiment into your regular trading.

As you have probably guessed, this type of strategy does not require too much technical analysis for your entries, stops, and targets as these can all be based on bigger picture items that we will look at next.

Carry Trading

There are other reasons to trade a longer term approach and one of them is for the carry interest that you will receive for holding a certain currency pair in a certain direction.

Carry trading is a very interesting proposition because it gives two incomes from one position in the market. The first is the interest paid to you for holding the position and the second is the capital appreciation you get when the market moves in your favour.

If you buy a currency of a country with a high interest rate against a currency from a country with a low interest rate then you will effectively earn the difference between the interest rates from each country. The opposite is true if you sell a higher interest currency against a low yielding currency then you will have to pay the difference each day at rollover.

To simplify this further, imagine that you took a loan from a bank that charges you an interest rate of 2% and then deposited that money into a bank that will pay you a higher interest rate of 5%. The difference is 3% and that is what you can keep as profit in this example.

Another great thing about carry trading is that lots of other traders have the same idea. If you can get in at the right time it can become a low risk trade. Other traders and institutions will want to get in and as a result drive price in your favour with each new trader jumping in on carry trade positions.

Carry trades should be approached over a period of months and it is also worth splitting your position into 3-5 pieces and planning your entries based on where the price may go over those coming weeks or months. Splitting positions will take the pressure off trying to pinpoint an entry in such a long term position.

Currency prices can be volatile so instead of viewing these price swings with fear you need to train your brain to view them as exciting opportunities. So you can get in at the market, receive some interest, and also plan where you will get in again if the price moves in your favour or against you in the short term.

Exiting the carry trade can be the trickiest part because we are not sure when the move will end. The reality is that carry trades can literally play out over years until something major shifts in the underlying fundamentals and causes a sharp unwind of those positions. Traders hate pain and losses so anything they consider to be a concern they will react to. However, these episodes can also be viewed as an opportunity because traders almost always overreact to good news and bad news alike.

When you see the price hit all-time highs be cautious and when you see prices plummeting despite nothing really changing fundamentally you should be figuring out how to take advantage of this opportunity and get in at a better price.

Generally speaking, splitting your trade over the course of a quarter or even a year can be a good way to time your entries and exits. There is nothing wrong with planning your year around a single trade and waiting patiently for prices to give you an opportunity to build your position. This is strictly position trading and is almost impossible to conduct if you are also day trading at the same time. The day-to-day noise going on in the market might just be too much of a distraction.

If you are a day trader and do want to carry trade also then simply do it on a separate account from the one that you are day trading in and that you do not even open during the day.

You can see the current interest rates that each central bank currently offers by using the internet resources that have already been provided or doing a quick internet search.

Let’s take a look at how the price can move in a carry trade and how you can plan your positions to take advantage of these moves.

We are going to take a look at one of the most famous carry trades in recent years in that of the GBPJPY pair. This carry trade lasted roughly from the beginning of 2000 all the way through to the global financial crisis that kicked off in mid-2007. If that crisis hadn’t happened the trade would have continued on and on until the interest rate differential changed.

You can see on the chart above that we have marked with red vertical lines where the trade started and finished on the monthly chart as it continued to climb higher year after year.

At the time the UK had interest rates between 3.5% and 5.75% during this time period while in Japan the interest rates were between 0% and 0.50% during the same period of time. This meant that no matter what happened investors would gain at least a positive swap of at least 3% and sometimes as much as 5.75% per year by holding this pair long.

Carry traders know that many other traders and investment funds love this kind of trade and the very fact that this type of trade attracts more buying than selling they know that there is an extremely high probability of the price moving higher over the long run too which means their trade goes up in value on top of the really nice interest rate swap.

The rates were so low in Japan because they had been going through at least a decade or more of crippling deflation while the UK had a vibrant economy with positive prospects. This set the stage for this popular trade to buy and hold the GBPJPY which rallied over 9,000 pips in 7 years as more and more traders and investment funds piled into the trade to seek a nice positive swap and the capital appreciation from the price going up.

There were of course large pullbacks along the way but as long as the central bank divergence held then the trade would always come back until the financial crisis hit which changed the overall big picture for the two currencies.

One of the cardinal rules with a carry trade is that you absolutely do not use leverage because if there is a large pullback you could very easily wipe out your trading account on a trade that was still good.

Trading Strategy Summary

Before you place any trade you need to have these questions answered and fully understood.

What is the cause of the move?

• Use the tools to determine what caused the move (Bloomberg, Newsquawk, ForexFacorty, etc.). The real time news feed is usually the best for short term trading.

What are the Fundamentals?

• How does the current move match or line up with the fundamentals for that currency?
• This helps to determine if the move is in line with the fundamentals or if there is a short term counter trend sentiment trade that may allow us to get in at a better price.

What is the Fair Value of the currency?

• Determine the last extreme high or low that happened while the current fundamentals have been in play.
• The fair value is the previous extreme high ( uptrend) or low ( down trend) as long as the fundamentals have not changed.

What is a good entry price?

• You compare where the current price is to where the fair value price is. If there is a large enough difference between the prices then it could be a good potential entry point.
• You can use the trading tools combined with trade setups with the technical strategies as well.

What is the current sentiment?

• After you have answered all the questions above it will be easy to determine what the short term sentiment is and whether it is in line with the fundamentals or not.

Keys to Successfully Executing Trading Strategies

Conviction:

• This is the key to successful trading...Period! Without conviction in your trading it will be virtually impossible for you to successfully executing your trading strategies. Please take the time to read our Wiki about Conviction in your Trading HERE.

Knowledge:

• Always increase your understanding of the markets because knowledge leads to confidence which leads to conviction.

Fundamentals and Sentiment:

• Focusing on these will lead you to the knowledge of what actually drives price movements in Forex.

Tune In:

• It’s not enough to just scan the news now and then. You must be constantly focussed on what is moving price and how the fundamentals and sentiment are playing out every day.

Do Not Overcomplicate Trading:

• Trading is a simple process that you get better at over time with practice and experience.

How to Tune Back into Trading

As traders, our job is to constantly be tuned into the markets and understand what is going on and how to make a profit from it every single day. This is a simple case of remaining within the flow of information, but this process can become very tiring and mentally exhausting over time. Taking time to remove your mind from this flow allows relaxation and recovery which can re-energize you for the months ahead.

Coming back from a break you should be eager to return to your desk and get back into that flow of information which allows you to earn your pips effectively. This section is designed to explain exactly how to tune back into the market so that you are fully prepared for trading and to ensure that you are not missing anything that may have changed during your time off.

How exactly do you tune back into the markets after time away from trading?

Research:

The key is to research and read all of your preferred news sources with the goal of making sure you fully understand what has been going on and what the current tone of the market is. To do this you follow a very simple plan which is laid out in this section:

When returning to your desk you should load up your saved bookmarks of financial news sites and spend plenty of time reading through the posted material. So the first step is to open up your news sources and start reading.

The best free sites are below for your reference and it is strongly recommend that you bookmark each one for future reference. There are also premium sites that you can use that are good which include Newsquawk, MNI, and Reuters Eikon.

These are the sites that you should read every day as part of your normal trading routine:

• http://www.forexlive.com/
• http://www.bloomberg.com/news/currencies/
• http://www.forexfactory.com/calendar.php

What are the exact steps you should take when trying to catch up with what has been going on?

Step 1:

The first step is to read the main feeds of each site for all of the highlights that stand out. For example, all of these sites offer a fantastic ‘front page’ where you can check out all of the recent activity and news that is currently impacting the markets.

One of the best parts is that they also offer analysis and opinions about each event so that you can start to build a picture in your mind of what seems to be going on across the market rather than trying to figure out if one article is more important than another. We are looking for a general theme that ‘everyone’ seems to be talking about.

Step 2:

Once you have read through the headlines you will then click and read each article in full that stands out so that you can get a real flavour of what is being said and how it has been moving the markets. This allows you to determine what is important and what is to be ignored. This might take a day or two to tune your brain back into the market but that is completely fine and it will be well worth your time.

Step 3:

You will now have several currencies that stand out to you and that you can focus on heading into your first day back at trading. The final step is to make sure that you read any new articles or news points that are released between now and your first trade to make sure that the themes are intact and that you are tuned in correctly.

If you have traders around you that trade in the same way it would be good to chat them up to see what the main things that they have been focussing on while you were away from trading.

Conclusion:

As you can see the process of tuning back into the markets is relatively simple and although you could spend significant amounts of money on premium feed there is a lot of information out there for free. The only thing that the premium feeds do is deliver the information faster which is not necessary when you are tuning back into the markets.

By replicating this process you will be fully prepared and ready to start making some pips.

Related Wikis

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• Pre-Trade Considerations
• Technical Trading Strategies
• Best and Worst Times to Trade
• Having an Edge in your Trading
• Essential Forex Trading Guide