By James Chen, CTA,CMT

The Official Advocate for Personal Investing Originally published JANUARY 2011. SFO magazine.

FX Chart AnalysisTake 2

One primary characteristic of trading forex differentiates it mark-

edly from trading in all other major financial markets. This is the

pairing requirement. Only the spot forex market, in contrast with

equities, commodities, bonds and other markets, requires each

trade to consist of two entities rather than one.

In the forex market, traders have the singular ability to

buy strength while simultaneously

selling weakness, thereby increasing the robustness of their directional

bias within a single trading position.

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The fact that currencies in the spot forex

market must be traded in pairs is a key ad-

vantage, especially when this characteristic is

combined with multiple timeframe analysis.

THE MAJORSAll currencies, including the major ones—

U.S. dollar (USD), euro (EUR), Japanese yen

(JPY), British pound (GBP), Swiss franc

(CHF), Australian dollar (AUD) and Ca-

nadian dollar (CAD)—cannot be traded in

isolation. Rather, they must be traded in

standardized pairs such as EUR/USD, AUD/

CAD or CHF/JPY.

USE THE EDGEOnce you understand the mechanics of trading

currencies, you should use this characteristic of

opposing currencies to your advantage.

The best method for accomplishing this is

through the use of strength and weakness

pairings. More specifically, you should pair the

strongest currencies with the weakest curren-

cies—long the strong and short the weak.

This pairing of strength and weakness

extremes fosters magnified directional

strength. Trend traders in all financial mar-

kets tend to buy strength or sell weakness.

In the forex market, you have the singular

ability to buy strength while simultaneously

selling weakness, thereby increasing the

robustness of your directional bias within a

single trading position.

HOW DO YOU PICK?The theory of strength and weakness pairings

may be logical, but the practical application of

identifying strength and weakness in currencies

can pose a challenge because you can accom-

plish it in several ways.

Although there may not be a best method

of spotting strength and weakness, perhaps

the most objective and accurate way, which

excludes all opinions, analyses and shades of

gray, is via price change.

More specifically, it is the percentage price

change of a currency, whether positive or

negative, during a given timeframe against

other currencies that makes such relationships

clear. This measurement provides an objective

and accurate gauge of a currency’s strength or

weakness against others.

To give a simple example of this method

for gauging currency strength and weakness,

suppose you want to determine the recent

strength or weakness of the U.S. dollar against

all other major currencies. You could take a

look at a chart of the U.S. Dollar Index, which

is a measure of the dollar against a weighted

basket of foreign currencies.

This would suffice for the greenback, but you

have little in the way of an equivalent for the

other major currencies.

Therefore, to employ a consistent compari-

son across currencies, the clearest and sim-

When trading these pairs, you must keep

in mind that buying (going long) the pair is

equivalent to buying the first currency (base

currency) while simultaneously selling, or

shorting, the second currency (counter cur-

rency). Therefore, a long EUR/USD position,

for example, would consist of a simultaneous

long euro position and short dollar position.

Conversely, a short EUR/USD would consist

of a simultaneous short euro position and long

dollar position.

You can also perform the multiple timeframe analysis on other major currencies. When this is complete, you should have strength and weak-ness data for all of the major currencies across three different timeframes.

Practically speaking, if you are to perform this analysis continually, you should employ some kind of dynamic database or spread-sheet that performs these calculations on an automatic and ongoing basis, rather than

subjecting yourself to the laborious process of manual data entry.

Once the strength and weakness data is ob-tained on an ongoing basis for the different cur-rencies across various timeframes, putting this information to practical use simply becomes a matter of waiting for the timeframes to agree in terms of identifying the strongest and weakest currencies for potential trading opportunities.

Use a Spreadsheet

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plest methodology is to take each currency

in question and compare its percentage price

change against those of the others for a cer-

tain period.

TAKE AN AVERAGEIn the example of USD, you can take its

change in price against EUR, JPY, GBP, CHF,

AUD and CAD for a week, for example, and

then take an average of these percentages.

You can use the resulting average percent-

age as a measure of the relative strength and

weakness of the dollar.

Although this methodology does not weight

each currency differently in the average,

as the U.S. Dollar Index does, it suffices for

providing a relative strength and weakness

measure among currencies.

You can use this same system simultane-

ously to measure the average percentage

price change of each major currency against

all others. After you obtain this information,

you can formulate a hierarchy of currencies

from the strongest to the weakest according

to each currency’s average percentage price

change for the given period.

The best way to perform these simple cal-

culations on an ongoing basis is through the

use of some type of spreadsheet or database,

where you can enter currency pair prices. This

simplifies the ongoing process of strength and

weakness comparisons tremendously.

MULTIPLE TIMEFRAMESOnce you establish the methodology for com-

paring currencies on a strength and weakness

basis, you can introduce the critical element of

multiple timeframe analysis.

There is essentially one primary condition

that you should seek when trading from mul-

tiple timeframe perspectives. That condition

is agreement.

There are often different trends and other

price action phenomena on various timeframes.

But when agreement occurs on several key time-

frames, a higher probability opportunity arises

both to assess correctly the directional bias as

well as to optimize your trade entries and exits.

As an example of this multiple timeframe

strength and weakness analysis, suppose you

want to assess currency strength and weak-

ness for three timeframes. For the purpose of

simplicity, you could choose weekly, daily and

hourly timeframes.

Once these are selected, you can initiate the

process for assessing strength and weakness

among currencies.

For JPY on the weekly timeframe, for ex-

ample, this would entail measuring the per-

centage price change from exactly one week

Copyright 2011 by Wasendorf & Associates Inc. All rights reserved. No part of this publication may be reproduced or transmitted in any form by any means, electronic or mechanical including posting to another website, photocopying, recording or by any informative storage and retrieval system without the written permission of Wasendorf & Associates Inc.’s President.

This article is strictly the opinion and conjecture of its writers and is intended solely for informative and educational purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. This article is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Information is obtained from sources believed to be reliable, but is in no way guaranteed. Further, there is no guarantee of any kind that is implied or possible where projections of future conditions are attempted. The publisher is not liable for typographical errors.

Commodity futures, securities, options and forex trading involve risk and are not suitable investments for everyone. Any investment should be carefully considered in light of an investor’s personal financial objectives and risk tolerance.

The article contained herein may provide hypothetical or simulated performance results. Hypothetical or simulated performance results have certain inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have over- or undercompensated for the impact, if any, of certain market factors such as the lack of liquidity. Simulated trading programs are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. Further, past performance does not guarantee future results.

There are often very different trends and other price action phenomena on

different timeframes.

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weakest would a trading signal using this ap-

proach be of higher accuracy and reliability.

For example, if strength and weakness analy-

ses for one week, 24-hours and one hour prior to

the current time all show that the pound is the

strongest currency and the franc is the weakest,

then you could consider the signal to buy GBP/

CHF to be strong.

GETTING OUTIn terms of trade exits, you can establish

criteria whereby, for example, when the

strongest/weakest currencies are no longer

the strongest/weakest on one, two or all three

of the timeframes, then an exit signal can be

generated.

CONFIRMATIONWhat exactly does multiple timeframe agree-

ment of strength and weakness represent? Sim-

ply, it shows trend and momentum agreement.

The strongest and weakest currencies on the

longest timeframe represent the overall trend.

If the middle timeframe agrees, price may

have just recovered from a retracement, cor-

rection or pullback and is now resuming in the

direction of the trend. Finally, if the shortest

timeframe agrees, you can consider short-term

momentum to be in the direction of the higher

two timeframes.

This agreement makes for a high-probability

forex trading approach that focuses on pin-

pointing the correct directional bias.

With this multiple timeframe strength/weak-

ness approach, you can take full advantage of

one of the most unique characteristics inherent

in trading the forex market.

James Chen is chief technical strategist at FX Solutions.

ago to the current time for USD/JPY, EUR/

JPY, GBP/JPY, CHF/JPY, AUD/JPY and CAD/

JPY. You can then average these weekly price

change percentages.

The same average price change analysis can

then be performed for the yen from exactly

one day ago and, then, exactly one hour ago.

MAKING A PLAYFor example, suppose that in a given week’s

span, you find the pound to be the strongest

(most positive) single currency in terms of av-

erage percentage price change against the other

currencies. Further suppose the Swiss franc is

the weakest (most negative) currency during

the same week. The bias for that week, there-

fore, would be for a long GBP/CHF position

(long GBP with simultaneous short CHF).

But a strength and weakness assessment on

only the one longer-term (weekly) timeframe

is generally not sufficient. Only with multiple

timeframe agreement would a higher probability

strength or weakness signal result.

So only if there is at least partial agreement

among timeframes that a given currency is the

strongest and another given currency is the