- The law of large number positives outweigh the negatives
- Fund managers will trade strength/weakness in a currency across the board
- Such strategies can help to maximise profit
Big Ben is an integral element in the New-Year countdowns and the
large-number law is not a bad maxim to follow as a trader. Photo: iStock
Any indicator you utilise on your charts will in effect be a smoothing out average that replicates in a microscopic fashion the law of large numbers. An average will thus show current on balance direction and average values.
There is no need for me to describe the advantages and applications of such indicators as it is obvious to us all....likewise, I assume we all acknowledge the disadvantages and weaknesses of these indicators.
However, as we all continue to utilise them, we unconsciously recognise that overall the positives outweigh the negatives.
The subject of chance is a lengthy topic so perhaps we should confine ourselves to a minor area first and then enhance the trade strategy afterwards. Perhaps a better strategy is to focus on how major fund players avoid risk and compound profits?
We are after all when trading, effectively acting as a business. We seek profits whilst minimising costs and of course risk factors. We may have trading accounts substantially smaller than a full CTA fund but never assume you cannot mimic their actions.
First, major fund traders will obviously assess markets seeking an edge that they can profit from. They will review each and every major forex market and assess pairing strengths/weaknesses for opening, closing or turning a trade.
Equally they will review their drawdown position and consider trade duration as a trading parameter. If drawdown remains high, then perhaps they are over trading or not being efficient with their funds as releasing funds by covering a trade reduces duration and frees funds to be more proactive and profitable in other marketplaces.
Remember CTA Funds need to pay bills just like us so they seek revenue streams too.
Next do you think that a forex fund will look at say the cable
and determine their trade stance? It is usual for such fund managers to consider each major trade pairing just as we do but the difference is that they will each day determine a FX bias not for a single currency pairing but for the single currency on the whole.
A fund manager will look at yen, but not in isolation. Photo: iStock
On June 1, I suggested the euro has become the dominant currency in ROC values, thus a long on EURUSD made a simple enough profit of 30 pips. But the fund manager would see the same trade and consider using the new bias to do the following:
LONG at 7am BST EURUSD
LONG at 7am BST EURGBP
LONG at 7am BST EURCAD
LONG at 7am BST EURCHF
They would not have traded EURJPY as Japan was suffering a major move from delaying its VAT policy. No fund manager would trade before announcements or from panic moves.
Consequently, once the dominant currency value is known, you trade all the liquid pairings and cover when the market moves to an illiquid stance at approximately 5pm BST currently.
The meagre single-trade profit I posted of 30 pips would then become a profit in excess of 200+ pips using the simple bias of the markets, (or if you like the market skew.....an often repeated topic in prior articles) and you can compound profits dramatically.
However this works mainly because of the law of large numbers....being exposed across all of the forex playing field maximises the potential for catching a big move. Thus you need to be in each and every pairing with the dominant bias as your focus.
Your normal stop management rules apply. Trade each pairing with the same stake size. You don't have to increase your market exposure as you can dilute your normal stake to cater for the extra trades....so risk remains as fixed as your normal trade values but you are trading the law of averages and not one single market place.
Thus, the example above for simplicity sake.... if I traded £50pp on EURUSD
, I would have amassed only 30 x £50 for a £1,500 profit.
The alternative wasfive5 trades opened at £10 per point so my true market stake is still effectively £50pp but the overall profit was 200 x £10pp for a £2,000 minimum profit.
Now I could easilly maximise potential profits in a variety of ways but lets stick to the pure basics here. The overall result enhanced the return on capital employed and spread the risk. Usually the predominant pairing would have a larger stake size than the others for me but we all have different trade parameters.
A word of caution though. Should you get a strong rally in one pairing, then assume 85 pips or greater is your take-profit level. When one pairing storms away, but not the others, then the law of averages also means it will drag that impulsive move back to its fellow FX pairings, so take the profit when this event occurs. Play the maths to your advantage.
Can this be improved?
Yes an obvious method is the converse of the above....look for the weakest currency weighting and short all the relevant pairings....this is where the JPY looks interesting but we also saw weakness in sterling which is what I traded. Remember the yen was due to a market panic after the event and this trade structure isn't about panic moves. The cable overall only accrued 140+pips on the day.
The real take away for any reader is that perhaps trading more as a business and establishing a fx weighting model such as the ROC/Skew scenario will compound your successes. Obviously I will post live updates to show what values I am looking at. Clearly as today is June 2nd I cannot post a chart for next weeks article posting as I do not know what the weightings will be next week but will post real time values as usual.
If nothing else hopefully this article will challenge your normal view of the markets and perhaps let you consider a new strategy to build on. Should you want to operate the ROC/Skew model then you can scroll through my weekly postings and slowly overlay each weekly article to get the full set up. Each and every week a different snippet has been posted that will always overlay another strategy to build a stronger trade signal.
Sometimes, it's about looking for weakness, not strength. Photo: iStock
— Edited by Martin O'Rourke*fxtime is an alias