Forex Pair Performance Strength Score Michael Burke Vice-president of Client Training and Education TSLabs@TradeStation.com Features Studies/Files Included: Focus: Technical Indicators Markets: Forex Workspace Time Perspective: Intermediate and long term Overview With dozens of forex pairs available to analyze and trade, the performance relationships among these pairs give us an opportunity to measure which currencies are performing relatively stronger or weaker compared to other currencies, and to find the pairings that best exploit these relative strengths and weaknesses. The Forex Pair Performance Strength Score is presented here as a set of tools to measure and monitor these performance relationships, and to assign a strength score to each individual currency as well as each currency pair. This is done by examining the performance of each currency across all its pairs and then combining the scores of the two currencies in each pair. This paper will focus only on the eight major (most widely traded) currencies: the U.S. dollar, Japanese yen, euro, Swiss franc, British pound, Canadian dollar, Australian dollar and New Zealand dollar. These eight currencies represent 28 unique tradable currency pairs. Forex Pair Symbology This section is a brief review of the basic principles of a forex pair symbol. Although many readers may already be familiar with this, it is offered here because an understanding of forex pair symbology and terminology is necessary in order to fully appreciate the concepts and methodology of the Performance Strength Score. Each cash forex symbol comprises two underlying currencies: Base Currency (EURUSD) The base currency in a forex pair symbol is the first symbol noted. In the case of EURUSD, the base currency is EUR (euro). This is the currency you are buying or selling. For example, if your trade size is 100,000 units, you are buying or selling 100,000 euros against U.S. dollars. Forex Pair Performance Strength Score Page 1 of 9
Quote Currency (EURUSD) The quote currency, sometimes called the secondary or terms currency, is the second symbol in a forex pair. In the case of EURUSD, the quote currency is USD (U.S. dollars). This is the currency price being quoted. For example, if EURUSD is currently quoted at 1.3310 bid / 1.3312 ask, then you would pay 1.3312 U.S. dollars to buy 1 euro and receive 1.3310 U.S. dollars to sell 1 euro. The realized profit or loss of a trade is always based on the quote currency. TradeStation automatically converts this into your native account currency at the end of the session, based on the current conversion rates. Figure 1: Forex Pair Symbol Terminology Measuring Forex Strength The first step in measuring the Forex Strength Score is to calculate a relative strength score for each of the eight major underlying currencies individually. This is done using the set of seven forex pairs for each of the eight underlying currencies. Since there are two currencies represented in each forex pair, if the strength score for a unique pair is positive, then the score value for the base (first) symbol in the pair is also positive and the score value for the second (quote) symbol in the pair must be negative. For example, if EURUSD has a positive momentum percentage value of.55, then the EUR would get a positive score value, +.55, and the USD gets a negative score value, -.55. We then accumulate the scores for each of the seven unique forex pairs to come up with the raw performance score for the underlying currency. In other words, we look at all seven pairs that contain the EUR and add up the scores. The performance score calculation for each of the seven forex pairs uses a smoothed momentum percentage divided by the standard deviation. Specifically, it uses a 5-bar momentum against a 13-bar <default input> momentum that is offset by 5 bars, and then divided by a 30-bar standard deviation. The final score value is average over 3 bars. The score can be used on any time-based interval depending on the trader s time horizon. Euro Score = (EURAUD + EURCAD + EURCHF + EURGBP + EURJPY + EURNZD + EURUSD) This formula is a little different for currencies that are not the base (first) currency of the symbol. For example, U.S. dollar: U.S. Score = (USDCAD + USDCHF + USDJPY) - (AUDUSD + GBPUSD + EURUSD + NZDUSD) Forex Pair Performance Strength Score Page 2 of 9
Notice that we must subtract the scores when the score currency is the quote (second) currency in the symbol, since a negative performance score for that pair actually means the score was positive for the quote currency. Let s plug in some sample performance numbers to illustrate the idea. U.S. Score = (.5 +.6 + (-.4)) - (.7 +.5 + (-.3) + (-.4)) = +.2 (Raw Total Score) This raw score for each underlying currency is then normalized to a larger number that can be compared and sorted more easily in charting or RadarScreen. Euro Score Example Table 1 shows the smoothed momentum percentage for each of the seven related euro currency pairs. It is these momentum values that normalize and combine into the Strength Score for the underlying euro currency. Table 1: Table with Forex Pair Smoothed Momentum Percentage Values and Final Score for Euro EURAUD EURCAD EURCHF EURGBP EURJPY EURNZD EURUSD Raw Score Performance -0.00160 0.01760 0.00060-0.01260 0.00640 0.00710 0.00560 0.02310 Euro Strength Score 3.35 Calculating the Strength Score for Each Forex Pair Once we have the normalized score for each of the eight major underlying currencies, the scores for the two underlying currencies in a specific pair are added together to make up the Strength Score for that pair. We then do this for each of the 28 forex pairs. Table 2 shows an example of Strength Scores for each of the major currencies. Table 2: Strength Score for the Major Currencies FX Strength Score (Daily Interval) Aussie British Pound Canadian Euro Japanese Yen New Zealand Swiss Franc U.S. 4.77 18.19-16.82 3.35-4.22-5.02 2.56-2.93 The strongest and weakest underlying currencies in Table 2 are the British pound and the Canadian dollar, with Strength Scores of +18.19 and -16.82, respectively, yielding a Strength Score of 34.92 for the pair. We take the Strength Score of the British pound and subtract the Strength Score of the Canadian dollar as follows: (+18.19 - (-16.82)) = +35.01 Final FX Scores will vary depending on the bar interval. Remember, the score itself is used only as a comparison against other scores at the same interval, and by itself is not very significant. Forex Pair Performance Strength Score Page 3 of 9
Figure 2: Strength Scores for the 28 Major Pairs Calculating this score for all 28 pairs, we can sort and rank the list of forex pairs in RadarScreen in order to find the strongest and weakest pairs relative to each other. 35.01 The weakest pair in figure 2 is CADCHF with a Strength Score of -19.38, the result of the Canadian dollar score of -16.82 and the Swiss franc score of +2.56. (-16.82 - (+2.56)) = -19.38 Since the Canadian dollar is the weakest underlying currency, it will have a reverse score effect when it is the second (quote) symbol in the pair, placing those pairs among the strongest/bullish (for example, GBPCAD or AUDCAD). Charting the Forex Pair Performance Strength Score The historical values of the Strength Score for an individual forex pair can be plotted in a chart in order to gauge the trend of the score and to see any visual correlations between the score and the price action. The plot of the TSL: FX Pairs Strength Score CH v changes color from red to green, or vice versa, as the score crosses above or below 0. It is important to remember that the score for a single cash forex pair is derived from the total score of the two underlying currencies that make up the cash forex symbol. Figure 3: Chart of EURUSD with TSL: FX Pairs Strength Score CH v Hidden Easter Egg The TSL_FX Currency Strength Score CH v indicator can also plot the score values for all eight underlying currency scores together - if the symbol in the chart is changed to any FX pair with HUF (Hungarian forint) as part of the symbol In this special case, the symbol in the chart is used only as a key in order to unlock this hidden feature. This is a useful display in the dynamics of how the strength score of the eight currencies interact and change over time. This also works in RadarScreen, where the first symbol is a major eight currency. (e.g. EURHUF) Forex Pair Performance Strength Score Page 4 of 9
Figure 4: Chart of AUDHUF with TSL: FX Currency Strength Score CH v Charting the Strength Score for the Underlying Currency Figure 5: EURUSD with TSL: FX Currency Strength Score CH It is not enough to know the momentum of just a single pair; it is equally important to know the trend of the Strength Score for each of the underlying currencies that make up the pair. For example, if we are going long EURUSD, it would be nice to know if the euro score is trending up and the U.S. dollar score is trending down in order to confirm the trading signal. The TSL: FX Currency Strength Score CH indicator plots the Forex Pair Performance Strength Score Page 5 of 9
Strength Score for each of the underlying currencies of a forex pair. You can see that when the two underlying currency scores cross, the TSL: FX Pairs Strength Score CH indicator for the forex pair crosses above or below zero on the same bar. One possible application of this information is to confirm a trading signal by waiting for one underlying currency to be above zero and trending higher and the other currency to be below zero and trending lower. To help visualize this concept, the TSL: FX Pair Strength Score CH plots a tick mark whenever one underlying currency score is above zero and the other is below zero, in the direction of the pair score. Scanning the Forex Pair Strength Score in RadarScreen RadarScreen is a powerful scanning and ranking tool that allows us to compare all 28 forex pair scores at any interval. In the RadarScreen window in figure 5, you can see all 28 currency scores along with the number of bars ago the last crossover occurred. By double clicking on the column header or formatting the sort criteria, you can rank all 28 scores. In this example, AUDCHF has the strongest Strength Score, using a daily bar interval, and EURAUD has the weakest. This is a good indication that the Australian dollar is the strongest of the eight currencies. Indicator plot colors are used in the RadarScreen cells to help identify several conditions; green font indicates the Strength Score is positive, while red font indicates the Strength Score is negative. Figure 6: RadarScreen Window with Pairs Sorted by Strength Score A green background indicates the Strength Score is positive, the base currency Strength Score is positive and the quote currency Strength Score is negative; that is, the individual Strength Scores confirm the positive Strength Score of the pair. A red background indicates the Strength Score is negative, the base currency Strength Score is negative and the quote currency Strength Score is positive; that is, the individual Strength Scores confirm the negative Strength Score of the pair. A gold cell background indicates that the two scores for an FX pair are crossing on the current bar; this could indicate a significant shift in momentum for that pair. Traders might use this ranking data to select symbols for a long position in one of the stronger pairs and a short position in one of the weaker pairs, using the background color to confirm that the Strength Score of the long currency of each trade is trending up and the Strength Score of the short currency in each trade is trending down. The CrossAgo column lets you know how long in bars a pair has been in the current positive or negative score mode. Traders may also want to make sure the two pairs are not overly correlated. In this case, you would probably not want to trade both GBPCAD (long/strongest) and CADCHF (short/weakest), as both symbols contain CAD. It might be better to find a non-cad pair for this. In figure 5, the weakest non-cad (and non-gbp) pair is the NZDCHF, which might be a good alternative short candidate. Note: For some additional discussion of forex correlation and tools for monitoring correlation, see the Analysis Concepts paper titled Understanding and Using Correlation Analysis. Forex Pair Performance Strength Score Page 6 of 9
Traders might use this data to explore taking a long position in one of the stronger pairs and a short position in one of the weaker, using the background color to confirm that the Strength Score of the long currency of each trade is trending up and the Strength Score of the short currency in each trade is trending down. You may also want to make sure the two pairs are not overly correlated. In this case, you would probably not want to trade both GBPCAD (long/strongest) and CADCHF (short/weakest), as both symbols contain CAD. It might be better to find a non-cad pair for this. In this sample RadarScreen, the weakest non-cad (and non-gbp) pair is the NZDCHF, which might be a good alternative short candidate. Note: For a discussion of forex correlation and tools for monitoring it, see the Analysis Concepts paper titled Understanding and Using Correlation Analysis. Overall Scores As in charting, you can display the overall score of the core eight FX currencies using the HUF key currency; for example, to display the euro overall score in RadarScreen, use the symbol EURHUF. Since the New Zealand dollar does not trade with the Hungarian forint, I used the symbol TRYHUF as the key symbol for the New Zealand dollar. Indicators Provided There are three indicators provided with this Analysis Concepts paper. 1. TSL: FX Strength Score RS v 2. TSL: FX Pairs Strength Score CH v 3. TSL: FX Currency Strength Score CH v Calculation procedure note: In order to process the intensive calculations and data requirements of these indicators more efficiently, the indicator values and plots update every 10 seconds and not every tick. Indicator TSL: FX Strength Score RS v The TSL: FX Strength Score RS v indicator calculates and plots the Strength Score across all 28 major currency pairs in RadarScreen. This indicator will not work in the Quotes window. Plot Score CrossAgo Description Plots the Strength Score for a currency pair. Number of bars since the two currency score crossed Input Default Description MoLength 13 The number of bars used to calculate the momentum percent value Note: The indicator also loads an additional 150 bars of historical data automatically to stabilize the calculations when needed. Always double check that the RadarScreen values match the values in charting. If they do not, you may need to add additional bars of historical data. Some minor decimal differences between chart and RadarScreen are okay and to be expected. Forex Pair Performance Strength Score Page 7 of 9
Indicator TSL: FX Pairs Strength Score CH v The TSL: FX Pairs Strength Score CH v indicator is the charting version of the RadarScreen indicator above. It plots the Strength Score for any of the 28 calculated forex pairs historically and in real time. Plot Score Zero SM Symbol Description Plots the Strength Score for a currency pair. Zero reference line Score confirmation indication Forex symbol score displayed Input Default Description MoLength 13 The number of bars used to calculate the momentum percent value. Indicator TSL: FX Currency Strength Score CH v The TSL: FX Currency Strength Score CH v indicator plots the strength score for the two underlying currencies that make up the forex pair in the chart. The indicator will plot all eight underlying currencies if the symbol in the chart is not one of the 28 calculated forex pairs. Plot There are two plots (Plot names vary based on the pair in the chart. Description Plots the individual Strength Scores of the two currencies in a pair or plots all eight FX pair scores based on the symbol in the chart. Input Default Description MoLength 13 The number of bars used to calculate the momentum percent value. FX data note: All of the indicators discussed in this document operate on a fixed set of symbols that cannot be changed. The 28 forex cash pair symbols are: AUDCAD AUDCHF AUDJPY AUDNZD AUDUSD CADCHF CADJPY CHFJPY EURAUD EURCAD EURCHF EURGBP EURJPY EURNZD EURUSD GBPAUD GBPCAD GBPCHF GBPJPY GBPNZD GBPUSD NZDCAD NZDCHF NZDJPY NZDUSD USDCAD USDCHF USDJPY Individual Score Symbols: AUDHUF CADHUF CHFHUF EURHUF GBPHUF JPYHUF TRYHUF USDHUF Forex Pair Performance Strength Score Page 8 of 9
Conclusion The Forex Pair Performance Strength Score uses the most basic principles of momentum and relative strength to produce a detailed look into the interrelated dynamics of the cash forex market. It can provide a high-level overview of how each currency is performing relative to the others, identify which currencies may be in trends that are accelerating or decelerating, and provide a number of useful data points and visuals to encourage new trading ideas and models to explore. Of course, a technical tool such as this is only one part of a comprehensive forex trading plan. The primary application of the Strength Score concept is symbol selection: that is, identifying those symbols that have the greatest potential based on their relative ranking and performance within the group of 28 symbols. Tracking the trend of the Strength Score can also be useful in developing entry and exit rules. Longer-term trend traders can utilize this concept on daily or weekly bar intervals and adjust the length input for the momentum calculation as desired. Remember, however, that longer input values tend to exaggerate the indicator lag effect. Intraday traders can use multiple time frames or intervals (intraday, daily, weekly) to gauge and confirm the mode or direction of a currency and then use that information to develop or augment intraday trading decisions. Bonus Content If you have not already done so, check out my FX Trader Pack that offers several FX-specific trading tools and utilities to enhance your FX trading with TradeStation. You can get it here for free and also watch my video: http://www.tradestation.com/education/events/on-demand-webcasts/markets/forex All support, education and training services and materials on the TradeStation website are for informational purposes and to help customers learn more about how to use the power of TradeStation software and services. No type of trading or investment advice is being made, given or in any manner provided by any TradeStation affiliate. Trading off-exchange foreign currencies carries a high level of risk and may not be suitable for all investors. There is a possibility that you may sustain a loss equal to or greater than your entire investment; therefore you should not invest or risk money you cannot afford to lose. Click here to read the Forex Risk Disclosure Statement. This material may also discuss in detail how TradeStation is designed to help you develop, test and implement trading strategies. However, TradeStation does not provide or suggest trading strategies. We offer you unique tools to help you design your own strategies and look at how they could have performed in the past. While we believe this is very valuable information, we caution you that simulated past performance of a trading strategy is no guarantee of its future performance or success. We also do not recommend or solicit the purchase or sale of any particular securities or derivative products. Any symbols referenced are used only for the purposes of the demonstration, as an example not a recommendation. Finally, this material may discuss automated electronic order placement and execution. Please note that even though TradeStation has been designed to automate your trading strategies and deliver timely order placement, routing and execution, these things, as well as access to the system itself, may at times be delayed or even fail due to market volatility, quote delays, system and software errors, Internet traffic, outages and other factors. TradeStation Group, Inc. Affiliates: All proprietary technology in TradeStation is owned by TradeStation Technologies, Inc. Equities, equities options, and commodity futures products and services are offered by TradeStation Securities, Inc. (Member NYSE, FINRA, NFA and SIPC). TradeStation Securities, Inc. s SIPC coverage is available only for equities and equities options accounts. Forex products and services are offered by the TradeStation Forex divisions of IBFX, Inc. (Member NFA) and IBFX Australia Pty Ltd, ABN 84 142 210 179, holder of AFSL #363972. Copyright 2001-2015 TradeStation Group, Inc. Forex Pair Performance Strength Score Page 9 of 9