I mentioned in the introduction that I focus on trending currency markets. EUR/USD is a great pair to look at for two reasons:
• It consistently trends
• It is cheap to trade

Why does EUR/USD trend?
It is critical to understand the fundamental reasons for a strategy’s required market condition (range or trend). It tells you the conditions where a technical strategy will most likely win or lose.

I trade trends. If the trend disappears, my strategy will no longer work.

This does not mean trying to explain every move on an intraday chart. You only need to answer the question why has EUR/USD trended over the past few years?

The answer in this case is interest rates. The European Central Bank (ECB) tends to lag the US Federal Reserve when it comes to interest rate decisions. Higher interest rates in Europe encouraged investors to move from dollars into an asset with higher yields.

The current trend shows euro strength and dollar weakness. If the market doubts that the euro’s interest rate will continue gaining against the dollar, then the trend will most likely pause. A “pause” in the trend means a ranging market - my performance would suffer if I continued trading the same way.

Apply interest rates to other pairs:
Looking at the GBP/JPY, the same reasoning applies. The yen interest rate is nearly stagnant. It is unlikely to vary by more than 25 basis points (0.25%) annually. Not surprisingly, the pair closely follows interest rate expectations for the UK and trends strongly.

Interest rates for the euro and pound tend to move in synch. This limits the potential for trends to develop. Trading the RSI strategy on EUR/GBP would likely result in consistent losses.

Avoiding mistakes:
There are many ways to make mistakes. Make sure to follow the rules if you trade the system.


1. Market conditions change. If volatility dies and EUR/USD falls into a 200 pip range for the next few months, I guarantee that the strategy will lose money. It is important to apply basic fundamental analysis to determine if an instrument will trend or not. After you decide the fundamentals look good, apply rule 2.

2. You must take all trades. The idea behind a system is that you follow it to the letter. Skipping a trade for fear of loss is not a reason. If you need any persuading, look at the AUD/USD. Most of the returns over the past 2 years came from a single trade. The remaining trades were neutral or negative. It takes a lot of faith to follow the system when 29 trades resulted in a 0% return. The big winner did not occur until trade #30.

3. Apply it to the appropriate time frames. Day trading the RSI strategy will turn a potentially good strategy into a money-drain. The minimum time frame is 60 minutes. As a general rule, longer term is better.

4. The percent accuracy is roughly 50% accurate on most time frames and pairs. You will lose half of the time. Trade a position size like you expect losses. Overleveraging, in my experience, is the single most common reason for blowing up forex accounts.

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Shaun Overton
OneStepRemoved.com
Strategy and Automated Trading Development