# What defines strength of forex trading in real time

(Last Updated On: August 28, 2017)

What defines strength of forex trading in real time

This was a question i asked online to my groups

What does the phrase a particular CURRNECY strengthen? What sort of indicator or math are at work here? Give me the details.

Here are 2 highly valuable responses I got: (BIG THANKS TO THEM FOR ANSWERING)

Hi Bryan,

You asked about individual currency strengths in the FX market and how they are calculated. There are different types (relative and absolute) and many different ways to calculate them, but I’ll give you a very simple example of absolute currency strength.

I’m sure you’re aware that rate-of-change (ROC) is essentially just the percentage move. Let’s say we are trying to calculate the absolute strength of USD:

• First we decide on a basket of currency pairs that include USD. For example; EURUSD, GBPUSD and USDCHF. In reality you would consider more than 3 pairs, but I’ll keep it simple for the sake of illustration.
• Then measure the ROC over some time period, e.g. the past week. That is, take each of our 3 currency pairs and calculate the percentage move over the last week. This could yield 1.1%, -0.4% and 0.9%. Note however that USD is the quote currency in EURUSD and GBPUSD, but is the base currency in USDCHF. This means that we have to invert the ROC values for EURUSD and GBPUSD (since an increase EURUSD or GBPUSD implies a devaluation in USD relative to EUR or GBP, respectively). So the final values are -1.1%, 0.4% and 0.9%.
• Then take the average: (-1.1+0.4+0.9) / 3 = 0.066%.
• There we have it, the absolute strength of USD. It can be interpreted as the average move for the past week compared to the other currencies in the basket (EUR, GBP and CHF). So in this example, USD slightly outperformed.

As I said above, this is just a very simple example. In reality you’ll use many more pairs in the basket, you’d calculate the absolute strength for each currency (not just USD) so that you can compare them, you could repeat the analysis for a variety of time periods and you may want to plot the strengths as time series in order to analyse the relationships between the individual currencies. You can also use bounded oscillators such as RSI in order to compute relative strength, and some people advocate the use of the geometric average as opposed to the arithmetic average, or even weighting each currency according to the daily traded volume (a 2% increase in EURGBP is more significant than a 2% increase in EURMXN, for example).

There’s a huge amount of information regarding this topic online, but here’s how it might look once everything has been computed:

As you can see, it offers great insight into how the individual currencies have been/are behaving, something that is not immediately obvious when examining the data of single currency pairs in isolation. In this image, you can see that EUR has been the best performing currency during the past year, and that JPY has been the worst. Hence if you’re a momentum trader you should be looking to go long EURJPY, and if you’re a mean-reversion trader you should be looking to short EURJPY.

—–

Hi B, you can use an index for a particular currency to see whether it strengthen or not. E.g. for USD it is DXY. And as all indexes, it is calculated from a basket of assests. In this case it is the basket of currency pairs which is weighted according to its daily traded turnover. You can create your own for every currency out there and to weight it with data from either Bank for International Settlements’ FX Survey 2016 or by a turnover on futures currency market on CME. Then you can play with these values and e.g. add it to 100% scale.

I like to watch the past month particular currency strength and its strength developmnet in this period. U can see the most weakest and the most strength currencies. So you can trade them this way weakest/strength. But as I said it is good to look at the development and as you can see on the pic e.g. USD it is the 3rd most strength currency over the last month, but it is slowly loosing the steam of breaking the highest high point here.

NOTE I now post my TRADING ALERTS into my personal FACEBOOK ACCOUNT and TWITTER. Don't worry as I don't post stupid cat videos or what I eat!
This entry was posted in Forex, Quant Analytics, Trading and tagged , , , , on by .