With a daily trading turnover of more than 6.6 Trillion U.S. Dollars, the forex market is one of the most liquid markets in the world. While the market offers traders countless opportunities to make extensive profits, it also carries excessive risk exposure. You need to have sound market knowledge and years of experience to trade the forex market successfully. However, the significance of trading tools and indicators for worthwhile trading can’t be ignored either. While different trading tools enable investors to improve their profitability, technical indicators help traders make informed trading decisions. In this piece, we discuss one of the most popular technical indicators – the Forex Strength Meter in detail.
What Is Forex Strength Meter?
Forex Strength Meter is also known as Currency Strength Meter. It is a technical indicator used to measure the strength of a currency. For example; if a currency pair EUR/USD rises, it helps traders to know whether the increase is because of the strengthening of the Euro (Eur), or the U.S. Dollar has lost its worth over the given time.
Traders can use it on platforms that support custom indicators, including but not limited to MetaTrader4 (MT4), and MetaTrader5 (MT5). After driving relevant information from the currency strength meter, traders apply it on the MT4/MT5 chart and formulates a trading strategy.
How does the currency strength meter work?
Using currency strength meter involves four steps listed below;
1) Select a base currency
2) Pair the base currency with other currencies
3) Calculate the relative strength of each currency in a pair
4) Find out the average score.
Traders use the forex strength meter as a filter tool. For example; if a currency pair i-e EUR/USD, NZD/USD, USDJPY appreciates or devalues over time, the currency strength meter enables traders to know what makes the currency pair move. Not to mention, the main essence of using the FX strength meter is to know either the base currency is getting stronger or the quote currency is becoming weaker in a specific time frame. It is worth mentioning here that time frames play a significant role to help you find the strength of a currency using the strength meter. For example, a currency might seem strong on a daily chart but it might be the weakest when seen in a monthly time frame.
Although the forex strength meter could help traders finding small opportunities, it is best to use it to see a broader picture of the market, especially if you prefer placing long-term trades.
How to measure the strength of currencies using a strength meter?
Usually, currency strength meters come with a customized measuring system. However, most of them measure the strength of a currency using a 1-10 scale measurement. On the measurement scale, the more the reading is close to 10, the greater will be the strength of a currency and vice versa. Not to mention, the measurement scale reading can even fall below 1.
Common mistakes people make while using forex strength meter
Mistake # 1 Using a currency strength meter without having the basic knowledge.
Sometimes traders use the currency strength meter just because they heard it to have been very effective for currency trading. There is no doubt in the effectiveness of the CSM, but the forex strength meter works on a formula – a specific method to find the strength of a currency. If you don’t follow the concerned method, how can you be assured of the trading outcomes with the forex strength meter? Secondly, if the formula only works for a specific time frame, for example – (24 hrs.) time frame, using it in the wrong time frame wouldn’t help either.
Mistake # 2 Using the forex strength meter to enter or exit trades.
Another common mistake that most traders make is that they time their trading entries based on the forex strength meter. For example, they buy a currency pair soon after finding it to be very strong using the currency strength meter. That’s wrong. The forex strength meter isn’t meant to generate trading signals. It merely lets you know the strongest or weakest currencies at a given time.
Let us explain it using a simple illustration.
As per the table shared above, the JPY is the strongest currency while GBP is the weakest one at times. However, the candlestick chart shows that it’s not the right time to sell GBP/JPY. Because chasing the market lowers after a big move and placing a stop loss might not work. There is a chance that you end up stopping on the pullback.
Mistake # 3 Choosing a lower time frame to apply currency strength meter.
Although the forex strength meter helps in measuring the price change over a specific time frame, still using it to determine the strongest or weakest currency in a lower time frame isn’t recommended. Because price surge amid a release of major economic news can lead to a false indication of a currency pair being strong or weak. Therefore, traders may prefer using it on a higher time frame to avoid miscalculation.
Common Issues with Currency Strength Meters
Although the currency strength meter is amongst the best trading indicators available in the market, still it comes with many issues. Some common issues that traders may face while using the forex strength meter, includes the following.
i) It sometimes makes MT4 stop working.
ii) It can even freeze your PC, requiring you to restart your computer.
iii) It sometimes generates whipsaw signals.
iv) It engages the processor of your PC to work with 100% capacity.
Some forex strength meters may even generate data that doesn’t go with the market conditions at all. On the other hand, some currency strength meters apply moving average filters while others rely upon filters, such as MACD and RSI. Applying too many filters with the currency strength meter can result in wrong signals being generated.
Not to mention, the listed above issues generally arises due to poor coding. Therefore, programmers need to pay special attention to the source code while designing it. Alternatively, traders can create a customized currency strength meter without coding. However, the best method to determine a currency strength is to use a currency correlation matrix. A carefully coded currency correlation matrix is more likely to resolve all of the mentioned issues besides producing better results.
Forex Correlation Matrix – The Real Currency Strength Meter
The evolving technology has transformed the forex strength meter into a forex correlation matrix. The currency correlations matrix shows the correlation between two forex pairs and is known for processing complex information with high reliability.
Mathematically, a correlation represents a numerical measurement of a relationship between two variables. To find the relationship between currencies, we exchange the variables with subjected currencies. The range for the currency correlation coefficient is between -1 to +1. If a currency correlation shows a reading of +1, it means that two forex pairs will move in the same direction, while -1 indicates the currency pairs will always have an opposite direction. Not to mention, the direction of the currency pairs having zero correlation coefficient remains arbitrary.
Forex pairs having strong linkage are known to have a high correlation. Similarly, when two forex pairs move in the same direction, they have a positive correlation. On the other hand, currency pairs moving in different directions are called negatively correlated. Generally speaking, It is very rare for two forex pairs to move in the same direction. If it happens, then it is called a perfect currency correlation.
How to use currency correlation to calculate currency strength?
Since currencies are always traded in pairs, therefore, the strength of each currency can be measured using the currency correlation matrix.
For example, if two currency pairs, such as GBPUSD & EURGBP correlate with a reading equals to -91, then it means that the said currency pairs are negatively correlated and will move in opposite directions. Hence, two short or long trades on these forex pairs may cancel one another.
Continuing our example, let’s further decode the relationship between each of the currency pairs. In the GBPUSD pair, GBP being the base currency represents the strengthening of the GBP against the U.S. Dollar in the long run. On the other hand, the GBP is the quote currency in the EURGBP pair and suggests the strengthening of the Euro against the GBP in a long trade.
Because the above-mentioned forex pairs are highly correlated to each other, we can say that GBP is the strongest currency that derives the market prices of the subjected pairs. Conclusively, it might not be wrong to say that the real currency strength meter is none other than the currency correlation matrix.
The Advantages of Using the Real Currency Strength Meter
A currency correlation matrix comes with several advantages, including but not limited to simplicity, reliability, and accessibility.
The majority of forex traders use the currency correlation matrix for short-term trades. It enables traders to immediately know the strengthening currencies. Hence, traders can make informed trading decisions.
One of the major benefits of using a currency strength meter is that it is fairly simple to understand. Most importantly, traders don’t have to be veterans to use it. Instead, even a novice trader can read the chart to ascertain the performance of different currencies.
Forex strength meter is available free of cost. Many brokers these days offer free currency strength meter plugins for MT4 and MT5. After having it download from a broker’s website, you just have to open the source folder of MT4/MT5 and install the plugin into it. Not to mention, some brokers also offer a few other indicators along with it.
How to Download a Currency Strength Meter
Since the currency correlation matrix is one the best forex strength meter that comes pre-installed with the supreme edition of MT4 and MT5 plugins, traders just have to download the respective version of the MetaTrader4 (MT4) or Meta Trader5 (MT5). Both MT4 and MT5 are the industry’s best trading platforms and are equally popular amongst the masses. Both platforms allow traders to use custom indicators along with the Expert Advisors. Besides a good selection of trading indicators built in the trading terminal of both MT4 and MT5, you can still add manually written indicators as many as you wish. MetaTrader also has a live simulator that enables traders to backtest their trading strategies.
Given below are a few simple steps that you can follow to download the MetaTrader platform and install the plugin for the supreme edition.
Step2: Navigate to the trading platforms section and select the MetaTrader4 or MetaTrader5 to download. Do not forget to download the MT4/MT5 supreme edition plugin as well.
Step3: Install both the platform and the plugin on your PC or laptop.
Step4: Open the MT4/MT5 trading platform and sign in using your live or demo account credentials.
Step5: Click on the expert advisor on the navigation panel available under the market watch window. Here you can see the list of available indicators that comes with the supreme edition plugin of MT4/MT5 along with the pre-installed currency strength meter.
How to Use the Forex Strength Meter
After having the MetaTrader Supreme Edition installed on your PC, you need to follow the given below steps to start using the currency strength meter.
Step1: Go to the navigation panel and maximize the expert advisors window.
Step2: Double click on the yellow highlighted currency correlation matrix. Alternatively, you can also drag and drop it onto an open chart.
Step3: Customize the popup window.
Step4: Click on the Ok button to open the currency correlation matrix.
Now you can start using the currency correlation matrix. If you are a novice trader, then you might find it a little confusing. However, rest assured that the real currency strength meter is very easy to use despite involving complex algorithms. Traders have the option to find the strength of currencies in a certain time frame. It is best to use up to 200 bars for Intraday traders. On the other hand, scalpers may find 50 bars to be enough to serve the purpose.
As a general recommendation, starting with the listed below intervals for different time frames may work the best:
- Scalpers should use M5 – 50 bars
- Intraday traders may try using H1 – 200 bars.
- Intraweek swing traders can use either H1 – 500 bars or H4 – 200 bars.
How to Make Most of the Currency Strength Meter
Remember the correlation between currency pairs does change and you can’t always rely on the past performance of the currency pairs to find out future correlations. Given below are some tips that you can use to develop a customize currency strength indicator and limit the exposure of your portfolio.
Tip # 1: Do no trade currency pairs that are anticipated to cancel out each other most of the time. Surely, trading such pairs that always move in the opposite direction is of no use.
Tip # 2: Find the forex pairs that always stay positively correlated. Trading such pairs will help you diversify your trading risk.
Tip # 3: You can also limit your losses by hedging two perfectly negative correlated pairs. Logic is simple, holding a currency pair that incurs a loss will automatically net off with the gain in the negatively correlated pair.
Not to mention, like any other technical indicator, you may find some loopholes in the currency correlation matrix. One of the prime limitations of the currency strength meter is that it offers only a limited piece of information. Therefore, it is crucial to see how well the information fits into a bigger picture.
Before placing your orders, ask yourself;
i) If there are enough fundamental reasons to support the findings of the currency strength meter
ii) Does the result of the currency strength meter go in line with the projections of other indicators?
iii) How likely it is for the trend to continue?