Tactical trading consideration in GBP/USD and USD/CHF

The routine short-term volatility of cable and Swissy suggest several important tactical trading refinements. The overarching idea here is to adjust your trading strategies to weather the erratic price action and higher overall volatility in these pairs in comparison to the larger EUR/USD.

lt may help to think of sailing a boat on a lake. When the wind is calm, you need to ighten up the sails to catch all the wind you can. But when the wind starts gusting, you need to let out some slack on the sails or you’re liable to get blown over. The same is true when trading cable and Swissy.

Reducing position size relative to margin

This first consideration is especially important in cable, due to its high relative value to the USD. With GBP/USD trading around 1.90 to the dollar ($1 = $1.90) a one-lot position (£100,000) eats up $1,900 in required margin at 100:1 leverage. A similar-size position in EUR,/USD (at 1.30) takes up only $130,000 and costs $1,300 in margin. If you’re going to trade in cable, you’ll need more margin than if you stayed with EUR/USD, USD/JPY, or Swissy.

Cable and Swissy’s higher volatility also argue for overall smaller position sizes. A smaller position will allow you to better withstand their short-term volatility and give you greater staying power relative to margin. If you’re willing to risk $500 in capital on a particular trade, that equates to 50 pips in EUR/USD and GBP/USD. But the chances of an adverse move of 50 pips in GBP/USD are far greater (routine, actually) than a 50-pip move in E.UR/USD.

Allowing a greater margin of error on technical breaks

If you’re basing your trades on technical levels of support and resistance, you need to anticipate that those levels will be tested at the minimum. In sterling and Swissy, tests of technical levels frequently result in false breaks as stops are triggered. If your stop loss is too close to the technical level, it's ripe for the picking by the market. Factoring in a margin of error when placing stop-loss orders can help - allow you to withstand any short-term false break. Using a margin of error may also require you to reduce your position size to give you greater flexibility and margin staying-power.

Anticipating overshoots and false breaks for position entry

When you’re looking to enter a position by selling on rallies or buying on dips, you’re probably focused on selling at resistance and buying on support. You can take advantage of cable and Swissy’s tendency to overshoot or make false breaks of technical levels by placing your limit order behind the technical level (above resistance, below support). If cable and Swissy break through the level, you’d be able to enter at a better price than you would have if you’d adhered to the technical level alone.

Alternatively, you can enter a portion of your desired position at the technical level and enter the rest at better prices if the level is breached, improving the average rate of your position. Worst-case scenario, the market only fills you for half of your desired position and then reverses. Best-case scenario, you establish your full desired position-at a-better rate than you expected and the market reverses. If the market keeps going against you, at least your average position rate is better than it otherwise would have been.

Being quick on the trigger

Cable and Swissy tend to move very quickly and may not spend a lot of time around key price levels. This favors traders who are decisive and quick on the trigger in terms of entering and exiting positions. Having a disciplined trading plan in place before you enter the market helps. Above all, avoid being distracted from your plan by the sharper price movements.

Another way you can take advantage of the short-term volatility of cable and Swissy is by using resting orders to get in and out. You may not be in front of your trading screen, or your click-and-deal trade may not have made it through on a rapid price fluctuation. A standing limit order will accomplish the same trade - only automatically and instantly if the price deals. Trailing stops are especially useful when you have a position that‘s moving the right way.

Resisting the contrarian urge following large directional moves

After an extended directional price move, many traders may feel inclined to trade in the opposite direction, if only for a short-term correction. Maybe you missed -the big move and think it’s ripe for a pullback. Or maybe it looks like the move has gone too far, too fast. Resist that urge in cable and Swissy.

On days with large directional price moves of more than 100 pips, cable and Swissy often finish out the trading day at the extremes of the price move (meaning at the highs on an up-move and at the lows on a decline). So even if you sell the high of a move up, you’re unlikely to get any joy on the day.

Picking your spots wisely

Instead of simply jumping into sterling or Swissy, the way you may in EUR/USD, you’re going to need to do a fair amount of watching and studying to get a handle on where appropriate entry points may be. Short-term volatility in cable and Swissy make for treacherous short-term trading conditions. You’ll greatly improve your chances of catching a favorable move if you step back and look at the medium and longer-term pictures (four-hour and daily) instead of getting caught up in the short-term volatility.

Price action behavior of GBP/USD and USD CHF

I group these two currency pairs together because they share similar market liquidity and trading interest, which are the main drivers of price action. The more liquid a market is, the more smoothly prices will move; the thinner the market, the more erratically prices will move. In both pairs, liquidity and market interest tend to be the thinnest among the majors, especially outside of European trading hours. As a result, both pairs typically trade with wider 3 to 5 pip prices relative to narrower spreads in EUR/USD and USD/JPY.

The most important trading characteristics of sterling and Swissy are as follows:

• Price action tends to be jumpy, even in normal market. Cable and Swissy are like long-tailed cats in a room full of rocking chairs - extremely nervous. In a relatively calm market, you can see prices in these two pairs jump around by routine 2 to 3 pip increments (say, from 20/25 to 22/27 or 23/28, back to 21/26, and then 24/29)

When prices are moving in response to news or data, those price jumps can be even more pronounced, frequently changing by 3 to 5 pips between prices. Online traders are also likely to get more “rates changed” responses when trying to deal on the current market price. That response means the price changed by the time your trade request was received and the attempted trade was not completed. The subsequent price may be 2 to 3 pips higher or lower than where you first tried to deal.

• Price action tends to see one-way traffic in highly directional markets. When news or data move the market, the price changes in Swissy and cable are apt to be the most abrupt. If a data report sends EUR/USD higher by a quick 20 to 30 pips, cable and Swissy are likely to see prices move by 30 to 40 pips or more. On top of that, cable and Swiss will remain highly directional and tend to see minimal pullbacks or backing and filling.

• Look at cable and Swissy as leading indicators for EUR/USD. One of the ways that experienced traders judge the level of buying or selling interest, how bid or offered a market is, during a directional move is by looking at how cable and Swissy are trading. For example, if bids in USD/CHF keep appearing in a relatively orderly fashion, say every 1 to 2 pips on a downswing, it’s a sign that the move is not especially extreme. On the other hand, ft the prices are dropping by larger increments and displaying very few bounces, it’s a strong indication that a larger move is unfolding.

• False breaks of technical levels occur frequently. Cable and Swissy also have a nasty habit of breaking beyond technical support and resistance levels, only to reverse-course and then trade in the opposite direction. And we’re not talking about just a few points beyond the level here, but more like 25 to 30 pips in many cases. The frequency of false breaks is a result of the relatively lower level of liquidity and market interest in these pairs. Instead of having a selling order at technical resistance, which you may reasonably expect in EUR/USD or USD/JPY, there may only be a stop-loss buying order beyond the resistance in cable and Swissy.

• Spike reversals are very common. The tendency of cable and Swissy to overshoot in extreme directional moves and to generate false breaks of technical levels means that spike reversals appear frequently on short term charts. Though the size of the spikes will vary depending on the market circumstances and current events, spike reversals of more than 30 to 40 points on an hourly closing basis should alert you to a potentially larger reversal taking place. The bigger the spike reversal (and it’s not uncommon to see 50 to 70 pip spikes in cable and Swissy), the more significance it holds for the future direction. 

Safe haven or panic button: USD/CHF

The Swiss franc has, or we should say had, a reputation for being a safe-haven currency. Apart from Switzerland's historical neutrality and legendary bank secrecy laws, this reputation is largely a relic of the Cold War. At the time, fears of a European ground war between the United States and the Soviet Union meant most European financial centers could be out of business in short order. In terms of a major European currency alternative to U.S. dollars or German deutsche marks, the CHF became the safe-haven currency during times of geopolitical tensions.

There are still plenty of people in the market who continue to refer to the CHF as a safe-haven currency and, indeed, knee-jerk buying of CHF will frequently occur in response to geopolitical crises or terrorism. But those market reactions are increasingly very short-lived, usually only a few minutes or hours now, before pre-existing trends reassert themselves.

Trading fundamentals of USD/CHF

Instead of portraying it as a safe-haven currency pair, I prefer to view USD/CHF as the panic button of forex markets. When unexpected geopolitical news hits the proverbial fan, USD/CHF usually reacts the fastest and the farthest.

In terms of overall market volume, USD/CHF only accounts for 4 percent of global daily trading volume according to the 2004 BIS survey. With such a small share of market turnover, you’d be right in wondering why it‘s considered a major pair in the first place. In terms of liquidity, Swissy is not a major.

Trading USD/CHF by the numbers

USD/CHF is quoted in terms of the number of CHF per USD. At a USD/CHF rate of 1.2545, it costs CHF 1.2545 to buy $1. USD/CHF trades in the overall direction of the U.S. dollar and inversely to the CHF. If the USD/CHF rate moves higher, the USD is strengthening and the CHF is weakening. The USD is the primary currency in the pairing, and the CHF is the secondary currency. That means

·     USD/CHF is traded in amounts denominated in USD. In online currency trading platforms, standard lot sizes are $100,000, and mini lot sizes are  $10,000.

·        The pip value, or minimum price fluctuation, is denominated in CHF.

·        Profit and loss accrues in CHF. For one standard lot position size, each pip is worth CHF 10; for one mini lot position size, each pip is worth CHF 1. To convert those amounts to USD, divide the CHF amount by the USD/CHF rate. Using 1.2500 as the rate, CHF 10 = $8 and CHF 1 = $0.80. The pip value will change over time as the level of the USD/CHF exchange rate fluctuates, with a lower USD/CHF rate giving a higher pip value in USD terms, and vice versa.

·         Margin calculations are typically calculated in USD. So it’s a straight forward calculation using the leverage rate to see how much margin is required to hold a position in USD/JPY. At 100:1 leverage, $1,000 of available margin is needed to open a standard-size position of 100,000 USD/CHF

Keeping the focus on Europe

When looking at economic fundamentals, its worth remembering that Switzerland conducts the vast share (about 80 percent) of its foreign trade with the Eurozone and remaining EU countries. So when it comes to the value of the CHF, the Swiss are most concerned with its level against the EUR as opposed to the USD.

The Swiss National Bank (SNB), the Swiss central bank, tends to get involved  in the forex market only when the Swiss franc is either too strong or too weak against the euro. If the CHF is too weak, it can import inflation (higher CHF prices for the same goods), upsetting the SNB’s carefully laid plans to tame inflation. If the CHF is too strong, it can hurt Swiss exports (more euros needed to buy the same Swiss goods).

The SNB typically prefers to use verbal intervention to influence the value of the CHF, and SNB comments frequently stir up USD/CHF and EUR/CHF trading. Since the introduction of the euro in 1999, EUR/CHF has been confined mostly to a relatively narrow range of 1.5000 to 1.6200, but as of this writing it’s pushing toward 1.65, drawing increased criticism from the SNB.

Important Swiss economic reports

Swiss data tends to get lost in the mix of data reports out of the United States and the Eurozone, with many in the market looking at Switzerland as a de facto Eurozone member. In that sense, market reactions to Swiss data and events primarily show up in EUR/CHF cross rates. The important Swiss data to keep an eye on are

• SNB rate decisions and speeches by directorate members
• KOF Index of Globalization Swiss leading indicator
• Retail sales
• Trade balance
• PPI and CPI
• Unemployment rate