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Issue 50

Wednesday, September 11, 2013

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 term

Overview
With dozens of forex pairs available to trade and analyze, the performance relationships among all 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 might best exploit these relative strengths and
weaknesses.
The Forex Pair Performance Strength Score concept is presented here as a set of tools to measure and
monitor these performance relationships and assign a strength score to each individual currency and also to
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: U.S. dollar, J apanese 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.

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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 seven forex pairs that contain each
underlying currency.
We calculate the performance for each of the seven forex cash pairs using a smoothed momentum
percentage. Specifically, we use the 3-bar simple average of the 13-bar percent change.
Since there are two currencies represented in each forex pair, if the momentum percentage for the pair is
positive, then the score value for the base (first) symbol in the pair is also positive and the score value for
the quote (second) 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:
Euro Score =(EURAUD +EURCAD +EURCHF +EURGBP +EURJ PY +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. Dollar Score =(USDCAD +USDCHF +USDJ PY) - (AUDUSD +GBPUSD +EURUSD +NZDUSD)

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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. Lets plug in some sample performance numbers to illustrate the idea.
U.S. Dollar 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 Illustration
Table 1 shows the smoothed momentum percentage for each of the seven related euro currency pairs. It is
these momentum values that normalize or combine into the Strength Score for the underlying euro currency.
The normalized score formula is the sum of all pairs related to a currency using average momentum percent
multiplied by 1,000 and divided by 7.

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 normalized scores
for the two underlying currencies in a specific pair make up the Strength Score for that pair. We then
calculate this final Strength Score for each of the 28 forex pairs.
Table 2 shows the Strength Score for each of the major currencies.

Table 2: Strength Score for the Major Currencies

Aussie
Dollar
British
Pound
Canadian
Dollar
Euro
Japanese
Yen
New
Zealand
Dollar
Swiss
Franc
U.S.
Dollar
FX Strength Score
4.77 18.19 -16.82 3.46 -4.22 -5.02 2.56 -2.93
(Daily Interval)

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


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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.
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 (table 2):
(-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 quote (second) 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 changes color from red to green, or vice versa, as the score
crosses above or below 0.

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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: EURUSD with TSL: FX Pairs Strength Score CH

Charting the Strength Score for the Underlying Currency
Figure 4: EURUSD with TSL: FX Currency Strength Score CH



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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
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.
Note: If the symbol in the chart is not a currency pair, the indicator will plot values for all eight underlying
currencies.
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 gives us the opportunity to see all 28 forex pairs together so we can sort and rank these pairs
by their Strength Score.
In the RadarScreen window in figure 5, we can see that the GBPCAD has the strongest Strength Score,
using a daily bar interval; CADCHF has the weakest.
Colors are used in the RadarScreen cells to help identify several conditions:
Green font =Strength Score is positive.
Red font =Strength Score is negative.
Green background =Strength Score is positive and base currency Strength Score is positive and
quote currency Strength Score is negative. That is, the individual Strength Scores agree with the
positive Strength Score of the pair.
Red background =Strength Score is negative and base currency Strength Score is negative and
quote currency Strength Score is positive. That is, the individual Strength Scores agree with the
negative Strength Score of the pair.


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Figure 5: RadarScreen Window with Pairs Sorted by Strength Score


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.

Indicators
There are three indicators provided with this Analysis Concepts paper.
1. TSL: FX Strength Score RS
2. TSL: FX Pairs Strength Score CH
3. TSL: FX Currency Strength Score CH


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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
The TSL: FX Strength Score RS 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 Description
Score Plots the Strength Score for a currency pair.

Input Default Description
MoLength 13 The number of bars used to calculate the momentum percent value
BarsToLoad 126
The number of bars of historical data to load; this value should be at least double
the MoLength Input plus 100 bars to match the data loaded into each row.

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.

Indicator -- TSL: FX Pairs Strength Score CH
The TSL: FX Pairs Strength Score CH 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 Description
Score Plots the Strength Score for a currency pair.

Input Default Description
MoLength 13 The number of bars used to calculate the momentum percent value.
BarsToLoad 500
The number of bars of historical data to load; this value should be the same as the
number of bars loaded into the chart.

Indicator -- TSL: FX Currency Strength Score CH
The TSL: FX Currency Strength Score CH 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 Description
There are two plots; plot names vary based
on the pair in the chart.
Plots the individual Strength Scores of the two currencies in a pair.

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Input Default Description
MoLength 13 The number of bars used to calculate the momentum percent value.
BarsToLoad 500
The number of bars of historical data to load; this value should be the same as
the number of bars loaded into the chart.

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 AUDJ PY AUDNZD AUDUSD CADCHF CADJ PY
CHFJ PY EURAUD EURCAD EURCHF EURGBP EURJ PY EURNZD
EURUSD GBPAUD GBPCAD GBPCHF GBPJ PY GBPNZD GBPUSD
NZDCAD NZDCHF NZDJ PY NZDUSD USDCAD USDCHF USDJ PY

Conclusion
The Forex Pair Performance Strength Score presented in this paper 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/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.
One possibility for further development of the Strength Score is to track over time changes in the relative
ranking of each symbol compared to the others. This ranking could be displayed over a historical period to
monitor the relative movement of each symbol within the list. This would allow the trader to more easily see
which symbols were moving up and down within the list, determine how long a symbol had been at a
specific level, and better identify trend reversals and rotations of strength.









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