Does the volume-based trading strategy really work?
In this episode of Truth About FX, Walter and Hugh dig into volume-based trading strategies that actually work in forex. If you are in the Naked Forex Now forum, you’ll know this guy Mark Fletcher. He shares a useful book about volume-based trading that you can use. Walter also shares some really cool tools that you can use to increase your win rate.
All these and more in this episode of the Truth About FX Podcast…
Download (Duration: 12:58 / 31.1 MB)
In This Episode:
01:10 – no central location
02:24 – futures over forex
03:35 – an interesting study
05:50 – elephant herder
07:00 – much more nimble
08:13 – little blips
09:21 – volume profiles
10:37 – slippery slope
11:52 – cool tools
Announcer: Sometimes, forex trading is a wild and wooly place to be. That’s why Hugh is here, to post your questions to Walter, the naked forex guy. Hugh’s got questions and Walter’s got the answers. Here at the Truth About FX Podcast.
Hugh: Hi, Walter. Do you know of any volume-based trading strategies that work in forex?
Walter: Yeah, this is interesting. There’s a guy in our forum, Mark Fletcher. He’s a really cool guy. He knows a lot about trading and automated trading in particular. He asked me about this and he actually flagged a book. I will put it in the show notes for anybody who is interested.
I have to admit, I have not read the book yet but I do think it’s possible. I also think it’s tricky. He said that he was working on some automated stuff around this volume and now he has this idea.
Traditionally, people always say, “No. You can’t do this” because forex in general, the real forex market and the forex retail market, there is no central location where it’ll all happens. It all kind of decentralized and all over the internet. That is why you get different prices with different brokers and different spreads and all that.
Everything is kind of a little bit fuzzy so you have to make a decision. You could look at your broker’s volume, if you can get that data. If you’re more in longer term position trading, you might look at futures volume. There’s ways like that around it but I think there are also those traders and I don’t know a lot about this. I’ve learned a little recently where you’re looking at kind of order flow.
These order flow traders which is really popular I think in the stock world. If you can get to what they call level two data, you can see where all the orders are. Obviously, you can do this in the real forex market if you have like a Reuters terminal and stuff like that, you can see where all the orders are.
But, here is the interesting thing about the retail world. Some platforms are actually allowing you to see these orders and you could use these information to kind of like take little scalps. I think that’s pretty typical amongst “order flow traders” in the stock world.
You could do that but I don’t really know enough about it. I think that a lot of these order flow traders actually prefer to trade futures over forex. Because of all those things we’ve talked about how there’s no centralized location you know.
It kind of makes sense if you want to go that way. You would probably be better off trading volume based order flow strategies. Where you’re kind of in and out, kind of looking at where the orders are stacking up and that kind of gives you an idea of where the market is likely to go.
It’s almost like you’re looking at magnets. You see these magnets and when the price gets close enough to the magnets, you’ll know it’s going to be probably move toward that magnet. Again, I have a very limited understanding on this. I think that’s kind of what they’re doing.
I think it is possible but if you’re really going to go down that path, it makes more sense for you to switch markets and either go into shares or into futures. I think that just makes more sense in terms of getting your hands on really good order flow data. So that is probably what I would do.
Hugh: Okay. Could there be an argument to say that if your broker is large enough in the retail world, it would kind of mirror what’s going on in the whole market? Do you think that’s reasonable?
Walter: I don’t think so. I mean, I don’t think so but there was an interesting study by the co-founder of the Oanda broker. I don’t think he has anything to do with it anymore. I can link him up in the show notes (Richard Olsen) for you guys.
He has like a fund in Switzerland. He’s a really interesting guy because he studied this. He had ticked data from Oanda going back years and years. And so, one of his questions was and this was at the last Live FXStreet Conference. I don’t know if you might be able to get recordings for that from people but I’m not sure.
Anyway, what was really cool about this is, he was saying, “Look, what’s interesting about the forex world is we say that is a massive market and it is so hard to move it. Blah, blah, blah… X trillion per day blah, blah, blah.. The trailing goes up every year. The amount of volume traded..” His study actually showed that it doesn’t take much to move the market.
You actually don’t need to have that big of an order to move the market. Now, the caveat is of course, you don’t move it that far but if you’re trading 10 Million, that is not a lot in terms of the overall volume or even maybe 5 Million depending on the time of the day, that can move the market a little bit.
That is what’s interesting about our market. It’s that on that side you can say, “Maybe the retail market can move it” but remember they are pretty much separate. Let’s say that all of the retail forex traders with all of the retail forex brokers make up 3% of the overall forex market. Which I think is about right. I might be a little bit off but it might be five, it might be two or whatever. I think it’s around 3% or so as of this recording.
If that is the case, even your biggest broker let’s say your biggest broker has half of all the volume in retail forex and that’s like the 1.5% of the volume even if all the traders took a trade at the same time. I guess it could. In theory it could but it’s highly unlikely. I just don’t see it likely to be the case.
Now people look at that and they say, “Well, that means that as retail traders we’re just kind of at the whims of what the banks and the big funds do”. I suppose you can say, “That’s true” but let me ask you a question.
If you are the elephant herder and you’re herding these big elephants around or if you’re a fly on the elephant’s back. Like if somebody wants to go somewhere, who has an easier job? I think it is the fly on the elephant’s back.
The elephant herder has got to do a lot of work to get these elephants all headed in the right direction. That’s kind of like these funds trying to move the market. They typically will probably do this during low volume periods around Christmas or Thanksgiving or interbank market.
If they really want to move the markets, that’s typically will you see them push around a bit when volume dries up. It’s a difficult thing to do. They can do it of course. Usually what they do is they just kind of write the orders. If you’re a bank and you see all these orders coming in from your clients, you can kind of just go with that.
I think it might be illegal now to put your proprietary trade ahead of your client’s trades. That used to be a tactic that banks would use. I don’t think they could do that anymore. I think the regulations have tightened there but the important thing to note here is that as a retail trader, you’re much more nimble.
You can move in and out of the markets much more easily than these big players can and so what that means is that it’s easy for you to ride the elephant’s back and go with it. That is one thing that I would point out.
People point out, “The broker is against me. The funds, the banks just move wherever they want and it’s all rigged” that sort of thing. Sure, you can think of it that way but the other way to think about it is, “If all these banks are really moving the markets, why don’t you just wait until it’s clear? That they’re moving the markets and ride that” that is another way to look at it.
I think we have advantages as forex traders. We still have pretty good leverage in most areas of the world, even though that’s changing. We can still look at the charts and make a decision where it’s going just like anyone else.
There are some systems that won’t work. There’s simply some trading systems that would not work if you were trading at a bank or a large fund and they can work if you were a stay-at-home retail trader, that’s true as well. That is another thing, some of the market is scalable. So that’s another advantage.
I think it’s unlikely that there are retail traders that are going to move the market. There’s little blips here and there when that happens but overall if you’re thinking kind of retail traders push the Euro 50 pips I would say, mostly no.
In Japan, they blame the housewives who were trading the Yen. They actually blame the housewives and I think that is ridiculous. If you’ll look at the actual volume of money during that time, during the carry traders as you say is moving out of Europe and going to Japan. That is what’s doing that. That’s moving it. It was not housewives at home trading the Yen so that was ridiculous.
Hugh: We’re on the topic of volume, do you have any thoughts on volume profile?
Walter: No. I don’t know. Do you know the name of the book. I will put it on the show notes. Do you know the name of the book, I think it was written by a woman who talked about using volume in forex? Do you know who it was?
Hugh: Anna Coulling.
Walter: Yeah, is that what you’re talking about?
Walter: She does volume profiles, is that what it is?
Hugh: She hasn’t do volume profiles but it’s kind of like one of the things that got me thinking about how’s volume are really usable in forex.
Walter: I think that’s the one. I’ll link that up in the show notes. That’s the one that Mark Fletcher recommended and I have to admit I haven’t read it yet. It’s an interesting idea. I feel like sometimes traders just have to, you kind of have to pick your tools.
I’m reading a book — it’s funny — with my son now every night and it’s about this boy who goes up against these beasts. Every time he’s faced with a beast, he has to choose. He goes into the battleroom and he’s given a choice. To choose these weapons off the wall. He can only choose one or two but there be like a dozens on there.
All really looks cool but I can’t get it because he has to get these upgrades. He has to win more battles to get these upgrades and be able to get more weapons or better weapons or tools and things like that.
I think traders are kind of the same way. I feel like it’s really tempting because we have all these indicators and all these tools available to us that we should use as much as we can but I think that is a slippery slope.
I feel like, we’re almost better off going, “You know what? I am going to use this and this. I’m going to use these two main tools and just build my strategy.” Now, if you want to do another strategy and start from scratch then you could certainly use two other tools. That’s great but I feel like there’s a real temptation.
I think the brokers were aware of this that there’s a real temptation. As retail traders for us to kind of throw everything including the kitchen sink and see what sticks. I know that because I did the same thing. I understand that. I did the exact same thing.
If you’re coming up with independent strategies that you want to run in parallel then it makes sense to add things that you think like volume profile or whatever. That makes sense to me but at a certain stage, if you’re just really trying to build a perfect system, the underlying thing here as a trader, ask yourself: why do I want to do this?
Is it because I don’t want to lose, is that why? I’m trying to improve my win rate, is that really what is going on here? Maybe I should work on that feeling or belief rather than adding on more indicator and stuff.
I’m not saying that this is what everyone does but a lot of perpetrators do this in the beginning, obviously. You can use these cool tools but if you’re already settled on some seed that work for you, I would stick to those and then build these other things as independent strategies and then see if they can work.
You have complementary strategies, where one is up, the other is down and so forth. That’s ideal really if that is what you want. That is the goal I think of every trader. To have this flattened out equity curve so that you don’t have a really deep drawdown. The way to do that is to trade complementary strategies.
I just want to mention that. I’m not pointing fingers to anyone. I just know that as traders, we sometimes get caught in this arm’s race. It’s like, that’s really good with this and this and I’ll just this to make it better. Do you know what I mean?
Walter: Yeah, that’s all.
Hugh: Cool, that’s a great point. Thanks, Walter.
Walter: Thank you.