How to use relative strength/weakness in Forex — GBPUSD example

25 de abr. de 2022

Ichimoku makes identifying trends very easy, but it can be difficult to know when to enter a trend. This factor is often overlooked by newer traders, and it makes a significant difference to risk-adjusted returns.

One of my favourite ways to identify when to enter a trend is to use the concept of relative strength or weakness. Put simply, relative strength or weakness is when you compare a security to an "index" and try to understand whether:

• The index is moving up, and your chosen security is moving up even faster = Relative Strength
  
• The index is moving down or ranging, and your chosen security is holding ground or moving slightly higher = Relative Strength
  
• The index is moving down, and your chosen security is moving down even faster = Relative Weakness
  
• The index is moving up or ranging, and your chosen security is holding ground or moving slightly lower = Relative Weakness
  

This concept is incredibly important to understand. It can turn a B+ setup into an A+ setup.

The question is then, how do you find relative strength? The really easy, beginner-friendly, way is to plot the "Rate of Change" (ROC). This is an included indicator in TradingView and simply tells you how quickly something is moving up or down. What you can do with ROC is to plot it against the symbol you're trading, and then plot it again against an index. An example of an index could be DXY for the USD. This index would work for pairs like USDJPY, USDEUR, USDGBP, etc. Any pair where USD is the base.

I found a perfect example of relative weakness on GBPUSD. I plotted the ROC for GBPUSD (green) and the ROC for all GBP pairs (red). Ichimoku already told me that GBPUSD was bearish and I was looking for an opportunity to go short. Notice, that when GBPUSD becomes weaker than all GBP pairs, there is almost no bullish pressure.

If you short when there is relative weakness, your trade would have almost zero drawdown, and you would be in profit almost instantly. Yes, you could short anywhere on this chart and make money if you didn't have a stoploss, but this is not how to trade like a professional. If you tried to short this morning when there was no relative weakness, you would have to suffer through +37 pips of drawdown before it started moving down again. Could you take that? Could your risk manager take that if you were trading someone else's money?

I encourage all traders to explore Relative Strength/Weakness. It is one of the most powerful concepts in trading, and as long as you have your "index" right, you can use this anywhere. Stocks, Forex, Crypto, Commoddities, etc.