Finding Themes with the Market Type Heatmap
One of the questions I like to ask aspiring traders is this: are you bullish or bearish anything right now? It seems like a dumb question but it actually gives a wealth of information regarding the trader’s mindset and whether he is thinking multidimensionally or not. Compare these 2 replies:
- I’m currently bullish on NzdUsd.
- I see strength in NZD across the board and prefer to play it against the USD which seems to be in some kind of pullback.
The first reply is immature and shows superficial analysis. The second reply tells a lot more: the trader has scanned the full spectrum of FX crosses and has identified a theme (NZD strength) and is puposefully playing it against USD due to some weakness.
The easy way to find themes in FX is to use a Heatmap – and we’ve built one!
The Market Type Heatmap
- +2 = Bull Fast
- +1 = Bull Normal
- 0 = Rangebound
- -1 = Bear Normal
- -2 = Bear Fast
The objective of the Market Type Heatmap is to illustrate strength of major currencies relative to others. For example, a trader might notice USDCAD rising and jump to the conclusion that the Canadian Dollar is weak. But taking a closer look, the USDCAD strength is more a product of USD strength than Cad weakness.
If a currency is strong against some trading partners but weak against others, it’s not a protagonist and we want to be following the protagonists at any moment in time. How can we systematically scan the FX universe attempting to find the current themes or best opportunities?
This is where the Heatmap comes into play. At the moment, the Kiwi is having a good run. But before taking a position, I want continued confirmation that Kiwi is the flavor of the week or if something else is stealing the spotlight of late. So here are questions to work your way around the Heatmap:
- What is the USD doing? Being the world’s reserve currency, it is often the main focus in FX..but not always.
- Run the ruler across Gbp, Euro, Yen, Usd against their main trading partners. Is any of them dominant or passive across the board?
What we’re trying to do is make sure that the strength of NZD is not an exception limited to NZDUSD. Before buying the NZD, I’d prefer to see it strong across the board. It’s then a case of matching the strongest vs. weakest, to see if an opportunity exists.
The Importance of Market Type Filtering
We are always hunting for value vs. risk, in order to make our life easy. If the USD is choppy or in a range, then it might be better to look outside the greenback for some action. We’re basically looking regularly for trending candidates, without exluding anything.
In order to filter out trending candidates, we are applying the lessons we have spoken about in abundance: using Market Types to enhance the odds. Our Must-Read section has a good collection of posts, as well as Sam’s Free Advanced Course for Smart Traders.
The chart above shows the Kiwi crosses with the Market Type Indicator (which will soon be available in our MT4 & TradingView section). By being selective and only trading in line with dominant themes, it becomes much easier to leg into trades.
One candidate that has been in the spotlight recently was EURNZD (short). The red lines are when the Daily Market Type shifted to either Bear Normal or Bear Fast. The hourly chart shows a potential entry trigger: fading short-term Bull-Fast Market Type switches in line with the Daily trend. Basically, taking the opposite side of the traders blinded by short-sightedness!
But you do not have to use this suggestion. The Heatmap will allow you to quickly identify strength and weakness within the FX market and then you can use whatever tools you prefer, to get aboard.
Over to You
Our Heatmap will be sent to Signal Subscribers and Pathway Subscribers. Instead, our Market Type Indicator will be released soon, and will be available for MT4 and TradingView.
Whenever possible, it’s best to simplify your trading endeavours and eliminate any possibility of analysis paralysis or conflicting signals. The concept of a Heatmap is nothing new: dealers have been using the same idea for ages. However, a Market Type heatmap is slightly smarter, since it points out not only dominant performance but actual dominant trending candidates.
By filtering out themes and remaining on the sidelines (protecting your capital) when nothing is really standing out, your trading will never be the same, for the better.
About the Author
Justin Paolini is a Forex trader and member of the team at www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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