Tutorial

Introducing ZeroFX – a next generation currency trend indicator

ZeroFX is a proprietary currency trend indicator running against three FX pairs – the EUR/USD, the GBP/USD (a.k.a. ‘cable’), and the AUD/JPY. We plan to support additional currency pairs in the future but the current set covers the most popular pairs among the FX traders we interviewed on Evil Speculator.

The creation of the ZeroFX was inspired by the success of the ‘Zero’ indicator which was originated in 2008 to run against the S&P E-Mini futures. The lessons learned since and in particular the much more effective trading style we developed using the Zero on the E-Mini suggested that an FX equivalent would be well worth the time and effort of development. However, the challenges of porting the indicator to the FX front were significant as the algorithms feeding the Zero are rather complex. Also, if you understand the principle how the foreign exchange market works then you may appreciate the complexity of developing an indicator that in essence produces a visualization of market momentum and participation.

The Forex (or FX) market is a completely unregulated global market in which trading does not occur on an exchange and does not have a physical address of doing business. Unlike in equities, which are traded through exchanges worldwide, such as the New York Stock Exchange or the London Stock Exchange, Forex transactions take place over-the-counter (OTC) between agreeable buyers and sellers from all over the world. This network of market participants is not centralized, therefore, very limited data flows from one broker to another.

For example, many fledgling FX traders who have transitioned over from equities merrily continue to use their volume indicators despite the fact that Forex does not offer any market-wide volume statistics. Thus any volume data you may receive is purely simulated or estimated and thus cannot be relied upon for trading. Again, remember that there is no central exchange, therefore volume data for FX is simply inaccessible. That despite recent reports suggesting that Forex is one of the most liquid markets in the world with an estimated average daily volume of nearly $4 Trillion.

Similarly most of the underlying data used in the original Zero simply does not exist on the Forex side and therefore had to be either re-created or replaced with home brewed equivalents. After several weeks of implementation we arrived at an early version of the ZeroFX which appeared to be a fitting candidate and produced similar signal characteristics as our original Zero running against the spoos. However several months of testing and refinement were still needed to produce what you see today. We experimented with various indicator settings as well as spent considerable time comparing minute vs. tick data. In the end we decided to use tick data to feed into ZeroFX despite the fact that even that is simulated on our FX data feed – it simply produced a more timely and better signal. Why exactly we admittedly do not know. A welcome and supporting benefit was that NinjaTrader (which is our underlying implementation platform) had introduced the concept of ‘equidistant’ charts, which allowed us to drive ZeroFX via single ticks while plotting a 5-min and 60min panel right above without running out of sync.

Before we get into what the ZeroFX works and why you should care about it let me first cover what is not: For one it is not a trading system – it is an indicator, meaning that it will not give you any entry or exit signals. However, what it does offer are email alerts during times of signal extremes – we will cover that further below. Second, it is not an oscillator – meaning there is no finite signal range (i.e. 1 – 100) – the signal is dynamic and actually had to be normalized in order to produce usable signals during times of high participation or significant momentum. Third, although it looks deceptively similar to for instance an RSI or stochastic indicator it has nothing in common with any traditional momentum or trend indicators – in fact the signals it plots are anticipatory and thus not reactive. That is a key difference we hope you will come to appreciate. Which also means the signal does generally not lag behind and often plots ahead of short term reversals. This actually takes some getting used to and often requires discipline on the part of the trader. Finally, as for now the ZeroFX remains to be a short term indicator good for playing intra-day swings. If you are a medium (as in weeks) to long term (as in months) FX trader then the ZeroFX will be of little use to you.

Now having covered what it doesn’t do let’s talk about what the ZeroFX does and how it works.

(click on the image or here to get to the live data feed)

As we were putting all the different pieces together to produce the final signal we were running it across several weeks of data and were pleasantly surprised by how similar it felt to our original Zero. If you have been a Zero sub for a while then you will most likely feel right at home. Here’s a run down of what makes the ZeroFX tick:

Lanes & Panels

There are three horizontal lanes on the current ZeroFX chart – each lane occupies one currency pair with a 60-min panel on the left and a 5-min panel being on the right. The base currency for FX is the one on the left – as you probably know. However, if you trade ZeroFX the symbol of interest is the cross currency. So, in the middle lane for instance we have two EUR/USD panels – and that should be used with a focus on trading the Dollar. On the top we have two AUD/JPY panels and that one should be used to trade the Yen. The two GBP/USD panels on the very bottom were mainly included due to its popularity and traditional trading volume.

Basics

There are currently two signal lines per each ZeroFX indicator panel – one in white and one in blue. The white one represents momentum and the blue histogram represents participation. How we do that is of course part of our secret sauce. In case you wonder – no, neither of them represent volume. The way to trade the ZeroFX depends on your personal trading style (e.g. trend vs. reversals vs. scalping, etc.) and thus this tutorial mainly aims at explaining the signal’s characteristics as opposed to how to exactly trade them.

In any case – for starters watch out for dips below the zero mark, which are obviously bearish – and conversely a pop above is bullish – in that respect it resembles a MACD or stochastic oscillator (with the latter having 50 in the center instead of 0). Usually the blue and white lines move in unison and you will rarely see one move down while the other one continues upward – if you do then take note and reduce your position size as most likely something unusual is going on. What you may however encounter more often are blue histogram spikes above the white line, which in essence are early harbinger of buying exhaustion; similarly on the bearish side blue line spikes below the white signal may indicate possible selling exhaustion. More on that below.

Divergences

As with the original Zero the real meat is in the divergences which are well worth waiting for. Based on prior observations we should also look out for swings above the +1 line and below the -1 line, which often represent buying in the former and selling exhaustion in the latter case. If you see a continued ramp higher but the signal line is diminishing then it may be time to get positioned to the short side – the inverse applies to long trades.

The chart above shows four good setups involving divergences – one (blue arrow) dropped but not far enough and probably would have gotten stopped out. The trick here is in being patient and waiting for a long significant divergent spike – then you set a stop nearby and simply forget about it. Finding a target is a bit more tricky – and we ourselves usually rely on VWAP (also on the chart) or the ZeroFX signal for our exit.

Signal Spikes

One of the most exciting phenomenon we encountered when trading with the ZeroFX were the signal spikes. As a matter of fact originally some of these signals pushed so high out or range that any prior data was miniaturized and any following was almost illegible until that monster spike had dropped off the chart. In order to remedy this problem we introduced a means of normalization which some of our traders started to refer to as ‘Christmas tree lights‘.

For instance looking at the chart above you will see several stars plotted near a significant bottom or a top. We don’t always get them in such close succession and thus this serves as a great example. Looking at that first selling exhaustion signal you notice two things – the actual signals on the ZeroFX panel have been truncated to 1.5 which based on prior observation appears to be a critical level, plus it allows for smaller signals to remain visible. In order to communicate the strength of those blue and/or white signal spikes we instead paint stars below or above the actual currency pair candle. That very first candle is accompanied by two blue stars and three white stars, which simply means the actual signals were near 2.0 for the blue participation signal and 3.0 for the white momentum signal. With a bit of imagination they indeed look a bit like Christmas tree lights hanging of those candles – and quite often Santa comes to town soon after.

Besides offering a means of normalizing the signal this technique also opened the door to alerting our subscribers to possible buying or selling exhaustion events. Here an example of the sort of email a subscriber may receive:

Extreme signal condition detected on 5-Minute AUDJPY panel:

White momentum signal DOWN spike to -3.69 – possible selling momentum exhaustion!
Blue participation signal DOWN spike to -1.85 – possible selling participation exhaustion!

Prior observation suggests that ZeroFX signal spike alerts are rather binary in nature, meaning they are either triggered within a few pips of a reversal or the tape keeps running in the same direction. Knowing this offers us minimal risk exposure by setting our stop just a few pips away from the 79.22 close of the trigger candle. It is also worth noting that a favorable Net-Line breach soon after (e.g. NLBL after sell exhaustion or NLSL after buy exhaustion) appears to increase the odds of success for this type of reversal trade.

We are going to cover Net-Lines below but the important message to take away is that these signals are pretty binary, a phenomenon that may be much appreciated by swing traders and scalpers. If you have traded more than a few years then you probably understand that being wrong is simply part of the game, as a matter of fact professional traders plan for it and what to do when proven wrong is part of any trading system worth its salt. The finer points of this are way outside the scope of this tutorial but you may simply enjoy the fact that setting a stop near the close of a signal condition alert will afford you minimal risk with large potential upside when placing your trades.

Net-Lines

As mentioned above we also decided to add Chris Carolan’s most excellent Net-Lines indicator to both the 60-min and 5-min panels of the ZeroFX. To new readers of Evil Speculator this may appear arbitrary but in recent past the inflection points shown by the Net-Lines indicator have become a core tool in our trading arsenal. We now heavily use it on our FX charts as well as on equities and commodities – in each vertical it has proven to increase our hit rate on discretionary trades significantly.

VWAP

Finally we are also are plotting the Volume Weighted Average Price indicator on all 5-min panels. It is basically a must have when trading index and commodities futures and has already proven itself to be a valuable addition to our regular Zero running against the S&P E-Mini. Thus far it seems to be serving us well on the FX side, in particular when it comes to planning our exits after for instance a divergence or signal spike event.

Considerations

Bear in mind that FX pairs move quite differently from equities and thus you will not see as much ‘no action’ (as in flat) tape as there is a lot more trading volume. The Forex market trades 24 hours a day, 6 days a week and is active from Sundays 5pm EST to Fridays 5pm EST. So no matter what part of our giant blue marble you happen to occupy – the ZeroFX is almost always running.

Subscribing to ZeroFX

Now, the really good news is that many of you guys are already subscribed to ZeroFX as it is part of the Zero subscription package (recurring as well as non-recurring). If you have never subscribed to anything here on Evil Speculator then you will need to sign up for the Zero here first to create your login credentials.

How to auto-reload the full-size PNG

First up – ditch IE and download Firefox – you’ll thank me later. There are two ways to auto-reload the ZeroFX. The first and easier one is to navigate to our HTTP auto-reloader, which automatically refreshes once every 20 seconds (the same interval the screen scraper uploads the Zero chart. The second way is to download the ReloadEvery plugin and follow the installation instructions – it’s pretty easy. Once you restarted your browser click on the first image on this page, which is the live screen grab that gets uploaded to our server once every minute. If you want you can also bookmark the following URL: http://evilspeculator.com/zerofx/zerofx.png

Now, after you are doing that, you are NOT looking at a web page anymore, you are looking at the raw PNG image. In order to auto-reload that one simply right click (or Control-click in Apple) in an area outside the image (otherwise you only get the image options). Scroll down to ‘ReloadEvery’ and select ‘Reload Every 1m’. Please do not select anything shorter than that as it won’t give you a newer image and we are only uploading one to the server once every minute anyway.

Voila – now you’re auto-reloading the image itself. You can set the page to full screen (F11 on Firefox) and you should be good to go. Full resolution screen grab, which auto-reloads once every 30 seconds. This should also be faster for you as it doesn’t auto-reload the rest of the page.

UPDATE: There is also an auto-reloader for Google Chrome now – similar functionality.

How to magnify the actual PNG

If you have followed the instructions above then you are looking at the raw image. If that one is scaled down by your browser then you might want to magnify it:

  • Firefox: You can either hit ALT + on your keyboard or simply click on the image once to magnify it.
  • Internet Explorer: Move your mouse into the image and don’t move it for a few seconds. You will see a box on the bottom right of the image. Clicking that box will expand the size to the full resolution.
SMS Instructions:

If you would like to receive free SMS alerts, here’s how – all this of course assumes that you already have a Gmail account:

  1. Sign into gmail
  2. Go to settings top right
  3. Click on filters
  4. Create a new filter
  5. Add from address ex. alerts@evilspeculator.com (where all alerts come from)
  6. Click next step
  7. Check forward to and add your SMS (e.g. 1234567890@txt.att.net for AT&T).
    You can find a mappings of most popular mobile providers here.
  8. Click create filter and your done.

If you are switching from an existing email account to Gmail then you also need to do this:

  1. Log into your EvilSpeculator membership profile.
  2. Change your old email address to your new Gmail address.
  3. Done – you should now receive all alerts at your Gmail address which will automatically be forwarded to your SMS number.

That’s it – from now on you should receive all your SMS messages for free and almost instantly.

Of course you can avoid having to do all the above by simply using your SMS email address (e.g. 1234567890@txt.att.net for AT&T) as your email address in your membership profile. However there are three strikes against that. First, I cannot guarantee delivery and also don’t know about delays. Second, you won’t receive alerts via email anymore. Third – I’m pretty sure those alerts are not free – but it might depend on your mobile provider’s offering.

Forex Broker:

Finding a good broker is key to successful trading in the Forex market. And it’s very possible that the one you’re clearing with right now may just have a few skeletons in the closet. When it comes to long term survival and consistent results in the market knowledge is power – which is why I strongly recommend you point your browser to my write up on ECN brokers which gives a good overview of how a Electronic Communications Network compares to a regular dealing desk (DD) or a straight through processing (STP) firm.





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