The Smart Money Indicator for Forex: Forex Strength Score: With a multitude of currencies trading (platforms such as TradeStation Global, for example, has 23 spot currencies resulting in more than 100 pairs) it is not always easy to choose which pair to trade. Ideally, you should trade those currencies that are stronger or weaker and do so in the pair that shows the most strength or weakness, right?
With these indicators we can assign a score to each currency individually, obtained by comparison with the rest of the currencies and also score which pair shows stronger or weaker, but starting from the individual scores of each currency.
What is Forex?
In case someone has just arrived to trading and doesn’t know what Forex is, let’s make a brief introduction.
Forex or FX is the abbreviation of Foreign Exchange. It is a market that is open 24 hours a day and that moves impressive amounts of money, more than 5 trillion dollars a day and is in fact the most liquid market in the world.
It is an OTC market (over the counter) which means that there is not a single clearing house and a single price for everyone as happens, for example, with futures. It is decentralized and each broker or liquidity provider has its own market, liquidity and conditions.
It is important to understand that in Forex one currency is always quoted against another, it is what we call a currency pair. There is always a base currency and a reference currency. For example, the EURUSD, which is the most traded pair in the world, collects the exchange rate between the euro (base or primary currency) and the US dollar (reference or secondary currency). If the EURUSD is quoted at 1.14000, this means that 1 EUR is quoted at 1.14 USD and the result of the trade will always be in dollars, the reference currency. If the EUR rises, the USD falls and vice versa, making it a market with more symmetrical movements than, for example, stocks.
In the Forex market there is no Last price like in the futures or stock markets. We will always see the bid and ask quotes, although the bid is the default displayed price.
It is a leveraged market, which means that in order to trade it it is not necessary to deposit the total amount of the trade. What we will do is deposit a margin that the broker retains as a hedge against possible losses. The margin required may vary due to various factors. Leverage is a double-edged sword, it is opportunity and it is risk. Most investors who lose money do so by leveraging too much, i.e. by taking too much risk. Caution, therefore.
Calculation of the Forex Strength Score indicator
Before entering into the graphical understanding of the indicator it is important to glimpse how the data it shows us are calculated.
The indicator is calculated on the 8 main currencies (EUR, USD, JPY, CHF, GBP, CAD, AUD, NZD) which gives us a total of 28 pairs. It is designed this way, but the code could be changed to include more currencies in the calculations if desired.
The first step is to get the score for each of the currencies in order to evaluate which ones are stronger or weaker than the others. To obtain this score we will use the 7 pairs that contain the corresponding currency.
Let’s look at the Euro and the Dollar as examples.
Euro Score = (EURAUD + EURCAD + EURCHF + EURGBP + EURJPY + EURNZD + EURUSD)
U.S. Dollar Score = (USDCAD + USDCHF + USDJPY) – (AUDUSD + GBPUSD + EURUSD + NZDUSD)
Note that in the Euro all pairs have the Euro as their base currency, but in the Dollar some pairs have the Dollar as their base currency and others have it as their secondary currency. This is important for the calculation since the base currencies are added while the secondary reference currencies are subtracted. For example, the EURUSD pair adds to the Euro score, but subtracts to the Dollar score.