A solid trading framework based on the timeless principles of game theory and the importance of the 24-hour nature of the Forex market

trading strategy probabilities

What is it with all these fancy casinos from Las Vegas in the U.S. to Macau in the Far East? One is bigger and more impressive than the other as you take in the awesome view driving down the Strip or set foot in Macau after getting off the ferry from Hong Kong. Well, the secret to their success is their edge. The casinos know that they have a statistical edge, which over time will bring them riches. The vast majority of players lose, and the longer they play, the more the casinos win. That is why they are always happy to spin the wheel, deal you a new hand or let you roll the dice. In this article we look at the way casinos operate and how we can structure our trading day to only play when the probabilities are heavily stacked in our favour.

Understanding probabilities

In the April 2012 issue of the Atlantic Magazine we read about Don Johnson and how he took home a total of $15 million playing blackjack. It seems impossible, right? Well, Don states in the article that he did not just walk into any casino and start playing like most folks do. He won all that money by understanding the probabilities and by negotiating the terms of the game. The house already has a significant advantage over the average player but a high roller can negotiate the “loss rebate”, meaning that on a $100,000 loss he could get away with paying the casino $90,000 or as in Don’s case, only $80,000. After the terms had been agreed the house edge was just a fraction better than 50 percent but with the discount on any loss, Don was in fact only risking 80 cents on the dollar. That is a great edge and on the hands when the odds were tilted in his favour he pressed his luck for all he was worth.


If there is one thing we as traders can learn from Don it is to make sure we only trade whenever the odds are in our favour. We do that by trading the currency pair which carries the lowest cost in relation to its average true range (ATR) with the broker who offers the tightest spread. The ATR is a measure of volatility and a very reliable indicator of how big a range we can expect to see during a trading day. So which currency pair makes the most sense to trade? Most people in Europe have a personal interest in either EUR/USD or GBP/USD as they have, at one time or another had to exchange their domestic currency for U.S. Dollars when they went on vacation or bought something online. Most also have an idea of what they think the U.S. Dollar is worth. Hence either of these pairs will likely be the starting point for anyone’s FX career.

Roulette and spreads

There is a fitting analogy between the two different versions of roulette and FX spreads that will help decide which of the crosses to trade if your only motive is to keep costs at a minimum. A roulette wheel has 18 red squares and 18 black squares. The difference lies in the number of green squares. In American roulette, there are two green squares, 0 and 00. In European roulette there is only one green square, 0. That gives the European wheel a house advantage of 2.7 percent while the American wheel sports a massive 5.7 percent edge. So which one would you play? The answer, of course, is none because the probabilities of winning are not on your side and you would be guaranteed to lose if you only stayed long enough. But if you had to try your luck at one of them then surely you would choose the European roulette wheel because your disadvantage is not as bad as playing the American one.

Using the same logic we will illustrate in the following example that unless you have an information advantage with regards to GBP/USD it makes much more sense trading EUR/USD. The former has in the last 100 days moved an average of 97 pips a day and typically has a 1.5-pip spread compared to a 1-pip spread on EUR/USD, which on average moved 98 pips a day in the same period. So you give up 1.02 percent of the ATR trading EUR/USD compared with 1.55 percent trading GBP/USD.

Keeping track of time

One of the great things about the FX market is that it is open 24 hours a day, 5 days a week. The flip side is that it preys on compulsive gamblers and keeps the uneducated glued at the screens for far longer than is conducive to disciplined trading. It is therefore really important to know at what time of the day your preferred FX pair is most active. Lose track of time and you lose sight of your goals.

By the way, did you ever wonder why there are no clocks up on the walls in casinos? That is because they want you to forget about time and overstay your welcome. The longer one stays the less disciplined the decision making tends to get. People will anchor their self-worth to the dollar amount at which they were most profitable and if the stack of chips start to dwindle they will promise themselves to try to make back what they have lost and then quit. It quickly turns into a game of revenge and usually ends with a player losing everything. Not only are you tired but you are now resorting to bets you would otherwise not have played.

Trade zones

In order to be successful we need to understand the importance of the 24-hour global nature of the markets. To illustrate what time is the most opportune for trading EUR/USD we have divided the 24-hour day into three segments that we call the Asian, the European and the U.S. session. We have then calculated the average movement for the pair in the past 100 days in these three different time zones. All times mentioned are expressed in Central European Time or CET.

During the Asian session (01:00 – 09:00) the EUR/USD moves an average of 40 pips. This session has the least liquidity and market makers tend to widen the spread significantly during these hours. The range of this session will serve as a pivot for the remainder of the European session.

During the European session (09:00 – 17:00) the EUR/USD moves an average of 80 pips. This session has the most liquidity, the tightest spreads and is divided into six trade zones illustrated in chart 1.1 and discussed in greater detail later.

During the U.S. session (17:00 – 01:00) the EUR/USD moves an average of 48 pips. When there is still room for profits we will stay the course but never enter a trade after 17:00.

With this information it is clear that the hours between 09:00 – 17:00 are the most active and the only time we want to trade EUR/USD. On occasions when we keep trades open overnight it is because the day closed on a really strong or extremely weak note and we expect follow-through ahead of the London open. Knowing by how much the pair typically moves in the U.S. and Asian sessions we can place our protective stop at a distance from the market that allows for normal volatility without stopping us out.

European session

We trade 30-minute candles because most economic data is released either at the bottom or at the top of the hour. If economic data surprises in either direction the market will quickly discount that information and we want to trade the imbalances in supply and demand as the market adjusts to the new reality. Trading 30-minute candles we have never missed an opportunity to trade the news and it has never failed at signalling any bigger intraday trend.

Trade zone #1 is between 08:00 – 09:30 and most of the time when we see the wick of the daily candle drawn. Remember the old adage, “The amateurs open the market and the professionals close it”. On most days we will stand down during this time segment to see how the opening flows resolve themselves. However, we will buy the market any time after 8:30 if the lows of the Asian session have been tested and rejected followed by a quick reversal candle that takes out the high of the range. By the same token, we will sell the market if the highs are tested and rejected followed by a move through the lows of the overnight range.

Trade zone #2 is between 09:30 – 11:30 and a big window of opportunity when the market has usually rejected either the upside or the downside and started to draw the body of the daily candle. This is where we get busy and try to catch as much of the ATR as possible. At the time of writing this article the 50-day ATR is 111 pips. Armed with this information a trader who does not know anything about the market can still make a fortune just by being able to identify a reversal and then shoot for the full ATR in the opposite direction. If you look at the market this way it is just a numbers game where it will cost you a pip to play with 111 pips of potential profits for anyone who nails the bottom and the top.

In the example in chart 1.1 price traded to a high of 1.3100 before coming back to break the lows of the Asian range at 1.3060. By then we had covered 40 pips, clearly reversed the order flow and the daily candle just turned red. Assuming we had seen the high of the day and the 50-day ATR being 111 pips, the downside target was 1.3060 – (0.0111 – 0.0040) = 1.2989. Statistically there were71 pips left in the trade with a reward to risk of almost 2:1 if you shorted the market at 1.3060 with a stop at the high of the day. How it makes its way to the target is irrelevant as long as the market does not have another reversal in store before the close. Eventually, the market traded down to 1.2965.

Trading strategy European trade zones

Trade zone #3 is between 11:30 – 13:00 and when most people are at lunch. We will stay in a trade during these hours but not initiate any new positions as the market tends to chop, run tight stops and show indecision as it waits for traders to get back to their screens.

Trade zone #4 is between 13:00 – 14:30 and when liquidity is back in the market after the lunch hour and traders have a shot at extending the trend. This is also when the first of the U.S. players start making their presence felt.

Trade zone #5 is between 14:30 and 15:00 and the time when most U.S. data is released. This candle will serve as a pivot for the rest of the day.

Trade zone #6 is between 15:00 – 17:00 and the final window in which to enter a trade if the ATR has not yet been completed. If the market has traded in a narrow range the odds increase of an explosive move towards the close as the market should keep pushing until it completes the full projected daily range. Also, that late in the day all the economic data has been released so in terms of news there is nothing left on the agenda to cause a shift in sentiment

Wisdom of crowds vs. contrarian foolishness

Price can get from A to B in a thousand different ways and the higher the time frame the more time for new information to reach the market. We only want to be in a trade for as short a time as possible when the market is the most active and we will seldom fade the most current 30-minute trend. Fading the trend is an expression that you think the market is wrong and you are right. We are not casting any judgement on being contrarian because it takes all kinds to make a market and there are many ways to skin a cat. However, in the space in which we are operating there is very little room and precious little time to pull consistent profits out of the market on a daily basis if you are contrarian. Knowing how tiny we are compared to the overall market our methodology is to be in synch with the market and fine tune our strategies to the volatility. We trade without a bias and have no opinions because they only limit our response when it comes to cutting losses. We simply want what the market wants.

Chart 1.2 shows the EUR/USD futures on a 5-minute time frame on March 7 when the ECB left interest rates unchanged. No action on the rate announcement but in the press conference afterwards the market interpreted comments by Draghi as bullish for the Euro. When trading the ECB, FOMC and NFP our initial setup is the same as for trading the London open off a test and rejection of the overnight range. For the ECB we pencil in the pre-ECB range which will serve as a pivot for the remainder of the day. As we saw the lows get tested and rejected we stood ready to enter the market long if it powered back up to the top of the range. Our initial stop was at the low of the reversal candle. The risk in putting on a long trade before the end of the press conference is the possibility of another comment which could have reversed sentiment once again. Potential reward could be huge if the message was interpreted as a shift in monetary policy.

Trading strategy EUR USD futures chart

Crowd psychology

A trade is just a trade but two trades in the same direction could be the start of a trend. Once the ball starts rolling it will attract fresh blood as new money joins the fray. The move will get the attention of more traders wanting to participate, driving prices even further. Eventually the market will hit an area where stops are triggered thus extending the trend even more and perhaps even exhausting it.

On a philosophical note, there is really no such thing as a queue.  There are only individuals standing in line one after another. Standing outside a bank to withdraw money they may be referred to as a queue but what happens after all but one leave? And just as a queue is nothing but a line of individuals who happen to show up at the same time, a trend is really just a bunch of trades executed in the same direction on a time line and will end as soon as everyone is in and there is no one left to commit more money.

Chart 1.3 shows the EUR/USD futures on a 5-minute time frame on March 8 when the NFP numbers were released. We stood ready to buy the market if the initial move lower was reversed but on this occasion the market continued to make lower highs. Our focus shifted from playing a reversal to figuring out how to get short with a risk to reward that still made sense. Most of the ATR had already been covered but with the data beating consensus by a huge margin and momentum usually preceding price we sold 1.3024 with a stop at 1.3066. As more money piled into the short side and traders stuck long started liquidating, the selling frenzy kept feeding on itself. The volume bar coloured red is where the selling climaxed as positions were squared and fortunes made and lost.

Trading strategy EUR USD

To further understand what drives EUR/USD we will explore how FX is a zero-sum game. Well, actually it is a negative-sum game when you factor in spreads and the occasional commission but that is beside the point. The bigger picture is that your gains come from someone else’s losses. Speculators take opposing sides of the trade and like any contract based market a position is kept open until offset by an opposing transaction.

Chart 1.4 shows EUR/USD on March 7 (grey on the chart) and March 8 (blue on the chart). March 8 has everything we look for with regards to tests of the overnight range, reversals and stop hunting. The market ran up and cleared stops above the Asian range before coming back inside the range again ahead of the NFP data. After the number was released some traders were caught on the wrong side of the market and if you are long and panic you will have to get out at the bid. The market will go wherever there is enough volume to match all the orders and the most obvious level on the downside was 1.3000. As a side note, big round numbers become psychological support and resistance levels simply because the brain processes 1.3000 a lot faster than 1.2987, for example. Between 1.3000 and the old swing low at 1.2965 there was an air pocket and prices fell quickly once it dawned on everyone that the figure was not going to hold. Once 1.2965 was broken a ton of stops were triggered as illustrated by the red volume bar. The bears had accomplished pushing prices to a level where they found sell stops and could get flat without moving the market adverse to their position.

trading strategy Asian session


The FX market is a place where the little guy can have a big idea and make a fortune. All you need to do is to identify one pattern which has a positive expectancy and execute it whenever it sets up at a time of day when liquidity is good. In poker the secret to success is not as much about winning huge pots as it is losing less when you lose and winning more when you win. Over time the cards will end up with an even distribution and it is up to you how to bet and fold in order to control risk. Hence the conflict is the one between the free will of the bet and the vagaries of the luck of the cards. The fact that the FX market is open 24 hours a day makes it easy to control risk because there are no gaps and slippage is never really an issue. However, it is also an open-ended game where the odds are constantly shifting. Certain times of the day are clearly not as favourable as others but if your strategy is based on identifying high probability setups in the European session and to trade risk appetite and mass psychology in the direction of the 30-minute trend then there is no better vehicle than the EUR/USD.

Patric Tengelin