When markets open there is often high initial price volatility before a trend emerges.
Unlike the stock market, the forex market does not have a daily open and close. Running across three different trading sessions, the forex market is open 24-hours a day, 5.5 days a week. Consequently, most traders don’t see the forex market as having an ‘opening’ session. However, this is not the case. There are larger trading volumes as banks around the world open for business, meaning that currency pairs are not immune from opening volatility.
As stop-losses are triggered on either side of the opening price, a stronger trend will often emerge. Although the trend may not last, knowing that there is often a fake-out followed by a stronger move is something of which traders can take advantage in their trading strategies.
Traders should watch the most frequently traded forex pairs, as these are the most liquid, as well as looking for a large increase in trading volume as the market opens. These pairs include the EUR/USD, the GBP/USD, the USD/JPY, the USD/CHF and the AUD/USD.
The London forex session, running from 8:00 GMT to 18:00 GMT, is an ideal candidate for this trade, one of the reasons being that the GBP/USD and EUR/USD are not as heavily traded prior to the open of this session as they are prior to the open of the New York session (which overlaps with the European session). When Germany and London open for trading, the volume of trades on these pairs ensues, with the USD/CHF being another good pair to keep an eye on.
The JPY is heavily traded in the Asian forex session, but in the one-hour overlap between the Asian and London sessions there is increased volatility for the GBP/JPY and the EUR/JPY.
Working off the open of the European markets, we have three pairs to watch starting from around 6:00 GMT (prior to the market opening) until about 10:00 GMT (after the markets have opened).
The set-up
Prior to a major market opening, forex pairs typically move within small ranges. However this is not always the case, and on days when there is a lot of movement prior to the European open, the set-up will be harder to see, which might mean that this strategy is not appropriate.
1. Using a 15-minute chart, traders should look for a calm pre-market, or a forex pair that has a definable pre-market range. 2. A breakout of the pre-market range is likely to occur. We do nothing, as this could be a fake breakout. Ideally the breakout should be small, either less than a third of the average daily range, or from 10 to 30 pips. 3. We watch for an engulfing candle pattern (a bullish engulfing pattern consists of an up body longer than the previous down candle, whereas a bearish engulfing pattern consists of a down body longer than the previous up candle) in the opposite direction of the original breakout (so if the breakout was up, we would want a bearish pattern). 4. We open a trade in the direction of the engulfing pattern, placing a stop just below the low of the bullish engulfing pattern (or the high of the bearish engulfing pattern). 5. To exit, a trader could either place a trailing stop on the trade, set limit orders based on the average movement during the early European session or the average daily range, or watch for the reverse engulfing pattern to close.
Considerations
Traders should be aware that not all signals will provide an entry and exit within the first couple of hours, with some signals developing later in the session. In this case it would be a good idea to exit using a trailing stop or limit order.
If multiple stops and limits are being triggered, traders shouldn’t make more than two trades in a given direction and just save the system for another day. And, if an initial breakout has momentum and runs more than 40 pips outside the pre-open range, traders shouldn’t make a trade in the opposite direction even if an engulfing pattern appears.
Traders can also increase their chances of success by looking for false breakouts against stronger long-term trends, as trades that go with longer-term trends have a higher chance of success. They could also trade in multiple lots (contracts) as this will allow for multiple exits, thus allowing them to break even on their risk before taking more profit.
Conclusion
Although the forex market is open 24-hours a day, there are still times of the day when more participants enter the markets, and these can provide great opportunities for forex traders. By watching for fake breakouts, reversal patterns and using multiple exits, a trader can potentially profit on a large portion of the average daily movement.