How To Trade the London FX Session

07/03/2012 6:00 am EST

Focus: FOREX

James Stanley

Trading Instructor, DailyFX Education

James Stanley of DailyFX.com explains the nuances of trading currency during the busy London session.

As new traders enter the FX Market, many are often seeking fast, and active price activity. The open of the London session at 3 a.m. (Eastern) is when many consider this type of behavior to be starting for the day in the FX Market. By many accounts, London is the heart of the FX market, with approximately 35% of daily volume transacted during this session.

As the US session begins 5 hours later, the environment can change quite a bit, as even more liquidity is entering the market; and this time it is coming from both sides of the Atlantic. For the purposes of this article, we are going to focus on the London session, before the US opens for business (between 3 a.m. and 8 a.m. Eastern Time).

Fast and Active
The slower Tokyo market will lead into the London session, and as prices begin to come from liquidity providers based in the United Kingdom, traders can usually see volatility increase.

As prices begin to come in from London, the "average hourly move" on many of the major currency pairs will often increase. Below is analysis on EUR/USD based on the time of day. Notice how much greater these moves are, on average, after the Asian session closes:

chart
Click to Enlarge

Support and resistance may be broken much more easily than it would during the Asian session (when volatility is usually lower).

These concepts are central to the trader’s approach when speculating in the London Session, as traders can look to use this volatility to their advantage by trading breakouts. When trading breakouts, traders are looking for volatile moves that may continue for an extended period of time.

This way, when they are wrong, they can cut their losses short. When they are right, they can maximize their gains.

How to Trade Breakouts
Trading breakouts during London is much the same as trading breakouts during any other time of day, with the addition of the fact that traders may expect an onslaught of liquidity and volatility at the open.

When traders look to trade breakouts, they are often seeking firm support or resistance to plot their trades. The chart below will illustrate a breakout setup in more detail.

chart
Click to Enlarge

As you can see, as our trader above found strong support on EUR/USD at 1.3000, this enabled them to place an entry order to go short when these support levels were broken.

The big benefit of this setup is risk management. Traders can keep stops relatively tight, with the ideology that if support is broken and does not move lower, the trader wants to cut their losses small. But if price does continue lower, this allows the trader to accumulate a handsome profit relative to the amount put up to risk.

The chart below will show the "after" of the breakout setup we previously looked at on the EUR/USD currency pair.

chart
Click to Enlarge

In the above setup, the trader didn’t even need an indicator to point out support, as pure price action provided the information needed.

As we looked at in Swing Trading the Forex Markets, traders can identify these key levels using a variety of different mechanisms.

Traders can incorporate pivot points, Fibonacci, or psychological whole numbers into their analysis (we outlined each in the aforementioned article); the key being that traders want to be comfortable and confident in the levels of support or resistance they are looking to play.

Price Channels
A favorite amongst traders looking to use breakout strategies is a simple indicator that is very much based on price action. Price Channels, aka "Donchian Channels," will outline the highest high and lowest low for the last X periods (with X being the number of candles input by the trader).

So, If I’m using 20 period price channels, I will be seeing the highest high and the lowest low of the last 20 periods.

chart
Click to Enlarge

This is a simple indicator, but it can help traders by the fact that it will denote these levels for us, and traders can easily see the highest high and lowest low in a quick glance.

This is a custom indicator for the Trading Station II platform, and we walk through adding it to the Marketscope charting package in the article How to Install Custom Indicators on Trading Station.

Once price channels are added, the trader can quickly glance at the chart to notice the high and low points that may be functioning as support and/or resistance, so that entries may be plotted appropriately.

James Stanley can be found at DailyFX.com.

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