Do the Hours I Trade Matter? Yes, Quite a Bit

07/07/2015 9:00 am EST

Focus: FOREX

David Rodriguez

Quantitative Strategist, DailyFX.com

By simulating a 'typical trader' using one of the most common and simple intraday range trading strategies there is, following RSI on a 15 minute chart, David Rodriguez, of DailyFX.com, demonstrates how time of day can greatly influence trading performance.

  • A study of 24 million real trades shows that performance can vary widely by time of trading day
  • Many strategies fail because they ignore market conditions
  • Using intraday seasonality could have an important impact on trading performance

Why do many traders fail at forex trading? Very often, we find that common trading strategies have limitations that few understand. This article attempts to explain why some of the most popular currency trading techniques fail and, more importantly, how we might fix them.

Why Might the Average Forex Trader Lose Money?

Experience and actual data shows that many forex traders do poorly for one of three key reasons:

  1. Poor money management techniques
  2. Poor use of leverage combined with sub-par money management techniques
  3. Poor market conditions for a given trader’s techniques and strategy. Many trading strategies do better in certain market conditions than others.

Our data on real client performance shows that traders on average do considerably worse during volatile market hours and through faster-moving markets. What does this look like and how might we look to improve on performance?

Looking at Real Trader Performance as a Start

We examine 24 million real trades placed across our five most popular currency pairs in the 12 months ending in Q1, 2015. If traders opened trades at a given hour of the trading day, what was the likelihood that they ultimately turned a profit?

Important note: trade winning percentage matters less than actual profitability. Thus, the chart below shows whether or not traders ultimately profited by trading a given currency pair at a specific hour of the day and not whether each individual trade was closed out at a profit.

Likelihood of Trader Profitability by Hour of Day in Top Five Currency Pairs, Q2, 2014-Q1, 2015

chart
Data source: Derived from FXCM Inc. accounts excluding Eligible Contract Participants, Clearing Accounts, Money Managers, Hong Kong, and Japan subsidiaries from April 1, 2014 to March 31, 2015 across 15 most traded currency pairs.
Click to Enlarge

There’s a lot going on in this chart, but the pattern should be fairly clear: on average, traders saw considerably higher chances of ultimately turning a profit if a trade was opened in certain hours over others. Before we go more in-depth, we’ll focus on the GBP/USD for further clarity and as a relevant example:

Likelihood of Trader Profitability by Hour of Day in GBP/USD, Q2, 2014-Q1, 2015

chart
Data source: Derived from FXCM Inc. accounts excluding Eligible Contract Participants, Clearing Accounts, Money Managers, Hong Kong, and Japan subsidiaries from March 1, 2014 to March 31, 2015 across 15 most traded currency pairs.
Click to Enlarge

If a trader opened British pound/US dollar trades between the hours of 4:00AM and 5:00AM ET, they ultimately turned a net-profit in the GBP/USD a mere 47% of the time. This stands in stark contrast with the opposite end—if a trade was opened between the hours of 8:00PM - 9:00PM ET (20:00-21:00), traders ultimately turned a net-profit in GBP/USD trades 55% of the time.

Likelihood of overall success was nearly 20% higher in the later period. Why? Let’s take a look at how the British pound behaves to better understand the major discrepancy.

NEXT PAGE: There’s a Fairly Clear Negative Relationship Here...

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Average Hourly Absolute Change in GBP/USD from 2005-2015

chart
Data source: GBP/USD price data derived from FXCM’s price servers from 2005-2015.
Click to Enlarge

Immediately, we see that hour-to-hour changes in the GBP/USD vary significantly per different time of day. On average, the Sterling moved 22 pips from 4:00AM-5:00AM ET versus less than 4 pips between 11:00PM-12:00AM (23:00-00:00), over five times as volatile.

If we compare this against average trader profitability, we’ll further see that there’s a fairly clear negative relationship here: traders are least profitable when markets are most active. Traders tend to see the best results during the Asian trading session. To see why volatility lines up so well with performance, we need to look at real trader behavior.

Modeling Trader Behavior – Buying Low, Selling High

Our data on real trader behavior suggests that most traders tend to follow a somewhat straightforward strategy: Range Trading or Mean-Reversion trading. Put simply, such a technique is broadly defined as buying when prices are low/at support and selling when prices are high and/or at resistance.

Range Trading can work if price is not breaking major price levels and continues trading within relatively narrow ranges, and indeed, this is typically the case during the quieter Asian Session hours. How might we match trading techniques to market conditions?

Does the Time of Day That I Trade Matter?

Yes. It matters a lot. We have constructed a strategy that closely approximates the performance of the average trader and we simulated that strategy’s performance on the GBP/USD. The results are not good.

Trade Rules for the RSI Trading Strategy

Buy Rule: When the 14-period RSI crosses above 30, buy.
Sell Rule: When RSI crosses below 70, sell.

chart
Data Source: FXCM Trading Station Desktop Strategy Backtester. GBP/USD 15-minute data from April 1,2015 to March 30, 2015
Click to Enlarge

Yet, once we factor in the time of day, things become interesting. We know that the Sterling tends to move less through certain hours...let’s use that to our advantage and make a rule to trade only during low-volatility times.

This next chart shows the exact same strategy over the exact same time window, but the system does not open any trades during the most volatile time of day, 6:00AM to 2:00PM ET (11:00AM to 7:00PM GMT).

Trade Rules for the RSI Asia Range Trading Strategy

Buy Rule: When the 14-period RSI crosses above 30, buy.
Sell Rule: When RSI crosses below 70, sell.

Trade Filter: Only allow the strategy to open trades before 6:00AM and after 2:00PM ET.

chart
Data Source: FXCM Trading Station Desktop Strategy Backtester. GBP/USD 15-minute data from April 1, 2014 to March 30, 2015
Click to Enlarge

By sticking to range trading only during the hours of 2:00PM to 6:00AM, the typical trader would have hypothetically been far more successful over the sampled period.

NEXT PAGE: What About a Game Plan for Other Currency Pairs?

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What About Other Currency Pairs?

Of course not all currencies are the same. The Japanese yen tends to see markedly more volatility than its European counterparts through the Asian trading session; these are the hours of the Japanese business day.

Average Hourly Absolute Change in USD/JPY from 2005-2015

chart
Data source: USD/JPY price data derived from FXCM’s price servers from 2005-2015.
Click to Enlarge

We simulated the same filter as we used with the euro/US dollar. The poor results speak for themselves.

chart
Data Source: FXCM Trading Station Desktop Strategy Backtester. USD/JPY 15-minute data from April 1, 2014 to March 30, 2015
Click to Enlarge

We find that the time filters have historically worked well for European currency pairs such as the British pound/US dollar and the euro/US dollar. We might range trade these currency pairs during the 2:00PM to 6:00AM time window.

Unfortunately, our optimal time window does not work well for Asian currencies. Our tests of different time windows on the USD/JPY, AUD/USD, and NZD/USD have not produced comparable improvements.

Game Plan: What Strategy May I Use?

Trade European currencies during the off hours using a range trading strategy.

Our data show that over the past ten years, many individual currency traders have been successful range trading European currency pairs during the off hours of 2:00PM to 6:00AM ET (7:00PM to 11:00AM GMT). Many traders have been very unsuccessful trading these currencies during the volatile 6:00AM to 2:00PM ET time period.

Asia-Pacific currencies can be difficult to range trade at any time of day as they tend to remain fairly active in what we would often consider off hours for most of the Western world.

Model Strategy: Range Trading with RSI on a 15 Minute Chart

For our models, we simulated a typical trader using one of the most common and simple intraday range trading strategies there is, following RSI on a 15 minute chart.

By David Rodriguez, Quantitative Strategist, DailyFX.com

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