Multi-currency mean reversion, also known as statistical arbitrage, is one of the safest entry strategies available to forex traders. It has a simple definition, can be traded visually by anyone and it works very well, provided you are trading correlated currency pairs. In this post, I’ll share how I use two simple indicators to find profitable mean reversion trades, at almost no risk and without going into the mathematics of it.
Please note that mean reversion opportunities do not happen very often and works better in timeframes H1 and above. So, this strategy will not trade like a machine gun. However, it will trade well.
The indicators
To trade this strategy with ease, we need the following indicators.
The former overlays many price charts in a single chart, and the latter overlays many oscillators in a single chart. When combined in the chart, it provides both a price overlay and an RSI overlay, which we can use to find opportunities.
Instrument selection
We’ll overlay five correlated pairs on the chart. In the above example, major EUR pairs have been overlayed, namely EURUSD, EURGBP, EURJPY, EURAUD and EURCHF. However, we can also overlay stock indices such as DJIA30, SP500, NASDAQ100, GER30 and FRA40.
But also USD pairs, such as AUDUSD, NZDUSD, GBPUSD and EURUSD.
It can also be applied to metals and other, less correlated groups.
How to trade
Every once in a while, one of the correlated pairs will be overbought and other oversold, both in price and RSI terms, moment at which we’ll short the overbought and buy the oversold and profit from a mean reversion with almost no risk.
However, there is an important filter that we must apply before trading. 1) The symbol we are buying must not be overbought in any of the higher timeframes and 2) The symbol we are shorting must not be oversold in any of the higher timeframes.
If everything checks, we just take the trade with exactly the same currency exposure on both sides. In the example above, I bought one lot of EURGBP and shorted one lot of EURJPY.
Closing the trade
The gap will eventually be closed, and will either make us a big profit or a small loss. Optionally, we can add exposure to both instruments as the uncorrelation expands into RSI levels 70, 80 and 90, up to six trades in total -three on each symbol-.
Conclusion
Multi-currency mean-reversion trading is one of the safest strategies we can use to enter the market. We won’t trade very often, but we’ll trade well.
Hi Arthur, another great lesson . Can you tell me please about the entry , is when one of the pairs closes out of the overbought/oversold area , both or none ? Many thanks.
You could trade just one of the two pairs, if you are completely sure that it is the one which will reverse. If you don’t know, you trade both, the overbought and the oversold. I normally wait at bar closing, or trade when I see the pattern, timing does not matter much if the gap is wide enough in both price and rsi.
How do you determine if it is overbought or oversold in price terms?
To determine overbought/oversold, you use the RSI. You need the price action to be divergent tho.
Perhaps we could use Bollinger bands in order to ascertain price being at divergent and overbought/oversold levels? Also, there is no such thing as risk free trading. There is nothing to stop both positions going against you and suffering a big loss.
This strategy is virtually risk free, the downside is that it does not happen very often. Bollinger bands won’t be of much help, but ATR and Standard Deviation might, as to ascertain the maximum negative excursion you might find.
Hi Arthur
This would appear to be a perfect strategy for an EA.
Have you a plan to create and EA ?
Yes, maybe one day!