According to Stock Trader's Almanac, the British pound has a tendency to form a seasonal bottom in the month of March with respect to the US dollar. This phenomenon is due to the financial adjustments that multi-national companies make at the end of United Kingdom's fiscal year, which ends in March. Companies delay making money transfer to the home country till after the end of the tax-year. This results in a pound-dollar currency pair (GBP/USD) making a seasonal bottom in March.
Using 25 years of data, the Almanac has analyzed GBP/USD's year-long seasonal pattern. The analysis shows that, generally, from March to August the British pound gains against the US dollar and from August to March US dollar gains.
Within this cycle, the pound has a tendency to retrace in June before resuming its uptrend. This retracement-resumption offers an opportunity that can be traded within a three-to-four week period. (There are many other similar seasonal trading ideas that you can find here.)
The CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB), tracks the currency pair, GBP/USD, and can be used as a trading vehicle.
Almanac's strategy calls for buying GBP/USD - or FXB, if using the ETF market - around June 28th and exiting the trade around July 23rd. From 1975 to 2010, the success rate of this strategy was 69.4%. Our back-testing produced a success rate of 62.1% for 1983 to 2011 period. So it seems that our application of this strategy is somewhat different then Almanac's application.
When we applied one of our variances of the entry-exit criteria then the success rate and average gains per trade improve significantly. The modified entry-exit strategy is based upon buying weakness and selling strength while taking advantage of the seasonal trend.
This approach - buying weakness and selling strength - is inspired by Larry Connors. In a runaway market, buying weakness and selling strength may turn out to be disastrous, but in a cyclical trend and for a very short duration this strategy provides a high probability of maximizing the result.
The trade is entered in a time period when the pound shows a tendency to form a short bottom in June. This period starts on the 10th trading day of June and lasts for next 20 days. Within this period, if the pair closes at 3-Day low then we go long at the close. After the 10th trading day of July, we exit the trade whenever the pair closes at a 3-Day high.
Below are the hypothetical results of this strategy applied in the Forex market - GBP/USD - since 1983. The gain/loss results are in PIPs and returns are calculated using a mini contract with 1-to-1 margin or $10,000 equity for each mini contract. The results do not include commission and other expenses.
The actual results for FXB vary but, in general, its success rate and profitably are similar.
|Original Strategy||Modified Strategy|
|# of Trades||29||29|
|Avg. PIPs Per Trade||119||157|
|Avg. Ret (Per Trade)||1.2%||1.6%|
|Max Draw Down||(7)%||(10)%|
|Avg. Trading Days Held||16||21|
|Total Trading Days Held||464||620|
|Avg. Calendar Days Held||24||30|
|Total Calendar Days Held||691||873|
|% of Time Invested||6.8%||8.2%|
Notice that the modified strategy is invested only 8.2% of the times with 45% return. The annualized comparison - if you can deploy such a strategy for a full year - would be a return of 552% - pretty impressive.
Using the maximum draw down, a better minimum equity amount for each mini-contract would be $5,000 or 2-to-1 margin. This gives an average return of 3.2% per trade. This is very good since the trades are held for an average of only 30 days.
FXB started trading in the year 2006. Since then our modified strategy produced an 83% success rate with an average return of 2.4% per trade lasting, on average, 31 days.
Below are these hypothetical trades (GBP/USD) since 1983 for the modified strategy:
|Entry Date||Entry||Exit Date||Exit||PIPs|
This mechanical entry-exit system has some limitations, which can be eliminated or reduced with a discretionary add-on - using charts and market conditions to enter and exit the trade.
For example, using a 5-period RSI to determine oversold and overbought conditions would have resulted in an entry in Late May and exit in early August in 2010 - with a potential 1500 PIP gain instead of 549. Similarly, in 2011 the entry would have been in late June and exit in late July - a potential gain of 330 PIP compared to a loss of 27 PIP. This year the entry was triggered on June 5th. (See arrows in the GBP/USD chart below)
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I may take a position in GBP/USD in the Forex market.
Disclaimer: Before employing this strategy in your live account please understand the rationale behind this seasonality pattern. Then run some back tests for the trade start-date and holding periods. Make sure that the risk level, max draw down, win ratio and average loss falls within your comfort zone and that you can withstand the draw down and the associated risk. Also read our disclaimer.