The summer is upon us. Traditionally this is a slow period for currency pairs. The forex market is still dominated by large banks and bankers. They, like other employees, like to take their annual holiday in the summer. Let’s take a look at a chart of the Euro to see the summer effect in force.

The rectangles on the chart above mark July and August, the two slowest months for many forex pairs. As can be seen on the chart above, trading activity tends to go down, volumes decrease and pairs usually trade in a range during this period of the year. Last year this wasn’t the case because we got some nice downward trend in the Euro. But going back several years, the effect is clearly visible. In fact if you want to see a similar trend during July/August like we had last year, you would have to go back all the way to 2008, at the height of the financial crisis.

The summer effect is starting to rear its ugly head this year as well. We’ve seen vicious reversals in most majors. For example today (July 7th) the Euro was down by 130 pips and then all of a sudden a rumor about Greece pushed the single currency higher by over 100 pips. Liquidity is low and even insignificant news can cause major moves in the currency pairs.

How do we trade the Summer Effect?

Now that we’ve established the existence of the summer effect, how do we trade it? Logically, since we’re dealing with a sideways market, our first pick should be oscillators. Let’s start with the most popular oscillator of them all, the Stochastic.

The rules of the system are as follows:

1. We wait for oversold condition (Stochastic below 20)
2. The main line (blue in our charts) has to cross above the green signal line
3. We exit when the main line crosses back below the signal line
4. Optional, place stoploss below the recent swing low

For shorts, the rules are reversed:

1. We wait for overbought condition (Stochastic above 80)
2. The main blue line has to cross below the green signal line
3. We exit when the main line crosses back above the signal line
4. Optional, place stoploss above the recent swing high

The chart above shows the Euro on a daily basis in the summer of 2013. The entries are shown with arrows while the exits are marked with Xs. If we followed the rules above, we should’ve taken 4 trades in total, two longs and 2 shorts. Three of these trades would’ve been small losers but the one winner would’ve more then made up for the losses. The total tally in pips terms was + 113 and this includes 1 pip for the spread. The average gain per trade was +28.25 pips.

Bollinger Bands System

Now let’s see how our system number two would’ve performed during the summer of 2013. First the ground rules:

1. We go long when prices hit the lower Bollinger Band
2. We exit when the price touches the middle between the BBands, the 20 SMA
3. Alternatively, we place our stoploss below the most recent swing low

For shorts:

1. We go short when the price hits the upper Bollinger Band
2. We exit at a touch of the 20 simple moving average in the middle
3. Alternatively, we define our risk by placing a stoploss above the recent swing high.

As can be seen on the chart above, during the summer of 2013 we only got sell signals. All three were winners, for a total of + 215 pips. If we added rule number 3, a tight stoploss above the recent swing high, the pip count decreases to + 132 pips. This is because in this scenario our second trade (which eventually reversed back down) would end up a loser. But for traders that like to keep their risk low, this stoploss placement may offer better risk adjusted returns.

Creating a Super System

What would happen if we combine the two systems? The initial push lower at the start of July didn’t quite hit the lower BBand so by using this system, we would've missed out on that reversal. But on the flip side, the Bollinger Bands System caught 3 winners in the latter part of August.

Compare this with the performance of the Stochastic Oscillator System. Here the one large winner came on the long side during July and the losers can in August. Now let's mix these two systems and see what we get!

The chart above shows all trades taken by the two systems. We left out 1 trade by the Stochastic System because we were already in a short by the rules of the Bollinger Bands system.

The total combined results of the two systems are 4 wins and 2 losses. Total pips count is + 358 pips, or + 59.666 pips per trade. Combining the two systems not only reduced our drawdown by added to our bottom line as well.
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