Trading Currency Baskets
09/17/2013 9:00 am EST
Jeremy Wagner of DailyFX Education explains what a currency basket is and the benefits of trading it instead of a currency pair.
A currency basket is simply a collection of trades with a single currency in common. Those collection of trades are placed in a way to isolate that common currency.
So for example, a US dollar basket might include the GBP/USD, EUR/USD, AUD/USD, and USD/JPY. If we buy the US dollar basket, we would sell GBP/USD, sell EUR/USD, sell AUD/USD, and buy USD/JPY. In that way, we are effectively long the US dollar while simultaneously selling it against the GBP, EUR, AUD, and JPY.
What are the benefits of trading a currency basket rather than a specific currency pair?
A huge advantage of a currency basket is that it provides a simple way to express your opinion in a currency. That opinion is expressed through diversification. By spreading your trades across four different pairs, your profit and loss in the US dollar, for example, is focused towards movements solely in the US dollar.
On the other hand, if we place a single trade in a single currency pair, then the exchange rate is subject to the counterpart to the US dollar. Let me explain further.
Assume we think the US dollar is going to gain strength. So we sell the EUR/USD currency pair rather than trading the USD buy basket. The greenback could end up broadly gaining strength, but losing against the euro. Perhaps a fundamental news release or positive comments came from the Eurozone causing traders to bid up the euro. As a result, we had an idea of US dollar strength, but tried to express that idea in the wrong manner and ended up with a losing trade due to the counterpart (namely the euro).
An additional benefit is that baskets can smartly smooth out market volatility. This is a big benefit during news announcements. If you wish to hold onto a basket position for several days, the volatility resulting from news announcements is likely to be reduced due to the diversification.
Rather than being subject to the movements of a specific pair, a basket trade is spread out over several pairs that mute the focus a single news announcement may deliver.
What Baskets are available?
You can essentially create any basket you would like by hand. Simply take the currency you wish to focus on and trade it against a group of other currencies.
To make things easier for you, the Mirror Trader platform allows you to open and close baskets of trades focusing on the five most liquid currencies in the world.
As a result, you can trade the following baskets through Mirror:
- USD Basket Buy or USD Basket Sell
- JPY Basket Buy or JPY Basket Sell
- EUR Basket Buy or EUR Basket Sell
- GBP Basket Buy or GBP Basket Sell
- AUD Basket Buy or AUD Basket Sell
- USD Carry Basket Buy or USD Carry Basket Sell
- JPY Carry Basket Buy or JPY Carry Basket Sell
A big challenge for basket traders
One thing I have noticed in talking with many traders over the years is their inability to trade consistently without having the perfect strategy. This means we need to see our accounts as a collection of trades rather than many individual trades. Too often, newer traders get caught up in what the most recent trade has done and neglect the longer-term performance of the account.
Therefore, especially for newer traders, using baskets may seem challenging at first because you need to retrain your mind to look at the profit or loss of the basket of trades. See through and ignore how each leg of the basket is performing and focus on the profit or loss of the basket.
By Jeremy Wagner, Head Trading Instructor, DailyFX Education