Broaden Your Trading Horizon

01/08/2014 9:00 am EST

Focus: FOREX

If you're restricting your trading to only the major currency pairs, you could be limiting your opportunities for profit, notes Adam Lemon of DailyForex.com.

Many retail traders start out either restricting their trading to a few pairs, or trading every instrument they can get their hands on. Why is this?

Taking the first example, there are frequently quoted reasons for a beginner to restrict themselves to just a few major pairs, such as the EUR/USD and GBP/USD. Some of these include:

  • These pairs are most active during European/North American hours, which might be the preferred hours of trading.
  • Spreads are low.
  • These pairs tend to “behave” technically, and most popular trading systems tend to be designed around their characteristics.
  • Avoiding the confusion and stress that can come from trying to day trade many different instruments at once.
  • Most material on the Internet is based on these currency pairs.

Are these really good reasons to restrict trading to just the EUR/USD and GBP/USD? I argue that they are not, and that traders should take a more sophisticated approach:

  • Pretty much every pair has its greatest volume and activity during European/North American hours anyway.
  • Having to pay a higher spread for minor pairs compared to the majors should not be any obstacle to profitability, provided that trades are held for the medium or long-term.
  • It is possible to devise perfectly good trading strategies for the pairs that tend to behave less technically.
  • Confusion can be avoided if you know what you are looking for and manage your desk with discipline.

It is incredible that there is so much material on the Internet that presents a trading system and ends with the throwaway line “works with the EUR/USD, GBP/USD, and should be OK with other pairs too.” It’s a little like a surgeon perfecting an operative procedure and grabbing a passerby to operate on!

This is not a good way to manage the transition from trading just a few pairs to looking for trades throughout the entire currency universe. It is much better to make this jump in a more controlled way, so don’t be like those traders that start with EUR/USD, get bored, and start trying to trade everything the same way.

Let’s look at some numbers that will demonstrate clearly why it is definitely worth being prepared to trade minor pairs. Here is a table showing the maximum percentage fluctuation in value by currency pair over the last three calendar years, including 2013 to date. The maximum fluctuation is effectively the value of the biggest winning trade you could have made without leverage on that pairs for the year given.

chart
Click to Enlarge

The first thing to note from these statistics is that it is most of the major pairs (EUR/USD, GBP/USD, USD/CHF, and USD/CAD) that have presented the most limited opportunities. See how EUR/USD, so beloved by new traders, actually offered less during 2013 than anything else, as did GBP/USD during both 2012 and 2011.

NEXT PAGE: Think of the Bigger Picture

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The next item of interest is that the big story of the last two years has been the Japanese yen. The best opportunities have been offered by going long against the JPY with just about anything, even the USD, but better results have been achieved with risk currencies such as the GBP and EUR. Even before the yen was topping the currency headlines, we can see that during 2011 it was still offering better opportunities than anything except the Swiss franc, which was in a strong uptrend during 2010 and 2011.

Finally, note how AUD/USD had more to offer every year than either EUR/USD or GBP/USD.

This should give plenty of food for thought to traders who think it is best to ignore the yen because they are asleep during Tokyo hours, or because they don’t like the high spreads and occasionally wild action on the yen crosses like GBP/JPY.

Of course, these numbers would not mean anything if it was really so much easier to trade pairs like EUR/USD than GBP/JPY. I contend that while it may be 50% more difficult, if there is going to be something like 300% more reward on offer, the extra risk is worth it! One solution could be to risk much less per pip on the yen pair and crosses, and use much wider stop losses. If you can do this and catch the beginning of a really big move, there is a lot of potential on the table to take advantage of.

It is worth taking a closer look at the claim that the yen crosses are hard to trade, in spite of their larger directional moves. While they do tend to be more volatile and “behave” less well technically, there is no reason why a trader cannot try to trade them from daily or four-hour charts using wide stops. If these crosses are hard to day trade, why day trade them? Continue day trading with the major pairs, and try to position/swing/trend trade with the yen crosses at the same time.

To sum up: try to think of the bigger picture. Each of the previous three years has had a “star” performing currency. It was the CHF in 2011 and the JPY in 2012 and 2013. It should help your results for 2014 if you do not exclude the next “star” from your trading, and make sure that you have some exposure to the yen and the Australian dollar. If you are going to stick to the majors, do include the USD.

Finally, you do not have to trade the crosses in the same way as you trade the majors. You could stick to the majors, and if it feels like long EUR/USD and long USD/JPY, why not just take a position right away long EUR/JPY? You don’t necessarily need to be watching the crosses technically to find the opportunities.

By Adam Lemon, Contributor, DailyForex.com

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