The Benefits of Expanding Your Trading Universe

03/12/2014 9:00 am EST

Focus: FOREX

Limiting your trading to just the major pairs can also limit your realm of possible trading opportunities, notes Tyler Yell of DailyFX.com.

A majority of the news coverage you’ll see on DailyFX and other sites will revolve around FX majors. This information is excellent for building a keen understanding of what are strong or weak currencies. However, you will be putting a major limitation on your trading opportunities if you only focus on the FX majors.

The Attraction of Only Trading Majors
Many traders will state that they will only trade a major currency pair such as EUR/USD, USD/JPY, or GBP/USD. This mindset is understandable as you’re likely to see a clear majority of coverage on these currency pairs. However, this limited view of trading opportunities can be a major mistake that can be easily remedied by looking at currency crosses or non-FX majors.

Current Open Interest at FXCM

chart
Courtesy of the DailyFX SSI Tool
Click to Enlarge

You can see above that at any given time, the open interest on FXCM’s book of client trades are concentrated around four trades. The concentration of open trades are often skewed in favor of EUR/USD around 30%, gold or XAU/USD around 15%, a similar reading for GBP/USD, and USD/JPY around 10%. Other majors command much less attention like AUD/USD, NZD/USD, or USD/CAD sitting around 5-7%. This imbalance, regardless of the technical opportunities, appears to be due to familiarity of majors and others wanting to trade what everyone else is trading.

The Benefit of Trading Crosses
My trading strategy has evolved over the years. A major part of my trading system’s evolution is looking for the “low-hanging fruit” in the FX marketplace. If you’re part of DailyFX on Demand, our eight-hour daily program that allows you to trade alongside seasoned traders, you’ll often see me run through an intra-day strong/weak analysis, which seeks to divide the strongest and weakest currency pairs among the G10.

Typical Strong/Weak Rating (Listed Weakest to Strongest)

Table

You can likely find a great boost in your trading by doing something similar. If you’re unfamiliar with taking a strong/weak approach, you’ll learn that the reasons for one currency becoming the strongest and another the weakest are many. However, strong /weak relationships often develop from an imbalance in monetary policy or interest rate guidance from a central bank along with a technical tipping point.

Here’s a question that often goes through my mind when I think about someone asking me what opportunities are available on EUR/USD or GBP/USD vs. EUR-crosses or GBP-crosses.

Why would you want to trade two very weak or two very strong currencies?

NEXT PAGE: Opening Up Your Trading Opportunities

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Of course, it’s your money and you can trade what your heart desires. However, I can’t imagine trading two very weak or two very strong currencies. A current example is USD/JPY. The JPY has resumed weakness after it topped out in early February 2014 around 100.72. Unfortunately, the upside is limited and even if the weak JPY resumes, an even weaker US dollar could upset those banking on JPY weakness taking on its 2013 form.

USD/JPY vs. EUR/JPY Displays the Difference

chart
Courtesy of Marketscope 2.0
Click to Enlarge

On the other side of the spectrum, what if both currencies are very strong? While we haven’t seen a scenario with USD being strong since early January, we have seen an example of EUR and GBP both being rather strong. With a scenario of two strong currencies, you will often see two economies that have extremely supportive fundamental data at the same time and technically, you’re likely to see a range. With a strong/strong scenario, the stronger currency of the two will be whichever has had the most recent news announcement, which makes the cross an unfavorable scenario for a trend following swing trader.

A Potential Set-Up with AUD/CAD
Referencing the open interest pie chart above, you don’t even see AUD/CAD. This means that a small amount of FXCM traders, likely less than 3%, are considering this opportunity that has a favorable fundamental and technical set-up in the near term. We’ve recently come off of a very favorable week of fundamental data out of Australia that brought a developing Ichimoku set-up for AUD/USD. On the other hand, Canada had a dismal employment report.

AUD/CAD Break Could Push Cross Higher

chart
Courtesy of Marketscope 2.0
Click to Enlarge

While the overall trend is down, given we’re trading lower than the March 2013 peak, the resurgence of the AUD brings focus to AUD/CAD upside. Technically, the cross just cleared the all-important 1.00 parity level (dotted-line on the chart above) has us looking higher in the next few weeks to the 1.03 level where resistance could be found via the Fibonacci technique. Most importantly though, it brings about a clear technical trade idea on a pair not normally traded, which could bring a distinct edge to your trading that others do not have because they only look to one or two currencies.

Closing Thoughts
This AUD/CAD set-up just shows you how trading outside of the FX majors can open up trading opportunities you may have not considered before. If you keep your focus only on the majors, it’s possible that they could only present unfavorable technical or fundamental pairings, which could limit the opportunities that are available in the FX market week in and week out.

By Tyler Yell, Trading Instructor, DailyFX.com

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