How Many Currency Pairs Should You Focus On?

01/23/2015 9:00 am EST

Focus: FOREX


For some traders, the thought of focusing on just one currency pair is enticing but can leave you short-handed in a few scenarios, so Tyler Yell, of DailyFX.com, highlights the alternative approach of having a handful of pairs that respond to different occurrences in the global financial market.

Talking Points:

  • The Enticement of Marrying One Currency
  • The Drawbacks of Having a Main Squeeze
  • An Alternative Approach

"You do things when the opportunities come along." Warren Buffett

It’s very easy to get overwhelmed when you begin trading forex. Every country has their own monetary policy mandates and important data points that determine what markets expect about future interest rate paths. Additionally, when you’ve become comfortable with how one economy and their respective currency is performing, you then need to find out how that currency will match up, relative to another currency with an identically complex back story. This complexity often begs the question, ‘Is it Okay for me as a new or time-crunched FX trader to just focus and trade on one currency pair in hopes of getting a piece of their moves and understanding their news?’

When the Moves are Clear, Single Pair Analysis and Trading Plans are Enticing

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Presented by FXCM’s Marketscope Charts
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The Enticement of Marrying One Currency

Presented with the earlier scenario, you can likely see why traders can desire to know and master one currency pair. A currency pair that you can know like the back of your hand, so that regardless of the data, you can suspect what the likely move will be and you can then have an edge is enticing, but sadly, can leave you with a lot less to trade than more. As you’ll soon see, there are a handful of common reasons why a pair could be better left on the shelf while it’s technical and or fundamental picture becomes clear enough to be worth the risk.

USD/JPY Is a Pair That Alternates Between Trend and Drawn-out Corrections

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Presented by FXCM’s Marketscope Charts
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The Drawbacks of Having a Main Squeeze

Markets are consistently in a one of two modes. Either the trend is advancing up or down or the trend is interrupted with a correction or pre-trend pattern. As you can see above, if you follow only one currency pair and that trend is in a multi-month consolidation pattern, you could easily find yourselves with limited opportunities relative to other currencies out there.

Another problem with only analyzing and trading one currency is that both currencies that make up the pair may either be very strong relative to other currencies or very weak relative to other currencies. When you have two currencies that are very weak or very strong, the technical opportunities that come from strong trends are usually absent.

EUR/CHF Combines Two Very Weak Currencies and the Chart Movement Is Nil

chart
Presented by FXCM’s Marketscope Charts
Click to Enlarge

An Alternative Approach

Here’s an alternative that could allow you to keep some time to yourselves while not being limited to only one currency. Pick one currency pair that represents different markets or sentiment stories. For example, EUR/JPY is highly correlated to the stock market so that pair could be your focus to take advantage of a stock market trend.

USD/CAD is a chart that is positively correlated to Oil along with USD/NOK and USD/MXN. Therefore, if you like to follow commodities like USO and want a currency play due to the correlation, you could look at those currencies.

Lastly, USD/CHF is a nice major to follow that has one currency with a central bank in the Federal Reserve that has discussed interest rate hikes in 2015, which is a rare event followed by another currency in the CHF that has a central bank that is dedicated to keeping the CHF weak through a EUR/CHF floor of 120 in order to ensure the CHF doesn’t weaken to a point that the Swiss Economy is hurt. This would also be an example of a strong/weak pair that you could follow and analyze. The only issue with this type of analysis is that it may need to be updated a few times a month to ensure your focus pair is the strongest versus the weakest.

Summary

The thought of having one currency that you know better than any other is enticing but can leave you short-handed in a few scenarios. Instead, a better approach would be to have a handful of pairs that respond to different occurrences in the global financial market. The diversified approach will still narrow your scope, while at the same time allowing you to take advantage of the lowest hanging fruit for trading.

By Tyler Yell, Trading Instructor, DailyFX.com

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