What Currencies Should I Trade? Considerations of Currency Pair Choices
There are many complicated choices a forex trader makes while refining their strategy and approach. One of the most important decisions to make is what currencies follow and trade. This article is not meant to touch on basics like Majors, ComDolls, and Exotics. It does assume that you already have a basic, working knowledge of these pairs. Instead, let's dive into methodology, pros, and cons of different choices.
General Trading Strategy
Did you develop your own trading strategy or are you using one of the many that are freely available on the internet? Knowledgeable traders may find that developing their own trading strategy using instruments they are comfortable with is the better choice for them. I believe that inexperienced traders are far better off using an already developed strategy, learning the components of that strategy, and mastering them. Most of us will never be Soros or Buffet. We are not reinventing the wheel here, particularly if you just heard about this forex thing and are exploring it yourself.
A trader that develops their own strategy is probably going to have the pair or pairs in mind that they are going to trade. A person that picks up a third party strategy should pay close attention to what the author and users of that strategy trades. There are particular nuances to different currency pairs that cause them to be a more favourable environment for certain strategies.
Not all strategies can function well for all currency pairs. If you're struggling to find success, it may be a compatibility issue between the strategy and currency pair(s) you are attempting to trade.
Every approach has pros and cons.
Considerations of Trading a Single Pair
A single pair strategy allows the trader to really hone their understanding of the movements of that pair and the economies that fuels it. It is much easier to follow and attempt to understand the fundamental factors of a single currency pair. Selecting a single currency, as opposed to a single pair, still requires a significant time and energy investment to understand the other half of the related currency pairs. The GBPJPY functions very differently from the USDJPY even though they both share the Japanese Yen.
Developing a deep understanding of a currency pair gives the trader a greater insight into what are they observing over time. That insight may provide an additional edge in picking winning trades out of the noisy quagmire that we try to find opportunity in.
A major con of a single pair strategy is the amount of limited opportunities. A part-time trader who is working full-time while trying to master forex is better suited to studying a limited number of currencies given time constraints and the responsibilities of life. A long-term, single pair strategy makes more sense for this type of trader.
On the other hand, a scalper may not want to limit themselves to only one currency pair worth of opportunities. The scalper needs to dedicate more focused time to their art if they want to find long-term success with it. Scalpers may make dozens of trades in the course of their day. They will not typically limit themselves to one pair so as to maximize the number of potential trades.
Should you want to focus on a single pair, a pair that includes your home nation's currency is a good choice. Other strong contenders include the EURUSD and USDJPY for the sheer amount of volume that is traded. They provide stronger signals because of the large amount of people trading them.
Considerations of Trading a Handful of Pairs
A handful of pairs may be appropriate for the trader that wants some diversity. It is a wise idea to not have a single, unifying currency in each pair. So if you want to trade the USD, pick maybe two pairs that include the USD and a pair or two from the Euro or Asian markets. A choice including EURUSD, USDJPY, and EURJPY can provide a diverse selection while still retaining and building familiarity.
Avoid picking correlative or inversely correlative pairs. Correlative pairs are those that tend to show similar signals with similar movements due to the closeness of the respective economies. An example of correlative pairs would include the EURUSD and GBPUSD. The Euro and the Pound share many similarities in price movements given the economics of the regions. An example of inverse correlative pairs includes EURUSD and USDCHF. They tend to head in opposite directions for much the same reason. The position of the USD on these pairs is why they are inversely correlated. If the EURUSD was USDEUR instead, they would be correlated.
It is better to put a single trade on a strong signal of one pair than it is to put two trades on two different signals in correlative pairs. The trader is essentially doubling their risk for the same chance of gain, which is not smart risk management.
Common Correlative Pairs:
EURUSD and GBPUSD
USDCHF and USDJPY
AUDUSD and EURUSD
EURUSD and NZDUSD
AUDUSD and GBPUSD
Common Inversely Correlative Pairs:
EURUSD and USDCHF
AUDUSD and USDJPY
GBPUSD and USDJPY
AUDUSD and USDCAD
GBPUSD and USDCHF
Considerations of Trading Many Pairs
There are plenty of traders and strategies out there that follow 10+ different pairs to find trading opportunities. This option may be good for traders that use a highly technical approach to analysis. The fact of the matter is, you're going to need a lot of time to keep up with the fundamentals of a dozen different pairs even if they do share similar currencies.
Consider a signal that appears on the correlative pairs EURUSD and GBPUSD. Both pairs will throw off similar signals, but choosing the best signal is going to require some working knowledge of the fundamental factors of both Britain and the Euro zone. Perhaps the trader uses technical analysis almost exclusively. Their indicators will be painting the picture for them. On the other hand, technical indicators do not lend much insight into what is coming tomorrow on the fundamental side. They are simply an interpretation of what the pair's price action has already done. Does the trader dive straight into a trade without any fundamental analysis even if the technicals look good?
Scalpers that follow multiple currencies still have an overall idea of fundamental factors that may be affecting their currency pairs. That knowledge may be as basic as knowing when open market overlaps or major news events would create the push and pull needed to generate profit.
The right choice for you is going to come down to your strategy and how much time you can invest in learning your chosen pairs. I am not of the opinion that a fully technical approach is possible to reach profitability. Fundamentals are always a factor because these are the events that cause people to take action and create the technical signals we see. Learning the fundamentals of one or a handful of currencies, even if you follow multiple pairs including that currency, seems like the better way to gain a winning edge in the markets.
There are authors of strategies that claim they can be used on any pair. That may technically be true, but that does not account for the efficiency that strategy may have on a given pair. A scalping strategy may claim to be useful on any pair, but if you take a scalping strategy that is successful on the EURUSD it may fail on the GBPJPY. A scalping strategy that functions on the EURUSD is dealing with a fairly consistent volume and price movements. You could take 5 or 10 pips of profit off of the EURUSD with little trouble. The GBPJPY, on the other hand, is prone to drastic and powerful swings. Going in for 5 or 10 pips is almost a fool's errand because there's no way to cut your stops tight enough to come out ahead.
Be certain to research your choice thoroughly and take the time to learn at least some of the basics of the currency. Personally, I keep a separate email account with alerts set to message me news surrounding the Federal Reserve, Bank of Japan, European Central Bank, important economic events, and the big names in the financial sectors. Anyone can do the same with their own choices to provide themselves a platform of potential information for fundamental analysis.
Low volume, weaker Exotics are going to suffer from more false signals than pairs like the EURUSD. If you intend to specialize, choose currency pairs that can provide consistency. Look to the Majors or ComDolls for consistency.