Specialize In Trading US Dollar (Part I)
You want to become a currency trader. The most important question that you will ask is which currency pairs are the best for trading? You should focus on the four major currency pairs EUR/USD, GBP/USD, USD/CHF and USD/JPY in the beginning. You should consider becoming a specialist in US Dollar. Yes, its true; you should become a specialist in understanding and trading the greenback.
Each currency pair actually consists of two currencies. So if you take a long position in GBP/USD then you are in fact buying British Pound and selling US Dollar. In each of the four major currency pairs, US Dollar is one currency of each pair.
This means that you should study and understand the fundamentals that drive the US Dollar and the US economy. You should also understand the workings of the Federal Reserve System (FED). Then you have done your homework. Now you can trade any one of the four major currency pairs as all of them depend on USD.
These four major pairs are the most liquid pairs in the currency markets and involve the vast majority of the currency trading. Think like this. Majors are the most heavily traded pairs in the currency markets. US Dollar is half of each major pair so if you can understand what drives the USD, it will have a huge impact on your trading plans.
Think whether USD will weaken or strengthen in the near and medium term. The only thing you need to determine is your bias for US Dollar before trading a major. Develop a system that guides you in forming an educated bias and then apply that bias to the major currency pairs.
Just to remind you, suppose you buy a currency pair. You are buying the first currency and selling the second currency in the pair! Suppose your form a bias that USD is going to strengthen. With this bias, you can go long on USD/CHF and USD/JPY. Similarly, you can go short on GBP/USD and EUR/USD.
With one bias, you have the potential of entering into four possible trades. However, each currency pair will react differently to US Dollar strengthening or weakening. Suppose Euro is also strengthening. Both Euro and US Dollar are strengthening at the same time. The currency pair EUR/USD will move less. USD/JPY will move more if JPY is weakening and USD is strengthening.
Lets say you can only afford to trade one standard lot. You have a bearish bias for USD. You can consider going long on either GBP/USD or EUR/USD. What pair you should trade? Which one!
Take a look at both GBP and the Euro. Try to find which of the two currencies is stronger right now. Trade the stronger currency. Take a look at the cross EUR/GBP. If it is down, it means EUR is weakening and GBP is strengthening. Trade GBP/USD!
You should always evaluate the currency correlations for the major currency pairs in every trading plan that you create. Correlation is determined by what is known as the correlation coefficient. Correlation coefficient always ranges between +1 and -1. The correlations between the currency pairs are dynamic and can change any time. So you need to calculate the correlations at least on weekly basis to give you a fair idea of how the correlations are changing.
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