Specialize In Trading USD (Part I)
If you are a currency trader and focus on the four major currency pairs EUR/USD, GBP/USD, USD/CHF and USD/JPY, then you should consider yourself a specialist in USD. Yes, its true! You are a specialist in 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 currency pairs are the most liquid pairs and involve the vast majority of the trading in the currency markets. You should think like this, majors are the most heavily traded pairs and US Dollar is half of each major pair. If I can understand what drives the USD, it will have a huge impact on my trading profits.
What do you think; USD will weaken or strengthen in the near and medium term. The only thing you need to determine is your bias for USD before each trade. Off course develop a system that guides you in forming an educated bias. Then apply that bias to the major currency pairs.
Just to remind you when you buy a currency pair, you are buying the first currency in the pair and selling the second currency. Suppose your form a bias that US Dollar is going to become stronger. With this bias, you can go long either on USD/CHF or USD/JPY. Similarly, you can go short either on GBP/USD or 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.
You have a bearish bias for USD. Lets say you can only afford to trade one standard lot. What pair you should trade? You can consider going long on either GBP/USD or EUR/USD. Which pair you should trade!
Take a look at British Pound (GBP) and the Euro (EUR) both at the same time. You should trade the stronger currency. Find out which of the two currencies is getting stronger. You can find that by taking a look at the EUR/GBP cross charts. If the EUR/GBP cross chart is going down, it means EUR is weakening and GBP is getting stronger. You should choose GBP/USD pair for entering a trade!
Always include an evaluation of the currency correlations for the major pairs in every trading plan that you make. The correlations between the currency pairs can change any time. So you need to calculate the correlations on weekly basis at least to give you a fair idea. Correlation is determined by what is known as the correlation coefficient which always ranges between +1 and -1.
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