Dealing in trillions on a daily basis, the Foreign Exchange Market, or Forex, has been attracting eager traders for decades now. The never-ending gold rush has handsomely rewarded some, kept most of the others in a middle ground in terms of gains and losses, and ruined the rest.
In essence, Forex trading is made up of exchanges of currencies. The entire profit made by traders is based on the difference in the exchange rates of the two currencies. However, partly as a result of the trades, these rates are constantly fluctuating. An unchanging long-term recipe for success is, therefore, a mathematical impossibility in such a volatile market. However, professional traders have established a few golden rules regarding pairing currencies.
Know the Currencies
The first and foremost rule when it comes to the pairing of currencies is to know them. Most traders specialize in one or two pairs and constantly tweak their strategies. While the profits are higher if you trade in more pairs, the risk is also higher. This is because you cannot keep track of the economic indicators that accompany each currency.
The combination of currencies is at the core of your entire trading activity. If at the beginning you should go for the mainstream currencies such as EUR, USD or GBP, as you gather experience you should add a notoriously unstable currency in one of your pairings. This will add risk, but you will be able to minimize it with ample experience and knowledge of the strong currency.
Pair Strong with Weak
As the entire process is based on the practice of exchanging, every activity on the Forex market is done in pairs of currencies. When you buy one currency, you expect the other to drop in price, making the one you bought to value more.
It is also important to note that currencies are not the same. Being used by productive economies that consistently benefit from positive economic indicators, the fluctuations of some are minor and their stability is greater. These are strong currencies. Conversely, weak currencies quickly lose their economic footing on the global market due to various reasons. Most commonly, these are political instability and bad economic performance.
The ideal case, then, is to match a strong currency, such as the dollar or the euro, with a weaker one. The strong-weak relationship is not static either. For example, while at certain points the dollar is stronger than the euro, sometimes the reverse is true. High and low points exist for every currency, but you can easily track them with a currency strength meter.
The degree of complexity sharply rises when currency pairs become correlated with each other. For example, the EUR/USD pair tends to have a negative correlation with USD/CHF and a positive one with GBP/USD. Similarly, the USD/CAD pair tends to be negatively correlated with the AUD/USD, GBP/USD and EUR/USD pairs.
Forex is a bustling market that is open 24 hours a day, 5 days a week. As the values of each currency and even each pairing is relative and interconnected to others, identifying and keeping track of the ideal pairing can be a bothersome but necessary activity.
Mind Interest Rates and Central Banks
Central banks are the largest financial actors that take part in the Forex market. Moreover, they are the guardians of their national economies. Their main point of focus is keeping the national currency within a reasonable level of stability. Without it, everything that is ascribed value in that currency – goods, services – can suffer price changes that are unsustainable on the long run.
Aside from their large financial resources, central banks also regulate national interest rates. After looking at the same economic indicators that every trader watches, they either increase interest rates – when the report is positive – or lower them if the report is negative.
As the interest rates are an indicator of future investments that will be made, they are one of the biggest drivers of the currency market, increasing or decreasing the attractiveness of a country. Predicting changes in the policies of central banks regarding interest rates is one of the most important concerns of a professional Forex trader. These predictions are the foundations of the trend.
Match time frame method with currency
Different strategies and methods are used for making a profit in the Foreign Exchange Market. Time frame is one of the things that define you as a trader. Day traders are quick on their feet and adaptable, swing traders patiently watch mid-term indicators, and finally, positional traders make their trades according to a long-term perspective of the market.
Using one-time frame when dealing with one pair, such as day trading in weak currency, may be more profitable in the short term. Conversely, stable currency pairings can provide better returns in the long run.
Aside from simply amassing a certain currency in the hope that its value will increase and that you will be able to sell it for a profit, you can also engage in support, resistance or breakouts. These are moments in which prices either shift or stabilize.
The method through which you will operate on the market is a further specialization of your profession as a trader. Aside from perfectly knowing the currencies you deal in, the economic indicators that may or may not foretell trends and the perfect time frame to trade, you will also have to master your method.
The Bottom Line
By following these four golden rules, your currency trading game as a whole will improve. As a trader, you are largely defined by the pairs you deal in and the method you are using. While knowledge of economic indicators and behavior is a definite asset, knowing when to risk and when to play safe is essential on the foreign exchange market. Unfortunately, it cannot be taught, only improved.
