A question I get asked a lot is which currency pair do I trade the most or is the best to trade? Personally, I only look at the setups which are according to my trading plan and risk management plan so the currency pairs do not matter.
Types of Currency Pairs
There are three categories of currency pairs; majors, crosses, and exotics. It is important to note that you only really need to follow 2-5 currency pairs to be profitable. You do not have to trade all the pairs and in fact, some are just too volatile and unpredictable. The following points will explain which currency pair’s fall into these three categories and the advantages or disadvantages of each.
The U.S. dollar is considered to be the major currency to be traded against and this the “major” forex currency pairs are the major countries that are paired with the U.S. dollar.
EUR/USD – Euro vs. the U.S. dollar (Euro or Fiber)
GBP/USD – British pound vs. the U.S. dollar (Sterling or Cable)
AUD/USD – Australia dollar vs. the U.S. dollar (Aussie)
NZD/USD – New Zealand dollar vs. the U.S. dollar (kiwi)
USD/JPY – U.S. dollar vs. the Japanese yen (the Yen)
USD/CHF – U.S. dollar vs. the Swiss franc (Swissie)
USD/CAD – U.S. dollar vs. the Canadian dollar (Loonie)
First off, many of the major currency pairs are correlated in their price movement, meaning they move almost identical to one another.
Analysis of two assets relationships using a past statistical data has a predictive value, it can identify potential forex trading opportunities and manage your exposure to risk. Correlation is typically measured in decimal form on the scale of -1 to +1 to give you a figure named a correlation coefficient.
- A positive correlation shows that two currency pairs will move in the same direction 100% of the time. That is a perfect positive correlation. Correlation between EUR/USD and GBP/USD is an accurate example as if EUR/USD is trading up, then GBP/USD is moving the same direction.
- A negative correlation indicates that two currency pairs will move in the opposite direction 100% of the time. EUR/USD and USD/CHF have a perfect negative correlation, thus if EUR/USD moves upwards, then USD/CHF goes downwards.
Naturally, the stronger a positive or negative correlation, the greater a predictive value is drawn from an analysis. Longer time frames used for a technical analysis shows more accurate information. Correlations over a 1 minute period have a little value, while monthly and yearly data provides the most reliable insight.
So what does this correlation business mean to you? It means you need to be careful when making your trading decisions so as to not double up your risk or trade against a position you currently have open. If you know which pairs or positive or negatively correlated you can then reduce your risk by not going long on 2 positively correlated pairs if the trend is down. Similarly, if you enter a long position on the EURUSD and a short on the USDCHF, you are essentially doubling your risk.
Money management is the biggest tool in your Forex trading toolbox, a correlation in Forex and money management can go hand in hand. If you trade across multiple currency pairs frequently, then you must be aware of correlations. If you are long on one currency pair and short on another, it could be that this trade is actually canceling itself out because they are both correlated the same way. Equally, if you are long and short on different pairs then you could be over-leveraged on one currency pair without even realizing.
Examples of strong positive correlations (Yearly time frame):
EUR/USD and GBP/USD
EUR/USD and AUD/USD
EUR/USD and EUR/CHF
AUD/USD and GOLD
Examples of strong negative correlations (Yearly time frame):
EUR/USD and USD/CHF
USD/CAD and AUD/USD
AUD/NZD and NZD/SGD
USD/JPY and GOLD
A commodity currency is a name given to currencies of countries which depend heavily on the export of certain raw materials for income. The major currencies that are also considered “commodity currencies” are the Australian dollar, Canadian dollar, and the New Zealand dollar.
Gold and silver are actual commodities, so they can also be considered “commodity currencies”, and once again they are traded in U.S. dollars, as we noted above.
The Russian Ruble, Colombian Peso and the Peruvian Sol are also commodity currencies however as they are on the exotic pairs list they are not traded that much.
The “crosses” are those currency pairs that are not paired vs. the U.S. dollar such as:
AUD/CAD – Australian dollar vs. the Canadian dollar
AUD/CHF – Australian dollar vs. the Swiss franc
AUD/JPY – Australian dollar vs. the Japanese yen
AUD/NZD – Aussie dollar vs. the New Zealand dollar
CAD/JPY – Canadian dollar vs. the Japanese yen
CHF/JPY – Swiss franc vs. the Japanese yen
EUR/AUD – Euro vs. the Australian dollar
EUR/CAD – Euro vs. the Canadian dollar
EUR/CHF – Euro vs. the Swiss franc
EUR/GBP – Euro vs. the British pound
EUR/JPY – Euro vs. the Japanese yen
EUR/NZD – Euro vs. the New Zealand dollar
GBP/AUD – British pound vs. the Australian dollar
GBP/CHF – British pound vs. the Swiss franc
GBP/JPY – British pound vs. the Japanese yen
NZD/JPY – New Zealand dollar vs. the Japanese yen
Instead of just looking at the seven “majors” dollar-based pairs, currency crosses provide more currency pairs for you to find profitable opportunities.
By trading currency crosses, you give yourself more options for trading opportunities because these currencies are not bound to the U.S. dollar, thus possibly having different price movement behaviors.
So while the majority of the markets will only trade on anti-U.S. dollar or pro-U.S. dollar sentiments, you can find new opportunities in currency crosses.
The “exotics” are those pairs that consist of developing and emerging economies rather than developed and already industrialized economies like the majors. Here is a list of some of the more commonly traded exotics:
USD/TRY – U.S. dollar vs. the Turkish lira
EUR/TRY – Euro vs. the Turkish lira
USD/ZAR – U.S. dollar vs. the South African Rand
USD/MXN – U.S. dollar vs. the Mexican peso
USD/BRL – U.S. dollar vs. the Brazilian real
USD/HKD – US dollar/Hong Kong dollar
JPY/NOK – Japanese yen/Norwegian krone
NZD/SGD – New Zealand dollar/Singapore dollar
GBP/ZAR – British pound/South African Rand
AUD/MXN – Australian dollar/Mexican peso
The group of Exotic currency pairs which are characterized by relatively low trading volumes and high spreads includes the least popular instruments available in the Forex market. They consist of currencies which liquidity is almost entirely provided by the main reserve currencies: the U.S. dollar and the Euro. The exotic currency pairs are not the best place to start as a new forex trader. There is more risk built into the exotics, this makes them more prone to “slippage” and it also means they have wider spreads than the majors and the crosses.
The risk involved with the exotics is not worth the hassle if you are a new trader. There are enough trading opportunities within the majors and crosses to keep you busy all year round.
Thanks for reading and come back soon to read an in-depth article on trading fx correlations.