August 26, 2009
How to Choose Currency Pairs
There are two main factors for choosing a currency pair.
1. The average daily range of PIPS that the pair moves.
2. The clarity of the patterns produced by the pair.
The EUR/USD has always been the pair that is most popular among Forex traders. And yet I never trade that pair primarily because it has a relative small average daily range of movement compared with some others. After closely following all the pairs every day for years, I discovered that most of the pairs are correlated directly or inversely. Almost all the pairs are doing something similar so there is no reason to trade all of them.
It does not really spread the risk to trade several pairs that are all doing the same thing. The GBP/JPY is the king of PIP movement so if you enter a trade on that pair you will get more profit for doing the same work compared with entering a trade on another pair. Many people are afraid of this pair because of the volatility but that is because they do not recognize patterns and entry signals and since it moves large number of PIPS, they are afraid of large losses rather than focusing on the large potential wins.
Clarity of pattern is the other primary factor and some pairs make no sense at all in terms of producing recognizable patterns. Since our trading decisions are based on signals and patterns, it makes sense to first look at the recent history of any pair being considered and see if the pair has a history of producing chaotic or recognizable patterns.
Often the EUR/JPY forms patterns that are more easily recognized than the GBP/JPY. Therefore it is more desirable to trade this pair even though the same movement will often produce more PIPS on the GBP/JPY. Since these two pairs are closely correlated I also often use the EUR/JPY to gain insight into the patterns being formed on the GBP/JPY because when an entry occurs it is likely to form on both pairs.
It is also a good idea to check the current status of the EUR/GBP in order to see which currency is stronger or weaker. This can tell you which of the two pairs, the GBP/JPY or EUR/JPY is likely to be favorable for going long or short. If the EUR/GBP is going up then the EUR is stronger than the GBP and therefore the EUR/JPY is favorable for any long entries while the GBP/JPY will be favorable for the short entries.
Because successful trading depends on the market forming trends, one of the most important insights to experience is that when a pair is correcting or consolidating that means that the trading opportunity has shifted to a different time frame. So the truth is, once you see how to recognize patterns within patterns you will know that the market is always tradable if you know which time frame the trade is producing the ideal formation of a trade entry and exit.
Filed under Forex Trading 1, Forex Trading Lessons by Scott Shubert
Comments on How to Choose Currency Pairs »
How to Choose Currency Pairs @ 7:37 pm
[...] Original post by Forex Trading Insights [...]
Scott,
I question the idea that range in pips, or simply capturing pips, is the key to profits in the Forex market. It seems to me that greater range affects both the risk and the reward equaly. Like trading higher time bars, trading greater volitility generaly requires a wider stop. Therefore, in both cases what really changes is the position size, requiring a smaller position size to maintain the same risk allowance.
For example: If I trade any of the pairs and capture a 1:3 risk/reward relationship, my profit and risk should be similar.
It seems to me, that the only ways to increase the profits while maintaining strict controls, are to seek and find trades with better risk/reward potential, to complete more successful trades in the same time period, or to minimize the initial risk through better timing, or to hold a trend well beyond the initial reward assessment.
Otherwise, great stuff.
Ken Long
Hi Scott,
I have been doing this kind of trades since a long time.
I also have on same screen Eur/usd, Gbp/Usd and Usd/Yen.
With the three pairs you mentioned - Eur/GBP, Eur/Yen and
Gbp/Yen. Total six pairs give you a view of the Big Circus.
The circus starts when Eur and GBP are taking rest. So timings are also known. What is holding is the fear. Asian traders use hedging (buying and selling same currency pair)
to control fear, margin and drawdown. I am from Hong Kong and I do what a normal trader does here. Hedge and wait for retracement, pullback to get rid of the hedge. No stop loss comes to mind unless it is 5 or 10 pips.
In order to have six charts in one screen, I use monitor display resolution to 1680 x 1050 so that I have don't have to use dual monitors.
I am keen on knowing the behaviour of Nzd, Aud and Cad. If you or someone who has spent a lot of chart time on watching the Commodity currency circus and has established a pattern to trade it please do share.
Thank you
Hi Ken.
I agree for the most part with your assessment. It is possible to make more profit on shorter time frames if you work hard for many hours per day but it is easier to trade longer term and not be glued to the computer. We emphasize trading on all time frames according to personal preference and what trades are available. If you stay in trades beyond the initial risk to reward assessment your assessment was wrong. We stay in trades until there is an exit signal.
Scott
Hi Scott,
Thanks for taking the time, I know how busy you must be right now.
Yes, day trading is only applicable if one has the time, and I prefer the slightly longer term trading, as your original course emphasizes.
Yet, I have found that I can make almost exactly the same amount of money, in dollars, or percent gain to the account, from a day trade as a longer term trade. If, I base my position size on the initial risk, and otherwise follow the same rules.
What I meant by holding beyond the initial risk reward assessment, was simply holding a position and waiting for the exit signal, vs taking a targeted profit, which can sometimes produce a much greater reward compared to the initial risk. I find both methods are justified, depending on circumstances.