theforexwriter’s Weblog

Let’s talk about some of the major currencies (USD, EUR, GBP, CHF, JPY, CAD, AUD). These comprise the currency pairs with the most action and the lowest spreads, and more brokers handle them. Many minor currencies have good features—the Mexican peso moves in long sharp trends that are a trader’s dream, more than recouping that enormous spread, and the BRIC nations of Brazil-Russia-India-China are all rocking—but we’ll get to them in some future entry.

I can’t emphasize enough that each individual currency pair has its own unique motion and characteristic “behavior patterns” that influence the way it should be traded. Experiment with several currency pairs to find one or two that suit your trading style, then get to know those pairs intimately through observation and paper trading prior to investing your money in the live forex market. It may take six months or more, but it’s worth it because of the money you save through not being “head-faked” by the market, as noted trader Dean Malone of CompassFX phrases it. Take the time now and learn all you can, find the currency pair that works for you, and practice before you trade. You’ll be glad you did.

Major players

According to data gathered by the Bank for International Settlements, USD, EUR, and GBP account for roughly two-thirds of the average daily volume in the forex trading market, and the U.S. dollar alone is involved in more than a third of all trades. That’s a tremendous amount of liquidity, and it gives EUR/USD in particular a deliberate, tick-tick-tick motion that seems ponderous in comparison to some of the more lightly-traded currency pairs. This liquidity also keeps slippage to a minimum, making EUR/USD great for scalpers and day traders who don’t want to lose a single pip, and it can take a long time to break through support and resistance levels with so many stop-losses and take-profits floating around “out there.”

All emotions, patriotic sentiments, and political leanings aside, the U.S. dollar remains the benchmark for the world’s currencies and U.S. economic data remains the major driving force in fundamental announcements. Yes, currency pairs react to announcements from other nations but to a lesser degree, and by sheer volume, forces related to USD movements continue to lead the market.

The Euro is a sort of “anti-dollar,” much like matter and anti-matter in the Star Trek universe, and even here U.S. announcements push the currency pair around more than those from the Eurozone. Check related currency pairs, such as GBP/USD or USD/CHF, and EUR/GBP or EUR/CHF, to see which side of the equation is forcing a movement (and for possible correlation trades).

The pound sterling is not quite as liquid as USD or EUR, so its movements are sharper and it doesn’t pull back as often on profit-taking. If you’re caught on the wrong side of a pound-cross trade, it’s generally best to just get out rather than wait for it to turn around or pull back, but if you’re on the right side of the trade, use a trailing stop to lock in profits. False breaks and false signals are also common here.

Because U.S. data tends to move the European currencies, traders who specialize in EUR/USD tend to watch GBP/USD or USD/CHF even if they don’t trade those currency pairs. These two often react in the same manner to the same announcements, but with their lower liquidity levels, they move more quickly, and if they breach a support or resistance level, chances are good EUR/USD will follow suit shortly.

The safe-havens

I should perhaps mention that JPY can also be considered one of the majors, as it’s on one side or the other of 16.5% of all forex trades, but because it tends to trade more in line with CHF than any of the currencies discussed above, I decided to put it here instead.

Because Switzerland and Japan are conservative countries with solid fundamentals and the lowest interest rates in the industrialized world, their currencies are considered to be more stable than most. When times and financial returns are good, investors tend to ignore them and dabble in riskier investments, but when economic and political crises slam the forex and stock markets, these same investors tend to run for shelter. Sometimes they head for commodities such as gold or crude oil, but often they run for the Swissie and the yen in the belief that, even if the rest of the world falls flat, these two bastions will remain strong.

For this reason, CHF and JPY don’t always trade in response to their nations’ fundamentals. JPY tends to reflect the amount of risk appetite or aversion amongst traders (see the discussion of AUD/JPY, below), while CHF, like the Euro, seems to be something of an “anti-dollar” and reflects how bullish or bearish traders feel toward the U.S. economy. Only a shift in interbank interest rates (very rare with these countries) or a sharp rise in unemployment or inflation seems able to spark a movement in CHF and JPY that is unrelated to these trends.

The commodities-related currencies

These nations depend heavily upon exports of raw materials and manufactured goods for economic growth, so when the prices of commodities are high (like now), their economies are generally booming. It’s best to be specific when using this trading technique. For example, Canada contains the greatest oil reserves in the world outside of the Middle East, so when the price of West Texas Intermediate pushes higher, watch for CAD to follow, especially if gold or building materials are also strengthening.

Around 80% of Canada’s exports head due south to the U.S., so when the U.S. economy is hurting it tends to drag that of Canada down with it. Right now crude oil is high but the housing market is soft, so building materials among other factors, such as slowing industrial growth and lowering interest rates, are beginning to weigh on CAD.

Commodities that comprise large chunks of Canada’s exports include crude oil, natural gas, foodstuffs, forestry products such as lumber and paper pulp, and metals and minerals such as gold, platinum, copper, zinc, and potash.

Australia exports iron ore, coal, gold, crude oil, wheat and other grains, and LNG. Because of Australia’s position in the Pacific, many of their exports head to Asia, Africa, or South America rather than North America or Europe, so their economy is less influenced by downturns in the developed world.

Currently the Australian economy is at the peak of an incredible expansion boom—perhaps just past the peak—and they’ve been growing so fast they’re superheating, with inflation 4.2% higher than this time last year and an interbank interest rate of 7.25%. However, there are signs that the government’s attempts to slow their explosive growth to something sustainable are finally taking hold, with retail sales and demand for housing loans falling off from multi-year highs.

Of special note is the currency pair AUD/JPY, which is a favorite of investors who stash their funds in what’s called the carry trade. In this strategy, an investor borrows money in a country with a low interest rate, such as Japan (0.50%—yes, that’s right, the Japanese interest rate is half a percentage point), then invest that money in another country with a high interest rate, such as Australia at 7.25% or New Zealand at 8.25%, although that one might soon be falling.

The investor’s funds earn the difference between the interest rates, but there’s the possibility that a change in the forex market could wipe out their earnings and even some of their capital, which happened in late July of 2007 when the currency pair lost over 2000 pips in four weeks, as shown below. Those huge heikin ashi candles to the right of the chart represent the start of the subprime mortgage fiasco, when investors out a carry-trade limb lost money by the decimal place.

Anyways, AUD/JPY serves as a barometer of investors’ risk appetite or aversion. When the big money feels comfortable putting their funds into something risky and potentially rewarding, they head for the carry trade and this currency pair goes up as they buy AUD and sell JPY. On the other hand, when financial markets implode and investors scramble for the shelter of safe-haven currencies, AUD/JPY turns down as they remove their funds from the carry trade and look for somewhere safer to stash it.

This see-saw pattern makes for a volatile currency pair with some huge and rewarding moves within fairly well-defined ranges, and it’s usually obedient to repeating support and resistance levels. Because this pair is open during Asian and Australian banking hours, roughly between 2:00 PM and 11:00 PM in the U.S., it’s a good one for evening U.S. traders who aren’t yet ready to leave their day jobs.

Happy trades to you.