5 min read
This story originally appeared on ValueWalk
The foreign exchange market lets you trade almost any world currency against another, exchanging them at the current going rate of both currencies. However, some currency pairs are traded more often than others. The U.S. dollar is especially important in forex, so many of the most popular pairs include the dollar.
Q1 2021 hedge fund letters, conferences and more
Types Of Currency Pairs
The forex market is always traded in currency pairs, and there are three different types of pairs: majors, minors and crosses. Majors are the most popular currency pairs, and they always include the U.S. dollar. They are usually the most liquid of all the available currency pairs. In fact, majors have the highest liquidity of the three types, although the trades can be crowded because of how popular these pairs are.
Minors and crosses do not include the U.S. dollar, although minors include one of the other major currencies, like the euro or the pound. They are less liquid than major pairs, so they can present more opportunities for traders. Crosses do not include any major currencies as part of the pair, so they are far less liquid than majors and minors.
Deciding Which Currency Pairs To Trade
Choosing which currency pairs to trade is a matter of strategy. For example, depending on what time of day you will executive your trades, not all markets will be available to you. The Asian currency markets open first, followed by the Middle East, and then Europe, followed by the U.S. While you can always trade some currencies except on weekends, you can’t trade in all markets at all hours of the day and night.
In building your strategy for currency trading, you should also choose currencies that are stable and predictable. Both factors are linked to their country’s economic health, which is why the U.S. is so popular as part of the pair. The economic health of a country impacts the value of its currency, which is why some currencies become more or less expensive compared to other currencies.
When you think a particular currency will go up or down versus another currency, you’re ready to make your trade. Here are some of the most popular currency pairs and strategies for trading them:
In all these pairs, the first currency listed is the base currency, and the second is whatever you’re changing the first one into for your trade.
The most popular currencies to trade against the U.S. dollar are the British pound, euro, Japanese yen, Canadian dollar, Swiss Franc, Australian dollar and New Zealand dollar. Europe and the U.S. are the world’s two major economies, so the EUR/USD and USD/EUR are the most frequently traded pairs, which means they are extremely liquid. Political movements in Europe and the U.S. influence which direction these currencies move against each other.
It also helps to understand which currency pairs are negatively and positively correlated with each other. Understanding these correlations allows you to create hedges among your currency trades. For example, the GBP/USD is usually negatively correlated with the USD/CHF and positively correlated with the EUR/USD because the pound is positively correlated with the franc and the euro. The difference between these pairs is that USD/CHF lists the dollar as the base currency, while the European currencies are the base currencies in the other pairs.
One of the more interesting strategies involves the dollar and the yen. The Japanese central bank buys large amounts of its currency to combat daily fluctuations in it. Thus, you could rake in some tremendous profits by going from the dollar to the yen at the right time to capitalize on those fluctuations.
The most popular currency pairs include a mixture of some of the currencies listed above against each other as well. For example, minor pairs like the euro versus the yen or the pound versus the yen could make good trades, depending on what’s happening in those respective countries or regions.
While the pound and the euro tend to be positively correlated, Brexit has created some interesting opportunities to profit off one by exchanging it from the other. The pair has become more volatile due to Brexit, which means more opportunities for profit if you can get the timing right. However, while the increased volatility creates more opportunities for profit, it also means larger chances for racking up losses if you aren’t careful.
Trading currencies can be very exciting, but you must tread carefully when making any decisions. You will have to follow the news carefully in the countries whose currencies you are trading to ensure the proper timing of your trades.