First off, I want to state, for the record, that I have [B]NOT[/B] tested, nor examined this idea in any detail whatsoever. It simply popped into my head, and I had to send it out to be examined before I forgot what it was.
I was examining the possibility of holding three opposing positions at once… for example:
My original thought was, if I held all three positions in equal amounts, would the daily interest rate cancel out across them?
Of course, the answer way ‘yes’; doing this is foolish in terms of Carry Trading, since the interest you gain from any of the pairs would be cancelled out by what you have to pay on the others.
But then I got to thinking… would the same be true of the price? If I gained a pip in AUDJPY, would I lose a pip in either of the other two to balance it out?
I don’t have any figures to back this one up, but I believe, [I]in theory[/I], the answer is also ‘yes’; your net gain would be zero across the board (less, actually, since you have to cough up the spread).
Now, I’m going to switch gears, and outline a standard physics problem (trust me, this relates); suppose you and a friend are floating in space (why not?), with no reference points to tell how fast you’re going, or in which direction. You can tell that your friend is moving towards or away from you, and how fast, but that’s all. How would you be able to tell how fast [I]you[/I] are going?
The answer is, you wouldn’t; your only reference is your friend, and so [I]relative[/I] to him, you know which way things are moving.
This is how I think of currency pairs; everything is in relation to [I]the other[/I] currency, not to anything concrete. If you [I]could[/I] tell that, say, USD is falling (absolutely), and that JPY was stable (absolutely), you would know to sell USDJPY and gain some pips. But of course, you can’t know changes absolutely, because there is no common reference to compare them to.
So how about we make one?
Drifting back into space… suppose another friend came along. Now, you can tell changes in relation to either friend, and they can tell changes in relation to each other. Now things become a little more telling, and give you some probabilities to follow:
- if both friends are moving away from you, in all likelihood, [I]you[/I] are the one who is moving away, and the other two are stable.
- If both friends are moving toward you, in all likelihood, [I]you[/I] are the one who is moving toward them, and the other two are stable.
- If friend A is moving toward you, and friend B is moving away, likelihood is that you are relatively stable, and its the other two that are moving.
- If friend B is moving toward you, and friend A is moving away, you are stable, and the other two are moving, but in the [I]opposite direction[/I] as in the previous point.
Of course, this isn’t foolproof; there’s no way to tell that the third friend is any more or less stable than the other two; but it gives you probabilities that you can use to bias your decisions.
Back to currency… let’s apply these ideas:
- If AUDUSD goes up and USDJPY goes down, AUDJPY doesn’t change much at all, and we can assume that USD is falling [I]absolutely[/I]… might be a good time to get in on other trades where USD is a factor?
- If AUDUSD goes up and USDJPY goes up, AUDJPY should be rising, and USD is relatively stable.
- If AUDUSD goes down and USDJPY goes down, AUDJPY should be falling, and USD is relatively stable.
- If AUDUSD goes down and USDJPY goes up, AUDJPY doesn’t change much at all, and we can assume that USD is rising [I]absolutely[/I]… another chance to look at other USD currencies?
I don’t know whether this is a [I]system[/I], per se… or more of way to think about currency changes. What’s more, the whole notion may be completely out to lunch since I’m so new at this stuff, and havn’t got any test-results to back this up.
I guess what I’m saying, [I]in theory[/I], is that if you see a trend in two of the pairs, you should be able to come up with a reasonable prediction of what the cross will do.
Any thoughts on whether I’ve just stumbled upon a moment of idiocy, brilliancy, or something someone else has already come up with?