I am currently trying to understand how things work in forex and have a couple things in my mind:
Say i open a BUY trade on EUR/USD. In the meantime i look for opportunities on other pairs, EUR/JPY and USD/CHF for example. The logical thing would be to look for a BUY opportunity in the EUR/JPY and a SELL opportunity in USD/CHF right? It doesn’t make much sense to buy EUR in one pair and sell it in other pair. I mean there are too things that can cause the price to change in a currency pair (let’s just take EUR/USD for example): EUR price is changing or USD price is changing (or both when people trade exactly this pair).
Now i look for trades in multiple currencies and i notice EUR/USD is a bit bullish and USD/CHF is also a bit bullish. So EUR/CHF must be even more bullish and have better trading opportunities. I just want to make sure i understand this so please tell if i’m right or not.
Could you be more specific? i don’t really understand.
Also, is there a good reason to stick to only one pair? I mean the opportunities don’t seem to come that often.
You have several different things going on in your post. First, there is the concept of currency correlation. As you noted, the EUR/USD is generally correlated with EUR/JPY. These two pairs are generally negatively correlated with the USD/CHF. If placing a long on EUR/USD you can usually expect it to be very similar to going long on the EUR/JPY or short on the USD/CHF. These correlations generally hold true over longer periods of time but in the very short time frames these pairs can move independently of each over. If you notice a long opportunity in the EUR/USD and EUR/JPY but also a long opportunity in the USD/CHF, it is possible to take advantage of a very short scalp to the long side on the USD/CHF (though I wouldn’t recommend it for reasons mentioned below).
What is more likely is that one of the pairs is either leading or it is lagging the moves of the others. As PPF pointed out, looking at indexes can often give a bit of insight as to which is which, using both the USDX and EURX. Once the lagging pair(s) is identified, an excellent trade opportunity can present itself. You have identified an anomaly. Something is wrong with one of the pairs you are looking at. For whatever reason, it is temporarily going the wrong way and is out of sync with the other correlated pairs. If the pairs are to maintain a correlation it must eventually revert back. Take advantage of it!
The next thing that comes to mind is should you trade just one of the pairs or trade all of the pairs? There are pros and cons to each method. One can argue that trading only one pair is preferred. This certainly eliminates paying the spread multiple times over correlated and negatively correlated pairs. Others will argue that the name of the game is pips. You may catch a 50 pip move on one pair whereas when you trade multiple pairs whose movements are linked together (in your example, three) then you could potentially make 150 pips on the same move. If you normally risk 3% per trade but only trade 1% on each of the three pairs then your end results will be similar. One advantage of trading all three is that one pair is likely to move more than the others and you will be able to take advantage of the larger move without knowing which pair is most likely to make that move. In the end, I don’t think it matters much. Trading just one of the pairs is certainly easier. If, however, you limit yourself to 1% on each trade you take (whether one or multiple ongoing trades) and treat all trades independent of each other, then by entering three trades you are entering into three times the risk and can make three times the profit. You are also subject to three times the potential loss.
Next, you are looking at the currency crosses. The synthetics were once nothing more than a mathematical computation of the currencies that made up the synthetic pair. They always moved directly proportional to the movement of the pairs that made up the synthetic. These pairs now move somewhat independently since most brokers trade them independently though there is, of course, an extremely strong correlation aspect of currency crosses that can not be eliminated.
The crosses can be useful in determining the relative strengths of currencies. As an example, you notice a long opportunity on both the AUD/USD and NZD/USD. Which to trade? Check the AUD/NZD. If the pair is strongly trending up (the AUD is the stronger currency) take the AUD/USD. If the AUD/NZD is trending down (meaning the NZD is the stronger currency), take the NZD/USD. Using the crosses as a gauge of relative strength for trades on the major pairs can eliminate paying the high spreads found on the crosses.
You’re asking a BIG question, about what goes up when and what currency affects another, correlation and the like, but to simplify all of that, you could use the index of the main pair.
Thank you very much for taking the time to help. I’m a beginner and don’t know much about how this works, but it’s becoming clearer now. The USD index is just what i have been looking for!
About crosses, that’s what i was thinking about. So it seems that finding among multiple pairs the strongest currency vs the weakest provides the best opportunities.
It’s not the whole story though, you’re on the right track to start off with, but it with being Saturday, you will always find the answers here shorter than usual, and with a few extra quips than usual, wait 'till Tuesday and we get quite serious about making PIPS.
