What currency pairs should we trade and why? And are there any ‘exotics’ that we could trade?

Feb 13 • Between the lines • 2370 Views • Comments Off on What currency pairs should we trade and why? And are there any ‘exotics’ that we could trade?

shutterstock_137039771It may surprise many traders to realise exactly what currencies are in the basket of currencies that make up the dollar index. Many of us will have made various assumptions as to what’s in and what’s not, so here’s the definitive definition and answer.

The US Dollar Index (USDX) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies. It is a weighted geometric mean of the dollar’s value compared only with “bucket” of 9 other major currencies which are:

* Euro (EUR), 57.6% weight
* Japanese yen (JPY) 13.6% weight
* Pound sterling (GBP), 11.9% weight
* Canadian dollar (CAD), 9.1% weight
* Swedish krona (SEK), 4.2% weight
* Swiss franc (CHF) 3.6% weight

For many traders the surprise element contained in the basket of currencies will undoubtedly be the Swedish Krona. Moreover, it may surprise traders that the krona has more ‘weighting’ than the Swiss franc, which is a currency many of us FX traders regularly trade, particularly as a pair with the greenback acting the base currency as it very often provides near perfect negative correlation with the most liquid of all pairs; EUR/USD.

Now we’re highlighting krona for a reason and it has to do with the title of the article, “what currency pairs should we trade and why?” All things being equal we should, in theory, be looking to trade the Swedish krona on a regular basis given its weighting, but there’s a reason why we don’t and I’m sure experienced traders know why before we get there with the answer…the spread when it’s paired up with any other currency is just too wide. Should this wider spread prevent us from trading currency pairs with SEK? Yes and no, allow us to explain…

The reason we’re highlighting the wide spread is to emphasise that, the lower down the time frames you trade, the more relevant and important the spread becomes, not just the liquidity of the currency which in relation to the Swedish krona should be quite high. In simple terms the closer to what many would term as “scalping” your trading strategy resembles then there are certain currency pairs that you simply can’t trade, unless you’re a masochist who’s determined to make the job harder than it has to be.

The spread at the most volatile times on USD/SEK can be as low as 6-10 pips, that’s as good as it gets, thereafter it’s anyone’s guess. The quote for the spread, during times when European markets are closed, can see the spread rise up to 30 pips or higher. Therefore it really is incredibly difficult to justify how we could build a scalping and or day trading strategy around any pair with spreads this wide.

If you’re aiming for ten pips then paying a spread of 10 pips plus commissions makes the exercise worthless. Aiming for 20 pips still doesn’t allow much latitude in terms of the occasional slip and the commissions. What under normal circumstances would be an excellent scalp or day trade – 20 pips gain minus the spread and commission leaving us with perhaps a net gain of 17 pips if we’re trading the EUR/USD, could be as low as 7 pips gained if trading a SEK denominated pair.

However, if we move up the time frames to perhaps daily charts, whilst employing a swing trading strategy, we can begin to see the benefits. Paying a ten pip spread when you’re aiming for perhaps 300 pips and risking 150 and you’ve entered based on the high probability set up triggering that you’ve used to very good effect for some time, is entirely logical and reasonable.

So why are we explaining what on the face of it looks like some of the most obvious advice we’ve ever delivered? Well would you believe how many of us traders fail to not only consider the costs of spreads and commissions in their overall trading plan, but also fail to recognize the opportunities that may exist in what previously they may have simply dismissed as exotic currency pairs that are untradable? It is in fact a very common oversight from both perspectives.

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