Most Profitable Currency Pairs To Trade – Generally the forex market is more trending than the stock market as a whole. Why? The stock market, which is a market for many individual stocks, is managed by micro-organizations of specific companies. On the other hand, the forex market is driven by macroeconomic trends that can sometimes take years to play out.
These trends are best expressed through major pairs and commodity currencies. Here we take a look at these trends, examining where and why they occur. Then we will also look at which pairs offer the best opportunities for range trading.
Most Profitable Currency Pairs To Trade
It is understandable why the United States, the European Union, and Japan have the most stable and active currencies in the world, but why the United Kingdom? After all, in 2020, India has a larger GDP ($2.65 trillion compared to the United Kingdom’s $2.63 trillion), while Russia’s GDP ($1.57 trillion) and Brazil’s GDP ($2.05 trillion) are almost equal to the total economic output of the UK.
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A description that applies to most of the forex market is tradition. The United States was the first economy in the world to develop a modern capital market, and at one time it was the British pound, not the US dollar, that was the world’s reserve currency. . Because of this heritage and London’s importance as a global forex trading center, the pound is still considered one of the world’s most popular currencies.
On the other hand, the Swiss currency has earned its place among the big four because of Switzerland’s famous neutrality and fiscal prudence. At one time the Swiss Franc was backed by 40% gold, but it was still called “liquid gold” to many traders in the forex market. In times of economic turmoil or stress, traders turn to the Swiss franc as a safe-haven currency.
The largest major pair – indeed, the most liquid financial instrument in the world – is EUR/USD. The pair trades around $1 trillion a day in notional value, 24 hours a day, five days a week, from Tokyo to London and New York. The two currencies represent the world’s two largest economies: the United States with an annual GDP of 21.43 billion US dollars and the Eurozone with a GDP of about 13,335.84 billion dollars.
Economic growth in the United States is better than that of the Eurozone (3.1% for the United States compared to 1.6%), but the Eurozone economy generates a net trade surplus while the United States has a recurring trade deficit. The euro’s excellent balance sheet position – and the size of the eurozone economy – have made the euro an attractive reserve currency against the dollar. As a result, many central banks, including Russia, Brazil and South Korea, have diversified their reserves into the euro. Clearly, this diversification process has taken many events or changes to affect the forex market. That is why one of the most important characteristics of successful trend trading in forex is long-term forecasting.
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To see the importance of this long-term forecast, take a look at the figures below, both of which use three simple moving-average (three SMA) filters.
Figure 1. Chart of the EUR/USD exchange rate from March 1 to May 15, 2005. Note that the recent price action indicates volatility and all three simple moving averages move side by side indicating the possibility of a bearish start. Photo by Sabrina Jiang © 2020
The triple SMA filter is a good way to measure trend strength. The basis of this filter is the short-term trend (seven-day SMA), medium-term trend (20-day SMA), and long-term trend (65-day SMA) all aligned into one. Direction, then trend is strong.
Figure 2. EUR/USD exchange rate chart from August 2002 to June 2005. All bars correspond to a week instead of a day (in Figure 1). And on this long-term chart, a completely different perspective emerges – with each downward move the uptrend remains intact, providing the starting point for new highs. Photo by Sabrina Jiang © 2020
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Some traders may wonder why we use the 65 SMA. The real answer is that we took this concept from futures trader and educator John Carter because these are the values he used. But the importance of the triple SMA filter is not in the specific SMA values, but rather in the interaction of the short, medium and long term price trends provided by the SMAs. As long as you use reasonable proxies for each of these trends, the Triple SMA filter provides valuable analysis.
Looking at EUR/USD from two different time points, we can see how the trend signals differ. Figure 1 shows the daily price action for March, April and May 2005, showing difficult movements with clear biases. However, Figure 2, all of the 2003, 2004 and 2005 weekly data table, and paint a different picture. According to Figure 2, EUR/USD remains in a clear trend despite several sharp corrections.
Warren Buffett, an investor known for trading long-term trends, has been heavily criticized for holding his long EUR/USD positions with few losses. But looking at the structure in Figure 2, it becomes clear why Buffett may have the last laugh.
The three most liquid commodity currencies in the forex market are USD/CAD, AUD/USD, and NZD/USD. The Canadian dollar is commonly referred to as the “loonie”, the Australian dollar as the “aussie” and the New Zealand dollar as the “kiwi”. These three countries are major exporters of goods and have a strong tendency towards the need for each main export product.
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For example, see Figure 3, which shows the relationship between the Canadian dollar and the price of crude oil. Canada is the largest oil exporter to the United States and oil comprises about 10% of Canada’s GDP.Energy Exploration Sector. USD/CAD trades inversely, so the Canadian dollar’s strength creates a bearish trend in the pair.
Figure 3. This chart shows the relationship between the loonie and crude oil prices. Canada’s economy is rich in oil reserves. The chart shows that when oil prices rise, it becomes less expensive for holders of Canadian dollars to buy US dollars. Photo by Sabrina Jiang © 2020
Although Australia does not have large oil reserves, the country is a rich source of precious metals and is the world’s second largest exporter of gold. In Figure 4 we can see the relationship between the Australian dollar and gold.
Figure 4. This chart shows the relationship between the Aussie price and the gold price (in US dollars). Note that the gold rally from December 2002 to November 2004 coincided with a strong appreciation of the Australian dollar. Photo by Sabrina Jiang © 2020
Best Currencies To Trade
In contrast to major currencies and block commodities, both of which offer traders the opportunity to own strong and long trends, cross currencies offer trading with better margins. In Forex, crosses are defined as currency pairs that do not contain the USD as part of the pair. EUR/CHF is one such cross, and is known to be perhaps the best ranged pair to trade. One reason is, of course, that there is very little difference in growth rates between Switzerland and the European Union. Both sectors operate on current account and follow a conservative fiscal policy.
A strategy for a range trader is to determine range parameters for a pair, divide these parameters by the average line, and buy below the average and sell above it. Range parameters are defined as the high and low between prices that change over a period of time. For example in EUR/CHF, a range trader may establish 1.5550 as the top of the range and 1.5050 as the bottom for the period between May 2004 and April 2005, with the midline of 1.5300 defining the buy and sell zone. (See below).
Figure 5. This chart shows EUR/CHF (May 2004 to April 2005), with 1.5550 at the top of the range and 1.5050 at the bottom and 1.5300 as the center line. A range trading strategy involves selling above the moving average and buying below the moving average. Photo by Sabrina Jiang © 2020
Cross currencies are very attractive for cross-border strategies because they represent currency pairs of culturally and economically similar countries; Imbalances between these currencies usually return to equilibrium. For example, it is difficult to understand that Switzerland is depressed, while the rest of Europe is happily expanding.
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The same tendency toward equity, however, cannot be said for stocks with similar characteristics. It is relatively easy to imagine how General Motors could file for bankruptcy while Ford and Chrysler continue to do business. Because currencies represent macroeconomic forces, they are not as sensitive to micro-level risks as individual company stocks. So the currency is very safe to trade.
However, risk is inherent in all speculation.
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