How To Identify Strong Currency Pairs In Forex
One of the key skills in forex trading is learning how to identify strong currency pairs. To do this, you need to be able to analyse the relative strengths and weaknesses of a currency pair at any given time. This will enable you to achieve optimal results when they are traded against each other in the market.
Currencies are always priced relative to another currency, with the value of most world currencies floating in response to supply and demand. Forex trading works by making a profit or loss based on the difference in price when you use a currency to buy or sell in the forex market at a strategic price point.
Monitoring the relative price of currencies is an ongoing task and there are advanced technical analysis tools that allow you to track patterns and changes in detail. For new traders, understanding the basics of how currencies work is a priority.
The difference between strong currencies and tradable currencies
The most tradable currencies are not always the strongest. For example, the Kuwaiti dinar (KWD) is the strongest currency in the world, with one Kuwaiti dinar worth about 3.26 US dollars (USD). This is largely due to the fact that Kuwait is a leading exporter of oil, which is one of the world’s most valuable commodities.
However, the KWD is not considered as a major currency pair in forex trading. This is because the KWD is not widely used and therefore has limited presence in global trade, and it has low volatility. This means that the value of the KWD does not fluctuate greatly and therefore does not present much opportunity to buy or sell at a profit.
The same is largely true of the three next strongest currencies in the world, the Bahraini dinar, the Omani Rial, and the Jordanian dinar respectively. These are countries with stable and well-regulated oil-based economies, but their currencies do not have much liquidity in the forex market.
The USD on the other hand is only the world’s 10th strongest currency, behind the British Pound (GBP) which is the fifth strongest currency in the world. The Swiss Franc (CHF) and the Euro (EUR) are the joint eighth strongest currencies in the world.
However, the US is the world’s largest economy by Gross Domestic Product (GDP), and the USD is the most traded currency in the world by a considerable margin. It’s also the largest reserve currency in the world, meaning that it is the currency held by most central banks.
The US is a business friendly country that has generated some of the richest and most powerful companies of the 21st century, such as Amazon, Google, and Facebook. This makes it an attractive destination for global investors and the USD is the most widely accepted currency in the world.
For this reason, the major currency pairs always include the USD because it is highly liquid, which means that huge volumes are traded on a daily basis. THe USD is involved in over half of all of the turnover of US$ 7.5 trillion in daily forex trades.
The major currency pairs
Now we have established the difference between the strongest currencies and the most tradable currencies, let’s have a look at the major currency pairs. These are the Euro and the US dollar (EUR/USD) which account for 20% of all forex trades. The Euro is the common currency of 19 of the 27 EU member states that was introduced between 1999 and 2002.
The Eurozone is one of the world’s strongest and most stable economies, with efficient cross-border trade and coordinated economic policies. It comprises many economically high-performing countries, including Germany, France and Spain. This makes the Euro one of the most attractive currencies for investors and traders.
The value of the Euro is strongly influenced by the unemployment rate, the Consumer Price Index, and the inflation rate. Therefore when you are using the Euro as one of your currency pair, you should closely follow the economic news for any imminent changes in these areas. For example inflation is particularly volatile in the Eurozone at the moment.
The other factor to bear in mind when trading the Euro is that its value is tied into smaller and sometimes less stable economies, such as Greece. This means that it can be volatile and more sensitive to political changes than other currencies.
The USD and the Japanese Yen (JPY) are the next most traded pair. The JPY is the most traded Asian currency and the third most traded currency in the forex market. Japan’s economy is a high performer on the world stage, and its currency is stable and regarded as a safe haven due to the highly controlled interest rates.
However the fact that the JPY is protected from fluctuations in interest rates and inflation means that it has low volatility and therefore does not offer much opportunity to make substantial profits. It’s seen as a secure and consistent currency that is useful when the markets are going through a period of turmoil.
The British Pound (GBP) is popular in forex trading because of its high value relative to the other major currencies. It’s most often paired with the USD and the EUR. The UK generally has a strong and relatively stable economy, although it has been going through a tough Brexit transition with some political uncertainty.
When considering trading GBP with the USD, pay attention to the time of day. 14.00 UK time is considered optimal, because this is the crossover period when both the London and New York markets are both active. When gauging the value of the GBP, look at the GDP, the Consumer Price Index, and the unemployment rate and average earnings.
The Swiss Franc (CHF) is something of an outlier in the major currencies, because the Swiss economy is small and it is not a member of the EU or the G-7 countries. The major draw of the CHF is that Switzerland is a gold rich nation that is regarded as a stable safe haven.
Gold is one of the world’s rarest commodities and it holds its value even during financial downturns, and this tends to protect the CHF from the worst effects of inflation. The pairing of the USD/CHF is therefore especially popular in times of high market volatility.
When considering trading with the CHF, study the value of the EUR, because the close proximity of Switzerland to the EU means that the two currencies tend to follow the similar market pathways.
The commodity currencies
THe commodity currencies refer to the currencies of economies which are rich in highly tradable commodity reserves that are usually in high demand around the world. These include oil, natural gas and other fuels, timber, dairy products, meat, precious metals, and grains.
A commodity is basically an essential raw ingredient, rather than a finished product or service. The major commodity currencies include the Canadian dollar (CAD), the Australian dollar (AUD) and the New Zealand dollar (NZD).
As previously mentioned, the currencies of the oil-producing nations such as Kuwait are included in this category and are among the strongest currencies in the world. However, because they are not widely traded on the global stage they are much less liquid, meaning that there are far fewer opportunities to buy and sell them at a profit.
However, trading in the major commodity currencies paired with the USD can be highly lucrative. The value of the currency is obviously highly correlated with the price of the commodities that they trade in, so a forex trader must keep a close watch on supply and demand in the market.
How to identify a strong currency pair
Forex traders aim to buy currencies that they expect to rise in value, by studying the market conditions that are most relevant to that currency, or to sell currencies that have risen in value since they bought them. They may also sell off currencies which they expect to fall in value in order to protect themselves from making a loss.
The market conditions that most strongly affect major currencies include interest rates, inflation, GDP, unemployment rates, and the Consumer Price Index. Wider geopolitical factors, such as elections, changes to economic policy, wars and natural disasters, also affect the stability and value of a currency.
When trading in the majors, the starting point will always be the US dollar index, or DXY. This measures the value of the USD against a basket of currencies that will include the other major currencies.
This will give the trader an indication of the comparative strength or weakness of the dollar compared to the other currency, and they can decide if the time’s right to buy or sell.
Remember that comparative currency strength is only one aspect of making a trade, and you also need to carry out further technical analysis to determine which is the best time to enter or exit the market.
If you are looking for instant forex funding please get in touch with us today.