When trading in FX, scouting for just the right currency pair can be time consuming. Of course, you’re looking for the pair on the verge of producing the next lucrative trade. Many times it’s hard to decide which pair is the one with the most momentum.
And even if you do invest all your time homing in on the “right” pair, you just might get it wrong. Getting wrong means you’ll ride on a trend that’s barely moving. Luckily, there are some rules of thumb to help guide you to those pairs that will generate the big swing you’re waiting for.
FX Risk On/Off
The first rule of thumb for FX pairs with big swings is to ensure that the two currencies belong to opposite groups. For example, one of the most popular divisions between FX pairs is between risk on and risk off currencies. Risk off currencies tend to rise when investors are “jittery;” prominent members of that group are the USD and JPY. On the other hand, risk on currencies tend to rise when investors’ appetite for risk has been whetted. Risk on currencies include the Aussie, the Kiwi, the Euro and most exotic pairs.
When you pick an FX pair which has currencies from opposing groups it has a greater chance of generating a big swing. That’s because you tend to get a dual movement. It’s not one currency which rises against the other it’s that one is rising while the other is falling. That divergence makes the pair’s fluctuation larger and therefore the potential could likewise be larger.
Let me give you an example as to how to put this particular rule of thumb to good use. Back in May 2014, when fears over the Eurozone surged, it was a classic risk on trade scenario. Selling the EUR/USD was one of the most lucrative FX trends since the Dollar was gaining and the Euro was losing. That created a much bigger fluctuation for the pair than it did for, say, the EUR/GBP or EUR/AUD. In those cases, both sides of the equation had currencies from the same groups that were losing value.
This rule of thumb is rather easy to spot. Is Russia in trouble? Good! The Russian Ruble is a classic risk on and it will be hit hard while the Dollar is most likely to gain. Thus your weapon of choice should be USD/RUB long which would gain the most.
The Broken Sideways
Another rule of thumb you can use is an FX pair with a broken range. One of the most noticeable things about an FX pair that trades sideways is that it stretches like a coil. The longer the pair trades sideways the stronger the burst of momentum will be upon a break. So, if you spot an FX pair that’s been on a sideways trend for long, keep an eye on it. When the break does eventually occur the swing could be lucrative.
Mean Reversion
Our last rule of thumb is basically to look for an FX pair that’s hit its maximal range. We’re talking either a triple top or a double bottom or some such other indicator. Any or all of those indicators could suggest that the latest trend has reached its climax. The reversal which comes in the aftermath usually is rather significant. There are numerous ways to identify a mean reversion, which we elaborated on in past articles. The key here is that once you identify it, as with the other rules of thumb, it raises the chance of generating a bigger swing.
In Conclusion
Of course, even following all of those rules of thumb can’t guarantee a gain. These rules, by their very nature, are meant to simplify things. And as we all know FX trading has many more layers, including risk which should always be taken into account. But there are many FX traders for whom these rules of thumb are especially valuable. For example, for those of you who find it a challenge to spot the right FX pair to focus on. Or for those who, often times, become frustrated by choosing the wrong FX pair to trade.
