Back to Basics

When it comes down to it, currency trading is all about matching weak currencies and strong currencies.

Just find a country that has weak a fundamental outlook or maybe a distressful political situation, and then match it with a country with positive or better fundamentals (i.e. rising employment, growing trade surplus, etc) or maybe a positive political outlook, then you can match their currencies together to make an intelligent directional trade.

Let's take a look at a recent, real world example:

On January 11th, 2007, both the Bank of England and the European Central Bank were set to release their decisions on their interest rate policy. Leading up to that morning, the markets speculated that the ECB hint that they would raise interest rates soon and the BoE would hold any hikes. Well, what a surprise the market got as the Bank of England raised rates to 5.25% and the ECB held rates at 3.50% on concerns of slowing growth in the Eurozone.

So, why would a currency trading pro, such as yourself, play a currency cross instead of matching either the Euro or the British Pound with the US Dollar? Well, here are a couple of scenarios to think about:

1. US Retail sales numbers were coming out soon after the interest rate decisions. If you had a weak outlook on the Euro and went short EURUSD, then a weak US Retail report would probably been bad for your trade as the US dollar would sell off.
2. Or if you maintained a strong outlook on the British Pound and decided to go long GBPUSD, then a dollar rally on a strong US retail sales report would have been very bad for you trade.

After the interest rate releases, we know the outlook on the Euro is weaker and the outlook of the British Pound is stronger, why don't we just short EURGBP? By taking this trade you get rid of the event risk of upcoming US data, plus you get a positive carry on your position!

Here's how you may have faired taking a short trade on EURGBP using this analysis:

As you can see from the chart, had you shorted at 0.6650 an hour or so after the interest rate decisions were announced, you would have caught the slow and steady move to 0.6600, and possibly further until fundamentals change for either the Euro or the Pound.

Again, this is just one example of matching weak with relatively stronger currencies. With six major currencies other than the US dollar, there are plenty of possibilities to find profitable trades, and avoid erratic volatility with the US dollar.