Just as there are big differences between penny stocks and large cap stocks currency pairs can also have different personalities.
Penny stocks are like lottery tickets. They can have wild swings and move quickly whereas large cap stocks generally trade more orderly with greater two-way flow.
In the world of forex, far flung emerging market currencies are more akin to penny stocks and they can be dangerous to trade due to lack of liquidity. However, even with the majors where liquidity is not a problem, there are some currencies that act more like penny stocks than others.
More specifically, the British pound / New Zealand dollar currency pair (GBP/NZD for short) is a beast with an average daily range of 275 pips. Compare that to a currency like the euro / Swiss Franc (EUR/CHF) which has an average daily range of only 88 pips. In fact we often consider pairs such as GBP/NZD the Googles of the Forex market.
Why is this important? Because in U.S. dollar terms, knowing which currency pairs are more or less volatile can make a big difference in trading performance.
If you have a $5,000 account and using $2,000 of that as margin for a 100,000 GBP/NZD contract, the currency pair’s intraday swings can equate to $1,861 fluctuation in your account value, which is huge. However if you are trading EUR/CHF on the other hand, the average daily fluctuation that you can expect is about 50% less or approximately $892.
To become a successful Forex trader you need to know which currency pairs are more volatile than others as this should affect your trading tactics and risk management because a 100 pip stop in EUR/CHF is very different from a 100 pip stop on GBP/NZD.
For EUR/CHF to move 100 pips, a significant news event that affects the currency pair over the course of a few days may be required.
For GBP/NZD however a 100 pip move can happen at a blink of an eye on a simple technical break. Remember, 275 pips is the average daily range for GBP/NZD but it is not uncommon to see this currency pair move 400 pips during the day.
Now just because a pair like GBP/NZD has a wide average daily range doesn’t mean that you need to avoid trading it. First 1 pip in GBP/NZD is worth less than 1 pip in EUR/CHF. On a 100,000 contract, a 1 pip move in GBP/NZD is worth approximately $6.80. The same move in EUR/CHF is worth approximately $10.10. So you can afford to have a stop that is further away from your entry price in GBP/NZD versus EUR/CHF.
Also, higher volatility currency pairs such as GBP/NZD can also trend for weeks and sometimes even months so if you catch a big move, it can be very profitable.
With that in mind, it is still smarter to take smaller positions, use a wider stop, less leverage and/or post a higher margin when trading currency pairs with wider average daily ranges – the ones that we consider “risky.”
As a rule of thumb, any currency pair that does not involve the U.S. dollar but includes the British pound or Euro is generally more risky. The reason why EUR/GBP and EUR/CHF are the exception, is because Switzerland and the U.K. economies are intimately connected to the Eurozone; so its difficult for the U.K and Switzerland to perform well if the Eurozone is suffering.
So, if the Eurozone and U.K. economies are doing poorly, euro and sterling will both be weak and this could keep EUR/GBP in a tighter trading range.
The same logic applies to Australia and New Zealand. AUD/NZD is a currency pair that generally has lower volatility and tighter trading ranges because Australia is New Zealand’s most important trading partner. So, if Australia is performing well, New Zealand will reap the benefits; but if Australia’s economy slows, New Zealand will feel the pain. The less reliance that these two countries have, the greater the potential trading range.
The bottom line is that you can trade risky currency pairs more safely if you can first recognize which pairs have greater ranges, and then adapt your stop or risk management tactics appropriately.
Until Next Time,
Ms. Kathy Lien is the Managing Director and Founding Partner of BKForex’s strategies. Ms. Kathy Lien is a leading currency expert with more than 15 years of forex market experience. Frequently touted as a trading prodigy, Ms. Lien graduated NYU Stern at 18 and immediately started working on the forex desk at JPMorgan. She started the #1 Forex news site DailyFX.com and is now a regular contributor to CNBC Squawk Box and a former host of CNBC’s forex show, Money in Motion. Ms. Lien is also an internationally-published author of the best-selling book, “Day Trading and Swing Trading the Currency Market” (now in its third edition) and “The Little Book of Currency Trading.” Her extensive experience in developing trading strategies using cross markets analysis earned her worldwide recognition. Ms. Lien has taught forex to thousands of traders and is invited to Asia, Europe multiple times a year to conduct beginner and advanced workshops.