The forex market is not as foreign as you think and selecting the right currencies to buy and sell can be easy. You don’t need a PhD in economics or decades of experience analyzing the global markets. In fact, the very same skills that are used to pick stocks can be used to pick currencies. The best part is that the same stories that drive equities, bond and commodities also drive forex.
One of the most unique aspects of the forex market is that currencies are traded in pairs, which means a value of one currency is always measured against another.
If this sounds complicated, it’s really not.
The best way to look at it is that at any point in time, your view on a particular currency pair should be based on whether you think one country will out/underperform another.
Picking currencies can be as easy as 1,2,3 if you follow this process:
1. Always Pair Strong with Weak. The best currencies to buy are the ones representing strong economies. Look for countries whose economic prospects are improving with economic data beating expectations and a central bank that is ideally in the process of (or looking to) raise interest rates. The best currencies to sell are the ones represents weakening economies. These are countries struggling because of weak export activity, domestic troubles, political uncertainties or other significant reasons that would require the central bank to take steps to promote growth through lower interest rates or Quantitative Easing. Pairing strong with weak puts the odds in your favor and sets you up for the highest quality forex trades.
2. Check the Economic Calendar. Unless you want to hold a forex position for months on end, the second step to selecting good forex trades is timing. Currencies move on economic data and thankfully reports that you typically follow if you are trading stocks like Non-Farm Payrolls, U.S. Retail Sales, FOMC and ECB rate decisions are the same ones that move the forex market. Currencies need a catalyst to “push” the trade in one direction or another. If you are pairing strong with weak, you are hoping that good data will only get better and bad data will only worse, which is often the case. If there is a piece of data that you think could go the other way and then it’s better to wait until the event risk passes before establishing a position in the currency pair.
3. Check the Charts. The last piece of the puzzle is to check the charts. You don’t want to buy an overbought currency pair or sell an oversold one. You also want to avoid buying if there is a lot of congestion above current levels or selling right above significant support. The best choice in those situations is to wait for some type of correction. If the charts give an “all clear”, then the stars are aligned for a high quality forex trade.
Now how does all of this work in real life?
The Euro / U.S. dollar currency pairing is a perfect example. Its no secret that the Eurozone economy is faltering so much so that the European Central Bank is talking about increasing stimulus in December.
The U.S. economy leaves a lot to be desired but is still stronger than many other countries and the Federal Reserve is talking about raising interest rates next month.
Selling EUR/USD as soon as you read this article could work but a much smarter move would be to check the economic calendar for a catalyst like U.S. retail sales, the December non-farm payrolls report or Eurozone PMIs. Then check the charts to see if the EUR/USD has bounced to a resistance level or recently broken a support level before getting into the trade.
Until next time,
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