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The Importance to Traders of learning the Personality of your Currencies

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Whether trading Forex, commodities, equities or futures, all tradable instruments have a personality type. …a manner in which they move based on reactions to posted economic data, or anticipated data, or even times of the day, week or year.

The well-used saying in equities of Sell in May And Go Away, is based on an irregular, but sometimes true, aspect of major US markets to flatten or decline over the northern summer when the vast majority of traders take holidays for all or part of this period. It probably should be Sell in June But Come Back Soon.

Traders like simple rules. However being a successful trader is rarely simple.

The basis behind these sayings is that currencies and equities display identifiable patterns that repeat and repeat. Learning these patterns is essential to making money out of trading Forex.

With forex trading, it is not just the individual currency characteristics and dynamics you need to understand, but how they perform as a trading pair.

So how do currency pairs perform differently from each other?

Currency pairs are a lot like people, each one has its own personality. They move in different ways, make different trading patterns and have different volatility levels.

Let’s start with some US dollar pairs.

EUR/USD

This is one of the most traded currency pairs in the market over any time frame. It is a great pair to trade as it offers very tight bid/ask spreads, is a very active pair with moderate volatility. Even this moderate volatility has been waning since late 2013. Its movements though are generally active enough that both day and short-term traders can turn a profit on trading this pair.

When trading this pair you need to check the broad economic picture of both the US and the Eurozone, as it has active monetary policymaker commentary on the domestic economy and currency.

EUR/USD tends to be negatively correlated to the USD/CHF and positively to the GBP/USD. What this means is that if EUR/USD goes up, then most likely USD/CHF will go down. This close relationship can be seen even on an intraday basis. In fact, this negative correlation is the closest relationship in the forex markets. You can take advantage of this relationship by opening both the EUR/USD and USD/CHF charts in your trading software, and compare both together. This way, you can have a better idea of where either pair could be moving next.

The EUR/USD tends to experience prolonged, seemingly inconclusive tests of technical levels, whether generated by trendline analysis (using longer period moving averages) or Fibonacci/Elliott wave calculations. This suggests breakout traders need to allow for a greater margin of error, say of 20-30 pips. (A pip is the smallest increment in which a foreign currency can trade with respect to identifying breaks of technical levels.) Another way to gauge whether EUR/USD is breaking out is to look to the less liquid USD/CHF and GBP/USD. If these pairs have broken equivalent technical levels, for example recent daily highs, then EUR/USD is likely to do the same after a lag.

When trading EUR/USD using very short-term indicators (less than 30 minutes) the trader is exposed to an increased likelihood of “whipsaw” movements.

Moving average convergence divergence (MACD) as a momentum study is well-suited to EUR/USD, particularly because it utilises exponential moving averages (greater weight to more recent prices, less to old prices) in conjunction with a third moving average, resulting in fewer false crossovers. Short-term (hourly) momentum divergences routinely occur in EUR/USD, but they need to be confirmed by breaks of price levels identified through trendline analysis to suggest an actionable trade. When larger moves are underway, traders are also likely to find the directional movement indicator (DMI) system useful for confirming whether a trend is in place.

USD/CHF

The USD/CHF is one of the least traded among the major currencies. It has a wider bid/ask spread than that of EUR/USD as a result. It is still a popularly traded pair and its movements are negatively correlated to that of EUR/USD. As the Swiss franc is seen as a safe-haven currency, it benefits greatly from geopolitical turmoil and unrest affecting global or regional financial markets.

Importantly USD/CHF tends to be influenced more by US and Eurozone fundamentals rather than domestic economic and monetary policy and statements. The overall volatility and general jitteriness of USD/CHF price action makes false breaks of technical levels common. These false breaks are frequently stop-loss driven and it is not unusual for prices to trade 15-25 points through a support/resistance level before reversing after the stop losses have been triggered.

Trendline analysis ( longer term moving averages) of periods less than an hour tends to generate more noise than tradable break points, so a focus on longer time periods (four hours or more) is likely to be more successful in identifying meaningful breaks. However, once a breakout occurs, surpassing the margin of error, the ensuing one-way price action favours traders who move quickly to take profits. In using RSI overbought/oversold parameters as a confirming indicator, ensure the trend has reversed before entering.

GBP/USD

GBP/USD is one of the top three currencies traded within the forex market. This pair is notorious for its wild and ultra-volatile movements, and caution is advised for new traders. Price breakouts tend more to be false and it is easy for traders to get whipsawed by market noise. The British pound tends to move in the same direction as EUR/USD although that is not always the case.

The volatility inherent in the GBP/USD makes the use of short-term (hourly and shorter) momentum oscillators problematic, due to both false crossovers and divergences between price/momentum that frequently occur in these time frames. Longer-period oscillators (four hours and more) are best used to highlight potential reversals or divergent price action, but volatility discourages initiating trades based on these alone. Instead, momentum signals need to be confirmed by other indicators, such as breaks of moving average based trendlines, RSI or parabolic SAR levels, before a trade is initiated.

USD/JPY

USD/JPY is the second most traded currency pair. USD/JPY has traditionally been the most politically sensitive currency pair, linked to various trade negotiations with the US and with the increasing strength of China, it has taken on a broader proxy role for the region.

This currency pair is most actively traded during the Asian session, and has a tight bid/ask spread most of the time. Its movements are smooth and the pair reacts quickly to the risk scenarios within financial markets. In times of risk aversion, the yen tends to strengthen against other currencies.

Since Japan is highly dependent on exports, the Bank of Japan has a strong interest in keeping the yen low compared to other currencies. On several occasions in the past, the Bank of Japan has physically intervened in the forex market by selling the yen against US dollars and Euros. Something to be watched closely by traders.
Due to the amount of trade hedging by Japanese asset managers, in terms of staggering currency orders at various price points, USD/JPY frequently encounters support or resistance at numerically round levels, even though there may be no other corresponding technical significance.

In terms of technical analysis, the USD/JPY tends to respond well to trendline/moving average analysis as perhaps the better technical tool for trading USD/JPY. Because of the clustering of Japanese institutional orders around technical or price levels, USD/JPY tends to experience fewer false breaks of moving average trendlines. Short-term trendlines, such as hourly or 15 minutes, can be used effectively, but traders need to operate on a similarly short-term basis; daily closing levels hold the most meaning in USD/JPY.

The USD/JPY has a propensity to trend over the medium-term (multiweek). This facet suggests traders should look to trend following tools such as moving averages (21- and 55-day periods are heavily used), DMI, and Parabolic SAR. Momentum oscillators such as the relative strength index (RSI), MACD or stochastics should generally be used on short to mid-term trading, but not on interday trades due to the trending and institutional nature driving USD/JPY.

AUD/USD

The AUD/USD is an aggressive currency pair for trading, always ready for action. It is also around the 6th highest traded amid the range of international currencies. The AUD/USD often fluctuates in line with the gold price.
The Australian dollar is a commodity based currency heavily influenced by the price of commodities which mainly comprise minerals and farms. The Australian dollar tends to fall or crash during the time prices of minerals go down and tend to move up during global expansion phases.

The AUD/USD shows a lot of price movements and fluctuations. Therefore, AUD/USD is a good and interesting currency pair to trade. In terms of timing, the European session is the most lucrative time for buying and selling of this currency pair.

The AUD/USD enjoys a favourable correlation with the USD/CAD, because of the fact that the positive correlation exists between the Canadian dollar and the Australian dollar since both these economies are similar in structure and also because of their dependence on resources which is a driving force behind their GDP.

The Yen Pairs

The EUR/JPY GBP/JPY AND AUD/JPY are sometimes referred to as wild animals. The monetary policy by the Bank of Japan with its massive commitment to money printing in recent times has lead to unprecedented volatility levels in the Yen pairs. These pairs can swing up 200 to 300 pips one day and then fall 200 pips the next. Use sensible money management (smaller lot size) with these currency pairs if you’re new to trading. They do however exhibit nice long trends from time to time and can hence be quite profitable if traded sensibly.

AUD/JPY

This is an important currency pair tied very closely to commodity prices and other carry trade elements. If you have a long position in the AUD/JPY pair you will gain around 0.5 to 0.6 of a pip each day you hold the trade.
While this sounds great at first, there is never complete certainty in trading. This trading opportunity is well known and exploited by retail and professional traders alike. When the trend in the Yen pairs reverses and carry trades unwind, the currency pairs with the biggest carry are usually hit the hardest on a percentage basis.

Summary

Each currency pair has its own characteristics and is influenced by different factors. It is important for a trader or investor to understand these characteristics and to trade or invest accordingly.

The more you understand the personality of a currency pair, the better you can select and adjust the technical tools to trade these currencies more profitably. A currency-specific approach is more likely to produce successful results than a one-size-fits-all application.

You may find that one of them suits your own trading or investing style better, and in that case, you can focus on what you think is best for you.

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