This is the way we have to approach trading.
When we trade currencies, we are always dealing in pairs - every trade involves buying one currency and shorting another. So the implicit bet is that one currency will beat out the other. If this is the way the FX market is structured, then the highest probability trade will be to pair a strong currency with a weak currency.
Fortunately, in the currency market we deal with countries whose economic outlooks do not change instantaneously. Economic data from the most actively traded currencies are released every single day, and they act as a scorecard for each country. The more positive the reports, the better or stronger a country is doing; on the flip side, the more negative reports, the weaker the country is performing.
Pairing a strong currency with a weak currency has much deeper ramifications than just the data itself. Each strong report gives a better reason for the central bank to increase interest rates, which in turn would increase the yield of the currency. In contrast, the weaker the economic data, the less flexibility a country’s central bank has in raising interest rates, and in some instances, if the data comes in extremely weak, the central bank may even consider lowering interest rates. The future path of interest rates is one of the biggest drivers of the currency market because it increases the yield and attractiveness of a country’s currency.
In addition to looking at how data is stacking up, an easier way to pair strong with weak may be to compare the current interest rate trajectory for a currency. For example, EUR/GBP - which is traditionally a very range-bound currency pair - broke out in the first quarter of 2006. The breakout occurred to the upside because Europe was just beginning to raise interest rates as economic growth was improving.
On the flip side, the U.K. raised interest rates throughout 2004 and the early part of 2005 and ended its tightening cycle long ago. In fact, U.K. officials lowered interest rates in August of 2005 and were looking to lower them again following weak economic data. The sharp contrasts in what each country was doing with interest rates forced the EUR/GBP materially higher and even turned the traditionally range-bound EUR/GBP into a mildly trending currency pair for a few months. The shift was easily anticipated, making EUR/GBP a clear trade based upon pairing a strong currency with a weak currency.
Because strength and weakness can last for some time as economic trends evolve, pairing the strong with the weak currency is one of the better ways for traders to gain an edge in the currency market
Read More : Always Pair Strong With Weak - Trading Secret
