As someone who has been in the forex markets for over a decade, I get a lot of questions during my average day. This has only become more frequent as I started to do analysis for various large forex portals on the web. While there are a ton of different things to learn over the course of your career, there are a certain number of common questions that I see appear in my inbox.
While the questions that I hear typically can be answered in a few sentences, there are other market related questions that can use a bit of explaining. The question “Which forex pairs to trade, especially when I am new?” is one that is often asked, and I think that there is a lot of confusion as to the differences between pairs, and why in the end – you can trade anyone that you want, but need to keep in mind that position size is probably the more important aspect to pay attention to.
The biggest myth that I think a lot of you are told at the outset is that you should be trading the majors, such as the EUR/USD until you are experienced. In the end, this is often because it serves the interests of the broker, and perhaps someone selling you on the idea of forex, as the lack of spread is often due to volatility. While there is something to be said about liquidity, you aren’t going to face many of them with your account, as you are trading against the broker, and not going into the interbank market itself.
So why do the “majors” attract so much attention?
Without a doubt, the majors will attract a lot of attention. But as I mentioned either, this is sometimes by design. This isn’t to say that you shouldn’t trade the majors, just that you need to avoid some of the traps set for you. You must understand that most of the market is set up to take your money. This is what makes the idea of a EUR/USD pair so appealing, as the spread is only 2 pips or less in most platforms. While this seems like a great way to make money, the broker understands that in order to make a decent profit on one of these pairs, you are going to need to place a lot of leverage on the trade. This is where they get you.
At the time of this writing, over the last year, the EUR/USD has averaged a move of just 0.70% per day. There have been months where it has been more like 0.25% per day. Imagine trying to get people excited about trading this instrument with those numbers. What was the solution? Allowing traders to “borrow” money so that they can lever the position up. After all, if the average move was as low as 0.25% at times, this means a return of just $2.50 on a trade in an account that is $1,000. Why did I pick this figure?
Fun fact: The average US account has roughly that amount in it. Think about it – if someone told you that you could be looking at those types of returns, you would rather trade more traditional markets such as stocks that have more protection attached to them. It is because of this phenomenon, or lack of it – as the currency markets aren’t much different than any other market as far as percentages are concerned – that people will lever up as much as possible. The broker knows this, and is more than willing to let you risk that capital in order to make it worth your time. Remember, leverage will work in both directions: both for and against you.
So while you are almost certainly working on your spreadsheet calculations of a daily 0.50% return, let me remind you that the average move of a pair doesn’t tell you if it is a move higher or lower. After all, you could see ten down days in a row, and you might be long of that market. Obviously, there is no way to be correct 100% of the time, and this is why the danger exists.
There is also the idea that “its only 2 pips.” This is where the marketer comes into play. I mean, its easier to sell the idea of trading forex if you are talking about overcoming a 2 pip spread instead of a 50 pip spread (or more) that you get in some of the more exotic pairs. (USD/NOK anyone?) The thing is that there is little difference in these markets, especially if you are using lower leverage than your broker is pushing on you.
Start thinking in percentages, not pips.
The average trader thinks of the markets in pips. While I understand that the pip is the most common measurement, the reality is that percentages is how you need to think about your gains and losses. What if I told you I once had a 1,200 pip gain in theUSD/SGD pair? Yes, that’s a great trade, and it was a long-term one. However, it was a small position. I think the gain was roughly 4%. I was testing out a system, and it appears that the trade that set up was the perfect one for that system. Also, when you are looking at volatility, you need to understand the percentages as well. The average professional trader in the FX markets has something like 7 to 10 times leverage going on. This is because a wild 3% day in a fast moving market can wipe out an account rather quickly if you are leveraged up to your eyeballs. Also, they tend to think about trading in the longer-term, not the next 5 minutes.
As a side note, it is my firm belief that algorithmic trading has all but killed short-term trading in the FX markets. You will never be as fast as the machines.
By dialing down leverage, and looking for volatility, you can come out ahead.
Let’s look at the GBP/NZD as an example. Over the last year, the average move has been 1% a day. This is much more appealing than the 0.7% that the EUR/USD has offered, and if you are looking at the possible returns, it makes sense that there should be more to be made from that pair. In fact, the larger range means you don’t need as much leverage to make a bit of money. Also, this brings up the point about short-term trading. It allows the broker to take your money quicker. However, if you are willing to dial down the leverage to say 10 x, you could have something like the following scenario:
10,000 unit position. (Far too many of you would have a 50,000 unit position. To get a feel of how dangerous that could be, multiply everything by 5 in both wins and losses.)
This makes for $0.79 a pip at the time of writing. This means that you can hang onto a trade for much longer, as a simple drop for the session won’t be enough to cause serious damage. In general, if you are trading with the trend, you should do well. This gives your position the ability to “breathe”, and deal with the day to day noise that the markets are so prone to. The average fund is pleased for a 20% return in a year, and this is part of the equation – being careful with your trading capital. By treat forex as a real market, and not the scalping machine that the brokers want you to, you have the ability to like more like a trader and less like “liquidity.”
So in conclusion…
The answer to the original question is that it doesn’t matter. However, you need to either be very patient with a pair that isn’t that volatile, or go looking to the more volatile pairs to benefit from their behavior. The leverage that you use will make a massive difference though, so keep that in mind. At the end of the day…
If your USD/MXN trade has a 200 pip spread, but those pips are only $0.02, what difference does it make? For reference, that pair averaged a 2,000 pip move per day over the last year. This sounds impressive, but was in fact only 1.05% per day. However, it doesn’t sell to the general public as well, and therefore isn’t pushed very hard. (There is a whole huge post I could do about the structure of how brokers make money on all of their traders, no matter if they are winners or losers. For now though, you need to trust me on this.)
If you are smart, you will find a great trend and follow it. Let the market and time work in your favor. There is the added bonus of being able to get away from the computer also.
Mar 08, 2018 12:19AM ET