Who is the Fattest Kid on our Forex Market Playground?
Hello traders! This week I will try to explain a bit about relative strength between individual currencies, help you choose which pair to trade, and suggest a couple of rules for your trading plan.
In the classes that I teach, obviously the topic of charts comes up, along with which currency is getting stronger vs. another when looking at the chart. An easy (and somewhat politically incorrect) way of remembering how the charts work is to think about a teeter totter or see-saw from our childhood playgrounds. When looking at that teeter totter from the side, if the right side is pointing up, the kid on the left side of the teeter totter is fatter than the kid on the right side. In the currency market, the base (currency on the left) is getting stronger than the quote (currency on the right). If the teeter totter is pointing down, the kid on the right side of the teeter totter is fatter than the kid on the left, which in forex means the quote is strengthening vs. the base currency.
One technique shown in class is how to compare individual currencies by looking at several different pairs that have the currency in it. With the US dollar, we have the US dollar index which can give us an idea how strong or weak our US dollar is. But if you want to judge the British Pound for example, one technique is to look at the GBP vs. several different currencies to gauge the GBP strength. Chart the EURGBP, GBPJPY, GBPCAD, GBPAUD, GBPCHF, etc. If the GBP is on the fat kid’s side of the teeter totter on most of the charts, you can assume that the GBP is relatively strong vs. most currencies, which might mean you would look for long trades of the GBP.
Another way to use our fat kid on the teeter totter playground analogy is when choosing an individual pair to trade. Say, for example, your trading plan allows you to enter one trade at a time. You are looking at the EURUSD pair and the GBPUSD pair, but are unable to choose which pair to trade. Which one should make you the most pips? My suggestion is to figure out who is the fattest kid (strongest currency) on the playground and who is the skinniest kid (weakest currency.) In the following three charts we are having a teeter totter contest, with each kid being paired up one at a time vs. the other kids.
In the first chart, the EURUSD, who is the fatter kid? If you answered the EUR, you are correct! Give the EUR one point. In the middle chart, the GBPUSD, who is the fatter kid? If you answered GBP, you are correct, give the GBP one point. In the third chart, the EURGBP, who is the fatter kid? If you answered GBP, you are correct! Give the GBP another point. So what is the final tally? GBP 2, EUR 1, USD 0. On our imaginary playground, the GBP is the fattest kid (strongest currency) and the USD is the skinniest kid (weakest currency.) So the trade that should make the most pips is the GBPUSD.