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A Smart Diversity Approach When Volatility Is High

By , Forex Trading Instructor
07 June 2013 19:00 GMT

Article Summary: Fear in the market often causes the biggest moves as few are willing to stay in a trade when news against their position breaks. Said in other terms, ‘markets often take the stairs higher, but the elevator down’. This article explains that big moves often happen off the back of only one or two currencies. By understanding this concept, you can adjust your portfolio to take maximum advantage of this dynamic in the Forex market.

Volatility is back. Over the last few weeks the US Dollar has been sold along with the AU Dollar and the Japanese Yen has been bought (with JPY crosses dropping). While there are many arguments as to the best pair to trade, there may be a better and simpler approach that you may have not considered.

Forget the Needle, Buy the Haystack

Learn Forex: When the GBP is Strong, It Is Often Strong across the Board

Diversity_Strategy_When_Volatility_Is_High_body_Picture_1.png, A Smart Diversity Approach When Volatility Is High

Presented by FXCM’s Marketscope Charts

Learn Forex: When JPY crosses are Weak, They Are Often weak across the Board

Diversity_Strategy_When_Volatility_Is_High_body_Picture_2.png, A Smart Diversity Approach When Volatility Is High

Presented by FXCM’s Marketscope Charts

When a specific currency is gaining strength across the board, you may be best served in buying that currency across a multitude of other currencies. This approach can easily be applied manually by finding three or four currencies paired with the favored currency and buying the currency in favor and selling against another major currency. The purpose of this approach is to find the right currency and spread analysis against multiple currencies so as to limit your risk.

For example, as the GBP shows you strength like we see above (or whatever currency is showing you strength at the time of your analysis) you can BUY GBPUSD, GBPAUD, GBPJPY, and SELL EURGBP. This way, you are allocating your analysis across a multitude of currencies in order to play the overall move as opposed to a specific currency against another.

You may also notice that the US Dollar is down currently so you can buy a multitude of other currencies against the US Dollar to diversify your risk. By diversifying your position to multiple trades, if the current trend of US Dollar weakness stays intact but one currency becomes temporarily weaker than the US Dollar you’re portfolio isn’t shot. Taking multiple positions against a specific currency (in this case the US Dollar) would represent something similar to an equally weight pie chart of your positions against the US Dollar.

Diversity_Strategy_When_Volatility_Is_High_body_Picture_3.png, A Smart Diversity Approach When Volatility Is High

Picture Courtesy of FXCM, LTD.

Continue Focusing On Important Economic Announcements

When one currency begins to fall out of favor against other currencies, it is often due to trends Economic News Announcements. Quite simply, this means that one currency begins to gather strength often when that currencies economic data points begin to surprise to the upside showing traders that things aren’t as bad a previously believed or are possibly getting better. The opposite applies to the downside with currencies that begin to weaken as economic data points begin to disappoint to the downside as traders find that things aren’t as great as they hoped they would be or are possible getting worse.

A New Approach to Diversity Big Trends

So far, we’ve discussed a manual method by finding one currency the market loves or hates and trading that against multiple other currencies. Another method that focuses on an individual currency against a basket of other currencies can be utilized through our Mirror Trader Platform (Free with an FXCM Account). On Mirror Trader, you can trade Major Currency Baskets where you can buy or sell a currency against 4 other major currencies in one click.

Given the latest moves, the USDOLLAR sold off across the board as the Japanese Yen was bought aggressively. As you see below, you could have taken a basket approach via Mirror Trader when your strategy signaled an opportunity of overall USDOLLAR weakness or the Yen’s overall strength. This could be applied if you deem appropriate by opening the USD Basket – Sell and JPY Basket – Buy.

Learn Forex: Mirror Trader’s Basket Trading Ability

Diversity_Strategy_When_Volatility_Is_High_body_x0000_i1025.png, A Smart Diversity Approach When Volatility Is High

Presented by FXCM’s Mirror Trader

If this diversified approach appeals to you, please make sure that you do not over leverage your account. If you’d like to learn more about risk management or controlling your exposure to loss when trading, you can register for our free online course here. By managing your risk and diversifying your trades, you’ll likely see fewer erratic account equity moves which for a trader is a very good thing.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@fxcm.com.

To be added to Tyler’s e-mail distribution list, please click here.

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07 June 2013 19:00 GMT