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How You Can Identify the Weakest Currency and Trade it Well

How You Can Identify the Weakest Currency and Trade it Well

Tyler Yell, CMT, Currency Strategist

Article summary: When traders look back on the first half of 2013, three currencies will likely come to mind. Those currencies are the Japanese Yen (JPY), the Australian Dollar (AUD), & the British Pound (GBP). These currencies were all on the losing end of very large moves. This helps pave the path for taking on the basket approach to analyzing and trading Forex moves with an edge.

In investing, what is comfortable is rarely profitable.”

-Robert Arnott

Trading is often a battlefield of extremes. Because you’re in the driver seat of your trading success, you need to decide how you’re going to identify an edge that you can trade. More than likely, the best edge will be to identify trends and take trades against or continue selling the weakest currencies.

This will likely go against what is comfortable to you. Many traders feel smart for buying a falling currency pair in attempts to ‘buy low and sell high’. However, a falling currency pair is often falling for a reason and as Newton shared with us hundreds of years ago, “an object in motion will tend to stay in motion with the same speed and in the same direction unless acted upon by an unbalanced force.”

How to Take Advantage of Trader Sentiment

If you’re familiar with our Speculative Sentiment Index (SSI), it is a favorite tool of many traders for a reason. In short, the SSI gives you a 30,000 foot view of trader positioning to see if retail traders are overloaded on one side of the trade. Sadly, retail traders consistently open positions against the trend which often gives way to a reliable signal that you can use to identify trends likely to continue.

Learn Forex: Sentiment on GBPUSD is hinting that the new drop could easily continue

How You Can Identify the Weakest Currency and Trade it Well

Courtesy of DailyFX, Speculative Sentiment Index

As you can see with the chart above where price is the green line and overall positioning is the shaded area, traders often go net long (majority is buying) as GBPUSD drops. Sadly, traders often flip to net short (majority is selling) when GBPUSD rises. By looking at nothing other than sentiment above, you can see that you would likely do well in opposing the crowd and not trying to sell the top or buy the bottom as trends are likely to continue.

Looking Ahead To a Weakening Currency

Retail forex traders help make up the (SSI). Since May 1st, the Australian dollar (AUD) has been the weakest currency dropping more than 1,150 pips against the USD since breaking below its 11 month range. The important point is that after AUDUSD broke below support near 1.0200 is when the pair made its 1,100+ pip move to the downside.

Learn Forex: Sentiment Can Help You See When a Trend Will Likely Continue

How You Can Identify the Weakest Currency and Trade it Well

When looking at the current SSI reading, the two currencies that look likely to continue their decent. Those two currencies are the GBP and the AUD. This means that you could open up a GBP Basket – Sell or AUD Basket – Sell on Mirror Trader to take advantage of the sentiment extremes that may precede a further drop for both pairs. Another option is to take individual trades by finding the stronger currency pairs and buying them against either the GBP or AUD.

Learn Forex: How to Trade the GBP Basket – Sell

How You Can Identify the Weakest Currency and Trade it Well

Presented ByMirror Trader

Closing Thoughts

We have no reason to believe the carnage with the AUD is done. However, by looking at sentiment and price, we do have reason to believe that the GBP may be jumping back into the hot seat and could face a fast drop in the second half of 2013. Continue to focus on the weakest currencies for a specific edge in trading FX by looking at trends and sentiment and here’s to a profitable second half of 2013!

Happy Trading!

--Written by Tyler Yell, Trading Instructor

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

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.