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Forex Trading Tip: Trading a Currency Rather than a Pair

Forex Trading Tip: Trading a Currency Rather than a Pair

2014-07-25 19:01:00
Jeremy Wagner, CEWA-M, Senior Strategist
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Talking Points:

  • What is a currency basket?
  • What are the benefits of trading a forex basket?
  • A big challenge for basket traders

What is a currency basket?

A currency basket is simply a collection of trades with a single currency in common. Those collection of trades are placed for the purpose to isolate that common currency.

So for example, a US Dollar basket might include the GBPUSD, EURUSD, AUDUSD, and USDJPY. If we buy the US Dollar basket, we would sell GBPUSD, sell EURUSD, sell AUDUSD, and buy USDJPY. In that way, we are effectively long the US Dollar while simultaneously selling it against the GBP, EUR, AUD, and JPY.

Forex Trading Tip: Trading a Currency Rather than a Pair

What are the benefits of trading a currency basket?

A huge advantage of a currency basket is that it provides a simple way to express your opinion in a currency. That opinion is expressed through diversification. By spreading your trades across four different pairs, your profit and loss in the US Dollar, for example, is focused towards movements soley in the US Dollar.

On the other hand, if we place a single trade in a single currency pair, then the exchange rate is subject to the counterpart to the US Dollar. Let me explain further.

Assume we think the US Dollar is going to gain strength. So we sell the EURUSD currency pair rather than trading the USD Buy basket. The Greenback could end up broadly gaining strength, but losing against the Euro. Perhaps a fundamental news release or positive comments came from the Eurozone causing traders to bid up the Euro. As a result, we had an idea of US Dollar strength, but tried to express that idea in the wrong manner and ended up with a losing trade due to the counterpart (namely the Euro).

An additional benefit is that baskets can smartly smooth out market volatility. This is a big benefit during news announcements. If you wish to hold onto a basket position for several days, the volatility resulting from news announcements is likely to be reduced due to the diversification.

Rather than being subject to the movements of a specific pair, a basket trade is spread out over several pairs that mutes the focus a single news announcement may deliver.

What Baskets are available?

You can essentially create any basket you would like by hand. Simply take the currency you wish to focus on and trade it against a group of other currencies.

To make things easier for you, the Mirror Trader platform allows you to open and close baskets of trades focusing on the five most liquid currencies in the world.

As a result, you can trade the following baskets through Mirror:

  • USD Basket Buy or USD Basket Sell
  • JPY Basket Buy or JPY Basket Sell
  • EUR Basket Buy or EUR Basket Sell
  • GBP Basket Buy or GBP Basket Sell
  • AUD Basket Buy or AUD Basket Sell
  • USDCarry Basket Buy or USDCarry Basket Sell
  • JPYCarry Basket Buy or JPYCarry Basket Sell

(If you wish to try out a basket, enroll for a free practice account at the bottom of this Mirror registration page.)

A big challenge for basket traders

One thing I have noticed in talking with many traders over the years is their inability to trade consistently without having the perfect strategy. This means we need to see our accounts as a collection of trades rather than many individual trades. Too often, newer traders get caught up in what the most recent trade has done and neglect the longer term performance of the account.

Therefore, especially for newer traders, using baskets may seem challenging at first because you need to retrain your mind to look at the profit or loss of the basket of trades. See through and ignore how each leg of the basket is performing and focus on the profit or loss of the basket.

Suggested Reading: Forex Trading Wisdom - Bias Your Trades

---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education

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