When you are in the process of choosing currency pairs to trade, you may want to consider pairing those with strong FX rates with the ones that are experiencing weaker rates.
Matching Currency Pairs
Foreign exchange trading is always carried out in pairs. Each trade you undertake involves purchasing one currency and selling another. The basis of your trade is that one currency’s rate will improve over another’s. In the forex world this means that you should pair a strong currency with a weaker currency. The one good factor in this market is that the major currency countries generally do not experience rapid changes to their economic climates. Economic data information releases related to the most actively traded currencies are normally released on a daily basis and this can be used as a scorecard for those countries that appear on the majors list. If the report is a positive one, it means that the country is doing well economically, whereas a negative report indicates that the country’s economic performance has declined.
The economic data is not the only consideration you should make when you pair currencies. If the economic reports are strong, the central bank may decide to increase the interest rates which, in turn, will push up the FX rates. In contrast to this, countries showing weak economic data offer their central bank less room to play when it comes to an increase in interest rates. During times when the economic data is extremely weak, it may prompt the central bank to lower the interest rates. When you trade currencies, this rise and fall of interest rates is a very important factor to watch. As soon as a country has a higher interest rate, investors shift their attention to gain a better return on their investment.
Using Interest Rates with FX Rates
Aside from researching and analysing a country’s economic data releases and the direction it may be going, you could look at the direction of the country’s interest rate to decide on a suitable currency pair to trade. For this example we will look at the EUR/GBP. This pair has remained a range-bound pair. During the first three months of 2006 the currency pair broke out. This breakout occurred on the upside as Europe chose to increase their interest rates because of the economic growth experienced in the zone.
This change brought about an increase in the currency pair and caused the traditionally range-bound pair to become a trending pair within a few months. This was an easy shift to anticipate and the choice to trade the pair was clear since one currency had more strength than the other. Currency weaknesses and strengths often remain for extended periods of time while the economic trends evolve. Forex traders are able to gain a profitable footing in the market by pairing a strong currency with a weaker one.
To use this trading method effectively, it is necessary for you to implement a strategy and plan that is suitable for this method and stick to it. It will be necessary for you to keep abreast of economic data related to your currency pairs as this will ensure that you are up to date with information as to the movements in interest rates.
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