Traders tend to focus on the here and now of price movements, watching a range of currency pairs and picking whichever ones look most active or technically interesting to trade. While it can be a good thing to be diversified and to spread your risk around the market, don’t fall into the trap of thinking that one currency is just the same as another. There is a deeper structure and meaning behind the major global currencies that is not widely discussed within the retail Forex community. Taking a few minutes to think about it could really help your trading and improve your returns, because all currencies are not equal.
USD is the Key
The USD is, by far, the most important currency in the world, primarily because the USA is the world’s only military and political superpower and a key driver of the global economy. For these reasons, the USD is the reserve economy of the world. If people anywhere in the world lose trust in their own currency, they turn to the USD. The currency of most nations usually measured, first of all, in relation to the USD. The US stock market is the most important stock market in the world and to invest in it, you need to have USD. If you liquidate your shares in it, you receive USD. Oil and gold and other commodities are primarily priced in USD. There is more USD floating around the world than any other currency, and it is the major currency of interest to speculators around the world, at least measured over the long term.
Of course there are other currencies of great size and importance, such as the EUR and JPY. However they are not even close to dislodging the USD from its prime position.
The USD Trends More Predictably than any other Currency
When back testing momentum models across a range of currencies, it is the USD pairs that can be shown to have trended the most reliably, whereas smaller currencies are far more volatile and unpredictable.
Momentum models apply the proposition commonly heard in trading “buy when it has been going up, and sell when it has been going down”. This methodology has not worked very well with more minor currencies, but can be proven to have been a profitable strategy over at least the past decade when applied to USD pairs.
For example, suppose you bought a currency pair each week when the price was higher than it was 6 months ago, and sold a currency pair when its price was lower than it was 6 months ago, exiting at the end of each week. The raw results, excluding spreads and interest charges, from 2002 to date are as follows, by pair:
USD Pairs
The average result per USD pair was in excess of a positive return of 20%.
As EUR/USD, GBP/USD and AUD/USD performed especially well, let’s test how the other EUR, GBP and AUD crosses performed:
Results for other look-back periods such as 3 months or 12 months are not shown here, but produce similar patterns.
This suggests that newer traders should have an easier time trading by sticking to the USD pairs, meaning the 4 majors and maybe also AUD/USD and NZD/USD, and trading in the same direction as longer-term trends. Another advantage of trading these pairs is that their spreads / commissions tend to be low.
