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Trading Tips

Picking the best forex pair(s) to trade

currencies

Chris as Winner’s Edge Trading did a post a couple months back with suggestions for how to go about picking the best pair or pairs for your forex trading. Essentially, his list came down to a handful of key considerations:

1) Your strategy or analytic methodology

2) Currency correlations and diversification

3) Liquidity

The list actually has eight factors in it, but I consider several of them to be essentially the same type of consideration. Thus my list of just three.

Let me expand on them.

Strategy considerations
In terms of #1, you are best off looking at currency pairs which are well suited to the approach you’ll be taking in your trading. Generally speaking, that will either be trend oriented or range-trading oriented. Thus, if you are a trend following trader you are going to be best off working in pairs which have strong trending characteristics in your chosen time frame. Likewise, if you favor a more mean reversion oriented approach, you’ll want pairs that tend toward ranging and/or sharp counter-trend moves.

Note that one currency pair can fall into both categories depending on time frame and market phase. If there are strong underlying factors at work, then in the higher time frames the pair will tend to trend, but maybe in the shorter time frames it may go through ranging periods. These things can and will change over time. As such, it makes sense for you to have a way to identify current market conditions.

Correlation/Diversification
If you’re trading primarily the major currency pairs it is very hard to truly have an uncorrelated portfolio of positions. You can only go 3-4 deep with majors and major crosses before you have one currency in multiple pairs, which automatically introduces correlation. And even then, certain currencies will tend to naturally be correlated based on the current economic environment. For example, the CHF and EUR will often be positively correlated because both are impacted by the fundamentals of the European economy.

You can certainly trade multiple pairs which share the same currency (e.g. USD/JPY, GBP/USD, AUD/USD). If so, however, you need to account for that in your risk management strategy. It is highly likely that all the pairs you trade sharing that common currency will move together based on the same factors. That’s great when the market goes in your direction as it will multiply your gains, but the same thing happens with your losses when the market goes the other way.

Liquidity
For the most part, liquidity isn’t a major concern for retail forex traders as your orders will usually get filled at or very close to your order price. Yes, during major news events there can be slippage when trading outside the major pairs and crosses – and even in the majors on occasion. If you’re operating in a higher time frame, though, that’s likely not a major concern.

The bigger consideration here is the cost of trading. The more liquid pairs have narrower bid/ask spreads. That can significantly impact your returns if you’re an active short-term trader, but maybe not so much if you playing the longer-term market moves.

How many?
One additional consideration I would add into the mix is how many pairs you should trade. This is a question which comes up a lot in trading forum discussions. To my mind, this all depends on your time frame. If you’re a day trader you’re likely going to want to keep your focus fairly narrow – especially if you’re in and out frequently (e.g. scalping). As you go out the time frames, though, you probably need to be tracking more pairs. It’s simply a function of providing yourself with enough trading opportunities.

In Chris’s post he also mentions personal preference, which I suppose can be an additional factor. If you want to truly be a good trader, though, you should be able to trade whatever market makes the most sense at the time.

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The Most Traded Currency Pairs

The question often comes up among forex traders (especially newer ones) as to which are the most traded currency pairs. There’s no central source of information from which we can figure out how the various currency pairs rank, but we can look to the periodic surveys done my the central banks and monetary authorities of the major global regions to get an idea. These reports are based on the survey of banks, so they don’t really capture activity on the retail level. That is currently only about 5% of total daily volume, though, and market prices are set in the inter-bank market in any case, so we’re not really missing much in the survey data.

Global Most Traded Currency Pairs

Coming up with a solid global ranking outside the top couple of forex pairs is a challenge because the regional reports tend to focus on the main pairs traded in those regions and don’t parse out some of the less active ones. For example, the USD/CAD and USD/CHF currency pairs are not reported individually in the Japanese data, so it’s hard to get them in the proper rank order. The list below is probably a pretty close representative of how things rank on a global basis, though (based on April 2011 data).

  1. EUR/USD
  2. USD/JPY
  3. GBP/USD
  4. AUD/USD
  5. USD/CHF
  6. USD/CAD
  7. EUR/JPY
  8. EUR/GBP

It should be noted that EUR/USD is way ahead of the other most traded currency pairs in terms of daily trading volume. That one pair does something like 50% more volume globally than both USD/JPY and GBP/USD combined.

You will notice that I did not include the more regionally-oriented forex pairs like USD/MXN, EUR/SEK, USD/KRW, etc. If you’re interested in them, I recommend exploring the individual report (links are provided below). Also, these figures are based on spot market volume, and do not include swaps, forwards, or options.


What Forex Pairs Should I Trade?

If you are a short-term trader then you’re going to want to focus on the most traded currency pairs because they are generally active enough in that time frame to be worthwhile, and also offer the best bid/ask spreads. If you are specifically a day trader or scalper, you’ll want to focus on the the top forex pairs for the region you trade in to further ensure the best trading conditions. Traders who operate in longer-term swing and position trades, though, need not concern themselves as much with focusing on the most traded currency pairs, though. The costs and requirements for short-term movement are not a real issue.


Most Traded Currency Pairs by Region

Here is a center-by-center breakdown of the top forex pairs for each region. Again, this is for spot trading only. Swaps, forwards, and options can add considerably to the volume totals (more in some regions than in others). If you want to see the full center totals you can follow the links to the individual reports.


London

London remains by far the highest volume trading center for foreign exchange. It therefor won’t come as much surprise that the global pair ranking is very similar to the one for this specific center. Based on the most recent data, here are the most traded currency pairs in for the London market.

  1. EUR/USD
  2. GBP/USD
  3. USD/JPY
  4. AUD/USD
  5. USD/CHF
  6. EUR/GBP
  7. USD/CAD
  8. EUR/JPY

As was the case with the global figures, EUR/USD does about 50% more volume itself than the next two pairs combined. There are a lot of pretty active regional pairs (non-Euro Zone continental currencies) as well as those listed above. See the Bank of England website for additional details.


U.S. (New York)

The second largest of the trading centers is the U.S., with New York still the main focal point. Here are the most traded currency pairs in for this region.

  1. EUR/USD
  2. USD/JPY
  3. GBP/USD
  4. AUD/USD
  5. USD/CAD
  6. EUR/JPY
  7. USD/CHF
  8. EUR/CHF
  9. EUR/GBP

The top non-majors currency pair in this region is USD/MXN, with USD/BRL only doing about a third of that volume. See the New York Fed website for additional details. Note that the Canadian Foreign Exchange Committee also does a volume survey, but it does not break the figures out into individual currency pairs.


Tokyo

Here are the most traded currency pairs in for the Japanese market. As indicated above, the Japanese report does not have very much depth in terms of specifically parsing out the most traded currency pairs, so the list isn’t as long as for other regions.

  1. USD/JPY
  2. EUR/USD
  3. EUR/JPY
  4. AUD/USD
  5. GBP/USD

There is a big drop off from USD/JPY to the EUR pairs,with the former doing between three and four times as much volume. Similarly, then another big drop to the other two most traded currency pairs from the EUR ones. See the Tokyo Foreign Exchange Market Committee website for further details.


Australia

Australia (primarily Sydney) has become a very significant market in global foreign exchange on a total volume basis. It’s not a broad market, however, in that trading in the Aussie dollar dominates (not surprisingly). Here are the most traded currency pairs.

  1. AUD/USD
  2. EUR/USD
  3. USD/JPY
  4. GBP/USD
  5. USD/CAD
  6. EUR/JPY
  7. EUR/GBP
  8. USD/CHF

Among the pairs trading in Australia, AUD/USD does about four times as much volume as EUR/USD, and it drops rapidly off even further after that. See the Reserve Bank of Australia website for further details.


Singapore

Singapore can’t compare to London or New York for sheer trading volume, but it is a broad-based market where most of the major Asian regional currencies trade. Here are the most traded forex pairs.

  1. EUR/USD
  2. USD/JPY
  3. GBP/USD
  4. AUD/USD
  5. EUR/JPY
  6. USD/CAD
  7. USD/CHF

The volume pattern in Singapore shows EUR/USD with nearly 2.5 times as much volume as USD/JPY. Interestingly, EUR/USD does about as much volume in Singapore as in Australia, both of which do about double the volume in Japan. See the SFEMC website for more details.