There is truly a gigantic amount of financial products available to trade. Stocks (and that’s already a large universe in itself), Bonds, ETFs (ever increasing in number), Commodities, Indices, Currencies, etc. In this article, we shall explore the advantages that currency trading has, if compared to other financial products.
It is not unreasonable to say that traders who are serious about their survival in the long run, will not only find currencies a “cheap” product to cut their teeth on, but also that the mindset required to trade currencies well gives traders a much firmer grasp of the multi-dimensional nature of the markets.
Let’s get the evident considerations out of the way first. We’ve all heard that currencies have “clean charts”, which makes them “ideal” for applying technical analysis. One part of this affirmation is true, the other is not. It’s true that stocks and even commodities (when they go limit up or down), for example, “gap” much more than currencies because it takes a very large and unexpected surprise in order to make a currency “gap” and therefore it doesn’t happen often.
So currencies flow 24 hours a day for 5 days a week in a smooth manner, as news and emerging fundamental output is discounted into price gradually. However, this doesn’t mean that currencies are the best place to apply technical analysis. On the contrary, given the currency market’s sheer size (compared to other markets) and given the fact that currencies are not primarily a speculative vehicle, it follows that global capital flows and the reasons behind those capital flows are the place to look, in order to comprehend currency movements. Not charts alone.
The second reason that makes currencies an ideal vehicle to start with is the way they move. Currencies are much more rangebound than stocks for example. Take Apple: the way it has performed, it seems like in the long-term it will reach the moon!
What happens if you get a buy signal on Apple after it makes a large move? Do you chase it? Do you wait and risk missing the trade completely (because by the time price starts pulling back, the catalyst has been digested and momentum is shifting)?
Or what about the Italian bank stock Unicredit? It clearly illustrated how stocks can actually loose 100% of their value (and even more than that if you incorporate recapitalizations into the picture) and go from €60 or even €80 per share, to ZERO!
Now currencies just don’t act like this: they cannot reach the moon, and they cannot go to zero. Currencies, even when they are trending, move in a wavelike pattern proceeding in a “2 steps forward, 1 step back” fashion. This means it’s difficult to actually “miss” a move in currencies. Whether you play daily, weekly or monthly pullbacks, there’s nearly always time to get aboard those 2-3 trends that occur every quarter in the currency markets. This just isn’t the case with stocks and most commodities. By the time they start turning around, it’s because a new move is forming.
Spread is the word
The third benefit that currencies have, on the trader’s mind, is that they naturally introduce the concept of “spread trading“. Currencies cannot exist as a stand alone product, because their value is always obtained in relation to another currency. For example, EURUSD is actually the relationship between the “Euro” and the “US Dollar”. So by being long EurUsd, a trader is in fact involved in 2 separate trades:
- long Euros
- short US Dollars
If you change the numerator, the value changes; if you change the denominator, the value changes. So naturally, the question becomes: why should I buy the Euro against the US Dollar? Why not buy the Euro against the NZ Dollar? Or why not buy something else against the US Dollar? The way to think about your currency trades should be in terms of spreads: look to increase the value of the spread as much as possible. If you want to buy Euros, then you should at least look at the Euro against it’s main trading partners (USD, GBP, JPY, AUD,CAD,NZD) before making a decision. It’s all about relative value.
When you start understanding the concept of spreads (or “pair trades”), multiple opportunities open up:
- if you think Gold is weak, would you sell it against USD? Why not against the Euro? And if you consider the volatility of Gold to be too high, perhaps you can think of selling AudUsd? Or Aud against something strong?
- you are thinking of buying the Nikkei. Would USDJPY be a better trade or a suitable solution with lower volatility?
- you’re thinking of buying Apple. A normal stock purchase of AAPL can be seen as a long AAPL/USD. So you are “funding” your purchase of AAPL with USD. But is there a more efficient way to create this trade?
- your outlook of the economy is turning bearish. Would it be better to buy bonds, or sell stocks?
Finally, currencies are driven by large money flows which are influenced by global events. Interest rate decisions, inflation, GDP growth expectations, productivity and labour market health. Understanding these macro drivers gives traders a comprehension of the big picture, the macroeconomic environment within which the various asset classes are moving.
Understanding the big picure is a great advantage, whether you trade stocks, bonds, commodities, ETFs or currencies.
Over to You
The currency market is really a great “gym” for enhancing your skills as a trader. It’s also a great place to start off – challenging, but great. And it’s also relatively cheap: spreads are competitive, and you can risk cents on trades (most brokers nowadays offer microlots).
Following currencies, if appraoched properly, will allow you to understand the bigger picture, and anticipate market transitions. It will allow you to take advantage of volatility and catch big moves, because you will understand what’s driving the market.
But all this will only happen if you have passion for the markets, and an ambition to understand more every day. There are no shortcuts, but with some clear guidance the path becomes much easier to walk.
About the Author
Justin Paolini is a Forex trader and member of the team at www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.