You know, when I was in the stock market, you would just see one thing being traded and quoted (ex. IBM, Google, GE, etc.).
However, when I came over to the currency market, I noticed that currencies were in “pairs” rather than just individually quoted and I always wondered why they were that way.
I came to learn that really, everything is a paired trade when you think about it. For instance, when you buy Google’s stock, it’s really like GOOG/USD. Why? Because you’re betting that Google will go up much more than just holding dollars or depositing your dollars in a savings account and earning the meager interest that it earns.
So if you felt that Google’s stock would perform better than your dollars in a savings account, then you’re exchanging your dollars for Google’s stock since you think it would go up more over time than your dollars and the outright interest that they earn.
In the same way, you value a currency by comparing it to what you think another currency is worth. After all, the dollar could perform one way vs. the euro (EUR/USD) and a totally other way vs. the Japanese yen (USD/JPY).
It’s Simple: Put your Money into the “Best Currency vs. the Worst Currency”!
It’s entirely possible that the dollar could lose value when compared to the euro but gain value when compared to the yen, for instance.
So the dollar’s strength is measured by its strength against another currency….OR…I could say it this way. A currency’s strength is determined by how much of another currency that it could buy at the time. If it can buy more today than it could yesterday, then it’s stronger. If not, it’s weaker.
Therefore, in the “pairing game”, what you want to do is buy the absolutely strongest currency and pair it against the poorest performing currency. As I often say, “If I could rig a fight, I’d want to put the strongest fighter vs. the weakest fighter and place my money on the stronger fighter”. Well, that’s exactly what we’re doing in currencies.
Some traders determine the “strongest fighter” by looking to the charts to see how well a currency is performing (trending) vs. other major currencies. Yet other traders will look to see which country has the best fundamentals overall and which has the poorest.
Either way you determine this, it’s important that you do so. You need to have an opinion. Not only that, you need to have a “strong opinion” on the pair you choose. That way, it will help to keep you in the trade when the pair goes bobbing all around and your account equity temporarily jumps around all over the place.
Find out which “Currency Camp” describes you!
Right now, there are “two camps” out there battling it out. One is the camp that thinks that the deflation out there still will carry on and that the central banks and governments of the world can’t possibly pull us out of it anytime soon. Those traders are the ones that feel their “strongest currencies” are the dollar and yen vs. most other foreign currencies (especially higher yielding currencies that they feel have the most to move down in interest rates like Australia or New Zealand).
In other words, they’d be short the AUD/USD, AUD/JPY, NZD/USD and NZD/JPY pairs since they feel that the deflation will draw people to the dollar and yen and away from the “high yielders”.
The “other camp” is the one that thinks inflation is returning and that the global economy is on the mend. They feel that we are past the trough of the global recession and we’re working our way out back into expansionary/inflationary mode and away from deflation and an economic contraction.
These traders are buying the countries with the highest inflation rates (again, like Australia, New Zealand and the U.K.) vs. the defensive plays of the dollar and yen. So they’d be buyers of AUD/USD, AUD/JPY, GBP/USD, GBP/JPY, NZD/USD and NZD/JPY for instance.
It will be a while before we see which side wins.
However, either way you feel, if you have an opinion about where the world is headed economically (inflationary or deflationary), then you have an opinion on which currency pairs to look towards.
Never pair “medium strength” players together though. Always, “rig the fight” by putting your strongest candidate against what you feel is your “worst candidate”. By doing this, you will have a pair or two that you feel the most strongly about and you will find that you hold up better when your P&L is bouncing around all over the place.
