Currency pairs are the backbone of forex trading. Most resources cover the basics – what are base and quote currencies and the types of currency pairs (majors, minors, exotics).
But there’s more to understanding how to read currency pairs that are not often talked about. This guide reveals the lesser known facts that will change the way you read and trade currency pairs.
Historical Context: Evolution of Currency Pairs
Currency trading has come a long way since the Bretton Woods Agreement in 1944. Before the agreement, currencies were backed by gold, making trading simple but limited.
The agreement established fixed exchange rates tied to the US dollar which was convertible to gold.
But in 1971, the US dropped the gold standard and we have the modern system of floating exchange rates.
Knowing this history is important because it’s the foundation for the volatility and price action we see in the forex market today.
The move from a fixed rate system to a floating one means currency values are now determined by supply and demand dynamics which are influenced by economic stability, interest rates and geopolitical events.
Behavioral Patterns and Special Pair Behavior
Beyond the usual advice of trading majors because they are liquid and stable, let’s get into the unique behavioral patterns of certain pairs that are not often talked about:
GBP/JPY (British Pound/Japanese Yen)
Known as the “dragon” in trading circles, GBP/JPY is notorious for its big and unpredictable moves.
This pair is very sensitive to risk sentiment so it’s ideal for traders who understand global risk dynamics.
For example, during times of political uncertainty in the UK or changes in Japan’s economic policies, GBP/JPY can get very volatile.
Note that this pair can give high reward trades but also high risk. Not recommended for beginners.
USD/MXN (US Dollar/Mexican Peso)
This exotic pair behaves differently from other pairs because of its sensitivity to US economic data and regional factors like oil prices and political stability in Mexico.
The USD/MXN pair is a trend follower. For example during the 2020 COVID-19 pandemic, the pair moved big influenced by oil prices and investor sentiment towards emerging markets.
For those who can handle the wide spreads and potential slippage, USD/MXN offers trend trading and mean reversion opportunities.
Pair Correlations and Hedging
Many traders know about currency pair correlations but few use them to their full potential.
Pair correlations can be positive or negative and can be used to hedge or double down on trades.
Here’s how:
- Positive Correlation: Pairs like EUR/USD and GBP/USD often move together because they both involve the US dollar. If the US dollar weakens, both EUR/USD and GBP/USD will rise. You can use this correlation to hedge your positions. For example if you’re long EUR/USD you could short USD/CHF, a negatively correlated pair to EUR/USD.
- Negative Correlation: Some pairs like USD/JPY and GBP/USD often move in opposite directions. This negative correlation is good for traders who want to diversify risk. By understanding these dynamics you can create strategies that balance your exposure and maximize returns.
Cultural and Political Factors on Currency Pairs
Currency trading is not just about numbers; it’s also about understanding cultural and political elements. Here’s how these factors impact specific pairs:
- JPY (Japanese Yen) as a Safe Haven: Japan has a low interest rate policy and the culture of saving and conservative investment in Japan makes the yen a safe haven during times of global uncertainty. The yen tends to strengthen when global markets are volatile making it a good hedge against riskier assets.
- CHF (Swiss Franc) and Switzerland’s Political Neutrality: The Swiss franc is a safe haven due to Switzerland’s stable political environment and neutrality in global conflicts. Understanding the historical context of Switzerland’s neutrality can help you predict CHF movements during times of geopolitical tension.
Advanced Indicators for Currency Pair Analysis
Many traders use basic indicators like moving averages or RSI. But there are advanced tools that can give you more:
- Fibonacci Retracement Levels: Used in pairs like USD/JPY because of its trend following nature. Fibonacci levels (23.6% and 38.2%) are good for retracement levels especially during major news events.
- Ichimoku Kinko Hyo: This Japanese charting method gives you a complete view of support, resistance and trend direction. It’s good for JPY pairs where it originated.
Conclusion
Reading currency pairs is more than just definitions and common sense.
Understanding historical context, unique behavior, correlations, cultural factors and using advanced technical tools can give you an edge.
The forex market is vast and dynamic and approaching it with a holistic strategy that includes these hidden elements can lead to better decisions and more profits.
In my opinion the most successful forex traders are those who dig deeper into the complex dynamics of currency pairs rather than following the herd.
This approach makes for more informed and potentially more profitable trades.