The FX Bootcamp Guide to Strategic and Tactical Forex Trading

TRADING A BASKET OF CURRENCIES

As you mature in your forex training, you may eventually choose to diversify your risk by trading a so-called “basket” of all four majors based on one correlated, simultaneous movement of the USD.

Let’s say you are currently trading four lots on the EUR/USD. If you are right, you’ll be totally right. However, if you’re wrong, you’ll be totally wrong.

With currency correlation, you spread the risk around so that you are only mostly right or wrong. Most of the time, the majors are moving in correlation, just at different speeds (see Table 7.5). So if you only bought EUR/USD and it moved slowly upward while the GBP/USD skyrockets, you were right in your USD analysis, you just bet on the wrong horse.

By putting a single lot on each of the major currency pairs based on their correlation, you are really betting on all the horses. Each of the trades will profit (or lose) differently, but you’ll be mostly right (or wrong). You don’t have to worry about how right or wrong. All you have to worry about is direction: up or down.

TABLE 7.5 Correlation Coefficients

So, for example, if you felt the USD was going to fall, you would place a lot on each of the major currencies, in contrast to placing four lots on just one pair. With this strategy, your basket of majors would look like Table 7.6.