A new year, a new decade and you have decided to trade foreign exchange. But which currencies are right for you, and which offer the most promising upside in the month ahead?
Let’s answer those questions separately, having first established a key principle of forex trading, which is that currencies have no intrinsic value and their worth is measured solely in terms of other currencies.
So, for example, when you read that “the dollar was weaker against the euro in today’s trading”, is that what is really meant, or is it the case that the euro was stronger against the dollar?
The dollar is king
This matters, because if the euro is rising for reasons unconnected with the prospects (or lack of them) for the US economy, it would be a mistake to assume America ought to be shunned by investors.
A classic case occurred in early 1985, when sterling fell to its lowest level against the dollar before or since - $1.06. But the UK economy was on a strong recovery track, and the story was purely one of dollar strength – too much strength, according to US exporters, who struggled to sell what had become overpriced goods in foreign markets.
This leads to two further principles of foreign exchange trading. One is that it is a zero-sum game, in which every winner must be matched by a loser. This is quite different from, for example, share markets, where everything can rise – or fall – at the same time.
The second is that currencies cannot be traded on their own – again in contrast to shares – but only in pairs, given that currencies can be priced only in other currencies.
So, which are the most attractive pairs just now? A third principle of forex trading is that the dollar is the sun around which the other monetary planets revolve, a unit in which two-thirds of world trade is denominated.
Forex’s “odd couples”
Not only does it represent the might of the world’s largest economy, but it is the “middle currency” in transactions involving minor denominations. When no-one is quoting a direct – or “cross” – rate between such currencies, there will always be a dollar rate for each, thus traders switch from the first currency into dollars and out again into the second currency.
We will come to the dollar in a moment. First, let’s look at one of the more intriguing pairs on offer, the South African rand against the Japanese yen.
Trade South African Rand / Japanese Yen CFD
Intriguing because this pair bridges two economies that are about as different as can be. South Africa remains a developing country but one that is rich in natural resources, from gold and coal to iron and steel. Japan has the world’s third-largest economy and practically no natural resources whatsoever.
On to another “odd couple” on forex markets, the Swiss franc/Chinese yuan. The former is, famously, the hardest currency in the world with an unrivalled record of holding its value, while the latter was, until recently, alleged to be manipulated downwards by the Chinese authorities to help the country’s exports.
It goes without saying that the Swiss and Chinese economies have very little in common.
By contrast, the trade between the Danish krone and Swedish krona links two relatively similar economies. Indeed, it may seem eccentric to suggest trading two currencies separated only by a single letter.
But it is precisely in such a tight configuration that opportunities for value can be found.
No list of currency pairs would be complete without sterling, a large currency sitting on a rather more modestly-sized economy. For those looking for a little excitement, the pair to trade would be the pound against the Hong Kong dollar, excitement not only because of the current unrest in Hong Kong but also because of accusations from China that Britain is interfering in the affairs of its former territory.
Prone to political interference
Our next pair comes from either end of North America, the Canadian dollar/Mexican peso. These two countries combine big differences in terms of living standards with a recent history of trade between the two.
Finally, the two biggest currencies in the western hemisphere, the US dollar and the euro. This is a monetary frontier across which huge volumes of trade and capital flow.
So, we have our six pairs. In each, which currency should be backed?
In yen/rand terms, the rand seems to be having trouble getting much above 7.60 yen, having been at about 7.78 on New Year’s Day, so it seems the momentum is not with it.
The Swiss franc has been on an upward track against the yuan for a year now, from 6.96 yuan to 7.16, and there seems little sign that it has topped out.
Denmark’s krone is currently worth 1.4 Swedish krona, up on 1.37 a year ago but down on recent peaks of 1.46 in October. The chart suggests the momentum may lie with the Swedes.
Sterling currently trades at 10.17 Hong Kong dollars, higher than 9.89 a year ago, before the protests erupted. That is only to be expected, but those with strong nerves may take a position in the dollar that will pay out if the matters in the territory can be normalised.
Canada’s dollar is currently worth 14.56 pesos, down on the 15.02 seen in August but the general trend remains favourable to the Canadians.
Finally, calling the path of the dollar and euro is a tricky business because they trade within a fairly close range. However, the pattern of the last year suggests at the very least that the dollar is holding steady at €0.90 with potential for upside.
Forex trading is not for the faint-hearted, not least because currency markets, by definition, are prone to political interference. But for those prepared to do their homework and accept one or two setbacks, it can be a satisfying and profitable area of activity.
Read more: Buy the dip: EUR/USD technical analysis.