Hello traders! This week’s newsletter comes to you from beautiful Colorado, where I’m taking my bi-annual trip to escape the Texas heat. While friends and family encourage me to move there – mainly so they have a great place to visit/vacation!- I can’t decide if the chilly winter and snow will be worth it. But enough about my personal stuff, this week’s newsletter will hopefully help to answer a question that comes up in nearly every class that I teach, namely, what is my favorite currency pair?
When teaching one of Online Trading Academy’s forex classes, I encourage new students to concentrate on just a handful of the potential currency pairs to trade. My recommendations are as follows: EURUSD, USDJPY, and one of our commodity pairs, either the USDCAD or the AUDUSD. The reasoning is pretty straightforward-the EURUSD and USDJPY have very tight spreads (the difference between the bid and ask) indicating lots of liquidity; and occasionally a commodity pair will offer us volatility or movement when the others might not be moving. After a few weeks of getting the “hang” of the forex market, you can certainly add more pairs to your list of potential trading opportunities. The next group would be the rest of the “major” pairs-GBPUSD, NZDUSD and the USDCHF. After a few weeks of that, then the new trader could add several “cross pairs,” basically, any of the major currencies against other major currencies. For example, the EURJPY, AUDJPY, EURGBP, etc. The factors that would go into deciding which pairs to trade include the spreads, margin requirements and the ATR (Average True Range.)
The Average True Range is a measurement of volatility, usually over the preceding 14 or 21 days. According to Investopedia.com:
DEFINITION of ‘Average True Range – ATR’
A measure of volatility introduced by Welles Wilder in his book: New Concepts in Technical Trading Systems.
The true range indicator is the greatest of the following:
- current high less the current low.
- the absolute value of the current high less the previous close.
- the absolute value of the current low less the previous close.
The average true range is a moving average (generally 14-days) of the true ranges.
INVESTOPEDIA EXPLAINS ‘Average True Range – ATR’
Wilder originally developed the ATR for commodities but the indicator can also be used for stocks and indexes. Simply put, a stock experiencing a high level of volatility will have a higher ATR, and a low volatility stock will have a lower ATR.
Here is a chart of the EURUSD with the ATR added to the bottom. Over time, you can see the volatility has fluctuated from a low of about 40 pips per day, to a high of about 198 pips per day. Again, this is the average movement over the preceding 14 days.
So when someone asks what is my favorite currency pair to trade, my answer always ends up being “it depends.” Mainly it depends on who has the highest ATR at the time! As a trader, I prefer to trade the more volatile pairs from the list of pairs previously mentioned. (On a side note, when trading for the rollover/daily interest rate payment, the ATR becomes secondary to the pairs that have the highest payout. But that is a topic for another newsletter.)
As you can see from this table, currently the EURUSD has an ATR of about 151 pips while the GBPUSD has an ATR of “only” 115. Using only this criteria the pair I would prefer to trade would be the EURUSD because it should offer more movement over the next few days. Comparing the AUDUSD’s 97 pips to the USDCAD’s 135 pips per day, the USDCAD would make more sense for the shorter term trader because of the higher ATR.
Please note, however, that the ATR shows WHAT ALREADY HAPPENED. When considering a longer term trade vs. just short term day trading, very often larger moves happen AFTER a period of consolidation (lower ATR.) Another consideration is the difference in pip values in dollar terms as they aren’t all the same! Because some pairs have a pip value that fluctuates based on the price of the pair, a comparison of actual dollar value fluctuations might be more helpful to the advanced trader. This topic is better covered in class or one of our Extended Learning Track online classes.
Back to the “favorite” currency pair, based on the above table, currently the Yen pairs and the EURUSD offer the highest ATR-which would be where I would focus my short term trading-my “favorite” pairs. Over time, my favorite pairs will change as the ATRs change. Again, longer term trades will have the rollover interest added to my decision making for trades held longer than a few days.
Until next time,