Many forex traders choose the currency pair for trading without much study. Many traders make the mistake of forming their opinion around only one currency in the pair, ignoring the other currency in the pair. Right choice of the currency pair is essential for making good returns.
US Dollar is the most important currency in the global economy. It is heavily traded against other currencies like Euro, British Pound, and Yen etc. Many trader trade currency pairs involving USD. They make the mistake of only studying US Dollar while ignoring the other currency in the pair.
This neglect of the other currency economic conditions can greatly hinder the profitability of the trade. It also makes the odds of a loss high.
When you trade against a strong economy, the chances of failure are more. The weak currency in the pair could flop badly while the strong currency in the pair may appreciate more than what you calculated.
Study the economies of both the currencies is essential before you decide to trade a particular currency pair. The best strategy is to choose the strong economy/weak economy pairing. This increases the potential of maximizing returns.
Lets make it clear with an example, FED announced its intention of containing inflationary pressures in the US economy in March 22, 2005 FOMC meeting. Most currencies depreciated against the dollar on the release of the announcement. During that time, other positive economic data also reinforced the dollar.
When the initial market reaction was over, GBP rebounded and recovered its lost strength, due to the consistent economic growth shown by the British economy at that time. However, JPY kept on depreciating due to the week performance of the Japanese economy during that time. Dollar almost gained more than 300 pips in two weeks against the Yen after March 22, 2005.
Therefore, USD strength had a much higher impact on the struggling Yen as compared to the consistently strong GBP.
Study the economies of both the currencies in the pair. Examine the behavior of various crosses. In short, when you choose the currency pair try to keep the strong economy/weak economy pairing in mind for maximum returns.
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