As I’ve written about before, one of the primary keys to successful Forex trading is not your system, it’s you, the trader. Once you fully understand the value of this you begin to stop looking outside yourself for a holy trading grail that will take you to the promised land of riches.
But beyond understanding yourself and habits as a trader and knowing you are the key to your success or failure, it is vital to take the time to understand currency strength and knowing that when you trade in the currency market, you are trading an individual currency, not a pair.
The Key to Profitable Trading
The linking of currencies in pairs can be the undoing of new traders who stop right there and think in terms of trading pairs, rather than learning that the key to trading lies in knowing that currency strength (or weakness) is calculated in relationship to another currency. And it’s in determining the relative currency strength or weakness of an individual currency which will help you decide what your trade should be.
When you view the EURUSD pair you should see that as two individual currencies. Your task then, is to decide which currency you are going to trade within that pair. And in order to do this you need to examine that specific currency in relationship to all other currencies in the market (at least the major ones) to determine its relative strength or weakness.
Proper Forex Trading is a little like Betting on a Horse Race
This is similar to determining how you are going to bet on a horse race you happen to be watching on a cloudy Sunday afternoon. In any given horse race there is often a horse that is the favorite to win. And sometimes there is a horse that given the right circumstances, say, a wet track, has the strong possibility of beating the odds on favorite – who never does his best on a wet track. We’ll call these two horses, horse 1 (great on dry track) and horse 2 (great on wet track); our pair to watch.
Many casual betters might look at how wet the track is, and then determine, based only on the records of horses 1 and 2, the pair, how they are going to place their bet. Really wet track, they bet on horse 2 and if the track is drier they bet on horse 1.
But a more informed better, just like a more informed forex trader, would understand that you can’t determine the best horse to win, unless you know about the other horses’ traits as well. You need to use knowledge of all those other horses (currencies), their strengths and weaknesses, to really make the strongest betting decision.
For example, what if you know that horse 3, though not as fast as horse 1 or 2, seems to have a knack for being the fastest out of the gate and can sometimes take the lead and keep it when they can get to the inside railing and stay there. And then there is horse 6, who has run many races with horses 1 and 2, and on the occasions that 6 has been in the starting gate on the left side of 2 has beaten 2, on a wet track, more than half the time. Now you have to evaluate the position of horse 6 in the starting gate relative to horse 2.
And maybe horse 5 is a total unknown while horse 4 is a wild card. There are a lot of horses (like currencies) to look at if you’re going to make your best decision. If you keep your eyes only on the top two horses and see them as a pair, you’re missing most of the information you need to make the best bet to win. You need to look at how a horse performs against every other horse it has run against.
Currencies, like horses, play off of each other. Yes, those “top” two horses might be talked about together all the time (like the EURUSD pair), but it is only by looking at one horse, and then in comparing that horse to all the other horses and factors (the wet track, the starting position) that you can make the decision that is more likely to get you to the winner’s circle.
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