Forex trading tip#1 - remember to always pit the strongest against the weakest - Written by Karthik

Lot of people/traders talk about how similar stock markets and the currency exchanges are. Both are leveraged products, both involve lots of risks and returns, both can be analysed using techies and fundies and we could go on and on about the similarities. But there is one crucial difference between how you trade stocks and how you trade currencies which many traders fail to realise and recognise. Due to the fact that they don't even realise it, they do not realise how powerful it can be and how it can be properly exploited to increase your profit potential and at the same time, decrease your risks as well.

The big crucial difference is the fact that in the FX market, i am talking about spot forex and not the futures, we always play one currency against the other while in the stock market, we always deal with only a single stock at any point of time. In other words, we are not bothered about how the share price of Microsoft is going to perform relative to the share price of Google. We are just going to be bothered about how it is going to go on its own respect. Whereas, in spot forex, we always need to see how one currency is going to perform relative to the other.

So, how does this affect our profit and risk potential? Imagine this scenario: assume that there are 2 boxing bouts, one in which Muhammed Ali (one of the greatest boxers of all time) is up against Joe Frazier (another very good fighter) and in another bout, you have Ali against yours truly (yes !! Thats me, Karthik). Assume that the odds are the same for both the bouts. Which bout would you place your bets on? It would of course be the one which pits yours truly against Ali. It does not mean that Joe cannot or never will beat Ali, its just that you want to be on the safer side, reduce your risk and make some very good,low-risk money. At the end of the day,Joe might even beat Ali, but you always play to the side which has lesser risk. And even if Joe does beat Ali, it is going to be a long, hard-fought excruciating fight which will make you keep biting your fingernails, not knowing the results till the last moment. While the bout between me and Ali is going to be a short straight forward low-tension fight. Now, can you think for a while and compare this scenario with the one in the spot forex markets ?

From the last article, assume that Ali is EUR, JPY is Joe and USD is yours truly. So, now the first bout translates to EURJPY and the second bout translates to EURUSD. For the past 2-3 weeks, we have seen that the euro has been strengthening, Instead of blindly going long on some pair based on its strength, you needed to spend 5-10 mins to find the best pair to go long. So, now, you have decided to go long on EUR. Choose the pair which pairs the Euro against the weakest. Surely, JPY is not the weakest. How do we know that. We can know this by seeing that it is gaining against USD. Now we know that USD is weaker. Now, we see whether USD is gaining against any other currency. We continue doing this till we find a currency which is not gaining against any others. Now, we see that USD is not gaining against any currency. So, we come to the conclusion that it is best to play the strongest, Euro, against the weakest, the USD. True to this, we can see that EURUSD has gained 600 pips in 2-3 weeks while no other pair has gained that much.

I could see that there were a lot of people who tried going long on GBPUSD, EURJPY etc. but all that you needed to do was go long on EURUSD. This guarantees good returns and the risks were also very low. If you had more money to invest, take more lots on EURUSD rather than going long on other pairs just because one of it was strong. In the boxing example, we knew Ali was strongest but we had to pick the bout which pitted the strongest against the weakeast.Lesser risk,lesser nail-biting,lesser tension, higher returns. So remember to always pit the strongest against the weakest.