Choosing the right forex instruments to trade is not the easiest thing to do, especially in 2021, when FX markets remain active and most currency pairs are being influenced by the ongoing pandemic, economic developments, and by the combination of fiscal and monetary stimuli. Traders need to focus on several key aspects, and this article will provide the 4 most important variables that you should consider when building an asset list.
#1 Weak vs. strong currency
Because forex trading is a sector in which traders need a combination of volatility and directional bias, finding weak vs. strong currencies is the best way to position yourself in an environment where choppiness and wild swings are less likely to occur. Throughout 2020, the US dollar had been the weaker currency, with the Euro and Pound benefitting accordingly.
Now that a new year has started, the situation can change. The US economic contraction is less severe than in other parts of the world, and with more stimuli on the way due to the incoming Democratic administration, flows might shift toward USD again, mainly due to higher growth prospects. Capital is constantly moving, and hence the responsibility of traders is to anticipate where trends unfold.
#2 Trading costs
“What is the cost of a trade?” should be a key question for all retail traders since wider spreads and overnight swaps can weigh in heavily on profitability or increase losses. For instance, in 2020 the Turkish Lira weakened substantially, yet retail trading on pairs including the currency would have been difficult, due to widening spreads as well as the increase in volatility. In some cases, it is better to stick with the popular currency pairs and avoid exotics, especially for traders with little experience.
#3 Trading strategy
It may not be obvious to many traders, but the same trading strategy won’t perform in the same manner on all currency pairs. Breakout setups are extremely powerful on very liquid pairs like EURUSD or GBPUSD, yet seem to have lower accuracy rates when moving to low-liquidity instruments such as GBPNZD and AUDJPY.
Higher liquidity means there is a lot of buyers and sellers at any given price level and thus each movement is backed by a large number of transactions. In the absence of information on how a trading strategy performs for various currency pairs, you can analyze past performance and see which assets stand out.
#4 Risk appetite
2020 will go down in history due to the surge in trading volumes reported by online brokers, but that does not mean all retail traders are created equal. On the contrary, traders have different risk profiles and will perform better or worse, depending on the level of psychological pressure.
Risk appetite thus becomes another factor to consider when choosing currency pairs. If you’re comfortable with higher risk, forex trading on exotic pairs shouldn’t generate damaging emotional reactions. For those who can function better when markets are stable, the popular currency pairs should be the best pick.
Regardless of how well any given asset is performing, as a trader you should at least factor in these 4 variables before deciding to start trading. There are no ideal assets so whatever your choices may be, keep in mind that there are going to be upsides and downsides all the time.