Chapter 17
Fundamental Trading Strategy: Pairing Strong with Weak

One of the best ways to approach currency trading on a fundamental basis is to pair the strongest currency with the weakest. Of course finding that pairing is rarely simple because it is not just about which countries are the strongest or weakest right now but instead which ones will become strong or weak going forward. Finding these currencies can also be challenging because we live in a global economy where the health of one major economy will affect the outlook of another. Yet buying a weak currency and selling a strong one unknowingly can be a big mistake that translates into large losses, so it is extremely important for forex traders to learn how to pair strong with weak to maximize returns. After doing so you can use technical analysis to help identify points of entry in the direction of the trend.

In 2015, for example, the European Central Bank introduced quantitative easing (QE) as a last ditch effort to boost inflation and stimulate growth. We know that QE lowers interest rates and erodes the value of a currency but selling euros blindly on March 9, 2015, when the central bank started buying bonds for the very first time, yielded only a short-lived decline in the currency. Instead it would have been smarter to look for opportunities to sell the currency against a strong one on rallies. One good candidate at the time was the British pound, which was benefiting from economic improvements and had a central bank that was moving closer to raising rates. Figure 17.1 shows how there was a lot of consolidation in EURGBP near 74 cents prior to the launch of Eurozone quantitative easing. This level proved to be resistance when the pair rallied in late March. Traders could have sold them, assuming that resistance would hold, or waited for the pair to revisit that level in April and May.

Figure 17.1 EURGBP Daily Chart—Quantitative Easing

Source: eSignal

Another way to pair strong with weak is to follow the direction of commodity prices. Oil prices bottomed at $43.46 in early 2015, having traded above $100 a barrel only 8 months earlier and started to turn higher in March. As a major oil producer, Canada would stand to benefit from stabilization in crude prices. At the time U.S. policy makers were talking about raising interest rates, the Australian dollar was benefitting from improving domestic conditions, and sterling soared on positive data and a victory by the incumbent during the 2015 general election. Selling any of these currencies and buying the Canadian dollar would have been a risky endeavor. Instead the best bet at the time was to sell the New Zealand dollar and buy the Canadian dollar or the NZDCAD pair because New Zealand reported extremely weak labor data that prompted policy makers to talk about easing. As you can see in Figure 17.2, NZDCAD started to turn lower just as oil prices moved higher in March.

Figure 17.2 NZDCAD Daily Chart—Oil

Source: eSignal

The best way to gauge strong versus weak is to monitor economic data surprises. While the ECB was buying bonds and implementing quantitative easing, Eurozone data started to improve and U.S. data started to weaken. The market had not anticipated this shift in dynamic as they had been looking for weak Eurozone data to reinforce QE and stronger U.S. data to push the Fed to tighten. This unexpected change drove EURUSD sharply higher, and buying breakouts in April and May as shown in Figure 17.3 would have been good bets.

Figure 17.3 EURUSD Daily Chart

Source: eSignal