Forex trading is unique in that it’s two markets together, as we trade in pairs of currencies like AUD/JPY or AUD/USD. So we have not one, but two currencies to keep our eye on. Forex traders need to watch the relative strength of each currency, buying when one is on the uptrend, strong, and selling on the downtrend, weak. It seems obvious, but identifying when this is happening is a fundamental requirement for traders and not always visible, especially when you are new to trading.
Factors Influencing Currency Strength And Weaknesses
A country does not necessarily want a strong currency as this can lead to exports becoming expensive and severely affecting its competitiveness in the international market. Conversely neither do they want a weak currency as this makes imports costly and ups the countries inflation rate. So ideally, a nation wants its currency stable; in the middle somewhere with little to no fluctuations.
For Forex traders, many variables affect a currency and knowing some of what these are is vital to successful Forex trading.
Three Key Elements To Be Aware Of
This element is also crucial to traders taken into context with other variables. A stable government with a history of sound economic policies and the rule of law attracts investments and in doing so strengthens the currency.
2. Economic Policies
Governments can experience fiscal problems, but strong currencies come from those countries with good anti-inflation policies and a tight discipline on its financial plans and implementation.
3. Interest Rates
To get a good return for their investments a country’s interest rate has to be high to attract foreign investors, which in turn strengthens that nation’s currency.
How To Identify Strength And Weakness Shifts In A Currency
It can be time-consuming, complicated and a little messy trying to identify the strength or weakness of an isolated currency. Questions arise like, is a currency strengthening on its own or because its pair is doing poorly? An online currency strength meter is one way to speed up the process and make more informed decisions about whether to buy or sell.
You can search online for Forex strength meters, or your current platform may have one. You are looking for a meter that looks at all the common currency pairs in real time. It will evaluate the strength or weakness levels and take into account the correlation of the base and quote currencies. You may have to buy one, but in the end your tools are essential, saving you time and money!
An example of the sort of visualisation you can get from a strength/weakness matrix (not current data.)
What Are You Looking For?
While this chart is a little busy, you can see each currency in isolation and compare it with another. You are looking to trade currencies that are gaining strength against a currency that is losing strength. So, it would be best if you searched for currencies that are moving away from each other.
- Look for the 0% line and observe where in relation to that line your chosen currency pair is.
- Are they repelling one another?
- Above the zero indicates an uptrend.
- Below zero indicates a downtrend.
- Determine the markets in an opposing nature, where the currencies are moving away from each other.
- Check if the currency is getting stronger/weaker against multiple currencies, not just each other.
- Avoid trading when currencies are flat, where both are sitting together moving sideways or parallel to each other.
A currency strength meter compliments your analysis tools. They usually rank the top 8 currencies and show how they have behaved over a period of time, typically 24 hours, but longer can also be found. This gives you an overview of how weak or strong they have been and helps you to make informed decisions on when to buy or sell. Of course, your charts also tell you the same thing, but they can be difficult to isolate, especially for new traders. As with any analysis, using one source alone is not productive, but using a strength meter along with other data collected can improve your overall trading strategy.