How to use FX futures to narrow down which forex pair to trade

A problem I have is that once a currency pair shows a viable trading setup, other related pairs often show the same setup too.   A reason for this phenomenon is that markets don’t operate in a vacuum.  When markets really move, everything move together.  So the highly correlated markets can scream for entry at the same time.  The real question though, is which one should I put my chips in?

There are limitless methods on how you can approach this.  The one I’ll talk about in this post is a simple method of comparing your candidates using the currency futures.  Why use the futures?  Because they provide a standardized platform, which is essential when comparing things.  As a bonus, there is a US dollar index futures to help with analysis of the dollar.  Not a trivial process on its own.

I will explain my method by way of an example.  This morning, I was considering to go long in AUD/JPY, CAD/JPY, AUD/USD, or short USD/CAD according to signals from my FTC setup.

Sure, I could have just choose which one to trade based on the RSI rating or some other indicator.  But I don’t put much faith in indicators for various reasons.  So a method I typical use is to just go through the charts to manulally identify which has better reward/risk or better support/resistance.  As you can imagine, this is very time consuming.

In practice, I only compare AUD/JPY vs. CAD/JPY and AUD/USD vs. USD/CAD, and then compare the winners of those two matches.  Like in a tournament.  Not that much of a hassle but the issue with this approach is that I’m adding another layer of uncertainty with all these unscientific comparisons.  That could have a significant negative impact on my trading.

In a good trading strategy, every step taken should be to improve your probability of success or the reward/risk ratio.  As such, it’s better to keep my process simple.

This is where the currency futures indices is of value.  They provide a big picture perspective and serve as a standardized data for comparison.  Using my example, I needed to choose between shorting US dollar or Japanese yen (I repeated the process for choosing AUD or CAD).  Figure 1 below shows the 4-hour chart of both currencies for the past 10 days.  It’s evident from the chart that the US dollar is in a range and the Japanese yen (actually it’s JPY/USD) is moving up.  1 point goes to US dollar trade.

Next, I identify the strength of the support/resistance to estimate in the case that the trade goes against me, which would have better cushioning.  It’s a crude form of risk estimation.

From the figure below, see that the dollar has a clear resistance just below 76 and it is currently stretched away from the cyan-coloured moving average.  Whereas the yen is near a recent top with no prior occurence and it has been sitting above the moving average for a while.  Another point for dollar short.

USD 2 : JPY 0.  Consequently, I went long AUD/USD this morning instead of AUD/JPY.

This is by no means a vigorous methodology.  I’m not saying that shorting US dollar is a good idea from this simplistic comparative process.  It’s just that my setup tells me to go long AUD/USD or AUD/JPY, this is just a quick and easy way to help me decide which trade to take.  Nothing more.

As an aside, some people may prefer to use currency ETF, UUP and FXY, instead.  But I don’t like to use ETF as a data source as the price is noisier because they are affected by other factors.

US dollar and Japanese yen futures indices

Related posts:

1. AUDJPY Short 81.37/77.17: Anatomy of my first 400+ pips trade
2. Retirement from futures trading and back to stocks
3. Paper trade: Short AUD/JPY @ 84.53, Stop 85.00
4. Paper Trade: retrying AUDJPY short @ 84.52, Stop 85
5. A good trade that could have been great: a lesson to take profit at target