Often in forex trading we hear the term trade strength against weakness, however sadly not many follow it. Determining a strong and weak currency before entering any pair is the most important criteria, in fact I would say it’s the core of the analysis. Calculating strength of single currency and making use of a currency strength meter supplies the trader insight the regular trader enjoying a shot after dark just doesn't need.
The quantity of motion of a moving body, the body being a currency, is measured in the degree at which a given currency is being bought or sold. The more and faster the buying or selling, the greater the momentum. Currency pairs only move because one currency is strong and the other is weak. This strength and weakness is how trends form and proceed in forex market. Indicators only make it easier for our eyes to identify, otherwise its always the strength and weakness of price which moves the markets.
If you trade currency pairs and base your trading decisions exclusively on what you see in a given currency pair’s price chart, you are only seeing a fraction of the big picture. A currency pair chart will show you only what the two currencies are doing relative to one another, it will not show you what the two currencies are doing in their entirety. So if the EURUSD currency pair is going up, does this mean that the Euro is strong and the Dollar is weak? Not necessarily, it means that the Euro is strong, relative to the Dollar.
How can one identify the relative strength of one currency in relation to another? This is when currency strength analysis comes into play. In order to identify the strength of the two currencies in a pair, one needs to assess how the two currencies are performing relative to all other currencies. For the sake of simplicity, if we wish to identify the strength of the two currencies in a pair, we must identify the strength of the two in relation to currencies that comprise the majority of trading volume for a given currency.
Simply looking at a currency pair chart and assuming that you are seeing all you need to see in order to trade the two currencies is a very daring assumption, as only a tiny portion of the information required in order to make trading decisions is represented in one currency pair chart. Performing a currency strength analysis on the other hand, really puts the odds in your favor, as you then have a much clearer understanding of what is rallying and what is selling off, across the board, and should always form the basis of any currency trading methodology.