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Understanding Forex Basket Trading
Written by: PaxForex analytics dept - Tuesday, 05 June 2018 0 comments
Currency price often favors continuity as displayed in the market's tendency to trend. At the core of these trends is often one currency that is becoming notably stronger or weaker than its counterparts. Once this momentum starts to grow, traders can take a diversified approach in the form of currency baskets to manage opportunities in the forex market while controlling exposure at the same time. Basket trading involves opening a series of correlated or uncorrelated trades, and after an adequate amount of time, closing the trades when the overall sum of the trades is positive i.e. when the net value of all open trades is positive or close to our targeted profit-value.
Basket trading is an effective strategy that you can tailor to your specific financial needs. This strategy is widely known for combining different currency pairs at one particular time and works best for a trader that prefers to juggle multiple charts. What’s great about basket trades is that you can use this strategy as an all long or all short approach, or you can combine the two. This strategy involves two of the oldest tricks of the trade– follow the trend and cut your losses early so that your profits can run.
As traders mature in their forex training, they may eventually choose to diversify the risk by trading a so-called “basket” of all four majors based on one correlated, simultaneous movement of the USD. Let’s say you are currently trading four lots on the EUR/USD. If you are right, you will be totally right.
However, if you are wrong, you will be totally wrong. With currency correlation, you spread the risk around so that you are only mostly right or wrong. Most of the time, the majors are moving in correlation, just at different speeds. So if you only bought EUR/USD and it moved slowly upward while the GBP/USD skyrockets, you were right in your USD analysis, you just bet on the wrong horse.
Basket trading is designed to achieve the goal and this technique is often used by automated traders, hedge funds and large institutional investors who have a lot of capital to invest. Small investors use basket trading as a way of risk reduction. Another key advantage is that basket trading allows investors and traders more effectively manage their business. Many traders create basket trading using a hedge or independent currencies to reduce risk. Hedging purpose is when there is trading for long and short currency pairs together.
Investors can create a basket trade that fits their investment objectives. Basket trades make it straightforward for investors to allocate their investments across multiple securities. Dollar and percentage allocations use a dollar amount or a percentage amount to distribute securities. Decisions can be made to add or remove individual or multiple currencies to the basket. Tracking the performance of a basket trade as a whole also saves time monitoring individual currencies and streamlines the administrative process.