Dominating foreign exchange (FOREX) markets globally, the EUR/USD boasts an average daily turnover of approx. $4 billion per day (of the total $5.3 trillion traded daily across all forex markets). Considered a highly liquid ‘major’ currency and one of the most heavily traded forex markets in the world (and best known currency pair), the EUR/USD accounts for almost 30% of all spot trades (also known as ‘cash trades’) executed in the FOREX market today.
Trading Basics: EUR/USD Currency Pair
FOREX trading involve the simultaneous buying of one currency (base currency: EUR) and the selling of the other currency (quote currency or counter currency: USD). The currency pair is considered a single unit that is bought or sold with the value of the base currency always equal to 1. For example, if the EUR/USD pair is quoted as 1.1600 that means it takes $1.16USD to purchase one EUR.
When a trader ‘buys’ a currency pair, they are effectively buying the base currency and selling the quote currency. The ‘bid’ (buy price) is the price at which market is willing to buy the base currency in exchange for the quote currency. Conversely, when a trader ‘sells’ a currency pair, they are selling the base currency and buying the quote currency. The ‘ask’ (sell price) is the price is the price at which market will sell the base currency in exchange for the quote currency. Note: The bid price always lower than the ask price.
Forex price movements are triggered by currencies either appreciating in value (strengthening) or depreciating in value (weakening).
The EUR/USD currency pair was first traded when the Euro was first issued in January 1999. Opening at 1.1795 and quickly falling considerably in value, the EUR/USD traded at a low of 0.8225 in October 2000 before re-reaching parity (1.0000) in November 2002. Trending higher and reaching its all time high level of 1.6037 in July 2008, the EUR/USD today (January 2015) trades down (from highs) at approx. 1.1640.
EUR/USD for Binary Option Traders
Because binary options traders are not concerned with how much an asset moves in price, only the direction, a binary options trader places a ‘call’ trade if they believe the price of the EUR/USD is set to rise, indicating that the counter currency (USD) will depreciate, whilst the base currency (EUR) will appreciate. Conversely, the binary options trader places a ‘put’ trade if they believe the price of EUR/USD is set to fall, indicating that the counter currency (USD) will appreciate, whilst the base currency (EUR) will depreciate.
Trading EUR/USD Correlations
Correlations between the world’s most heavily traded currency pairs (and/or commodities) are common. That is, a correlation of +1 means two currency pairs move in the same direction 100% of the time. A correlation of -1 means they will move in the opposite direction 100% of the time while a correlation of zero means no relation between currency pairs exists. Knowledge of correlations can be used for trading advantage including predicting the direction of the market, avoiding overexposure, doubling of profitable positions and hedging against risk.
A positive correlation Identifying that two currency pairs move in the same direction, the EUR/USD pair is positively correlated with both the GBP/USD and the AUD/USD. With a correlation coefficient of approx. +0.90, this means, that when the EUR/USD rises, both the GBP/USD and AUD/USD appreciate respectively.
Identifying that two currency pairs move in the opposite direction (an inverse relationship), the EUR/USD is negatively correlated with both the USD/CHF and the USD/JPY. With a correlation coefficient of approx. -0.90, this means, that when the EUR/USD rises, both the USD/CHF and USD/JPY depreciate respectively.
Correlation Trading with Ranges
For binary options traders who are not concerned with how much the FOREX pair moves in price, only the direction, a positive correlation will assist in identifying when a move is about to occur but it will not identify the direction. For direction confirmation, traders can look to the ‘range’ (the difference between the high and the low for a period) for signals.
For example, the GBP/USD is known to have a larger range than the EUR/USD. This means while the pairs are positively correlated and generally move in the same direction, the GBP/USD has lower lows and higher highs than the EUR/USD. When the range of the GBP/USD is lagging (also known as range lag) behind the range of the EUR/USD, binary traders can identify a potential directional trade setup.
A confident binary options trader may also double their position size by placing call (or put) trades on both markets which are positively correlated, enabling the opportunity of increased (double) profits.
For binary traders, trading negatively correlated currency pairs allows traders to diversify strategies, use trade alternatives and manage risk through hedging. For example, the correlation co-efficient confirms the EUR/USD is negatively correlated with the USD/CHF. This means if the EUR/USD is rising, traders can place a ‘put’ trade again the USD/CHF in the assumption that the currency pair will depreciate. Alternatively, should the EUR/USD currency pair’s price action not offer clear direction signals, the USD/CHF may offer a clearer alternative directional trade (inversed).
Further, traders may use a negative correlation to hedge against risk. That is, because the two currencies move in opposite directions, when one currency trade looses, the other wins offering a profit. Appearing counter-productive, a trader may use a binary option to hedge against risk on a FOREX position held in the market.
Responsible money management ensures that the losses don’t mitigate the profits.