Most forex traders use forex to put on directional trades. In other words, they anticipate a direction and trade to profit from being right on that direction. The critical success factors in directional trading is finding a optimal entry and of course, timing the exit. The rewards of directional trading are great and commensurate with the challenges. In addition to directional trading, forex traders can also play volalilty and Over-The-Counter options provide a vehicle for volatility plays. But today, I want to share some thinking on a different kind of forex trading that is available to the spot trader- correlation trading or spread trading.

 

Spread trading in forex goes beyond directional trades or volalitity plays. Its basis is the fact the currencies reflect major fundamental forces that permeate global markets. These forces involve interest rate differentials, commodity cycles, global growth, and equity sector performance. The result is a powerful synchronicity between currencies themselves, and between currencies and other markets.   The spread trader looks for the conditions when a currency goes outside its expected range of pricing. The spread trader is not playing a direction, but rather is playing a reversion to the mean.   The spread trade, when it presents itself is a great opportunity to have fundamental and technical factors converge to produce a profitable results.

 

Lets look at an example of the EURUSD and the GBPUSD

 

It visually appears extremely wide. How wide? The following spread summary shows that the spread price is all the way out of the statistical distribution. It is at the tail and in the 5.73 percentile. We can surmise its not likely to last. Ultimately, any analysis has to provide actionable knowledge. So lets come to a conclusion.

 

 

Conclusion and Recommendation: Trade a narrowing of the EURUSD against the GBPUSD.

 

 

Even the beginning trader can spot an opportunity. This spread will not last. It will narrow in a variety of ways. The trader doesn’t have to predict how. The spread trade lets the market take care of that. There are several ways to tactically implement this:

1- Buy the GBPUSD and Sell the EURUSD as two separate positions. 

2- Sell the EURGBP pair directly

3. Buy a Put on the EURGBP Pair- 3 month

4. Buy a Put on the EURUSD and a Call on the GBPUSD

 

All of these are in play and can allow the forex trader maximum flexibility in adjusting strategies and tactics to their goals and risk tolerances.

There are many spread opportunities in todays market that traders should explore.More will be pointed out in the future. The major point is that spread analysis and trading can become a useful tool for the spot forex trader

Abe Cofnas is the president for Learn4x.com and founder of Currencygames.com. He has provided a worldwide audience with analysis and insight on what moves the forex market. He is noted forex trainer and speaker and provides a a unique approach of integrating fundamental and technical analysis. He was selected as the first forex trader columnist for Futures Magazine, writing a monthly column covering forex for the last 7 years, and has also provided unique content for their Web site. He is the author of The Forex Trading Course- Published by John Wiley  which provides a getting started workbook on forex trading. Mr. Cofnas holds a Master's degree in political science, and a second Master's degree in public policy analysis from the University of California at Berkeley. He can be reached at: learn4x@earthlink.net