Currency “translations”

When the U.S. equity and bond markets are open during the U.S. session, foreign investors have to convert their domestic currencies, such as Japanese yen, Euros, and Swiss francs, into dollar dominated assets in order to carry out their transactions. With the market overlap, GBP/JPY and GBP/CHF have the widest daily ranges. Most currencies in the forex market are quoted with the U.S. dollar as the base and primarily traded against it before translating into other currencies.

In the case of the GBP/JPY, for a British pound to be converted into Japanese yen, it has to be traded against the dollar first, then into yen. Therefore, a GBP/JPY trade involves two different currency transactions — GBP/USD and USD/JPY — and its volatility is ultimately determined by the correlations of the two derived currency pairs. Because GBP/USD and USD/JPY have negative correlations (which means they move in opposite directions), the volatility of GBP/JPY is amplified. Movement in SD/CHF can be explained similarly, but it has a greater intensity.

Trading currency pairs with high volatility can be lucrative, but it is important to bear in mind the risk is very high as well. Traders should continuously revise their strategies in response to market conditions, because abrupt moves in exchange rates can easily stop out their orders or nullify long-term strategies.

For more risk-averse traders, U.S. dollar/Japanese yen (USD/JPY), Euro/U.S. dollar (EUR/USD), and U.S. dollar/Canadian dollar (USD/CAD) appear to be good choices, because these pairs combine decent trading ranges with lower risk. They are highly liquid, which allows an investor to secure profits or cut losses promptly and efficiently. The modest volatility of these pairs also provides a favorable environment for traders who want to pursue long-term strategies.