EUR/USD

The EUR/USD’s premier status reflects the fact that the U.S. and Eurozone are the world’s two largest economic zones. The Euro is one of the three legs of the world’s major currency blocs (EUR, USD, JPY), and thus reflects major shifts in global asset allocations. Also, the Euro is the second-most significant reserve currency after the U.S. dollar, accounting for nearly 60 percent of the composite U.S. dollar index. In this sense, the Euro frequently acts as a foil to the U.S. dollar and is the primary currency in which overall dollar sentiment is expressed. Of course, EUR/USD will respond to Europe specific developments, such as interest-rate changes and economic data, but more frequently it will be the dollar side of the equation that drives the currency pair.

As a result, traders need to be aware of the dominant themes driving the market and understand whether it is a U.S.- or European-based story behind a move.

The EUR/USD’s liquidity is unmatched by any other major currency pair, reflected in its tighter spreads and tendency to trade tick by tick. Moreover, EUR/USD receives additional liquidity through the crosses” (non-dollar cross-rates such as EUR/CHF and EUR/GBP), as less-liquid dollar pairs (e.g., USD/CHF and GBP/USD) are turned into more-liquid cross positions. For example, if a hedge fund sells a large amount (e.g., more than $50 million) of USD/CHF to an interbank market maker, the market maker is unlikely to be able to unload the trade on the market without driving the price significantly against himself and locking in a quick loss. Instead, the market maker will immediately buy the equivalent dollar amount of EUR/USD, creating a long EUR/CHF position (long EUR/USD + long USD/CHF = long EUR/ short CHF).

Given the deeper liquidity of EUR/CHF vs. USD/CHF, the market maker now has a chance to exit theoverall position with less slippage and possibly even at a profit. This cross flow can distort price action in a countertrend fashion as a cross position is then exited. This makes EUR/USD ideal for very short-term traders, because they are able to open or close positions with minimal slippage.

The depth of interest and liquidity in EUR/USD can lead to prolonged tests of support and resistance as limit orders at these levels are absorbed by the market. This can create the impression a directional move is stalling, sometimes inducing a brief reversal, when it is simply a matter of time before the market is able to work its way through orders.

Apart from major data releases, EUR/USD tends to exhibit its greatest volatility during the previously mentioned periods of session illiquidity.