Relative Strength Between Currencies: Choosing the Strongest Against the Weakest

[Fairman]

Relative Strength Between Currencies: Choosing the Strongest Against the Weakest

Instead of picking a pair and guessing its direction, relative strength analysis asks which currencies are strongest and weakest, and then pairs them.

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The logic is that a pair's move combines two stories. If the euro is strong across the board, and the yen is weak across the board, EUR/JPY is likely to have a stronger, cleaner trend than EUR/USD when the dollar is neutral. Buying the strongest against the weakest aims to put you where momentum is greatest on both sides.

To measure, calculate each currency's performance against all the others over a chosen period, such as the last week or month. Average the results to produce a strength score for each currency. Rank them.

Then look for pairs combining a top-ranked currency with a bottom-ranked one. Use your usual technical process to find entries on those pairs, in the direction of the strength difference.

Periodically, rankings change. A currency that was strongest can fade quickly, so recompute regularly.

Be aware of limitations. Strength is backward-looking and says nothing about how long a trend persists. The approach may lead you into extended moves, with poor entry points and the risk of reversals.

It also tends to concentrate exposure in a few currencies, so apply total risk limits.

Practical step: compute the one-week strength of the eight major currencies from a set of cross rates, and list the best and worst pairs.

[Fairman]

Strong versus weak pairs often look great on the chart because the move is already well along. Still need a sensible entry, otherwise you're just buying the top of the strongest trend. What I do is use the ranking only to choose which pair to watch for the week, then wait for a normal pullback setup on that pair. If GBP is strongest and JPY weakest, I watch GBPJPY for a pullback to a level on the hourly or four hour chart and enter on a sign of the trend resuming. Sometimes the pullback never comes and I miss it. That's fine. Entering late at the extreme after a 300 pip run usually ends badly.

[Fairman]

Watch for concentration. If the yen is weakest, you can end up long three yen crosses at once and call it diversified. It's one trade. When the yen suddenly strengthens, all three lose at the same time, often sharply. If you want exposure to that theme, pick the single cleanest pair and size it normally, or split one position's normal risk across two pairs. Writing open positions by currency helps catch this. If the list shows short JPY three times, your real risk on that one idea is three times what you think. That's usually the moment a strength meter strategy turns into a big losing day.