Building a Forex Basket

Building a forex basket requires special technique and a few key components. Now is the best time to get started on your own forex basket trading journey, with rates in the developed world plunging while economic opportunity awaits in the emerging markets.

The name of the game with forex basket trading is to design a basket of multiple currencies which act both independently and dependently, as well as provide for asset stability, but also generate positive cash flow.

Start with an Anchor

The starting point for any forex basket should be in finding a solid anchor currency around which the rest of your basket can be designed. The anchor currency must be moderately stable in price, but also offer political and economic stability as well. Solid anchor candidates change frequently, but the Japanese Yen has been used in basket trading for a long time.

Borrowing yen is extremely inexpensive due to their central bank's activity to spur economic development. In addition, since Japan is part of the developed world and enjoys a stable, but not entirely robust economy, nor any political instability, its currency is a perfect candidate to finance the rest of the basket.

There are instances in which you can have two anchor currencies in order to spread your risk. However, if you are to introduce another currency into your forex basket, it is best to pick a currency that is similar to your anchor in total yield, but offers a different type of economy.

Income Currency

The anchor currency allows the forex basket to be leveraged inexpensively, but this benefit is not helpful at all unless the basket can move the net short anchor currency capital into net long positions of an income currency.

The New Zealand dollar is frequently considered to be a strong income currency due to its traditionally higher rates. In more vicious down cycles when central bank activity reaches its peak, it is also possible for currencies such as the Euro, which is backed by a prudent central bank, to be used as a secondary income currency.

Greater diversity in income is perhaps more important than diversity in the anchor currency. Since a forex basket will be net long these pairs, income currencies have to remain stable, or at least amongst one another, in order to produce profits. Unless the anchor is a wildly volatile economy, it is unlikely that low rates in the home country will create enough inflation to cause any devaluation concerns.

Commodity Currency

Finally, to balance out the integrity of the basket, it is wise to add a “commodity currency,” one that represents a very commodity heavy country with high carry income. Australia is a common candidate for this portion of the basket since it relies on a commodity driven export economy, and it has for a long time offered yields far beyond what can be found in any other developed area.

The commodity currency is important because it is the final anchor between your forex basket and the rest of the currency market. Commodities have earned the reputation of an effective short on all currencies. When other global currencies lose value, commodities rise, often giving lift to the high yielding Australian dollar.

Forex basket trading is both rewarding and profitable, but requires attention to macroeconomic events that other shorter term strategies may ignore. While the forex basket is considered one of the safest of currency speculation, excessive reliance on one currency, or excessive leverage across the board, can quickly turn an otherwise healthy forex basket into a falling portfolio.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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