How is currency strength measured?
It can be described as an indicator, reflecting many factors related to a currency, for example, fundamental data, overall economic performance, or interest rates. It can also be calculated from currency in relation to other currencies, usually using a pre-defined currency basket. A typical example of this method is the US Dollar Index (USDX). You can read more about US Dollar Index in our Telegram channel.
There are two types of currency strength calculations: based on fundamental or price data. Generally, price-based currency strength is calculated from the USDX, which is used as a reference for other currency indexes. The basic idea behind these indicators is to buy strong currency and to sell weak currency. If some currency pair (let’s say NZD/USD) is in uptrend, you are able to determine whether this happens due to NZD strength or USD weakness. For the calculation of indexes of this kind, major currencies are usually used because they represent up to 90% of the whole Forex market volume.
As for the calculation based on fundamentals – it is measured by aggregating various leading economic reports, like GDP, PMI, CPI, interest rates, etc. You can watch at these data in real time with our economic calendar.
Companies make their own currency strength meters that display the relative strength of each currency for the last 24 hours. Sometimes they show each currency against another currency, essentially just showing you how each currency pair is doing. Others combine all the pairs associated with a currency to come up with an overall strength of a currency. The information is usually presented in a “heat map” format, or sometimes in the form of a line graph. An example of such meter is below.
How to use currency strength in trading?
Say, for example, that you look at the indicators and see that the USD is really strong today. To take advantage of this, you want to find another currency, and it’s better to find something weak. You look at the EUR and let’s imagine that euro is weak because of some bad news. Buying a strong currency versus a weak currency probably give you a decent trade opportunity.
Notice, that this is one of the indicators for traders, not a sole signal, but an element of a trading strategy. Don’t use it without other reasons to open a trade. Other reasons may include RSI in oversold (for long trades) or overbought (for short trades) zones, chart patterns, or candlesticks formations.
In a nutshell, there are just two steps:
- Find a currency that has suddenly turned weak or strong. Use economic calendar and price charts in FBS Trader or Meta Trader 5 platform to identify strengths or weaknesses.
- Find an opposite currency (strong for weak and vice versa). Check the chart to see if there is a trade you can justify there.
To make things clear, let’s look at an example. As for August 31, 2021, US Dollar Index has been falling for several days, as we can see on the chart.
We search for the strong currencies and find New Zealand dollar (NZD) that is rising because of the broad surge in Asian economy. Let’s look at the NZD/USD pair chart.
Here we can see that NZD is very bullish against USD, but the RSI oscillator is overbought. It’s wiser to wait a little bit and then buy NZD/USD pair (information is given only as example of a trade and is overdue now).
To sum up, currency strength helps you find markets where there is real imbalance that you can potentially exploit and make money.