Learn the Forex basket trading strategy so you don’t put all your eggs in one basket. It is well known that diversification is one of the most time-tested principles in trading. Throughout this forex trading guide, you’re going to learn how to diversify your trades across multiple currency pairs by using the forex basket trading method.
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The most challenging part of forex trading is finding ways to manage your investment risk. And, managing the forex risk is synonymous with having a profitable trading strategy. The harsh truth is that developing an edge in the market is hard
You need to know when it’s time to get in and when it’s time to get out if you want to be a successful trader. And, while it sounds easy, in practice, is a lot harder than that. There is a reason why 95% of traders lose money.
But, there is hope.
What if we told you can be smarter than that and develop an edge around two core trading aphorisms:
- The trend is your friend
- Cut your losses short and let your winners run
And, that’s the foundation of the forex basket trading strategy.
Let’s start by understanding forex basket trading and how it works.
What is Basket Trading Forex?
In forex, basket trading involves buying and selling different correlated or uncorrelated currency pairs at one time where the market lines up. The aim is that after sufficient time the sum of all open positions is in positive territory and the trades can be closed with a profit. This means that the sums of all profits and the sums of all losses are positive.
Instead of trading one currency, you focus on a basket of currency pairs.
Some positions may cancel each other due to the positive and negative correlation between different currency pairs. In this regard, you can also construct a market-neutral strategy using a basket of currency pairs.
Learn more about market-neutral strategy, which has helped traders not only in the forex market but the stock market as well.
To understand how basket trading works, let’s take an example of how a basket trade can be constructed using different currency pairs.
How Basket Trading Works?
Essentially, what we try to accomplish is looking at a particular currency pair that has a clear trend (bullish or bearish). Once you establish the general direction of that particular currency pair, based on the strength and weakness of the 2 currencies, we can choose our basket of currencies.
For example, if among all the currency pairs you have determined a strong USD/JPY bearish trend, this will be our base FX pair to establish our basket.
If the overall direction of USD/JPY is down, it means the Japanese Yen is strengthening.
See the forex chart below:
Once we have done our USD/JPY analysis, we can now spread our risk across all YEN crosses.
So, instead of going short only USD/JPY, we also go short GBP/JPY, EUR/JPY and AUD/JPY.
See the currency chart below:
Just by looking at this particular chart, we can notice that while the broad-based JPY strength can be seen across all YEN crosses, some currency pairs move at a faster speed.
So, if you planned to only risk 4% on the USD/JPY trade, now that you have 4 currency pairs all aligning up, you can risk 1% on each currency pair individually.
While the forex basket trading method is designed to spread out the risk it still has a major flaw.
The success of this strategy is strongly tied to your ability to correctly read the forex market trends.
Even if you have the best basket trading ideas, if you get the trend wrong, you’re doomed to fail.
Our proprietary forex basket trading system is designed to eliminate the directional trading element.
But, before we reveal our own unique method, let’s outline a few reasons why the forex basket trading method is worth getting your time.
Why Use Forex Basket Trading System
The most important thing about trading basket currencies is that it takes away from the zero or hero trading environment.
What do we mean by that?
Forex trading or any market (stocks, futures, commodities, cryptocurrencies, etc.) is very emotional. Basically, all market prices are driven by fear and greed. We’re all fearful to take a loss and greedy when it comes to taking the profits.
So, by using forex basket trading you can detach yourself from this concept of being right on every trade. Traders who assume they can win every position will inevitably wrong into trouble. You can let the market do its thing and take the loss when you’re wrong and profit when you’re right.
Secondly, basket trading is a form of diversifying your investment risk.
Instead of allocating the risk to one single trading idea, basket trading allows us to allocate the same amount of risk, bust spread across multiple currency pairs.
Next, we’re going to showcase a brief demonstration of the forex basket trading strategy.
Forex Basket Trading Strategy
As explained, the conventional basket trading method involves selecting a basket of currency pairs based on the currency pair that presents the clearest trend. But, we all know that the market never moves in a straight line, it moves up and down in swing waves.
And, we all know that all trends have an end and eventually they reverse.
So, what we have done is the make the forex basket strategy into a non-directional strategy.
Important Note* our basket trading strategy is non-directional in the sense that the overall positions can generate a positive outcome even if we’re wrong on the forex market direction.
This means that we’re still going to try to forecast the trend and position accordingly.
Now let’s give you a framework or base for our currency basket method.
Step #1 Determine the US Dollar Trend Direction
There are some standard methods to determine the trend direction of a currency.
You can use the price structure in terms of higher highs and higher lows to define an uptrend or lower lows and lower highs to define a downtrend. But, you can also use technical indicators.
Just for simplicity, we’re going to use the US dollar index chart below:
Based on the above DXY chart, we have determined that the US dollar is getting stronger.
The expectation is for the dollar to gain strength against its major counterparts.
The next step is obviously to determine what currency pairs to buy and what currency pairs to sell. This is what will determine the success of this strategy.
Step #2 Select our Currency Pairs
The currency pair selection will be done according to which currency pairs are moving in tandem with the US dollar and which currency pairs are moving against the US dollar strength.
To accomplish this, we’re going to track which currency pairs have been moving in the previous days in the same direction with the US dollar.
See the chart below:
The only two currency pairs that have benefited the most from the dollar strength were AUD/USD and EUR/USD. On the other hand, USD/CAD traded almost flat while GBP/USD showed restrain movement to the downside ignoring the dollar strength.
So, what we want to do in this situation is to:
- Buy the dollar against those currencies that have moved in tandem with the dollar strength (i.e. sell EUR/USD and sell AUD/USD)
- Sell the dollar against those currencies that have ignored the dollar strength (i.e. buy GBP/USD and sell USD/CAD)
Note* the risk is going to be spread equally across all 4 currency pairs. I.E. we’re going to buy and sell the same number of lots.
Now, let’s track, what would have happened to our positions at the end of the first trading day. Our currency portfolio would look something like this:
- Sell EUR/USD trade (-2 pips loss)
- Sell AUD/USD trade (-3 pips loss)
- Sell USD/CAD trade (-16 pips loss)
- Buy GBP/USD trade (-27 pips loss)
After the first trading day, the sum of all of our positions would be -50 pips. The results are pretty disappointing, but let’s consider moving forward and see what would happen after 10 days.
Our currency positions would look something like this:
- Sell EUR/USD trade (+79 pips won)
- Sell AUD/USD trade (+105 pips won)
- Sell USD/CAD trade (-80 pips loss)
- Buy GBP/USD trade (-14 pips loss)
The sum of our wins and losses is +90 pips.
Now, with this approach, some positions will inevitably generate some losses. What we aim is to construct a currency portfolio that is non-directional and makes us money regardless if we’re wrong on the trend direction.
As we said in the title you have to learn to win when you lose.
Losing trades are anyway part of the job of being a trader.
Another approach that you can use to implement the forex basket trading method is to use a forex currency index, like the US dollar index
Basket Trading using a Currency Index
A currency index is an index that measures the value of one currency against a basket of foreign currencies. Most traders are only familiar with the US dollar index DXY, but the reality is that you can construct an index for the GBP, EUR, JPY and other currencies.
Some trading platforms have built-in different currency basket index that you can use for free.
For this forex basket trading system, we would need to use a combination of a minimum of three instruments.
Let’s assume we want to gauge the strength and weakness of the British Pound across the board.
For this purpose, we’re going to use the British Pound index and two other GBP crosses like GBP/USD and GBP/JPY.
See the forex chart below:
This basket trading strategy involves gauging the strength and weakness of currency pairs by studying the price structure and the relationship between the currency pairs.
What we mean by this is we look to find clues in the price action for possible divergence signals between the currency pairs. And, then act based on that information.
If the British Pound index makes a new higher high, but one of the GBP crosses fails to make a new higher high that is a sign of weakness and a possible reversal signal.
See the forex chart below:
We can note that both the British Pound index and GBP/USD move in tandem, but the GBP/JPY breaks the correlation and fails to make a new higher high.
In this trade situation, we can sell the currency pair that is the weakest i.e. GBP/JPY.
But at the same time, we can sell the whole GBP crosses to spread our risk evenly across multiple currency pairs. Now, as you can tell, basket trading can be implemented in various ways. You can experiment with different types of trading scenarios and come up with your own unique forex basket trading strategy.
Final Words – Forex Basket Trading Method
In summary, losing trades can be a good thing if you prepare strategically by implementing successful forex basket strategies. The forex basket trading strategy has the potential for a massive amount of profits if you’re good at picking up currency pairs and implement superior risk management techniques.
Being a consistent trader, it’s not a one-time event; it has to be a habit. In order to be a consistent trader, you need to be involved with multiple currency pairs as this will increase the probability of your success. With basket trading, even if some currency pairs will show losses, you’ll have others that will offset those losses and you’ll come victorious in the end.
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