The choice of the right currency pair in forex trading is very vital. Many traders make the mistake of shaping opinion around only one currency, ignoring the other currency in the pair.
Most of the trades involve US Dollar as either the base currency or the counter currency. Many traders make the mistake of only studying the economic factors that have the potential of affecting dollar.
In the forex market, this neglect of the foreign economic conditions can greatly hinder the profitability of the trade. It also increases the odds of a loss. You need to know a small bit of fundamental analysis when you make your choice of the currency pair.
The chances of failure are more when you trade against a strong economy. The weak currency in the pair could tank terribly while the strong currency in the pair may become stronger than what you calculated.
While choosing a currency pair to trade, one should study the economies of both the currencies. Finding the strong economy/weak economy pairing is the best strategy to use when maximizing returns.
For example, when FED announced its intention of containing inflation in March 22, 2005 FOMC meeting; most of the other currencies tanked against the dollar. A string of other positive economic data also reinforced the dollar.
When the initial reaction was over, GBP rebounded and recovered its strength, due to the impressive economic growth of British economy at that time. But, Yen kept on depreciating due to the week performance of the Japanese economy during that time. Dollar gained more than 300 pips in two weeks against the Yen during this time.
Therefore, USD strength had a much higher impact on the struggling Yen as compared to the consistently strong GBP.
Study the economies of both the currencies in the pair. Examine the behavior of various crosses. In small, when you choose the currency pair try to keep the strong economy/weak economy pairing in mind for maximum returns.