Many forex traders choose the currency pair for trading without much study. Many traders make the mistake of forming their opinion around only one currency in the pair, ignoring the other currency in the pair. Right choice of the currency pair is essential for making good returns.
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.
This neglect of the other currency economic conditions can greatly hinder the profitability of the trade. It also makes the odds of a loss high.
When you trade against a strong economy, the chances of failure are more. The weak currency in the pair could flop badly while the strong currency in the pair may appreciate more 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 market reaction was over, GBP rebounded and recovered its lost strength, due to the consistent economic growth shown by the British economy at that time. However, JPY kept on depreciating due to the week performance of the Japanese economy during that time. Dollar almost gained more than 300 pips in two weeks against the Yen after March 22, 2005.
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 short, when you choose the currency pair try to keep the strong economy/weak economy pairing in mind for maximum returns.