Foreign exchange, or forex, trading involves buying and selling different currencies in pairs. When you trade forex, the currency you buy is referred to as an asset, while the currency you sell is called a base currency. Understanding the differences between asset and base currencies is key for forex traders.
In this comprehensive guide, we’ll explain exactly what an asset is in forex trading and how asset currencies work. Read on to learn:
- What an asset currency is in forex
- How to choose the right asset currencies
- Key factors that impact asset currencies
- Popular asset currency pairs for trading
- Tips for effectively trading asset currencies
What Is An Asset Currency In Forex?
In the forex market, an asset currency is the currency being bought or traded against the base currency in a currency pair. It represents the numerator in a forex pair and is located on the left side.
For example, in the EUR/USD currency pair, the euro is the asset currency while the U.S. dollar is the base currency. This means 1 euro can be exchange for a variable amount of U.S. dollars. The euro fluctuates against the dollar based on the relative strength and economic factors of each currency.
When you’re buying or going long on a currency pair, you are buying the asset currency and simultaneously selling the quote or base currency. If you think the asset currency will rise in value compared to the base, you will buy that pair. The opposite is true when selling or going short.
Essentially, asset currencies are the “products” that traders are buying and selling in forex pairs. Choosing currencies likely to appreciate against their base pair is key to successful forex trading.
How To Choose Asset Currencies For Trading
With dozens of potential currencies to trade, how do you know which will make the best asset currencies for your trading strategy? Consider these key factors:
- Relative economic strength – Look for currencies from economies that show strong economic growth, stability, and financial health. These currencies tend to appreciate against currencies from weaker economies.
- Interest rates – Currencies with higher interest rates tend to attract foreign capital and increase demand. This leads to currency appreciation.
- Inflation rates – Look for currencies with low, stable inflation. High inflation decreases a currency’s value.
- Political stability – Currencies from politically stable countries are generally safer assets versus currencies tied to political unrest or uncertainty.
- Central bank policy – Central banks impact currency valuations through monetary policy, intervention, and interest rates. Consider a central bank’s stances and goals.
- Trade flows & balance – Currencies from countries with stronger trade surpluses and balances tend to be more valued.
- Technical analysis – Analyze price trends, volatility, volume, and market sentiment using charts and indicators to gauge a currency’s momentum.
The best asset currencies have fundamental economic and technical factors working in their favor. Always research potential asset currencies before trading to determine if appreciation potential exists against the base currency.
5 Key Factors That Impact Asset Currencies
Asset currencies don’t fluctuate in a vacuum. There are a number of interconnected global economic factors that impact their valuations against base currencies. Consider these top five:
1. Relative Interest Rates
Central banks increase or decrease interest rates to influence economic factors. Higher interest rate currencies typically attract greater foreign investment, boosting demand for the currency and its relative value.
If a currency has a significantly higher interest rate than another, it will likely appreciate as investors seek to capitalize on the rate difference through the carry trade.
2. Economic Performance & Outlook
An economy’s overall performance and future outlook directly impacts its currency’s value. Key metrics like GDP growth, unemployment, manufacturing activity, and business confidence affect perceptions of the economy.
Strong economic data boosts the likelihood of a currency rising against its pairs. Weakness has the opposite effect.
3. Monetary Policy Shifts
Central bank decisions around monetary policy, like adjusting interest rates or buying bonds to increase money supply, greatly sway currency valuations. Loose, dovish policy weakens currency value while hawkish tightening strengthens it.
Changes in policy direction often cause significant currency movements. Paying attention to central bank meetings and communications is critical.
4. Political Stability & Uncertainty
An unstable political climate increases uncertainty, impacting currency volatility and valuations. Elections, referendums, unrest, and regime changes can all cause swift currency reactions.
Geopolitical risks, wars, pandemics, and natural disasters also erode investor confidence, prompting flight to safe-haven currencies.
5. Risk Sentiment & Market Psychology
Currency trading is driven by market psychology around risk. During times of growth and stability, traders embrace risk and bid up asset currencies tied to higher yields.
In times of volatility and uncertainty, traders flock to safe havens, selling riskier or volatile currencies. Monitoring overall risk sentiment is key.
By analyzing these 5 core factors, traders can better forecast price movements between asset and base currencies.
Popular Asset Currencies For Trading
While you can trade all currencies in the forex market, certain currencies tend to be favored assets among traders due to their liquidity, volatility, and fundamentals:
Euro (EUR)
The euro is the second most traded currency behind the U.S. dollar and the official currency of the Eurozone. Its high liquidity and volatility against USD, GBP, JPY, and other major currencies make it a top asset.
U.S. Dollar (USD)
The U.S. dollar is the dominant global reserve currency and most widely traded in forex. USD is involved in nearly 90% of all forex transactions. Major USD pairs include EUR/USD and USD/JPY.
Japanese Yen (JPY)
The yen holds major market share in forex volumes. Japan is the world’s third largest economy. JPY is commonly traded against USD, EUR, GBP, AUD, and other major pairs.
British Pound (GBP)
The official currency of the United Kingdom, GBP is the fourth most traded currency in forex markets. It sees high liquidity and volatility against USD, EUR, JPY, CAD, and AUD.
Australian Dollar (AUD)
AUD has grown popularity as an asset currency based on Australia’s commodity exports and relatively high interest rates. It’s commonly traded against USD, JPY, EUR, GBP, and NZD.
Swiss Franc (CHF)
Known as a safe haven, the Swiss franc trades against EUR and USD in major pairs. The Swiss National Bank often intervenes to suppress excessive appreciation of the franc.
Canadian Dollar (CAD)
CAD is strongly correlated to oil prices and trades heavily against USD and EUR. The Bank of Canada has a hawkish stance on inflation, impacting valuations.
These seven currencies account for the vast majority of global forex trading volumes and offer excellent liquidity. Focus your analysis on their fundamentals and technicals.
Tips For Trading Asset Currencies Successfully
Here are some key tips and strategies to trade asset currencies profitably:
- Analyze fundamentals – Follow economic data, news, and events that may impact valuations between currency pairs.
- Study central bank policy – Interest rate changes and monetary policy shifts will directly impact currency valuations.
- Track risk sentiment – Monitor overall risk appetite and market fear. Uncertainty benefits safe havens while optimism favors higher-yields.
- Utilize technical analysis – Spot price trends and ranges. Indicators like moving averages and MACD can identify opportunities.
- Manage risk – Use stop losses and maintain appropriate position sizing to limit downside. Don’t risk more than 1-2% of capital per trade.
- Watch correlations – Some currencies move closely together while others may diverge. Understand these relationships.
- Be flexible – Remain nimble and objective. If your outlook on a currency pair changes, don’t stay married to the original view.
Properly researching, analyzing, and managing trades focused on the strongest asset currencies can lead to success in forex markets long-term.
Conclusion
Choosing the right currencies to buy and sell is central to forex trading success. Asset currencies represent the “products” that traders exchange in currency pairs, planning to sell at a higher valuation.
The best asset currencies come from countries with strong economic fundamentals and healthy outlooks. Factors like GDP, interest rates, and monetary policy impact their valuations.
Focus your trading on highly liquid major pairs involving currencies like the U.S. dollar, euro, pound, yen, and Australian dollar. Analyze the fundamentals and technical price trends to determine which currencies to buy as assets versus sell as bases.
With the right approach, trading asset currencies can diversify an investment portfolio and potentially lead to impressive profits. Just remember to also manage risk appropriately.
Want to start trading forex asset currencies? Open a risk-free practice account to sharpen your skills before trading live markets. What asset currencies are you watching right now? Let us know in the comments section below!
