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Forex Basket Trading Strategy
Basket Trading Strategy
Diversification is a golden rule in trading, which is the basis of basket trading strategy. In other words, don't put all your eggs in one basket.
Basket trading in Forex is selling and buying different currency pairs simultaneously, they can be both correlated or uncorrelated. The goal is to exit in surplus after closing all open positions. That is, not every position needs to be won, but the total must be positive. But before we start, if you are new to trading in Forex, it is best to start with the basics, “What is Forex trading”.
KEY TAKEAWAYS
- A basket trade is a portfolio management strategy to purchase or sell a large number of securities at the same time. Strategy can be applied on futures and Forex trading as well.
- Basket trades allow investors to create a trade that is customized for them, which allows for easy distribution across many securities, and that gives them control over their investments.
- Trading baskets can be a various mix, from collections of securities and currency pairs to commodities and investing products.
What is Basket Trading
Basket trading is a type of trading that simultaneously trades a group of different securities or currency pairs. It can be used on different financial markets f.e. Forex, stock, futures, etc.
Strategy lets a trader create a list of stocks, called a basket, that he/she can save, trade, manage and track as one entity. Baskets can be used to invest in and track stocks grouped by investment style, market sector, life event, or any classification trader choose.
Note: It is important to have a good understanding of the economics of the currencies that the investor trades.Basket Trading Example
Firstly, trader should find a particular currency pair that has a clear trend - bullish or bearish. After determining the general direction of a particular currency pair based on the strengths and weaknesses of the two currencies, a basket of currencies can be selected.
For example, if a trader has established a strong USD/JPY bearish trend, it will become the base Forex pair for his/her basket. USD/JPY bearish trend means that the Japanese Yen is strengthening.
Once establishing that Yen is strengthening, instead of going short only for USDJPY pair, trader should diversify - also go short for GBP/JPY, EUR/JPY and AUD/JPY.
So if a trader planned to risk 4% only on the USD/JPY trade, now this risk can be distributed on four currency pairs - 1% on each currency pair individually. Of course, if the main trend is established wrong, losses are inevitable.
GeWorko Method
GeWorko method is a great tool for revealing correlated instruments, portfolios and trading them. This method allows traders to create a portfolio where a financial asset is quoted by another, it could be quantitative, percentage, and price ratios.
After a trader has created a portfolio, he/she can follow assets relations - figuring out if they exist (relations), for example, if relationship graph is a constant straight line it means that when one asset changes the other changes equally, or constant oblique line, it means when one asset grows the other decreases, and the trader can make a conclusion what to sell or buy.
A distinctive feature of the method is the way of expressing the value of an underlying asset, or a portfolio, through the value of a quoted asset, or a portfolio of assets based on the ratio of their prices. The GeWorko method extends the currency cross-rate model to arbitrary assets and asset portfolios.
Benefits of Basket trading
- Basket trading helps investors control their investments. Traders can add or remove individual or several securities to the basket. Tracking the overall performance of the basket of transactions also saves time monitoring individual securities and simplifies the administrative process.
- Basket trades make it easy for investors to disperse their investments across multiple securities. Investments are typically distributed using share quantity, dollar amount, or percentage weighting. Share quantity assigns an equal number of shares to each holding in the basket. Dollar and percentage allocations use a dollar amount or a percentage amount to distribute securities.
- Investors can create a basket that matches their investment goals. Baskets can contain stocks from a specific sector or stocks with a specific market cap.
Bottom Line
Basket trading strategy doesn’t have disadvantages, the whole purpose of it is to diversify the risks. Benefits include - personalized choice, easy distribution and control. Basket trading strategy can be applied on futures and Forex trading as well.
Losing trades is an integral part of basket trading as well, and traders should be prepared for it when creating a portfolio. When using this strategy it is important to have in portfolio assets that will offset those losses so as to come out with a profit.
Basket trading strategy has the potential for a big amount of profits, if done wisely.