Sunday, December 28, 2008

Trading GBP/JPY

Some time ago I wrote about GBP/JPY. Today I received the following eMail:

i really like the way you descibe gbp/jpy in the blog globetrader and i really want to learn more about gbp/jpy market as the way u seen it or trade u have any system,e book,or whatever that can enrich my knowledge on this gbp/jpy market.. i only trade on gbp/jpy but only a small trader and plan to increase lot by few months.

The system, the things I look at in trading can be found in my blog. Sometimes I rearrange them, put things together in a different way, but they are all there. I’m trading for some time now and the longer you trade the more you will find that there is nothing new. Just ways to look at things this or that way.

Sure not every market is the same. Some markets move slowly like a big river, others move fast, but still predictable and then there are markets which are just too fast to trade, which have swings you can’t survive in the long run.

GBP/JPY is called the widow maker…and for a reason

I hope you have learned already that there are major pairs in Forex trading and then there is the rest. Some pairs of this rest are still traded very active, but with the exception of a few days and weeks they are at the mercy of the majors. The 6 (eventually 7) majors are all traded against the US-Dollar and they are EUR/USD, JPY/USD, GBP/USD followed by USD/CHF, USD/CAD, AUD/USD and the last NZD/USD. You might add the Renminbi, but as the Chinese currency is not free floating, it’s not(yet) in the list.

EUR/JPY is the major cross-currency followed by a big gap and then the GBP/JPY and the EUR/GBP, followed by the other former carry-trade currencies (AUD/JPY CAD/JPY and NZD/JPY). Other cross-currencies I would just not look at, as they are not actively traded.

What is the difference between a cross-currency and one of the majors? Why do I have to concern myself with the GBP/USD market if I want to trade the GBP/JPY market (or the USD/JPY market)

Unlike other markets the FX market is interconnected. There are no imbalances. Every cross-rate can be expressed by looking at each of the two against a third currency. And guess, what that third currency is? The US-Dollar as the most liquid currency in the world.

Assume you are a big player being in need of Japanese Yen and what you have is British Pound. You go ahead and trade British Pound against the Yen? I wouldn’t guess so! You would crush the market, actually you wouldn’t but only because all other big players would compensate for your folly and let you pay for it. You not being dumb will avoid that folly and you will first trade your GBP against the USD, which might move the market by a few ticks but nothing major and then you will trade the USD against the Yen, which will result in nearly no movement at all as the USD/JPY market is extremely liquid and as big as your trade might seem, it’s just a small one compared to the daily total trade volume in the USD/JPY market.

But your trade will still influence the GBP/JPY market as the GBP/JPY exchange rate will not be found by market forces of Buyers looking for Sellers or vice versa. The GBP/JPY exchange rate is found by doing the following calculation: GBP/JPY = GBP/USD * USD/JPY

And if there is any deviation at all from that mathematical result (maybe caused by market orders which bring the GBP/JPY market out of line) then arbitrage programs will make sure, that the GBP/JPY exchange rate will be back at the mathematical correct value in no time at all. Any deviation from that value is riskfree money. A deviation from the correct value of 0.0001 times is a huge amount of money, which arbitrage can give you absolutely riskfree. So if you want to trade GBP/JPY you actually are trading 2 markets: The GBP/USD market and the USD/JPY market.

If you can do that and if you can read both of these markets without a problem, then go ahead and give yourself the new challenge of trading the GBP/JPY market. But if you are new or just not as experienced, then I would suggest you first master the USD/JPY and the GBP/USD markets before you take a look at the GBP/JPY market. Yes you can make fantastic profits in that market, but can you survive 50 to 100 pip moves against you, which are just a wiggle in the longer trend? Will you be able to use adequate Stops in that market? Are you prepared for the spike in GBP/JPY if GBP/USD trades up to 1.4710 while USD/JPY trades at 90.60 and can you tell me without a second thought what direction the spike in GBP/JPY will have, when GBP/USD and USD/JPY both retrace, when GBP/USD retraces back to support at 1.4660 while USD/JPY remains in the 90.50 to 90.70 range. Do you know what Stop to use, when you are long GBP/JPY at 133.25 in that scenario?


Do your account a favor and master the major pairs first. GBP/JPY will still be there, when you are ready to trade it.