Forex Basket trading refers to a concept of buying or selling a large number of currency pairs simultaneously. It is a trading strategy that can be commonly used by institutional traders to hold positions in specific sectors and to diversify portfolios.
The strategy gets its name “basket” because a trader can buy or sell multiple assets at the same time, thus creating a “basket” of positions.
Basket trading was originally applied in the stock market, but now it is used in various financial markets, including the forex market.
What is Forex Basket Trading?
In the forex market, currencies tend to move with the trend, whether in uptrend or downtrend for a long duration. Basket trading measures the strength or weakness of a currency pair and executes trades based on this analysis.
For implementing basket trading, a trader buys or sells currency pairs at the same time. This is usally done so that if price moves against the trader’s position on one asset, it will move in their favour on another. Thus, it can be seen as another way to diversify a trading portfolio.
Basket trading requires traders to hold positions for a specific period in portions. This way, a trader executes multiple trades at once.
Traders can use two different pairs in the Basket to go long or short. For example, a trader may wish to short EUR/USD and long GBP/USD.
Besides this, forex traders can apply Basket trading if the price of currency pairs moves at a particular amount.
Once, the Basket is implemented, traders can view each trading positions. Traders can close these positions one at a time or a number of them.
Basket Trading Example
For this example, we’ll pick only seven currency pairs. However, basket trading can involve much more, depending on the underlying trading strategy.
Suppose a trader selects EUR/USD, GBP/USD, AUD/USD, USD/JPY, CHF/USD, EUR/JPY, and USD/CAD. He analyzed the market situation and found EUR/USD, GBP/USD, AUD/USD, and EUR/JPY is on the rise, while USD/JPY, CHF/USD, and USD/CAD is declining.
He buys the pairs that are on the rise and sells those which are in decline. The trader distributes 50% of the amount on EUR/JPY and AUD/USD while 50% on the remaining five pairs. By allocating the amount between the pairs, he would profit from either all currency pairs or some.
In the above example, there is a chance that all of these currency pairs would move against the trader’s will. Even if some of them go in the opposite direction, the trader could still benefit from the remaining currency pairs.
It’s important to note that retail traders don’t often apply Basket trading, as large amounts are required. But, institutional traders may try to take full advantage of the Basket.
Some institutions and corporate firms may rely on Basket trading, as they buy and sell large quantities of assets; it is difficult to execute trades altogether.
One of the advantages of Basket trading is traders can use it in various markets at the same time. For example, a trader can pick Basket of forex, stocks, and commodities.
Basket trading can be done as an automated trading strategy. A trader could in theory program the code for buying only those Basket of currency pairs that are moving downwards. So, later he/she can sell them at a higher price.
Basket Trading Strategy
One of the strategies that traders apply with the Basket is USD shorts. The approach involves selling USD against a group of currencies.
Traders who apply this approach believe that the USD may decline. They diversify their portfolio by trading against a single currency.
If a single currency shows a significant drop, traders positions are diversified. Currency appreciation represents an increase in one currency’s value relative to other currencies.
Forex Basket Trading Conclusion
Forex Basket trading is when a trader chooses multiple currency pairs at once to try and diversify their selection. It can lead to signficant drawdowns if not done correctly but can also be used to create a diversified trading portfolio.
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