Watch your risk when trading multiple forex positions
The other day I received an email from a fellow in which he was describing his trading of and thoughts about USD/JPY and EUR/JPY. He was trading both currency pairs long at the same time, and made mention of his concerns about the potential reaction of his positions to a pending bit of economic data. That got me wondering if he realized what he was doing from a risk perspective.
One of the easiest traps for a new forex trader to fall into is ratcheting up their risk by taking on multiple positions which are highly correlated. For example, if you go long USD/JPY and long EUR/JPY you are essentially going double short the Japanese Yen. Anything which happens to impact the JPY is going to hit both those positions. Now, if you’ve made the requisite adjustments and cut your position size down you might be fine, but a lot of traders don’t do that. They think of the two pairs as seperate things and take positions as if that were the case.
This is the same type of mistake that a trader going long EUR/USD and short USD/JPY makes. Those are both short U.S. Dollar positions. If the USD makes a run it is likely to do so comparably against both currencies, meaning that if you’re on the wrong side of that move you could lose twice what you had originally thought of as your risk.
Adding to the issue here is when one puts on two positions which actually change the net exposure they are taking. For example, going long EUR/JPY and short USD/JPY is basically the same as going long EUR/USD. The JPY parts of those trades essentially cancel out (depending on position sizes, of course). What this means for the trader is that his account P&L is now mostly driven by EUR/USD in a double dose, not two seperate single shot positions.
These overlapping exposures are one of the reasons why I and other experienced forex folks recommend that new traders stick to having just one position on at any given time. My own personal advice is that if you want to be long or short a given currency (like USD or JPY), pick the one pair including that currency which looks the best (or worst) out of those available, and just trade that one.
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