Constructing currency pairs from basket relative strength

A position is already two currencies

A currency is not traded as a standalone instrument. Every position is a quote of one unit against another. Currency translation means expressing one currency only through another, so any position is simultaneously long one unit and short the other.

A long pair holds the base unit and sells the quote unit at the same time. A short pair reverses those two legs. Because quotes are two-sided, one constructed position can combine relative strength in one currency with relative weakness in another.

Rank the basket before you pick a pair

Strength and weakness are defined only by comparison, so construction starts from a liquid benchmark basket such as the dollar, euro, yen, pound, and Swiss franc. The Australian and Canadian dollars are available as extra members.

Intermarket analysis here means comparing several currencies through that shared basket so one pair is placed in a broader strength-and-weakness regime instead of being judged from a single quote.

Each candidate is scored by trend direction and net percentage price change against the other basket members over a chosen horizon that may be weekly, monthly, daily, or hourly. A currency is not compared with itself. The relative-strength index in this workflow is that ordering by percentage price change over the defined sampling interval and lookback, so the strongest and weakest units can be selected for pair construction.

Net the changes and assemble the quote

Net-basket change is the combined appreciation or depreciation of one currency versus every other member of the benchmark set over the chosen lookback. In a five-currency euro illustration, one-week percentage changes versus the remaining basket members were 1.71 percent against the dollar, 2.89 percent against the yen, minus 0.99 percent against the pound, and 2.76 percent against the Swiss franc.

After those basket comparisons are netted, the most appreciated currency is treated as strongest and the most depreciated as weakest. If those ranks persist, strength-weakness pairing assembles one quote that holds the most basket-supported currency long and the least basket-supported currency short. In the illustration that pair was euro versus yen.

Use the same ranks to exit

The same basket ranking can also mark an exit when the two legs relative strength or weakness changes enough to suggest the prevailing trends are ending or reversing.

Unweighted percentage-change ranking across pairs is not a precise weighting scheme, but it is presented as sufficient to separate relative strength from relative weakness.