It is of utmost importance for individual/retail traders to find the best currency pair to trade. As a retail trader, you will only have $1,000 to $10,000 in your trading account. For you, opportunity cost is a real cost as an individual trader. If you commit your funds to anyone currency pair, those funds cannot be used in other possibly more profitable trades in other currency pairs.
In forex trading, almost all the currency pairs are linked to one another, one way or the other. As an individual trader, if you only trade US dollar, you risk missing promising trades and opportunities offered by other currency pairs.
Most of the trading is done through the direct buying/selling of US dollar. You should always keep an eye on the crosses in order to gauge the strength/weaknesses of a currency. This will tell you which currency pair is the best to trade.
You may ask, what are the crosses? Currency pairs that do not involve USD are known as Crosses such as EUR/JPY, EUR/GBP, EUR/AUD, CHF/GBP etc. Almost more than 90% of the currency pairs that are actively traded in the forex markets involve the USD. In simple language, over 90% of the all the currency trades have USD on one side of the trade either long or short. So what is so special about a cross that you should know?
Lets make it clear with an example. A good method to trade equities is to trade from big to small. Suppose, you determine that the stock market is bouncing and is expected to rise. But you have limited funds as an individual investor; so you should choose your stocks carefully.
It would be good to look at the sector specific indices like health, energy, transport, education, technology. Find the most promising sector among them. Once you have identified a promising sector, you should look within that sector. Find the most promising companies that are expected to perform well over the coming months and buy their stocks. This big to small thinking is very solid. You need to think in the same manner while trading currencies.
Movements in crosses should never be overlooked as they can often hide the footsteps of large players. For example, a major investor like Warren Buffet may be bullish on Euro due to some fundamental reasons. He may try to fly under the radar and buy Euros against Pound Sterling, Swiss Francs, and Yen etc. Warren Buffet is sometimes heavily involved in currency trading when he senses an opportunity. He has sometimes been successful and sometimes unsuccessful.
Crosses are extremely important to swing or momentum traders! They are used as forecasting tools to predict which currencies lead the pack. Ignore the crosses and you will be often stuck with currency pairs that do not move much.
Limited funds in your account means you should always try to choose the currency pair that is expected to move the most. But, how exactly can you come to a reasonable conclusion? By taking a look at the crosses!
Cross movements either work to amplify the move of a major currency pair or minimize the effects. For example, in EUR/USD, if Euro is dropping against US Dollar but rising against the Pound, the net effect would be to limit the size of the EUR/USD fall. If ERU/GBP is rising, it is telling us that the Euro is outperforming the British Pound.
Limited funds means you need to choose the best currency pair? Any EUR/USD selling pressure is likely to be offset by the buying pressure of EUR/GBP. GBP/USD sales are likely to be amplified by the cross sales EUR/GBP.
Since, EUR/GBP is rising; it would be better to short GBP also called the Cable instead of Euro. In simple words, you should short the pair GBP/USD; the chances are you will make many pips as compared to shorting EUR/USD. If we had not done our homework and randomly picked one of the two currency pairs for shorting, we may have missed a good opportunity.