USD/CHF Forex Trading Strategy

USD/CHF Currency Pair Overview

This article will cover the following

  • Overview of the US economy
  • Overview of the Swiss economy
  • Properties of the USD/CHF cross
  • Average spread, volatility, correlation to other pairs
  • Trading strategies
  • and more

As you well know, the US dollar is the world’s major reserve currency, which stood on one side of 87% of all trades in the Forex market as of April 2013, according to a report by the Bank for International Settlements. The Swiss franc, on the other hand, albeit not so popular, has the status of safe haven, rendering it very appealing during times of political or economical distress. Switzerland is well known for its political neutrality and stable and discreet banking system.

It is no wonder then that the USD/CHF cross is among the most traded ones, albeit trailing far behind the leaders. To be exact, the Swiss franc stood on 5.2% of all trades in the Forex market as of April 2013, according to the Triennial Central Bank Survey by the BIS, ranking it 6th by popularity. The USD/CHF pair accounted for 3.4% of total turnover, also taking the 6th place.

US economy

United-States-Flag-1-iconThe United States is the world’s largest economic power with a nominal Gross Domestic Product (GDP) at the amount of $16.8 trillion in 2013. It represents almost 25% of the global nominal GDP. It is also the world’s second-largest trading nation.

The US economy is primarily service-oriented, as almost 80% of the GDP is produced by sectors such as real estate, transportation, financial services, other business services and health care.

The country is the second-largest manufacturer in the world with an industrial production of $2.43 trillion during 2013, or larger than the output of Germany, France, India and Brazil combined. Major industries are petroleum, steel, automobile production, aerospace, construction and agricultural machinery, chemicals, electronics, telecommunications.

Moreover, as of 2013 the United States is the third-largest producer of oil (8 453 000 barrels per day, or 9.97% of the global total oil production) and the largest natural gas producer (66.5 billion cubic feet per day).

Taking into account the sheer size of the US economy and its pillars of strength, one can clearly understand the effect of economic data from those sectors on the US dollar, and in turn on the global Forex market. After all, the greenback stands on one side of 87% of all trades.

Major economic indicators

– Non-farm Payrolls

– Consumer Price Index

– Producer Price Index

– Trade Balance

– ISM Non-manufacturing

– ISM Manufacturing

– Federal Reserve Minutes

– Consumer Confidence (Conference Board and Thomson Reuters/University of Michigan survey)

– Retail Sales

– Industrial Production

To learn more about the indicators listed above, read our article “Profile of United States’ Dollar – Major Economic Reports

Swiss economy

Switzerland-iconSwitzerland is one of the most prosperous economies in the world, famous for its highly-skilled labor force and financial and political stability. With a Gross Domestic Product of $371.2 billion (purchasing power parity) in 2013, it is the 37th biggest economy in the world. Although this would seem small at first glance, Switzerland ranked 11th by GDP per capita at $54.800 in 2013.

The Swiss political and economic stability, transparent legal system, low corporate taxes and efficient capital markets, as well as international neutrality have made the country a safe haven for investors, especially during the global financial crisis, adding to its currency’s value. As a result, Switzerland has become the world’s largest destination for offshore capital, making it increasingly dependent on a steady tide of foreign investment.

Due to the country’s diversified economy, the confidentiality and financial stability which attract capital flows tend to drive growth during times of global financial crises and risk aversion, while trade flows boost the economy during times of prosperity and an overall risk-prone environment. Gross Domestic Product composition by sector of origin in 2013 was as follows:

– agriculture: 0.7%
– industry: 26.8%
– services: 72.5%

Although Switzerland remains outside the European Union, its economy is very closely tied and heavily reliant on the EU as a trade partner. Switzerland enjoys extensive trade flows with its European neighbors, as well as the US and other markets across the globe with interest for its high-quality goods.

euro-iconLater in the article we will explore the correlations between USD/CHF and other pairs and what will instantly become obvious is the high positive correlation with the euro. This is especially obvious during times of stable global political relations and economic conditions when the franc’s value is not boosted additionally by safe haven demand.

That said, a trader might expect that when the euro moves in a certain direction and the franc doesn’t follow up instantly, it should eventually narrow the gap, based on the historic evidence of high positive relation. The same is in force when the franc leads with a move and the euro is projected to respond. However, keep in mind that the relation between the two changes during times of economical and political instability, especially when central bank policies begin to diverge in response to unique risks within each country.

Major economic indicators

– GDP

– Consumer Price Index

– Retail Sales

– KOF Leading Indicators

– Trade Balance

– SVME Manufacturing PMI

– ZEW Economic Sentiment Index

To read more about the indicators listed above, please refer to our article “Profile of the Swiss Franc – Characteristics and Major Economic Indicators

Properties of the USD/CHF cross

Average Spread

Depending on the Forex broker used, the spread can be fixed, floating, or both. For the purpose of this article, we have chosen the average spreads provided by 10 brokers, namely Saxo Bank, Dukascopy, Alpari UK, XM, Forex.com, FxPro, Markets.com, eToro, FXCM and Iron FX, and aggregated all the spread data provided to a single average spread, in the USD/CHF case – 2.0 pips.

Relative performance against other pairs

We conducted a series of calculations to gauge the performance of the EUR/USD pair relative to other crosses which include either the euro, or the US dollar over a certain period of time. For details about the calculation’s results, visit the appendix. Calculations are conducted on the basis of the EUR/USD cross, which registered a prominent high on May 8th 2014 at 1.3993. Thus from here on, we calculate the movement of each euro and USD cross with May 8th as a starting point and spanning to the December 31st close.

In the case of the USD/CHF pair, in Table 1 we see that cross jumped by 12.935% during the tracked period, which ranks the Swiss franc 12th in our currency performance list (Table 1.1).

Correlations to other pairs

arrows_correlationIn finance, correlation refers to the connection between two assets and how they move in relation to each other. As a key component of advanced portfolio management, correlation is crucial for achieving maximized risk-adjusted return. Ranging between -1 and +1, a correlation close to the upper limit means that the two currencies are moving in almost perfect consonance, allowing for almost no diversification, and vice versa. A correlation of 0, which in the world of finance practically does not exist, means that movement of the two assets is completely random.

Below you can see a table containing pairs with some of the strongest positive and negative correlations relative to USD/CHF. The statistics are derived from daily market data encompassing 300 periods, spanning back from January 8th, 2015.

Top 5 positive correlations
USD/DKK 0.99
USD/JPY 0.93
CAD/JPY 0.89
USD/RUB 0.83
USD/SGD 0.83
Top 5 negative correlations
EUR/CAD -0.86
EUR/CHF -0.87
GBP/USD -0.91
NZD/USD -0.92
EUR/USD -0.99

Notice the correlation to EUR/USD, almost perfect negative, which means that when the euro gains against the dollar, the Franc will lose against the dollar by the same amount (i.e. EUR and CHF have almost perfect positive correlation). Of course, the tracked period encompasses only 300 periods, thus historical volatility will not be so close to perfection, but it will still likely be at least 0.9.

Volatility

Volatility in Forex refers to the fluctuations a currency exhibits during trading. In turn, these fluctuations directly impact the amount of risk a trader is subjected to, but also his return. A higher volatility means that the currency could potentially perform a sudden and drastic move in either direction over a short period of time.

In contrast, low volatility implies that the exchange rate does not have the potential for wide fluctuations and instead moves at a steady pace over a longer period of time. Lower volatility carries less risk for market participants but it is also much harder to profit from, especially by shorter-term traders such as scalpers and day traders.

For the purpose of our article, we have selected to display volatility calculated for 2014 on a daily basis. Check the table below.

Date High Low Intraday Vol. Daily Vol.
Dec 31, 2014 0.9949 0.9877 0.729% 0.862%
Dec 30, 2014 0.9922 0.9864 0.588% 0.813%
Jan 01, 2014 0.9028 0.8905 1.381% 1.370%
Jan 01, 2014 0.8931 0.8906 0.281% 0.779%
Average for the year 0.583% 0.619%

As can be seen from the table, USD/CHF showed an average intraday volatility of ~0.58% during the selected 52 weeks, while the pair’s average day-to-day volatility was ~0.62%. During the examined period the pair tended to show a lower volatility in comparison with other majors such as NZD/USD, for instance. For a more comprehensive comparison, see Table 4 in the appendix.

At the beginning of the year the pair tended to have the most significant daily volatility. In late January and early February the cross showed daily moves of about 76-78 pips. As the year progressed, daily volatility decreased, as in June and July the pair showed daily moves of about 60 pips. The lowest daily volatility (about 55 pips) was registered in late August, at little over 55 pips.

Within a trading day the highest volatility was registered between 12:00 and 15:00 GMT (15-20 pips), when both European and US traders are active. The lowest volatility during the trading day was recorded between 3:00 and 5:00 GMT and between 21:00 and 23:00 GMT (under 10 pips).

Within a trading week the pair tended to show the highest volatility on Thursday (about 70 pips), with Wednesday and Friday tying for the second place at little over 60 pips, and the lowest volatility was seen on Monday (about 50-55 pips).

Carry trade

percentage_signCarry trades are one of the most popular trading strategies used in the Forex market. When performing a carry trade, a trader typically sells a currency with a relatively low interest rate, while buying a higher-yielding one. The aim is to profit from the difference in interest rates, which can be substantial, especially when taking into account leverage. To learn more about carry trades, please read our article “Using Carry Trades to Maximize Profit“.

The USD/CHF pair is currently not used for carry trades. Both the Federal Reserve and the SNB have set interest rates at rock bottom levels. However, this might change in the mid and long-term. The Federal Reserve has committed to begin raising borrowing costs in 2015, having already concluded its Quantitative Easing program.

On the other hand, the SNB imposed negative interest rates on December 18th, 2014, and reaffirmed its minimum exchange rate of CHF 1.20 per euro, underscoring its commitment to keep the floor enforced with the “utmost determination”. An interest rate of –0.25% was imposed on sight deposit account balances at the SNB after recent factors prompted increased demand for safe haven investments, the central bank said, with the introduction of the measure expected to ease demand for the currency and support the minimum exchange rate to the euro.

This monetary policy divergence is what could make the USD/CHF pair suitable for carry trades in the future, but just not yet. However, the Federal Reserve is not expected to hike interest rates to “normal” levels until at least 2017, so USD/CHF will take take time to build up carry trade appeal, if it does at all.

Using a basic carry trade calculator shows us that going long on USD/CHF with a standard lot and holding the position over 30 days would earn us around $40 in interest, respectively $4.0 for a mini lot and $0.40 for a micro lot. For comparison, going long on NZD/USD with the same parameters would earn us $267 for a standard lot.

Trading strategies

strategy_iconDifferent strategies can be employed when trading the USD/CHF pair. The pair is most liquid during European and US trading sessions, and more particularly when key economic indicators are released. Logically, the most intense trading will occur at the release of economic reports such as the US non-farm payrolls and unemployment rate, economic sentiment, manufacturing and non-manufacturing activity growth, durable goods orders, consumer inflation, retail sales etc, and respective key data from Switzerland.

Trading the major economic releases and other events without the help of technical analysis is basically done using three general strategies – using a proactive, a reactive or a mixed approach. Proactive trading suggests entering a position ahead of the release of the data and basing your decision on analysts’ forecasts, while the reactive approach implies entering the market after the data is published. Logically, a mixed approach combines the previous two. To learn more about these styles of fundamental trading, read our articles “Trading the News – Proactive Approach“, “Trading the News – Reactive Approach” and “Trading the News – Combining the Proactive and the Reactive Approaches“.

As we already mentioned, the strong positive correlation between the euro and the Swiss franc can be used to your advantage. By knowing that USD/CHF and EUR/USD move in such a distinct consonance, once one of the pairs moves, there is a very high chance that the other will follow up and act accordingly. This gives you a small hint in what direction to enter the market, shortly before it moves.

In some cases EUR/USD will lead the movement, and USD/CHF will follow, and vice versa. However, keep in mind that there is always a chance for the correlation to weaken or even break up at some point, especially when the ECB and SNB enter divergent monetary stances.