The Video - Introduction to the Swiss Franc

The Video - Introduction to the Swiss Franc

16 July 2016, 08:08
Sergey Golubev

Switzerland is one of the richest countries in the world, and while its economic policies and practices largely conform with EU standards, the country's population rejected accession negotiations with the EU in March of 2001. So, at least for the foreseeable future, the Swiss Franc is expected to remain one of the world's most actively traded currencies, with two dominating features that are important to us as forex traders.

Although this status has started to wane somewhat in recent years, the Swiss Franc has historically been considered one of the world's primary safe haven currencies, which means that money flows into the Swiss Franc during times of economic or geopolitical uncertainty. The primary reasons why this is the case are:
  1. The country's ability to remain out of Global Conflicts, a reputation it solidified by remaining neutral during both World Wars.
  2. Its economic stability and relatively low inflation rates.
  3. The fact that up until recently the currency was 40% backed by gold.
  4. Its reputation for high quality financial institutions and banking secrecy.

In 2005 the Swiss government sold the nations vast gold inventory, and as a result the currency is no longer backed by gold. Some argue that because of this the Swiss Franc has lost much of its safe haven status, something that there will surely be more tests of in the years to come.

The second thing that it is important for traders to understand about the Swiss Franc, is its strong correlation with the Euro. As the Swiss Franc is quoted on the opposing side of the Dollar when compared to the Euro, this means that the USD/CHF currency pair has a strong negative correlation with the EUR/USD currency pair. The two currency pairs shows the strong negative correlation of over 90% between the two currency pairs, resulting from the strong economic ties between Switzerland and the European Union.

The first reason that it is important for traders to understand this strong negative correlation, is so that they can take it into account when considering trades in both currency pairs. As the two currency pairs have such a high negative correlation, there is a very good possibility that a trader's technical analysis will show a buy signal in the EUR/USD, while at the same time showing a sell signal USD/CHF, or vice versa.

If this trader happened to be blind to the negative correlation we have just outlined, he or she may think that they are putting on two completely different trades. As we have just shown however, what this trader would actually be doing is doubling their exposure to the move they were trying to capture. Conversely, if a trader were to trade these pairs in the same direction, then they would effectively be reducing the potency of both trades, as the negative correlation between the two currency pairs will act to offset the gains or losses that result on each trade.

As the Swiss Franc is no where near as liquid as the Euro, on an intraday basis it is important to be aware that this negative correlation can breakdown some what. Lastly, should the Swiss political and/or economic environment (especially monetary policy) start to substantially diverge from that of the Eurozone, you could see a breakdown of this negative correlation on the longer timeframes as well.

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