Oil and Currency Trading
Wall Street watches oil prices like a hawk. Remember the early part of 2008 when oil prices skyrocketed from near $70 to almost $150 within a few months. This was more than a 100% increase in oil prices. Many hedge funds heavily betted on the increase in oil prices and made a windfall.
It is being studied whether the increase in the oil prices was due to speculation by the hedge funds. When the stock markets crashed in the middle of 2008, most of the hedge funds had to liquidate their investments in crude oil futures to cover the redemption pressure on them. Oil prices collapsed. Oil prices are down now due to low consumer demand because of the global recession. But it is being predicted by the experts that with a recovery in the global economy, the oil demand will rise and the prices will go up again. Oil demand in China and India plays a major role now.
As oil prices go up, consumers are forced to spend more on oil. The more they spend on oil, the less they can spend on other products. The less they spend on other products, the less profit companies make. Declining profits made by these companies mean declining stock prices.
The opposite is also true. The less the oil prices become, the more Wall Street becomes optimistic about the profit potential of companies. This increased optimism leads to increase in stock prices. Two large futures exchanges are used to determine the prices of oil. They are the New York Mercantile Exchange (NYME) and the International Petroleum Exchange (IPE).
Historically, rising oil prices have been associated with falling stock markets. NYME is where most of the crude oil futures are traded. By monitoring the movement of the crude oil futures in NYME, you can develop a feel of the future economic situation of the United States. Since oil is heavily traded in US Dollar, this affects the US Dollar. The net effect is however a bit complicated.
Lets take a look at it more closely to understand the two effects that pull USD with oil. When oil prices increase, the demand for US Dollar also increases. Most of the countries need US Dollar to pay for their oil imports. High demand for US Dollar means that it should appreciate.
But this is not the whole story. Increased oil prices also take its toll on the US economy. The question is which effect is more important for the forex markets.
The effect varies for different currency pairs. Suppose you are watching a currency pair that involves the USD and a currency representing a country that does well during the times of high oil prices. Take Canada that has huge oil reserves after Saudi Arabia. The effect would be depreciation in the value of USD/CAD pair. US imports more oil from Canada than any other country. And if you are watching a currency pair that involves USD and a currency whose economy is harmed by the rising oil prices, the demand for USD will rise.
So some currencies have positive correlation with oil prices and other currencies have negative correlation with rising oil prices. The currency pair CAD/JPY shows the strongest reaction to rising oil prices. Japan imports almost 100% oil.
Watch for CAD/JPY currency pair, when oil prices are going to rise again. CAD is positively correlated with oil prices. JPY is negatively correlated. So CAD/JPY has the strongest reaction to the increase in oil prices. It can be a very good currency pair to trade during times of oil price boom.
Why You Should Trade the Crosses?
Finding the right currency pair to trade should be of utmost importance to you as an individual trader. As an individual trader you will only have $1000 to $10,000 at the most as equity in your trading account. Opportunity cost is a real cost for most individual traders. Funds committed to anyone position are funds that cannot be used for in other possibly more profitable trades.
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 in the currency markets is done through the direct buying/selling of USD. You should always keep an eye on the crosses while deciding about a trade in order to gauge the strength/weaknesses of a currency. This way you know which currency pair is the best to trade.
What are the crosses, you may ask? Currency pairs that do not involve the dollar are known as Crosses such as EUR/AUD, CHF/GBP, EUR/JPY, EUR/GBP etc. Almost 90% of the currency pairs that are actively traded in the forex markets involve the US dollar. In simple terms, over 90% of the all the currency trades have US Dollar on one side of the trade. So what is so special about a cross?
Lets make it clear. A reasonable way to trade equities is to trade from big to small. Suppose, you determine that the stock market is expected to rise. But since you have limited funds as individual investors, you need to choose your stocks carefully.
It would be good to look at the sector specific indices. Find the most promising sector. From there, you should look within that index. Find the most promising companies that are expected to perform well over the coming months. This big to small thinking is very solid. You need to think in the same manner while trading forex.
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 are leading the pack. Ignore the crosses and you will be stuck often with currency pairs that do not move at all.
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 sometimes work to amplify the move of a major currency pair or sometimes these movements minimize the effects. For example, in EUR/USD currency pair, if Euro is dropping against USD but rising against the GBP also called Cable, the net effect would be to limit the size of the EUR/USD fall. If ERU/GBP is rising, it is an indication that the Euro is outperforming the British Pound.
Since you have limited funds, which currency pair is the best to chose? Any EUR/USD selling pressure is likely to be offset by the buying pressure of EUR/GBP. GBP/USD sales will 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.
Fundamental Trading Strategy Based on Interest Rate Differentials
As a forex trader, you should be aware of the role played by the interest rate changes in the general economic and investment climate. You should know that interest rates are an essential part of investment decisions and can drive currency markets as well as the stock and commodities markets in either direction. After the unemployment figures, Federal Open Market Committee (FOMC) rate decisions are the second largest currency market moving release.
The impact of the interest rate changes not only have short term consequences but also have long term impact on the currency markets. One Central Banks decision can affect more than a single currency pair in the interconnected forex markets.
In forex trading, an interest rate differential is the difference between the base currency interest rate and the quoted currency interest rate. In the currency pair, EUR/USD, EUR is the base currency and USD is the quoted or counter currency. The interest rate differential for the EUR/USD pair will be the difference between the Euro interest rate and the USD interest rate.
Understanding the relationship between the interest rate differentials and the currency pairs can be very profitable for you as a forex trader. In addition to the Central Banks overnight interest rate decisions, expected future overnight rates as well the expected timing for the interest rate changes can be crucial to the currency pair movements.
The reason why this is profitable is that international investors like big banks, hedge funds and institutional investors are yield seekers. They actively keep on shifting funds from the low yield assets to high yield assets.
Interest rate differentials are considered to be the leading indicators for currencies. London Inter Bank Offer Rate (LIBOR) and the 10 year government bond yields are usually used as leading indicators of currency appreciation or depreciation.
Lets take an example, suppose the Australian 10-year government bond yield is 5.25%. The US 10-year government bond yield is 1.75%. The yield spread in this case would be 350 basis points in favor of the Australian Dollar.
Suppose the Australian government raised its interest rate by 25 basis points. The 10 year Australian government bond yield would also appreciate to 5.50%. Now, the new yield spread is 375 basis points in favor of AUD. The AUD will also be expected to appreciate against USD.
The general rule of thumb used by professional traders is that when a yield spread increases in favor of a certain currency that currency is expected to appreciate against the other currency in the pair. This is important information for you as a trader. Interest rate data is available on Bloomberg. Keep track of the currencies in the currency pairs that you trade with that data.
Seasonal Trends in Forex Markets
You as a forex trader can either use fundamental analysis or technical analysis in studying the forex markets and making predictions about the future. The savvier among you will try to combine both in making predictions about the future direction a particular currency is going to follow.
Fundamental analysis depends on the study of underlying economic factors that affect currency markets. Technical analysis is based on the premise that past price action can be used to make predictions about the future price action in forex markets.
There is something known as, The January Effect. Many stock traders must be familiar with this term. This effect is based on a simple observation that during the last day of December and the fifth trading day in January stock prices tend to rally.
There is nothing extraordinary about the January Effect. The effect takes place due to the fact that many investors try to recognize capital gains or losses at the end of the year due to tax reasons. Many corporations also try to window dress their balance sheets at the end of the year.
The interesting fact is that seasonality is not peculiar to the stock markets. Forex markets also tend to show seasonal effects. Seasonality is defined as a pattern that occurs at a particular time of the year.
The January Effect also affects forex markets due to the fact that many investors who are adjusting their stock positions try to convert their local currencies into dollars at that time.
However, the January Effect is more pronounced in certain currency pairs as compared to others. For example, dollar shows pronounced January Effect against some currencies but not other. The Summer Effect also takes place when dollar shows a summer seasonality when it tends to rise in USD/JPY and USD/CAD in the beginning of July and give back its gains by August.
There are many other seasonal patterns in currency pairs. However, it does not mean that you should believe in these effects blindly. Just keep them in your mind when trading.
Seasonality only shows that there are strong chances that during a particular time of the year, the chances of a particular currency pair going up or down are more.
In some years, the effect may be pronounced. In others, not so pronounces. As a forex trader, you should keep these seasonal effects at the back of your minds while trading during that time of the years. You need to just understand these seasonal patterns.
Factors That Affect the Forex Markets in the Short Term
Fundamental traders depend on fundamental analysis in trading forex. Technical traders depend on technical analysis in trading forex. But the importance of economic data cannot be underestimated in shaping trading strategies.
USD is the most important currency in the world. 90% of currency transactions are done in USD. In almost most of the currency trades, USD is either the base currency or the counter currency.
Choosing the right currency pair to trade is very important for you. USD is the most important currency and most probably you will be also trading USD most of the time. You should know that the release of certain economic data has significant and lasting impact on USD.
With time, you will learn that forex markets reaction to the release of different economic data also changes with time. US GDP figures used to be important for USD but they dont impact much.
EUR/USD is the most liquid pair in the forex market and is heavily traded. The release of Nonfarm Payrolls (NFP) data on the first Friday of each month has become important in recent years. These figures makes EUR/USD and other pairs involving US Dollar highly volatile for some time until the markets digest the importance of these figures.
Similarly, the release of US housing sales number every month has become very significant for USD in the recent years. Previously, forex markets used to give more importance to US Trade Balance.
If you depend on range trading as a trading strategy, you should avoid the day NFP data is released for trading. This is a highly volatile and jittery day for the forex market.
However, as a breakout trader, understanding of which economic data is expected to be released can help you in your trading. You should plan your trades in accordance with the importance of the economic data to be released.
In brief, knowledge that certain economic indicators make the forex markets move most is important for you as a trader. It is also important for you to know that particular economic data, the market considers most important at any point in time.
You should also know which data causes knee jerk reaction in the markets and which pieces of data will have lasting reaction in the forex markets.
Learn How To Trade Forex
Learning forex trading should not be difficult. With decent understanding of money management rules and a good trading strategy, you should be ready for conquering the forex markets.
You should always try to understand the big picture. You should start each trading session by looking at the daily charts. After looking at the daily charts zoom into 4hr, 1hr, 30min, 15 min etc charts. Forex trading is about interpreting the past price action as well as about interpreting the future price action.
You need to ask: Is the market ranging or trending before each trade. You should ask: Is there any long term patterns that have developed. By taking a general look at the different charts you will develop a general understanding of how the forex markets are behaving in the short as well as the long term.
You should try to understand the general direction of your favorite currency pairs. You can use candlestick analysis and moving averages (simple as well as exponential) to identify long term patterns and reversals.
Bollinger bands applied to 4hr charts can be used to identify the daily trading range. Most of the price action is expected to be within the Bollinger bands. Any moves outside the bands can be viewed as short term abnormalities and ignored.
Do some scenario planning, once you have a general overview of the market. Make sure you know what news is scheduled to be released and what is the expected market reaction.
Understanding the big picture does not mean knowing the whole picture. You should only focus on your favorite pairs. It takes a longtime and effort to understand a currencys behavior, how it reacts to things like oil prices, interest rates etc. So concentrate only on a few pairs in forex trading.
Always try to take notes and keep a daily trading journal in which start by analyzing the general direction of the markets for that day. What is your thinking about how the markets are going to react to different news that is expected to be released that day? Your entry and exit for the trade. What is your expected profit?
After each trade, look at what went wrong and how to avoid it in future trading! In case of a good trade that made you pips, analyze how many pips you could have made more and how to tweak your trading strategy for better results in the future trades.
Keep these general tips in mind while you learn forex trading. Never ever trade without putting stop losses! Practice on the demo account for at least three months before starting live trading with your real money.
Peter Bain
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There’s no set formula for how expansion input can impact a currency’s value, however while the interest rate outlook is commonly neutral, as in no dense conviction on the direction of 2 nations’ rates, the expansion topic gets to be more vital. Inflation is the bogeyman that all medial bankers have bad dreams in regards to. Even while inflation is low, they still fret in reference to it.
This is in balance to less fluid currency sets like GBP/USD or AUD/USD, for which exchanging desks might not have a devoted dealer. All those EUR/USD dealers count up to enormous portions of market interest, which boosts overall exchanging liquidity. EUR/USD is the currency set that pits the US dollar contrary to the lone currency of the Euro sector, the euro. The Euro sector refers to a grouping of nations in the European Union (EU) that in 1999 retired their own nationwide monies and adopted a unified lone currency. In one dropped swoop, at middle of the day on January 1, 1999, the Deutsche mark, Italian lira, French franc, and 9 other European monies vanished and the euro came into being.
Concentrate on the reports made obtainable by chief economical institutions. Most online currency exchanging stands additionally offer assorted kinds of market analysis and examination, so while you’re choosing which broker you should open your account with, check out the premium (not to be bewildered with amount) of its analysis offerings.
Fibonacci retracements should be drawn after crucial directional cost moves while it’s transparent (or as transparent as it might be) that the directional movement has stoped and reversed direction. (For more on Fibonacci levels, see Chapter ten and the following area. You could draw the retracements by utilizing the Fibonacci retracement drawing instrument that’s normal in most charting systems.
Trade interconnected hedging normally comes into the spot market in 2 prime forms: At few of the everyday currency fixings: The biggest is the London after-noon fixing, which takes place each day at four p.m. local time, which correlates to eleven a.m. eastern time (ET) The Tokyo fixing takes place each day at 8:55 a.m. Tokyo time, which correlates to 6:55 pm eastern time (ET) A fixing is a format supported by an trade or medial bank where for profit hedgers submit requests to purchase or sell monies beforehand. The requests are then filled at the triumphing spot rate (the rate is fixed) at the time of the fixing. The variance between the portion of purchasing and promoting requests usually outcomes in a net portion that needs to be purchased or sold in the market previous to the fixing time. On some days, this could see big portions (few hundred million dollars to a billion dollars, or more) being acquired or sold in the hour or so leading up to the fixing time. After the fix, that market interest is huge.
In a trending atmosphere, costs might proceed to move in the direction of the swing however at slower pace, inducing propulsion to deviate. To know for certain, you need to delay for verification from costs before you enter a trade based on a deviation. Utilizing propulsion in ranges and swings Propulsion pointers work best in range atmospheres, where cost movements are moderately limited.
If you’re small a currency (currency), it’s like having borrowed a loan. Just as you could anticipate making interest on a bank deposit or paying interest on a loan, you should anticipate an interest boost or cost for keeping a currency position over the change in value. The catch in currency exchanging is that if you carryover an open position from one value date to the next, you have 2 bank accounts engaged.
The outcome has been an attempt by numerous nationwide governments to start to diversify their reserves away from the USD and into other chief monies. The euro, the Japanese yen, and, to a lesser extent, the British punch have been the principal beneficiaries of this switch. However before you imagine the sky is dropping, the USD continues to be the major reserve currency globally and most reserve diversification attempts are concentrated on new reserves being developed.
Remarks by officials from the Reserve Bank of Australia (RBA), the medial bank, and the finance priest might move the Aussie market deeply. The boom in Asian regional expansion over the past years and high levels of global financial expansion have profited the Australian economy in current years. Those high levels of expansion have carried with them moderately high levels of inflation, eliciting the RBA to persistently climb interest rates.
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