Trading forex is a big picture game. Understanding how the dollar moves and moreso, what moves it is all part of that bigger picture. When you understand the relationships you are less likely to be blindsided by price movement and events that are highly correlated to forex pairs.
But first things first…before getting to the U.S. Dollar to forex pairs correlations we must look at what moves the dollar itself.
So what are the markets that effect the greenback?
Look know further than the market pulse charts of crude oil, gold, and Fed Funds. This is a simple way to understand markets that most forex traders seldom consider and know little about. There’s no need to get complicated, but there are some basics that can give you an edge.
Let’s start with the dollar and crude oil which typically have an inverse relationship. The relation is beneficial to track not only for the effect on the greenback but also crude’s effect on the USD/CAD.
The next chart is the dollar and gold. Now a couple things to mention here. First, I will go back to these correlation again and again in the blog so you can see the relationship on an on-going basis. Second, while popular thinking has it that the USD/CAD, AUD/USD, and NZD/USD are “commodity currencies“, I believe that even the “majors” are comm dolls to an extent because of their relationship back to the dollar and the dollar’s relationship back to certain commodities. This is a departure from more accepted thinking but the more we examine these relationships in this blog, the more you will see it’s effective and true!
With gold (and you can also include the continuous commodity index in this thinking as well) you will see that there in not only the dollar correlation but also the AUD/USD and NZD/USD correlation.
Finally let’s take a look at the Fed Funds chart. It’s important the you look at the front month, and I look at this once a day to see if there are any dramatic changes. This chart allows me to see what the Fed Funds rate is expected to be month to month so ofcourse looking at the front month contract as FOMC rate decisions are coming up offers tremendous insight.
Let’s wrap this discussion of Fed Funds futures with some simple “Fed Funds math”. If you want to know what’s “baked into the cake” for the next decision on rates take the front month trading price. In this example that would be 99.75 for the March 2009 Fed Funds. Take that number and subtract it from 100.00, which represents a 0.00 (zero) Fed Funds rate. 100.00 – 99.75 = 0.25. The number that been discounted is the rate of .25%. This means that there is no expected change for March.
Forex traders have an incredible view of the markets and world economies. This is one step into taking this view and making it applicable.
…more to come!