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“aussie Forex Analysis: Local Factors Impacting Profit Potential” – The general forex market generally has more of a trend than the general stock market. Why? The stock market, which is really a market of many individual stocks, is governed by the micro-dynamics of particular companies. On the other hand, the forex market is driven by macroeconomic trends that can sometimes last for years.
These trends are best demonstrated through major pairs and commodity block currencies. Here we look at these trends, exploring where and why they are emerging. We then also look at what types of pairs offer the best opportunities for range trading.
“aussie Forex Analysis: Local Factors Impacting Profit Potential”
There are only four major currency pairs in Forex, which makes it quite easy to follow the market. They are:
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It’s understandable why the US, EU and Japan would have the world’s most active and liquid currencies, but why the UK? Finally, as of 2020, India has a larger GDP ($2.65 trillion compared to the United Kingdom’s $2.63 trillion), while Russia’s GDP ($1.57 trillion) and Brazil’s GDP ($2.05 trillion) dollars) is almost equivalent to the UK’s total economic output.
The explanation that applies to most of the forex market is tradition. Great Britain was the first economy in the world to develop sophisticated capital markets, and at one time the British pound, rather than the US dollar, served as the global reserve currency. Because of this heritage and London’s dominance as the world’s center for foreign exchange trading, the pound is still considered one of the world’s leading currencies.
The Swiss franc, on the other hand, earns its place among the big four because of Switzerland’s renowned neutrality and fiscal prudence. The Swiss franc was once 40% backed by gold, but it is still known as “liquid gold” to many traders in the forex market. In times of turmoil or economic stagnation, traders turn to the Swiss franc as a safe-haven currency.
The largest major pair, arguably the world’s most liquid financial instrument, is the EUR/USD. The pair trades at a nominal value of almost $1 trillion a day, from Tokyo to London to New York, 24 hours a day, five days a week. The two currencies represent the world’s two largest economic entities, the United States with an annual GDP of $21.43 trillion and the Eurozone with an estimated GDP of $13,335.84 billion.
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Although US economic growth has been much better than the Eurozone (3.1% for the US and 1.6% for the Eurozone), the Eurozone economy generates net trade surpluses while the US runs chronic trade deficits. The eurozone’s high balance sheet position and the size of the eurozone economy have made the euro an attractive alternative reserve currency to the dollar. As such, many central banks, including Russia, Brazil and South Korea, have diversified some of their reserves into the euro. Obviously, this diversification process took time, as do many events or movements that affect the forex market. This is why one of the key attributes of successful trend trading in Forex is the longer term perspective.
To see the importance of this long-term perspective, take a look at the figures below, both of which use three simple moving average (three SMA) filters.
Figure 1: Graphs the EUR/USD exchange rate in 2005. from March 1 to May 15. Note that the recent price action indicates volatility and the possible start of a downtrend as all three simple moving averages line up below each other. Image by Sabrina Jiang © 2020
The three SMA filter is a good way to measure the strength of trends. The basic premise of this filter is that if the short-term trend (seven-day SMA), intermediate trend (20-day SMA) and long-term trend (65-day SMA) are all aligned into one. direction, then the trend is strong.
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Figure 2: Charts the EUR/USD exchange rate in 2002. from August to 2005 June. And in this long-term chart, a completely different view emerges. an uptrend remains intact when each downtrend does little more than provide a starting point for new highs. Image by Sabrina Jiang © 2020
Some traders may wonder why we use the 65 SMA. The real answer is that we got this idea from John Carter, a futures trader and educator, because these were the values he used. But the importance of the three SMA filter is not in the specific SMA values, but in the interaction of the short-term, intermediate-term and long-term price trends provided by the SMAs. As long as you use reasonable proxies for each of these trends, the three SMA filter will provide valuable analysis.
By looking at EUR/USD from two different time frames, we can see how different the trend signals can be. Figure 1 shows the 2005 daily price action for March, April and May showing volatile movement with a clear bearish bias. Figure 2, however, shows weekly data for all of 2003, 2004, and 2005 and paints a very different picture. According to Chart 2, EUR/USD remains in a clear uptrend despite some sharp corrections along the way.
Warren Buffett, a well-known investor known for long-term trend trades, has been heavily criticized for holding his massively long EUR/USD position, which has suffered some losses along the way. But looking at the pattern in Figure 2, however, it becomes much clearer why Buffett may have the last laugh.
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The three most liquid commodity currencies in the foreign exchange markets are USD/CAD, AUD/USD and NZD/USD. The Canadian dollar is affectionately known as the “loonie”, the Australian dollar as the “Aussie” and the New Zealand dollar as the “kiwi”. These three countries are huge commodity exporters and often trend very strongly in line with demand for each of their main exports.
For example, look at Figure 3, which shows the relationship between the Canadian dollar and crude oil prices. Canada is the largest exporter of oil to the US and almost 10% of Canada’s GDP comes from energy exploration. USD/CAD is trading inversely, so Canadian dollar strength is creating a bearish trend for the pair.
Figure 3: This chart shows the relationship between the exchange rate and the price of crude oil. Canada’s economy is a very rich source of oil reserves. The chart shows that as the price of oil rises, it becomes cheaper for someone holding Canadian dollars to buy US dollars. Image by Sabrina Jiang © 2020
Although Australia does not have many oil reserves, the country is a very rich source of precious metals and is the second largest exporter of gold in the world. In Figure 4 we can see the relationship between the Australian dollar and gold.
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Chart 4: This chart shows the relationship between Australian and gold prices (in USD). Notice how the gold rally from December 2002 to November 2004 coincided with a very strong rally in the Australian dollar. Image by Sabrina Jiang © 2020
Unlike major and commodity block currencies, both of which offer traders the strongest and longest-term trend opportunities, currency crosses represent the best range-bound trades. In Forex, crosses are defined as currency pairs that do not have the US dollar as part of the pairing. EUR/CHF is one such crossover and is known to be perhaps the best ranged pair to trade. One reason, of course, is that there is very little difference between the growth rates of Switzerland and the European Union. Both regions have current account surpluses and are committed to fiscally conservative policies.
One strategy for range traders is to determine range parameters for a pair, divide these parameters by the average line, and simply buy below the average and sell above it. Range parameters are determined by the high and low between which prices fluctuate during a given period. For example, range traders with EUR/CHF can 2004 from May to 2005 between April, set 1.5550 as the top and 1.5050 as the bottom range, with the 1.5300 midline demarcating the buy and sell zones. (See below).
Chart 5: This is a chart of EUR/CHF (May 2004 to April 2005), with 1.5550 as the top and 1.5050 as the bottom of the range, and 1.5300 as the middle line : A single range trading strategy involves selling above the average and buying below the average. Image by Sabrina Jiang © 2020
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Remember that domain traders are direction agnostic. They just want to sell relatively overbought terms and buy relatively oversold terms.
Cross currencies are so attractive for a ranging strategy because they represent currency pairs of culturally and economically similar countries; Therefore, imbalances between these currencies often return to equilibrium. It’s hard to imagine, for example, Switzerland falling into depression while the rest of Europe happily expands.
The same trend of balance, however, cannot be said for stocks of a similar nature. It’s easy to imagine how, say, General Motors could file for bankruptcy even if Ford and Chrysler continue.
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