Foreign exchange traders, both seasoned and new, heavily focus their trading strategies on technical indicators – moving averages and trend lines– when trading the euro or British pound. And, they rarely take a look at other markets for additional hints in market direction. But, these other markets can sometimes hold the key to a profitable position or a losing trade in the foreign exchange market.
For years, professional money managers have looked at secondary markets for confirming a position. Using advanced charting programs, these professionals are able to see relationships between certain markets – revealing movements between investments in the same or different direction. Some of these correlations are commonly known to the market – crude oil and the Canadian dollar or gold futures and the Australian dollar. And, some are not so common – like the U.S. dollar/Japanese yen exchange rate and short-term rate on Japanese government bonds.
Let’s take a quick peek at some other markets that can offer insights into potential foreign
Look to Bond Yields
Believe it or not, currency and bond markets are very closely related.
The direction of both investment assets is widely dependent on a country’s economic environment and monetary policy. If an economy is showing strength, global investors will buy bonds that are being offered by a particular country – always looking for stable and high rates of return. This will cause demand for the country’s currency to increase, thus appreciating the value of the currency. Global investors interested in investing in the country (and its infrastructure) will always have to transact in the country’s currency. They go hand in hand.
Currency Futures
Derivative instruments – like currency futures – are also great in confirming short-term trends in foreign exchange rates.
In the equity markets, stock brokers and traders will look towards market volume in confirming momentum. Currency traders, instead, will use currency future open interest in gauging the market’s demand for a particular currency. This type of information can be used to predict the future demand not only for currencies, but commodities as well.
Credit Default Swap Markets
A relatively unknown market, credit default swaps or CDS instruments can be great in showing long-term sentiment for individual currencies.
Introduced and widely used in the last 14 years, credit default swaps are contracts protecting a buyer’s position against a potential credit event. For example, a money manager can insure the creditworthiness of $100 million in Japanese government bonds by paying an insurance premium. In the event of a default or debt crisis, the money manager would be able to recoup the value of their bonds. So, much like currency futures, credit default swaps are a great way of telling how bullish or bearish the market is on a particular currency.
Conclusion
When used correctly, these market indicators can add great confirmation to individual trades – boosting overall investment return. With the increased interconnectivity of the global markets these days, it pays to understand market relationships. And, it helps investors to profit greatly from them. (Many spot currency cross pairs are not traded against each other directly.
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I hope the above currency trading article was of help to you.
Anthony DiChi at TradeCurrencyNow,
America’s Forex News and currency information source.