Trading Forex with Other Asset Classes | You might think that the $5 trillion a day forex market might be too big to get caught up in the movements of other smaller asset classes, but that’s not the case. The forex market does not move in isolation – what other asset classes do can have major effects on currency prices. Here’s how:
>>> Stock Markets: If the stock market is going up, check the local currency – sometimes it can do the same. The Bank for International Settlements (BIS) believes that there is a connection between forex and stocks. In her view, forex trading can lead stock investors traveling abroad to get better returns. Investors need to trade forex for two reasons:
1. Purchase of foreign assets
2. To hedge their revenue
Between June 2013 and May 2014, a bewildering thing happened: The eurozone economy underperformed many other global economies, but the euro was rising. Rather than being driven by fundamentals, the single currency has been moving in line with the Euro Stoxx stock index, which is up nearly 10 percent over that period.
Trading Forex with Other Asset Classes
>> Commodities: This is one of the most talked about interrelationships because the vast majority of commodities are priced in US dollars. Therefore, when the US dollar rises, commodity prices can go down because you need fewer dollars to purchase your commodity. The reverse is also true if the value of the dollar falls. If you see a sudden change in the value of the dollar, take a look at what gold and oil prices are doing.
Commodity/Forex correlation does not end there. Some commodity currencies can also move with commodity prices. For example, Canada is the sixth largest oil producer in the world, so if the price of oil is going up, this could be good news for the fundamentals of the Canadian economy, which can also be good news for the Canadian dollar, and vice versa if the price of oil is falling.
>>> Bond yields: An economy that offers higher yields on its bonds can be an attractive place to buy currencies for obvious reasons. Therefore, countries with higher bond yields can see their currencies appreciate compared to countries with lower bond yields. But beware: sometimes high bond yields can spell disaster. For example, during the financial crisis in 2008, yields on two-year bonds in Iceland rose to 13%, but the government had to pay that much to attract money because the economy was on its knees. It required a bailout, and the Icelandic krona fell more than 100 percent between 2007 and 2010.
>>> USD/JPY and the Nikkei: This is a common correlation between assets, but it may not move as you expect. Since the yen is considered a safe haven, investors tend to buy it during periods of market distress. When the Nikkei falls, the yen can rise, affecting the USD/JPY pair. The reverse can also be true, so when the yen goes down (the USD/JPY goes up), the Nikkei could be on a higher rally.
Multiple factors can drive the forex markets. Relationships with other markets are just one factor, but they can be very effective. When you trade forex, keep in mind that currencies are not traded in isolation.