Currency Trading For Dummies. Kathleen Brooks

closes each day on the IMM at 2 p.m. central time (CT), which is 3 p.m. ET. Many futures traders like to square up or close any open positions at the end of each trading session to limit their overnight exposure, or for margin requirements. Currency futures are covered in Chapter 14.

      

The 30 to 45 minutes leading up to the IMM closing occasionally generate a flurry of activity that spills over into the spot market. Because the amount of liquidity in the spot currency market is at its lowest in the New York afternoon, sharp movements in the futures markets can trigger volatility in the spot market around this time. There’s no reliable way to tell if or how the IMM close will trigger a move in the New York afternoon spot market, so you just need to be aware of it and know that it can distort prices in the short term.

      The U.S. dollar index

      The U.S. dollar index is traded on the Intercontinental Exchange (ICE). The dollar index is an average of the value of the U.S. dollar against a basket of six other major currencies, but it’s heavily weighted toward European currencies.

The exact weightings of other currencies in the U.S. dollar index are

       Euro: 57.6 percent

       Japanese yen: 13.6 percent

       British pound: 11.9 percent

       Canadian dollar: 9.1 percent

       Swedish krona: 4.2 percent

       Swiss franc: 3.6 percent

      The European currency share of the basket — Eurozone, United Kingdom, Sweden, and Switzerland — totals 77.3 percent. From time to time, the currency weightings may be adjusted.

      THE RISE OF THE CHINESE RENMINBI

      China has been climbing the global economic ranks. At the time of writing, it was the world’s second-largest economy, but the same is not true for the Chinese currency, the renminbi (also known as the yuan). Although the role of the renminbi in global forex trading has surged, according to the 2019 BIS Triennial Central Bank Survey, the renminbi was the eighth most-traded currency in the world, with a share of 4.3 percent in global forex volumes. However, most of this trading activity is for trade purposes only.

      The renminbi is a managed currency, which means that the Chinese government controls its value. This makes it very difficult to trade for speculative purposes. Either the currency doesn’t move very much (because it can move only within a controlled band, which means there are few trading opportunities), or the government intervenes out of the blue, creating a wave of volatility that can take you out of your position before you know it.

      Most currency brokers allow you to trade the renminbi, but why would you want to? Some people believe that the Chinese government will eventually loosen its control over the renminbi and allow it to trade freely. Due to the importance of the Chinese economy, if the currency could trade freely, the renminbi might become a currency that would be liquid enough to rival the U.S. dollar. For now, though, it doesn’t look like Beijing will embark on a liberal currency regime any time soon.

      Warning: A managed currency like the renminbi can be fairly illiquid, so it can experience large price moves if the government suddenly chooses to intervene. Due to this, trading the renminbi is considered risky.

The U.S. dollar is the most important global currency, with the bulk of forex trading usually involving the dollar on one side of the transaction. Commodities are priced in dollars, and a vast amount of global currency reserves held by central banks is in dollars. This makes the dollar (also affectionately referred to as the “greenback” or the “buck”) the most liquid currency in the world. As a trader, you need to know whether the dollar is strong or weak. The U.S. dollar index helps you do this because it gives you a broad-based view of how the dollar is performing in the G10 forex space. As a currency trader, be sure to follow the U.S. dollar index, especially its technical developments.

      

The easiest way to trade the U.S. dollar index is through a futures account (see Chapter 14) using call and put options, which are covered in Chapter 15.

Looking at Currencies and Other Financial Markets

      As much as we like to think of the forex market as the be-all and end-all of financial trading markets, it doesn’t exist in a vacuum. You may even have heard of some of these other markets: gold, oil, stocks, and bonds.

      There’s a fair amount of noise and misinformation about the supposed interrelationship among these markets and currencies or individual currency pairs. To be sure, you can always find a correlation between two different markets over some period of time, even if it’s only zero (meaning the two markets aren’t correlated at all).

      

Be very careful about getting caught up in the supposed correlations between the forex market and other financial markets. Even when a high degree of correlation is found (meaning the two markets move in tandem or inversely to each other), it’s probably over the long term (months or years) and offers little information about how the two markets will correlate in the short term (minutes, hours, and days). The other point to consider is that even if two markets have been correlated in the period, you have no guarantee that the correlation will continue to exist now or into the future. For example, depending on when you survey gold and the U.S. dollar, which supposedly have a strong negative correlation, you may find a correlation coefficient of as much as –0.8 (a solidly negative correlation) or as low as –0.2 (very close to a zero correlation, meaning that the two are virtually noncorrelated).

Always keep in mind that all the various financial markets are markets in their own right and function according to their own internal dynamics based on data, news, positioning, and sentiment. Will markets occasionally overlap and display varying degrees of correlation? Of course, and it’s always important to be aware of what’s going on in other financial markets. But it’s also essential to view each market in its own perspective and to trade each market individually.

      With that rather lengthy disclaimer in mind, the following sections look at some of the other key financial markets and show what conclusions we can draw for currency trading.

      Gold

      Gold is commonly viewed as a hedge against inflation, an alternative to the U.S. dollar, and a store of value in times of economic or political uncertainty. Over the long term, the relationship is mostly inverse, with a weaker USD generally accompanying a higher gold price, and a stronger USD coming with a lower gold price. However, in the short run, each market has its own dynamics and liquidity, which makes short-term trading relationships generally tenuous.

      

Overall, the gold market is significantly smaller than the forex market, so if we were gold traders, we’d sooner keep an eye on what’s happening to the dollar, rather than the other way around. With that noted, extreme movements in gold prices tend to attract currency traders’ attention and usually influence the dollar in a mostly inverse fashion.

      Oil

      A lot of misinformation