The Forex market does not operate in isolation; it is intricately connected to other financial markets. Understanding these intermarket correlations can provide traders with a more comprehensive perspective on currency price movements. By analyzing what’s happening in other markets, traders can often anticipate or confirm moves in the Forex market, allowing them to make more informed trading decisions. In this section, we’ll explore some of the key correlations that exist between the Forex market, the U.S. Dollar Index (USDX), gold, and other markets.
THE U.S. DOLLAR INDEX (USDX)
The U.S. Dollar Index (USDX) is a critical tool in intermarket analysis, as it measures the value of the U.S. dollar against a basket of six major foreign currencies. The USDX provides a comprehensive view of the dollar’s strength and can be used to predict movements in currency pairs that include the U.S. dollar.
The USDX is represented on a chart, just like any currency pair, and traders can use it as an “indicator” of dollar strength. When the USDX is bullish (rising), it signals that the U.S. dollar is strengthening across the board, which can influence how dollar-related currency pairs behave. Conversely, when the USDX is bearish (falling), it reflects dollar weakness, which also impacts currency pairs.
TRADING USING THE USDX
To effectively use the USDX in your Forex trading, you need to understand the role of the U.S. dollar in the currency pair you’re trading. Whether the USD is the base currency or the quote currency will determine how movements in the USDX influence the currency pair.
USD as the Base Currency
When the U.S. dollar is the base currency, as in USD/JPY, a rising USDX (bullish dollar) suggests that the USD/JPY pair is likely to trend upwards as well. This is because the strength of the dollar is reflected in its relative value against the yen. Conversely, if the USDX is bearish, expect USD/JPY to decline, as dollar weakness leads to a falling pair.
Example:
When the USDX shows a clear downtrend, we would expect USD/JPY to also follow a downward trajectory, reinforcing the idea of intermarket correlation.
Figure: USDX in a Downtrend.
Figure: USD/JPY Following the Downtrend.
USD as the Quote Currency
If the U.S. dollar is the quote currency, as in EUR/USD, the relationship flips. A bullish USDX implies that the USD is gaining strength, which will likely push the EUR/USD pair down. Conversely, a bearish USDX indicates a weakening dollar, which should push EUR/USD up as the euro strengthens against the dollar.
Example:
A rising USDX suggests a downtrend in EUR/USD, confirming the negative correlation between the two.
Figure: USDX in an Uptrend
Figure: EUR/USD in a Downtrend.
By regularly monitoring the USDX, traders can gain additional confirmation or early signals regarding the direction of major currency pairs, particularly those involving the U.S. dollar.
GOLD AND THE U.S. DOLLAR
Gold has long been viewed as a hedge against inflation and a safe-haven asset, particularly in times of economic uncertainty. Its price movements are inversely correlated with the U.S. dollar. Understanding the relationship between gold and the U.S. dollar can provide valuable insights into Forex price movements.
USD as the Base Currency
When the U.S. dollar is the base currency (e.g., USD/CAD), an increase in gold prices often correlates with a decrease in the value of the U.S. dollar. This leads to a downtrend in currency pairs like USD/CAD, as the weakening dollar loses value against the Canadian dollar. Conversely, when gold prices fall, we often see an uptrend in pairs like USD/CAD, as the strengthening U.S. dollar gains ground.
Figure: Inverse Relationship Between Gold and USD/CAD.
USD as the Quote Currency
When the U.S. dollar is the quote currency (e.g., EUR/USD), rising gold prices typically signal an upward move in the currency pair. The rising price of gold indicates weakening U.S. dollar strength, and as a result, the pair appreciates. When gold declines, we typically see currency pairs with the dollar as the quote currency moving downward.
Figure: Direct Relationship Between EUR/USD and Gold.
This inverse correlation between gold and the U.S. dollar means that traders should pay close attention to movements in gold prices when trading currency pairs involving the U.S. dollar.
OTHER COMMODITIES AND CURRENCIES
The U.S. dollar isn’t the only currency that’s tied to commodity prices. Certain currencies, often referred to as “commodity currencies,” have a strong correlation with the price movements of specific commodities. Understanding these relationships can further enhance your trading strategies.
- Canadian Dollar (CAD) and Oil
The Canadian dollar is closely tied to the price of crude oil. Canada is one of the world’s largest oil producers, and its economy is significantly influenced by oil exports. As a result, when oil prices rise, the CAD tends to strengthen, particularly against the U.S. dollar (as seen in the USD/CAD pair). Conversely, falling oil prices usually lead to a weaker CAD. Monitoring oil prices is crucial when trading the Canadian dollar. - Australian Dollar (AUD) and Gold
Australia is a major producer of gold, and the Australian dollar (AUD) is often influenced by gold prices. When gold prices rise, the AUD tends to appreciate, particularly against currencies like the U.S. dollar (AUD/USD). A decline in gold prices, on the other hand, often leads to a weaker AUD. - New Zealand Dollar (NZD) and Dairy
The New Zealand economy is heavily reliant on dairy exports, making the New Zealand dollar (NZD) sensitive to global dairy prices. Traders can use dairy price movements as an additional tool when trading NZD pairs.
By being aware of these commodity correlations, traders can better anticipate currency movements and make more informed trading decisions.
STOCK MARKETS AND FOREX
Stock market performance can also have an impact on Forex trading. In general, when stock markets are performing well, we often see riskier currencies (such as the AUD and NZD) appreciating, as investors are more willing to take risks. Conversely, when stock markets are underperforming, safe-haven currencies like the U.S. dollar, Japanese yen, and Swiss franc tend to strengthen as investors seek safety. More on this later.
Risk Sentiment
Currencies like the AUD, NZD, and CAD tend to appreciate in risk-on environments, while the JPY, CHF, and USD typically strengthen in risk-off scenarios. Understanding the current risk sentiment in the global stock markets can therefore give traders an edge in predicting movements in these currencies.
Intermarket correlations provide traders with powerful tools to anticipate and confirm currency movements. By analyzing the U.S. Dollar Index, commodity prices, and stock market trends, traders can gain a deeper understanding of the forces that drive currency prices. The Forex market doesn’t exist in a vacuum; instead, it moves in response to a variety of external factors. When used correctly, intermarket analysis can become an integral part of your trading strategy, helping you make more informed and profitable decisions.