Forex Basics and Beyond
By Ed Ponsi, President of FXEducator.com
Q) Hi Ed, as a New Year exercise, I was running through some of the major currency pairs and I was kind of shocked when I analyzed the AUD/USD pair. A great double-bottom seems to have laid itself out on the daily charts, and prices are currently near the neck line @ 0.6950. If I recall clearly, the EUR/USD only a few weeks ago formed a similar pattern and sprung to the topside rapidly. It could be that AUD/USD is preparing for a similar fate by following the same pattern, and could be a DEJA VU (with money to be made)?
Ed Ponsi) Hi Abs, thank you for your email. Sure looks like you might be onto something here; the price action on the daily chart shows AUD/USD breaking to its highest point since October of last year. The formation could be considered a double-bottom or perhaps even a cup and handle
So, while the technical analysis looks good, what about the fundamentals? The Aussie dollar is a commodity currency, and commodities have performed poorly of late, to put it mildly. Any bet on Aussie right now is a bet that commodities have bottomed – and I do think we are closer to the bottom than the top, but still some potential downside. Additionally, there is the interest rate differential; while the Reserve Bank of Australia's current rate (4.00%) is expected to drop, it will remain higher than the Fed Funds rate as long as it stays above 0.25%, and I think it's a good bet that the RBA won't go that low. Speaking of Australia's central bank, they helped to put in the bottom of the formation by intervening in the currency markets late last year. The RBA stepped into the market and bought Aussie dollars, which helped to keep the AUD/USD exchange rate above .6000. With this confluence of technical and fundamental factors, you might have yourself a good setup here – it all depends on the commodities market. Good luck!
Q) Ed, I'm very interested in Forex trading but totally lack the knowledge to even comprehend the outcome. The TA side I have down cold due to 20-plus years of trading activity. The question - what is the value of a trade if the underlying moves up say 1 pip? OK, I buy a mini lot of 10k EUR/USD at say 1.3999. Now if the price moves to 1.4000 what is my gain on the trade? Discount commissions or bid/ask spread.
Ed Ponsi) Great question! To answer this and other concerns, let me first explain the different types of accounts. The types of accounts are differentiated by the size of one lot in each account, with each level greater than the one beneath it by a factor of ten:
Standard Account = 100,000 units per lot
Mini Account = 10,000 units per lot
Micro Account = 1000 units per lot
Referring to the scenario in your question, the value of one pip on the EUR/USD currency pair would be:
Standard Account = $10
Mini Account = $1
Micro Account = 10 cents
The part of your question that deals with commissions is a bit more difficult, since just like in the stock market, every Forex broker has their own commission structure. Many Forex brokers charge only the spread, with their commission and other fees included within that spread, but some charge a commission in addition to the spread. Also, some Forex brokers offer fixed spread platforms, while others offer variable spreads (and some offer both). My recommendation would be to open and trade a Forex demo account (it's free) to get used to the values of the various currency pairs and how they move. Everything that you already know about technical analysis applies to the currency market, so you are ahead of the game on that count. Trading a demo account will educate you on these other issues without the risk of loss. Good luck!
Q) Hi Ed, I'm a loyal reader and find your articles very interesting. My question is about the relationship between the U.S. Dollar and the U.S. stock market. I'm confused because I read an article of yours pointing out that the relationship is inverse, maybe I didn't understand. If the dollar rises, stocks go down. My confusion arises because my reasoning is as follows: If the stock market is bullish, then people around the world would want to get in. If so, they would have to buy dollars to buy U.S. stocks, creating demand for the dollar and the stock market and pushing both up. The inverse would be true if the situation were reversed. So, under my train of thought, the relationship is positive and not inverse. I would appreciate if you can clear up my confusion.
Ed Ponsi) Great question! What you are saying makes sense and is often the case; however we are in an unusual and abnormal market situation to say the least. Think of it this way; stock markets all around the world performed poorly in the latter part of 2008, and all types of traders dumped equities en masse, with the intention of stashing that cash in a safe place. But where are they going to put it? One safe haven is the U.S. Treasury market; the problem is you need U.S. Dollars in order to buy U.S. Treasuries. This means that investors all around the world have been exchanging their home currencies for the U.S. Dollar, and putting the proceeds into U.S. Treasuries. This in turn has driven the price of Treasuries through the roof, bringing yields down to incredibly low levels (see figure 1).
Figure 1: U.S. Treasury yields collapsed in 2008. Source: Bloomberg.com
Back in the late 1990's, a bull market in stocks drew investors to the U.S. to invest in the NASDAQ. Consequently, the USD performed well at that time. Today it is the bond market that is attracting all of the attention, but eventually that will change, too. When yields on Treasuries begin to rise, it may be the first sign that this bond rally is coming to an end. Good luck!
