A Three Dimensional Approach To Forex Trading
by Anna Coulling
Still a safe haven, and likely to remain so, although other currencies are starting to nibble away at this
once traditional role. As forex traders understanding market sentiment towards the US dollar should
be paramount. Therefore, the dollar index is always the first port of call, and I like to use the FXCM
version as it gives me a much clearer picture, particularly for intra day trading. All the technical
analysis techniques covered in this book can be applied to this chart.
If and until the Fed stop their QE program, the currency is likely to remain weak. In addition the
currency has now joined the yen as a mainline funding currency for the carry trade. When this starts to
unwind, then watch out!
Political with a capital P. The problem with the euro is trading it without an opinion. Almost
impossible, since the currency has been written off so many times, by so many people, that it is very
difficult to ignore the chatter. The euro, in its present format will go - eventually, but with the Chinese
reducing their dollars in favour of euros, not just yet! Because it is such a political currency it is
fiendish to trade with any certainty, and price action is often illogical.
In many ways the markets are now so inured to bad news in Europe, that as each subsequent crisis
unfolds, the reactions become less and less volatile. Indeed, a minor crisis is often welcomed as
‘good news’! In stark contrast to the US dollar the euro is increasingly seen as a high risk currency.
When risk is on, them the euro will generally rise.
Safe haven and politics all rolled up in one neat package. The darling of the carry trade and another
funding currency to match the US dollar. Protected and loved by the Bank of Japan, the yen will
always come first when any decision has to be made. As interest rates start to rise, watch the yen
weaken further, and faster, as the carry trade comes into play once again.
Remember the English breakfast of sausage and egg. The chicken is involved, but the pig is
committed! The pound is the chicken of Europe, involved but not committed, and long may it continue.
Mr Reliable could best describe sterling, and despite the recent downgrade from the ratings agency
(but then who cares about them anyway) a solid currency in every respect. Indeed, respectable sums it
up, with the financial centre of the world and the Bank of England underpinning this currency. No real
drivers or major influencing factors, although increasingly seen as a safe haven and an alternative to
Another solid and well managed currency, but which catches a cold each time China sneezes.
Commodities hold the key, and in the last few years, the currency is increasingly seen as a safe haven,
but with a ‘risk’ label due to the high interest rates and carry trade drivers. Expect to see the currency
strengthen as interest rates rise globally, with hot money flowing in, provided the Chinese economy
continues on track.
Just as the Australian dollar is linked to its largest trading partner, China, so the Canadian dollar is
heavily influenced by its next door neighbor, the US. Strength or weakness in the US economy will
always impact Canada directly and quickly, which can make the USD/CAD a tricky pair to trade. In
addition, commodities play their part with oil in particular, and if we throw the yen into the mix,
trying to establish what is driving the currency can be difficult. Nevertheless, another solid currency
representing a well managed economy. Remember that the weekly oil stats release on a Wednesday,
will impact the Canadian dollar more than the US dollar, even though the data is released in the US.
New Zealand Dollar
In the majors, the preferred currency of the carry trade, with subsequent flows of hot money, although
in recent years this has become less of an issue, with the interest rate falling below that of the
Australian dollar. However, once rates start to climb again, watch for buying of the currency,
particularly against the yen. A great ‘trending’ currency as a result, but when the trend reverses, watch
out - they can move equally fast in the opposite direction as money flows out again. The Australian
economy also plays a part, as one of New Zealand’s largest trading partners, and of course
commodities are in the mix, although soft commodities are more significant. In fact, China has
recently become New Zealand’s largest export market for dairy based products, such as milk powder,
butter and cheese. Indeed the NZD came under pressure recently following a problem with milk
powder exports to China.
A very tricky currency to ‘put in a box’ in any well defined way. Norway is certainly stable, and
extremely wealthy, and in many ways similar to Switzerland in this respect, particularly given its
huge oil fund. Yet the currency struggles to be accepted as a ‘safe haven’ by investors which is rather
odd, given its huge current account surplus. Oil, of course, is one of the determining factors for the
currency, but in a currency whose volumes can be light during the trading day, volatility can be an
issue. One opportunity on the horizon with the Krone is the prospect of rising interest rates due to the
housing market which has been booming recently. This may force the Norwegian central bank (Norges
Bank) to step in and raise interest rates, much against global trends. With rates in Europe falling and a
possible increase for the Krone, this could see the development of a longer term trend, particularly if
coupled with any move higher for oil.
Two words sum up the Swiss franc - ‘safety’ and ‘security’. Over the last few years Switzerland has
increasingly been seen as another ‘safe haven’ country, under pinned by gold. Unlike Norway,
overseas investors have been flooding in, and buying the Swiss franc, particularly from Europe. The
SNB has attempted to weaken the currency several times, but with little effect so far. Swiss interest
rates reflect those in the rest of the world, so this is not hot money, but simply panic driven flows.
Gold underpins everything, but watch out if the bank wins the referendum to sell some of its gold
reserves. This will not be good news for the currency, which could see these same investors use the
door marked ‘exit’, and move elsewhere.
South African Rand
Moving to some of the more exotic currencies which can offer excellent trading returns, but equally
can be extremely volatile and fast moving. The South African Rand is a case in point and a currency
influenced by a variety of factors. The first is, of course, commodities and gold, then comes demand
from China, and finally we have the interest rate differentials. At the current rate of 5% this is
attractive, but for how much longer? After all, as major currencies start to move back to this level,
with Australia leading the way, the decision is then between a ‘risk safe haven’ high yield currency vs
a ‘high risk’ high yield currency.
The recent weakness in gold has also been a factor, and as with many other countries dependent on
China, any slowdown in the economy will be reflected directly in the rand. As an exotic currency it is
extremely volatile with wide spreads. Japanese investors have been increasingly dominant in this
currency moving into higher yields, underpinned by gold, but with the resurgence in risk, these
investors are now selling the currency and moving back into ‘risk assets’ in particular Japanese and
US equities, with the rand being sold as a consequence. As an ‘exotic’ currency, this may not be
available on regular trading platforms, but can be traded as a future through the CME.
The Mexican peso is one to watch, as it is poised to become a key currency for forex traders over the
next few years. If this is not on your list - ADD IT now! The Mexican economy is increasingly seen as
stable, with a central bank that has managed the financial crisis well, and with the transition almost
complete from a commodity driven export market to one built on technology, the peso is the one to
watch. Overseas investors are flooding into the country for all the right reasons, and whilst the
interest rates are attractive for the ‘hot money’ speculators at 4%, the flows here are manageable, and
not purely speculative. As a result, the peso has been strengthening against most of the major
currencies, and once again for investors and longer term speculators, a choice between a volatile
currency offering slightly higher yields, against a stable currency with marginally lower yields, it is
really no contest. Expect to see further strength in the peso against the major currencies.
As with the rand, if this is not available on your trading platform, the CME offer futures and options
under emerging markets.
The VIX of the currency world, which unlike the Japanese yen tends to weaken when the economy is
weak, and strengthen when demand begins to pick up. Therefore, expect a return to strength once
global markets begin to emerge from the carnage of the recent crisis. The currency is extremely
volatile and indeed it is rare to see a candlestick with no wick. Generally they have wicks to both top
and bottom. Very much a currency for longer term trading based on an analysis of the fundamentals
and economic cycles initially.
The Major Currency Pairs
Having looked at some of the principle currencies, along with some of the more exotic currencies,
which may become, ‘majors’ of the future, let’s now look at the major currency pairs, followed by
some of the cross currency pairs, and how these characteristics are reflected.
This may be the most widely traded currency pair in the forex market, but it is one of the most
difficult. On one side we have a political currency now considered high risk, and on the other we
have the US dollar, safe haven, yet increasingly manipulated by the FED policies. This pair is always
promoted by brokers as the one to trade, primarily because of highly competitive spreads. This may
have been the case a few years ago, but in my view this is no longer a valid argument. It may be very
liquid, and is generally the pair that has the tightest spreads in the market, but these are about the only
benefits. This is a pair I rarely consider, and rarely trade. It is a wolf in sheep’s clothing. Billions of
dollars have been lost by speculators shorting this pair. Each time there is a new crisis in Europe, the
latest being in Cyprus, the COT report shows the same patterns, with a massive build in short
positions. The ECB then step in with supporting rhetoric, the storm passes and the euro duly recovers.
Furthermore, the EUR/USD is a classic example of just how dramatically the forex market has
changed over the last five years. As I said in the introduction to this book, the rule book has been torn
up, and this is one of the casualties. Any book on trading forex, written before 2008, would have
suggested that the FX markets trend strongly, are driven by interest rate differentials, and that the
EUR/USD was the place to start given the depth of liquidity and strength of the two currencies. None
of this is true at present. It may change in the future, but not in the short term. So my advice, is to look
elsewhere, and NOT start here. There are many others pairs to choose from, and the cross currency
pairs in particular offer increasingly good trading opportunities.
This is another currency pair where we can tear up the rule book. Once upon a time, this pair was
considered almost impossible to trade, and certainly not a ‘novice’ pair with two ‘safe haven’
currencies battling for supremacy. Then along came QE, which both central banks have embraced
with enthusiasm. In the case of the Japanese, rather too enthusiastically as the BOJ prepares to release
its 9th and most aggressive version yet. The BOJ are desperate to weaken the yen further, and to date
they have succeeded in grand style, making this one of the ‘no decision’ trades of the year. But
remember, when global interest rates start moving higher once again, then the yen will be sold even
more strongly, with any counterbalance effect from the US dollar, only having a muted effect.
After all, if the carry trade explodes back in the market, which it will, then the yen will be the prime
candidate once again, with strong trends in this and other yen based pairs. Furthermore, with the yen,
when risk on appetite is in the ascendancy, then the Japanese will be selling the yen and moving into
equities, and giving the BOJ a further helping hand. All good news for the Bank of Japan, moving
forward. In contrast the Federal Reserve’s attempts at QE seem restrained and almost amateurish.
The message is clear. Ignore the older forex trading books - the ‘old rules’ no longer apply. It is time
to move away from a single currency pair. Start trading the USD/JPY, but if you prefer to trade the
euro, then simply move to the EUR/JPY as this correlates extremely closely with the USD/JPY,
particularly on the hourly, daily and weekly timeframes. This is a positive correlation as you would
Cable is in complete contrast to the EUR/USD. Solid steady and reliable, it ticks along like Big Ben,
rarely volatile and generally predictable, and whilst it does have periods of excitement, the reasons
are generally clear and self evident. There are no politics with the pound, and it is increasingly seen
as a safe haven and an alternative to the euro. Before the financial crisis, the GBP/USD and the
EUR/USD would generally have moved in lockstep together, with both moving higher or lower on US
dollar strength and weakness. This relationship has long since broken down, and now the two react
and move independently, with the primary driver for the EUR/USD being politics in Europe, whilst
for Cable it is the UK economy. The good old British pound keeps plodding along, and despite the
recent downgrade, confidence in the currency was only temporarily dented, before strength returned.
This is not an exciting pair to trade, but then trading success is not about excitement, it’s about making
money. The trading range typically is between 70 and 100 pips per day, and this is the currency which
tends to set the tone for the London session following the open in Europe and from the overnight in
If you are a novice or inexperienced trader, I would urge you to consider starting with the GBP/USD.
The Aussie dollar is one of those currency pairs which gets a ‘double boost’ whenever the US dollar
weakens or strengthens, given its association with commodities, and as result tends to develops
strong trends. One only has to look back over the last few years and see how the extended bull run in
commodities has been reflected in the pair. More recently, the pair has been in an extended phase of
consolidation, with the bullish trend having run out of steam as the commodity super cycle begins to
slow. China is the biggest influence on this pair. Next the interest rate differential is also playing its
part, and with an economy that is stable and well managed, providing China does not implode, then
we can expect to see interest rates rising in Australia thereby increasing the differential between the
two currencies. Hot money flows should see the pair continue higher in due course. Fundamental
news has a major influence on the pair with Chinese data leading the way, NOT US data.
As you might expect the pair correlate positively with the NZD/USD but only on the longer term
timeframes of weekly and above.
The biggest influence on the USD/CAD is the US, with the pair almost a mirror image of the
AUD/USD on the longer term charts, and following the longer term cycle in commodities. Oil is the
predominant commodity so once again a double whammy for the pair, with movements in the US
dollar reflected in the oil price, as well as the Canadian dollar. As mentioned earlier, the weekly oil
stats can have a significant impact mid-week, with any draw or build reflected in strength or
weakness for the currency.
A very similar picture to the AUD/USD pair. A well managed economy which has survived the worst
of the financial crisis, but once again it is China which influences the pair strongly. Another
commodity currency and in its relationship with the US dollar, any effect is magnified as commodity
prices rise and fall with strength or weakness in the US dollar. In addition, with China now taking
over the number one spot as New Zealand’s primary export market, any bad fundamental news here,
will instantly impact the currency, along with the Australian dollar. As you would expect correlation
between the two pairs is relatively strong, particularly over the longer term time frames.
Again, as with the USD/JPY, this is ‘safe haven’ meets ‘safe haven’, but in the case of the Swiss
franc, underpinned by gold. This is one correlation that still holds good, with the USD/CHF moving
inversely to the EUR/USD and maintaining this relationship across all the time frames, despite
repeated interventions by the SNB (Swiss National Bank), which only goes to prove the greater
power of the market.
As an aside, some traders believe they have stumbled on a magic hedge, when this relationship is first
discovered, and that trading long ( or short ) in both provides the ideal ‘safe bet’. I’m afraid this is
completely wrong. This is simply constructing the EUR/CHF in another way, and using two pairs to
do it, so an expensive way to trade a cross currency pair!
Over the longer term charts, the USD/CHF has reflected the strength in commodities, with strong
buying on safe haven demand also moving the pair lower. However, as economies start to recover,
and better returns become available elsewhere, then expect to see the Swiss franc being sold, as
money is moved out of safe haven and into higher yielding assets. Does this mean the euro will
weaken against the US dollar - to which the answer is yes, provided the correlation continues to hold.
Further weakness in gold could speed this process along, and indeed if the SNB gets its way and is
able to sell off some of the gold reserves, this may be the trigger for investors to move elsewhere and
into higher yielding assets. Moreover, as the current recession comes to an end, with inflationary
pressure still some way off, demand for gold may fall.
One other tip with the USD/CHF and EUR/USD correlation. If you are trading the EUR/USD, then
using volume price analysis is a great way to validate the price action using an ‘associated’ market.
After all, if the volume and price is confirming the trend higher for one currency pair, then you
SHOULD be seeing the exact opposite in the other!
Another commodity currency pair with oil again the defining commodity. Again the pair react to the
twin forces of US dollar price movements, coupled with the associated movements in oil, so a double
whammy effect. The problem with this pair is that, unlike the others in this list, it is relatively thinly
traded and therefore can be very volatile. Furthermore, there is little liquidity in the Norwegian bond
markets. Norway is certainly a safe haven, but to date the krone has failed to attract the inflows of
currency to establish it in the markets with this tag.
The key here will be any interest rate changes which are likely to be triggered by the housing bubble.
The housing bubble has been developing for some time, and this could provide the catalyst with oil
and the US dollar adding a further boost.
The Cross Currency Pairs
As I mentioned at the start of this chapter, the old rules in forex trading have gone, and as result we
have to adapt and change as well. No longer are the major currency pairs the ‘de facto’ standard for
us as forex traders. The world has changed and so has the world order of currencies and currency
pairs. It is indeed ironic that I have suggested that you avoid trading the EUR/USD for the foreseeable
future. This would have been unthinkable a few years ago.
Therefore, let me highlight some of the cross currency pairs which I hope you will investigate for
yourself. I accept the spreads will be wider, and yes you may have to take a slightly longer term view
in order to make the maths work in your favour, but nevertheless, you can find some great trading
opportunities in these pairs. As a fellow trader once said: ‘let the cross be your boss’. You just have
to lift up your eyes, your time horizon and your perspective a little - not a lot, just a little!
In addition there is a further, perhaps self evident reason, which is this - you will no longer be at the
mercy of the US dollar. Naturally, the market will always be dollar centric, but its effect on these
pairs will simply be indirect. Here are my suggestions.
Move the euro to a different pair and its behavior changes almost completely. It’s as though the
influence of the slow and measured UK pound brings the political upstart into line. The pair moves in
a controlled way, is rarely volatile, and driven more by genuine market sentiment and fundamental
news, than by the eternal politics that dominates the price action in the major. Here is a pair of the old
school, the way forex markets ‘used to be’. Price action swings along at an even pace, supported by
the economic releases and the technical picture. In many ways this is a great currency pair for
It will never set the world on fire, but neither will it frighten you to death. It is a currency pair that
many traders ignore, but is an excellent one, in my humble opinion, for gauging the TRUE market
sentiment for the euro, devoid of politics, and also disassociated from the US dollar. So a clear view
of the euro in every sense of the word. It is not a pair that will make you a fortune quickly, but it is a
reliable and solid currency pair that behaves in the way currency pairs used to behave. You will make
money with it, as it is predictable and follows the ‘rules’, and I say hurrah for that!
The EUR/GBP has a very strong correlation with the GBP/CHF pair across all time frames, with an
I’ve chosen the AUD/JPY pair here, but to be honest we could have chosen any of the yen currency
pairs, as they all correlate very closely, driven by the Japanese yen which dominates the pairs.
Therefore, get the direction for the yen correct, and you are then spoilt for choice. Furthermore, with
the FXCM yen index, you have the perfect chart to reveal yen strength and weakness against the four
major currencies, so use it!
The reason I selected the AUD/JPY is simple - it is a proxy pair for risk, and is the currency pair
which should be checked each day for an assessment of market mood and sentiment. The same could
be said for the EUR/JPY which used to have a very strong positive correlation with the S&P500, but I
prefer the AUD/JPY. Here we have a commodity currency with a high yield, balanced by the counter
currency of safe haven and the funding currency for the carry trade. As with all yen pairs, the index to
watch is the Nikkei 225. If the index is rising then money will be flowing into high risk and out of low
risk. The yen will therefore weaken as Japanese ( and other investors ) sell the yen and move into
Another of the yen pairs, and if you remember this is one that has a relatively close correlation to the
price of oil. Canada as a major exporter, and the Japanese as a major importer. If oil prices are
rising, at the same time as the yen is being weakened by ‘risk on’ or politics, then the pair will move
quickly. The weekly oil stats release on the economic calendar will also play their part here, with any
build in reserves, bad for the price of oil and any draw, generally good. So there are several
influences here, but as always with the yen crosses, get the direction right and you make money very
I have included this pair as it is an interesting combination of ‘commodity currency’ vs ‘commodity
currency’. Near neighbour vs near neighbour. Australia and New Zealand are very similar in terms of
exports and stability with similar risk profiles for their currencies. Surprisingly this pair trend
extremely well, but only in the longer term timeframes, once you move beyond the hourly chart.
Therefore, this is definitely a pair to consider for longer term swing or trend trading. And as I
mentioned earlier, given the spreads on many of these pairs will be wider than the more usual one or
two pips of the majors, a longer term approach is required.
In this pair the question is which commodities are dominating and why, and as I outlined earlier, the
Australian dollar is closely connected to hard commodities whilst the New Zealand is more aligned
to the ‘softs’. In addition, both now have China as their largest export market, and both have
comparable interest rates. Therefore, what are the likely drivers of this currency pair, and again the
answer is very much China. So, even if the Chinese economy does slow down, the Chinese people
still have to eat, this is likely to have a greater impact on the AUD rather than the NZD. This would
then be reflected in the pair in a move lower.
There are, of course, many cross currency pairs and impossible to cover them all here, so to round off
this section, I just wanted to end with one I would suggest you DO NOT trade, unless you actively
enjoy watching paint dry. And that is the EUR/CHF. If you are prepared to wait months, and I do mean
months, for a trend to develop, then this pair may offer some trading opportunities. However, it
remains rangebound for extremely long periods, and more likely to bore you out of a position before