The Dollar Index driving Futures Currencies

By far, the biggest market on a global scale is the currency market. It trades over Five billion dollars in notional value daily, making it also one of the most liquid markets in the world. In this week’s article I will delve into what drives price movement in the Currency futures as well as many of the commodities markets.

First, the futures currency market differs from the “spot market” currencies in a few ways. Simply, in the futures market we trade all of what are commonly referred to as the “majors,” or put another way, they are the currencies of the top Industrialized nations of the world. These are quoted against the US Dollar which is different than the spot market because in that market, each world currency can be “paired” against another. This results in a vast number of combinations that can be traded. Not so in Futures, which makes the analysis much more streamlined. The “Majors” as they are deemed by currency traders include the Euro, British Pound, Japanese Yen, Swiss Franc, and both the Canadian, and Australian Dollar. You can also trade the New Zealand Dollar, the Mexican Peso, and other emerging market currency in the futures market, but these contracts are not liquid so they would not be advisable to trade.

The fact that Currency futures are all pegged against the US Dollar makes it imperative that anyone trading these has a solid understanding of the supply and demand imbalances that occur in the US dollar index ($DXY). The Dollar Index is a basket of currencies that are measured against the US dollar. The Biggest component is the Euro currency which represents close to 60% of the value of the index.

As a result of the Euro being such a big piece of the Dollar index pie the inverse correlation between the two is very strong. We can see this clearly demonstrated in the two charts below.

A key probability enhancer is to find areas where the $DXY will turn up after it has been declining or turn down after a rally. Finding these areas beforehand would give a trader an edge as to whether to aggressively be pursuing long or short entries in the Currency futures.

In addition, the strength or weakness of the US Dollar also has ramifications in the commodities markets. As I mentioned before, the key is to find the turning points in the Dollar index to give us a leading indication of where the commodities are likely to go. In the two charts below we can see how having a better understanding of these concepts can help a trader change her results.

The first chart shows the supply and demand zones of the US Dollar Index with vertical lines on the dates where price turned. In the second chart we plot the daily price of the Copper futures contract. As we can see, the date where the Dollar index turned down coincides with finding a bottom and then starting a nice rally. A month later as the Dollar Index fell into its demand zone notice that about the same day, Copper peaked and then turned down.

So the bottom line is that if you’re trading Futures currencies and commodities and do not have situational awareness of where supply and demand is in the US Dollar then you don’t have an edge. And speaking of situational awareness, if you’re currently trading without an edge it is tantamount to you flying blind, and who wants to do that? So get a plan, have an edge, and most likely your results will improve.

Until next time, I hope everyone has a great week.

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