How to Trade Fundamentals With Currency Crosses
Trading fundamentals with currency crosses offers a unique opportunity for forex traders to capitalize on the economic dynamics of two different countries without the direct influence of the U.S. dollar. Currency crosses, which involve pairs that do not include the U.S. dollar, can provide more diverse trading opportunities and potentially higher profits when properly analyzed through fundamental factors. In this article, we’ll explore how to effectively trade currency crosses by leveraging fundamental analysis.
Understanding Currency Crosses
A currency cross is a forex pair that excludes the U.S. dollar. Examples include the EUR/JPY (Euro/Japanese Yen), GBP/AUD (British Pound/Australian Dollar), and AUD/CAD (Australian Dollar/Canadian Dollar). These pairs are often less liquid than major pairs like EUR/USD or USD/JPY, but they can be influenced by the economic conditions and monetary policies of the countries involved.
Why Trade Currency Crosses?
Trading currency crosses allows traders to focus on the relative strength or weakness of two currencies without the overshadowing impact of the U.S. dollar. This can provide a clearer picture of economic dynamics between the two economies. Additionally, currency crosses can sometimes offer less crowded trades, leading to more stable trends and reduced volatility.
Fundamental Factors to Consider
Fundamental analysis involves evaluating the economic, political, and social factors that influence a currency's value. For currency crosses, it’s crucial to assess the fundamentals of both countries involved in the pair.
1. Interest Rates
Interest rates are a primary driver of currency values. Central banks use interest rates to control inflation and stabilize their economies. When a country raises its interest rates, its currency typically strengthens because higher rates attract foreign capital. Conversely, lower interest rates can weaken a currency.
Example: If the European Central Bank (ECB) increases interest rates while the Bank of Japan (BOJ) maintains low rates, the EUR/JPY cross may rise as investors seek higher yields in the Eurozone.
2. Economic Indicators
Key economic indicators, such as Gross Domestic Product (GDP), inflation rates, and employment data, provide insights into a country’s economic health. A growing economy with low inflation and high employment levels is likely to have a strong currency.
Case Study: Consider the GBP/AUD pair. If the UK releases better-than-expected GDP growth figures while Australia faces economic challenges like declining commodity prices, the GBP may appreciate against the AUD.
3. Political Stability and Geopolitical Events
Political events, such as elections, government policies, and geopolitical tensions, can significantly impact currency values. Traders should monitor political developments in the countries involved in their currency crosses.
Example: If the UK faces political instability due to Brexit negotiations, the GBP may weaken against other currencies, including the AUD, making the GBP/AUD pair a potential sell.
How to Analyze and Trade Currency Crosses
1. Compare Economic Outlooks
When trading currency crosses, it’s essential to compare the economic outlooks of the two countries involved. This involves analyzing recent economic data releases, central bank statements, and future economic projections.
Example: Suppose the Australian economy is expected to benefit from rising commodity prices while the Canadian economy faces challenges due to declining oil prices. In this scenario, a trader might consider buying the AUD/CAD pair.
2. Monitor Central Bank Policies
Central bank policies play a crucial role in determining currency strength. Traders should closely follow announcements from the central banks of the countries involved in the currency cross. Understanding the central bank's stance on monetary policy, such as interest rate changes or quantitative easing programs, can provide valuable trading signals.
Case Study: If the Reserve Bank of Australia (RBA) hints at an interest rate hike while the Bank of Canada (BOC) indicates a dovish stance, the AUD/CAD cross might become more attractive for long positions.
3. Use Correlation Analysis
Correlation analysis can help traders understand the relationship between currency pairs. For example, if two currency crosses have a strong positive correlation, they tend to move in the same direction. Conversely, a negative correlation indicates that the pairs move in opposite directions. This analysis can be useful when diversifying trades or hedging positions.
Example: If EUR/JPY and GBP/JPY have a strong positive correlation, and you are bullish on the Japanese yen, you might consider selling both crosses.
4. Incorporate Technical Analysis
While fundamental analysis is key to understanding the broader economic trends, technical analysis can help pinpoint entry and exit points. Traders can use tools such as moving averages, Fibonacci retracements, and support/resistance levels to refine their trading strategies.
Case Study: In the EUR/JPY pair, if fundamental analysis suggests Euro strength, but the pair is nearing a strong resistance level on the chart, traders might wait for a breakout above that level before entering a long position.
Conclusion
Trading fundamentals with currency crosses requires a deep understanding of the economic factors influencing both currencies involved. By focusing on interest rates, economic indicators, political stability, and central bank policies, traders can make informed decisions. Additionally, combining fundamental analysis with technical analysis and correlation studies can enhance trading strategies, leading to potentially more profitable outcomes.
Incorporating these elements into your trading approach can help you navigate the complexities of currency crosses, making it possible to capitalize on global economic trends without the direct influence of the U.S. dollar.
