In late October, I started noticing a tug-of-war going on in the stock market. It shows up on the charts by forming a symmetrical triangle turned sideways on the chart. Triangles typically have five major pushes to each side of the triangle before breaking out. Some time ago, it was nearing the completion of the fifth pass, so I told my valued clients that a stock market breakout was likely coming within the coming week or two maximum.
Well, sure enough just a few short days later, the stock market broke out of the triangle pattern on the daily chart of the S&P 500 and started heading south. This was a huge tip for currency traders. You see, when stock market breakouts happen like that, it illustrates currency traders which currencies will likely benefit and which ones will likely suffer from the breakout. In the industry, we call it the “risk on” or “risk off” trade. When stocks breakout southward the risk-off trade is in play and when stocks breakout northward on the chart, the risk-on trade is in play. Now as investors, you just need to know who’s in the risk-on and risk-off camps. The risk-on currencies are the ones that tend to track stocks and commodities closely and often carry higher interest rates.
So some of the risk-on currencies are the Australian dollar, New Zealand dollar, Canadian dollar and even sometimes the euro and the pound. Emerging market currencies like the Mexican peso, South African rand, etc. are also risk-on currencies since they are influenced by commodities and have higher interest rates.
The risk-off currencies are the defensive currencies like the U.S. dollar, Swiss franc and yen. The dollar is really taking the lead right now as the “defensive currency of choice” because the central banks of Switzerland and Japan have made the other ones essentially bad defensive choices because of these central banks intervening in their currencies to weaken them.
So if you have an opinion on where stocks are heading, whether up or down…then you also have an opinion of whether the risk-on trade will be in play or if the risk-off trade will be in play. And knowing that, you’ll be able to know which currencies have an edge and which ones don’t. Then you can play them against each other.
For instance, if the risk-off trade favors the dollar and hurts the Aussie dollar and New Zealand dollars then you can sell-short AUD/USD or NZD/USD and benefit from both dynamics going on there.
So keep an eye on what stocks [and even commodities] are doing and you’ll have a great take on what is going on in the currency market even though you may not have as much experience in the currency market. This is a great way to take your stock market experience and translate it into what that means in the currency market.
As investors , you will find that transacting your trades in the currency market (rather than the stock market) can carry some distinct advantages such as: no commissions, just the spread to pay…less slippage, quicker fills on your orders, 24-hour a day trading, etc. Happy investing in the currency market Disclaimer: This is just a research piece and not an investment advice. All financial transactions carry a RISK.
The writer is a financial market economist and commodity expert with 12 years of financial market experience. He graduated from University of Chicago, Booth School of Business, USA & IBA Karachi. He can be reached at. Blogs at www.economistshan.blogspot.com
