Taming the volatile Australian Dollar – A great currency for beginner forex traders
You have your trading plan, your brokerage account is open and you’re excited to get started. The next step is picking the right forex pair to focus on.
Each forex pair has its own personality, with different market and economic forces at play in each market. Some pairs have a tendency to make clean-trending moves, while others tend to be more range-bound.
The Australian Dollar – AUD/USD – is a common starting point for beginning Forex traders. This market has a reputation for having friendly price action, and provides quite frequent trend-following opportunities.
About the AUD
The AUD is considered a commodity currency, due to Australia being a major exporter of products such as iron ore and wheat – this means the AUD price action is greatly affected by moves in the commodities markets.
The AUD is also extremely sensitive to economic growth and demand from China – Australia’s largest trading partner. China’s economic boom over the past decade was a large factor in pushing the AUD/USD up to a peak of around 1.10 in 2011.
With China’s slowing growth over the past few years, the AUD has gradually dropped to the low .70 area – this multi-year movement has provided a great long term trend-following opportunity for traders looking to short the AUD – this means placing a trade, looking to profit from a drop in the currency.
The AUD has the reputation of providing clear price action, with the tendency for smooth trends, especially over the past few years. Here are some basic trade set-ups to look for in trending markets:
Pullbacks to the moving average
The pullback is perhaps the most classic of trading set-ups. A pullback set-up occurs when the market is making a move in one direction, then “pulls back” in the opposite direction – effectively setting up for the next leg in the overall trend.
Many traders look for the market to pull back to their chosen moving average, before opening a trade. For example, the 200MA is pointed downward, the trader could wait for the market to pullback to the 200MA before opening a short-trade position.
A breakout trade occurs when the market pushes through a previous key level. For example, if the market has turned around at a certain level – when the market approaches this level in future, and is able to push through it, this is considered a breakout.
A breakout is perhaps the simplest way to get on a trend following trade, but there is always the risk of no follow through occurring after you enter the trade – many traders manage this risk by combining multiple set-ups.
The moving average crossover signal is a very systematic trade set-up where a shorter-term moving average (e.g. 20MA) crosses from one side of a longer-term moving average (e.g. 50MA) to the other, indicating a potential trend in that direction.
Most forex traders look for a combination of trade setups or signals before entering a trade. For example, a trader may wait for a moving over crossover to occur, and then start watching the market closely, looking to enter on a pullback to the moving average.
AUD/JPY – Profiting from the carry trade
The carry trade is a slightly more advanced trading strategy. This is where a trader sells a currency with a relatively low interest rate and simultaneously purchases a different currency with a higher interest rate.
A trader using the strategy, captures the interest rate differential between the two currencies – depending on the amount of leverage used in the trade, the differential can add up to a substantial dollar amount – deposited into the trading account each day, just for holding the position.
The Australian dollar currently has a globally-high interest rate of 1.75%, while the Japanese yen sits on the other side of the scale with a globally low interest rate of -.1%. This creates a situation where the AUD/JPY is a favoured currency pair for forex traders focused on a carry trade strategy.
The real benefit of this strategy is captured when a trader looks for long-bias trade set-ups – allowing for profits from the movement of the AUD/JPY, as well as profits from the interest rate differential
All charts are courtesy of CMC Markets Australia.