Markets do not exist in isolation and to learn FOREX well you must understand that stocks & shares, bonds, futures, indices, commodities, and FOREX are all interrelated. The world is becoming more and more connected. It is very easy for individual traders and large trading institutions to move money between different tradeable items. The economies of the world are also tightly bound as was demonstrated very effectively in the recent crash from 2008.
There is a whole branch of trading called inter-market analysis where traders study the relationships between different trading instruments. The intention is to find correlations that can help predict the future movement in the markets and to make money. Many of the correlations are related to the perception of risk and where money is moved at any one time. The big players can transfer their investments very quickly to where they believe they will get higher returns or safer.
What kinds of correlations are there and why do they work?
Well let's take some examples.
Inflation & Gold
If there is a perception in the market that price inflation is increasing then the value of traders' money is decreasing unless they do something. One of the favored instruments to invest in at this time is Gold. You can see this presently (April 2011) where the price of Gold is rising steadily because it is seen as a hedge against inflation. In other words investors are buying Gold so as to offset the value of their money as it decreases over time.
Oil versus US Dollar
There is an inverse relationship between the value of the US dollar and oil, or at least there seems to be. Why would this happen? Well there are many theories such as:
a) As the value of the dollar drops, the price of dollar denominated commodities has been boosted.
b) If the price of oil goes up, and a country is a net importer of oil such as the US, the this will worsen their balance of trade deficit, and this weaken the value of their currency.
c) The dollar is coming under pressure as the reserve currency for purchasing oil, with other alternatives such as the euro becoming more prominent. This has started to undermine the value of the dollar.
I suspect is could be a mixture of all these examples and others. The important point is that as a trader we can take advantage of this as we trade. There is also a correlation between the Canadian CAD and the oil price as well due to the fact that Canada is a major oil exporter.
AUD (Australian Dollar) and GOLD
The AUD has a relationship with the price of GOLD because Australia is a major exporter of Gold. Therefore the more the country can sell the better its trade deficit will be and the value of its currency will rise. Because the New Zealand economy is so inter-related with the Australian there is also a strong correlation between the value of the NZD with the price of Gold.
To summarise, its important to understand these relationships because they can help you fortify your analysis on a particular currency pair. This is another conjunction; if your charts are telling you the EURUSD is dropping and you can see that the price of oil is going up then that is more supporting evidence. For more information click on the link below.
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