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the supposed relationship between oil and the USD or other currencies, such as CAD, NOK (Norwegian krone), or JPY. The idea is that, because some countries are oil producers, their currencies are positively (or negatively) affected by increases (or decreases) in the price of oil. If the country is an importer of oil, the theory goes, its currency will be hurt (or helped) by higher (or lower) oil prices.

      Correlation studies show no appreciable relationships to that effect, especially in the short run, which is where most currency trading is focused. When there is a long-term relationship, it’s as evident against the USD as much as, or more than, any individual currency, whether an importer or exporter of black gold.

The best way to look at oil is as an inflation input and as a limiting factor on overall economic growth. The higher the price of oil, the higher inflation is likely to be and the slower an economy is likely to grow. The lower the price of oil, the lower inflationary pressures are likely (but not necessarily) to be. Because the United States is a heavily energy-dependent economy and also intensely consumer-driven, the United States typically stands to lose the most from higher oil prices and to gain the most from lower oil prices. We like to factor changes in the price of oil into our inflation and growth expectations, and then draw conclusions about the course of the USD from them (see Chapter 7). Above all, oil is just one input among many.

      Stocks

      Stocks are microeconomic securities, rising and falling in response to individual corporate results and prospects, while currencies are essentially macroeconomic securities, fluctuating in response to wider-ranging economic and political developments. As such, there is little intuitive reason that stock markets should be related to currencies. Long-term correlation studies bear this out, with correlation coefficients of essentially zero between the major USD pairs and U.S. equity markets over the last five years.

      The two markets occasionally intersect, though this is usually only at the extremes and for very short periods. For example, when equity market volatility reaches extraordinary levels (say, the Standard & Poor’s [S&P] loses 2+ percent in a day), the USD may experience more pressure than it otherwise would — but there’s no guarantee of that. The U.S. stock market may have dropped on an unexpected hike in U.S. interest rates, while the USD may rally on the surprise move.

      In another example, the Japanese stock market is more likely to be influenced by the value of the JPY, due to the importance of the export sector in the Japanese economy. A rapid rise in the value of the JPY, which would make Japanese exports more expensive and lower the value of foreign sales, may translate to a negative stock-market reaction on the expectation of lower corporate sales and profitability.

      

In the world of currencies, the investing and speculative choices for participating have expanded greatly since the last edition of this book. I (coauthor Paul) think that currency exchange-traded funds (ETFs) are a fantastic way to speculate in the currency markets without all the head-scratching complexity of forex and currency futures (check out ETFs in Chapter 13). Another currency-related vehicle that has grown tremendously in terms of popularity and acceptance in recent years has been cryptocurrencies. Find out more in Chapter 16.

      RISK ON/RISK OFF: WAX ON, WAX OFF

      One of the first things new clients ask is what risk on/risk off means. This is a piece of financial market jargon that all traders should know, because it can determine the direction of a currency. Risk on/risk off refers to changes in investment behavior in response to global economic conditions. For example, when risk is perceived as being low, risk on/risk off states that investors tend to engage in higher-risk activities; in contrast, when the risks are perceived as high, investors tend to move toward lower-risk investments.

      Risky currencies include emerging markets and some of the less liquid G10 currencies, such as the Scandis (the Norwegian krone and Swedish krona), CAD, AUD, and NZD. Interestingly, most of the higher-risk currencies are also the currencies of commodity producers. According to risk on/risk off, these currencies should fall when risk is perceived as being high.

In contrast, the JPY, the CHF, and, occasionally, the USD are considered safe havens and tend to be bought during periods when risk aversion is high. The JPY is probably the most-famous safe haven; it can rally when the risk is centered in Japan. For example, after the 2011 Japanese tsunami, the yen surged.

      Bonds

      Fixed income and bond markets have a more intuitive connection to the forex market because they’re both heavily influenced by interest rate expectations. However, short-term market dynamics of supply and demand interrupt most attempts to establish a viable link between the two markets on a short-term basis. Sometimes the forex market reacts first and fastest depending on shifts in interest rate expectations. At other times, the bond market more accurately reflects changes in interest rate expectations, with the forex market later playing catch-up (because it takes longer to turn a bigger ship around).

      

Overall, as currency traders, you definitely need to keep an eye on the yields of the benchmark government bonds of the major-currency countries to better monitor the expectations of the interest rate market. Changes in relative interest rates exert a major influence on forex markets. (See Chapter 7 for more on interest rates and currencies.)

Getting Started with a Practice Account

      For newcomers to currency trading, the best way to get a handle on what currency trading is all about is to open a practice account at any of the online forex brokers. Most online forex brokers offer practice accounts to allow you to experience the real-life price action of the forex market. Practice accounts are funded with “virtual” money, so you’re able to make trades with no real money at stake and gain experience in how margin trading works.

      Practice accounts give you a great chance to experience the minute-to-minute price movements of the forex market. You’ll be able to see how prices change at different times of the day, as well as how various currency pairs may differ from each other. Be sure to check out the action when major news and economic data is released, so you can get a sense of how the forex market reacts to new information.

      In addition to witnessing how the forex market really moves, you can

       Start trading in real market conditions without any fear of losing money.

       Experiment with different trading strategies to see how they work.

       Gain experience using different orders and managing open positions.

       Improve your understanding of how margin trading and leverage work.

       Start analyzing charts and following technical indicators.

      

We think using a practice account while you read this book is a great way to experience many of the ideas and concepts we introduce. If a picture is worth a thousand words, then a real-time currency trading platform with constantly changing prices, market updates, and charting tools has to be worth a book. We’d like to think we’re pretty good at explaining how currency trading works, but nothing beats being able to see it for yourself.

      

We recommend that you open practice accounts with a few different

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