Forex Investment and Currency Trading

As much as we like to think of the forex market as the be-all and end-all of financial trading markets, it doesn’t exist in a vacuum. You many even have heard of some these other markets: gold, oil, stocks, and bonds.

There’s a fair amount of noise and misinformation about the supposed inter-relationship among these markets and currencies or individual currency pairs. To be sure, you can always find a correlation between two different markets over some period of time, even if it’s only zero (meaning, the two markets aren’t correlated at all).

Be very careful about getting caught up in the supposed correlations between the forex market and other financial markets. Even when a high degree of correlation is found (meaning, the two markets move in tandem or inversely to each other), it’s probably over the long term (months or years) an offers little information about how the two market will correlate in the short term (minutes, hours, and days). Even worse, what it may suggest about the short-term relationship may be flat out wrong and, therefore, dangerous.

The other point to consider is that even if two markets have been correlated in some past period, you have no guarantee that the correlation will continue to exist now or into the future. For example, depending on when you survey gold and the U.S. dollar, which supposedly have a strong negative correlation, you may find a correlation coefficient of as much as -0.8 (a solidly negative correlation) or as low as -0.2 (very close to a zero correlation, meaning that the two are virtually noncorrelated).

Always keep in mind that all the various financial markets are markets in their own right and function according to their own internal dynamics based on data, news, positioning, and sentiment. Will markets occasionally overlap and display varying degrees of correlation? Of course, and it’s always important to be aware of what’s going on in other financial markets. But it’s also essential to view each market in its own perspective and to trade each market individually.

Gold

Gold is commonly viewed as a hedge against inflation, an alternative to the U.S. dollar, and as a store of value in times of economic or political uncertainty. Over the long term, the relationship is mostly inverse, with a weaker USD generally accompanying a higher gold price, and a stronger USD coming with a lower gold price. However, in the short run, each market has its own dynamics and liquidity, which makes short-term trading relationships generally tenuous.

Overall, the gold market is significantly smaller than the forex market, so if we were gold traders, we’d sooner keep an eye on what’s happening to the dollar, rather than the other way around. With that noted, extreme movements in gold prices tend to attract currency traders’ attention and usually influence the dollar in a mostly inverse fashion.