Two weeks ago, the article "Thunder From Down Under" was published, and in that article we discussed the reasons why the Australian Dollar was showing such great strength.
Although the Reserve Bank of Australia did not raise rates as anticipated on April 4, the Aussie has not been derailed. In fact, the currency has reached a series of new 10-year highs vs. the U.S. Dollar (see Figure 1).
Figure 1: Australian Dollar reaches a series of multi-year highs vs. the U.S. Dollar. Source: Saxo Bank
The Australian Dollar didn't stop there. In addition to the U.S. Dollar, the Aussie is absolutely crushing the Japanese Yen, as the AUD/JPY pair also reached a series of multi-year highs (see Figure 2).
Figure 2: Australian Dollar rallies to new highs vs. the Japanese Yen. Source: Saxo Bank
When the Reserve Bank of Australia announced on April 4 that it would keep the benchmark interest rate at 6.25%, it was just delaying the inevitable. Traders still expect an Australian rate hike, only now they expect it in May.
Aussie was not the only currency to run roughshod over the Yen. For the first time this century, Euro breached 160.00 vs. the beleaguered Japanese currency (see Figure 3).
Figure 3: Euro reaches multi-year highs vs. the Japanese Yen. Source: Saxo Bank
Ok, let's get to your questions:
Q) Reports coming from the US are pointing toward slowing economy combined with higher inflation. Could you comment on the consequences of the above-mentioned scenario for the USD?
Ed Ponsi) Great question. When an economy slows, as is now happening in the U.S., inflation usually subsides. This is because strong growth creates wealth and increases spending, which can be described as too much money chasing too few goods. If a company can sell all of the goods it produces at the current price, why not raise prices and see if consumers are willing to "pay up"? Slowing growth tends to reduce these price pressures, because goods are no longer flying off of the shelves.
The wild card in this scenario is the price of energy products. Imagine this scenario; if the price of energy (gasoline, heating oil, jet fuel, ect.) is consistently rising, this will affect the personal finances of individuals in a negative way. People in general will have less money to spend on other things if a greater part of their budgets are spent on energy products, and this could cause growth to slow. Slower growth is a potential side effect of higher energy prices.
Unfortunately, higher energy prices can simultaneously boost inflation. For example, consider the goods for sale on the shelves of your local supermarket or shopping mall; many of these products are transported via vehicles that burn oil and gasoline, and now the cost of operating these vehicles is rising. Companies will try to absorb the higher cost in order to remain competitive, but at some point these higher prices may be passed on to the consumer. Also, energy prices are often a factor in the manufacturing process, and because of this the prices of many manufactured goods may also rise.
The above scenario puts Ben Bernanke and the Federal Reserve between a rock and a hard place, because one of the Fed's key tools used to fight inflation is a higher interest rate. This tends to slow growth and reduce price pressures. The problem is, strong growth is not the cause of this current round of inflation, and higher interest rates will exacerbate any economic slowdown. Meanwhile, lower rates could further ignite inflation.
Which way will the Fed turn? My opinion is that growth will slow enough to allow the Fed to cut interest rates several times before the end of the year. Falling interest rates tend to have a negative effect on the underlying currency, in this case the U.S. Dollar. The USD is already on shaky ground, and a drop in the price of energy could provide welcome relief for Dollar bulls. However, I am troubled when I hear pundits on CNBC and elsewhere make assumptions that energy prices will fall. They are falling into the trap of believing that prices are artificially high and must revert to earlier levels. While I would love to see oil reach new lows, I can't allow that desire to cloud my judgment. Just like the price of any stock or a currency, the price of oil doesn't "have to" do anything, and if it were really worth less than the current price, the cost would fall immediately to reflect that fact. The truth is nobody knows with certainty which way energy prices will go next.
Q) How much do I need to get started realistically in the Forex Market? I was going to start out with about $2000, would that be feasible? Should I consider a mini account?
Ed Ponsi) Thank you for your question. I'm sure U.S. stock traders are familiar with the Pattern Day Trader (PDT) rule, which places certain trading restrictions on accounts that have a balance of less than $25,000. The good news is that the Forex market a) has no such PDT restriction, and b) offers mini accounts that allow traders to reduce their risk substantially by trading positions that are only a fraction of the size of standard Forex positions. You could sufficiently fund a mini account with $2000 USD, and trade without restrictions.
Many Forex brokers and market makers allow customers to fund accounts with just a few hundred dollars, but I don't recommend doing this. In order to use good risk management, you must have enough leeway to allow your trades to run without risking too large of a percentage of the account on any one trade. When we attempt to trade with a few hundred dollars, we are "painting ourselves into a corner" and limiting our options. The result is usually a stop that is too close, or a level of risk that is not conducive to good trading. Instead of trading with too little capital, use a demo account to gain trading experience without risking any of your own capital. Simply google the term "forex demo account" and you'll see numerous free practice accounts available for download. Most of these offer real-time quotes and charts.
Q) Do you have any tips for info overload and getting distracted?
Ed Ponsi) Traders are bombarded with an incredible array of facts, opinions, and gadgets. We have "experts" on financial programs telling us what to buy and sell, and we have charting programs that include dozens of indicators. I would just like to offer this thought ??“ keep it simple. There is no need to overcomplicate the trading process. Here are a few practical tips:
- Learn to listen to yourself only. Don't worry about the advice of a financial guru, or of the person next to you in a trading room. If someone gives you bad advice, will they share in the losses of your account? Of course not. When we listen to others, we are rejecting responsibility for our own actions and attempting to place that responsibility on someone else. Learn to trust your own opinions ??“ in fact, avoid forming strong opinions about the market. Instead, be willing to trade what you see in front of you on your charts.
- Simplify your charts. Don't check 15 indicators and 8 time frames before placing a trade. Instead, use two or three indicators and no more than two or three time frames for a particular trading style. When we look at too many different indicators, it becomes almost impossible to place a trade.
- Don't overanalyze trading situations. This is a trap that many intelligent traders fall into. If a trade meets your entry criteria, and the risk is acceptable, go ahead and place the trade. Don't sweat over every tick on the chart.
- Have a definite plan. This will reduce the stress of trading immeasurably. When we have a definite trading plan, we avoid making rash decisions that can short-circuit a perfectly good trade. If we are following a detailed plan, we have completed the decision making process before the trade is even entered. This means no spur-of-the-moment decisions, no "getting out because I'm scared", and no adding to losers because "it seemed like a good idea at the time". Cutting off the possibility of these actions will simplify your overall trading experience. I hope this helps!
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.