So far, I have given reasons for why it is important to know not just what is going on in the Forex market, but in the other security markets as well. In this article I will discuss the importance of equity markets on currency values and how these two markets are related.
Equity markets, or the stock market, are where people are allowed to buy a piece of ownership in a company. There are equity markets all around the world and these markets are tracked in a single number by stock price averages. There are many averages around the world but there are a few important ones. In the US they are the Dow Jones Industrial Average (the dow) and the Standards and Poors 500 (the S&P 500). In the UK it is the Financial Times and Stock Exchange (the FTSE 100), and in Japan it is the Nikkei 225.
Just because each equity market is unique to a particular country that does not mean that they only affect that countries currency. Instead, they affect all currencies at different times of the day based on when they are actively being traded. For example, during the US session, while the US stock exchanges are being traded, the Dow and S&P 500 are influencing and being influenced by currency exchange rates. But while most Americans are sleeping, the UK exchange is open and the FTSE 100 has a strong relationship with currencies. Depending on what time of the day you trade, you would watch a different market average.
The attribute of the market that stock prices are showing is risk appetite. As investors become hungry for more risk they will buy more stock which will be seen as in increase in the stock averages. Likewise they will buy the currencies that are seen as risky currencies.
For the most part currencies and stock averages have a positive relationship. This means that they move in the same direction, as stock prices go up so does the strength of currencies. There are three major exceptions to this relationship: USD, JPY and CHF. These three currencies generally move in the opposite direction of stock prices. As stock prices go up these currencies become weaker, and as stock prices go down they strengthen.
While USD and CHF are seen as safe currencies, which strengthen in times of risk aversion since investors are concerned with reducing losses and not maximizing returns, the JPY weakens in times of risk appetite because it is a funding currency. The Japanese central bank holds a very low interest rate, which means that it is cheap to borrow yen and buy a riskier currency with it. So when investors no longer want to hold the risky currencies, due to risk aversion, they must buy back the yen they borrowed which will strengthen JPY.
Following the stock averages is most important when trading during their opening time. This is because the opening of these markets can cause violent swings in the Forex market. These moves appear to occur with no reason if you focus solely on the Forex market.
It is important to note that the equity markets move in tandem with the Forex market. So the reason to watch equities is to explain movements in the Forex market not to predict them. However, at times the equity markets are easier to follow than the Forex markets since there is generally more information about them, so you can trade the sentiment in an equity market by making a trade in the Forex market.
