What Moves Shares Also Moves Forex

The forex market is one of the oldest markets in the world. Believe it or not, the first ever currency transaction occurred by 2000 BC in the form of a receipt that represented grain stored in granaries in ancient Mesopotamia. The first paper money can be traced back to the Tang Dynasty in China (618-907) and was introduced in Europe in 1661. In contrast, the first share exchange in Australia was established in 1861 in Melbourne while the New York Stock Exchange was established more than four decades earlier in 1817. Yet only in the past 15 years have individual investors begun to discover what is not only the oldest, but also the largest market in the world. The reason is because for many years before that, forex was a club limited to the largest players with the deepest pockets in the world, such as banks, institutional investors and hedge funds. However the evolution of technology has given individual investors unique access to the forex market and within a decade, volume has more than doubled.

In recent months, exchange rates have received some newfound attention thanks to the rapid and aggressive appreciation of the Australian dollar, which climbed to a record high of $1.10 against the US dollar in early May. For some investors, the gains in the Aussie have led them to wonder how they could get involved and take a view on whether the rise will continue or recede. Other investors wondered how the strength of the currency could affect their share holdings. Consumers, on the other hand, have taken advantage of the AUD strength by shopping online from vendors in other countries, to the dismay of local retailers. Those who have discovered currencies have found that what moves forex are often the same things that move shares, making the intellectual shift less of a challenge. The reason why this dynamic exists is because currencies are generally seen as little confidence indicators for a country.

Five Factors Driving Share Prices

From a fundamental perspective, there are five key drivers of share prices:

1. Company News and Earnings – If a company announces good news or its earnings surprises to the upside, this is generally positive for the share price. If the news or earnings is negative, it can lead to a sell-off in the shares 
2. Country Specific Economic Data – By the same token, improvements in economic data for a country, such as a stronger employment report, tend to be positive for the share market broadly while weaker data could send shares tumbling.
3. Interest Rate Changes and Comments by Central Banks – When a central bank raises interest rates or talks about wanting to do so, the share market may react negatively because higher borrowing costs makes life more difficult for businesses. Talk of lower interest rates is generally received positively by investors.
4. Commodity Prices – Higher commodity prices can help to lift the shares of resource companies, but for other companies that do not stand to benefit from higher prices, their share values could suffer. In contrast, lower commodity prices will hurt resource companies and benefit everyone else who would otherwise have to pay higher costs.
5. Market Sentiment or Risk Appetite – Market sentiment is also very important. If investors feel nervous for one reason or another, it could weigh on the share market in general. This happens often when there is a sharp sell-off in US markets, which can therefore lead to a catch-up move when Australia opens for trading. 

Five Factors Driving Forex Movements (minus one) 

In many ways these are the same five things that typically affect the movement of currencies, with one exception.

1. Company News and Earnings – Unless the news or earnings is from a major multinational company and it is a big surprise to the market, corporate earnings and news generally do not have a major impact on currency values.
2. Country Specific Economic Data – Economic data, on the other hand, is VERY important. If Australian retail sales are extremely strong, it can be very positive for shares because it indicates that the economy is performing well. At the same time, it should also be very positive for the Australian dollar. When economic data disappoints, however, it can provide a big drag on equities and the currency.
3. Interest Rate Changes and Comments by Central Banks – Unlike shares, currencies usually benefit from interest rate hikes or any comments from central bank officials that suggest a hike is likely. Investors around the world shift money from one country to another in search of high and growing yield (interest rates), which is one of the main reasons why the Australian dollar has performed so well.  It is also the reason why the US dollar has performed so poorly. Interest rates in the US are among the lowest in the world and for the time being, the US central bank has no plans to change that reality.
4. Commodity Prices – Like shares, some currencies will benefit from higher commodity prices while others will be hurt. As big resource producers, the Australian, New Zealand and Canadian dollars tend to rise when commodity prices rise and fall when it declines. Since commodities are priced in US dollars, we tend to see higher commodity prices coincide with a weaker US dollar. The euro and British pound also have a positive relationship with oil because the central banks of those countries have a mandate to maintain inflation below a certain rate.
5. Market Sentiment or Risk Appetite – Finally market sentiment can have a unique but important impact on currencies. When investors are optimistic, they like to buy currencies with higher yields (such as the AUD, NZD, EUR) and fund it by selling currencies with a low yield (like USD, JPY and CHF). When they are nervous, they will reverse those trades causing the USD, JPY and CHF to rally and the AUD, NZD and EUR to fall.

What Separates Forex from Shares

With all of this in mind, you may be eager to trade, but before doing so, it is important to be aware of seven unique characteristics of forex trading:

1. 24 Hour Market – The forex market is open 24 hours a day, 5.5 days a week, which means that anything can happen when you are asleep! This makes it extremely important to use stops and manage trades accordingly.
2. High Leverage – There is significantly higher leverage in forex than in other markets, which can magnify profits and losses.
3. Rollover – Since currencies are interest bearing instruments, a long Australian dollar / short U.S. dollar trade (long AUD/USD) will earn interest while a short Australian dollar / long USD trade requires paying interest on a daily basis.
4. Currencies are Traded in Pairs – The value of one currency is determined in relation to another currency. For example, if the AUD/USD rate is 1.10, it means that Australian dollar is worth 1.10 US dollars. As a result movements in the AUD/USD value can be caused by changes in sentiment towards the AUD, USD or both.
5. The Most Liquid Currencies – Finally, unlike shares where there are thousands of companies to pick from, most forex trading volume is concentrated in the eight most actively traded currencies making it less cumbersome to follow.

So for those investors with an interest in forex trading, hopefully this article helps you navigate the way and understand that many of the factors that you may already be accustomed to watching for your share trading are the same ones that affect the forex market.