Using Equity Indexes to Trade Forex: Part 1

Many traders will look at the economic news releases, the currency charts, or both when assessing whether a currency pair is likely to go up or down. However, did you know that the equity markets can also be used to analyse the currency markets? Specifically, the main equity indices can be powerful tools for predicting the movements of currencies.

china-stockmarket-forexthinkThe stock markets are the most widely covered in the mainstream media. This is possibly because the general public finds the narratives associated with the companies that make the products they buy more interesting than those of other markets.

It’s worth remembering that the forex markets and the stock markets are actually intrinsically linked, because in order to buy stocks from a particular country you need to have the local currency. For example, to buy Japanese stocks, European investors have to first exchange their euros (EUR) into yen (JPY). This will increase demand for JPY, and exert an upwards pressure on the price of the JPY. By the same token, selling euros to buy JPY will increase the supply of euros, driving the value of the euro lower.

When a regional or national stock market is booming, money tends to flow in from all around the world, driving up demand for that country’s currency. However, when a stock market is struggling, international investors will soon take their money out of that market and find a more profitable place to put their money.

Although you might not, as a forex trader, be interested in stocks, you should still keep an eye on the major stock markets. If one country’s stock market is doing better than another, you should know that money will probably be flowing from the country with the weak stockmarket to the one with the strong stockmarket.

This could cause a rise in the value of the country with the strong stockmarket’s currency, and a depreciation in the value of the country with the weaker stockmarket’s currency. As a general rule, strong stock market equals strong currency, while weak stock market equals weak currency.

This provides a profit opportunity, as if you bought the currency from the country with the strong stock market and sold the currency from the country with the weak stock market, then all things being equal you would profit.

In the next installment, we shall be giving you a round-up of all the major stock indices that you, as a forex trader, should be following.