Good day readers and fellow currency traders. Let me start this article by thanking you all for your questions and e-mails in response to my last article, which you can find by clicking here. If you haven’t yet read it, it was a piece solely dedicated to the psychology and mental game of trading. As my teaching career expands I’m finding more and more students of the markets getting interested in this side of trading and judging by your responses and comments which you sent to me it seems you found it helpful so that makes me a happy writer! With such an abundance of feedback following that article, I decided to dedicate this week’s offering to publicly answering one of the top questions I’ve received over the last couple of weeks. Sometimes it’s good to let you guys decide the topics as you are the ones who are reading the articles. Please keep the questions and e-mails coming and I assure you I’ll get round to answering you and may be including your question in a future article. Let’s begin with the question from Dana H in Denver:
Hi Sam. Firstly thanks for the articles every week. You and Rick Wright definitely keep things interesting for us. I am interested in hedging myself when the value of the US dollar changes and I’ve heard that there are ways to trade the dollar directly. What would you suggest are the most practical and effective ways to buy and sell the US dollar on a regular basis? Thanks, Dana H, Denver
Firstly, let me say that I think it’s a good idea that you’re thinking about hedging the value of the US dollar, especially considering things like inflation and the general cost of living that affect most of us in everyday life. It’s amazing how many people I find worldwide completely forget about the impact of the buying power of their home currency and I love it when they start to become aware that there are things they can do about appreciating and depreciating currency valuations. After all, why should you suffer just because your currency is? Anyone hoping to take a greater level of control in their financial future really does need to be aware of how they can hedge themselves in these market conditions.
The first thing you need to look at is a way of tracking the value of the dollar itself and that will come from looking at a chart of the Dollar Index market. The dollar index is much like any stock market index and is derived from a basket of currencies valued against the dollar itself in a price weighted format. The currencies involved are the Euro, the British Pound, the Japanese Yen, the Swedish Krona, the Canadian Dollar and the Swiss Franc. Because obviously there were far more currencies in the European Union before the establishment of the Euro single currency, the Euro itself carries the greatest price weighting in the dollar index as a result, which is 57.6% of the entire index with 13.6% to the Yen, 11.9% to the Pound, 9.1% to the Canadian Dollar, 4.2 to the Krona and 3.6% to the Swiss Franc. The Dollar Index chart looks like this:
As you can see from the picture above, the chart looks pretty much like any other market and that is exactly how it should be treated. We can apply the Online Trading Academy core strategy to find objective levels of supply and demand that the institutions are creating on the dollar index, just like we would on any other currency pair, stock or futures contract. However, the Dollar index itself cannot be traded in the format I’ve shown above, much like we can’t trade the NASDAQ index or the Dow Jones index outright. Therefore, we would have to look to derivatives and thankfully one such product exists and that is the dollar index futures contract, which looks like this:
Above we have a screenshot of the Dollar Index futures contract. This looks pretty much like a mirror image of the other chart doesn’t it? Well, that’s because it’s a derivative of the dollar index and therefore will move in exactly the same way and create the same levels of supply and demand for trading entries and exits. There will be minor changes in the prices here and there as this is a derivative product, however across the board is generally the same as the cash index chart itself. The contract is simply known as the Dollar Index Futures and its trading symbol is DX. The contract itself trades on ICE exchange (Intercontinental Exchange) and is valued at any given time in the following manner: $1000 x The Index Value. So with this in mind if the DX was trading at 80.89, as in the above chart, this would make the value of 1 contract to be $80,809. The margin required to trade this product on ICE, is set by the exchange itself and is at the time of this article writing $880 per contract, giving significant leverage to deal with. A single tick fluctuation is worth $5.00 profit or loss.
As we can see, the DX futures contract is a great way for any market speculator to participate in the movements of the currency for both speculative and hedging purposes. It’s a decent size product with a really good margin and not too much exposure. Yet for every positive there is often a negative. In this case that negative being that you would need to fund the futures account and pay for the data feeds required in order to trade the product. Some of you reading this may therefore be looking at this as probably not the most economic way to hedge the price of the US dollar. There is a solution at hand though and let me assure you that you probably already have access to engage it. Let’s take a look at one more chart:
Does this chart look familiar to you? If you are an active FX trader, then you will notice immediately that it’s a chart of none other than the EURUSD. Why might I be showing you this? When compared to the chart of the DX contract, you will see that it is pretty much a direct inverse of it. This is due to the fact that the Dollar Index itself is made up of over half price-weighting by the Euro, hence both markets and charts have such a high degree of correlation. So, to keep things simple as a spot FX trader, you can trade the EURUSD pair as a substitute to trading the DX contract itself. The only thing to remember is that one will be hitting levels of Demand when the other will be hitting levels of Supply. Keep this in mind and you have for yourself an easy way to hedge yourself on the Dollar. I hope you found this useful.
Wishing you a profitable week,