HOW TO TRADE AUD/USD Table of Contents How to Trade AUD/USD .................................................................................................................... 3 Australian Dollar Introduction......................................................................................................... 3 A Brief History of the Currency and the Reserve Bank of Australia .............................................. 3 Fundamentals to Prioritize for AUD/USD ....................................................................................... 3 Unique Characteristics of the Australian Dollar ............................................................................. 4 AUD/USD Tools and Resources ...................................................................................................... 5 Psychology and Risk Management Foundations ........................................................................... 6 AUD/USD Technical Strategies ...................................................................................................... 7 Disclaimer .......................................................................................................................................... 9 www.dailyfx.com 2 HOW TO TRADE AUD/USD How to Trade AUD/USD Australian Dollar Introduction The Australian Dollar is the official currency of Australia and all of its territories. Traders often refer to it as the “Aussie”. It is the 5th most-traded currency around the world which makes it one of the more liquid ones, especially when paired against the US Dollar. This coupling is ubiquitously referenced to as “AUD/USD” where AUD is the base and USD is the quote currency. A Brief History of the Currency and the Reserve Bank of Australia The Australian Dollar replaced the Australian Pound in 1966 and was pegged to the US Dollar in 1967. The Reserve Bank of Australia (RBA) managed the exchange rate. The central bank’s inception dates back to 1911 when legislation was created to form the Commonwealth Bank. It was not until the Reserve Bank Act of 1959 that the RBA was established. This transferred banking powers to it from the Commonwealth Bank. In 1983, the Australian Dollar started trading as a free-floating currency, making it sensitive to the RBA’s evolving monetary policy as it manages the economy. It does this by adjusting its official cash rate to achieve an inflation target of 2-3 percent, on average, over time. Other tools it uses include open market operations and targeted yield curve control. Fundamentals to Prioritize for AUD/USD Fundamentally, monetary policy is an important aspect of driving the Australian Dollar. When inflation is on the rise locally, the RBA typically raises rates, and lowers them when it needs to stoke price growth. All else being equal, rising interest rates usually bode well for a currency, and vice versa. That is because a key part of a currency’s appeal is its rate of return. So what should traders watch for? Consumption is the largest segment of Australia’s economy, with services accounting for about 2/3 of Gross Domestic Product (GDP). Another 25% is derived www.dailyfx.com 3 HOW TO TRADE AUD/USD from industry. According to the RBA, mining and manufacturing accounted for about 16% of output as of October 2020. Australia is a key exporter of natural resources like iron ore and coal. This means external forces can often make their way into Australia’s economy, influencing inflation, the central bank and the Australian Dollar. On the chart below, I point out the slowdown in global GDP growth since 2008. As world output slowly faded, Australian CPI growth - or the pace of increase in the cost of a basket of goods that the RBA closely monitors to approximate inflation – slowed. To help counter this, the RBA reduced interest rates to support a return to the inflation target. Unique Characteristics of the Australian Dollar According to the Observatory of Economic Complexity (OEC), in 2018 about 36% of Australian exports headed to China, which is Australia’s largest trading partner. Most of those goods were iron ore (58%) and coal briquettes (16%). This means that growth fluctuations in China, the world’s second-largest economy, can have a material impact on Australian output. www.dailyfx.com 4 HOW TO TRADE AUD/USD On the chart below is Chinese manufacturing PMI compared to an Australian Dollar index since 2008. The former is a measure of industrial activity. Readings above 50 indicate expansion while those below it mark contraction. Both data series have been smoothened out using a 12-month moving average. As you can see, the Australian Dollar can track Chinese manufacturing activity for extended periods of time AUD/USD Tools and Resources Because Australia’s economy can be sensitive to external forces and Chinese economic output, the Australian Dollar tends to take on a ‘risk-sensitive’ role. On the chart below is AUD/USD overlaid with S&P 500 futures from the second half of 2019 and until late October 2020. The 20-day rolling correlation tended to stay positive. Keep in mind that correlation does not imply causation. Check out the DailyFX economic calendar for timely updates on Australian and Chinese data During 2020, the coronavirus outbreak ravaged global growth, causing central banks around the world to reduce lending rates to near-zero levels. Prospects that the RBA would keep rates low for some time likely helped AUD/USD focus more on its role as a growth-linked currency. With that in mind, it could be helpful for Aussie traders to get acquainted with the psychology of stock markets. www.dailyfx.com 5 HOW TO TRADE AUD/USD Chart Created in TradingView Psychology and Risk Management Foundations Since the Australian Dollar can be sensitive to global stock markets, it also tends to be a more volatile currency relative to some major alternatives. This means you can typically expect more price fluctuations compared to pairs like EUR/USD or USD/JPY. You will often find AUD within the top 3 G10 currencies in implied volatility rankings against the US Dollar. Traders ought to take this into account when considering risk management. This can be done using the average true range (ATR) indicator with a moving average (MA) – see below. When the MA (with a period of 5) is 0.0050, this means that the distance from highs to lows averaged 50 pips over the past 5 days (using a daily chart). This could give you an idea of how far prices may go ahead for stops. Needless to say, however, past performance is not indicative of future results. Learn more about managing AUD/USD risk with tools provided by IG Academy www.dailyfx.com 6 HOW TO TRADE AUD/USD Chart Created in TradingView AUD/USD Technical Strategies When it comes to technical analysis in foreign exchange markets, keep in mind that forex is usually a 24-hour market. This means that with the exception of weekends, gaps tend to occur infrequently versus other financial markets. This should be taken into account when identifying key candlestick formations, like a Shooting Star. Gaps may not be present, but that doesn’t necessarily invalidate patterns. On the chart below in the lower left corner, I highlighted a Shooting Star that preceded a turn lower in early September 2020. A closer look revealed that the traditional upside gap associated with the candle was absent. Higher levels of liquidity and less choppiness in forex markets can make for cleaner trendline and chart pattern analysis. On the lower right corner is an example of a rising support line from 2016 to early 2018. Focusing on the top left corner, a bearish Rising Wedge was seen preceding AUD/USD’s turn lower in late 2016. It signaled the resumption of the previous downtrend earlier in the year. Momentum can also have key technical implications for AUD/USD. On the top right corner, negative RSI www.dailyfx.com 7 HOW TO TRADE AUD/USD divergence preceded AUD/USD’s top in early 2018. That was a sign of fading upside momentum as the price set higher highs, but RSI did not. AUD/USD Daily and Weekly Chart Chart Created in TradingView Learn to Trade with a free demo account from IG Get your Demo Now Leveraged trading in foreign currency or off-exchange products on margin carries significant risk and may not be suitable for all investors. We advise you to carefully consider whether trading is appropriate for you based on your personal circumstances. Forex trading involves risk. Losses can exceed deposits. We recommend that you seek independent advice and ensure you fully understand the risks involved before trading. www.dailyfx.com 8 HOW TO TRADE AUD/USD Disclaimer DailyFX Market Opinions Any opinions, news, research, analyses, prices, or other information contained in this report is provided as general market commentary, and does not constitute investment advice. DailyFX will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 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It is the responsibility of visitors to this website to ascertain the terms of and comply with any local law or regulation to which they are subject. High Risk Investment Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain losses in excess of your initial investment. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts. www.dailyfx.com 9