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Why has the euro become so expensive relative to the dollar? How do traders profit in the currency market?
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FX vs. Equities and Futures: Quiz Answers

1. If the US stock market rallies the US dollar SHOULD
Strengthen. A rallying stock market in any part of the world provides an ideal investment opportunity for individuals regardless of geographic location and as a result there is a strong correlation between a country's equity market and its currency. If the equity market is rising, investment dollars will flow in to seize the opportunity. Alternatively, falling equity makes will have domestic investors selling their shares to seize investment opportunities abroad. In the United States in particular, there is a very strong correlation between the performance of the US stock market and the US dollar. As a result, currency traders closely follow the US equity markets to predict how the US dollar will perform against the euro.

2. If the US current account deficit widens due to Japanese sell off of US treasures, the US dollar SHOULD
Weaken. The trade balance shows the net difference over a period of time between a nation's exports and imports. When a country imports more than it exports, the trade balance will show a deficit, which is generally considered unfavorable. For example, if US consumers wanted Japanese products, major automobile dealers might sell US dollars to pay for the import of Japanese vehicles with yen. The flow of dollars outside the US would then lead to depreciation in the value of the US dollar. From the standpoint of a national economy, a deficit in and of itself is not necessarily a bad thing it simply requires net foreign capital inflows to finance the deficit (investment flows into US stock or bond market). A large and growing current account deficit in the US requires net foreign capital inflows on the order of at least $1.8 billion per day. Smaller than expected net foreign purchases offer a possible signal that the deficit may be becoming unsustainable as foreigners lose their appetite for US assets. This would serve to weaken the US dollar.

3. In a surprise decision, the FED raises interest rates by 50 bp. The US dollar SHOULD
Rally. Currency traders look at data related to interest rates very closely as interest rate differentials are strong indicators of potential currency movements. Traditionally, if a country raises its interest rates, the currency of that country will strengthen in relation to other countries because countries with high interest rates will be capable of attracting foreign investment i.e individuals and Governments will exchange their local currency for the currency of that country. Indicators that have the biggest impact on interest rates are PPI, CPI, and GDP. Generally the timing of an interest rate move is known in advance. They take place after regularly scheduled meetings by the BOE, FED, ECB, BOJ, and other central banks.

The table below documents the fall of US interest rates. While ECB rates were cut repeatedly during this time as well, the overnight rate on the euro remained higher than the US dollar throughout the period in reference.

US Interest Rate Cuts
Date Amt. of Rate Change New Rate
June 27, 2001 50 Basic Points 3.75%
August 21, 2001 25 Basic Points 3.50%
September 17, 2001 50 Basic Points 3.00%
October 2, 2001 50 Basic Points 2.50%
November 6, 2001 50 Basic Points 2.00%
December 11, 2001 25 Basic Points 1.75%

The series of rapid interest rate cuts made by the Federal Reserve really manifested themselves in the US dollar's valuation during the course of the first half of 2002. After the barrage of rate cuts ending on December 11, 2001, the euro-US dollar exchange rate soared, reaching approximately .9975 by the beginning of July 2002. This marked an increase of approximately 12.26% from its December value of .8885. Clearly, the rapid series of interest rate cuts had left their mark.

4. If oil prices surge to record highs, what effect will this have on the US dollar?
Negative. A country's dependency on oil is very important in determining how its currency will be impacted by a change in oil prices. Intensive energy users (or net oil importers) will be more negatively impacted than other countries. The US is one of the world's largest net oil importers and thus it will be more sensitive to oil prices than other countries. Higher oil prices act like a tax hike while falling oil prices benefit consumers in the same way as tax cut. For corporations, higher oil prices can translate into lower profits. Countries with alternative fuel sources, and other resources have the ability to switch from strict oil dependence to other energy sources, which helps to reduce their exposure and sensitivity.

5. An increase in unemployment numbers in the US will have what effect on the US dollar?
Negative. Currency prices reflect the balance of supply and demand for currencies. A primary factor affecting supply and demand is the overall strength of the economy. The unemployment rate is a strong indicator of a country's overall economic strength and thus is a contributor to the underlying shifts in supply and demand for that currency. When unemployment is high, the economy may be weak - and its currency may fall in value.

The US economy had experienced the bursting of the dot-com bubble, thus leaving legions of its work force unemployed. As a result, the US unemployment numbers continued to rise - thus creating a spiral of economic weakness that helped to create a weaker US dollar. The table below documents the fall of the US workforce since the advent of the new millennium.

Unemployment as an Indicator of Economic Strength
Year Annual Unemployment Rate
2000 4.0%
2001 4.7%
2002 5.58%
2003 6.5%
Why is chart reading so popular in FX?
Another popular strategy for picking trades is technical analysis, or chart reading, where traders use charts to assess buying and selling interest in the market. Charts provide a visual way to spot trends and ranges, and to find good entry and exit prices.

Hundreds of thousands of currency traders use charts to spot levels at which to enter and exit the markets-and in doing so, make these technical levels even more significant! Since technicals are self-fulfilling and not difficult to learn, they have become even more popular. Live FX Charts

Where can I learn more?
You don't have to be an economic genius to trade currencies! Many traders begin to take advantage of opportunities in the FX market by learning how to read charts and following major news developments for the currencies that they trade. The easiest way to start learning is to download a practice currency trading account and making trades. Currency News

Test out your skills with a free practice trading account!
With a free demo currency account, you can place mock trades based on your opinion of where the market is going. To learn the mechanics of a currency trade and download a free practice account. Free Practice Account