Forex Education and Analysis

Monday, 04 May 2009
By Ryan Teeples

Sadly, the newspapers and TV news shows are full of talking heads and so-called "experts" predicting the future of the market and the new direction of the US economy. Most of these experts and pundits couldn't trade a dollar for a donut. But many of these jokers are telling the world we're at the start of a new bull market in equities, while others continue to preach doom and gloom and predict protracted recession and bearishness.

We who are in the market are left wondering who do believe, and pondering the question: "Is this a new bull market for US stocks or will the down-trend continue?" And if so, why should you as a forex trader care?

To learn more about the way markets interact, be sure to watch our daily Intermarket Analysis Video and read How Stocks and Bonds Work Together.

A look at the daily chart (below) of the Dow Jones Industrial Average indeed is impressive. We see a nice solid uptrend over a solid period of time. But that's not the entire story.



As we take a look at the weekly chart (below), we see a different picture. While we've seen a nice run up from a bottom in March, we are still well below our long-term resistance levels. In fact, from a technical perspective, this week is an important one for the Dow, as it is approaching a 100% fibonacci level which has been an area of consolidation in the past.

If these concepts of support and resistance are unfamiliar to you, be sure to read Understanding Support and Resistance.

Until we get on top of those resistance levels, we would be unwise to call it a bull market.

So why should forex traders care? There are two specific reasons why US equities prices are an important factor in forex trading.



Bond Demand and Prices

As the US stock market grows, so too does demand for individual stocks, funds and indexes. Large institutions put a large portion of their portfolios in conservative US Dollar-backed investments (like bonds) when the stock market is uncertain, expecially when the global economy is down. But as stocks become attractive, those investors begin moving money out of those conservative instruments and into stocks.

This drives down demand for the USD and it can weaken against the majors. Interest rates being equal.


Inflation

Growth in US equities is often associated with inflation. When that happens, the Federal Reserve is inclined to raise the Fed Funds Rate, causing demand for the USD to rise due to the higher yield on US backed instruments.

So while demand for USD backed investments declines when stocks are growing, it can quickly rebound if the Fed raises rates.

So keeping on top of the US stock market becomes critical.