In this article I want to discuss the problem that a lot of traders bring on to themselves by not being aware of "environmental" considerations.
When we speak about the trading environment, we’re talking about the issues and developments that can affect currency price movement that are very important to be aware of.
One of the things that can be a great clue to currency directions is the condition of the US dollar. Note that I said ONE of the things—not the only thing, and in fact the US dollar may react differently in different market conditions.
But one factor that you should consider when you’re trading the forex markets is the action on the US dollar index, especially if you’re trading a US dollar cross pair. The idea here is that if the US dollar index has reached its 5 day Average Daily Range at or around the same time as other US dollar based pairs are reaching their 5 day Average Daily Ranges, it adds strength to the trade.
Specifically, we use a 5 day Average Daily Range (ADR) for a day trading indicator, to help us gauge whether or not a pair has moved to an extreme or not. There’s no magic in using 5 days—it just seems to pick up any sudden volatility changes more quickly that longer time periods.
So if you think about his, when the US dollar index reaches its 5 day ADR, and other currency pairs are reaching their 5 day ADR’s, you could say the these pairs are reaching extremes. We could expect them to find a top or bottom, and then look for one of 2 things: a place to take profits on an existing position, or a counter trend trading opportunity.
To further help you decide on when a pair might be exhausted, it is very useful to determine if that pair has bumped up against any higher time frame support or resistance price levels. If so, and the price of that pair has also reached its 5 day Average Daily Range, there’s a very good possibility of an imminent price reversal, or at least a price stall.
As with any indicator, I would strongly caution you NOT to use this information "stand alone". You should always consider other factors when you look to take on short term trades like this. And one very important factor is the market "environment".
The market environment refers to things like global factors, the market reaction to fundamental news releases, the condition of the equity markets, etc. There is a relationship between the aforementioned factors and the movement of currencies. Understanding this can greatly enhance your chances of success.
So, together with the market environment, I hope you can see that the range that the US dollar index has traveled during a trading day can have a direct relationship with the movement of currencies.
In my experience as a long time trader and forex coach, these environmental factors are not often understood by most traders, so I would encourage you to at least take a look at them for yourself. Notice things like the movement of the currency prices in relation to movements in the stock markets. This awareness can really be a big help to your trading results!
I hope this article has at least made you think a bit about these environmental considerations.
All the best,
Vic Noble
