US Dollar Index – Can We Use it As a Benchmark For Overall Market Direction in Forex Trading?

How good is the US Dollar Index for forex traders? Can you use it like the stock indexes DOW JONES and the S&P 500 as a benchmark for the overall market direction. The conventional wisdom in stock trading is to find the direction of the market from one of the indexes like the DOW or the S&P 500, find the strongest sector and finally winnow down to the strongest stock in the sector. The premise is this that a rising tide lifts all boats!

Can we use the US Dollar Index in forex trading like the the stock indexes in stock trading? Most probably not. US Dollar index is a totally different animal. If you ask any economist how good is the US Dollar Index, he may say it is no good. Since 1999, when the EURO replaced 12 European currencies, US Dollar Index (USDX) hasn’t changed much.

Now USDX is comprised 73% of European currencies. This limits it’s usefulness as a benchmark comprised of basket of currencies. So it may not be good at representing USDJPY currency pair or perhaps any other currency pair involving USD apart from USDEUR to some extent. What we can say is that it has uncertain value in trading individual currency pairs.

However, it may have a limited value in trading commodities like the gold and crude oil. But there is a US Dollar Index Indicator that you use to predict the market direction. Watch this video that shows two powerful indicators that can change the way you have been trading forex!

Point and Figure Charts – Getting a Better Feel of The Market Direction

Charts came into existence to visualize the changing numbers. Charts make the data analysis and identification of trends easy by giving a visual edge to the numbers, especially when the data is huge and is rapidly changing.

Charts also evolved over time to make the interpretation of the data easier. There are various types of charts which are used in trading markets, right from line charts to bar charts to candlestick charts. One issue with all these different kinds of charts is that they all take into consideration every price movement. Candlestick charts give us a better picture because we only know the range of the movement during the selected time frame but still all the price movements are captured. While trading in Forex, stocks and other commodities, every change in price may not be really desired to be analyzed. Many changes in the price may just be like unwanted noises and these noises need to be ignored.

A trader, primarily, would be interested only in knowing the real price movements which indicate a real trend or the break from a trend. To get the picture of the real market trends we use various technical indicators various traditional types of charts. Point and Figure or P&F charts are a cut above the others and present us an opportunity to get a feel about the trends even without the technical indicators. Point and Figure charts give the real feel of the market by filtering out unimportant market movements and taking into account the movements which are significant and which really matter. A trader, with his or her experience and skills, decides as to what amount of the change in the price should be considered as significant. P & F charts take into account only these pre-decided amounts of change in the prices.

Components of point and figure charts:

1) Box Size: Box size is the price movement in any particular market direction (up, down or range) which is worth noting. While trading Forex, we may consider a 10-pips move as the box size if the market is not very volatile. The box size should depend on the volatility and we can consider bigger box sizes when the market is very volatile. The P&F chart would ignore any market movement which is less than a box size.

2) Reversal size: Reversal size is nothing but a change in the price which indicates that reversal in the ongoing trend may be taking place. Like the box size, we decide an amount (number of pips) as reversal size. If the price moves in the opposite direction to the ongoing trend and if the change is equal to or more than the reversal size, then only we would consider that the trend may be reversing.

The best part of point and figure charts is that we can plot the chart manually because we do not have to take into account every price change but only the significant ones. A point and figure chart is plotted by using the “box size” and the “reversal size” and to give a clear visual feel about the market trends while ignoring the unwanted noises of the market. Simple trend lines can be used to see the resistance and support levels and the breakouts to make trading decisions.

How to Know Market Direction

One of the most important things you must know before buying any stock is the direction of the general market. 90% of all stocks go UP in a general bull market and 90% of all stocks go DOWN in a major bear market.

But how do you know why even the so-called “good” ones go down when they haven’t lost their value. Sales, profits, everything remains the same yet these stock decline in price.

Your broker or financial planner won’t tell because almost none of them have been taught this simple technique. You can check it out yourself.

In the newspaper Investors Business Daily there is published several times each week the IBD Mutual Fund Index. Look at the 200-day Moving Average dotted line. When the direction of that line is going up it is a bull market. When the direction of that line turns down as it did this past July it is a bear market. Very simple.

This index is made up of 24 large mutual funds. They own hundreds if not thousands of different stocks. This dotted line that is computed every day is composed of those thousands of stocks. From the direction of the dotted line it clearly indicates a bull or a bear market.

This is a very long term signal and is not for short term trading. It is ideal for retirement and college plans. The inexperienced investor does require any knowledge of fundamental or technical trading techniques.

It is advisable for those not following the IBD Index when buying any stock, ETF or mutual fund there should be an open stop loss order placed immediately. With mutual funds it will have to be a mental stop where the investor keeps track. The most any prudent investor is willing to lose is about 10%. He might risk more, but that is up to each individual. Don’t rely on any broker to protect an account.

Once a market starts down it begins to feed on itself. Buyers hunker down and slowly disappear. The prudent investor will look at his portfolio statement carefully every month. If any mutual fund goes down more that the set amount he has decided upon (maybe 10%) he should call his broker and all that money transferred into a money market account.

Money market funds do not pay much, but even if the amount is zero percent at least the money is being secured while waiting for the next buying opportunity.

All investors and even day traders should be aware of general market direction as it will aid in establishing equity positions.