This means that you can get a reading on the direction that gold is likely to move in by monitoring for big moves in the forex markets - as forex moves precursor those in gold.
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Whilst you can trade the dollar against any other currency, it’s predominantly traded against Euros (depicted as EUR/ USD) or British Pounds (GBP/ USD). For both currency pairs the exchange rate is stated as the value of one Euro or Pound against the US Dollar – i.e. GBP/ USD 1.6000 means that for every British Pound I hold it is worth 1.6000 US Dollars.
Gold acts like a currency in its own right and, as it’s priced in dollars, it makes sense to think of its “exchange rate” being that of its current price for an ounce of gold.
All exchange rates are linked – so if the current gold price (i.e. “gold’s exchange rate”) is $1600 per ounce and the exchange rate between the GBP/ USD is 1.6000 (keeping things simple) we can deduce that if I’m holding £10,000 then I can purchase 10 ounces of gold (£10,000 x 1.6000 = $16,000/ $1,600 = 10 ounces) . If the dollar weakens against the pound to a rate of GBP/ USD 2.0000 my £10,000 would now buy me 12.5 ounces of gold (£10,000 x 2.0000 = $20,000/ $1,600 = 12.5 ounces).
Because I can now buy more gold for the same amount of money it represents a better investment and so I’m all over it it…but so is everyone else who is holding £’s (or whichever currency has advanced against the $) and so very quickly the price of gold increases due to increased demand. Simple economics.
Irrespective of the direction - if there is a substantial change to the value of dollar it tends to result in an inverse impact to the price of gold and, as gold reacts to the dollar price, it passes through its own technical thresholds which exacerbate or limit the impact.
The following charts from 23rd November 2012 help illustrate this. Bear in mind that the 23rd Nov was supposed to be a quiet day trading as it was the Friday after Thanksgiving in the US and so is traditionally treated almost like a public holiday and therefore trading is very light. The first two charts are hourly EUR/ USD and GBP/ USD respectively:
How can we use this in Gold Trading?
You need to still be aware of the technical picture in gold itself – resistance & support levels, Fibonacci and Elliot Wave patterns, trendlines and moving averages will all play a part in exacerbating or limiting the impact of dollar-driven movements as we’ve highlighted above.
Having the EUR/ USD and GBP/ USD charts open throughout the day and monitoring for big movements should be a given. Make sure that you check them before making trading decisions – they can influence when you enter or exit, or when you move your stop loss.
When you see a strong movement in either direction which converges with a technical breakthrough on the gold chart, jump on it – more often than not it will work in your favour and usually with large gains to be made.
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