AUD/USD Forex Trading Strategy

AUD/USD Currency Pair Overview

This article will cover the following

  • Overview of the Australian economy
  • Overview of the US economy
  • Properties of the AUD/USD cross
  • Average spread, volatility, correlation to other pairs
  • Trading strategies
  • and more

The AUD/USD cross is among the most popular ones, not only because of the Australian economy’s size, but also due to the country’s important role on the international trade scene, particularly in the commodity markets. According to a report by the Bank for International Settlements, AUD/USD accounted for 6.8% of the Forex market’s turnover as of April 2013.

It is well known that the US dollar is the world’s major reserve currency. It stood on one side of 87% of all trades in the Forex market as of April 2013. Meanwhile, the Australian dollar, also known as the Aussie, was the fifth most traded currency, participating in 8.6% of all trades. This was an improvement in its positions as AUD stood on one side of 7.6% of all trades in 2010.

Australian economy

Australia-Flag-iconAustralia is the 12th largest economy worldwide with a nominal GDP of $1.56 trillion in 2013, according to data by The World Bank. In terms of purchasing power parity, Australia’s GDP is the 18th highest in the world ($998.3 billion in 2013, according to the CIA World Factbook).

The Australian economy is service-oriented, with the respective segment accounting for 68.8% of the nation’s total GDP. Major sectors are finance, tourism, media, education and logistics. Australia’s “Big Four” banks are among the 50 safest banks in the world as of April 2012.

Australia’s industrial sector accounts for 27.3% of the total GDP, where 21% of country’s labor force is occupied. The manufacturing sector was at its peak during the 1960s, contributing to 25% of the GDP, while its share has fallen to below 10% since then. The agricultural sector accounts for 4% of the total GDP, while 3.6% of nation’s labor force is occupied in the sector.

The Australian dollar is one of the so-called commodity-based currencies, which, just as the Canadian dollar, has a high positive correlation to the prices of commodities being exported by the country.

Australia has signed Free Trade Agreements with many countries, with the most prominent one being with New Zealand. However, the nation’s economic development in recent years has been strongly influenced by trade relations with China, as the latter became Australia’s largest export partner in 2009 (prior to 2009 the largest export market was Japan).

According to the CIA World Factbook, in 2012 Australia’s largest export partners were: China (with a share of 29.5% of overall exports), Japan (19.3%), South Korea (8.0%), India (4.9%). At the same time, its largest import partners in 2012 were: China (with a share of 18.4% of overall imports), the United States (11.7%), Japan (7.9%), Singapore (6.0%), Germany (4.6%), Thailand (4.2%), South Korea (4.1%).

Major economic indicators

– Gross Domestic Product

– Trade Balance

– Consumer Price Index (CPI)

– Producer Price Index (PPI)

– Employment Change

To learn more about the indicators listed above, please read our article “Profile of Australia’s Dollar – Major Economic Reports

United States economy

United-States-Flag-1-iconThe United States is the world’s largest economic power with a nominal Gross Domestic Product (GDP) at the amount of $16.8 trillion in 2013. It represents almost 25% of the global nominal GDP. It is also the world’s second-largest trading nation.

The US economy is primarily service-oriented, as almost 80% of the GDP is produced by sectors such as real estate, transportation, financial services, other business services and health care.

The country is the second-largest manufacturer in the world with an industrial production of $2.43 trillion during 2013, or larger than the output of Germany, France, India and Brazil combined. Major industries are petroleum, steel, automobile production, aerospace, construction and agricultural machinery, chemicals, electronics, telecommunications.

Moreover, as of 2013 the United States is the third-largest producer of oil (8 453 000 barrels per day, or 9.97% of the global total oil production) and the largest natural gas producer (66.5 billion cubic feet per day).

Taking into account the sheer size of the US economy and its pillars of strength, one can clearly understand the effect of economic data from those sectors on the US dollar, and in turn on the global Forex market. After all, the greenback stands on one side of 87% of all trades, according to the BIS.

Major economic indicators

– Non-farm Payrolls

– Consumer Price Index

– Producer Price Index

– Trade Balance

– ISM Non-manufacturing PMI

– ISM Manufacturing PMI

– Federal Reserve Minutes

– Consumer Confidence (Conference Board and Thomson Reuters/University of Michigan survey)

– Retail Sales

– Industrial Production

To learn more about the indicators listed above, please refer to our article “Profile of United States’ Dollar – Major Economic Reports

Currency pair properties

Average spread

Depending on the Forex broker used, the spread can be fixed, floating, or both. For the purpose of this article, we have chosen the average spreads provided by 10 brokers, namely Saxo Bank, Dukascopy, Alpari UK, XM, Forex.com, FxPro, Markets.com, eToro, FXCM and Iron FX, and aggregated all the spread data provided to a single average spread, in the AUD/USD case – 1.97 pips.

Relative performance against other pairs

Muscles-iconWe conducted a series of calculations to gauge the performance of the EUR/USD pair relative to other crosses which include either the euro, or the US dollar over a certain period of time. For details about the calculation’s results, visit the appendix. Calculations are conducted on the basis of the EUR/USD cross, which registered a prominent high on May 8th 2014 at 1.3993. Thus from here on, we calculate the movement of each euro and USD cross with May 8th as a starting point and spanning to the December 31st close.

In the case of the AUD/USD pair, in Table 1 we see that cross slid by 12.924% during the tracked period. From the US dollar’s point of view (as it is represented in the table, i.e. “inverted“) the greenback gained 12.924% versus the Australian dollar, which ranks it 11th in our list of performers against the greenback.

Correlations to other pairs

In finance, correlation refers to the connection between two assets and how they move in relation to each other. As a key component of advanced portfolio management, correlation is crucial for achieving maximized risk-adjusted return. Ranging between -1 and +1, a correlation close to the upper limit means that the two currencies are moving in almost perfect consonance, allowing for almost no diversification, and vice versa. A correlation of 0, which in the world of finance practically does not exist, means that movement of the two assets is completely random.

Below you can see a table containing pairs with some of the strongest positive and negative correlations relative to AUD/USD. The statistics are derived from daily market data encompassing 300 periods, spanning back from January 8th, 2015.

Top 5 positive correlations
AUD/CAD 0.94
GBP/USD 0.92
NZD/USD 0.91
EUR/USD 0.82
EUR/CHF 0.66
Top 5 negative correlations
USD/CHF -0.84
USD/JPY -0.88
USD/TRY -0.90
USD/CAD -0.94
USD/SGD -0.97

Volatility

Volatility in Forex refers to the fluctuations a currency exhibits during trading. In turn, these fluctuations directly impact the amount of risk a trader is subjected to, but also his return. A higher volatility means that the currency could potentially perform a sudden and drastic move in either direction over a short period of time.

In contrast, low volatility implies that the exchange rate does not have the potential for wide fluctuations and instead moves at a steady pace over a longer period of time. Lower volatility carries less risk for market participants but it is also much harder to profit from, especially by shorter-term traders such as scalpers and day traders.

For the purpose of our article, we have selected to display volatility calculated for 2014 on a daily basis. Check the table below.

Date High Low Intraday Vol. Daily Vol.
Dec 31, 2014 0.8217 0.8153 0.785% 1.207%
Dec 30, 2014 0.8205 0.8119 1.059% 1.209%
Jan 01, 2014 0.8943 0.8839 1.177% 0.743%
Jan 01, 2014 0.8918 0.8877 0.462% 0.259%
Average for the year 0.762% 0.735%

We have estimated the intraday and daily volatilities using two calculations for the time span of January 1st 2014 – December 31st 2014. The formulas look as follows:

– Intraday volatility (%) = [(Intraday High – Intraday Low) / Intraday Low]%

– Daily Volatility (%) = [(Current Daily High – Previous Daily Low) / Previous Daily Low]%]

Based on our calculations, we estimate that the AUD/USD pair achieved an average intraday volatility of ~0.76% for 2014, while day-to-day volatility was at ~0.74%. Compared to other currency pairs (as you would see in case you check out the other articles in this guide), the AUD/USD pair was significantly more volatile, compared to EUR/USD, but less volatile as opposed to other of the majors. Check out Table 4 in the appendix for a more comprehensive comparison.

Digging deeper into the numbers, we see that in 2014 the pair showed biggest daily volatility in the beginning of the year, from January through May (at 90-95 pips), after which it gradually declined to bottom out in late August-early September when it reached 70 pips. A rebound then followed, reaching its peak in late November-early December at 75-80 pips.

In weekday terms, AUD/USD sees greatest volatility on Tuesday and Thursday at around 80 pips, closely followed by Wednesday. Intraday volatility typically spikes half-way through the Asian trading session, around 0:00-1:00 GMT at 20-25 pips, which is when economic data from Australia are released, and between 12:00 and 15:00 GMT when US economic indicators come in (slightly below 20 pips). Increased intraday volatility, albeit lower, is observed at European opening hours( at around 15-17 pips).

Carry trade

percentage_signCarry trades are one of the most popular trading strategies used in the Forex market. When performing a carry trade, a trader typically sells a currency with a relatively low interest rate, while buying a higher-yielding one. The aim is to profit from the difference in interest rates, which can be substantial, especially when taking into account leverage. To learn more about carry trades, please read our article “Using Carry Trades to Maximize Profit“.

AUD/USD is one of the preferred pairs used in carry trades. It is so because Australia is among the developed nations with the highest interest rates. Using a basic carry trade calculator shows us that going long on AUD/USD with a standard lot and holding the position over 30 days would earn us around $185 in interest, respectively $18.5 for a mini lot and $1.85 for a micro lot. For comparison, going long on NZD/USD with the same parameters would earn us $267, while shorting EUR/USD would yield $20 for a standard lot over 30 days.

However, the interest rate divergence may narrow in the mid and long-term. The Federal Reserve has committed to begin raising borrowing costs in 2015, having already concluded its Quantitative Easing program. When this happens, and if the Reserve Bank of Australia keeps its stance unchanged, this would reduce AUD/USD’s carry trade potential, leaving aside the two currencies’ valuation of course.

The Reserve Bank of Australia decided to keep the cash rate unchanged at 2.5% at its November 2014 meeting. However, policy makers noted that despite the Australian dollar’s depreciation, it still remained above most estimates of its fundamental value, and agreed that further exchange rate depreciation was likely to be needed to achieve balanced growth in the economy. Minutes from the meeting showed members discussed the factors that might warrant an easing of monetary policy in 2015 that would respond to market expectations.

Nevertheless, the Board decided that its current monetary stance is appropriate to achieve sustainable growth in demand, while keeping inflation around the targeted level.

Trading strategy

Different strategies can be employed for AUD/USD. Trading the Australian dollar is most intense during Australian working hours (generally overlapping with the Asian trading session), while the US dollar is most active during US trading hours. Logically, trading peaks at the release of economic reports such as the US non-farm payrolls and unemployment rate, economic sentiment, manufacturing and non-manufacturing activity growth, durable goods orders, consumer inflation, retail sales and the respective Australian economic gauges.

Trading the major economic releases and other events without the help of technical analysis is basically done using three general strategies – via a proactive, a reactive or a mixed approach. Proactive trading suggests entering a position ahead of the release of the data and basing your decisions on analysts’ forecasts, while the reactive approach implies entering the market after the data is published. Logically, a mixed approach combines the previous two. To learn more about these styles of fundamental trading, read our articles “Trading the News – Proactive Approach“, “Trading the News – Reactive Approach” and “Trading the News – Combining the Proactive and the Reactive Approaches“.

As we said earlier, due to Australia’s reliance on the exploitation and successful marketing of its natural resources on foreign markets, the Aussie’s value is influenced by prices of commodities. This correlation is particularly visible when it comes to gold.

As the second-biggest producer of gold, its national currency is usually favored by any increase in commodity prices. In case prices fall, the Australian dollar will usually also lose value. This, although not always, tells traders that if gold rises and AUD still hasn’t responded, it will likely do so eventually, providing an early indication for long positions.

Technical strategy

A trading strategy common for all currency pairs is to base your decision-making on the analysis of different time frames. This of course can be applied to the AUD/USD pair as well. We have described such a trading system in the article “Forex Trading Strategy Based on Analyzing Multiple Time Frames“. Please, read on.