Who should consider trading the Australian dollar against the US dollar?
Anyone with a considered view of the likely relative performance of the two economies, with special reference to the Australian currency’s traditional status as a proxy for commodity prices.
Someone who expects a change in interest rates that is likely to have a material effect on the value of one currency in relation to the other.
Day traders. For those able to duck in and out of these currencies, the interplay between the Australian dollar and the US dollar is an obvious one on which to take short-term positions.
What do I need to know about the Australian dollar and the US dollar?
The Australian dollar is a reputable currency freely traded across the world, but it is essentially a national denomination issued for use in one of the smaller members of the Group of 20 leading economies.
The US dollar is the mainstay of the world financial system and is widely held globally by central banks, companies and investors. It is the currency of the world’s largest economy.
The Australian dollar is no longer tied exclusively to the ups and downs of the prices of the commodities with which the country is so well-endowed. But it remains for many traders a proxy play on the market in natural resources.
The US dollar sits on tops of an enormously varied economy and is not vulnerable to shifts in any one sector of business or industry or the change in any one world market price.
The US dollar is the denomination in which most commodities, including those produced by Australia, are priced. This adds a special twist to the relationship between the two currencies.
What are the factors that influence the relationship between the Australian dollar and the US dollar?
Australia is a resource-rich country positioned close to the growing markets of Asia, hungry for its commodities. But if Australia is a supplier to the emerging markets, the US has been a huge consumer of the exports of countries such as China. Thus the stronger the emerging-market performance, the greater the upward pressure on Australia’s currency and the likely downward pressure on the US dollar.
Changes in the open-market price of commodities can be expected to have a disproportionate influence on the Australian dollar. America has huge natural resources and world-leading mining, extraction and agricultural businesses, but the economy is simply too broad and diverse to be unduly affected.
Interest-rate changes are a key influence on all currency ‘pairs’. At present, the US central bank, the Federal Reserve Board, is gradually tightening monetary policy, while the Reserve Bank of Australia (RBA) has held its rate steady at the all-time low level of 1.5 per cent. The Fed’s rate is currently in a target range of 0.75 per cent to 1 per cent. If the Fed rate overtakes that of the RBA, there could be a significant currency impact.
Political developments in either country are another possible influence on the Australian dollar/US dollar exchange rate. These range from a change of government to an indecisive election result.
Interplay between the Australian dollar, the US dollar and Australian commodity exports, which are mostly priced in US dollars, is a key influence and one that needs to be thoroughly understood by the would-be trader.
The basics of trading the Australian dollar and the US dollar
The most straightforward way is simply to buy or sell the currencies concerned, either through your bank or using a trading account with a financial institution. This is a simple method of taking a position on these currencies, but it can be expensive and inefficient.
Futures and options, derivative products that let you trade the currencies without taking possession of them. But futures trading can go the ‘wrong way’, potentially wiping out your original stake – and more. You can walk away from an option, but you pay an upfront charge for this privilege.
Contracts for difference (CFDs) are a relative newcomer to the financial scene but have emerged as the single most popular way to trade in markets of all types. A CFD is a contract between a trader and a broker to pay each other the difference between the price of an asset on the day the contract is signed and the price on the day it is terminated. They are leveraged products, meaning you can gain exposure by investing only a percentage of the full value of the trade you want. Whilst this gives opportunity for greater profit, you risk losing more than your deposit if the market moves against you. A second risk is that rapid price changes can cause your account balance to change quickly. If you do not have enough funds in your account to cover these situations, there is a risk your position may be closed automatically when your balance falls below a certain level, known as the close-out level. Stop-orders can limit risk but, in fast moving markets, prices might rise above or fall below the desired level before a sale can be executed. This may increase losses.
eToro offers CFD trading in Australian dollar/US dollar
What in general should I bear in mind about currency trading?
Since the post-war system of fixed currencies broke down in the early 70s, most advanced-economy currencies have ‘floated’, that is, they have been left to find their own level on the foreign exchanges. The exchange rate is simply a price, the price of one currency expressed in terms of another.
In contrast to all other types of financial assets, currencies cannot be bought except with another currency. That may sound obvious, but it would be thought strange if swapping houses were the only way to acquire a home. Uniquely in financial markets, currency trading is what is known as a zero-sum game – for every currency that rises, another has to fall.
What should I consider with regard to trading the Australian dollar and US dollar?
Australia and the United States are friendly democracies with mature economies and a shared approach to the rule of law and open markets. Both currencies are liquid – the Australian dollar is actually one of the most actively-traded denominations in the world. But they are very different monetary units issued in quite distinct economies and the relationship between them is complex.
Is trading the Australian dollar/US dollar right for me?
Quite possibly, if you have checked out all the different angles in this currency pair and are confident you have a good grasp of what drives the fluctuations in their relative values.
*This content is intended for educational purposes only, and shouldn't be considered investment advice.
*Past performance is not an indication of future results. All trading carries risk. Only risk capital you're prepared to lose.