A Brief Guide to Trading the AUD/USD Currency Pair

A Brief Guide to Trading the AUD/USD Currency Pair

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Get ready to learn everything you need to know about AUD/USD. This article will explore the characteristics, advantages, and drivers behind this popular forex pair. We’ll offer some valuable insights that can help you better understand how to effectively trade AUD/USD and navigate its unique market dynamics.

What Is AUD/USD?

AUD/USD, commonly known as the Aussie dollar, is a currency pair that represents the exchange rate between the Australian dollar (AUD) and the US dollar (USD). In this pair, the AUD is the base currency, and the USD is the quote currency. The exchange rate tells us how many US dollars are needed to purchase one Australian dollar. For example, if the AUD/USD rate is $0.6600, you need 0.66 USD to purchase 1 AUD.

AUD/USD is one of the most traded currency pairs in the foreign exchange market, thanks to its high liquidity and the prominent role both countries play in the global economy. AUD is considered a commodity currency due to Australia's vast natural resources. Similarly, USD is the world's primary reserve currency. This makes AUD/USD an attractive option for traders seeking exposure to the export-based Australian economy and the ever-present US dollar.

History of AUD/USD

The history of the AUD/USD currency pair can be traced back to 1966, when the Australian dollar was first introduced, replacing the Australian pound. Initially, AUD was pegged to the British pound, but in 1971, it was switched to a peg against the US dollar. In 1983, the Australian government decided to float the currency, allowing its value to be determined by supply and demand forces in the financial markets.

Over the years, the AUD/USD exchange rate has been influenced by a variety of factors, like changes in global commodity prices, shifts in monetary policies, and significant geopolitical events. For example, during the early 2000s, the AUD/USD pair experienced a prolonged bullish trend, driven by a boom in the price of iron ore, coal, gold, and oil - four of Australia’s largest exports - and strong demand from China. During the 2008 financial crisis, AUD/USD plummeted as investors flocked to the safe-haven USD.

When commodity prices slumped in 2015, oil, iron ore, and coal prices fell sharply, sending AUD/USD on a multi-year downtrend. In mid-2015, the Australian dollar almost reached parity with the New Zealand dollar (NZD), a level not seen since the 1970s.

During the Coronavirus crash of 2020, AUD/USD fell over -17% over two weeks and hit parity with the New Zealand dollar. However, a strong rebound in commodity prices helped drive AUD/USD to new heights in 2020 and 2021, almost climbing to its 2018 high.

This has been compounded by the interest rate differential between the Federal Reserve and the Reserve Bank of Australia (RBA). The RBA recently paused rate hikes and has lagged slightly behind the Fed in hiking interest rates. This restrictive US monetary policy has helped to bolster demand for the US dollar over the Australian dollar.

Characteristics of the AUD/USD Currency Pair

One of the most significant characteristics of AUD/USD is its volatility. The pair tends to be more volatile than other major currency pairs due to its sensitivity to commodity prices, particularly iron ore, coal, and gold. Economic releases that affect the demand for these commodities may directly impact the value of the Australian Dollar.

Moreover, AUD/USD is heavily influenced by changes in global risk sentiment. When sentiment is bullish, AUD/USD typically rises alongside commodity demand and vice versa, often referred to as a procyclical currency. Australia’s export demand is particularly reliant on China, with the country accounting for 36.4% of exports in 2019-20 (Australian Department of Foreign Affairs and Trade). As a result, AUD/USD forex traders should pay close attention to economic data from China, including gross domestic product (GDP) figures and manufacturing data.

AUD/USD is also highly liquid. As one of the most heavily traded currency pairs in the forex market, accounting for 5.1% of global trading volume (Statista), it offers traders tight spreads, low costs, and quick order execution.

AUD/USD’s correlations with other forex pairs are also worth considering. It shares a high correlation with NZD/USD, given the similarities between the Australian and New Zealand economies. AUD/USD positively correlates with other forex pairs featuring a safe-haven currency, like the Swiss franc’s (CHF) AUD/CHF or the Japanese yen’s (JPY) AUD/JPY. USD/CAD, the US dollar to the Canadian Dollar, has a strong negative correlation since CAD is also a commodity-based currency.

Major Advantages of Trading AUD/USD

Trading the AUD/USD currency pair comes with several advantages. First, its high liquidity ensures that traders can easily enter and exit positions, seldom facing slippage, wide spreads, and increased costs often seen with less liquid forex pairs.

Additionally, the Australian dollar and the US dollar are effectively opposites. AUD is driven by commodity demand, rising when the global outlook is positive. Meanwhile, USD is seen as a safe haven, generally rising when the global outlook is negative. This allows traders to benefit from increased volatility compared to other similar pairs, like EUR/USD or GBP/USD.

AUD/USD is also one of the most active forex trading pairs, seeing plenty of activity throughout the London, New York, Tokyo, and Sydney sessions. London and New York will always see the most volume, being the world’s largest financial centres. However, the Tokyo and Sydney trading hours still see decent volume, given the Australian dollar’s relevance to these markets.

Market Participants in Trading AUD/USD

The AUD/USD currency pair attracts diverse market participants, each with different motives and objectives. Central banks, like the Reserve Bank of Australia (RBA) and the US Federal Reserve, can influence the pair's exchange rate through fiscal and monetary policy. Commercial banks are crucial in facilitating currency exchange for their clients and contribute to the pair's liquidity through trading desks.

Institutional investors, including hedge funds and pension funds, also participate in trading AUD/USD as part of their investment strategies, looking to profit from price fluctuations or diversify their portfolios. Retail traders engage in speculative trading or use the pair as a hedging tool. Collectively, these market participants contribute to the high trading volumes of the AUD/USD currency pair.

Using Fundamental Analysis

Fundamental analysis is an essential tool for traders and investors looking to understand and forecast AUD/USD’s future direction. While there are many facets to fundamental analysis, there are a few key things to watch out for that can heavily influence the pair’s price movements.

Commodity Prices

Besides the commodities mentioned, like iron ore, coal, gold, and oil, Australia also exports plenty of natural gas, beef, and wheat. Changes in supply or demand for any of these goods can impact the price of the Australian dollar. Data on crop planting, harvests, mining outputs, and more can be found through Australia's Bureau of Agricultural and Resource Economics and Sciences (ABARES).

Economic Releases

Economic data releases, like employment figures, inflation rates, GDP growth, and trade balance statistics, can offer insights into the health of Australian and US economies. Given Australia’s strong economic ties to Asia, particularly China and Japan, these countries' GDP, manufacturing, and sales data can also affect the AUD/USD exchange rate.

Monetary Policy

The RBA and the Federal Reserve can heavily influence the pair through interest rate adjustments and statements. At the time of writing, Australia’s interest rate stands at 3.6%, while the US’s is at 5%. This increases demand for the US dollar, and all else being equal, will drive AUD/USD lower.

Geopolitical Events

Lastly, geopolitical events, like trade disputes, political developments, or natural disasters, can also cause volatility in the pair. As discussed, Australia’s vulnerability to the Asian market means it’s worth staying on top of news in these economies. It could be argued, for instance, that China’s zero-Covid policy and subsequent drop in demand for Australian commodities was one of the leading causes for AUD/USD’s decline in 2022.

Using Technical Analysis

Technical analysis is another valuable tool for traders looking to capitalise on AUD/USD’s price movements. This approach involves analysing historical data, indicators, and patterns to identify potential trends and future price changes. Often, fundamental analysis is used to set a directional bias, while technical analysis is used to confirm this bias and find entries and exits based on price action.

Common chart patterns, like wedges, double tops/bottoms, and flags, can help traders determine the market’s next moves. Meanwhile, identifying support and resistance levels - areas where price has reversed in the past - can show optimal places to enter and exit a trade.

Many technical analysts employ indicators, like the Relative Strength Index (RSI), Bollinger Bands, and moving averages, to confirm trends and spot potential reversal areas. By combining these tools with fundamental analysis, chart patterns, and support and resistance, traders can create a viable forex trading strategy for the AUD/USD pair.

Most Active Trading Times

The AUD/USD currency pair experiences varying activity levels throughout the trading day, with the most significant price movements typically occurring during overlapping market sessions. As discussed, the New York and London sessions see the most volume, with the overlap between 12 p.m. and 4 p.m. GMT being the busiest.

However, the Sydney and Tokyo sessions can also offer plenty of trading opportunities. As Australia’s native currency, it’s no surprise that the Sydney session is highly active. The Tokyo session, opening 3 hours after Sydney, represents the start of the Asian trading day. The overlap between the two sees considerable volume, rising further when London opens. Volume tends to taper once the New York session closes at 8 p.m. GMT.

Tips for Trading AUD/USD

Trading the AUD/USD currency pair can be tricky without a solid understanding of market mechanics and a well-developed forex trading strategy. While your strategy will likely be unique to you and your style, there are some general best practices to be aware of when trading AUD/USD.

Risk Management

The commodity-driven nature of AUD/USD makes it highly volatile, which can lead to both significant gains and losses. While risk management should always be a priority, it’s imperative when trading this pair. Set appropriate stop-loss levels, use position sizing to limit risk exposure, and monitor your average risk-to-reward ratio to ensure long-term sustainability.

Trade With the Trend

Commodities move in cycles, often trending for an extended period. This has helped to contribute to the overall trendiness of AUD/USD compared with other forex pairs. Consequently, identifying the trend on both higher and lower timeframes can increase the likelihood of a profitable trade. Technical indicators, like moving averages, and market structure, can help you gauge the market’s direction.

Stay On Top of Economic Data

There are certain economic releases especially important to AUD/USD. From the US perspective, non-farm payrolls (NFPs), inflation data, and GDP should be watched carefully, especially in today’s high-inflation environment. In Australia, employment, inflation, and GDP data are also meaningful, as are trade balances because of its export-based economy. Economic news from China and Japan should also be observed.

Monitor Commodity Prices

Lastly, tracking the prices of key commodities such as iron ore, coal, and gold can offer valuable insights into potential AUD/USD price movements. You can also keep an eye on output data from the ABARES mentioned earlier.

Open a Trading Account for AUD/USD

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Sign up and choose between a Live Account or a Demo Account to practice your strategies and familiarise yourself with our broad range of trading platforms. With over 40 international awards, 24/7 multilingual customer support and 17+ years in the business, FP Markets is a globally leading Forex and CFD brokerage.  

 

 

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Source - database | Page ID - 34552

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