Gold Prices and Forex

Forex traders frequently delve into other markets other than the currency pairs generally associated with foreign exchange trading. Some will invest in individual stocks, stock indexes, bonds, options and commodities future contracts. They are certain to encounter several ways to speculate in the value of gold. Many forex providers do make gold trading accessible to their clients. It is really up to the broker, but there are some interesting factoids worth familiarizing oneself with.

In the United States, forex providers are regulated to the extent that they can only offer gold trading at 1:1 leverage. This mind boggling restriction on forex providers is even harder to understand when it is possible to trade gold futures contracts on the Chicago Mercantile Exchange (CME) at day trading margins of $500 per 100 troy ounce contract, meaning that at current prices of around $1700 per ounce, a $500 margin deposit controls $170,000 of gold. This equates to a leverage level of 340:1. This punitive approach to forex providers regarding gold trading displays even less logic when you realize that futures exchanges like the CME also offer currency trading at similar leverages, while U.S. forex providers are limited to a maximum level of 50:1 for currency.

Here in NZ forex brokers offer variable leverages for gold, with 100:1 being commonplace. Does this mean that someone in New Zealand should trade gold? At least it is worthwhile here, but it should never be forgotten that gold is extremely volatile; meaning that at 100:1 leverage, a small change in the price of gold will have an extremely profound effect on a trader’s equity. There is a way, however, to use the fluctuation in the price of gold to assist in making high probability currency trades.

To understand this, open a gold chart in your simulated trading account, and watch how that chart will mirror the price changes of certain currency pairs. This tendency is known as correlation. If a currency pair rises and falls to match the rise and fall of gold prices, the two are said to be positively correlated. If they move in opposite directions, they are said to be negatively correlated.

To use this for currency pair trading, it helps to be aware that when traders view the U.S. dollar as weak or losing strength, they will purchase gold as a safe haven, causing the price to rise. Forex traders can be reasonably assured in this circumstance that any currency pair, such as the EUR/USD or AUD/USD that contains the United Stated dollar as the quote currency will rise in price, that is the euro and Australian dollar will gain against the U.S. dollar.

Currency pairs such as the USD/JPY and USD/CHF, on the other hand, with the dollar as the front currency, will tend to decline, meaning that the yen and Swiss franc will lose ground to the dollar. Since gold is typically much more volatile than any of these currency pairs, the fluctuations in the price of gold can be used to signal the appropriate trade in any of the above currency pairs.

Correlation is seldom perfect. Observe carefully and learn to anticipate when the currency markets will act in accordance with correlation, when there will be a time lag between the change of gold prices and the corresponding change in currency pair prices, and when currencies might actually diverge completely from their customary correlation with gold.


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