Tactical trading considerations in USD/ CAD, AUD/USD, and NZD/USD

I group these three currency pairs together because they share many of the same trading traits and even travel as a pack sometimes - especially Aussie and Kiwi, given their regional proximity and close economic ties. Whether they’re being grouped as the commodity currencies, the commonwealth currencies, or just smaller regional currencies versus the U.S. dollar, they can frequently serve as a leading indicator of overall USD market direction.

Liquidity and market interest are lower

One of the reasons these pairs tend to exhibit leading-characteristics is due to the lower relative liquidity of the pairs, which amplifies the speculative effect on them. If sentiment is shifting in favor of the U.S. dollar, for example, the effect of speculative interest - the fast money - is going to be most evident in lower-volume currency pairs.

When a hedge fund or other large speculator turns around a directional bet, on the U.S. dollar (for example, from short to long), it’s going to start buying U.S. dollars across the board (meaning against most all other currencies). A half-billion EUR/USD selling order (650 million USD equivalent at 1.3000 EUR/USD) is relatively easily absorbed in the high-volume, liquid EUR/USD market and may move it only a few points (say, 5 to 10 pips, depending on the circumstances). However, a proportionately smaller order to sell Aussie, sell Kiwi, or buy USD/CAD (large speculators will typically allocate smaller position sizes to less-liquid currency pairs), amounting to only 100 million or 200 million in notional terms, may generate a 10- to 40-pip movement in these currency pairs, depending on the time of day and overall environment.

In general, you need to be aware that overall liquidity and market interest in these pairs is significantly lower than in the majors. On a daily basis, liquidity in these pairs is at its peak when the local centers (Toronto, Sydney, and Wellington) are open. London market makers provide a solid liquidity base to bridge the gap outside the local markets, but you can largely forget about USD/CAD during the Asia/Pacific session, and the Aussie and Kiwi markets are problematic after the London/European session close until their financial centers reopen a few hours later. The net result is a concentration of market interest in these currency pairs among the major banks of the currency countries, which has implications of its own.

Price action is highly event driven

As a result of the overall lower level of liquidity in these currency pairs, in concert with relatively high levels of speculative positioning (at times), you've got the ultimate mix for explosive reactions after currency-specific news or data comes out. Change Canadian tax policy so it inhibits foreign investment, and you're looking at a sea change in sentiment against the CAD. lf expectations are running high for an NZD interest-rate hike, and a key inflation report contradicts that outlook (it's lower than expected), we‘ve got a relatively small market, probably over positioned in one direction (long NZD/USD), that's all heading for the exit (selling) at the same time.

The bottom line in these currency pairs is that significant data or news surprises, especially when contrary to expectations and likely market positioning, tends to have an outsized impact on the market. Traders positioning in these currencies need to be especially aware of this and to recognize the greater degree of volatility and risk they're facing if events don’t transpire as expected. It’s one thing if Eurozone CPI comes in higher than expected, but it’s another thing entirely if Australian CPI surprises to the upside.

A data or event surprise typically leads to a price gap when the news is first announced. If the news is sufficiently at odds with market expectations and positioning, subsequent price action tends to be mostly one-way traffic, as the market reacts to the surprise news and exits earlier positions. If you’re caught on the wrong side after unexpected news in these pairs, you’re likely better off getting off as soon as possible than waiting for a correction to exit at a better level. The lower liquidity and interest in these currency pairs mean you’re probably not alone in being caught wrong-sided, which tends to see steady, one-way interest, punctuated by accelerations when additional stop-loss order levels are hit.

All politics and economic data is local

Most of our discussion of market drivers’ centers on economic data and monetary policy, but domestic political developments in these smaller-currency countries can provoke significant movements in the local currencies. National elections, political scandals, and abrupt policy changes can all lead to upheavals in the value of the local currency. The effect tends to be most pronounced on the downside of the currency’s value (meaning, bad news tends to hurt a currency more than good news - if there ever is any in politics - helps it). Of course, every situation is different, but the spillover effect between politics and currencies is greatest in these pairs, which means you need to be aware of domestic political events if you’re trading in them.

In terms of economic data, these currency pairs tend to participate in overall directional moves relative to the U.S. dollar until a local news or data event triggers more concentrated interest on the local currency. If the USD is under pressure across the board, for instance, USD/CAD is likely to move lower in concert with other dollar pairs. But if negative Canadian news or data emerges, USD/CAD is likely to pare its losses and may even start to move higher if the news was bad enough. If the Canadian news was CAD-positive (say, a higher CPI reading pointing to a potential rate hike), USD/CAD is likely to accelerate to the downside, because USD selling interest is now amplified by CAD buying interest.

Technical levels can be blurry

The relatively lower level of liquidity and market interest in these currency pairs makes for sometimes-difficult technical trading conditions. Trend lines and retracement levels in particular are subject to regular overshoots. Prices may move beyond the technical level - sometimes only 5 to 10 pips, other times for extensive distances or for prolonged periods - only to reverse course and re-establish the technical level later.

The basic reason behind this tendency to overshoot technical levels is that market interest is concentrated in fewer market-makers for these pairs usually the local banks of the currency country. The result is a concentration of market interest in fewer hands, which can result in order levels being triggered when they may not be otherwise. For example, if you're an interbank market-maker watching a stop-loss order for 5 million AUD/USD, it’s not a big deal, because 5 million Aussie is transacted easily. But if you have a stop loss for 50 million or 100 million AUD/USD, you’re going to need to be fast (and, likely, pre-emptive) to fill the order at a reasonable execution rate.

If the price break of a technical level is quickly reversed, it’s a good sign that it was just a position-related movement. If fresh news is out, however, you may be seeing the initial wave of a larger directional move.