Currency Wars Have Taken Over

11/28/2011 3:30 pm EST

Focus: CURRENCY

Merlin Rothfeld

Instructor and Host of Powertrading Radio, Online Trading Academy

Because of its size, the currency market can move other asset classes quickly and effectively, and investors need to understand how that can affect their holdings, says Merlin Rothfeld in this exclusive interview with MoneyShow.com.

We used to talk about correlation between assets. Are we seeing anything like that now?

Well, let's look at it from a slightly different perspective. Correlation, there's always correlation, and people are using one asset class to help anticipate what's going to happen in other asset classes.

But for the listeners out there, I'd like to set the stage a little bit differently. Let's look at it from the perspective that most people trade one asset class, so let me put my stock trader hat on and say I just trade equities. I'm a New York Stock Exchange, Nasdaq kind of guy, that's how I roll.

In doing so, we kind of put our blinders on and say, "I'm going to focus on how GE (GE) is performing, or Apple (AAPL)," and earnings and things like that. Is that really what's going to move the equity? Well, not necessarily.

You have this universe of stocks. If we visually in our heads, let's do a theatre of the mind. Let's say the stock market is the size of a golf ball. That market is being influenced by many other markets, and markets that are far bigger.

Let's say you have the equity markets and then we take the futures market. Well, the futures market is somewhat of a predicting element for the equity markets, the indexes at least. Let's say that's the size of a tennis ball. So we've got the golf ball, now the golf ball is inside the tennis ball.

We go out even further and we can look at the bond market, and now we're looking at let's say a basketball, and they're all inside of each other. If I move the basketball, what happens to the other two asset classes?

They move too.

They move with it. Now if I move the golf ball, how easy is it for me to move the basketball? It's hard. It can happen, but it's got to have an amazing amount of inertia.

Well, if we look at the currency markets they're even bigger. I don't even know what's bigger than the basketball.we'll say one of those exercise balls, those giant squishy ones. That is really the kind of biggest market out there, and if we look at the currency market we can get a higher probability trade of which way things are going to go in the equity markets.

I'll give you a good example. The last two times they've mentioned quantitative easing, the markets have done what? They've shot straight up, and you're going well, but as the market makes the dollar weaker you would think the opposite. Well, with a weak dollar, it actually is a catalyst for the market, because more money flows in to the US equity markets.

So what's more important to know, what's going to happen with Apple stock, or know what's going to happen with the currency? With the currency, because that will influence everything. Again, it goes into having a ball inside of a ball inside of a ball.

The relationship between those give us a greater understanding of how the markets work, and I think that once we have a greater understanding of those four asset classes I mentioned-equities, futures, currencies, and.bonds-once we know how those work, the reports that come out, the different rates that come out, the announcements will influence the greater one first, the currencies, and then all of a sudden our trades can become better on the smaller time frames, smaller levels.

All it is doing is allowing us to have a lower risk, higher probability trade, which is what we should all be striving for in every aspect of our lives.

The currency picture has been the same since last year when Greece started falling apart, and then the euro started looking dicey, and now we've got something going on with the dollar.

Five years ago, currencies weren't even really a mainstream thing. Now they are the mainstream thing, and everybody is influenced, and they're all being pushed around by one country or another.

We will see if it changes, but I have a feeling it's going to be the currency wars going forward. So understand those, and you'll understand the markets.

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