Demystifying Currency Trading: What to Track To Trade USDINR

Currency trading has been an enigma for most of us, despite getting traded on Indian exchanges for more than 10 years. However, in the back drop of regulatory changes like peak margin, currency is seeing better participation and volume from all kinds of participants. Here is an attempt by us at Kotak Securities, to demystify currency trading, mainly USDINR and makes thing easier for an individual. It is for information and learning purpose only.

Currency trading is no different than trading any other asset class. The only difference is that unlike in equity or commodities, where you trade on a single underlying, like gold, copper or a particular stock; in currencies, you trade currency of one country vs another. For example - USD vs INR, where USD is the currency of USA and INR is the currency of India. In other words, it is like a pair trading.

Given that currency pairs are largely influenced by macro factors like, monetary policy (dovish/hawkish), economic growth (high/low), inflation (high/low/moderate), external trade (export vs import) etc., at times, it becomes difficult to monitor these macro developments and their medium to long term impact on the currency pair. However, there are some real time indicators that one can use to gauge the short term movement in USDINR.

What are those indicators?

1) Dollar Index (DXY) - It is an index which tracks the dollar movement against 6 major leading currencies in the world. It is like your NIFTY index, made up of 50 stocks and gives a broad direction of equity market. Similarly, DXY gives the broad indication of dollar movement globally. Higher the dollar index, stronger the dollar.

For example – In CY20, when COVID first struck in March, DXY jumped from 96/97 level to 103 and from there retraced to as low as 89.50/90. During the same time, USDINR moved from around 72.50 to 76.50+ level and slowly pulled back as DXY came down. The price of DXY can be tracked on real time basis to gauge the broader dollar movement.

2) Crude Oil - Crude oil is the biggest import item in India's import basket, with an almost 20-22% share. Higher the crude price, more negative it is for INR (on depreciation side). Normally, it is seen as crude prices move higher, it’s sensitivity to INR also increases, as it starts impacting our trade number adversely. At the end, India is a net importer country.

For example – Right now, Brent crude is quoting above $70+. Last year, it also traded in negative and average crude basket price for India in FY21 was $44.50, saving a lot of precious dollar for India. But presently, as oil prices moving higher, INR can come under pressure due to higher import. Again one can track crude oil prices on real time basis.

3) Capital Flows - As it is quite common to track FPIs number in equity market, similarly, FX traders watch the capital flows in economy. Higher the flows (inward), higher the possibility of INR appreciating against dollar. Similarly, higher the outflows, more rupee can weaken against dollar.

The only difference is that in equity, market participants normally track FPI numbers in equities; FX participants watch FPI flows across equity and debt both, plus FDI. Last year, in FY21, India saw the record flows under FPI ($36.84 bln) and FDI route ($81.7 bln). Though this data is not available on real time, FPI data can be tracked on NSDL website with one-day lag.

4) EM currencies vs Dollar - The way we monitor how some of our peer markets are doing in equities, like DOW, HangSang etc., to take a cue; similarly, in currencies, FX traders track how other Emerging Market (EM)/regional currencies are doing against dollar. Some of the closely tracked EM currencies in Asia are Chinese Yuan (CNY), Indonesian Rupiah (IDR), Korean Won (KRW), Malaysian Ringgit (MYR) etc. In FY21, most of the EM currencies appreciated against dollar and so was INR. Again, one can track the performance of other currencies like CNY, IDR, KRW and MYR on real time basis to gauge the broad trend in INR as well.

5) Risk Sentiment - It broadly defines how market at large is looking at risk. Better the risk sentiment, better for EM currencies (stronger against dollar). The best indicator to gauge risk sentiment is performance of global equity market and other risk assets like commodities. Risk sentiment is also dependent upon global growth and liquidity.

6) RBI intervention - This is difficult to track/guess when RBI can intervene in FX market, but given the larger objective of central bank to control extreme volatility, one can only get to know post facto. We need to remember that FX also has an impact on external trade (export/import) and competitiveness of Indian products in international market. Hence, RBI, at times, also has to intervene to ensure orderly price movement and maintain export competitiveness. In FY21, RBI bought record dollar ($101 bln) to stop rupee appreciating too much, due to flows.

FY21 was an exceptional year, when everything went right for INR, right from record flows to weaker dollar (DXY) to lower oil price to a buoyant risk sentiment. It was only due to RBI intervention at lower level that rupee didn’t see much appreciation. However, a combination of above on the reverse side (stronger dollar, higher oil and capital outflows) with risk-off sentiment can adversely impact INR as well, on opposite side.

Source: Cognecis, PPAP, NSDL, RBI

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