Forex Trading, The Domino Effect

The domino effect is an advanced topic for forex traders. The basic description of the domino effect is that one or more currency pairs in an individual currency group make a fairly strong movement up or down, based on individual currency strength or weakness. Then, the remaining pairs in the same currency group start moving in the same direction, like dominoes falling.

The domino effect can occur session over session as currency pairs in the same group begin moving, then the movement spreads to the other pairs in the same currency group in the next trading session. There are two trading sessions, the Asian trading session and the main trading session. The domino effect can also proceed day after day, with one or more pairs in the same currency group moves today and the rest move tomorrow or the next day. Since this is hard to visualize we will provide many examples to make the concept clear.

When the first pair or pairs move it is like the first domino falling. When the other pairs in the same individual currency group follow the first pair it is like dominoes lined up next to each other falling and knocking each other over. Each currency pair is a domino because you have leading and lagging pairs and their individual movement cycles.

Currency groups are like the JPY pairs, USD pairs, CAD pairs, etc. We follow eight currency groups with our trading system, and there are 7 pairs in each group.

The domino effect is hard to explain and understand for almost all forex traders, but it is certainly easy to see. Any forex trader who has some fundamental knowledge of multiple time frame analysis and parallel and inverse analysis has the proper foundation to understand the domino effect. If you drill down the time frames daily on all 28 pairs, the domino effect will unfold right in front of you, as long as your charts are set up by individual currency.

If a forex trader treats an individual pair like an island with no outside influences, they will fail miserably. But a trader who understands how the dominoes fall will see the pips coming on any pairs likely before the move even starts. This lesson is our most advanced topic.

What Causes the Domino Effect To Occur?

The domino effect occurs because the forex market is a huge, efficient market. It is the largest and most efficient market in the world. More things happen on the spot forex in one day than the entire New York Stock Exchange in 90 days. All worldwide economic news, political announcements and economic announcements, price levels, and market movements are known to everyone, nothing is hiding and everything is priced in for retail and institutional traders.

The inefficiencies that occur in the forex daily must balance out at some point because the market is so large and efficient. When the first domino falls, if you can spot it, then the other currency pair movements will follow. One currency can start to strengthen or weaken, then it starts spreading to other pairs within the same common currency group of pairs.

Domino Effect Examples

If you are not quite sure what the domino effect is at this point, lets list some examples to get you fully knowledgeable on this subject. 99% of forex traders are stuck looking at one or two pairs with ineffective forex technical analysis and indicators. They will never see the entire forex market as a series of dominoes, even though the charts are right in front of them on their computer screen. They cannot see the larger picture, only because they are not looking, not willing to look, or have the wrong indicator setup that does not account for individual currency movements, consolidations, support levels, etc. The information is clearly available to them as well as any other trader. So traders need to set up our free forex trend indicators by individual currency and start analyzing the market daily across various time frames, then the dominoes will come into clear view.

Domino Effect Example 1

The situation is that all of the JPY pairs are oscillating in large ranges over 5 day cycles. These pairs have finished a down cycle and are currently stalled at support. The the expectation is for them to start to oscillate back to the upside, but you are waiting for some confirmation from the market. The AUD and NZD news drivers come out in the Asian session and then the AUD/JPY and NZD/JPY start to move up first. Later in the European session the GBP/JPY, EUR/JPY and CHF/JPY follow, and in the US session after the CAD news, the CAD/JPY and USD/JPY follow to the upside. The JPY weakness starts in the Asian session, then spreads to the rest of the JPY pairs in the main session and the dominoes all fall. In some cases the USD/JPY might move up the next day, but eventually all of the JPY pairs go up. This is an extremely important example because traders are seeing new movements start on the JPY pairs and they might be able to ride the up cycles for 5 days. We have a separate lesson where traders can see many examples and illustrations of ranging forex pairs to supplement this discussion.

This is a simple and straightforward example of the domino effect, but now it now becomes plausible to predict movements on certain pairs by always looking at the larger picture. All of the JPY exotic pairs go up first, then the USD/JPY lags and follows them up last. If you miss the first domino falling, it is still not too late to make pips. If a trader is only trading one pair or has their trend indicators set up wrong, they will never see this. Check out our forex videos and we can show any trader the right way to set up their indicators.

Domino Effect Example 2

In the main trading session the EUR/USD and GBP/USD rise, and the USD/CHF and USD/CAD both fall. Later that day the Asian session starts and there is a scheduled news driver from the AUD (Australian Dollar) on the news calendar. After the news the AUD/USD rises strong and "plays catch up" or "dominoes up" after the news driver. In this case some of the inefficiencies of the forex market are correcting themselves again as the USD weakness hits another pair.

Domino Effect Example 3

Using support or resistance breakouts to find the dominoes:

The EUR/USD and AUD/USD break important resistance in the main trading session. Also, the USD/CAD and USD/CHF break through to new lows. The USD weakness is clearly coming into the market on 4 pairs. The GBP/USD is sitting at resistance, but there is important GBP news tomorrow on the economic news calendar. The next day, after the news, the GBP/USD breaks through its resistance and “catches up” to the rest of the USD pairs based on USD weakness. This is a more obvious case of the domino effect, but traders still miss it because their trading system has failed them again.

The inefficiency of the market is corrected and it occurred with some level of predictability. How much intelligence does this take to spot? None. Just thorough market analysis with a set of very simple forex trend indicators, observing the market movements, and checking the news calendar.

Domino Effect Example Number 4

All of the CHF pairs are moving sideways and somewhat choppy and directionless. The CHF/JPY breaks to the downside and is clearly moving. When you notice the move it seems odd. What happens next? At this point you really don't know, because you have limited information, only one pair moved so you are not quite sure. But rest assured this is likely the first domino to fall. Very soon more dominoes will begin to fall. If the CHF/JPY continues down, either a lot of pairs will start to move based on either CHF weakness or JPY strength. The market has sent a powerful signal, but most traders simply cannot understand that the dominoes are now falling and the movement will spread to many other pairs and the market may be trending again.

At this point here is the proper course of action: You must carefully drill down the charts on the CHF and JPY pairs and set price alerts at any potential or probable breakout points. This will increase your odds tremendously to catch the next strong movement. In the ensuing trading sessions you can wait for the price alerts to hit, or monitor The Forex Heatmap® for CHF weakness of JPY strength.

So in this example the forex market has sent you a strong signal that many pairs were going to begin moving, as traders you must be a good detective to try to locate the pairs which are likely to move next. We have the tools and techniques to do this, while most traders will never see or comprehend any of this, staring at technical indicators on one pair. The clues and signals the market sends to you are right on your computer but can be easily missed. Spotting the first or first and second domino to move is important because in a non-trending market the first domino could initiate a new trend or series of trends in one or more pairs. This is very powerful.

Domino Effect Example Number 5

Trends and The Domino Effect:

In a non trending, choppy, or tight ranging market, traders should continue to set audible price alerts, and look for new trends to form daily. Significant breakout points and as the new trends start or breakouts occur you will be able to catch these movements with the help of tools like The Forex Heatmap®. The heatmap will spot every move on the market, including the initial movements when trends are breakouts are starting. Then look for the next domino using multiple time frame analysis by individual currency, to try to spot the next movements.

Domino Effect Example Number 6

The domino effect can also signal the end of trend cycles and help with more accurate trade exits. The market can go from trending to consolidating in the course of a few days. You can have several groups of pairs trending, then all of them begin consolidating. Over the next couple of days some pairs will see reversals against the trend "reversal dominoes", that may be good for some short term trades against the major trends. As a trader are you able to spot all of these situations. Example: AUD strength is currently driving the market. The AUD/USD and AUD/CAD hitting strong resistance, then EUR/AUD approaches major support, the remaining AUD pairs are getting closer to some major support or resistance level. It might be time to exit any trades based on AUD strength you are currently in based on these observations.

Domino Effect Example Number 7

Reserve currencies and commodity based currencies:

We trade eight currencies in our trading system. The CAD, AUD, and NZD based pairs are commodity based currencies, the remaining 5 currencies are reserve currencies. This information affects the market movements and sometimes helps with predicting what pairs might move next.

If the GBP/AUD and GBP/CAD and moving sideways, then start going up and build new trends, this means that the GBP is starting to strengthen versus the commodity based currencies. The most likely domino to fall next is the GBP/NZD. This pair will likely go up next because the GBP is strong against two of the other commodity based currencies, so we would expect the market to adjust and balance out the movements.

If the GBP goes up against the AUD, CAD and NZD, the next logical step after that would be for the GBP to continue strengthening against the reserve currencies. The GBP/USD and GBP/CHF should then start to move up as the dominoes continue to fall. The GBP can also start to strengthen against the reserve currencies first, then spread to the commodity based currencies, the opposite of the above example.

Conclusions About The Domino Effect

The domino effect is real. Currency pairs are not independent of each other, they are part of an overall framework of the forex market. Movement begets more movement as billions and trillions of dollars flow in and out of currencies daily. Our job, as traders, is to figure out where the movements are now and what pairs can be affected tomorrow and next week. When you see a market movement that creates an inefficiency, take note of it and remember that at some point the most efficient market in the world will make corrections to fix any imbalances. By being observant and using our tools and techniques you should be able to start predicting what pairs and groups of pairs will move next. Introducing a level of predictability to forex trading is only possible by taking a broad view of the market with careful analysis using these tools and techniques.