In the realm of foreign exchange trading, we recognize currency pairs to isolate themselves into multiple different groups. For instances, we have JPY pairs, EUR pairs, USD pairs, etc. The Domino Effect is an advanced topic for forex traders whereby there aren’t necessarily any fixed rules. It is merely an observation to be made. From the observations, traders will be able to position themselves accordingly.
As the name suggests, there is a domino effect that occurs on the markets across multiple currency pair groups and timeframes. Think of it this way, the US Dollar Index (DXY) measures the value of the US Dollar against a basket of many other global currencies. Therefore, any news that would affect the value of the US Dollar may see a movement in one pair first, before being seen across other pairs.
The reason this occurs is because of the flawed tunnel vision that traders tend to have. In the case, for example, of consolidation on EURUSD and economic news favoring the US Dollar causes it to break out to the downside, then you would see that the dollar has strengthened against one currency. As such this would minutely affect the US Dollar Index (DXY), and for retail traders and institutions watching may even affect their sentiments. Therefore, those trading on other pairs will inevitably trade in favor of the US Dollar based on those sentiments.
There is no guarantee as to the timeframe in which each currency pair will move according to the other. It may occur as quickly as an hour-by-hour movement or whenever a new trading session opens, or even as slow as occurring the next day. This type of domino effect occurs over a span of time due to different trading sessions.
Typically, you would have the trading day starting off with the Asian session, then the main session before closing on the American Session. So, let’s say that JPY pairs are oscillating between certain levels and they have just finished a down cycle and are at a support. Traders looking at the situation from a technical standpoint will look to buy, however, they would wait for information and confirmation from the market.
Should news regarding AUD or NZD be released, that would be the trigger where traders will see the pairs AUD/JPY and NZD/JPY start moving upwards. Later in the European session, they will see EUR/JPY, GBP/JPY and CHF/JPY follow. Finally, in the US session, USD/JPY and CAD/JPY will follow the momentum upwards. Here you see that the movement of the Japanese Yen’s weakness begins in the Asian session and the trend continues throughout the next two sessions.
If you keep your eye out on the domino effect, you will find it to be useful to plan your trades according to different sessions. As traders look for movement in one area, you can predict potential movement in other areas. Therefore, having this observational skill will prove useful as a form of maximizing your profits if you’re a day trader looking to trade across all the sessions.