SMT Divergence
What do you need to know when trading on forex assets!
Almost all currency pairs are related to each other, here is an example of how it works...
Let's simplify the correlations by using arrows to visualize how the movement of one currency affects the other:
When the euro (EUR) strengthens against the US dollar (USD), the franc (CHF) usually weakens against the US dollar.
When the British pound (GBP) strengthens against the US dollar (USD), the Japanese yen (JPY) is likely to weaken against the US dollar.
When the Australian dollar (AUD) strengthens against the US dollar (USD), the New Zealand dollar (NZD) often strengthens against the US dollar as well.
When the US dollar (USD) strengthens against the Canadian dollar (CAD), the euro (EUR) often weakens against the US dollar.
When the US dollar (USD) strengthens against the Japanese yen (JPY), the British pound (GBP) can drop against the US dollar.
When the euro (EUR) strengthens against the US dollar (USD), the Australian dollar (AUD) also tends to strengthen against the US dollar.
It is very important to know this information when opening two or more trades at the same time. When you are looking for a position, you should understand that opening a long on EUR/USD will mean that you cannot open a short on AUD/USD at the same time, because these assets are positively correlated with each other, which means that they will always move in the same direction.
How can I apply this to finding positions?
Let's take the example of DXY to EURUSD
These assets move as follows, when DXY goes up, EURUSD goes down
However, there are times in the market when these assets break this correlation and at this point we come into play.
Example:
DXY updates the local high and EUR in turn does not update the local low, this is what is considered SMT, when we notice this, we can look for short-term positions in the opposite direction of the trend in order to obtain a level of liquidity.
As we can see, the euro is updating the local high and the DXY failed to update the local low, which instantly led to a change in market movement.
This is quite a big topic, so I'm giving you a framework to understand how it works, and I'll be marking it on my charts later to improve your understanding.