Currency trading is fundamentally an issue of supply and demand. This will be a familiar concept to any experienced futures trader. For example, with the global economy contracting, there is less demand for energy. Stockpiles have increased. The fundamentals of weak demand and oversupply has driven down oil prices.

Canada, a big oil producer, benefited from high demand last summer. It attracted foreign investment and that drove the Canadian dollar (CAD) higher against the U.S. dollar. But in the current reversal, investors have fled the CAD, once worth $1.10 USD, now worth $0.75. This shows that there is a clear relationship between commodities futures prices and the value of the CAD.

Another example is one from the equities market. When the Dow Jones Index contract falls the fixed income market rises as investors seek safe havens. How do you use this basic knowledge to profit in forex?

Hedge funds love leverage. They get this by using their client funds as collateral and borrowing cheap money against it. A hedge fund will borrow (sell) a cheap currency, such as the Japanese yen (JPY), against a currency offering higher interest rates. This is called the Carry trade.

Now with the market turned, hedge funds have exited these carry trades.

The key here is that the loans were in JPY. This means as the stock markets fall, hedge funds are buying yen to pay back their loans that were borrowed in the Japanese currency.

Valuations change when money flows from one economy to another. When you buy a Chinese product, the money flows to China, that economy benefits and its currency should appreciate. That begs one final question: why is the U.S. dollar strong when this economy is in such poor shape?

The short answer has to do with the USD being the reserve currency of the world. When the rest of the world is hurting, they move money to the U.S. as a safe heaven. Also the Fed was more aggressive in cutting interest rate than Europe, so like the yen, the U.S. dollar was a short in numerous carry trades.

But when do you actually enter a trade? For that, we need to examine technical analysis and enter trades when both the fundamentals and technicals align.

The most common technical indicators are moving averages. I prefer exponential moving averages. I use the 21- and 55-period EMAs to measure the direction of the overall market. If the 21-period is above the 55-period the market is bullish. If below, then the market is bearish. The market should be heading in the same direction as your fundamental bias. If not, wait for the market to align with your bias.

It is normal, however, for price to rise in falling markets. To measure price action, I use the five- and the eight-period EMA. Even though the overall action is down, price at the moment can rise. However, the best trades are ones in which you have multiple factors: fundamentals, long-term and short-term technicals in your favor.

The below chart shows the British pound last October. Fundamentally we were bears. On Oct. 20 the 21-period EMA crossed below 55-period showing a market change towards the bears. The next day shows the five-period EMA crossing below the eight-day confirming a bearish price shift. When all three forces are working together, your odds of success are greater.

Lets look at the CAD as a specific example. Lets say you think crude oil bottomed around $35 and is ready to move back up. Based on this opinion, you believe that the Canadian dollar will gain value. If the CAD is to gain value, you will look for short trade opportunities on this USD/CAD pair, indicating the CAD is stronger than the USD.

The far right chart in the above graphic shows a one-hour candle in the CAD. Technically speaking, the market is rising. However, price action is falling and has broken below the 21-period EMA. You think itll fall back to the hourly 55-period EMA.

The chart on the far left shows 15-minute candles. You notice that price has been falling for a while, but is now consolidating. Will it fall or will it rise? The 21/55 cross is a technical indicator pointing down. About 90 minutes after the cross on the 15 minute chart, a breakout occurs on the center one-minute chart. Note the cross and price riding the five-period EMA to the down side. Why is this fall so smooth? Because the three time frames agree with your long-term bias, CAD strength. However the hourly chart, because the 21-period is still above the 55, suggests that your short trade may not last very long.

Before you put money on the line, test these strategies.

Wayne McDonell is the chief currency coach at FxBootcamp.com, a live forex training organization. He is a member of the National Futures Association and registered as a commodities trading advisor. His book Strategic & Tactical Forex Trading (Wiley Publishing) is available at Amazon.com. His currency trading presentation, recently conducted at Future Magazines I-Trade Show, is available for free at www.futuresmag.com.