Worried about a stock crash? US dollars could help.

Key points

• The S&P 500 index is 5% away from new highs near 4,800
• US dollar and the S&P 500 have been negatively correlated for the past three years
• USD hit extremes against currencies like JPY, AUD and EUR during stock market downturns

Is US dollar a good hedge for stocks?

In recent years, the relationship between the US dollar and the stock market has shown a consistent inverse correlation - meaning that when stocks go down, the dollar tends to go up, and vice versa. This relationship has been particularly pronounced since the start of the pandemic.

For traders looking to hedge against a potential stock market crash or reduce their exposure to stocks, the US dollar has proven to be a decent hedge. During both the pandemic crash in early 2020 and the bearishness of 2022, the dollar saw appreciation as stocks fell. In fact, the dollar reached historic extremes against currencies such as the yen, euro, pound, and Australian dollar during these times.

To gain exposure to the US dollar as a hedge, traders can consider trading forex pairs such as the EUR/USD, USD/JPY and GBP/USD. These major currency pairs tend to have lower margin requirements and higher liquidity compared to minor pairs. Since forex pairs offer exposure to another currency simultaneously, it is important for traders to consider what factors influence the opposing currency and current market conditions. Traders with aligned opinions may choose one pair while others looking for only US dollar exposure may take positions in multiple pairs to diversify.

While the inverse correlation between the dollar and stocks has been observed in recent years, it's not guaranteed to persist indefinitely.

By understanding the inverse relationship between the dollar and stocks, traders can consider forex pairs to gain long dollar exposure. However, it's important to remember that correlations can change, and risk management is crucial when implementing a hedge.

How to trade US dollar

1. Open an account to get started, or practice on a demo account
2. Choose your forex trading platform
3. Open, monitor, and close positions on USD pairs

Trading forex requires an account with a forex provider like IG. USD pairs can be found in IG's platform under the 'USD Pairs' pairs tab. Many traders also watch major forex pairs like GBP/USD and USD/JPY for potential opportunities based on economic events such as inflation releases or interest rate decisions. Economic events can produce more volatility for forex pairs, which can mean greater potential profits and losses as risks can increase at these times.

You can help develop your forex trading strategies using resources like IG’s Trading Academy. Once your strategy is developed, you can follow the above steps to opening an account and getting started trading forex.

Your profit or loss is calculated according to your full position size. Leverage will magnify both your profits and losses. It’s important to manage your risks carefully as losses can exceed your deposit. Ensure you understand the risks and benefits associated with trading leveraged products before you start trading with them. Trade using money you’re comfortable losing.