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Currency Trader (200708)


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  • 1. Strategies, analysis, and news for FX Traders August 2007 Volume 4, No. 8 DOLLAR AT THE CROSSROADS: LONG-TERM Battered buck testing key INTEREST RATES: levels p. 38 Implications for currencies p. 34 TREND RUNS IN CURRENCIES: Facts and figures p. 16 INTERNATIONAL TRADE AND EXOTIC CURRENCIES: CURRENCIES, Trading outside part 2 p. 26 the “majors” p. 8 THE YEN’S new uptrend? p. 12
  • 2. CONTENTS Contributors . . . . . . . . . . . . . . . . . . . . .6 Advanced Strategies Minor currencies and federal reserve trade weights . . . . . .26 Global Markets A continuation of last month’s analysis Beyond the majors: The exotic waters of the relationship between trade and of emerging-market currencies . . . . . .8 currencies undermines one of the basic Some forex brokers are offering access to premises of the floating exchange-rate more currency pairs, but you need to know system. the risks associated with these markets before By Howard L. Simons you consider trading them. By Currency Trader Staff Trading Basics Long-term interest rates On the Money and the U.S. dollar . . . . . . . . . . . . . . .34 The rising yen — What the recent rise in T-bond and T-note here we go again . . . . . . . . . . . . . . . .12 yield implies for the FX market. The yen has been on the rise vs. the dollar. By David Mantell Find out if it’s a reversal or just a correction. By Barbara Rockefeller Spot Check U.S. dollar index . . . . . . . . . . . . . . . .38 Trading Strategies The greenback has recently established Short-term trends all-time lows against many currencies. in the EUR/USD pair . . . . . . . . . . . . .16 Find out what analysis of the dollar index This study shows how often different runs says about the probabilities of the buck’s of consecutive higher or lower highs, lows, next move. and closes occur in the euro/dollar pair. By Currency Trader Staff By Currency Trader Staff continued on p. 4 2 August 2007 • CURRENCY TRADER
  • 3. CONTENTS Industry News New NFA proposal could cause significant shakeup among forex brokerages . . . . . . . . . . . . . . . .42 The National Futures Association wants new capital requirements that could force several forex brokerages out of business. Global Economic Calendar . . . . . . . . .48 USFE to list forex futures . . . . . . . . .42 Key dates for currency traders. The United States Futures Exchange will roll out currency futures that mimic New Products and Services . . . . . . . . .49 the pricing of spot forex positions. The Face of Trading . . . . . . . . . . . . . . .49 Rolling with the punches. Currency Futures . . . . . . . . . . . . . . .44 Currency fund manager performance. Key Concepts . . . . . . . . . . . . . . . . . . . .50 Global News Briefs . . . . . . . . . . . . .45 Events . . . . . . . . . . . . . . . . . . . . . . . . . .51 Conferences, seminars, and other events. International Market Summary . . . . . . . . . . . . . . . . . . . . . . .46 Forex Trade Journal . . . . . . . . . . . .52 Currency, interest rate, and equity Too late to sell the dollar? A position performance from around the globe. in the dollar index futures tells the tale. Have a question about something you’ve seen in Currency Trader? Submit your editorial queries or comments to Looking for an advertiser? Consult the list below and click on the company name for a direct link to the ad in this month’s issue of Currency Trader. Advertising index CMS Forex Forex Expo Market Technicians Assoc. Currency Trader Bookstore MetaStock Deutsche Bank FXCM NewsTrader Pro eSignal TradeGuider InterbankFX 4 August 2007 • CURRENCY TRADER
  • 4. FOREX By far the largest cash value traded FREE Book market in the world. The trade happening in the forex markets across the globe currently exceeds US$1.9 trillion/day (on average). Why is it the fastest growing segment for individual investors and many former equity and futures traders? MetaStock, the leading creator of technical analysis software, is excited about the FOREX market — and for good reason. It’s one of the best ways for YOU to get started in investing. To help you along, we want to give you a FREE copy of “Successful FOREX Trading.” Written by the former Chief Trading Instructor for FOREX Capital Markets. This book explains technical analysis as it relates to currency trading. This valuable information is FREE, no strings attached. To get your copy, visit our web site, or give us a call at (800) 432-4917 and mention the promotion code CT67 Click Here for your FREE Book About the author Edward Ponsi is the President of FXEducator LLC and is the former Chief Trading Instructor for Forex Capital Markets (FXCM). An experienced trader and mentor, Ed gives personal, one-on- one trading instruction to students around the world, and has advised hedge funds, Interbank traders, and individuals of all levels of skill and experience. This is neither a solicitation to buy or sell any type of financial instruments, nor intended as investment recommendations. All investment trading involves multiple substantial risks of mon- etary loss. Don’t trade with money you can’t afford to lose. Trading is not suitable for everyone. Past performance, whether indicated by actual or hypothetical results or testimonials are no guarantee of future performance or success. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS OR TESTIMONIALS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. Furthermore, all internal and external computer and software systems are not fail-safe. Have contingency plans in place for such occasions. Equis International assumes no responsibility for errors, inaccuracies, or omissions in these materials, nor shall it be liable for any special, indirect, incidental, or consequential damages, including without limitation losses, lost revenue, or lost profits, that may result from the reliance upon the information materials presented.
  • 5. CONTRIBUTORS CONTRIBUTORS Howard Simons is president of A publication of Active Trader ® Rosewood Trading Inc. and a strategist for Bianco Research. He writes and speaks fre- For all subscriber services: quently on a wide range of economic and financial market issues. Barbara Rockefeller ( is an Editor-in-chief: Mark Etzkorn international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank Managing editor: Molly Flynn and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies (For Dummies, 2004), 24/7 Senior editor: Jeff Ponczak Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and Contributing writers: Barbara Rockefeller, How to Invest Internationally, published in Japan in 1999. A Howard Simons, Marc Chandler book tentatively titled How to Trade FX is in the works. Editorial assistant and David Mantell is a currency trader at Chicago Global Webmaster: Kesha Green Investors, where he trades currency futures in the euro, yen, British pound, Swiss franc, and Canadian dollar. He began his Art director: Laura Coyle career in the financial markets 15 years ago as a financial advisor. Mantell is a former equity research analyst, having President: Phil Dorman covered the media & telecommunications (wireline and wire- less) industries. As part of his MBA, Mantell attended the Publisher, ESSEC Business School in Paris. He can be contacted at Ad sales East Coast and Midwest: Bob Dorman Thom Hartle ( is director Ad sales of marketing for CQG and a contributing edi- West Coast and Southwest only: Allison Ellis tor to Active Trader magazine. In a career span- ning more than 20 years, Hartle has been a commodity account executive for Merrill Classified ad sales: Mark Seger Lynch, vice president of financial futures for Drexel Burnham Lambert, trader for the Federal Home Loan Bank of Seattle, and edi- Volume 4, Issue 8. Currency Trader is published monthly by TechInfo, Inc., tor for nine years of Technical Analysis of Stocks & Commodities 150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2007 TechInfo, Inc. All rights reserved. Information in this publication may not be magazine. Hartle also writes a daily market blog called hartle stored or reproduced in any form without written permission from the publisher. & flow ( The information in Currency Trader magazine is intended for educational pur- poses only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Traders are advised to do their own research and testing to determine the validity of a trading idea. Trading and investing carry a high level of risk. Past performance does not guarantee future results. 6 August 2007 • CURRENCY TRADER
  • 6. GLOBAL MARKETS Beyond the majors: The exotic waters of emerging market currencies Experience required: There are opportunities in emerging-market currencies, but traders should nonetheless be careful about venturing outside the highly liquid major currency pairs. BY CURRENCY TRADER STAFF W expand their offerings to include emerging-market or “exotic” currencies. hile the vast majority of forex trading occurs in the so-called “majors” — the currencies of G-10 countries — some retail forex brokerages are beginning to Such currencies include the Mexican peso, South African “Exotic currency pairs provide traders with the ability to take advantage of trends that can be established by large money taking positions in these less-liquid currencies,” says Paul Jamgotch, dealing desk manager at GFT. “Exotics are also attractive to traders who keep their eyes on the fun- damental factors that can affect these smaller financial mar- kets. Also, it gives retail traders a way to speculate in the rand, Singapore dollar, Thailand baht, Brazilian real, and economies of countries that don’t offer easy access to other Hong Kong dollar. trading vehicles, such as bonds or stocks.” There are many reasons forex trading revolves around a Diversification is another argument in favor of expand- handful of currency pairs, most of which include either the ing into the exotic arena. U.S. dollar or the euro, but the most important are liquidity and stability. It’s often said the forex market is the most liq- uid in the world, and that liquidity is based on the stability Some strategists caution that only the of a few countries and regions that, through history and for- tune, have come to dominate global trade and finance. It is no coincidence that oil and gold are priced globally in dol- most seasoned retail players should lars. For example, Brazil is a developing country at the fore- enter the exotic currency arena front of a Latin American boom — several countries are bucking for “first-world” status. But despite the fact it’s had because of its higher volatility, lower one of the hottest currencies in recent years, Brazil has gone through a few “new” currencies in the past two decades as liquidity, and wider spreads. its economy has busted and boomed. Nonetheless, some emerging market currencies are edg- ing into the mainstream of the forex world. “Having exposure to just the major pairs really narrows the scope of a trader’s portfolio,” says Richard Lee, curren- Why trade exotics? cy strategist at FXCM. “Portfolio returns in emerging mar- Some analysts contend exotic currencies tend to trend bet- kets are also outpacing major-currency investments.” ter than the majors because their economies are often nar- While FXCM currently does not provide access to emerg- rowly focused, or even dependent on one specific industry ing market currencies on their retail platform, they do pro- or investment theme. vide research in the Hong Kong and Singapore dollars, as GFT Forex and currently include exotic cur- well as the Chinese yuan. rency trading on their retail trading platforms. “Additional instruments are good because they offer 8 August 2007 • CURRENCY TRADER
  • 7. diversification,” says Richard Olsen, co-founder of think when trading emerging markets because retail “Anyone trading any market wants to diversi- traders are not used to violent fluctuations. fy.” ”Unless retail investors trade crosses such as the Oanda gradually began adding exotic cross rates to its pound/yen, they are more [accustomed to] 30-pip daily retail platform starting in 2006 and Olsen says it has been fluctuations,” he says. “The rand moves almost 10 times met with “an astonishing amount of interest.” Oanda has that in single session. However, you always have to take a fairly wide offering of exotic currency crosses, including continued on p. 10 crosses with the euro dollar vs. emerg- ing market currencies. (For a list of Oanda’s current exotic pairs offer- ings see: spreads/all_spreads.shtml.) Higher risk levels With opportunity, of course, comes risk. Brian Dolan, chief currency strategist at, a division of Gain Capital, says his firm currently does not offer emerging market cur- rencies to retail clientele because of liq- uidity and the lack of running prices. “There is tremendous potential in some of the [exotic currencies], but it is a whole new level of risk versus the G- 10 currencies,” he says. Wider spreads, more volatility Forex traders should not jump into the world of the exotics without a great deal of research and understanding of the risks associated with these curren- cies. Some strategists caution that only the most seasoned retail players should enter this arena because of the higher volatility, lower liquidity, and wider spreads these currencies tend to display. “The spreads on exotics can be fair- ly wide because these markets are less liquid,” says GFT’s Jamgotch. “Retail traders need to keep in mind there is limited liquidity in many exotic pairs, which means spreads tend to widen when these local financial markets are not open. “The typical GFT spread for the USD/ZAR (U.S. dollar/South African rand pair) is 150 pips, and during some market conditions, such as when the South African market is closed, it is not uncommon for the spread to widen to more than 500 pips.” FXCM’s Lee says volatility and liq- uidity are bigger concerns than people CURRENCY TRADER • August 2007 9
  • 8. GLOBAL MARKETS continued FIGURE 1 — DOLLAR/RAND “Whatever you do, put on small trades,” suggests Oanda co-founder In late July the U.S. dollar/South African rand pair was just beginning to penetrate Olsen. the bottom of its long-term range and was trading at its lowest level in a year. Longer-term plays Given the wider spreads and reduced liquidity of some exotic currencies, some strategists feel the longer-term time frame is a better choice than day trading in this arena. Dolan cautions those interested in expanding into the exotics. “For the retail guy, the risks probably outweigh the rewards,” he says. “If they do get into it, it has to be more of a strategic and longer-term play.” Olsen agrees on the time frame out- look. “While a euro/dollar trader might trade a two- to three-hour position, a yuan play could last two to five weeks,” Source: ADVFN ( he says. “Trades put on in emerging market currencies are different in into account the pip cost, which essentially puts things back nature, and tend to be on more of a long-term time frame.” into perspective.” A pip in the ZAR currently is worth about $1.45 vs., say, Do your homework roughly $10 for a pip in the euro/dollar pair. Gaining access to the appropriate fundamental information “Another factor retail traders should be aware of is the needed to make trading decisions may be harder when volatility in exotic currencies around fundamental news looking at the exotic currency landscape. releases can be much higher than in major currencies,” says “There are fewer news announcements and bank GFT’s Jamgotch. “This means market gaps and slippage are research available for some of these exotic currencies,” says more common.” GFT’s Jamgotch. “This means that it can be more difficult for retail traders to conduct proper research needed to Keep things small make informed decisions based on fundamental data.” As market conditions can shift rapidly in the exotic curren- cy environment, strategists advise retail customers to mon- “Exotic” to watch: South African rand itor and limit position sizes carefully. FXCM’s Lee says the South African rand (ZAR) is a curren- “Exotic currencies can become very volatile and illiquid cy to watch near-term (Figure 1). without warning,” Jamgotch says. “Given the recent attention on carry trades and interest For example, he pointed to when the Thai baht fell more rates, I still think that the ZAR has some potential,” he says. than four percent against the U.S. dollar in December 2006 ”Technically, however, I might be waiting a bit for a better when the Bank of Thailand imposed penalties on invest- price, as we’re approaching a major support level (in late ments held for less than a year. Spreads on the U.S. dol- July).” lar/Thai baht cross spiked from 5 pips to 100 or more, The South African Reserve Bank hiked interest rates in depending on the institution. Jamgotch says many market early June from 9.0 percent to the current 9.5 percent. makers chose not to offer Thai baht crosses during this tur- Bullish interest-rate differentials alone favor the rand vs. bulent time. the U.S. dollar’s 5.25 percent fed funds rate. Exotic currency traders also have to face the reality that it Looking at the differential, Lee says it’s still a good per- may be difficult to exit positions because of lack of liquidi- centage to play. ty outside of local trading hours. “At the end of the day, it is almost like a futures market Rand: Key fundamentals position, when the futures close at 2 o’clock and you can’t Gold and platinum prices are two factors that drive the get out until the next day,” warns’s Dolan. For South African rand; some traders essentially use the rand as example, he notes that outside of North American trading a proxy for the world gold market. hours, liquidity is “pretty poor” in the Mexican peso. Clyde Wardle, senior emerging market FX strategist at 10 August 2007 • CURRENCY TRADER
  • 9. HSBC, notes the rand strengthened roughly five percent improved,” Wardle says. “Liquidity is still very loose from June to July. across the globe, which encourages managers to search for “It was at 7.20-7.30 in early June and now it has moved yield.” below 7.00,” he says. The main risk, Wardle warns, is the external environ- As of late July, the USD/ZAR was trading at 6.88. Wardle ment. If global stock markets were to come under pressure, pointed to the rally in the gold market from late June as one money managers could trim exposure to emerging-market factor supporting the rand in recent weeks. positions, which would likely result in a weaker rand. HSBC forecasts overall gross domestic product (GDP) growth at 5.4 percent for South Africa in 2007, vs. 2006’s 5.0-percent reading. Inflation remains high, which has been a driver toward tighter monetary policy. The May CPI ex-food and energy figure posted a 6.4-percent reading year- over-year in South Africa. “The economy is improving and has been improving for the past cou- ple of years,” Lee says. “GDP and manufacturing are healthy and con- sumer spending has picked up.” Wardle adds in the past the South African Reserve Bank had discomfort with currency strength below 7.00 amid worries that it would hurt domestic manufacturing. “Given rising inflation, the central bank should be comfortable with the strengthening currency,” he says. Rand: Key price levels Overall, HSBC forecasts continued strengthening in the rand toward 6.75 by the end of third quarter. Weakness is seen into early 2008, with a first- quarter forecast of 7.25. “I’m looking for a technical break of the support the currency pair is cur- rently trading at, around the 6.8606 (the May 8 low),” Lee says. “If this level is broken, I would be looking to initiate a long around that area with targets set at 6.4050, just below the 6.427, 76.4-percent Fibonacci retrace- ment of the 5.9446-7.983 bull wave.” Global risk appetite helps, too The global environment remains favorable toward emerging markets, which is positive for the rand. Also, given its relatively high interest rate, the rand has been a player in the glob- al carry trade, as well. “The global risk appetite has CURRENCY TRADER • August 2007 11
  • 10. ON THE MONEY The rising yen — here we go again Japan’s unique economy — and culture — will play major roles in determining whether the current yen strength has legs. BY BARBARA ROCKEFELLER L ast month’s article (“The hammer and the yen,” Currency Trader, July 2007) discussed a potential trend reversal in the Japanese yen (JPY) that is developing the way we feared. So far the yen has risen about 4.00 points from the June 22 low at 124.15, and no matter what indicator you draw on the chart, it’s a clear reversal (see Figure 1, which shows the dollar-yen rate cators used to signify overbought or oversold (not shown), the yen is still “weak” and hasn’t even headed up toward the overbought level. This implies the up move may have a long way to go. Drawing the standard error channel starting farther back in time (from the May 2006 high of 109.00) shows the cur- rent move’s trendline would meet the upper boundary of with an inverted scale so yen strength vs. the dollar appears the channel at 119.50 sometime around Aug. 20 if it contin- as an up move). ues at the same slope (Figure 2). This perspective of the The yen staged a breakout over the standard error chan- channel shows the current yen move to be only a secondary nel drawn from the March yen high. The current price is correction of the bigger primary down move. This is proba- well over the red 20-day moving average and less than 100 bly the correct interpretation, but it doesn’t pass the “So points from the green 200-day moving average — the latter what?” test if you are trying to trade the yen. The bottom usually considered the “long-term” average that often acts line is, if you are trading the yen, you have to be long. as resistance, like the channel top. Price has also surpassed the previous highest high from early June (gold horizontal Learning to love the yen…for now line). It’s interesting that on the basis of the relative But a real problem with going long the yen is that it’s diffi- strength index (RSI) and the stochastic oscillator, two indi- cult to understand the reasons behind the currency’s rise. Typically, when a trend reversal occurs you can identify the sentiment shift as FIGURE 1 — DAILY DOLLAR-YEN (INVERTED SCALE) it is occurring and know what’s com- The yen has made a strong move off its June low vs. the dollar, pushing ing at least a few days in advance. This above near-term resistance and positioning itself for a run at the 200-day time there’s a full plate of “reasons” for moving average. the reversal, but none of them are com- pelling. Even taken as a whole they are not particularly powerful. Besides, the countervailing reasons for the yen to remain in its primary downtrend have not gone away. Let’s look at the reasons we can comfort ourselves with as we buy yen. First, there was a serious policy shift at the Japanese Ministry of Finance in late June (see “The hammer and the yen”). The government simply no longer sees a weak yen as acceptable. Not only is the government worried about pressure from other countries, notably France, but a weak yen makes energy and commodities expensive in yen terms, which is a negative for small and medium-sized firms, includ- ing many exporters. Sony, Honda, and the other big names are experienced hedgers (and cost-cutters), but smaller Source: Data — Reuters DataLink; charts — MetaStock firms suffer. 12 August 2007 • CURRENCY TRADER
  • 11. FIGURE 2 — WEEKLY DOLLAR-YEN (INVERTED SCALE) The reversal on the daily time frame currently is nothing more than a correction It’s wise to respect a stated policy in the yen’s long-term downtrend. shift such as this because governments can be powerful influences, although we hardly ever see the influence at work. It’s done behind the scenes using what is euphemistically called “moral suasion.” In a phone call, over drinks, or at the golf course, an official makes a gentle suggestion to a banker or broker, (“…and Bob’s your uncle”), and the disliked behavior stops instantly. Governments regulate banks and brokers, plus they tax everybody. You disobey a government official’s suggestion at your peril. And in Japan, respect for authority runs high. There are numerous ways the gov- ernment could nudge institutions away from a weaker yen. Japanese retail investors are avidly pursuing accounts denominated in other curren- cies, for example, but that would tend not to be the focus. Instead, attention Source: Data — Reuters DataLink; charts — MetaStock would likely turn to cutting lines of credit to speculators, chiefly hedge banks fall victim to dud loans to such funds, especially if they invested in institutions — or forex trades, either. U.S. sub-prime paper. This would kill Presumably, lending to hedge funds two birds with one stone — halting an has been curtailed, along with credit outflow from yen and reducing expo- lines for simple position-taking trad- sure to high-risk paper. ing. As for lending to domestic The sub-prime housing problem in Japanese funds, Japan’s nine biggest the U.S. has already hit a number of banking groups have more than ¥1 tril- hedge funds, the main players in the lion ($8.3 billion) in various instru- carry trade. An Australian hedge fund ments backed by U.S. sub-prime mort- hired Blackstone to advise it on sub- gages, according to the JiJi newswire. prime investments, and immediately In late July, Financial Services everyone suspects these investments Agency (FSA) chief Yuji Yamamoto were made with borrowed yen. We told the press the government is close- don’t know that for a fact, but the mere ly monitoring Japanese financial insti- suspicion suffices to goad some tution risk-management practices. The traders into imagining that if there is FSA finds the banks “well-prepared.” one firm doing this, there might be Considering the entire banking sector dozens. was in the tank only 10 years ago and As far as we know, no hedge fund survived only with massive govern- using borrowed yen to invest in U.S. ment bailouts, we wonder whether sub-prime has actually gone under, this can be true, but never mind. We and we do not know if the sub-prime should probably assume that problem is going to contaminate other Yamamoto told the banks to stop collateralized debt funds to the point investing in the sector and perhaps of failure. But from the hysteria in the even to dump some of the paper. Such blogosphere, you’d think widespread trades are, in effect, repatriation, and institutional failure is imminent. automatically entail buying yen. Nearly all hedge funds are non- This presupposes the Japanese insti- Japanese, but if Japanese banks are tutions do not just switch to better- providing the funding, they are at risk, quality foreign paper. After all, the too. yield differential is still vastly in the Japan has no intention of letting its continued on p. 14 CURRENCY TRADER • August 2007 13
  • 12. ON THE MONEY continued Other Barbara Rockefeller articles: “The hammer and the yen” Currency Trader, July 2007. favor of the Australian dollar, New Zealand dollar, British Recent statements by Japan’s Ministry of Finance hint at pound, euro, and U.S. dollar. If the Japanese government were big things on the horizon for the yen. asking its financial institutions to forego that additional yield, it would be a shocking interference with private business. “Too big to fail” (That doesn’t mean they wouldn’t do it.) Currency Trader, June 2007. Another “reason” behind the yen’s rise is the widely expect- If the dollar is poised to rebound, it might be getting help ed Bank of Japan (BOJ) rate hike in September or October, where it least expects it. although possibly as early as August. This argument really doesn’t hold water. A rate hike would still leave a very large “Do stocks hold the key to currency levels?” gulf between Japanese and foreign paper, although we can Currency Trader, May 2007. admit that if the famously reticent BOJ were to raise rates in the The correlation between stock market and currency prices absence of inflationary pressure in the name of “normaliza- isn’t what many people think. tion” and a nod to superior growth, then we need to pay atten- “The coming commodity boom” tion; more hikes will be on the way. This is a tremendously con- Currency Trader, April 2007. tentious issue: Under what circumstances should a central Commodities are already having an impact on global bank, facing zero inflation, raise rates? economies. One answer is that Japan has failed to become a global finan- cial center on par with New York or London, but has not aban- “The yen: Canary in the currency coal mine” doned the objective. Japan has the world’s second-largest econ- Currency Trader, March 2007. omy but Tokyo is not the world’s second largest financial cen- Keep an eye on capital flows and the yen — they could ter. In fact, Tokyo has lost rank over the past 15 years. The be telling you more about the dollar than first meets Tokyo Stock Exchange is the world’s second-largest after the the eye. New York Stock Exchange, but its capitalization is only 10 per- cent of world capitalization, even as emerging markets rocket “Indicator failure and scientific analysis” higher. It had one-third of world capitalization in 1990. Currency Trader, February 2007. Foreigners don’t want to list their companies in Tokyo, with This discussion of market biases and fallacies provides a only 25 listing last year, from 125 the year before. New York, more rigorous way to think about trading. even with the deterrent of Sarbanes-Oxley rules, attracted “Reserve diversification, Part II” more than 440 in 2006. Worse, in recent years the Tokyo Stock Currency Trader, January 2007. Exchange has had some huge technology failures that shut What is the U.S. doing to ensure the Chinese government down trading for entire days. Despite being the land of elec- will not alter the $700 billion it has in U.S. dollar reserves? tronics, the exchange is considered technologically deficient. Singapore and Hong Kong, with tiny economies, are bigger “Charts are not enough” and more dynamic — and associated by language, history, and Currency Trader, December 2006. culture with China, which is rapidly displacing Germany as Breaking down price action in light of the news. the third largest economy. The first study group on enhancing Japan’s position as an “When will the yen go to the moon?” international financial center was held in 2003, but it seems to Currency Trader, October 2006. be new FSA chief Yamamoto who is reviving the initiative. He The fundamentals are all pointing toward an up move in adheres to the belief that you can’t be a major world financial the Japanese yen. So what’s it waiting for? center with a falling currency that fails to reflect good econom- ic fundamentals, which in Japan’s case is the highest growth “Why is everybody losing money in forex?” rate in the world in 2006. However, wishing to be a world Currency Trader, September 2006. Despite unprecedented liquidity, professional currency financial center is not the same thing as knowing how to get managers have had a rough go of it in 2005 and 2006. there. Has something changed in the forex world? Is it even remotely reasonable to assume that engineering a stronger yen can be viewed as a prerequisite to this goal, and “Gauging trader commitment” let’s worry about the rest of the components of becoming a Currency Trader, August 2006. world center later on? Yes. It is exactly the kind of straight-line Is this a good breakout or a false move? The thinking we have seen from Japan in the past — and oddly, it Commitment of Traders report can help currency traders often succeeds. fill in some of the holes left by the absence of traditional Working on becoming a world financial center could remain volume data in forex. an objective of whatever government is in office, and Prime Minister Shinzo Abe and his coalition government risk losing You can purchase and download past articles at power in the July 29 elections. Even if Yamamoto does not remain the FSA chief, the next guy would be bound by the 14 August 2007 • CURRENCY TRADER
  • 13. overarching government objective. in the yen for the past six months, Japan has a splendid history of long- because hedge fund managers have a term planning. The next FSA head will “strong hand.” It's not easy to stam- pick up the internationalization effort pede them out of lucrative positions. where Yamamoto left off. But each manager has a breakeven Having a stronger currency based in point and nerves get frayed even part on higher interest rates is not the when the yen is hundreds of points only obstacle Yamamoto faces in try- away. After all, currencies can move ing to make Tokyo a global financial hundreds of points in a short while center. He also has to overcome a pen- and currencies are famous for over- chant for regulatory red tape that sti- shooting, too. fles innovation and encourages people More importantly, folks riding the to find ways around regulatory agen- coattails of the yen carry trade, includ- cies (including the FSA itself) instead ing those with plain vanilla futures of simply asking for exceptions and and forwards, are easy to panic. As help. risk aversion rises with every new Most observers say the biggest story about losses in subprime and problems are cultural. To be an inter- other collateralized debt that was mis- national center, you have to attract for- priced, incompetently rated by the rat- eigners to live and work in Tokyo. But ings agencies, or can’t be marked to the language is difficult to learn and market with any confidence, the carry has complex nuances — the word for trade gets lumped in with other paper “risk” didn’t exist in Japanese, and deemed “high-risk.” This is not accu- comes from English. Women are sec- rate — with the carry trade, all you ond-rate citizens and not represented need to know is your breakeven point. at executive levels, a waste of half the You can count on the forex market to manpower of the country. Japan has provide sufficient liquidity for an its fair share of smart people, but argu- orderly exit at just about any hour of ing and disagreeing with others is the day or night. With truly high-risk socially unacceptable. It makes brain- paper, the unknowns are plentiful, storming particularly difficult. And including markets so thin (illiquid) respect for older people, while laud- that no trading gets done at all. But the able, restrains brash youngsters from relative ease of exit doesn't matter to making a splash. But splashiness and those prone to panic — the yen carry disorder are what you need to sponsor trade is considered speculative, and change. plenty of traders will simply dump positions. The story is the story Add to that a possible rate hike and Of all the reasons for the yen to be on a government determined to rise in the upswing, the sub-prime hedge the ranking of global financial centers fund story seems to be the one that has on the back of a high currency and you captured traders’ imagination. That have a recipe for further gains. we have no hard evidence of yen- Is this a castle built out of spun funded hedge-fund failures and no sugar? You bet. The whole thing can evidence of a lending pullback, come crashing down if the sub-prime whether government-mandated or problem fades away with no big insti- not, is no deterrent to traders. It’s a tutional failures, Abe loses the elec- juicy story. It makes sense. All it will tion, the BOJ refuses to raise rates take is one outright yen-funded because there is no inflationary reason hedge-fund failure to send the yen to to raise rates, and the timetable for the moon. restoring Tokyo to world status is seen The yen can also go to the moon if to be a project for a decade, not the carry trades actually do get unwound. next three months. But in the mean- We have been pooh-poohing that time, you have to go with the flow. story, which has been used to explain any and every minor bounce upward For information on the author see p. 6. CURRENCY TRADER • August 2007 15
  • 14. TRADING STRATEGIES Short-term trends in the EUR/USD pair Analyzing both the duration and size of different price moves can clue you in to more accurate trade setups. BY CURRENCY TRADER STAFF A common problem in the markets is trading with hindsight. For example, you make a trade, book a profit, and then watch the move continue — realizing you left money on the table by not being more patient. Other times you wait for that nice run that never materializes. Trading with hindsight can introduce psychological issues when managing a trade. You might think you can judge by the current conditions whether a big move is at hand or not. But if you second-guess yourself for getting out too early or too late, you’ll have problems taking the next trade. FIGURE 1 — DAILY EUR/USD Two sharp runs — one up, one down — are marked on the chart. How often does this currency pair make consecutive daily higher highs or lows? Source: CQGNet ( 16 August 2007 • CURRENCY TRADER
  • 15. FIGURE 2 — WEEKLY EUR/USD The review period spanned July 2003 through June 2007. Source: CQGNet ( The best way to avoid this is to per- form a thorough analysis of market behavior and get some hard numbers on which to base your trades. You will know what typical market behavior is and can develop strategies around that knowledge. In addition, perform- ing this type of market analysis on a regular basis will alert you to changes in market volatility. For example, in Figure 1, the price run next to arrow “A” is a run of 13 consecutive higher highs but only six consecutive higher closes. Arrow “B” marks a run of four consecutive lower lows, but only three consecutive lower closes. The question is, just how often do such runs occur? This analysis dissects trend runs using daily bars of the euro/U.S. dol- lar (EUR/USD) pair from July 1, 2003 through June 29, 2007 and identifies the number of consecutive higher or lower highs, higher or lower lows, and higher or lower closes in different continued on p. 18 CURRENCY TRADER • August 2007 17
  • 16. TRADING STRATEGIES continued TABLE 1 — HIGHER HIGHS VS. LOWER LOWS daily price range behavior. The EUR/USD trend was up for more than four years, which is The top half of Table 1 compares one day’s session reflected by the slight edge in the numbers for higher prices (top half of the table) vs. lower prices (bottom half of the table). to the next day’s session, detailing the number of times there were consecutive higher highs (HH), HH HL HC HH+HC HH+HL+HC higher lows (HL), higher closes (HC), higher highs 543 531 524 367 300 and higher closes (HH +HC), and higher highs, high- 52.11% 50.96% 50.29% 35.22% 28.79% er lows, and higher closes (HH+HL+HC) The bottom half of Table 1 shows the number of LL LH LC LL+LC LL+LH+LC times there were consecutive lower lows (LL), lower highs (LH), lower closes (LC), lower lows and lower 503 492 512 332 256 closes (LL +LC), and lower lows, lower highs, and 48.27% 47.22% 49.14% 31.86% 24.57% lower closes (LL+LH+LC). First, the percentage change (on a closing basis) for price moves, as well as other patterns. the entire review period was a gain of just over 17 percent. Figure 2 shows the review period using weekly bars, but The table shows the influence of this long-term trend, but it the analysis was performed on daily data. is relatively minor — the numbers in the top half of the table are slightly larger than the bottom. A closer look at the Up moves vs. down moves numbers points to some interesting price action. To get a handle on typical moves vs. what could be consid- The market made either a higher high, higher low, or ered outliers, Tables 1 and 2 show the EUR/USD’s basic higher close more than 50 percent of the time — unsurpris- ing given the long-term trend. However, combining higher highs and higher closes dropped the per- centage to 35 percent of the time, and back-to-back higher highs, higher lows, and higher closes occurred just under 29 percent of the time. This sug- gests that despite the buying pressure from one session to the next, traders tended to take profits going into the close over 70 percent of the time. None of the statistics in the bottom half of the table break the 50-percent level. However, the percentage of lower closes was higher than the per- centage of lower lows or lower highs. This implies there were inside days when the market essentially paused; when the market could not generate an up move, traders moved out of long positions, producing lower clos- es. The percentage of consecutive lower lows and lower closes is just under 32 percent and the percentage of consecutive lower lows, lower highs, and lower closes is slightly less than 25 percent. The bullish trend is 18 August 2007 • CURRENCY TRADER
  • 17. TABLE 2 — EUR/USD RUNS Despite the EUR/USD’s upward bias, the market posted seven consecutive higher closes (HC) only three times, while it made seven consecutive lower closes on five different occasions. HC HH+HC HH+HL+HC No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2 Count 3 13 28 56 117 254 0 2 8 25 69 150 0 0 4 15 46 109 % 0.29% 1.25% 2.69% 5.37% 11.23% 24.38% 0.00% 0.19% 0.77% 2.40% 6.62% 14.40% 0.00% 0.00% 0.38% 1.44% 4.41% 10.46% LC LL+LC LH+LL+LC No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2 Count 5 15 31 58 111 242 0 3 10 22 53 131 0 2 7 16 35 87 % 0.48% 1.44% 2.98% 5.57% 10.65% 23.22% 0.00% 0.29% 0.96% 2.11% 5.09% 12.57% 0.00% 0.19% 0.67% 1.54% 3.36% 8.35% also reflected in these two statistics, because they suggest trend was up during the review period, Table 2 has some there were times the market traded lower than the previous interesting details. First, there were more times the market session, but buyers came in and bid the market up to a high- closed down seven consecutive times than up. Of course, er closing price. the difference (two) is not statistically significant, but the Table 2 displays a more detailed breakdown of the fre- number of runs of consecutive lower closes is larger than quency and length of runs in the EUR/USD pair. The “No. the number of consecutive higher closes from lengths of of days” row is the number of sessions that met the criteria. four to seven days. (However, the percentage price changes For example, “7” means a run of seven (or more) consecu- continued on p. 20 tive days; “6” means a run of six or more sessions, etc. Although, the table does not explic- itly show the exact number of occur- rences in each category, simple arith- metic reveals the answers. For exam- ple, there were 117 runs of three or more consecutive higher closes (HC); these 117 runs are also part of the 254 runs of two or more consecutive high- er closes (254 occurrences). As a result, there were 137 (254 - 117) runs of only two consecutive days of higher closes. The top half of Table 2 shows the market made seven consecutive high- er closes only three times, or just 0.29 percent of the time. The same statistics are detailed for consecutively higher highs and higher closes (HH+HC), and higher highs, higher lows, and higher closes (HH+HL+HC). The bot- tom half of the table shows the infor- mation for lower closes (LC), lower lows and lower closes (LL+LC), and lower highs, lower lows, and lower closes (LH+LL+LC). In light of the fact the long-term CURRENCY TRADER • August 2007 19
  • 18. TRADING STRATEGIES continued TABLE 3 — MARKET PERFORMANCE The percentage price moves from one to five days is shown for the total review period as well as for 12-month sub-periods. Total D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM Avg 0.02% 0.41% -0.42% 0.03% 0.60% -0.59% 0.05% 0.74% -0.72% 0.07% 0.86% -0.82% 0.08% 0.97% -0.90% Med 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68% STD 0.56% 0.35% 0.35% 0.77% 0.47% 0.49% 0.93% 0.57% 0.59% 1.08% 0.65% 0.68% 1.19% 0.73% 0.75% 7/1/2003-6/30/2004 Avg 0.02% 0.51% -0.53% 0.05% 0.74% -0.75% 0.08% 0.92% -0.92% 0.10% 1.07% -1.05% 0.14% 1.21% -1.17% Med 0.04% 0.41% -0.45% 0.10% 0.64% -0.58% 0.17% 0.81% -0.70% 0.27% 0.95% -0.80% 0.35% 1.12% -0.87% Max 1.91% 1.99% 0.00% 2.39% 2.62% 0.00% 2.99% 3.25% 0.00% 3.49% 3.62% 0.00% 3.94% 3.99% 0.00% Min -1.93% 0.00% -2.11% -2.80% 0.00% -3.19% -2.97% 0.00% -3.47% -3.32% 0.00% -3.47% -3.69% 0.00% -3.85% STD 0.71% 0.41% 0.44% 0.96% 0.55% 0.61% 1.12% 0.65% 0.73% 1.31% 0.76% 0.83% 1.43% 0.84% 0.92 7/1/2004-6/30/2005 Avg -0.01% 0.39% -0.44% -0.01% 0.57% -0.63% -0.02% 0.70% -0.77% -0.03% 0.82% -0.89% -0.04% 0.91% -1.00% Med -0.02% 0.30% -0.35% -0.02% 0.46% -0.50% 0.02% 0.57% -0.62% 0.00% 0.68% -0.71% 0.02% 0.81% -0.77% Max 1.84% 1.95% 0.00% 1.90% 2.01% 0.00% 2.12% 2.20% 0.00% 2.35% 2.53% 0.00% 2.50% 2.68% 0.00% Min -1.44% 0.00% -1.66% -2.36% 0.00% -2.53% -3.21% 0.00% -3.37% -3.05% 0.00% -3.37% -3.68% 0.00% -3.90% STD 0.56% 0.34% 0.36% 0.79% 0.45% 0.51% 0.98% 0.53% 0.63% 1.14% 0.61% 0.72% 1.28% 0.67% 0.81% 7/1/2005-6/30/2006 Avg 0.03% 0.42% -0.42% 0.06% 0.62% -0.58% 0.08% 0.78% -0.70% 0.11% 0.92% -0.78% 0.14% 1.04% -0.86% Med 0.00% 0.33% -0.33% 0.02% 0.49% -0.49% 0.04% 0.60% -0.60% 0.05% 0.74% -0.66% 0.06% 0.84% -0.71% Max 1.70% 1.91% 0.00% 2.52% 2.73% 0.00% 2.56% 3.03% 0.00% 2.79% 3.03% 0.00% 2.76% 3.03% 0.00% Min -1.23% 0.00% -1.38% -2.15% 0.00% -2.24% -2.23% 0.00% -2.46% -2.42% 0.00% -3.01% -2.56% 0.00% -3.01% STD 0.54% 0.36% 0.31% 0.77% 0.51% 0.40% 0.92% 0.62% 0.49% 1.05% 0.69% 0.55% 1.15% 0.76% 0.61% 7/1/2006-6/30/2007 Avg 0.02% 0.31% -0.28% 0.04% 0.44% -0.40% 0.07% 0.54% -0.47% 0.09% 0.63% -0.53% 0.11% 0.71% -0.58% Med 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45% Max 1.15% 1.27% 0.00% 1.48% 1.73% 0.00% 1.97% 2.06% 0.00% 2.26% 2.51% -0.01% 2.76% 2.84% -0.01% Min -1.05% 0.00% -1.12% -1.42% 0.00% -1.48% -2.04% 0.00% -2.19% -2.01% 0.00% -2.25% -2.13% 0.01% -2.36% STD 0.36% 0.23% 0.21% 0.52% 0.32% 0.30% 0.62% 0.38% 0.37% 0.71% 0.44% 0.43% 0.79% 0.49% 0.47% during these runs is not included here.) Size of price moves There’s a similar pattern in the number of higher highs Table 3 details the percentage size of price moves from one and higher closes (HH+HC) relative to lower lows and to five days in length for the entire review period, as well as lower closes (LL+LC). Neither category had any runs last- in 12-month increments. Included are the average, median, ing seven consecutive days, but the percentage of six- and maximum, minimum, and standard deviation for each five-day runs of lower lows and lower closes edged out the close-to-close move, largest up move (LUM), and largest percentage of higher highs and higher closes. down move (LDM) for each period (see “Understanding The final comparison is higher highs, higher lows, and Table 3” for details about the statistics). higher closes (HH+HL+HC) vs. lower highs, lower lows, For example, for the entire analysis period, the average and lower closes (LC). There were two runs of six consecu- three-day close-to-close change was a gain of 0.05 percent, tive LH+LL+LC days on the bear side, and the five-day and the maximum gain was +2.99 percent (which occurred in four-day runs outnumbered the HH+HL+HC counterparts. the July 1, 2003 to June 30, 2004 period) and the largest continued on p. 22 20 August 2007 • CURRENCY TRADER
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  • 20. TRADING STRATEGIES continued three-day, close-to-close decline was -3.21 percent (from the The median close-to-close price move was negative over the July 1, 2004 to June 30, 2005 period). The average three-day next three sessions, after which the market rebounded. LUM was +0.74 percent and the average three-day LDM Figure 3 compares the performance after the pullback was -0.72 percent. patterns and the typical market performance. Because the long-term trend was up, let’s see if some of continued on p. 24 the information from Table 3 can pro- vide insight as to what the market did following pullbacks. Understanding Table 3 Two-day pullbacks Table 3 summarizes price behavior for dif- Table 4 compares Table 3’s median ferent scenarios. It shows the average, price moves for the entire the analysis median, maximum, and minimum price period and the final 12 months of the changes from: review period (July 3, 2006 to June 30, 1. The initial closing price to the 2007) to: 1) the median moves after closing prices of the next five days two-day, -1.44 percent (or greater) (D1 to D5); declines, 2) two consecutive days of LL+LH+LC, and a combination of 1 2. The closing price to each following and 2. day’s highest high (largest up move, The 1.44-percent drop was chosen or “LUM”); because the median two-day LDM was 3. The closing price to each following -0.46 percent and the standard devia- day’s lowest low (largest down move, tion was 0.49 percent; therefore, a two- or “LDM”). day drop larger than -1.44 percent was exceptionally big (more than two stan- dard deviations). Also, the standard deviations (StD) for the close-to-close changes are Despite the EUR/USD’s long-term included. uptrend, you would have taken some heat if you bought pullbacks when the Figure A shows the close-to-close moves, LUMs, and LDMs from the market made two consecutive lower initial bar to the two subsequent bars. lows, lower highs, and lower closes: TABLE 4 — PULLBACK PATTERN To determine whether a certain type of pullback represented a trade opportunity, the EUR/USD’s median price action was compared to a pattern consisting of a two-day, -1.44-percent correction where both days had lower lows, lower highs, and lower closes. D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM Overall 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68% 7/3/2006-6/30/2007 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45% 2-day LL+LH+LC -0.03% 0.30% -0.35% -0.06% 0.47% -0.51% -0.03% 0.56% -0.63% 0.10% 0.69% -0.71% 0.18% 0.81% -0.77% (87 instances) 2-day drop -1.44% 0.02% 0.30% -0.45% 0.02% 0.49% -0.51% 0.17% 0.65% -0.65% 0.31% 0.77% -0.67% 0.15% 1.06% -0.74% (40 instances) Combination 0.02% 0.30% -0.44% 0.14% 0.47% -0.52% 0.11% 0.64% -0.63% 0.32% 0.74% -0.68% 0.21% 0.94% -0.74% (27 instances) 22 August 2007 • CURRENCY TRADER
  • 21. TRADING STRATEGIES continued However, the combination of two FIGURE 3 — PULLBACK COMPARISON consecutive LH+LL+LC days and a two-day, -1.44 percent decline was fol- A two-day drop with lower lows, lower highs, and lower closes was followed with three more sessions of lower median close-to-close changes. lowed by larger than average upside moves for days two through five. The largest median close-to-close change occurred after four sessions. Robust analysis Combining the analysis of “runs” — consecutive days of higher or lower highs, lows, and closes — with price moves of different sizes provides a dif- ferent way to conceptualize concepts such as market exhaustion than rely- ing on off-the-shelf indicators or gut feeling. Finally, as Table 3 illustrates, volatility has been declining, as the standard deviation for the five-day close-to-close changes This highlights the importance of updating your analysis on has fallen in each 12-month section of the review period. a regular basis. Related reading “New Zealand dollar trading numbers” “Euro/yen: Tips and tendencies” Currency Trader, June 2007. Currency Trader, December 2006. Detailed analysis of the “kiwi” dollar’s trading tendencies Euro/yen by the numbers: Stats and tendencies for short- and characteristics. term forex players. “Dollar-yen trading tendencies” “Breaking down the euro” Currency Trader, April 2007. Currency Trader, November 2006. The dollar-yen’s trading characteristics are examined on Studying the euro’s daily and intraday performance statistics daily and intraday time frames. offers guidelines for systematic and discretionary traders. “Deciphering the British pound” “The yen stands alone” by Howard L. Simons. Currency Trader, March 2007. Currency Trader, March 2006. The British pound has been a volatile — and mostly bullish The usual rules of the currency world don’t necessarily — currency in recent months. Find out how it trades from apply to the Japanese yen. Will that continue to be the day to day. case, or is Japan poised to revamp its economic model in a way that will dramatically alter the yen’s longstanding “Dollar-Canada by the numbers” dynamics? Note: This article is also part of the Currency Trader, January 2006. “Howard Simons: Advanced Currency Concepts, Vol. 1” As the only purely North American major currency pair, the article collection, which contains nine Currency Trader dollar-Canada rate occupies a unique position. We break articles by Howard Simons. down its short-term performance to reveal daily and intraday tendencies. You can purchase and download articles at 24 August 2007 • CURRENCY TRADER
  • 22. ADVANCED STRATEGIES Minor currencies and federal reserve trade weights The verdict is in: Currency rates don’t affect trade. BY HOWARD L. SIMONS L entire premise behind the floating exchange-rate regime of ast month’s article “Currencies and federal reserve the past 35 years is wrong. trade weights” (Currency Trader, July 2007), which examined major currencies’ impact on Federal As all currency traders learn quickly, major currencies have different trading patterns and represent different Reserve trade weights, concluded: “A review of U.S. trade underlying economies than minor currencies, which are patterns with major currency trading partners reveals little buffeted more by speculative capital flows even as their evidence that a weaker currency leads to greater export markets are shallower than the majors’. Will analysis of the competitiveness and a lower ability to import.” In short, the minors support the findings of the FIGURE 1 — THE CHINESE YUAN AND ITS WEIGHT IN U.S. TRADE study of the majors, or are Federal Reserve trade weights for the minor currencies more sensitive to changes in the currencies them- selves? Recap of data and methodology First, the analysis process used here is identical to that used last month: To maintain its trade-weighted dol- lar index (http://www.federalre-, the Federal Reserve must keep track of the changing use of various currencies the U.S. receives in return for its exports and pays for its imports. In these FIGURE 2 — THE TAIWAN DOLLAR AND ITS WEIGHT IN U.S. TRADE charts, export weights are depicted in blue and import weights in green. These weights are calculated on an annual basis and, of necessity, after the fact. Because the Federal Reserve is unable to license its dollar index for commercial purposes, many traders are unfamiliar with this data. Also, these currency weights reflect their use in bilateral trade with the U.S. and do not reflect total bilateral trade. This is critical for countries from whom the U.S. imports large quantities of goods priced in dollars, such as crude oil and various metals. Annual data are of little trading use 26 August 2007 • CURRENCY TRADER
  • 23. The entire premise FIGURE 3 — THE HONG KONG DOLLAR AND ITS WEIGHT IN U.S. TRADE behind the floating exchange-rate regime of the past 35 years is wrong. in a continuous market such as cur- rencies. We can create smoothed series of import and export weights via a sta- tistical technique called “cubic spline interpolation.” This technique is used twice in the charts below — once to FIGURE 4 — THE SINGAPORE DOLLAR AND ITS WEIGHT IN U.S. TRADE create quarterly series from the annu- al numbers and a second time to create monthly numbers from the quarterly results. The resulting interpolations are far easier to absorb than the annual num- bers, but as they involve two separate data transformations, we did not attempt any further statistical analy- sis against monthly currency values (presented in red in the charts). In addition, please be advised all curren- cies are displayed in the “USD per” convention familiar to traders of the euro, the British pound, and currency futures. The currency scale is inverted for currencies commonly expressed as FIGURE 5 — THE KOREAN WON AND ITS WEIGHT IN U.S. TRADE “per USD,” so a rising red line always conveys strength vs. the dollar and a falling red line always conveys weak- ness. A second passage from last month is mentioned here for clari- ty: Even though the principal advocate of floating exchange rates, the late Milton Friedman, was the antithesis of a protectionist, his arguments have been seized by this faction to the extent that the notion a weaker currency continued on p. 28 CURRENCY TRADER • August 2007 27
  • 24. ADVANCED STRATEGIES continued should stimulate exports and reduce FIGURE 6 — THE THAI BAHT AND ITS WEIGHT IN U.S. TRADE imports will be referred to as the “pro- tectionist argument.” East Asian currencies With all the political rhetoric call- ing for a stronger Chinese yuan, it is easy to lose sight of the fact that export weights to China rose steadily between 2000 and 2006. Moreover, as China’s wealth level grows, so should both the volume and the value-added content of its imports from the U.S. This so- called “marginal propensity to import” is characteristic of all growing economies. The surge in import weights FIGURE 7 — THE MALAYSIAN RINGGIT AND ITS WEIGHT IN U.S. TRADE from China is, of course, the dom- inant feature in Figure 1. No nation on earth has China’s cost advantages in labor, a state-con- trolled banking system with over $1 trillion in foreign exchange reserves, low levels of environ- mental and safety costs, and pro- ductivity advantages from new plants and equipment. Given these advantages, we do need to ask whether any level of the yuan (CNY) would have offset these formidable advantages; the bet- ting here is the yuan could be much stronger with no adverse FIGURE 8 — THE INDONESIAN RUPIAH AND ITS WEIGHT IN U.S. TRADE effects on Chinese exports. Taiwan’s importance as an exporter to the U.S. has been declining steadily since the mid- 1980s. In all likelihood, exports from Taiwan have been displaced by exports from China. The island’s share in U.S. export weights has tracked changes in the TWD to a degree (Figure 2). This indicates some measure of currency price elasticity in Taiwan’s import decisions. Hong Kong provides an inter- esting rebuttal to the protectionist argument. Although its currency has been locked in a tight range since the mid-1980s, its clude the uptrend in export weights between 1986 and 1996 import weights have fallen steadily since then (Figure 3). If meant the HKD was overvalued. the protectionist argument was correct, we would have to Neither is likely. As in the Taiwan example, the simplest conclude the Hong Kong dollar (HKD) was overvalued at explanation is the best. Hong Kong’s exports to the U.S. this lower range. Moreover, we also would have to con- have been displaced by exports from China. 28 August 2007 • CURRENCY TRADER
  • 25. We can draw the same conclusion by examining Asian crisis (Figure 8). The 1997 collapse of the rupiah (IDR) Singapore, which we will group with the East Asian rather preceded a decline — not the theorized increase — in than the South Asian countries by virtue of its largely import weights. The same cannot be said for export Chinese population. The 1997-2001 decline in the SGD did weights, however: Indonesia’s sudden impoverishment led nothing to arrest its falling import continued on p. 30 weights, and the 2002-2006 rally didn’t do anything to accelerate the FIGURE 9 — THE PHILIPPINE PESO AND ITS WEIGHT IN U.S. TRADE downtrend already in place (Figure 4). These simply reflect China’s ascendancy. Export weights to Singapore rose modestly in the mid-1990s “Asian Tiger” epoch, but have flattened since. The final East Asian currency is the Korean won (KRW, Figure 5). This currency was hugely affected by the 1997-1998 Asian crisis. Although import weights from Korea — which had been in decline since 1988 — reversed after the KRW’s plunge and declined after the KRW’s post-2004 rally, the real impact was the large drop in export FIGURE 10 — THE MEXICAN PESO AND ITS WEIGHT IN U.S. TRADE weights to Korea during the Asian crisis. This reflected both changes in the currency and the large drop in Korean national income during this period. South Asian currencies Speaking of the Asian crisis, let’s look at the currency that started it all, the Thai baht (THB). Prior to 1998, both the import and the export weights for the baht were trending higher (Figure 6). The cheaper baht did nothing to increase its import weights, and the loss of purchasing power in Thailand did surprisingly little to FIGURE 11 — THE BRAZILIAN REAL AND ITS WEIGHT IN U.S. TRADE reduce export weights to Thailand. Overall, Thailand’s contribution to U.S. trade is and has been fairly minor. The picture for Malaysia is simi- lar to that of Thailand (Figure 7). Both import weights from Malaysia and export weights to it grew rapidly between 1986 and 1996 — and were unaffected by the ringgit’s (MYR) sharp drop. Neither the MYR nor the course of the Malaysian economy affected its trade weights with the U.S. Indonesia also suffered in the CURRENCY TRADER • August 2007 29
  • 26. ADVANCED STRATEGIES continued after the PHP fell in 1997, but FIGURE 12 — THE ARGENTINE PESO AND ITS WEIGHT IN U.S. TRADE export weights to the suddenly poorer country actually trended higher between 1998 and 2003 before falling sharply in 2004. Latin American currencies Mexico is a special case on several levels. Its peso (MXN) has col- lapsed on three separate occasions without triggering the macroeco- nomic collapses normally associ- ated with such events. As a mem- ber of NAFTA, its trade with the U.S. on both the import and export sides has grown regardless FIGURE 13 — THE VENEZUELAN BOLIVAR AND ITS WEIGHT IN U.S. TRADE of the currency. Its major source of foreign exchange, crude oil exports, is priced in USD, and it has another major source of dol- lars, the remittances of Mexican nationals living and working in the U.S. And like Colombia, Mexico has large, undocumented sources of U.S. dollars. U.S. export weights to Mexico surged after NAFTA and have lev- eled off near a large 15 percent level (Figure 10). Import weights from Mexico have fallen as many of the light manufactured exports from Mexican maquiladora plants have been displaced by cheaper FIGURE 14 — THE CHILEAN PESO AND ITS WEIGHT IN U.S. TRADE goods from China. All of these fac- tors combine to make the MXN rate largely irrelevant as the U.S.’s fourth-largest trading partner. The Brazilian real (BRL) has a short history. It came into being in 1994 following the untimely demise of a long list of predeces- sors, but even so it has managed to collapse three times in 12 years. In defiance of the protectionists’ the- ories, the impact on import weights has been minimal (Figure 11). Export weights to Brazil have declined since 1997, a period in which economic growth in Brazil to a swift decline in export weights, one that has yet to has been strong. This may be a rare case when the currency recover. price elasticity of demand exceeds income elasticity of The last South Asian currency to be examined is the demand. Philippine peso (PHP), which is yet another refutation of Argentina, like Brazil, has gone through multiple curren- the protectionists (Figure 9). Its import weights fell sharply cies. These have included the peso ley, the austral, and a 30 August 2007 • CURRENCY TRADER
  • 27. direct peg to the USD. There is also the little matter of fre- India, Russia, Saudi Arabia, and Israel represent special quent defaults, nationalizations, and other non-currency cases and thus are discussed on a non-geographic basis. impediments to the free flow of goods and services. The growing importance of the U.S.-India bilateral eco- Import weights from Argentina scarcely have budged nomic relationship is not reflected well in the trade data; it since 1992 (Figure 12). Export continued on p. 32 weights to Argentina began to fall in 1999 as the country suffered FIGURE 15 — THE COLOMBIAN PESO AND ITS WEIGHT IN U.S. TRADE during its dollar-peg epoch, and then collapsed going into the 2002 debt default. They have rebound- ed somewhat with the peso (ARS); this is an income effect, not a cur- rency effect. Import weights from Venezuela have been quite low, as Venezuela’s chief export to the U.S., crude oil, is priced in USD (Figure 13). Export weights have fallen as the bolivar has weakened during the Chavez era; it’s diffi- cult to discern whether this is cur- rency-related, income-related, or political. FIGURE 16 — THE INDIAN RUPEE AND ITS WEIGHT IN U.S. TRADE Chile enjoys so much a reputa- tion as South America’s success story that first-time observers have trouble absorbing the extent of the peso’s (CLP) decline since 1988. Export weights to Chile rose between 1988 and 1996 even as the CLP fell, and then fell into 2003 as the CLP fell (Figure 14). Factors other than currency move- ments likely were involved. In addition, the weights of imports from Chile have increased even as the CLP rose after 2003. Chile’s efficiencies in agricultural exports — its leading export, copper, is priced in USD FIGURE 17 — THE RUSSIAN RUBLE AND ITS WEIGHT IN U.S. TRADE — probably account for this. Export weights to Colombia have tracked movements in the peso (COP) in a manner consis- tent with standard theory (Figure 15). Import weights from Colombia have increased since 2002 even in the face of a firmer COP. The U.S.-Colombia trade picture is so distorted by undocu- mented flows that further com- ments will be withheld. Other currencies The final group of currencies for CURRENCY TRADER • August 2007 31
  • 28. ADVANCED STRATEGIES continued FIGURE 18 — THE ISRAELI SHEKEL AND ITS WEIGHT IN U.S. TRADE tion of the Indian economy far more than the decline in the rupee (INR, Figure 16). Export weights to India have jumped since 2001 even as the rupee has remained near its lows. Export weights to Russia fell during the country’s 1998 default and have rebounded since the ruble’s (RUB) modest recovery (Figure 17). Bilateral trade between the U.S. and Russia is very small and is confined to specialty goods and minerals. The increasing import weights from Israel during the shekel’s FIGURE 19 — THE SAUDI RIYAL AND ITS WEIGHT IN U.S. TRADE (ILS) 1982-2002 decline are as expected in classic theory (Figure 18). The generally increasing export weights to Israel during this same period are antithetical to classic theory. Too much U.S.- Israel trade is dollar-denominated or is confined to sectors such as technology and military hardware for currency movements to be a real factor. Finally, we come to a special case — Saudi Arabia. The riyal (SAR) is de facto fixed — note the range — and import weights skirt near zero (Figure 19). Their princi- is increasingly a “post-industrial” relationship. Included pal export is priced in USD. Export weights to Saudi are skilled labor imported from India and information Arabia have declined somewhat over the years, but given services outsourced to India. the importance of military hardware and other sensitive Import weights have been increasing steadily since the exports to Saudi Arabia, this data stream probably does late 1980s, which in all likelihood reflects the moderniza- not reveal much. Can’t fight the data Related reading We have reviewed 26 currencies with as many as 34 years of trade data accounting for 100 percent of the Federal “Currencies and Federal Reserve trade weights” Reserve’s trade-weighting scheme. Currency Trader, July 2007. We found some isolated instances wherein export The theory that a weaker dollar makes U.S. goods and weights to countries whose currencies had appreciated services more competitive abroad sounds nice, but the facts rose and some isolated instances wherein import weights argue otherwise. from countries whose currencies had depreciated rose. These were noted duly. “Howard Simons: Advanced Currency Concepts, Vol. 1” The preponderance of evidence, however, is income A discounted collection that includes many of the articles elasticities, trade agreements, economic integration, and listed here. the terms in which goods and services are priced, among other factors, are all more important than currencies in You can purchase and download past articles at affecting trade flows. For information on the author see p. 6. 32 August 2007 • CURRENCY TRADER
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  • 30. TRADING BASICS Long-term interest rates and the U.S. dollar Rising long-term Treasury yield should imply a higher dollar — at some point — but history shows many other factors can get in the way of that easy assumption. BY DAVID MANTELL FIGURE 1 — CHANGING YIELD CURVE Comparing the yield curve on July 2 and March 5 shows the curve has regained its “normal” shape — upward sloping, with long-term interest rates higher than short-term rates. F ollowing the direction of short-term interest rates is a vital part of determining the likely direction of a particular currency or currency pair. But what can long-term interest rates tell us about the future price behavior of currencies? Rising long-term interest rates have been very much in the news lately. On June 13, the yield on the 10-year T-note climbed to a five-year high of 5.327 percent. The 4.50-per- cent note finished June at a yield of 5.03 percent — 54 basis points higher than its March 7 low of 4.49 percent. (For a review of T-notes and their terminology, see “Treasury backgrounder.”) Normally, the yield curve — which depicts the difference between short-term and long-term Treasury yields — rises, reflecting the higher yields usually associated with longer Supported by a strong May retail sales report (the best Treasury maturities (Figure 1). When short-term yields are showing in more than a year), traders have become less higher than long-term yields, as has recently been the case, convinced the Federal Reserve will cut short-term interest the curve is referred to as “inverted” — a condition that has rates. At least one interpretation, then, of the rise in long- One interpretation is the rise in long-term rates portends improvement in the prospects for economic growth; another is that improved economic growth could be accompanied by higher inflation. historically been interpreted as a warning sign that a reces- term rates is that it portends improvement in the prospects sion is looming. With the recent increase in long-term rates, for economic growth (see “Doom, gloom, and long-term however, the yield curve has returned to its normal shape. interest rates,” Active Trader, September 2007). What’s behind the jump in long-term interest rates? Another interpretation is that improved economic 34 August 2007 • CURRENCY TRADER
  • 31. FIGURE 2 — DOLLAR WEAK VS. EURO Despite the recent long-term rate increase, the dollar has remained weak vs. most major currencies — reflected in the new highs reached by the euro/dollar pair. growth could be accompanied by higher infla- tion. However, recent price data suggests infla- tion remains mild and appears to be under control. The personal consumption expendi- tures index (excluding food and energy), a key inflation measure, increased 1.9 percent in May vs. the same period last year. This is the small- est year-over-year increase since March 2004. The currency connection What are the ramifications for the U.S. dollar? If higher long-term rates are indicative of an improving U.S. economy, that would be bullish for the greenback. If there is an inflation com- ponent to stronger economic growth, and if higher long-term rates are indicative of that, Source: TradeStation the Fed will be more likely to raise short-term rates. That, too, would be positive for the U.S. Treasury backgrounder dollar, causing investors searching for high short-term yields to put their cash in the U.S. Treasury notes and bonds are debt securities issued by the United Overall, higher long-term rates are fairly States Treasury. They are considered debt instruments because by promising for the U.S. dollar. Thus far, howev- purchasing them you are loaning money to the Treasury depart- er, this has not been reflected in the dollar’s ment, which then pays you interest (determined by a “coupon rate”) action against most major currencies, includ- on a semiannual basis and returns the principal when the bond or note matures on the maturity date. T-bonds and T-notes are also ing the euro (Figure 2). called “fixed-income” securities because of the fixed coupon pay- ment an investor receives while holding the bond or note. What does the past tell us? T-notes are issued in maturities of two, three, five, and 10 years; The U.S. economy experienced a similar sce- T-bonds have maturities greater than 10 years (e.g., the 30-year T- nario in April of 2006. On Jan. 23, 2006, the 10- bond). The minimum bond or note size is $1,000. For example, if year T-note yielded 4.36 percent — one basis you purchased a $1,000 10-year T-note with a 4-percent coupon point lower than its yield on the first day of (the “4-percent note”), you would receive $20 every six months, 2006. By April 26 (roughly the same time peri- totaling $40 per year; the $1,000 would be paid back to you on the od as our current scenario), its yield had maturity date 10 years from now. A bond or note’s yield is its climbed 76 basis points to 5.12 percent, and it coupon payment divided by the price — in this case, $40/$1,000 = remained at or above 5 percent through July 4 percent. 28. Strong new home sales and robust orders Treasury futures prices indicate a percentage of “par” price, which for any Treasury bond or note is 100. T-bond prices consist for durable goods helped propel long-term of the “handle” (e.g., 100) and 32nds of 100. For example, 98-14 is interest rates higher. a price that translates to 98-14/32nds or $984.38 for a $1,000 How did the dollar perform vs. the Euro T-bond. T-notes are priced in a similar fashion, except they can during this time period? On Jan. 23, the include one-half of a 32nd — for example, 98-14+ is 98- euro/dollar (EUR/USD) rallied strongly to 14.5/32nds, or 984.53 for a $1,000 T-note. continued on p. 36 CURRENCY TRADER • August 2007 35
  • 32. TRADING BASICS continued FIGURE 3 — 2006 SCENARIO Related reading After a jump in long term rates last year, the dollar also weakened vs. the euro — and for the most part has continued to do so since. “The obscure key to successful FX trading” Currency Trader, November 2004. Watch what the pros watch: Explore the relationship between currencies, bond yields, and interest rates. Note: This article is also part of the discounted article set “Barbara Rockefeller ‘Big Picture’ collection, Vol. 1: 2004-2005.” “Interest rate shuffle” Currency Trader, February 2006. Interest rates are a key forex market catalyst, and from the U.S. to Japan, some central banks are poised to adjust their interest rate policies. Note: This article is also part of the Kathy Lien currency collection. Source: TradeStation “Trading a steeper yield curve” Active Trader, July 2006. close at 1.2303 (Figure 3). By April 26 it One possible explanation for the rela- With the Fed giving signals the end had rallied to 1.2453 — meaning, the tive strength in the euro vs. the dollar of the rate-hike cycle is near, we dollar had weakened vs. the euro. The is that traders were expecting the gap explore two techniques — one well- EUR/USD pair continued to rally into between short-term interest rates in known, the other more obscure — May before pausing and eventually Europe and the U.S. to narrow. to trade a widening spread between short-term and long-term interest reaching a high of 1.2979 in early June In theory and generally speaking, rates. 2006. the dollar should strengthen when Arguably, the improving health of long-term rates are rising. But as “Treasury bonds and notes” the U.S. economy should have been shown here, other factors may out- Active Trader, June 2005. reflected in a strengthening dollar. As weigh or completely override any pos- T-bonds and T-notes are used as a it turned out, U.S. economic activity sible lift the dollar might expect to see source of income for investors and was so robust the Federal Reserve from rising long-term rates. as a trading vehicle by speculators. raised the federal funds rate at both its Nonetheless, although short-term Here’s an overview of the Treasury May 2006 (to 5.00 percent) and June interest rates are usually the focus of market, from the cash market to 2006 meetings (to 5.25 percent, where currency analysis, long-term interest bond ETFs and futures. it currently stands). rates bear watching, especially in At the same time, though, the regard to fundamental economic con- You can purchase and download past Eurozone economy was quickly gain- cerns that drive the big-picture action articles at ing steam and the European Central in the forex market. purchase_articles.htm. Bank (ECB) had embarked on a cam- paign to raise short-term interest rates. For information on the author see p. 6. 36 August 2007 • CURRENCY TRADER
  • 33. SPOT CHECK Spot check: U.S. dollar index As dollar-denominated currency FIGURE 1 — CONSPICUOUS LOW pairs continue to set new records, After penetrating the December 2004 low, the dollar index fell 0.03 below the the dollar index is testing long-term April 1995 low of 80.05 on July 24. support levels. Some indicators point down, but there are mixed signals further out. BY CURRENCY TRADER STAFF T he long-battered dollar found lit- tle respite in July, falling to a new all-time low vs. the euro (EUR) and setting multi-decade lows against the Canadian dollar (CAD), British pound (GBP), Australian dollar (AUD), and New Zealand dollar (NZD). Source: TradeStation The last time things looked this grim for the buck was in December 2004, when the U.S. dollar index (DXY) fell to 80.39 (Figure FIGURE 2 — WEEKLY RUN 1). At the time, pundits predicted apocalypse As of the week ending July 20, the dollar index had fallen more than for the currency, citing the deficit(s), the Iraq 3 percent from the high five weeks earlier and had established a new War, and growing reserve diversification, a seven-week low. among other factors, but were quickly silenced by a year-long rally that, while hard- ly reversing the dollar’s overwhelming long- term downtrend, sent dollar bears into hiber- nation for a while. Here we are again. As of mid- to late-July, the dollar index had just penetrated the December 2004 low, with the next milestone — the April 1995 low of 80.0 — in its sights. After that, the index’s next target is its all time low, 78.33, established in 1992. Is the dollar going to pull off another head fake, a la 2005, or is downside follow-through more probable this time? Rather than dwell on the possible effects of economic intangibles such as the collapse of the sub-prime lending market, let’s look at what the price action in the U.S. dollar index Source: TradeStation portends for the future. 38 August 2007 • CURRENCY TRADER
  • 34. TABLE 1 — DXY AFTER SEVEN-WEEK NEW LOW AND 5-WEEK, 3% DROP The dollar index tended to fall, but not dramatically, in the first six weeks after the kind of week that ended July 20. However, performance was more mixed in weeks seven and eight (not shown). Monthly data Week: +1 LUM LDM +2 LUM LDM +3 LUM LDM As of July 20, the dollar index Avg -0.14 0.85 -0.92 -0.38 1.12 -1.36 -0.42 1.32 -1.73 had established a new two- Med -0.23 0.78 -0.73 -0.45 0.93 -1.06 -0.52 1.03 -1.39 year (24-month) low and a Max 2.76 2.94 0.00 2.93 3.77 0.00 4.17 4.95 0.00 monthly low that was at least Min -2.57 0.00 -4.80 -4.67 0.00 -5.81 -4.90 0.00 -6.07 one percent below the previ- StD 1.17 0.67 0.83 1.59 0.93 1.17 1.97 1.09 1.43 ous month’s low. The price %<0 57.95% 61.36% 55.68% action after the 20 other times this has happened since 1990 Week: +4 LUM LDM +5 LUM LDM +6 LUM LDM (April 2004 being the most Avg -0.48 1.51 -2.04 -0.40 1.70 -2.27 -0.29 1.85 -2.43 recent occurrence) is a mixed Med -0.50 1.31 -1.64 -0.40 1.56 -1.93 -0.33 1.66 -2.03 bag: For the first four months Max 3.71 4.95 0.00 4.18 5.23 0.00 4.32 5.23 0.00 after establishing these lows, the average month-to-month Min -5.73 0.00 -6.41 -6.71 0.00 -7.63 -6.94 0.00 -7.63 closing price moves were posi- StD 2.20 1.20 1.63 2.48 1.31 1.86 2.66 1.40 1.98 tive but the median moves %<0 61.36% 59.09% 55.68% were negative, which suggests a smaller number of large TABLE 2 — FOUR-WEEK RUNS OF LOWER HIGHS, gains skewed the average higher. LOWER LOWS, LOWER CLOSES In fact, several of these 24-month lows — especially Four-week runs of lower highs, lows, and closes in the dollar when two occur back-to-back — have preceded sharp index were followed by continued selling, most noticeably in upturns, one of the most notable being the 2005 rally after weeks 1-6. The index did, in fact, close lower the week consecutive 24-month lows with one-percent low-to-low ending July 20, keeping the pattern’s perfect week-1 record declines in November and December 2004. of lower closes intact. After a simple new 24-month low, the dollar index’s tra- Week: +1 +2 +3 +4 jectory was mixed for the first three months but more con- Avg -0.96 -1.26 -1.32 -1.46 sistently upward from months five through eight. Med -0.71 -0.98 -1.54 -1.12 Weekly analysis Max -0.11 0.77 0.63 1.72 Analyzing the pattern on the weekly level paints a more Min -2.57 -4.67 -3.10 -4.90 bearish picture for the intermediate-term action in the dol- StD 0.73 1.32 1.20 1.65 lar index. As of the week ending July 20, the index had %<0 100.00% 80.00% 80.00% 85.00% fallen more than 3 percent from the high five weeks earli- er (Figure 2) and had made a seven-week low, a price Week: +5 +6 +7 +8 move that has happened 88 times since 1990. Avg -1.25 -1.01 -0.99 -0.95 Table 1 summarizes what happened after these weeks. Med -1.04 -1.51 -1.53 -0.92 The table shows the average, median, maximum, mini- Max 2.64 2.71 3.73 1.81 mum, and standard deviation of the price moves from the Min -6.71 -4.17 -4.08 -3.27 close of the pattern week to the closes, highs, and lows of StD 1.84 1.62 1.97 1.78 the next six weeks. The “+1,” “+2,” etc., columns contain the moves from the close of the pattern week to the closes %<0 85.00% 75.00% 55.00% 65.00% of the next six weeks; the LUM (largest up move) columns show the changes from the close of the pattern week to the highest highs of the subsequent weeks; and the LDM (largest down move) columns show the changes from the close of the pattern week to the lowest lows of the subsequent weeks. The “%<0” row continued on p. 40 CURRENCY TRADER • August 2007 39
  • 35. SPOT CHECK continued shows the percentage of the close-to-close changes that 4 below the pattern week’s close 61.36 percent of the time. were negative for each week. Although these numbers point downward, the standard For example, Table 1 shows the median move from the deviations show there is a great deal of variability, especial- pattern week’s close to the week 4 close was -0.50, while the ly in regard to the closing moves at each interval. Also, the median LUM was 1.31 and the median LDM was -1.64 bearish edge declined in weeks 7 and 8 (not shown), both of (highlighted in blue). Finally, the dollar index closed week which had mixed results — neither bearish nor bullish. Table 2 shows the results of a different test of FIGURE 3 — DAILY PERSPECTIVE weekly data — the performance after four con- Near-term action on the daily chart also pointed lower. The low of the secutive weeks of lower weekly highs, lows, and July 18 outside bar (third-to-last bar) was the lowest low of the past 30 closes. This time the statistics are shown only for bars and was more than 0.025 percent below the previous low. The final the closes eight weeks after the pattern. There bar (July 20) was another outside day that fulfilled the pattern criteria. were only 21 previous examples of such runs (dating back to 1998), but the subsequent price action was fairly consistently downward for the next eight weeks, although less so in weeks 7 and 8 (reminiscent of the previous study). Also, week 1 closed lower in every instance. Short-term analysis Research on the daily time frame resulted in looking at a pattern centered on the July 18 out- side bar (higher high and lower low than pre- ceding bar). This day, which is the third-to-last bar in Figure 3, was also the lowest low of the past 30 bars and was more than 0.025 percent below the previous low. Table 3 shows the dollar index’s performance in the first 10 days after 20 examples of this pat- tern dating back to 2000. The percentages associ- ated with lower closes and larger LUMs than Source: TradeStation LDMs is evident. (This analysis was the reason behind a trade detailed in the Forex Trade TABLE 3 — DOLLAR INDEX AFTER OUTSIDE DAY, 30-DAY LOW The dollar index continued to decline after outside bars that were also 30-day lows that were 0.025 percent below the previous low. These statistics led to a trade in the dollar index futures. Day: +1 LUM LDM +2 LUM LDM +3 LUM LDM +4 LUM LDM +5 LUM LDM Avg -0.28 0.21 -0.49 -0.28 0.33 -0.67 -0.44 0.36 -0.84 -0.42 0.38 -0.93 -0.53 0.39 -1.06 Med -0.13 0.18 -0.24 -0.23 0.27 -0.59 -0.35 0.27 -0.71 -0.30 0.27 -0.81 -0.39 0.29 -0.96 Max 0.28 0.90 -0.04 1.36 1.53 -0.04 1.14 1.73 -0.18 0.58 1.73 -0.21 1.37 1.73 -0.29 Min -1.51 0.00 -1.85 -1.96 0.00 -2.10 -1.71 0.00 -2.13 -2.82 0.00 -2.97 -2.68 0.00 -3.19 StD 0.46 0.20 0.47 0.70 0.35 0.53 0.66 0.39 0.56 0.74 0.41 0.69 0.81 0.40 0.72 %<0 75% 60% 80% 70% 80% Day: +6 LUM LDM +7 LUM LDM +8 LUM LDM +9 LUM LDM +10 LUM LDM Avg -0.65 0.42 -1.18 -0.79 0.45 -1.29 -0.73 0.46 -1.39 -0.58 0.55 -1.48 -0.69 1.11 -1.65 Med -0.77 0.29 -1.15 -1.01 0.31 -1.30 -0.67 0.31 -1.30 -0.56 0.34 -1.53 -0.97 0.96 -1.53 Max 1.80 2.11 -0.29 1.43 2.14 -0.29 1.64 2.14 -0.29 2.95 3.18 -0.29 3.15 3.96 -0.65 Min -2.97 0.00 -3.19 -2.91 0.00 -3.28 -2.80 0.00 -3.28 -3.59 0.00 -3.72 -3.82 0.23 -4.57 StD 0.96 0.49 0.72 0.84 0.51 0.73 0.90 0.50 0.70 1.31 0.70 0.75 1.45 0.93 0.86 %<0 80% 89% 89% 74% 74% 40 August 2007 • CURRENCY TRADER
  • 36. Journal on p. 52.) FIGURE 4 — SHORT-TERM PATTERN VS. TYPICAL PERFORMANCE Figure 4 compares the median closing The post-pattern down moves were all significantly larger (anywhere from 10 changes from days 3 to 10 in Table 2 to to 50 times) than the dollar index's typical behavior during this period. the dollar index’s median behavior (“benchmark”) over the entire analysis period (i.e., the median of all one-day closing changes, all two-day closing changes, etc.). The post-pattern down moves were all significantly larger (any- where from 10 to 50 times) than the dol- lar index’s “random” behavior during this period — see the line representing the ratio of the pattern to the benchmark. Also, notice July 20 — the final bar in Figure 3 — was another outside day that fulfilled the pattern criteria. The unquantifiable issues Logical arguments can be made why the dollar should rise or fall in the coming weeks or months, but these arguments are difficult to substantiate with data. The Federal Reserve kept its short-term interest rate unchanged (for the eighth consecutive time) at its most recent meeting in late June. Barring any unforeseen economic or market developments, the odds right now are that it will do the same at its August and September meetings. As the dollar index hovers near key levels, one thing different from 2004 is the markets’ more sub- dued reaction to a significantly weaker dollar. And, as the dollar faked out the financial world by rallying when sentiment was extremely negative at the outset of 2005, one must wonder if the lower level of concern today is a sign of more downside potential for the buck. There are certainly indicators galore signaling the dollar is dramatically “oversold,” but such indicators have been saying the same thing for months. Nonetheless, such an obvious support level is likely to inspire greater market volatility. There are many traders who have bought around this level expecting the dollar to rebound, and just as many ready to pile on if the buck drops through support. This analysis was intentionally conducted a cou- ple of weeks (July 18-20) before publication to give readers the ability to compare its implications to how the market has actually behaved since the research was concluded. The numbers here can serve as guideposts, so traders can see if the mar- ket is behaving as its past behavior suggests it should. CURRENCY TRADER • August 2007 41
  • 37. INDUSTRY NEWS INDUSTRY NEWS A capital idea New NFA proposal could cause significant shakeup among forex brokerages ew rule changes proposed by the National Futures The NFA estimates the new rules, combined with existing N Association (NFA) could have a significant effect on several brokerages that trade foreign exchange. The NFA wants to raise capital requirements for all regis- rules, will force firms to have at least $10 million in adjusted net capital to remain in business. According to data obtained from the CFTC, the new rules tered Forex Dealer Members (FDM) to $5 million, plus it would leave only six forex brokerages: FXCM, GFT Forex, wants improved accounting standards. The NFA is hoping Oanda, FXSolutions, Gain Capital, and CMS. the increased standards will prevent the ongoing problem of forex brokerages going bankrupt and/or committing fraud. NFA’s concerns The proposal could potentially wipe out 90 percent of The NFA listed four specific reasons for the rule change. existing forex brokerages, although it’s likely major consoli- First, trading spot forex, which FDMs do, creates more risk dation would occur if the rule passes. Forex brokerage FXCM than trading futures and options listed on an exchange. has been the most vocal supporter of the rule, although they Second, since spot forex is not a priority under the NFA’s have received support from some other big firms. Bankruptcy Code, it’s particularly important for FDMs to Naturally, there is opposition from the less-capitalized have adequate capital. firms. In a comment letter to the NFA, Knight Capital Group, Plus, two of the three bankruptcy proceedings in which which owns Hotspot FX, agreed that greater oversight is the NFA has taken part in the past four years have involved needed but doesn’t think a “one-size-fits-all” solution will smaller FDMs, and with the cumulative amount of retail work. funds under account surpassing $1 billion, the NFA is con- “Certain FDMs, like Hotspot, do not operate their business cerned that an FDM might be unable to meet its financial like a traditional dealer. They automatically offset (real-time) obligations to its customers. all client trades with bank market makers or client sub- Earlier in the year, Concorde Forex Group (CFG Trader) scribers. was shut down by the NFA and forced to liquidate all open As such, Hotspot effectively operates on a ‘riskless princi- positions because it was undercapitalized. CFG Trader cus- pal’ basis on behalf of its clients, thereby reducing dramati- tomers collectively lost about $1 million, and the NFA says cally any associated risk with that transaction and its clients’ this incident was a catalyst for the new rule, particularly the funds,” Knight said in the letter. new accounting requirements. “Thus, since Hotspot and other FDMs similarly situated When CFG’s books were examined after its trading was do not directly offset client trades, they are not subject to the suspended, it was discovered the firm’s assets were held in same market volatility and risk as are FDMs that take the multiple accounts, company and customer funds were com- other side of client trades and put their client accounts mingled, CFG had no anti-money laundering program and (deposits) at risk.” no internal compliance staff, and it had never been audited. Since 2000, the NFA has authorized Forex Dealing licenses As a result, firms that meet the new capital requirements to more than 50 firms. However, many of these firms went will also have to file an internal control report prepared by an out of business because they were undercapitalized, and independent auditor, and the NFA would have limited abili- fraud continues to be a problem in the forex brokerage arena. ty to request certification of an FDM’s finances. Also, each As of July 2007, there were 43 licensed FDMs operating. FDM would have to designate an individual to oversee the According to the NFA, 30 have adjusted net capital of less firm’s finances, and that person would be subject to disci- than $5 million, and only four of those 30 have more than $3 pline if accounting and capitalization rules are not million. The average adjusted net capital of those 30 firms is followed. less than $1.5 million. Spot on USFE to list forex futures he United States Futures Exchange (USFE) will begin The contracts are retail-sized, with a tick worth $5 for the T offering spot equivalent futures (SEF) on Sept. 21. The contracts will trade 23 hours per day. The USFE will begin with six contracts — U.S. dollar/euro, three U.S.-dollar based contracts, 500 yen for the JPY/USD contract, and five Swiss franc and five Canadian dollars for the CHF/USD and CAD/USD contracts, respectively. U.S. dollar/British pound, U.S. dollar/Australian dollar, SEFs are structured to automatically allocate the cost-of- Japanese yen/U.S. dollar, Swiss franc/U.S. dollar, and carry associated with holding a spot forex position open Canadian dollar/U.S. dollar. overnight, making them identical to a spot position. 42 August 2007 • CURRENCY TRADER
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  • 39. CURRENCY FUTURES Managed money: Barclay Trading Group’s currency trader rankings for June 2007 Top 10 currency traders managing more than $10 million as of June 30, ranked by June 2007 return Light at end of tunnel 2007 Rank Trading June YTD $ Under for currency traders? (millions) advisor return return mgmt. 1. Stark Quant. Inv. (Currency Fund) 8.26 18.7 57.1M Currency traders are taking baby steps toward prof- 2. Wooster Asset Mgmt (Portage Fund) 6.80 22.58 79.3M itability, as the Barclay’s Currency Traders Index (CTI) 3. Stonebrook Structured Products (FXC) 5.82 11.10 25.1M crept up 0.52 percent in July, bringing its 2007 gain to 4. Appleton Cap'l (Appleton 25% Risk) 5.40 10.04 199.3M 0.9 percent. 5. ABN AMRO Asset Mgmt (Curr USD) 5.01 8.25 152.4M That may not send investors in the 114 managed 6. FX Concepts (DMC) 4.57 4.51 7600.0M money programs (currency futures and spot forex) 7. DKR Capital (DKR Strat. Currency) 4.40 4.13 40.0M that comprise the index racing for a withdrawal slip, 8. Grossman Asset Mgmt (IPS Currency) 3.54 5.49 1110.0M but it does represent the highest level of profit the CTI 9. Harmonic Capital (Gl. Currency) 3.33 19.17 N/A has enjoyed this year. 10. Sunrise Cap'l Partners (Currency Fund) 3.15 9.77 125.9 The CTI still lags behind seven of the six other Top 10 currency traders managing less than $10 million and more than $1 million indices comprised by Barclay’s. The CTA index, as of June 30, ranked by June 2007 return Barclay’s catch-all index, is up 2.2 percent through 1. Metro Forex Inc (Tri Gl FX) 5.07 18.54 4.0M July. 2. High Desert Currency Mgmt 3.57 22.99 2.7M The CTI is trying to avoid its third straight losing 3. Spectrum Asset Mgmt LLC (Currency) 2.71 3.60 6.0M year, which would be a first in the 20-year history of 4. MIGFX Inc (Retail) 2.70 20.56 5.1M the index. 5. Marek D. Chelkowski (Forex) 2.50 17.82 1.0M The Barclay BTOP FX Index, which tracks the 6. UMJ Tekniko Fund 2.20 -8.52 7.6M largest investable currency trading programs and 7. FEM Currency Portfolio Ltd 2.20 -2.29 2.3M accounts for at least half of the investable assets of all 8. SSgA Absolute Return Currency Fund 1.91 4.65 9.2M programs tracked by Barclay, gained 0.2 percent in 9. EMC Capital Mgmt (Currency) 0.70 0.91 2.1M July and is up 3.3 percent for the year. 10. Capricorn Advisory Mgmt (fxMT Growth) 0.62 7.72 5.2M The index, which has been calculated since the beginning of 2005, made an all-time high of 1,053.60 Source: The Barclay Group ( on July 23. It fell in the final week of the month, clos- Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. ing July at 1.040.79. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. CURRENCY FUTURES SNAPSHOT The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s as of July 26 liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. Contract Pit Elec Exch Vol OI 10-day % 20-day % 60-day % Volatility sym sym move rank move rank move rank ratio /% rank Eurocurrency EC 6E CME 155.6 199.8 -0.36% 0% 2.08% 65% 0.86% 17% .22 / 55% Japanese yen JY 6J CME 120.7 288.0 3.04% 100% 2.81% 100% 1.01% 56% .48 / 100% British pound BP 6B CME 83.3 151.1 0.95% 20% 2.61% 67% 2.43% 78% .30 / 30% Swiss franc SF 6S CME 66.4 105.8 -0.12% 0% 1.79% 65% 0.79% 41% .37 / 58% Canadian dollar CD 6C CME 49.3 141.0 -0.84% 100% 1.42% 22% 5.18% 30% .13 / 32% Australian dollar AD 6A CME 38.0 113.1 0.61% 0% 4.22% 94% 5.06% 60% 21 / 58% Mexican peso MP 6M CME 19.5 76.2 -2.16% 100% -1.39% 90% -0.66% 40% .60 / 90% New Zealand dollar NE 6N CME 3.6 41.7 -0.04% 100% 3.38% 53% 5.41% 47% .28 / 73% U.S. dollar index DX NYBOT 3.6 30.2 -0.19% 5% -2.19% 65% -1.58% 52% .17 / 38% Euro / Japanese yen EJ NYBOT 1.2 28.7 -3.21% 100% -1.21% 100% -0.20% 38% .42 / 97% Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts. LEGEND: past sixty 20-day moves; for the 60-day move, the % rank field shows how the most recent 60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100% Sym: Ticker symbol. means the current reading is larger than all the past readings, while a reading of 0% means Vol: 30-day average daily volume, in thousands. the current reading is lower than the previous readings. OI: 30-day open interest, in thousands. Volatility ratio /% rank: The ratio is the short-term volatility (10-day standard deviation of 10-day move: The percentage price move from the close 10 days ago to today’s close. prices) divided by the long-term volatility (100-day standard deviation of prices). The % 20-day move: The percentage price move from the close 20 days ago to today’s close. rank is the percentile rank of the volatility ratio over the past 60 days. 60-day move: The percentage price move from the close 60 days ago to today’s close. This information is for educational purposes only. Currency Trader provides this data The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the in good faith, but assumes no responsibility for the use of this information. Currency percentile rank of the most recent move to a certain number of the previous moves of the Trader does not recommend buying or selling any market, nor does it solicit orders to same size and in the same direction. For example, the % rank for 10-day move shows buy or sell any market. There is a high level of risk in trading, especially for traders how the most recent 10-day move compares to the past twenty 10-day moves; for the 20- who use leverage. The reader assumes all responsibility for his or her actions in the day move, the % rank field shows how the most recent 20-day move compares to the market. 44 August 2007 • CURRENCY TRADER
  • 40. GLOBAL NEWS BRIEFS Interest Rates EUROPE The Bank of England raised its bank rate in July by 0.25 percent to 5.75 percent, continuing a cycle of Germany’s June jobless rate fell 0.3 percent from the increases that began in August 2006 when the rate previous month to 8.8 percent, a drop of 1.7 percent from was raised to 4.75 percent. A booming UK economy June 2006. has caused the BOE to keep raising rates. The UK’s unemployment rate for March to May fell The Bank of Canada increased its overnight fund- 0.1 percent from the previous three-month period to 5.4 ing rate in July 0.25 percent to 4.5 percent, ending a percent. The rate was unchanged from the same three- long period of rate neutrality. The last rate hike for the month period in 2006. Great White North came in May 2006, when rates increased to a multi-year high of 4.75 percent. The Central Bank of Brazil dropped its selic rate 0.50 percent in July to an all-time low of 11.5 percent. The cut is the 17th since September 2005, when the ASIA & AUSTRALIA Selic was 19.75 percent. Australia’s June unemployment rate grew 0.1 percent The Central Bank of Chile raised its discount rate to 4.3 percent compared to the previous month, a drop of 0.25 percent in July to 5.25 percent. The rate hike 0.5 percent compared to the same month in 2006. comes after Chile dropped rates 0.25 percent in January for the first time in five years. Preliminary data shows that Hong Kong’s jobless rate for the second quarter dropped 0.1 percent from the pre- The Bank of Israel increased its short-term lend- vious quarter to 4.2 percent, the lowest rate in nine years. ing rate in July, ending a long period of loosening The rate was 0.5-percent lower than the second quarter of rates with a 0.25-percent hike to 3.75 percent. It was 2007. According to a government press release, “In the the first rate increase in a year after seven straight next few months, the entry of fresh graduates and school decreases. leavers will continue to affect the labor force and unem- ployment figures. The near-term outlook of the labor The People’s Bank of China increased its one- market will depend on whether the pace of job creation year yuan lending rate 0.27 percent to 6.84 percent in the economy is sufficient to absorb the newcomers.” in July. Singapore’s Q1 unemployment rate rose 0.3 percent The Bank of Indonesia dropped its reference rate from the previous quarter to 2.9 percent and also gained again in July 25 basis points to 8.25 percent. The rate 0.3 percent from the first quarter a year ago. cut was the third in as many months, the 12th in 13 months, and the 13th since April 2006 when the rate stood at 12.75 percent. The Bank of Korea raised its overnight call rate 25 AMERICAS basis points in July 4.75 percent. The hike was the first in a year but is the sixth increase since the end of Brazil’s Q1 2007 GDP increased 0.8 percent year-over- 2004. year as the services sector produced a 1.7-percent increase in its GDP contribution. The Central Bank of the Philippines dropped its overnight borrowing rate significantly, cutting the Canada’s Q1 2007 unemployment rate remained rate 1.5 percent to 6 percent in July. The Philippines unchanged at 6.1 percent from the previous quarter and had not dropped rates in more than five years. the same quarter a year earlier. “Employment growth resumed in June, up an estimated 35,000, following little The Bank of Thailand dropped its 1-day (repo) rate change in April and May,” Statistics Canada said in a 0.25 percent to 3.25 percent in July, its fifth rate cut in press release. ”Despite this gain, the national unemploy- 2007. The cuts follow more than four years of steady ment rate remained at 6.1 percent for the fifth consecu- increases. tive month, as more people entered the labor force in June in search of work.” CURRENCY TRADER August 2007 45
  • 41. INTERNATIONAL MARKET SUMMARY FOREX (vs. U.S. DOLLAR) Current price vs. 1-month 3-month 6-month 52-week 52-week Previous Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank 1 Thai baht 0.03394 8.64% 9.10% 19.30% 0.03394 0.02625 3 2 New Zealand dollar 0.8081 5.81% 8.84% 15.64% 0.8106 0.6141 1 3 Brazil real 0.5434 4.40% 10.47% 15.49% 0.5434 0.4362 13 4 Australian dollar 0.8845 4.34% 6.84% 12.73% 0.8862 0.7413 2 5 South African rand 0.1468 4.34% 3.82% 4.56% 0.1487 0.1253 12 6 British pound 2.0624 3.13% 3.14% 4.37% 2.0653 1.8383 6 7 Swedish krona 0.1501 2.95% 1.56% 4.89% 0.151 0.1344 14 8 Euro 1.3823 2.59% 1.76% 6.28% 0.13852 1.2482 10 9 Japanese yen 0.008283 2.58% -1.79% 0.52% 0.00877 0.00805 16 10 Canadian dollar 0.9584 2.31% 7.54% 13.15% 0.9644 0.842 5 11 Singapore dollar 0.6644 2.20% 0.58% 2.01% 0.6647 0.6278 15 12 Swiss franc 0.8304 2.03% 0.23% 3.36% 0.8415 0.7829 11 13 Russian ruble 0.03939 1.94% 1.42% 4.37% 0.03941 0.03702 7 14 Indian rupee 0.02484 1.22% 2.69% 9.96% 0.02485 0.02125 17 15 Chinese yuan 0.1324 0.84% 2.16% 2.80% 0.1324 0.1247 9 16 Taiwan dollar 0.03051 -0.07% 1.29% 0.46% 0.03098 0.02983 4 17 Hong Kong dollar 0.1279 -0.08% -0.08% -0.23% 0.1288 0.1264 8 As of July 25 *based on one-month gain/loss ACCOUNT BALANCE Rank Country 2007 Ratio* 2006 2008+ Rank Country 2007 Ratio* 2006 2008+ 1 Singapore 39.644 27.1 36.288 41.939 13 Mexico -9.197 -1 -1.475 -13.461 2 Switzerland 68.511 17.6 69.825 68.139 14 France -51.972 -2.2 -46.304 -58.5 3 China 303.651 10 238.536 356.617 15 India -23.768 -2.4 -19.298 -24.568 4 Hong Kong 19.449 9.6 19.388 19.924 16 UK -81.402 -3.1 -68.122 -87.983 5 Netherlands 55.176 7.7 46.989 58.007 17 Australia -46.24 -5.6 -40.856 -46.743 18 U.S. -834.623 -6.1 -856.661 -866.145 6 Taiwan 25.924 7.1 25.187 27.875 19 South Africa -17.418 -6.4 -16.415 -17.385 7 Sweden 28.06 6.6 28.447 30.096 20 Spain -127.459 -9.4 -108.019 -142.416 8 Russia 72.902 6.2 95.6 67.797 9 Germany 161.938 5.3 146.361 164.71 Totals in billions of U.S. dollars 10 Japan 166.586 3.9 170.355 159.142 *Account balance in percent of GDP +Estimate 11 Brazil 8.939 0.8 13.648 3.26 Source: International Monetary Fund, World Economic Outlook 12 Canada 9.351 0.7 21.464 7.612 Database, April 2007 46 August 2007 • CURRENCY TRADER
  • 42. NON-U.S. DOLLAR FOREX CROSS RATES Currency 1-month 3-month 6-month 52-week 52-week Rank pair Symbol July 25 gain/loss gain/loss gain/loss high low Previous 1 Aussie $/Franc AUD/CHF 1.0654 2.21% 6.59% 9.07% 1.0654 0.9288 2 2 Real/Canada $ BRL/CAD 0.5672 1.98% 2.74% 2.07% 0.5695 0.5046 19 3 Aussie $/Canada $ AUD/CAD 0.9232 1.93% -0.65% -0.37% 0.9493 0.8321 5 4 Real/Yen BRL/JPY 65.6218 1.72% 12.49% 14.92% 65.8319 52.4921 12 5 Real/Euro BRL/EUR 0.3932 1.71% 8.56% 8.68% 0.3932 0.3474 15 6 Aussie $/Yen AUD/JPY 106.809 1.70% 8.81% 12.21% 107.715 87.19 1 7 Aussie $/Euro AUD/EUR 0.64 1.65% 4.99% 6.08% 0.6409 0.5831 3 8 Real/Pound BRL/GBP 0.2635 1.19% 7.11% 10.67% 0.2658 0.2339 18 9 Aussie $/Pound AUD/GBP 0.4289 1.13% 3.57% 8.01% 0.4292 0.3932 4 10 Pound/Yen GBP/JPY 249.018 0.49% 5.02% 3.83% 251.095 212.943 7 11 Pound/Euro GBP/EUR 1.492 0.44% 1.34% -1.81% 1.5296 1.4547 8 12 Euro/Yen EUR/JPY 166.908 0.00% 3.62% 5.74% 168.96 145.736 10 13 Real/Aussie $ BRL/AUD 0.6146 -0.03% 3.42% 2.47% 0.6326 0.5859 20 14 Canada $/Yen CAD/JPY 115.732 -0.32% 9.50% 12.57% 117.849 98.32 6 15 Franc/Canada $ CHF/CAD 0.8667 -0.33% -6.81% -8.65% 0.9751 0.8564 17 16 Canada $/Euro CAD/EUR 0.6934 -0.34% 5.67% 6.46% 0.7083 0.639 9 17 Franc/Euro CHF/EUR 0.6007 -0.56% -1.52% -2.75% 0.6371 0.5948 14 18 Franc/Yen CHF/JPY 100.261 -0.59% 2.05% 2.83% 101.852 92.62 11 19 Canada $/Pound CAD/GBP 0.4648 -0.83% 4.26% 8.42% 0.4805 0.4271 13 20 Franc/Pound CHF/GBP 0.4027 -1.06% -2.82% -0.96% 0.436 0.4016 16 GLOBAL STOCK INDICES 1-month 3-month 6-month 52-week 52-week Rank Country Index July 25 gain/loss gain/loss gain/loss high low Previous 1 India BSE 30 15,699.33 8.36% 10.42% 9.92% 15,868.85 10,323.77 7 2 Hong Kong Hang Seng 23,362.18 7.06% 13.76% 13.03% 23,534.38 16,566.39 1 3 Brazil Bovespa 55,998.54 3.62% 12.73% 25.31% 58,292.88 34,127.48 3 4 Canada S&P/TSX composite 14,105.32 1.90% 3.16% 9.11% 14,646.82 11,407.27 13 5 Singapore Straits Times 3,633.54 1.49% 8.05% 16.89% 3,685.15 2,397.94 8 6 U.S. S&P 500 1,518.09 1.36% 1.52% 6.61% 1,555.90 1,257.19 11 7 South Africa FTSE/JSE All Share 29,076.33 0.76% 2.97% 13.93% 30,041.90 20,331.27 – 8 Australia All ordinaries 6,378.00 0.31% 3.32% 10.86% 6,469.20 4,892.00 9 9 Japan Nikkei 225 17,858.42 -1.27% 3.61% 2.29% 18,300.39 14,839.49 5 10 UK FTSE 100 6,454.30 -2.04% -0.12% 2.95% 6,754.10 5,752.60 10 11 Switzerland Swiss Market 8,922.70 -2.39% -5.37% -2.31% 9,548.10 7,741.80 14 12 France CAC 40 5,837.11 -2.76% -1.85% 4.06% 6,168.15 4,915.90 12 13 Mexico IPC 31,103.53 -2.85% 5.64% 16.01% 32,564.35 19,800.03 6 14 Germany Xetra Dax 7,692.55 -3.00% 4.76% 14.48% 8,151.57 5,542.38 4 15 Italy MIBTel 31,877.00 -3.24% -6.18% -2.23% 34,369.00 27,576.00 15 GLOBAL SHORT-TERM INTEREST RATES Country Interest rate Rate Last change Feb. 07 Aug. 06 U.S. Fed Funds Rate 5.25 0.25 (June 06) 5.25 5.25 Japan Overnight call rate 0.5 0.25 (Feb. 07) 0.5 0.25 Eurozone Refi rate 4 0.25 (June 07) 3.5 3 UK Repo rate 5.75 0.25 (July 07) 5.25 4.75 Canada Overnight funding rate 4.5 0.25 (July 07) 4.25 4.25 Switzerland 3-month Swiss Libor 2.5 0.25 (June 07) 2 1.5 Australia Cash rate 6.25 0.25 (Nov. 06) 6.25 6 New Zealand Cash rate 8 0.25 (June 07) 7.25 7.25 Brazil Selic rate 11.5 0.5 (July 07) 13 14.25 Korea Overnight call rate 4.75 0.25 (July 07) 4.5 4.5 Taiwan Discount rate 3.125 0.25 (June 07) 2.875 2.5 India Reverse repo rate 6.5 0.5 (March 07) 6 6 South Africa Repurchase rate 9.5 0.5 (June 07) 9 8 GLOBAL BOND RATES Rank Country Rate July 25 1-month 3-month 6-month High Low Previous 1 Germany BUND 112.23 1.67% -1.47% -2.49% 118.91 109.92 4 2 U.S. 10-year T-note 106.19 1.01% -1.73% 0.03% 109.205 103.21 3 3 Japan Government Bond 132.54 0.30% -1.17% -1.66% 135.31 130.96 5 4 Australia 10-year bonds 93.865 0.12% -0.29% -0.34% 94.52 93.705 2 5 UK Short sterling 93.74 0.00% -0.36% -0.44% 95.16 93.65 1 All data as of July 25 CURRENCY TRADER August 2007 47
  • 43. GLOBAL ECONOMIC CALENDAR AUGUST/SEPTEMBER MONTH August 1 U.S.: ISM 21 Germany: Employment report Canada: CPI; retail trade; Japan: Account balances Legend leading indicators Great Britain: Monetary policy CPI: Consumer price index committee meeting 22 Japan: Monetary policy meeting ECB: European Central Bank Australia: Index of commodity prices 23 Japan: Monetary policy meeting FOMC: Federal open market committee 2 ECB: Governing council meeting Germany: National accounts GDP: Gross domestic product Japan: Monetary base Philippines: Monetary board meeting ISM: Institute for supply Great Britain: Monetary policy management 24 U.S.: Durable goods committee meeting Japan: Corporate service price index PPI: Producer price index 3 U.S.: Employment report 25 Mexico: Monetary policy announcement Germany: Retail turnover Economic Release time 26 release (U.S.) (ET) 4 GDP 8:30 a.m. 27 Israel: Announcement of changes in the CPI 8:30 a.m. 5 interest rate ECI 8:30 a.m. 6 Germany: Orders received and 28 Canada: Employment report PPI 8:30 a.m. manufacturing turnover Poland: Monetary policy council meeting ISM 8:30 a.m. Unemployment 8:30 a.m. 7 U.S.: FOMC meeting 29 Poland: Monetary policy council meeting Personal income 8:30 a.m. Germany: Production index Thailand: Monetary policy committee Durable goods 8:30 a.m. Australia: Reserve bank meeting meeting Retail sales 8:30 a.m. 8 U.S.: Wholesale inventories 30 U.S.: GDP Trade balance 8:30 a.m. Great Britain: Inflation report Canada: Balance of payments Leading indicators 10 a.m. Germany: Foreign trade; bankruptcies Czech Republic: Czech National Bank Australia: Official reserve assets board meeting 9 31 Canada: GDP 10 Japan: Corporate goods price index Australia: International reserves and foreign currency liquidity AUGUST 2007 11 29 30 31 1 2 3 4 12 September 5 6 7 8 9 10 11 13 U.S.: Retail sales 1 12 13 14 15 16 17 18 Japan: Balance of payments 2 19 20 21 22 23 24 25 Great Britain: PPI 3 Japan: Account balances 26 27 28 29 30 31 1 Australia: Statement on monetary policy Germany: Retail turnover 14 U.S.: PPI; trade balance Australia: Index of commodity prices SEPTEMBER 2007 Japan: Monetary survey 4 U.S.: ISM 26 27 28 29 30 31 1 Great Britain: CPI Japan: Monetary base 2 3 4 5 6 7 8 15 U.S.: CPI Australia: Reserve bank meeting 9 10 11 12 13 14 15 Canada: Manufacturing survey Brazil: Monetary policy committee 16 17 18 19 20 21 22 Great Britain: Employment report meeting 23 24 25 26 27 28 29 Norway: Monetary policy meeting 5 Great Britain: Monetary policy South Africa: Monetary policy council committee meeting 30 1 2 3 4 5 6 meeting Canada: Interest rate announcement 16 Germany: CPI Brazil: Monetary policy committee South Africa: Monetary policy council meeting The information on this page is subject to change. Currency meeting 6 ECB: Governing council meeting Trader is not responsible for 17 Germany: PPI Great Britain: Monetary policy the accuracy of calendar dates Canada: Wholesale trade committee meeting beyond press time. Germany: Orders received and 18 manufacturing turnover 19 20 U.S.: Leading indicators Great Britain: Capital issues 48 August 2007 • CURRENCY TRADER
  • 44. NEW PRODUCTS & SERVICES TradeStation has launched its new forex trading plat- and prioritizing management and staff time spent with form, one that enables the design, back-testing and automa- investors. Pinpoint Market Intelligence will be available to tion of forex trading strategies based on inside, interbank all public companies and delivered to Nasdaq-listed spreads. Forex trades may now be executed directly from companies through the Market Intelligence Desk (MID). the TradeStation order bar or market depth window, or Pinpoint Market Intelligence is expected to launch through the use of macros or full automation. TradeStation’s in the fourth quarter of 2007 and will be available to com- new pricing plan offers tighter “inside” spreads — as small panies listed on all U.S. exchanges. Pricing is based on trad- as $10 per 100,000 deal lot for the most liquid currency pairs ing volume, market cap, and additional — in exchange for a reasonable “round-turn” commission services purchased. For more information visit that will typically be $5.00 per 100,000 deal lot. In addition to the new forex offering, this release of the TradeStation platform, TradeStation 8.3, contains numerous fundamental InstantBull Inc. has implemented a new ranking sys- data indicators, PaintBar Studies, and strategy components tem that continuously monitors the top 100 stock market that support the design and testing of fundamental data bloggers on the Web. The system is based on impartial rank- strategies, and increased optimization of analysis technique ings from services at Alexa and Technorati. The new soft- calculations for Chart Analysis and RadarScreen. A detailed ware release is free and also features “daily ticker trends” description of the new features, functions, and enhance- under’s “Hot” tab. Investors can view ments in TradeStation 8.3 is available at search trends for the most popular tickers over the course of the last four days. For more information, visit The Nasdaq plans to launch a new investor analytics service through its subsidiary — “Pinpoint Market Intelligence,” which is analysis of institutional pur- Note: New Products and Services is a forum for industry businesses chases and sales of a specific stock. This analysis is provid- to announce new products and upgrades. Listings are adapted from press releases and are not endorsements or recommendations from ed confidentially to the issuer and is used for measuring the Active Trader Magazine Group. E-mail press releases to and benchmarking investor relations program effectiveness Publication is not guaranteed. THE FACE OF TRADING Rolling with the punches BY CURRENCY TRADER STAFF to make sure that never happened again,” he says. He attended seminars and studied technical analysis. In Name: Steve Misic early 2004, Misic decided to trade full-time. For many years Age: 50 he had worked nights, and even after he quit his job his Lives/works in: Hoffman Estates, Ill. body clock was still set to awaken in the early hours of the morning. Trading around 2 a.m in the forex market was a S teve Misic first got into stock market investing in the early 1990s, but like many other traders he became more active as the tech-stock bubble expanded into 2000. Misic would often call in buy-and-hold trades from his cell phone while driving a bakery sales good fit for him. He relied on traditional technical analysis, basing his short-term trading on support and resistance concepts. Most important lesson learned: “Trading makes a route. There wasn’t much to it, he remembers. person humble. I’ll never get it all taken away from me “I was trading from my truck,” he says. “It was one-way again because I learned from the last bubble. Right now, — you just bought it and it went up.” momentum trading is all the rage again, but eventually As everyone knows, however, the ride didn’t last forever. there will be a sell-off. I’ve learned how to trade When the bubble burst, Misic, like many others, rode most technically.” his holdings down. After that, he decided to learn how to trade. To read the complete profile, see the October 2007 issue of Active “After I lost money in the bubble, I wanted to learn a way Trader magazine ( CURRENCY TRADER • August 2007 49
  • 45. KEY CONCEPTS Carry trades involve buying (or lending) a currency with a Stochastic oscillator: A technical tool designed to high- high interest rate and selling (or borrowing) a currency with a light shorter-term momentum and “overbought” and “over- low interest rate. Traders looking to “earn carry” will buy a sold” levels (points at which a price move has, theoretically at high-yielding currency while simultaneously selling a low- least, temporarily exhausted itself and is ripe for a correction yielding currency. or reversal). Calculation: The stochastic oscillator consists of two lines: Outlier: An anomalous data point or reading that is not rep- %K and a moving average of %K called %D. The basic sto- resentative of the majority of a data set. chastic calculation compares the most recent close to the price range (high of the range - low of the range) over a particular Relative strength index (RSI): Developed by Welles period. Wilder, the relative strength index (RSI) is an indicator in the For example, a 10-day stochastic calculation (%K) would be “oscillator” family designed to reflect shorter-term momen- the difference between today’s close and the lowest low of the tum. It ranges from zero to 100, with higher readings suppos- last 10 days divided by the difference between the highest high edly corresponding to overbought levels and low readings and the lowest low of the last 10 days; the result is multiplied reflecting the opposite. The formula is: by 100. The formula is: RSI = 100 – (100/[1+RS]) %K = 100*{(Ct-Ln)/(Hn-Ln)} where where RS = relative strength = the average of the up closes over Ct is today’s closing price the calculation period (e.g., 10 bars, 14 bars) divided by the Hn is the highest price of the most recent n days (the default average of the down closes over the calculation period. value is five days) Ln is the lowest price of the most recent n days For example, when calculating a 10-day RSI, if six of the The second line, %D, is a three-period simple moving days closed higher than the previous day’s close, you would average of %K. The resulting indicator fluctuates between 0 subtract the previous close from the current close for these and 100. days, add up the differences, and divide the result by 10 to get the up-close average. (Note that the sum is divided by the total Fast vs. slow: The formula above is sometimes referred to as number of days in the look-back period and not the number of “fast” stochastics. Because it is very volatile, an additionally up-closing days.) smoothed version of the indicator –– where the original %D For the four days that closed lower than the previous day’s line becomes a new %K line and a three-period average of this close, you would subtract the current close from the previous line becomes the new %D line –– is more commonly used (and low, add these differences, and divide by 10 to get the down- referred to as “slow” stochastics, or simply “stochastics”). close average. If the up-close average was .8 and the down Any of the parameters –– either the number of periods used close average was .4, the relative strength over this period in the basic calculation or the length of the moving averages would be 2. The resulting RSI would be 100 - (100/[1+2]) = 100 used to smooth the %K and %D lines –– can be adjusted to - 33.3 = 66.67. make the indicator more or less sensitive to price action. Horizontal lines are used to mark overbought and oversold Standard error channel: The linear regression line is a stochastic readings. These levels are discretionary; readings of straight line that minimizes the distance between itself and 80 and 20 or 70 and 30 are common, but different market con- every data point in the series you are working with. A standard ditions and indicator lengths will dictate different levels. error measures the variance from the linear regression. Subtracting the standard error from the linear regression line Variance and standard deviation: Variance measures yields the bottom of the standard error channel, and adding it how spread out a group of values are — in other words, how to the linear regression value gives you the top of the channel. much they vary. Mathematically, variance is the average The standard error channel is a parallel concept to Bollinger squared “deviation” (or difference) of each number in the Bands, which use the standard deviation calculation to set group from the group’s mean value, divided by the number boundaries above and below a moving average to capture vari- of elements in the group. ance away from the average. Because the moving average is a For example, for the numbers 8, 9, and 10, the mean is 9 wavy line, the Bollinger Bands are wavy, too, and also widen and the variance is: or narrow as variability rises or falls. The standard error does {(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = .667 the same thing, only with straight lines. Now look at the variance of a more widely distributed set The critical difference is that you don’t need to choose a of numbers — 2, 9, and 16: starting and ending point for Bollinger Bands, because they {(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67 track a moving average that constantly discards old data and The more varied the prices, the higher their variance — the refreshes itself with new data. To construct a useful linear more widely distributed they will be. The more varied a mar- regression channel, however, you have to pick reasonable ket’s price changes from day to day (or week to week, etc.), starting and ending points. It’s still “mathematics” and thus a the more volatile that market is. better way to draw a trendline than using your eye alone, but A common application of variance in trading is standard your choice of starting and ending points is inherently judg- deviation, which is the square root of variance. The standard mental. Most practitioners chose an obvious lowest low or deviation of 8, 9, and 10 is: .667 = 0.82; the standard devia- highest high. tion of 2, 9, and 16 is: 32.67 = 5.72. 50 August 2007 • CURRENCY TRADER
  • 46. EVENTS Event: Forex Trading Expo Event: TradeStation Futures Symposium Date: Sept. 15-16 For more information: Dates and locations are listed Location: Mandalay Bay Hotel and Casino, Las Vegas here or visit For more information: Visit Date: Oct. 18-20 Location: Costa Mesa, Calif. Date: Dec. 6-8 Event: FIA and OIC New York Location: Hallandale, Fla. Equity Options Conference Date: Sept. 19-20 Location: Grand Hyatt New York Event: 20th Annual IFTA Conference For more information: Visit Date: Nov. 8-11 and click on “Conferences.” Location: Sharm el Sheikh, Egypt For more information: Visit Event: Paris Trading Show Date: Sept. 21-22 Location: Espace Champerret, Paris, France Event: The Traders Expo Las Vegas For more information: Visit Date: Nov. 15-18 Location: Mandalay Bay Resort and Casino, Las Vegas, Nev. Event: Wealth Expo For more information: Visit For more information: Dates and locations are listed here or visit Date: Sept. 29-Oct. 1 Event: 23rd Annual Futures & Options Expo Location: Seattle, Wash. Date: Nov. 27-29 Location: Hyatt Regency Chicago, Chicago, Ill. Date: Nov. 30-Dec. 2 For more information: Visit Location: Schaumburg, Ill. and click on “Conferences.” HIT YOUR MARK! Advertise in Active Trader Magazine Contact Bob Dorman Ad sales East Coast and Midwest (312) 775-5421 Allison Ellis Ad sales West Coast and Southwest (626) 497-9195 Mark Seger Account Executive (312) 377-9435 51 August 2007 • CURRENCY TRADER
  • 47. FOREX TRADE JOURNAL Even at historically low levels, analysis demands taking a short position in the dollar index futures. TRADE Date: Thursday, July 19. Entry: Short September dollar index futures (DXU07) at 80.22. Reason(s) for trade/setup: The dollar index is at multi-year lows (see “Spot check,” p. 38), but signs point toward con- tinued weakness. Patterns similar to the July 18 low bar have been followed by lower closes more than 70 percent of the time on each of the following 10 days (20 Source: TradeStation patterns tested since 2000). If the trade is wrong, it should become apparent relatively quickly: The dollar should rally the Canadian dollar on this day). However, the dollar index quickly off this obvious chart support if dollar bulls (who was showing signs of strength toward the end of the session no doubt have been buying around this level) have their and had bounced back almost to 80.00. way with the market. We kept the stop at its original level, as the market has not moved enough to merit lowering it by a significant amount. Initial stop: A close above 80.49, which is the July 18 high. The risk on this trade is very small, and reducing it to noth- The market could very well move sideways or slightly high- ing would serve no purpose except to virtually eliminate er to try to fake out traders before making another down- any profit potential. Further volatility is likely, but the initial side thrust. profitable move will make it easier to absorb. Initial target: 79.10, which is 0.10 above the next round- Update, July 25: The market made a decisive move to the number price below 80.00. Take partial profits and trail a upside, with the dollar index futures gapping more than stop behind the remainder of the position. 0.30 higher and closing at 80.52, stopping out the trade. The next day price turned back down and was trading at 80.35 RESULT around midday. Although this jump looks like it could be the beginning of Exit: 80.52. a move off resistance, we will consider re-entering on the short side if follow-through does not materialize. It would Reason for exit: Initial stop triggered. be just like the market to attempt to throw traders off track with a move like this before continuing lower. Profit/loss: -0.27. Note: Initial trade targets are typically based on things such as the Trade executed according to plan? Yes. historical performance of a price pattern or trading system signal. However, because individual trades are dictated by immediate cir- Outcome: After recouping much of its big decline on July cumstances, price targets are flexible and are often used as points at 20, the dollar index futures gapped lower on July 24 and which to liquidate a portion of a trade to reduce exposure. As a result, traded as low as 79.87 (the buck fell more than 1 percent vs. initial (pre-trade) reward-risk ratios are conjectural by nature. TRADE SUMMARY Date Contract Entry Initial Initial IRR Exit Date P/L LOP LOL Trade stop target length 7/19/07 DXU07 80.22 80.49 79.10 4.15 80.52 7/25/07 -0.30 (0.4%) +0.35 -0.30 4 days Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade). 52 August 2007 • CURRENCY TRADER
  • 48. THIS MONTH’S ADVERTISERS Click on these boxes to link directly to these advertiser’s web sites CURRENCY TRADER • August 2007 53
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