Strategies, analysis, and news for FX Traders




 August 2007
Volume 4, No. 8




DOLLAR AT THE CROSSROADS:              ...
CONTENTS




     Contributors . . . . . . . . . . . . . . . . . . . . .6   Advanced Strategies
                          ...
CONTENTS




      Industry News
        New NFA proposal could cause
        significant shakeup among
        forex brok...
FOREX
By far the largest cash value traded
                                                                               ...
CONTRIBUTORS
                                                                                          CONTRIBUTORS




  ...
GLOBAL MARKETS




                    Beyond the majors:
                      The exotic waters
                of emerg...
diversification,” says Richard Olsen, co-founder of            think when trading emerging markets because retail
Oanda.co...
GLOBAL MARKETS continued



FIGURE 1 — DOLLAR/RAND                                                                     “Wh...
HSBC, notes the rand strengthened roughly five percent          improved,” Wardle says. “Liquidity is still very loose
fro...
ON THE MONEY



      The rising yen — here we go again
         Japan’s unique economy — and culture — will play major ro...
FIGURE 2 — WEEKLY DOLLAR-YEN (INVERTED SCALE)
                                               The reversal on the daily tim...
ON THE MONEY continued

Other Barbara Rockefeller articles:
“The hammer and the yen”
Currency Trader, July 2007.          ...
overarching government objective.           in the yen for the past six months,
Japan has a splendid history of long-     ...
TRADING STRATEGIES



                        Short-term trends
                         in the EUR/USD pair
             ...
FIGURE 2 — WEEKLY EUR/USD
The review period spanned July 2003 through June 2007.




Source: CQGNet (http://www.cqg.com)

...
TRADING STRATEGIES continued




 TABLE 1 — HIGHER HIGHS VS. LOWER LOWS
                                                  ...
TABLE 2 — EUR/USD RUNS

Despite the EUR/USD’s upward bias, the market posted seven consecutive higher closes (HC) only thr...
TRADING STRATEGIES continued




TABLE 3 — MARKET PERFORMANCE

The percentage price moves from one to five days is shown f...
bringing Deutsche Bank,
                                          the world’s No.1 FX bank, to the retail market


Now the...
TRADING STRATEGIES continued




 three-day, close-to-close decline was -3.21 percent (from the              The median cl...
TRADING STRATEGIES continued




   However, the combination of two
                                              FIGURE 3...
ADVANCED STRATEGIES



             Minor currencies
       and federal reserve trade weights
                            ...
The entire premise                         FIGURE 3 — THE HONG KONG DOLLAR AND ITS WEIGHT IN U.S. TRADE


 behind the floa...
ADVANCED STRATEGIES continued



should stimulate exports and reduce
                                           FIGURE 6 —...
We can draw the same conclusion by examining Asian crisis (Figure 8). The 1997 collapse of the rupiah (IDR)
Singapore, whi...
Currency Trader (200708)
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Currency Trader (200708)

  1. 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. 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. 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 webmaster@currencytradermag.com. 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 Forexrtadingseminar.com MetaStock Deutsche Bank FXCM NewsTrader Pro eSignal FXStreet.com TradeGuider Forex.com InterbankFX 4 August 2007 • CURRENCY TRADER
  4. 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. 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 www.currencytradermag.com financial market issues. Barbara Rockefeller (http://www.rts-forex.com) is an Editor-in-chief: Mark Etzkorn international economist with a focus on foreign exchange. She metzkorn@currencytradermag.com has worked as a forecaster, trader, and consultant at Citibank Managing editor: Molly Flynn and other financial institutions, and currently publishes two mflynn@currencytradermag.com daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies (For Dummies, 2004), 24/7 Senior editor: Jeff Ponczak jponczak@currencytradermag.com 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 kgreen@currencytradermag.com Investors, where he trades currency futures in the euro, yen, British pound, Swiss franc, and Canadian dollar. He began his Art director: Laura Coyle lcoyle@currencytradermag.com 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- pdorman@currencytradermag.com 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: dmantell@chicagoglobalinv.com. Bob Dorman bdorman@currencytradermag.com Thom Hartle (http://www.thomhartle.com) 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- aellis@currencytradermag.com 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 mseger@currencytradermag.com 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 (http://www.hartleandflow.com). 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. 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 Oanda.com 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. 7. diversification,” says Richard Olsen, co-founder of think when trading emerging markets because retail Oanda.com. “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: https://fxtrade.oanda.com/ spreads/all_spreads.shtml.) Higher risk levels With opportunity, of course, comes risk. Brian Dolan, chief currency strategist at Forex.com, 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. 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 (http://www.advfn.com) 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 Forex.com’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. 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. 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. 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. 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 http://www.activetradermag.com/purchase_articles.htm. remain the FSA chief, the next guy would be bound by the 14 August 2007 • CURRENCY TRADER
  13. 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. 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 (http://www.cqg.com) 16 August 2007 • CURRENCY TRADER
  15. 15. FIGURE 2 — WEEKLY EUR/USD The review period spanned July 2003 through June 2007. Source: CQGNet (http://www.cqg.com) 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. 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. 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. 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. 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. 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 http://www.activetradermag.com/purchase_articles.htm 24 August 2007 • CURRENCY TRADER
  22. 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- serve.gov/releases/H10/Weights/), 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. 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. 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. 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

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