Volume 1, No.

GLOBAL IMBALANCE
Do deficits really matter?
THE POUND-YEN
carry trade

SETTING UP TRADES
with macro factors

THE AUSSIE DOLLAR:

Back on top?

TODAY’S
hottest cross rates

ECONOMIC REPORTS
that move the forex market

FUTURES EXCHANGE
gets into the forex game
 CONTENTS

Editor’s Note . . . . . . . . . . . .6

Contributors . . . . . . . . . . . . .8

Letters . . . . . . . . . . . . . . . . .9

Industry News
Reuters and the Chicago Mer-
cantile Exchange: A match made
in heaven?
We take a closer look at the part-
nership between the CME’s efx
platform and the Reuters platform.
By Carlise Peterson . . . . . . . . .10

Global Economy
The End of BOE Rate Hikes?
Housing prices in the U.K. are
cooling, possibly holding back the Bank of
England from further interest-rate tightening.
By Currency Trader Staff . . . . . . . . . . . . .12 The Big Picture
The Great Global Imbalance hoax . .16
Hot rates A different take on the economic forces that
A review of the forex market’s most com- could shape the dollar’s future.
pelling currency pairs. By Barbara Rockefeller
By Currency Trader Staff . . . . . . . . . . . . .13

Currency Characteristics
The short-term British pound/Japanese
yen carry trade . . . . . . . . . . . . . . . .22
See how the 5 p.m. (ET) daily rollover has
influenced GBP/JPY’s price moves since
2001.
By Currency Trader Staff

Currency Strategies
The macro factor . . . . . . . . . . . . . .28
A top-down approach to understanding and
trading forex.
By Dave Floyd

continued on p. 4

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 CONTENTS

Forex Resources . . . . . . . . .34

Currency Basics . . . . . . . . .36

Economic reports in the Forex
market
Which economic reports have the
greatest impact on the FX market?
By Carlise Peterson

International Market Summary . .42

Indicators in this issue . . . . . . . . .47
Indicator Basics
Simple Moving Average . . . . . . . . .44 Forex Diary . . . . . . . . . . . . . . . . .48
The basics of the most widely used technical Analysis of a trade.
tool — the simple moving average.
By Currency Trader Staff Global Economic Calendar . . . . . .49

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4 December 2004 • CURRENCY TRADER

 EDITOR’S NOTE

Ball of confusion

A s 2004 draws to a close, the forex market

seems to be setting up some kind of a
cliffhanger, with the U.S. dollar in the starring role. Will it
or won’t it veer over the edge? Half the trading world
seems to be banking on a big dollar
With so many currency pairs wandering in consolida-
tion, how this problem works itself out will have serious
repurcussions for all forex traders and investors.
If you want to get away from the dollar (at least hypo-
thetically) for a little while, “The
rebound in 2005 (despite Fed short-term British pound/Japanese
Chairman Alan Greenspan’s com- yen carry trade ” (p. 22) looks at an
ments that clobbered the bulk on Nov. Open to debate is interesting pattern in the pound-yen
19), while the other half is looking for rate that should interest short-term
the currency to really fall out of bed whether the G7 will traders looking to take advantage of
after stabilizing (somewhat) recently. one of the unique characteristics of
Also open to debate is whether the attempt to engineer a the forex market — the transition from
G7 will attempt to engineer a “soft one trading center to the next
landing” for the greenback or let the “soft landing” for the throughout the 24-hour market day.
market cut its legs out from under it. Also, “Hot rates” (p. 13) includes a
The overall economic and intermar- greenback or let the big-picture look at the Aussie dol-
ket picture is about as confusing as it lar/yen pair.
could be. While the dollar is weak, market cut its legs out But all roads in forex still have a
commodities are up, stocks are up and tendency to lead to the dollar, and the
treasury yields are down. The normal from under it. question hanging over the market
relationships seem dead or on serious now is: Will the dollar come alive in
vacation. ‘05?
In “The Great Global Imbalance
Hoax” (see p. 16), Barbara Rockefeller looks at the dollar’s
Mark Etzkorn, Editor-in-chief
drop in terms of the real implications of the U.S.’s current
account deficit and the fear that foreign investors, especial-
ly central banks, will withhold demand for U.S. securities,
especially treasuries, until the dollar stops dropping.
Rockefeller argues there’s more to this story than meets the
eye, and the deficit is mostly a red herring.

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 CONTRIBUTORS

A publication of Active Trader ®
Barbara Rockefeller (www.rts-

forex.com) is an international economist
For all subscriber services: with a focus on foreign exchange. She has
www.currencytradermag.com worked as a forecaster, trader and consultant
at Citibank and other financial institutions,
Editor-in-chief: Mark Etzkorn and currently publishes two daily reports on
metzkorn@currencytradermag.com
foreign exchange. Rockefeller is the author
Managing editor: Molly Flynn of Technical Analysis for Dummies (2004), 24/7
mflynn@currencytradermag.com Trading Around the Clock, Around the World
(John Wiley & Sons, 2000), The Global Trader
Senior editor: Jeff Ponczak
jponczak@currencytradermag.com (John Wiley & Sons, 2001) and How to Invest
Internationally, published in Japan in 1999. A
Associate editor: David Bukey
dbukey@currencytradermag.com book tentatively titled How to Trade FX is in
the works.
Associate editor: Carlise Peterson
cpeterson@currencytradermag.com

Editorial and Web assistant: Kesha Green

kgreen@currencytradermag.com
Dave Floyd is a professional FX and
stock trader who has been trading on behalf
Art director: Laura Coyle
lcoyle@currencytradermag.com of his own account since 1994. He currently
offers an FX Advisory Service and FX
President: Phil Dorman
pdorman@currencytradermag.com Managed Accounts through his firm, Aspen
Trading Group (www.aspentrading.com).
Publisher,
Ad sales East Coast and Midwest:
Bob Dorman
bdorman@currencytradermag.com

Ad sales
West Coast and Southwest only:
Allison Ellis
aellis@currencytradermag.com

Classified ad sales: Mark Seger

mseger@currencytradermag.com

Volume 1, Issue 3. Currency Trader is published monthly by TechInfo, Inc., 150

S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2004 TechInfo,
Inc. All rights reserved. Information in this publication may not be stored or
reproduced in any form without written permission from the publisher.

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.

8 December 2004 • CURRENCY TRADER

 LETTERS

audience, which is best served by online Dollar daze

distribution.
However, the magazine is designed and I enjoyed the story on the dollar’s
formatted to print out in perfect page form. behavior after elections (“Elections
Readers who want hard copies of certain and the U.S. dollar,” Currency Trader,
articles only need to hit their print buttons. November 2004) but I think it, and
We are aware the Zinio Reader software Maria Fiorini Ramirez’ dollar outlook
currently only allows for printing two (“The dollar and the deficit”), high-
pages at a time, but Zinio has indicated light one of the basic challenges of
they are looking at that issue and trading: The best idea in the world
things could change in the future. sometimes doesn’t mean anything.
Both articles make good cases for a
• stronger dollar (in the near-term and
further out), but as yet, the dollar has
Awww, Canada remained weak.
No paper trail? It won’t be that way forever, but it
I must say that Currency Trader stands just goes to show you how hard it is to
Great job with this magazine! But one for quality. It is a very informative and know when a trend will stop being
question: Are you ever going to have a educational magazine and has no real your friend, and the limitations of
printed version? competition in the subject area. The net rationale analysis.
community was in need of something
— Dan Imperato like this. Keep up the good work! — Jerry Blancard

We have no plans for a print edition. — Ivan Ballevona

Currency Trader is designed for a global Toronto

To advertise to the readers of

Currency Trader

call
Bob Dorman
at
(312) 775-5421
or send an e-mail to
bdorman@activetradermag.com
with “Ad inquiry” in the subject line.
 INDUSTRY NEWS

Reuters and the Chicago Mercantile

Exchange: A match made in heaven?
What’s behind the CME-Reuters partnership and will individual forex traders be able
to take advantage of it?

T he Chicago Mercantile
Exchange and Reuters
LLC are planning to
open up currency
futures trading to a wider customer
base. And the partnership is more than
just the CME displaying its market
Reaction in the FX markets has been
positive.
“It’s a good idea because more and
more traders are now watching FX
futures and the spot FX prices for indi-
cations and potential price action,”
says Dave Floyd, trader and owner of
were only a handful of players, they
would all know each other.
Anonymity will add to the appeal of
the system,” he says.
With 17,500 stations around the
world, Reuters brings the mainstream
interbank FX market to the partner-
data on Reuters terminals, as some in
the industry previously thought.
The two organizations have agreed
to electronically connect their foreign
exchange networks: the eFX futures
contracts traded on CME’s Globex
electronic trading system and Reuters’
Dealing 3000 system, which trades
spot forex. The agreement is scheduled
to go live for beta testing in December.
The partnership should have a sig-
nificant impact on CME currency vol-
ume, adding depth and liquidity,
according to Richard Sears, managing
director for foreign exchange in the
products and services division of the
CME.
“We’ve displayed [our data] in spot-
equivalent terms,” he says. “We now
quote it the way the cash [forex] mar-
kets do. It takes futures contracts and
strips the interest-rate bit out so
[traders] can compare futures prices to
spot prices.”

Positive reaction in FX market Aspen Trading. “It reminds me of the ship, while the CME contributes a dif-
The partnership basically breaks down way we used to watch the S&P futures ferent group: The CME’s customer
barriers between futures and spot so closely for clues on what stocks base is 50 percent hedge funds and
forex market participants. Specifically, might be about to make a move.” commodity trading advisors (CTAs).
Reuters will take a market data feed Despite concerns by some critics
from CME and convert the currency that FX is too big a market for an Credit risks
futures prices into the spot forex rates exchange model, “it simply isn’t,” If the partnership works, the implica-
the interbank market is accustomed to Sears says. tion is many of the parties involved will
using. “The bigger it gets the better. If there have to relax their credit-risk con-

10 December 2004 • CURRENCY TRADER

 • • • PIPS
CHINESE COMPANIES GET HELP

A trio of financial groups –– ABN Amro, Credit Suisse First Boston
and ING –– are going to offer derivatives that will help Chinese com-
panies minimize fluctuations in currencies. The firms are able to offer
the products thanks to a loosening of financial rules by the Chinese
straints. Banks that usually only trade
Government. The derivatives will allow Chinese businesses to hedge
with other banks would not potential-
against swings in the price of foreign currencies. Other firms are inter-
ly be trading directly with hedge funds
ested in offering the derivatives but are awaiting approval from China.
and CTAs.
But the CME/Reuters stance is that
while Reuters will provide easier
FOREX ON THE TIFFE
access to the wider range of trading

Published reports indicate the Tokyo International Financial Futures
opportunities, the CME will offer
Exchange (TIFFE) will start a forex margin trading market early in
credit intermediation.
The agreement offers a method of FX 2005. Both individuals and institutions will be able to trade on the
exchange, which will begin by trading the U.S. dollar, euro, pound and
removing credit as an obstacle to the
search for new liquidity and brings a TIFFE Australian dollar. Traders on the exchange will have 10 times lever-
age (i.e., a $10,000 deposit will allow them to trade $100,000 worth of
regulated product to a market with an
securities).
appetite for regulation. The CME
operates a capital-efficient market
because it functions as a central coun-
terparty (CCP) that assumes responsi- CME volume update
bility for trade clearing.

T
While some banks might not want he Chicago Mercantile Ex- (eFX) also set a record on Friday, Oct.
to operate in that environment, the change electronic trading vol- 27 with 270,648 contracts traded, com-
cost of capital usage, which will ume in November achieved a pared to the previous overall eFX
increase in the future, means any effi- new trading record of 3.7 million con- record of 236,000 set on Oct. 28. The
ciency will be seized on. The market tracts. This was the second time the strong volume in CME eFX was driv-
model of futures exchanges, with their exchange traded more than three mil- en by a record in EuroFX futures on
central counterparties, is appealing to lion contracts in a single day electron- CME Globex of 143,331. The exchange
market participants, Sears says. The ically, the last time being 3.5 million also set a new record in CME
idea is, if this deal develops as it contracts traded on Aug. 6. Eurodollar futures traded on CME
could, there’s a chance the spot FX CME electronic foreign exchange Globex with 2.1 million contracts.

world will adopt an exchange model
and the CME and Reuters will be the
two major beneficiaries. Dollar policy
“This is a whole new opportunity

U
for [us] to get bank customers,” Sears .S. Treasury Secretary John statement issued at the end of their
says. Snow gave no signal of a shift meeting in Berlin, reinforcing the view
Reuters and the CME have worked in the U.S. dollar policy on that major nations have accepted the
together before in the development of Nov. 17 after it slumped to yet another need for a weaker dollar to correct the
the Globex platform. low against the euro. U.S.’s trade gap.
Additionally, rumors emerged in He maintained steadfast language The G20’s call for more Asian cur-
mid-November the CME is interest- in recent weeks when asked about the rency flexibility was seen putting
ing in acquiring Instinet, Reuters’ dollar, apparently ruling out any U.S. more downward pressure on the dol-
stock-trading business, to broaden its support for intervention to stem the lar, according to news reports.
trading reach beyond futures. slide in the currency. Financial markets had been specu-
“Acquisitions and consolidation are Snow has denied the argument lating the G20, which includes the
an important part of CME’s growth that Washington favors a weaker cur- Group of Seven (G7) rich nations and
strategy, but we do not comment on rency to help exports and the econo- big developing countries such as
any specific aspect of that strategy,” my. China, might create the kind of inter-
says David Prosperi, spokesperson for In addition, G20 policymakers made national accord the G7 struck in 1986
the CME.
no mention of the dollar’s slide in a to manage major currencies.

CURRENCY TRADER • December 2004 11

 THE GLOBAL ECONOMY

The end of BOE rate hikes

Is the tightening cycle in the U.K. complete?

BY CURRENCY TRADER STAFF

Housing prices have stopped rising 2.2-percent growth rate, Stephansen
and by some measures have even reg- forecasts overall GDP growth at 2.8
fter a series of aggressive istered declines in recent months. percent in the UK in 2005. BNP

A rate hikes over the past

year, the Bank of England
(BOE) held its repo rate
steady at 4.75 percent at its Nov. 4
meeting. Many analysts believe this
Although housing-price inflation
still registered a hefty 13.8 percent
year-over-year increase in September,
actual housing prices declined -0.1
percent during September, according
Paribas’ official forecasts for 2005 GDP
growth are slightly lower at 2.5 per-
cent.
“They’ve had a very strong econo-
my over the past few months,” says
may mark the end of the tightening to the UK Office of the Deputy Prime Tom Rogers, senior currency analyst at
cycle in Britain — at least for now. The Minister (ODPM). However, the key Thomson Financial. “They are grow-
next meeting is set for Dec. 9. point for the BOE is “the rate of ing stronger than the rest of Europe.”
“The BOE inflation report was a bit increase has decelerated substantial- In other economic news, the UK
less concerned about inflation going ly,” Lynch says. “We had been seeing trade deficit narrowed sharply in
forward,” notes Bob Lynch, currency price increases at a 20-percent per year September to 4.5 billion pounds from
strategist at BNP Paribas in New York. rate.” 5.2 billion pounds. Analysts point to
“We do think the tightening cycle is In terms of overall growth in Britain, an 11-percent jump in exports to non-
complete.” Kathleen Stephansen, director of glob- European Union countries as the key
factor behind the shrinking gap.
Broad-based improvement occurred,
FIGURE 1 — TESTING RESISTANCE
with impressive gains to Asia, includ-
In November the pound-dollar rate (GBP/USD) had reached the upper trendline ing a 15-percent increase to China and
of a triangle consolidation on the weekly chart. 27-percent increase to Japan.
British pound/U.S. dollar (GBP/USD), weekly 1.9
Pound picture
What has this meant for the British
pound? The sterling soared to a 12-
1.8 year high at $1.91 in February 2004,
driven in part by aggressive BOE rate
hikes and the positive interest rate dif-
1.7 ferentials those hikes created for the
currency.
However, since February, the
1.6 pound-dollar rate has formed a trian-
gular consolidation pattern on the
weekly chart with the most recent
1.5 swing-high resistance around $1.87
and swing-low support around $1.77
(Figure 1). As of mid-November, the
pound had edged toward the upper
Apr. July Oct. 2003 Apr. July Oct. 2004 Apr. July Oct. end of that range and is poised to test
Source: TradeStation resistance at the $1.87 area.

Analysts point to signs the housing al economic research at Credit Suisse Macro factors
market is cooling off in Britain as one First Boston, says the economy isn’t Renewed weakness in the U.S. dollar,
factor that could keep the BOE on the doing too badly. While a soft patch which saw the euro push to all-time
sidelines in the months ahead. was seen in the third quarter with a highs in the $1.30 area, have helped

12 December 2004 • CURRENCY TRADER

support sterling in recent weeks, ana- from higher oil prices. The ECB’s only is definitely holding the pound back
lysts say. mandate is to ensure price stability. from making stellar gains,” he
Another factor that supported the The inflationary impact from stronger explains.
pound from mid-October to early energy prices could move the central
November was reserve shifting from bank to raise rates there. The technicals
dollar assets into the pound by the Looking at the charts, Rogers high-
Bank of India. However, Rogers notes U.S. dollar action lights key levels for forex traders to
as of mid-November they stopped However, given the market’s general watch on the downside. He points to
buying sterling. acceptance that the tightening cycle is the bottom coming in at $1.8393.
The key question for forex traders is: likely over in Britain, action in the ster- “We bounced off the bottom three
what will the end of BOE rate hikes ling may, at least in the short-term, be times in the past two weeks,” he says.
mean for the pound, which has been driven by the direction of the U.S. dol- “If we go below that level a lot of peo-
stuck in a narrowing consolidation? lar. ple will start to think the uptrend is
From an interest-rate differential “As opposed to developments in the over.”
standpoint, Credit Suisse First UK, the key hinge point for the pound Andrew Chaveriat, technical analyst
Boston’s Stephansen notes “the ECB is the dollar,” Lynch says. at BNP Paribas, also says the key level
[European Central Bank] hasn’t begun Thomson Financial’s Rogers expects on the upside is $1.8770, the July high.
hiking yet. Since the BOE is at the end the pound to test the $1.88/1.90 area Gains through that key resistance
of its tightening cycle, this policy before the year is over. point would target a retest of the $1.91
divergence could bring a correction to “I don’t think the dollar sell-off is area, he says.
the sterling.” over yet,” he explains. “I would be bullish at this point and
ECB left rates steady at its early While Rogers is upbeat on the out- buy these dips,” he says.
November meeting at 2.00 percent. look for the pound, he does note that He also highlights the $1.83 area as
ECB President Jean Claude Trichet recent gains in the sterling have not key to watch on the downside.
highlighted improvements in econom- kept pace with euro and Swiss franc “A close under there would signal a
ic strength in the euro zone area, but strength. deeper retracement,” Chaveriat con-
warned about the negative impact “Because rates are likely on hold, it cludes.

Hot rates
Japanese, Australian, and Canadian currencies offer some of the most compelling forex trades right now.

BY CURRENCY TRADER STAFF

ondering what the pushed to its highest level (around notably China, have been able to artifi-

W most active and inter-

esting forex rates to
trade right now are?
Currency Trader asked three analysts
for their top cross rates heading into
81.75) since March 2004, Dolan high-
lights a number of fundamental and
technical factors that could make that
trend switch gears. Generally, Dolan
favors selling the Australian dollar vs.
cially keep their currency levels rela-
tively weak despite robust growth,
“the next major shift will likely see
these currencies appreciate,” Dolan
says. Any strengthening of the Chinese
the New Year and they chose the yen. currency would probably spill over to
AUD/JPY, AUD/USD, and USD/ While fundamental factors are posi- the yen.
CAD. tive for both of these currencies, Dolan A second factor likely to support a
According to Brian Dolan, director believes the yen is more likely to retreat in the AUD/JPY rate over the
of research at Gain Capital, action in appreciate amid “potential for revalu- next several months is a decline in
the AUD/JPY could prove interesting ation of the Asian currencies,” which “uridashi” issuance, Dolan speculates.
over the next several months. While would allow the yen to strengthen, he Uridashi refers to non-yen fixed-
AUD/JPY had, as of mid-November, says. While many Asian countries, continued on p. 14

CURRENCY TRADER • December 2004 13

 THE GLOBAL ECONOMY continued

FIGURE 1 — AUD/JPY: POISED TO DROP?

In addition to fundamental factors, a potential head-and-shoulders top in the AUD/JPY rate implies the possibility of a
correction down to the 74.00/75.00 level.

Australian dollar/Japanese yen (AUD/JPY), weekly 89.00

88.00
87.00
H 86.00
85.00
S 84.00
Resistance level 83.00
S 82.00
81.00
80.00
79.00
78.00
77.00
76.00
Neckline (target level) 75.00
74.00
73.00
72.00
71.00
70.00
69.00
68.00
67.00
66.00

MACD 2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
-1.5
Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. 2004 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov.
Source: Gain Capital

income instruments sold to Japanese (established by a trendline connecting highest in the industrialized world
investors. Uridashi denominated in the tops of the two shoulders) holds, right now.
Australian dollars have been a popular he looks for an eventual retreat back to “That is a good solid yield for any-
choice among Japanese investors, sim- approximately 74.00/75.00 (the level one to be sitting on right now,” Callow
ply because of higher Aussie interest of the pattern’s “neckline”) over the says.
rates. However, “uridashi issuance next six months. Also, the country is enjoying solid
peaked in 2003 and is expected to fundamentals, including a strong
decline further this year,” Dolan notes. Another look down under domestic economy lately, with unem-
As the Japanese economy continues Sean Callow, currency strategist at ployment in October hitting its lowest
to show signs of improvement, Ideaglobal, offers another top cross level (5.3 percent) since 1978. Gross
Japanese investors may choose to keep rate pick. He points to the AUD/USD domestic product growth is expected
their investment dollars at home. If the as a hot cross to watch. A daily chart to remain robust in the 3.5 percent
decline in uridashi issuance continues, reveals the Australian dollar has been area.
the demand for Aussie dollars will screaming higher vs. the U.S. dollar in “The strong domestic economy
decrease. recent weeks (see Figure 2). The cross underpins the relatively high interest
Finally, Dolan highlights a potential rate soared from a low at 68.53 in early rates, with no fears of a rate cut,”
head-and-shoulders top formation on September to the 78.45 area in mid- Callow says.
the monthly AUD/JPY chart as a neg- November. Another factor supporting addition-
ative factor (see Figure 1). Dolan says First, Australia is boasting an inter- al gains in the AUD/USD is the rising
as long as the 82.50 resistance area est rate of 5.25 percent, or the second continued on p. 21

14 Click on this ad for more information

 THE BIG PICTURE

The Great Global

IMBALANCE HOAX
Is the U.S. account deficit a real

problem, or is the Federal Reserve

concerned about something else when

it publicly talks down the dollar?

16 December 2004 • CURRENCY TRADER

BY BARBARA ROCKEFELLER that. In 2000, the trade imbalance again Once you get past the ornate lan-
became a big topic in the foreign guage, you realize this is practically an
exchange market. That time, the dollar invitation to sell dollars. It’s also a
rose against the euro. near-verbatim repeat of what
What’s different this time is the Greenspan said in 2000, except then he
Federal Reserve is doing most of the was speaking in a considerably more

F rom November 2003 to

February 2004, and again
going into year-end 2004,
the dollar fell more than
10 percent against the Euro. In each
case, the underlying cause of the dol-
lar’s drop was universally reported to
talking. The fear of inadequate foreign
funding of the current account deficit
has been voiced by a whole slew of
Fed officials, both regional Federal
Reserve Board presidents such as Janet
Yellen (San Francisco) and Robert
McTeer (Dallas) as well as Fed
relaxed, almost offhand way. This
time, Greenspan was speaking at a
major European conference and knew
his words would flash around the
world in seconds.
Treasury Secretary John Snow con-
tributes to open acceptance of the dol-
be the “structural global imbalance,” Governor Ben Bernanke. lar falling when he says, on principle,
whereby the U.S. runs a huge current Ahead of the G20 meeting in Berlin, U.S. policy is for a stronger dollar, but
account deficit that is offset by foreign-
ers, including central banks, who buy
U.S. financial assets. Fed chairman Alan Greenspan’s comments at the
It’s not so much the U.S. current
account deficit itself that propels the G20 meeting in Berlin were practically an invitation
dollar downward, but the fear that for-
eign investors, especially central
banks, will withhold demand for U.S.
to sell dollars.
securities, especially Treasuries, until
the dollar finishes dropping or the real Fed Chairman Alan Greenspan laid if the market wants to take the dollar
return is compellingly greater than the down the rules for thinking about the down, the U.S. believes in free mar-
return on equivalent assets. global imbalance (www.federalre- kets.
We’ve been here before. In fall 1985, serve.gov/BoardDocs/speech-
the countries that later came to be es/2004): Consensus opinion
known as G7 (U.S., Great Britain, “The question now confronting us is By now, everybody is talking about the
Germany, France, Canada, Japan, and how large a current account deficit in dollar’s inevitable further decline,
Italy) met secretly at the Plaza Hotel in the United States can be financed with even an august figure such as for-
New York and decided to drive down before resistance to acquiring new mer Fed chairman Paul Volcker speak-
the price of the dollar to correct a trade claims against U.S. residents leads to ing of a 75 percent probability of a cur-
imbalance of about $120 billion annu- adjustment. Given the size of the U.S. rency “crisis” sometime in the next
ally. The dollar fell 21 percent against current account deficit, a diminished five years. Publications ranging from
the Deutchemark the following year, appetite for adding to dollar balances The Economist, Business Week and Wall
and another 18 percent the year after must occur at some point.” continued on p. 18

CURRENCY TRADER • December 2004 17

 THE BIG PICTURE continued

FIGURE 1 — TWO CURRENT ACCOUNT PANICS: EURO/DOLLAR, 2003-2004 were willing to increase their net hold-
In late 2003 and currently, the dollar has plunged vs. the euro. ings of dollar-denominated assets by
5.8 percent in a month when the dollar
euro (EUR), daily 1.33 was falling by 1.3 percent. Crisis?
1.32
1.31 What crisis?
1.30 We have no hard evidence anybody
1.29
1.28 is unhappy about owning dollar-
1.27 denominated assets. In fact, the most
1.26
1.25 recent Treasury capital flow report
1.24 (Nov. 16) reports that net portfolio
1.23
1.22 investment rose to $63.4 billion in
1.21 September (from an upwardly-revised
1.20
1.19 $59.9 billion in August). Net portfolio
1.18 flows into the U.S. are averaging $72.2
1.17
1.16 billion per month so far this year, com-
1.15 pared to $58.2 billion in 2003 and $47.9
1.14
1.13 billion in 2002. And the cumulative
1.12 annual inflows are stunning — $649.5
Oct. Nov. Dec. 2004 Feb. Mar. Apr. May June July Aug. Sept. Ocr. Nov. billion in the first nine months of 2004:
Source: eSignal a 26 percent increase over 2003’s
$514.5 billion. Considering the actual
Street Journal to mass-market maga- would go into relatively deeper reces- rate of return on short-dated money is
zines and network TV news all sions and import even less from the zero or negative, this is quite a feat.
solemnly declare the dollar is going to U.S. This is a real Catch-22. China, for example, is sitting on $60
hell in a handbasket. So why do we have the Federal billion in dollar cash.
Traders flinch at such a consensus, Reserve and the U.S. Treasury out on The capital inflows are more than
because when everybody agrees and the conference circuit goading the for- enough to cover the current account
has already positioned himself short eign exchange market into a frenzy deficit, which is running at an annual
dollars, there’s nobody left to sell and over the current account deficit? After rate of about $665 billion. To speak of a
push the price down. all, the current account deficit has been funding crisis is to cry wolf, and
But academics and some analysts growing steadily since 2000 — the dol- Greenspan admits it:
flinch, too, because the global imbal- lar has gone up, down and sideways “Current account imbalances, per
ance is not necessarily a bad thing. during the same period. (In fact, it has se, need not be a problem, but cumula-
Besides, devaluing the dollar won’t fix done all three in the past year.) These tive deficits...raise more complex
anything — the trade deficit will not moves are not correlated with changes issues. Market forces should over time
improve by much. A 10-percent drop in the deficit, as illustrated by Figure 1. restore, without crises, a sustainable
in the dollar induces less than a 10-per- The global imbalance obviously U.S. balance of payments. At least this
cent (if any) improvement in the trade does not have a direct one-to-one rela- is the experience of developed coun-
balance. tionship with the dollar. From an eco- tries, which since 1980, have managed
Growth in the U.S. generates more nomic standpoint, in the typical trade- and eliminated large current account
imports than growth in other coun- deficit situation, importers create an deficits, some in double digits, without
tries. Even if all the major countries oversupply of the currency. In this major disruptions.”
had the same growth rate, the U.S. case, the oversupply of dollars should “Sustainable” deficits is a reference
would still import more than other make it less valuable. However, when to a study in 2000 by the Fed showing
countries would import, including demand for dollars is high for invest- the outer limit of a current account
from the U.S. Because correcting the ment purposes, the power of the trade deficit is about 5 percent, and after
current account imbalance is mostly a deficit to depress the dollar’s price that, currency depreciation kicks in as
case of correcting the trade imbalance, becomes weak, and everybody knows an balancing mechanism (www.feder-
the only way for the U.S. to export it. alreserve.gov/pubs/ifdp/2000/692/
more than it imports would be to go This is why, from a trader’s view- default.htm). Deficits become unsus-
into slower growth or even recession. point, the monthly trade figures don’t tainable when they reach or surpass 5
But the rest of the world relies on the contain useful information. These percent of a nation’s GDP.
U.S. for export-led growth, so if the days, it’s the capital flow report that The U.S. is beyond that point today.
U.S. imports less, other countries counts. In September, global investors The Q2 current account deficit stands

18 December 2004 • CURRENCY TRADER

at 5.7 percent of GDP, compared to the ment talking the dollar down is just a at all. It’s not about the current
previous high of 4.5 percent in 2000 precautionary measure. After all, you account, either, except as a reflection of
and 3.5 percent in 1986. The U.S. can argue the deficit is an integral part something else going on — the low
deficit is also about 1 percent of global of the international monetary system U.S. savings rate, which is joined at the
GDP and more importantly, takes today. Foreigners borrow in the dollar hip to the deficit. In short, it’s about
back, in the form of capital flows, as well as hold it as a store of wealth. nothing less than the sustainability of
about two-thirds of the cumulative In many instances, they use their store- the U.S. economy.
current account surpluses of all the of-wealth dollars as collateral for dol- It’s the other big fact of American
world’s surplus countries, according lar debt. Recently the National Bureau financial life: The U.S. is not only a
to Larry Summers, former Treasury of Economic Research sponsored a debtor nation, it is also a nation of
Secretary and now President of paper arguing the availability of these debtors. The saving rate in the U.S. is
Harvard University. The size is dollars “liberates” capital formation in only 1 to 2 percent of income, and has
unique. No country has ever run such poor countries from inefficient domes- been falling for over 20 years. In fact, it
massive deficits before. tic financial markets. The economists has fallen the most since 2000. All
say the empirical evidence (using value judgments aside, when a coun-
This time it’s different
Can we really say the U.S. is exempt
from the same fate that befell other In the peculiar way of markets, an official public
countries with unsustainable deficits?
Well, yes, and this is the sense in acceptance of the dollar falling can have the
which the Fed and the Treasury are
begging the market, “Please don’t perverse effect of lifting the dollar, at least for
throw me in the briar patch, Br’er
Fox.” None of the academic studies a while.
involves a country that has the world’s
largest and freest economy, that is the
sole military superpower, and that China as a test case) bears out the idea. try imports capital but then spends it
possesses the world’s largest financial This helps to explain why emerging on consumption goods rather than
markets boasting the highest liquidity, market countries show an outflow of capital investment, it is failing to pre-
transparency and variety of instru- some $450 billion in the latest year to pare for the future. From the point of
ments. rich countries, which seems like an view of the Fed chairman and Treasury
We honestly don’t know what con- aberration, unless some of the capital secretary as stewards of the economy,
stitutes “sustainability” regarding the is being recycled back to them in the it’s not the sustainability of the current
U.S., and we don’t want to find out. form of collateralized debt. account deficit we should be question-
We don’t know whether the dollar ing, but rather the sustainability of
should fall because of the current Debt: The story behind the U.S. growth. Abundant, cheap foreign
account deficit, but the attitude in story money has led us onto the path of
Washington seems to be, "Let’s talk it If the U.S. financial authorities are not profligacy, economically speaking.
down ahead of time, just in case." as scared as they want us to think, The high capital inflows have led
Without some amelioration of the what are they really up to? Talking the the U.S. into the bad habit of spending
deficit today, by next year it could be dollar down is, strangely, one way of too much and saving too little. How do
6.5 percent of GDP, 7.8 percent in 2008, talking it up. In the peculiar way of you induce people to save? In a free
or 13 percent by 2010, according to markets, an official public acceptance market economy, you give them
other studies cited by Summers. We of the dollar falling can have the per- inducements, like higher returns that
know we can escape through the briar verse effect of lifting the dollar, at least are more desirable than a better car or
patch of devaluation, but we have no for a while. To some extent, this is a another pair of shoes. Higher returns
idea what we would do if the current function of relief that everything is out can be delivered via tax breaks, too,
account deficit was 13 percent of GDP in the open, but it’s also a mark of but tax breaks are not the Fed’s to give.
and then the world’s investors decided respect and confidence in a govern- Higher returns are.
to bail out of dollar assets. Other coun- ment that hasn’t always earned praise But alas, all that foreign money is lit-
tries have survived such high deficits, from economists and financial experts erally standing in the way. In
but other countries don’t have the on other matters, such as fiscal recti- September, San Francisco Fed Presi-
U.S.’s place in the world. tude and trade protectionism. dent Yellen got this particular current
We have to ask whether the govern- But I suspect it’s not about the dollar continued on p. 20

CURRENCY TRADER • December 2004 19

 THE BIG PICTURE continued

account panic rolling by saying the Fed The market talks about the sustain- The wildly uneven cost of labor can
wants to normalize interest rates by ability of the current account deficit. never be equilibrated by mere curren-
nudging them higher, but the relatively Financial economists talk about the cy price adjustments. China will
high dollar is an obstacle. The Fed sustainability of the inward capital always be able to compete with U.S.
wants to normalize interest rates to a flows. But the Fed and the Treasury companies and export to the U.S. more
historically neutral level, thought to be view both the current account and the than it imports.
about 3 to 3.5 percent (from the current capital account as a by-product of real Because of the unique and unprece-
2 percent). But the Fed can manage economic activity, and what they talk dented position of the U.S. in the
rates only at the very short end of the about is the sustainability of U.S. world economy and financial system,
yield curve. The relatively high dollar growth. If it takes a weaker dollar, so devaluing the dollar is not going to
draws in foreign capital that allows
rates at the longer end of the yield
curve to be artificially low. The U.S. is not only a debtor nation; it is also
The last thing the Fed wants is a cri-
sis where it has to raise interest rates to a nation of debtors.
prevent a run on the currency, which is
what happened in the UK in 1991. The
Bank of England raised rates 3 percent be it. The dollar is not the central thing. take the current account deficit to zero
in the space of a few days in an effort In this context, it’s only a unit of or transform it into a surplus. Asian
to control the pound falling out of the account. This is the sense in which all revaluation will go a long way toward
European Rate Mechanism (the occa- the hullabaloo about the sustainability reducing the horrendous size of the
sion of Mr. Soros’ fabled billion-dollar of the current account is a hoax. It is deficit, but even after China, South
profit). It may not be too fanciful to sustainable today, but as the U.S. econ- Korea and the others revalue, we will
imagine that the Fed has been deliber- omy becomes less independently still have a trade deficit for decades to
ately driving the dollar down to avoid capable of prosperity, the longer it come. The terms of trade are against
exactly this outcome — not because it relies on foreign savings. the U.S. — Americans simply have too
gives a fig about the dollar per se, but Now we have come full circle. The high a standard of living relative to the
because it wants to set rates in its own current account deficit is not really cre- rest of the world. Moreover, as
time and according to its own ideas. ating a dollar crisis — the Fed and the Greenspan said in Berlin, raising the
Consider the Fed’s mandate. Yes, it Treasury are talking it down. They savings rate in the U.S. will go toward
has to maintain financial market stabil- must know the lower dollar will not fixing the true current account prob-
ity, but it’s far more interested in cause much improvement in the cur- lem, the dependence on foreigners, but
growth and employment than in the rent account, even if other efforts it can’t do the whole job. So, even in
terms of trade, except as the terms of behind the scenes are successful in the best of all possible worlds, we are
trade influence domestic production. pressuring China to revalue the ren- stuck with a "structural" deficit. The
Here is the hidden agenda. The Fed mimbi. It’s silly to be selling the dollar next job for the market is to decide
wants to normalize rates, not for the against the euro and other European upon a deficit-to-GDP ratio it can live
sake of normalization, but to prevent a currencies when Europe accounts for with. What’s the number? Something
run on the dollar and to restore the only about 9 percent of trade. China south of 5% of GDP.
incentive to save. After all, if the U.S. alone accounts for 30 percent of the The true solution to the U.S. current
consumed less and saved more, the deficit, and a growing proportion of it. account deficit is to let it wax and wane
trade deficit would be substantially Asia, including Japan, accounts for with cyclical developments, but not to
lower and no one would feel the urge over half of the deficit. depend on offsetting foreign capital
to stage a run on the dollar in the first But negotiations to get Asian coun- inflows. Foreign capital inflows should
place. The U.S. would not need capital tries, especially China, to repeg or to be the icing on the cake, not the cake.
flow from foreign countries to fund the float their currencies are matters of The cake should be domestic savings
current account deficit — it would state, not of economic and financial adequate to fund capital investment.
have sufficient domestic savings to management. China’s revaluation, The only way to lift up the savings rate
buy all the government and corporate which will probably occur within the is to raise the rate of return. Who is in
debt instruments on offer. This is not to next year, will provide some minor charge of rates of return? The Fed —
say the Fed places a moral judgment relief in the current account, but not a but also the folks in Washington who
on saving as a social virtue, but rather permanent fix. After all, China has bil- pass tax bills. Privatization of Social
as the one truly sustainable mecha- lions of people willing to work for Security, anyone?

nism to ensure further growth and pennies in order to get a bicycle, a
employment. sewing machine and indoor plumbing. For information on the author see p. 8.

20 December 2004 • CURRENCY TRADER

 THE GLOBAL ECONOMY continued from page 14

FIGURE 2 — AUD/USD: MORE ROOM TO MOVE?

cost of exports. Australia is a major
exporter of coal, wheat, natural gas, The Aussie dollar has skyrocketed vs. the U.S. dollar since September. The next
technical resistance zone is around 80.00 –– the level of the February 2004 top.
gold and steel. The Reserve Bank of
Australia estimated its commodity Australian dollar/U.S. dollar (AUD/USD), weekly 0.80
price has risen 16 percent year-over-
0.78
year, as of October.
“That directly helps Australia’s 0.76
export revenue,” Callow explains. 0.74
Callow also notes that speculators
0.72
looking for a place to put on bearish
trades on the U.S. dollar have an 0.70
advantage of buying the Aussie dollar 0.68
because, “you get a decent yield pick-
0.66
up and are not likely to face a central
bank on the other side. The Reserve 0.64
Bank of Australia does intervene at 0.62
times, but generally it is small scale.
They will not be trying to take on the 0.60
market.” 0.58
Near term, Callow sees the 0.56
AUD/USD testing the 80.00 mark, 2003 Apr. July Oct. 2004 Apr. July Oct.
possibly before year-end. If that level
cracks, Callow expected additional Source: TradeStation
upside momentum toward the 82.00
or 83.00 area by first quarter 2005. FIGURE 3 — USD/CAD: SET TO CHALLENGE THE ROUND NUMBER
The USD/CAD rate has continued to set new lows after breaking below a series
Weak buck trade of short consolidations. With no previous chart level to reference, the “whole
Guy Gengle, vice president of dealing number” of 1.18 is the next likely support level to watch.
at Global Forex Trading (GFT), points
to the U.S. dollar/Canadian dollar U.S. dollar/Canadian dollar (USD/CAD), daily 1.38
(USD/CAD) as a hot trade to watch.
1.36
Over the longer-term, Gengle says “I
don’t think you can negate the weaker 1.34
(U.S.) dollar.”
A look at a daily USD/CAD chart 1.32
reveals a steady and strong down-
1.30
trend in the USD, and the CAD at its
highest level vs. the buck in more than 1.28
a decade.
As of mid-November, the USD/ 1.26
CAD had pushed to a new low at the
1.24
1.18 area (Figure 3). Gengle sees
potential for a short-term corrective 1.22
bounce in the dollar, vs. Canada,
which could offer short-term traders 1.20
plenty of opportunity, he said. A cor- 1.18
rective rebound could see USD/CAD June July Aug. Sept. Oct. Nov.
bounce up toward the $1.22/1.23 Source: TradeStation
zone, Gengle speculates.
Looking beyond any market correc- Gengle says. On the downside, he high- haps even as low as $1.12/1.13.

tion, however, the longer-term down- lighted the $1.18 area as a “big level.”
trend in the U.S. dollar vs. the Declines through that floor could open To read about a trade in the USD/CAD
Canadian dollar was likely to resume, the door to further depreciation, per- rate, see this month’s Forex Diary (p. 48).

CURRENCY TRADER • December 2004 21

 CURRENCY CHARACTERISTICS

The short-term
British pound/Japanese yen
carry trade
BY CURRENCY TRADER STAFF

It pays to have a currency pair’s rollover charges on your side.

Find out how the daily rollover has affected GBP/JPY — a popular carry trade — in recent years.

R ollover fees are often

overlooked, yet they
can seriously affect a
forex trade’s profit or
loss, depending on the currency pair,
your forex dealer’s rules and each
trade’s length. These charges are based
rollover time — typically 5 p.m. ET.
For example, if you go long
GBP/USD and hold it “overnight,” or
past 5 p.m., your forex broker may
give you a small credit because you
bought British pounds and sold U.S.
dollars at the same time, and short-
trade “rolls over” into the next day.
(For more information about rollovers,
see “Rollover fees: Understanding the
fine print.”)
While rollovers don’t apply to intra-
day traders, this feature is the crux of
the carry trade, or buying a currency
on the interest-rate difference between term interest rates are currently higher with a higher interest rate and simulta-
the currency you buy and the one you in Great Britain than the U.S. Similarly, neously selling one with a lower rate
sell (or vice versa) when you trade a if you short this currency pair, your and earning the difference between
currency pair and hold it past the daily broker may charge a small fee as the both rates (see “Getting a lift from the
carry trade,” Currency Trader, Oct.
2004). Like dividends, any rollover
FIGURE 1 — AVERAGE DAILY GBP/JPY MOVES, MARCH 2001 TO OCT. 2004 fees you earn (or owe) are separate
Over the past three years, the GBP/JPY currency pair has slumped at the start from the currency pair’s gains or loss-
of the week and began a slight rally on Wednesday. This pattern suggests that es, but they can help enhance a trade’s
traders boost the GBP/JPY as they attempt to gain from Wednesday’s profit or mitigate its loss if the daily
two-day rollover. rollover is in your favor.

Average GBP/JPY daily performance,

Rollover opportunity?
March 2001 to October 2004
Many traders view the carry trade as a
0.05%
longer-term (i.e., days, weeks or
Average gain/loss (%)

0.04%
0.03% months) approach since the interest you
0.02% earn is based on the trade’s length. In
0.1% theory, however, it’s possible to buy a
0.00% currency pair such as the British
-0.01%
-0.02%
pound/Japanese Yen (GBP/JPY),
-0.03% whose base currency’s interest rate (4.75
-0.04% percent) is much higher than the quote
Monday Tuesday Wednesday Thursday Friday currency’s rate (0 percent), just before
the day’s rollover, earn the rollover cred-
it and exit the trade following this event.
Source: Fxtrek
Because GBP/JPY’s rollover credit is

22 December 2004 • CURRENCY TRADER

three times as large on Wednesdays to Rollover fees:
account for the weekend (see sidebar),
this study focuses on the currency
Understanding the fine print
pair’s behavior in the days and hours

G
surrounding this weekly occurrence.
etting a straightforward answer about daily rollover fees from your
We analyzed daily GBP/JPY per-
forex broker isn’t easy. Although rollover fees are based on the short-
formance since March 2001 to find out
term interest-rate differences of the two currencies you exchange for
how Wednesday’s triple rollover costs
one another in the forex spot (cash) market, each FX dealer has its own rules,
influenced this pair’s behavior. We
which can make the process confusing.
then studied hourly GBP/JPY price The spot market has a two-day settlement period, which means that if you buy
data surrounding each day’s 5 p.m. one GBP/JPY standard lot (£100,000) on Tuesday, the transaction will settle on
rollover time since January 2003 to Thursday. If you hold this trade past 5 p.m. on Tuesday, your broker will roll the
find out how this event affected intra- settlement forward to Friday and may add between $1 and $20 to your account
day price moves. as they calculate interest you earned.
Overall, GBP/JPY slumped on As of Nov. 16, Great Britain’s short-term interest rate was 4.6 percent higher
Monday and Tuesday, but rose than Japan’s (4.75 percent and 0.15 percent, respectively, according to
Wednesday through Friday. On an Forexnews.com). Therefore, the daily rollover credit on this trade is roughly
intraday basis, GBP/JPY climbed as the $12.60, or ($100,000 * 4.6 percent)/365. (The actual rollover amount depends on
5 p.m. rollover approached and sold off your balance and the difference between GBP’s borrowing rate and JPY’s lending
rate.)
in the early evening — a pattern that
Wednesday’s rollover is three times as large because it accounts for interest
was magnified on Wednesday. Both earned over the weekend. For example, if you enter and exit a trade on
tendencies suggest traders bid up Wednesday prior to rollover, both trades settle on Friday. However, if you hold the
prices in anticipation of the daily trade “overnight” and close it after the rollover, your trade won’t settle until
rollover, especially Wednesday’s three- Monday, and you earn (or pay) three days of interest instead of one. Trades that
day interest-rate payoff. should settle on holidays also earn (or owe) an additional day’s interest.
However, forex dealers are not obligated to pay interest. Some brokers, such
The short-term GBP/JPY carry as Forex Capital Markets (FXCM), only credit your account if you trade with at
trade least 2 percent margin. Oanda calculates interest earned on currency pairs each
On March 19, 2001, the Japanese gov- second, instead of once a day. Other brokers charge a daily rollover fee even if
ernment lowered its overnight inter- you’re long a higher-interest-rate currency.
Most FX dealers’ rollover time is 5 p.m. ET, but other brokers such as GFT
est-rate target to 0 percent and has
Forex and MG Financial Group roll positions forward at 3 p.m. ET.
held it at that level for 44 months,
which means that traders can borrow
the yen and pay no short-term interest.
In contrast, Great Britain’s short-term TABLE 1 — AVERAGE DAILY GBP/JPY STATS — MARCH 2001 TO OCT. 2004
interest rate was 5.75 percent in early
March 2001, and has been at least 3.50 Wednesdays and Thursdays have been GBP/JPY's most bullish days since the
percent over the same period. Japanese government lowered short-term interest rates to zero on March 19, 2001.
Therefore, the British pound/Japanese Monday Tuesday Wednesday Thursday Friday
yen has provided a daily rollover pay-
Instances 186 187 189 187 186
ment for buyers since March 2001.
Figure 1 shows the average daily Avg: 0.00% -0.03% 0.03% 0.04% 0.02%
GBP/JPY performance on each day of Med: -0.04% -0.02% 0.07% 0.09% -0.01%
the week from March 20, 2001 to Benchmark: 0.01% 0.01% 0.01% 0.01% 0.01%
October 29, 2004 (935 trading days),
Max: 1.92% 2.05% 2.00% 2.08% 2.11%
and compares each price move to its
benchmark move, or typical daily Min: -1.51% -1.94% -2.74% -2.26% -1.79%
behavior during the same period. Pct. >0: 46.24% 48.66% 56.61% 57.75% 49.46%
Because the forex market trades 24
Source: Fxtrek
continued on p. 24

CURRENCY TRADER • December 2004 23

 CURRENCY CHARACTERISTICS continued

Average and median

average performance and compares it
to its median, benchmark, maximum

T he mean (or average) of a set of values is the sum of the values divid-
ed by the number of values in the set. If a set consists of 10 numbers,
add them and divide by 10 to get the mean.
A statistical weakness of the mean is that it can be distorted by exceptionally
large or small values. For example, the mean of 1, 2, 3, 4, 5, 6, 7, 200 is 28.5
and minimum values. The table also
lists each day’s percentage of positive
moves. A comparison of the table’s
average and median values suggests
GBP/JPY’s lackluster performance
(228/8). Take away 200, and the mean of the remaining seven numbers is 4,
during the first two days of the week is
which is much more representative of the numbers in this set than 28.5.
accurate, but its climb on Wednesday
The median can help gauge how representative a mean really is. The median
and Thursday might be slightly higher
of a data set is its middle value (when the set has an odd number of elements) or
than Figure 1 shows.
the mean of the middle two elements (when the set has an even number of ele-
For example, the pound/yen’s aver-
ments). The median is less susceptible than the mean to distortion from extreme,
age is flat on Monday, but its median is
non-representative values. The median of 1, 2, 3, 4, 5, 6, 7, 200 is 4.5 ((4+5)/2),
-0.04 percent, which suggests a few
which is much more in line with the majority of numbers in the set.
extreme positive moves skewed the
average higher than it should be.
hours a day, our Comstock data (via percent, but Wednesday’s 0.03-percent Similarly, Wednesday’s and Thurs-
FXtrek) measured each day from 5 gain began a modest three-day rally, day’s medians are higher than their
p.m. ET to 5 p.m. the next day. which beat its benchmark each day and average values, which suggest the
The daily price moves in Figure 1 are totaled 0.09 percent. The figure shows opposite condition.
quite small, but they illustrate interest- the pound/yen posted the largest aver- GBP/JPY’s largest average and
ing patterns. GBP/JPY tended to trade age daily gain (0.04 percent) on median gains (0.04 and 0.09 percent,
sideways on Monday, lagging its 0.01- Thursday, and inched 0.02 percent respectively) as well as its highest
percent benchmark. On Tuesday, the higher on Friday. probability of gains (57.75 percent) oc-
currency pair dropped an average -0.03 Table 1 (see p. 23) shows each day’s curred on Thursday.

FIGURE 2 — AVERAGE FOUR-HOUR GBP/JPY PRICE MOVES, JANUARY 2003 TO OCTOBER 2004
The daily 5 p.m. (ET) rollover time only seems to influence GBP/JPY on Wednesdays and Thursdays. Wednesday’s rollover
costs are doubled to account for holding the currency pair over the weekend, and the figure shows that GBP/JPY rose on
Wednesday afternoon prior to the 5 p.m. rollover and briefly dropped after the event.

Average four-hour GBP/JPY performance during the week, January 2003 to October 2004
0.06%

0.04%
Average gain/loss (%)

0.02%

0.00%

-0.02%

-0.04%

-0.06%
a.m.
a.m.
p.m.
p.m.

9 p.m.
1 a.m.

a.m.
a.m.
p.m.
p.m.

9 p.m.
1 a.m.

a.m.
a.m.
p.m.
p.m.

9 p.m.
1 a.m.

a.m.
a.m.
p.m.
p.m.

9 p.m.
1 a.m.

a.m.
a.m.
p.m.
p.m.

5 p.m. to 9 p.m.
9 p.m. to 1 a.m.
5
9
1
5

5
9
1
5

5
9
1
5

5
9
1
5

5
9
1
5
to
to
to
to

5 p.m. to
9 p.m. to

to
to
to
to

5 p.m. to
9 p.m. to

to
to
to
to

5 p.m. to
9 p.m. to

to
to
to
to

5 p.m. to
9 p.m. to

to
to
to
to
R

R
a.m.
a.m.
a.m.
p.m.

a.m.
a.m.
a.m.
p.m.

a.m.
a.m.
a.m.
p.m.

a.m.
a.m.
a.m.
p.m.

a.m.
a.m.
a.m.
p.m.
1
5
9
1

1
5
9
1

1
5
9
1

1
5
9
1

1
5
9
1

Monday Tuesday Wednesday Thursday Friday Sunday

Source: Fxtrek

24 December 2004 • CURRENCY TRADER

 TABLE 2 — AVERAGE FOUR-HOUR STATS, JANUARY 2003 TO OCTOBER 2004
While the most dramatic drop occurred from the four-hour period before the 5 p.m.(ET) rollover
to four hours after the event on Wednesday (0.03-percent average gain to -0.05-percent aver-
When the clock age loss), the currency pair lost ground between these two periods on each day of the week
strikes five
1 a.m. to 5 a.m. to 9 a.m. to 1 p.m. to RR 5 p.m. to 9 p.m. to
Figure 1 and Table 1 show 5 a.m. 9 a.m. 1 p.m. 5 p.m. 9 p.m. 1 a.m.
GBP/JPY rose toward the
middle of the week, but Monday 95 95 95 95 95 94
they don’t indicate wheth- Avg: -0.05% 0.03% -0.01% 0.01% -0.02% 0.03%
Med: -0.03% 0.01% -0.01% 0.01% -0.01% 0.04%
er Wednesday’s unique
Max: 0.59% 1.28% 0.55% 0.88% 0.79% 0.76%
rollover affects the pair’s
Min: -0.74% -0.79% -1.17% -0.42% -0.90% -0.62%
price moves surrounding Pct >0: 45.26% 51.58% 48.42% 51.58% 46.32% 58.51%
this event. To find out if this
weekly occurrence has Tuesday 94 94 94 94 94 94
influenced GBP/JPY prices, Avg: -0.02% -0.03% -0.04% 0.01% -0.01% 0.00%
Med: -0.01% -0.03% -0.03% 0.00% -0.01% 0.00%
we studied hourly price
Max: 0.83% 1.01% 0.73% 0.81% 0.33% 0.38%
data from Jan. 1, 2003 to
Min: -1.04% -0.78% -0.85% -0.51% -0.58% -0.69%
Oct. 31, 2004, or 475 trading Pct. > 0: 47.87% 47.87% 44.68% 51.06% 48.94% 45.74%
days, and divided each day
into six 4-hour periods, Wednesday 95 95 95 95 94 94
with the 5 p.m. rollover as Avg: -0.02% 0.04% 0.04% 0.03% -0.05% 0.00%
Med: -0.01% 0.03% 0.04% 0.04% -0.04% 0.00%
the focal point: 1 a.m. to 5
Max: 0.58% 0.93% 0.90% 0.52% 0.45% 0.78%
a.m., 5 a.m. to 9 a.m., 9 a.m.
Min: -0.94% -1.06% -0.74% -0.41% -0.61% -0.43%
to 1 p.m., 1 p.m. to 5 p.m., 5 Pct. >0: 46.32% 52.63% 54.74% 53.68% 32.98% 51.06%
p.m. to 9 p.m. and 9 p.m. to
1 a.m. the next day. Thursday 95 95 95 95 95 95
Figure 2 shows the aver- Avg: 0.02% 0.02% 0.06% 0.06% 0.04% 0.00%
Med: 0.04% -0.01% 0.07% 0.07% 0.02% -0.03%
age gains or losses for each
Max: 0.67% 1.07% 0.97% 0.37% 0.68% 0.82%
four-hour period during
Min: -0.81% -0.80% -0.64% -0.31% -0.26% -0.40%
the entire week (30 total Pct. >0: 52.63% 49.47% 60.00% 65.26% 52.63% 37.89%
periods), which start and
end at 1 a.m. ET on Friday* 96 96 96 96 96 95
Monday morning. (The Avg: -0.06% -0.02% -0.02% 0.05% -0.04% -0.02%
Med: -0.06% -0.02% -0.05% 0.06% -0.04% -0.02%
forex market is closed from
Max: 0.54% 0.90% 0.98% 0.81% 0.86% 0.45%
Friday at 5 p.m. to Sunday
Min: -1.14% -0.88% -0.71% -0.51% -0.76% -0.57%
at 2 p.m. Our data resumed Pct. > 0: 42.71% 45.83% 41.67% 60.42% 45.83% 42.11%
on Sunday at 5 p.m., except
between July 18 and Oct. Overall 475 475 475 475 474 472
31, 2004, when it began on Avg: -0.03% 0.01% 0.01% 0.03% -0.02% 0.00%
Med: -0.02% -0.01% 0.00% 0.03% -0.02% -0.01%
Sundays at 4 p.m.)
Max: 0.83% 1.28% 0.98% 0.88% 0.86% 0.82%
A distinct pattern
Min: -1.14% -1.06% -1.17% -0.51% -0.90% -0.69%
appears in the two four- Pct. >0: 46.95% 49.47% 49.89% 56.42% 45.36% 47.03%
hour periods surrounding
each day’s 5 p.m. rollover, * The forex market closes at 5 p.m. on Friday so the evening hours (5 p.m. to 9 p.m.) shown here are
actually Sunday's price moves (see Figure 2).
which is labeled “R” in
Figure 2. GBP/JPY gained Source: Fxtrek
ground from 1 to 5 p.m.
and fell from 5 to 9 p.m. each day than its post-rollover, eight-hour gain Figure 2 also shows that the currency
except Thursday. Although GBP/JPY from 5 p.m. to 1 a.m. (0.12 percent and pair’s tendency to rise prior to this
continued to rise immediately follow- 0.04 percent, respectively). event and sell off afterwards has been
ing Thursday’s rollover, the currency On Tuesday and Friday, GBP/JPY strongest on Wednesday. The
pair’s rally in the eight hours leading fell throughout the day except in the pound/yen increased 0.11 percent in
up to rollover was three times as large four-hour period from 1 p.m. to 5 p.m. continued on p. 26

CURRENCY TRADER • December 2004 25

 CURRENCY CHARACTERISTICS continued

the 12 hours preceding rollover — the than 50 percent. widened from -0.51 to -0.90 percent,
figure’s second highest 12-hour gain Table 2’s larger gains and losses also and its chance of gains dropped from
— and then dropped -0.05 percent in correspond to greater chances of mov- 56.42 to 45.36 percent following the
the subsequent four hours. ing in the desired direction. For exam- rollover — two further signs the
Despite this brief loss, Figure 2 ple, Thursday’s 0.06-percent increases decline is accurate.
shows GBP/JPY’s most bullish period in the two four-hour segments from 9 Figure 3 highlights GBP/JPY’s aver-
occurred from Wednesday at 5 a.m. to a.m. to 5 p.m. have two of the table’s age four-hour gains and losses on
Wednesday and Thursday and com-
pares them to the currency pair’s overall
FIGURE 3 — FOUR-HOUR PRICE MOVES REVISITED performance. Though the pound/yen’s
This figure compares Wednesday’s and Thursday’s four-hour GBP/JPY perform- Wednesday performance adheres to the
ance with the overall pattern since January 2003. The currency pair tended to established pattern, its bullish behavior
rise in the 12 hours preceding its 5 p.m. (ET) rollover and sell off in the early on Thursday stands out.
evening. However, GBP/JPY was most bullish on Thursdays as it gained ground GBP/JPY posted average gains in
from 5 a.m. to 1 a.m. the next day. five of Figure 3’s six periods on
Thursday, which was the only day the
Average four-hour GBP/JPY performance
currency pair gained ground following
surrounding the 5 p.m. (ET) rollover time
each rollover (see Figure 2 and Table 2).
(Wednesday vs. Thursday vs. overall),
January 2003 to October 2004 Wednesday
0.08% Thursday One hour at a time
To analyze the pound/yen’s behavior
0.06% Friday
around the 5 p.m. rollover in more
Average gain/loss (%)

0.04% detail, we measured the currency

0.02% pair’s hourly gains and losses from 1
p.m. to 9 p.m. and focused on the two
0.00%
hours immediately surrounding the
-0.02% daily rollover. Figure 4 is similar to
-0.04% Figure 3, but shows GBP/JPY’s aver-
age performance over a shorter time-
-0.06%
1 a.m. to 5 a.m. to 9 a.m. to 1 p.m. to R 5 p.m. to 9 p.m. to frame.
5 a.m. 9 a.m. 1 p.m. 5 p.m. 9 p.m. 1 a.m. In general, the pound/yen rallied
during three of the four hours prior to
Source: Fxtrek
rollover and sold off between 5 p.m.
and 6 p.m. The currency pair then
Thursday at 9 p.m. three highest probabilities of gains (60 traded sideways in the final three
Table 2 (see p. 25) compares various and 65.26 percent, respectively). hours. It’s no surprise GBP/JPY
statistics for all 30 four-hour periods Wednesday’s shift from a 0.03-per- gained ground on Thursday during
shown in Figure 2 (average, median, cent average gain from 1 p.m. and 5 seven of the eight hours shown in
maximum and minimum values and p.m. to a -0.05-percent loss following Figure 4, but it’s interesting the one
percentage of positive moves). The the rollover is the second-largest lackluster hour occurred right after the
table’s final six rows summarize the dropoff between time segments. rollover. Wednesday’s gains and losses
pound/yen’s intraday performance. However, the currency pair’s probabil- are less consistent, but it’s clear that
The table shows that each period’s ity of gains sank from 53.68 to 32.98 GBP/JPY fell further than usual fol-
average and median values are rough- percent in that same period — the lowing that triple rollover.
ly in line with each other, which indi- table’s largest probability decline. Table 3 is identical to Table 2, except
cates GBP/JPY’s gains and losses in Table 2’s summary statistics confirm it tracks the pound/yen’s performance
Figure 2 are fairly reliable. As expect- GBP/JPY tended to climb briefly prior in hourly segments. The currency
ed, all but one of the periods’ average to rollover and sink after the event. pair’s average price moves are even
gains in Table 1 also have a greater Overall, the currency pair rose 0.03 smaller here than in Table 2, but
chance of gaining ground than losing percent, on average, from 1 p.m. to the GBP/JPY still tended to increase
it (i.e., the percentage of positive 5 p.m. rollover and then fell 0.02 per- slightly as 5 p.m. approached and sink
moves is greater than 50 percent). cent in the following four hours. following it.
Similarly, each of the table’s average Although this change is small, the This study’s average price moves
losses has a winning percentage of less prior period’s biggest individual loss seem almost too small to trade, but

26 December 2004 • CURRENCY TRADER

TABLE 3 — HOURLY STATS
Although the average hourly GBP/JPY changes are quite small, there is a distinct shift in the two hours surrounding the daily 5 p.m.
rollover. The percentage of positive price moves sinks from above 50 percent to below that level on each day (except Thursday).

1 to 2 p.m. 2 to 3 p.m. 3 to 4 p.m. 4 to 5 p.m. R 5 to 6 p.m. 6 to 7 p.m. 7 to 8 p.m. 8 to 9 p.m.

Monday Avg: 0.01% -0.02% 0.00% 0.02% -0.01% -0.01% 0.01% -0.01%
Med: 0.02% -0.01% 0.00% 0.01% -0.01% 0.00% 0.01% -0.01%
Max: 0.73% 0.25% 0.20% 0.27% 0.31% 0.32% 0.60% 0.45%
Min: -0.58% -0.35% -0.20% -0.19% -0.41% -0.26% -0.62% -0.56%
Pct. > 0: 55.79% 43.16% 49.47% 56.84% 45.26% 49.47% 51.58% 47.37%
Tuesday Avg: 0.01% -0.02% 0.00% 0.02% -0.01% 0.00% 0.00% 0.01%
Med: 0.02% -0.03% 0.01% 0.02% 0.00% 0.01% -0.01% 0.02%
Max: 0.39% 0.34% 0.20% 0.36% 0.33% 0.18% 0.31% 0.41%
Min: -0.34% -0.37% -0.34% -0.15% -0.26% -0.20% -0.30% -0.39%
Pct. > 0: 56.38% 38.30% 52.13% 59.57% 46.81% 54.26% 45.74% 55.32%
Wednesday Avg: 0.01% -0.02% 0.03% 0.01% -0.02% -0.02% 0.00% -0.01%
Med: 0.01% -0.02% 0.02% 0.01% -0.01% -0.01% -0.01% -0.01%
Max: 0.36% 0.33% 0.28% 0.24% 0.13% 0.47% 0.36% 0.32%
Min -0.48% -0.37% -0.23% -0.20% -0.26% -0.35% -0.53% -0.81%
Pct. > 0: 55.79% 43.16% 69.47% 56.84% 42.11% 40.00% 46.32% 48.42%
Thursday Avg: 0.01% 0.01% 0.02% 0.01% -0.02% 0.01% 0.01% 0.03%
Med: 0.02% 0.01% 0.01% 0.02% 0.01% 0.01% 0.01% 0.03%
Max: 0.37% 0.24% 0.31% 0.20% 0.22% 0.20% 0.53% 0.38%
Min -0.19% -0.21% -0.20% -0.16% -0.26% -0.24% -0.30% -0.28%
Pct. > 0: 56.25% 54.17% 54.17% 58.33% 52.08% 54.17% 56.25% 59.38%
Friday* Avg: 0.00% 0.01% 0.01% 0.02% -0.06% 0.01% 0.01% 0.00%
Med: -0.01% 0.01% 0.00% 0.02% -0.04% 0.02% 0.02% -0.01%
Max: 0.39% 0.31% 0.29% 0.35% 0.56% 0.43% 0.51% 0.45%
Min -0.35% -0.45% -0.20% -0.28% -0.83% -0.57% -0.41% -0.35%
Pct. > 0: 47.37% 54.74% 44.21% 57.89% 32.63% 58.95% 56.84% 46.32%
Overall Avg: 0.01% -0.01% 0.01% 0.02% -0.02% 0.00% 0.00% 0.00%
Med: 0.01% 0.00% 0.01% 0.02% -0.01% 0.01% 0.01% 0.01%
Max: 0.73% 0.34% 0.31% 0.36% 0.56% 0.47% 0.60% 0.45%
Min -0.58% -0.45% -0.34% -0.28% -0.83% -0.57% -0.62% -0.81%
Pct. > 0: 54.32% 46.74% 53.89% 57.89% 43.79% 51.37% 51.37% 51.37%
* The forex market closes at 5 p.m. on Friday so the evening hours (5 p.m. to 9 p.m.) shown here are actually Sunday's price moves (see Figure 2).
Source: Fxtrek

FIGURE 4 — HOURLY GBP/JPY PERFORMANCE

Table 2 shows these tendencies are
On an hourly basis, the currency pair rose two hours before the 5 p.m. (ET)
more compelling when multiple rollover and fell immediately following it.
measures of performance such as
average, median and percentage of Average hourly GBP/JPY performance
positive moves all point in the same surrounding the 5 p.m. (ET) rollover time
direction. (Wednesday vs. Thursday vs. overall), Wednesday
January 2003 to October 2004 Thursday
Figures 2 and 3 suggest going long 0.04%
Average gain/loss (%)

GBP/JPY at 1 a.m. on Thursday, hold 0.03% Friday

the trade past the 5 p.m. rollover and 0.02%
exit at 9 p.m. Figure 4 shows you may 0.01%
have to weather a small drop follow- 0.00%
ing the rollover, and you won’t earn as -0.01%
much interest if you entered the trade -0.02%
-0.03%
on Wednesday. However, you’ll prob- 1 to 2 2 to 3 3 to 4 4 to 5 R 5 to 6 6 to 7 7 to 8 8 to 9
ably profit more from higher GBP/JPY p.m. p.m. p.m. p.m. p.m. p.m. p.m. p.m.
prices than from additional rollover
fees.

Source: Fxtrek

CURRENCY TRADER • December 2004 27

 CURRENCY STRATEGIES

The macro factor

Most active traders favor technical trading approaches, but the effectiveness of price-based
approaches depends on understanding the macroeconomic and fundamental factors
driving the currency market.

BY DAVE FLOYD

W hile most individ-

ual traders doubt
the usefulness of
fundamental
macroeconomic analysis, many of the
largest players in the FX market rely
heavily on it.
or

Although the conclusions you draw

from macro or technical analysis might
ultimately be similar, having a tangible
rationale for entering the market, as
opposed to simply obeying a line on a
chart, can do a great deal to bolster
confidence in your trading and deepen
your understanding of how foreign
exchange works.
We’ll review some of the key macro
factors in the FX markets and see how
they can provide insight into potential traders at a given time. They are easy fits those currencies.
market moves. Then we’ll look at some to understand and illustrate in the In a time with historically low inter-
recent trades illustrating how to com- market. est rate yields worldwide, traders will
bine macro research with technical often accept greater risk to seek out
patterns. Interest rates: those markets offering the highest
Although there are any number of Attracting capital yield. In the U.S., the Federal Funds
fundamental factors at work in the FX An interest rate differential is the rate is at 2 percent after the Federal
market at a given time, we will spread between the prevailing interest Reserve raised the rate .25 points at its
address the following three: interest rates in two countries. All else being Nov. 9 meeting, while New Zealand
rate differentials, commodity prices equal, capital flows to countries offer- has an equivalent rate of 6.25 percent
and the level of risk aversion among ing higher interest rates, which bene- (the next meeting is this month, with

28 December 2004 • CURRENCY TRADER

 FIGURE 1 — CANADIAN DOLLAR AND COMMODITIES
The USD/CAD rate tends to move inversely to commodity prices, shown here
by the Reuters/Commodity Research Bureau (CRB) index. The correlation figures show the
negative relationship between the two. Note the five-year correlation (far right) is -0.81,
no hike expected), making indicating the two price series have had a strong tendency to move in opposite directions.
the New Zealand dollar
(NZD) a more attractive USD/CAD vs. CRB Index
currency to hold than the 1.65 300
U.S. dollar (USD) in terms 280
of yield. 1.55
However, the NZD’s 260
yield does not represent a USD/CAD CRB Index
1.45 240
risk-free rate. If the NZD
depreciated vs. the USD 220
during the time of your 1.35
investment in New 200
Zealand, the rate differen- 1.25 180
tial advantage could be 2001 2002 2003 2004
wiped out. Hence, gain- Correlations
ing an extra 4.25 percent
(the difference between 1.00
the two rates) per annum 0.00
while also enjoying the -1.00
-0.83 -0.91 -0.86 -0.79 -0.38 0.10 -0.68 -0.81
potential capital apprecia-
tion on the long NZD 5D 10D 1M 3M 6M 1 year 2 year 5 year
position itself has been a
Source: 4Cast
logical move for many
traders.
FIGURE 2 — OIL AND YEN
Commodity prices The fact the euro/Japanese yen rate tends to be positively correlated to crude oil (meaning
Commodities are the driv- the yen drops in value as crude appreciates) underscores the yen’s vulnerability
ing force of growing to rising oil prices.
economies. China has
Brent crude vs. EUR/JPY
emerged as a major player 46 Brent EUR/JPY 145
in worldwide manufac- 41
135
turing and has become a 36
31 125
large consumer of com- 26 115
modities such as oil and 21 105
grains. Surprisingly, how-
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
2003
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Nov.
Dec.
2004
Feb.
Mar.
Apr.
May
June
July
Aug.
Sept.

ever, China does not pro-

duce much in the way of 0.13 0.75 0.93 0.77 0.53 0.53 0.40 0.35
agriculture, so commodi- 1.00
0.00 Correlations
ty-based economies that
stand to export heavily to 5D 10D 1M 3M 6M 1 year 2 year 5 year
China, such as Australia, Source: 4Cast
New Zealand and
Canada, will benefit. ty prices, meaning the CAD gets relations between the two series over
Figure 1 shows how the U.S. dol- stronger relative to the USD as com- different time periods (five days, 10
lar/Canadian dollar (USD/CAD) modity prices rise. Below the price days, one month, etc.). Negative cor-
rate is inversely related to commodi- chart is a list of several statistical cor- continued on p. 30

CURRENCY TRADER • December 2004 29

 CURRENCY STRATEGIES continued

FIGURE 3 — RISK AVERSION THERMOMETER relation figures reflect data series that
move in opposite directions, with -
This gauge of investor risk tolerance developed by RBC Capital Markets 1.00 representing a perfectly inverse
increases when traders are more averse to risk and decreases when they are
relationship (one goes up while the
more willing to accept risk.
other goes down proportionally).
Positive correlation figures reflect the
opposite, with +1.00 representing
15
two series moving in tandem.
Risk thermomter at +/- 7.6 points

Risk averse Another notable historical relation-

10
ship is the impact of rising oil prices on
Japan, represented by the Nikkei stock
5
index and the Japanese yen (JPY).
0
Higher oil prices have a negative
impact on global economic growth as a
-5
whole, and Japan specifically because
it is highly dependent on imported oil.
-10 With oil prices rising significantly
Risk seeking over the past year, the impact on both
-15 Japan and the global economy has
Sept. Dec. Mar. June Sept. Dec. Mar. June Sept. been noticeable. And when global eco-
2002 2002 2003 2003 2003 2003 2004 2004 2004 nomic growth is poised to slow, in this
case because of higher oil prices, Japan
Source: RBC Capital Markets
typically suffers.
Given a large percentage of Japan’s
FIGURE 4 — NZD BENEFITS FROM RISK-SEEKING capital inflows are the result of equity
In late May 2004 — a high point in the Risk Aversion Thermometer in Figure 3
purchases, the link between higher oil
— the New Zealand dollar (NZD) took off to the upside. prices and a weaker yen and Nikkei is
clear. If global economic growth is
waning, Japan will be negatively
New Zealand dollar/U.S. dollar (NZD/USD), daily 0.6600 impacted because they are a large
exporter. Hence, equity inflows into
0.6500 Japan will decrease when growth
slows or is expected to slow — and ris-
0.6400 ing oil prices have been an impedi-
ment to global growth. Figure 2 (p. 29)
0.6300 shows Brent crude oil and the
euro/Japanese yen (EUR/JPY) rate,
along with various correlation figures.
0.6200

The risk environment

0.6100
The final macro component we will
discuss is the prevailing attitude of
Risk aversion peaks. New Zealand 0.6000 traders and investors toward assum-
dollar goes on a multi-month run vs. ing risk. There are many methods for
the U.S. dollar. 0.5900 estimating this factor, and a wise
approach is to consult several inputs
19 26 3 10 17 24 31 7 14 21 28 5 12
and create a composite barometer or
May June July
index.
Source: eSignal When public risk-tolerance is high
in the stock realm, you will likely see

30 December 2004 • CURRENCY TRADER

 FIGURE 5 — CAD TURNING POINT
As was the case with the New Zealand dollar (NZD), May 2004 turned out to be
an inflection point for the Canadian dollar vs. the U.S. dollar.

U.S. dollar/Canadian dollar (USD/CAD), daily

A similar pattern is seen

in USD/CAD. The CAD 1.400
also appreciates significantly
solid interest in IPOs, highly specula- vs. the USD in the
following months.
tive stocks, etc. The same dynamic
exists in currencies. For example, the
NZD, CAD and Australian dollar 1.350
(AUD) are considered “risk-seeking”
currencies. Given they are “reflation
plays” –– a trade that is banking on
economic growth developing –– and 1.300
sensitive to commodity prices, they
are usually more sensitive to changes
in the global economy.
Such currencies will typically have
an inverse relationship to investor risk
tolerance. Figure 3, which shows the Sept. Jan. 2004 May Sept.
Risk Aversion Thermometer, a trader
risk gauge created by RBC Capital
Source: eSignal
Markets, illustrates the rise and fall of
risk tolerance. Figure 4 shows the
NZD/USD rate embarking on a FIGURE 6 — DIVERGING INTEREST RATES
multi-month uptrend around the
Diverging interest-rate policies in New Zealand (continued rate hikes) and
same time the Risk Aversion
Australia (end of a rate-hike cycle) cause the AUD/NZD rate to tumble in August
Thermometer in Figure 3 peaked.
2004. Several bullish candles and a flat-to-higher stochastic oscillator accompa-
Figure 5 shows the same pattern in the nied an initial bottom and rebound in September.
USD/CAD, where the downtrend
actually reflects Canadian dollar gains Austalian dollar/New Zealand dollar (AUD/NZD), daily
vs. the U.S. dollar.
The relationships described here Given that this bar closed and opened higher than 1.120
the previous bar, and was confirmed by the daily
are by no means static. However,
and weekly stochastics, the long is initiated on the
seeking out simple associations such next bar opening, 1.0580. The stop loss is simply 1.110
as these can identify favorable trade placed 10 pips below the wave low, 1.0520.
conditions, as well as avoid trades 1.100
that might look good from a technical
perspective, but have potential weak- 1.090
nesses on the macro level.
1.080
Macros at work in the market
For the past few years both New 1.070
Zealand and Australia have benefited
handsomely from rising commodity 1.060
prices and exports to China.
In late August 2004 the Reserve
1.050
Bank of New Zealand (RBNZ) raised 100
rates yet again — the fifth .25-point
hike in 2004 — because the prospect of
50
an overheating economy was seen as a
greater potential problem than a rapid
rise in interest rates. Despite the fact 0
China’s growth was moderating, the 26 2 9 16 23 30 6 13 20
RBNZ believed dampening specula- August September
continued on p. 32 Source: eSignal

CURRENCY TRADER • December 2004 31

 CURRENCY STRATEGIES continued

tion in the housing sector was its first “lag factor” of eight to 12 months, fall while the stochastic indicator made a
priority. 2004 was shaping up to be a potential higher low. A similar pattern appeared
Meanwhile, Australia had paused a adjustment period for the AUD/NZD in Figure 7 (Another factor that led to
monetary tightening cycle while rate. Although some key economic the conclusion the AUD/NZD was
awaiting more data on housing, retail data still had not yet been released in due to turn up was the fact that the
sales and inflation. The result was the early October, the market was begin- daily chart was completing the fifth
sharp decrease in the AUD/NZD ning to bet the pace of economic wave of an Elliott Wave pattern.) A
shown in Figure 6 (p. 31). While this growth was starting to wane — a long trade was initiated on the next
day’s open at 1.0580, with a stop at
FIGURE 7 — WEEKLY PERSPECTIVE 1.0520, which was 10 pips below the
most recent low.
The weekly AUD/NZD chart included a signal similar to the one on the daily
As expected, either the rapid rise in
chart –– a higher stochastic and a bar opening higher than the previous bar.
interest rates in New Zealand or some
conclusion to the tightening process
Austalian dollar/New Zealan dollar (AUD/NZD), weekly 1.180 would be the catalyst needed to propel
AUD/NZD higher (see Figure 8). The
1.160 catalyst materialized on Oct. 27 when
the RBNZ indicated its monetary tight-
ening phase was nearing completion.
1.140
The new landscape now clearly favored
Australia, as it indicated rate hikes may
1.120 not be done. The currency pair quickly
traded back through its 50-day expo-
nential moving average (EMA) before
1.100
touching the 200-day EMA at 1.1030.
On Nov. 9, the New Zealand Finance
1.080 Minister indicated he was “uncomfort-
able with the current value of the NZD”
1.060 and the currency was likely nearing a
top and would face headwinds going
forward. The result was a nice push
100
Stochastic back above the 200-day EMA. (As of
Nov. 10, the trade was still open, with a
50 revised stop loss of 1.0790.)
The Euro/British pound (EUR/
0
GBP) rate provides another example of
Nov. Dec. Jan. Feb. Mar. Apr. May June July Aug. Sept. the insights macro factors contribute
2004 to a trade. This scenario, which also
resulted in a long position, is some-
Source: eSignal
what similar to the AUD/NZD exam-
ple. In this case, we were looking for a
chart certainly does not look like a viewpoint that was ultimately reflect- contraction in the rate differential
“buy” from a technical perspective, ed in the charts. between the European Union and
there were broader reasons to believe After many weeks of relentless price Britain.
the currency pair could be putting in a declines, the daily and weekly charts Britain had been aggressively raising
bottom. (Figures 6 and 7, respectively) con- rates through 2004 in an effort, as Bank
Macroeconomic theory supports the firmed a bottom could be in place as of England (BOE) president Eddie
idea the aggressive rate hikes by the defined by the stochastic oscillator. On George stated, “to stem the tide in the
RBNZ would soon filter through New the second-to-last candle in Figure 6 rapid increase in housing prices.” The
Zealand’s economy, impacting (p. 31), the AUD/NZD rate made a BOE was determined to nip this prob-
growth. With a typical interest rate higher low and closed above the open lem in the bud rather than let a full-

32 December 2004 • CURRENCY TRADER

 FIGURE 8 — ROLE REVERSAL
The AUD/NZD rate took off to the upside in late October when New Zealand
announced it was halting rate hikes and Australia left the door open for further
hikes.

Austalian dollar/New Zealand dollar (AUD/NZD), daily 1.130

1.120
scale economic bubble develop and
burst, thereby throwing cold water on 1.110
consumer spending, which could send
the economy into a recession. 1.100
It was at this time the European
1.090
Central Bank (ECB) had halted rate
cuts, as the economy was beginning to
1.080
enjoy the benefits of relaxed monetary
policy. The inevitable conclusion was 1.070
rates would rise on the European con-
tinent but not in Britain. The prevail- 1.060
ing carry trade environment (a carry
trade consists of buying the currency 1.050
Stochastic 100
with the higher interest rate vs. the
currency with the lower interest rate 50
in order to capture yield) was drawing
to a close and a possible interest rate 0
“catch-up” in Europe vs. UK was in 23 30 6 13 20 27 4 11 18 25 1 8
store. See “The short term British September October November
pound/Japanese yen carry trade” on
p. 22 for more information. Source: eSignal
The charts, of course, were already
bearing this out, but again, a tangible FIGURE 9 — CONTRACTING RATE DIFFERENTIAL
macro story allows one to really stay
Interest rate shifts between the euro and British pound resulted in a rally in the
with a trade knowing what logically
EUR/GBP rate. The pullback in the latter part of August offered technical traders
should unfold.
an opportunity to enter the existing trend.
Figure 9 shows the EUR/GBP rate.
In this case, there was a straightfor-
Euro/British pound (EUR/GBP), daily
ward pullback within an uptrend.
0.690
Pullbacks within clearly established
trends offer a clear edge vs. trying to
0.685
pick bottoms; trends tend to continue
after periods of consolidation at sup-
0.680
port levels.
The EUR/GBP moved higher in the
0.675
subsequent weeks. Continued com-
ments from the Bank of England sig-
0.670
naled rate hikes were all but done,
while the ECB left the door open for
0.665
further hikes.
The dollar’s continued weakness
0.660
also played a role in pushing this
trade higher. With Asian central banks 100
Stochastic
intervening to protect their currencies
from appreciating vs. the dollar, the
euro bore the brunt of the dollar 50
weakness because the ECB rarely con-
ducts direct open market intervention 0
in the euro.
19 26 2 9 16 23 30 6 13 20 27 4
August September October
For information on the author see p. 8. Source: eSignal

CURRENCY TRADER • December 2004 33

 FOREX RESOURCES

Bulletin boards

M arket-related bulletin boards and chat

rooms aren’t hard to find. Those catering
specifically to forex and currency trading
are not as plentiful, however.
Additionally, message boards are only helpful if they’re
active and full of participants. A board doesn’t help if a
legitimate post is greeted by more silence than somebody
(e.g., Main Discussion, Trading for a Living, Trading Styles
and Strategies, Tools of the Trade, etc.), and many have
thousands of views and hundreds of replies.
That’s a good sign, because it indicates questions will get
answered, or at least generate a discussion. There’s nothing
more frustrating to a person with a legitimate comment or
question than to post it and get no responses, forcing the
trying to use pesos in London, or a Swiss franc in Toronto. poster to try again at another site.
Unfortunately, when it comes to the Internet, you have to Additionally, the site is easy to navigate. Threads are list-
go through a lot of coal to find a diamond. While discussion ed singularly, one after the other, and reading the replies
sites focusing exclusively on the FX world can be found can also be done in an easy, organized fashion. MoneyTec is
with a simple Web search, discovering the ones that actual- also good because it is completely devoid of advertisements
ly have some substance requires a little more research. on the main forums page, although some forums are spon-
One of the best boards are the forums at MoneyTec sored. (Some of the posts are from firms and individuals
(www.moneytec.com/forums/index.php). There are more trying to sell a product, but this is the case at any message
than two dozen forums, divided into several categories board.)

MoneyTec.com

MoneyTec features numerous highly traficked message boards.

34 December 2004 • CURRENCY TRADER

 Judging from the posts we looked at, it
seemed users at MoneyTec had developed a NEW PRODUCTS
sense of community — it was obvious in many
cases certain posters had become familiar with
each other, as posts mentioned other members
Global Forex Trading now offers Pro Commentary via its
by name and some asked specific questions of currency trading software, DealBook FX 2. Available as an analyt-
specific posters. ic feature inside of DealBook, Pro Commentary helps traders
Plus, there were very few posts that strayed observe bullish or bearish relationships and trends for the following
from the main topic of the thread. This is often the currency pairs: USD/JPY, EUR/USD, USD/CHF and GBP/USD.
death of message boards — interspersed with Pro Commentary comprises daily, weekly and monthly analysis,
legitimate conversation are posts that add noth- and caters to traders who enjoy bullish or bearish forecasts for vari-
ing to the discussion, and only serve to discredit able timeframes: intraday support and resistance levels with daily
or otherwise blur the poster or the message. This forecasts, daily support and resistance levels with weekly fore-
can cause new posters to avoid a site, preventing casts, and monthly reports providing weekly support and resist-
the site from growing and eventually minimizing ance levels with monthly forecasts. For more information, see
or negating its effectiveness. www.gftforex.com.
Oanda.com, (www.oanda.com) also features a
good message board (www2.oanda.comcgi-
Need To Know News is a real-time Web-based audio news
bin/msgboard/ultimatebb.cgi). It has eight service for traders. The service provides breaking, market-moving
forums and the threads inside are lively and and tradable news on equities and futures, fixed-income, foreign
active. Forex News (www.forexnews.com/
exchange, the economy, earnings and corporate and geopolitical
forum/ forum.asp) has a decent forum as well
developments. The target audience includes proprietary and insti-
— active, but poorly organized.
tutional trading firms, brokerages (IBs and FCMs included) and
Another good site is the Forex Forum section
individual independent traders. Need To Know News offers a free
of Forex Factory (www.forexfactory.com/forex-
trial. Subscriptions are $95 a month for individual users with multi-
forum).
Forex Forum only has three main forums — user discounts available. Visit www.NeedToKnowNews.com for
General Forex Discussion, Town Square and more information.
Forex Related News. But the General Forex
Discussion forum is lively, with almost 400
alert!fxT, developed by MG Financial Group, is a proprietary
threads as of mid-November. What’s better, many invention that keeps traders connected to the market 24 hours a
of the threads have multiple replies, and when day, seven days a week. Using a variety of communication chan-
we checked, the entire first page (18 different top- nels, alert!fxT can update an investor via any wireless method.
ics) had been replied to within the past week. alert!fxT offers three different alerts: rate, indicator and customized.
ForexForum.net (www.forexforum.net) has a For more information, go to www.mgforex.com.
fair amount of forums, but only minimal partic-
ipation. Although people are reading the posts
Forexvoice (www.forexvoice.com) provides live audio forex
(as evidenced by the number of views), very few rates of major currencies. Forexvoice’s technology allows you to
are taking the time to respond. receive and listen to live forex rates on your PC via the Internet 24
Elite Trader (www.elitetrader.com), a site orig- hours a day. Forexvoice delivers accurate real time forex rates on:
inally designed for stock traders, has since EUR/USD, USD/JPY, USD/CHF, GBP/USD, EUR/JPY, EUR/GBP.
branched out into other instruments, including A one-month subscription is $62.50 and a three-month subscription
forex, and the site — which claims more than is $165.00.
30,000 members — is consistently crowded.
While forex forums — FX Trading and FX
Brokers — comprise only two of the dozens of
forums at Elite, both feature heavy traffic and
plenty of responses. One thread in the FX Trading forum for if you have a serious topic worthy of discussion.
was started on Aug. 16, 2004, and was still going strong as Although Elite Trader isn’t specifically designed for forex
of late November — it has more than 2,000 responses and trading, it’s probably the best option for forex traders look-
48,000 views. Those are the kind of eyeballs you’re looking ing for a place to share ideas and questions.

CURRENCY TRADER • December 2004 35

 CURRENCY BASICS

Economic reports
in the forex market
A look at the top economic indicators and when
they are most likely to shape market sentiment.

BY CARLISE PETERSON

M acro analysis in the

FX market is com-
plicated for many
traders because for-
eign exchange participants don’t nec-
essarily digest economic data the same
way as their stock counterparts, and
“My thinking is the
employment report is more
significant now in terms of
assessing the economy,” he
says. “[Employment] is the
prevailing model of growth;
it’s supposed to be strong in
there’s also data from multiple coun- what we thought was a
tries to contend with. It takes a vigilant growing economy. You
trader to stay on top of it all. won’t have a sustainable
Not all the reports have immediate economy without jobs.”
importance, but some are crucial, and The U.S. Labor Depart-
it is essential to know which constitute ment’s monthly payroll
news and affect market sentiment and numbers — which reflect
which are irrelevant at a given time. the actual payroll statistics of non-farm mately will determine the direction of
“How economic reports affect the jobs — is important to the U.S. dollar the dollar,” he says. “You’re not going
FX markets depends on whether because a vigorous jobs report could to buy a big-ticket item such as a
you’re trading in a declining, or weak- drive interest rates higher, which can refrigerator when times are tough. It’s
ening environment,” says Brian Dolan, make the dollar more attractive to for- a real-time indicator.”
vice president of research at Gain eign investors. A weak report softens Lots of U.S. retail activity (read
Capital. “Fundamentals have a lot of demand for U.S. currency because it shopping) firms up interest rates, which
weight in a weakening environment.” puts downward pressure on rates, is bullish for the dollar. However, an
Naturally, reports that reflect the potentially making the dollar less overly robust retail sales report can
U.S. job market are more important appealing to foreign investors. cause trouble for the dollar because
during a weak economic environment. “The employment report plays a many of the goods U.S. consumers buy
When the environment strengthens critical role in the actions of the dol- are imported. A jump in imports
and the economy is improving, infla- lar,” says Alex Beuzelin, foreign increases demand for non-dollar cur-
tionary reports become more of a exchange market analyst at Ruesch rencies to pay for all of the imports,
focus. International. “The markets view it as which can hurt the dollar.
a good barometer of economic activity Durable goods orders are important
Jobs, jobs and jobs and it plays a role as to why the Fed because they provide a look at what
Dolan lists the top report in the current raises and lowers rates.” products will be produced in the
environment as — not surprisingly — months ahead. The actual goods are
the non-farm payroll numbers (released Consumption and spending products with a life expectancy of at
as part of the monthly employment According to Dolan, the second group least three years. A jump in orders sug-
report, and almost always the most of key indicators is “hard data” such as gests employees and factories will be
closely-watched U.S. economic indica- retail sales and durable goods, both of busy, while a decline suggests assem-
tor), followed by retail sales, personal which are related to private consump- bly lines will slow and plants may
income expenditures and durable tion. close, which is bad for the economy.
goods. “[Private consumption] is what ulti- Another indicator that falls into the

36 December 2004 • CURRENCY TRADER

 Trading the payroll number
“real-time” private consump-

O
tion category is the personal n Monday, Oct. 4, before the September employment number came out, the
income and spending report, European market began to price in a better-than-expected jobs report by
released by the Bureau of buying up the dollar, as shown in Figure 1 of the USD/CHF rate. After a
Economic Analysis. It records sharp rally from 1.2530 to 1.2670, the market settled into a narrow sideways
the income Americans receive range between approximately 1.2610 to 1.2670 through Thursday. In the final eight hours
and how much they spend and before the employment number release, the market made several feints, first down out of
save. A vigorous increase in the range (chasing out weak longs who had bought anticipating a strong non-farm pay-
income and spending is good roll number) and then up (squeezing out weak shorts who had sold the break of the
for the dollar as high con- range). At the moment of the NFP release (8:30 a.m. Friday, Oct. 8), the market had
sumer demand encourages returned to the midpoint of the range around 1.2630/40.
growth and places upward
pressure on interest rates, but
too much spending can trigger FIGURE 1 — MOVING THE MARKET
inflationary worries. At the beginning of the week culminating in the release of the September employment num-
“Reports that pertain to bers, traders bought up the USD/CHF in anticipation of a strong report. The weak report on
consumer spending are Oct. 8 almost instantaneously wiped out those gains.
important to the currency
USD/CHF 1.273
markets right now,” says 1.272
Beuzelin. “[This data] is very Upside squeeze 1.271
1.270
important –– if it is true the of weak shorts 1.269
and stop-loss orders 1.268
U.S. economy is moving out 1.267
of its soft patch. The Fed is 1.266
1.265
optimistic [about the econo- Gap lower on 1.264
my] and the FX market is weak NFP 1.263
1.262
skeptical of that optimism, so 1.261
1.260
participants pay more atten- 1.259
tion to consumer reports.” 1.258
1.257
Narrow sideways 1.256
range while market 1.255
Inflationary measures Downside shake-out 1.254
awaits NFP of longs pre-NFP 1.253
The third most important set 1.252
of economic statistics, accord- Sharp rally as
1.251
1.250
ing to Gain’s Dolan, is infla- market prices in 1.249
tion data, including that a solid NFP report 1.248
1.247
reflected in the Institute for 1.246
1.245
Supply Management (ISM) 1.244
report, inventory data, and 1.243
consumer prices. 10/1 10/3 10/4 10/5 10/6 10/7 10/8 10/10 10/11
The ISM report provides Source: Brian Dolan, director of research, Gain Capital
one of the first glimpses
inside the economy every The non-farm payrolls (NFP) number came in at +96,000, well below consensus
month. It surveys purchasing expectations and much weaker than optimistic longs had expected. (August’s NFP job
managers in the manufactur- gain was also revised lower.) The negative reaction was instantaneous as the market
ing and non-manufacturing gapped 100 points lower to 1.2530 as trapped longs tried to exit. The initial reaction to
(i.e., service) industries, the the NFP data erased Monday’s entire rally, which was based on the market pricing in a
latter in a separate report later strong NFP report.
in the month. Although the
report sounds rather dry, it is
closely monitored because the activity barometer for manufacturing activity expanding or contracting when it real-
of manufacturing purchasing agents in general. ly is not. For example, a gross domes-
reflects the pickup in demand for man- Some lagging indicators may indi- tic product (GDP) report can affect a
ufactured products, which in turn is a cate the economy is supposedly continued on p. 38

CURRENCY TRADER • December 2004 37

 CURRENCY BASICS continued

few months of consumer confidence rates, making the dollar more attrac- change in retail prices over time in a
reports, Dolan says, as the nation tive to foreign investors. basket of 200 assorted goods and serv-
spends and consumes according to As the economy grows stronger, ices. It does not have as much of an
what the GDP reveals. eventually the focus shifts to inflation- effect as some other reports on the FX
The GDP’s effect on the FX market is ary indicators such as the Consumer markets, but can still have an impact
determined by how strong or weak the Price Index (CPI), Dolan says. The CPI because of its relevance to interest rates.
report is. A strong report tends to spur reflects price inflation in retail goods If rates surge on growing inflation con-
corporate profits and firm up interest and services by measuring the average cerns, it can hurt the U.S. dollar. High

Economic reports

T he meaning of a particular number can be debated

endlessly, depending on the market context it
occurs in. No number can ever be considered a
concrete indicator of inflation or the state of the economy.
For example, today’s inflationary employment report may be
next for a fixed basket of consumer products, used as a
common measure of inflation. The “Core CPI” does not
include food and energy prices.
• Who puts it out: Bureau of Labor Statistics
(http://stats.bls.gov).
offset by next week’s benign CPI. True trends in economic • When it’s released: 8:30 a.m. ET around the 15th of
statistics only emerge over time. the month for the previous month’s data (i.e., the March CPI
However, that does not prevent the markets from reacting is released around April 15).
in knee-jerk fashion to report releases. Traders will respond • What it means: A rising CPI indicates increasing infla-
particularly dramatically when a number “surprises” the tion, while a high CPI indicates already high inflation.
market, coming in notably higher or lower than expected. According to standard economic theory, inflation increases
While these reactions are often short-lived, they still pose when supply no longer can keep up with demand, which
problems (or opportunities, depending on your perspective) usually occurs at or near the peak of the business cycle and
for traders. It is only in retrospect that most people can label when the unemployment rate is low.
a particularly dramatic number a sea change or an anomaly. High inflation, or expectations of high inflation, usually
Here’s a quick summary of some of the major U.S. eco- leads to higher interest rates, as lenders of money want to
nomic report releases. be compensated for the diminishing purchasing power of
their dollars. Higher interest rates, in turn, mean higher
Employment costs of doing business for all parties in the economy (both
• What it is: Two surveys measuring 1) the number of investors and companies).
people on payrolls and 2) the unemployment rate. Also
measures average hourly earnings and the length of the Gross Domestic Product (GDP)
average work week. • What it is: A quarterly measure of the production and
• Who puts it out: Bureau of Labor Statistics consumption of goods and services, broken down into sev-
(www.stats.bls.gov). eral sub-categories.
• When it’s released: 8:30 a.m. ET on the first Friday of • Who puts it out: Bureau of Economic Analysis
the month after actual month (i.e., November’s employment (www.bea.doc.gov).
statistics are released in early December). • When it’s released: 8:30 a.m. ET, approximately one
• What it means: The payroll report –– probably the month after the end of each quarter.
most widely watched report in the financial markets –– • What it means: GDP is used to define business peaks and
measures the current state of the economy by way of the troughs, and together with employment data, it gives an impor-
employment situation. It is more of a lagging indicator. tant indication of productivity growth and economic strength.
Strong employment is generally considered the bedrock Usually a growth rate between 2.0 and 2.5 percent is con-
of a solid economy. The more people who work and the sidered positive when combined with an unemployment rate
more money they make, the more money they can spend, of 5 to 6 percent. A higher growth rate and/or a lower unem-
which will increase the demand for goods and services. ployment rate might indicate inflationary pressure. A lower
However, if supply can’t keep up with demand, inflation can growth rate might indicate the economy is stalling. A rela-
develop, as explained in the next section. tively large increase of inventories might indicate a future
decrease in the growth rate, as production (supply) at least
Consumer Price Index (CPI) temporarily has outgrown demand.
• What it is: The difference in price from one month to the Thus, both numbers too low or too high can be interpret-

38 December 2004 • CURRENCY TRADER

U.S. inflation erodes the value of dollar- can hurt the dollar because the Fed can much of a concern right now,” says
based investments held by foreigners. respond so aggressively as to jeopard- Dolan.
A related measure is the Producer ize U.S. economic growth altogether.
Price Index (PPI), which measures the However, a gradual rise in inflation Imports and exports
change in prices paid by businesses for accompanied by well-timed tightening In his book The Secrets of Economic
raw and semi-finished goods (as of interest rates can lead to a steady or Indicators, Bernard Baumohl, director of
opposed to what consumers pay for rising dollar. The Economic Outlook Group and for-
finished products). A fast-rising PPI “Inflationary indicators are not as continued on p. 40

ed negatively, depending on the current position in the busi- • Who puts it out: Institute for Supply Management
ness cycle. The fear of inflation, for example, generally gets (www.ism.ws).
more pronounced the longer a high-growth period lasts. • When it’s released: 10 a.m. ET on the first business
day of the month after the actual month.
Retail Sales • What it means: The index is designed to fluctuate
• What it is: The most timely, albeit volatile, report of con- around 50, with readings above 50 indicating a growing
sumer spending patterns, excluding any type of services. economy. Too-high numbers or extended periods of growth
• Who puts it out: U.S. Census Bureau might indicate the economy is about to overheat. Using ISM
(www.census.gov). index, a business cycle trough could be defined as a read-
• When it’s released: 8:30 a.m. ET around the 13th of ing at or above 44 a few months in a row.
the month after the actual month. The markets are very sensitive to unexpected discrepan-
• What it means: As is the case with the CPI, rising retail cies in this number, especially if that also coincides with a
sales numbers might indicate demand is about to outstrip turning point in the index.
supply, which might lead to higher inflation. However,
because the data doesn’t include services, but does include Industrial Production (IP) and Capacity Utilization
gas, cars and food, it is very volatile and subject to large • What it is: A monthly measure of the domestic industri-
seasonal changes and subsequent revisions. al output, weighted according to each input category’s rela-
tive importance.
Durable Goods • Who puts it out: Federal Reserve Board (www.federal-
• What it is: The current demand (new orders) and sup- reserve.gov)
ply (shipments) balances in the economy. • When it’s released: 9:15 a.m. ET around the 15th of
• Who puts it out: U.S. Census Bureau the month after the actual month.
(www.census.gov). • What it means: It’s an indication of different trends with-
• When it’s released: 8:30 a.m. EST around the 26th of in various industries. In addition, it estimates the “capacity
the month after the actual month. utilization” (the level of potential production capacity at which
• What it means: The durable goods number is another a business, such as a factory, is operating) within the econ-
volatile indicator. It measures the demand for, and supply of, omy, which, must be interpreted carefully because of the dif-
domestic products with an expected life length of at least one ficulty of estimating the maximum capacity in the first place.
year, including both “intermediate” goods (for instance, build-
ing materials) and finished goods (cars, computer equip- One aspect of these reports that has become evident is
ment, etc.). The report monitors the rate of growth within their imprecise nature. Aside from highly publicized criti-
several large industry sectors, such as auto and electronics. cisms of how indicators such as the CPI have been calcu-
If demand is higher than supply it might indicate a new lated in the past, traders should understand these reports
period of economic growth is around the corner. However, are merely barometers that are subject to seasonal fluctua-
if demand stays above supply while unemployment is low, it tions, anomalous readings and yes, human error. Many of
also might indicate higher inflation ahead, as the industry them are regularly revised, so the number that shook the
will meet the demand with higher prices rather than market a month ago may turn out to imply something differ-
increased production. This is most likely to occur at the end ent when it is updated and revised.
of a bull market and at the peak of the business cycle.
Each month Currency Trader includes a Currency Calendar
Institute for Supply Management (ISM) index listing upcoming report releases. The Active Trader Calendar,
• What it is: A monthly survey of 300 purchasing man- which includes specific stock, futures and options information,
agers, representing 20 different industries. can be found at www.activetradermag.com/calendar.htm.

CURRENCY TRADER • December 2004 39

 CURRENCY BASICS continued

mer Time magazine economics nomic numbers fluctuate dramatical- months, and some key reports, such as
reporter, lists the economic data with ly from month to month. Also, almost the September industrial production
the most impact on the dollar as the all of these numbers are released after data, have come in weaker than
employment report, international the fact. expected.
trade, GDP, the current account deficit For example, although the employ- The U.K. central bank’s rate-setting
and industrial production/capacity uti- ment report is generally regarded as body, the Monetary Policy Committee,
lization. The ISM report and consumer the most important economic report in has been hiking rates in an attempt to
prices are further down Baumohl’s list, all markets, it is a lagging indicator curb the inflationary pressures stem-
although still in the top 10. and there are often tremendous ming primarily from rampant con-
International trade summarizes changes in the payroll figures from sumer demand, particularly in the
import and export activity between the month to month. The difference housing market, according to Beuzelin.
U.S. and other countries. In general, between October, when 337,000 jobs “If we see housing prices continuing
the foreign exchange market views were created (nearly double what Wall to cool, that will weigh on the pound
any kind of increase in trade surplus as Street expected), and September, when but be good for the dollar,” he says.
favorable to the dollar, according to only 96,000 jobs were created, is a Although some believe certain eco-
Baumohl’s book. recent example. Accordingly, analysts nomic reports in general are untrust-
“Trade data is extremely important and traders often average certain eco- worthy, there are economic reports
to the FX markets right now, especially nomic figures over several periods to and data relationships that prove con-
if the GDP is above 5 percent,” smooth the readings. sistently reliable, Dolan says. For
Beuzelin says. example, in Japan, machine orders are
The current account balance data International numbers closely watched. If machine orders
summarizes the net change in four Not only is there a slew of U.S. data to sink but tool orders rise, there will
areas: merchandise trade, services, remember, there are also crucial probably be more machine orders next
income flows (the net income received reports released in other countries that month.
from investing in foreign assets) and affect currency prices. Traders need to “You have to really know the data,
unilateral transfers (transfers of for- investigate which economic data is know what to look for and what mat-
eign aid, government grants and pen- most critical in a certain country dur- ters and why,” he says. “Investors
sion payments). ing a given period. have been pulling out of Japan — or
Participants in the FX markets gen- For example, in addition to housing the media has been saying that money
erally pay more attention to this data prices and retail sales, manufacturing, is leaving Japan — because the econo-
than other types of traders. A deterio- industrial production and trade bal- my isn’t growing. But [the machine
ration in the U.S. current account bal- ance data are important in the U.K. orders and tool orders] data proves
ance — essentially a broad accounting and Japan because they tend to be otherwise.”
of America’s trade and investment more manufacturing and export-ori- All types of FX traders — not just
relationship with the rest of the world ented countries, according to Dolan. fundamentally-oriented players —
— will, over time, wear away the value He also says understanding things must inevitably keep abreast of eco-
of the dollar. If the trade balance or the such as employee compensation, nomic conditions at home and abroad
difference in the value of a country’s which often differs from practices in if they want to avoid being broadsided
imports and exports rises and moves the U.S., makes interpreting non-U.S. by the market.
toward surplus, it can hurt the dollar, data more meaningful. “Investors should really be betting
according to Baumohl. “In Japan, private consumption data on consumer confidence,” Dolan says.
This data has more impact when the is very important, like it is here,” he If consumer spending is not picking
economy is weakening and is current- says. “But there, overtime earnings up consistently in Japan, it will under-
ly being closely monitored. and seasonal bonus data are also mine the yen and the dollar, Beuzelin
“U.S. growth has moderated extremely important. Bonuses com- says. It addresses the issue of whether,
enough that it makes [it more likely] prise a significant amount of Japanese in the long run, Japan can sustain its
account deficits will have an impact on income, and if they are declining, you growth and whether wages are grow-
the dollar,” Beuzelin says. can bet private spending will fall.” ing too.
In Japan, numbers depend on where “Over time, the underlying econom-
Never cut and dried the main economic liabilities are, ic performance of a country deter-
Although economic numbers can according to Beuzelin. Exports are mines how well a currency will per-
offer great insight into the economy very important there as well. form,” Beuzelin says.
and the behavior of the FX market, it’s Lately, U.K. economic data has been “You cannot understate the impor-
risky to put too much emphasis on an weakening slightly: housing prices tant of economic indicators as a driver
individual reading because many eco- have moderated over the last few of FX market activity.”

40 December 2004 • CURRENCY TRADER

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 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 South African 0.1729 6.07% 14.23% 11.22% 0.1729 0.135 3

rand

2 Australian 0.7922 5.91% 11.20% 9.44% 0.8005 0.6773 1

dollar

3 Swiss 0.8781 5.65% 11.19% 8.51% 0.8821 0.7559 4

franc

4 Swedish 0.1492 5.56% 11.73% 9.65% 0.1493 0.1283 6

krona

5 Brazilian 0.3665 4.58% 7.56% 12.55% 0.3663 0.3103 16

real

6 euro 1.3307 4.52% 9.72% 7.79% 1.3329 1.1758 7

7 Taiwanese 0.03109 4.18% 5.50% 4.02% 0.03132 0.02801 12

dollar

8 Thai 0.02542 4.05% 5.43% 3.03% 0.02592 0.0239 15

baht

9 Canadian 0.8493 3.96% 10.37% 13.29% 0.8532 0.7138 5

dollar

10 British 1.8944 3.47% 5.51% 2.95% 1.9141 1.7086 10

pound

11 New Zealand 0.7179 3.45% 8.86% 11.53% 0.7207 0.591 2

dollar

12 Japanese 0.009724 3.37% 6.23% 7.22% 0.00979 0.0087 8

yen

13 Singapore 0.6115 1.72% 4.42% 3.79% 0.6115 0.5775 9

dollar

14 Russian 0.03532 1.56% 3.11% 2.38% 0.0354 0.0336 11

rouble

15 Indian 0.02227 1.53% 2.74% 0.90% 0.02303 0.02145 14

rupee

16 Hong Kong 0.1287 0.08% 0.39% 0.31% 0.129 0.1281 13

dollar
As of Nov. 26, 2004
INTEREST RATES
Rank Country Rate Nov. 26 1-month 3-month 6-month Previous
1 Germany BUND 118.42 1.07% 3.06% 5.49% 1
2 Japan Government Bond 138.75 0.09% 2.13% 0.94% 2
3 Australia 3-year bonds 94.75 0.09% 0.35% N/A 5
4 UK Short sterling 95.15 0.05% 0.33% 0.45% 3
5 U.S. 10-year T-note 112.015 -1.11% -0.21% 2.47% 4

42 December 2004 • CURRENCY TRADER

 NON-U.S. DOLLAR FOREX CROSS RATES
1-month 3-month 6-month 52-week 52-week
Rank Rate Symbol Current gain/loss gain/loss gain/loss high low Previous
1 Aussie $ Yen 81.482 2.59% 5.31% 2.38% 85.559 74.28 2
2 Aussie $ Pound 0.4183 2.53% 6.02% 6.69% 0.4273 0.372 1
3 Franc Yen 90.3319 2.34% 5.28% 1.38% 90.8151 80.5368 5
4 Franc Pound 0.4636 2.26% 6.02% 5.74% 0.4647 0.4179 3
5 Aussie $ Canada $ 0.9331 1.99% 0.91% -4.44% 1.0534 0.8863 8
6 Franc Canada $ 1.0343 1.72% 0.91% -5.51% 1.1054 0.9952 13
7 Aussie $ Euro 0.5955 1.46% 1.65% 1.78% 0.6358 0.5643 7
8 Franc Euro 0.6603 1.26% 1.70% 0.83% 0.665 0.6297 11
9 Euro Yen 136.84 1.15% 3.71% 0.60% 139.03 125.81 15
10 Real Yen 37.5987 0.98% 1.15% 5.47% 39.3067 34.3301 16
11 Real Pound 0.193 0.88% 1.92% 9.64% 0.1991 0.1714 14
12 Canada $ Yen 87.3705 0.59% 4.41% 6.54% 89.7805 78.0564 6
13 Canada $ Pound 0.4484 0.49% 5.13% 10.66% 0.454 0.397 4
14 Real Canada $ 0.4305 0.35% -3.41% -1.14% 0.4684 0.4212 19
15 Aussie $ Franc 0.9026 0.28% 0.02% 1.03% 0.9894 0.8547 9
16 Pound Yen 194.93 0.12% -0.71% -4.53% 208.03 185.52 10
17 Real Euro 0.2747 -0.22% -2.66% 4.88% 0.2909 0.2575 18
18 Canada $ Euro 0.6384 -0.60% 0.72% 5.95% 0.6635 0.5916 12
19 Pound Euro 1.4253 -0.99% -4.57% -5.13% 1.5279 1.4096 17
20 Real Aussie $ 0.4615 -1.71% -4.42% 3.12% 0.5039 0.4276 20

GLOBAL STOCK INDICES

1-month 3-month 6-month 52-week 52-week

Rank Country Index Current gain/loss gain/loss gain/loss high low Previous
1 Brazil Bovespa 24,998 8.60% 9.66% 23.72% 25,072 17,601 8
2 Hong Kong Hang Seng 13,895.03 7.50% 7.99% 15.85% 14,091.89 10,917.65 12
3 Germany Xetra Dax 4,154.27 7.03% 7.75% 6.90% 4,202.45 3,618.58 10
4 India BSE 30 6,035.03 6.36% 14.91% 15.79% 6,249.6 4,227.5 3
5 Mexico IPC 12,076.08 6.08% 15.55% 16.67% 12,078.88 8,288.43 2
6 US S&P 500 1,182.65 6.05% 6.56% 5.73% 1,188.46 788.9 11
7 Egypt CMA 1,181.58 6.02% 17.49% 24.01% 1,181.58 783.06 6
8 Australia All ordinaries 3,922.9 5.22% 9.81% 12.76% 3,928.2 3,173.3 4
9 Italy MIBTel 22,458 4.85% 9.23% 9.59% 22,665 19,655 5
10 France CAC 40 3,782.2 4.30% 4.03% 3.23% 3,856.01 3,396.59 9
11 Switzerland Swiss Market 5,548.5 3.94% 2.09% -2.22% 5,941.7 5,264.5 15
12 Singapore Straits Times 2,028.43 3.50% 5.39% 12.41% 2,050.78 1,205.31 13
13 UK FTSE 100 4,741.5 3.33% 6.07% 6.39% 4,823.8 4,283 7
14 Canada S&P/TSX composite 9,057.97 2.65% 8.02% 8.16% 9,059.29 7,822.34 1
15 Japan Nikkei 225 10,833.75 1.49% -2.73% -2.94% 12,195.66 7,606.69 14

ACCOUNT BALANCE

Rank Country 2004 Ratio* 2003 2005+ Rank Country 2004 Ratio* 2003 2005+
1 Hong Kong 16.404 10 16.697 16.598 9 United Kingdom -43.338 -2 -33.39 -43.098
2 Taiwan 21.3 6.9 29.202 19.378 10 Spain -33.066 -3.4 -23.549 -36.462
3 Germany 118.525 4.4 52.933 129.726 11 United States -631.268 -5.4 -530.669 -641.678
4 Japan 159.402 3.4 136.238 148.931 12 New Zealand -4.102 -4.4 -3.267 -4.151
5 Denmark 4.289 1.8 6.327 4.543 13 Australia -32.036 -5.3 -30.212 -30.248
6 Canada 28.195 2.9 17 25.243
Totals in billions of U.S. dollars
7 France -12.761 -0.6 5.474 -13.246 +
*Ratio: Account balance in percent of GDP; Estimate
8 Italy -18.074 -1.1 -21.942 -13.315
Source: International Monetary Fund, World Economic Outlook
Database, October 2004

CURRENCY TRADER • December 2004 43

 INDICATOR BASICS

Simple Moving Average

New traders: Learn the logic and uses of the simple moving average.
BY CURRENCY TRADER STAFF

T
Applications
he simple moving average (SMA) is probably Moving averages smooth price action and are primarily
the best-known technical indicator. It is used to used to highlight and define trends. Longer moving aver-
smooth price action and highlight trends. ages (e.g. 50, 100, 200 days) reflect long-term trends; short-
er moving averages (e.g. five days, 10 days, 20 days) reflect
Calculation short-term trends.
The SMA is the average price of an instrument over a spe- A basic moving average-based definition of a trend is that
cific time period: a market is in an uptrend when it is trading above its mov-
ing average and in a downtrend when it is trading below its
n-day moving average = Sum(Pricet, Pricet-1 ... moving average. The magnitude of the “trend,” however,
Pricet-N)/n depends on the length of the moving average. For example,
where, a stock may be trading above its five-day moving average,
Price t = today’s price and thus be in a very short-term uptrend, but at the same
Price t-n = price n days ago time be trading below its 50-day moving average, and be in
an intermediate- to longer-term downtrend.
For example, a 20-day moving average is the average Figure 1 shows three moving averages on a daily chart of
price of the most recent 20 days. The closing price is usually the USD/CAD currency pair: a five-day (red), a 20-day
used in the calculation, although the high, low, opening or (blue) and a 60-day (green). Each average reflects — to
average price of a price bar can be substituted. To calculate, varying degrees — the strong downtrend that commenced
add the closing prices of the last 20 days and divide by 20. in June 2004. Notice that the longer the moving average, the
As a market moves forward in time, the newest price is smoother the line — the more the shorter-term market fluc-
added to the average and the oldest is dropped from it. tuations (“noise”) are filtered out.
Table 1 shows a series of daily closing prices and the five- The basic moving average trend signal is the crossover,
day SMA values that result from progressively averaging which occurs when price moves from below the moving
the five most recent days’ prices. average to above it (signaling rising prices and an uptrend)
Moving averages can be calculated for any time frame — or moves from above the moving average to below it (sig-
daily, intraday, weekly, monthly, etc. For a five-minute bar naling falling prices and a downtrend). In Figure 1, notice
chart, for example, a 10-bar moving average would be the at the far left of the chart, the price bars were above the 20-
average price of the 10 most recent five-minute bars. We will and 60-day SMAs; price first crossed below the 20-day
continue the discussion in terms of daily bars for simplicity. average, then the 60-day average, signaling the market was
turning lower. (Also notice the change in direction of the
60-day SMA from up to down in early July; some traders
TABLE 1 — CALCULATING THE SMA also define trends in terms of the direction of a moving
Calculating a five-day simple moving average: With each average.)
new day, the most recent closing price is added to the Similarly, trend changes can be signaled by a moving
moving average calculation and the oldest price is dropped average crossover, which occurs when a shorter-term mov-
from it. ing average (say, 20 days) crosses above or below a longer-
term moving average (say, 60 days). When the shorter aver-
Date Close 5-day SMA
Day 1 13.00 age crosses above the longer average, an uptrend is
Day 2 12.25 implied; a downtrend is suggested when the shorter aver-
Day 3 12.13 age crosses below the longer average. In Figure 1, the five-
Day 4 12.19 day average crossed below the 20-day average almost at the
Day 5 11.88 12.29 Average of day 1 to day 5
same time (in late June) the 20-day average crossed below
Day 6 12.00 12.09 Average of day 2 to day 6
Day 7 11.94 12.03 Average of day 3 to day 7 the 60-day average, reflecting the price shift from uptrend
Day 8 11.31 11.86 Average of day 4 to day 8 to downtrend.

44 December 2004 • CURRENCY TRADER

 FIGURE 1 — SIMPLE MOVING AVERAGES
Five-day, 20-day and 60-day SMAs smooth price action and highlight trend to
varying degrees.
Key points
Because they track the average price of U.S. dollar/Canadian dollar (USD/CAD), daily 1.38
a market over time, moving averages
lag price action in direct proportion to 20-day SMA 1.36
the number of days (referred to as the 1.34
period length or lookback period) used 60-day SMA
to calculate them. The longer the mov- 1.32
Price
ing average, the greater the lag. This crossovers
means that trend changes signaled by 1.30
longer-term moving averages will
5-day SMA 1.28
occur long after the actual change in
price direction has taken place. 1.26
Essentially, moving averages signal
trends after the fact. 1.24
Figure 2 highlights this. The longer
1.22
the moving average, the longer it takes
to signal (by virtue of price crossing 1.20
below the moving average) the down-
trend that began in February 2004 in the July August September October November
EUR/USD currency pair. Price did not Source: TradeStation
remain consistently below the 100-day
moving average (green) until nearly a FIGURE 2 — MOVING AVERAGE CROSSOVERS
month after it crossed definitively The longer the moving average, the more it lags changes in price direction.
below the 20-day moving average (red). Price crossed below the 100-day SMA well after it moved below the 20-day and
There are many penetrations above 60-day SMAs.
and below the 20-day moving average
in Figure 2 (as well as the five- and 20- Euro/U.S. dollar (EUR/USD), daily
day average in Figure 1). Although 60-day SMA 1.28
moving averages filter out market
noise and highlight price direction in 100-day SMA 1.26
trending markets, they are subject to
frequent whipsaws (when price cross-
1.24
es repeatedly above and below the
average) in non-trending markets, or
20-day 1.22
in any kind of market when the mov-
SMA
ing average is too short — and thus too
sensitive — to price fluctuations. 1.20
Figure 3 (p. 46) shows how price
repeatedly jumps above and below a 1.18
30-bar SMA (on a 10-minute bar chart)
when USD/CAD is in the initial side- 1.16
ways (trading range) period but stays
consistently above the moving average
during the subsequent strong up Dec. 2004 Feb. Mar. Apr. May June
move. A basic moving-average trend- Source: TradeStation
change signal — a crossover above or
below the moving average — would technically occur with age — or any other technical indicator, for that matter. It is
each one of the penetrations during the sideways period, impossible to know, except in retrospect, what length moving
underscoring one of the primary limitations of using mov- average will perform “best” — that is, provide reasonably
ing averages. timely indication of trend changes without excessive whip-
One method to avoid overly frequent moving-average saw action. There are no magic numbers — despite repeated
penetrations is to increase the length of the moving average. popular references to 50-day and 200-day moving averages,
However, this decreases the timeliness of trade signals. for example. A lookback period that tracks the market well
This also highlights another aspect of using moving aver- continued on p. 46

CURRENCY TRADER • December 2004 45

 INDICATOR BASICS continued

FIGURE 3 — THE WHIPSAW PROBLEM

Price repeatedly crosses above and below the moving average when the mar-
ket moves sideways, which would result in many “false signals” for traders used with other tools and techniques.
using a basic price-moving average crossover approach. For example, they can function as trade
filters: If price is above a moving aver-
U.S. dollar/Canadian dollar (USD/CAD), 10-minute
1.208 age of a certain length, only buy signals
from a short-term pattern strategy can
1.206
be acted upon.
1.204

1.202
Variations
1.200 There are other types of moving aver-
ages besides the simple moving aver-
1.198 age. Most of these variations alter the
1.196 basic moving average calculation to
30-bar emphasize more recent price action.
SMA 1.194 The two most popular are the weight-
1.192 ed moving average (WMA) and the
exponential moving average (EMA).
1.190 A five-day simple moving average is
Whipsaws
1.188
simply the sum of the five most recent
closes divided by five; each day’s price
5:20 7:30 9:40 11:50 14:00 16:10 18:20 20:30 11/18 3:00 5:10 7:20 9:30 11:40
is given equal emphasis in the calcula-
Source: TradeStation
tion. By comparison, a five-day
weighted moving average would mul-
FIGURE 4 — SIMPLE, WEIGHTED AND EXPONENTIAL MOVING AVERAGES tiply each day’s price by a certain fac-
WMAs and EMAs emphasize more recent price action, while SMAs treat each tor, with the most recent price receiv-
price equally. The WMA and EMA here respond faster than the SMA to the end ing the heaviest weighting. The sum of
of the uptrend. these weighted closes would then be
divided by the sum of the weighting
Euro/Japanese yen (EUR/JPY), weekly
1.40 factors to derive the WMA.
The EMA is a special kind of weight-
1.38
ed moving average that uses all the
1.36 prices available (rather than a set num-
ber of bars, e.g. 20 or 50), using what is
1.34
called a smoothing constant (ranging
1.32 from 0 to 1) to weight prices.
A full discussion of weighted and
1.30
exponential moving averages is outside
26-week WMA
1.28 the scope of this introductory article.
Visit www.activetradermag.com for
1.26
more information on these tools and
1.24 consult the other resources listed below.
26-week EMA
Figure 4 compares 26-bar simple
1.22
(red), weighted (blue) and exponential
26-week SMA 1.20 (green) moving averages on a weekly
chart. The distinguishing characteristic
1.18
of weighted and exponential moving
Nov. Dec. 2003 Feb. Mar. Apr. May June July Aug. Sept. Oct. averages is that they will emphasize
Source: TradeStation the most recent price activity, which is
sometimes helpful and sometimes
one month might perform horribly the next. misleading. In this case, price was above all three averages
Despite their popularity, some traders believe moving during the uptrend (the WMA, which hugged price most
averages alone are not useful trading tools (as opposed to closely) was penetrated once; the WMA and EMA began to
being analytical tools) because they are backward-looking by turn slightly lower in August while the SMA continued to
nature and too simple to offer any edge (i.e., specifically move higher — even though price had peaked in late May.
because so many people use them). However, SMAs can be The January 2005 edition of Currency Trader will cover

46 December 2004 • CURRENCY TRADER

 Additional research
weighted and exponential moving averages in greater detail.
Trading Systems and Methods (3rd Edition), Perry Kaufman
Bottom line 1998, John Wiley & Sons, New York.
The simple moving average is a basic indicator used to
smoothing price action and defining trends, but it is not a Schwager on Futures: Technical Analysis, Jack Schwager,
sophisticated trading tool. It is impossible to know the 1996, John Wiley & Sons, New York.
“best” moving average length to use to define the dominant
Technical Analysis of the Financial Markets, John Murphy
trend because market conditions constantly change.
1999, New York Institute of Finance, New York.
In non-trending or highly volatile markets, moving aver-
ages can result in repeated “whipsaws” and false signals. You can purchase past articles at
Trading strategies built on moving averages generally require www.activetradermag.com/purchase_articles.htm and down-
extra filters or rules to compensate for these limitations.
load them to your computer.

INDICATORS IN THIS ISSUE

FIGURE 1 — 10-BAR STOCHASTIC OSCILLATOR
Stochastic basics
The stochastic oscillator consists of two lines: %K and a
The stochastic indicator is an oscillator, which is a tech-
three-period moving average of %K called %D. The indicator
nical tool designed to highlight shorter-term momentum
follows the general swings of the USD/CAD, although the
and “overbought” and “oversold” levels (points at which a
overall downtrend skews the indicator slightly to the down-
price move has, theoretically at least temporarily
side: Notice the stochastic’s lows are further below the
exhausted itself and is ripe for a correction or reversal).
“oversold” line (20) than the indicator’s highs are above the
“overbought” line (80).
Calculation
The stochastic oscillator consists of two lines: %K and a U.S. dollar/Canadian dollar (USD/CAD), daily 1.40
moving average of %K called %D. The basic stochastic 1.39
calculation compares the most recent close to the price 1.38
range (high of the range – low of the range) over a partic- 1.37
ular period. 1.36
1.35
For example, a 10-day stochastic calculation (%K) 1.34
would be the difference between today’s close and the 1.33
lowest low of the last 10 days divided by the difference 1.32
between the highest high and the lowest low of the last 1.31
10 days; the result is multiplied by 100. The formula is: 1.30
10-day slow stochastic 100
%K = 100*{(Ct-Ln)/(Hn-Ln)} 80
%D Overbought 60
Ct is today’s closing price
Oversold 40
Hn is the highest price of the most recent n days (the %K 20
default value is five days)
Ln is the lowest price of the most recent n days June July August
The second line, %D, is a three-period simple moving Source: TradeStation
average of %K. The resulting indicator fluctuates
between 0 and 100. used in the basic calculation or the length of the moving
averages used to smooth the %K and %D lines –– can be
Fast vs. slow adjusted to make the indicator more or less sensitive to price
The formula above is sometimes referred to as “fast” sto- action.
chastics. Because it is very volatile, an additionally smoothed Horizontal lines are used to mark overbought and oversold
version of the indicator –– where the original %D line stochastic readings. These levels are discretionary; readings
becomes a new %K line and a three-period average of this of 80 and 20 or 70 and 30 are common, but different market
line becomes the new %D line –– is more commonly used conditions and indicator lengths will dictate different levels.
(and referred to as “slow” stochastics, or simply “stochas-
tics”). Figure 1 shows a 10-day stochastic: The lookback peri- Related reading: “Indicator Insight: Stochastics,” Active
od is 10 days and a three-day moving average is used to Trader, August 2000, page 82.
smooth both the %K and %D lines.
You can purchase and download past Active Trader arti-
Any of the parameters –– either the number of periods cles at www.activetradermag.com/purchase_articles.htm .

CURRENCY TRADER • December 2004 47

 FOREX DIARY

Playing a fake-out breakout.

LAST MONTH’S TRADE Last month’s trade completed shortly after press time. The U.S.
dollar/Canadian dollar currency pair (USD/CAD) followed through to
Date: Friday, Oct. 29, 2004. the downside when the next trading session began (later on the same
day we marked the trade to market). The market eventually fell to and
Entry: Sell the USD/CAD at 1.2182. through our exit point and we took our profit accordingly.

LAST MONTH’S TRADE SUMMARY

Date Rate Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
10/29/04 USD/CAD 1.2182 1.2308 1.2055 1.01 1.2055 11/4/04 +.0127 .0152 -.0099 4 days
(1.04%)

NEW TRADE
U.S. dollar/Canadian dollar (USD/CAD), 120-minute 1.235
Date: Monday, Nov. 8, 2004.
1.230
Entry: Buy the USD/CAD at 1.1930.
1.225
Reason(s) for trade/setup: This trade is
based on analysis discussed in the 1.220
November 2004 issue of Currency Trader Profit target level
describing the potential for a longer-term 1.215
Exit and
reversal in the USD/CAD rate.
go short 1.210
at 1.1935
Initial stop: 1.1866, which is 33 pips below Long at
1.205
the day’s low. This trade constitutes bottom 1.1930
picking, so we’ll want to exit if the currency
1.200
pair does not quickly move in our direction. (Previous
trade
1.995
Initial target: 1.2155, which is the low of the exit)
consolidation the market broke below. We
will take partial profits at this level, raise the 10/26 10/27 10/28 10/29 11/1 11/2 11/3 11/4 11/5 11/8 11/9 11/10 11/11 11/14 12:00
stop and look for a move above the high of Source: TradeStation
the consolidation. Even if an up move turns
out to be merely a temporary correction, a move to the most
recent resistance (former support) level would be logical. Trade executed according to plan? No.

Lesson(s): The market basically languished after we

RESULT entered the market. We exited and reversed position because
the market’s behavior negated the original trade premise.
Exit: 1.1935. With the dollar’s weakness still intact and the currency
pair’s inability to move in the (initially) expected direction
Reason for exit: Discretionary exit based on the currency — despite two fairly strong intraday moves in that direction
pair’s formation of a trading range and repeated failure to — the USD/CAD seems poised to try to move back down;
follow-through on upside moves. This led us to reverse the current consolidation is looking more like a pause on the
positions in anticipation of a downside breakout. daily chart. If a market doesn’t do what it’s “supposed” to
do, it’s often a sign it’s going to do the opposite.
Profit/loss: + 5 pips. We basically scratched the long position, so we lose noth-
ing by reversing the trade.

TRADE SUMMARY
Date Rate Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
11/8/04 USD/CAD 1.1930 1.1866 1.2155 1.01 1.1935 11/15/04 +.0005 .0114 -.0022 6 days

Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit dur-
ing lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

48 CURRENCY TRADER • December 2004

 CALENDAR & EVENTS DECEMBER

Monday Tuesday Wednesday Thursday Friday Saturday

1 2 3 4
U.S.: ISM report ECB: Governing U.S.:
on business Council meeting Employment
Australia: Index Japan: Monetary report
of commodity base
prices Germany: Retail
Japan: Account turnover;
balances Employment

6 7 8 9 10 11
Germany: Orders Australia: Great U.S.: Wholesale inventories U.S.: PPI
received and Official Britain: Great Britain: Monetary Japan: Corporate
manufacturing reserve Monetary Policy Committee meeting goods price index
turnover assets Policy Japan: Balance of payments
Committee Germany: Production index;
meeting Foreign trade

13 14 15 16 17 18
U.S.: Retail U.S.: Trade balance; FOMC U.S.: CPI ECB: Governing Council U.S.: CPI
sales meeting and General Council Canada: CPI
Great Italy: Balance of payments meeting Germany:
Britain: PPI Canada: Manufacturing Bankruptcies
survey; Trade balance
Japan: Monetary survey

20 21 22 23 24 25
U.S.: Leading indicators Canada: U.S.: GDP U.S.: Durable
Canada: Wholesale Retail trade; Canada: goods
trade Leading Employment
U.S.: GDP Canada: GDP
Great Britain: Capital indicators Canada: Great Britain:
issues Employment Productivity; GDP:
Germany: PPI Balance of
Payments

27 28 29 30 31
Japan: Corporate Australia: International
service price index reserves and foreign
currency liquidity
Italy: International
reserves and foreign
currency liquidity

Legend
CPI: Consumer Price GDP: Gross Domestic
Index Product
ECI: Employment Cost PPI: Producer Price Index
Index ECD: European Central The information on this page is subject to change.
FOMC: Federal Open Bank Currency Trader is not responsible for the accuracy of calendar dates beyond press time.
Market Committee

Month 2004 • CURRENCY TRADER 49