TRADING SUPPORT AND RESISTANCE IN THE AUD P.

31
Strategies, analysis, and news for FX traders

April 2012 Volume 9, No. 4

Focus on cross rates p. 6 Analyzing the Taiwan dollar’s profitability p. 22

Intraday forex H&S setups p. 16 The dollar and Treasuries: Not the relationship you think p. 10

CONTENTS

Contributors .................................................4 Global Markets

Events .......................................................26
Conferences, seminars, and other events.

Canadian dollar active on the crosses .....6
The dollar/Canada pair hasn’t been doing much, but the Canadian dollar has made some notable moves vs. other currencies in recent months. By Currency Trader Staff

Currency Futures Snapshot ................. 27 Managed Money Review ....................... 27
Top-ranked managed money programs

International Markets ............................ 28
Numbers from the global forex, stock, and interest-rate markets.

On the Money A tipping point for bonds and the dollar? ......................................... 10
The March rise in U.S. Treasury yields might be the end of a 30-year cycle, but it doesn’t necessarily forecast the course of the dollar. By Barbara Rockefeller

Forex Journal ...........................................31
Beware of the too-tight stop.

Trading Strategies

Intraday FX swing-reversal ..................... 16
Rethinking a common chart pattern results in a hybrid continuation-reversal setup. By Currency Trader Staff

Looking for an advertiser?
Click on the company name for a direct link to the ad in this month’s issue. Ablesys Dallas Traders Expo eSignal FXCM Nadex

Advanced Concepts Taiwan: The Cold War fiction that worked ................................... 22
Until self-reinforcing behavior runs its course (aka “the bubble bursts”), a firmer TWD and greater returns on Taiwanese assets are being provided courtesy of the Fed and the BOJ. By Howard L. Simons

Global Economic Calendar ........................ 26
Important dates for currency traders.

Questions or comments?
Submit editorial queries or comments to webmaster@currencytradermag.com
2 April 2012 • CURRENCY TRADER

CONTRIBUTORS

TRADING SUPPORT AND RESISTANCE IN THE AUD P. 31
Strategies, analysis, and news for FX traders

A publication of Active Trader ®

April 2012 Volume 9, No. 4

For all subscriber services:
www.currencytradermag.com

Focus on cross rates p. 6 Analyzing the Taiwan dollar’s profitability p. 22

Intraday forex H&S setups p. 16 The dollar and Treasuries: Not the relationship you think p. 10

Editor-in-chief: Mark Etzkorn metzkorn@currencytradermag.com Managing editor: Molly Goad mgoad@currencytradermag.com Contributing editor: Howard Simons

Contributing writers: Barbara Rockefeller, Marc Chandler, Chris Peters Editorial assistant and webmaster: Kesha Green kgreen@currencytradermag.com

President: Phil Dorman pdorman@currencytradermag.com Publisher, ad sales: Bob Dorman bdorman@currencytradermag.com Classified ad sales: Mark Seger seger@currencytradermag.com

q Howard Simons is president of Rosewood Trading Inc. and a strategist for Bianco Research. He writes and speaks frequently on a wide range of economic and financial market issues.

Volume 9, Issue 4. Currency Trader is published monthly by TechInfo, Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright © 2012 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 purposes 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.

q Barbara Rockefeller (www.rts-forex.com) is an international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dummies, Second Edition (Wiley, 2011), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and How to Invest Internationally, published in Japan in 1999. A book tentatively titled How to Trade FX is in the works. Rockefeller is on the board of directors of a large European hedge fund.

4

April 2012 • CURRENCY TRADER

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GLOBAL MARKETS

Canadian dollar active on the crosses
The dollar/Canada pair hasn’t been doing much, but the Canadian dollar has made some notable moves vs. other currencies in recent months.
BY CURRENCY TRADER STAFF
As of late March the U.S. dollar/Canadian dollar pair (USD/CAD) had been trading largely sideways in recent weeks, with a modest 2.72-percent decline since the beginning of 2012 (Figure 1). However, traders looking for movement had to look no further than various CAD cross rates, which have been very active in recent months. The Euro/Canadian dollar (EUR/CAD) pair made a big move in the last quarter of 2011 (Figure 2), while the Canada/ yen rate (CAD/JPY) gained a whopping 14.06 percent in the first quarter of 2012 (Figure 3). The Canadian overnight central bank interest rate remains at 1 percent, with few analysts expecting a change in monetary policy this year. However, the currency attracts speculative flows given its status as a “commodity currency” as well as a safe-haven bid because of its AAA rating and Canada’s stronger economic growth relative to other G7 countries.

According to Charles St-Arnaud, forex strategist and economist at Nomura, the Canadian economy is expected to post moderate economic growth numbers for 2012, with gross domestic product (GDP) in the 2.2-percent range — down slightly from FIGURE 1: DOLLAR/CANADA 2011’s 2.5-percent rate and 2010’s 3.2-percent pace. BNP Paribas forecasts a 2-percent 2012 GDP pace. However, Mark Hopkins, senior economist at Moody’s Analytics points out that Canada was the first G7 country to come out of recession. But, he adds, Canada’s slowdown reveals “where they are in the business cycle.” While stronger growth data in the U.S. has encouraged consumers with pent-up household demand to buy more, Canada is a different story. “It’s already past the snap-back phase and there is a natural tendency for things to slow down and moderate,” Hopkins explains. According to BNP Paribas economist Bricklan Dwyer, Canadian consumers have become “exhausted on the debtlevel side.” He says recent data indicates The USD/CAD pair had settled into a range as spring began, having fallen consumers are running debt levels at from its late-2011 highs. Most analysts see potential for the Canadian 152.9 percent of disposable personal currency to strengthen further, but modestly, vs. the U.S. dollar. income.
April 2012 • CURRENCY TRADER

Economic picture

6

St-Arnaud agrees, noting, “Going forward there is a lot of risk. Household debt levels are extremely high and housing prices have increased dramatically over the past three years.”

FIGURE 2: EURO/CANADA

Canadian housing bubble?

Economists say one of the biggest risks to the Canadian growth forecast is the state of the housing market. Extremely low interest and mortgage rates have fueled a massive increase in home prices. “Over the past two years, housing prices have increased by 11 to 12 percent,” St-Arnaud says. “There are a lot of similarities to what happened in the U.S. in 2006-2007. If we saw a big drop in housing prices it would leave the personal spending side of the economy extremely weak.” On the flip side, Hopkins remains optimistic the Canadian housing market will have a soft landing without any help, arguing that “slowing job growth and the threat of higher rates will contribute to a general slowdown in [housing] demand.”

The pair posted a big down move in late 2011.

FIGURE 3: CANADA/YEN

Interest rates

The Bank of Canada (BOC) has been holding its official lending rate at 1 percent, and most analysts expect rates to remain unchanged through year-end, with a hike to occur sometime in 2013. “Our forecast is steady through 2012,” Hopkins says. BNP Paribas expects a rate hike in the second half of 2013. “At 2 percent [GDP], the economy isn’t exactly roaring where they would need to tighten,” Dwyer says. Vassili Serebriakov, currency strategist at Wells Fargo, forecasts the first BOC rate hike in the first quarter of 2013, with subsequent rate hikes to bring the official rate to 2 percent by the end of 2013. St-Arnaud, however, sees a 0.50-percent rate hike from the BOC this year. “I’m convinced they will hike before year’s
CURRENCY TRADER • April 2012

The Canadian dollar rocketed to the upside vs. the Japanese yen, but some analysts wonder about the move’s sustainability.

7

GLOBAL MARKETS

end,” he says. “It will be a preventative hike, because the longer you keep rates low the more imbalances you are creating in the whole system.”

Other fundamental factors

sector has declined 13.2 percent of total value of output,” he says. “The economy has been trying to deal with that shift, which is turning into a more service or consumption economy, similar to the U.S.”

About 25 percent of total Canadian exports are energyrelated products, with another 20 percent coming from manufactured products, including automotive components and auto parts. In general, analysts cite a positive correlation between the price of crude oil and the Canadian dollar. Simply put, higher WTI crude oil prices boost the Canadian economy and strengthen the Canadian currency. “[Oil] exports have been growing at a very quick pace at the end of 2011,” St-Arnaud notes. He says total exports increased 4.4 percent in 2011, and he forecasts a similar pace for 2012. On the manufacturing side of the economy, some analysts believe a longer-term structural shift has been occurring in recent years, given the appreciation of the Canadian dollar vs. the U.S. dollar over the past decade. In early 2002 the USD/ CAD pair was as high as $1.61, while in late March this year it was closer to parity (1.00), and not too far from its November 2007 pre-financial crisis low of .9060. Last summer dollar/Canada hit a low of .9400 in July. “Historically, the Canadian dollar has traded at about 75 to 80 cents [of the U.S. dollar],” Hopkins says. “It’s been a real problem for the manufacturing sector.” Hopkins believes this is another factor that will keep the BOC on hold this year. “The loonie is so strong, if they get out in front of the Fed, it will pressure exports,” he explains. A rising currency tends to increase the cost of a country’s exports, which could, in turn, dampen demand for Canadian goods. Nonetheless, Dwyer says the CAD’s longer-term bull trend has caused some deterioration in the Canadian manufacturing sector. “Since 2000, the manufacturing
8

Price action

Ray Attrill, BNP Paribas head of forex strategy North America, says the Canadian dollar’s outlook “is a function of quite a few moving parts.” Going forward, some of the key fundamental drivers include the state of the Canadian housing market, the direction of the U.S. dollar, whether or not QE3 will occur, BOC rate hikes relative to the U.S. Fed’s moves (i.e., will bullish interest rate differentials come into play?), the price of crude oil, the pace of global economic growth, and the risk sentiment/ aversion balance. “There are a lot of different arguments for whether [the CAD] will outperform or underperform,” Attrill notes. Of course, the overall direction of the U.S. dollar will be the key determinant of dollar/ Canada action. “We still think there is a reasonable chance the Fed will be forced to come back to the table with QE, which keeps us cautiously bearish on the [U.S.] dollar,” Attrill says. The Canadian dollar is traditionally grouped with other so-called “commodity currencies” including the Australian (AUD) and New Zealand (NZD) dollars. Some forex analysts expect the CAD to outperform the Aussie and kiwi dollars, especially if Chinese economic growth continues to slow. Australia and New Zealand are much more dependent than Canada on Chinese growth. Attrill, however, has a different view. He notes the CAD is a very low-yielding currency, especially compared to the Aussie dollar. “We think China will pick up, and with currency volatility back to its lowest levels since Lehman’s collapse, it’s conducive to carry trade activity — which leaves the Aussie dollar as a standout,” he says. Highlighting another key fundamental factor, Attrill says, “We do not think oil prices will fall anytime soon, which has CAD basically trending up with oil and with
April 2012 • CURRENCY TRADER

global risk appetite.” “The risk at the moment is that the global economy may Since early February, dollar/Canada has largely been be decelerating faster than anticipated,” he says. “If asset range-bound between $1.0051 and .9850. “There is not a market conditions deteriorate as a result, the recent bout of great deal going on with the USD/CAD exchange rate yen weakness is very much in question.” right now,” notes Andrew Cox, Citi currency strategist. Noting the prevalent bias in the shorter-term trading “It is far from an exciting story unless you have been short community has been short yen, he adds, “Yen strength volatility.” could return rapidly as short-term market participants In the near term, Cox doesn’t see a catalyst that will unwind yen-funded carry positions.” move the pair out of its trading. “It’s an exchange rate In assessing the Aussie/Canada cross, Serebriakov constuck in between a number of different forces,” he cedes this cross has attracted more “speculative” type of says. “The Canadian dollar is strong relative to the USD, money flows. “China is slowing and the U.S. economy is the currency of its largest trading partner, and as a result picking up, and there is an argument to be made for the the strong loonie serves as a significant headwind for Canadian dollar to outperform relative to the Aussie dolexport growth and poses downside risks for domestic lar,” he says. inflation.” The AUD/CAD pair was trading around 1.0440 in late However, other currency analysts are targeting addiMarch (Figure 4). Serebriakov points to the November 2011 tional strength for the Canadian dollar vs. the greenback low of 1.0110 as a “good medium-term target.” on a longer-term basis. “The Canadian dollar will continue He also sees some value in waiting on the EUR/CAD to appreciate — we have a target at .9500 by year-end,” rate, which has shifted into a sideways mode lately. “There St-Arnaud says. is significant resistance at 1.3480 — that could be a level to Attrill holds a similar view, citing the U.S. dollar side of sell, targeting a move to the 1.2875 area,” he says. y the equation. “We see dollar/Canada near parity through the end of the second quarter, but at .9500 by the end of 2012 — and that is more a function of the U.S. dollar losing steam in the second half FIGURE 4: AUSSIE/CANADA and would be predicated on QE3,” he says. However, Attrill warns there is big “tail risk” for this constructive view of the CAD. “If you have a housing-bubble burst, all bets are off on a stronger CAD,” he explains. Serebriakov says the medium-term view (three to six months) is for Canadian dollar strength. In late March he gave a threemonth target of .9700 and a six-month target of .9600.

Canadian cross rates

Although dollar/Canada may be stuck in a range, Cox says he sees more opportunity for CAD on the crosses. Regarding the CAD/JPY rate, for example, he notes that although the CAD has posted impressive gains vs. the yen in recent months, the sustainability of that trend is in question.
CURRENCY TRADER • April 2012

China’s outlook looms large in the AUD/CAD pair’s future performance.

9

On THE MONEY ON the Money

A tipping point for bonds and the dollar?
The March rise in U.S. Treasury yields might be the end of a 30-year cycle, but it doesn’t necessarily forecast the course of the dollar.
BY BARBARA ROCKEFELLER

The yield on the benchmark 10-year U.S. T-note rose from a low of 1.797 percent on Jan. 31 to a high of 2.397 percent on March 20 — a huge jump. During March, the bond market switched gears from risk aversion — a possible

renewal of recession and low rates for another two years — to risk appetite. The new stance was inspired in part by better U.S. data (especially payrolls), but mostly by a perceived shift in the institutional environment — specifically, a seemingly less-dovish Fed. Barbara Rockefeller Currency Trader Mag April 2012 If the new stance is correct, bond Figure 1. Reuters US T-Note Yield FIGURE 1: REUTERS US T-NOTE YIELD yields should rise further to reflect 38 a historically normal 2- to 3-percent 37 spread over inflation. This is of great 36 35 interest to FX traders, because as a 34 general rule a currency’s value fol33 lows real yield: If the real yield is ris32 31 ing, the dollar should rise, too. Some 30 analysts went so far as to suggest that 29 28 what was ending was the long, long 27 bull market in Treasuries that dates 26 back to the days of Paul Volcker’s Fed 25 24 chairmanship, when the T-note yields 23 peaked at 15.8 percent (1981). 22 21 We need to test the plausibility of 20 this Big New Idea. U.S. economic 19 data during the first quarter was 18 17 pretty good, with special attention 16 to payrolls and the happy observa15 tion job-seekers were coming back (so 14 improvements in the unemployment 2011 FebruaryMarch April May June July August September October November December 012 2 February March April May J rate were real and not due only to Has the bond market gotten ahead of itself? The 10-year yield index broke out of fewer seekers). the upside of a down-trending channel in January, but as of late March it had not But data always takes a backseat to surpassed its October high. institutional factors. In March, Fed Source: Chart — Metastock; data — Reuters and eSignal

10

April 2012 • CURRENCY TRADER

Barbara Rockefeller Currency Trader Mag April 2012 Figure 2. Reuters US T-Note Yield, Weekly

FIGURE 2: REUTERS US T-NOTE YIELD, WEEKLY
85 80 75 70 65 60 55 50 45 40 35 30 25 20 15 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Current T-note yields are far below their historical norms.

Chief Ben Bernanke refrained from mentioning the need for additional stimulus, from which the market deduced QE3 was off the table. Logically, the accompaniment to such a bias would be to shorten the period of “extraordinary accommodation” from the promised end of 2014 to a closer date, something mentioned by regional Fed Presidents Jeffrey Lacker (Richmond) and James Bullard (St. Louis). Reinforcing the idea the Fed is not committed to QE3, New York Fed President William Dudley said a decision on QE3 depends on the data. To cap it off, the Fed held a conference of top global central bankers on the subject of the timing and methodology of ending quantitative easing. Participants included the two other major central banks that have used quantitative easing, Bank of Japan Governor Masaaki Shirakawa and Bank of England Governor Mervyn King. It’s of some interest the European Central Bank (ECB) sent former Gov. Jean-Claude Trichet rather than anyone with current working knowledge of the ECB’s version of QE, the Long-Term Repo Operation (three-year tenor, nearly €1 trillion). Note the Fed has not definitely taken QE3 off the table. Refraining from mentioning the elephant in the room doesn’t mean the elephant isn’t there. As Fed Gov. Dudley stressed, a decision about QE3 has not been made and will not be made until more data has been accumulated. The bond market has almost certainly gotten ahead of itself. Figure 1 shows the 10-year note yield index. The yield fell from a high of 3.744 percent on Feb. 9, 2011 to a low of 1.696 percent on Sept. 23, 2011. It then bounced to a

high of 2.407 percent on Oct. 27, 2011 before settling into a sideways range. Yes, the index broke out of the upside of the down-sloping channel in January 2012, but as of late March it had not surpassed the October high. Figure 2 shows the U.S. T-note yield over a longer time frame. The blue line is the linear regression from the highest point (November 1994 at 8.038 percent) to today. The gold lines mark the 4- to 5-percent range that would be “normal” if return were at the historic average of 2- to 3-percent over inflation. Current yields are clearly far below both measures, and moreover, the latest rise in yield looks like pretty small potatoes on this scale. It’s clearly far too early to be identifying a big-cycle turning point in bond yields. Nonetheless, from left field comes evidence that risingrecovery sentiment is becoming more solid. The left field in this case is the TIPS market (inflation-protected Treasuries). The strong bias in favor of rates rising sooner than expected can be seen in the negative yield on the last two TIPS auctions. Buyers of the $13 billion of 10-year TIPS on March 22 accepted a negative yield of 0.089 percent — a record low — presumably because they expected the Fed will be paying out down the road when inflation materializes after all. In other words, the negative yield is a vote of no-confidence in the Fed. Similarly, the January auction had a negative yield of 0.046 percent. To evaluate the negative yield, you need the break-even rate, which is the difference between yields on nominal 10-year notes and 10-year TIPS. In late March it was at 2.38 percent, meaning bond-market buyers expect an

CURRENCY TRADER • April 2012

11

ON THE MONEY

Barbara Rockefeller Currency Trader Mag April 2012 Figure 3. Reuters US T-Note Yield vs. Dollar Index (Green)

FIGURE 3: REUTERS US T-NOTE YIELD (BLACK) VS. DOLLAR INDEX (GREEN)
38 38 37 37 36 36 35 35 34 34 33 33 32 32 31 31 30 30 29 29 28 28 27 27 26 26 25 25 24 24 23 23 22 22 21 21 20 20 19 19 18 18 17 17 16 16 15 15 14 14 13 February March April May June July August September ctober O November December 2012 February March April May J

Treasury yields don’t necessarily lead the dollar higher. History shows this assumed relationship is weak and inconsistent.
Barbara Rockefeller Currency Trader Mag April 2012 Figure 4. US T-Note (Inverted) vs Dollar Index (Green)

FIGURE 4: U.S. T-NOTE (BLACK, INVERTED) VS. DOLLAR INDEX (GREEN)
15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 91.0 90.5 90.0 89.5 89.0 88.5 88.0 87.5 87.0 86.5 86.0 85.5 85.0 84.5 84.0 83.5 83.0 82.5 82.0 81.5 81.0 80.5 80.0 79.5 79.0 78.5 78.0 77.5 77.0 76.5 76.0 75.5 75.0 74.5 74.0 73.5 73.0 72.5 72.0 71.5 71.0 70.5 70.0 2008 J J A S O N D 2009 M A M J J A S O N D 2010 M A M J J A S O N D 2011 M A M J J A S O N D 2012 M A M

The inverted 10-year T-note yield and the dollar index appear to be somewhat more in sync, except the dollar index led yields higher until around May 2011.
12

annual inflation rate of more than 2.38 percent over the next decade. If we assume they seek a “normal” fixed income return of 2 to 3 percent, they expect inflation to be between 4.38 to 5.38 percent. It’s noteworthy the indirect bidders, a category that includes foreign buyers, took more than 40 percent of the March auction. The implication is the world at large expects the Fed to have a hard time getting the genie back in the bottle; all that new money supply from quantitative easing will end up causing inflation. As for the bond “leading” the dollar upward, it ain’t necessarily so. Figure 3 shows the T-note yield charted against the dollar index. During this roughly one-year time period, the dollar index was actually “leading” the yield. This makes no sense. Instead of assuming a tight correlation between yields and the dollar, we should deduce the relationship is weak and inconsistent because of frictions arising from other factors, including yield trends in the dollar-index basket and other assets, such as oil. The dollar index includes the Euro (57 percent), Japanese yen, British pound, Swiss franc, Swedish krona, and Canadian dollar. So, first we have to look at Euro yields — but there really isn’t such a thing. Yields exist for each of the 17 Eurozone members, and range from about 12 percent for Spain to 2 percent (and sometimes less) for the German Bund. Greece currently yields about 20 percent. Italy saw a drop from 6 percent before year-end to under 5 percent by mid-March but then the yield crept back over 5 percent. As for Japan, its 10-year yield is about 1.04 percent and has fallen 0.18 percent year-over-year, so with U.S. yields on the rise the Japanese yen
April 2012 • CURRENCY TRADER

was a screaming sell during February and March (from 76.03 on Feb. 1 to 84.18 on March 15). Canada, too, saw its 10-year yield drop, to 2.20 percent in late March and down more than 1 percent from the year before. In fact, traders said the one they were watching the most was the Bund, and instead of following the U.S. yield higher on the idea of global recovery, it dipped below 2 percent in late March. Bottom line, the yields embedded in the dollar index are varied, offering only a confusing comparison with the U.S. note itself. Viewing the 10-year note yield inversely with the dollar index has become popular, although it doesn’t make economic sense if we believe, as a general rule, currency follows yield. It makes sense only if we use risk-appetite/risk-aversion as the vector for transmitting sentiment about currencies. Therefore, when U.S. yields fall on risk aversion because of events elsewhere in the world — European peripheral debt crises, China perhaps suffering a not-so-soft landing — the rising dollar is a direct function of the safe-haven portfolio flow. In Figure 4 the inverted 10-year T-note yield and the dollar index appear to be moving somewhat more in sync, except the dollar index is still leading the note up until about May 2011. This is an interesting time for the note to start leading the dollar, since QE2 ended in June 2011. But if we look at the note index vs. the dollar index on a bigger scale, with the note index inverted, we get minestrone (Figure 5). The dollar index failed to track the note index for years on end. So let’s go back to the non-inverted version on a big scale (Figure 6). Again we see a correlation of the dollar index with the note index, imperfect though
CURRENCY TRADER • April 2012

Barbara Rockefeller Currency Trader Mag April 2012 Figure 5. US T-Note (Inverted) vs Dollar Index (Green)—Weekly with 20-Period Moving Aver-

FIGURE 5: U.S. T-NOTE (BLACK, INVERTED) VS. DOLLAR INDEX (GREEN), WEEKLY, WITH 20-PERIOD MOVING AVERAGE
135 15 130 20 125 25 120 30 35 40 45 50 55 60 65 70 75 75 80 70 115 110 105 100

95 90 85 80

1985 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20

Barbara Rockefeller Currency Trader Mag April 2012 Figure 6. US T-Note vs Dollar Index (Green)—Daily
85 80 75 70 65 60 55 50 45 40

Comparing the inverted yield index to the dollar index on a larger scale shows the dollar index failed to track yields for years.

FIGURE 6: U.S. T-NOTE (BLACK) VS. DOLLAR INDEX(GREEN), DAILY
135 130 125 120

115 110 105 100

95 90

35 85 30 80 25 20 15 1985 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20 75 70

Yields and the dollar were negatively correlated between 1995 to 2002.

13

ON THE MONEY

it may be, especially the long period from 1995 to 2002 when the two were negatively correlated. Net-net, neither the direct nor the inverted correlation stories hold water over a long period of time. Our hypothesis is unproven that pending rate increases, already being baked into the cake by the bond market, should lift the dollar. Whether this is true depends on conditions in the realm of risk-appetite/risk-aversion. In high-risk situations when U.S. yields are falling because of external events, the dollar may rally as a safe haven. This is the inverse-correlation relationship, but it is not a permanent correlation. When risk appetite is healthier and U.S. yields rise on expectations of higher growth and inflation, flows may be siphoned from the dollar to higher-yielding or more exciting currencies and asset classes. Yes, it is perverse. More robust growth and expectations of higher interest rates “should” favor the issuing currency. In the case of the dollar, those two expectations nurture the conditions that permit traders to flee the safe haven and seek gains elsewhere. Given the many decades over which the dollar persistently devalued, this should not come as a surprise. What are the conditions that would deliver both rising yields and a rising dollar? Two big-picture events come to mind. The first is a geopolitical catastrophe, such an Iran closing the Strait of Hormuz and the U.S. forcibly opening it up again. The dollar always benefits from the U.S. taking a military initiative, for reasons no one really understands. While the price of oil would no doubt soar (at least initially), and rising oil prices tend to be dollar-negative, it might be different next time. After all, the U.S. is becoming less dependent on energy imports and the military gain plus a modicum of energy self-sufficiency may override the oil price effect. In any case, the Fed has proven itself to

The implication is the world expects the Fed to have a hard time getting the genie back in the bottle — all that new money supply from QE will end up causing inflation.

be adamantly against responding to oil price changes as a motive for monetary policy change. Another condition that would promote simultaneous rallies in both Treasury yields and the dollar index is the U.S. government adopting some kind of balanced budget commitment, whether an actual constitutional amendment or just an informal agreement it would be the sane and reasonable thing to do. We have postulated the Maastricht Treaty (and now the Fiscal Compact) in the Eurozone, mandating caps on budget deficits, are the new “gold standard” that savers and yieldseekers have sought for centuries. Investors are so enamored of the idea that they continue to add to Euro reserves even though it’s obvious that only two or three of the 17 Eurozone members are actually achieving the objective. Nothing would restore the dollar’s luster like a balanced budget commitment. The ratings agencies would restore the America’s triple-A rating. The dollar would rally like a banshee. The problem, of course, is that Congress is too divided and rancorous to agree on any such thing, and no one would ever accuse Washington of taking the sane and reasonable course of action. A serious sticking point would be the need for an escape clause that allowed deficit spending during recessions. This is the proven Keynesian remedy, but with plenty of folks declining to accept it (and even if it were magically accepted) it’s not clear anyone could have confidence the escape clause would be used fairly and responsibly. In the end, it’s unwise to see rising U.S. yields as a consistent and reliable indicator of a higher dollar. The lateMarch rise in U.S. 10-year yields may indeed be the end of a 30-year yield cycle, but unfortunately that doesn’t help us forecast the dollar. To do that, you also need to be able to forecast real risk and the perception of risk.y For information on the author, see p. 4.

14

April 2012 • CURRENCY TRADER

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TRADING STRATEGIES

Intraday FX swing-reversal
Rethinking a common chart pattern results in a hybrid continuation-reversal setup.

BY CURRENCY TRADER STAFF

Most chart-pattern traders tend to divide patterns into certain categories, such as reversal or continuation, the former indicating a change in trend direction and the latter signaling a resumption of the existing trend after a correction or pause. But such definitions are sometimes not much more than preconceptions we foist upon price action. Figure 1 shows a pattern that formed on March 28, 2011 on a 20 minute chart of the Aussie/U.S. dollar pair (AUD/ USD). It consists of six relative highs and lows that formed over the course of 21 bars (seven hours), with the following general characteristics: After making a new high (1), price drops to a 10-bar low (2), swings up to a four-bar

high (3), swings back down to a new (30-bar) low (4), back up to a 13-bar high (5) and, finally, down again to a fivebar low (6). No doubt many faithful chartists will think “head-andshoulders bottom” when they see Figure 1, even though, perhaps, the decline from the peak isn’t necessarily lengthy or large enough to constitute a qualifying trend for the “classic” H&S reversal pattern. The ultimate low at point 4 would be the inverted head, while the lows at points 4 and 6 would be the inverted shoulders. The typical interpretation of this well-traveled pattern would be to go long on a move above the “neckline,” which here is the dashed line connecting relative highs 3 and 5. Price does, in fact, make a strong move FIGURE 1: NAME THAT PATTERN on the bar of the breakout — but, as Figure 2 shows, the rally evaporated almost immediately, and a long position would have been in the red before the next bar ended. One of the drawbacks of buying on strength or selling on weakness in this fashion is that it places a trade at a disadvantage if even a temporary and relatively mild correction occurs — which is highly likely, after a strong move. Even if the market eventually moves back in the direction of the trade, no one likes being underwater if they don’t have to be. For example, buying on the breakout of the neckline would result in a long position around 1.0285, assuming price must trade at least one pip above the breakout point. By comparison, a trader who bought, say, closer to relative low 6 (around It might look like an inverted head-and-shoulders pattern, but this formation 1.0263, which was a little below relais better understood by abandoning preconceptions and quantifying its tive low 2 and above relative low 4) characteristics. would be in a position to either capture
April 2012 • CURRENCY October 2010 • CURRENCY TRADER

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TRADING STRATEGIES

FIGURE 2: PATTERN RESOLUTION a roughly 30-pip gain or, at the worst, suffer a smaller loss when the pair subsequently dropped. Throwing out all preconceptions based on visual analysis and focusing instead on the pattern’s quantitative aspects offers a way to define a setup that can identify buying points that sometimes mark continuation points within trends and, other times, larger reversals (within an intraday context). The goal is to enter at a point that presents an opportunity to capture a shortterm gain, with the potential to ride a longer move if it emerges.

Breaking down the pattern
The pattern was followed by a small rally that quickly reversed.

FIGURE 3: ADDITIONAL PATTERNS

Let’s define the pattern’s components in greater detail (but still in abstract form). Relative highs and lows 1-6 could be described as follows: 1. A relative high that is greater than or equal to the highest high of the preceding n bars. 2. A relative low that is lower than or equal to the lowest low of the preceding n bars and x percent below the relative high from step 1. 3. A relative high that is greater than or equal to the highest high of the preceding n bars and x percent above the relative low from step 2. 4. The pattern’s ultimate low, which must be below the relative low from step 2. 5. A relative high that is greater than or equal to the highest high of the preceding n bars and x percent above the ultimate low from step 4.
April 2012 • CURRENCY TRADER

Neither pattern followed a notable downtrend, but both imply a move to the upside.

18

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CURRENCY TRADER • April 2012

19

TRADING STRATEGIES

TABLE 1: PATTERN CHARACTERISTICS
1 Date 3/28/11 1 2 3 4 5 6 3/30/11 1 2 3 4 5 6 3/31/11 1 2 3 4 5 6 4/5/11 1 2 3 4 5 6 4/24/11 1 2 3 4 5 6 2 3 RH or RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL RH RL 4 Price 1.0314 1.0265 1.0283 1.0252 1.0284 1.026 1.0332 1.0296 1.0321 1.0288 1.0326 1.0295 1.036 1.0335 1.035 1.0318 1.0354 1.0334 1.0341 1.0304 1.0333 1.0288 1.0323 1.0301 1.0775 1.072 1.0737 1.0711 1.0741 1.0714 -0.51% 0.16% -0.24% 0.28% -0.25% -0.36% 0.28% -0.44% 0.34% -0.21% -0.24% 0.15% -0.31% 0.35% -0.19% -0.35% 0.24% -0.32% 0.37% -0.30% -0.48% 0.18% -0.30% 0.31% -0.23% 5 % swing 6 N-bar high/ low 40 10 4 30 13 5 40 9 5 18 16 8 40 6 6 24 14 1 16 40 5 40 7 7 40 40 2 40 11 7 6 2 2 7 2 0.08% 3 5 2 6 3 0.16% 5 3 2 5 1 0.16% 3 4 5 6 3 0.08% 7 3 4 5 1 0.13% 7 Bars after prev. RH/RL 8 RL (2/6) diff.

6. A relative low that is less than or equal to the lowest low of the preceding n bars, and above the ultimate low from step 4. Note: All relative highs (RH) and relative lows (RL) must be preceded and succeeded by at least one lower high or higher low, respectively. These definitions are not exhaustive; additional (or alternate) parameters could be used. For example, the definition for RL6 could include a requirement that it be at least x percent below RH5 or no more than y percent away from RL2. There is also the matter of how many bars the pattern must contain — specifically, the maximum and/or minimum number of bars between the six RHs and RLs. In Figure 1, for example, RL2 is seven bars after relative high RH1, RH3 occurs three bars after RL2, RH4 (the pattern’s lowest low) occurs four bars later, RH5 is five bars later, and RH6 is three bars later. At this point, however, our goal is to keep the definition as simple as possible. Figure 3 shows two similar patterns from March 30 and 31, 2011. There are two aspects to these potential setups that bear mentioning. First, both occur while the market is in an overall uptrend (the rally that preceded the first example is not visible on the chart). As a result, although neither pattern followed a notable downtrend — and so cannot be
April 2012 • CURRENCY TRADER

Analyzing the size, duration, and spacing of the different price swings makes it possible to begin modeling the pattern.

20

TABLE 2: SUMMARY PARAMETER CHARACTERISTICS
% swing Med. RH 1 RL 2 RH 3 RL 4 RH 5 RL 6 -0.36% 0.18% -0.31% 0.34% -0.23% -0.39% 0.20% -0.32% 0.33% -0.24% -0.24% 0.28% -0.24% 0.37% -0.19% -0.51% 0.15% -0.44% 0.28% -0.30% Avg. Max. Min. Med. 40 10 5 30 13 7 N-bar high/low Avg. 35.2 21 4.4 30.4 12.2 5.6 Max. 40 40 6 40 16 8 Min. 16 6 2 18 7 1 5 3 2 6 2 4.8 3.4 3 5.8 2 7 5 5 7 3 3 2 2 5 1 Bars after prev. RH/RL Med. Avg. Max. Min.

The median and average values for the various categories are fairly consistent. The extreme values, however, will be used to model the pattern and analyze futures examples.

classified as potential reversal patterns — they’re being identified as bullish setups. Second, the March 31 example underscores the advantage of being able to enter a long trade in the vicinity of RL6. Doing so in this case would have provided an opportunity to capture a 30- to 40-pip move before the market reversed to the downside. In short, rather than thinking in terms of a head-andshoulders pattern – or any other formation – let’s look at the setup as a congestion pattern with defined support and resistance. Identifying these levels will make it possible to construct a trading approach that goes long at a relative low price level.

Pattern parameters

We’ll start by using a few sample patterns to develop a model of the price action we want to identify. Table 1 shows the size and duration of the price swings of the patterns from Figures 1-3, plus two more patterns that formed in April 2011 (not shown). The numbers in the second column represent each price swing (as numbered in Figures 1-3), the third column denotes each as an RH or RL, the fourth column shows the high or low for each bar, the fifth column shows the percentage size of the swing from the previous RH or RL, the sixth column show the how many of the preceding highs or lows each RH or RL exceeded, the seventh column shows how the number of bars between each RH and RL, and the final column shows the absolute difference between RL2 and RL6. For example, for the March 28 pattern shown in Figures 1 and 2, RL2 occurred at 1.0265, which marked a 0.48-percent decline from the RH1 high of 1.0314. Also, RL2 was lower than the previous 10 lows, and it occurred seven bars after RH1. (Note: 40 bars was used as a maximum for the “N-bar high/low” category; any lengths longer than
CURRENCY TRADER • April 2012

this are listed as 40.) Table 2 shows the median, average, maximum, and minimum values for the “% swing,” “N-bar high/low,” and “Bars after prev. RH/RL” fields from Table 1. Although this is only a small sample, the median and average values for the different categories are fairly consistent. For example, the median and average “% swing” values are all within 0.02 percent of each other, and other than the discrepancy between the median and average N-bar high/ low values for RL2 (10 and 21, respectively) all the other figures are in the same ballpark, too. (The N-bar high/low figures for RH1 must be interpreted in light of the 40-bar maximum for this parameter; the actual median and average are much higher.) Although median and average values are good for getting a handle on typical pattern characteristics, the maximum and minimum values in Table 2 have more practical value in identifying and comparing future instances of the pattern. We’ll start with the following parameters derived from Table 2, relaxed slightly (by an increment of one, up or down) to allow for variability in future samples: 1. RH1 must be greater than or equal to the highest high of the preceding 15 bars. 2. RL2 must be at least 0.22 percent below RH1, less than or equal to the lowest low of the preceding five bars, and occur between two and eight bars after RH1. 3. RH3 must be at least 0.14 percent above RL2, greater than or equal to the highest high of the preceding bar, and occur between one and six bars after RL2. continued on p. 32
21

ADVANCED CONCEPTS TRADING STRATEGIES

Taiwan: The Cold War fiction that worked
Until self-reinforcing behavior runs its course (aka “the bubble bursts”), a firmer TWD and greater returns on Taiwanese assets are being provided courtesy of the Fed and the BOJ.
FIGURE 1: OPTIONS MARKET COMFORTABLE WITH STRONGER TWD

BY HOWARD L. SIMONS
Whenever a diplomatic agreement or political compromise seems too cute by half, it usually is. Take a look at the U.S. Constitution’s punting of the slavery issue: Slaves would be counted as three-fifths of a person and the slave trade could last another 20 years. It took a very bloody civil war and three amendments to the Constitution to settle those issues. But the 1972 Shanghai Communiqué — signed by the United States and what was then a desperately poor and politically unsettled People’s Republic of China, declaring there was one China and Taiwan was part of that China — has stood the test of time, or at least four decades. The implicit understanding was the Taiwan issue either would be resolved to the mainland’s satisfaction or that all parties would agree to ignore the inconvenience of an independent Republic of China parked off China’s coast. Never mind Taiwan was under a mainland-based government for
April 2012 • CURRENCY TRADER

There were no significant jumps in excess volatility in 2010 as the TWD strengthened as part of that year’s overall emerging-market rally.

FIGURE 2: TWD DECLINING AGAINST YEN

The TWD’s drop vs. the JPY since mid-2007 was accelerated by the unwinding of yen carry trades into the TWD.

22

all of four years (1946-1949) out of the entire 20th century, defined as: and those years were during the civil war between the Communists and the Nationalists. Once the Nationalists max(H, Ct−1 ) 2 C 2 .5* ln −.39 * ln * 260 1/ 2 were exiled to Taiwan, a situation made tenable only N min(L, Ct−1 ) Ct−1 by the overwhelming U.S. naval and air superiority in N i=1 the region, they set about building one of the few Cold War fictions that worked: Where are East Germany, East Pakistan and South Vietnam today? Korea remains dividWhere N is the number of days between 4 and 29 that ed, but that division is between a successful country and a minimizes the function: basket case. 1 N N * * | (P − MA) | * | ΔMA | Taiwan would go on after 1972 to become an ecoN i=1 Vol 2 nomic powerhouse and to have by the mid-1980s the world’s largest reserves of foreign exchange. The island is still FIGURE 3: TWD NOT A FUNCTION OF RELATIVE INTEREST RATE EXPECTATIONS TO USD (TOP) AND JPY (BOTTOM) prosperous, is still chafing under

∑[

[ ( (

))

( (

)) ]

]

its Asian-style combination of economic freedom without what Americans would consider full political freedom, but it has lost many of its export markets, particularly in high-end electronics, to the mainland.

The cross rates

As we have done several times when discussing Asian currencies (see “No whacks at the Philippines,” April 2011, “The Baht and I,” May 2011, “Malaysia on the jagged edge,” June 2001 or “Hong Kong dollar still made in Japan,” August 2011), we will analyze the cross-rate of the Taiwan dollar (TWD) to the Japanese yen (JPY) as well as to the U.S. dollar (USD). Not only has Japan been an important commercial trading partner and financing source for Taiwan over the years, but Japan occupied Taiwan for much of the 20th century prior to 1945. First, let’s take a look at the TWD against the USD overlaid with its excess volatility, which is the ratio of the implied volatility for three-month non-deliverable forwards to high-low-close (HLC) volatility, minus 1.00, as a measure of the market’s demand for insurance. HLC volatility is
CURRENCY TRADER • April 2012

Although we should expect the differential between the TWD FRR6,9 and those of both the USD FRR6,9 and the JPY FRR6,9 to lead the TWD by three months, this does not appear to be the case, with the exception of late 2007.

23

ADVANCED CONCEPTS ON THE MONEY

Figure 1 shows the options market appears comfortable with a stronger TWD. There were no significant jumps in excess volatility in 2010 as the TWD firmed as part of that year’s general emerging-market rally. Interestingly, some of the highest readings for excess volatility occurred during the tech boom and bust of 1999-2001 as many of the capital inflows to Taiwan were seen as unstable and the

dot-com implosion wreaked havoc on the island’s export industries. Because the market for options on the JPY/TWD rate is quite new, we will simply display the cross-rate in Figure 2. The dominant feature of the past five years has been the TWD’s drop against the JPY once the credit crisis started to grow in mid-2007. The unwinding of yen carry trades into the TWD certainly accelerated this process. A brief stabilization FIGURE 4: TWD HAS CONVERGED TO SHORT-TERM RATE SPREAD TO USD in 2010 ended with the massive (TOP) AND PARALLELS THE SPREAD TO JPY (BOTTOM) repatriation of JPY following the March 2011 earthquake and tsunami.

Interest rates

For both the USD and JPY cases, the currency exchange rate and the three-month interest rate spread move in a parallel but not particularly statistically significant manner.

The unwinding of carry trades is linked to one of the key variables we have used to analyze nearly all currencies, the interest-rate expectation differential as measured by the forward-rate ratios between six and nine months (FRR6,9). This is the rate at which we can lock in borrowing for three months starting six months from now, divided by the ninemonth rate itself. The more this FRR6,9 exceeds 1.00, the steeper the money market yield curve is. We should expect the differential between the TWD FRR6,9 and those of both the USD FRR6,9 and the JPY FRR6,9 to lead the TWD by three months, with the normal effect being a greater differential leading to a stronger TWD. This does not appear to be a strong relationship for either currency, with the exception of the late-2007 period (Figure 3). As the Taipei Interbank Offered Rate (TAIBOR) market did not develop until September 2005, it is impossible to determine whether the TWD ever was a function of
April 2012 • CURRENCY TRADER

24

expected interest-rate differentials or whether it has been 2007 when central banks decided the answer to every mostly a function of asset-linked financial flows. question was more money. As “self-reinforcing behavior” We can observe, however, a simple interest rate link simply is a synonym for “bubble,” we know it will end, more common to less-developed markets and economies and end badly, at some point. Until then, a firmer TWD than those on Taiwan, and that is the interest rate spread and greater returns on Taiwanese assets are there, courtesy at the three-month horizon (Figure 4). In both the USD and of both the Federal Reserve and the Bank of Japan. y JPY cases, the currency exchange rate and the three-month interest rate spread move in a parallel but not particularly For information on the author, see p. 4. statistically significant manner. If the U.S. or Japan ever find a way to get themselves out of their respective near-zero percent inter- FIGURE 5: USD CARRY INTO TWD (TOP), JPY CARRY INTO TWD est rate worlds, we should expect to see downward pressure on the TWD.

Stock markets and carry trades

The most powerful determinant of the TWD, especially against the USD, appears to be carry trade-induced flows into Taiwanese assets, represented here by the relative performance of the Taiwanese stock market against both the U.S. and Japan in USD terms. If we map the excess carry return of borrowing either the USD or the JPY and lending into the TWD against the relative performance of the Taiwanese stock market as measured by MSCI, we see an extremely strong linkage in the U.S. case from 1999 forward (Figure 5). The yen carry trade, as noted above, lapsed in importance after the U.S. went to quantitative easing in March 2009. This self-reinforcing cycle of funds chasing stock market performance and pushing the carry trade recipient’s currency higher has been seen around the world with increasing intensity since

In the U.S. case, an extremely strong excess carry return linkage appears from 1999 forward.

CURRENCY TRADER • April 2012

25

GLOBAL ECONOMIC CALENDAR
CPI: Consumer price index ECB: European Central Bank FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. FOMC: Federal Open Market Committee GDP: ross domestic product G ISM: Institute for supply management LTD (last trading day): The final day trading can take place in a futures or options contract. PMI: Purchasing managers index PPI: Producer price index Economic release (U.S.) GDP CPI ECI PPI ISM Unemployment Personal income Durable goods Retail sales Trade balance Leading indicators Release time (ET) 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 8:30 a.m. 10:00 a.m.

April 1 2 3 4
U.S.: March ISM manufacturing report ECB: Governing council interest-rate announcement Brazil: March CPI Canada: March employment report UK: Bank of England interest-rate announcement LTD: April forex options; April U.S. dollar index options (ICE) U.S.: March employment report

18 UK: February employment report 19 20 21 22

South Africa: March CPI

U.S.: March leading indicators Hong Kong: January-March employment report Canada: March CPI Germany: March PPI Mexico: March employment report

5 6 7 8 9 10 11 12

23 Hong Kong: March CPI 24 Mexico: April 15 CPI
Australia: Q1 CPI

Australia: Q1 PPI

25 FOMC interest-rate decision 26 South Africa: March PPI 27 28 29

U.S.: March durable goods and Brazil: March employment report U.S.: Q1 GDP (advance) and employment cost index France: March PPI Japan: March employment report and CPI

Brazil: March PPI Mexico: March PPI and March 31 CPI Japan: Bank of Japan interest-rate announcement U.S.: April trade balance and March PPI Australia: March employment report France: March CPI Japan: March PPI U.S.: March CPI Germany: March CPI UK: March PPI

30 Canada: March PPI 31 1 2 3 4
India: March CPI

U.S.: March personal income

13 14 15

May
U.S.: April ISM manufacturing report Germany: March employment report U.S.: April unemployment report LTD: May forex options; May U.S. dollar index options (ICE)

The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.

16 India: March PPI
UK: March CPI

U.S.: March retail sales Canada: Bank of Canada interest-

17 rate announcement

EVENTS
Event: The Trading Show Brazil 2012 Date: April 24-27 Location: Hotel Unique, Sao Paulo, Brazil For more information: Go to www.terrapinn.com Event: The MoneyShow Las Vegas Date: May 14-17 Location: Caesars Palace For more information: Go to www.LasVegasMoneyshow.com
26

Event: The Traders Expo Dallas Date: June 6-9 Location: Hyatt Regency Dallas at Reunion For more information: Go to www.DallasTradersExpo.com Event: The Trading Show Date: June 25-27 Location: Navy Pier, Chicago For more information: Go to www.terrapinn.com

April 2012 • CURRENCY TRADER

CURRENCY FUTURES SNAPSHOT as of March 30
Market EUR/USD AUD/USD GBP/USD JPY/USD CAD/USD MXN/USD CHF/USD U.S. dollar index NZD/USD E-Mini EUR/USD Sym EC AD BP JY CD MP SF DX NE ZE Exch CME CME CME CME CME CME CME ICE CME CME Vol 262.1 134.0 102.1 102.9 91.6 43.9 43.8 25.0 12.2 4.2 OI 244.5 144.2 152.7 134.5 115.6 148.3 43.6 49.4 26.9 6.2 10-day move / rank 1.26% / 60% -2.99% / 95% 0.99% / 62% 0.69% / 33% -0.75% / 70% -1.77% / 89% 1.50% / 60% -1.18% / 50% -1.13% / 38% 1.26% / 60% 20-day move / rank 1.01% / 31% -4.20% / 91% 1.00% / 45% -1.20% / 11% -1.05% / 50% -1.05% / 45% 1.29% / 36% -0.41% / 10% -1.63% / 43% 1.01% / 31% 60-day move / rank 3.05% / 95% -0.13% / 4% 2.49% / 90% -7.40% / 100% 1.58% / 29% 6.64% / 51% 4.33% / 100% -3.01% / 100% 3.96% / 28% 3.05% / 95% Volatility ratio / rank .24 / 38% .27 / 47% .29 / 8% .17 / 2% .30 / 68% .15 / 20% .28 / 48% .32 / 58% .17 / 23% .24 / 38%

Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. Note: Average volume and open interest data includes both pit and side-byside electronic contracts (where applicable). LEGEND: Volume: 30-day average daily volume, in thousands. OI: 30-day open interest, in thousands. 10-day move: The percentage price move from the close 10 days ago to today’s close. 20-day move: The percentage price move from the close 20 days ago to today’s close. 60-day move: The percentage price move from the close 60 days ago to today’s close. The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. For example, the % rank for the 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it shows how the most recent 60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100% means the current reading is larger than all the past readings, while a reading of 0% means the current reading is smaller than the previous readings. Volatility ratio/% rank: The ratio is the shortterm volatility (10-day standard deviation of prices) divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

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Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

CURRENCY TRADER • April 2012

27

INTERNATIONAL MARKETS
CURRENCIES (vs. U.S. DOLLAR)
Rank Currency 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Canadian dollar Russian ruble Great Britain pound Taiwan dollar Hong Kong dollar Chinese yuan Singapore dollar South African rand Swiss franc Euro Thai baht Japanese yen Australian Dollar New Zealand dollar Swedish krona Indian rupee Brazilian real March 27 price vs. U.S. dollar 1.004115 0.03432 1.589155 0.033795 0.12873 0.1583 0.79347 0.13064 1.102155 1.328385 0.03254 0.01209 1.048405 0.818705 0.148785 0.019125 0.551695 1-month gain/loss 0.35% 0.12% 0.11% -0.15% -0.17% -0.31% -0.33% -0.75% -1.24% -1.26% -1.35% -1.83% -1.96% -2.08% -2.47% -5.63% -5.68% 3-month gain/loss 2.47% 6.93% 1.74% 2.38% 0.13% 0.62% 2.55% 6.55% 3.16% 1.70% 1.88% -5.73% 3.18% 5.79% 2.37% 3.46% 2.65% 6-month gain/loss 3.59% 10.72% 2.56% 3.08% 0.40% 1.37% 3.20% 6.08% -0.05% -1.34% 1.15% -7.60% 7.46% 5.84% 2.59% -4.09% 1.92% 52-week high 1.059 0.0366 1.6702 0.03510 0.129 0.1589 0.832 0.1518 1.3779 1.4842 0.0336 0.0132 1.1028 0.8797 0.1662 0.0226 0.65 52-week low 0.9467 0.0303 1.5308 0.032 0.1281 0.1521 0.7606 0.1166 1.0459 1.2657 0.031 0.0117 0.9478 0.7397 0.1427 0.0181 0.5288 Previous 11 1 14 12 16 15 13 3 5 8 2 17 10 6 9 7 4

GLOBAL STOCK INDICES
Country 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Japan Germany U.S. Mexico Singapore Switzerland Brazil Italy Australia France South Africa UK Hong Kong India Canada Index Nikkei 225 Xetra Dax S&P 500 IPC Straits Times Swiss Market Bovespa FTSE MIB All ordinaries CAC 40 FTSE/JSE All Share FTSE 100 Hang Seng BSE 30 S&P/TSX composite March 27 10,255.15 7,078.90 1,412.52 38,956.32 3,018.91 6,269.40 66,037.00 16,498.73 4,391.60 3,469.59 33,858.22 5,869.50 21,046.91 17,257.36 12,512.04 1-month gain/loss 6.45% 3.35% 3.29% 3.10% 2.45% 2.04% 1.22% 1.17% 0.85% 0.82% -0.04% -0.78% -0.81% -1.08% -1.48% 3-month gain/loss 21.50% 20.19% 11.62% 5.03% 12.91% 6.50% 13.85% 10.55% 6.03% 11.81% 5.50% 6.57% 12.98% 8.71% 6.68% 6-month gain loss 19.11% 25.77% 20.18% 15.31% 10.75% 12.67% 22.47% 11.39% 8.07% 14.76% 10.10% 10.87% 16.09% 4.44% 5.85% 52-week high 10,255.15 7,600.41 1,416.58 38,956.32 3,227.28 6,604.50 70,108.00 22,575.30 5,069.50 4,137.97 34,426.74 6,103.70 24,468.60 19,811.10 14,314.50 52-week low 8,135.79 4,965.80 1,074.77 31,659.30 2,521.95 4,695.30 47,793.00 13,115.00 3,829.40 2,693.21 28,391.18 4,791.00 16,170.30 15,135.90 10,848.20 Previous 1 2 8 11 6 15 3 9 13 7 14 10 5 4 12

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April 2012 • CURRENCY TRADER

NON-U.S. DOLLAR FOREX CROSS RATES
Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Currency pair Canada $ / Real Euro / Real Yen / Real Aussie $ / Real Canada $ / Yen Pound / Aussie $ Pound / Yen Pound / Franc Euro / Aussie $ Euro / Yen Franc / Yen Aussie $ / New Zeal $ Euro / Franc Aussie $ / Yen New Zeal $ / Yen Pound / Canada $ Aussie $ / Franc Euro / Pound Franc / Canada $ Euro / Canada $ Aussie $ / Canada $ Symbol CAD/BRL EUR/BRL JPY/BRL AUD/BRL CAD/JPY GBP/AUD GBP/JPY GBP/CHF EUR/AUD EUR/JPY CHF/JPY AUD/NZD EUR/CHF AUD/JPY NZD/JPY GBP/CAD AUD/CHF EUR/GBP CHF/CAD EUR/CAD AUD/CAD March 27 1.82005 2.40783 0.02191 1.890034 83.075 1.515785 131.475 1.441845 1.26706 109.9 91.19 1.28054 1.20527 86.735 67.735 1.58265 0.951235 0.835905 1.09764 1.322945 1.044115 1-month gain/loss 6.39% 4.69% 4.04% 3.38% 2.26% 2.12% 1.99% 1.38% 0.68% 0.61% 0.61% 0.10% 0.03% -0.12% -0.22% -0.23% -0.73% -1.35% -1.58% -1.60% -2.30% 3-month gain/loss -0.17% -0.92% -8.19% -0.03% 8.72% -1.40% 7.94% -1.38% -1.44% 7.90% 9.45% -2.46% -1.42% 9.47% 12.24% -0.72% 0.02% -0.03% 0.67% -0.76% 0.69% 6-month gain loss 1.63% -3.20% -9.37% 4.86% 12.14% -4.56% 11.03% 2.62% -8.18% 6.81% 8.20% 1.53% -1.29% 16.32% 14.58% -0.99% 7.52% -3.80% -3.51% -4.75% 3.74% 52-week high 1.8379 2.5367 0.0246 1.9172 88.95 1.626 139.19 1.5027 1.4011 122.63 105.79 1.3656 1.3158 89.46 68.81 1.6354 0.99 0.9038 1.3569 1.4316 1.0755 52-week low 1.5997 2.204 0.0186 1.6402 72.63 1.4637 117.58 1.1778 1.2188 97.22 80.46 1.2354 1.0376 72.72 57.23 1.5302 0.7477 0.8239 1.0415 1.2917 0.9977 Previous 19 13 21 18 5 15 6 20 10 3 1 16 12 4 2 14 17 7 8 9 11

GLOBAL CENTRAL BANK LENDING RATES
Country United States Japan Eurozone England Canada Switzerland Australia New Zealand Brazil Korea Taiwan India South Africa Interest rate Fed funds rate Overnight call rate Refi rate Repo rate Overnight rate 3-month Swiss Libor Cash rate Cash rate Selic rate Korea base rate Discount rate Repo rate Repurchase rate Rate 0-0.25 0-0.1 1 0.5 1 0-0.25 4.25 2.5 9.75 3.25 1.875 8.5 5.5 Last change 0.5 (Dec 08) 0-0.1 (Oct 10) 0.25 (Dec 11) 0.5 (March 09) 0.25 (Sept 10) 0.25 (Aug 11) 0.25 (Dec 11) 0.5 (March 11) 0.75 (Mar 12) 0.25 (June 11) 0.125 (June 11) 0.25 (Oct 11) 0.5 (Nov 10) Sept. 2011 0-0.25 0-0.1 1.5 0.5 1 0-0.25 4.75 2.5 12 3.25 1.875 8.25 5.5 March 2011 0-0.25 0-0.1 1 0.5 1 0.25 4.75 2.5 11.75 3 1.75 6.75 5.5

CURRENCY TRADER • April 2012

29

INTERNATIONAL MARKETS
GDP AMERICAS
Argentina Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore Argentina Brazil Canada France Germany UK Australia Hong Kong Japan Singapore

Period
Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4 Q4

Release date
3/26 3/6 3/2 3/28 2/15 3/27 3/29 3/7 2/1 2/29 2/13 2/24

Change
5.0% 4.2% 1.5% 0.2% 0.0% 0.6% 3.3% 0.4% 3.0% 12.0% -0.6% 3.8%

1-year change
15.6% 6.5% 5.4% 1.7% 2.6% 2.9% 10.3% 2.8% 6.5% 14.2% -2.3% 3.8%

Next release
delayed 6/1 6/1 6/29 5/15 6/28 6/21 6/6 5/11 5/31 5/17 5/25

EUROPE AFRICA ASIA and S. PACIFIC

Unemployment AMERICAS

Period
Q4 Feb. Feb. Q4 Feb. Nov.-Jan. Feb. Dec.-Feb. Jan. Q4

Release date
2/22 3/22 3/9 3/1 3/29 3/14 3/8 3/19 3/2 1/31

Rate
6.7% 5.7% 7.4% 9.4% 7.2% 8.4% 5.2% 3.2% 4.5% 2.0%

Change
-0.5% 0.2% -0.2% 0.1% -0.2% 0.1% 0.0% 0.2% -0.1% 0.0%

1-year change
-0.6% -0.7% -0.3% 0.1% -0.4% 0.5% 0.2% -0.2% -0.2% -0.2%

Next release
delayed 4/26 4/5 4/10 5/2 4/18 4/12 4/19 4/27 4/30

EUROPE

ASIA and S. PACIFIC CPI

Period
Argentina Feb. Feb. Feb. Feb. Feb. Feb. Feb. Q4 Feb. Feb. Jan. Feb. Brazil Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

Release date
3/13 3/9 3/23 3/30 3/20 3/9 3/29 1/25 3/22 3/30 3/2 3/23

Change
0.7% 0.5% 0.1% 0.8% 0.4% 0.6% 0.9% 0.0% 0.3% 0.5% 0.2% -0.3%

1-year change
9.7% 5.8% 2.6% 3.6% 3.2% 4.1% 8.3% 3.1% 4.7% 7.6% 0.3% 4.6%

Next release
4/13 4/5 4/20 4/27 4/20 4/13 4/26 4/24 4/23 4/30 4/27 4/23

AMERICAS

EUROPE AFRICA ASIA and S. PACIFIC

PPI AMERICAS EUROPE AFRICA ASIA and S. PACIFIC
Argentina Canada France Germany UK S. Africa Australia Hong Kong India Japan Singapore

Period
Feb. Feb. Feb. Feb. Feb. Feb. Q4 Q4 Feb. Feb. Feb.

Release date
3/13 3/30 3/30 3/20 3/9 3/29 1/23 3/13 3/14 3/12 3/29

Change
1.0% 0.2% 0.8% 0.4% 0.6% 0.9% 0.3% 0.2% 0.4% 0.2% 0.4%

1-year change
12.6% 1.7% 3.6% 3.2% 4.1% 8.3% 2.9% 6.5% 7.0% 0.6% 4.8%

Next release
4/13 4/30 4/27 4/20 4/13 4/26 4/23 6/14 4/16 4/12 4/27

As of March 30 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.

30

April 2012 • CURRENCY TRADER

FOREX TRADE JOURNAL

Beware of the too-tight stop.
TRADE
Date: Tuesday, March 27, 2012. Entry: Long the Aussie dollar/U.S. dollar pair (AUD/ USD) at 1.0493. Reason for trade/setup: This position was set up by the AUD/USD’s adherence to the longer-term support and resistance formed by the converging trendlines that bounded the big consolidation in the second half of 2011 (see upper chart inset). After breaking out above the upper trendline, the pair paused, pulled back, then bounced after touching the lower trendline during the week ending March 30. Believing the pair had successfully tested resistance, a limit buy order was entered on the expectation of a pullback from the recent high above 1.0550. The position was filled at 1.0493 on March 27. Initial stop: 1.0308, which is a little below the March 22 low of 1.0336. Initial target: 1.0635. Secondary target: 1.0789.

RESULT
Exit: 1.0308. Profit/loss: -0.0185. Outcome: Price traded lower with a vengeance in the first 48 hours after the trade entry, and to make a long story short, the trade was stopped out four pips above the low of the day on March 29 — immediately before the market reversed intraday to close near its high around 1.0386. But that is neither here nor there. Stops get hit, sometimes right before the market turns around. The real story is that although the stop might appear to have given the trade plenty of room, it was actually relatively tight, given the trade catalyst came from the weekly time frame. The move down to 1.0304 looks like a big downtrend on the two-hour chart, but it was only a modestly lower low on the daily chart and a barely noticeable penetration of the up-trendline on the weekly time frame. y
Note: Initial trade targets are typically based on things such as the historical performance of a price pattern or a trading system signal. However, because individual trades are dictated by immediate circumstances, price targets are flexible and are often used as points at which to liquidate a portion of a trade to reduce exposure. As a result, initial (pre-trade) reward-risk ratios are conjectural by nature.

Source: TradeStation TRADE SUMMARY Date 3/27/12 Currency pair AUD/USD Entry price 1.0493 Initial stop 1.0308 Initial target 1.0635 IRR 0.77 Exit 1.0308 Date 3/29/12

P/L point -.0185 % -1.76%

LOP .0002

LOL -.0189

Trade length 2 days

Legend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade). MTM: marked-to-market — the open trade profit or loss at a given point in time.

CURRENCY TRADER • April 2012

31

TRADING STRATEGIES

FIGURE 4: EXPANDING THE PATTERN

Additional patterns based on the preliminary model suggest going long after RH5 when price pulls back to within a certain distance of RL2. This provides the opportunity to profit from either a quick upswing or a longer-term up move, with a stop below RL4.

4. RL4 must be below RL2 and occur between one and six bars after RH3. 5. RH5 must be at least 0.27 above RL4, greater than or equal to the highest high of the preceding six bars, and occur between four and eight bars after RL4. 6. RL6 must be at least 0.18 percent below RH5, less than or equal to the low of the preceding bar, and above the ultimate low from step 4.

Entering trades

Figure 4 shows two patterns (from May 19 and 20) that appear to fulfill the criteria. However, only the first one does. In the second pattern, RH5 was higher than only the preceding four highs, while the minimum threshold is five highs. (If nothing else, this is a signal more patterns need to be studied and/or the parameters need to be adjusted.) The object of all the preceding analysis was to identify entry rules based on a very simple bit of price behavior. In all these pattern examples, price pulls back from a relative high and makes a relative low (RL2). After a bounce, price falls again to make a lower relative low (RL4), then bounces — establishing a support zone between these two relative lows. This zone provides the entry point for a long trade, the logic being that a subsequent retracement to this area is likely to be followed by another upswing; a move
32

below the lowest low (RL4) negates the significance of the support, so a stop-loss would be placed below this level. Buying at this relative low level provides an edge over buying on an upside breakout, after some price momentum has already been exhausted. However, the patterns in Figure 4 add a new twist: In both cases RL6 is above RL2, so price — although it pulled back enough on a percentage basis to satisfy the original pattern criteria — didn’t actually enter the buy zone between RL2 and RL4. This brings us back to the significance of the final column in Table 1, which is the absolute distance between RL2 and RL6. Instead of triggering a buy when price drops between RL2 and RL4, a trade could alternately be initiated when price pulls back (after establishing RH5) to within a certain distance of RL2.

Further research

The details involved in defining even a simple pattern such as this can be daunting, but objectifying trade rules always pays dividends — even if a setup or technique is ultimately employed on a discretionary basis. In this case, taking a new look at a seemingly common pattern showed the potential for a flexible setup that signaled both reversal and continuation entries in the AUD/USD pair. We will follow this pattern and explore different ways to quantify and trade it in future issues of Currency Trader. y

April 2012 • CURRENCY TRADER

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