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Strategies, analysis, and news for FX traders

October 2014
Volume 11 No. 10

with the
p. 27

Emerging FX
exposure p. 10
China slowdown:
FX impact p. 6

ECB opens
the spigot
p. 14

The relationship
between stock
returns and
currencies p. 22



Advanced Concepts
Major currencies and capitalization-

Global Markets

dependent stock returns.......................... 22

The China factor: FX impact ......................6

The relationship between equity returns and

The world’s second largest economy

currencies is not one-size-fits-all.

continues to slow.

By Howard L. Simons

By Currency Trader Staff

Forex Journal............................................27
On the Money

Going with the flow in the Aussie dollar.

The troublemaking yen............................ 10
Emerging markets are especially
exposed to recent developments.
By Barbara Rockefeller

ECB lays out game plan .......................... 14
After rocking the FX market on Sept. 4 with a
surprise rate cut, the ECB released the details
of its stimulus plan in early October.
By Currency Trader Staff

BarclayHedge Rankings......................... 15
Top-ranked managed money programs.

Looking for an
Click on the company
name for a direct link to the
ad in this month’s issue.

Spot Check
Aussie dollar: Monthly and
weekly patterns......................................... 16
The Australian dollar tumbled last month and
hit a conspicuous support level. A buying
opportunity or time for shorts to reload?


By Currency Trader Staff

Questions or comments?
Submit editorial queries or comments to

October 2014 • CURRENCY TRADER


The Global Trader (John Wiley & Sons. Copyright © 2014 Editor-in-chief: Mark Etzkorn Trading with the trend p.currencytradermag. and currently publishes two daily reports on foreign exchange. Past performance does not guarantee future Volume 11. trader. strategy or approach. Rockefeller is the author of Technical Analysis for Dummies.CONTRIBUTORS AUSSIE DOLLAR PATTERN PROBABILITIES P. 4 October 2014 • CURRENCY TRADER . A book tentatively titled How to Trade FX is in the works. Lake Zurich. 22 Contributing editor: Howard Simons Editorial assistant and webmaster: Kesha Green kgreen@currencytradermag. All rights Classified ad sales: Mark Seger m. The Foreign Exchange Matrix (Harriman House. 2011). No. Illinois 60047. 24/7 Trading Around the Clock. 10 China slowdown: FX impact p. Currency Trader is published monthly by TechInfo. and news for FX traders A publication of Active Trader ® October 2014 Volume 11 No. He writes and speaks frequently on a wide range of economic and financial market issues. Second Edition (Wiley. It is not meant to Managing editor: Molly Goad mgoad@currencytradermag. 16 Strategies. and consultant at Citibank and other financial institutions. published in Japan in 1999. Traders are advised to do their own research and testing to determine the validity of a trading idea. 10 For all subscriber services: www. Trading and investing carry a high level of risk.seger@currencytradermag. Rockefeller is on the board of directors of a large European hedge President: Phil Dorman q Howard Simons is president of Rosewood Trading Inc. 14 metzkorn@currencytradermag. q Barbara Rockefeller (www. 10. Inc. Information in this publication may not be stored or reproduced in any form without written permission from the publisher. promote or in any way imply the effectiveness of any trading system. Publisher. and How to Invest Internationally. 2001).com Contributing writers: Barbara Rockefeller. The information in Currency Trader magazine is intended for educational purposes only. PO Box 487. 2013). 6 The relationship between stock returns and currencies p. Inc. Around the World (John Wiley & Sons. pdorman@currencytradermag. 27 ECB opens the spigot p. 2000).com) is an international economist with a focus on foreign exchange. ad sales: Bob Dorman bdorman@currencytradermag. Marc Chandler Emerging FX exposure p. She has worked as a forecaster.

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and the decline is coming from very high levels. has major trade ties with China.3-7.9% year-over-year. “The Xi Jinping/Li Keqiang government has been increasingly critical of the scale of the 2008-09 stimulus conducted by its predecessor.” Callow says.” The real estate situation is still unfolding and there’s uncertainty about how these dominos might fall. Clearly there is room for them to fall further.7% in 2013. it’s unsettling for any country with significant exports to China.” He also projects 2014 ending GDP will be a little above 7%. senior currency strategist at Westpac Institutional Bank. The housing market in China has cooled dramatically in the wake of the credit-fueled price surge. the [economic] slowdown is from the massive imbalances over the past five years. down from 7. “Developers continue to discount aggressively to clear their stock and sellers are maintaining abundant supply in the secondary market. but some economists warn the final number could come in even lower.5%. Chinese authorities quickly responded with a massive stimulus program of 4 trillion yuan.” Pressler says.” Pressler says. it’s necessary to take a macro view. From boom to… Most analysts estimate China’s 2014 GDP will be around 7. or renminbi (around $653 billion) in the fourth quarter of 2008.GLOBAL MARKETS The China factor: FX impact The world’s second-largest economy continues to slow.” Speculators chased rising prices in the expanding Chinese real estate market in recent years. House prices fell in 61 of China’s 70 largest cities from June to July. according to Northern Trust Company vice president James Pressler. “Fundamentally. according to a Wells Fargo Securities 6 research note.” Recent data is slowing In August. which can depress certain commodity-related currencies.” he says. “With the aggregate October 2014 • CURRENCY TRADER . the world’s second-largest economy. This figure represented the weakest growth since December 2008. loans were flooding into the property market. called that number “particularly unnerving. for example. In an intertwined global economy. but the jury is still out on how much the Asian powerhouse is cooling. house prices in China’s four top-tier cities have risen about 60% on balance since 2005. slowing Chinese GDP weighs on commodity demand. But once the global financial crisis hit. which helped the economy rebound. is slowing. below economists’ expectations and down from 9% in July. BY CURRENCY TRADER STAFF China. That’s hardly news. but as the slowest pace since the global crisis. seeing it as creating unnecessary financial risks. As Wells Fargo reports: “By our estimates. “The government started worrying it was generating too much credit and started reigning in credit targets. To understand the main factors behind the slowdown from China’s pre-Lehman doubledigit numbers. Australia.” Fast forward to 2014. Chinese industrial production growth slumped to 6. Chinese GDP hit a red-hot peak of 14% in 2007. and many developers and investors are now stuck with non-performing loans. as well as the potential ramifications of a collapse in its overheated housing market. they poured a lot of investment into building and housing. Sean Callow. “You started seeing speculators enter the market and people [began] building far more housing than demand could account for. They are no longer able to sustain the credit bubble that [drove] past growth. “This is hardly a poor result. he says. Chinese growth plummeted to 6.6% in the first quarter of 2009. and a slowdown in the Chinese economy has a ripple effect on the Aussie economy and currency. “There was a lot of infrastructure building.

and also prices gage debt.? What are the risks to the years before the financial collapse . Mid-level banks could Regional forex developments fail. dollars.” In related regional currency market action.S. research note.. have also been hit he says. with help from the steep fall in commodity prices.S. accordsays the Aussie and kiwi dollar declines were in part relating to Pressler. There is more price weakness to come. “China still very much controls foreign ed to the slowdown in the Chinese economy.” real (BRL) and the Russian ruble (RUB). September saw Wells Fargo Securities global economist Jay Bryson significant declines in both the Australian dollar (AUD. investment.S. the price declines that have registered to date What are the risks? do not yet come close to that threshold.FIGURE 1: AUSSIE DECLINE demand-supply position closer to balance than in previous cycles. the global effects would be limited. “Although property prices are beginning to move lower. economy continues to struggle in China closely. Australia exports iron ore. the Brazilian China is not the most transparent economy in the world. Callow concludes. “Banks in Europe owned a lot of subprime and mortand China. we will be watching property developments sequent collapse. and the natural ‘buyer on dips’ in a falling market.” The Australian dollar tumbled 7% in September.” he says. However. with the extent of yuan gains reduced somewhat by central bank reserve accumulation — buying erty prices on the order of roughly 25% to wipe out the equity in the Chinese real estate sector. it’s Source: TradeStation difficult to be bearish on the yuan.” he says. one source of real strength this year has been China’s trade surplus. “As a huge net importer of commodities.. doesn’t think this is a “Lehman Brothers sort of thing. “Nonpoint over the next year or two. Just because China Chinese economy and the global economy if its real estate has not experienced a financial crisis to date due to falling downturn turns into a crash? property prices does not necessarily mean it won’t at some “Credit markets could lock up. a year before credit markets there comparisons to the Chinese real estate surge and in the United States started to freeze and more than two what happened in the U. “The rest of iron ore have declined significantly. “We look for USD/CNY to end the of collapse tomorrow.” he says. “This has been very resilient.” is contributing to the currency weakness.” There are other factors impacting the Aussie and kiwi Also.S. As a result. even if the Chinese real estate downturn were Wells Fargo Securities currency strategist Eric Viloria to turn south.” rest of the world.” performing loans could rise to the point where they are a burden on future credit generation.” However.08. New Zealand’s of the world doesn’t own Chinese mortgages. Still relatively fresh off its own housing bubble and sub“That said. though. Figure 2).S. Callow also notes that despite the deceleration in Chinese growth momentum. U. The Case-Shiller index of U. the real estate sector isn’t necessarily on the brink CURRENCY TRADER • October 2014 7 . “There isn’t a lot of foreign invest“The data coming out of China is on the soft side.” he says. “There Bryson agrees. have the same impact as our subprime crisis had on the which is negative for the New Zealand dollar.” he says. “It would take a decline in propyear around 6. hard. which ment to catch contagion. It affected European banks.” Pressler says. pointing to the 2007-2008 situation in the are strong trade linkages between Australia. Are prices peaked in July 2006. high-net worth is presently positioned on the sell side. house to regain normalcy in its housing and labor markets. which could cause a collapse in confidence.” Figure 1) and the New Zealand dollar (NZD. and dairy prices have been falling. the U.” Bryson wrote in a U. This has capped the import bill and helped produce very large surpluses. New Zealand. It wouldn’t exports are agricultural. China is enjoying a favorable shift in its terms of trade as it pays significantly less for its iron ore and crude oil. “But I say that with a little hesitation because Two other commodity-related currencies.

8600. yields moving higher. it tends to weigh on those two currencies. the USD/ CNY daily fix has been in a tight range between 6.0000 between early 2011 and spring 2013. but so is the U. HSBC targets the NZD at .” Callow warns if Chinese growth doesn’t pick up soon.6600. “Aussie and kiwi are some of the currencies that are more sensitive to the overall risk environment. means upside risk on any better China data.S. Yuan outlook The Chinese yuan remains a managed currency.” Also. which would involve a recovery bounce from late-September levels around . He notes his team is more constructive on the outlook for the New Zealand dollar saying the recent weakness “has been a bit overdone. AUD and NZD will be most jittery. “Before. head of G-10 FX strategy Americas HSBC. “Beijing weakened the currency during the first four months of the year to help struggling exporters. there will be more damage to currencies sensitive to China rather than the Chinese yuan itself — including AUD. it’s a reasonable reference.” Viloria says. NZD. China is a big driving factor. As of late September. then let it appreciate modestly after major trade partners complained of currency manipulation. has the Australian dollar finishing the year at . which implies the Aussie dollar value at . but as a 8 long-term reference as to where the currency should move toward.” he says. “[trade linkages] are more pronounced between Australia and China than for the kiwi. “Some of the fair value estimates for the Aussie show it as being overvalued. For now we stick with our 0.GLOBAL MARKETS FIGURE 2: COLLAPSING KIWI The New Zealand dollar fell 11% between July and late September. the USD/CNY rate stood at about 6. Source: TradeStation as well. and the Malaysian ringgit.” Bob Lynch. And there’s good reason. Chinese authorities widened the band the yuan can trade within (a certain amount above and below its reference rate. now it is 2%.7900.” he says.8700 by year-end. the one-time “darling” of the FX market that traded mostly above 1.1 over the next six months (Figure 3). “When you have U.” Viloria explains. which is set daily).90 end-2014 target on AUD/USD.” Pressler explains. “In the event of a more dramatic economic deceleration or a credit/liquidity crisis in 2015. October 2014 • CURRENCY TRADER .1710. continues to lose its luster.1424 and 6. He cites the OECD’s measure of purchasing power parity. rate environment. However. “This.“Of these. the band was 1% above or below.” he says. “The yuan is widely considered undervalued.S.” he says.” Lynch says. too — it’s not all downside risk. “It is a simplistic valuation measure that typically doesn’t align with any exchange rate. and from a global perspective the currency is still considered cheap. Pressler adds the balancing act between maintaining strong exports and aggravating trade partners has been difficult for China this year — a situation made worse by an economic slowdown that has been shored up only by the export sector. The Australian dollar.13. Chinese authorities would quickly weaken the yuan to support the economy and deal with angry politicians in Washington as an afterthought. Viloria sees the potential for it to decline to 6. Since June. of course. which benefits Chinese exporters but makes it more difficult for China’s trade partners to sell their own goods to the Chinese.

” Pressler notes. there is always concern about China’s international reserves. Pressler pegs the odds at 30% of “something really bad happening in China” that requires a dramatic policy shift. they’ll choose themselves. At that point.S. which have continued to trade near historic highs. Treasuries would take a hit and yields would go up.” Pressler says. of course. the yuan still trades in a managed band.S. But don’t count on China’s allegiance. Would they use them to generate cash to start pumping money into the banking system? Would they liquidate some of those reserves and put them out on the market to fund its own programs? The price of U.” Then. prices could drop and yields could rise significantly.S. Source: TradeStation 9 . you’d see the yuan depreciate and the price of Chinese goods would fall for those in the U. dollars. “China will try to support its export industry.S.” Being holders of such a large amount of Treasury securities gives the Chinese government a vested interest in their value.S. “Right now all those Treasuries just sit in the People’s Bank of China. y CURRENCY TRADER • October 2014 Despite some relaxation on the part of Chinese authorities. which have now topped $4 trillion. Treasuries. “If [Chinese] policymakers have to choose between themselves and someone else. Source: TradeStation FIGURE 4: THE TREASURY SCENARIO If China dumps U. It would put an immediate risk premium into the U. “Where do the ripples go?” he asks. Treasury market. China’s reserve fund “has a war chest of over $1 trillion U.FIGURE 3: CHINESE YAWN Black swan Looking ahead to 2015.

data — Reuters 10 subject. having bought ¥12 trillion (about $110 billion) in foreign securities over the five months to August. The September breakout in the Japanese yen (JPY) can be interpreted as a gloomy prognosis for the world economy. (The Federal Reserve is sufficiently worried about financial stability that it named Vice Chairman Stanley Fisher to head a new committee on the FIGURE 1: YEN RANGE Source: Chart — Metastock. It could also become the source of financial market instability. now in its 26th month. but realistically the government needs to promote capital investment more than look after consumers’ immediate disposable income. Massive amounts of quantitative easing have finally resulted in yen depreciation. The Japanese government instructed the Government Pension Fund to diversify out of Japanese Government Bonds (JGBs) and into higher-yielding and foreign assets. October 2014 • CURRENCY TRADER . something Japan could use in its quest to reverse its trade deficit. The monthly report from BOA Merrill Lynch notes investors are obeying. Analysts. the dollar/ Japanese yen has gained more than 500 points.12 (April 2014). are delighted. Higher import prices are a burden to the beleaguered Japanese consumer (who just got hit with a higher consumption tax). data — Reuters FIGURE 2: YEN LONG-TERM Source: Chart — Metastock. the current price has exceeded the 62% Fibonacci retracement. Figure 2 shows the 200-day moving average (green) chasing price upwards.45 on Sept.05 at the end of August to an intraday high of 109. Forecasters say 110 is a natural place for a pause (and probably a juicy corrective pullback) before the pair goes on to 120 or 125. which could include anything from Spanish equities to a shopping mall in Kansas. Figure 1 shows a strong breakout after many months of range trading between 100. not to mention the Japanese government and Bank of Japan (BOJ). BY BARBARA ROCKEFELLER Breakouts are a fine opportunity for traders but a headache to economists.76 (February 2014) to 104. 18. from 104. In the first three weeks of September. albeit without reference to the dollar/yen). too. a level not seen since June 2007.On the Money ON THE MONEY The troublemaking yen Emerging markets are especially exposed to recent developments.

CTA REGISTERED WITH THE CFTC ® This is a limited time offer.ablesys. OF CERTAIN MARKET FACTORS. With the yield spread likely to widen against yen-denominated assets. since we are warned by experts not to trust the data. Futures Trading System & Option Trading System . And it’s all investor classes — insurance firms. SUCH AS LACK OF LIQUIDITY.2 billion. THESE RESULTS DO NOT REPRESENT ACTUAL TRADING.0 ✔ Anywhere & Anytime for Stocks & Forex SINCE 1995 Reader’s Choice Awards 1997-2014 in Stock Trading System. It’s a plain. The problem is the yen’s depreciation sets off a vicious circle instead of a virtuous one — yield-seeking in emerging markets and previously second-tier or questionable assets. THE TESTIMONIAL MAY NOT BE REPRESENTATIVE OF THE EXPERIENCE OF OTHER CLIENTS AND THE TESTIMONIAL IS NO GUARANTEE OF FUTURE PERFORMANCE OR SUCCESS. among others. INC.34 Announcing AbleTrend Mobile (ATM) Award Winning Trading Software with Real Time Streaming Data Celebrating AbleSys 20 Years of Excellence 1997 . and exporting deflation. as the world’s third. the outflow is likely to continue.for the first major capital outflow since 2010. In the first eight months of the year. which until recently (upon acceptance of extraordinary measures by the European Central Bank) was the victim of an overvalued currency. the country with the most to lose is China. 24. and Options ✔ AbleTrend Mobile (ATM) app real time version ✔ Access award-winning AbleTrend signals ✔ Real time alerts for Buy/Sell/Stop ✔ At a glance workspace views of Intraday Charts OF EXCELLENCE 1994 – 2014 ✔ Real Time streaming data included ($49. investment trusts. CA 94545 • Tel: 510-265-1883 • Fax: 510-265-1993 THESE RESULTS ARE BASED ON SIMULATED OR HYPOTHETICAL PERFORMANCE RESULTS THAT HAVE CERTAIN INHERENT LIMITATIONS. saying “he wants to be careful about the impact on local economies from the recent weakening of the currency. while South Korea and Taiwan see an immediate effect. The world is not failing to notice. but the banking system is thought to be exceptionally fragile — and shadow banking still out of control. In the region. • Hayward. Act Now! Order at www.or fourth-largest economy. Japanese Prime Minister Shinzo Abe gave a nod to the currency war aspect of the falling yen on Sept. FDI fell 1. Nobody is talking about a hard landing. Futures. old-fashioned “currency war” of the sort Brazilian Finance Minister Guido Mantega complained about at the Seoul G20 summit in 2012. at least not yet. But the data we have implies growth is slowing and may fail to match the government’s goal of 7. industrial production and other measures disappointing on the downside in recent months. and trust accounts. FOREX.8% to $78. ALSO. IF ANY. UNLIKE THE RESULTS SHOWN IN AN ACTUAL PERFORMANCE RECORD.2014 For Stocks. TECHNICAL ANALYSIS OF STOCKS & COMMODITIES LOGO AND AWARD ARE TRADEMARKS OF TECHNICAL ANALYSIS. a scary competition between Japan and China (with both trampling other exporters in the region). You never know how much to worry about China.95 Ablesys Corp. down 14% year-over-year and the lowest in four years. Some CELEBRATING analysts say Japanese deflation was already exported to Europe. has a “vibration effect” on relative world prices. • 20954 Corsair Blvd. SIMULATED OR HYPOTHETICAL TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT.” Japan. THESE RESULTS MAY HAVE UNDER-OR OVER-COMPENSATED FOR THE IMPACT. with purchasing managers indices. BECAUSE THESE TRADES HAVE NOT ACTUALLY BEEN AbleTrend 7.95/mon value) ✔ Introductory 30 day trial at $9. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THESE BEING SHOWN. Foreign direct investment (FDI) in August this year was only $7.5% this year.

Even the central bank predicts a net capital outflow of $95 billion this year. Morgan Stanley. chiefly from the end of QE in the U. note Alibaba generates 90% of its revenues from Chinese consumers. which spread like an infectious disease from Thailand to the rest of Asia and then to Argentina and Russia. With Chinese inflation relatively tame at 2% in August. Also. the Peoples Bank of China could believe it has the latitude to devalue. emerging markets are vulnerable to a massive correction as global investors withdraw capital. and besides. plus (perhaps) a new hostility toward foreign companies by Chinese regulators. Meanwhile. A Barclays “inflation-adjusted” measure shows the ruble is 26% overvalued over the 10-year average. as shown by the Shanghai stock index (Figure 4). but then allowed the revaluation to resume (Figure 3). 17. following MSCI. and oil. too. the classic double-whammy. some commodity prices are at their lowest levels in years — iron ore hit a five-year low in late September.S. There’s something a little fishy about the world’s second-largest economy holding the world’s biggest IPO in another country. To be fair. rate increase. It’s a currency war. Long-Term Capital Management and triggering Fed-engineered rescue. Their borrowing costs will surge and their currencies will fall. however. from 6. Remember the Asian crisis of 1997-98. is a member of the Eurozone. and that’s after the currency fell 35% from its level of six years ago and 12% just since June this year. forecasts the ruble down to 40 to the dollar by the end of 2015. A key reason is recognition of overcapacity. For a short period from mid-January to end-April. Does this look like the stock index of a robust and thriving economy? The Alibaba IPO in New York disguises that. when it comes to progress on opening up the equity market to both issuers and investors.253. data — Reuters billion. They know it. and other industrial metals are all lower. capital outflow is big. we FIGURE 4: SHANGHAI COMPOSITE STOCK INDEX Source: Chart — Metastock.S.S. Even before the Fed policy meeting in September. the most since 2008. The ruble is particularly vulnerable to a crash. that is supposed to raise U. copper. player. The FTSE Emerging index fell for 10 straight days. Emerging markets are already under pressure. Colombia’s Finance Minister Mauricio Cardenas told the press “everyone is getting prepared” for a U. Also. China has high leverage and excess capacity at the same time. perception of too little growth — even if short of a hard landing — has the potential to upset all emerging markets. but in those cases the assumption of consumer demand is more solidly based. eventually bringing down a big U. While we expect the Chinese government to downplay and sugar-coat the economic data. all the main emerging market currencies.25%. China still fears free markets. Russia’s Sberbank says stock funds lost $78 million in the week of Sept.S. and a falling currency that recently hit a six-month low. Uncertainty about the course of the Chinese economy and policy is very high. data — Reuters 12 could say the same thing was true of Deutsche Telekom or China Mobile. next door to Turkey. which added Greece to its MSCI EM index — and Greece. has a long way to go to match Turkey at 9. but Turkey has a ton of debt. A little imported inflation can’t hurt too much. for example. a critical geographic location in the current war on ISIS. even if it’s the one with the largest economy. but they do know a pinball effect is all too likely — a crisis in one place becomes a crisis in another that seems unrelated. something it had done only twice before — during the 1998 Asia crisis and in 2008. Overall. political issues. Note that S&P Ratings reclassified Greece as an emerging market. China let the yuan fall. including the Indian rupee. emerging markets were beginning to feel the fallout.ON THE MONEY FIGURE 3: CHINESE YUAN (INVERTED) Source: Chart — Metastock. only if China stops revaluing the yuan and starts devaluing it instead.0428 to the dollar to 6. The U. according to Bloomberg.S. fell. October 2014 • CURRENCY TRADER . There’s a disconnect between the investors and the users. Analysts don’t really know how “contagion” works in financial markets. Brazilian real. yields to levels more competitive with emerging market yields. Turkish lira and Russian ruble.

and being held at bay only by uncertainty over mean “lower for longer” or it could mean that once the what the Fed is going to do and when.25% to 4%. it ISIS. For end-2016. For more it means Dudley accepts inflation remaining moderate information on the author. The Fed is not in a position Barbara Rockefeller (www. saying the data shows “significant ers are overleveraged in emerging market holdings. Fed does start raising rates. The probability of contagion from 2. ECB president Mario Draghi admitted the Euro is weak for the very good reasons of divergence in growth and policies: As he said: “The exchange-rate movement reflects the different path of monetary policies in Europe versus the monetary policies in other important countries. The most recent Federal Open Market next year.8%.only gain support from additional flows out of emerging er to achieve our two objectives. per se. at least for a while. see p. the range is 0. if it places any weight A consequence of the rising dollar is its anti-inflation on them at all. in which case the dollar can would tend to dampen inflation. This could minute. but both numbers We seldom get this clear a Big-Picture outlook for the are higher than in June. it looks like emerging markets are going mandate.75-3.S. itself influenced by safe-haven “If the dollar were to strengthen a lot.” And rates will remain low for fallout could be drastic and start affecting developedthe same “considerable time” after tapering ends. Fed Chairman Janet Yellen retained a focus on unsataffect developed-country asset managers. there is no threat from inflation. Committee confused the markets with words coming out emerging markets are in for a hurricane. the forecasts range ETF’s (black is Vanguard’s version VWO and green is the from zero to 3%. but the dam can burst. Meanwhile. In other words.Countries from India to Indonesia to Mexico are seeing the countries…[W]e have a mandate and we have to comply effects already. the underutilization of labor. and that allows the Fed to remain in extreme accommodation mode FIGURE 5: EMERGING MARKET ETFS for longer. the Fed itself doesn’t know whether emerging markets to developed markets is rising by the growth will be robust and it’s safe to hike rates. The Fed is in no Whether the UK and U. So it would make it hard. 4. So obviously we would markets. as managers scramble for liquidity.” to dodge a bullet. Red supTo be fair. If it means anything.” This is just an observation and has no policy implication. and the author of the new cally. But the “dot plot” of the members’ forecasts of the Fed We could even see contagion to European and U. And just as the relentlessly dovish but the members’ projections for interThai devaluation and sovereign debt crisis in 1998 spread est rates coming out more hawkish than at the last meetaround the world. and this clear a connection between curly revised its GDP “central tendency” forecast from 3.0% by the end of 2016. Figure 5 shows two emerging market equity ning lack of consensus. Get ready.50% by the end of port is already broken. Our monetary policy will stay accommodative through time for an extended period of time while other countries’ monetary policies may gradually acknowledge that recovery is taking place in their Source: Chart — Metastock. y take that into account. because of the currency effect. too. 2015 and 2. if it wants to. As New York Fed President William Dudley said: increases in the yield curve. EEM). Fed places on charts like Figure 5.flows because of Ukraine/Russia and the Middle East/ quences for growth. with this. or the hikes are deferred until later quarters. data — Reuters CURRENCY TRADER • October 2014 13 . the dollar is the Treasury’s job. Even weirder. iShares MSCI emerging markets version. the Fed downwardmajor currencies. equity funds rate at various dates in the futures indicates a stunmarkets. If the dollar were to appreciate a lot. book The Foreign Exchange Matrix (Harriman House). the pace will be faster than we It would be interesting to know how much weight the now expect. country assets. start hiking rates in Q1 or Q2 hurry to raise rates.1% to rencies and equities. If these managisfactory job growth. it would have conse. We’ll do everything that is needed within our However. we never know how contagion will ing. The dollar rally is held back by tepid is an international econoto approve or disapprove of the dollar’s level — technimist with a focus on foreign exchange.rts-forex.25-1. the median estimate is 1. For end-2015.S.

2 ECB MEETING Source: TradeStation 14 When the European Central Bank (ECB) unexpectedly cut interest rates on Sept.ON THE MONEY ECB lays out game plan After rocking the FX market on Sept.5% by Oct. the ECB released the details of its stimulus plan in early October.3%.1% to -0. 4 the ECB lowered three interest rates — its main refinancing rate by 0. 4 with a surprise rate cut.3% in September. and its deposit facility rate (the rate it pays on deposited funds) by 0.05%. 2. On Sept. in the opposite direction.2%. market reaction was more reserved — and. and Eurozone unemployment remains in double digits. The ECB’s moves were specifically intended to combat Eurozone deflation.1% to 0. SMEs) rather than sitting on it. which left the stimulus programs as the sole topic of interest. October 2014 • CURRENCY TRADER . On Oct. In other words. The Eurozone’s Harmonized Index of Consumer Prices (HICP) was wallowing at 0. 2 ECB President Mario Draghi again stressed interest rates are now at their effective low. its marginal lending facility rate (the overnight bank lending rate) by 0. When the ECB finally announced the details of its “allin” stimulus efforts on Oct. BY CURRENCY TRADER STAFF FIGURE 1: SLIP-SLIDIN’ EURO’ Source: TradeStation FIGURE 2: OCT. the ECB wants banks to start circulating money throughout the economy (specifically targeting small and medium enterprises. Meanwhile. The negative deposit facility rate means the ECB is charging institutions to park their money at the central bank. it caught most market players off guard and had the inevitable effect on the Euro. which tumbled more than 1. 4 and announced wide-ranging economic stimulus measures. which is the lowest reading since October 2009 and far below the ECB’s mandate to maintain longerterm inflation a little below 2%.6% vs.1% to 0. 1 (Figure 1). the ECB has lowered its Eurozone GDP forecasts for 2014 and 2015. the dollar on the day and subsequently dropped another 2. at least for a day in the Euro.

9 2 Cambridge Strategy (Extended Mkts) 3 Investment Capital Adv (Managed Accts) 3.7 4 Fornex (Foyle) 5 Valhalla Capital Group (Int'l AB) 1. and to a great extent the behavior we’ve seen is an outcome of the different economic situations and the business-cycle differences between us and most of the other jurisdictions.S. 12 (the end of the week after the Sept. 2 Q&A session — other than affirming the currency is “irreversible.31% 4.42% 9.0 2.8 8 Cambridge Strategy (Emerging Mkts) 3.6 2 P/E Investments (FX Aggressive) 6.10% 1.0 4 LCJ FX Fund Strategy 3.6 6 Orwell Capital (Currency Alpha) 0. .59% 0.52% 4.58% 3400. They will begin in Q4. (millions) 1 24FX Global Advisors 7.22% -5. At its Oct.67% 77.96% 56.) -0.35% -6.24% 73. 2.0 9 Hartswell Capital Mgmt (Apollo) -0.98% 4.” a move opposed by Germany and others who favor financial austerity. which in turn induces diverging paths in our monetary policies.84% 3400. y Euro holds ground Most analysts and traders believe an unstated goal of the policy measures is to make Eurozone exports more attractive by cheapening the Euro. which had been trending lower since spring.” He stated (more than once) the exchange rate is “not a policy target for us” but acknowledged it was “important for price stability and growth. Curr.62% 290.56% 4.0 Based on estimates of the composite of all accounts or the fully funded subset method.67% 567. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.87% 4. 17) was -1. the Euro was essentially flat one week later (which in this case would be the week ending Sept.69% 2.0 9 Gables Capital Mgmt (Global FX) 3. where the decline from the close of the first week to the fourth week was at least 4%. trading session. Earlier in the week the Euro/U. Draghi was cagey about the Euro in the Oct. as expected.7 trillion — a 35% increase from current levels.0 Top 10 currency traders managing less than $10M & more than $1M 1 Whitmore Capital LP 12.92% 7.54% 7. However.47%.8 10 TrueAlpha Capital Mgmt (Gl Currency) -0.34% 10.02% -5.67% -0.54% 139.5 5 Quantica Capl (Diversified FX) 3.80% 19.77% 2. Does not reflect the performance of any single account. However. the ECB announced it would launch a program to purchase “non-financial private sector assets.80% 12.” The ECB reiterated the programs would have a “sizeable impact” on its balance sheet. BarclayHedge Rankings: Top 10 currency traders managing more than $10 million (as of Aug.0 6 First Quadrant (TCA L/S USD 20%) 3. As noted.24% 6. 19) and the return after six weeks (corresponding to the week ending Oct. dollar rate (EUR/USD) made a seventh consecutive lower weekly low — something it has done only six times before. The pattern consists of four consecutive weekly lower lows. The are expected to last “at least two years. upside follow-through on Oct. 3 had the potential to contribute to a higher weekly close and raise the prospect of a break in the downtrend.37% 60.20% -4. The bank had previous stated its goal was to increase that side of the ledger to its early 2012 level of approximately €2.00% 1.6 8 Rhicon Currency Mgmt (Sys.2 0. the ECB held interest rates steady.0 7 Mifte Capital (FX Alpha) 3.21% -3.0 10 Rhicon Currency Mgmt (Strategic) 2. then reversed to its levels before the meeting and. approximately halfway through the U. 31 ranked by August 2014 return) Trading advisor August return 2014 YTD return $ Under mgmt.62% 0.” The Euro rallied initially as the ECB press conference unfolded.18% 42.73% 3.39% 10. turned back up and was trading at a two-day closing high — and closing in on an intraday high and a threeday closing high (Figure 2). and released details about its asset-backed security (ABS) and covered-bond purchase programs.4 7 MDC Trading 0.01% 6. Highlights of the initiatives: 1. the Euro had already exceeded that loss by the beginning of October. After the 45 previous instances of this pattern. One model of weekly Euro price action as of Sept.92% 11.Purchase programs To help kick-start economic activity. 4 surprise rate cut) pointed to a continued decline in the intermediate term.77% 21. 2 meeting.37% 6.S. starting with Euro-denominated covered bond purchases in the second half of October.0 3 P/E Investments (FX Standard) 4.

the U. if it does (or has already). 2.S.8659.and eight-month lows The AUD/USD pair came within 24 pips of making an eight-month low in September. The black and gray lines show the median and average “benchmark” returns for all one. the Aussie dollar had not penetrated the September low of . dollar pair (AUD/USD) is preparing to “pull up” and recoup some of its losses.SPOT CHECK Aussie dollar: Monthly and weekly patterns The Australian dollar tumbled last month and hit a conspicuous support level. it will have FIGURE 1: EXTENDING LOSSES October 2014 • CURRENCY TRADER . and 60% by month 3. As of Oct.e. This would suggest that aside from a greater chance of downward price action in the first month (the negative median return). We’ll start with further analysis of the monthly time three-month periods in the 41-year analysis window. those that did not immediately follow a previous seven-month low) since 1974. 29. although (as evidenced by the flat-to-negative average return line) there were occasionally some relatively big down moves. The chart presents a mostly ambiguous picture of what typically happens after a new seven-month low in the Aussie dollar.S. having dropped to . Figure 2 shows the pair’s performance in the three months after the 47 previous instances of initial seven-month lows (i. The percentage of times the pair closed higher at each monthly interval (not shown) supports these generalizations: The AUD/USD rate was higher only 38% of the time at the close of month 1. and the Aussie dollar hit a new seven-month low. Seven.. price was more often higher after two and three months. The median return line 16 starts in negative territory and rises while the average line does precisely the opposite.5% vs. With the pair clearly having reached an intermediateterm support level — the one defined by the January 2014 low — the question as October unfolds is whether the Australian dollar/U. dollar by Sept. Is this a buying opportunity or time for shorts to reload? BY CURRENCY TRADER STAFF September wasn’t a great month for the antipodal currencies — the Australian and New Zealand dollars had both tumbled more than 7. 1 before rebounding. or if it will continue to push immediately to even lower levels. The chart shows the median (blue) and average (red) returns from the close of month making the new seven-month low to the closes of the next three months. but that percentage increased to 58% by month 2. in the process dropping to its lowest level since July 2010 (Figure 1).8662 on Oct.

the support zone that encompasses the 2010 lows and the 2004 and 2005 highs (as well as the September 2008 low and the late-2007. Any significant penetration of the 38.2% level will have many traders eyeing this zone. (Note: The massive sell-off and rebound during the 2008-2009 financial crisis is treated as an aberration in this context. Fibonacci enthusiasts will notice the January and September lows both occurred at the 38. or is downside penetration likely? Let’s see what things look like on the weekly time frame. early-2007 highs) coincides fairly neatly with the 50% retracement level (around . So has the sell-off likely ended. Returning to Figure 1. The percentage of higher returns at each interval were identical to the figures for seven-month lows. remaining in positive territory and above the benchmark average line for the first two months. 19 (marked with CURRENCY TRADER • October 2014 17 . FIGURE 3: AFTER NEW EIGHT-MONTH LOWS FIGURE 4: WEEKLY PERSPECTIVE Weekly price patterns Figure 4 shows the AUD/USD pair hit a new 26-week low during the week ending Sept. The performance after these events is shown in Figure 3 — very similar to the return profile in Figure 2.7920). except that the day 1 returns are marginally more bearish and the average return line is less bearish overall. there are also a couple subjective factors to consider.) Furthermore.FIGURE 2: AFTER NEW SEVEN-MONTH LOWS established a new initial eight-month low — something that has happened 45 previous times since 1974.2% retracement level of the 2001-2011 rally.

19 wasn’t FIGURE 6: AFTER NEW 26-WEEK LOWS AND LOW CLOSES just a new 26-week low.SPOT CHECK the red arrow). The week ending Sept. less frequently at week 2. The AUD/USD pair closed up more frequently than the benchmark frequency on only three days — 1. This is simply to provide a way to compare the current post-pattern performance to the historical performance. Of course. remaining mostly in negative territory. these are a bit more bearish than those in Figure 5. at which point the median return pushes higher but the average return sags. and 8 — and both median and average returns were negative from week 2 through week 5. 6. Figure 5 shows the pair’s historical performance in the eight weeks after the 88 previous instances of initial new 26-week lows since September 1974. the week FIGURE 5: AFTER NEW 26-WEEK LOWS ending Oct. 3. The returns flit above and below the mildly bullish benchmark returns until week 5. 26 would be week 1. The green bars show the pair closed higher more frequently than the overall market at weeks 1. it was also a new 26-week low close. Figure 6 show the results after the 74 previous instances of this signal. this time the upturn in the median return was much milder and the downturn in the average return was more significant. The numbers above the bars show how the weeks following the most recent instance (the week ending Sept. while the light green bars show the percentage of higher closes for all one. 3 would be week 2. and the same number of times at weeks 4 and 5. In addition. this isn’t the only way to model the AUD/USD’s recent price 18 October 2014 • CURRENCY TRADER . 6.. the week ending Sept. eight-week periods. and so on. however.e. and 8. Figure 5 tells us the AUD/USD pair has tended to trade haphazardly after making a new 26-week low. 19) would coincide with historical return profile — i. The dark green bars at the bottom of the chart represent the percentage of times the pair closed higher than the close of the 26-week low at each weekly interval.

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PLUS 1. Other weekly patterns FIGURE 8: THREE CONSECUTIVE LOWER WEEKLY LOWS AND CLOSES. Figure 7 shows the mixed returns that occurred after these events. with consistently negative (and down-trending) averOctober 2014 • CURRENCY TRADER .SPOT CHECK FIGURE 7: FOUR CONSECUTIVE LOWER WEEKLY LOWS.5% drop from the close three weeks ago to the current low. and dropped significantly (3. This performance is the most bearish we’ve seen so far. for example. 26. posted four consecutive lower weekly lows as of Sept. Figure 8 shows the AUD/USD’s returns after 61 instances of three consecutive weeks of lower lows and closes. let’s look at other. Unfortunately. The pair had. PLUS 3. Accordingly. The challenge is to describe the market action accurately but avoid a degree of specificity that results in too few historical examples and/or increases the likelihood of curve-fitting. along with a 1. 5). This describes the pair’s condition the week ending Sept.5% LOSS 20 The severity of the Aussie dollar’s recent sell-off makes it difficult to find plentiful analogs for comparison. 26. this pattern appeared only 22 previous times over the past 40 years.3%) from the close three weeks early (week of Sept.3% LOSS action. more general patterns that might offer some clues.

26: four consecutive lower weekly lows and a close in the final week that is in the bottom 45% of the week’s range. The numbers argue the opposite case. These results are less consistent. when the median return is -0. These mostly bearish returns bottom at week 4. which shows the performance after the simplest of the weekly patterns — five consecutive lower lows. Another pattern that describes the AUD/USD’s condition as of Sept. FIGURE 10: FIVE CONSECUTIVE LOWER WEEKLY LOWS Taken as a whole… Although these performance profiles appear to be all over the map. Finally. even if they cannot rule out some upside action along the way.FIGURE 9: FOUR CONSECUTIVE LOWER WEEKLY LOWS WITH < 45% CLOSE age and median returns. and the percentage of higher closes below 50% at every interval. common sense would have argued in favor of at least a temporary upside correction in the AUD/USD pair. but still mostly bearish. y CURRENCY TRADER • October 2014 21 . In late September. there’s Figure 10.91% and the percentage of higher closes is only 27. with most of the negativity occurring in the first two to three weeks.7%. they have a unifying characteristic: None of them unambiguously imply bullish action for the Aussie dollar in the near future. Figure 9 shows the results after 36 instances. which had 39 previous instances.

3 0.47. October 2014 2010 • CURRENCY TRADER .65 Russell 2000 0. represented here by the Russell 1000 index (RUI). The logic here is large corporations have more global presence and do business in more currencies than do smaller firms. the rolling three-month correlation of returns has been surprisingly stable since the 2002 low.1 0. LARGE.S.75 2.00 Three-Month Rolling Correlation Of Returns FIGURE 1: U.55 1. 1999 = 2. they allow for some interesting mind games involving crocodiles living beneath your nearest manhole cover.90 2. including. The differences between large.And Small-Capitalization Stocks' Correlation Stable2002 Since 2002 STOCKS’ CORRELATION STABLE SINCE 0.8 However.9408.4 0.5 Log10(Total Return). we see parallel return paths for the two indices. As a result.885 1. 8. Over the period beginning with the January 1999 advent of the Euro. being more subject to the vagaries of currency movements than their small-capitalization brethren in the Russell 2000 index (RUT).2 0.S. Russell 1000 & 2000 Jan. we should first establish whether or not this is true.00 2.6 0. Large.922. But do they have a place in market analysis? No.and smallcap stocks is more in the variance of small stocks’ returns than in their return paths.9 22 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 1999 Correlation 0. Not only do they add a little spice to the dreary realities of living in the big city.60 Russell 1000 1.TRADING STRATEGIES ADVANCED CONCEPTS Major currencies and capitalization-dependent stock returns The relationship between equity returns and currencies is not one-size-fits-all. the Russell 2000 has demonstrated it is a higher-beta version of the Russell 1000 on a total return basis: R2tr = 1.80 2.95 2. the 2008 financial crisis and its aftermath (Figure 1). as demonstrated by its continuously in-sample average of 0. r2 = . As different responses would make sense only if the Russell 1000 and 2000 indices had material divergences in behavior.70 2. once we move past the dot-com bear market of 2000-2002 and its enormous impact on the large-capitalization stocks of the technology sector. BY HOWARD L. of course not. SIMONS Urban legends are fun.840 * R1tr . surprisingly enough.0 0.AND SMALL-CAPITALIZATION U.85 2. Let’s take the urban legend about large-capitalization stocks.

178 0.529 0.693 1.0017 JPY 0.439 1. These carry returns TABLE 2: RUSSELL 2000 REGRESSION SYNOPSES effectively represent a continuous long ln(R2000 TR) = f(ln((CurrencyTR)) futures position for each currency. dollar (USD) into a set of seven major currencies.618 2. Finally.986 0.012 0.0021 we should see large swaths of magenta repGBP 1.217 0.153 0.028 0.448 - 0.0039 resenting the correlation of the Russell 1000 index to individual currencies outside the CAD 1.0049 changes in major currencies.80 standard set forth in FAS 133 as a bona fide hedge.469 0. the r-squared.0011 relations of returns between the Russell 1000 CHF 0.673 2.574 0.630 0. in Figures 2-8 JPY 0.671 3. of Stockret=f(Currencyret) and isolate the partial correlaSeveral things stand out immediately. Third.477 0. This indicates serial correlation in the residuSEK 0.555 0.S.516 2. similar. we can look at two sets of regression statistics ing the total return series into daily percentage returns.0076 will be referred to as “excess correlation” for the Russell 1000. again with the exception of the EUR 0.0050 Now let’s turn to the rolling three-month corAUD 0. for the Russell 2000 is greater for each curRussell 1000 Russell 2000 rency carry return series.016 4.626 2.409 returns are poor explicators for stock index returns. the Durbin-Watson statistics (DW) for all of the GBP 0.427 0.432 0.756 0.765 0. Beta Const R-squared DW If large-capitalization stocks are more sensitive than small-capitalization stocks to EUR 1.0043 SEK 0.051 We can account for this serial correlation by convertCURRENCY TRADER • October 2014 2010 23 .365 0. we want these to CAD 0.336 6.750 0.190 0. Now let’s run the regressions in the form (Tables 1 and 2).521 0. for the Russell 2000 against the currency tion coefficient.0034 CAD 0.580 0.129 Japanese yen.416 0.940 0.0071 index’s correlation of returns.0075 tan columns representing the Russell 1000 SEK 1.440 0.234 0. CHF 1. none of the r-squared levels meets the JPY 0. CHF 0. for the currency carry’s daily return (Table carries are higher than those for the Russell 1000 (with 3).875 0.790 1. The two sets of partial correlation coefficients are very the exception of the Japanese yen and its negative beta).TABLE 1: RUSSELL 1000 REGRESSION SYNOPSES ln(R1000 TR) = f(ln((CurrencyTR)) Major currencies and capitalization Beta Const R-squared DW EUR 0. or relative variances. the betas. This tells us the more-volatile Russell 2000 has a greater relative movement to the major currencies than does the Russell 1000. These periods AUD 0.192 0.170 0.670 0.010 0. First.079 0.00.536 0.0057 and 2000 total return indices and the carry returns of the U.354 0.428 be near 2.157 regressions involved are very near zero. of stock index returns against the currency carry returns or ln(Pt0/Pt-1).284 0. This tells us we should not expect to see systematiand by significant margins.557 0. TABLE 3: PARTIAL CONTRIBUTION Second.112 0. or percentage of variance explained.283 als as opposed to a random and white-noise process — a telltale sign the independent variables of currency carry AUD 0.0082 Before we begin the graphic narration.0028 GBP 0. or correlation after removing the effect of other variables.909 0.269 0.

5 115 0. Japanese Yen FIGURE 3: CORRELATION RETURNS.1 90 -0.1 85 -0. 8. Correlations for the Russell 1000 have tended to be absolutely greater throughout the data sample. RUSSELL INDICES VS.7 1999 -0. Both occurred during periods of USD strength vs.9 2003 70 2001 -0.3 105 0. INDICES VS. is explained best by noting Japan is both a smaller customer and supplier to Russell 2000 firms than to the Russell 1000 firms in industries such as automobiles. the yen presents a very different case (Figure 3). Jan. YEN 24 24 R2000:JPY 100 JPY Carry 0.5 Correlation history If we look at the case of the Euro. regardless of trends either in the U.S. EUR 135 R1000:EUR 0. Euro FIGURE 2: CORRELATION RETURNS.5 Carry Return. This pattern’s persistence. USD : EUR. given Japan’s diminishing role in the U.S. where Japan has remained a major factor.ON ADVANCED THE MONEY CONCEPTS cally greater correlation of returns for the stock indices against the currency carry indices in the following charts.3 80 2013 2012 2010 2009 2007 2006 65 2004 -0. We should expect the observed high degree of excess absolute correlation for the Russell 1000 against the Canadian dollar (Figure 4). Russell Indices Vs. 1999 = 100 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 105 R1000:JPY 0. Russell RUSSELL Indices Vs. 1999 = 100 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 0. the very sort of market condition alleged to be deleterious to large-capitalization equities with major global operations.1 85 -0. trade picture and as a source of external financing for the U.5 Carry Return. USD : JPY.S. Jan.7 R2000:EUR 125 EUR Carrry 0.9 65 Correlation Of OF Returns. 8.3 75 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 -0. stock market or in the yen’s carry return against the dollar.. As we should expect from the summary regression statistics.3 95 0. The October October 2010 2014 •• CURRENCY CURRENCY TRADER TRADER . we see periods of strong absolute excess correlation for the Russell 1000 during the 1999 tech bubble and again during the 2010 Eurozone financial crisis (Figure 2). Correlation OF Of Returns. the Euro.1 95 -0.7 2000 75 1999 -0.

5 110 0. USD : SEK.8 Carry Return.6 1999 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 0. Russell Indices Vs. RUSSELL INDICES VS. SEK 130 125 0.2 115 110 0.S. 1999 = 100 80 Correlation Of Returns.S.9 75 Carry Return. RUSSELL INDICES VS.1 110 -0. most of the firms in these sectors are large-capitalization companies.1 95 90 -0. not in the Russell 2000.4 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 85 -0. and the early phases of the Eurozone sovereign credit crisis. USD : CAD. and Canada are linked in a free trade agreement and have a long history of inter-subsidiary trade by their major companies. GBP FIGURE 5: CORRELATION RETURNS.1 85 -0. British Pound VS.0 105 100 -0.5 R2000:SEK 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 SEK Carry -0. basic materials.3 130 0. USD : GBP.5 140 0. here the linkages are not in the resource sectors but rather in the financial sector and in the cross-rate between the pound and the Euro. Shifts in the CAD have a very direct effect on a host of firms in the energy.Correlation Of Returns. RUSSELL INDICES 145 R1000:GBP 140 R2000:GBP 0. 1999 = 100 U. the early stages of recovery from the financial crisis. industrial.2 95 90 -0. so too was Switzerland until the Swiss National Bank started to intervene against the CHF in December 2009 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 0.3 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 1999 -0. It has had three periods of significant excess correlation for the Russell 1000 — the technology bubble in effect in 1999.5 100 90 Correlation OfOF Returns. A similar phenomenon can be found in the case of the British pound (Figure 5). These effects were especially pronounced during and after the financial crisis as the Bank of England engaged in many of the same quantitative easing policies the Federal Reserve employed.6 135 GBP Carry 130 0.7 CAD Carry 150 0.3 80 R1000:SEK -0. Russell Indices Vs. However. CAD 160 R2000:CAD 0.9 70 65 25 . If Sweden was something of a capital haven. 1999 = 100 CURRENCY TRADER • October 2014 2010 170 R1000:CAD Carry Return. Jan.7 1999 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 0. Swedish Krona FIGURE 6: CORRELATION OF RETURNS. The Swedish krona (Figure 6) does not have a compelling narrative as it is not a major conduit of global finance nor is it a major trading partner of the U. 8. 8. Financial firms in the too-big-to-fail category are in the Russell 1000. Jan.4 125 120 0.7 120 115 0.1 120 -0. 8.3 105 100 0. and technology sectors. Russell Indices Vs. The second period coincided with low excess correlation between the Russell 1000 and the Euro and suggests the krona was on the receiving end of some capital flight out of the Eurozone. Jan. Canadian Dollar FIGURE 4: CORRELATION OF RETURNS.

0 and eventually imposed the franc ceiling of 1.0 110 -0. CHF 160 0. the excess correlation for the Russell 1000 virtually disappeared.6 190 0. October 2014 • CURRENCY TRADER .4 No single answer 70 Carry Return. USD : CHF.4 130 0. RUSSELL INDICES VS. Swiss Franc FIGURE 7: CORRELATION OF RETURNS.0 110 -0. 4. Australian Dollar FIGURE 8: CORRELATION OF RETURNS. AUD 26 250 R1000:AUD 230 R2000:AUD 0.7 Carry Return.4 170 0. Russell Indices Vs.2 150 130 0. The question of whether various minor currencies have a systematic effect will be addressed next month.3 0. Jan.7 R1000:CHF 0. USD : AUD.5 80 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 1999 -0. y Howard Simons is president of Rosewood Trading Inc.ON ADVANCED THE MONEY CONCEPTS Correlation Of Returns. 8. by virtue of the large resource sector exposure for both economies (Figure 8). Finally. Jan. Once Chinese import growth started to slow in late 2011 and the largecapitalization mining firms started to decline.5 CHF Carry 150 140 0. The analysis suggests no systematic excess correlation exists across major currencies and time for the Russell 1000.8 70 Correlation Of Returns.3 90 -0.8 AUD Carry 210 0. Russell Indices Vs. That move confined the carry returns into the CHF and ended a period of strong excess correlation for the Russell 1000.4 -0. we should expect the excess correlation pattern for the Russell 1000 against the carry into the Australian dollar after the financial crisis to resemble that for the Canadian dollar.1 100 -0.20 against the Euro in September 2011 (Figure 7). 1999 = 100 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 1.2 120 0.6 R2000:CHF 0. RUSSELL INDICES VS.6 -0. 1999 = 100 Rolling Three-Month Correlation of Returns Against Russell 1000 & 2000 0.2 2013 2012 2010 2009 2007 2006 2004 2003 2001 2000 90 1999 -0.1 0. For more information on the author. At best there is a series of anecdotes applicable for individual currencies and for unique market environments. several of these anecdotes are sector specific. see p.2 -0. 8.

Trade length: duration of trade in calendar days. 29 trading session — while we were sleeping in the U. Source: TradeStation initial (pre-trade) reward-risk ratios are conjectural by nature. but pattern analysis indicated low odds of significant upside movement for the next few weeks. RESULT Exit: . TRADE Date: Sept. However.8720 Profit/loss: +0. LOL: largest open loss (maximum potential loss during life of trade).0005 Trade length 5 Legend – IRR: initial reward/risk ratio (initial target amount/initial stop amount). price had already rebounded and looked to have formed at least a temporary bottom.8720 9/29/14 P/L point % 0. We took profits on a minor intraday pullback. 4 predecessor. 2014 Entry: Short the Australian dollar/U. Reason for trade/setup: The two previous Trade Journals featured trades that.0132 Outcome: It was good we didn’t attempt another countertrend position because there was virtually no significant up movement after the trade was entered. One factor in the trade is the Oct.50 0. By the time we woke up. dollar (AUD/USD) pair at .8671. as evidenced by its Sept. because individual trades are dictated by immediate circumstances.8671 IRR MTM Date 1.8852.49% LOP LOL 0. CURRENCY TRADER • October 2014 27 .8973 0.S. a little above the January 2014 low of . while acknowledging the prevailing trend. y Note: Initial trade targets are typically based on things such as the historical performance of a price pattern or a trading system signal. we might have to make a decision about whether to liquidate it early. The one minor downside to the trade was the pair came within 11 ticks of the profit target in the Australian Sept.8973 Initial target: . attempted (unsuccessfully) to extract extra profits by taking countertrend positions.0170 -0. As a result. The pair had already sold off around 6% on the month. and there’s nothing blocking price from challenging its low for the year (see weekly chart inset). price targets are flexible and are often used as points at which to liquidate a portion of a trade to reduce exposure. TRADE SUMMARY Date 9/24/14 Currency Entry Initial Initial pair price stop target AUD/USD 0.0132 1. 2 European Central Bank meeting.FOREX TRADE JOURNAL Going with the flow in the Aussie dollar. which has the potential to rock the FX market.8659.S. which indicated further downside for the currency. If the trade is still open the day before the meeting. Initial stop: .8852 0. MTM: marked to market (the trade’s open profit or loss at a given point in time). 24. LOP: largest open profit (maximum available profit during lifetime of trade). This trade instead goes in the direction of the Aussie dollar’s downtrend — despite its relative maturity — because of the analysis in this month’s Spot Check.