Ctm 201107

July 2011

Volume 8, No. 7

Strategies, analysis, and news for FX traders

Dissecting the Bloomberg currency

indices p. 24

The reality of interest rates and forex p. 12

Trading algorithmic support & resistance

with Widner Bands p. 20

Loonie tunes: North America’s strongest

dollar p. 6

Scaling the AUD’s lofty heights p. 16

2 July2011•CURRENCY TRADER

CONTENTS

Contributors .................................................4

Global Markets

Is the U.S. dragging down Canada? .........6The Canadian currency is North America’s strongest dollar, but its fate is closely tied to the fortunes of its neighbor to the south.By Currency Trader Staff

On the Money

The dirty little secret of big-picture macro in FX ...........................12The unreal reality of real return and currency movement.By Barbara Rockefeller

Spot Check

Aussie dollar ............................................16The Aussie dollar has been on a remarkable run against its U.S. cousin. Does it have any gas left in the tank?By Currency Trader Staff

Trading Strategies

Algorithmic support and resistance: Trading Widner oscillators in FX ............20A technique developed for stock trading is tested on a basket of currencies.By Daniel Fernandez

Advanced Concepts

Weighting for correlation ........................24The Bloomberg currency indices can provide a mental anchor for assessing strength and weakness, but don’t expect them to become dominant trading or hedging vehicles.By Howard L. Simons

Global Economic Calendar ........................28Important dates for currency traders.

Events .......................................................28Conferences, seminars, and other events.

Currency Futures Snapshot .................29

International Markets ............................30 Numbers from the global forex, stock, and interest-rate markets.

Forex Journal ...........................................33

A false breakout trade in the Aussie dollar.

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CONTRIBUTORS


Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Contributing editor:

Howard Simons

Contributing writers:

Barbara Rockefeller,

Marc Chandler, Chris Peters

Editorial assistant and

webmaster: Kesha Green

[email protected]

President: Phil Dorman

[email protected]

Publisher, ad sales:

Bob Dorman

[email protected]

Classified ad sales: Mark Seger

[email protected]

Volume 8, Issue 7. Currency Trader is published monthly by TechInfo, Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright © 2011 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 perfor-mance does not guarantee future results.

For all subscriber services: www.currencytradermag.com

A publication of Active Trader®

CONTRIBUTORS

qHoward 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.

qBarbara 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. Rock-

efeller is on the board of directors of a large European hedge fund.

qDaniel Fernandez is an active trader with a

strong interest in calculus, statistics, and econom-

ics who has been focusing on the analysis of forex

trading strategies, particularly algorithmic trading

and the mathematical evaluation of long-term system

profitability. For the past two years he has published his research

and opinions on his blog “Reviewing Everything Forex,” which

also includes reviews of commercial and free trading systems and

general interest articles on forex trading (http://mechanicalforex.

com). Fernandez is a graduate of the National University of Colom-

bia, where he majored in chemistry, concentrating in computational

chemistry. He can be reached at [email protected].







www.currencytradermag.com

http://www.rts-forex.com

http://mechanicalforex.com

http://mechanicalforex.com


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GLOBAL MARKETS

Prior to the 2008-2009 global economic crisis and reces-sion, the Canadian dollar (CAD) had been strengthening vs. its U.S. counterpart for years, with the USD/CAD pair falling from about $1.61 in early 2002 to a spike to .9000 in November 2007 (Figure 1). The rush to safety during the global financial crisis saw a massive unwinding of long-Canada positions, propelling dollar/Canada back into the

$1.30 range. However, since May 2009 the Canadian dollar has reasserted its overall strengthening trend, and the pair nearly tested its pre-global recession lows in April-May 2011.

Overall, Canada boasts a better structural fiscal situation than the U.S., and the central bank has already hiked rates post-global crisis, while the U.S. Fed has remained on hold.

“The economy is performing quite soundly,” says Nick Bennenbroek, head of currency strategy at Wells Fargo. “We are seeing steady employ-ment increases on a month-by-month basis.”

Canada also enjoys support, both economically and on the FX front, as a major global commodity exporter. However, that dynamic has also turned the Canadian dollar (the “loo-nie” in FX parlance) into a risk-type of asset, similar to the other major “commodity currencies” such as the Brazilian real and the Australian dollar.

However, while Canadian funda-mentals are generally bullish, the country’s economy is inextricably linked to its southern neighbor, and slower-than-expected growth forecasts for the U.S. could translate into weak-

Is the U.S. dragging down Canada?

The Canadian dollar is North America’s strongest currency,

but its fate is closely tied to the fortunes of its neighbor to the south.

BY CURRENCY TRADER STAFF

FIGURE 1: MONTHLY DOLLAR/CANADA

The question is whether the recent bounce marks a significant bottom or is just a pause in the USD/CAD long-term downtrend. Source for all charts: TradeStation

CURRENCY TRADER•July2011 7

er growth for Canada. After hitting its lowest post-crisis low in early May 2011

at .9400, the U.S. dollar took the lead and the pair bounced toward .9900 (Figure 2). What’s behind the turnaround in the dollar/Canada trend? Is it just a temporary correction, or did the early-May low mark a significant bottom? How does the economic forecast look for Canada heading into the second half, and what’s ahead for Canadian monetary policy?

Downward revisionsSome economists have downwardly revised their 2011 gross domestic product (GDP) forecasts for Canada in the wake of the unexpected renewed weakness in the U.S. economy. Pointing to previous GDP forecasts of 3.7 percent for Canada, Moody’s Analytics senior economist Mark Hopkins says his expectations for growth this year are now around 3 percent.

“We’ve revised it downward as the weakness in the U.S. is coming out,” he says. “About three-quarters of Canadian exports go to the U.S.”

Jonathan Basile, economist at Credit Suisse notes, “Everyone is really con-cerned about what happens when the Fed is done [with quantitative easing.] With U.S. unemployment at 9 percent, the economy isn’t going to get much help from the Fed. U.S. concerns affect Canada because we are Canada’s big-gest trading partner.”

It is, Basile explains, the classic eco-nomic ripple effect.

“We’ve had a strong global picture for exports, but when you have signs that manufacturing is slowing and the star player got hurt, what’s the rest of the team going to do?” he says. “The U.S. is on the injured reserve list.”

Hopkins describes the slowdown in the U.S. as “explain-able.” Among other factors, he cites the oil shock, which saw crude oil prices surge to nearly $115 per barrel in early May, and Eurozone sovereign-debt uncertainty, which has sparked jitters across global markets.

The numbersStrong growth numbers emerged from Canada in early 2011. Fourth-quarter 2010 GDP came in at 3.3 percent and first quarter 2011 at 3.9 percent, according to Hopkins. “A lot of that was the pickup in exports, manufacturing, and sustained commodity exports,” he says.

Basile forecasts a 2.9-percent Canadian GDP rate for Q2, but he notes the risk is for a lower reading. Overall, Basile expects a 3.1-percent GDP pace this year, following 2010’s 3.2-percent pace.

“We saw a strong start to 2011, but the mid part of the

FIGURE 2: DAILY DOLLAR/CANADA

The USD/CAD turned around in May after two years of nearly one-way (down) trading.

http://www.currencytradermag.com/index.php/c/Key_Concepts


GLOBAL MARKETS

year may show more volatility,” he says. “There is a gen-eral sense of slowdown permeating the financial markets. The Japanese earthquake has had its impact on the global supply chain, particularly manufacturing and autos, which affects Canada.”

BOC policy outlookMost analysts expect the Bank of Canada (BOC) to hike rates in the second half of the year, which could translate into support for the Canadian dollar vs. the greenback. The BOC is set to meet next on July 19, but the consensus is for the bank to hold rates steady at that meeting.

During the recession the BOC dropped its overnight lending rate to 0.25 percent, but in September 2010 hiked rates back up to 1 percent. While that level has held steady since then, analysts are looking for another increase.

“The central bank will raise rates in the second half of the year,” Bennenbroek says. “Inflation has risen closer to the central bank target, which is why we think the BOC

will hike.” The April consumer price index (CPI) showed inflation

rising to 3.3 percent, while the 12-month rate of change of core CPI (ex-food and energy) stood at 1.6 percent, accord-ing to Hopkins.

Basile expects the BOC to begin hiking rates again at its September meeting, bringing the overnight rate to 1.25 percent, with additional hikes in the second half to end the year at 1.75 percent. However, he notes that “the markets have already priced out moves.”

Hopkins gave 50-50 odds the BOC would hikes rates in September by .25 percent, and he expects the official rate to rise to 1.50 percent by year-end.

“I think we [could] start to see more inflation passing into the core,” he says.

Currency actionWhat, specifically, sparked the dollar/Canada turnaround in early May? Look no further than the factors that have

disrupted financial markets as a whole in recent months.

“The weaker Canadian dollar has a lot to do with the European debt crisis and equity market weakness,” Bennenbroek says. “It is a growth-sensitive currency, or risk currency, and anything that makes market par-ticipants more nervous will impact it.”

Sebastien Galy, currency strategist at Societe Generale, voices a similar observation.

“USD/CAD has moved higher in line with fears of a global slow-down,” he says. “Commodities came under pressure, while past increases in oil prices have left many U.S. consumers in a vulnerable situation. Canada, with exposure to both oil and the U.S. economy, suffered con-sequently from this — though admit-tedly, it was quite a moderate move given the risks.”


Sean Callow, senior currency strategist at Westpac Institutional Bank, adds: “USD/CAD has been choppy in recent weeks, struggling to set a fresh direction as it is torn between the weight on the U.S. dollar from poor U.S. data, and a lack of compelling reasons to buy CAD given pres-sure on global commodities and growth momentum, the Bank of Canada’s neutral near-term outlook and, of course, the fact that bad news on the U.S. economy is also bad news for Canada’s [export sector].”

For Callow, it all adds up to a relatively flat outlook. “The next month or so we are neutral USD/CAD, with

a target of .9800, but would prefer to sell into rallies because global growth is likely to pick up some-what during the third quarter, sup-porting commodity prices and [the Canadian dollar],” he says.

Risk on, risk offThe Canadian dollar has been trad-ing more like a risk asset in recent months, sensitive to bouts of global risk aversion. Brian Dolan, chief currency strategist at Forex.com, says the May-June rally is a func-tion of a recent “risk-off” environ-ment.

“When the U.S. numbers come in bad, people feel more risk aver-sion and move into the dollar, Treasuries, and other safe havens like the Swiss franc and yen,” he says. “They dump commodity cur-rencies like Aussie, Canada, and the kiwi (New Zealand). If U.S. data comes in good, the dollar goes down.”

There might be more of the same on the horizon, accord-ing to some analysts. “I’m still in the risk-aversion camp,” Callow says. “I don’t think people have fully priced in the slowdown we are likely to see in the second half.”

Dolan believes crude oil is still an important factor. “If crude falls below $90-91, it will indicate further ero-

sion and weakness in global demand, and that could ratch-et dollar/Canada higher,” he says.

The Canadian dollar tends to benefit from rising oil prices, because it is an oil-exporting nation, while falling oil prices tend to be loonie negative.

A good bottom? Was the early May low at .9400 a significant bottom?

“The May 2 low is there to stay for a while, as it will take the global and U.S. economy recovering sufficiently to break such a level,” Galy says. “Continued stress in European peripherals should come back to haunt this cur-rency pair. Furthermore, the market has not yet adapted to

the lower level of potential growth in G10 economies, and to some extent the degree to which the Fed can stay dovish. We target the .9300 level by year end; that is a slow downside, with an asymmetric risk of spikes.”

TD Securities chief FX strategist Shaun Osborne sees lessening momentum on a shorter-term horizon: “The medium- to long-term down-trend in USD/CAD appears to be trying to reverse,” he notes. “The rebound in USD/CAD in May was suf-ficient enough to break the back of the two-year trend resistance from the 1.3000 area reached in late 2008 and early 2009. So far, however,

the recovery has been relatively limited, and the lack of topside progress is starting to suggest the recovery may be stalling.”

Osborne thinks there’s room for the USD/CAD pair to retest 1.0000 in the coming weeks, “but the market’s strug-gle to sustain gains above .9800 the past couple of weeks serves as a warning that the rebound may be running out of momentum.”

However, he notes a sustained push through 1.0000 should lead the market to believe a deeper rebound —

“There is a general sense

of slowdown permeating

the financial markets. The

Japanese earthquake has

had its impact on the global

supply chain, particularly

manufacturing and autos,

which affects Canada.”

— Jonathan Basile, economist at Credit Suisse


GLOBAL MARKETS

back into the 1.0000-1.0800 range that prevailed from late 2009 through early 2011 — is achievable.

“Par looks to be pivotal,” Osborne says. “Above par should see an extension toward 1.0800-1.0900 (retrace-ment resistance and the old range highs) late this year or early next year. Failure to extend through par in July-August probably means we remain in a .9400/1.0000 range for a while longer.”

Canadian cross ratesSome analysts say looking to play the Canadian dollar on the crosses — vs. the Japanese yen or Australian dollar — may offer superior trading opportunities than the USD/CAD pair.

“The better play might be long CAD crosses such as CAD/JPY and CAD/AUD, or as we say Down Under, short AUD/CAD,” Callow says. “With a benchmark rate of just 1 percent and a comparatively healthy banking and housing sector, the Bank of Canada has plenty of tight-ening ahead of it, certainly more than we will see in Japan or Australia — the latter already running moderately con-tractionary monetary policy. Markets are priced for only one 25-basis point BOC hike by February 2012. The risks on this are clearly skewed to faster tightening on improvement in Canadian, and particularly U.S., growth in coming weeks and months.”

Callow notes the CAD/AUD pair tested .9500 in June (around 1.0555 in Figure 3, which shows the AUD/CAD rate), the lowest level since 2004, and should recover to .9800 on any signs of life in the U.S. economy.

“If the U.S. outlook brightens to the extent we expect later in the third quarter, CAD could return to parity with AUD,” he says. “The RBA (Reserve

Bank of Australia) is unlikely to tighten before November 2011 and even if it does, further moves are very doubtful.”

“Long CAD/JPY is built on a similar premise,” Callow says. “If markets are currently too pessimistic on global growth, but instead it proves to be ‘darkest before the dawn,’ then CAD/JPY could easily rally to 86.00-87.00, with the BOJ (Bank of Japan) retaining super-loose mon-etary policy and Japan’s recovery from the earthquake and tsunami proving to be sluggish.”

Galy points to the Aussie/CAD cross as one to watch.“We like AUD/CAD as a somewhat safer bet within the

commodity block,” he says. “If you presume sentiment is too negative on Asia, you like AUD, and if you presume the U.S. dollar will stay under pressure while the global economy is moving too slowly for another super spike in oil, CAD should relatively underperform targeting 1.0600 from 1.0347.” y

FIGURE 3: CANADIAN CROSSES

Some analysts believe trading the Canadian dollar vs. the Aussie dollar (top) and Japanese yen (bottom) offer better trade opportunities than trading it against the U.S. dollar.


77-subscribe0610 4/15/10 2:51 PM Page 15

www.activetradermag.com

What are the big picture macro factors in FX? Nearly everyone will list interest rates first, followed by inflation, then GDP growth, and finally the trade or current account balance. But a hard look at the data reveals a dirty little secret of FX — interest rates are not that reliable. Part of the problem is defining which interest rate we should be talking about, and another part lies in measuring the “real” (after-inflation) rate. But even if we could get perfect data, suspicion lingers: the top macro factor is just not that good.

In FX it’s an unhappy fact of life the factors that push and pull currency prices are maddeningly inconsistent — or rather, traders are inconsistent in their treatment of the variables. When sentiment is unfriendly toward a currency, a tepid bit of data will be interpreted as negative and posi-tive data may be ignored altogether. Sometimes traders care about Factor A and make trades based on that factor alone, but then it falls out of favor and Factor B becomes the vogue. It doesn’t help at all that inconsistent, unreli-able, and often spurious correlations with other assets (such as oil) are used as overriding factors regardless of what relative interest rates and other macro variables are suggesting.

Traders’ inconsistent treatment of the big-picture macro factors that should influence FX rates is probably the big-gest grievance newcomers experience. The stock of a com-pany whose sales and income just surprised to the upside by 50 percent will always get a price boost. An equivalent rule for FX can’t be formulated. For example, it might be automatically assumed that a country with accelerat-ing growth will experience a rise in inflation and thus an impending rate hike, so the currency is a buy. But apart from comparison with other countries’ conditions, three exogenous factors can throw a monkey wrench into this analysis:

1. The technical picture may argue against a further rise (e.g., the currency has already reached a previ-ous intermediate high, another resistance line, or a Fibonacci number, and traders have already reached

their position limit).2. Another asset class assumed to be highly correlated is

not confirming the expected FX move.3. The institutional environment — for example, a gov-

ernment pressuring the central bank ahead of an elec-tion — argues against the logical conclusion (the rate hike).

A good example is the Australian dollar (AUD). In June, growth was high and the government was predisposed to additional rate hikes. But fear of a global slowdown damp-ened commodity prices and the AUD fell against all other major currencies despite the valid growth and inflation scenario. Moreover, the AUD/USD was toppy — straining and failing to match the May high.

In short, even when the key variables can be sorted into a model of what should be driving FX prices, we must also account for interference from the technicals, from unstable and unreliable correlations with other asset classes, and from institutions, mostly national governments but some-times supranational institutions such as the OECD, IMF, OPEC, and G7 or blocs within those groups (e.g., the BRICs, who spoke of a “currency war” at the G20 summit in September 2010).

The word “interference” implies noise, but these intru-sions into the economist’s model are more than noise — they shape interpretation of the data itself. It’s one thing to read inflation in Germany is 3 percent and quite another to hear it’s 2 percent in Mexico. We immediately know 3 percent in Germany is too high and 2 percent in Mexico is unusually low, and thus the policy responses will be very different — a case of the institutional environment influ-encing data interpretation.

In the economist’s perfect world, where all other things are equal, accelerating growth does indeed (usually) lead to inflation, and rising inflation does indeed (usually) lead to higher interest rates and a higher currency.

But consider a case where the model is fatally flawed. Japan often reports stunningly high growth in the first

On the Money


ON THE MONEY

The dirty little secret of big-picture macro in FX

The unreal reality of real return and currency movement.

BY BARBARA ROCKEFELLER


quarter of the calendar year (the fourth quarter of its fiscal year, which ends March 31). The Japanese yen doesn’t rise after the GDP release because everyone knows Japan is in a decades-long deflationary recession. Exceptional growth in a single quarter will not suffice to prod the Bank of Japan into higher rates. Besides, many traders will have already bought yen going into the end of the first calendar quarter on the myth of yen repatria-tion, and the yen has likely already reached the end of its technical tether.

Global investing rule 2The first rule of investing is to preserve capital. The second rule is, the only reason to venture outside the home-country market is to get a higher real after-tax return than you can get at home. If the return is not higher, after inflation and after tax, there is no valid financial reason to take the currency risk. There might be a non-financial reason, such as fear of expropriation or punitive taxation (see rule 1), but in the end, the real yield differential is the whole enchilada. Today we have to add portfolio diversification as a reason to accept a lesser return, but the investor still sorts and prioritizes on the basis of real return.

Ah, but which return — monthly? The overnight rates that command our acute attention to central bank policy statements? Two-year notes? Ten-year notes? As a general observa-tion, the 10-year relative real yield is the baseline case. The dollar often waxes and wanes along with the 10-year note yield, as shown in Figure 1, which compares the Reuters 10-year T-note yield index to the Euro/dollar. Sometimes there is a lag of a week or two, but over this time period the cor-relation looks pretty good. The logic is sensible, too: Yields fall when buyers flood into the safe-haven U.S. Treasury market, either as the classic alternative to a stock market decline or because of some other event that increases risk aversion. The longer time frame works, too, as indicated by the equally con-vincing monthly comparison in Figure 2.

But wait a minute. The yield shown here is the notional yield, not the real

(after-inflation) yield. Subtracting inflation reveals more discrepancies, especially in 2009, when the real return reached 5.66 percent in July but the dollar reached a new

FIGURE 1: U.S. 10-YEAR NOTE YIELD INDEX (BLACK) VS. EUR/USD (INVERTED SCALE, GREEN)

Sometimes there is a lag of a week or two, but over this time period the correlation between the 10-year T-note yield index and the Euro/dollar (EUR/USD) rate is evident. Source: Chart — Metastock; data — Reuters and eSignal

1992A M J J A S O N D 1993M A M J J A S O N D 1994M A M J J A S O N D 1995M A M J J A S O N D 1996M A M J J A S O N D 1997M A M J J A S O N D 1998M A M J J A S O N D 11.311.321.331.341.351.361.371.381.391.401.411.421.431.441.451.461.471.481.491.501.511.521.531.541.551.561.571.581.591.601.611.621.631.641.651.661.671.681.691.701.711.721.731.741.751.761.771.781.791.801.811.821.831.841.851.861.871.881.891.901.911.92

-3.3-3.2-3.1-3.0-2.9-2.8-2.7-2.6-2.5-2.4-2.3-2.2-2.1-2.0-1.9-1.8-1.7-1.6-1.5-1.4-1.3-1.2-1.1-1.0-0.9-0.8-0.7-0.6-0.5-0.4-0.3-0.2-0.10.00.10.20.30.40.50.60.70.80.91.01.11.21.31.41.51.61.71.81.92.02.12.22.32.42.52.6RelativeRealYieldGermany/US(1.32000,1.32000,1.32000,1.32000,-0.29000),USD/DEM(1.67110,1.67110,1.67110,1.67110,-0.00320)

Barbara RockefellerCurrency Trader Mag July 2011Fig 1. US 10-Year Note Yield Index vs. EUR/USD Daily BasisEUR/USD is Green

2009February April May June July AugustSeptemberNovember 2010 February April May June July AugustSeptemberNovember 2011 February April May June J1.161.171.181.191.201.211.221.231.241.251.261.271.281.291.301.311.321.331.341.351.361.371.381.391.401.411.421.431.441.451.461.471.481.491.501.511.521.53

20.521.021.522.022.523.023.524.024.525.025.526.026.527.027.528.028.529.029.530.030.531.031.532.032.533.033.534.034.535.035.536.036.537.037.538.038.539.039.540.040.541.041.5

FIGURE 2: U.S. 10-YEAR T-NOTE YIELD INDEX (BLACK) VS. EUR/USD MONTHLY BASIS (INVERTED SCALE, GREEN)

A longer-term comparison of the 10-year T-note yield and the dollar also shows a high degree of correlation.



Barbara RockefellerCurrency Trader Mag July 2011Fig 2. US 10-Year Note Yield Index vs. EUR/USD Monthly Basis (Eur invertedscale)—Euro is Green

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20122.0

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ON THE MONEY

intermediate low and fell to near the level of the previous July when the real return was -1.59 percent (Figure 3). You could argue 2008 and 2009 represented a special case, but that defeats the purpose of having a big picture investing rule.

It gets worse when you widen the data to include the real rate of return in Germany (10-year Bund yield minus inflation). Figure 4 shows the real return against the euro/dollar exchange rate. If the real return is the top macro factor, you’d expect the return and the Euro price to move in the same direction, but they do not. In fact, the real return has gone from 3 percent at the beginning of 2010 to -2.3 percent at the end of May 2011, while the Euro continued to rise. How can it be that a currency goes higher as its real rate of return is falling?

Note, however, that Germany has had an advantage in relative real return since the inception of the Euro in 1999 (Figure 5). But when we com-pare the relative real yield advantage to the actual EUR/USD rate, the drop in the German advantage in 2007 was not matched by a drop in the Euro — in fact, the Euro rose, as it did when the German advantage went negative in 2009 (Figure 6).

These charts do not bear out the thesis that the relative real rate of return is determinative. The U.S. 10-year yield does better on its own, with no after-inflation adjustment and no comparison to the Bund. Although “expected inflation” would be a bet-ter variable than actual inflation (and there are some fancy leading and lagging tricks that could be applied to get a better fit), traders don’t even

FIGURE 4: REAL 10-YEAR BUND YIELD (BLACK) VS. EUR/USD MONTHLY BASIS (GREEN)

The real rate of return in Germany is represented by the 10-year Bund yield minus inflation.



Barbara RockefellerCurrency Trader Mag July 2011Fig 4 Real 10-Year Bund Yield vs. EUR/USD Monthly Basis

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201

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FIGURE 3: REAL U.S. 10-YEAR YIELD (BLACK) VS. EUR/USD MONTHLY BASIS (GREEN)

Subtracting inflation reveals discrepancies in the T-note yield/dollar correlation, especially in 2009.



Barbara RockefellerCurrency Trader Mag July 2011Fig 3 Real US 10-Year Yield (Dots) vs. EUR/USD Monthly Basis (Eur invertedscale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201

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have easy access to the real return today, let alone an advanced indicator like expected real return.

In fact, it took many, many hours to accumulate the data to construct these charts. Traders may check the 10-year yields in the daily newspaper and have inflation rates and inflation trends memorized, but they do not actually look at the relative real return for the simple reason that no one prepares it and makes it easy to consult. In recent years, risk appetite and risk aversion have been important drivers of 10-year yields and currencies alike, but not in an equal way.

The European Central Bank (ECB) has led us to believe it will be hiking interest rates at its July meeting while it is assumed the Fed will sit on its hands for many more months after the conclusion of QE2 at the end of June. You might expect the German yield curve to move up all along the yield curve and perhaps to steepen as well, giving the Euro its usual real-return advantage.

But it ain’t necessarily so. If traders think expected inflation in Germany is on the decline while at the same time the Fed is behind the curve (and thus the U.S. yield curve will steepen), the dollar is the currency that should benefit. But will the dollar rise on such an outlook? If relative real return is so weak a factor in determining exchange rates, you shouldn’t count on it. The Euro has proven it can thrive even on a negative relative real return and in the face of massive sovereign risk. And yet, based on these charts, if U.S. 10-year yields rise for whatever reason, we must expect the dollar to tag along in close sympathy, whatever is hap-pening on the inflation front in either country. yFor information on the author, see p. 4.

FIGURE 5: REAL YIELD ADVANTAGE GERMANY OVER U.S. (MONTHLY)

Germany has had an advantage in relative real return since the 1999 inception of the Euro.



Barbara RockefellerCurrency Trader Mag July 2011Fig 6 Real Yield Advantage Germany over US (monthly)

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

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FIGURE 6: REAL YIELD ADVANTAGE GERMANY OVER U.S. (BLACK) VS. EUR/USD (MONTHLY, GREEN)

The decline in the German real yield advantage was not matched by a drop in the Euro in 2007 or 2009.



Barbara RockefellerCurrency Trader Mag July 2011Fig 7 Real Yield Advantage Germany over US vs. EUR/USd (monthly)Euro is Green

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20

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SPOT CHECK


In late June, the Australian dollar/U.S. dollar pair (AUD/USD) was trading near the lower end of a nearly two-month triangular consolidation after hit-

ting 1.1000 on May 2 — its highest level since 1982 (Figure 1). The high capped an almost one-year, 36.5-percent rally off the May 2010 low of

.8067 — an exclamation point on the pair’s 83-percent rebound from its October 2008 financial-collapse low of .6007.

Just two years after that low, AUD/USD had reclaimed its pre-collapse high and tagged 1.0000 for the first time in 29 years as the

post-panic equity market rally and economic rebound reversed the 2008-2009 flight into the U.S. dollar. Figure 2 shows how the upward burst that drove the pair to 1.1000 occurred only after a lengthy consolidation between October 2010 and March 2011, during which the Aussie/dollar rate swung above and below parity.

At the midpoint of the year, there is one overriding funda-mental factor to consider: Will the conclusion (at the end of June)

of the Federal Reserve’s second round of quantitative easing (“QE2”) remove downward pressure on the U.S. currency and set

the stage for a more accelerated AUD/USD down move? Or will the end of the program have little or no effect, as some analysts argue? A

secondary fundamental factor is whether the Reserve Bank of Australia’s expected interest-rate hike in August is already priced into the market, and if

additional increases are likely through the end of the year.These considerations aside, analysis of recent price action suggests the recent contraction is in line with historical precedent, while the outlook for additional Aussie dollar weakness is

Aussie dollar

The Aussie dollar has been on a remarkable run against its U.S.

cousin. Does it have any gas left in the tank?

BY CURRENCY TRADER STAFF



mixed (although pullback to test 1.0000 or at least the top of the October-March range appears in the works).

Weekly perspectiveFigure 2 shows the week ending May 6 was an outside week (a bar with a higher high and lower low) and in this case, a week that closed below the previous week’s close. It also capped a seven-week rally during which each weekly high was above the high of the week two weeks earlier. Table 1 shows the AUD/USD pair’s median close-to-close moves for each of the six weeks after seven pattern variations based on these characteristics:

1. Outside bar (week) with a lower close (OB w/LC).

2. OB w/ LC that is also above the high of the previous 12 bars (HH12-OB w/LC).

3. Seven consecutive weekly highs that are higher than the highs two weeks earlier (7HH-2).

4. 7HH-2 with the final bar having a lower close (7HH-2 w/LC).

5. 7HH-2 with the final bar closing below the close two bars earlier (7HH-2 w/LC2).

6. 7HH-2 with the final bar closing below the closes of two preceding bars (7HH-2 w/DLC).

7. 7HH-2 with the final bar closing below the close of either of the two preceding bars (7HH-2 w/LC1or2).

Patterns were analyzed back to 1977. The table also shows the number of instances of each pattern, which

FIGURE 2 WEEKLY AUSSIE DOLLAR

May began with an outside week that closed lower, capping a seven-week rally.

FIGURE 1: DAILY AUSSIE DOLLAR

The AUD/USD pair has moved lower since early May, breaking out of the bottom of a consolidation pattern on June 27.

18 October2010•CURRENCY TRADER18 July2011•CURRENCY TRADER

SPOT CHECK

ranges from 59. Figure 3 shows the patterns’ performance graphically. After some bullish moves in the initial two

weeks, most of the pattern variations (especially the final three in Table 1) indicate weaker price action in weeks 4-6.

However, the patterns with the most instances tend to be more bullish, while those with the least tend to be most bearish. Overall, though, even the patterns followed by bullish price action underperformed the market by the end of the six-week review period.

The reason so many pattern varia-tions were included was precisely because of how few formations were available for historical comparison. (That there were only 13 outside weeks with lower closes that also had higher highs than the preceding 12 weeks in 34 years is somewhat remarkable — an indication of the rar-ified air the AUD/USD had entered in early May.) As of June 28, the pair had dropped more than .0500 from the May high.

FIGURE 3: WEEKLY PATTERN PERFORMANCE

Most of the patterns variations were followed by negative performance in weeks 4-6, and all underperformed the market’s bullish baseline performance after six weeks

TABLE 1: WEEKLY PATTERN VARIATIONSNo. instances 1 2 3 4 5 6

OB w/LC 27 0.0010 0.0035 0.0079 0.0024 -0.0019 0.0063

HH12-OB w/LC 13 0.0021 0.0001 -0.0056 -0.0042 -0.0126 -0.0080

7HH-2 59 0.0030 0.0024 0.0079 0.0064 0.0012 0.0067

7HH-2 w/LC 21 0.0044 0.0098 0.0019 0.0024 -0.0036 0.0067

7HH-2 w/LC2 17 0.0009 0.0027 0.0010 -0.0011 -0.0083 -0.0080

7HH-2 w/DLC 16 0.0037 0.0053 -0.0021 -0.0004 -0.0060 -0.0069

7HH-2 w/LC1or2 15 0.0009 0.0027 -0.0051 -0.0011 -0.0126 -0.0080

Market median 0.0025 0.0043 0.0061 0.0069 0.0072 0.0090

Analysis of related patterns based on low-closing outside weeks or seven-week rallies gives mixed signals, although most patterns indicate weakness in weeks 4-6 and underperformance of the market in general.


A quick look at some monthly patternsFigure 4 shows a monthly chart of the Aussie/U.S. dollar pair. Besides highlighting the pair’s overall uptrend over the past decade, it also shows the following pattern: A large high-to-high jump from March to April, followed by a slightly higher monthly high and lower close in May.

The March-April high-to-high move was more than 5 percent — something that’s only occurred 13 other times since 1971. Adding additional (but still very broad) criteria to model the price action between March and June — e.g., a close high in the range of the month with the 5-percent higher high fol-lowed by a month with a low close — wiped out almost all previous instanc-es. Loosening the pattern criteria to require: an only 2-percent high-to-high gain along with a monthly close in the upper half of the month’s range (April) followed by a month with a higher high that closes lower than the previ-ous month and in the bottom half of the month’s range (May); or an only 2.5-percent high-to-high gain along with a monthly close in the upper half of the month’s range (April) followed by a month that closes lower than the previous month and in the bottom half of the month’s range (May) produced the results shown in Table 2. Although only producing a scant 14 and 18 examples, respectively, the post-pat-tern performance was mostly negative for the next six months (pattern 1 much more so than pattern 2).

With the Aussie dollar already (at the begin-ning of July) nearly two

months past the May high, the question is whether the existing down move has already fulfilled most or all of the mild bearish implications of the patterns reviewed here. The most liberal reading of the stats would suggest there’s more room on the downside (a view likely held by most chart watchers observing the recent downside breakout and looking for a challenge of parity — see the Forex Trade Journal), but shifts in the fundamentals (additional Aussie rate hikes or a QE2 campaign that ends with a whimper rather than bang) will upend that prognosis. y

TABLE 2: MONTHLY PATTERNSMonth (instances) 1 2 3 4 5 6

Pattern 1 14 -0.0008 -0.0047 -0.0110 -0.0024 -0.0069 -0.0229

Pattern 2 18 0.00425 0.0035 -0.0115 0.0037 -0.0033 -0.0174

FIGURE 4: MONTHLY AUSSIE DOLLAR

The pair, which jumped more than 5 percent high-to-high from March to April, made a slightly higher high in May before closing lower that month.

20 October2010•CURRENCY TRADER20 July2011•CURRENCY TRADER

The algorithmic determination of support and resis-tance has always been a key issue in mechanical trading. Support and resistance are generated as a consequence of traders being influenced by past price movements, gener-ating supply and demand regions based on both technical and psychological factors that influence the way a market moves.

Because support and resistance levels are so fundamen-tal to market behavior, it is important to determine them in an objective way. Many techniques are based on subjec-tive definitions of support and resistance, such as those based on visual chart inspection. The following approach explores a mechanical strategy based on the Widner sup-port and resistance oscillators, which will be tested on a basket of currency pairs.

Widner’s oscillatorsDr. Mel Widner’s oscillators, the Widner Resistance Oscillator (WRO) and the Widner Support Oscillator (WSO), are designed to detect and trade support and resis-tance levels in a mechanical fashion.

The indicators begin by objectively defining support and resistance as follows: If the highest high (lowest low) four bars ago is the highest (lowest) price of the most recent nine bars, that price becomes a resistance (support) level. The indicators then measures how many of the most recent six resistance (support) levels the current closing price is below (above). The oscillators apply a scoring system that gives values of 100 when price is above all six levels and zero when price is below all six levels. When the indica-tors are at intermediate levels (e.g., 40-60) there is no meaningful interpretation, other than price is between both extremes. For users interested in understanding the indica-tor in more detail, a MetaTrader 4 version of the indicator

can be viewed and copied by clicking here. Because the WSO and WRO were originally designed

to trade the stock market, it is worthwhile to address the question of whether or not they can be used to develop a profitable multi-instrument strategy for FX trading. The following approach is similar to the one originally proposed by Widner, which was intended to capture long-term trends on the daily time frame using different WSO/WRO averages to gauge how price has been reacting to support and resistance levels at different time intervals.

Developing a forex strategyThe idea behind the system is to buy when price has remained above most support levels for a long time and above all resistance levels in the short term, with the oppo-site being the case for short trades. The system uses four- and 50-period moving averages (MA) of the WSO/WRO oscillators, per Widner’s original settings. Long trades are entered when the 50-period WSO MA is above 95 percent and the four-period WRO MA is above 90 percent on the most recent closed bar. Conversely, a short trade is trig-gered when the 50-period WRO MA is below 5 percent and the four-period WSO MA is below 10 percent. Long trades are exited when the WRO is below 5 percent, while short trades are closed when the WSO is above 95 percent, which ensures trades are closed when there is an indica-tion price has been moving against the short-term trend.

The system also places a stop-loss two times the 14-day average true range (ATR) from the entry, and the per-trade risk is designed to yield an average risk of 2 percent per trade using the following equation:

Trade size = (0.01*accountbalance)/(ATR*contractsize)

TRADING STRATEGIESTRADING STRATEGIES

Algorithmic support and resistance: Trading Widner

oscillators in FX

A technique developed for stock trading is tested on a basket of currencies.

BY DANIEL FERNANDEZ

http://www.currencytradermag.com/index.php/c/Strategy_Code



Figure 1 shows a sample trade from 2010 on the Euro/U.S. dollar pair (EUR/USD). In this case a position was entered at 1.3622 as the WSO average reached 95 percent while the WRO average was above 90 percent. Because the 14-day ATR was 0.0150, a stop-loss was set at 1.3472 and (assuming an account size of $100,000) the trade size was 0.67 [(0.01*100,000)/(0.0150*100,000)]. Notice how the posi-tion was closed when there was significant evidence price was breaking below short-term resis-tance levels; the trade was exited when the four-period WRO MA dropped below 10 percent. (In all charts the top indicator is the 50-period WSO/WRO MA and the bottom one is the four-period oscillator. The reddish indicator is always WSO and the green indicator is the WRO.)

Strategy resultsThis system was evaluated on daily data from June 2000 to March 2011 using the MetaTrader 4 platform. The strategy was tested on a basket of five currency pairs: the Euro/U.S. dollar (EUR/USD), British pound/U.S. dol-lar (GBP/USD), Australian dollar/U.S. dollar (AUD/USD), New Zealand dollar/U.S. dollar (NZD/USD) and the U.S. dollar/Swiss Franc (USD/CHF).

Table 1 shows the strategy was prof-itable on all pairs, although results

vary dramatically from one to the next. The EUR/USD and NZD/USD pairs had high returns while the USD/CHF and GBP/USD posted only marginal gains, trading around breakeven through most of the test period. Profitable pairs were generally characterized by extended trends without strong short-term retracements, while those with the worst results tended to suffer significant retracements shortly after the strategy detected the establishment of a long-term

FIGURE 1: TRADE EXAMPLE

A long trade was entered at 1.3622 when the WSO average (red) reached 95 percent while the WRO average (green) was above 90 percent.

TABLE 1: WIDNER OSCILLATOR SYSTEM RESULTS

EUR/USD GBP/USD AUD/USD NZD/USD USD/CHF PortfolioTotal return 29% 7% 26% 51% 9% 185%

Avg. annual profit 2.19% 0.69% 2.11% 3.82% 0.80% 9.22%

Max. drawdown 5.30% 13.88% 16.90% 8.88% 11.08% 30%

Win % 53% 39% 43% 42% 38% 42%

Profit/loss ratio 2.01 1.88 2.3 3.4 2.18 2.4

Profit factor 2.32 1.19 1.76 2.4 1.33 1.8

Ulcer Index 2.57 7.26 7.43 3.82 5.62 9.61

No. of trades 28 31 30 29 29 147

Trade cost* 2 4 5 8 4 -

The system was profitable on all the currency pairs in the portfolio, but some had greater returns than others. *Pips per trade

trend (through the 50-period WSO/WRO MA). Figure 2 shows the equity curve for the entire portfo-

lio. The system as a whole exhibits the typical profile of a long-term trend-following system, with sharp bursts of gains followed by more extended drawdown periods.

The strategy’s long-short trading characteristics were markedly asymmetric: Short trades had a much lower winning percentage (e.g., only 28 percent of short posi-tions were profitable vs. 45 percent of long positions in the NZD/USD), although this was offset by a larger profit-to-

loss ratio. Generally, short positions are less frequently followed by down moves, but these moves are much stronger when they do occur, while long trades are more likely to be prof-itable but to a lesser degree because of the slower pace of the moves. This is an outgrowth of the macroeconomic factors that trigger sharp USD rallies (usually risk aversion), while bearish USD moves are generally much more long-term and subtle (for example, those resulting from AUD or NZD carry trades vs. the USD).

Pluses and minusesFigure 3 highlights the important strengths and weaknesses of the WSO/WRO strategy. Although the strategy is exceedingly good at exploiting trend moves that lack large retracements, it is often fooled by slow-moving market conditions, where trading ranges can cause the oscillators to determine very tight support and resistance levels. As a result, it might be a good idea to include a volatility breakout tool to this strategy so trades can only be opened when there is already signifi-cant short-term momentum in favor of the strategy.

The statistical characteristics in Table 1 also suggest the strategy falls into the classic trend-following cat-egory — extended drawdowns (some-times longer that 1,500 days) are prev-alent, while the moves that bring most of the profits are scarce but extremely efficient. The low winning percent-age, high profit-to-loss ratio, and high Ulcer Index (9.61) suggest the strategy would be difficult to trade psycho-logically. However with an average


TRADING STRATEGIES

FIGURE 3: STRENGTHS AND WEAKNESSES

The strategy does a great job of exploiting trends that lack large retracements, but it is often fooled by slow-moving market conditions that result in tight support and resistance levels.

FIGURE 2: PORTFOLIO EQUITY CURVE

The equity growth is characterized by bursts of gains and lengthier drawdown periods.




compounded annual profit of 9.22 per-cent and a maximum drawdown of 30 percent, the system does achieve better results as a portfolio.

Figure 4 details the system’s yearly returns on a portfolio basis. The strat-egy had three years of losses, but it functioned as a good hedge against stock performance, as the year of the financial crisis (2008) was its second-most profitable year.

A successful initial testThe tests indicate that Widner’s WSO/WRO ideas are applicable to forex, generating a portfolio result that, while not spectacular, was profitable without any optimization. However, you should consider this to be very preliminary work regard-ing the potential of these indicators, as the objective here was merely to show the applicability of this concept in cur-rency trading and not to develop the best possible trading

system. Certainly many modifications to improve the strategy,

such as optimizations of the MA trigger-level thresholds or the introduction of supplemental signals (i.e., a volatility breakout filter) are possible. yFor information on the author, see p. 4.

FIGURE 4: ANNUAL RETURNS

The system had three losing years, but the second-best year was 2008.

http://www.managedfuturestodaymag.com


TRADING STRATEGIESADVANCED CONCEPTS

Truly famous last words are hard to come by; the best-remembered often are those unintentionally ironic or just downright silly. Consider, for example, the purported last words of Alfred Graf von Schlieffen, developer of the eponymous plan put into action by Imperial Germany at the opening of World War I: “Remember to keep the right flank strong.” His successor, Helmuth von Moltke failed to heed the advice and the rest is quite literally history. Or those of Pancho Villa: “Don’t let it end like this. Tell them I said something.”

Here is a set of famous last words you are unlikely to hear even from their creator: “Don’t get into the business of index management.” What was initially a good market-ing tool by Charles Dow and Edward Jones to sell their

Wall Street Journal, a simple shorthand for answering the question “How did the market do today?” has morphed into a monstrosity of hundreds of thousands of little benchmarks sprawled across equities, fixed-income, cur-rencies, commodities, real estate, and all manner of non-traditional (translation: This is a bright orange tree frog—do not get near it) investments.

Currency indexationThe demand for indices is, however, as insatiable as the incontinence of suppliers, and so the search for the per-fect (or at least serviceable) currency index continues (see “The index approach to currency risk management,” April 2006). The venerable dollar index (see “What drives the

dollar index?” January 2006) occupies a great deal of mind space amongst traders, but none of the attempts to create a duplicate index for the Euro (see “The Euro index: The dollar index meets its match,” May 2006) have taken hold.

In the case of currencies, just as with commodities, there is little agree-ment regarding what should be the driving factor in assembling an index; at least stock indices have gravitated toward market- and price-weighting schemes. Should a currency index be based on trade flows, financial flows, trading liquidity, or some other mea-sure? Should they include major and minor currencies or currencies pegged directly to, say, the U.S. dollar, or allowed only to fluctuate in a narrow band? Should the weights of the cur-rencies be fixed, as has been the case for the dollar index since inception, or should they be rebalanced? If so, on

Weighting for correlation

The Bloomberg currency indices can provide a mental anchor for assessing strength and

weakness, but don’t expect them to become dominant trading or hedging vehicles.

BY HOWARD L. SIMONS

One of the surprises of long-term history of the index weights is its relatively small fluctuations. The Euro’s weight has increased, and is the largest single component in compiling each of the currency indices.

FIGURE 1: WEIGHTS IN BLOOMBERG CORRELATION INDICES


what basis?The quants at Bloomberg addressed these questions and

developed a set of correlation-weighted indices (BCWI) for a group of 10 major currencies. These include the U.S., Australian, Canadian and New Zealand dollars, the Japanese yen, the Euro, the Swiss franc, the British pound, the Norwegian krone and the Swedish krona. The indices are based on statistical measures designed to maximize the degree of variance explained for each currency. The exact methodology is available on Bloomberg and will not be rep-licated here. In a marked departure from all other currency indices, the weights used for each currency are updated daily. The actual indices published are the cumulative profit and loss, ignor-ing interest, starting in January 1975.

The long-term history of the weights involved contains a few surprises, not the least of which is the relatively small fluctuations over more than 35 years (Figure 1). The weight of the Euro has increased and is the largest single component in compiling each of the currency indices; and while this may be expected given the long bouts of USD weakness over the period and the number of major currencies in the Euro bloc, the high weights for the GBP, CHF, SEK and NOK give the BCWI scheme a very Eurocentric flavor. So much for the rise of the BRIC nations, the importance of the Mexican peso to the U.S., or the wide swath of East Asian currencies: None are considered in the BCWI family. In fairness, the Chinese yuan has not traded freely and was a very minor currency until the 1990s, the Russian ruble was the currency of a country that went out of business in 1991 before its present incarnation, and the Brazilian real was not introduced until 1994. Remember, do not get into the business of index management: These are the sorts of issues that will make your life miserable on the good days.

Other surprises include the CAD’s greater weight than the USD and the gradual diminution of the JPY. In addi-tion, the NZD has a greater weight than the AUD even though Australia is linked far more closely to the millen-nial success of the Pacific Basin than New Zealand.

The history of the indicesNow let’s get to the more interesting aspect — the rise and fall of the 10 dif-ferent BCWI over time. (As an aside, while the BCWI are set to Jan. 2, 1975

= 100 on a daily basis, the charts in this section use weekly data and therefore are set to Jan. 3, 1975 = 100.) First, let’s look at the three Northern European currencies, the GBP, NOK and SEK (Figure 2). The SEK has been the most per-sistently weak over time and the GBP has been the most volatile within a broad range. The NOK has trended side-ways since the mid-1980s.

The two currencies with the strongest gains over time have been the JPY and CHF (Figure 3). This is an interest-ing duo, as both currencies have had a reputation over the past 15 years as low-interest funding currencies for carry trades. Indeed, it is this use that explains much of

The SEK has been the most persistently weak over time and the GBP has been the most volatile within a broad range. The NOK has trended sideways since the mid-1980s.

FIGURE 2: ERRATIC DECLINE OF N. EUROPEAN CURRENCIES

The two currencies with the strongest gains over time have been the JPY and CHF, both of which have a reputation over the past 15 years as low-interest funding currencies for carry trades.

FIGURE 3: YEN AND SWISS FRANC MOST PERSISTENT GAINERS

the action in the JPY, especially: The rest of the world gets overly short the yen to fund investment elsewhere and then has to engage in massive bouts of short-covering each time a financial crisis leads to a shedding of risk.

Also, both Japan and Switzerland tend to have significant “must-do” activity in their currencies. The persis-tent trade surpluses Japan runs means its customers have to buy yen to pay their Japanese suppliers, and the safe-haven inflow (polite version) of funds from various Middle Eastern and for-mer Soviet Union commodity export-ers into Switzerland periodically puts upward pressure on the CHF.

Now let’s turn to the three non-U.S. dollars, the CAD, AUD and NZD (Figure 4). While the bilateral exchange rate between the U.S. and Canada has moved in favor of the CAD in recent years, this is some-thing of an illusion according to the BCWI. According to this measure, the rate has gone nowhere for a very long period of time. The same illusion applies to the NZD and AUD; both currencies turned lower in the 1980s and never recaptured the losses. This certainly seems like news to anyone who has watched the rise and fall of the Australian dollar, especially, over the years.

Now we can look at the Big Two, the USD and EUR (Figure 5). The USD chart looks rather familiar; its largest feature remains its massive rally in the early 1980s, one that was mirrored between 1997 and 2002 in the BCWI. The EUR chart simply fails to capture the large bilateral swings of the Euro and its predecessors against the dollar over time. The BCWI ver-sion of the Euro looks, well, boring.

ON THE MONEY


ADVANCED CONCEPTS

The BCWI shows the U.S.-Canada exchange rate has gone nowhere for a very long period of time. Similarly, the NZD and AUD both turned lower in the 1980s and never recaptured their losses.

FIGURE 4: CANADIAN DOLLAR HAS RETAINED VALUE

Although USD line looks familiar, retaining the massive rally in the early 1980s, the EUR chart doesn’t capture the large bilateral swings of the Euro (and its predecessors) against the dollar over time.

FIGURE 5: U.S. DOLLAR AND EURO NEAR WHERE THEY STARTED


Comparison against other indicesNow let’s compare the BCWI for the USD and EUR against other common indices for both curren-cies on a monthly basis. For the dollar, we will compare the BCWI against the dollar index and the Federal Reserve’s trade-weighted dollar index (Figure 6). Along with the dollar index, the BCWI overstates the greenback’s strength against the Federal Reserve index in the early 1980s, and against both other indices in 2001-2002. The construction of the BCWI treats down-turns in Europe as major gains in the dollar regardless of the trade weights employed in the Federal Reserve meth-odology.

In the Euro case, we can compare the BCWI to the Euro index and to the simplest of many European Effective Exchange Rates calculated by the European Central Bank, the 12-country index (they have a 41-country index; is that a bureaucracy out of control, or what?). The EER-12 index is back-calculated to April 1981 and the Euro index to January 2001 (do not go into index management). In Figure 7, the BCWI overstates the Euro’s strength against both indices in 2001-2003 and overstated the Euro’s weakness in the first half of 2010.

A currency anchorIn the end, the BCWI offers an interest-ing and very rigorous methodology for measuring a currency against a set of counterparts. These indices can provide a mental anchor for assessing strength and weakness, but because bilateral trade arrangements are based overwhelmingly in single-currency terms (and as interest-rate arbitrage against a basket whose weights change every day by design is a bit challeng-ing), we probably should not expect these indices to become dominant trad-

ing or hedging vehicles. Let’s hope those are not destined to become famous last words. yFor information on the author, see p. 4.

The BCWI treats downturns in Europe as major gains in the dollar, regardless of the trade weights used in the Federal Reserve’s dollar-index methodology.

FIGURE 6: THREE DIFFERENT DOLLAR INDICES

The BCWI overstates the Euro’s strength against the other two indices in 2001-2003, and overstated the Euro’s weakness in the first half of 2010.

FIGURE 7: THREE DIFFERENT DOLLAR INDICES


CPI: Consumer price indexECB: European Central BankFDD(firstdeliveryday):Thefirstday on which delivery of a com-modityinfulfillmentofafuturescontract can take place.FND(firstnoticeday):Alsoknownasfirstintentday,thisisthefirstdayonwhichaclear-inghouse can give notice to a buyer of a futures contract that it intends to deliver a commodity in fulfillmentofafuturescontract.The clearinghouse also informs the seller.FOMC: Federal Open Market CommitteeGDP: Gross domestic productISM: Institute for supply management LTD(lasttradingday):Thefinalday trading can take place in a futures or options contract.PMI: Purchasing managers indexPPI: Producer price index

Economic Release release(U.S.) time(ET)GDP 8:30 a.m.CPI 8:30 a.m.ECI 8:30 a.m.PPI 8:30 a.m.ISM 10:00 a.m.Unemployment 8:30 a.m.Personal income 8:30 a.m.Durable goods 8:30 a.m.Retail sales 8:30 a.m.Trade balance 8:30 a.m.Leading indicators 10:00 a.m.

GLOBAL ECONOMIC CALENDAR

July

1U.S.: June ISM manufacturing reportJapan: May unemployment report and CPI

234 Canada: May PPI56

7

Australia: June unemployment reportBrazil: June CPI and PPIMexico: June CPI and PPIUK: Bank of England interest-rate announcementECB: Governing council interest-rate announcement

8

U.S.: June unemployment rateCanada: June unemployment report UK: June PPILTD: July forex options; July U.S. dollarindex(ICE)

91011

12

U.S.: May trade balanceFrance: June CPIGermany: June CPIJapan: June PPI and Bank of Japan interest-rate announcementUK: June CPI

13 UK: June unemployment report

14 U.S.: June PPI and retail salesIndia: June PPI

15 U.S.: June CPI161718

19

U.S.: June housing startsCanada: Bank of Canada interest-rate announcementHong Kong: Q2 unemployment report

20 Germany: June PPISouth Africa: June CPI

21U.S.: June leading indicatorsHong Kong: June CPIMexico: June unemployment report

22 Canada: June CPI232425 Australia: Q2 PPI26

27U.S.: June durable goods and fed beige bookAustralia: Q2 CPI

28Germany: June unemployment reportSouth Africa: June PPI

29

U.S.: Q2 Employment cost indexCanada: June PPIIndia: June CPI Japan: June unemployment report and CPISouth Africa: Q2 unemployment report

30 France: June PPIAugust

1 U.S.: July ISM manufacturing report2 U.S.: June personal income3

4

UK: Bank of England interest-rate announcementECB: Governing council interest-rate announcement

5

U.S.: July unemployment reportBrazil: July CPICanada: July unemployment reportJapan: Bank of Japan interest-rate announcementUK: July PPILTD: August forex options; August U.S.dollarindex(ICE)

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

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CURRENCY FUTURES SNAPSHOT as of June 29

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-by-side 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 short-term 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.

BarclayHedge Rankings: Top 10 currency traders managing more than $10 million

(as of May 31 ranked by May 2011 return)

Trading advisor Mayreturn

2011 YTD return

$ Under mgmt.

(millions)

1. 24FX Management Ltd 7.23% 32.84% 54.62. ACT Currency Partner AG 3.81% 6.98% 19.03. VortexFXAG(VFMA) 3.17% -2.77% 25.74. Olsen(OlsenInvest-AF) 1.57% 6.10% 50.05. Metro Forex Inc 1.42% 16.40% 147.26. Gedamo(FXAlpha) 1.34% 8.27% 14.17. RhiconCurrencyMgmt(Strategic) 1.20% 1.76% 360.08. CapricornCurrencyMgmt(FXG10CHF) 1.00% 4.89% 14.09. AnelloAssetMgmt(IsisFX) 0.92% -1.67% 13.0

10. CenturionFx Ltd 0.89% -0.02% 11.2Top 10 currency traders managing less than $10M & more than $1M

1. Adantia(FXAggressive) 9.51% 15.70% 1.22. Sagacity(HedgeFX100) 7.47% 14.74% 1.43. Iron Fortress FX Mgmt 6.70% 9.95% 2.34. ValhallaCapitalGroup(Int'lAB) 5.58% 15.25% 1.95. CenturionFxLtd(6X) 5.34% -1.99% 8.06. WealthBuilderFXGroup(LowRisk) 3.35% 10.53% 3.07. VaskasCapitalMgmt(GlobalFX) 3.02% -4.62% 3.28. BasuandBraun(Everest) 2.19% 11.28% 2.09. HalionCapital(Conservative) 1.21% 17.61% 1.7

10. CapricornCurrencyMgmt(FXG10USD) 1.01% 4.44% 3.0

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.

Market Sym Exch Vol OI 10-day move / rank

20-day move / rank

60-day move / rank

Volatility ratio / rank

EUR/USD EC CME 323.2 218.1 1.85%/40% 0.17%/8% 1.38%/9% .29/45%

AUD/USD AD CME 114.8 105.5 1.41%/86% -0.69%/23% 2.90%/41% .24/30%GBP/USD BP CME 114.1 98.2 -0.75%/8% -1.96%/85% -0.46%/23% .56/80%JPY/USD JY CME 105.4 94.0 0.05%/8% 0.03%/3% 3.94%/96% .27/20%CAD/USD CD CME 86.2 96.9 1.11%/100% 0.24%/7% -0.38%/35% .54/98%CHF/USD SF CME 42.8 59.3 2.22%/43% 0.98%/19% 10.68%/92% .17/22%MXN/USD MP CME 34.4 118.1 1.72%/100% -1.40%/54% 0.69%/4% .38/78%U.S. dollar index DX ICE 31.4 52.1 -1.31%/44% 0.46%/17% -1.36%/14% .33/55%NZD/USD NE CME 9.2 29.5 2.35%/25% 0.07%/0% 7.13%/77% .20/13%E-Mini EUR/USD ZE CME 6.0 5.2 1.85%/40% 0.17%/8% 1.38%/9% .29/45%

Note:Averagevolumeandopeninterestdataincludesbothpitandside-by-sideelectroniccontracts(whereapplicable).Priceactivityisbased on pit-traded contracts.

INTERNATIONAL MARKETS


CURRENCIES (vs. U.S. DOLLAR)

Rank CurrencyJune 27 price vs.

U.S. dollar1-month gain/loss

3-monthgain/loss

6-monthgain/loss

52-week high

52-week low Previous

1 Swedish krona 0.153455 3.43% 1.31% 8.75% 0.1662 0.1281 142 Great Britain pound 1.59589 2.29% 1.76% 5.74% 1.6702 1.4999 83 Canadian dollar 1.011705 1.06% 0.25% 3.10% 1.0576 0.94 134 Thai baht 0.03257 0.97% -0.48% -0.77% 0.0338 0.0304 115 Australian Dollar 1.048995 0.92% 3.19% 5.47% 1.0966 0.8384 106 Indian rupee 0.02192 0.48% -0.25% 0.34% 0.0227 0.021 97 Hong Kong dollar 0.128365 0.09% 0.14% -0.02% 0.129 0.1282 68 Russian ruble 0.03538 -0.01% 0.06% 7.82% 0.0366 0.0314 12

9 Taiwan dollar 0.034615 -0.16% 1.72% 2.34% 0.0351 0.031 5

10 Chinese yuan 0.154465 -0.28% 1.04% 2.09% 0.1546 0.1466 311 Euro 1.418905 -0.34% 0.38% 7.77% 1.4842 1.2206 1512 Singapore dollar 0.807455 -0.48% 1.34% 4.46% 0.8175 0.715 713 New Zealand dollar 0.811355 -0.56% 7.09% 7.76% 0.8245 0.6849 2

14 Brazilian real 0.62304 -1.29% 1.98% 4.58% 0.6384 0.5441 16

15 South African rand 0.14493 -1.39% -2.14% -3.73% 0.1518 0.1284 1716 Japanese yen 0.01243 -1.53% -0.41% 1.45% 0.0127 0.0112 417 Swiss franc 1.200255 -4.19% 5.79% 10.58% 1.200255 0.9157 1

GLOBAL STOCK INDICES

Country Index June 27 1-month gain/loss

3-month gain/loss

6-month gain loss

52-week high


1 Switzerland Swiss Market 5,990.80 8.32% 2.05% -1.20% 6,739.10 5,935.00 12 Italy FTSE MIB 19,297.11 7.95% -5.36% 1.55% 23,273.80 18,807.20 153 Canada S&P/TSX composite 12,966.49 6.41% -0.68% 2.59% 14,329.50 11,065.50 24 Australia All ordinaries 4,513.80 5.46% -1.48% -2.28% 5,069.50 4,213.00 135 Brazil Bovespa 61,217.00 5.03% -4.31% -5.17% 73,103.00 60,056.00 106 Hong Kong Hang Seng 22,041.77 4.88% 0.22% 1.24% 24,988.60 19,777.80 117 South Africa FTSE/JSE All Share 30,897.05 4.81% 3.21% 1.16% 32,778.12 26,009.23 38 France CAC 40 3,796.55 4.07% -0.65% 2.30% 4,169.87 3,321.35 99 U.S. S&P500 1,280.10 3.98% 1.60% 5.85% 1,370.58 1,010.91 6

10 UK FTSE 100 5,722.30 3.79% 0.58% -0.96% 6,105.80 4,790.00 711 Singapore Straits Times 3,048.28 2.86% 2.56% -0.75% 3,313.61 2,770.12 412 Germany Xetra Dax 7,107.90 0.78% 3.24% 2.76% 7,600.41 5,809.37 1213 Mexico IPC 35,601.73 0.61% -2.58% -6.07% 38,876.80 30,542.50 814 Japan Nikkei225 9,578.31 -0.59% 0.46% -8.05% 10,891.60 8,227.63 515 India BSE30 18,412.41 -0.79% -3.57% -8.80% 21,108.60 17,295.60 14


NON-U.S. DOLLAR FOREX CROSS RATES

Rank Currency pair Symbol June 27 1-month gain/loss

3-month gain/loss

6-month gain loss

52-week high


1 Pound / Franc GBP/CHF 1.330265 6.71% -3.81% -4.37% 1.6642 1.3292 16

2 Aussie $ / Franc AUD/CHF 0.873975 5.34% -2.46% -4.62% 0.9818 0.8729 18

3 Euro / Franc EUR/CHF 1.18294 3.95% -5.11% -2.54% 1.3858 1.1823 21

4 Pound / Yen GBP/JPY 128.35 3.90% 2.17% 4.22% 139.19 126.1 13

5 Canada $ / Yen CAD/JPY 81.39 2.62% 0.66% 1.62% 88.95 78.75 19

6 Aussie $ / Yen AUD/JPY 84.365 2.51% 3.61% 3.92% 89.46 73.69 11

7 Canada $ / Real CAD/BRL 1.62379 2.38% -1.69% -1.41% 1.725 1.589 7

8 Aussie $ / Real AUD/BRL 1.68364 2.25% 1.19% 0.85% 1.7515 1.4528 3

9 Aussie $ / New Zeal $ AUD/NZD 1.29166 1.59% -3.64% -2.24% 1.3746 1.2174 15

10 Pound / Aussie $ GBP/AUD 1.521355 1.35% -1.38% 0.25% 1.8042 1.5158 9

11 Pound / Canada $ GBP/CAD 1.577425 1.22% 1.50% 2.56% 1.6412 1.5396 4

12 Euro / Yen EUR/JPY 114.13 1.22% 0.79% 6.22% 122.63 106.43 20

13 New Zeal $ / Yen NZD/JPY 65.27 0.97% 7.51% 6.20% 66.89 56.86 8

14 Euro / Real EUR/BRL 2.277345 0.97% -1.57% 3.05% 2.3842 2.1671 10

15 Aussie $ / Canada $ AUD/CAD 1.036855 -0.13% 2.93% 2.30% 1.0513 0.8911 5

16 Yen / Real JPY/BRL 0.01995 -0.23% -2.33% -2.97% 0.0212 0.0186 2

17 Euro / Aussie $ EUR/AUD 1.35273 -1.26% -2.72% 2.22% 1.4911 1.2947 14

18 Euro / Canada $ EUR/CAD 1.40249 -1.38% 0.13% 4.53% 1.4316 1.276 12

19 Euro / Pound EUR/GBP 0.88914 -2.57% -1.36% 1.91% 0.8995 0.8098 17

20 Franc / Yen CHF/JPY 96.485 -2.63% 6.22% 8.98% 96.485 80.72 6

21 Franc / Canada $ CHF/CAD 1.18637 -5.19% 5.52% 7.26% 1.18637 0.9474 1

GLOBAL CENTRAL BANK LENDING RATES

Country Interest Rate Rate Last change Dec-10 Jun-10United States Fed funds rate 0-0.25 0.5(Dec.08) 0-0.25 0-0.25Japan Overnight call rate 0-0.1 0.1(Oct.10) 0.1 0.1Eurozone Refi rate 1.25 0.25(April11) 1 1England Repo rate 0.5 0.5(March09) 0.5 0.5Canada Overnight rate 1 0.25(Sept10) 1 0.5Switzerland 3-monthSwissLibor 0.25 0.25(March09) 0.25 0.25Australia Cash rate 4.75 0.25(Nov10) 4.75 4.5New Zealand Cash rate 2.5 0.5(March11) 3 2.5Brazil Selic rate 12.25 0.25(June11) 10.75 9.5Korea Korea base rate 3 0.25(March11) 2.5 2Taiwan Discount rate 1.875 0.125(June11) 1.625 1.25India Repo rate 7.25 0.5(May11) 6.25 5.25South Africa Repurchase rate 5.5 0.5(Nov.10) 5.5 6.5


INTERNATIONAL MARKETS

GDP Period Release date Change 1-year change Next release

AMERICASArgentina Q1 6/17 -5.2% 9.9% 9/16

Brazil Q1 6/3 1.3% 4.2% 9/6Canada Q1 5/30 2.1% 6.0% 8/31

EUROPEFrance Q1 6/29 0.9% 1.5% 9/28

Germany Q1 5/13 1.7% 5.6% 8/16UK Q1 6/28 1.7% 4.6% 10/5

AFRICA S. Africa Q1 5/31 2.9% 13.1% 8/30

ASIA and S. PACIFIC

Australia Q1 6/1 -0.2% 1.2% 1/9Hong Kong Q1 5/13 -4.7% 11.0% 8/12

India Q1 5/31 7.8% 17.2% 8/31Japan Q1 5/19 -0.9% -3.7% 8/15

Singapore Q1 5/27 4.6% 11.2% 8/19

Unemployment Period Release date Rate Change 1-year change Next release

AMERICASArgentina Q1 5/20 7.4% 0.1% -0.9% 8/22

Brazil May 6/22 6.4% 0.0% -1.1% 7/19Canada May 6/10 7.4% -0.2% -0.7% 7/8

EUROPEFrance Q1 6/3 9.2% -0.1% -0.3% 9/1

Germany May 6/30 6.0% -0.1% -1.2% 7/28UK Feb.-April 6/15 7.7% -0.3% -0.3% 7/13

ASIA and S. PACIFIC

Australia May 6/9 4.9% 0.0% -0.3% 7/7Hong Kong March-May 6/16 3.5% 0.0% -1.1% 7/19

Japan April 5/19 4.7% 0.1% -0.4% 7/1Singapore Q1 5/30 1.9% -0.3% -0.3% 7/29

CPI Period Release date Change 1-year change Next release

AMERICASArgentina May 6/15 0.8% 9.7% 7/14

Brazil May 6/7 0.5% 6.6% 7/7Canada May 6/29 0.7% 3.7% 7/22

EUROPEFrance May 6/15 0.1% 2.0% 7/12

Germany May 6/10 0.0% 2.3% 7/12UK May 6/14 0.2% 4.5% 7/12

AFRICA S. Africa May 6/22 0.5% 4.6% 7/20

ASIA and S. PACIFIC

Australia Q1 4/27 1.6% 3.3% 7/27Hong Kong May 6/21 5.2% 5.1% 7/21

India May 6/30 0.5% 8.7% 7/29Japan April 5/27 0.3% 0.3% 7/1

Singapore May 6/29 0.6% 4.5% 7/25

PPI Period Release date Change 1-year change Next release

AMERICASArgentina May 6/15 0.9% 12.5% 7/14Canada April 5/31 0.5% 5.0% 7/4

EUROPEFrance May 6/30 -0.9% 17.6% 7/30

Germany May 6/20 0.0% 6.1% 7/20UK May 6/10 0.2% 5.3% 7/8

AFRICA S. Africa May 6/30 0.4% 6.9% 7/28

ASIA and S. PACIFIC

Australia Q1 4/21 1.2% 2.9% 7/26Hong Kong Q1 6/13 3.5% 8.2% 9/15

India May 6/14 0.7% 9.1% 7/14Japan May 6/10 -0.1% 2.2% 7/12

Singapore May 6/29 2.5% 7.6% 7/29 As of June 30 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.


TRADE SUMMARY

Date Currencypair

Entryprice

Initial stop

Initial target IRR MTM Date

P/LLOP LOL Trade

lengthpoint %6/27/11 AUD/USD 1.0430 1.0379 1.0532 2.00 1.0487 6/28/11 .0057 0.55% 0.0070 -0.0007 1 day

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.

FOREX TRADE JOURNAL

TRADE

Date: Monday, June 27, 2011.

Entry: Long the Australian dollar/U.S.

dollar pair (AUD/USD) at 1.4030.

Reason for trade/setup: After drift-

ing lower for several weeks after its early

May top (see “Spot check”), on June 27 the

Aussie dollar/U.S. dollar pair punched

decisively through the bottom of a triangular consolida-

tion. Rather than short on the expectation of an immediate

continuation move, we established a long position in antic-

ipation of the move being a false breakout of an all-too-

obvious congestion pattern. (A longer-term short position

would be viable after such a rebound.) This paper-trade

position was established on a pullback after the intraday

rebound from the day’s low (see chart inset).

Initial stop: 1.0379, 0.12 below the entry day’s low.

Initial target: 1.0532.

RESULT

Exit: Trade still open.

Profit/loss: +.0057.

Outcome: The first 24 hours or so gave little indication

whether the trade idea would work. The pair had wan-

dered a little higher, tagging 1.0500. yTo see the result of this trade, go to www.currencytradermag.com after July 5.

Note: Initial trade targets are typically based on things such as the historical per-formance of a price pattern or a trading system signal. However, because individ-ual 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 expo-sure. As a result, initial (pre-trade) reward-risk ratios are conjectural by nature.

A false breakout trade

in the Aussie dollar.

Source: TradeStation

http://www.currencytradermag.com

Ctm 201107

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