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    CANADIAN DOLLARS RESISTANCE CHECK P. 10

    eptember 2013

    olume 10, No. 9

    Strategies, analysis, and news for FX traders

    System testing inthe yen & pound p. 20

    The FX taperingtrade p. 6

    The Polish zlotyssweet spot p. 26

    Stress in the forexmarket p. 14

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    2/352 September2013CURRENCY TRADER

    CONTENTS

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

    Global Markets

    The tapering trade.......................................6Although everyone knows tapering is a done

    deal, theres plenty of uncertainty about how it

    will play out in the FX market.

    By Currency Trader Staff

    Spot Check

    Dollar/Canada plays with resistance..........10Can the USD/CAD pair continue to make new

    52-week highs and emerge from its longer-term

    dormancy?By Currency Trader Staff

    On the Money

    Too much conditionality ...........................14

    The markets can handle some uncertainty, but

    the lead-up to the Feds eventual announcement

    on tapering may be stressing the system.

    By Barbara Rockefeller

    Trading Strategies

    System testing in dollar/yen

    and pound/dollar pairs .............................20

    Different currency pairs require different testing

    parameters when developing trading systems.

    ByDaniel Fernandez

    Advanced Concepts

    The Polish zloty

    (pronounced Zloty)................................ 26

    Analysis of the Polish currency suggests Poland

    shouldnt be in a rush to join the Euro.

    By Howard L. Simons

    Global Economic Calendar .........................30

    Important dates for currency traders.

    Events ........................................................30Conferences, seminars, and other events.

    Currency Futures Snapshot ........................31

    BarclayHedge Rankings .............................. 31

    Top-ranked managed money programs

    International Markets ................................... 32

    Numbers from the global forex, stock, and

    interest-rate markets.

    Forex Journal................................................ 35

    Going short as a prelude to a long position.

    Looking for an

    advertiser?

    Click on the company

    name for a direct link to the

    ad in this months issue.

    Ablesys

    eSignal

    FXCM

    Interactive Brokers

    NinjaTrader

    The World MoneyShow Toronto

    Questions or comments?Submit editorial queries or comments to

    [email protected]

    mailto:[email protected]:[email protected]
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    CONTRIBUTORS

    4 September2013CURRENCY TRADER

    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]

    Classifed ad sales: Mark Seger

    [email protected]

    Volume 10, Issue 9. Currency Trader is published monthly by TechInfo,Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright 2013 TechInfo,Inc. All rights reserved. Information in this publication may not be stored orreproduced in any form without written permission from the publisher.

    The information in Currency Trader magazine is intended for educationalpurposes only. It is not meant to recommend, promote or in any way implythe effectiveness of any trading sys tem, strategy or approach. Traders areadvised to do their own research and testing to determine the validity of atrading 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 nancial 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 atCitibank and other nancial institutions, and currently

    publishes two daily reports on foreign exchange. Rockefel-

    ler is the author ofTechnical 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), The Foreign Exchange Matrix

    (Harriman House, 2013), and How to Invest Internationally,

    published in Japan in 1999. A book tentatively titled How

    to Trade FX is in the works. Rockefeller is on the board of

    directors of a large European hedge fund.

    qDaniel Fernandezis an active trader

    with a strong interest in calculus, statistics,

    and economics who has been focusing on

    the analysis of forex trading strategies,

    particularly algorithmic trading and the

    mathematical evaluation of long-term sys-

    tem protability. For the past two years he has published

    his research and opinions on his blog Reviewing Every-

    thing Forex, which also includes reviews of commercial

    and free trading systems and general interest articles on

    forex trading (http://mechanicalforex.com). Fernandez isa graduate of the National University of Colombia, where

    he majored in chemistry, concentrating in computational

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

    mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.rts-forex.com/http://mechanicalforex.com/mailto:dfernandezp%40unal.edu.co?subject=mailto:dfernandezp%40unal.edu.co?subject=http://mechanicalforex.com/http://www.rts-forex.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]
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    6/356 September2013CURRENCY TRADER

    GLOBAL MARKETS

    At the outset of the fourth quarter financial marketsremained firmly focused on the U.S. Federal Reserve andwhen so-called tapering, or the planned cutback inasset purchases currently $85 billion per month in assetpurchases will occur. Fed chairman Ben Bernanke hassignaled the central banks intentions to begin taperingthis year, and markets are anticipating an announcement atthe Sept. 17-18 Federal Open Market Committee (FOMC)

    meeting.Its important to remember that tapering is not the sameas tightening its just the beginning of what will be avery long process of reversing the extraordinary monetaryaccommodation that began during the global financial cri-sis in 2008 and persists to this day. The Feds exit strategywill have many moving parts, and the bank has repeat-edly reminded the markets that the timing and executionof the tapering process will be data-dependent. Althoughthere have been signs of improvement in the U.S. econo-my, some analysts argue the recovery is still fragile, andnumerous risks remain on the horizon.

    If the Fed doesnt taper in September, there are sched-

    uled FOMC meetings in late October and mid-Decemberthat could also initiate the process. However, the forexmarket is generally expecting tapering to begin inSeptember, and a delay could trigger a volatile marketreaction. Alternately, other analysts and traders believe themarket might be setting up for a buy the rumor, sell thefact type of trade.

    Getting ready to exitThe Fed is optimistic the U.S. economic recovery finallyhas some legs enough to allow the central bank to begindownsizing the $85 billion in bond and mortgage-backedsecurity purchases it makes each month. There is no expec-

    tation the Fed will cut the federal funds rate currentlyat 0-0.25% until well after it terminates its quantitativeeasing program. Nonetheless, investors and traders inthe U.S. and abroad have been jittery about the inaugu-ration of tapering.

    The market is so focused on the timing of the firsttaper, its almost as if [everyone] is forgetting this is a pro-cess that could take a very long time, says Laura Rosner,

    U.S. economist at BNP Paribas.Many economists are forecasting a modest initial cut-back in the range of $10 to 20 billion per month. Timingis one thing, magnitude is another, says Ryan Sweet,director at Moodys Analytics. They want to start smallbecause inflation is still too low. The personal consumptionexpenditure (PCE) is 1.4% year-over-year.

    While Moodys Analytics expects the Fed to announcethe start of tapering at the September meeting, BNPParibas believes the Fed will drag its feet until itsDecember meeting. (The Aug. 21 release of the minutesfrom the June 20-21 FOMC revealed the Fed believed theU.S. economy would be stronger in the second half of

    2013, and conditions were on track for tapering to com-mence by the end of the year. However, the Fed avoideddiscussing timing more specifically than that.)

    Our forecast is for a December start to tapering, whichwill proceed until September of next year, Rosner says.We think it will be evenly split between Treasuries andagencies, with a $10 billion reduction in Treasuries from$45 billion to $35 billion and a $10 billion reduction inagency mortgage-backed securities from $40 billion to $30billion.

    This would leave the Fed still purchasing $65 billion inassets each month still a very accommodative stance in addition to maintaining near-zero interest rates. An

    The tapering tradeAlthough everyone knows tapering is a done deal, theres plenty of

    uncertainty about how it will play out in the FX market.

    BY CURRENCY TRADER STAFF

    http://www.currencytradermag.com/index.php/c/Key%20Concepts#QRhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#QRhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#QRhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#QRhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#QR
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    actual rate increase is not expected until mid-2015.

    Timing factorsFed officials have successfully broadcast their taperingintentions and communicated policy moves ahead of timeto the financial markets. But have the markets over-antic-ipated the unwinding process? One analyst thinks thatmight be the case.

    The market is a bit ahead of itself expecting Fed taper-ing in September it may be disappointed, says MarcChandler, global head of currency strategy at BrownBrothers Harriman.

    Rosner explains why the Fed may choose to hold steadyin September. Fed officials have expressed caution anda desire to be sure they do not start the process prema-turely, she says. The [economic] picture is still verymixed and there are emerging risks we are learning moreabout. There is the possibility of fiscal negotiations stallingaround the debt ceiling, the budget, and the continuationresolution. This will be coming to the forefront again, butmarkets are not focusing on it right now.

    The federal governments current spending resolutionis set to expire on Sept. 30, setting up a potential politicalshowdown. A short-term resolution could be passed tokeep the government operating for a few months, but thereis still the possibility for a market-rattling governmentshutdown. A battle could emerge over how to deal withthe next round of scheduled sequester-related spendingcuts. Also, uncertainty over a so-called grand bargain toaddress comprehensive tax reform and entitlement reformremains.

    There are economic risks that could emerge over theuncertainty over the political process, Rosner says. Fortapering to be successful it would be good to start the pro-

    cess when the data are on the upswing and other risks arenot on the horizon. The timing of the start of tapering mat-ters because it has the potential to damage confidence andcreate uncertainty and stress.

    Market reactionAll the talk and expectation about tapering begs thequestion: Is tapering already priced in? Mostly, but not

    entirely, it seems, says Sean Callow, senior currency strat-egist at Westpac Institutional Bank. Surveys of economistsfind about two-thirds looking for the first move on Sept.18. There has been a great deal of discussion in FX marketsabout the timing of tapering, so no one will be shocked bya September move.

    But looking at the other side of the coin, what could hap-pen if no tapering is announced in September?

    On that headline, Brown Brothers HarrimansChandler says, the dollar sells off and medium-terminvestors want to take advantage of the sell-off and buythe dollar.

    Likely impactWhen the Fed finally does announce tapering inSeptember, October, or December which currencies willbe the forex winners and losers?

    There is no doubt many investors look at tapering asthe potential start of a very lucrative multi-quarter or evenmulti-year trade, betting on sustained recovery in theU.S. economy, boosting the U.S. dollar against virtuallyevery currency, Westpacs Callow says. The questionhowever is whether confirmation of such a Fed move willproduce a major response. Bernanke raised the prospect ofa reduction in QE way back in May at his Joint EconomicCommittee appearance. The danger for U.S. dollar bulls is

    The forex market is generally

    expecting tapering to begin in

    September, and a delay could trigger

    a volatile market reaction.

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    8/358 September2013CURRENCY TRADER

    GLOBAL MARKETS

    that confirmation of tapering provesto be a classic sell the fact episode,as was seen with QE2 in November2010.

    Chandler also notes the potential fora buy the rumor, sell the fact typeof trade once tapering is announced.The market is leaning too much oneway, he says.

    Looking ahead, Callow says wheth-er the U.S. dollar makes sustainedgains on tapering depends on whetherthe Fed feels confident the economyhas sufficiently rebounded from itssoft first half. Reducing QE modestlyin the face of mixed data, he notes,could give the impression the Fedfelt obliged to trim QE because theyhad talked about it so much and had

    increasing doubts about its efficacy.The general view is the U.S. dollarwill be a broad-based winner oncetapering is announced. Tapering ...will reduce the amount of liquidityand will lead to upward pressure oninterest rates, which is dollar-support-ive, says Charles St-Arnaud, NomuraFX strategist and economist. Weexpect the latter months of the year tobe very positive for the dollar.

    The U.S. dollar index (DXY) hasbeen in a broad trading range since

    its multi-year downtrend hit its nadirin 2008 (Figure 1). St-Arnaud believesthe greenback could be at a pivotallonger-term turning point.

    We think the constant declinesweve seen in the U.S. dollar over thepast decade are coming to an end, hesays. Weve reached a level where itshould be reversed. There was a lotof negativity priced into the dollar,including structural issues, the twindeficits, and a negative trade balance.But we have an economy that will

    FIGURE 1: A REAL DOLLAR TURNING POINT?

    The U.S. dollar has traded in a wide range since bottoming in 2008, but some

    analysts see the possibility of a major trend reversal as a result of the QEtapering process.

    Source for all figures: TradeStation

    FIGURE 2: YEN ON THE HOT SEAT

    Tapering could extend the Japanese yens current downtrend.

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    need less imports in the future. Shale gas and shale oil ishelping that.

    Nomuras year-end targets reflect dollar appreciationacross the board. We expect the yen to end the year at1.02, the Euro/U.S. dollar to be below 1.25, the Canadiandollar at $1.10, and the Australian dollar at .8600,St-Arnaud says.

    Big losersAccording to Callow, there will be many currency losers asa result of the tapering process foremost among themthe Japanese yen (Figure 2). The yen is an obvious loser,given the stark contrast with the BOJs (Bank of Japans)open-ended QE, which might even be increased at the Oct.31 BOJ meeting, he says. The Euro is also at risk if theEurozone economy falters again, as we expect. Obviously,a fall in the EUR/USD pair would be welcomed byEuropean policymakers.

    However, Nomuras St-Arnaud believes the biggestlosers will be emerging-market currencies. They will beharder hit than developed currencies, he says.

    Callow agrees. The biggest fireworks might be inemerging markets, where currencies that drew heavy

    demand during episodes of QE as alternatives to U.S. dol-lar have already suffered bouts of heavy selling, he says.In a research note to clients, Normura analysts comment-

    ed on the risks to Latin American cur-rencies: In a research note to clients,Nomura analysts commented on therisks to Latin American currencies: Astronger U.S. dollar in the context of atapering expansion of the Feds balancesheet and flattish commodity pricespromises challenges ahead. We believethat we could see a winners cursedynamic in the region, as countries

    that have received the most portfolioflows see their currencies depreciatethe most, despite having relativelystronger fundamentals. Perhaps, we seeslightly more risk in Mexico than in therest of [Latin America] since this is thecountry that has received more inflowsin the past months. Figure 3 shows theMexican peso (MXN) gave back someof its gains vs. the dollar in spring andsummer after strengthening over theprevious year.

    For emerging-market currencies, the

    impact of a rising dollar on global commodity prices isa key piece of the puzzle. Many Latin American nationsare commodity exporters, and because most commoditiesare priced in U.S. dollars, a rising greenback would makethose commodities more expensive in the global market-place, which could weigh on demand. If the Feds movein tandem with a strong dollar ends up causing commod-ity prices to weaken, the moves on the BRL (Brazilian real),CLP (Chilean peso) and COP (Colombian peso) could bejust the beginning of a prolonged adjustment, Normurastates in its research note.

    Volatility aheadTheres plenty of fodder for churning market action thisfall and trading opportunities regardless of whetherthe Fed does or doesnt taper in September.

    Assuming the Fed starts tapering for the right reasons obvious economic strength and it is not half-hearted,such as a token $5-10 billion reduction, the U.S. dollarshould gain, Callow says.

    However, he notes there are no precedents for the Fedsunwinding of its record monetary stimulus or the Bank ofJapan sustaining its maximum-speed QE, let alone hav-

    ing both occur simultaneously. Investors, he notes, shouldbrace themselves for unintended side effects. Perhaps thesafest prediction is greater volatility, he says.y

    FIGURE 3: MEXICAN PESO

    Normura sees more tapering-related risk in the Mexican peso than most other

    Latin American currencies.

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    10/3510 October2010CURRENCY TRADER

    Dollar/Canadaplays with resistance

    Can the USD/CAD pair continue to make new

    52-week highs and emerge from its longer-term dormancy?

    BY CURRENCY TRADER STAFF

    SPOT CHECK

    10 September2013CURRENCY TRADER

    Having traded for the better part of three years in a trad-ing range between roughly .9450 and 1.0650, the U.S.dollar/Canadian dollar pair (USD/CAD) establishedsomething of a minor milestone in June when it hit its first52-week high since October 2011.

    In Figure 1 blue dots highlight weeks dollar/Canada hita new 52-week high three consecutive weeks betweenJune 21 and July 5, and before that the two consecutiveweeks in September-October 2011. At the far left of thechart is the new yearly high from March 2009, which wasthe last in a series of new 52-week highs the pair madewhen the 2008-2009 financial crisis drove safe-haven fundsinto the dollar and propelled dollar/Canada off its late-

    2007 all-time low, as shown in Figure 2.Figure 3 shows the USD/CADs performance after

    initial 52-week highs (i.e., those that were not precededthe previous week by a 52-week high) between May 1974and August 2013. There were 53 such weeks during thisanalysis window. The chart shows the average and median

    price moves from the close of the week that made the new52-week high to the closes of the next 12 weeks. To providea benchmark to provide context for these moves, the chartalso shows the average and median price changes for allone- to 12-week periods in the analysis window.

    Although the price action after new 52-week highs isclearly more bullish than the USD/CADs benchmark per-formance, this edge occurs almost entirely in the first threeweeks, after which price tends to move sideways to lower(extrapolating from the combined behavior of the averageand median returns).

    Also, the USD/CADs mostly flat benchmark perfor-mance is a result of the pairs roughly offsetting long-term

    bull and bear markets over the past 40 years. It would thusbe logical to analyze the performance after new 52-weekhighs in different market conditions, yet all but a handfulof the 53 instances represented in Figure 3 occurred duringthe two major bull phases 1974-1985 and 1992-2001 marked on Figure 2.

    This makes it impossible to learn much from the per-

    FIGURE 1: WEEKLY DOLLAR/CANADA

    In June and early July, the USD/CAD pair made three consecutive

    52-week highs, pulled back, and tested this resistance area in late

    August.

    FIGURE 2: MONTHLY DOLLAR/CANADA

    The 2008-2009 run-up interrupted the downtrend that had prevailed

    in the USD/CAD rate since 2002.

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    11/35CURRENCY TRADERSeptember2013 11

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    12/3512 September2013CURRENCY TRADER

    SPOT CHECK

    formance of the eight bear-phase examples from 1986-1991

    and 2002-2013 shown in Figure 4, although the trajec-tory of their price action is pretty much what wed intuitduring a downtrend: Although the average and medianreturns were both positive one week after new 52-weekhighs, both were negative at week 2; the median returncontinued to decline, while the average return jumped topositive territory in weeks 3-9 before turning negative inthe final three weeks.

    In short, the USD/CADs performance after 52-weekhighs during these bear phases could be described asmostly incidences of false upside breakouts perhaps ahigher close after a week or two, but an eventual return to

    the downtrend. This, in fact, is a fairly accurate descriptionof what happened after the new 52-week highs in Figure 1.And, with only eight examples, it is easy to confirm that.But for the bullish aberration during the 2008-2009 finan-cial crisis, we are left with the unsatisfying conclusion thatnew 52-week highs are generally followed by additionalprice gains (mostly in the first three weeks) during bullmarkets, while theyre followed by declines in bear mar-kets when they occur at all.

    The question now is whether dollar/Canadas long con-solidation and slow (but steady) climb since September2012 (a gain of nearly 10% as of the end of August) por-tends the beginning of another bullish phase in which new

    52-week highs imply continued gains, or if the pairs latestrally is simply a move toward the upper end of its tradingrange that is destined to fail.

    Here, two observations are relevant. The first is that dol-lar/Canada in late August was in the process of testingwhat at that point was a well-established resistance areadefined by the June-July 52-week highs and the 2011 highs;a move above 1.0608 (the high of the week ending July 5),would constitute a new 52-week high which, if it occursin the next several weeks, would be a relatively quick reoc-currence and would reinforce bullish momentum. Bullishphases, after all, should be characterized by regularlyrecurring new highs.

    Second, fundamental and sentiment factors mostlydriven by anticipation of a scaling back of the FederalReserves quantitative easing program are still alignedin favor of the U.S. dollar. Arguably, the biggest threat toU.S. dollar strength in the near future is a failure of the Fedto announce a definitive plan to begin its tapering pro-cess after its Sept. 17-18 meeting.

    However, given dollar/Canadas traditional fits-and-starts trading behavior illustrated by the zigzagging dailyprices in Figure 5, the pair is unlikely to catapult above itsrecent highs in parabolic fashion. Pullbacks should allowtraders wishing to test the long side to enter at relativelyadvantageous levels.y

    FIGURE 3: USD/CAD AFTER NEW 52-WEEK HIGHS

    The pair outperformed its benchmark price moves after hitting new

    52-week highs, but the bulk of the typical gain occurred in the first

    three weeks.

    FIGURE 4: AFTER 52-WEEK HIGHS IN BEAR MARKETS

    There were only a handful of examples, but new 52-week highs

    tended to bring a false hope of bullish follow-through when dollar/

    Canada was in a downtrend.

    FIGURE 5: DAILY DOLLAR/CANADA

    If history is any guide, run-ups in the USD/CAD pair are unlikely to

    extend too far without a correction.

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    The FX market is gearing up for a historic change theannouncement by the Federal Reserve of a reduction inits purchases of Treasuries and mortgaged-backed securi-ties from $85 billion per month. Anticipation of this eventhas been building since May the 10-year T-note yieldrose from 1.64% on May 1 to nearly 3% by the last week ofAugust 2013, a two-year high (and up from 1.40% in July2012).

    But Fed tapering is combining with events that devel-

    oped separately, including stock market bubbles, com-modity price wobbles, and emerging market distress. Thebottom line is the Feds decisions will reach far beyondAmerican shores.

    The Fed may be being blamed for global disruptionsthat are not entirely its fault, but the final goal is admirable to restore the conditions that are necessary for equilib-rium in various markets. The problem is the Feds policyprocedures, and to a certain extent, those of the Bank of

    England, are creating too much uncer-tainty. Market players are supposed

    to be able to juggle such unknowns,but when there are too many balls inthe air, the surfeit of conditionalitiesbecomes overwhelming and the resultis chaotically jumpy prices across mul-tiple markets.

    Too much uncertainty from

    too much conditionalityThe Fed has never said exactly whenit will begin tapering, by how much,or over what period. Normally,markets can live with a degree of

    uncertainty, but this time, as the firstconsensuses on timing and amountstarted falling apart, longer-termyields spiked and flopped threetimes (Figure 1). The yield index brokeits 20-day moving average and hand-drawn support twice since mid-July,and its not unfair to label the Juneand July highs spiky. The linearregression channel, extended from thelast data point, indicates the yield maybe 3.221% by Sept. 30, in a standard

    error range of 3.018% to 3.429%. Note

    On the Money

    14 September2013CURRENCY TRADER

    ON THE MONEY

    Too much conditionalityThe markets can handle some uncertainty, but the lead-up to the Feds

    eventual announcement on tapering may be stressing the system.

    BY BARBARA ROCKEFELLER

    FIGURE 1: U.S. 10-YEAR NOTE YIELD INDEX

    When the initial consensuses on tapering started falling apart, longer-term yields

    spiked and flopped three times. The projection of the linear regression channel

    indicates the yield may reach 3.22% by Sept. 30.

    Source: Chart Metastock; data Reuters and eSignal

    9 25 4March

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    the lowest of the hand-drawn support lines matches uppretty well with the channels bottom. Its nice when thathappens, since it seems like a confirmation of support.

    In late August, the thinking was that unless the Sept.6 nonfarm payrolls report is catastrophically low (below100,000), the Fed would announce tapering at its Sept.17-18 policy meeting and start implementing it in October.The early estimates from fixed-income analysts were fortapering to proceed at a rate of $20 billion per month, andthe Fed said nothing to disabuse the market of that notion.The Feds silence lent credence to the idea, although some

    complained the Fed could be more forthcoming and namean amount itself. And yet some analysts wrote taperingwould be postponed or reduced to a really low number,like $5 billion.

    In mid-August, the New York fed released its Julyprimary dealer survey showing a modification. Nowthe pros think the Fed will cut purchases by $15 billion,split $10 billion in Treasuries and $5 billion in mortgage-backed securities. Then there will be a second tapering inDecember for another $15 billion, albeit perhaps in differ-ent proportions. Note that if the Fed cuts $30 billion in thisfashion, it will be still be purchasing $55 billion per monthin Jan. 1, 2014 and that sum certainly still constitutes

    extraordinary accommodation. The dealers, however, areholding to the timeline of an end to QE by June 2014.

    So why did the 10-year yield rise so far, so fast andwith three violent pullbacks? The explanation seems tobe that investors accept the tapering scenario but dontbelieve the Feds forward guidance that the fed fundsrate will remain at zero for an extended period, likely 2015,according to primary dealer surveys. Remember, the fedfunds rate has been near zero since December 2008. Heresthe Feds statement on forward guidance from the minutesof the July FOMC meeting:

    [T]he Committee decided to keep the target range for the fed-

    eral funds rate at 0 to percent and currently anticipatesthat this exceptionally low range for the federal funds ratewill be appropriate at least as long as the unemploymentrate remains above 6 percent, inflation between one andtwo years ahead is projected to be no more than a half per-centage point above the Committees 2 percent longer-rungoal, and longer-term inflation expectations continue to bewell anchored.

    The Atlanta fed blog had an Aug. 19 post, DoesForward Guidance Reach Main Street? that noted: All

    but one FOMC participant expects the funds rate to belifted off the floor in 2015, with the median projection thatthe fed funds rate will be 1 percent by the end of 2015.

    But the market disagrees with the FOMC, and severalpress reports indicate the market is expecting the first fedfunds rate hike in 2014, not 2015. For example, the CMEGroups Fed Watch puts a 52% probability on the firstrate hike occurring in December 2014, and those odds onlyincrease through the first half of 2015. Using fed fundsfutures to predict rate changes has not proven to be a reli-able process, but never mind the point is, the marketdoesnt trust the Fed to stay its hand as promised.

    Its never a good thing when markets dont trust their

    central banks, but in the case of the U.S., its worse,because foreigners, including central banks, hold a vastamount of government issuance. Withdrawals from bondmutual funds and ETFs were already at $30.3 billion bythe third week of August the third biggest drop for anymonth on record. For perspective, October 2008 had with-drawals of $42 billion, according to investment researchfirm TrimTabs. To be fair, panic was worse earlier in thetapering debate $67.1 billion in June 2013.

    As for official foreign government holdings, the latestdata is for June from the Treasury International CapitalSystem (TICS) report. It shows China cut holdings by$1.268 billion from May. Japan cut $20.3 million, and Hong

    Its never a good thing when markets dont

    trust their central banks, but its worse in

    the case of the U.S., because foreigners,

    including central banks, hold a vast

    amount of government issuance.

    http://macroblog.typepad.com/macroblog/2013/08/does-forward-guidance-reach-main-street.htmlhttp://macroblog.typepad.com/macroblog/2013/08/does-forward-guidance-reach-main-street.htmlhttp://macroblog.typepad.com/macroblog/2013/08/does-forward-guidance-reach-main-street.htmlhttp://macroblog.typepad.com/macroblog/2013/08/does-forward-guidance-reach-main-street.htmlhttp://macroblog.typepad.com/macroblog/2013/08/does-forward-guidance-reach-main-street.html
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    Kong, $1.22 million. The TICS report can be tricky, becauseholders can switch to corporate debt and to equities, notleaving the U.S. market (or the dollar) altogether. All thesame, total foreign government holdings of U.S. Treasurypaper fell to $4.0092 trillion in June from $4.0728 trillion inMay (and $4.097 trillion in March).

    Analysts arent too worried about a drop in foreign hold-ings, because, as the Chinese have said, its the only gamein town and to dump Treasuries would be self-defeating.But European Central Bank (ECB) chief Mario Draghi say-ing (as he did a year ago) he would do whatever it takesto preserve the Eurozone, even intervening in the sover-eign bond market, makes European paper and the Eurolook a lot more attractive than before, and blessedly free ofconditionalities.

    Where the rubber meets the roadWhere capital outflow is a real issue is not the U.S. butrather emerging markets. In recent weeks, stock marketsand currencies in Brazil, India, Indonesia, Malaysia, thePhilippines, Turkey, and South Africa have headed south,and in a hurry.

    Several emerging countries (Brazil, India, Malaysia,Turkey) have intervened in the currency market and/orstarted experimenting with capital controls. Interventionreduces reserves, of course, with Turkey spending 12.7%,Indonesia, as much as 13.6%, and the Ukraine, 10%,according to the Financial Times. Indian reserves are downa more modest 5.5%, and Brazil, 1.8%. Nomura reportedthat reserves in 21 emerging economies have fallen $153billion from their peak this spring, a level of spending that

    hasnt been seen since 2008. The International MonetaryFund (IMF) Cofer report, by the way, shows emerging-market central banks held $7.4 trillion in reserves at theend of Q1, so hundreds of millions in intervention is notfatal.

    Emerging-market stock declines and intervention arelikely to stay on the front page for some time to come.The Brazilian central bank chief didnt attend the KansasCity feds symposium in Jackson Hole, Wyo., so he couldstay home and baby-sit the real, already down 15% yearto date, the biggest drop after the South African rand. Theexodus from emerging-market equities and currencies isstaggering as much as $1 trillion since May, according

    to Bloomberg. The head of the Brazil Development Banktried to put a good spin on the reals sell-off, pointing outthat a stronger dollar will tend to create favorable condi-tions in the medium term for our competitiveness. But inpractice, as economist Carmen Reinhart said on the side-lines of Jackson Hole in a Bloomberg Television interview,

    Emerging markets had a capital flow bonanza lastingseveral years, the golden boom years, and the probabilityof a banking crisis, the probability of a currency crash, theprobability of a default, all increase afterward.

    In other words, so far we have avoided the contagionthat occurred in the 1997-98 Asian debt crisis, but the pro-cess is just beginning and its too soon to say a fresh crisiscan be avoided. So far, the Turkish lira and Indian rupeeare at historic lows, and the Indonesian rupiah is the low-est its been since 2009. The Malaysian ringgit and Thaibaht are at three-year lows, too. Is it enough that emerg-ing-market devaluation will promote exports?

    Unfortunately, the answer may be no. Failure to takeadvantage of yield-seeking capital inflows with structuralreforms is also behind the current capital flight. India, forexample, didnt fix inefficient and corrupt sectors, such asenergy. Labor market restrictions and failing electric powerand transportation systems are a drag on the export sec-tor no matter how low the rupee goes. Besides, inflationis very high, about 10%, but the public has a deep and notunjustified distrust of the banking and investment firms, asshown by a deep preference for gold. India is the worldssingle largest gold importer even after restrictions intro-duced this year. Not to put too fine a point on it, but whenthe citizens prefer gold, theres something wrong with the

    financial system.The Reserve Bank is about to get a new chief who isthought to be smart and capable, but honestly, theres justso much one institution can do. The risk is that the ReserveBank will raise rates too high and choke off what growththe economy can eke out against already gale-force head-winds.

    Cracks can be seen in other emerging markets, too.Mexico is about to invite foreign oil companies to startjoint exploration with state-owned Pemex, but the progno-sis is not bright for a surge in production and exports; thebureaucracy is too dense.

    China seems to be holding its own, with better purchas-

    Be skeptical of forecasts of a rising

    dollar based solely on the yield story.

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    ing managers indices and the like, but analysts still worryabout zombie banks and a banking sector crisis if a trueaccounting unmasked all the non-performing assets inthe system. One of the governments crackdowns entailedhalting the construction of government buildings, whichwere starting to rival Versailles. And again, the public haspreferred to put its savings anywhere but in bank accountsand other investments, especially real estate. The land-scape is dotted with empty condo towers and ghost towns.

    An emerging-market survey would not be completewithout mentioning Greece. German Finance MinisterWolfgang Schaeuble recently made an off-hand commentabout Greece needing another bailout, and the European

    peripheral bond market didnt burp. The minister forprivatization had to resign after appearing too cozy witha buyer of state assets and he is the third privatiza-tion minister to resign in a year. Privatization is $1 billionshort of its target, money that is needed by specific datesto redeem maturing bonds. And in July, the tax authorityjust wrote off more than 65% of taxes (about 42 billion) asuncollectible.

    Wither copper?Analysts use different proxies for global growth, includ-ing the Baltic Dry Index and the CRB commodities index,but lets take a look at copper. Figure 2 shows the crash

    in demand during 2008 that took price to a multi-yearlow, followed by recovery in 2009 and 2010, and a peak inearly 2011. But in 2012 copper declined again, in large partbecause of a drop in imports by China. The market is stillnot recovering to full-speed-ahead levels, despite favorablenews about Chinese demand, which resulted in copperimports hitting a 14-month high in July (with iron ore at arecord high).

    China accounts for about 40% of global demand forindustrial metals, including copper. Insiders in the coppertrading world measure Chinese demand in part on thespread between the world futures price and the premiumpaid for the physical stuff in Chinese warehouses. This has

    recently been at the highest since 2000, when China wasjust beginning a rapid ascent to its current powerhousestatus.

    But there are some issues with this rosy outlook. For onething, the Chinese government has been cracking downon leverage, including the use of metals as collateral toget credit for non-trading purposes. For another, coppermining and refining is not keeping pace with demand,especially from emerging markets like China and India,where consumers increasingly want better housing andthat includes plumbing. In a nutshell, a supply shortagecontributes to whatever firmness can be detected in copperprices over the summer of 2013; the downward slope of

    FIGURE 2: COPPER CONTINUOUS FUTURES (MONTHLY)

    In 2012 copper started sagging again, in large part because of a drop in imports

    by China. The market has still not recovered to its previous levels, despite

    favorable news about Chinese demand.

    Source: Chart Metastock; data Reuters and eSignal

    2006 2007 2008 2009 2010 2011 2012 2013 2014 201

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    the resistance line is not encouraging. If there is vibrantlyresurgent demand in China in combination with supply

    shortages, the price of copper should be high and rising.This is, by the way, one of those times when looking at achart of monthly data is useful.

    Meanwhile, the Commodity Futures TradingCommission is investigating banks that own metals ware-houses and also trade metals for their own account andserve as intermediaries for other traders. Can there bea big, fat conflict of interest in here? Metals users in theU.S. say there is, and subpoenas are already flying. Bigbanks own oil tankers (Morgan Stanley) while Goldmanowns everything from coal mines to utilities, and JPMorganChase is buying up geothermal plants in the Far

    West. In fact, JP MorganChase just paid a big fine ($285million) and gave back profits ($125 million) arising froma case of alleged price manipulation in energy markets and is exiting the physical commodities trading businessaltogether.

    But elsewhere, physical commodity trading firms arespringing up under every bush The Economist maga-zine reports the number of trading firms in Geneva alonedoubled (to 400) from 2000 to 2011. Now couple increasedoversight (and, possibly, pricing that is more reflective oftrue supply and demand) with the rising cost of leverage,

    whether the Fed raises the funds rate next year or the yearafter. Commodities trading is a leverage business. At the

    least we can expect higher volatility in commodities, whichaffects suppliers such as Canada and Australia, as well asothers without a G7 currency.

    FX groupingsThe FX world is increasingly becoming divided intogroups that reflect strength or vulnerability to the Fedsupcoming actions. In the first group are the dollar, Euro,and pound, with the Euro holding its own despite havinga yield disadvantage of nearly 150 basis points (Germanbund vs. Treasuries). The U.S. will have to offer a biggerpremium to get a currency effect.

    The second group consists of the commodity curren-cies the Canadian, Australian, and New Zealand dol-lars which are about to become ever more vulnerable tocommodity price volatility as leverage becomes costly.

    The third group is emerging-market currencies, whichhave to raise interest rates delicately to avoid capitaloutflows while maintaining growth. This group can stillexhibit contagion and deliver another global crisis.

    The fourth group is not a group at all its the yen,which is highly correlated to the Nikkei stock index. Itsthe best intermarket correlation we have. The correlation

    with the yield differential is weak andtends to work the usual way: favoring

    the dollar as yields rise, except whensomething else is not interfering, suchas safe-haven flows back to yen. TheSwiss franc, by the way, sometimesbelongs to the Euro group and some-times to the yen group.

    Bottom line: be skeptical when yousee forecasts of a rising dollar basedsolely on the yield story. There aredeep undercurrents below the surface,and so far, only emerging marketsare behaving in a predictable man-ner. Figure 3 shows the dollar index

    (green) with the 10-year T-note yield.The relationship is not consistent.There are two spiky highs in the dol-lar index over the past few months,while the yield index is a one-waystreet.yBarbara Rockefeller (www.rts-forex.com) isan international economist with a focus onforeign exchange, and the author of the newbook The Foreign Exchange Matrix (Har-riman House). For more information on theauthor, see p. 4.

    FIGURE 3: U.S. 10-YEAR NOTE YIELD INDEX VS. DOLLAR INDEX

    The dollar index/10-year yield relationship is inconsistent. The dollar index

    (green) has made two spiky highs over the past few months, while the yield

    index has moved almost exclusively upward.

    Source: Chart Metastock; data Reuters and eSignal

    February April May June July August September November 2013 February April May June July August September

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    Whats most important when developing a forex trading

    system? A currency pair s most recent behavior, or itsbroad characteristics over a long time period? How much

    data do you need to develop trading rules, and how much

    follow-up data is necessary to verify its performance?

    These were some of the questions addressed in FX

    trading system development: Outperforming your tests

    (Currency Trader, August 2013), which explored the prob-

    ability of success of trading systems using different in-

    sample(IS) and out-of-sample (OS) period lengths in the

    Euro/U.S. dollar (EUR/USD). The study revealed that

    larger in-sample periods used for system generation led

    to better probabilities, with the highest success rate associ-ated with the longest test period (5,000 days).

    However, the study didnt evaluate other currency pairs,

    so it was unclear whether this characteristic was universal

    or merely specific to the EUR/USD. To expand our per-

    spective, lets perform the same analysis on two additional

    currency pairs, the U.S. dollar/Japanese yen (USD/JPY)

    and the British pound/U.S. dollar (GBP/USD), and see

    how the probabilities of out-of-sample success compare to

    the EUR/USD pair.

    The testing process

    The study used price-based strategies generated on dailydata from Jan. 1, 1986 to Aug. 1, 2012 using the Kantu

    software (see note at end of article). In-sample periods

    ranged from 500 to 5,500 days, while out-of-sample peri-

    ods ranged from 200 to 800 days. For each IS/OS combina -

    tion, 1,000 different trading systems with coefficients of

    determination above 0.9 were generated, all with trading

    frequencies of more than 10 trades per year.

    The systems were created using randomly distributed,

    non-overlapping IS/OS combinations. For example, when

    generating systems for the 1,000-IS/200-OS combination,

    a system might have been generated on IS price data fromFeb. 10, 2001 to Nov. 7, 2003 (1,000 days) and then tested

    on OS data from Nov. 8, 2003 to May 26, 2004 (200 days).

    This study generated fewer systems than the EUR/USD

    study (1,000 vs. 5,000) because systems satisfying the 0.9

    determination coefficient threshold in the IS period were

    about five times less frequent in the USD/JPY and GBP/

    USD pairs than in the EUR/USD.

    Tests were repeated at least three times to ensure repro-

    ducibility. In the GBP/USD pair, however, only a limited

    number of tests were conducted using longer IS periods

    TRADING STRATEGIESTRADING STRATEGIES

    System testing in dollar/yen

    and pound/dollar pairsDifferent currency pairs require different testing parameters when developing trading systems.

    BY DANIEL FERNANDEZ

    http://www.currencytradermag.com/downloads/index.php?i=phttp://www.currencytradermag.com/downloads/index.php?i=phttp://www.currencytradermag.com/downloads/index.php?i=phttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#CDhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#CDhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#CDhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#CDhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#OPhttp://www.currencytradermag.com/downloads/index.php?i=p
  • 7/29/2019 Ctm 201309

    21/35CURRENCY TRADERSeptember2013 2

    (more than 4,000 days) because of the

    scarcity of systems with high determi-nation coefficients.

    Test results

    The OS probabilities of success for the

    USD/JPY (Figure 1) and GBP/USD

    pairs (Figure 2) follow significantly

    different patterns than that exhibited

    by the EUR/USD (Figure 3). These

    charts show the percentage of systems

    that were profitable in OS testing (ver-

    tical axis) in terms of the IS and OSperiod lengths (horizontal axis).

    Both the USD/JPY and (especially)

    GBP/USD pairs have greater than

    50% odds of OS profitability using

    very short IS period lengths, as well as

    positive average daily profit values

    characteristics that were not evident in

    the EUR/USD. The former phenom-

    enon hints at something fundamental:

    Generating systems on small amounts

    of data can lead to successful tradingin these pairs. This means, historically,

    these pairs have exhibited conditions

    similar to those in their immediate

    past, while the EUR/USD requires

    much more data in order to develop

    profitable trading systems.

    Interestingly, Figure 1 shows the

    USD/JPY pairs odds of OS profitabil-

    ity initially increase as the IS period

    grows, but this probability drops sig-

    FIGURE 1: USD/JPY OUT-OF-SAMPLE SYSTEM PROFITABILITY

    The yen/dollars percentage of systems that were profitable in OS testing in termsof the IS and OS period lengths.

    FIGURE 2: GBP/USD OUT-OF-SAMPLE SYSTEM PROFITABILITY

    Like the dollar/yen pair, the GBP/USD had better than 50% odds of OS

    profitability using very short IS data periods, as well as positive average daily

    profit values characteristics that were not present in the EUR/USD pair.

  • 7/29/2019 Ctm 201309

    22/35

    nificantly after the 3,000 day-mark,

    eventually falling below 50% at 5,500

    days. Also, the longer OS periods (800

    days, blue dots) also have the highest

    probabilities of success (greater than

    70%), while the shorter OS periods

    (200 days, red dots) have much lowersuccess in OS testing. This is clearly

    a result of the potential for more sys-

    tems to experience drawdowns that

    dominate the performance of short

    OS periods. This ordering of the OS

    period lengths hints to a trading edge

    around the 3,000 day IS threshold,

    with longer OS trading offering better

    odds of success.

    In contrast, in Figure 2 the GBP/

    USD never produces the initial above-50% probability of success using short

    IS periods (less than 1,500 days),

    suggesting that market conditions

    changed drastically enough in this

    pair to render larger data periods

    irrelevant.

    Bettering in-sample

    performance

    The percentage of systems that

    exceeded IS profits in the OS testsfollow similar trends. The USD/JPY

    peaks around the 3,000 IS period

    length, with values mostly dropping

    after this point (Figure 4). Also, there

    is no convergence of different OS peri-

    ods toward high IS period lengths,

    which suggests there is a better chance

    of surpassing IS results with low OS

    period lengths. This means a low OS

    period length has a lower chance of

    22 September2013CURRENCY TRADER

    TRADING STRATEGIES

    FIGURE 3: EUR/USD OUT-OF-SAMPLE SYSTEM PROFITABILITY

    The OS profitability of trading systems in the EUR/USD pair increased with longer

    IS periods.

    FIGURE 4: EXCEEDING IN-SAMPLE PERFORMANCE USD/JPY

    In the dollar/yen, the percentage of systems that exceeded IS profitability in theOS period peaked around a 3,000-day IS period length.

  • 7/29/2019 Ctm 201309

    23/35CURRENCY TRADERSeptember2013 23

    being profitable (only slightly above

    50%), but if youre profitable i.e., if

    your system is not within a drawdown

    phase you are likely to exceed IS

    per-trade profit expectations.

    In the pound/dollar, Figure 5 shows

    an increased probability of systemsexceeding IS profitability as the IS

    length increases, but the effect is

    diminished by the below-50% prob-

    ability of selecting a winning strategy,

    along with the negative average daily

    return of the generated strategies.

    Average daily profitability follows

    a similar curve to the profitable OS

    probabilities. In the USD/JPY pair

    there was a peak at around 3,000 days,

    with a maximum value close to $10/day (Figure 6). This value is higher

    than the maximum value found in the

    EUR/USD study, which was close to

    $6/day (not shown). Its also worth

    noting significant values (more than

    $4/day) accompany low IS periods

    in both the USD/JPY and the GBP/

    USD (Figure 7), suggesting you can

    get positive mean profits for systems

    generated using very short IS period

    lengths (less than 1,000 days).

    Different instruments,

    different design strategies

    This extension of the system-testing

    study shows the same system design

    approach did not apply to different

    currency pairs. Although the EUR/

    USD analysis showed system genera-

    tion should be based on very long IS

    periods (more than 5,000 days), the

    FIGURE 5: EXCEEDING IN-SAMPLE PERFORMANCE GBP/USD

    The pound/dollars overall increasing probability of systems exceeding IS

    profitability was diminished by a below-50% probability of having a winning

    strategy and a negative average daily return (see Figure 6).

    FIGURE 6: AVERAGE DAILY PROFITS USD/JPY

    Average daily profitability in the USD/JPY pair peaked around 3,000 days, with a

    maximum value close to $10/day.

  • 7/29/2019 Ctm 201309

    24/3524 September2013CURRENCY TRADER

    TRADING STRATEGIES

    current study shows the story is different for the USD/JPY

    and GBP/USD pairs. Although the USD/JPY might benefit

    from medium-term IS periods (3,000 days), the GBP/USD

    had optimal performance using very short IS periods (less

    than 1,000 days).

    This means that while, historically, it might have worked

    to generate a system for the EUR/USD using 13 years of

    daily data, the same approach would have failed in the

    USD/JPY and the GBP/USD, where using eight and two

    years, respectively, would have worked best. This sug-

    gests updating strategies based on smaller amounts of data

    might be justified for currency pairs that tend to reflect the

    market conditions of the recent past. In these cases, large

    amounts of past data might be irrelevant.

    A final note on the dollar/yen

    This analysis also hints that the USD/

    JPY has a higher potential for the gen-

    eration of more profitable strategies

    in OS conditions, as both the average

    daily profit and the probability to suc-

    ceed in the OS are higher (at optimal

    values) than they are for the EUR/

    USD a conclusion that is valid only

    for price-based strategies.y

    You can repeat this study, or conduct your

    own tests in other instruments, using the

    demo version of the Kantu software available

    at http://mechanicalforex.com/kantu-system-

    generator. Daniel Fernandez is an active

    trader focusing on forex strategy analysis,

    particularly algorithmic trading and the

    mathematical evaluation of long-term sys-

    tem proftability. For more information on

    the author, see p. 4.

    FIGURE 7: AVERAGE DAILY PROFITS GBP/USD

    Average daily profits of more than $4/day accompany low IS periods in both the

    USD/JPY and the GBP/USD.

    Updating strategies based on smaller

    amounts of data might be justified

    for some currency pairs.

    http://mechanicalforex.com/kantu-system-generatorhttp://mechanicalforex.com/kantu-system-generatorhttp://mechanicalforex.com/kantu-system-generatorhttp://mechanicalforex.com/kantu-system-generator
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    25/35CURRENCY TRADERSeptember2013 25

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  • 7/29/2019 Ctm 201309

    26/3526 September2013CURRENCY TRADER

    TRADING STRATEGIESADVANCED CONCEPTS

    When the book is closed on human history and theystart handing out the hardware at that Big Award Showin the Sky, Poland is going to win the Lousy Choice ofNeighbors prize by acclamation. This is a place whose oneunquestioned natural border is the Baltic Sea in the northand, arguably, the Carpathian Mountains in its otherwiseundefined southeast. Other than that, its history includes

    losing large chunks of land to an expanding Prussia fromthe west, an expanding Russia from the east, Austria fromthe south, and during the Thirty Years War to invadingSwedes under Gustavus (Hop on the bus, Gus) Adolphus.

    It disappeared once in the 18th century after a series ofpartitions, reemerged as an independent country after thecollapse of imperial Germany and tsarist Russia in World

    War I, with borders swung farinto what is now Russia andwith a corridor to the Baltic atDanzig. That lasted 20 years andabout three months before Polandwas repartitioned between NaziGermany and the Soviet Union;this triggered World War II inEurope. After the Poles foughtbravely and hopelessly in a losingeffort, Free Polish soldiers joinedthe Allied cause and participated

    in the air war against Germanyand in the Italian campaign, mostheroically at Monte Cassino. Theywere rewarded for their efforts bywatching France being rewardeda victors share and by beingresubjugated to Russian rule withborders shoved almost 200 mileswest to the lines of the Oder andNeisse rivers.

    However, he who laughs lastlaughs best: The collapse of

    The Polish zloty(pronounced Zloty)

    Analysis of the Polish currency suggests Poland shouldnt be in a rush to join the Euro.

    BY HOWARD L. SIMONS

    Excess volatility has been very low since 2004, and was not very large in either

    direction before 2004.

    FIGURE 1: OPTIONS MARKET MORE COMFORTABLEWITH WEAKER PLN/USD RATE

  • 7/29/2019 Ctm 201309

    27/35CURRENCY TRADERSeptember2013 27

    the Soviet bloc began with the 1980 Polish dockworkersstrikes in Gdansk (the former Danzig) under Lech Walesa.

    The once and future zloty

    The Polish currencys name, zloty, derives, like that of somany others, from golden. It came and went in variousforms and valuations with the country itself, but alwaysremained in secondary circulation with official coins of therealm. Once again, it may disappear into the Euro at somepoint after 2015 according to current projections, but givenPolands history and luck, the Euro might disappear twominutes after the official announcement is made. We shall

    see.Regardless, the zloty (PLN) trades heavily against both

    the USD and the EUR and has been a borrower of theSwiss franc (CHF) as part of the franc carry trade. As theCHF has been capped against the EUR since September2011, for now lets focus on the exchanges into the USDand EUR, even though the CHF has traded below thefranc ceiling regularly since January 2013.

    The PLNs history has been much less exciting thanthe countrys history. The excess volatility, or ratio ofthe implied volatility for three-month non-deliverableforwards to high-low-close (HLC) volatility, minus 1.00,

    has been very low in absolute terms since 2004 and wasnot very large in either direction before 2004 (Figure 1).Restated, the demand by USD holders for insurance on thePLN is muted. About all we can say in this regard is themarket is slightly more comfortable with a weaker PLN.As a refresher, HLC volatility is defined as:

    Where N is the number of days between 4 and 29 that

    minimizes the function:

    The excess volatility measure on a EUR basis is more

    descriptive (Figure 2). Here it rises before the PLN weak-ens and falls before the PLN strengthens and has beendoing so since 1999. This behavior is a very strong signalof active two-way trade between the two currencies and,tellingly, in a world of overt currency-fixing, of a relativelyunencumbered trade at that.

    The excess volatility measure on a EUR basis rises before the PLN weakens and falls

    before the PLN strengthens. This signals an active two-way trade between the two

    currencies and a relatively unencumbered trade.

    FIGURE 2: OPTIONS MARKET MORE COMFORTABLEWITH WEAKER PLN/EUR RATE

    http://www.currencytradermag.com/index.php/c/Key%20Concepts#CDhttp://www.currencytradermag.com/index.php/c/Key%20Concepts#CD
  • 7/29/2019 Ctm 201309

    28/35

    ON THE MONEY

    28 September2013CURRENCY TRADER

    ADVANCED CONCEPTS

    Interest rates

    The PLN has been a well-behaved currency as well interms of expected interest ratedifferentials, as measured by thedifference in forward rate ratiosbetween six and nine months(FRR6,9) against the USD andEUR. This did not change muchafter the reliability of LIBORcame into question after March2008 (see Major currencies andThe Great LIBOR Kerfuffle,Currency Trader,June 2013).The general pattern has beenfor the PLN to firm against theUSD as a weak lagging functionof the difference between thePLN FRR6,9 and USD FRR6,9.Relatively higher expected inter-est rates boost the PLN, but notgreatly (Figure 3).

    The pattern has been quitedifferent for the expected inter-est rate differential between thePLN and EUR (Figure 4). This isattributable in large part to theEurozones difficulties in select-ing one longer-term course formonetary policy and stickingto it. The enormous but discon-tinuous steepening of the EURFRR6,9 from mid-2010 onwardspushed the differential lower

    but did not lead to significantweakening of the PLN on thecross-rate. Restated, the Eurohad its own problems and thezloty was not going along forthe ride. Something else was atwork.

    Carry trades and

    relative asset returnsThe last factor we will look at isone of the more telling, and that

    Relatively higher expected interest rates boost the PLN, but not greatly.

    FIGURE 3: PLN A WEAK FUNCTION OF RELATIVEINTEREST RATE EXPECTATIONS TO USD

    The enormous but discontinuous steepening of the EUR FRR6,9 from mid-2010

    onwards pushed the differential lower but didnt lead to significant weakening of thePLN on the cross-rate.

    FIGURE 4: PLN SELDOM A FUNCTION OF RELATIVEINTEREST RATE EXPECTATIONS TO EUR

  • 7/29/2019 Ctm 201309

    29/35CURRENCY TRADERSeptember2013 29

    is the excess carry returns on bor-rowing either the USD or EUR yes, for much of this historythe CHF was the currency bor-rowed most and lending intothe PLN.

    In the case of the dollar carry,the relative performance of Polishequities to American equitiesmirrored the excess carry returnuntil October 2011 (Figure 5).

    The U.S. stock market strength-ened after this date and Polishstocks started to weaken as theEurozone economy turned softer.Once again, neighbors matter.

    A parallel construct for theEUR carry into the PLN andPolish performance relative to theEurozone confirms this economicdependence. Here the two mea-sures have been in convergencefor more than a decade (Figure

    6). A stronger carry into the PLNand relatively stronger Polishstock market performance arelargely one and the same.

    An external observer mightconclude Poland has as much ofa happy medium as it is goingto get. Its currency can tradeagainst the dollar without havingto match the European CentralBanks peripatetic policies, and itsasset markets can remain linkedto the Eurozones without havingto worry about the course of theFederal Reserves policies. Givenits history, Poland should takethis deal now and worry aboutjoining the Euro later.yHoward Simons is president of Rose-

    wood Trading Inc. and a strategist for

    Bianco Research.For more information

    on the author, see p. 4.

    The relative performance of Polish equities to American equities mirrored the excess

    carry return until October 2011, after which the U.S. stock market strengthened andPolish stocks started to weaken as the Eurozone economy softened.

    FIGURE 5: USD CARRY INTO PLN OUTPACING

    RELATIVE STOCK PERFORMANCE

    The two measures have been in convergence for more than a decade. A stronger

    carry into the PLN and relatively stronger Polish stock market performance are

    largely one and the same.

    FIGURE 6: EUR CARRY INTO PLN IN CONVERGENCEWITH RELATIVE STOCK PERFORMANCE

  • 7/29/2019 Ctm 201309

    30/3530 September2013CURRENCY TRADER

    CPI: Consumer Price Index

    ECB: European Central Bank

    FDD(rstdeliveryday):Therst

    day on which delivery of a com-modityinfulllmentofafutures

    contract can take place.

    FND(rstnoticeday):Also

    knownasrstintentday,thisis

    therstdayonwhichaclear-nghouse can give notice to abuyer of a futures contract that itntends to deliver a commodity infulllmentofafuturescontract.

    The clearinghouse also informsthe seller.

    FOMC: Federal Open MarketCommittee

    GDP: Gross Domestic Product

    ISM: Institute for SupplyManagement

    LTD(lasttradingday):Thenal

    day trading can take place in a

    futures or options contract.

    PMI: Purchasing Managers Index

    PPI: Producer Price Index

    Economic Releaserelease(U.S.) time(ET)

    GDP 8:30 a.m.

    CPI 8:30 a.m.

    ECI 8:30 a.m.

    PPI 8:30 a.m.

    SM 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

    September

    1

    2

    3 U.S.: August ISM index

    4

    U.S.: Fed beige book and July tradebalanceAustralia: Q2 GDPCanada: Bank of Canada interest-rate announcement

    5

    Japan: Bank of Japan interest-rateannouncementUK: Bank of England interest-rateannouncementECB: Governing council interest-rateannouncement

    6

    U.S.: August employment reportBrazil: August CPI and PPICanada: August employment reportLTD: September forex options;September U.S. dollar index options(ICE)

    78

    9 Mexico:Aug. 31 CPI and AugustPPI10 South Africa: Q2 GDP

    11

    France: Q2 employment reportGermany:August CPIJapan:August PPIUK:August employment report

    12

    Australia:August employmentreportFrance: August CPIHong Kong: Q2 PPI

    13 U.S.: August PPI and retail sales

    14

    15

    16

    India:August PPILTD: September forex futures;September U.S. dollar index futures(ICE)

    17

    U.S.: August CPIHong Kong: June-Aug. EmploymenreportSouth Africa: Q2 employment reporUK:August CPI and PPI

    18

    U.S.: FOMC interest-rate announce-ment and August housing startsSouth Africa: August CPIFDD: September forex futures;September U.S. dollar index futures(ICE)

    19 U.S.:August leading indicators

    20 Canada:August CPIMexico:August employment report

    2122

    23 Hong Kong: Q2 GDP and AugustCPI24 Mexico: Sept. 15 CPI

    25 U.S.: August durable goods

    26U.S.: Q2 GDPBrazil:August employment reportSouth Africa:August PPI

    27U.S.:August personal incomeFrance: Q2 GDPJapan: August CPI

    28

    29

    30 France:August PPIIndia:August CPI

    31October

    1

    U.S.: September ISM manufacturingindexGermany: September employmentreportJapan: September employment

    2 ECB: Governing council interest-rateannouncement3

    4

    U.S.: SeptemberGermany: August PPIJapan: Bank of Japan interest-rateannouncement

    The information on this page is sub-

    ect to change. Currency Traderis

    not responsible for the accuracy of

    calendar dates beyond press time.

    Event: Quant Invest 2013Date: Sept. 24-26Location: Hotel Lutetia, ParisFor more information:Go to www.terrapinn.com

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    EVENTS

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    31/35CURRENCY TRADERSeptember2013 31

    CURRENCY FUTURES SNAPSHOTas of Aug. 30

    The information does NOT constitute trade

    signals. It is intended only to provide a brief

    synopsis of each markets 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 todays close.20-day move: The percentage price move

    from the close 20 days ago to todays close.

    60-day move: The percentage price move

    from the close 60 days ago to todays 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 pastsixty 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 July 31 ranked by July 2013 return)

    Trading advisorJuly

    return2013 YTD

    return

    $ Undermgmt.

    (millions)

    1 GablesCapitalMgmt(GlobalFX) 5.33% 26.75% 33

    2 SequoiaCapitalFundMgmt(FX) 5.20% 14.85% 61.2

    3 OrtusCapitalMgmt.(CurrencyAggr) 3.92% -22.50% 1076

    4 ABCArbitrageAM(ABCAFX) 2.46% 1.22% 415 Excalibur Absolute Return Fund 1.23% 1.03% 170

    6 Gedamo(FXAlpha) 1.21% 4.37% 26.4

    7 DynexCorp(Currency) 1.09% 1.32% 30

    8 BBKBisangBlassKavena(Currencies) 0.96% 11.54% 14.5

    9 Algo K Alpha EUR/USD Currency Fund 0.95% -4.36% 22

    10 QFSAssetMgmt(QFSCurrency) 0.80% -5.69% 456

    Top 10 currency traders managing less than $10M & more than $1M

    1 SMILe