Currency Trader 1006

8/8/2019 Currency Trader 1006

1/49

October 2006

olume 3, No.10

ASIA:

yen, yuan, and beyond p. 8

THE MOST IMPORTANTeconomic report for

FX traders p. 20

CURRENCY

SYSTEM ANALYSIS:Outside-bar opportunity

system p. 28

HOW CURRENCIESimpact your other

investments p. 24

WILL THE YENtake off? p. 14

October 2006 Strategies, News, and Analysis for Forex Trader


2/49

Contributors . . . . . . . . . . . . . . . . . . . .6

Global Markets . . . . . . . . . . . . . . . . . .8Changing of the economic guard:

The shift toward East Asia

The Dragon, the Rising Sun, the Sleeping

Giant: Who will drive the Asian

economy and currency market in the

years to come?

By Currency Trader Staff

The Big Picture . . . . . . . . . . . . . . . .14When will the yen go to the moon?The fundamentals are all pointing

toward an up move in the Japanese yen.

So whats it waiting for?

By Barbara Rockefeller

Trading Strategies . . . . . . . . . . . . .20Market-moving economic reports

If you think the monthly employment

report is the release most likely to move

the forex market, you need to update

your analysis.

By Kathy Lien and John Kicklighter

Advanced Strategies . . . . . . . . . . .24

Currencies and conventionalU.S. investments

The financial media often reports on

moves in the stock and bond markets

vis--vis currency fluctuations, but these

relationships might not be what you expect.

By Howard L. Simons

Currency System Analysis . . . . . .28Outside bar opportunity system

Industry News

Retail, hedge funds

fuel forex growth . . . . . . . . . . . . . . .32The interest in forex trading both spot

and futures continues to grow as an

increasing number of hedge funds and

retail traders are trading currencies.

By Jim Kharouf

CONTENTS

2 October 2006 CURRENCY TRADER

continued on p. 4


3/49
http://www.propfx.com/


4/494 October 2006 CURRENCY TRADER

CONTENTS

Have a question about something youve seen inCurrency Trader?

Submit your editorial queries or comments to

[email protected].

Looking for an advertiser?Consult the list below and click on the company name for a direct link to the ad in this months

issue ofCurrency Trader.

Index of advertisers

Coup does little to slow

baht rally . . . . . . . . . . . . . . . . . . . . .33A military coup in Thailand only causes

a blip in the Thai bahts uptrend.

Yuan strengthens vs. dollar . . . . . . .33While the Chinese yuan still faces

government-imposed restrictions on how

much it can change in value each day, it

nonetheless has continued to push higher

vs. the U.S. dollar.

Currency Futures . . . . . . . . . . . . . .34CME begins Korean won tradingThe Chicago Mercantile Exchange listed

Korean won futures and options in mid-

September.

Currency fund manager

performance . . . . . . . . . . . . . . . . . . .34

Global News Briefs . . . . . . . . . . . . .36

International Market Summary . .38

Global Economic Calendar . . . . . .42Key dates for currency traders.

Key Concepts . . . . . . . . . . . . . . . . . .43References and definitions.

Events . . . . . . . . . . . . . . . . . . . . . . . .44Conferences, seminars, and other events.

New Products and Services . . . . .44

Web Watch . . . . . . . . . . . . . . . . . . . .45Forex Day Trader Blog

Forex Trade Journal . . . . . . . . . . . .46A meandering market presents a trading

challenge.

FXCM

Forex.com

InterbankFX

BrokersMatrix.com

eSignal

NewsTrader Pro

MetaStock

FXCM Currency Trading Expo

Forex Capital Investors

Las Vegas Traders Expo

Currency Trader Bookstore

Futures Trading Summit

DynamicTrend
mailto:[email protected]:[email protected]


5/49
http://www.forex.com/linkc.html?src=ccytradermagOCT06



Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Flynn

[email protected]

Contributing editor: David Bukey

[email protected]

Contributing editor: Jeff Ponczak

[email protected]

Contributing Writers:

Marc Chandler, Barbara Rockefeller

Editorial assistant and

Webmaster: Kesha Green

[email protected]

Art director: Laura Coyle

[email protected]

President: Phil Dorman

[email protected]

Publisher,

Ad sales East Coast and Midwest:

Bob Dorman

[email protected]

Ad sales

West Coast and Southwest only:

Allison Ellis

[email protected]

Classified ad sales: Mark Seger

[email protected]

Volume 3, Issue 10. Currency Traderis published monthly by TechInfo, Inc.,150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright 2006TechInfo, Inc. All rights reserved. Information in this publication may not bestored or reproduced in any form without written permission from the publisher.

The information in Currency Tradermagazine is intended for educational pur-poses only. It is not meant to recommend, promote or in any way imply theeffectiveness of any trading system, strategy or approach. Traders are advisedto do their own research and testing to determine the validity of a trading idea.Trading and investing carry a high level of risk. Past performance does notguarantee future results.

For all subscriber services:www.currencytradermag.com

A publication ofActive Trader

CONTRIBUTORSCONTRIBUTORS

Kathy Lien is the chief currency strate-

gist at FXCM and author of the books High

Probability Setups in the Currency Market

(Investopedia Ebook, 2006) and Day Trading

the Currency Market (John Wiley & Sons, 2005).

Lien provides research and analysis for DailyFX.com, one of

the leading forex research sites for individual online traders.

Kathy has written for CBS Market Watch, Active Trader, and

other magazines. She is frequently quoted on CNBC,

Bloomberg, the Wall Street Journal, and Reuters, and has

taught seminars across the country. She has also hosted trad-

er chats on EliteTrader, eSignal, and FXStreet, sharing her

expertise in both technical and fundamental analysis.

Barbara Rockefeller(www.rts-forex.com) is an inter-

national 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

ofTechnical Analysis for Dummies (2004), 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 tentative-

ly titled How to Trade FX is in the works.

Howard Simons is president of

Rosewood Trading, Inc. and a strategist for

Bianco Research. He writes and speaks fre-

quently on a wide range of economic and

financial market issues.

Jim Kharoufis a business writer and editor with morethan 10 years of experience covering stocks, futures, and

options worldwide. He has written extensively on equities,

indices, commodities, currencies, and bonds in the U.S.,

Europe, and Asia. Kharouf has covered international deriva-

tives exchanges, money managers, and traders for a variety

of publications.
http://www.rts-forex.com/http://www.rts-forex.com/


7/49

About the authorEdward Ponsi is the President of FXEducator LLC and is the former Chief

Trading Instructor for Forex Capital Markets (FXCM). An experienced trader

and mentor, Ed gives personal, one-on-one trading instruction to students

around the world, and has advised hedge funds, Interbank traders, and

individuals of all levels of skill and experience.

What is FOREX? Why is it the fastest growing

segment for individual investors and manyformer equity and futures traders?

MetaStock, the leading creator of technical analysis software, is excited about the FOREX

market and for good reason. Its one of the best ways for YOU to get started in investing.To help you along, we want to give you a FREE copy ofSuccessful FOREX Trading. Written

by the former Chief Trading Instructor for FOREX Capital Markets. This book explains

technical analysis as it relates to currency trading. This valuable information is FREE, no

strings attached. To get your copy,visit our web site, or give us a call at (800) 432-4917

and mention the promotion code CT36.Click Here

for your FREE Book

This is neither a solicitation to buy or sell any type of nancial instruments, nor intended as investment recommendations. All investment trading involves multiple substantial risks of mon -etary loss. Dont trade with money you cant afford to lose. Trading is not suitable for everyone. Past performance, whether indicated by actual or hypothetical results or testimonials are noguarantee of future performance or success. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT,

THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS OR TESTIMONIALS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULARTRADING PROGRAM. Furthermore, all internal and external computer and software systems are not fail-safe. Have contingency plans in place for such occasions. Equis International assumesno responsibility for errors, inaccuracies, or omissions in these materials, nor shall it be liable for any special, indirect, incidental, or consequential damages, including without limitationlosses, lost revenue, or lost prots, that may result from the reliance upon the information materials presented.
http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36http://www.metastock.com/ct36


8/49

While many economists still point to theU.S. as the key driver of global economic

growth, market watchers admit that agradual shift in power, capital, and

wealth toward the East Asian region is occurring withChina, of course, seen as the major force in that arena.

Even though China is larger and growing faster, the U.S.is still the engine of the worlds growth, says KenGoldstein, economist at The Conference Board in New YorkCity. We have the financial capital, we have the reservecurrency of the world, and we have natu-ral resources.

Nonetheless, no one can ignore thegrowing tide.

Global growth is shifting in that direc-tion, says Brian Fabbri, chief economistat BNP Paribas, East Asia.

The growth numbers out of China havebeen astounding in recent years and havecontinued to surprise economists amidexpectations for a slowdown.

China is growing at a blistering paceand India has not been far behind, saysCharmaine Buskas, economist atMoodys Economy.com. The U.S. willincreasingly become less of a locomotive

of growth.After all, notes Goldstein, China istrying not to grow by 10-11 percent, whilethe U.S. struggles to grow at 3 percentand the growth rate in Europe is even lower.

China has chalked up double-digit gross domestic prod-uct (GDP) readings for several years running now, withforecasts in the 9- to 10-percent region again for 2006. Overthe past several years China has managed to defy manyeconomists forecasts for economic slowdown. And, withmassive infrastructure building and investment dollarsbeing poured into pre-2008 summer Olympic activity, fore-casts now say this above-trend pace of GDP growth will

likely continue. Despite concerns regarding economic over-heating, the managed nature of the Chinese economy,

which includes price controls for a variety of key consumerproducts, has for the time being kept inflation down, atleast at the consumer level.

Chinese growth picture

The two main drivers behind the surging Chinese growthnumbers remain massive exports, which continue to fuelthe record-breaking size of the U.S./Chinese trade imbal-

ance and fixed-asset investment.Second quarter 2006 GDP growth

surged 11.3 percent, but economistsexpect moderation toward 10 percent in

the fourth quarter.China continues to benefit from its

undervalued currency (the renminbi, oryuan), which keeps its exports flowingout the door. The Chinese trade surplusrocketed to $18.8 billion in August, thefourth consecutive month of new recordhighs. In U.S. dollar terms, exportsgained 32.8 percent year-over-year.Annual exports in 2005 were upwards of$762 billion, with the U.S. being the singlelargest importer, according to James

Pressler, associate international econo-mist at the Northern Trust Co. in Chicago.Chinas trade surplus shows no signs

of slowing down, says Sean Callow, sen-ior currency strategist at Westpac Institutional Bank inSingapore. The official news agency, Xinhua, predicts thesurplus will exceed $20 billion per month before 2006 isover. This infuriates trading partners such as the U.S. andEurope and inflames protectionist sentiments.

Despite international pressure from the worlds financeministers, only a minimal amount of appreciation in theyuan has occurred since the initial 2.1-percent upward shiftin July 2005.

GLOBAL MARKETS

The Far East is being hailed as the economy of tomorrow.

What does that mean for currencies in the near future?

Changing of the economic guard:

The shift toward East Asia


BY CURRENCY TRADER STAFF


9/49CURRENCY TRADER October 2006 9

It has been very disappointing,Pressler says. Usually a country that runssuch a huge trade surplus would appreciatetheir currency dramatically. The currency isstill artificially weak, even though it hasbeen rising. Currently, the yuan is tradingat about 7.95 to the U.S. dollar. Some ana-

lysts say it should be trading more in the6.95 or even 6.50 region right now, if marketforces were allowed to dominate.

The U.S. has tried to influence theChinese to revalue the yuan by as much as1015 percent. However, market watchersnote the global pressure on China hasseemingly resulted in more resolve ontheir part to do what is best for their coun-try.

Most China watchers expect yuanappreciation to continue in the months

ahead (Figure 1), but at a continued slowand measured pace. Presslers year-endtarget is 7.90 for the yuan. By the end of2007, he estimated the yuan could see parity with the HongKong dollar, now pegged at 7.78 to the U.S. dollar.

Surging money supply equals credit boom

With the yuans relatively low market value and hugemonthly exports, Chinas money supply levels have beenbooming. Chinese M2 money supply growth increased 17.9percent in August, following Julys 18.4 percent year-over-year jump.

[The massive money supply growth] is fueling a creditboom in China, which explains why investment is growingso fast, says Virendra Singh, senior economist at MoodysEconomy.com.

Easy domestic credit conditions within China are fuelinga building boom, which includes new factories, bridges,roads, and apartment buildings.

Most of these assets have been built on credit, Singhsays. There are roughly 7,000 banks in China and these areall controlled by regional governments. It is like turning thespigot on and borrowing money.

Economists warn of potential vulnerability for the econ-

omy if the investment bubble bursts; the level of non-per-forming loans would likely increase.Basically, there is too much money chasing too few

goods, says Charmaine Buskas, economist at MoodysEconomy.com. There have been signs of possible over-heating in many sectors. Real estate is pricey, especially inBeijing and Shenzhen.

Some have criticized the Bank of China for not raisingmonetary policy rates enough. In 2005, the rate for inter-bank loans stood at 2.86, while the current level comes inaround 3.33 percent, says Singh. Given the 9.5 percent GDPgrowth rate, basically they borrow money at the 5.6 per-cent lending rate and get a 9.5-percent return.

Trouble spot

Several potentially troublesome factors lurk in the back-ground of the Chinese economic picture, but few loom larg-er than non-performing loans. Singh says a worst-case sce-nario outlook could be the equivalent of the U.S. savings andloan crisis in the 80s.

Economist Goldstein agrees this is a situation worth moni-toring.

China has a big bad-loan problem, he notes. Many

loans are to state enterprises from state-run banks. A lot ofpaper gets shuffled back and forth.

Northern Trust Companys Pressler estimates that cur-rently over 15 percent of loans are not being regularly serv-iced.

If you were to view the Chinese banking system underWestern [standards], it would be considered an insolventsystem, he says.

Nonetheless, foreign direct investment continues to pro-pel the Chinese economy forward, amid the attraction oflow labor costs.

Foreign direct investment is expanding at a 20- to 30-

percent basis, Pressler says. Everyone wants to make suretheir stuff is produced there.

What goes up must come down

While Chinese growth continues to plow ahead, econo-mists note the longer it continues at this frenzied pace, thegreater the risks become of a more extreme meltdown.

Recent growth has confounded expectations, Buskassays. The longer China expands at this blistering pace, thehigher the risk that it comes crashing down.

Buskas adds that the downside risks outweigh theupside risks for Chinese growth.

China still caps how much the yuan can fluctuate, but last month the currency

made its biggest move since last year.

FIGURE 1 CHINESE YUAN

Source: www.advfn.com

continued on p. 10



They cant afford to grow at 9, 10, 11 percent, Goldsteinadds. It is in their interest to gradually cool off to 7 to 8 per-cent. However, its awfully hard to hit the brake withouthitting it too hard.

After the Olympic boost

Investment dollars are being poured into massive infra-

structure projects ahead of the 2008 summer Olympics inBeijing. This includes everything from upgrading hotelsand tourist facilities to new restaurants and small entrepre-neurial business ventures aimed at capturing tourist dol-lars. Economists say growth should continue unfetteredthrough opening ceremonies in 2008, barring any unexpect-ed breakdown in the overall economic picture.

The Olympics could be a corrective trigger, Buskassays. Once the Olympics are over, a major source ofgrowth will be over.

Others, however, point to the huge role the U.S. plays asa consumer of Chinese-made goods.

A slowdown in China is contingent on what happens inthe U.S., Singh says.

He feels an orderly decline in the U.S. housing marketcould contribute to an orderly economic slowdown inChina.

Given the intertwined nature of global economies, whathappens to China will ultimately impact other countries inthe region as well.

If something happens to China, it will have an impacton all of East Asia. China is the spider in the middle of theweb, Singh says.

The other big power

Economists say Japan, which has recently ended its zero-interest rate policy and appears to have finally won a pro-longed battle against deflation, has taken a backseat toChina in the region.

Japan is still bigger than China, but Japan does not drivethe East Asian region any more, Singh says. China is now

the driving economy for the region as a whole. Japans second-quarter GDP numbers contained no sur-

prises. Real growth data moved from 0.8 percent to 1.0 per-cent on a quarter-over-quarter annualized basis. WestpacsCallow forecast overall Japanese growth at about 2.7 per-cent in 2006, while Northern Trusts Pressler forecast a 2.5-percent GDP reading for the year.

Japan is in a little bit of a pickle, Buskas says. Foryears, their economy was mired in deflation and late lastyear price pressures started to pick up. In July they raisedrates for the first time in nearly a decade. But, since then,prices have started to go south again. The data isnt follow-

ing through.

Sluggish consumer

Looking at the economy overall, Buskas notes, you havestrong external sectors from exports. And, the business sideof the economy is doing well. But the consumer side of theeconomy is not doing well.

Goldstein agrees that one of the biggest problems facing Japan was to get the consumer market up and runningagain after a long period of dormancy.

The bottom line for Japan is that the consumer needs toshift away from their high savings rate and start spending

to bolster domestic demand.While most economists believe deflation is

now a thing of the past for Japan, Buskas is notso certain.

Its not very clear whether Japan actuallyhas defeated the deflation drag, she notes.She cites the second-quarter GDP deflator asevidence. That figure posted a -0.8 percentyear-over-year reading, reflecting weak pricingpower. Also, in July, real wages fell 1.0 percenton a year-over-year basis.

After years of easy money, the Bank of Japan

hiked the overnight rate to 0.25 basis points inJuly. Analysts do not foresee additional hikes atthe Oct. 13 or Nov. 16 meetings.

Stronger yen next year

While dollar/yen (Figure 2) has mostly beenstuck in a large consolidation range for muchof 2006, Buskas remains optimistic about theprospects for yen appreciation in the monthsahead.

She sees potential for dollar/yen to eventu-ally move toward the 105.00 region, amid

GLOBAL MARKETS continued

The yen has recently been losing ground vs. the dollar, but some analysts are

looking for renewed strength and a drop in the pair to 110.00 or lower.

FIGURE 2 JAPANESE YEN

Source: TradeStationcontinued on p. 12


11/49
http://www.interbankfx.com/



GLOBAL ECONOMY continued

expectations for stronger Japanesegrowth. Other factors supportive to theyen are central bank diversification awayfrom the U.S. dollar.

Westpacs Callow also predicts yenappreciation. He predicts strength toward108.00 by March 2007 and 105.00 by June

2007.

India: The sleeping giant

Shifting to another emerging economicpowerhouse in the region, India has cap-tured much media attention of late.

With its large, well-educated, English-speaking workforce, India has arrived onthe global scene with the potential tobecome a key player in the years ahead.While economists bandy compellinglong-term forecasts, not many are pre-

dicting India will eclipse China any timesoon.

Clearly, for a half a century, India hasbeen a country of enormous potential, Goldstein says. Ifthere is a sleeping giant in Asia, it is India.

But in regard to India he also references Charles deGaulles supposed comment on Brazil: It is a country ofenormous potential and it always will be.

Nonetheless, strong domestic demand and solid externaldemand, especially for business process outsourcing havebeen supporting solid growth numbers in India, notes Dr.Ruth Stroppiana, Moodys Economy.com India economist.

She calls for GDP growth just below 7 percent in 2006,which follows growth of 8.3 percent in 2003, 8.5 percent in2004, and 8.5 percent in 2005.

Buskas says Indias growth patterns have been differentfrom Chinas. India has some structural issues going for it, shenotes, pointing to its workforce and its flexible government.

It doesnt have its hands tied by a former Communistregime, she says. Also, the run-up in foreign direct invest-ment hasnt been as sharp in India as China.

Stroppiana adds, In recent years, the China factor hashad a large impact on global trade and investment patterns.While Indias ascendancy is also being felt, it will be quite

some time before India will have a major impact on theglobal trade or investment picture.

Tighter monetary policy

The Reserve Bank of India has been on a tightening path,hiking rates three times since the beginning of the year in aneffort to battle rising inflation expectations there. The short-term policy rate now stands at 6.00 percent the highest infour years and some analysts expect another hike to 6.25percent before year-end.

The Indian rupee, recently trading around 45 to the U.S.dollar, has been depreciating against the greenback inrecent months (see Figure 3). However, Stroppiana forecasts

some strengthening into year-end in the wake of the appar-ent end to the U.S. Feds tightening cycle, which had beenoffering underlying support to the dollar.

It may be some time, however, before individual retailtraders are checking out the rupee for short-term day trad-ing opportunities.

By international standards, India is still considered to bea relatively closed economy, Stroppiana says. Eventhough the government has made some progress in open-

ing Indias doors to international flows of investment andtrade, it will be some time before this process is complete.

Demographics and economics

According to economists, both demographics and econom-ics are key reasons behind the global growth shifting tidetoward East Asia. A slowdown in U.S. growth, now forecastfor 2007, could also help exacerbate this shift.

The countries with the greatest potential for FX appreci-ation due to sound macroeconomic fundamentals areSingapore, Malaysia, and Korea, Callow says. Of course,the Chinese yuan could rise substantially, but we dont

expect the authorities to allow it to do so.The bottom line?There will be a cyclical re-weighting of growth towards

Asia and away from the U.S. in 2007 as the U.S. economyslows down, Callow says.

But, for now, Goldstein feels the U.S. remains the drivingforce in the global economy.

However, there clearly has been a slow change dictatedby the rising importance of East Asia, he says. There hasbeen a gradual shift in the center of power toward East Asiaand that is only going to continue to accelerate. That is goodnews for the U.S. Some of the burden has been lifted fromour shoulders and put on theirs.

The rupee is not destined to become an actively traded currency just yet,

according to market watchers. However, some think the country is poised for

China-like growth in several years.

FIGURE 3 INDIAN RUPEE

Source: www.advfn.com


13/49
http://www.dynamictrend.com/dtct96



The yen is a unique problem for the funda-mentalist: Its perverse. In the late 90s,

Japans banks were failing left and right andits economy was falling into a recession that

became deflationary, but the yen went up. This makes nosense, and neither do the current setups that, based on thefundamentals, would dictate a different direction. Is logic ofno use at all with this currency?

In September, a number of extraordinary events tookplace that should have had had an enormous effect on theyen, but failed to impactnoticeably the currency. Fourstand out. First, the merchan-dise trade surplus (for August)

rose an eye-popping 95.5 per-cent to 200.5 billion ($1.71 bil-lion) from 102.5 billion a yearearlier. As we all know fromthe preaching of the conven-tional-wisdom crowd, a coun-try with a high and rising tradesurplus has an undervaluedcurrency, and the marketshould respond by driving thecurrency up in anticipation ofrebalancing.

Second, the Group of Seven(G7) met in Singapore, chaired by Japanese Finance MinisterHeizo Takenaka. It made nodirect comment on the Japaneseyen in its communiqu, but before the meeting a Germanfinance ministry official com-plained the yen was too weakvis--vis the euro. Right afterthe G7 communiqu wasreleased on Saturday, Sept. 16,European Central Bank chief

Jean-Claude Trichet claimed the G7 had indeed spoken aboutthe too-strong yen and had agreed it was too high.

We imagine such lack of courtesy insulting the host athis own table, so to speak and diplomacy on Trichetspart has created a storm of harsh words behind the scenes.A day later, minister Takenaka said the G7 had not official-ly discussed the yen, but whether they did or not, for onetop official to speak out of turn is unheard of, especiallyconsidering underlings had spent months carefully craftingthe nuances of the official G7 statement.

THE BIG PICTURE

When will the yengo to the moon?

Despite a raft of supporting factors, the yen has failed to follow through on its potential

to surge higher. But that doesnt mean it never will.

BY BARBARA ROCKEFELLER

Two highlights: The dollar/yen rate has broken out above a resistance line. Second, the

yens appreciation stopped at the 62-percent Fibonacci retracement level of the movefrom the December 2004 low to the December 2005 high.

FIGURE 1 WEEKLY DOLLAR/YEN

Source: data eSignal (www.esignal.com); chart MetaStock by Equis (www.metastock.com).



The forex market assumed (for a day or two, anyway) the Japanese would bow, however reluctantly, to Europeanwishes and talk the yen down. This jawboning process isoften quite effective, especially if the market believes talkwill be followed by outright intervention.

The Japanese know more about intervention than anyone

on the planet, having spent some $300 billion from 2003 toMarch 2004 trying to prevent the yen from getting toostrong vs. the U.S. dollar.

But wait a minute. Wheres Japans self-interest instrengthening their currency? It might be nice for foreignbuyers of Japanese stocks and bonds, but surely its bad forexports, and Japan is an export-driven economy.

Also, Chief Cabinet Secretary Shinzo Abe won the vote ofthe ruling Liberal DemocraticParty and took over as PrimeMinister from the retiringJunichiro Koizumi on Sept. 24.

Koizumi is a remarkable per-son, hailed by the Economistmagazine as the man whoremade Japan. He wrestledcontrol from political factionsin April 2001 and forced mon-umental change on a mori-bund economy and aging soci-ety. Some observers fear Abemay turn out to be an old-school, back-room opportunistwho rules in a way that leads

mostly to gridlock and a gla-cial pace of change. Abe hasalready threatened the inde-pendence of the Bank of Japanby opining it should delay ratehikes, something that does notsit well with BOJ GovernorToshihiko Fukui. (Abe has alsocommitted to fixing relationswith China, Japans no. 1 trad-ing partner, while at the sametime visiting the contentious

Yasukuni war shrine.)If Abe is going to be a weak prime minister (at least com-pared to Koizumi), quarreling with the BOJ and the like, thereform movement will falter. Reform is what brought aboutthe revival of the Japanese economy and a stronger yen, soAbe could be a factor for a weaker yen.

Finally, new U.S. Treasury Secretary Henry Paulson visit-ed China and reached a consensus regarding the policiesthat need to be in place for the yuan to rise, if not the tim-ing of those policies. The week of his visit, the yuan rose 0.5percent, the biggest one-week move since its July 2005revaluation. Annualized, the weekly move was 26 percent,a pace that should satisfy even the most diehard critics in

the U.S. Senate and elsewhere.The same week, the Chinese central bank announced a

freer interest-rate market, which is a prerequisite for a fullyfloating exchange rate. All of this is a bit vague and not real-ly satisfactory the new money market will still be underthe control of the central bank, for example but it points

toward a stronger yuan in the upcoming year. Since the yenis traded as a proxy for the yuan (because its more accessi-ble and has greater liquidity), youd think the yen would bestronger. Instead, the yen has weakened from 114.60 onAug. 1 to 118.27 on Sept 18.

Three of these four big-picture factors would dictate astronger yen; only the new prime minister and a potentialdrop-off in reform suggest otherwise. There are a few other

potential stronger-yen factors, too, including the demograph-ic time bomb that is already going off, requiring Japan toremove some of its tremendous national savings (about $800billion) from the U.S. Treasury to fund the pensions of its oldpeople. This would necessitate selling dollars and buying yen.Also, global investors continue to buy Japanese securities(mostly equities), having earlier been underweight inJapan.

With the majority of factors supporting a giant rise in theyen, we must assume tension is quite high. Most forecasterssee the yen at 105 to 110, or even 100, sometime soon, in line

continued on p. 16

Seen in this long-term perspective, the euro/yens move has been a single uptrend.

Extending the linear regression channel into the future (dotted lines) implies a euro/yen

rate of 176 by the end of 2008.

FIGURE 2 MONTHLY EURO/YEN




THE BIG PICTURE continued

with their forecasts earlier in the year. It might be a mysterywhy its not happening, but analysts are unwilling to aban-don their forecasts.

Look at the chartWhen in doubt, look at what the chart is saying. Figure 1 isa weekly chart of the U.S. dollar/Japanese yen rate(USD/JPY). Two things stand out. First, the dollar/yen hasbroken a resistance line to the upside, meaning the dollar ishigher and likely to go higher and thus the yen is lower andlikely to go lower. This doesnt square at all with the con-

ventional wisdom that a giant trade surplus leads to astronger currency.

Second, the yens appreciation stopped at the 62-percentFibonacci retracement level of the move from the December

2004 low to the December 2005 high. Fibonacci levels can beunreliable for every time they seem to be effective, thereare a hundred times they are not but its a curiosity. Also,the two spike lows (circles) indicate a double bottom, whichcould imply the yen will get weaker still.

Against the euro, the yens weakness is more pro-nounced. Figure 2 is a monthly euro/yen (EUR/JPY) chart

extending back to Oct. 31, 2000. Seen inthis perspective, the pairs move hasbeen a single uptrend, although it flat-tened out in 2002 and surpassed thehighest high (140) from 2003 only in

March 2006. If we extend the linearregression channel into the future (dot-ted lines), it is easy to imagine the euroat 176 yen by the end of 2008.

In the long run, the fundamental fac-tors favoring a stronger yen must over-whelm these weak-yen tendencies

and when they do, watch outbelow. Figure 3 shows at least10 occasions when the dol-lar/yen crashed. In mostinstances, these were cases of

the yen being bought asopposed to the dollar beingsold. (Dont forget sentiment isa two-way street.)

The critical point for dol-lar/yen traders is the speedand sharpness of the moves.Table 1 summarizes three cases.The most recent instance, inApril-May this year, was spec-tacularly violent. We shouldassume the next time the yen

becomes a target of traderexcess, it will again move in anextreme way.

Figure 3 shows a linearregression channel from thehighest high at year-end. 2005is broader than the red sup-port line from Figure 1, whichit easily accommodates. Thechannel is wide because itincorporates the April-Maydollar crash. If the linearregression correctly identifies

There have been at least 10 dollar/yen crashes in recent years. In most instances,

they were the result of the yen being bought rather than the dollar being sold. If the lin-

ear regression correctly identifies the trend, it implies a dollar/yen level of 113.80 by

year-end, with a maximum range of 118.30 to 109.40.

FIGURE 3 LONG-TERM DOLLAR/YEN


The dollar/yen rate has posted some very sharp down moves (meaning the yen

is rising) in the past, most recently in April and May of this year.

TABLE 1 EXTREME YEN UP MOVES (SPOT BASIS)

Dates High low Points

04/14/06 05/02/06 (2 weeks) 118.67 109.60 9.07

08/01/03 04/02/04 (28 weeks) 117.11 103.89 13.22

01/25/02 07/19/02 (24 weeks) 134.56 116.75 17.81


17/49

the trend, we should expect a dol-lar/yen level of 113.80 by year-end,with a maximum range of 118.30 to109.40. Given the fundamentals and

the political atmosphere, the low endseems more likely.

If the euro/yen is stable at 145 yen,a yen forecast at 109.40 gives us aderived euro/dollar rate of 1.3254. Wecant really expect the euro/yen toremain stable, but its an interestingdeduction.

Most small traders cant afford totake a position a la Warren Buffett on abig-picture trend forecast like this, sit-ting through the inevitable corrections

and retracements. But it would bewise to be aware that if and when thedollar/yen breaks out to the down-side, its a wonderful opportunity.

For information on the author see p. 6.

Other Barbara Rockefeller articles:

Why is everybody losing money in forex?

Currency Trader, September 2006.

Despite unprecedented liquidity, professional currency managers have had a

rough go of it in 2005 and 2006. Has something changed in the forex world?

Gauging trader commitment

Currency Trader,August 2006.

Is this a good breakout or a false move? The Commitment of Traders report

can help currency traders fill in some of the holes left by the absence of

traditional volume data in forex.

Trading pullbacks in foreign exchange

Currency Trader, July 2006.

Discover some new ideas including the Tuesday pullback for trading

corrections in the currency market.

Barbara Rockefeller Big Picture Collection, Vol. 1: 2004-2005.

This 11-article collection contains forex market analysis and commentary

Barbara Rockefeller wrote forCurrency Traderbetween October 2004 and

December 2005, available at a 30-percent discount.

You can purchase and download past articles at

www.activetradermag.com/purchase_articles.htm.

Related reading
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.brokersmatrix.com/redir.php?deststat=7http://www.activetradermag.com/purchase_articles.htm


18/49

Get FREE, Professional Forex Strategies!Visit our website today and discover professional strategies for

trading the largest, most liquid financial market in the world.

For your FREE strategies, go to: www.esignal.com/offer/forex

GTIS Forex databy individualcontributor

Currency spreadsfor easy contributor

comparison

Advanced chartingfor serious analysisof the market

Market-movingnews from world-wide sources
http://www.esignal.com/offer/forexhttp://www.esignal.com/offer/forexhttp://www.esignal.com/offer/forexhttp://www.esignal.com/offer/forexhttp://www.esignal.com/offer/forexhttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/forex


19/49

Unlock the Secrets

of Forex Trading

eSignal is a division of Interactive Data Corporation (NYSE: IDC).*All fees will be refunded to you, minus any taxes and applicable add-on service/exchange fees, if you cancel within the first 30 days of service. Call for details. x13475

Sign up now for your risk-free,

30-day trial of eSignal!*

800.287.2513www.esignal.com/offer/ct

Would you like to unlock the secrets of

Forex trading? What does it take to trade the

market that never sleeps?

Find out from eSignal, the award-winning

provider of market data and technical analysis.

eSignal offers you market-leading Forex tools,

including fast, reliable data. And, for a limited time,

you can receive FREE Forex trading strategies

that explain how to trade the largest, most liquid

financial market in the world.

Plus, you can sign up for a risk-free, 30-day trial

and experience what eSignal can do for you. Call or

visit us online today!

eSignal puts the worlds foreign currency markets at your

fingertips with the tools you need to trade Forex successfully.

eSignal offers you:

Real-time, 24-hour Forex data with spot,

cross and forward rates

Quality data, including Forex market depth,

at affordable prices

Buy/sell indicators and customizable

technical analysis

Bank, broker and synthetic prices

Daily and intraday charting and historical data

Advanced charting and powerful back testing

eSignal has been voted Best Real-Time Data andBest Delayed Data by the readers of Technical Analysisof Stocks & Commoditiesmagazine every year since 1993.

eSignal has been voted Best Real-Time Data, BestEnd-of-Day Data, Best Software for U.S. End-of-Day

Traders and Best Software for U.S./U.K. Intra-DayTraders by the members of the Trade2Win website.
http://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/offer/cthttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/http://www.esignal.com/esignal/features/featureslist/default.asphttp://www.esignal.com/offer/ct



Economic data is either your best friend or your

worst enemy. Everyones experience withnews flow is different: Breakout traders thriveon trading off events while range traders pre-

fer to stay away from the markets when important econom-ic reports are released.

Many traders have been told repeatedly that non-farmpayrolls (part of the monthly employment report) is the sin-gle most important economic release to watch regardlessof whether you trade currencies, commodities, stocks, orbonds. This may have been true in 2004 and part of 2005,but in 2006 the release of the payroll number is no longerthe most market-moving event for the U.S. dollar.

Instead, an index that barely had any significance 18 to 24months ago has stripped payrolls of its No. 1 title. Thispiece of data is the Institute of Supply Managements indexof manufacturing sentiment, also known as the ISM manu-facturing report.

Goodbye payrolls, hello ISM

In 2004 and part of 2005, the markets focus on payrolls was

justified. The U.S. economy was recovering from two con-secutive quarters of slower growth in the second half of2004 and the Federal Reserve needed evidence to proceedwith the tightening cycle it began in June of that year.

Payroll reports at the time were extremely volatile, withreadings swinging from a low of 38,000 in July 2004 to ahigh of 338,000 in October, followed by a move back downto 76,000 in January 2005. As a measure of employment inthe U.S., the payroll number is extremely important becauseit gives traders a clear look at how healthy the economy is

and could potentially be in the future.

The general belief is that the higher employment is, themore likely consumers will spend liberally, which would bepositive for growth. Taken one step further, in an environ-ment where growth is already performing well, strongerpayrolls suggest the Federal Reserve might have to raiseinterest rates in order to tame the growth. For the U.S. dol-lar, higher interest rates tend to be perceived as bullishbecause it increases the yield offered by dollar-denominat-ed assets.

Fed changes its focus

So what has changed? Since the middle of 2005 the Federal

Reserve has been gradually shifting its focus from growthto inflation. Economic growth has been decent, with GDPhitting a high of 5.6 percent on a quarterly basis in the firstquarter of 2006 and payrolls averaging approximately140,000 since the beginning of the year.

At the same time, oil prices were climbing an infla-tionary red flag for central banks around the world. SinceDecember 2005, oil prices increased from approximately

$58 a barrel to a high of $78.40 in July 2006 before settlingback down to current levels. Throughout this period, everymajor central bank talked about the price pressures stem-ming from the higher cost of oil and warned about theirneed to be vigilant about inflation. This turned inflationinto the primary focus of the market, at the expense ofgrowth.

The ISM report comes out on the first business day ofevery month, which gives the market a sneak peak at howlater releases on both inflation and growth might turn out.

TRADING STRATEGIES

Market-movingeconomic reportsThe payrolls number is no longer the king of the hill

when it comes to reports most likely to move currencies.

BY KATHY LIEN AND JOHN KICKLIGHTER

Since the middle of 2005 the Federal Reserve has been

gradually shifting its focus from growth to inflation.


21/49



TRADING STRATEGIES continued

2004 report are still on the 2006 list, but there have been some importantshifts. The Treasury InternationalCapital (TICS) flow report, which wasthe third most market-moving indica-

tor, has fallen to the bottom of the list,while retail sales has moved from sev-enth up to fourth.

It is also important to mention thatpayrolls still has the biggest knee-jerk reaction, which we quantified asthe trading range 60 minutes after therelease. Yet on a day-today basis,ISM has a more lasting effect.

Why the change?

The shifting importance of fundamen-

tals is partly because of the aforemen-tioned shift in the Federal Reservesfocus toward inflation. However thereare other factors that play a role aswell. Overall market activity hasdeclined over the past few years. Ascentral banks wind down their tight-ening cycles, there is less uncertaintyin the markets. In contrast, tradersspent the past few years guessing howfar the Fed would raise interest ratesand when it would eventually stop.

As a result, the average daily tradingrange of the EUR/USD has shrunkfrom 111 pips in 2004 to 104 pipsbetween June 2005 and June 2006.

Fundamentals are important forevery trader even technical ones.Knowing when economic data cancause the most volatility in the mar-kets is a valuable piece of information.Depending upon your specific tradingstrategy, it will help you to decidewhen to be in the markets and when

to stay out.As the world changes, so does theimportance of different economicdata. This is why it is imperative fortraders to stay on top of what is mov-ing the markets and, more important-ly, when. Contrary to popular belief,the days that non-farm payrolls arereleased are not the only ones that cancause sharp moves in the forex mar-ket.


Related reading

Other articles by Kathy Lien:

Forex trading: Understanding the currency market

Active Trader, July 2004.

What makes currencies tick? Find out which economic factors help shape the

short-term and long-term forex landscape.

Dollar-yen: The year's hottest carry trade

Currency Trader, August 2005.The buck was on the short side of many carry trades last year, but the current

rate-hike cycle offers the opportunity to go long the dollar and short the yen.

Getting a lift from the carry trade

Currency Trader, October 2004.

Correctly assessing the risk environment paves the way to capitalize on the

interest-rate differentials between currencies.

Interest-rate shuffle

Currency Trader, February 2006.

Interest rates are a key forex market catalyst, and from the U.S. to Japan,

some central banks are poised to adjust their interest-rate policies.

Volatility-based currency trading


Market volatility can be a complex subject, but understanding a few basic

principles can help you implement strategies to capitalize on volatility extremes.

(Note: The five articles above will be available as a set at a 45-percent discount

through Nov. 5.)

Articles on economic reports:

Elections and the U.S. dollar, by David Bukey

Currency Trader, November 2004.

Will the U.S. presidential election knock the dollar out of its slump? We analyze

the impact of elections on the dollar over the past 31 years to see whats in

store for the greenback.

The current account deficits impact on the U.S. dollar, by David Bukey


In many traders minds, the growing U.S. account deficit is tied to the U.S. dol-

lars long-term slide. Find out how the dollar has behaved surrounding quarterly

current account releases since 1994.

The international trade report and the U.S. dollar, by David Bukey

Currency Trader, March 2005.

Many economists connect the widening U.S. trade deficit to the U.S. dollars

three-year slump. This short-term view analyzes how the greenback performsaround the monthly trade balance report.

Playing the numbers game

by Mark Etzkorn, Jeff Ponczak, and Thomas Stridsman

Active Trader, March 2001.

Economic numbers can send the market into a tailspin or launch it to the moon

on any given morning. Find out what these numbers are telling you about the

economy and the market. (Note: This article provides background on different

economic reports but discusses them in the context of the stock market.)


http://www.activetradermag.com/articlecollectionoct06lien.htmhttp://www.activetradermag.com/articlecollectionoct06lien.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/articlecollectionoct06lien.htmhttp://www.activetradermag.com/articlecollectionoct06lien.htm


23/49WWW.FXCMEXPO.COM

2days22currency trading superstars50workshops, andhundreds of tipsand ways to improve your currency trades!

CURRENCY TRADING INVOLVES SIGNIFICANT RISK OF LOSS AND MAY NOT BE SUITABLE FOR ALL INVESTORS. UNIQUE EXPERIENCES AND PAST PERFORMANCES DO NOT GUARANTEE FUTURE RESULTS.

Learn about currency trading Improve your trading success Try out the newest currency trading software Attend this EXPO!

FOREX CAPITAL MARKETS, FINANCIAL SQUARE 32 OLD SLIP, 10TH FLOOR, NEW YORK, NY 10005 USA.

Global Investor

Keynote: Jim Rogers

Editor-in-Chief, Dailyfx.com

Currency Forecaster: Kathy Lien

Author ofMarket Wizards

Rare Appearance: Jack Schwager

Justin Fox

Editor-at-Large: Fortune Magazine

ADVANCE

REGISTRATION

Pre-register NOW at WWW.FXCMEXPO.COM

and avoid the $20 registration fee.

FREE

Steve Nison

The Candlestick Man

Over Free Workshops on Currency Trading50

Event Co-hosted by
http://www.fxcmexpo.com/http://www.fxcmexpo.com/http://www.fxcmexpo.com/http://www.fxcmexpo.com/



T

he question What does the dollar affect?was addressed from macroeconomic andbroad market points of view last month. Insummary, the currency exchange rate in

both the U.S. and in every other country or bloc with itsown currency is the economys single most important price.If that price is wrong (no matter how you wish to defineright or wrong when no single rate can solve all marketrelationships simultaneously) everything else in the econo-my will have to adjust.

A second conclusion is the relationship between curren-cies and other financial markets tends to be far weaker andmuch less stable than commonly believed.

We live, for better or worse, in a culture that demandssound-bite answers to even the most complex issues. On aday when the greenback moves more than one percent

against, say, the euro, you can be assured a financialreporter will want to know what it means for stocks, as ifstocks are a monolithic entity. Some of the rarer and morespecialized journalists might ask about bonds, as if theentire world of fixed-income could be compressed into theyield on Treasury bonds and nothing more.

A market of stocks

Although indexation has driven the behavior of individualstocks together in a manner contrary to the fondest hopes ofthe worlds fundamental analysts when you buy or sell

an index exchange-traded fund such as the SPDR for theS&P 500 (SPX) or the QQQQ for the NASDAQ 100, do youanalyze the prospects for all 500 or 100 stocks? signifi-cant differences remain over time.

No one could dispute the rise and fall of the technologysector from 1998-2002 or the huge upward movement ofenergy and mining firms from 2003 onward. But all we needare divergences at the margin to justify the old Wall Streetchestnut, Its a market of stocks, and not a stock market.

Standard & Poors has divided the SPX into 10 economicsectors and 130 (presently; the number changes frequently)industry groups beneath those sectors. The 10 economic

sectors and the three largest member stocks of each are list-ed in Table 1. Is it possible to determine the impact at themargin of various currency changes on the behavior ofthese sectors and groups?

First, lets concentrate on the performance of each grouprelative to the SPX. This ratio can then be converted into aseries of daily returns, or percentage price changes, and

regressed against a time seriesof the daily returns for curren-cies such as the euro, Japaneseyen, and Canadian dollar.

The time period begins in

April 2004, when the FederalReserves rate-hike course wasestablished. We should filterout all relationships below acertain confidence interval in this case 90 percent. Theresulting regression coeffi-cients, or betas, can then besorted into those with statisti-cally significant positive andnegative relationships to thecurrencies.

ADVANCED STRATEGIES

Currenciesand conventional U.S. investments

The assumed relationships between currency fluctuations and stocks and bondshave difficulty holding up under close scrutiny.

continued on p. 26

TABLE 1 SECTORS AND STOCKS

Economic sector Largest three membersBasic materials DuPont, Dow Chemical, Monsanto

Consumer discretionary Comcast, Home Depot, Time Warner

Consumer staples Procter & Gamble, Altria, Wal-Mart

Energy ExxonMobil, Chevron, ConocoPhillips

Financial Citigroup, Bank of America, AIG

Healthcare Pfizer, Johnson & Johnson, Merck

Industrial General Electric, United Parcel, United Technologies

Technology Microsoft, Cisco, IBM

Telecommunications AT&T, Verizon, BellSouth

Utilities Exelon, Duke Energy, TXU

Standard & Poors divides the S&P 500 into 10 economic sectors, which are shown here

along with the three largest stocks in each sector.

BY HOWARD L. SIMONS
http://www.currencytradermag.com/backissues.htmhttp://www.currencytradermag.com/backissues.htmhttp://www.currencytradermag.com/backissues.htm


25/49



ADVANCED STRATEGIES continued

Table 2 shows the results of thisanalysis. Negative betas imply the rel-ative performance of the group fallswhen the currency strengthens; posi-tive betas imply the relative perform-ance of the group rises when the cur-

rency strengthens. The more negativeor positive the beta, the more acute therelationship is.

For example, the relative perform-ance beta of the airlines group (which is100 percent Southwest Airlines), is anegative 0.361. At the lower right-handcorner of the table, the relative perform-ance beta of the gold group (which is100 percent Newmont Mining) to theeuro is a strongly positive 1.457.

What themes emerge from this

analysis? Lets start with those groupshurt by a weaker U.S. dollar (that is,those with negative betas in Table 2).They are concentrated in the economicsector known as consumer staples goods and services considered the most recession-proof anddefensive investments. The top cells of the table include drugretailers, food distributors, food retailers, tobacco, brewers,soft drinks, packaged foods, and household products. Theconsumer discretionary sector and pharmaceuticals are rep-resented as well.

Do these groups have a strong import-export component?

No, and therein lies a surprise. Many analysts regard a weakdollar as beneficial to these firms, to the extent they repatri-ate earnings into dollars and therefore acquire more dollarswhen it weakens. This idea that more of a weaker currency isa benefit has always been an illusion, and we have demon-strated it thus. Moreover, many of these multinational con-

sumer firms have large expenditures in foreign currenciesand therefore see their real, currency-adjusted operatingexpenses rise when the dollar weakens. Finally, we need toremind ourselves a weaker dollar means reduced spendingpower in the hands of the American consumer. As the cur-rency weakens, the consumer is impoverished.

What about those groups whose relative performance

improves when the dollar weakens? The list here is domi-nated by firms in the basic materials, energy, and financialsectors. Two common threads emerge here the strongglobal economic growth underway since April 2004 and thestill-stimulative monetary policy over the period. Eventhough the Federal Reserve was raising rates, it was raising

them too slowly to crimp either growth or inflation-ary expectations. These below-neutral interest ratescontributed to the profitability of the financial sector.

Also, it is fair to say that when the Federal Reservestimulated the American consumer with low interestrates, the increased demand was met by Chinese

exports, and China had to build the infrastructurenecessary to ramp up production. This required bothenergy and raw materials, hence the strong perform-ance of these sectors.

In both cases for groups affected positively andnegatively by the dollar there is a way to answerthe question, What is the effect on stocks? withmore than a grunt and a simple up or down.

Currencies affect stocks in sector-specific ways.

Corporate bonds

Is there a similar differentiation in the world of cor-porate bonds? Corporate bonds traditionally traded

TABLE 3 CORPORATE BOND-CURRENCY RELATIONSHIPS

Economic sector CAD JPY EURBasic materials (0.254) (0.071) (0.005)

Consumer discretionary (0.207) (0.162) (0.080)

Consumer staples (0.107) (0.092) (0.105)

Energy (0.044) (0.023) (0.045)

Financial (0.249) (0.117) (0.050)

Healthcare 0.086 0.061 0.207

Industrial (0.131) 0.141 (0.108)

Technology (0.136) (0.149) 0.051

Telecommunications (0.270) (0.357) (0.099)

Utilities (0.102) (0.088) (0.099)

Healthcare was the only sector for which credit costs rose in a

weak-dollar environment. The euro did not have a strongly negative

relationship with the credit stress of any sector.

OAS levels typically rise during recessions and bear markets and fall with oppo-

site conditions. However, they have been in a tight trading range for more than

two years.

FIGURE 1 U.S. CORPORATE BOND SPREADS


27/49

as a spread to Treasuries; investment-grade issues werequoted as such and even high-yield bonds could beexpressed as a measure known as option-adjusted spread(OAS). OAS, expressed in basis points, accounts for all theembedded call, put, and sinking-fund features common incorporate bonds and makes them equivalent to Treasuries.

OAS levels reflect credit stress in the world of corporatebonds. They rise during recessions and during bear marketsand fall when the opposite occurs. Yet in an unusual turn ofhistory, they have been in a tight trading range for morethan two years (Figure 1).

The reason this trading range has persisted involves amajor structural change in the corporate bond market. Theadvent of credit default swaps (CDS) means bond investorsno longer trade the fairly illiquid corporate bonds but buythe CDS instead. A CDS acts much like a put option on abond the buyer of protection can put the bond or cashequivalent back to the protection seller at par in the event of

a credit default such as a bankruptcy or a material down-grade. As the bonds remain intact, their OAS remains flatand the action shifts to the costs of the CDS, also expressedin basis points.

We can construct an index of CDS costs for each of theS&P economic sectors CDS. Just as we did for the relativeperformance of stocks, we can regress the returns for theseindices against the returns on the currencies. A positivecoefficient means credit stress rises for the sector as the cur-rency strengthens; a negative coefficient means credit stressfalls as the currency strengthens. The results for each sectorare displayed in Table 3.

The results are rather extraordinary. Healthcare is theonly sector wherein credit costs rise in a weak-dollar envi-ronment. Beyond that, there are only two more cases of aweaker dollar causing higher corporate credit stress industrials with respect to the Japanese yen and technologywith respect to the euro.

Several sectors appear to do very well indeed duringweak-dollar environments. Basic materials, financials, andtelecommunications all benefit when the Canadian dollarfirms. Telecommunications also experiences much lesscredit stress during a strong Japanese yen environment.And the euro, for all the time and attention devoted to its

movements, has no strongly negative relationship with thecredit stress of any sector.If stocks float on a sea of corporate bonds you will not

be interested in buying the stock of a firm whose bonds arein trouble then we should conclude that a weaker dollarhas little negative impact on either the corporate bond mar-ket or, by extension, the stock market.

There we have it: The next time a breathless financialpundit proclaims the world did not end that day in spiteof a weaker dollar, you can smile knowingly. The relation-ship simply does not exist in the data.


CURRENCY TRADER October 2006 27

What does the dollar really affect?

Currency Trader, September 2006.

Find out how stocks, gold, and other markets actually

respond to changes in the dollar.

The dollar and its hidden risks

Currency Trader, August 2006.

A look at the dollar in light of its recent performance vs.

the yen and the euro.

Of commodities and currencies

Currency Trader, July 2006.

Analyzing historic market relationships reveals some

interesting facts about movements in many so-called

commodity currencies.

The yen carry trade, currencies, and U.S. bonds

Currency Trader, June 2006.

The latest source of anxiety for bond traders has some

surprising connections to the currency market. Find out

the story behind U.S. Treasuries, the Japanese yen, and

the Chinese yuan.

The euro index: The dollar index meets its match

Currency Trader, May 2006.

A look at the development of a viable and tradable

euro index.

The index approach to currency risk management

Currency Trader, April 2006.

Using dollar index futures to hedge non-dollar

investments.

The yen stands alone

Currency Trader, March 2006.

The usual rules of the currency world havent necessarily

applied to the Japanese yen. Will that continue to be

the case?

Remember the forgotten currency


Its often labeled a commodity currency, but the

Canadian dollar tends to be ruled by other factors.

Heres a look at the factors impacting Canadian

dollar movements.

What drives the dollar index?

Currency Trader, January 2006.

Market watchers often point to deficits and interest-

rate differentials to explain the dollars behavior, but

analysis shows these factors might not be in the

drivers seat after all.

The dollar index and firm exchange rates

Currency Trader, December 2005.

The majority of currency traders are familiar only with the

current floating-rate system. Are we about to enter a

new firm exchange rate era dominated by the dollar

and euro?



Related readingOther Howard Simons articles:
http://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htmhttp://www.activetradermag.com/purchase_articles.htm


28/49

Market: Euro futures (EC) or euro (EUR/USD).

System concept: This system is derived fromthe article Trading the euro inside-out(Currency Trader , September 2005), which ana-lyzed the performance after both inside and out-side bars in the euro.

The research found outside bars that closestrongly and are either much higher than the pre-ceding bar, or higher than at least the three pre-ceding bars, or both, were most likely to be fol-

lowed by upside follow through. However, thegains came mostly eight to 14 days after the out-side bar.

Outside bars represent short-term volatilitysurges and are often watched to determinewhether they are followed by any kind of pre-dictable price behavior. For example, an outsidebar with an extremely high close might a sign offurther upside price action. Many popularassumptions turn out to be incorrect, but thesehypotheses are easy to quantify and test.

The following test documents an attempt to

translate the statistical information from theTrading the euro inside-out analysis into a trad-ing strategy with specific entry, exit, and risk con-trol rules. The resulting system is designed to tradeonly intermittently (roughly once a month) andtake quick profits when the appropriate patternappears. Most of the time it will be out of the mar-ket.

The original analysis helped us make logicaldecisions regarding profit target and stop place-ment. First, the gains after the tenth day after theoutside bars in question tended to underperform

the markets typical returns. Second, the mediangain after these outside bars peaked at the tenthbar, as did the probability of a gain (approximately64 percent). Finally, the most volatility occurred inthe first three days after the outside bar, and thefirst day after the outside bar was the only day ofthe first 10 to have a negative median return. (Thisimmediate reaction makes sense, given the tendency for amarket to move at least temporarily in the opposite direc-tion after an exceptionally large move.)

The following trade rules are designed to take advantageof these characteristics.

Rules:

1. Go long on tomorrows open if today is an outside daythat closed above todays open, closed aboveyesterdays close, and has a high above the highs ofthe past three days.

2. Exit with a limit order 0.0250 above the entry price.

CURRENCY SYSTEM ANALYSIS

Outside bar opportunity system


After a brief drawdown at the beginning of the test period, the

system equity moved steadily higher.

FIGURE 2 EQUITY CURVE

The strategy goes long on the open after an outside bar meetingspecial criteria. Different rules are used for exits.

FIGURE 1 SAMPLE TRADES

Source: TradeStation




3. Exit any open position on the close of the 10th dayafter the outside day.

4. Exit with a loss if the market closed below the low ofthe outside day.

The 10-day exit period is used because the patterns edge(over the euros natural upward drift) was shown to dimin-ish after that point. The 0.0250 profit target was a little lessthan the median largest gain 16-19 days after the patternmove and represents a rare, outsized profit (in the first 10

days after the pattern) that should be capturedwhenever available.

Figure 1 shows a few representative tradesover the past few months.

Money management: Futures trade onecontract per signal.

Starting equity: $100,000 (nominal).Deduct $10 commission and slippage pertrade.

Test data: The system was tested on bothdaily continuous euro futures prices (EC) anddaily spot euro prices (EUR/USD).

Test period: May 14, 2001 to Sept. 22, 2006.

System results: The system produced 49trades over the test period, 31 of which (63.27percent) were winners. Both the equity curve(Figure 2) and drawdown curve (Figure 3)show the drawdowns were minimal. The max-

Currency System Analysis strategies are tested on a portfolio

basis (unless otherwise noted) using Wealth-Lab Inc.s testing

platform. If you have a system youd like to see tested, please

send the trading and money-management rules to:

[email protected].

Disclaimer: Currency System Analysis is intended for educa-

tional purposes only to provide a perspective on different

market concepts. It is not meant to recommend or promote

any trading system or approach. Traders are advised to do

their own research and testing to determine the validity of a

trading idea. Past performance does not guarantee future

results; historical testing may not reflect a systems behavior

in real-time trading.

continued on p. 30

Total net profit $45,382.50

Gross profit $77,792.50

Gross loss -$32,410.00

Profit factor 2.4

Open position P/L $0.00

Total number of trades 49

Percent profitable 63.27%

Winning trades 31

Losing trades 18Avg. trade net profit $926.17

Avg. winning trade $2,509.44

Avg. losing trade -1,800.56

Ratio avg. win:avg. loss 1.39

Largest winning trade $4,780.00

Largest losing trade -$3,545.00

Largest winner as % of gross profit 6.14%

Largest loser as % of gross loss 10.94%

Maximum consecutive winning trades 6

Maximum consecutive losing trades 4

Avg. bars in winning trades 8.55

Avg. bars in losing trades 5.83

Return on initial capital 45.38%

Annual rate of return 7.03%

Buy & hold return 48.90%

Percent of time in the market 20.87%

Longest flat period 122 days

Maximum drawdown (intra-day peak to valley) -$12,640.00

As percent of initial capital 12.64%

Net profit as percent of drawdown 359.04%


STRATEGY SUMMARY: EURO (EC) FUTURES

Period Net profit % Gain Profit factor # Trades % Profitable

1/1/2006 9/25/06 $3,872.50 2.74% 4.06 5 60.00%

1/1/2005 1/1/2006 $10,595.00 7.86% 2.09 14 57.14%

1/1/2004 1/1/2006 $8,835.00 6.47% 1.49 22 54.55%

1/1/2003 1/1/2006 $32,240.00 28.50% 2.41 33 63.64%

1/1/2002 1/1/2006 $41,785.00 40.33% 2.57 42 64.29%

1/1/2001 1/1/2006 $45,382.50 45.38% 2.4 49 63.27%


ROLLING PERIOD ANALYSIS (ANNUAL)
mailto:[email protected]:[email protected]:[email protected]


30/49

imum number of consecutive losing trades was four, com-pared to a maximum winning streak of six.

The bulk of the strategys profits accrued between trades12 and 28 (November 2002 to February 2004), although thesystem continued to generate profits. Figure 4 shows the

systems monthly returns.The 2.4 profit factor is healthy without being

suspiciously high, and the 1.39 average win-ning/losing trade ratio reflects a similar stability.

One of the most advantageous aspects of thesystem is how little time it was in the market only 20.87 percent. Even so, its return on initialcapital was just 3.5 percent less than the buy-and-hold return (assuming a trader would have evenwanted to hold a euro position for five years).

The testing discovered the profit target and timeexit parameters did not artificially boost the sys-tems performance: Exit lengths from two to 20days were all profitable in testing; the 10-day inter-val was not an optimized value. The profit-targetrule actually lowered net profit slightly (vs. not

using it at all), but also slightly improved some ofthe reward-risk characteristics.

The test on spot forex prices produced compara- ble results. The basic difference is the pattern appeared inthe futures data a few more times than in the cash data. Thesecond Strategy Summary table shows the spot tests basicstatistics.

The system only goes long and it could be argued its per-

CURRENCY SYSTEM ANALYSIS continued

FIGURE 3 DRAWDOWN CURVE

Drawdowns were extremely modest, and most were short-lived.

http://www.optionstradermag.com/


31/49

formance is solely attributable to the long-term uptrend thathas dominated the euro for the past five years. That said, thegains following the outside bar pattern were larger than theeuros typical gains during this period and furthermore, thepattern did not altogether fail when it appeared in the mar-kets congestions and downtrends. Most importantly, the

pattern appeared far less frequently when the market wastrending strongly lower (it barely traded in 2005, when theeuro was in a major downtrend), which is a fortuitous built-in self-defense mechanism.

The system was intentionally designed andapplied to one market. Although some tradersargue any system or pattern must prove profitableacross many markets to be a valid trading idea, thatpoint is certainly debatable. However, applying thesame rules (except for the absence of the profit tar-get) to the pound/dollar (GBP/USD), Australiandollar/U.S. dollar (AUD/USD), and dollar/yen

(USD/JPY) produced positive results, although notas positive as the euros performance. The winningpercentages ranged from 46.47 to 52.38 and theprofit factors ranged from 1.26 to 1.59.

Bottom line: The outside bar opportunity sys-tem is the type of intermittent trade signal thatcan be used alongside any number of comple-mentary patterns or strategies. It trades infre-quently, but its low exposure translates intomuch higher gains relative to time in the market.

The basic pattern signal shows promise. Itwould certainly be worthwhile to test other risk-

control and trade management techniques that might extractmore value from it. (Traders may wish to experiment withsome kind of trailing-stop technique that might give posi-tions the opportunity to gain even more, for example.) Also,it leaves open the possibility of complementing the pattern

with a wholly independent short-selling approach.

Currency Trader Staff

CURRENCY TRADER October 2006 31

The systems most profitable period (2002early 2003) was followed by the

strategys worst stretch, although very few signals were triggered at all during

this period. Of the months that triggered signals, 23 were profitable and 14

were unprofitable.

FIGURE 4 MONTHLY RETURNS

STRATEGY SUMMARY: SPOT EUR/USD

Profit factor 2.41

Total number of trades 43

Percent profitable 62.79%

Winning trades 27

Losing trades 16

Avg. trade net profit $712.33

Avg. winning trade $1,941.85

Avg. losing trade -1,362.50

Ratio avg. win:avg. loss 1.43

Largest winning trade $4,190.00

Largest losing trade -2,730.00

Max. consecutive winning trades 5

Max. consecutive losing trades 4

Avg. bars in winning trades 8.33

Avg. bars in losing trades 7.5

Return on initial capital 30.63%

Annual rate of return 5.01%

Buy & hold return 47.81%

Percent of time in the market 19.52%

Longest flat period 136 daysSource: TradeStation

http://www.forexcapitalinvestor.com/


32/49

In the past few years, forex trading has moved into themainstream, a big step for an asset class long viewedas a peripheral market for retail traders. Now, along

with its traditional base of banks and big institutional users,the currency market is attracting growing numbers ofhedge funds, money managers, corporations, and retailtraders, both in the spot forex market and on severalexchanges that offer currency futures and options contracts.

Exchange-traded currency futures contracts are offeredby the Chicago Mercantile Exchange (CME) and the NewYork Board of Trade (NYBOT), who will soon be joined by

the Philadelphia Stock Exchange (PHLX), which plans tolaunch currency options and futures in the fourth quarter.The growth in spot forex, which trades more than $2 tril-

lion per day globally, is because of a number of factors, butnone more important than the proliferation of electronic trad-ing systems that have opened the market to more users thanever. Electronic platforms are improving functionality, whichalso invites more sophisticated and high-volume traders.

The growth in forex trading has been fantastic, says GlennStevens, managing director of Gain Capital in New York. A lotof it has to do with the basics of this industry that make it a veryappealing marketplace. The other reason is that other marketshavent been so appealing to trade, given the trends that are not

there in equities, the dot-com bust, and the low interest rateenvironment that weve had for such a long time globally.

These factors provided a great opportunity for a largerset of people to trade forex directly, he continues. Retailand institutional users now look at FX as an alternativeasset class.

The hedge-fund boom has particularly fed forex growth.When you look at the overall market, you have to look at

hedge funds as the most active and fastest growing segment,says Harrell Smith, manager of securities and investmentspractice for Celent in New York. The number of forex-basedhedge funds have increased over the past several years. Andhedge funds have been at the forefront of automated trading.

Hedge funds and other institutions looking to protectcurrency risk are finding a variety of ways to integrate forexfutures into their portfolios. Firms are now utilizing moresophisticated strategies to lock in currency rates.

Richard Chappetto, director of business development atPeregrine Financial Group in Chicago, echoed the commentsof many in the forex space about hedge fund activity, whichcontinues to rise significantly as spot forex and currencyfutures markets offer faster and more sophisticated tradingfunctionality. This is the customer base most exchanges andbrokers are looking to attract.

I see more hedge funds moving at least a portion of theirportfolios into this space, Chappetto says. It gives them

the liquidity and volatility they need. And the currenciestrend well, which is something these traders really like.

As more participants join in, Chappetto believes this yearwill become a historical milestone for the asset class.

When we look back five years from now, well saythats when it really started, Chappetto says.

The recent growth in the space has spurred renewedefforts by derivatives exchanges to put more focus on cur-rency futures and options. The leading exchange in curren-cy futures is the CME, where volume has migrated from thefloor to its Globex trading platform over the past five years

and posted impressive volume gains. Today, roughly 85percent of the exchanges currency volume is electronicallytraded, up from 61 percent in 2003 and just less than 30 per-cent in 2001, when the CME began trading FX futures elec-tronically during floor trading hours.

The growth in the breadth of players in foreign exchangeis probably one of the bigger changes in the market, saysRick Sears, managing director, CME foreign exchange. Theemergence of prop traders, who consider themselves to be asgood as the big banks when it comes to market making, hasbeen another reason why were growing.

To help expand that diversity, CME began offering a feeincentive program last November to commodity trading

advisors and hedge funds active in forex. The move wasspurred in part by competition from the likes of Eurex U.S.,which entered the forex space last September with six cur-rency pairs on its 23-hour-per-day trading engine and lowerexchange fees. Eurex U.S. added eight more forex contractsin January, although it has failed to attract volume.

The CME also has been able to further integrate with theOTC market by listing its forex futures contracts on theReuters 3000 platform and forging a joint venture called FXMarketSpace to trade and clear forex spot and forwards.

While the CME is the clear leader in forex futures, it is notthe only player. The NYBOT has a slate of currency andcross-rate futures, with volume concentrated in the U.S.

dollar index (DX) futures contract.The NYBOT will try to pump more life into its forex

products when it begins listing financial futures contracts onthe Chicago Board of Trades eCBOT electronic trading plat-form in November.

Meanwhile, Eurex U.S. has gained an equity partner inMan Financial. The agreement could leverage theexchanges sizeable distribution network and expand itsforex futures platform.

Finally, the PHLX announced it will launch options onthe U.S. dollar/euro and U.S. dollar/British pound in thefourth quarter, along with matching futures contracts on itssubsidiary exchange, the Philadelphia Board of Trade.

INDUSTRY NEWS


On the rise

Retail, hedge funds fuel forex growthBY JIM KHAROUF



The coup in Thailand on Sept. 19 thatousted Prime Minister ThaksinShinawatra temporarily halted a

strong run for the nations currency.The morning of the coup the Thai baht had

been trading at all-time highs vs. the U.S. dollar,reaching a price of 37.03. The currency climbedto 37.89 that afternoon before closing at 37.74.The next day, it closed at 37.77 its highestclose since Aug. 4 (Figure 1).

However, the baht traded as low as 37.05 on Sept. 21 andclosed at 37.34. It has moved up slightly since then, closingat 37.51 on Sept. 28. But since the coup (which had been

rumored for some time) came with minimal conflict andappears to have been a success, some analysts think thegovernmental change could be good for the economy.

General Sondhi Boonyaratklin seized control of the gov-ernment, revoked the constitution, and promised to appointa civilian government within two weeks of the coup. He alsopledged a new version of the Thai constitution, and arestoration of democracy within a year.

Fitch Ratings, an international firm specializing in pro-viding credit ratings for countries, said the coup could lead

to a downgrade of Thailands credit. However, the firm alsosaid that considering the growing unhappiness withShinawatra led to concerns about the Thai economy, the

change in leadership could actually bring about some eco-nomic stability.King Bhumibol Adulyadej, who has ruled in Thailand for

60 years, reportedly knew of the coup attempt and was infavor of it. That has helped ensure the transition was most-ly peaceful.

While analysts say some short-term downward movementin the baht is not unlikely, they dont expect a long-term neg-ative effect. However, most agree that if any uncertainty orturmoil emerges latently from the coup, all bets are off.

The Chinese governments decision toslowly allow greater fluctuationbetween its yuan (renminbi) currency

and the U.S. dollar has proven beneficial, as theyuan reached all-time highs against the green-back in late September.

The yuan closed Sept. 28 at 7.8935, an increase

of 4.7 percent from the 8.28 level the yuan waspegged at until July 2005 (Figure 1). The curren-cy has not traded above 8.00 since mid-August.

The move comes despite restrictions fromthe Chinese government the yuan can onlymove 0.3 percent in one day, a limit other countries including the U.S. want increased or abolished.Nonetheless, the Chinese remain steadfast in their commit-ment to a gradual relaxation of yuan policy.

Zhou Xiaochuan, the governor of the Peoples Bank ofChina, told International Monetary Fund and World Bankmembers that supply and demand would dictate furtherfluctuation.

However, at the G7 meeting in mid-September, financialchiefs from the group nations released a statement sayinggreater exchange rate flexibility was necessary for em

Currency Trader 1006

Documents

Transcript of Currency Trader 1006