Currency Trader October 2012

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October 2012 Volume 9, No. 10 Strategies, analysis, and news for FX traders Q4 FOREX: WHERE THE ACTION WILL BE P. 6 Europe and the Euro battle reality p. 12 How to test your support and resistance levels p. 16 Understanding import prices and the dollar p. 20

Transcript of Currency Trader October 2012

Page 1: Currency Trader October 2012

October 2012

Volume 9, No. 10

Strategies, analysis, and news for FX traders

Q4 FOREX: WHERE THE ACTION WILL BE P. 6

Europe and the Euro battle reality p. 12

How to test your support and resistance levels p. 16

Understanding import prices and the dollar p. 20

Page 2: Currency Trader October 2012

2 October2012•CURRENCY TRADER

CONTENTS

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

Global MarketsFX in Q4 .......................................................6Although all eyes seem to be on the Euro,

another currency is attracting analyst interest in

Q4.

By Currency Trader Staff

On the MoneyThe uncertainty principle ........................12How long can the Euro defy logic?

By Barbara Rockefeller

Trading StrategiesTesting the significance of support and resistance ...........................16This technique will allow you to determine if your

methodofdefiningsupportorresistancehas

anypredictivevalue.

By Friedhelm Düsterhöft and Daniel Fernandez

Advanced ConceptsThe dollar and non-petroleum import prices ............................................20Anupdateonthestrange—andoverlooked—

consequencesofU.S.monetarypolicies.

By Howard L. Simons

Global Economic Calendar ........................24Importantdatesforcurrencytraders.

Currency Futures Snapshot .................25

Managed Money Review .......................25Top-rankedmanagedmoneyprograms

International Markets ............................26Numbersfromtheglobalforex,stock,and

interest-ratemarkets.

Forex Journal ...........................................30Early entry for a swing trade in the Euro.

Looking for an advertiser?

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Questions or comments?Submit editorial queries or comments to

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Page 3: Currency Trader October 2012

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CONTRIBUTORS

4 October2012•CURRENCY TRADER

Editor-in-chief:MarkEtzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Contributing editor:

Howard Simons

Contributing writers:

BarbaraRockefeller,

Marc Chandler, Chris Peters

Editorial assistant and

webmaster: Kesha Green

[email protected]

President: Phil Dorman

[email protected]

Publisher, ad sales:

Bob Dorman

[email protected]

Classified ad sales: MarkSeger

[email protected]

Volume9,Issue10.CurrencyTraderispublishedmonthlybyTechInfo,Inc.,POBox487,LakeZurich,Illinois60047.Copyright©2012TechInfo,Inc.Allrightsreserved.Informationinthispublicationmaynotbestoredorreproducedinanyformwithoutwrittenpermissionfromthepublisher.

TheinformationinCurrencyTradermagazineisintendedforeducationalpurposesonly.Itisnotmeanttorecommend,promoteorinanywayimplytheeffectivenessofanytradingsystem,strategyorapproach.Tradersareadvisedtodotheirownresearchandtestingtodeterminethevalidityofatradingidea.Tradingandinvestingcarryahighlevelofrisk.Pastperfor-mance does not guarantee future results.

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CONTRIBUTORS

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

qBarbara Rockefeller (www.rts-forex.com) is an international economist with a focus on foreign exchange. She has worked as a forecaster, trader, and consultant at Citibank and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical Analysis for Dum-mies, Second Edition (Wiley, 2011), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and How to Invest Internationally, pub-lished 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 Fernandez is an active trader with a strong interest in calculus, statistics, and eco-nomics who has been focusing on the analysis of forex trading strategies, particularly algorithmic trading and the mathematical evaluation of long-term system profitability. For the past two years he has published his research and opinions on his

blog “Reviewing Everything Forex,” which also includes reviews of commercial and free trading systems and general interest ar-ticles on forex trading (http://mechanicalforex.com). Fernandez is a graduate of the National University of Colombia, where he majored in chemistry, concentrating in computational chemistry. He can be reached at [email protected].

qFriedhelm Düsterhöft is an active FX trader and one of the major contributors to the Asirikuy community founded by Daniel Fernan-dez. His main interests are quantitative finance methods and applications. He previously worked as a mathematical technical assistant with a focus on statistics, operations research, and program-ming. He can be reached at [email protected].

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6 October2012•CURRENCY TRADER

GLOBAL MARKETS

Heading into the fourth quarter, the global financial mar-kets remain gripped by uncertainty. Big-picture questions remain regarding the stability of the Euro, the pace of Chinese economic slowdown, and the potential impact (if

any) of massive central bank quantitative easing programs. Meanwhile, the U.S. is mired in full-time politicking

ahead of its November elections, putting the fiscal cliff on the back burner until the lame-duck congressional session.

Will the threatened spending cuts and tax increases actually go into effect, and what will hap-pen if they do?

China jitters, Euro quiversBethAnn Bovino, deputy chief economist at Standard & Poor’s, says domestically, the fiscal cliff issue makes it difficult for the U.S. economy to gain traction in the near term.

“The fiscal cliff has been driv-ing the worries U.S. businesses and consumers are facing,” she says. “Will there be new taxes in the forefront? Will consumers no longer be able to claim the mortgage tax deduction? It is keeping people more cautious on spending.”

FX in Q4

Although all eyes seem to be on the Euro, another currency is attracting analyst interest in Q4.

BY CURRENCY TRADER STAFF

FIGURE 1: EURO/AUSSIE

Some analysts like the EUR/AUD pair as a short Euro play in the fourth quarter.

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CURRENCY TRADER•October2012 7

Bovino also points out the larger dampening effects of the global macroeconomic picture. “There are still a lot of worries about what could happen to [Eurozone] members who ask for additional assistance, and is the slowdown in China turning into a hard landing?” she says, noting a sig-nificant amount of Chinese exports head to the Eurozone, and a sharper recession in the Eurozone could impact Chinese growth.

China also factors into the perspective of Greg Anderson, North American head of FX strategy at Citi Group. He says his favorite trade is to “sell the Euro for the fourth quarter,” and he sees the Euro/Aussie cross (EUR/AUD) as a way to play that outlook (Figure 1). “The market has gotten very bearish on China and, as a result, the Aussie has suffered,” Anderson explains.

The EUR/AUD rallied to 1.25 on Sept. 18 off its early-August low, and Anderson sees potential for the Euro/Aussie cross to retest the early August low around 1.16.

“The bet is the [China slowdown] is not as bad as what is priced in,” Anderson says. “There probably won’t be any RBA (Reserve Bank of Australia) cuts and the data will make people more comfortable on China heading into 2013.”

On the other side of the cross, Anderson believes “the market has gotten too complacent on Europe. Look for bad economic numbers out of Europe and more rate cuts.”

Canada in the mixAnderson also puts in a word for shorting the Euro/Canada (EUR/CAD) cross in the fourth quarter (Figure 2). If you expect U.S. economic data to continue to be better than Europe’s, he argues, using the Canadian dollar in the cross allows traders the “benefit of North America without the credit risk.” He explains that, because the U.S. has yet to craft solutions to its long-term fiscal and debt issues, there are worries U.S. debt could face future downgrades. The Canadian picture is much different.

“The Bank of Canada is not implementing quantitative easing, so that’s not a drag on the currency,” Anderson says.

The bullish CAD perspective also reflects a certain out-look on Asia. “If you believe Asian growth will see a bit of a rebound, that’s good for commodity prices, and you do get some benefit on CAD from that as well,” Anderson notes. He sees a potential Q4 EUR/CAD target of 1.21.

FIGURE 2: EURO/CANADA

The EUR/CAD pair offers a short Europe/long North America trade, without U.S. dollar risk.

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GLOBAL MARKETS

Mexico in the spotlightNick Bennenbroek, head of currency strategy at Wells Fargo, also calls for a short Euro play in the fourth quarter, but he suggests the Mexican peso (MXN) as the other side of the cross. Mexico boasts solid economic trends, and both industrial and retail activity are picking up, according to Bennenbroek.

“Generally, it has a favorable set of fundamentals,” he says. “Their central bank is on hold and not easing. The peso would clearly gain if we were to see an improvement in the European debt situation.”

A key to the peso’s outlook could be the current state of risk sentiment or risk aversion. “The peso shows a rela-tively high sensitivity to global equity market swings,” he says. “It tends to be a risk-sensitive currency.” Looking ahead, Bennenbroek sees potential for the peso to move toward 12.20 vs. the dollar. As of early October, the USD/MXN rate was trading around 12.85.

“I’m looking to go long the Mexican peso on the crosses vs. the Euro or the dollar,” Bennenbroek says. “It makes sense in the fourth quarter.”

The bullish Mexican peso theme echoed among other currency analysts. “I think that short Euro makes sense since the structural issues in Europe are far from fixed and we could still have some periods of high tensions,” says

Charles St-Arnaud, FX strategist at Nomura. “However, I don’t think the trade should be done against the U.S. dol-lar. I would prefer to do it in crosses like the GBP (British pound), SEK (Swedish krona), and MXN. The MXN peso is particularly attractive given our positive view of Mexico.” Nomura says the EUR/MXN pair (Figure 3) has the poten-tial to retest the August lows around 16.10.

Alvise Marino, foreign exchange strategist at Credit Suisse, also picks the Mexican peso as one of his favored fourth-quarter plays. “Mexico is an undervalued currency with good yield,” he says. “It is exposed to one of the regions of the world with one of the better growth rates — the U.S. — and from a valuation standpoint, Mexico is of the cheapest currencies in the FX spectrum.”

Marino also highlights growth differentials, noting “Europe has a massive recession and Asia is slowing” while the U.S. has “some momentum.” Mexico has large trade ties to the U.S. and benefits from a growing outlook here.

Enrique Alvarez, head of Latin American research at Ideaglobal, cites the positive growth and yield differential outlook for the Mexican economy and currency. He fore-casts a 3.5-4% GDP growth rate for Mexico in 2012. “It’s a solid growth rate with a large growth differential to devel-oped markets,” he says.

FIGURE 3: EURO/PESO

After bouncing off its June-July lows, the EUR/MXN pair began to sag again in mid-August.

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GLOBAL MARKETS

Looking at Mexican growth, Alvarez explains that much of it is export driven, but domestic demand and consump-tion are coming back. “There is flexibility to pump the consumer side if something happens to the external side,” he says.

Currently, the central bank lending rate is at 4.5%, which is wildly attractive compared to the U.S., Europe, and Japan. Overall, Mexico’s monetary policy outlook is stable, Alvarez says, although he sees the potential for higher rates in the second half of 2013 contingent on how the inflation outlook plays out.

A monthly chart of the peso shows the Mexican currency remains above pre-Lehman Brothers collapse levels vs. the dollar (Figure 4). In August 2008, the peso was trading as low as 9.85, but it then shot up to 15.58 in March 2009 and has since remained above 11.00.

Alvarez says the Mexican authority’s willingness to allow the currency to appreciate is a key factor driving the current peso fascination.

“The Mexican authorities have an inflation problem generated by higher import prices for food stuffs, such as corn,” he says. “You have to pay for these items in dollars, but as the currency appreciates, the local cost in pesos is

smaller.” Alvarez compares the peso’s recent trend to the situation

in the Brazilian currency, the real (BRL). “Brazil is busy intervening in the market, but Mexico is letting their cur-rency appreciate,” he explains. “That’s one of the major reasons the peso is on the preferred side. Mexico is using it as a buffer against imported inflation. It creates a clearer path for investors to go long the peso.”

Also, while the Mexican economy is heavily linked to the U.S., Alvarez notes the country has been diversifying its export destinations in recent years, including significant inroads into Latin America, which would help buffer the Mexican economy in the event of a downturn in the U.S. Another twist that benefits Mexico in this regard: “Every time the U.S. slows, they offshore more production into Mexico to take advantage of the cost basis,” Alvarez says. “Every time you see a plant close in Michigan or Ohio, a lot of that work gets done in Mexico.”

Peso targetsAlvarez expects additional peso appreciation into year-end, with an initial USD/MXN target at 12.50 and a break off that level opening the door to a move to 12.30.

FIGURE 4: DOLLAR/PESO

In September the USD/MXN pair approached its 2012 lows.

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CURRENCY TRADER•October2012 11

“[Mexican authorities] are going to let the currency go at least until they get to 12.00,” he says. “It helps them to control inflation.”

On the crosses, Alvarez describes a long MXN/BRL trade as an “intervention story,” explaining the BRL is locked in a range because the Brazilian authorities have “made it very clear they don’t want the currency to appre-ciate more than two to the dollar.”

Alvarez also argues for long Mexican peso plays vs. the Chilean and Colombian pesos. “Those currencies have strengthened so much it has undercut their export sectors,” he explains. Bottom line? “Long MXN on all three sides,” he concluded.

Back to the U.S.Of course, there’s bound to be action in the balance between the U.S. dollar and the Euro (Figure 5). “We are bullish on the U.S. dollar vs. the Euro — that’s our number one call,” says Michael Woolfolk, managing director at BNY Mellon. “We think the Euro has become overvalued recently. We don’t think the Euro appreciation was fully justified by the fundamentals. We expect further down-ward adjustment to the economic outlook for Europe and

we still think there is a material chance for a Greek exit.” Woolfolk, who says he sees a better than 50% chance

of a Greek exit from the Eurozone by year-end, points to the 1.25 level for the EUR/USD pair as an initial objective, with the potential for additional losses.

Offering a divergent view, Bob Lynch, head of G-10 FX strategy Americas HSBC, says his firm expects the Euro to move up to 1.35. “We think the dollar is going to be weak-er on the back of renewed concerns on the fiscal backdrop highlighted by post-election negotiations,” he says. That contrasts with Lynch’s expectation of “a more stable back-drop in the Eurozone.”

On the U.S. side of the equation, Lynch says how the U.S. manages the fiscal cliff is key.

“We don’t necessarily see it as a positive for the dollar in any scenario,” he says. “If it hits, we could see further Fed easing. If it is postponed, we could see better growth prospects but government sovereign credit ratings could be at risk.”

There are many conflicting forces at play as the year winds to a close. Jeremy Lawson, senior U.S. economist at BNP Paribas says his firm sees the fourth quarter as a chal-lenge for the global economy as a whole. y

FIGURE 5: EURO/DOLLAR

Most analysts foresee a weaker Euro vs. the dollar in Q4, although there are some divergent opinions.

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More than 70% of financial professionals surveyed by State Street Global Advisors believe that over the next year we will get a “tail-risk event,” known to regular folks as a shock, that triggers a sell-off and possibly poses a real threat to the financial system. In other words, Lehman redux.

The list of tail-risk events includes: global recession, Eurozone breakup, bank insolvency, China hard-landing, oil prices, and new asset bubbles arising from central bank stimulus. Notice the survey respondents fear a cyclical event (recession) as much as they do on a structural one (Eurozone breakup).

And, according to the 300 elite global managers sur-veyed, currency markets are most at risk.

Poppycock. First of all, a true tail-risk event is really a Black Swan — something that has not been imagined. But we can imagine these possibilities, so they can’t be true Black Swans. Also, we have experienced most of these events before, even a Eurozone breakup if we extrapolate from the demise of its two predecessors. A hard landing in China is the only one that would be new.

As for currency markets: Every currency cannot be attacked at the same time — when you are selling one, you are buying another. Maybe the currency market is purport-edly the most at risk because if investors are exiting the Eurozone and emerging markets, they must be buying dol-lars (or gold). For this group of survey respondents, this is a bad outcome, since they bought into the gospel of asset diversification several decades ago. A strong dollar over any extended period invalidates all that work. As Paul Volcker said after the Plaza Accord and before the Louvre Accord, it’s a funny world in which a strong dollar is a bad thing.

Lehman taught us two things: Fair value has no meaning without liquidity, and hedges are always imperfect, some-times fatally so. Throughout the 2007-2009 crisis there was never a systemic shortage of liquidity in the FX market.

Forex forwards and options continued to serve as hedges with exactly the same efficacy as they did before the crisis.

The rise in uncertainty is a mixed blessing. It can be viewed as a good thing because of the observer effect — the idea that the act of observing a process can change the process being observed. If we’re worried about banks failing or China having a hard landing, perhaps banks and China will take better care to avoid the thing that is feared. On the other side of the coin, though, listing the things to be feared risks neglecting other things that should be equally feared.

It’s easy to draw up a list of neglected fears, or ones that could just as easily have been included in the State Street survey:

1. The U.S. Congress does not address the fiscal cliff and the U.S. does indeed go into recession.

2. QE3 does not work, as Philadelphia Fed President Charles Plosser believes. Fed chief Ben Bernanke comes to think the unemployment situation in the U.S. is structural, and the Fed declares itself out of tools.

3. Mitt Romney wins the election and ratings agencies downgrade U.S. debt on the grounds an unrealistic deficit-cutting plan will not work and will instead result in never-ending and ever-rising public sector deficits.

4. The U.S. and Israel go to war with Iran and/or Hugo Chavez departs the political scene in Venezuela. In both cases, the price of oil goes ballistic.

5. Massive fraud is uncovered at a bank, broker, or met-als dealer, including counterfeiting of gold bars. (In heaven, Newton laughs.)

6. The European Stability Mechanism is leveraged by four times to €2 trillion, but it’s still not enough to contain a run on Spanish and Italian bonds, whose yields rise above 7%. Governments fall repeatedly, street riots become the norm, and nothing gets done. Catalonia secedes and civil war ensues.

On the Money

12 October2012•CURRENCY TRADER

ON THE MONEY

The uncertainty principle

How long can the Euro defy logic?

BY BARBARA ROCKEFELLER

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CURRENCY TRADER•October2012 13

7. The Bank of Japan introduces yet another round of quantitative easing but the dollar/yen rate continues to intervention-zone levels around 70-75; Japan impos-es capital controls to halt FX market speculation.

Again, if we can imagine these events, they are not really Black Swans. For what it’s worth, a reasonable judgment would be that Obama wins a second term, the fiscal cliff is fixed, QE3 does work, and recovery in real estate leads the U.S. into a sustainable recovery. War with Iran is avoided through diplomacy. The Japanese clench their teeth and live with an overvalued yen.

We might even consider the possibility that the other tail — the favorable one — will experience an Event, e.g., the increasing energy indepen-dence of the U.S. liberates poli-cy-makers and diplomats from restraint in Middle Eastern affairs out of economic self-interest.

That leaves the European Stability Mechanism (ESM), leveraged or not, and the abil-ity of troika officials to herd politicians and the public into the “right” courses of action — meaning, those courses that validate the viability of the Euro. Spain is the current focus. Spanish bond yields are rising again as Prime Minister Mariano Rajoy delays applying for a formal sovereign bailout. The top three northern countries against freeload-ers — Germany, Finland, and the Netherlands — jointly suggested the €100 billion promised for the Spanish bank-ing sector bailout may not be forthcoming after all, since it can be used as a “back door” to a sovereign bailout. To get a sovereign bailout, Spain has to apply and become subject to as-yet unspecified conditions.

Some analysts suggest conditions have to get a lot worse in Spain before Rajoy can sell a bailout to the public. In other words, Rajoy is not playing a cat-and-mouse game with European Central Bank (ECB) chief Mario Draghi — he is playing it with domestic politicians, labor leaders, and the Spanish public. Others postulate Spain is drag-ging its heels and trying to lure Italy into its orbit because, together, they would have greater resistance to conditional-ity. This means some analysts are watching the Spain-Italy yield spread and not just the Spain-Bund and Italy-Bund spread. (Oh, good, another spread to watch.)

In any case, there are wheels within wheels here. It’s complicated, it’s destabilizing, and it distracts attention from the real job, which is to improve competitiveness through structural reform. If you can’t devalue your cur-rency, you need to devalue the cost of labor. Of the means of production (land, labor, and capital), labor is the only one that politicians can affect. Spanish and Italian unions are all too aware they are the focus. (Gains in labor pro-ductivity across the Eurozone have been very poor over the past decade, with Spain outperforming Italy and bailed-out Ireland near the top of the list.)

But as market commentators constantly remind us, for-get the economic facts; what counts is the perception of

the facts. Someone who appreci-ates this point is German Finance Minister Wolfgang Schaeuble, who says Spain is doing better than markets are acknowledging. Spain, he says, needs to regain investor confidence, also noting “ending speculation is crucial.” Spain needs to communicate to the market how wonderfully planned reforms will work. The German finance minister cheering on the Spanish prime minister is something of an unlikely sight. For his part, Rajoy said the pur-pose of the Spanish banking sec-tor bailout is to prove the Euro is

not reversible: “We are a club.” Well, no. The purpose of the Spanish banking sector bail-

out is to bail out the Spanish banks and prevent wholesale impoverishment of Spanish citizens and businesses. Still, the appearance of goodwill is Euro-favorable.

In fact, it’s Euro-favorable any time Europeans face facts. One that must be faced is both Spain and Italy will need massive reform in terms of both fiscal sustainability and competitiveness. If a sovereign bailout crisis is what it takes to get the public to accept fiscal and structural reform, so be it.

Schaeuble and others would prefer Spain refrain from provoking a crisis in order to get domestic approval of a bailout — in other words, show backbone and leadership. A skillful politician should be able to convince the public of a good course of action without invoking a crisis. Of course, politicians invoke and invite crises all the time in gridlocked political environments. (And those of us who live in glass houses should not throw stones.)

The problem is not that shocks could become real, it’s

Every currency cannot be attacked at the same

time — when you are selling one, you are

buying another.

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ON THE MONEY

that markets are so numb to them they no longer respond appropriately and proportion-ately. For example, from July 25 to Sept. 17 the Euro rose from 1.2054 to 1.3172 on hopes a methodology was found to rescue the European peripher-als from Greece’s fate (default and possible exit). The high point was ECB chief Draghi asserting he would do “what-ever it takes” to preserve the Eurozone, including buy sovereign bonds, over the grim-faced objection of Germany’s Bundesbank.

As the Spanish situation deteriorated in late September, however, the Euro dipped only about 25%. You have to ask whether 25% is the appropriate amount. It seems that wishful thinking is providing Euro support despite the prospect of Rajoy deliberately aiming for a crisis.

But maybe wishful thinking is warranted. To be fair, Europe is feeling its way through these crises as they develop. In the absence of a viable institutional infrastruc-ture — mostly a pan-EMU treasury that issues Eurobonds and a pan-EMU transfer mechanism for unemployment and pension benefits — it’s only natural developments occur by fits and starts. The institutional shortcomings of the Eurozone practically mandate this mode of operation — kicking the can down the road only a few feet further while bureaucrats and politicians struggle to fill in the blanks.

A perfect case is Draghi inventing a €100 billion Spanish bank sector bailout — but only after the European bank-ing system is brought under a single regulator. This clever move implies the needed infrastructure can be put in place on an evolutionary basis instead of a revolutionary basis, which we might consider the U.S. model. In practice, the U.S. model was not invented in one fell swoop, either. Recall the messy and uneven process by which a national bank was established; we didn’t get the Federal Reserve until 1913.

Call it nation-building by serial crises. It’s a dangerous methodology, but markets are growing accustomed to it.

In this light, the Euro’s periodic upward corrections are not irra-tional. When uncertainty rises too much and the Euro (accordingly) falls sharply, the stewards of the evolving institutional framework come up with whatever new remedy will get the Eurozone one more kick down the road.

Aside from the drawback of depending on crises to get prog-ress, the fits-and-starts process of building a sovereign can tend

toward overdoing centralization and standardization. This is the criticism of Czech president Vaclav Klaus, who says Greece should be happy to escape the straightjacket of the EMU, which is victimizing the Greeks. Klaus is the author a new book titled Europe: The Shattering of Illusions. The shift toward concentration of power in central bureaucra-cies is a big drawback to joining the EMU, and the Czech Republic accepts these conditions only reluctantly.

In fact, Klaus is in no hurry to formalize admission to the EMU, which was approved in 2004 but has no imple-mentation date. The Czechs can wait until 2074, as far as he is concerned. This way the Czech Republic gets some of the benefits of unification (such as trade advantages) but none of the responsibility (such as contributing to the ESM or ECB capital requirements). Bloomberg reports the Czech koruna was the world’s best performer against the Euro in the decade ending December 2010, up 40% in the period. The koruna is up about 2% so far this year. And Czech 10-year koruna debt costs a mere 2.4%, compared to 4.8% for Poland and 7.2% for Hungary (two other countries awaiting admission). The days when countries such as Cyprus rushed to join the Euro empire are over. Of the six non-Euro member states (Sweden, Poland, Czech Republic, Hungary, Romania, and Bulgaria), Sweden’s currency has been a stellar performer, from 11.064 against the dollar in July 2001 to 5.8171 in April 2008 (and 6.545 as of mid-September).

The logical deduction is the elimination of transactional friction that comes with a single currency does not out-weigh the disadvantages of convergence to the point of

The institutional shortcomings of the Eurozone practically mandate kicking the can down the road

while bureaucrats and politicians struggle to

fill in the blanks.

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CURRENCY TRADER•October2012 15

conformity — and costly conformity, too. This should be the real issue when considering the Euro’s level, not the stage of whatever crisis we happen to be in at a given moment. Traders and investors are all too aware that evo-lution is not always progress.

Overall, the market is unhappy with endless crises and lagging decision-making. The Euro has been on a declin-ing big-picture trend since the July 2008 high at 1.6038. The lowest low since then is 1.1877 from the week of June 11, 2010 (Figure 1). This low surpasses the 50% retracement of the up move from October 2000, but the low was fleeting and wasn’t matched at the next big bump down in July 2012 (1.2144). It’s possible the 50% retracement is a true floor. It’s also possible that magical thinking can carry the Euro back up to the resistance line — 1.4360 by year-end 2012 and 1.3990 by year-end 2013. But an equally likely scenario could see the Euro dip to the November 2005 low (horizontal line at 1.1672) or worse, the support line of 1.0792 at year-end 2012. This is a very wide range.

Current forecasts see the Euro oscillating between 1.2000 and 1.3000 to year-end, with a bias to the downside. What we need to worry about the most is traders acting as though the background environment is normal and par-ing back short positions when they become extreme, even if the true condition consists of serial emergencies being badly addressed and the rational thing to do would be to

continue selling. FX market acceptance of the perpetual crisis mode is not

doing Eurozone leaders any favors. To a certain extent, the FX market, together with the bond market, is the steward of sane analysis. We cannot expect leaders to do a better job of sovereign-building unless they are pushed to the wall by market prices. It’s especially discouraging to hear the German finance minister complain about speculation. Schaeuble should recognize that he needs the FX and bond market speculators to give him accurate feedback on the crisis process.

As the fourth quarter progresses, consensus is building that a Grexit will occur just after the new year. In the usual perverse way of the FX market, a Grexit is Euro-favorable, as would be Spain’s application for a sovereign bailout, anticipated to take place before Greece leaves the EU. So, while conventional thinking may point toward a continu-ation of the downtrend, there is a very real possibility of the Euro spiking to — but not beyond — the resistance line around 1.4360.

It seems the Euro “should” go downward out of sheer disapproval of the management-by-crisis process, but we have to worry about the market becoming immune to tail-risks as they become “normal.” y

For information on the author, see p. 4.

FIGURE 1: THE EURO’S UNCERTAIN PATH

Despite its sharp upswings, the EUR/USD pair is in a longer-term decline dating back to its 2008 peak. Source: Chart — Metastock; data — Reuters and eSignal

Barbara RockefellerCurrency Trader Mag Oct 2012Figure 1. Big-Picture Euro (Weekly)

999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20

0.80

0.85

0.90

0.95

1.00

1.05

1.10

1.15

1.20

1.25

1.30

1.35

1.40

1.45

1.50

1.55

1.600.0%

23.6%

38.2%

50.0%

61.8%

100.0%

Page 16: Currency Trader October 2012

16 October2010•CURRENCY TRADER16 October2012•CURRENCY TRADER

The idea that some price levels have more importance than others is a long-standing belief in trading and analy-sis. Such levels, commonly called support and resistance (S&R), help traders find and predict areas of increasing or decreasing demand, according to how price behaved in the past.

However, the often vague and obscure definitions given by many traders and analysts make it difficult to evalu-ate the true efficacy of support and resistance levels, and whether these levels have any statistical significance.

Here we’ll outline an algorithmic approach for defining support and resistance and evaluate whether its results are statistically meaningful. However, the process used to test the significance of these levels can be applied to any S&R definition to determine how predictive the levels are likely to be — that is, whether they are likely to act as reversal points in the future.

Evaluation methodThe first step in the process is to define S&R level predic-tions, the relevance of which is determined by counting breakout and bounce patterns that occur at each level dur-ing a given test period. The breakout-bounce analysis con-sists of checking where each price bar in the test period is relative to a defined S&R level, as follows:

1. If the bar’s low is above the upper edge of the S&R zone, record a “1.”

2. If the bar’s high is below the lower edge of the S&R zone, record a “-1.”

3. Record a “0” in all other cases.

After all price bars are analyzed, assign the following pattern designations to the price action in the test period:

1. -1/0/-1 = “bounce below” (a downturn off the bottom of a support-resistance zone).

2. 1/0/-1 = “cross down” (downside breakout of a sup-port-resistance zone).

3. 1/0/1 = “bounce above” (a bounce off the top of a support-resistance zone).

4. -1/0/1 = “cross up” (upside breakout of a support-resistance zone).

Figure 1 shows examples of these four patterns based on an S&R zone between .8781 and .8791 in the Euro/U.S. dollar pair (EUR/USD). The bottom panel shows each bar’s designation as either 1, -1, or zero, based on whether price bounces off of or breaks through the S&R zone.

The evaluation process consists of a few simple steps. First, you must establish an S&R definition methodol-ogy. Next, make predictions based on applying those S&R zones in one time period — for example, make predic-tions for 2001 using data from 2000. In this case, 2000 will be the evaluation period and 2001 will be the test period. Then count the number of bounce-breakout patterns in the test period using the previously outlined definitions. Finally, you must establish whether these counts are statis-tically distinguishable from those derived from randomly assigned S&R levels.

This methodology facilitates the evaluation of narrow S&R zones in which price is expected to bounce within a range (as in the example in Figure 1), rather than S&R

TRADING STRATEGIESTRADING STRATEGIES

Testing the significance of support and resistance

This technique will allow you to determine if your method of defining support or resistance has any predictive value.

BY FRIEDHELM DÜSTERHÖFT AND DANIEL FERNANDEZ

Page 17: Currency Trader October 2012

CURRENCY TRADER•October2012 17

defined by a very specific price level. This is useful in the currency markets, because the differences in price data from different providers can poten-tially result in slightly different S&R levels, depending on the method used to define them.

Defining S&R as high-low levelsIn the forex market, support and resis-tance can be thought of as zones where the demand for one of the currencies in a pair has faded. For example, in the EUR/USD pair the high of a bar with a close below the high can be thought of as a level at which demand for EUR was scarcer, forming resistance in the EUR/USD rate. Similarly, the lows of bars that close above the low can be thought of as levels where demand for USD has dried up, serving as support for the EUR/USD rate.

Extending this logic, we can define an S&R methodology whereby the relevance of a particular S&R level is established by how frequently high or low prices hit that level. We can use the following process to define S&R zones in this manner:

1. Note the highest and lowest price levels achieved during a given evaluation period (for example, the year 2000).

2. For each one-tick (0.0001) price level between these values, determine the number of lows and highs that were +/- 10 ticks (0.0010) from each level. This number is the level’s score.

3. Normalize the scores by divid-ing each price-level’s score by the highest score for the year.

Figure 2 illustrates this high-low analysis for 2009 in the EUR/USD pair.

FIGURE 1: BOUNCES VS. BREAKOUTS

The four patterns were used to evaluate whether price bounced or broke through a defined support-resistance zone.

FIGURE 2: DEFINING HIGH-LOW SUPPORT AND RESISTANCE

Support-resistance zones were defined according to how frequently daily highs or lows came within 10 ticks (pips) of each .0001 price increment.

Page 18: Currency Trader October 2012

The predictive value of these levels can then be objec-tively tested in a future period. After obtaining the S&R-zone predictions for the test period, we can now apply the previously described analysis to see whether the results are statistically relevant when compared to randomly defined S&R levels.

Each predicted S&R zone is tested over the forecast horizon, searching for all breakout-bounce patterns that occur within this period. Because there are two support/resistance (bounce) and two breakout (cross) patterns, four counts are obtained for each touched zone (one for each pattern; if price does not touch a zone, nothing is record-ed). From these counts the percentage of resistance pat-terns relative to all patterns is calculated, which is defined as the “resistance ratio” for each zone.

The more frequently a bounce pattern occurs (i.e., if the zone functions as support or resistance and turns back price), the closer to 1.00 the ratio gets. Conversely, if only breakout patterns occur, the ratio is 0. For example, if a particular S&R zone was associated with 12 bounce patterns and eight breakout patterns, its resistance ratio would be 0.60, or 60%. A frequency histogram can be used to show which ratios are the most frequent. In this case, the average resistance ratio was 57%, which means price bounced more often at these levels than it crossed them, suggesting they might have some statistical edge in fore-casting future support or resistance.

Comparison to random standard and resistanceTo determine if there is a true statistical edge, however, we must perform the same analysis on randomly drawn S&R levels, which we can generate through the following procedure:

1. Note the highest and lowest price levels achieved dur-ing an evaluation period (for example the year 2000).

2. Calculate a random number between 0 and 1.3. Multiply this number by the range (the difference

between highest high and lowest low obtained in step 1) and add it to the lowest low. This gives the lower boundary of a support and resistance zone for the fol-lowing year.

4. Add one tick to the lower edge to get the upper boundary (alternately, add four ticks).

5. Repeat all steps 1,000 times for each year to predict.

Figure 3 compares the frequency distribution of the resistance ratios for the randomly generated S&R zones (using both one and four ticks) to the ratios from the high-low method. Some immediate observations: The peaks are close together, indicating the average resistance ratios are very similar regardless of which method, random or high-low, is used. Also, the highest point of the resistance ratio distribution moves to the right as the random zone width is increased, suggesting the shift of the high-low

18 October2012•CURRENCY TRADER

TRADING STRATEGIES

FIGURE 3: RESISTANCE RATIO FREQUENCY DISTRIBUTION

Comparing the resistance ratio distributions of randomly generated S&R levels and those defined by the high-low method showed there was little difference between the two approaches.

Page 19: Currency Trader October 2012

CURRENCY TRADER•October2012 19

peak (with an average width of 2.6 ticks) is caused only by the increase in the average zone size. This suggests zone width has an influence on the resistance ratios.

Overall, however, the distributions are very similar, casting doubt on the hope that the high-low prediction method offers a superior forecast.

ScoreThe next thing to look at is the score, which should provide an estimation of how “hard” a zone is. The closer the resistance ratio gets to 1, the less price has crossed a zone, which should result in a diagonal line when plotting prediction scores against resistance percent — i.e., the higher a zone’s score, the higher its resistance ratio should be if it is functioning as support or resistance.

Figure 4’s x/y plot of the data shows a wide cloud of values with a nearly horizontal orientation. The linear regression (blue line) has a minor downward slope with a very low R² value. In line with the previous findings, the

center of the cloud is around 58%. The low R² implies there is a low linear correlation

between the score magnitude and the resistance ratio (if a high score was related to a high resistance ratio, the R² value would be 1). Overall, the analysis shows the score does not provide a meaningful indication about the quality

of a resistance level forecasted by the high-low method.

Evaluating the quality of S&R predictionsThe process outlined here offers an objective way to evaluate whether a given S&R-defining methodology can, in fact, be a predictive tool for identifying future price bounces and breakouts.

In this example, the high-low method proved to have no edge over randomly drawn levels; it does not have a statistical edge in pre-dicting future levels at which price is likely to bounce or break out.

Does your manual or algorithmic method for defining S&R have any true predictive power? Now you have a tool to find out. y

For information on the authors, see p. 4.

FIGURE 4: SCORE VS. RESISTANCE RATIO

There’s no evident correlation between a zone’s score and the resistance ratio.

Related readingDaniel Fernandez Currency Strategy CollectionThis20-articlesetcontainsforextradingstrategyarticleswritten by Currency Trader contributorDanielFernandezbetweenNovember2009andDecember2011.Thesearticlescovertradingideasandsystemsbasedoneverythingfrompricepatternsandindicatorstoseasonaltendenciesandmarketrelationships.

Calculating the significance of support and resistanceActive Trader, March 2007The“significanceindicator”usestheadvantagesofthemedianpricetoprovideobjectivesupport-resistanceanalysis.

Implied volatility: An overlooked tool for stock and futures tradersActive Trader,April2006Impliedvolatilityisn’tjustforoptionplayers—itcanprovideusefulmarketestimatesandforward-lookingsupportandresistancelevelsforalltraders.

Trading support and resistance zonesActive Trader,August2006Whenitcomestorealtrading,it’shelpfultodefinesupportandresistanceintermsofzonesratherthanpreciselevels.

Page 20: Currency Trader October 2012

20 October2012•CURRENCY TRADER

TRADING STRATEGIESADVANCED CONCEPTS

The author has stated for years none of the advances in financial theory and practice have emanated from winning traders. This is a modification of an earlier assertion that all advances are made by the losers; the logic behind such a misanthropic outlook is winning traders go home or to

a bar, or to a bar and then home, or to a bar and someone else’s home, while the losers sit around stewing about what went wrong until they come up with a reason.

The reason for the modification is simple: As machines, not people, increasingly make trading decisions and the

programming may be done by people who never have traded for their own account in their lives, they cannot be counted among the winning traders.

The results can be confusing. High-frequency and algorith-mic trades are not designed to capture underlying economic relationships, only small statisti-cal perturbations. They do not capture actual relationships so much as they do perceived sta-tistical relationships in fashion at the moment. Consider the two intraday charts from June 15, 2011, a day otherwise unnotable save for a strong downturn in the Euro on one of the many days during that period when a bailout

The dollar and non-petroleum import prices

An update on the strange — and overlooked — consequences of U.S. monetary policies.

BY HOWARD L. SIMONS

The S&P 500 quickly followed the Euro lower, registering an r2 of 0.97 for the day.

FIGURE 1: YOU, TOO, CAN BE AN ALGORITHMIC TRADER

99.000%

99.125%

99.250%

99.375%

99.500%

99.625%

99.750%

99.875%

100.000%

100.125%

99.000%

99.125%

99.250%

99.375%

99.500%

99.625%

99.750%

99.875%

100.000%

100.125%

100.250%

100.375%

100.500%

8:30

8:

40

8:50

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00

9:10

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20

9:30

9:

40

9:50

10

:00

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0 11

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:00

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:40

14:5

0

Euro, 0830 CST = 100%

Sep.

S&

P 50

0 E-

Min

i Fut

ures

, 083

0 C

ST =

100

%

You, Too, Can Be An Algorithmic Trader

SPX

EUR

r2 = .970  

Page 21: Currency Trader October 2012

CURRENCY TRADER•October2012 21

of Greece appeared at risk (Figures 1 and 2). The prices for September 2011 E-Mini S&P 500 futures (ESU11), July 2011 crude oil (CLN11), and the cash price for the Euro are re-indexed to 0830 CST and are displayed at one-minute intervals.

Once the Euro broke lower, the S&P 500 followed quickly (Figure 1). Over the day, the r2 — or percentage of variance explained — of the two markets was an astound-ing 0.97; any practicing econometrician starts to wonder if there is something wrong with either the data or the analy-sis at that point.

The relationship was not quite as strong between the Euro and crude oil (Figure 2); crude oil lagged the Euro for about two hours intraday, as if the memo had been delayed in transit. Even so, the r2 here is a still-high 0.86. All the tools and technology available to high-frequency traders could be distilled to saying, “If the Euro breaks, sell both crude oil and the S&P 500.” You really don’t need an advanced degree for that, do you?

Another good theory come and goneAll this brings us to the actual topic: the relationship

between non-petroleum import prices and the dollar. You may be surprised to learn the U.S. maintains an index for non-petroleum import prices, but this is in keeping with such oddities as core inflation, which excludes categories such as food and energy no one seems to buy, and is part of the great government excuse-making factory: “See, if it were not for petroleum prices shooting higher, we would not have seen import prices rise.”

Macroeconomic theorists have, for years, operated on the notion a weaker currency should lead to higher prices for imports and greater demand for exports; this was part of the original argument for floating exchange rates made in the late 1960s and early 1970s. It is a crying shame this theory has yet to work on a broad and consistent basis (see “Currencies and federal reserve trade weights,” July 2007). It has, as we will see here, worked for some currency pairs over some periods of time; if gravity worked with the same consistency, we would all be flying about randomly.

First, let’s compare the import index to two different measures of the U.S. dollar, the IntercontinentalExchange’s dollar index (DXY) and the Federal Reserve’s broad trade-weighted dollar index (TWD, not to be confused with the

Crude oil lagged the Euro for roughly two hours intraday, but the r2 for the pair still came in at 0.86.

FIGURE 2: CRUDE OIL AND THE EURO

99.000%

99.125%

99.250%

99.375%

99.500%

99.625%

99.750%

99.875%

100.000%

100.125%

95.50% 95.75% 96.00% 96.25% 96.50% 96.75% 97.00% 97.25% 97.50% 97.75% 98.00% 98.25% 98.50% 98.75% 99.00% 99.25% 99.50% 99.75%

100.00% 100.25% 100.50% 100.75% 101.00% 101.25% 101.50%

8:30

8:

40

8:50

9:

00

9:10

9:

20

9:30

9:

40

9:50

10

:00

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0

Euro, 0830 CST = 100%

Ju

ly C

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Oil

Futu

res,

083

0 C

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100

%

Crude Oil Lagged Euro For About Two Hours

CLN

EUR

r2 = .862  

Page 22: Currency Trader October 2012

ON THE MONEY

22 October2012•CURRENCY TRADER

ADVANCED CONCEPTS

Taiwan dollar). The six-member DXY’s weights have been fixed since inception; the TWD’s weights are recalculated annually as part of the Federal Reserve’s H10 report on foreign exchange rates.

Figure 3 shows an inverse relationship between the import index (led three months) and the TWD through 1994 and then a direct relationship thereafter. For the DXY, what had been no rela-tionship through 1994 turned into a direct relationship thereafter.

We should ask, therefore, what magical event or events occurred at the start of 1995 to justify this switch to index conformance. Three developments come to mind: This is the period when NAFTA was starting to affect trade patterns, when China fixed the yuan, and when the conse-quences of the Mexican peso’s collapse led the Clinton Treasury Department to look after the interests of wayward bankers.

The Federal Reserve ended its period of rate hikes at the start of 1995 and began a long series of what became known as “Greenspan puts” followed by Bernanke puts: Each time the financial markets let out a bleat, they were sated with more money until we arrived at 0% interest rates in December 2008 and outright money-printing in March 2009.

The Euro (EUR) and the Canadian dollar (CAD) had unstable relationships vs. the import index until the Fed began aggressively lowering rates after the dotcom bust. By May 2003 those relationships were strong and direct.

FIGURE 4: NON-PETROLEUM IMPORT PRICES AND KEY CURRENCIES

70%

75%

80%

85%

90%

95%

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95

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Euro And C

anadian Dollar, D

ec. 1988 = 100%

Impo

rt P

rices

Ex-

Petr

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000

= 10

0 Le

d 3

Mon

ths

Imports Ex-Petr.

EUR

CAD

The TWD and the import index had an inverse relationship through 1994 and a direct relationship after. The DXY and the import index had no relationship through 1994 and a direct relationship after.

FIGURE 3: NON-PETROLEUM IMPORT PRICES AND THE DOLLAR

60

65

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95

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97

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1988

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1990

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1994

1995

1996

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1998

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2001

2002

2003

2004

2005

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2007

2008

2009

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2011

ICE &

Federal Reserve D

ollar Index, Inverse Scale Jan. 1997 = 100

Impo

rt P

rices

Ex-

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000

= 10

0 Le

d 3

Mon

ths

Non-Petroleum Import Prices And The Dollar

Imports Ex-Petr.

DXY

FRB Broad TWD

Page 23: Currency Trader October 2012

CURRENCY TRADER•October2012 23

Because the TWD is non-tradable, it must remain a laboratory curiosity for now. If we delve into the trad-able DXY, we find only two of the six currencies involved have a leading relationship to the non-petroleum import price index — the Euro (EUR) and the Canadian dollar (CAD). In both of these cases, the relationship was incon-sistent and unstable until the Federal Reserve became very aggressive in lowering interest rates in the aftermath of the dotcom bust. By May 2003, a month whose importance will be revisited shortly, the relationship between the EUR, the CAD, and non-petroleum import prices became strong and direct (Figure 4).

A reversal of signNow let’s switch from an absolute to a relative frame of reference and normalize non-petroleum import prices to the Producer Price index (PPI). A remarkable and indeed unacceptable change in pattern emerges after the afore-mentioned May 2003 date (Figure 5). Before May 2003, the date when the Federal Reserve began its first war on deflation, import prices rose faster than the PPI as the dol-

lar weakened. This, to the joy of some we are sure, was expected behavior.

After May 2003, however, normalized non-petroleum import prices fell as the dollar weakened. This is the exact opposite of what you might expect. The post-May 2003 era of loose money stimulated the U.S. consumer as intended, but this consumer demand increasingly was met by for-eign producers in the dollar bloc, such as China. The prices of producer goods, the denominator in our fraction of normalized import prices, were pulled higher. The prices of consumer goods exported to the U.S. faced downward pressure, and that pushed the numerator lower.

This mechanism, by which the prices of non-petroleum imports fell relative to the PPI, was the direct result of American monetary policies. It also had the odd effect of making exporters to the U.S. accept lower margins and become one of the few losers in the war on deflation.

Look hard in a textbook on international economics for a theory calling this shot in advance. You will not find it. y

For information on the author, see p. 4.

Before May 2003, when the Federal Reserve began its first war on deflation, import prices rose faster than the PPI as the dollar weakened.

FIGURE 5: EXPORTERS TO U.S. LOST WAR ON DEFLATION

Rel. Price = -0.0049 * FRTWD + 1.46 R2 = 0.917

Rel. Price = 0.0036 * FRTWD + 0.389 R2 = 0.714

70.0%

75.0%

80.0%

85.0%

90.0%

95.0%

100.0% 87

.5

92.5

97.5

102.

5

107.

5

112.

5

117.

5

122.

5

127.

5

132.

5

Rel

ativ

e Pr

ice

Inde

x, N

on. P

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Ja

n. 1

995

= 10

0%

Federal Reserve Trade-Weighted Dollar

Exporters To U.S. Lost War On Deflation

Jan. 1995 - May 2003

Jun. 2003 - May 2012

Page 24: Currency Trader October 2012

24 October2012•CURRENCY TRADER

CPI:ConsumerpriceindexECB:EuropeanCentralBankFDD(firstdeliveryday):Thefirstdayonwhichdeliveryofacom-modityinfulfillmentofafuturescontractcantakeplace.FND(firstnoticeday):Alsoknownasfirstintentday,thisisthefirstdayonwhichaclear-inghousecangivenoticetoabuyer of a futures contract that it intendstodeliveracommodityinfulfillmentofafuturescontract.The clearinghouse also informs the seller.FOMC:FederalOpenMarketCommitteeGDP:GrossdomesticproductISM:Instituteforsupply management LTD(lasttradingday):Thefinaldaytradingcantakeplaceinafuturesoroptionscontract.PMI: Purchasing managers indexPPI:Producerpriceindex

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

GLOBAL ECONOMIC CALENDAR

October

1U.S.: SeptemberISMmanufacturingreportCanada: August PPI

23

4UK: BankofEnglandinterest-rateannouncementECB: Governingcouncilinterest-rateannouncement

5

U.S.: SeptemberemploymentreportBrazil: SeptemberCPI Canada: SeptemberemploymentreportJapan: BankofJapaninterest-rateannouncementLTD: Octoberforexoptions;OctoberU.S.dollarindexoptions(ICE)

678 Brazil: SeptemberPPI

9 Mexico: Sept.30CPIandSeptemberPPI

10 U.S.: Fedbeigebook

11

U.S.: August trade balanceAustralia: SeptemberemploymentreportFrance: SeptemberCPIGermany: SeptemberCPI

12 U.S.: SeptemberPPIJapan: SeptemberPPI

131415 U.S.: Septemberretailsales

India: SeptemberPPI

16 U.S.: SeptemberCPIUK: SeptemberCPIandPPI

17 U.S.: SeptemberhousingstartsUK: Septemberemploymentreport

18U.S.: SeptemberleadingindicatorsHong Kong: July-Septemberemploymentreport

19Canada: SeptemberCPIGermany: SeptemberPPI Mexico: Septemberemploymentreport

2021

22 Hong Kong:SeptemberCPI

23 Canada: BankofCanadainterest-rate announcement

24U.S.: FOMCinterest-ratedecisionAustralia: Q3CPIMexico: Oct.15CPISouth Africa: SeptemberCPI

25U.S.: SeptemberdurablegoodsBrazil: SeptemberemploymentreportSouth Africa: SeptemberPPI

26 U.S.: Q3GDP(advance)Japan: SeptemberCPI

272829 U.S.: Septemberpersonalincome

30

Canada: SeptemberPPIGermany: Septemberemploymentreport Japan: Septemberemploymentreport

31France: August PPIIndia: SeptemberCPISouth Africa: Q3employmentreport

November1 U.S.: October ISM manufacturing

index

2U.S.: OctoberemploymentreportAustralia: Q3PPICanada: Octoberemploymentreport

34567 Brazil: October CPI and PPI

8

U.S.: SeptembertradebalanceAustralia: OctoberemploymentreportMexico: Oct.31CPIandOctoberPPIUK: BankofEnglandinterest-rateannouncementECB:Governingcouncilinterest-rateannouncement

9Germany: October CPILTD:Novemberforexoptions;NovemberU.S.dollarindexoptions(ICE)

Theinformationonthispageissub-jecttochange.Currency Trader is notresponsiblefortheaccuracyofcalendardatesbeyondpresstime.

Page 25: Currency Trader October 2012

CURRENCY TRADER•October2012 25

CURRENCY FUTURES SNAPSHOT as of Sept. 28

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields. Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable).

LEGEND:Volume: 30-day average daily volume, in thousands.OI: 30-day open interest, in thousands.10-day move: The percentage price move from the close 10 days ago to today’s close.20-day move: The percentage price move from the close 20 days ago to today’s close.60-day move: The percentage price move from the close 60 days ago to today’s close.The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size and in the same direction. For example, the % rank for the 10-day move shows how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it shows how the most recent 60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100% means the current reading is larger than all the past readings, while a reading of 0% means the current reading is smaller than the previous readings. Volatility ratio/% rank: The ratio is the short-term volatility (10-day standard deviation of prices) divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

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

(as of Aug. 31 ranked by August 2012 return)

Trading advisor Augustreturn

2012 YTD return

$ Under mgmt.

(millions)

1. 24FX Management Ltd 4.95% 17.12% 50.32. Gedamo(FXAlpha) 4.51% 13.32% 19.63. Gedamo(FXOne) 2.61% 7.46% 31.94. RhiconCurrencyMgmt(Strategic) 1.90% -1.63% 280.05. JWPartners(FXMacro) 1.78% 1.94% 18.96. INSCHCapitalMgmt(KintilloX3) 1.48% 9.77% 60.87. Olsen(OlsenInvest-AF) 1.42% 3.05% 30.08. SilvaCapitalMgmt(Cap.Partners) 1.06% 6.79% 18.49. CapricornCurrencyMgmt(FXG10CHF) 1% 8.48% 14.0

10. CambridgeStrategy(EmergingMkts) 0.87% 3.27% 57.0Top 10 currency traders managing less than $10M & more than $1M

1. KMJCapital(Currency) 3.11% 13.65% 5.02. ValhallaCapitalGroup(Int'lAB) 2.47% 7.70% 1.53. JarrattDavis(ManagedFX) 2.40% 15.27% 4.94. HartswellCapitalMgmt(Apollo) 2.25% 27.81% 3.25. BBK(RESCOL/SFX) 1.97% -2.61% 3.36. FourCapital(FX) 1.39% -0.01% 1.57. Iron Fortress FX Mgmt 1.36% -4.40% 9.58. CapricornCurrencyMgmt(FXG10USD) 1.05% 7.17% 9.59. GAMCurrencyHedge(USD) 0.21% 6.22% 6.7

10. TridentAssetMgmt.(Gl.Currency) 0.03% 0.10% 7.0

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

Market Sym Exch Vol OI 10-day move / rank

20-day move / rank

60-day move / rank

Volatility ratio / rank

EUR/USD EC CME 255.4 268.7 -1.95%/100% 2.82%/59% 3.72%/85% .32/68%

AUD/USD AD CME 126.1 171.6 -2.47%/91% 0.18% / 0% 0.77% / 10% .14 / 2%GBP/USD BP CME 100.5 130.0 -0.54%/100% 2.22%/73% 3.96%/91% .14/5%JPY/USD JY CME 90.3 132.1 0.47%/38% 0.90%/38% 2.43%/57% .60/90%CAD/USD CD CME 86.4 161.4 -1.53%/100% 0.77%/15% 3.03%/47% .19/23%MXN/USD MP CME 41.7 185.8 -1.88%/100% 3.21%/70% 3.87%/30% .10/15%CHF/USD SF CME 38.0 46.6 -1.29%/100% 2.23%/54% 3.07%/85% .27/65%U.S. dollar index DX ICE 19.6 55.7 1.31%/100% -1.47%/37% -4.23%/92% .23/32%NZD/USD NE CME 16.0 28.0 -0.65%/56% 3.27%/92% 2.94%/26% .14 / 8%E-MiniEUR/USD ZE CME 4.5 5.8 -1.95%/100% 2.82%/59% 3.72%/85% .32/68%

Note:Averagevolumeandopeninterestdataincludesbothpitandside-by-sideelectroniccontracts(whereapplicable).Priceactivityisbasedonpit-tradedcontracts.

Page 26: Currency Trader October 2012

INTERNATIONAL MARKETS

26 October2012•CURRENCY TRADER

CURRENCIES (vs. U.S. DOLLAR)

Rank CurrencySept. 27 price vs.

U.S. dollar1-month gain/loss

3-monthgain/loss

6-monthgain/loss

52-week high

52-week low Previous

1 Indianrupee 0.018775 3.96% 7.16% -1.83% 0.0203 0.0174 102 Euro 1.2874 2.89% 3.00% -3.09% 1.4168 1.2099 33 GreatBritainpound 1.617435 2.29% 3.66% 1.78% 1.6261 1.5308 74 Swiss franc 1.0647 2.18% 2.31% -3.40% 1.1599 1.0074 25 South African rand 0.121475 2.01% 2.79% -7.02% 0.1338 0.1159 156 Taiwan dollar 0.034015 1.90% 1.92% 0.65% 0.0343 0.032 177 Russian ruble 0.03201 1.83% 5.87% -6.73% 0.0345 0.0291 48 Singaporedollar 0.81217 1.57% 3.96% 2.36% 0.8193 0.7606 12

9 NewZealanddollar 0.82103 1.21% 3.92% 0.28% 0.8415 0.7397 6

10 Japaneseyen 0.01286 1.18% 2.27% 6.37% 0.0132 0.0119 1611 Canadian dollar 1.018035 1.00% 4.57% 1.39% 1.0334 0.9467 512 Thai baht 0.032265 0.51% 2.56% -0.85% 0.0329 0.031 813 Swedishkrona 0.15172 0.21% 7.20% 0.00% 0.1572 0.1374 1

14 Hong Kong dollar 0.12897 0.04% 0.07% 0.19% 0.129 0.1282 14

15 Chinese yuan 0.1578 -0.10% -0.25% -0.32% 0.1589 0.1557 916 Brazilianreal 0.49211 -0.28% 1.66% -10.80% 0.5917 0.4801 1317 Australian Dollar 1.03605 -0.43% 3.22% -1.18% 1.0808 0.9478 11

GLOBAL STOCK INDICES

Country Index Sept. 27 1-month gain/loss

3-month gain/loss

6-month gain loss

52-week high

52-week low Previous

1 India BSE30 18,579.50 5.09% 9.50% 7.66% 18,866.90 15,135.90 52 Hong Kong Hang Seng 20,762.29 4.87% 7.72% -1.35% 21,760.30 16,170.30 93 Brazil Bovespa 60,240.00 3.66% 13.43% -8.78% 68,970.00 49,433.00 84 Germany Xetra Dax 7,290.02 3.44% 17.03% 2.98% 7,478.53 5,125.44 45 Italy FTSE MIB 15,450.14 2.91% 16.14% -6.36% 17,158.70 12,295.80 16 U.S. S&P500 1,447.15 2.60% 8.66% 2.45% 1,474.51 1,074.77 137 Canada S&P/TSXcomposite 12,338.85 2.41% 8.13% -1.38% 12,788.60 10,848.20 118 Mexico IPC 40,729.70 1.89% 3.14% 4.55% 41,600.60 32,258.40 159 Switzerland SwissMarket 6,545.90 0.84% 9.16% 4.41% 6,620.10 5,307.80 12

10 Australia All ordinaries 4,402.80 0.68% 7.81% 0.26% 4,515.00 3,905.20 611 Singapore Straits Times 3,059.43 0.49% 7.67% 1.34% 3,088.45 2,521.95 1412 UK FTSE 100 5,779.40 0.06% 4.63% -1.54% 5,989.10 4,868.60 1013 South Africa FTSE/JSEAllShare 35,616.60 -0.42% 5.54% 5.19% 36,550.08 29,688.89 714 France CAC 40 3,439.32 -0.68% 12.28% -0.87% 3,600.48 2,793.22 315 Japan Nikkei225 8,949.87 -1.49% 2.51% -12.73% 10,255.20 8,135.79 2

Page 27: Currency Trader October 2012

CURRENCY TRADER•October2012 27

NON-U.S. DOLLAR FOREX CROSS RATES

Rank Currency pair Symbol Sept. 27 1-month gain/loss

3-month gain/loss

6-month gain loss

52-week high

52-week low Previous

1 Euro / Aussie $ EUR/AUD 1.24262 3.34% -0.21% -1.93% 1.3943 1.1614 7

2 Euro / Real EUR/BRL 2.616095 3.19% 1.32% 8.65% 2.651 2.2481 5

3 Pound / Aussie $ GBP/AUD 1.561155 2.73% 0.43% 2.99% 1.626 1.4637 10

4 Euro / Canada $ EUR/CAD 1.264595 1.88% -1.49% -4.41% 1.4082 1.2164 13

5 Euro / Yen EUR/JPY 100.09 1.71% 0.70% -8.93% 110.83 94.65 2

6 Yen / Real JPY/BRL 0.026135 1.48% 0.60% 19.28% 0.0262 0.021 17

7 Canada $ / Real CAD/BRL 2.068725 1.28% 2.86% 13.66% 2.0827 1.6917 8

8 Pound / Canada $ GBP/CAD 1.588785 1.28% -0.86% 0.39% 1.6354 1.5515 16

9 Franc / Canada $ CHF/CAD 1.04584 1.17% -2.16% -4.72% 1.1553 1.0128 12

10 Pound / Yen GBP/JPY 125.75 1.12% 1.35% -4.35% 132.81 117.58 6

11 Franc / Yen CHF/JPY 82.78 1.01% 0.02% -9.22% 91.90 78.81 1

12 Euro / Franc EUR/CHF 1.209165 0.69% 0.68% 0.32% 1.2406 1.2003 15

13 Euro / Pound EUR/GBP 0.79596 0.59% -0.64% -4.78% 0.8799 0.7779 11

14 Pound / Franc GBP/CHF 1.519145 0.11% 1.32% 5.36% 1.5434 1.3877 18

15 NewZeal$/Yen NZD/JPY 63.835 0.03% 1.61% -5.76% 68.81 57.23 4

16 Aussie $ / Real AUD/BRL 2.10533 -0.14% 1.53% 10.79% 2.1525 1.7221 14

17 Canada $ / Yen CAD/JPY 79.15 -0.19% 2.23% -4.72% 84.49 72.63 3

18 Aussie $ / Canada $ AUD/CAD 1.017695 -1.41% -1.28% -2.53% 1.0755 0.9981 20

19 Aussie $ / Yen AUD/JPY 80.55 -1.60% 0.91% -7.13% 88.31 72.72 9

20 Aussie$/NewZeal$ AUD/NZD 1.26187 -1.64% -0.67% -1.46% 1.3229 1.2557 19

21 Aussie $ / Franc AUD/CHF 0.97309 -2.55% 0.89% 2.30% 1.0328 0.8729 21

GLOBAL CENTRAL BANK LENDING RATES

Country Interest rate Rate Last change March 2012 Sept. 2011United States Fed funds rate 0-0.25 0.5(Dec08) 0-0.25 0-0.25

Japan Overnightcallrate 0-0.1 0-0.1(Oct10) 0-0.1 0-0.1Eurozone Refi rate 0.75 0.25(July12) 1 1.5England Reporate 0.5 0.5(March09) 0.5 0.5Canada Overnightrate 1 0.25(Sept10) 1 1

Switzerland 3-monthSwissLibor 0-0.25 0.25(Aug11) 0-0.25 0-0.25Australia Cash rate 3.5 0.25(June12) 4.25 4.75

NewZealand Cash rate 2.5 0.5(March11) 2.5 2.5Brazil Selic rate 7.5 0.5(Aug12) 9.75 12Korea Korea base rate 3 0.25(July12) 3.25 3.25Taiwan Discount rate 1.875 0.125(June11) 1.875 1.875India Reporate 8 0.5(Apr12) 8.5 8.25

South Africa Repurchaserate 5 0.5(July12) 5.5 5.5

Page 28: Currency Trader October 2012

28 October2012•CURRENCY TRADER

INTERNATIONAL MARKETS

GDP Period Release date Change 1-year change Next release

AMERICASArgentina Q2 9/21 21.2% 15.0% 12/21Brazil Q2 8/31 6.6% 5.6% 11/30

Canada Q2 8/31 0.1% 3.5% 11/30

EUROPEFrance Q2 9/28 0.0% 0.5% 12/28

Germany Q2 8/14 0.7% 1.7% 11/15UK Q2 9/27 1.0% 2.2% 12/21

AFRICA S. Africa Q2 9/11 1.2% 8.3% 12/6

ASIA and S. PACIFIC

Australia Q2 9/5 1.0% 3.2% 12/5Hong Kong Q2 8/10 -1.5% 3.6% 11/16

India Q2 8/31 3.4% 12.0% 11/30Japan Q2 8/13 0.3% 1.4% 11/12

Singapore Q2 8/24 -0.5% 4.1% 11/23

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

AMERICASArgentina Q2 8/21 7.2% 0.1% -0.1% 11/19Brazil Aug. 9/20 5.3% -0.1% -0.7% 10/25

Canada Aug. 9/7 7.3% 0.0% 0.0% 10/5

EUROPEFrance Q2 9/6 9.7% 0.1% 0.6% 12/11

Germany Aug. 9/27 5.4% -0.4% -0.6% 10/30UK May-July 9/12 8.1% 0.0% 0.1% 10/17

ASIA and S. PACIFIC

Australia Aug. 9/6 5.2% 0.0% 0.0% 10/11Hong Kong June-Aug. 9/18 3.2% 0.0% 0.0% 10/18Japan Aug. 9/28 4.2% -0.1% -0.2% 10/30

Singapore Q2 7/31 2.0% -0.1% -0.2% 10/31

CPI Period Release date Change 1-year change Next release

AMERICASArgentina Aug. 9/12 0.9% 10.0% 10/12Brazil Aug. 9/5 0.4% 5.2% 10/19

Canada Aug. 9/21 0.2% 1.2% 10/19

EUROPEFrance Aug. 9/12 0.7% 2.1% 10/11

Germany Aug. 9/12 0.4% 2.1% 10/11UK Aug. 9/18 0.5% 2.5% 10/16

AFRICA S. Africa Aug. 9/19 0.2% 5.0% 10/24

ASIA and S. PACIFIC

Australia Q2 7/15 0.5% 1.2% 10/24Hong Kong Aug. 9/20 0.0% 3.7% 10/22

India Aug. 9/28 1.0% 10.3% 10/31Japan Aug. 1/9 0.1% -0.4% 10/26

Singapore Aug. 9/24 0.7% 3.9% 10/23

PPI Period Release date Change 1-year change Next release

AMERICASArgentina Aug. 9/12 1.0% 12.8% 10/12Canada Aug. 10/1 -0.1% -0.3% 10/30

EUROPEFrance Aug. 9/28 1.2% 2.6% 10/31

Germany Aug. 9/20 0.5% 1.6% 10/19UK Aug. 9/7 0.5% 2.2% 10/16

AFRICA S. Africa Aug. 9/27 0.7% 5.1% 10/25

ASIA and S. PACIFIC

Australia Q2 7/23 0.5% 1.1% 11/2Hong Kong Q2 9/13 1.5% -0.7% 12/13

India Aug. 9/14 1.1% 7.6% 10/15Japan Aug. 9/12 0.3% -1.8% 10/12

Singapore Aug. 9/28 2.4% 2.0% 10/29 As of Sept. 30 LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment rate.

Page 29: Currency Trader October 2012

CURRENCY TRADER•September2010 29

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Page 30: Currency Trader October 2012

30 October2012•CURRENCY TRADER

TRADE

Date: Monday, Oct. 1, 2012.

Entry: Long the Euro/U.S. dollar pair (EUR/USD) at 1.2898.

Reason for trade/setup: This paper trade was based on pattern analysis that indicated the down swing as of Oct. 1 had better-than-average odds of being followed by a three-day or longer rally. The pattern consisted of a day with a low at least .0020 lower than the previous 10 lows that close higher.

Past setups that “worked” basically fell into two camps: those that were followed by one- to three-day up swings before another downturn emerged, and those that were followed by sustained, longer-term (e.g., 20 or more days) up moves. Those that lost significantly tended to be losers quickly, trading immediately and significantly below the entry day’s low. Accordingly, an initial modest target will be established to take advantage of the initial expected rebound, with a second, more distant target a little below the mid-September high.

The trade was entered around noon ET when price pulled back from its early session high of 1.2938 because a bullish ISM report that morning had triggered a strong stock market rally and a dollar sell-off. The early entry is in expectation of a rally to a new intraday high and a close near the high of the day. A close below the previous day’s close of 1.2849 would negate the setup and prompt an early exit.

Initial stop: 1.2781.

Initial target: 1.3006; take partial profits and raise stop to protect remainder of position. Second target: 1.3141.

RESULT

Exit: Trade still open.

Profit/loss: -.0006, marked to market at 1:30 p.m. ET on Oct. 1.

Outcome: Although there was a mild bounce after the trade entry, the market subsequently pulled back more significantly (as low as 1.2882), although by 2:30 p.m. ET (after the end of the London FX session but before the New York close) the trade was bouncing around a little below breakeven.

The wisdom of the early entry is debatable, since the pattern’s probabilities were based on the position of the closing price. Anticipating the level of the close introduced another degree of uncertainty into the trade. yNote: Initial trade targets are typically based on things such as the historical per-formance of a price pattern or a trading system signal. However, because individ-ual trades are dictated by immediate circumstances, price targets are flexible and are often used as points at which to liquidate a portion of a trade to reduce expo-sure. As a result, initial (pre-trade) reward-risk ratios are conjectural by nature.

Early entry for a swing trade in the Euro.

TRADE SUMMARY

Date Currencypair

Entryprice

Initial stop

Initial target IRR MTM Date

P/LLOP LOL Trade

lengthpoint %

10/1/12 EUR/USD 1.2898 1.2781 1.3006 0.92 1.2892 10/1/12 -.0006 -0.05% .0009 -.0016 1 dayLegend — IRR: initial reward/risk ratio (initial target amount/initial stop amount). LOP: largest open profit (maximum available profit during lifetime of trade). LOL: largest open loss (maximum potential loss during life of trade). MTM: marked-to-market — the open trade profit or loss at a given point in time.

FOREXTRADEJOURNAL

Source: TradeStation