Strategies, analysis, and news for FX Traders

August 2007
Volume 4, No. 8

DOLLAR AT THE CROSSROADS: LONG-TERM

Battered buck testing key INTEREST RATES:
levels p. 38 Implications for
currencies p. 34
TREND RUNS IN CURRENCIES:
Facts and figures p. 16 INTERNATIONAL
TRADE AND
EXOTIC CURRENCIES: CURRENCIES,
Trading outside part 2 p. 26
the “majors” p. 8

THE YEN’S
new uptrend? p. 12
 CONTENTS

Contributors . . . . . . . . . . . . . . . . . . . . .6 Advanced Strategies

Minor currencies and
federal reserve trade weights . . . . . .26
Global Markets A continuation of last month’s analysis
Beyond the majors: The exotic waters of the relationship between trade and
of emerging-market currencies . . . . . .8 currencies undermines one of the basic
Some forex brokers are offering access to premises of the floating exchange-rate
more currency pairs, but you need to know system.
the risks associated with these markets before By Howard L. Simons
you consider trading them.
By Currency Trader Staff
Trading Basics
Long-term interest rates
On the Money and the U.S. dollar . . . . . . . . . . . . . . .34
The rising yen — What the recent rise in T-bond and T-note
here we go again . . . . . . . . . . . . . . . .12 yield implies for the FX market.
The yen has been on the rise vs. the dollar. By David Mantell
Find out if it’s a reversal or just a correction.
By Barbara Rockefeller
Spot Check
U.S. dollar index . . . . . . . . . . . . . . . .38
Trading Strategies The greenback has recently established
Short-term trends all-time lows against many currencies.
in the EUR/USD pair . . . . . . . . . . . . .16 Find out what analysis of the dollar index
This study shows how often different runs says about the probabilities of the buck’s
of consecutive higher or lower highs, lows, next move.
and closes occur in the euro/dollar pair. By Currency Trader Staff
By Currency Trader Staff
continued on p. 4

2 August 2007 • CURRENCY TRADER

 CONTENTS

Industry News
New NFA proposal could cause
significant shakeup among
forex brokerages . . . . . . . . . . . . . . . .42
The National Futures Association wants
new capital requirements that could force
several forex brokerages out of business.
Global Economic Calendar . . . . . . . . .48
USFE to list forex futures . . . . . . . . .42 Key dates for currency traders.
The United States Futures Exchange
will roll out currency futures that mimic New Products and Services . . . . . . . . .49
the pricing of spot forex positions.
The Face of Trading . . . . . . . . . . . . . . .49
Rolling with the punches.
Currency Futures . . . . . . . . . . . . . . .44
Currency fund manager performance. Key Concepts . . . . . . . . . . . . . . . . . . . .50

Global News Briefs . . . . . . . . . . . . .45 Events . . . . . . . . . . . . . . . . . . . . . . . . . .51

Conferences, seminars, and other events.
International Market
Summary . . . . . . . . . . . . . . . . . . . . . . .46 Forex Trade Journal . . . . . . . . . . . .52
Currency, interest rate, and equity Too late to sell the dollar? A position
performance from around the globe. in the dollar index futures tells the tale.

Have a question about something you’ve seen in

Currency Trader?
Submit your editorial queries or comments to
webmaster@[Link].

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4 August 2007 • CURRENCY TRADER

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About the author
Edward 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.

This is neither a solicitation to buy or sell any type of financial instruments, nor intended as investment recommendations. All investment trading involves multiple substantial risks of mon-
etary loss. Don’t trade with money you can’t afford to lose. Trading is not suitable for everyone. Past performance, whether indicated by actual or hypothetical results or testimonials are no
guarantee 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 PARTICULAR
TRADING PROGRAM. Furthermore, all internal and external computer and software systems are not fail-safe. Have contingency plans in place for such occasions. Equis International assumes
no responsibility for errors, inaccuracies, or omissions in these materials, nor shall it be liable for any special, indirect, incidental, or consequential damages, including without limitation
losses, lost revenue, or lost profits, that may result from the reliance upon the information materials presented.
 CONTRIBUTORS
CONTRIBUTORS

 Howard Simons is president of

A publication of Active Trader ® Rosewood Trading Inc. and a strategist for
Bianco Research. He writes and speaks fre-
For all subscriber services: quently on a wide range of economic and
[Link] financial market issues.

 Barbara Rockefeller ([Link] is an

Editor-in-chief: Mark Etzkorn international economist with a focus on foreign exchange. She
metzkorn@[Link]
has worked as a forecaster, trader, and consultant at Citibank
Managing editor: Molly Flynn and other financial institutions, and currently publishes two
mflynn@[Link] daily reports on foreign exchange. Rockefeller is the author of
Technical Analysis for Dummies (For Dummies, 2004), 24/7
Senior editor: Jeff Ponczak
jponczak@[Link] Trading Around the Clock, Around the World (John Wiley &
Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and
Contributing writers:
Barbara Rockefeller,
How to Invest Internationally, published in Japan in 1999. A
Howard Simons, Marc Chandler book tentatively titled How to Trade FX is in the works.

Editorial assistant and

 David Mantell is a currency trader at Chicago Global
Webmaster: Kesha Green
kgreen@[Link] Investors, where he trades currency futures in the euro, yen,
British pound, Swiss franc, and Canadian dollar. He began his
Art director: Laura Coyle
lcoyle@[Link]
career in the financial markets 15 years ago as a financial
advisor. Mantell is a former equity research analyst, having
President: Phil Dorman covered the media & telecommunications (wireline and wire-
pdorman@[Link]
less) industries. As part of his MBA, Mantell attended the
Publisher, ESSEC Business School in Paris. He can be contacted at
Ad sales East Coast and Midwest: dmantell@[Link].
Bob Dorman
bdorman@[Link]
 Thom Hartle ([Link] is director
Ad sales of marketing for CQG and a contributing edi-
West Coast and Southwest only:
Allison Ellis
tor to Active Trader magazine. In a career span-
aellis@[Link] ning more than 20 years, Hartle has been a
commodity account executive for Merrill
Classified ad sales: Mark Seger
Lynch, vice president of financial futures for
mseger@[Link]
Drexel Burnham Lambert, trader for the
Federal Home Loan Bank of Seattle, and edi-
Volume 4, Issue 8. Currency Trader is published monthly by TechInfo, Inc., tor for nine years of Technical Analysis of Stocks & Commodities
150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2007
TechInfo, Inc. All rights reserved. Information in this publication may not be magazine. Hartle also writes a daily market blog called hartle
stored or reproduced in any form without written permission from the publisher.
& flow ([Link]
The information in Currency Trader magazine is intended for educational pur-
poses only. It is not meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or approach. Traders are advised
to do their own research and testing to determine the validity of a trading idea.
Trading and investing carry a high level of risk. Past performance does not
guarantee future results.

6 August 2007 • CURRENCY TRADER

 GLOBAL MARKETS

Beyond the majors:

The exotic waters
of emerging market currencies
Experience required: There are opportunities in emerging-market currencies, but traders should
nonetheless be careful about venturing outside the highly liquid major currency pairs.

BY CURRENCY TRADER STAFF

W
“exotic” currencies.
hile the vast majority of forex trading
occurs in the so-called “majors” — the
currencies of G-10 countries — some
retail forex brokerages are beginning to
expand their offerings to include emerging-market or

Such currencies include the Mexican peso, South African

“Exotic currency pairs provide traders with the ability to
take advantage of trends that can be established by large
money taking positions in these less-liquid currencies,”
says Paul Jamgotch, dealing desk manager at GFT. “Exotics
are also attractive to traders who keep their eyes on the fun-
damental factors that can affect these smaller financial mar-
kets. Also, it gives retail traders a way to speculate in the
rand, Singapore dollar, Thailand baht, Brazilian real, and economies of countries that don’t offer easy access to other
Hong Kong dollar. trading vehicles, such as bonds or stocks.”
There are many reasons forex trading revolves around a Diversification is another argument in favor of expand-
handful of currency pairs, most of which include either the ing into the exotic arena.
U.S. dollar or the euro, but the most important are liquidity
and stability. It’s often said the forex market is the most liq-
uid in the world, and that liquidity is based on the stability Some strategists caution that only the
of a few countries and regions that, through history and for-
tune, have come to dominate global trade and finance. It is
no coincidence that oil and gold are priced globally in dol-
most seasoned retail players should
lars.
For example, Brazil is a developing country at the fore-
enter the exotic currency arena
front of a Latin American boom — several countries are
bucking for “first-world” status. But despite the fact it’s had because of its higher volatility, lower
one of the hottest currencies in recent years, Brazil has gone
through a few “new” currencies in the past two decades as liquidity, and wider spreads.
its economy has busted and boomed.
Nonetheless, some emerging market currencies are edg-
ing into the mainstream of the forex world. “Having exposure to just the major pairs really narrows
the scope of a trader’s portfolio,” says Richard Lee, curren-
Why trade exotics? cy strategist at FXCM. “Portfolio returns in emerging mar-
Some analysts contend exotic currencies tend to trend bet- kets are also outpacing major-currency investments.”
ter than the majors because their economies are often nar- While FXCM currently does not provide access to emerg-
rowly focused, or even dependent on one specific industry ing market currencies on their retail platform, they do pro-
or investment theme. vide research in the Hong Kong and Singapore dollars, as
GFT Forex and [Link] currently include exotic cur- well as the Chinese yuan.
rency trading on their retail trading platforms. “Additional instruments are good because they offer

8 August 2007 • CURRENCY TRADER

diversification,” says Richard Olsen, co-founder of think when trading emerging markets because retail
[Link]. “Anyone trading any market wants to diversi- traders are not used to violent fluctuations.
fy.” ”Unless retail investors trade crosses such as the
Oanda gradually began adding exotic cross rates to its pound/yen, they are more [accustomed to] 30-pip daily
retail platform starting in 2006 and Olsen says it has been fluctuations,” he says. “The rand moves almost 10 times
met with “an astonishing amount of interest.” Oanda has that in single session. However, you always have to take
a fairly wide offering of exotic currency crosses, including continued on p. 10
crosses with the euro dollar vs. emerg-
ing market currencies. (For a list
of Oanda’s current exotic pairs offer-
ings see: [Link]
spreads/all_spreads.shtml.)

Higher risk levels

With opportunity, of course, comes
risk. Brian Dolan, chief currency
strategist at [Link], a division of
Gain Capital, says his firm currently
does not offer emerging market cur-
rencies to retail clientele because of liq-
uidity and the lack of running prices.
“There is tremendous potential in
some of the [exotic currencies], but it is
a whole new level of risk versus the G-
10 currencies,” he says.

Wider spreads,
more volatility
Forex traders should not jump into the
world of the exotics without a great
deal of research and understanding of
the risks associated with these curren-
cies. Some strategists caution that only
the most seasoned retail players
should enter this arena because of the
higher volatility, lower liquidity, and
wider spreads these currencies tend to
display.
“The spreads on exotics can be fair-
ly wide because these markets are less
liquid,” says GFT’s Jamgotch. “Retail
traders need to keep in mind there is
limited liquidity in many exotic pairs,
which means spreads tend to widen
when these local financial markets are
not open.
“The typical GFT spread for the
USD/ZAR (U.S. dollar/South African
rand pair) is 150 pips, and during some
market conditions, such as when the
South African market is closed, it is not
uncommon for the spread to widen to
more than 500 pips.”
FXCM’s Lee says volatility and liq-
uidity are bigger concerns than people

CURRENCY TRADER • August 2007 9

 GLOBAL MARKETS continued

FIGURE 1 — DOLLAR/RAND “Whatever you do, put on small

trades,” suggests Oanda co-founder
In late July the U.S. dollar/South African rand pair was just beginning to penetrate
Olsen.
the bottom of its long-term range and was trading at its lowest level in a year.

Longer-term plays
Given the wider spreads and reduced
liquidity of some exotic currencies,
some strategists feel the longer-term
time frame is a better choice than day
trading in this arena. Dolan cautions
those interested in expanding into the
exotics.
“For the retail guy, the risks probably
outweigh the rewards,” he says. “If they
do get into it, it has to be more of a
strategic and longer-term play.”
Olsen agrees on the time frame out-
look.
“While a euro/dollar trader might
trade a two- to three-hour position, a
yuan play could last two to five weeks,”
Source: ADVFN ([Link] he says. “Trades put on in emerging
market currencies are different in
into account the pip cost, which essentially puts things back nature, and tend to be on more of a long-term time frame.”
into perspective.”
A pip in the ZAR currently is worth about $1.45 vs., say, Do your homework
roughly $10 for a pip in the euro/dollar pair. Gaining access to the appropriate fundamental information
“Another factor retail traders should be aware of is the needed to make trading decisions may be harder when
volatility in exotic currencies around fundamental news looking at the exotic currency landscape.
releases can be much higher than in major currencies,” says “There are fewer news announcements and bank
GFT’s Jamgotch. “This means market gaps and slippage are research available for some of these exotic currencies,” says
more common.” GFT’s Jamgotch. “This means that it can be more difficult
for retail traders to conduct proper research needed to
Keep things small make informed decisions based on fundamental data.”
As market conditions can shift rapidly in the exotic curren-
cy environment, strategists advise retail customers to mon- “Exotic” to watch: South African rand
itor and limit position sizes carefully. FXCM’s Lee says the South African rand (ZAR) is a curren-
“Exotic currencies can become very volatile and illiquid cy to watch near-term (Figure 1).
without warning,” Jamgotch says. “Given the recent attention on carry trades and interest
For example, he pointed to when the Thai baht fell more rates, I still think that the ZAR has some potential,” he says.
than four percent against the U.S. dollar in December 2006 ”Technically, however, I might be waiting a bit for a better
when the Bank of Thailand imposed penalties on invest- price, as we’re approaching a major support level (in late
ments held for less than a year. Spreads on the U.S. dol- July).”
lar/Thai baht cross spiked from 5 pips to 100 or more, The South African Reserve Bank hiked interest rates in
depending on the institution. Jamgotch says many market early June from 9.0 percent to the current 9.5 percent.
makers chose not to offer Thai baht crosses during this tur- Bullish interest-rate differentials alone favor the rand vs.
bulent time. the U.S. dollar’s 5.25 percent fed funds rate.
Exotic currency traders also have to face the reality that it Looking at the differential, Lee says it’s still a good per-
may be difficult to exit positions because of lack of liquidi- centage to play.
ty outside of local trading hours.
“At the end of the day, it is almost like a futures market Rand: Key fundamentals
position, when the futures close at 2 o’clock and you can’t Gold and platinum prices are two factors that drive the
get out until the next day,” warns [Link]’s Dolan. For South African rand; some traders essentially use the rand as
example, he notes that outside of North American trading a proxy for the world gold market.
hours, liquidity is “pretty poor” in the Mexican peso. Clyde Wardle, senior emerging market FX strategist at

10 August 2007 • CURRENCY TRADER

HSBC, notes the rand strengthened roughly five percent improved,” Wardle says. “Liquidity is still very loose
from June to July. across the globe, which encourages managers to search for
“It was at 7.20-7.30 in early June and now it has moved yield.”
below 7.00,” he says. The main risk, Wardle warns, is the external environ-
As of late July, the USD/ZAR was trading at 6.88. Wardle ment. If global stock markets were to come under pressure,
pointed to the rally in the gold market from late June as one money managers could trim exposure to emerging-market
factor supporting the rand in recent weeks. positions, which would likely result in a weaker rand.
HSBC forecasts overall gross
domestic product (GDP) growth at 5.4
percent for South Africa in 2007, vs.
2006’s 5.0-percent reading. Inflation
remains high, which has been a driver
toward tighter monetary policy. The
May CPI ex-food and energy figure
posted a 6.4-percent reading year-
over-year in South Africa.
“The economy is improving and
has been improving for the past cou-
ple of years,” Lee says. “GDP and
manufacturing are healthy and con-
sumer spending has picked up.”
Wardle adds in the past the South
African Reserve Bank had discomfort
with currency strength below 7.00
amid worries that it would hurt
domestic manufacturing.
“Given rising inflation, the central
bank should be comfortable with the
strengthening currency,” he says.

Rand: Key price levels

Overall, HSBC forecasts continued
strengthening in the rand toward 6.75
by the end of third quarter. Weakness
is seen into early 2008, with a first-
quarter forecast of 7.25.
“I’m looking for a technical break of
the support the currency pair is cur-
rently trading at, around the 6.8606
(the May 8 low),” Lee says. “If this
level is broken, I would be looking to
initiate a long around that area with
targets set at 6.4050, just below the
6.427, 76.4-percent Fibonacci retrace-
ment of the 5.9446-7.983 bull wave.”

Global risk appetite helps,

too
The global environment remains
favorable toward emerging markets,
which is positive for the rand. Also,
given its relatively high interest rate,
the rand has been a player in the glob-
al carry trade, as well.
“The global risk appetite has

CURRENCY TRADER • August 2007 11

 ON THE MONEY

The rising yen — here we go again

Japan’s unique economy — and culture — will play major roles in determining whether
the current yen strength has legs.

BY BARBARA ROCKEFELLER

L ast month’s article (“The hammer and the yen,”

Currency Trader, July 2007) discussed a potential
trend reversal in the Japanese yen (JPY) that is
developing the way we feared. So far the yen
has risen about 4.00 points from the June 22 low at 124.15,
and no matter what indicator you draw on the chart, it’s a
clear reversal (see Figure 1, which shows the dollar-yen rate
cators used to signify overbought or oversold (not shown),
the yen is still “weak” and hasn’t even headed up toward
the overbought level. This implies the up move may have a
long way to go.
Drawing the standard error channel starting farther back
in time (from the May 2006 high of 109.00) shows the cur-
rent move’s trendline would meet the upper boundary of
with an inverted scale so yen strength vs. the dollar appears the channel at 119.50 sometime around Aug. 20 if it contin-
as an up move). ues at the same slope (Figure 2). This perspective of the
The yen staged a breakout over the standard error chan- channel shows the current yen move to be only a secondary
nel drawn from the March yen high. The current price is correction of the bigger primary down move. This is proba-
well over the red 20-day moving average and less than 100 bly the correct interpretation, but it doesn’t pass the “So
points from the green 200-day moving average — the latter what?” test if you are trying to trade the yen. The bottom
usually considered the “long-term” average that often acts line is, if you are trading the yen, you have to be long.
as resistance, like the channel top. Price has also surpassed
the previous highest high from early June (gold horizontal Learning to love the yen…for now
line). It’s interesting that on the basis of the relative But a real problem with going long the yen is that it’s diffi-
strength index (RSI) and the stochastic oscillator, two indi- cult to understand the reasons behind the currency’s rise.
Typically, when a trend reversal occurs
you can identify the sentiment shift as
FIGURE 1 — DAILY DOLLAR-YEN (INVERTED SCALE) it is occurring and know what’s com-
The yen has made a strong move off its June low vs. the dollar, pushing ing at least a few days in advance. This
above near-term resistance and positioning itself for a run at the 200-day time there’s a full plate of “reasons” for
moving average. the reversal, but none of them are com-
pelling. Even taken as a whole they are
not particularly powerful. Besides, the
countervailing reasons for the yen to
remain in its primary downtrend have
not gone away.
Let’s look at the reasons we can
comfort ourselves with as we buy yen.
First, there was a serious policy shift at
the Japanese Ministry of Finance in
late June (see “The hammer and the
yen”). The government simply no
longer sees a weak yen as acceptable.
Not only is the government worried
about pressure from other countries,
notably France, but a weak yen makes
energy and commodities expensive in
yen terms, which is a negative for
small and medium-sized firms, includ-
ing many exporters. Sony, Honda, and
the other big names are experienced
hedgers (and cost-cutters), but smaller
Source: Data — Reuters DataLink; charts — MetaStock
firms suffer.

12 August 2007 • CURRENCY TRADER

 FIGURE 2 — WEEKLY DOLLAR-YEN (INVERTED SCALE)
The reversal on the daily time frame currently is nothing more than a correction
It’s wise to respect a stated policy in the yen’s long-term downtrend.
shift such as this because governments
can be powerful influences, although
we hardly ever see the influence at
work. It’s done behind the scenes
using what is euphemistically called
“moral suasion.” In a phone call, over
drinks, or at the golf course, an official
makes a gentle suggestion to a banker
or broker, (“…and Bob’s your uncle”),
and the disliked behavior stops
instantly. Governments regulate banks
and brokers, plus they tax everybody.
You disobey a government official’s
suggestion at your peril. And in Japan,
respect for authority runs high.
There are numerous ways the gov-
ernment could nudge institutions
away from a weaker yen. Japanese
retail investors are avidly pursuing
accounts denominated in other curren-
cies, for example, but that would tend
not to be the focus. Instead, attention Source: Data — Reuters DataLink; charts — MetaStock
would likely turn to cutting lines of
credit to speculators, chiefly hedge banks fall victim to dud loans to such
funds, especially if they invested in institutions — or forex trades, either.
U.S. sub-prime paper. This would kill Presumably, lending to hedge funds
two birds with one stone — halting an has been curtailed, along with credit
outflow from yen and reducing expo- lines for simple position-taking trad-
sure to high-risk paper. ing. As for lending to domestic
The sub-prime housing problem in Japanese funds, Japan’s nine biggest
the U.S. has already hit a number of banking groups have more than ¥1 tril-
hedge funds, the main players in the lion ($8.3 billion) in various instru-
carry trade. An Australian hedge fund ments backed by U.S. sub-prime mort-
hired Blackstone to advise it on sub- gages, according to the JiJi newswire.
prime investments, and immediately In late July, Financial Services
everyone suspects these investments Agency (FSA) chief Yuji Yamamoto
were made with borrowed yen. We told the press the government is close-
don’t know that for a fact, but the mere ly monitoring Japanese financial insti-
suspicion suffices to goad some tution risk-management practices. The
traders into imagining that if there is FSA finds the banks “well-prepared.”
one firm doing this, there might be Considering the entire banking sector
dozens. was in the tank only 10 years ago and
As far as we know, no hedge fund survived only with massive govern-
using borrowed yen to invest in U.S. ment bailouts, we wonder whether
sub-prime has actually gone under, this can be true, but never mind. We
and we do not know if the sub-prime should probably assume that
problem is going to contaminate other Yamamoto told the banks to stop
collateralized debt funds to the point investing in the sector and perhaps
of failure. But from the hysteria in the even to dump some of the paper. Such
blogosphere, you’d think widespread trades are, in effect, repatriation, and
institutional failure is imminent. automatically entail buying yen.
Nearly all hedge funds are non- This presupposes the Japanese insti-
Japanese, but if Japanese banks are tutions do not just switch to better-
providing the funding, they are at risk, quality foreign paper. After all, the
too. yield differential is still vastly in the
Japan has no intention of letting its continued on p. 14

CURRENCY TRADER • August 2007 13

 ON THE MONEY continued

Other Barbara Rockefeller articles:

“The hammer and the yen”
Currency Trader, July 2007. favor of the Australian dollar, New Zealand dollar, British
Recent statements by Japan’s Ministry of Finance hint at pound, euro, and U.S. dollar. If the Japanese government were
big things on the horizon for the yen. asking its financial institutions to forego that additional yield,
it would be a shocking interference with private business.
“Too big to fail” (That doesn’t mean they wouldn’t do it.)
Currency Trader, June 2007. Another “reason” behind the yen’s rise is the widely expect-
If the dollar is poised to rebound, it might be getting help ed Bank of Japan (BOJ) rate hike in September or October,
where it least expects it. although possibly as early as August. This argument really
doesn’t hold water. A rate hike would still leave a very large
“Do stocks hold the key to currency levels?” gulf between Japanese and foreign paper, although we can
Currency Trader, May 2007. admit that if the famously reticent BOJ were to raise rates in the
The correlation between stock market and currency prices
absence of inflationary pressure in the name of “normaliza-
isn’t what many people think.
tion” and a nod to superior growth, then we need to pay atten-
“The coming commodity boom” tion; more hikes will be on the way. This is a tremendously con-
Currency Trader, April 2007. tentious issue: Under what circumstances should a central
Commodities are already having an impact on global bank, facing zero inflation, raise rates?
economies. One answer is that Japan has failed to become a global finan-
cial center on par with New York or London, but has not aban-
“The yen: Canary in the currency coal mine” doned the objective. Japan has the world’s second-largest econ-
Currency Trader, March 2007. omy but Tokyo is not the world’s second largest financial cen-
Keep an eye on capital flows and the yen — they could ter. In fact, Tokyo has lost rank over the past 15 years. The
be telling you more about the dollar than first meets Tokyo Stock Exchange is the world’s second-largest after the
the eye. New York Stock Exchange, but its capitalization is only 10 per-
cent of world capitalization, even as emerging markets rocket
“Indicator failure and scientific analysis” higher. It had one-third of world capitalization in 1990.
Currency Trader, February 2007. Foreigners don’t want to list their companies in Tokyo, with
This discussion of market biases and fallacies provides a
only 25 listing last year, from 125 the year before. New York,
more rigorous way to think about trading.
even with the deterrent of Sarbanes-Oxley rules, attracted
“Reserve diversification, Part II” more than 440 in 2006. Worse, in recent years the Tokyo Stock
Currency Trader, January 2007. Exchange has had some huge technology failures that shut
What is the U.S. doing to ensure the Chinese government down trading for entire days. Despite being the land of elec-
will not alter the $700 billion it has in U.S. dollar reserves? tronics, the exchange is considered technologically deficient.
Singapore and Hong Kong, with tiny economies, are bigger
“Charts are not enough” and more dynamic — and associated by language, history, and
Currency Trader, December 2006. culture with China, which is rapidly displacing Germany as
Breaking down price action in light of the news. the third largest economy.
The first study group on enhancing Japan’s position as an
“When will the yen go to the moon?” international financial center was held in 2003, but it seems to
Currency Trader, October 2006. be new FSA chief Yamamoto who is reviving the initiative. He
The fundamentals are all pointing toward an up move in adheres to the belief that you can’t be a major world financial
the Japanese yen. So what’s it waiting for? center with a falling currency that fails to reflect good econom-
ic fundamentals, which in Japan’s case is the highest growth
“Why is everybody losing money in forex?”
rate in the world in 2006. However, wishing to be a world
Currency Trader, September 2006.
Despite unprecedented liquidity, professional currency financial center is not the same thing as knowing how to get
managers have had a rough go of it in 2005 and 2006. there.
Has something changed in the forex world? Is it even remotely reasonable to assume that engineering a
stronger yen can be viewed as a prerequisite to this goal, and
“Gauging trader commitment” let’s worry about the rest of the components of becoming a
Currency Trader, August 2006. world center later on? Yes. It is exactly the kind of straight-line
Is this a good breakout or a false move? The thinking we have seen from Japan in the past — and oddly, it
Commitment of Traders report can help currency traders often succeeds.
fill in some of the holes left by the absence of traditional Working on becoming a world financial center could remain
volume data in forex. an objective of whatever government is in office, and Prime
Minister Shinzo Abe and his coalition government risk losing
You can purchase and download past articles at power in the July 29 elections. Even if Yamamoto does not
[Link] remain the FSA chief, the next guy would be bound by the

14 August 2007 • CURRENCY TRADER

overarching government objective. in the yen for the past six months,
Japan has a splendid history of long- because hedge fund managers have a
term planning. The next FSA head will “strong hand.” It's not easy to stam-
pick up the internationalization effort pede them out of lucrative positions.
where Yamamoto left off. But each manager has a breakeven
Having a stronger currency based in point and nerves get frayed even
part on higher interest rates is not the when the yen is hundreds of points
only obstacle Yamamoto faces in try- away. After all, currencies can move
ing to make Tokyo a global financial hundreds of points in a short while
center. He also has to overcome a pen- and currencies are famous for over-
chant for regulatory red tape that sti- shooting, too.
fles innovation and encourages people More importantly, folks riding the
to find ways around regulatory agen- coattails of the yen carry trade, includ-
cies (including the FSA itself) instead ing those with plain vanilla futures
of simply asking for exceptions and and forwards, are easy to panic. As
help. risk aversion rises with every new
Most observers say the biggest story about losses in subprime and
problems are cultural. To be an inter- other collateralized debt that was mis-
national center, you have to attract for- priced, incompetently rated by the rat-
eigners to live and work in Tokyo. But ings agencies, or can’t be marked to
the language is difficult to learn and market with any confidence, the carry
has complex nuances — the word for trade gets lumped in with other paper
“risk” didn’t exist in Japanese, and deemed “high-risk.” This is not accu-
comes from English. Women are sec- rate — with the carry trade, all you
ond-rate citizens and not represented need to know is your breakeven point.
at executive levels, a waste of half the You can count on the forex market to
manpower of the country. Japan has provide sufficient liquidity for an
its fair share of smart people, but argu- orderly exit at just about any hour of
ing and disagreeing with others is the day or night. With truly high-risk
socially unacceptable. It makes brain- paper, the unknowns are plentiful,
storming particularly difficult. And including markets so thin (illiquid)
respect for older people, while laud- that no trading gets done at all. But the
able, restrains brash youngsters from relative ease of exit doesn't matter to
making a splash. But splashiness and those prone to panic — the yen carry
disorder are what you need to sponsor trade is considered speculative, and
change. plenty of traders will simply dump
positions.
The story is the story Add to that a possible rate hike and
Of all the reasons for the yen to be on a government determined to rise in
the upswing, the sub-prime hedge the ranking of global financial centers
fund story seems to be the one that has on the back of a high currency and you
captured traders’ imagination. That have a recipe for further gains.
we have no hard evidence of yen- Is this a castle built out of spun
funded hedge-fund failures and no sugar? You bet. The whole thing can
evidence of a lending pullback, come crashing down if the sub-prime
whether government-mandated or problem fades away with no big insti-
not, is no deterrent to traders. It’s a tutional failures, Abe loses the elec-
juicy story. It makes sense. All it will tion, the BOJ refuses to raise rates
take is one outright yen-funded because there is no inflationary reason
hedge-fund failure to send the yen to to raise rates, and the timetable for
the moon. restoring Tokyo to world status is seen
The yen can also go to the moon if to be a project for a decade, not the
carry trades actually do get unwound. next three months. But in the mean-
We have been pooh-poohing that time, you have to go with the flow.
story, which has been used to explain
any and every minor bounce upward For information on the author see p. 6.

CURRENCY TRADER • August 2007 15

 TRADING STRATEGIES

Short-term trends
in the EUR/USD pair
Analyzing both the duration and size of different price moves can clue you
in to more accurate trade setups.
BY CURRENCY TRADER STAFF

A common problem in the markets is trading

with hindsight. For example, you make a
trade, book a profit, and then watch the
move continue — realizing you left money
on the table by not being more patient. Other times you wait
for that nice run that never materializes.
Trading with hindsight can introduce psychological
issues when managing a trade. You might think you can
judge by the current conditions whether a big move is at
hand or not. But if you second-guess yourself for getting
out too early or too late, you’ll have problems taking the
next trade.

FIGURE 1 — DAILY EUR/USD

Two sharp runs — one up, one down — are marked on the chart. How often does this currency pair make consecutive daily
higher highs or lows?

Source: CQGNet ([Link]

16 August 2007 • CURRENCY TRADER

FIGURE 2 — WEEKLY EUR/USD
The review period spanned July 2003 through June 2007.

Source: CQGNet ([Link]

The best way to avoid this is to per-

form a thorough analysis of market
behavior and get some hard numbers
on which to base your trades. You will
know what typical market behavior is
and can develop strategies around
that knowledge. In addition, perform-
ing this type of market analysis on a
regular basis will alert you to changes
in market volatility.
For example, in Figure 1, the price
run next to arrow “A” is a run of 13
consecutive higher highs but only six
consecutive higher closes. Arrow “B”
marks a run of four consecutive lower
lows, but only three consecutive lower
closes. The question is, just how often
do such runs occur?
This analysis dissects trend runs
using daily bars of the euro/U.S. dol-
lar (EUR/USD) pair from July 1, 2003
through June 29, 2007 and identifies
the number of consecutive higher or
lower highs, higher or lower lows,
and higher or lower closes in different
continued on p. 18

CURRENCY TRADER • August 2007 17

 TRADING STRATEGIES continued

TABLE 1 — HIGHER HIGHS VS. LOWER LOWS

daily price range behavior.
The EUR/USD trend was up for more than four years, which is
The top half of Table 1 compares one day’s session
reflected by the slight edge in the numbers for higher prices (top
half of the table) vs. lower prices (bottom half of the table). to the next day’s session, detailing the number of
times there were consecutive higher highs (HH),
HH HL HC HH+HC HH+HL+HC higher lows (HL), higher closes (HC), higher highs
543 531 524 367 300 and higher closes (HH +HC), and higher highs, high-
52.11% 50.96% 50.29% 35.22% 28.79% er lows, and higher closes (HH+HL+HC)
The bottom half of Table 1 shows the number of
LL LH LC LL+LC LL+LH+LC times there were consecutive lower lows (LL), lower
highs (LH), lower closes (LC), lower lows and lower
503 492 512 332 256
closes (LL +LC), and lower lows, lower highs, and
48.27% 47.22% 49.14% 31.86% 24.57%
lower closes (LL+LH+LC).
First, the percentage change (on a closing basis) for
price moves, as well as other patterns. the entire review period was a gain of just over 17 percent.
Figure 2 shows the review period using weekly bars, but The table shows the influence of this long-term trend, but it
the analysis was performed on daily data. is relatively minor — the numbers in the top half of the
table are slightly larger than the bottom. A closer look at the
Up moves vs. down moves numbers points to some interesting price action.
To get a handle on typical moves vs. what could be consid- The market made either a higher high, higher low, or
ered outliers, Tables 1 and 2 show the EUR/USD’s basic higher close more than 50 percent of the time — unsurpris-
ing given the long-term trend.
However, combining higher highs
and higher closes dropped the per-
centage to 35 percent of the time, and
back-to-back higher highs, higher
lows, and higher closes occurred just
under 29 percent of the time. This sug-
gests that despite the buying pressure
from one session to the next, traders
tended to take profits going into the
close over 70 percent of the time.
None of the statistics in the bottom
half of the table break the 50-percent
level. However, the percentage of
lower closes was higher than the per-
centage of lower lows or lower highs.
This implies there were inside days
when the market essentially paused;
when the market could not generate
an up move, traders moved out of
long positions, producing lower clos-
es.
The percentage of consecutive
lower lows and lower closes is just
under 32 percent and the percentage
of consecutive lower lows, lower
highs, and lower closes is slightly less
than 25 percent. The bullish trend is

18 August 2007 • CURRENCY TRADER

TABLE 2 — EUR/USD RUNS

Despite the EUR/USD’s upward bias, the market posted seven consecutive higher closes (HC) only three times, while it made
seven consecutive lower closes on five different occasions.

HC HH+HC HH+HL+HC
No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2
Count 3 13 28 56 117 254 0 2 8 25 69 150 0 0 4 15 46 109
% 0.29% 1.25% 2.69% 5.37% 11.23% 24.38% 0.00% 0.19% 0.77% 2.40% 6.62% 14.40% 0.00% 0.00% 0.38% 1.44% 4.41% 10.46%

LC LL+LC LH+LL+LC
No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2
Count 5 15 31 58 111 242 0 3 10 22 53 131 0 2 7 16 35 87
% 0.48% 1.44% 2.98% 5.57% 10.65% 23.22% 0.00% 0.29% 0.96% 2.11% 5.09% 12.57% 0.00% 0.19% 0.67% 1.54% 3.36% 8.35%

also reflected in these two statistics, because they suggest trend was up during the review period, Table 2 has some
there were times the market traded lower than the previous interesting details. First, there were more times the market
session, but buyers came in and bid the market up to a high- closed down seven consecutive times than up. Of course,
er closing price. the difference (two) is not statistically significant, but the
Table 2 displays a more detailed breakdown of the fre- number of runs of consecutive lower closes is larger than
quency and length of runs in the EUR/USD pair. The “No. the number of consecutive higher closes from lengths of
of days” row is the number of sessions that met the criteria. four to seven days. (However, the percentage price changes
For example, “7” means a run of seven (or more) consecu- continued on p. 20
tive days; “6” means a run of six or
more sessions, etc.
Although, the table does not explic-
itly show the exact number of occur-
rences in each category, simple arith-
metic reveals the answers. For exam-
ple, there were 117 runs of three or
more consecutive higher closes (HC);
these 117 runs are also part of the 254
runs of two or more consecutive high-
er closes (254 occurrences). As a result,
there were 137 (254 - 117) runs of only
two consecutive days of higher closes.
The top half of Table 2 shows the
market made seven consecutive high-
er closes only three times, or just 0.29
percent of the time. The same statistics
are detailed for consecutively higher
highs and higher closes (HH+HC),
and higher highs, higher lows, and
higher closes (HH+HL+HC). The bot-
tom half of the table shows the infor-
mation for lower closes (LC), lower
lows and lower closes (LL+LC), and
lower highs, lower lows, and lower
closes (LH+LL+LC).
In light of the fact the long-term

CURRENCY TRADER • August 2007 19

 TRADING STRATEGIES continued

TABLE 3 — MARKET PERFORMANCE

The percentage price moves from one to five days is shown for the total review period as well as for 12-month sub-periods.

Total D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM
Avg 0.02% 0.41% -0.42% 0.03% 0.60% -0.59% 0.05% 0.74% -0.72% 0.07% 0.86% -0.82% 0.08% 0.97% -0.90%
Med 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68%
STD 0.56% 0.35% 0.35% 0.77% 0.47% 0.49% 0.93% 0.57% 0.59% 1.08% 0.65% 0.68% 1.19% 0.73% 0.75%
7/1/2003-6/30/2004
Avg 0.02% 0.51% -0.53% 0.05% 0.74% -0.75% 0.08% 0.92% -0.92% 0.10% 1.07% -1.05% 0.14% 1.21% -1.17%
Med 0.04% 0.41% -0.45% 0.10% 0.64% -0.58% 0.17% 0.81% -0.70% 0.27% 0.95% -0.80% 0.35% 1.12% -0.87%
Max 1.91% 1.99% 0.00% 2.39% 2.62% 0.00% 2.99% 3.25% 0.00% 3.49% 3.62% 0.00% 3.94% 3.99% 0.00%
Min -1.93% 0.00% -2.11% -2.80% 0.00% -3.19% -2.97% 0.00% -3.47% -3.32% 0.00% -3.47% -3.69% 0.00% -3.85%
STD 0.71% 0.41% 0.44% 0.96% 0.55% 0.61% 1.12% 0.65% 0.73% 1.31% 0.76% 0.83% 1.43% 0.84% 0.92

7/1/2004-6/30/2005
Avg -0.01% 0.39% -0.44% -0.01% 0.57% -0.63% -0.02% 0.70% -0.77% -0.03% 0.82% -0.89% -0.04% 0.91% -1.00%
Med -0.02% 0.30% -0.35% -0.02% 0.46% -0.50% 0.02% 0.57% -0.62% 0.00% 0.68% -0.71% 0.02% 0.81% -0.77%
Max 1.84% 1.95% 0.00% 1.90% 2.01% 0.00% 2.12% 2.20% 0.00% 2.35% 2.53% 0.00% 2.50% 2.68% 0.00%
Min -1.44% 0.00% -1.66% -2.36% 0.00% -2.53% -3.21% 0.00% -3.37% -3.05% 0.00% -3.37% -3.68% 0.00% -3.90%
STD 0.56% 0.34% 0.36% 0.79% 0.45% 0.51% 0.98% 0.53% 0.63% 1.14% 0.61% 0.72% 1.28% 0.67% 0.81%

7/1/2005-6/30/2006
Avg 0.03% 0.42% -0.42% 0.06% 0.62% -0.58% 0.08% 0.78% -0.70% 0.11% 0.92% -0.78% 0.14% 1.04% -0.86%
Med 0.00% 0.33% -0.33% 0.02% 0.49% -0.49% 0.04% 0.60% -0.60% 0.05% 0.74% -0.66% 0.06% 0.84% -0.71%
Max 1.70% 1.91% 0.00% 2.52% 2.73% 0.00% 2.56% 3.03% 0.00% 2.79% 3.03% 0.00% 2.76% 3.03% 0.00%
Min -1.23% 0.00% -1.38% -2.15% 0.00% -2.24% -2.23% 0.00% -2.46% -2.42% 0.00% -3.01% -2.56% 0.00% -3.01%
STD 0.54% 0.36% 0.31% 0.77% 0.51% 0.40% 0.92% 0.62% 0.49% 1.05% 0.69% 0.55% 1.15% 0.76% 0.61%

7/1/2006-6/30/2007
Avg 0.02% 0.31% -0.28% 0.04% 0.44% -0.40% 0.07% 0.54% -0.47% 0.09% 0.63% -0.53% 0.11% 0.71% -0.58%
Med 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45%
Max 1.15% 1.27% 0.00% 1.48% 1.73% 0.00% 1.97% 2.06% 0.00% 2.26% 2.51% -0.01% 2.76% 2.84% -0.01%
Min -1.05% 0.00% -1.12% -1.42% 0.00% -1.48% -2.04% 0.00% -2.19% -2.01% 0.00% -2.25% -2.13% 0.01% -2.36%
STD 0.36% 0.23% 0.21% 0.52% 0.32% 0.30% 0.62% 0.38% 0.37% 0.71% 0.44% 0.43% 0.79% 0.49% 0.47%

during these runs is not included here.) Size of price moves

There’s a similar pattern in the number of higher highs Table 3 details the percentage size of price moves from one
and higher closes (HH+HC) relative to lower lows and to five days in length for the entire review period, as well as
lower closes (LL+LC). Neither category had any runs last- in 12-month increments. Included are the average, median,
ing seven consecutive days, but the percentage of six- and maximum, minimum, and standard deviation for each
five-day runs of lower lows and lower closes edged out the close-to-close move, largest up move (LUM), and largest
percentage of higher highs and higher closes. down move (LDM) for each period (see “Understanding
The final comparison is higher highs, higher lows, and Table 3” for details about the statistics).
higher closes (HH+HL+HC) vs. lower highs, lower lows, For example, for the entire analysis period, the average
and lower closes (LC). There were two runs of six consecu- three-day close-to-close change was a gain of 0.05 percent,
tive LH+LL+LC days on the bear side, and the five-day and the maximum gain was +2.99 percent (which occurred in
four-day runs outnumbered the HH+HL+HC counterparts. the July 1, 2003 to June 30, 2004 period) and the largest
continued on p. 22

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three-day, close-to-close decline was -3.21 percent (from the The median close-to-close price move was negative over the
July 1, 2004 to June 30, 2005 period). The average three-day next three sessions, after which the market rebounded.
LUM was +0.74 percent and the average three-day LDM Figure 3 compares the performance after the pullback
was -0.72 percent. patterns and the typical market performance.
Because the long-term trend was up, let’s see if some of continued on p. 24
the information from Table 3 can pro-
vide insight as to what the market did
following pullbacks.
Understanding Table 3
Two-day pullbacks Table 3 summarizes price behavior for dif-
Table 4 compares Table 3’s median ferent scenarios. It shows the average,
price moves for the entire the analysis median, maximum, and minimum price
period and the final 12 months of the changes from:
review period (July 3, 2006 to June 30, 1. The initial closing price to the
2007) to: 1) the median moves after
closing prices of the next five days
two-day, -1.44 percent (or greater)
(D1 to D5);
declines, 2) two consecutive days of
LL+LH+LC, and a combination of 1 2. The closing price to each following
and 2. day’s highest high (largest up move,
The 1.44-percent drop was chosen or “LUM”);
because the median two-day LDM was 3. The closing price to each following
-0.46 percent and the standard devia-
day’s lowest low (largest down move,
tion was 0.49 percent; therefore, a two-
or “LDM”).
day drop larger than -1.44 percent was
exceptionally big (more than two stan-
dard deviations). Also, the standard deviations (StD) for the close-to-close changes are
Despite the EUR/USD’s long-term included.
uptrend, you would have taken some
heat if you bought pullbacks when the Figure A shows the close-to-close moves, LUMs, and LDMs from the
market made two consecutive lower initial bar to the two subsequent bars.
lows, lower highs, and lower closes:

TABLE 4 — PULLBACK PATTERN

To determine whether a certain type of pullback represented a trade opportunity, the EUR/USD’s median price action was compared
to a pattern consisting of a two-day, -1.44-percent correction where both days had lower lows, lower highs, and lower closes.

D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM
Overall 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68%

7/3/2006-6/30/2007 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45%

2-day LL+LH+LC -0.03% 0.30% -0.35% -0.06% 0.47% -0.51% -0.03% 0.56% -0.63% 0.10% 0.69% -0.71% 0.18% 0.81% -0.77%
(87 instances)
2-day drop -1.44% 0.02% 0.30% -0.45% 0.02% 0.49% -0.51% 0.17% 0.65% -0.65% 0.31% 0.77% -0.67% 0.15% 1.06% -0.74%
(40 instances)
Combination 0.02% 0.30% -0.44% 0.14% 0.47% -0.52% 0.11% 0.64% -0.63% 0.32% 0.74% -0.68% 0.21% 0.94% -0.74%
(27 instances)

22 August 2007 • CURRENCY TRADER

 TRADING STRATEGIES continued

However, the combination of two

FIGURE 3 — PULLBACK COMPARISON
consecutive LH+LL+LC days and a
two-day, -1.44 percent decline was fol- A two-day drop with lower lows, lower highs, and lower closes was followed
with three more sessions of lower median close-to-close changes.
lowed by larger than average upside
moves for days two through five. The
largest median close-to-close change
occurred after four sessions.

Robust analysis
Combining the analysis of “runs” —
consecutive days of higher or lower
highs, lows, and closes — with price
moves of different sizes provides a dif-
ferent way to conceptualize concepts
such as market exhaustion than rely-
ing on off-the-shelf indicators or gut
feeling. Finally, as Table 3 illustrates,
volatility has been declining, as the
standard deviation for the five-day close-to-close changes This highlights the importance of updating your analysis on
has fallen in each 12-month section of the review period. a regular basis.

Related reading
“New Zealand dollar trading numbers” “Euro/yen: Tips and tendencies”
Currency Trader, June 2007. Currency Trader, December 2006.
Detailed analysis of the “kiwi” dollar’s trading tendencies Euro/yen by the numbers: Stats and tendencies for short-
and characteristics. term forex players.

“Dollar-yen trading tendencies” “Breaking down the euro”

Currency Trader, April 2007. Currency Trader, November 2006.
The dollar-yen’s trading characteristics are examined on Studying the euro’s daily and intraday performance statistics
daily and intraday time frames. offers guidelines for systematic and discretionary traders.

“Deciphering the British pound” “The yen stands alone” by Howard L. Simons.
Currency Trader, March 2007. Currency Trader, March 2006.
The British pound has been a volatile — and mostly bullish The usual rules of the currency world don’t necessarily
— currency in recent months. Find out how it trades from apply to the Japanese yen. Will that continue to be the
day to day. case, or is Japan poised to revamp its economic model in a
way that will dramatically alter the yen’s longstanding
“Dollar-Canada by the numbers” dynamics? Note: This article is also part of the
Currency Trader, January 2006. “Howard Simons: Advanced Currency Concepts, Vol. 1”
As the only purely North American major currency pair, the article collection, which contains nine Currency Trader
dollar-Canada rate occupies a unique position. We break articles by Howard Simons.
down its short-term performance to reveal daily and intraday
tendencies. You can purchase and download articles at
[Link]

24 August 2007 • CURRENCY TRADER

 ADVANCED STRATEGIES

Minor currencies
and federal reserve trade weights
The verdict is in: Currency rates don’t affect trade.

BY HOWARD L. SIMONS

L examined major currencies’ impact on Federal

entire premise behind the floating exchange-rate regime of
ast month’s article “Currencies and federal reserve
the past 35 years is wrong.
trade weights” (Currency Trader, July 2007), which
As all currency traders learn quickly, major currencies
have different trading patterns and represent different
Reserve trade weights, concluded: “A review of U.S. trade
underlying economies than minor currencies, which are
patterns with major currency trading partners reveals little
buffeted more by speculative capital flows even as their
evidence that a weaker currency leads to greater export
markets are shallower than the majors’. Will analysis of the
competitiveness and a lower ability to import.” In short, the
minors support the findings of the
FIGURE 1 — THE CHINESE YUAN AND ITS WEIGHT IN U.S. TRADE
study of the majors, or are Federal
Reserve trade weights for the
minor currencies more sensitive to
changes in the currencies them-
selves?

Recap of data and methodology

First, the analysis process used
here is identical to that used last
month:
To maintain its trade-weighted dol-
lar index ([Link]
[Link]/releases/H10/Weights/), the
Federal Reserve must keep track of the
changing use of various currencies the
U.S. receives in return for its exports
and pays for its imports. In these
FIGURE 2 — THE TAIWAN DOLLAR AND ITS WEIGHT IN U.S. TRADE charts, export weights are depicted in
blue and import weights in green.
These weights are calculated on an
annual basis and, of necessity, after
the fact. Because the Federal Reserve is
unable to license its dollar index for
commercial purposes, many traders
are unfamiliar with this data.
Also, these currency weights reflect
their use in bilateral trade with the
U.S. and do not reflect total bilateral
trade. This is critical for countries
from whom the U.S. imports large
quantities of goods priced in dollars,
such as crude oil and various metals.
Annual data are of little trading use

26 August 2007 • CURRENCY TRADER

 The entire premise FIGURE 3 — THE HONG KONG DOLLAR AND ITS WEIGHT IN U.S. TRADE

behind the floating

exchange-rate
regime of the past
35 years is wrong.
in a continuous market such as cur-
rencies. We can create smoothed series
of import and export weights via a sta-
tistical technique called “cubic spline
interpolation.” This technique is used
twice in the charts below — once to FIGURE 4 — THE SINGAPORE DOLLAR AND ITS WEIGHT IN U.S. TRADE
create quarterly series from the annu-
al numbers and a second time to create
monthly numbers from the quarterly
results.
The resulting interpolations are far
easier to absorb than the annual num-
bers, but as they involve two separate
data transformations, we did not
attempt any further statistical analy-
sis against monthly currency values
(presented in red in the charts). In
addition, please be advised all curren-
cies are displayed in the “USD per”
convention familiar to traders of the
euro, the British pound, and currency
futures. The currency scale is inverted
for currencies commonly expressed as FIGURE 5 — THE KOREAN WON AND ITS WEIGHT IN U.S. TRADE
“per USD,” so a rising red line always
conveys strength vs. the dollar and a
falling red line always conveys weak-
ness.

A second passage from last

month is mentioned here for clari-
ty:
Even though the principal advocate
of floating exchange rates, the late
Milton Friedman, was the antithesis
of a protectionist, his arguments have
been seized by this faction to the extent
that the notion a weaker currency
continued on p. 28

CURRENCY TRADER • August 2007 27

 ADVANCED STRATEGIES continued

should stimulate exports and reduce

FIGURE 6 — THE THAI BAHT AND ITS WEIGHT IN U.S. TRADE
imports will be referred to as the “pro-
tectionist argument.”

East Asian currencies

With all the political rhetoric call-
ing for a stronger Chinese yuan, it
is easy to lose sight of the fact that
export weights to China rose
steadily between 2000 and 2006.
Moreover, as China’s wealth level
grows, so should both the volume
and the value-added content of its
imports from the U.S. This so-
called “marginal propensity to
import” is characteristic of all
growing economies.
The surge in import weights FIGURE 7 — THE MALAYSIAN RINGGIT AND ITS WEIGHT IN U.S. TRADE
from China is, of course, the dom-
inant feature in Figure 1. No
nation on earth has China’s cost
advantages in labor, a state-con-
trolled banking system with over
$1 trillion in foreign exchange
reserves, low levels of environ-
mental and safety costs, and pro-
ductivity advantages from new
plants and equipment. Given
these advantages, we do need to
ask whether any level of the yuan
(CNY) would have offset these
formidable advantages; the bet-
ting here is the yuan could be
much stronger with no adverse
FIGURE 8 — THE INDONESIAN RUPIAH AND ITS WEIGHT IN U.S. TRADE
effects on Chinese exports.
Taiwan’s importance as an
exporter to the U.S. has been
declining steadily since the mid-
1980s. In all likelihood, exports
from Taiwan have been displaced
by exports from China. The
island’s share in U.S. export
weights has tracked changes in
the TWD to a degree (Figure 2).
This indicates some measure of
currency price elasticity in
Taiwan’s import decisions.
Hong Kong provides an inter-
esting rebuttal to the protectionist
argument. Although its currency
has been locked in a tight range since the mid-1980s, its clude the uptrend in export weights between 1986 and 1996
import weights have fallen steadily since then (Figure 3). If meant the HKD was overvalued.
the protectionist argument was correct, we would have to Neither is likely. As in the Taiwan example, the simplest
conclude the Hong Kong dollar (HKD) was overvalued at explanation is the best. Hong Kong’s exports to the U.S.
this lower range. Moreover, we also would have to con- have been displaced by exports from China.

28 August 2007 • CURRENCY TRADER

 We can draw the same conclusion by examining Asian crisis (Figure 8). The 1997 collapse of the rupiah (IDR)
Singapore, which we will group with the East Asian rather preceded a decline — not the theorized increase — in
than the South Asian countries by virtue of its largely import weights. The same cannot be said for export
Chinese population. The 1997-2001 decline in the SGD did weights, however: Indonesia’s sudden impoverishment led
nothing to arrest its falling import continued on p. 30
weights, and the 2002-2006 rally
didn’t do anything to accelerate the FIGURE 9 — THE PHILIPPINE PESO AND ITS WEIGHT IN U.S. TRADE
downtrend already in place (Figure
4). These simply reflect China’s
ascendancy. Export weights to
Singapore rose modestly in the
mid-1990s “Asian Tiger” epoch,
but have flattened since.
The final East Asian currency is
the Korean won (KRW, Figure 5).
This currency was hugely affected
by the 1997-1998 Asian crisis.
Although import weights from
Korea — which had been in decline
since 1988 — reversed after the
KRW’s plunge and declined after
the KRW’s post-2004 rally, the real
impact was the large drop in export
FIGURE 10 — THE MEXICAN PESO AND ITS WEIGHT IN U.S. TRADE
weights to Korea during the Asian
crisis. This reflected both changes
in the currency and the large drop
in Korean national income during
this period.

South Asian currencies

Speaking of the Asian crisis, let’s
look at the currency that started it
all, the Thai baht (THB). Prior to
1998, both the import and the
export weights for the baht were
trending higher (Figure 6). The
cheaper baht did nothing to
increase its import weights, and the
loss of purchasing power in
Thailand did surprisingly little to FIGURE 11 — THE BRAZILIAN REAL AND ITS WEIGHT IN U.S. TRADE
reduce export weights to Thailand.
Overall, Thailand’s contribution to
U.S. trade is and has been fairly
minor.
The picture for Malaysia is simi-
lar to that of Thailand (Figure 7).
Both import weights from
Malaysia and export weights to it
grew rapidly between 1986 and
1996 — and were unaffected by the
ringgit’s (MYR) sharp drop.
Neither the MYR nor the course of
the Malaysian economy affected its
trade weights with the U.S.
Indonesia also suffered in the

CURRENCY TRADER • August 2007 29

 ADVANCED STRATEGIES continued

after the PHP fell in 1997, but

FIGURE 12 — THE ARGENTINE PESO AND ITS WEIGHT IN U.S. TRADE
export weights to the suddenly
poorer country actually trended
higher between 1998 and 2003
before falling sharply in 2004.

Latin American
currencies
Mexico is a special case on several
levels. Its peso (MXN) has col-
lapsed on three separate occasions
without triggering the macroeco-
nomic collapses normally associ-
ated with such events. As a mem-
ber of NAFTA, its trade with the
U.S. on both the import and
export sides has grown regardless
FIGURE 13 — THE VENEZUELAN BOLIVAR AND ITS WEIGHT IN U.S. TRADE of the currency. Its major source of
foreign exchange, crude oil
exports, is priced in USD, and it
has another major source of dol-
lars, the remittances of Mexican
nationals living and working in
the U.S. And like Colombia,
Mexico has large, undocumented
sources of U.S. dollars.
U.S. export weights to Mexico
surged after NAFTA and have lev-
eled off near a large 15 percent
level (Figure 10). Import weights
from Mexico have fallen as many
of the light manufactured exports
from Mexican maquiladora plants
have been displaced by cheaper
FIGURE 14 — THE CHILEAN PESO AND ITS WEIGHT IN U.S. TRADE
goods from China. All of these fac-
tors combine to make the MXN
rate largely irrelevant as the U.S.’s
fourth-largest trading partner.
The Brazilian real (BRL) has a
short history. It came into being in
1994 following the untimely
demise of a long list of predeces-
sors, but even so it has managed to
collapse three times in 12 years. In
defiance of the protectionists’ the-
ories, the impact on import
weights has been minimal (Figure
11). Export weights to Brazil have
declined since 1997, a period in
which economic growth in Brazil
to a swift decline in export weights, one that has yet to has been strong. This may be a rare case when the currency
recover. price elasticity of demand exceeds income elasticity of
The last South Asian currency to be examined is the demand.
Philippine peso (PHP), which is yet another refutation of Argentina, like Brazil, has gone through multiple curren-
the protectionists (Figure 9). Its import weights fell sharply cies. These have included the peso ley, the austral, and a

30 August 2007 • CURRENCY TRADER

direct peg to the USD. There is also the little matter of fre- India, Russia, Saudi Arabia, and Israel represent special
quent defaults, nationalizations, and other non-currency cases and thus are discussed on a non-geographic basis.
impediments to the free flow of goods and services. The growing importance of the U.S.-India bilateral eco-
Import weights from Argentina scarcely have budged nomic relationship is not reflected well in the trade data; it
since 1992 (Figure 12). Export continued on p. 32
weights to Argentina began to fall
in 1999 as the country suffered FIGURE 15 — THE COLOMBIAN PESO AND ITS WEIGHT IN U.S. TRADE
during its dollar-peg epoch, and
then collapsed going into the 2002
debt default. They have rebound-
ed somewhat with the peso (ARS);
this is an income effect, not a cur-
rency effect.
Import weights from Venezuela
have been quite low, as
Venezuela’s chief export to the
U.S., crude oil, is priced in USD
(Figure 13). Export weights have
fallen as the bolivar has weakened
during the Chavez era; it’s diffi-
cult to discern whether this is cur-
rency-related, income-related, or
political.
FIGURE 16 — THE INDIAN RUPEE AND ITS WEIGHT IN U.S. TRADE
Chile enjoys so much a reputa-
tion as South America’s success
story that first-time observers
have trouble absorbing the extent
of the peso’s (CLP) decline since
1988. Export weights to Chile rose
between 1988 and 1996 even as
the CLP fell, and then fell into
2003 as the CLP fell (Figure 14).
Factors other than currency move-
ments likely were involved.
In addition, the weights of
imports from Chile have
increased even as the CLP rose
after 2003. Chile’s efficiencies in
agricultural exports — its leading
export, copper, is priced in USD FIGURE 17 — THE RUSSIAN RUBLE AND ITS WEIGHT IN U.S. TRADE
— probably account for this.
Export weights to Colombia
have tracked movements in the
peso (COP) in a manner consis-
tent with standard theory (Figure
15). Import weights from
Colombia have increased since
2002 even in the face of a firmer
COP. The U.S.-Colombia trade
picture is so distorted by undocu-
mented flows that further com-
ments will be withheld.

Other currencies
The final group of currencies for

CURRENCY TRADER • August 2007 31

 ADVANCED STRATEGIES continued

FIGURE 18 — THE ISRAELI SHEKEL AND ITS WEIGHT IN U.S. TRADE

tion of the Indian economy far
more than the decline in the rupee
(INR, Figure 16). Export weights to
India have jumped since 2001 even
as the rupee has remained near its
lows.
Export weights to Russia fell
during the country’s 1998 default
and have rebounded since the
ruble’s (RUB) modest recovery
(Figure 17). Bilateral trade between
the U.S. and Russia is very small
and is confined to specialty goods
and minerals.
The increasing import weights
from Israel during the shekel’s
FIGURE 19 — THE SAUDI RIYAL AND ITS WEIGHT IN U.S. TRADE
(ILS) 1982-2002 decline are as
expected in classic theory (Figure
18). The generally increasing
export weights to Israel during
this same period are antithetical to
classic theory. Too much U.S.-
Israel trade is dollar-denominated
or is confined to sectors such as
technology and military hardware
for currency movements to be a
real factor.
Finally, we come to a special
case — Saudi Arabia. The riyal
(SAR) is de facto fixed — note the
range — and import weights skirt
near zero (Figure 19). Their princi-
is increasingly a “post-industrial” relationship. Included pal export is priced in USD. Export weights to Saudi
are skilled labor imported from India and information Arabia have declined somewhat over the years, but given
services outsourced to India. the importance of military hardware and other sensitive
Import weights have been increasing steadily since the exports to Saudi Arabia, this data stream probably does
late 1980s, which in all likelihood reflects the moderniza- not reveal much.

Can’t fight the data

Related reading We have reviewed 26 currencies with as many as 34 years
of trade data accounting for 100 percent of the Federal
“Currencies and Federal Reserve trade weights” Reserve’s trade-weighting scheme.
Currency Trader, July 2007. We found some isolated instances wherein export
The theory that a weaker dollar makes U.S. goods and weights to countries whose currencies had appreciated
services more competitive abroad sounds nice, but the facts rose and some isolated instances wherein import weights
argue otherwise. from countries whose currencies had depreciated rose.
These were noted duly.
“Howard Simons: Advanced Currency Concepts, Vol. 1” The preponderance of evidence, however, is income
A discounted collection that includes many of the articles elasticities, trade agreements, economic integration, and
listed here. the terms in which goods and services are priced, among
other factors, are all more important than currencies in
You can purchase and download past articles at affecting trade flows.
[Link]
For information on the author see p. 6.

32 August 2007 • CURRENCY TRADER

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 TRADING BASICS

Long-term interest rates

and the U.S. dollar
Rising long-term Treasury yield should imply a higher dollar — at some point — but history shows
many other factors can get in the way of that easy assumption.

BY DAVID MANTELL

FIGURE 1 — CHANGING YIELD CURVE

Comparing the yield curve on July 2 and March 5 shows the
curve has regained its “normal” shape — upward sloping,
with long-term interest rates higher than short-term rates.

F
ollowing the direction of short-term interest
rates is a vital part of determining the likely
direction of a particular currency or currency
pair. But what can long-term interest rates tell
us about the future price behavior of currencies?
Rising long-term interest rates have been very much in
the news lately. On June 13, the yield on the 10-year T-note
climbed to a five-year high of 5.327 percent. The 4.50-per-
cent note finished June at a yield of 5.03 percent — 54 basis
points higher than its March 7 low of 4.49 percent. (For a
review of T-notes and their terminology, see “Treasury
backgrounder.”)
Normally, the yield curve — which depicts the difference
between short-term and long-term Treasury yields — rises,
reflecting the higher yields usually associated with longer Supported by a strong May retail sales report (the best
Treasury maturities (Figure 1). When short-term yields are showing in more than a year), traders have become less
higher than long-term yields, as has recently been the case, convinced the Federal Reserve will cut short-term interest
the curve is referred to as “inverted” — a condition that has rates. At least one interpretation, then, of the rise in long-

One interpretation is the rise in long-term rates portends improvement

in the prospects for economic growth; another is that improved
economic growth could be accompanied by higher inflation.
historically been interpreted as a warning sign that a reces- term rates is that it portends improvement in the prospects
sion is looming. With the recent increase in long-term rates, for economic growth (see “Doom, gloom, and long-term
however, the yield curve has returned to its normal shape. interest rates,” Active Trader, September 2007).
What’s behind the jump in long-term interest rates? Another interpretation is that improved economic

34 August 2007 • CURRENCY TRADER

 FIGURE 2 — DOLLAR WEAK VS. EURO
Despite the recent long-term rate increase, the dollar has remained
weak vs. most major currencies — reflected in the new highs reached
by the euro/dollar pair.

growth could be accompanied by higher infla-

tion. However, recent price data suggests infla-
tion remains mild and appears to be under
control. The personal consumption expendi-
tures index (excluding food and energy), a key
inflation measure, increased 1.9 percent in May
vs. the same period last year. This is the small-
est year-over-year increase since March 2004.

The currency connection

What are the ramifications for the U.S. dollar?
If higher long-term rates are indicative of an
improving U.S. economy, that would be bullish
for the greenback. If there is an inflation com-
ponent to stronger economic growth, and if
higher long-term rates are indicative of that, Source: TradeStation
the Fed will be more likely to raise short-term
rates. That, too, would be positive for the U.S. Treasury backgrounder
dollar, causing investors searching for high
short-term yields to put their cash in the U.S. Treasury notes and bonds are debt securities issued by the United
Overall, higher long-term rates are fairly States Treasury. They are considered debt instruments because by
promising for the U.S. dollar. Thus far, howev- purchasing them you are loaning money to the Treasury depart-
er, this has not been reflected in the dollar’s ment, which then pays you interest (determined by a “coupon rate”)
action against most major currencies, includ- on a semiannual basis and returns the principal when the bond or
note matures on the maturity date. T-bonds and T-notes are also
ing the euro (Figure 2).
called “fixed-income” securities because of the fixed coupon pay-
ment an investor receives while holding the bond or note.
What does the past tell us?
T-notes are issued in maturities of two, three, five, and 10 years;
The U.S. economy experienced a similar sce- T-bonds have maturities greater than 10 years (e.g., the 30-year T-
nario in April of 2006. On Jan. 23, 2006, the 10- bond). The minimum bond or note size is $1,000. For example, if
year T-note yielded 4.36 percent — one basis you purchased a $1,000 10-year T-note with a 4-percent coupon
point lower than its yield on the first day of (the “4-percent note”), you would receive $20 every six months,
2006. By April 26 (roughly the same time peri- totaling $40 per year; the $1,000 would be paid back to you on the
od as our current scenario), its yield had maturity date 10 years from now. A bond or note’s yield is its
climbed 76 basis points to 5.12 percent, and it coupon payment divided by the price — in this case, $40/$1,000 =
remained at or above 5 percent through July 4 percent.
28. Strong new home sales and robust orders Treasury futures prices indicate a percentage of “par” price,
which for any Treasury bond or note is 100. T-bond prices consist
for durable goods helped propel long-term
of the “handle” (e.g., 100) and 32nds of 100. For example, 98-14 is
interest rates higher.
a price that translates to 98-14/32nds or $984.38 for a $1,000
How did the dollar perform vs. the Euro
T-bond. T-notes are priced in a similar fashion, except they can
during this time period? On Jan. 23, the include one-half of a 32nd — for example, 98-14+ is 98-
euro/dollar (EUR/USD) rallied strongly to 14.5/32nds, or 984.53 for a $1,000 T-note.
continued on p. 36

CURRENCY TRADER • August 2007 35

 TRADING BASICS continued

FIGURE 3 — 2006 SCENARIO

Related reading
After a jump in long term rates last year, the dollar also weakened vs.
the euro — and for the most part has continued to do so since.
“The obscure key to successful
FX trading”
Currency Trader, November 2004.
Watch what the pros watch: Explore
the relationship between currencies,
bond yields, and interest rates.
Note: This article is also part of the
discounted article set “Barbara
Rockefeller ‘Big Picture’ collection,
Vol. 1: 2004-2005.”

“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.
Note: This article is also part of the
Kathy Lien currency collection.
Source: TradeStation

“Trading a steeper yield curve”

Active Trader, July 2006. close at 1.2303 (Figure 3). By April 26 it One possible explanation for the rela-
With the Fed giving signals the end had rallied to 1.2453 — meaning, the tive strength in the euro vs. the dollar
of the rate-hike cycle is near, we
dollar had weakened vs. the euro. The is that traders were expecting the gap
explore two techniques — one well-
EUR/USD pair continued to rally into between short-term interest rates in
known, the other more obscure —
May before pausing and eventually Europe and the U.S. to narrow.
to trade a widening spread between
short-term and long-term interest
reaching a high of 1.2979 in early June In theory and generally speaking,
rates. 2006. the dollar should strengthen when
Arguably, the improving health of long-term rates are rising. But as
“Treasury bonds and notes” the U.S. economy should have been shown here, other factors may out-
Active Trader, June 2005. reflected in a strengthening dollar. As weigh or completely override any pos-
T-bonds and T-notes are used as a it turned out, U.S. economic activity sible lift the dollar might expect to see
source of income for investors and was so robust the Federal Reserve from rising long-term rates.
as a trading vehicle by speculators. raised the federal funds rate at both its Nonetheless, although short-term
Here’s an overview of the Treasury May 2006 (to 5.00 percent) and June interest rates are usually the focus of
market, from the cash market to 2006 meetings (to 5.25 percent, where currency analysis, long-term interest
bond ETFs and futures.
it currently stands). rates bear watching, especially in
At the same time, though, the regard to fundamental economic con-
You can purchase and download past
Eurozone economy was quickly gain- cerns that drive the big-picture action
articles at
[Link] ing steam and the European Central in the forex market. 
purchase_articles.htm. Bank (ECB) had embarked on a cam-
paign to raise short-term interest rates. For information on the author see p. 6.

36 August 2007 • CURRENCY TRADER

 SPOT CHECK

Spot check: U.S. dollar index

As dollar-denominated currency
FIGURE 1 — CONSPICUOUS LOW pairs continue to set new records,
After penetrating the December 2004 low, the dollar index fell 0.03 below the the dollar index is testing long-term
April 1995 low of 80.05 on July 24.
support levels. Some indicators
point down, but there are mixed
signals further out.

BY CURRENCY TRADER STAFF

T
he long-battered dollar found lit-
tle respite in July, falling to a new
all-time low vs. the euro (EUR)
and setting multi-decade lows
against the Canadian dollar (CAD), British
pound (GBP), Australian dollar (AUD), and
New Zealand dollar (NZD).
Source: TradeStation
The last time things looked this grim for
the buck was in December 2004, when the
U.S. dollar index (DXY) fell to 80.39 (Figure
FIGURE 2 — WEEKLY RUN
1). At the time, pundits predicted apocalypse
As of the week ending July 20, the dollar index had fallen more than
for the currency, citing the deficit(s), the Iraq
3 percent from the high five weeks earlier and had established a new
War, and growing reserve diversification,
a seven-week low.
among other factors, but were quickly
silenced by a year-long rally that, while hard-
ly reversing the dollar’s overwhelming long-
term downtrend, sent dollar bears into hiber-
nation for a while.
Here we are again. As of mid- to late-July,
the dollar index had just penetrated the
December 2004 low, with the next milestone
— the April 1995 low of 80.0 — in its sights.
After that, the index’s next target is its all
time low, 78.33, established in 1992.
Is the dollar going to pull off another head
fake, a la 2005, or is downside follow-through
more probable this time?
Rather than dwell on the possible effects of
economic intangibles such as the collapse of
the sub-prime lending market, let’s look at
what the price action in the U.S. dollar index
Source: TradeStation portends for the future.

38 August 2007 • CURRENCY TRADER

 TABLE 1 — DXY AFTER SEVEN-WEEK NEW LOW AND 5-WEEK, 3% DROP
The dollar index tended to fall, but not dramatically, in the first six weeks after the kind of
week that ended July 20. However, performance was more mixed in weeks seven and
eight (not shown).

Monthly data Week: +1 LUM LDM +2 LUM LDM +3 LUM LDM

As of July 20, the dollar index Avg -0.14 0.85 -0.92 -0.38 1.12 -1.36 -0.42 1.32 -1.73
had established a new two- Med -0.23 0.78 -0.73 -0.45 0.93 -1.06 -0.52 1.03 -1.39
year (24-month) low and a Max 2.76 2.94 0.00 2.93 3.77 0.00 4.17 4.95 0.00
monthly low that was at least Min -2.57 0.00 -4.80 -4.67 0.00 -5.81 -4.90 0.00 -6.07
one percent below the previ- StD 1.17 0.67 0.83 1.59 0.93 1.17 1.97 1.09 1.43
ous month’s low. The price %<0 57.95% 61.36% 55.68%
action after the 20 other times
this has happened since 1990 Week: +4 LUM LDM +5 LUM LDM +6 LUM LDM
(April 2004 being the most
Avg -0.48 1.51 -2.04 -0.40 1.70 -2.27 -0.29 1.85 -2.43
recent occurrence) is a mixed
Med -0.50 1.31 -1.64 -0.40 1.56 -1.93 -0.33 1.66 -2.03
bag: For the first four months
Max 3.71 4.95 0.00 4.18 5.23 0.00 4.32 5.23 0.00
after establishing these lows,
the average month-to-month Min -5.73 0.00 -6.41 -6.71 0.00 -7.63 -6.94 0.00 -7.63
closing price moves were posi- StD 2.20 1.20 1.63 2.48 1.31 1.86 2.66 1.40 1.98
tive but the median moves %<0 61.36% 59.09% 55.68%
were negative, which suggests
a smaller number of large TABLE 2 — FOUR-WEEK RUNS OF LOWER HIGHS,
gains skewed the average higher. LOWER LOWS, LOWER CLOSES
In fact, several of these 24-month lows — especially
Four-week runs of lower highs, lows, and closes in the dollar
when two occur back-to-back — have preceded sharp index were followed by continued selling, most noticeably in
upturns, one of the most notable being the 2005 rally after weeks 1-6. The index did, in fact, close lower the week
consecutive 24-month lows with one-percent low-to-low ending July 20, keeping the pattern’s perfect week-1 record
declines in November and December 2004. of lower closes intact.
After a simple new 24-month low, the dollar index’s tra-
Week: +1 +2 +3 +4
jectory was mixed for the first three months but more con-
Avg -0.96 -1.26 -1.32 -1.46
sistently upward from months five through eight.
Med -0.71 -0.98 -1.54 -1.12
Weekly analysis Max -0.11 0.77 0.63 1.72
Analyzing the pattern on the weekly level paints a more Min -2.57 -4.67 -3.10 -4.90
bearish picture for the intermediate-term action in the dol- StD 0.73 1.32 1.20 1.65
lar index. As of the week ending July 20, the index had %<0 100.00% 80.00% 80.00% 85.00%
fallen more than 3 percent from the high five weeks earli-
er (Figure 2) and had made a seven-week low, a price Week: +5 +6 +7 +8
move that has happened 88 times since 1990. Avg -1.25 -1.01 -0.99 -0.95
Table 1 summarizes what happened after these weeks. Med -1.04 -1.51 -1.53 -0.92
The table shows the average, median, maximum, mini-
Max 2.64 2.71 3.73 1.81
mum, and standard deviation of the price moves from the
Min -6.71 -4.17 -4.08 -3.27
close of the pattern week to the closes, highs, and lows of
StD 1.84 1.62 1.97 1.78
the next six weeks. The “+1,” “+2,” etc., columns contain
the moves from the close of the pattern week to the closes %<0 85.00% 75.00% 55.00% 65.00%
of the next six weeks; the
LUM (largest up move)
columns show the changes
from the close of the pattern
week to the highest highs of
the subsequent weeks; and
the LDM (largest down
move) columns show the
changes from the close of the
pattern week to the lowest
lows of the subsequent
weeks. The “%<0” row
continued on p. 40

CURRENCY TRADER • August 2007 39

 SPOT CHECK continued

shows the percentage of the close-to-close changes that 4 below the pattern week’s close 61.36 percent of the time.
were negative for each week. Although these numbers point downward, the standard
For example, Table 1 shows the median move from the deviations show there is a great deal of variability, especial-
pattern week’s close to the week 4 close was -0.50, while the ly in regard to the closing moves at each interval. Also, the
median LUM was 1.31 and the median LDM was -1.64 bearish edge declined in weeks 7 and 8 (not shown), both of
(highlighted in blue). Finally, the dollar index closed week which had mixed results — neither bearish nor bullish.
Table 2 shows the results of a different test of
FIGURE 3 — DAILY PERSPECTIVE weekly data — the performance after four con-
Near-term action on the daily chart also pointed lower. The low of the
secutive weeks of lower weekly highs, lows, and
July 18 outside bar (third-to-last bar) was the lowest low of the past 30 closes. This time the statistics are shown only for
bars and was more than 0.025 percent below the previous low. The final the closes eight weeks after the pattern. There
bar (July 20) was another outside day that fulfilled the pattern criteria. were only 21 previous examples of such runs
(dating back to 1998), but the subsequent price
action was fairly consistently downward for the
next eight weeks, although less so in weeks 7
and 8 (reminiscent of the previous study). Also,
week 1 closed lower in every instance.

Short-term analysis
Research on the daily time frame resulted in
looking at a pattern centered on the July 18 out-
side bar (higher high and lower low than pre-
ceding bar). This day, which is the third-to-last
bar in Figure 3, was also the lowest low of the
past 30 bars and was more than 0.025 percent
below the previous low.
Table 3 shows the dollar index’s performance
in the first 10 days after 20 examples of this pat-
tern dating back to 2000. The percentages associ-
ated with lower closes and larger LUMs than
Source: TradeStation LDMs is evident. (This analysis was the reason
behind a trade detailed in the Forex Trade
TABLE 3 — DOLLAR INDEX AFTER OUTSIDE DAY, 30-DAY LOW

The dollar index continued to decline after outside bars that were also 30-day lows that were 0.025 percent below the previous
low. These statistics led to a trade in the dollar index futures.

Day: +1 LUM LDM +2 LUM LDM +3 LUM LDM +4 LUM LDM +5 LUM LDM
Avg -0.28 0.21 -0.49 -0.28 0.33 -0.67 -0.44 0.36 -0.84 -0.42 0.38 -0.93 -0.53 0.39 -1.06
Med -0.13 0.18 -0.24 -0.23 0.27 -0.59 -0.35 0.27 -0.71 -0.30 0.27 -0.81 -0.39 0.29 -0.96
Max 0.28 0.90 -0.04 1.36 1.53 -0.04 1.14 1.73 -0.18 0.58 1.73 -0.21 1.37 1.73 -0.29
Min -1.51 0.00 -1.85 -1.96 0.00 -2.10 -1.71 0.00 -2.13 -2.82 0.00 -2.97 -2.68 0.00 -3.19
StD 0.46 0.20 0.47 0.70 0.35 0.53 0.66 0.39 0.56 0.74 0.41 0.69 0.81 0.40 0.72
%<0 75% 60% 80% 70% 80%

Day: +6 LUM LDM +7 LUM LDM +8 LUM LDM +9 LUM LDM +10 LUM LDM
Avg -0.65 0.42 -1.18 -0.79 0.45 -1.29 -0.73 0.46 -1.39 -0.58 0.55 -1.48 -0.69 1.11 -1.65
Med -0.77 0.29 -1.15 -1.01 0.31 -1.30 -0.67 0.31 -1.30 -0.56 0.34 -1.53 -0.97 0.96 -1.53
Max 1.80 2.11 -0.29 1.43 2.14 -0.29 1.64 2.14 -0.29 2.95 3.18 -0.29 3.15 3.96 -0.65
Min -2.97 0.00 -3.19 -2.91 0.00 -3.28 -2.80 0.00 -3.28 -3.59 0.00 -3.72 -3.82 0.23 -4.57
StD 0.96 0.49 0.72 0.84 0.51 0.73 0.90 0.50 0.70 1.31 0.70 0.75 1.45 0.93 0.86
%<0 80% 89% 89% 74% 74%

40 August 2007 • CURRENCY TRADER

Journal on p. 52.) FIGURE 4 — SHORT-TERM PATTERN VS. TYPICAL PERFORMANCE
Figure 4 compares the median closing The post-pattern down moves were all significantly larger (anywhere from 10
changes from days 3 to 10 in Table 2 to to 50 times) than the dollar index's typical behavior during this period.
the dollar index’s median behavior
(“benchmark”) over the entire analysis
period (i.e., the median of all one-day
closing changes, all two-day closing
changes, etc.). The post-pattern down
moves were all significantly larger (any-
where from 10 to 50 times) than the dol-
lar index’s “random” behavior during
this period — see the line representing
the ratio of the pattern to the benchmark.
Also, notice July 20 — the final bar in
Figure 3 — was another outside day that
fulfilled the pattern criteria.

The unquantifiable issues

Logical arguments can be made why the
dollar should rise or fall in the coming
weeks or months, but these arguments
are difficult to substantiate with data.
The Federal Reserve kept its short-term interest
rate unchanged (for the eighth consecutive time) at
its most recent meeting in late June. Barring any
unforeseen economic or market developments, the
odds right now are that it will do the same at its
August and September meetings.
As the dollar index hovers near key levels, one
thing different from 2004 is the markets’ more sub-
dued reaction to a significantly weaker dollar.
And, as the dollar faked out the financial world by
rallying when sentiment was extremely negative at
the outset of 2005, one must wonder if the lower
level of concern today is a sign of more downside
potential for the buck.
There are certainly indicators galore signaling
the dollar is dramatically “oversold,” but such
indicators have been saying the same thing for
months. Nonetheless, such an obvious support
level is likely to inspire greater market volatility.
There are many traders who have bought around
this level expecting the dollar to rebound, and just
as many ready to pile on if the buck drops through
support.
This analysis was intentionally conducted a cou-
ple of weeks (July 18-20) before publication to give
readers the ability to compare its implications to
how the market has actually behaved since the
research was concluded. The numbers here can
serve as guideposts, so traders can see if the mar-
ket is behaving as its past behavior suggests it
should.

CURRENCY TRADER • August 2007 41

 INDUSTRY NEWS INDUSTRY NEWS
A capital idea

New NFA proposal could cause

significant shakeup among forex brokerages
ew rule changes proposed by the National Futures The NFA estimates the new rules, combined with existing

N Association (NFA) could have a significant effect on

several brokerages that trade foreign exchange.
The NFA wants to raise capital requirements for all regis-
rules, will force firms to have at least $10 million in adjusted
net capital to remain in business.
According to data obtained from the CFTC, the new rules
tered Forex Dealer Members (FDM) to $5 million, plus it would leave only six forex brokerages: FXCM, GFT Forex,
wants improved accounting standards. The NFA is hoping Oanda, FXSolutions, Gain Capital, and CMS.
the increased standards will prevent the ongoing problem of
forex brokerages going bankrupt and/or committing fraud. NFA’s concerns
The proposal could potentially wipe out 90 percent of The NFA listed four specific reasons for the rule change.
existing forex brokerages, although it’s likely major consoli- First, trading spot forex, which FDMs do, creates more risk
dation would occur if the rule passes. Forex brokerage FXCM than trading futures and options listed on an exchange.
has been the most vocal supporter of the rule, although they Second, since spot forex is not a priority under the NFA’s
have received support from some other big firms. Bankruptcy Code, it’s particularly important for FDMs to
Naturally, there is opposition from the less-capitalized have adequate capital.
firms. In a comment letter to the NFA, Knight Capital Group, Plus, two of the three bankruptcy proceedings in which
which owns Hotspot FX, agreed that greater oversight is the NFA has taken part in the past four years have involved
needed but doesn’t think a “one-size-fits-all” solution will smaller FDMs, and with the cumulative amount of retail
work. funds under account surpassing $1 billion, the NFA is con-
“Certain FDMs, like Hotspot, do not operate their business cerned that an FDM might be unable to meet its financial
like a traditional dealer. They automatically offset (real-time) obligations to its customers.
all client trades with bank market makers or client sub- Earlier in the year, Concorde Forex Group (CFG Trader)
scribers. was shut down by the NFA and forced to liquidate all open
As such, Hotspot effectively operates on a ‘riskless princi- positions because it was undercapitalized. CFG Trader cus-
pal’ basis on behalf of its clients, thereby reducing dramati- tomers collectively lost about $1 million, and the NFA says
cally any associated risk with that transaction and its clients’ this incident was a catalyst for the new rule, particularly the
funds,” Knight said in the letter. new accounting requirements.
“Thus, since Hotspot and other FDMs similarly situated When CFG’s books were examined after its trading was
do not directly offset client trades, they are not subject to the suspended, it was discovered the firm’s assets were held in
same market volatility and risk as are FDMs that take the multiple accounts, company and customer funds were com-
other side of client trades and put their client accounts mingled, CFG had no anti-money laundering program and
(deposits) at risk.” no internal compliance staff, and it had never been audited.
Since 2000, the NFA has authorized Forex Dealing licenses As a result, firms that meet the new capital requirements
to more than 50 firms. However, many of these firms went will also have to file an internal control report prepared by an
out of business because they were undercapitalized, and independent auditor, and the NFA would have limited abili-
fraud continues to be a problem in the forex brokerage arena. ty to request certification of an FDM’s finances. Also, each
As of July 2007, there were 43 licensed FDMs operating. FDM would have to designate an individual to oversee the
According to the NFA, 30 have adjusted net capital of less firm’s finances, and that person would be subject to disci-
than $5 million, and only four of those 30 have more than $3 pline if accounting and capitalization rules are not
million. The average adjusted net capital of those 30 firms is followed.
less than $1.5 million.

Spot on

USFE to list forex futures

he United States Futures Exchange (USFE) will begin The contracts are retail-sized, with a tick worth $5 for the

T offering spot equivalent futures (SEF) on Sept. 21. The

contracts will trade 23 hours per day.
The USFE will begin with six contracts — U.S. dollar/euro,
three U.S.-dollar based contracts, 500 yen for the JPY/USD
contract, and five Swiss franc and five Canadian dollars for
the CHF/USD and CAD/USD contracts, respectively.
U.S. dollar/British pound, U.S. dollar/Australian dollar, SEFs are structured to automatically allocate the cost-of-
Japanese yen/U.S. dollar, Swiss franc/U.S. dollar, and carry associated with holding a spot forex position open
Canadian dollar/U.S. dollar. overnight, making them identical to a spot position.

42 August 2007 • CURRENCY TRADER

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 CURRENCY FUTURES
Managed money: Barclay Trading Group’s
currency trader rankings for June 2007
Top 10 currency traders managing more than $10 million
as of June 30, ranked by June 2007 return
Light at end of tunnel 2007
Rank Trading June YTD $ Under
for currency traders? (millions) advisor return return mgmt.
1. Stark Quant. Inv. (Currency Fund) 8.26 18.7 57.1M
Currency traders are taking baby steps toward prof- 2. Wooster Asset Mgmt (Portage Fund) 6.80 22.58 79.3M
itability, as the Barclay’s Currency Traders Index (CTI) 3. Stonebrook Structured Products (FXC) 5.82 11.10 25.1M
crept up 0.52 percent in July, bringing its 2007 gain to 4. Appleton Cap'l (Appleton 25% Risk) 5.40 10.04 199.3M
0.9 percent. 5. ABN AMRO Asset Mgmt (Curr USD) 5.01 8.25 152.4M
That may not send investors in the 114 managed 6. FX Concepts (DMC) 4.57 4.51 7600.0M
money programs (currency futures and spot forex) 7. DKR Capital (DKR Strat. Currency) 4.40 4.13 40.0M
that comprise the index racing for a withdrawal slip, 8. Grossman Asset Mgmt (IPS Currency) 3.54 5.49 1110.0M
but it does represent the highest level of profit the CTI 9. Harmonic Capital (Gl. Currency) 3.33 19.17 N/A
has enjoyed this year. 10. Sunrise Cap'l Partners (Currency Fund) 3.15 9.77 125.9
The CTI still lags behind seven of the six other Top 10 currency traders managing less than $10 million and more than $1 million
indices comprised by Barclay’s. The CTA index, as of June 30, ranked by June 2007 return
Barclay’s catch-all index, is up 2.2 percent through 1. Metro Forex Inc (Tri Gl FX) 5.07 18.54 4.0M
July. 2. High Desert Currency Mgmt 3.57 22.99 2.7M
The CTI is trying to avoid its third straight losing 3. Spectrum Asset Mgmt LLC (Currency) 2.71 3.60 6.0M
year, which would be a first in the 20-year history of 4. MIGFX Inc (Retail) 2.70 20.56 5.1M
the index. 5. Marek D. Chelkowski (Forex) 2.50 17.82 1.0M
The Barclay BTOP FX Index, which tracks the 6. UMJ Tekniko Fund 2.20 -8.52 7.6M
largest investable currency trading programs and 7. FEM Currency Portfolio Ltd 2.20 -2.29 2.3M
accounts for at least half of the investable assets of all 8. SSgA Absolute Return Currency Fund 1.91 4.65 9.2M
programs tracked by Barclay, gained 0.2 percent in
9. EMC Capital Mgmt (Currency) 0.70 0.91 2.1M
July and is up 3.3 percent for the year.
10. Capricorn Advisory Mgmt (fxMT Growth) 0.62 7.72 5.2M
The index, which has been calculated since the
beginning of 2005, made an all-time high of 1,053.60 Source: The Barclay Group ([Link])
on July 23. It fell in the final week of the month, clos- Based on estimates of the composite of all accounts or the fully funded subset method.
Does not reflect the performance of any single account.
ing July at 1.040.79.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

CURRENCY FUTURES SNAPSHOT The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s
as of July 26 liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.

Contract Pit Elec Exch Vol OI 10-day % 20-day % 60-day % Volatility

sym sym move rank move rank move rank ratio /% rank
Eurocurrency EC 6E CME 155.6 199.8 -0.36% 0% 2.08% 65% 0.86% 17% .22 / 55%
Japanese yen JY 6J CME 120.7 288.0 3.04% 100% 2.81% 100% 1.01% 56% .48 / 100%
British pound BP 6B CME 83.3 151.1 0.95% 20% 2.61% 67% 2.43% 78% .30 / 30%
Swiss franc SF 6S CME 66.4 105.8 -0.12% 0% 1.79% 65% 0.79% 41% .37 / 58%
Canadian dollar CD 6C CME 49.3 141.0 -0.84% 100% 1.42% 22% 5.18% 30% .13 / 32%
Australian dollar AD 6A CME 38.0 113.1 0.61% 0% 4.22% 94% 5.06% 60% 21 / 58%
Mexican peso MP 6M CME 19.5 76.2 -2.16% 100% -1.39% 90% -0.66% 40% .60 / 90%
New Zealand dollar NE 6N CME 3.6 41.7 -0.04% 100% 3.38% 53% 5.41% 47% .28 / 73%
U.S. dollar index DX NYBOT 3.6 30.2 -0.19% 5% -2.19% 65% -1.58% 52% .17 / 38%
Euro / Japanese yen EJ NYBOT 1.2 28.7 -3.21% 100% -1.21% 100% -0.20% 38% .42 / 97%
Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.
LEGEND: past sixty 20-day moves; for the 60-day move, the % rank field shows how the most recent
60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100%
Sym: Ticker symbol.
means the current reading is larger than all the past readings, while a reading of 0% means
Vol: 30-day average daily volume, in thousands. the current reading is lower than the previous readings.
OI: 30-day open interest, in thousands. Volatility ratio /% rank: The ratio is the short-term volatility (10-day standard deviation of
10-day move: The percentage price move from the close 10 days ago to today’s close. prices) divided by the long-term volatility (100-day standard deviation of prices). The %
20-day move: The percentage price move from the close 20 days ago to today’s close. rank is the percentile rank of the volatility ratio over the past 60 days.
60-day move: The percentage price move from the close 60 days ago to today’s close. This information is for educational purposes only. Currency Trader provides this data
The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the in good faith, but assumes no responsibility for the use of this information. Currency
percentile rank of the most recent move to a certain number of the previous moves of the Trader does not recommend buying or selling any market, nor does it solicit orders to
same size and in the same direction. For example, the % rank for 10-day move shows buy or sell any market. There is a high level of risk in trading, especially for traders
how the most recent 10-day move compares to the past twenty 10-day moves; for the 20- who use leverage. The reader assumes all responsibility for his or her actions in the
day move, the % rank field shows how the most recent 20-day move compares to the market.

44 August 2007 • CURRENCY TRADER

 GLOBAL NEWS BRIEFS

Interest Rates
EUROPE
 The Bank of England raised its bank rate in July by
0.25 percent to 5.75 percent, continuing a cycle of
 Germany’s June jobless rate fell 0.3 percent from the increases that began in August 2006 when the rate
previous month to 8.8 percent, a drop of 1.7 percent from was raised to 4.75 percent. A booming UK economy
June 2006. has caused the BOE to keep raising rates.

 The UK’s unemployment rate for March to May fell  The Bank of Canada increased its overnight fund-
0.1 percent from the previous three-month period to 5.4 ing rate in July 0.25 percent to 4.5 percent, ending a
percent. The rate was unchanged from the same three- long period of rate neutrality. The last rate hike for the
month period in 2006. Great White North came in May 2006, when rates
increased to a multi-year high of 4.75 percent.

 The Central Bank of Brazil dropped its selic rate

0.50 percent in July to an all-time low of 11.5 percent.
The cut is the 17th since September 2005, when the
ASIA & AUSTRALIA Selic was 19.75 percent.

 Australia’s June unemployment rate grew 0.1 percent  The Central Bank of Chile raised its discount rate
to 4.3 percent compared to the previous month, a drop of 0.25 percent in July to 5.25 percent. The rate hike
0.5 percent compared to the same month in 2006. comes after Chile dropped rates 0.25 percent in
January for the first time in five years.
 Preliminary data shows that Hong Kong’s jobless rate
for the second quarter dropped 0.1 percent from the pre-  The Bank of Israel increased its short-term lend-
vious quarter to 4.2 percent, the lowest rate in nine years. ing rate in July, ending a long period of loosening
The rate was 0.5-percent lower than the second quarter of rates with a 0.25-percent hike to 3.75 percent. It was
2007. According to a government press release, “In the the first rate increase in a year after seven straight
next few months, the entry of fresh graduates and school decreases.
leavers will continue to affect the labor force and unem-
ployment figures. The near-term outlook of the labor 
The People’s Bank of China increased its one-
market will depend on whether the pace of job creation year yuan lending rate 0.27 percent to 6.84 percent
in the economy is sufficient to absorb the newcomers.” in July.
 Singapore’s Q1 unemployment rate rose 0.3 percent
from the previous quarter to 2.9 percent and also gained  The Bank of Indonesia dropped its reference rate
again in July 25 basis points to 8.25 percent. The rate
0.3 percent from the first quarter a year ago.
cut was the third in as many months, the 12th in 13
months, and the 13th since April 2006 when the rate
stood at 12.75 percent.

The Bank of Korea raised its overnight call rate 25
AMERICAS basis points in July 4.75 percent. The hike was the
first in a year but is the sixth increase since the end of
 Brazil’s Q1 2007 GDP increased 0.8 percent year-over- 2004.
year as the services sector produced a 1.7-percent
increase in its GDP contribution.  The Central Bank of the Philippines dropped its
overnight borrowing rate significantly, cutting the
 Canada’s Q1 2007 unemployment rate remained rate 1.5 percent to 6 percent in July. The Philippines
unchanged at 6.1 percent from the previous quarter and had not dropped rates in more than five years.
the same quarter a year earlier. “Employment growth
resumed in June, up an estimated 35,000, following little
change in April and May,” Statistics Canada said in a
 The Bank of Thailand dropped its 1-day (repo) rate
0.25 percent to 3.25 percent in July, its fifth rate cut in
press release. ”Despite this gain, the national unemploy- 2007. The cuts follow more than four years of steady
ment rate remained at 6.1 percent for the fifth consecu- increases.
tive month, as more people entered the labor force in
June in search of work.”

CURRENCY TRADER August 2007 45

 INTERNATIONAL MARKET SUMMARY
FOREX (vs. U.S. DOLLAR)
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank

1 Thai baht 0.03394 8.64% 9.10% 19.30% 0.03394 0.02625 3

2 New Zealand dollar 0.8081 5.81% 8.84% 15.64% 0.8106 0.6141 1

3 Brazil real 0.5434 4.40% 10.47% 15.49% 0.5434 0.4362 13

4 Australian dollar 0.8845 4.34% 6.84% 12.73% 0.8862 0.7413 2

5 South African rand 0.1468 4.34% 3.82% 4.56% 0.1487 0.1253 12

6 British pound 2.0624 3.13% 3.14% 4.37% 2.0653 1.8383 6

7 Swedish krona 0.1501 2.95% 1.56% 4.89% 0.151 0.1344 14

8 Euro 1.3823 2.59% 1.76% 6.28% 0.13852 1.2482 10

9 Japanese yen 0.008283 2.58% -1.79% 0.52% 0.00877 0.00805 16

10 Canadian dollar 0.9584 2.31% 7.54% 13.15% 0.9644 0.842 5

11 Singapore dollar 0.6644 2.20% 0.58% 2.01% 0.6647 0.6278 15

12 Swiss franc 0.8304 2.03% 0.23% 3.36% 0.8415 0.7829 11

13 Russian ruble 0.03939 1.94% 1.42% 4.37% 0.03941 0.03702 7

14 Indian rupee 0.02484 1.22% 2.69% 9.96% 0.02485 0.02125 17

15 Chinese yuan 0.1324 0.84% 2.16% 2.80% 0.1324 0.1247 9

16 Taiwan dollar 0.03051 -0.07% 1.29% 0.46% 0.03098 0.02983 4

17 Hong Kong dollar 0.1279 -0.08% -0.08% -0.23% 0.1288 0.1264 8

As of July 25 *based on one-month gain/loss

ACCOUNT BALANCE
Rank Country 2007 Ratio* 2006 2008+ Rank Country 2007 Ratio* 2006 2008+
1 Singapore 39.644 27.1 36.288 41.939 13 Mexico -9.197 -1 -1.475 -13.461
2 Switzerland 68.511 17.6 69.825 68.139 14 France -51.972 -2.2 -46.304 -58.5
3 China 303.651 10 238.536 356.617 15 India -23.768 -2.4 -19.298 -24.568
4 Hong Kong 19.449 9.6 19.388 19.924 16 UK -81.402 -3.1 -68.122 -87.983
5 Netherlands 55.176 7.7 46.989 58.007 17 Australia -46.24 -5.6 -40.856 -46.743
18 U.S. -834.623 -6.1 -856.661 -866.145
6 Taiwan 25.924 7.1 25.187 27.875
19 South Africa -17.418 -6.4 -16.415 -17.385
7 Sweden 28.06 6.6 28.447 30.096 20 Spain -127.459 -9.4 -108.019 -142.416
8 Russia 72.902 6.2 95.6 67.797
9 Germany 161.938 5.3 146.361 164.71 Totals in billions of U.S. dollars
10 Japan 166.586 3.9 170.355 159.142 *Account balance in percent of GDP +Estimate
11 Brazil 8.939 0.8 13.648 3.26 Source: International Monetary Fund, World Economic Outlook
12 Canada 9.351 0.7 21.464 7.612 Database, April 2007

46 August 2007 • CURRENCY TRADER

 NON-U.S. DOLLAR FOREX CROSS RATES
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol July 25 gain/loss gain/loss gain/loss high low Previous
1 Aussie $/Franc AUD/CHF 1.0654 2.21% 6.59% 9.07% 1.0654 0.9288 2
2 Real/Canada $ BRL/CAD 0.5672 1.98% 2.74% 2.07% 0.5695 0.5046 19
3 Aussie $/Canada $ AUD/CAD 0.9232 1.93% -0.65% -0.37% 0.9493 0.8321 5
4 Real/Yen BRL/JPY 65.6218 1.72% 12.49% 14.92% 65.8319 52.4921 12
5 Real/Euro BRL/EUR 0.3932 1.71% 8.56% 8.68% 0.3932 0.3474 15
6 Aussie $/Yen AUD/JPY 106.809 1.70% 8.81% 12.21% 107.715 87.19 1
7 Aussie $/Euro AUD/EUR 0.64 1.65% 4.99% 6.08% 0.6409 0.5831 3
8 Real/Pound BRL/GBP 0.2635 1.19% 7.11% 10.67% 0.2658 0.2339 18
9 Aussie $/Pound AUD/GBP 0.4289 1.13% 3.57% 8.01% 0.4292 0.3932 4
10 Pound/Yen GBP/JPY 249.018 0.49% 5.02% 3.83% 251.095 212.943 7
11 Pound/Euro GBP/EUR 1.492 0.44% 1.34% -1.81% 1.5296 1.4547 8
12 Euro/Yen EUR/JPY 166.908 0.00% 3.62% 5.74% 168.96 145.736 10
13 Real/Aussie $ BRL/AUD 0.6146 -0.03% 3.42% 2.47% 0.6326 0.5859 20
14 Canada $/Yen CAD/JPY 115.732 -0.32% 9.50% 12.57% 117.849 98.32 6
15 Franc/Canada $ CHF/CAD 0.8667 -0.33% -6.81% -8.65% 0.9751 0.8564 17
16 Canada $/Euro CAD/EUR 0.6934 -0.34% 5.67% 6.46% 0.7083 0.639 9
17 Franc/Euro CHF/EUR 0.6007 -0.56% -1.52% -2.75% 0.6371 0.5948 14
18 Franc/Yen CHF/JPY 100.261 -0.59% 2.05% 2.83% 101.852 92.62 11
19 Canada $/Pound CAD/GBP 0.4648 -0.83% 4.26% 8.42% 0.4805 0.4271 13
20 Franc/Pound CHF/GBP 0.4027 -1.06% -2.82% -0.96% 0.436 0.4016 16
GLOBAL STOCK INDICES
1-month 3-month 6-month 52-week 52-week
Rank Country Index July 25 gain/loss gain/loss gain/loss high low Previous
1 India BSE 30 15,699.33 8.36% 10.42% 9.92% 15,868.85 10,323.77 7
2 Hong Kong Hang Seng 23,362.18 7.06% 13.76% 13.03% 23,534.38 16,566.39 1
3 Brazil Bovespa 55,998.54 3.62% 12.73% 25.31% 58,292.88 34,127.48 3
4 Canada S&P/TSX composite 14,105.32 1.90% 3.16% 9.11% 14,646.82 11,407.27 13
5 Singapore Straits Times 3,633.54 1.49% 8.05% 16.89% 3,685.15 2,397.94 8
6 U.S. S&P 500 1,518.09 1.36% 1.52% 6.61% 1,555.90 1,257.19 11
7 South Africa FTSE/JSE All Share 29,076.33 0.76% 2.97% 13.93% 30,041.90 20,331.27 –
8 Australia All ordinaries 6,378.00 0.31% 3.32% 10.86% 6,469.20 4,892.00 9
9 Japan Nikkei 225 17,858.42 -1.27% 3.61% 2.29% 18,300.39 14,839.49 5
10 UK FTSE 100 6,454.30 -2.04% -0.12% 2.95% 6,754.10 5,752.60 10
11 Switzerland Swiss Market 8,922.70 -2.39% -5.37% -2.31% 9,548.10 7,741.80 14
12 France CAC 40 5,837.11 -2.76% -1.85% 4.06% 6,168.15 4,915.90 12
13 Mexico IPC 31,103.53 -2.85% 5.64% 16.01% 32,564.35 19,800.03 6
14 Germany Xetra Dax 7,692.55 -3.00% 4.76% 14.48% 8,151.57 5,542.38 4
15 Italy MIBTel 31,877.00 -3.24% -6.18% -2.23% 34,369.00 27,576.00 15
GLOBAL SHORT-TERM INTEREST RATES
Country Interest rate Rate Last change Feb. 07 Aug. 06
U.S. Fed Funds Rate 5.25 0.25 (June 06) 5.25 5.25
Japan Overnight call rate 0.5 0.25 (Feb. 07) 0.5 0.25
Eurozone Refi rate 4 0.25 (June 07) 3.5 3
UK Repo rate 5.75 0.25 (July 07) 5.25 4.75
Canada Overnight funding rate 4.5 0.25 (July 07) 4.25 4.25
Switzerland 3-month Swiss Libor 2.5 0.25 (June 07) 2 1.5
Australia Cash rate 6.25 0.25 (Nov. 06) 6.25 6
New Zealand Cash rate 8 0.25 (June 07) 7.25 7.25
Brazil Selic rate 11.5 0.5 (July 07) 13 14.25
Korea Overnight call rate 4.75 0.25 (July 07) 4.5 4.5
Taiwan Discount rate 3.125 0.25 (June 07) 2.875 2.5
India Reverse repo rate 6.5 0.5 (March 07) 6 6
South Africa Repurchase rate 9.5 0.5 (June 07) 9 8
GLOBAL BOND RATES
Rank Country Rate July 25 1-month 3-month 6-month High Low Previous
1 Germany BUND 112.23 1.67% -1.47% -2.49% 118.91 109.92 4
2 U.S. 10-year T-note 106.19 1.01% -1.73% 0.03% 109.205 103.21 3
3 Japan Government Bond 132.54 0.30% -1.17% -1.66% 135.31 130.96 5
4 Australia 10-year bonds 93.865 0.12% -0.29% -0.34% 94.52 93.705 2
5 UK Short sterling 93.74 0.00% -0.36% -0.44% 95.16 93.65 1
All data as of July 25

CURRENCY TRADER August 2007 47

 GLOBAL ECONOMIC CALENDAR AUGUST/SEPTEMBER
MONTH
August
1 U.S.: ISM 21 Germany: Employment report
Canada: CPI; retail trade;
Japan: Account balances
Legend leading indicators
Great Britain: Monetary policy
CPI: Consumer price index
committee meeting 22 Japan: Monetary policy meeting
ECB: European Central Bank
Australia: Index of commodity prices 23 Japan: Monetary policy meeting
FOMC: Federal open market
committee 2 ECB: Governing council meeting Germany: National accounts
GDP: Gross domestic product Japan: Monetary base Philippines: Monetary board meeting
ISM: Institute for supply Great Britain: Monetary policy
management
24 U.S.: Durable goods
committee meeting Japan: Corporate service price index
PPI: Producer price index
3 U.S.: Employment report 25 Mexico: Monetary policy announcement
Germany: Retail turnover
Economic Release time 26
release (U.S.) (ET) 4
GDP 8:30 a.m. 27 Israel: Announcement of changes in the
CPI 8:30 a.m.
5 interest rate
ECI 8:30 a.m. 6 Germany: Orders received and 28 Canada: Employment report
PPI 8:30 a.m. manufacturing turnover Poland: Monetary policy council meeting
ISM 8:30 a.m.
Unemployment 8:30 a.m. 7 U.S.: FOMC meeting 29 Poland: Monetary policy council meeting
Personal income 8:30 a.m. Germany: Production index Thailand: Monetary policy committee
Durable goods 8:30 a.m. Australia: Reserve bank meeting meeting
Retail sales 8:30 a.m.
8 U.S.: Wholesale inventories 30 U.S.: GDP
Trade balance 8:30 a.m.
Great Britain: Inflation report Canada: Balance of payments
Leading indicators 10 a.m.
Germany: Foreign trade; bankruptcies Czech Republic: Czech National Bank
Australia: Official reserve assets board meeting
9 31 Canada: GDP
10 Japan: Corporate goods price index Australia: International reserves and
foreign currency liquidity
AUGUST 2007 11
29 30 31 1 2 3 4 12 September
5 6 7 8 9 10 11 13 U.S.: Retail sales
1
12 13 14 15 16 17 18 Japan: Balance of payments 2
19 20 21 22 23 24 25 Great Britain: PPI 3 Japan: Account balances
26 27 28 29 30 31 1 Australia: Statement on monetary policy Germany: Retail turnover
14 U.S.: PPI; trade balance Australia: Index of commodity prices
SEPTEMBER 2007 Japan: Monetary survey 4 U.S.: ISM
26 27 28 29 30 31 1 Great Britain: CPI Japan: Monetary base
2 3 4 5 6 7 8 15 U.S.: CPI Australia: Reserve bank meeting
9 10 11 12 13 14 15 Canada: Manufacturing survey Brazil: Monetary policy committee
16 17 18 19 20 21 22 Great Britain: Employment report meeting
23 24 25 26 27 28 29 Norway: Monetary policy meeting 5 Great Britain: Monetary policy
South Africa: Monetary policy council committee meeting
30 1 2 3 4 5 6
meeting Canada: Interest rate announcement
16 Germany: CPI Brazil: Monetary policy committee
South Africa: Monetary policy council meeting
The information on this page is
subject to change. Currency meeting 6 ECB: Governing council meeting
Trader is not responsible for 17 Germany: PPI Great Britain: Monetary policy
the accuracy of calendar dates
Canada: Wholesale trade committee meeting
beyond press time.
Germany: Orders received and
18
manufacturing turnover
19
20 U.S.: Leading indicators
Great Britain: Capital issues

48 August 2007 • CURRENCY TRADER

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THE FACE OF TRADING

Rolling with the punches

BY CURRENCY TRADER STAFF to make sure that never happened again,” he says.
He attended seminars and studied technical analysis. In
Name: Steve Misic early 2004, Misic decided to trade full-time. For many years
Age: 50 he had worked nights, and even after he quit his job his
Lives/works in: Hoffman Estates, Ill. body clock was still set to awaken in the early hours of the
morning. Trading around 2 a.m in the forex market was a

S teve Misic first got into stock market investing in

the early 1990s, but like many other traders he
became more active as the tech-stock bubble
expanded into 2000. Misic would often call in buy-and-hold
trades from his cell phone while driving a bakery sales
good fit for him. He relied on traditional technical analysis,
basing his short-term trading on support and resistance
concepts.

Most important lesson learned: “Trading makes a

route. There wasn’t much to it, he remembers. person humble. I’ll never get it all taken away from me
“I was trading from my truck,” he says. “It was one-way again because I learned from the last bubble. Right now,
— you just bought it and it went up.” momentum trading is all the rage again, but eventually
As everyone knows, however, the ride didn’t last forever. there will be a sell-off. I’ve learned how to trade
When the bubble burst, Misic, like many others, rode most technically.”
his holdings down. After that, he decided to learn how to
trade. To read the complete profile, see the October 2007 issue of Active
“After I lost money in the bubble, I wanted to learn a way Trader magazine ([Link]

CURRENCY TRADER • August 2007 49

 KEY CONCEPTS

Carry trades involve buying (or lending) a currency with a Stochastic oscillator: A technical tool designed to high-
high interest rate and selling (or borrowing) a currency with a light shorter-term momentum and “overbought” and “over-
low interest rate. Traders looking to “earn carry” will buy a sold” levels (points at which a price move has, theoretically at
high-yielding currency while simultaneously selling a low- least, temporarily exhausted itself and is ripe for a correction
yielding currency. or reversal).
Calculation: The stochastic oscillator consists of two lines:
Outlier: An anomalous data point or reading that is not rep- %K and a moving average of %K called %D. The basic sto-
resentative of the majority of a data set. chastic calculation compares the most recent close to the price
range (high of the range - low of the range) over a particular
Relative strength index (RSI): Developed by Welles period.
Wilder, the relative strength index (RSI) is an indicator in the For example, a 10-day stochastic calculation (%K) would be
“oscillator” family designed to reflect shorter-term momen- the difference between today’s close and the lowest low of the
tum. It ranges from zero to 100, with higher readings suppos- last 10 days divided by the difference between the highest high
edly corresponding to overbought levels and low readings and the lowest low of the last 10 days; the result is multiplied
reflecting the opposite. The formula is: by 100. The formula is:
RSI = 100 – (100/[1+RS]) %K = 100*{(Ct-Ln)/(Hn-Ln)}
where where
RS = relative strength = the average of the up closes over Ct is today’s closing price
the calculation period (e.g., 10 bars, 14 bars) divided by the Hn is the highest price of the most recent n days (the default
average of the down closes over the calculation period. value is five days)
Ln is the lowest price of the most recent n days
For example, when calculating a 10-day RSI, if six of the The second line, %D, is a three-period simple moving
days closed higher than the previous day’s close, you would average of %K. The resulting indicator fluctuates between 0
subtract the previous close from the current close for these and 100.
days, add up the differences, and divide the result by 10 to get
the up-close average. (Note that the sum is divided by the total Fast vs. slow: The formula above is sometimes referred to as
number of days in the look-back period and not the number of “fast” stochastics. Because it is very volatile, an additionally
up-closing days.) smoothed version of the indicator –– where the original %D
For the four days that closed lower than the previous day’s line becomes a new %K line and a three-period average of this
close, you would subtract the current close from the previous line becomes the new %D line –– is more commonly used (and
low, add these differences, and divide by 10 to get the down- referred to as “slow” stochastics, or simply “stochastics”).
close average. If the up-close average was .8 and the down Any of the parameters –– either the number of periods used
close average was .4, the relative strength over this period in the basic calculation or the length of the moving averages
would be 2. The resulting RSI would be 100 - (100/[1+2]) = 100 used to smooth the %K and %D lines –– can be adjusted to
- 33.3 = 66.67. make the indicator more or less sensitive to price action.
Horizontal lines are used to mark overbought and oversold
Standard error channel: The linear regression line is a stochastic readings. These levels are discretionary; readings of
straight line that minimizes the distance between itself and 80 and 20 or 70 and 30 are common, but different market con-
every data point in the series you are working with. A standard ditions and indicator lengths will dictate different levels.
error measures the variance from the linear regression.
Subtracting the standard error from the linear regression line Variance and standard deviation: Variance measures
yields the bottom of the standard error channel, and adding it how spread out a group of values are — in other words, how
to the linear regression value gives you the top of the channel. much they vary. Mathematically, variance is the average
The standard error channel is a parallel concept to Bollinger squared “deviation” (or difference) of each number in the
Bands, which use the standard deviation calculation to set group from the group’s mean value, divided by the number
boundaries above and below a moving average to capture vari- of elements in the group.
ance away from the average. Because the moving average is a For example, for the numbers 8, 9, and 10, the mean is 9
wavy line, the Bollinger Bands are wavy, too, and also widen and the variance is:
or narrow as variability rises or falls. The standard error does {(8-9)2 + (9-9)2 + (10-9)2}/3 = (1 + 0 + 1)/3 = .667
the same thing, only with straight lines. Now look at the variance of a more widely distributed set
The critical difference is that you don’t need to choose a of numbers — 2, 9, and 16:
starting and ending point for Bollinger Bands, because they {(2-9)2 + (9-9)2 + (16-9)2}/3 = (49 + 0 + 49)/3 = 32.67
track a moving average that constantly discards old data and The more varied the prices, the higher their variance — the
refreshes itself with new data. To construct a useful linear more widely distributed they will be. The more varied a mar-
regression channel, however, you have to pick reasonable ket’s price changes from day to day (or week to week, etc.),
starting and ending points. It’s still “mathematics” and thus a the more volatile that market is.
better way to draw a trendline than using your eye alone, but A common application of variance in trading is standard
your choice of starting and ending points is inherently judg- deviation, which is the square root of variance. The standard
mental. Most practitioners chose an obvious lowest low or deviation of 8, 9, and 10 is: .667 = 0.82; the standard devia-
highest high. tion of 2, 9, and 16 is: 32.67 = 5.72.

50 August 2007 • CURRENCY TRADER

 EVENTS

Event: Forex Trading Expo Event: TradeStation Futures Symposium

Date: Sept. 15-16 For more information: Dates and locations are listed
Location: Mandalay Bay Hotel and Casino, Las Vegas here or visit [Link]
For more information: Visit
Date: Oct. 18-20
[Link]
Location: Costa Mesa, Calif.
Date: Dec. 6-8
Event: FIA and OIC New York Location: Hallandale, Fla.
Equity Options Conference
Date: Sept. 19-20
Location: Grand Hyatt New York Event: 20th Annual IFTA Conference
For more information: Visit Date: Nov. 8-11
[Link] and click on “Conferences.” Location: Sharm el Sheikh, Egypt
For more information: Visit
[Link]
Event: Paris Trading Show
Date: Sept. 21-22
Location: Espace Champerret, Paris, France Event: The Traders Expo Las Vegas
For more information: Visit [Link] Date: Nov. 15-18
Location: Mandalay Bay Resort and Casino,
Las Vegas, Nev.
Event: Wealth Expo For more information: Visit
For more information: Dates and locations are listed [Link]
here or visit [Link]
Date: Sept. 29-Oct. 1 Event: 23rd Annual Futures & Options Expo
Location: Seattle, Wash. Date: Nov. 27-29
Location: Hyatt Regency Chicago, Chicago, Ill.
Date: Nov. 30-Dec. 2
For more information: Visit
Location: Schaumburg, Ill.
[Link] and click on “Conferences.”

HIT YOUR MARK!

Advertise in Active Trader Magazine

Contact Bob Dorman

Ad sales East Coast
and Midwest
bdorman@[Link]
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Ad sales West Coast
and Southwest
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Account Executive
seger@[Link]
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51 August 2007 • CURRENCY TRADER

 FOREX TRADE JOURNAL

Even at historically low levels,

analysis demands taking a short
position in the dollar index futures.

TRADE

Date: Thursday, July 19.

Entry: Short September dollar index

futures (DXU07) at 80.22.

Reason(s) for trade/setup: The dollar

index is at multi-year lows (see “Spot
check,” p. 38), but signs point toward con-
tinued weakness. Patterns similar to the
July 18 low bar have been followed by
lower closes more than 70 percent of the
time on each of the following 10 days (20
Source: TradeStation
patterns tested since 2000). If the trade is wrong, it should
become apparent relatively quickly: The dollar should rally the Canadian dollar on this day). However, the dollar index
quickly off this obvious chart support if dollar bulls (who was showing signs of strength toward the end of the session
no doubt have been buying around this level) have their and had bounced back almost to 80.00.
way with the market. We kept the stop at its original level, as the market has not
moved enough to merit lowering it by a significant amount.
Initial stop: A close above 80.49, which is the July 18 high. The risk on this trade is very small, and reducing it to noth-
The market could very well move sideways or slightly high- ing would serve no purpose except to virtually eliminate
er to try to fake out traders before making another down- any profit potential. Further volatility is likely, but the initial
side thrust. profitable move will make it easier to absorb.

Initial target: 79.10, which is 0.10 above the next round- Update, July 25: The market made a decisive move to the
number price below 80.00. Take partial profits and trail a upside, with the dollar index futures gapping more than
stop behind the remainder of the position. 0.30 higher and closing at 80.52, stopping out the trade. The
next day price turned back down and was trading at 80.35
RESULT around midday.
Although this jump looks like it could be the beginning of
Exit: 80.52. a move off resistance, we will consider re-entering on the
short side if follow-through does not materialize. It would
Reason for exit: Initial stop triggered. be just like the market to attempt to throw traders off track
with a move like this before continuing lower.
Profit/loss: -0.27.
Note: Initial trade targets are typically based on things such as the
Trade executed according to plan? Yes. historical performance of a price pattern or trading system signal.
However, because individual trades are dictated by immediate cir-
Outcome: After recouping much of its big decline on July cumstances, price targets are flexible and are often used as points at
20, the dollar index futures gapped lower on July 24 and which to liquidate a portion of a trade to reduce exposure. As a result,
traded as low as 79.87 (the buck fell more than 1 percent vs. initial (pre-trade) reward-risk ratios are conjectural by nature.

TRADE SUMMARY
Date Contract Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
7/19/07 DXU07 80.22 80.49 79.10 4.15 80.52 7/25/07 -0.30 (0.4%) +0.35 -0.30 4 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

52 August 2007 • CURRENCY TRADER

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to link directly
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web sites

CURRENCY TRADER • August 2007 53

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54 August 2007 • CURRENCY TRADER