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May 2013

Volume 10, No. 5

Strategies, analysis, and news for FX traders

Price-pattern FX portfolio strategy P. 16

Aligning trade triggers: Multiplesignals, increased momentum p. 20

Forex nightmare: Centralbanks loom over market p. 10

The dollar, imports, and ination p. 22

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2/312 May2013CURRENCY TRADER

CONTENTS

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

Global Markets

Emerging Asia strong,

but wary of yen depreciation .....................6

Theres more diversity than ever among Asian

economies, and some currencies are better

situated than others to take advantage of the

regions booming growth.

By Currency Trader Staff

On the Money

Traders nightmare ..................................10

Looming central bank actions may appear to be

potential triggers for certain currency moves, butyou cant count on the FX market following the

script.

By Barbara Rockefeller

Trading Strategies

A price-action portfolio FX strategy ......16

A non-optimized price-pattern system shows

potential on a three-currency portfolio.

ByDaniel Fernandez

Two is better than one ...........................20

Aligning multiple trade triggers helps increase

the odds of a momentum move.

By Greg Michalowski

Advanced Concepts

Currencies and relative

import infation......................................... 22

Despite the Feds quantitative easing, capitalexports to the U.S. will keep the trade-weighted

dollar stronger than it would be otherwise.

By Howard L. Simons

Global Economic Calendar ........................26

Important dates for currency traders.

Events .......................................................26

Conferences, seminars, and other events.

Currency Futures Snapshot.................28

BarclayHedge Rankings........................28

Top-ranked managed money programs

International Markets............................ 29

Numbers from the global forex, stock, and

interest-rate markets.

Looking for an

advertiser?

Click on the company

name for a direct link to the

ad in this months issue.

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CONTRIBUTORS

4 May2013CURRENCY TRADER

Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Contributing editor:

Howard Simons

Contributing writers:

Barbara Rockefeller,

Marc Chandler, Chris Peters

Editorial assistant and

webmaster: Kesha Green

[email protected]

President: Phil Dorman

[email protected]

Publisher, ad sales:

Bob Dorman

[email protected]

Classifed ad sales: Mark Seger

[email protected]

Volume 10, Issue 5. Currency Trader is published monthly by TechInfo,Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright 2013 TechInfo,Inc. All rights reserved. Information in this publication may not be stored orreproduced in any form without written permission from the publisher.

The information in Currency Trader magazine is intended for educationalpurposes only. It is not meant to recommend, promote or in any way implythe effectiveness of any trading sys tem, strategy or approach. Traders areadvised to do their own research and testing to determine the validity of atrading idea. Trading and investing carry a high level of risk. Past perfor-mance does not guarantee future results.

For all subscriber services:www.currencytradermag.com

A publication of Active Trader

CONTRIBUTORS

qHoward Simons is president of

Rosewood Trading Inc. and a strategist

for Bianco Research. He writes and speaks

frequently on a wide range of economic

and nancial market issues.

qBarbara Rockefeller(www.rts-forex.com) is an

international economist with a focus on foreign exchange.

She has worked as a forecaster, trader, and consultant at

Citibank and other nancial institutions, and currently

publishes two daily reports on foreign exchange. Rockefel-

ler is the author ofTechnical Analysis for Dummies, Second

Edition (Wiley, 2011), 24/7 Trading Around the Clock, Around

the World (John Wiley & Sons, 2000), The Global Trader

(John Wiley & Sons, 2001), The Foreign Exchange Matrix

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

published in Japan in 1999. A book tentatively titled How

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

directors of a large European hedge fund.

qDaniel Fernandezis an active trader

with a strong interest in calculus, statistics,

and economics who has been focusing on

the analysis of forex trading strategies,

particularly algorithmic trading and the

mathematical evaluation of long-term sys-

tem protability. For the past two years he has published

his research and opinions on his blog Reviewing Every-

thing Forex, which also includes reviews of commercial

and free trading systems and general interest articles on

forex trading (http://mechanicalforex.com). Fernandez is

a graduate of the National University of Colombia, where

he majored in chemistry, concentrating in computational

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

q Greg Michalowskiis the chief currency analyst at

FXDD (www.fxdd.com) and author of the bookAttacking

Currency Trends (John Wiley & Sons). Retail forex traders

can learn from his 28 years of market experience and getreal-time market analysis at www.livestream.com/FXDD

and www.fxddnow.com daily. An upcoming article will

look at how to nd the low-risk E=MC2 energy levels,

with a twist.
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]

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http://clk.atdmt.com/FXM/go/416656061/direct/01/

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GLOBAL MARKETS

While global GDP continues to limp along in the secondquarter, emerging Asian economies offer a bright spotamong the economic clouds. The International MonetaryFund (IMF) recently trimmed its 2013 global GDP forecastto 3.3%, with advanced economies averaging a 1.2% rateand emerging and developing economies growing at a

5.3% pace this year.On a relative growth basis, emerging Asia specifically is

standing tall among world economies. The IMF forecastsa 5.9% GDP rate in 2013 for the Association of SoutheastAsian Nations (ASEAN), which includes Indonesia,Malaysia, Philippines, Thailand, and Vietnam.

Asian regional currencies should be able to hold theirown in 2013, given that the uncertainties in the globaleconomy are likely to persist, especially in the Eurozone,says Maya Ann Pinto, economist at IDEAglobal Ltd.

Most of the region will successfully approach its poten-tial GDP by year-end, according to Glenn Levine, senior

economist at Moodys Analytics. It will continue to be thefastest-growing region in the world, with low risks, thoughits heavy reliance on exports means the sluggish U.S. andEuropean recoveries will drag on growth.

However, the sustained easy-money policies of devel-oped nations has led to an interesting brew of market,trade, and currency factors, leaving many unansweredquestions for the region.

Quantitative easing and global monetary policy arean issue, Levine says. There are questions about howcentral banks across Asia, particularly in the ASEAN, willhandle hot-money inflows stemming from excessivelyloose monetary policy in the U.S., UK, and Japan. Asset

prices have risen strongly across Southeast Asia but cen-tral banks have been reluctant to raise interest rates forfear of lifting their currencies and snuffing out exports.The result, Levine warns, could be capital controls.

While Figure 1 shows the Japanese yen has weakeneddramatically in response to the Bank of Japans (BOJ)monetary policies, some emerging Asian currencies havestrengthened. But the weaker yen does have implicationsfor other export-driven Asian nations, which could lead toadditional bouts of forex intervention this year.

The Thai baht (THB) has been a strong performer, gain-ing roughly 6% on the year vs. the U.S. dollar through

Emerging Asia strong, butwary of yen depreciation

Theres more diversity than ever among Asian economies, and some currencies are

better situated than others to take advantage of the regions booming growth.

BY CURRENCY TRADER STAFF

FIGURE 1: DOLLAR/YEN

The Japanese yen has weakened dramatically as a result of

the Bank of Japans (BOJ) monetary policies.

Source: TradeStation
http://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Concepts

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mid-April and around 11% since July 2012 before bouncinglate in the month (Figure 2). The Indian rupee (INR) hasthe second-strongest Asian currency thus far in 2013, witha 1.9% increase into late April (Figure 3). Perhaps more sig -nificant: Most Asian currencies have strengthened dramati-cally vs. the yen.

Diverging economiesOne of the important developments forex traders need tounderstand are the nuances among the various emergingAsian economies. Sean Callow, senior currency strategist atWestpac Institutional Bank, says the most notable of thesehas been the extent of divergence within Asia. No longer

is the decision simply to buy or sell USD/Asia, he says.Callow illustrates the point by noting that a longThai baht vs. the Korean won (KRW) trade would havereturned almost 12% through April. The baht has been itsown story, with Thailands economy recovering stronglyfrom the late 2011 floods, helped by loose monetary andfiscal policy, he says. In contrast, Korean growth hasundershot, while North Korean tensions have exceeded theusual bluster. The Indian rupee has been helped by eas-ing inflation pressures but remains historically weak. TheSingapore dollar has been undermined by disappointinglysoft growth (-0.6% GDP in Q1 2013), Callow says.

Callow stresses the importance of understanding the

fundamentals of individual nations rather than the regionas whole, which he says was the case for much of the post-financial crisis period.

At the moment, the [recovery] process is yieldinguneven results in terms of economic strength, says Dr.Francisco Larios, chief emerging-market economist atDecision Economics, Inc. The smaller economies aroundChina, such as the Philippines and Indonesia, are bouncingback more strongly than China. Its all happening tenu-ously and the recovery is in the very early phases.

Larios says recent data out of China suggests its econ-omy is moving sideways, at best. The rate of growth in

China is below what most people expected, he says,pointing to a first-quarter 2013 GDP rate of 7.7%, a slow-down from the fourth-quarter 2012 pace of 7.9%. Thethree largest economies in the region China, India, andKorea are weak from within, he adds, referring todomestic consumption and investment.

Nonetheless, Larios believes Asia is the fastest-growing

region in the world and will probably continue to be.The currency implications are straightforward. It is stillan environment for these currencies to gain vs. the U.S.dollar, amid continuation of quantitative easing in theU.S., he says.

Pinto believes the regions strong internal fundamentalswill be a bullish factor for its currencies. Strong fun-damentals of the regional economies, strong growth ledby domestic demand, current account surpluses in mostcountries, contained fiscal deficits in most countries, andcontained inflation in most countries are likely to continueto attract foreign inflows and guide FX performance in

2013, he says.

The PhilippinesLooking at country-specific GDP forecasts for 2013,Nomura estimates the following: China 7.7%; thePhilippines 6.4%; Indonesia 6.1%; India 5.2%; Thailand4.5%; Malaysia 4.3%; Taiwan 3%; South Korea 2.7%; HongKong 2.5%; and Singapore 2.4%.

The Philippines could be one of the regions star per-formers for the year. We expect the Philippines willgrow 6.7% in 2013, a touch higher than 2012s 6.6%, saysKatrina Ell, associate economist at Moodys Analytics.The Philippines defied the global downturn and was one

of the few economies to accelerate in 2012.Ell says Philippine President Benigno Aquinos policies,

which include curbing budget deficits, actively encourag-ing foreign investment, and clamping down on corruption,have fueled economic optimism and led to a surge in for-eign inflows. Portfolio inflows rose 67% year over year in

FIGURE 2: THAI BAHT

The Thai baht (THB) gained roughly 6% on the year vs. the

U.S. dollar through mid-April.

Source: ADVFN.com

FIGURE 3: INDIAN RUPEE

The Indian rupee (INR) has been the second-strongest

Asian currency on the year.

Source: ADVFN.com

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GLOBAL MARKETS

December, pushing full-year investment to a 10-year high,she says. The stock market has risen 6% (as of late April),while the peso is at a five-year high against the dollar(Figure 4). The central bank is now concerned about capital

inflows fueling asset price bubbles and is amending exist-ing regulation to deter speculative inflows.

TaiwanMoodys Analytics forecasts 2013 GDP growth of 3.4% forTaiwan, a nation that is balancing some economic strengthswith a few challenges. Its participating in the smart-phone and tablet market, but it also has a large presencein the fading personal computer industry, according toEll. Strong growth in smart phones and tablet comput-ers has been at the expense of PCs. In the March quarter,global PC shipments fell 13.9% year over year, the steepestdecline on record.

Also, despite evidence to the contrary, Ell says Taiwanscentral bank denies claims of frequent currency manipula-tion. During a recent legislative session, Governor PerngFai-nan professed the Taiwan dollars value is decided bythe international market. But Taiwans central bank isconsidered amongst the biggest currency manipulators inAsia, Ell says. In the past year, well-placed sources notethe central bank has been unwavering in its commitmentto stem the appreciation of the Taiwan dollar, interveningon most trading days.

Ell explains there has been unrelenting upward pres-sure on emerging-market assets after major central banks,

including the U.S. and Japan, engaged in large-scalequantitative easing. A rising Taiwan dollar is undesirablebecause it hurts the competitiveness and bottom line of thecountrys export manufacturers, which are the economys

growth drivers. Admitting to significant interventionopens Taiwan up to global criticism, not least from majorcompetitor South Korea, Ell notes.

IndiaLevine forecasts 6% GDP growth for India, driven by solidconsumer demand and an improvement in private busi-ness investment.

The Indian rupee has been flat and fairly stable in2013, he says. Indias current account deficit remains aconcern, though the government has been [taking steps] toensure it remains financed, including the trip through theU.S. by Finance Minister P Chidambaram. Risks remainweighted to the downside.

The recent plunge in commodity prices could be a ben-efit to India.

Commodity importers like India should benefit from asustained drop in the prices of oil and gold in particular,given these two items account for a large proportion ofthe countrys current account deficit, Pinto notes. Thiswould have a positive impact on the INR. However,the reverse holds true for commodity exporters likeIndonesia.

South KoreaMoodys Analytics forecasts a 2.5% GDP rate for Korea in2013. Most sectors are weak, Levine says. Residentialinvestment is likely to remain a drag on growth. Exportmanufacturing will be key and depends heavily on contin-

ued strong growth in China. A better recovery in the U.S.would lift growth above this forecast.Looking ahead, Larios explains Chinas key role in

South Koreas outlook. If the Chinese economy becomesmore dynamic and domestic demand picks up, you willsee Korea export more, he says. Within the next 12 to18 months, the Korean won will benefit more becausethe Korean economy will probably improve just becauseKorea is tied tightly to China through trade.

SingaporeMoodys Analytics estimates a 2013 GDP pace of 2.8%pace for Singapore. The key drivers of growth are ser-

vices, such as tourism and finance, and also residentialproperty, says Moodys economist Alaistair Chan. TheSingapore dollar has been on an appreciating path vs. theUSD, which is partly to do with the governments deci-sion to maintain an appreciating currency to keep infla-tion pressures down.

Forex trendsCallow cites the Korean won as his top pick, despite thecurrencys recent sluggishness (Figure 5). We think theKorean won is ready to rebound, he says. The worst isprobably past in terms of growth, with fresh fiscal stimu-lus by the new government adding to low interest rates

FIGURE 4: PHILIPPINE PESO

Government efforts to curb budget deficits, encourage

foreign investment, and clamp down on corruption have

fueled economic optimism in the Philippines and led to a

surge in foreign inflows.

Source: ADVFN.com

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9/31CURRENCY TRADERMay2013 9

and likely better growth momentum in China in secondand third quarter.

Noting recent military tensions, Callow adds it looks asif the North Korean threat will prove to be mostly anannoyance for Seoul markets. USD/KRW 1080 seems eas-

ily achievable during the second quarter, he says. Themain risk to the short USD/KRW trade is from USD/JPY if the latter surges again, it could support USD/KRW,with the JPY/KRW cross rate sensitive to export competi-tiveness.

Looking for Asias Swiss franc? Pinto suggests theSingapore dollar (SGD). If risk aversion spikes anew, thelikes of the SGD will do well given the currencys safe-haven status, she says. Singapore enjoys a strong currentaccount surplus. [Also,] it is one of a dwindling pool ofAAA economies.

Can the Thai baht continue its recent run? Prior to theTHB becoming the best performer in the Asian regionalcurrency space in 2013, the top performers in 2012 werethe KRW and the PHP, Pinto notes. However, both SouthKorea and the Philippines took steps to temper their cur-rencies appreciation because of competitiveness concerns.In fact, following the THBs outperformance thus far thisyear, verbal intervention from the Thai authorities hasbeen seen of late, which spurred some profit-taking weak-ness [the week ending April 26] for fear of actual interven-tion to stem the pace of THBs gains, Pinto explains. Thiswould be a constraint on the [bahts] upside.

Marc Chandler, global head of currency strategy atBrown Brothers Harriman, identifies three main strategies

to profit in the forex markets: Go with the trend, go forthe carry trade or mean reversion, he says. Specifically,Chandler suggests buying Korea and selling Thailand for amean-reversion play (Figure 6). Take a currency that hasbeen one of the weakest and pit it against a currency thathas been one of the strongest, he says.

Central bank intervention

and the Japan factorHowever, analysts warn forex traders need to be waryof the potential for central bank interventions. Japansactions, for example, have implications for the entireregion.

Japans recent aggressive monetary easing and con-comitant weakness in the JPY have raised concerns in Asia,especially in those economies that most closely competewith Japans exports, such as South Korea and Taiwan,Pinto says. With the Japanese yen seen weakening fur-ther, the authorities in these countries could intervene andimplement other measures to cap gains in their currenciesto avoid losing out.

Michael Woolfolk, global markets strategist at Bank ofNew York Mellon, agreed yen weakness was a major factoraffecting the region. Emerging Asian countries are export-ers, he says. Their export-led growth model is underthreat if their currencies are strengthening vs. the yen.

Already in 2013, Woolfolk says Korea and Taiwan haveintervened by selling their own currencies and buyingdollars. They want to keep their own currencies weak,he says. We expect this to be a growing trend. It is nowviewed as acceptable in the international community tokeep your currency weak. China has been doing it for thepast 10 years and, famously, has built up a $3.5 trillion inreserves.

Woolfolk notes that since June 2012, the Japanese cur-rency has dropped 25.8% vs. the Korean won, 24% vs. theSingapore dollar, and 28.6% vs. the Thai baht.

It makes it challenging to export at prices that are 30%

higher than last summer, Woolfolk explains. The compe-tition in monetary policy and the weakening of the dollarand the yen are forcing their currencies higher and under-mining their exports. The [yen] weakness has been severerecently and I expected intervention.y

FIGURE 5: KOREAN WON

Some analysts think the KRW will continue to rebound

against the dollar, implying more down movement in the

USD/KRW rate.

Source: ADVFN.com

FIGURE 6: KOREA/THAILAND

Long Korea/Short Thailand is a potential mean-reversion

play.

Source: ADVFN.com

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10/31

A crisis is brewing in the FX market,but its not a giant rally or a crash its an absence of trend. As everytrader knows, the worst of all possibleworlds is when prices move sidewayswithout momentum. You think yousee a trend or a correction in a trend,but, really, your eyes deceive you. Acertain amount of self-delusion (wish-

ful thinking) is proved by losses pilingup.

One of the worst periods was thesummer of 2006, when the Euro/dol-lar wobbled around in a narrow range,seemingly without direction (Figure1 and Table 1). Figure 2 suggests wecould be entering another period oflow trend in the Euro/dollar pair(EUR/USD). The center line is a linearregression that slopes downward andpoints roughly toward 1.2850. The redlines mark support and resistance and

form a triangle narrowing to an apexaround the same level.

Underlying interest rate fundamen-tals suggest we wont be getting abreakout, either. The general pictureis the U.S. will be raising rates whilethe Eurozone will be lowering them.Even if both ideas are correct, diver-gent rate changes are going to take avery long while, certainly months andpossibly years, and even then will runa rocky course.

The Federal Reserve is preparing

On the Money


ON THE MONEY

Traders nightmareLooming central bank actions may appear to be potential triggers for certain

currency moves, but you cant count on the FX market following the script.

BY BARBARA ROCKEFELLER

FIGURE 1: EURO, SUMMER 2006

The Euro/dollar pair wobbled in a narrow range for months in mid-2006.

Source: Chart Metastock; data Reuters and eSignal

3April

10 17 24 1May

8 15 22 29 5June

1 2 1 9 2 6 3July

10 17 24 31 7August

14 21 28 4 11September

18 25 2 9October

16 23 30 6 13November

20 27 4 11December

18 25 120

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.2

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

1.3

TABLE 1: SPRING-SUMMER 2006 EURO MONTHLY RANGES

Period High-low High-low range (points) Average

May 2006 1.2972-1.2550 422 1.2761

June 2006 1.2980-1.2479 501 1.2730

July 2006 1.2940-1.2696 244 1.2818

Aug. 2006 1.2875-1.2626 249 1.2750

Sept. 2006 1.2783-1.2484 299 1.2633

Monthly high-low ranges in the EUR/USD pair shrank as price wandered

sideways.
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the market for a tapering off ofquantitative easing thatwill begin as soon as it sees congenial employment condi-tions, possibly as soon as late summer this year. Taperingmeans the Fed will buy less than its current $85 billion permonth in U.S. government paper and mortgage-backedsecurities, or changing the mix of the two types, or possi-bly changing the maturities of the paper.

Nobody knows whether the reduction will be $2 mil-lion, $2 billion, or $20 billion, and comments from Fed ViceChairman Janet Yellen indicate the Fed might change theamount and composition from month to month on percep-tion of evolving conditions $2 billion one month, $20billion the next month, and zero the third month. But the

Fed has announced it is now contemplating a TaperingProcess, and once the Tapering Process is completed,a change in the Fed funds rate would be on the table.Tapering is not raising rates per se, but rather allowing themarket to raise rates if it chooses to. In fact, the Fed hascommitted to keeping rates the same until at least 2015.When market commentators speak of the Fed tighteningor being hawkish in regard to the tapering process, theyare misusing the language and misleading the reader.

Meanwhile, Eurozone economic conditions are worsen-ing with every data release. The market is enamored ofthe idea the European Central Bank (ECB) may cut ratesfrom 0.75% to 0.50% sometime soon, possibly May or June.

During April, Bundesbank president and ECB GoverningCouncil member Jens Weidmann said the ECB may enter-tain a rate cut if conditions are sufficiently recessionaryand severe. ECB president Mario Draghi has said cuttingrates would probably not boost bank lending by any sig-nificant amount (the presumed intended goal of any cut)and, indeed, the ECB has always been loathe to cut rates toboost growth, since its sole mandate is to control inflation.

However, Eurozone inflation has been in a downwardtrend for many months and is now comfortably belowthe 2% target, so the ECB has permission to cut rates fromboth the data and the Bundesbank a powerful combina-tion. Even if a cut would goose activity only a little, a valid

reason to cut would be to show the ECB is responsiveto conditions and not insensitive to unemployment, and

therefore boost confidence in the institution. The ECB carespassionately about confidence, as well as credibility. A ratecut would do no harm and may do some good on the con-fidence front.

One area where a rise in confidence can be detected isever-lower peripheral bond yields. Spain, for example,which had a 10-year note yield of 7.69% in July 2012 on thebanking-sector crisis, is enjoying a 4.26% yield as of April24, down a full 100 basis points (bp) from 5.25% at the endof January. In April the Spanish Treasury issued more billsand notes than targeted, to higher demand than earlier inthe year, and at lower cost. Lower peripheral yields arealso the result of expected inflows from Japanese institu-

tional investors (see below).Thus, the current environment is one in which the U.S.

is perceived as hawkish (rates going higher) and the ECBis perceived as dovish (rates going lower). In the conven-tional way of looking at relative interest rates as a keyexchange-rate determinant, falling rates in Europe shouldbe Euro-negative and rising rates in the U.S. should bedollar-favorable.

But we always need to watch out for the word should.For one thing, a rise in confidence in the ECB may inspireforeign investors to increase equities holdings (possibly atthe expense of U.S. allocations), raise M&A activity, and/orincrease allocations of Euros to official reserves, something

FIGURE 2: EURO

More recently, the EUR/USD pair has been forming a

narrowing triangle pattern with a slight downward bias


2006 2007 2008 2009 2010 2011 2012 2013 2

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:
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ON THE MONEY

already in progress.More troublesome, perception of hawkishness at the Fed

does not always result in rates actually rising. This is theGreenspan conundrum, first expressed by then-chairmanAlan Greenspan in Congressional testimony in February2005. The Fed had raised rates by 150 bp in the previoussix months but longer-term rates, specifically the 10-yearnote, had not risen in sync. Numerous explanations haveemerged over the years, including restrained inflationexpectations, a savings glut in emerging markets andemerging-market official reserve-building, and an increasein the corporate preference for large cash reserves.

The Fed today faces a tremendous challenge in not onlybeating the Greenspan conundrum but in pushing andprodding rates higher all along the yield curve, and notin some odd or unusual pattern. The Fed will particularlywant to avoid an inverted yield curve, wherein the two-year rate yields more than the 10-year. Despite the joke

that an inverted yield curve has predicted 37 of the lastthree recessions, some market players persist in beingoverly worried about an inverted yield curve as not natu-ral. Another worry is the bond vigilantes those overlyfearful of inflation will become ascendant. Then theyield curve would become too steep.

The Fed is well aware that managing the TaperingProcess is going to be difficult, tiresome, and sometimesconfusing. After all, we never had quantitative easingbefore in the U.S. and no country has ever had it on thesame scale as the U.S., let alone experience in winding itdown.

The Tapering Process may cause the Fed to lose some of

the markets confidence if the outcome is a serious degreeof price volatility or hint of instability. Its unclear whatmeasures should be used, by the Fed or other analysts, tomeasure instability. Equity markets just love a dovishcentral bank and rate cuts, so if the ECB cuts rates, equityindex rallies in Europe will seem justified. But what aboutU.S. equity indices as the Fed tapers off QE? As noted,tapering is not actually raising rates and it might not suc-ceed in getting the market to raise rates, either. Equitytraders are about to become quite confused. Its entirelypossible that some point of the Tapering Process will endthe cheap money, Fed-fuelled equity rally.

The putative ECB rate cut has a big downside, too the

idea that central banks can overcome bad economic databy making money cheaper. This is the grimy undersideof Keynesianism overreliance on central banks to fixanything and everything, something Weidmann, Draghi,and Fed chief Ben Bernanke, have all warned against. Infact, you have to wonder if rising equity markets are nota flashing light to Mr. Draghi. Confidence is nice, but thecentral bank should not reward speculators when whatsreally needed is structural reform, and that is being post-poned because of the counterproductive nature of exces-sive austerity. Spain, Ireland, and Portugal, along withCyprus and Greece, are being given extra time to repayborrowings from the troika. Bizarrely, Germany continuesto get closer to a truly balanced budget.

But reliance on central banks does have one good fea-ture: a decline in the need for safe havens. Central bankresponsiveness is a good thing, even faintly democratic,in its own right. Rising confidence in the ECB implies the

world is safe for the embrace of risk (a dollar-negative).And yet there is a shark in the koi pond Japansupcoming quantitative easing, to the tune of 7 trillionor more each month in Japanese government bonds. TheBank of Japan (BOJ) intends to buy approximately $70 bil -lion, vs. $85 billion for the U.S. But the Japanese economyis about $5.9 trillion and the U.S. economy is about $16trillion, so the Japanese QE is proportionately far larger. Bythe time its done the BOJ will have raised its balance sheetfrom 35% to 60% of GDP by the end of 2014.

The expected buying is also more than expected monthlyissuance, meaning yields should go even lower, driv-ing regular buyers of Japanese bonds to other markets.

Anticipation of this has already contributed to a drop inyields across all the usual suspects, including the U.S.,Germany, and even peripheral Europe. Japanese institu-tional buyers of JGBs, prominently insurance companies,are already publicly discussing plans to diversify into for-eign assets.

In May Japan got a free pass from the G20, whichdeclined to censure Japan for seeking yen devaluation,and buying into the argument that Prime Minister ShinzoAbes initiatives are a domestic-oriented effort to recoverfrom deflationary recession and not a currency war tacticto drive up exports. The outcome was predictable: Thedollar/yen is surging near the benchmark 100 level and

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the Nikkei 225 stock index is rallying like crazy and nearlycatching up to global indices.

The FX market is never willing to take prices in astraight line, though. Figure 3 shows the dollar/yenmoved from a high of 124.15 on June 22, 2007 to a low of75.57 on Oct. 31, 2011. It has now retraced about 50% of themove (99.65), and that seems to be a stopping point. Someanalysts say we need a fat correction before the dollar/yen can top 100, while others say it will be an easy levelto break. Time will tell. One factor will be how seriouslyFX players take renewed skepticism that the Abe plan willserve its purpose ending deflation and recession in asustainable way.

The Organisation for Economic Co-operation andDevelopment (OECD) recently released its annual report

on Japan expressing strong doubts. It notes Japanese pub-lic debt has grown faster than the economy for over 20years and the vast pile of debt is the paramount policychallenge. It also points out Japan may have deflation,but its a stable deflation in equilibrium. The organization,agreeing with similar warnings from the IMF, would liketo see a plan to reduce debt over the medium term that iscredible. For example, Japan plans to spend an extra 10.3trillion on public works but this may be just a temporaryboost to growth while the debt remains far longer. Raisingthe debt ceiling is problematic, since already existing debtwill be over 240% of GDP next year, the highest in theworld.

OECD says current plans for fiscal consolidation areskimpy and not workable. Japan will be spending 215 for

every 100 it collects in taxes this calendar year. The so-called primary deficit (excluding repayments) will be 6.9%this year, and the OECD would prefer to see it around3.2%. Even with consumption-tax hikes planned for 2014and 2015, reaching a better primary deficit level would bea stretch.

As numerous analysts have pointed out over manyyears, Japan has structural as well as cyclical problems,chief among them an aging population, the lowest birthrate in the world, and a shrinking labor force to supportthe social safety net. It also has a bias against immigration.One key engine of growth, research and innovation, is aheavily sponsored top priority, but a shortage of people

begets a shortage of entrepreneurs.Japan also has a culture of savings over spending, even

if the public believes (and surveys indicate they do) thegovernment will succeed in raising inflation to 2%. Cashcant cure these issues. What cash can do is light a fireunder asset bubbles. One ray of light from this deductionis a return to rising real estate prices in Japan, which neverreally recovered from the 1989 crash. As we know from theAmerican and European experience during the 1990s and2000s, rising real estate prices inspire animal spirits andhelps fuel other market rallies. The Japanese are alreadyshowing a renewed interest in gold, for example.

Thus, we have tension between the resolve of the Abe

FIGURE 3: JAPANESE YEN

The dollar/yens recent surge has taken the pair to a 50% retracement of its

2007-2011 decline.


2006 2007 2008 2009 2010 2011 2012 2013 2

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1.05

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1.15

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1.70

2005 2006 2007 2008 2009 2010 2011 2012 2013 2

75

80

85

90

95

100

105

110

115

120

125

0.0%

23.6%

38.2%

50.0%

61.8%

100.0%

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ON THE MONEY

government to boost growth and inflation and a strongand reasonable doubt the Abe plan can work, and withoutfatally negative side effects. A likely outcome could well bethe dollar/yen meandering up and down inside a range ofroughly 90 to 100, as shown in Figure 4. Even if the dollar/yen gets to 105 and 110, the big part of the move is prob-ably over and additional dollar gains will be hard foughtand easily lost. Like the Euro/dollar, a narrowing high-lowrange is likely for the dollar/yen. Again, the average FX

trader can still make gains in this environment, but willneed to change tools and techniques, including a severereduction in expected holding period and narrowing of thestop-target bands.

Timing is everything. The Fed is going to take a verylong time months and years to put the TaperingProcess in gear. BOJ and ECB action is expected far sooner.The timing differences could provide an escape hatch fromever-narrower trading ranges. The BOJ is expected to startacting the first week of May, and capital outflows couldoccur immediately. They are probably already priced intothe dollar/yen but they are not, so far, reported in Japansweekly Ministry of Finance capital flow report. When the

report starts showing real money moves, perhaps the dol-lar/yen range will get a breakout. Japanese institutionalinvestors tend to move slowly and carefully, however.

Its also possible the ECB will refuse to cut in May orJune, if it cuts at all. If it refuses to cut rates soon, trad-ers will recalibrate expectations. Here, the prospect of abreakout is far lower, since market players may just pushout the rate-cut expectation to later months or to specificdata releases, like unemployment.

Once the cat is out of the bag, dont expect it to go backin. And as for a bias in favor of one currency or anotherarising from relative rate differentials, its not clear thatcutting rates will be Euro-negative or raising rates will bedollar-favorable. The dollar/yen stands on its own uniquecircumstances, to which the interest rates is not centralsince we expect little movement and we know the direc-

tion downward.yBarbara Rockefeller (www.rts-forex.com) is an international econo-mist with a focus on foreign exchange, and the author of the newbook The Foreign Exchange Matrix (Harriman House). For moreinformation on the author, see p. 4.

FIGURE 4: JAPANESE YEN POSSIBLE RANGE

The dollar/yen could oscillate in a range from roughly 90 to 100.


2006 2007 2008 2009 2010 2011 2012 2013 2

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10ecember

17 24 31 72013

14 21 28 4 11February

18 25 4March

11 18 25 1April

8 15 2 2 29 6

May13 20 27 3

June10 17 24 1

July8 15 22

8484

85

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8788

88

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9292

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100100

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103
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16/3116 October2010CURRENCY TRADER16 May2013CURRENCY TRADER

A parameter-less price-action FX strategy (CurrencyTrader, April 2013) explored the creation of an algorithmicstrategy for the Euro/U.S. dollar (EUR/USD) pair thatused a simple price-based technique. The strategy, testedon daily data, produced profitable simulated results from1987 to 2012.

The next step in this process is to increase the robustnessand profitability of this trading approach by designingprice-action strategies that work across several instru-ments. Here well analyze a strategy to see if it generatespositive results across multiple currency pairs using the

same logic.

Strategy generation

The trading system was generated using a data-miningapproach on daily historical price from 1988 to 2000 forthe Euro/U.S. dollar (EUR/USD), U.S. dollar/Japaneseyen (USD/JPY), and the British pound/U.S. dollar (GBP/USD). Deutsche mark/U.S. dollar (DEM/USD) datawas substituted for the EUR/USD prior to January 2000.Trading costs of 2 pips were used for EUR/USD, and 3pips for both GBP/USD and USD/JPY.

Of the more than 1 million candidate systems generated

through this process, only those with very high Pearsonlinear regressioncoefficients (greater than 0.9) were accept-ed for further analysis. From this group, the most profit-able setup with the lowest standard deviationbetween theresults for the three pairs was selected.

Final testing on this system was conducted using dailydata from January 1988 to August 2012, which includesa 12-year period (2000-2012) that is not part of the initialsystem-generation data set.

The trading strategy

The final strategy consists of only five comparisonsbetween daily open, high, low, and close prices there are

no other parameters. The strategy is always in the market:As a stop-and-reverse system, long trades are exited onshort-entry signals and vice versa. The trading rules (alongwith simple formulas for clarity) are:

Long entry (short exit):

1. Todays close is below its open (Close[0] < Open[0]).2. Todays open is above the low two days ago (Open[0]

> Low[2]).3. Todays range is greater than the range seven days

earlier (Range[0] > Range[7]).

4. Yesterdays close is above the close seven days ago(Close[1] > close[7]).

5. Yesterdays close is above the high four days ago(Close[1] > high[4]).

Short entry (long exit):

1. Todays close is above its open (Close[0] > Open[0]).2. Todays open is below the high two days ago (Open[0]

< High[2]).3. Todays range is greater than the range seven days

earlier (Range[0] > Range[7]).4. Yesterdays close is below the close seven days ago

(Close[1] < close[7]).5. Yesterdays close is below the low four days ago(Close[1] < Low[4]).

In the formulas, 0 refers to the most recently complet-ed (closed) daily bar, 1 is the day before that, etc. Tradesare entered the next day (tomorrow) at the market (on theopen).

This pattern enters trades in the direction of the trendestablished over the past eight bars (rule 4) on a retrace-ment that occurs on the final bar (rule 1) with expand-ing momentum (rule 3). The rules also ensure the trendis steady by comparing two extreme midpoints of the

TRADING STRATEGIESTRADING STRATEGIES

A price-action

portfolio FX strategyA non-optimized price-pattern system shows potential on a three-currency portfolio.

BY DANIEL FERNANDEZ
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7/29/2019 Ctm 201305


price movement (rules 2, 4, and 5). This

means the pattern is attempting to takeadvantage of a trend-following oppor-tunity by entering when momentumin the direction of the current trend isshowing signs of short-term exhaus-tion. Figure 1 shows some sampletrades in 2012 in the USD/JPY pair(with an enlargement of the January2012 pattern, with the pattern barsnumbered according to the formulas).The strategy clearly behaves as a trend-following system.

The trade simulations used an initialbalance of $100,000 USD. Trade sizeswere adjusted for volatility using theaverage true range (ATR) indicator soa move of two times the 20-day ATRwould result in a 0.75% loss. For exam-ple, if the 20-day ATR was 0.0150 (150pips), the trade size would be adjustedso a move of 300 pips would cause aloss of 0.75% of the account balance.

The ATR length does not have a greatinfluence on the results of the strategy

because the ATR affects only the posi-tion size. Shorter or longer ATR periodsproduce fairly equivalent results, pro-vided the ATR values are not exceed-ingly small (e.g., less than five days), asa reasonably accurate estimate of typi-cal daily volatility is needed.

Test results

The strategy was evaluated both interms of the individual currency pairsand at the portfolio level. Figure 2shows the equity curves for each pair

FIGURE 1: SAMPLE TRADES

The pattern, which spans only eight price bars, identifies advantageous points at

which to enter in the direction of the trend.

FIGURE 2: INDIVIDUAL EQUITY CURVES

The equity curves for the EUR/USD (blue), GBP/USD (light green) and USD/JPY

(dark green) pairs highlight the lack of correlation between their drawdowns.
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while Figure 3 shows the portfolioequity curve. Table 1 summarizes theperformance statistics for all test runs.

There was a distinct lack of cor-relation between the currency pairsmaximum drawdowns that is,their drawdowns did not generallycoincide resulting in a portfoliomaximum drawdown of only 16.1%.Adding the individual drawdownswould imply a maximum drawdownof 36.78%. The decline in the maxi-mum drawdown length at the portfo-lio level is similarly dramatic, with theportfolio value coming in at 587 daysvs. an average of 1,088 for the threecurrency pairs.

This means the three pairs profitand loss periods hedged each otherquite well (as can be confirmed bycomparing the equity lines in Figure2). However, its worth noting theUlcer Index didnt decrease signifi-cantly at the portfolio level, highlight-ing the fact that the portfolios distri-bution of drawdown periods is similarto those of the individual instruments.

As expected, Table 1 also shows the

portfolio annualized average returnis close to the sum of the returnsfor the three currency pairs, greatlyincreasing the strategys compoundingeffect. This explains why the portfolioachieved a final profit of more than3,000% while none of the individualpairs exceeded 300%. The portfo-lios annual returns also representan improvement over the individualresults, with only three losing yearsout of 25, and two of those years los-


TRADING STRATEGIES

TABLE 1: PERFORMANCE SUMMARY

EUR/USD USD/JPY GBP/USD Portfolio

No. of trades 363 377 392 1,132

Absoluteprot 298% 198% 178% 3,110%

Avg. annual return 5.75% 4.65% 4.44% 15.50%

Protfactor 1.63 1.51 1.6 1.6

Winning percentage 49% 49% 49% 49%

Reward-to-risk ratio 1.67 1.58 1.64 1.65

Max. drawdown (%) 10.70% 14.29% 11.78% 16.10%

Max. drawdown (days) 1,113 days 1,036 days 1,117 days 587 days

Max. loss 6.22% 6.46% 7.84% 7.84%

Avg. loss 1.11% 1.03% 0.93% 1.02%

Ulcer Index 4.15 5.66 4.55 5.71

No. of years 25 25 25 25

FIGURE 3: PORTFOLIO EQUITY CURVE

The non-synchronized individual equity curves produced a smoother composite

portfolio curve.

7/29/2019 Ctm 201305


ing less than 1% loss (Figure 4).The portfolio reward-to-risk ratio,

profit factor, and winning percentageare comparable to the individual fig-ures, highlighting the strategys con-sistency across the different currency

pairs.Another interesting point is how the

strategy behaved during non-trendingconditions. Long-term trend-followingsystems on the daily time frame gen-erally have difficulty dealing withtrading ranges, when no clear trenddevelops and significant retracementscan occur. For example, the GBP/USDbehaved in this manner from 2009 to2012 a losing period for many trendstrategies but the price-based strate-

gy managed to trade profitably duringthis period.Figure 5 shows how the strategy

reacted far more quickly than an average long-termtrend-following system, using only information from themost recent eight-day periods to assess trend direction.Although there were significant consolidation periods, thesystems many successful trend-following trades kept thesystem in winning territory.

Finally, its important to consider the strategys riskmanagement. Although it trades without a stop-loss, themaximum portfolio loss was just 7.84% and the averageloss was just above 1% (refer to Table 1). The strategy

could be modified to include a stop-loss without signifi-cantly affecting its profitability, but this step was not takenhere to avoid using any parameters that could be subject tooptimization.

Price action simple and effective

This study suggests a simple price-action strategy cangenerate historically profitable results on multiple cur-rency pairs across more than 25 years of testing withoutany optimization. This always-in-the-market strategy rep-resents an example of what can be achieved through the

use of a simple price-action approach,although several modifications have thepotential to improve historical results,including: using price-based exit criteria,as well as profit-taking and stop-loss tar-gets.

Also, although this test illustrates aprice-based system designed to workacross three currency pairs, there is noreason the same design principles couldnot be applied to many other pairs, oreven other markets, to find patterns that

generate a desired historical outcome.yDaniel Fernandez is an active trader focusing

on forex strategy analysis, particularly algo-

rithmic trading and the mathematical evalu-

ation of long-term system protability. The

system in this article was generated using the

Kantu system generator, available at http://

mechanicalforex.com/kantu-system-generator.

For more information on the author, see p. 4.

FIGURE 4: ANNUAL RETURNS

The portfolio was profitable in 22 of the 25 test years.

FIGURE 5: BRITISH POUND TRADES, 2009 TO 2012

The system performed reasonably well during non-trending periods. Winning

trades are highlighted with green circles, losing trades with red circles.
http://mechanicalforex.com/kantu-system-generatorhttp://mechanicalforex.com/kantu-system-generatorhttp://users/MAG/Dropbox/CT/0513%20May%20CT/sh%20HD/Working5.17.04/Magazine%20Files/CT/2013%20CT/0813%20August%20CT/CurrencyTrader0813.pdfhttp://users/MAG/Dropbox/CT/0513%20May%20CT/sh%20HD/Working5.17.04/Magazine%20Files/CT/2013%20CT/0813%20August%20CT/CurrencyTrader0813.pdfhttp://mechanicalforex.com/kantu-system-generatorhttp://mechanicalforex.com/kantu-system-generator

7/29/2019 Ctm 201305


TRADING STRATEGIES

Two is better than one

Aligning multiple trade triggers helps increase the odds of a momentum move.

BY GREG MICHALOWSKI

In one of a series of TV commercials for a cell phone com-pany, an adult moderator asks a group of children ques-tions, including Whats better, doing two things at once orjust one? The children around the table all yell Two! inunison, and one of the boys in the group starts to shake hishead and hands at the same time to illustrate the point.

The exchange gets the companys point across aboutthe benefit of multi-tasking on their phones, and its areminder of the advantages of entering the market whentwo or more technical reasons point to a trade at the sameprice level. This approach improves the chances of successbecause it enters when theres an increase in the energyin the market. Traders need only follow the directionalmomentum up or down.

However, following this approach doesnt guarantee

success on any individual trade a news headline can

derail a trade in an instant, for example but it is a wayto find lower-risk trades and generate solid gains.

Energy = MC2

In high school physics your teacher likely did his or herbest to explain Einsteins equation E=MC2. Without get-ting too complicated, the equation states that energy (E) isequal to an objects mass (M) times the speed of light (C)squared. The speed of light is a constant, so energy increas-es as mass increases.

Theres a certain analogy in trading. Lets alter the equa-tion by changing M to Multiple Reasons to Trade. Morereasons to trade at a certain price level will tend to increasethe energy of the market, either up or down. It may notbe comparable to the speed of light, but you should antici-

pate a momentum move that is faster than normal whena certain price level is associated withmultiple trade triggers. Profit potentialincreases for traders who anticipatethis energy and follow the price actionaccordingly.

Low-risk trade setupsWhen looking for a low-risk tradesetup with multiple entry reasons, itsbest to use technical tools that tend tobe followed by many people, are easilyvisualized, and which provide a defini-

tive buy or sell bias. The more tradersthat are likely to act on a breakout,the better the odds of an energizedmomentum move. In forex trading,the following tools satisfy these threerequirements: 100- and 200-bar simplemoving averages (SMA), trendlines,and Fibonacci retracements.

Figure 1 shows an hourly (60-min-ute) chart of the Euro/U.S. dollar pair(EUR/USD) with a 100-hour SMA(blue line) and a 200-hour SMA (greenline); both moving averages attract

FIGURE 1: ONE PRICE LEVEL, MULTIPLE TRADE SIGNALS

There were three reasons to go long around 1.2923: the 100-hour SMA, a

move to the top of a pennant/wedge pattern, and the horizontal support-

resistance level.

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technical buying or selling. For example, on March 20price traded above the 100-hour SMA but none of the60-minute bars closed above it, suggesting traders werehappy to sell at that level. In fact, price peaked right at the200-hour SMA and sold off.

On March 21, the pair once again found willing sellersnear the 100-hour SMA and, on March 22, the 100-hourSMA again functioned as a resistance level. Clearly the

100-hour MA was creating its own energy, with sellersleaning against it as a way to define and limit risk. Noticeat the final bar on the chart, the 100-hour SMA was around1.2923.

Figure 1 also includes several trendlines. The first lineto focus on is the horizontal one that starts at the blue 1on March 13 at 1.2923. Price bottomed at this level onthat day and bounced. Moving from left to right, the bluenumbers highlight hourly bars that topped or bottomedat 1.2923. Also, in several other instances, price topped orbottomed within six or so pips of the line.

These horizontal lines can be thought of asRemembered Lines, because market participants tend

to remember such levels and traders use them to defineand limit risk. Like the 100-hour SMA, energy is createdaround this line, which in this case is at 1.2923 the samelevel as the final 100-hour SMA reading.

The next trendlines in the chart are those defining thenarrowing pennant or wedge formation, the highs andlows of which are marked with the red numbers. TheEUR/USD pair tested the upward-sloping trendline atthe bottom of the pattern five times, while it tested thedownward-sloping line at the top the pattern four times.On March 22, price tested the bottom trendline for thefourth and fifth times and held. From those lows, pricemoved higher and by the end of the chart was testing the

patterns upper trendline at the now-familiar 1.2923 level.These three simple, visual technical tools were all con-

verging around 1.2923, giving multiple reasons to tradeat that level. When this happens, its time to anticipatean energy move either an upside breakout, or anotherswing to the downside if resistance holds once again. Likethe preschoolers in the ad, we can surmise two or eventhree reasons to trade are better than one.

In our example the EUR/USD pair did, in fact, breakabove the 1.2923 level, as shown in Figure 2. Because thereare multiple reasons to trade, a buy entry should be exe-cuted near the level in anticipation of an upside momen-tum move. The next task is managing the trade.

Trade managementThe first step in managing the trade is to set exit targetsat progressively higher technical levels derived from thesame tools used to enter the trade trendlines, mov-ing averages, and Fibonacci retracements. The targets inFigure 2 include:

1. A 38.2% retracement of the March 15-19 down move(refer to Figure 1 for the derivation of the Fibonacciretracement levels). That level is at 1.2943 and wouldresult in a 20-pip gain.

2. The 200-hour SMA (green line) at 1.2951. This wouldincrease the gain to 28 pips.

3. A 50% retracement of the March 15-19 down move,which would occur at 1.2975 and would result in a42-pip gain.

4. A 61.8% retracement of the March 15-19 down move(1.3005). Reaching this target would lead to an 83-pipprofit.

FIGURE 2: TRADE TARGETS

Mapping out target levels helps confirm the bias and increase confidence in the

trades progress.

continued on p. 25

7/29/2019 Ctm 201305


TRADING STRATEGIESADVANCED CONCEPTS

Writer H.L. Mencken once observed, For every com-plex problem, there is a solution that is simple, neat, andwrong. This describes much of modern economics andprobably a great majority of prehistoric economics as well:An apparently simple relationship soon is surrounded byfootnotes, exceptions, and codicils so vast they give off theimpression economists are a bunch of devious louts inca-pable of agreeing with reality, much less with each other.

The linkages between currencies and trade weights fallinto this category. The classic response is a stronger curren-

cy makes a countrys exports more expensive and thereforelowers both its current account surplus and its share in itscustomers current balances (see Currencies and FederalReserve trade weights and Minor currencies and FederalReserve trade weights, Currency Trader, July and August2007).

If only this assertion was substantiated in the fourdecades of data available since the collapse of the BrettonWoods fixed-exchange rate regime and the adoption offlexible exchange rates.

Key U.S. suppliersFor a stronger currency to havethese effects on current accountbalances it must raise the price ofimports denominated in that cur-rency relative to the importersbase level of inflation.

This is a readily testable propo-sition; our good friends at theBureau of Labor Statistics (BLS)keep track of these import priceindices. We can normalize them

to the GDP deflator distributeddown from quarterly to monthlydata using cubic spline interpola-tion and match them against a setof five currencies re-indexed tothe December 2003 starting pointfor the Chinese and Mexicanimport indices.

The currencies selected are theCanadian dollar (CAD), Mexicanpeso (MXN), Chinese yuan(CNY), Euro (EUR), and Japaneseyen (JPY). Together they account

Currencies and relative

import inflationDespite the Feds quantitative easing, capital exports to the U.S. will keep

the trade-weighted dollar stronger than it would be otherwise.

BY HOWARD L. SIMONS

The five currencies relative import price indices (RIP), which are the BLS numbers

relative to the GDP deflator, have varied widely over time. The Eurozones RIP has

been the least volatile of the group.

FIGURE 1: IMPORT INFLATION TRENDS DIVERGE WIDELY

82.5%

87.5%

92.5%

97.5%

102.5%

107.5%

112.5%

117.5%

122.5%

127.5%

132.5%

137.5%

142.5%

147.5%

Dec-92

Mar-94

Jun-95

Sep-96

Dec-97

Mar-99

Jun-00

Sep-01

Dec-02

Mar-04

Jun-05

Sep-06

Dec-07

Mar-09

Jun-10

Sep-11

Dec-12

ImportInflatio

nRelativeToGDPDeflator

Dece

mber2003=100%

Canada R.I.P.

EU R.I.P.

Mexico R.I.P.

China R.I.P

Japan R.I.P.

7/29/2019 Ctm 201305


for 76% of the weight in the Federal Reserves trade-weighted import balances. Their relative import priceindices (RIP, no pun intended), which are the BLS numbersrelative to the GDP deflator, have varied widely over time(Figure 1).

They also have something of a Rorschach test qualityto them. For example, Japans RIP has been flat through-

out the post-March 2009 quantitative easing era, whileChinas RIP has moved up and down in a manner similarto Canadas even though the two countries export mixesto the U.S. are very different. The Canadian and MexicanRIPs have increased over time, but both have demon-strated a strong capacity to move lower quickly whenevents such as the 2008-2009 financial crisis dictate. Finally,the Eurozones RIP has been the least volatile of the quin-tet even though both the dollar and the Euro are definedagainst each other so heavily.

Now lets look at the currency index (CI) for each ofthe five currencies. In Figure 2 the MXN is displayed on aseparate scale to account for its strong depreciation against

the USD during the 1990s. Interestingly enough, and forall of the complaining about the grudging revaluation ofthe CNY, it has appreciated more against the USD than thecurrencies of the other major exporters to the U.S.

Lead-lag relationshipsWe should not expect a contemporaneous response to cur-rency changes in the RIPs; it takes time for currencies tochange supplier relationships and for orders to be affected.What is surprising is how quickly these lead-times operate.It might be reasonable to expect something along the orderof three to six months, but in the cases of the CAD and theEUR, the lead-times are three and two months, respective-

ly (Figure 3). What this tells us is exporters are very willingto sacrifice operating margins to maintain market share.

None of the other three currencies examined have ademonstrable leading relationship to their associated RIP.This is quite understandable in the Chinese case, where thecountrys on-again/off-again revaluation policy has dis-torted statistical relationships. More importantly, Chinas

cost advantages have precluded erosion of its competitiveposition via a stronger CNY. The Japanese case has beensimpler: Deflationary pressures there led to years of astronger JPY and continual deterioration of its competitive-ness in export markets.

It is important to note China has long feared a repriseof the Japanese experience with a rising JPY during the1980s; they see it as having led to Japans consecutiveLost Decades. No country can remain the cheapest laborsource and world pollution haven forever. China hasbeen losing some export markets to cheaper labor sourcessuch as Vietnam, and its pollution crisis is reaching thepoint where it could threaten social order. Adjustments to

Chinas production cost structures are inevitable and willtake years to unfold.

A second process will be underway among Chinascustomers (particularly the U.S.): the reestablishment ofdomestic supply chains in response to higher import costs.Higher international transit costs and cheaper domesticnatural gas have created incentives for manufacturing toreturn to the U.S. This process will take years to unfold, asmuch of the manufacturing culture of the U.S. has lapsedinto disuse since the early 1970s.

The one risk to this scenario will be an aggressive moveby China to impede the CNYs revaluation. The short-termbenefits to China will involve current account surpluses;

Despite complaints of China only grudgingly allowing revaluation of the yuan, theCNY has appreciated more against the USD than the currencies of the other major

exporters to the U.S.

FIGURE 2: CURRENCY TRENDS

65%

85%

105%

125%

145%

165%

185%

205%

225%

245%

265%

285%

305%

325%

345%

365%

65%

70%

75%

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

130%

135%

140%

145%

Dec-92

Mar-94

Jun-95

Sep-96

Dec-97

Mar-99

Jun-00

Sep-01

Dec-02

Mar-04

Jun-05

Sep-06

Dec-07

Mar-09

Jun-10

Sep-11

Dec-12

MexicanPe

so,Dec.2003=100%

CAD,EUR,CNYAndJPY,

Dec.2003=100%

Canada C.I.

EU C.I.

China C.I.

Mexico C.I.

Japan C.I.
http://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Conceptshttp://www.currencytradermag.com/index.php/c/Key_Concepts

7/29/2019 Ctm 201305

24/31

ON THE MONEY


ADVANCED CONCEPTS

the U.S. will enjoy complemen-tary benefits of cheaper imports.But this will be one more exercisein kicking the can down the road,as if policymakers anywhere

would stoop to such tactics.Finally, Mexico has had a

hybrid situation involving thelarge dominance of intrasubsid-iary transfers, free-trade agree-ment preferences, and a largecrude oil export sector priced inUSD. Fluctuations in the MXNover time have affected theMexican RIP, but not in a statisti-cally significant manner.

Competitive devaluationThe global urge to improve eco-nomic fortunes by trashing thepurchasing power of fiat moneycould work to the advantageof U.S. consumers and import-ers over time. The effects of thedownside breakout in the JPYstarting in November 2012 havenot been felt yet, but they will beif Japan succeeds in recapturingthe share of U.S. imports it haslost over the past quarter-century.

Japans weight in the U.S.import picture has declined from25.87% in 1986 to 7.85% in 2012.If the yen-weakening campaignis executed through large-scalepurchases of U.S. assets, thosecapital exports must be matchedby increased exports of goodsand services to the U.S., andthe effect of incremental supplyalways involves lower prices andhence downward pressure on rel-ative import prices. (Incidentally,

Canadas share of U.S. exportshas declined very significantly over the same period aswell, from 20.34% in 1986 to 13.95% in 2012.)

Capital exports to the U.S. involve purchases of USD-denominated assets, both financial and real, which willkeep the trade-weighted dollar stronger than it wouldbe otherwise despite the Federal Reserves best efforts atmoney-printing. The trade-weighted dollar has declinedat an average annual rate of only 3.91% since the March2009 inception of quantitative easing.

Imports will remain a relatively stable portion of the U.S.inflation picture for as long as this vendor financing mech-anism persists. Efforts made elsewhere to devalue curren-

cies involve vendor financing of the U.S. as a customer,along with the export of cheaper goods and services to theU.S. to offset those capital exports. The U.S. consumer willget the benefit of those cheaper goods and services even asdomestic industries more insulated from global competi-tion, such as medical care and education, continue to soar

in price.yHoward Simons is president of Rosewood Trading Inc. and a

strategist for Bianco Research. For more information on the

author, see p. 4.

The RIPs response to currency changes is surprisingly quick lead times of two

and three months for the EUR (top) and the CAD (bottom), respectively.

FIGURE 3: THE EURO LEADS RELATIVE IMPORT PRICE INDEX

65%

70%

75%

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

130%

95.00%

96.25%

97.50%

98.75%

100.00%

101.25%

102.50%

103.75%

105.00%

106.25%

107.50%

108.75%

110.00%

111.25%

112.50%

Dec-92

Ma

r-94

Jun-95

Sep-96

Dec-97

Ma

r-99

Jun-00

Sep-01

Dec-02

Ma

r-04

Jun-05

Sep-06

Dec-07

Ma

r-09

Jun-10

Sep-11

Dec-12

EUR,Dec.2003=100%

EURImportIndexRelativeToGDPDeflator

Led3Months,

Dec.

2003=100

%

EU R.I.P.

EU C.I.

r2=.689

THE CAD LEADS RELATIVE IMPORT PRICE INDEX

80%

85%

90%

95%

100%

105%

110%

115%

120%

125%

130%

135%

140%

92.5%

97.5%

102.5%

107.5%

112.5%

117.5%

122.5%

127.5%

132.5%

137.5%

142.5%

147.5%

Dec-92

Jun-94

Dec-95

Jun-97

Dec-98

Jun-00

Dec-01

Jun-03

Dec-04

Jun-06

Dec-07

Jun-09

Dec-10

Jun-12

CAD,Dec.200

3=100%

CADImportIndex

RelativeToGDPDeflator

Led2Month

s,

Dec.

2003=100%

Canada R.I.P.

Canada C.I.

r2=.784

7/29/2019 Ctm 201305


Defining risk and riding the momentumBecause the entry level has three supporting technicalreasons, there should be an energy momentum move thatpushes price higher. Although traders should anticipatethis momentum and have confidence in the position, thepositions risk still needs to be defined and limited.

Figure 3 shows the risk on the initial trade limited bya stop-loss at 1.2910, where lows and highs occurred onvarious days dating back to March 14. Because an energymove is expected, traders should feel confident price

should not go below this level. Setting this stop limits thetrades initial risk to 13 to 16 pips.

As the example shows, the momentum did, in fact, pushprice higher. The EUR/USD pair breached the successivetarget levels, and on the way found willing buyers lookingto take advantage of the renewed upward energy from thebreakout. When price moves above the 200-hour SMA, thestop-loss was raised to the entry level (which was wherethe 100-bar SMA was on March 22). This is a prudent stepin case the market reverses.

When price gets to the third target (the 50% retracementlevel) at 1.2975 (the green 3), the stop-loss can logically beraised just below the 200-hour SMA (the green 2), guaran-

teeing an approximately 28-pip profit. When the final legsurged higher to the 61.8% retracement level (the fourthtarget) at 1.3006, the retracement level was joined by thelows from a week earlier (green shaded horizontal line).

Just like having multiple trade signals, if there are mul-tiple reasons to get out of a trade, its likely a good timeto either lighten up and take partial profits, or exit the fullposition and look for the next low-risk trading opportu-nity.

Strength in numbersEven a group of precocious preschoolers understand thattwo or three (or even more) is better than one. If you wantto improve your entry levels so you are trading at pointswhere there is likely to be energy, line up simple, visualtechnical signals.yGreg Michalowski is the chief currency analyst at FXDD

(www.fxdd.com) and author of the book Attacking Currency

Trends (John Wiley & Sons). He will be giving a free presentation at

the FXDD MastersLive conference (www.fxddmasterslive.com)

in Orlando on May 11. For more information on the author, see p. 4.

FIGURE 3: STOP-LOSS

The EUR/USD pair made a high-momentum move after the breakout above

1.2923 level and paused after hitting the fourth target level.

TRADING STRATEGIES continued from p. 21

7/29/2019 Ctm 201305


CPI: Consumer price index

ECB: European Central Bank

FDD(rstdeliveryday):Therst

day on which delivery of a com-modityinfulllmentofafutures

contract can take place.

FND(rstnoticeday):Also

knownasrstintentday,thisis

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

fulllmentofafuturescontract.

The clearinghouse also informsthe seller.

FOMC: Federal Open MarketCommittee

GDP: Gross domestic product

ISM: Institute for supplymanagement

LTD(lasttradingday):Thenal

day trading can take place in a

futures or options contract.

PMI: Purchasing managers index

PPI: Producer price index

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

GDP 8:30 a.m.

CPI 8:30 a.m.

ECI 8:30 a.m.

PPI 8:30 a.m.

SM 10:00 a.m.

Unemployment 8:30 a.m.

Personal income 8:30 a.m.

Durable goods 8:30 a.m.Retail sales 8:30 a.m.

Trade balance 8:30 a.m.

Leading indicators 10:00 a.m.

GLOBAL ECONOMIC CALENDAR

May

1U.S.:April ISM manufacturingreport and FOMC interest-rateannouncement

2U.S.: March trade balanceECB: Governing council interest-rateannouncement

3U.S.:April employment reportAustralia: Q1 PPILTD: May forex options; May U.S.dollar index options (ICE)

4

5 Australia: Q1 GDP

6

7 South Africa: Q1 employment report

8 Brazil: Q1 CPI and PPI

9

Australia:April employment rateMexico:April 30 CPI and April PPI

UK: Bank of England interest-rateannouncement

10Canada:April employment rateHong Kong: Q1 GDP

11

12

13 U.S.:April retail sales

14Germany:April CPIIndia:April PPIJapan:April PPI

15

U.S.:April PPIGermany: Q1 GDPUK:April employment report

16U.S.:April CPI and housing startsJapan: Q1 GDP

17U.S.:April leading indicatorsCanada:April CPI

18

19

20Hong Kong: February-Aprilemployment report

21Germany:April PPIHong Kong:April CPIUK:April CPI and PPI

22Japan: Bank of Japan interest-rateannouncementSouth Africa:April CPI

23Brazil: March employment reportMexico: Q1 GDP and May 15 CPI

24U.S.:April durable goodsMexico:April employment report

25

26

27

28 South Africa: Q1 GDP

29

Brazil: Q1 GDPCanada: Bank of Canada interest-rate announcementGermany:April employment report

30U.S.: Q1 GDPCanada:April PPISouth Africa:April PPI

31

U.S.:April personal incomeCanada: Q1 GDPIndia: Q1 GDP and April CPIJapan:April employment report andCPI

June

1 U.S.: May ISM manufacturing report

2

3

4

5 U.S.: Fed beige book

6Brazil: May PPIECB: Governing council interest-rateannouncement

7

U.S.: May employment reportBrazil: May CPICanada: May employment reportMexico: May 31 CPI and May PPILTD: June forex options; June U.S.dollar index options (ICE)

The information on this page is sub-

ect to change. Currency Traderis

not responsible for the accuracy of

calendar dates beyond press time.

Event: The First Friday-Forex in ParisDate: May 24Location: Paris, FranceFor more information: Go to www.salonat.com

Event: The Trading Show ChicagoDate: June 24-25Location: Downtown Marriott, ChicagoFor more information: Go to www.terrapinn.com

Event: The MoneyShow San FranciscoDate: Aug. 15-17Location: San Francisco Marriott MarquisFor more information: Go to www.moneyshow.com

Event: The Trading Show West CoastDate: Oct. 21-22Location: San FranciscoFor more information: Go to www.terrapinn.com

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