CT200908

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August 2009

Volume 6, No. 8

Strategies, analysis, and news for FX traders

LATIN AMERICAN CURRENCIES

ride out recession p. 8

THE DOLLARthrough year-end

p. 12

PIVOTS

and confirmation p. 28

THE BUCK

coiled to spring? p. 18

INSIDE

the Russian ruble p. 32

MOMENTUM

IN THE FX MARKET:

the day-of-the-month

effect p. 22

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CONTENTS

2 August 2009 CURRENCY TRADER

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

Global Markets

Latin America plows ahead . . . . . . . . . . . . .8Latin America and its currencies have bounced

back strongly from the global economic rupture.

Is it too much?

By Currency Trader Staff

On the Money

The future of the dollar . . . . . . . . . . . . . .12The global economy might be turning a corner.

What does that mean for the major dollar

currency pairs over the next several months?

By Kathy Lien

The dollar still has a chance . . . . . . . . . . .18The stabilizing economic picture doesnt

seem to have benefited the buck very much.

By Barbara Rockefeller

Trading Strategies

Intra-month currency seasonality . . . . . .22A study of momentum strategy returns shows

performance improves significantly duringspecific times of the month.

By Chris Peters

Candlestick confirmation techniques . . .28Multiple time frames and pivot analysis are

used to put chart patterns in context.

By Gareth Burgess

Events . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

Conferences, seminars, and other events.

Advanced Strategies

Post-bubble ruble trouble and reversal . .32Which rate matters most, the Russian ruble

vs. the dollar, or the ruble vs. the Euro?

By Howard L. Simons

continued on p. 4

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Have a question about something youve seen in

Currency Trader?

Submit your editorial queries or comments to

[email protected].

Looking for an advertiser?

Consult the list below and click on the company name for a direct link

to the ad in this months issue ofCurrency Trader.

CONTENTS

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Trade The News

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IMF offers $250 billion to

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Emerging economies receive a boost from the

IMFs recovery actions, and China, Russia, and

France continue to put pressure on the U.S.

dollars reserve status.

By Chris Peters

International Markets . . . . . . . . . . . . . .40

Numbers from the global forex, stock,

and interest-rate markets.

Global Economic Calendar . . . . . . . . . . . .43

Important dates for currency traders.

New products & services . . . . . . . . . . . . . .44

Key concepts . . . . . . . . . . . . . . . . . . . . . . . 45

Forex Journal . . . . . . . . . . . . . . . . . . . . . 46Stopped out of a short trade at the high tick.

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Unexpected Central Bank Rate Cut

Signicant FX Chart Formation

Sector Check: China Policy Adjustment

Game Changing Stock Event

Key Technical Levels Ahead of ECB

Surprise OPEC Production Level Outlook

Dealer Chatter: Option Barrier Ahead

EIA Gas Inventories

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Howard Simons is president o

Rosewood Trading Inc. and a strategist fo

Bianco Research. He writes and speaks fre

quently on a wide range of economic and

financial market issues.

Kathy Lien ([email protected]) is aninternationally published author and director o

currency research for FX360.com and GFT. The

second edition of her book, Day Trading and

Swing Trading the Currency Market, was released

by John Wiley & Sons in December 2008. Sh

also runs an FX signal service, BKForex Adviso

(http://www.bktraderfx.com/site/), with Boris Schlossberg

one of the few investment advisory letters focusing strictly

on the forex market. Prior to joining GFT, Lien was the chief

strategist of DailyFX.com. A seasoned forex analyst and trad

er, Lien has direct interbank experience. In the past, she

worked at JPMorgan Chases Cross Markets and Foreign

Exchange Trading groups, using both technical and funda

mental analysis to trade spot forex and options. She also has

experience trading interest-rate derivatives, bonds, equities

and futures. She has taught seminars around the world on day

and swing trading the currency market.

Barbara Rockefeller(http://www.rts-forex.com ) is an

international economist with a focus on foreign exchange. She

has worked as a forecaster, trader, and consultant at Citibankand other financial institutions, and currently publishes two

daily reports on foreign exchange. Rockefeller is the author o

Technical Analysis for Dummies (For Dummies, 2004), 24/7

Trading Around the Clock, Around the World (John Wiley & Sons

2000), The Global Trader (John Wiley & Sons, 2001), and How to

Invest Internationally, published in Japan in 1999. A book tenta

tively titled How to Trade FX is in the works. Rockefeller is on

the board of directors of a large European hedge fund.

Gareth Burgess is founder of the CharWorkshop http://www.chart-workshop.de, a

provider of technical views for investors, and

author of the book Trading and Investing in th

Forex Markets Using Chart Techniques (John

Wiley & Sons, 2009). He has more than 10 years

of experience applying chart techniques and is a dedicated

private investor. Burgess studied at the University o

Liverpool, Great Britain, and the University of Konstanz

Germany, where he graduated with honors. He also holds a

masters research degree. Burgess can be contacted a

[email protected].

6 August 2009 CURRENCY TRADER

Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Associate editor: Chris Peters

[email protected]

Contributing editor:Howard Simons

Contributing writers:

Barbara Rockefeller, Marc Chandler

Editorial assistant and

webmaster: Kesha Green

[email protected]

Art director: Laura Coyle

[email protected]

President: Phil Dorman

[email protected]

Publisher,

Ad sales East Coast and Midwest:

Bob Dorman

[email protected]

Ad sales

West Coast and Southwest only:

Allison Chee

[email protected]

Classified ad sales: Mark Seger

[email protected]

Volume 6, Issue 8. Currency Traderis published monthly by TechInfo, Inc.,161 N. Clark St., Suite 4915, Chicago, IL 60601. Copyright 2009 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 Tradermagazine is intended for educational pur-poses only. It is not meant to recommend, promote or in any way imply theeffectiveness of any trading system, strategy or approach. Traders are advisedto do their own research and testing to determine the validity of a trading idea.Trading and investing carry a high level of risk. Past performance does notguarantee future results.

For all subscriber services:www.currencytradermag.com

A publication ofActive Trader

CONTRIBUTORSCONTRIBUTORS

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S

everal of the largest Latin American currencieshave posted double-digit gains vs. the U.S. dol-lar since risk appetite returned to the global

marketplace this spring. However, globalmoney managers arent just seeking the areas high yields.A look at the underlying fundamentals shows several Latincountries are boasting solidprospects for economic growth amajor factor attracting investmentflows to the region.

Having been buffered to a cer-tain extent from the worst of theglobal market shocks over the pastyear, most of the major Latineconomies are expected to emerge

from their recessions later in 2009.More observers are saying theundisciplined, inflationary prac-tices that have haunted variousLatin countries are a thing of thepast, especially in Brazil, which isviewed as the brightest star in theLatin constellation.

Latin America is doing much,much better than in previous crisesbecause of a better macro economicsituation, says Alfredo Coutino,

director of Latin America researchat Moodys Economy.com. Theregion has corrected major imbal-ances fiscally, inflation is down,and monetary policy has beenmanaged consistently.

With limited exposure to U.S.mortgage debt, Latin banking wasrelatively unscathed by the U.S.toxic asset crisis. This allowed key Latin American govern-ments to build on prudent fiscal policies that have bolsteredthe regions structural economic improvements in recentyears.

Latin American governments generated fiscal flexibilityduring the commodity boom, Coutino says. They savedextra revenues and the governments have been able to put

those savings back into the economy to strengthen theirdomestic markets. The region is being hit, but the fall ismuch milder than in previous crises.

Could be worse

(it is, elsewhere)

As is the case in virtually everycorner of the world, the Latinregion is expected to contract in2009. Credit Suisse forecasts a 2.5-percent decline in gross domesticproduct (GDP) growth this year vs.

a 4.3-percent gain in 2008 and a 5.7-percent rate in 2007. MoodysEconomy.com forecasts a 1.5- to2.5-percent decline in LatinAmerica in 2009. In 2010, however,Credit Suisse expects a quickrebound, to 3.6 percent GDPgrowth.

In terms of specific countries,Moodys Economy.com projects a6.8-percent decline in 2009Mexican GDP growth, a 0.8-per-

cent decline in Argentina, a 1.5-percent decline in Chile, a 1.2-per-cent decline in Columbia, a 1.3-per-cent decline in Venezuela, a 0.9-percent gain for Brazil, and a 2.3-percent gain in Peru.

Except for Mexico, these num-bers are better than performance inthe G10 economies. By compari-

son, Credit Suisse forecasts a 2.3-percent decline in U.S.GDP in 2009, a 5.4-percent decline in Japan, a 4.3-percentdecline in the Eurozone, and a 4.1-percent decline in theUK.

GLOBAL MARKETS

8 August 2009 CURRENCY TRADER

Latin America

plows aheadMexicos woes aside, the regions currencies have feastedas risk appetite has returned in recent months.

Latin America is doing

much, much better than

in previous crises because

of a better macro economicsituation. The region has

corrected major imbalances

fiscally, inflation is down,

and monetary policy

has been managed

consistently. Alfredo Coutino,

director of Latin America research

at Moodys Economy.com

BY CURRENCY TRADER STAFF

8/8/2019 CT200908

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However, Coutinonotes two differentpictures have emerg-ed from the regionduring this recession.

There is a division between central andsouth, he says. Thegroup of countries inSouth America aredoing better thanCentral America and

Mexico.In general, South

American countriesare holding up better,thanks to more diver-sified internationaltrade.

Brazil is a [major]trading partner with the U.S., but it also has trade withAsia. Chile, Columbia, and Peru also have trade links withAsia, Coutino says. [Central American and Mexican]economies depend to a great extent on the U.S. business

cycle, and since the U.S. is facing a recession, it has a nega-tive impact on [those regions].

Mexico hit hard

Economists agree Mexico has suffered the most. Mexicohas a very, very weak economy, says Michael Woolfolk,senior currency strategist at Bank of New York Mellon. Itsin a free fall.

Woolfolk notes Mexicos first-quarter GDP plummeted21.5 percent on an annualized basis. The consensus fore-cast is for a 7.1-percent decline for 2009 overall. Ideaglobalforecasts a -8-percent GDP number.

Mexicos northern neighbor looms large in this perform-ance, or lack thereof.The number one difficulty for Mexico is the correlation

of its economy to the U.S. economy, says Enrique Alvarez,head of Latin American financial market research atIdeaglobal. We havent seen a recession this profound in20-25 years. Mexican exports of manufactured productsand automobiles, he explains, have been greatly depressed.

The Mexican central bank has eased monetary policy,slashing 3.75 percent off its benchmark interest rate thisyear, which stood at 4.50 percent as of July. On the fiscalside, Alvarez notes the government has tried the usualinfrastructure stuff, but the success has been tepid at best.

Another factor that hurt Mexican economic growth is theH1N1 flu outbreak, which had a negative impact on secondquarter output, according to Coutino.

The flu outbreak in April and May really interrupted

economic activity, he says. Our estimates show GDP con-tracted an additional 2 percent in the second quarter as aresult of the flu outbreak.

The government ordered businesses to close for severalweeks during that period, resulting in business losses.Coutino notes Mexico City accounts for 20 percent of totalGDP for the country, so even a short-lived shutdown has alarge impact.

To make matters worse, a credit-rating downgradebefore year-end by the major ratings agencies is possible. InMay, Standard & Poors slashed the outlook on MexicosBBB+ rated debt (the third-lowest investment-grade rating)

from stable to negative.Fixed-income markets are increasingly apprehensiveabout a ratings downgrade in Mexico, Alvarez says. Itcould easily become the victim of a one-notch downgrade.

In turn, he adds, this could result in a little less confi-dence on the currency side.

Overall, the Mexican economy is expected to face thestrongest headwinds.

It is difficult to see [the Mexican peso] as a winning cur-rency until the U.S. economy picks up and we see a reacti-vation of the automotive sectors, Alvarez says.

CURRENCY TRADER August 2009

continued on p. 10

The Brazilian real has made significant gains against the U.S. dollar since the USD/BRL pairpeaked above 2.8000 last November. Some analysts see the pair dropping as low as 1.8000 by

year-end.

Source: ADVFN.com

FIGURE 1 BRAZILIAN REAL

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10/4810 August 2009 CURRENCY TRADER

Brazil remains

the star

Analysts uniformly

point to Brazils domi-nant position on thesunny side of the Latinstreet. Alvise Marino,emerging marketsanalyst at Ideaglobal,says Brazil was agood pick in both theshort and long term. Itis definitely one of thesuccess stories withinLatin America.

Brazil, a major com-modity exporter ofiron ore, soybeans,orange juice, coffee,sugar and, to a smallerextent, crude oil, has been supported by the rebound inglobal commodity prices in recent months.

In its June Emerging Markets FX Roadmap publication,HSBC analysts wrote: The CRB Index has climbed 25 per-cent since the rally in equities started in March, with oil up55 percent in the same period. Copper prices, which startedto rise as early as the end of last year, have risen a stagger-

ing 80 percent year-to-date. The impact of higher prices forraw materials has varied across the region, but there is noquestion that it has become a critical source of support.

Also, Brazils domestic economy has remained resilient.Brazil has a very strong domestic consumer, Marino

says. We didnt see retail sales contract during the latestrecession. It never went negative.

He notes the lowest retail sales reading was in March (1.3percent year-over-year). The figure subsequently surged to7 percent in April, and Mays reading came in at 4.0 percent.

Analysts also cite Brazils trade balance as an attractiveinvestment hook. As of June, the country boasted a $4.6-bil-

lion surplus, according to Marino.The Brazilian central bank has slashed its selic rate from13.75 percent to 8.75 percent this year. Analysts say the eas-ing cycle likely ended with the latest rate reduction in July.

There is a strong possibility this is the bottom, Marinosays.

Despite the recession, foreign direct investment (FDI) inBrazil remains solid according to Clyde Wardle, senioremerging markets FX strategist at HSBC. He says year-to-date FDI flows into Brazil in late July stood at $12.7 billion.

FDI has held up pretty well, he notes. Brazil has seenthe largest inflows [in the Latin region] especially on port-folio investments. As investors put money back to work,

Brazil is a favored destination.Lets look at how the currencies have fared in the wake of

the regions economic challenges this year.

Currencies on fire

From March 2 through July 28, several Latin currenciessoared vs. the U.S. dollar. The Brazilian real (BRL) led the

way with a whopping 29.75 percent gain (Figure 1), withthe Columbian peso close on its heels with a 27.94-percentsurge. The Mexican peso (MXN), despite its moredepressed economic outlook, enjoyed a healthy rally byassociation, jumping 16.33 percent vs. the dollar during thattime frame (Figure 2). The Chilean peso also staked out animpressive 11.81-percent gain.

Now the question is which currencies still have room togo, and which are overvalued? says Igor Arsenin, head ofLatin America strategy at Credit Suisse.

U.S. equity markets bottomed in March, and currencymarket watchers agree that month marked a shift in global

risk appetite, which has been a major driver of the stellargains in Latin currencies.Clearly, the [Latin] currencies have benefited from a

strong rebound in risk-based assets, Wardle says. Theyare fairly well correlated with global equity markets.Everything is still being driven by risk around the world.

Wardle found a three-month rolling correlation of .70(where 1.00 represents perfect positive correlation) betweenthe S&P 500 and a basket that included the currencies ofArgentina, Brazil, Chile, Columbia, Mexico, and Peru.

It is a rare day the basket goes up when the S&P goesdown, or vice versa, Wardle says.

GLOBAL MARKETS

After rebounding vs. the buck earlier in the year, the peso has consolidated, with the USD/MXN

pair establishing a support zone a little above 13.0000.

Source: ADVFN.com

FIGURE 2 MEXICAN PESO

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Currency specifics

Whats ahead for the key currencies? The Brazilian real,which was trading around 1.90 in late July, is expected to

continue to appreciate into year-end. Woolfolk forecasts ayear-end target of 1.85 vs. the dollar, and a 1.80-target intothe first quarter 2010. Coutino also predicts a 1.80 BRL byyear-end.

At the other end of the spectrum lies the Mexican peso.Despite the bearish Mexican economy, the peso surged16.83 percent from March through late July against the dol-lar. But its no Brazilian real, analysts say.

The Mexican peso rally was by association, Woolfolksays. He notes that many global players invest via a basket,which tends to be diversified over a region. Therefore,someone who is investing in a Latin currency exchange-

traded fund (ETF) could be inadvertently long the Mexicanpeso.

The Mexican peso performance has defied gravity,Woolfolk adds. We expect it to depreciate vs. the U.S. dol-lar this year. His banks year-end target is 14.75.

However, Arsenin at Credit Suisse thinks the Mexicanpeso is clearly cheap by historical standards. It alwaystraded around 11 before Lehman. (The peso was trading

around 13.20 in late July, which is well off the 15 level it wasat in March.)

Another peso also may have overshot on the upside.

The Columbian peso has gone too far, Arsenin says.The risks in Columbia are a little asymmetric. By year-endwe see it at 2200.

He also advises traders to be wary of the Columbianpesos volatility.

It tends to overshoot, he says. The market is notexceptionally deep and the locals tend to go in either onedirection or the other.

Despite the improved economic recovery prospects laterthis year and into 2010, analysts conclude the Latincurrencies will be vulnerable to renewed bouts of globalrisk aversion. Just as almost all markets moved in lockstep

to the downside in the midst of the financial meltdown,they have rebounded similarly in recent months as panicsubsided.

Everything has rallied in line with the stock markets,Wardle says. The risk is external, coming from a correctionin the stock market. Unfortunately, everything still seems tobe very much tied together. If the S&P 500 goes to 800, itwill put pressure on the currencies in the [Latin] region.

CURRENCY TRADER August 2009

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ON THE MONEY

On any given day, themarkets appetite forU.S. dollars will deter-mine the trend for

most, if not all, the major currencypairs. As the currency that changeshands most often, what drives thedollar will change as well.Sometimes the greenback trades oneconomic fundamentals, other timeson political developments, and mostrecently it has been driven by riskappetite, which basically refers to thedegree of investor optimism.

Since the beginning of the year, theU.S. dollar has not responded to eco-

nomic fundamentals. If it did, thedollar would rise on good data andfall on bad; instead, the completeopposite has been happening. This isconfusing for many traders, but ifyou understand the dollars safe-haven status is the only thing thatmatters right now, it is easier to seewhy the dollar falls when there isgood news and rises when there isbad.

For example, a strong stock rally

usually means risk appetite ishealthy, in which case investors willlook to move their money out of thesafety of U.S. dollars and into higher-yielding (and riskier) currencies. Ifstocks collapse, it usually meansinvestors are nervous and riskaverse, which usually leads to a flowof funds into low-yielding, safe-haven currencies such as the U.S.dollar and Japanese yen.

12 August 2009 CURRENCY TRADER

The EUR/USD pair has been highly correlated to the S&P 500 this year, with

the dollar weakening vs. the Euro when the stock market rallies and vice versa.

The pair has had difficulty sustaining rallies because of the strong possibility

the Eurozone will be last region to recover from the global economic downturn.

Source: Dealbook

FIGURE 2 EURO/DOLLAR

BY KATHY LIEN

FIGURE 1 EUR/USD AND THE S&P

Source: FX360.com

Risk appetite has been the major dollar driver in recent months,

but economic stabilization may bring other factors to the fore.

The future of the dollar

continued on p. 14

8/8/2019 CT200908

13/48

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14/4814 August 2009 CURRENCY TRADER

The correlation between the Euro/U.S. dollar pair(EUR/USD) and the S&P 500 has been greater than 80 per-cent since the beginning of the year, illustrating how impor-tant stocks are to currencies (Figure 1). This will change, ofcourse, and eventually the dollar will rise, but that mayonly happen when global economies are well on the road torecovery and investors can stop thinking about return of

capital and start thinking about return on capital.In the meantime, the future of the dollar largely depends

on the pace of recovery in the U.S. economy. But how thedollar trades against the majors will be influenced by whatis going on in the other countries as well. The U.S. economyis recovering, albeit at an excruciating slow pace. For mostof the world, the worst is over, but robust growth will have

to wait.

ON THE MONEY

Seasonal patterns

in the currency market

Currency Trader, February 2009.In a topic from the latest edition of

her book, Day Trading and Swing

Trading the Currency Market, the

author describes annual patterns

that have persisted for many years

in the Euro and Swiss franc.

Is the U.S. dollar headed higher?

Currency Trader, September 2008.

Several factors will work together to

chart the greenbacks course in Q4.

Five things that move

the currency market

Currency Trader, April 2008.

A handful of basic catalysts drive

currency moves

short-term and long-term.

Forex Q4:

The carry trade and

the U.S. dollar

Currency Trader, September 2007.

Certain currencies are looking moreattractive than others

as we head into year-end.

Market-moving

economic reports

Currency Trader, October 2006.

The payrolls number is no longer

the king of the hill when it comes to

reports most likely to move curren-

cies.

Related reading:

Other Kathy Lien articles

8/8/2019 CT200908

15/48CURRENCY TRADER August 2009 15

The dollar itself is plagued with problems, most havingto do with the growing budget deficit and how the Obamaadministration plans on paying for all of its stimulus pro-grams. Higher taxes are the answer, but that also has con-sequences. Because currency traders care more aboutwhere a currency pair is headed than where the U.S. econ-omy is headed, it may be more interesting to look at thefuture of the dollar relative to the indi-

vidual major currencies.

EUR/USD

After falling below 1.25 in March, the improvement in risk

appetite drove the EUR/USD to a high of 1.4340 in June(Figure 2). Since then, the currency pair has had a tough

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.

Dollar-yen:

The years hottest carry trade

Currency Trader, August 2005.

When trading currencies, youre

essentially dealing with the relation-

ships between countries and their

economies. The interest-rate differ-

ential between countries plays a piv-

otal role in deciding which currencies

to buy and which to sell. The carry

trade is designed to capitalize on the

relationship between two countries

interest rates and currencies.

Volatility-based currency trading

Currency Trader, February 2005.

Market volatility can be a complex

subject, but understanding a few

basic principles can help you imple-

ment strategies to capitalize on

volatility extremes.

Getting a lift

from the carry trade

Currency Trader, October 2004.

Correctly assessing the risk environ-

ment paves the way

to capitalizing on the interest-rate dif-

ferentials between

currencies.

continued on p. 16

8/8/2019 CT200908

16/4816 August 2009 CURRENCY TRADER

time rallying because of the strongpossibility the Eurozone will be thelast region to recover. With the stingi-

est asset purchase program of thethree major economies (U.S., UK, andEurozone), the Eurozone will soonfeel the consequences of reboundingoil prices and a strong currency.

The IMF predicts the Eurozoneeconomy will continue to contract in2010, while other major countries areexpected to grow. Even though con-sumer and business-survey indica-tors such as PMI reports have beenimproving, data on real activityshows few signs of stabilization, andthe fear is that rising unemploymentwill weigh on consumption andactivity. As a result, a Eurozonerecovery could come much slowerthan in other parts of the world,which means the Euro could under-perform the U.S. dollar over the nextsix months.

GBP/USD

The rally in the British pound/dollarpair (GBP/USD) since March hasbeen much smoother than the rally inthe EUR/USD (Figure 3). The Bank ofEngland (BOE) has had a generousquantitative easing program, and thestabilization of the economy suggeststheir efforts are working. According tothe latest unemployment report forthe month of June, the number of job-less claims rose by the smallestamount in 12 months.

However, the UKs recovery hasbeen feeble and the BOE may increaseits asset purchase program by 25 bil-lion. This could push the GBP/USDlower in the near term, but with suchtremendous stimulus behind itswings, the UK economy, and thus theGBP/USD, could recover earlier andstronger than most people expect.

USD/JPY

Politically, Japan is plagued with

ON THE MONEY

Aggressive steps by the Bank of England might push the GBP/USD lower in the

near term, but ultimately the pound could recover earlier and stronger than

widely expected.

FIGURE 3 POUND/DOLLAR

Source: Dealbook

The USD/JPY pair moves according to risk if the U.S. economy continues to

recover, USD/JPY would do so as well.

Source: Dealbook

FIGURE 4 DOLLAR/YEN

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17/48CURRENCY TRADER August 2009 17

problems. Low approval ratings couldforce Prime Minister Taso Aso toresign, which would be very negative

for the Japanese yen (Figure 4). Whenfinance minister Shoichi Nakagawawas forced to resign earlier this year because of apparent drunken com-ments made at the G7 meeting inRome, currency traders assaulted theyen.

Economically, however, signs ofimprovement are beginning to emergein the Japanese economy. Strongergrowth in China has supported con-

sumer spending and encouraged theBank of Japan to upgrade its economicoutlook three months in a row.Nonetheless, seasoned USD/JPYtraders know this currency pair movesnot on Japanese fundamentals but onrisk appetite in the overall market.Therefore, if the U.S. economy contin-ues to recover, USD/JPY would do soas well.

The commodity currencies

The U.S. dollar could struggle againstthe commodity currencies theAustralian, New Zealand, andCanadian dollars over the mediumterm. Chinas foreign exchangereserves have topped $2 trillion, andalthough some of that money will berecycled into U.S. dollars, as a savvyinvestor China will be interested indiversifying.

Based upon its past investment pat-terns, there is a decent chance China

will be looking for new stakes inAustralian, New Zealand, or Canadianresource companies. Even if they meetresistance politically, they couldattempt to boost their oil and goldreserves, which would indirectly bene-fit the Canadian and Australian dol-lars.

When the global recovery gains trac-tion, the primary risk will be runawayinflation. Gold is seen as an inflationhedge and because of that, China may

want to stock up now.

How does the dollar

perform after a recession?

The one thing everyone seems to cur-rently agree on is the recession should,for the most part, be over in 2010. Withthat in mind, we should start thinkingabout how the dollar could performafter a recession.

In the past 30 years, there have been

three recessions. The most recent last-ed from March 2001 to November2001. The one before that lasted from July 1990 to March 1991. The currentrecession has been most commonlycompared to the recession in the 1980s,which started in July 1981 and lasteduntil November 1982, a period of 14months.

Based upon this limited data set, theonly pattern that emerges is dollarweakness against the Japanese yen 12

months after the recession (Table 1).When the 2001 recession ended, thedollar traded higher against both theEuro and Japanese yen for the firstthree months but then gave back itsgains over the next eight months. Inthe 1990s, the dollar traded higheragainst the Euro but lower against the Japanese yen three months after therecession ended, falling further againstthe yen over the next eight months butrecovering from its losses against the

Euro. In the 1980s, the dollar fell threemonths after the recession and contin-ued to fall over the next eight monthsagainst the yen, but recovered againstthe Euro.

For information on the author see p. 6.

After the most recent recessions, the dollar has tended to weaken against the yen

on an intermediate-term basis.

TABLE 1 POST-RECESSION DOLLAR BEHAVIOR

Recession Time EUR/USD USD/JPY S&P 500

Early 1980s One month after 3.80% -6.25% 4.26%

recession Three months after 2.15% -6.11% 11.01%

Six months after -3.70% -4.95% 21.92%12 months after -11.96% -6.09% 23.94%

Early 1990s One month after -3.54% -1.86% 1.09%

recession Three months after -6.98% -2.02% -1.01%

Six months after 0.00% -5.22% 2.93%

12 months after 2.06% -5.42% 7.62%

Early 2000s One month after -1.14% 6.29% 1.89%

recession Three months after -2.26% 8.76% -4.35%

Six months after 4.29% 0.71% -6.35%

12 months after 11.01% -0.66% -17.83%

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The big question today is, how long will riskappetite continue to keep the dollar on thedefensive? The corollary to that question is,when will recovery and growth become the

dominant sentiment and thus favor the dollar?Its bizarre that the economy with the best-looking recov-

ery from the Great Recession is getting so little respect, andin fact continues to be disdained. Good news is shrugged

off and bad news is exaggerated into terrible, dollar-dump-ing news. For example, the majority of S&P 500 companiesreporting Q2 earnings in July exceeded analyst expecta-tions. The S&P 500 index went up dramatically during July, even crossing the 200-day moving average on theupside and holding above the 23.6-percent Fibonacciretracement level it first penetrated in early May (Figure 1).This level has proven to function as support, at least so far.

Good economic data has back-stopped corporate earnings. Retail

sales are okay, to everyones sur-prise, and housing may be stabiliz-ing. Everyone knows unemploy-ment will keep rising, but becausewe know, upcoming scary unem-ployment numbers will lose some oftheir power to shock. Tradersdeclined to freak out over the nearfailure of a major financial-sectorplayer, CIT the only other majorplayer since Lehman not to get agovernment bailout.

Many companies are sitting onpiles of cash (roughly $1 trillion)ready to be put toward the capitalexpenditures that are the leadingedge of a more robust recovery.Without capital spending, the recov-ery will be L-shaped even thoughthe stock market is acting as thoughit will be V-shaped. Despite this dis-connect, animal spirits are high inequities. Everyone is afraid of losingthe turn, and that alone is creating

the turn.

ON THE MONEY

BY BARBARA ROCKEFELLER

18 August 2009 CURRENCY TRADER

FIGURE 1 STOCK MARKET RECOVERY (S&P 500)The S&P 500 rallied strongly in July, penetrating the 200-day moving average

and holding above the 23.6-percent Fibonacci retracement level.

Source: Chart Metastock; data Reuters and eSignal

The dollar still has a chanceThe spiky action in the Euro/dollar pair makes forecasting difficult.

TABLE 1 NET EQUITY TRANSACTIONS ($US BILLIONS)

Recently, Americans have bought nearly three times as much foreign stock as foreigners have purchased U.S. stock. This

is why stock markets in places like Brazil and China are forming massive bubbles. At the beginning of August the S&P 500

was up about 34 percent from its March low.

Source: U.S. Treasury (www.treas.gov/tic/ticsec.shtml)

12 months 12 months

2007 2008 thru May 2008 thru May 2009

Foreign purchases of U.S. equities $15.1 $23.4 $82 $28.7

Foreign equities purchased by U.S. residents -$229.2 $101.8 -$164.4 $84.3

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But in currencies the dollar isshunned as an investment destina-tion, at least in equities, despite theU.S. having the biggest stock market

of any country. Foreign purchases ofU.S. equities have never been a domi-nant part of capital flows to the U.S. that goes to U.S. government bills,notes, and bonds but the tepidflows into equities over the past yearmight be seen as evidence of a nega-tive attitude toward the dollar.

Check out the selected data pointsfrom the monthly TreasuryInternational Capital Systems (TICS)report (Table 1). Foreigners are buying

only about one-third as much U.S.equities as U.S. residents are buyingforeign equities. This represents a ter-rible loss of power and prestige forthe U.S. stock market. If the FIFOthesis is correct that the U.S. wasthe first in the financial sector crisisand Great Recession, and it will be thefirst out the lack of interest in U.S.equities is even more stunning.Perhaps its old scandals like Enronand WorldCom coming home to

roost. Or perhaps its somethingelse, like a desperate bid to earn back the 30 to 40 percent that waslost in U.S. equities last year.

How do you get back a loss ofthat magnitude? You bet the ranchon a high-risk hand. This is whystock markets in places such asBrazil and China are forming mas-sive bubbles. At the beginning ofAugust the S&P 500 was up about34 percent from its March low. By

contrast, the Brazilian Bovespa,Shanghai Composite, and IndianBombay stocks indices were upmore than 80 percent (Figure 2). TheS&P has support around the 25-per-cent retracement level, but theseindices have surpassed their 50-per-cent retracement levels (not shown).

Nobody would argue these mar-kets are more honest, transparent, orwell regulated than the U.S. market.It may be true the emerging markets

The U.S. stock market made a strong move off its March low, but its been

nothing compared to the huge rallies posted by the major Brazilian, Chinese,

and Indian stock indices.

FIGURE 2 SELECTED FOREIGN STOCK INDICES

Source: Chart Metastock; data Reuters and eSignal

CURRENCY TRADER August 2009 19

After bottoming last fall as the financial crisis was peaking, the Aussie dollar

rallied strongly against both the U.S. dollar and the Japanese yen.

FIGURE 3 AUD/USD AND AUD/JPY

Source: Chart Metastock; data Reuters and eSignalcontinued on p. 20

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ON THE MONEY

are somewhat decoupled from the advanced-economyGreat Recession because their banks and investors did notengage in high-risk mortgage derivatives or excessiveleverage, but never mind as export-led economies, theyare still suffering from the slowdown blues.

Preference for high risk can also be seen in demand forcommodity currencies such as the New Zealand dollar(NZD), Australian dollar (AUD), and Canadian dollar(CAD). In some ways, this preference ignores certain fun-damentals New Zealands high deficit (100 percent ofGDP), Canadas reliance on the U.S. economy, not to men-tion the irrational price of oil. Oil is rising because tradersexpect demand to rise even though current demand hasbeen falling.

The Australian dollar vs. the Japanese yen (JPY) is thequintessential symbolic marker for risk preference. After bottoming last fall as the financial crisis was reaching its

peak, the AUD rose strongly against both the U.S. dollarand the yen (Figure 3). The recovery, in fact, is almost thefull 62-percent Fibonacci retracement. The genetic rules dic-tating the Fibonacci sequence in daisy petals and nautilusshells do not necessarily apply to human behavior in trad-ing markets, but so many people watch Fibonacci retrace-ment levels that it would be foolish to ignore them. Doesthis mean the AUDs rise will stall any minute now? Yes,probably, but stall is not the same thing as halt or reverse.The only thing that would halt or reverse the AUDs risewould be a change in risk preference.

And yet it is possible the dollars downtrend, marked byaberrant spikes on the daily chart, is not really as powerful

as it may seem. The upward spikes inthe Euro are abnormal the resultof one-time events. The downwardspikes are strange, too.

These spikes ruin the chartbecause they take away the ability to

use standard measurement tech-niques, such as old-fashioned sup-port and resistance. These S&R lines,whether hand-drawn or generatedby straight-line channels, have beenbroken all over the place during thepast year without at the same timeyielding a usable forecast. Each spikecan be attributed directly to someRisk Event. You cant use trend iden-tification if trends are spoiled byspikes. Small spikes we can deal

with, but giant spikes like these ren-der standard trend-following techni-cal analysis almost useless, at leaston the daily time frame.

At first glance, it looks like theEuro is about to break through theresistance of the down-sloping red

line and match the early June spike high of 1.4340 (Figure4). But is that the correct test? Perhaps we should givethought to whether the previous spike high, 1.4719 fromDec. 18, 2008 (horizontal blue line), is the correct level toworry about. At least that level would be above the 62-per-

cent Fibonacci retracement and would provide clear guid-ance on what to do next.None of these previous levels are very good as a test of

market sentiment. If each spike high and low was a func-tion of some unrepeatable one-time risk event, this chart isof almost no use at all. The next spike could as easily beEuro downward, which is probably what would happen ifan emerging-market stock market bursts and traders seeksafe-haven in the dollar. In fact, the spikes have been spacedapproximately two or three months apart; its getting to betime for another one.

Another chart perspectiveNow lets consider a tool that removes some of the spikeproblem the point-and-figure chart, which ignores timeand places an upward X or a downward O on the chart onlyif a new high or low is made. If the security is trading in thesame range as before, there is no entry on the chart at all. Allthats left are the meaningful moves (which the chartistgets to define).

Figure 5 shows a monumental amount of compression.You might think such compression destroys the ability touse point-and-figure charts for trading purposes. How doyou trade without opens and closes? But plenty of peopleuse more sensitive intraday point-and-figure charts for

20 August 2009 CURRENCY TRADER

None of the previous spike levels represent a very good test of market sentiment.

FIGURE 4 EUR/USD STANDARD BAR CHART WITH SPIKES

Source: Chart Metastock; data Reuters and eSignal

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daily trading, and in any case, this daily format is use-ful for seeing the big picture. In the current situation,the extreme data compression puts the spikes in bet-ter perspective. (On this chart, notice the starting dateon the left is 1995. This means the chart uses all theavailable data for the spot Euro, which technically

didnt come into existence until 1999. The data beforethen was created by Reuters using legacy currencydata.)

Many of the chart-analysis tools used on regularbar charts, including support and resistance, are alsoapplicable to point-and-figure charts. Figure 5 showsa symmetrical triangle with an apex at 1.2925. This isa surprising outcome, but consistent with the manyforecasters from the big trading banks who have beensaying for months, based on fundamental and FIFOanalysis, that the EUR/USD pair should be in the1.20s, not the 1.40s.

A new O will form if the Euro falls under 1.3546(breaking below the triangles lower boundary), some800 points from the price near the end of July. Wow,800 points is a lot and not normally expected. Butremember two things: First, the Euro-dollar has beenspiky for more than a year, with at least six 800-pointor larger moves over a two- to three-month time frame.Second, point-and-figure charting ignores time.

A year-end forecast of 1.2500 for the Euro/dollar remainsa real possibility, and perhaps one with equal probability to

the scenario that has the Euro retesting the aberrant spikehighs around 1.4700 or 1.6000.

For information on the author see p. 6.

CURRENCY TRADER August 2009 21

The point-and-figure chart shows a large consolidation pattern

a symmetrical triangle.In this chart the box size is 0.3124

(which was the 14-day ATR during the October 2008 spike) and

the reversal amountis three.

FIGURE 5 EUR/USD IN POINT-AND-FIGURE MODE

Source: Chart Metastock; data Reuters and eSignal

Bubble contamination, Currency Trader, July 2009.

Pondering the nature of the currency-commodity relationship.

Risk aversion, Currency Trader, June 2009.

Extraordinary times call for out-of-the-box

thinking about markets.

Forecasting follies, Currency Trader, May 2009.

The only technicals that provide tradable forecasts are

patterns but you have to be on the correct time frame

and you cant forget about the fundamentals.

Listening to the chart, Currency Trader, April 2009.

While everyone debates the ramifications of various policy

measures, what is the Euro/dollar chart saying?

Rational fear and the forex market

Currency Trader, March 2009.

Analysis of several intermarket relationships suggests the role

of risk aversion in the forex market is no cut-and-dried issue.

Competitive devaluations, the EMU, and the yen

Currency Trader, February 2009.

Currency devaluation never works in the long run just ask

Japan but that doesnt mean panicky governments wont

use it to try to stem the flow of blood in the near term.

The Euro: Prosperity or perdition?

Currency Trader, January 2009.

The belief the Euro sell-off has ended may be based on some

false assumptions about how the U.S. and Europe are

handling the economic crisis.

The six Ds of depression, Currency Trader, December 2008.

The buck has gotten a bounce from the recent financial panic,

but the longer-term picture isnt quite as bullish.

Euro and dollar at parity? Currency Trader, November 2008.

A few short months ago the world was contemplating Euro $2.

Now, the talk is all about Euro $1. What are the odds it will

happen?

Crisis of confidence, Currency Trader, October 2008.

As Wall Street and Washington prove themselves equally

inept, the dollar suffers.

Related reading: Other Barbara Rockefeller articles

You can purchase and download past articles at

http://store.activetradermag.com.

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TRADING STRATEGIES

22 August 2009 CURRENCY TRADER

Seasonality is often refer-

enced in the commodity

and equity markets, butthe idea that a market fol-

lows certain patterns at certain times

of the year (or month, or day of the

week, etc.) is less commonly men-

tioned with respect to currencies.

In the commodity market especially,

seasonal patterns are typically dis-

cussed in the context of a particular

commoditys growth or production

cycle. In financial markets, such pat-

terns are less tangible, but manytraders take into account factors such

as the time of the year (e.g., the

October-May bullish period in the

stock market) or the typical behavior

around the release of certain economic

reports.

However, a recent paper makes a

case that certain periods of the month

might be better than others for trading

momentum strategies in the forex mar-

ket. Day-of-the-Month Effects in thePerformance of Momentum Trading

Strategies in the Foreign Exchange

Market, by Richard D. F. Harris,

Evarist Stoja, and Fatih Yilmaz,

appeared in the Winter 2009 edition of

The Journal of Trading. The study

focused on the performance of a

momentum-based trading strategy

during specific times of the month. To

evaluate results, the authors used the

Sharpe ratio, a risk-adjusted perform-

ance measure that compares invest-

ment return in excess of a risk-free rate

of return (such as from a short-termgovernment bond) to volatility, which

is represented by the standard devia-

tion of returns. The higher the Sharpe

ratio, the better the risk-adjusted per-

formance.

The authors analyzed the perform-

ance of a momentum strategy in a

portfolio of G10 currencies (Euro,

British pound, Canadian dollar,

Japanese yen, Swiss franc, and

Swedish krona) measured against theU.S. dollar, comparing both the Sharpe

ratio and the maximum drawdown for

each day.

The study used a basic momentum

strategy that simply compared todays

exchange rate with the exchange rate

one month earlier. If todays rate was

higher than the past exchange rate, the

currency was bought and held for one

month; if the current rate was lower,

the currency pair was sold short andheld for one month.

The strategy was applied to a 10-

year test period from May 1997

through May 2007. Carry-interest

charges were included, but trading

costs, which were deemed negligible

for monthly trading in the foreign cur-

rency market, were ignored.

Study results

The study found the Sharpe ratio

remained low through the first 10 days

of the month (meaning the risk-adjust-ed returns were not great), but then

spiked from day 12 through day 15,

peaking on day 13. The ratio remained

relatively low during the next few

days before peaking a second time

around day 22, and then remained rel-

atively high through the end of the

month.

This, according to the authors,

implies that toward the end of the sec-

continued on p. 24

Intra-monthcurrency seasonality

A recent study suggests certain times of the month are more favorablefor trading momentum strategies in the forex market.

BY CHRIS PETERS

The strategy, which determined

momentum by comparing todays

closing price to the closing price

20 days ago, lost 3 percent over

10 years.Initial capital $10,000.00

Ending capital $9,700.07

Net profit -$299.93

Net profit -3.00%

Exposure 9.28%

Net risk adjusted return -32.32%

Annual return -0.30%

Risk adjusted return -3.27%

Number of trades 496

Avg. profit/loss -$0.60

Avg. profit/loss -0.09%Winners 242 (48.79%)

Total profit $1,246.83

Avg. profit $5.15

Avg. profit 2.36%

Losers 254 (51.21%)

Total loss -$1,546.76

Avg. loss -$6.09

Avg. loss -2.42%

TABLE 1 20-DAY BREAKOUT

RESULTS

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dbFXis Deutsche Bank's Online Margin FX

Trading platform for individuals and

small institutions. dbFX clients have

the benefit of a spectrum of research from Deutsche Bank ana-

lysts, covering global markets with a local view point. In the fol-

lowing excerpt we hear from Bankim Chadha, Global Head of

FX Research on his medium term perspectives for the dollar.

Excerpt From: July 2009 FX Perspectives

Our medium-term forecasts embody the view that rate

differentials will re-emerge as a key driver of the dollar and

that a gradual global recovery as per Deutsche Banks economic

forecasts will continue to push rate differentials in favor of the

dollar. Key negatives for the dollar with recovery are

higher oil prices and capital outflows on improvementsin risk appetite.

We provide four perspectives on anchors and driv-

ers of the dollar:

1) Valuation leaves limited room for another

multi-year downtrend. Our lines-in-the-sand

framework indicates the trade-weighted dollar is

12% cheap to fair value. More significantly, it is 8%

above the bottom of its historical valuation band. A

discrete or disorderly decline out of bonds would

likely see increased risk aversion and be short-lived.

On the major crosses: the euro is already more than

20% above our fair value estimate of 1.15; the

commodity currencies are expensive but less so;

sterling is modestly expensive; and the yen is near

fair value.

2) From repatriation to expatriation, dollar in step

with flows. Our preferred measure of the

medium-term flows driver of the dollar, the basic

balance (3m sum of trade deficit and select capital

flows) has improved as a narrowing in the tradedeficit more than offset diminished capital inflows.

The dollar is slightly cheap (5%) on this measure.

The trade deficit is set to widen on higher oil prices,

but capital inflows have also risen recently.

3) Whats driving the dollar: oil, risk, and rate

differentials? For EURUSD, the 3m correlation of

changes with oil prices is highest, followed by the

VIX and is lowest with rate differentials. But 1m

correlations indicate this is changing, with rate

differentials having risen to the top. On USDJPY,

rate differentials predominate.

4) Are rate differentials an anchor for the dollar? The

correlation between the levels of the daily deutschemark-

dollar rate and interest differentials since 1977 (when data is

first available) is a strong 0.72. Over the last 32 years, long

periods of positive correlation have been punctuated by 5

episodes of negative correlations, including the present one.

These episodes averaged 10 months in duration and we are

in the 9th month of the present one. Considering rate

differentials as an anchor suggests a fair value for EURUSD

of 1.20 presently. The residual from this relationship, a

measure of the rates-adjusted risk premium on the dollar,

have been driven significantly by oil prices and the VIX.

Visit dbfx.com/ct for more sample research.

Deutsche Banks Perspectives on the anchors and drivers of the dollar

ADVERTISEMENT

8/8/2019 CT200908

24/48

ond week of the month (days 12 to 15), and at

the beginning of the fourth week (day 22),

returns in excess of the risk-free rate were

based less on the inherent volatility of the mar-

ket than at other times of the month.

The analysis also found drawdowns during

these times of the month were lower. Average

maximum drawdowns were fairly large in the

early days of the month, with a nearly 19-per-

cent peak average maximum drawdown on

day 8. However, drawdowns dropped steadily

from days 10 through 14, down to around 12

percent. From days 21 through 25, the maxi-

mum daily drawdowns dropped significantly

(to below 10 percent), but then rose again toend the month.

During the Sharpe ratio peaks, the daily

standard deviation was smallest. According to

the study: The seasonal pattern of volatility

over the sample period matches the seasonal

pattern of the Sharpe ratio quite closely. In par-

ticular, volatility is notably lower in the second

half of the month, particularly during days 13-

15 and days 20-23. As volatility increases, the

ability to predict price movement decreases,

reducing performance of the momentum-based strategy.

Explaining the pattern

In the report, the authors link the studys

results to the release of important news items

throughout the month (economic numbers,

etc.). Acknowledging that tracking all news

that could impact the forex market was impos-

sible, the authors focused on 36 U.S. macroeco-

nomic data releases, and then tracked their

release dates for each month during the 10-year test period.

They found days 21 to 23 contained the lowest concen-

tration of news releases of any period of the month. This led

them to conclude that not only can momentum-based trad-

ing strategies produce excess returns independent from an

increase in risk, but applying these strategies during the

less volatile times between news announcements can poten-

tially improve trade results.

Additional tests

To provide some additional insight into the studys find-

ings, we tested a similar strategy from July 14, 1999 through

July 14, 2009. The entry signal was a 20-day closing break-

out:

1. Go long when the close is above the close 20 days ago.

2. Go short when the close is below the close 20 days ago.

3. Exit all trades after 20 days.

The strategy was tested on the same portfolio of curren-

24 August 2009 CURRENCY TRADER

TRADING STRATEGIES

continued on p. 26

Two periods, near the middle of the month and near the end, produced

more consistent profits, coinciding with the results of the study.

FIGURE 2 AVERAGE PROFITS BY DAY OF THE MONTH

The number of trades increased significantly in the latter part of

the month.

FIGURE 1 NUMBER OF TRADES BY DAY OF THE MONTH

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8/8/2019 CT200908

26/48

cies as the academic study. A maximum of five

simultaneous trades were taken. Commissions

and slippage were not assessed. Table 1 shows

the performance results of the systems 496

trades, 49 percent were winners, averaging 2.4

percent profit per winning trade. The system

lost money overall, returning -3 percent in 10

years.

Figure 1 shows the number of trades by day

of the month for days 1 through 29. The mosttrades occurred near the end of the month,

beginning around day 20. Figure 2 shows aver-

age daily trade profits. Two periods stand out by exhibiting

relatively consistent gains, with only a couple of small aver-

age daily losses: day 9 to day 13 and day 21 to day 27. But

because the system employs such a long holding period, the

immediate effects of the market moves captured by the sys-

tem are difficult to distinguish.

One-day moves

Figure 3 shows the average profit results for the same sys-

tem with only a one-day holding period to illustrate the

directional momentum following a trade signal. The results

appear to strengthen the case for the mid-month period

(days 10 to 17), with larger profits relative to any other peri-

od of the month. However, in this case the end of the month

performed significantly worse.

Reducing the trade length to one day greatly increased

the number of trades, more than tripling it to 1,528 trades.

Despite the increased number of trades, however, the sys-

26 August 2009 CURRENCY TRADER

Day-of-the-month effectsin the Performance of Momentum trading

Strategies in the Foreign Exchange Market,

By Richard D.F. Harris, Evarist Stoja, and Fatih

Yilmaz. Journal of Trading 4, no. 1 (Winter

2009): 48-55.

Breakout timing

Currency Trader, July 2009.

This analysis indicates certain times of the

month may be more favorable than others for

short-term breakout strategies.

Seasonal patterns in the currency market

by Kathy Lien

(Currency Trader, February 2009).

In a topic from her book, Day Trading and

Swing Trading the Currency Market, the author

describes persistent annual patterns in the

Euro and Swiss franc.

You can purchase and download pastCurrency

Traderarticles athttp://store.activetradermag.com

Related reading

TRADING STRATEGIES

The results of a more active system repeated the pattern of more

signals occurring in the middle and at the end of the month.

FIGURE 4 TRADE ACTIVITY

The results from using a one-day trade length highlighted a mid-month

profitable period.

FIGURE 3 ONE-DAY HOLDING PERIOD PROFITS

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27/48CURRENCY TRADER August 2009 27

tems percentage of winning trades

and net profit remained almost exactlythe same, with 49 percent winning

trades and a 3-percent net loss.

Figure 4 shows the number of trades

initiated on each day of the week. A

second period of increased activity

emerged in the middle of the month.

The results are far from definitive,

but they do seem to slightly reinforce

the notion that certain periods of the

month might be friendlier to a

momentum-type strategy. To explorethis notion further, the 20-day break-

out system was tested, this time taking

trades only from days 10 to 15 and 20

to 25. These periods coincided with

the most advantageous periods identi-

fied in both the academic study and

the testing conducted in this article.

Table 2 shows that limiting the

trades to these two periods increased

the systems profitability from a 3-per-

cent loss to a 1.1-percent loss, and

improved almost all the other per-

formance statistics compared to Table1.

Table 3 shows the results of a final

test conducted on a shorter-term (10-

day) breakout system that held trades

for five days. While the net profit

remained about the same, the system

was able to turn the same net profit

from fewer trades and had a higher

risk-adjusted return.

Check your calendarsAs explained in the academic study,

certain times of the month tend to be

more volatile than others, and a strate-

gy could benefit from taking this fac-

tor into account. Focusing on the times

of the month that are most beneficial

to a system may not turn a losing sys-

tem into a winner, but it could reduce

the amount of time you are in the mar-

ket and improve a strategys reward-

risk characteristics.

Restricting the system to trade during

specific periods of the month didnt

make it profitable, but it improved

performance.

Initial capital $10,000.00Ending capital $9,890.91

Net profit -$109.09

Net profit -1.09%

Exposure 7.99%

Net risk adjusted return -13.65%

Annual return -0.11%

Risk adjusted return -1.37%

Number of trades 417

Avg. profit/loss -$0.26

Avg. profit/loss 0.06%

Winners 211 (50.60%)Total profit $1,040.86

Avg. profit $4.93

Avg. profit 2.38%

Losers 206 (49.40%)

Total loss -$1,149.95

Avg. loss -$5.58

Avg. loss -2.32%

TABLE 2 RESTRICTED TRADING

Applying the same restrictions to a shorter-term breakout system also improved

results, reducing the systems exposure while retaining the same level of profitability.

Without With

period restrictions period restrictions

Initial capital $10,000.00 $10,000.00Ending capital $10,866.57 $10,831.77

Net profit $866.57 $831.77

Net profit 8.67% 8.32%

Exposure 8.45% 5.35%

Net risk adjusted return 102.58% 155.57%

Annual return 0.83% 0.80%

Risk adjusted return 9.87% 14.99%

Number of trades 1,905 1,046

Avg. profit/loss $0.45 $0.80

Avg. profit/loss 0.07% 0.11%

Winners 993 (52.13%) 556 (53.15%)Total profit $3,498.50 $2,293.96

Avg. profit $3.52 $4.13

Avg. profit 1.37% 1.35%

Losers 912 (47.87%) 490 (46.85%)

Total loss -$2,631.93 -$1,462.19

Avg. loss -$2.89 -$2.98

Avg. loss -1.35% -1.31%

TABLE 3 10-DAY BREAKOUT

8/8/2019 CT200908

28/48

TRADING STRATEGIES

28 August 2009 CURRENCY TRADER

Japanese candlesticks can be difficult

to decipher, especially on the daily

time frame in the FX market. One

problem is choosing the right open-

ing and closing times. Should you use the New

York close at 10 p.m. GMT or midnight GMT?

Should you use the daily trading range from 6

a.m. GMT until 10 p.m. GMT? The bulk of the

trading between banks occurs in that time win-

dow, so it is unlikely they are interested in what happens

between 10 p.m. GMT and midnight. Although it is a highlydebated topic, do you ignore the Sunday evening market and

wait for the Monday European session to begin?

Weekly candlesticks address the time frame problem, and

they also form the basis of chart analysis that can be used to

determine overall market sentiment and to find trade and

investment opportunities.

Figure 1 shows a weekly chart of the Euro/U.S. dollar pair

(EUR/USD) at the point price hit resistance at the 50-percent

Fibonacci retracement level of last falls sell-off. There was an

initial weekly close just below the 50-percent level that result-

ed in a hanging-man candlestick, a potential sign somethingwasnt right with the bullish sentiment and that there could

be a short-sale opportunity within the next few sessions.

Moving to the daily time frame to analyze the price action

during the following week yielded an important clue. In the

middle of that week (June 2-3) a signal known as a tweezer

pattern formed (Figure 2). This double-candlestick pattern

warned the market had found strong resistance and that it

would most likely continue to retreat from the established

resistance level. Traders long from the previous session had

been quickly stopped out or were possibly caught in the mar-

Patterns, pivots, and indicators point to

the same price action.

A potentially bearish candlestick known as a hanging man formed as

price reached the 50-percent retracement level of the down move.

Source: TeleTrader Professional (http://professional.teletrader.com)

FIGURE 1 WEEKLY CHART: HANGING MAN

BY GARETH BURGESS

A tweezer pattern on the daily time frame also implieddownside price action.

Source: TeleTrader Professional (http://professional.teletrader.com)

FIGURE 2 DAILY CHART: TWEEZER PATTERN

Candlestick

confirmationtechniques

8/8/2019 CT200908

29/48CURRENCY TRADER August 2009 29

ket, the net result being that most would get out of their

trades or reverse position, causing the market to drop even

more.

This type of candlestick pattern is easy to identify on a

chart, but what is the best method incorporating it within a

strategy? Confirmation is the only way to determine

whether or not a signal will have the expected result, and auseful tool for doing this is to apply what is known as a

pivot range to the short-term time frame while keeping

the bigger picture in mind.

Calculating the pivot range

The first step in determining the pivot

range is to add the high, low, and clos-

ing prices of the most recent daily price

bar or candlestick and divide by three

to create an average price, or pivot

line:

1. Pivot line 1 = (H+L+C)/3

A second pivot line is created by

adding the high and low prices and

dividing by two:

2. Pivot line 2 = (H+L)/2

To create the pivot range, add andsubtract the absolute value of the dif-

ference between the two pivot lines

from the first pivot line.

3. Pivot range high =

pivot1 + abs(pivot1 pivot2)

4. Pivot range low =

pivot1 abs(pivot1 pivot2)

The result is two price levels that can

be used to determine support andresistance on the shorter time frame.

In this example the pivot range calcu-

lations are:

1. Pivot line 1 = (1.4338 + 1.4108 +

1.4144)/3 = 1.4196

2. Pivot line 2 = (high 1.4338 +

1.4108)/2 = 1.4223

3. Pivot range high = 1.4196 +

abs(1.4223 1.4196) = 1.4223

4. Pivot range low =1.4196 abs(1.4223 1.4196)

= 1.4169

These numbers are a variation of classic pivot calcula-

tions (see Related reading).

Figure 3 shows a pivot range based on the price action of

the second (negative) day of the tweezer pattern fromFigure 2. Ideally you would want to see the upper level act

as resistance and the lower level as a breakout point that

continued on p. 30

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30/48

would confirm the bearish daily tweezer signal and the

bearish weekly hanging-man signal. Calculating this range

assists in trade planning and allows you to create a strategy

with defined reward-risk parameters. In Figure 3, price

breaks out of the downside of the pivot range, confirming

the candlestick patterns.

Also note the short-term trade opportunities within the

pivot range. Admittedly, the hard downside breakout and

return into the pivot range that occurred during the next

days session would have caught traders who initially went

short at the low of the pivot range, but this 50-pip range would also

have created favorable conditions

for short-term trading.

The real value of such a range,

however, is being able to watch the

levels to confirm support and

resistance and then wait for the ini-

tial breakout, which in this case

was expected to occur on the

downside. For example, a short

position could be initiated 15 pips

below the low of the pivot range

with a stop-loss 15 pips above the

lowest pivot level.

The daily tweezer pattern in this

example implied downward pres-

sure, in which case placing a sell-

stop (entry) order just below the

pivot-range low with a stop-loss

above the pivot-range high still

would have been within thereward-risk parameter of the setup.

The risk would be approximately

50 pips vs. a potential reward of 300

to 350 pips, on the expectation price

would find demand toward the low

of the hanging-man candlestick

from the weekly chart.

Basing an investment decision on

a candlestick signal alone is not

advisable; confirming signals on

the daily or weekly chart is a must.The pivot range is there to help

define risk.

Confirming a pivot range

It is also useful to confirm the daily

pivot range itself. This can be done

by applying a momentum indica-

tor. Figure 4 shows an example

using the moving average conver-

gence-divergence (MACD) his-

30 August 2009 CURRENCY TRADER

TRADING STRATEGIES

The pivot range contains much of the short-term price action, with resistance on the

upside and a breakout occurring (as expected) to the downside.

Source: TeleTrader Professional (http://professional.teletrader.com)

FIGURE 3 PIVOT RANGE

A momentum indicator such as the MACD can be used to confirm the other signals.

Source: TeleTrader Professional (http://professional.teletrader.com)

FIGURE 4 MACD CONFIRMATION

8/8/2019 CT200908

31/48CURRENCY TRADER August 2009 31

togram (the difference between the main MACD line

and the signal line).

A few hours before the breakout, the MACD his-

togram crossed below the zero line, a bearish signal;

price, however, found support at the lower level of the

pivot range and moved higher over the next two

hours. A divergence occurred when the MACD his-

togram crossed below zero and price moved higher

another warning the market was probably moving in

the wrong direction. Because the upper level of the

pivot range had already been tested as resistance, the

bias for a down move became that much stronger.

The result of such a setup is not only a potentially

good reward-risk balance, but it provides easily iden-

tifiable daily and weekly candlestick signals. The

pivot range helps define levels at which the market is

expected to find support or resistance before continu-ing to move in the anticipated direction.

For information on the author see p. 6.

Want to read more? Go to the Currency Trader Web site after

Aug. 10 for extended analysis and additional examples from

this article.

Book:Trading and Investing in the Forex Markets Using

Chart Techniques

By G.A. Burgess (2009, John Wiley & Sons).

Articles:Putting pivot points to the test

Active Trader, November 2006.

Many view pivot points as potential intraday support and

resistance areas, but does the market really respond to these

levels the way traders expect?

Pivot points and candlesticks

Currency Trader, February 2005.

Augmenting pivot-point analysis with candlestick formations

helps determine potential turning points in the forex market.

Pivotal trading

Active Trader, September 2000.

Pivot points provide an easy way to estimate tomorrows

significant price levels based on todays high, low, and close.

You can purchase and download past articles at

http://store.activetradermag.com

Related reading

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