Forex Journal - January 2010 by DPR International Pte Ltd

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WINNING TRADES BEGIN HERE...

FOREX MARKETS

2010

WHAT’S AROUND THE CORNER FOR FOREX U.S. DOLLAR OUTLOOK THREE FAVORITE EMERGING MARKET CURRENCY TRADES FOR 2010

OUTLOOK FOR THE EUR/USD

Vol III #01

MICA(P) 124/07/2009 ISSN 1793-8457 JAN. 2010 A$9.95 • HK$68 • RM$19.80 • S$9.80 • AED20 • KD2.0 • SR 20 • BD 2.0 • RD 2.0 • QR20

2010 SHOULD RESEMBLE 2008

Also inside: SPOTTING FALSE BREAKOUTS, SWING TRADING WITH POINT & FIGURE TECHNIQUES, PRINCIPLES OF MONEY MANAGEMENT, THE HOLY GRAIL OF TRADE SET-UPS, TREND AND MARKET CYCLES FOR EFFECTIVE SWING TRADING AND MORE

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contents [ ammunition for the forex trader ]

PAGE 60

PAGE 10

[ analysis ]

3 favourites for 2010

Jack Crooks covers three emerging currency picks that consider the impact of

global rebalancing.

[ forex ]

false breakouts

Raul Lopez leads a discussion of support and resistance levels and how their analysis can be

used to spot false breakouts.

[ forecasts ]

trading principles

of Risk-to-Reward Ratio & Position Sizing Trading plans. Sunil Mangwani takes a close

look at the money management and position sizing elements of a trading plan.

[ money management ]

40 4

monthly currency forecast forecast for major currency pairs.

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Our regular contributor, Dar Wong, provides his monthly

We offer: • 29 major currency pairs, 24 hours, with spreads from 3 pips* • A flexible margin policy • Automated execution • Fixed spreads in all market conditions* • Professional charts featuring over 140 indicators/oscillations • Professional and expert customer service support from 7am to 10:30pm, Mondays to Fridays, Singapore time • Flexible contracts • Low minimum deposit of US$250

contents [ ammunition for the forex trader ]

PAGE 15

PAGE 29

PAGE 62 PAGE 51

PAGE 57

[ technical analysis ]

08 15 18 22 29 44 51 57 62 64 68 75 79 88 6

voice LETTER FROM THE EDITOR OF THE FOREX JOURNAL analysis ELLIOT WAVE PATTERNS: THE HOLY GRAIL OF TRADE SET-UPS? technique THE BIG NEWS DAY TRAP. AND HOW IT AFFECTS YOU swingers THE FOREX MARKET WITH POINT & FIGURE TECHNIQUES trends DEFINING MARKET CYCLES FOR EFFECTIVE SWING TRADING bubbles A CONTRARIAN VIEW OF THE DOLLAR 2010 dollar IAN NAISMITH DISCUSSES DEVELOPING MARKET MODELS markets THE OLD MAID, GLOBAL IMBALANCES AND CARRY TRADE middle east 174.41TRENDS IN THE GULF CURRENCIES5 MM trend ANALYSIS LOOKING AT THE POSSIBILITIES FOR THE U.S. DOLLAR gold INDEXDANIELCODE ON THE U.S. DOLLAR INDEX AND GOLD outlook INSIGHT INTO THE INVERSELY CORRELATED DOLLAR TREND latvia THE OPENING ACT FOR AN ECONOMIC EPIDEMIC IN EASTERN EUROPE? upcoming A LISTING OF UPCOMING FOREX RELATED EVENTS

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[ quoatables ]

When people are “ in doubt, they tend to look to others to confirm their behavior. Some people would rather adopt other's opinions rather than form their own.

“

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- Jon C. Sundt

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from the editor’s desk Welcome to the January 2010 issue of The Forex Journal! This is the time of year that we make holiday resolutions to change our lives, our futures, or our ways of doing things. If you want to become more successful in your trading, this is the time to consider the methods that you use and how those methods are applied. Taking the time to prepare properly is merely the first step in the journey to becoming a successful trader. Occasionally, the time required for preparation may be measured in months and years rather than days and weeks. Ultimately, it is worth the effort. However, the important thing to remember is that it is a journey and not a sprint to a ‘finish line.’ Having a workable plan helps keep your trading goals in focus. To enjoy a successful long-term trading career, it is vitally important to have a trading business plan and a trading methodology that incorporates market entry, exit, risk management and money management. Of these elements, risk management and money management are the most important. Keep your trade methodology simple. Time-tested trading rules that are simple often provide the best approach to achieving consistent profits.

[ to research and educate]

PUBLISHER & MANAGING EDITOR Dickson Yap dickson@forexjournal.com

ASSOCIATE EDITOR Roger Reimer roger@forexjournal.com

In this issue of The Forex Journal, Steve Griffiths outlines how to identify and use the ABC correction to the first move off of an important high or low. Howard Friend outlines and discusses a strategy to profit using the ‘traps’ after the release of economic data. John Needham considers the U.S. Dollar Index a valuable and underrated tool for traders and investors when performing analysis on other markets. Jaime Johnson provides analysis of the EUR/USD currency pair, the dollar index and gold in preparation for 2010. Peter Pontikis investigates the possibilities for the Gulf currencies and the Gulf Cooperation Council as their discussion have become more open and relevant in the aftermath of the global financial crisis and high oil prices. Our regular contributor, Dar Wong, provides his monthly currency market analysis and commentary.

CONTRIBUTORS

Claus Vistesen discusses which currencies should pick up the slack if the dollar is to correct to the new global fundamentals to relieve global imbalances. George Clement looks at each of seven major currency pairs and makes a fundamental and technical case for the direction of each in 2010. Ian Naismith discusses developing market models that incorporate various indicators or use single indicators that provide consistent positive results most of the time. Todd Krueger leads a discussion of Point & Figure charting and its benefit of removing market noise from the chart. Jack Crooks covers three emerging currency picks that consider the impact of global rebalancing. Sunil Mangwani takes a close look at the money management and position sizing elements of a trading plan. Raul Lopez leads a discussion of support and resistance levels and how their analysis can be used to spot false breakouts. P.A. Rajan provides analysis looking at the possibilities for the U.S. Dollar Index moving into 2010 as major questions linger. Raghee Horner brings to us ideas about how to use market phase, market memory and clock angles to improve our trading. Jason Farkas of Elliot Wave International outlines why we may see a return to across-the-board asset declines in 2010.

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At The Forex Journal, we work to deliver a balance of material. I am sure that you will find each article informative and educational. We have a highly qualified group of contributors and they enable us to provide a broad range of material. We are always very grateful for their contributions. I hope The Forex Journal becomes an important part of your trading education I wish you well in your trading journey and hope that you enjoy this issue of The Forex Journal.

Roger Reimer, Associate Editor

L E T T E R S TO T H E E D I TO R The editors of The Forex Journal™ magazine would like to hear from you, our readers. Tell us what you think about the articles we publish. Tell us which people or companies you’d like to see us write about more—or less. Praise us, criticize us, and ask us questions. We regularly publish letters from our readers in the print version of our magazine, reserving the right to edit them for length and clarity. Please include your full name, address and telephone number. Thank you. DICKSON YAP (MANAGING EDITOR, THE FOREX JOURNAL)

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Claus Vistesen, Dar Wong, George Clement, Howard Friend, Ian Naismith, Jack Crooks, Jaime Johnson, Jason Farkas, John Needham, P.A. Rajan, Peter Pontikis, Raghee Horner, Raul Lopez, Steve Griffiths, Sunil Mangwani and Todd Krueger

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#18-01, Singapore 048616 TEL (65) 6312 8091, FAX (65) 6312 8091 ADVERTISING advert@forexjournal.com CIRCULATION circ@forexjournal.com COPYRIGHT@2009 DPR INTERNATIONAL PTE LTD. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photo copying, recording, or otherwise, without the prior written permission of the copyright holder. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the under standing that the authors and the publisher are not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. In commodity trading, as in stock, and mutual fund trading, there can be no assurance of profit. Losses can and do occur. As with any investment, you should carefully consider your suitability to trade and your ability to bear the financial risk of losing your entire investment. It should not be assured that the methods, techniques, or indicators presented in this magazine will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples in this magazine are for educational purposes only. This is not a solicitation for any order to buy and sell. The information contained herein has been obtained from sources believed to be reliable, but cannot be guaranteed as to accuracy of completeness, and is subject to change without notice. The risk of using any trading method rests with the user.

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F E AT U R E D A N A LY S I S

3Favorite

Emerging Market Currency Trades

for GLOBAL REBALANCING IS A MAJOR MACROECONOMIC THEME IN TRADING AS WE MOVE INTO 2010. JACK CROOKS COVERS THREE EMERGING CURRENCY PICKS THAT CONSIDER THE IMPACT OF GLOBAL REBALANCING. 10

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2010

lobal rebalancing is the major macroeconomic theme that will likely dominate trading in all asset classes during 2010. We think it will be a powerful driver for the currency markets in general and particularly powerful for emerging market currencies as the year evolves. This article considers the impact of rebalancing and lays out the reasons for our top three emerging market currency picks for 2010 – picks that we believe on an absolute return basis will far exceed anything available among the major pairs. Three sub-themes / premises that are key to our view for a currency selection include:

• The U.S. dollar is significantly undervalued against the currencies of the industrialized world • Asian bloc currencies are overvalued versus the Chinese yuan and significantly undervalued against the major currencies • Emerging market currencies as a block are overvalued versus underlying fundamentals

INSIGHT JACK CROOKS

EUROZONE: getting squeezed as their economic future becomes murky again

Two weeks ago, the potential default of Dubai World shook global markets. Things in Dubai calmed down before concern began growing again. The takeaway from this black swan event was a whole lot of questions. To boil it down to the most important questions:

• Who else is vulnerable to default? • Have we not escaped the financial crisis? • Are my investments safe?

“The question, “Where does the Fed fit in?” will be the primary driver of the currency market over the next few months.”

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F E AT U R E D A N A LY S I S

hese questions have caused global investor sentiment to perk up and take look around. One glaring issue that has surfaced is Greece. The fiscal condition of Greece has not been completely unknown for some time. The severity of their condition is on the rest of Europe’s radar. The Maastricht Treaty sets a cap on budget deficits at 3% of GDP. It was believed that Greece was sitting somewhere around double that allowed level. But, it turns out though that the true deficit is actually north of 12%. The big risk here is to the European Monetary Union, otherwise known as the euro. Greece needs to get its house in order, European Monetary Union officials need to mend obvious violations of the common currency agreement, and this all needs to happen at a time when there is already enough risk in the system. CAN ANYONE HELP GREECE?

Perhaps no one except Greece but they are obviously in no position to accomplish anything quickly. If Greece does receive cross-border aid, it does not exactly set a good precedent for a handful of other EMU member countries who are not exactly fiscally prudent. Portugal, Ireland, Italy and Spain all come to mind. (In fact, shortly after Greece received a credit downgrade early this week, it was followed by a similar downgrade for Spain.) But a real collapse in Greece could quickly bring the validity

Chart 1: EUR/SGD Weekly Chart

and effectiveness of the euro into question. And as soon as that happens, the knee jerk reaction will be a quick turn to the U.S. dollar, which will shake up the correlations to which everyone has become so accustomed. Upshot/Forecast – Greece will continue to fester in 2010. Concerns will grow over the viability of the entire European Monetary Union. It will be bad news for the euro. ASIA – WHERE CURRENCY GOES TO DIE...

“It’s like déjà vu, all over again.” We can only imagine what Yogi Berra would be saying if he were in the financial services business. Dynamics that existed in previous financial crises exist in the current financial crisis – only the parties have shifted places. The U.S. boasts the role as primary deficit nation with China the role of primary surplus nation. The rest of Asia plays a supporting role to China. Meaning – they all have become focused on exporting goods to developed nations. But there is another dynamic within Asia that has influenced the currencies. China has kept its yuan suppressed, not letting its value rise despite its strong underlying economy. It has done this to support demand for its exports (a low yuan makes Chinese goods seem less expensive to foreign buyers.) China’s currency policy is the key source of global imbalance and is growing more dangerous for the world economy. Yet China believes they are being picked on. We believe Martin Wolfe, columnist for the Financial Times, nailed it with four replies to China’s false complaints: “First, whatever the Chinese may feel, the degree of protectionism directed at their exports has been astonishingly small, given the depth of the recession. Second, the policy of keeping the exchange rate down is equivalent to an export subsidy and tariff, at a uniform rate – in other words, to protectionism. Third, having accumulated $2,273 billion in foreign currency reserves by September, China has kept its exchange rate down, to a degree unmatched in world economic history. Finally, China has, as a result, distorted its own economy and that of the rest of the world. Its real exchange rate is, for example, no higher than in early 1998 and has depreciated by 12 percent over the past seven months, even though China has the world’s fastest-growing economy and largest current account urplus.”… China’s managed exchange rate is shifting adjustment pressure on to other countries. This was disruptive before the crisis, but is now worse than that in this post-crisis period: some advanced countries, notably Canada, Japan, and the eurozone, have already seen big appreciations of their currencies. They are not alone.” Someone has to take on the adjustment when China manipulates.

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INSIGHT JACK CROOKS

ut the rest of the Asian bloc, when they are not exporting to China, they are competing with China for exports to other nations. Thus they have taken steps, though less blatant, to keep their currencies from stifling their export economies. Asian bloc players are increasingly concerned about China’s over-aggressive trade policies and the pressure it asserts on them. Vietnam recently devalued its currency to help it become more competitive against China. However, that option is not available to the large countries in the Asian bloc. This from an excellent and well researched story that appeared in The New York Times on December 11, 2009 about the negative impact China is having on surrounding economies that once benefited from China’s growth: “To varying degrees, others are voicing the same complaint. Take the 10 Southeast Asian nations in the Association of Southeast Asian Nations, known as ASEAN, a regional economic bloc representing about 600 million people. After a decade of trade surpluses with ASEAN nations that ran as high as $20 billion, the surplus through October totaled a bare $535 million, according to Chinese customs figures, and appears headed toward a 10-year low. That is prompting some rethinking of the conventional wisdom that China’s rise is a windfall for the whole neighborhood.” “Vietnam just devalued its currency by 5 percent, to keep it competitive with China. In Thailand, manufacturers are grousing openly about their inability to match Chinese prices. India has filed a sheaf of unfair-trade complaints against China this

year covering everything from I-beams to coated paper.” “The Asia-Pacific Economic Cooperation forum, the biggest regional group, last month urged the adoption of ‘market-oriented exchange rates’ for Asian currencies without mentioning – or needing to mention – China’s currency, which many economists say China keeps artificially undervalued to promote its own exports.” “…China has taken some steps to mollify complainers. In April, it proposed a $10 billion investment fund to help build badly needed roads, railways and ports in Southeast Asia, and a $15 billion fund to give Asian nations low-interest development loans.” But it has so far done little to address regional and global unease over the value of its currency, the renminbi. Because the currency is lashed by effective government fiat to the sinking American dollar, China’s exports have become significantly cheaper in countries whose own currencies have not compensated for the dollar’s recent fall. In Asia, the renminbi is doubly significant. During the 1997 Asian economic crisis, the values of many regional currencies collapsed, making their goods cheap to foreign buyers. The Chinese won the gratitude of their neighbors – and cast their country as a responsible power – by keeping the renminbi’s value fixed. That prevented a competitive spiral of devaluations that many economists feared might make the crisis much worse. The latest financial crisis tells a different story: China’s exchange rate controls are cited as a leading cause of huge global imbalances that contributed to the collapse of 2008. This time, China has resisted pressure to untie the renminbi from the dollar and let it rise. And its neighbors’ exports have suffered as a result.

Chart 2: Long USD - Hungarian forint (HUF)

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F E AT U R E D A N A LY S I S

“…In October, Indonesia’s Trade Ministry invoked World Trade Organization rules and slapped a 145 percent safeguard tariff on Chinese nail imports, pending negotiations to settle complaints that the Chinese are competing unfairly.” Irvan K. Hakim, a co-chairman of the Indonesian Iron and Steel Industry Association, said he had aired those sorts of complaints to Chinese officials for years. He did not appear optimistic about a meeting of the minds. “China is China, you know?” he said, shrugging. “Even the U.S. cannot talk to China.” Upshot/Forecast – There is a lot of pressure growing in Asia. If China does not budge on the currency front (doubtful they will), we expect tariffs against Chinese goods will continue to rise – quickly. This could lead to retaliation by China, which is not good. It could create another major risk event that could be sustained.

The winner in this environment would be the U.S. dollar, among the major currencies. The euro would be hit hard again. So we have a situation of pure overvaluation of the euro-block currencies and the chance for a risk event rising by the day, thanks to China’s predatory policies, rising Greece default prospects, and Dubai debt problems creating some run-of-themill emerging market contagion. Best Single Trade Flowing From Risk Aversion – And Still a Good One TRADE #1: Short Euro / Singapore dollar

Chart 1 on the previous spread is the weekly euro / Singapore dollar cross-rate from March 2008 until today. The big move down in the pair starting in March 2008 shows just how much the Singapore dollar (and other Asian-bloc currencies) outperformed the industrialized world currencies (except for the U.S. dollar) during the last great risk aversion event we have labeled the credit crunch. On the bright side, in recent weeks we have learned that Chinese manufacturing is roaring along, etc., etc., blah, blah, blah. Basically, China will have no trouble achieving 8% growth for full-year 2009. That has loosened some of the global pressure on China to funnel money into its consumer sector and balance out its overweight export sector. (Though there is still plenty of concern swirling around lately regarding the quality of growth that China has been experiencing; much, perhaps far too much, is attributable to excess investment and excess liquidity looking for places to hide.) So, with China seemingly back to normal ... money continues to flow into Asia, which might help neutralize some of the growing trade pressures. This is a growth scenario, one that assumes a modicum of resumption in U.S. consumer demand. We still believe the euro falls relative to the dollar in this environment, which means the EUR/SGD cross still falls, but likely more gradually than it would in a risk aversion scenario.

Pure risk bets: South Africa and Hungary TRADE #2: Long USD – South African rand (ZAR)

We have all become aware at how tightly correlated asset markets have become. If we were not noticing it before the financial crisis, it was tossed under a microscope once the capital started ebbing and flowing with each tiny change in risk appetite. At times, weaker investments have been dragged higher with stronger investments. And at other times, strong investments have been dragged lower with weak investments. Two currencies come to mind as fitting nicely into the former dynamic – dragged higher despite poor fundamentals. The rand

We have maintained a negative view on the South African rand for the last couple months – since May actually. For most of that time, the rand has thrown it in our faces, extending its rally versus the U.S. dollar despite some longer-term problems shaping up for South Africa. For starters, South Africa remains in recession. Consumer spending has fallen for five straight quarters, and consequently production is slowing dramatically. While improvement is showing up in various period-over-period numbers, it is far from the type of growth needed to sustain the South African economy. Specifically, stabilizing the job market is a top priority for the fairly new administration headed by Jacob Zuma. There have already been some shifts in the top economic officials. Speculation seems to say Zuma is aligning his new officials on the side of the ANC and labor unions. There have also been instances of Zuma abusing power. The President has become a smooth-talker full of promises. The problem is – they are empty promises without sound, sensible follow-through. Empty promises cannot save an economy no matter how hard you work to bolster confidence among citizens. And it is particularly unsettling when you start promising jobs but there are none to go around. The result of this notion that the government can create jobs and keep its citizens happy has been, ironically, angry citizens with high expectations but without any jobs. That is part of the reason for another problem – crime. Recently a United Nations commissioner for Human Rights, a South African native, broached the topic and specifically called attacks on foreigners “gravely alarming.” Perhaps that is an understatement. As this article reveals, crime could be part of an incurable social destruction, taking place in South Africa. Sooner or later, think the brain-drain in South Africa and the desperate crime will eventually lead down the road to Zimbabwe for the country. It is bad news for the currency to say the least. USD – South African Rand Weekly: The downtrend going back to October 2008 has been broken. We have seen a test of the low (red line) and weekly MACD (yellow circle) has given a buy signal.

Continued on page 84 >> T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

TFJ ANALYSIS WHAT TO TRADE AND HOW TO TRADE IT: SWING TRADING, MARKET OBSERVATIONS AND MORE

The Holy Grail of Trade Set-ups?

The simple approach to analysis is often all that is needed to uncover excellent trades. Steve Griffiths outlines how to identify and use the ABC correction to the first move off of an important high or low.

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TECHNICAL ANALYSIS

ELLIOT WAVE PATTERN

One lesson learned over years of trading is that the simple approach to analysis is often all that is needed to uncover excellent trades. Arguably, one of the clearest trade set-ups for a professional trader should be the simple ABC correction. I have outlined not only how this clean ABC correction can yield profitable trade opportunities, but how simple and easy-to-recognise it can be.

Chart 1

Taking this a step further, when the basic ABC correction occurs at a certain juncture in a market, it can produce one of the most profitable trades available. This happens when the simple ABC correction develops as part of the first correction to the first move off of an important high or low. In Elliott wave terms, this is the Wave 2 correction.

Chart 2

This is a simple ABC correction on a daily chart of the EUR/USD. The most important point is that this ABC correction unfolded as part of the first correction to the initial swing off of an important low: (See Chart 2, left). The EUR/USD made a major low in March 2009, followed by an initial rally off the low. The simple ABC pattern appeared during the “first correction” to this “initial rally.” This is the Type 1 trade set-up in MTPredictor.

When this correction is complete, it can lead into a Wave 3 type move, which is usually the strongest and longest swing in a typical 5-wave sequence. This swing has the largest profit potential in any Elliott wave pattern, so being able to trade it can be highly profitable. Chart 1 shows an example (top right).

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

So, why is this set-up so important? Often, this initial correction is the springboard for an extremely strong move. Moving forward in time in Chart 3, we can see how once this particular corrective ABC pattern was complete, the EUR/USD proceeded to rally strongly. Reaching the Typical Wave 3 WPT target in October 2009.

TEXT STEVE GRIFFITHS

Chart 3

Clearly, identifying these set-ups can result in enormously profitable trades. This is why this set-up is nicknamed the ‘Holy Grail’ of trade set-ups at MTPredictor and is the principal trade setup sought out of the possible ABC corrective variants. More importantly, this setup is straightforward to identify with its mathematical simplicity – a simple ABC correction that unfolds as part of the first correction to the first move off of an important high or low.

Chart 4

Compare this with the potential profit as the EUR/USD rallied to approximately 1.4960 (at the Typical Wave 3 WPT target), representing a profit of 1,921 pips. This was a risk/reward of approx 12.5 to 1. Over time, this can result in a track record where the losses are kept small relative to the profits – which is what essential low risk/high return trading is all about.

The MTPredictor software program can scan for, automatically identify and assess this set-up in markets.

n the previous example, being able to identify the end of the correction enabled the trader to enter a very profitable trade precisely at the start of the strong move. This has the major advantage of reducing the initial (money) risk on the trade, particularly compared with the potential profit from these Type 1 set-ups.

Expanding on this theme, Chart 4 shows how the ABC correction developed exactly at the Typical Wave C WPT (Wave Price Target) support zone. Anticipating that the market was reversing at this zone enabled the trader to enter the market with a very small initial (money) risk. This means being long from 1.3039 (ignoring slippage and commission) with the initial protective stop loss at 1.2885 – an initial risk of only 154 pips per Forex lot.

This particular trade setup can unfold in any market and on any timeframe (from weekly charts down to 3-minute charts). Whether you trade UK equities, U.S. equities, futures or Forex, the identification of this set-up should arguably be a major part of your trading plan. The simple ABC correction is one of the most overlooked set-ups among the arsenal of techniques that are available today. The Type 1 trade set-up (as labelled by MTPredictor software), where the correction develops as part of the first correction to the first move off an important high or low could be as close as possible to the Holy Grail of trade set-ups. TFJ

Steve Griffiths is the managing director of MTPredictor Ltd and the developer of the MTPredictor software program, designed exclusively to scan for, identify and risk-evaluate ABC corrections, as well as all of the Elliott wave sequences. For more information, please visit the MTPredictor web site at www.MTPredictor.com.

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T E C H N I CA L A N A LY S I S

TRADING STRATEGIES

Swing Trading Techniques: The release of certain economic data often produces extreme market movement. Howard Friend outlines and discusses a strategy to profit using the ‘traps’ after the release of economic data. TECHNICAL VERSUS FUNDAMENTAL TRADING

echnical analysis or Fundamental analysis? The debate as to which trading methodology to use has been raging for decades.

The pure fundamental trader examines economic data, balance sheets, intermarket correlations and political developments with a view to determining whether a market is correctly priced. After making a value judgement as to where a market should be, the trader aims to take advantage of any discrepancies between the current price and what is deemed to be fair value. Fundamental traders are deeply concerned with why a market is moving in a given direction. The pure technical trader is not as concerned with the underlying fundamentals driving a market, preferring to limit the inputs they look at to data derived mainly from the market price. The pure technician believes that market psychology is the key factor, and that markets trend and reverse in a predictable manner producing patterns on the charts, which can be exploited. The technician has an array of tools relating to trend, momentum, market sentiment and overbought/oversold status.

sides becomes more acute on days when an important piece of news is released. TRADING ON BIG NEWS DAYS

Consider a day trader who trades from intraday charts. Imagine that it is approaching 8.30am Eastern Standard Time on the first Friday of the month when the U.S. Non-Farm Payroll report is released. This piece of economic data often produces extreme market movement as traders who are typically lightly positioned or flat going into the data release put on new positions based on the report number. If a technical trader gets a buy or sell signal just before the number is released, does he or she take the trade and hold the position through the release? It would be foolish to do so as a number or a revision of a previous number that is far from consensus market expectations often causes the market to move sharply from the pre-release price to another level without trading at prices in between.

“While fundamental traders would be foolish to ignore the powerful trend of a security that does not reflect where they think value ‘should’ be.”

This news-driven ‘gap’ can sometimes see the market suddenly trade significantly above or below one’s stop-loss exit level, creating a larger loss than allowed for by the trader's money management rules. Surely, the best strategy in this case would be to wait until after the data release before making a trade? The problem with this approach is that it is possible to miss most of the move, buying into a trend when many of the early buyers are selling out. It would be shame to miss out on what could be one of the best trading opportunities of the month. What should the trader do?

While the two approaches to the market puzzle may sometimes be at odds and ‘never the twain shall meet,’ it would be unwise for proponents of both methodologies to disregard valuable information that could be gleaned from the other camp, i.e. trading in a vacuum. While fundamental traders would be foolish to ignore the powerful trend of a security that does not reflect where they think value ‘should’ be.

BIG MOVES ARE OFTEN PRECEDED BY MARKET ‘TRAPS’

An example would be a bear market in stocks that sees prices becoming cheaper and cheaper. Similarly, technical traders should maintain a healthy respect for the fundamentals, particularly those trading over a short timeframe with a correspondingly close stop loss levels. The need for mutual respect on both

In my opinion, many of the best trading opportunities arise as a result of a false breakout of some kind. Most of the time for example, this theory applies to the technical approach where the breach of a support level fails to see follow through selling and a powerful move unfolds in the opposite direction.

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TEXT HOWARD FRIEND

The Big News Day Trap...

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T E C H N I CA L A N A LY S I S

TRADING STRATEGIES

Chart 1

I call this set-up a ‘Bear Trap.’ It is the technical traders ‘selling the break’ who become trapped and it is their stop-loss buying that ultimately drives the price higher as they exit their losing short positions, heading for the exits at the same time.

owever in this case, the traders who have become ‘trapped’ are the fundamental traders who reacted to the economic data just released. Assume that the Non-Farm Payroll number comes out so far from market expectations that it is implicitly bearish for a particular market and generates heavy selling pressure just after the release. However by the close of the session, the newsrelated decline has been reversed generating losing open positions for those who sold ‘on the news.’ Many times, I have witnessed just such a move lead to a very powerful advance often lasting for several days! HOW TO PROFIT FROM NEWS-RELATED TRAPS

From a trading perspective, I would say that the best way to approach these ‘big news’ days is to wait until after the release of the data rather than entering a position and holding it over the release. It often happens that once the data is released, markets see a knee-jerk reaction as fundamentally driven traders take a position, particularly if the number is significantly stronger or weaker than the market consensus expectations.

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However, perverse as it may seem, the markets have a habit of seeing a very powerful movement in the OPPOSITE direction to the initial post-release movement, much to the frustration of those who take a position based on the data. To take advantage of just such a move, I like to follow this three-step process. • Prior to the report release, I record the price of the market I want to trade. This point will be known as the ‘news origin price’ and will be my entry price should the market generate a ‘significant’ move after the release. • Then, I calculate price levels that if hit would constitute ‘significant’ movement due to the news indicating that new money is being committed to the market. I would say that any movement that sees the expansion of the global session range by at least 50% is ‘significant,’ particularly if it also breaches yesterday’s high or low in the process. • I wait for the release. If any of the threshold levels previously outlined are hit by the close of the session (give or take a few pips), I look to enter a position in the opposite direction if and only if, the ‘news origin price’ is seen again during the global session. If the market returns to this level having made a ‘significant’ post-release move as outlined, then all of the news-driven traders will suddenly find themselves underwater and they are the ones who will chase the price higher or lower in stop-loss related buying or selling. If the trade is triggered, I place a protective stop-loss on the other side of the day’s range looking to trail it as the trade (hopefully) moves into profit.

TEXT HOWARD FRIEND

Chart 2

A trade target naturally depends on timeframe. I would stress that a move of this nature is often good for a 2 to 1 or 3 to 1 reward-to-risk ratio, if not by the close of the session then certainly over subsequent days. If the trade is triggered, I look to exit at three separate levels (PT1, PT2, and PT3), which is calculated if the trade is triggered. I hold the trade until the stop level is hit, all of the profit objectives are met, or at 22.00 CET on the third trading day after the entry date. If the trade is triggered on a Friday, I will exit on around the U.S. close on Wednesday. THE U.S. NON-FARM PAYROLL ‘TRAP’

Let’s look at an example of this trading strategy in action using EUR/USD after the release of U.S. Non-Farm Payroll report in October 2009. Just before the data release, EUR/USD was trading at 1.4543. The number came out much worse than market expectations (263,000 versus a market expectation of -170,000), resulting in a violent knee-jerk sell off that saw a test of the buy set-up level at 1.4480, as can be seen in Figure 1 (green line).

level (PT 1) was hit at 1.4606 and the stop was moved up from 1.4479 to the breakeven point, creating a risk-free trade. Figure 1

Over the next few days, EUR/USD managed to extend its advance to 1.4763, over 200 pips above the original entry price and at a level that could have generated a profit in excess of 3 times the potential loss. Figure 2

The next time a significant data release such as U.S. NonFarm Payrolls occurs, look to join a post-release reversal that could last for several days! I wish you the best in your trading.TFJ

Howard Friend is Chief Market Strategist at MIG Bank based in Neuchatel, Switzerland. He has worked as trader and market analyst for over 20 years and has developed proprietary trading methods to time the markets. Howard can be reached at h.friend@migbank.com or via www.migbank.com.

After hitting the buy set-up level at 1.4480, EUR/USD reversed sharply to trade back at the news origin price at 1.4543 generating a buy signal with a stop-loss at 1.4479, which is just below the session low. Within a few hours, the first take profit

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POINT & FIGURE CHARTING

From here to there... but how?

SWING TRADING THE FOREX MARKET WITH POINT & FIGURE TECHNIQUES Point & Figure charting is ideal for the Forex market as its major advantage is the ability to remove market noise from the chart. Todd Krueger leads a discussion of this 100-year old trading method and its benefits.

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existence since the late 1800s and was used extensively by Richard D. Wyckoff during his prolific trading career in the early 1900s. Point & Figure charting is ideal for the Forex market as one of its major advantages is the ability to remove market noise from the chart and the Forex market has more random market noise than most markets. In a typical Forex cross-rate, it is not uncommon to have over 100-pips of market noise, which is a major cause of stops being hit when they are too close to the current market price. Another advantage of the P&F chart, particularly when used in the Forex markets, is its ability to ride the long trends that frequently occur in these markets. We are talking about trends lasting from several months to several years with moves greater than 1000-pips being very, very common. The currency markets are the greatest trending markets in existence and the Point & Figure methodology allows us to ride these trends for monster gains when traded properly.

TEXT TODD KRUEGER

P&F is also ideal for the individual Forex trader as it is a rulebased approach that instills mental discipline, translates the understanding of trading psychology onto the chart and has at its very core a built-in trading plan. These are the same areas that most losing traders have problems with and do not know how to overcome. In my communications with Forex traders, I have found that the vast majority of traders are using very short-term charts and they are trading an indicator-based approach like MACD, CCI or Stochastics. To make matters worse, they are trying to gain 20 pips to 50 pips in profit with their approach. This is extremely difficult to achieve on a consistent basis because the random market noise is greater than the profit target. The probabilities are very high that the market noise will hit their stop and take them out of the trade before their profit goal is achieved.

to produce a reversal on our chart. Reversal size is also a determining factor how sensitive the chart is to price reversals. Chart 1 has a box size of 100-pips and a reversal size of 3 boxes. So on Chart 1, we will add an X to the X column every time the price moves 100-pips higher. It will take a 300-pip price movement to the downside to start a new column of O’s showing that supply is moving the price lower. For each additional 100-pip price move lower, we will add another O to our column of O’s until the market reverses higher by at least 300-pips. Then, a new X column begins as we shift the new X column to the right of the previous column of O’s. Can you see how this method puts an asymmetrical trend filter on the chart? It only takes 1 box size to advance the chart in the direction of the current trend

SOURCE TRADE NAVIGATOR

Chart 1

Pont & Figure charts eliminate the time element from the chart as they only track price action and display the ongoing battle areas between supply and demand. Price movement is depicted by X and O symbols placed in separate columns – the column of X’s represents demand pushing price higher and the column of O’s represents supply pushing the price lower (please refer to Chart 1). Each X and O is assigned a point (pip) value as part of the chart set up, this is called the 'box size' and it determines how sensitive the chart is to price movement. Chart 1 has a box size of 100-pips on the EUR/USD cross-rate. During the chart set up, we also have to determine the reversal size. This is the number of boxes required

but it takes 3 box sizes to reverse it. It is this trend filter that will allow us to stay in trend trades much longer than any other charting method. (See Chart 2, next page, top) For this article, I want to show a very powerful buy set up called the 'triple top buy.' This is another of the great benefits of a Point & Figure chart – you cannot invent a trade that does not exist on the chart. We do not have a buy set up until the chart formation objectively appears on the chart. This is a great aid to the struggling trader that is trading without a trading plan and is losing because of it!

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POINT & FIGURE CHARTING

SOURCE TRADE NAVIGATOR

Chart 2

s you refer to Chart 2, you will see that I have drawn a blue horizontal line connecting 3 X’s, since the first 2 X’s represent a price level on the chart where supply has come in and knocked the market lower, it is easy to visualize that if price takes out this level that the market should explode higher. Why? Because the market is exceeding an important level on the chart where the bears successfully took control from the bulls on 2 separate attempts to move price higher. Once this level is breached, demand objectively exceeds supply and since the bears could not prevent price from advancing, they have to buy to cover their short positions, which will fuel the price to move higher.

would not put us into a short trade. (See Chart 3, next page, top) There are several other chart conditions that contribute to making this a much stronger buy set up than the standard triple top buy. As you look at Chart 3, you will see that I have added two 45degree trend lines, which are commonly used on a P&F chart. The first area that I would like you to look at is where the down sloping trend line is broken by the long X column.

“Point & Figure charting is ideal for the Forex market as one of its major advantages is the ability to remove market noise from the chart...”

This trend line had contained price action as the bulls repeatedly tried to push price higher but the trend line provided resistance to each failed rally.

Without the overhead supply in the market from these aggressive sellers, the demand exceeds the supply and the price will move higher.

When price breaks above this resistance line, it provides a clue that the market dynamics are beginning to change and the bears are losing control.

Once we are in the trade, we want to stay in until a column of O’s breaks below the previous column of O’s showing that the up trend is waning. At the time of writing this article, this uptrend is still intact although if another O is added to the right-hand column of O’s that would be the sell signal to get out of the long trade but

To provide further proof that the bears are losing control, please look at the up sloping support line that is drawn on the chart supporting prices at consistently higher lows. This shows that the bulls are taking control at higher prices after the bears have attempted to drive the price down with less effect each time.

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TEXT TODD KRUEGER

SOURCE TRADE NAVIGATOR

Chart 3

his provides an ideal trading background for a triple top buy signal. When the buy signal occurs on this chart, we can objectively see that the bears are out of ammunition to successfully drive price down again. The resulting up move has provided a monster gain that is still going as of this writing.

The entry on this trade was just over 1.3850 and the current price level that we would be stopped out is at 1.4549. This is a 700pip move occurring over a span of about 6 months â&#x20AC;&#x201C; from mid June 2009 to mid December 2009. I hope that you are getting a sense for how easy it is to stay in a trend trade with the Point & Figure chart. You do not get out until the chart objectively tells you to. As with any true trading methodology, there are rules and patterns that need to be learned before it can be used effectively. There are also nuances that you will learn that will make your results more effective but can only be learned by actively trading the methodology. And so it is with Point & Figure, I have only covered one buy set up and some nuances that make the pattern much more successful. There is not room in this article to cover every rule and nuance, but my hope is that this article has ignited a creative spark that will allow you to see the power of a century old trading methodology that can unlock the profit potential in your Forex trading. It just does not make sense to me to watch Forex traders jump over $100 bills to try to grab pennies as they ignore the true profit potential of the best trending markets in the world! TFJ

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TRADING STRATEGIES

Don’t let your analysis fall apart...

SPOTTING FALSE BREAKOUTS IN THE FOREX MARKET Support and resistance levels are an important part of trading analysis. Raul Lopez leads a discussion of support and resistance levels and how their analysis can be used to spot false breakouts.

t is important to spot support and resistance levels. But it is even more important to determine when the market has been rejected from support and resistance levels, or better yet, how to spot false breakouts so we do not get trapped by them. In this article, I will explain the methodology I use to determine • When the market has been rejected from an important long-term level, • When the market is trading at an important level, • False Breakouts.

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First things first, we need to make sure we are using the right methodology to determine important support and resistance levels. By definition; Supports are levels or zones where the market has been rejected more than once, preventing it from falling below that zone or level. The more times the market has been rejected from such a zone, the more important the support level becomes.

TEXT RAUL LOPEZ

Resistances are levels or zones where the market has been rejected more than once, preventing the market from trading above that zone or level. The more times the market has been rejected from such a zone, the more important the resistance level becomes.

nce the market breaks an important support level, it becomes an important resistance level and by the same token, once the market breaks an important resistance level, it becomes an important support level. Under these circumstances, the balance of support and demand changes. When the market breaks an important support level and it becomes resistance, what was thought as a “cheap” price (the support level kept the market from falling below this zone) becomes an “expensive” price (and the market is likely to get rejected as it approaches to this level as bears are likely to take the command of the market around that zone). Why are these support and resistance levels so important? Because at those levels the market is likely to be rejected: When Long – If a long position is entered near an important support level, the likelihood of our trade increases in our favor (since the market was previously rejected around this zone or level) – bulls outnumber bears.

Okay, we know what is likely to happen when the market approaches to an important long-term support or resistance level, now we need to know when to take proper action. A key to spotting false breakouts is that important long-term support and resistance levels are not levels, but ranges or zone. You might want to test this. Pull up any daily chart and you will see that important support and resistance levels are okay even if you move them a few pips up or down. The best way to define the range or zone in which each long-term support or resistance is valid, is by looking at the short-term charts. Let’s take a look at some charts to clarify this concept. In the GBP/USD daily chart below, the market seems to be trading below an important support level (which makes it a resistance level). At the moment of this chart, many traders would be looking for shorting opportunities, as the GBP/USD is trading below the important long-term support level. Now, let’s take a closer look at the short-term charts and try to determine the range it is trading in (see Chart 2 on next page): Blue lines – Support and Resistance levels taken from the long-

term charts Green Lines – Support and resistance levels taken from the

When Short – If a short position is entered near an important

resistance level, the likelihood of our trade increases in our favor (since the market was previously rejected around this zone or level) – bears outnumber bulls.

short-term charts In the GBP/USD hourly chart, we can determine the zone or range the market is trading in. We know the market is trading in

Chart 1: GBP/USD Daily Chart

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Chart 2: GBP/USD Hourly Chart

this range because it is so close to the long-term resistance level (blue line). In order to have a valid breakout or rejection, the market needs to break the short-term support level (breakout) or the short-term resistance level (rejection). This way a map can be created.

HOW CAN THIS INFORMATION BE USED?

We could avoid trading during false breakouts or rejections (where most traders get caught). Once we have determined the short-term range or zone, we need to wait for the market to break the short-term level before looking for a trade opportunity.

Valid Breakout â&#x20AC;&#x201C; When the market starts to

trade below 1.6190 (short-term support level) Valid rejection â&#x20AC;&#x201C; When the market

Having a trading plan of what the market needs to do before starting to look for a trade opportunity will help with your discipline, and will help you become more a more consistent trader. TFJ

starts to trade above 1.6336 (short-term resistance level) If the market keeps trading between the short-term support and resistance levels, the market is said to be trading at an important longterm support or resistance level. Going back to the daily chart, judging by where the market was trading at that moment, we know that even though the market is trading below the long-term support level, it is a false breakout, because the market is still trading above the short-term support level. By the same token, if it were trading above the long-term support level, but below the short-term resistance level, it would be a false rejection. In order to be a valid rejection, the GBP/USD would need to trade above 1.6336 (short-term resistance level).

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Raul Lopez is the CEO &Founder/Instructor of StraightForex. He is a full-time Forex trader and also trains traders around the world to help them achieve their goals. Raul is also an economist and got interested in the Forex market back in his college days. He got involved in several companies related to the foreign exchange market. He has always liked to do things different, this attribute made him try different ways to profit from the Forex market. After years of research, trading, learning, and teaming up with several traders around the globe, he finally found what he was looking for â&#x20AC;&#x201C; consistency in trading profits. Raul can be reached at www.straightforex.com

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SWING TRADING

TEXT RAGHEE HORNER

DEFINING THE TREND AND MARKET CYCLES FOR EFFECTIVE SWING TRADING

n my career as a trading educator, I have communicated with thousands of retail traders searching for the next trading indicator that will transform them into a successful trader. For most of them, this unfortunately will never happen. Although each individual trader has their own weaknesses to overcome, I have found that the collective problems of losing traders can primarily be grouped into trading psychology, mental discipline, trading expectations and trading plans. The basis of using any trading strategy must be determining the market direction, which can also be referred to as market phases or cycles. I was first introduced to market cycles as I was reading about Dow theory. A basic tenet of Dow theory was that market trends have three specific phases. Remember that while the psychology of market phases can be applied to any market, the bias of the stock market is bullish. Since Charles Dow wrote about the equities market in the early1900s, much of his writings reflect this bullish directional bias. In other words, most equities traders and investors look for a stock to go up. As Forex traders though, we are equally ready to go long or go short. Please keep this in mind as I go through the phases. It is worth mentioning that Charles Dow never referred to “Dow Theory” in his writings over the course of over 250 editorials. This was done posthumously. However, traders in every market knowingly or unknowingly are affected by the ideas in his editorials even today – regardless of the market they trade.

ILLUSTRATION BAGALAGALAGA

The first market phase of a trend is accumulation. The psychology of this phase is best described as when investors or traders “in the know” are buying. The fact that these participants are “in the know” also denotes a certain amount of “secrecy” or “stealth” in that the market should not move rapidly higher out of a sideways range. Accumulation phases visu-

Charles Dow wrote his editorials about the equities market in the early1900s and his ideas affect traders even today – regardless of the market they trade. Raghee Horner brings to us ideas about how to use market phase, market memory and clock angles to improve our trading.

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SWING TRADING

The 30-minute EUR/USD and the market phases identified by the 34ema Wave

The daily EUR/USD and the Fibonacci number based “Lazy Days Lines”

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TEXT RAGHEE HORNER

ally appear on a chart as a range bound market, usually quiet and narrow as if not to call too much attention to the underlying activity. It is for this reason that accumulation usually goes unnoticed. After accumulation comes the trend or “mark up.” Remember that for stocks, it is an uptrend. However, I want to keep with the idea that as Forex traders, we can benefit from Dow theory as long as we remember that in the currency market accumulation can also be followed by a downtrend. The trend, as I will refer to it for this phase or cycle, is when price typically trades above the resistance or below the support of the accumulation range. News, data or even volume could be the catalyst for the breakout. Regardless of how the trend began, as it persists, more and more participants notice the move and want to get on board. The only reason an uptrend can continue is that more participant are willing to buy the market at a higher and higher price. It should also be added that these same participants are willing to buy corrections and it is these corrections (or lows in the uptrend) that become the backbone or trendline of the move. An up trend’s backbone is a progression of higher lows.

So having this understanding of market trends, thus began my pursuit of determining what type and how many entry strategies I would need to employ to trade the different psychologies of the market. Based upon Dow theory, there are essentially three phases and therefore three strategies I would need. • A trend following strategy • A breakout/breakdown strategy • A fading strategy Each strategy would capitalize on the psychology that drove prices into a tight range, a wide range or a trend. Later, I would add another strategy to handle trend-to-trend transitions • A trend reversal strategy Initially, my problem was how do I determine the market phase. This was solved with a tool that I had been using to identify support and resistance within a trend – my 34 period exponential moving average Wave (34ema Wave). The indicator was an elegantly simple trio of exponential moving averages set on the Fibonacci level of 34. The three moving averages are:

The final market stage is distribution. Now again I must add that these phases do not always occur one after another as described here. Phases can be skipped; phases can transition from one type of sideways market to another and then can also transition from uptrend to downtrend. The distribution phase is volatile, wide ranging and reflects the psychology of confusion and panic. The name comes from the idea that at the height of speculation, the market participants “in the know” from accumulation and even the early trend participants distribute their shares to the market. The market, in the distribution phase, represents those speculative latecomers. At the top and bottom of strong trends, the speculative frenzy can be seen as holdings change hands and one group realizes profits at the expense of the other. This is the way the market works.

The reason for the 34 period setting came from exhaustive testing as to which Fibonacci number seemed to best offer support and resistance and which could adjust quickly enough but also be conservative enough to offer a visual footprint of the market’s direction.

I am not neglecting the downtrend phase or “mark down.” Simply put, after any sideways move just as prices could rally higher through resistance, they can sell-off through support. Regardless, the downtrend phase is akin to the trend phase discussed earlier. Any trend is really the result of imbalance. In a sideways market, like accumulation, there is a certain balance between supply and demand. The more “balanced” a market is, the tighter the range between the floor and ceiling. The wider the range – as in distribution – the less balance there is in the market. But complete imbalance comes during a trend where either the amount of demand exceeds supply (uptrend) or supply exceeds demand (downtrend),

Now while I may not use a strict interpretation of the phases of market trends, Dow theory has had a significant impact on my own trading. It led me to pursue how I could identify the market phases (I refer to them as cycles) with a more real time, objective indicator. The fact is that trendlines are powerful but terribly lagging tools for trend identification.

• The 34 period exponential moving average of the high • The 34 period exponential moving average of the close • The 34 period exponential moving average of the low

I tested the Fibonacci series from 13 to 1,597 and while 34 was my final selection; other Fibonacci numbers would later become what I still use today and refer to as my “Lazy Days Lines.” This was not all that went into the use of the 34ema Wave for market phase identification. The second step would be how I could not only use and rely on the consistency of the readings, which I call “clock angles.” (see charts, left) he challenge many traders face when using technical tools such as moving averages are the discretion that is injected into the analysis process. Discretionary analysis is effected on a number of things. Two of the main issues are experience and more so in my opinion, the actual view of the data on the chart. I realized that there was not a set amount of data that traders included on their charts. The choice to include data was random and based upon visual comfort and not the relevance of the amount of data. In order to find consistency, I worked up a “market memory” or lookback for each timeframe I analyzed. A market memory basically set forth a guideline for the view of the chart I was viewing regardless of the size of the chart or my screen which are both random factors when you consider all the different platforms and charting set ups that all traders use.

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The 30-minute EUR/USD and the market phases identified by the 34ema Wave

y main timeframes are the 15, 30, 60, 240minute, daily and for very short intraday trading, the 5-minute. Each timeframe has a market memory. There is a relevant amount of price action that is ideal to analyze trends, highs, low, last major moves, draw trendlines, etc. Too much data and there is a chance that less relevant data could effect the final trading decision because of the lines and levels it will yield on the chart. Too little data and important lines and levels can be missed. The market memory or lookback settings I use are as follows: 15-minute chart, three to five days 30-minute chart, one to two weeks 60-minute chart, two weeks 240-minute chart, four to six weeks Daily chart, one year 5-minute chart, two days

Notice that these market memory settings are not fixed – they are guidelines. Most charting platforms will not scroll to exactly these settings, so the idea is to work as closely to these lookbacks as possible. I would rather err on the side of slightly too much data than too little. Having your chart view within the market memory appropriate for each timeframe does two very important things. First, it makes your analysis more objective since the amount of data is fixed and within the market memory of that timeframe. What I mean by this is that short-term timeframes usually have

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short-term memory for past support and resistance levels. For example, a high on a 240-minute chart may not be significant within the psychology of a 15-minute chart. These two timeframes represent two different looks at intraday price action. The second thing that market memory does is put the angle of the 34ema Wave lines in the consistently and accurate clock angle. The angle that the moving average travels will signal the market phase that a timeframe is currently in. Too little data will artificially flatten the moving averages while too much data can steepen the lines too much. It is consistency and accuracy we are looking for. For the purposes of this article, the mark up and mark down cycles will be discussed here for trend following trades known as swing trading. Swing trading itself it a relatively simple entry and like all entries there is a time and place for it. Swing trades allow a trader to capitalize on a correction of the trend and buy into near term weakness in an overall uptrend or sell into near term strength in an overall downtrend. The key here is the overall trend – as indicated by the 34ema Wave – and the amount of the correction. The first issue to tackle is – How to define a trend? Using the angle of the three 34 period exponential moving averages, a “clock angle” can be taken within the appropriate market memory for the timeframe. Imagine taking an arrow or using the drawing tools in your charting platform to extend the middle line of the Wave, the 34period exponential moving average close as I have done in the chart of the USD/JPY 30-minute.

TEXT RAGHEE HORNER

otice the angle of ascent? If you were to identify this angle, what number on a clock face it is pointing at, would you say it is “1 or 2?” If so, you have the idea behind clock angles! On this intraday chart of the USD/JPY, the 30minute timeframe requires a lookback of at least one week to put the Wave in the proper perspective. Since the angle is heading higher at “two o’clock” then the market phase or cycle is a mark up or uptrend.

FINDING YOUR WAY?

In this uptrend, swing trades long can be set up in corrections to Fibonacci retracement levels of 38.2% or greater, at psychological levels like the nearby 89.50, and even the Wave itself. Using the top line of the Wave in this instance would be taking advantage of the support the trio of Fibonacci-base moving averages offers. That level is currently 89.46. Now remember that moving averages are dynamic levels that will adjust according to price action. Fibonacci retracement levels and psychological levels are static. As long as prices are moving higher in this timeframe in a “two o’clock” angle, pullbacks that extend all the way down the Wave low (the 34-period exponential moving average low) can be bought. If prices transition the Wave to a more sideways angle, the swing entry is no longer valid. If prices break down through the support of the 34-period exponential moving average low, the swing entry is no longer valid. In fact, if prices break down through the Wave, it is an early indication of a trend reversal on this timeframe. Remember that all analysis is timeframe specific. This is a great place to begin incorporating market cycles into your overall trading strategy especially if you have been experiencing “hit or miss” trading results due to ineffective strategy application. Remember each market phase or cycle has a strategy that is appropriate for the underlying price movement and psychology. Consider this next time you add a new strategy to your approach and also when you choose to apply it to the market.TFJ

Raghee Horner is a private trader, founder of EZ2Trade Software, blogger, and author. She is a regular contributor at a number of sites including FX Street, Trading Markets, Baby Pips, Forex Pros, StockTwits, eSignal and Autochartist. She is a featured speaker at the Forex and Traders Expos as well as the International Stock Exchange. Her commentary and analysis is seen daily by thousands of traders at her personal blog ragheehorner.com. She has written articles for Technical Analysis of Stocks and Commodities, Currency Trader, and Your Trading Edge magazine. Raghee trades from her home in Coral Springs, Florida where she lives with her husband, Herb, and their two dogs. She can be reached at ragheehorner@yahoo.com

“Remember that while the psychology of market phases can be applied to any market, the bias of the stock market is bullish.”

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T R A D I N G SY S T E M D E V E LO P M E N T

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MONEY MANAGEMENT

TEXT SUNIL MANGWANI

PRINCIPLES OF MONEY MANAGEMENT IN TRADING THE RISK-TO-REWARD RATIO & POSITION SIZING Trading plans are typically prepared from the charts concentrating on the method. Sunil Mangwani takes a close look at the money management and position sizing elements of a trading plan. J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

T R A D I N G SY S T E M D E V E LO P M E N T

MONEY MANAGEMENT

MONEY MANAGEMENT IS THE MOST CRUCIAL ASPECT OF A TRADING PLAN.

So, let’s assume that a trader has a WinLoss ratio of 60%. This means that out of every 10 trades taken, a trader would get 6 winning trades and 4 losing trades. The only way to achieve gains in the account is by maintaining the required RR ratio.

ronically, this is the part of the plan that is usually ignored by most traders. A trade plan is a requirement to succeed in trading and the plan must incorporate the 3 M’s – Money, Mind & Method in that order. If we divide a trading plan on a scale of 10, then:

risk of loss, while still enabling the participation in major price gains. It is probably the most critical aspect of trading and the most overlooked. A sound money management policy becomes an absolute must in the Forex markets, due to the use of high leverage.

If a trader is keeping a stop loss level of 50 pips, then the expected profits from the trade must be at least 100 pips.

Money – which is the Money

As the popular saying goes “take care of your losses, and the profits will come by itself.”

The trader has 4 losing trades @ 50 pips = (-) 200 pips.

Trading is a business of probabilities and you are in control only until the moment of the entry. Afterward, the market dictates where the price will go. You cannot control

The trader has 6 winning trades @ 100 pips = (+) 600 pips.

Management, would take up 5 parts. Mind – which is the discipline and patience of a trader to follow a plan, would take up 3 parts. Method - which is the technical analysis, would take up only 2 parts. Unfortunately since trading plans are prepared entirely from the charts, we tend to concentrate only on the Method part, ignoring the Money and Mind. But unless all of the 3 M’s are taken into account, a trader has a small chance of success. Looking at the most important factor of money management – let me repeat a few points from a previous article “Trading with Stops.”

Looking at the mathematics:

Net result after 10 trades = (+) 400 pips.

“What you can control is minimizing losses and protecting gains through a welldefined money management strategy.”

THE FIRST PRIORITY OF A TRADER IS TO CONSERVE THE CAPITAL.

The trader’s capital is his bloodline. Without it, one cannot trade, so preserving it becomes a matter of utmost importance. It is only natural that when we take a trade, we tend to focus on potential profits rather than dwell on possible losses. We are usually so convinced that the trade will be profitable that we tend to ignore the possible losses that would occur should the trade go wrong. One must accept that losses in trading are inevitable, but a successful trader is one who manages and controls these losses. Therefore a trader must have a money management policy, which is nothing but a set of techniques that help minimize the

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this, just like you cannot control with 100% certainty, the amount of profit (or loss) that will result. But what you can control is minimizing losses and protecting gains through a welldefined money management strategy. A sound ‘Money Management’ policy is based on 2 simple concepts:

• A correct Risk-to-Reward ratio. • Correct Position sizing, where the “Position sizing” simply means the amount of capital that a trader should risk on any trade. Risk-to-Reward ratio – One must always keep the Risk- to-Reward ratio at a minimum of (1 to 2) and above. Let’s use simple mathematics to understand the concept of the RR ratios. First and foremost, one must accept that losses are a part of trading and one will have losing trades.

Conclusion – a trader can achieve gains in the account, even after getting 4 losing trades out of 10.

Now, try changing the RR ratio to 1 to 1, and look at the results. This drastically reduces the gains in the account. And if we reduce the RR ratio to less than 1 to 1, then we get negative results. At the end of 10 trades, if I do not get sizable gains in my account, I would be simply wasting my time. To achieve a worthwhile increase in the capital (after spending the time and effort) one must maintain the correct RR ratio. Unfortunately, most traders ignore this simple fact. POSITION SIZING.

The Golden rule for the ideal “position sizing” is never risk more than 2% of your trading capital at any time. Very few traders and investors realize the importance of balanced position sizing. Traders often make the mistake of ignoring the size of their trading account when taking on new positions. As a result, many unknowingly join the ranks of high-risk over-traders, and soon find themselves in big trouble.

TEXT SUNIL MANGWANI

Position sizing protects you by limiting the amount of capital, when you are the most vulnerable. This reduces the total amount of loss. Position Size Formula

The correct position size can be determined by a mathematical formula – Position size (for a standard account) PS = (E / 2500) – 1. Where E is the account equity. Position size (for a mini account) PS = (E / 500) – 1. Where E is the account equity.

The position size is entirely dependent on the account equity, thus underlying the importance of an account being well capitalized. The correct position sizing is often a combination of the correct “Risk Management” and “Money Management.” RISK MANAGEMENT:

• Make sure you are well capitalized. This is not a business for those who are not. The only way to win at trading is to have larger and more positions when you are right and less positions when you are wrong. • Maintaining the same number of lots for each trade reduces the profitability of a trade. • Varying lot sizes is the MOST impor-

tant thing you must do, if you want to be successful. MONEY MANAGEMENT:

∑ • Never let a winner become a loser. • Adjust your stops as the market moves with you. Let us have a look at a trade example, which was taken and managed by incorporating these aspects. The 1-2-3 chart pattern is one of the most effective and simple trading patterns. It is the nature of price to move in waves, forming this pattern on a pullback. This pattern is also a very strong indication of a change of trend. The advantage of this pattern is that we can define the entry,

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T R A D I N G SY S T E M D E V E LO P M E N T

stop and exit levels precisely, enabling the trade to be effectively managed. Let us have a look at a bullish 123 pattern, which we identified on the GBP/USD on the 1hour time frame. First, define the entry, stop and exit levels of this expected trade, so we can define our money management rules.

e use Fibonacci ratios for this purpose, and the Fibonacci Expansions are ideal for the 1-2-3 pattern. We use this Fibonacci ratio to determine the entry, exit and stop levels.

MONEY MANAGEMENT

Entry at 1.6455 and price target at 1.6699 = Reward of 244 pips. The Risk-to-Reward ratio for this trade works out to (1 to 3) This is acceptable and we can take this trade. (If we do not get a RR ratio of (1 to 2), we simply do not take the trade.)

Assume that we are trading a mini account with a capital of USD 5000. As per the position size formula PS = (E / 500) – 1.

To keep the maximum capital exposure to 2%, we can trade with only 1 mini-lot.

The Position Size for this trade = (5000 / 500) – 1 = 9.

Once again, this puts us at a disadvantage, since we cannot manage our trades efficiently with only one lot.

“Only if one milks a trade of all possible profits, can one have an edge in the money management plan.”

Now that we have precisely defined the trade levels, let's check if this trade fits into the principles of money management.

(I have put this formula in an Excel sheet where it automatically calculates the correct position size when the capital amount is entered, making it easier to calculate)

The Risk-to-Reward Ratio

Entry at 1.6455 and stop loss level at 1.6375 = Risk of 80 pips.

Trading with 9 mini lots at a stop loss level of 80 pips puts our entire risk at 720 pips. On a mini account, this equates to USD 720. This risk of USD 720 on a capital of USD 5000 works out to 14.40%. This is outside the money management rules and is not acceptable.

Position size

Entry – at the break of

the FE 23.6 level at 1.6455 Stop – just below the point 3 of the pattern (or the FE 00.0 level) at 1.6375 Exit – the FE 100.00 level at 1.6699

But we will also be following the rule of not exposing more than 2% of the entire capital at any given time.

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We can trade a maximum of 9 mini lots on this trade.

Ideally, one should trade with multiple lots to take profits from the trade and use trailing stops to remain in the trade should price go further.

We can see that with trade parameters of this size, one should have a capital of at least USD 10,000 to allow trading with 2 lots. Let’s enter the trade with 2 mini lots (assuming we have a capital of USD 10,000) and devise our trading plan around that.

TEXT SUNIL MANGWANI

Now, we have our position size and money management rules precisely defined in our trading plan and manage the trade, based on the risk management principles. One should lock in some profits when price reaches the first technical level. In this case the 61.8 expansion level coincides with the swing high of point 2, and this would be a good place to lock in some profits. We use this as the profit Target.1, and close 1 lot at this Fib level (1.6577).

just as simple as that. It is not a requirement to trade every set up and there will be more opportunities. The final “Trade Plan” is always the trader’s personal decision, based on the risk factor, amount of capital available and amount of profit that the trader is looking for. It is really a question of juggling various factors to get the correct system....but hey, nobody said that trading is easy.

Sunil Mangwani has been trading the Forex market since the last 9 years and specializes in using the Fibonacci ratios and Harmonic Patterns for analyzing price movement. With his vast knowledge and in-depth study in the field of technical analysis, he devises effective trading systems using the principles of 3M’ – Money, Mind & Method.

Trading must be treated like a business. ∑ At this stage, we shift the stop to our entry level. Now, we have locked in a profit. Since we have shifted our stop to the entry level, we are at a no-risk situation. Even if price reverses for some reason, we have walked away with this profit. ∑ Now we have the second lot running for the Profit Target.2 at Fib level of FE 100.0. We close the second lot when price achieves this target. We have managed the trade as per the rules laid down in our trading plan. Only if one milks a trade of all possible profits, can one have an edge in the money management plan. This simply means that one must have a definite plan before one enters a trade. When making a trading plan, remember to plan not only for the upside, but the downside too. The successful traders are the ones who are well prepared for all the possibilities before entering a trade.

Like everything in life, you have to visualize what you want to accomplish before you can get there. With the proper planning there are very few surprises. You will not get rich overnight, but you will be able to get there. Many have done it. TFJ

He has worked as content provider and article writer with different websites and has been regularly contributing technical articles to different magazines like “Traders” and “The Trading-Journal.” In his years of trading and his vast experience of teaching technical analysis, he realized that applying technical analysis is not enough to be a successful trader. One can be successful in this exciting, fulfilling and yet demanding business, if and only if, one has a definite plan on how to approach the market. If a trader has an iron clad “Trading Plan” with the 3M’s, it automatically puts the trader into the top 15% bracket of the winners. He conducts special coaching for developing specific trade plans at www.fibforex123.com. His vast repertoire of services on this website includes a ‘Live Trading room,’ ‘Personal mentorship’ and ‘Modules on trading techniques.’ He can be contacted at shellcon@eth.net and sunil@fibforex123.com For more information, visit www.fibforex123.com

LET ME END WITH SOME PRACTICAL TRADING TIPS:

∑ If you want to trade one standard lot, I would recommend dividing it into 3 mini lots. This gives you the flexibility to take profits at different stages, and thus protect your capital. ∑ One must be sufficiently capitalized. Under capitalization puts you at a disadvantage and you cannot manage your trades effectively. (The above-mentioned example simply shows this fact.) ∑ If a trade does not fit within the rules of money management, do not take it. It is

Avoid the teeth but enjoy your meal...

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CURRENCY FORECAST

MARKET OUTLOOK

Our regular contributor, Dar Wong, provides his monthly forecast for major currency pairs.

Monthly Currency Forecast

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TEXT DAR WONG

OUTLOOK FOR USD/JPY The U.S. economy expanded moderately in the last quarter as consumer spending rose with rising manufacturing output. The housing slump stopped and buyers started to grab homes by taking advantage of the tax incentives combined with affordable prices. The American Non-Farm job report, released in the first week of December, indicated that November jobs fell by 11,000 workers. This is less than the median forecast. The jobless rate declined and held at 10 percent. Another report showed that consumer credit declined in October by USD 3.51 billion, or at a 1.7 percent annual rate, signalling an easing in household spending and an increase in confidence. The U.S. factory orders in October increased 0.6 percent. The Institute for Supply Management-Chicago (ISM) Inc. said its business index rose to 56.1 in November from 54.2, the highest level since August 2008.

tenth time and fell 25.7 percent in the three months ending September 30 from a year earlier. Machinery orders declined 4.5 percent in October. A separate report on producer prices fell for an eleventh month in November, declining 4.9 percent from a year earlier, rekindling concerns of deflation. Japanâ&#x20AC;&#x2122;s Gross Domestic Product (GDP) rose in the third quarter at an annualized 1.3 percent, which was slower than the initial estimate of 4.8 percent. Consumer spending climbed 0.9 percent while exports increased 6.5 percent from the second quarter. From a technical analysis viewpoint, USD/JPY rebounded very quickly from the recent bottom at 84.81 due to both fundamental intervention and a strong technical reversal. In our opinion, this market is very much dependent on the economic performance of Japan in the first quarter. Theoretically, continued weakening of Japanâ&#x20AC;&#x2122;s economy will push

SOURCE NETDANIA (2009)

USD/JPY as of December 11, 2009

nother positive figure reported in December was an unexpected narrowing in the U.S. trade deficit. A weaker dollar and the global stimulus programs have created offshore demand for exports for a sixth consecutive month. The U.S. Commerce Department said the trade gap shrank 7.6 percent to USD 32.9 billion from a revised USD 35.7 billion in September. In Japan, corporations cut spending at a record pace in the third quarter due to the continued impact of the global recession. Capital spending excluding software purchases declined for the

the USD/JPY rate down. On the other hand, the release of bad news from other emerging markets or market intervention by the Bank of Japan (BOJ) will initiate an instant flight into the dollar. From the technical outlook, we foresee a consolidation in the 86.00 â&#x20AC;&#x201C; 87.00 region. If the aforementioned bottom can be guarded, it is a possibility for the market to thread above 90.00 in January. In fact, we expect a retracement in the first quarter to around 95.00 before the progressive sell-off continues perhaps throughout the whole year! Abandon long positions if the market breaks below the bench-

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CURRENCY FORECAST

MARKET OUTLOOK

SOURCE NETDANIA (2009)

EUR/USD as of December 11, 2009

mark support at 84.50. This could be possible if Japan continues to see red numbers and exports deteriorate in the first quarter.

OUTLOOK FOR EUR/USD

uropean confidence in the economic outlook improved in November to the highest level of the last year. The overall economic strength of the 16-nations has shown a potential recovery from the global crisis. An index for executive and consumer sentiment rose for an eighth straight month in November to 88.8 from previous reading of 86.1. London-based Markit Economics said the European manufacturing index rose to 51.2 from 50.7 in October. In November, another report that measures Europe’s service and manufacturing industries expanded to 53.7 from its previous reading of 53, the largest increase in over two years. As the largest economy in the Eurozone, Germany’s November unemployment fell a seasonally adjusted 7,000 with a decline of 8.1 percent. Factory orders unexpectedly fell for the first time in eight months in October, led by a decline in export demand, dropping 2.1 percent from September, when they rose 1.3 percent (above).

trade from the high side of 1.5000 in January but trade progressively lower. As we expect the dollar to be window-dressed in the first quarter of the year, there is a possibility for the market to trade down to 1.4200 sometime in the second quarter based on the analysis of the proprietary concepts of PowerWave TradingTM structure. The market needs to violate the strong support zone at 1.4600 in the near future before our projection can be realized. After midyear, we still maintain a bullish trend in EUR/USD for long-term portfolio appreciation if the U.S. economy continues to weaken, while Eurozone may expand its credit tightening.

OUTLOOK FOR GBP/USD The United Kingdom services index reported at 56.6 by Chartered Institute of Purchasing and Supply (CIPS) in November, compared with 56.9 in the previous month. The British consumer sentiment recorded at 73, unchanged from October, and may help pull the economy recovery through the year-end. Gross Domestic Product (GDP) declined 0.3 percent in the third quarter, less than previously estimated, as manufacturing and services contracted less than initial figures (above, opposite page).

Technically, we have abandoned the northern trend that we previously had predicted. In fact, the trend cycle halted at the recent high of 1.5144 and began to correct. We foresee a continued digestion that will last for the coming few months before the bull market resumes.

Released in December, approvals for housing loans reached 55,000 in October, the highest level since December 2007, making an up turn amid the housing slump. The number of property buyers increased about 140% when compared to 23,000 loans advanced in January 2009.

On the release of news relating to Dubai’s financial woes, the EUR/USD declined heavily. We expect the market to retrace up and

Central bank policymakers assured the continuity of the assetpurchase-program financed with 200 billion pounds. Completion

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TEXT DAR WONG

SOURCE NETDANIA (2009)

GBP/USD as of December 11, 2009

of this stimulus program is expected in two months’ time with liquidity circulating in the markets. Technically, we have also abandoned the northern trend targeting 1.7700 for the time due to the expiration of the market time cycle. According to my latest research, GBP/USD should head progressively lower into the first quarter just like the EUR/USD. From our studies, we have identified a consolidation phase that will possibly form in January at about 1.6700. If this resistance can hold, we expect a continued decline will initiate. In the hindsight, we have projected the market to probably reach 1.5000 in the second quarter. Our potential exit targets are set at S1 – 1.5800, S2 – 1.5400 and S3 – 1.5000 respectively. TFJ

Dar Wong has 20 years of experience in trading global derivatives and the Forex markets. His past employment in the financial industry involved Bank of America, Bankers Trust, Barclays ZW and as a senior floor trader with S.B. Shearson (Citigroup). Currently, he is a book author and writes for The Borneo Post and financial magazines. He also functions as a hedge advisor, coach and seminar speaker and manages his own personal account. Using his PowerWave Trading™ concept developed since 1998, Dar has groomed many retail and corporate traders to become financially successful in leveraged trading. You may read his Forex weekly report by visiting www.pwforex.com

“In Japan, corporations cut spending at a record pace in the third quarter due to the continued impact of the global recession.”

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C U R R E N CY T R A D I N G

MARKET OUTLOOK

George Clement looks at each of seven major currency pairs and makes a fundamental and technical case for the direction of each in 2010.

A CONTRARIAN VIEW OF THE DOLLAR 2010 2009 saw everything on the investment world‘s menu. First, there was fear of depression and deflation. Then, stock markets made a U-turn, pointing to an economic development far better than most of the prophesies. The dollar recovered in the first quarter; later, inflation sorrows emerged again. The dollar lost considerable territory in the wake of these considerations. Then, as if the stock market would like inflation – the contrary is true – rose so much this year that there is talk of a frothy stock market, even the word "bubble" appears in outlooks. Obviously, we cannot shake off the impressive bubbles of the past 15 years, even as each one of them burst. We are accustomed to "irrational exuberance," not only in the financial world – take a long look at professional sports. That is what the majority expects – continued forming of exaggerations in the investment world, including Forex. Since what the majority expects is later proven to be wrong, it is only prudent to consider different aspects. What if the economy keeps growing, as the stock markets are promising and inflation stays at digestible low levels? There are examples for phases like this. Between 1880 and 1910, England and the U.S. went through a similar period. Again, the same picture after 1950 to the end of the 1960s. Both times emerged after a big monetary and fiscal expansion, precisely at the start characterized by great unsecurity in the business and political world.

No More BubBles

These are only two examples. But they illustrate that economic growth without spiralling inflation is possible, even after the enormous global fiscal and monetary expansion seen this year. Different developments moving in unison are necessary to ignite a secular inflation phase, like the one emerging from 1970 through 1980. For instance, the labor market is still moderate and commodities left their price hikes, a different story to the circumstances in the seventies. These developments are being neglected right now. The only hint to inflation is the mammoth monetary expansion, but the formula for inflation is defined as "monetary supply multiplied by increased money circulation." This makes sense – what would you be doing with more money if you are only stuffing your mattress with it? The old rule should still apply, even though it went out of fashion for economists who state that the financial world today is different. Much quicker money flows are seen as a reason, due in part to new technology as well as a huge derivative market. So monetary expansion or contraction is what is being observed, and by some only M1, the nearest monetary size. But have a look at the banks’ behavior – instead

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TEXT GEORGE CLEMENT

of conveying the central banks‘ low cost debt to their customers, they are stifling credit demand with restrictive rates and rules. This is their typical behavior in bad times and has stayed the same as long as money has existed. Why alter an old economic rule if not even those institutions who are deeply involved in the works change their stance? Deflation is not likely anymore, although some commentators have begun to anticipate it once again, comparing the U.S. to the state of Japan at the end of the nineties. This is a little like comparing apples with oranges. First, Japan sports a completely different culture and always has had a knack for saving, not for spending binges. Second, the deep tandem involvement of manufacturing and the financial sector has led to an encrusted business structure, giving resilience little chance. Finally, the banking industry is still far off the flexibility of western banks with America ranking at the top of that list. But things are about to enter a completely different scene. For instance, more calls for financial regulation. A thing the writer does not like, but probably a phenomenon of a new age without bubbles. Believe it or not, even the U.S. Federal Reserve is in the crossfire of Congress. The House Financial committee has already approved historical changes towards regulation by putting a yoke on the Federal Reserve. If the Senate’s corresponding committee approves the same (it has plans to curtail the Fed’s activities, too), it would mean the Federal Reserve could lose the monopoly to determine money supply and give loans to banks, since it has to report its activities to the GAO (Govenment Accountability Office) in such a case. A "yea" by Congress would mean the Fed loses one of its last pieces of political independence. Here the pendulum swings too

far on the wrong side, led partly by populist motives of politicians – banks have lost a lot of public support in these times. But again, it is probably the new age knocking on the door. John Maynard Keynes' views of the economic world, fancied in his day, out of fashion for a long time thereafter, are making their comeback, by the way, on bookshelves and in discussion forums (chart 1).

aving said all of this, after a turbulent year, which has seen the banking industry tumble, calling for and given shelter by the State, a more moderate development is likely to set in in 2010, for the financial world and for Forex especially. True, the twin deficits (or even triple if you count the Fed, sticking its neck out to help), will probably be hard to tackle in the coming years. Most of the market participants reckon with a weaker dollar for next year. But deficits do not stay forever, and chances for an overall improvement of the global economy are growing. Technically speaking, a look at Chart 1 of the tradeweighted Dollar Index above confirms the mentioned negative stance – the long-term picture shows an intact, several times confirmed, downtrend of the U.S. dollar. Recoveries within this downtrend can be expected, but not above the trend line. Chart buffs used to hold tight to a trend, "which is your friend." But only until it is broken and is oversold, others say, being fundamentalists, who prefer to observe the fundamental development to see what really happens, not even paying attention to what the central banks are saying. If we have a close look at the economic development, not only in the U.S., we come to the conclusion that the recession of 2008 and 2009 would go down history lane as a U-turn or almost V-recovery. Compare that to the W recovery, also possible, like 1980 to 1984, but that occurred in another macro-economic world, nota bene.

Chart 1: Long-Term Dollar Index, Weekly

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he baffling thing after these developments is the state of expectations, reflected in all sorts of financial instruments. Some developments remain a mystery. For instance, commodity prices and precious metals have risen and are widely expected to rise further, giving more arguing fodder to the doomsayers of inflation. But stock markets have risen as well and keep rising in the same time, although a price-inflationary development is extremely hated by these and bond markets alike. Either the stock market is wrong and will experience some bigger down correction or the bull market in commodities (including precious metals) has seen its highs. The latter is more likely. A good example that expectations here could turn sour are the headlines of newspapers and magazines. When a certain move in the financial world was impressive and making its way to the headlines, like now with gold, the main impetus of the movement is about to end. One may call that a simplistic view, but that has happened in the past over and over with all sorts of investments. Remember the nowadays shunned expression, "New World Order," of the 1990s? A wise man commented, "First it is not new, and second it is no order." Apropos gold: "Gold has had its days, but they are over. Its worth is only industrially defined in coming times, as for other precious metals." These words witnessed the gold price at well below $300 per ounce at price levels when even central banks got rid of the stuff. Shortly after that, a new phrase was invented as an explanation for the price inflation losing more and more steam and the stock market remaining positive. "The Great Moderation," the phase beginning after 1985 was then widely discussed, meaning the goodby to turbulent times before 1980 and looking ahead to prosperous times. Only a few observers saw that phase paving the way to other exaggerations, incubating an ever-increased bubble, that burst

Chart 2 : EUR/USD, Long-Term Weekly

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dangerously at the end. That certainly was a near knockout, demanding huge effort to stay upright. The facts based on technical and fundamental conclusions speak for a weaker dollar longer term, even from present low levels, a contrary development is more likely to set in during 2010. First, the technical analyst's view does not consider the long-term heavily oversold situation of the U.S. dollar. In other words, the market appears to soon be outbombed on the downside (see Chart 1, previous page). Second, provided that moderate economic growth can be sustained characterized by inflation under control, the negative factors around the dollar will vanish eventually, leaving room to quite a substantial recovery starting mid-2010. By then, the inverse correlation of the U.S. currency with the stock markets in the face of harder facts than reflecting a future development would disappear. Later in the year, a longer consolidation phase for the dollar could set in, but on higher levels first, by ending the year about 30% higher against its trading partners. Let us peek deeper into 2010 for the major currency's development by distinguishing the market between commodity pricerelated currencies and the others. Here the euro, heavily overpriced if one considers the purchasing power parity against the U.S. dollar is a centerpiece. The correct price for the euro should be at 1.20 and below, not 1.60 and above. The pound is overpriced as well, but not as much as the euro, most likely losing its high volatility style next year and more or less following the U.S. dollar sideways trend for 2010, see-sawing longer term in slow moves between current prices and 1.45. While the Swiss franc is likely to follow its big brother, the euro. The yen is a completely different story. A real deflation currency example

TEXT GEORGE CLEMENT

for now, it will keep the scent of being strong, an expectation that could vanish in 2010 when Japan could make a new start by reinflating at last, followed by considerably better economic growth than is expected now. The yen also will lose territory against the dollar. Prices in USD/JPY towards the 1.0000 level are in the cards. Based on the outlook for commodities, which speak for prices around present levels in view of increased supply but still good demand, the related currencies are subject to slowly losing their attraction in 2010. Lower prices for the Australian dollar and New Zealand dollar against the U.S. dollar, but still about the same against the crossings are likely.

irst would be the New Zealand dollar already in a sideways trend for a longer term, followed by the Australian dollar still in an uptrend but most likely losing steam. Af course, the CAD/USD, heading already towards the levels where it belongs against the neighboring U.S. dollar, above 1.0000, and then back to at least around 1.1500

The comments below describe the different movements so far by chart-technical and fundamental analysis of the EUR, GBP, CHF, JPY, then by commodity-related CAD, AUD, NZD. IN CHART 2, EUR/USD, LONG-TERM WEEKLY: Fundamental – A euro at or below 1.20 against the dollar seems

a more realistic level, not only in the face of probably waxing debt woes in the currency's zone, but measured by purchasing power parity as well. These being longer-term considerations, the ample money supply and resulting low short-term interest rates are not exactly supporting factors for the euro. Conclusion – Lower euro in 2010 against the dollar.

Technical – Dominated by a several times confirmed uptrend, the conclusion seems to be simple: stick to that uptrend. But look twice – a massive overhead supply will limit further upmoves, taking the steam off the upswing. Then observe the clearly long-term overbought situation, i.e. the market had too much thrust. Conclusion – A trend change is in the cards. IN CHART 3, THE GBP/USD, LONG-TERM WEEKLY: Fundamental – Although the economy is on a slight recovery

move, the home-made factors in Britain, like some more inflation, the row over the budget and the elections next year, create uncertainty about the currency's development, illustrated by the repeated selling tone in the pound. Conclusion – A lower trading bandwidth against the U.S. dollar. Technical – The long-term sideways trend, well-established

between 1.7000 and 1.6000, may continue for a while from where a breakout downwards is in the cards, only to build up a lower consolidation phase. Conclusion – Wider trading range between 1.5000 on the upside and 1.3800 emerging in 2010. IN CHART 4, THE USD/CHF, LONG-TERM WEEKLY Fundamental – On a smaler scale, the Swiss franc still follows its

big brother euro. No wonder, being its major trading partner and with the Swiss National Bank very keen to mimic the Eurozone's monetary policy – under no circumstances do the Swiss want to repeat former experiences with an overvalued currency, hurting industry badly. Lately there are – yet nothing more than weak – signs of a takeoff against the EUR/USD development, a possibility we have to reckon with in 2010. Conclusion – A stronger market for the USD/CHF in 2010, but not to the extent of EUR/USD. Technical – The prolonged downtrend in the pair shows an early bottoming process, scratching the upside of the downtrend line.

Chart 3 : GBP/USD, Long-Term Weekly

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Chart 4 : USD/CHF, Long-Term Weekly

Heavily oversold now, the market is "bombed out" at the downside. Although there is much overhead supply to be overwhelmed first, stronger action have to be taken into account. Conclusion – Upmoves for 2010, followed by a longer consolidation between 1.1000 and 1.06000.

market observers, although more of these steps are to follow. A recovering economy should finally do the trick to remove the yoke of deflation. Conclusion – A weaker yen in 2010, giving the USD/JPY market a boost. Technical – The otherwise well-established downtrend in USD/JPY

CHART 5 : USD/JPY, LONG-TERM WEEKLY Fundamental – The present main theme, a stubbornly sticking

deflation development, resulting in a strong yen, may fade in 2010. The Bank of Japan is taking definite steps by increasing all means of quantitative methods to reinflate the economy. Not enough, say

Chart 5 : USD/JPY, Long-Term Weekly

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is meeting stark support now. This combined with the heavily oversold situation make room for recovery moves toward the 1.0000 mark, a long-term resistance area. Conclusion – A new trading range for 2010 between 1.0000 and 98.00. Later in the year, even the 1.0000 mark may be broken by further upside moves.

TEXT GEORGE CLEMENT

Chart 6 : USD/CAD, Long-Term Weekly

IN CHART 6, THE USD/CAD, LONG-TERM WEEKLY: Fundamental – Canada‘s economy, a large chunk of it dominated

by natural resource exports to the United States enjoys now a better outlook for the coming year. It might be modest though, since the other part of the economy depends on the still somewhat depressed service industry. The central bank is keeping interest rates low, following an expanding monetary policy. The currency's relation with commodity prices, a boon so far, will continue. There are probably no more further rises in raw materials to set in, with demand to remain but increasing supply. Conclusion – A weaker development in the USD/CAD market.

Technical – The downtrend broke its line to the upside now, still losing selling momentum. This and the fact of an oversold market on support levels should lead to a higher-priced market in 2010, heading towards 1.2000. IN CHART 7, THE AUD/USD, LONG-TERM WEEKLY: Fundamental – The Australian central bank is one of the few insti-

tutions raising interest rates slowly. Nourishing a tight trade relationship with China, Australia's economy is well on track, with rising inflation expectations, too. Real interest rates would not sup-

Chart 7 : AUD/USD, Long-Term Weekly

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Chart 8: NZD/USD, Long-Term Weekly

port the currency, still under the influence of commodity price development only stabilizing on lower levels. Conclusion – A lower Australian dollar against the dollar for 2010. Technical – Reaching its limits at the 0.9500 level, characterized as stark resistance, the Australian dollar is losing upward momentum, scratching at the downside of the uptrend line. Beyond that the market is long-term outright oversold, rife for a downmove. Conclusion – Support testing at lower levels will be the theme for 2010, first around 0.8700, then 0.8500. CHART 8 : NZD/USD, LONG-TERM WEEKLY Fundamental – Australia's smaller brother differs only in land-

scape and the heavier dependence on agriculture, but the economy is still profiting from the positive ripple effects extending the influence of China over Australia. The outlook for the New Zealand dollar is more or less characterized by the same facts as valid for Australia, with the exception of overall agriculture prices, which halted their rise earlier than other raw material markets. Conclusion – A declining New Zealand dollar (against the Australian dollar, too) for 2010. Technical – The New Zealand dollar already broke its upward trend against the U.S.dollar from overbought levels, pointing to a further extension of the young downtrend. Conclusion – Levels around 0.6400 could be reached in 2010.

George Clement, Swiss e Trade, founded 1999 and located in Zurich/Switzerland. Specialists in electronic trading of Forex and CFD‘s. Alfred Escherstrasse 26, 8002 Zurich, phone +41 44 206 10 60, www.swissetrade.com

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There are reasons why the dollar can finish the year lower or finish the year higher and 2010 may offer many seesaw opportunities.

20 10 U Ou .S tlo . D ok oll ar

Ian Naismith discusses developing market models that incorporated various indicators or use single indicators that provide consistent positive results most of the time.

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THE ENVIRONMENT FOR THE U.S. DOLLAR IN 2010 MIGHT OFFER ONE OF THE MOST SEESAW OPPORTUNITIES IN RECENT YEARS.

isted below are reasons why the dollar can finish the year lower or finish the year higher. The important element to remember is that the likelihood of increased volatility compared to most years, (including 2009) will present technical trading opportunities that could give positive results regardless of how the U.S. dollar finishes for 2010. In our mutual fund, The Currency Strategies Fund (Ticker: FOREX), we try to capture return ranges of different G-10 currencies, emerging market currencies, gold, and the Dollar Index. We concentrate on capturing ranges of cycles and limiting drawdown through hedging techniques. We cannot ignore the daily reminder in the news or on the charts – the Dollar Index is within 8% of its all time low going into the end of 2009.

However, the banks did not lend the money – they just bought more Treasuries, which prettied their balance sheets. The result of all this money shifting around is the Treasury incurred about a trillion dollars more in debt in about 3-months, the Federal Reserve absorbed the toxic assets and the banks won. The trend in 2009 has been a thumbs’ up approach to record deficit spending. When coupled with more expensive future questionable changes, it challenges a sustained recovery in the economy that may require holding the lid down on low interest rates and more printing of the greenback. This presents an “obvious” problem going forward for the value of the U.S. dollar.

“In Japan, corporations cut spending at a record pace in the third quarter due to the continued impact of the global recession.”

The fiscal policy changes that were enacted in 2008 to prevent financial system devastation, or what many considered an impending depression have led to financial projections into the future from the Federal Open Market Committee that will challenge the value of the dollar through 2010 and beyond. A major factor of the decline of the Dollar Index is the ascension of the euro relative to the U.S. dollar (the euro makes up 57.6% of the Dollar Index) of almost 30% in the last 11 years. Looking at monthly chart paints the story quite clearly – with the exception of its poor showing in 2005 (with a maximum annual drawdown of less than 15%), the euro rallied against the dollar quite handily from its introduction to circulation in January of 2002 until the sudden reaction in September, 2008, of a baked-in financial crisis that had been brewing for years. Going into 2010, there is a stew of broadly conflicting trends that are colliding due to the uncharted waters that can either continue the dollar decline or its rise – it will be a real tug-of-war. In our office, we “feel” the U.S. dollar has a hard road long into the future, as we are technically driven, we choose not to inject our feelings into trading and money management.

The enormity of the recent financial policy changes is directly related to additional corrective policies in 2010 if the experiment does work or, possibly, more “stimulus” if the first economic stimulus proves to run out of steam. It could run out of steam because the original reason for the stimulus seems to be compromised. In a nutshell, the Treasury borrowed U.S. dollars through the sale of Treasury notes and deposited the money at the Federal Reserve. Then, the Fed used the money to help the banks reduce toxic liabilities.

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Since we are in the midst of watching the banks and Federal Reserve create “Financial Frankenstein,” it is unclear if the last 9-month rebound of the successful anti-U.S. dollar trade will stick through 2010.

Despite the fact that the dollar has been waving red flags warning us of the out of control United States debt, continued buying of foreign currencies and commodities, and widening trade deficits, the dollar has a few arrows left in its quiver before the red flags are replaced with a white flag. First, the other “obvious” side of the coin was the concurrent and absolute retreat to the U.S. dollar and Japanese yen when the financial collapse began showing itself in the latter part of the 3rd quarter of 2008. A marked decline in equities in 2010 would force liquidation of risk assets, which are currently a popular financing engine, and the short U.S. dollar would enjoy a broad buy-back. There could be a lock-in of profits in 2010 because of the incredible rally that has occurred since March 2009. In addition, in the near future, there is potential that an underestimated negative financial after-shock could happen that forces the world to again embrace the U.S. dollar as a safe haven. It is hard to fathom that the sheer size and speed of financial engineering that took place last year would not echo an aftershock of some level – ever. Another potential nudge for the dollar is the reaction the Federal Reserve might have when inflation arrives at the party. If the markets continue to benefit through 2010 due to

TEXT IAN NAISMITH

the stimulus programs enacted and the credit markets continue to stabilize, the specter of inflation will appear and likely cause selling pressure on U.S. Treasuries that has not been seen since the interest rate decrease. Understandably, central banks continue to dump the U.S. dollar in favor of stronger currencies. Due to a world shift of demographics and the strengthening of emerging markets, this diversification is expected to continue indefinitely. However, in 2010, the trend of central banks’ move away from the dollar may have a temporary reversal, due to the Federal Reserve raising interest rates. If there is a tightening of the current interest rate differentials between the U.S. dollar and other global currencies, especially the euro – it could spark a rally in the dollar due to the potential toppling of its current status of being the currency of choice for the carry trade. Again, we believe that it makes sense to prepare for the likely increase in global currency volatility for 2010 as many of these events converge. Below is the depth of opportunity presented on a calendar basis for the US Dollar Index. This illustrates that whether the dollar resurges or not in 2010, if you are diligent with adhering to your technical discipline, you can have a good year regardless of the dollar's direction. Keep in mind, the drawdown and run up percentages, on average, tend to be higher for single currency pairs to the U.S. dollar – thus presenting wider opportunities for capturing ranges. US Dollar Index calendar year results:

creation, following through and managing risk. At the very least, a good trader should have a few models to track each pair. Many times, a single model or indicator, whether momentum or contrarian-based can produce good results for several months, even years before it stops working. It is important to track how each model and/or indicator is doing relative to others for at most the last 50 rolling trading days, and use the ones that are producing the best results consistently. Determine what is acceptable with returns and volatility relative to each pair. As an example, if one model is producing a positive 1.1 times the prevailing buy and hold return, but is also 1.5 times more volatile than buy and hold, and, it is producing anxiety, find a happy medium between return and volatility. If there are enough tracking models in your arsenal, you can increase your chances of capturing the range of each side of the trade consistently over an extended period of time. When constructing models or using indicators, try to be creative. Many popular indicators used by Forex traders are potent in measurable periods of time. The most common I hear about are pivot points, moving averages, Bollinger bands, Fibonacci, Average True Range, etc. Use modifications of different indicators and place them with one another. T he comparison and construction possibilities are literally endless. I have dug up a few home grown models out of our technical arsenal that use modifications of popular indicators. The first example is an independent model using 2 different compressed moving averages. The second is an independent model using “conjoined” Bollinger bands. The third example demonstrates the flow of the models. The fourth example demonstrates the return potential when dynamically tracking concurrent models and choosing the superior model.

f course, this “perfect trader” only did 2 trades per year at the best entry and exit points long and short the U.S. Dollar Index and grew the portfolio from $100,000 to $857,390. The key is finding entry and exit points that increase your chances of capturing range. The next bit of information concentrates on trading strategies, model

This is an example of being creative with 2 different moving averages trading the U.S. Dollar Index long and short with the intention of correlating with the euro when it is strong against the dollar and vice-versa. It is a weekly chart using a 2-period simple moving average compared to a 2-period Hull moving average. This example is trading at the close of each week, with no intra-week trades.

The formula is Below:

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Chart 1 - SMA & HMA

s you can see above in Chart 1, the goal of capturing the majority of return for each side of the trade as it cycled was successful from the beginning of the equity curve until June 2006. Between June 2006 and August 2008 – the model was not optimal when compared to other models that were tracking in line with the goal. The exiting of this model into others would have increased efficiency and adherence to the goal. Even as this chart sits, it delivered slightly better results with 20% less drawdown and 83% of the volatility than the buy and hold EUR/USD pair. This is an example of imbedding a shorter time frame of one Bollinger band within another Bollinger band. It is measured weekly, with the longer period at 26 weeks with a +2 / -2 Standard Deviation. The embedded Bollinger is a 4-week period with a +2 / -2 Standard Deviation. This example is trading at the close of each week. The formula is:

result as the simple moving average and Hull moving average example. However, there is quite a bit of less volatility and the model is working at times the simple moving average and Hull moving average is not and vice-versa. Here is an overlay of the simple moving average and Hull moving average example, the modified Bollinger example with the EUR/USD and USD/EUR buy and holds. As you can see in Chart 3 – Simple Moving Average-Hull Moving Average with Modified Bollinger Band EUR-USD, USD-EUR, there are periods of time where the simple moving average and Hull moving average or modified Bollinger will track the superior side of the trade. When the 2 models are compared side-by-side, the effect can be dramatic. The next example is using a rolling 8-week look back period choosing the model with the most return. They are com-

26 Wk BOL high band / current price + 26 Wk BOL high band / 4 Wk BOL low band Current price / 26 Wk BOL Low band 4 Wk BOL low band / 26 Wk BOL low band

If the sum is less than 1, it is long the U.S. Dollar Index. If the sum is greater than 1, it is short the U.S. Dollar Index Again, in Chart 2 – Modified Bollinger Band, nearly the same end

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pared on a weekly basis and the portfolio is allocated to the superior model. The portfolio is allocated either to the simple moving average and Hull moving average model or the modified Bollinger. This example is traded at the close of each week.

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Chart 2 – Modified Bollinger Band

Chart 3 – Simple Moving Average-Hull Moving Average with Modified Bollinger Band EUR-USD, USD-EUR

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Chart 4 – Two-model comparison

s you can see in Chart 4 – Two-model comparison, the result did not outperform the “perfect trader,” but it efficiently captured the majority of accumulated gain and shorted during the majority of accumulated loss during each cycle of the U.S. Dollar Index. Compounding with low drawdown is a wonderful thing.

The main point to take from this is – develop models that incorporated various indicators or use single indicators that provide consistent positive results most of the time. Use what works and is easy to execute in your technical arsenal, but make sure to run concurrent evaluations of all of your models/indicators simultaneously to choose which model is being allocated and which ones are not. Follow through with your work. Building technical models takes time and thought – second-guessing and inactivity simply is a confirmation that you do not believe in your own creation.TFJ

Ian Naismith and Anthony Welch co-own Sarasota Capital Strategies, Inc., an SEC Registered Investment Advisor in Osprey, Florida. They co-manage a currency mutual fund - The Currency Strategies Fund (Ticker: FOREX). Both are frequently quoted in most major financial publications and are regular speakers at financial industry conferences. Sarasota Capital Strategies, Inc. is a member of the National Association of Investment Managers (NAAIM), where Naismith serves as Vice-President. Ian Naismith can be reached at ian@etfpros.com or via his website www.thecurrencyfund.net

Restaurants • City Guide • Bars & Nightlife • Shops & Services 56

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TEXT CLAUS VISTESEN

How does it all fit together?

FOREX MARKETS 2010 THE OLD MAID, GLOBAL IMBALANCES AND CARRY TRADE The discussion of global imbalances has many faces, but in the context of Forex and currency markets the focus tends to gravitate towards the need for the U.S. dollar to fall. Claus Vistesen discusses who should pick up the slack if the dollar is to correct to the new global fundamentals.

ld Maid is a card game where the simple task is to avoid holding a given card (usually the Queen of Spades) at the end. Even in the company of good friends however, holding the ‘Old Maid’ at the end is not fun. Often, you have to buy the drinks, drop a piece of clothing or endure other travails.

And as it turns out, the global Forex market is not unlike this good old game of cards where the ‘Old Maid’ is proxied by having a strong currency on whose shoulders the correction of global macroeconomic imbalances must invariably fall. In this way, and although one sometimes gets the feeling that everyone believes that everybody may actually export their way out of their current misery, buying one country’s currency means selling another and

thus, someone (be it an individual economy or a group/basket of economies) must end up holding the ‘Old Maid.’ The discussion of global imbalances has many faces, but in the context of currency fluctuations and Forex markets the focus tends to gravitate towards the need for the U.S. dollar to fall. This was evident before the crisis and still is. If this seems obvious to the most ardent dollar bears and to those who still see a structurally important role for the dollar going forward, it has been far less evident who should pick up the slack if the dollar is to correct to the new global fundamentals. In this way, key emerging economies are still pegging their currency to the green back and in general; while most claim to see the benefit of a strong currency, they do not want it to be their currency.

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The interesting point here for economists and Forex traders alike is that whoever might appear to hold the ‘Old Maid’ today may not hold it tomorrow. In fact, this game will ultimately have to give way for a structurally more lasting setup in which a so far unspecified group of economies will have to face the prospect of doing the heavy lifting in the context of global imbalances. The important point to take home is that while intra-G3 currency moves may seem to suggest otherwise, rebalancing can never occur along this axis. This means that rebalancing must be narrated in relation to big emerging markets where the counterpart to dollar weakness has to come in the form of a basket of economies such as Brazil, India, China, Indonesia, Turkey etc. However, these economies are not happily assuming this role either. If they are not outright fixing their currency to the whims of the U.S. dollar (and thus the Fed’s quantitative easing), they are busy contemplating how to slap capital controls on to stem the flood of money coming in as a result of cheap funding opportunities in U.S. dollar and/or Japanese yen. In short, they do not want the appreciation either. On we go into a market environment driven by the search for yield where any sign that an economy may be able to sustainably offer a higher yield will trigger currency appreciation proxied by capital inflows to high yielding currencies funded by borrowing in low yielding currencies (carry trades). The structural and theoretical factors that underpin such currency movements are important to emphasize even if they are an

Figure 1A – EURIBOR, VIX and Equities

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integral part of currency traders’ vocabulary. In a theoretical sense, we are talking about the non-existence of the uncovered interest rate parity that has come to be known as carry trade fundamentals. These fundamentals specify the well-known correlation between low yielding currencies and risky assets as well as market volatility. Concretely, this is the tendency for low yielding currencies to appreciate in conjunction with a fall in risky assets and an increase in market volatility. Low yielding currencies traditionally have counted the Swiss franc and the Japanese yen and have consequently been known to react on risk sentiment in the market where periods of low risk aversion saw these currencies used as funding currencies in carry trades that would subsequently unwind during periods of above average volatility. With respect to the market, this means that above and beyond safe haven flows towards the G3 in periods of drama, interest differentials matter especially so, expectations of future interest differentials. Moreover, empirical evidence suggests (see e.g. Vistesen (2009) ) that periods in which the difference between low volatility and high volatility periods are large and significant, will also be the periods in which carry trade fundamentals are strongest (even if cross-asset correlations are always subject to notable time variation). Beyond the mechanics of the carry trade, this market feature also raises some fundamental questions about the effectiveness and transmission of global monetary policy Vistesen (2009) and Hugh (2009). To see this, consider the question of where all the liquidity provided by the Bank of Japan, the European Central

TEXT CLAUS VISTESEN

Figure 1B – EURIBOR, VIX and Equities

Bank and the Federal Reserve is actually going. Surely, the aim with such aggressive policies is to mend the domestic economies, but in a world where emerging economies continue to move along at +5% growth rates low policy rates in the G3 act as a sheet anchor for carry trading activity. The flipside to this is the receiving economies where raising rates to quell the inflation that must come on the back of hot money inflows only serves to worsen the problem much to the chagrin of the bankers. Thus, and with a number of central banks stuck near the zero bound, raising rates only intensifies the pressure. This has been abundantly clear in economies such as Brazil, India, New Zealand, Australia, and most importantly in the CEE where many economies actually depegged back in 2008 with respect to the euro because it was believed that the carry flows would lead to nominal appreciation that would choke off inflation. It initially did, but as risk aversion increased the CEE currencies plummeted. This is my view of global capital markets where the globalization of monetary policy drives carry trades to effectively weaken the control with which economies can deploy monetary policy to e.g. fight asset bubbles. It is important to keep this in mind in the points that follow. THE G3 IN 2009 – A RECOVERY IN THE WORKS?

Even if economic activity in the first half of 2009 was heavily affected by the economic turmoil, the second half has seen the bulk of the developed world race back towards positive growth rates and, according to many, a recovery.

Moreover, and in stark contrast to the complete seizure of credit markets and wholesale lending markets that marked the height of the financial crisis in H02-2008, 2009 was the year, starting in the second quarter, that volatility and interbank rates declined to more soothing levels and where risky assets returned to their former buoyancy (figure 1A, previous page, 1B this page).

he question is whether this situation will continue into 2010. This seems to be a precondition for the hopes of a sustained V-shaped recovery. Additionally, currency markets will take much of their direction from this too, since the extent to which carry trades continue to fly will depend a lot on the effect and speed of ”normalization” by part of G3 central banks. In this context, it is paramount to distinguish between transitory and structural factors where the former seem to be the main driver of the upbeat sentiment and recent pickup in economic activity. The main point is that with a very opaque economic outlook, markets may err strongly on the timing and actual moves by central bank as well as on the outlook itself. This is, in part, a natural function of the fact that central banks themselves are not certain of how to play the situation going into 2010. Personally, I am skeptical when it comes to the idea of a sustained recovery. It is important to emphasize that while the global economy, in relation to the Lehman Brothers fallout, may have dodged the initial bullet that would have led to a catastrophe and an immediate cascade of company and sovereign defaults, the

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structural setup has not changed much. Events in Dubai, the ongoing difficulties in Spain, Eastern Europe and most recently the jitters of the Greek sovereign debt are all timely reminders that perhaps, the real crisis that policy makers will be unable to avert lies ahead of us and not behind us. Moving on to major currencies, the big story with respect to G3 flows in 2009 was without a doubt the ongoing weakness of the U.S. dollar versus the euro and Japanese yen that gathered pace as the recovery took hold and especially as financial markets normalized with risky assets shooting for the moon (figure 2, right). In 2009 and using the average daily value between January 2008 and December 2009 as index 100, the U.S. dollar consequently weakened some 8.3% against the euro and 3.4% against the Japanese yen. One thing is the relative measures of weakness and quite another is the levels observed. Consequently, a EUR/ USD at +1.45 and a USD/JPY fluctuating in the 80s are levels where policy makers in Europe and Japan start to grow weary.

G3 FOREX THEMES FOR 2010 – BUY THE ‘OLD MAID’

The immediate answer to the question has to be ‘no.’ After having scanned a vast array of 2010 predictions and analysis from the hands of some of the finest research shops, I am convinced that the market believes that the U.S. dollar will claw back some of its lost ground vis-a-vis the euro and Japanese yen in 2010. Generally, the major theme for G3 Forex markets in 2010 will be central bank policy and specifically the ease and speed with which unconventional monetary policies are withdrawn as well as the lag with which nominal interest rates follow. So far, the three big central banks are assuming their usual roles with the European Central Bank rolling out a rather hawkish discourse on the removal of wholesale bank financing through its Enhanced Credit Support, over to the Federal Reserve promising low interest rates well into 2010 and only gradually speaking of removing quantitative easing and finally on to the Bank of Japan who actually reentered quantitative easing at an emergency meeting in the beginning of December and where we can expect the current rock bottom interest rate level to remain for as a far as the eye can see.

“In a G3 context, 2010 clearly holds the potential for dollar strength, but timing and intensity is going to differ.”

Consider the European Central Bank’s continuing “commitment” to the U.S. authorities’ commitment to a strong dollar policy and the outright hints of intervention by part of the Japanese Ministry of Finance and the Bank of Japan and you get an impression of the kind of small but important skirmishes in an intra G3 context. As ever, holding ’Old Maid’ is fiercely contested. The G3 story of 2009 highlights the big change observed with respect to the role as global carry trade funder. Thus and while the Bank of Japan has been running ‘zero interest rate policy/quantitative easing’ (ZIRP/QE) for the better part of the 21st century and seemed secure as the global carry trade funder, something changed this time around. Consequently, we had the Bank of England, to a lesser extent the European Central Bank, and most importantly the Federal Reserve who have all been forced committing to very low levels of interest rates in order to fight off deflation and to support the restoration of a financial system that has been mortally wounded during the evolving crisis. Especially the Fed’s frontloaded and aggressive policy response seems to have pushed the tables around in a G3 context. Thus, as risky assets began to fly in 2009 and volatility retraced to pre-crisis levels, it was the U.S. economy that benefited, so to speak, from a weak U.S. dollar to become the main funder of global carry trade flows and not the Japanese yen much to the dissatisfaction, no doubt, of Japan who could no longer rely on continuing weak JPY to boost exports as the global economy left the intensive ward.

Going back to the idea of a global game of cards, we can say that 2009 saw the euro and Japan jointly holding ’Old Maid’ relative to the U.S. and the question becomes – will this prevail into 2010?

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This sequential line-up is not consistent with the levels of the G3 crosses moving into 2010 and it would seem a sound call to expect the U.S. dollar to take back some of its loss, most notably the Japanese yen, which looks set to become, yet again, the funding currency of choice. Essentially, the Japanese economy is not only highly dependent on exports to grow; it is also reeling under the yoke of a +2% deflation rate. This means that the Ministry of Finance will likely bully the Bank of Japan into drastic measures in terms of buying government bonds as well as potential intervention. In a context where the U.S. economy moves into whatever form of trend growth it may be able to generate and with the employment situation potentially improving into the first half of 2010, the Federal Reserve may have to change discourse and even the slightest hint from Bernanke that the Fed’s stance is about to change should favor the U.S. dollar. The EUR/USD also looks like a good sell, but the timing should be different according to Societe Generale who sees the EUR/USD gunning for 1.60 in H01 2010. Underpinning this view is a continued rally in risky assets and a cautious Federal Reserve relative to the European Central Bank. So far the

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European Central Bank is looking more hawkish than the Fed, which means that the EUR/USD may continue to enjoy support, but in my opinion this only goes to the unwinding of unconventional measures. On the last European Central Bank meeting, it was worth noting the extent to which Trichet voiced the utmost sensitivity with respect to the economic outlook. In short, talk is preciously cheap in this context and the underlying economic fundamentals strongly favor the U.S. not so much because the U.S. will power ahead, but because major risks loom in Europe with the focus in particular on the fallout from Spain and Greece as well as the ongoing and unresolved mess in big parts of Eastern Europe. It will be very interesting to see whether the European Central Bank maintains the discourse of ”normalization” which will have to entail a view on nominal interest rates sooner or later. Personally, I am very uncertain that we will see the European Central Bank raising rates before the Federal Reserve since it would entail an undue appreciation of the euro not consistent with fundamentals.

In my book, the EUR/USD looks way too high even in the 1.40s. However, we have seen before that this pair may continue to rally, so it is worth treating this one with care. Societe Générale sees dollar weakness sustained (except versus the Japanese yen) well into 2010 and the EUR/USD continuing to drift upwards. I only conditionally agree. Especially, I would emphasize the fact that the risks to the euro, by far, outmatch those to the U.S. dollar currently. In this way, I am less sanguine when it comes to the continuation of the “recovery” and the rally in risky assets. Buying the ‘Old Maid.’ If the rally in risky assets continues into 2010 and beyond, the euro will be holding the ‘Old Maid’ among the G3. If the recovery is stopped in its tracks, it is very likely that it will be from an event conjured in Europe making the U.S. dollar holder of Old Maid. The former looks the most plausible scenario at this point in time with the notable qualifier that the U.S. dollar should strengthen against the Japanese yen. In this way, the Old Maid will shift hands from the Japanese yen to the euro and potentially the U.S. dollar with the outlook for the EUR/USD not easy to call. TFJ

In summary and mixing the market professionals’ call (Societe Générale) with my own, I would emphasize the following; In a G3 context, 2010 clearly holds the potential for dollar strength, but timing and intensity is going to differ. Most major research houses see the USD/JPY as a strong candidate for a correction that could move the pair back in the 100s. I concur with that observation. Whatever speed the U.S. economy will have in 2010, Japan will be the laggard and the Bank of Japan will be dragged kicking and screaming into a full out battery of quantitative easing measures.

Claus Vistesen is a Danish economist who specializes in macroeconomics. He will graduate as MSc in Applied Economics and Finance from the Copenhagen Business School in February 2010 after which he intends to pursue a postgraduate degree in economics. His primary research interests include demographics, macroeconomics and international finance. He can be contacted through his e-mail (clausvistesen@gmail.com) or through his website (clausvistesen.squarespace.com) where you can also find most of his writing.

Figure 2 – G3 Currencies

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MIDDLE EAST

Trends in the Gulf Currencies

On the Eve of the Next Decade... Discussions about the Gulf currencies have become more open and relevant in the aftermath of the global financial crisis and high oil prices. Peter Pontikis discusses the possibilities for the Gulf currencies and the Gulf Cooperation Council.

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TEXT PETER PONTIKIS

iscussions about the Gulf currencies have become more open and relevant in the aftermath of the global financial crisis of last year following the Gulf region’s oil boom-bust and the ‘new’ recovery’s effect in recent weeks on some of the leveraged corporations and public entities in the region. Recently, the most high profile credit event recently has been the requested debt moratorium of Dubai World and its construction arm – Nakheel. This has certainly challenged the credibility and policies of the constituent economic members of the Gulf Cooperation Council (GCC), the European Union equivalent of the region, with the world still jittery after the collapse of Lehman Brothers (though it has been pointed out that Dubai World is only a 10th the size of Lehman and NOT a bank). While certainly focusing the attention of the global investor community on the potential for sovereign and semi-sovereign credit default in the emerging market trade, this regional crisis also posed a focused currency question as to where to now for the Gulf currencies? On the face of it, the region has benefited extraordinarily from the decline the U.S. dollar coupled with sustained record high oil prices filling their national economies and sovereign coffers with significant external account surpluses. Such good news though is not unambiguous. For most of the currencies of the Gulf economies are and remain pegged to the U.S. dollar with only a few exceptions (notably the Kuwaiti dinar shown below).

It has been pointed out in the past that a Gulf regional monetary policy and currency union has only modest immediate economic benefits for Gulf Cooperation Council members. This has been shown by the Council’s self imposed 2010 deadline for a monetary union likely to pass with the Gulf falling short of its stated goals at the start of this decade and new century to create a platform that would have allowed a collective overhaul of the region’s monetary policy regimes – including a move away from the dollar peg as policies in the U.S. and the region have at least in this early post-recovery phase diverged markedly. This first step has been mooted of the creation of a shadow currency or a GCC version of the precursor currency to the euro, the European Currency Unit (ECU) that so successfully transited the multiple European currencies of the time into the euro late last century. The creation of this Gulf equivalent of the European Currency Unit would not only lead to better management of the transit from the many to the one, but would serve the twin practical and symbolic needs of a single unit of account and valuation as well as the commitment to a regional monetary union. However the prospect of a gulf currency union remains distant for now with the United Arab Emirates (UAE) yet to rejoin the monetary union program and the Kuwaiti dinar doing its shadow dance with the Euro/USD for the time being. The currency markets of the region continue their semblance of equilibrium in the absence of cooperation. With all of the inherent dangers and risks that a (weakened) U.S. dollar denominated peg for time being transfer into other markets and asset classes. The question here is – for how much longer? TFJ

The Kuwaiti dinar’s own swings in recent years have tended to track trends in the euro/USD rate. This has suggested implicitly the erstwhile ‘pegged’ regional cousin currencies were exposed to volatile liquidity flows that the Kuwaiti economy would have been to an extent insulated from as Kuwaiti dinar to the U.S. dollar 2007 Forex rate swings mitigate overseas changes in overseas interest rates and money supply policy – notably the U.S. and the broader G7 economies. A fact that has presented the Gulf Cooperation Council monetary and fiscal authorities with enormous inflationary challenges as a record low U.S. dollar combined with the liquidity effects of incoming oil revenues saw double digit growth (and inflation) rates strain the balance sheets and economic behaviours of the region. All of which has come to us symptomatically in the aforementioned Dubai World crisis of recent weeks. From an economically purist point of view, the region has only modest intra-regional trade and most risks between Gulf Cooperation Council members were ostensibly mitigated by their own long standing maintenance of dollar pegs. However, the fact that the United Arab Emirates (UAE) currency, and the region’s second largest economy, is not officially in the Gulf Cooperation Council monetary policy program and with the Kuwaiti Dinar remaining in a floating posture, we are faced with a region of inconsistent currency regimes that open some risk (indeed encourage) financial arbitrage across borders and regionally.

Peter Pontikis is an alternative investment management specialist for ANZ Private Bank and has consulted in the past with Asian central banks among other things in the area of foreign exchange intervention strategies. He has authored a book on foreign exchange and is the treasurer of the International Federation of Technical Analysts (www.IFTA.org). The above opinions are strictly his own. He can be reached on peter.pontikis@anz.com

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MARKET OBSERVATIONS

U.S. DOLLAR

Where now Mr. Bear?

CAN THE U.S. DOLLAR INDEX SUSTAIN ITS BEAR TREND IN 2010? Major questions linger in the minds of traders and investors about the trend of the U.S. dollar in 2010. P.A. Rajan provides analysis looking at the possibilities for the U.S. Dollar Index moving into 2010.

009 has turned out to be a negative year for U.S. Dollar Index. The major question that lingers in the minds of traders and investors is whether the U.S. dollar can sustain its bear trend in 2010 or not. This article attempts to explore a possible road map for the dollar in 2010 using Elliot wave analysis, intermarket analysis and trend and momentum studies.

and time. The monthly standard error band is flat and wide (The 80-month time series forecast has also flattened after a 7-year bear market) so we may expect a volatile Elliot wave flat correction for the index (a double bottom in traditional chart terms).

Let's start with a monthly chart of the U.S. Dollar Index with a standard error band (40 periods) along with a probable Elliot wave count (see Chart 1, top right). An 80-period time series forecast is also superimposed in the chart.

The analysis suggests that the Dollar Index may attempt to rally in 2010 after a successful retest of support at 73.50 for another attempt at the 2009 high of 89.62. It may dip below this level in case of an expanded flat correction. The range from 79.50 to 81.50 is a critical level for the medium term downtrend. A break above this zone would signal the reversal for the Dollar Index.

The Dollar Index appears to have completed a five-wave Elliot wave cycle at 73.56 during March 2008. The swing low at 73.56 is a Fibonacci projection target for the 2001 major bear trend and it was also made with bullish divergence in the monthly MACD. The subsequent corrective uptrend looks incomplete in terms of price

Intermarket analysis is a valuable tool to confirm the validity of a trend. The USD carry trade is more pronounced in gold and the stock market in 2009. Analyzing these markets would be helpful in predicting / confirming the Dollar Indexâ&#x20AC;&#x2122;s direction in coming months.

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TEXT P.A. RAJAN

Chart 1

Chart 2

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MARKET OBSERVATIONS

U.S. DOLLAR

“Should I go up?”

GOLD FUTURES

Elliot wave analysis of gold suggests that the metal may be in the fifth wave of its 1999 major bull trend. The monthly Relative Strength Index also displays a potential failure swing cum bearish divergence, which is common for typical fifth wave situations (see Chart 2, previous page, bottom). Intermarket divergence also exists between gold and silver because the new high for gold has not yet been confirmed by silver. The Wave I-III resistance line would provide formidable resistance for the commodity, which is around 1350 / 1400. We should also keep an eye on Fibonacci projection targets at 1252 and 1332. The metal could reverse the uptrend from this resistance zone. A move below 1026 / 1007 would confirm that a major top is in place for gold.

Elliot wave theory tells us that an impulse wave (five wave pattern, [A] in a corrective downtrend should be followed by another impulse wave [C] with a target below the wave [A] low. The ongoing wave [B] corrective uptrend in DJIA may exhaust in 2010. The tough resistance for the index may be at its 61.8% retracement level (11,246) followed by a congestion zone at 11,635 / 11,867. A move below 9,116 / 8,878 would signal the resumption of the major bear trend. To sum up, the Dollar Index has maintained an inverse relationship with commodities and the stock market during 2009. Our technical analysis suggests that the ongoing uptrend in gold and the stock market is vulnerable for a reversal in 2010, which supports a possible double bottom formation for the U.S. Dollar Index. We advise U.S. dollar bears to be watchful when the index reaches closer to its swing low 73.56 in 2010.

DOW JONES INDUSTRIAL AVERAGE

Elliot wave analysis of the long-term chart of the Dow Jones Industrial Average implies that a 32-year Elliot wave five wave bull cycle (1975 through 2007) might have completed at its 2007 top at 14,198.10, which is closer to a Fibonacci projection target (see Chart 3, right top). It should also be noted that the top had been made with a failure swing cum bearish divergence in the quarterly Relative Strength Index. It is premature to assume that the major bear trend that started in 2007 has completed in 2 years. Further analysis of DJIA’s weekly chart shows that the 2007 bear trend has unfolded in impulsive five waves with a Fibonacci relationship between sub waves (see Chart 4, bottom right).

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The retest of the low may offer a low risk buying opportunity for investors / traders during the coming New Year. TFJ

P.A. Rajan is a technical analyst with MF Global Singapore and provides daily technical analysis reports on stock indices and commodities with trading strategies to their clients. He also provides weekly technical trade recommendations on Singapore stock CFDs and speaks on technical analysis and market outlook regularly in investor forums on behalf of MF Global. He is an Affiliate in the Market Technicians Association (MTA) and has passed two levels of the Chartered Market Technician (CMT) program. He may be contacted at prajan@mfglobal.com.sg

TEXT P.A. RAJAN

Chart 3

SOURCE METASTOCK

Chart 4

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MARKET OBSERVATIONS

THE U.S. DOLLAR AND GOLD

Through thick and thin...

Dearest Dollar WITHER AND HENCE... John Needham considers the U.S. Dollar Index a valuable and underrated tool for traders and investors when performing analysis on other markets. In this edition, he focuses the attention of Danielcode on the U.S. Dollar Index and gold.

oday, we look at the U.S. Dollar Index (DX), its travails and triumphs over the past 18 months and its likely path for 2010 and beyond. I will show what a valuable and underrated tool this market is for traders and investors alike and the building blocks that you should consider in assessing what the future holds. Some of these considerations are of a fundamental nature – the kind of information prized by economists and talking heads. Whatever their absolute truth, market “fundamentals” are the most useless of all trading tools as they

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inevitably fail to account for “Time.” Many scoff at the notion that timing is necessary, let alone possible. But as you will see, “Time” to traders is almost important as “Price,” both major weapons in the traders’ armament. PRICE – THE 1ST DEGREE OF TRADING

Nothing is more important than Price, the 1st degree of trading. Whatever assumptions or insights we may get from our other trading weapons, price always takes precedence. Price is what pays. You cannot go to your wife or girlfriend and say “I made 62 days

TEXT JOHN NEEDHAM

of trading time today, and here is a nice diamond bracelet!” Only price action is rewarded in trading and investing, although knowledge of time and angles makes it possible to finesse entries. The Danielcode is primarily about Price. The unique mathematical matrix that is the Danielcode creates secret price levels that markets know and recognize but that others do not see. That is our edge. DC price numbers control all markets in all timeframes. So, let’s see the possibilities for Dollar Index as we wander down the lane of insights. Chart 1 is the monthly chart for DX that has been controlling the major price swings since July 2001. I published this chart in February 2008 with the expectation that 70.40 would be an important low. And so it has been, as traders both in this market and in gold know only too well. Two major DC price sequences have controlled this market for the past eight years. They will likely continue to control its destiny. The darker blue lines have been and continue to be the dominant price cycles with the lighter blue lines providing inflection points. TIMING THE DOLLAR – THE 2ND DEGREE OF THE MARKETS

that historically, when the Dollar Index and gold trend together, the pattern never exceeds three months and always ends with a substantial move in one or the other. I realize that “never” and “always” are strong words, particularly for intermarket correlations, so it pays to know about these occasional anomalies. In this case, the dollar took a hit as the linear correlation dissolved and we reverted to the more customary inverse correlation. Chart 2 (next page) will refresh your memory of the Danielcode time cycles that led us to the call for the dollar to make a low at $70.40 in March 2008. This was published in the public domain some weeks prior. The next work that we did on the dollar indicated that we had a target of 90.20 as a high for the rally and Chart 3 below illuminates that call. That was fairly simple. We see the Danielcode black line, the last level of support and resistance for the appropriate swing, appearing in many charts in multiple timeframes. This is the DC price level calling the major lows in the Australian SPI 200 Index and the Shanghai Composite Index in March 2009 and November 2008 respectively.

In previous articles (see the “Articles” tab at the Danielcode website, www.thedanielcode.com), I have shown how we called the Chart 1

low in the Dollar Index for March 2008 and how that assisted us in calling for a top in gold and silver simultaneously. The relationship between the dollar and gold is one that is important for gold traders and investors. Some months ago, I wrote an article setting out that the usual inverse correlation between these markets had ended and that they were trending in unison. That article showed

So far, we have managed to be fairly prescient on the ‘ups and downs’ of the dollar and it seems that we are now at another watershed moment for the dollar. On July 27th, 2009, I published the following Danielcode Time Cycle Chart on the DC website. Chart 4 (opposite) is under the “Trading Reports” tab at the web

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MARKET OBSERVATIONS

THE U.S. DOLLAR AND GOLD

site and has been available free to all who are interested enough to study this amazing timing phenomenon. The chart shows two primary time targets highlighted by the red rectangles. Remember that we are in the business of trading probabilities, and we always require price action to prove that the turn has been made. So far, we have had some price action and it appears that an intermediate low of some importance is near, but price action always is right – theories and forecasts are highly fallible.

hart 5 (next page, top) updates this chart to its current status and simplifies it for clarity. We can see that the second time grouping focused on the 6-day period ending November 26th as the high probability time target for at least an interim low. At the time of writing, we have at least a recognizable low precisely on that target date. It combined two iterations of the 62 DC “week” cycle, which is a priChart 2 mary time cycle of 62, one of just 3 time cycles that define all markets, and 2.5 “times” the primary cycle at 155 trading days. Note that the same cycles gave us the 2009 high in this market in the DC week closing March 2006. Not bad for a chart posted for public view over 5 months ago. So, we have a tradable low, but that is just part of the story.

you in some detail in the two “Master Class” articles at the DC website. Market timing cycles are part of the dark arts of trading – known only to a few and understood by even fewer. At the March lows in the equities, which the Danielcode forecast to the day and to within a couple of tics, conventional wisdom gave birth to the idea that this low had been called in advance when nothing could be further from the truth. 97% of traders were bearish according to sentiment reports at that low which meant that at the most 3% could have been right and the fact that almost all commentators and advisory services now claim that they saw that low in advance is really just a rewriting of history. So now we have the 1st and 2nd degrees of chart analysis in place. Price is the 1st degree and Time is the 2nd degree. In our timing chart earlier, you may not have seen that the low of the

If you are interested in the proper construction of market timing cycles, the correct methodology is laid out for Chart 3

November 26, 2009 bar was 74.17, just 2 ticks from the DC blue line target. We have at that time and price, a confluence of axis – what W.D. Gann referred to as “Time and Price being squared.” And that is important. A turn at the DC black line of 72.78 that I have long awaited would have been more satisfying, but we have what the market gives us and price and time recognition at least, has occurred. None of this is set in stone. The defini-

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TEXT JOHN NEEDHAM

tive turn signals have not been confirmed yet. Much is still to unfold. That is always the way in markets.

ket closes on Wednesday above that number, the most likely prospect is a pullback to the center of the channel, which for the next period will be at 1128.”

ANGLES – THE 4TH DEGREE OF MARKETS

Having dealt with Price and Time, we can now turn our attention to the 4th degree of markets – Angles. This simple device combines elements of the vertical axis of charts, which is price, and the horizontal axis, time. The tool I use for this exercise is a regression channel, which is available on most charting packages. Mine comes from Genesis Financial Technologies of Colorado Springs USA. I have used these charts for about 16 years with great satisfaction. In statistical analysis, there is something magical about standard deviation. You can read as much or as little as you like about it at various math websites, but the condition we are interested in is that markets find it hard to close more than 2 standard devia-

And you of course had the T.03 signals as well. Some part of $8000 per one contract! And Silver; and more. Well this just finished off a great week.” And, it got better. Chart 6 (next page, bottom) shows how this simple analysis set up a trade worth some part of over $10,000 per one Comex contract. These little gifts make your equity curve and show that analysis pays. Have we digressed by wandering into gold? Not really. The Dollar Index is directly and inversely (usually) correlated to many markets, and I wanted to give you a simple example of the benefits of thinking about the 4th degree.

Chart 4

tions away from the mean on most timeframes. Last Wednesday, December 2, I published a chart showing Comex gold closing above 2 standard deviations from the mean on the DC 6-day chart. I advised that the likely outcome of this action was a fast pullback to the mean. This excerpt is from a published article and members forum at the DC website:

Regression channels have a number of purposes, one of which is to define trend. In talking about trend, we must always define the time period that we are interested in. Markets habitually have a number of different trends on differing time cycles happening contemporaneously – an up trend in one timeframe may be a downtrend in another.

“Gold-DC 9 day chart Prop trend signal is up. Regression channel signal is up. Current period bar completes 12/02

That indeed is the position in the Dollar Index as it rallies out of its appointed turn on the DC time cycles. As Chart 6 shows, the trend on the 6-day chart is verging up. The setup bar for the minor trend change is complete and awaits confirmation, or rejection shortly.

Markets find it hard to close above the regression channel. The upper edge of the channel is at 1175. If this mar-

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MARKET OBSERVATIONS While the trend on the DC “monthly” chart remains firmly down as Chart 7 shows.

THE U.S. DOLLAR AND GOLD

Chart 5

You can approximate these regression channels on your own charts, but for a more nuanced understanding of regression channels, you need to know that all markets have a unique vibration that once attained, never changes. For the Dollar Index it is 62, and strangely for Gold it is 44. This means Chart 6a

currency, money issued by U.S. Treasury is ultimately just a promise to pay, backed by the full faith and credit of the U.S. government. Notionally, given a static net worth of that “full faith,” every additional dollar that is issued dilutes the value at the margin of every dollar already in circulation.

that the precise range of the regression channels varies for each market, but just to see the effect of this study, use 2 standard deviations as your tool and you will not be far off. FUNDAMENTALS

The U.S. dollar is the world’s reserve currency. It is the lifeblood of international finance. No other currency is close to challenging for pre-eminence despite some woolly thinking from the fringe dwellers. And, it is also a fiat currency. That means that it has no ascertainable value, unlike the ill-fated Gold Standard, which is much mourned by gold buffs, but which in truth also had elements of a fiat currency as the U.S. government varied the “official” price of gold in 1933 and 1934. The value of the dollar is just what the market says it is, and the main mover in that ongoing debate is the President of the United States through his servant – the U.S. Treasury. As a fiat

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As the economy grows and population expands, so does the money and “promises” in circulation. Hopefully, the full faith and credit expands in concert. Markets also price in risk. What the dollar is worth in calm times is different to its value in times of financial stress. Safe haven status has a value too. Two fundamental forces driving the dollar are the promises being made by the U.S. in the form of deficit spending, bank bailouts, operating deficits, bad debt and suspect mortgage purchases and the billions or perhaps trillions in guarantees and international understandings that are well-hidden from the public’s eyes. These are things of which we can only guess. The second factor is the standard economic response to nation rebuilding. Globalization, which is just a fancy term for labor arbitrage, has seen the U.S. industrial base hollowed out as jobs have been outsourced to those with cheaper operating systems in wages, conditions, compliance and environmental standards. That means the East. The major challenge for a

TEXT JOHN NEEDHAM

President looking to find work for 9 million or more unemployed in United States is answering the questions ‘Where and How?.’

its industrial backbone.

So, the two major driving forces of U.S. dollar value are aligned – and both say down. Add a bit of tinkering at the fringes as Bernanke et al continue with near zero official interest rates to help bankers prize their way back to solvency by cannibalizing access to cheap taxpayers funds to lend to the same taxpayers. Not only does nobody seem to mind, but the mindless economists who control the groupspeak of the U.S. proletariat, actually praise Bernanke and Geithner, the two most responsible for failing to oversee the U.S. banking system, as they now rob Peter to pay Paul.

obs for realtors are not coming back. Nor are many of the jobs in construction, hospitality and the services industries. The much vaunted “green jobs” are not going to create the kinds of numbers required to create near full employment in U.S., and for our international readers, the decisions on the value of the dollar are peculiarly for the U.S. alone to make.

Factually, the U.S. is going to have to rebuild its factories to create a large enough pool of employment for its unskilled and semi-skilled labor – just the people hurting most from present unemployment. This is not glamorous or sexy. It will not be the thrust of major political speeches, nor will it make the front page of the major newspapers at least not in these terms. But realists understand that Chart 6b more output and more jobs from established factories is what it is going to take.

It is a strange world indeed when savers are sacrificed to make good the fate of the most intemperate lenders – the banks. One major ramification of the devaluing of the U.S. dollar that seems to excite no comment is China’s policy of pegging its currency to

The single greatest help that government can offer to exporters (remember the U.S. consumer is tapped out, so exports are more important than ever to this economy), is to make their goods more competitive internationally. That means weakening the exchange rate, as a weaker dollar makes exports cheaper and imports more expensive. This is just what the U.S. needs if it is going to rebuild Chart 7

the dollar. While buckets of angst are regularly emitted over the perceived under valuation of the yuan, not much is said about the fact that as United States devalues, so does China. That is what the peg is for Sport. Bernanke’s recent comment that the decline in the U.S. dollar is “orderly” is code for “we will devalue as fast as we can, but not at a rate that draws too much attention.” That is a rational approach in these desperate times on behalf of those looking for work in America.

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MARKET OBSERVATIONS

THE U.S. DOLLAR AND GOLD

NOW THE HENCE

My best appreciation of what the charts are saying, combined with a dose of common sense and realism, (qualities sadly lacking these days), is to take a step back and utilize our regression channel, but on a much longer time span. We may be seeing an intermediate low in the Dollar Index as we have “Time and Price” from our Danielcode charts and as W.D. Gann said so presciently, “When time and price are squared a change in trend will occur.”

John Needham is a Sydney Lawyer and Financial Consultant. He publishes The Danielcode Report and writes occasionally on other markets. He lives with his family in Australia and New Zealand. John can be reached at jneedham@thedanielcode.com or via his website www.thedanielcode.com

But he did not tell us what timeframe he was referring and like most of Mr. Gann’s pronouncements, a number of alternative interpretations are open to the thinking man. My best guess is that we may see a rally now. With short interest in the Dollar Chart 8

Index at historic highs, a rally that gets into the stops will grow wings. But that will just be another rally and signpost along a single road. Here is that road:

I like 59.53 as our foreseeable destination in this market. Breaking 60c will have enough shock value to make this a headline event, and it is still just on trend. I hope that the various techniques that I am expounding here will be of interest and assistance to you. If they pique your interest to think more about markets and to think in different ways, I will be succeeding in my aims. For those that want to learn more about these techniques there is a plethora of information available at the Danielcode website, and I invite you to visit us at any time. TFJ

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“For whosoever shall be ashamed of me and of my words, of him shall the Son of man be ashamed, when he shall come in his own glory, and in his Father's, and of the holy angels.” - Luke 9:26

MARKET ANALYSIS

EUR/USD OUTLOOK

TEXT JAIME JOHNSON

2010

The Outlook for the EUR/USD >

Being on the right side of the EUR/USD market can give insight into the inversely correlated dollar trend, which impacts other global markets. Jaime Johnson provides analysis of the EUR/USD currency pair, the dollar index and gold in preparation for 2010.

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MARKET ANALYSIS

EUR/USD OUTLOOK

BEING ON THE RIGHT SIDE OF THE EUR/USD TREND CAN NOT ONLY PUT YOU IN A PROFITABLE FOREX TRADING POSITION...

t can give insight to the inversely correlated dollar trend which has ramifications for many global markets. While many analysts and traders give their EUR/USD forecasts from a fundamental perspective, I am giving mine from a pattern perspective.

The following article will focus on the long-term pattern position of the EUR/USD to help determine trend direction for 2010 based on analysis used for my own trade strategies and the trade strategies I use in the Dynamic Trader Daily Forex Report and my NoBSForex Trading Course. This analysis is based on Elliott Wave Theory and price and time targets based on Fibonacci ratios.

The EUR/USD will be compared to the pattern of the dollar index, which is inversely correlated. I will also take a look at gold, which does not correlate as well as the inversely correlated dollar index, but tends to trend with EUR/USD. Before continuing, I am going to cut to the chase. As of this writing (the 2nd week of December 2009), the EUR/USD is in the position for a multi-month, if not multi-year high. If this is the case, the EUR/USD should be in a bear trend for 2010 and potentially much longer. Now, let me explain why from a pattern perspective. THE EUR/USD

Chart 1 is monthly EUR/USD data through the first week of December 2009. The EUR/USD market was in a consistent bull trend from October 2000 to July 2008 that unfolded in an Elliott Wave five-wave pattern. A correction to a five-wave trend usually

The oscillator used in the analysis and following charts is called the ‘Dtoscillator,’ which is a combination of stochastic and RSI. Almost any price indicator such as the RSI or the MACD will identify the same momentum positions shown in these charts.

reaches at least the 50% retracement of the fivewave trend. While the October 2008 low was just a few points above the 50% retracement, the July-October 2008 decline did not meet several important characteristics of a completed correction. Typically, corrections make at least three waves and ideally complete in the typical time target for a corrective low, the 38.2% – 61.8% time retracement zone of the five-wave rally. The JulyOctober 2008 decline did

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TEXT JAIME JOHNSON

November 2009 monthly close, both monthly oscillators were in the overbought zone, which is a signal that upward momentum should be coming to an end, or at least slowing down, putting the EUR/USD in the position for a multi-month high. While this chart is only through the first week of December 2009, the oscillators were bearish (the fast line had crossed to below the slow line), a stronger signal for a multi-month high. Now we have pattern, price and momentum all signaling for at least a multi-month high. not meet the three-wave minimum for a typical correction and fell far short of the 38.2% time retracement. The October 2008 low should be taken out before a correction is complete. Ideally, a corrective decline off the July 2008 high should not be complete before mid-2011, the 38.2% time retracement and may not be complete until April 2013. So the assumption is that October 2008 low is only the first wave of a corrective decline or a wave A and the rally off the October 2008 low should be the second wave of the correction or wave B. So far, this rally has unfolded in a three-wave pattern or a corrective pattern, which is characteristic of a wave B with the November high slightly below the 78.6% retracement of the wave A decline (the July 2008 – October 2008 decline). The 78.6% retracement is not only at a strong resistance level; it is also the maximum price target for a typical wave B. This does not mean a wave B cannot exceed the 78.6% retracement, but this a price target where a wave B often completes. As of early December 2009, the pattern and price position suggest a multi-month, if not multi-year high should be near completion. Let’s take a look at momentum. There are two oscillator settings in Chart 1, one with a shorter look back period and a second that is smoother with a longer look back period. Both correlate relatively well with the swings of the EUR/USD. At the

Let’s look at one more thing in Chart 2 that supports the idea that EUR/USD is in position for a multi-month high. Chart 2 is EUR/USD weekly data from the July 2008, wave 5 high through December 9, 2009. Not only is the November high slightly below the 78.6% retracement of the July 2008 – October 2008 decline, it is in the typical wave c of B price target. As mentioned above, wave B of a correction often unfolds in a three- wave pattern, as the wave B off the October 2008 low appears to be doing. The typical price target for the completion of the third wave of this rally, or the typical wave c of B target includes the 100% alternate price projection of the Oct. 2008 – December 2008 rally off the March 2009 low and the 78.6% retracement of the July 2008 – March 2009 decline.

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MARKET ANALYSIS

EUR/USD OUTLOOK

UR/USD has made three waves up from the October 2008 low, which is typical for a wave B corrective rally and has reached what is the typical price target zone to complete a wave c of wave B. With monthly momentum overbought or bearish, the EUR/USD is in the ideal position to complete a wave B corrective high.

THE DOLLAR INDEX

Chart 3 is dollar index continuous monthly data. Because the dollar index is heavily weighted toward the EUR/USD, for the most part it trades inversely to the EUR/USD. As you can see in the monthly chart, patterns are nearly identical besides a couple of things. While the reversal dates are not exactly the same, they are similar. The probable wave B off the November 2008 high may be unfolding in an irregular corrective ABC correction where the minor wave b traded above the November 2008 wave A high. However, the position is the inverse of the EUR/USD – the pattern, price position and momentum are all in the typical position to complete a wave B low, which should be followed by a multi-month if not multiyear rally to at least above the March 2009 high. GOLD

What would support the analysis in this article? Remember “support” does not mean “confirm.” As of this writing, there are two initial signals that would support the completion of a multi-month high. The first is a bearish monthly reversal signal, a monthly close below its open and ideally below the prior month’s close (you should know by now if December made a bearish reversal signal). The second is a decline below the low of the week ending November 6 (see the horizontal blue line in Chart 2). This is a minor swing low at the time of this writing. A decline below a minor swing low is the initial signal for a trend reversal. NOW WHAT?

Okay, so there is compelling evidence for a high in the EUR/USD lasting several months, if not years, at or near completion. Now what? Sell the farm and go short? One thing you must realize is that every bear trend has corrective bull trends. If the wave counts in the EUR/USD charts are correct, any multiday, or multi-week rallies should only be corrections in a bear trend lasting at least several months. When and where these corrections will occur can only be projected once the wave B off the October 2008 low is complete. So the trade strategies you use must be determined by what timeframe you trade.

“Now we have pattern, price and momentum all signaling for at least a multi-month high.”

Chart 4 shows gold continuous monthly data. Gold usually trends with the EUR/USD. The chart shows a potential fivewave rally unfolding from the August 1999 low and if the November 2008 low is a wave 4 low, the December high at the time of this writing is slightly above the typical wave 5 target which includes the 127% – 162% external retracement zone (a strong resistance zone) of the March 2008 – November 2008 potential wave 4 decline.

At the November 2009 close, the monthly momentum was bearish just like the bearish EUR/USD momentum. Gold has reached the price and monthly momentum position for a monthly top and a possible completion of a five-wave trend up from the August 1999 low as of the first week in December. However, at this point in time, gold will have to make a decline to below the July 2009 swing low at 905.9 for a pattern signal the Wave-5 high is complete. The sharp rally of the July 2009 low is typical of the panic buying of a final speculative, blow-off top. What tends to follow the completion of a blow-off top? A sharp reversal.

As of now, I can advise to always use objective trade entry strategies, always use stop-losses, trade more than one unit and have exit strategies for each unit, use stop-loss adjustment strategies, use a money management plan and most importantly, be disciplined enough to stick to these trade strategies. For education on practical trade strategies for every timeframe to take advantage of the potential decline and corrective rallies in the EUR/USD, check out my NoBSFX Trading course (info below). MORE INFORMATION AS THE MARKET UNFOLDS

With the EUR/USD, as well as any other market, more information on whether the longer-term outlook is correct or not is revealed as the market unfolds. For continued analysis of the EUR/USD and six of the other top forex markets as they unfold throughout the potential pivotal year of 2010 and for further education on the analysis used in this article, check out the Dynamic Trader Daily Forex Report (info below).TFJ

ONLY IN A POSITION FOR A HIGH

This analysis shows the patterns and positions of three markets suggesting that a high lasting several months in the EUR/USD may be near completion. However, this analysis could be wrong!!! What would void this analysis? A rally above the July 2008 high would signal the probable wave count off the October 2008 low is another five-wave rally signaling the EUR/USD should continue to rally.

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

Jaime Johnson is the co-author and chief technical analyst and trade strategist for the Dynamic Trader Forex Report, as well as for the Dynamic Trader Futures and Stock and ETF Reports. He recently completed the long awaited NoBSForex Trading Course, a sevenhour workshop teaching the trade strategies he uses on a daily basis. For more information, go to www.NoBSForexTrading.com. For more information on the daily reports go to www.DynamicTraders.com.

MARKET ANALYSIS

ANALYSIS METHODOLGY

TEXT JASON FARKAS

2010 Should Resemble 2008, But Worse. LATVIA'S CURRENCY PROBLEM COULD LEAD TO AN EASTERN EUROPEAN EPIDEMIC...

Latvia may well be the opening act for an economic epidemic in Eastern Europe just as Thailand was in Asia in the late 1980s and early 1990s. Jason Farkas of Elliot Wave International outlines why we may see a return to across-the-board asset declines in 2010. nsight to the inversely correlated dollar trend which has ramifications for many global markets. While many analysts and traders give their EUR/USD forecasts from a fundamental perspective, I am giving mine from a pattern perspective.

We expect to see a return to 2008’s across-the-board decline in assets in 2010, and virtually the only place to hide will be in shortterm U.S. Treasuries or safe cash equivalents. The return of riskaversion should heighten the demand for U.S. dollars as investors scramble to raise cash to pay off debts and unwind carry trades. Although it seems that the dramatic and unprecedented actions of global governments and central banks have succeeded in forestalling a financial panic, it is the public’s confidence in them that will collapse along with equity indexes in 2010. How, though, can the markets fall if central bankers and governments can simply ride to the rescue again? This question assumes that someone is in control; but the markets are in control, and, as we will show, more than a few of them appear to be ripe for a major turn. Several markets have traced out highly reliable wave patterns, forming the basis for our 2010 outlook. [Editor's note: For a brief description of Elliott wave analysis, please see the sidebar, “Counting Elliott Waves.”] Let’s look at why currency and economic troubles in a relatively minor player could precede the further collapse in global equities and perhaps ultimately (if incorrectly) be blamed for kicking off the renewed crisis we foresee.

THAILAND AND LATVIA – CURRENCY CRISIS REDUX

Thailand and Latvia are two countries in opposite hemispheres with very few economic ties. Latvia may well be the opening act for an economic epidemic in Eastern Europe just as Thailand was in Asia in the late 1980s and early 1990s. At that time, the Asian economic miracle was alive and well in Thailand. Its GDP growth averaged 9-plus% per year from 1985 through 1996. A boom in real estate and stocks developed along with the economy, which fueled capital inflows and increased leverage. It appeared to be a virtuous cycle that continued until asset prices hit a temporary top in the summer of 1997. From that point forward, Thailand’s markets collapsed – the Thai baht lost over 50%; the Thai Set Index lost over 70% in the following year. The Thai government devalued the baht in July 1997 because its coffers were low from its attempts to support the currency peg to the U.S. dollar. After the devaluation, the virtuous cycle reversed, stifling economic activity and fueling currency and asset declines as the crisis swept to Indonesia, Malaysia, the Philippines and South Korea. This crisis came to be known as the “Asian contagion.” The International Monetary Fund issued emergency loans to the region in 1997. At the time, the longer-term trend of the global economy was still up, so the IMF rescue package seemed to work. The region’s markets and economies turned up in 1998.

J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

MARKET ANALYSIS

MARKET OUTLOOK

ow, however, the longer-term trend for the global economy has turned down, providing one reason that explains why the International Monetary Fund loans to Eastern Europe have failed to spark a similar economic recovery.

THE BEGINNING OF THE EASTERN EUROPEAN EPIDEMIC

Latvia’s economic run-up prior to 2008 was similar to Thailand’s. Since the 1998 collapse of the ruble and the Russian default, the Latvian economy had recovered and grown impressively. It had one of the fastest-growing GDPs in Europe this decade, and in 2004 Latvia joined the European Union. Everything seemed fine until the fall of 2007 when most of the world’s equity markets topped. After years of excess leverage and consumption, and the collapse of 2008 and 2009, Latvia is now one of the weakest links in the Eastern European chain. Even as many countries’ GDPs have turned higher, Latvian third quarter GDP fell another 19%. With exports down 28% this year, many private-sector manufacturers are closing up shop and some are going underground. As a result, employment and GDP have shrunk, causing further pressure on the country’s already unstable banks.

With economies slowing, thanks in part to consumers switching from spending to saving; governments are generating less revenue, so sovereign defaults become a real possibility. Should we see a default or devaluation in Latvia, or elsewhere in the region, it will likely spill over to other countries (such as Lithuania, Estonia, Bulgaria, Ukraine, Kazakhstan and Hungary), creating an Eastern European epidemic. In addition, Swedish, Greek, and other European banks are significantly exposed to Eastern Europe, and further losses may lead to bank failures and a curtailment of lending at home. Keep in mind that developed nations’ banks have previously been overexposed in Eastern Europe, with big consequences. The largest bank in Austria failed in 1931 partly due to loan losses. Panic conditions spread to Germany and then to Britain, which ultimately resulted in Great Britain's decision to abandon the gold standard in September 1931. What might happen this time around? COMMON PATHS - DIFFERENT OUTCOMES

Markets often set up for a change in trend when the majority of people still believe that the prior trend is in force. A car that wishes to reverse must slow its forward progress and stop prior to backing up. We believe that the Latvian currency is a market that has slowed, stopped and reversed even though it may not yet be obvious.

The defense of the Latvian currency peg to the euro is draining the country’s treasury, just as a similar peg drained Thailand’s in 1997. Since the government is having difficulty selling bonds at an affordable rate, there is no easy way to solve Latvia’s problems – it is going to be default, devaluation or depression. Why? It is similar to what happened to Lehman Brothers in late 2008. When the possibility of a corporate bankruptcy becomes larger, lenders typically call loans or demand additional collateral, which accelerates a company’s demise (e.g., Lehman Brothers and Bear Stearns). A similar process occurs when the likelihood of currency devaluation becomes larger. Lenders typically withdraw capital from the region, which leaves businesses and consumers without access to credit. This credit crunch heightens the likelihood of default or devaluation. Since 90% of Latvian loans are denominated in foreign currency, devaluation would make repayment impossible. Swedbank, the largest lender in Latvia, recently noted that 54% of its Latvian mortgage loans are underwater. Those are problems for the lender as much as for the borrower, and devaluation would force banks to curtail loans.

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

It seems that the US dollar is just beginning a long advance versus the Latvian currency shown by the following evidence:

TEXT JASON FARKAS

Five-wave rally – In Elliott wave

analysis, after a five-wave pattern finishes, a three-wave pullback is due. A five-wave rally in USD/LVL ran from April 2008 into October 2008 as the USD gained 33% versus the Latvian Lat. The five-wave rally also means that the larger trend is up. Three-wave decline – Since the October 2008 top, a three-wave decline has unfolded, marked A-B-C on the chart. Also, waves C and A of wave (B) are nearly equal, which is a common Elliott wave relationship. After a five-wave advance and a three-wave retreat, Elliott’s rules suggest that we now look for another five-wave advance. Broken Trendlines – Trendlines on price and the rate-of-change (ROC) have been broken, signaling that the trend may be reversing. Momentum divergence – The bullish ROC divergence that was registered into the October bottom also suggests that the wave (B) decline is mature. A push above zero would add additional evidence to the bullish case. We anticipate another five-wave advance to be under way now with a minimum target of above 0.5784. The rally has the potential to reach substantially higher levels if devaluation becomes reality. OTHER MARKETS SHOW SIMILAR PATTERNS

The US Dollar Index shows a completed pattern to the downside similar to the USD/LVL. Most other dollar rates are also ready to turn. It is not just currency markets where we expect major turns to occur. At Elliott Wave International, we have been covering what we call the “All the Same Market” phenomena. As you can see in this group of four charts of silver, the euro/US dollar index, crude oil and the S&P 500 Index, formerly distinct asset classes are rising and falling together. Why is this? We believe that the primary driver of asset prices is not liquidity, as many believe. Instead, it is the belief in the “liquidity machine” at the Federal Reserve. As long as investors believe in the power of the U.S. Congress to spend and the Federal Reserve to “print,” then asset prices rise. However, wave patterns suggest that markets are headed for a fall, and when they do, as we pointed out earlier, the belief in the government’s overseers is likely to fall dramatically along with assets. So, with every tick lower in the Dow and every tick up in the U.S. dollar in 2010, the belief that government is in control will evaporate.

SUMMARY

Regardless whether Latvia is the first major trouble spot of 2010, we suggest that investors exercise caution, because trouble is coming. The USD/LVL has begun to rally before any headlines have appeared to say that problems in Latvia and the Baltic region are becoming systemic. With the recent debt issues cropping up in Dubai, Greece and Spain, it seems that some of the weaker economies in the global debt bubble are on a course for implosion. We strongly recommend risk-aversion in 2010. If we are right, it just might save your financial life. If we are wrong, you only lose out on opportunity costs, and that is a trade with a very nice reward relative to the risk. TFJ

Jason Farkas, CMT, worked for 14 years as a technical analyst and futures, options and equity trader before joining Elliott Wave International in 2009 as a currencies analyst. He writes a Weekly Insight column for Elliot Wave International's currencies subscribers. Learn more about this service at www.elliottwave.com/wave/CurrenciesSS

J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

M A R K E T A N A LY S I S

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

STYLE POINTS

TEXT JASON FARKAS

Figure A (below) illustrates the basic building block of the Wave Principle. Elliott observed that when prices rally in a bull market, they do so in five distinct waves, which he called motive or impulse waves. Once a five-wave move is complete, prices decline in three waves, correcting a portion of the preceding advance. Elliott used numbers to identify impulsive phases and letters for corrective phases of price activity. Once the sequence is complete, the pattern repeats in larger and smaller versions of this same basic pattern. The same holds true for bear markets, in which case this pattern is inverted – fivewave declines are followed by three-wave rallies. Elliott waves are a useful forecasting tool because they reflect human emotions that unfold in similar patterns each and every cycle. As such, investment markets belong in the domain of psychology more than economics. Traditional economics cannot and does not explain why investment bubbles occur so frequently. If, indeed, investment market participants are “rational,” why were most investors bullish the EUR/USD in July 2008 and bearish in October 2008? (See Figure B,left; DSI data courtesy of MBH Commodity Advisors www.trade-futures.com) The answer is that investment market participants, rather than being rational, are emotional, and their emotions trace out five-waves-up, three-waves-down patterns that R.N. Elliott discovered. Does this mean that humans are not at all rational? No. Humans are rational when acting in an economic capacity, such as a trip to the grocery store. Say, for instance, that oranges were to double in price. Would you expect there to be a stampede to buy oranges to take advantage of further gains? Hardly. The rational grocery shopper would wait for the price to come back down. Instead, stampedes happen on days such as Black Friday, when low prices cause eager, happy buyers to show up. However, the opposite behavior holds true in financial markets, where investors and traders snap up equities whose prices are rising while they ignore or sell equities whose prices are falling.

Counting Elliott Waves – The Wave Principle The Wave Principle is a form of technical analysis, based on crowd psychology and pattern recognition. Ralph Nelson Elliott first discovered it in the 1930s, after having spent many years analyzing stock market data. What Elliott observed was that stock prices trend and reverse in recognizable patterns. After naming, defining, and illustrating 13 such patterns, he went on to describe how they connect, forming larger and smaller versions of themselves – what he later called the Wave Principle.

J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

F E AT U R E D A N A LY S I S << Continued from page 14 Chart 3: USD /HUF Weekly chart

TRADE #2: Long USD - Hungarian forint (HUF)

And for less fateful reasons, the Hungarian forint has been on our list of overvalued currencies for several months now. Early on, Hungary recognized that they were in a rough spot. The financial crisis brought to light Hungary’s over-exposure to foreign loans and foreign banks. That is not a good thing when crisis shocks the financial system. And so Hungary was quick to enlist the help of the International Monetary Fund et al to provide stimulus money and provide Hungary some time to get things back in order. But that deal came with some stipulations, perhaps cosmetic but nonetheless requirements to keep Hungary in line.

“If you can trade these currencies with proper position sizing, sit through corrections and ride the trends, we think it is well worth the risk.” Just so happens though that Hungary’s government has needed to spend money to support its economy. And, it just so happens the IMF contract was clear about Hungary’s fiscal position coming unraveled. It is not supposed to, but it seems like it is.

before-seen 9.8%” fall in spending. And that led to a reduction in agriculture, industrial production, construction and services.

Basically amounting to a sixth consecutive quarterly slide in growth; perhaps worst for the markets was that all this was worse than had originally been expected. That obviously leaks into the other side of the equation – monetary policy. Especially in the currency market, monetary policy (interest rates) play a huge role in separating the “worthy” from the “unworthy.” Considering the move lower in interest rates and the expectations for further declines, the Hungarian forint falls in the “unworthy” category. This is one among many reasons why the forint has tended to weaken most quickly at times when investors seek to peel back risk. USD / Hungarian Forint – We see a very similar chart setup in USD/UF as we see above in the South African rand – weekly trend break and buy signal on MACD. The Forint shows a secondary trend break, we are expecting it to accelerate higher from here.

Three trading ideas that we think will smoke any available in the major pair world. Keep in mind nothing goes up in a straight line – so give these trades some breathing room. Plus, emerging market currencies are by nature volatile and spreads are wider. If you can trade these currencies with proper position sizing, sit through corrections and ride the trends, we think it is well worth the risk. TFJ

Jack Crooks has over 20 years experience in the currency, equity and futures arena. He has held key positions in brokerage, money management, trading and research.

And with all the concern circling around Dubai, Greece and Spain ... it is only logical to throw Hungary into the group of fiscal drunkards. But hey, look at what they have to deal with ...

Jack is founder and president of Black Swan Capital LLC and Black Swan Capital Management. Prior to entering the investment arena, Jack worked in various corporate finance positions. He has written extensively on the subject of global currencies and international economics.

A close look into the final third quarter GDP numbers for Hungary shows a huge mess. The biggest factor – a “never-

He can be reached at jcrooks@blackswantrading.com or via his website www.blackswantrading.com

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

If you are a forex trader – this is THE magazine for you!

THE FOREX JOURNAL is brought to you by a dedicated team, written by enthusiasts for enthusiasts.

ASIA-PACIFIC’S FIRST FOREX MAGAZINE

C O N T R I B U TO R S

Raul Lopez

Claus Vistesen

Steve Griffiths Sunil Mangwani Todd Krueger

Dar Wong

George Clement Howard Friend Ian Naismith

Jaime Johnson Jason Farkas John Needham

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J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

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T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

JA N U A R Y 2 0 1 0

Economic Calendar The right events for the right information to help you to trade better... UPCOMING EVENTS FEB 2, 2010 The Euromoney Asia Forex Forum 2010 The FX market is the world’s largest and most liquid, with $3,200bn being traded daily across the globe. As investors move away from the US dollar, sterling and yen and flows make their way back into Asia, huge opportunities are emerging to make money in Asian currencies. Venue: Pan Pacific Hotel, Singapore Organiser: Euromoney Asia FEB 3, 2010 – FEB 6, 2010 The World Money Show Orlando If you missed The World Money Show Orlando 2009 or if you’d like to revisit key points of the keynotes, here’s another chance to hear what these renowned financial experts shared about how they evaluated the markets— where we were, where we are going, and how to identify (and profit) from the opportunities that lie ahead. Venue: Gaylord Palms Resort, Orlando, United States Organiser: Money Show FEB 13, 2010 – FEB 16, 2010 The Traders Expo New York Thousands of your fellow traders attended the 2009 Traders Expo New York to exchange ideas, discuss new indicators, and learn the strategies that top traders use to make their living in the markets. Venue: Marriott Marquis Hotel, New York, United States. Organiser: Money Show FEB 17, 2010 Global Forex Traders Conference The Global Forex Traders Conference is a new 1-day event hosted by IBTimesFX and ForexTV. The conference differentiates itself from others by its focus on education (thought-challenging panels and conferences that are aimed to helping traders make more successful trades) and the presence of 2 worlds in one place: the institutional and the retail world. Venue: The Embassy Suites, New York Hotel Organiser: IBTimesFX & Forex TV APR 7, 2010 – APR 10, 2010 The Traders Expo Los Angeles Thousands of your fellow traders attended the 2009 Traders Expo Los Angeles to exchange ideas, discuss new indicators, and learn the strategies that top traders use to make their living in the markets.

T h e Fo re x J o u r n a l J A N U A R Y 2 0 1 0

Venue: Pasadena Convention Center, Los Angeles, United States. Organiser: Money Show MAY 10, 2010 – MAY 13, 2010 The Money Show Las Vegas The Money Show in Las Vegas, you will gain the knowledge and insights you need to make smart investment decisions in 2010 and beyond. Attend and hear leading experts reveal where they see growth opportunities in stocks, bonds, ETFs, commodities, options, and which markets overseas they see outperforming in the near term. Don't miss this extraordinary event. Venue: Caesars Palace, Las Vegas, United States. Organiser: Money Show MAY 20, 2010 – MAY 21, 2010 Middle East Forex Trading Expo & Conference 2010 under the theme “Trade with Confidence” aims to provide individuals, retail & institutional investors, and professionals, the latest trading techniques, new trading tools & signals available, and choose among the trusted brokers that will help them in their trading habit to grow their investment portfolio and achieve short and long term trading objectives. Venue: Habtoor Grand Hotel, Sin El Fil, Beirut, Lebanon Organiser: Money Show

E C O N O M I C CA L E N DA R Legend AU = Australia BoE = Bank of England BoJ = Bank of Japan CPI = Consumer price index

CGPI = Corporate goods price indes

GDP = Gross Domestic Product

ECB = European Central Bank EU = European Union

ISM = Inst. for Supply Mgmt. JN = Japan

CPM = Chicago Purchasing Managers

FOMC = Federal Open Market Committee

MPC = Monetary Policy Com.

ECONOMIC RELEASE GDP CPI ECI PPI EMPLOYMENT PERSONAL INCOME BUSINESS INVENTORIES DURABLE GOODS RETAIL SALES TRADE BALANCE

RELEASE TIME (EST) 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM 8.30AM

ECONOMIC RELEASE HOUSING STARTS PROD. & CAPACITY UTILIZATION LEADING INDICATORS CONSUMER CONFIDENCE UNI OF MIC CONS. SENTIMENT WHOLESALE INVENTORIES PHILADELPHIA FED SURVEY EXISTING HOME SALES

RELEASE TIME (EST) 8.30AM 9.15AM 10 AM 10 AM 10 AM 10 AM 10 AM 10 AM

ECONOMIC RELEASE CONSTRUCTION SPENDING CPM REPORT REPORT ON BUSINESS ON-MANUFACTURING NEW HOME SALES CHICAGO FED NATIONAL ACTIVITY INDEX FEDERAL BUDGET CONSUMER CREDIT

PMI = Purchasing managers index NAPM = National Association of Purchasing Managers PPI = Producer price index SK = South Korea

RELEASE TIME (EST) 10 AM 10 AM 10 AM 10 AM 10 AM 2 PM 3 PM

The information on this page is subject to change. The Forex Journal is not responsible for the accuracy of calendar dates beyond press time.

Mon. Jan. 04

Tues. Jan. 05

Wed. Jan. 06

Fri. Jan. 08

US – ISM MFG INDEX FOR JAN - NOV CONSTRUCTION SPENDING DATA

US – NOV FACTORY ORDERS DATA - NOV PENDING HOME SALES DATA

US - ISM NON-MFG INDEX FOR DEC - FOMC MINUTES HELD ON DEC 16

US – UNEMPLOYMENT DATA FOR DEC - NOV WHOLESALES TRADE DATA - NOV CONSUMER CREDIT DATA

Tues. Jan. 12

Wed. Jan. 13

Thur. Jan. 14

Fri. Jan. 15

US – INTERNATIONAL TRADE DATA FOR NOV

US – DEC TREASURY BUDGET DATA

US – RETAIL SALES DATA FOR DEC - IMPORT & EXPORT PRICES FOR DEC

US – CPI DATA FOR DEC - INDUSTRIAL PRODUCTION DATA FOR DEC - CONSUMER SENTIMENT FOR JAN

Mon. Jan. 18

Tues. Jan. 19

Wed. Jan. 20

Thur. Jan. 21

US HOLIDAY: MARTIN LUTHER KING JR. DAY

US - TREASURY INTERNATIONAL CAPITAL DATA FOR JAN - HOUSING MARKET INDEX FOR JAN

US – DEC HOUSING STARTS DATA - PPI DATA FOR DEC

US – DEC LEADING INDICATORS DATA

Mon. Jan. 25

Tues. Jan. 26

Wed. Jan. 27

Fri. Jan. 29

US – EXISTING HOME SALES DATA

US – DEC CONSUMER CONFIDENCE DATA

US - FOMC MEETING ANNOUNCEMENT

US - GDP DATA - CONSUMER SENTIMENT FOR JAN - EMPLOYMENT COST INDEX FOR Q4:09

ALL MARKETS CLOSED

Thur. Jan. 28 US – DURABLE GOODS ORDERS DATA FOR DEC

J A N U A R Y 2 0 1 0 T h e Fo re x J o u r n a l

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