November 2005 - Strategies, News and Analysis

November 2005 • Strategies, News and Analysis for Forex Traders
Volume 2, No. 11
WALLWOOD CONSULTANTS
FOREX EDUCATORS TURNED CTA MAKE THE GRADE
• THE BEST TIMES TO TRADE • BARBARA ROCKEFELLER

different currencies Technicals duel
fundamentals
• EURO STRATEGY
ANALYSIS • AUSSIE AND
reveals market KIWI DOLLARS:
tendencies What’s the play?
• CURRENCY OUTLOOK FOR:

Dollar/Canada,
dollar/yen, Euro/dollar
CONTENTS
Zero-interest rate policy weighs

on yen . . . . . . . . . . . . . . . . . . . . . . . .14
Will the yen fight back to its 2002
price levels?
By Currency Trader Staff
Of Kangaroos and Kiwis:

The dollars down under . . . . . . . . . . .16
Find out what the future has in store for
Australia and New Zealand’s economies
and currencies.
By Marc Chandler and Michael Woolfolk
Dollar depreciation likely to resume . .20

The buck still faces challenges as the
year winds down.
By Tim Clayton
Big Picture
Contributors . . . . . . . . . . . . . . . . . . . . .6 Fundamentals duel the technicals . . .24
The market often processes “news” in
mysterious ways, but that’s part of trading.
Letters . . . . . . . . . . . . . . . . . . . . . . . . . .8 By Barbara Rockefeller
Currency Trader Interview

Industry News Wallwood Consultants practice
Congress, industry debate what they preach . . . . . . . . . . . . . . . . .30
CFTC authority . . . . . . . . . . . . . . . . . .10 A look at how a two-man forex firm
While futures firms want to expand the successfully trades the forex market.
power of the Commodity Futures Trading By Currency Trader Staff
Commission to help fight fraud, others are
worried about giving the CFTC too much Currency Strategies
clout. Price behavior in the Euro . . . . . . . . .34
MFE/MAE analysis sheds light on the
Bernanke tabbed as new Fed head . . .11 Euro and how to trade it.
With Alan Greenspan set to retire in By Thom Hartle
January, President Bush selected
economist Ben Bernanke to be
Greenspan’s successor.
Forex Resources . . . . . . . . . . . . . . . .11
Global Markets
The New Darling: Dollar/Canada . . . . .12
Can Canada keep up its strength
into next year?
By Currency Trader Staff
continued on p. 4
2 November 2005 • CURRENCY TRADER

CONTENTS
Currency Futures . . . . . . . . . . . . . . .45

News and trading statistics from the
currency futures world.
Currency Basics . . . . . . . . . . . . . . . .46

Comparing moving averages
A comparison of different types of
moving averages.
Currency Trader Q&A By Thom Hartle
Catching up with Richard Olsen . . . . .37
A brief conversation with Olsen Group Global Economic Calendar . . . . . . .50
founder Richard Olsen.
By Currency Trader Staff Events . . . . . . . . . . . . . . . . . . . . . . . . .51
Currency Strategies International Market Summary . . .52

Trading around the clock, part I . . . . .38
What are the best times to trade Global News Briefs . . . . . . . . . . . . .54
different currency pairs?
By Kathy Lien Forex Trade Journal . . . . . . . . . . . .55
Currency System Analysis . . . . .42 Key Concepts and Definitions . . . .56

Dual timeframe stochastics.
Have a question about something you’ve seen in

Currency Trader?
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CONTRIBUTORS
CONTRIBUTORS
Barbara Rockefeller (www.rts-forex.com) is an international

economist with a focus on foreign exchange. She has worked as a fore-
caster, trader, and consultant at Citibank and other financial institu-
tions, and currently publishes two daily reports on foreign exchange.
Rockefeller is the author of Technical Analysis for Dummies (2004), 24/7
Trading Around the Clock, Around the World (John Wiley & Sons, 2000),
A publication of Active Trader ® The Global Trader (John Wiley & Sons, 2001), and How to Invest
Internationally, published in Japan in 1999. A book tentatively titled
How to Trade FX is in the works.
For all subscriber services:
www.currencytradermag.com
Thom Hartle is a private trader and president of
Editor-in-chief: Mark Etzkorn Market Analytics Inc. (www.thomhartle.com). In a
metzkorn@currencytradermag.com career spanning more than 20 years, Hartle has been a
commodity account executive for Merrill Lynch, vice
Managing editor: Molly Flynn president of financial futures for Drexel Burnham
mflynn@currencytradermag.com Lambert, trader for the Federal Home Loan Bank of
Seattle, and editor for nine years of Technical Analysis
Associate editor: David Bukey
of Stocks & Commodities magazine.
dbukey@currencytradermag.com
Marc Chandler is the head of global foreign
Contributing editors: Jeff Ponczak exchange strategies at Brown Brothers Harriman and
jponczak@currencytradermag.com, an associate professor at New York’s School of
Continuing and Professional Studies. From May 2001
Contributing writer: Carlise Peterson through Oct. 1, 2004, he was chief currency strategist at
HSBC Bank USA. Prior to HSBC, he was the chief cur-
Editorial assistant and rency strategist at Mellon Financial, a senior currency
Webmaster: Kesha Green strategist at Deutsche Bank, and the director of
kgreen@currencytradermag.com research at EZA Associates.
Art director: Laura Coyle Michael J. Woolfolk is senior currency strategist and vice presi-
lcoyle@currencytradermag.com dent in the Global Markets Division at The Bank of New York. He is
responsible for North American currency research at the Bank of New
President: Phil Dorman York and is the chief architect and product manager for the highly
pdorman@currencytradermag.com acclaimed interactive Portfolio Monitor (iPFM), which tracks the cross-
border investment trends of the Bank’s $10 trillion custody business. As
Publisher, the sole press contact for the New York dealing room, he appears regu-
Ad sales East Coast and Midwest: larly on television and radio, and is frequently cited in the financial
Bob Dorman press. Before joining the Bank of New York, he worked at Credit Suisse
bdorman@currencytradermag.com First Boston as a currency analyst in their London and New York
offices. Woolfolk is currently an adjunct faculty member of New York
Ad sales University and teaches a course on international political economics.
West Coast and Southwest only:
Allison Ellis José Cruset (jose@wealth-lab.com) is a private trader, software
aellis@currencytradermag.com engineer, and trading system researcher. He holds an MBA and a
NASD-Series 3 certificate and has worked many years in the banking
Classified ad sales: Mark Seger industry.
mseger@currencytradermag.com
Kathy Lien is a chief strategist at FXCM, where
she is responsible for research and analysis for
DailyFX.com, including technical and fundamental
Volume 2, Issue 11. Currency Trader is published monthly by TechInfo, Inc., research reports, market commentaries, and trading
150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2005 strategies. She was an associate at JPMorgan Chase,
TechInfo, Inc. All rights reserved. Information in this publication may not be
stored or reproduced in any form without written permission from the publisher. where she worked for more than three years in credit
derivatives, cross markets, and foreign exchange trad-
The information in Currency Trader magazine is intended for educational pur-
poses only. It is not meant to recommend, promote or in any way imply the ing. Lien’s experience encompasses trading both in
effectiveness of any trading system, strategy or approach. Traders are advised and out of the forex market, including interest rate derivatives, bonds,
to do their own research and testing to determine the validity of a trading idea.
Trading and investing carry a high level of risk. Past performance does not equities, and futures. She has written for various industry publications
guarantee future results. and news outlets, including CBS MarketWatch, and she is frequently
quoted on Bloomberg and Reuters. She is also author of the new book
Day Trading The Currency Market (John Wiley & Sons).

LETTERS
Spot vs. futures
T
he Euro FX trade shown in the September issue Spot forex prices don’t have an official “close” because the trading
refers to the September contract, but the chart session keeps moving to different market centers around the globe.
shown is for continuous futures. Why? Is it better to In most cases, though, the New York session closing price is often
do one’s analysis on continuous futures charts as opposed used as the closing price on daily bars.
to spot forex charts? When it comes to actually buying and selling, it’s important to
Thank you for your suggestions. reference the instrument you’ll be trading — futures or spot. You
can gain important insights analyzing both price series, however.
—Joseph The differences between spot and futures data is sometimes
misrepresented. The December issue of Currency Trader will fea-
In this case, using the continuous futures chart was simply a mat- ture an article comparing spot forex and currency futures data.
ter of convenience. Whenever the contract you are trading or ana-
lyzing is the “front month” contract (the one closest to expira-
tion), the continuous futures data will be the same as the front-
month data. At the time this trade was entered (early August), the
Back issues and articles
September Euro FX contract was the front-month contract, which How do I acquire all of the past issues?
means the prices on the continuous futures
chart were identical to the September con- — Christian
tract price.
For longer-term historical analysis or Individual Currency Trader (and Options
system testing, continuous futures are nec- Trader) articles are now available for
essary because of the price jumps that occur download through the Active Trader
from one contract month to the next. Also, store (www.activetradermag.com/pur-
you won’t be able to reference historical chase_articles.htm).
highs and lows if you simply use the cur- Also, in the near future, we will be
rent front month. In terms of futures, it’s a offering compilations of back issues
good idea to look at both continuous and on CD. Check our Web sites for
individual contract month price data. updates.
The major difference between spot forex
data and currency futures data (on a daily
basis) is the location of the closing price.
Three good tools for targeting customers . . .
— CONTACT —
Bob Dorman Allison Ellis Mark Seger
Ad sales East Coast and Midwest Ad sales West Coast and Southwest Account Executive
bdorman@activetradermag.com aellis@activetradermag.com mseger@activetradermag.com
(312) 775-5421 (626) 497-9195 (312) 377-9435

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INDUSTRY NEWS
Broad or narrow?
Congress, industry debate CFTC authority
T he Commodity Futures Modernization Act,

passed by Congress in 2000, gave the Commodity
Futures Trading Commission the authority to reg-
ulate foreign currency futures and options contracts as long
as they didn’t fall under another jurisdiction.
certain the CFTC would concentrate its efforts on those vital
areas of our economy.”
Opponents of a broad fix fear that legitimate business
transactions (e.g., the purchase of foreign currency at a cur-
rency exchange, or transactions done by a bank or insur-
However, the recent Zelener case, in which a court ruled ance company) would suddenly be under CFTC jurisdic-
that spot forex transactions that called for delivery within tion.
two days were cash contracts and therefore not under the “Nearly every prior [change in federal law] involving
jurisdiction of the CFTC, even though the contracts were the scope of CFTC jurisdiction has caused significant
often “rolled over” like a typical futures contract and disputes or uncertainty with adverse consequences,”
bought on margin, raised questions as to how says Marc Lackritz, president of the Securities
much power the CFTC actually has (see “Court Industry Association. “It is imperative that
case brings CFTC’s authority into question,” Congress avoids legislative initiatives that
Currency Trader, May 2005). will create these problems in new areas of
As a result, the CFTC has asked for greater economic activity — particularly where no
power in handling similar cases. A Senate compelling public policy case has been pre-
committee wants to give it to them, in the sented for enacting legislation that might
form of the Commodity Exchange give rise to such risks.”
Reauthorization Act (CERA). The CERA, Chicago Mercantile Exchange chairman
which is on the calendar for a full vote by the Terry Duffy believes that addressing possible
Senate, extends the CFTC’s powers to cover situa- violations in other commodities only after multi-
tions like those in the Zelener case. ple cases of fraud have occurred is a case of
Nonetheless, a debate rages as to just how much closing the barn door after the horse has left.
power the CFTC should have. While some believe any “Under the Zelener case, it does not matter
new rule changes should affect only foreign exchange trans- what the dealer actually does or what the customer actual-
actions, others think a variety of commodities should also ly expects,” Duffy says. “The sharp operators and bucket
be covered. shops have already figured out that the rationale of the
“The Zelener case is not only about foreign exchange Zelener opinion can apply to commodities other than forex.
products,” says Charles Carey, chairman of the Chicago How soon will it be before the CFTC’s jurisdiction and its
Board of Trade. “The contract the Zelener Court found to be retail consumer protections are reduced to irrelevance?”
outside the jurisdiction of the CFTC may just as easily be Duffy says the solution is a rule change that removes any
utilized by scammers to induce the unsuspecting to invest ambiguity from the existing law that allowed the Zelener
in other commodities. decision and applies to all commodity products, not just
“Such fraudulent operators could cause a scandal similar forex. Duffy and the CME have proposed legislation that
to those involving options on sugar and other commodities provides for this without giving the CFTC power over spot
in the mid-70s. Such a scandal could, as then, reflect forex or interbank transactions.
adversely on the legitimate financial services and deriva- “The trick is to protect retail customers without upsetting
tives industry in the U.S.” jurisdictional boundaries that were agreed to in the
However, those who wish to limit the CFTC’s authority CFMA,” says Daniel Roth, president of the National
are concerned that new rules could give the Commission Futures Association (NFA). “Some have suggested that the
too much power and distract it from its original mission. best approach is to address Zelener only with respect to
“The FIA disagrees with those who seek a broad fix,” forex products. Forex is the current scam of choice among
says John Damgard, president of the Futures Industry fraudsters, but limiting a Zelener fix to forex ignores the his-
Association (FIA). “Expanding the CFTC’s jurisdiction to tory of sales practice fraud and will not, in our view, really
apply to any form of non-futures contracts would have pro- address the problem.
found and, FIA believes, adverse implications for the “In NFA’s 20 years of experience, we have seen that boil-
CFTC’s ability to discharge its oversight of futures and er rooms really prefer to sell physical commodities that
options exchange-trading, especially given the agency’s retail customers deal with all the time. Sugar, gold, unlead-
structure and limited resources.” ed gasoline, heating oil — these are the products that boiler
“Congress granted the CFTC exclusive jurisdiction over rooms have historically favored. Foreign exchange rates, by
the futures and related options markets in order to make contrast, are fairly arcane.”

Goodbye, Mr. Greenspan
Bernanke tabbed as new Fed head
W ith the imminent retirement of 18-year Federal

Reserve Chairman Alan Greenspan when his
term expires at the end of January, the unenvi-
able task of keeping the economy in check while making
sure his comments don’t lead to a meltdown on Wall Street
Jones and S&P 500 had their biggest one-day increases since
April on the day Bernanke’s nomination was announced.
“Ben has done path-breaking work in the field of mone-
tary policy, taught advanced economics at some of our top
universities, and served with distinction on the Fed’s Board
has been given to Ben Bernanke. of Governors,” Bush said at a press conference. “He’s
Bernanke, the chairman of President Bush’s Council of earned a reputation for intellectual rigor and integrity. He
Economic Advisers, was appointed by Bush on Oct. 24 to commands deep respect in the global financial communi-
fill Greenspan’s rather large shoes. A former Fed governor, ty.”
Bernanke is well-liked and experts believe his confirmation Bernanke said his first priority would be to maintain con-
process will be quick and easy. tinuity with the policies and strategies established during
The stock market agreed with the selection, as the Dow the Greenspan years.
FOREX RESOURCES
Inspired by the book The Wisdom of Crowds by James Surowiecki,

www.ConsensusView.com was launched to discover whether the idea
that the many are smarter than the few can give traders an edge in the financial
markets. The Web site allows participants in the stock, forex, and futures mar-
kets to forecast the direction of the markets and in return see the consensus view
of where a market is heading. Participation is free and there is $12,000 of prize
money for the best forecasters, with an additional prize of $250 for the person
that referred them to the site. ConsensusView.com is the first Web site to open
the voting to all members of the trading community and to capture the consen-
sus on a daily basis. It keeps track of the hit rates of individual participants as
well as the hit rate of the consensus. Voting for all markets opens at 4:30 a.m.
London time and closes for each market as soon as it opens. Voters then get to
see the consensus view for that market. Furthermore, the site displays the top
five forecasters in each market as well as individual and consensus view hit
rates. The site covers the constituents of the S&P 500, the FTSE 100, and the top
70 stocks on the Toronto Stock Exchange. It also covers the 40 most actively trad-
ed futures markets as well as the 20 most actively traded forex currency pairs.
The EFX Group Williamsburg branch is now offering hedge funds and
institutions their lowest available Tier 3 commission rate. Commissions are
based on the total dollar amount of currency traded each month; retail accounts
are initially charged $7 per $100,000 traded. At the end of each month, the total
dollar amount traded is calculated and a commission rebate is issued. Hedge
funds and institutions that open an account through the Williamsburg branch
will automatically receive their lowest rate of $5 per $100,000 traded, which is
normally only available after $70 million in currency is traded each month. For
more information on the three tiers and rates, visit
www.efxgroup.com/williamsburg.
CURRENCY TRADER • November 2005 11

GLOBAL MARKETS
The New Darling: Dollar/Canada

Commodities and favorable interest rates put the pluck in the Canadian buck.
The energy outlook looms large in the currency’s future.
BY CURRENCY TRADER STAFF
D espite a modest upside correction in the U.S.

dollar/Canadian dollar rate (USD/CAD) into
mid-October (Figure 1), the overriding long-
term bear trend remains intact and currency
watchers expect renewed weakness in this pair into year-end.
Since early 2002, the Canadian dollar has been in a strong
appreciation mode, and for now that long-term trend is in
actually skewed more toward natural gas than crude oil.
Natural gas comprises 6 percent of the total Canadian
export basket, she says, vs. 5.6 percent of crude exports.
Nonetheless, sharp rallies in both those energy products
have benefited the Canadian dollar.
“Canadian natural gas exports comprised 16 percent of
U.S. natural gas consumption in 2004,” Buskas says.
force, analysts say. The USD/CAD has plunged from a She adds that Canada exports more than one million bar-
record-high $1.61 in January 2002 to the lowest levels in rels per day of crude oil to the U.S. “Canada is a small, but
more than a decade at $1.1586 in September 2005 (Figure 2). important energy exporter, given its proximity to the U.S.,”
“It is the currency in vogue right now,” says Tim she says.
Mazanec, senior FX strategist at Investor’s Bank & Trust Co.
Tightening phase
Commodity currency Another supportive factor to the Canadian currency (espe-
Analysts say the massive appreciation in the Canadian dol- cially the non-U.S. dollar cross rates) going forward is the
resumption of an interest-rate tightening cycle by the BOC.
lar can in large part be attributed to the bullish cycle in com-
modities. Canada, a large commodity producer and The BOC has begun raising rates in an attempt to slow
exporter, has benefited from the bull runs in the energy, the economy and reign in burgeoning inflation. As had
lumber, and metals markets over the past several years. been widely expected, the BOC pulled the trigger on a rate
“The Bank of Canada’s commodity index is up 25.7 per- hike on Oct. 18, pushing the overnight rate 25 basis points
cent from last year,” says David Powell, currency analyst at(bp) higher to 3 percent, the highest level in more than two
Ideaglobal. years. That move was the second hike in 2005, after a 25-bp
The BOC has comprised a weighted index of the com- hike in September.
modities that Canada produces. The weights of some key Also, in its policy statement, the BOC said additional rate
components are as follows: crude oil 21.40, lumber 13.58, hikes would be needed over the next four to six quarters to
keep inflation on target. The central bank utilizes monetary
and natural gas 10.69. Details on that index can be found at:
www.bankofcanada.ca/en/rates/commod2.html. policy to keep inflation near the midpoint of a 1- to 3-per-
A sharp rise in demand for energy products in recent cent range.
years has helped to bolster the Canadian economy and cur- Currency market participants recently honed in on the
rency. Charmaine Buskas, foreign exchange economist at bank’s comments that the Canadian economy “appears to
Economy.com, notes the Canadian energy export market is be operating at its full production capacity.”
“Previously, the BOC had predicted that
wouldn’t happen until the second half of 2006,”
U.S. DOLLAR /CANADIAN DOLLAR AT A GLANCE Powell says. “The output gap has now closed.”
Average daily range (past 40 days) .0097 While ahead of the October rate hike, most
Average weekly range (past 26 weeks) .00222 analysts had expected the BOC to remain on
52-week high/low 1.2694 / 1.1630 hold at its next meeting on Dec. 6. Now ana-
U.S. CAN lysts say the forecasts have shifted. Most mar-
Prevailing interest rates (%) 4.0 3.0 ket watchers expect another 25-bp hike in
Next central bank meetings Dec. 13 Dec. 6 December, which would bring the overnight
GDP Q3 2005* Q2 2005 Q1 2005 rate to 3.25 percent by year-end.
US CAN US CAN US CAN Looking beyond that, Economy.com’s
3.8 3.2 3.3 2.7 3.8 3.2 Buskas expects another 50 bps of tightening in
All data as of Nov. 1 *Estimate 2006.

FIGURE 1 — U.S. DOLLAR/CANADIAN DOLLAR, DAILY
Narrowing interest-rate Despite the bounce this month, the long-term downtrend reflecting the
differentials Canadian dollar’s strength is still intact.
The BOC’s latest rate hike narrows the
U.S.-Canada interest-rate differential. As of
Nov. 1, the U.S. fed funds rate was at 4.00
percent, in the wake of 12 consecutive rate
hikes by the Federal Reserve.
Despite the narrowing, “the interest rate
differential is still in favor of the U.S,” says
Bob Lynch, head of G-10 FX strategy,
America at HSBC. In fact, analysts say
Dollar/Canada has trended lower in recent
years in spite of negative interest-rate dif-
ferentials.
Nonetheless, the BOC and the Fed are
raising rates at the same pace — Mazanec
says both banks are expected to raise them
at the next three meetings.
A look at the data

Lynch believes the fundamental backdrop Source: TradeStation
is relatively positive for Canada because it
runs a trade surplus and has the best fiscal
FIGURE 2 — U.S. DOLLAR/CANADIAN DOLLAR, MONTHLY
position within the G-7.
In 2004 Canada’s gross domestic product After making record highs in 2002, the USD/CAD made new lows in September
(GDP) performance came in at 2.8 percent, 2005.
vs. expectations for 2.7 percent this year.
Into 2006, however, Mazanec says the
Canadian economy may grow upwards of
3.0-3.5 percent.
Economy.com’s Buskas estimates third-
quarter GDP at 3.2 percent and fourth quar-
ter at 3.1 percent.
On the inflation front, consumer prices
shot up 2 percent year-over-year in August,
while core prices gained 1.7 percent.
On the crosses
There has been increased interest in trading
the Canadian dollar on the crosses, accord-
ing to HSBC’s Lynch. Analysts say buying
the Canadian dollar vs. the Euro, Swiss
franc, and Japanese yen has been a favored
play, given Canada’s positive interest-rate.
“It is the favorite currency for people to
be ‘longing’ right now,” says Ideaglobal’s Source: TradeStation
Powell.
Key levels Mazanec reiterates a long-held market adage: “You never

Looking ahead, energy prices will be a key factor of addi- really want to go against the trend, until the trend is bro-
tional Canadian dollar strength. Analysts say if energy prices ken.”
hold near current levels or strengthen, it will likely translate He points to the $1.1950 level as key resistance to watch
into further Canadian dollar gains vs. the greenback. on the upside for the USD/CAD.
Most analysts expect the USD/CAD to retest the “A close above that level might give us a signal that a low
September low of $1.1586 before year-end. Ideaglobal’s is in,” he concludes. Conversely, a push back under $1.1650
Powell saw potential toward the $1.14 area by year-end. and “traders would start looking for $1.1200.”

GLOBAL ECONOMY continued
Zero-interest rate policy weighs on yen

Japan’s stronger economic performance would seem to be good news for the yen, but the country’s
sustained zero-interest rate policy is keeping the pressure on.
U.S. DOLLAR/JAPANESE YEN AT A GLANCE
Average daily range (past 40 days) .84
A fter three years of bearish Average weekly range (past 26 weeks) 1.89
action, U.S. dollar/Japanese 52-week high/low 115.99 / 101.68
yen (USD/JPY) bulls have U.S. JP
controlled the market for Prevailing interest rates (%) 4.00 0
much of 2005 (Figure 1). And with bullish Next central bank/
interest rate differentials strongly favoring monetary meetings Dec. 13 Nov. 18
the U.S. dollar, most currency watchers GDP Q3 2005* Q2 2005 Q1 2005
expect the uptrend in dollar/yen to contin- U.S. JP U.S. JP U.S. JP
ue into year-end. 3.8 0.4 3.3 3.3 3.8 5.8
All data as of Nov. 1 *Estimate
Dollar/yen tested major long-term sup-
port at the 101.50 area in January 2005
and that floor proved to be a solid
launching pad for months of steady FIGURE 1 — DOLLAR/YEN, MONTHLY
gains in the pair. Since that January Dollar/yen bulls have been in control since the market bottomed at the
low, dollar/yen bulls have propelled beginning of this year.
the pair toward the 116 level as of late
October (Figure 2).
Plain and simple, bullish interest
rate differentials in the U.S. dollar’s
favor have been a major factor pro-
pelling dollar/yen higher for much of
this year. As of Nov. 1, the U.S. Fed
funds rate stands at 4 percent vs. the
Bank of Japan’s zero-interest rate poli-
cy.
Searching for yield

Analysts point to an outflow of
domestic Japanese money as a factor
weighing on the yen, as investors
there chase higher yields elsewhere.
“Japanese individuals are fed up
with zero interest on bank deposits,”
says Masaaki Kanno, managing direc-
tor at JP Morgan in Toyko.
“Japanese investors are understand- Source: TradeStation
ably attracted to much higher yields
available offshore,” says Sean Callow, senior currency points. Japanese demand for bonds such as New Zealand’s
strategist at Westpac Institutional Bank in Singapore. “For has been very robust — not just from institutions, but also
instance, U.S. two-year Treasury bonds offer almost 4 basis from retail, individual investors.”
points of pick-up over two-year Japanese government In recent weeks, speculators have jumped on the
bonds, while New Zealand offers a huge 5.90 extra basis dollar/yen bull trend bandwagon as well. Callow noted that

FIGURE 2 — DOLLAR/YEN, DAILY
the recent Committment of Traders
data, released by the CFTC, revealed September and October were especially strong months for the currency pair,
that large speculators had built up their which had peaked just shy of 116 as of Oct. 25.
highest long dollar/yen futures posi-
tions since 1999.
Higher levels for dollar/yen

Several market watchers saw potential
for the dollar/yen to continue its rally
into year-end. JP Morgan’s Kanno tar-
geted gains in dollar/yen by the end of
December at 118 and as high as 120 by
March 2006.
“As long as the Fed continues to
hike the Fed funds rate in November
and December, widened interest rate
differentials will induce further capital
outflow from Japan,” Kanno says.
Tim Mazanec, senior foreign
exchange strategist at Investor’s Bank
& Trust, noted that the 115 level is sig-
nificant on a longer-term basis for the
dollar/yen. As of late October, it had Source: TradeStation
pushed above that key level, climbing
as high as 115.99. more upbeat than we had expected, which tends to suggest
“The 115 level has been critical over the past four years as the bank may indeed be taking some cautious steps forward
both support and resistance,” he says. “If we can stay above in terms of preparing markets for a policy shift,” says Dr.
it, that would be extremely bullish and we could see gains Matthew Cairns, senior economist at Economy.com.
toward the 122 area over the next six to 12 months.” Cairns noted that the BOJ has outlined three conditions that
In the Oct. 21 issue of The Global Economy This Week, ana- will need to be met for the bank to shift its current policy.
lysts at Credit Suisse First Boston bumped up their three- “Core consumer prices must stop falling at least for a few
month dollar/yen forecast to 117. months, and board members must be sure that prices won’t
“We have moved toward a more yen-negative forecast resume their fall,” he says. “Also, the bank must be confi-
near term as Japanese investors unhedge existing stocks of dent about the overall strength of the economy.”
hedged foreign assets, overshadowing foreign inflow to JP Morgan’s Kanno believes that a 0.25-percent rate hike
equities,” CSFB analysts wrote. could occur in the second half of 2006.
However, other market watchers believe the end of the
Brighter economic prospects ahead zero-interest rate policy could take even longer. In the
Despite calls for further weakening in the Japanese curren- fourth quarter 2005 Global Forex Outlook report, analysts at
cy vs. the dollar, economists say Japan’s overall fundamen- Ideaglobal wrote, “we do not look for an ending of ZIRP
tal outlook is improving. [zero-interest rate policy] during the 12-month forecast
“We are optimistic about Japan’s recovery, seeing a horizon and feel that an actual hike can occur in the period
growth of at least trend in 2005 at 2.0%,” says Westpac’s of November 2006-May 2007.”
Callow.
Job creation is expected to continue, with expectations for MOF back in play?
the overall unemployment rate to fall to 3.8 percent in 2006 For now, the Ministry of Finance has been on the sidelines
from an expected 4.3 percent in 2005. in terms of dollar/yen action. But if the recent rally contin-
The September general election win by Prime Minister ues, some say the MOF may step back into play.
Junichiro Koizumi was seen as a bullish factor for the “There is some likelihood that the Ministry of Finance
Japanese economy, as a major goal of Koizumi’s is privati- will make a dollar selling intervention if dollar/yen goes
zation of the Japanese postal system (which also includes above 120,” Kanno says.
the nations largest bank), which is seen as constructive for While analysts generally contend central banks have a
longer-term growth there. difficult time changing a long, strong trend in the foreign
exchange market, shorter-term currency traders need to
End of zero-interest rate policy in sight? stay on their toes around major price levels, which could
“The BOJ’s most recent assessment of the economy was potentially draw in central bank intervention.

GLOBAL MARKETS
Of Kangaroos and Kiwis:

The dollars down under
The past few years have been good
to the Aussie and Kiwi dollars, but
uncertainties over global commodity
demand and interest-rate shifts could alter
the landscape for these currencies.
BY MARC CHANDLER AND MICHAEL WOOLFOLK
FIGURE 1 — AUSSIE DOLLAR
T
Favorable interest-rate differentials and a positive outlook for commodities have
he Australian and New fueled both the Aussie and Kiwi dollars in recent years.
Zealand dollars are
interesting currencies for
speculators, investors,
and economists, but are not regarded
as major currencies. Their liquidity has
traditionally been concentrated in the
local markets, but over the past couple
of years interest has grown globally, for
a number of reasons (Figure 1).
From an economic point of view,
one of the most interesting things dis-
tinguishing the antipodean currencies
from the Canadian dollar, with which
they often get lumped together, is that
both Australia and New Zealand have
significant current account deficits.
According to an Economist magazine
survey, Australia’s current account
deficit is expected to be almost 6 per-
cent this year and a still-wide 5.5 per-
cent next year. New Zealand’s trade Source: TradeStation
deficit is on pace this year to reach
nearly 8 percent of GDP, and any improvement next year is Japan. The Swiss franc has declined about 11 percent
likely to be marginal. against the U.S. dollar from January through late October
Both the Australian and New Zealand dollars have lost this year and the Japanese yen has depreciated about 11.5
ground against the U.S. dollar this year (Figure 2). But their percent over the same period.
less than 3-percent declines mean that on a relative basis In fact, one popular trade this year among some specula-
they have outperformed currencies from countries with tive players and Japanese investors has been buying the
sizeable current account surpluses, such as Switzerland and Australian and/or New Zealand dollars against the Japanese
A popular trade this year among some speculative players and Japanese
investors has been buying the Australian and/or New Zealand dollars against
the Japanese yen.
yen (Figure 3). In early October, the New Zealand dollar much as last year’s levels and appear to be an important
reached an eight-year peak against the yen and the source of demand for the New Zealand dollar.
Australian dollar recorded a seven-year high against the yen.
Forex speculators have been drawn to the trade in part to Economic analysis
express a favorable view of commodities. Australia, for The New Zealand economy appears to be on somewhat
example, is the world’s fourth largest producer of copper, more solid footing than Australia’s. At 1.1 percent, Q2
and copper prices have rallied sharply to new all-time growth was stronger than consensus expectations. The
highs. Some traders also emphasize the role of Australia as widening current account deficit appears to reflect robust
a producer of gold, which recently reached 17-year highs. domestic demand. Building approvals, while still below last
year’s levels, rose 6.8 percent in August to a five-month
Interest rate differentials: high.
Advantage New Zealand? The Australian economy is more fragile. Housing and
Market players have also been attracted to the relatively high consumer spending, previously important growth engines,
yields offered by Australia and New Zealand. Their key rates, are slowing, without new leadership emerging. Some
comparable to the U.S. Fed Funds rate,
stand at 5.5 percent and 6.75 percent, FIGURE 2 — KIWI DOLLAR
respectively. Official interest rates in The Australian and New Zealand currencies have lost ground to the U.S. dollar
Australia have been on hold since they this year, but not as much as many other currencies. Looking forward, the New
were last raised in March. In contrast, Zealand dollar may be better positioned than the Aussie dollar.
New Zealand hiked its official rate to 7
percent on Oct. 27, the eighth hike since
the beginning of last year. Another hike
in December is also possible.
Although the yield pick up for the
U.S. (3.75 percent Fed Funds rate,
which will likely rise to 4.25 percent by
year-end) and European investors (2.0
percent key rate, with the ECB likely
on hold for at least several months), is
substantial, it is even more significant
for Japanese investors, where
overnight interest rates remain close to
zero and 10-year bond yields are
around 1.45 percent. Australia’s 10-
year bond yields are around 5.35 per-
cent and New Zealand’s 10-year bond
yields are just below 6 percent.
A number of corporations, including
Germany’s agriculture and forestry
financial corporation Rentenbank, Source: TradeStation
The New Zealand dollar is better positioned to hold its own. Its central bank is one
of the few that can keep pace with the Fed’s tightening in the coming months.
supranational agencies such as the World Bank, and sover- hoped exports would assume the mantle, but these fell
eigns such as the Province of Ontario, have offered New about 3 percent in August to a five-month low. Commodity
Zealand dollar-denominated bonds in Japan aimed at retail exports, which account for about 10 percent of Australia’s
investors. GDP, have weakened, especially foodstuffs and fibers. For
Reports suggest Japanese retail investors have shifted example, the export of wheat and other cereals are off 38
their preference from Australian fixed-income instruments percent year-over-year and world exports have fallen by 14
to New Zealand denominated issues. At a little less than percent in the July-August period.
NZD $20 billion, the issuance of these bonds, called “uri- Unlike New Zealand, Australia also recorded a decline in
dashi” and “eurokiwi,” are running at nearly twice as continued on p. 18

GLOBAL ECONOMY continued
imports, suggesting domestic demand is soft. Some meas- common in the foreign exchange market.
ures of consumer confidence stand at two-year lows despite There is an exchange traded fund for Australian stocks — the
a fairly tight labor market. Unemployment in Australia MSCI Australian index (EWA). Even with the sharp decline in
stands at 5 percent, down from 5.7 percent a year ago. Australian shares in recent days, it is still up more than 10 per-
Rising gasoline prices and a softer housing market appear cent on the year and about 41 percent year-over-year.
to have taken their toll. A popular way to play Australia’s commodity exposure
Profit-taking on commodity and energy companies, fears is through BHP (symbol BHP), the world’s largest mining
the U.S. economy may be slowing, and a sell-off in global company. It trades as an ADR and is up about 31.5 percent
year-to-date and up almost 48 percent
year-over-year. Another Australian
FIGURE 3 — AUSSIE DOLLAR/YEN
company, Rinker (RIN), has attracted
In 2005, some traders and Japanese investors have been buying the Australian much interest as a way to get some
(or New Zealand) dollar against the Japanese yen. Australian market exposure as well as
play the U.S. construction sector
(housing and reconstruction). Rinker is
the biggest supplier of cement blocks
in the U.S. It is up about 88 percent
over last year and about 43 percent
year-to-date.
Currency outlooks
The near-term outlook for the
Australian dollar is favorable, especial-
ly if the U.S. dollar corrects from its
broad September/October rally.
However, unless the economic data
convinces the market a Reserve Bank of
Australia (RBA) hike is likely in the
first quarter of 2006, the AUD can buck
the generally firm tone for the U.S. dol-
lar. In a strong U.S. dollar environment,
the Australian dollar may generally
fare even better than the Swiss franc,
Source: TradeStation Euro, or yen.
The New Zealand dollar is better
equity markets triggered a sharp sell-off in Australian positioned to hold its own. Its central bank is one of the few
stocks recently. The S&P/ASX 200 Index dropped 4.3 per- that can keep pace with the Fed’s tightening in the coming
cent on Oct. 5 and 6, the largest two-day decline since months, which may help the Kiwi hold up on a cross basis
September 2001, when the terrorist attack on New York City as well. The NZD could rise into the $0.7100-0.7150 area,
triggered a 4.7-percent decline. The sell-off has come from which capped during the summer, from its current $0.6960
lofty levels as the index made its record high on Sept. 29. area. That said, an advance above $0.7100 would violate a
Australia’s GDP is about $400 billion, while New Zealand’s six-month downtrend and could trigger a stronger move.
is around $59 billion. Australia is New Zealand’s largest trad-
ing partner, absorbing about a fifth of its exports and account- Balancing acts
ing for about a quarter of its imports. Given the size consider- Australia and New Zealand both suffer from structural cur-
ations and economic integration of New Zealand with rent account imbalances owing partly to their geographical
Australia, many equity investors take a combined view of isolation. Despite being important commodity exporters,
their currencies, although playing the Aussie/Kiwi cross is both economies are highly developed and driven by con-
Interest rates in New Zealand and Australia typically offer a 100-200 basis point
premium over rates in countries with similar risk and inflation.
sumer spending. Given the relative wealth of Aussie and rate differentials can impact antipodean currency valua-
Kiwi consumers and the largely commodity-based nature tion.
of the local economies, many consumer goods are imported
from the U.S., Europe, Japan, and Emerging Asia. In con- Searching the horizon
trast to other developed nations, Australia and New Looking forward, the long-term outlook is not favorable
Zealand’s structural trade deficits are inflexible to foreign for the antipodean currencies. Tighter monetary and fiscal
exchange rates because of this lack of domestic production policies globally are likely to slow global demand for
of substitute consumer goods. Aussie and Kiwi commodity exports as well as lower com-
Australia’s current account has been in deficit for more modity prices in general. With current account imbalances
Tighter monetary and fiscal policies globally are likely to slow global demand for
Aussie and Kiwi commodity exports as well as lower commodity prices in general.
than 40 years, and has varied between -2 to -7 percent of unlikely to correct significantly over the next several years,
GDP over the past twenty years. This measure cycles every the expected compression in interest-rate differentials will
four to five years with changes in the economy and value of undermine the value of the AUD and NZD on reduced
the currency. demand for locally denominated deposits and bonds.
New Zealand’s current account deficit is less well- Given the regional popularity of AUD/JPY and NZD/JPY
behaved owing to the economy’s high degree of geograph- carry trades, monetary tightening in Japan may have a
ic isolation and dependence on imported goods. Over the strong negative impact on antipodean currency value. The
past 15 years it has varied from -3 to -8 percent of GDP. Bank of Japan will eventually end their zero interest rate
Concerns have emerged recently over both the pace of the policy (ZIRP) and begin lifting rates as soon as Q2 2006.
current account deterioration as well as the level. Another factor likely to weigh heavily upon interest-rate
In both instances, structural current account imbalances differentials and local currencies is housing prices. Much
are financed by structural net inflows of both direct and like circumstances in the U.S. and UK, real estate prices in
portfolio investment. One reason for this is interest rates in urban and vacation areas have soared over the past five
New Zealand and Australia typically offer a 100-200 basis years. The housing market and the risk of a downward
point premium over rates in countries with similar risk and destabilizing correction appears to be a policy consideration
inflation. This interest rate premium attracts foreign invest- at the respective central banks.
ment into deposits and fixed income instruments that serve The problem is most pronounced in Australia, although
to finance the structural current account imbalances in both New Zealand and Australian interest rates tend to be posi-
countries. tively correlated. While new home sales and real estate con-
The two factors that have a material impact on this bal- tinue to rise, the RBA will be reluctant to cut interest rates
ance — and therefore on the value of the local currencies — despite tepid consumer price inflation. Once the real estate
are growth and interest-rate differentials. As interest rate sector begins to cool, the RBA will have greater policy flex-
differentials rise, there is an increased attraction for local ibility and could begin cutting rates.
deposits and fixed income instruments. The AUD/USD and Whereas the near-term outlook is positive for the
NZD/USD rates thus tend to rise as interest rate differen- antipodeans, the longer-term outlook looks increasingly
tials rise. A countervailing factor is the pace of economic negative, dependent upon the compression of interest-rate
growth. As the economy accelerates, the current account differentials over the next two years and the extent of the
deteriorates. Unless interest-rate differentials correspond- impending slowdown in global growth.
ingly widen, the local currency comes under pressure. Of particular note is the variable outlook of the AUD and
This is in fact what happened during 1996 to 2001. NZD against the majors. The much-anticipated decline of
Economic growth was strong while interest-rate differen- the USD against emerging Asian currencies in general and
tials were narrow. AUD/USD fell below 0.50 in 2001 from the Chinese yuan (CNY) in particular has yet to materialize.
0.80 in 1996. Similarly, NZD/USD fell to 0.40 from 0.70 in It’s assumed China will continue to intervene to keep cur-
1996. The depreciation in the NZD was so severe that by rency appreciation in check. If it curtails its currency inter-
late 2000, the AUD/NZD cross-rate had risen to 1.30. This vention, the AUD and NZD might find another source of
prompted calls in some quarters for a currency union support.
between the AUD and NZD. Steady improvement in the
AUD/NZD cross-rate to 1.10 by 2002 buried such talk. For information on the author see p. 6.
Nonetheless, this demonstrated how growth and interest- Questions or comments? Click here.

GLOBAL MARKETS
Dollar depreciation
likely to resume
The near-term outlook is relatively stable, but major market forces could be lining up to exert more
pressure on the dollar as time passes.
BY TIM CLAYTON
Y ield factors will remain very important in

the short term, and confidence in further
U.S. interest rate hikes will offer dollar sup-
port, especially as the higher yield structure
will discourage speculative selling.
The market has, however, already factored in further rate
increases, which will make it more difficult for the U.S. cur-
lar will be much more vulnerable to any shortfall in capital
inflows, and this could be decisive in pushing the U.S. dol-
lar lower. Late in the fourth quarter, dollar losses toward
1.25 are likely.
Dollar takes advantage of yield support

The dollar has continued to draw strength from yield con-
rency to secure fresh buying inter- siderations over the past few
est. Also, growth will likely falter weeks, with a short-lived push to
as consumer spending comes the 2005 EUR/USD low of 1.1870
under pressure; this would trigger in October.
a significant deterioration in dol- Inflation and interest rate con-
lar sentiment as markets would siderations will tend to dominate
anticipate a peak in U.S. interest in the short term, especially with
rates. the jump in reported U.S. inflation.
Although the dollar’s structural Consumer prices rose 1.2 percent
weaknesses tended to be of sec- in September, with the annual
ondary importance over the past inflation rate pushing to a 15-year
two quarters, they certainly high of 4.9 percent.
should not be ignored. The high Core inflation indicators have
U.S. current account deficit will remained under control; the
sustain the risk that dollar confidence will crumble, while underlying consumer price index increase (CPI) held at 0.1
underlying central bank reserve diversification away from percent for September. The annual increase fell to 2 percent
the U.S. currency will continue. (For an in-depth look at from 2.2 percent and the Federal Reserve’s preferred meas-
central bank diversification, read “Foreign exchange ures of inflation have held below 2 percent over the past
reserves — the who, what, and why,” in the January 2006 few months. The central bank still fears the jump in energy
issue of Active Trader magazine, which will be available in and raw material costs will gradually feed wider inflation-
December.) ary pressures over the next few months.
In the short term, market forces are likely to be near bal- The Federal Reserve has increased interest rates at its past
ance, limiting dollar moves, with a 1.1870-1.22 range in the 11 meetings and there is a strong probability it will tighten
Euro/dollar rate realistic (Figure 1), and the Euro likely to again at the beginning of November. Futures markets have
gain support from a tough European Central Bank (ECB) priced in at least one further increase after that and there are
stance and potential rate increase this quarter. Once the cap- expectations short-term rates will increase to 5 percent over
ital repatriation flows stop toward the end of 2005, the dol- the course of 2006, compared with current Euro levels of 2

percent. Ten-year T-note yield spreads over German bunds straints on Fed tightening starting in early 2006.
have also increased to levels last seen in 1999, but the
Federal Reserve will need to anchor inflation expectations Important change at the Fed
to sustain attractive real yields. Additional uncertainty over Fed policy is likely to be creat-
ed early in 2006 when Chairman Alan Greenspan’s term in
Growth doubts likely to increase office comes to an end after 18 years. Ben Bernanke, head of
The Fed, however, has a dual mandate of maintaining price the Council of Economic Advisors, has been nominated to
stability and the highest possible level of employment. It succeed Greenspan and has pledged policy continuity. (see
It is possible the U.S. rate-hike cycle will peak at the end of 2005,
making the dollar vulnerable going forward.
will, therefore, be placed in a very difficult situation if there “Bernanke tabbed as new Fed head”). The new chairman is
is a rise in inflation at the same time as a deteriorating econ- likely to be slightly more cautious in the short term, espe-
omy. cially given his previous unease over deflationary trends in
The U.S. labor market remained strong in the third quar- the economy, which could deter further rate increases. It is
ter and the unemployment level remained low at 5.1 per- possible the rate-hike cycle will peak at the end of 2005,
cent. There is still likely to be unease over the sustainability making the dollar vulnerable going forward.
of consumer spending, especially as the savings rate is Interest rate levels will still offer some support even if the
already at a very low level. In this environment, any nega- Fed halts the tightening process. With U.S. rates at 1 per-
tive income shock will quickly result in lower spending cent, the dollar was vulnerable to selling pressure during
growth. continued on p. 22
Retail sales rose 0.2 percent in
September, a 1.1-percent increase
FIGURE 1 — EURO/DOLLAR, DAILY
excluding auto sales, but spending
was inflated by the sharp rise in gaso- The Euro lost ground vs. the dollar in September, but there is evidence the
line prices. Consumer confidence lev- buck’s strength will not last, given the challenges it faces in the coming year.
els have continued to deteriorate, with
little evidence of a recovery from the
hurricane Katrina shock. Although
confidence levels do not have a strong
predictive track record for consumer
spending trends, there will still be con-
cern over underlying conditions, espe-
cially if high energy prices are sus-
tained or employment growth slows.
In this context, the housing sector
will remain very important for the U.S.
economy and the currency. If prices
hold firm there will be a much-
reduced risk of a drop in consumer
spending. Conversely, any significant
drop in prices would increase the
threat to consumer spending. Overall,
the risks to retail demand will increase,
especially as rising long-term interest
rates will push up mortgage rates.
Source: TradeStation
There are, therefore, likely to be con-

GLOBAL MARKETS continued
FIGURE 2 — THE INTEREST RATE PICTURE
Interest rate differentials have shifted in favor of the dollar since 2004. While the
ECB repo rate has remained steady, the U.S. Fed funds rate had increased to 4
2003 and 2004 — there was a strong percent by Nov. 1.
incentive for investors to use the dollar
as a global “funding currency” and
invest in high-yield securities. Higher
U.S. interest rates have discouraged
dollar selling, and there has been a
greater temptation to use currencies
such as the Euro and yen as funding
vehicles. Given the rise in short-term
yields, the dollar will, therefore, be less
vulnerable to selling pressure, but it
will still be vital to sustain confidence
in the U.S. economy.
Don’t forget trade

The underlying U.S. trade deficit has
shown some signs of stabilization, but
the position is still precarious, with a
deficit of $59 billion for August.
Initially, the deficit will continue to
be inflated by high oil imports, and the
U.S. current account deficit is liable to be at least 6.5 percent dependent on short-term capital inflows to avoid deprecia-
of GDP for 2005. The U.S. has, so far, avoided payment dif- tion. The most recent capital flows data has been encourag-
ficulties, but a deficit at this level is unlikely to be sustain- ing, with net inflows of $91.3 billion for August supported
able in the medium term. by strong flows into U.S. bonds. Inflows at this level would
China’s trade surplus with the U.S. has continued to rise, alleviate short-term financing concerns and underpin the
with a $22 billion shortfall reported for August, as imports dollar. The overall risks are, however, likely to be asymmet-
from China continued to increase rapidly. There will be the rical given the wide current account deficit and likely drop
risk of escalating trade tensions if the U.S. deficit continues in official inflows.
to increase, with political pressure for stronger Asian cur-
rencies. These tensions would also increase the risk of wider ECB on alert
selling pressure on the dollar. The Euro-zone growth prospects will remain subdued in
There hasn’t been any official intervention in the curren- the near term, but there is some evidence of a German
cy markets over the past few months. The European and revival and the economy is also gaining support from the
Asian central banks are, however, likely to discourage fur- weaker Euro. Overall growth rates will remain uninspiring
ther strong dollar gains, especially as a weaker or at least a at best.
competitive dollar will be seen as an important element in The Euro-zone consumer inflation rate increased to a
narrowing global trade imbalances. Some dollar selling is revised 2.6 percent in September from 2.5 percent and the
also likely to be seen as an important element of medium- ECB will be concerned over the inflation outlook, especial-
term central bank reserve management. ly as inflation is above the 2-percent target. Although the
underlying inflation rate is under control, the bank will be
Capital flows vital on high alert and anxious to avoid secondary inflation from
The capital account trends will remain important for the taking hold.
U.S. currency. The Homeland Investment Act (which tem- The ECB will continue to face a tough balancing act in the
porarily removes the disincentive for U.S. businesses to short term as it would prefer to avoid higher interest rates
keep offshore profits offshore for tax purposes) will contin- given the fragile state of demand. The ECB will, however,
ue to provide tax breaks for capital repatriation back to the need to control inflation expectations, especially with rising
U.S. until the end of 2005. The lower tax rate will encourage money supply growth. It will consider a rate increase in the
a flow of funds back to the U.S. during the fourth quarter fourth quarter and will continue the tough rhetoric even if
and offer important balance of payments support. rates are left at 2 percent. A tighter ECB stance would offer
There is, however, likely to be underlying reserve diver- support to the Euro.
sification away from the U.S. currency and, with direct
investment flows still weak, the dollar will be more For information on the author see p. 6.

THE BIG PICTURE
Fundamentals duel
the technicals
Fundamentals may rule the den in the long run, but short-term reactions
in the market are often based on anything but rational analysis.
BY BARBARA ROCKEFELLER
W e like to say that a really juicy piece of

fundamental information will trump the
technicals every time. Technicals are the
quantification of what traders think and
believe, and what they think and believe is shaped by the
fundamentals. Fundamentals include economic news, insti-
tutional arrangements, business conditions, and the occa-
themselves for action if the news varies significantly from
the consensus forecast.
News encompasses three types of events. The first is eco-
nomic data and developments, which rotate in importance
over time. Sometimes trade balance is important, some-
times it’s not. For the past few years as we have all puzzled
over the jobless recovery, the U.S. non-farm payrolls report
sional dash of politics. has been a zinger, causing one-day price spikes, sometimes
But is it really true that fundamentals trump technicals? in both directions on the same day. The short list of news
The forex market has become so enamored of technical items that move the forex market includes:
analysis that today we have to question whether the funda-
mentals actually do rule the market. Sometimes it seems • GDP
traders are perverse in their response to “real” events, inter- • Inflation (various forms — PPI, CPI, PCE, GDP
preting them to suit the chart instead of adjusting the chart deflator, ECI)
to reflect economic reality. • Trade balance and current account balance
Let’s look at a few cases from the past few months and try • Capital flow reports
to name a winner. • Payrolls
• Institute of Supply Management (ISM) Index and
Three types of fundamental events regional indices (Chicago, Empire State)
The “fundamentals” are real economic data, developments • Leading indicators, business confidence, and
in related markets, and “institutional” changes, such as cen- consumer confidence
tral bank policy decisions. Very little of what passes for • University of Michigan consumer confidence
“news” is actually new. In nearly every case, we know the • Durable goods orders
news is coming — usually to the exact minute — and we • Housing starts and existing home sales
also know the likely range of the data or the expected con- • Retail sales
tent of the announcement.
It is a triumph of the electronic age that we have so much Notice that money supply growth, bank lending, and
information and can usually slot it into context, to boot. other financial sector information is not of much interest
Newspapers and newswires tell us, for example, the current today for evaluating the U.S. economy and the dollar,
quarterly GDP growth rate vs. the previous quarter, the although it was the only thing traders looked at in the early
annualized rate, the last time it was so high or low, how it 80s (it is still watched today in Europe and Japan).
compares to the growth rate for the same period in other Truthfully, traders are bored by this type of news. They
countries, and so on. Traders in the foreign exchange mar- respond to it in the expected ways — buying, grudgingly, if
ket keep track of about a dozen of these “factors” and gird a number surpasses the upper limit of an estimated range.

And while a few points can be made by responding swiftly, last fall. But this is often an excuse that forex traders use to
the period surrounding a news release hardly ever delivers justify taking trades they wanted to take, anyway.
a real change in the direction of a price. You don’t get a The price of oil is a good example. We went through a
trend reversal from “ordinary” fundamental data, at least period late last summer when the rising price of oil was
not from a single news release, although sometimes you get considered especially bad for Japan, because Japan imports
a break of support or resistance from a single release. As we all its oil. In fact, Japan is the most energy-efficient country
have seen with the breakouts caused by spikes on the pay- in the G7, producing more units of output per unit of ener-
roll news, those breakouts
usually fizzle. It takes a build-
up of additional releases FIGURE 1 — MARKET OVERREACTION
pointing in the same direction There may have been no logical reason for the dollar to sell off so severely as Hurricane
as the breakout release for Katrina hit the Gulf Coast at the end of August, but the price action was already fueled by
perception to shift and a new the approximately 61.8-percent retracement of the Euro’s up move from July to mid-August.
trend to form.
It is tedious to keep track of
the economic releases. Often,
one-time nuggets of informa-
tion, such as the Research and
Development “Scoreboard” of
the world’s largest 1,000 com-
panies released in October by
the UK Department of Trade
and Industry, are more inter-
esting than the same old data
series. U.S. companies
increased R&D by 7 percent in
each of the past four years,
while European companies
spent only 2 percent. The
Lisbon accord said Europe
would aim for R&D spending
of 3 percent of GDP per year
by 2010 to become the world
leader in high-tech, bio-med,
and other areas. Now that is a
lost dream. Returning to capi- Source: Chart — MetaStock; Data — eSignal and Reuters
tal investment in R&D, Japan
spent 4 percent. (The surprise was South Korea, with a spec- gy input than anyone else, so to tar Japan with oil’s brush
tacular annual growth in R&D investment of 40 percent.) was just a rationalization for shorting the yen.
If you are trying to predict where global equity capital When Hurricane Katrina hit the U.S. Gulf coast, the mar-
will flow based on success in R&D, assuming success is a ket sold off the dollar against the Euro from 1.2188 on Aug.
function of spending, you’d have to pick the dollar over the 31 to 1.2589 on Sept. 2. There is no true economic basis for
Euro and the yen over the Euro, too. But, as you no doubt such an overreaction. One barrel of oil is the same as any
already know, you wouldn’t buy dollars for this reason for other barrel of oil, so it makes no difference whether the
a long-term holding period any more than you would sell U.S. produces oil or buys its oil from the world market. It
dollars for a long-term holding period because of the cur- certainly makes sense for the price of oil to rise, but almost
rent account deficit. none for the price of the dollar to fall. The real reason for the
dollar to fall was that traders had already observed a near-
Related markets 61.8-percent retracement of the Euro’s up move from July to
News from related markets sometimes dominates overall mid-August (Figure 1).
sentiment toward the dollar, as we have seen with the Many traders in the forex market keep track of Fibonacci
widening interest-rate differential favoring the dollar since continued on p. 26

THE BIG PICTURE continued
FIGURE 2 — A PATTERN UNFOLDS
The Euro/dollar up move in early September quickly failed, and the market formed a that removed 0.5-1 percent of
double top. growth from German GDP
would be an economic disas-
ter, too. But in the U.S., with
GDP at 3.3 percent in Q2 and
headed for 4 percent or more
in Q3, the temporary reduc-
tion in growth from the natu-
ral disaster is manageable.
Here is where context
counts. Anyone observing the
dollar fall on Sept. 1 and 2
could deduce the move was
unjustified based on the fun-
damentals and that the
“news” was being interpreted
incorrectly. And the chart
immediately began to exhibit
a double top, which is one of
the more reliable standard
patterns (Figure 2). If the price
falls below the lowest point of
the “M” (see mid-August), it
almost always follows
Source: Chart — MetaStock; Data — eSignal and Reuters through with a substantial
drop. (A little move back
numbers and this was an especially easy one to spot. The upward, such as the one that occurred on Oct. 6, is also very
bounce up off the retracement line was facing a heavy head- common.)
wind in the form of talk about upcoming interest-rate To draw a tentative conclusion: Currencies are joined at
increases in the U.S., so traders needed a better-than-usual the hip to the fixed-income and money markets because,
after all, real capital flows are based on competing real rates
of return. But real capital flows constitute only a small por-
Forex prices move more on each of tion of total forex trading and we often see forex price
moves that are contrary to the rational comparison of finan-
the five days leading up to a FOMC cial returns.
Other markets, such as equities, oil, and gold, are only
sporadically decisive factors in forex prices, and even then
meeting than they do afterwards. can be exploited for their shock effect rather than any rea-
sonable and plausible economic scenario.
excuse to keep the move going. Hurricane Katrina fit the You want to know what is right and reasonable in the
bill nicely and had the added benefit (for dollar shorts) of fundamentals, but you shouldn’t always trade on it right
creating the spectacle of the world’s richest country failing away when the market is in a perverse frenzy.
to provide timely and adequate relief to its own citizens.
The can-do country couldn’t. This is an instance where the Institutional news
giant miasma of anti-U.S. sentiment that hangs over the dol- Institutional news has the potential to be the biggest mover
lar took concrete form. of them all but, again, it is often used for shock effect to get
It quickly became clear, however, that the hurricane a move that was already pre-ordained by the technicals on
would take away only 0.5 to 1 percent of GDP in the near- the chart.
term — and actually add to GDP in later quarters as re- Consider the rejection of the European Union
building began. Germany, the Eurozone’s biggest economy, Constitution. The first “no” vote came from France on May
will get 0.8-1.2 percent growth this year. A natural disaster 29. The Euro had already swooned from above 1.3600 to

1.2535 on May 27, so it was hardly a surprise the public’s The forex market has a preference
rejection of the constitution took the Euro further down to
1.2385 on May 31 and 1.2159 on June 1, when the Dutch
voted.
for big events that are also a shock,
The failure of the Europeans to forge a constitution is a
reflection of dissatisfaction with the way the EU is working
whether they are true and useful
and evolving, a malaise some analysts say could even spell
the end of the Union. Any system that delivers low growth information or not.
and persistent high unemployment may have a humane
social model, but it cannot be said to be a successful eco- the euro traded under the launch rate for the rest of 1999 to
nomic model. However, the Euro stopped dropping barely near the end of 2003, but traders got the idea in their minds
one month later, in July 2005. Nothing had changed. Europe last spring the Euro “should” trade in a range of 1.20 to 1.25
was still rejecting the principles of ruthless capitalism and during summer 2005, and sure enough, any forays beyond
market economics, still turning its head from competition those boundaries have been short-lived.
and open borders (for services, at least), and still (mostly)
against enlargement to include countries like Turkey and The yield playing field
even the Baltic states. Finally we come to the main event — the ever-rising yield
Did traders forget the giant risk to the European experi- advantage of the dollar over the Euro and yen. The news
ment only one month after this stupendous failure? In a events associated with this rising relative return are the
word, yes. And the reason is not hard to find — the trains Federal Open Market Committee (FOMC) meetings — the
are still running, the stock markets are open (and rising), continued on p. 28
banks are still busy acquiring
one another, and business
goes on as before. Most of all, FIGURE 3 — TESTING A LEVEL
nobody — not even the The idea formed last spring that the Euro should trade in a range of 1.20 to 1.25, and
Italians — is seriously consid- any moves beyond those boundaries have not lasted very long.
ering the death of the Euro
and a return to the legacy cur-
rencies. The Euro is a done
deal. The accounting has all
been switched over, the old
banknotes burned.
The market was willing to
respond to the rejection of the
Constitution right after the
vote because it was consistent
with the trend already in
place, but it was unwilling to
let it hang like a stone around
its neck for very long, espe-
cially when the Euro was
approaching the “historic”
low from May 30, 2004 at
1.1760 (Figure 3). This level is
very close to the January 2,
1999 euro launch rate at 1.1670
and the opening price the next
day at 1.1786.
We have no idea why a
return to this level is being Source: Chart — MetaStock; Data — eSignal and Reuters
resisted so strenuously, since

THE BIG PICTURE continued
big Kahuna of events. FOMC meetings marry economic and would indicate higher oil prices are no more damaging to
financial expectations with hard institutional news. the U.S. economy than elsewhere, and maybe less so.
Everyone knows when the Federal Reserve will release its Another case comes from the institutional side of the
decision, and since it started raising rates in June 2004, the news. Last February when the Euro was falling, European
outcome has not been a surprise. All the same, you’d think Central Banks (ECB) President Jean-Claude Trichet warned
the Fed’s periodic decisions would deeply influence prices that the central bank could raise interest rates specifically to
in the forex market. protect the Euro from free-fall. The threat carried very little
Alas, you would be wrong. Using data prepared by credibility but the Euro spiked upward anyway. Again in
Stuart Johnston at TimeandTiming.com, forex prices move October, both Trichet and another ECB policy board mem-
more on each of the five days leading up to a FOMC meet- ber have made the same threat, this time with a little more
ing than they do afterwards. The Swiss franc, for example, credibility since inflation is indeed on the rise in Europe,
has consistently moved although most money market
down more often than it observers think an actual rate
has moved up in every The best — but by no means hike is not going to occur
five-day, four-day, three- until after the new year, if
day, two-day and one-day
period ahead of the past 62
satisfactory — conclusion is that the then. And even if the ECB
does raise rates, the U.S. will
FOMC meetings. The aver- still have a decisive yield
age move over the five fundamentals do not rule the market advantage (200 or more basis
periods is 11.3 points. points) over Europe. Still, the
On the day of the meet-
ing, and in the one-day,
consistently and reliably. possibility of an ECB rate
hike raises the riskiness of
two-day, three-day, four- holding a long dollar posi-
day, and five-day periods after the 62 meetings, it has also tions, so the “news” of a possible European rate hike
moved down more often than up, but by tiny amounts — prompts a dollar sell-off.
3.9 points, on average. Note that in those 62 meetings, the But the market has again showed it likes the thrill of
Fed was not always raising rates; on many occasions, it was uncertainty, and it responded by buying Euros even in the
lowering them. last few days leading up to an FOMC meeting, where the
The same conclusion arises from examination of the data outcome is known. It is perverse to buy the Euro when the
for the Euro, Japanese yen, Canadian dollar, Australian dol- next real-life central bank outcome favors the dollar; a sign
lar, and Mexican peso. The Japanese yen moves (usually the market is not operating on hard facts and clear-eyed
down) by an average of 13.08 points per day on each the five analysis, but rather thrill-seeking — and using a rise in “risk
days ahead of meetings and by a mere 4.32 points the day of aversion” to justify it. It’s no wonder the chart sometimes
a meeting and the five days after it. In the Euro, the pre- seems to rule the interpretation of serious economic materi-
meeting move is 29.4 points per day, and the post-meeting al instead of the other way around.
move is 6 points. Of course, the swings are far wider — the
average disguises the range — but the principle holds that Long run vs. short run
pre-meeting swings are bigger than post-meeting swings. The best — but by no means satisfactory — conclusion is
This means more than the market anticipates a move and that the fundamentals do not rule the market consistently
buys on the rumor. It means the rate-change FOMC event is and reliably. Maybe the fundamentals rule in the long run,
not “news” because it is not also a shock. This is a testament but the long run is nothing more than a series of short-runs,
to the good public relations of the Fed, but at the same time, and in the short run, the market is often in the grip of a chart
it deprives traders of what should be a value-laden news pattern that tickles the imagination, a rumor that defies
item. common sense — a story or scenario that is patently false,
The forex market has a preference for big events that are or just plain thrill-seeking.
also shocks, whether they are true and useful information or In the end, the duel is not between the fundamentals and
not. Some commentators in the forex market have taken to the technicals, but between rational decision-making based
combining all three sets of factors and weighting them on facts and analysis, and traders who need to make money
according to “riskiness.” An abrupt rise in the price of oil, for by going with the flow, even when that means taking seem-
example, raises the level of risk. Risk-averse FOREX market ingly irrational positions.
participants would sell dollars on a rise in the overall riski-
ness of holding dollars, even when sound economic analysis For information on the author see p. 6.

CURRENCY TRADER INTERVIEW
Wallwood consultants
practice what they preach
These two former brokers and forex educators are posting some of the best returns of the year
among currency money managers.
M ario Kelly and Daryl Swain, forex traders

and principals of Wallwood Consultants
Ltd., put to lie the adage, “Those who
can’t do, teach.”
Formerly partners in a forex education and advisory
service, Kelly and Swain taught forex trading before
launching their commodity trading advisor (CTA) —
drawdown of -32.27 percent), the firm has posted double-
digit gains each year (Table 1).
Kelly and Swain, both 42, operate Wallwood from offices
outside London and in Spain. They trade exclusively in the
spot forex market (typically using 6:1 leverage) and cur-
rently manage $10 million. Figure 1 shows a VAMI chart of
the firm’s equity growth along with that of the S&P 500 and
which, over nearly five years of trading, has posted some Barclay CTA Index.
quite respectable numbers. Kelly and Swain both have held various positions in the
Through September, Wallwood was up 19.72 percent on forex industry, and immediately prior to starting their own
the year, placing it at the top of the Barclay Group’s business, they were execution traders at CMC Markets, a
(www.barclaygrp.com) forex CTA rankings. The firm’s total forex trading firm and brokerage. They launched what
return since inception in January 2001 is 96.40 percent — a would eventually become their CTA when they were (as
19.29-percent compound annual return. Other than a 9.45 they say in Britain) “made redundant” in 1997. They decid-
percent loss in 2003 (the year they suffered their worst ed to set up a forex advisory and educational service, ini-
tially for some of their former clients.
The business wasn’t intended to be a long-term
My impression is that a lot of

people tend to have more
money than sense when it
comes to trading.
proposition, according to Kelly. Although neither
one of them had managed money before, he and
Swain were set on it, and they eventually began
trading their own funds to refine their trading
approach.
“It’s all very well telling people how to trade,
but we might as well do it ourselves and show
them what we tell them to do does work,” Kelly
says.
One of the advantages of their former position
Daryl Swain Mario Kelly
as brokers at CMC, according to Kelly, was they
got to see the different missteps non-professional

FIGURE 1 — WALLWOOD VALUE ADDED MONTHLY INDEX (VAMI) LINE
traders often make.
“My impression is that a lot of peo- Wallwood's performance is compared here (in terms of the growth of an
ple tend to have more money than initial $1000 investment) to the S&P 500 (blue line) and the Barclay CTA Index
sense when it comes to trading,” Kelly (green line).
says. “They make really basic mis-
takes, like not having stops in place
and leaving positions unattended.
They don’t realize what they’re doing.
“The unique thing we had when we
devised our trading system is that we
saw a lot of [order] flows and a lot of
different trading models,” he contin-
ues. “You try to take the good bits of
most of them. Our initial trading
model mainly looked at how clients
traded and avoided the mistakes they
made. It doesn’t work totally — we
have had our drawdowns. It’s impos-
sible to say you’ll win on every single
trade.”
Kelly describes Wallwood’s
approach as essentially systematic —
with the exception of one discre- Source: The Barclay Group (www.barclaygrp.com)
tionary analytical component — with
a primary focus on limiting losses,
which they accomplish partly by limit- TABLE 1 — WALLWOOD ANNUAL RETURNS order at 1.1980.” And I’ll say,
ing their exposure to the market. They “To me it looks like 1.1975.”
Through the end of September, Wallwood
enter the market on price breakouts Consultants was up nearly 20 percent on the And either I persuade him or
(long or short), and then use a position- year. he persuades me, or maybe
management approach that incorpo- we’ll split the difference.
rates a trailing stop that tightens as a Year Return Let’s say we’re out of the
position progresses. 2005 YTD 19.72% market now (Oct. 4). Looking
“We use a mathematically based 2004 42.63% at the Euro/dollar, we’d prob-
algorithm that is, effectively, based on 2003 -9.45% ably have an order at 1.1880
swing trading,” Kelly says. “If we expe- on the downside and 1.1980
2002 11.43%
rience a certain amount of losses, we on the upside. We’re actually
2001 31.80%
pull out of the market and then wait for long the market at the
a period before entering again.” Source: The Barclay Group (www.barclaygrp.com) moment at 1.1952, where the
market is now. (See Figure 2.)
CT: Is it fair to characterize your approach as a shorter-
term breakout-type system? CT: In terms of limiting your losses, how do you go about
MK: Yes. It involves a bit of breakout, a bit of Elliott Wave setting stop points?
when it comes to counting oscillations, and support and MK: They’re based on support and resistance.
resistance. The MACD (moving average convergence-diver-
gence indicator) is involved as well, once again in counting CT: So, relative to a support or resistance level you’re plac-
oscillations. We’re not 100 percent governed by one thing. ing a stop —
MK: — between 30 and 60 points behind the market.
CT: Support and resistance seem to play a pivotal role in
your trading. How do you define these levels? Is it a discre- CT: What about taking profits?
tionary process, or are you using some variation of standard MK: We’re fairly unique in that we try to run the position
channel breakouts, or something else? up until a set parameter.
MK: By looking at charts, really. It is more discretionary,
because it tends to be the two of us looking at the chart and CT: A profit target of some kind?
determining the levels. Daryl might say, “I think we need an continued on p. 32

CURRENCY TRADER INTERVIEW continued
FIGURE 2 — SHORT-TERM SUPPORT AND RESISTANCE MK: Winning trades, obviously, tend
to last longer than losing trades, for the
Kelly and Swain use charts (usually 60-minute and 10-minute) to determine
simple fact that some sort of trend
support and resistance levels. On the day of the interview, Kelly gave this hypo-
must be ensuing. A winning trade
thetical example of typical support and resistance they might determine on a
60-minute chart if they were looking to enter the market. (At the time, they were might last for 48 hours; a losing trade
already long the Euro/dollar pair.) could be as short as an hour.
But it varies. Friday is non-farm
payroll (i.e., the U.S. employment situa-
tion report is released). Sometimes the
market can be very volatile and a trade
can last only a matter of minutes.
CT: What time frame are you analyz-

ing when you’re determining support
and resistance?
MK: We tend to look at hourly and 10-
minute charts. It’s a short-term system,
really.
CT: Is the system you’re using now

essentially the same one you’ve been
using since you started managing
money?
MK: No, we have tweaked it. We were
more aggressive earlier on, in that we
tended to be involved in the market
very much throughout. We’d have
Source: TradeStation months where we’d be up 15 percent
and the next month we might be down
MK: No, it’s a set parameter — I’m not going to say what it 10 percent.
is. What we’ve done the last year and a half is become more
cautious; when we reach a set [loss level] we’ll pull out and
CT: Okay, but you have some criteria? let the market rest for a bit. That can obviously work against
MK: Yes. you because you’re liable to miss moves. For example, we
happened to be out of the market when the French voted
CT: Is it a trailing stop-type of approach? “no” in the EU referendum on May 29, so we missed a lot
MK: Yes, we trail stops, but price has to get to a certain of that down move.
level before we use the stop. Conversely, [the last week of September] there was a lot
of up-and-down movement in the Euro, which, had we
CT: Which currency pairs do you trade? been trading, would have hurt us. The irony is, the cautious
MK: Solely the Euro/dollar and dollar/yen. There are approach — although the returns have been a little lower
times we might be long both Euro/dollar and dollar/yen, than they were before — has tended to attract more profes-
which makes a sort of synthetic Euro/yen cross. sional money for us to manage.
CT: Do you stick to these pairs just because of their liquid- CT: Your returns are less volatile.
ity? MK: Yes, and that seems to be what the more professional
MK: Liquidity, and also [because these currency pairs investors are looking for.
reflect liquidity in the three different forex trading time
zones]: In Asia you might see the yen take a very strong CT: Does this mean you’re in the market less than you
reaction. In Europe, it would be in the Euro; before the Euro, used to be, or that you’ve scaled back your position sizes?
it was the Deutsche mark. In the U.S. time zone, the U.S. MK: We’re in the market less than before, but we’re still in
dollar moves. it more than out of it.
CT: How long does a typical trade last? CT: Can you describe the genesis of your trading model or

approach? How long did it take you? Did you do any back- year so far.
testing of any kind? MK: Yes, we’ve been very consistent, very steady. At the
MK: I’m a great non-believer in back-testing, because it’s moment, we’re up 19 percent for the year. (See Table 2.)
just very arbitrary. Initially, we traded our own personal
account for about a year. That CT: What do you think your edge is?
had big swings. We changed MK: I think we are quite dedicated to
gears during that period — TABLE 2 — 2005 MONTHLY RETURNS forex, and we do monitor it exten-
playing about with leverage, Through September, Wallwood had only two sively. There’s very little time when
and so on. down months in 2005. we’re not monitoring the markets,
even when we don’t have positions.
Month Return
CT: So that was essentially an
“incubation” phase — real-time 2005 YTD 19.72% CT: What kind of weight do you put
trading instead of testing? January 4.94% on fundamental considerations?
MK: Yes. We would alter trade February 1.67% MK: We’re obviously very aware of
size, leverage, and stop param- March 1.77% fundamental news — economic
eters. But from day one of the April 5.13% reports and events such as Hurricane
incubator phase, the idea of May 0.48% Katrina. We do pay attention to fun-
trailing orders behind a posi- June -0.41% damental news, but that’s not the
tion was always one of the July 3.15% main driver in determining what
main cornerstones of the sys- August 1.94% position we have at any point in time.
tem, as was monitoring the September -0.32% That’s determined by the way the
market 24 hours a day. Source: Wallwood Consultants (www.wallwood.com) train moves — the way the market
swings.
CT: Your annual returns show
that 2003 was the bad year. What went wrong that year and CT: So there’s never a situation when a big event — a
what did you learn from it? change of central bank policy, for example — would make
MK: We were continuously involved in the market, and it you override any systematic trading rules you had?
just kept catching us, really. MK: If the market reacts to it, we would get positioned
accordingly by our stop-in order. Look at the Bank of China.
CT: Do you mean you were getting whipsawed? They announced recently they were expanding the yuan’s
I’m a great non-believer in back-testing, because it’s just very arbitrary.

Initially, we traded our own personal account for about a year.
MK: Yes, quite a lot. Many breakouts were false and we’d range. There were a lot of people who thought the dol-
go back into the market and the same thing would occur lar/yen rate would never go above 112, and it’s up near
again. It was in the latter part of that year — probably 114.50. (It rallied to nearly 116 in the weeks after this interview.)
around October — that we decided to take the approach of I have a very cynical approach to the market, to be hon-
not being involved in the market throughout. est. Ten people could tell me, “You have to buy this, you
Also, we decided the distance at which we were trailing have to buy this,” but I’ll just sit back and see what hap-
stops was too far. There were times we had very good unre- pens.
alized profits, but then we’d give them back. It’s all very
well having an unrealized profit of 90 points or so if you CT: Is there any discretion other than determining the sup-
only end up booking a 5 or 10-point profit. port and resistance levels?
MK: No; that’s it. And with that, it’s something anyone
CT: To prevent this, do you tighten the trailing stop as time who knows a certain amount of technical analysis could
goes by and trail closer to price the longer the trade is open? more or less gauge.
MK: Yes, we use a mathematical formula to tighten the stop
loss at a certain point and time. CT: So what are your plans for the business?
MK: To get bought by Citibank (he laughs).
CT: On the flip side, it looks like 2005 has been a very good

TRADING STRATEGIES
Price behavior in the Euro

Applying a simple breakout system to the Euro/U.S. dollar rate highlights the market’s tendencies and
provides guidelines for trading strategies.
BY THOM HARTLE
T he Euro/U.S. dollar pair (EUR/USD) started

a bull market in October 2000 that, as of now,
seems to have peaked in December 2004
(Figure 1). That overall uptrend contained the
normal range of market behavior — trading ranges, upside
breakouts that led to sustained rallies, and corrections.
Analyzing a simple trading approach from January 2000
The strategy
The strategy was a basic short-term breakout approach that
consisted of buying when the EUR/USD closed above the
previous week’s high and selling short when the pair closed
below the previous week’s low. The strategy was always in
the market.
In addition to measuring the profit or loss for each trade
to September 2005 sheds light on the typical market behav- signal, the maximum favorable excursion (MFE) and maxi-
ior during this period and offers clues about how to take mum averse excursion (MAE) were calculated.
advantage of certain kinds of price action. The breakout The maximum favorable excursion is the largest open
strategy in question was not intended to be a viable trad- profit attained during a trade and the maximum averse
able approach in and of itself, but rather to provide research excursion is the largest open loss in a trade. These terms
that could be the basis for building or enhancing a trading were introduced by John Sweeney and detailed in his book,
strategy. Campaign Trading: Tactics and Strategies to Exploit the Markets
(Wiley Finance Editions, 1996). MFE
FIGURE 1 — EUR/USD BULL TREND and MAE analysis is a valuable tool for
understanding the typical price behav-
The Euro has been in a bull market vs. the U.S. dollar for nearly five years, ior that occurs between a trade’s entry
although a notable top formed at the end of 2004. and exit, and can lead to intelligent
EUR/USD, monthly
Analysis summary
Concept: Maximum favorable
excursion (MFE) and maximum
averse excursion (MAE) measure
the largest open profit or loss,
respectively, of a trade.
Purpose: MFE and MAE analy-

sis is a valuable tool for under-
standing the typical price behavior
that occurs between a trade’s
entry and exit, and can lead to
intelligent rules for setting better
targets and stop points.
Sample uses: Profit targets and

stop points can be improved
through MFE/MAE analysis. Also,
the characteristics of typical win-
ning and losing trades can be
identified.
Source: Chart Courtesy CQGNet, Inc.

FIGURE 2 — EQUITY CURVE
rules for setting better targets and stop The breakout strategy had 80 total trades. Typical of most breakout/trend-fol-
points. lowing trading strategies, a few large winners overcame many losing trades.
Figure 2 is the running sum of prof-
its and losses for the trading strategy.
As is often the case with breakout sys-
tems, there were long periods (in this
case three years) when the equity line
moved sideways to down, after which
some sustained price trends lead to
good profits. The strategy ultimately
netted 3,677 pips.
Figure 3 is compares the strategy’s
equity line to the EUR/USD closing
price. The approach captured some of
the market’s sustained trends, missed
others, and was predictably chopped
up during the sideways periods.
Looking at the results Source: eSignal

The system produced 80 total
trades — 40 long and 40 short.
Thirty-two trades were prof- FIGURE 3 — EQUITY CURVE VS. EUR/USD PRICE
itable — a 40-percent win rate,
The EUR/USD closing prices are plotted vs. the strategy’s equity curve. The Euro bot-
which is typical of tomed in 2000, but did not start trending until 2002 when the breakout strategy started
breakout/trend-following capturing profits.
strategies.
There were 15 winning long
trades with an average profit
of 441 pips, and 25 losing long
trades with an average loss of
156 pips (a 2.83 average win-
ing trade/average losing
trade ratio). Of the 40 short
trades, 17 were winners, with
an average profit of 233 pips.
The 23 losing short trades had
an average loss of 131 pips (a
1.78 average wining
trade/average losing trade
ratio).
The bull market aided the
profitable long trades but did
not help the losing long trades
— the average losing short Data: eSignal
signal was actually better
(smaller) than the average losing long trade. Now let’s see still closed with profits.
what MFE/MAE analysis tell us about this market and this Even a trade with as many as 100 pips of open profit was
kind of trading approach. not guaranteed to be a winner. However, all but one of the
Figure 4 shows the profit or loss and MFE and MAE for trades that reached an open profit of 251 pips or more (16 of
each long trade; the chart is sorted by MFE. As the MFE the 40 trades) ended up as winners. The one loss (-12 pips)
readings climb, the MAEs also rise, but there were two had an open profit of 310 pips.
anomalous trades that had MAEs larger than -300 pips and continued on p. 36

TRADING STRATEGIES continued
The average MFE for long trades FIGURE 4 — LONG TRADE ANALYSIS
was 344 pips and the average MAE The bars show the profit/loss, MFE, and MAE for the 40 long trades. All trades
was -152 pips. Seven of these trades except one had to reach an open profit larger than 250 pips to close out with a profit.
exceeded 750 pips in open profit, with
the largest (in late 2003) having a MFE
of 1,268 pips.
Figure 5 shows the profit or loss,
MFE and MAE for the short trades,
again sorted by MFE. The effect of the
bull market is apparent. The average
MFE for the short positions was only
271 pips (vs. 344 pips) for the long
positions. But the average short-trade
MAE was -143 pips — smaller than the
-152 pip average long-trade MAE.
Only two short trades exceeded 750
pips in open profit, with the largest
open profit hitting 1,001 pips. (Two of
the three largest open profits occurred
in 2005, a sign the market might have
Source: eSignal
turned from bull to bear.)
Despite the prevailing bull condi-
tions, 17 of 19 times the open profit FIGURE 5 — SHORT TRADE ANALYSIS
was 255 pips or greater and the short
trade was closed out for a profit. The profit/loss, MFE, and MAE for the 40 short trades are sorted by the MFEs.
Finally, the bull market also biased Seventeen of 19 trades had to reach an open profit of greater than 255 pips to
trade length. The average long posi- close out with a profit.
tion lasted 29 days — the longest was
100 days and the shortest was just
three days. The average short position
was held for 23 days — the longest
was 74 days and the shortest was three
days.
Putting the numbers to use

Now that we have the numbers, how
do we apply them to trading? There
are a few ways to incorporate this data.
First, the process of forming a hypo-
thetical track record, including prof-
it/loss, MFE, MAE, and trade length,
is a fundamental step toward refining
trading rules. Profit targets can be
determined based on typical favorable Source: eSignal
price movement, stop-loss points can
be based on MAEs, and the types of trades that ultimately ing ranges false breakouts lead to solid moves in the other
are not profitable can be identified. direction.
In this case, the MFE analysis indicates trades that do not Finally, if the MFEs seem to shift, as they did in early 2005
exceed 250 pips in open profit tended to be closed out at a (the two largest MFE for short trades occurred in January
loss. This leads to the idea of tracking breakouts beyond the and April 2005), it could indicate a change in the trend.
previous week’s high or low and looking for reversals of the This type of analysis — which provides concrete statistics
near-term trend if the 250-pip point is not broken. On the about market behavior and trade characteristics — gives the
other hand, a move 250 pips beyond the close of the break- most useful inputs for trading approaches.
out bar implies a very strong trend.
Many of the trades with MFEs smaller than 100 pips had For information on the author see p. 6.
MAEs of more than 200 pips. This implies that during trad- Questions or comments? Click here.

CURRENCY TRADER Q&A
Catching up with
Richard Olsen
FX innovator Richard Olsen discusses the reaction of some
of his trading models to recent market events.
R ichard Olsen is chairman and CEO of the

Zurich-based Olsen Group, which compris-
es several financial research, trading, and
market-service companies:
(www.oanda.com), an online forex brokerage/market
OANDA
maker; Olsen Financial Technologies, which makes soft-

ware tools for gathering, cleaning, and analyzing high-fre-
There was an additional 1-percent drop in the Euro in the
morning on Monday, Oct. 3. The model had to rebalance its
positions to maintain its maximum exposure limits. When,
at last on Thursday, Oct. 7, the Euro bounced back, the
model could not recoup its losses (as would typically have
been the case) because it was off-balance due to the
increased positions it had inherited.
quency data; and Olsen Invest, a money-management firm On Monday, Oct. 10, we decided to cut our losses. We
Olsen founded in November 2002. closed the existing positions and restarted the trading mod-
Olsen Invest has six U.S. dollar accounts (each initially els in normal mode without memory of the incurred losses.
funded with $10,000) with varying risk profiles. Currency Here’s an analysis of these events: The trading models
Trader interviewed Richard Olsen in its first issue (October and infrastructure are comparable to a complex automat-
2004), an article that was published and updated in the ed factory. The safety measures implemented to prevent
December 2005 issue of Active Trader magazine. unforeseen losses were insufficient, otherwise the event
We talked to him again in early October to discuss some would not have occurred — our infrastructure was thus
developments with the Olsen Invest “Live Accounts.” subject to Murphy’s law.
If the operational mishaps had not occurred, the trading
CT: The live accounts seemed to have suffered larger models would have generated 0.3-percent return in
than normal drawdowns in September. Could you com- September, and — including the Euro’s rebound on Oct. 7 –
ment on the causes? the models would have generated a 1.2-percent return in
RO: In the wake of Hurricane Katrina, the U.S. dollar expe- September and October, which is a very different result
rienced a rapid down move against all other major curren- from the massive (-9.88 percent) drawdown.
cies, especially the Euro. Our models handled the initial We have restarted the models, but have lowered tem-
impact well. porarily the return target of the standard profile from the
At the time we were worried the dollar would continue standard 15 percent to 8 percent. We have started an imme-
to drop, so to manage risk, we increased the hedge of the diate program to upgrade the trading model infrastructure
dollar to protect ourselves against a further massive drop. and improve the defensive mechanisms. As soon as we
But our expectation proved wrong and the dollar recovered. have completed the enhancements, we will hike the return
We have a parameter in the model that monitors the bid-ask target to the standard 15 percent.
spread. We use it for unexpected news events, such as 9/11, to It’s important to emphasize that the drawdown was not
switch the model into “conservative” mode — whenever the because of the models themselves. The models did their job.
model detects a widening of the spread, [it] adjusts its behav- The drawdown originated on the part of the defensive
ior and becomes more conservative. Typically, OANDA pub- mechanisms. Over the past four weeks, we have learned
lishes a spread of 1.5 basis points. Temporarily, it halved the many painful lessons and we are making every effort to
spread from 1.5 to 0.8 basis points, which had the effect of enhance these safety mechanisms.
priming the model to become more aggressive, and [it] In the middle of July, we released new trading models
increased its positions significantly. that allow us to increase the trade frequency and improve
We don’t want to interfere with the model; we decided to the rebalancing of exposure between exchange rates. The
let it work itself out of its positions. In hindsight, this was models improve the stability of returns.
the wrong decision. In response to the outcome of the We are highly confident the long-term performance of
German election, the Euro made another significant drop our models will fulfill expectations, and the recent draw-
that culminated in massive sell-offs in the Euro, Swiss franc, down will, from a longer-term perspective, be a temporary
and other currencies on Friday of the previous week. (however painful) blip.

TRADING STRATEGIES
Trading around the clock,

part I
Volume and volatility ebbs and flows in different currency pairs as trading moves from one market center to
the next. You’ll trade more efficiently if you know which pairs to focus on at different times. In the first of two
articles adapted from her new book, Day Trading the Currency Market (John Wiley & Sons,
available late November), Kathy Lien analyzes the character of the Asian and European trading sessions.
BY KATHY LIEN
T iming is everything in currency trading.

Because the foreign exchange market oper-
ates 24 hours a day, it’s impossible for a trad-
er to track every market move and make an
immediate response at all times. To devise an effective
investment strategy, it’s important to note the amount of
market activity during different trading periods in order to
In addition to liquidity, a currency pair’s trading range is
heavily dependent on geographical location and macroeco-
nomic factors. Knowing what time of day a currency pair
has the widest or narrowest trading range will help traders
improve their capital allocation.
The following analysis outlines the typical trading activ-
ity of major currency pairs in different time zones to see
maximize the number of trading opportunities during the when different pairs are the most volatile. Table 1 tabulates
hours in which you operate. the average pip range for the different currency pairs dur-
TABLE 1 — CURRENCY PAIR RANGES
The numbers represent the average pip range. Forex volatility is highest during the European trading session, followed by
the U.S. session. The two sessions overlap during the busy four-hour period from 8 a.m. to noon ET.
Asian session European session U.S. session U.S./Europe overlap Europe/Asia overlap
7 p.m.-4 a.m. 2 a.m.-noon 8 a.m.-5 p.m. 8 a.m.-noon 2 a.m.-4 a.m.
EUR/USD 51 87 78 65 32
USD/JPY 78 79 69 58 29
GBP/USD 65 112 94 78 43
USD/CHF 68 117 107 88 43
EUR/CHF 53 53 49 40 24
AUD/USD 38 53 47 39 20
USD/CAD 47 94 84 74 28
NZD/USD 42 52 46 38 20
EUR/GBP 25 40 34 27 16
GBP/JPY 112 145 119 99 60
GBP/CHF 96 150 129 105 62
AUD/JPY 55 63 56 47 26
All times ET
Source: Day Trading the Currency Market by Kathy Lien. Courtesy of John Wiley & Sons.

FIGURE 1 — ASIAN SESSION VOLATILITY
The pound/franc and pound/yen rates had the most price activity during the
Asian trading session.
ing various time periods between 2002

and 2004. All sessions are described in
terms of U.S. Eastern Standard Time
(ET).
Asian session (Tokyo):

7 p.m. to 4 a.m. ET
Forex trading in Asia is conducted in
major regional financial hubs. During
the Asian trading session, Tokyo has
the largest market share, followed by
Hong Kong and then Singapore.
Despite the flagging influence of the
Japanese central bank on the forex
market, Tokyo remains one of the most
important currency centers in Asia. It Source: Day Trading the Currency Market by Kathy Lien. Courtesy of John Wiley & Sons.
is the first major Asian market to open
each morning, and many large participants often use the the European trading session.
trade momentum established there to gauge market At the opposite end of the spectrum, the Australian dol-
dynamics and devise their trading strategies. lar/Japanese yen (AUD/JPY), British pound/U.S. dollar
Trading in Tokyo can be thin from time to time. Large (GBP/USD), and U.S. dollar/Swiss franc (USD/CHF) are
investment banks and hedge funds are known to try to use good choices for more risk-averse traders. The moderate
the Asian session to run important stop and option barrier volatility of these currency pairs helps shield traders and
levels. Figure 1 provides a ranking of the different currency their investment strategies from the irregular market moves
pairs and their ranges during the Asian trading session. resulting from intraday speculative trades. As a result, these
For more risk-tolerant traders, U.S. dollar/Japanese yen pairs allow medium-term to long-term traders to take fun-
(USD/JPY), British pound/Swiss franc (GBP/CHF), and damental factors into account when making decisions.
British pound/Japanese yen (GBP/JPY) are good picks
because their broad ranges (averaging 90 pips) provide European session (London):
short-term traders with lucrative profit potential. 2 a.m. to noon ET
Foreign investment banks and institutional investors, London is the largest and most important dealing center in
which hold mostly dollar-dominated assets, generate a sig- the world, with a market share of more than 30 percent,
nificant number of USD/JPY transactions when they enter according to the 2004 Triennial Central Bank Survey of
the Japanese equity and bond markets. Japan’s central Foreign Exchange and Derivatives Market Activity pub-
bank, with more than $800 billion of U.S. Treasury securi- lished by the Bank for International Settlements (BIS).
Tokyo has the largest market share during the Asian trading session,
followed by Hong Kong and Singapore.
ties, also plays an influential role in affecting the supply and Most of the forex dealing desks of large banks are located
demand of USD/JPY through its open market operations. in London, and the majority of major forex transactions are
Finally, large Japanese exporters are known to use the completed during London hours because of the market’s
Tokyo trading session to repatriate their foreign earnings, high liquidity and efficiency.
which heightens fluctuations in the dollar/yen rate. Also, The vast number of market participants and their high
the GBP/CHF and GBP/JPY rates remain highly volatile, as transaction values make London the most volatile forex
central bankers and large market players start to scale market of all. As shown in Figure 2, the ranges for half of
themselves into positions in anticipation of the opening of continued on p. 40

TRADING STRATEGIES continued
FIGURE 2 — EUROPEAN SESSION VOLATILITY

Six currency pairs had average volume above 80 points (pips), and four had
volume greater than 100 points during the European trading session, which the 12 major currency pairs surpass the
straddles both the Asian and U.S. sessions. 80-pip line, the benchmark that was
used to identify volatile pairs. The
British pound/Japanese yen
(GBP/JPY) and British pound/Swiss
franc (GBP/CHF) pairs had the largest
average ranges — 140 and 146 pips,
respectively.
The GBP/JPY and GBP/CHF pairs
are well suited for risk-seeking traders.
Their high volatility reflects the peak
of daily trade activity, as large market
participants are in the process of com-
pleting the global currency conversion
cycle. London hours are directly con-
nected to both the earlier Asian session
and the later U.S. session: As soon as
large banks and institutional investors
are finished repositioning their portfo-
lios, they need to start converting the
European assets into dollar-denomi-
Source: Day Trading the Currency Market by Kathy Lien. Courtesy of John Wiley & Sons.
nated ones again in anticipation of the
opening of the U.S. market. The com-
bination of these two reconversions by the big players is the
major reason for the extremely high volatility during this
Related Reading period.
More risk-tolerant traders have plenty of other pairs to
Other articles by Kathy Lien: choose from. The Euro/U.S. dollar (EUR/USD), U.S. dol-
lar/Canadian dollar (USD/CAD), British pound/U.S. dol-
“Dollar-yen: The year’s hottest carry trade”
lar (GBP/USD), and U.S. dollar/Swiss franc (USD/CHF)
Currency Trader, August 2005.
rates, with average ranges of around 100 pips, are ideal
How the U.S. interest rate hike cycle offered the oppor-
picks because their high volatilities offer abundant oppor-
tunity to go long the dollar and short the yen.
tunities to enter the market. As mentioned earlier, trading
between the European currencies and the dollar picks up
“Volatility-based currency trading”
again because the large participants have to reshuffle their
Currency Trader, February 2005.
portfolios for the opening of the U.S. session.
How to use inside bars and volatility comparisons to
For more risk-wary traders, the New Zealand dollar/U.S.
spot trade opportunities.
dollar (NZD/USD), Australian dollar/ U.S. dollar
(AUD/USD), Euro/Swiss franc (EUR/CHF), and
“Getting a lift from the carry trade”
Australian dollar/Japanese yen (AUD/JPY), with average
Currency Trader, October 2004.
ranges of approximately 50 pips, are good choices. These
The mechanics of the carry trade are explained.
pairs provide traders with high interest incomes in addition
to potential trade profits. They allow investors to determine
“Forex Trading: Understanding the currency market”
their direction based on fundamental economic factors and
Active Trader, July 2004.
are less prone to losses because of intraday speculative
A review of how the foreign currency market works
trades.
and the economic factors that drive it.
For information on the author see p. 6.
You can purchase and download past articles at
www.activetradermag.com/purchase_articles.htm. Next month: A look at the U.S. forex trading session, as well as
the “overlaps” between the Asian and European sessions and the
European and U.S. sessions.

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CURRENCY SYSTEM ANALYSIS
FIGURE 1 — EXAMPLE TRADE

Using stochastic signals on daily and weekly timeframes creates a longer-term
system. The buy was executed when the weekly stochastic crossed below 70
Dual timeframe within 10 days of the daily stochastic.
stochastics
Market: Currencies.
System concept: This system uses

a multiple timeframe approach to
trade a well-known technical indicator,
the stochastic oscillator, in an uncon-
ventional way. Trades are taken only if
the indicator gives signals on both the
daily and weekly time frames. To
judge the effectiveness of this
approach, we also will compare the
results of the system to those based
exclusively on weekly or daily time
frames.
The traditional application of the
stochastic oscillator is to wait for it to
reach an extreme level — typically,
above 70 to indicate an over- Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)
bought condition, and below 30
to indicate an oversold level — FIGURE 2 — EQUITY CURVE
and enter the market in the
The system was quite profitable, especially over the past three years.
opposite direction.
This system turns that inter-
pretation inside out. It goes long
when the %K lines of 10-day and
two-week slow stochastic indi-
cators both cross below 70; it goes
short when the indicators cross
above 30. This has the effect of
using the stochastic to signal
longer-term trend trades rather
than shorter-term countertrend
trades.
Rules:
Use 10-day and two-week slow
stochastic oscillators, both of
which use five-day smoothings
instead of the usual three-day
smoothing:
1. Go long and exit short the next day at market if both Figure 1 shows a trade example in the Euro. The upper
indicators (%K lines) cross below 70 within 10 trading pane includes both the daily stochastic (in blue) and weekly
days. stochastic (in red). On Nov. 19, 2002, the daily stochastic
2. Go short and exit long the next day at market if both crossed below 70, but the system did not take action until the
indicators (%K lines) cross above 30 within 10 trading weekly stochastic also crossed below this threshold on Nov.
days. 29. The system went long the next day (Dec. 2) and stayed in
3. Place a stop-loss above or below the entry price a dis- the trade until both stochastic indicators crossed above 30.
tance of the 10-day average true range (ATR). The system exited on July 28 with a 17-point profit. Notice

FIGURE 3 — DRAWDOWN CURVE
that during the holding peri- The strategy’s profitability had a dark side, though: Long drawdown periods could
od the daily stochastic make the system difficult to trade.
crossed the 30 line three more
times; a system based on the
daily stochastic would have
exited the position much ear-
lier.
Money management:
Risk a maximum of two per-
cent of account equity per
trade. The number of con-
tracts is calculated using the basis price
STRATEGY SUMMARY
(the closing price the day before the
entry day), the stop-loss level, and the Long + Short Long Only Short Only
contract’s point value (the dollar value Starting capital $100,000 $100,000 $100,000
of a one-point move). The stop level is Ending capital $665,410.63 $668,801.13 $96,609.50
the value of the 10-day ATR. Net profit $565,410.63 $568,801.13 $-3,390.50
For example, if a contract has a point Net profit % 565.41% 568.80% -3.39%
value of $1,250, assume the system goes Annualized gain % 13.46% 13.50% -0.23%
long at $100, its basis price, and the stop Exposure 6.36% 4.03% 5.33%
is at $99.50. To determine the trade’s
dollar risk, multiply the point value Number of trades 149 75 74
($1,250) by the difference between the Avg profit/loss $3,794.70 $7,584.02 $-45.82
basis price and the risk-stop ($100 - Avg profit/loss % 0.79% 1.18% 0.39%
$99.50 = $0.50). Because a single con- Avg bars held 42.22 42.96 41.47
tract’s dollar risk is $675 in this case, the
two-percent ($2,000) risk threshold Winning trades 32 20 12
allows us to buy three contracts. Winning % 21.48% 26.67% 16.22%
continued on p. 44 Gross profit $1,257,830.29 $893,064.59 $364,765.70
Avg profit $39,307.20 $44,653.23 $30,397.14
Avg profit % 7.91% 7.40% 8.75%
LEGEND: Starting capital — Equity at the beginning of the sim- Avg bars held 139.13 131.00 152.67
ulation period • Ending capital — Equity at the end of the simu-
lation period • Net profit — Profit at end of test period, less com- Max consecutive 3 3 3
mission • Net profit % — Profit at end of test period in percent of
starting equity • Annualized gain % —Compounded annual Losing trades 117 55 62
growth rate • Exposure — The area of the equity curve exposed to
long or short positions, as opposed to cash • Number of trades — Losing % 78.52% 73.33% 83.78%
The total number of round-trip trades plus open positions • Avg Gross loss $-692,419.64 $-324,263.45 $-368,156.20
profit/loss — The average profit/loss per trade in dollars • Avg Avg loss $-5,918.12 $-5,895.70 $-5,938.00
profit/loss % —The average percentage profit/loss per trade
• Avg bars held — The average number of bars held per trade Avg loss % -1.16% -1.09% -1.23%
• Winning trades — The total number of winning trades • Avg bars held 15.72 10.95 19.95
Winning % — The percentage of winning trades • Gross profit Max consecutive 12 9 22
— The total profit generated by the winning trades, minus com-
missions and slippage • Avg profit — The average profit per win-
ning trade • Avg profit % — The average percentage profit per Max drawdown $-279,004.16 $-244,815.19 $-228,547.75
winning trade • Avg bars held — The average number of bars Max drawdown % -42.57% -39.63% -70.29%
held per winning trade • Max consecutive — The maximum
number of consecutive winners • Losing trades — The total num- Max drawdown date 8/27/2004 3/12/2004 6/9/2004
ber of losing trades • Losing % — The percentage of losing trades Sharpe ratio 0.60 0.63 0.16
• Gross loss — The total loss generated by the losing trades,
minus commissions and slippage • Avg loss — The average loss
per losing trade • Avg loss % — The average percentage loss per Currency System Analysis strategies are tested on a portfolio basis (unless otherwise noted) using
losing trade • Avg bars held — The average number of bars held Wealth-Lab Inc.’s testing platform. If you have a system you’d like to see tested, please send the
per losing trade • Max consecutive — The maximum number of trading and money-management rules to editorial@currencytradermag.com.
consecutive losers • Max drawdown — Largest decline in equity Disclaimer: Currency System Analysis is intended for educational purposes only to provide a
in dollars • Max drawdown % — Largest percentage decline in
perspective on different market concepts. It is not meant to recommend or promote any trading
equity • Max drawdown date — Date on which the max draw-
system or approach. Traders are advised to do their own research and testing to determine the
down was realized • Sharpe ratio — Annualized average return
divided by the annualized standard deviation of returns. validity of a trading idea. Past performance does not guarantee future results; historical testing
may not reflect a system’s behavior in real-time trading.

CURRENCY SYSTEM ANALYSIS continued
FIGURE 4 — EQUITY CURVE: DAILY STOCHASTIC ONLY

After 15 years of seesaw returns, the daily-only system was back where it started.
Test data: The system was
tested on the following cur-
rency futures: British pound
(BP), Euro FX (EC), Japanese
yen (JY), Swiss franc (SF); data
from Pinnacle Data Corp.
(www.pinnacledata.com).
Test period: January 1990

to January 2005.
Starting equity: $100,000.

Deduct $20 commission per
round-trip trade per contract
and two ticks of slippage per
stop order.
Test results: The system

was very profitable, produc-
ing an annualized return of 13.36 FIGURE 5 — EQUITY CURVE: WEEKLY STOCHASTIC ONLY
percent, but it also had very sig-
The weekly-only system posted an overall profit, but its results were not as good as
nificant drawdowns. The sys- the dual timeframe system.
tem’s equity curve (Figure 2)
highlights its gains as well as its
volatility.
Figure 3 (drawdown curve)
details the system’s large (up to
42.57 percent) and long draw-
downs. It takes the system a long
time to recover completely from
a drawdown. Also, the average
profit per trade is only 0.79 per-
cent, making this system vulner-
able to higher slippage and com-
mission costs. Furthermore, the
system has a low number (21.48
percent) of winning trades, so it
makes most profits with only
few trades, similar to traditional
trend-following systems. Aside
from this, however, the results
are impressive, especially considering the system’s low frame system) after 15 years of simulation. The ending cap-
exposure of only 6.36 percent. ital was $412,197 — not bad, but not as much as the
To compare the effectiveness of using the indicator on $665,410 profit for the dual system.
two timeframes, we ran two more tests — one using only
the daily stochastic and another using only the weekly sto- Bottom line: The system was quite profitable, but this
chastic. profitability was accompanied by volatility. Using the sto-
Figure 4 shows the equity curve of a daily-only system. chastic on both the daily and the weekly timeframes result-
The system swung wildly up and down, and after 15 years ed in improved profitability vs. using the indicator on either
ended with roughly the same equity it started with. individual timeframe. Regardless of what of trading
Figure 5 shows the results of a weekly-only system. This approach you use, consider incorporating different time-
system’s equity increased overall, but there also were long frames.
periods without new equity highs and — more importantly
— a much lower overall profit (relative to the dual time- —José Cruset of Wealth-Lab

CURRENCY FUTURES
FX traders seeing red in 2005
W
ith two months left in the year, professional cur- performance of a hypothetical $1,000 investment based on
rency traders are poised to see their first down the index’s daily returns from Dec. 30, 2004 to Oct. 26,
year in more than a decade, according to data 2005.
from a top managed money-tracking firm.
FIGURE 1 — BTOP FX INDEX VAMI
The Barclay Group’s (www.barclaygrp.com) Currency
Traders Index was down -2.07 percent on the year through The largest currency fund managers were down marginally
Oct. 26. Barclay’s tracks the performance of commodity on the year toward the end of October.
trading advisors (CTAs) and hedge funds. The last time
their currency index finished a year in the red was 1994,
when professional currency managers posted a 5.96-per-
cent loss for the year on the heels of a 3.33-percent loss in
1993. These back-to-back declines were the index’s only los-
ing years since 1987.
CTAs haven’t had a good year overall. Barclay’s total
CTA index stood at -0.66 percent for the year on Oct. 26.
However, end-of-year stock market bullishness — if it
materializes — could have the potential to push the overall
index into the black.
Barclay’s BTOP FX Index, which reflects the performance
of the largest currency managers, was down only -1.1 per-
cent on the year, and was down a marginal -0.14 percent in
October. Figure 1 shows the Value Added Monthly Index
Source: The Barclay Group (www.barclaygroup.com)
(VAMI) line for the BTOP FX index for 2005. It reflects the
CURRENCY FUTURES SNAPSHOT The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s
as of 10/26/05 liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.
Contract Pit Elec Exch Vol OI 10-day % 20-day % 60-day % Volatility

sym sym move rank move rank move rank ratio/% rank
Eurocurrency EC 6E CME 124.3 131.9 0.32% 38% 0.30% 20% -0.88% 15% .39 / 77%
Japanese yen JY 6J CME 45.2 154.3 -1.42% 35% -2.56% 62% -3.63% 74% .29 / 50%
British pound BP 6B CME 40.9 77.9 1.40% 83% 0.59% 11% 0.36% 14% .35 / 72%
Swiss franc SF 6S CME 35.3 70.1 0.27% 20% 0.75% 26% -0.23% 6% .38 / 55%
Canadian dollar CD 6C CME 32.7 104.4 0.01% 0% 0.35% 10% 3.98% 52% .22 / 33%
Australian dollar AD 6A CME 18.1 66.4 0.01% 0% -0.33% 22% -1.39% 34% .33 / 18%
Mexican peso MP 6M CME 14.5 71.5 0.55% 33% 0% 0% -2.67% 93% .28 / 30%
U.S. dollar index DX NYBOT 4.7 18.0 -0.16% 25% 0.03% 0% 0.76% 15% .37 / 62%
Euro / Swiss franc RZ NYBOT 1.6 19.1 0.08% 25% -0.42% 37% -0.59% 32% .48 / 98%
Euro / Japanese yen EJ NYBOT 1.3 15.3 1.83% 95% 2.98% 94% 2.92% 79% .30 / 33%
Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.
LEGEND: The “% rank” fields for each time window (10-day all the past readings, while a reading of 0% means the
Sym: Ticker symbol. moves, 20-day moves, etc.) show the percentile rank of current reading is lower than the previous readings.
the most recent move to a certain number of the previous These figures provide perspective for determining how
Vol: 30-day average daily volume, in thousands.
moves of the same size and in the same direction. For relatively large or small the most recent price move is
OI: 30-day open interest, in thousands. example, the % rank for 10-day move shows how the compared to past price moves.
10-day move: The percentage price move from the most recent 10-day move compares to the past twenty Volatility ratio/% rank: The ratio is the short-term volatil-
close 10 days ago to today’s close. 10-day moves; for the 20-day move, the % rank field ity (10-day standard deviation of prices) divided by the
20-day move: The percentage price move from the shows how the most recent 20-day move compares to long-term volatility (100-day standard deviation of prices).
close 20 days ago to today’s close. the past sixty 20-day moves; for the 60-day move, the % The % rank is the percentile rank of the volatility ratio
60-day move: The percentage price move from the rank field shows how the most recent 60-day move com- over the past 60 days.
close 60 days ago to today’s close. pares to the past one-hundred-twenty 60-day moves. A
reading of 100% means the current reading is larger than
This information is for educational purposes only. Currency Trader provides this data in good faith, but cannot guarantee its accuracy or timeliness. Currency Trader assumes no
responsibility for the use of this information. Currency Trader does not recommend buying or selling any market, nor does it solicit orders to buy or sell any market. There is a
high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
November 2005 • CURRENCY TRADER 45

CURRENCY BASICS
Comparing moving averages

This review provides simple ways to interpret and apply the most commonly used moving averages.
BY THOM HARTLE
FIGURE 1 — SIMPLE MOVING AVERAGE
T he moving average is a funda-

mental tool for smoothing price
action and revealing trend. In the
early days of technical analysis,
traders simply looked for a crossover of the
moving average (i.e., when price crosses above
or below its average) as a sign the trend had
The 10-bar SMA smoothes price but lags market turning points. When
price slips (point B), the moving average continues to rise. But at point
C, the SMA turns down, following the declining prices.
changed. Today, traders have shorter-term

trading horizons, so the moving average is also
used as a “decision filter.” For example, if price
is above its moving average, then the trend is
up, and the trader will look for short-term buy
setups (rather than sell setups).
Although moving averages can simplify
price action and highlight the underlying trend,
they also trail behind (lag) price action — the
longer the moving average, the more it lags
price. There are several types of moving aver-
ages; traders originally used the simple moving Source: eSignal
average (SMA) because it was easy to under-
stand and calculate. Over time, other smoothing techniques over time (e.g., the 50-day and 200-day moving averages),
were incorporated to reduce the lag inherent in the SMA. but there is no moving average length that will best reflect
Here, we will compare the three most common moving the trend in all conditions and markets. The following
average types — simple, weighted, and exponential. examples use several representative moving average
There is no “correct” number of bars to use in a moving lengths.
average. Certain “look-back” periods have become popular
There is no “correct” number of bars to use in a moving average. Certain

“look-back” periods have become popular over time, but there is no moving
average length that will best reflect the trend in all conditions and markets.

FIGURE 2 — 10-DAY SMA
At point A, the Euro/U.S. dollar peaks, and its 10-day SMA turns down three
days later. The retracement (point B) doesn’t affect the SMA much, and price
Simple moving average rallies above its moving average well before the SMA turns up (point C).
Our first example uses a 10-bar SMA,
but technicians commonly use moving
averages as long as 200 days (approxi-
mately one year in trading days) to
define the long-term trend, as well as a
combination of moving averages such
as four-, nine-, and 21-day periods to
simultaneously track three trends.
To calculate a 10-bar SMA, add the
last 10 bars’ closes and divide by 10.
When the next bar closes, the most dis-
tant closing price in the look-back peri-
od is dropped, the new bar’s closing
value is added, and the new sum is
divided by 10.
Figure 1 shows simulated prices with
a 10-bar SMA. (Notice it takes 10 closes
to plot the first SMA value.) At point A,
the simple moving average is near the
Source: eSignal
middle of the price range. As price
begins to rise, the simple moving aver-
FIGURE 3 — 10-DAY WMA VS. SMA
age turns up a few closes later, illustrat-
ing the moving average’s inherent lag. The weighted moving average tracks price action closer than the simple moving
The average continues to rise despite a average. The WMA’s turning points (points A and C) occur before the SMA’s.
short-term retracement (point B), and Point B’s price rise did not materially affect the WMA.
both values climb after that.
Next, price forms a double top and,
as it declines, the simple moving aver-
age crests and turns down (point C).
During the drop, the SMA trended
down despite a final countertrend rise.
Figure 1 shows the benefits and
drawbacks of simple moving averages.
Despite short-term, counter-trend
movements, the SMA filters out this
noise and continues in the direction of
the trend. But the SMA’s lag is notice-
able when price changes direction.
Figure 2’s daily chart of the Euro/
U.S. dollar currency pair shows the
same characteristics as in Figure 1.
Here, the simple moving average fol-
lows the market as it peaks and then
turns down (point A). The market
Source: eSignal
continued on p. 48

CURRENCY BASICS continued
FIGURE 4 — 10-DAY EMA VS. SMA point B’s countertrend move did not
derail the descent of the WMA.
The EMA turns each time price closes above or below it (points A and B), and
the EMA turns up slightly at point C.
Exponential moving averages
The exponential moving average
(EMA) uses a special algorithm (the
“smoothing constant”) that weights
price by a percentage factor. There are
two versions of the EMA calculation.
Both versions use a smoothing con-
stant to weight the closing price and
adjust the previous day’s EMA value.
The constant uses a formula to approx-
imate the value of a SMA:
SC = 2/(n + 1)
where
n = the look-back period for a simple
moving average
SC = a smoothing constant between 1
and zero
Source: eSignal
Therefore, if n = 10:
retraces (point B), but the moving average continues to SC = 2/(10+1) = 2/11 = 0.1818
trend lower. At point C, price rallies above its moving aver-
age and the MA turns up. We see the same lag at points A The first version of the EMA calculation multiplies
and C when the market reverses the trend. today’s close by the smoothing constant and yesterday’s
EMA by 1 minus the smoothing constant:
Weighted moving averages
One reason the SMA lags price is because all prices are (today’s close * 0.1818) + (yesterday’s EMA * 0.8182)
equally weighted — the current close and the first close
have the same impact on the average. A weighted moving The second approach uses the following formula:
average (WMA) uses specific multipliers to weight each
price, giving the most weight to the most recent price and (today’s close - yesterday’s EMA)* 0.1818) + yesterday’s
reducing this emphasis the further back in time you go. EMA
Thus, the most current price impacts the WMA more than
the last price in the look-back window. The formulas show how important today’s close is rela-
For example, a 10-bar WMA multiplies the current price tive to the previous day’s EMA. If today’s close is above
by 10, the next most recent price by 9, the next by 8, and so yesterday’s EMA for the first time, the EMA will immedi-
on. The sum of these weighted prices is divided the sum of ately turn up. If today’s close is less than yesterday’s EMA,
the weights, which is 55 (10 + 9 + 8 + 7… 1) in this example. the average will immediately turn down.
Figure 3 compares a 10-bar WMA (blue) to the 10-bar SMA There is no lag between today’s close and the direction of
(red). Notice the WMA crests and troughs (points A and C) the EMA. During trading ranges, however, the EMA will
ahead of the SMA. The WMA responds much quicker to the flip back and forth.
reversal patterns at the top and bottom, which took approxi- Figure 4 compares a 10-day EMA to the 10-day SMA. At
mately five days. In contrast, the SMA required either more points A and D the EMA reverses direction once the Euro
time or a more dramatic price move to reverse its trend. But crosses above or below it. It is a little less noticeable, but at

FIGURE 5 — WMA/EMA CROSSOVER SIGNALS
If the 20-day EMA is rising, the trend is up and price moves below the three-
day WMA represent buy opportunities (green area). If the EMA is falling, the
area between the EMA and WMA can be considered a sell zone (red).
points B and C, the EMA turns up

because price closes above it.
The EMA is best applied to markets
that are prone to spike reversals. A
market that moves into a lengthy trad-
ing range will be constantly crisscross-
ing this average.
Applying moving averages

Think of the moving average as exact-
ly what its name says: the average
price. Many years ago, traders viewed
a cross of the moving average as a sign
the trend has changed direction. But it
doesn’t make sense the trend has
changed direction simply because
price is somewhere above or below its
Source: eSignal
average.
On the other hand, if the average
price is rising or falling, then it pro-
vides information about the trend’s direction. A rising aver-
Related reading age price indicates the trend is up; a falling moving average
reflects a descending trend.
“The weighted moving average system” These two ideas can be used together with two different
Active Trader, November 2004. moving averages and look-back periods. Figure 5 shows the
A test of a WMA crossover system on a futures Euro/ U.S. dollar with a 20-day EMA and a three-day WMA.
portfolio. For example, you could consider the direction of the expo-
nential moving average as the trend. If the EMA is rising, the
“Trend vs. countertrend indicators” trend is up. If the EMA is falling, the trend is down.
Active Trader, June 2004. Next, the three-day WMA can be considered a level of
An explanation of how technical indicators work and the value. If the trend is up as defined by a rising EMA and
differences between trend-following and countertrend price is below yesterday’s WMA (we don’t know today’s
calculations. reading until the close), then price is cheap relative to the
upward trend. Consider the area between the rising EMA
“Indicator Insight: and the WMA as a buy zone (green area) for intraday and
Weighted and exponential moving averages” short-term setups.
Currency Trader, January 2005. If the trend is down (the EMA is declining) and current
How to calculate and interpret weighted and exponen- price is above yesterday’s WMA, then price is expensive rel-
tial moving averages. Includes simple comparison tests ative to the downward trend. The area between the falling
of different moving averages. EMA and the WMA is a sell zone (red area).
Moving averages can be used as a frame of reference to
“Indicator Insight: Simple moving average,” indicate the trend and whether the current price is cheap or
Currency Trader, December 2004. expensive relative to the trend. Considering how trends in
A primer on the calculation and application of simple forex tend to persist, having a tool that keeps you looking
moving averages. for opportunities on the right side of the trend is a very wise
first step towards profitability.
You can purchase and download past articles at
www.activetradermag.com/purchase_articles.htm. For information on the author see p. 6.
Questions or comments? Click here.

GLOBAL ECONOMIC CALENDAR NOVEMBER/DECEMBER
MONTH
Monday Tuesday Wednesday Thursday Friday Saturday
1 2 3 4 5
U.S.: ISM report on Japan: Monetary ECB: U.S.:
business; FOMC meeting base Governing Unemployment
Japan: Account balances Germany: council
Australia: Index of Unemployment meeting Germany: Orders
commodity prices Australia: received and
Reserve bank manufacturing
meeting turnover
7 8 9 10 11 12
Germany: U.S.: Wholesale U.S.: Trade Japan: Corporate
Production index inventories balance goods price index
Australia: Official Great Britain: Great Britain:
reserve assets; Monetary policy Monetary policy
statement on committee meeting committee
monetary policy Germany: Foreign meeting
trade
14 15 16 17 18 19
U.S.: Retail sales U.S.: PPI U.S.: CPI ECB: Great Britain: Capital Germany:
Japan: Monetary survey Governing issues PPI
Japan: Balance of Great Britain: CPI Great Britain: council Japan: Bank of Japan
payments Unemployment Unemployment meeting meeting
Germany: CPI Germany: Bankruptcies
Great Britain: PPI Canada: Manufacturing Italy: Balance Great Britain: Canada: Wholesale trade
survey of payments Retail sales
21 22 23 24 25 26
U.S.: Leading Germany: Canada: Leading Japan: Corporate
indicators National accounts indicators service price index
Canada: Retail Canada: CPI Great Britain:

trade GDP
28 29 30 1 2
U.S.: Durable U.S.: GDP U.S.: ISM U.S.:
goods Germany: Retail turnover; unemployment ECB: Governing Unemployment
Canada: GDP council meeting
Canada: Australia: International reserves and Japan: Account Japan:
Unemployment foreign currency liquidity balances Monetary base
Italy: International reserves and foreign Australia: Index of
currency liquidity commodity prices
5 6 7 8 Legend
Canada: Bank of Great Britain: Great Britain:
CPI: Consumer Price Index
Canada meeting Monetary policy Monetary policy
committee meeting committee meeting ECB: European Central Bank
Germany: Orders Germany: Production FOMC: Federal open market committee
received and Australia: Official index GDP: Gross Domestic Product
manufacturing reserve assets; New Zealand: ISM: Institute for Supply Management
turnover Reserve bank meeting Reserve bank meeting PPI: Producer Price Index
The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.

EVENTS
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For more information: Visit www.coesfx.com. Date: Dec. 12

Dates and locations listed below.
Location: New York, N.Y.
Date: Nov. 2
Instructor: FX-Strategy’s Doug Schaff
Location: Atlanta, Ga. and Phoenix, Ariz.
For more information: Visit www.fx-strategy.com
Date: Nov. 7, 8
•
Location: Houston, Texas
Event: The Traders Expo Las Vegas
Date: Nov. 9, 10
Date: Dec. 13-16
Location: Dallas, Texas
Location: Paris Resort, Las Vegas, Nev.
•
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Date: Nov. 4-5 •
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•
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Event: Futures & Options Expo 2005 280-8440
Date: Nov. 8-10 •
Location: Hyatt Regency, Chicago, Ill. Event: The Traders Expo New York
For more information: Visit Date: Feb. 18-21

www.futuresindustry.org/expo
Location: Marriott Marquis Hotel, New York, N.Y.
•
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Presenters: Larry McMillan, Al Brinkman, and David S. •

Nassar
Event: National Association of Active Investment
Date: Nov. 11-12 Managers (NAAIM) Annual Conference
Location: Atlanta, Ga. Date: April 30-May 3
For more information: Call (973) 362-4558 or e-mail Location: The Ritz Carlton, Phoenix, Ariz.
info@optionstrategist.com
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• naaim@mindspring.com or call (888) 261-0787
Event: Forex Trading Expo
Date: Nov. 19-20
Location: Mandalay Bay Hotel, Las Vegas, Nev.
For more information: Visit

www.forextradingexpo.com

INTERNATIONAL MARKET SUMMARY
FOREX (vs. U.S. DOLLAR)
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank
1 New Zealand 0.7031 1.95% 2.30% -4.21% 0.7464 0.6677 11

dollar
2 Thai 0.02449 0.57% 1.22% -3.51% 0.02621 0.02362 7

baht
3 Swiss 0.7769 0.35% 0.68% -9.02% 0.8879 0.7642 15

franc
4 Brazilian 0.4424 0.11% 5.74% 10.90% 0.4521 0.3457 1

real
5 Hong Kong 0.129 0.08% 0.23% 0.54% 0.1291 0.128 4

dollar
6 Russian 0.035 -0.34% 0.49% -3.14% 0.03643 0.03454 6

rouble
7 British 1.768 -0.44% 1.69% -8.35% 1.955 1.7271 10

pound
8 Euro 1.1983 -0.56% -0.68% -9.05% 1.3667 1.1866 12
9 Singapore 0.5902 -0.58% -2.15% -2.86% 0.6186 0.5858 9

dollar
10 Australian 0.7514 -0.81% -1.58% -4.10% 0.7988 0.7364 5

dollar
11 Canadian 0.8427 -1.42% 2.58% 3.67% 0.8629 0.7851 2

dollar
12 Taiwanese 0.02967 -1.58% -6.50% -7.38% 0.03253 0.02955 16

dollar
13 Swedish 0.1257 -2.23% -1.67% -13.44% 0.152 0.1249 14

krona
14 Japanese 0.00866 -2.66% -3.80% -9.61% 0.00983 0.00862 13

yen
15 Indian 0.02219 -2.88% -3.97% -3.20% 0.02317 0.02183 8

rupee
16 South African 0.152 -3.36% 0.07% -9.21% 0.1783 0.1427 3

rand
As of Oct. 25, 2005 *based on one-month gain/loss
INTEREST RATES
Rank Country Rate Oct. 25 1-month 3-month 6-month Previous
1 UK Short sterling 95.46 -0.18% -0.27% 0.38% 1
2 Australia 3-year bonds 94.575 -0.26% -0.20% -0.05% 2
3 Japan Government Bond 137.32 -1.30% -2.45% -1.70% 3
4 U.S. 10-year T-note 108.235 -1.83% -2.64% -2.56% 5
5 Germany BUND 121.01 -1.98% -1.36% 0.15% 4

NON-U.S. DOLLAR FOREX CROSS RATES
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol Oct. 25 gain/loss gain/loss gain/loss high low Previous
1 Franc / Yen CHF / JPY 89.7366 2.93% 4.32% 0.53% 91.6645 85.1568 16
2 Real / Yen BRL / JPY 51.0949 2.69% 9.19% 18.69% 51.5191 37.0284 1
3 Pound / Yen GBP / JPY 204.18 2.20% 5.27% 1.14% 205.6 189.5 13
4 Euro / Yen EUR / JPY 138.38 2.10% 3.00% 0.51% 141.59 130.6 15
5 Franc / Canada $ CHF / CAD 0.9224 1.73% -1.96% -13.18% 1.0778 0.9064 20
6 Aussie $ / Yen AUD / JPY 86.702 1.60% 2.13% 4.94% 87.322 76.95 10
7 Real / Canada $ BRL / CAD 0.5252 1.49% 3.22% 7.48% 0.5316 0.4212 5
8 Canada $ / Yen CAD / JPY 97.3369 1.20% 6.15% 12.11% 98.1942 83.2354 6
9 Real / Aussie $ BRL / AUD 0.5895 1.00% 7.19% 14.45% 0.5984 0.4584 4
10 Franc / Euro CHF / EUR 0.6483 0.85% 1.36% 0.00% 0.6632 0.6382 17
11 Franc / Pound CHF / GBP 0.4395 0.80% -0.98% -0.61% 0.4647 0.4289 18
12 Real / Euro BRL / EUR 0.3693 0.68% 6.39% 18.28% 0.3765 0.2702 2
13 Aussie $ / Canada $ AUD / CAD 0.8921 0.58% -4.28% -8.07% 0.9837 0.8819 19
14 Real / Pound BRL / GBP 0.2503 0.56% 4.12% 17.78% 0.2567 0.1868 3
15 Pound / Euro GBP / EUR 1.476 0.00% 2.33% 0.66% 1.5124 1.4057 14
16 Aussie $ / Euro AUD / EUR 0.6272 -0.26% -0.88% 4.54% 0.6424 0.5666 11
17 Aussie $ / Pound AUD / GBP 0.4251 -0.38% -3.34% 3.93% 0.4398 0.3916 12
18 Canada $ / Euro CAD / EUR 0.7035 -0.85% 3.26% 11.67% 0.7207 0.6008 7
19 Canada $ / Pound CAD / GBP 0.4768 -0.96% 0.90% 11.09% 0.4893 0.4162 8
20 Aussie $ / Franc AUD / CHF 0.9674 -1.18% -2.29% 4.51% 0.9945 0.8635 9
GLOBAL STOCK INDICES

1-month 3-month 6-month 52-week 52-week
Rank Country Index Oct. 25 gain/loss gain/loss gain/loss high low Previous
1 Egypt CMA 1,990.59 3.77% 11.10% 21.66% 2,064.16 1,107.12 2
2 Switzerland Swiss Market 6,939.7 2.22% 6.28% 14.98% 7,046.4 5,301.7 6
3 Japan Nikkei 225 13,280.62 0.91% 11.43% 16.62% 13,783.6 10,575.23 5
4 Germany Xetra Dax 4,872.97 -0.20% 0.62% 12.85% 5,138.02 3,838.98 11
5 U.S. S&P 500 1,196.54 -1.57% -2.72% 2.88% 1,245.86 1,090.29 14
6 France CAC 40 4,396.99 -1.82% -0.57% 9.19% 4,651.11 3,599.37 9
7 Mexico IPC 15,367.87 -1.83% 8.02% 19.46% 16,186.35 11,160.16 4
8 India BSE 30 7,991.74 -2.89% 6.08% 20.19% 8,821.84 5,558.14 3
9 Singapore Straits Times 2,226.46 -2.99% -3.73% 4.00% 2,399.75 1,947.42 15
10 Australia All ordinaries 4,350.08 -3.77% 0.33% 7.83% 4,625.3 3,688.3 12
11 UK FTSE 100 5,182.1 -4.47% -1.71% 6.12% 5,515 4,551.6 10
12 Italy MIBTel 25,069 -4.70% -2.42% 4.39% 26,969 21,293 8
13 Hong Kong Hang Seng 14,424.88 -4.99% -2.56% 4.68% 15,508.57 12,743.42 13
14 Canada S&P/TSX composite 10,363.74 -5.22% 0.01% 9.14% 11,118.03 8,720.44 7
15 Brazil Bovespa 29,498 -6.09% 16.84% 14.46% 32,052 22,390 1
ACCOUNT BALANCE
Rank Country 2005 Ratio* 2004 2006+ Rank Country 2005 Ratio* 2004 2006+
1 Hong Kong 17.808 10.3 16.119 18.678 9 UK -40.981 -1.9 -42.086 -40.118
2 Taiwan 14.369 4.3 18.606 16.26 10 Spain -69.382 -6.2 -55.266 -80.067
3 Japan 153.101 3.3 172.07 140.484 11 U.S. -759.018 -6.1 -668.082 -805.179
4 Germany 121.064 4.3 103.828 121.937 12 New Zealand -7.946 -7.4 -6.141 -8.34
5 Canada 16.689 1.5 22.159 19.529 13 Australia -38.765 -5.7 -39.797 -35.419
6 Denmark 4.797 1.9 6.001 5.468 Totals in billions of U.S. dollars
+
*Account balance in percent of GDP, Estimate
7 France -27.253 -1.3 -8.396 -31.022
Source: International Monetary Fund, World Economic Outlook
8 Italy -29.877 -1.7 -14.963 -24.394 Database, September 2005

GLOBAL NEWS BRIEFS MARKET SUMMARY
FOREX/INTERNATIONAL
EUROPE The second-quarter unemployment rate for Singapore

increased 0.1 percent to 3.4 percent, but dropped 0.2 per-
cent compared to Q2 of 2004.
France’s August unemployment rate remained
unchanged at 9.9 percent compared to July and was 0.1 per-
cent lower than September 2004. The UK’s jobless rate also
remained steady at 4.7 percent, compared to August and
AMERICAS
the same month a year earlier.
Canada’s jobless rate for September fell 0.1 percent to
Opposing views on a rate hike by various European 6.7 percent from the previous month and dropped 0.4 per-
Central Bank officials in mid-October painted a cloudy pic- cent compared to September 2004. Information, culture
ture for financial markets. While chief economist Otmar and recreation, and educational services jobs increased, as
Issing implied a December rate hike was possible, ECB well as self-employment.
Executive Board member José Manuel Gonzalez-Paramo
said there was no need for immediate action. The ECB A governor for the Bank of Canada said if China would
interest rate is currently at a record-low 2 percent, a level it increase the value of its currency against the U.S. dollar
has remained at for more than two years. faster, it would help the world economy with its current
account balances. “Our view, which we’ve stated very
clearly to the Chinese and stated very clearly publicly, is
ASIA & THE SOUTH PACIFIC that the least-cost way to make some of these [account bal-
ance] adjustments is for some nominal appreciation of the
renminbi against the U.S. dollar,” said David Dodge in tes-
Japan’s August jobless rate dropped 0.1 percent to 4.3 timony before a Canadian Senate banking committee.
percent from July, a decrease of 0.5 percent compared to the
same month in 2004. The central bank of Brazil said it was closely watching
fuel and food prices before deciding on whether to change
An upgrade in consumer price forecasts by the Bank of interest rates at its next meeting, and also said the country’s
Japan indicates the Bank’s mostly hands-off policy toward inflation was showing signs of being mild. These remarks
interest rates may end in 2006. The Japanese economy is came after Copom (Brazil’s monetary-policy committee)
getting better and oil prices continue to stay at elevated lev- raised the Selic interest rate in October a half-point to 19.5
els, helping Japan out of seven years of deflation. Although percent. The move comes after the Selic was cut by a quar-
Japan’s trade surplus for September declined from the pre- ter-point in September, the first rate decline in 17 months.
vious year for the sixth-straight year, the 21.1-percent fall (to
957 billion yen; $8.31 billion) was much less than predicted. A group of analysts in Mexico expect inflation in the
country to increase about 0.3 percent in the first half of
The preliminary unemployment rate for Hong Kong in October, which would be a decrease from 0.5 percent in
September dropped 0.2 percent to 5.5 percent compared to the first half of October 2004. Reuters polled 25 analysts,
the preceding month, a four-year low and a drop of 1.3 per- whose responses ranged from 0.19 to 0.48 percent.
cent from September 2004.
The CAFTA trade agreement passed earlier this year
Australia’s September jobless rate rose 0.1 percent from between the U.S. and seven Central American countries
the previous month to 5 percent, a decrease of 0.4 percent could finally produce some deals. U.S. Commerce
from the same month a year ago. Secretary Carlos Gutierrez said in mid-October he was
heading a group of 18 business leaders on a trip to El
India’s GDP for Q2 rose 12.8 percent compared to the Salvador, Guatemala, and Honduras in hopes of exposing
previous quarter. the U.S. countries to the opportunities in Central America.
Increased global trade forecasted

The World Trade Organization predicted an increase in global goods trade growth in 2006. Economists for the WTO
expect year-over-year growth of 7 percent in 2006, a half-point higher than predictions for 2005. While growth was 9
percent in 2004, reduced consumer and business confidence in more robust economies is blamed for the decline. The
WTO said the 7-percent figure is based on a modest recovery in the world economy.
54 CURRENCY TRADER • November 2005

FOREX TRADE
EDITOR’S NOTEJOURNAL
Sell signals on short- and long-

term timeframes trigger a short
trade in the USD/CAD rate.
TRADE
Date: Friday, Oct. 28, 2005.
Entry: Short the Canadian dollar/U.S.

dollar (USD/CAD) pair at 1.1773.
Reason(s) for trade/setup: Testing

indicated the three-day pattern ending
Oct. 28 (which ironically might look bull-
ish on the chart) had a favorable probabil-
ity of being followed by a price drop. This
analysis also jibed with longer-term analy- Source: TradeStation
sis of monthly data suggesting the downtrend had a better-
than-average chance of reasserting itself after the “inside Profit/loss: -.0029 (-.025 percent)
month” of October.
Trade executed according to plan? So far.
Initial stop: The most recent swing high (Oct. 24, 1.1922)
represents too large a risk for this trade, so we’ll set the stop Outcome: At this point, there seems to be little to do but
at 1.1857. wait for the trade to be stopped out (although the market
was retreating intraday on Nov. 1 when we last checked the
Initial target: 1.1600, which is just above the Sept. 30 low position). But there’s no point in rushing to the exit, as this
of 1.1587. We will exit half the position at this level and would simply remove the remaining chance the trade has
lower the stop on the remainder of the position to protect to turn profitable.
profits. An interesting aspect to this trade was that visual inspec-
tion of the chart led us to believe the market was likely to
bounce higher. However, experience has shown us that this
RESULT is more a coincidence than anything else. The pattern analy-
sis is what counts; what a chart “looks like” can be deceiv-
Exit: 1.1802 — trade marked to market on Nov. 1. ing.
Reason for exit: Position still open. Click here to see the result of this trade.
TRADE SUMMARY
Date Currency Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
10/28/05 USD/CAD 1.1773 1.1857 1.1600 2.06 1.1802 (MTM) 11/1/05 -.0029 (-.025%) .0044 .0084 3 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade). MTM: marked to market – the
profit/loss of the position based on the current price.
November 2005 • CURRENCY TRADER 55

KEY CONCEPTS AND DEFINITIONS
Carry trades involve buying (or lending) a currency with %K and a moving average of %K called %D. The basic sto-
a high interest rate and selling (or borrowing) a currency chastic calculation compares the most recent close to the
with a low interest rate. Traders looking to “earn carry” will price range (high of the range - low of the range) over a par-
buy a high-yielding currency while simultaneously selling a ticular period.
low-yielding currency. For example, a 10-day stochastic calculation (%K) would
be the difference between today’s close and the lowest low of
Fibonacci series: A number progression in which each the last 10 days divided by the difference between the high-
successive number is the sum of the two immediately pre- est high and the lowest low of the last 10 days; the result is
ceding it: 1, 2, 3, 5, 8, 13, 21, 34, 55, and so on. multiplied by 100. The formula is:
As the series progresses, the ratio of a number in the series
divided by the immediately preceding number approaches %K = 100*{(Ct-Ln)/(Hn-Ln)}
1.618, a number that is attributed significance by many traders Ct is today’s closing price
because of it appearance in natural phenomena (the progres- Hn is the highest price of the most recent n days (the
sion a shell’s spiral, for example), as well as in art and architec- default value is five days)
ture (including the dimensions of the Parthenon and the Great Ln is the lowest price of the most recent n days
Pyramid). The inverse, .618 (.62), has a similar significance.
Some traders use fairly complex variations of Fibonacci The second line, %D, is a three-period simple moving
numbers to generate price forecasts, but a basic approach is average of %K. The resulting indicator fluctuates between 0
to use ratios derived from the series. and 100.
For example, if a stock broke out of a trading range and Fast vs. slow: The formula above is sometimes referred to
rallied from 25 to 55, potential retracement levels could be as “fast” stochastics. Because it is very volatile, an addition-
calculated by multiplying the distance of the move (30 ally smoothed version of the indicator –– where the original
points) by Fibonacci ratios –– say, .382, .50, and .618 –– and %D line becomes a new %K line and a three-period average
then subtracting the results from the high of the price move. of this line becomes the new %D line –– is more commonly
In this case, retracement levels of 43.60 [55 - (30*.38)], 40 [55 - used (and referred to as “slow” stochastics, or simply “sto-
(30*.50)] and 36.40 [55 - (30*.62)] would result. chastics”).
Similarly, after a trading range breakout and an up move Any of the parameters –– either the number of periods
of 10 points, a Fibonacci follower might project the size of the used in the basic calculation or the length of the moving aver-
next leg up in terms of a Fibonacci ratio –– e.g., 1.382 times ages used to smooth the %K and %D lines –– can be adjusted
the first move, or 13.82 points in this case. to make the indicator more or less sensitive to price action.
The most commonly used ratios are .382, .50, .618, .786, Horizontal lines are used to mark overbought and over-
1.00, 1.382, and 1.618. Depending on circumstances, other sold stochastic readings. These levels are discretionary; read-
ratios, such as .236 and 2.618, are used. ings of 80 and 20 or 70 and 30 are common, but different mar-
ket conditions and indicator lengths will dictate different lev-
Moving average convergence-divergence (MACD): els.
Although it is often grouped with oscillators, the MACD is Related reading: “Indicator Insight: Stochastics,” Active
more of an intermediate-term trend indicator (although it can Trader, August 2000, page 82.
reflect overbought and oversold conditions).
The default MACD line (which can also be plotted as a his- True range (TR): A measure of price movement that
togram, as is the case in the accompanying article) is created accounts for the gaps that occur between price bars. This cal-
by subtracting a 26-period exponential moving average culation provides a more accurate reflection of the size of a
(EMA) of closing prices from a 12-period EMA of closing price move over a given period than the standard range cal-
prices; a nine-period EMA is then applied to the MACD line culation, which is simply the high of a price bar minus the
to create a “signal line.” low of a price bar. The true range calculation was developed
by Welles Wilder and discussed in his book New Concepts in
MACD = EMA(C,12)-EMA(C,26) Technical Trading Systems (Trend Research, 1978).
Signal line = EMA(MACD,9) True range can be calculated on any time frame or price
bar — five-minute, hourly, daily, weekly, etc. The following
Standard buy signals are given when the MACD crosses discussion uses daily price bars for simplicity.
above its signal line (preferably when the indicator is at a rel- True range is the greatest (absolute) distance of the follow-
atively high level, reflecting an overbought condition); the ing:
opposite is true for sell signals. 1. Today’s high and today’s low.
2. Today’s high and yesterday’s close.
Option barriers: Price levels a currency pair must reach to 3. Today’s low and yesterday’s close and.
result in the payout of a forex option.
Average true range (ATR) is simply a moving average of
Stochastic oscillator: A technical tool designed to high- the true range over a certain time period. For example, the
light shorter-term momentum and “overbought” and “over- five-day ATR would be the average of the true range calcula-
sold” levels (points at which a price move has, theoretically tions over the last five days.
at least temporarily exhausted itself and is ripe for a correc-
tion or reversal). You can purchase and download past Active Trader articles at
Calculation: The stochastic oscillator consists of two lines: www.activetradermag.com/purchase_articles.htm .

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November 2005 • Strategies, News and Analysis for Forex Traders

• THE BEST TIMES TO TRADE • BARBARA ROCKEFELLER

• CURRENCY OUTLOOK FOR:

Zero-interest rate policy weighs

Of Kangaroos and Kiwis:

Dollar depreciation likely to resume . .20

Currency Trader Interview

Forex Resources . . . . . . . . . . . . . . . .11

2 November 2005 • CURRENCY TRADER

Currency Futures . . . . . . . . . . . . . . .45

Currency Basics . . . . . . . . . . . . . . . .46

Currency Strategies International Market Summary . . .52

Currency System Analysis . . . . .42 Key Concepts and Definitions . . . .56

Have a question about something you’ve seen in

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4 November 2005 • CURRENCY TRADER

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Barbara Rockefeller (www.rts-forex.com) is an international

6 November 2005 • CURRENCY TRADER

Spot vs. futures

Three good tools for targeting customers . . .

8 November 2005 • CURRENCY TRADER

The Premier Convention for Forex Traders

Steve Nison Rob Booker

5 Reasons Why You Should Attend The Forex Trading Expo

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Congress, industry debate CFTC authority

T he Commodity Futures Modernization Act,

10 November 2005 • CURRENCY TRADER

W ith the imminent retirement of 18-year Federal

Inspired by the book The Wisdom of Crowds by James Surowiecki,

CURRENCY TRADER • November 2005 11

The New Darling: Dollar/Canada

BY CURRENCY TRADER STAFF

D espite a modest upside correction in the U.S.

12 November 2005 • CURRENCY TRADER

A look at the data

Key levels Mazanec reiterates a long-held market adage: “You never

CURRENCY TRADER • November 2005 13

Zero-interest rate policy weighs on yen

BY CURRENCY TRADER STAFF

U.S. DOLLAR/JAPANESE YEN AT A GLANCE

Average daily range (past 40 days) .84

Searching for yield

14 November 2005 • CURRENCY TRADER

Higher levels for dollar/yen

CURRENCY TRADER • November 2005 15

Of Kangaroos and Kiwis:

CURRENCY TRADER • November 2005 17

CURRENCY TRADER • November 2005 19

Y ield factors will remain very important in

Dollar takes advantage of yield support

20 November 2005 • CURRENCY TRADER

CURRENCY TRADER • November 2005 21

FIGURE 2 — THE INTEREST RATE PICTURE

Don’t forget trade