Friday January 14, 2005 - 11:35:13 GMT
Share This Story
Black Swan Capital - www.blackswantrading.com
The currency life cycle
“When I first look at a trade, I don’t ask, ‘What is the potential profit I can realize?’ but rather, ‘What is the potential loss I could suffer?’”
“The Fed may drop its plan to lift rates at a ‘measured’ pace, language used through five quarter-point increases last year, St. Louis Fed bank President William Poole said late yesterday. The dollar extended gains after European Central Bank council member Axel Weber said higher U.S. rates and faster U.S. growth compared with the euro region will support the currency,” Bloomberg reported this morning.
Bingo! Right on our script for the dollar! I think conversion flow from extreme dollar bearish is under way, albeit at the very early stage.
I noticed a significant change in the story of several currency bank analyst types this morning reading as I read the financial “news.” Many are reflecting a “new theme” (which should not be new to readers of this morning missive) of a rising interest rate differential favoring the dollar. Heck, a heretic from Dresdner Kleinwort Wasserstein (now that’s a mouthful), quoted by Reuters, actually had the gall to say, “something tangible maybe coming out (from the Bush administration) to tackle the budget and current account deficits.” Some people just have no manners whatsoever.
Here’s a more near-term look at the same daily euro chart I presented here yesterday—the déjà vu chart. I have added some letters today and some potential Fib levels for your perusal…
(euro chart with levels)
The next key support for euro-$ is 1.3025. If it manages to slice through there, the next logical resting point should be somewhere near 1.2820.
Currency Life Cycle
Ok, that’s the technical picture. But earlier I mentioned “conversion flow.” Here is a roadmap of a typical currency cycle. It should help put the term “conversion flow” into perspective for you.
1. Extreme bearishness—this is the stage where “shoe shine boys” are shorting the currency and can articulate the rationale to anyone and everyone who will listen. This is when things seem the most bearish, but are in reality most bullish (as later can be seen with the elusive gift of hindsight).
2. Conversion flow—this is the stage when bears start to question their “so obvious” rationale for being short. It is the stage where the flaw in perception of the crowd begins to be recognized by members of the crowd. Conversion flow has an early stage and a more advanced stage. It is why we see increased volatility when the trend changes. The players begin to realize something has changed. But they realize it at different times.
3. Perception of the trend—this is the stage where the crowd recognizes that a new trend may be underway. They have discarded the old rationale and are beginning to accept the new one.
4. Capitulation to the trend—now the trend is fully underway. The crotchety old diehard bears can’t hold out hope any longer—they capitulate and buy into the new trend. Often this is a sign that the new trend is actually becoming a bit stale, for now even the diehards are along for the ride.
5. Extreme bullishness—now the “shoe shine boys” are buying the currency and are articulating the rationale to anyone and everyone who will listen. This is when things seem the most bullish, but are in reality most bearish.
That is typically the five stages of the currency life cycle. I think we are through stage one in the dollar and early in stage two—conversion flow. But, as I said, I have defined a typical cycle. The market is rarely typical in real life. However, if we are going to play, it can be helpful to have a framework. In the end, we are simply laying down our money and taking our chances. But if we can identify where we are in the life cycle, I think it can inch the probabilities of winning in our favor.
(Footnote: I credit John Percival, editor of the Currency Bulletin for much of what I have presented above. Mr. Percival is an old hand in the currency markets; and I dare say he has proven to know more than anyone I have ever read when it comes to currencies.)
Forex Trading News
Daily Forex Market News
Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."