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Tuesday July 24, 2007 - 15:11:26 GMT
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Dollar Bears Feasting...but yin and yang are still out there!

Quotable

“Discomfort guides my tongue
And bids me speak of nothing but despair.”

William Shakespeare

FX Trading – Dollar bears feasting…but yin and yang are still out there!

When it comes to a well established trend—it ain’t as easy as it looks.  Pleading guilty to more than my share of uttering seemingly trite investment phrases (my disclaimer), when someone tells me the “trend is your friend” I naturally want to answer, “Duh!”  But maybe it really is that simple!

Unfortunately, when you’re a natural skeptic of the crowd you rarely believe it’s that simple, especially when even shoeshine boys are able to regurgitate the consensus rationales for a falling dollar. The fact is the consensus can be right for a lot longer than they should be.  I use the phrase “should be” because for all intents and purposes, many players riding the trend are sitting on stale rationales which should have been discounted in the price already.  But that’s why they call them “self-reinforcing” trends.  They take on a character of their own, and if the crowd keeps throwing money onto the trend, the rationales don’t matter.  It becomes a self-reinforcing and self-fulfilling trend.

But as we know in life, and in markets, all good things come to an end.  And that end shows up usually when least expected.  To put it into Zen terminology; it’s the yin and yang of markets. 

Things are the most bullish when the crowd sees them as most bearish; and vice versa.

                                           Yin/Yang Symbol (see pdf version) 

The yin/yang symbol shows a glimmer of hope growing in the midst of despair (white dot inside the bigger piece of pie); and vice versa, the seeds of despair growing inside universal optimism.  Is there any better way to symbolize the transition from bear to bull or bull to bear?   

Of course this seeming piece of wisdom begs the question: How do you know when things are most bullish and bearish i.e. the end of a trend is near?  Short answer: you don’t.  But if you’re luck you get some hints.  Use those hints, but don’t confuse knowing and timing.

We can’t remember the number of times or amount of money lost by confusing the difference between knowing a trend will end, and timing its demise; the two are “very different kettles of fish,” as my good stiff upper lip friend Andrew is so found of saying.

Do we have any seemingly reliable way of timing the end of a trend in currencies? Seemingly reliable is defined as something that has stood the test of time in at least pushing the odds slightly in your favor.  Open interest is one of the few that helps in this regard.  Open interest in the currency futures markets measure sentiment.  We are trying to gauge and identify sentiment extremes i.e. every dollar seller who wants to be in is in, so there is no more selling power left to push the dollar lower; therefore a bounce or intermediate change in trend may ensue on news that is better than expected. 

Below is the US$ Index Future Daily:

    See the PDF  versiion for today's chart

The circles on the charts correspond with key bottoms in the dollar at the top part of the chart; and the circles at the bottom represent relative peaks in open interest levels.  A perfect indicator it is not—but nothing is. 

We all know the rationales: Slowing US growth driven by subprime mortgage problems leading the Fed to stay in easy mode while the rest of the world heads off into growth as far as the eye can seeing proving once and for all that the world economy can decouple from the big dog—Uncle Sam. 

So far so good—the dollar’s price action is validating the news.  But we get a look at US GDP for the second quarter on Friday.  If everyone who wants to be in this trade is in, it may only take the news to be less bad for the dollar to stage a bounce.  If not, we are fast approaching the all-time low on the dollar index at 7820 (and 8000 is in important psychological level too).  Through the 7820-level and the self-feeding/self-fulfilling trend may gather increasing momentum—not sure the powers to be want to see that area tested…stay tuned! 

Jack Crooks

 

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