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Thoughts From the Forex Trenches

May 2, 2011

 

In this Issue:

What is behind the Weak Dollar?

Creating a Trading System

Trend Following

New! D.O.G. Index

 

1. Jay Meisler’s Insights:

 

What is Behind the Weak Dollar?

By Jay Meisler

 

Ask how much of dollar weakness is due to fundamentals and how much is due to intervention/excess reserves buildup/diversification.

You can say if emerging market currencies especially Asia, were allowed to free float upwards, there would be no intervention, no build up of excess reserves, less diversification and less upward pressure on other currencies, such as the euro, aud, etc.

Instead, we have the Bernanke led Fed pumping money like a waterfall into an economy that lacks loan demand and the money finds its way into stocks, commodities, and out of the dollar, etc. My fear is an ugly end to this saga and hope I am wrong. Bernanke seems pretty sure he can exit smoothly.

So we are in a cycle where it is hard to see the end until something forces someone or the collective markets to say enough. It would probably take a meltdown in the US Treasury market for the Fed to pay notice. Up until now, it has had a free ride with equities rising, bonds behaving and the dollar bearing the brunt of the US loose fiscal and monetary policy mix in an environment of benign neglect. The test for US bonds may come when QE2 ends and the Fed is no longer depressing yields through bond purchases.

Otherwise, there seems no reason to fight it for now. Maybe eur/usd 1.50 and/or aud 1.10 see a pause or maybe these turn out to be acceleration points. In any case, these pivotal levels have a magnetic pull and only back below 1.48 and/or 1.08 would postpone the risk. In any case, keep an eye on emerging market currencies (and oil producers) as this is where diversification pressures on the dollar are coming from.
 

 

Jay Meisler is an author co-founder of Global-View.com, the leading forex discussion site for more than a decade and home of the original forex forum, where traders from around the globe come for the latest breaking news, flows, rumors and trading ideas, and the Retail Forex Traders Association. Jay has worked as a chief forex dealer at a U.S. bank branch, fund manager and independent trader. Jay has an MBA from Columbia University and a B.A. from Queens College.

 

 

2. Straight Talk:

 

Create a Trading System

By Alex Benjamin Sassoon

 

Creating a trading system from scratch can be very costly and time consuming and complicated.  With this in mind a K.I.S.S. approach has both merit and appeal as we all lack the required skill set of sufficient capital, time and programming capabilities.

 

What is required is a good eye to recognize that certain patterns repeat themselves in a fractal style.  If one can identify a pattern it becomes relatively easy to create a set of rules that follow the basic principles of ‘If this then do that’.  The next stage is to apply some form of filter which in reality just becomes another ‘If’ statement.

 

The basic system has at its core a setup then a trigger then an expected result.  In other words one wants to identify the pattern then set the rule that creates the order entry and then have an exit strategy either to close out the trade profitably or to limit the loss

In words of one syllable this is represented by Selection – Timing – Management.

 

There has to be one acid test to any system and that is a question?  Is the system consistently profitable?  Anything that is returning a positive result three times out of five is a positive return.  By the same token if it is not consistently profitable then rather than discard the system which many will do then instead turn the rule of the order entry upside down.  IE: do the opposite and then as if by magic the system will suddenly appear to be profitable.

 

 

Here is an example of something that was first identified by Henry Wheeler Chase in the 1930s. Curt Kessler subsequently acquired all of Chasse’s papers.. Later on Kessler and Larry Williams were partners and so the identification of ringed highs and ringed lows was quantified into a tradable pattern.

 

This identification of a pattern is the setup or selection.

The setup is the break of rotation of a series of higher lows and higher highs (or lower highs and lower lows) where the break stops the natural advancement of price.  This then creates either two way risk as opposed to the previous one time directional advancement or else it creates a reversal.  Either way it matters not to the system.

 

The entry or the trigger can be the absolute break of the low of the high bar (high of the low bar) or it could be the close of the bar that ends below the low of the high bar (above the high of the low bar). Again either way it matters little to the system but may have a marginal impact on total return.

 

The timing of the entry may be a factor for some but one must remember that the point of systematic trading is to be objective not subjective and to be without emotion and to be disciplined.  The concept should be fruition or stop.  The concept is to always take the next trade and keep doing it until it no longer works.

The management of the trade is paramount in terms of managing the initial entry and setting a stop loss.  The stop is always initially placed just outside the opposite side of the setup bar but one could use a variation of the open and/or close of the setup bar or even the trigger bar together with timing techniques to create a tighter stop.  Once the trade starts to work then various risk and money management techniques can be applied to achieve the result. Techniques that involve measured moves, trailing profit stops or partial take profits from a multiple initial position size which may appeal to those that want to effectively pay for the stop in advance.

 

Filters could be added to aid with the decision process of entry. EG: use a 10 period moving average where the trigger bar must close through the average before the order entry is elected.  This will create less entries but may occasionally help avoid a whiplash.

 

In terms of what are the ideal timeframes to apply this system to then the answer is any timeframe but establish that with the lower timeframes not only will there be a higher frequency of transaction but the expected result must be tempered to suit the market conditions.

 

Alex is a 35 year veteran of the financial markets and has worked in every aspect of the business from market maker to portfolio fund manager and broker to individual trader. Alex is a trader who additionally runs a financial portal website dedicated to helping train and educate traders and can be found at TradingClinichttp://tradingclinic.com and is a regular contributor to GVI.

 

Alex can be contacted under Tonbridge AL by going to Global-View.com Forex Forum and click on the Members link under Post a Message.

 

 

 

3. Tech Talk:

 

Trend Following:

By Donald C. Wilcox

 

I often get questions about finding ways one can determine the probable extent that a trading instrument could move during the life of its current trend. How does one ‘know’ that the unfolding move could last one big figure (100 pips) or perhaps five big figures (500 pips/ticks) or even more? Thus, the basic question involves just how far will a specific instrument (in this case a currency pair) move when its consolidation period is completed?

 

My first response is always about the use of technical analysis in determining the probability of a move in the market. My second response is in regards to fine-tuning methods of such analysis to fit the appropriate time frame and trading capital requirements involved. If one is aware of the technical reasons for a potential move then the answersof just how far the move could last lies in front of them. The tools of technical analysis provide the clues in figuring out any potential trend. There are many types of tools to be used in technical analysis. For the sake of simplicity I simple break them down to fall into two categories – either charts or studies. The use of chart patterns and/or indicators can greatly assist in anticipating and (more importantly) catching market moves.

 

Chart patterns:

The pattern analysis on charts is helpful in seeking out potential moves in the financial markets (currency pairs for me). There are two broad categories of charts – continuation patterns and reversal patterns. Such pattern analysis is helpful in determining if a trend is underway, continuing or near its final stage. Simple knowing which type of category your time frame involves is a good starting point. However, not all patterns come to fruition and many encounter periods of refinements to the breakout levels (better described as ‘choppy’ price patterns). The beauty of patterns is that the risk/reward parameters are clearly defined. If one has reason founds reasons to be IN a trade, then reasons to be OUT of the trade are also defined at the same time. 

 

 

The above chart is the British Pound against the Japanese Yen (Referred to as Sterling Yen in the spot currency lingo). A chart pattern known as the Head and Should formation is underway with a break of the neckline back on May 16th. Now during the second week of June the pattern remains valid, but the measured move objective  has not been achieved and the neckline is in danger of being breeched on the upside (nullifying the pattern).  Well under pattern analysis, the risk remains above the neckline set at 198. The objective would be the 191 level for this cross  The objective is determined by taking the value of the high (205) and subtracting it from the value of the neckline (198). The potential move on this chart pattern is seven big figure (or 700 tick/pips). That is a sizable move in the currency market. The pattern has enabled us to see a potential move and calculate the potential profit point and gives an idea of where the suggested stop loss order needs to be place (Above the neckline).  This all fits into the realm of sensible risk/reward style trading. Sounds great on paper. But as mid June strolls around, the trade is turning towards breakeven after being some 400 pips in the money just six trading sessions ago. Here is where emotion now gets the upper hand on those who try to use a system to trade.  Does one now lock in a small profit (one never goes broke taking a profit) or take the risk of being stopped out with a loss? As hard as it seems, one has to remain with the pattern despite its emotional roller-coaster effects on the psyche.  Successful trading is all about defining WHO you are and sticking with that definition through thick or thin.

 

 

Studies

The use of studies is another area of technical analysis that helps to determine the possibility of new emerging trends. It is very important to know which indicators are historically effective in specific market conditions. There are indicators that work better in consolidation markets and others that work ideally in a trending market. In the early stages of a new trend, the ossicilators (RSI, Stochastics) can flash ‘overbought and over sold’ conditions for periods of time that will likely outlast most retail traders capital, particularly if one is highly leveraged.  Other trend following techniques miss a good portion of a move before ‘confirming’ a trend.

 

Here again is the Sterling yen chart that used the chart pattern for a measure move. Now we will use technical indicators to allow us enjoy a

 

 

Using the indicator MACD as the trade trigger, we sell the Sterling Yen cross upon confirmation that the MACD crossed under (and closed under) the zero line. This signal remains valid at the time of writing since the MACD remains under the ZERO line. This trade was enacted back on May 3rd when the cross was at the 198.51 level. The open position did move about 100 pips against the opening level a few days later, but the MACD signal did not move back above the ZERO line.

 

This level of trade entry is a bit better under the MACD then if we waited for the H&S chart pattern used in the first scenario to be confirmed with the neckline break on May 16th. However, unlike chart patterns, solely relying on indicators gives no idea what would nullify the MACD signal in this case or how far into (or out of the money) the trade will result in. Such uncertainly adds to the traders anxiety, especially if high profile economic data is set for release. Emotions again can override the signal. The trade anxiety can be reduced  by introducing a SECOND indicator to use as a stop. We shall use the parabolic study as a trailing stop. The use of a second study builds in some relief that a risk management system is being implemented.

 

The parabolic stop in the Sterling yen example was elected back on  June 10th at the 196.65 level. This would have resulted in almost a 200 pip profit (198.51 entry minus 196.65 exit)  But the original signal that presented the short Sterling yen position remains valid at the time of this writing. Does one re-enter again? There are always lots of questions and doubts in trading. That is the nature of the beast.

 

One of the problems in staying with the trend using technical indocators is the powerful human emotion of being right ‘correct’. Even when trying to use a technical system to trade the emotional effect can override any chart or indicator. Humans love being right and locking in profits too soon  seems to be a consequence of that emotion. When one happens to be correct with a favorable position in a trend, it is very tempting to lock in profits for the sake of the ego. (same way in which not to admit one’s analysis is wrong in NOT taking a loss). But it is frustrating to watch the forecasted move unfold with out sustaining a position. How does one overcome this?

 

To me it is all about disciple and risk management and sticking with your ‘system’. Easier said then done.

 

Finally, there is always the question about which indicators is reliable or what time frames for chart patterns are best? To answer, one has to look into their trading soul and define what they are. Basic question to ask include: 1) are you a day trader, position trader, event driven, systems trader, etc. 2) what are your risk parameters and capital requirements.  Once you define who you are, then it is reasonable to see what type of trends your style is capable of achieving.

 

Donald C. Wilcox covers the geopolitical, economic and technical developments of the global financial markets and their resultant impact on Forex rates, pricing levels, and long-term valuations for Helia Resource LTD, which consults to the top banks and hedge funds around the world.

Wilcox is a twenty-five year veteran of Forex trading and strategy, and helped established corporate currency trading at Oppenheimer & Co. in 1991. He was later the Senior Proprietary Foreign Currency Dealer at the New York branch of the Bank of Yokohama.

 

 

 

4. Forex Industry News:

 

New: Global-View.com D.O.G. Index

By John Bland

 

We have recently launched the Global-View.com D.O.G. Index, which shows the change in the purchasing power of the U.S. dollar against the top trading currencies, gold and oil. If you look at the chart on D.O.G. Index  it shows the D.O.G. index falling below the pivotal .50 level, indicating the U.S. dollar has lost over half of its purchasing power in terms of foreign currencies, oil and gold since the euro was launched on January 1, 1999. The .50 level will then become a barometer of sentiment for the dollar, as reflected in performance vs. these three components.

 

The Global-View.com D.O.G. (Dollar, Oil and Gold) Index


Most successful forex traders keep track of more than one market at a time when trading. They keep an eye on a number of key forex relationships, and also watch the price of benchmark instruments such as gold and oil. In an effort to summarize the movement of all these items, Global-view.com has developed the "D.O.G." (Dollar, Gold and Oil) index. The "D.O.G." index reduces to a single number the daily value of the dollar for top forex trading currencies, gold and oil. The index falls as the purchasing power of USD weakens and rises as it gains.

The forex value of the dollar is based on the USD change against the top six trading currencies (Eurozone euro, British pound, Japanese yen, Swiss franc, Canadian dollar and Australian dollar) weighted by trading volumes based on data reported in the BIS Triennial Forex Survey.

The weighted USD value is then mixed with the change in the price of gold and oil to produce an index much like that published for stock prices (January 2, 1999=1.00). So that the volatile price of gold does not completely dominate the calculation, the index is adjusted by the historical price volatility of each of the three major components. The goal is to arrive at a subjective measure of the purchasing power of the U.S. currency relative to these three key items.

As indicated, the base date for the index (index=1.00) is January 2, 1999. That was the first official trading date of the euro, and close to the start of the millennium. As of the April 15, 2011 close, the composite index had fallen from its 1.00 base in 1999 to 0.506. The USD sub-component was 0.75, oil was 0.41 and gold 0.19.

 

 

John M. Bland is an author and co-founder and partner of Global-View.com. Prior to Global-View.com, he was a forex trader and a private-label forex analyst for a top Fed watching service in NYC. He has been a corporate forex advisor and also worked in international liability management for a major N.Y. money center bank. John holds an MBA from the University of California at Berkeley and a B.A. in International Economics from Berkeley.






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