Strategies, Analysis, And News for FX Traders

Strategies, analysis, and news for FX traders

January 2010 Volume 7, No. 1

IS THE DOLLAR rally for real? p. 12

INTERVIEW: Thomas Stridsman p. 30

THE YEAR AHEAD in currencies p. 8

CURRENCY CARRY and yield-curve trading p. 24

THE TURTLE SYSTEM for FX p. 18

CONTENTS

Advanced Strategies Currency carry and yield-curve yield-curve trading . .24

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Examining the currency-bond connection. By Howard L. Simons

Global Markets Forex 2010 . . . . . . . . . . . . . . . . . . . . . . . . . .

8

 A look at the key themes poised poised to drive the currency market in the coming year.

Currency Trader Interview Thomas Stridsman puts research to work . . . . . . . . . . . . . . . . . . . . 30 System designer applies principles in

By Currency Trader Staff 

currencies and commodities. By Currency Trader Staff 

On the Money Bees in the bonnet . . . . . . . . . . . . . . . . . .

12

continued on p. 4

Does the dollar’s new uptrend have legs? By Barbara Rockefeller 

Trading Strategies The Turtle system: Forex performance analysis . . . . . . . . . . . 18 Testing the original Turtle trading rules in today’s currency market. By Daniel Fernandez 

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January 2010 • CURRENCY CURRENCY TRADER TRADER

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CONTENTS

Currency Futures Snapshot . . . . . . . . 34 International Markets . . . . . . . . . . . . . . 36 Numbers from the global forex, stock, and interest-rate markets.

Global Economic Calendar  . . . . . . . . . . 39 Important dates for currency traders.

Key concepts . . . . . . . . . . . . . . . . . . . . .

40

Events

40

...... ....... ....... ......

Conferences, seminars, and other events.

Forex Journal . . . . . . . . . . . . . . . . . . . . . 43 New products & services . . . . . . . . . . . 42

Right on one dollar, wrong on the other.

Have a question about something you’ve seen in Currency Trader ? Submit your editorial queries or comments to [email protected].

Looking for an advertiser? Consult the list below and click on the company name for a direct link to the ad in this month’s issue of  Currency Trader .  Ablesys

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CONTRIBUTORS CONTRIBUTORS



Simons

is president of 

Rosewood Trading Inc. and a strategist for

 A publication of  Active  Active Trader ®

Bianco Research. He writes and speaks fre-

For all subscriber services:

quently on a wide range of economic and

www.currencytradermag.com Editor-in-chief: Mark Etzkorn

Howard

financial market issues.

[email protected]

Managing editor: Molly Goad [email protected]



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

Contributing writer: Chris Peters

national economist with a focus on foreign exchange. She

[email protected]

has worked as a forecaster, forecaster, trader, and consultant at Citibank 

Contributing editor: Howard Simons

Contributing writers: Barbara Rockefeller, Marc Chandler 

Editorial assistant and

and other financial institutions, and currently publishes two daily reports on foreign exchange. Rockefeller is the author of Technical of  Technical Analysis for Dummies (For Dummies, 2004), 2004), 24/7 Trading Around the Clock, Around the World (John Wiley & Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and

webmaster: Kesha Green

How to Invest Internationally  Internationally  , published in Japan in 1999. A

[email protected]

  book tentatively titled How to Trade FX is in the works.

Art director: Laura Coyle

Rockefeller is on the board of directors of a large European

[email protected]

hedge fund.

President: Phil Dorman  [email protected]

Publisher,



Daniel Fernandez is an active trader

Ad sales East Coast and Midwest:

with a strong interest in calculus, statistics,

Bob Dorman

and economics who has been focusing on the

[email protected]

Ad sales West Coast and Southwest only:  Allison Chee [email protected]

Classified ad sales: Mark Seger  [email protected]

analysis of forex trading strategies, particularly algorithmic trading and the mathematical evaluation of long-term system profitability. profitability. For the past two years he has published his research and opinions on his blog “Reviewing Everything Forex,” which also includes reviews of commercial and free trading systems and general interest articles on forex trading (http://fxre(http://fxre-

Volume 7, Issue 1. Currency Trader is Trader is published monthly by TechInfo, Inc., 161 N. Clark St., Suite 4915, Chicago, IL 60601. Copyright © 2009 TechInfo, TechInfo, Inc. All rights reserved. Information in this publication may not be stored or  reproduced in any form without written permission from the publisher.

views.blogspot.com). views.blogspot.com ). Fernandez is a graduate of the

The information in Currency Trader magazine Trader magazine is intended for educational purposes only. It is not meant to recommend, promote or in any way imply the effectiveness of any trading system, strategy or approach. Traders are advised 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 guarantee future results.

chemistry, concentrating in computational chemistry.

6

National University of Colombia, where he majored in He can be reached at [email protected] [email protected]..

January 2010

• CURRENCY CURRENCY TRADER TRADER

Dealer Chatter: Option Barrier Ahead

Surprise OPEC Production Level Outlook

Sector Check: China Policy Adjustment

Key Technical Levels Ahead of ECB

Unexpected Central Bank Rate Cut

EIA Gas Inventories

Signicant FX Chart Formation

Game Changing Stock Event

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GLOBAL MARKETS

Forex 2010 Who will hike first, by how much, and when? Interest rates and the retraction of the massive global financial stimulus will likely dominate the forex market in coming months. FIGURE 1 — THE FIRST TO HIKE

The Royal Bank of Australia was the first major central bank to raise interest rates after the cycle of deep, coordinated rate cuts that dominated 2008 and most of 2009. The Aussie dollar came close to its pre-sell-off high before pulling back in November.

BY CURRENCY TRADER STAFF

A

Source: TradeStation

FIGURE 2 — DOLLAR ON THE REBOUND?

 After giving back most of its 2008 gains in 2009, the U.S. dollar  staged a rally in the final month of 2009.

s the door closed on 2009, most economists argued the global economy was recovering — reflected in forecasts of  global economic output in the 3.1-3.8 percent range for 2010. Some areas of the world, primarily emerging market nations and commodity-exporting countries, are expected to continue to lead the way out of the Great Recession, while industrialized countries such as the U.S., Japan, and the Eurozone, are expected to struggle a little more. This will likely drive fresh themes in the foreign exchange market in 2010 as traders get back to the   business of monitoring growth and interest-rate differentials. In reviewing some of the key variables that could drive the forex market in the months ahead, one looms especially large. “We are looking to see how central banks will pull out of the extraordinary stimulus they have  been providing,” says Steven Englander, chief currency strategist for the Americas at Barclays Capital. “In the past six weeks, markets have again  become sensitive to interest-rate differentials.” Return to rates

Source: TradeStation

8

For much of 2009, however, those differentials didn’t drive forex markets. Instead, factors such as safe-haven dollar buying, risk appetite, and risk  aversion drove currency trends. In the weeks and months ahead, currency traders might begin refocusing on more “traditional” forex drivers, including the monetary policy rates set by global central  banks. The U.S. remains one of the most accommodative nations in terms of monetary policy, with its fed funds rate set at zero to 0.25 percent. The Fed is scheduled to meet next on Jan. 27, but policy watchers expect no rate change to emerge from January 2010 • CURRENCY TRADER

FIGURE 3 — NEAR-TERM DOLLAR EDGE

 A Fed quicker to hike rates than the ECB would lay a bullish that meeting. The European Central Bank (ECB), foundation for the dollar vs. the Euro in 2010, but longer-term the which meets on Jan. 14, is expected to maintain its buck could come under pressure. 1-percent lending. Rounding out the G3, Japan’s rate lies at 0.10 percent, and given the slow growth and deflationary conditions Japan still faces, market watchers say it could be years before it hikes rates. Broadening the focus to the G10, Australia was the first major industrialized nation to hike rates in 2009. With the Australian rate currently at 3.75 percent, market watchers expect additional tightening at the Feb. 2 Reserve Bank of Australia meeting. Forex traders are likely to continue focusing on who’s hiking when and how high, and reward the currencies with higher rates via long positions. The Aussie dollar (AUD) mounted a huge rally off its February-March bottom before pausing in November (Figure 1). 1). Source: TradeStation Nonetheless, all eyes will be on the U.S. Federal Reserve in the months to come, with traders sifting through every Fed speech and announcement for clues “We think the market will begin to price in a Fed rate about when the Fed will shift on rates. hike,” he explains. “[However], once it is clear the pace of  Fed tightening will be moderate, the dollar will come under Varied Fed forecasts pressure.” The bank’s 12-month EUR/USD target is 1.4500. Views are mixed on the when the U.S. Fed will begin to hike Barclays forecasts a 1-percent Fed funds rate by the end rates, but many market watchers have turned friendly on of 2010. Englander notes that still means “real interest rates the U.S. dollar, which rallied in the final weeks of 2009 after are going to be negative.” (Real interest rates are simply the selling off for the majority of the year (Figure 2). 2). interest rate minus the inflation rate.) Wells Fargo economist Sam Bullard stresses the heightMichael Woolfolk, managing director at BNY Mellon, ened focus on the Fed. “All the attention is on when they voices an even more aggressive forecast — a 1.50-percent will implement an exit strategy,” he says. “Timing is such a Fed funds rate by the end of the year. He believes the Fed key thing in this recovery.” will begin to signal it is concerned about asset price bubbles Wells Fargo forecasts a moderate 2.2-percent U.S. GDP and potential inflation in the next couple of months. increase in 2010 — which is considered to be a “sub-par” “In February and March, we’ll likely hear it from FOMC pace, Bullard notes. members, speaking between meetings,” he says. “It is the composition of the growth and the pace that is going to be disappointing to many people,” he says. “The G3 vs. everyone else recovery in the U.S. is not strong enough to have a sharp v- Growth differentials should be another key driver in the FX shape. Firms are not aggressively hiring.” arena in 2010, especially the different economic challenges Bullard says Wells Fargo doesn’t expect the Fed to tight- facing facing the G3 countries countries vs. the other G10 countries. countries. The G3 en rates until the fourth quarter of 2010, and the total countries (U.S., Eurozone, and Japan) “all have major fiscal increase in the Fed funds rate to be 0.50 percent for the year. issues,” Englander says. “These countries have been liquidMeanwhile, Barclays Capital has a slightly more aggres- ity providers, and looking ahead they will be more focused sive forecast, as they expect the Fed to hike rates toward the on trying to stimulate growth. It is going to be a long time end of the third quarter. By comparison, Barclays expects until they recover, and the U.S. is far from being out of the the ECB to hold off on raising rates until the beginning of  woods.” 2011. “The advanced economies most involved in the capital That translates into a “dollar bullish” outlook for much of  markets system will have a more sluggish recovery,” 2010, Englander notes. The bank has a six-month Euro/U.S. Bullard adds. continued on p. 10  dollar (EUR/USD) target of 1.4000 (Figure 3). CURRENCY TRADER • January 2010

9

GLOBAL MARKETS

FIGURE 4 — THE CARRY TRADE: DOLLAR OUT, YEN IN

Factors in favor of the dollar and against the Japanese yen have led some analysts to look for gains in the dollar/yen pair this year.

take into account output gaps in Europe and   Japan,” Japan,” Englander Englander says. says. “There is already already more excess capacity in the G3 than in emerging markets right now.” This factor goes back to the inflation picture, because excess capacity is helping to keep down inflation in the U.S. and other G3 countries. Englander also notes emerging markets are way ahead of the G3, emerging from recession faster and in a stronger position. And other G10 countries, such as commodity exporters Australia, New Zealand, Canada, and Norway, “didn’t let their fiscal positions blow out like the G3,” Englander says. Return to the yen carry

Another potential shift in the forex markets this year is a change in the carry-trade currency. The U.S. dollar, with its extremely low interest rates,  became a leg in the carry trade last year as money managers borrowed the greenback to finance riskiSource: TradeStation er and potentially higher-yielding trades. However, with the specter of Fed tightening loomFIGURE 5 — GO CANADA ing over the forex market in 2010 at some point, The Canadian dollar could be poised to show relative strength vs. analysts say expectation is enough to shift carry its U.S. cousin. trade action back to the Japanese yen, where rates are expected to remain low for some time to come. “Among our key FX market themes for 2010 are a continued U.S. dollar recovery, a return of the  Japanese yen and the Swiss franc to the status of  ‘carry trade’ currencies, a shift to a policy of renminbi ( yuan)  yuan) strength, and greater differentiation  between emerging market currency performance,” wrote Nick Bennenbroek in the December “Wells Fargo FX Express Monthly.” He pinpointed a $1.32 12-month target for EUR/USD pair. Forex strategist at BNP Paribas Sebastien Galy agrees. “We think a side effect of monetary tightening will be that the dollar will be less cheap to fund with,” he says. “Over the year, we see a broad strengthening of the dollar. The yen is a better Source: TradeStation funding currency. Japan is a deep underperformer Meanwhile, Englander notes, “the rest of the world is to Asia; they are in deep trouble, in a deflationary spiral, shifting its focus to prevent inflation from rebounding.” and there is absolutely no reason to hike anytime soon.” Barclays forecasts average G3 GDP growth in 2010 at roughly 2.8 percent vs. a 4.6-percent forecast for Latin A dollar bottom? America and a 6.6-percent pace for Asia. Many analysts have begun to turn bullish on the U.S. dolThat compares to Wells Fargo’s 2010 GDP forecasts for lar. China at 8.8 percent, India at 8.1 percent, Brazil at 2.8 per“A definitive multi-week bottom for the U.S. dollar cent, Korea at 5.2 percent, Mexico at 2.8 percent, Japan at 2.3 (USD) looks to be in place. The key to the story is that relapercent, the UK at 1.7 percent, and the Eurozone at 1.9 per- tive growth momentum and yields are shifting back in the cent. USD’s favor,” strategists wrote in “Westpac’s Top Trades “Those are real differences in growth and that doesn’t for Q1 2010.” One of these trades is to go long the U.S. dol10

January 2010 • CURRENCY TRADER

FIGURE 6 — INDIAN INFLATION STORY

India could let its currency appreciate to keep inflation down.

lar index (DXY) at 75.60-76.90, with a target at 80.00 and a stop at 74.90. Analysts at BNP Paribas also see upside potential for the dollar. Their 2010 “FX Trading Ideas” report cited buying the dollar/yen pair (USD/JPY) with a target at 110.00 as their top trade (Figure 4). 4). BNP analysts wrote: “We   believe the USD will rally throughout 2010, while the JPY will be the outright underperformer. Over the past year the USD was the funding currency of choice for carry trades and speculative investment in higher risk assets. However, we expect this to change for the coming year, with the yen regaining its historical funding currency status. Japan will remain locked in deflation, implying that Japanese rates will remain low and the currency weak.”

Source: www.advfn.com

FIGURE 7 — A BUDGET WON?

The Korean won has been described as “cheap” at current levels.

Other FX winners

Shifting over to other potentially “hot” currencies in the year ahead, a number of commodity exporting nations and emerging market countries made the top of the list. Englander says the Canadian dollar has room to appreciate in the months ahead (Figure 5). 5). “We see about 6 percent appreciation in the Canadian dollar vs. the U.S,” he says. “We like Canada — we expect it to be below parity (1.00) within a year’s time.” Independent forex economist Charmaine Buskas agrees the Canadian dollar is worth watching. “The long-term fundamentals look positive, Source: www.advfn.com and given the amount of evidence pointing to the fact the global recovery will continue to gather traction, it’s [will help] demand for Canadian exports. Again, this will the long-term outlook that is going to become increasingly support the Canadian dollar. “Dollar/Canada (USD/CAD (USD/CAD)) has already made its way important in the year ahead,” Buskas says. “The fact the the Canadian government does not face the kind of deficits that down to $1.04 [in late December], and that’s in thin holiday have swollen the government’s balance sheets in the U.S. markets. When markets get going again and liquidity and players come back to their desks, the pair has the potential and UK bodes well for the Canadian dollar.” Buskas explains another factor that could help the to head back down to parity,” Buskas adds. Another commodity exporting country to keep an eye on Canadian dollar is, ironically, better prospects for the U.S. “The recovery in the U.S. is getting some wind at its is Norway, according to Englander. “Norway should do  back,” she says. “The tone of both business and consumer- extremely well,” he says. related sentiment continues to improve as the economy improves. This means whatever safe-haven bid the U.S. Emerging currencies dollar had in previous months will continue to come off, In the stronger emerging-market and G10 countries, and that should benefit the Canadian dollar. Moreover, as growth and valuation stories are developing, which should companies in the U.S. and other countries continue to face support appreciation in their currencies in the year ahead. improving demand, they will need to restock their shelves Englander lists Korea, Indonesia, and India (Figure 6) as and start to slowly rebuild their inventories, which have countries to watch.  been very tightly managed in the past months. As such, this continued on p. 41 CURRENCY TRADER • January 2010

11

ON THE MONEY

Bees in the bonnet The U.S. interest-rate story is driving the dollar, for good or ill. BY BARBAR BARBARA A ROCKEF ROCKEFELL ELLER ER

T

raders sometimes get a single bee in their bonnet and focus on it to the exclusion of everything else. Today the interest-rate cycle turning point is one of those bees. The forex market is following the money market in believing the Fed will raise rates as early as June. It doesn’t matter if this is good economics or even a reasonable expectation, given Bernanke’s reluctance to move prematurely. It’s enough that the bee started buzzing. This is good news for trend-following traders because acceptance of the turning point by the majority takes a familiar form. First we get the News Shock, in this case the good news in early December that payrolls fell only 11,000 in November, about one-tenth the forecast. Then we get

comments from top analysts analysts — this time it was BNP Paribas and Merrill Lynch declaring the dollar’s days in the wilderness were ending. After that, it’s confirmation from the Commitments of  Traders (COT) report, which for the week of Dec. 15 showed the majority of speculators had shifted from short dollars to long dollars: a net Euro short of 16,448 contracts, a sharp turnabout from the net Euro long of 51,045 contracts from Oct. 6, itself the largest long since Jan. 8, 2008. Figure 1 shows the U.S. dollar index (DXY) broke the top of its channel the very day of the News Shock and never looked back. It easily pushed above the previous high from a month earlier. earlier. In just two weeks, DXY retraced 24 percent percent of the down move from the March 2009 peak. What we should expect next FIGURE 1 — DOLLAR TURNAROUND is some zigzagging, as the early The dollar index broke the top of its channel and eclipsed the previous month’s high,   birds take profit and former recapturing around 24 percent of what it lost in the sell-off from the March 2009 top. holdouts and newcomers use temporary dips to jump on the  bandwagon. At a guess, the dollar index could easily reach the congestion zone near the 38-percent retracement level (circle) by the end of February (dotted line), or perhaps the 50-percent retracement level. Contributing factors

Source: Chart — Metastock; data — Reuters and eSignal

12

Markets never move in straight lines, of course, so it’s helpful to identify potential stumbling   blocks. First, the interest-rate turning point is not the only thing happening in the world of  finance. The dollar got a traditional safe-haven boost from the Dubai World debacle — one of  the most badly handled business failures of all time. It’s a January 2010 •

CURRENCY CURRENCY TRADER TRADER

government-owned company whose government claimed it had never offered a sovereign guarantee, but then got a large measure of support from a neighboring sovereign. This puts the world of sovereign risk on a new footing altogether.

FIGURE 2 — SOFT OIL

The consensus seems to be oil could remain in the $70 to $80 range because of weak U.S. and European demand.

We are about to see if the Fed can manage inflation without raising everyone’s interest rates to Volckerian levels. Also new to the world of finance is two out of  three ratings agencies downgrading the sovereign paper of Greece below the collateral-grade level accepted by the European Central Bank  Source: Chart — Metastock; data — Reuters and eSignal (ECB). One important European official, former Finance Minister of Germany Peer Steinbrueck, said it was FIGURE 3 — THE BOND FACTOR unthinkable the European The dollar also got support from rising bond yields, which are higher mostly in response Union (EU) would abandon to improved growth estimates for the U.S. economy. Greece. However, a current ECB member, Austrian Central Bank Governor Ewald Nowotny, said the EU and the ECB would not intervene, and   besides, Greece doesn’t need intervention. Really? The Greek budgetdefici deficit/G t/GDP DP ratio ratio is quadru quadru-ple the rate allowed by the Stability Pact, 12.7 percent vs. 3 percent. Athens has yet to voice a credible plan for rectifying its fiscal situation, whereas other struggling Economic and Monetary Union (EMU) peripherals such as Ireland and Spain are making Herculean efforts to do so. There is something brewing continued on p. 14

CURRENCY CURRENCY TRADER TRADER •

January 2010

Source: Chart — Metastock; data — Reuters and eSignal

13

ON THE MONEY

FIGURE 4 — THE END OF THE THE DOLLAR CARRY CARRY TRADE

in the Austrian banking secIf rising U.S. interest rates push carry trades away from the buck as a funding currency, tor, tor, too. One bank was nationthe dollar could recover much of the ground it lost vs. the yen since June 2007. alized unexpectedly, and regulatory authorities are reportedly watching at least one other big bank like a hawk. Nobody thinks there has  been full disclosure of all the  bad loans made by European   banks; suspicions linger that losses arising from Eastern Europe and the Baltic states have yet to be revealed. This is not the same thing as the repudiation of sovereign responsibility in the Dubai situation, but its very murkiness arouses fear among international investors   because they can’t be sure what is safe — let alone guaranteed, and by whom. Nobody thinks Greece would leave the EMU or if it Source: Chart — Metastock; data — Reuters and eSignal did, the EMU as a whole would in some way “fail.” 3). This is a difficult subject at year-end, with most Still, the dollar has been and will probably remain a benefi- (Figure 3). ciary of uncertainty in these matters. Certainly resolution of  fixed-income traders saying they are done for the year, but the Dubai World debt-payment suspension and the Greek  still lightening up their holdings to a heavier cash weight. situation would remove a cause of dollar demand; even Yields are higher all along the curve, which is steepening as postponement of the Greek problem relieves pressure on well, mostly in response to higher growth estimates for the the Euro. No one believes Greece will have complied with U.S. economy — even if higher growth doesn’t necessarily EMU treaty obligations by the new deadline, 2013, but include rosy estimates for the employment numbers that promises are deferring the moment of truth. The focus of  started the whole thing. worry is now transferred from corporate credit and mortgage credit to sovereign credit, and from the U.S. to Europe and the Middle East. Crude oil was soft during the same period — in fact, it had been falling for about four weeks before the interestrate cycle turning point (Figure 2). 2). You might say it set the stage, allowing the performance to go on. We are all accustomed to the dollar and oil moving inversely to one another and the ridiculous circular reasoning that goes along Nobody follows the interest-rate cycle more closely than with it. Still, the latest consensus on oil is that it will remain around $70 to $80 because of anemic demand in the U.S. the bond crowd. They are weathering the end of the govand Europe, even if demand from emerging markets in gen- ernment’s “extraordinary measures,” including the Fed’s eral (and China in particular) remains robust. What hap- purchase of Treasuries, the commercial paper and other pened to the forecasts of oil oi l reaching $150? Forgotten for the credit programs (which ended Dec. 31), and the biggie, the moment. This is remarkable, since the first talk of “green purchase of mortgage-backed securities slated to end March 31. shoots” earlier this year triggered a big rise in oil. continued on p. 16  Also, the dollar got support from rising bond yields

When hopes are so high, a loss of confidence could be deeply dollar negative.

14

January 2010 •

CURRENCY CURRENCY TRADER TRADER

ON THE MONEY

FIGURE 5 — DOWNTRENDING YEN, UPTRENDING NIKKEI

There is a strong inverse correlation between the yen and the Japanese stock market.

ended its corporate bond-buying program and it has no anti-deflationary initiatives on the table, except the same old government-spending programs. The dollar’s position

Source: Chart — Metastock; data — Reuters and eSignal

Moreover, the bond gang is accepting with good grace the idea the Fed can raise rates without lifting the Fed funds rate itself. (It can do that by changing the amount of interest it pays banks on reserves, for example.) We could see a divergence between the Fed managing bank credit activity and the Fed managing the money supply. This has never  been done before in the U.S. economy. Changing the earnings on funds (instead of just the cost of funds, as with the Fed funds rate) is a second tool for the Fed, which has too few. Yes, the Fed created $1 trillion in new money supply,   but nearly all of that went to bank excess reserves rather than leaking out, with inflationary perniciousness, into the economy. In short, we are about to see if the Fed can use new tools to manage inflation without raising everyone’s interest rates to Volckerian levels. Tiered Tiered interest rates without capital controls — what an idea. In the space of a month, we have gone from wondering when major central banks would start disclosing their exit strategies, to having the whole process planned out — in the U.S. Meanwhile, the ECB ended its 12-month special repo funding, but the European Commission is still reluctantly disclosing bank losses and fretting over new capital adequacy requirements from the Bank for International Settlements. In Japan, the government squeaks that it “will not tolerate” a return of deflation, but the Bank of Japan 16

The U.S. is clearly the global leader economically and institutionally. The dollar benefits when the U.S. takes decisive action, even if (perversely) it’s inherently negative action, such as the Iraq wars. For the Fed to announce that extraordinary programs will expire on schedule may not seem like “decisive action,” but the market will interpret it that way, probably because the rest of  the official financial world is so muddled and inconsistent. So what can go wrong? High on the list has to be something new from China, which has taken the sullen stance that it hates having to buy U.S. Treasuries with its excess reserves but has no choice. When the dollar was falling, derogatory comments from Chinese officials always had an additionally negative effect. There’s no reason to suppose China will be quiet in 2010. Another possibility is a geopolitical surprise from any of  the big trouble spots such as Iran and Pakistan. There could   be a resurgence of terrorism, or a natural disaster; there could be some kind of fiscal disaster from California or New York, two famously dysfunctional state governments. The U.S. government could decide to break up Citigroup. After all, we have not actually solved the moral hazard issue — banks that are too big to fail. In fact, we have gotten bigger banks, if fewer of them. The number of potential shocks never really goes down. The most likely negative is not a shock per se — it’s rising unemployment in the U.S. that persists many months into the new year, sapping confidence in the recovery. This is where the cruel realities of American-style capitalism come home to roost, and not only in the humanitarian arena. It has often been observed that businesses tend to shy away from capital spending — the engine of growth — as long as unemployment remains high. This is a kind of  CURRENCY TRADER TRADER January 2010 • CURRENCY

Related reading: Other Barbara Rockefeller articles

negative feedback cycle, and it is also deflationary. If the new model for the forex market is “growth leads,” the U.S. has to keep delivering growth, and there are some economists who foresee a dip in economic activity activity in 2010. 2010. A loss of conficonfidence could be deeply dollar-negative when hopes are so high. One thing to feel confident about is with U.S. rates purportedly about to rise, the dollar will stop being a funding currency for carry trades , leaving the   Japanese yen on that hook again. It’s uncertain whether the shift will be gradual or abrupt, but it seems logical the dollar will recover at least half, if not all the ground it lost since the crisis began in June 2007. At that time the dollar/yen (USD/JPY) peaked at 124 and then fell as low as 86.40 by the end of November (Figure 4). 4). A 50-per 50-percen centt retra retracem cement ent would take the dollar back to around 105. The inverse correlation of the yen and the Nikkei 225 stock index is the strongest of all the cross-security correlations, and the longest lasting. A downtrending trending yen implies implies an ever-rising Nikkei. Figure 5 shows the USD/JPY, Nikkei 225, and the iShares MSCI Japan Index fund (EWJ), which tracks the MSCI Japan. The new dollar rally could fall apart at the seams at any moment. It has barely begun, it’s fragile, and we’re not accustomed to it. The market is full of  diehard deficit haters who think the U.S. deficits are fatal to the dollar in the longterm. They will always have an anti-dollar bias. But the new rally is based on the  biggest factor in the forex pantheon — a turning point in the interest-rate cycle. Fortunes will be made, and all from one  bee.

“The easy fix” Currency Trader , December 2009. The dollar has for some time been supported primarily by lip service from government officials. What could really make a difference in the buck’s prospects? “Bucks, bonds and the new bully in town” Currency Trader , November 2009. The massive U.S. debt has many fearing the worst for the U.S. dollar. Perhaps the sentiment is overdone. “It’s the price of oil, stupid” Currency Trader , October 2009.  A major drop in crude prices could help boost the dollar. dollar. Will it happen? “Are fundamentals coming back?” Currency Trader , September 2009.  Assessing the signs of change in the FX market. “The dollar still has a chance” Currency Trader , August 2009. The stabilizing economic picture doesn’t seem to have benefited the buck very much. “Bubble contamination” Currency Trader , July 2009. Pondering the nature of the currency-commodity relationship. “Risk aversion” Currency Trader , June 2009. Extraordinary times call for out-of-the-box thinking about markets. “Forecasting follies” Currency Trader , May 2009. The only technicals that provide tradable forecasts are patterns — but you have to be on the correct time frame and you can’t forget about the fundamentals. “Listening to the chart” Currency Trader , April 2009. While everyone debates the ramifications of various policy measures, what is the Euro/dollar chart saying? “Rational fear and the forex market” Currency Trader , March 2009.  Analysis of several intermarket relationships suggests the role of risk aversion in the forex market is no cut-and-dried issue. “Competitive devaluations, the EMU, and the yen” Currency Trader , February 2009. Currency devaluation never works in the long run — just ask Japan — but that doesn’t mean panicky governments won’t use it to try to stem the flow of blood in the near term. “The Euro: Prosperity or perdition?” Currency Trader , January 2009. The belief the Euro sell-off has ended may be based on some false assumptions about how the U.S. and Europe are handling he economic crisis.

For information on the author see p. 6. 6. CURRENCY CURRENCY TRADER TRADER • January 2010

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TRADING STRA STRATEGIES TEGIES

The Turtle system: Forex performance analysis The Turtle rules were much more than breakout signals. These tests on a currency portfolio incorporate the volatility-adjusted position-sizing rules that were integral to the approach. BY DANIEL DANIEL FERNAN FERNANDEZ DEZ

O

ne of the most popular trading strategies of the past 30 years is the “Turtle” trading system Richard Dennis and his partner Bill Eckhardt designed to discover whether virtually anyone could be trained to trade profitably by following a set of systematic rules that determined position sizing as well as trade entry and exit points (see “Turtle tales”). tales”). It has been the subject of  much debate and a great deal of misinterpretation and misinformation over the years. The system, which was developed in the 1980s and intended to be traded across a broad portfolio of futures (which originally included the Swiss franc, French franc, Deutsche mark, British pound, Canadian dollar, and  Japanese yen contracts), was designed to capture intermediate and longer-term trends.

How well it does in today’s spot forex market is the sub ject of the following analysis. We’ll test the original Turtle rules on seven currency pairs over nine years of recent price data and see how the system holds up. The basic Turtle rules

A detail detailed ed descr descript iption ion of of the Turt Turtle le tradin trading g system system appeared in a 37-page document titled “The Original Turtle Trading Rules” (OriginalTurtles.org, (OriginalTurtles.org, 2003) published free of  charge on the Internet by former Turtle Curtis Faith in response to what he saw as the unethical sale of the Turtle trading methods by another former Turtle and also “on a Web site by a non-trader.” non-trader.” The system tested here is System 2 from that document. document. He also discussed these rules in his  book The Way of the Turtle (McGraw-Hill, 2007; see “Related reading”). The Turtle system is a FIGURE 1 — TURTLE TRADE  breakout trend-following method, and there were shorter-term and longerThe longer-term Turtle Turtle system tested here enters on a 55-day breakout and  term versions of the system. exits on a 20-day breakout. In this case, we’ll experiment with the longer-term version, which enters in the direction of a 55-day high/low   breakout (i.e., above the highest close of the past 55 days or below the lowest continued on p. 20 

TABLE 1 — SPREAD CHARGES

Trading costs are reflected in the different per-trade spreads charged  to each currency pair. Pair

Spread

EUR/USD

2

GBP/USD

3

USD/JPY

3

NZD/USD

5

AUD/USD

Source: MetaTrader 

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5

USD/CHF

3

EUR/JPY

4

January 2010 • CURRENCY CURRENCY TRADER TRADER

Retracement Retracement or reversal? reversal? It’s a typical scenario: You’re You’re holding a position in the market, and a sudden move in the wrong direction makes you wonder if the move is a retracement or a reversal. A retracement is a temporary pullback, when price bounces off support and resumes the direction of the original trend. A reversal occurs when price breaks breaks through the support level and continues to move against the original trend. When you’re confronted with these moves, you may wonder: 1. Should I surrender surrender and take the loss? loss? 2. If not, how much money am I willing to risk? 3. Should I set a stop-loss stop-loss based on a percentage or  dollar amount? How do I choose the “right” amount? 4. If I take the loss loss and the market resumes resumes the trend I anticipated, should I reenter? 5. Should I stick with with my original strategy strategy even when I experience a deep drawdown? 6. Is there a way to identify support levels when entering the market? This last question is the most important: If you knew the market support levels, you could use them to test market strength. When a market fails to penetrate a support level and resumes the anticipated trend, that movement is likely a retracement. You You could add to your position when a retracement occurs. On the other hand, if the market penetrates the support level and closes beyond it, the move-

ment is likely a reversal. When this happens, you might want to exit the position and cut your losses short. Identifying an objective support level is the key to distinguishing retracements and reversals; is there a way to determine these levels? The answer is yes! AbleTrend 7.0 places blue dots (“T2 stops”) below the price bars, providing support levels at your fingertips. AbleTrend AbleTrend 7.0 T2 stops offer the following advantages: 1. T2 stops are 100% 100% objective because they they are defined by the market’s own support levels. 2. The scientific calculations calculations behind T2 T2 stops are universal — not curve-fitted. 3. T2 stops can be backtested to reveal the the characteristics of individual markets. 4 There There are no delays because because T2 T2 stops are are updated updated with each new tick. 5. T2 stops are proprietary proprietary for the exclusive use of  software owners. 6. T2 stops can boost boost your confidence, because “you have seen it happen hundreds of times” historically and in real time. Confidence is critical for  successful trading. 7. Users can take advantage advantage of “sweet spot entries” by entering the market right after prices test a T2 stop support level and resume the original trend. These entry points are often close to T2 stops.

The market is always changing, but T2 stops remain unchanged. Once you see them work time and time again, again, you will learn to rely on T2 stops. AbleTrend T2 stops can help you thrive in today’s volatile markets.

TRADING STRATEGIES

Turtle tales This excerpt from “Curtis Faith: Turtle tales” (Active Trader, June 2007) recounts the origins of the Turtles and some of the observations of one of the group’s original members, Curtis Faith. Richard Dennis and William Eckhardt had already made millions in the markets when they got the idea for the Turtle experiment. The two disagreed about whether great traders were the product of nature or nurture, with Eckhardt believing successful traders had inherent skills and Dennis arguing that anyone could be taught to outperform in the markets. The pair decided to launch a trading program to settle the debate. They would teach a group of neophytes their system and then give real trading accounts to those who successfully completed the training. As legend has it, the group’s moniker stemmed from Dennis’ Dennis’ visit to a turtle farm outside Singapore; he claimed he and Eckhardt would be able to “grow” traders like turtles. AT: You wrote in your book ( The The Way of the Turtle, Turtle , McGraw-Hill, 2007) the initial  training period was only two weeks, and then you were given a small account to trade during a kind of probationary period. What was the trading process like? CF: We put on our positions in chunks called “units.” Normally, the size of the unit would depend on the volatility of the market, so in a low-volatility market, we might have a lot of contracts on, while in a high-volatility market, we’d have fewer contracts on. For the probationary period, our unit size was three contracts in every market, just to make things simple. By comparison, later on we’d have unit sizes of 20, 30, or 50 contracts, in some cases. The system’s entry and exit rules were things I’d seen before. The normalization of volatility across markets and the idea of adjusting the quantity you traded based on the volatility of particular markets was a new concept at that time. AT: You’ You’re re talking about adjusting the number of contracts so the dollar value of  the positions is kept constant in different markets, right? CF: Right. So, assuming everything else was equal, our positions tended to go up and down about the same [dollar] amount every day. That was an innovative concept. I’d run many, many [system] tests before, but it was always a matter of considering the profits in, say, corn, soybeans, gold, and silver separately, whereas Rich [Dennis] really looked at things from a total portfolio perspective. You get completely different answers if you look at trading from a portfolio perspective; you come to different conclusions about whether you should be trading a particular  market. AT: What kind of freedom were you given? CF: We could do whatever we wanted within the framework of what we’d been taught. With respect to markets, we were essentially told, “Pick your markets and be consistent with them — don’t pick and choose trades.” We could decide, say, we weren’t comfortable trading one of the thinner markets, such as coffee. In my case, I didn’t like the S&P 500 because I didn’t think it trended well for the type of short-term systems we were trading. So I never traded it. But we weren’t supposed to pick and choose trades, and that’s where people got into trouble. They would decide a particular trade in a particular market was too risky — and that would be the one that would end up making 50 percent on the year. — Currency Trader Staff 

20

close of the past 55 days) and exits on a 20-day high/low breakout in the opposite direction. The system attempts to capture trends of medium- to long-term duration, with the average profitable position lasting more than two months. Figure 1 shows a sample trade in the EUR/USD pair. More important than the entry and exit signals, the system has a series of  rules dictating trade size and stop placement. Positions are “normalized” according to volatility so dollar risk is the same from trade to trade and market to market — an approach, Faith noted, that enhances the benefits of diversification. To see detailed examples of the volatilityadjusted position-sizing rules, click  here between here  between Jan. 6 and Jan. 31. Also, the system pyramids trade entries, adding to positions when a market moves in a trade’s favor. After an initial entry signal, the system adds up to three additional positions (referred to as “units”) if a market moves favorably by by half the 20-day average true range (ATR). For example, if a long trade is entered in a market at a price of 100.00 and the 20-day ATR at the time is 5 points, another long entry would be executed if price reaches 102.50. The system’s stop-loss is two times the 20-day ATR, adjusted to the most recent trade when the market is moving in the position’s favor. In the previous trade example, the stop-loss would have initially been placed at 90.00. If the 20-day ATR at the time of  the second trade entry (at 102.50) was 4.00, the stop for both open positions would become 102.50 - (2*4.00) = 94.50. Historical testing

All tests were performed on daily data from June 1, 2000 to June 1, 2009 using Metatrader 4. The rules were applied to seven currency pairs: Euro/U.S. dollar (EUR/USD), British pound/U.S. dollar (GBP/USD), U.S. dollar/Japanese yen (USD/JPY), New Zealand dollar/U.S. dollar continued on p. 22 

January 2010 •

CURRENCY CURRENCY TRADER TRADER

TRADING STRATEGIES

Test results

TABLE 2 — INITIAL TEST RESULTS RESULTS

Table 2 shows the tests results. The system did not perform well on all currency pairs.  Although five of seven pairs had positive average annual returns, overall  Five of seven pairs had positive average average was 11 percent — compared to an average maximum drawdown of  annual returns (and three of those were 47 percent. above 20 percent), but the average for the Avg. Avg entire portfolio was 11 percent. Four of the Currency yearly Max. No. Win profit/avg. pairs had mediocre to poor results, with pair return drawdown trades % loss ratio some, including the NZD/USD and the EUR/USD 27% 23% 147 47% 2.44 AUD/USD, producing very high drawdowns (in excess of -60 percent). The averGBP/USD 8% 34% 151 34% 2.73 age maximum drawdown was 47 percent. USD/CHF -1% 40% 185 26% 2.58 Figures 2 and 3 reveal substantial differUSD/JPY 3% 33% 141 37% 2.02 ences in the equity curves for EUR/USD NZD/USD 22% 66% 168 30% 3.63 and NZD/USD, respectively. The AUD/USD 20% 64% 154 32% 3.47 EUR/USD pair made new equity highs at EUR/JPY -1% 67% 157 37% 2.50 least every two years while the NZD/USD had an extremely profitable period Median: 8% 40% 154 34% 2.58  between 2002 and 2005 followed by a drawAverage: 11% 47% 158 35% 2.49 down that lasted until mid-2008 — nearly three years. (NZD/USD), Australian dollar/U.S. dollar (AUD/USD), Like any trend-following system, the Turtle trading sysU.S. dollar/Swiss franc (USD/CHF), and Euro/Japanese tem generates highly profitable trades when the market yen (EUR/JPY). Table 1 shows the spreads that were moves aggressively, aggressively, such as when the economic crisis startassessed per trade for each pair in the testing process. ed to fuel strong rallies in 2008. During this period, the The initial account equity was $100,000. The strategy was EUR/USD pair had a single trade that produced a profit of  also tested in paper trading on the EUR/USD from January nearly 70 percent of the initial account equity. Winning 2009 to June 2009; the results matched those of the test trades are the exception to the rule — all the pairs had winning percentages below 50 percent, and all but FIGURE 2 — EUR/USD EQUITY CURVE one were below 40 perThe EUR/USD pair made a new equity high at least every two years. cent. However, the average profit/average loss ratio shows the average winning trade was two-and-half times the size of the average losing trade for portfolio as a whole. The Turtle system’s drawdowns are mostly the result of whipsaw FIGURE 3 — NZD/USD EQUITY EQUITY CURVE trades — i.e., false  breakouts, when a trade The NZD/USD equity curve was much different from the EUR/USD’s: The pair’s extremely profitable is triggered in one 2002-2005 period was followed by a nearly three-year drawdown. direction but price quickly reverses, stopping out the trade (a process that can repeat many times in nontrending market conditions, resulting in a long series of losing trades). This was the case   between 2005 and 2008 .

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January 2010 • CURRENCY CURRENCY TRADER TRADER

FIGURE 4 — WHIPSAWS

Related reading

Like any trend-following system, the Turtle approach is subject to repeated whipsaw trades.

Daniel Fernandez articles:

“Adaptive FX money management” Currency Trader , November 2009 Historical tests illustrate the impact of a dynamic money-management regime on strategy performance. Other articles:

“Curtis Faith: Turtle tales”  Active Trader , June 2007 Nearly 20 years after the famous trading experiment ended, a graduate of the original “Turtle” class of 1983 talks about his experiences ( Active Trader interview). Trader  interview). “Modified turtle soup”  Active Trader , December 2009  A Trading Trading System Lab analysis analysis of an inversion of the shorter-term Turtle signals.

in AUD/USD and NZD/USD. Figure 4 shows examples of these losing trades in the NZD/USD.

Source: MetaTrader 

Making adjustments

TABLE 3 — USING A QUICKER EXIT

The test results indicated it might be possiShortening the exit breakout threshold to 10 days improved the strategy’s  ble to increase the system’s profitability by reward-risk characteristics. characteristics. simply shortening the exit breakout threshAvg. Avg old, which would liquidate trades more Currency yearly Max. No. Win profit/avg. quickly and give back less when a retracepair return drawdown trades % loss ratio ment occurs. Rather than optimize values EUR/USD 43% 17% 165 50% 2.60 for each currency pair, Table 3 shows the results using a 10-day exit rule across the GBP/USD 11% 35% 173 39% 2.37  board. USD/CHF 3% 31% 191 33% 2.44 This change reduced the average maxiUSD/JPY 13% 31% 149 44% 2.18 mum drawdown by 9 percent while NZD/USD 6% 58% 196 38% 1.94 increasing the average and median yearly AUD/USD 15% 39% 188 44% 2.05 profits by 3 percent. Aside from this overall EUR/JPY 6% 57% 168 33% 2.52 improvement in the strategy’s reward-risk  profile, closing positions faster also Median: 11% 35% 173 39% 2.37 increased the average winning rate by 4 Average: 14% 38% 176 40% 2.30 percent; fewer trades reached the stop-loss point. The average profit/average loss ratio was minimally impacted, with the median declining Trading the Turtle system from 2.58 to 2.37. However, this change also resulted in a Because the big trend moves the Turtle system relies on higher number of trades. These additional entry opportuni- don’t happen frequently, traders must be prepared to ties often occurred in the middle of long-term trends, and weather extended drawdown periods — up to two years — are one of the main reasons for the increase in profitability.  before being rewarded with substantial profits. It’s worth noting that all the currency pairs became net The original Turtle system didn’t perform terribly in this profitable with the reduction of the exit period. The currency portfolio, but making a simple, unoptimized EUR/USD, EUR/USD, USD/JPY USD/JPY,, and EUR/JPY pairs benefited benefited the adjustment of cutting the exit threshold in half improved most from this modification, while AUD/USD and results notably, notably, shrinking the drawdown and boosting profNZD/USD suffered the most adverse in terms of profitabil- its. Further modifications may reveal additional i nsights. ity. However, these pairs also saw their maximum drawdowns shrink 25 and 8 percent, respectively. respectively. For information on the author auth or see p. 6. CURRENCY CURRENCY TRADER TRADER • January 2010

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 ADVANCED STRATEGIES

Currency carry and yield-curve trading Carry traders of all stripes: A bull market in a country’s country’s bonds is often accompanied accompanied by a weakening in the carry return into that currency, and other facts you should know. FIGURE FIG URE 1 — STEEP STEEP U.S U.S.. SWAP SWAP CUR CURVE VE LED TO U.S. EQUITY EQUITY UNDERPER UNDERPERFORMAN FORMANCE CE The swap carry for the U.S. shows a small top during the Federal Reserve’s first  declaration of war on deflation in May 2003, marked with a green vertical line.

FIGURE 2 — AUSTRALIAN AUSTRALIAN TWO-TEN CARRY LINKED TO CURRENCY CURRENCY AFTER MA MAY 6, 2003 The flood of money coming out of the U.S. spurred demand for Australia’s resource exports and led to a return flow of capital into Australia, Australia, where influx pushed swap yields lower and lowered the swap return differential.

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BY HOWARD HOWARD L. SIMONS

T

wo traders walk into a   bar. One says, “I borrow at the short end of  the yield curve and lend at the long end of the yield curve when it is positively sloped. I focus on the spread between twoyear and 10-year instruments. I guess you could say I‘m a carry trader.” er.” The other says, “I borrow at the the short end of the yield curve in one currency and lend three months later in another currency when the rate at which I borrow is less than the rate at which I lend. I guess you could say I’m a carry trader, too.” The punch line is both traders are doing pretty much the same thing. The key difference, of course, is the term trader is taking on a great deal of yield-curve risk over a longer period of time while the currency trader is taking on very hedgeable spot-market risk over a short period of time. But beyond that similarity, the two traders live on opposite ends of the trading universe and almost certainly trade on different desks and share virtually no information. Logic says the two carry trades should be related in some form to each other. After all, if a country drives its interest rates down toward zero, as Japan, Switzerland, and the U.S. have done in turn, they open up carry trades (see “Looking at the carry trade,” June 2007, “The short, awful life of the dollar carry trade,” August 2008, and “Franc-ly my dear, I don’t give a carry,” September January 2010 • CURRENCY CURRENCY TRADER TRADER

FIGURE 3 — BRITISH POUND TWO-TEN CARRY CARRY LINKED TO CURRENCY CURRENCY AFTER MA MAY Y 6, 2003  A massive lowering of British short-term short-term interest rates culminating with with a move to quantitative quantitative easing in March 2009 led to both a lower currency carry and a bull  market in British bonds.

2008). Moreover, carry trades are the one class of long-term currency trades capable of producing significant excess returns (see “Currency traders should be humbler,” May 2007). That same stimulus at the short end of the yield curve should have some, impact on longer maturities. (But not necessarily proportionate impact.) As is always the case in such matters, we should expect to learn more from what we cannot explain directly — the residuals of the process and the various anomalies of the market relationship. Two variables will be examined for nine currencies: first, the return on the carry trade of borrowing the U.S. dollar (USD) and lending in each currency; second, the return on the trade of financing a 10-year fixedFIGURE 4 — NEW ZEALAND DOLLAR DOLLAR TWO-TEN CARRY CARRY LINKED TO CURREN CURRENCY CY AFTE AFTER R MAY MAY 6, 2003 rate receiving position on a swap in the non-USD currency with a two-year The New Zealand economy is tied to short-term external financing — a dangerous  position. fixed-rate paying position on a swap in the non-USD currency. The return on the swap trade will be presented on an inverse scale; as you move toward the more positive num  bers on the bottom, the return on the 10-year fixed-rate receiving position has increased; this is similar to saying there has been a bull market in bonds. The currency carry trade is presented on a normal scale. Here, as the numbers become more positive, the return on financing short-term deposits in another currency with USD   borrowings has increased. We should expect the two curves to move in similar directions: A bull market in bonds often occurs in the context of lower short-term interest rates and hence lower returns on the currency carry three-decade-long bull market in human history. If we look  trade. at the swap carry for the U.S., we see a small top during the Finally, Finally, the scales are displayed as incremental returns to Federal Reserve’s first declaration of war on deflation deflation in the base indexing date of the Jan. 4, 1999 advent of the Euro. May 2003, marked with a green vertical line (Figure 1). 1). The  bull market resumed and hit what may turn out to be a genThe U.S U.S.. base base erational top in December 2008. Before moving into the series of charts for the non-USD curNote what happened to the performance of the U.S. stock  rencies, let’s take a look at the U.S. market with a different market vis-à-vis the MSCI World Free index in l ocal currendimension. The U.S. has been in a secular bond bull market cy terms after May 2003. The U.S. underperformed the rest since 1981. This ranks as perhaps the most-disbelieved continued on p. 26  CURRENCY CURRENCY TRADER TRADER • January 2010

25

 ADVANCED STRATEGIES FIGURE 5 — CANADIAN TWO-TEN TWO-TEN CARRY CARRY LINKED AFTER SEPTEMBER 2005 Unlike other currencies, the key month for the CAD was September 2005, not May 2003.

Country cases

The country with the greatest conformance to the hypothesis that swap carry and currency carry are linked is, rather surprisingly, Australia after May 2003 (Figure 2). 2). The flood of money coming out of  the U.S. spurred demand for Australia’s resource exports (see “What’s down with the Australian dollar?” March 2008) and led to a return flow of capital into Australia. That capital influx pushed swap yields lower and lowered the swap return differential. The one prominent exception during the post-May 2003 period occurred during the financial crisis’ peak in 2008-2009; the plunge in Australian bond yields coincided with a flight out of the Aussie dolFIGURE 6 — SWEDISH SWEDISH KRONA TWO-TEN CARRY CARRY LINKED WEAKL WEAKLY Y lar (AUD) as resource exports and TO CURRENC CURRENCY Y AFTE AFTER R MAY MAY 6, 2003 prices fell. Australia raised shortThe SEK’s carry to the USD was far less active after May 2003 than was the return term interest rates in October 2009, on the swap trade. and this served to arrest some of  the one-way nature of the AUD’s carry trade. Next in line comes the British pound, and there is an interesting twist. The two countries most affected by the financial crisis were the U.S. and the UK, and the UK very well may have gotten the worst of it. The two financial systems were linked closely during the post-May 2003 credit bubble and then stayed linked during the very depths of the financial crisis (Figure (Figure 3). A massive massive lowering lowering of British short-term interest rates culminating with a move to quantitative easing in March 2009 led to both a of the world significantly after this date and after the lower currency carry and a bull market in British bonds. Federal Reserve’s second declaration of war on deflation in The New Zealand dollar (NZD) is next on the list — and December 2008. And yet the Federal Reserve continues and yes, there does seem to be an English-speaking theme here is likely to continue targeting the U.S. stock market with — even though the carry most affecting the kiwi has been low interest rates for a long time to come despite this rather that based on the Japanese yen (see “Getting carried away demonstrable failure. That policy will affect both the cur- with the kiwi,” July 2008). The small New Zealand econorency carry indices seen here and the swap market differ- my is tied to short-term external financing, and that is entials. always a dangerous spot (Figure 4). 4). Let’s hope they fare  better than Iceland in this regard. 26

January 2010 • CURRENCY CURRENCY TRADER TRADER

FIGURE 7 — NORWEGIAN KRONE TWO-TEN TWO-TEN CARRY NOT LINKED TO CURRENC CURRENCY Y AFTER MA MAY Y 6, 2003 2003 The NOK carry to the USD has been unimportant and has scarcely moved in the same direction as the return on the swap trade.

We can end the list of English speakers with bilingual (just ask them and they will tell you) Canada. Unlike other currencies where the May 2003 date is significant, the key date for the Canadian dollar (CAD) was September 2005 (Figure 5). 5). It’s quite hard to point to a single development which may account for this belated linkage, but once it occurred, it remained quite strong going into the depths of the financial crisis in 2008-2009. Two Nordic currencies, the Swedish krona (SEK) and the Norwegian krone (NOK), are on the list, and the two  behave differently as is their wont (see “Nordic currency confusion,” November 2008). The SEK’s carry to the USD was far less active active after May May 2003 than was the return on the swap trade (Figure 6). 6). This is an odd case where mid- and long-term interest rates seem to be carrying more of the adjustment burden within an economy than

the currency exchange rate is carrying externally. externally. Of course, the primary currency trade for the SEK is not its carry to the dollar but its spot rate vs. the Euro. continued on p. 28 

 ADVANCED STRATEGIES FIGURE 8 — EURO TWO-TEN CARRY CARRY NOT LINKED TO CURRENCY CURRENCY AFTER MA MAY Y 6, 2003

link between their carry to the dollar and the swap trade returns. The Euro has had a positive carry to the dollar for years and has been in a bull market for bonds since May 2003, but the two moves are operating without any apparent connection to one another (Figure 8). How can we account for this? The European Central Bank has a single mandate — price stability — while the Federal Reserve has the infamous dual mandate of both price stability and full employment. The Federal Reserve clearly has leaned to full employment since the late 1990s as evidenced by its role in the serial inflation of financial   bubbles. These conflicting mandates have created swap markets out-ofphase with one another and with the currency carry trade. As an aside, this out-of-phase character is consistent FIGURE 9 — SWISS TWO-TEN CARRY CARRY LINKED TO CURRENCY CURRENCY with the idea global currency markets AFTER MA MAY 6, 2003 orbit around the central exchange rate The CHF’s carry against the dollar has been minimal for nearly five years while it  of the USD-EUR trade (see “The dollar remains in its own bond bull market. The link between the two trades is weak  index and ‘firm’ exchange rates,” because the carry trade largely has been a non-factor. non-factor. December 2005). Switzerland is one of the few countries whose short-term interest rates have competed with the dollar for the   basement in recent years. As a result, the Swiss franc’s (CHF) carry against the dollar has been minimal for nearly five years while it remains in its own   bull market for bonds (Figure 9). The link between the two trades is weak    because the carry trade largely has  been a non-factor. Finally, we come to the champion of  low interest rates, Japan. Here the longterm carry against the dollar has been a money loser, but the long-term bull market for bonds and the return on the swap trade have been linked erratically The case of the Norwegian krone is far simpler: The NOK to the money-losing carry trade as both the U.S. and Japan carry to the USD has been unimportant and scarcely moved have raced to zero in a leapfrog fashion (Figure 10). 10). in the same direction as the return on the swap trade (Figure 7). 7). Norway became the first European country to The second front raise short-term interest rates in October 2009; this has had The critical takeaway is, as predicted, what was not disno discernible effect on the carry trades. played directly. While not all swap trades are joined at the The last group of currencies has almost no discernible hip to the currency carry trade, none move counter to it. The Euro has had a positive carry to the dollar for years and has been in a bull  market for bonds since May 2003, but the two moves are operating without any  apparent connection to one another.

28

January 2010 • CURRENCY CURRENCY TRADER TRADER

This means our two trader friends who walk into the bar should strike up more than a passing acquaintance; a successful carry trade into a currency generally reflects higher short-term interest rates in that currency, and therefore likely invites a   bearish position in that country’s   bond market as well. The opposite holds true, true, too: A bull market market in a country’s bonds often is accompanied by a weakening in the carry return into that currency. Both of our trader friends could help themselves by keeping an eye on each other’s markets. Not as a short-term trading indicator; that won’t work. The gain will come from understanding the dynamics  behind their own market.

FIGURE 10 — JAP JAPANESE ANESE YEN TWO-TEN CARRY ERRATICALL ERRATICALLY Y LINKED TO CURRENCY CURRENCY AFTER MA MAY 6, 2003  Although the long-term carry against the dollar has been a money loser, the long-term bull market for bonds and the return on the swap trade have been linked  erratically to the money-losing carry trade as both the U.S. and Japan have raced to zero in a leapfrog fashion.

For information on the author see p. 6.

Related reading: Other Howard Simons articles “A parody of of purchasing purchasing power” power” Currency Trader , December 2009. Is there such as thing as a currency “fair value”?

“A cross rate to bear,” bear,” Currency Trader , May 2009. The Euro/yen pair isn’t just a currency cross rate — it’s a gauge of global risk.

“The hidden cost of illiquidity” Currency Trader , November 2009. Evidence mounts that we actually failed to learn the lessons of the Great Depression.

“And it’s one, two, three — what are we trading for?” Currency Trader , April 2009. They don’t call them frontier frontier markets for nothing. A look at Vietnam’s Vietnam’s currency and stock market over the past few years.

“How Eastern Europe got carried away” Currency Trader , October 2009. The Swiss National Bank’s move to quantitative easing in March reopened the Swiss franc-Eastern Europe carry trade.

“Sovereign credit risk and currencies” Currency Trader , March 2009. Government actions are perversely rewarding the guilty: As a nation’s credit rating deteriorates, its borrowing costs fall and its currency, at least temporarily, rises.

“Hungary’s Blue Danube Waltz” Currency Trader , September 2009.  A look at a unique currency slated to be absorbed by the Euro in the next few years. “Post-bubble ruble trouble and reversal” Currency Trader , August 2009. Which rate matters most, the Russian ruble vs. the dollar, or the ruble vs. the Euro? “Won flew over the carry’s nest,” Currency Trader , July 2009. For better or worse, Korea’s currency seems to function as a basic risk barometer. barometer. “Currency volatility and long-term treasury returns” Currency Trader , June 2009. The belief that higher currency volatility leads to steeper yield curves and negative bond returns has been challenged by the 2008-2009 financial upheaval.

CURRENCY CURRENCY TRADER TRADER • January 2010

“Minor trends make minor friends” Currency Trader , February 2009. Do minor currencies offer trading opportunities the majors don’t? Find out what the numbers say. “Let the trend be your friend: The majors” Currency Trader , January 2009. If currencies trend so much, why do trend followers usually have such blah performance? This and other questions are answered in this study of currency trends. “Howard Simons: Advanced Currency Concepts, Vol. 1”  A discounted collection collection that includes many of the articles articles listed here.

29

CURREN CUR RENCY CY TRA TRADER DER INTERVIEW INTERVIEW

Thomas Stridsman

puts research to work Practicing money management, mathematical expectancy, and patience in the forex market. BY CURREN CURRENCY CY TRADER TRADER STAFF STAFF

W

ith decades of experience as a trading system designer and financial writer, Thomas Stridsman’s market career has entered a new phase. The author of two books on system design, Trading Systems That Work (McGraw-Hill, 2000) and Trading Systems and Money Management (McGraw-Hill, 2003), Stridsman has also written extensively on these topics for Active Trader (as well as Currency Trader) , where he worked as both a senior staff editor and contributing editor before taking his trading ideas to a different venue. His systematic approach is currently at work in the markets courtesy of his commodity trading advisory (CTA), Stridsman Managed Accounts, through which he trades primarily currencies. Together with the Swedish management company AlfaKraft, he also is in the process of  launching a series of futures-based hedge-fund and man-

aged-account programs for diversified commodities, energy products, and currencies. A native of Sweden Sweden and currently currently living living outside outside Stockholm, Stridsman has named many of his trading programs after streets and neighborhoods in Chicago, where he lived for a decade (his currency program is named Lakeview, after the north side neighborhood). We spoke with Stridsman toward the end of 2009 about his trading career. CT:

What currencies are you trading?

TS:

I stick to the majors vs. the U.S. dollar (Euro, Japanese

 yen, British pound, Swiss franc, Australian dollar, Canadian dollar, and New Zealand dollar), and, since I’m located in

Sweden, the Swedish krona, which I trade partially as a hedge against depreciation on my trading account, which is in U.S. dollars. CT:

Building a trend-following system is easy; being competitive long-term demands deep, rigorous research in complex money management. 30

How do your trading approaches or systems reflect your philosophy about markets and how they work?

I am, and have always been, been, a technical trend follower. follower. Even though I have a degree in macro economics, I don’t care why the markets do what they do — I don’t care about any fundamentals, and I don’t forecast in any way. way. I read daily briefs from a couple of forecasting analysts — one a fundamentalist, the other is into Elliot Wave and Fibonacci. I think it’s both funny and pathetic how they alter their opinions almost on a daily basis, mixing time frames and reasons, sometimes even without regard to what they wrote yesterday. TS:

January 2010 •

CURRENCY CURRENCY TRADER TRADER

I read them, anyway, so I can keep up my end of a market discussion, as I have noticed people almost get offended if they ask me about the markets and I give them the true answer, which would be, “I have no clue.” So in short, my philosophy is to just follow the damn trends.

Trading one sector only, you have nothing working for you when all the [markets] in the sector suddenly correlate against you, so I had to add a correlation filter to my otherwise very standard breakout system. continued on p. 32 

CT:

What kind of trading approaches are you using?

First of all, I am 100-percent systematic and I only work with daily data and breakout-type patterns based on 15- to 25-day look  back periods. The few times in my life I’ve tried to deviate from the systematic approach, I have failed. I have a 100-percent track record in that regard. Sure, being a systematic trend follower also induces some pain from time to time, but overall results move slowly in the right direction. Trend followers need to learn to sit on their hands from time to time, and other times endure the pain from what seems like a never-ending string of whipsaw trades. That  just comes with the style. TS:

CT:

Is the system you’re trading  designed specifically for currencies, or is it the same system, or type of  system, you’ve designed for other  markets?

I’ve been trading currencies for about two years now. When I worked as a researcher and writer prior to trading currencies, I mostly constructed systems for multi-sector portfolios. What surprised me, and what I had to learn the hard way, was how vulnerable you are to correlations when you trade only one sector. I took a huge hit early on — in the spring of 2008 — because of this, but I adapted well when I recognized the root problem. The systems I’m using for my currency trading are adaptations of  multi-sector systems, mostly   because of the correlation issue. I recently started to trade a larger commodity portfolio as well, with systems very similar to my currency systems. TS:

CURRENCY CURRENCY TRADER TRADER •

January 2010

31

CURRENCY TRADER INTERVIEW

CT: Are

you trading more than one system? Are your systems always in the market?

I’m trading two systems, and both are capable of staying out of the market completely from time to time. In fact, that’s exactly what’s going on with one of the systems right TS:

now (late December). It has no trades in any market at the moment. This is because of the correlation issues I just mentioned. CT:

What about money management? What’s your  approach, and what role does that  contribute to your performance relative to the entry and exit signals themselves?

Those who have read my   books know that I believe money management is much more important than the systems themselves, as long as the systems have a positive mathematical expectancy. The money management algorithm should do the income-generating work. The signal-generating systems should just feed that algorithm with a flow of money, in and out, to work on. That’s the way it should   be. In reality, reality, I, too am trapped by real-life constraints, with an account too small to make the most of what I   just mentioned. So, in my current situation, the systems are more important, relatively speaking, than I would like them to be. With an account three to five times larger than my current funds, I would be able to start correcting this relationship. TS:

CT:

Has there been a big difference between your system performance in testing and real-market   performance? Have there been any  “surprises”?

Not really, other than the correlation issues I mentioned. Living in Europe and trying to work  European day-time hours, I’ve noticed the most unanticipated, costly part of my trading is when I need to roll commodity contracts in very thin markets. But because trading forex doesn’t have that issue, the results have   been mostly as expected. Sometimes there can be discrepancies in the data, because there is no single correct data feed in forex trading, TS:

32

January 2010 •

CURRENCY CURRENCY TRADER TRADER

  but profits and losses work both ways, and I have a few simple rules for dealing with that. CT:

What unique ideas or tactics do you think you use?

In terms of the currency trading, I don’t think I do anything unique and different from other trend-following currency traders. That said, as a trend follower, you need to be more patient than most people. Trend following can be really dull, so if you like action-packed days, trend following is not for you. I guess my main tactic is to be patient. TS:

Okay,, so how do CT: Okay

I need to internalize only two facts about a system: that I understand and accept the logic behind it, and that it has a positive mathematical expectancy.

you “compete,” so to speak, with other 

tom I’m up 42 percent over the past 18 months. So, from fall 2008 to spring 2009 — which most people probably think of  as the most negative period, because that’s when the stock  market tanked the most — I was doing really well, thanks first to a couple of good long-dollar trades, and then, when the markets reversed, a couple of short-dollar trades. On top of that I had a natural long-dollar position relative the Swedish krona because my account equity is in U.S. dollars. In fact, the results of many trend-following currency and commodity traders over this period are a good reminder that there are plenty of opportunities, even in what seems like the darkest times. You just have to look a  bit further than news headlines.

trend-followers?

That’s a good question; let me answer it in two parts. First, [I compete] simply by not going broke. I mentioned how I took a big hit early on because of misjudging how the markets could correlate against me. Well, many trend-following currency traders did the same without learning the lesson from it — they continued to trade too big and subsequently went out of business with 60- to 70-percent losses, among them a rather famous outfit that was frequently a top-ranked CTA CTA in the currency sector. sector. Second, it’s a slow process, during which you have to make any prospective investors aware of the fact you’re capable of producing a slightly better risk-adjusted return than most other trend followers. Unfortunately, Unfortunately, this process can take several years before it becomes really obvious, dur- CT: What’s the most important thing to consider as a ing which time you just have to refrain from trying to swing trader? for the fences. TS: To me, it’s important to understand that as a trend folIt all goes back to what you asked about money manage- lower, you have to learn to let both the good and bad times ment. Building a trend-following system is easy; being com- slide, and try to remain zen about the whole thing. Since it’s petitive long-term demands deep, rigorous research in com- supposed to be a statistics game, including both good and plex money management.  bad outliers, I think it would be devastating to pick a few good trades and try to model your systems around them. CT: Do you have any program targets — risk-adjusted  That would only result in a system too curve-fitted to those reward, etc.? instances, which would be terrible to trade forward in real targets of any kind for the actual trades — time; likewise if you try to build a system avoiding a few TS: No goals or targets it’s just a matter of letting the markets do what they do, and large losers. following them with a trailing stop. Estimated long-term I actually work quite hard at avoiding knowing too much performance targets would be around 15 percent per year, about the nitty-gritty about my systems, during both real preferably with a Sharpe ratio around 0.7 or so. trading and research. Regarding the system itself, I need to internalize only two facts: that I understand and accept the CT: What was it like dealing with the market disruption durlogic behind it, and that it has a positive mathematical ing the financial crisis last year and earlier this year? expectancy. TS: The last five to six months of 2009 were very dull. On a trade-by-trade basis — regardless of the actual outFollowing a strong May and June, a bunch of whipsaw come of the trade — all I need to ask myself i s, did I do what trades put many currency and commodity trend followers I was supposed to do? Probably the best setup you can have in drawdowns, and I’m no exception. At the end of October as a trend follower is a string of losing trades in the same I was down 1.8 percent for the year; I think Barclay’s cur- market in the same direction. You just need to place the next rency trader’s index was up less than 1 percent. trade the same way. Right now, for example, I’m making In 2008, I was up 5 percent, after a strong comeback in the some money in the yen, but other than that I have two to second half of the year, following the correlation-related three losers in a row in everything else. But I trust the mathdrawdown I mentioned earlier. From the drawdown bot- ematical expectancy will work in my favor in the end. TS:

CURRENCY CURRENCY TRADER TRADER •

January 2009

33

CURRENC CURR ENCY Y FUTU FUTURES RES SNAPSH SNAPSHOT OT

as of Dec. 29

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.

Market

Symbol Exchange Volume

OI

10-day move/% rank

20-day move/% rank

60-day move/% rank

Volatility ratio/rank

Eurocurrency 

EC

CME

249.4

148.7

-2.00% / 31%

-4.28% / 87%

-1.62% / 54%

.30 / 48%

British pound 

BP

CM E

100.7

80.1

-2.44% / 90%

-3.20% / 55%

-0.11% / 2%

.51 / 67%

Japanese yen

JY

CM E

94.5

110.4

-3.61% / 77%

-6.13% / 100%

-2.54% / 100%

.38 / 68%

-2.77% / 53%

3.20% / 8%

 Australian dollar 

AD

CM E

84.4

102.5

-2.24% / 47%

.25 / 57%

Canadian dollar 

CD

CM E

77.7

80.8

1.58% / 82%

1.33% / 26%

3.80% / 40%

.49 / 92%

Swiss franc 

SF

CME

55.0

43.5

-0.48% / 13%

-2.92% / 76%

-0.23% / 18%

.18 / 12%

Mexican peso

MP

CM E

24.4

102.9

-1.52% / 70%

-1.10% / 71%

4.86% / 84%

.40 / 33%

U.S. dollar index 

DX

ICE

16.1

40.7

1.89% / 24%

4.34% / 86%

1.76% / 91%

.31 / 67%

New Zealand dollar 

NE

CME

7.0

19.3

-1.08% / 22%

0.22% / 0%

0.28% / 0%

.28 / 72%

E-Mini eurocurrency 

ZE

CME

3.1

2.4

-2.00% / 31%

-4.28% / 87%

-1.62% / 54%

.30 / 47%

Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable).

Managed money: Barclay Trading Group’s currency trader rankings for November 2009

LEGEND: Volume: 30-day average daily volume, in thou-

Top 10 currency traders managing more than $10 million as of Nov. 30, ranked by November 2009 return.

sands. OI: 30-day open interest, in thousands. 10-day move: The percentage price move from the close 10 days ago to today’s close.

Rank Tr Trading advisor

Nov. return

2009 YTD return

$ Under   mgmt. (millions)

20-day move: The percentage price move from

1.

Dacharan Capital (High Exposure)

10.51%

33.53%

11.0

the close 20 days ago to today’s close.

2.

Friedberg Co. Mgt. (Curr.)

6.74%

-36.13%

60.7

60-day move: move: The percentage price move from

3.

Cambridge Strategy (Emerging Mkts)

4.81%

26.62%

60.0

the close 60 days ago to today’s close.

4.

MIGFX Inc (Retail)

3.22%

5.85%

10.5

5.

IKOS G10 Currency Fund

2.84%

17.69%

498.7

6.

Hathersage (Long Term Currency)

2.83%

-8.50%

511.4

7.

QFS Asset Mgt (QFS Currency)

2.82%

16.85%

619.0

8.

Sunrise Cap'l Partners (Currency Fund)

2.33%

0.11%

20.9

and in the same direction. For example, the %

9.

Cambridge Strategy (Asian Mrkts)

2.16%

1.29%

270.0

rank for the 10-day move shows how the most

10. Metro Forex Inc (Tri Gl FX)

2.01%

18.04%

114.6

The “% rank” rank” fields fields for each time window (10day moves, 20-day moves, etc.) show the percentile rank of the most recent move to a certain number of the previous moves of the same size

recent 10-day move compares to the past twenty

Top 10 currency traders managing less than $10 million and more than $1 million as of Nov. 30, ranked by November 2009 return.

10-day moves; for the 20-day move, it shows how the most recent 20-day move compares to the past sixty 20-day moves; for the 60-day move, it

1.

D2W Capital Mgmt (Radical Wealth)

shows how the most recent 60-day move com-

2.

pares to the past one-hundred-twenty 60-day moves. A reading of 100% 100% means the the current reading is larger than all the past readings, while a reading of 0% means the current reading is smaller than the previous readings.

30.10%

181.60%

2.7

Rove Capital (Dresden)

5.39%

21.36%

2.2

3.

QuantFX AM (Managed Account)

2.30%

23.85%

1.8

4.

H3 Global Advisors (Currency)

1.53%

-7.05%

3.0

5.

Sagacity (HedgeFX100)

1.43%

32.40%

1.5

6.

Aurapoint Asset Mgmt. (Broadbeach)

1.24%

50.72%

1.8

7.

Overlay Asset Mgmt. (Emerging Mkts)

1.06%

5.14%

6.6

Volatility ratio/% rank: The ratio is the short-term

8.

Quant Trading (FX Quant 11)

0.98%

16.30%

4.1

volatility (10-day standard deviation of prices)

9.

Aurora Futures Corp (FX)

0.64%

-2.95%

1.8

0.45%

13.88%

4.0

divided by the long-term volatility (100-day standard deviation of prices). The % rank is the percentile rank of the volatility ratio over the past 60 days.

34

10. Armytage AAM (Trading 1)

Source: BarclayHedge (www.barclayhedge.com (www.barclayhedge.com). ). Based on estimates of the composite of all accounts or the fully funded subset method. Does not reflect the performance of any single account. PAST PAST RESULTS RESULTS ARE NOT NECESSARIL NECESSARILY Y INDICATIVE INDICATIVE OF FUTURE PERFORMANCE.

January 2010 •

CURRENCY CURRENCY TRADER TRADER

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INTERNATIONAL INTERNA TIONAL MARKETS CURRENCIES CURRENCIES (vs. U.S. DOLLAR)

Rank*

Country

Currency

Current price vs. U.S. dollar

1-month gain/loss

3-month gain/loss

6-month ga gain/loss

52-week high

52-week low

Previous rank

1

Canadian dollar

0.95275

1.49%

3.94%

9.83%

0.9795

0.7653

14

2

Chinese yuan

0.14665

0.14%

0.14%

0.24%

0.14665

0.1455

9

3

Indian rupee

0.02135

0.00%

3.14%

3.64%

0.02185

0. 0 .01858

6

4

Hong Kong dollar

0.12895

-0.04%

-0.08%

-0.08%

0.1291

0.1288

7

5

South African rand

0.13285

-0.23%

-1.52%

4.85%

0.1383

0.09322

16

6

Russian ruble

0.0339

-0.29%

1.95%

5.61%

0.03524

0. 0 .02695

3

7

Taiwanese dollar

0.031

-0.32%

0.49%

2.14%

0.03138

0.02835

8

8

Thai baht

0.02995

-0.33%

0.67%

2.04%

0.03018

0. 0.02712

2

9

New Zealand dollar

0.7059

-0.50%

-1.85%

9.36%

0.7635

0.4892

17

10

Brazilian real

0.56725

-1.06%

2.04%

10.31%

0.5882

0.3999

13

11

Singapore dollar

0.7101

-1.47%

0.56%

3.28%

0.7256

0.6

4

12

Australian dollar

0.8844

-2.21%

1.88%

9.55%

0.9405

0.6247

10

13

Swiss franc

0.96615

-2.56%

-0.73%

4.67%

1.0087

0.8353

11

14

British pound

1.5955

-2.88%

0.01%

-3.45%

1.7042

1.3501

5

15

Swedish krona

0.13765

-3.54%

-4.44%

7.29%

0.148

0.1068

15

16

Euro

1.4383

-3.72%

-2.10%

2. 2.32%

1.5144

1. 1.2455

12

17

Japanese yen

0.01095

-5.60%

-1.79%

4.29%

0.01179

0.00986

1

 As of  Dec. 28 *based on one-month gain/loss

ACCOUNT BALANCE Rank Country Norway 1 2 Singapore 3 Hong Hong Kong ong 4 Sw Sweden 5 Netherlands 6 Germany 7 Taiwan 8 Ja Japan 9 Switzerland 10 Canada 11 Korea 12 UK 36

2008 Ratio* 88.008 19.478 26.983 14.831 30.6 0.621 14.21 4.219 9 37.279 7.783 65.746 7.497 235.257 6.405 24.894 6.361 157.079 3. 3.199 12.065 2.412 7.606 0.507 -6.406 -0.69 -46.457 -1 -1.733

2007 61.811 39.209 25.5 25.52 29 39.054 59.598 250.263 32.975 210.967 43.032 14.53 5.876 -75.483

2009+ 51.41 20.501 22.2 22.288 88 25.403 55.648 94.248 28.216 96 96.891 29.731 -34.309 26.979 -44.735

Rank Country Belgium 13 14 Czech ech Repu epublic blic 15 Italy 16 Au Australia 17 U.S. 18 Ir Ireland 19 Sp Spain

2008 -12.891 -6. -6.669 669 -78.812 -46.605 -706.068 -13.886 -153.665

Ratio* -2.547 -3.0 -3.08 83 -3.406 -4.599 -4 -4.889 -5.189 - 9. 9.592

2007 7. 7.772 -5. -5.483 483 -5 -51.208 -57.305 - 72 726.572 -13.876 -144.435

2009+ -4.455 -4. -4.075 075 -5 - 52.42 -29.89 -369.787 -3.925 -86.701

Totals in billions of U.S. dollars *Account *Account balance balance in in percen percentt of of GDP GDP +Estimate +Estimate Source: International Monetary Fund, World Economic Outlook Database, October 2009.

January 2010 • CURRENCY CURRENCY TRADER TRADER

NON-U.S. DOLLAR FOREX CROSS RATES Rank

Currency pair

1 Canada $ / Yen 2 New Zeal $ / Yen 3 Aussie $ / Yen 4 Franc / Yen 5 Pound / Yen 6 Canada $ / Real 7 Euro / Yen 8 Aussie $ / Franc 9 Pound / Franc 10 Pound / Aussie $ 11 Euro / Pound 12 Euro / Franc 13 Aussie $ / Real 14 Euro / Aussie $ 15 Aussie $ / New Zeal $ 16 Euro / Real 17 Aussie $ / Canada $ 18 Franc / Canada $ 19 Pound / Canada $ 20 Yen / Real 21 Euro / Canada $

Symbol

Dec. 28

1-month gain/loss

3-month gain/loss

6-month gain/loss

52-week high

52-week low

Previous

CAD/JPY NZD/JPY AUD/JPY CHF/JPY GBP/JPY CAD/BRL EUR/JPY AUD/CHF GBP/CHF GBP/AUD EUR/GBP EUR/CHF AUD/BRL EUR/AUD AUD/NZD EUR/BRL AUD/CAD CHF/CAD GBP/CAD JPY/BRL EUR/CAD

87.06 64.5 80.925 88.28 145.815 1.6797 131.52 0.91545 1.65095 1.80395 0.9024 1.4897 1.55925 1.6275 1.2532 2.5366 0.92835 1.01405 1.6746 0.0193 1.5102

7.36% 5.24% 3.58% 3.08% 2.75% 2.59% 1.91% 0.37% -0.35% -0.69% -0.76% -1.13% -1.15% -1.48% -1.68% -2.66% -3.64% -4.00% -4.31% -4.46% -5.11%

5.94% 0.03% 3.94% 1.14% 1.92% 1.79% -0.15% 2.63% 0.72% -1.84% -2.00% -1.31% -0.23% -3.82% 3.81% -4.09% -1.98% -4.51% -3.79% -3.26% -5.78%

5.43% 4.96% 5.28% 0.47% -7.31% -0.44% -1.71% 4.66% -7.79% -11.86% 6.08% -2.19% -0.69% -6.52% 0.21% -7.21% -0.24% -4.69% -12.09% -5.62% -6.80%

90.3149 69.5573 85.314 91.549 163.057 1.9871 139.2 0.9462 1.8112 2.2902 0.9804 1.5483 1.6702 2.07 1.2939 3.4055 0.9895 1.1583 1.9173 0.027 1.7263

70.6656 45.12 46.508 75.396 118.782 1.6003 112.045 0.728 1.512 1.7438 0.8399 1.4575 1.4741 1.5947 1.1742 2.5382 0.7812 0.999 1.6344 0.01868 1.5048

20 21 17 18 16 14 19 11 4 5 15 12 9 13 2 10 6 7 3 1 8

GLOBAL GLOBAL STOCK STOCK INDICES INDICES Rank

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Country

Index

Japan Nikkei 225 France CAC 40 Germany Xetra Dax Italy FTSE MIB Mexico IPC Switzerland Swiss Market UK FTSE 100 Singapore Straits Times Australia All ordinaries U.S. S&P 500 South Africa FTSE/JSE All Share India BSE 30 Canada S&P/TSX composite Brazil Bovespa Hong Kong Hang Seng

Dec. 28

1-month gain/loss

3-month gain/loss

6-month gain/loss

52-week high

52-week low

Previous

10,634.23 3,947.15 6,002.92 23,302.56 32,610.51 6,591.00 5,437.60 2,855.68 4,856.70 1,127.78 27,655.20 17,401.56 11,701.81 67,902.00 21,480.22

13.79% 7.26% 6.70% 6.27% 5.34% 5.27% 4.76% 4.52% 2.99% 2.93% 2.83% 2.81% 2.22% 1.28% -1.56%

6.24% 3.19% 4.65% -0.75% 10.91% 4.80% 5.26% 8.61% 3.84% 6.10% 10.65% 3.26% 3.20% 10.74% 4.33%

8.70% 23.59% 22.88% 22.03% 33.25% 21.08% 26.63% 23.24% 25.09% 21.63% 23.99% 17.69% 11.69% 30.24% 15.93%

10,767.00 3,951.78 6,011.28 24,559 32,724.80 6,608.60 5,437.60 2,862.85 4,897.50 1,130.38 27,888.90 17,457.30 11,802.40 69,785.00 23,099.60

7,021.28 2,465.46 3,588.89 12,332 16,756.70 4,235.00 3,460.70 1,455.47 3,090.80 666.79 18,120.69 8,047.17 7,479.96 35,722.00 11,344.60

15 11 7 13 8 10 4 6 14 1 9 5 3 2 12

GLOBAL SHORT-TERM SHORT-TERM INTEREST INTEREST RATES RATES Country U.S. Japan Eurozone UK Canada Switzerland Australia New Zealand Brazil Korea Taiwan India South Africa

Interest rate Fed funds rate Overnight call rate Refi rate Repo rate Overnight funding rate 3-month Swiss Libor Cash rate Cash rate Selic rate Overnight call rate Discount rate Repo rate Repurchase rate

Rate (%) 0-0.25 0.1 1 0.5 0.25 0.25 3.75 2.5 8.75 2 1.25 4.75 7

Last change 0.5 (Dec. 08) 0.2 (Dec. 08) 0.25 (May 09) 0.5 (March 09) 0.25 (April 09) 0.25 (March 09) 0.25 (Dec. 09) 0.50 (April 09) 0.5 (July 09) 0.5 (Feb. 09) 0.25 (Feb. 09) 0.25 (April 09) 0.5 (Aug. 09)

June 09 0-0.25 0.1 1 0.5 0.25 0.25 3 2.5 9.25 2 1.25 4.75 7.5

Dec. 08 0-0.25 0.1 2.5 2 1.5 0.5 4.25 5 13.75 3 2 6.5 11.5

GLOB GL OBAL AL BOND BOND RATE RATES S Rank 1 2 3 4 5

Country UK Japan Australia Germany U.S.

Rate Short sterling Government Bond 10-year bonds BUND 10-year T-note

CURREN CURRENCY CY TRADER TRADER • January 2010

Dec. 28

99.31 13 139.36 94.31 121.42 115.52

1-month 0.08% -0.38% -0.51% -1.40% -4.59%

3-month -0.18% 1.21% -0.50% -0.12% -2.26%

6-month 0.42% 0.04% -0.11% 0.38% -0.76%

High 99.52 140.32 96.16 126.53 127.62

Low 98.01 135.45 94.14 117.47 112.90

Previous 2 5 4 1 3 37

INTERNA INTE RNATIONA TIONAL L MARKE MARKETS TS Gross Domestic Product* Period AMERICAS Argentina Brazil Canada EUROPE France Germany UK

Q3 Q3 Q3 Q3 Q3 Q3

Release date

Change

12/18 12/10 11/30 11/13 11/13 12/22

1-year change

-0.4% 1.3% 0.8%

Next release

-0.4% -1.2% -6.6%

0.3% 1.5% 1.1%

AFRICA S. Africa

3/17 3/11 3/1

-1.9% -2.9% -3.1%

Release date

Period Q3

11/24

ASIA AND SOUTH PACIFIC PACIFIC Australia Q3 Hong Kong Q3 India Q3 Japan Q3 Singapore Q3

2/12 2/12 1/26

12/16 11/13 11/30 11/17 11/26

1-year change

Change -12.2%

0.2% -7.8% 3.3% -0.1% 0.3%

Next release

-21.8%

-2.5% -2.0% 8.8% -0.3% 0.6%

2/23

3/3 2/24 2/26 NLT 2/28 NLT 2/19

* Final estimates, at current prices, seasonally adjusted

Unemployment Period

Release date

AMERICAS Argentina Q3 Brazil Nov. Canada Nov. EUROPE France Q3 Germany Oct. UK Aug.-Oct.

Rate

1-year Change change

Next release

12/14 12/26 12/4

9.1% 7.4% 8.5%

0.3% -0.1% -0.1%

1.3% -0.2% 2.1%

3/15 1/28 1/8

12/10 12/1 12/8

9.1% 7.5% 7.9%

0.0% -0.1% 0.0%

1.7% 0.4% 1.9%

3/4 1/5 1/20

Period

Release date

ASIA AND SOUTH PACIFIC PACIFIC Australia Nov. 12/10 Hong Kong Se Sept.-Nov 12 12/17 Japan Nov. 12/25 Singapore Q3 10/30

1-year Next Change change release

Rate

5.7% 5.1% 5.2% 3.4%

0.0% -0.1% 0.1% 0.1%

1.2% 1.3% 1.2% 1.1%

1 /1 4 1/19 1/29 1/29

CPI Period AMERICAS Argentina Brazil Canada EUROPE France Germany UK

Nov. Nov. Nov. Nov. Nov. Nov.

Release date 12/11 12/9 12/17 12/15 12/9 12/15

Change 0.8% 0.4% 0.6% 0.1% -0.1% 0.3%

1-year change 7.1% 4.2% 1.0% 0.4% 0.4% 1.9%

Next release 1/13 1/13 1/20 1/13 1/14 1/19

Period AFRICA S. Africa

Oct.

ASIA AND SOUTH PACIFIC PACIFIC Australia Q3 Hong Kong Nov. India Oct. Japan Nov. Singapore Nov.

Release date 11/25

Change 0.0%

1-year change 5.9%

Next release 12/15

10/28 12/21 11/30 12/25 12/23

1.0% 0.1% 1.2% -0.2% 0.2%

1.3% 0.5% 11.5% -1.9% -0.2%

1/27 1/21 12/31 1/29 1/25

Release date

Change

1-year change

Next release

PPI Period AMERICAS Argentina Brazil Canada EUROPE France Germany UK

Nov. Nov. Oct. Nov. Nov. Nov.

Release date 12/11 12/8 11/30 12/22 12/18 12/11

Change 0.9% -0.1% -0.3% 0.2% 0.1% 0.2%

1-year change 8.5% -4.6% -6.3% -4.5% -5.9% 2.9%

Next release 1/13 1/7 1/5 2/1 1/20 1/8

Period AFRICA S. Africa

Nov.

ASIA AND SOUTH PACIFIC PACIFIC Australia Q3 Hong Kong Q4 India Nov. Japan Nov. Singapore Nov.

12/17

10/26 12/14 12/11 12/10 12/29

0.8%

0.1% 0.1% 1.3% 0.1% 1.7%

-1.2%

0.2% -2.0% 4.8% -4.9% 5.6%

1/28

1/25 3/12 1/7 1/14 1/29

LEGEND: Change: Change from previous report release. NLT: No later than. Rate: Unemployment Unemployment rate.  As of Dec. 30. 38

January 2010 • CURRENCY CURRENCY TRADER TRADER

GLOBAL ECO GLOBAL ECONOM NOMIC IC CALENDAR CALENDAR Legend

January

CPI: Consumer price index ECB: European Central Bank FDD (first delivery day): The first day on which delivery of a commodity in fulfillment of a futures contract can take place. FND (first notice day): Also day):  Also known as first intent day, this is the first day on which a clearinghouse can give notice to a buyer  of a futures contract that it intends to deliver a commodity in fulfillment of a futures contract. The clearinghouse also informs the seller. FOMC: Federal Open Market Committee

1

ISM: Institute for supply management

3 4

December ISM report

5

Canada: November PPI Germany: November employment report

7

8

PMI: Purchasing managers index

Economic Release time release (U.S.) (E T ) GDP 8:30 a.m. CPI 8:30 a.m. ECI 8:30 a.m. PPI 8:30 a.m. ISM 10:00 a.m. Unemployment 8:30 a.m. Personal income 8:30 a.m. Durable goods 8:30 a.m. Retail sales 8:30 a.m. Trade balance 8:30 a.m. Leading in indicators 10:00 a. a.m.

27 28 29 30 31

1

2

3

8

9

5

6

7

8

2

3

9

10

4

5

11 12 13

21 22 23 24 25 26 27 2

3

4

5

28

U.S.: December durable goods Brazil: December employment report Germany: December employment report South Africa: December PPI

29

U.S.: Q4 GDP (advance) (advance) and and employment cost index Canada: December PPI Japan: December employment report and CPI

14

U.S.: December retail sales Australia: December employment report Germany: December CPI Japan: December PPI ECB: Governing council interest-rate announcement

15

6

The information on this page is subject to change. Currency Trader is Trader  is not responsible for the accuracy of  calendar dates beyond press time. CURRENCY CURRENCY TRADER TRADER • January 2010

U.S.: December CPI

20

30 31

February 1

U.S.: December personal income; January ISM report France: December PPI

2

18

6

14 15 16 17 18 19 20 28 1

U.S.: December employment report UK: December employment report; December PPI LTD: January currency options

U.S.: FOMC interest-rate announcement Australia: Q4 CPI South Africa: December CPI

France: December CPI

19

FEBRUARY 2010 31 1

27

13

17

24 25 26 27 28 29 30 4

Japan: December CPI and PPI UK: Bank of England interest-rate announcement

Japan: Bank of Japan interest-rate announcement

U.S.: November trade balance

17 18 19 20 21 22 23 3

24 26

12

16

2

23

Australia: Q4 PPI

11

10 11 12 13 14 15 16

31 1

Mexico: December  employment report; January CPI

10

JANUARY 2010 7

22

9

PPI: Producer price index

6

U.S.: December leading indicators Hong Kong: December CPI

25

6

LTD (last trading day): The final day trading can take place in a futures or options contract.

5

21

2

GDP: Gross domestic product

4

MONTH JANUARY/FEBRUARY

Canada: Bank of Canada interest-rate announcement UK: December CPI U.S.: December PPI and housing starts Canada: December CPI Germany: December PPI Hong Kong: October-December  employment report UK: November employment report

3 4 5

U.S.: January employment report Canada: January employment report

39

KEY KE Y CO CONC NCEP EPTS TS Carry trades involve buying (or lending) a currency

True range can be calculated on any time frame or price with a high interest rate and selling (or borrowing) a cur-  bar — five-minute, hourly, daily, weekly, etc. The following rency with a low interest rate. Traders looking to “earn discussion uses daily price bars for simplicity. simplicity. True range is carry” will buy a high-yielding currency while simultane- the greatest (absolute) distance of the following: ously selling a low-yielding currency. currency. 1. Today’s high and today’s low. measure of price price movement movement that that 2. Today’s high and yesterday’s close. True range (TR): A measure accounts for the gaps that occur between price bars. This 3. Today’s low and yesterday’s close. calculation provides a more accurate reflection of the size of  a price move over a given period than the standard range Average true range (ATR) is simply a moving average of  calculation, which is simply the high of a price bar minus the true range over a certain time period. For example, the the low of a price bar. bar. The true range calculation was devel- five-day ATR ATR would be the average of the true range calcuoped by Welles Wilder and discussed in his book  New lations over the last five days. Concepts in Technical Trading Systems (Trend Research, 1978).

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January 2010 • CURRENCY CURRENCY TRADER TRADER

GLOBAL MARKETS continued from p. 11

FIGURE 8 — ROOM TO MOVE

“These are all fast growing countries where the currencies are cheap or the governments have been intervening,” he says. “Allowing the [Indian] currency to appreciate is one of the most efficient ways to keep inflation down.” Galy highlights the Korean won (KRW), along with the Indonesia rupee (INR), and the Israeli shekel (ILS) as currencies with potential in 2010. He calls the Korean won “cheap” with room for upside appreciation in 2010 2010 (Figure (Figure 7). 7).

Some analysts say that although a significant CNY revaluation is unlikely in the next six months, there is room for the yuan to strengthen vs. the dollar — i.e., the USD/CNY rate could decline.

“In addition to staying long the KRW against the USD, where intermittent volatility can be expected should risk aversion rear its head again, as it surely will, we favor cross-regional currency plays, including buying KRW against   JPY, a clear winner in 2009,” BNP analysts wrote in their report. Source: www.advfn.com Galy says a pick-up in inflation in Indonesia and Israel could spark central bankers there to soon, though. “solve it by tightening policy and letting the currency “Beijing has made it very clear its stable CNY policy will appreciate.” continue until it is more confident in an export-led Chinese BNP analysts wrote: “Our general view on the Israeli recovery,” Webster adds. “Nor will it relent to internationshekel is that of an undervalued currency on the basis of the al pressures short-term to increase FX flexibility to help corcountry’s highly supportive balance of payments. We rect global imbalances. In other words, China’s policymakexpect the shekel to strengthen more noticeably in 2010, ers are still acutely sensitive to the view that, independent especially in times of a rise in global volatility. The Israeli of government/central bank stimulus, private-sector driven economy has been by all means outperforming that of  Chinese output is likely to continue to fall short of sustained many emerging markets countries during the credit crisis growth recovery.” partly thanks to a strong local banking sector.” As a result, Webster says, a “de-pegging” or meaningful Many emerging-markets countries, including Indonesia, CNY revaluation is unlikely to occur within the next six Korea, Korea, and India, India, have have increa increased sed their their reserv reserves es to help help months, or until China has regained some competitive edge prevent steep appreciation of their currencies. However, over newly industrialized Asian economies. But there is Englander says that trend could be changing and EM coun- room for the yuan to strengthen vs. the dollar. tries might intervene less. “Nevertheless, as far as USD/CNY is concerned, the U.S. “As inflation becomes more of a concern, the benefits of  currency might be seen easing from current levels of  keeping an artificially weak currency diminish and the around 6.82 to around the 6.60 mark by end of 2010,” he advantages of currency strength grow,” he says. says. “If this sort of move occurs, almost all of the softening is likely to occur in the second half of the year.” China

Stephen Webster, director of UK-based TopEcon consulting, believes the Chinese yuan (CNY) is a key currency to watch in 2010 (Figure 8), despite its continued “managed float” vs. a small basket of currencies (dominated by the U.S. dollar). “Emerging Asia — Asia excluding Japan — is highly dependent on China as a destination for its exports, and FX linkages in the region are pivotal in this respect,” he says. “For example, Taiwan and South Korea are particularly export dependent on China. The sheer scale of China’s exports to the rest of the world also makes the CNY a currency of clear international focus.” Don’t expect a major policy shift from China any time CURRENCY TRADER •

January 2010

Back to normal?

Overall, 2010 appears poised to see the return of several key forex market drivers — refocusing on interest-rate and growth differentials, and a de-emphasis of the dollar as a funding currency for carry trades in favor of the yen. “I think the big risk-on, risk-off theme that dominated 2009 is probably not going to be nearly as important,” Englander says. Instead, currency traders and money managers will will be focusing focusing on which countr countries ies will come back back to a normal policy regime the quickest. “The countries that can do that will have strong currencies,” he says. “The laggards will continue to face pressure.” 41

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January 2010 •

CURRENCY CURRENCY TRADER TRADER

FOREX FOR EX TRAD TRADE E JOU JOURNAL RNAL

Dollar/Canada fails to budge, despite broader buck rally. TRADE Date: Wednesday, Dec. 16, 2009. Entry: Long the U.S. dollar/Canadian dollar pair

(USD/CAD) at 1.0644. Reason for trade/setup: This trade was based on

the combination of the U.S. dollar’s broader shortterm strength and the USD/CAD’s volatility contraction: a recipe for an upside breakout. In retrospect, the trade from last month’s Forex   Journal was a victim of the USD/CAD’s extended contraction, which persisted another month before this trade presented itself. With the pair nestled in an increasingly tight congestion pattern, a breakout is only a matter of time. With the dollar index (DXY) having successfully tested its November low and  broken out above the November high, arrows are pointing higher. With the market trading around 1.0610, we  bracketed it with a limit order below the market at 1.0591 and a buy-stop order above at 1.0644 (a little above the afternoon high).

Source for all charts: TradeStation

Profit/loss: -.0053.

the morning after the entry. Unfortunately, it turned out to  be a classic fake-out. Price sagged over the next two days (not without giving some false hope by pausing around the  breakout level most of Dec. 18) before collapsing on Dec. 21 and stopping out the trade. Meanwhile, the dollar soared overall, especially on Dec. 17, and followed through with solid, if unspectacular gains over the next three days. Dollar/Canada retreated right   back into the middle of its trading range, which was two months old at that point. 

Outcome: What a frustrating trade — the U.S. dollar

Note: Initial trade targets are typically based on things such as the historical per-

Initial stop: 1.0591. Initial target: 1.0860.

RESULT Exit: 1.0591.

made big gains vs. most currencies during the holding peri-  formance of a price pattern or a trading system signal. However, because indiod, but went nowhere vs. the Canadian buck. vidual trades are dictated by immediate circumstances, price targets are flexible The trade started out promisingly enough. The pair and are often used as points at which to liquidate a portion of a trade to reduce didn’t pull back to the limit price, but triggered an entry at exposure. As a result, initial (pre-trade) reward-risk ratios are conjectural by the buy-stop level and followed through strongly to 1.0745 nature. TRADE SUMMARY

Date

Currency pair

Entry price Initial stop

In Initial target

IRR

Exit

Date

P/L Point

12/17/09 USD/CAD 1.0644

1.0591

1.086

4.08

1.0591 12/21/09 -.0053

LOP

LOL

Trade length

.0101

-.0053

3 days

% -0.50%

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). CURRENCY CURRENCY TRADER TRADER •

January 2010

43

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