A Three Dimensional Approach To Forex Trading
by Anna Coulling
US Dollar
Still a safe haven, and likely to remain so, although other currencies are starting to nibble away at this
once traditional role. As forex traders understanding market sentiment towards the US dollar should
be paramount. Therefore, the dollar index is always the first port of call, and I like to use the FXCM
version as it gives me a much clearer picture, particularly for intra day trading. All the technical
analysis techniques covered in this book can be applied to this chart.
If and until the Fed stop their QE program, the currency is likely to remain weak. In addition the
currency has now joined the yen as a mainline funding currency for the carry trade. When this starts to
unwind, then watch out!
Euro
Political with a capital P. The problem with the euro is trading it without an opinion. Almost
impossible, since the currency has been written off so many times, by so many people, that it is very
difficult to ignore the chatter. The euro, in its present format will go - eventually, but with the Chinese
reducing their dollars in favour of euros, not just yet! Because it is such a political currency it is
fiendish to trade with any certainty, and price action is often illogical.
In many ways the markets are now so inured to bad news in Europe, that as each subsequent crisis
unfolds, the reactions become less and less volatile. Indeed, a minor crisis is often welcomed as
‘good news’! In stark contrast to the US dollar the euro is increasingly seen as a high risk currency.
When risk is on, them the euro will generally rise.
Yen
Safe haven and politics all rolled up in one neat package. The darling of the carry trade and another
funding currency to match the US dollar. Protected and loved by the Bank of Japan, the yen will
always come first when any decision has to be made. As interest rates start to rise, watch the yen
weaken further, and faster, as the carry trade comes into play once again.
British Pound
Remember the English breakfast of sausage and egg. The chicken is involved, but the pig is
committed! The pound is the chicken of Europe, involved but not committed, and long may it continue.
Mr Reliable could best describe sterling, and despite the recent downgrade from the ratings agency
(but then who cares about them anyway) a solid currency in every respect. Indeed, respectable sums it
up, with the financial centre of the world and the Bank of England underpinning this currency. No real
drivers or major influencing factors, although increasingly seen as a safe haven and an alternative to
the euro.
Australian Dollar
Another solid and well managed currency, but which catches a cold each time China sneezes.
Commodities hold the key, and in the last few years, the currency is increasingly seen as a safe haven,
but with a ‘risk’ label due to the high interest rates and carry trade drivers. Expect to see the currency
strengthen as interest rates rise globally, with hot money flowing in, provided the Chinese economy
continues on track.
Canadian Dollar
Just as the Australian dollar is linked to its largest trading partner, China, so the Canadian dollar is
heavily influenced by its next door neighbor, the US. Strength or weakness in the US economy will
always impact Canada directly and quickly, which can make the USD/CAD a tricky pair to trade. In
addition, commodities play their part with oil in particular, and if we throw the yen into the mix,
trying to establish what is driving the currency can be difficult. Nevertheless, another solid currency
representing a well managed economy. Remember that the weekly oil stats release on a Wednesday,
will impact the Canadian dollar more than the US dollar, even though the data is released in the US.
New Zealand Dollar
In the majors, the preferred currency of the carry trade, with subsequent flows of hot money, although
in recent years this has become less of an issue, with the interest rate falling below that of the
Australian dollar. However, once rates start to climb again, watch for buying of the currency,
particularly against the yen. A great ‘trending’ currency as a result, but when the trend reverses, watch
out - they can move equally fast in the opposite direction as money flows out again. The Australian
economy also plays a part, as one of New Zealand’s largest trading partners, and of course
commodities are in the mix, although soft commodities are more significant. In fact, China has
recently become New Zealand’s largest export market for dairy based products, such as milk powder,
butter and cheese. Indeed the NZD came under pressure recently following a problem with milk
powder exports to China.
Norwegian Krone
A very tricky currency to ‘put in a box’ in any well defined way. Norway is certainly stable, and
extremely wealthy, and in many ways similar to Switzerland in this respect, particularly given its
huge oil fund. Yet the currency struggles to be accepted as a ‘safe haven’ by investors which is rather
odd, given its huge current account surplus. Oil, of course, is one of the determining factors for the
currency, but in a currency whose volumes can be light during the trading day, volatility can be an
issue. One opportunity on the horizon with the Krone is the prospect of rising interest rates due to the
housing market which has been booming recently. This may force the Norwegian central bank (Norges
Bank) to step in and raise interest rates, much against global trends. With rates in Europe falling and a
possible increase for the Krone, this could see the development of a longer term trend, particularly if
coupled with any move higher for oil.
Swiss Franc
Two words sum up the Swiss franc - ‘safety’ and ‘security’. Over the last few years Switzerland has
increasingly been seen as another ‘safe haven’ country, under pinned by gold. Unlike Norway,
overseas investors have been flooding in, and buying the Swiss franc, particularly from Europe. The
SNB has attempted to weaken the currency several times, but with little effect so far. Swiss interest
rates reflect those in the rest of the world, so this is not hot money, but simply panic driven flows.
Gold underpins everything, but watch out if the bank wins the referendum to sell some of its gold
reserves. This will not be good news for the currency, which could see these same investors use the
door marked ‘exit’, and move elsewhere.
South African Rand
Moving to some of the more exotic currencies which can offer excellent trading returns, but equally
can be extremely volatile and fast moving. The South African Rand is a case in point and a currency
influenced by a variety of factors. The first is, of course, commodities and gold, then comes demand
from China, and finally we have the interest rate differentials. At the current rate of 5% this is
attractive, but for how much longer? After all, as major currencies start to move back to this level,
with Australia leading the way, the decision is then between a ‘risk safe haven’ high yield currency vs
a ‘high risk’ high yield currency.
The recent weakness in gold has also been a factor, and as with many other countries dependent on
China, any slowdown in the economy will be reflected directly in the rand. As an exotic currency it is
extremely volatile with wide spreads. Japanese investors have been increasingly dominant in this
currency moving into higher yields, underpinned by gold, but with the resurgence in risk, these
investors are now selling the currency and moving back into ‘risk assets’ in particular Japanese and
US equities, with the rand being sold as a consequence. As an ‘exotic’ currency, this may not be
available on regular trading platforms, but can be traded as a future through the CME.
Mexican Peso
The Mexican peso is one to watch, as it is poised to become a key currency for forex traders over the
next few years. If this is not on your list - ADD IT now! The Mexican economy is increasingly seen as
stable, with a central bank that has managed the financial crisis well, and with the transition almost
complete from a commodity driven export market to one built on technology, the peso is the one to
watch. Overseas investors are flooding into the country for all the right reasons, and whilst the
interest rates are attractive for the ‘hot money’ speculators at 4%, the flows here are manageable, and
not purely speculative. As a result, the peso has been strengthening against most of the major
currencies, and once again for investors and longer term speculators, a choice between a volatile
currency offering slightly higher yields, against a stable currency with marginally lower yields, it is
really no contest. Expect to see further strength in the peso against the major currencies.
As with the rand, if this is not available on your trading platform, the CME offer futures and options
under emerging markets.
Korean Won
The VIX of the currency world, which unlike the Japanese yen tends to weaken when the economy is
weak, and strengthen when demand begins to pick up. Therefore, expect a return to strength once
global markets begin to emerge from the carnage of the recent crisis. The currency is extremely
volatile and indeed it is rare to see a candlestick with no wick. Generally they have wicks to both top
and bottom. Very much a currency for longer term trading based on an analysis of the fundamentals
and economic cycles initially.
The Major Currency Pairs
Having looked at some of the principle currencies, along with some of the more exotic currencies,
which may become, ‘majors’ of the future, let’s now look at the major currency pairs, followed by
some of the cross currency pairs, and how these characteristics are reflected.
EUR/USD
This may be the most widely traded currency pair in the forex market, but it is one of the most
difficult. On one side we have a political currency now considered high risk, and on the other we
have the US dollar, safe haven, yet increasingly manipulated by the FED policies. This pair is always
promoted by brokers as the one to trade, primarily because of highly competitive spreads. This may
have been the case a few years ago, but in my view this is no longer a valid argument. It may be very
liquid, and is generally the pair that has the tightest spreads in the market, but these are about the only
benefits. This is a pair I rarely consider, and rarely trade. It is a wolf in sheep’s clothing. Billions of
dollars have been lost by speculators shorting this pair. Each time there is a new crisis in Europe, the
latest being in Cyprus, the COT report shows the same patterns, with a massive build in short
positions. The ECB then step in with supporting rhetoric, the storm passes and the euro duly recovers.
Furthermore, the EUR/USD is a classic example of just how dramatically the forex market has
changed over the last five years. As I said in the introduction to this book, the rule book has been torn
up, and this is one of the casualties. Any book on trading forex, written before 2008, would have
suggested that the FX markets trend strongly, are driven by interest rate differentials, and that the
EUR/USD was the place to start given the depth of liquidity and strength of the two currencies. None
of this is true at present. It may change in the future, but not in the short term. So my advice, is to look
elsewhere, and NOT start here. There are many others pairs to choose from, and the cross currency
pairs in particular offer increasingly good trading opportunities.
USD/JPY
This is another currency pair where we can tear up the rule book. Once upon a time, this pair was
considered almost impossible to trade, and certainly not a ‘novice’ pair with two ‘safe haven’
currencies battling for supremacy. Then along came QE, which both central banks have embraced
with enthusiasm. In the case of the Japanese, rather too enthusiastically as the BOJ prepares to release
its 9th and most aggressive version yet. The BOJ are desperate to weaken the yen further, and to date
they have succeeded in grand style, making this one of the ‘no decision’ trades of the year. But
remember, when global interest rates start moving higher once again, then the yen will be sold even
more strongly, with any counterbalance effect from the US dollar, only having a muted effect.
After all, if the carry trade explodes back in the market, which it will, then the yen will be the prime
candidate once again, with strong trends in this and other yen based pairs. Furthermore, with the yen,
when risk on appetite is in the ascendancy, then the Japanese will be selling the yen and moving into
equities, and giving the BOJ a further helping hand. All good news for the Bank of Japan, moving
forward. In contrast the Federal Reserve’s attempts at QE seem restrained and almost amateurish.
The message is clear. Ignore the older forex trading books - the ‘old rules’ no longer apply. It is time
to move away from a single currency pair. Start trading the USD/JPY, but if you prefer to trade the
euro, then simply move to the EUR/JPY as this correlates extremely closely with the USD/JPY,
particularly on the hourly, daily and weekly timeframes. This is a positive correlation as you would
expect.
GBP/USD
Cable is in complete contrast to the EUR/USD. Solid steady and reliable, it ticks along like Big Ben,
rarely volatile and generally predictable, and whilst it does have periods of excitement, the reasons
are generally clear and self evident. There are no politics with the pound, and it is increasingly seen
as a safe haven and an alternative to the euro. Before the financial crisis, the GBP/USD and the
EUR/USD would generally have moved in lockstep together, with both moving higher or lower on US
dollar strength and weakness. This relationship has long since broken down, and now the two react
and move independently, with the primary driver for the EUR/USD being politics in Europe, whilst
for Cable it is the UK economy. The good old British pound keeps plodding along, and despite the
recent downgrade, confidence in the currency was only temporarily dented, before strength returned.
This is not an exciting pair to trade, but then trading success is not about excitement, it’s about making
money. The trading range typically is between 70 and 100 pips per day, and this is the currency which
tends to set the tone for the London session following the open in Europe and from the overnight in
Asia.
If you are a novice or inexperienced trader, I would urge you to consider starting with the GBP/USD.
AUD/USD
The Aussie dollar is one of those currency pairs which gets a ‘double boost’ whenever the US dollar
weakens or strengthens, given its association with commodities, and as result tends to develops
strong trends. One only has to look back over the last few years and see how the extended bull run in
commodities has been reflected in the pair. More recently, the pair has been in an extended phase of
consolidation, with the bullish trend having run out of steam as the commodity super cycle begins to
slow. China is the biggest influence on this pair. Next the interest rate differential is also playing its
part, and with an economy that is stable and well managed, providing China does not implode, then
we can expect to see interest rates rising in Australia thereby increasing the differential between the
two currencies. Hot money flows should see the pair continue higher in due course. Fundamental
news has a major influence on the pair with Chinese data leading the way, NOT US data.
As you might expect the pair correlate positively with the NZD/USD but only on the longer term
timeframes of weekly and above.
by Anna Coulling
US Dollar
Still a safe haven, and likely to remain so, although other currencies are starting to nibble away at this
once traditional role. As forex traders understanding market sentiment towards the US dollar should
be paramount. Therefore, the dollar index is always the first port of call, and I like to use the FXCM
version as it gives me a much clearer picture, particularly for intra day trading. All the technical
analysis techniques covered in this book can be applied to this chart.
If and until the Fed stop their QE program, the currency is likely to remain weak. In addition the
currency has now joined the yen as a mainline funding currency for the carry trade. When this starts to
unwind, then watch out!
Euro
Political with a capital P. The problem with the euro is trading it without an opinion. Almost
impossible, since the currency has been written off so many times, by so many people, that it is very
difficult to ignore the chatter. The euro, in its present format will go - eventually, but with the Chinese
reducing their dollars in favour of euros, not just yet! Because it is such a political currency it is
fiendish to trade with any certainty, and price action is often illogical.
In many ways the markets are now so inured to bad news in Europe, that as each subsequent crisis
unfolds, the reactions become less and less volatile. Indeed, a minor crisis is often welcomed as
‘good news’! In stark contrast to the US dollar the euro is increasingly seen as a high risk currency.
When risk is on, them the euro will generally rise.
Yen
Safe haven and politics all rolled up in one neat package. The darling of the carry trade and another
funding currency to match the US dollar. Protected and loved by the Bank of Japan, the yen will
always come first when any decision has to be made. As interest rates start to rise, watch the yen
weaken further, and faster, as the carry trade comes into play once again.
British Pound
Remember the English breakfast of sausage and egg. The chicken is involved, but the pig is
committed! The pound is the chicken of Europe, involved but not committed, and long may it continue.
Mr Reliable could best describe sterling, and despite the recent downgrade from the ratings agency
(but then who cares about them anyway) a solid currency in every respect. Indeed, respectable sums it
up, with the financial centre of the world and the Bank of England underpinning this currency. No real
drivers or major influencing factors, although increasingly seen as a safe haven and an alternative to
the euro.
Australian Dollar
Another solid and well managed currency, but which catches a cold each time China sneezes.
Commodities hold the key, and in the last few years, the currency is increasingly seen as a safe haven,
but with a ‘risk’ label due to the high interest rates and carry trade drivers. Expect to see the currency
strengthen as interest rates rise globally, with hot money flowing in, provided the Chinese economy
continues on track.
Canadian Dollar
Just as the Australian dollar is linked to its largest trading partner, China, so the Canadian dollar is
heavily influenced by its next door neighbor, the US. Strength or weakness in the US economy will
always impact Canada directly and quickly, which can make the USD/CAD a tricky pair to trade. In
addition, commodities play their part with oil in particular, and if we throw the yen into the mix,
trying to establish what is driving the currency can be difficult. Nevertheless, another solid currency
representing a well managed economy. Remember that the weekly oil stats release on a Wednesday,
will impact the Canadian dollar more than the US dollar, even though the data is released in the US.
New Zealand Dollar
In the majors, the preferred currency of the carry trade, with subsequent flows of hot money, although
in recent years this has become less of an issue, with the interest rate falling below that of the
Australian dollar. However, once rates start to climb again, watch for buying of the currency,
particularly against the yen. A great ‘trending’ currency as a result, but when the trend reverses, watch
out - they can move equally fast in the opposite direction as money flows out again. The Australian
economy also plays a part, as one of New Zealand’s largest trading partners, and of course
commodities are in the mix, although soft commodities are more significant. In fact, China has
recently become New Zealand’s largest export market for dairy based products, such as milk powder,
butter and cheese. Indeed the NZD came under pressure recently following a problem with milk
powder exports to China.
Norwegian Krone
A very tricky currency to ‘put in a box’ in any well defined way. Norway is certainly stable, and
extremely wealthy, and in many ways similar to Switzerland in this respect, particularly given its
huge oil fund. Yet the currency struggles to be accepted as a ‘safe haven’ by investors which is rather
odd, given its huge current account surplus. Oil, of course, is one of the determining factors for the
currency, but in a currency whose volumes can be light during the trading day, volatility can be an
issue. One opportunity on the horizon with the Krone is the prospect of rising interest rates due to the
housing market which has been booming recently. This may force the Norwegian central bank (Norges
Bank) to step in and raise interest rates, much against global trends. With rates in Europe falling and a
possible increase for the Krone, this could see the development of a longer term trend, particularly if
coupled with any move higher for oil.
Swiss Franc
Two words sum up the Swiss franc - ‘safety’ and ‘security’. Over the last few years Switzerland has
increasingly been seen as another ‘safe haven’ country, under pinned by gold. Unlike Norway,
overseas investors have been flooding in, and buying the Swiss franc, particularly from Europe. The
SNB has attempted to weaken the currency several times, but with little effect so far. Swiss interest
rates reflect those in the rest of the world, so this is not hot money, but simply panic driven flows.
Gold underpins everything, but watch out if the bank wins the referendum to sell some of its gold
reserves. This will not be good news for the currency, which could see these same investors use the
door marked ‘exit’, and move elsewhere.
South African Rand
Moving to some of the more exotic currencies which can offer excellent trading returns, but equally
can be extremely volatile and fast moving. The South African Rand is a case in point and a currency
influenced by a variety of factors. The first is, of course, commodities and gold, then comes demand
from China, and finally we have the interest rate differentials. At the current rate of 5% this is
attractive, but for how much longer? After all, as major currencies start to move back to this level,
with Australia leading the way, the decision is then between a ‘risk safe haven’ high yield currency vs
a ‘high risk’ high yield currency.
The recent weakness in gold has also been a factor, and as with many other countries dependent on
China, any slowdown in the economy will be reflected directly in the rand. As an exotic currency it is
extremely volatile with wide spreads. Japanese investors have been increasingly dominant in this
currency moving into higher yields, underpinned by gold, but with the resurgence in risk, these
investors are now selling the currency and moving back into ‘risk assets’ in particular Japanese and
US equities, with the rand being sold as a consequence. As an ‘exotic’ currency, this may not be
available on regular trading platforms, but can be traded as a future through the CME.
Mexican Peso
The Mexican peso is one to watch, as it is poised to become a key currency for forex traders over the
next few years. If this is not on your list - ADD IT now! The Mexican economy is increasingly seen as
stable, with a central bank that has managed the financial crisis well, and with the transition almost
complete from a commodity driven export market to one built on technology, the peso is the one to
watch. Overseas investors are flooding into the country for all the right reasons, and whilst the
interest rates are attractive for the ‘hot money’ speculators at 4%, the flows here are manageable, and
not purely speculative. As a result, the peso has been strengthening against most of the major
currencies, and once again for investors and longer term speculators, a choice between a volatile
currency offering slightly higher yields, against a stable currency with marginally lower yields, it is
really no contest. Expect to see further strength in the peso against the major currencies.
As with the rand, if this is not available on your trading platform, the CME offer futures and options
under emerging markets.
Korean Won
The VIX of the currency world, which unlike the Japanese yen tends to weaken when the economy is
weak, and strengthen when demand begins to pick up. Therefore, expect a return to strength once
global markets begin to emerge from the carnage of the recent crisis. The currency is extremely
volatile and indeed it is rare to see a candlestick with no wick. Generally they have wicks to both top
and bottom. Very much a currency for longer term trading based on an analysis of the fundamentals
and economic cycles initially.
The Major Currency Pairs
Having looked at some of the principle currencies, along with some of the more exotic currencies,
which may become, ‘majors’ of the future, let’s now look at the major currency pairs, followed by
some of the cross currency pairs, and how these characteristics are reflected.
EUR/USD
This may be the most widely traded currency pair in the forex market, but it is one of the most
difficult. On one side we have a political currency now considered high risk, and on the other we
have the US dollar, safe haven, yet increasingly manipulated by the FED policies. This pair is always
promoted by brokers as the one to trade, primarily because of highly competitive spreads. This may
have been the case a few years ago, but in my view this is no longer a valid argument. It may be very
liquid, and is generally the pair that has the tightest spreads in the market, but these are about the only
benefits. This is a pair I rarely consider, and rarely trade. It is a wolf in sheep’s clothing. Billions of
dollars have been lost by speculators shorting this pair. Each time there is a new crisis in Europe, the
latest being in Cyprus, the COT report shows the same patterns, with a massive build in short
positions. The ECB then step in with supporting rhetoric, the storm passes and the euro duly recovers.
Furthermore, the EUR/USD is a classic example of just how dramatically the forex market has
changed over the last five years. As I said in the introduction to this book, the rule book has been torn
up, and this is one of the casualties. Any book on trading forex, written before 2008, would have
suggested that the FX markets trend strongly, are driven by interest rate differentials, and that the
EUR/USD was the place to start given the depth of liquidity and strength of the two currencies. None
of this is true at present. It may change in the future, but not in the short term. So my advice, is to look
elsewhere, and NOT start here. There are many others pairs to choose from, and the cross currency
pairs in particular offer increasingly good trading opportunities.
USD/JPY
This is another currency pair where we can tear up the rule book. Once upon a time, this pair was
considered almost impossible to trade, and certainly not a ‘novice’ pair with two ‘safe haven’
currencies battling for supremacy. Then along came QE, which both central banks have embraced
with enthusiasm. In the case of the Japanese, rather too enthusiastically as the BOJ prepares to release
its 9th and most aggressive version yet. The BOJ are desperate to weaken the yen further, and to date
they have succeeded in grand style, making this one of the ‘no decision’ trades of the year. But
remember, when global interest rates start moving higher once again, then the yen will be sold even
more strongly, with any counterbalance effect from the US dollar, only having a muted effect.
After all, if the carry trade explodes back in the market, which it will, then the yen will be the prime
candidate once again, with strong trends in this and other yen based pairs. Furthermore, with the yen,
when risk on appetite is in the ascendancy, then the Japanese will be selling the yen and moving into
equities, and giving the BOJ a further helping hand. All good news for the Bank of Japan, moving
forward. In contrast the Federal Reserve’s attempts at QE seem restrained and almost amateurish.
The message is clear. Ignore the older forex trading books - the ‘old rules’ no longer apply. It is time
to move away from a single currency pair. Start trading the USD/JPY, but if you prefer to trade the
euro, then simply move to the EUR/JPY as this correlates extremely closely with the USD/JPY,
particularly on the hourly, daily and weekly timeframes. This is a positive correlation as you would
expect.
GBP/USD
Cable is in complete contrast to the EUR/USD. Solid steady and reliable, it ticks along like Big Ben,
rarely volatile and generally predictable, and whilst it does have periods of excitement, the reasons
are generally clear and self evident. There are no politics with the pound, and it is increasingly seen
as a safe haven and an alternative to the euro. Before the financial crisis, the GBP/USD and the
EUR/USD would generally have moved in lockstep together, with both moving higher or lower on US
dollar strength and weakness. This relationship has long since broken down, and now the two react
and move independently, with the primary driver for the EUR/USD being politics in Europe, whilst
for Cable it is the UK economy. The good old British pound keeps plodding along, and despite the
recent downgrade, confidence in the currency was only temporarily dented, before strength returned.
This is not an exciting pair to trade, but then trading success is not about excitement, it’s about making
money. The trading range typically is between 70 and 100 pips per day, and this is the currency which
tends to set the tone for the London session following the open in Europe and from the overnight in
Asia.
If you are a novice or inexperienced trader, I would urge you to consider starting with the GBP/USD.
AUD/USD
The Aussie dollar is one of those currency pairs which gets a ‘double boost’ whenever the US dollar
weakens or strengthens, given its association with commodities, and as result tends to develops
strong trends. One only has to look back over the last few years and see how the extended bull run in
commodities has been reflected in the pair. More recently, the pair has been in an extended phase of
consolidation, with the bullish trend having run out of steam as the commodity super cycle begins to
slow. China is the biggest influence on this pair. Next the interest rate differential is also playing its
part, and with an economy that is stable and well managed, providing China does not implode, then
we can expect to see interest rates rising in Australia thereby increasing the differential between the
two currencies. Hot money flows should see the pair continue higher in due course. Fundamental
news has a major influence on the pair with Chinese data leading the way, NOT US data.
As you might expect the pair correlate positively with the NZD/USD but only on the longer term
timeframes of weekly and above.
(Share) In The Currency Jungle
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