Currency Trader Magazine (08-2006) (Finance Forex Trading Review Analysis Commentary)

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AUSSIE AND KIWI DOLLARS:
Whats the play?
JAPAN HIKES,
yen says, Yikes!
TRADING WITH THE
adaptive moving average
COMMITMENT OF
Traders report
THE DOLLARS
hidden risks
August 2006
Volume 3, No. 8
Contributors . . . . . . . . . . . . . . . . . . . .6
Global Markets
Aussie/dollar shrugs off
volatile first half . . . . . . . . . . . . . . . . .8
Whats in store for the Aussie dollar
after its roller-coaster first half?
By Currency Trader Staff
New Zealand: Kiwi dollar losing
its high-yield luster . . . . . . . . . . . . .10
The other currency down under faces
a few economic challenges in
the coming months.
Big Picture . . . . . . . . . . . . . . . . . . . .12
Gauging trader commitment
Is this a good breakout or a false move?
The Commitment of Traders report can
help currency traders fill in some of the
holes left by the absence of traditional
volume data in forex.
By Barbara Rockefeller
Trading Strategies . . . . . . . . . . . . .16
The adaptive moving average
How do you improve on a moving average?
Make it responsive to volatility changes.
Advanced Strategies . . . . . . . . . . .22
The dollar and its hidden risks
A look at the dollar in light of its recent
performance vs. the yen and the euro.
By Howard L. Simons
Currency System Analysis . . . . . .28
HLR breakout
CONTENTS
2 August 2006 CURRENCY TRADER
continued on p. 4
CONTENTS
Have a question about something youve 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 months
issue of Currency Trader.
Index of advertisers
FXCM
MetaStock
Currency Trader Bookstore
InterbankFX Dynamic Trend
Forex.com
Forex Capital Investors
The Forex Trading Expo
Currency Basics . . . . . . . . . . . . .32
Trading forex the mini way
Mini forex trading is a lower-cost
alternative to full-sized futures and
spot forex.
By Darrell Jobman
International
Market Summary . . . . . . . . . . . . . . .34
Global News Briefs . . . . . . . . . . . . .36
Currency Futures . . . . . . . . . . . . . .37
News and data from the currency
futures world.
Industry News
Japan ends
zero interest-rate policy . . . . . . . . . .38
For the first time in more than 15 years,
the Bank of Japan is committed to
raising the countrys interest rates.
RefcoFX finds a new suitor . . . . . . .39
In limbo since the bankruptcy of
its parent company, RefcoFX.com
has a new owner in Gain Capital.
Global Economic Calendar . . . . . .40
Key dates for currency traders.
Events . . . . . . . . . . . . . . . . . . . . . . . .42
Conferences, seminars, and other events.
Key Concepts . . . . . . . . . . . . . . . . . .42
References and definitions.
Forex Trade Journal . . . . . . . . . . . .44
A dollar/yen trade gets a boost from
an important bit of economic news.
About the author
Edward Ponsi is the President of FXEducator LLC and is the former Chief
Trading Instructor for Forex Capital Markets (FXCM). An experienced trader
and mentor, Ed gives personal, one-on-one trading instruction to students
around the world, and has advised hedge funds, Interbank traders, and
individuals of all levels of skill and experience.
What is FOREX? Why is it the fastest growing
segment for individual investors and many
former equity and futures traders?
FREE FOREX Trading Book
MetaStock, the leading creator of technical analysis software, is excited about the FOREX
market and for good reason. Its one of the best ways for YOU to get started in investing.
To help you along, we want to give you a FREE copy of Successful FOREX Trading. Written
by the former Chief Trading Instructor for FOREX Capital Markets. This book explains
technical analysis as it relates to currency trading. This valuable information is FREE, no
strings attached. To get your copy, visit our web site, or give us a call at (800) 432-4917
and mention the promotion code CT36.
Click Here
for your FREE Book
This is neither a solicitation to buy or sell any type of fnancial instruments, nor intended as investment recommendations. All investment trading involves multiple substantial risks of mon-
etary loss. Dont trade with money you cant afford to lose. Trading is not suitable for everyone. Past performance, whether indicated by actual or hypothetical results or testimonials are no
guarantee of future performance or success. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT,
THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS OR TESTIMONIALS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR
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no responsibility for errors, inaccuracies, or omissions in these materials, nor shall it be liable for any special, indirect, incidental, or consequential damages, including without limitation
losses, lost revenue, or lost profts, that may result from the reliance upon the information materials presented.
Successful
Editor-in-chief: Mark Etzkorn
[email protected]
Managing editor: Molly Flynn
[email protected]
Contributing editor: David Bukey
[email protected]
Contributing editor: Jeff Ponczak
[email protected]
Contributing Writers:
Marc Chandler, Barbara Rockefeller
Editorial assistant and
Webmaster: Kesha Green
[email protected]
Art director: Laura Coyle
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President: Phil Dorman
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Publisher,
Ad sales East Coast and Midwest:
Bob Dorman
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Ad sales
West Coast and Southwest only:
Allison Ellis
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Classified ad sales: Mark Seger
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Volume 3, Issue 8. Currency Trader is published monthly by TechInfo, Inc.,
150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright 2006
TechInfo, Inc. All rights reserved. Information in this publication may not be
stored or reproduced in any form without written permission from the publisher.
The information in Currency Trader magazine is intended for educational pur-
poses 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.
For all subscriber services:
www.currencytradermag.com
A publication of Active Trader
CONTRIBUTORS
CONTRIBUTORS
Howard Simons is president of Rosewood Trading
Inc. and a strategist for Bianco Research. He writes and
speaks frequently on a wide range of economic and finan-
cial market issues.
Barbara Rockefeller (www.rts-forex.com) is an
international economist with a focus on foreign exchange.
She has worked as a forecaster, trader, and consultant at
Citibank and other financial institutions, and currently
publishes two daily reports on foreign exchange.
Rockefeller is the author of Technical Analysis for Dummies
(2004), 24/7 Trading Around the Clock, Around the World
(John Wiley & Sons, 2000), The Global Trader (John Wiley &
Sons, 2001), and How to Invest Internationally, published in
Japan in 1999. Abook tentatively titled How to Trade FX is
in the works.
Darrell Jobman is editor-in-chief of www.tradinge-
ducation.com, a Web site providing free information and
education to traders. He is an acknowledged authority on
the financial markets and has been writing about them for
more than 35 years.
Jos Cruset ([email protected]) is a private trad-
er, software engineer, and trading system researcher. He
has an MBA and a NASD-Series 3 certificate and has
worked many years in the banking industry.
ads0906 7/11/06 12:17 PM Page 37
A
fter massive volatility rocked
the Australian dollar/U.S. dol-
lar pair (AUD/USD) from
February through May, the cur-
rency is trading around 0.7660 at the end of
July, just slightly higher than at the beginning
of 2006.
Several factors whipped the Aussie/dol-
lar to a low at 0.7015 in late March and back
to a peak at 0.7795 in mid-May establish-
ing the current 52-week low and 52-week
high in little more than a month but indi-
cate the remainder of the year may bring
more steadiness to the currencys trade
(Figure 1).
Looking back, the Aussie/dollar entered 2006 with a
slightly bearish bias; the currency pair had been zig-zagging
lower off the March 2005 peak at 0.7986 (Figure 2). The inter-
est rate outlook was fairly steady, as the Reserve Bank of
Australia (RBA) had been on hold since March 2005. In mid-
March 2006, however, the pace of selling accelerated and the
currency plunged to 0.7015, the current low for the year.
The March sell off was caused by a massive unwinding
of Japanese yen-funded Aussie dollar long positions, and
also declining Uridashi issuance, says Prakriti Sofat, econ-
omist at Ideaglobal Ltd. It also coincided with the Japanese
fiscal year-end, a time when Japanese investors repatriate
funds home. (Uridashi is referring to debt issued to
Japanese retail investors in a foreign currency.)
The pace of Aussie and New Zealand issuance has
slowed, agrees Rhonda Staskow, regional director FX
Americas at Thomson Financial-IFR Markets. Japanese
investors have begun looking elsewhere for yield, includ-
ing the U.S., Mexico, and South Africa.
Rate hike bolsters Aussie dollar
The Aussie/dollar rebounded strongly from the 0.7015
region its lowest trade since September 2004 and
soared to 0.7795 in mid-May. Gains in commodity prices
and new expectations that the RBA would hike rates sup-
ported the currency. At its May 3 meeting, the RBAdid, in
fact, hike rates by 0.25 basis points, bringing the cash rate
target to 5.75 percent. The central bank pointed to
increased inflationary risks from domestic and interna-
tional trends when announcing the adjustment. On July 5,
however, the RBAkept monetary policy steady.
After subsequently topping out at 0.7795 on May 11, the
Aussie/dollar was hit with another round of steady sell-
ing, pressuring the currency to its late-June low of 0.7268.
Analysts pointed to the mini-emerging market crisis
(see From emerging to submerged, Active Trader,
GLOBAL MARKETS
In less than six weeks this spring, the Aussie/dollar pair swung up
and down strongly enough to establish its current 52-week high
and low levels.
FIGURE 1 RECENT AUSSIE VOLATILITY
AUSSIE DOLLAR/U.S. DOLLAR AT A GLANCE
Daily range (past 40 days): Average: 0.0065 Median 0.0063
Weekly range (past 26 weeks): Average: 0.0154 Median 0.0155
52-week high/low: 0.7792/0.7015
AUS U.S.
Prevailing interest rates (%): 6.00 5.25
Next central bank meetings: Sept. 6 Aug. 8
Sept. 20
GDP (annualized growth) Q2 2006* Q1 2006 Q4 2005
AUS U.S. AUS U.S. AUS U.S.
0.5 2.5 3.1 5.6 2.7 1.8
*Estimate All data as of July 31
The Australian dollar staged a strong rally from its nearly two-year low vs. the U.S. dollar in May and then
promptly sold off again. The economic fundamentals paint a mixed picture for the Aussie dollars future.
Aussie/dollar
shrugs off volatile first half
BY CURRENCY TRADER STAFF
Source: TradeStation
CURRENCY TRADER August 2006 9
October 2006) that plagued global markets during May and
June as a factor in the Aussie/dollar sell off. During that
time, global portfolio managers tugged assets out of emerg-
ing markets as a wave of risk aversion and expectations
of higher interest rates across the industrialized world
spread through the marketplace.
[The Australian dollar/Swiss franc] tends to be an indi-
cator of risk aversion, Staskow says.
Huge selling occurred in that cross rate in the late spring.
Traders were going long the Swiss as a safe haven and get-
ting out of high-yield carry trades [such as the Aussie dol-
lar], Staskow says.
RBA action ahead?
The next RBA meeting is scheduled for Aug. 2 and some
analysts see the potential for another interest-rate adjust-
ment.
Australia will hike rates, Staskow predicts. She points to
the strong June Australian employment data, which
revealed the overall unemployment rate is at a 30-
year low of 4.9 percent, while 52,000 new jobs were
created when an increase of only 10,000 was expect-
ed.
Also, higher petrol prices and Aussie dollar
weakness early in the year may have boosted
import inflation, she adds.
Sean Callow, senior currency strategist at
Westpac Institutional Bank, also expects a rate hike
Aug. 2 with the potential of a move to 6.25 percent
in the fourth quarter. Another meeting will follow
on Sept. 6.
Economic growth and inflation
Overall, Australias economic outlook remains
strong. Callow forecasts a 3.5 percent year-over-year
gross domestic product (GDP) reading in 2006, up
from 2.5 percent in 2005.
The pace into 2007 could accelerate to 4 percent
or higher, bolstered by commodity exports, which
could cut the trade deficit, and also from supportive
fiscal policy and a resilient housing sector, he
explains.
The inflation picture has heated up with headline CPI post-
ing a 3-percent year-over-year rise in the first quarter 2006.
Cross rates
Several analysts view the long Aussie dollar/short New
Zealand dollar as a favored play on the crosses. With the
pair currently trading around 1.2150 (Figure 3), Callow sees
potential for a move to around 1.30 by the years end.
This cross is an attractive play whenever there is a sub-
stantial divergence in the macro fundamentals of Australia
and New Zealand, he explains. During the second half,
all the momentum seems to be in Australias favor, as the
RBA tightens policy further into a strong economy, while
New Zealand struggles.
Ideaglobals Sofat agrees this trade has bullish potential
toward 1.30 by year-end amid narrowing interest-rate dif-
ferentials and terms of trade favoring the Aussie.
Looking ahead
Most analysts see relative stability for the Aussie dollar,
though some risks remain on the horizon.
A repeat of the May-June global risk aversion sell off
could impact the Aussie dollar negatively.
The Australian economy remains vulnerable to global
growth expectations and a slowdown in commodity
prices, says Kathleen Stephansen, head of global econom-
ics at Credit Suisse.
However, most expect smooth sailing between now and
the end of the year for the Aussie dollar. Callow does not
expect AUD/USD to revisit the March low at 0.7015 and
looks for the pair to end the year around 0.7400. Similarly,
Ideaglobals Sofat pegged her year-end target for the
Aussie/dollar at 0.7500 very close to the mid-July level.
Some analysts see the potential for the Aussie dollar/New Zealand dollar
(kiwi) rate to rise in the second half this year if Australia can maintain
economic momentum.
FIGURE 3 THE AUSSIE-KIWI CROSS
Source: ADVFN (www.advfn.com)
Although the March 2006 sell off was sharp, the Aussie/dollar
pair had been declining since March 2005.
FIGURE 2 LONGER-TERM DOWNTREND
T
he New Zealand dollar has taken a hit this
year, driven lower by narrowing global inter-
est-rate differentials and bearish sentiment
regarding the New Zealand economy. The
New Zealand dollar/U.S. dollar rate (NZD/USD) has
plunged from a high around 0.7000 in mid-January to a late-
June low around 0.5927 (Figure 1).
Analysts point to New Zealands huge current account
deficit, which recently hit 10.5 percent of GDP, as a drag on
the countrys economy and currency (the kiwi), and a
prominent factor driving the currency sharply lower in the
early months of 2006.
The current account deficit was clearly unsustainable
and it was only a matter of time before the kiwi suffered a
correction, says Glenn Levine, economist at Moodys
Economy.com.
This factor, along with narrowing interest-rate differen-
tials vs. Europe, Japan, and the U.S., as well as slowing
domestic growth, triggered a massive selling of kiwi dollars
during the first three months of the year.
Growth expectations have dropped dramatically
because of higher rates, notes Rhonda Staskow, regional
director FX Americas at Thomson Financial-IFR Markets.
New Zealands cash rate currently stands at 7.25 percent,
the level it has been at since December
2005. Analysts say the high short-term
rates are finally impacting the econo-
my in a negative fashion.
Yields not as attractive at
first glance
Despite boasting yields at 7.25 percent
the highest in the industrialized
world analysts say global invest-
ment flows havent been a bullish fac-
tor for the kiwi.
You only get 7.25 percent by invest-
ing very short term, because the yield
curve remains steeply inverted, says
Sean Callow, senior currency strategist at Westpac
Institutional Bank. Two-year bonds are around 6.50 per-
cent and the 10-year is around 5.85 percent not so tanta-
lizing compared to a liquid T-note.
Grim GDP forecasts
New Zealands economic picture isnt helping the dampen-
ing outlook for its currency. Economists at Westpac forecast
a 1.5-percent gross domestic product (GDP) reading for
2006 vs. 2.3 percent in 2005. Westpac expects growth to
remain weak, with 2007 figures to come in at 1.2 percent.
Economy.coms Levine also projects weak (1.4 percent)
growth for 2006.
The economy is headed for a hard landing this year, he
says. The domestic economy is in real trouble, weighted
down by elevated interest rates, record levels of household
debt, a stagnant housing market and plummeting business
and consumer confidence.
Levine doesnt think relative global economic strength
will be enough to keep the New Zealand economy afloat.
With the currency weakening and the global economy
still in pretty good shape, exports should start to pick up in
the second half of the year, but this wont be enough to pre-
vent a sharp slowing in 2006 growth, he says.
GLOBAL MARKETS continued
New Zealand:
Kiwi dollar losing its high-yield luster
As it flirts with three-year lows, economic red flags are cutting into the kiwis prospects.
NEW ZEALAND DOLLAR/U.S. DOLLAR AT A GLANCE
Daily range (past 40 days): Average: 0.0071 Median: 0.0066
Weekly range (past 26 weeks): Average: 0.0168 Median 0.0173
52-week high/low: 0.7197/0.5927
NZ U.S.
Prevailing interest rates (%) 7.25 5.25
Next central bank meetings Sept. 14 Aug. 8
Sept. 20
GDP (annualized growth) Q2 2006* Q1 2006 Q4 2005
NZ U.S. NZ U.S. NZ U.S.
2.2 2.5 2.2 5.6 2.2 1.8
*Estimate All data as of July 31
Inflation worries
The latest inflation data out of New
Zealand sparked concerns among mar-
ket watchers. Consumer prices surged
a higher-than-expected 1.5 percent for
the second quarter, which put the
annualized rate at 4 percent. This data
lends credence to the idea the Reserve
Bank of New Zealand (RBNZ) will
have to keep monetary policy steady,
despite the slowing growth prospects,
analysts say.
The second-quarter data confirmed
there is absolutely no scope for a near-
term rate cut, says Levine.
He expects the central bank to
remain on hold until the first quarter
of 2007, when he expects a drop in the
inflation rate, back within the RBNZs
target 1-3 percent band.
Callow agrees monetary policy was
likely on hold throughout 2006.
We expect they wont cut rates
until first quarter 2007, though of
course the market will price it in,
which should hurt NZD/USD, he
says.
The RBNZ most recently met on July
27 and left monetary policy
unchanged. The next meeting will be
Sept. 14.
Looking into 2007, Credit Suisse
forecasts 1.25 points of interest-rate
easing through 2007, with potential for
a 2007 year-end cash rate at 6.00 per-
cent.
Looking ahead
Analysts believe further tightening
moves from other central banks will
put downward pressure on the kiwi
dollar. Global risk appetite will be key,
as well.
A rise in risk aversion is bad news
for the illiquid kiwi, as New Zealand
tries to fund its huge current account
deficit, Callow explains. We would
like to sell NZD/USD on any rallies to
0.6300. Key support is at 0.5930.
By year-end, Callow sees a possible
retreat to 0.5700, which would be the
currency pairs lowest level since June 2003 (Figure 2).
Tim Mazanec, senior FX strategist at Investors Bank &
Trust, says 0.6300 and 0.6425 are key resistance levels, not-
ing the latter level represented resistance in April and May.
If gains push the currency through that resistance, he says,
it would open the door to 0.6685, a Fibonacci retracement
target from the 2006 high to low. However, he favors a
weaker kiwi dollar in the weeks ahead, given his bias for
higher U.S. rates. If the resistance zone holds, though,
Mazanec expects a retest of the 0.5927 low.
Although it has rebounded slightly since spiking to a new major low in late
June, the NZD/USD pair must contend with a weakening New Zealand
economy in the months to come.
FIGURE 1 STEEP HILL TO CLIMB
Having punctured the 2004 and 2005 bottoms, the kiwi dollar is flirting with
three-year lows. The most recent bottom occurred at 0.5927.
FIGURE 2 TESTING RESISTANCE?
Y
ou can be the best chart reader on the planet
and still lose money trading. Losses are gener-
ally a function of bad money management,
such as setting a profit target unreasonably
high or a stop too low.
But losses can also be a function of not having the feel
of the market. Lets define feel as a grasp of what the main
players are thinking and doing. You may think that other
traders are in buying mode, but are they? You know only if
you can see the actual buying volume.
As technical analyst and author Joe Granville and others
have noted, a real rally is accompanied by rising volume. If
prices are rising but volume is flat or falling, watch out.
New buyers fresh blood are not joining the rally, and
it may not last.
Very high volume at a market high may mean the top is
in. If volume is extremely high and price is making new
record highs, many traders have a lot at stake and any
significant price drop can
cause a stampede of cov-
ering. As in price analy-
sis, an extreme often pre-
cedes a reversal.
Finally, if volume is
building during a consol-
idating or sideways peri-
od, we expect a breakout
but we dont necessar-
ily know in which direc-
tion.
Volume changes are a
dandy supplement to
technical indicators and
fundamentals. Forex
traders are severely hand-
icapped by not having
good volume informa-
tion, as stock traders
have. In the spot market,
there is no volume infor-
mation, because every
trade is a private transac-
tion between customer
and bank. Wire service
reports tell us that vol-
ume is heavy or the
market is thin, but thats
not very specific and does
us little good.
THE BIG PICTURE
Gauging
trader commitment
Analyzing the euro with Commitment of Traders data sheds light
on the strength or weakness of price moves.
BY BARBARA ROCKEFELLER
Traders from all groups downsized their positions prior to the trading-range breakout in early
August. Commercial traders (blue), who had been net long, changed to net short by the time the
breakout occurred. The breakout rally quickly failed.
FIGURE 1 AWAITING A BREAKOUT, EURO JULY 2005
Source: chart MetaStock; data Reuters
In futures, the ex-
change doesnt publish
volume until after the
close. For real-time
analysis, all thats avail-
able is tick volume,
which is less than ideal.
You get a change in the
tick whether the new
trade was one contract
or a hundred, and while
you can check Time &
Sales to see the actual
volume, its a cumber-
some process. If you are
trading in an intraday
time frame, by the time
you see big volume
developing, its proba-
bly too late.
What traders are
really doing
Instead of looking at
raw volume, though,
you can look at the
Commitment of Traders
(COT) report and make
some educated guesses about how to trade certain situa-
tions. You wont get a price forecast, but you will get infor-
mation that is directly relevant to your trading.
Take, for example, the period in July 2005 when the euro
futures (EC) were trading sideways in a range from 1.1980
to 1.2290 (Figure 1). Every three to five days, the price
reversed. In the first week of August the euro rose above the
ranges resistance line. Breakouts must always be respected,
and a long trade executed in the next six days probably pro-
duced a profit, since the euro put in a new high at 1.2505 on
Aug. 12.
But look at the top window of the chart. This shows the
net long or short positions held by three types of traders
defined by the Commodity Futures Trading Commission
(CFTC): the commercials (blue); the large non-commer-
cials (green), otherwise known as large speculators; and
the small non-commercials (red), who are mostly small
speculators (i.e., retail traders).
The green non-commercials are net short 24,842 contracts
the first week of July, while the red small speculators are net
short 2,522 contracts. Offsetting the two short groups are
the blue commercials, who are net long 27,394 contracts.
Now look at the next week. Everyone has downsized
their positions, and they continue to do so until the first
week of August, when the total number of contracts is only
2008, or 10 percent of the level the month before.
Yes, breakouts must be respected, but in this case we see
they cant always be trusted. If the green speculators really
thought the euro rally was going to continue, they would
have bought more contracts. They did go from net short to
net long, but only for one week as price was peaking, and
then they went short again. Accordingly, the feel of the
market is not really all that bullish. In fact, nobody seems to
have much sentiment at all. Also, liquidity is low, meaning
if you make an off-market bid or offer, it will probably just
sit there and not get filled, whereas in a highly liquid mar-
ket, there is always somebody who will shoot at anything
that moves.
Market activity
Futures volume is a little tricky. Because every buyer has a
counterpart on the short side, the two together constitute a
single contract. Total contract volume in the example above
is 27,394. Volume is not the same thing as liquidity, which is
better measured by open interest.
Open interest is the total number of contracts still out-
standing i.e., open positions that have not yet been offset.
If a new buyer is creating a fresh long position and buys a
contract, and the seller is also opening a fresh short posi-
tion, open interest increases by one contract. However, if the
buyer is just replacing a different long party who is selling,
no new long position is being created; rather a change of
ownership of an existing position is occurring. Open inter-
continued on p. 14
Open interest was flat throughout the entire period. The new high on Aug. 12 is suspect because
a big upside move that is not accompanied by higher volume and an increase in open interest
lacks real support.
FIGURE 2 JUDGING THE BREAKOUT
THE BIG PICTUREcontinued
est is still one because the number of open contracts
remains the same.
Now look at Figure 2, which contains the same informa-
tion as Figure 1, plus open interest in the center window.
Open interest was flat through the entire period, at levels
around 150,000. The new high on Aug. 12 is fishy, as it is not
confirmed by a rise in open interest. Abig upside move that
is not accompanied by higher volume and an increase in
open interest lacks real support; a significant amount of
new money is not flowing into the market.
As a rule, when volume and open interest are rising, a
price move will probably continue in the same direction.
When they are flat or declining, the trend is probably going
to end.
Understanding the COT report
The COT report is issued late every Friday afternoon by the
CFTC for trading during the week ending the previous
Tuesday. That means the data is stale by three business
days, but dont let that bother you you can still get pow-
erful information from it.
You can bet that a lot of others are studying it over the
weekend, too. Interest in the COT report has risen since the
publication last fall of Larry Williams book, Trade Stocks &
Commodities with the Insiders: Secrets of the COT Report
(Wiley, 2005) and
stepped-up reporting by
the financial press.
The COT report breaks
down open interest by
the categories of com-
mercial and non-com-
mercial, with commer-
cials defined as market
participants having an
underlying cash business
for which their futures
positions provide a
hedge. In other words, if
Company X sells Blue
Widgets to Germany, it
expects to be long euros
by the amount of quarter-
ly sales, and will take a
short position to offset or
hedge the upcoming
receipt of euros. Firms
registered as commer-
cials get somewhat better
margin rates because
they tend to be less active
traders and thus take less
risk.
Non-commercials are mostly large speculators such as com-
modity funds and pools, and sometimes banks and brokers.
The balance of open interest is derived and assumed to
consist of both small speculators and small commercial
hedgers, which do not have to register with the CFTC.
One of the reasons the COT report is neglected by many
traders is that its hard to read and to use. Take a look at
www.cftc.gov/cftc/cftccotreports.htm. The CFTC has
improved the reports formatting (and speeded up its
release to every week and for data covering the most recent
week), but the information is still presented in a raw format.
Youd at least have to download it to a spreadsheet to con-
duct any analysis.
Fortunately, an outfit named Shatterfield (www.shatter-
field.com) makes it easy to capture the data and analyze it
in graphic form. For a small fee, you can get their down-
loader and display charts like the ones shown here (in
MetaStock), or in Excel, TradeStation, and other charting
packages. Anumber of other services are also available, but
Shatterfields program contains a special proprietary
strength indicator that shows the long/short percentage of
each trader category. Figure 3 shows the most recent COT
data in July this year.
The highlighted middle window shows the strength indi-
cator, which is scaled in percentage points. The number rep-
The highlighted middle window shows the percentage of traders in each category that are long.
Eighty percent of large specs were long euro futures as of the latest available reading in July,
while 78 percent (100 minus the 22-percent long position shown here) of commercials were short.
FIGURE 3 EVALUATING STRENGTH
resents the percentage of traders in each category that are
long. Eighty percent of large speculators are long euros,
while 78 percent (100 minus 22 percent) of blue commer-
cials account for the offsetting shorts. The high large-spec
position denotes a real commitment to the trend, while the
high participation rate by the blue commercials indicates a
similar commitment.
Now check out open interest in the window below that.
During the second week of June, the large specs reduced
their outstanding contracts, meaning they cashed in net
long positions. A week later the small specs cashed in, and
a week after that, the blue commercials. Because the June
contract had already rolled to the September contract by the
time the commercials reduced their holdings, its likely
some of this is profit-taking. Notice that the week before,
price fell quite a bit from 1.2992 to 1.2534 before rising
again somewhat. Commercials are supposed to be hedgers
and immune to the lure of profit-taking, so this may not be
the correct interpretation.
The real point is that total open interest fell and the
strength indicator contracted a little in each trader category,
but total net positions (top window) remained at near-record
high levels 76,569 contracts the week of June 20 after the
all-time high of 88,196 the week before. (The record high
number of contracts that week made all the press reports.)
Uh-oh, here we go again a very high volume figure
that is not accompanied by higher price highs, with open
interest falling and the percentage of participants in each
category on the consensus side of the trade being
reduced. This is extreme volume not being confirmed and
validated by higher prices, and with commercials removing
about half their previous level of interest, as shown in the
open-interest drop from 217,570 contracts the
week of June 20 to 112,183 the next week.
Commercial interest rose a little in each of the fol-
lowing weeks, but they basically cleared out of
the market.
As in July last year, we cant really expect a
higher high unless the commercials come back.
What can we deduce from this about price direc-
tion? First, there are a lot of speculators who are
long euros in a falling market. At some point, they
may hit stops or otherwise decide to bail out. The
euro is thus at risk of a technical correction,
only this time its market-action technical and not
the charting kind. Or, the commercials could
come back, providing the engine for additional
opposing trades by the specs assuming the
commercials do not switch sides.
The commercials do switch sides from time to
time, which offers a tremendous opportunity for
small traders. The commercials are not always
right in terms of making profit from their long or
short positions, but they should always be watched for their
behavior.
For information on the author see p. 6. You can get a free 2-week
free trial of Barbara Rockefeller's daily forex commentary at
www.rts-forex.com.
Volume: The ultimate guide to sentiment,
by Barbara Rockefeller
(Currency Trader, January 2006).
A previous discussion on interpreting volume and using
the COT report in forex.
Larry Williams looks inside futures
(Active Trader, January 2006).
Larry Williams discusses his book on the COT report
and his techniques for using COT data in futures and
stocks.
Floyd Upperman: Digging into COT data
(Active Trader, February 2006).
A commodity trading advisor shares his insights on
interpreting the COT report and the methods he out-
lines in his book on the subject.
Barbara Rockefeller Big Picture Collection,
Vol. 1: 2004-2005.
This 11-article collection contains forex market analysis
and commentary Barbara Rockefeller wrote for
Currency Trader between October 2004 and December
2005. (This article set is available at a 30-percent dis-
count.)
You can purchase and download past articles at
www.activetradermag.com/purchase_articles.htm.
Related reading
TRADING STRATEGIES
The adaptive
moving average
Making a moving average responsive to volatility changes results
in a dynamic, more accurate indicator.
M
oving averages
smooth price data,
simplifying the up
and downs of a mar-
ket into a more understandable line that
highlights the trend. However, the
smoothing process introduces lag: The
longer a moving averages look-back
period, the more the average trails
behind changes in price direction. On
the other hand, moving averages with
short look-back periods respond more
quickly to price changes but, because
they reverse direction on minor price
moves, they can lead to whipsaw losses.
A moving average length that was
appropriate last week might be inap-
propriate next week as market condi-
tions change. One potential solution to
this problem is to use a moving aver-
age that adjusts to market volatility by
lengthening when the market is mov-
ing sideways and trading in a choppy
fashion (making it less responsive) and
shortening when the market is trend-
ing (making it more responsive).
In his book Smarter Trading (McGraw-Hill, 1995), Perry
Kaufman detailed a method for calculating an adaptive
moving average that fit this role. To see how it works, the
following examples compare it to a simple moving average
(SMA). First, two SMAs with different look-back periods
will be compared to highlight the attributes of each. In this
case, price crossing the moving average is not important;
rather, it is the direction of the moving average that identi-
fies the trend.
Starting out simple
Figure 1 is a 45-minute bar chart of the euro/U.S. dollar pair
(EUR/USD) with a five-bar SMA (red) and 30-bar SMA
(blue).
The five-bar SMA (red) and 30-bar SMA (blue) turned up at point A. At the
peak (point B), the five-bar SMA turned down while the 30-bar SMA kept rising.
However, the five-bar SMA turned down two times before the peak.
FIGURE 1 ADAPTIVE MOVING AVERAGE
Source: CQGNet (www.cqg.com)
Both moving averages turned up quickly in reaction to
the dramatic rise at point A. The market advanced to point
B and then turned down. Notice the longer 30-bar moving
average continued to rise during the uptrend, but did not
turn down following the peak point B. At the end of the
chart the 30-bar SMAwas still indicating the trend was up.
By contrast, the five-bar SMAturned down almost immedi-
ately after the peak at point B however, it also turned
down twice before the actual peak in the market, which the
30-bar average did not.
Figure 2 shows the same prices with an adaptive moving
average (AMA) added. The AMA adapts to market volatil-
ity and trend by switching to a shorter-term look-back peri-
od when the market is trending up or down and changing
to a longer-term look-back period when the market begins
to move sideways.
At point A, the AMAjoined the five-bar SMAduring the
initial advance. Then when the market
corrected to point B, the five-bar SMA
turned down while the AMA stayed
nearly flat and the 30-bar SMAcontin-
ued to rise.
When the market began to advance
again, all the moving averages
climbed. At point C, the market pulled
back and consolidated and the five-bar
SMA turned down; the AMA and the
30-bar SMA, however, kept rising.
When the market peaked at point D,
the five-bar SMA turned down, the
AMA went flat, and the 30-bar SMA
kept rising. At point E the market was
trending lower. The AMA joined the
five-bar SMAto the downside, but the
30-bar SMA was still reflecting an
uptrend.
Figure 2 illustrates how the AMA
responded as the market changed
from trend to consolidation and back.
Overall the AMA showed a tendency
to stay with the trend better than
either the five-bar SMAand the 30-bar
SMA.
Lets look at how the AMA is con-
structed.
From exponential
Kaufman designed the AMAto track the degree of noise in
the trend. For example, if a market is advancing with very
small countertrend moves, there is very little noise and you
would want the moving average to closely track the trend,
which would require a moving average with a short look-
back period.
However, if the market is moving sideways and the clos-
es are tending to simply reverse from one period to the
next, the degree of noise is high and you would want a
moving average with a longer look-back period to filter out
this noise and avoid false signals. Kaufmans technique was
to modify the exponential moving average (EMA) with an
algorithm that would adjust the averages smoothing con-
stant (SC) according to the ratio of market direction to
volatility.
The formula for the EMAis:
EMA = SC * (close-EMA
(-1)
) + EMA
(-1)
where:
SC = smoothing constant
close = close of the bar
EMA
(-1)
= previous bars EMAreading
The smoothing constant is a value between 0 and 1 that
determines the length of the EMA. (Typically, to begin
calculating an EMA, you use the SMA value for the initial
reading.) To convert an SMAlook-back period into an EMA
smoothing constant, the following formula can be used:
SC = 2/(n+1)
Where n is the look-back period in an SMA.
continued on p. 18
The green line is an adaptive moving average (AMA). During the uptrend that
started at A, the AMA advanced like the two SMAs but it did not turn down at
points B and C the way the five-bar SMA (red) did. Also, the AMA turned down
at point E, although the 30-day SMA (blue) did not.
FIGURE 2 ADAPTIVE MOVING AVERAGE
TRADING STRATEGIEScontinued
For example, a 10-period SMA
equates to an EMA with a smoothing
constant of 0.1818 (SC = 2/[10+1]).
One difference between the EMA
and the SMAis the EMAcalculation is
the difference between the close and
the EMA. Therefore, if the close is
above the EMA, even for the first time,
the difference is positive and the EMA
will turn up. Similarly, if the close is
below the EMA, even for the first time,
the difference is negative and the EMA
will turn down.
An SMA does not necessarily
change direction because of this rela-
tionship, because the close is just one
of many used in the average calcula-
tion. For a 10-period SMA, for exam-
ple, the current close is only one-tenth
of the 10 closes used to calculate the
indicator. As a result, the SMAis not as
responsive to quick price changes. The
EMAis better suited to deal with these
attributes of the market.
to adaptive
The AMA builds on the EMA by making it responsive to
trend and volatility. The formula is:
AMA= C * (close
t
-AMA
(t-1)
) + AMA
(t-1)
The difference between the AMA and EMA calculations
is the adaptive aspect of the smoothing constant, which is
designated in the formula by the letter C. There are a few
steps involved to arriving at C. The first is calculating the
efficiency ratio (ER), which is the ratio of price direction to
price volatility.
1. Direction = close
t
- close
t-n
where:
close
t
= current close
close
t-n
= close n bars ago.
2. Volatility = sum (absolute value (close
t
close
(t-1)
),n)
(This formula sums the absolute values of the one-bar
close-to-close differences over n bars. Kaufman suggest-
ed n equal 10.)
For example, if a currency closed up 10 bars in a row, the
ER would equal 1 because the direction and the volatility
would be equal. If the market moved up and down to close
unchanged after 10 bars, the ER would equal zero.
Therefore, the more the market is trending, the higher the
ER, and the more the market moves sideways, the smaller
the ER value.
The ratio is used as a scaling constant based on the degree
of trend between 0 and 1, but not trend in reference to up or
down. Because direction could be a negative number, we
will take the absolute value of direction/volatility to not
have the ratio scale between -1 and 1.
The next step is to establish boundaries for the length of
the AMA i.e., the shortest (fast) and longest (slow) look-
back periods it will reflect (since, technically, these could be
unlimited). The following formula is used to create a range
for the averages smoothing constant (SSC):
SSC = ER * (Fast
SC
Slow
SC
) + Slow
SC
where:
ER = efficiency ratio
Fast
SC
= fast EMAsmoothing constant
Slow
SC
= slow EMAsmoothing constant
Recall the EMA smoothing constant uses the formula
2/(n+1) to approximate the number of bars in an n-bar
SMA. Kaufman suggested the AMA range from a two-bar
look-back period (fast) to a 30-bar look-back period (slow).
In this case, the resulting smoothing constants would be:
Fast = 2/(2 + 1) = 0.6667
Slow = 2/(30 + 1) = 0.0645
During the decline to point C the AMA (green) closely followed the markets
swings, but not as jaggedly as the five-day SMA. The AMA went flat during
sideways periods.
FIGURE 3 RESPONSIVE, BUT NOT TOO RESPONSIVE
continued on p. 20
TRADING STRATEGIEScontinued
Therefore, SSC = ER * (0.6667 - 0.0645) + 0.0645.
If the market is trending, then the ER will be near 1 and
the SSC will be weighted toward the fast smoothing con-
stant. If the market is moving sideways, then the ER will be
near 0 and the SSC will be weighted toward the slow
smoothing constant.
Finally, Kaufman noted if the market was trading side-
ways, which would push the AMA to behave like a 30-day
EMA, the AMAwould still edge up and down. Squaring the
smoothing constant reduces this effect. Therefore:
C = SSC
2
and finally,
AMA= C * (close
t
-AMA
(t-1)
) + AMA
(t-1)
Now that the math is finished, lets look at more exam-
ples using the AMAin the Euro/U.S. dollar pair.
Figure 3 continues the price action from Figure 2. The
market trended down to point Aand then rallied to point B.
The 30-bar SMA continued to rise and did not turn down
until well after the second, lower peak at B. The market then
stair-stepped its way down to point C. The 30-bar SMA
trended lower during this period while the five-bar SMA
zig-zagged up and down with each price swing. The AMA
followed the markets shorter-term swings as price moved
gradually lower, and it also went flat during sideways price
action (which the five-day SMA did
not do). Overall, the AMAwas a better
smoothed representation of the mar-
ket.
Figure 4 jumps ahead in time. The
market rallied dramatically, and again
the AMA moved horizontally when
EUR/USD moved sideways around
point A. The five-bar SMA began to
turn slightly lower.
Flexibility and responsiveness
The adaptive moving averages
strength is its ability to respond to
changing market conditions, which is
a problem for studies that use fixed
look-back periods.
Using a fixed look-back period is
like trying to fit the market to a tem-
plate. Because the market is always
changing, static approaches are likely
to have limited success. Using adap-
tive studies is a potential way to
improve results. Also, the AMA might
be appropriate for smoothing other
indicators.
The AMA tracked the trend upward, but went flat at point A when the market
moved sideways. It turned up again quickly when the uptrend resumed.
FIGURE 4 TRACKING THE TREND
Related reading
Weighted and exponential moving averages
Currency Trader, January 2005.
A detailed introduction to weighted and exponential
moving averages that includes performance compar-
isons to the simple moving average.
Measuring trend momentum by Tushar Chande
Active Trader, June 2001.
Most technical analysis indicators monitor either price
direction or price momentum. Here's an indicator that
does both, changing its behavior with the dynamics of
the market.
Thom Hartle Trading Strategy and Analysis
collection, Vol. 1: 2001-2004
In this collection of 15 Active Trader articles from 2001
to 2004, trader, analyst, and contributing editor Thom
Hartle tackles various aspects of strategy, analysis, and
trade execution. (This collection is available for a 30-
percent discount through the Active Trader store.)
Introducing
a NEW product of
Dynamic Trend Profle
makes me feel like a genius.*
L
ets say you are a hunter confronted with a
charging rhinoceros. You take careful aim,
squeeze the trigger of your suitably heavy gun,
and hit the rhino square in the forehead. He
keeps coming.
Who has the problem now?
Currency traders face a similar if less dramatic dilemma
on occasion. The fundamentals, or in this discussion the
quantitative indicators, behind a given market may look to
favor a given currency, but the market
starts moving in the other direction.
Such was the case for the U.S. dollar
(USD) vis--vis both the euro (EUR)
and the Japanese yen (JPY) by the late
spring of 2006. Both currencies were
strengthening against the USD and for
non-parallel reasons based on the three
separate quantitative indicators below.
Short-term interest rate
expectations
The standard three-month non-deliv-
erable forward can be described in
large part as a short-term interest rate
arbitrage. The buyer of the JPY is bor-
rowing the USD, selling the USD, and
buying the JPY at the spot rate and
then lending the JPY. In three months,
the trade can be unwound or rolled
over for another three months. The
rollover rates can be locked in using
forward rate agreements; this is why
the forward rate ratio (FRR) for various currencies LIBOR
over the six-nine month horizon is such a useful tool. This
FRR is the rate at which borrowing costs can be locked in
for three months starting six months from now, divided by
the nine-month rate itself. The more the number exceeds
1.00, the steeper the yield curve; numbers less than 1.00
indicate inversion.
The USD FRR
6,9
fell sharply in the two years of Federal
Reserve tightening beginning in mid-2004 (Figure 1). By
ADVANCED STRATEGIES
The dollar
and its hidden risks
What are historical market relationships telling us about the dollars prospects?
BY HOWARD L. SIMONS
The USD six-month/nine-month FRR dropped sharply in the two years of Fed
rate tightening beginning in mid-2004. However, the 6/9 FRRs for both the
EUR and JPY steepened beginning in June and November 2005, respectively.
FIGURE 1 SIXNINE MONTH LIBOR FORWARD RATE RATIOS
contrast, the FRR
6,9
for both the EUR
and JPY steepened beginning in June
and November 2005, respectively. All
else held equally, we should think the
flatter USD money market curve
would support the greenback in 2006
as it did in 2005. But all else is never
held equal.
Linking comparative curves
to currencies
Now lets restate the information in
these FRR curves into differences and
see whether the courses of the two
currencies can be related to them.
If we map the difference between the
USD and USD FRR
6,9
against the
course of the EUR itself, we see two
patterns emerge (Figure 2). First, there
is a defined leading relationship. The
FRR spread leads the EUR by 31 weeks.
We should expect FRR changes made
today to be reflected in the exchange
rate seven months from now. Second,
the spread is as negative as it ever has
been; never before in the history of the
EUR has its FRR
6,9
been as steep rela-
tive to the USDs. The only other peri-
od of prolonged negativity occurred
between mid-1999 and the end of 2000,
a time of EUR weakness. Finally, the
trend which began in 2004 actually
accelerated after Ben Bernanke was
appointed to be chairman of the
Federal Reserve in October 2005; this
defies the popular belief Bernanke is an
easy-money inflationist.
What happens if we repeat the
exercise with the JPY? As was the
case with the EUR, the steepness of
the JPY relative to the dollar is near its
highest level since the advent of the
EUR (Figure 3). And as was the case
with the EUR, the FRR spread leads
movements in the currency, in this
continued on p. 24
As was the case with the EUR in Figure 2, the FRR spread leads movements
in the JPY, in this case by 19 weeks. Also, the steepness of the JPY relative to
the dollar is near its highest level since the advent of the EUR. The rectangle
shows a previous period when divergent FRRs preceded a significant sell off in
the JPY.
FIGURE 3 SHORT-TERM RATE EXPECTATIONS SHOULD FAVOR DOLLAR
Two characteristics emerge when comparing the difference between the USD
and EUR six-month/nine-month FRRs to the EUR: The FRR spread leads the
EUR by 31 weeks and the spread is currently as negative as it ever has been.
FIGURE 2 SHORT-TERM RATE EXPECTATIONS FAVOR DOLLAR
ADVANCED STRATEGIEScontinued
case by 19 weeks. Past performance
does not predict future results, but
note how a previous period of diver-
gent FRRs in 2000 (Figure 3, magenta
rectangle) preceded a significant sell-
off in the JPY. The assumption then
was the Federal Reserve would begin
cutting interest rates aggressively in
the aftermath of the burst stock mar-
ket bubble and this would stimulate
economic growth in the U.S. vis--vis
Japan. The ability of the JPY to rally in
such an environment suggests the cur-
rency market is making the opposite
bet today that the long string of rate
hikes in the U.S. will slow the pace of
U.S. growth while Japan continues to
prosper in the general Asian econom-
ic boom.
Volatility
If exchange rates were nothing more
than short-term interest rate arbitrage,
we would have to conclude the USD
should be much stronger than it is. Is
this conclusion supported by the
options market? The implied volatili-
ty of a currency forward represents the
markets assessment of future uncer-
tainty and the willingness to pay
insurance against this uncertainty.
The three-month volatility of USD
forwards for a EUR-domiciled buyer
generally falls as the EUR strengthens
(Figure 4). The average lead time is 13
weeks, or one quarter. The most recent
data shows volatility rising as the EUR
rallies, which indicates those going
long the EUR are also buying USD
option protection. This is a market
uncomfortable with its own trend.
The JPY exhibits a different relation-
ship. The three-month volatility for a
JPY forward for a USD-domiciled
buyer falls as the JPY strengthens
(Figure 5). The average lead time here
is 23 weeks, or nearly six months. The
most recent data shows volatility ris-
In contrast to Figure 4, the three-month volatility for a JPY forward for a USD-
domiciled buyer falls as the JPY strengthens. The average lead time here is 23
weeks. The most recent data shows volatility rising, which indicates an
increased demand for protection by USD holders against a stronger JPY.
FIGURE 5 HIGHER PRICE OF INSURING AGAINST JPY APPRECIATION
The three-month volatility of USD forwards for a EUR-domiciled buyer general-
ly falls as the EUR strengthens (the average lead time is 13 weeks). The most
recent data shows volatility rising as the EUR rallies.
FIGURE 4 DECLINING ACCEPTANCE OF A STRONGER EURO
ing, which indicates an increased
demand for protection by USD hold-
ers against a stronger JPY. Unlike the
case of the EUR, the JPY market
appears quite comfortable with the
notion of a stronger JPY.
Stock market indications
While we do not normally think of
equity markets containing informa-
tion on relative currency movements,
they in fact are quite useful in this
regard. Stock prices discount informa-
tion on future returns, and in a global
market those future returns reflect the
currency-adjusted competitiveness of
the country in question. In addition,
global stock investors have to convert
their funds into the local currency to
participate in the local stock market.
Both of these factors combine to inject
a vital element of expected returns on
capital into the currency equation.
The relative performance of the U.S.
stock market as measured by the
Russell 3000 index to the Morgan
Stanley Capital International Euro
index led movements in the EUR by
an average of 22 weeks, or five
months, until the end of 2005 (Figure
6). We can summarize the observed
counterintuitive relationship by say-
ing capital appeared to flow to the
stock market with the weakest
prospective currency as if both sides
of the Atlantic were somehow able to
devalue themselves to prosperity. The
situation reversed significantly in
2006. The EUR strengthened even as
the European equity markets outper-
formed the U.S. Did something simi-
lar occur in Japan?
Not at all; in fact, the lead-lag rela-
tionship reverses here. Relative stock
market performance between the
Russell 3000 and the Nikkei 225 lead
movement in the JPY by 20 weeks
continued on p. 26
Relative stock market performance between the Russell 3000 and the Nikkei
225 lead movement in the JPY by 20 weeks i.e., the currency leads the
relative stock market performance when it comes to the JPY.
FIGURE 7 THE YEN LEADS RELATIVE STOCK MARKET PERFORMANCE
The relative performance of the U.S. stock market led movements in the EUR
by an average of 22 weeks, or five months, until the end of 2005. In 2006, the
EUR strengthened even as the European equity markets outperformed the U.S.
FIGURE 6 RELATIVE STOCK PERFORMANCE AND THE EURO
(Figure 7). In other words, the currency leads the relative
stock market performance when it comes to the JPY. A
stronger JPY often is the sign of Japanese investors and
firms repatriating JPY for whatever reason and parking
these funds in the Japanese stock market.
Risk as the missing variable
Much has been made of the ability of certain physical com-
modity markets, gold and crude oil among them, to rise
under the weight of investor funds regardless of funda-
mentals. In the case of crude oil in particular, futures mar-
kets cannot be regarded as inventory scorecards as much as
the fully insured forward costs of a replacement barrel. Its
as if the market is daring you to go short in the face of sup-
ply risk.
We now see this operating in the currency market.
Despite the messages sent from these key quantitative indi-
cators and others reflecting sounder fundamentals for the
USD, the market is convinced the U.S. will undertake a
repudiation of its substantial international debts by debas-
ing the USD. After all, this was the official policy of the U.S.
in 1985-1986 and again in 1993-1995. With the U.S. twin
deficits claiming an ever-larger share of world savings, the
risk of debasement is huge.
But there is no need to simply dwell on the oft-stated
negatives for the USD. In the case of the JPY in particular, it
would be simplistic to state the USD is going to weaken
against the JPY. Afar better description is the currency and
equity markets together agree Japans relative growth
prospects are stronger than those for the U.S. at this point
in the cycle. This will increase both Japanese interest rates
and demand for yen-denominated assets. While the net
effect is going to be the same a stronger JPY we should
not regard it ipso facto as a repudiation of the dollar.
And, of course, the vagaries of the European political
economy should give pause to those who might like to see
the EUR emerge as a reserve currency. The last two years
have seen the rejection of the EU constitution and a widen-
ing of French and Italian sovereign debt spreads vis--vis
Germany.
The conclusion we reach is there are no single rules for
the currency world. Each situation, each market environ-
ment is different in critical aspects, and what worked well
last year can fail spectacularly today. There is a name for
watching the market and making decisions: Speculation,
derived from the Latin word to watch. It is an honorable
endeavor, one we should all recommend to others in an
uncertain world.
For information on the author see p. 6.

ADVANCED STRATEGIEScontinued
Of commodities and currencies
Currency Trader, July 2006.
Analyzing historic market relationships reveals some
interesting facts about movements in many so-called
commodity currencies.
The yen carry trade, currencies, and U.S. bonds
Currency Trader, June 2006.
The latest source of anxiety for bond traders has some
surprising connections to the currency market. Find out
the story behind U.S. Treasuries, the Japanese yen, and
the Chinese yuan.
The euro index: The dollar index meets its match
Currency Trader, May 2006.
A look at the development of a viable and tradable
euro index.
The index approach to currency risk management
Currency Trader, April 2006.
Using dollar index futures to hedge non-dollar
investments.
The yen stands alone
Currency Trader, March 2006.
The usual rules of the currency world havent necessarily
applied to the Japanese yen. Will that continue to be
the case?
Remember the forgotten currency
Currency Trader, February 2006.
Its often labeled a commodity currency, but the
Canadian dollar tends to be ruled by other factors.
Heres a look at the factors impacting Canadian
dollar movements.
What drives the dollar index?
Currency Trader, January 2006.
Market watchers often point to deficits and interest-
rate differentials to explain the dollars behavior, but
analysis shows these factors might not be in the
drivers seat after all.
The dollar index and firm exchange rates
Currency Trader, December 2005.
The majority of currency traders are familiar only with the
current floating-rate system. Are we about to enter a
new firm exchange rate era dominated by the dollar
and euro?
Related reading
Other Howard Simons articles:
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Market: Currencies.
System concept: Typical channel breakout systems go
long when price hits an x-day high and go short when price
hits an x-day new low in hopes the trend will continue.
However, such approaches usually detect trends quite late
and thus give up a large part of
their profits.
The following system tries to
address this problem by enter-
ing positions a bit before price
actually penetrates a breakout
level. The tool used to do this is
the HighestLowestRange (HLR)
indicator, which shows prices
relative location within the
high-low range of the past x
bars. If price is at the bottom of
the range (a new low), the indi-
cators value is 0; if price is at
the top of this range (a new
high), its value is 1 (or, 100 per-
cent); if price is exactly between
these boundaries, the HLR indi-
cator value is 0.5 (50 percent).
This system enters long when
the HLR indicator moves above
0.8 and reverses position when
the HLR indicator drops below
0.2. In other words, if price
reaches the upper or lower 20
percent of the current chan-
nel, it takes action. The test
will apply these parameters
to an HLR based on a 40-day
breakout system.
Figure 1 shows two trades
in the British pound (BP).
The lower window shows
price, along with the 40-day
high and 40-day low break-
out levels. The upper win-
dow shows the HLR indica-
tor with its two threshold
lines in red. On Feb. 7, the
system went short when the
HLR indicator dropped
below 0.2. The next day
price crossed the lower
boundary of the Donchian
channel. The system stayed
in this trade until July 19,
when the HLR indicator
climbed above 0.8. The sys-
CURRENCY SYSTEM ANALYSIS
The system caught a downtrend in the British pound and reversed direction much earlier
than a system based on a standard 40-day breakout channel.
FIGURE 1 SAMPLE TRADES
Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)
HLR breakout
Equity increased consistently during almost the entire 15-year test period, but system
performance was volatile toward the end.
FIGURE 2 EQUITY CURVE
tem made 3.4 points on this trade. Using the standard
breakout levels, the profit would have been only 2 points.
Rules:
1. Go long the next day at the market when the HLR indi-
cator rises above 0.8.
2. Exit long and go short the next day at the market when
the HLR indicator drops below 0.2.
Test data: The system was tested on the following cur-
rency futures portfolio: British pound (BP), euro (EC),
Japanese yen (JY), and Swiss franc (SF). Data source:
Pinnacle Data Corp. (www.pinnacledata.com).
LEGEND: Starting capital Equity at the beginning of the
simulation period Ending capital Equity at the end of the
simulation period Net profit Profit at end of test period,
less commission Net profit % Profit at end of test period in
percent of starting equity Annualized gain %
Compounded annual growth rate Exposure The area of the
equity curve exposed to long or short positions, as opposed to
cash Number of trades The total number of round-trip
trades plus open positions Avg profit/loss $ The average
profit/loss per trade in dollars Avg profit/loss % The aver-
age percentage profit/loss per trade Avg bars held The
average number of bars held per trade Winning trades The
total number of winning trades Winning % The percentage
of winning trades Gross profit The total profit generated
by the winning trades, minus commissions and slippage Avg
profit $ The average profit per winning trade Avg profit %
The average percentage profit per winning trade Avg bars
held The average number of bars held per winning trade
Max consecutive The maximum number of consecutive win-
ners Losing trades The total number of losing trades
Losing % The percentage of losing trades Gross loss
The total loss generated by the losing trades, minus commissions
and slippage Avg loss $ The average loss per losing trade
Avg loss % The average percentage loss per losing trade
Avg bars held The average number of bars held per losing
trade Max consecutive The maximum number of consecu-
tive losers Max drawdown $ Largest decline in equity in
dollars Max drawdown % Largest percentage decline in
equity Max drawdown date Date on which the max draw-
down was realized Wealth-Lab score An overall measure
of profitability, exposure (efficiency), and risk Profit factor
Gross profit divided by gross loss Recovery factor Net
profit divided by max. drawdown Payoff ratio Average
profit of winning trades divided by average loss of losing trades
Sharpe ratio Annualized average return divided by the
annualized standard deviation of returns Ulcer index A
measure of the portfolios overall volatility Wealth-Lab error
term The average of the absolute values of all percentage dis-
tances along the equity curve from its linear regression line
Wealth-Lab reward ratio Annual percentage return divided
by the Wealth-Lab error term Luck coefficient The per-
centage profit of the largest winning trade divided by the average
percentage profit of all winning trades Pessimistic rate of
return Astatistical adjustment of the wins to losses ratio that
estimates the worst-expected return from previous results
Equity drop ratio The standard deviation of all drops in the
equity curve measured from each equity low to the previous
equity high divided into the annualized return.
Currency System Analysis strategies are tested on a
portfolio basis (unless otherwise noted) using Wealth-
Lab Inc.s testing platform. If you have a system youd
like to see tested, please send the trading and money-
management rules to
[email protected].
Disclaimer: Currency System Analysis is intended for
educational purposes only to provide a perspective
on different market concepts. It is not meant to rec-
ommend or promote any trading system or
approach. Traders are advised to do their own
research and testing to determine the validity of a
trading idea. Past performance does not guarantee
future results; historical testing may not reflect a sys-
tems behavior in real-time trading.
continued on p. 30
Long + Short Long Only Short Only
Starting capital ($) 1,000,000 1,000,000 1,000,000
Ending capital ($) 4,207,435.90 3,191,707.35 2,015,728.55
Net profit ($) 3,207,435.90 2,191,707.35 1,015,728.55
Net profit (%) 320.74 219.17 101.57
Annualized gain (%) 10.05 8.04 4.78
Exposure (%) 5.74 3.97 4.77
Number of trades 228 112 116
Avg. profit/loss ($) 14,067.70 19,568.82 8,756.28
Avg. profit/loss (%) 0.91 0.87 0.94
Avg. bars held 57.16 53.96 60.25
Winning trades 88 46 42
Winning (%) 38.60 41.07 36.21
Gross profit ($) 11,983,416.66 6,554,129.96 5,429,286.70
Avg. profit ($) 136,175.19 142,481.09 129,286.73
Avg. profit (%) 5.87 5.44 6.33
Avg. bars held 96.28 86.41 107.10
Max consecutive 7 6 7
Losing trades 140 66 74
Losing (%) 61.40 58.93 63.79
Gross loss ($) -8,775,980.76 -4,362,422.61 -4,413,558.15
Avg. loss ($) -62,685.58 -66,097.31 -59,642.68
Avg. loss (%) -2.21 -2.31 -2.11
Avg. bars held 32.57 31.35 33.66
Max consecutive 13 11 18
Max drawdown ($) -1,727,305.00 -1,462,334.25 -2,901,756.50
Max drawdown (%) -31.82 -55.37 -75.09
Max drawdown date 9/21/2004 3/28/2002 12/30/2005
Wealth-Lab score 119.42 90.40 25.00
Profit factor 1.37 1.50 1.23
Recovery factor 1.86 1.50 0.35
Payoff ratio 2.66 2.36 2.99
Sharpe ratio 0.63 0.43 0.32
Ulcer index 12.38 20.34 27.75
Wealth-Lab error term 7.27 13.01 16.66
Wealth-Lab reward ratio 1.38 0.62 0.29
Luck coefficient 3.50 2.97 3.24
Pessimistic rate of return 1.38 1.25 1.29
Equity drop ratio 0.31 0.74 1.32
STRATEGY SUMMARY
Test period: January 1991 to December 2005.
Starting equity: $1,000,000 (nominal). Deduct $20 com-
mission per round-trip trade per contract and apply two
ticks of slippage per order.
Money management: Risk a maximum of 3-percent
account equity per trade. The number of contracts is calcu-
lated using the basis price (the closing price the day prior to
entry), the stop-loss level (four times the 10-day average
true range), the contracts point value (the dollar value of a
one-point move), and the portfolios total equity.
For example, if a contract has a point value of $250,
assume the system goes long at a basis price of $100 and its
stop level is $90. To determine the trades dollar risk, multi-
ply the point value ($250) by the difference between the
basis price and the stop level (100 - 90 = 10). Therefore, a sin-
gle contracts dollar risk is $2,500.
If the portfolios total equity before entering the position
was $1,000,000 and you cannot risk more than 3 percent of
your total equity ($30,000), you would buy 12 contracts.
Test results: The portfolio equity curve (Figure 2) shows
a strong increase in the first year and continuous increases
during the next nine years of the test period. The final five
years are marked by high volatility and sideways perform-
ance.
Figure 3 reflects this behavior: There are drawdowns up
to 31.8 percent toward the end of
the test run a high figure, espe-
cially when taking into account
the systems annualized 10-per-
cent gains. The first 10 years look
much better most drawdowns
are between 5 and 15 percent.
The yearly performance (Figure
4) shows only three negative
years out of 15, but the results are
unevenly distributed: The annual
performance varies between -9.5
percent and 54 percent. Such
volatility is surely too high for the
average trader, especially consid-
ering that, on average, only 5.74
percent of account equity is used.
However, because the number
of trades over 15 years is only
228, more testing over a larger
portfolio of currencies would
provide more accurate results.
Also, different thresholds and
look-back parameters should be
tested to be sure the result is not
based on coincidence.
Bottom line: Using the HLR
indicator can help trend-follow-
ing systems to enter potential
trends earlier than the classic
channel breakout approach, but
the results here were mixed. The
system was profitable and relatively stable in the first two
thirds of the test period but became highly volatile in the
final third.
However, testing across a wide range of parameters helps
ensure they are robust. For test results of the HLR indicator
on a larger group of futures (including non-currency mar-
kets), see the Futures Trading System Lab in the September
2006 issue of Active Trader.
Jos Cruset of Wealth-Lab
CURRENCY SYSTEM ANALYSIScontinued
The system suffered several large drawdowns toward the end of the test period.
FIGURE 3 DRAWDOWN CURVE
The system had 12 profitable years but the annual results are uneven.
FIGURE 4 ANNUAL RETURNS
CURRENCY BASICS
Trading forex
the mini way
While foreign currency is the worlds largest financial market,
it can also be quite cost prohibitive. However, with mini forex futures and mini spot trading,
traders can participate in the forex world with much less money at risk.
BY DARRELL JOBMAN
B
ecause of its global reach, the forex market
has become a favorite of traders from pro-
fessional money managers seeking to diver-
sify their portfolios into a new asset class to
individual retail speculators trying to make a profit.
The forex market is attractive to traders for many rea-
sons. Because it trades virtually around the clock, it reacts
instantaneously to geopolitical tensions, natural disasters,
and economic reports.
For some traders, abrupt price changes could be devas-
tating if they trade the larger forex contracts, says Jim
Wyckoff, senior market analyst for TradingEducation.com.
Trading mini forex lots or mini currency futures contracts
gives them much better leverage than they can get in stocks,
where they must put up at least 50 percent of the purchase
price, and with much less risk than they might have in the
futures markets.
Where to trade?
Traders with experience in futures may want to trade forex
futures; those more familiar with stocks and bonds may be
more comfortable in a spot (cash) forex account. The decision
could also depend on the amount of money available. Trading
both futures and spot forex requires separate accounts,
although firms that handle transactions in both venues can
transfer money quickly from one account to the other.
Futures. The Chicago Mercantile Exchange lists futures
on a number of foreign currencies, including the Polish
zloty and Israeli shekel, as well as some cross-rates.
However, most of the activity is in the majors euro,
Japanese yen, Swiss franc, British pound, and the New
Zealand and Canadian dollars vs. the U.S. dollar. Most of
the trading is done electronically. Each trading day begins
at 5 p.m. and runs overnight through 4 p.m. the next day.
The best liquidity is between 7:20 a.m. and 2 p.m., the regu-
lar pit-trading hours.
There are only two mini-forex futures contracts: the euro
(E7) and the Japanese yen (J7). Both are half the size of the
regular contract, with a one-point move worth $6.25.
Typical margin set by the exchange (which can change) is
around $1,400 per mini contract compared to $2,700-$2,800
for the full-size contracts.
The quoting convention for some currency futures may
be a little strange. Instead of a cash market price of, say, 110
yen per U.S. dollar, forex futures trade in terms of dollars
per yen, or 0.009091 in this case (9/10 of a cent).
The advantages of futures include trading in a
centralized marketplace with multiple bid/ask
prices; pricing is transparent and available to every-
one, regardless of size or location; there is no count-
er-party risk because the exchange clearing organi-
zation is on the other side of every trade; and
anonymity for those who want it. Futures advocates
contend that your biggest risk as a spot forex trader
may not be market risk, but the firm you are dealing
with. Many spot forex firms are not regulated by
any government agency.
The cash forex market. The standard trade-lot size
Central time GMT time
Tokyo open 6:00 p.m. 23:00
Tokyo close 3:00 a.m. 08:00
London open 2:00 a.m. 07:00
London close 11:00 a.m. 16:00
New York open 7:00 a.m. 12:00
New York close 4:00 p.m. 21:00
TABLE 1 MARKET HOURS IN MAJOR FINANCIAL CENTERS
Source: Xpresstrade
in the cash forex market is 100,000 units of a currency, but
each lot in a mini forex account is only one-tenth that size,
or 10,000 units. Aone-point change in price (i.e., a pip) is
usually worth $1 in a mini lot instead of $8-$10 in the full-
sized version. As a result, risk in a mini forex account is
much less, and the amount of margin needed may be only
several hundred dollars. However, a larger amount is rec-
ommended (the minimum is set by each firm, not the
exchange as is the case in forex futures).
For the trader trying to learn the ropes of forex trading or
wanting to test a trading strategy, the lower financial outlay
is welcome news. Of course, profits also arent as large, but
if one mini lot is too small for you, theres nothing that says
you cant trade two or three lots, or five lots or 100 lots,
especially as you become more experienced in forex trad-
ing. This provides more flexibility to scale in and out of
positions at different price levels.
Most spot forex firms also list 20 or more pairs, so you
arent limited to trading a foreign currency against the U.S.
dollar. Its just as easy to trade, for example, the British
pound against the Japanese yen, giving you additional
opportunities to profit.
In almost all cases, whichever pairs are available for trad-
ing in a full account can be traded in a mini account.
However, you should double-check with the brokerage just
to be sure.
In addition to the smaller size, lower margins, less risk,
and greater flexibility, there are other advantages to mini
forex spot trading. There is true 24-hour trading with no
overnight gaps (Table 1); bid/ask prices are always avail-
able, even in thin trading hours; and there are no quarterly
contract expirations, so time and contract month are not
considerations as they are in futures.
Plus, spot forex firms typically provide customers with
real-time quotes, charts, and news at no charge (even for
mini forex traders), as well as a trading platform and demo
or simulated accounts in which traders can practice before
they begin trading with real money. If you are shopping for
a mini forex firm, be sure to check out all of these features
as well as its margin and leverage rules.
The mini forex contract may seem small, but its one of the
best ways to get more bang for your buck with the least risk.
For information on the author see p. 6.

INTERNATIONAL MARKET SUMMARY
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank
1 South African rand 0.1455 5.59% -13.39% -10.74% 0.1678 0.1327 16
2 Australian dollar 0.7674 5.11% 0.96% 2.37% 0.7792 0.7014 14
3 New Zealand dollar 0.6178 3.62% -3.30% -9.39% 0.7198 0.5925 15
4 British pound 1.8636 2.60% 2.04% 5.44% 1.9025 1.7048 12
5 Euro 1.276 1.67% 0.97% 5.50% 1.2978 1.1638 8
6 Swedish krona 0.1383 1.62% 1.69% 5.25% 0.145 0.1206 4
7 Brazilian real 0.4594 1.50% -3.53% 1.93% 0.4867 0.4054 1
8 Thai baht 0.02641 1.46% -1.27% 3.00% 0.0267 0.02388 5
9 Japanese yen 0.008723 1.44% -0.75% 2.31% 0.00919 0.00824 13
10 Singapore dollar 0.6337 1.21% 0.17% 3.14% 0.6408 0.5859 6
11 Swiss franc 0.8114 1.13% 0.47% 4.24% 0.8383 0.7525 9
12 Russian rouble 0.0373 1.03% 1.63% 4.45% 0.03746 0.03447 2
13 Hong Kong dollar 0.1287 0.00% -0.23% -0.16% 0.1291 0.1283 3
14 Indian rupee 0.02152 -0.46% -3.50% -5.45% 0.02302 0.02123 7
15 Taiwanese dollar 0.03046 -0.68% -2.87% -2.68% 0.03197 0.02955 11
16 Canadian dollar 0.8839 -1.03% -1.31% 1.60% 0.9148 0.8116 10
FOREX (vs. U.S. DOLLAR)
Country Interest rate Rate Last change December 2005 June 2005
U.S. Fed Funds Rate 5.25 0.25 (June 06) 4.5 3.5
Japan Overnight call rate 0.25 0.25 (July 06) 0 0
Euro Refi rate 2.75 0.25 (June 06) 2.25 2
UK Repo rate 4.5 0.25 (Aug. 05) 4.5 4.5
Canada Overnight funding rate 4.25 0.25 (May 06) 3.5 2.5
Switzerland 3-month Swiss Libor 1.5 0.25 (June 06) 1 0.75
Australia Cash rate 5.75 0.25 (May 06) 5.5 5.5
New Zealand Cash rate 7.25 0.25 (Dec. 05) 7.25 6.75
Brazil Selic rate 14.75 0.5 (July 06) 17.25 19.75
Korea Overnight call rate 4.25 0.25 (June 06) 4 3.25
Taiwan Discount rate 2.5 0.125 (June 06) 2.25 2
India Reverse repo rate 6 0.25 (July 06) 5.5 5
South Africa Repurchase rate 7.5 0.5 (June 06) 7 7
GLOBAL INTEREST RATES
As of July 30 *based on one-month gain/loss
1-month 3-month 6-month 52-week 52-week
Rank Country Index July 30 gain/loss gain/loss gain/loss high low Previous
1 Egypt CMA 1,880.66 10.83% -12.68% -27.14% 2,653.25 1,657.42 11
2 Mexico IPC 20,252.33 5.77% -1.91% 7.44% 21,917.51 14,000.14 14
3 Hong Kong Hang Seng 16,955.04 4.23% 1.76% 7.63% 17,328.43 14,189.47 1
4 Switzerland Swiss Market 7,946.50 3.85% -1.25% 2.02% 8,158.90 6,364.30 6
5 UK FTSE 100 5,974.90 2.43% -0.80% 3.38% 6,137.10 5,130.90 3
6 Brazil Bovespa 37,381.00 2.05% -7.39% -2.25% 42,062.00 25,734.00 15
7 Canada S&P/TSX composite 11,823.68 1.82% -3.12% -1.04% 12,494.72 10,145.12 7
8 France CAC 40 5,028.51 1.26% -3.08% 1.86% 5,329.16 4,288.15 9
9 Italy MIBTel 28,131.00 0.88% -4.39% 0.97% 30,154.00 24,336.00 5
10 India BSE 30 10,680.23 0.67% -9.89% 8.44% 12,671.11 7,537.50 12
11 U.S. S&P 500 1,278.55 0.66% -2.45% -0.52% 1,326.70 1,168.20 4
12 Germany Xetra Dax 5,705.42 0.39% -5.07% 0.80% 6,162.37 4,726.33 10
13 Singapore Straits Times 2,429.44 -0.24% -6.94% 0.72% 2,666.33 2,190.07 8
14 Japan Nikkei 225 15,342.87 -1.05% -9.25% -7.30% 17,563.37 11,614.71 13
15 Australia All ordinaries 4,932.70 -2.01% -5.27% 2.51% 5,340.00 4,277.00 2
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol July 30 gain/loss gain/loss gain/loss high low Previous
1 Aussie $ / Canada $ AUD/CAD 0.8685 6.20% 2.24% 0.75% 0.9396 0.8178 18
2 Aussie $ / Yen AUD/JPY 88.0098 4.40% 1.71% 0.09% 91.34 82.09 13
3 Aussie $ / Franc AUD/CHF 0.946 3.93% 0.42% -1.79% 0.9945 0.9023 19
4 Aussie $ / Euro AUD/EUR 0.6017 3.42% 0.00% -2.94% 0.641 0.5761 20
5 Real / Canada $ BRL/CAD 0.5199 2.56% -2.31% 0.31% 0.5517 0.4746 4
6 Aussie $ / Pound AUD/GBP 0.4118 2.41% -1.10% -2.92% 0.435 0.3985 17
7 Franc / Canada $ CHF/CAD 0.9183 2.18% 1.75% 2.59% 0.9674 0.8646 12
8 Pound / Yen GBP/JPY 213.694 1.15% 2.85% 3.05% 216.557 196.36 9
9 Pound / Euro GBP/EUR 1.4609 0.94% 1.02% -0.05% 1.4911 1.4102 16
10 Euro / Yen EUR/JPY 146.31 0.23% 1.75% 3.13% 148.05 133.51 6
11 Real / Yen BRL/JPY 52.6745 0.06% -2.88% -0.39% 55.8704 45.0592 2
12 Real / Euro BRL/EUR 0.3601 -0.17% -4.51% -3.38% 0.3976 0.3331 5
13 Franc / Yen CHF/JPY 93.0102 -0.32% 1.16% 1.84% 94.34 86.3973 7
14 Franc / Euro CHF/EUR 0.6358 -0.55% -0.52% -1.23% 0.6542 0.6306 14
15 Real / Pound BRL/GBP 0.2465 -1.08% -5.52% -3.37% 0.2721 0.2271 3
16 Franc / Pound CHF/GBP 0.4354 -1.45% -1.58% -1.16% 0.4472 0.4325 10
17 Canada $ / Yen CAD/JPY 101.353 -2.44% -0.63% -0.69% 104.635 90.6843 8
18 Canada $ / Euro CAD/EUR 0.6928 -2.66% -2.31% -3.70% 0.739 0.6657 15
19 Real / Aussie $ BRL/AUD 0.5988 -3.43% -4.54% -0.45% 0.6573 0.5433 1
20 Canada $ / Pound CAD/GBP 0.4744 -3.54% -3.32% -3.64% 0.5041 0.4561 11
NON-U.S. DOLLAR FOREX CROSS RATES
GLOBAL STOCK INDICES
ACCOUNT BALANCE
Rank Country 2006* Ratio 2005 2007
+
1 Hong Kong 18.858 10.1 18.987 20.021
2 Taiwan 18.827 5.4 16.366 20.688
3 Germany 98.315 3.6 114.828 122.689
4 Japan 140.175 3.2 163.891 133.621
5 Canada 39.305 3.1 24.974 38.305
6 Denmark 6.387 2.4 6.13 7.295
7 Italy -18.524 -1.1 -26.645 -11.923
8 France -40.647 -1.9 -27.628 -44.796
9 UK -61.298 -2.7 -58.053 -66.244
Rank Country 2006* Ratio 2005 2007
+
10 Australia -40.783 -5.6 -42.241 -41.832
11 U.S. -864.189 -6.5 -804.951 -899.351
12 Spain -93.668 -8.1 -85.897 -104.255
13 New Zealand -9.471 -8.9 -9.581 -8.365
Totals in billions of U.S. dollars
*Account balance in percent of GDP
+
Estimate
Source: International Monetary Fund, World Economic Outlook
Database, April 2006
GLOBAL BOND RATES
Rank Country Rate July 30 1-month 3-month 6-month Previous
1 U.S. 10-year T-note 106 1.65% 0.77% -1.99% 3
2 Germany BUND 116.78 1.27% 1.04% -2.98% 5
3 Japan Government Bond 132.01 0.27% -0.47% -3.56% 4
4 UK Short sterling 95.06 0.00% -0.19% -0.38% 1
5 Australia 10-year bonds 94.095 -0.13% -0.21% -0.56% 2
The G8 met in St. Petersburg, Russia, July 15-17,
where issues of global free trade, global imbalances,
and energy prices were top priorities. Leaders set a
one-month deadline to revive recent global free trade
talks, as disagreements over farm subsidies and
industrial tariffs had previously stalled the discussion.
A three-month deadline was set to end talks over a
bilateral deal that could help Russia join the World
Trade Organization (WTO). Six of the eight leaders
said they supported using nuclear energy as a way to
provide energy security and as a cleaner source of
power that could help stem global warming. Russia
softened its position on the Energy Charter by agree-
ing to open its energy sector to foreign investment, but
Russia refused to ratify the international rule book.
FOREX/INTERNATIONAL MARKET SUMMARY GLOBAL NEWS BRIEFS
Preliminary estimates show the UKs second-quarter GDP
increased 0.8 percent compared to Q1 and grew 2.6 percent on
Q2 2005. The countrys jobless rate increased 0.3 percent to 5.4
percent from the period covering March to May. The rate grew
0.7 percent compared to the same period in 2005.
Frances May unemployment rate fell 0.2 percent from
the previous month to 9.1 percent. That number was down
1 percent from May 2005.
Germanys June jobless rate took a similar dip, falling
0.3 percent from May to 10.5 percent. That represented a
0.8-percent drop from May 2005.
The Bank of Slovenia increased its benchmark
Lombard rate by 50 basis points in July to 4.5 percent. The
increase was the third 0.5-percent move since February, and
the Bank released a statement saying it expects the tighten-
ing policy to continue.
EUROPE
Preliminary data indicates Hong Kongs jobless rate
increased 0.1 percent from March to May, reaching 5 per-
cent. The rate grew 1 percent when compared to the same
period the previous year. Despite the entry of some fresh
graduates and [those who left school], the labor force
showed a small reduction in overall terms in April-June
2006, said a Hong Kong government spokesperson.
Australias June unemployment rate remained stable at
4.9 percent, a 0.1-percent drop from June 2005.
Indias second quarter economy grew 13.4 percent
when compared to the same quarter in 2005.
The Central Bank of Turkey boosted its overnight bor-
rowing rate 0.25 percent to 17.5 percent in July. The rate
move comes on the heels of an enormous 3-percent increase
in June. Prior to that, the bank had not raised rates in three
years.
The Bank of Israels short-term lending rate increased 0.25
percent in July to 5.5 percent. This marks the seventh increase
since the rate was lowered to 3.5 percent in January 2005.
ASIA & THE SOUTH PACIFIC
Brazils economy in the first quarter grew 1.4 percent
from the previous quarter and 3.4 percent from the same
quarter in 2005. The economy was boosted by growth in
industry, services, and agriculture.
Canadas June unemployment rate remained at 6.1
percent, 0.6 percent lower than the rate in June 2005. This
32-year low continued as employment increased 1.3 per-
cent, or 216,000 jobs more than double the growth of the
first half of 2005. Large job increases occurred in the health
care and social assistance sectors, while declines in full-
time jobs were offset by gains in part-time work.
In a hotly contested election, conservative Felipe
Calderon of the National Action Party won Mexicos pres-
idential election by a less than one-percent margin
about 220,000 votes out of 41 million. He beat Andres
Manuel Lopez Obrador, his leftist rival and former mayor
of Mexico City. Mexicans living abroad, mostly in the U.S.,
were allowed to vote for Mexicos president for the first
time, but registered numbers were lower than expected.
Obrador said he would contest the election results in court.
Calderon replaces Vicente Fox and will serve a six-year,
non-renewable term. His party won about 41 percent of
the congressional seats, snatching the majority position
away from the centrist Institutional Revolutionary Party.
AMERICAS
G8 meeting
Japans June unemployment rate fell to 4 percent, a
decrease of 0.1 percent from the previous month and 0.4
percent from June 2005.
CURRENCY FUTURES
This information is for educational purposes only. Currency Trader provides this data in
good faith, but assumes no responsibility for the use of this information. Currency
Trader does not recommend buying or selling any market, nor does it solicit orders to
buy or sell any market. There is a high level of risk in trading, especially for traders
who use leverage. The reader assumes all responsibility for his or her actions in the
market.
LEGEND:
Sym: Ticker symbol.
Vol: 30-day average daily volume, in thousands.
OI: 30-day open interest, in thousands.
10-day move: The percentage price move from the close 10 days ago to todays close.
The % rank fields for each time window (10-day 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 and in the same direction. For example, the % rank for 10-day move shows
how the most recent 10-day move compares to the past twenty 10-day moves; for the 20-
day move, the % rank field shows how the most recent 20-day move compares to the
CURRENCY FUTURES SNAPSHOT
as of July 31
The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each markets
liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.
Contract Pit Elec Exch Vol OI 10-day % 20-day % 60-day % Volatility
sym sym move rank move rank move rank ratio/% rank
Eurocurrency EC 6E CME 137.8 150.2 1.88% 100% -0.29% 8% 0.49% 7% .26 / 63%
Japanese yen JY 6J CME 61.8 163.4 2.04% 100% -0.54% 16% -0.90% 31% .38 / 67%
British pound BP 6B CME 45.9 86.3 2.64% 100% 1.04% 24% 0.81% 16% .23 / 67%
Swiss franc SF 6S CME 37.4 64.4 1.26% 90% -0.83% 39% -0.24% 12% .21 / 45%
Canadian dollar CD 6C CME 32.9 86.7 0.26% 0% -1.36% 46% -2.18% 94% .16 / 2%
Australian dollar AD 6A CME 19.9 49.6 2.49% 85% 3.07% 59% -0.75% 21% .40 / 73%
Mexican peso MP 6M CME 12.6 58.2 0.28% 0% 3.56% 44% 0.25% 3% .17 / 12%
U.S. dollar index DX NYBOT 3.8 17.1 -1.83% 89% 0.28% 7% 0.20% 38% .26 / 72%
Euro / Japanese yen EJ NYBOT 1.4 32.7 -0.04% 25% -0.08% 0% 2.29% 54% .22 / 3%
Euro / British pound GB NYBOT 1.1 9.1 -0.74% 25% -1.86% 76% -0.26% 21% .15 / 0%
Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.
past sixty 20-day moves; for the 60-day move, the % rank field shows how the most recent
60-day move compares to the past one-hundred-twenty 60-day moves. Areading of 100%
means the current reading is larger than all the past readings, while a reading of 0% means
the current reading is lower than the previous readings.
Volatility ratio/% rank: The ratio is the short-term volatility (10-day standard deviation of
prices) 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.
NYBOT introduces
new currency pairs
T
he New York Board of Trade began trading 10
new currency pairs in July: euro/South
African rand (YZ), British pound/Australian
dollar (QA), pound/New Zealand dollar (GN),
pound/Canadian dollar (PC), pound/Norwegian
krone (PK), pound/South African rand (PZ),
pound/Swedish krona (PS), New Zealand
dollar/Japanese yen (ZJ), Norwegian krone/yen
(KY), and Swedish krona/yen (KJ). Options on the
futures are also available for trading.
FXMarketSpace gets
institutional support
F
XMarketSpace, a joint venture between
Reuters and the Chicago Mercantile Exchange,
received a boost in July when several large
banks, hedge funds, and trading firms signed up to
participate. Banks such as ABN Amro, Merrill Lynch,
and UBS and managed money firms such as Citadel
and Penson have all agreed to join the venture, which
is intended to become the first centrally cleared elec-
tronic marketplace for spot currency trading.
FXMarketSpace is scheduled to launch in 2007, with
testing to begin later this year.
Managed money: Barclay Trading Groups
currency trader rankings for June 2006
Top 10 currency traders managing more than $10 million as of June 30,
ranked by June 2006 return
2006 $ Under
June YTD mgmt.
Rank Trading advisor return return (millions)
1 Friedberg Comm. Mgmt. (Curr.) 19.07 21.71 64.8M
2 24FX Management Ltd 4.80 19.5 12.7M
3 FX Concepts (Global Currency) 4.45 3.33 1200.0M
4 Algorithmic Trading (Currency) 3.90 43.74 10.0M
5 KMJ Capital Mgmt (Currency) 3.82 4.51 15.7M
6 Absolute Asset Mgmt. (FX) 3.68 14.23 25.3M
7 Alder Cap'l (Alder Global 20) 3.10 0.04 99.2M
8 Appleton Cap'l (Appleton 25% Risk) 2.10 -20.07 129.3M
9 FX Concepts (Multi-Strategy Fund) 1.93 -4.98 191.0M
10 Coe Capital Advisors (Diversified FX) 1.92 9.44 14.5M
Top 10 currency traders managing less than $10 million and more than $1 million
as of June 30, ranked by June 2006 return
1 Pro-Active FX (Managed Accounts) 8.40 38.88 5.9M
2 Black Flag (Gl. Macro) 3.40 -0.12 2.0M
3 Winton Capital Mgmt. (Currency Fund) 1.05 -8.36 5.1M
4 Worldwide Capital Mgmt 1.00 60.93 1.8M
5 TradeCom Currency Trader 0.65 -8.37 2.0M
6 Perreard Partners Investments 0.30 1.05 4.6M
7 Coe Capital Advisors (Carry) 0.30 18.42 2.5M
8 Harmoney Invest. Mgrs. (ProFund FX) 0.20 4.46 7.4M
9 Forex Funds 0.20 2.71 7.5M
10 High Desert Currency Mgmt -0.09 3.18 2.0M
Source: The Barclay Group (www.barclaygrp.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 RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
INDUSTRY NEWS
Where was the yen?
Japan ends zero interest-rate policy
W
hile Japan has hinted for months it was consid-
ering ending its zero interest-rate policy, the
Bank of Japans announcement in mid-July that
it raised interest rates for the first time in six years was still
quite significant.
The increase to 0.25 percent was the countrys first since
August 2000. However, that proved to be little more than a
false alarm, as the stock market collapse in the U.S. sent
rates back to zero soon afterwards. This time, however, the
BOJ said it is committed to a tightening cycle, which would
be Japans first since 1989.
The BOJ had long hesitated to raise rates, citing deflation
and economic stagnation. However, the BOJ said in a state-
ment that keeping the zero interest-rate policy could have
caused disruptive swings in the economy.
The BOJ also said it would be very cautious about raising
rates again, keeping them low for some time, and had no
intention of raising them again at the next BOJ meeting Aug. 10.
While the markets had been expecting the price move, they
still reacted negatively to the news. The night before the July
14 rate hike, the Nikkei 225 closed at 15,097.95. By the close
July 19, it was down to 14,500.26 almost a 4-percent drop.
As of July 31, it stood at 15,456.81.
Perhaps more surprising was the immediate decline in the
yen (Figure 1). While rising interest rates are generally bull-
ish for a nations currency, the yen dropped almost 2 percent
in the two days after the announcement, although it did
bounce back shortly thereafter. As of late July, it was at
114.55, a 1.3 percent appreciation in the yen from the
announcement date and almost 3 percent from the July 19
low.
However, Brian Dolan, director of research at Forex.com,
says the yens decline was not totally unexpected.
You have to put the move in context, he says. The BOJ
had essentially been preparing the markets for many
months for the eventual end of the zero interest-rate policy.
The main thing the market was focusing on was guidance
for future rate hikes.
Dolan says that since the BOJ announced it
would be very careful about further increases, the
25 basis-point hike was not enough to spark great
buying in the yen, especially because it still faces
substantial yield disadvantages.
Blake Morrow, forex product manager at GlobalTec
Solutions, says that because there was practically no
buying of the yen right after the announcement, sell-
ers figured it was safe to get back in.
Also, I think some of the currency pairs, such as
the dollar/yen, euro/yen, and pound/yen were
breaking some technical levels, and that just accel-
erated the move, Morrow says.
Additionally, says Joseph Trevisani, chief market
analyst of FX Solutions, carry trades selling a
low-yielding currency vs. buying a high-yield one
were not as prevalent in the days and weeks
leading up to the announcement. After the
announcement, when it became clear that the
Japanese interest rate would remain low, the carry
trades resumed.
Although Dolan doesnt believe the rate hike will
have that big of an immediate impact on the
Japanese economy, he does believe it is a notewor-
thy move.
In the sense it represents a turning point in global inter-
est rate levels, it is significant for the six-month outlook, he
says. The Japanese economy is strong, and inflation is at a
risk of becoming more of an issue than it has been in near-
ly a generation. But I dont think thats sufficient to derail
the Japanese economy.
While Morrow agrees the near-term implications are
minimal, he thinks its important to keep a close eye on
what Japan does in the next several months.
If Japan continues to raise interest rates at a measured
pace, Japanese investors could potentially start massively
selling their U.S. assets, Morrow says. That could push
the U.S. dollar much lower than current levels and poten-
The yen dropped when the Bank of Japan announced on July 14 that it
would raise interest rates for the first time in six years, but the yen had
already been losing ground to the dollar (reflected in the uptrend on
this dollar/yen chart).
FIGURE 1 YEN WEAKENS VS. DOLLAR
But not everybodys happy
Refco FX finds a new suitor
C
ustomers of online forex firm RefcoFX.com have
been in limbo since RefcoFXs parent company,
Refco LLC, went bankrupt in October.
Attempts earlier this year by FXCM to buy the assets of
RefcoFX fell through, but it appears RefcoFX finally has a
savior in Gain Capital. Gain agreed to buy RefcoFXs 17,000
accounts in a deal that will eventually allow Refco cus-
tomers to regain 100 percent of their account balances.
[Gain has] both the financial and operational resources
necessary to help achieve a smooth transition for customers
and to offer continued support for their ongoing trading
needs, says Refco chief restructuring officer David Pauker.
Also, Pauker adds, Gain and its retail subsidiary Forex.com
are registered futures brokers regulated by the National
Futures Association (NFA) and the Commodity Futures
Trading Commission (CFTC), which RefcoFX was not.
However, the terms of the new deal are not sitting well
with many RefcoFX customers. Under the agreement, cus-
tomers with less than a $150 balance will receive a full
recovery of their account balance if they open an account
with Forex.com and trade at least once, and anybody with
less than $40 could immediately withdraw their funds.
Larger customers will also receive full recovery 25
percent of their account will be paid every six months if
they meet certain conditions. Mark Galant, CEO of Gain
Capital, says customers who choose to open accounts with
Gain but do not fully recover their balances would still
retain all rights to that balance if they chose to make a claim
against Refco as an unsecured creditor.
A group of RefcoFX traders have hired an attorney to
protest the deal, claiming the terms are unreasonable.
According to Todd Duffy, an attorney representing the
Refco group, traders would need to make 240 trades per
month for six months just to qualify for a full reimburse-
ment.
Jeffrey Matkin, who says his account at RefcoFX is in six
figures, cant understand why Refco agreed to a deal that
would make it so difficult for their customers to get their
money back.
I wont get everything back for two years, he says.
And thats two years where the money is just sitting stag-
nant, not getting any kind of return.
A Refco spokesperson said the firm believes the Gain
offer is the best one available and the one most likely to
allow customers to get their money back. She also said
Refco will still entertain offers from other bidders.
However, when it filed its opinion with the court regard-
ing the sale to Gain, Refco admitted that most customers
would probably not go through the motions necessary to
get a full refund.
Besides customer accounts, RefcoFX also owes more than
$100 million to other creditors. Additionally, it is a guaran-
tor of Refcos bank debt and bonds, which are more than $1
billion, and is considered collateral by Refcos lenders.
After the deal, Forex.com would have about 50,000
accounts.
Refcos Capital Markets division (RCM) which prima-
rily consists of institutional customers are also likely to
see some compensation. Traders with securities accounts
could get up to 70 cents on the dollar, while forex customers
will get a little more than a quarter.
However, forex customers would also receive a lump-
sum payment of $221 million if the deal becomes official.
RCM customers are collectively owed more than $2 bil-
lion, and Refco has faced numerous lawsuits from clients.
However, if RCM clients agree to the terms of the settle-
ment, they will drop their claims.
As of late July, more than 50 firms and hedge funds had
signed the agreement, including RCMs largest creditor, VR
Capital Group. However, RCMs most famous client vet-
eran trader Jim Rogers was among the last to join.
Rogers originally held off from signing in an effort to
reclaim the $372 million he claims RCM owes his funds.
Signing the agreement means Rogers legal team will drop
the lawsuits it had against RCM.
Had Rogers refused to accept the settlement, it could
have put the entire deal in jeopardy.
Refco trustee Marc Kirschner has asked a federal bankrupt-
cy judge to approve the deal, saying it will allow for an order-
ly breakup of RCMs assets and avoid a freefall liquidation.
tially disrupt the global economy.

As for where the yen is headed, Trevisani believes Japan
will not necessarily have the biggest say in the matter.
The longer-term outlook in the dollar/yen depends
more on the strength or weakness of the dollar than on
intrinsic Japanese factors, he says. Although if there is
dramatic change in the Japanese economy, that could
become an element.
The U.S. dollar is continually buffeted by external
events the price of oil, political instability in the Middle
East, potential and real terrorism, the health of the U.S.
economy, and the Fed interest-rate policy, Trevisani adds.
These factors will have more impact on the dollar and
hence on the yen in the near future than any likely combi-
nation of bilateral U.S./Japanese developments.
At year-end, Morrow expects the dollar/yen to be
around 1.12, while Dolan thinks more rate increases toward
the end of the year and in early 2007 will strengthen the yen.
I think youll see some dollar weakness, and that will
send the rate down to the 1.10-1.12 area, he says. As that
side of the equation leads to yen appreciation, I think were
looking at something in the 105-108 area.
15
U.S.: PPI
The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.
CPI: Consumer Price
Index
ECB: European Central
Bank
FOMC: Federal Open
Market Committee
GDP: Gross domestic
product
ISM: Institute for Supply
Management
PPI: Producer Price Index
Legend
MONTH
28
Canada:
Unemployment
Monday Tuesday Wednesday Thursday Friday Saturday
GLOBAL ECONOMIC CALENDAR
AUGUST/SEPTEMBER
14
Japan: Monetary
survey
Germany: CPI
26
19
21
Canada: Retail
trade
16
U.S.: CPI
Canada:
Manufacturing
survey
Brazil: Monthly
survey of trade
17
U.S.: Leading
indicators
Brazil: Domestic
federal public
debt and open
market
operations
18
Great Britain:
Capital issues
Germany: PPI
Canada:
Wholesale trade
22
Canada: CPI
24
U.S.: Durable goods
Japan: Corporate serv-
ice price index
Germany: National
accounts
Brazil: Fiscal policy;
unemployment
25
Mexico:
Monetary
policy
announce-
ment
23
Canada: Leading
indicators
Brazil: Monetary
policy and credit
operations
29
7 8
U.S.: FOMC meeting
Germany: Production
index; foreign trade
Australia: Official
reserve assets
9
U.S.: Wholesale
inventories
30
U.S.: GDP
Canada: Balance
of international
payments
31
ECB: Governing council meeting
Germany: Retail turnover; unemployment
Canada: GDP
Australia: International reserves and
foreign currency liquidity
Italy: International reserves and foreign
currency liquidity
10
U.S.: Trade balance
Japan: Balance of
payments; corporate
goods price index;
monetary policy
meeting
11
U.S.: Retail sales
Japan: Monetary
policy meeting
Brazil: CPI
Italy: Balance of
payments
12
1
U.S.: Unemployment;
ISM
Japan: Account
balances
Australia: Index of
commodity prices
4
Japan:
Monetary
base
5
Brazil: Monthly
survey of mining and
manufacturing
physical production
Australia: Reserve
bank meeting
7
U.S.: Wholesale inventories
Japan: Monetary policy meeting
Great Britain: Monetary policy
committee meeting
Germany: Production index
Australia: Official reserve
assets
8
Japan: Monetary
policy meeting
Germany: Foreign
trade; bankruptcies
6
Great Britain: Monetary
policy committee meeting
Canada: Interest rate
announcement
Germany: Orders received
and manufacturing turnover
Brazil: CPI
3
ECB: Governing
council meeting
Great Britain:
Monetary policy
committee
meeting
4
U.S.: Employment
Germany: Orders received and man-
ufacturing turnover; bankruptcies
Australia: Statement on monetary
policy
Brazil: Monthly survey of mining and
manufacturing physical production
ads0906 7/11/06 10:36 AM Page 55
EVENTS
Event: The Options Intensive
Dates: Aug. 24-25, Oct. 26-27, Nov. 9-10
Time: 8 a.m -5 p.m.
Location: The Options Institute at the CBOE,
Chicago, Ill.
For more information: Call (877) THE-CBOE
Event: The Wealth Expo

Date: Sept. 7-9
Location: Dallas, Texas
Event: The Forex Trading Expo

Date: Sept. 8-9
Location: Mandalay Bay Hotel & Casino,
Las Vegas, Nev.
For more information: Visit www.tradersexpo.com
Event: Traders Retreat

Date: Oct. 13-15
Location: CasaBlanca Resort & Spa, Mesquite, Nev.
For more information: Visit
www.traders-retreat.com
Event: Linda Raschkes 10th Annual Trading Seminar

Date: Nov. 3-5
Location: Sheraton Chicago Hotel & Towers
Event: Second Annual MARHedge Trading Forum

Date: Nov. 16
Location: Stamford, Conn.
For more information: Visit www.marhedge.com
Event: The Traders Expo Las Vegas

Date: Nov. 16-19
Location: Mandalay Bay Hotel & Casino,
Las Vegas, Nev.
For more information: Visit www.tradersexpo.com
Event: 22nd Annual Futures & Options Expo

Date: Nov. 28-30
Location: Hyatt Regency Chicago
www.futuresindustry.org/conferen-2156.asp
KEY CONCEPTS
Exponential moving average (EMA): The simple
moving average (SMA) is the standard moving average cal-
culation that gives every price point in the average equal
emphasis, or weight. For example, a five-day SMA is the
sum of the most recent five closing prices divided by five.
Weighted moving averages give extra emphasis to more
recent price action. Exponential moving average (EMA)
weights prices using the following formula:
EMA= SC * Price + (1 - SC) * EMA(yesterday)
where
SC is a smoothing constant between 0 and 1, and
EMA(yesterday) is the previous days EMAvalue.
You can approximate a particular SMA length for an
EMAby using the following formula to calculate the equiv-
alent smoothing constant:
SC = 2/(n + 1)
where
n = the number of days in a simple moving average of
approximately equivalent length.
For example, a smoothing constant of 0.095 creates an
exponential moving average equivalent to a 20-day SMA
(2/(20 + 1) = 0.095). The larger n is, the smaller the constant,
and the smaller the constant, the less impact the most recent
price action will have on the EMA. In practice, most soft-
ware programs allow you to simply choose how many days
you want in your moving average and select either simple,
weighted, or exponential calculations.
www.lbrgroup.com/index.asp?page=Events
Purchase past articles!
Purchase and download articles from
Active Trader, Currency Trader, and Options Trader
Magazines.
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articles by:
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ads0706 5/10/06 2:31 PM Page 77
Date Currency Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
7/11/06 USD/JPY 114.35 113.31 116.60 2.16 116.60 (1st half) 7/17/06 +2.25 (1.97%) 2.93 -0.19 4 days
116.40 (2nd half) 7/21/06 +2.05 (1.79%) 4.52 -0.19 8 days
TRADE SUMMARY
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).
FOREX TRADE JOURNAL
Playing the dollars strength against
yen weakness.
TRADE
Date: Tuesday, July 11, 2006.
Entry: Long the U.S. dollar/Japanese yen rate
(USD/JPY) at 114.35.
Reason(s) for trade/setup: Last months
Forex Trade Journal featured analysis indicat-
ing dollar bullishness based on price patterns
in the dollar index (DXY). A long trade (in the
dollar index futures) inspired by that analysis
turned out to be a loser. This trade marks a sec-
ond attempt to capture a potential dollar up
move, expressed through the dollar/yen pair.
The dollar has shown more strength against
the yen than other major currencies recently,
despite the late-June, early-July decline. From
mid-May to June 27 the dollar/yen rallied 7.1
percent, while the dollar index gained just a little more than
4 percent; similarly, the dollar gained only around 3.7 per-
cent against the euro.
If the dollar is poised for more strength and the yen for
more weakness, the current pullback in the dollar-yen rate
is an opportune entry point. On July 10, the currency pair
capped a three-day decline by making a new 20-day low
but rallied to close near its high.
Initial stop: 113.31, 0.13 below the July 10 low.
Initial target: 116.60, 0.10 below the June 27 high. Take
partial profits and raise stop.
RESULT
Exit: 116.60 (first half); 116.40 (second half).
Profit/loss: + 2.25 (first half); +2.05 (second half).
Reason for exit: Initial target hit (first half); trailing stop
hit (second half).
Trade executed according to plan? Yes.
Outcome: The trade benefited almost immediately from
the Bank of Japans July 14 announcement it would raise
interest rates (to 0.25) for the first time in six years. The yen
stumbled prior to the announcement (the dollar-yen rate
jumped more than a full point on July 12) and fell further on
the actual news.
Price hit the initial target of 116.60 on July 17, at which
point the stop was raised to 115.77 (0.39 below the low of
the day), locking in a profit on the total trade. Another up
move the next day took the dollar/yen to 117.57, and the
stop was raised again to 116.41.
The high of the move (117.87) came the next day, July 19,
but the market also turned lower that day, closing at 116.87.
It took two more days for the trade to be stopped out.
In retrospect, it seems as if taking additional profits on
the move above 117 would have been prudent, but at the
time there was no way to know whether the market would
reverse or keep running.
Note: Initial trade targets are typically based on things such as the his-
torical performance of a price pattern or trading system signal.
However, because individual trades are dictated by immediate circum-
stances, price targets are flexible and are often used as points at which
to liquidate a portion of a trade to reduce exposure. As a result, initial
(pre-trade) reward-risk ratios are conjectural by nature.
THIS MONTHS
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tially disrupt the global economy.

Event: The Wealth Expo

Event: The Forex Trading Expo

Event: Traders Retreat

Event: Linda Raschkes 10th Annual Trading Seminar

Event: Second Annual MARHedge Trading Forum

Event: The Traders Expo Las Vegas

Event: 22nd Annual Futures & Options Expo

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