Category Archives: Forex Analysis

General forex analysis and broad market themes

Quiet day favours further risk appetite

I have to score the ho-hum day in markets on Friday as a win for the bulls. I expected a further pullback in risk sentiment, especially with the soft Italian bond auction. My feeling is that this means EUR/USD is on its way to 1.44 and USD/CAD down to 0.9800.

I live blogged all day Friday at ForexLive so some expanded thoughts are there. My end-of-day comments are at Intermarket Strategy.

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Trade Review: AUD/CAD (+311 pips)

Entered AUD/CAD long at 1.0248 on 12 Aug added on Aug 15 at 1.0295. Exited 23 Aug (+147 pips) at 1.0395 and 30 Aug (+164 pips) at 1.0459. Result: +311 pips.


Entered with a stop at 1.01 and a target of 1.05. Greatest open loss: 80 pips Greatest open gain: 340 pips.

Technicals were the primary driver for a long AUD/CAD entered on Aug. 12. The weekly chart caught my attention due to the dragonfly reversal. I also noted how rate hikes were overpriced in Canada.

My full reasoning was here

I noted that my next best idea was short CHF/JPY and that would have also been an excellent trade that was never in a negative position and gained as much as 600 pips in the same time frame.

After the break of 1.03 on Aug 14, we waited for a pullback and doubled our long position at 1.0295.

On Aug. 17 we noted there was no reason to take profits but the pair went on to post its worst one-day performance of the trade, falling 100 pips.

Despite this, we remained confident and felt a bounce to 1.03 (at least) was about to happen.

We went back to the weekly chart on Friday and it continued to look lucrative.

On Aug 22 we were rewarded with a surge to 1.04. We accurately saw this as a great time to take some profits. This allowed us to hang onto the second part of the trade for an additional 60 pips (above where we sold the first unit).

What I’ve learned: I may have rushed into buying the second unit after the break of 1.03. As we saw, there was a deeper pullback than I anticipated and this was the only time I was nervous about the trade. I targeted 1.05 so I may have exited the trade too soon. The weekly chart looks like it will get to at least 1.0550 but I’m nitpicking at a great trade.

 

What I’m happy about: Lots. I saw a lucrative pattern on a weekly chart and hung onto the trade for close to three weeks. The thing I’m most proud of is the way I sold the first part of the trade at the perfect time, nearly nailing the top on the bounce over 1.04 and locking in a nice profit that allowed me to easily wait out the next run toward the ultimate target. Opening a trade with two units or adding a second unit early on is my favourite manner of trading because it gives me this flexibility. I’m also pretty happy about noting that short CHF/JPY was my second favourite idea.

 

 

 

 

 

 

 

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Taking Stock, Looking to Buy USD

Today marks one month since The New Crisis started. It’s a good time to reflect and flesh out some thoughts on markets and where we’re heading. The lone trading position we’re holding is a long AUD/CAD position. He sold half of it for a 150 pip profit earlier in the week and we’re holding the other half, expecting it to go to 1.05 (spot is at 1.0348, about 50 pips higher than our entry point).

We planned to post far more trading tips here over the past month but it has been such a fast, emotional market that there haven’t been the clear trends and signals that I’m looking for. We blogged about GBP/USD for several days but the elements never aligned for us and we stayed on the sidelines. At the moment, we are thinking about jumping in on the short side.   First, let’s talk about the past month. Thinking about that time, the events that pop into my head the most quickly are:

  1. The debt ceiling debate
  2. The S&P downgrade
  3. Q2 GDP and the revision to +0.4%
  4. The Philly Fed falling to -30.4
  5. Consumer sentiment (Reuters/U Mich) falling
  6. The volatility
  7. The run/retreat in gold

 

So what has changed?

The clear casualty has been confidence. It’s hard to believe all those events took place in only a month because they have profoundly changed the mood in markets and the mood in the United States. Talk of a second recession is ubiquitous and in some ways, that is a self-fulfilling prophesy.

My own feeling is that the US will avoid a technical recession but the outcome will be far worse. It has long been my belief that the US is about to repeat the Japanese ‘lost decade’. Very slow growth and very low inflation for a very long time.

Given the differences in US culture, income disparity, low personal savings rate and fiscal squeeze the likelihood is that the US experience will be worse than what has occurred in Japan. On the upside, the largest multinational corporations will continue to profit from growth in emerging markets and China. Aside from gold and commodities, these are the only places to invest for the coming decade.

But this isn’t an investing blog, it’s a forex trading blog.

What’s going on now is the process of forming a top. This is most obvious in commodity currencies where you have investors still trying to pile into the carry trade only to be wiped out again. This will end badly. Commodity currencies, especially NZD, are going to be hit hardest in the coming weeks as risk unravels.

Why am I so confident that the risk rally is over?

Simply put: bonds. The fixed income market was first in the financial crisis and it’s first now. The bond traders are the smartest and best on Wall Street. If people are piling into 5-year T-notes at yields less than 1%, something very bad is about to happen in other markets. In this environment, you cannot be long stocks, risk FX or in any trade that has worked for the past two years.

Everything is about to reverse. When that happens where do you want to be? The US dollar. When the panic hits everything will need to be unwound. Traders will want to get out of every trade and the one they’re in the most is short USD.

In the month ahead, we will be looking to buy USD at attractive levels against the commodity currencies as we enter The New, Yet Unnamed, Crisis. The best money is going to be made in the early days so be prepared.

 

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GBP/USD Breaks Out

Cable broke out on Tuesday. In yesterday’s post, we noted that we thought the bias was to the upside, despite the resistance around 1.6475. When that level broke, the pair rallied more than 100 pips. We talked about buying at 1.6500 and perhaps some of you did, but we did not have a buy order in play.

 

The reason we didn’t have a buy order is because we hoped the pair would come back and re-test 1.6475. It’s an effect called ‘buyer’s remorse’ where the pair will re-test a breakout level. This is generally where we like to pickup breakouts. Sometimes we miss the trade but it diminishes the number of false breakouts.

 

With cable trading at 1.6513 at the moment, we are getting an itchy trigger finger. What’s making us hesitant is that we have had 5 consecutive days of gains in the currency that we believe holds a heavy short interest. The weekly IMM data from the CFTC shows GBP is the only currency held short against the USD. That could mean we have been experiencing a short-covering rally. If that’s the case, it’s probably running out of gas and could reverse.

 

Ideally, we would like to see a day or two of consolidation with the pair generally holding above 1.6450. This would relieve somewhat overbought conditions and give us the confidence to aggressively buy. At the moment, we’re going to wait, watch and stay disciplined.

 

Our AUD/CAD trade was up more than 200 pips on Tuesday but has pulled back to 1.0312, which is still 60 pips above our first unit and 20 pips above the portion we added on Monday. We will stay patient but might trim some of our exposure on a close below 1.0296. We are still very confident in this trade and like how the technicals have progressed.

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Cable at Inflection Point

We are awed by the trading possibilities of the GBP/USD daily chart at the moment. We see amazing opportunities to make money long or short depending how the market breaks.

GBPUSD Aug 16

GBP/USD Daily Since Jan

Cable hit the highest since May on Tuesday but it only exceeded the prior high by one pip before slipping back below 1.6450. The area around 1.6475 has now become a critical inflection point. We see a minor bias higher because the break lower after the first two tries at 1.6474 was rejected so aggressively. What makes us hesitant to buy is the lack of follow-thru above 1.6475 on the break.

If cable does break above 1.6475 we don’t expect 1.6547 to offer much resistance. Instead, we anticipate a straightforward rally to 1.6747 and a likely test of 1.7000.

We are in no rush to jump in here. We may see a slide all the way down to 1.6325 before we get the conditions to rally. We will buy on a break above 1.6500.

Alternatively, if GBP/USD falls below 1.6300, we will sell on expectations of a move back to 1.60, or lower.

In either case, we expect to make upwards of 200 pips, so we can afford to be patient.

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Bought AUD/CAD at 1.0248

Technicals were the primary driver for a long AUD/CAD trade I entered Friday. I announced the trade on twitter via FX_Button.

 

Every Friday, shortly before the market close, I take a look at the weekly charts and see if anything jumps out. This turnaround, along with probably reversals in CHF crosses caught my attention. The reversals in CHF look convincing but I’m reluctant to fight the huge upward trend in CHF.

 

Let’s have a look at AUD/CAD weekly chart.

 

AUDCAD Weekly Aug 12
AUD/CAD Weekly One-year

The dragonfly doji reversal pattern is what jumped out. AUD also looks strong against USD but with this trade I minimize the difficult risk on/risk off trade.

 

Breaking down the fundamentals also creates a convincing trade. Despite the furor about the soft AUD jobs data and potential rates cuts this year, we are not yet convinced. The RBA took a small step toward HIKING rates at the last meeting, while warning about potential downside risks off shore. It appears as though some of those risks are coming to pass (esp. in US and Europe) but that, alone, will not be enough for the RBA to cut rates. At the same time, Chinese and Japanese data has been stronger than expected.

 

The same risks apply to Canada. What leaves CAD more vulnerable is that the market is pricing in rate hikes in Canada in the coming six months. With US growth faltering, we highly doubt those hikes are still on the table. If fact, we see the BOC as more likely to cut rates that the RBA.

 

With this trade, we will look to add around 1.03 for an initial target of 1.05. So far the early Asia-Pac trade has been good to us after a curious rally in CAD in the final 30 minutes of trading on Friday but us behind 35 pips almost immediately. Those losses have been recovered with the pair gaining 80 pips so far this week.

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July Trade Review: USD Longs (-60 pips)

USD longs versus CHF (at 80.12) and JPY (at 77.92) on July 27. Stopped out of both trades on July 29 July 29. Result: -60 pips

USDCHF trade analysis July 27
USD/CHF Hourly July 25-30
USDJPY trade analysis July 27-11
USD/JPY Hourly July 26-30

Entered with stops at 79.82 (30 pips) and 77.62 (30 pips). Greatest open loss: 30 pips. Greatest open gain: CHF +34 pips; JPY negligible

I entered this pair of trades at the same time. This was late on Wednesday, with a weekend debt ceiling deadline looming. The idea was simple: any good news about the US debt ceiling debate would lead to a pop in USD/JPY. At the same time, USD/JPY had leveled out around 0.8000 so it looked well supported.

What I should have known better: Never bet on the sanity of US politicians. They continued to bumble along until the weekend and eventually made a deal with hours to spare before the Aug. 2 deadline. Part of the reason I erred was because I believed it was necessary to have a deal before the weekend. Media reports mislead me. The lesson, I guess, it to only trade politics if you know the system inside out.

What I’m happy about: The stop was certainly in the right spot. I for 30 pips I bought myself 36 hours of negotiations. When the deal was finalized, it led to a 120 pip (JPY) and 140 pip (CHF) bounce. The rallies were about what I expected. So I took a gamble with 4×1 odds in my favour and lost on bad timing.

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Focus on Rumours and Financials

Rumours like the ones we saw today about trouble at SocGen are just the beginning. The three L’s of the rumour-monger are about to take front stage: liquidation, losses, litigation.

The 17% drop in the S&P 500 since the beginning of July is going to generate fund liquidations. Every holding in a funds will get rag-dolled when overall losses in the fund are in excess of 20%. The rumours of withdrawals and liquidations will cause many magnitudes more damage than the withdrawals themselves.

Losses are coming in an economy that is underperforming expectations. As Warren Buffett said: “It’s only when the tide goes out that you learn who is swimming naked.” Financials are especially vulnerable because talk and rumours of losses ALWAYS precede the real thing and cause far more damage.

Litigation is a special ‘L’ in the list because the declines now are coming on the heels of the financial crisis. We are now precisely in the window of time (3-4 years after the event) when lawsuits will peak. Talk of $40-50 billion in lawsuits hitting Bank of America related to mortgage fraud have hit. The desperation in the economy and markets is going to spark others.

We are major believers in following central banks for guidance and with what we heard from the Fed and the RBA in the past 10 days, we think the message is clear. The US is on the precipice of another recession. Now it’s time to sort out who will survive.

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Stocks Have Bottomed But AUD Hasn’t

The S&P 500 will continue to rebound after the post-FOMC rally but forex market risk trades like AUD/USD will underperform as the market adjusts to the zero-growth reality in the United States.

The FOMC decision set off a wild round of trading. In less than two hours, the S&P 500 traded in a 117 point range. Eventually stocks closed at the daily highs and pulled risk trades along for the ride.

Here are some highlights of the FOMC decision:

  • The Fed committed to keeping rates low until “at least through mid-2013”
  • Three FOMC members dissented to ‘mid-2013’ saying they preferred to keep the vague commitment to low rates “for an extended period.”
  • The Fed said growth so far this year “has been considerably slower” than expected. They noted a deterioration in the labor market. There is no longer any mention of “the recovery”. They also noted that temporary factors like the tragedy in Japan account for only some of the recent weakness.
  • Previously, the Fed said it expected the recovery “to pick up” in the coming quarters. It now expects “a somewhat slower” place of recovery. They compounded the downgrade by saying that downside risks have increased.
  • The outlook for inflation was downgraded.
  • The Committee discussed the range of policy tools available to promote a stronger economic recovery… and “is prepared to employ these tools”

The final point was key because it helps explain the rebound in risk assets. It sounds like the Fed has several ideas on how to boost the economy, if need be. The thinking is that after Jackson Hall something will be implemented. This was the course of action with QE2.

To us, a larger factor was the relative value of stocks compared to bonds. After the FOMC, ten-year Treasury yields touched a record low of 2.03%. Dividends on 22 of the 30 stocks in the Dow yield more than 10 years and the average yield is 3.26%. The market tried to bully the Fed into QE3. The Fed didn’t bite (yet at least) so the market took a second look at where it could stash its money and decided risk assets were still a good bet.

That’s the takeaway for the immediate term, but what about the next 4-6 months?

We believe the market is in the process of pricing in a long period of near-zero growth in the US — something akin to the Lost Decade in Japan.

The US government is tapped out and spending cuts will continue no matter the economic state. This will be a headwind to growth, cutting about 0.5% per year from GDP.

The Fed is tapped out as well. There is nothing the Fed can do to lending rates that will stimulate growth. Borrowing rates are next-to-nil and we they don’t have a mandate or the power to get the economy moving.

This scenario may sound negative for stocks but it’s not as bad as it sounds. 1) Companies with solid (A+) ratings can borrow at extremely low  rates. 2) The worldwide economy is growing, booming in some places. Multinationals are making a larger and larger portion of their revenues abroad.

In the forex market, this doesn’t translate into the ‘risk trade’. Slower US growth will hurt commodities more than corporate profits so commodity currencies will underperform. CAD is especially vulnerable because a) rate hikes are priced in. b) Canada is highly integrated with the US. c) raw commodity exports are a large part of the Canadian economy. d) Canadian house prices are overvalued.

The first thing to break down will be the carry trade. This has already begun and will continue as AUD/USD falls to 90-cents. The Canadian dollar will be the next to decline. Traders will increasingly look to emerging market currencies.

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