Trading Systems, Fibonacci and Forex Q & A

Trading Systems, Fibonacci and Forex Q & A
By Ed Ponsi

Greetings from New York City! I have some great email questions this week about a variety of topics – please keep those questions coming! Let's get started with a question about trading during the U.K. session…

Q) Hello Ed! I've been following you for the past year or so; I like your articles! I have a full time job, and I'm almost sure that I will not be able to wake up around 2 or 3 AM to trade when the London markets open. Is there any pair that I could trade after 5 PM ET? That's when I get home from work ... I think I heard that Australian markets open at 5 PM ET...so AUD/USD would be a good pair to trade (I'm also wondering about volume at this time of day).

Ed Ponsi) Thank you for your question. There was a time when I used to get up around 3:00 am (New York time) to place trades at the beginning of the London session. Since London is 5 hours ahead of New York, 3 am New York time translates to 8 am London time – a time of day when breakouts are common. Breakouts are common at the beginning of the London session because London is the world's capital of Forex trading. There is a tremendous rush of volume that enters the market at this time because so many big institutional traders are based in the U.K. and Europe. It is also the time of day when economic news out of the U.K. hits the newswires. Here's an example; on December 1, 2008, the GBP/USD broke out of a sideways consolidation at around 8 am London time (3 am New York time). The pair fell nearly 400 pips over the next eight hours (see figure 1).

Figure 1: GBP/USD hourly chart shows a breakout at the start of the U.K. session. Source: Saxo Bank

If you are looking for particular pairs to trade at around 5 pm New York time, you are correct to be concerned about volume. 5 pm Eastern is a "dead zone", and any moves that occur at that time are likely to retrace. If you are working regular hours and do not wish to get up early, why not wait until the Asian markets really get rolling, around 7 pm New York time? The Japanese Yen tends to be very active from about 7 pm to midnight, so you might find great trades in EUR/JPY, GBP/JPY, and of course USD/JPY. Good luck!

Q) Great article and agree with your conclusions. On the subject of Fib fans and arcs, I believe the reason why they work is because of business cycles, reporting periods and accounting periods. There could a coincidental reason why an FX pair has a major turn about the same time each year or it could be that the flow of money may have something to do with it. Small turns are not as obvious but the major ones are. Time, price and astronomical observations are what Gann theory is based on and I postulate the time factor is what makes arcs and fans tend to work.

There are so many unanswered occurrences in life and we are never going to be able to explain them so your simplistic approach works fine. I tried for almost a decade to get Gann theory to work and now believe that simple is best. Our psychological side I believe is more important than all of this complexity.

Ed Ponsi) Very well put. I also made that journey from simple support and resistance to gradually more and more complicated systems, culminating in Elliot Wave and Gann techniques, and guess where I wound up? I ended up right back where I started, with simple but robust trading techniques that are based on market tendencies. I think it is intuitive for intelligent traders to believe that highly complicated systems might be more effective than simple techniques, but my experience has been the opposite – it was the simple things that wound up being the most effective, at least for me. To me, this is just another example of the counter-intuitive nature of trading. For the uninitiated, here is a Gann wheel (see figure 2).

Figure 2: A Gann wheel, designed to predict both price and timing of market moves. Source: Acrotec

Q) Dear Ed, thanks a lot for your informative articles on Forex trading. I've been a Forex trader for over one year. I have tried Forex signals, trading systems, trade analysis from pros. But still it ain't easy. My main question is, what is your comment on the trading systems out there? Is there anyone that you have ever tried and what were the results? I subscribed to XXX (signal provider company name removed by E.P.) but it made me lose a lot of money (demo of course). I also subscribed to another signal provider who was also so inaccurate. Please start a debate about the trading systems.

Ed Ponsi) Thank you for your email, I'm very thankful that you decided to try out this trading system in a demo account. I wish there were more room for debate on this topic, but I feel strongly that there is little of anything of value to new traders in the form of signal services, trading systems, etc. – in fact, there are many shady operators working in this area. I would like to refer you to an earlier article that I wrote on this topic titled, "Scamming the Scammers", that might be helpful in understanding this part of the trading world.

Most of these scammers measure their "performance" in terms of how many pips they made. What they don't tell you is how many pips they lost. By the way, no real trader measures his or her performance in this manner. Real traders measure performance in terms of percentage gains/losses over the course of a month, quarter, year, or since inception.

Here's the bottom line – you have to learn how to trust your own analysis. This can only be done by doing the work and learning to trade correctly. Once you can analyze currencies yourself, you'll stop looking to outside sources such as the ones mentioned above. Signal services and trading systems may seem like nice shortcuts to the novice trader, but they only serve to delay the real work that needs to be done. Good luck!

More Ed Ponsi on CNBC

As Obama prepares to pick his top economic team, Sean Callow, senior currency strategist, Westpac Bank discusses what this means for the currency markets, with Ed Ponsi, president at FX Educator.com and CNBC's Martin Soong & Sri Jegarajah.

CLICK HERE to view

Citigroup's shares are worth 5-6 times more than where they are right now, says Bill Smith, president, SAM Advisors. He tells CNBC's Martin Soong why he is still holding the stock while Ed Ponsi, president at FX Educator.com explains why he would choose to do the opposite.

CLICK HERE to view

The Great Fibonacci Debate

The Great Fibonacci Debate

By Ed Ponsi

Greetings from Acapulco! Even in mid-November, the weather here is warm and sunny - perfect for the beach. I have a great question from a reader this week about Fibonacci. Fib strategies have become very popular, but today there are so many permutations and variations on this basic theme that sometimes the useful aspects of this technique get lost in the shuffle. This question opened the door for what we might call the "Great Fibonacci Debate". Read on!

Q) Hi Ed, I have a few quick questions about Fibonacci arcs. Do you think they have any value, and do you use them? To me it seems like a working idea (Fibonacci numbers) is being taken a step too far (like calculating an RSI on an RSI). I've always thought, the more lines you draw on a chart, the more chance you have of the price being around one of the lines.

With the arcs sometimes the price "stalls" above or below them, but I can overlay a drawing my 3 year old son made and find the price stalling around his lines too :) And of course, the examples found in books and on the web are chosen as examples because they prove the author's point.
In your books you stated that you were a bit skeptical about Fibonacci numbers until seeing that they work. I was the same until reading your book and seeing them work while watching prices move. Also, as you said, because their use is so widespread, it becomes a self-fulfilling prophecy. The use of Fibonacci arcs doesn't seem so widespread, and I'm not sure whether they work because of some "mystical" order in the universe or not...Thank you in advance for your answer.

Ed Ponsi) Thank you for your question, you are right on the money. I agree that Fibonacci is a self-fulfilling prophecy, in other words it works because people believe it will work. For example, let's say that some traders believe that Fibonacci works, maybe even big traders like institutions, banks, and hedge funds. If these traders believe that EUR/USD will hit resistance when a leg of the downtrend retraces 38.2%, some of them will place sell orders at that exact point. If enough sell orders accumulate at that level, a wave of selling pressure will be unleashed on the currency pair if and when the 38.2% level is reached. Perhaps that is what happened in late October, as EUR/USD rocketed straight up to the 38.2% retracement of the move that began in mid-September and promptly reversed (see figure 1)


Figure 1: 38.2% Fibonacci retracement acts as resistance on the EUR/USD daily chart. Source: Saxo Bank

Is this a coincidence? It could be, but isn't it kind of strange that a movement of about 2500 pips would choose that exact location to stage a major reversal? I was highly skeptical of Fibonacci techniques when I first learned about them, but I have seen so many cases like the one above that I've become a believer myself.

Now if I'm correct in my assessment that Fibonacci works because it is self-fulfilling, then it makes sense to use it in the form that is used by most traders. You'll notice that in my examples, although I often display additional levels, I use only the 38.2%, 50%, and the 61.8% Fibonacci retracement levels – that's all. I don't use Fib extensions, Fib arcs, or Fib Trendlines. I stick with the major retracement levels because that's where I believe most traders focus their attention. After all, we don't want our order sitting out there alone; on the contrary, we want as many "friends" as possible entering the same trade at the same time as we are. A large enough quantity of buy or sell orders, bunched up together in a strategic location, could change the direction of the exchange rate.

So what about Fibonacci Fans? These are Trendlines that are created from Fib retracement levels. Now I don't necessarily believe that Fib Fans are used as widely as Fib retracements, so I don't use them. On the other hand, take a look at the recent action on the daily chart of USD/CAD; after staging a huge rally, the pair pulls back to its 61.8% Fib Fan line before finding support. Again, this could be a coincidence – in fact I believe it probably is a coincidence, because I don't believe that huge numbers of institutional traders are using Fib Fans as a part of their analysis (see figure 2).


Figure 2: 61.8% Fibonacci Fan line acts as support on the USD/CAD pair. Source: Saxo Bank

Finally, there are Fibonacci Arcs, Fibonacci Extensions and the rest of the ever-growing Fibonacci family of indicators. Fibonacci Arcs are curved lines that anticipate support and resistance in the same way that Fibonacci Fans do. I don't use them personally, because I don't believe that they are widely used by institutional traders. It's helpful to keep the following in mind – software that provides Fibonacci Arcs and hundreds of other indicators to Forex traders have only been widely available to the general public for about fifteen years, since the dawn of the internet boom. Yet somehow, traders made money before all of this fancy software became available. Could it be that traders made money over the years by keeping things simple, without all of the bells and whistles that are available today, and that modern day traders are turning the simple act of trading into an overcomplicated mess? Hmmm…

In recent years, it has also become trendy to use Fibonacci settings on moving averages and Bollinger Bands, among other things. In my opinion this is just ridiculous; it's not as if these numbers contained some magic key to the universe, so let's not treat them that way. In summary, if you're new to Fibonacci, take it slow and stick with the basic stuff, like Fib retracements, and good luck!

Too Funny - Ed Ponsi on CNBC

Watch me crack up the hosts of CNBC's Squawk Box with my comments on Citibank...near the end of this video.

CLICK HERE to watch the video

The Pound is Losing Weight

The Pound is Losing Weight
By Ed Ponsi

Hello from New York! It seems that one of my comments from last week's article confused the heck out of a few folks, and that's not surprising because it goes against conventional Forex trading wisdom. Please take a look:

Q) Hi Ed, just a quick question regarding your newsletter, I found it great. You explained in the last few lines that 'When the ECB and the Bank of England get serious about growth and cut rates more deeply, expect to see these currencies recover'. Is it not true that currencies get weaker if the interest rate is lowered? Can you explain what I am missing? Look forward to reply.

Q) It has always been my understanding that when there are rate cuts, the currency tends to weaken, not recover. It seems that the UK and EU have a lot farther to go with regards to rate cuts and therefore, the currency has more potential to weaken than the US dollar. Is this still the case?

Ed Ponsi) Thank you for your questions, it's nice to know that someone is paying attention! You're both right, conventional wisdom would say that higher rates would support the Euro and the British Pound, yet I stated that rate cuts were needed to improve the weakness we've seen in these currencies. Have I lost my mind? Not completely, but that's a question for another newsletter.

In a normal market, I'd agree that conventional wisdom would apply, and that lower rates would hurt the Pound and Euro – but the situation we find ourselves in is anything but normal. The fact that the Euro and Pound have higher interest rates than the U.S. Dollar has done nothing to prevent them from being crushed over the past three months, and currencies with even higher yields, like the Australian Dollar and the New Zealand Dollar, have been equally bad (unless you're short). In the current Bizzarro World of Forex trading, it is the low yielding currencies that have taken center stage as the strongest currencies, and the high yielders that have fallen the hardest – the exact opposite of normal Forex activity. Here is the current interest rate environment for the major currencies:

Currency

Interest Rate
New Zealand Dollar 6.5% Australian Dollar 5.25% Euro 3.25% British Pound 3.00% Canadian Dollar 2.25% Swiss Franc 2.00% U.S. Dollar 1.00% Japanese Yen 0.3%

Consider this; the two best performing currencies of the major currencies during the third quarter have also been the two with the lowest yields – the U.S. Dollar and the Japanese Yen. In the U.S., the Fed Funds Rate sits at 1.00%, and is expected to fall to as low as 0.5%. Meanwhile, the Bank of Japan has lowered rates to 0.3%. Yet the greenback and the Yen have been crushing everything in sight - it's the carry trade in reverse!

Here's the way I see it – all of the above countries are going into or are already in a recession, and the policy of keeping rates relatively high in Europe and Great Britain is going to lead to an even deeper recession in those places. Mervyn King and Jean Claude Trichet, the respective leaders and chief policy makers of the Bank of England and the European Central Bank, seemed unduly concerned about inflation at a time when growth should've been the major concern. But as we will see next, that view is changing...

Q) Hi Ed. Wow exactly it happened!

"If the entire civilized world is falling into a recession, why is the Pound taking it on the chin? The Bank of England's Monetary Policy Committee has simply been too slow to cut the U.K.'s benchmark interest rate, which remains at 4.5%. The MPC's reasoning is that it must control inflation, but with world markets collapsing and crude oil falling below $70 per barrel, the pendulum has shifted and the time for action has come. In my opinion, the MPC should immediately be cut by another 150 basis points, but that's highly unlikely. I'm looking for more downside on the Pound."

You know what I feel today, I think King Mervyn has signed up for your newsletter and he's simply following you. Just kidding, anyway what is your opinion now on GBP after their rate cut? Thanks, keep up the good work.

Ed Ponsi) Thanks for your email and your kind words. The big rate cut by the Bank of England shows that King and the Monetary Policy Committee now "get it", however belatedly, and that the problem is not inflation, it is growth. In a complete about-face, King now says he is ready to reduce rates to 'whatever level is necessary' to counter the economic storm. Some even believe a zero percent rate is possible in the U.K. next year. That's a far cry from his "fight inflation" mantra from earlier this year. Don't be surprised to see the BoE cut by another 100 basis points as they try to get on top of the growth problem – a problem that would've been less damaging if they hadn't fallen behind the curve earlier. The damage is reflected in the daily chart of GBP/USD, which continues to spiral downward (see figure 1).

Figure 1: GBP/USD continues to probe new lows, crossing below 1.5000. Source: Saxo Bank

How low will it go? Nobody knows for sure, but I certainly wouldn't recommend stepping in front of this freight train. A look at the monthly chart shows big support at 1.4000, formed way back in the early part of this decade, which could come into play (see figure 2).

Figure 2: GBP/USD monthly chart shows a major support near 1.4000. Source: Saxo Bank

Last but not least, the GBP/JPY currency pair, one which we've been bearish for months, continues to plumb the depths and is also threatening to reach new lows (see figure 3).

Figure 3: Descending triangle on GBP/JPY suggests new lows are coming. Source: Saxo Bank

Once again, don't fight the trend. Good luck!

Forex TV - PM Exchange

Hi Everyone,

Here is a clip from yesterday's Forex TV appearance. We discuss the immediate future for the US Dollar, the Euro, the British Pound, and the Japanese Yen. Enjoy!

Dollar and Yen on Fire, But For How Long?

Dollar and Yen on Fire, But For How Long?

By Ed Ponsi

The plunge in EURUSD has Americans everywhere asking one very important question: is it too late to catch a flight to Germany for Oktoberfest?

Greetings from London! We are living and trading in historic times, as the credit crunch has thrust the U.S. Dollar and the Japanese Yen into the stratosphere, while crushing the British Pound, the Euro, and other major currencies. To get a feel for the scope of this move, let's have a look at the monthly chart of the Great Britain Pound – U.S. Dollar chart (symbol GBP/USD). We can see that the GBPUSD rally, which lasted for the better part of this decade, has given back the majority of its gains in just three months. A drop of nearly 4000 pips has sent the pair crashing through all of its major Fibonacci support levels.

London is one of my favorite places to visit, but it's even more fun for an American like me when my currency has some real buying power. For example, a nice meal at the pub next door to my hotel still costs about 30 GBP, same price as usual. Last November, when the GBPUSD exchange rate was about 2.10, that meal cost $63 (30 x 2.10 = 63). Now that the exchange rate has plunged to 1.60, that same meal, as measured in U.S. Dollars, costs just $48 (30 x 1.60 = $48). Now take that meal and multiply it by all of the goods and services that Americans purchase from the U.K., and you get a feel for the size of this move, and the impact it has on these two countries.

Of course, the rise of the dollar is not contained to the British Pound; the rampaging U.S. currency has also undone most of this decade's Euro rally as well. The plunge in EURUSD has Americans everywhere asking one very important question: is it too late to catch a flight to Germany for Oktoberfest? Sadly, the answer is yes. If it seems like it's only been a few months since the once-mighty Euro was smashing it's way to new all time highs vs. the greenback, that's because it really has been just a few months.

The buck is rallying due to frazzled investors dumping shares and stashing the proceeds into U.S. Treasuries, one of the best ports for financial safety in any storm. When you buy a Treasury, you are really lending money to the U.S. government. The vast size of the U.S. government's debts makes for a huge, liquid market in U.S. Treasuries, where institutional traders can ride out the storm. For more on this topic, check out last week's article "Forex and U.S. Treasuries".

Although the USD has rocked the house recently, there is another currency that has been so strong, it has even beaten the buck. Of course I'm talking about the Japanese Yen, which has been on an incredible roll vs. the rest of the world. The Yen has performed particularly well against the Great Britain Pound, which comes as no surprise to regular readers of this column. Two weeks ago, we walked readers through a short sale trade of GBPJPY, and in an early September article we laid out the technical case for shorting this currency pair, followed by another article that presented a fundamental argument for selling it. Well, I don't think anyone could have anticipated what a fantastic pair this would be to sell short, as GBPJPY crashed to multi-year lows. Once again, thanks for your kind words and congratulations to all of you who shorted GBPJPY along with me

I'm sure many of us wish the GBPJPY Express would continue its southbound trek, but nothing lasts forever. While its way too early to call an end to the trend, its might be difficult for the Yen to keep this pace due to the threat of intervention by the Bank of Japan and other Group of Seven central banks. In other words, Japan is threatening to sell the Yen in massive quantities in order to weaken it, causing pairs like GBPJPY to rise. Because Japan has an export based economy, a strong Yen is bad for business, as big exporters like Toyota and Canon are losing sales due to the falling exchange rates of USDJPY, EURJPY, and GBPJPY. Japan may even get help from other G7 countries in weakening its currency, according to an October 27 statement from the G7 itself. This rare currency volatility warning by the G7 has been interpreted as a sign that Japan and others may step into foreign exchange markets and artificially force down the Japanese currency if the Yen continues on its current rampage.

"We are concerned about the recent excessive volatility in the exchange rate of the yen and its possible adverse implications for economic and financial stability," said the G7 statement. While this may sound innocent enough, the implications of the statement are huge. If Japan intervenes, the real winner will be the U.S. Dollar, the currency that the Bank of Japan (BoJ) is most likely to buy in mass quantity as it is selling Yen. If the BoJ starts pushing USDJPY higher, do not get in the way – in its last major intervention, the central bank caused USDJPY to climb about 700 pips over a three-week period in early 2004.

Last but not least, thank you for all your kind comments and emails regarding my recent series of appearances on CNN. Yes, it was a blast and as you can tell, I loved every minute of it.

Ed Ponsi

Forex and U.S. Treasuries

Hola from Mexico City! It seems that the markets are interconnected to a greater degree than ever before – last week's article on the Dow/ Japanese Yen trade is just one example of this phenomenon. With that in mind, I have a great question from a reader this week regarding another important relationship - the impact of the buying and selling of U.S. Treasuries on the Forex market. Here it is!

Q) Hi Ed, I follow your work and it's provided some very good insight. I have a two-part question. With all the short term volatility we're seeing, I read that the TED spread is one of many good barometers for this. In order to gauge the next stage in the cycle should we be looking at the 2 year or 10 year Treasury to gauge what's coming 6 months to a year from now? Also, how are the Treasury yields interpreted? Thanks for your response.

Ed Ponsi) Thank you for your question, I'll take part two of the question first. When it comes to interpreting Treasury yields, there is an inverse relationship between price and yield. In other words, when the price of the bond rises, that bond's yield falls. For example, let's say that you purchased a new bond with a yield of 4% at a price of 100, also known as "par". Let's assume that a year passes, interest rates rise, and new bonds come available that yield 5% at par. Well, assuming that the safety and the maturity date of the bonds are similar, the 4% bond is no longer as attractive as the 5% bond. You can't sell the 4% bond for 100, because bond buyers will simply opt to purchase the higher-yielding 5% bond at the same price. So, you must sell the bond at a discount price. To the new purchaser, his return on the 4% bond is actually closer to 5%, because when it matures, the bond he purchased at a discount (less than 100) will be worth 100. This makes up for the fact that the bond yields only 4%.

The recent fear that has gripped global markets is reflected in all maturities of U.S. Treasuries, but especially on the short end, for example the 3-month Treasury bill. Why is so much of the action contained in the near-term maturities? Imagine that you are a hedge fund manager, and you want to protect your clients. You simply want to get out of the markets and stash that cash in a safe place. You start buying 3-month Treasuries (T-Bills), because no matter what happens, you are going to get all of your money back at par within three months. Fund managers, investment bankers, and other investors, both individual and institutional, have been piling into T-Bills at an incredible rate – they have been buying, which drives the price higher and the yield lower. Here is a chart of the yield of a three-month T-Bill (see figure 1).

Figure 1: The yield on 3-month T-Bills craters in mid-October. Source: theFinancials.com

Last week, the yield on 3-month T-Bills dropped to virtually nothing. Investors were scooping them up anyway, because in a risky environment such as the one we're in right now, the philosophy of "better safe than sorry" is the way to go. Investors enjoy the certainty of knowing that no matter what happens to the price of these investments between now and the maturity date, they will mature at par.

The same can be said for the 2-year and 10-year Treasuries, but that is a longer time to wait and a lot of opportunities missed until maturity. So traders who opt for Treasuries with longer maturities have "price risk" – if they want to free that capital to invest at any point prior to maturity, they will have to take what they can get on the open market when they sell those Treasuries. Short and long term maturities offer the certainty of knowing that you can get your capital back at par, but many of the current buyers of 2-year and 10-year Treasuries will not wait until maturity to cash out. Somebody out there has been buying 2-year Treasuries, as evidenced by the chart (see figure 2).

Figure 2: 2-year U.S. Treasuries rise in price as the credit crunch intensifies. Source: Saxo Bank

This is a weekly chart of the price of 2-year U.S. Treasuries. The huge spike that appears to occur in late 2007 is a "bad tick" and should be ignored. A rising price indicates that investors are buying, and as the price rises, the yield is falling. Notice how the price begins to climb in the summer of 2007 - right around the time when the word "subprime" entered our vocabulary. Prices fell (and yields rose) in early 2008, as markets calmed down a bit, and then prices began to rise again (driving yields lower) this summer as the crisis became full-blown with the collapse of Lehman Brothers.

Regarding the TED Spread, which is explained in this previous article, it is a terrific way to gauge market fear, much like the VIX (volatility index). Both have come off of extreme highs, showing a possible light at the end of the tunnel for equity markets (see figure 3).

Figure 3: TED Spread drops suddenly, indicating greater confidence in bank lending. Source: Saxo Bank

It appears that banks are now more willing to lend money than they were last week, when the TED Spread hit its recent peak. Still, the level of fear is much higher than normal. Prior to the collapse of Lehman in September, the TED spread was about 1%. If it falls back into that 1% range, it will indicate that confidence has returned, and that the worst of the credit crisis may have passed. That would bode well for stocks, and bond prices would likely fall as traders pull money out of Treasuries and put that capital to work in the equity markets.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Ed Ponsi

The British Pound Gets Pounded

Tomorrow, I'll fly to London, a place I visit often on business. For many Americans, London has been as expensive place to visit during the past few years, but it's becoming cheaper by the minute as the British Pound has plunged beneath $1.63.

This represents a drop of 48 U.S. cents since the Pound peaked at $2.11 back in November. That might not sound like much, but in the highly leveraged world of Forex trading, it is a huge move of 4800 pips. A big chunk of that move, about 1000 pips, has occurred over the past three days.

What is wrong with the British Pound? Well, Prime Minister Gordon Brown has made it clear today that the U.K is heading into a recession, echoing comments made earlier this week by Mervyn King. King, the Governor of the Bank of England, also commented that the U.K.'s banking system was closer to collapse earlier this month than it has been since World War 1.

The amazing collapse of the British Pound has unwound most of the currency's gains for this decade against the U.S. Dollar. Measuring from the low point of June 2001, when the GBP/USD pair reached a nadir of $1.36, and the highs of November 2007, above $2.11, the pair has lost more than 60% of this decade's gains. It smashed through Fibonacci levels all the way down, falling like a piano pushed off of the top of the London Eye (see figure 1).

Figure 1: GBP/USD breaks all major Fibonacci levels on the monthly chart. Source: Saxo Bank

GBP/USD Chart

So where will the Pound go from here? Major support is located in the $1.55 area, which last acted as support in 2003. The rate of decline here is astounding, and traders who buy GBP right now might be catching the proverbial knife. I'll short rallies, if there are any to speak of.

If the entire civilized world is falling into a recession, why is the Pound taking it on the chin? The Bank of England's Monetary Policy Committee has simply been too slow to cut the U.K.'s benchmark interest rate, which remains at 4.5%. The MPC's reasoning is that it must control inflation, but with world markets collapsing and crude oil falling below $70 per barrel, the pendulum has shifted and the time for action has come. In my opinion, the MPC should immediately cut by another 150 basis points, but that's highly unlikely. I'm looking for more downside on the Pound.

One final note, I'm scheduled to appear live on CNN Business International on Monday, Nov. 27. See you then!

Ed Ponsi is the President of www.FXEducator.com and www.EdPonsi.com. He has appeared on CNN, CNBC, the BBC and Fox Business News, and is a frequent guest lecturer at trading events and seminars around the world. Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ponsi is featured on the FXEducator.com DVD series, Forex Trading with Ed Ponsi, and is the author of the best-selling book Forex Patterns and Probabilities

Using Stocks to Trade Forex

How can traders use recent stock market volatility to make money trading Forex?

CLICK HERE to read the article!

Light at the End of the Tunnel

Forex traders have been enjoying incredible volatility lately – provided that they’ve widened their stops and targets. Moves of several hundred pips in one hour are not uncommon, while similar moves used to occur over the course of a day. I’ve been trading the Japanese Yen against the British Pound (GBP/JPY) recently, taking advantage of the weakness in the U.K. economy (and by extension, the Pound) and the fact that the Japanese Yen Loves Misery. There have been plenty of opportunities to sell this pair, which has stabilized - at least temporarily – in the 170’s.

Figure 1: GBP/JPY downtrend has stabilized for the moment. Source: Saxo Bank

GBP/JPY Chart

Using this downtrend as a guide, I’ve been selling the GBP/JPY pair short when the 14-period Relative Strength Index (RSI) indicates that the pair is overbought in the short term. RSI exists on a scale that runs from 0 to 100, with readings above 70 indicating an overbought situation, while readings below 30 point to an oversold situation. A buy signal is given when RSI crosses above 30 after passing below, and a sell signal is indicated when RSI crosses below 70 after passing above. Since the currency pair is in a downtrend, I’m only interested in the sell signals, and I ignore the buy signals. This prevents me from trading against that fierce downtrend that is so clearly indicated in the daily chart (see figure 2).

Figure 2: Two sell signals and one buy signal on GBP/JPY hourly chart. Source: Saxo Bank

GBP/JPY Hourly Chart

How long will this continue? Well, there may be a light at the end of the tunnel. For the first time in weeks, we are getting word that banks are lowering the rates they are charging each other for 3-month USD loans. If this keeps up, expect the credit crisis to ease, and the Yen to reverse. Also, there might be a double bottom forming on the GBP/JPY daily chart (see figure 1). But for now, it’s too early to call the top on JPY, so until the Yen shows some technical weakness, I’ll continue to buy it vs. GBP and EUR.

Ed Ponsi is the President of www.FXEducator.com and www.EdPonsi.com. He has appeared on CNN, CNBC, the BBC and Fox Business News, and is a frequent guest lecturer at trading events and seminars around the world. Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ponsi is featured on the FXEducator.com DVD series, Forex Trading with Ed Ponsi, and is the author of the best-selling book Forex Patterns and Probabilities.

Hang 'Em High!

Hang 'Em High!

By Ed Ponsi

Ed Ponsi examines the Congressional grilling of Lehman Brothers' former CEO, and asks the question: In 2008, is it a crime to have money in America?

The other day, I was placing a short on GBP/JPY, trying to determine the exact location of my stop, when I heard the voice of defeat bleeding through my speakers. It was Richard Fuld, disgraced former CEO of the now-bankrupt investment giant Lehman Brothers, explaining himself before a Congressional committee:

"I want to be very clear, I take full responsibility for the decisions I made and for the actions I took. I feel horrible about what has happened to the company and its effects on so many."

I think it's a great idea to have a committee to determine what went wrong and how a similar boondoggle can be prevented in the future. I sure would like to know the rationale behind the investment grade ratings that were placed on toxic subprime paper. But most of all, I'm interested in learning if Mr. Fuld and his associates at Lehman looted the company on their way out the door. But the committee didn't seem interested in getting to the truth, or in finding solutions. Instead, the committee seemed intent on punishing Mr. Fuld, well, for being wealthy.

Enter Henry Waxman, D-Calif., chairman of the House Oversight and Government Reform Committee. Waxman repeatedly asked Fuld if it was true he made between $400 and $500 million running the company since 2000 – as if Fuld's impressive compensation somehow implied guilt. Waxman listed Fuld's collection of property – including a $14 million dollar ocean-front villa in Florida and a home in the exclusive ski resort of Sun Valley, Idaho. "You and your wife have an art collection filled with million dollar paintings." Waxman said. The chairman seemed more concerned with outing Fuld as a rich guy, as opposed to exposing any wrongdoing.

What is the point of these questions? Are we trying to convict this guy of having money? If so, he's guilty! But in the America where I live, it is not a crime to have money.

There are rumblings of shady dealings in the final days of Lehman, most notably the steering of millions of dollars to executives as the firm was in full collapse. The company allegedly sought $23.2 million in "special payments" for three outgoing executives just days before the collapse, according to internal documents. This disgusting act is the equivalent of looting a gravesite. If that happened, then any and all of the Lehman perpetrators should be prosecuted to the full extent of the law. String em' up! If Fuld was involved, I look forward to seeing him take the "perp walk". He'll have an awfully hard time enjoying that ocean front villa from behind bars.

I'd just like to point something out – Fuld did not benefit from the collapse of Lehman Brothers. In fact, he lost a great deal of his own money, along with his job and his reputation. Fuld still holds about 10 million—now worthless—shares in the firm. Think about that for a second; he lost 10 million dollars for every one dollar decline in LEH stock, which traded near $70 per share about a year ago. That's a loss of nearly $700 million dollars! That had to leave a mark, even for a guy like Fuld. Don't get me wrong, he won't be dining in a soup kitchen any time soon, but that's got to hurt!

Fuld owned all of the wonderful things enumerated by Waxman long before Lehman fell. As far as we know right now, he did not benefit in any way by being the captain of a sinking ship, or by becoming the butt of a million jokes, or by becoming a dark footnote in U.S. financial history. Soon after the bankruptcy announcement, Fuld was allegedly punched in the face by a co-worker in the Lehman gym. Journalist Vicki Ward told CNBC, "He was on a treadmill with a heart monitor on. Someone was in the corner, pumping iron and he walked over and he knocked him out cold.” Ouch!

Yes, he has a lot of money, and that seemed to be the point of Waxman's line of questioning. Fuld would have a great deal more money right now if Lehman hadn't gone under. Why was money the focal point of Waxman's questions? Perhaps Mr. Waxman believes that the public is bloodthirsty and wants revenge, that we can be lured into class warfare, and that we are not concerned with the facts. And while Waxman set the tone, this "Hang 'em high" mentality is also evident in the questions of the other members of the committee. If Fuld committed any crimes – if he was involved in the heinous act of steering millions to executives as Lehman fell – then could we please talk about that, and not simply beat the guy up for being rich? If any crime was committed, then that should be the focus of the discussion. Let's not pretend that it is a crime to have money in America.

Investment Terminology 2008: It's a very good time to be a trader, but maybe not such a good time to be an investor. Still, with the way markets are behaving, those of us who wear both the trading and investing hats could use a reason to smile right about now. On that note, thanks to one of our readers for sending this to me via email:

CEO = Chief Embezzlement Officer.
CFO = Corporate Fraud Officer.
VALUE INVESTING = the art of buying low and selling lower.
P/E RATIO = the percentage of investors wetting their pants as the market keeps falling.
BROKER = what my broker has made me.
FINANCIAL PLANNER = a person whose phone has been disconnected.
STANDARD & POOR = description of an investor's life in general.
INSTITUTIONAL INVESTOR = a frustrated investor who's now locked away in an institution.
MARKET CORRECTION = something that occurs the day after you invest in the market.
CASH FLOW = the movement your investment makes as it disappears down the drain.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

When Central Banks Attack

By Ed Ponsi, President, FXEducator.com

New York City - After yesterday's barrage of rate cuts, today we are seeing salvos fired by the central banks of Hong Kong (50 bps to 2.00%), Taiwan (25 bps to 3.25%), and South Korea (25 bps to 5.00%). This comes hot on the heels of yesterday's simultaneous cuts by the ECB (100 bps), the Fed, the Bank of England, and the Bank of Canada (50 bps), and many others.

All of this cheap money is wonderful, but even if all of the world's central banks cut rates to zero, banks would still be reluctant to lend money. As the old saying goes, you can lead a horse to water, but you can't make that horse lend money to banks at reasonable rates. Or something like that. Nobody is going to put a gun to a banker's head and force him to lend money. Nobody wants to be the last person to lend money to the next victim, the next Bear Stearns or Lehman Brothers.

For evidence of this, take a look at the Ted Spread, a fear gauge that climbed to its highest point in a decade just after the announcement of the joint central bank action. The Ted Spread is the difference between LIBOR and the yield of the 3-month US Treasury, and yesterday it climbed above 4%. This means that banks are demanding 400 basis points above what they would receive from the Treasuries, which have no risk. For most of this decade the Ted Spread has lingered beneath 1%. Banks are demanding higher rates to compensate for the perceived risk of lending to financial institutions.

One final thought; the cover of Time magazine features a Depression-era photo of men crowding in line beneath a sign that reads "Free Soup". I'm not one to call tops and bottoms, but if history is any guide, this could be an early sign of a bottom. Historically, excessive exuberance or excessive pessimism, as reflected by magazine covers and other forms of pop culture, are signs of a market turn. In late 1999, as the Nasdaq was rocketing to a gain of over 80% for the year, magazine covers featuring bulls were all the rage. There were even two prime time TV shows about Wall Street and the stock market. Needless to say, one year later, nobody wanted to talk stocks.

How To Trade In Challenging Times

How To Trade In Challenging Times

By Ed Ponsi

Okay, so things are rough out there. Bear Stearns, Lehman Brothers, Washington Mutual, American International Group, B&B, Freddy and Fannie and the rest of the gang have all either gone to that Big Vault in the Sky, or are on life support. The proverbial "other shoe" has dropped so many times that we've all lost count – and the carnage isn't yet complete. But just because the world is facing financial Armageddon, and long-term investments are falling apart faster than the New York Mets in September, that doesn't mean your trading account has to suffer. In fact, some traders thrive in this rock 'em, sock 'em environment. Just take a look at the volatility in the Great Britain Pound – U.S. Dollar currency pair (symbol GBP/USD). Note how the candles on the left side of the chart are much bigger than on the right, indicating that the daily range has expanded dramatically. Also, take a look at the Average True Range indicator (ATR), which shows us that the average daily range of GBP/USD over the past 14 trading days now exceeds 300 pips! (See figure 1).


Figure 1: GBP/USD's average daily volatility has risen to over 300 pips. Source: Saxo Bank

This level of volatility hasn't been seen since the year 2000, and the type of wild action it creates will be welcomed by some traders and avoided by others. Here are three key thoughts to help you trade safely and securely during these challenging and historic times.

Nimble – Things are happening quickly out there, and the wide swings in volatility are causing markets to move faster and farther than before. In fact, volatility in the currency markets is at its highest point since the year 2000. What's a trader to do? Traders looking for quick intraday moves need to keep their finger on the trigger at all times – especially when they are already in a trade. The game changes quickly, so be ready for action at a moment's notice. Put your mouse cursor directly above the exit button, and keep your finger poised above the mouse. That way, you'll never be taken by surprise, and you'll always be ready to close your position.

Pip Slip – Prepare for slippage, as fast moving markets may cause some surprising fills. This is a common occurrence in the stock markets, but currency traders have been largely immune to slippage - that is, until the recent spike in volatility changed the game and turned the trading world upside down. How to deal with this problem? Plan ahead and don't be surprised when you get a bad fill; in fact, make it part of your game plan. When performing your calculations, assume that the price you receive for both buys and sells will be slightly worse than you would normally anticipate. Not only will you be prepared for a bad fill, but you may find yourself pleasantly surprised when you get a good one!

Park It - Trading in this fast-paced environment isn't meant for those with a nervous stomach. In fact, many of us would be better served by simply staying out of the trade and watching from the sidelines until the markets settle down. Always remember that part of our jobs as traders is to know when to avoid trading. The truth is you should never feel as if you absolutely have to place a trade, and you should only place trades when you feel that the odds are in your favor. Selectivity is the key; you will make more money from one good trade than you will from ten mediocre trades, so maintain your focus and only take the best trading opportunities.

Question of the Week

Q) Ed, I keep hearing about LIBOR in connection with the bailout but I'm not familiar with this term. Can you please explain what it means and why it is important to traders?

Ed Ponsi) Thank you for your question. LIBOR is short for London Interbank Offered Rate, and it represents the cost of borrowing dollars overnight in London. On September 30th, the last day of the third quarter and the day after the bailout plan first failed to pass through Congress, LIBOR spiked an incredible 431 basis points to 6.88%. Let's think about that for a minute; banks are charging each other an annual rate of 6.88% for overnight loans! They must be pretty frightened to charge such a high rate, perhaps because no bank wants to lend money, only to find out later that the borrower has evaporated.

In a way, you could say that LIBOR is a "fear gauge", and it is telling us right now that banks do not want to lend money to other banks except at ridiculous rates. This is despite the fact that the Fed and other central banks are constantly pumping liquidity into the system, jamming the banks full of cash so that they'll be more willing to lend. Many of the banks are just hoarding this added capital for their own needs instead of lending it out to others, defeating the purpose of the Fed's actions.

Right now we are seeing strength in the U.S. dollar, and that is because the USD tends to perform well when fear is high. But this will pass; fear is a temporary condition, and as bad as it may seem right now, things will eventually get better. When they do, watch out – the bill will come due for this mess, and when it does, it will weigh heavily on the greenback. Enjoy the USD rally while it lasts.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Ed Ponsi

ATR and the TED Spread

Greetings from New York! This week, we have answers to your questions about Average True Range, the TED Spread, and more.

CLICK HERE to read the article

Ed Ponsi on CNN Today....

Hi Everybody,

I'm back on CNN International today between 7pm and 8pm London time (bet. 2pm and 3pm New York time). See you then!

Ed

Disaster Trading: Your Responses

Wow! Last week was the very first time I've asked for your responses to a question, and the feedback was overwhelming. If you missed last week's article, a philosophical question was posed; is it ok to place trades that are designed to profit from a natural disaster such as a hurricane? For the sake of clarity, I want to be clear that I am talking about trades that are specifically engineered to benefit from a disaster, not trades that just happened to be affected by one. I mentioned that I once traded for an outfit that had an "unwritten rule" against designing trades in this manner, and I continue to adhere to this attitude, but that doesn't mean that I don't respect those who disagree – I do, especially after reading your thoughtful responses.

I'd also like to point out that this is very different from the argument that blames speculators for all that is wrong with the markets. There are those who blamed speculators for driving the price of oil to $147 per barrel; now that the price has fallen more than $50 per barrel and is below $100, do we hear any praise for the speculators? I haven't heard a word of it, and I don't expect to. Speculators are always present in every market, whether that market is going up or down, and they are a necessary ingredient as they provide the liquidity that allows non-speculative market participants to have a counter party to their trades. Without the liquidity provided by speculators, markets would be thinner and consequently more volatile.

No matter whether you agreed or disagreed with me on this one, I'm very pleased not only with the quantity, but with the quality of your responses. It's clear to me now that not only am I reaching a fairly broad audience, but a thoughtful and intelligent audience as well, so I thank you one and all. My apologies, as only a small percentage of the responses could be accommodated - there were many good letters that you won't see here, due to limitations of time and space. Let's get to some of the highlights of your comments on this topic - plenty of you believe that it is wrong to place a trade specifically designed to benefit from a disaster:

"I completely disagree on trying to make profits on disasters. The market is full of opportunities, so if we cannot help those people, we might at least don't be a part of a bigger damage."

"I agree...I do not personally like the idea of trading off of other's misery. On a related subject, it seems that the "hot" new thing to do is buy "life settlements" also known as viaticals...that is, betting on when someone will die, and grabbing part of the life insurance. I think that is despicable, disgusting, and a reprehensible way to make a buck...but that's just me."

…But even more of you felt that it was ok – but usually with a few caveats. Here is a compelling argument in favor of disaster trading:

"Ed, There's nothing wrong with taking trades in anticipation of disasters. I cannot distinguish doing that from anyone who sells survival or emergency preparedness gear in their business. They profit from selling such gear because there's a good chance it's going to be used...and we've had plenty of disasters that show it's a good idea to have that stuff around. Should people not buy emergency gear? Of course, they should. And there's nothing wrong with selling it. By your logic, nobody should sell that gear, because they'd be likely to be making money off the misfortunes of others."

"I believe it is acceptable for a trader to take a position on this. Traders are in the business of making a profit with the least risk and if it means taking a position due to a disaster I do not see it being unethical. In my view any fundamental factor should be recognized and if a trader wants to trade the effect it could have it is acceptable. Now my closing thought is this - many people were adversely affected by these fundamental factors (losing jobs, losing homes, huge capital losses, etc.), but many traders profited. Was this unethical enrichment?"

"Do undertakers and funeral homes profit off disaster? Is that ‘wrong'? Profiting off disasters might be distasteful but it isn't immoral unless you are doing something that causes or worsens the disaster. If a store owner can raise prices on lanterns and candles in anticipation of, or because of, a hurricane, that will encourage more store owners to carry these items in the future. What's immoral about that?"

Several of you suggested that the profits from a disaster trade should be donated to the victims:

"The middle ground, and generous thing to do, would be to pay the profits from disasters into disaster funds to assist those badly affected."

"What's wrong is price gouging when disasters occur -- when people try to sell a $1 bottle of water for $5. I'll agree that's objectionable (and indeed, criminal). But if I see that a disaster will occur, and I make a trade based on a sound fundamental reason, I see nothing wrong with it. Perhaps, with my profit, I can donate more money to aid disaster victims."

"Take a percentage of whatever profits you make (what % is also your choice) and donate it to help the people you feel you made money off of. That way you are not only doing your job to the best of your ability, you are also helping those in need.... and if you choose to cheer out loud, do it because you were able to help someone else in need just by doing what you do best, TRADE!"

Some felt that we could extend this idea into other areas of trading:

"I found your discussion of trading during disasters very interesting. The picture you painted of traders cheering while others were suffering painted a very vivid picture. I have struggled with a similar idea. That is, trading against the economy of one's country. I cannot feel good about cheering a long EUR/USD position when that means that the NFP has plunged. If the NFP goes down it means friends, relatives and countrymen are losing their jobs, and the USA economy is tanking. Not much different than a disaster, really. Or am I not seeing things correctly?"

That brings up an interesting point. I did quite well shorting the U.S. Dollar earlier this year, as I'm sure many of you have over the past few years. I always told myself that it was ok because although various U.S. government officials claimed to support a "strong Dollar policy", I've felt very strongly that in reality they wanted the USD to weaken, in order to benefit big U.S. exporters. Because of this I never felt bad about shorting the buck – even as I've been calling for a change in this policy, because of its deleterious effects on the average American. It's not the traders, but the policies of our government that made the buck such a great short this decade.

Here is a great letter from a person who is both an investor and a relief worker:

"As a Disaster Worker I volunteer with agencies at the local, State and Federal level, and as an investor, I'd like to say that I find trading to profit from natural disasters to be fully acceptable. There are whole industries that depend on disasters for their livelihood, and no-one objects to them. Indeed, they are suppliers to governments, and necessary partners in the mitigation, preparedness, response and recovery process.

If they are not only allowed to profit from disasters, but encouraged to do so, shouldn't the investor, using only a computer or telephone be allowed the same ability? As long as none of us becomes "Lex Luthor", able to cause or control these disasters, then I see no problem with the ethics of the situation."

Here's a great thought on this topic:

"Is it morally right? I guess that depends on the individual and how driven they are by FEAR and GREED. And they should also ask themselves if they are sticking to their trading plan, I have not yet ever talked or met a trader that had developed a trade plan to trade natural disasters only."

And finally, let's end this on a high note!

"Thanks for regularly challenging your readership with excellent material on the currency market."

You're welcome, and thank you one and all for your participation – it's encouraging to have readers who are up to the task of dealing with these important issues, and who are able to express themselves their opinions while remaining civil. I'll see you again next week with a new topic.

Disaster Trading

Q) I'm just trying to figure out what you mean when you say it's wrong to make money off a natural disaster. If I trade for a living, then am I supposed to ignore a pending natural disaster? Am I supposed to take a few days off of trading (or a few weeks) until the threat of the natural disaster has passed? What if I was long the dollar when I heard about the hurricane, would it be would wrong and unethical to change my opinion and close my positions out due to that news? If I trade professionally, and I don't, then I would be a fool to ignore any information that could change my opinion or the markets opinion and help me make money.

Just for the record I never considered shorting or buying the dollar based on the hurricane because I don't see the correlation in this particular case. But I think your statements about whether people try and trade this news or not were insulting and ignorant. Nobody is making money off the misfortunes of others. They are making money off of other market participants. It's a shame that natural disasters, and human caused disasters happen in the first place...but they do. And to ignore the potential consequences those disasters may have on a market would be totally and undeniably idiotic...and a recipe for disaster.

Ed Ponsi) Thank you for your question and comments. Maybe I'm being old fashioned here, but I think it's wrong to bet on Death, Destruction, and Disease to win, place, and show. I'm sorry to hear that you find my stance "insulting and ignorant" as you put it, but I guess we'll just have to agree to disagree. In my years as a Wall Street trader, my employer frowned upon such "disaster trading". He didn't want to hear his traders cheering as the body count rose, so I guess he was old fashioned, too.

I certainly never said that anyone should stop trading due to a pending natural disaster, or that anyone should ignore the consequences of such a disaster. That would be foolish. But that is very different from trying to profit from an anticipated disaster. For example, if you are short the USD due to technical or fundamental reasons and an earthquake occurs in the US, you were not trying to game the disaster. In this example, it's possible that you may have benefitted from a natural disaster, but that wasn't the specific intent. That would be very different from placing trades that were specifically designed to profit from an earthquake. There is a huge difference between those two things; one is passive, and one is active.

I'd like you hear from our readers on this one; what do you think? Is it wrong to create trades that are specifically designed to profit from disasters, natural or otherwise? Or as traders, is it just our job to place the trades and ring the register, regardless of the circumstances? Let me hear your opinions at info@fxeducator.com

Read and Grow Rich

Read and Grow Rich

Greetings from Acapulco! It's cloudy, wet, and humid, not exactly great beach weather, but it's a perfect time to follow up on last week's article and answer a great question from a reader. Keep those questions coming!

In last week's article, titled "Deadly Hurricanes and Dangerous Assumptions", we discussed at length the reasoning behind shorting the Great Britain Pound and going long the Japanese Yen (GBP/JPY). The idea was to short the weakling of the group (GBP, which has been falling relentlessly) and go long the Japanese Yen, which is the only currency other than the U.S. Dollar that has been performing well recently. Please note that when that article was written on September 1 (published on September 2), the GBP/JPY pair was trading at a major support level, at about 195.50, as indicated on the Figure 3 chart from last week's article. Also indicated was a potential catalyst for a break of that support level, in the final sentence, "The Japanese Yen tends to perform well when equities markets perform poorly, so if recent stock market weakness persists, look out below."

Look out below, indeed. Now it is Friday, September 5. Take a look at the "Last" price on the weekly chart, and I guess it's safe to say that support has broken. The last price just under 188.00 indicates a gain of about 750 pips this week. The low price of 186.01 indicates that at one point, the weekly gain was about 950 pips. It's time to ring the register. Hey, it beats working for a living!

I've already heard from some of you who sold GBP/JPY short after reading last week's column, and while I appreciate all of your kind comments and praise, I want you to know that you deserve all of the credit – congratulations! Whenever we take a trade, the credit or the blame always goes to the person who hit the button or clicked the mouse. Trading is not a good business for those who do not take responsibility for their own actions, but it's a great business if you have the ability to stand up and admit when you're wrong – and there is nothing wrong with taking credit when you're right. If you hit the button, then you deserve the credit for those times when you win, just as you deserve the blame for those times when you lose.

More Ammo for GBP Bears

In the Forex market, there is a clear connection between technical and fundamental analysis that does not exist in the stock market. The technical weakness in GBP/JPY that was indicated on the charts is backed by fundamental information. At the same time that the chart was breaking down, the OECD released its predictions for growth in the third and fourth quarters of 2008. The OECD is the Organization for Economic Cooperation and Development, which describes itself as an "international organization helping governments tackle the economic, social and governance challenges of a globalised economy". Interestingly, they picked Japan to have the strongest growth of any G7 country, while predicting a recession for the United Kingdom. The U.K. was the only G7 country to receive that distinction.

Under these circumstances, it shouldn't be too surprising that the Yen has the British Pound on its heels, and one could say that the Yen is fundamentally - and technically - stronger than the Pound. Even if the OECD's predictions turn out to be inaccurate, they are a respected organization and their opinion carries some heavy weight. For more on the OECD, visit their website at http://www.oecd.org.

Deadly Hurricanes and Dangerous Assumptions

In this week's newsletter, we explore questions about the currency market's reactions to past disasters - the reactions may surprise you. Also, answers to more of your email questions.

CLICK HERE TO READ THE ARTICLE

Forex Q&A with Ed Ponsi

Forex Q&A with Ed Ponsi

We have some great questions from our readers this week; please keep them coming! Most of these relate to our recent discussion on volume, starting with a star pupil from Canada who is now managing money professionally. Here we go!

Q) I was reading your articles on the volume in Forex and I would have to say that the numbers are actually not as increased as people think they are. Correct me if I am wrong, the actual daily dollar value is up, but the true value of a US dollar is actually less today than it was a few years back. So the daily dollar value is greater but people must also take into consideration that a buck is less today than what it used to be.

By the way, how are things with you? Keep up the good work, and I know I have said it before but thanks for the great course; it really set me in the correct direction and gave me the foundation to build on.

Ed Ponsi) The student has become the master! Just kidding, as usual you are always asking the right questions and making astute observations. It's a pleasure to have students like you in the class, and you deserve 100% credit for your success. You are absolutely correct – since the U.S. Dollar has taken such a beating over the past seven years, we must consider that the increase in Forex volume would have been less (as measured in USD) if the greenback had maintained its value. Still, Forex as a retail instrument is growing at an incredible rate - so much so that some of the world's biggest banks are finally entering the retail market. Expect volume figures to explode in the coming years if this trend continues, as major financial institutions begin to offer Forex trading to their clients alongside other services. With the biggest names in trading and investment just now entering the field, retail Forex trading might become as commonplace and mainstream as stock trading.

Q) Thanks Ed, as always good stuff. So if key times have volume significance, would it be safe to say then that a breakout occurring at 5 pm Eastern time should fail at a major support or resistance level, and one appearing at a key time like 3 am Eastern time should plow through most support and resistance levels? Also are the prints a valid tool in Forex trading like stocks? Would we see tremendous velocity at the key times on them to gauge which direction to take a trade?

Ed Ponsi) Thank you for your email, you're definitely on the right track. Not only do breakouts that occur at or around 5 pm Eastern time tend to fail, they usually fizzle out before they reach any significant support or resistance levels. Because of this, moves that occur at this time of day make excellent candidates for "fade" techniques, which is a type of trade that goes against a breakout because of the assumption that the move will not follow through. On the other hand, moves that occur after 3 am Eastern time have a better chance of success. In cases such as this, an opening range breakout strategy would be more appropriate. It's not unusual to see strong breakouts early in the London session, due to an increase in volume and the increased possibility of major economic news releases, so a fade strategy would be less likely to work at that time.

It would be difficult to discern any meaningful information from time and sales, or prints, in the Forex market, because not every trade would be included; this is due to the vast size of the currency markets. Since there is no central location where all Forex trades are processed, no individual or entity would have the ability to tally all of these trades and put them together. Because of this, whatever prints you are viewing show only a partial snapshot of what is really happening in the overall market, a snapshot that may or may not be representative of what is really going on. Because of this, it would be dangerous to read too much into prints on the Forex market.

Q) Hi Ed, I was wondering if you would do the honor of providing a brief description - maybe 2 or 3 paragraphs - describing your primary approach to foreign exchange trading from a strategy perspective.

Ed Ponsi) Thank you for your question. Regarding technique, I'm primarily a trend trader. I look for situations where the technicals mesh with the fundamentals - if there is a clear trend in place, and if the fundamentals confirm what I see on the chart, I'm going to try to grab a chunk of that trend. One thing I'm very cautious about is trading the breakout - if the trend is moving upwards, I want to go long but I don't want to buy into a currency as it's hitting new highs. Because there are so many false breakouts in Forex trading, my strategy is to try to catch the pullbacks. That way, even if the currency pair fails to break through, there is still some potential for profit when the pair reaches resistance.

One of my favorite situations is a false breakout that moves against the trend. These types of breakouts have a high failure rate, and they also set the stage for a "slingshot" trade in the opposite direction. It's a great setup, and I'm constantly looking for it. If the trend is strong enough, I might not use a target at all; instead, I'll trail a stop. I like to trail stops manually, moving them strategically instead of automatically. That way, I can keep my stop beneath a trend line or a moving average, instead of moving it to an arbitrary location - which is often exactly what happens when we use automatic trailing stops.

Q) I am nearing the end of my enlistment in the Army and my goal is to become a professional trader. Do you have any advice that I might solicit on starting out? I would highly value any suggestions and experiences you could share with me.

Ed Ponsi) Thank you for your question. When I started out, I traded for a few years on my own, and then went to work for a firm on Wall Street...that's where it all came together. By working as an employee at a trading firm, I learned a lot of the finer points of trading that I write about in this column.

My best advice would be to build a track record of at least six months of profitable trading, and then try to parlay that into a job as a trader. Trading jobs exist in various places all over the US, although there are higher concentrations in certain areas like New York and Chicago. Your military background is a plus; it indicates that you can follow a structured system of rules. The ability to maintain discipline while trading is one of the main ingredients to a successful career.

Finally, if you are really serious about this, there is nothing that can stop you. Some firms might have requirements that are difficult to satisfy; for example, some quant firms require a degree in mathematics. But others are only interested in one thing - can you trade successfully? If you can prove that you can, you will eventually knock on a door that will be opened to you. Good luck!

The Dollar Continues to Roll

The Dollar Continues to Roll

In last week's article, I mentioned that the sharp move lower in the Euro – U.S. Dollar currency pair (EUR/USD) still had room to run, and that "Euro has a very good chance to break this new support level" (near 1.4950) based on the velocity of the move. You could also add to that the fact that the weekly candle closed near its low, signifying that shorts were unwilling to take profits going into the weekend. Well, here we are one week later, and the EUR/USD currency pair is now nearly 300 pips lower than it was at last week's close. Not only that, but once again the weekly EUR/USD candle closed near its lows, once again indicating that shorts remain reluctant to take profits, and sellers may have still more inventory of Euros to unload (see figure 1).

Figure 1: EUR/USD continues to fall hard on the weekly chart. Source: Saxo Bank

The next major support levels appear to be 1.4500 (psychological) and 1.4350 (old support from late 2007 – early 2008). The velocity of the move shows near panic on the part of sellers, some of whom are trying to protect the huge profits they made buying Euros on the way up. As you can see from the weekly chart in figure 1, many Euro longs may still be holding on to profitable positions despite the vicious pullback of the past two weeks. This just goes to show how long and persistent trends in the Forex market can be.

Question of the Week

Q) Hi Ed, I read your articles every week and I always learn something new, thank you so much! In last week's article, you mentioned that Forex volume is so high that it would be impossible to count all of it, yet in the same article you mentioned that the daily average volume in the Forex market is $3.1 trillion USD per day. Forgive me if I'm missing something, but if the volume is so high that nobody can keep track of it all, where does that $3.1 trillion figure come from?

Ed Ponsi) Thank you for your kind comments and for your question. It's true that Forex volume is so high that accurate volume figures are not available, but every three years, the Bank of International Settlements (BIS) surveys major Forex market participants and then creates a volume estimate based on the information gathered. The most recent BIS survey, completed in 2007, yielded the estimated volume figure that I reported last week as $3.1 trillion (turns out it's actually closer to $3.2 trillion), a figure that is widely quoted and accepted. This figure represents an increase in volume of about 70% from the 2004 survey. According to the BIS, the $3.2 trillion average daily volume is equivalent to:

The survey even breaks down volume figures by geographic location. The United Kingdom continues to dominate the Forex markets, as it is home to many large banks and funds that are prominent players in the world of currencies. These stats only serve to reinforce London's reputation as the world's capital of Forex trading (see figure 2):

Figure 2: Breakdown of daily volume figures by location. Source: BIS Triennial Survey 2007

Finally, the Bank of International Settlements offers a volume breakdown by currency pair. Note that EUR/USD has the greatest volume by far; it's not a coincidence that this currency pair has the tightest spread on nearly every Forex trading platform. Generally speaking, high volume leads to tight spreads in the Forex market (see figure 3).

Figure 3: Breakdown of daily volume figures by currency pair. Source: BIS Triennial Survey 2007

Question of the Week, Part ll

Q) Regarding finding good volume information, you recently wrote:"...If a breakout occurs during a time of day when volume is known to be high, it would be reasonable to assume that the breakout is occurring on high volume; if it occurs during a time of day when volume is known to be low, the opposite would be true." What are those "known" times of day? Opening of markets, etc.?

Ed Ponsi) Thank you for your question. As you mentioned, the opening of markets, in other words morning in any given geographic location, is the time of day when the bulk of trading is done. For example, referring to the image in figure 2, more volume is generated in the U.K. than in any other location. So, it stands to reason that when it is morning in London, volume tends to be high. You could also say the same thing about the U.S., which is second only to the U.K. in Forex trading volume. Since morning in New York coincides with lunchtime in London, it is reasonable to assume that just as things are settling down a bit in the U.K., traders in the U.S. wake up and start trading. Also, most economic indicators are released in the morning, so this creates added volatility and can also attract added attention from traders. So, if a breakout occurs when it is morning in the U.S. and/or the U.K. – anywhere from 3 a.m. to noon New York time - then I would assume that the volume is likely to be high.

On the other hand, what if a breakout occurs at 5 pm U.S. East coast time? Well, that is a pretty quiet time of day in the U.S., as most New York traders are on their way home or having dinner. When it is 5 pm in New York, it is 10 pm in London, so I wouldn't expect too much activity from traders in the U.K. Also, when it is 5 pm in New York, it is only 5 am in Singapore and 6 am in Tokyo, too early for any meaningful activity from these Asian trading capitals. Taking all of this into account, I would assume that a breakout that occurs at 5 pm New York time is occurring on low volume and has a high likelihood of failure.

The Homer Simpson Breakout

Last week saw a breakout of historic proportions, as the U.S. Dollar got up off of the mat and roared higher across the board, crushing everything in its path. Here we see the Euro – U.S. Dollar currency pair (EUR/USD) crashing back to earth on the weekly chart after hitting a new lifetime high above 1.6000 just a few weeks ago. The pair has found support at a former level of resistance from late last year (see figure 1).

Figure 1: EUR/USD plunges from a failed ascending triangle. Source: Saxo Bank

Looking at the chart, I'd have to say the Euro has a very good chance to break this new support level and continue lower, just based on the sheer velocity of the move. An awful lot of people made an awful lot of money on the Euro uptrend, and now it's time for them to ring the register.

If you are a regular reader, you know that this is a bittersweet moment; as an American, I'm happy to see my currency strengthening, as I've been constantly railing against the weak USD in articles such as this one, titled The US Dollar and the Thief in the Night. Because of that piece I was invited onto Larry Kudlow's show on CNBC. But is the greenback really doing all that well, or is this just a case of the Euro and other currencies doing poorly? To find out, let's look at the hourly chart and pinpoint the genesis of this move. The Euro began to fall in earnest around 9:00 am New York time on August 7, right at the time when European Central Bank chief Jean Claude Trichet said that European economic growth would be "particularly weak" through the third quarter (see figure 2).

Figure 2: Trichet speech ignites the USD rally as the Euro gets crushed. Source: Saxo Bank

So last week's big move is not a vote of confidence in the U.S Dollar; instead, it shows a lack of confidence in the Euro. Still, the tide has turned at least for now, so don't try to fight this move. Also, don't feel too bad for traders who were short the greenback for most of this year, myself included. The weak USD trend has been my friend for quite a while, and it's sad to say goodbye to that friend for now. Until now, this year has been one of the best in memory for USD shorts. Right now it is too early to tell, but if a new trend of USD strength emerges, you can bet trend traders will be riding it.

Why the Euro REALLY Fell…

A one euro coin has turned up in Spain bearing the face of Homer Simpson instead of that of the country's king, a sweetshop owner told Reuters on Friday. Jose Martinez was counting the cash in his till in the city of Aviles, northern Spain, when he came across the coin where Homer's bald head, big eyes and big nose had replaced the serious features of King Juan Carlos. "The coin must have been done by a professional, the work is impressive," he told Reuters. "I've been offered 20 Euros for it."

The Learning Curve

The Learning Curve

Hola from Mexico City! I have another great question from a reader this week. Hopefully the answer will help prevent some of you from making the same mistakes I made when I got started in trading. Read on!

Question of the Week

Q) Mr. Ponsi, I found your response to the automated system very interesting. I am in the process of training myself for the Forex....hopefully in the correct way. I realize as well (having worked with a demo account) that you can be "punished" if you do not know what you are doing!

I would like to know how YOU got to be where you are. Did you have struggles? How long was it before the "light bulb" went off in your head? I consider myself an intelligent person; I am a physician and have had extensive training, 12 years beyond college. How long was it before you felt comfortable with what you were doing? I have heard some say six months. Of course no one can truly predict where the market will go after you get in and I have heard statistics that even the best Forex traders are correct 50-70% of the time. Do you feel bad when your trades go the wrong way or have you disciplined yourself to extract from the emotion?

Ed Ponsi) Thank you for your question. I started out as a part time stock trader in the mid nineties, and I freely admit that at that time I had no idea what I was doing. Luckily for me, I began my trading career at the beginning of the biggest bull market in history – at a time when all you had to do to make money was buy tech stocks and watch them skyrocket. There was a popular saying at the time, "don't confuse brains with a bull market". After making money on my own for a few years, I realized that I was not yet a good trader, just fortunate to be in the right place at the right time. If I wanted to make a career out of trading, I was going to have to learn how to do it properly.

Determined to succeed, I went about the task of getting hired on Wall Street. After months of emailing my resume and trading record to every Wall Street firm that I could find, I finally got an interview, and I was hired. Let me tell you, it wasn't Goldman Sachs. I was hired by what is called a "boutique" trading firm, based on my trading record for the previous two years, and because of my determination. Part of that determination was my willingness to travel over 100 miles each way, every day, to get to work.

The beautiful thing was, this firm was a meritocracy – you rose or fell based on your performance. Unfortunately, most of us fell. I was one of a group of 20 that was hired. What I didn't know at the time was the firm expected most of us to fail, they were just hoping that one or two of us would pan out. The next month, there would be 20 more new hires, and 20 more the month after that. Out of all of these new hires, only a handful of us were expected to survive.

And so I began. I was confident, having done very well for myself in the two prior years, despite my lack of real trading knowledge. My new employers gave me a blueprint for success and put restrictions on my trading, using good risk management rules. I had never even heard of risk management up to that point, and I soon learned that it would be the key to success. My instructions were simple; I was to have no large losses, period. This was a big change from my prior freewheeling style, but I was trading their money and I wanted to do it right, so I set about taking small losses.

The next two months were psychological torture, as I could not seem to reconcile my old style of trading to the new, stringent risk rules that were imposed upon me. During that time, I couldn't sleep and I could barely eat. It really bothered me that I was losing, and it bothered me even more that I was losing someone else's money. After surviving the dreaded "learning curve", I finally began to win and I never looked back.

Why did the firm stick with me during this difficult time? Because they monitored my actions closely, they could see that I never took a large loss – no matter what. They knew that the ability to avoid large losses is the most important skill in trading. Since I already knew how to lose like a professional, it was only a matter of time until I learned how to win like one. Once I learned how to hang on to my winners, the account balance began to rise, and I never looked back. It was a long two months, but life was never the same after that.

Do I still feel bad when trades go the wrong way? A little, but I understand that my feelings don't matter, and that losing is a part of winning. I'm not going to change my tactics if I have a few losses, because those techniques have worked for me for many years. Small losses lead to large gains, as I learned long ago; in fact, small losses are a necessary ingredient to winning. If I see someone who is not taking small losses, or a trader who never seems to lose, I know that person is setting himself up for a big loss.

It's true that markets are unpredictable, and that's why we have to use a stop on every trade, without exception. One of the things that I learned on Wall Street is that nobody is right all of the time; that is just fantasy. The beautiful part of trading is you don't have to have a crystal ball or the ability to see the future in order to make money as a trader. You create your analysis, put on your best trade, and if you're wrong, get out. On the other hand, if you're right, know how to maximize the gain. If you use this philosophy, win-loss percentage becomes meaningless. There are many successful traders who have unimpressive win-loss percentages, but it is not our job as traders to be right. Our job is to lose small when we're wrong, and win big when we're right