Beat Down on the Pound

Beat Down on the Pound

By Ed Ponsi, Fresident, FXEducator.com

Back in November, I wrote an article titled "The Pound is Losing Weight" that mentioned a huge support level at 1.40 for GBP/USD. Well, after creating a temporary support at the 1.4460 area, we finally got there last week, with the British Pound collapsing to that level and beyond

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The Ruble is Rubble

The Ruble is Rubble

By Ed Ponsi, Online Trading Academy Forex Instructor

Russia's economy is in serious trouble. Russia is the world's largest energy exporter, and with the price of a barrel of oil sliding back below $40, there has been a sharp decline in capital flows to this Communist country. Russia needs oil at $70 in order to balance its budget, but with the world economy sliding into a recession, even conflict in the Middle East and threats of further OPEC production cuts haven't generated a sustained rally in crude. Without that oil money coming in, the Russian Ruble is falling hard against the USD. Russia has devalued the Ruble gradually since November, and the move appears to be accelerating (see figure 1).


Figure 1: Ruble hits a six year low vs. USD as Russia devalues its currency. Source: Saxo Bank

In addition to the price of oil, there are other problems. Many of the debts owed by Russia are priced in U.S. Dollars; this means that as the Ruble grows weaker, it becomes harder to repay these debts. Since the Ruble has lost about 25% of its value vs. the greenback since August 2008, those debts are now about 25% harder to repay.

Another key problem is leadership; investment capital is fleeing Russia partly because of the unpredictable and gangster-like behavior of its leaders. Investors have withdrawn more than $200 billion from Russia since the beginning of August, according to BNP Paribas. Why should investors put money into a country where free market capitalism has a tenuous hold at best? Why gamble on a country that plays an annual game of chicken with its customers, cutting off gas supplies in the dead of winter in order to gouge prices? Why take the risk that the unpredictable leadership might nationalize your company, thus rendering your investment worthless?

If Russia's economic problems lead to political upheaval, will the current leadership use force to stay in power? The current regime has shown no aversion to the use of violence to achieve political and economic gain. Their mugging of Georgia on the night of the opening of the 2008 Summer Olympics (the timing was an attempt to keep the story off of the front pages) is evidence of that. Taking all of this into consideration, is it any wonder that investment capital is fleeing Russia faster than you can say "Mikhail Gorbachev?"
The Four Horsemen, Revisited

Almost exactly one year ago today, I wrote an article titled "The Four Horsemen, the S&P, and the Yen." In that article, I pointed out that the S&P 500 had formed a massive double-top, a very bearish formation that indicates the end of an uptrend, and that key stocks such as Apple, Google, Amazon, and Research in Motion had formed the ominous pattern as well. Let's take a look at the 1-year performance of the S&P 500 and those stocks since then (figures as of the Jan. 14, 2009 close courtesy of AOL finance).

Stock Symbol


Price

GOOG


-53.97%

RIMM


-53.24%

AAPL


-52.33%

AMZN


-41.49%

S&P


-40.67%

The article also pointed out a head and shoulders in the GBP/JPY pair and a double-top in EUR/JPY – two currency pairs that closely mirror the action seen in the equity markets. This is a good example of the following; whether you're trading an index, a stock, or a currency pair, technical analysis is a valuable tool. No matter which vehicle you choose to trade, a trend is still a trend, a reversal is still a reversal, and a double-top is still a double-top. This also means that if you understand technical analysis and how to apply it correctly, you can trade most financial markets.
Question of the Week

Q) Good evening, Ed. I have just completed your recent article regarding the time you spend during vacation catching up on reading. Thanks for the reading tips! I have a question; do you consider pivot points a reliable support and resistance tool? It appears that pivot point levels serve as a road map in determining the direction of the intraday moves. Can you give us your thoughts on the use of pivot points?

Ed Ponsi) Hi Renee, good to hear from you! Pivot points can be useful intraday, but if you think about it, you could get the same effect by simply selling a break below support or buying a break above resistance. You could also use support and resistance areas as targets instead of using the pivot points R3 or S3 as targets. To sum up, I think that pivot points can work, but they don't necessarily work better than good old support and resistance. Good luck!
Is It All in the Digits?

According to a Cambridge University study, the length of a trader's fingers may reveal the size of his income. The longer the ring finger is compared with the index finger, the bigger his pay is likely to be, a study of London traders found. The secret may be revealed in the "digit ratio", which reflects the length of the index finger divided by the length of the ring finger, according to a study of 44 London traders. Traders with long ring fingers made an average of about $1 million USD, compared with $90,956 USD earned by traders with shorter ring fingers, according to the study.

Previous research has found that the digit ratio reflects how much testosterone an unborn baby was exposed to in the womb. Those exposed to high levels of the hormone are more sensitive as adults to testosterone that creates feelings of confidence and encourages risk-taking.

The long-ringed-fingered among us should keep one thing in mind; while those sensitive to high testosterone levels (risk-takers) may make more money, they may be more prone to blowing up their accounts, too. In traders on a winning streak, testosterone will keep rising until the hormone eventually causes manic, irrational behavior, turning the boom into a bust, said J.M. Coates in a separate study published last year in the Proceedings of the National Academy of Sciences. Let's be careful out there!

Forex Basics and Beyond

Forex Basics and Beyond

By Ed Ponsi, President of FXEducator.com

Q) Hi Ed, as a New Year exercise, I was running through some of the major currency pairs and I was kind of shocked when I analyzed the AUD/USD pair. A great double-bottom seems to have laid itself out on the daily charts, and prices are currently near the neck line @ 0.6950. If I recall clearly, the EUR/USD only a few weeks ago formed a similar pattern and sprung to the topside rapidly. It could be that AUD/USD is preparing for a similar fate by following the same pattern, and could be a DEJA VU (with money to be made)?

Ed Ponsi) Hi Abs, thank you for your email. Sure looks like you might be onto something here; the price action on the daily chart shows AUD/USD breaking to its highest point since October of last year. The formation could be considered a double-bottom or perhaps even a cup and handle

So, while the technical analysis looks good, what about the fundamentals? The Aussie dollar is a commodity currency, and commodities have performed poorly of late, to put it mildly. Any bet on Aussie right now is a bet that commodities have bottomed – and I do think we are closer to the bottom than the top, but still some potential downside. Additionally, there is the interest rate differential; while the Reserve Bank of Australia's current rate (4.00%) is expected to drop, it will remain higher than the Fed Funds rate as long as it stays above 0.25%, and I think it's a good bet that the RBA won't go that low. Speaking of Australia's central bank, they helped to put in the bottom of the formation by intervening in the currency markets late last year. The RBA stepped into the market and bought Aussie dollars, which helped to keep the AUD/USD exchange rate above .6000. With this confluence of technical and fundamental factors, you might have yourself a good setup here – it all depends on the commodities market. Good luck!

Q) Ed, I'm very interested in Forex trading but totally lack the knowledge to even comprehend the outcome. The TA side I have down cold due to 20-plus years of trading activity. The question - what is the value of a trade if the underlying moves up say 1 pip? OK, I buy a mini lot of 10k EUR/USD at say 1.3999. Now if the price moves to 1.4000 what is my gain on the trade? Discount commissions or bid/ask spread.

Ed Ponsi) Great question! To answer this and other concerns, let me first explain the different types of accounts. The types of accounts are differentiated by the size of one lot in each account, with each level greater than the one beneath it by a factor of ten:

Standard Account = 100,000 units per lot

Mini Account = 10,000 units per lot

Micro Account = 1000 units per lot

Referring to the scenario in your question, the value of one pip on the EUR/USD currency pair would be:

Standard Account = $10

Mini Account = $1

Micro Account = 10 cents

The part of your question that deals with commissions is a bit more difficult, since just like in the stock market, every Forex broker has their own commission structure. Many Forex brokers charge only the spread, with their commission and other fees included within that spread, but some charge a commission in addition to the spread. Also, some Forex brokers offer fixed spread platforms, while others offer variable spreads (and some offer both). My recommendation would be to open and trade a Forex demo account (it's free) to get used to the values of the various currency pairs and how they move. Everything that you already know about technical analysis applies to the currency market, so you are ahead of the game on that count. Trading a demo account will educate you on these other issues without the risk of loss. Good luck!

Q) Hi Ed, I'm a loyal reader and find your articles very interesting. My question is about the relationship between the U.S. Dollar and the U.S. stock market. I'm confused because I read an article of yours pointing out that the relationship is inverse, maybe I didn't understand. If the dollar rises, stocks go down. My confusion arises because my reasoning is as follows: If the stock market is bullish, then people around the world would want to get in. If so, they would have to buy dollars to buy U.S. stocks, creating demand for the dollar and the stock market and pushing both up. The inverse would be true if the situation were reversed. So, under my train of thought, the relationship is positive and not inverse. I would appreciate if you can clear up my confusion.

Ed Ponsi) Great question! What you are saying makes sense and is often the case; however we are in an unusual and abnormal market situation to say the least. Think of it this way; stock markets all around the world performed poorly in the latter part of 2008, and all types of traders dumped equities en masse, with the intention of stashing that cash in a safe place. But where are they going to put it? One safe haven is the U.S. Treasury market; the problem is you need U.S. Dollars in order to buy U.S. Treasuries. This means that investors all around the world have been exchanging their home currencies for the U.S. Dollar, and putting the proceeds into U.S. Treasuries. This in turn has driven the price of Treasuries through the roof, bringing yields down to incredibly low levels (see figure 1).

Figure 1: U.S. Treasury yields collapsed in 2008. Source: Bloomberg.com

Back in the late 1990's, a bull market in stocks drew investors to the U.S. to invest in the NASDAQ. Consequently, the USD performed well at that time. Today it is the bond market that is attracting all of the attention, but eventually that will change, too. When yields on Treasuries begin to rise, it may be the first sign that this bond rally is coming to an end. Good luck!

What I Did on My Winter Vacation

What I Did on My Winter Vacation

By Ed Ponsi, President, FXEducator.com

If you think I spent the past week chilling on a beach in Rio and enjoying the scenery, you're only half right; I also took the opportunity to catch up on some long-overdue reading. Not all of these books are new, but each of them has something unique to offer. My highly subjective scoring system will rate these books on a scale of one to five pips, with the lowest score equaling one pip and the highest score equaling five. Here we go!

"A Bull in China" by Jim Rogers – Trading legend Rogers is best known for success with the Quantum Fund, which he co-founded with George Soros, and for making the early call on the huge commodities rally that ended in 2008. He is a trader/investor who chooses his battles very carefully and holds for the long-term. Despite his tremendous success in the financial arena, Rogers comes across as extremely down to earth, someone you'd like to swap trading stories with over a cold beer. Previous books by the author detail his adventures riding a motorcycle around the world ("Investment Biker") and his fervor for the futures markets ("Hot Commodities").

You've got to hand it to Rogers; he doesn't just talk the talk, he walks the walk – his belief that the U.S. Dollar is destined to fall has led him to divest himself of all U.S. assets and move his family to Singapore, where he can better participate in the ongoing economic explosion that is China. Rogers compares China in 2008 to the U.S. in 1908 in terms of economic potential. Then comes the strength of the book; the author quickly moves beyond the introductory portion and reveals solid, practical reasons and methods for investing in China. Rogers breaks down the myriad share classes that Westerners must navigate if they wish to participate in this market, and explains why China's present currency policy should lead to a future boom in share prices. The book is an extremely easy read; if you've seen Rogers on TV you know that he gets right to the point, so let's give our highest score of 5 pips to "A Bull in China".

"The Age of Turbulence" by Alan Greenspan – I can't tell you how many times in the past I've stood in a trading room, sharing puzzled looks with other traders as we tried to determine what the heck Alan Greenspan was trying to communicate to us. Is he bullish or bearish? Greenspan was a master of the art of obfuscation; his comments were intentionally ambiguous as he attempted to inform the markets without roiling them. So of course, I was reluctant to read a book written by a man who has a reputation for talking in circles. What a pleasant surprise that his book turned out to be straightforward, informative, and entertaining. The first half is a fast-moving biography, filled with entertaining anecdotes and insightful commentary. Greenspan presents himself as a somewhat nerdy economist who worked hard and became a success, but at the same time he is ever willing to poke fun at himself. The stories are great; Greenspan talks about his relationships with economic and political luminaries and gives his fair assessment of every U.S. President from Gerald Ford to George W. Bush. He also writes about his friendship with philosophical novelist Ayn Rand and her influence on his work (she nicknamed him "The Undertaker" for his dour demeanor and dark suits). The second half of the book has a slower pace, but presents interesting lessons on his policies and how he sees the future. The bottom line: this is a worthwhile read; get it if only for the first half, and you will get a good sense of who Greenspan really is, and what it is like to be a Fed Chairman. This book gets a score of 4.5 pips.

"Freakonomics" by Steven Levitt and Stephen Dubner – This book has a fascinating premise; why not take the statistical measures that an economist like Greenspan might use to determine the direction of the economy and apply them to everyday life? This is a great concept, and the book begins promisingly, as the authors apply economic models to everything from real estate agents to Sumo wrestlers to schoolteachers. The surprising results often reveal the hidden motives of the subjects in question. One of the so-called "economic detectives" infiltrates a street gang and breaks down its structural hierarchy, describing its economic model as similar to a McDonald's franchise. However, this promising book fizzles as it keeps repeating the same themes, such as crime and cheating. I'd like to see the authors apply this concept to a wider range of subjects, as many types of human behavior are driven by economic concerns – meaning that there is virtually no limit to the potential applications of the book's unifying concept. Good in parts but wildly uneven; let's give Freakonomics a score of 3.5 pips.

"Fooled by Randomness" by Nassim Nicholas Taleb – Here's an interesting question; how much of our performance as traders is based on skill, and how much of it is due to luck? Taleb clearly believes that financial markets contain a high degree of random activity, and that good risk management is the only protection from it. In the process, he rips financial engineering as a pseudoscience, and calls into question the importance of the heretofore all-important track record of a trader (what if the trader was not really good, only his style worked well during a specific period of time?). The author compares various traders and explains why the best trader isn't necessarily the one who makes the most money. He calls into question the importance of back testing, since you can only test things that have already happened, and the future does not always equal the past. Taleb mocks the Nobel Prize winners who led the Long Term Capital Management hedge fund to ruin, for failing to even consider the possibility that their analysis might be wrong. Finally, the author warns of the "Black Swan" – those seemingly unforeseeable random events that render analysis useless and send the quants back to the drawing board, over and over again. This eye-opening book gets a score of 4 pips.

That's all for now, but tune in next week as we get back to charting the market and answering your questions. See you then!

The Hottest Spot South of Havana

The Hottest Spot South of Havana

By Ed Ponsi, President of FXEducator.com

Greetings from Rio de Janeiro! It's summertime here, hot and humid and rainy. While we wait for the weather to clear (in anticipation of a trip to the beach), let's take a look at the beleaguered local currency, the Brazilian Real (symbol BRL).

The Brazilian Real is a commodity currency, meaning that it tends to do well when commodities prices rise, and performs poorly when they fall. Since commodites prices have collapsed in recent months, the Real has been punished accordingly, losing 22 percent vs. the U.S. Dollar since Sept. 26. The currency has weakened by more than 30 percent since August, when it reached a nine-year high against the dollar.

Crude oil is the #3 export of Brazil, and the sharp decline in energy prices has weighed heavily on the currency. Brazil is also a big producer of copper, which has been hammered lately. Coffee is also a big product, along with commodities such as soybeans, iron ore and sugar. When commodity prices recover, the Real should recover as well.

The recent decline of the Real is in sharp contrast to its overall performance. In fact, it has been the best-performing emerging-market currency over the past four years. Much was made of the fact that Brazilian supermodel Gisele Bundchen prefers payment in Real over U.S. Dollars, a strategy that would have rewarded her richly up until the currency's recent nosedive. In case you were wondering, supermodels are not officially listed as an export of Brazil.

Brazil's benchmark interest rate is a whopping 13.75 percent. This is in response to high inflation; the country posted 12-month consumer price inflation of 6.4 percent through the end of November. This is well above the Central Bank target of 4.5 percent.

Brazilian interest rates are set by the Banco Central do Brasil, which is popularly referred to as the Central Bank. The Central Bank takes a hands-on approach to the currency markets, and intervenes frequently to drive exchange rates to desired levels. Although in recent years this has meant purposefully weakening the Real vs. the U.S. Dollar, the Central Bank has acted to strengthen the currency within the past month. When the Central Bank wants a stronger Real, they puchase their own currency and sell U.S. Dollars in the open market. When they want to weaken the Real, they simply do the opposite.

The Central Bank projects that growth will slow to 3.2 percent in 2009 from 5.6 percent growth projected for this year. This is in sharp contrast to most of the world's major economies, which are currently experiencing negative growth.

While the high rate of interest may be a temptation to go long the Real, let the buyer beware. Goldman Sachs economists predict the Central Bank will cut Brazil's benchmark interest rate in January and ease rates six times in 2009, lowering the benchmark rate by a total of 150 basis points. While these actions, if taken, would bring the rate down to 12.25 percent, Goldman had previously estimated a rate increase of 150 basis points in the year. One could say that Goldman's expectations have taken a 300 basis point swing, from 15.25 percent down to 12.25 percent. While the Central Bank left rates unchanged at its December 10 meeting, it did discuss the possibility of a rate cut. This event changed more than a few minds about the future of Brazil's interest rates.

Final thought on the beaches here; newbies tend to believe that Copacabana or Ipanema are the best beaches in Rio because their names have been immortalized in popular songs. This is not the case. According to the locals, the best beaches in Rio are the ones you've never heard of. Besides, the hit song by Barry Manilow isn't actually about Copacabana Beach, but about a club named after the beach. Otherwise, it would be the hottest spot South of Havana.
Year-End Thoughts

There are certain things that every trader should do at the end of the year. I recommend highly that you perform this quick excercise. Take a look at your trading record for 2008, and calculate how much net interest you received (or paid) for the year. This is interest collected or paid due to positions, not simply interest you may have received on money that was idling in your account. What I have found is that traders who pay little heed to swaps (the amount of interest charged or collected on a given Forex trade) tend to pay a good deal more than they realized, because the numbers really add up over the course of a year. By the same token, traders who are cognizant of these issues tend to collect interest. In fact, the amount of interest collected can sometimes make the difference between a profitable trader and an unprofitable trader.

This is not to say that we should only take trades that result in positive interest, also called positive carry. Such a strategy would have proved disastrous in 2008, as interest rates on many high-yielding currencies were slashed repeatedly, causing them to plunge. But the amount of interest that is charged or collected per trade is a knowable quantity, and should be factored into the profit and loss equation.
Thank You!

I just want to say thanks to all of the loyal readers out there. 2008 has been another great year, and I hope that 2009 brings happiness to all of you. Who would have ever guessed that 2008 would bring a huge rally in the Japanese Yen, and the collapse of so many currencies? What will happen in 2009? Will the "carry trade" spring back to life after being devastated in 2008? Will the massive USD rally come to its conclusion? Will we get beyond this credit mess, or will it linger for years? These are the questions that are on traders' minds, along with many others. In addition to the wonderful rewards that the trading business can bring, it is the uncertainty and the unknowable future that keeps us coming back for more. It's a beautiful feeling to wake up every morning and ask yourself, "What is going to happen today? " Best of luck in 2009!