Forex Q&A with Ed Ponsi

Forex Q&A with Ed Ponsi

By Ed Ponsi, FXEducator.com

Greetings from New York! We have a couple of great questions for you this week, so let's get started:

Q) Hi Ed, how long would you say it could take to go from stock trading to Forex trading? Can the same technical analysis be applied?

Ed Ponsi) Thank you for your email. If you are a stock trader and you're thinking about making a switch to Forex, I have great news! Everything that you already know about technical analysis applies to the Forex market. In the currency markets, we see the same double-tops, double-bottoms, head and shoulders, and other patterns that you are used to seeing in the equity markets. We use support and resistance in the same way that other traders do, and we use moving averages, MACD, average true range, and all of the other familiar indicators. Also, the currency markets feature strong trends which can last for years, so if you are a trend trader you will really enjoy trading Forex (see figure 1).


Figure 1: Long term trends are evident on the weekly chart of EUR/USD. Source: TradeStation

How long will it take to make the switch from stocks to Forex? That answer really depends on the individual, as it could take anywhere from a few days to a few months. I made the transition from stocks to Forex a few years ago, and at first I was hesitant. After all, there are two currencies involved in every currency trade; I can remember wondering if there would be two different prices on the chart! Of course, I learned later that there would only be one price – more accurately described as the exchange rate – on every Forex chart.

It took a while for me to realize that I needed to use longer time frames in Forex than I was previously using to trade stocks. This realization was a breakthrough in my transition process; if you are trading U.S. stocks, you have exactly 6 ½ hours per day to place trades, assuming that you are not trading the pre-market or post-market sessions. This causes traders to think in terms of shorter time frames, unless they are swing traders or position traders. Forex, on the other hand, is a 24-hour market, and although movement can be sudden and dramatic, most of the activity plays out over a longer period of time. Also, keep in mind that in the Forex market, we are not trading individual companies; instead, we are trading entire economies! The fortunes of any individual company can change dramatically in a relatively short period of time (Lehman Brothers, anyone?), but the world's major economies are massive compared to individual companies, and their fates change more slowly. This creates a huge advantage for Forex traders, and is the main reason why trends in the Forex market tend to be so dramatic and persistent. Many traders like to say, "The trend is your friend," but in the Forex market, we could say that the trend is your best friend. Good luck!

Q) Hi Ed, the question I wanted to ask you relates to the strength of Asian currencies in the near and distant future, and, in particular, the Chinese Yuan. Perhaps it is fair to say that, as the Pound was replaced by the U.S. Dollar some time ago and fell sharply over a number of years, then maybe we should prepare for what currency is likely to appreciate more in the long-term against the U.S. Dollar.

The Chinese currency is not free to trade at the moment, so the question is this: what is the best way to take advantage from the likely future appreciation of Asian currencies? Would the Singaporean Dollar and the Hong Kong Dollar be a partial answer? Thank you in advance for your help.

Ed Ponsi) Thank you for your question. If you are going to play the demise of the U.S. Dollar, you're going to need patience - although U.S. spending policies that have recently been enacted will serve to accelerate this process. As you mentioned, the reserve currency of the eighteenth and nineteenth centuries was without a doubt the British Pound. The GBP gradually ceded its throne to the greenback as the U.S. economy became the world's largest in the early twentieth century. The fall of the British Empire coincided with the collapse of the British Pound.

The most likely candidates to succeed the U.S. Dollar as the world's reserve currency are the Chinese Yuan and the Euro. China's economy will become the world's largest during the next ten to twenty years; meanwhile, countries such as Poland and Denmark may be drawn to the Euro as it has weathered the current economic storm in reasonably good shape - at least so far. Many pundits originally believed the European Monetary Union would fall apart when confronted with its first major crisis, but now other countries are accelerating their plans to adopt the single currency.

There is much to like about the Singapore Dollar (SGD). Singapore does not have a central bank; instead, its currency is managed by the Monetary Authority of Singapore. The MAS is seriously committed to low inflation, and unlike many central banks, it does not manage its monetary system via interest rates. Singapore is poised to benefit from the continuing explosion of growth in China.

Another long-term play on China's growth is the Hong Kong Dollar. The HKD trades within a narrow band vs. the U.S. Dollar, and it will be extremely difficult to maintain that band if the greenback falls apart. The HKD has traded between 7.75 and 7.85 vs. the USD for years. A sudden collapse in the USD could lead to a sudden and dramatic strengthening of the Hong Kong Dollar. Both the HKD and the SGD would be good candidates to include in a diversified currency portfolio designed to protect against weakness in the USD.

Did Someone Say "Carry Trade"?

Did Someone Say "Carry Trade"?
By Ed Ponsi, President, FXEducator.com

Greetings from New York! After another great trip to the U.K., it's good to be home in the U.S.

I received quite a few comments about last week's chart showing a massive double-bottom formation on the Australian Dollar/U.S. Dollar pair (AUD/USD). As it turns out, this formation is popping up in a number of pairs involving the Aussie and also the New Zealand Dollar (NZD). For instance, here is the same bullish pattern on the NZD/USD currency pair (see figure 1).

Figure 1: NZD/USD attempts to break out from a double-bottom formation. Source: Trade Station

Compare this chart to AUD/USD, and you'll see that the New Zealand Dollar is lagging behind its Aussie neighbor, falling short of the breakout point near .6000. Why is the "Kiwi" (so-called because of the picture of a kiwi bird on the New Zealand Dollar coin) having such a tough time in comparison to the AUD? Traders believe that New Zealand's central bank, the Reserve Bank of New Zealand, isn't finished cutting rates, and expect to see a 2.5% rate after the RBNZ's next meeting on April 30th. RBNZ Governor Alan Bollard recently said that the central bank is "projecting interest rates to remain at relatively low levels for an extended period," which also helps explain weakness in the Kiwi.

We haven't discussed carry trades in quite a while, but this strategy may be coming back into vogue. Many assume that carry trades must include a short position in the Japanese Yen, but this is not the case; any currency that possesses low interest rates becomes a viable shorting candidate for this trading strategy. Current interest rates reveal a number of excellent potential candidates among the majors:

Japanese Yen 0.10%; U.S. Dollar, Swiss Franc 0.25%; Canadian Dollar and Great Britain Pound 0.5%

And which of the major currencies have the highest rates, making them appropriate for the long side of the trade? Australian Dollar and New Zealand Dollar, both currently at 3%, are the highest yielding of the majors, but as we will see, there are other currencies that currently feature higher yields.

Regarding AUD/USD and NZD/USD, suffice it to say that U.S. rates have remained below Australian and New Zealand's rates for the past decade, and there is no scenario in which I can envision the U.S. Fed Funds rate exceeding the benchmark rates of those two countries. What about AUD/JPY and NZD/JPY? Those currency pairs are looking pretty bullish, sporting – you guessed it – double-bottom formations. Here is a look at AUD/JPY (see figure 2).

Figure 2: AUD/JPY breaks out of a bullish double-bottom formation. Source: Trade Station

A quick look at the daily chart of NZD/JPY reveals a very similar situation, as the pair also has broken out of a double-bottom formation. This trade also produces positive carry, as New Zealand's benchmark interest rate is higher than Japan's (see figure 3).

Figure 3: NZD/JPY daily chart reveals another successful double-bottom breakout. Source: Trade Station

One last piece of evidence that the carry trade has returned; an equally weighted basket of currencies consisting of Turkish Lira, Brazilian Real, Hungarian Forint, Indonesian Rupiah, South African Rand and Australian and New Zealand dollars – purchased with Japanese Yen, U.S. Dollars and Euros - earned an annualized 196% from March 2 to April 10. In other words, those taking the trade were long high-yielders such as the Brazilian Real and the South African Rand, and at the same time, they were short low-yielders like the Japanese Yen and U.S. Dollar, with the added diversification of using baskets instead of individual currencies. That same trade produced a 41% annualized loss from September, when Lehman collapsed, through February. Benchmark rates in those seven "long" economies range from a low of 3% in New Zealand and Australia to Brazil's astronomical 11.25%. Here is a three-year chart of these two baskets – it appears that a bottom may be forming (see figure 4).

Figure 4: A basket chart of high-yield vs. low yield currencies shows a bounce. Source: Bloomberg.com
Paradise? Not Really…

Fiji's central bank recently slashed the country's currency value to boost exports and tourism. The Reserve Bank of Fiji appointed Sada Reddy as the bank's new governor, one day after the former central bank governor was removed. Reddy immediately announced that the Fiji dollar was to be devalued by 20%, a decision that will probably send inflation soaring.

Fiji's international credit rating was downgraded last month from stable to negative, but the currency devaluation might drive tourists to the island paradise – assuming that their finances haven't been damaged by the current worldwide economic downturn. Thanks to the devaluation, the cost of a vacation to Fiji effectively drops by 20%. However, Fiji is currently run by a military regime, which is heavily censoring news and threatening to jail and deport journalists who report on political events there. Maybe it isn't such a great place to visit after all.
Comment of the Week

Q) I just read your email and I came across your article regarding the protests and the G20 summit. Well I though it was great; I am not sure whether you or a ghost writer wrote it, but it made sense to me. I think the problem with any country that has experienced wealth for too long takes what the previous generation did for granted. I am South African and it never ceases to amaze me how socialistic Britain has become, the Polish could teach them a thing or two about communism.

Ed Ponsi) Thank you for your email. No ghost writer here, just me. It seems that people everywhere forget the lessons of history, and those who forget history are doomed to repeat it. Poland has recent memories of Communist oppression, so they don't need to be reminded of the evils of that failed ideology. Meanwhile, in the U.S. and other fortunate countries, we seem to be wandering down the path of Communism, perhaps because we have no experiences that compare to those of Poland or other afflicted countries. There is an easy way and a hard way to learn anything, and I'm still hoping we in the U.S. can learn the easy way – through the experiences of others – as opposed to the hard way, where we repeat those experiences out of ignorance or foolishness.

My Name is Ed, and I’m a Capitalist

My Name is Ed, and I’m a Capitalist
By Ed Ponsi, FXEducator.com

Cheers from London! It's been an exciting week, complete with visiting dignitaries, rioting in the streets, and the cracking of a major terrorist plot right here in the U.K. I love it here in London, one of the greatest cities in the world, but all things considered, I'm ready to go home!
On the Steps of the Bank of England

On April 2, one day after the G20 riots in London, I made my way from my hotel to the headquarters of the Bank of England. On the previous day, at that same location, thousands of protesters clashed with police and vandalized a retail office of the Royal Bank of Scotland. When I arrived, a few hundred protesters remained, accompanied by nearly as many police. The walls of the BoE bore graffiti such as "Break the Bank" and "Fight Inflation, Eat the Rich." The protesters I spoke with were young, intelligent, and committed, and they truly seemed to believe that capitalism is the root of all evil. A young lady wore a shirt proclaiming her status as a "Free Range Human." One young man handed out flyers purporting to explain in a rational manner the evils of capitalism and extolling the virtues of communism and anarchy (does it really qualify as anarchy if someone is handing out flyers?). None of the protesters appeared to be over the age of 25.

As an unrepentant, lifelong capitalist, I was not upset that these folks were disparaging my way of life. These people were not evil, just misguided and inexperienced in the ways of the world. It's easy to be a committed anarchist when you're living in the basement of your parents' suburban home. These kids don't know that communism enslaves people into poverty, and that for many people around the world, capitalism represents the only hope of freedom. I would love for them to speak with one of the many thousands of people who risked their lives to escape communism for a chance at a better life.

I imagine that five years from now, many of those protesters will have children, and will need a place to call home. By then, I wonder how many of them will be seeking loans from – or even working for – the very banks that they now denounce and despise. Perhaps by tasting the rotten fruit of communism, these young lads and ladies will learn how morally bankrupt that failed system truly is. I imagine that down the line, some of them will become staunch free-marketers, once they have seen for themselves that despite its flaws and its wounded reputation, capitalism still is the greatest economic system on earth.
For Those About To Rock

When the global downturn hit, the prices of commodities such as gold, copper, and other base metals were crushed, and commodity currencies such as the Australian Dollar were hammered right along with them. Now that some analysts claim to see the first "green shoots" of economic recovery, will demand for those metals rise again? Let's connect the dots; a strengthening world economy should lead to increased construction, especially in China. This would in turn lead to increased demand for base metals, a crucial construction component and a major export of Australia. As demand increases for Australia's exports, the economy down under should kick into gear, thereby justifying a rise in the Aussie currency.

While economic figures remain grim, markets do not necessarily reflect the current environment; many analysts believe that markets are predictive, and any improvement in the economy will be foreshadowed by the markets prior to its actual occurrence. With that in mind, it's interesting to note that the Australian Dollar has formed a rather massive double-bottom formation, a possible indication of better things to come (see figure 1).

Figure 1: AUD/USD weekly chart shows a bullish double-bottom formation. Source: Trade Station

Whether or not the AUD/USD pair can break out of this formation is not the issue, in my opinion. Even if Aussie pulls back to the area below .6500, there could be limited downside risk because Australia's central bank, the Reserve Bank of Australia, has openly admitted to boosting the currency several times when it reached that area in late 2008. The RBA is committed to preventing the Aussie from tumbling below .6000, after nearly reaching parity vs. the USD last summer. Also, this trade currently has positive carry (meaning that traders can collect interest, similar to a stock dividend except currency traders collect it every day) because Australia's benchmark interest rate, currently 3.25%, is higher than the U.S. Fed Funds rate of 0.25%. So, traders who are long Aussie vs. the greenback can capture interest in addition to any appreciation they might receive from the trade. This would certainly be a long-term trade with very wide targets and stops (ideally beneath .6000), but the upside potential is huge – potentially back to last year's high near .9850 – and there is little nearby resistance if the double-top can be completed.
Question of the Week

Q) Just read your article on the Reserve Currency Debate and had a general question. If in fact that proposal would go through for a super currency and all nations would be on board, what would happen to the Forex market, would it still be there?

Ed Ponsi) Thank you for your question. Yes, the U.S. Dollar would still exist, along with the Euro, the British Pound, and all of the familiar currencies, but the USD would be supplanted as the reserve currency of the world. This might not occur by official decree but over a period of time; for example, at one time the British Pound was the world's reserve currency. The greenback did not suddenly replace the Pound Sterling; it was a gradual process that occurred over a period of years. Likewise, there was a time when the sun never set on the British Empire. Empires rise and fall, and the British Empire was no exception. In my opinion, the reserve currency issue is about more than money, it is a question of economic power and influence: Will America remain a powerful and influential nation in the future, or will the U.S. choose to let her economic empire fall?

The Reserve Currency Debate

The Reserve Currency Debate

By Ed Ponsi, President of FXEducator.com

Greetings from London! The Group of Twenty (G20) meeting is in full force just a few miles away, and the world is waiting to see if world leaders can come to a consensus on how to deal with the financial crisis. Some feel that at least part of the problem lies in the U.S. Dollar's status as the world's reserve currency. Lately there has been much talk about shifting the world's reserve currency away from the U.S. Dollar and toward a so-called "super currency."

First of all, what is a reserve currency? Reserve currencies are held by governments and institutions outside the country of issue and are used to finance international economic transactions, including trade and the payment of debts. A country might stockpile U.S. Dollars in case they may want to sell them and purchase their own currency, in order to boost the exchange rate. This is known as intervention, and it has happened recently in Australia, Brazil, and Mexico, among other places. Another reason to keep a supply of USD handy is because key commodities, such as oil and gold, are priced in U.S. Dollars.

Why do countries want to replace the U.S. Dollar as the world's reserve currency? If the U.S. Dollar becomes volatile, as it has recently, this can cause large swings in the value of financial holdings outside the U.S. A strong dollar makes it much more difficult for entities outside the U.S. to pay back loans that are denominated in USD. Critics also say that the United States enjoys an unfair benefit as the printer of the world's premier reserve currency.

And of course, haters like Venezuela's Hugo Chavez and Iran's Mahmoud Ahmadinejad would love to see the U.S. lose the prestige and influence that comes with possessing the world's reserve currency. "Soon we will not talk about dollars because the dollar is falling in value and the empire of the dollar is crashing," said Chavez on November 19, 2007. "Naturally, with the crash of the dollar, America's empire will crash." Ahmadinejad has led the charge for OPEC nations to price oil in currencies other than the U.S. Dollar, which he refers to as a "worthless piece of paper."

Please understand that any shift away from the USD toward either the Euro or a "super currency" would be devastating for the U.S. Dollar. To illustrate this, please consider the events of March 25, 2009. On that day, Treasury Secretary Timothy Geithner responded to a question from a reporter. The reporter asked Geithner for his thoughts about the proposal by the governor of China's central bank to replace the dollar with a new global reserve currency. Here is Geithner's reply:

"We're actually quite open to that suggestion – you should see it as rather evolutionary, rather building on the current architecture rather than moving us to global monetary union," he said. As word of these remarks reached traders, the greenback abruptly lost 180 pips to the Euro in just eight minutes, and suffered a similar plunge against other currencies (see figure 1).

Figure 1: Euro rockets higher vs. USD on 1-minute chart, and then reverses. Source: Trade Station

A few minutes later, Geithner furiously backpedaled on his comments by saying that there is "no change in dollar as world's reserve currency and likely to remain so for long time." As those words crossed the newswire, the buck reversed course and gained back most of the ground lost just minutes earlier.

I think Geithner is a bright guy, but am I the only one who is growing tired of his on the job training? For years, the U.S. Treasury Secretary has repeated one mantra, over and over. Here it is: "A strong dollar policy is in the best interests of the U.S." That's it. Mr. Geithner should commit those words to memory.

The scary part is that his comments seem very well thought out and articulate, so I don't think it was a gaffe. What if in his heart of hearts, his initial comments reflect his true feelings on the subject? What if he really believes that the USD should be replaced as the world's reserve currency, that such a move would be "evolutionary" as he put it? What sort of an impact would that have on the U.S. Dollar? Consider the damage that Mr. Geithner was able to do in eight minutes, and now imagine if that policy – to which he says he is "quite open" - was actually implemented. How far would the U.S. Dollar fall in eight days, in eight months, or in eight years? One can only hope that we never find out.

So what is this so called "super currency" that would replace the U.S. Dollar as the world's reserve currency if China and Geithner have their way? The likely choice would be an SDR. In 1969, the International Monetary Fund (IMF) created an international reserve currency called a Special Drawing Right, or SDR. An SDR is not an actual currency, but an artificial currency that is really created from a basket of currencies. That basket consists of the Euro, Japanese Yen, British Pound, and U.S. Dollar.

We in the U.S. take it for granted that the Dollar is the dominant currency of the world, but this was not always the case – the Great Britain Pound once held the title as the world's reserve currency. The U.S. Dollar was not always the reserve currency, and it will not remain the reserve currency of the world if we allow it to fall. Please keep in mind that the actions we take today have consequences for the future.


Ed Ponsi