Author Archives: John Forman

Since peaking out in mid-March just shy of 1.13, USD/CAD has been making fairly rapid progress to the downside. With the market having now broken 1.07 to the downside, however, it is probably a good point to look for the volatility to ease off and some support to develop. A starting point for thinking that way is the seasonal pattern for the pair. It has generally been a negative one for the last several weeks, but over about the next month or so that shifts to a more positive bias. This certainly isn’t to say 2014 couldn’t see the market go against the historical averages, but it gives us a reason for caution when considering playing the short side from here.

Perhaps more significant, though, is the weekly chart pattern. As can be seen below, the market has now retraced to just above the peak from July 2013. That peak was in a rejection zone from the spike high of October 2011 and even when it was broken in December it took a few weeks before the market could muster enough strength to pull clear. That suggests strong resistance, which now likely means good support.

USD/CAD chart

Of course one thing that could be seen as working in favor of a continuation in USD/CAD lower is the fact that the Bollinger Bands have only relatively recently begun expanding. Normally this would indicate a likely early-stage trend situation. In this instance, however, the Bollingers could continue expanding for a little while still without the market moving much as they catch up to the volatility seen of late.

What looks to be a good play from here is to watch for the market to move back up toward the area above 1.08 where it found support in May that was finally broken a couple weeks ago. That support should now be resistance if the market is to remain strongly bearish. Thus, a failed rally back in that direction would make for a good entry to play an eventual continuation to new lows for the move. And if the market can get clear above that resistance, then it’s probably not as weak as we might think.

For my PhD research I am working with a data set that includes a couple of million trades. On a whim the other day I decided to have a look at how those trades break down in terms of a few different metrics. It’s not stuff that is likely to play any significant part in my dissertation beyond inclusion for descriptive purposes, but I thought it would be interesting for trades to see.

One of the things that jumps out of the data right away is clear evidence for what academics refer to as the disposition effect, but we traders simply know as holding our losers and cutting our winners. I’ve written about this a couple of times before (here and here). In case you have any doubts about how much this really happens, let me give you a couple of numbers.

In the approximately 2.4 million trades I’ve run the analysis on, the average holding period for a winning trade is just slightly over 1 day. In the case of losing trades it’s just shy of 1.7 days. In other words, trades are holding losers almost 70% longer than winners.

If that’s not enough evidence, I’ll toss in another tidbit. The average winning trade gains 0.194%. This is just looking at how much the exchange rate moved over the course of the trade. It doesn’t take into account the leverage used, so it’s not a net realized return. I’ll get to how things look once leverage is factored in momentarily. In terms of the losing trades, the average loss is 0.37%, so losers are almost twice as big as winners. Doesn’t sound like these traders are cutting their losses and letter their winners run, does it?

The win rate for all these trades comes in at just under 63%. Putting that together with the figures above, we get an expectancy in terms of the exchange rate move captured of:

(.63 x 0.194%) + (.37 x -0.37%) = -0.01468%

So what we have here is a situation where the average trade is a fractional loser. Now let’s factor in leverage, which I wrote about recently as well. Here’s where things get a bit ugly.

The average amount of leverage used in winning trades comes in at just under 7.7:1 while the leverage used on the losing trades averages almost 10.6:1. That’s a difference of about 30%, which is quite significant. So not only are forex traders failing to cut their losers and hold their winners, they’re also using more leverage on those trades.

Plugging the leverage factors into our expectancy formula we get:

(.63 x 0.194% x 7.7) + (.37 x -0.37% x 10.6) = -0.51%

That means on average each trade done is costing the traders in this sample just about a half a percent of their account balance. Not very good, eh?

On the positive side, these figures provide guidance in how to improve one’s own expectancy. The three elements of relative leverage used, win %, and the ratio of average gain to average loss are all areas a trader can look to address. They just have to not fixate on in the win% when they should spend at least as much time considering the other parts of the equation.

On the back of insurgent activity in Iraq, crude oil prices have popped up above recent highs. This isn’t something yet which breaks the long-running trading range I noted previously, but it is a development we need to keep an eye on moving forward. We can see why by first taking a look at the weekly chart below.

Crude Oil weekly chart

Notice how narrow the Bollinger Bands have become thanks to the relatively narrow range either side of about 102 seen over the months before the recent rally. As indicated by the lower plot on the graph, the Band Width reached its narrowest point in years, which by itself tells us to be on the lookout for a volatility expansion – most likely as part of a new trend. The oil rally above 105 is seeing the Bands start to widen out, which suggests that a volatility/range expansion has begun. The range being resolved positively is supported by the clear pattern of rising lows we can see going back to 2012.

That said, there’s definitely some resistance overtop at this stage. The market hasn’t been able to sustain moves above 108 at all since it peaked near 115 in 2011. And even if the market is able to overcome that resistance, the precipitous way oil sold off after making its 2008 high indicates the potential for resistance remaining a factor above 115.

Still, in the monthly time frame the Bollingers have turned higher and are very narrow. That paints a pretty positive picture for prices. A monthly close above 110 or so would probably get the Bands starting to widen out – a positive trend indication. If the Bands weren’t so narrow I’d suggest that we could actually see the kind of low volatility grind higher bullish trend that develops sometimes. With recent volatility so low, however, the odds would tend to favour at least some kind of short-term rapid range expansion before a trend settles in.

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Gold got rather uppity a short while back. After an uneventful couple of months trading in an increasingly narrow range either side of about 1295, the market broke down sharply and eventually got to near 1240. As you can see in the daily chart below, that move came out of a very narrow Bollinger Band set-up, which is quite often the precursor to high volatility moves.


As much as the move in narrow Bands to start expanding can signal the beginnings of a new trend, in a case where the Bands have become exceedingly narrow the dynamic can change a bit. In those cases the market has been so tightly controlled that the eventual break is quite violent, as we’ve seen in gold. And as is the case here, a major initial move quickly peters out as the initial impetus fades.

This is not to say further movement in the direction of the break can’t or won’t come. A continuation of the break can indeed eventually develop to create a more lasting trend. A lot depends on the bigger picture, however.

This would certainly seem to be the case where gold is concerned. A look to the weekly chart provides us some perspective. You’ll quickly observe that here too we have a situation involving narrow Bollinger Bands, which could be setting the stage for a new trend in that time frame.


The proximity of the market to the lower Band is enough reason to suspect that we might yet see a period of consolidation and maybe a bounce in gold from the shorter time frame perspective. There is also reason to look for the Bands to narrow a bit further in the weekly time frame as they are not quite as tight as they were before previous major expansions. A bit more time in the current range would facilitate that.

That said, we could see a Band expansion from here. It would certainly happen if the market were to break through the 1240 support zone and head for 1200. The market repeatedly rejected attempts to break below that latter level in the last year or so, however, so it likely won’t be one easily taken out. That’s another reason to be cautious about playing gold from the short side at this juncture. The risk/reward profile is a bit better for long plays, even if the bigger perspective view probably favors the bears a bit more.

Narrow ranges and light volumes are the subject of a recent blog post by Brett Steenbarger in which he talks about the impact of such market conditions on trader performance. Brett’s specific focus is on stocks, but as I’ve written before, low volatility has been a feature of multiple markets such as interest rates and the USD.

Specific attention has recently turned to the VIX. As can be seen in the daily chart below, the so-called Fear Index has reached its lowest level since the first part of 2013. When the VIX is low it tends to make some market observers nervous, getting them looking for stocks to take a tumble.

VIX and S&P 500

We’ve seen quite a few low VIX readings in the last couple of years, and they have indeed generally been followed by some kind of market reversal. While those downside moves have at times been quite sharp, they’ve never done any real technical damage and the overall trend has remained positive. In fact, the high volatility episodes have tended to be relatively brief, which is often a good indication of a strong trend. Still, a quick 5% drop like we saw the S&P 500 experience early this year is something which can rattle traders- perhaps even more so in a situation like we’re in now where at least part of the market is quite sensitive to the idea that we’re due for a reversal.

While I certainly can envision the S&P 500 experiencing a sharp sell-off at some point in the not too distant future, I’m not overly worried at this point about a major top developing. The market psychology doesn’t really feel excessively positive to me here. I will, however, be keeping an eye on how the ranges in the currency and yield markets eventually resolve, as they will certainly play a part of the future direction – and amplitude – of the stock market’s path forward.

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The other day Trade Leader Alex Kazmarck offered his thoughts on GBP/USD, suggesting the pound was probably due for a retracement in the near future. While I don’t disagree with his view on cable, in light of the comments from Bank of England boss Carney last week as to the timing of eventual rate hikes by the central bank, it’s is worth taking a broader view of sterling. I start with EUR/GBP.

The thing which stands out for me on the weekly chart below is the recent turn up in the width of the Bollinger Bands. The Bands have gotten extremely narrow of late – more narrow than at any point in the last several years, as can be seen in the relative width line at the bottom of the chart. That is a set up for a market to see a rapid increase in volatility, usually as the result of a new trend.


Of specific interest to us right now where EUR/GBP is concerned is the way the Band Width has increased on the recent break of 0.8150. This tends to indicate confirmation of the move, suggesting we are at the outset of a new leg lower in the cross’s move down from last year’s peaks. With the market getting into the high trading density area down to about 0.8000, it would be no problem at all to imagine it slipping toward that latter level.

We also have an extremely narrow Band situation on the GBP/JPY. Here too the Bands have gotten more relatively narrow than has been the case at any point over the last several years. In this case, however, we haven’t year seen them start to widen out, which make sense since there hasn’t been any kind of range break yet.


Supportive of GBP/JPY moving higher again eventually is the price pattern. It has the look of a bull flag or pennant, both of which are generally seen as positive continuation patterns. This is generally supported by the fact that more of the trading has been toward the upper end of the consolidation area than the lower, indicating stronger buying pressure. There is also a modest bullish seasonal pattern to the cross this time of year.

Switching to GBP/AUD, we have a similar if slightly different scenario. Here the Bollingers have also gotten narrow, though not to the historical levels seen in the earlier crosses. A look at the price pattern on the weekly chart shows us shorter periods of consolidation, and in fact a recent break down from the one either side of about 1.85 that happened earlier this year.


Still, we do have relatively narrow Bands that are starting to widen out once more, as in the case of EUR/GBP. This is a potentially negative situation for sterling, as said expansion in the Bands is coming in conjunction with weakness in the cross. We have what is looking like a potential failed rally following the break down from the earlier consolidation, creating a lower high, lower low situation. The one positive element is the proximity of the highs from mid-2013 to act as support. They are not very far below the recent lows.

What that leaves us with is a key range for GBP/AUD of about 1.75 to 1.83. I think the way the market breaks from here will tell us the direction of the next major move.

So we have is a situation where the pound looks like it could yet make further gains against the euro and the yen, but might be set to lose ground against the Aussie. That fits a scenario where the markets perceive the latter to potentially benefit from a stronger global economy, but the former two to continue to lag because of lingering internal economic issues. Sterling thus occupies a middle ground.

At the recent FOMC meeting we got another announcement from the Federal Reserve that it would again taper back again the amount of Treasury debt it was purchasing each month – the fourth such move. We also got word that the central bank expects to keep paring back its QE purchases in the face of an improving US economic outlook, which has market participants anticipating that the $45bln in monthly asset purchases still in place will be wound completely down as 2014 progresses.

So what do the markets think of all this? Well, not very much really. As can be seen from the daily chart of US 10yr yields below, rates actually took a bit of a tumble in the days following the FOMC meeting, though they have largely recovered recently.

Daily chart, US 10 year yields - click to enlarge

One would normally expect Treasury yields to be at least looking like they wanted to move higher in the face of an improving economy and the steady reduction in purchases by the Fed. Instead, however, we’ve had a couple of months of the market going basically nowhere. This is, in fact, part of a broader consolidation in rates which dates back to the middle of 2013 on the heels of the big rally up from the 2012 lows.

Weekly US 10 year yields chart - click to enlarge

It’s worth making note of how narrow the Bollinger Bands have gotten of late. As the lower plot in the chart above shows, the Band Width relative to the middle Band (20-period average) is basically in line with its low readings from about this time in 2010 and 2011. In both cases the eventual market moves which followed were substantial. If anything, this current consolidation is even more intense than those proceeding ones, which could be setting the market up for some really serious trending action in the months ahead.

First, of course, the range needs to be broken. The Bollingers don’t help much in the way of indicating which way things eventually resolve. The chart, however, does provide some help. We still have a higher high, higher low situation in the weekly timeframe. This generally biases things to the upside. If yields can push back above 2.80% it would establish yet a higher high in the pattern, which would be a further positive indication.

Admittedly, however, the recent action does have a bearish bias to it. Were the market to drop below 2.450% it would represent both a key support break and a widening of the Bollingers. That would be a decidedly negative indication – or at least the set-up for a nasty head fake by the market.

The other day there was a post looking at the May seasonal biases for the USD. It talked about this month being the strongest for the greenback over the last five years. While that may be true, five years of monthly figures is definitely not enough to draw much in the way of statistically significant findings. In that short a period of time, we really need to have a look at potential causality to see if the pattern is likely to persist in 2014.

Fundamentally, May does not stand out as a month which suggests itself as a candidate for a strong seasonal pattern. It is not a time of year where we would expect to see major international capital flows that way we see around year-end. Nor it is even a quarter-end month.

So what might be the explanation for May being a good month for the USD?

Well, stock market performance could be a big part of it – or at least the psychology related to that performance. You see, as the monthly S&P 500 chart below shows, in three of the last 5 years the US market has been down in May – in a couple of cases quite sharply.

S&P 500 Monthly Chart showing May - click to enlarge

Now consider that for much of the time since 2007 the markets were in a risk-on/risk-off binary type of state where asset markets like stocks and safe-haven markets like the dollar moved largely in opposite directions. This could be a significant factor in why the dollar has done well in May in the last few years, especially against the likes of the EUR and AUD as that previous blog post indicated. The question to be considered now is whether the conditions are in place for a similar sort of story to unfold this year. Are we in a risk-on/off type market and are stocks likely to struggle over the next few weeks.

Certainly there are voices calling for a “Sell in May and go away” approach to the equity markets at this point. Personally, though, even if that’s the case I’m not a big fan of the current USD set up. It looks weak in the weekly timeframe to me.

In terms of the seasonals, my own research does indicate a positive general USD pattern this month based on a 30 year sample. EUR/USD is not really part of that equation, however. It has been just about a 50/50 bet in May since inception. The AUD and GBP have both been on the receiving end of that dollar strength, and to a lesser degree so has the JPY. Interestingly, however, the CHF has been on the other side of things. These are perhaps worth keeping in mind as you trade this month.

We have an interesting situation that’s developed in AUD/USD. Over the last couple of months the Aussie has rallied off the lows near 0.8700 from early in the year to having recently ticked up above 0.9400. This is somewhat against the pattern of quiet forex markets I mentioned last week hearing some complaints about of late. As you can see in the weekly chart below, the latest upside action has caused the Bollinger Bands to start widening out.


Now normally when the Bands start widening we look at the possibility that the market is starting a new trend. While that could be the case again here, there are a couple reasons why I’m not inclined to lean in that direction this time.

The first reason for my caution is the relative width of the Bands in this instance. As can be seen in the lower plot of the chart, the Bands didn’t get quite as narrow as they’ve gotten ahead of previous big moves. That isn’t strictly required, and the Band width was still pretty narrow, but just not quite as optimal as I’d like.

More significantly, the chart pattern doesn’t favor a major move higher at this point. We have a clear pattern of lower highs and lower lows suggestive of a down-trending market. Could this move be the one that signals a trend change? Certainly, but even in that case the immediate upside potential likely is limited because of the resistance in the 0.9600 area. That’s where the 2011 and 2012 lows came in and where the AUD/USD rally in the latter part of last year stalled out. I’d expect the market to struggle to overcome that resistance, especially at present having already made a significant rally. This is why I would not be inclined to trade from the long side at this stage. I’d want to see a period of consolidation, including a new higher low, before looking for a real meaningful break of 0.9600.

In an email exchange recently a friend of my working in the markets bemoaned the dull state of the forex market these days. I recall well how much grumbling there was in the middle 2000s about how little action there was in exchange rates at that time. I asked my friend if this was anything like that. His response was that the markets are the worst he’s ever known. No doubt there’s a fair bit of hyperbole in that statement, but this is a fellow who was a bank dealer in London back in the 1980s, so he’s seen a thing or two.

Overstated or not, the market has definitely gotten less volatile recently. As the weekly chart below shows, the USD Index has been in a quite narrow range for the last few months. That’s seen the Bollinger Bands get to their narrowest since 2006.

Weekly USD Index chart - click to enlarge

The range-bound dollar is linked to range-bound interest rates. As the 10-year Treasury Note yield chart below shows, the volatility there has dried up considerably of late as well. Exchange rates are closely tied to interest rates, and especially interest rate differentials. When those rates aren’t moving, it tends to keep the forex market quiet.

Weekly 10 year treasury chart - click to enlarge

Interestingly, though, the USD Index chart belies what’s been happening in the dollar exchange rates to a certain degree. If we look to the likes of EUR/USD and GBP/USD we can see weakening trends at work. These are being countered by an opposing trend in USD/CAD and USD/JPY (though in the latter case ranging is more the theme). That makes this a market where you want to be looking at specific pairs, not the major USD pattern as depicted by the index.

That said, however, the narrowness of the Bollinger Bands and interest rates suggests something big is building. One need only look at what has happened in the markets after the Bands got as narrow as they have become recently to see the potential for market mayhem this set-up represents. I’m definitely not calling for another Financial Crisis type experience for the markets. I think, however, that it won’t be too much longer before my friend is no longer complaining about dull markets.