Author Bio

A while back, motivated by persistent misinformation being presented in the media, I did a quick study of volatility in various markets. It was something I repeated here last year using weekly rather than daily data. Markets have had lots of different things happening recently, so I decided to re-run the daily data study, this time using 5 years of data rather than just the 1 year I went with the first time around. Also, rather than showing the figures in tabular format, I’ve decided to make things more visual and put the results in a pair of charts.

Here is the first one which compares four exchange rates, four major US stock indices, eight big cap common stocks, four major commodities, and four key US interest rate instruments (using futures for the latter two groups). It looks at volatility from the perspective of the standard deviation of daily % returns. This basically gives us an idea of how much of a change we see in each market on a given day.

The results are consistent which my prior analysis. The interest rate and exchange rate markets are noticeably lower in volatility than commodities, stocks, and stock indices. The major forex pairs move roughly about the same amount as longer maturity fixed income instruments like T-Bonds (using a price basis rather than an interest rate basis).

The second chart uses average daily ranges as the comparison point. The ranges are calculated as (High – Low)/Prior Day’s Close. This allows us to look at percentages for all markets so we’re comparing apples to apples.

There’s a bit of shuffling around in the order in which the markets rank when looking at ranges rather than returns, but generally the pattern is the same. Interest rate and exchange rate markets fall on the low end of the scale while individual stocks and commodities are on the high end.

The first reason for showing these images to you is so the next time someone tells you how risky the forex market is you can show them the comparison and ask them if they want to reconsider.

The other reason I bring this subject up is to provide a better understanding of volatility across markets , which factors into things like bid/ask spreads, margin requirements, and the like. This should help in your investment asset allocation process – or at least to have some insight into how different markets move if you’re just focusing on only one or two. Of course once you start applying leverage you can create a situation where any market can result in a very volatile account equity line.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Equity prices have vaulted to within touching distance of all-time highs, and the upturn in investors’ fortunes has pushed valuation ratios to levels that have preceded protracted periods of poor stock market performance in the past.  The widespread belief that stock market returns mean revert over long horizons means that it could well be possible to use the information contained in high valuation ratios to time the market, and capture the favorable combination of lower risk and higher returns.

An interesting paper authored by Elroy Dimson, Paul Marsh, and Mike Staunton of the London Business School, and recently published in the ‘Credit Suisse Global Investment Returns Yearbook,’ casts doubt on this view.  The academics assess the predictive ability of a cyclically-adjusted price-dividend ratio – the ratio of the current real index level to the average of the preceding ten years’ real dividends – across a variety of world stock markets, and conclude that, “we learn far less from valuation ratios about how to make profits in the future than about how we might have profited in the past.”

The choice of valuation metric appears reasonable, since dividend payments, unlike earnings, cannot be manipulated, and often reflect a company’s own view of its long-term earnings power.  However, there is no theoretical reason as to why a cyclically-adjusted dividend-price ratio should mean-revert, since the higher multiple might simply reflect substantive changes in the percentage of earnings that companies decide to pay to shareholders.

It is important to appreciate that stock market value is made up of both current dividends and expectations for future growth.  The pace at which dividends grow in the future depends on the percentage of earnings that a company distributes to its owners, and the rate at which retained earnings are reinvested in the business.  In other words, a low dividend yield might simply reflect a lower payout ratio, and higher expectations of future growth.

Historical data for the US demonstrates that the corporate sector’s payout ratio has been in secular decline for decades.  The ten-year average payout ratio dropped from a peak of almost ninety per cent in 1940, when expectations for future growth were virtually non-existent, to below forty per cent in 2007, when expectations for uninterrupted growth for the indefinite future held sway.  Long-term differences in payout policy means that it is impossible to identify a mean around which the cyclically-adjusted dividend-price ratio might oscillate.

Financial theory suggests that we should be able to observe a negative relationship between corporations’ payout ratios and subsequent growth rates in earnings and dividends.  In other words, higher growth rates would be expected to follow lower payout ratios and vice versa, but if this expectation is frustrated, then the dividend-price ratio might retain some predictive ability, as disappointing growth outcomes are reflected in lower share values.

The historical evidence in both the UK and the US reveals that low payout ratios have typically been followed by surprisingly low real growth rates over subsequent ten-year periods, and not the high rates of expansion that might have been expected at the outset.  This surprising outcome suggests that the corporate sector is either over-investing, or that  competitive markets quickly erode excess returns, or that low payout ratios reflect management’s intention to signal lower future growth to shareholders.

In light of the above, the dividend-price ratio does retain some predictive ability regarding future real returns, but it is still not possible to say what level is indicative of fair value.  As a result, it would be wise to replace the cyclically-adjusted dividend-price multiple with a valuation metric that rests on sounder theoretical footing.

In this regard, the Q-ratio, developed by the late Nobel laureate James Tobin in 1969, is a natural choice.  This metric measures the market value of equity relative to its replacement cost, and a fundamental relationship should exist between the market value and replacement cost; corporations should be valued at their cost of creation in the long-run, and as a result, the multiple should hover around unity given rational expectations.

The “law of one price” or “build-or-buy” arbitrage should ensure that the relationship holds over long horizons.  A ratio above unity implies that it is cheaper to invest in new capital rather than buy existing capital, while a figure below unity suggests the opposite.  The historical data confirms that the Q-ratio does indeed demonstrate mean-reverting properties, and importantly, the analysis reveals that the adjustment takes place through a change in real share prices rather than changes in the capital stock.  In other words, Tobin’s Q can be used to predict long-term real returns.

Unfortunately for equity investors, the current value of Tobin’s Q is almost forty per cent above its long-term mean – a level that has rarely been exceeded in the past.  The ratio’s elevated level, in tandem with its mean-reverting properties, does not mean a catastrophic decline is imminent, but it does suggest that disappointing real returns are virtually assured over long horizons.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Last week the big headline grabbing market development was the plunge in silver prices on the heels of a hike in the margin requirement for the futures contracts. There were loads of news stories about how that increase in margin drove prices lower.

Hope you didn’t actually believe that.

Here’s the deal. The only people forced to close out positions like those in silver when there’s a hike in the margin requirements are folks who are highly leveraged. Guess who that is? Hint, it ain’t the big traders and institutions. Who does that leave? You got it, the little guy who’s trading positions too big for his account in the first place. These folks don’t represent a significant portion of the market.

Want proof? Take a look at the open interest (OI) in the front-month silver contract. If there was a massive liquidation we’d see OI plunge. As the chart below shows (red line), though, front-month OI has only drifted lower, which is what it normally does when the contracts roll as they did the week before last.

So why did silver fall so far so fast? Because it went up too far too fast and the margin hike gave folks an excuse to sell. Take a look at the green Average True Range (ATR) line. Even before the market tanked, ATR was already well higher than it’s been in years. That tells us of a market getting very frothy, that’s subject to a reversal.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

There’s a lot of talk these days about inflation and the impact of Fed policy on the dollar and the extension through the weaker dollar into higher commodity prices. Those looking to flame the Fed for its quantitative easing (QE) and generally loose monetary policy point to the falling dollar as the cause for oil going up above $100 and gold crossing $1500. While it’s certainly true that the greenback is lower (the USD Index has been as much as about 12% off it’s January peak), is the weak dollar really to blame for things like the rising cost of gasoline at the pump? Let’s take a look at what the charts have to say about it all.

First is a comparative chart of oil prices in dollars and oil priced in euros. The chart below covers the last year’s trading. The red line is the dollar value of a barrel of oil, referencing the left scale. The black line is the euro price of a barrel off oil (using front month futures), with that price on the right scale. Both scales are logarithmic so they express similar percentage moves between noted levels.

Now, the chart above doesn’t show relative % gains for oil in the two currencies. Those are +31.3% in USD terms and +22.6% in EUR terms. This is about what we’d expected given the relative performance of EUR/USD over that time. The point of the chart is that aside from wiggles where oil has done better in one currency than the other for a period of time, the pattern of the two lines is consistent. Oil has been moving higher in roughly the same pattern, regardless of what currency we’re talking about.

Now let’s take a look at gold (again front month futures). Once more, the red line is in dollar terms and references the left scale, and the black line is euro terms referencing the right scale.

In this case, gold is up 29.6% against the USD and 19.4% in EUR terms. Again, that difference can be explained by the change in EUR/USD over the last year, which is as it should be. Here, though, we see a lot more variation in performance. In dollar terms gold has been in a fairly steady uptrend with only two relatively minor retracements. In euro terms, however, the ride has been much more dramatic. Those periods when the EUR line diverges considerably from the USD line are periods when EUR/USD was selling off.

The chart below highlights the variation between how gold and oil trade relative to the dollar. It shows EUR/USD on the top with the correlation between EUR/USD and gold plotted in red and the one with oil plotted in green.

Notice how much choppier the green line is than the red. That means the correlation between oil and EUR/USD is much more fickle than the one between EUR/USD and gold. That said, however, oil has spent more time with a positive correlation (meaning rising oil with rising EUR/USD and falling oil with falling EUR/USD). The gold correlation has been much more balanced. In particular, the gold correlation has been more negative when EUR/USD is falling.

Now, correlation does not mean causality. It just shows how similar the movement patterns are without looking at why that might be. The way I would tend to read the above, however, is to say that rising gold is more a factor of what’s happening in the currency arena than rising oil prices. If you think about the implications of increasing money supply (which is what loose monetary policy is), then it makes sense. Gold is something with what could essentially be called a near fixed supply (very slowly increasing), so the more dollars there are the higher the value of gold per dollar (or any other currency). Oil has a different dynamic which is must more closely tied to economic considerations and geopolitics.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

On the Currensee Facebook page yesterday a link was provided to a Fidelity article about how the stock market is climbing a wall of worry. In light of that, I thought it would be worth taking a look at the last time the stock market was seen to be climbing a wall of worry back in 2003/04 as it recovered from the tech bubble bursting and the impact of 9/11.

Here’s a weekly chart of the S&P 500 index going back to 2002. The two lower plots are the Normalized Average True Range (N-ATR) and the Bollinger Band Width Indicator (BWI). The former is a measure of range volatility (find articles I’ve written about N-ATR at Trade2Win and TASC) while the latter looks at the volatility of closing prices by measuring the width of the Bollinger Bands relative to their center point (the 20-period moving average).

The thing I’d like to focus on is how N-ATR has followed a similar course recently as it did during the recovery in 2003 in that it has fallen pretty steadily as the market has rallied. It’s not back to about the top of the range it was in for most of 2004-2007, during which time the market was working steadily higher. Similarly, BWI has also fallen back down into the area where it was during last decade’s major bull market. This doesn’t mean we’re sure to get a repeat of the that kind of rally, but it certainly makes a good case to expect something like that, especially given the underlying general investment psychology in the economy. Bear markets are often indicated by rising volatility, not falling volatility.

We can take a comparable look at the Dollar Index.

Here we obviously have a bit of a different pattern. Volatility in the USD Index as indicated by N-ATR (remember, that’s period range volatility) has fallen, but is nowhere near where it was in 2007 before the financial crisis began. I’d argue that you don’t want to give those lows too much thought as any long-time market pro will tell you that was an unusually quite market, despite the persistent down trend. I would say that the index has basically normalized, with both N-ATR and BWI at about the midpoint of where their readings have been over the last decade.

What this indicates to me is that in the currency market we are no longer in crisis mode trading. The risk-on/risk-off swings that were so common are no longer to be seen as a major driving force barring some kind of major new event. Instead, we’re back to trading more on the big macroeconomic drivers like interest rate differentials, and trade and capital flows.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In honor of the Masters, and inspired by a recent Currensee tweet, let me draw some parallels between golf and trading. I’m not a golfer. The extent of my playing has been a whopping total of 9 holes. I do watch the game, though, especially the majors. I mean come on! Who doesn’t enjoy watching Tiger Woods pull amazing shots out of seemingly nothing and just dominate the field when he’s on his game?

Anyway, it’s risk control that comes to mind when watching even the best players in the world play. Good golfers understand that things can go bad very, very quickly. It’s much harder to get birdies than to get bogeys. Moreover, the best possible score you can get on a given hole is a 1 if you get a hole-in-one. There’s no limit to how bad a score you could make, though. Methinks I see some commonalities with trading there.

Experienced golfers have a very similar mindset to experienced traders. Sure, they take their chances and go after opportunities when presented. No risk means no opportunity for gain, after all. They do not (mostly) take stupid, needless risks, though. You will often hear them talk about making sure they don’t make six by doing something foolish when the situation strongly suggests that a five is going to be a good score.

That sounds to me an awful lot like cutting your losses short. Good golfers know that sometimes they just have to accept their lumps and not let things get any worse. Similarly, good traders know that staying in a trade that’s gone against them in hopes that it comes back is a good way to end up with an even bigger loss.

Good golfers know how to grind out the results. Good traders do exactly the same thing. Both develop a plan of action and execute it. Sometimes things go well and you get that really good shot – that really good trade. Sometimes they go against you. Sometimes you do something stupid and it works out well. Most of the time doing something foolish means bad news.

How often do you see a golfer make one bad mistake, then completely lose it? They go from having a good scoring run to suddenly getting a series of bogies and double bogies. It’s not that they’ve changed anything mechanically in the matter of a couple of holes. They just lost it mentally. Their confidence went completely away. Sound familiar? Think Rory McIlroy on Sunday.

There are two things that really make good golfers and good traders stand out. The have a plan and stick to it, and they quickly shift their focus to the next shot, the next trade. The past doesn’t exist. What you did on the last shot or trade doesn’t matter. It’s only about how you execute the next one.

You might be thinking that someone like Tiger is all about skill. While it’s hard to argue that he’s a better shot maker than most, it’s also true that Tiger practices and seeks to improve his game relentlessly, not just in terms of swing execution, but also in round management and decision-making. Good traders, ones seeking trading mastery, do exactly the same thing.

So the next time you’re on the course or watching a round on TV, think about the parallels to trading. It’s another way to learn and find ways to get better.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Adam at Forex Blog has posted a critique of a Wall Street Journal article which discusses the pending loss of primary reserve currency status for the US dollar. The WSJ article, written by Barry Eichengreen, provides some very interesting information about the use of the dollar in global trade and financial transactions. For example, 85% of foreign-exchange transactions world-wide are trades of other currencies for dollars, and the dollar is the currency of denomination of half of all international debt securities, though in the latter case I’d ask what share of those debt securities are actually US government and related agency debt. Eichengreen believes, however, that the dollar will lose preeminence in the next 10 years.

Here are his reasons why:

1) Changes in technology mean exchanging less prominent currencies is less difficult and expensive than it was.

2) The dollar will soon have real rivals with the euro and Chinese yuan as the most likely candidates.

3) The dollar is at risk of losing its safe-haven status.

Let me address these points individually.

Changing Technology
I’ve been around long enough to remember when trading was done by telephone, not online. The technology has come along in leaps and bounds in the last decade or so. It’s not just better tech, though, that makes for lower costs. It’s also the fact that as forex market volumes have increased, and there’s become more competition in the brokering and dealing arena, spreads have come down significantly. That’s where you get the real cost savings.

It’s worth noting, though, that as transaction costs have declined, we haven’t seen any real marked shift in currency reserves. The dollar is still just about the same proportion of global reserves now as it has been for years. Technological improvements, as Adam notes in his piece, don’t really impact the supply and demand for a currency. Maybe just a bit on the margins.

Rival Currencies
There have always been rivals to the dollar for the top spot. When the euro was launched it was immediately viewed by some as a challenger for the crown (though obviously not by those who thought the Euro Zone would blow apart). Why else do you think the SWIFT code for the exchange rate to the dollar was chosen to be EUR/USD rather than USD/EUR? It’s been a dozen years now, though. As Adam notes, the euro suffers from being comprised of diverse parts. The debt and equity markets are fragmented among the constituent countries, countries with different credit and economic profiles. This makes for a much more shallow market for global investors to park their cash.

As for China, until the yuan is fully floated, it’s not even a debate. Even if the yuan were freely floating right now, it would still be a big ask for it to challenge the dollar for prime reserve currency status. The Chinese financial markets are in their infancy. It will take much more than just 10 years for them to get big enough to be able to support major capital flows. Even the Asian Development Bank doesn’t see the yuan as being a major factor in the currency reserve area. Adam notes that they forecast it will only account for 3-12% of international reserves by 2035.

What about the Swiss franc or the Japanese yen? Switzerland is too small an economy for the franc to ever be a major reserve currency. The Japanese economy is obviously a major one, but a key factor in being a prime reserve currency is having a balance of payments deficit. Japan does not have that (though things could change as the population there continues to age). This is also something that works against the yuan.

Loss of Safe-Haven Status
Eichengreen makes the point that recent economic and fiscal developments have caused the world to rethink the stability of the US markets and economy, putting the country’s ability to sustain its track record of paying its obligations in doubt. It’s a fair point. As Adam commented, though, this is old news, and is also of concern for the likes of the Yen and the Euro as well. The financial crisis didn’t only do damage to the US system.

I disagree, however, with Adam calling the yen a, if not the, premier safe-haven currency now. Yes, the yen absolutely benefits greatly when the markets go into flight-to-quality mode. That, however, is related to the carry trade where yen are being borrowed to fund investments in other currencies. Scared investors bail out of those investments, meaning they convert their money back to yen and pay off the loans they took out. This is not the same as capital flowing into yen-denominated securities the way it flows into US Treasury securities in a panic.

For all the issues with deficits and the like, the US Treasury market remains the place risk averse money goes. So long as that remains the case, the dollar will remain the primary safe haven currency. There may be times when other currencies step in to the spotlight, as the franc has done recently on geopolitical developments, but those are transitory periods and not the real panic situations.

The Bottom Line
The dollar is not going to lose its position at the top of the heap any time soon. That’s not to say there won’t be variation in its exchange rate values, because there most certainly will be. That’s also not to say countries and companies won’t diversify their holdings, because they will as suits their needs. It’s just that no major alternatives are going to be viable in the near future.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In the last post of the Ask the Expert series, Scott Boyd and Dean Popplewell began chiseling away at a question we received about spotting trend reversal.  Today they will focus on another facet of trend reversal: using Bollinger Bands.

Traders have long understood the relationship between volatility and trends. Volatility – that is, the degree by which an exchange rate varies over time – tends to increase as a market trend gathers momentum. This is because traders are buying and selling in greater frequency as they attempt to get in on the trend. However, as the trend nears the end of its run and traders slow their activity, volatility naturally declines.

Because volatility provides immediate feedback on the level of market activity, it is an important technical indicator. One of the most common methods of measuring forex volatility is through the use of Bollinger Bands placed over a price chart as demonstrated below:

Bollinger Bands show changes in market volatility through the width of the two bands formed by the three lines, and the more volatile the currency pair price, the wider the bands grow. In the example above, you can see the bands widening as the price decreases until it reaches a point where the bands suddenly narrow. This indicates that volatility has quickly tailed off which means that market activity has reduced.

Coming as it does following a price decline, this is a strong indication that the rate is likely to increase as market participants consider the new market price. If the price finds support and buyers come in at the current price, the bands will widen in response to the increased activity.

You can learn more about Bollinger Bands on the OANDA fxTrade website.

Next time we’ll continue discussion of spotting trend reversal by looking at different price patterns. Okogba Papa Woyin-Emi (who sent in this question via Facebook), you have been keeping our expert panel busy answering this one! Have questions for Scott and Dean? Send them to us via Facebook and Twitter. We are excited to see what you come up with.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Welcome back to our Ask the Expert series with Oanda’s Scott Boyd and Dean Popplewell. This week’s question comes from our Facebook page:

Okogba Papa Woyin-Emi asked “What are the best ways to spot trend reversal?”

Great question, and not one that can be answered fully in a single post. So we’re going to tackle this important topic in multiple phases, starting with… spotting trend reversal using Relative Strength Index:

Regardless of individual trading strategies, all traders share a common goal – identifying as early as possible, potential trend reversal points. The earlier you can get in on a reversal, the greater the potential for profit. Unfortunately, it is also true that the earlier you act, the greater the chance that what you thought was a trend reversal is really just a fluctuation and once the tend resumes, you may suddenly find yourself on the wrong side of the trend!

To help avoid this scenario, there are several approaches you can take to improve your analysis of the current market trend. Generally speaking, analysis falls into one of two types – fundamental analysis and technical analysis. Fundamental analysis consists of news events such as central bank actions or the latest unemployment figures. The rule of thumb is that when news is seen as a positive sign for a country’s economy, the currency tends to perform better. While the correlation between economic performance and exchange rates is helpful when defining an overall trading strategy, this approach offers little insight into potential reversal points.

This is where technical analysis comes in. Technical analysis involves the use of charts and historical prices in an attempt to determine future prices and over the years, a whole host of technical indicators have been developed. We don’t have room to discuss them all here, but we’ll cover a few our favorite indicators and show you how they can be incorporated into your own studies.

Relative Strength Index

The Relative Strength Index (RSI) calculates the total average losses and gains for a currency pair and uses this information to determine the strength of the latest price in relation to the previous price. A numerical value is determined as part of the RSI calculation and this number is plotted on a chart segmented from 0 to 100 and placed at the bottom of a price chart as illustrated below:

If the RSI value falls in the 30 or under range in the chart, it is considered undersold suggesting that the market could soon start buying the currency pair thereby pushing the rate higher. A reading of 70 or higher on the RSI scale is considered overbought and identifies a potential opportunity to short the currency pair ahead of a falling exchange rate.

In addition to the undersold and overbought designations, traders also look for what are known as centerline cross-overs. When the RSI crosses over and above the center line (50 on the scale), the buyers are winning and upwards momentum is gaining. When the RSI crosses under and below the centerline, the sellers are gaining and the downwards trend is gaining momentum.

For more detailed information on these and other technical indicators, we invite you to check out OANDA’s fxTrade technical analysis tutorial.

We’ll have more on this topic soon, including how to spot trend reversal using Bollinger Bands and different price chart patterns. Have questions for Scott and Dean? Send them to us via Facebook and Twitter. We are excited to see what you come up with.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

We asked our Facebook fans to submit their questions for our Ask the Experts series. We gathered a lot of great questions—and don’t worry, we’ll get to them all in due time—and passed them along to our experts, none other than Scott Boyd and Dean Popplewell of Oanda. So here’s this week’s question:

Mani Mohseni asked “What is the Ichimoku Cloud strategy?”

Well Mani, here is your answer, brought to you by Scott and Dean:

At first glance, the Ichimoku Kinki Hyo – or Ichimoku Cloud – may seem nothing more than a dizzying array of lines and colors. In reality, it is actually a very clever indicator that provides feedback on support and resistance levels, trend direction, and trend strength.

To define the Ichimoku Cloud,  A total of five components are calculated. These are placed on a price chart as five individual lines and include:

1. Tenkan-Sen (Conversion Line)
2. Kijun-Sen (Base Line)
3. Chikou Span (Lagging Span)
4. Senkou Span A (Tenkan-Sen + Kijun-Sen)
5. Senkou Span B (Highest high price + Lowest low price)

The “cloud” is formed by the Senkou Span A and Senkou Span B lines with Senkou Span A (green line) representing one boundary of the cloud and Senkou Span B (yellow line) forming the other boundary. When placed on a price chart, the Ichimoku Cloud appears as follows:

Identifying Trends with Ichimoku Clouds

There are two basic ways that traders use the Ichimoku Cloud to identify trends. The first one compares the current market price (the grey min / max line in this price chart) with the cloud formed by the Senkou Span A and Senkou Span B lines. When the price is rising above the cloud, the trend remains positive as the buyers outnumber the sellers – when the price is below the cloud, the sellers are winning over the buyers.

The color of the cloud itself has significance. In the example above, the cloud is shaded green to indicate a rising trend, and yellow when the trend is falling. Note that most trading platforms enable you to set your own colors for all these elements.

In addition to the position of the price within the cloud, traders look for buy and sell signals generated by crossovers. For example, when the Tenkan-sen line crosses over and above the Kijun-sen, this is considered a buy signal. A sell signal results when the Tenkan-sen crosses under and below the Kijun-sen. This works because the Kijun-sen is calculated using more of the most recent prices than the Tenkan-sen. This means the Kijun-sen reacts more slowly to price changes than the Tenkan-san and when it is crossed by the Tenkan-san, it indicates increasing momentum in the current trend.

This concept should seem very familiar to those who work with multiple moving averages where traders typically employ a fast moving average and a slower moving average. When the fast moving average catches and crosses over the slower moving average, a buy or sell signal is generated depending on the direction of the crossover.

Finally, the Chikou Span provides insight into the strength of a buy or sell signal. Like the Kijun-sen, the Chikou Span – known as the Lagging Span – reacts more slowly to price changes. If the Chikou Span is below the current price, the sell side still has momentum, but if the Chikou Span is above the current price, momentum is with the buyers.

This illustrates just some of the analysis feedback provided by the Ichimoku Cloud. You can learn more about the Ichimoku Kinko Hyo and other forex indicators at the OANDA fxTrade website.

Have questions for Scott and Dean? Send them to us via Facebook and Twitter. We are excited to see what you come up with.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.