Pips Weigh In

A new contributor to the Currensee Blog, Wenjie Tang is the lead trader at Trade Leader Alpha Harvest.

I often hear forex traders, some of them with years of trading experience, talk about what percent of their balance they use to trade. They are thinking about risk management concepts too simply:

How much money do you use to trade? “I use 10% of balance”

On a single trade? “I never put more than 5% on a single trade.”

Well, do you think that position is large? “I think that position is small because it’s less than 5% of balance!”

I believe the majority forex traders (mostly retail traders) don’t really understand the idea of leverage and position size. Let me list some of common questions from retail traders:

  1. What leverage do you use to trade?
  2. Is this leverage the same as margin rate that your broker gives?
  3. How shall we control position size?
  4. Is 5% of balance position is small or big?

To correct the assumptions behind those questions, let's begin with the idea of the "risk" of a trade.

Simple definition: how much money you can to lose or you can afford to lose. Assume that you have 10,000USD in your margin account. If you decide you can afford to lose 500USD on a bad trade, then 5% is the risk for a trade. If overall, you only want to allow 10% loss for several trades, than you can enter more trades, but they should not be allowed to lose more than 1,000USD all together.

Furthermore, when you get 1% margin rate from your broker, how much money do you actually use to trade for a 5% risk trade? Here comes the tricky part. You have to understand the idea of stop loss. If you trade EUR/USD and have 100 pips for SL in mind, then 5% risk on a trade means you can trade 0.5 lot. (1 lot = 100,000).

Here is the calculation:

  • 5% risk on a 10,000 USD account = 500 USD
  • 1 pip EUR/USD / lot = 10 USD
  • 100 pip stop loss / lot needs =1,000 USD
  • To stick to your 500 USD risk limit, you can trade only 0.5 lot with your 100 pip stop.

Wait a minute? What if SL is 200 pips away? And what if SL is just 20 pips? Which way is riskier? As long as you stick to the formula, it’s equally risky, because risk is still 5% of balance, which is 500USD. In case of 200 pips, you can just open 0.25 lot. With 20 pips SL, you can open 2.5 lots.

What are the leverages for above three cases? What if broker gives 200 leverage? I'll leave that math to my readers, but my point is that it doesn’t matter, you should only focus on how much money you can lose.

After all, risk is always the only thing we can control in trading. Once you see an opportunity to trade, calculate the SL and then trading lot size.

In complicated models, pros like to use probability models to evaluate the overall risk when there are a lot of trades. The idea is that if we enter 100 trades with each risking 0.1%, theoretically, the overall risk should be less than 10% because of the correlation or lack of correlation between the 100 trades. Retail traders probably should not attempt this.

So, what then are the correct questions to ask? Answering these questions will allow you to use the formulas above to get a better handle on risk:

  1. Risk in terms of % of balance per trade or on all positions
  2. Pip value and stop loss
  3. Trade lot size

What now? Once your risk is controlled, if you stick to your plan and the market goes your way, you can let your profits run!

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Here at Currensee towers, we talk about alternative investing a lot: we talk about how good alternative investments are uncorrelated with traditional investments, we talk about how spot Forex is an alternative investment, and we love to talk about how a diversified portfolio of Currensee Trade Leaders can be an alternative investment.

Recently, there's been some discussion in the media about investing in art, specifically contemporary art. (If you're not up to speed, "contemporary" art mean art by living artists, or at least artists recently living.) It seem on the face of it, you can't get much more alternative than art.  Let's take a closer look.

First off, there's a difference between buying art for an investment and investing in art. Investing in foreign currency doesn't usually mean having stacks of euros and yen stashed around your house any more than investing in gold or pork bellies means having those things in your house. It turns out that there are funds that buy and sell the art so you don't have to. You miss out on the "dividends" of enjoying the works of art and impressing visitors, but you also get a fund manager making the choices for you and diversifying the portfolio or collection of art, most likely more than you could do on your own.  But the problems of actual art ownership still fall to the fund, as Forbes puts it,

... the real problem with art funds is this: While holding art doesn’t produce annual returns, art funds incur considerable annual expenses, including storage, maintenance, insurance and transaction costs...

As you might expect, people who want to enjoy the art are not always the same people who want to enjoy the investment results of art. More from the same Forbes piece:

Of the 2,000 affluent individuals that Barclays surveyed globally for a June report, “Wealth Insights: Profit or Pleasure?, ” only 10% said they bought fine art purely as an investment. “ Most are buying for their own enjoyment or for cultural or social reasons,” concludes Davies.

Some would call art an alternative investment because it's relatively illiquid, even in an investment fund format, fine art works are thinly traded.  Are they uncorrelated to the broader markets?  That's harder to say, since many wealthy art buyers are probably getting their disposable art-buying income from the profits of their investments in stocks, bonds, businesses, and real estate.  Ask any art dealer what happens to their business when the stock market tanks, and I think you'll have your answer.

Both Reuters and the New York Times posit that the new super-rich, tech entrepreneurs, are not buying art like prior generations did. The Times says it's because they feel excluded from the art world,

And considering their net worths, technology innovators and the venture capitalists who back them are not collecting much art, according to people in both the tech and art worlds.

The Wall Street Journal suggests that wealthy techies are more likely to buy into art that's digital or conceptual, because it speaks to their areas of expertise more than conventional media.

Reuters comes back and says that tech company investing is just as insular if not more so:

...start-up culture is in fact one of the very few areas which is less transparent than the art world. You need to be invited to a tech party; gallery openings, by contrast, you just turn up to. If you want to buy the work of a certain artist, then with a little bit of diligence and persistence you can probably manage to do so somehow. And it’s downright easy to phone up the gallery and at least find out how much that artist’s works cost. If you want to invest in a certain start-up, by contrast, doing so is pretty much impossible unless you know the right people. And valuations aren’t kept quiet so much as they’re kept absolutely secret.

Venture Capital and Private Equity certainly qualify as alternative investments, so it seems that fine art might also fill the bill.  As we noted here last month, wealthy investors are often attracted to mysterious investments with uncertain contents and fancy managers, so it seems not so far-fetched they might buy into a fund of contemporary art they don't understand either.

There's room in a good portfolio for almost anything if it's allocated responsibly with regard to your other investments and personal financial goals. Is art an alternative investment for you? We're thinking probably not, unless you know a lot about it or have a fund manager or financial adviser who does. Or unless you really just want to look at it on the wall.

In the end Wednesday, the markets got just about what was expected from the FOMC and Fed boss Ben Bernanke. While a certain notable French bank who shall remain nameless (OK, it was Société Générale) came out with 70% odds of a $600bln round of new quantitative easing (aka QE3), that was an outlier view. Most folks in the fixed income and forex markets (we don’t pay much attention to the stock guys :) ) were looking for a continuation of the Operation Twist program in which the Fed sells short-term treasuries it owns and buys longer-term ones.

These expectations are why in the end the various global markets basically just continued on the course they had already begun earlier in the day, albeit with a little volatility after the FOMC statement and into Bernanke’s press conference. Following the extension of Twist, the Fed chief’s comments about standing ready to do whatever may become necessary were predictable. He’s been saying that for some time now. Why not? It’s true. It’s always true. The Fed will do what it thinks it needs to do when it thinks it needs to do it. Folks seem to read QE3 expectations into that every time he says it, though.

To that end, it occurred to me yesterday that the folks who keep calling for QE at the next FOMC meeting are kind of like the folks who set dates for the end of the world, then when it doesn’t happen they revise to a future date.

The thing that had me sure there was no QE3 coming this week was a comment Bernanke made a little while ago that he was seeing no signs of deflationary risks at present. Deflation risk was a big factor in the justification for QE in prior rounds, so if he’s not seeing that risk now, the odds of QE3 drop despite economic developments. Now, the Fed forecasts released yesterday did feature lower inflation expectations, but nothing leaning toward deflation. That will be something to watch morning forward.

At this stage, the bigger issue at hand is going to be the value of the signals coming from the Treasury market. As I wrote a couple weeks ago, the Fed already owns a large portion of outstanding long-term Treasury paper. The extension of Twist is only going to make that share grow. The bond market guys I work with say basically the Fed will be buying all of the long-dated paper the Treasury issues for the rest of the year. This is going to further shrink the “float” of long-dated securities, which could make the likes of US 10yr yields even more volatile because it will take increasingly smaller volume to move them around.

Considering how correlated USD/JPY tends to be to those rates, the higher volatility in yields could make for some interesting action in that exchange rate. Notice in the chart below how much time the correlation between the two markets is positive and how even when it turns negative it is just briefly and only marginally so. If the 10yr yield becomes less valuable as an indicator due to the Fed’s dominant holdings, we could see the relationship between it and USD/JPY breakdown.

Operation Twist Chart

Also, things could get interesting on the short end of the yield curve as well.

The Fed normally holds a lot of short-dated Treasury paper which it uses in open market operations to keep short-term yields in line with policy. The Twist operation has already seen a lot of that paper sold as the Fed has bought long-dated securities. The expectation in the bond market is that the Twist extension will result in the Fed not having any shorter-term paper left. That could create some interesting dynamics at the front end of the yield curve. Considering how important overnight interest rates are to currency exchanges rates, there is the prospect of some periods of unusual activity in the months ahead. As a result, it will be worth keeping track of what the Fed is doing.

This is one of those times when understanding structural elements of the markets can be important.

 

A question came up during the webinar last week regarding stop hunting. One of the attendees was curious about it, no doubt having heard the term bandied about among retail traders. This gets brought up on a fairly regular basis, mostly by folks who saw their stop get hit in a market that quickly reverses back in the direction of their trade (see Stop-hunting is NOT the problem some people say). Let me try to clarify things.

A definition
First, let me explain what exactly stop hunting (running) means.

Basically, what we’re talking about here is one or more market participants attempting to manipulate prices such that the market reaches a level where preset orders are believed to reside in order to trigger those orders. Notice I didn’t specifically say “stop” orders there. They could be stops or limits. It doesn’t really matter. Those attempting to hunt those orders are just looking to get them triggered for their own purposes.

Why stop hunt?
So what are those purposes?

Imagine there are a bunch of buy orders residing at 100. What is likely to happen if the market hits 100 and triggers those orders? The market will probably go higher, right? If you know (or think) those orders are there and have the ability to push the market in that direction, can you see how you might want to trip those buy orders and then sell into the subsequent market move either to take profits on a long position or to sell at a better price?

This sort of thing has been going on for many, many years. Stories have come out of the futures trading pits (and probably from stock exchange floors too) for ages. It also happens in the inter-bank market where the primary pricing of forex rates is done.

Where retail forex is concerned, stop hunting is generally talked about more in terms of brokers manipulating prices. The fact that some retail brokers act as counter-party to their customers trades (market-making or dealing desk brokers) rather than acting as middle men (ECN or Straight Pass Through brokers) is seen as incentivizing said brokers to move prices against their customers to trigger their stop loss orders so the broker can profit from customer losses.

The reality
Back in the early days of retail forex there probably were unsavory brokers who manipulated prices to their advantage, and may still be in certain corners of the globe. Things have gotten much tighter in recent years, though, so if you stick with a reputable firm you’ll be free of that sort of abuse. In fact, as much as some like to bad-mouth the new regulations put in place in the US by the NFA and CFTC, part of what they have done is to put brokers under a spotlight to ensure these sorts of things don’t happen, and are punished if they do. In fact, one forex forum member put it to the test and found no evidence of stop hunting by retail forex brokers.

In other words, if you get stopped out on a price spike, it’s not your broker stop-hunting you. They get their prices from the inter-bank market, so if there was stop hunting being done it was almost certainly happening at that level.

Stop hunting will continue to go on in the markets, but it’s not something you should worry about. If you trade for any length of time you will inevitably fall victim to an adverse price move that takes you out of a trade only to see it reverse. There are any number of things that can make that happen. Where you are concerned, it’s either bad luck or bad stop location. A lot of those who claim they were stop-hunted just placed their stop too close to the market and either don’t realize it or don’t want to take the blame for poor decision-making.

 

The yen is an enigma to many forex market participants. It doesn’t trade like the European currencies, nor does it move like the commodity currencies. Oftentimes, it trades against the dollar the opposite way we would expect given the broader market actions.

There are a lot of things that go into yen trading, like the fiscal year-end in March, that make it unique. That has been furthered along in recent times by the aftereffects of the earthquake. This is all within the broader context of an economy that has struggled to do anything for many years now, with little prospect of reversing that any time soon. The low Japanese interest rates as a result have kept the yen at or near the top of the list of favorite currencies to borrow for carry trade purposes.

We saw a lot of the Japanese bugaboos hit the yen hard during the February/March period when USD/JPY rallied from testing 76 to the downside to probing 84 on the upside. That came after many months of the market going sideways at a time when the markets were looking at the US economy improving, which was supporting the dollar.

As you can see from the chart below, the weekly Bollinger Bands got VERY narrow as a result of the long consolidation. The rally since the range break has taken the Band width in the opposite direction, getting it to near its highest level in the last couple years.

USDJPY Chart

The market has obviously since retraced some of the rapid rally, thanks in part to weaker US economic data starting to get traders thinking the Fed may decide it needs to act to further loosen monetary policy. We’ll find out this week just how far down the path that thought really has gone. In the mean time, we have an interesting technical picture.

I’ve added two lines to the weekly chart which represent important levels for the market from here. The upper one is the high from April of 2011 above 85. The lower line is the high from late October and early November that should now be support. Those create a very good set of bounds between which the market can consolidate while the Bollinger Bands work back toward at least a more normal width.

Drilling down a bit, it is worth looking at the price distribution charts to fine tune the analysis. The chart below features monthly distributions (based on daily moves). Where they are thick, the market has spent the most time. Call these attraction zones. Where they are thin, the market hasn’t spent much time there at all. Call these rejection areas.

USD/JPY Chart

This month USD/JPY moved down to test the price level from February where the market spent the most time (though granted, not very much because of that month’s trending action). The market has bounced from there, essentially rejecting what should have been a good attraction area. As this was also above the peak from Q3 last year, it can be considered an indication of strength. As a result, I like the prospects for the market to work back up toward recent highs. That is perfectly reasonable, even within an overall consolidation.

So what’s the implication of this?

Well, if the market just shifts into consolidation for a while then I think it probably just indicates a market that overreacted to the recent softer US data (especially the jobs report). If USD/JPY eventually extends the rally from 76 to break the April 2011, it will probably do so on the basis of a combination of the concerns about US growth abating but the same not being the case for Japan. The limiting factor, though, is the trade imbalance. If the US economy strengthens sufficiently to increase import demand, that will eventually flow through to benefit the yen.

 

The first quarter is well and truly over, and investment managers are busy restructuring their portfolios to reflect their updated views of the world.  Unfortunately, far too much time is devoted to the identification of new ‘buy’ ideas, when weeding out the portfolio’s deadwood would in all likelihood prove to be a more fruitful pursuit.  Instead, most investors fund new positions through the sale of winning positions, and consistently violate the investment dictum, “Ride your winners, cut your losers.”

Research shows that investors view the sell decision as being three times more difficult to make than the buy decision, yet the typical investment manager spends seven times more time and energy seeking out new investments than they do on terminating stale old positions.  As Philip Fisher observes in his classic, ‘Common Stocks and Uncommon Profits’, “More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason.”

Holding on to losing trades

http://www.ostrichheadinsand.com/

To appreciate the psychological process of aversion to a certain loss, which occurs during risky decision-making and causes investors to hold on to losing positions for far too long, consider the following problems:

Problem One: Imagine that you face the following choice.  You can accept €3,000 for certain, or you can gamble with an 80 per cent chance of winning €4,000 and a 20 per cent chance of winning nothing.  Would you accept the guaranteed €3,000 or take the gamble?

Problem Two: Imagine that you face the following choice.  You can pay €3,000 for certain, or you can gamble with an 80 per cent chance of losing €4,000 and a 20 per cent chance of losing nothing.  Would you pay the guaranteed €3,000 or take the gamble?

Both problems have the same expected value except that the former is defined in the domain of profit and the latter in the domain of loss.  The different choices made are striking in that most individuals take the certain gain offered in the first problem, and accept the gamble offered in the second problem.  Indeed, Nobel Prize winner Daniel Kahneman – working alongside the late Amos Tversky – found that 84 per cent of test subjects selected the guaranteed sum in the first problem, and 70 per cent chose to take the gamble in the second problem.

This bizarre behaviour stems from our neural circuitry, which has evolved to pursue rewards and avoid danger.  Brain scans that track oxygenated blood flow, show that the anticipation of monetary reward triggers the release of dopamine – the body’s pleasure chemical from which the term ‘dope’ is derived – and produces a biological effect that is equivalent to a high sparked by the ingestion of cocaine or love-making.  Further, our innate desire for instant gratification motivates us to capture certain gains through the sale of winning positions far too soon.

Meanwhile, at the other end of the spectrum, actual or prospective financial loss activates the same part of the brain as physical pain, and the hurt caused by a $100 loss is roughly 2 ½ times greater than the pleasure derived from a $100 profit.  Adrenaline is secreted into the bloodstream in response to the threat of financial loss, and the feelings of anxiety, fear and nervousness that arise can be of such intensity that they override the intentions of even the most deliberate thinking.

To avoid the pain arising from a prospective financial loss, most investors bury their heads in the sand like ostriches and pretend the loss doesn’t really exist.  Needless to say, behaving like a 200-pound bird with a two-ounce brain inevitably proves self-defeating, as losing positions continue to grate on performance.  Disturbingly, some investors compound the problem, and add to the losing position in a desperate attempt to increase the chances of breaking even.

The human brain perceives the potential rewards and losses on Wall Street in the same manner that our ancestors struggled for survival on the Serengeti, yet most investors believe that the resulting emotional quirks, which cause the average investor to come up short in the financial markets applies to others and not to them.  However, investors’ tendency to sell winners too soon and hold losers too long is widely documented across the globe.

One study shows that investment managers in Israel hold losing positions more than twice as long as winners.  Another study demonstrates that Finnish investors are 1 ½ times more likely to sell a stock after a sharp rise than after a fall.  Finally, a comprehensive US study shows that among more than 400,000 trades in 8,000 accounts at a US discount brokerage, more than one-fifth of retail investors never sold a single stock that had dropped in price.

The dictum, ‘Ride your winners, cut your losers’ ranks among the most important in the investment rulebook, as human nature causes investors to do the exact opposite.  Bernard Baruch, the legendary early-twentieth century investor known as the Lone Wolf of Wall Street, observed that “Even being right 3 or 4 times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he has been wrong.”  Investors should take note and act accordingly.

Previously posted on 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.

One of my Treasury market colleagues brought up an interesting subject today by way of asking me how many euros the Swiss National Bank (SNB) owns as a result of its intervention to prevent the franc from being too overvalued against the Eurozone currency (which I’ve discussed before). The discussion point he was working toward was that the SNB likely has been a major buyer of German government debt as a result of its euro purchases. That and the flow of capital out of the EZ periphery (Greece, Spain, Portugal, etc.) in to German paper has served to depress yields there.

Consider this. The ECB has set the overnight rate for the euro at 1%, yet the German 2yr yield is currently running at about 0.14%. Compare that to the US were the Fed has set overnight rates at basically 0% and 2yr yields are currently about 0.27%. This negative yield spread (-13 basis points currently) is part of what’s been keeping EUR/USD under pressure.

The chart below shows the relationship between the 2yr Germany-US yield spread and the EUR/USD rate. The upper plot is EUR/USD. The middle plot is the yield differential. The lower plot is the rolling 20-day correlation between the two. Notice how that correlation has been positive the vast majority of the time.

EURUSD Yield Spread

The big question out there among many market participants is why the euro isn’t weaker given all the problems in Europe at the moment. We can look at the low rates in the US and Germany as part of the equation. It’s hard for the yield spread to go too much lower from here so long as US rates aren’t on the rise and Bernanke (and the last US jobs report) has done a pretty good job of keeping them down. If the positive correlation holds, it will likely take improved US economic expectations driving US yields higher to really help push EUR/USD down.

 

I threw the question of what I should write about this week to a former manager of mine who was a forex dealer back in his younger years and now makes a living telling folks what’s happening in the markets. He tossed back a surprisingly good question:

How can technicals be relevant when central banks are trying to manipulate the market- BOJ with USD/JPY and SNB with EUR/CHF?

I’m sure this is something that others have pondered as well.

Here’s my view on it – speaking as someone who is very much a practicing technical analyst.

Currency intervention by a central bank or other monetary authority (in the US intervention is directed by the Treasury, though it’s executed by the NY Federal Reserve Bank) is just another news item or event that influences exchange rates. Those of us who’ve been around the markets for a while have seen a great many dramatic market reactions to all kinds of developments. Some of them have been triggered by data releases. Some have been driven by news events. Some have been caused by speakers. And some have been the result of intervention action. Heck, some of the moves have come just from the suggestion of intervention without it actually happening.

In other words, intervention is just one more thing that is reflected in the price action we see on the charts. Furthermore, it’s also something that is incorporated into the market’s expectation of the future as part of the price action we’re seeing now. The more market participants anticipate intervention, the more they will factor that into their trading and by extension the more it will influence the price action we see. It works in the same way that stock traders will price in anticipated share buybacks or weak earnings. All markets are discounting mechanisms in some fashion or another, and we can analyze the patterns that are developed in the price action through that process.

So, from my perspective, I don’t view technicals as any less useful in a market where intervention may happen. I use the same methods I would in any other case.

Now, having said that, intervention certainly presents the potential for a major volatility spike on the event (or even the hint of it). If your trading strategy or market analysis is ill-suited to that kind of thing, then while that risk is in the markets you may be best advised to either change the pair(s) you trade or to lengthen your trading time frame out to one where sharp intraday moves aren’t so much of a concern. Alternatively, you could adjust your risk so that you have less exposure for trades going against the likely direction of intervention (like when going short USD/JPY if you think the Bank of Japan is going to sell yen). The analysis doesn’t change, but how you then use it does.

 

Even if one is a short-term trader, it is worth taking a look at the longer-term chart from time to time to see how things are developing in the higher time frames. My daily work has me usually focusing on daily and intraday charts, but now and again I’ll flip over to the weekly chart to gain that broader perspective. The thing I noticed today was an interesting development on the weekly USD Index chart.

As you can see below, the Bollinger Bands in that time frame have been getting progressively narrower since about the first part of the year. They are now very narrow. In fact, on a relative basis (as shown by the purple Band Width Indicator sub-plot) they are as narrow now as they got late in Q3 last year. Notice what happened then.

USD Chart Bollinger Bands

Since the USD Index is heavily weighted to the euro, we basically see the same narrow-Band situation for EUR/USD as we do for the index – just with the chart inverted.  We see similar tight Bollinger set-ups in GBP/USD and USD/CHF, which isn’t too much of a surprise given how closely related those currencies are from a fundamental (and central bank) perspective these days.

The interesting thing, however, is that once you get outside the European currencies the story is different – considerably so in some cases. The narrow-Band situation actually produced a major breakout in USD/JPY earlier this year. Now we’re seeing the market consolidate after its powerful rally.

JPY Chart

In the case of AUD/USD, we’ve got a market basically working through a sizeable range that’s been working since the highs were put in last year. We’re now seeing the market having turned down from its latest swing up, looking quite like it’s headed back for the bottom of the zone.

AUD Chart

If we flip AUD/USD over we get a pretty close approximation of how USD/CAD has traded. There difference, though, is in the recent action. Where the Aussie has been selling off, the Loonie has been holding steady over the last couple of months.

CAD Chart

So what does this all seem to say?

My interpretation would be this. The relatively better performance of the CAD vs. the AUD is indicative of at least the perception of the situations with the US and China respectively. These currencies are seen as closely linked via trade to their large neighbors, so as the US data has gotten better, the CAD has been supported, and as the China data has disappointed, the AUD has weakened.

Japan is largely its own situation. There is certainly some impact from China there, but mainly the yen trades as a function of two things. One is the stagnant economy in Japan, which is showing little sign of doing anything any time soon. The other is US interest rates. The correlation between USD/JPY and the US 10yr yields is quite strong as higher US rates make the yen more attractive as a carry trade funding currency than the dollar, plus more attractive for investment returns.

Then there’s Europe. To my mind, the ranging we’ve seen in the major pairs there is reflective of the markets getting a handle on where everything stands. We’re basically waiting on the next meaningful development. My guess at this point is that will have more to do with the US than it will Europe. I say that because the market seems to see the Eurozone issues as pretty clear with little change expected out of the ECB for a while. If anything the leaning is toward further loosening of policy by that central bank.

In the case of the US, though, the situation is on more of a knife’s edge. As we saw from the reaction to the FOMC meeting minutes Tuesday afternoon, there have been a number of market participants looking for another round of QE3 from the Fed (including the likes of Goldman Sachs). At the same time, though, we have others who see the US on a good sustained growth path. The USD is likely waiting to see which side is going to win that argument. How the USD Index moves out of its current consolidation will be indicative of which way that fight ends up going.

 

Month and quarter ends are always interesting times in the market, with all kinds of capital flows offering the potential to move markets. This time of year in particular we also have Japanese fiscal year end to add to the mix. As we near the finish this quarter, though, I’d like to take a look at what might be coming our way in the next one. Specifically, I want to take a look at the research I’ve done on forex seasonal trading patterns to see what’s ahead for the market.

April is not a very strong month for the USD. In fact, statistically it has been one of the worst. Looking at data back to the early 1980s, we can see that in general terms the dollar has fallen about 60% of the time and lost about 0.5% in value against the other major currencies (I’m not specifically using the USD Index here, but close). The pattern is even stronger since the introduction of the euro. Going back to 1998, the dollar has been down 61.5% of the time for an average annual loss of 0.72%. Only December has a more negative pattern.

One thing that is worth noting, though, is that we would expect to see a positive transition over the next few weeks. We can see that on the chart below, which looks at the 1-month forward returns on a week-by-week basis (measuring 7-day periods, not calendar weeks).

USD rolling returns chart

The featured area is the next 4 weeks, with week 14 representing April 1 to April 7. We can see we start April off in a period of strong negative indications for the dollar, a pattern which began a couple weeks ago. That shifts from negative to positive as we get into the middle part of April, though.

As for what to play on the other side, the pound is the major currency with the best April statistics. The GBP been up in general terms nearly 70% of the time during the month since the euro launch for an average 0.45% gain.

We would therefore expect GBP/USD to have a strong positive bias heading into April and that is indeed the case, as the weekly returns chart shows.

GBPUSD rolling returns chart

Notice here, though, that the pattern shift is much more swift, if also more abbreviated.

This seasonal bias information isn’t a suggestion to go out and get long GBP/USD, though. These biases are just that, biases. There are no sure things and even when the market does move in line with tendencies it can do so in a very choppy fashion. As such, you would likely be better off using this information to help shade your trading – like perhaps being more aggressive on trades you do in the direction of the bias and less so against it.

It’s all about putting the odds as far in your favor as possible. This sort of data, if used prudently, can help you do that.

Now, as to what this means for the global markets…

That’s a bit trickier now that we aren’t seeing the same market patterns that we were seeing in the past whereby the dollar and stocks and interest rates all had pretty well-defined relationships. As a result, we need to be aware of whether the market is in “risk” mode whereby stocks and commodities are rising and the dollar is falling, or in the recent mode whereby the dollar and US Treasury yields have moved together, mainly as a function of whether the market sees more QE coming from the Fed. I personally don’t expect anything like that, but Bernanke has done is best to keep the markets thinking he’s inclined to maintain an accommodative monetary policy and doesn’t want to see long-term rates rising too much.