Fed Paper: Power of Technical Analysis in Forex is Declining

Being a practitioner of fundamental analysis, you could say that I’m always on the lookout for hard evidence that fundamental analysis is superior to technical analysis. Thus, I was delighted to discover a working paper (“Technical Analysis in the Foreign Exchange Market“) by the St. Louis Branch of the Federal Reserve Bank, released just this month. Alas, the paper barely touched upon fundamental analysis, but its conclusions on technical analysis in the currency markets were startling. In short, the effectiveness of technical analysis in the currency markets has declined steadily since the 1970s, such that only the most sophisticated/complicated strategies are currently profitable.

Rather than conduct original research, the report’s authors â€" Christopher J. Neely, an assistant vice president and economist at the Federal Reserve Bank of St. Louis, and Paul A. Weller, the John F. Murray Professor of Finance at the University of Iowa â€" performed a meta analysis of the existing research. They cited a litany of studies, covered a variety of topics, sometimes with contradictory conclusions. In order to ensure comprehensiveness, they looked at the profitability of numerous types of technical analysis indicators, across numerous currency pairs, over time, in different types of trading environments, and adjusted for risk.

All of the earlier studies, dating back to the 1960s, established the profitability of technical analysis, even when it was simplistic. Since then, however, most studies have shown steadily declining effectiveness: “TTRs [Technical Trading Rules] ere able to earn genuine risk-adjusted excess returns in foreign exchange markets at least from the mid-1970s until about 1990…and that rule profitability has been declining since the late 1980s.” The same trend has unfolded in the last decade, as traders have relied increasingly on computerized trading strategies: “Kozhan and Salmon (2010), using high frequency data, find that trading rules derived from a genetic algorithm were profitable in 2003 but that this was no longer true in 2008.”

Given that the two authors also concede that the financial markets are undoubtedly inefficient and that currency markets in particular are filled with observable trends, how should we understand this decline in the effectiveness of technical analysis? In one word, the answer is competition. “Profit opportunities will generally exist in financial markets but…learning and competition will gradually erode ["arbitrage away"] these opportunities as they become known.” In addition, there has been a “dramatic rise in the volume of algorithmic trading,” which has given rise to a so-called financial arms race to develop ever-more sophisticated trading strategies.

Indeed, the research shows that “more complex strategies will persist longer than simple ones. And as some strategies decline as they become less profitable, there will be a tendency for other strategies to appear in response to the changing market environment.” In addition, technical analysis that is used to trade exotic (i.e. less liquid) currencies is more likely to be profitable than major currencies, especially the US Dollar.

The report opens the door to further research, by indicating that “Technical trading can be consistently profitable in certain circumstances.” As if it wasn’t already clear, though, the vast majority of technical traders (perhaps all traders for that matter) are destined to be outmaneuvered and will ultimately lose money trading forex. Another way of looking at this, however, is that the the savviest traders â€" those that can spot complex trends and execute trading strategies quickly â€" still have a chance at earning consistent profits.

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Citizens Of The World Unite!

« Rates Steady, Inflation Worries! | Home

By Mike Conlon | January 14, 2011

Here It Comes!

Over the last few days I have been harping on the inflation and it is starting to rear its ugly head.  Yesterday, ECB President Trichet surprised the markets by mentioning the risk it imposes to economic recovery.  One would think that the sovereign debt issues he is dealing with would be caution enough, but he took the opportunity to add fuel to the fire with his hawkish comments, sending the Euro higher.

This did not escape the Chinese, however, as they raised bank reserve requirements by 50 basis points in an attempt to curb lending to reduce their money supply to slow down demand.  Treasury Secretary Geithner noted yesterday that Yuan appreciation may not be such a big deal anymore, as higher prices in China will reduce demand for their goods, which will reduce their overall current account surplus.  On a personal note, I can confirm that indeed prices and domestic demand in China are increasing as businesses that have been working with China are now seeking cheaper alternatives.  Keep your eye on India, folks.

Earlier this morning, German CPI data came in as expected but showing signs that inflation may be on the rise which would fall in line with Trichet’s comments.  This could cause a rise in Euro zone interest rates, despite the need for cheaper re-fi costs for the PIIGS countries.  PPI input data in the UK was also higher, boosting the Pound.

And lastly, CPI data here in the US came in hotter than expected, as the headline number showed a 1.5% rise vs. an expectation of 1.3%.  This comes as no surprise as agricultural commodities have been soaring higher, so be prepared to pay more for food and energy unless something is done to combat this problem.

However, equities and commodities markets are lower which highlights China’s influence on those markets as they are the only country that appears to be doing something to attempt to put the brakes on from a monetary policy standpoint.   Though allowing their currency to appreciate would go a long way to combat their problem.  In time.

In the forex market:

Aussie (AUD):   The Aussie is lower across the board as the China’s attempts at a slowdown will affect the Australian economy greatly as China is the largest buyer of Australian exports.

Kiwi (NZD):   The Kiwi is also lower for the same reasons as the Aussie, for as Australia goes so does NZ only to a lesser extent.

Loonie (CAD):   The Loonie is also lower this morning as a pullback in commodities, particularly oil, is weighing on the currency.   However, it is strengthening vs. USD off of the morning lows as it traded close to parity.  (Click chart to enlarge)

Euro (EUR):   The Euro is mixed this morning, trading higher against the commodity currencies but lower against the rest.  After yesterday’s spectacular run higher, the Euro may be experiencing a bit of “buy the rumor, sell the news” as CPI data in Germany was as expected.  In addition, Euro zone trade balance figures showed a deficit vs. an expected surplus.  (Click chart to enlarge)

Pound (GBP):  The Pound is higher across the board as PPI input data came in much higher than expected.   If this translates over to higher CPI data (which is to be reported next Tuesday), then the BOE may be under major pressure to do something about monetary policy through either a reduction of bond-buying or a rate hike.

Dollar (USD):   The Dollar is giving back earlier gains after the CPI data was reported as the market has no conviction that the Fed will do anything about rates or QE2 anytime soon and would prefer to allow US citizens to pay the extra tax (inflation) on necessities rather than potentially harm the banks and the housing market by normalizing policy.  The Lame-stream media is reporting that retail sales rose .6% for the month of December, which makes 6 months in a row, but insiders know that the market was really expecting a rise of .8%.  Never ruin a good story for the want of a few facts!

Yen (JPY):   The Yen is mixed this morning as various carry trades are unwound and the safe haven status of the Yen is in demand as the potential Chinese slowdown affects demand and risk appetite.

Citizens of the world unite!

Consider this a “capitalist manifesto”.  Your government (wherever you are) has sold you down the river to protect the banks and the financial elite.  You know, the people who got the world into this financial mess in the first place.

Now they expect you to pay MORE for the basic necessities you require to live.  How are they doing this?  Through the insidious tax known as inflation.  Inflation affects us all equally, but not proportionally.

When prices of food and energy move higher, it becomes harder to make ends meet, especially for working-class folk.   Do you think that the CEO of a big bank cares that it costs that the price of milk goes higher, or that the cost to heat one’s home is through the roof.  Not at all, its pocket-change to him.

Yet he’s protected by the Fed under the guise of “too big to fail”, so he gets to not only keep his job but pay himself an enormous bonus to boot!  Never mind the fact that it was you, the tax-payer, who allowed this charade to continue despite having no say in the matter.

Now they want you to pay even more!  This isn’t just a US phenomenon, look at what is happening around the globe.  A weak US dollar is driving prices higher and exceptionally low interest rates around the globe have flooded the world economy with too much cash chasing too few goods.  Central banksters could reduce this through tightening monetary policy by raising rates, but they are too afraid to harm their bankster buddies!

So what can you do about it?  The answer friends, is the forex market.  Protect yourself from those who want to harm you by allowing your wealth to disappear through inflation.  It’s no coincidence that central bankster is not an elected position!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here!  Don’t miss out on the world’s fastest growing market!

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US Prices Rise as Energy Costs Increase

Wholesale prices rose sharply in the US during the month of December but the jump was due almost entirely on energy cost increases. The Producer Price Index rose 1.1 percent compared to 0.8 percent the month before. However, heating oil was up 12.3%, while the cost of gasoline rose 6.4%.

Excluding energy and food costs, prices rose just 0.2% last month. This actually represents a slowdown from November’s 0.3% increase.

Source: BBC News

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Japanese Yen Due for a Correction in 2011

Based on every measure, the Japanese Yen was the world’s best performing major currency in 2010. It notched up gains every one of its 16 major counterparts, and was the only G4 currency to appreciate on a trade-weighted basis. Against the US Dollar, it rose 10%, and touched a 15-year high in the process. However, there is reason to believe that the Yen is now overvalued, and that 2011 will see it decline to more sustainable levels.

I am still somewhat baffled as to why the Yen has risen so inexorably. It is said that “Hindsight is 20/20,” but in this case the benefit of hindsight doesn’t really provide any additional clarity. Of course, there was the Eurozone Sovereign debt crisis and the consequent shift of funds into safe-haven currencies, but let’s not forget that the fiscal problems of Japan are even more pronounced than in the EU. Premiums on credit default swaps signal that the probability of a Japanese government default is twice as high as it is for the US, and there are rumors of a downgrade in its sovereign credit rating. As one commentator summarized, “Just how the Japanese have got away with running up a debt to GDP ratio of over 200% (higher than the PIIGS and the U.S.) is beyond me.” Of course, it helps that this debt is financed almost entirely by domestic savings and is consequently not vulnerable to the changing whims of foreigners, but even so!

Meanwhile, the opportunity cost of investing in Japan is high. While inflation is moot, equity returns are low and bond yields are even lower. “Japanese 10-year yields, the lowest among 32 bond markets tracked by Bloomberg data, will end 2011 at 1.24 percent from 1.19 percent today, according to a weighted forecast of economists surveyed by Bloomberg News.” Combined with low short-term rates, it would seem that the Japanese Yen would be the perfect candidate for a carry trade strategy.

Although foreigners remain net buyers of Japanese Yen, the current account/trade surplus is gradually narrowing, with the former falling 16% year-over-year and the latter dropping 46%. It seems that “consumers overseas increasingly spurn Japanese products in favor of lower-priced goods from South Korea and other nations.”

Even the Japanese seem to prefer other currencies. According to NIKKEI, “Japanese investors were net buyers of foreign mid- and long-term bonds to the tune of 21.94 trillion yen in 2010, the most since comparable data began being compiled in January 2005.” Japanese companies are also taking advantage of the expensive Yen and strong balance sheets to buy overseas assets. The Economist reports that, “Japanese companies are sitting on a hoard of cash totalling more than ¥202 trillion ($2.4 trillion)…Many companies have earmarked vast sums for acquisitions in 2011 and beyond.”

With GDP projected to fall to 1% in 2011, there would seem to be very little reason to continue buying the Yen. According to the most recent CFTC Commitment of Traders Report, speculators are building up massive short positions in the Yen. Meanwhile, the Central Bank of China is quietly paring down its Yen holdings. Even the Bank of Japan seems to have embraced this inevitability, as it is has already stopped intervening in forex markets on the Yen’s behalf.

According to a Bloomberg News Survey, “Japan’s currency will tumble almost 10 percent against the dollar this year.” Very few analysts think that the bottom will complete fall out from under the Yen, but the majority (myself included) expect a correction of some kind.

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All Eyes on the US Dollar in 2011

According to Standard Life Investments, the US Dollar will be one of the top currencies in 2011. (The other currency they cited was the British Pound). How can we understand this notion in the context of record high gold prices and commentary pieces with titles such as “Timing the Inevitable Decline of the U.S. Dollar?”

The Dollar finished 2010 on a high note, both on a trade-weighted basis and against its arch-nemesis, the Euro. Speculators are now net long the Dollar, and according to one analyst, it is now fully “entrenched in rally mode.” Never mind that its performance against the Yen, Franc, and a handful of emerging market currencies was less than stellar; given all that happened over the last couple years, the fact that the Dollar Index is trading near its recent historical average means that the bears have some explaining to do.

To be sure, none of the long-term risks have been addressed. US public debt continues to surge, and will not likely abate in 2011 due to recent tax cuts. Short-term interest rates remain grounded at zero, and long-term yields have only just begun to inch up, which means that risk-taking investors still have cause to shun the Dollar. Ironically, signs of economic recovery in the US have reinforced this trend: “The [positive economic] data, which one would ultimately assume is positive for the U.S., looks better for risk, which in turn puts downward pressure on the dollar.” Finally, the the Financial Balance of Terror makes the US vulnerable to a sudden decision by Central Banks to dump the Dollar.

So what’s driving the Dollar in the short-term? The main factor is of course continued uncertainty in the Eurozone over still-unfolding fiscal crisis, which is directly driving a shift of capital from the EU to the US. Next, the budget-busting tax cuts that I mentioned above are predicted to both boost economic growth and make it less likely that the Federal Reserve Bank will have to deploy the entire $600 Billion that it initially set aside for QE2. (To date, it has spent “only” $175 Billion in this follow-up campaign, compared to the $1.75 Trillion that it deployed in QE1). According to The Economist, “JPMorgan raised its growth forecast for the fourth quarter of next year to 3.5% from 3% as a result [of the tax cuts]. Macroeconomic Advisers, a consultancy, says the new package could raise growth to 4.3% next year, up from its current forecast of 3.7%.”

In fact, long-term rates on US debt have started to creep up. They recently surpassed comparable rates in Canada, and even risk-taking investors are taking notice: “U.S. bond yields are attractive and interesting again,” indicated one analyst. Of course, when analyzing the recent increase in bond yields, it’s impossible to disentangle inflation expectations from concerns over default from optimism over economic. Nevertheless, the consensus is that rates/yields can only rise from here: “The CBO [Congressional Budget Office] estimates that interest rates on 3-month bills and 10-year notes will reach 5.0% and 5.9%, respectively, by 2020.”

As if this wasn’t enough, the exodus out of the US Dollar over the last few decades has virtually ceased, with the US Dollar still accounting for a disproportionate 62.7% of global forex reserves. Furthermore, economists are now coming out of the woodwork to defend the Dollar and argue that its supposed demise is overblown. At last week’s annual meeting of the American Economic Association (and in a related research paper), Princeton University economist Peter B. Kenen “argued that neither Europe’s nor China’s currency presents a valid substituteâ€"nor an International Monetary Fund alternative to the dollar that was created some 40 years ago.” Even if the RMB was a viable reserve currency â€" which it isn’t â€" Kenen points out that for all its bluster, China has shied away from taking a more active leadership role in solving global economic issues.

In short, as I’ve argued previously, the Dollar is safe, not just for the time being, but probably for a while.

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Mother Nature Unleashed!

« Currency Games! | Home

By Mike Conlon | January 11, 2011

The Aussie is once again lower as flooding continues to ravage the country.  This could have a seriously negative effect on the Australian economy, as this is the worst flooding in nearly 100 years.  Here in the US, we are bracing for another major snowstorm along the eastern coast, which could also cause an economic slowdown.  This could have inflationary consequences in the energy sector, as supply and demand are affected accordingly.

One region whose climate is looking better is the Euro zone, as overnight Japan said they would be looking to buy Euro bonds to help the support the region.  While not truly a philanthropic venture, this makes sense from an investment perspective as yields are likely to be higher than elsewhere.  In addition, the Portuguese PM has stated that no aid is needed, though we’ve heard that before.  So the Euro is higher, the Yen is lower.

Retail sales in the UK were lower putting pressure on the Pound as austerity measures begin to take effect.  The market is waiting on Thursday’s BOE rate decision.

The Loonie is higher as oil is up trading just under $90, as the weather on the East coast may increase demand, and the Alaska oil pipeline situation is still in flux.  Adding to Loonie strength is the notion that Canada, and not New Zealand, may be the next to raise interest rates sometime in Q2, according to range of analysts.

Here in the US, we have some Fedspeak going on today, with no major news slated.  Both stocks and commodities are higher, so today looks like some risk taking.

In the forex market:

Aussie (AUD):   The Aussie is lower in the wake of the flooding, and trade balance figures came in lower than expected on dwindling exports.  This is a major natural disaster which could cause economic slowdown, which means that the RBA would stay steady with rates for some time.

Kiwi (NZD):   The Kiwi is also lower as signs that NZ may have avoided an official recession have increased, though the economy is far from operating on all cylinders.  Home-building approvals rose 8.8%, and improved confidence may help improve GDP figures, which were negative last quarter after NZ was rocked with an earthquake.

Loonie (CAD):   The Loonie is higher across the board as eyes are turning toward the Canadian economy for the next sign of interest rate growth.  Increased US demand has helped Canadian exports and higher oil prices due to inclement weather and possible supply shocks have buoy the Loonie higher.  Money flows from the antipodean currencies show that the market expects the BOC to be the next to move on rates.  (Click chart to enlarge)

Euro (EUR):   The Euro is trading higher in a bit of a relief rally as Japan has said that they want to buy Euro debt as well, providing the region with yet another bidder.  This may help keep rates from spiraling out of control, which will allow PIIGS countries to issue debt without having to offer inflated rates of interest that the market may demand.  The ECB is also releasing its rate decision on Thursday, but expect that to have little impact.  (Click chart to enlarge)

Pound (GBP):   The Pound has regained some earlier losses and is trading higher despite retails sales figures which came in showing a decrease of .3%.  Thursday’s rate decision will show whether there is a shift in policy statement or not.

Dollar (USD):   Not much happening here in the US from an economic data standpoint, but US stock earnings season is upon us and so far positive results have lifted markets higher.  Fedspeaker Plosser today said that he expects to see growth this year of 3-3.5%.

Yen (JPY):   The Yen is weaker as Finance minister Noda said that Japan would buy European debt.  It looks like Japan is about to start making its own carry trades!

While the weather outside may be frightful, the climate inside is delightful if you are a currency investor!

Economic stability appears to be taking place and we are seeing signs that economies that were slow to grow may be catching up; and those who were quick to grow may be slowing down.  As the economic landscape evens itself out, money flows will make their way to best the best performing economies.

Investors who can stay ahead of the curve can profit from these global shifts.  Inflationary pressures and austerity measures will be two of the biggest clues as to where money flows will go, as Central bankers scramble to find balance.

So buy the winners and sell the losers and your account balance will thank you later!

To learn more about how you can take advantage of world events through the currency market, be sure to check out our currency trading courses!

To follow these events live with a free, real-time practice account, click here!  Don’t miss out on the world’s fastest growing market!

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Pressure Mounts on Portugal to Address Debt

Here we go again. Just two weeks into the new year and pressure is mounting on Portugal to secure additional funding now before it is forced to accept an emergency bail-out. For its part, Portugal denies that it needs any outside help and is attempting to raise funds through the sale of government bonds.

Unfortunately, buyers are demanding higher returns in exchange for the increased risk and Portugal has been forced to increase the yield on ten-year notes to more than seven percent in order to attract buyers. This represents a premium of roughly 380 basis points over ten-years bonds issued by Germany and is simply not sustainable.

We have, of course, seen this movie before. First it was Greece and then â€" less than three months ago â€" it was Ireland telling everyone that would listen that everything was fine and that there was no crisis. The government kept repeating the line right up until late November when it agreed to take nearly $90 billion in an emergency bailout. As part of the deal, it also promised to slash spending and raise taxes to bring the country’s deficit back to Eurozone guidelines of three percent of GDP.

Those calling for Portugal to arrange for loans through the EU and the IMF now want the deal done before Portugal slides further towards insolvency. There is a fine line between a preventative action and an act of desperation, but the difference in perception between the two is immense. Either way, the euro will weaken and the longer action is delayed, the greater the potential impact on the euro.

Containing negative fallout from Portugal is also seen as critical for preventing the debt contagion from spreading to other countries. Already, Spain is being touted as the next victim casting a chill over the entire region as Spain makes up about 10 percent of the Eurozone economy. Greece, Ireland, and Portugal combined make up only about 6 percent.

Some analysts have even suggested that while Europe can provide sufficient funds to prevent Portugal from collapsing, Spain’s economy is beyond the EU’s capacity to re-inflate. What happens should that occur is anybody’s guess, but it does bring into question the ability of the euro to continue as a viable currency.

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