Currency Trader (200708)

Strategies, analysis, and news for FX Traders

August 2007
Volume 4, No. 8

DOLLAR AT THE CROSSROADS: LONG-TERM
Battered buck testing key INTEREST RATES:
levels p. 38 Implications for
currencies p. 34
TREND RUNS IN CURRENCIES:
Facts and figures p. 16 INTERNATIONAL
TRADE AND
EXOTIC CURRENCIES: CURRENCIES,
Trading outside part 2 p. 26
the “majors” p. 8

THE YEN’S
new uptrend? p. 12

CONTENTS

Contributors . . . . . . . . . . . . . . . . . . . . .6 Advanced Strategies
Minor currencies and
federal reserve trade weights . . . . . .26
Global Markets A continuation of last month’s analysis
Beyond the majors: The exotic waters of the relationship between trade and
of emerging-market currencies . . . . . .8 currencies undermines one of the basic
Some forex brokers are offering access to premises of the floating exchange-rate
more currency pairs, but you need to know system.
the risks associated with these markets before By Howard L. Simons
you consider trading them.
By Currency Trader Staff
Trading Basics
Long-term interest rates
On the Money and the U.S. dollar . . . . . . . . . . . . . . .34
The rising yen — What the recent rise in T-bond and T-note
here we go again . . . . . . . . . . . . . . . .12 yield implies for the FX market.
The yen has been on the rise vs. the dollar. By David Mantell
Find out if it’s a reversal or just a correction.
By Barbara Rockefeller
Spot Check
U.S. dollar index . . . . . . . . . . . . . . . .38
Trading Strategies The greenback has recently established
Short-term trends all-time lows against many currencies.
in the EUR/USD pair . . . . . . . . . . . . .16 Find out what analysis of the dollar index
This study shows how often different runs says about the probabilities of the buck’s
of consecutive higher or lower highs, lows, next move.
and closes occur in the euro/dollar pair. By Currency Trader Staff
By Currency Trader Staff
continued on p. 4

2 August 2007 • CURRENCY TRADER

CONTENTS

Industry News
New NFA proposal could cause
significant shakeup among
forex brokerages . . . . . . . . . . . . . . . .42
The National Futures Association wants
new capital requirements that could force
several forex brokerages out of business.
Global Economic Calendar . . . . . . . . .48
USFE to list forex futures . . . . . . . . .42 Key dates for currency traders.
The United States Futures Exchange
will roll out currency futures that mimic New Products and Services . . . . . . . . .49
the pricing of spot forex positions.
The Face of Trading . . . . . . . . . . . . . . .49
Rolling with the punches.
Currency Futures . . . . . . . . . . . . . . .44
Currency fund manager performance. Key Concepts . . . . . . . . . . . . . . . . . . . .50

Global News Briefs . . . . . . . . . . . . .45 Events . . . . . . . . . . . . . . . . . . . . . . . . . .51
Conferences, seminars, and other events.
International Market
Summary . . . . . . . . . . . . . . . . . . . . . . .46 Forex Trade Journal . . . . . . . . . . . .52
Currency, interest rate, and equity Too late to sell the dollar? A position
performance from around the globe. in the dollar index futures tells the tale.

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one trading instruction to students around the world, and has advised hedge funds, Interbank
traders, and individuals of all levels of skill and experience.

This is neither a solicitation to buy or sell any type of financial instruments, nor intended as investment recommendations. All investment trading involves multiple substantial risks of mon-
etary loss. Don’t trade with money you can’t afford to lose. Trading is not suitable for everyone. Past performance, whether indicated by actual or hypothetical results or testimonials are no
guarantee of future performance or success. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT,
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losses, lost revenue, or lost profits, that may result from the reliance upon the information materials presented.

CONTRIBUTORS
CONTRIBUTORS

Howard Simons is president of
A publication of Active Trader ® Rosewood Trading Inc. and a strategist for
Bianco Research. He writes and speaks fre-
For all subscriber services: quently on a wide range of economic and
www.currencytradermag.com financial market issues.

Barbara Rockefeller (http://www.rts-forex.com) is an
Editor-in-chief: Mark Etzkorn international economist with a focus on foreign exchange. She
metzkorn@currencytradermag.com
has worked as a forecaster, trader, and consultant at Citibank
Managing editor: Molly Flynn and other financial institutions, and currently publishes two
mflynn@currencytradermag.com daily reports on foreign exchange. Rockefeller is the author of
Technical Analysis for Dummies (For Dummies, 2004), 24/7
Senior editor: Jeff Ponczak
jponczak@currencytradermag.com Trading Around the Clock, Around the World (John Wiley &
Sons, 2000), The Global Trader (John Wiley & Sons, 2001), and
Contributing writers:
Barbara Rockefeller,
How to Invest Internationally, published in Japan in 1999. A
Howard Simons, Marc Chandler book tentatively titled How to Trade FX is in the works.

Editorial assistant and
David Mantell is a currency trader at Chicago Global
Webmaster: Kesha Green
kgreen@currencytradermag.com Investors, where he trades currency futures in the euro, yen,
British pound, Swiss franc, and Canadian dollar. He began his
Art director: Laura Coyle
lcoyle@currencytradermag.com
career in the financial markets 15 years ago as a financial
advisor. Mantell is a former equity research analyst, having
President: Phil Dorman covered the media & telecommunications (wireline and wire-
pdorman@currencytradermag.com
less) industries. As part of his MBA, Mantell attended the
Publisher, ESSEC Business School in Paris. He can be contacted at
Ad sales East Coast and Midwest: dmantell@chicagoglobalinv.com.
Bob Dorman
bdorman@currencytradermag.com
Thom Hartle (http://www.thomhartle.com) is director
Ad sales of marketing for CQG and a contributing edi-
West Coast and Southwest only:
Allison Ellis
tor to Active Trader magazine. In a career span-
aellis@currencytradermag.com ning more than 20 years, Hartle has been a
commodity account executive for Merrill
Classified ad sales: Mark Seger
Lynch, vice president of financial futures for
mseger@currencytradermag.com
Drexel Burnham Lambert, trader for the
Federal Home Loan Bank of Seattle, and edi-
Volume 4, Issue 8. Currency Trader is published monthly by TechInfo, Inc., tor for nine years of Technical Analysis of Stocks & Commodities
150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2007
TechInfo, Inc. All rights reserved. Information in this publication may not be magazine. Hartle also writes a daily market blog called hartle
stored or reproduced in any form without written permission from the publisher.
& flow (http://www.hartleandflow.com).
The information in Currency Trader magazine is intended for educational pur-
poses only. It is not meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or approach. Traders are advised
to do their own research and testing to determine the validity of a trading idea.
Trading and investing carry a high level of risk. Past performance does not
guarantee future results.


GLOBAL MARKETS

Beyond the majors:
The exotic waters
of emerging market currencies
Experience required: There are opportunities in emerging-market currencies, but traders should
nonetheless be careful about venturing outside the highly liquid major currency pairs.

BY CURRENCY TRADER STAFF

W
expand their offerings to include emerging-market or
“exotic” currencies.
hile the vast majority of forex trading
occurs in the so-called “majors” — the
currencies of G-10 countries — some
retail forex brokerages are beginning to

Such currencies include the Mexican peso, South African
“Exotic currency pairs provide traders with the ability to
take advantage of trends that can be established by large
money taking positions in these less-liquid currencies,”
says Paul Jamgotch, dealing desk manager at GFT. “Exotics
are also attractive to traders who keep their eyes on the fun-
damental factors that can affect these smaller financial mar-
kets. Also, it gives retail traders a way to speculate in the
rand, Singapore dollar, Thailand baht, Brazilian real, and economies of countries that don’t offer easy access to other
Hong Kong dollar. trading vehicles, such as bonds or stocks.”
There are many reasons forex trading revolves around a Diversification is another argument in favor of expand-
handful of currency pairs, most of which include either the ing into the exotic arena.
U.S. dollar or the euro, but the most important are liquidity
and stability. It’s often said the forex market is the most liq-
uid in the world, and that liquidity is based on the stability Some strategists caution that only the
of a few countries and regions that, through history and for-
tune, have come to dominate global trade and finance. It is
no coincidence that oil and gold are priced globally in dol-
most seasoned retail players should
lars.
For example, Brazil is a developing country at the fore-
enter the exotic currency arena
front of a Latin American boom — several countries are
bucking for “first-world” status. But despite the fact it’s had because of its higher volatility, lower
one of the hottest currencies in recent years, Brazil has gone
through a few “new” currencies in the past two decades as liquidity, and wider spreads.
its economy has busted and boomed.
Nonetheless, some emerging market currencies are edg-
ing into the mainstream of the forex world. “Having exposure to just the major pairs really narrows
the scope of a trader’s portfolio,” says Richard Lee, curren-
Why trade exotics? cy strategist at FXCM. “Portfolio returns in emerging mar-
Some analysts contend exotic currencies tend to trend bet- kets are also outpacing major-currency investments.”
ter than the majors because their economies are often nar- While FXCM currently does not provide access to emerg-
rowly focused, or even dependent on one specific industry ing market currencies on their retail platform, they do pro-
or investment theme. vide research in the Hong Kong and Singapore dollars, as
GFT Forex and Oanda.com currently include exotic cur- well as the Chinese yuan.
rency trading on their retail trading platforms. “Additional instruments are good because they offer


diversification,” says Richard Olsen, co-founder of think when trading emerging markets because retail
Oanda.com. “Anyone trading any market wants to diversi- traders are not used to violent fluctuations.
fy.” ”Unless retail investors trade crosses such as the
Oanda gradually began adding exotic cross rates to its pound/yen, they are more [accustomed to] 30-pip daily
retail platform starting in 2006 and Olsen says it has been fluctuations,” he says. “The rand moves almost 10 times
met with “an astonishing amount of interest.” Oanda has that in single session. However, you always have to take
a fairly wide offering of exotic currency crosses, including continued on p. 10
crosses with the euro dollar vs. emerg-
ing market currencies. (For a list
of Oanda’s current exotic pairs offer-
ings see: https://fxtrade.oanda.com/
spreads/all_spreads.shtml.)

Higher risk levels
With opportunity, of course, comes
risk. Brian Dolan, chief currency
strategist at Forex.com, a division of
Gain Capital, says his firm currently
does not offer emerging market cur-
rencies to retail clientele because of liq-
uidity and the lack of running prices.
“There is tremendous potential in
some of the [exotic currencies], but it is
a whole new level of risk versus the G-
10 currencies,” he says.

Wider spreads,
more volatility
Forex traders should not jump into the
world of the exotics without a great
deal of research and understanding of
the risks associated with these curren-
cies. Some strategists caution that only
the most seasoned retail players
should enter this arena because of the
higher volatility, lower liquidity, and
wider spreads these currencies tend to
display.
“The spreads on exotics can be fair-
ly wide because these markets are less
liquid,” says GFT’s Jamgotch. “Retail
traders need to keep in mind there is
limited liquidity in many exotic pairs,
which means spreads tend to widen
when these local financial markets are
not open.
“The typical GFT spread for the
USD/ZAR (U.S. dollar/South African
rand pair) is 150 pips, and during some
market conditions, such as when the
South African market is closed, it is not
uncommon for the spread to widen to
more than 500 pips.”
FXCM’s Lee says volatility and liq-
uidity are bigger concerns than people

CURRENCY TRADER • August 2007 9

GLOBAL MARKETS continued

FIGURE 1 — DOLLAR/RAND “Whatever you do, put on small
trades,” suggests Oanda co-founder
In late July the U.S. dollar/South African rand pair was just beginning to penetrate
Olsen.
the bottom of its long-term range and was trading at its lowest level in a year.

Longer-term plays
Given the wider spreads and reduced
liquidity of some exotic currencies,
some strategists feel the longer-term
time frame is a better choice than day
trading in this arena. Dolan cautions
those interested in expanding into the
exotics.
“For the retail guy, the risks probably
outweigh the rewards,” he says. “If they
do get into it, it has to be more of a
strategic and longer-term play.”
Olsen agrees on the time frame out-
look.
“While a euro/dollar trader might
trade a two- to three-hour position, a
yuan play could last two to five weeks,”
Source: ADVFN (http://www.advfn.com) he says. “Trades put on in emerging
market currencies are different in
into account the pip cost, which essentially puts things back nature, and tend to be on more of a long-term time frame.”
into perspective.”
A pip in the ZAR currently is worth about $1.45 vs., say, Do your homework
roughly $10 for a pip in the euro/dollar pair. Gaining access to the appropriate fundamental information
“Another factor retail traders should be aware of is the needed to make trading decisions may be harder when
volatility in exotic currencies around fundamental news looking at the exotic currency landscape.
releases can be much higher than in major currencies,” says “There are fewer news announcements and bank
GFT’s Jamgotch. “This means market gaps and slippage are research available for some of these exotic currencies,” says
more common.” GFT’s Jamgotch. “This means that it can be more difficult
for retail traders to conduct proper research needed to
Keep things small make informed decisions based on fundamental data.”
As market conditions can shift rapidly in the exotic curren-
cy environment, strategists advise retail customers to mon- “Exotic” to watch: South African rand
itor and limit position sizes carefully. FXCM’s Lee says the South African rand (ZAR) is a curren-
“Exotic currencies can become very volatile and illiquid cy to watch near-term (Figure 1).
without warning,” Jamgotch says. “Given the recent attention on carry trades and interest
For example, he pointed to when the Thai baht fell more rates, I still think that the ZAR has some potential,” he says.
than four percent against the U.S. dollar in December 2006 ”Technically, however, I might be waiting a bit for a better
when the Bank of Thailand imposed penalties on invest- price, as we’re approaching a major support level (in late
ments held for less than a year. Spreads on the U.S. dol- July).”
lar/Thai baht cross spiked from 5 pips to 100 or more, The South African Reserve Bank hiked interest rates in
depending on the institution. Jamgotch says many market early June from 9.0 percent to the current 9.5 percent.
makers chose not to offer Thai baht crosses during this tur- Bullish interest-rate differentials alone favor the rand vs.
bulent time. the U.S. dollar’s 5.25 percent fed funds rate.
Exotic currency traders also have to face the reality that it Looking at the differential, Lee says it’s still a good per-
may be difficult to exit positions because of lack of liquidi- centage to play.
ty outside of local trading hours.
“At the end of the day, it is almost like a futures market Rand: Key fundamentals
position, when the futures close at 2 o’clock and you can’t Gold and platinum prices are two factors that drive the
get out until the next day,” warns Forex.com’s Dolan. For South African rand; some traders essentially use the rand as
example, he notes that outside of North American trading a proxy for the world gold market.
hours, liquidity is “pretty poor” in the Mexican peso. Clyde Wardle, senior emerging market FX strategist at


HSBC, notes the rand strengthened roughly five percent improved,” Wardle says. “Liquidity is still very loose
from June to July. across the globe, which encourages managers to search for
“It was at 7.20-7.30 in early June and now it has moved yield.”
below 7.00,” he says. The main risk, Wardle warns, is the external environ-
As of late July, the USD/ZAR was trading at 6.88. Wardle ment. If global stock markets were to come under pressure,
pointed to the rally in the gold market from late June as one money managers could trim exposure to emerging-market
factor supporting the rand in recent weeks. positions, which would likely result in a weaker rand.
HSBC forecasts overall gross
domestic product (GDP) growth at 5.4
percent for South Africa in 2007, vs.
2006’s 5.0-percent reading. Inflation
remains high, which has been a driver
toward tighter monetary policy. The
May CPI ex-food and energy figure
posted a 6.4-percent reading year-
over-year in South Africa.
“The economy is improving and
has been improving for the past cou-
ple of years,” Lee says. “GDP and
manufacturing are healthy and con-
sumer spending has picked up.”
Wardle adds in the past the South
African Reserve Bank had discomfort
with currency strength below 7.00
amid worries that it would hurt
domestic manufacturing.
“Given rising inflation, the central
bank should be comfortable with the
strengthening currency,” he says.

Rand: Key price levels
Overall, HSBC forecasts continued
strengthening in the rand toward 6.75
by the end of third quarter. Weakness
is seen into early 2008, with a first-
quarter forecast of 7.25.
“I’m looking for a technical break of
the support the currency pair is cur-
rently trading at, around the 6.8606
(the May 8 low),” Lee says. “If this
level is broken, I would be looking to
initiate a long around that area with
targets set at 6.4050, just below the
6.427, 76.4-percent Fibonacci retrace-
ment of the 5.9446-7.983 bull wave.”

Global risk appetite helps,
too
The global environment remains
favorable toward emerging markets,
which is positive for the rand. Also,
given its relatively high interest rate,
the rand has been a player in the glob-
al carry trade, as well.
“The global risk appetite has


ON THE MONEY

The rising yen — here we go again
Japan’s unique economy — and culture — will play major roles in determining whether
the current yen strength has legs.

BY BARBARA ROCKEFELLER

L ast month’s article (“The hammer and the yen,”
Currency Trader, July 2007) discussed a potential
trend reversal in the Japanese yen (JPY) that is
developing the way we feared. So far the yen
has risen about 4.00 points from the June 22 low at 124.15,
and no matter what indicator you draw on the chart, it’s a
clear reversal (see Figure 1, which shows the dollar-yen rate
cators used to signify overbought or oversold (not shown),
the yen is still “weak” and hasn’t even headed up toward
the overbought level. This implies the up move may have a
long way to go.
Drawing the standard error channel starting farther back
in time (from the May 2006 high of 109.00) shows the cur-
rent move’s trendline would meet the upper boundary of
with an inverted scale so yen strength vs. the dollar appears the channel at 119.50 sometime around Aug. 20 if it contin-
as an up move). ues at the same slope (Figure 2). This perspective of the
The yen staged a breakout over the standard error chan- channel shows the current yen move to be only a secondary
nel drawn from the March yen high. The current price is correction of the bigger primary down move. This is proba-
well over the red 20-day moving average and less than 100 bly the correct interpretation, but it doesn’t pass the “So
points from the green 200-day moving average — the latter what?” test if you are trying to trade the yen. The bottom
usually considered the “long-term” average that often acts line is, if you are trading the yen, you have to be long.
as resistance, like the channel top. Price has also surpassed
the previous highest high from early June (gold horizontal Learning to love the yen…for now
line). It’s interesting that on the basis of the relative But a real problem with going long the yen is that it’s diffi-
strength index (RSI) and the stochastic oscillator, two indi- cult to understand the reasons behind the currency’s rise.
Typically, when a trend reversal occurs
you can identify the sentiment shift as
FIGURE 1 — DAILY DOLLAR-YEN (INVERTED SCALE) it is occurring and know what’s com-
The yen has made a strong move off its June low vs. the dollar, pushing ing at least a few days in advance. This
above near-term resistance and positioning itself for a run at the 200-day time there’s a full plate of “reasons” for
moving average. the reversal, but none of them are com-
pelling. Even taken as a whole they are
not particularly powerful. Besides, the
countervailing reasons for the yen to
remain in its primary downtrend have
not gone away.
Let’s look at the reasons we can
comfort ourselves with as we buy yen.
First, there was a serious policy shift at
the Japanese Ministry of Finance in
late June (see “The hammer and the
yen”). The government simply no
longer sees a weak yen as acceptable.
Not only is the government worried
about pressure from other countries,
notably France, but a weak yen makes
energy and commodities expensive in
yen terms, which is a negative for
small and medium-sized firms, includ-
ing many exporters. Sony, Honda, and
the other big names are experienced
hedgers (and cost-cutters), but smaller
Source: Data — Reuters DataLink; charts — MetaStock
firms suffer.


FIGURE 2 — WEEKLY DOLLAR-YEN (INVERTED SCALE)
The reversal on the daily time frame currently is nothing more than a correction
It’s wise to respect a stated policy in the yen’s long-term downtrend.
shift such as this because governments
can be powerful influences, although
we hardly ever see the influence at
work. It’s done behind the scenes
using what is euphemistically called
“moral suasion.” In a phone call, over
drinks, or at the golf course, an official
makes a gentle suggestion to a banker
or broker, (“…and Bob’s your uncle”),
and the disliked behavior stops
instantly. Governments regulate banks
and brokers, plus they tax everybody.
You disobey a government official’s
suggestion at your peril. And in Japan,
respect for authority runs high.
There are numerous ways the gov-
ernment could nudge institutions
away from a weaker yen. Japanese
retail investors are avidly pursuing
accounts denominated in other curren-
cies, for example, but that would tend
not to be the focus. Instead, attention Source: Data — Reuters DataLink; charts — MetaStock
would likely turn to cutting lines of
credit to speculators, chiefly hedge banks fall victim to dud loans to such
funds, especially if they invested in institutions — or forex trades, either.
U.S. sub-prime paper. This would kill Presumably, lending to hedge funds
two birds with one stone — halting an has been curtailed, along with credit
outflow from yen and reducing expo- lines for simple position-taking trad-
sure to high-risk paper. ing. As for lending to domestic
The sub-prime housing problem in Japanese funds, Japan’s nine biggest
the U.S. has already hit a number of banking groups have more than ¥1 tril-
hedge funds, the main players in the lion ($8.3 billion) in various instru-
carry trade. An Australian hedge fund ments backed by U.S. sub-prime mort-
hired Blackstone to advise it on sub- gages, according to the JiJi newswire.
prime investments, and immediately In late July, Financial Services
everyone suspects these investments Agency (FSA) chief Yuji Yamamoto
were made with borrowed yen. We told the press the government is close-
don’t know that for a fact, but the mere ly monitoring Japanese financial insti-
suspicion suffices to goad some tution risk-management practices. The
traders into imagining that if there is FSA finds the banks “well-prepared.”
one firm doing this, there might be Considering the entire banking sector
dozens. was in the tank only 10 years ago and
As far as we know, no hedge fund survived only with massive govern-
using borrowed yen to invest in U.S. ment bailouts, we wonder whether
sub-prime has actually gone under, this can be true, but never mind. We
and we do not know if the sub-prime should probably assume that
problem is going to contaminate other Yamamoto told the banks to stop
collateralized debt funds to the point investing in the sector and perhaps
of failure. But from the hysteria in the even to dump some of the paper. Such
blogosphere, you’d think widespread trades are, in effect, repatriation, and
institutional failure is imminent. automatically entail buying yen.
Nearly all hedge funds are non- This presupposes the Japanese insti-
Japanese, but if Japanese banks are tutions do not just switch to better-
providing the funding, they are at risk, quality foreign paper. After all, the
too. yield differential is still vastly in the
Japan has no intention of letting its continued on p. 14


ON THE MONEY continued

Other Barbara Rockefeller articles:
“The hammer and the yen”
Currency Trader, July 2007. favor of the Australian dollar, New Zealand dollar, British
Recent statements by Japan’s Ministry of Finance hint at pound, euro, and U.S. dollar. If the Japanese government were
big things on the horizon for the yen. asking its financial institutions to forego that additional yield,
it would be a shocking interference with private business.
“Too big to fail” (That doesn’t mean they wouldn’t do it.)
Currency Trader, June 2007. Another “reason” behind the yen’s rise is the widely expect-
If the dollar is poised to rebound, it might be getting help ed Bank of Japan (BOJ) rate hike in September or October,
where it least expects it. although possibly as early as August. This argument really
doesn’t hold water. A rate hike would still leave a very large
“Do stocks hold the key to currency levels?” gulf between Japanese and foreign paper, although we can
Currency Trader, May 2007. admit that if the famously reticent BOJ were to raise rates in the
The correlation between stock market and currency prices
absence of inflationary pressure in the name of “normaliza-
isn’t what many people think.
tion” and a nod to superior growth, then we need to pay atten-
“The coming commodity boom” tion; more hikes will be on the way. This is a tremendously con-
Currency Trader, April 2007. tentious issue: Under what circumstances should a central
Commodities are already having an impact on global bank, facing zero inflation, raise rates?
economies. One answer is that Japan has failed to become a global finan-
cial center on par with New York or London, but has not aban-
“The yen: Canary in the currency coal mine” doned the objective. Japan has the world’s second-largest econ-
Currency Trader, March 2007. omy but Tokyo is not the world’s second largest financial cen-
Keep an eye on capital flows and the yen — they could ter. In fact, Tokyo has lost rank over the past 15 years. The
be telling you more about the dollar than first meets Tokyo Stock Exchange is the world’s second-largest after the
the eye. New York Stock Exchange, but its capitalization is only 10 per-
cent of world capitalization, even as emerging markets rocket
“Indicator failure and scientific analysis” higher. It had one-third of world capitalization in 1990.
Currency Trader, February 2007. Foreigners don’t want to list their companies in Tokyo, with
This discussion of market biases and fallacies provides a
only 25 listing last year, from 125 the year before. New York,
more rigorous way to think about trading.
even with the deterrent of Sarbanes-Oxley rules, attracted
“Reserve diversification, Part II” more than 440 in 2006. Worse, in recent years the Tokyo Stock
Currency Trader, January 2007. Exchange has had some huge technology failures that shut
What is the U.S. doing to ensure the Chinese government down trading for entire days. Despite being the land of elec-
will not alter the $700 billion it has in U.S. dollar reserves? tronics, the exchange is considered technologically deficient.
Singapore and Hong Kong, with tiny economies, are bigger
“Charts are not enough” and more dynamic — and associated by language, history, and
Currency Trader, December 2006. culture with China, which is rapidly displacing Germany as
Breaking down price action in light of the news. the third largest economy.
The first study group on enhancing Japan’s position as an
“When will the yen go to the moon?” international financial center was held in 2003, but it seems to
Currency Trader, October 2006. be new FSA chief Yamamoto who is reviving the initiative. He
The fundamentals are all pointing toward an up move in adheres to the belief that you can’t be a major world financial
the Japanese yen. So what’s it waiting for? center with a falling currency that fails to reflect good econom-
ic fundamentals, which in Japan’s case is the highest growth
“Why is everybody losing money in forex?”
rate in the world in 2006. However, wishing to be a world
Currency Trader, September 2006.
Despite unprecedented liquidity, professional currency financial center is not the same thing as knowing how to get
managers have had a rough go of it in 2005 and 2006. there.
Has something changed in the forex world? Is it even remotely reasonable to assume that engineering a
stronger yen can be viewed as a prerequisite to this goal, and
“Gauging trader commitment” let’s worry about the rest of the components of becoming a
Currency Trader, August 2006. world center later on? Yes. It is exactly the kind of straight-line
Is this a good breakout or a false move? The thinking we have seen from Japan in the past — and oddly, it
Commitment of Traders report can help currency traders often succeeds.
fill in some of the holes left by the absence of traditional Working on becoming a world financial center could remain
volume data in forex. an objective of whatever government is in office, and Prime
Minister Shinzo Abe and his coalition government risk losing
You can purchase and download past articles at power in the July 29 elections. Even if Yamamoto does not
http://www.activetradermag.com/purchase_articles.htm. remain the FSA chief, the next guy would be bound by the


overarching government objective. in the yen for the past six months,
Japan has a splendid history of long- because hedge fund managers have a
term planning. The next FSA head will “strong hand.” It's not easy to stam-
pick up the internationalization effort pede them out of lucrative positions.
where Yamamoto left off. But each manager has a breakeven
Having a stronger currency based in point and nerves get frayed even
part on higher interest rates is not the when the yen is hundreds of points
only obstacle Yamamoto faces in try- away. After all, currencies can move
ing to make Tokyo a global financial hundreds of points in a short while
center. He also has to overcome a pen- and currencies are famous for over-
chant for regulatory red tape that sti- shooting, too.
fles innovation and encourages people More importantly, folks riding the
to find ways around regulatory agen- coattails of the yen carry trade, includ-
cies (including the FSA itself) instead ing those with plain vanilla futures
of simply asking for exceptions and and forwards, are easy to panic. As
help. risk aversion rises with every new
Most observers say the biggest story about losses in subprime and
problems are cultural. To be an inter- other collateralized debt that was mis-
national center, you have to attract for- priced, incompetently rated by the rat-
eigners to live and work in Tokyo. But ings agencies, or can’t be marked to
the language is difficult to learn and market with any confidence, the carry
has complex nuances — the word for trade gets lumped in with other paper
“risk” didn’t exist in Japanese, and deemed “high-risk.” This is not accu-
comes from English. Women are sec- rate — with the carry trade, all you
ond-rate citizens and not represented need to know is your breakeven point.
at executive levels, a waste of half the You can count on the forex market to
manpower of the country. Japan has provide sufficient liquidity for an
its fair share of smart people, but argu- orderly exit at just about any hour of
ing and disagreeing with others is the day or night. With truly high-risk
socially unacceptable. It makes brain- paper, the unknowns are plentiful,
storming particularly difficult. And including markets so thin (illiquid)
respect for older people, while laud- that no trading gets done at all. But the
able, restrains brash youngsters from relative ease of exit doesn't matter to
making a splash. But splashiness and those prone to panic — the yen carry
disorder are what you need to sponsor trade is considered speculative, and
change. plenty of traders will simply dump
positions.
The story is the story Add to that a possible rate hike and
Of all the reasons for the yen to be on a government determined to rise in
the upswing, the sub-prime hedge the ranking of global financial centers
fund story seems to be the one that has on the back of a high currency and you
captured traders’ imagination. That have a recipe for further gains.
we have no hard evidence of yen- Is this a castle built out of spun
funded hedge-fund failures and no sugar? You bet. The whole thing can
evidence of a lending pullback, come crashing down if the sub-prime
whether government-mandated or problem fades away with no big insti-
not, is no deterrent to traders. It’s a tutional failures, Abe loses the elec-
juicy story. It makes sense. All it will tion, the BOJ refuses to raise rates
take is one outright yen-funded because there is no inflationary reason
hedge-fund failure to send the yen to to raise rates, and the timetable for
the moon. restoring Tokyo to world status is seen
The yen can also go to the moon if to be a project for a decade, not the
carry trades actually do get unwound. next three months. But in the mean-
We have been pooh-poohing that time, you have to go with the flow.
story, which has been used to explain
any and every minor bounce upward For information on the author see p. 6.


TRADING STRATEGIES

Short-term trends
in the EUR/USD pair
Analyzing both the duration and size of different price moves can clue you
in to more accurate trade setups.
BY CURRENCY TRADER STAFF

A common problem in the markets is trading
with hindsight. For example, you make a
trade, book a profit, and then watch the
move continue — realizing you left money
on the table by not being more patient. Other times you wait
for that nice run that never materializes.
Trading with hindsight can introduce psychological
issues when managing a trade. You might think you can
judge by the current conditions whether a big move is at
hand or not. But if you second-guess yourself for getting
out too early or too late, you’ll have problems taking the
next trade.

FIGURE 1 — DAILY EUR/USD
Two sharp runs — one up, one down — are marked on the chart. How often does this currency pair make consecutive daily
higher highs or lows?

Source: CQGNet (http://www.cqg.com)


FIGURE 2 — WEEKLY EUR/USD
The review period spanned July 2003 through June 2007.

Source: CQGNet (http://www.cqg.com)

The best way to avoid this is to per-
form a thorough analysis of market
behavior and get some hard numbers
on which to base your trades. You will
know what typical market behavior is
and can develop strategies around
that knowledge. In addition, perform-
ing this type of market analysis on a
regular basis will alert you to changes
in market volatility.
For example, in Figure 1, the price
run next to arrow “A” is a run of 13
consecutive higher highs but only six
consecutive higher closes. Arrow “B”
marks a run of four consecutive lower
lows, but only three consecutive lower
closes. The question is, just how often
do such runs occur?
This analysis dissects trend runs
using daily bars of the euro/U.S. dol-
lar (EUR/USD) pair from July 1, 2003
through June 29, 2007 and identifies
the number of consecutive higher or
lower highs, higher or lower lows,
and higher or lower closes in different
continued on p. 18


TRADING STRATEGIES continued

TABLE 1 — HIGHER HIGHS VS. LOWER LOWS
daily price range behavior.
The EUR/USD trend was up for more than four years, which is
The top half of Table 1 compares one day’s session
reflected by the slight edge in the numbers for higher prices (top
half of the table) vs. lower prices (bottom half of the table). to the next day’s session, detailing the number of
times there were consecutive higher highs (HH),
HH HL HC HH+HC HH+HL+HC higher lows (HL), higher closes (HC), higher highs
543 531 524 367 300 and higher closes (HH +HC), and higher highs, high-
52.11% 50.96% 50.29% 35.22% 28.79% er lows, and higher closes (HH+HL+HC)
The bottom half of Table 1 shows the number of
LL LH LC LL+LC LL+LH+LC times there were consecutive lower lows (LL), lower
highs (LH), lower closes (LC), lower lows and lower
503 492 512 332 256
closes (LL +LC), and lower lows, lower highs, and
48.27% 47.22% 49.14% 31.86% 24.57%
lower closes (LL+LH+LC).
First, the percentage change (on a closing basis) for
price moves, as well as other patterns. the entire review period was a gain of just over 17 percent.
Figure 2 shows the review period using weekly bars, but The table shows the influence of this long-term trend, but it
the analysis was performed on daily data. is relatively minor — the numbers in the top half of the
table are slightly larger than the bottom. A closer look at the
Up moves vs. down moves numbers points to some interesting price action.
To get a handle on typical moves vs. what could be consid- The market made either a higher high, higher low, or
ered outliers, Tables 1 and 2 show the EUR/USD’s basic higher close more than 50 percent of the time — unsurpris-
ing given the long-term trend.
However, combining higher highs
and higher closes dropped the per-
centage to 35 percent of the time, and
back-to-back higher highs, higher
lows, and higher closes occurred just
under 29 percent of the time. This sug-
gests that despite the buying pressure
from one session to the next, traders
tended to take profits going into the
close over 70 percent of the time.
None of the statistics in the bottom
half of the table break the 50-percent
level. However, the percentage of
lower closes was higher than the per-
centage of lower lows or lower highs.
This implies there were inside days
when the market essentially paused;
when the market could not generate
an up move, traders moved out of
long positions, producing lower clos-
es.
The percentage of consecutive
lower lows and lower closes is just
under 32 percent and the percentage
of consecutive lower lows, lower
highs, and lower closes is slightly less
than 25 percent. The bullish trend is


TABLE 2 — EUR/USD RUNS

Despite the EUR/USD’s upward bias, the market posted seven consecutive higher closes (HC) only three times, while it made
seven consecutive lower closes on five different occasions.

HC HH+HC HH+HL+HC
No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2
Count 3 13 28 56 117 254 0 2 8 25 69 150 0 0 4 15 46 109
% 0.29% 1.25% 2.69% 5.37% 11.23% 24.38% 0.00% 0.19% 0.77% 2.40% 6.62% 14.40% 0.00% 0.00% 0.38% 1.44% 4.41% 10.46%

LC LL+LC LH+LL+LC
No. of days 7 6 5 4 3 2 7 6 5 4 3 2 7 6 5 4 3 2
Count 5 15 31 58 111 242 0 3 10 22 53 131 0 2 7 16 35 87
% 0.48% 1.44% 2.98% 5.57% 10.65% 23.22% 0.00% 0.29% 0.96% 2.11% 5.09% 12.57% 0.00% 0.19% 0.67% 1.54% 3.36% 8.35%

also reflected in these two statistics, because they suggest trend was up during the review period, Table 2 has some
there were times the market traded lower than the previous interesting details. First, there were more times the market
session, but buyers came in and bid the market up to a high- closed down seven consecutive times than up. Of course,
er closing price. the difference (two) is not statistically significant, but the
Table 2 displays a more detailed breakdown of the fre- number of runs of consecutive lower closes is larger than
quency and length of runs in the EUR/USD pair. The “No. the number of consecutive higher closes from lengths of
of days” row is the number of sessions that met the criteria. four to seven days. (However, the percentage price changes
For example, “7” means a run of seven (or more) consecu- continued on p. 20
tive days; “6” means a run of six or
more sessions, etc.
Although, the table does not explic-
itly show the exact number of occur-
rences in each category, simple arith-
metic reveals the answers. For exam-
ple, there were 117 runs of three or
more consecutive higher closes (HC);
these 117 runs are also part of the 254
runs of two or more consecutive high-
er closes (254 occurrences). As a result,
there were 137 (254 - 117) runs of only
two consecutive days of higher closes.
The top half of Table 2 shows the
market made seven consecutive high-
er closes only three times, or just 0.29
percent of the time. The same statistics
are detailed for consecutively higher
highs and higher closes (HH+HC),
and higher highs, higher lows, and
higher closes (HH+HL+HC). The bot-
tom half of the table shows the infor-
mation for lower closes (LC), lower
lows and lower closes (LL+LC), and
lower highs, lower lows, and lower
closes (LH+LL+LC).
In light of the fact the long-term



TABLE 3 — MARKET PERFORMANCE

The percentage price moves from one to five days is shown for the total review period as well as for 12-month sub-periods.

Total D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM
Avg 0.02% 0.41% -0.42% 0.03% 0.60% -0.59% 0.05% 0.74% -0.72% 0.07% 0.86% -0.82% 0.08% 0.97% -0.90%
Med 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68%
STD 0.56% 0.35% 0.35% 0.77% 0.47% 0.49% 0.93% 0.57% 0.59% 1.08% 0.65% 0.68% 1.19% 0.73% 0.75%
7/1/2003-6/30/2004
Avg 0.02% 0.51% -0.53% 0.05% 0.74% -0.75% 0.08% 0.92% -0.92% 0.10% 1.07% -1.05% 0.14% 1.21% -1.17%
Med 0.04% 0.41% -0.45% 0.10% 0.64% -0.58% 0.17% 0.81% -0.70% 0.27% 0.95% -0.80% 0.35% 1.12% -0.87%
Max 1.91% 1.99% 0.00% 2.39% 2.62% 0.00% 2.99% 3.25% 0.00% 3.49% 3.62% 0.00% 3.94% 3.99% 0.00%
Min -1.93% 0.00% -2.11% -2.80% 0.00% -3.19% -2.97% 0.00% -3.47% -3.32% 0.00% -3.47% -3.69% 0.00% -3.85%
STD 0.71% 0.41% 0.44% 0.96% 0.55% 0.61% 1.12% 0.65% 0.73% 1.31% 0.76% 0.83% 1.43% 0.84% 0.92

7/1/2004-6/30/2005
Avg -0.01% 0.39% -0.44% -0.01% 0.57% -0.63% -0.02% 0.70% -0.77% -0.03% 0.82% -0.89% -0.04% 0.91% -1.00%
Med -0.02% 0.30% -0.35% -0.02% 0.46% -0.50% 0.02% 0.57% -0.62% 0.00% 0.68% -0.71% 0.02% 0.81% -0.77%
Max 1.84% 1.95% 0.00% 1.90% 2.01% 0.00% 2.12% 2.20% 0.00% 2.35% 2.53% 0.00% 2.50% 2.68% 0.00%
Min -1.44% 0.00% -1.66% -2.36% 0.00% -2.53% -3.21% 0.00% -3.37% -3.05% 0.00% -3.37% -3.68% 0.00% -3.90%
STD 0.56% 0.34% 0.36% 0.79% 0.45% 0.51% 0.98% 0.53% 0.63% 1.14% 0.61% 0.72% 1.28% 0.67% 0.81%

7/1/2005-6/30/2006
Avg 0.03% 0.42% -0.42% 0.06% 0.62% -0.58% 0.08% 0.78% -0.70% 0.11% 0.92% -0.78% 0.14% 1.04% -0.86%
Med 0.00% 0.33% -0.33% 0.02% 0.49% -0.49% 0.04% 0.60% -0.60% 0.05% 0.74% -0.66% 0.06% 0.84% -0.71%
Max 1.70% 1.91% 0.00% 2.52% 2.73% 0.00% 2.56% 3.03% 0.00% 2.79% 3.03% 0.00% 2.76% 3.03% 0.00%
Min -1.23% 0.00% -1.38% -2.15% 0.00% -2.24% -2.23% 0.00% -2.46% -2.42% 0.00% -3.01% -2.56% 0.00% -3.01%
STD 0.54% 0.36% 0.31% 0.77% 0.51% 0.40% 0.92% 0.62% 0.49% 1.05% 0.69% 0.55% 1.15% 0.76% 0.61%

7/1/2006-6/30/2007
Avg 0.02% 0.31% -0.28% 0.04% 0.44% -0.40% 0.07% 0.54% -0.47% 0.09% 0.63% -0.53% 0.11% 0.71% -0.58%
Med 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45%
Max 1.15% 1.27% 0.00% 1.48% 1.73% 0.00% 1.97% 2.06% 0.00% 2.26% 2.51% -0.01% 2.76% 2.84% -0.01%
Min -1.05% 0.00% -1.12% -1.42% 0.00% -1.48% -2.04% 0.00% -2.19% -2.01% 0.00% -2.25% -2.13% 0.01% -2.36%
STD 0.36% 0.23% 0.21% 0.52% 0.32% 0.30% 0.62% 0.38% 0.37% 0.71% 0.44% 0.43% 0.79% 0.49% 0.47%

during these runs is not included here.) Size of price moves
There’s a similar pattern in the number of higher highs Table 3 details the percentage size of price moves from one
and higher closes (HH+HC) relative to lower lows and to five days in length for the entire review period, as well as
lower closes (LL+LC). Neither category had any runs last- in 12-month increments. Included are the average, median,
ing seven consecutive days, but the percentage of six- and maximum, minimum, and standard deviation for each
five-day runs of lower lows and lower closes edged out the close-to-close move, largest up move (LUM), and largest
percentage of higher highs and higher closes. down move (LDM) for each period (see “Understanding
The final comparison is higher highs, higher lows, and Table 3” for details about the statistics).
higher closes (HH+HL+HC) vs. lower highs, lower lows, For example, for the entire analysis period, the average
and lower closes (LC). There were two runs of six consecu- three-day close-to-close change was a gain of 0.05 percent,
tive LH+LL+LC days on the bear side, and the five-day and the maximum gain was +2.99 percent (which occurred in
four-day runs outnumbered the HH+HL+HC counterparts. the July 1, 2003 to June 30, 2004 period) and the largest
continued on p. 22


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three-day, close-to-close decline was -3.21 percent (from the The median close-to-close price move was negative over the
July 1, 2004 to June 30, 2005 period). The average three-day next three sessions, after which the market rebounded.
LUM was +0.74 percent and the average three-day LDM Figure 3 compares the performance after the pullback
was -0.72 percent. patterns and the typical market performance.
Because the long-term trend was up, let’s see if some of continued on p. 24
the information from Table 3 can pro-
vide insight as to what the market did
following pullbacks.
Understanding Table 3
Two-day pullbacks Table 3 summarizes price behavior for dif-
Table 4 compares Table 3’s median ferent scenarios. It shows the average,
price moves for the entire the analysis median, maximum, and minimum price
period and the final 12 months of the changes from:
review period (July 3, 2006 to June 30, 1. The initial closing price to the
2007) to: 1) the median moves after
closing prices of the next five days
two-day, -1.44 percent (or greater)
(D1 to D5);
declines, 2) two consecutive days of
LL+LH+LC, and a combination of 1 2. The closing price to each following
and 2. day’s highest high (largest up move,
The 1.44-percent drop was chosen or “LUM”);
because the median two-day LDM was 3. The closing price to each following
-0.46 percent and the standard devia-
day’s lowest low (largest down move,
tion was 0.49 percent; therefore, a two-
or “LDM”).
day drop larger than -1.44 percent was
exceptionally big (more than two stan-
dard deviations). Also, the standard deviations (StD) for the close-to-close changes are
Despite the EUR/USD’s long-term included.
uptrend, you would have taken some
heat if you bought pullbacks when the Figure A shows the close-to-close moves, LUMs, and LDMs from the
market made two consecutive lower initial bar to the two subsequent bars.
lows, lower highs, and lower closes:

TABLE 4 — PULLBACK PATTERN

To determine whether a certain type of pullback represented a trade opportunity, the EUR/USD’s median price action was compared
to a pattern consisting of a two-day, -1.44-percent correction where both days had lower lows, lower highs, and lower closes.

D1 LUM LDM D2 LUM LDM D3 LUM LDM D4 LUM LDM D5 LUM LDM
Overall 0.01% 0.31% -0.32% 0.02% 0.49% -0.46% 0.08% 0.59% -0.55% 0.08% 0.71% -0.63% 0.11% 0.81% -0.68%

7/3/2006-6/30/2007 0.01% 0.25% -0.23% 0.03% 0.39% -0.33% 0.09% 0.50% -0.37% 0.09% 0.56% -0.42% 0.14% 0.61% -0.45%

2-day LL+LH+LC -0.03% 0.30% -0.35% -0.06% 0.47% -0.51% -0.03% 0.56% -0.63% 0.10% 0.69% -0.71% 0.18% 0.81% -0.77%
(87 instances)
2-day drop -1.44% 0.02% 0.30% -0.45% 0.02% 0.49% -0.51% 0.17% 0.65% -0.65% 0.31% 0.77% -0.67% 0.15% 1.06% -0.74%
(40 instances)
Combination 0.02% 0.30% -0.44% 0.14% 0.47% -0.52% 0.11% 0.64% -0.63% 0.32% 0.74% -0.68% 0.21% 0.94% -0.74%
(27 instances)



However, the combination of two
FIGURE 3 — PULLBACK COMPARISON
consecutive LH+LL+LC days and a
two-day, -1.44 percent decline was fol- A two-day drop with lower lows, lower highs, and lower closes was followed
with three more sessions of lower median close-to-close changes.
lowed by larger than average upside
moves for days two through five. The
largest median close-to-close change
occurred after four sessions.

Robust analysis
Combining the analysis of “runs” —
consecutive days of higher or lower
highs, lows, and closes — with price
moves of different sizes provides a dif-
ferent way to conceptualize concepts
such as market exhaustion than rely-
ing on off-the-shelf indicators or gut
feeling. Finally, as Table 3 illustrates,
volatility has been declining, as the
standard deviation for the five-day close-to-close changes This highlights the importance of updating your analysis on
has fallen in each 12-month section of the review period. a regular basis.

Related reading
“New Zealand dollar trading numbers” “Euro/yen: Tips and tendencies”
Currency Trader, June 2007. Currency Trader, December 2006.
Detailed analysis of the “kiwi” dollar’s trading tendencies Euro/yen by the numbers: Stats and tendencies for short-
and characteristics. term forex players.

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The dollar-yen’s trading characteristics are examined on Studying the euro’s daily and intraday performance statistics
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The British pound has been a volatile — and mostly bullish The usual rules of the currency world don’t necessarily
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day to day. case, or is Japan poised to revamp its economic model in a
way that will dramatically alter the yen’s longstanding
“Dollar-Canada by the numbers” dynamics? Note: This article is also part of the
Currency Trader, January 2006. “Howard Simons: Advanced Currency Concepts, Vol. 1”
As the only purely North American major currency pair, the article collection, which contains nine Currency Trader
dollar-Canada rate occupies a unique position. We break articles by Howard Simons.
down its short-term performance to reveal daily and intraday
tendencies. You can purchase and download articles at
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ADVANCED STRATEGIES

Minor currencies
and federal reserve trade weights
The verdict is in: Currency rates don’t affect trade.

BY HOWARD L. SIMONS

L entire premise behind the floating exchange-rate regime of
ast month’s article “Currencies and federal reserve
the past 35 years is wrong.
trade weights” (Currency Trader, July 2007), which
examined major currencies’ impact on Federal As all currency traders learn quickly, major currencies
have different trading patterns and represent different
Reserve trade weights, concluded: “A review of U.S. trade
underlying economies than minor currencies, which are
patterns with major currency trading partners reveals little
buffeted more by speculative capital flows even as their
evidence that a weaker currency leads to greater export
markets are shallower than the majors’. Will analysis of the
competitiveness and a lower ability to import.” In short, the
minors support the findings of the
FIGURE 1 — THE CHINESE YUAN AND ITS WEIGHT IN U.S. TRADE
study of the majors, or are Federal
Reserve trade weights for the
minor currencies more sensitive to
changes in the currencies them-
selves?

Recap of data and methodology
First, the analysis process used
here is identical to that used last
month:
To maintain its trade-weighted dol-
lar index (http://www.federalre-
serve.gov/releases/H10/Weights/), the
Federal Reserve must keep track of the
changing use of various currencies the
U.S. receives in return for its exports
and pays for its imports. In these
FIGURE 2 — THE TAIWAN DOLLAR AND ITS WEIGHT IN U.S. TRADE charts, export weights are depicted in
blue and import weights in green.
These weights are calculated on an
annual basis and, of necessity, after
the fact. Because the Federal Reserve is
unable to license its dollar index for
commercial purposes, many traders
are unfamiliar with this data.
Also, these currency weights reflect
their use in bilateral trade with the
U.S. and do not reflect total bilateral
trade. This is critical for countries
from whom the U.S. imports large
quantities of goods priced in dollars,
such as crude oil and various metals.
Annual data are of little trading use


The entire premise FIGURE 3 — THE HONG KONG DOLLAR AND ITS WEIGHT IN U.S. TRADE

behind the floating
exchange-rate
regime of the past
35 years is wrong.
in a continuous market such as cur-
rencies. We can create smoothed series
of import and export weights via a sta-
tistical technique called “cubic spline
interpolation.” This technique is used
twice in the charts below — once to FIGURE 4 — THE SINGAPORE DOLLAR AND ITS WEIGHT IN U.S. TRADE
create quarterly series from the annu-
al numbers and a second time to create
monthly numbers from the quarterly
results.
The resulting interpolations are far
easier to absorb than the annual num-
bers, but as they involve two separate
data transformations, we did not
attempt any further statistical analy-
sis against monthly currency values
(presented in red in the charts). In
addition, please be advised all curren-
cies are displayed in the “USD per”
convention familiar to traders of the
euro, the British pound, and currency
futures. The currency scale is inverted
for currencies commonly expressed as FIGURE 5 — THE KOREAN WON AND ITS WEIGHT IN U.S. TRADE
“per USD,” so a rising red line always
conveys strength vs. the dollar and a
falling red line always conveys weak-
ness.

A second passage from last
month is mentioned here for clari-
ty:
Even though the principal advocate
of floating exchange rates, the late
Milton Friedman, was the antithesis
of a protectionist, his arguments have
been seized by this faction to the extent
that the notion a weaker currency
continued on p. 28


ADVANCED STRATEGIES continued

should stimulate exports and reduce
FIGURE 6 — THE THAI BAHT AND ITS WEIGHT IN U.S. TRADE
imports will be referred to as the “pro-
tectionist argument.”

East Asian currencies
With all the political rhetoric call-
ing for a stronger Chinese yuan, it
is easy to lose sight of the fact that
export weights to China rose
steadily between 2000 and 2006.
Moreover, as China’s wealth level
grows, so should both the volume
and the value-added content of its
imports from the U.S. This so-
called “marginal propensity to
import” is characteristic of all
growing economies.
The surge in import weights FIGURE 7 — THE MALAYSIAN RINGGIT AND ITS WEIGHT IN U.S. TRADE
from China is, of course, the dom-
inant feature in Figure 1. No
nation on earth has China’s cost
advantages in labor, a state-con-
trolled banking system with over
$1 trillion in foreign exchange
reserves, low levels of environ-
mental and safety costs, and pro-
ductivity advantages from new
plants and equipment. Given
these advantages, we do need to
ask whether any level of the yuan
(CNY) would have offset these
formidable advantages; the bet-
ting here is the yuan could be
much stronger with no adverse
FIGURE 8 — THE INDONESIAN RUPIAH AND ITS WEIGHT IN U.S. TRADE
effects on Chinese exports.
Taiwan’s importance as an
exporter to the U.S. has been
declining steadily since the mid-
1980s. In all likelihood, exports
from Taiwan have been displaced
by exports from China. The
island’s share in U.S. export
weights has tracked changes in
the TWD to a degree (Figure 2).
This indicates some measure of
currency price elasticity in
Taiwan’s import decisions.
Hong Kong provides an inter-
esting rebuttal to the protectionist
argument. Although its currency
has been locked in a tight range since the mid-1980s, its clude the uptrend in export weights between 1986 and 1996
import weights have fallen steadily since then (Figure 3). If meant the HKD was overvalued.
the protectionist argument was correct, we would have to Neither is likely. As in the Taiwan example, the simplest
conclude the Hong Kong dollar (HKD) was overvalued at explanation is the best. Hong Kong’s exports to the U.S.
this lower range. Moreover, we also would have to con- have been displaced by exports from China.


We can draw the same conclusion by examining Asian crisis (Figure 8). The 1997 collapse of the rupiah (IDR)
Singapore, which we will group with the East Asian rather preceded a decline — not the theorized increase — in
than the South Asian countries by virtue of its largely import weights. The same cannot be said for export
Chinese population. The 1997-2001 decline in the SGD did weights, however: Indonesia’s sudden impoverishment led
nothing to arrest its falling import continued on p. 30
weights, and the 2002-2006 rally
didn’t do anything to accelerate the FIGURE 9 — THE PHILIPPINE PESO AND ITS WEIGHT IN U.S. TRADE
downtrend already in place (Figure
4). These simply reflect China’s
ascendancy. Export weights to
Singapore rose modestly in the
mid-1990s “Asian Tiger” epoch,
but have flattened since.
The final East Asian currency is
the Korean won (KRW, Figure 5).
This currency was hugely affected
by the 1997-1998 Asian crisis.
Although import weights from
Korea — which had been in decline
since 1988 — reversed after the
KRW’s plunge and declined after
the KRW’s post-2004 rally, the real
impact was the large drop in export
FIGURE 10 — THE MEXICAN PESO AND ITS WEIGHT IN U.S. TRADE
weights to Korea during the Asian
crisis. This reflected both changes
in the currency and the large drop
in Korean national income during
this period.

South Asian currencies
Speaking of the Asian crisis, let’s
look at the currency that started it
all, the Thai baht (THB). Prior to
1998, both the import and the
export weights for the baht were
trending higher (Figure 6). The
cheaper baht did nothing to
increase its import weights, and the
loss of purchasing power in
Thailand did surprisingly little to FIGURE 11 — THE BRAZILIAN REAL AND ITS WEIGHT IN U.S. TRADE
reduce export weights to Thailand.
Overall, Thailand’s contribution to
U.S. trade is and has been fairly
minor.
The picture for Malaysia is simi-
lar to that of Thailand (Figure 7).
Both import weights from
Malaysia and export weights to it
grew rapidly between 1986 and
1996 — and were unaffected by the
ringgit’s (MYR) sharp drop.
Neither the MYR nor the course of
the Malaysian economy affected its
trade weights with the U.S.
Indonesia also suffered in the


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