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August 2006
Volume 3, No. 8
AUSSIE AND KIWI DOLLARS:

What’s the play?
JAPAN HIKES,
yen says, ‘‘Yikes!’’
TRADING WITH THE

adaptive moving average
COMMITMENT OF
Traders report
THE DOLLAR’S
hidden risks
CONTENTS
Big Picture . . . . . . . . . . . . . . . . . . . .12

Gauging trader commitment
Is this a good breakout or a false move?
The Commitment of Traders report can
help currency traders fill in some of the
holes left by the absence of traditional
volume data in forex.
By Barbara Rockefeller
Trading Strategies . . . . . . . . . . . . .16

The adaptive moving average
How do you improve on a moving average?
Make it responsive to volatility changes.
By Currency Trader Staff
Advanced Strategies . . . . . . . . . . .22

The dollar and its hidden risks
A look at the dollar in light of its recent
performance vs. the yen and the euro.
By Howard L. Simons
Contributors . . . . . . . . . . . . . . . . . . . .6 Currency System Analysis . . . . . .28

HLR breakout
Global Markets
Aussie/dollar shrugs off
volatile first half . . . . . . . . . . . . . . . . .8
What’s in store for the Aussie dollar
after its roller-coaster first half?
New Zealand: Kiwi dollar losing

its high-yield luster . . . . . . . . . . . . .10
The other “currency down under” faces
a few economic challenges in
the coming months.
continued on p. 4
2 August 2006 • CURRENCY TRADER

CONTENTS
Currency Basics . . . . . . . . . . . . .32

Trading forex the mini way
Mini forex trading is a lower-cost
alternative to full-sized futures and
spot forex. RefcoFX finds a new suitor . . . . . . .39
By Darrell Jobman In limbo since the bankruptcy of
its parent company, RefcoFX.com
International has a new owner in Gain Capital.
Market Summary . . . . . . . . . . . . . . .34
Global Economic Calendar . . . . . .40

Global News Briefs . . . . . . . . . . . . .36 Key dates for currency traders.
Currency Futures . . . . . . . . . . . . . .37 Events . . . . . . . . . . . . . . . . . . . . . . . .42

News and data from the currency Conferences, seminars, and other events.
futures world.
Key Concepts . . . . . . . . . . . . . . . . . .42

Industry News References and definitions.
Japan ends
zero interest-rate policy . . . . . . . . . .38
For the first time in more than 15 years, Forex Trade Journal . . . . . . . . . . . .44
the Bank of Japan is committed to A dollar/yen trade gets a boost from
raising the country’s interest rates. an important bit of economic news.
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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-
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A publication of Active Trader ® Howard Simons is president of Rosewood Trading

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ads0906 7/11/06 12:17 PM Page 37
GLOBAL MARKETS
Aussie/dollar
shrugs off volatile first half
The Australian dollar staged a strong rally from its nearly two-year low vs. the U.S. dollar in May — and then
promptly sold off again. The economic fundamentals paint a mixed picture for the Aussie dollar’s future.
BY CURRENCY TRADER STAFF
A
fter massive volatility rocked AUSSIE DOLLAR/U.S. DOLLAR AT A GLANCE
the Australian dollar/U.S. dol-
Daily range (past 40 days): Average: 0.0065 Median 0.0063
lar pair (AUD/USD) from
Weekly range (past 26 weeks): Average: 0.0154 Median 0.0155
February through May, the cur-
52-week high/low: 0.7792/0.7015
rency is trading around 0.7660 at the end of
AUS U.S.
July, just slightly higher than at the beginning
Prevailing interest rates (%): 6.00 5.25
of 2006.
Next central bank meetings: Sept. 6 Aug. 8
Several factors whipped the Aussie/dol-
Sept. 20
lar to a low at 0.7015 in late March and back
GDP (annualized growth) Q2 2006* Q1 2006 Q4 2005
to a peak at 0.7795 in mid-May — establish-
AUS U.S. AUS U.S. AUS U.S.
ing the current 52-week low and 52-week
0.5 2.5 3.1 5.6 2.7 1.8
high in little more than a month — but indi-
*Estimate All data as of July 31
cate the remainder of the year may bring
more steadiness to the currency’s trade
(Figure 1). currency plunged to 0.7015, the current low for the year.
Looking back, the Aussie/dollar entered 2006 with a “The March sell off was caused by a massive unwinding
slightly bearish bias; the currency pair had been zig-zagging of Japanese yen-funded Aussie dollar long positions, and
lower off the March 2005 peak at 0.7986 (Figure 2). The inter- also declining Uridashi issuance,” says Prakriti Sofat, econ-
est rate outlook was fairly steady, as the Reserve Bank of omist at Ideaglobal Ltd. “It also coincided with the Japanese
Australia (RBA) had been on hold since March 2005. In mid- fiscal year-end, a time when Japanese investors repatriate
March 2006, however, the pace of selling accelerated and the funds home.” (Uridashi is referring to debt issued to
Japanese retail investors in a foreign currency.)
“The pace of Aussie and New Zealand issuance has
FIGURE 1 — RECENT AUSSIE VOLATILITY
slowed,” agrees Rhonda Staskow, regional director FX
In less than six weeks this spring, the Aussie/dollar pair swung up Americas at Thomson Financial-IFR Markets. “Japanese
and down strongly enough to establish its current 52-week high investors have begun looking elsewhere for yield, includ-
and low levels. ing the U.S., Mexico, and South Africa.”
Rate hike bolsters Aussie dollar

The Aussie/dollar rebounded strongly from the 0.7015
region — its lowest trade since September 2004 — and
soared to 0.7795 in mid-May. Gains in commodity prices
and new expectations that the RBA would hike rates sup-
ported the currency. At its May 3 meeting, the RBA did, in
fact, hike rates by 0.25 basis points, bringing the cash rate
target to 5.75 percent. The central bank pointed to
increased inflationary risks from domestic and interna-
tional trends when announcing the adjustment. On July 5,
however, the RBA kept monetary policy steady.
After subsequently topping out at 0.7795 on May 11, the
Aussie/dollar was hit with another round of steady sell-
ing, pressuring the currency to its late-June low of 0.7268.
Analysts pointed to the “mini-emerging market crisis”
Source: TradeStation (see “From emerging to submerged,” Active Trader,

FIGURE 2 — LONGER-TERM DOWNTREND
Although the March 2006 sell off was sharp, the Aussie/dollar
October 2006) that plagued global markets during May and pair had been declining since March 2005.
June as a factor in the Aussie/dollar sell off. During that
time, global portfolio managers tugged assets out of emerg-
ing markets as a wave of risk aversion — and expectations
of higher interest rates across the industrialized world —
spread through the marketplace.
“[The Australian dollar/Swiss franc] tends to be an indi-
cator of risk aversion,” Staskow says.
Huge selling occurred in that cross rate in the late spring.
Traders were going long the Swiss “as a safe haven and get-
ting out of high-yield carry trades [such as the Aussie dol-
lar],” Staskow says.
RBA action ahead?

The next RBA meeting is scheduled for Aug. 2 and some
analysts see the potential for another interest-rate adjust-
ment.
“Australia will hike rates,” Staskow predicts. She points to
the strong June Australian employment data, which Source: TradeStation
revealed the overall unemployment rate is at a 30-
FIGURE 3 — THE AUSSIE-KIWI CROSS
year low of 4.9 percent, while 52,000 new jobs were
created when an increase of only 10,000 was expect- Some analysts see the potential for the Aussie dollar/New Zealand dollar
ed. (kiwi) rate to rise in the second half this year if Australia can maintain
Also, higher petrol prices and Aussie dollar economic momentum.
weakness early in the year may have boosted
import inflation, she adds.
Sean Callow, senior currency strategist at
Westpac Institutional Bank, also expects a rate hike
Aug. 2 with the potential of a move to 6.25 percent
in the fourth quarter. Another meeting will follow
on Sept. 6.
Economic growth and inflation

Overall, Australia’s economic outlook remains
strong. Callow forecasts a 3.5 percent year-over-year
gross domestic product (GDP) reading in 2006, up
from 2.5 percent in 2005.
“The pace into 2007 could accelerate to 4 percent
or higher, bolstered by commodity exports, which
could cut the trade deficit, and also from supportive Source: ADVFN (www.advfn.com)
fiscal policy and a resilient housing sector,” he
explains. ferentials and terms of trade favoring the Aussie.
The inflation picture has heated up with headline CPI post-
ing a 3-percent year-over-year rise in the first quarter 2006. Looking ahead
Most analysts see relative stability for the Aussie dollar,
Cross rates though some risks remain on the horizon.
Several analysts view the long Aussie dollar/short New A repeat of the May-June global risk aversion sell off
Zealand dollar as a favored play on the crosses. With the could impact the Aussie dollar negatively.
pair currently trading around 1.2150 (Figure 3), Callow sees “The Australian economy remains vulnerable to global
potential for a move to around 1.30 by the year’s end. growth expectations and a slowdown in commodity
“This cross is an attractive play whenever there is a sub- prices,” says Kathleen Stephansen, head of global econom-
stantial divergence in the macro fundamentals of Australia ics at Credit Suisse.
and New Zealand,” he explains. “During the second half, However, most expect smooth sailing between now and
all the momentum seems to be in Australia’s favor, as the the end of the year for the Aussie dollar. Callow does not
RBA tightens policy further into a strong economy, while expect AUD/USD to revisit the March low at 0.7015 and
New Zealand struggles.” looks for the pair to end the year around 0.7400. Similarly,
Ideaglobal’s Sofat agrees this trade has bullish potential Ideaglobal’s Sofat pegged her year-end target for the
toward 1.30 by year-end amid narrowing interest-rate dif- Aussie/dollar at 0.7500 — very close to the mid-July level.
CURRENCY TRADER • August 2006 9

GLOBAL MARKETS continued
New Zealand:
Kiwi dollar losing its high-yield luster
As it flirts with three-year lows, economic red flags are cutting into the kiwi’s prospects.
T he New Zealand dollar has taken a hit this Sean Callow, senior currency strategist at Westpac
year, driven lower by narrowing global inter- Institutional Bank. “Two-year bonds are around 6.50 per-
est-rate differentials and bearish sentiment cent and the 10-year is around 5.85 percent — not so tanta-
regarding the New Zealand economy. The lizing compared to a liquid T-note.”
New Zealand dollar/U.S. dollar rate (NZD/USD) has
plunged from a high around 0.7000 in mid-January to a late- Grim GDP forecasts
June low around 0.5927 (Figure 1). New Zealand’s economic picture isn’t helping the dampen-
Analysts point to New Zealand’s huge current account ing outlook for its currency. Economists at Westpac forecast
deficit, which recently hit 10.5 percent of GDP, as a drag on a 1.5-percent gross domestic product (GDP) reading for
the country’s economy and currency (the “kiwi”), and a 2006 vs. 2.3 percent in 2005. Westpac expects growth to
prominent factor driving the currency sharply lower in the remain weak, with 2007 figures to come in at 1.2 percent.
early months of 2006. Economy.com’s Levine also projects weak (1.4 percent)
“The current account deficit was clearly unsustainable growth for 2006.
and it was only a matter of time before the kiwi suffered a “The economy is headed for a hard landing this year,” he
correction,” says Glenn Levine, economist at Moody’s says. “The domestic economy is in real trouble, weighted
Economy.com. down by elevated interest rates, record levels of household
This factor, along with narrowing interest-rate differen- debt, a stagnant housing market and plummeting business
tials vs. Europe, Japan, and the U.S., as well as slowing and consumer confidence.”
domestic growth, triggered a massive selling of kiwi dollars Levine doesn’t think relative global economic strength
during the first three months of the year. will be enough to keep the New Zealand economy afloat.
“Growth expectations have dropped dramatically “With the currency weakening and the global economy
because of higher rates,” notes Rhonda Staskow, regional still in pretty good shape, exports should start to pick up in
director FX Americas at Thomson Financial-IFR Markets. the second half of the year, but this won’t be enough to pre-
New Zealand’s cash rate currently stands at 7.25 percent, vent a sharp slowing in 2006 growth,” he says.
the level it has been at since December
2005. Analysts say the high short-term
rates are finally impacting the econo- NEW ZEALAND DOLLAR/U.S. DOLLAR AT A GLANCE
my in a negative fashion. Daily range (past 40 days): Average: 0.0071 Median: 0.0066
Weekly range (past 26 weeks): Average: 0.0168 Median 0.0173
Yields not as attractive at 52-week high/low: 0.7197/0.5927
first glance NZ U.S.
Despite boasting yields at 7.25 percent Prevailing interest rates (%) 7.25 5.25
— the highest in the industrialized Next central bank meetings Sept. 14 Aug. 8
world — analysts say global invest- Sept. 20
ment flows haven’t been a bullish fac- GDP (annualized growth) Q2 2006* Q1 2006 Q4 2005
tor for the kiwi. NZ U.S. NZ U.S. NZ U.S.
“You only get 7.25 percent by invest- 2.2 2.5 2.2 5.6 2.2 1.8
ing very short term, because the yield *Estimate All data as of July 31
curve remains steeply inverted,” says

FIGURE 1 — STEEP HILL TO CLIMB
Inflation worries Although it has rebounded slightly since spiking to a new major low in late
The latest inflation data out of New June, the NZD/USD pair must contend with a weakening New Zealand
Zealand sparked concerns among mar- economy in the months to come.
ket watchers. Consumer prices surged
a higher-than-expected 1.5 percent for
the second quarter, which put the
annualized rate at 4 percent. This data
lends credence to the idea the Reserve
Bank of New Zealand (RBNZ) will
have to keep monetary policy steady,
despite the slowing growth prospects,
analysts say.
“The second-quarter data confirmed
there is absolutely no scope for a near-
term rate cut,” says Levine.
He expects the central bank to
remain on hold until the first quarter
of 2007, when he expects a drop in the
inflation rate, back within the RBNZ’s
target 1-3 percent band.
Callow agrees monetary policy was
likely on hold throughout 2006.
“We expect they won’t cut rates
until first quarter 2007, though of Source: TradeStation
course the market will price it in,
which should hurt NZD/USD,” he
FIGURE 2 — TESTING RESISTANCE?
says.
The RBNZ most recently met on July Having punctured the 2004 and 2005 bottoms, the kiwi dollar is flirting with
27 and left monetary policy three-year lows. The most recent bottom occurred at 0.5927.
unchanged. The next meeting will be
Sept. 14.
Looking into 2007, Credit Suisse
forecasts 1.25 points of interest-rate
easing through 2007, with potential for
a 2007 year-end cash rate at 6.00 per-
cent.
Looking ahead
Analysts believe further tightening
moves from other central banks will
put downward pressure on the kiwi
dollar. Global risk appetite will be key,
as well.
“A rise in risk aversion is bad news
for the illiquid kiwi, as New Zealand
tries to fund its huge current account
deficit,” Callow explains. We would
like to sell NZD/USD on any rallies to
0.6300. Key support is at 0.5930.”
By year-end, Callow sees a possible Source: TradeStation
retreat to 0.5700, which would be the
currency pair’s lowest level since June 2003 (Figure 2). it would open the door to 0.6685, a Fibonacci retracement
Tim Mazanec, senior FX strategist at Investor’s Bank & target from the 2006 high to low. However, he favors a
Trust, says 0.6300 and 0.6425 are key resistance levels, not- weaker kiwi dollar in the weeks ahead, given his bias for
ing the latter level represented resistance in April and May. higher U.S. rates. If the resistance zone holds, though,
If gains push the currency through that resistance, he says, Mazanec expects a retest of the 0.5927 low.

THE BIG PICTURE
Gauging
trader commitment
Analyzing the euro with Commitment of Traders data sheds light
on the strength or weakness of price moves.
BY BARBARA ROCKEFELLER
Y ou can be the best chart reader on the planet

and still lose money trading. Losses are gener-
ally a function of bad money management,
such as setting a profit target unreasonably
high or a stop too low.
But losses can also be a function of not having the “feel”
of the market. Let’s define feel as a grasp of what the main
you can see the actual buying volume.
As technical analyst and author Joe Granville and others
have noted, a real rally is accompanied by rising volume. If
prices are rising but volume is flat or falling, watch out.
New buyers — fresh blood — are not joining the rally, and
it may not last.
Very high volume at a market high may mean the top is
players are thinking and doing. You may think that other in. If volume is extremely high and price is making new
traders are in buying mode, but are they? You know only if record highs, many traders have a lot at stake — and any
significant price drop can
FIGURE 1 — AWAITING A BREAKOUT, EURO JULY 2005 cause a stampede of cov-
Traders from all groups downsized their positions prior to the trading-range breakout in early
ering. As in price analy-
August. Commercial traders (blue), who had been net long, changed to net short by the time the sis, an extreme often pre-
breakout occurred. The breakout rally quickly failed. cedes a reversal.
Finally, if volume is
building during a consol-
idating or sideways peri-
od, we expect a breakout
— but we don’t necessar-
ily know in which direc-
tion.
Volume changes are a
dandy supplement to
technical indicators and
fundamentals. Forex
traders are severely hand-
icapped by not having
good volume informa-
tion, as stock traders
have. In the spot market,
there is no volume infor-
mation, because every
trade is a private transac-
tion between customer
and bank. Wire service
reports tell us that “vol-
ume is heavy” or “the
market is thin,” but that’s
not very specific and does
Source: chart — MetaStock; data — Reuters
us little good.

FIGURE 2 — JUDGING THE BREAKOUT
Open interest was flat throughout the entire period. The new high on Aug. 12 is suspect because
a big upside move that is not accompanied by higher volume and an increase in open interest
In futures, the ex- lacks real support.
change doesn’t publish
volume until after the
close. For real-time
analysis, all that’s avail-
able is tick volume,
which is less than ideal.
You get a change in the
tick whether the new
trade was one contract
or a hundred, and while
you can check “Time &
Sales” to see the actual
volume, it’s a cumber-
some process. If you are
trading in an intraday
time frame, by the time
you see big volume
developing, it’s proba-
bly too late.
What traders are

really doing
Instead of looking at
raw volume, though,
you can look at the Source: chart — MetaStock; data — Reuters
Commitment of Traders
(COT) report and make
some educated guesses about how to trade certain situa- they can’t always be trusted. If the green speculators really
tions. You won’t get a price forecast, but you will get infor- thought the euro rally was going to continue, they would
mation that is directly relevant to your trading. have bought more contracts. They did go from net short to
Take, for example, the period in July 2005 when the euro net long, but only for one week as price was peaking, and
futures (EC) were trading sideways in a range from 1.1980 then they went short again. Accordingly, the “feel” of the
to 1.2290 (Figure 1). Every three to five days, the price market is not really all that bullish. In fact, nobody seems to
reversed. In the first week of August the euro rose above the have much sentiment at all. Also, liquidity is low, meaning
range’s resistance line. Breakouts must always be respected, if you make an off-market bid or offer, it will probably just
and a long trade executed in the next six days probably pro- sit there and not get filled, whereas in a highly liquid mar-
duced a profit, since the euro put in a new high at 1.2505 on ket, there is always somebody who will shoot at anything
Aug. 12. that moves.
But look at the top window of the chart. This shows the
net long or short positions held by three types of traders Market activity
defined by the Commodity Futures Trading Commission Futures volume is a little tricky. Because every buyer has a
(CFTC): the “commercials” (blue); the large “non-commer- counterpart on the short side, the two together constitute a
cials” (green), otherwise known as large speculators; and single contract. Total contract volume in the example above
the small non-commercials (red), who are mostly small is 27,394. Volume is not the same thing as liquidity, which is
speculators (i.e., retail traders). better measured by “open interest.”
The green non-commercials are net short 24,842 contracts Open interest is the total number of contracts still out-
the first week of July, while the red small speculators are net standing — i.e., open positions that have not yet been offset.
short 2,522 contracts. Offsetting the two short groups are If a new buyer is creating a fresh long position and buys a
the blue commercials, who are net long 27,394 contracts. contract, and the seller is also opening a fresh short posi-
Now look at the next week. Everyone has downsized tion, open interest increases by one contract. However, if the
their positions, and they continue to do so until the first buyer is just replacing a different long party who is selling,
week of August, when the total number of contracts is only no new long position is being created; rather a change of
2008, or 10 percent of the level the month before. ownership of an existing position is occurring. Open inter-
Yes, breakouts must be respected, but in this case we see continued on p. 14

THE BIG PICTURE continued
FIGURE 3 — EVALUATING STRENGTH
The highlighted middle window shows the percentage of traders in each category that are long.
Eighty percent of large specs were long euro futures as of the latest available reading in July, (Wiley, 2005) and
while 78 percent (100 minus the 22-percent long position shown here) of commercials were short. stepped-up reporting by
the financial press.
The COT report breaks
down open interest by
the categories of com-
mercial and non-com-
mercial, with commer-
cials defined as market
participants having an
underlying cash business
for which their futures
positions provide a
hedge. In other words, if
Company X sells Blue
Widgets to Germany, it
expects to be long euros
by the amount of quarter-
ly sales, and will take a
short position to offset or
hedge the upcoming
receipt of euros. Firms
registered as commer-
cials get somewhat better
margin rates because
they tend to be less active
Source: chart — MetaStock; data — Reuters traders and thus take less
risk.
est is still one because the number of open contracts Non-commercials are mostly large speculators such as com-
remains the same. modity funds and pools, and sometimes banks and brokers.
Now look at Figure 2, which contains the same informa- The balance of open interest is derived and assumed to
tion as Figure 1, plus open interest in the center window. consist of both small speculators and small commercial
Open interest was flat through the entire period, at levels hedgers, which do not have to register with the CFTC.
around 150,000. The new high on Aug. 12 is fishy, as it is not One of the reasons the COT report is neglected by many
confirmed by a rise in open interest. A big upside move that traders is that it’s hard to read and to use. Take a look at
is not accompanied by higher volume and an increase in www.cftc.gov/cftc/cftccotreports.htm. The CFTC has
open interest lacks real support; a significant amount of improved the report’s formatting (and speeded up its
new money is not flowing into the market. release to every week and for data covering the most recent
As a rule, when volume and open interest are rising, a week), but the information is still presented in a raw format.
price move will probably continue in the same direction. You’d at least have to download it to a spreadsheet to con-
When they are flat or declining, the trend is probably going duct any analysis.
to end. Fortunately, an outfit named Shatterfield (www.shatter-
field.com) makes it easy to capture the data and analyze it
Understanding the COT report in graphic form. For a small fee, you can get their down-
The COT report is issued late every Friday afternoon by the loader and display charts like the ones shown here (in
CFTC for trading during the week ending the previous MetaStock), or in Excel, TradeStation, and other charting
Tuesday. That means the data is stale by three business packages. A number of other services are also available, but
days, but don’t let that bother you — you can still get pow- Shatterfield’s program contains a special proprietary
erful information from it. strength indicator that shows the long/short percentage of
You can bet that a lot of others are studying it over the each trader category. Figure 3 shows the most recent COT
weekend, too. Interest in the COT report has risen since the data in July this year.
publication last fall of Larry Williams’ book, Trade Stocks & The highlighted middle window shows the strength indi-
Commodities with the Insiders: Secrets of the COT Report cator, which is scaled in percentage points. The number rep-

Related reading
“Volume: The ultimate guide to sentiment,”
by Barbara Rockefeller
(Currency Trader, January 2006).
A previous discussion on interpreting volume and using
resents the percentage of traders in each category that are the COT report in forex.
long. Eighty percent of large speculators are long euros,
while 78 percent (100 minus 22 percent) of blue commer- “Larry Williams looks inside futures”
cials account for the offsetting shorts. The high large-spec (Active Trader, January 2006).
position denotes a real commitment to the trend, while the Larry Williams discusses his book on the COT report
high participation rate by the blue commercials indicates a and his techniques for using COT data in futures and
similar commitment. stocks.
Now check out open interest in the window below that.
During the second week of June, the large specs reduced “Floyd Upperman: Digging into COT data”
their outstanding contracts, meaning they cashed in net (Active Trader, February 2006).
long positions. A week later the small specs cashed in, and A commodity trading advisor shares his insights on
a week after that, the blue commercials. Because the June interpreting the COT report and the methods he out-
contract had already rolled to the September contract by the lines in his book on the subject.
time the commercials reduced their holdings, it’s likely
some of this is profit-taking. Notice that the week before, “Barbara Rockefeller ‘Big Picture’ Collection,
price fell quite a bit —from 1.2992 to 1.2534 — before rising Vol. 1: 2004-2005.”
again somewhat. Commercials are supposed to be hedgers This 11-article collection contains forex market analysis
and immune to the lure of profit-taking, so this may not be and commentary Barbara Rockefeller wrote for
the correct interpretation. Currency Trader between October 2004 and December
The real point is that total open interest fell and the 2005. (This article set is available at a 30-percent dis-
strength indicator contracted a little in each trader category, count.)
but total net positions (top window) remained at near-record
high levels — 76,569 contracts the week of June 20 after the You can purchase and download past articles at
all-time high of 88,196 the week before. (The record high www.activetradermag.com/purchase_articles.htm.
number of contracts that week made all the press reports.)
Uh-oh, here we go again — a very high volume figure
that is not accompanied by higher price highs, with open short positions, but they should always be watched for their
interest falling and the percentage of participants in each behavior.
category on the “consensus” side of the trade being
reduced. This is “extreme” volume not being confirmed and For information on the author see p. 6. You can get a free 2-week
validated by higher prices, and with commercials removing free trial of Barbara Rockefeller's daily forex commentary at
about half their previous level of interest, as shown in the www.rts-forex.com.
open-interest drop from 217,570 contracts the
week of June 20 to 112,183 the next week.
Commercial interest rose a little in each of the fol-
lowing weeks, but they basically cleared out of
the market.
As in July last year, we can’t really expect a
higher high unless the commercials come back.
What can we deduce from this about price direc-
tion? First, there are a lot of speculators who are
long euros in a falling market. At some point, they
may hit stops or otherwise decide to bail out. The
euro is thus at risk of a “technical” correction,
only this time it’s market-action technical and not
the charting kind. Or, the commercials could
come back, providing the engine for additional
opposing trades by the specs — assuming the
commercials do not switch sides.
The commercials do switch sides from time to
time, which offers a tremendous opportunity for
small traders. The commercials are not always
right in terms of making profit from their long or

TRADING STRATEGIES
The adaptive
moving average
Making a moving average responsive to volatility changes results
in a dynamic, more accurate indicator.
FIGURE 1 — ADAPTIVE MOVING AVERAGE
M
The five-bar SMA (red) and 30-bar SMA (blue) turned up at point A. At the
oving averages
peak (point B), the five-bar SMA turned down while the 30-bar SMA kept rising.
smooth price data, However, the five-bar SMA turned down two times before the peak.
simplifying the up
and downs of a mar-
ket into a more understandable line that
highlights the trend. However, the
smoothing process introduces lag: The
longer a moving average’s look-back
period, the more the average trails
behind changes in price direction. On
the other hand, moving averages with
short look-back periods respond more
quickly to price changes but, because
they reverse direction on minor price
moves, they can lead to whipsaw losses.
A moving average length that was
appropriate last week might be inap-
propriate next week as market condi-
tions change. One potential solution to
this problem is to use a moving aver-
age that adjusts to market volatility by
lengthening when the market is mov-
ing sideways and trading in a choppy Source: CQGNet (www.cqg.com)
fashion (making it less responsive) and
shortening when the market is trend- case, price crossing the moving average is not important;
ing (making it more responsive). rather, it is the direction of the moving average that identi-
In his book Smarter Trading (McGraw-Hill, 1995), Perry fies the trend.
Kaufman detailed a method for calculating an adaptive
moving average that fit this role. To see how it works, the Starting out simple
following examples compare it to a simple moving average Figure 1 is a 45-minute bar chart of the euro/U.S. dollar pair
(SMA). First, two SMAs with different look-back periods (EUR/USD) with a five-bar SMA (red) and 30-bar SMA
will be compared to highlight the attributes of each. In this (blue).

Both moving averages turned up quickly in reaction to next, the degree of noise is high and you would want a
the dramatic rise at point A. The market advanced to point moving average with a longer look-back period to filter out
B and then turned down. Notice the longer 30-bar moving this noise and avoid false signals. Kaufman’s technique was
average continued to rise during the uptrend, but did not to modify the exponential moving average (EMA) with an
turn down following the peak point B. At the end of the algorithm that would adjust the average’s smoothing con-
chart the 30-bar SMA was still indicating the trend was up. stant (SC) according to the ratio of market direction to
By contrast, the five-bar SMA turned down almost immedi- volatility.
ately after the peak at point B — however, it also turned The formula for the EMA is:
down twice before the actual peak in the market, which the
30-bar average did not. EMA = SC * (close-EMA(-1)) + EMA(-1)
Figure 2 shows the same prices with an adaptive moving
average (AMA) added. The AMA adapts to market volatil- where:
ity and trend by switching to a shorter-term look-back peri- SC = smoothing constant
od when the market is trending up or down and changing close = close of the bar
to a longer-term look-back period when the market begins EMA(-1) = previous bar’s EMA reading
to move sideways.
At point A, the AMA joined the five-bar SMA during the The smoothing constant is a value between 0 and 1 that
initial advance. Then when the market
corrected to point B, the five-bar SMA FIGURE 2 — ADAPTIVE MOVING AVERAGE
turned down while the AMA stayed
The green line is an adaptive moving average (AMA). During the uptrend that
nearly flat and the 30-bar SMA contin- started at A, the AMA advanced like the two SMAs but it did not turn down at
ued to rise. points B and C the way the five-bar SMA (red) did. Also, the AMA turned down
When the market began to advance at point E, although the 30-day SMA (blue) did not.
again, all the moving averages
climbed. At point C, the market pulled
back and consolidated and the five-bar
SMA turned down; the AMA and the
30-bar SMA, however, kept rising.
When the market peaked at point D,
the five-bar SMA turned down, the
AMA went flat, and the 30-bar SMA
kept rising. At point E the market was
trending lower. The AMA joined the
five-bar SMA to the downside, but the
30-bar SMA was still reflecting an
uptrend.
Figure 2 illustrates how the AMA
responded as the market changed
from trend to consolidation and back.
Overall the AMA showed a tendency
to stay with the trend better than
either the five-bar SMA and the 30-bar
SMA.
Let’s look at how the AMA is con- Source: CQGNet (www.cqg.com)
structed.
From exponential… determines the “length” of the EMA. (Typically, to begin

Kaufman designed the AMA to track the degree of noise in calculating an EMA, you use the SMA value for the initial
the trend. For example, if a market is advancing with very reading.) To convert an SMA look-back period into an EMA
small countertrend moves, there is very little noise and you smoothing constant, the following formula can be used:
would want the moving average to closely track the trend,
which would require a moving average with a short look- SC = 2/(n+1)
back period.
However, if the market is moving sideways and the clos- Where n is the look-back period in an SMA.
es are tending to simply reverse from one period to the continued on p. 18

TRADING STRATEGIES continued
FIGURE 3 — RESPONSIVE, BUT NOT TOO RESPONSIVE

During the decline to point C the AMA (green) closely followed the market’s
For example, a 10-period SMA
swings, but not as jaggedly as the five-day SMA. The AMA went flat during
equates to an EMA with a smoothing sideways periods.
constant of 0.1818 (SC = 2/[10+1]).
One difference between the EMA
and the SMA is the EMA calculation is
the difference between the close and
the EMA. Therefore, if the close is
above the EMA, even for the first time,
the difference is positive and the EMA
will turn up. Similarly, if the close is
below the EMA, even for the first time,
the difference is negative and the EMA
will turn down.
An SMA does not necessarily
change direction because of this rela-
tionship, because the close is just one
of many used in the average calcula-
tion. For a 10-period SMA, for exam-
ple, the current close is only one-tenth
of the 10 closes used to calculate the
indicator. As a result, the SMA is not as
responsive to quick price changes. The
EMA is better suited to deal with these Source: CQGNet (www.cqg.com)
attributes of the market.
ER, and the more the market moves sideways, the smaller
…to adaptive the ER value.
The AMA builds on the EMA by making it responsive to The ratio is used as a scaling constant based on the degree
trend and volatility. The formula is: of trend between 0 and 1, but not trend in reference to up or
down. Because direction could be a negative number, we
AMA = C * (closet-AMA(t-1)) + AMA(t-1) will take the absolute value of direction/volatility to not
have the ratio scale between -1 and 1.
The difference between the AMA and EMA calculations The next step is to establish boundaries for the length of
is the adaptive aspect of the smoothing constant, which is the AMA — i.e., the shortest (fast) and longest (slow) look-
designated in the formula by the letter “C.” There are a few back periods it will reflect (since, technically, these could be
steps involved to arriving at C. The first is calculating the unlimited). The following formula is used to create a range
efficiency ratio (ER), which is the ratio of price direction to for the average’s smoothing constant (SSC):
price volatility.
SSC = ER * (FastSC – SlowSC) + SlowSC
1. Direction = closet - closet-n
where:
where: ER = efficiency ratio
closet = current close FastSC = fast EMA smoothing constant
closet-n = close n bars ago. SlowSC = slow EMA smoothing constant
2. Volatility = sum (absolute value (closet – close(t-1)),n) Recall the EMA smoothing constant uses the formula
(This formula sums the absolute values of the one-bar 2/(n+1) to approximate the number of bars in an n-bar
close-to-close differences over n bars. Kaufman suggest- SMA. Kaufman suggested the AMA range from a two-bar
ed n equal 10.) look-back period (fast) to a 30-bar look-back period (slow).
In this case, the resulting smoothing constants would be:
For example, if a currency closed up 10 bars in a row, the
ER would equal 1 because the direction and the volatility Fast = 2/(2 + 1) = 0.6667
would be equal. If the market moved up and down to close Slow = 2/(30 + 1) = 0.0645
unchanged after 10 bars, the ER would equal zero.
Therefore, the more the market is trending, the higher the continued on p. 20

TRADING STRATEGIES continued
Therefore, SSC = ER * (0.6667 - 0.0645) + 0.0645.

Related reading If the market is trending, then the ER will be near 1 and
the SSC will be weighted toward the fast smoothing con-
stant. If the market is moving sideways, then the ER will be
“Weighted and exponential moving averages”
near 0 and the SSC will be weighted toward the slow
Currency Trader, January 2005.
smoothing constant.
A detailed introduction to weighted and exponential Finally, Kaufman noted if the market was trading side-
moving averages that includes performance compar-
ways, which would push the AMA to behave like a 30-day
isons to the simple moving average.
EMA, the AMA would still edge up and down. Squaring the
smoothing constant reduces this effect. Therefore:
“Measuring trend momentum” by Tushar Chande
Active Trader, June 2001. C = SSC2
Most technical analysis indicators monitor either price
direction or price momentum. Here's an indicator that and finally,
does both, changing its behavior with the dynamics of
the market. AMA = C * (closet-AMA(t-1) ) + AMA(t-1)
“Thom Hartle Trading Strategy and Analysis Now that the math is finished, let’s look at more exam-
collection, Vol. 1: 2001-2004” ples using the AMA in the Euro/U.S. dollar pair.
In this collection of 15 Active Trader articles from 2001 Figure 3 continues the price action from Figure 2. The
to 2004, trader, analyst, and contributing editor Thom market trended down to point A and then rallied to point B.
Hartle tackles various aspects of strategy, analysis, and The 30-bar SMA continued to rise and did not turn down
trade execution. (This collection is available for a 30- until well after the second, lower peak at B. The market then
percent discount through the Active Trader store.) stair-stepped its way down to point C. The 30-bar SMA
trended lower during this period while the five-bar SMA
You can purchase and download past articles at zig-zagged up and down with each price swing. The AMA
www.activetradermag.com/purchase_articles.htm. followed the market’s shorter-term swings as price moved
gradually lower, and it also went flat during sideways price
action (which the five-day SMA did
not do). Overall, the AMA was a better
FIGURE 4 — TRACKING THE TREND
smoothed representation of the mar-
The AMA tracked the trend upward, but went flat at point A when the market ket.
moved sideways. It turned up again quickly when the uptrend resumed. Figure 4 jumps ahead in time. The
market rallied dramatically, and again
the AMA moved horizontally when
EUR/USD moved sideways around
point A. The five-bar SMA began to
turn slightly lower.
Flexibility and responsiveness

The adaptive moving average’s
strength is its ability to respond to
changing market conditions, which is
a problem for studies that use fixed
look-back periods.
Using a fixed look-back period is
like trying to fit the market to a tem-
plate. Because the market is always
changing, static approaches are likely
to have limited success. Using adap-
tive studies is a potential way to
improve results. Also, the AMA might
Source: CQGNet (www.cqg.com)
be appropriate for smoothing other
indicators.

“Dynamic Trend Profile
makes me feel like a genius.*”
Introducing
a NEW product of
ADVANCED STRATEGIES
The dollar
and its hidden risks
What are historical market relationships telling us about the dollar’s prospects?
BY HOWARD L. SIMONS
L
keeps coming.
et’s say you are a hunter confronted with a the forward rate ratio (FRR) for various currencies’ LIBOR
charging rhinoceros. You take careful aim, over the six-nine month horizon is such a useful tool. This
squeeze the trigger of your suitably heavy gun, FRR is the rate at which borrowing costs can be locked in
and hit the rhino square in the forehead. He for three months starting six months from now, divided by
Who has the problem now?

the nine-month rate itself. The more the number exceeds
1.00, the steeper the yield curve; numbers less than 1.00
Currency traders face a similar if less dramatic dilemma indicate inversion.
on occasion. The fundamentals, or in this discussion the The USD FRR 6,9 fell sharply in the two years of Federal
quantitative indicators, behind a given market may look to Reserve tightening beginning in mid-2004 (Figure 1). By
favor a given currency, but the market
starts moving in the other direction. FIGURE 1 — SIX–NINE MONTH LIBOR FORWARD RATE RATIOS
Such was the case for the U.S. dollar
The USD six-month/nine-month FRR dropped sharply in the two years of Fed
(USD) vis-à-vis both the euro (EUR) rate tightening beginning in mid-2004. However, the 6/9 FRRs for both the
and the Japanese yen (JPY) by the late EUR and JPY steepened beginning in June and November 2005, respectively.
spring of 2006. Both currencies were
strengthening against the USD and for
non-parallel reasons based on the three
separate quantitative indicators below.
Short-term interest rate

expectations
The standard three-month non-deliv-
erable forward can be described in
large part as a short-term interest rate
arbitrage. The buyer of the JPY is bor-
rowing the USD, selling the USD, and
buying the JPY at the spot rate and
then lending the JPY. In three months,
the trade can be unwound or rolled
over for another three months. The
rollover rates can be locked in using
forward rate agreements; this is why

FIGURE 2 — SHORT-TERM RATE EXPECTATIONS FAVOR DOLLAR
Two characteristics emerge when comparing the difference between the USD
and EUR six-month/nine-month FRRs to the EUR: The FRR spread leads the
contrast, the FRR 6,9 for both the EUR EUR by 31 weeks and the spread is currently as negative as it ever has been.
and JPY steepened beginning in June
and November 2005, respectively. All
else held equally, we should think the
flatter USD money market curve
would support the greenback in 2006
as it did in 2005. But all else is never
held equal.
Linking comparative curves

to currencies
Now let’s restate the information in
these FRR curves into differences and
see whether the courses of the two
currencies can be related to them.
If we map the difference between the
USD and USD FRR 6,9 against the
course of the EUR itself, we see two
patterns emerge (Figure 2). First, there
is a defined leading relationship. The
FRR spread leads the EUR by 31 weeks.
We should expect FRR changes made FIGURE 3 — SHORT-TERM RATE EXPECTATIONS SHOULD FAVOR DOLLAR
today to be reflected in the exchange As was the case with the EUR in Figure 2, the FRR spread leads movements
rate seven months from now. Second, in the JPY, in this case by 19 weeks. Also, the steepness of the JPY relative to
the spread is as negative as it ever has the dollar is near its highest level since the advent of the EUR. The rectangle
been; never before in the history of the shows a previous period when divergent FRRs preceded a significant sell off in
EUR has its FRR 6,9 been as steep rela- the JPY.
tive to the USD’s. The only other peri-
od of prolonged negativity occurred
between mid-1999 and the end of 2000,
a time of EUR weakness. Finally, the
trend which began in 2004 actually
accelerated after Ben Bernanke was
appointed to be chairman of the
Federal Reserve in October 2005; this
defies the popular belief Bernanke is an
easy-money inflationist.
What happens if we repeat the
exercise with the JPY? As was the
case with the EUR, the steepness of
the JPY relative to the dollar is near its
highest level since the advent of the
EUR (Figure 3). And as was the case
with the EUR, the FRR spread leads
movements in the currency, in this
continued on p. 24

ADVANCED STRATEGIES continued
FIGURE 4 — DECLINING ACCEPTANCE OF A STRONGER EURO

The three-month volatility of USD forwards for a EUR-domiciled buyer general- case by 19 weeks. Past performance
ly falls as the EUR strengthens (the average lead time is 13 weeks). The most does not predict future results, but
recent data shows volatility rising as the EUR rallies. note how a previous period of diver-
gent FRRs in 2000 (Figure 3, magenta
rectangle) preceded a significant sell-
off in the JPY. The assumption then
was the Federal Reserve would begin
cutting interest rates aggressively in
the aftermath of the burst stock mar-
ket bubble and this would stimulate
economic growth in the U.S. vis-à-vis
Japan. The ability of the JPY to rally in
such an environment suggests the cur-
rency market is making the opposite
bet today — that the long string of rate
hikes in the U.S. will slow the pace of
U.S. growth while Japan continues to
prosper in the general Asian econom-
ic boom.
Volatility
If exchange rates were nothing more
than short-term interest rate arbitrage,
FIGURE 5 — HIGHER PRICE OF INSURING AGAINST JPY APPRECIATION we would have to conclude the USD
should be much stronger than it is. Is
In contrast to Figure 4, the three-month volatility for a JPY forward for a USD- this conclusion supported by the
domiciled buyer falls as the JPY strengthens. The average lead time here is 23
options market? The implied volatili-
weeks. The most recent data shows volatility rising, which indicates an
ty of a currency forward represents the
increased demand for protection by USD holders against a stronger JPY.
market’s assessment of future uncer-
tainty and the willingness to pay
insurance against this uncertainty.
The three-month volatility of USD
forwards for a EUR-domiciled buyer
generally falls as the EUR strengthens
(Figure 4). The average lead time is 13
weeks, or one quarter. The most recent
data shows volatility rising as the EUR
rallies, which indicates those going
long the EUR are also buying USD
option protection. This is a market
uncomfortable with its own trend.
The JPY exhibits a different relation-
ship. The three-month volatility for a
JPY forward for a USD-domiciled
buyer falls as the JPY strengthens
(Figure 5). The average lead time here
is 23 weeks, or nearly six months. The
most recent data shows volatility ris-

FIGURE 6 — RELATIVE STOCK PERFORMANCE AND THE EURO
ing, which indicates an increased The relative performance of the U.S. stock market led movements in the EUR
demand for protection by USD hold- by an average of 22 weeks, or five months, until the end of 2005. In 2006, the
ers against a stronger JPY. Unlike the EUR strengthened even as the European equity markets outperformed the U.S.
case of the EUR, the JPY market
appears quite comfortable with the
notion of a stronger JPY.
Stock market indications

While we do not normally think of
equity markets containing informa-
tion on relative currency movements,
they in fact are quite useful in this
regard. Stock prices discount informa-
tion on future returns, and in a global
market those future returns reflect the
currency-adjusted competitiveness of
the country in question. In addition,
global stock investors have to convert
their funds into the local currency to
participate in the local stock market.
Both of these factors combine to inject
a vital element of expected returns on
capital into the currency equation.
The relative performance of the U.S.
stock market as measured by the FIGURE 7 — THE YEN LEADS RELATIVE STOCK MARKET PERFORMANCE
Russell 3000 index to the Morgan
Relative stock market performance between the Russell 3000 and the Nikkei
Stanley Capital International Euro 225 lead movement in the JPY by 20 weeks — i.e., the currency leads the
index led movements in the EUR by relative stock market performance when it comes to the JPY.
an average of 22 weeks, or five
months, until the end of 2005 (Figure
6). We can summarize the observed
counterintuitive relationship by say-
ing capital appeared to flow to the
stock market with the weakest
prospective currency as if both sides
of the Atlantic were somehow able to
devalue themselves to prosperity. The
situation reversed significantly in
2006. The EUR strengthened even as
the European equity markets outper-
formed the U.S. Did something simi-
lar occur in Japan?
Not at all; in fact, the lead-lag rela-
tionship reverses here. Relative stock
market performance between the
Russell 3000 and the Nikkei 225 lead
movement in the JPY by 20 weeks
continued on p. 26

ADVANCED STRATEGIES continued
Related reading
Other Howard Simons articles:
(Figure 7). In other words, the currency leads the relative “Of commodities and currencies”
stock market performance when it comes to the JPY. A Currency Trader, July 2006.
stronger JPY often is the sign of Japanese investors and Analyzing historic market relationships reveals some
firms repatriating JPY for whatever reason and parking interesting facts about movements in many so-called
these funds in the Japanese stock market. “commodity currencies.”
Risk as the missing variable “The yen carry trade, currencies, and U.S. bonds”
Much has been made of the ability of certain physical com- Currency Trader, June 2006.
modity markets, gold and crude oil among them, to rise The latest source of anxiety for bond traders has some
under the weight of investor funds regardless of funda- surprising connections to the currency market. Find out
mentals. In the case of crude oil in particular, futures mar- the story behind U.S. Treasuries, the Japanese yen, and
kets cannot be regarded as inventory scorecards as much as the Chinese yuan.
the fully insured forward costs of a replacement barrel. It’s
as if the market is daring you to go short in the face of sup- “The euro index: The dollar index meets its match”
ply risk. Currency Trader, May 2006.
We now see this operating in the currency market. A look at the development of a viable — and tradable
Despite the messages sent from these key quantitative indi- — euro index.
cators and others reflecting sounder fundamentals for the
“The index approach to currency risk management”
USD, the market is convinced the U.S. will undertake a
Currency Trader, April 2006.
repudiation of its substantial international debts by debas-
Using dollar index futures to hedge non-dollar
ing the USD. After all, this was the official policy of the U.S.
investments.
in 1985-1986 and again in 1993-1995. With the U.S. twin
deficits claiming an ever-larger share of world savings, the “The yen stands alone”
risk of debasement is huge. Currency Trader, March 2006.
But there is no need to simply dwell on the oft-stated The usual rules of the currency world haven’t necessarily
negatives for the USD. In the case of the JPY in particular, it applied to the Japanese yen. Will that continue to be
would be simplistic to state the USD is going to weaken the case?
against the JPY. A far better description is the currency and “Remember the forgotten currency”
equity markets together agree Japan’s relative growth Currency Trader, February 2006.
prospects are stronger than those for the U.S. at this point It’s often labeled a “commodity currency,” but the
in the cycle. This will increase both Japanese interest rates Canadian dollar tends to be ruled by other factors.
and demand for yen-denominated assets. While the net Here’s a look at the factors impacting Canadian
effect is going to be the same — a stronger JPY — we should dollar movements.
not regard it ipso facto as a repudiation of the dollar. “What drives the dollar index?”
And, of course, the vagaries of the European political Currency Trader, January 2006.
economy should give pause to those who might like to see Market watchers often point to deficits and interest-
the EUR emerge as a reserve currency. The last two years rate differentials to explain the dollar’s behavior, but
have seen the rejection of the EU constitution and a widen- analysis shows these factors might not be in the
ing of French and Italian sovereign debt spreads vis-à-vis driver’s seat after all.
Germany.
The conclusion we reach is there are no single rules for “The dollar index and ‘firm’ exchange rates”
the currency world. Each situation, each market environ- Currency Trader, December 2005.
ment is different in critical aspects, and what worked well The majority of currency traders are familiar only with the
last year can fail spectacularly today. There is a name for current floating-rate system. Are we about to enter a
watching the market and making decisions: Speculation, new “firm exchange rate” era dominated by the dollar
derived from the Latin word “to watch.” It is an honorable and euro?
endeavor, one we should all recommend to others in an You can purchase and download past articles at
uncertain world. www.activetradermag.com/purchase_articles.htm.
For information on the author see p. 6.

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CURRENCY SYSTEM ANALYSIS
HLR breakout
Market: Currencies. long when price hits an x-day high and go short when price
hits an x-day new low in hopes the trend will continue.
System concept: Typical channel breakout systems go However, such approaches usually detect trends quite late
and thus give up a large part of
FIGURE 1 — SAMPLE TRADES their profits.
The following system tries to
The system caught a downtrend in the British pound and reversed direction much earlier
address this problem by enter-
than a system based on a standard 40-day breakout channel.
ing positions a bit before price
actually penetrates a breakout
level. The tool used to do this is
the HighestLowestRange (HLR)
indicator, which shows price’s
relative location within the
high-low range of the past x
bars. If price is at the bottom of
the range (a new low), the indi-
cator’s value is 0; if price is at
the top of this range (a new
high), its value is 1 (or, 100 per-
cent); if price is exactly between
these boundaries, the HLR indi-
cator value is 0.5 (50 percent).
This system enters long when
the HLR indicator moves above
0.8 and reverses position when
Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com) the HLR indicator drops below
0.2. In other words, if price
FIGURE 2 — EQUITY CURVE reaches the upper or lower 20
percent of the current chan-
Equity increased consistently during almost the entire 15-year test period, but system
nel, it takes action. The test
performance was volatile toward the end.
will apply these parameters
to an HLR based on a 40-day
breakout system.
Figure 1 shows two trades
in the British pound (BP).
The lower window shows
price, along with the 40-day
high and 40-day low break-
out levels. The upper win-
dow shows the HLR indica-
tor with its two threshold
lines in red. On Feb. 7, the
system went short when the
HLR indicator dropped
below 0.2. The next day
price crossed the lower
boundary of the Donchian
channel. The system stayed
in this trade until July 19,
when the HLR indicator
climbed above 0.8. The sys-

tem made 3.4 points on this trade. Using the standard the HLR indicator drops below 0.2.
breakout levels, the profit would have been only 2 points.
Test data: The system was tested on the following cur-
Rules: rency futures portfolio: British pound (BP), euro (EC),
1. Go long the next day at the market when the HLR indi- Japanese yen (JY), and Swiss franc (SF). Data source:
cator rises above 0.8. Pinnacle Data Corp. (www.pinnacledata.com).
2. Exit long and go short the next day at the market when continued on p. 30
STRATEGY SUMMARY LEGEND: Starting capital — Equity at the beginning of the

simulation period • Ending capital — Equity at the end of the
Long + Short Long Only Short Only simulation period • Net profit — Profit at end of test period,
less commission • Net profit % — Profit at end of test period in
Starting capital ($) 1,000,000 1,000,000 1,000,000 percent of starting equity • Annualized gain % —
Ending capital ($) 4,207,435.90 3,191,707.35 2,015,728.55 Compounded annual growth rate • Exposure — The area of the
equity curve exposed to long or short positions, as opposed to
Net profit ($) 3,207,435.90 2,191,707.35 1,015,728.55 cash • Number of trades — The total number of round-trip
Net profit (%) 320.74 219.17 101.57 trades plus open positions • Avg profit/loss $ — The average
Annualized gain (%) 10.05 8.04 4.78 profit/loss per trade in dollars • Avg profit/loss % —The aver-
age percentage profit/loss per trade • Avg bars held — The
Exposure (%) 5.74 3.97 4.77 average number of bars held per trade • Winning trades — The
total number of winning trades • Winning % — The percentage
of winning trades • Gross profit — The total profit generated
Number of trades 228 112 116 by the winning trades, minus commissions and slippage • Avg
Avg. profit/loss ($) 14,067.70 19,568.82 8,756.28 profit $ — The average profit per winning trade • Avg profit %
— The average percentage profit per winning trade • Avg bars
Avg. profit/loss (%) 0.91 0.87 0.94 held — The average number of bars held per winning trade •
Avg. bars held 57.16 53.96 60.25 Max consecutive — The maximum number of consecutive win-
ners • Losing trades — The total number of losing trades •
Losing % — The percentage of losing trades • Gross loss —
Winning trades 88 46 42 The total loss generated by the losing trades, minus commissions
Winning (%) 38.60 41.07 36.21 and slippage • Avg loss $ — The average loss per losing trade •
Avg loss % — The average percentage loss per losing trade •
Gross profit ($) 11,983,416.66 6,554,129.96 5,429,286.70 Avg bars held — The average number of bars held per losing
Avg. profit ($) 136,175.19 142,481.09 129,286.73 trade • Max consecutive — The maximum number of consecu-
Avg. profit (%) 5.87 5.44 6.33 tive losers • Max drawdown $ — Largest decline in equity in
dollars • Max drawdown % — Largest percentage decline in
Avg. bars held 96.28 86.41 107.10 equity • Max drawdown date — Date on which the max draw-
Max consecutive 7 6 7 down was realized • Wealth-Lab score — An overall measure
of profitability, exposure (efficiency), and risk • Profit factor —
Gross profit divided by gross loss • Recovery factor — Net
Losing trades 140 66 74 profit divided by max. drawdown • Payoff ratio — Average
Losing (%) 61.40 58.93 63.79 profit of winning trades divided by average loss of losing trades
• Sharpe ratio — Annualized average return divided by the
Gross loss ($) -8,775,980.76 -4,362,422.61 -4,413,558.15 annualized standard deviation of returns • Ulcer index — A
Avg. loss ($) -62,685.58 -66,097.31 -59,642.68 measure of the portfolio’s overall volatility • Wealth-Lab error
term — The average of the absolute values of all percentage dis-
Avg. loss (%) -2.21 -2.31 -2.11 tances along the equity curve from its linear regression line •
Avg. bars held 32.57 31.35 33.66 Wealth-Lab reward ratio — Annual percentage return divided
by the Wealth-Lab error term • Luck coefficient — The per-
Max consecutive 13 11 18 centage profit of the largest winning trade divided by the average
percentage profit of all winning trades • Pessimistic rate of
Max drawdown ($) -1,727,305.00 -1,462,334.25 -2,901,756.50 return — A statistical adjustment of the wins to losses ratio that
estimates the worst-expected return from previous results •
Max drawdown (%) -31.82 -55.37 -75.09 Equity drop ratio — The standard deviation of all drops in the
Max drawdown date 9/21/2004 3/28/2002 12/30/2005 equity curve — measured from each equity low to the previous
equity high — divided into the annualized return.
Wealth-Lab score 119.42 90.40 25.00

Currency System Analysis strategies are tested on a
Profit factor 1.37 1.50 1.23 portfolio basis (unless otherwise noted) using Wealth-
Recovery factor 1.86 1.50 0.35 Lab Inc.’s testing platform. If you have a system you’d
like to see tested, please send the trading and money-
Payoff ratio 2.66 2.36 2.99 management rules to
Sharpe ratio 0.63 0.43 0.32 editorial@currencytradermag.com.
Ulcer index 12.38 20.34 27.75 Disclaimer: Currency System Analysis is intended for
educational purposes only to provide a perspective
Wealth-Lab error term 7.27 13.01 16.66 on different market concepts. It is not meant to rec-
Wealth-Lab reward ratio 1.38 0.62 0.29 ommend or promote any trading system or
approach. Traders are advised to do their own
Luck coefficient 3.50 2.97 3.24 research and testing to determine the validity of a
Pessimistic rate of return 1.38 1.25 1.29 trading idea. Past performance does not guarantee
future results; historical testing may not reflect a sys-
Equity drop ratio 0.31 0.74 1.32
tem’s behavior in real-time trading.

CURRENCY SYSTEM ANALYSIS continued
Test period: January 1991 to December 2005. was $1,000,000 and you cannot risk more than 3 percent of
your total equity ($30,000), you would buy 12 contracts.
Starting equity: $1,000,000 (nominal). Deduct $20 com-
mission per round-trip trade per contract and apply two Test results: The portfolio equity curve (Figure 2) shows
ticks of slippage per order. a strong increase in the first year and continuous increases
during the next nine years of the test period. The final five
Money management: Risk a maximum of 3-percent years are marked by high volatility and sideways perform-
account equity per trade. The number of contracts is calcu- ance.
lated using the basis price (the closing price the day prior to Figure 3 reflects this behavior: There are drawdowns up
to 31.8 percent toward the end of
the test run — a high figure, espe-
FIGURE 3 — DRAWDOWN CURVE
cially when taking into account
The system suffered several large drawdowns toward the end of the test period. the system’s annualized 10-per-
cent gains. The first 10 years look
much better — most drawdowns
are between 5 and 15 percent.
The yearly performance (Figure
4) shows only three negative
years out of 15, but the results are
unevenly distributed: The annual
performance varies between -9.5
percent and 54 percent. Such
volatility is surely too high for the
average trader, especially consid-
ering that, on average, only 5.74
FIGURE 4 — ANNUAL RETURNS percent of account equity is used.
The system had 12 profitable years but the annual results are uneven. However, because the number
of trades over 15 years is only
228, more testing over a larger
portfolio of currencies would
provide more accurate results.
Also, different thresholds and
look-back parameters should be
tested to be sure the result is not
based on coincidence.
Bottom line: Using the HLR

indicator can help trend-follow-
ing systems to enter potential
trends earlier than the classic
channel breakout approach, but
the results here were mixed. The
entry), the stop-loss level (four times the 10-day average system was profitable and relatively stable in the first two
true range), the contract’s point value (the dollar value of a thirds of the test period but became highly volatile in the
one-point move), and the portfolio’s total equity. final third.
For example, if a contract has a point value of $250, However, testing across a wide range of parameters helps
assume the system goes long at a basis price of $100 and its ensure they are robust. For test results of the HLR indicator
stop level is $90. To determine the trade’s dollar risk, multi- on a larger group of futures (including non-currency mar-
ply the point value ($250) by the difference between the kets), see the Futures Trading System Lab in the September
basis price and the stop level (100 - 90 = 10). Therefore, a sin- 2006 issue of Active Trader.
gle contract’s dollar risk is $2,500.
If the portfolio’s total equity before entering the position —José Cruset of Wealth-Lab

CURRENCY BASICS
Trading forex
the mini way
While foreign currency is the world’s largest financial market,
it can also be quite cost prohibitive. However, with mini forex futures and mini spot trading,
traders can participate in the forex world with much less money at risk.
BY DARRELL JOBMAN
B ecause of its global reach, the forex market

has become a favorite of traders from pro-
fessional money managers seeking to diver-
sify their portfolios into a new asset class to
individual retail speculators trying to make a profit.
The forex market is attractive to traders for many rea-
sons. Because it trades virtually around the clock, it reacts
both futures and spot forex requires separate accounts,
although firms that handle transactions in both venues can
transfer money quickly from one account to the other.
Futures. The Chicago Mercantile Exchange lists futures
on a number of foreign currencies, including the Polish
zloty and Israeli shekel, as well as some cross-rates.
However, most of the activity is in the “majors” — euro,
instantaneously to geopolitical tensions, natural disasters, Japanese yen, Swiss franc, British pound, and the New
and economic reports. Zealand and Canadian dollars — vs. the U.S. dollar. Most of
“For some traders, abrupt price changes could be devas- the trading is done electronically. Each trading “day” begins
tating if they trade the larger forex contracts,” says Jim at 5 p.m. and runs overnight through 4 p.m. the next day.
Wyckoff, senior market analyst for TradingEducation.com. The best liquidity is between 7:20 a.m. and 2 p.m., the regu-
“Trading mini forex lots or mini currency futures contracts lar pit-trading hours.
gives them much better leverage than they can get in stocks, There are only two mini-forex futures contracts: the euro
where they must put up at least 50 percent of the purchase (E7) and the Japanese yen (J7). Both are half the size of the
price, and with much less risk than they might have in the regular contract, with a one-point move worth $6.25.
futures markets.” Typical margin set by the exchange (which can change) is
around $1,400 per mini contract compared to $2,700-$2,800
Where to trade? for the full-size contracts.
Traders with experience in futures may want to trade forex The quoting convention for some currency futures may
futures; those more familiar with stocks and bonds may be be a little strange. Instead of a cash market price of, say, 110
more comfortable in a spot (cash) forex account. The decision yen per U.S. dollar, forex futures trade in terms of dollars
could also depend on the amount of money available. Trading per yen, or 0.009091 in this case (9/10 of a cent).
The advantages of futures include trading in a
TABLE 1 — MARKET HOURS IN MAJOR FINANCIAL CENTERS centralized marketplace with multiple bid/ask
prices; pricing is transparent and available to every-
Central time GMT time one, regardless of size or location; there is no count-
Tokyo open 6:00 p.m. 23:00 er-party risk because the exchange clearing organi-
Tokyo close 3:00 a.m. 08:00 zation is on the other side of every trade; and
London open 2:00 a.m. 07:00 anonymity for those who want it. Futures advocates
London close 11:00 a.m. 16:00 contend that your biggest risk as a spot forex trader
New York open 7:00 a.m. 12:00 may not be market risk, but the firm you are dealing
New York close 4:00 p.m. 21:00 with. Many spot forex firms are not regulated by
any government agency.
Source: Xpresstrade
The cash forex market. The standard trade-lot size

in the cash forex market is 100,000 units of a currency, but In almost all cases, whichever pairs are available for trad-
each lot in a mini forex account is only one-tenth that size, ing in a full account can be traded in a mini account.
or 10,000 units. A one-point change in price (i.e., a “pip”) is However, you should double-check with the brokerage just
usually worth $1 in a mini lot instead of $8-$10 in the full- to be sure.
sized version. As a result, risk in a mini forex account is In addition to the smaller size, lower margins, less risk,
much less, and the amount of margin needed may be only and greater flexibility, there are other advantages to mini
several hundred dollars. However, a larger amount is rec- forex spot trading. There is true 24-hour trading with no
ommended (the minimum is set by each firm, not the overnight gaps (Table 1); bid/ask prices are always avail-
exchange as is the case in forex futures). able, even in thin trading hours; and there are no quarterly
For the trader trying to learn the ropes of forex trading or contract expirations, so time and contract month are not
wanting to test a trading strategy, the lower financial outlay considerations as they are in futures.
is welcome news. Of course, profits also aren’t as large, but Plus, spot forex firms typically provide customers with
if one mini lot is too small for you, there’s nothing that says real-time quotes, charts, and news at no charge (even for
you can’t trade two or three lots, or five lots or 100 lots, mini forex traders), as well as a trading platform and demo
especially as you become more experienced in forex trad- or simulated accounts in which traders can practice before
ing. This provides more flexibility to scale in and out of they begin trading with real money. If you are shopping for
positions at different price levels. a mini forex firm, be sure to check out all of these features
Most spot forex firms also list 20 or more pairs, so you as well as its margin and leverage rules.
aren’t limited to trading a foreign currency against the U.S. The mini forex contract may seem small, but it’s one of the
dollar. It’s just as easy to trade, for example, the British best ways to get more bang for your buck with the least risk.
pound against the Japanese yen, giving you additional
opportunities to profit. For information on the author see p. 6.
INTERNATIONAL MARKET SUMMARY
FOREX (vs. U.S. DOLLAR)
Current
price vs. 1-month 3-month 6-month 52-week 52-week Previous
Rank* Country Currency U.S. dollar gain/loss gain/loss gain/loss high low rank
1 South African rand 0.1455 5.59% -13.39% -10.74% 0.1678 0.1327 16
2 Australian dollar 0.7674 5.11% 0.96% 2.37% 0.7792 0.7014 14
3 New Zealand dollar 0.6178 3.62% -3.30% -9.39% 0.7198 0.5925 15
4 British pound 1.8636 2.60% 2.04% 5.44% 1.9025 1.7048 12
5 Euro 1.276 1.67% 0.97% 5.50% 1.2978 1.1638 8
6 Swedish krona 0.1383 1.62% 1.69% 5.25% 0.145 0.1206 4
7 Brazilian real 0.4594 1.50% -3.53% 1.93% 0.4867 0.4054 1
8 Thai baht 0.02641 1.46% -1.27% 3.00% 0.0267 0.02388 5
9 Japanese yen 0.008723 1.44% -0.75% 2.31% 0.00919 0.00824 13
10 Singapore dollar 0.6337 1.21% 0.17% 3.14% 0.6408 0.5859 6
11 Swiss franc 0.8114 1.13% 0.47% 4.24% 0.8383 0.7525 9
12 Russian rouble 0.0373 1.03% 1.63% 4.45% 0.03746 0.03447 2
13 Hong Kong dollar 0.1287 0.00% -0.23% -0.16% 0.1291 0.1283 3
14 Indian rupee 0.02152 -0.46% -3.50% -5.45% 0.02302 0.02123 7
15 Taiwanese dollar 0.03046 -0.68% -2.87% -2.68% 0.03197 0.02955 11
16 Canadian dollar 0.8839 -1.03% -1.31% 1.60% 0.9148 0.8116 10
As of July 30 *based on one-month gain/loss
GLOBAL INTEREST RATES

Country Interest rate Rate Last change December 2005 June 2005
U.S. Fed Funds Rate 5.25 0.25 (June 06) 4.5 3.5
Japan Overnight call rate 0.25 0.25 (July 06) 0 0
Euro Refi rate 2.75 0.25 (June 06) 2.25 2
UK Repo rate 4.5 0.25 (Aug. 05) 4.5 4.5
Canada Overnight funding rate 4.25 0.25 (May 06) 3.5 2.5
Switzerland 3-month Swiss Libor 1.5 0.25 (June 06) 1 0.75
Australia Cash rate 5.75 0.25 (May 06) 5.5 5.5
New Zealand Cash rate 7.25 0.25 (Dec. 05) 7.25 6.75
Brazil Selic rate 14.75 0.5 (July 06) 17.25 19.75
Korea Overnight call rate 4.25 0.25 (June 06) 4 3.25
Taiwan Discount rate 2.5 0.125 (June 06) 2.25 2
India Reverse repo rate 6 0.25 (July 06) 5.5 5
South Africa Repurchase rate 7.5 0.5 (June 06) 7 7

NON-U.S. DOLLAR FOREX CROSS RATES
Currency 1-month 3-month 6-month 52-week 52-week
Rank pair Symbol July 30 gain/loss gain/loss gain/loss high low Previous
1 Aussie $ / Canada $ AUD/CAD 0.8685 6.20% 2.24% 0.75% 0.9396 0.8178 18
2 Aussie $ / Yen AUD/JPY 88.0098 4.40% 1.71% 0.09% 91.34 82.09 13
3 Aussie $ / Franc AUD/CHF 0.946 3.93% 0.42% -1.79% 0.9945 0.9023 19
4 Aussie $ / Euro AUD/EUR 0.6017 3.42% 0.00% -2.94% 0.641 0.5761 20
5 Real / Canada $ BRL/CAD 0.5199 2.56% -2.31% 0.31% 0.5517 0.4746 4
6 Aussie $ / Pound AUD/GBP 0.4118 2.41% -1.10% -2.92% 0.435 0.3985 17
7 Franc / Canada $ CHF/CAD 0.9183 2.18% 1.75% 2.59% 0.9674 0.8646 12
8 Pound / Yen GBP/JPY 213.694 1.15% 2.85% 3.05% 216.557 196.36 9
9 Pound / Euro GBP/EUR 1.4609 0.94% 1.02% -0.05% 1.4911 1.4102 16
10 Euro / Yen EUR/JPY 146.31 0.23% 1.75% 3.13% 148.05 133.51 6
11 Real / Yen BRL/JPY 52.6745 0.06% -2.88% -0.39% 55.8704 45.0592 2
12 Real / Euro BRL/EUR 0.3601 -0.17% -4.51% -3.38% 0.3976 0.3331 5
13 Franc / Yen CHF/JPY 93.0102 -0.32% 1.16% 1.84% 94.34 86.3973 7
14 Franc / Euro CHF/EUR 0.6358 -0.55% -0.52% -1.23% 0.6542 0.6306 14
15 Real / Pound BRL/GBP 0.2465 -1.08% -5.52% -3.37% 0.2721 0.2271 3
16 Franc / Pound CHF/GBP 0.4354 -1.45% -1.58% -1.16% 0.4472 0.4325 10
17 Canada $ / Yen CAD/JPY 101.353 -2.44% -0.63% -0.69% 104.635 90.6843 8
18 Canada $ / Euro CAD/EUR 0.6928 -2.66% -2.31% -3.70% 0.739 0.6657 15
19 Real / Aussie $ BRL/AUD 0.5988 -3.43% -4.54% -0.45% 0.6573 0.5433 1
20 Canada $ / Pound CAD/GBP 0.4744 -3.54% -3.32% -3.64% 0.5041 0.4561 11
GLOBAL STOCK INDICES

1-month 3-month 6-month 52-week 52-week
Rank Country Index July 30 gain/loss gain/loss gain/loss high low Previous
1 Egypt CMA 1,880.66 10.83% -12.68% -27.14% 2,653.25 1,657.42 11
2 Mexico IPC 20,252.33 5.77% -1.91% 7.44% 21,917.51 14,000.14 14
3 Hong Kong Hang Seng 16,955.04 4.23% 1.76% 7.63% 17,328.43 14,189.47 1
4 Switzerland Swiss Market 7,946.50 3.85% -1.25% 2.02% 8,158.90 6,364.30 6
5 UK FTSE 100 5,974.90 2.43% -0.80% 3.38% 6,137.10 5,130.90 3
6 Brazil Bovespa 37,381.00 2.05% -7.39% -2.25% 42,062.00 25,734.00 15
7 Canada S&P/TSX composite 11,823.68 1.82% -3.12% -1.04% 12,494.72 10,145.12 7
8 France CAC 40 5,028.51 1.26% -3.08% 1.86% 5,329.16 4,288.15 9
9 Italy MIBTel 28,131.00 0.88% -4.39% 0.97% 30,154.00 24,336.00 5
10 India BSE 30 10,680.23 0.67% -9.89% 8.44% 12,671.11 7,537.50 12
11 U.S. S&P 500 1,278.55 0.66% -2.45% -0.52% 1,326.70 1,168.20 4
12 Germany Xetra Dax 5,705.42 0.39% -5.07% 0.80% 6,162.37 4,726.33 10
13 Singapore Straits Times 2,429.44 -0.24% -6.94% 0.72% 2,666.33 2,190.07 8
14 Japan Nikkei 225 15,342.87 -1.05% -9.25% -7.30% 17,563.37 11,614.71 13
15 Australia All ordinaries 4,932.70 -2.01% -5.27% 2.51% 5,340.00 4,277.00 2
ACCOUNT BALANCE
Rank Country 2006* Ratio 2005 2007+ Rank Country 2006* Ratio 2005 2007+
1 Hong Kong 18.858 10.1 18.987 20.021 10 Australia -40.783 -5.6 -42.241 -41.832
2 Taiwan 18.827 5.4 16.366 20.688 11 U.S. -864.189 -6.5 -804.951 -899.351
3 Germany 98.315 3.6 114.828 122.689 12 Spain -93.668 -8.1 -85.897 -104.255
4 Japan 140.175 3.2 163.891 133.621 13 New Zealand -9.471 -8.9 -9.581 -8.365
5 Canada 39.305 3.1 24.974 38.305
6 Denmark 6.387 2.4 6.13 7.295 Totals in billions of U.S. dollars
7 Italy -18.524 -1.1 -26.645 -11.923 *Account balance in percent of GDP +Estimate
8 France -40.647 -1.9 -27.628 -44.796 Source: International Monetary Fund, World Economic Outlook
9 UK -61.298 -2.7 -58.053 -66.244 Database, April 2006
GLOBAL BOND RATES

Rank Country Rate July 30 1-month 3-month 6-month Previous
1 U.S. 10-year T-note 106 1.65% 0.77% -1.99% 3
2 Germany BUND 116.78 1.27% 1.04% -2.98% 5
3 Japan Government Bond 132.01 0.27% -0.47% -3.56% 4
4 UK Short sterling 95.06 0.00% -0.19% -0.38% 1
5 Australia 10-year bonds 94.095 -0.13% -0.21% -0.56% 2

GLOBAL NEWS BRIEFS MARKET SUMMARY
FOREX/INTERNATIONAL
Japan’s June unemployment rate fell to 4 percent, a

decrease of 0.1 percent from the previous month and 0.4
EUROPE percent from June 2005.
Preliminary estimates show the UK’s second-quarter GDP

AMERICAS
increased 0.8 percent compared to Q1 and grew 2.6 percent on
Q2 2005. The country’s jobless rate increased 0.3 percent to 5.4 Brazil’s economy in the first quarter grew 1.4 percent
percent from the period covering March to May. The rate grew from the previous quarter and 3.4 percent from the same
0.7 percent compared to the same period in 2005. quarter in 2005. The economy was boosted by growth in
industry, services, and agriculture.
France’s May unemployment rate fell 0.2 percent from
the previous month to 9.1 percent. That number was down Canada’s June unemployment rate remained at 6.1
1 percent from May 2005. percent, 0.6 percent lower than the rate in June 2005. This
32-year low continued as employment increased 1.3 per-
Germany’s June jobless rate took a similar dip, falling cent, or 216,000 jobs — more than double the growth of the
0.3 percent from May to 10.5 percent. That represented a first half of 2005. Large job increases occurred in the health
0.8-percent drop from May 2005. care and social assistance sectors, while declines in full-
time jobs were offset by gains in part-time work.
The Bank of Slovenia increased its benchmark
Lombard rate by 50 basis points in July to 4.5 percent. The In a hotly contested election, conservative Felipe
increase was the third 0.5-percent move since February, and Calderon of the National Action Party won Mexico’s pres-
the Bank released a statement saying it expects the tighten- idential election by a less than one-percent margin —
ing policy to continue. about 220,000 votes out of 41 million. He beat Andres
Manuel Lopez Obrador, his leftist rival and former mayor
of Mexico City. Mexicans living abroad, mostly in the U.S.,
were allowed to vote for Mexico’s president for the first
ASIA & THE SOUTH PACIFIC
time, but registered numbers were lower than expected.
Obrador said he would contest the election results in court.
Preliminary data indicates Hong Kong’s jobless rate Calderon replaces Vicente Fox and will serve a six-year,
increased 0.1 percent from March to May, reaching 5 per- non-renewable term. His party won about 41 percent of
cent. The rate grew 1 percent when compared to the same the congressional seats, snatching the majority position
period the previous year. “Despite the entry of some fresh away from the centrist Institutional Revolutionary Party.
graduates and [those who left school], the labor force
showed a small reduction in overall terms in April-June
2006,” said a Hong Kong government spokesperson. G8 meeting
The G8 met in St. Petersburg, Russia, July 15-17,
Australia’s June unemployment rate remained stable at
where issues of global free trade, global imbalances,
4.9 percent, a 0.1-percent drop from June 2005.
and energy prices were top priorities. Leaders set a
one-month deadline to revive recent global free trade
India’s second quarter economy grew 13.4 percent
talks, as disagreements over farm subsidies and
when compared to the same quarter in 2005.
industrial tariffs had previously stalled the discussion.
A three-month deadline was set to end talks over a
The Central Bank of Turkey boosted its overnight bor-
bilateral deal that could help Russia join the World
rowing rate 0.25 percent to 17.5 percent in July. The rate
Trade Organization (WTO). Six of the eight leaders
move comes on the heels of an enormous 3-percent increase
said they supported using nuclear energy as a way to
in June. Prior to that, the bank had not raised rates in three
provide energy security and as a cleaner source of
years.
power that could help stem global warming. Russia
softened its position on the Energy Charter by agree-
The Bank of Israel’s short-term lending rate increased 0.25
ing to open its energy sector to foreign investment, but
percent in July to 5.5 percent. This marks the seventh increase
Russia refused to ratify the international rule book.
since the rate was lowered to 3.5 percent in January 2005.

CURRENCY FUTURES
Managed money: Barclay Trading Group’s
currency trader rankings for June 2006
Top 10 currency traders managing more than $10 million as of June 30,
NYBOT introduces ranked by June 2006 return
new currency pairs 2006 $ Under
June YTD mgmt.
he New York Board of Trade began trading 10 Rank Trading advisor return return (millions)
T new currency pairs in July: euro/South

African rand (YZ), British pound/Australian
dollar (QA), pound/New Zealand dollar (GN),
1 Friedberg Comm. Mgmt. (Curr.)
2 24FX Management Ltd
3 FX Concepts (Global Currency)
19.07
4.80
4.45
21.71
19.5
3.33
64.8M
12.7M
1200.0M
pound/Canadian dollar (PC), pound/Norwegian 4 Algorithmic Trading (Currency) 3.90 43.74 10.0M
krone (PK), pound/South African rand (PZ), 5 KMJ Capital Mgmt (Currency) 3.82 4.51 15.7M
pound/Swedish krona (PS), New Zealand 6 Absolute Asset Mgmt. (FX) 3.68 14.23 25.3M
dollar/Japanese yen (ZJ), Norwegian krone/yen 7 Alder Cap'l (Alder Global 20) 3.10 0.04 99.2M
(KY), and Swedish krona/yen (KJ). Options on the 8 Appleton Cap'l (Appleton 25% Risk) 2.10 -20.07 129.3M
futures are also available for trading. 9 FX Concepts (Multi-Strategy Fund) 1.93 -4.98 191.0M
10 Coe Capital Advisors (Diversified FX) 1.92 9.44 14.5M
FXMarketSpace gets Top 10 currency traders managing less than $10 million and more than $1 million
institutional support as of June 30, ranked by June 2006 return
1 Pro-Active FX (Managed Accounts) 8.40 38.88 5.9M
XMarketSpace, a joint venture between 2 Black Flag (Gl. Macro) 3.40 -0.12 2.0M
F Reuters and the Chicago Mercantile Exchange,

received a boost in July when several large
banks, hedge funds, and trading firms signed up to
3 Winton Capital Mgmt. (Currency Fund) 1.05
4 Worldwide Capital Mgmt
5 TradeCom Currency Trader
1.00
0.65
-8.36
60.93
-8.37
5.1M
1.8M
2.0M
participate. Banks such as ABN Amro, Merrill Lynch, 6 Perreard Partners Investments 0.30 1.05 4.6M
and UBS and managed money firms such as Citadel 7 Coe Capital Advisors (Carry) 0.30 18.42 2.5M
and Penson have all agreed to join the venture, which 8 Harmoney Invest. Mgrs. (ProFund FX) 0.20 4.46 7.4M
is intended to become the first centrally cleared elec- 9 Forex Funds 0.20 2.71 7.5M
tronic marketplace for spot currency trading. 10 High Desert Currency Mgmt -0.09 3.18 2.0M
FXMarketSpace is scheduled to launch in 2007, with
Source: The Barclay Group (www.barclaygrp.com)
testing to begin later this year. Based on estimates of the composite of all accounts or the fully funded subset method.
Does not reflect the performance of any single account.
PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.
CURRENCY FUTURES SNAPSHOT The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s
as of July 31 liquidity, direction, and levels of momentum and volatility. See the legend for explanations of the different fields.
Contract Pit Elec Exch Vol OI 10-day % 20-day % 60-day % Volatility

sym sym move rank move rank move rank ratio/% rank
Eurocurrency EC 6E CME 137.8 150.2 1.88% 100% -0.29% 8% 0.49% 7% .26 / 63%
Japanese yen JY 6J CME 61.8 163.4 2.04% 100% -0.54% 16% -0.90% 31% .38 / 67%
British pound BP 6B CME 45.9 86.3 2.64% 100% 1.04% 24% 0.81% 16% .23 / 67%
Swiss franc SF 6S CME 37.4 64.4 1.26% 90% -0.83% 39% -0.24% 12% .21 / 45%
Canadian dollar CD 6C CME 32.9 86.7 0.26% 0% -1.36% 46% -2.18% 94% .16 / 2%
Australian dollar AD 6A CME 19.9 49.6 2.49% 85% 3.07% 59% -0.75% 21% .40 / 73%
Mexican peso MP 6M CME 12.6 58.2 0.28% 0% 3.56% 44% 0.25% 3% .17 / 12%
U.S. dollar index DX NYBOT 3.8 17.1 -1.83% 89% 0.28% 7% 0.20% 38% .26 / 72%
Euro / Japanese yen EJ NYBOT 1.4 32.7 -0.04% 25% -0.08% 0% 2.29% 54% .22 / 3%
Euro / British pound GB NYBOT 1.1 9.1 -0.74% 25% -1.86% 76% -0.26% 21% .15 / 0%
Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is based on pit-traded contracts.
LEGEND: past sixty 20-day moves; for the 60-day move, the % rank field shows how the most recent
Sym: Ticker symbol. 60-day move compares to the past one-hundred-twenty 60-day moves. A reading of 100%
means the current reading is larger than all the past readings, while a reading of 0% means
Vol: 30-day average daily volume, in thousands. the current reading is lower than the previous readings.
OI: 30-day open interest, in thousands. Volatility ratio/% rank: The ratio is the short-term volatility (10-day standard deviation of
10-day move: The percentage price move from the close 10 days ago to today’s close. prices) divided by the long-term volatility (100-day standard deviation of prices). The %
20-day move: The percentage price move from the close 20 days ago to today’s close. rank is the percentile rank of the volatility ratio over the past 60 days.
60-day move: The percentage price move from the close 60 days ago to today’s close. This information is for educational purposes only. Currency Trader provides this data in
The “% rank” fields for each time window (10-day moves, 20-day moves, etc.) show the good faith, but assumes no responsibility for the use of this information. Currency
percentile rank of the most recent move to a certain number of the previous moves of the Trader does not recommend buying or selling any market, nor does it solicit orders to
same size and in the same direction. For example, the % rank for 10-day move shows buy or sell any market. There is a high level of risk in trading, especially for traders
how the most recent 10-day move compares to the past twenty 10-day moves; for the 20- who use leverage. The reader assumes all responsibility for his or her actions in the
day move, the % rank field shows how the most recent 20-day move compares to the market.

INDUSTRY NEWS BY CURRENCY TRADER STAFF
Where was the yen?
Japan ends zero interest-rate policy
W
hile Japan has hinted for months it was consid- ish for a nation’s currency, the yen dropped almost 2 percent
ering ending its zero interest-rate policy, the in the two days after the announcement, although it did
Bank of Japan’s announcement in mid-July that bounce back shortly thereafter. As of late July, it was at
it raised interest rates for the first time in six years was still 114.55, a 1.3 percent appreciation in the yen from the
quite significant. announcement date and almost 3 percent from the July 19
The increase to 0.25 percent was the country’s first since low.
August 2000. However, that proved to be little more than a However, Brian Dolan, director of research at Forex.com,
false alarm, as the stock market collapse in the U.S. sent says the yen’s decline was not totally unexpected.
rates back to zero soon afterwards. This time, however, the “You have to put the move in context,” he says. “The BOJ
BOJ said it is committed to a tightening cycle, which would had essentially been preparing the markets for many
be Japan’s first since 1989. months for the eventual end of the zero interest-rate policy.
The BOJ had long hesitated to raise rates, citing deflation The main thing the market was focusing on was guidance
for future rate hikes.”
FIGURE 1 — YEN WEAKENS VS. DOLLAR Dolan says that since the BOJ announced it
The yen dropped when the Bank of Japan announced on July 14 that it would be very careful about further increases, the
would raise interest rates for the first time in six years, but the yen had 25 basis-point hike was not enough to spark great
already been losing ground to the dollar (reflected in the uptrend on buying in the yen, especially because it still faces
this dollar/yen chart). substantial yield disadvantages.
Blake Morrow, forex product manager at GlobalTec
Solutions, says that because there was practically no
buying of the yen right after the announcement, sell-
ers figured it was safe to get back in.
“Also, I think some of the currency pairs, such as
the dollar/yen, euro/yen, and pound/yen were
breaking some technical levels, and that just accel-
erated the move,” Morrow says.
Additionally, says Joseph Trevisani, chief market
analyst of FX Solutions, carry trades — selling a
low-yielding currency vs. buying a high-yield one
— were not as prevalent in the days and weeks
leading up to the announcement. After the
announcement, when it became clear that the
Japanese interest rate would remain low, the carry
trades resumed.
Although Dolan doesn’t believe the rate hike will
have that big of an immediate impact on the
Japanese economy, he does believe it is a notewor-
Source: TradeStation
thy move.
and economic stagnation. However, the BOJ said in a state- “In the sense it represents a turning point in global inter-
ment that keeping the zero interest-rate policy could have est rate levels, it is significant for the six-month outlook,” he
caused disruptive swings in the economy. says. “The Japanese economy is strong, and inflation is at a
The BOJ also said it would be very cautious about raising risk of becoming more of an issue than it has been in near-
rates again, keeping them low “for some time,” and had no ly a generation. But I don’t think that’s sufficient to derail
intention of raising them again at the next BOJ meeting Aug. 10. the Japanese economy.”
While the markets had been expecting the price move, they While Morrow agrees the near-term implications are
still reacted negatively to the news. The night before the July minimal, he thinks it’s important to keep a close eye on
14 rate hike, the Nikkei 225 closed at 15,097.95. By the close what Japan does in the next several months.
July 19, it was down to 14,500.26 — almost a 4-percent drop. “If Japan continues to raise interest rates at a measured
As of July 31, it stood at 15,456.81. pace, Japanese investors could potentially start massively
Perhaps more surprising was the immediate decline in the selling their U.S. assets,” Morrow says. “That could push
yen (Figure 1). While rising interest rates are generally bull- the U.S. dollar much lower than current levels and poten-

tially disrupt the global economy.” economy, and the Fed interest-rate policy,” Trevisani adds.
As for where the yen is headed, Trevisani believes Japan “These factors will have more impact on the dollar and
will not necessarily have the biggest say in the matter. hence on the yen in the near future than any likely combi-
“The longer-term outlook in the dollar/yen depends nation of bilateral U.S./Japanese developments.”
more on the strength or weakness of the dollar than on At year-end, Morrow expects the dollar/yen to be
intrinsic Japanese factors,” he says. “Although if there is around 1.12, while Dolan thinks more rate increases toward
dramatic change in the Japanese economy, that could the end of the year and in early 2007 will strengthen the yen.
become an element. “I think you’ll see some dollar weakness, and that will
“The U.S. dollar is continually buffeted by external send the rate down to the 1.10-1.12 area,” he says. “As that
events — the price of oil, political instability in the Middle side of the equation leads to yen appreciation, I think were
East, potential and real terrorism, the health of the U.S. looking at something in the 105-108 area.”
But not everybody’s happy
Refco FX finds a new suitor
C
ustomers of online forex firm RefcoFX.com have “And that’s two years where the money is just sitting stag-
been in limbo since RefcoFX’s parent company, nant, not getting any kind of return.”
Refco LLC, went bankrupt in October. A Refco spokesperson said the firm believes the Gain
Attempts earlier this year by FXCM to buy the assets of offer is the best one available and the one most likely to
RefcoFX fell through, but it appears RefcoFX finally has a allow customers to get their money back. She also said
savior in Gain Capital. Gain agreed to buy RefcoFX’s 17,000 Refco will still entertain offers from other bidders.
accounts in a deal that will eventually allow Refco cus- However, when it filed its opinion with the court regard-
tomers to regain 100 percent of their account balances. ing the sale to Gain, Refco admitted that most customers
“[Gain has] both the financial and operational resources would probably not go through the motions necessary to
necessary to help achieve a smooth transition for customers get a full refund.
and to offer continued support for their ongoing trading Besides customer accounts, RefcoFX also owes more than
needs,” says Refco chief restructuring officer David Pauker. $100 million to other creditors. Additionally, it is a guaran-
Also, Pauker adds, Gain and its retail subsidiary Forex.com tor of Refco’s bank debt and bonds, which are more than $1
are registered futures brokers regulated by the National billion, and is considered collateral by Refco’s lenders.
Futures Association (NFA) and the Commodity Futures After the deal, Forex.com would have about 50,000
Trading Commission (CFTC), which RefcoFX was not. accounts.
However, the terms of the new deal are not sitting well Refco’s Capital Markets division (RCM) — which prima-
with many RefcoFX customers. Under the agreement, cus- rily consists of institutional customers — are also likely to
tomers with less than a $150 balance will receive a full see some compensation. Traders with securities accounts
recovery of their account balance if they open an account could get up to 70 cents on the dollar, while forex customers
with Forex.com and trade at least once, and anybody with will get a little more than a quarter.
less than $40 could immediately withdraw their funds. However, forex customers would also receive a lump-
Larger customers will also receive full recovery — 25 sum payment of $221 million if the deal becomes official.
percent of their account will be paid every six months — if RCM customers are collectively owed more than $2 bil-
they meet certain conditions. Mark Galant, CEO of Gain lion, and Refco has faced numerous lawsuits from clients.
Capital, says customers who choose to open accounts with However, if RCM clients agree to the terms of the settle-
Gain but do not fully recover their balances would still ment, they will drop their claims.
retain all rights to that balance if they chose to make a claim As of late July, more than 50 firms and hedge funds had
against Refco as an unsecured creditor. signed the agreement, including RCM’s largest creditor, VR
A group of RefcoFX traders have hired an attorney to Capital Group. However, RCM’s most famous client — vet-
protest the deal, claiming the terms are unreasonable. eran trader Jim Rogers — was among the last to join.
According to Todd Duffy, an attorney representing the Rogers originally held off from signing in an effort to
Refco group, traders would need to make 240 trades per reclaim the $372 million he claims RCM owes his funds.
month for six months just to qualify for a full reimburse- Signing the agreement means Rogers’ legal team will drop
ment. the lawsuits it had against RCM.
Jeffrey Matkin, who says his account at RefcoFX is “in six Had Rogers refused to accept the settlement, it could
figures,” can’t understand why Refco agreed to a deal that have put the entire deal in jeopardy.
would make it so difficult for their customers to get their Refco trustee Marc Kirschner has asked a federal bankrupt-
money back. cy judge to approve the deal, saying it will allow for an order-
“I won’t get everything back for two years,” he says. ly breakup of RCM’s assets and avoid a freefall liquidation.

GLOBAL ECONOMIC CALENDAR AUGUST/SEPTEMBER
MONTH
Monday Tuesday Wednesday Thursday Friday Saturday
Legend 3 4
ECB: Governing U.S.: Employment
CPI: Consumer Price GDP: Gross domestic council meeting Germany: Orders received and man-
Index product ufacturing turnover; bankruptcies
ECB: European Central ISM: Institute for Supply Great Britain: Australia: Statement on monetary
Bank Management Monetary policy policy
FOMC: Federal Open PPI: Producer Price Index committee Brazil: Monthly survey of mining and
Market Committee meeting manufacturing physical production
7 8 9 10 11 12
U.S.: FOMC meeting U.S.: Wholesale U.S.: Trade balance U.S.: Retail sales
inventories Japan: Monetary
Germany: Production Japan: Balance of policy meeting
index; foreign trade payments; corporate Brazil: CPI
goods price index; Italy: Balance of
Australia: Official monetary policy payments
reserve assets meeting
14 15 16 17 18 19
Japan: Monetary U.S.: PPI U.S.: CPI U.S.: Leading Great Britain:
survey Canada: indicators Capital issues
Manufacturing Brazil: Domestic
Germany: CPI survey federal public Germany: PPI
Brazil: Monthly debt and open
survey of trade market Canada:
operations Wholesale trade
21 22 23 24 25 26
Canada: Retail Canada: CPI Canada: Leading U.S.: Durable goods Mexico:
trade indicators Japan: Corporate serv- Monetary
ice price index policy
Brazil: Monetary Germany: National announce-
policy and credit accounts ment
operations Brazil: Fiscal policy;
unemployment
28 29 30 31 1
Canada: U.S.: GDP ECB: Governing council meeting U.S.: Unemployment;
Unemployment Germany: Retail turnover; unemployment ISM
Canada: Balance Canada: GDP Japan: Account
of international Australia: International reserves and balances
payments foreign currency liquidity Australia: Index of
Italy: International reserves and foreign commodity prices
currency liquidity
4 5 6 7 8
Japan: Brazil: Monthly Great Britain: Monetary U.S.: Wholesale inventories Japan: Monetary
Monetary survey of mining and policy committee meeting Japan: Monetary policy meeting policy meeting
base manufacturing Canada: Interest rate Great Britain: Monetary policy
physical production announcement committee meeting Germany: Foreign
Germany: Orders received Germany: Production index trade; bankruptcies
Australia: Reserve and manufacturing turnover Australia: Official reserve
bank meeting Brazil: CPI assets
The information on this page is subject to change. Currency Trader is not responsible for the accuracy of calendar dates beyond press time.

ads0906 7/11/06 10:36 AM Page 55
EVENTS
Event: Linda Raschke’s 10th Annual Trading Seminar

Event: The Options Intensive Date: Nov. 3-5
Dates: Aug. 24-25, Oct. 26-27, Nov. 9-10 Location: Sheraton Chicago Hotel & Towers
Time: 8 a.m -5 p.m. For more information: Visit
www.lbrgroup.com/index.asp?page=Events
Location: The Options Institute at the CBOE,
Chicago, Ill. •
For more information: Call (877) THE-CBOE Event: Second Annual MARHedge Trading Forum
• Date: Nov. 16
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Date: Sept. 7-9 For more information: Visit www.marhedge.com
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Event: The Forex Trading Expo Date: Nov. 16-19
Date: Sept. 8-9 Location: Mandalay Bay Hotel & Casino,
Las Vegas, Nev.
Location: Mandalay Bay Hotel & Casino,
Las Vegas, Nev. For more information: Visit www.tradersexpo.com
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For more information: Visit
www.traders-retreat.com
•
KEY CONCEPTS
Exponential moving average (EMA): The simple alent smoothing constant:

moving average (SMA) is the standard moving average cal-
culation that gives every price point in the average equal SC = 2/(n + 1)
emphasis, or weight. For example, a five-day SMA is the where
sum of the most recent five closing prices divided by five. n = the number of days in a simple moving average of
Weighted moving averages give extra emphasis to more approximately equivalent length.
recent price action. Exponential moving average (EMA)
weights prices using the following formula: For example, a smoothing constant of 0.095 creates an
exponential moving average equivalent to a 20-day SMA
EMA = SC * Price + (1 - SC) * EMA(yesterday) (2/(20 + 1) = 0.095). The larger n is, the smaller the constant,
where and the smaller the constant, the less impact the most recent
SC is a “smoothing constant” between 0 and 1, and price action will have on the EMA. In practice, most soft-
EMA(yesterday) is the previous day’s EMA value. ware programs allow you to simply choose how many days
you want in your moving average and select either simple,
You can approximate a particular SMA length for an weighted, or exponential calculations.
EMA by using the following formula to calculate the equiv-

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FOREX TRADE JOURNAL
Playing the dollar’s strength against

yen weakness.
TRADE
Date: Tuesday, July 11, 2006.
Entry: Long the U.S. dollar/Japanese yen rate

(USD/JPY) at 114.35.
Reason(s) for trade/setup: Last month’s

Forex Trade Journal featured analysis indicat-
ing dollar bullishness based on price patterns
in the dollar index (DXY). A long trade (in the
dollar index futures) inspired by that analysis
turned out to be a loser. This trade marks a sec-
ond attempt to capture a potential dollar up
move, expressed through the dollar/yen pair.
The dollar has shown more strength against
Source: TradeStation
the yen than other major currencies recently,
despite the late-June, early-July decline. From
mid-May to June 27 the dollar/yen rallied 7.1
percent, while the dollar index gained just a little more than Outcome: The trade benefited almost immediately from
4 percent; similarly, the dollar gained only around 3.7 per- the Bank of Japan’s July 14 announcement it would raise
cent against the euro. interest rates (to 0.25) for the first time in six years. The yen
If the dollar is poised for more strength and the yen for stumbled prior to the announcement (the dollar-yen rate
more weakness, the current pullback in the dollar-yen rate jumped more than a full point on July 12) and fell further on
is an opportune entry point. On July 10, the currency pair the actual news.
capped a three-day decline by making a new 20-day low Price hit the initial target of 116.60 on July 17, at which
but rallied to close near its high. point the stop was raised to 115.77 (0.39 below the low of
the day), locking in a profit on the total trade. Another up
Initial stop: 113.31, 0.13 below the July 10 low. move the next day took the dollar/yen to 117.57, and the
stop was raised again to 116.41.
Initial target: 116.60, 0.10 below the June 27 high. Take The high of the move (117.87) came the next day, July 19,
partial profits and raise stop. but the market also turned lower that day, closing at 116.87.
It took two more days for the trade to be stopped out.
In retrospect, it seems as if taking additional profits on
RESULT the move above 117 would have been prudent, but at the
time there was no way to know whether the market would
Exit: 116.60 (first half); 116.40 (second half). reverse or keep running.
Profit/loss: + 2.25 (first half); +2.05 (second half). Note: Initial trade targets are typically based on things such as the his-
torical performance of a price pattern or trading system signal.
Reason for exit: Initial target hit (first half); trailing stop However, because individual trades are dictated by immediate circum-
hit (second half). stances, price targets are flexible and are often used as points at which
to liquidate a portion of a trade to reduce exposure. As a result, initial
Trade executed according to plan? Yes. (pre-trade) reward-risk ratios are conjectural by nature.
TRADE SUMMARY
Date Currency Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
7/11/06 USD/JPY 114.35 113.31 116.60 2.16 116.60 (1st half) 7/17/06 +2.25 (1.97%) 2.93 -0.19 4 days
116.40 (2nd half) 7/21/06 +2.05 (1.79%) 4.52 -0.19 8 days
Legend: IRR — initial reward/risk ratio (initial target amount/initial stop amount); LOP — largest open profit (maximum available profit
during lifetime of trade); LOL — largest open loss (maximum potential loss during life of trade).

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