WILL THE U.S.

SUPPORT
THE DOLLAR? FX TRADING SYSTEM ANALYSIS:
The latest outlook on Tweaking a trend system
9

the greenback
NEW FX SENTIMENT
7
8
INDICATOR
INTRADAY CANDLESTICK 12 6
PATTERNS: 13
5
4
Trading the morning star 11
9
formation 8
6 10
3 1
98 2
7
FOREX BASICS: 7
1

Understanding 5 2
6
rollover fees 34
4 5
5
12 3 3
6
13 1 2 4
12
9
11 7
8
10
9
88 9
7
7
6 6 1
55 3
4
3
4
32 2
1

TRADING DEMARK'S SEQUENTIAL

12
Counting down to FX trend reversals
 CONTENTS

Editor’s Note . . . . . . . . . . . . . . . . . . .6

Contributors . . . . . . . . . . . . . . . . . . .8

Letters . . . . . . . . . . . . . . . . . . . . . . . . .9

Industry News
by Carlise Peterson
What’s the future of OTC
currency derivatives?
The Bank for International Settlements
released the second part of its
tri-annual survey, this time summing
up the OTC market for currencies.
How did it fare?. . . . . . . . . . . . . . 10

Tsunami fails to shock Asian

currency market
A look at the countries hit by the
tsunami and whether the devastation
is likely to affect their currencies. .11

Forex brokerage develops

sentiment gauge
An explanation of FXCM’s new speculative
sentiment index, which it says is a more
useful form of the Commitment of Traders
report. . . . . . . . . . . . . . . . . . . . . . . . . . 12
Global Economy
Dollar worries: Overdone or on the money?
Concerns mount in some circles about fallout
from the weak dollar.
By Currency Trader Staff. . . . . . . . . . . . . .14

Forex Resources
Web sites, seminars and other products
and services for FX traders. . . . . . . . . . .17

The Big Picture

Trends, retracements and news in
foreign exchange
A discussion of the nature of trends,
corrections and information assimilation in
the forex market.
By Barbara Rockefeller. . . . . . . . . . . . . . .18

Currency Futures . . . . . . . . . . . . . . . .23

continued on p. 4

2 January 2005 • CURRENCY TRADER

 CONTENTS

Currency System Analysis

Basic currency trend system
By Michael Schneider. . . . . . . . . . . . . . . . .24

Trading Strategies
Countertrend forex trading with TD
Sequential
How to determine when a trend really isn’t
your friend –– i.e., when it’s about to
disappear.
By Tom DeMark and Rocke DeMark. . . .28
Indicator Basics
Intraday candlestick patterns for FX Weighted and exponential moving
How to combine intraday candlestick averages
patterns with conservative money A primer for new traders on weighted and
management. exponential moving averages.
By Jared Martinez. . . . . . . . . . . . . . . . . . . .34 By Currency Trader Staff. . . . . . . . . . . . . .42

Forex Diary. . . . . . . . . . . . . . . . . . . . . . . . .38 Software Screening

FXtrek’s IntelliChart Desktop
Currency Calendar. . . . . . . . . . . . . . . . .39 Reviewed by Peter Theodores . . . . . . . .46

Currency Basics International Market Summary

FX rollover fees
New traders: Learn about the fees
associated with holding forex positions
overnight.
By Carlise Peterson. . . . . . . . . . . . . . . . . .40
Market performance statistics and news
from around the globe. . . . . . . . . . . . . . . . .50
Indicators in this Issue
Elliot Wave basics. . . . . . . . . . . . . . . . . . . . .53

Have a question about something you’ve seen in

Currency Trader?
Submit your editorial queries or comments to
webmaster@currencytradermag.com.

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visit www.currencytradermag.com/ziniohelp.htm.

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Consult the list below and click on the company name for a direct link to the ad in this month’s
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4 January 2005 • CURRENCY TRADER

gain0205 12/9/04 4:40 PM Page 6
 EDITOR’S NOTE

The trends
they are a-changing?

T he new year began auspiciously in the mar-

kets, as stocks turned tail on a nascent rally
on Monday, Jan. 3, and followed up with
even more intense selling the following day.
Interestingly, at the same time the dollar continued to
bounce off its Dec. 30 low. By Wednesday, Jan. 5, the
euro/U.S. dollar rate (EUR/USD) was testing its December
On the fundamental side of things, in the Global Markets
section we discuss whether spreading concern over the dol-
lar is reaching a critical mass, and whether (and how) the
U.S. will support the currency in the months to come.
This issue introduces a new feature –– Currency System
closing low, around 1.3227; a break- Analysis –– that tests the performance
down below that level would increase of a mechanical trading system on a
the odds of a real reversal, which portfolio of currency pairs. This
would give dollar bulls a significant The tsunami’s global month we look at the historical per-
shot in the arm. The buck has already formance of a basic trend-following
posted more significant reversals vs. implications will place system, and then add two modifica-
other currencies, including the British tions to see how they impact prof-
pound and Swiss franc. the currency market itability and stability. The article
This is speculation, however. If the breaks the numbers down in detail,
dollar turns back down, a month from
now it will appear obvious in retro-
on the front lines of the allowing you to see the system’s
strengths and weaknesses over time.
spect that this New Year’s dollar rally Given the prospect of progressively
was just a correction –– a temporary
economic challenges higher interest rates over the coming
blip in its long downtrend. year, still-lofty oil prices, unrelenting
Distinguishing between a reversal and facing the world in the turmoil in the Middle East, as well as
a correction in real time is, well, the potential economic fallout from
impossible. But that doesn’t mean coming year. the tsunami that devastated Asia in
there aren’t ways to improve forecast- the last week of 2004 (a subject few
ing techniques in this regard. economists or analysts seem to be fac-
In this month’s cover story, trader and author Tom toring into their analysis), 2005 is likely to be a memorable
DeMark –– who has worked in the trading operations of year.
market luminaries such as George Soros, Paul Tudor Jones
and Steve Cohen –– illustrates the application of one of his
signature techniques, Sequential, in the forex market. It’s an
unorthodox, but objective method designed to identify
potential reversal points by examining the relationships
between bars over extended periods.
This trend-change identification process is well known to
many futures and stock traders who have read DeMark’s
books, but many currency traders (outside of DeMark’s
Mark Etzkorn, Editor-in-chief
institutional clientele and associates) might be less familiar
with it.

6 January 2005 • CURRENCY TRADER

 CONTRIBUTORS
CONTRIBUTORS

Tom DeMark (tomdemark.com) is president

of Market Studies Inc., a provider of proprietary
market timing indicators and analysis to major
quote vendors, including Bloomberg, CQG, ILX-
Thomson, Aspen Graphics and FutureSource. He
A publication of Active Trader ® is also president of Markets Advisory Inc., an exclusive market
timing service available to a select sophisticated audience of
For all subscriber services: institutional money managers. Legg Mason and Markets
www.currencytradermag.com Advisory are joint venture partners in the market timing serv-
ice arena.
Editor-in-chief: Mark Etzkorn
metzkorn@currencytradermag.com

Barbara Rockefeller (www.rts-forex.com) is an interna-
Managing editor: Molly Flynn tional economist with a focus on foreign exchange. She has
mflynn@currencytradermag.com
worked as a forecaster, trader and consultant at Citibank and
other financial institutions, and currently publishes two daily
Associate editor: Carlise Peterson
cpeterson@currencytradermag.com reports on foreign exchange. Rockefeller is the author of
Technical Analysis for Dummies (2004), 24/7 Trading Around the
Associate editor: David Bukey Clock, Around the World (John Wiley & Sons, 2000), The Global
dbukey@currencytradermag.com Trader (John Wiley & Sons, 2001) and How to Invest
Internationally, published in Japan in 1999. She is currently writ-
Contributing editor: Jeff Ponczak ing a book tentatively titled How to Trade FX.
jponczak@currencytradermag.com

Editorial and Web assistant: Kesha Green
Michael Schneider has been involved in trading since
kgreen@currencytradermag.com 1982 when he was head of the special interest group invest-
ments of the German Apple user group and operated one of the
Art director: Laura Coyle
first low-cost quote vendors in Germany. He later incorporated
lcoyle@currencytradermag.com
a small trading company that served clients in Europe (prima-
President: Phil Dorman rily Monaco). Currently he is head of the supervisory board of
pdorman@currencytradermag.com a German stock firm and director of a second company that
manages international projects. In addition, he manages the
Publisher, office of the German Vereinigung Technischer Analysten e.v.,
Ad sales East Coast and Midwest:
which is the German member of the International Federation of
Bob Dorman
bdorman@currencytradermag.com Technical Analysts.

Ad sales
West Coast and Southwest only:

Peter Theodores (spottradinggroupfx@yahoo.com) is a
Allison Ellis New York based forex-trader/money manager for
aellis@currencytradermag.com Access Currency and president of Spot Trading
Group fx, a trading company he founded with his
Classified ad sales: Mark Seger brother. He began his career 10 years ago in equi-
mseger@currencytradermag.com
ties at Generic Trading before expanding into the
currency market.

Volume 2, Issue 1. Currency Trader is published monthly by TechInfo, Inc.,

150 S. Wacker Drive, Suite 880, Chicago, IL 60606. Copyright © 2005
TechInfo, Inc. All rights reserved. Information in this publication may not be
stored or reproduced in any form without written permission from the publisher.
The information in Currency Trader magazine is intended for educational pur-
poses only. It is not meant to recommend, promote or in any way imply the
effectiveness of any trading system, strategy or approach. Traders are advised
to do their own research and testing to determine the validity of a trading idea.
Trading and investing carry a high level of risk. Past performance does not
guarantee future results.

Jared F. Martinez was introduced to currency trading in
1978, when he founded a U.S.-based publishing company
whose products were produced in Japan. He eventually sold
the publishing business and dedicated himself full-time to cur-
rency trading. Martinez later established Market Traders
Institute Inc., a trading academy. In 1998 he launched FOREX-
TIPS.com, an interactive, online virtual classroom that offers
24-hour online trading mentoring and assistance.

8 January 2005 • CURRENCY TRADER

 LETTERS

Currency trading system analysis September issue?

I’ve enjoyed Currency Trader so far, but I was wondering if
I found an interesting article about the British Pound in
you were planning on having something like the Trading
your “Sample Articles” but I can’t find the September
System Lab features that are in Active Trader.
issue of the magazine where the article originally ran.
— Terry, Massachusetts
Please let me know where I can find a link to download
the September issue in either PDF or Zinio format.
Yes, we are, as a matter of fact –– beginning with this issue.
Thank you for your assistance.
— Chuck Milich
•
The October issue was the first issue of Currency
Acrobatic readers Trader. The article you refer to is from a back issue of
Editor’s note: In December 2004, Currency Trader began offer-
Active Trader. If you want it in PDF format, you can pur-
ing subscribers an Adobe Acrobat Reader version of Currency
chase it through the Active Trader Store at www.active-
Trader in addition to the existing Zinio Reader version.
tradermag.com.
I enjoy your magazine –– thank you for making it available in
Adobe format. I just received your e-mail about it and imme-
diately downloaded the December issue in Adobe.
— Greg Barman, Denver Could you please make the back issues (October 2004,
November, 2004) available in PDF?
Thank you very much for providing an Acrobat version of — The Winslows
your great magazine. Now I’ll be able to enjoy the articles,
and check out the advertisements. They are: Subscribers will receive e-mail instructions on how to
— Greg Cass access back issues of Currency Trader.

To advertise to the readers of

Currency Trader

call
Bob Dorman
at
(312) 775-5421
or send an e-mail to
bdorman@activetradermag.com
with “Ad inquiry” in the subject line.
 INDUSTRY NEWS
Bank for International Settlements releases second part of tri-annual survey
What’s the future of
OTC currency derivatives?
I n early December, the Bank for
International Settlements re-
leased the second part of its tri-
annual survey –– the latest sta-
tistics on positions in the global over-
the-counter (OTC) derivatives market.
These comprise the preliminary results
of the second part of the Triennial
Central Bank Survey of Foreign
Exchange and Derivatives Market
Activity as well as the regular semian-
nual OTC derivatives statistics.
For the first time, the BIS also pub-
lished measures of dealer concentration
in various derivatives markets, taken
from the regular semiannual statistics.
The triennial survey covers market
participants in 44 jurisdictions.
However, both surveys cover the esti-
mated amounts outstanding and gross
market values of foreign exchange,
interest rate, equity and commodity
derivatives traded in OTC markets.
Furthermore, they both refer to the
worldwide consolidated positions of
reporting dealers.
The first part of the survey was pub-
FIGURE 1 — HERFINDAHL INDICES FOR GLOBAL OTC DERIVATIVES MARKETS (ALL REPORTED CONTRACTS)
For foreign exchange derivatives markets, concentration remained stable over the period, with a continued higher level of
concentration for options than forwards and swaps.
Interest rate contracts
Swaps USD
Options USD 1,800
Swaps EUR
Options EUR
1,400
1,000
600
200
1998 1999 2000 2001 2002 2003
Source: BIS
10
BY CARLISE PETERSON
lished on Sept. 28 and covered turnover
in traditional foreign exchange markets
and OTC currency and interest rate
derivatives markets. The final results on
turnover and amounts outstanding in
foreign exchange and OTC derivatives
markets will be published in spring 2005.
OTC interest rate products, the
largest segment of the market, expand-
ed by 16 percent in the first half of 2004.
Most of the growth came from interest
rate swaps, up 15 percent. Among
swaps, notional amounts increased,
especially in the case of dollar- and ster-
ling-denominated contracts, up by 25
percent and 22 percent, respectively.
In currencies, activity increased in
dollar-based derivatives, up by 15 per-
cent, as well as yen-based derivatives,
up by 18 percent. Business with report-
ing dealers was quite strong, up by 25
percent, while that with other financial
institutions was up a more subdued 7
percent. Business with non-financial
customers decreased slightly.
Gross market values fell by 8 per-
cent to $6.3 trillion. Over the past year
Foreign exchange contracts
Swaps
Options 1,800
1,400
1,000
600
200
1998 1999 2000 2001 2002 2003
the cost of replacements of overall
OTC derivatives contracts fell by near-
ly 20 percent, thus reducing from 4.7
percent to 2.9 percent of overall
notional amounts.
The Committee on the Global
Financial System (CGFS) has asked the
BIS to calculate and publish Herfindahl
indices for OTC derivatives markets.
The Herfindahl-Hirschman Index is a
common measure of market concentra-
tion. It is calculated by squaring the
market share of each firm competing in
the market and then summing the
resulting numbers. For example, for a
market consisting of four firms with
shares of 30, 30, 20 and 20 percent, the
HHI is 302 + 302 + 202 + 202 = 2600.
The main indication from the
Herfindahl indices for the OTC deriva-
tives market for the end of 1998 to
mid-2004 is that concentration in the
main OTC derivatives markets either
remained stable or increased slightly.
A second indication is that concentra-
tion levels for the larger OTC deriva-
tives markets (measured by the out-
Equity-linked contracts
Swaps USD
Options USD 1,800
Swaps EUR
Options EUR
1,400
1,000
600
200
1998 1999 2000 2001 2002 2003
January 2005 • CURRENCY TRADER
 FIGURE 2 — HERFINDAHL INDICES FOR INTEREST RATE AND FOREIGN EXCHANGE DERIVATIVES
All reported contracts, contracts between reporters, and between reporters and non-reporters1.
Swaps USD Swaps EUR Foreign exchange 2
Reporter Reporter
Reporters/non-reporters Reporters/non-reporters
700 All contracts 700 All contracts 700

600 600 600

500 500 500

Reporter 400 400 400

Reporters/non-reporters
All contracts
300 300 300
1998 1999 2000 2001 2002 2003 1998 1999 2000 2001 2002 2003 1998 1999 2000 2001 2002 2003
1 “Reporters” (“reporting dealers”) are defined as those institutions whose head office is located in a Group of 10 (G10) country and which
participate in the semiannual OTC derivatives market statistics; reporters include all branches and subsidiaries of these entities worldwide;
and they are mainly commercial and investment banks and securities houses, including their branches and subsidiaries and other entities
which are dealers.
2 Forwards, forex and currency swaps.

Source: BIS
standing estimated amounts) were
lower and more stable than concentra-
tion levels in the smaller markets. A
third indication, based on the concen-
tration levels for contracts between
reporting financial institutions, is that
the inter-dealer market for most types
of derivatives contracts has a level of
concentration similar to, or slightly
higher than, the overall market.
For USD, JPY, GBP, CHF and CAD-
denominated interest rate swaps, there
was a slight increase in concentration,
while concentration levels remained
unchanged in the markets for EUR
and Swedish kronor (SEK) swaps. For
interest rate options, USD, EUR and
GBP concentration levels remained
largely the same but were less stable,
while concentration increased for
other major currencies.

Tsunami fails to shock Asian currency market

Initial fears give way to cautious optimism in forex market.
espite an early drop in the “I don’t see any major effects on the “Japan’s major export market is U.S.

D Japanese yen shortly after last

month’s Asian tsunami catas-
trophe, most forex analysts believe the
currency markets will not suffer much
of an adverse affect in coming months.
The yen weakened in the tsunami’s
aftermath, but had largely recouped its
losses as of Jan. 5. Currencies in some
smaller Asian countries were hit harder.
Thailand is likely to be one of the most
impacted countries, since tourism
accounts for more than 5 percent of its
economy. Its currency –– the baht ––
might decline in value, according to ana-
lysts, but the disaster did not weigh too
heavily on the overall markets, perhaps
in part because of the focus on the
humanitarian aspect of the tragedy.
Most forex players say the yen’s
decline should not be overly troubling
to market participants.
Japanese economy, short or long term,
because most of the countries hit are
not major consumers,” says Omer
Esiner, market analyst with Ruesch
International. “There certainly was a
knee-jerk reaction at first. The yen has
fallen against the dollar, but it has not
been due to the tsunami, it is due to
the dollar’s recent strength.”
For the most part, damage to
tourism-heavy areas occurred in coun-
tries that do not have actively traded
currencies, says Brian Dolan, director
of research with Gain Capital Markets.
“This really is not going to amount
to any kind of major loss in the mar-
kets,” he says. “Everyone is more con-
cerned with how to help.”
“The [tsunami’s] impact on curren-
cies has been minimal,” says Dave
Floyd, founder of Aspen Trading.
and China, so Indonesia and Thailand
represent a smaller portion. The recent
weakness in yen is more a factor of the
dollar finally gaining some ground
versus all G20 currencies.”
Some say the disaster could help
Asian currencies.
“Rather than negatively impacting
local Asian currencies, it appears that
the tsunami will actually promote
Asian currency strength,” says Michael
Woolfolk, senior currency strategist
with the Bank of New York. “The dis-
aster was confined to non-industrial
areas that do not have a large impact
on local economic activity. While eco-
nomic growth is expected to remain
largely unchanged, the importation of
disaster relief and related construction
activity is expected to stimulate
demand for local currencies.”

CURRENCY TRADER • January 2005 11

 INDUSTRY NEWS continued

Forex brokerage develops

sentiment gauge
Firm develops a proprietary counterpart to the CFTC commitment of traders report.

F
FIGURE 1 — EXAMPLE OF DAILY USD/JPY NET POSITIONING SHIFT orex Capital Markets
On July 21, net positioning in USD/JPY shifted from long to short into extreme (FXCM) introduced a
positioning. At the same time, a brief sell-off ended, and USD/JPY went on to new product called
rally more than 300 pips while net positioning remained short. the Speculative Senti-
ment Index (SSI) that tracks the
U.S. dollar/Japanese yen (USD/JPY), daily collective positions of speculative
5.00 113.00
112.00 (“non-commercial”) traders based
3.00 on FXCM’s proprietary customer
111.00
110.00 flow information.
1.00
109.00 FXCM calculates the index for the
-1.00 108.00 four most popularly-traded currency
107.00 pairs: EUR/USD, USD/JPY,
-3.00 106.00 GBP/USD and USD/CHF. The con-
105.00 cept is similar to the Commodity
-5.00 Futures Trading Commission’s
104.00
(CFTC) widely-used COT report.
-7.00 103.00
However, while the CFTC releases its
6/18 5:00

6/29 13:00

7/8 13:00

7/20 5:00

7/29 13:00

8/9 13:00

8/18 13:00

8/27 13:00

9/7 13:00

9/17 5:00

9/2813:00

10/8 13:00

10/19 13:00

numbers only once a week, the SSI is

calculated in real-time.
A negative SSI number indicates
Source: FXCM
traders are net short, while a positive
number indicates they are net long.
FIGURE 2 — FURTHER PRICE REVERSAL IN USD/JPY The absolute value of the number rep-
A case similar to the one in Figure 1 occurred on Oct. 8 when positioning shift- resents the amount by which longs
ed from net short to net long, coinciding with the beginning of the current exceed shorts or vice versa. For exam-
extended sell-off in USD/JPY. ple, if the SSI in the EUR/USD is 2.55,
it means long customer positions in
U.S. dollar/Japanese yen (USD/JPY), daily the EUR/USD exceed short positions
5.00 113.00
4.00
by a ratio of 2.55 to 1. Excessively high
112.00 or low index values imply most of the
3.00
2.00 111.00 speculative market is positioned in a
1.00 particular direction.
0.00 110.00
-1.00 A press release from FXCM states:
109.00
-2.00 “In addition to providing more timely
-3.00 108.00
information, the FXCM SSI leverages
-4.00 107.00
-5.00 FXCM’s globally diverse client base of
-6.00 106.00 speculative traders. The data used to
7/16 13:00

7/20 13:00

7/22 5:00

7/26 5:00

7/27 13:00

7/29 5:00

7/30 13:00

8/3 5:00

8/14 13:00

8/26 5:00

construct the SSI is `scrubbed’ clean of

trading anomalies and unusually
large orders to provide the most accu-
rate picture of market sentiment.” It is
Source: FXCM
derived from a set of roughly 50,000

12 January 2005 • CURRENCY TRADER

 FIGURE 3 — PRICE REVERSAL IN EUR/USD
In addition to shifts in positioning being a contrarian indicator, the highlighted
areas demonstrate that persistent contrarian positioning by clients actually sup-
ports the opposing trend. In the area highlighted to the left, positioning in the
EUR/USD remained in net long for two weeks as prices continued to move lower.

Euro/U.S. dollar (EUR/USD), daily

5.00 1.300
4.00
1.280
3.00
2.00 1.260
1.00
technically-based short-term traders. 1.240
0.00
The COT reports provide a break-
-1.00
down of each Tuesday’s open interest 1.220
-2.00
for markets in which 20 or more traders
-3.00 1.200
hold positions equal to or above the
reporting levels established by the -4.00
1.180
CFTC. The weekly reports for Futures- -5.00
Only Commitments of Traders and for -6.00 1.160
6/18 5:00

6/29 13:00

7/8 13:00

7/20 5:00

7/29 13:00

8/9 13:00

8/18 13:00

8/27 13:00

9/7 13:00

9/17 5:00

9/2813:00

10/8 13:00

10/19 13:00
F u t u re s - a n d - O p t i o n s - C o m b i n e d
Commitments of Traders are released
every Friday at 3:30 p.m. ET.
Source: FXCM
According to FXCM, any SSI num-
ber above or below +/-3 generally rep-
resents extreme positioning. As a con- FIGURE 4 — NET POSITIONING IN GBP
trarian indicator, FXCM says the SSI is On Oct. 25, the ratio of longs to shorts in the GBP/USD is currently 1.36, which
most effective when the customer base is within range and below the extreme +/- 3 level. The index has been volatile,
is positioned “incorrectly.” The firm flipping into net long territory after spending slightly less than 48 hours in net
says traditional technical indicators short territory. Open interest decreased by 16% as the amount of short position-
actually confirm the effectiveness of ing fell 43%, indicative of short covering.
the indicator itself. When conventional British pound/U.S. dollar (GBP/USD), daily
technicals are performing well, most 6.00 1.880
traders will be positioned on the cor- 5.00 1.860
rect side of the market, which means a 4.00
1.840
tool designed to fade the consensus, 3.00
such as the SSI, will be a losing propo- 1.820
2.00
sition.
1.00 1.800
FXCM says the SSI will perform best
in relatively uncertain conditions –– 0.00 1.780
choppy markets or periods of informa- -1.00
1.760
tion updating and forecast corrections -2.00
that lead to potentially severe and 1.740
-3.00
abrupt price reversals. In these 1.720
-4.00
instances, the technical-based specula-
6/18 5:00

6/29 13:00

7/8 13:00

7/20 5:00

7/29 13:00

8/9 13:00

8/18 13:00

8/27 13:00

9/7 13:00

9/17 5:00

9/2813:00

10/8 13:00

10/19 13:00

tive community tends to be positioned

incorrectly more often than not, a con-
sequence of unclear or conflicting
short-term indicators.
Although some traders we spoke to
feel the SSI could be a helpful tool (at
least one, albeit smaller brokerage,
offers a similar product) for FXCM
traders, the fact it reflects the trading
activity of one firm made it less com-
Source: FXCM
pelling than the COT, which uses cur- “With the SSI, the information is
rency futures data from the Chicago more recent and therefore should be
Mercantile Exchange (CME) –– a more able to provide a fresher outlook into
comprehensive source. strengthening and weakening trends,”
However, some traders see it as a says Dale Sumy, a trader with
potentially useful tool. Blackstone Capital Markets.

CURRENCY TRADER • January 2005 13

 GLOBAL ECONOMY
Dollar worries:
Overdone
or on the money?
How long can the U.S. equity and bond markets sustain
a weak dollar? Some say don’t worry about it,
while others contend the buck is running out of luck.
BY CURRENCY TRADER STAFF
I n the weeks following the U.S.
presidential election, dollar
bears appeared to build re-
newed zeal. The euro pushed
above the $1.34 level in early
December while the dollar/yen dip-
ped below Y102.00. In early December
the dollar hit multi-year lows vs. sev-
eral major currencies. By one trade-
weighted measure from the Federal
Reserve Banks, the dollar fell nearly 29
percent from February 2002 against
liquid currency pairs, excluding
China.
A bear market in the greenback is
firmly entrenched on the longer-term
time frame, but many economists and
market analysts are now questioning
what the impact of continued deterio-
ration in the U.S. dollar could have on
the U.S. economy, stock and bond mar-
kets.
For now, U.S. stock and bond mar-
ket prices have not reacted sharply to
the falling dollar. But, if the greenback
continues to decline at a steady, strong
pace, economists see a number of trou-
blesome issues.
“If China and Japan lose interest in
14
buying U.S. bonds to finance the
deficit, it could become a financial cri-
sis,” says Dave Sloan, economist at
4CAST Inc. He calls this a “realistic
concern,” but adds that it is “difficult
to know when it could happen.”
Another concern of market watchers
is the potential inflationary pressure
that a weaker dollar could bring.
“As the dollar falls, the price of
imported goods rises,” says Sean
Callow, currency strategist at
Ideaglobal. “The pressure builds up
for importers to pass along higher
costs to consumers.”
That, in turn, could result in higher
U.S. interest rates.
Trade imbalance
The latest data from the U.S. Depart-
ment of Commerce revealed a $51.6
billion trade deficit in September, with
$149 billion in imports and $97.5 bil-
lion in exports. That is down from June
2004’s record $55 billion trade deficit.
Analysts at Briefing.com point out that
trade with Pacific Rim countries
accounts for roughly half of the deficit,
with China being the largest compo-
nent at 30 percent. Western Europe
accounts for roughly 20 percent of the
trade deficit.
Key figures in the Bush Admini-
stration believe that a weaker dollar
can, in fact, aid America’s huge trade
imbalance. A weaker dollar increases
the price of imports for Americans,
while decreasing the price of American
exports abroad. The idea is that
Americans will buy fewer imports and
foreigners will buy more U.S. goods.
Callow says the weaker dollar “isn’t
causing any great problems for the
U.S. economy right now, and longer-
term it should filter through to
increase exports and reduce the
January 2005 • CURRENCY TRADER

imports bill.”
Another factor that has been weigh-
ing on the dollar is the rising trend of
the current account deficit, which is
estimated at about 5.4 percent of U.S.
gross domestic product. In early
December, official details of the U.S.
third quarter current account deficit
hadn’t been released, but forecasts call
for a $171 billion reading.
“Some people think the U.S. has
gone too far with the current account
deficit,” says Ken Goldstein, econo-
mist at the Conference Board in New
York.
Will foreigners pull out?
If foreign investors become worried
about capital loss on their investments
caused by dollar deterioration, they
could slow their investment inflows
into U.S. capital markets.
“For European investors, even if the
U.S. stock market goes up 5 percent,
what if the dollar loses 10-15 percent?”
Callow says.
Foreigners must first buy U.S. dol-
lars to invest in U.S. capital markets
and a continued retreat in the currency
could discourage new foreign invest-
ment or even trigger some investors to
cash out of U.S. trades. Bonds and
stocks are vulnerable, Callow warns.
Because of the huge current account
Key figures in the Bush Administration believe
a weaker dollar can, in fact, aid America’s huge trade
imbalance by stifling domestic demand for imports
and increasing demand for U.S. goods abroad.
deficit, “the U.S. is reliant on the rest of
the world to invest in it heavily every
day,” he says.
Looking at recent data from the U.S.
Treasury Department, foreign net pur-
chases of U.S. Treasuries from January
through September 2004 totaled $302
billion. From the first quarter 2004 total
CURRENCY TRADER • January 2005
FIGURE 1 — BEEN DOWN SO LONG…
After setting new lows against many major currencies in early December, the
dollar bounced back –– only to drop sharply on Dec. 15.
U.S. dollar index ($DXYO), daily
August September
Source: TradeStation
of $146 billion, however, a slowdown
has already been seen. Third quarter
purchases came in at $56 billion.
“That is a big thumbs down from
foreign investors about how they see
the U.S.,” Callow says. “There is plen-
ty of evidence they are a lot cooler on
it than they used to be.”
Taking a look at foreign investment
in U.S. equity markets, the U.S.
Treasury Department reported for-
eigners were actually net sellers of $2
billion in stocks from January to
September 2004. That compares to $50
billion of equity purchases in 2002 and
$38 billion in 2003.
“The world is a lot less inclined to
invest in the U.S. than they used to be.
Surely the dollar has played a role in
90
89
88
87
86
85
54
83
82
October November December
that,” Callow says.
The danger, according to some mar-
ket watchers, is that a continuing
retreat in the dollar could accelerate
U.S. inflation. That could trigger the
Federal Reserve to increase interest
rates faster than the market currently
expects, in order to address inflation
from a falling dollar.
“If China and Japan stop buying, it
would push interest rates a lot higher
and could hurt the economy very seri-
ously,” Sloan concludes.
Economic codependency?
Some people argue, however, it is
unlikely foreign central banks would
stop supporting the U.S. Treasury mar-
ket.
“If they cease it will send the dollar
spiraling even lower, which would
damage their economies, too,” Sloan
notes.
Goldstein agrees.
“The Europeans and Asians com-
plain about the current account deficit,
but in fact they need it,” he says. “We
act as a sponge for them. They can earn
more money by investing here than
anywhere else.”
The bottom line is American con-
continued on p. 16
15
 GLOBAL ECONOMY continued
sumers are buying foreign products.
“They complain that we import too
much,” Goldstein adds. “But where do
we import it from? They need us as a
market. This is not just a story about us
consuming too much and investing
too little. It is a story about everybody
else –– they don’t consume enough.”
Stock and bond market
implications
What could this mean for equities and
stocks? Callow speculates that an “out
of control dollar rout with the euro in
the high $1.40s heading to $1.50” could
send the yield on the U.S. 10-year
above 6.00 percent and spark a 15-per-
cent pullback in the U.S. stock market.
After all, equities would be faced with
rising interest rates and inflation,
which are both historically negative
factors for stocks.
Jim Glassman, senior economist at
JP Morgan Chase in New York, offers
another view.
“These doomsday scenarios make
no sense,” he says. “It’s like we are in a
pre-Copernican age in which everyone
thinks the world revolves around the
trade deficit. The U.S. is not doing any-
thing wrong. The trade deficit is where
it is because China has linked to the
dollar and Japan is trying to get out of
their deflation scenario.
“The problem is that a very large part
of the world has linked to the dollar to
stay competitive,” he continues. “[Asian
countries] want stable currencies so
they will look like attractive places for
companies to come and build factories.
We are buying their goods, but they
aren’t buying ours. We aren’t the cause
of the problem. The problem is the
underperforming world economy.”
Intervention around
the corner?
In recent weeks, rumblings about pos-
sible central bank intervention have
ricocheted around the currency mar-
ket. Some pointed to the Bank of Japan
(BOJ) and the European Central Bank
(ECB) as likely candidates to attempt
to stem the dollar’s slide. Both have
voiced concerns the weaker dollar
16
could impede economic growth in
Japan and the euro zone. A weaker
dollar results in more expensive
European and Japanese goods vs. U.S.
products, and it ultimately increases
the competitiveness of U.S. companies
overseas.
The Bush Administration has
offered no signs that it will intervene
to support the U.S. dollar.
“Even though the government pro-
fesses that its strong dollar policy
hasn’t changed, the market regards
“These dollar doomsday scenarios make no sense,”
says JP Morgan Chase economist Jim Glassman.
“It’s like we’re in a pre-Copernican age in which
everyone thinks the world revolves around the trade
deficit.”
that as completely hollow,” Callow
says. “The Administration keeps say-
ing the currency values should be set
in the market.”
What’s the magic number?
Few analysts have a definitive answer
when it comes to the question: How
low does the dollar have to fall to trig-
ger a negative spiral throughout the
U.S. capital markets?
There is speculation, however, that
a move to $1.45-$1.50 in the euro
could spark intervention from the
ECB. Looking at the yen, analysts
speculated it would take a retreat to
the Y97.00/96.00 area to spark BOJ
intervention.
The reserve currency
Another concern discussed in recent
months is whether or not the U.S. dol-
lar will remain the world’s reserve cur-
rency, given its long-term bear market.
However, Goldstein questions
whether other countries even want to
fill the void.
“It’s not clear that the BOJ or the
ECB even wants their currency to
become the global reserve currency,”
Goldstein says.
However, this is not a question that
will likely be answered in terms of
months; it may take years or even
decades to resolve the answer, some
analysts say. One possibility is the
world could move toward a multiple-
reserve system, in which perhaps the
reserve “currency” could be a combina-
tion of currencies –– say, the euro and
yen.
Looking at the weaker dollar, and
the huge U.S. trade deficit and current
account deficit, Goldstein concludes,
“It’s a problem and it isn’t going to go
away. But it isn’t going to be a dooms-
day scenario. We could have this con-
versation again in December 2005 and
very little could have changed.”
What’s a trader to do?
“When everyone is on one side of the
boat, you want to be nimble,”
Glassman says. “Be aware the mood
could change. Don’t be shocked if the
dollar rebounds.”
He sees potential for a rebound in
the U.S. dollar back toward the $1.15
area vs. the euro in 2005.
A key factor traders will want to
watch in early 2005 is the potential for
a Chinese revaluation.
“If the Chinese currency was higher,
no one would be complaining about
the weak dollar,” says Tom Rogers,
senior currency analyst at Thomson
Financial. He speculates a Chinese
revaluation could relieve the upward
pressure on the euro.
“We could see a huge sell-Europe,
buy-Asia trade,” he says.

January 2005 • CURRENCY TRADER
 FOREX RESOURCES

www.forex-training.com

M
ost forex brokerages have a “training” sec- By far the best tool is the free demo account. Signing up
tion, where potential (or existing) cus- takes just a few minutes, and the demo allows you to buy
tomers can go to learn more about trading and sell a host of currency pairs, plus gold and crude oil,
currencies. However, few sites are as dis- using market, limit or stop orders. All orders are executed
creet about hiding the name of the brokerage as www.forex- as they would be in a real account, and the platform
training.com. includes profit/loss totals for each individual trade as well
The site is a product of brokerage GCI Financial, although as the entire portfolio (Figure 1). Traders who delve deeper
you’d have a hard time figuring that out from the training and become more educated will find the demo program a great
home page. The only mention of GCI is a small banner ad in helper before they start using real money.
the upper right corner –– the name of the brokerage isn’t Three beneficial links outside the “Getting Started” section
even mentioned when you click on the link that allows you discuss margin requirements, overnight interest, calculating
to sign up for a live account. pip values and hedging. These links are not posted in any log-
That’s a refreshing
change-of-pace from the www.forex-training.com
way most brokerages ––
Forex-training’s free demo account has real-time data and profit-loss totals.
forex or otherwise ––
operate. Plus, the site
itself has some good in-
formation for those
unfamiliar with forex.
The “Getting Started”
link on the right side of
the page presents eight
steps –– Market Back-
ground, Open a Demo
Account, Market
Trading Decisions,
Entering Trades, Con-
trolling Risk, Exiting
Trades, Open a Live
Account and Trading
Resources –– toward
trading forex.
Each of the steps is
linked to another page
that provides greater
details. For example,
Market Background
discusses currency pairs
and spot forex vs. cur-
rency futures, while Entering Trades provides a brief ical order –– the first three are listed consecutively, while the
overview of market, limit and stop orders. hedging link is stuck between Placing Orders and Open a Live
The information for new traders is not sufficient to “go Account (both of which were covered in Getting Started).
into battle” with, but it’s a good start. While experienced traders aren’t likely to gain much
Making Trading Decisions includes links to a dozen basic from Forex-Training.com (although the demo trading
indicators –– Bollinger Bands, MACD, RSI, etc. –– and pro- account could be helpful), those looking to get into the forex
vides simple explanations of each. The Trading Resources business will find the site a good place to begin. However,
section is also helpful, as it links to a glossary, charts, news, they’ll definitely need more reading and research before
quotes and a few other sites that may be of use. plunking down real money on a trade.

CURRENCY TRADER • January 2005 17

 THE BIG PICTURE
Trends, retracements and
news in foreign exchange
BY BARBARA ROCKEFELLER
I
n December, the foreign
exchange market behaved in a
peculiar way. The euro/dollar
was trending strongly upward
on dollar-negative news, but the trend
then wobbled and gave back some of
its gains on news that traders chose to
interpret as not dollar-negative, even
though it really was just as dollar-neg-
ative as the earlier news. Why did that
happen? The answer lies in traders
18
twisting the meaning of the news to
match the price action they expected to
see on the chart. Traders wanted a
retracement of the upmove, so they
manufactured it out of the smallest
evidence. A manufactured retracement
is very common in foreign exchange.
To recognize a manufactured retrace-
ment, you need to understand how
professional traders view FX market
trendedness.
Most professionals trade in all time-
frames, but even if they trade in only
one, they consult charts on all.
A trader at a bank or brokerage firm
is usually in and out of the same cur-
rency at least five, and as many as 50,
times a day, with a one- to two-hour
holding period. The goal is to make a
few bucks on the spread between buy-
ing and selling with customers and
counterparts. To do that consistently a
trader must get the price direction
right, not necessarily focusing on
heavy-duty economics. Ask a trader
whether a particular factor is impor-
January 2005 • CURRENCY TRADER
tant, and he or she will answer in
terms of how many points he or she
One of the most fascinating aspects of the forex
expects it to move the currency.
A smaller group of professionals,
market is how commentators twist and bend news
including traders at hedge funds, are
“position traders,” meaning they delve and data to fit what they think the price should do.
into the big-picture economics and put
on trades with holding periods of retracements, two of which are difficult to say this chart shows a sin-
many months. This can be the most marked. A position trader who bought gle downtrend from mid-May to mid-
profitable form of trading, because of the euro at the low of about 86 cents in December 2004. The retracements look
the potential to capture virtually all of January 2002 and was still holding it like uptrends in their own right, and in
a trend with almost no transaction today would have a gain of 46.50 fact they are identified as “trends” by
cost. (Actually, if transaction costs are cents, or a percentage return of 54 per- the crossovers of multiple moving
very low, more profit is made by enter- cent on the face amount. Assume averages (7, 10, 15 and 20 days). By
ing and exiting the same trend several leverage of 10 times, and the return is that reckoning, there are nine trends
times and picking up a little
extra gain on the retrace- FIGURE 1 — TRENDS AND RETRACEMENTS
ments –– and every trend, no
matter how well-behaved, The lines overlaid on the price series are one interpretation of the euro's trends. The
contains retracements.) move from 2002 forward could be considered a single trend with several large retrace-
People who don’t work for ments.
big institutions are the non-
professionals, but they num- Euro (EUR), monthly
ber in the hundreds of thou- 1.35
sands and are all over the
1.30
world. The timeframes they
trade mirror the professional 1.25
timeframes, but they tend to
concentrate in the shorter 1.20
end, because low capitaliza-
1.15
tion generally means shorter-
term trades with fewer 1.10
chances for the market to
jump up and bite the trader 1.05
with a nasty loss. People who 1.00
have been in the market a
long time see the change in 0.95
price behavior resulting from
the influx of the new non- 0.90
professional FX traders. 0.85
Trendedness is reduced and
choppy moves are choppier. 0.80
FX prices don’t trend all
1998 1999 2000 2001 2002 2003 2004
the time, and opinions differ Source: eSignal
over exactly how much they
do. Figure 1 is a monthly
chart of the euro over its lifetime. The 540 percent, or 180 percent per annum. on this chart. This demonstrates that a
green lines on the price series repre- To do that, of course, you would have trend is in the eye of the beholder, and
sent one perspective of the euro’s to have ridden out the retracements, in the techniques you use to identify it.
trends, although other lines may be which are the secondary moves oppo- A different technique might zero in on
equally valid. Notice the move from site to the trend. any of the smaller retracements and
2002 to the end of the chart can be con- Now consider trendedness in the classify them as trends, too.
sidered a single trend with several big Japanese yen in Figure 2 (see p. 20). It’s continued on p. 20

CURRENCY TRADER • January 2005 19

 THE BIG PICTURE continued

After the Federal Reserve raised a warning flag contains at least two moves in the
countertrend direction.
Nobody has ever published empiri-
about foreigners potentially losing their appetite for cal evidence proving that FX moves
follow an Elliott Wave sequence, and
U.S. securities because of the huge current account there is plenty of evidence that other
patterns are more common. But that
deficit, the monthly capital flow report became the hasn’t stopped traders from expecting
and sometimes getting them –– the
most important piece of data in the world. self-fulfilling prophecy.
In fact, one of the most fascinating
aspects of the forex market is how
Every trader picks his own time- sionals do. That’s why we have indica- commentators twist and bend news
frame and therefore his own definition tors that show a currency is over- and data to fit what they think the
of a trend. The trend concept is useful bought or oversold. A simple observa- price should do, based on an unproven
chiefly to maintain perspective and tion of a loss of momentum works theory.
sanity. It doesn’t necessarily dictate the pretty well, too. But in FX, a new
next trade. You may be able to see the appreciation of how retracements Technicals and fundamentals
euro or yen is in a long-term uptrend, develop (or should develop) is becom- The persistence of trendedness is
but also perceive the trend is momen- ing widespread. On the whole, it is because of traders grabbing hold of
tarily tired and the next best trade is to based on the Elliott Wave theory one or two key ideas and hanging on
bet on a minor correction; i.e., go short. which states that a trend proceeds by like a terrier with a bone until a bigger
You can use technicals to make a impulse waves punctuated by correc- idea comes along. The big themes
countertrend trade, and most profes- tive waves, and the corrective wave don’t change much over the years,
either, so the longer you trade
the FX market, the easier it is to
FIGURE 2 — TREND IN THE EYE OF THE BEHOLDER understand why traders
respond the way they do to cer-
Unlike the euro example in Figure 1, the "retracements" in the yen could be defined as
tain types of news and econom-
trends in their own right, and they are identified as such by the crossovers of multiple
ic developments. If you can
moving averages.
forecast the news and economic
115.5 data, you can get a head start on
Japanese yen (JPY), monthly
115.0 what the majority of traders are
114.5 going to do. Anticipating trader
114.0
113.5 reaction to news allows you to
113.0 forecast the direction of a trend
112.5
112.0 and bet on it early –– when the
111.5 juiciest profits are to be made.
111.0
110.5 It might sound silly to say
110.0 “forecast the news” when obvi-
109.5
109.0 ously no one has a crystal ball,
108.5 but in practice we usually know
108.0 the probable range of any par-
107.5
107.0 ticular piece of news and can
106.5 guess how traders will act along
106.0
105.0 the spectrum of possible out-
105.0 comes. For example, after the
104.5
104.0 Federal Reserve raised a warn-
103.5 ing flag about foreigners poten-
103.0
102.5 tially losing their appetite for
102.0 U.S. securities because of the
101.5 huge current account deficit, the
March April May Judy July August Sept. Oct. Nov. Dec. monthly capital flow report
Source: eSignal
became the most important

20 January 2005 • CURRENCY TRADER

 FIGURE 3 — EURO RETRACEMENT
piece of data in the world.
Ahead of the October data The euro has been trending upward powerfully since the current account problem pushed
release on Dec. 15, the previ- itself to the forefront of the news in September 2004. It retraced sharply the first week of
ous month saw an inflow of December, but most analysts believe the euro will break the upside resistance line (red)
as it has done twice before.
$65 billion and the monthly
average for the year-to-date 50
was $72 billion. Also, the
November trade deficit had
just come in at $55.5 billion. 0
Never mind the trade report
was for a different month -50
than the capital flow report.
Euro (EUR), daily 1.38
In the rough arithmetic of
1.37
trading, it didn’t take a rocket 1.36
scientist to figure out the cap- 1.35
ital inflow had to be higher 1.34
than the trade deficit to avoid 1.33
1.32
being hugely dollar-negative.
1.31
Then the news came out –– 1.30
incoming foreign investment 1.29
fell to only $48.1 billion. The 1.28
dollar tumbled vs. the euro by 1.27
1.26
36 points in 15 minutes and by
1.25
56 points over the next three 1.24
hours, in a straight line. If you 1.23
had known the number was 1.22
going to be bad, the trade 1.21
1.20
would have been a no-brainer. 7 13 20 27 4 11 18 25 1 8 15 22 29 6 13 20 27
Actually, many people had September October November December
guessed the number was Source: eSignal
going to be bad. One clever
analysis noted that inflows into corpo- Chairman Alan Greenspan, had been deficit. Because there is nothing the
rate bonds the month before (the $67 harping on the issue for more than two U.S. can do (at least nothing that
billion month) was abnormally high. months, practically inviting traders to would provide an instant fix), these
Corporate issuance (selling of corporate sell the dollar –– a big-picture environ- bad numbers have risen to the top of
bonds) in the relevant reporting month mental factor that had set the tone for the list of important factors.
had been abnormally low. Therefore, it an anti-dollar bias. Also, the sheer size
was likely the net inflow would fall of the number was frightening. The Market rationalizations
If the capital flow report had been a
much higher number, the dollar would
Of all the upcoming news items FX traders may use not have fallen quite so much, but it
was already in a strong downtrend to
to rationalize their short dollar positions, the price of begin with, so it would only be a mat-
ter of time before data came along to
oil is high on the list. push the dollar lower. Traders twist
factors to fit whatever prejudice they
already hold. For example, traders
short by the amount of reduced corpo- trade deficit was a record $55.5 billion, ignored the fact that, the same week
rate bonds sold to foreigners, which is higher than expected and the fifth con- this bad news came out, the Fed raised
pretty much what occurred. secutive month over $50 billion. rates, normally a factor that supports
But even if you do not have access to Worse, the deficit with China –– the the dollar.
fancy analysis like this, you could have sorest of sore spots — was $16.8 bil- But traders dismissed the rate hike
made the same guess. Numerous lion, up 27 percent over the year before as “old news” since it was already
Federal Reserve officials, including and more than 30 percent of the total continued on p. 22

CURRENCY TRADER • January 2005 21

 THE BIG PICTURE continued
fully priced in. If the Fed had raised
rates by 50 basis points instead of 25
basis points, the hike might have offset
the bad trade and capital flow data.
But it was obvious the Fed wasn’t
going to raise rates by more than 25,
because it told us so –– rate increases
would be by “measured” amounts.
Of all the news items FX traders
may use to rationalize their short dol-
lar positions, the price of oil is high on
the list. Say oil prices rise again.
Traders will interpret the news as
worse for the dollar than for other cur-
rencies, even though European
economies tend to see a bigger second-
round inflationary effect from higher
energy prices than the U.S. (or Japan,
which is the most energy-efficient of
all the major countries). But you can
“spin” the oil news as worse for the
dollar on the grounds that higher
expected inflation in Europe will pres-
sure the European Central Bank to
raise its own interest rates.
Funny, the market doesn’t care much
about rates when a rate hike would
seemingly support the dollar, but now
it’s using a short-term interest rate to
justify supporting a different currency.
It is wildly inconsistent and even hyp-
ocritical, but this is the kind of slant
that develops when bias toward a cur-
rency is strong. All bad news sticks to
the out-of-favor currency like Velcro,
while undeniably good news slides off
the currency like it is Teflon.
That’s why we can’t make a list of
FX factors once and for all and give
each one a weight. A factor has one
weight when the price is in an impulse
wave –– i.e., trending strongly –– but a
different weight when the price is in a
corrective mode.
Anatomy of a retracement
The euro has been trending upward
powerfully since the first week of
September 2004 (see Figure 3, p. 21),
when the current account problem
pushed itself to the forefront of the
news (see “The Great Global
Imbalance Hoax,” Currency Trader,
December 2004). The trend picked up
steam in October and November,
22
punctuated by a couple of minor
retracements (defined here as a series
of lower lows and lower closes that
persists for longer than three periods
in an uptrend).
In the first week of December, the
euro retraced quite a lot. In fact, daily
lows twice penetrated the lower
boundary of the linear regression
trend channel. Nobody actually
thought a trend reversal could be in
When bias toward a currency is strong, all bad news
sticks to the out-of-favor currency like Velcro, while
undeniably good news slides off the currency like it
is Teflon.
the works, but when prices fall by a
large amount like this, traders who
went long near the highs are suffering
and don’t want to see their losses get
bigger. A wave of stop-loss selling
takes place, complicated in this
instance by pre-holiday and year-end
profit-taking by position traders who
had gotten in much earlier.
Most analysts believe the euro will
break the upside resistance line (red),
as it has done twice before.
Meanwhile, the euro is in the grip of
the technicals, which dictate the
retracement should take a particular
form — the Elliott Wave sequence.
Traders twisted the meaning of fresh
data during the retracement week to
match that expectation. Specifically, the
current account deficit was not as bad
as expected, so the euro fell. In any
objective analysis, this is a perverse
move based on a faulty interpretation.
In fact, it depends on looking at the
data in seasonally adjusted terms; in
unadjusted terms, the current deficit
was worse. The deficit is still 6.1 percent
of GDP, the critical number that under-
lies the dollar downtrend in the first
place, and the most recent data indi-
cates a third consecutive quarter of
worsening deficits.
Economists scratch their heads at
this willful misreading of the news,
but technical traders just try to figure
out where the retracement will end so
they can re-enter. There are two possi-
bilities on the chart. We can wait for
the price to break upside resistance, or
we can watch the indicator in the
upper window, a momentum oscilla-
tor, to signal the euro is oversold. Once
the indicator pops up from the over-
sold line, the trader has a bigger profit
potential than if he or she was waiting
for resistance to break.
Traders will line up the true weight
of the news with the corresponding
price change. If news continues to be
badly dollar-negative in any objective
evaluation but the euro fails to rise, the
price is still in the grip of the technical
traders who think their retracement
hasn’t ended. If the news is only mild-
ly dollar-negative but the euro rises
anyway, it may be time to consider a
new position even if neither of the two
technical indicators on the chart give
the signal –– some other technical indi-
cator can always be found to justify the
position the news suggests.
The market makes the news
It might seem odd the news doesn’t
dominate the price action in foreign
exchange. You’d think hard data
would always have the same effect on
price moves –– but it doesn’t. The
same data is powerful during a trend
and feeble when a trend is either not
present or in the process of retracing. It
pays to know what the professionals
are thinking, and you can be sure that
a good part of what they are thinking
is informed by the chart itself.

For information on the author see p. 8.
January 2005 • CURRENCY TRADER
 CURRENCY FUTURES as of 1/3/05
Record yearly volume in 2004 for CME; FX futures lead Globex increase

T
he Chicago Mercantile
Exchange posted total 2004
annual volume of more than
787 million contracts, with growing
strength in currency futures.
Overall, fourth quarter trading activi-
ty was strong, with an average daily
volume of almost 3.1 million contracts,
up 33 percent from the same period in
2003. Leading the increase was a 79 per-
cent rise in currency trading, averaging
252,000 contracts per day. It was the first
quarter CME currency volume aver-
aged more than 200,000 contracts per
day.
The CME December volume of cur-
rency products was 6.8 million, com-
pared to 4.7 million in November. For
the year, currency product volume
reached 51.2 million, compared to 34
million in 2003.
Currency option volume reached
363,053 contracts in December 2004,
compared to 250,693 in December 2003.
Year-over-year, volume increased to 2.4
million from 2.1 million.
Volume in several currency futures
increased dramatically over the past
month. The Japanese yen increased to 1 2004 volume was 2.7 million compared
million contracts in December com- to 1.6 million in 2003.
pared to 650,503 in November. While the euro didn’t see dramatic
Contracts for the yen increased to 7.4 month-over-month volume –– 2.6 mil-
million in 2004 compared to 6 million in lion December contracts compared to
2003. Australian dollar futures had vol- 2.1 in November –– its yearly volume
ume of 377,473 contracts in December, increase was nearly double at 20.4 mil-
compared to 212,576 in November. The lion in 2004 compared to 11.2 in 2003.

CME to hold first Global FX Summit
Chicago Mercantile Exchange will host its first-ever Global FX Summit on Jan. 19,
mainly due to increased interest in the FX markets. The half-day summit, held at
CME, will feature foreign exchange industry leaders including a roundtable dis-
cussion with Robert Savage, managing director of FX sales at Goldman Sachs;
Bill Brown, managing director at Morgan Stanley; Cornelius Luca, author of
Trading in the Global Currency Markets; Barbara Rockefeller of Rockefeller
Treasury Group; and Yra Harris, independent currency trader.
“We believe this summit will provide anyone –– from the novice FX investor to
an experienced trader –– with valuable insight into the FX market and a deeper
understanding of the benefits of CME’s exchange model,” says Rick Sears, man-
aging director and head of the foreign exchange product group at the CME.
The summit will begin at 1:30 p.m. with a one-hour educational seminar geared
to those who are new to FX trading. Two concurrent sessions will follow, one
designed for the proprietary firms, trading arcades and individuals, which will
cover trading platforms, cash markets, futures and options. The other session, for
hedge funds, CTAs and investment managers, will look at electronic platforms,
trading strategies and risk management issues.

The information does NOT constitute trade signals. It is intended only to provide a brief synopsis of each market’s
CURRENCY FUTURES SNAPSHOT liquidity, direction and levels of momentum and volatility. See the legend for explanations of the different fields.

Contract Sym Exch Vol OI 10-day % 20-day % 60-day % Volatility

move rank move rank move rank ratio/rank
Euro EC CME 93.8 160.1 0.55% 14 1.27% 8 8.74% 78 .27 / 32%
Japanese yen JY CME 33.4 141.3 1.56% 75 -0.10% 9 8.24% 100 .21 / 25%
Canadian dollar CD CME 24.8 72.9 1.64% 50 -1.15% 6 4.66% 34 .30 / 75%
British pound BP CME 20.4 76.5 -1.68% 100 -2.29% 100 6.86% 79 .20 / 19%
Swiss franc SF CME 18.0 60.7 0.97% 36 -1.01% 100 10.03% 81 .16 / 12%
Mexican peso MP CME 11.9 80.1 0.17% 0 -2.11% 100 0.46% 20 .28 / 0%
Australian dollar AD CME 11.1 58.5 2.20% 29 -0.64% 13 7.62% 70 .24 / 22%
U.S. Dollar Index DX NYBOT 3.1 22.5 -0.42% 18 -0.02% 0 -7.14% 74 .16 / 15%
Euro / Japanese yen cross rate EJ NYBOT 1.5 17.7 -0.58% 100 0.19% 7 2.27% 67 .37 / 41%
New Zealand dollar NZ CME 0.7 11.8 0.31% 11 -1.32% 100 6.26% 56 .16 / 7%
Euro / Swiss franc cross rate RZ NYBOT 0.3 6.2 0.52% 16 1.17% 55 -0.28% 16 .16 / 2%
South African rand RA CME 0.3 3.1 2.42% 60 2.27% 14 15.69% 97 .11/ 0%
Russian ruble RU CME 0.1 2.0 1.85% 86 1.34% 29 6.75% 100 .29 / 41%

LEGEND:
Sym: Ticker symbol.
Vol: 30-day average daily volume, in thousands.
OI: Open interest, in thousands.
10-day move: The percentage price move from the
close 10 days ago to today’s close.
20-day move: The percentage price move from the
close 20 days ago to today’s close.
60-day move: The percentage price move from the
close 60 days ago to today’s close.
The “% Rank” fields for each time window (10-day
moves, 20-day moves, etc.) show the percentile rank of
the most recent move to a certain number of the previ-
ous moves of the same size and in the same direction.
For example, the “% Rank” for 10-day move shows how
the most recent 10-day move compares to the past
twenty 10-day moves; for the 20-day move, the “%
Rank” field shows how the most recent 20-day move
compares to the past sixty 20-day moves; for the 60-
day move, the “% Rank” field shows how the most
recent 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 the current reading is lower
than the previous readings. These figures provide per-
spective for determining how relatively large or small the
most recent price move is compared to past price
moves.
Volatility ratio/rank: The ratio is the short-term volatility
(10-day standard deviation of prices) divided by the
long-term volatility (100-day standard deviation of
prices). The rank is the percentile rank of the volatility
ratio over the past 60 days.

This information is for educational purposes only. Currency Trader provides this data in good faith, but cannot guarantee its accuracy or timeliness. Currency Trader assumes
no responsibility for the use of this information. Currency Trader does not recommend buying or selling any market, nor does it solicit orders to buy or sell any market. There is
a high level of risk in trading, especially for traders who use leverage. The reader assumes all responsibility for his or her actions in the market.
CURRENCY TRADER • January 2005 23
 CURRENCY SYSTEM ANALYSIS

Basic currency trend system

FIGURE 1 — SAMPLE TRADE
System concept: This system is
based on the popular idea that over long The basic system buys after a close above the 20-day high and sells after a
periods, currencies have a strong tenden- close below the 20-day low.
cy to trend. The basic system is a simple,
intermediate-term breakout rule –– going Highest (high, 20) 0.7260
Australian dollar/U.S. dollar 0.7240
long/covering shorts on a close above 0.7220
(AUD/USD), daily
the 20-day high, and selling/going short 0.7200
on a close below the 20-day low (a “stop- 0.7180
and-reverse” system). We then experi- 0.7160
0.7140
ment with two modifications to see if 0.7120
they help or hurt this basic approach. 0.7100
The first modification is to exit trades Buy 0.7080
when the price closes above or below the 0.7060
0.7040
10-day high or low. The purpose of this 0.7020
rule is to get out of losing positions more Sell 0.7000
quickly, and to give back fewer open short 0.6980
profits on winning trades. 0.6960
0.6940
The second modification is an entry fil- 0.6920
ter: Long entry signals will be acted upon Lowest (low, 20) 0.6900
only when the bar preceding the break- 0.6880
out bar closes in the lower 50 percent of 0.6860
0.6840
its range, while short signals will be
taken only when the bar preceding the 1
breakout bar closes in the upper 50 per- 1
cent of its range. This rule is based on a 0
0
concept proposed by Tom DeMark that 0
breakouts are more forceful when they
are less anticipated. Source for all figures: Wealth-Lab Inc. (www.wealth-lab.com)

Rules:
1. Enter long and cover shorts on the next bar’s FIGURE 2 — EQUITY CURVE: ORIGINAL SYSTEM
open when price closes above the 20-day high.
2. Enter short and exit longs on the next bar’s The basic system performed fairly well over the long run.
open when price closes below the 20-day low.
2,500,000
2,400,000
Risk control and money management: Size 2,300,000
each position so the maximum loss when stopped 2,200,000
out never exceeds 2 percent of account equity. 2,100,000
2,000,000
1,900,000
Test data: In this test we ran the coded systems over 1,800,000
a period of 10 years of a portfolio of daily FX Data in 1,700,000
Account balance ($)

1,600,000
the following currency pairs: Australian dollar/U.S. 1,500,000
dollar (AUD/USD), Euro/U.S. dollar (EUR/USD), 1,400,000
British pound/U.S. dollar (GBP/USD), U.S. 1,300,000
1,200,000
dollar/Swiss Franc (USD/CHF), U.S. dollar/Japanese 1,000,000
yen (USD/JPY) and U.S. dollar/Brazilian real 900,000
(USD/BRL). Note: Currency pairs for which the U.S. 800,000
700,000
dollar is the base currency (e.g., USD/JPY) were 600,000
inverted (e.g., JPY/USD) to enable portfolio testing in 500,000
terms of dollars. Data source: Comstock Data/FXtrek 400,000
300,000
(www.fxtrek.com). 200,000
Interest rate (rollover) fees were not calculated. 100,000
We also did not include commissions and slippage 0
1/5/95 10/4/95 7/26/96 5/21/97 3/16/98 1/7/99 10/29/99 8/22/00 6/15/01 4/10/02 1/3/03 11/25/03 9/17/04
because these costs are typically reflected in the bid-
Equity Cash Linear Reg Long Short
ask spread. However, if you wish to estimate these
costs you can multiply the number of trades by 10
(which is the value of one pip for 100,000 units of the base pips you wish to assess for commissions and slippage.
currency), and then multiply this figure by the number of We chose an initial account size of $1,000,000 for the port-

24 January 2005 • CURRENCY TRADER

 FIGURE 3 — EQUITY CURVE: MODIFIED SYSTEM
The modifications made the system slightly less risky, but cut into
folio, which will be traded in chunks of 100,000 units of
profits disproportionally.
the respective base currency using 2-percent margin.
This requires that for every 100,000 units of a base cur- 2,200,000
rency traded, we must have 2,000 units as margin in our 2,150,000
2,100,000
account. (The exception is the JPY, which is traded in 2,050,000
chunks of 10,000,000 JPY to keep the pip value in line 2,000,000
1,950,000
with the other currencies.) 1,900,000
1,850,000
1,800,000
Test period: December 1994 to December 2004 (except 1,750,000

Account balance ($)

the Brazilian real, which spanned January 1999 to 1,700,000
December 2004. 1,650,000
1,600,000
1,550,000
Starting equity: 1,000,000 USD. 1,500,000
1,000,000
950,000
Basic system test results: The system produced a 900,000
850,000
net profit of 145.43 percent, which translates to an annu- 800,000
alized return of 9.43 percent. In comparison, buying and 750,000
700,000
holding the portfolio over the test period returned 650,000
120.14 percent. 600,000
550,000
The maximum portfolio drawdown was -25.89 per- 500,000
cent, compared to a total loss (and then some) of initial 450,000
1/5/95 10/4/95 7/26/96 5/21/97 3/16/98 1/7/99 10/29/99 8/22/00 6/15/01 4/10/02 1/31/03 11/25/03 9/17/04
equity (-316.67 percent) through buy and hold. The
Equity Cash Linear Reg Long Short
annual return table shows the system had nine consecu-
continued on p. 26

STRATEGY SUMMARY ANNUAL RETURNS

Original system Original system
Profitabilty Trade statistics Period $ % % Max Exposure Entries Exits
Net profit ($): 1,454,264.70 No. trades: 294 starting Return Return DD
Net profit (%): 145.43 Win/loss (%): 37.76 1/6/95 -48,440.00 -4.84 -21.18 4.98 28 23
Exposure (%): 7.10 Avg. gain/loss ($): 0.55 1/1/96 48,919.88 5.14 -13.26 7.06 29 29
Profit factor: 1.5 Avg. hold time (days): 48.79 1/2/97 95,300.25 9.53 -14.22 5.89 32 32
Payoff ratio: 2.28 Avg. profit (winners): $39,487.34 1/2/98 15,190.25 1.39 -12.08 5.56 30 30
Recovery factor: 3.25 Avg. hold time (winners): 79.02 1/4/99 74,990.00 6.75 -9.38 5.82 30 29
Drawdown Avg. loss (losers): -$16,004.54 1/3/00 216,309.88 18.24 -7.97 7 27 27
Max. DD (%): -25.89 Avg. hold time (losers): 30.25 1/2/01 167,319.63 11.93 -15.01 7.98 32 32
Longest flat days: 903 Avg. consec. win/loss: 5/9 1/1/02 226,210.38 14.41 -20.57 8.51 32 32
1/1/03 351,785.00 19.59 -11.33 7.35 27 27
Modified system
1/1/04 306,679.75 14.28 -14.89 8.33 27 27
Profitabilty Trade statistics
Net profit ($): 467,255.50 No. trades: 195 Modified system
Net profit (%): 46.73 Win/loss (%): 36.92 1/6/95 89,289.88 8.93 -10.08 1.37 12 11
Exposure (%): 3.17 Avg. gain/loss ($): 0.16 1/1/96 55,629.88 5.11 -10.18 3.14 14 14
Profit factor: 1.28 Avg. hold time (days): 26.13 1/2/97 78,930.13 6.89 -8.78 2.53 18 16
Payoff ratio: 1.94 Avg. profit (winners): $30,044.38 1/2/98 -82,390.00 -6.73 -10.18 1.71 14 17
Recovery factor: 1.25 Avg. hold time (winners): 44.82 1/4/99 17,090.25 1.5 -7.87 2.86 22 20
Drawdown Avg. loss (losers): -$13,788.13 1/3/00 99,410.00 8.58 -6.9 3.45 25 23
Max. DD (%): -21.05 Avg. hold time (losers): 15.19 1/2/01 -6,690.00 -0.53 -9.97 3.99 25 26
Longest flat days: 1005 Avg. consec. win/loss: 5/10 1/1/02 67,750.13 5.41 -10.79 4.53 18 20
1/1/03 379,519.88 28.77 -10.01 4.12 20 17
LEGEND: Net profit — Profit at end of test period, less commission • Exposure — 1/1/04 -231,285.13 -13.62 -21.05 3.32 27 28
The area of the equity curve exposed to long or short positions, as opposed to cash •
Profit factor — Gross profit divided by gross loss • Payoff ratio — Average prof-
it of winning trades divided by average loss of losing trades • Recovery factor — Currency System Analysis strategies are tested on a portfolio basis
Net profit divided by max. drawdown • Max. DD (%) — Largest percentage (unless otherwise noted) using Wealth-Lab Inc.’s testing platform.
decline in equity • Longest flat days — Longest period, in days, the system is If you have a system you’d like to see tested, please send the
between two equity highs • No. trades — Number of trades generated by the sys- trading and money-management rules to editorial@currencytradermag.com.
tem • Win/loss (%) — the percentage of trades that were profitable • Avg. trade
— The average profit/loss for all trades • Avg. winner — The average profit for
winning trades • Avg. loser — The average loss for losing trades • Avg. hold Disclaimer: Currency System Analysis is intended for educational purposes only
time — The average holding period for all trades •Avg. hold time (winners) — to provide a perspective on different market concepts. It is not meant to recom-
The average holding time for winning trades • Avg. hold time (losers) — The mend or promote any trading system or approach. Traders are advised to do their
own research and testing to determine the validity of a trading idea. Past perform-
average holding time for losing trades • Avg. consec. win/loss — The maximum
ance does not guarantee future results; historical testing may not reflect a sys-
number of consecutive winning and losing trades
tem’s behavior in real-time trading.

CURRENCY TRADER • January 2005 25

 CURRENCY SYSTEM ANALYSIS continued

FIGURE 4 — DRAWDOWN: ORIGINAL SYSTEM

tive winning years, with only the first year
failing to turn a profit. Like any trend-following system, this one was subject to extended drawdowns.
The period return analysis shows that
0.00%
smaller time windows –– quarterly, monthly, -2.00%
weekly –– were roughly 50 percent prof- -4.00%
-6.00%
itable, with a slight bias toward the prof- -8.00%

Drawdown
itability. One conclusion you can draw from -10.00%
-12.00%
this data: Wait until the year is done –– do -14.00%
not abandon the system during unprofitable -16.00%
-18.00%
weeks, months or quarters if you want to -20.00%
reap its long-term rewards. -22.00%
-24.00%
The maximum drawdown of 25 percent is 1/5/95 10/2/95 7/22/96 5/13/97 3/4/98 12/23/9810/14/99 8/3/00 5/25/01 3/18/02 1/6/03 10/27/03 8/17/04
not too bad for this type of system, but
chances are the longer the time window FIGURE 5 — DRAWDOWN: MODIFIED SYSTEM
examined, the larger the maximum draw- For the most part, the modifications reduced the size of the system’s drawdowns,
down will be. When you trade this system, although the most recent approached 20 percent.
you should always expect to lose 25 to 30 0.00%
percent of your total funds, even when risk- -2.00%
ing only 2 percent of your capital with every -4.00%
-6.00%
Drawdown

trade. Do not be misled by the smaller year- -8.00%

ly drawdown figures; drawdown does not -10.00%
stop at the end of the year. (It might be inter- -12.00%
esting to see how a money management -14.00%
-16.00%
approach such as Optimal f or a change in -18.00%
the percentage capital risked per trade -20.00%
would affect the results.) 1/5/95 10/2/95 7/22/96 5/13/97 3/4/98 12/23/9810/14/99 8/3/00 5/25/01 3/18/02 1/6/03 10/27/03 8/17/04
Overall, the system is robust because it
relies only on a single parameter (the breakout period –– in were better in the original test. The entry filter we used is
this case, 20 days). Optimization has not been used in select- likely more appropriate for longstanding, well-defined sup-
ing this parameter. If you’re trading a portfolio and use port or resistance levels that many traders are aware of; a
enough funds, this approach might be feasible if you are will- simple 20-day high or low is less of a psychological barrier.
ing to accept extended drawdowns until you see a profit. (Analysis of individual trades showed losing trades often
(And frankly, an annualized 9-percent profit was larger than reversed after a few days, regardless of whether the initial
we expected to see from this type of system.) entry signal was right or wrong.)

Modifying the system: One criticism of the system might Bottom line: This study shows how it does not always pay
be that the basic stop-and-reverse approach will frequently to tinker with a simple, robust system. By making it more
give back lots of open profits. Another weak point seems to complex, you add to its unpredictability.
be the low number of “correct” signals (which is, admittedly, ––Michael Schneider of Wealth-Lab
a hallmark of all long-term trend-following systems). The fol-
lowing system attempts to address these issues with the pre-
viously discussed modifications. PERIODIC RETURNS
Original system
Rules: % Max. Max.
1. Enter long on the next bar’s open when price closes Avg. Sharpe Best Worst profitable consec. consec.
above the 20-day high IF the bar preceding the breakout return ratio return return periods profitable unprofitable
bar closed in the lower 50-percent of its range. Weekly 0.20% 0.62 10.19% -8.24% 52.21 12 8
2. Exit long on the next bar’s open when price closes below Monthly 0.87% 0.61 16.92% -8.79% 50.00 4 7
the 10-day low. Quarterly 2.66% 0.56 40.12% -10.96% 57.50 6 4
3. Enter short on the next bar’s open when price closes Yearly 9.64% 1.26 19.59% -4.84% 90.00 9 1
below the 20-day low IF the bar preceding the breakout Modified system
bar closed in the upper 50 percent of its range. Weekly 0.09% 0.39 5.13% 6.92% 48.56 10 8
4. Cover short on the next bar’s open when price closes Monthly 0.38% 0.38 11.60% -6.29% 49.17 4 5
above the 10-day high. Quarterly 1.10% 0.41 15.57% -8.30% 55.00 4 4
Yearly 4.43% 0.4 28.77% -13.62% 70.00 3 1
Modified system results: The first impression from the
modified results is the system has slightly less exposure at LEGEND: Avg. return — The average percentage for the period • Sharpe ratio —
the expense of less profits. The portfolio profit decreased to Average return divided by standard deviation of returns (annualized) • Best
46.73 percent and the number of trades shrank from 294 to return — Best return for the period • Worst return — Worst return for the peri-
od • Percentage profitable periods — The percentage of periods that were prof-
195. But this did not pay off in terms of a substantially small- itable • Max. consec. profitable — The largest number of consecutive profitable
er drawdown or fewer losing trades. periods • Max. consec. unprofitable — The largest number of consecutive
Also, statistics such as profit factor, recovery factor, etc., unprofitable periods

26 January 2005 • CURRENCY TRADER

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 CURRENCY STRATEGIES

Currencies have long been praised for their capacity

to trend, but in today’s market, an objective
countertrend technique might be a forex trader’s
most valuable asset. TD Sequential is designed to
identify trend exhaustion points and keep you one
step ahead of the trend-following crowd.

Countertrend forex trading

with TD SEQUENTIAL
1 2
BY TOM DEMARK AND ROCKE DEMARK 4
2 3 5
1

T here is a market adage that describes the modus operandi of almost

all currency traders: “The trend is your friend.”
Granted, that is often the case. However, to make it more truthful, we have
added the corollary “unless the trend is about to end.” This qualifier has never
9
11
12
13

been more appropriate for the forex market than in recent times.
Markets will trend, but research proves this is the exception rather than the 8 9
8
rule. Overall, markets trend 25 to 30 percent of the time, which means 70 to 75 7
percent of the time they move within defined trading ranges. 10
Historically, currency markets were more likely to trend than traditional
commodities, financial, or stock markets because policy decisions made by 7
central banks were coordinated, and these collective actions influenced cur- 6 6
rency relationships for extended periods of time. In recent years, however, 5
5
that interdependency has diminished and currency price behavior has mim- 4
icked that of other conventional markets. 4
Psychologically, it is simple to buy an advancing market and sell a declin- 3
ing market. Most traders attempt to operate in harmony with the trend, and
the news associated with such price movement serves to reinforce that ten- 3
dency and provide an excuse for its perpetuation. This is simply human 2
nature –– all of us want to be on the side of a winner, and the news accompa- 1
nying a trend is written to justify its existence. Eventually, however, the trend
exhausts itself and, almost by default, it is reversed or, at least, interrupted.
Typically, stock specialists, market makers and brokerage trading desks
supply needed liquidity by positioning themselves against the prevailing
trend. Their collective countertrend activities are responsible for price exhaus-
tion periods.
continued on p. 30

28 January 2005 • CURRENCY TRADER

 9

8
7
12
6
5
13
4
11
9
9
6 10 1
8 3 2
7 1
8
5 2

7
4 5
6 3
2 3 6
4
9

7
8

1
3

CURRENCY TRADER • January 2005 29

 CURRENCY STRATEGIES continued

Professional traders subsequent price bar’s low must be

less than the lows of both Setup bars 6
S everal currency strategists and traders specialize in applying TD Sequential
and other TD indicators to the currency markets. and 7. Until that occurs, the anticipat-
One is Jason Perl, Global Head of the Fixed Income, Rates and Currency ed price “hiccup,” or reaction, is less
Technical Strategy Group at UBS Investment Bank. He has been using these likely to occur.
studies for the past 10 years –– identifying, among other events, the USD/JPY A sell Setup is a series of at least nine
top in 1998, the U.S. bond highs in June 2003 and March 2004, the April 2004 consecutive closes greater than the
Nikkei high and the May 2004 EUR/USD low, using TD Sequential. close four price bars earlier. Prior to the
Kurt Magnus, head of foreign exchange sales at WestPac Bank, has given
first bar of this series, a TD Price Flip
numerous seminars on these indicators, as have Bloomberg trading specialists
must occur to initialize the Setup –– i.e.,
Doug Tengler, Terry Gaut, Paul Salerno, Roderick Bentley, Brendan Scholey,
Trevor Neil, Greg Byrnes and David Keller. Other contributors include: from CQG the close of the bar immediately before
Inc., Stan Yabroff in the U.S. and Shaun Downey in London; from Thomson bar No. 1 of the prospective sell Setup
Financial, Phil Doyle and John Kozey; from Morgan Stanley, Rick Bensignor, must be less than or equal to the close
head of technical research; Ed Solari, Senior Technical Strategist at the Bank of four price bars earlier. If the Setup
Montreal; Paul Day at HSBC; Kevin O’Dowd at Legg Mason; Tim McCullough at series is interrupted at any time prior to
West LB AD; Lindsay Glass, Blake Bertea and Steve Shirley from Oppenheimer; completion, the bar numbers are erased
Chuck Gall from RBC; Dain Rauscher; and from UBS Gerald Chan and Robert and the process must start again.
HY Lam. Typically, when a sell Setup is com-
—Tom DeMark pleted and perfected, price has a ten-
Check out next month's issue for insights on TD Sequential from some of these
dency to at least react to the downside
market professionals.
or move sideways for a while. A sell
Setup is perfected when either the high
of Setup bar 8, the high of Setup bar 9 or
A tool for identifying the ends high or low two periods earlier. a subsequent price bar’s high is greater
of trends than the highs of both Setup bars 6 and
TD Sequential is designed specifically Buy and sell Setups 7. Until that occurs, the anticipated
to predict potential price exhaustion Buy Setup is a series of at least nine price reaction is less probable.
and likely price reversals. This consecutive closes less than the close
methodology is designed to become four price bars earlier. Prior to the first Countdown
progressively less bearish as price bar of this series, proper “initializa- Buy Countdown begins when a buy
declines and, conversely, less bullish as tion” must occur in the form of a TD Setup has completed (once the mini-
price advances, contradicting the Price Flip. This means the close prior mum requirement of nine consecutive
behavior of most trend-following to setup close No. 1 must be greater closes less than the close four days ear-
traders. than or equal to the close four price lier is fulfilled). Beginning on the ninth
TD Sequential provides much-need- bars earlier; only then can the buy Setup bar, a process is applied that
ed discipline and removes the emotions Setup process begin. (Note: For cash compares the close of that price bar vs.
associated with trend trading. It also currency markets, use the New York the low two bars earlier: If the close is
gives a distinct edge to traders who close, which is 10 p.m. London time, as less than or equal to the low two price
operate in size, allowing them to buy the end of the trading day.) bars earlier, then a Countdown is
when supply is most plentiful and to Once a minimum of nine consecu- recorded.
sell when demand is most aggressive. tive closes less than the corresponding Just as a buy Setup series’ bars are
Markets move in impulses or waves. closes four price bars earlier are ful- numbered, so too are bars in a
No move, either up or down, is unin- filled, these bars are numbered 1 Countdown, except in a different color.
terrupted. There is a natural rhythm or through 9. If that series is interrupted Once 13 valid Countdown bars have
cadence associated with price move- at any time prior to completion, the occurred (note: Countdown bars do not
ment in any market. This is apparent count is erased and the process must have to be consecutive), the downside
on any time frame, from one-minute to begin anew. price momentum is likely to be
monthly. This rhythm can be measured Typically, when a buy Setup is com- exhausted. Additionally, to ensure the
and followed according to the tenets of pleted and “perfected,” price has a ten- price action is sufficiently low relative
TD Sequential, which has two compo- dency to at least react to the upside or to the prior price action, the following
nents: 1) TD Setup, which is momen- move sideways –– i.e., after a con- qualifier is used: The low of buy
tum-based and compares the closing firmed Setup, the prevailing down- Countdown bar 13 must be less than or
price with the close four periods earlier trend corrects for a period of time. To equal to the close of Countdown bar 8.
and, 2) TD Countdown, which is trend- “perfect” a buy setup, either the low of There are two events that cancel a
based and compares the close with the Setup bar 8, the low of Setup bar 9 or a buy Countdown prior to completion:

30 January 2005 • CURRENCY TRADER

FIGURE 1 — BRITISH POUND
After the sell Setup series (green numbers) that completed in late May 2004, the pound’s upward momentum was interrupted
for two weeks.
British pound (GBP), daily

13 1.88
12
11
10 7
89 6 8 9
45 1.86
7
3 1
78 3 56
2 1.84
9 1 12
4
3
2
45
6 1
3 1.82
5 6 2
7 9 4
6 78
8 5
5
3
3 12 4 1.80
4 ++
12
67
+ ++ 1.78
89 1112 13
10
1.76

1.74
10 17 24 1 8 15 22 1 8 15 22 2 9 16 23 1 8 15 22 1 8 15
May 2004 June 2004 July 2004 August 2004 September 2004 October 2004
Source: Bloomberg, Inc.

The first occurs if, subsequent to the Because of additional selling from a close greater than or equal to the close
completion of a buy Setup, a price new group entering the market, a four price bars earlier — the
bar’s low and the prior price bar’s downtrend will unexpectedly intensi- Countdown process will “Recycle”.
close are both above the highest price fy from time to time. If the selling Sell Countdown inverts the rules for
of the entire buy Setup series. In these becomes sufficiently intense for an a buy Countdown: It begins once the
instances, the buy Setup is cancelled extended period of time to produce a minimum sell Setup requirement of
and you must begin to look for a new new buy Setup that extends past the nine consecutive closes greater than
Setup series. The second cancellation minimum nine to at least 18 consecu- the close four bars earlier is fulfilled
occurs when a contradictory sell Setup tive closes less than the close four bars for a sell setup. Beginning on bar 9 of
appears before the completion of the earlier — prior to the completion of the the Setup, a series of closes (which do
Countdown. Countdown or prior to a subsequent not have to be consecutive) greater
than or equal to the high two price
bars earlier must occur. The rules for
Historically, currencies have tended to trend because cancelling a sell Countdown are
inverted as well.
coordinated policy decisions by central banks On the daily time frame, completed
Countdown “13s” coincide with a mar-
influenced currency relationships for extended ket’s top or bottom approximately four
or five times a year. On shorter time-
periods of time. In recent years, however, that frame charts, the number of Countdown
13s will increase commensurately.
interdependency has diminished and currency price
Trading forex with TD
behavior has mimicked that of other markets. Sequential
The following daily charts illustrate
continued on p. 32

CURRENCY TRADER • January 2005 31

 CURRENCY STRATEGIES continued

FIGURE 2 — EURO
Although both the sell Countdown in early January and the buy Countdown in mid May marked trend reversals, price tested
the 13 price level in each case and then made secondary Setup 9 series.

Euro (EUR), daily

23 1.300
9 1
78 789
12
13 6 1.280
5
11 4
10 9 6
68 3 1 5
4
97 1 2
85 2 1.260
67 4 123
5123 5
36
131234 4
12 9 1.240
11 78
910
889 1
7
667 3
1.220
55 1 3 2
44
3 4
3 5 6 45
2 2
1 6
12 789 1.200
7

8
9 12
10
11 13 1.1800

24 1 8 15 22 1 8 15 22 2 9 16 23 1 8 15 22 1 8 15 22 3 10 17 24 1 8 15 22 1 8 15 22 2 9 16 23 1 8 15 22 1 8 15 22 1
Dec. 2004 Jan. 2004 Feb. 2004 March 2004 April 2004 May 2004 June 2004 July 2004 August 2004 Sept. 2004 Oct. 2004
Source: Bloomberg, Inc.

the application of TD Sequential to
cash currency trading.
Figure 1 (see p. 31) of the cash
British pound (GBP/USD) shows a sell
Setup series (green numbers) that com-
pleted in late May 2004; the red arrow
above the “9” indicates the sell Setup
was “perfected.” Notice the upside
progress was interrupted for 11 trad-
ing days after this bar, as price moved
sideways and then declined.
The Countdown process then
began, with the qualifying bars labeled
Operating against the trend is often difficult because
it contradicts human nature.
with red numbers. The peak of the
rally was marked by a Countdown
“13” and exhausted the upside for this
market.
Notice another sell Setup devel-
oped simultaneously with this
Countdown (the second series of green
numbers, below the red Countdown
numbers). This sell Setup was not per-
fected until the high close (day 12 of
the Countdown) because days 8 and 9
of the sell Setup were below Setup day
7, and the high of Setup day 7 was not
exceeded until two days after the sell
Setup day 9, which happened to be the
Countdown “12” day, and the highest
close of the rally.
In late July a buy Setup was perfect-
ed on day 8; a short-term rally ensued,
followed by a buy Countdown. Note
the Countdown 12 bar appeared in
mid September, followed by five aster-
isks before the Countdown 13 bar
occurred. Each asterisk day would
have been a “13,” but that designation
was deferred because the lows of these
bars were not as low or lower than the
close of Countdown bar 8. Once a
valid Countdown 13 bar occurred,
however, downside pressure subsided
and the market rallied.
Figure 2 of the euro/U.S. dollar
(EUR/USD) illustrates a sell
Countdown in early January and a buy
Countdown in mid-May. Although
both Countdown 13s marked trend
reversals, price tested the 13 price level
in each instance and then recorded sec-
ondary Setup 9 series. Both Setup 9
series were perfected, which served to
reinforce the original 13’s.
Also, the Setup 9/Countdown
13/Setup 9 series that completed at the
late-July bottom was particularly inter-
esting because it defied conventional
technical wisdom, which at that point
interpreted the trend as bearish on the
daily, weekly and monthly time frames.
In October, another perfected Setup 9
appeared that stalled the uptrend for a
few days, after which the market
entered the Countdown process.
In Figure 3 of the Australian dol-
lar/New Zealand dollar cross rate
(AUD/NZD), four of the five Setup
series have arrows that coincide with

32 January 2005 • CURRENCY TRADER

FIGURE 3 — AUSTRALIAN DOLLAR/NEW ZEALAND DOLLAR
The two Countdown 13 bottoms were immediately followed by profitable upside price moves.

Australian dollar/New Zealand dollar (AUD/NZD), daily

1.180

12
3
1.160
4
5 78
6
9
1.140
1
12 3
234
45 5 78
6 9 1.120
6 45 34
6 9 3 5
7 1 1
78 12 2 2
8 1
9
34 5678 1.100
910 5
11 13 6
12 78 9 4
1
1.080
23 3
45 9 10 12
11
6
12
13 1.0600
78

15 22 3 10 17 24 1 8 15 22 1 8 15 22 2 9 16 23 1 8 15 22 1 8 15 22 1 8 15 22 1
April 2004 May 2004 June 2004 July 2004 August 2004 September 2004 October 2004 November 2004
Source: Bloomberg, Inc.

either a short-term price reversal or

price consolidation. The two Count-
down 13 bottoms had immediate
upside price responses that proved to
be profitable moves.
Forecasting trends instead of
following them
The advantage of using TD Sequential
instead of conventional trend-following
methods is that you can buy into weak-
ness and sell into strength (and do so in
size). When following trends, entry
competition produces slippage and
price gaps that cut into performance.
Operating against the trend is often
difficult because it contradicts human
nature. However, these examples show
there are distinct advantages to doing
so, and TD Sequential is an indicator
designed specifically to accomplish
this goal.

Related reading
“Tom DeMark: Objectively speaking”
Active Trader, November 2001.
An extended interview with Tom DeMark.
“Demarking trend exhaustion zones”
Active Trader, July 2002.
This article illustrates how to use Tom DeMark’s TD Sequential and TD
Combo indicators to identify trend-exhaustion zones.
“Absolute price projections”
Active Trader, July 2004.
Tom DeMark applies objective price projection tools to historical price
examples results to generate a stock market a forecast.
“DeMark variation”
Active Trader, September 2001
This is a Trading System Lab based on a simple pattern, named TD Carrie,
described by Tom DeMark in his book New Market Timing Techniques.

For information on the author see p. 8. You can purchase past articles online at www.activetradermag.com/pur-
chase_articles.htm and download them to your computer.
TD Sequential, TD Setup, TD Countdown
and TD Price Flip are registered trade-
marks.

CURRENCY TRADER • January 2005 33

 CURRENCY STRATEGIES

Intraday candlestick
patterns for FX
This analysis of two candlestick patterns illustrates the process
of defining trade risk, profit and money management.

BY JARED MARTINEZ

FIGURE 1 — CANDLESTICK OPPORTUNITIES

Two long trades and two short trades based on candlestick patterns set up over the
course of two days in the EUR/USD rate. These patterns are relatively easy to spot and
occur on all time frames.
Euro/U.S. dollar (EUR/USD), 30-minute
occur relatively frequently and
Sell an engulfing
are easy to identify. Figure 1
bearish candle
1.232 shows four tradable candle-
Sell an stick patterns that formed dur-
engulfing bearish ing a 48-hour period on a 30-
candle 1.228 minute chart.
Candlestick formations can
be traded the same basic way,
regardless of the time frame or
1.224
Buy a morning star specific pattern. After you go
long in an uptrend upon the
completion of a pattern, place a
1.220 protective stop-loss order 10
pips below the low of the for-
mation when watching a bid
1.216 chart and a profit-taking limit
order 10 pips below the high of
a previous candle whose high
Buy a tweezer bottom
is above both the two preced-
1.212
9/21/2004 9/22/2004 ing candles and two succeed-
Source: MTI Trend Trader ing candles. The rules are
almost identical for a short
trade in a downtrend: Place a protec-
tive stop-loss order 15 pips above the

T rading Japanese candle-

stick patterns on 30- or
60-minute charts in the
direction of the prevail-
ing trend allows traders to define risk
and profit-taking levels based on a for-
mation’s specific structure.
There are various candlestick pat-
terns, consisting of either one or more
candlesticks (see “Candlestick basics,”
p. 36) that imply either bullish or bear-
ish follow-through. These patterns
high of the formation and a profit-tak-
ing limit order 10 pips above the low
of a previous candle whose low is
below both the two preceding candles
and two succeeding candles.
The following examples illustrate

34 January 2005 • CURRENCY TRADER

 FIGURE 2 — MORNING STAR FORMATION

these rules on two basic kinds of pat- Buy in the direction of the trend at the opening of the next candle after the can-
terns: the bullish morning star and the dle that completes the pattern.
bearish tweezer top.
Opening
The morning star pattern price of
Buy at the opening
A morning star is a bullish candlestick the bearish
of the next candle
pattern that appears at the end of a candle
downward price swing. An ideal
morning star is a three-candlestick Close of the
pattern (see Figure 2). The first candle bullish candle
must be in the
is a long bearish candle; the second is upper 40% of
a small-bodied “spinning top”-like the bearish can-
candle (white or black) that can gap dle’s range.
below the body of the previous bear-
ish candle; and the third is a long,
bullish candle that closes well into the
first bearish candle’s body.
The first long bearish candle con-
firms the strength of the downswing.
Protective stop-loss order 10 pips below the low
The subsequent small real body can-
Source: MTI Trend Trader
dle suggests the bears have, at
least temporarily, lost their
power to push prices lower. FIGURE 3 — MORNING STAR LONG TRADE
Finally, the long, bullish candle The profit-taking approach of placing a limit order 10 pips below the most recent high
shows the bulls have gained liquidated this long trade just before the market turned to the downside. The logic of
control of the market, indicating taking profits in this fashion is based on the idea that a market is likely to correct after a
a high probability of a reversal test or a previous high or low.
and rally. Euro/U.S. dollar (EUR/USD), 30-minute
1.233 was a previous high
Trading rules
When a morning star formation 1.232
Exit 10 pips below
appears in an uptrend: the previous high at
1.232 for a 55-pip profit
1. Go long on the open of the 1.228
Buy after the close of the candle
candle following the long, bull-
that completes the formation of
ish candle that completes the the morning star
formation. Note: some morning 1.224
star patterns can have several Place the protective
small-bodied candles between stop-loss order to
the first (long bearish) and final risk 33 pips
1.220
(long bullish) candles.
2. Place a protective stop-loss
order 10 pips below the pat-
tern’s low. 1.216
3. Identify the three most
recent past highs that are pre-
ceded and succeeded by two 1.212
lower highs and place a limit 9/21/2004 9/22/2004 9/23
continued on p. 36 Source: MTI Trend Trader

CURRENCY TRADER • January 2005 35

 CURRENCY STRATEGIES continued

order 10 pips below the high offering a
minimum return of 1.5 times the
trade’s risk (i.e., the entry price minus
the stop-loss price).
In a downtrend, the inverted morn-
ing star pattern is called an evening
star. Simply reverse the rules for the
morning star long trade: Enter short
after the formation completes, place a
protective stop-loss order 15 pips
above the pattern’s high when watch-
ing a bid chart, and a profit-taking
Candlestick basics
limit order 10 pips above the previous
low (identified in the same manner
described in Step 3) that offers a mini-
mum return of 1.5 times the trade’s
risk. Figure 3 (p. 35) shows a long trade
example in the euro/U.S. dollar rate.
Always wait until a pattern’s last
candle closes before entering a trade. If
you try to get an early jump on a trade
by anticipating where the candle will
close (thus assuming the pattern will
complete), you risk entering the mar-
ket without a valid pattern having
formed.
The stop-loss is placed 10 pips below
the formation’s low because the market
has a tendency to test these extremes,
and you must be out of the way to
avoid getting stopped out unnecessari-
ly. From experience, when price pene-
trates the low or high of a pattern on
this time frame by more than 10 pips, it
provides the bulls or bears with
enough energy to keep moving in that
direction.
The profit-taking order is
placed 10 pips below a past high
(or above a past low) because
bulls are trying to take out previ-
ous highs and bears are trying to

I
take out previous lows. After new
n Figure A, the trading period’s high and low are represented by
highs and/or lows are made, a
the highest and lowest points of the candlestick, while the ses-
pullback or retracement usually
sion’s open and close are represented by the top and bottom of
follows. This approach gets you
the wider part of the candlestick.
out before a new high (or low) is
The thin lines at the tops and bottoms are called shadows, and the
made and a sharp pullback
wider parts are called real bodies. The candle is white (or hollow) if the
occurs, taking away all your prof-
close was above the open and black (or filled) if the close was below the
it.
open.
Candle A closed higher than the open and candle B closed below the
The tweezer top pattern
open. Candle C closed above the open — the open was the low price of
A tweezer top is a bearish pattern
the day, and the close was the high price of the day. Candle D illustrates
that often appears at the end of a
the opposite condition. Finally, candle E opened and closed at the same
rally, signifying a dip or reversal.
price; it is identical to its bar-chart equivalent.
It is easy to spot because it looks
like a pair of tweezers –– two
FIGURE A — CANDLESTICKS
candles with small bodies and
Different candlesticks appear alongside their bar-chart equivalents. Candles use long shadows above them (see
the same price information as standard price bars, but display it to highlight bull- Figure 4). Notice that none or
ish and bearish activity. several candles can occur
between the two candles with the
Upper
shadow long “tweezer” shadows. The
High High High rules are the same for trading the
C D inverted morning star pattern, or
Close Open
High
evening star:
High
Close Open
1. Go short on the close of the
Open Close pattern.
Real
body 2. Place a protective stop-loss
order 15 pips above the pattern’s
Open Low Close
high.
Low
Open
3. Identify the three most
Close
recent past lows that are preced-
Low Low Low ed and succeeded by two higher
E
A B lows and place a limit order 10
Lower shadow pips above the low that offers a
minimum return of 1.5 times the
Source: MTI Trend Trader
trade’s risk (i.e., the entry price

36 January 2005 • CURRENCY TRADER

 FIGURE 4 — TWEEZER TOP FORMATIONS

minus the stop-loss price).

This is a bearish pattern signifying a potential top. Tweezer tops can consist of
Tweezer bottoms are the opposite of
two or more candles. At least two candles must have long shadows that extend
tweezer tops (see the first pattern that above the bodies of the candles. The shadows must comprise a minimum of 60
occurs in Figure 1). Invert the rules for percent of the candles’ total range.
tweezer tops to trade these bullish pat-
terns. Equal height (within Equal height (within
Figure 5 shows a tweezer top in the a couple pips) a couple pips)
U.S. dollar/Japanese yen rate. In this
case, the pattern consisted of just two
bars, and the downside follow-
Shadow minimum 60%
through was immediate. Body maximun 40%

Money management
Even with the best trading methodolo- Or
gy, you will go out of business if you
Ideal Realistic
don’t have a sound money-manage-
ment plan.
Many great traders are cor-
rect only 50 to 60 percent of the FIGURE 5 — TWEEZER TOP TRADE
time. With these odds, it is This tweezer top on Dec. 16, 2004 occurred at the top of a bounce in a prevailing
imperative that for every dollar downtrend. Entry occurs on the close of the bar that completes the pattern (the second
of risk, you gain a minimum of tweezer bar, in this case), and the stop is placed above the high of the pattern.
$1.50. The question is how 105.0
U.S. dollar/Japanese yen (USD/JPY), 15-minute
much of your capital do you
104.9
commit to a position?
Generally, a prudent guide- Tweezer Top 104.8
line is to risk no more than 5 104.7
percent of your equity on any
104.6
given trade, with 2 to 3 percent
as your average. (Professional 104.5
money managers will usually 104.4
risk no more than .25 to 2 per-
104.3
cent of account equity on any
given trade. However, they are 104.2
accountable to investors, most 104.1
of whom cannot handle big
risks and drawdowns. 104.0
Volume
Individual traders will general- 0.11
ly take greater risks than fund 0.00
managers.) -0.11
For example, if you have a
trading account of $10,000 and 12/16/2004 12/17/2004
risk 2 percent of equity per Source: MTI Trend Trader
trade, you need to use a protec-
tive stop of no more than $200, with a have confidence you will live to trade abilities on your side from trade to
limit order of perhaps $400 in profit (a another day even if your current posi- trade, reducing the stress and emotion
reward of two times risk). In most tion turns out to be a loser. from trading.
cases $200 represents only a 20-pip Emotions can sabotage the best trad-
stop (at $10 a pip). Most trades Patterns plus money ing plan. By using consistent trade-
described here require a 30- to 50-pip management execution rules and following conser-
stop, which is $300 to $500 in risk, or 3 This approach allows you to set well- vative money-management parame-
to 5 percent of a $10,000 account. defined stop and profit-taking levels ters, you increase your odds of long-
The goal of such guidelines is to based on a specific candlestick pattern. term survival and success.

avoid trading emotionally. If you limit This makes it possible to use money
your exposure on each trade, you can management rules that keep the prob- For information on the author see p. 8.

CURRENCY TRADER • January 2005 37

 FOREX DIARY

U.S. dollar/Canadian dollar (USD/CAD), daily

The trend is your friend, 1.30

until it’s about to end… 1.28

1.26

TRADE
1.24

Date: Tuesday, Nov. 16, 2004. Initial stop

1.22

Entry: Short the U.S. dollar/Canadian

dollar rate (USD/CAD) at 1.1941.
Reason(s) for trade/setup: This position
was mentioned in the summary of last
month’s Forex Diary: “With the dollar’s
weakness still intact and the currency October
pair’s inability to move in the (initially)
expected direction –– despite two fairly
strong intraday moves in that direction ––
the USD/CAD seems poised to try to
move back down; the current consolidation is looking more
like a pause on the daily chart. If a market doesn’t do what
it’s `supposed’ to do, it’s often a sign its going to do the
opposite.”
In other words, it seemed as if the USD/CAD’s inability
to bounce back after the early November breakdown
implied the longer-term downtrend would reassert itself.
(This trade was initiated at the same time the previous long
trade was liquidated.)
Initial stop: 1.2186, or 35 pips above the Oct. 28 low, which
is the resistance level implied by the low of the late October
to early November consolidation.
Initial target: 1.1696, which makes the target the same as
the initial risk.
RESULT
Exit: 1.1800.
1.20
Exit at
1.1800
1.18
Short at 1.1941
Initial target
November December
Source: TradeStation
Profit/loss: + 141 pips.
Trade executed according to plan? No.
Lesson(s): This trade spent 12 days capturing a little more
than half the potential profit that was available after eight
days. The low of 1.1715 that day (Nov. 26) was only 19 pips
away from the initial target price, but we failed to take
profits because we thought the market would move lower.
It would have been impossible to know that would be the
lowest low for at least the next month, but in retrospect, it’s
difficult not to wonder if it would have been appropriate to
consider the initial target as having been fulfilled. (Part of
the problem may have been the arbitrary nature of the ini-
tial target price.)
An extremely fortuitous fill near the low of the day on
Dec. 2 managed to keep this trade from being a loser.
Perhaps a more modest initial profit target –– even smaller
than the initial risk –– would have been a good idea. By tak-
ing only partial profits, we’d still have the opportunity to
capitalize on a bigger move.

Reason for exit: Discretionary exit.

TRADE SUMMARY
Date Rate Entry Initial Initial IRR Exit Date P/L LOP LOL Trade
stop target length
11/16/04 USD/CAD 1.1941 1.2186 1.1696 1.00 1.1800 12/2/04 +.0141 .0226 -.0145 12 days
(1.18%)

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).

38 CURRENCY TRADER • January 2005

 GLOBAL ECONOMIC CALENDAR JANUARY

Monday
Monday Tuesday
Tuesday Wednesday
Wednesday Thursday
Thursday Friday
Friday Saturday
Saturday

Legend 1
CPI: ISM: Institute
Consumer for Supply
Price Index Management
GDP: Gross PPI: Producer
Domestic Price Index
Product

3 4 5 6 7 8
U.S.: ISM Australia: Index Japan: Monetary Germany: Retail U.S.: Employment
of commodity base balance
prices Germany:
Japan: Account Orders received
balances and manufacturing
Germany: turnover
Employment

10 11 12 13 14 15
U.S.: Wholesale Germany: U.S.: Trade U.S.: Retail sales U.S.: PPI
inventories Production index balance ECB: Governing Council
Great Britain: PPI meeting Germany: CPI
Australia: Official Great Britain: Germany: Bankruptcies;
reserve assets Monetary Policy National account Italy: Balance
Germany: Foreign Committee Japan: Balance of payments; of payments
trade meeting Corporate goods price index

17 18 19 20 21 22
Great Britain: CPI U.S.: CPI Canada: Canada: U.S.: Leading
Manufacturing Wholesale trade indicators
Canada: Leading Great Britain: survey
indicators Employment Great Britain:
Germany: PPI Capital issues
Japan: Monetary Canada: CPI
survey

24 25 26 27 28
Canada: Retail Great Britain: U.S.: Durable U.S.: GDP
trade GDP goods

Japan: Canada:
Corporate Employment
service price
index

30 31
Canada: GDP
Australia: International
reserves and foreign
currency liquidity
Italy: International reserves
and foreign currency
liquidity

The information on this page is subject to change. CurrencyTrader is not responsible for the accuracy of calendar dates beyond press time.

January 2005 • CURRENCY TRADER 39

 CURRENCY BASICS

FX
rollover
fees
Did you know you can make ––
or be charged –– extra money
when you hold forex
positions overnight?

BY CARLISE PETERSON

W hen it comes to nuts-and-bolts analysis

and trading, analyzing forex price data
isn’t any different from analyzing stock
or futures prices. Markets go up, down
or sideways, and everyone is trying to buy low and sell
high, one way or another. But one aspect of forex trading
that is different than equities and commodities is the little
issue of rollover fees.
Forex rollover fees are costs you either earn or are
charged for holding forex positions overnight. They are not
related to futures contract rollovers –– the transition from
one contract month to the next and the process of re-estab-
lishing an existing position in the new contract.
Forex settlement and carrying costs
In the spot forex market, trades settle in two business days.
For example, if you short 100,000 euros on Tuesday, techni-
cally, you should deliver 100,000 euros on Thursday.
However, to avoid this position maintenance headache,
most forex brokerages automatically roll over all open posi-
tions (i.e., “swap” the trade forward) to the next settlement
date two business days in the future, at 5 p.m. ET daily.
Rollover fees are the overnight “carrying costs” assessed
to forex positions. They are based on the difference between
two currencies’ interest rates, and they can affect any posi-
tion you hold past the 5 p.m. ET closing/rollover time.
Interest-rate fees are either added to or subtracted from
your account depending on whether the interest rate on the
long currency in your pair is higher or lower than the short
currency’s interest rate.
For example, if you buy the euro/U.S. dollar rate
(EUR/USD), you’re effectively long the euro and short the

40 January 2005 • CURRENCY TRADER

dollar. If you hold the trade past 5 p.m. ET, you might Trade 2: Buy 2 lots of GBP/USD on Monday and settle
receive a small credit as the firm rolls your position forward the next day
one day and applies the difference between the long cur-
Lot value: GBP 100,000
rency’s (euro) higher interest rate and the short currency’s
(U.S. dollar) lower rate. Conversely, if you short the Opening price: 1.5600
EUR/USD rate, your account would be debited the same
Yearly interest rate differential:
amount.
= GBP 4.00% - USD 1.25% = 2.75%
It’s important to read the fine print and see how a partic-
ular FX dealer applies rollover fees. Some firms always Calculation: GBP 100,000*2*(2.75%/360)*1 = $15.28
charge rollover fees, but they might only credit rollover fees (Source for formulas: FXCM)
to customers who maintain a certain account size. Day
(These examples are approximations and are intended
traders who never hold positions overnight avoid rollover
only to illustrate rollover calculations. Real results will dif-
fees. Also, currency futures, such as those traded on the
fer based on prevailing rates and a firm’s policy toward
Chicago Mercantile Exchange, are not subject to rollover
assessing these fees.)
fees.
Notice in the first trade the U.S. dollar interest rate is sub-
tracted from the Japanese yen rate because it is a short posi-
Rollover scenarios
tion –– i.e., it represents selling dollars and buying yen. As
The greater the interest rate spread between two currencies
a result, the position would be assessed a rollover fee of
in a pair, the higher the potential rollover fee. For example,
$-6.94. The second trade would earn a rollover fee of $15.28.
the interest rate differential between the (long) U.S. dollar
and the (short) Japanese yen might result in a rollover of
When the clock strikes five
just $2 per lot, while the interest rate differential between
Here’s a typical rollover fee process: Generally, at 5 p.m. ET
the British pound (which has a much higher rate than the
funds are automatically subtracted or added to accounts
dollar) and the Japanese yen might produce a rollover of
with open positions because of automatic rollover. For
$15.
accounts maintaining at least 2 percent or greater margin
Rollover fees are typically posted in the “interest” col-
equity, funds are added for positions in which the client is
umn on most forex trading platforms every day between 2
long the currency bearing the higher interest rate and
and 5 p.m. ET. Here’s how rollover is calculated:
deducted in the opposite case.
It’s important to remember for positions that are open on
Rollover fee: (No. of lots*No. of units per lot*Yearly
Wednesday and held overnight, the amount added or sub-
interest rate differential)/360*No. of days
tracted to an account as a result of rolling over a position
tends to be around three times the usual amount. This
The following trade examples show the results of being
three-day rollover accounts for settlement of trades through
either long or short the currency with the higher interest
the weekend period. (See “The short-term British
rate.
pound/Japanese yen carry trade,” December 2004 Currency
Trader to read about a strategy that incorporates this three-
Trade 1: Sell 2 lots of USD/JPY on Monday and settle day rollover process.)
the next day
Know your market
Lot value: USD 100,000 (JPY12,200,000)
New forex traders are often caught off guard by rollover
Opening price: 122.00 fees, and short-term traders may be especially frustrated by
these costs cutting into their profits. However, they are part
Yearly interest rate differential:
of forex trading and, depending on the strategy and curren-
= JPY .0% - USD 1.25% = -1.25%
cy pairs you trade, rollovers can be just as beneficial as they
Calculation: USD 100,000*2*(-1.25%/360)*1 = $-6.94 are, at other times, unwelcome.

CURRENCY TRADER • January 2005 41

 INDICATOR BASICS

Weighted and exponential

moving averages
Weighted and exponential moving averages are designed to be more responsive to price changes
than the simple moving average. But there are advantages and disadvantages to this sensitivity.

FIGURE 1 — 50-DAY MOVING AVERAGE COMPARISON

The red line is the SMA, the blue line is the WMA and the green line is the EMA.
The averages bunch together during the sideways trading range period. When
the USD/CHF embarks on a downtrend, the WMA hugs price most closely, fol-

O ne of the most basic lowed by the EMA and the SMA.

trading tools is the U.S. dollar/Swiss franc (USD/CHF), daily
simple moving aver- Price closes
above the WMA 1.28
age (SMA), which is and EMA
the average price of a market over a
certain time period. A five-day SMA is 1.26
the sum of the five most recent closing
prices divided by five; each day’s price
is equally weighted in the calculation. 1.24
Other types of moving averages
give greater weight to recent prices 1.22
based on the idea that current market
activity is more relevant than more dis-
tant activity, and that such altered 1.20
moving averages will be more respon-
sive to price movement –– i.e., change 1.18
direction more quickly when price
changes direction. The two most popu-
lar variations of this type are the 1.16
weighted moving average (WMA) and June July August September October November
the exponentially weighted moving Source: TradeStation
average or, simply, exponential mov-
ing average (EMA). on. (The most recent close in a 20-day WMA would be
Figure 1 is a daily chart with 50-day simple, weighted weighted by 20, the previous day would be weighted by 19,
and exponential moving averages. etc.) The closes are then multiplied by their respective
weighting factors. These results are added together (216.25)
Calculation: Weighted moving average and then divided by the sum of the weighting factors (in
A weighted moving average multiplies each bar’s closing this case, 15). The result is a five-day WMA value of 14.42,
price by a “weighting factor” based on the number of bars in compared to a SMA value of 13.
the average (its “lookback period” or “period length”). The
most recent close receives the heaviest weighting and thus Calculation: Exponential moving average
has the greatest impact on the moving average value. Each The EMA is a specific type of WMA that uses something
previous day in the average is weighted progressively less. called a “smoothing constant” to weight prices according to
The sum of the weighted closes is then divided by the the following formula:
sum of the weighting factors over the period to derive the
WMA value. Table 1 shows how a five-day weighted mov- EMA = SC * P + (1 - SC) * EMA(yesterday)
ing average would be calculated, and how it compares to a where
five-day simple moving average. SC = a smoothing constant between 0 and 1;
The most recent day is given a weight of 5, the next most P = today’s closing price; and
recent day a weight of 4, the next day a weight of 3, and so EMA(yesterday) = the previous day’s EMA value.

42 January 2005 • CURRENCY TRADER

 TABLE 1 — WEIGHTED VS. SIMPLE MOVING AVERAGE CALCULATIONS
You can approximate a particular The WMA uses specific weighting factors for each bar, with the most recent bar
SMA length for an EMA by using the receiving the heaviest weighting.
following formula to calculate the
equivalent smoothing constant: Closing Weighting Weighted
price factor closing price*
SC = 2/(n + 1) Day 1 10.00 1 10.00
where Day 2 10.50 2 21.00
n = the number of days in a simple
Day 3 11.25 3 33.75
moving average of approximately
equivalent length. Day 4 14.75 4 59.00
Day 5 (most recent day) 18.50 5 92.50
For example, a smoothing constant of Sum of weighting factors: 15
.095 creates the EMA equivalent of a 20-
Sum of weighted closes: 216.25
day SMA, since 2/(20 + 1) = .095; a
smoothing constant of .33 creates the 5-day SMA
EMA equivalent of a five-day SMA (average of closing prices): 13.00
[2/(5 + 1) = .33]. The smaller the n is, the 5-day WMA
larger the constant; the larger the con- (sum of weighted closing
stant, the more impact the most recent prices divided by sum of
price action will have on the EMA. weighting factors): 14.42
To calculate an EMA from scratch, * Closing price times weighting factor
you must substitute another value for
the first EMA (yesterday) variable in
the EMA formula. Typically, the equiv-
TABLE 2 — EXPONENTIAL MOVING AVERAGE
alent SMA value is used. Table 2 shows how a “five-day”
EMA would be calculated, using the five-day SMA value The EMA uses a “smoothing constant” to emphasize
recent prices.
from Table 1 as the starting point.
On Day 6, 13.00 is used for the EMA (yesterday) value.
Day Closing 5-day 5-day
On Day 7 (and every day thereafter), the previous day’s
price SMA EMA
EMA (in this instance, 13.66) is used for EMA (yesterday).
Day 1 10
Interpretation and use Day 2 10.5
Like simple moving averages, WMAs and EMAs smooth Day 3 11.25
price action and are primarily used to highlight and define
Day 4 14.75
trends. The classic moving average-based definition of a
trend is that an uptrend exists when a market is above its Day 5 18.50 13.00
moving average and a downtrend exists when it is below Day 6 15.00 14.00 13.66
its moving average. Longer moving averages (e.g., 50, 100 Day 7 14.22 14.74 13.84
days) reflect long-term trends; shorter moving averages
Day 8 16.89 15.87 14.85
(e.g., five days, 10 days) reflect short-term trends.
The most basic moving average trend signal is the price Day 9 18.10 16.54 15.92
crossover, which occurs when price moves from below a Day 10 19.93 16.83 17.24
moving average to above it (signaling rising prices and an
uptrend) or moves from above a moving average to below
it (signaling falling prices and a downtrend). direction of the trend.
Similarly, trend changes are also signaled by a moving Some short-term traders favor EMAs and WMAs because
average crossover, which occurs when a shorter-term mov- they react to price shifts more quickly than the SMA, which
ing average (say, 20 days) crosses above or below a longer- makes them more useful for defining shorter-term trends
term moving average (say, 60 days). and shorter-term trading approaches. Exponential averages
Moving averages are not always necessarily used to sig- especially are often favored by short-term traders who wish
nal trades themselves: Many trading ideas are based on to have as smooth a moving average line as possible with-
using moving averages to define trend direction, comple- out experiencing too much lag.
mented by specific chart patterns that signal trades in the continued on p. 44

CURRENCY TRADER • January 2005 43

 INDICATOR BASICS continued

FIGURE 2 — TRENDS AND WHIPSAWS In Figures 1 (p. 42) and 2, for the
most part, the WMA tracks the price
All types of moving averages generally perform well in trending periods, but
series most closely and responds most
they also tend to share the same negative fate in sideways markets.
quickly to price changes, followed by
U.S. dollar/Canadian dollar (USD/CAD), 10-minute the EMA and the SMA. However,
1.204
increased responsiveness has draw-
1.203 backs as well as advantages.
WMA
1.202 WMAs and EMAs, like SMAs, are
SMA
subject to frequent whipsaws (when
1.201
price crosses repeatedly above and
1.200 below the average) in non-trending
1.199 markets, or in any kind of market
when the moving average is too short
1.198
(and overly sensitive) to price fluctua-
1.197 tions.
EMA 1.196 Notice in Figure 1 that in late June
1.195
price closed above the WMA and EMA
–– a crossover that could be interpret-
1.194
ed as a buy signal –– while remaining
1.193 below the SMA. Price immediately
1.192 turned back down. A similar pattern
occurred near the end of the 10-minute
9:50 11:30 13:10 14:50 16:30 18:10 19:50 21:30 11/16 2:30 4:10 5:50 chart in Figure 2.
Source: TradeStation One method to avoid excessive
moving-average penetrations is to
FIGURE 3 — WEEKLY CHART
increase the length of the moving aver-
As in the other charts, the WMA and EMA tend to hug price more closely, which age. However, this also decreases the
is an advantage in some cases and a disadvantage in others. average’s responsiveness, regardless
1.42
of whether it is an SMA, WMA or
U.S. dollar/Canadian dollar (USD/CAD), weekly
EMA. Over time, though, the differ-
SMA 1.40 ence between using an SMA or an
1.38 EMA becomes less significant. For
example, every early response to a
EMA 1.36
trend change by an EMA is likely to be
1.34 balanced by a whipsaw that would not
1.32 have occurred using an SMA.
Figure 3 shows a weekly chart with
1.30 26-week simple, weighted and expo-
1.28 nential moving averages. As in the
WMA
other figures, sometimes the respon-
1.26
siveness of the WMA and EMA is ben-
1.24 eficial and sometimes it is a drawback.
1.22 Ultimately, the choice to use a particu-
lar kind of EMA must be based on test-
1.20
ing and a trader’s experience with a
1.18 particular trading strategy.
Sept. Oct. Nov. Dec. 2004 Feb. Mar. Apr. May June July Aug. Sept. Oct. Nov. Dec. Table 3 shows some basic perform-
Source: TradeStation ance statistics for two tests of compa-
rable simple, weighted and exponen-
tial moving averages. The first test
Key points compared the performance of 100-day
Because they average price over time, all moving averages simple, weighted and exponential moving averages as the
lag price action relative to the number of days used to cal- basis of a moving average crossover system: The system
culate them. The goal of using a WMA or EMA is to reduce went long when price crossed above the 100-day average
lag by emphasizing more recent price action. and reversed position when price crossed below the aver-

44 January 2005 • CURRENCY TRADER

 TABLE 3 — COMPARISON TEST: WMA, EMA AND SMA
age. The test spanned Dec. 7, 1999 to
Dec. 8, 2004 in the euro/U.S. dollar The WMA produced the most profitable results on the daily test, while the EMA
rate (EUR/USD). fared best on the intraday test.
The second test traded the same sys- EUR/USD rate, daily test (five years)
tem on 60-minute price bars of the U.S. SMA All trades Long trades Short trades
dollar/Japanese yen rate (USD/JPY)
Total net profit ($14,910.00) $5,710.00 ($20,620.00)
from Oct. 28, 2004 to Dec. 8, 2004.
The overall profitability for each Gross profit $41,360.00 $33,080.00 $8,280.00
type of moving average was the same Gross loss ($56,270.00) ($27,370.00) ($28,900.00)
in all the tests. In the daily EUR/USD Total number of trades 62 31 31
test, the WMA produced the best Percent profitable 14.52 16.13 12.90
results (meaning it lost the least
money), followed by the SMA and the
WMA
EMA. In the 60-minute USD/JPY test,
the EMA performed best , followed by Total net profit ($1,090.00) $13,840.00 ($14,930.00)
the WMA and the SMA. Gross profit $47,820.00 $36,270.00 $11,550.00
Gross loss ($48,910.00) ($22,430.00) ($26,480.00)
Bottom line Total number of trades 74 37 37
Weighted and exponential moving
Percent profitable 13.51 18.92 8.11
averages are calculations designed to
make the basic moving average more
responsive to price movement. They EMA
do not “solve” the inherent problems Total net profit ($16,890.00) $7,050.00 ($23,940.00)
of the SMA (e.g., whipsaws, lag), but Gross profit $47,190.00 $37,550.00 $9,640.00
in certain trading situations they can Gross loss ($64,080.00) ($30,500.00) ($33,580.00)
offer an alternative for short-term
Total number of trades 84 42 42
traders who are focused primarily on
the most recent price action and short- Percent profitable 9.52 9.52 9.52
er trends.

USD/JPY rate, 60-minute bars (two months)
SMA All trades Long trades Short trades
Total net profit (¥212,000.00) (¥275,000.00) ¥63,000.00
Related reading
Gross profit ¥302,000.00 ¥13,000.00 ¥289,000.00
To learn more about moving
Gross loss (¥514,000.00) (¥288,000.00) (¥226,000.00)
averages and their uses, consult the
following sources: Total number of trades 43 21 22
Percent profitable 11.63 4.76 18.18
“Indicator Basics:
Simple Moving Average”
WMA
Currency Trader, December 2004
Total net profit (¥348,000.00) (¥351,000.00) ¥3,000.00
Technical Analysis Gross profit ¥350,000.00 ¥34,000.00 ¥316,000.00
of the Financial Markets
Gross loss (¥698,000.00) (¥385,000.00) (¥313,000.00)
by John Murphy
(New York Institute of Finance, 1999). Total number of trades 47 23 24
Percent profitable 14.89 4.35 25.00
Schwager on Futures:
Technical Analysis
EMA
by Jack Schwager
(John Wiley & Sons, 1996 ). Total net profit (¥133,000.00) (¥245,000.00) ¥112,000.00
Gross profit ¥364,000.00 ¥28,000.00 ¥336,000.00
Trading Systems and Methods
Gross loss (¥497,000.00) (¥273,000.00) (¥224,000.00)
(3rd Edition)
by Perry Kaufman Total number of trades 36 18 18
(John Wiley & Sons, 1998). Percent profitable 13.89 5.56 22.22

CURRENCY TRADER • January 2005 45

 TECHNOLOGY

Software Screening: FXtrek’s IntelliChart Desktop

REVIEWED BY PETER THEODORES

Software Summary

F Xtrek’s IntelliChart is a
customizable, real-time
analysis program suitable
for beginning to ad-
vanced forex traders. Newer traders
will appreciate its user-friendly envi-
ronment, while more experienced
Product: FXtrek’s IntelliChart Desktop
What it is: Real-time forex charting software with quote
windows, customizable indicators, alerts and
multiple data feeds.
Who it is for: Currency traders
traders can take advantage of Skill level: Beginner to intermediate users
“IntelliScript,” which allows you to cre-
Company: FXtrek.com.
ate alerts and indicators as well as back-
test trading strategies on historical data. Web site: www.fxtrek.com
Address: 1234 Summer St., fifth floor
Data
Stamford, CT 06905 USA
Because the forex spot (cash) market is
not centralized, prices for any currency Contact information: General — info@fxtrek.com; technical support —
pair will vary at any given time support@fxtrek.com; sales — sales@fxtrek.com
depending on the data source.
Price: Desktop version — $100/month;
IntelliChart Desktop provides access to
Online version –– $50/month.
two of the largest data forex feeds avail-
able: Forex Capital Markets (FXCM) Upside: Versatile charting package offering everything
and S&P Comstock. The FXCM option needed for technical analysis at a great price.
provides the latest bid and ask prices User-friendly for all experience levels. IntelliScript
from its forex brokerage, while S&P feature builds custom indicators and alerts ––
Comstock shows prices averaged from excellent for applying proprietary formulas.
multiple sources. Both real-time data
Downside: Technical support should be a bit more accessible
feeds track dozens of currency pairs
(i.e., an online chat with a live representative or at
and update constantly in IntelliChart’s
least a 24-hour phone number); however, the
quote and chart windows.
e-mail service is prompt. Retrieving historical data
Historical intraday data based on
could be faster. Intelliscript requires a
any multiple of minutes or hours (i.e.,
programming background.
one minute, three minute, hourly, four
hour etc.) goes back at least 24 hours, Minimum system Online version –– No special operating
but intraday data in five-minute incre- requirements: system requirement for java charts; Desktop
ments begins on Jan. 2, 2003. Ten years version –– Windows 95 or higher.
of daily data is also available. The pro-
Recommended: Pentium 500 MHZ or higher, at least 128 MB
gram also supports Dynamic Data
RAM; MS Java (latest version).
Exchange (DDE), which enables real-
time data linkage to an Excel spread-
sheet. and alerts from scratch via its Charting. IntelliChart can plot line,
IntelliScript feature, and it exports his- bar, candlestick and point-and-figure
Features torical data to a clipboard or a text file. chart styles in more than 60 time
IntelliChart Desktop has more extensive (For a complete list of differences frames, including tick, minute, hourly,
tools than the scaled-back online version between desktop and online versions, daily, weekly and monthly intervals. Its
of the program. For example, the desk- visit www.fxtrek.com/manual/Prod zoom feature allows you to expand and
top version allows you create indicators Comparison.asp.) condense price data on a chart in set

46 January 2005 • CURRENCY TRADER

 FIGURE 1 — CHARTING
This figure shows a two-day, 30-minute EUR/USD candlestick chart with five- and 30-
period simple moving averages (black and green lines, respectively). You can add up to
time intervals –– for example, 40 indicators and modify their parameters or use the IntelliScript tool (Figure 3) to add
you can view 12 five-minute custom alerts and formulas.
bars over the past hour or 72 of
them over the past six hours.
You can also pinpoint specific
time frames, i.e., 23 daily bars
from Dec. 1 to Dec. 31 or 24
hourly bars on Nov. 24.
The chart’s data window
displays each interval’s price
and indicator values, which is
useful because you can easily
compare them over different
periods by glancing at two
chart windows.
IntelliChart lets you add as
many as 40 indicators and
drawing tools (including
Fibonacci retracements,
Andrews Pitchfork and Gann
lines) to a chart. All these fea-
tures are very versatile; you
can modify colors, line thick- Source: Fxtrek
ness and channels as well as
overlay multiple indicators. display, which provides more space to trading strategies by generating buy
You can change the parameters of vir- arrange charts and quote windows. It and sell signals on historical data. Most
tually all the indicators, and you can also allows you to group multiple charting packages offer basic alerts (i.e.,
create studies of studies –– for exam- chart windows and save them as a a signal is triggered when EUR/USD
ple, you can overlay moving averages chart template. Each page then reaches a certain price), but IntelliScript
or Bollinger Bands on the RSI. becomes a separate tab at the bottom takes this feature to another level with
Figure 1 shows a two-day, 30- of the screen, and you can switch completely modifiable alerts based on
minute candlestick chart of the among them with a mouse click. multiple indicators.
euro/U.S. dollar (EUR/USD) with Figure 2 shows a chart page with For example, Figure 3 (p. 49) shows a
five- and 20-period simple moving four windows: a quote window of 13 “crossover alert” that indicates when
averages (black and green lines, currency pairs with current price infor- the EUR/USD’s five-period exponential
respectively). Candlesticks that close mation (bid, ask, daily change, high, moving average (EMA) crosses above
above the prior close are blue; those low, open and time), and two-day, 30- its 10-period EMA. You can set an alert
that close below it are red. minute candlestick charts of based on any indicator and easily add
Quote window. IntelliChart’s real- EUR/USD and USD/JPY with them to charts: Simply chose your indi-
time quote window displays eight momentum and Schaff TC applied to cators and add their parameters. A text
columns of basic market data (symbol, them. The fourth window, a five-day, window appears when IntelliScript
bid and ask prices, daily change, high, 30-minute USD/CHF chart (lower alerts are triggered, or the alert can be
low, open and time) for up to 14 cur- left), includes hand-drawn trendlines. sent via sound, e-mail or a SMS cell-
rency pairs. The columns can’t be mod- You can minimize a template (or the phone message.
ified, but you can add or delete rows individual windows within them) as You can also create and apply origi-
and customize background colors. well as run other programs, such as a nal indicators to a chart with
Setting up price alerts in a quote news feed or trade-execution interface, IntelliChart’s programming language.
window is easy: Simply right-click a on top of one with no interference. For example, Figure 3’s crossover alert
symbol and add a price value. Basic Fonts and background colors are easy is a true/false statement, but you can
price alerts can also be placed in chart to modify. also plot values such as a 10-day stan-
windows the same way. IntelliScript. This tool lets you cus- dard deviation or the daily range (high
Layout and chart templates. tomize predefined market alerts or indi- - low) on charts. Its formula language,
IntelliChart supports multi-monitor cators, create original ones and back-test continued on p. 48

CURRENCY TRADER • January 2005 47

 TECHNOLOGY continued
FIGURE 2 — MULTI-WINDOW LAYOUT
Chart "pages" consist of multiple quote and chart windows you can customize and save as a file. This page consists of a
quote window and three 30-minute candlestick charts: USD/CHF, EUR/USD and USD/JPY.
Source: Fxtrek
which uses indicators and nearly 70
variables, isn’t very difficult to learn,
but it does require some basic pro-
gramming skills.
IntelliScript’s programming lan-
guage can also generate buy and sell
signals based on real-time or historical
data, which lets you back-test trading
rules. The program displays buy and
sell arrows on charts and calculates a
strategy’s historical performance.
Schaff TC. IntelliChart offers a unique
feature titled “The Schaff Trend Cycle,”
or Schaff TC, which is a proprietary indi-
cator developed by Doug Schaff to iden-
tify trend cycles within the moving aver-
age convergence-divergence (MACD)
indicator. It shows trend/cycle direction,
tops and bottoms within a trend and
potential trade entry and exit points (see
Figure 2, bottom right).
48
Performance
IntelliChart is easy to install and config-
ure. Both online and desktop versions
are very user-friendly, and you can
launch chart or quote windows and set
up page layouts fairly intuitively. Using
the program with more than one moni-
tor isn’t difficult –– just “slide” each
window to another monitor and
change its size with your mouse.
To open a new chart, just select a cur-
rency pair and its timeframe from the
pull-down menu. Navigation within
each chart’s menu is straightforward,
and you can change currency pairs,
timeframe and chart type add drawing
tools and indicators, as well as modify
the window’s appearance. Default col-
ors and fonts are clear, but the chart
may become difficult to read if you add
too many indicators and lines. It can
require some handiwork to get each
line’s color and thickness right.
We didn’t have trouble running
IntelliCharts on a 3.2 GHz PC with 512
MB RAM, but we also tested it on a
slower machine that didn’t even meet
FXtrek’s minimum requirements with-
out performance problems. The pro-
gram didn’t slow down or crash even
when other programs ran simultane-
ously, and there was no disruption to
the data feed. However, loading charts
with lots of historical data could be
faster, and exporting data to a text file
took longer than it should.
Help manual and tech support
IntelliChart includes a thorough
instruction manual in its help menu.
The manual is easy to understand and
includes everything you need to know
about its features.
Our only complaint was the inability
January 2005 • CURRENCY TRADER
 FIGURE 3 — ALERT AND INDICATOR BUILDER
FXtrek’s IntelliScript feature lets you build original alerts and indicators. The crossover alert
to call for help with prob- shown here is triggered when EUR/USD’s five-period EMA crosses above its 10-period EMA.
lems; FXtrek only provides
technical support via e-
mail. However, we
received prompt and thor-
ough replies to our e-mails.

Bottom line
FXtrek’s IntelliChart con-
tains features for both
newer and more experi-
enced forex traders. It
includes a wide range of
tools at a competitive
price. Its screen resolution
is crisp, and most of its fea-
tures are easy to learn.
IntelliScript is the pro-
gram’s best feature:
Simply set its rules and
parameters, and the pro-
gram does the rest.

For information on the author Source: Fxtrek

see p. 8.

In this month’s Active Trader magazine…

The February 2005 issue of Active Trader Magazine is on newsstands now. Among its features:

In-depth analysis of how the consumer price index (CPI) report affects the stock market each
month, and whether the number will have more impact in an inflation-conscious environment.

Strategy articles on swing trading with Fibonacci percentages, a new volume-price indicator
designed to validate trends and a T-note spread-trading approach based on yield-curve analysis.

Market news: Are big option traders manipulating stocks?

Technology for traders: How to protect your home trading network from outside attacks.

The business of Trading: Tax law changes and what they mean for traders.

…and many other articles.

Coming in the March 2005 issue of Active Trader (on newsstands in February):

Trading strategies using volume channel lines that define price support and resistance, diagonal option spreads, and the second article on the new
VPCI volume-price indicator. Also, we analyze the stock market’s historical reaction to the producer price index (PPI) report.

Market news: The SEC ruling on the trade-through rule and a look at the new “climate” futures.

An interview with author, trader and educator Dan Gramza.

Technology for traders: a review of the ErlangerQuote analysis software and how to save time, money and frustration by guarding against
spam, spyware and viruses.

Go to www.activetradermag.com to subscribe, or visit your local Barnes & Noble, Borders or Books-A-Million store to buy a copy of Active Trader.

CURRENCY TRADER • January 2005 49

 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 0.1788 3.30% 12.30% 10.96% 0.1779 0.135 1

rand

2 Indian 0.02285 2.49% 4.51% 4.25% 0.02303 0.02145 15

rupee

3 Euro 1.3618 2.28% 9.72% 10.59% 1.3332 1.1758 6

4 British 1.9351 2.10% 6.54% 5.60% 1.955 1.7479 10

pound

5 Russian 0.03602 1.94% 4.97% 4.30% 0.03593 0.03392 14

ruble

6 Brazilian 0.3724 1.85% 6.47% 13.64% 0.3735 0.3103 5

real

7 Swedish 0.1512 1.32% 10.25% 12.10% 0.1516 0.1283 4

krona

8 Swiss 0.8806 1.00% 9.97% 8.91% 0.8879 0.7559 3

franc

9 Thai 0.02564 0.86% 6.01% 4.49% 0.02592 0.0239 8

baht

10 New Zealand 0.7226 0.65% 8.01% 11.87% 0.7266 0.591 11

dollar

11 Taiwanese 0.03119 0.32% 5.67% 4.20% 0.03132 0.02801 7

dollar

12 Singapore 0.6108 -0.11% 3.14% 4.11% 0.6138 0.5775 13

dollar

13 Hong Kong 0.1285 -0.16% 0.23% 0.16% 0.129 0.1281 16

dollar

14 Japanese 0.009707 -0.18% 7.43% 4.21% 0.00982 0.0087 12

yen

15 Australian 0.7778 -1.85% 8.38% 9.96% 0.8005 0.6773 2

dollar

16 Canadian 0.8206 -3.50% 4.18% 9.92% 0.8532 0.7138 9

dollar
As of Dec. 28, 2004 *based on one-month gain/loss
INTEREST RATES
Rank Country Rate Dec. 28 1-month 3-month 6-month Previous
1 Germany BUND 118.47 0.04% 2.14% 5.74% 1
2 Australia 3-year bonds 94.735 -0.02% 0.12% N/A 3
3 UK Short sterling 95.14 -0.05% 0.22% 0.44% 4
4 Japan Government Bond 138.35 -0.29% 0.07% 3.78% 2
5 U.S. 10-year T-note 111.16 -0.77% -1.76% 2.77% 5

50 January 2005 • CURRENCY TRADER

 NON-U.S. DOLLAR FOREX CROSS RATES
1-month 3-month 6-month 52-week 52-week
Rank Rate Symbol Current gain/loss gain/loss gain/loss high low Previous
1 Real/Canada $ BRL/CAD 0.4542 5.22% 2.44% 4.14% 0.4684 0.4212 14
2 Franc/Canada $ CHF/CAD 1.0738 3.68% 6.07% -1.12% 1.1054 0.9952 6
3 Real/Aussie $ BRL/AUD 0.4791 3.67% -2.09% 4.07% 0.5018 0.4276 20
4 Euro/Yen EUR/JPY 140.28 2.45% 2.47% 6.62% 140.78 125.81 9
5 Pound/Yen GBP/JPY 199.39 2.24% -0.97% 1.44% 208.03 189.07 16
6 Real/Yen BRL/JPY 38.3799 2.04% -1.03% 9.83% 39.3067 34.3301 10
7 Aussie $/Canada $ AUD/CAD 0.9485 1.62% 4.42% 0.05% 1.0534 0.8863 5
8 Franc/Yen CHF/JPY 90.745 0.46% 2.74% 4.90% 91.5016 80.5368 3
9 Real/Pound BRL/GBP 0.1925 -0.26% -0.05% 8.52% 0.1985 0.1714 11
10 Pound/Euro GBP/EUR 1.4215 -0.27% -3.52% -5.55% 1.5279 1.4096 19
11 Real/Euro BRL/EUR 0.2736 -0.40% -3.58% 3.44% 0.2909 0.2575 17
12 Aussie $/Yen AUD/JPY 80.147 -1.67% 1.07% 6.00% 85.559 74.28 1
13 Franc/Pound CHF/GBP 0.4551 -1.87% 3.67% 3.49% 0.4647 0.4179 4
14 Franc/Euro CHF/EUR 0.6467 -2.10% 0.26% -1.79% 0.665 0.6297 8
15 Aussie $/Franc AUD/CHF 0.8836 -2.15% -1.75% 1.15% 0.9894 0.8547 15
16 Canada $/Yen CAD/JPY 84.5643 -3.32% -3.51% 5.96% 89.7805 78.0564 12
17 Aussie $/Pound AUD/GBP 0.4021 -4.03% 1.99% 4.63% 0.4264 0.372 2
18 Aussie $/Euro AUD/EUR 0.5714 -4.22% -1.49% -0.68% 0.6358 0.5643 7
19 Canada $/Pound CAD/GBP 0.4242 -5.70% -2.52% 4.60% 0.454 0.397 13
20 Canada $/Euro CAD/EUR 0.6028 -5.91% -6.15% -0.73% 0.6497 0.5916 18
GLOBAL STOCK INDICES
1-month 3-month 6-month 52-week 52-week
Rank Country Index Current gain/loss gain/loss gain/loss high low Previous
1 India BSE 30 6563.48 8.05% 16.77% 26.30% 6568.57 4227.5 1
2 Mexico IPC 12912.69 6.48% 16.03% 21.50% 12914.67 8632.13 5
3 Japan Nikkei 225 11424.13 5.17% 5.33% -4.03% 12195.66 9859 15
4 Italy MIBTel 23526 4.54% 10.29% 9.70% 23526 19655 9
5 Brazil Bovespa 26117 4.28% 11.05% 22.08% 26145 17601 1
6 Australia All ordinaries 4049.3 3.12% 10.16% 13.11% 4049.3 3173.3 8
7 U.S. S&P 500 1213.54 2.55% 8.53% 6.61% 1214.17 1053.41 6
8 Germany Xetra Dax 4261.79 2.52% 8.91% 4.52% 4262.24 3618.58 3
S&P/TSX
9 Canada composite 9287.4 2.47% 7.22% 8.81% 9287.4 7859.39 14
10 Switzerland Swiss Market 5686.5 2.43% 4.79% -0.35% 5941.7 5264.5 11
11 Egypt CMA 1209.43 2.30% 12.42% 25.70% 1219.22 797.24 7
12 Hong Kong Hang Seng 14196.95 2.13% 8.78% 14.10% 14339.06 10917.65 2
13 Singapore Straits Times 2058.12 1.44% 3.84% 11.74% 2076.59 1690.35 12
14 UK FTSE 100 4798.1 1.18% 4.81% 5.82% 4823.8 4283 13
15 France CAC 40 3824.83 1.11% 4.11% 1.39% 3856.01 3452.41 10

ACCOUNT BALANCE

Rank Country 2004 Ratio* 2003 2005+ Rank Country 2004 Ratio* 2003 2005+
1 Hong Kong 16.404 10 16.697 16.598 9 United Kingdom -43.338 -2 -33.39 -43.098
2 Taiwan 21.3 6.9 29.202 19.378 10 Spain -33.066 -3.4 -23.549 -36.462
3 Germany 118.525 4.4 52.933 129.726 11 New Zealand -4.102 -4.4 -3.267 -4.151
4 Japan 159.402 3.4 136.238 148.931 12 Australia -32.036 -5.3 -30.212 -30.248
5 Canada 28.195 2.9 17 25.243 13 United States -631.268 -5.4 -530.669 -641.678
6 Denmark 4.289 1.8 6.327 4.543
Totals in billions of U.S. dollars
7 France -12.761 -0.6 5.474 -13.246 +
*Ratio: Account balance in percent of GDP; Estimate
8 Italy -18.074 -1.1 -21.942 -13.315
Source: International Monetary Fund, World Economic Outlook
Database, October 2004

CURRENCY TRADER • January 2005 51

 GLOBAL NEWS BRIEFS
AMERICAS

Argentina’s third-quarter 2004 GDP grew by 10.9 per-
cent. The country’s jobless rate (not seasonally-adjusted) fell
1.6 percent in November to 13.20 percent.

Brazil’s economy grew at a 6.1-percent annual rate in the
third quarter of 2004, its biggest gain since 1996.
Unemployment in Brazil decreased by 0.4 percent to 10.5
percent in October.

Canada’s growth rate increased by 0.8 percent in the third
quarter compared to the previous quarter and rose by 3.3
percent year-to-year. A boom in manufacturing, wholesale
and retail sectors drove growth, but “the economy ended the
quarter on a weak note, with no growth in September, fol-
lowing 0.4 percent growth in August and 0.3 percent in July,”
according to a Statistics Canada press release. Canada’s
unemployment rate rose slightly to 7.3 percent in November.

Mexico had a record high $61.496 billion in foreign reserves
at the end of 2004, as the No. 5 crude oil producer in the world
benefitted from high oil prices even as the central bank
attempted to control growth. The total is up from $57.4 billion
at the end of 2003. Mexico has deposited most of the money in
a special savings fund or spent it on infrastructure projects.

Year-end inflation in Venezuela dropped nearly eight
percent from 2003, finishing at 19.2 percent. The country is
one of many that benefitted greatly from the oil-price boom,
as increased revenue allowed the government to increase
spending. Unemployment also improved, as the December
rate of 10.9 percent was down from 12.8 percent the month
before and 14.6 percent from a year ago.
EUROPE

France’s October jobless rate stayed stable at 9.9 percent,
showing no change from either the previous quarter or the
same month in 2003, according to preliminary figures.
“Bolstered by a rise in industrial output and healthier con-
sumption, France’s GDP could increase by 0.6 percent in Q4,
bringing growth for 2004 as a whole to 2.1 percent –– the
best performance since 2000,” said the INSEE, France’s
National Institute of Statistics and Economic Studies in its
December 2004 economic analysis report.

Germany’s jobless rate for November increased to 10.3
percent, which was a 0.2 percent gain on October 2004 and
a 0.3 percent gain on November 2003.
52

The United Kingdom’s unemployment rate for the third
quarter decreased by 0.1 percent compared to the previous
quarter and dropped 0.3 percent compared to the same
quarter in 2003, according to preliminary data from the
United Kingdom Office of National Statistics.
ASIA & THE SOUTH PACIFIC

Australia’s third quarter economy grew by 0.3 percent
compared to Q2 but increased by 3.0 percent compared to
the same quarter in 2003. Unemployment in November
dropped 0.1 percent to 5.2 percent compared to the previous
month and fell 0.5 percent compared to November 2003.

Hong Kong’s preliminary GDP in the third quarter increased
1.9 percent from the previous quarter and 4.4 percent com-
pared to Q3 2003. The November unemployment figure
came in at 6.7 percent, unchanged from October 2004. “The
upturn of the Hong Kong economy extended well into the
third quarter of 2004,” said K.C. Kwok, the government
economist, in a press release. “The Hong Kong economy
should be on track for the 7.5-percent growth forecasted in
August.”

Japan’s October jobless rate grew 0.1 percent compared
to the previous month, but fell 0.4 percent compared to the
same month in 2003.

Toshiro Muto, deputy governor of the Bank of Japan
(BOJ), said in late December he was unsure if the country
would be able to escape deflation in 2005. Although the fis-
cal year does not begin until April, Muto told a Japanese
newspaper it was not clear whether deflation would be
eliminated in 2005-06, or if the country would have to wait
until 2006-07. The BOJ will continue its fiscal policy of
"quantitative easing" until it determines the economy is
ready for a shift — most likely, when it sees year-to-year
increases in the Consumer Price Index.
AFRICA

South Africa’s economy grew 5.6 percent in the third
quarter compared to Q2, as growth accelerated for the fifth
straight quarter. “All the main sectors –– agricultural pro-
duction, mining, manufacturing, services — recorded strong
growth in the third quarter of 2004,” said the South African
Reserve Bank in its December 2004 Quarterly Bulletin.
January 2005 • CURRENCY TRADER
 INDICATORS IN THIS ISSUE

Elliott Wave basics

BY ACTIVE TRADER STAFF

E
lliott Wave is a descriptive form of technical
analysis based on the concept that price action
unfolds in identifiable, structured waves that
define both trend and countertrend moves.
Ralph Nelson Elliott (1871-1948) introduced his ideas
through a series of letters to Charles J. Collins, who help
Elliott published The Wave Principle in 1938. Also with
Collins’ aid, Elliott published a series of articles in Financial
World magazine in 1939.
Today, Elliott Wave theory is probably best known
through the work of Robert R. Prechter Jr., who in 1978 coau-
thored with A.J. Frost the book, Elliott Wave Principle: Key to
Stock Market Profits (John Wiley & Sons, 10th edition, 2001).
Waves and fractals
Elliott Wave theory contains elements of a mathematical
concept known as a fractal, which is an object or shape that
has self-similarity on different scales.
Fractals are found in a variety of phenomena. For exam-
ple, if you look at a mountain from a distance you see a
peak with relatively smooth sides leading up to it. As you
move closer, you begin to see how the sides of the mountain
are actually made up of smaller sub-peaks and sides, which
consist of even smaller peaks and sides, all sharing a simi-
lar basic structure or pattern.
Similarly, part of wave theory is the idea that any wave
cycle is part of a larger wave cycle that adheres to the same
rules, and is also composed of smaller wave cycles with the
same structure.
FIGURE 1 — THE BASIC WAVE COUNT
The impulse (trend) move consists of waves 1 to 5. The
corrective (countertrend) move consists of waves a, b and c.
Many devotes of Elliott Wave consider price action to be
a natural phenomena driven by human emotion, which
makes the fractal aspect of wave patterns an effective way
to understand and describe the price movement.
Types of waves: Impulses and corrections
Because Elliott Wave is a descriptive, rather than quantita-
tive, analytical approach, it is really a type of visual pattern
recognition. Figure 1 shows the basic Elliott Wave count,
which consists of two phases: the first consists of numbered
price moves, or waves, while the second contains lettered
price waves. Numbered phases are “impulse” or trending
waves; the lettered phases are called “corrective” or coun-
tertrend waves.
Impulse moves are composed of five waves (1 to 5), with
waves 1, 3 and 5 in the direction the dominant trend, and
waves 2 and 4 against the trend. A basic rule of wave iden-
tification is the bottom of wave 4 cannot overlap the top of
wave 1.
Corrective moves consist of three waves, labeled a, b, c. A
five-wave impulse move followed by a three-wave correc-
tive move completes one wave cycle.
Figure 2 , which shows how wave patterns are subdivid-
ed into smaller-degree patterns or expanded into patterns of
a higher degree, illustrates the fractal aspect of Elliott Wave.
continued on p. 54
FIGURE 2 — SUBWAVES:
THE “FRACTAL” NATURE OF ELLIOT WAVE
This chart shows how any wave consists of subwaves with
the same structure. For example, wave 1, which is the first
upwave in an impulse wave, is made up of five smaller
impulse waves.

5 (1)
5
v
iii
b
3 i b
3 iv
a v
iii a
1 ii
1 4 v
c i c
iv 4
iii (2)
ii
i
2 iv 2
ii

CURRENCY TRADER • January 2005 53


The following examples are described in terms of an
uptrend, but the same patterns are used if the trend is
down.
Interpreting waves
There are psychological and practical interpretations associ-
ated with the wave patterns shown in Figures 1 and 2. For
example, Wave 1 is the first advance in a trend move and
usually will be driven by short covering and professional
buying, indicating a turn from bearishness to bullishness.
Wave 2, which corrects wave 1, is often accompanied by
a high degree of pessimism. For example, if this wave count
was occurring on a weekly chart of the stock market, a
wave-2 bottom might coincide with dire forecasts about
both the economy and the stock market.
Following the wave-2 low (which must be above the
wave 1 low), a rally above the peak of wave 1 (signaling a
wave-3 advance) will be considered a very bullish event,
most likely occurring in tandem with news that has sud-
denly turned favorable. At this point, investor sentiment
will be optimistic.
Wave 4 corrects wave 3. Now, the mood of the market
will likely remain stable. Wave 5 can be considered the last
hurrah, a peak in optimism immediately before a decline
that corrects the entire five-wave impulse advance. The typ-
ical target for the subsequent a-b-c corrective phase is the
wave-4 low. Sometimes wave 5 will take the form of an
upward diagonal triangle.
Regarding impulse waves: Wave 3 can never be the short-
est impulse wave in a valid wave pattern, but either wave 1
or 5 can be longer than the other.
Regarding the relationship between corrective waves 2
and 4 within an impulse move: According to Elliott Wave
theory, if corrective wave 2 was long and complex, correc-
tive wave 4 should be simple and swift, and vice-versa –– a
concept referred to as “alternation.”
The Fibonacci connection
Fibonacci ratios (i.e., 38.2 percent, 61.8 percent, 138 percent,
and so on) play an import role in Elliott Wave analysis. (See
“The Fibonacci series,” for an explanation of Fibonacci
numbers.)
In Elliott analysis, one price wave should typically be
able to be described in terms of a Fibonacci relationship to
another wave –– for example, the length of wave 3 might be
138.2 percent of the length of wave 1, or wave 2 could bot-
tom at the 61.8-percent retracement level of wave 1.

This material was excerpted from the article, “The Elliott Wave
challenge,” from the March 2004 issue of Active Trader magazine.
54
The Fibonacci series
T
he Fibonacci series is a number progression in
which each successive number is the sum of
the two immediately preceding it: 1, 2, 3, 5, 8,
13, 21, 34, 55, and so on.
As the series progresses, the ratio of a number in the
series divided by the immediately preceding number
approaches 1.618, a number that is attributed signifi-
cance by many traders because of it appearance in nat-
ural phenomena (the progression a shell’s spiral, for
example), as well as in art and architecture (including
the dimensions of the Parthenon and the Great
Pyramid). The inverse, .618 (.62), has a similar signifi-
cance.
Some traders use fairly complex variations of
Fibonacci number to generate price forecasts, but a
basic approach is to use ratios derived from the series to
calculate likely price targets.
For example, if a stock broke out of a trading range
and rallied from 25 to 55, potential retracement levels
could be calculated by multiplying the distance of the
move (30 points) by Fibonacci ratios –– say, .382, .50
and .618 –– and then subtracting the results from the
high of the price move. In this case, retracement levels
of 43.60 [55 - (30*.38)], 40 [55 - (30*.50)] and 36.40 [55
- (30*.62)] would result.
Similarly, after a trading range breakout and an up
move of 10 points, a Fibonacci follower might project the
size of the next leg up in terms of a Fibonacci ratio ––
e.g., 1.382 times the first move, or 13.82 points in this
case.
The most commonly used ratios are .382, .50, .618,
.786, 1.00, 1.382 and 1.618. Depending on circum-
stances, other ratios, such as .236 and 2.618, are used.
Additional reading
The following articles have more information about
Fibonacci numbers:
“Technical Tool Insight: Fibonacci ratios” (Active Trader,
April 2002).
This is a detailed primer on the properties of Fibonacci
numbers.
“Absolute price projections,” by Tom DeMark and
Rocke DeMark (Active Trader, July 2004).
This article explores the authors’ unique application of
Fibonacci ratios to determine potential price targets.
You can purchase and download past Active Trader arti-
cles at www.activetradermag.com/purchase_articles.htm .
CURRENCY TRADER • January 2005