Trader Resources

Forex positioning analytics available

The forex broker Saxo Bank has an interesting set of analytics some folks may find very interesting. It’s kind of like a Commitment of Traders report for exchange rate pairs based on their customers in that it shows the balance of longs and shorts.

If nothing else, the graph above shows just how dominant EUR/USD is in terms of retail forex trading volume. The other pairs shown don’t combine to match it.

You can change the granularity of the data depicted on the chart both in terms of the days included and whether you’re looking at hourly or daily data. There’s a set of explanations included on the page down below the charts. For forex traders, and perhaps folks looking at the macro view, this could be a useful tool.

Trading Book Reviews

Book Review: Investing with Volume Analysis

[easyazon-link asin=”0137085508″][/easyazon-link]If you want to learn just about everything there is to know about incorporating volume in your trading or investing you’re going to want to pick up a copy of [easyazon-link asin=”0137085508″]Investing with Volume Analysis[/easyazon-link] by Buff Dormeier. The author is a Chartered Market Technician (CMT) and an experienced money manager and he’s pulled together for this book a very comprehensive collection of volume studies and indicators, including some of his own devising.

This isn’t just some encyclopedia of volume analysis tools, though. There is considerable discussion of how to implement them, including studies demonstrating their performance. The author also discusses recent developments (high frequency trading, etc.) in the markets and their impact on volume and the analysis thereof.

My one issue with the book is that it has the feel of a manifesto, especially early on, and there are some religious undertones which may bother some readers. Most of that stuff is in the first few chapters which provide some background and historical perspective of volume and technical analysis. At times I found the reading slow going through that section, though it gets easier later.

All in all, I found this a very useful book. If you are looking to use volume in your trading/investing and market analysis, this is definitely the book for you.

Make sure to check out all my trading book reviews.

Trading Tips

Volatility Changes Across Markets

A recent blog post got me thinking about where volatility stands now compared to where it’s been. Here’s what I found for stocks and the dollar. Both of the charts below is a weekly which includes two measures for viewing volatility. Normalized Average True Range (N-ATR) measures average period high/low ranges (You can find articles I’ve written about N-ATR at Trade2Win and TASC). The Band Width Indicator (BWI) measures the distance between the Bollinger Bands, which is standard deviation of closing prices.

Dollar Index
Here we see that while volatility has certainly fallen well off from where it was during the worst of the financial crisis, it hasn’t quite got back down to average levels from before then. It’s worth noting, though, that volatility heading into the start of the problems in 2007 was ridiculously low. I don’t expect to see it get back to those kinds of levels.

S&P 500 Index
Volatility in the stock market, however, has now fallen back to about the same levels it was at during the middle of the last decade. This is something very important to keep note of because N-ATR tends to be low turning sustained uptrends, but rise into market tops.

Trading Tips

Some Numbers on Stock Market Earnings Reactions

I’m reading a book on trading based on company earnings announcements at the moment. I’ll post a review when I’m done, but there was something I wanted to share right away. It speaks to the question “Why didn’t the market rise on the positive news?” that comes up all the time (and which is among the questions answered in the Trading FAQs book). The book has a table in it showing how stocks have reacted to earnings surprises over I believe a 25-year period. It breaks down like this:

Positive Earnings Surprise
Market Rallies 60.55%
Market Falls 39.45%

Negative Earnings Surprise
Market Falls 61.05%
Market Rallies 38.95%

Good news isn’t always good news and bad news isn’t always bad news.

Trading Tips

Using Secondary Indications in Your Market Analysis

Yesterday Adam at Forex Blog put up a blog post looking at the British Pound, specifically in terms of GBP/USD. He throws a lot of different stuff into his assessment of the UK currency, part of which is looking at the prospects for a rate hike by the Bank of England. To that end, let me share two charts I keep an eye on in my work.

This first chart shows the spread of UK 2 year Gilt rates over the US 2yr Treasury Note rate, with the spread’s correlation to GBP/USD in red as the lower plot.

The second chart is the same as the one above, but swapping German Bunds in place of US Treasuries and running the correlation against EUR/GBP instead of GBP/USD.

I offer up these charts for a couple of reasons. One is to show the sort of secondary analysis professionals use to assess the markets. Another is to show how frequently market correlations can change. We would expect a positive linkage between the UK/US rate spread and GBP/USD and a negative one between the UK/German spread and EUR/GBP, but that’s not always the case.

The third reason for showing these charts is to show what’s been going on in these spreads lately. The UK/German spread has fallen sharply, strongly indicating the market’s view on whether it will be the ECB or BoE the moves first to hike rates has moved strongly in favor of the former. Things are less dramatic in the UK/US spread, but the breakdown there hints that fixed income traders have become less confident about a BoE rate move in the short-term in general, not just as opposed to the timing of the ECBs action. These are the sorts of things the professionals are looking at and thinking about in making their market judgements. It’s all related.

Trading Tips

Non-Arguments Against Fundamental Analysis

I’m going to join Adam from Forex Blog in taking on a post at Counting Pips titled The Problem with Forex Fundamental Analysis. Obviously, the focus of these pieces is on forex, but really the ideas apply to pretty much all markets.

The author of the latter has defined fundamental analysis in this way:

Fundamental analysis mainly focuses on the overall state of the economy, interest rates, monetary policies which are basically the economic conditions of a country.

These are three arguments made why having a fundamental analysis focus “will be disastrous”.

By the time you receive economic news it will have already been reflected in the charts.
This will tend to be true if the data is largely anticipated. If everyone expects the Fed to hike rates by 25bp at the next meeting then that is bound to get factored into market prices in advance of it happening. A recent example of this is the rise in the euro following hints from the head of the ECB that there could be a rate hike in April.

This, however, doesn’t not account for surprises where an event or data item is nowhere near market expectations. Those sorts of developments are the ones that produce high volatility reactions.

But it doesn’t take a big variance from expectations to cause a market reaction. Unless the market is 100% sure of something there will remain room for reaction. Think of it this way. If the market is only 75% sure the Fed is going to raise rates at its next meeting, it’s probably only going to price about 75% of the hike into current prices. This is why trades pay such close attention to all the Fed speak so they can gauge the probabilities and factor them in.

Economic data is skewed and biased by those reporting it
This may be true, but I’m not inclined to think it matters. Traders and market analysts tear apart every piece of data they get their hands on to see what’s what. They also have secondary sources of information beyond just that reported by the government. They know when things look dicey and react accordingly.

Everyone reacts the same way to news, producing a herd mentality
This would seem to tie in closely with the question from my Trading FAQs book “Why doesn’t everyone trade in the same direction?” The fact of the matter is, they don’t. Anyone who’s been in the markets long enough has seen plenty of times when the market reacts very strongly in one direction only to eventually reverse. That seems pretty good evidence to me that not everyone is included in the initial herd.

But We Miss the Point Entirely
All of the arguments against fundamental analysis listed above are strongly slanted toward trading off immediate term developments – the data and news that’s just hit the wires. This, though, isn’t fundamental trading. It’s news trading. It’s trying to figure out what the market is expecting and how it’s positioned ahead of time and knowing how best to react to the headlines when they hit. Fundamental analysis is taking the bigger picture view with macro trends and valuations in mind. That’s the complete opposite to news trading.

If you want a reason not to use fundamental analysis in your trading, there’s really one one major one. Because of it’s longer timeframe focus, fundamental analysis is of little use for short-term traders beyond providing of the underlying macro scenario.

The Basics

Top Factors Influencing Exchange Rates

During my usual roaming around the web I came across an entry from Oanda titled Top 5 Factors Affecting Exchange Rates. Those five factors are:

1. Interest Rates
2. Employment Outlook
3. Economic Growth Expectations
4. Trade Balance
5. Central Bank Actions

I think whoever authored this item actually made things a lot more complicated than need be and has things here are a couple of different levels in the discussion. There are only two things which impact the exchange rate of a currency – items which speak directly to the supply/demand equation. One is capital flow. The other is trade flow. Everything else speaks to one or both of those primary movers.

A swirl of overlapping influences
Let’s take the first entry above, interest rates, as an example. What impact does the level of interest rates, or the change in that level, have on a currency’s exchange rates? The most direct impact is on the capital flow side in terms of making a currency more or less attractive to investors (either for investing or for borrowing, as we’ve seen from the carry trade). Interest rates also factor into the trade flow side in as much as they have an impact on the domestic economy and the ability of domestic consumers to purchase and/or produce trade goods.

The second item on the list is Employment Outlook, which to my mind either feeds up into or spins off out of #3, Economic Growth Expectations. That then speaks to the trade flow side of equation (#4) and prospectively to interest rates as well. As noted above, that latter element feeds through into the capital flow side of the equation.

And keep in mind that where exchange rates are concerned everything must be taken in comparison to something else. You cannot look at one economy in a vacuum because the exchange rates are determined by looking at two matched against each other.

The one “external” force in all this is government or central bank intervention. Some are quite active in attempting to influence exchange rates directly. For example, at this writing Brazil is buying dollars twice a day to keep the real from appreciating. Not all countries do this, though, and most of the time it’s only done in perceived extreme circumstances to keep the markets getting out of order.

Another kind of intervention is government regulation and fiscal policy. These things, however, flow through into the capital flow and trade flow considerations. They do not directly act on exchange rates.

Now, some will say that inflation directly impacts the value of a currency. In purchasing power terms that is most definitely true. Inflation only has an indirect impact on exchange rates, however, as a contributing factor in the determination of capital and trade attractiveness. After all, if every economy is experiencing 10% inflation, there is no relative impact for exchange rates.