Even with 30 years of navigating the currency markets as
trader, advisor and analyst, I still argue that consistent success
in predicting currency rate moves is difficult to achieve. My
longevity in the markets does indicate, however, that I have an
approach to market analysis that gets me into winning strategies
more often than not (and more often than most). My approach
combines three distinct types of analysis: fundamental, technical
and sentiment.
I am a firm believer that the best currency
players in the market (certainly those that have skin in the game)
base their decisions on some combination of these three types of
analysis, as I do.Fundamental Analysis : This type of analysis is
the most commonly employed by currency market participants. It is
the study of economic news and information that can influence the
macroeconomic fortunes of the countries whose currencies are being
analyzed. A country's economic data (GDP, industrial production,
employment, etc.), interest rate levels and international trade and
investment flow data are under scrutiny by fundamental analysts. It
is what we learned in Econ 101.
The fundamental data that are followed the most closely at the
moment are U.S. employment data and U.S. housing data.
Interestingly, aside from housing data in the UK, GDP growth in
China and interest rates in Australia and New Zealand, very few
fundamental data from other countries is significant enough to move
or influence the currency markets to any great extent as is U.S.
data. We are definitely the 800-pound gorilla in the
marketplace.
As most of us are painfully aware, U.S. employment and housing
data remain at depressed levels - this has been dollar-bearish. In
fact, the market expects that until employment picks up (even if
housing picked up), the Fed will keep interest rates low...very
low. Global investors and speculators will, therefore, continue to
borrow dollars cheaply, and then sell them in favor of currencies
with more attractive interest rates (a.k.a. the "dollar carry
trade"). This explains why the currencies with the highest
short-term interest rates - the Brazilian real, the South African
rand, the Australian dollar, and the New Zealand dollar - also
happen to be the currencies which have appreciated the most against
the dollar this year at 29 percent, 28 percent, 25 percent and 24
percent respectively.
Technical Analysis : There are 46 currencies that
are actively traded in the marketplace. The overwhelming amount of
fundamental data available on these 46 countries explains why
technical analysis of the currency markets is becoming more
widespread than fundamental analysis. Technical analysis of the
currencies entails the study of historical price data - more often
than not, simply open-high-low-close FX rate data. The study of
this data is typically done using charts, where one can observe
price patterns, trends and momentum.
As tech guru John J. Murphy stated, "While the fundamental side of
the financial equation addresses the what and why of market
dynamics, the technical side is primarily concerned with the when
and where." In other words, the technician, while having some
interest in the cause, is much more focused on the effect.
Briefly, there are three main principals of technical analysis: 1)
the market discounts everything (all relevant information about a
currency is reflected in the current rate); 2) prices move in
trends (once a trend is clear, the probability of that trend
continuing is high); and 3) history repeats itself (traders
collectively repeat the behavior of the traders that preceded them
and their emotions regarding prices rotate from greed to fear and
optimism to pessimism during market peaks and troughs).
The chart below shows the U.S. dollar index, a weighted average of
the exchange rates of six major world currencies - the euro,
Japanese yen, British pound, Canadian dollar, Swedish krona, and
Swiss franc.
Source: SVB Financial Group , Bloomberg
Technical analysts quickly point out that the trend for the dollar
is clearly down. Not only is the index trading well beneath the
down trendline (the blue dashed line), but the two long-term moving
averages (MAs) of the index (the two most popular MAs are the
50-day and 200-day) crossed over each other (an important bearish
signal) in May, and both averages are simultaneously declining
(another bearish signal).
Sentiment Analysis : This last type of analysis is
grounded in human nature. It is where we try to understand crowd
opinion or herd mentality, and how that may influence FX rates.
Sentiment analysis is often my best bet for catching market
reversals.
On a qualitative basis, we can observe consumer confidence data.
Since the American consumer is looked upon by countries all over
the world as the consumer of last resort, the currency market pays
close attention to data on consumer confidence/sentiment for hints
about global trade and economic growth. The market interprets a
lack of confidence by American consumers as a sign of a weakening
economy and low interest rates, and leading to, once again, a weak
dollar.
On a quantitative basis, I follow the Commitments of Traders (COT)
reports, which are published weekly by the Commodity Futures
Trading Commission (CFTC). The reports detail "open interest" on
U.S. exchange-traded (futures) contracts, distinguishing between
commercial and non-commercial positions. I use the data to help
identify extreme positions (on a historical basis) of long or short
currencies held by large non-commercial speculators. It is widely
accepted that the non-commercial traders -individual traders, hedge
funds, and financial institutions - have a greater impact on the
market than do commercial hedgers. When extreme positions in a
currency are reported, the market for that currency can be
considered excessively bullish or bearish, and then a more
defensive strategy is recommended. The most recent COT report shows
that short U.S. dollar/long foreign currency positions are not at
extreme levels, so further weakness in the dollar is certainly
possible.
So, now you know three types of analysis that can be used when
navigating the turbulent waters of the currency markets. They
complement each other well, giving the analyst a multidimensional
picture of the foreign currency under scrutiny. If time constraints
and availability of data make it difficult to delve deeply into all
three, feel free to contact your SVB foreign exchange advisor or
trader for assistance.