Foreign Exchange Technical Market (Part 3))

Commodity Prices and Currency Movements

Predicting the next move in the markets is the key to making money in trading - but putting this simple concept into action is much harder than it sounds. Professional forex traders have long known that trading currencies requires looking beyond the world of FX. The fact is that currencies are moved by many factors - supply and demand, politics, interest rates, economic growth, and so on. More specifically, since economic growth and exports are directly related to a country's domestic industry, it is natural for some currencies to be heavily correlated with commodity prices. The top three currencies that have the tightest correlations with commodities are the Australian dollar, the Canadian dollar and the New Zealand dollar. Other currencies that are also impacted by commodity prices, but have a weaker correlation, are the Swiss franc and the Japanese yen. Knowing which currency is correlated with what commodity and why can help traders understand and predict certain market movements. Here we look at currencies correlated with oil and gold and show you how you can use this information in your trading.

In 2005, oil and gold set record highs and were two of the biggest drivers of currency movements that year. In fact, the dollar reacted very differently across various currencies simply because of that particular currency's correlation with commodity prices. Therefore, knowing what type of movement to expect in the Canadian dollar if oil prices drop, for example, will definitely help you make smarter decisions.

Oil and the Canadian Dollar
Oil is one of the world's basic necessities - at least for now, most people in developed countries cannot live without it. In 2005, the price of oil at its peak was close to 65% higher than where it started in January of the same year. Since hitting a high above $70 a barrel in August 2005, oil prices retraced 18%, ending 2005 approximately 40% higher. There was a time when we would expect such volatility only from a penny stock, but this has become our reality. The rise in oil prices has brought a great big smile to the faces of oil producers - and a nice fat boost to their pocketbooks. Oil consumers, on the other hand, have had to pinch pennies throughout the rally. As a net oil exporter, Canada has benefited the most from the rally in oil, while Japan - a major net oil importer - has suffered the most.

Over the past three years (2003-2005), the correlation between the Canadian dollar and oil prices has been approximately 80%. Canada is the ninth largest producer of crude oil in the world, and it continues to climb up the list, with production in oil sands increasing regularly. In 2000, Canada surpassed Saudi Arabia as the United States' most significant oil supplier. Unbeknownst to many, the size of Canada's oil reserves is second only to those in Saudi Arabia. The geographical proximity between the U.S. and Canada, as well as the growing political uncertainty in the Middle East and South America, makes Canada one of the more desirable places from which the U.S. can import oil. But Canada does not service only U.S. demand. The country's vast oil resources are beginning to get a lot of attention from China, especially since Canada has recently stumbled upon a new stash of oil after a reclassification of its Alberta oil sands to the "economically recoverable" category. This makes the Canadian dollar one of the currencies best positioned to benefit from an ongoing surge in oil prices.

The chart below shows the clearly positive relationship between oil and the Canadian loonie. In fact, it should come as no surprise that the price of oil actually acts as a leading indicator for the price action in the CAD/USD. Since the traded instrument is the inverse, or USD/CAD, it's important to note that based on the historical relationship, when oil prices go up, USD/CAD falls.

Oil and the Japanese Economy
At the other end of the spectrum, Japan imports 99% of its oil (compared to the U.S., which imports 50%). It is one of the world's largest net oil importers. Japan's lack of domestic sources of energy, and its need to import vast amounts of crude oil, natural gas and other energy resources, makes it particularly sensitive to changes in oil prices. Japan also lacks the flexibility to switch to nuclear power because it is a huge net importer of uranium for its nuclear power plants. In 2003, the country's dependence on imports for primary energy stood at more than 79%. Oil provided Japan with 50% of its total energy needs, coal with 17%, nuclear power 14%, natural gas 14%, hydroelectric power 4%, and renewable sources a mere 1.1%. Therefore, when oil prices skyrocket, the Japanese economy suffers.

An Attractive Oil Play: CAD/JPY
Looking at this from a net oil exporter/importer perspective, the currency pair that tops the list of currencies to trade to express a view on oil prices is the Canadian dollar against the Japanese yen. In fact, over the past two years, CAD/JPY has had an 85% positive correlation with oil prices. As we can see in Figure 2 below, more often than not, oil prices tend to be the leading indicator (as with USD/CAD) for CAD/JPY price action with a noticeable delay. As oil prices continued to rally, CAD/JPY easily broke the $100 level to hit a high of $105 before reversing. The "Oil vs CAD/JPY" chart also clearly shows the delayed reversal in CAD/JPY - which would have been a perfect trading opportunity.
Figure 2 - A look at the correlation between the price of oil and the price action in the CAD/JPY from December 2002 to September 2005

Going for Gold
Gold traders may also be surprised to hear that trading the Australian dollar is just like trading gold. As the world's third largest producer of gold, the Australian dollar has an 85% positive correlation with the precious metal. Generally speaking, this means that when gold prices rise, the Australian dollar appreciates as well. The proximity of New Zealand to Australia makes Australia a preferred destination for exporting New Zealand goods. Therefore, the health of New Zealand's economy is closely tied to the health of the Australian economy, which explains why the NZD/USD and the AUD/USD have had a 96% positive correlation over the past three years (2003-2005). Interestingly enough, the NZD/USD actually has an even stronger correlation with gold than the AUD/USD does - the correlation has been 90% over the past three years.

Figure 3 - A look at the correlation between the price of gold and the price action in the NZD/USD from December 2002 to September 2005

A weaker, but still important, correlation is that of gold prices and the Swiss franc. The country's political neutrality and the fact that its currency used to be backed by gold have made the franc the currency of choice in times of political uncertainty. From December 2002 until September 2005, USD/CHF and gold prices had an 85% positive correlation. However, the relationship broke down somewhat in September 2005 as the U.S. dollar decoupled from gold price movements.
Trading Currencies as a Supplement to Trading Oil or Gold
For seasoned commodity traders, it may also be worthwhile to look at trading currencies as an alternative or a supplement to trading commodities. In addition to being able to capitalize on a similar outlook (e.g. higher oil), traders may also be able to earn interest if they are on 2% margin or higher. When trading currencies, you are dealing with countries, and countries have interest rates, of course. For example, in the CAD/JPY trade, a trader who was long CAD/JPY would be able not only to make nice gains, but also to earn up to 3% in interest income. The rough estimate of 3% comes from taking Canada's central bank rate, which is the amount earned, and subtracting the 0% rates paid for shorting the Japanese yen. These are un-leveraged rates, which means that with 10 times leverage, for example, net of any exchange rate changes, the interest income would be that much higher. Leverage also makes the trade riskier, which is certainly something to keep in mind when trading FX.

Along the same lines, if you shorted CAD/JPY to express a short oil view, you would end up paying interest. If you're a commodity trader looking for a bit of a change from the usual pro gold trade (for example), commodity currencies such as the AUD/USD and NZD/USD provide good opportunities worth looking into.

Conclusion
If you want to trade commodity currencies, the best way to use commodity prices in your trading is to always keep one eye on movements in the oil or gold market and the other eye on the currency market, watching how quickly it responds. Due to the slightly delayed impact of these movements on the currency market, there is generally an opportunity to overlay a broader movement that is happening in the commodity market to that of the currency market. Bottom line, it never hurts to be more informed about commodity prices and how they drive currency movements.
Capture Profits Using Bands And Channels

Widely known for their ability to incorporate volatility and capture price action, Bollinger bands have been a favorite staple of traders in the FX market. However, there are other technical options that traders in the currency markets can apply to capture profitable opportunities in swing action. Lesser-known band indicators such as Donchian channels, Keltner channels and STARC bands are all used to isolate such opportunities. Also used in the futures and options markets, these technical indicators have a lot to offer given the vast liquidity and technical nature of the FX forum. Differing in underlying calculations and interpretations, each study is unique because it highlights different components of the price action. Here we explain how Donchian channels, Keltner channels and STARC bands work and how you can use them to your advantage in the FX market.

Donchian Channels
Donchian channels are price channel studies that are available on most charting packages and can be profitably applied by both novice and expert traders. Although the application was intended mostly for the commodity futures market, these channels can also be widely used in the FX market to capture short-term bursts or longer-term trends. Created by Richard Donchian, considered to be the father of successful trend following, the study contains the underlying currency fluctuations and aims to place profitable entries upon the start of a new trend through penetration of either the lower or upper band. Based on a 20-period moving average (and thus sometimes referred to as a moving average indicator), the application additionally establishes bands that plot the highest high and lowest low. As a result, the following signals are produced:
• A buy, or long, signal is created when the price action breaks through and closes above the upper band.
• A sell, or short, signal is created when the price action breaks though and closes below the lower band.
The theory behind the signals may seem a little confusing at first, as most traders assume that a break of the upper or lower boundary signals a reversal, but it is actually quite simple. If the current price action is able to surpass the range's high (provided enough momentum exists), then a new high will be established because an uptrend is ensuing. Conversely, if the price action can crash through the range's low, a new downtrend may be in the works. Let's look at a prime example of how this theory works in the FX markets.
Keep an Eye on Momentum

One of the key tenets of technical analysis is that price frequently lies, but momentum generally speaks the truth. Just as professional poker players play the player and not the cards, professional traders trade momentum rather than price. In forex (FX), a robust momentum model can be an invaluable tool for trading, but traders often grapple with the question of what type of model to use. Here we look at how you can design a simple and effective momentum model in FX using the moving average convergence divergence (MACD) histogram.

Why Momentum?
First, we need to look at why momentum is so important to trading. A good way to understand the significance of momentum is to step outside of the financial markets altogether and look at an asset class that has experienced rising prices for a very long time - housing. House prices are measured in two ways: month-over-month increases and year-over-year increases. If house prices in New York were higher in November than in October, then we could safely conclude that demand for housing remained firm and further increases were likely. However, if prices in November suddenly declined from prices paid in October, especially after relentlessly rising for most of the year, then that might provide the first clue to a possible change of trend. Sure, house prices would most likely still be higher in a year-over-year comparison, lulling the general public into believing that the real estate market was still buoyant. However, real estate professionals, who are well aware that weakness in housing manifests itself far earlier in month-over-month figures than in year-over-year data, would be far more reluctant to buy under those conditions.

In real estate, month-over-month figures provide a measure of rate of change, which is what the study of momentum is all about. Much like their counterparts in the real estate market, professionals in the financial markets will keep a closer eye on momentum than they do on price to ascertain the true direction of a move.

Using the MACD Histogram to Measure Momentum
Rate of change can be measured in a variety of ways in technical analysis; a relative strength index (RSI), a commodity channel index (CCI) or a stochastic oscillator can all be used to gauge momentum. However, for the purposes of this story, the MACD histogram is the technical indicator of choice.
First invented by Gerry Appel in the 1970s, the MACD is one of the simplest, yet most effective, technical indicators around. When used in FX, it simply records the difference between the 26-period exponential moving average (EMA) and the 12-period exponential moving average of a currency pair. In addition, a nine-period EMA of MACD itself is plotted alongside the MACD and acts as a trigger line. When MACD crosses the nine-period line from the bottom, it signifies a change to the upside; when the move happens in the opposite manner, a downside signal is made.

This oscillation of the MACD around the nine-period line was first plotted into a histogram format by Thomas Aspray in 1986 and became known as the MACD histogram. Although the histogram is in fact a derivative of a derivative, it can be deadly accurate as a potential guide to price direction. Here is one way to design a simple momentum model in FX using the MACD histogram.

1. The first and most important step is to define a MACD segment. For a long position, a MACD segment is simply the full cycle made by the MACD histogram from the initial breach of the 0 line from the underside to the final collapse through the 0 line from the topside. For a short, the rules are simply reversed. Figure 1 shows an example of a MACD segment in the EUR/USD currency pair.

Figure 1

2. Once the MACD segment is established, you need to measure the value of the highest bar within that segment to record the momentum reference point. In case of a short, the process is simply reversed.

3. Having noted the prior high (or low) in the preceding segment, you can then use that value to construct the model. Moving on to Figure 2, we can see that the preceding MACD high was .0027. If the MACD histogram now registers a downward reading whose absolute value exceeds .0027, then we will know that downward momentum has exceeded upward momentum, and we'll conclude that the present set-up presents a high probability short.

If the case were reversed and the preceding MACD segment were negative, a positive reading in the present segment that would exceed the lowest low of the prior segment would then signal a high probability long.

Figure 2
What is the logic behind this idea? The basic premise is that momentum as signified by the MACD histogram can provide clues to the underlying direction of the market. Using the assumption that momentum precedes price, the thesis of the set-up is simply this: a new swing high in momentum should lead to a new swing high in price, and vice versa. Let's think about why this makes sense. A new momentum swing low or high is usually created when price makes a sudden and violent move in one direction. What precipitates such price action? A belief by either bulls or bears that price at present levels represents inordinate value, and therefore strong profit opportunity. Typically, these are the early buyers or sellers, and they wouldn't be acting so quickly if they didn't believe that price was going to make a substantive move in that direction. Generally, it pays to follow their lead, because this group often represents the "smart money crowd".

However, although this set-up may indeed offer a high probability of success, it is by no means a guaranteed money-making opportunity. Not only will the set-up sometimes fail outright by producing false signals, but it can also generate a losing trade even if the signal is accurate. Remember that while momentum indicates a strong presence of trend, it provides no measure of its ultimate potential. In other words, we may be relatively certain of the direction of the move, but not of its amplitude. As with most trading set-ups, the successful use of the momentum model is much more a matter of art than science.

Looking at Entry Strategies
A trader can employ several different entry strategies with the momentum model. The simplest is to take a market long or market short when the model flashes a buy or a sell signal. This may work, but it often forces the trader to enter at the most inopportune time, as the signal is typically produced at the absolute top or bottom of the price burst. Prices may continue further in the direction of the trade, but it's far more likely that they will retrace and that the trader will have a better entry opportunity if he or she simply waits. Figure 3 demonstrates one such entry strategy.

Figure 3

Sometimes price will retrace against the direction signal to a far greater degree than expected and yet the momentum signal will remain valid. In that case, some skilled traders will add to their positions - a practice that some traders have jokingly termed "SHADDing" (for "short add") or "LADDing" (for "long add"). For the novice trader, this can be a very dangerous maneuver - there is a possibility that you could end up adding to a bad trade and, therefore, compounding your losses, which could be disastrous. Experienced traders, however, know how to successfully "fight the tape" if they perceive that price offers a meaningful divergence from momentum.

Placing Stops and Limits
The final matter to consider is where to place stops or limits in such a set-up. Again, there are no absolute answers, and each trader should experiment on a demo account to determine his or her own risk and reward criteria. This writer sets his stops at the opposite 1 standard deviation Bollinger Band setting away from his entry, as he feels that if price has retreated against his position by such a large amount, the set-up is quite likely to fail. As for profit targets, some traders like to book gain very quickly, although more patient traders could reap far larger rewards if the trade develops a strong directional move.

Conclusion
Traders often say that the best trade may be the one you don't take. One of the greatest strengths of the momentum model is that it does not engage in low probability set-ups. Traders can fall prey to the impulse to try to catch every single turn or move of the currency pair. The momentum model effectively inhibits such destructive behavior by keeping the trader away from the market when the countervailing momentum is too strong.

Figure 4

As Kenny Rogers once sang in "The Gambler", "You've got to know when to hold them, and you got to know when to fold them". In trading, as in poker, this is the true skill of the game. The simple momentum model we've described here is one tool that we hope will help currency traders improve their trade selection process and make smarter choices.
Make Sharp Trades Using Andrew's Pitchfork

Invented by and named after renowned educator Dr Alan H. Andrews, the technical indicator known as Andrew's pitchfork can be used by traders to establish profitable opportunities and swing possibilities in the currency markets. On a longer-term basis, it can be used to identify and gauge overall cycles that affect the underlying spot activity. Here we explain what this indicator is and how you can apply it to your trades using two different approaches: trading within the lines and trading outside the lines.
Defining the Pitchfork
Available on numerous programs and charting packages, Andrew's pitchfork (sometimes referred to as "median line studies") is widely recognized by both novice and experienced traders. Comparable to the run-of-the-mill support and resistance lines, the application offers two formidable support/resistance lines with a middle line that can serve as both support/resistance or as a pseudo-regression line. Andrews believed that market price action would gravitate towards the median line 80% of the time, with wild fluctuations or changes in sentiment accounting for the remaining 20%. As a result, the overall longer-term trend will (in theory) remain intact, regardless of the smaller fluctuations. If sentiment changes and supply and demand forces shift, prices will stray, creating a new trend. It is these situations that can create significant profit opportunities in the currency markets. A trader can increase the accuracy of these trades by using Andrew's pitchfork in combination with other technical indicators, which we'll discuss below.

Applying the Pitchfork
In order to apply Andrew's pitchfork, the trader must first identify a high or low that has previously occurred on the chart. The first point, or pivot, will be drawn at this peak or trough and labeled as point A (as shown in Figure 1).

Once the pivot has been chosen, the trader must identify both a peak and a trough to the right of the first pivot. This will most likely be a correction in the opposite direction of the previous move higher or lower. Turning to Figure 1, the minor correction off of the trough (point A) will serve nicely as we establish both points B and C.

Once these points have been isolated, the application can be placed. The handle of the formation begins with the pivot point (point A) and serves as the median line. The two prongs, formed by the following peak and trough pair (points B and C), serve as the support and resistance of the trend.

Figure 1 - Application of Andrew's pitchfork to a chart showing the price action of the EUR/USD. The pivot point (A) has been drawn at a previously occurring trough, and points B and C have been established to the right of the pivot. The line drawn from point A is the median line, while the two "prongs" serve as support and resistance.

When the pitchfork is applied, the trader can either trade within the channel or isolate breakouts to the upside or downside of the channel. Looking at Figure 2, you can see that the price action works well serving as support and resistance where traders can enter off of bottoms (point E) and sell from tops (point D) as the price will gravitate towards the median. As always, the accuracy of the trade improves when confirmation is sought. A basic price oscillator will be just enough to add to the overall trade.

Figure 2 - Application of the pitchfork on an uptrending GBP/USD. Notice the multiple opportunities offered to the trader inside and outside the boundaries.

Additionally, the trader can initiate positions on breaks of the support and resistance. Two great examples are presented at points F and G. Here, the market sentiment shifted, creating price action that strayed from the median line and broke through the channel trendlines. As the price action attempts to fall back into the median area, the trader can capture the windfall that tends to happen. However, as with any trade, sound money management and confirmation must play important roles.

Trading Within the Lines
Let's take a look at how a trader might profit from trading within the lines. Figure 3 is a good example, as it shows us that the price action in the EUR/CAD currency pair has bounced off of the median line and has risen to the top resistance of the pitchfork (point A1). Zooming in a little closer in Figure 4, we see a textbook evening star formation. Here, the once-rising buying momentum has started to disappear, forming the doji, or cross-like, formation right below the upper prong. When we apply a stochastic oscillator, we see a cross below the signal line, which confirms downside momentum.

Taking these indications into consideration, the trader would do well to place the entry at point X (Figure 4), slightly below the close of the third candle. Using sound money management and including an appropriate stop loss, the entry would be executed on the downward momentum as the price action once again gravitates towards the median line. Even better, here, the trader would be entered into a profitable position of close to 1000 pips over the life of the trade.
Figure 3 - Another great setup in the EUR/CAD cross currency: we see a prime example of an "inside the line" profit opportunity as price action approaches the 1.5000 figure.
Figure 4 - A closer look at the opportunity reveals textbook technical formations that aid the entry. Here, the trader can confirm the trade with the downward crossover in the stochastic and the evening star formation.

Trading Outside the Lines
Although trading outside the lines occurs considerably less frequently than within, they can lead to extended runs. However, they can be slightly trickier to attempt. The assumption here is that the price action will gravitate back towards the median, like wayward price action within the lines. But it is possible that the market has decided to shift its direction; therefore, the break outside may very well be a new trend forming. To avoid a catastrophic loss, simple parameters are added and placed in order to capture the retracements into the channel and, at the same time, filter out adverse movements that ultimately result in traders closing their positions too early.

Looking at Figure 5, we see that the price action at point A offers such an opportunity. The chart shows that the EUR/USD price action has broken through support in the first week of April. Once the break has been identified, we isolate and zoom in to obtain a better perspective.

Figure 5 - Notice how the price action gravitates once again towards the median. This is a great opportunity, but money management and strategy remain important in capturing the run-up.

In Figure 6, the trader is offered multiple opportunities to trade a break back into the overall trend as the underlying spot consolidates in ranging conditions. However, the real opportunity lies in the break that occurs later on in October. More specifically, the trader can see that the price action ranges or consolidates prior to the break, establishing the $1.1958 support level (blue line). Using a moving average convergence divergence (MACD) price oscillator, the individual sees that a bullish convergence signal is forming, as there is a large peak and a subsequently smaller secondary peak in the histogram. The entry is key here. The trader will see a potential breakout opportunity as the price rises to test the upper resistance at $1.2446.

Figure 6 - The convergence in the MACD, combined with the decline in the underlying spot price, suggests a near-term upward break.

How would you place the entry in this example? First, you need to make sure that the upper resistance is tested before you even consider a trade. If the resistance is not tested, it may mean that a downward trend is in the works, and by knowing this, you will have saved yourself from the trouble of entering into a non-profitable trade. You can see in Figure 6 that the price action breaks back into the prongs in early October, hitting a high of $1.2446. If the price action can break above this resistance, it will confirm a further rise in the price action, as fresh buying momentum will have entered the market. As a result, you should place your entry 30 pips above the target (red line), with your subsequent stop applied upon entry. Once your order is executed, the stop should be applied 5 pips below the previous session low. Given buying momentum, the assumption is that the low will not be tested because the price action will continue to rise and not spike downward.

Breaking It Down Step-by-Step
Although the two methods discussed here (trading within the lines and trading outside the lines) may seem somewhat complex, they are quite easily applied when you break them down step-by-step. Traders will find that the pitchfork method yields far better results when applied to major currency pairs such as the EUR/USD and GBP/USD because of their nature to trend rather than range. Cross currencies, although they do exhibit trending patterns, tend to be choppier and yield less satisfying results.

Figure 7 - Identifying two great opportunities in the NZD/USD currency pair.

Now, let's break the process down. The NZD/USD currency pair, seen in Figures 7, 8 and 9, presents a perfect example of both "within the lines" and "outside the lines" opportunities that traders can capitalize on. First we'll take the in-line approach, choosing example A in Figure 7:
1. Identify price action that has broken through the median line and that is approaching the upper resistance prong.
2. Testing the upper resistance prong, recognize a textbook evening star or another bearish candlestick pattern. Looking at Figure 8, we see a textbook evening star formation at point X. This will serve as the first signal.
3. Confirm the decline through a price oscillator. In Figure 8, a downward cross occurs in the stochastic oscillator, confirming the following downtrend in the currency. Also notice how the cross occurs before the formation is complete, giving traders a heads up.
4. Place the entry slightly below the close of the third and final candle of the formation. As little as 5 pips below the low will usually suffice in these situations.
5. Apply a stop to the position that is approximately 50 pips above the entry. If the price action rises after the evening star, traders will want to exit as soon as possible to minimize losses but still maintain a healthy risk measure. In this example, the entry would ideally be placed at 0.6595, with a stop at 0.6645 and a target of 0.6454 - an almost 3:1 risk/reward ratio.

For breaks outside the trendlines, we take a look at the next example, point B in Figure 7. Here, the price action has broken above the upper trendline but looks set to retrace back to the median or middle line. Using the same NZD/USD currency pair, let's take another approach:

1. Identify the price action moving toward the median or middle line. What traders want to confirm is that the price is indeed falling and will break back through the upper trendline. In Figure 9, the currency spot falls through the trendline, confirming selling pressure.
2. Identify the significant support/resistance line. Here, traders will want a confirmed break of a significant support level in order to isolate sufficient momentum and increase the probability of the trade.
3. Place the entry order 30 pips below the support level. In our example (see Figure 9), since the support level is at the 0.7200 figure, the entry would be placed at 0.7180. The following stop would be applied slightly above the 0.7300 figure - the previous session's high - and give us an almost 2:1 risk/reward ratio when we take profits at the 0.7000 price.
4. Receive confirmation through a price oscillator. The downward cross that occurs when the stochastic oscillator is used gives traders ample confirmation of the break of support in the price.

Figure 9 - Taking a closer look, a great opportunity exists as the price action moves towards the median line.

Conclusion
Although it is primarily applied in the futures and equities forums and seldom used in the currency markets, Andrew's pitchfork can provide the currency trader with profitable opportunities in the longer or intermediate term, capitalizing on preferably longer market swings. When the pitchfork is applied accurately and is used in combination with strict money management and textbook technical analysis, the trader is able to isolate great setups while weeding out the sometimes choppier price action in the forex markets that may increase his or her losses. If all of the criteria above are applied, the trade will be able to ride its way to profitability compared to its shorter-term peers.
Trading On News Releases
One of the great advantages of trading currencies is that the forex market is open 24 hours a day (from 5pm EST on Sunday until 4pm EST Friday). Economic data tends to be one of the most important catalysts for short-term movements in any market, but this is particularly true in the currency market, which responds not only to U.S. economic news, but also to news from around the world. With at least eight major currencies available for trading at most currency brokers and more than 17 derivatives of them, there is always some piece of economic data slated for release that traders can use to inform the positions they take. Generally, no less than seven pieces of data are released daily from the eight major currencies or countries that are most closely followed. So for those who choose to trade news, there are plenty of opportunities. Here we look at which economic news releases are released when, which are most relevant to forex (FX) traders, and how traders can act on this market-moving data.
Which Currencies Should Be Your Focus?
The following are the eight major currencies:

1. U.S. dollar (USD)
2. Euro (EUR)
3. British pound (GBP)
4. Japanese yen (JPY)
5. Swiss franc (CHF)
6. Canadian dollar (CAD)
7. Australian dollar (AUD)
8. New Zealand dollar (NZD)

This is just a sample of some of the more liquid derivatives based on the currencies above:

1. EUR/USD
2. USD/JPY
3. AUD/USD
4. GBP/JPY
5. EUR/CHF
6. CHF/JPY

As you can see from these lists, the currencies that we can easily trade span the entire globe. This means that you can handpick the currencies and economic releases to which you pay particular attention. But, as a general rule, since the U.S. dollar is on the "other side" of 90% of all currency trades, U.S. economic releases tend to have the most pronounced impact on the market.

Trading news is harder than it may sound. Not only is the reported consensus figure important, but so are the whisper number and the revisions. Also, some releases are more important than others; this can be measured in terms of both the significance of the country releasing the data and the importance of the release in relation to the other pieces of data being released at the same time.

When Are News Releases Issued?
Figure 1 lists the approximate times (EST) at which the most important economic releases for each of the following countries are published. These are also the times at which you should be paying extra attention to the markets, if you plan on trading news releases.

Country
Currency
Time (EST)

U.S.
USD
8:30 - 10:00

Japan
JPY
18:50 - 23:30

Canada
CAD
7:00 - 8:30

U.K.
GBP
2:00 - 4:30

Italy
EUR
3:45 - 5:00

Germany
EUR
2:00 - 6:00

France
EUR
2:45 - 4:00

Switzerland
CHF
1:45 - 5:30

New Zealand
NZD
16:45 - 21:00

Australia
AUD
17:30 - 19:30
Figure 1 - Times at which various countries release important economic news.

What Are the Key Releases?
When trading news, you first have to know which releases are actually expected that week. There are many ways to do this, but Daily FX provides a very comprehensive calendar. Second, it is key for you to know which data is important. The Daily FX calendar bolds the important releases and also lists the "consensus" figures. Generally speaking, these are the most important economic releases for any country:

1. Interest rate decision
2. Retail sales
3. Inflation (consumer price or producer price)
4. Unemployment
5. Industrial production
6. Business sentiment surveys
7. Consumer confidence surveys
8. Trade balance
9. Manufacturing sector surveys

Depending on the current state of the economy, the relative importance of these releases may change. For example, unemployment may be more important this month than trade or interest rate decisions. Therefore, it is important to keep on top of what the market is focusing on at the moment.

The list in Figure 2 ranks the most market-moving data for the U.S. in 2004, on both a 20-minute and a daily basis. The difference in reaction is generally attributed to the depth of the data. Some releases provide barely more information than the headline number, while others provide extensive tables that can be subject to different interpretations. Keep in mind that U.S. dollar data tends to be the most important in the FX market because the dollar is involved in 90% of all currency trades.
As of 2004 (20-Minute): As of 2004 (Daily):
1. Unemployment (Non-Farm Payrolls)
1. Unemployment (Non-Farm Payrolls)
2. Interest Rates (FOMC Rate Decisions) 2. Interest Rates (FOMC Rate Decisions)
3. Trade Balance 3. Foreign Purchases of U.S. Treasuries (TIC Data)
4. Inflation (Consumer Price Index)
4. Trade Balance
5. Retail Sales 5. Current Account
6. GDP
6. Durable Goods
7. Current Account
7. Retail Sales
8. Durable Goods 8. Inflation (Consumer Price Index)
9. Foreign Purchases of U.S. Treasuries (TIC Data) 9. GDP
Figure 2 - Ranking of the most market-moving data for the U.S. in 2004.

How Long Does the Effect Last?
According to a study by Martin D. D. Evans and Richard K. Lyons published in the Journal of International Money and Finance (2004), the market could still be absorbing or reacting to news releases hours, if not days, after they are released. The study found that the effect on returns generally occurs in the first or second day, but the impact does seem to linger until the fourth day. The impact on order flow, on the other hand, is still very pronounced on the third day and is still observable on the fourth day.

How Do I Actually Trade News?
A study published in the spring of 2005 on Daily FX found that, on average during 2004, the top nine U.S. releases led to a 56 pip reaction in the EUR/USD in the first 20 minutes following the release. Depending on the nature of the release, the movement could actually range in size from 33 to 124 pips. This broad range shows how significant news trading can be for short-term traders.

The most common way to trade news is to look for a period of consolidation ahead of a big number and to just trade the breakout on the back of the number. This can be done on both a short-term intraday basis and a daily basis. Let's look at the chart in Figure 3 as an example. After a weak number in September, the market was holding its breath ahead of the October number, which was to be released to the public in November. In the 17 hours before the release, the EUR/USD was confined within a tight 30-pip trading range. For news traders, this would have provided a great opportunity to put on a breakout trade, especially since the likelihood of a sharp move at this time was extremely high.

Figure 3 - This chart illustrates the indecision of the market leading up to the October non-farm payroll numbers, which were released in early November. Note the increase in volatility that occurred once the worse than expected news was released.

We mentioned earlier that trading news is harder than you might think. Why? The primary reason is volatility. You can be making the right move but end up being stopped out, or the market may simply not have the momentum to sustain the move.

Let's look at the chart in Figure 4 as an example. This chart shows activity after the same release as the one shown in Figure 3, but on a different time frame to show how difficult trading news releases can be. On Nov 4, 2005, the market had expected 120,000 jobs to be added to the U.S. economy, but instead only 56,000 jobs were added. This sharp disappointment led to an approximately 60-pip sell-off in the dollar against the euro in the first 25 minutes after the release. However, the dollar's upside momentum was so strong that the gains were quickly reversed, and an hour later, the EUR/USD had broken its previous low and actually hit a 1.5-year low against the dollar. Opportunities were plentiful for breakout traders, but bullish momentum in the dollar was so strong that such a bad payrolls number failed to put a sustainable dent in the currency's rally. One thing you should keep in mind is that, on the back of a good number, a strong move should also see a strong extension.

Figure 4 - This intraday chart shows that, while the worse than expected non-farm payroll numbers sent the EUR/USD rate upward for a short period of time, the strong momentum of the U.S. dollar was able to take control and push the dollar higher. Keep in mind that when the EUR/USD rate falls, the U.S. dollar is going upward, and vice versa.

Can I Avoid Getting Hit by Volatility When Trading News?
The answer to capturing a breakout in volatility without having to face the risk of a reversal is to trade FX SPOT options, which are a new breed of product that traders are just beginning to discover. If you search online, you can find a number of different FX brokers that offer a variety of different exotic options. Exotic options generally have barrier levels and will be profitable or unprofitable based upon whether the barrier level is breached. The payout is predetermined and the premium or price of the option is based on the payout. The following are the most popular types of exotic options to use to trade news releases:
• Double one-touch option
• One-touch option
• Double no-touch option A double one-touch option has two barrier levels. Either one of the levels must be breached prior to expiration in order for the option to become profitable and for the buyer to receive the payout. If neither barrier level is breached prior to expiration, the option expires worthless. A double one-touch option is the perfect option to trade for news releases because it is a pure non-directional breakout play. As long as the barrier level is breached - even if the price reverses course later - the payout is made.
A one-touch option only has one barrier level, which generally makes it slightly less expensive than a double one-touch option. The same criterion holds - the payout is only made if the barrier is breached prior to expiration. This is a good option to buy if you actually have a view on whether the number will be stronger or weaker than the market's consensus forecast.

A double no-touch option is the exact opposite of a double one-touch option. There are two barrier levels, but in this case, neither barrier level can be breached before expiration - otherwise the option payout is not made. This option is great for news traders who think that the economic release will not cause a pronounced breakout in the currency pair and that it will continue to range trade.

FX SPOT options are a viable alternative for those who do not care to get whipsawed in the markets by undue volatility before they actually see the spot price move in their desired direction.

Conclusion
As we've seen, the currency market is particularly prone to short-term movements brought on by the release of economic news from both the U.S. and the rest of the world. If you want to trade news successfully in the FX market, key considerations to keep in mind are knowing which releases are expected when, which ones are most important given current economic conditions and, of course, how to trade based on this market-moving data. A variety of exotic options are available for traders who want to capture a breakout in volatility without having to face the risk of a reversal; do your research and stay on top of economic news and you could reap the rewards
The Memory of Price
Double tops and double bottoms are some of the most common price reversal patterns in the currency market. The familiar M- or W-shaped patterns appear regularly on anything from 15-minute charts to weekly studies. Here we look at how you can identify these patterns and use them to make reasoned, profitable trades in forex.

Identifying Double Tops
In the interest of clarity, we'll focus on double tops, but be aware that the rules are simply reversed for double bottoms. The basic double top price pattern has three stages: 1) the price makes a short-term swing high, 2) this is then followed by a slight retracement, and finally, 3) the price makes another assault on the swing highs, only to be rejected once more as the reversal pattern completes itself.

Why do these patterns recur? The underlying assumption is that price has a memory. As the price of an asset approaches a prior point of resistance or support, traders will begin to aggressively buy or sell ahead of these levels based on the belief that since these prices recently held, they will hold once again. This method is often quite profitable, but as we will see later on, even if this setup fails, it may still offer promise to traders willing to view this pattern in an unconventional way.

To properly trade a double top, a trader first needs to determine what constitutes a proper retrace in the formation. Otherwise, the price pattern may look like a simple consolidation range, which would greatly lower the probability of success in the trade. A simple and effective way to calculate a retrace in a double top is to use Fibonacci retracement levels. The retrace segment should be at least 38.2% of the prior move in order to be considered valid. Figure 1 shows this dynamic in action.

Figure 1 - The 38.2% Fibonacci level is the minimum amount of retracement needed to establish the beginning of a valid double top formation.

Don't Anticipate - Wait for Confirmation
Once the retrace segment is established, the next step is to properly position yourself for the double top. Novice traders will simply try to anticipate a double top by laying out limit orders at or near the prior swing high. This approach is often a mistake that creates unnecessary losses. If you look at Figure 2, you will see that a runaway trend would have bulldozed right through a trader's short in the GBP/USD, as price relentlessly rallied against the position.

Figure 2 - This chart is an example of the loss that can occur when a trader anticipates the second top by placing a short sale order before he/she confirms the strength of the earlier resistance.

Instead of anticipating resistance at a double top, traders should let the market confirm their assumption that such resistance actually exists. In order to have a minimum of confidence that a double top is indeed in place, traders need to wait for a red candle to form at the resistance levels, as shown in Figure 3.

Figure 3 - A bearish looking candle near the earlier resistance can be used as a signal that the previous resistance is strong and that a second top may be forming.

Make a Good Entry
Finally, in order to achieve a good entry, you shouldn't simply jump in with a market order to sell on the next candle. Instead, you should place a limit sell order somewhere in the middle of the prior day's range. This tactic has two substantial benefits. If the double top does indeed form, you would be optimally positioned with a superb price entry. On the other hand, if price decides to make one final thrust upward, you would be likely to survive as your excellent entry would allow you to set a stop wide enough to escape any last-minute thrusts.

Figure 4 - Placing a limit order at a resistance level that has shown its strength is key to drastically increasing your odds of a successful trade.

The Traditional Setup and What To Do If It Fails
To summarize, here are the rules to properly trade classic double top formations:
1. Determine that a true retrace segment has been put in place by using Fibonacci retracement levels to measure minimum levels of correction.
2. Wait until the price actually shows weakness on the charts by printing a red candle at the expected resistance level.
3. Using the red candle as a reference point, enter a limit sell order somewhere in the middle of that candle's range.
4. Set a stop at least 50 points above the most recent swing high to avoid being taken out on a fake spike.
5. Target at least the length of the prior segment for good risk to reward potential.
This traditional double top/double bottom trading setup is an "oldie but a goodie". It can be an extremely profitable trading strategy, but it is not the only way to extract gains from such price action. What happens when these setups fail? What happens when price barrels through resistance, as shown in Figure 5?

Figure 5 - Once the price of an asset breaks through a support or resistance level, it can become difficult to determine where it is headed.

Most traders would simply abandon these trades and move on to the next setup, but not unlike a valuable antique hidden in a country barn, these busted trades hold enormous promise for those traders willing to look beyond the surface. Contrary to popular opinion, former resistance and support levels still exert a gravitational pull on price, creating a very strong possibility that it may reverse in the near future.

Let's look at the same EUR/USD trade from Figure 5 a few days later. What happened? Price did indeed set a short-term swing top a few hundred points higher than the original resistance point.

Figure 6 - This chart is an example of how the price of an asset often retraces back toward a broken support or resistance level.

How can a currency trader take advantage of such price dynamics? More importantly, how can you protect yourself from the possibility of a runaway market should you be wrong in your assumption that a reversal is just around the corner? One possible way to find an intelligent stop point that will provide ample room for price to bounce, without exposing you to an excessive amount of risk, is to use the preceding price action as a guide.

Here is how a fakeout double top setup might work:
1. Once the price has exceeded the prior swing high, do nothing until price shows a sign of weakness with a red candle - which indicates a drop in price for that day.
2. Measure the amplitude of the preceding retrace segment from the segment's swing high to its lowest low.
3. Add the value of the length of this segment to the most immediate swing high and make that your stop.
4. Initiate one-half of your position at a sell limit at about the midpoint of the red candle's range.
5. If price moves counter to your direction, initiate the other half of your position midway to your stop point.
6. If price turns in your favor, target the original resistance point of the "fake out" double top.


Let's apply this setup to the specific example of the EUR/USD trade. First, you would measure the amplitude of the retrace segment, which is approximately 300 points. Then you would add that amount to the swing high to establish a proper stop point. In this case, the stop provided plenty of room to remain in position until it turned in the traders' favor.

Figure 7 - This chart illustrates that a stop loss is generally set to equal the swing high plus the height of the earlier retracement, which in this case is nearly 300 points.

Why would you want to use the prior retrace segment as a guide for setting stops? If price does indeed have a memory, then - under normal conditions - there should be some symmetry in price movement. Therefore, price swings should not exceed in thrust what they produced in a retrace. If they do, then it's clear that a powerful new trend is in place and traders needs to cover their shorts and retreat, protecting their capital.

Most importantly, using the prior retrace segment as a guide for setting stops provides a logical reference point for you as a trader to gauge the status of your trade. In his book "The Logical Trader" (2002), Mark Fisher notes that a logical reference point is one of the key ingredients for success for the technically-oriented trader. Since a trader can never predict the accuracy of any particular trade, having a logical method to ascertain when a trade is wrong is the single most important skill that a currency trader can develop.

Conclusion
Although many academics argue that price movements are completely random and unpredictable, technically-oriented traders heartily dispute this thesis. They believe that price graphs represent the cumulative opinions of millions of traders and, like many products of human activity, possess an institutional memory that can be analyzed and traded. The fakeout double top/double bottom setup is one such example of this premise that you may employ profitably in forex trading.
Make the Currency Cross Your Boss
In the stock market, a trader has the opportunity to choose from more than 5,000 companies - hundreds of which will rally in the most vicious of bear markets and thousands of which will crash during the strongest of bull runs. But in the currency market, such divergent possibilities do not seem to exist. In this article, we'll look at how forex traders can use currency crosses to make a wide variety of trades that are unaffected by the day-to-day fluctuations of the greenback.
All Currency Bets Are the Same
When dealing in the major currency pairs, most traders are presented with only one choice: dollar bull or dollar bear? Regardless of whether a trader is long the GBP/USD (British pound-U.S. dollar) or the EUR/USD (euro-dollar), or short the USD/CHF (dollar-Swiss franc) or USD/JPY (dollar-Japanese yen), the unifying theme in all of these positions is that the trader is bearish on the greenback. Therefore, the question of which of the four trades should be taken is immaterial, since all of them will likely be profitable if the dollar is weak and all will lose money if the dollar is strong.

Granted, this may sound like a gross oversimplification of the forex market. We'll be the first to acknowledge that some currencies can and do challenge this paradigm - the Canadian dollar is one good recent example of such a dynamic. Buoyed by skyrocketing oil prices, the loonie has turned into a petrocurrency as Canada has become the United States' No.1 supplier of crude. As a result, while other major currencies like the euro, the yen and the pound have recently declined against the U.S. dollar, the Canadian dollar has gained in value. However, this is an exception that proves the rule.

To better understand how this works, let's take a look at the two charts below. Figure 1 looks at the performance of the seven most liquid currency pairs in forex, composed of the four majors:
• EUR/USD
• USD/JPY
• GBP/USD
• USD/CHF
and the three commodity pairs:
• USD/CAD
• AUD/USD
• NZD/USD
Figure 1 looks at activity on a single trading day - Oct 12, 2005. To normalize the data, we converted every pair so that its performance could be analyzed accurately. Typically, if the dollar were weak, the EUR/USD would rise and the USD/CHF would decline; however, in Figure 1 we have made the adjustment so that the returns are consistent vis a vis the dollar.

Figure 1 - In forex, some currency pairs are quoted in terms of the U.S. dollar (e.g. EUR/USD), while others are not (e.g. USD/CHF). By inverting the pairs that are not expressed in terms of the dollar, we can compare the strength/weakness of each pair relative to the dollar.

Figure 2 looks at activity on the same trading day - Oct 12, 2005 - for the Dow Jones Industrial Average.

Figure 2 - In FX, most traders (those trading the seven most liquid currency pairs) are presented with only one choice - dollar bull or dollar bear - but the stock market is less straightforward. As this chart shows, even when an index like the DJIA is down overall, many of its stocks can be up, making it harder to take a purely bearish or bullish outlook.

Both of these charts clearly illustrate that while the stock market is truly a market of stocks, the currency market is really a market of dollars and anti-dollars. The central reason why this is so is that the dollar serves as the reserve currency for the world's central banks. Therefore, when speculators are bullish on the dollar, capital will flow from all the major currencies into the greenback and vice versa when the sentiment reverses.

Crosses Offer More Possibilities
If you look closely at Figure 1, however, you'll notice that the capital flows are far from uniform. Some currencies appreciate substantially against the dollar, while others gain barely a few basis points. This difference in performance against the greenback creates profit opportunities for market players who choose to trade in currency crosses. Crosses are simply a measure of the relative strength of an individual currency against the dollar. Crosses are distinguished by the fact that they do not include the dollar as either the numerator or the denominator of the pair. As such, they offer traders a tremendous opportunity to make far more nuanced bets in the currency market than the simple pro- or anti-dollar trade.

What makes crosses especially interesting to currency traders is the fact that they can provide much cleaner trend or range signals which will be unaffected by the day-to-day oscillations of the greenback.

To better understand how crosses work, let's examine the following two charts, which look at data over the same period of time (from July 1, 2005 to Oct 14, 2005). While the most liquid financial instrument in the world - the EUR/USD - has done nothing but range aimlessly during the period in question, frustrating both bulls and bears (see Fig. 3), the CAD/JPY has displayed one of the purest trends in recent memory, gaining almost 1,000 points without any material retracement (see Fig. 4).

Figure 3 - The EUR/USD has traveled between support and resistance, making it very frustrating for bulls and bears alike.
Figure 4 - Traders of currency crosses were able to profit from the prolonged uptrend of the CAD/JPY.

Why did the CAD/JPY rally? As we mentioned earlier, the Canadian dollar is a petrocurrency that has received a tremendous boost from the stratospheric rise in the price of crude. The yen, on the other hand, is the principal victim of high oil prices because it is the only highly industrialized country in the world that must rely on imports for 99.5% of its petroleum needs. The CAD/JPY therefore has an 89% correlation with the price of oil.

Canny traders who bet on an oil rally could have expressed that opinion very effectively in the currency market through a long CAD/JPY position. Even better, they would have harnessed a positive yield differential in the process. With the loonie currently yielding 2.75%, while the yen rates remain at 0%, the interest rate differential alone was 275 basis points or 27.5% annualized using a standard 10:1 leverage factor. (This essentially means that since FX traders can use $1 of capital to control $10 worth of currency, the gain from the 275 basis point differential will be 10 times larger than if traders did not use leverage.)

Carry or Capital Gains
Crosses can be as volatile as the most heavily-traded stocks during the heyday of the NASDAQ bubble or as sedate as a 'AAA'-rated dividend-yielding utility share on the NYSE. Trading in crosses can focus on carry strategies that try to profit from interest rate differentials between the currencies or it can be focused on pure capital gains speculation. Trades can also be based on economic analysis or political news. Some crosses can trend for months, while others will be highly range-bound. In short, the possibilities with currency crosses are endless. Let's look at the charts below to see some examples of recent trades in the crosses that demonstrate these ideas.

The Carry Trade
One of the most popular trades in foreign exchange is the carry trade, which involves going long a high-yielding currency against a low-yielding one. Looking at the seven most liquid crosses in the world, no pair has shown a greater interest rate differential than the NZD/JPY pair. In mid-Oct 2005, the New Zealand dollar, nicknamed the "kiwi", yielded 6.75% (the Reserve Bank of New Zealand subsequently increased that rate to 7% at the end of October). The Japanese yen., on the other hand, yielded 0% (as of Oct 2005), and the Bank of Japan's zero interest rate monetary policy is expected to remain in effect until all vestiges of deflation are gone from the Japanese economy. The spread between the currencies was a whopping 675 basis points, and as a result, carry trade speculators plowed into the cross, increasing its value by 400 pips between July and Oct 2005.

Figure 5 - The NZD/JPY pair gained momentum in the three months shown here in response to widespread speculation that the NZD rate would increase to 7% in Nov 2005. Carry trade speculators plowed into the cross in order to gain exposure to this higher rate differential, causing the NZD/JPY to increase in value.

The Political Trade
In mid-Sept 2005, both Japan and Germany had elections. In Japan, Prime Minister Junichiro Koizumi ran on a reform agenda that called for the privatization of the Japanese postal service, a quasi-banking institution with $3 trillion in deposits and 25,000 branches. In Germany, the reform-minded candidate Angela Merkel ran against the standing Chancellor Gerhard Schroeder. While Koizumi's message resonated well with the Japanese voters as he headed to an overwhelming win, Merkel's victory over Schroeder was hard-fought - the two contenders were locked in a struggle for leadership for more than a month after the German elections were initially held. In Sept 2005, therefore, the EUR/JPY cross presented a tremendous profit opportunity as a de facto "Koizumi/Schroeder spread". Indeed, from Sept 9 to Sept 12, the cross tumbled nearly 200 points as traders bid up the yen and shorted the euro as a response to the election results.

Figure 6 - The chart above shows the weakness in the euro which could be attributed in part to the uncertainty over the outcome of the German elections. FX traders were more inclined to place their money in the Japanese yen, because the political situation in Japan was more certain.

The Economic Trade
Consistent disparities in economic performance can sometimes offer very profitable trades in the crosses. A case in point is the price action in the second half of 2005 in the EUR/CHF currency cross. The massive declines in the two currencies during the first half of 2005 were beneficial for both the euro zone and Switzerland since both regions are heavy exporters and both generate substantial trade surpluses. However, the smaller and more nimble Switzerland did not suffer from the political and institutional disarray that pervaded the euro zone after the rejection of the EU Constitution in the summer of 2005. With much better unemployment numbers (3.8% in Switzerland vs. 9.9% in EU) and faster growing retail sales (4.7% vs. 0.9%), Switzerl