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December 2011

Volume 8, No. 12

Strategies, analysis, and news for FX traders

The Europeancrisis and theforex market

p. 12

Conducting awalk-forward teston an FX volatility

breakout systemp. 18

Dollar index

deconstruction:Understanding theDXYs drivers p. 22

Dollars down under:

Aussie and kiwioutlook p. 6

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2/322 December2011CURRENCY TRADER

CONTENTS

Contributors................................................. 4

Global Markets

Aussie up, Aussie down .............................6

Analysts argue whether the currencies have put

in long-term tops, but all agree risk sentiment

remains key to the prospects for the Aussie and

New Zealand dollars.

By Currency Trader Staff

On the Money............................................ 12

The long, deep game

If it can survive its crisis with only Greece leav-

ing the EMU, Europe will have the gold-standardcurrency for a whole new generation. To that

end, the IMF may end up getting involved.

By Barbara Rockefeller

Trading Strategies

Walk-forward analysis of a volatility

breakout system ......................................18

Progressively updating a trading system to

recent market data provides insight into how

robust the technique is and allows it to adjust to

changing market conditions.

By Daniel Fernandez

Advanced Concepts

Decomposing the Dollar Index ...............22

Analyzing the DXY shows how all trades involve

comparing alternatives and those alternatives

have to be accounted for on a complete cost

basis.

By Howard L. Simons

Global Economic Calendar ........................28

Important dates for currency traders.

Events .......................................................28

Conferences, seminars, and other events.

Currency Futures Snapshot.................29

International Markets............................ 30

Numbers from the global forex, stock, and

interest-rate markets.

Looking for an

advertiser?

Click on the company

name for a direct link to thead in this months issue.

eSignal

FXCM

Nadex

Ninja Trader

Questions or comments?Submit editorial queries or comments to

[email protected]
mailto:[email protected]:[email protected]://www.fxcm.com/

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http://www.fxcm.com/

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CONTRIBUTORS

4 December2011CURRENCY TRADER

Editor-in-chief: Mark Etzkorn

[email protected]

Managing editor: Molly Goad

[email protected]

Contributing editor:

Howard Simons

Contributing writers:

Barbara Rockefeller,

Marc Chandler, Chris Peters

Editorial assistant and

webmaster: Kesha Green

[email protected]

President: Phil Dorman

[email protected]

Publisher, ad sales:

Bob Dorman

[email protected]

Classifed ad sales: Mark Seger

[email protected]

Volume 8, Issue 12. Currency Trader is published monthly by TechInfo,Inc., PO Box 487, Lake Zurich, Illinois 60047. Copyright 2011 TechInfo,Inc. All rights reserved. Information in this publication may not be stored orreproduced in any form without written permission from the publisher.

The information in Currency Trader magazine is intended for educationalpurposes only. It is not meant to recommend, promote or in any way implythe effectiveness of any trading sys tem, strategy or approach. Traders areadvised to do their own research and testing to determine the validity of atrading idea. Trading and investing carry a high level of risk. Past perfor-mance does not guarantee future results.

For all subscriber services:www.currencytradermag.com

A publication of Active Trader

CONTRIBUTORS

qHoward Simons is president of Rosewood

Trading Inc. and a strategist for Bianco Research.

He writes and speaks frequently on a wide range

of economic and nancial market issues.

qBarbara Rockefeller(www.rts-forex.com) is an international

economist with a focus on foreign exchange. She has worked as a

forecaster, trader, and consultant at Citibank and other nancial

institutions, and currently publishes two daily reports on foreign

exchange. Rockefeller is the author ofTechnical Analysis for Dum-

mies, Second Edition (Wiley, 2011), 24/7 Trading Around the Clock,

Around the World (John Wiley & Sons, 2000), The Global Trader

(John Wiley & Sons, 2001), and How to Invest Internationally, pub-

lished in Japan in 1999. A book tentatively titled How to Trade FX

is in the works. Rockefeller is on the board of directors of a large

European hedge fund.

qDaniel Fernandezis an active trader with a

strong interest in calculus, statistics, and econom-

ics who has been focusing on the analysis of forex

trading strategies, particularly algorithmic trad-

ing and the mathematical evaluation of long-term

system protability. For the past two years he has

published his research and opinions on his blog Reviewing Eve-

rything Forex, which also includes reviews of commercial and

free trading systems and general interest articles on forex trading

(http://mechanicalforex.com). Fernandez is a graduate of theNational University of Colombia, where he majored in chemistry,

concentrating in computational chemistry. He can be reached at

[email protected].
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.currencytradermag.com/http://www.rts-forex.com/http://mechanicalforex.com/mailto:[email protected]:[email protected]://mechanicalforex.com/http://www.rts-forex.com/http://www.currencytradermag.com/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]

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GLOBAL MARKETS

In early December, the Australian/U.S. dollar pair (AUD/USD) had been trading at virtually the same level it wasat the end of 2010, around 1.0200 (Figure 1). However, thatnearly unchanged value doesnt reflect the major swings

the pair made throughout the year.The AUD/USD rate hit 1.1080 in July its highest level

since January 1982. However, as the Eurozone sovereigndebt situation continued to deteriorate in late summer and

early fall, AUD/USD plunged belowparity to .9387 in early October as riskaversion swept the globe and moneymanagers rushed back into the per-ceived safety of the U.S. dollar andU.S. dollar denominated debt (Figure2). The Aussie dollar clearly was heldcaptive to the risk-on, risk-off outlookin global money swings.

Amongst the G-10 currencies, theAussie is everyones favorite due toits [high] yield and strong fiscal andgrowth fundamentals, says Greg

Anderson, senior FX strategist at Citi.But when the markets get into apanic, [money managers] close off longpositions in the Aussie.

In early December, risk appetite wasat least temporarily back on, which isshort-term bullish for Aussie/dollar.As the new year approaches, severalquestions swirl around the Aussiecurrency, including whether the latestmove by the Reserve Bank of Australiasignals the start of a new monetary

Aussie up, Aussie down

Analysts argue whether the currencies have put in long-term tops, but all agree risk sentiment

remains key to the prospects for the Australian and New Zealand dollars.

BY CURRENCY TRADER STAFF

FIGURE 1: WEEKLY AUSSIE/U.S. DOLLAR

The Aussie dollar entered December 2011 almost exactly where it ended

December 2010, but it moved around a lot in between.

Source for all figures: TradeStation

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7/32CURRENCY TRADERDecember2011

policy trend or was it simply a one-time cut?

Also, the New Zealand dollar(kiwi) often trades in the same man-ner as the Aussie dollar, but is not asfavored by bigger players because of itslower liquidity. Will the kiwi face thesame issues as the Aussie dollar?

Fundamentals

Australia weathered the 2008-2009global financial crisis the best amongG-10 nations, escaping the sustainednegative growth suffered by virtuallyevery other mature economy. It wasthe only major advanced industrial-ized nation to sidestep recession, saysWells Fargo economist Tim Quinlan.They only had one quarter of negative

GDP growth. The accepted economicdefinition of recession is two consecu-tive quarters of negative GDP growth.

However, a number of challenges and setbacks for theAussie economy emerged in early 2011, including the mas-sive devastation from the floods in the northeast portionof the country. Also, the Japanese earthquake and tsunamiimpacted Australian growth because a good deal of Aussieexports end up in Japan.

These factors held back the Aussie economy, Quinlansays, noting the countrys -3.4 percent GDP figure forthe first quarter of 2011. However, Q2 saw the economy

bounce back with a 4.8-percent growth rate.Overall, bright spots remain, which analysts believe

should keep Australias annual GDP in positive terri-tory. We expect the Australian economy will grow 1.8percent in 2011, says Katrina Ell, associate economistwith Moodys Analytics. We expect GDP will grow 4 per-cent in 2012 as mining investment and reconstruction inQueensland drive stronger growth. Australias economyis showing signs of resilience amid a gloomy global back-drop. The mining boom is pushing full steam ahead, whichis driving strong expansion in construction and invest-ment. Ell adds the entire country is benefiting from the

mining boom, which has contributed to a low unemploy-ment rate and solid wage growth.

Overall, Australian growth is led by its exports, withcoal accounting for a major portion. Ieisha Montgomery,associate economist at Northern Trust, says coal represent-ed 19.8 percent of Australias total export basket, with 25percent of their exports heading to China and 19 percentto Japan. Australias top four trading partners are China,Japan, South Korea, and India, which leaves the Eurozoneand the U.S. having much less influence on their overall

growth. Quinlan notes that only 4.1 percent of Australiasexports head to Europe, with 4.0 percent winding theirway to the U.S.

Nonetheless, despite a looser connection betweenAustralia and Western Europe, what unfolds ahead inthe Eurozone and U.S. will trickle back to Australia in themonths ahead.

Ultimately, all [Australian] exports to China are rawmaterials, which are turned into manufactured goods andsold to many places, including Europe, Quinlan says.

The biggest risk to Australias economic outlook is amarked slowdown in China, which would weigh heavily

FIGURE 2: DAILY AUSSIE/DOLLAR

The AUD/USD pair sold off fairly sharply after peaking above 1.1000 in July.

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GLOBAL MARKETS

on demand for Australias resources and prompt business-es to abandon investment plans, Ell explains.

The spillover to weaker employment, confidence, andhousehold incomes would cause consumers to pull back,she says. Nevertheless, China is headed for a soft landingin 2012, and if this [view] looks at risk, the Chinese gov-ernment has the capacity to respond swiftly. Meanwhile,if conditions in Europe deteriorate markedly, credit condi-tions could tighten and trigger a crisis of confidence.

Even if Australia begins to slow, Ell is optimistic the

country is well positioned to deal with moderating growth.If Australias growth is hampered, monetary and fiscalpolicymakers have scope to stimulate the economy, shesays. Policymakers would lower interest rates to stimulateconsumer spending and the housing market. Sound fiscalmanagement and a low debt burden give the governmentroom to provide a fiscal stimulus and still preserve theeconomys long-term prospects.

Monetary policy

After a year on hold, on Nov. 1 the Reserve Bank ofAustralia (RBA) cut its official monetary policy rate by

0.25 percent to 4.50 percent. The official rate in Australia,now at 4.5 percent, is still the highest rate among theworlds developed economies, wrote Wells Fargo econo-mists in the Nov. 16 Global Chartbook research note. Thecut reflects a move from a restrictive monetary policy toone that is more accommodative in light of the weakerglobal growth outlook. While the headline rate of infla-tion remains slightly elevated, the downtrend in the coreinflation rate grants the RBA the scope necessary to pivotits policy to a more supportive stance without concern onengendering runaway inflation.

Why did they ease? In the months leading up to the

meeting there was continued deterioration in the Europeansovereign-debt situation, which had the IMF and OECDdownwardly revise forecasts for emerging [country]growth, Quinlan says. He adds that with approximately66 percent of Australias exports heading to either Japan oremerging-market economies, slower growth in emergingeconomies would dampen demand for Australias exportsector.

Most market watchers expect the RBA to take a wait-and-see approach in the near term. The bank is scheduledto meet on Dec. 6; most analysts anticipate it will hold

steady on rates. The Reserve Bank of Australia will likely

remain on the sidelines and keep rates on hold for theforeseeable future, despite market expectations for furthercuts, Ell says. However, if Europes debt situation wors-ens and impacts Australia and its trading partners, furtherrate cuts are expected.

Anderson says the interest-rate outlook for Australiahinges on the external environment, because the domesticsituation probably doesnt warrant a rate cut.

New Zealand fundamentals

On the New Zealand front, Moodys Analytics forecastsoverall 1.2 percent GDP growth in 2011 and a 1.6 percentforecast for 2012. Overall, the countrys economy is slightlylagging its larger neighbor.

New Zealands economy is growing below trend, withpersistent household deleveraging contributing to weakprivate consumption, says Fred Gibson, associate econo-mist at Moodys Analytics. Given the governments com-mitment to returning the budget to surplus by 2015, thepublic sector is providing minimal support to growth. Onthe upside, soft commodity exports are strengthening asAsias growing middle class demands a high quality and

reliable source of dairy and meat products.While Australias outlook depends heavily on China

and emerging Asia, New Zealand can be viewed as a littlesister to Australia, heavily dependent on the countrys eco-nomic fortunes.

Australia is New Zealands biggest trading partner,Montgomery explains, noting that 23 percent of NewZealand exports head to Australia, with 11.2 percent goingto China. Some of its key exports include forestry prod-ucts, meat, dairy, and wool.

Interestingly, the major earthquake that struck NewZealand in February 2011 should actually contribute to

better GDP figures in 2012. Earthquake reconstructionshould ramp up growth in 2012 and should help the realestate sector, Montgomery says. Shes forecasting 2.8 per-cent GDP growth in New Zealand next year.

New Zealand has several other factors working in itsfavor.

Sustained Asian demand for New Zealands soft com-modity exports is helping support growth, Gibson says.The recent Rugby World Cup and the influx of some85,000-plus tourists have helped drive a rise in retailspending. Investment is building gradually as capital

imports grow, suggesting firms are gearing up to rebuild

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9/32CURRENCY TRADERDecember2011 9

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GLOBAL MARKETS

Christchurch.The kiwi/dollar rate (NZD/USD) has also come under

pressure in the early fall months because of the same fac-tors impacting the Aussie dollar (Figure 3).

The major driver behind the sustained depreciationof the kiwi has been increased risk aversion because ofEuropes sovereign debt crisis, Gibson says. Growinguncertainty and volatility in financial markets haveprompted investors to shun perceived riskier currenciessuch as the kiwi in favor of haven currencies such as theyen. This has caused the kiwi to depreciate sharply, despitelittle change in economic fundamentals since July.

For now, market watchers see the Reserve Bank of NewZealand (RBNZ) on hold at 2.50 percent, after a rate cut inthe aftermath of the February earthquake.

We believe that rates will remain on hold until March2012 to help safeguard growth against a deteriorating glob-al recovery, Gibson says. Barring another global creditcrunch, we think the RBNZ will start its tightening cycle

from March 2012 by reversing this years 50-basis-pointinsurance cut. A further 25-basis-point hike is expected inthe third quarter of 2012.

Forex action

Risk appetite and prevailing market sentiment will likelydrive the Aussie dollar in the near future.

The second risk comes off, people come back in andbuy Aussie first, Anderson notes. That will continue nextyear. I expect it to be the star performer in the G-10.

Anderson holds a roughly comparable view for thekiwi/dollar: Its similar, but not quite as liquid. It doesnthave as high a yield, so its slightly less attractive, heexplains.

Major tops?

There is some discord among analysts regarding the sum-mer highs scored by the Aussie and kiwi dollars. Some saythose could represent major long-term tops for the cur-

rencies, while others expect renewedstrength later in 2012.

Among those expecting these highsto represent longer-term resistance isStephen Roberts, chief economist-Aus-tralia at Nomura. When asked if the1.1000 area represented an importanthigh, Roberts says it probably [willbe] a peak for quite a while to comegiven the likely persistent headwindsto global growth prospects from fis-cal consolidation and deleveraging in

much of the developed world.Sean Callow, senior currency strate-

gist at Westpac Institutional Bank,holds a similar view.

It is indeed looking increasinglyas though the mid-2011 peaks around1.1000 were the cycle high for AUD/USD, he says. Since then we havehad a sea change in the RBA view,from a firm tightening bias to anactual rate cut, and more to come.AUD has lost some of its high yield

FIGURE 3: DAILY KIWI

The New Zealand dollar also declined after hitting new highs over the summer. Its fate is

largely tied to that of its Australian cousin.

8/2/2019 Ctm 201112


luster, with the two-year bond spread falling below 300basis points for the first time since July 2009. As the globaleconomy has cooled, Australias commodity prices havefallen about 17 percent from the April highs. Along withheightened equity volatility, such factors produce fairvalue estimates no higher than the low .90s.

However, Callow adds its by no means all doom andgloom for the AUD. Should the U.S. economy slowenough for the Fed to adopt QE3, AUD would be one ofthe key beneficiaries quite possibly the best performer,he says. Moreover, Australias very strong fiscal positionshould underpin demand for AUD government bonds.

He explains the Australian government noted in its mid-fiscal-year update that the average net debt position ofthe major advanced economies (G7) is projected to reach92.9 percent of GDP in 2016, more than 10 times higherthan the expected peak in Australias net debt of 8.9 per-cent of GDP.

There has been no sign of slackening in demand forAustralian Commonwealth government bonds, he says.Australias trade position should also remain strongerthan its historical average, with mining sector investmentvery robust and the terms of trade holding at elevatedlevels despite decline in recent months, Callow says. Sowhile European turmoil may well knock AUD/USD to,say, 0.93 before year end, we do not expect a slide of any-where near the magnitude of late 2008.

Turing to the kiwi, he notes that NZD/USD shouldswing with global risk sentiment as AUD does, with our

one-month target at 0.71.

Euro resolution

Brian Dolan, chief currency strategist at Forex.com, saysthe Eurozone debt crisis will be a pivotal factor for theAussie dollar in the weeks and months ahead.

Aussie/dollar is still captive to overall risk sentiment,which is dominated by the Eurozone debt crisis, he says.Unless the ECB changes its mandate to enable it to buygovernment debt directly or it steps in to lend to the IMF[so they can buy Eurozone debt], it is likely to keep Aussieand kiwi under pressure.

Michael Woolfolk, managing director at BNY Mellon,offers a more optimistic scenario.

We expect risk appetite to rebound next year on resolu-tion of the European debt crisis, he says. Assuming thatunfolds, Woolfolk cited his firms forecasts for the Aussie/dollar pair to hit 1.1000 by the middle of 2012 and 1.1500

by the end of the year.Part of that view, Woolfolk explains, includes a generally

negative outlook for the U.S. dollar, with U.S. interest ratesexpected to stay at zero and the belief the U.S. Fed willengage in some form of quantitative easing, he says.

Once we get some type of finality to the European situ-

ation, the safe-haven flows will reverse and leave the U.S.,which will be favorable for the Aussie, loonie (Canadiandollar) and dollar bloc as well, Woolfolk says. He high-lights targets of 0.8730 for kiwi/dollar by mid-year and0.9350 for year-end 2012.

Dont be sucked into the Euro break-up scenario that isbeing peddled right now, he adds. Its not going to hap -pen. The Eurozone will survive and prosper in the comingyears, though maybe with a few less members.y

Should the U.S. economy slow

enough for the Fed to adopt QE3,

AUD would be one of the key

beneficiaries quite possibly the

best performer.

Sean Callow, senior currency strategist at

Westpac Institutional Bank

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12/32

Europe seems to be on the financial rocks, with five of17 governments having fallen this year, peripheral bondyields at eye-watering levels, and even Germany unableto sell bonds. European equity markets are tanking andtaking other markets with them. Data indicates a recessionis looming; the Bundesbank forecasts 0.5-percent GermanGDP growth in 2012 at the low end.

Nonetheless, Figure 1 shows the Euro/U.S. dollar pair(EUR/USD) is not dramatically below the midpoint(1.3958) of the range from its high of 1.6038 on July 18,

2008, to its low of 1.1877 on June 11, 2010. In fact, in Aprilof this year the Euro penetrated upside resistance, andalthough in September it broke downside support, the sec-ondary support line (gray) in Figure 1 may hold.

We can complain about the markets asymmetrical treat-ment of the Euro (good news is overvalued and bad newsis dismissed or downplayed), but the Euros resiliencereflects more than a Teflon coating its miraculous. If allthese woes befell another currency, it would have depreci-ated by 20 to 40 percent or more. Somewhere, presumably,

there must be long-term investors

with an abiding faith in the sustain-ability of the Eurozone experimentand the principles that underlie theEuro. If we use the two-year note asthe correct benchmark during a crisis,we see some distress and divergencebetween the Euro and German two-year note, but still a strong correlation(Figure 2). Since the Germans wouldrather underfund an auction than paytoo high a price, the Euro still has astrong foundation.

Europe on the rocksIn late November Germany auctioned6 billion worth of 10-year bunds butwas able to sell only 3.64 billion, or60 percent, with an average yield of1.98 percent. The bid-to-cover ratiowas a horrible 1.1, compared to a bid-to-cover of 3.15 the day before in U.S.five-year notes, which was the higheston record in the past 10 years. TheU.S. sold seven times as much, too $35 billion. In the weeks leading up

to the failed German auction, Market

On the Money


ON THE MONEY

The long, deep game

If it can survive its crisis with only Greece leaving the EMU, Europe will have the gold-standard

currency for a whole new generation. To that end, the IMF may end up getting involved.

BY BARBARA ROCKEFELLER

FIGURE 1: EUR/USD

Despite Europes woes, the EUR/USD pair is not dramatically below the

midpoint of its July 2008 to June 2010 range.

Source: Chart Metastock; data Reuters and eSignal

8/2/2019 Ctm 201112


News International (MNI) reported large Asian playerswere selling European bonds, including bunds. However,on many days MNI was also reporting large Asian players

were continuing to buy Euros at interim lows, presumablyfor reserve diversification purposes.

Meanwhile, as political crises swelled and receded inGreece, Italy, and Spain, the 10-year yield on their bondsrose above 6 percent and, for Italy, above 7 percent thelevel at which other governments (Ireland, Portugal) hadfallen. Sure enough, all three governments were replaced.The new leaders will institute the same reforms andausterity budgets as the already fallen governments, soeconomically and financially nothing has changed exceptthe names on the doors. In fact, its still not clear Greecewill be getting the 8 billion of bailout money if two new

government coalition partners continue to refuse to signthe reform/austerity letter demanded by the EuropeanCommission a cliffhanger.

Everyone recognizes government deficits need to be cutpretty much everywhere and the financial sector needsrecapitalization. Germany and the new ECB PresidentMario Draghi insist the ECB not be used as a lender oflast resort and that there be no new pan-EMU Eurobondissuance, but a viable European Financial Stability Facility(EFSF) backstop has yet to be designed.

Vitriol abounds. In a recent diatribe, Nick Farage, aBritish member of the European Parliament, said it was adisgrace for the EU to be ousting democratically elected

governments in Greece and Italy. Addressing EU PresidentHerman Van Rompuy,European Commissionchief Jos ManuelBarroso, Eurogroupleader Jean-ClaudeJuncker, and EFSF presi-dent Olli Rehn, Faragesaid, Here we are onthe edge of a financialand social disaster andin the room today wehave the four men who

are supposed to beresponsible. And yetwe have listened to thedullest, most techno-cratic speeches Ive everheard ... You are all indenial. By any objectivemeasure the Euro is afailure. And who exactlyis responsible, who isin charge out of all youlot? The answer is noneof you because none of

you have been elected; none of you have any democraticlegitimacy for the roles you currently hold within this cri-sis. And into this vacuum, albeit reluctantly, has stepped

Angela Merkel. And we are now living in a German-dominated Europe something that the European proj-ect was actually supposed to stop. Something that thosewho went before us actually paid a heavy price in bloodto prevent. I dont want to live in a German-dominatedEurope and nor do the citizens of Europe. (Source: www.ukipmeps.org/articles_263_Farage-Puppet-governments-installed-in-Greece-and-Italy.html.)

This speech is a Holy cow! moment. Farage is railingas much against a German-dominated Europe as againstinadequate leadership. But he is wrong. A German-dominated Europe is exactly what Europe has had for

more than a century and also exactly what the EMU mem-bers states signed on for when they signed the MaastrichtTreaty.

The key components of the Maastricht Treaty are anindependent central bank based on Bundesbank prin-ciples specifically, one in which all policy decisions aredirected toward low inflation. Hard on the heels of theMaastricht Treaty came another German initiative, theStability and Growth Pact, which limits annual deficits to 3percent of GDP and total government debt to 60 percent ofGDP. The signatories to these two treaties were willing toagree with Germany on these issues for one simplereason German could reunify East and West sectors on

its own terms but would give up the Deutsche mark.

FIGURE 2: GERMAN TWO-YEAR NOTE

There is still a strong correlation between the Euro and German two-year note.

Source: www.fxthoughts.com
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ON THE MONEY

Consider the timeline. Reunification began in 1990,the Maastricht Treaty forming the Eurozone was signedin 1992, and the Stability and Growth Pact was signedin 1997. The Euro was launched Jan. 1, 1999. Why was itworth anything to the other countries that Germany wouldgive up the Deutsche mark? Their currencies had beenexplicitly pegged to the DM (or at least compared to it) fordecades, in the snake and the European Rate Mechanism

(ERM). The Deutsche mark was the standard for excellencein economic management in the post-war world. The othercountries wanted to reduce the influence of Germany (andthe Bundesbank) on the other European economies andcurrencies. Germany giving upthe Deutsche mark was a real-world way of doing that, farbeyond its symbolic value. Ineffect, what Germany gave upwas its central place in the cur-rency world.

And what did the rest ofEurope get out of it? By shel-

tering under the Eurozoneumbrella they got lower inter-est rates than they could havegotten on their own. They gotrid of periodic currency crisesand painful devaluations. Theygot capital inflows inspired byrelative currency market stabil-ity. They also got bigger trans-fers in the form of agriculturaland development subsidies. Whole towns were rebuilton European money, including the port city of Valencia,Spain, which went on to host the Americas Cup yacht race.

To be fair, Germany gave up something it didnt want inthe first place: the potential for the DM to be the targetof destabilizing hot-money inflows in crises, much as theSwiss franc is today.

But Germany benefits in other ways, too. The Germanexport boom over the past decade is due as much toother EMU members as to emerging markets. Think-tankanalyst Sebastian Mallaby, the Paul A. Volcker senior fel-low in international economics at the Council on ForeignRelations, wrote in the Nov. 24, 2011 Financial Times:

[T]he currency union that makes adjustment in theperiphery so excruciating is the very same currency unionthat handed Germany its export boom. Rather than con-

demning lazy southerners, the Germans should share theloot.

Germany has benefited more than it acknowledgesthrough the monetary channel, too. During the Eurosfirst decade, interest rates across the Eurozone fell towardGerman ones, and low-saving southern countries appearedto derive a subsidy from the credit rating of high-savingnorthern ones. But, far from being a boon to the periphery,

centralized monetary policy proved appropriate for theEUs mature core, but too loose for inflation-prone catch-up economies. By an irony that inflation-hating Germanshave trouble seeing, Ireland and Spain suffered property

and banking busts at least partlybecause monetary policy was tooGerman. Rather than scorn thelosers, Germany should compen-sate them.

Mallaby is defending the pointof view that Germany should bewilling to pay more to save theEurozone. Whether in the form of

the ECB monetizing debt (likethe Fed), backing a Eurobond,or through some other measure,Germany should rebalance itsperception of self-interest; it has alot to lose if the Eurozone were tobreak up.

Consider the assumptionsEurozone political leaders, espe-

cially in France, have baldly stated they want the Euroto supplant the dollar as the worlds reserve currency.Becoming the reserve currency is not a stated goal of any

of the treaties, but its surely present in the back of every-ones mind.

Another concept at work is that no country ever pros-pered by devaluing its currency. So while academics andtechnocrats plead for the ECB to become a lender of lastresort, possibly going as far as engaging in quantitativeeasing (as conducted by Japan, the U.S., the UK, and evenSwitzerland), Germany and the ECB oppose this formof monetization of debt. They say their opposition is toenforce the Stability Pact, but underlying the Stability Pactis the core concept that monetization leads to devalua-tion. The tactic of monetizing debt flies in the face of the

long game, which is to forge a stable currency based on the

The U.S. has had a

depreciation policy for

most of the 40 years

since President Nixontook the U.S. off the gold

standard in 1971.
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expectation of no inflation or devaluation, ever.German Chancellor Angela Merkel and the Bundesbankwant the Euro to be as well-grounded as the Deutschemark. Two top Bundesbank officials President AxelWeber and Vice President Jrgen Stark went so faras to resign on losing the argument that the ECB shouldbuy a limited amount of sovereign debt. So far the ECBhas bought less than 300 billion in sovereign debt in thesecondary market Stark and Weber presumably wouldhave had the amount be zero. Current Bundesbank chiefJens Weidmann has taken upon himself the job as ECB-watcher and enforcer, saying By assuming the role oflender of last resort for highly indebted member states, the

bank would overextend its mandate and shed doubt on thelegitimacy of its independence. To follow this path wouldbe like drinking seawater to quench a thirst.

The Germans are accused of selfishness and even sabo-tage of the Eurozone experiment,but its possible to interpret theirmulish stubbornness as some-thing else: the desire to sponsorthe worlds first bulletproof fiatcurrency. After all, let us not for-get the U.S. has had a policy ofdepreciation for most of the 40years since President Nixon tookthe U.S. off the gold standard in1971. Sometimes it has been anexplicit policy and the U.S. hasbullied others into cooperating,such as the Nixon 10-percentimport surcharge and trade defi-cit targets in 1973, as well as thePlaza Accord in 1985. Other times the policy was implicit.Rarely did the U.S. aim for a stable or appreciating curren-cy, one of the exceptions being the Reagan-Volcker regimein the early 1980s. During the Clinton years, TreasurySecretary Robert Rubin declared a strong dollar is in the

U.S. best interests, the so-called strong-dollar mantra, butby the time of the 2007-08 financial crisis and the adventof quantitative easing, the phrase was falling flat, eventhough current Treasury Secretary Timothy Geithner con-tinues to say it. No one believes him: zero-percent interestrates, quantitative easing, and the Twist all point towarda weaker dollar, not a stronger one.

The Feds fear of deflation is real, but many observ-ers fear the refusal to live with and manage deflation canlead to only one thing inflation down the road. TheFed asserts it has the means to identify impending infla-tion and the will to cut it off at the pass, but not everyonehas confidence the Fed can deal with another round of the

kind of stagflation the U.S. suffered after the first oil shock

in 1973. A sense of grim foreboding lies over the land.If the Eurozone can survive the current financial crisiswith no more than one country leaving the EMU (Greece),Europe will be in the drivers seat as the gold-standardcurrency for a whole new generation. It wont matterwhether the Fed is able to contain inflation, Europe willhave the one thing investors want above all else: a rock-solid anti-inflation commitment. This is the long gameMerkel and the Bundesbank are playing.

At a guess, they wont win without some help. Thiswill mostly likely come from the International MonetaryFund (IMF), egged on by emerging-market countries suchas Brazil, Russia, India, and China, who have already

complained bitterly about U.S. policy being selfish andconducting the equivalent of a currency war. However, thisterm is inappropriate and there is little evidence the U.S.has a grand plan that entails deliberately harming other

countries for its own self-inter-est. It would be more accurate but no less damning tosay the U.S. is indifferent tohot-money inflows into emerg-ing markets that arise from thequest for yield by investors andspeculators. The U.S. has a splitattitude toward market inter-vention: Let the markets rulewhen its global capital flowsbut hands off U.S. intervention-ist monetary policy directedtoward U.S. institutions and theU.S. economy.

What can the IMF do? Itsmandate is to act as a lender of last resort to governmentsin temporary distress. We might think its embarrassingfor a major player such as the EMU to seek and to acceptfinancial aid from the IMF, although the UK is certainly amajor player and has done it. Besides, the IMF insists on

getting paid first and promptly (years, not decades), andso far has always succeeded. IMF aid is temporary andintended to restore imbalances in a crisis, which is precise-ly what exists in the Eurozone today. The IMF generallyembraces a monetarist approach and fiscal retrenchment,which is fine with the Bundesbank and ECB. The IMF alsousually calls for a devaluation, but thats not a hard andfast rule.

If the IMF could act as the lender of last resort, lettingthe ECB off the hook, the EMU would be buying time,exactly as it has been doing since Greece confessed tolying about its public finances in fall 2009. Recently theIMF announced it was preparing to expand its short-term

lending facility, renamed from the Precautionary Lending

If all these woes befell

a currency other than

the Euro, it would have

depreciated by 20percent or more.

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ON THE MONEY

Line to the Precautionary Lending and Liquidity Line(PLL). According to the IMF statement, the PLL will beavailable in broader circumstances, including as insur-ance against future shocks and as a short-term liquiditywindow to address the needs of crisis bystanders duringtimes of heightened regional or global stress and break thechains of contagion. It will be a lending facility designedto provide short-term liquidity to what it calls crisisbystanders, rather than just those impacted by naturaldisasters or rebuilding after a war.

The IMF has available lending resources of about $652billion, which together with 440 billion in the beefed-up EFSF might be enough to pull both governments andbanks out of the hole they are sliding into. In addition, theECB could lend to the IMF to increase the amount, and theIMF can turn around and lend to any government seekingaid, such as Greece, Spain, or Italy. Note that almost all ofthe IMFs lendable resources come from central banks which, of course, includes the U.S. Federal Reserve, so theFed would become a lender once-removed to distressed

European governments. In fact, the ECB could borrowdirectly from the Fed under the central bank swap lineand send that money to the IMF, too. You can view thisas a neat trick by Germany to avoid responsibility or as aperfectly legitimate fall-back under current internationalfinance rules.

An interesting aspect of the IMF bailout idea is that itwould allow the BRICs to get involved indirectly. China,for one, has declared support for some countries (includ-ing Spain) and for the EFSF, but evidently declined tomake a new commitment when EFSF CEO Klaus Reglingvisited Beijing in November 2011. Note that the EFSFalready operates in conjunction with the IMF. Because the

IMF demands it be repaid first, that might reassure BRICmembers. A fun problem is if China were given the extravotes it deserves in the IMF based on population andGDP (as proposed at the Pittsburgh G20 meeting in 2009),it would have more votes than the smallest G7 country,Canada. Europe may have an incentive to stand behindChina getting more IMF votes. Today, the single biggestvoter and contributor to the IMF is the U.S., at 17 percent.

Although the idea purloined from Karl von Clausewitzthat finance is war by other means is a bit of a stretch, itsometimes seems to come close. At an Asian summit, theU.S. declared itself a resident Pacific power, as a maritimenation, as a trading nation and as a guarantor of securityin the Asia Pacific region. The U.S. was warning China offfrom the South China Sea territorial fight it has been wag-ing bilaterally with smaller countries in a grab for under-sea resources. China backed down for the moment terri-torial claims will be decided by a multilateral process, notby China bullying countries one-by-one.

If and when it is announced the IMF has been called

in to consult with the Eurogroup, ECB, EuropeanCommission, and/or the EFSF, we are at risk of a tre-mendous rally in the Euro. We dont know for sure this isthe German plan, but kicking the can down the road hasworked so far, and in retrospect, has been leading to theIMF all along. Therefore, we do not buy into the scenariothat has the Euro falling ever farther. In fact, it may sta-bilize near the midpoint of the range in Figure 1, around1.3950. Keep in mind that another beneficiary of a rallyingEuro will be European equity markets (Figure 3).y

For information on the author, see p. 4.

FIGURE 3: MAJOR EUROPEAN EQUITY INDICES

European equity markets would be another beneficiary of a rallying Euro.

Source: Chart Metastock; data Reuters and eSignal

:

2007F MA M J J A S O N D 2009M A MJ J A S O N D 2010 A MJ J A S O N D 2011M A MJ J A S O N

250

300

350

400

450

500

550

x10

BlackGerman DAXGoldFrench CACBlueMadridRedAthens

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A frequent question that arises when developing a tradingstrategy is how to properly determine specific parameters.Because market conditions are constantly changing, itsunrealistic to expect a system with fixed parameters toperform at a consistently high level over long time periods.But how do you decide if a strategy should use a certainstop-loss, profit target, or indicator period length ratherthan another? Whats the best way to adjust parametersover time?

The answer to these questions usually comes throughoptimization the process of testing multiple parametervalues on historical data to see which set gives the bestresults best being something that can be measured in

different ways. However, optimization presents anotherproblem: the potential for excessive fitting of a systemto past market conditions, which is likely to result in farworse results in future trading. For example, say a tradingsystem uses a moving average as one of its inputs and ahistorical test shows that a length of 24 days produced thehighest net profit, but that all other lengths between 20 and30 days performed poorly. Using a 24-day moving averagelength would be a poor choice for future trading because itis likely a fluke; this parameter selection is merely fitted tothe past data conditions, which are unlikely to be repeatedin the future.

TRADING STRATEGIESTRADING STRATEGIES

FIGURE 1: WALK-FORWARD TESTING

Walk-forward analysis applies optimized parameters

from the most recent period (blue rectangles) to the

subsequent forward-test periods (green rectangles),

re-optimizing the parameters at regular intervals.

Walk-forward analysisof a volatility breakoutsystem

Progressively updating a trading system to recent market

data provides insight into how robust the technique is and

allows it to adjust to changing market conditions.

BY DANIEL FERNANDEZ

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Walk-forward analysis is one of the most powerful tech-niques for evaluating whether a strategy can survive theparameter selection process that is, whether the ideaof optimizing and using a given set of best parametersis justified. In this procedure a strategy is optimized for

a period ofx bars and the results of the optimization areused fory bars in the future, at which point the proce-dure is repeated to obtain the parameter settings for thesubsequent trading period. This process of walking thestrategy forward through successive sets of new data isdesigned to keep the system as up to date as possible withchanging market conditions.

Figure 1 illustrates how this is carried out. The blue rect-angles represent the optimization periods and the greenrectangles represent the subsequent forward-testing peri-ods to which the optimized parameter settings are applied.By running a 10-year test with constant re-optimizationand the use of the best parameters through every newforward-testing period, we can get a very good idea ofhow our strategy handles changing parameter values, andwhether doing this makes sense.

The system

To illustrate the walk-forward analysis process, we will usea daily time frame trend-following strategy (based on vola-tility breakouts) that includes two parameters. Basically,the system takes a position in the direction of the mostrecent days momentum (as determined by whether theclose is above or below the open) as long as that momen-tum exceeds a certain threshold, the logic being that such

a move will be followed by more price movement in thesame direction:

1. Go long if the most recent days close is above theopen and the open-to-close range is greater than xpips.

2. Go short if the most recent daysclose is below the open and theopen-to-close range is greater thanx pips.

3. Close a position after it has beenopen fory days.

4. Only one trade can be open at atime.

5. Trade 0.00001 times the currentaccount balance per signal.

This type of strategy is perfect forillustrating walk-forward analysisbecause it has a limited number ofparameters that can be optimizedquickly and conveniently. Other thanthe position-sizing rule (step 5), thestrategy has no inherent dynamic capa-

bilities (such as volatility adapted indicators). As a result,the only way the system can possibly adapt to evolvingmarket conditions is by changing parameters x (the intra-day move threshold that determines trade entry) and/or y(the holding period).

The walk-forward process

The strategy was applied to the Euro/U.S. dollar pair(EUR/USD) over a 10-year period starting in January2001 and ending in January 2011, with optimization ofparameters x andy conducted every 50 calendar days onthe most recent 300 calendar days. Parameter x was opti-mized from 10 and 500 pips in 10-pip increments (10, 20,30, 40500), whiley was optimized between one and 50days in one-day increments (1, 2, 3, 450). The best resultfor each optimization period was defined as the largestnet profit; the parameter set that produced this result wasused for the subsequent segment of the forward test (thenext 50-day period). Trading costs of 2 pips per trade were

applied throughout the test.The primary advantage of this analysis is that it elimi-nates hindsight: Although we dont know which param-eters will be used for each upcoming 50-day period, wehave a very clear process for establishing how to derivethese values from the previous data. In the end we have aresult that tells us how our strategy will behave if we had

FIGURE 2: EQUITY CURVE

The system was profitable overall, with one major drawdown followed by a new

equity high at the end of the test window.

TABLE 1: STRATEGY STATISTICS

Annualized return 19.65%

Max. drawdown 32.87%

Win percent 58%

Reward/risk ratio 1.41

Ulcer Index 10.79

Profit factor 1.94

No. of trades 171

The strategys performance statistics were solid an

average compound yearly profit of 19.65 percent and a

maximum drawdown of 32.87 percent.

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applied a constant set of rules for theselection of parameters through thewhole test.

Results

Figure 2 shows the systems equitycurve using the parameters derivedfrom the walk-forward process. Thesystem was profitable overall, indicat-ing the technique has an edge that ismaintained in the long-term basedon the constant re-optimization of the

systems parameters. Table 1 showsthat the strategys basic performancemetrics were quite good, with anaverage compound yearly profit of19.65 percent and a maximum draw-down of 32.87 percent. The maximumdrawdown length was 644 days, inline with what we would expect for atrend-following system on the dailytime frame.

The monthly returns in Figure 3show the best-performing condi-tions for this system have actuallydeveloped within the past three years(despite the most significant draw-down also occurring during this peri-od). This highlights how re-optimiza-tion allowed the strategy to functionduring the financial crisis even thoughsuch extreme conditions had not pre-viously appeared in the test period.When a strategy fails to produce prof-itable results in walk-forward analysis,it implies the strategys best parameterchoice always lagged the changes in

market conditions. Such systems havea high probability of always givingcurve-fitted results and theres a highchance their profitability is entirelybased on hindsight.

Its also interesting how the opti-mum parameters evolved over time.These changes show us how marketconditions have changed and if thesystem has actually adapted. Figure4 shows the entry (x, bottom) andexit (y, top) parameters oscillated


TRADING STRATEGIES

FIGURE 4: EVOLVING PARAMETER VALUES

The exit (top) and entry (bottom) parameters oscillated significantly over the

course of the test.

FIGURE 3: MONTHLY RETURNS

Re-optimization helped the strategy continue to perform during the financial

crisis.

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substantially throughout the test period, implying that thestrategys character has varied significantly in responseto changing market conditions. Table 2 shows the entryparameter ranged from 50 to 150 pips, had a median valueof 60, and a mode (most frequently occurring value) of 50.(The estimated mode, which derives a hypothetical modevalue based on a data sets median and average values,was also 50.) The exit parameter (number of days untilexit) ranged from 1 to 49, with a median of 15 (average 18)and a mode of 6 (estimated mode of 9).

When extreme drastic market changes occurred (e.g.,during the financial crisis) the system adapted by drasti-cally reducing the time to exit trades (from 30 to six daysbetween July 2007 and March 2009) and increasing the

threshold for opening a trade (from 50 to 100 pips over thesame period) in essence adapting the system to the factthat larger, shorter-term moves were the best bet.

Walk-forward analysis offers a way to build a tradingstrategy without any parameter-selection bias. You can

evaluate a strategy over a long-term period using adefined set of rules for choosing parameters, removingmuch of the potential hindsight and curve-fitting inherent

in regular trading system creation. Using simple tradingtechniques, such as the one described here, and evaluatingthem through walk-forward analysis is an excellent way todetermine their level of robustness.yFor information on the author, see p. 4.

TABLE 2: PARAMETER RANGES

x(entry) y(exit)

Max. 150 49

Min. 50 1

Avg. 65 18Med. 60 15

Mode 50 6

Est. mode 50 9

Over time, the optimum value for the entry

parameter (x) was a little more stable than the

optimum exit parameter (y).
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TRADING STRATEGIESADVANCED CONCEPTS

One of the cultural annoyances new traders have to over-

come is the difference between the interbank and Chicago

Mercantile Exchanges International Monetary Market

(IMM) conventions. The interbank market, with certain

prominent exceptions such as the Euro, British pound,

and both the Australian and New Zealand dollars, quotes

currencies in per USD terms. The IMM convention is to

quote everything in USD per terms.

One writer was told back in the 1970s the IMM conven-

tion was necessary for purposes of clearing and margining,

and this does, in fact, make sense: a customers account

could hold just a single currency, the U.S. dollar, and be

managed accordingly. A more cynical answer was prof-

fered in the 1980s: When currency futures started during

the early 1970s, the sentiment wasoverwhelmingly dollar-bearish,

and by quoting the futures in

terms that rose when the dollar

weakened, a bullish bet on the

yen or Deutsche mark would be

accompanied by a rising number

if successful.

Why the introduction? The

answer, for purposes of this

article, is simple: We will be dis-

cussing carry trade returns intothe dollar indexs six components

and summing those returns in

an index. Thus a successful bull-

ish bet on the dollar indexs

components will have a rising

number meaning a successful

bullish outlook on a dollar index

(DXY) position itself is expressed

as a bearish opinion on the DXY

and produces a lower number. A

higher carry return into the six

Decomposing the dollar index

Analyzing the DXY shows how all trades involve comparing alternatives and

those alternatives have to be accounted for on a complete cost basis.

BY HOWARD L. SIMONS

Of the dollar indexs six components, only the return into the British pound has been

significantly positive.

FIGURE 1: INTEREST-RATE SPREAD RETURN FOR DOLLAR INDEX

65

70

75

80

85

90

95

100

105

110

115

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

January4,

1999=1

00

JPY

GBP

EUR

CHF

SEK

CAD

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components and a lower DXY

index reading are two ways of

expressing the outcome, but

they can be confusing. As an

aside, futures traders who thinkof bonds in terms of price often

stumble when they enter the cash

market and are forced to think in

terms of yield.

Carry components

The dollar carry trade (see The

short, awful life of the dollar

carry trade, August 2008) can be

broken into two components: the

net interest-rate spread from bor-

rowing the USD and lending into

another currency, and the spot

rate return. Over time, the inter-

est-rate spread for high-yielding

currencies such as the Argentine

peso or Turkish lira can over-

whelm their negative spot rate

returns and make them good

investments for dollar-domiciled

investors.

Figure 1 shows the interest-

rate spread returns since theJanuary 1999 advent of the Euro.

Surprisingly, only the return into

the British pound has been signif-

icantly positive. (March 18, 2009,

the date when quantitative easing

began, is marked with a vertical

line in all accompanying charts.)

Now lets weight these spread

returns by the fixed weights of

the DXYs components, which

are: EUR 57.6 percent, JPY 13.6

The combined net interest-rate spread for borrowing the dollar and lending into the

DXY components has been negative over time.

FIGURE 2: INTEREST-RATE SPREAD RETURNFOR DOLLAR INDEX (INDEX-WEIGHTED)

52.5

55.0

57.5

60.0

62.5

65.0

67.5

70.0

72.5

75.0

77.5

80.0

82.5

85.0

87.5

90.0

92.5

95.0

97.5

100.0

102.5

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

Janua

ry

4,

1999=1

00

CHF

SEK

CAD

GBP

JPY

EUR

On an unweighted basis, five of the six components have gained on the USD over

time, with the GBP being the one exception.

FIGURE 3: SPOT RATE RETURN FOR DOLLAR INDEX COMPONENTS

70

80

90

100

110

120

130

140

150

160

170

180

190

200

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

Januar

y

4,

1999=

100

JPY

GBP

EUR

CHF

SEK

CAD
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percent, GBP 11.9 percent, CAD

9.1 percent, SEK 4.2 percent, and

CHF 3.6 percent. The combined

net interest-rate spread for bor-

rowing the dollar and lendinginto the DXY components has

been negative over time, which is

hard to imagine today given the

Bernanke Federal Reserves mon-

ey-printing proclivities (Figure 2).

Figure 3 repeats the exercise

with the spot rate returns. On

an unweighted basis, five of the

six components have gained on

the USD over time, with the GBP

being the one exception.Once we apply the index

weights, the combined spot rate

return over time has been less

impressive than we have been

led to believe indeed, the peak

occurred just before the 2008

financial crisis hit (Figure 4).

Finally, lets re-integrate the

interest-rate spread and spot

rate components, first on an

unweighted basis (Figure 5) andlater on a weighted basis (Figure

6). While many believe the bet

against the dollar has been a one-

way affair for 40 years, the actual

economic return of going short

the dollar and long the six com-

ponents has been a struggle. By

September 2011, the net return on

the trade was about the same as it

was in November 2007.

ON THE MONEY


ADVANCED CONCEPTS

The actual economic return of going short the dollar and long the six components has

been a struggle.

FIGURE 5: EXCESS CARRY RETURN FOR DOLLAR INDEX COMPONENTS

60

70

80

90

100

110

120

130

140

150

160

170

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

Janua

ry

4,

1999

=1

00

JPY

GBP

EUR

CHF

SEK

CAD

Applying the index weights shows the combined spot rate return over time has been

less impressive than we have been led to believe.

FIGURE 4: SPOT RATE RETURN FOR DOLLARINDEX COMPONENTS (INDEX-WEIGHTED)

35

40

45

50

55

60

65

70

75

80

85

90

95

100

105

110

115

120

125

130

135

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

Jan

uary

4,

1999

=

100

CHF

SEK

CAD

GBP

JPY

EUR

8/2/2019 Ctm 201112


Net carry returns and

other markets

Finally, as many traders regard

the linkages between the DXY

and key commodity markets such

as crude oil or gold or between

the DXY and U.S. equities asconstant, lets look at the roll-

ing three-month correlations of

returns involved.

In the case of crude oil and

gold, we will use the Dow Jones-

UBS total return sub-indices for

each commodity; these include

the effects of roll yield and the

return on collateral. The correla-

tion of returns between the DXY

carry index constructed here andgold is not only much lower than

commonly believed, but it peaked

in April 2005 and has gone nega-

tive thrice since then. The DXY

and crude oil never had much of

a link between them prior to the

widespread adoption of long-

only commodity index trading

in the 2003-2004 time frame, and

that stands out in Figure 7.

If we repeat the exercise for

large- and small-capitalization

U.S. equities as measured by the

Russell 1000 and Russell 2000

indices, respectively, we see a

similar time-dependent relation-

ship (Figure 8). The carry returns

for the DXY against both stock

indices had been negative until

2004 and only climbed into

strongly positive ground during

and after 2009, with a prominent

By September 2011, the net return on the trade was about the same as it was in

November 2007.

FIGURE 6: EXCESS CARRY RETURN FOR DOLLAR INDEX COMPONENTS

35

40

45

50

55

60

65

70

75

80

85

90

95

100

105

110

115

120

125

Jan-99

Jun-99

Dec-99

Jun-00

Dec-00

Jun-01

Nov-01

May-02

Nov-02

May-03

Nov-03

Apr-04

Oct-04

Apr-05

Oct-05

Apr-06

Sep-06

Mar-07

Sep-07

Mar-08

Sep-08

Feb-09

Aug-09

Feb-10

Aug-10

Jan-11

Jul-11

January

4,

1999=

100

CHF

SEK

CAD

GBP

JPY

EUR

The correlation of returns between the DXY carry index and gold peaked in April 2005

and has gone negative three times since. The DXY and crude oil never had much of

a link prior to the widespread adoption of long-only commodity index trading in 2003-

2004.

FIGURE 7: THREE-MONTH ROLLING CORRELATION OF RETURNS:DXY VS. GOLD AND WEST TEXAS INTERMEDIATE

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Apr-99

Sep-99

Mar-00

Sep-00

Mar-01

Aug-01

Feb-02

Aug-02

Feb-03

Aug-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jun-06

Dec-06

Jun-07

Dec-07

Jun-08

Nov-08

May-09

Nov-09

May-10

Nov-10

Apr-11

Oct-11

Correlation

Crude Oil

Gold

8/2/2019 Ctm 201112

26/32

ON THE MONEY


ADVANCED CONCEPTS

detour to the downside during the QE2 era.

In all cases, traders should be careful about

assuming relationships where none may

exist outside of a momentary fashion in the

markets created by policies such as quantita-

tive easing or a stampede by institutions intovehicles such as long-only commodity index

funds.

Covering all bases

It is understandable so many traders look at

the spot rate return of going into the DXY

basket and never stop to ask, What is the

opportunity cost? Am I incurring net interest-

rate spread losses as part of this trade? Which

DXY components are contributing to what

aspects of the total return picture?While understandable, this is not excusable,

however. All trades involve the comparison of

alternatives, and those alternatives have to be

accounted for on a complete cost basis.y

For information on the author, see p. 4.

The carry returns for the DXY against both stock indices were negative until 2004 and only

climbed into strongly positive ground during and after 2009 (with a prominent downside detour

during the QE2 era).

FIGURE 8: THREE-MONTH ROLLING CORRELATION OF RETURNS:DXY VS. RUSSELL STOCK INDICES

-0.7

-0.6

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Apr-99

Sep-99

Mar-00

Sep-00

Mar-01

Aug-01

Feb-02

Aug-02

Feb-03

Aug-03

Jan-04

Jul-04

Jan-05

Jul-05

Jan-06

Jun-06

Dec-06

Jun-07

Dec-07

Jun-08

Nov-08

May-09

Nov-09

May-10

Nov-10

Apr-11

Oct-11

Correlation

Russell 2000

Russell 1000
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CPI: Consumer price index

ECB: European Central Bank

FDD(rstdeliveryday):Therst

day on which delivery of a com-modityinfulllmentofafutures

contract can take place.

FND(rstnoticeday):Also

knownasrstintentday,thisis

therstdayonwhichaclear-nghouse can give notice to abuyer of a futures contract that itntends to deliver a commodity in

fulllmentofafuturescontract.

The clearinghouse also informsthe seller.

FOMC: Federal Open MarketCommittee

GDP: Gross domestic product

ISM: Institute for supplymanagement

LTD(lasttradingday):Thenal

day trading can take place in a

futures or options contract.

PMI: Purchasing managers index

PPI: Producer price index

Economic Releaserelease (U.S.) time (ET)

GDP 8:30 a.m.

CPI 8:30 a.m.

ECI 8:30 a.m.

PPI 8:30 a.m.

SM 10:00 a.m.

Unemployment 8:30 a.m.

Personal income 8:30 a.m.

Durable goods 8:30 a.m.Retail sales 8:30 a.m.

Trade balance 8:30 a.m.

Leading indicators 10:00 a.m.

GLOBAL ECONOMIC CALENDAR

December

1U.S.: November ISM manufacturingreportFrance: Q3employmentreport

2U.S.: November employment reportCanada: November employmentreport

3

45

6Canada: Bank of Canada interest-rate announcementBrazil: Q3GDP

7 Australia: Q3GDPBrazil: November PPI

8

Australia: November employmentreportBrazil: November CPIMexico: NovemberPPIandNov.30CPIUK: Bank of England interest-rate

announcementECB: Governing council interest-rateannouncement

9

U.S.: October trade balanceGermany: November CPIUK: November PPILTD: December forex options;December U.S. dollar index options(ICE)

10

11

12 Japan: November PPI

13

U.S.: November retail sales and

FOMC interest-rate announcementFrance: November CPIHong Kong: Q3PPIUK: November CPI

14India: November PPISouth Africa: November CPIUK: November employment report

15 South Africa: November PPIU.S.: November PPI

16 U.S.: November CPI

17

18

19

Hong Kong: Sept.-Nov. employmenreportLTD: December forex futures;December U.S. dollar index futures(ICE)

20

Canada: November CPIGermany: November PPIHong Kong: November CPIJapan: Bank of Japan interest-rateannouncement

21FDD: December forex futures;December U.S. dollar index futures(ICE)

22

U.S.: Q3GDPandNovemberleading indicatorsBrazil: November employmentreportMexico: November employmentreportandDec.15CPIUK: Q3GDP

23

U.S.: November personal incomeand durable ordersFrance: Q3GDPandNovember

PPI24

25

26

27

28 Japan: November employmentreport and CPI

29

30 India: November CPI

January

1

2

3

U.S.: December ISM manufacturingreportGermany: November employmentreport

4

5 Canada: November PPI

6

U.S.: December employment reportBrazil: December CPILTD: January forex options; JanuaryU.S. dollar index options (ICE)

The information on this page is sub-

ect to change. Currency Traderis

not responsible for the accuracy of

calendar dates beyond press time.

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Event: The International Traders Expo LondonDate:March23-24Location: Queen Elizabeth II Conference Centre, LondonFor more information:Click here.

EVENTS
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CURRENCY FUTURES SNAPSHOT as of Nov. 29

The information does NOT constitute trade

signals. It is intended only to provide a brief

synopsis of each markets liquidity, direction,

and levels of momentum and volatility. See

the legend for explanations of the different

fields. Note: Average volume and open

interest data includes both pit and side-by-

side electronic contracts (where applicable).

LEGEND:

Volume: 30-day average daily volume, in

thousands.

OI: 30-day open interest, in thousands.

10-day move: The percentage price move

from the close 10 days ago to todays close.20-day move: The percentage price move

from the close 20 days ago to todays close.

60-day move: The percentage price move

from the close 60 days ago to todays 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 previous moves of

the same size and in the same direction. For

example, the % rank for the 10-day move

shows how the most recent 10-day move

compares to the past twenty 10-day moves;

for the 20-day move, it shows how the most

recent 20-day move compares to the pastsixty 20-day moves; for the 60-day move,

it 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 smaller than the previous

readings.

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.

BarclayHedge Rankings:Top 10 currency traders managing more than $10 million

(as of Oct. 31 ranked by October 2011 return)

Trading advisorOctoberreturn

2011 YTDreturn

$ Undermgmt.

(millions)

1. Silva Capital Mgmt (Cap. Partners) 13.08% -10.84% 16.3

2. MIGFX Inc (Retail) 10.74% 73.78% 45.0

3. CenturionFx Ltd (6X) 5.51% 32.50% 19.5

4. Regium Asset Mgmt (Ultra Curr) 4.07% 22.66% 36.65. Gedamo (FX Alpha) 3.99% 23.18% 18.8

6. ACT Currency Partner AG 2.07% 18.69% 20.0

7. Cambridge Strategy (Emerging Mkts) 1.74% 1.90% 90.0

8. IPM Global Currency Fund (C) 1.37% -5.36% 174.0

9. Olsen (Olsen Invest - AF) 1.18% 7.89% 30.0

10. Gain Capital Mgmt (MAC 4X) 0.98% 0.74% 27.6

Top 10 currency traders managing less than $10M & more than $1M

1. Adantia (FX Aggressive) 7.23% 35.47% 1.7

2. Iron Fortress FX Mgmt 6.90% 46.11% 3.2

3.Greenwave Capital Mgmt (GDS Beta)

4.76% 3.14%4.0

4. Valhalla Capital Group (Intl AB) 4.37% 29.92% 2.1

5. Armytage AAM (Asian Currency) 3.39% -9.70% 2.3

6. Four Capital (FX) 2.53% 2.71% 1.8

7. BEAM (FX Prop) 2.40% 0.43% 2.0

8. Blue Fin Capital (Managed FX) 1.40% 3.58% 9.3

9. Basu and Braun (Everest) 1.14% 4.36% 1.9

10. Halion Capital (Conservative) 0.98% 29.10% 6.5

Based on estimates of the composite of all accounts or the fully funded subset method.

Does not reflect the performance of any single account.

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.

Market Sym Exch Vol OI10-day

move / rank

20-day

move / rank

60-day

move / rank

Volatility

ratio / rank

EUR/USD EC CME 315.7 237.5 -2.06%/53% -4.24%/55% -6.02%/87% .29/10%

AUD/USD AD CME 133.7 133.1 -1.25%/13% -5.03%/54% -5.82%/70% .44/32%

GBP/USD BP CME 97.2 163.3 -1.79%/62% -3.25%/49% -3.72%/87% .41/50%

JPY/USD JY CME 82.4 148.4 -1.06%/8% 0.13%/13% -1.49%/84% .49/87%

CAD/USD CD CME 79.1 117.7 -1.18%/33% -3.46%/56% -4.45%/69% .31/23%

MXN/USD MP CME 34.3 91.5 -2.82%/60% -4.92%/50% -10.90%/69% .23/43%

U.S. dollar index DX ICE 27.8 60.0 1.40%/29% 2.28%/37% 4.07%/65% .30/12%

CHF/USD SF CME 23.9 27.3 -1.33%/13% -5.14%/48% -14.33%/95% .07/0%

NZD/USD NE CME 6.1 25.3 -1.87%/25% -5.97%/60% -9.90%/89% .30/13%

E-Mini EUR/USD ZE CME 5.6 6.2 -2.06%/53% -4.24%/55% -6.02%/87% .29/10%

Note: Average volume and open interest data includes both pit and side-by-side electronic contracts (where applicable). Price activity is

based on pit-traded contracts.

8/2/2019 Ctm 201112

30/32

INTERNATIONAL MARKETS


CURRENCIES (vs. U.S. DOLLAR)

Rank CurrencyNov. 28

price vs.U.S. dollar

1-monthgain/loss

3-monthgain/loss

6-monthgain/loss

52-weekhigh

52-weeklow

Previous

1 Hong Kong dollar 0.128265 -0.33% -0.01% -0.18% 0.1288 0.1281 15

2 Chinese yuan 0.156605 -0.34% -0.08% 1.66% 0.1578 0.1496 123 Taiwan dollar 0.032875 -1.10% -4.59% -5.04% 0.03510 0.0321 14

4 Japanese yen 0.01287 -2.24% -1.30% 4.29% 0.0132 0.0117 13

5 Thai baht 0.03186 -2.37% -4.55% -3.28% 0.0336 0.0314 16

6 Great Britain pound 1.54446 -3.63% -5.64% -6.04% 1.6702 1.5407 5

7 Russian ruble 0.031615 -4.27% -8.94% -11.11% 0.0366 0.0306 3

8 Singapore dollar 0.76169 -4.38% -8.37% -5.69% 0.832 0.7572 10

9 Canadian dollar 0.95553 -4.71% -6.22% -6.61% 1.059 0.9467 11

10 Indian rupee 0.019055 -5.46% -12.09% -13.76% 0.0226 0.0189 17

11 Euro 1.3246 -5.65% -8.64% -6.91% 1.4842 1.2901 7

12 Swiss franc 1.075735 -6.20% -13.26% -7.72% 1.3779 0.996 913 Brazilian real 0.529855 -7.58% -14.74% -14.53% 0.65 0.5288 2

14 Australian Dollar 0.97196 -8.08% -8.07% -8.96% 1.1028 0.9478 1

15 Swedish krona 0.14274 -8.10% -10.15% -10.22% 0.1662 0.1422 4

16 South African rand 0.11732 -8.21% -16.13% -18.66% 0.1518 0.1166 8

17 New Zealand dollar 0.741105 -8.60% -11.74% -9.12% 0.8797 0.7207 6

GLOBAL STOCK INDICES

Country Index Nov. 281-monthgain/loss

3-monthgain/loss

6-monthgain loss

52-weekhigh

52-weeklow Previo

1 Mexico IPC 35,558.18 -3.13% 1.55% -0.23% 38,876.80 31,659.30 8

2 South Africa FTSE/JSE All Share 31,829.34 -3.24% 5.07% -1.73% 32,894.11 28,391.18 10

3 Switzerland Swiss Market 5,522.70 -5.64% 1.40% -14.65% 6,739.10 4,695.30 12

4 Brazil Bovespa 56,017.00 -5.87% 2.11% -12.41% 71,924.00 47,793.00 11

5 Australia All ordinaries 4,125.80 -6.47% -4.80% -13.07% 5,069.50 3,829.40 5

6 UK FTSE 100 5,312.80 -6.83% 0.84% -11.31% 6,105.80 4,791.00 6

7 Canada S&P/TSX composite 11,640.21 -7.02% -6.91% -15.83% 14,329.50 10,848.20 15

8 U.S. S&P500 1,192.55 -7.20% -1.45% -11.35% 1,370.58 1,074.77 9

9 Singapore Straits Times 2,694.43 -7.27% -0.25% -14.73% 3,280.77 2,521.95 14

0 Japan Nikkei225 8,287.49 -8.43% -6.37% -12.81% 10,891.60 8,135.79 13

1 India BSE30 16,167.13 -9.20% -1.52% -11.33% 20,664.80 15,478.70 7

2 Germany Xetra Dax 5,745.33 -9.47% 1.33% -19.76% 7,600.41 4,965.80 2

3 Hong Kong Hang Seng 18,037.81 -9.90% -9.20% -22.20% 24,468.60 16,170.30 4

4 France CAC 40 3,012.93 -10.02% -4.48% -23.58% 4,169.87 2,693.21 3

5 Italy FTSE MIB 14,578.23 -12.46% -3.72% -29.88% 23,273.80 13,115.00

8/2/2019 Ctm 201112


NON-U.S. DOLLAR FOREX CROSS RATES

ank Currency pair Symbol Nov. 281-monthgain/loss

3-monthgain/loss

6-monthgain loss

52-weekhigh

52-weeklow

Previou

1 Yen / Real JPY/BRL 0.024285 5.75% 15.75% 22.00% 0.0246 0.0186 21

2 Pound / Aussie $ GBP/AUD 1.589015 4.83% 2.64% 3.21% 1.6373 1.4806 18

3 Canada $ / Real CAD/BRL 1.8034 3.11% 10.00% 9.26% 1.8282 1.5997 20

4 Pound / Franc GBP/CHF 1.43593 2.76% 8.80% 1.84% 1.5639 1.1778 13

5 Euro / Aussie $ EUR/AUD 1.36319 2.66% -0.60% 2.28% 1.4228 1.2947 19

6 Euro / Real EUR/BRL 2.49996 2.09% 7.16% 8.91% 2.5367 2.1692 17

7 Pound / Canada $ GBP/CAD 1.616335 1.13% 0.62% 0.62% 1.6354 1.5302 10

8 Euro / Franc EUR/CHF 1.23223 0.67% 5.41% 0.95% 1.3283 1.0376 15

9 Aussie $ / New Zeal $ AUD/NZD 1.311485 0.57% 4.17% 0.18% 1.3746 1.2354 4

10 Aussie $ / Real AUD/BRL 1.83441 -0.54% 7.83% 6.51% 1.8452 1.6066 12

11 Euro / Canada $ EUR/CAD 1.386245 -0.99% -2.58% -0.32% 1.4316 1.2811 11

12 Pound / Yen GBP/JPY 120.04 -1.39% -4.37% -9.88% 139.19 117.7 5

13 Franc / Canada $ CHF/CAD 1.1258 -1.57% -7.50% -1.18% 1.3569 1.0124 14

14 Aussie $ / Franc AUD/CHF 0.90353 -2.00% 5.98% -1.35% 0.9749 0.7477 3

15 Euro / Pound EUR/GBP 0.85739 -2.12% -3.20% -0.96% 0.9038 0.8297 16

16 Canada $ / Yen CAD/JPY 74.25 -2.51% -4.99% -10.45% 88.95 72.63 9

17 Euro / Yen EUR/JPY 102.95 -3.46% -9.04% -10.72% 122.63 101.41 7

18 Aussie $ / Canada $ AUD/CAD 1.017195 -3.53% -1.97% -2.51% 1.0612 0.9708 2

19 Franc / Yen CHF/JPY 83.600 -4.04% -12.11% -11.50% 105.79 82.68 8

20 Aussie $ / Yen AUD/JPY 75.41 -6.10% -6.96% -12.84% 89.46 72.72 1

21 New Zeal $ / Yen NZD/JPY 57.59 -6.49% -10.59% -12.85% 67.97 56.86 6

GLOBAL CENTRAL BANK LENDING RATES

Country Interest rate Rate Last change May 2011 Nov 2010

United States Fed funds rate 0-0.25 0.5(Dec.08) 0-0.25 0-0.25

Japan Overnight call rate 0-0.1 0-0.1 (Oct. 10) 0-0.1 0-0.1

Eurozone Refi rate 1.25 0.25(Nov11) 1.25 1

England Repo rate 0.5 0.5(March09) 0.5 0.5Canada Overnight rate 1 0.25(Sept10) 1 1

Switzerland 3-monthSwissLibor 0 0.25(Aug11) 0.25 0.25

Australia Cash rate 4.5 0.25(Nov11) 4.75 4.75

New Zealand Cash rate 2.5 0.5(March11) 2.5 3

Brazil Selic rate 11 0.5(Nov11) 12 10.75

Korea Korea base rate 3.25 0.25(June11) 3 2.5

Taiwan Discount rate 1.875 0.125(June11) 1.75 1.5

India Repo rate 8.5 0.25(Oct11) 7.25 6.25

South Africa Repurchase rate 5.5 0.5(Nov.10) 5.5 5.5

8/2/2019 Ctm 201112

32/32

INTERNATIONAL MARKETS

GDP Period Release date Change 1-year change Next release

AMERICAS

Argentina Q2 9/16 26.1% 20.1% 12/16

Brazil Q2 9/6 8.7% 9.0% 12/6

Canada Q3 11/30 1.1% 5.9% 3/2

EUROPE

France Q2 9/28 0.4% 3.2% 12/23

Germany Q3 11/15 0.8% 2.5% 2/15

UK Q2 10/5 0.5% 4.5% 12/22

AFRICA S. Africa Q3 11/29 2.7% 10.8% 2/28

ASIA and S.PACIFIC

Australia Q2 9/7 2.7% 6.3% 12/7

Hong Kong Q3 11/11 6.5% 4.3% 2/1

India Q3 11/30 1.0% 16.0% 2/29

Japan Q3 11/14 3.4% 14.5% 2/13

Singapore Q3 11/25 2.0% 6.1% 2/24

Unemployment Period Release date Rate Change 1-year change Next release

AMERICAS

Argentina Q3 11/21 7.2% -0.1% -0.3% 2/22

Brazil Oct. 11/24 5.8%

Documents

Ctm 201112