Tuesday, 22 May 2012

Supplemental Site Day

A. Double Top and Double Bottom

The Double Top and Double Bottom Charting Patterns
One of the charting patterns commonly used by FX traders is that of the double top and double bottom. The double bottom is a pattern where the currency pair touches a low point twice without being able to sustain a break through that point. The double bottom is a charting pattern that suggests where the market may find support.

Conversely, a double top pattern shows a currency pair reaching resistance twice and failing to break through. The chart below offers some insight into how traders can incorporate the double bottom and double top patterns into their trading strategies.

B. Strength of Trends: ADX/DMI
Strength of Trends: A Look at ADX/DMI

Two commonly used indicators in technical analysis -- especially in the futures and equities markets -- are ADX and DMI. Both essentially allow traders to gauge the strength of a trend in the market, thereby helping them to determine if the market is rangebound or trending.
When ADX and DMI are displayed on a chart, three lines will appear. Those lines are as follows:
  • Positive Directional Index (+DI): Measures the strength of the trend for an upward movement in price.
  • Negative Directional Index (-DI): Measures the strength of the trend for a downward movement in price.
  • Average Directional Line (ADX): Measures the strength of the overall trend in the market, regardless of direction.
Those three lines can be used as follows:
  • If ADX is strong -- such as above 25 -- the market is trending strongly. Rangebound strategies may not work well.
  • If Positive DI is above Negative DI, the market is considered to be bullish; if the opposite is true, the market is deemed to be bearish.
  • ADX can be used to determine the strength of the directional trend, as suggested by Positive and Negative DI.
C. JPY Overview
Japanese Yen (JPY)
Japan is the third largest economy in the world with GDP valued at over US$4Trl in 2002 (behind the US and the entire Eurozone or EMU). The country is also one of the world's largest exporters and is responsible for over $400bln in exports per year. Manufacturing and exports account for nearly 20% of GDP. This has resulted in a consistent trade surplus, which creates an inherent demand for the JPY, despite severe structural deficiencies. Aside from being an exporter, Japan is also a large importer of raw materials for the production of their goods. The primary trade partners for Japan in terms of both imports and exports are the US and China. China is becoming an increasingly important trade partner, as China's inexpensive goods have allowed it to gain a larger share of Japan's import market.

Japanese Banking Crisis
In the 1980s, Japan's capital market was one of the most attractive markets for international investors seeking investment opportunities in Asia. They had the most developed capital markets in the region and their banking system was considered to be the one of strongest in the world. The country was experiencing above-trend economic growth and near-zero inflation. This resulted in rapid growth expectations, boosted asset prices and rapid credit expansion, leading to the development of an asset bubble. Between 1990-97, the asset bubble collapsed, inducing a USD$10trl fall in asset prices, with the fall in real estate prices accounting for nearly 65% of the total decline, which is worth two years of national output. This fall in asset prices sparked the banking crisis in Japan. It began in the early 1990s and then developed into a full blown systemic crisis in 1997 following the failure of a number of high profile financial institutions. Many of these banks and financial institutions extended loans to the builders and real estate developers at the height of the asset bubble in the 1980s, with the land as the collateral. A number of these developers defaulted after the asset bubble collapse, leaving the country's banks saddled with bad debt and collateral worth sometimes 60-80% less than when the loans were taken out. Due to the large size of these banking institutions and their role in corporate funding, the crisis had profound effects on both the Japanese and global economy. As a result, enormous bad debts, falling stock prices and a collapsing real estate sector have crippled the Japanese economy for almost two decades.

With Japan experiencing deflationary conditions, each succeeding month of deflation raises the real burden of the banks' outstanding debt. To date, the Japanese Ministry of Finance and Bank of Japan is still grappling with this problem and has only injected capital into these ailing banks as a solution to prevent bankruptcies. Since the beginning of the crisis, they have hoped that the banks would grow their way back to health.

In addition to the banking crisis, Japan has the highest debt level of all of the industrialized countries, at over 140% of GDP. The chart below shows the country's deteriorating fiscal positions, with public debt continuing to rise, which has resulted in the country experiencing over 10 years of stagnation. With this high debt burden, Japan stands at risk of a liquidity crisis.

The banking sector has become highly dependent on a government bailout. As a result, the JPY is very sensitive to political developments such as speeches by government officials with rhetoric that may indicate potential changes in monetary and fiscal policy, attempted bailout proposals, and any other rumors.

Key Indicators for JPY

Balance of Payments, Trade Surplus

These two indicators measure the capital flows and trade flows in and out of Yen. Because Japan is so sensitive to exports and is also a major investor in foreign markets, these two pieces of data are important in tracking the overall flow in and out of Yen. If the Yen strengthens significantly below the 100 level to the dollar, the possibility of trade being affected is very real, and Trade Surplus releases could become significant. The Bank of Japan’s goal in keeping USDJPY artificially inflated is to keep Japanese exports competitive, so trade surplus data that does not meet expectations may give the BoJ new resolve to intervene in USDJPY.

Tankan Survey
The Tankan is a short-term survey of Japanese businesses—divided according to size—that gives an overall outlook of the business climate in the coming months. Published four times per year, the Tankan is watched as a leading indicator, because it summarizes confidence in the future of the economy.

Trading JPY

  • USDJPY is the most heavily traded of all Yen crosses, as the US is the most significant trading partnerfor Japan.
  • In the past this pair has been characterized by frequent and decisive intervention by the Bank of Japan,who has actively bought US dollars for years in the interest of keeping the Yen weak and makingJapanese exports attractive in the US. If USDJPY approaches 100, then there may again be intervention.
  • Unlike ECB intervention, which may occur at certain times due to market conditions, BoJ interventionshould be considered an intrinsic part of trading UDSJPY.
  • Intervention creates strong support levels, which the BoJ defends rigorously. If the market pressure downwards makes a certain price level untenable for the BoJ, it will usually retreat to a slightly lower level and repeat the process of defending it as long as possible.
  • The goal of intervention is to eliminate speculators from the market. Banks and corporations that must physically exchange dollars for Yen can not be removed from the market by intervention, but the BoJ can scare speculative short sellers out of the market by making it too risky for them to hold positions.
Although volume of the Euro against the Franc and the Pound has surpassed that of the dollar, EURJPY remains less heavily traded than USDJPY. Trading in EURJPY is technically more stable than USDJPY for the reason that the Bank of Japan is more interested in the price of the Yen vs. the dollar, and USDJPY is where most intervention occurs. Because USDJPY exchange rates are often driven mainly by USD strength and weakness, EURJPY is a more reliable measure of JPY strength relative to other currencies.

Like EURJPY, GBPJPY has less volume than USDJPY, but it trades more smoothly because BoJ intervention almost always occurs in USDJPY. GBPJPY can be used as a more reliable measure of JPY strength than USDJPY, since often pairs involving the dollar move based on USD weakness or strength rather than the strength of other currencies. Because there is less trading volume in this cross, spreads are typically wider than the major pairs, but it is still a relevant cross.

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