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Leave a Comment You must be logged in to post a comment. r Part I Chapters 1—9 focuses on the forces that move prices, also known as fundamentals. The topics included in the fundamentals show the reader how to use fundamental knowledge to arrive at trading decisions. The chapters provide insight on how currency price movements are affected by things like interest rates, interest rate differentials, trade-weighted indexes, commodities, housing data, China, and more.

r Part II Chapters 10—15 focus on technical knowledge—how to read and analyze charts. The reader will build specific knowledge about the components of technical analysis and how to evaluate price action in terms of classical and advanced tools including: support and resistance, retracement concepts, trend analysis, and volatility and momentum indicators.

Nontraditional charting using renko and three-line break are featured. The final chapter includes questions that the reader should be able to answer at that point. They are designed to help you assess how well you understand the material and guide you in finding and using valuable information for scanning currency conditions. Ultimately, all knowledge needs to be actionable. It is my hope that experience of trying forex trading is enhanced by this book and that forex trading becomes a journey which is enjoyable for its enormous challenges and more profitable than it otherwise would be.

I applaud them for their courage to pursue the challenges of forex trading and I have learned much from them about how to teach forex with improved effectiveness. I must acknowledge the late Professor Aaron Wildavsky, at the Graduate School of Public Policy, who shaped my thinking skills more than 30 years ago into the tools of inquiry that allowed this book to emerge.

He has conducted seminars in the United States, London, and Dubai as well as online training in all time zones. Cofnas founded www. com in as the desktop forex trading industry started to provide education and training in this field. com, a company providing forex education and global forex competitions. He has been in the financial service industry as an equity broker, futures, and forex trader since He currently lives in Longwood, Florida, with his wife, Paula, where he conducts research on artificial intelligence programs using cellular automata and enjoys digital photography.

He has a daughter Paige, 25, and a son Paul, These forces are accepted by economists around the world as responsible for changes in the value of currencies. The person learning to trade forex or trying to improve his or her trading will benefit from a gain of knowledge of these fundamentals. In fact, as you will see, fundamental forces act as leading indicators of currency movement. and global interest rates, economic growth, and market sentiment toward the dollar are the key ingredients that shape trading opportunities.

Part I provides basic knowledge on how these factors impact forex prices and how they can be used in selecting trading opportunities. The reader will learn why fundamentals are important to foreign exchange forex traders as well as what kind of economic activity are most important in affecting price movements.

These include interest rates, interest rate differentials, economic growth, and sentiment regarding the U. You have an opponent the market. In game of chance the key feature is that everyone faces the same odds and therefore the same level of information.

In these games, no player can change the odds. Playing forex, however, is not a game of odds. Participants in forex trading do not share the same amount of information. In forex, this asymmetry of information results in advantages and disadvantages to trades. Some players have more information than the others. In forex, information about fundamental aspects of economies does not arrive simultaneously to all participants. The real important question is what kind of knowledge and information can improve trading performance.

The search for an edge starts with a fundamental understanding of the nature of the forex market. Having a foundation of knowledge in fundamentals is a first step in evolving into a winning trader. In getting acquainted with the forex market, most people start by looking only at price charts and price patterns. This is called technical analysis. moves those charts is called fundamental analysis.

The goal of Part I is to identify the components of fundamental analysis in regard to forex and then provide a recipe for developing your own fundamental analysis of a currency pair. Why take time to look at forex fundamentals? Why should fundamentals matter if a trade is done off a short-term time interval such as the 5-minute chart? The short answer is that one cannot separate the fundamentals from the technical analysis without exposing oneself to great distortions in understanding the forex market.

Foreign exchange is by its nature both fundamental and technical and reflect the increased globalization of the world economy. It is worthwhile to note the comments of the late, great Milton Friedman in a conversation with Dallas Fed president Richard Fisher: The really remarkable thing about the world is how people cooperate together.

How somebody in China makes a little bit of your television set. Or somebody in Malaysia produces some rubber. And that rubber is used by somebody in the United States to put on the tip of a pencil, or in some other way. What has happened has been an enormous expansion in the opportunities for cooperation.

html Consider the following: every transaction in the world settles in a currency. What makes forex fascinating as a market and as a trading vehicle is the fact that currencies provide an intimate linkage to the world economy.

The currency trader by putting on a currency trade becomes a participant the world economy. The trader is participating as a speculator looking for a very short-term profit. The forex trader is riding on a global wave. Some will surf the waves, jumping on and off; others will stay in much longer and face the volatility.

Forex trading becomes possible because the world is constantly assessing and reassessing the value of one currency against another. The forex currency trader is looking to tap into this stream of changing values. The challenge is to find the right combination of tools that can assist the trader in finding high-probability profitable trades.

In meeting this challenge, the first step is understanding what moves currencies over time. In putting together a recipe for successful forex trading, knowing the fundamental chemistry of forex is highly recommended. Anyone who doubts this should simply look at daily headlines that evoke names and places that are part of the daily consciousness of a trader.

These names should be familiar to all traders: Bernanke, Fukui, Trichet, Xiaochuan. Mention the capitals Pyongdong, Baghdad, Tehran, and they evoke emotions of fear and crises.

These and other factors mix together and form the chemistry of forex, which results in shifts of sentiment regarding the U. These shifts in sentiment cause price reactions and shift the balance between buyers and sellers. They are one of the most important factors that affect forex prices, as interest rates are the modern tool that central banks use as a throttle on their economies.

The central banks of the world do not hesitate to use this important tool. In recent years almost all of the central banks increased interest rates. The European Central Bank raised interest rates eight times from December 6, , to June 13, , to a level of 4. Interest rate increases do much more than slow down an economy; they also act as a magnet to attract capital to bonds and other interest-bearing instruments. There can be no doubt of the critical role interest rates play in forex price movements.

Some forex traders learned this lesson when the U. stock market sold off on February 27, It was precipitated by traders getting out of their carry trade positions. Since billions of dollars were sold to be converted back into yen, equity markets were also affected because equity positions had to be sold to buy back the yen positions. In Figure 1. dollar—Japanese yen USDJPY pair that day.

FIGURE 1. C All rights reserved worldwide. Source: CQG Inc. The housing sector in the United States, as well as other nations, provides a major share of wealth, consumer spending, and job creation. Recent years have seen an international housing boom, with prices growing at more than 10 percent per year in many countries.

Canada, Norway, and Sweden shared more than 10 percent growth. The United States, in the face of a slowdown, saw prices up 7 percent. This means that the value of homes around the world has doubled in the past 10 years, and as a result the increased wealth has fueled economic growth and consumer purchase.

Closely watched are data releases that relate to housing activity. The economic reasoning is that consumers start seeing a decline in housing values and restrain their consumer spending. One of the most important factors related to housing market strength in recent years has been mortgage equity withdrawals MEWs. As home prices have increased around the world, consumers take out loans against their mortgages, which stimulates consumption.

During periods of housing booms, MEWs rise. MEWs have been, in fact, calculated to contribute to the growth of gross domestic product GDP. Figure 1. However, if MEWs slow down, this can portend a decline in consumption and a slowdown in the economy.

If and when a slowdown in MEWs occurs, central bankers view it as lessening the likelihood of an interest rate increase. Source: Census Bureau, Bureau of Economic Analysis. have fun. They may very well have used it to buy another house or not spent it at all, but added it to savings. Economists really are not certain. Carroll, an economics professor at Johns Hopkins University.

The wealth effect, as the phenomenon is called, is twice as high for housing wealth as it is for stock wealth, Mr. Carroll and his associates said. At the end of , the data on MEWs showed a large decline from the year before in the United States. This was an early indicator of a slowdown in the U. economy because it is estimated that two-thirds of the money from MEWs goes for consumption. So the forex trader seeing signs of an MEW slowdown can get ready for its effect to take place months in advance.

The importance of housing data as a factor in shaping currency moves has been highlighted further by the events relating to subprime mortgages in the United States. Economic forces ultimately worked to create mortgage delinquencies and a collapse in this market. For the forex trader it is a clear case where fundamentals affect the dollar. More housing weakness translates to weaker consumer demand and that translates to lowering the probability of interest rate increases.

HOUSING DATA AS A LEADING INDICATOR What is important to realize about fundamental analysis of housing sector data is that the trader can identify pending changes in trends and direction of the economy. By understanding housing data, one can develop a fundamental viewpoint that leads to trading strategies before technical price patterns reflect the change. For example, in Table 1.

new housing starts. The year was a year of a high level of housing starts peaking in February at 2. After January , the data showed a decline, and by August , the decline in housing starts reached levels of The forex trader may not have picked the start of the slump by looking at this kind of data, but clearly would have seen that right after the start of new home starts were in a period of weakening.

When housing starts reached a peak and then started declining, it was difficult to be pro-dollar. In this case the new housing start data was a very reliable leading indicator that interest rates would not increase. A valuable source for assessing housing activity in the United States is the survey releases of the National Association of Housing Builders NAHB.

The survey asks respondents to rate general economic and housing market conditions. The survey results in the summer of were at a peak on all HMI component measures. significant weakening in the housing market, which was an omen that increases in rates were increasingly not likely.

At the end of , the HMI survey shows that the previous rate of decline in housing starts was slowing down. This can be interpreted as possible bottoming out of the housing market. Using this data, those traders expecting an interest rate decrease would have to reconsider their confidence in a rate cut. The importance of housing data as an indicator for traders is reflected in the fact that new sources of data on housing are being developed for investors.

It is a benchmark measure for housing prices. It tracks the value of single-family homes in the United States. Twenty metropolitan areas are tracked, and the index is measured monthly.

The TABLE 1. last Tuesday of each month at 9 A. is the release time of the announcement. Traders looking for leading indicators of a housing recovery will likely see it in increases in housing prices tracked by this monthly index, posted at www. Detailed housing data can also be found at www. ALSO WATCH HOUSING EQUITY SECTOR STOCKS Another way for the forex trader to get a grip on housing data is to watch equities that are housing related. For example, Lennar Homes is a leading home builder.

Its stock price and earning forecasts offer good clues regarding the direction of the housing market and by inference interest rate policies Figure 1. Chart courtesy of Aspen Graphics, www. When these housing equity stocks start probing their weekly support, resistance, and trend lines, the trader will have clues as to a potential change in the housing market.

HOUSING DATA AND GREAT BRITAIN As discussed earlier, housing provides a strong indicator regarding interest rates throughout the world.

For example, as ended, the situation in Great Britain regarding housing indicated a very strong housing market and therefore supported sentiment of interest rate increases by the Bank of England.

In , housing prices inflated by nearly 10 percent in Great Britain. Economist Diana Choyleva believed prices could rise by as much as 15 percent in In other words, expectations of an interest rate cut in Britain would require evidence of a slowdown in housing price increases. The trader trading the British pound should watch British housing data very carefully and gain an edge in shaping trading strategy.

A useful web site for staying on top of British housing data is www. SUMMARY Tracking changes in how an economy is growing is clearly an important part of gaining a sense of whether a currency will be strengthening or weakening. The relationship of growth and currencies applies throughout the world. An increase in interest rates tends to strengthen the currency. The trader needs to go further than just knowing what the rate levels are.

They trader needs to assess whether the economy is strengthening or weakening. Housing data is one of the most important areas that affect the decision to increase rates, keep rates the same, or decrease rates. The forex trader should keep track of housing data when trading a currency. Much progress has been made over the decades. In the period of through , inflation levels in industrialized countries were near the 7.

A decade later, in , inflation levels ranged at the much lower level of 3 percent. Many central banks, in fact, announce inflation targets. In fact, Bernard Bernanke, the successor to Alan Greenspan, has favored formal inflation targeting for the U. Central banks around the world monitor inflation and raise interest rates to try to slow down inflation.

Central banks often include in their statements accompanying interest rate decisions that they will be vigilant over potential risks of inflation. A fear of lingering inflation tends to generate in the market the anticipation of higher rates, and therefore works to support the buying of a currency.

That is also why strong retail prices tend to undermine bond prices. Bondholders fear increased rates because they reduce the attractiveness of the bonds they hold, and the market lowers the prices of the bonds in order to equalize the yield of the old bonds with the new interest rates.

Inflation is the ever-present yet stealthy ghost that spooks the forex market and challenges central banks. It is particularly difficult to track. even among the best economists on how to measure and detect inflation, and as a result there are many data sets relating to inflation.

Central banks all over the world are trying to get an accurate answer to the question of what is true core inflation? This level of complexity in measuring inflation sets up the forex market for surprises when data comes along that inflation has not been contained.

Surprises can be expected. For example, in December , when inflation data rose the highest in 30 years, it provided a boost in the dollar value as more traders were betting that the Fed would not decrease rates, or might even increase rates. The challenge to getting a true measure of inflation has also been a focus of recent activity in Britain.

The Office of National Statistics is introducing a new inflation calculator that allows persons to calculate their own inflation measure! In other words, the other measures [such as the Retail Price Index RPI , the Retail Price Index excluding Mortgage Payments RPIX , and the Harmonized Index of Consumer Prices HCIP ] are still in force, but there is recognition that inflation needs more measures for an accurate assessment.

This confusion and debate over how to detect inflation in Great Britain underscores the issue is an international one. The Monetary Policy Committee of the Bank of England www. htm offers more details on this subject. D in economics to follow inflation data. There are many key measures of inflation that are tracked.

But you have to check the central bank web sites. The best way to do this is to first check the web site of the central bank. They contain a great deal of information on inflation and inflation policy. Core inflation refers to the components of inflation that are more durable and not a result of temporary events, such as a hurricane. Core inflation excludes food and energy prices, which vary temporarily.

The PCE is now the favorite measure used by the Federal Reserve. However, in an attempt to be even more accurate, economists have gone further and developed a trimmed PCE, which is designed to give a truer view of inflation. Table 2. The Producer Price Index PPI is another key measure that is reported and tracked. The PPI measures what businesses charge one another for everything from iron ore and diesel fuel to cases of soda pop.

The U. Bureau of Labor Statistics generates PPI data for over different product categories, reflecting price pressures among different industries. A net PPI figure, of course, is more general in nature www. In November , the PPI surprisingly rose 2 percent higher than the month before. The index had not risen by that much in a single month in more than 32 years, since the energy and stagflation crises of the mids. The fact that the PPI and the core inflation may differ adds to the uncertainty of the true condition of the economy regarding inflation.

The Consumer Price Index CPI tracks consumer price changes given a fixed basket of goods and is part of the data set watched by traders in all countries. Bureau of Labor Statistics provides comprehensive data on inflation and, in fact, tracks the various inflation rates. It conducts extensive sampling of 87 urban areas, 50, homes, and 23, retail establishments.

From time to time, the CPI basket changes to more accurately reflect new items TABLE 2. available in the economy. Tracking gold, the Commodity Research Bureau, and other commodity indexes and patterns will also help you get a handle on inflation. We look at the commodity-currency connection in Chapter 5.

The main point here is that the forex trader needs to pay serious attention to inflation rates and expectations of inflation rates, because they are a key to discerning what the central banks fear, and a clue to whether they will raise interest rates.

Which Countries Have Inflation above the Target Rate? Take the indicators or economic data releases coming out and group them. Which are leading? Which are lagging? Which are coincident? Which countries have inflation rates over 2 percent? Which country has a central bank policy to increase inflation?

Countries that are experiencing economic growth generate more jobs in their economy. Consumer spending therefore increases. In turn, the demand for housing increases as people have more disposable income and can better afford housing. The transactions of a modern economy intimately involve global flows of capital as exports and imports are part and parcel of the vitality of an economy.

The term economic growth is really a wide category. How is economic growth measured and tracked by the forex trader?

The rate of economic growth or development of a country is mainly measured essentially by its gross domestic product GDP , so news about GDP becomes an essential ingredient in shaping trader sentiment about the value of a currency.

A slowdown or expected slowdown in GDP translates into anticipation that interest rates will not go higher or may even decrease. The importance of economic development statistics in currency trading is evidenced by the fact that whenever an economic data release is scheduled, the currency market hesitates in its price movements and then often moves vigorously when the news surprises the market. In fact, one of the best times to trade is after a news release. Technical strategies for trading the news will be thoroughly explored in a later chapter.

Traders can gain insight into economic growth and development data by following several sources that track global economic growth, such as the Organisation for Economic Co-operation and Development www.

org , the Group of Seven, www. ca , and the World Trade Organization www. A growing economy has new job creation and lower levels of employment. An economy that is slowing down or showing signs of slowing down has increased jobless claims, a declining rate of job creation, and higher unemployment levels.

Whenever job data is released by governments, the forex markets react. There are many layers of information regarding employment data. Manufacturing Employment Payroll Employment of Wage and Salary Workers Total Population of the United States U. Employment in Service-Producing Industries Civilian Unemployed for 15 Weeks and Over Civilian Unemployed for Less Than 5 Weeks Median Duration of Unemployment Unemployed: all civilian workers Unemployment Rate U.

Employment in Construction U. Employment in Finance, Insurance, and Real Estate U. Employment in Goods-Producing Sectors U. Employment in Mining U.

Employment in Services U. Employment in Transportation and Public Utilities U. Employment in Retail Trade Industry U. Employment in Wholesale Trade Industry For more information on job data, visit the following web sites: www.

com www. As long as the world is dependent on hydrocarbon-based energy, oil prices become a factor in stimulating or delaying economic growth. In the near term, higher oil prices result in reducing economic growth expectations as well. Higher hydrocarbon prices portend increases in transportation costs and the perunit cost of outputs in the economy, and therefore become an inflationary factor in the costs of goods.

One of the most important aspects of oil prices is that the market reaction to oil price increases often tends to overemphasize its importance, particularly for the U. translates into only a 3. A quick rise in oil prices, or even just the fear of a rise, offers trading opportunities.

Hurricane Katrina is a good example, as we saw some countries benefit from high crude oil prices, while others did not. The result impacts currency prices as well. Closely tracking oil is important in shaping currency-trading strategies.

See Figure 3. Oil has another impact. Oil-producing countries have amassed huge sums of money, and what they do with their increasing petrodollars impacts currency values. FIGURE 3. Source: CQG, Inc. Copyright © The economies of Organization of Petroleum Exporting Countries OPEC nations are accumulating current account surplus due to petrodollars that are nearing 30 percent of their GDP!

If oil producers start to shift into nondollar assets such as the euro and pound sterling, the dollar fundamentally weakens. This has already begun. OPEC and Russia data showed that the dollar holdings were cut from 67 percent to 65 percent. It was not a coincidence that the highs of the euro coincided with the last known shift of oil producers from dollars to euros. It is also not a coincidence that the Canadian dollar strengthens when oil prices increase and weakens when oil prices decline.

We can see that crude oil patterns have had wide ranges and are likely to continue to have such swings. This will benefit the forex trader. YIELD CURVE AND ECONOMIC GROWTH As Arturo Estrella and Frederic S. Source: Federal Reserve Bank of New York.

Guessing what phase of the business cycle an economy is in is a great game. Is the economy going into a recession? However, sentiment about an expected recession is not stopped by lack of data. One of the most important measures that traders track is the shape of the yield curve. The yield curve is defined as the difference between the year Treasury note and the 3-month Treasury bill.

We see here the key role that interest rates play in reflecting expectations in the market. The Federal Reserve Bank of New York published an important study of the yield curve and recessions, which included a table relating probability of recession to the yield curve Table 3.

A separate study see Figure 3. We can see that the yield curve provides an important barometer for the future GDP growth. With regard to the yield curve, what is particularly important to track for the forex trader is the shape of the yield curve. Is it flat? Is it upward sloping? Is it inverted? These are the key patterns to observe. In normal times, people are willing to pay more for longer-term maturities and bonds.

This is a natural reaction to the fact that there is more risk over a longer period of time. But a slowdown or fear of a recession causes the market to demand higher interest rates for short-term borrowing.

The yield curve becomes inverted. Short-term interest rates become greater than longer-term rates! Note: The figure plots 4-quarter GDP growth together with the quarter term spread upper panel and the 1-quarter short rate lower panel lagged 4 quarters.

common interpretation is that when the yield curve inverts, a recession is coming. An inverted yield curve situation makes it difficult for the central banks to increase rates and more likely, in fact, that rates may decrease.

Such a situation becomes negative for the dollar or any currency involved. A flat yield curve indicates uncertainty about the economy. On December 27, , the yield curve inverted for a few days for the first time in five years.

Also, there is no guarantee that an inverted yield curve will always predict a recession, but when the yield curve inverts, the forex trader should be very vigilant. Strategies favoring a weaker dollar or currency pair should be considered.

The formula for those who want to set up an Excel spreadsheet is www. federal reserve. bond, the 3-month yield, and the federal funds rate at www.

On March 21, according to the current model, the probability of a recession due to the relationship between the year and 3-month bond yield curve was 52 percent.

Table 3. One month later, on April 21, the data showed that the probability of a recession was even lower, at These probabilities are the results of models. They are not guarantees but do give insights into what the professional economists are thinking.

A further visualization of the relationship between a recession and the yield curve as developed by the Federal Reserve researchers is shown in Figure 3. Obviously, a great FIGURE 3. Federal Funds Rate for 50 Percent Probability of Recession Occurring in Next 12 Months.

Source: www. deal of work is being constantly done by economists to try to pinpoint the probability of a recession. At the same time, ask yourself the question: Is the dollar getting stronger or weaker? Doing this assignment will help you sharpen your understanding of sentiment toward the dollar and whether that sentiment reflects economic fundamentals. This chapter provides a review of key China developments that every trader should know about. Watching Chinese economic developments is likely to become a daily pastime for many traders all over the world.

China is impacting every region of the world and every industry. This occurred after a 21 percent increase in imports from China to the 25 countries forming the European Union Financial Times, March 23, , p.

exports to China grew almost percent, while U. exports to the rest of the world rose by only 16 percent. During that period, China accounted for roughly 25 percent of total U. Fred Bergsten, Bates Gill, Nicholas R. Lardy, and Derek Mitchell, China: The Balance Sheet: What the World Needs to Know Now about the Emerging Superpower. New York: PublicAffairs, CHINA REVALUES YUAN: A TURNING POINT? On July 21, , after more than a decade of strictly pegging the renminbi to the U.

dollar at an exchange rate of 8. This was the beginning of a long-term strategy to integrate China into the world economy by easing the ability of capital to flow into and out of the country. The ability to exchange currency is a key factor in this process of integration. The revaluation signaled that China was beginning to allow the strengthening of its currency. As of March , the renminbi value was at approximately 7. This means that it takes fewer renminbi 6 percent to convert to one dollar since revaluation.

Many economic studies believe that a free-floating Chinese currency would appreciate by 20 percent. The five currencies are the U. dollar, the yuan, the yen, the Korean won, and the pound. However, the exact weighting of these currencies in the basket is not being disclosed and there may be other currencies included.

Even though the Chinese currency known as the renminbi does not float on the market, and it is tied to the dollar within a narrow price, the influence of China on global currency flows is profound.

There is increasing pressure on China to allow the renminbi to increase in value, either through a wider managed envelope or through a full float. A full float is highly unlikely because the Chinese government is not interested in giving up control of its economy, which would occur in a full float.

Any increase in the value of the renminbi could result in a significant benefit to exporters in the United States and Japan. In recent years, even speculation that the Chinese were about to allow the renminbi to increase in value led to price moves that strengthened the Australian dollar and the yen.

China is becoming a global economic power that impacts the economic development of the world. It is the processing plant of the world, wherein many product components are imported and then put together.

But just over 40 percent of its trade is with Asia. Federal Reserve chairman Bernard Bernanke at the Chinese Academy of Social Sciences Beijing, China, December 15, : The emergence of China as a global economic power is one of the most important developments of recent decades. For the past twenty years, the Chinese economy has achieved a growth rate averaging nearly 10 percent per year, resulting in a quintupling of output per person [see Figure 4. Currently, however, this process is not balanced.

The Chinese export more than they import, and therefore accumulate a great deal of cash. dollars will have a major impact on the direction of the U. The Chinese State Administration of Foreign Exchange SAFE is the key agency on the future of these dollar reserves. For the forex trader, following Chinese developments and intentions on global trade and currency policies can be rewarding because it can point the way for new trading opportunities.

One big effect could result from a possible slowdown in the China economy. RMB 12, 10, 8, 6, 4, 2, 00 20 95 19 90 19 85 19 80 19 75 19 70 19 65 19 60 0 19 c04 FIGURE 4. Sources: National Bureau of Statistics, China Statistical Yearbook ; National Bureau of Statistics Plan Report. cover the U. budget deficit. An economic crisis in China has the potential to raise the U. interest rates, thereby placing major additional costs on U.

businesses and individual consumers and producing dislocation in the U. It could also exacerbate Chinese domestic political tensions in an unpredictable fashion. October 30, If a possible slowdown in China worries U. assets worries them even more.

dollar around the world. This is historically an extremely high level that no other country has been able to sustain for any significant period. The danger is that the U. economy could suffer a precipitous decline if the ability of the United States to borrow ever-greater amounts should end abruptly. Interest rates and inflation might suddenly soar as the dollar fell and the stock market crashed. Since the Chinese growth rate of over 10 percent per year GDP generates a voracious appetite for resources such as oil, copper, steel, iron ore, cement, and Ag complex, the countries that provide these resources experience a demand for their dollars.

When China buys copper from Australia, renminbi must be converted into Australian dollars. This provides support for the Australian dollar and the Australian economy.

Since China imports major resources such as copper from Australia, the aussie would be affected by a potential Chinese slowdown. Also, Japan, a significant trading partner of China, and its currency will often weaken or strengthen on expectations of a Chinese slowdown or sustained growth. Chinese influence has begun to extend also to Africa. For example, Chinese exports are beginning to shift to the Suez Canal, rather than going around Africa. This is causing Turkey, Italy, and other nations to invest in Egypt to tap into Chinese export to Europe.

In the coming years, the trading world will focus on whether China can control its growth rate, avoid inflation, and increase its currency float.

Traders need to keep track of key performance parameters such as Chinese GDP and inflation projections, as well as Chinese interest rate decisions. Between and July , China increased its interest rates to reach a level of 6. Whether this will work is unknown. But as China, which is now the seventh largest economy in the world and the second largest in purchasing power parity, becomes more of a consumer economy, the status of the Chinese economy will become easier to monitor.

Companies such as Home Depot, Wal-Mart, Kingfisher British , and Best Buy are entering the Chinese market, and many other firms are acquiring Chinese companies. As a result, the coming years will provide more reliable data on Chinese consumer spending and growth.

The Shanghai Composite Index is very sensitive to whether the renminbi will strengthen. Their value would increase Wall Street Journal, March 22, , p. com and find the latest value of the renminbi in the quote table that is supplied.

It is listed as the symbol CNY as shown in Figure 4. Is it getting stronger or weaker? FIGURE 4. Commodities are key resources in world growth, and they impact global inflation. This chapter focuses on what the forex trader should know about the commodity connection to currencies. T GOLD Gold price movements are important for currency traders to understand.

But gold is also a commodity on its own, adding strength or weakness to currencies of countries that produce gold. South Africa, of course, is the leading producer of gold, but its currency, the rand, is not floating, so traders can look to the Australian dollar and the Canadian dollar for trading those currencies when gold patterns provide trading opportunities.

Gold price action can also be a misleading guide to the currency trader. In recent years, Gold has attracted a great deal of investment demand from exchange-traded funds ETFs. In , ETFs were buying 20 tons of gold, and this rose to tons in The trader who looks at gold prices rising may interpret it as a reaction to the dollar, when it actually can be reacting as a function of investment demand. Figure 5. Dollar Index USDX. Central banks have an important role regarding gold. They hold gold as part of their reserves see Figure 5.

FIGURE 5. the USDX. reserves, and 15 percent is in gold. The key variable that can affect currency prices is whether a central bank will increase its gold reserves and thereby decrease its reserves of dollars or another currency. As a result, rumors of central banks increasing gold reserves can disrupt currency prices.

The idea that gold is important to currency moves is sound, but needs to be qualified and put in the context of world events. Sometimes gold acts as a store of value in times of crises. But the correlations between gold moves and currency moves provide a great deal of variation. The trader needs to be vigilant regarding what factors are moving gold. At the end of the day, in the words of Phillip M. Source: Phillip M. Hildebrand, member of the Governing Board, Swiss National Bank.

For example, copper plays an important part in the industrial development of China. As the world grows, more copper is in demand. The forex trader has to ask the question: Who benefits from copper demand? To answer this question, we should look at who produces copper.

Australia is the second largest producer of copper, and since its currency is freely floating, the Australian dollar can be traded. The commodity connection with currencies is particularly strong for the Australian dollar, the New Zealand dollar, and the Canadian dollar. A closer look is presented in our section on currency personalities. CRB INDEX Traders looking to track the commodity and currency relationships should follow the Commodity Research Bureau CRB Index. The CRB Index consists of a basket of commodities and provides a useful measure of potential inflationary pressure.

When commodity prices rise, this price increase can spread into the economy by increasing the costs of production and goods. This inflationary tendency is closely watched by central banks. We can see in Figure 5. EQUITIES AND FOREX The relationship between currencies and equities is an area of interest that is becoming increasingly evident and important for traders to become knowledgeable about.

In all equity markets around the world, exporting sectors benefit from a weaker home currency or the expectation of one. DaimlerChrysler, Renault, and Peugot suffer share declines when the euro surges beyond expectations.

As we noted in our section on China Chapter 4 , when there is speculation that the renminbi will increase, many Chinese equities increase in stock value due to expectations that their assets will increase in value. housing sector equities have a direct link to forex. Dow Jones Industrial Index suffered its worst day in four years, was a direct example of the link between equities and forex.

The sell-off was precipitated by a sudden fall in the dollar against the yen. This decline caused a liquidity crisis as hedge funds needed to sell equities to release funds to buy back their positions in the yen. See Chapter 1 for a discussion of this event. As globalization increases, strong currency moves will impact equity markets as it did on February In a real sense, tracking equities where their dollar earnings are important can benefit a trader in providing leading indicators of forex price moves.

The relationship between the dollar and the equity markets is further underscored by the Dow Jones Industrial Index reaching historic highs. This occurred as the USDX entered into an extended downtrend see Figure 5. Why has the relationship been inverse between the equity market and the value of the dollar? A deeper look reveals the answer. As the dollar value declines versus other currencies, the companies that export to the rest of the world benefit from increased sales, as exports become more attractive to foreign buyers.

Additionally, multinational corporations having assets abroad experience an increase in the dollar value of those assets. the Dow. Are any of these commodities in a channel pattern? These reports are results of extensive professionally designed surveys that are conducted on a regular basis in many countries. When these survey results are released, they provide important information on expectations regarding the economy of a country. This information is seriously assessed by central banks in determining their next moves in controlling inflation.

Growth in business or consumer confidence has inflationary potential, while a decline in business or consumer confidence portends economic slowdown. When these releases come out, they move the market, especially if the results are surprising.

Beyond having an impact upon their release, confidence indicators can also provide a leading indicator for the forex trader. If business confidence is at its highest in years, the market will interpret it as positive for the currency because greater confidence indicates expansion and growth of an economy. Where there is expectation of expansion and growth, there is the concomitant expectation of interest rates not going lower and possibly going higher.

These confidence surveys are not perfect predictors of resulting currency moves. They are one of the most important ingredients in the mix of fundamental forex factors. Some of the important confidence indicators are listed on page 42 and should be followed. Their release times are tracked in the numerous economic calendars available, and strategies for trading these economic data releases should be learned by traders. It is interesting to note that every major country has its version of investor and business confidence indicators.

These form in effect a leading indicator about currency directions. de IFO Business Climate Survey www. de Institute of Supply Managers www. aspx U. Sentiment Indicators r Consumer Confidence www. htm r Fed Beige Book released two weeks prior to Federal Open Market Committee meetings, eight times a year r ISM Nonmanufacturing www.

cfm r Empire State Manufacturing Survey monthly report, www. html r Chicago PMI ISM Nonmanufacturing released on the third business day of the month, can be found at www. cfm r Philadelphia Business Outlook Survey monthly, www. com and Find the Next Business or Consumer Confidence Report Release Time Watch what happens upon the release to the currency pairs.

This chapter focuses on how a trader can gain an understanding about the strength and weakness of a currency. The concept of a tradeweighted currency basket is introduced as well as how to obtain the latest trade-weighted information and data that can be directly used in trading. I TRACKING CURRENCY STRENGTH: HOW STRONG IS A CURRENCY? We can be convinced that currencies reflect world opinion about how well an economy is doing or expected to do. The next step in fundamental analysis is to be able to make a judgment about a particular currency itself.

Ultimately, the question arises for the trade: How strong is the currency? In spot forex trading, the trade itself is always a paired event of one currency against another. But when a trader makes a judgment about the strength or weakness of a currency by only comparing one currency against another usually the U.

dollar , the conclusion can be misleading as to the global strength or weakness of the currency. When trading majors where the U. dollar is part of the pair, the comparative question becomes: How strong is the U. dollar against that currency? question of how strong a particular currency is on its own terms without reference to another pair, the trade-weighted index TWI is used by economists and should also be used by currency traders. The TWI represents how well the currency of a country is doing against a basket of other currencies.

The currencies included in the TWI are those that reflect the major trading relationships with the index currency. Each currency receives a weight in the index that reflects its importance. For example, in Table 7. We can also see that Canada and many other nations have a very small percentage component of the TWI. Each year the central bank and economists adjust the weights to reflect changing realities of international trade.

As China increases its trading relationships around the world, it will receive more weight in TWIs. The point is that the TWI represents a way TABLE 7. dollar European euro Chinese renminbi Sourth Korean won New Zealand dollar U.

pound sterling Singapore dollar New Taiwan dollar Indonesian rupiah Malaysian ringgit Hong Kong dollar Thai baht Saudi Arabian riyal Canadian dollar Indian rupee Vietnamese dong South African rand Papau New Guinea kina UAE dirham Phillippine peso Swedish krona Swiss franc By knowing the TWIs of each currency, the forex trader can detect a strengthening and weakening of a currency and also get a sense of how a currency can be impacted by events in countries of their trading partners.

Many traders often ask the question: What do you think of the U. dollar or yen, pound, or euro? One important way of answering is from the perspective of the TWI. Each currency gains a trading personality, and knowing the TWI for each currency is very useful, because it will reflect the big picture much more accurately. Most recently, the International Index Company issued a new product line called iBoxxFX® , which are indices that are, in fact, trade weighted.

They allow an average forex trader to take a snapshot of the strength of a currency without the noise of the forex market. Table 7. Notice how each currency index reflects the varying importance of its different trading partners. We will see shortly that these trade weights are a clue to defining the fundamental personality of a currency. Before that time, it was pegged to the dollar, and before that it was pegged to the British pound. By floating its currency, the market sets the value of the currency and the central bank can avoid the necessity of intervening by buying and selling dollars to keep the currency value.

But a floating currency also permits capital to float out of a country. The fear of floating is great among totalitarian regimes and emerging countries that want to maintain control of their economy. By looking at the aussie TWI see Table 7. The role of Australia as a global trading country makes it an attractive currency to trade. The recent years of economic expansion have created strength in this currency.

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Which are coincident? After January , the data showed a decline, and by August , the decline in housing starts reached levels of Is it flat? The United States, in the face of a slowdown, saw prices up 7 percent. Where there is expectation of expansion and growth, there is the concomitant expectation of interest rates not going lower and possibly going higher.

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