Identifying Market Swings - Medium and Long Term Trading

I think it's very good.

Maybe you can ask Astellas when he is finished with the book to see if it's good or not.

Basically, I look for extreme levels in commercial and large traders in OPPOSITE directions.

Commercials represent corporations hedging against currency movements to protect profits, while the large traders represent speculation.

What you will notice is that commercials tend to BUY when the currencies move DOWN and SELL when currencies move UP, so that they are always right at reversal points and wrong through out most of the trend.

Where as the large traders are WRONG at the reversal points and correct in the "meat" of the trend.

When you see that commercials and large traders are at extreme opposite levels then this can indicate reversals.

Having said this, I think the best indicator for investor sentiment is when you look at fundamental developments and see how it impacts the price action on the charts.

So far I am about half way through Victor Sperandeo's 1993 book entitled ‘Methods of a Wall Street Master’. I was concerned that the book might be a little dated but so far this has not been the case. This is because Victor is more into discussing human psychology and how and why that brings about an economy. Of course human psychology doesn’t change so therefore the ideas and information presented in the book, so far, are timeless.

The book is by no means a light read though and if you are like me you will want to re-read every page a few times to make sure you really understand the points Victor is trying to get across. Mind you, I was like that with the Mr Men books as well. The author does expect you to have some basic knowledge of economics, and I have very little. I was not familiar with some of the terms/products mentioned, but a quick google on these will give you a sufficient definition to allow you to continue.

There is also a useful chapter on technical analysis which tells you how to plot non-subjective trendlines and spot the warning signs for a trend change.

I am currently on chapter 10 where Victor talks about the business cycle, and what he believes brought about the boom and bust cycle. I don’t think the fellow cares much for Banks.

So far, so good.

ill be buying, keep us posted

Hi Razor

From post 107 above you mention that you’ll be looking for AUDUSD to reach 0.87, or possibly 0.85 or lower before looking for a long in AUDJPY and possibly AUDUSD, but that this will depend on fundamental development and the presence of medium term [technical] exhaustion points. May I ask you to elaborate a little on how you will know when you see these two line up.

For example, with regards to the fundamentals I believe you’ll be looking for China to settle its monetary tightening policy, and that this, combined with what investors will consider to be bargain commodity prices, will lead to risk appetitive. But how will you derive fundamentally that this might be about to occur ? Will you be monitoring for news announcements coming out of China that suggest easing, and then combined with the fact that AUDUSD isn’t making lower lows (exhaustion at major support) consider that it’s time to start placing long orders ?

What if AUDUSD starts going up before AUDJPY ? Will you look for evidence that the carry-trade isn’t shifting over to the JPY just yet and therefore go long AUDUSD until there is such evidence of JPY becoming the preferred carry trade ?

Thanks as always.

Great questions, Astellas. This is exactly what you should be asking in order to start anticipating market swings.

From post 107 above you mention that you’ll be looking for AUDUSD to reach 0.87, or possibly 0.85 or lower before looking for a long in AUDJPY and possibly AUDUSD, but that this will depend on fundamental development and the presence of medium term [technical] exhaustion points. May I ask you to elaborate a little on how you will know when you see these two line up.

Let me start by saying that, right now I can only speculate as to what will happen and it's impossible to know a lot of these things ahead of time.

For instance it can be one event, like the sovereign debt problems in Europe, that trigger risk aversion and a completely different unrelated development that triggers risk appetite. So we have to keep up with current events to see what is happening. The good news is that these develop over time so there are never really any quick sudden changes.

For example, with regards to the fundamentals I believe you’ll be looking for China to settle its monetary tightening policy,

Yes, I think everyone would like to see the fallout of China's monetary tightening to make sure that the "engine" behind the global recovery will be just as strong when the global economy moves from recovery to expansion.

and that this, combined with what investors will consider to be bargain commodity prices, will lead to risk appetitive.

Yes, don't forget the European sovereign debt problems. I think many investors would like to see that these deficits are under control and aren't going to weigh down economic developments.

But most definitely, when commodity prices get low enough, it will mean low inflation, which will mean the economy has cooled down enough to continue economic expansion and thus to warrant risk taking again.

But how will you derive fundamentally that this might be about to occur ? Will you be monitoring for news announcements coming out of China that suggest easing, and then combined with the fact that AUDUSD isn’t making lower lows (exhaustion at major support) consider that it’s time to start placing long orders ?

We shouldn't limit ourselves only to the developments in China. Instead we need to look at the bigger picture and look at the different scenarios that can develop over time. By doing this, we can see all possible outcomes and anticipate likely events and how they will impact the currency markets.

What if AUDUSD starts going up before AUDJPY ? Will you look for evidence that the carry-trade isn’t shifting over to the JPY just yet and therefore go long AUDUSD until there is such evidence of JPY becoming the preferred carry trade ?

This is good and exactly what I was going to suggest.

Let's play the "What if" game and see what would need to happen in the different scenarios.

I can give you all of my opinions, but let's do this interactively. I'll ask some questions and you give me your opinions and together we can come up with some likely scenarios.

First some basics. Australia has the highest interest rates of the major economies, so it will attract a lot of foreign money into the country. Australia is also highly exposed to developments in China, so the Aussie economy can not expand without demand for it's commodities, if it doesn't come from China it needs to come from somewhere else.

OK, so we have several different outcomes that can happen at the end of the current correction when risk appetite comes back in again.

Scenario 1: AUDJPY and AUDUSD continue downwards. This is the situation we are in now during risk aversion. But let's assume that the markets move back into risk appetite and that all the other currencies are strengthening against the USD and JPY.

How would we get into a situation like this? What would need to happen in Australia? What would need to happen with China's demand for commodities from Australia?

Scenario 2: AUDUSD and AUDJPY both turn upwards. This can only happen if the markets move into risk appetite, right?

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

For instance, would the Australian economy need to expand faster or slower than US? Japan?

Scenario 3: AUDUSD heads up, AUDJPY continues down. Would this be risk appetite or risk aversion? If you said risk appetite then you are correct, AUDUSD can't appreciate in risk aversion.

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

Then US compared to Japan?

Scenario4: AUDUSD continues down, AUDJPY heads upwards. Would this be risk appetite or risk aversion? If you said risk appetite then you are correct, AUDJPY can't appreciate in risk aversion.

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

Then US compared to Japan?

If we can answer these questions, then we can see what developments will be the most probable and what we should be watching for.

So go ahead, I'll wait for your answers to continue ......

Hi guys, I realy like this thread and especially Razorjack's posts. I learn lot's of new stuff. I even read books that were recommended here.
I'll try to help to solve your scenarios :]

Scenario 1: AUDJPY and AUDUSD continue downwards. But markets move back into risk appetite and all the other currencies are strengthening against the USD and JPY.
So I think it must something bad to happen in Australia with regard to it's economy (or they have to lower interest rates rapidly). China has finished with monetary tightening and has the demand for commodities, except from Australia (for some reason).

Scenario 2: AUDUSD and AUDJPY both turn upwards.
China has finished with monetary tightening and has the demand for commodities. China's economy improves -> also Australia's economy improves. Economies of US and Japan expand much slower.

Scenario 3: AUDUSD heads up, AUDJPY continues down.
Risk appetite has raised, economies of China, Australia and Japan improve and exapand. On the other side, US economy expands much slower, or it retrogrades. Expanding Japanese economy raises the value of JPY and because of that, USD is the preferable currency for carry trades.
Japanese economy expand as fast or faster then economies of China and Australia.

Scenario4: AUDUSD continues down, AUDJPY heads upwards.
It's the same as in the scenario #3, but the position of US and Japan is switched.

Well, I think that Japanese economy won't change much. US economy is starting to expand, but pretty slowly. China will finish with monetary tightening, and it's economy will continue to expand pretty fast. I have no idea about Australia and it's economy, but I think, it will copy the situation in China. In the view of these facts, I'll tip the scenario #2 as the most feasible.

Well done Aqw3R!

Move to the head of the class! :nerd:

Just remember that China's economy has been cooling off for the past few weeks and this has reduced the pressure for further monetary tightening. There may be further tightening, but the pressure will continue to ease the further the economy cools.

The real pressing matter is the sovereign debt problems in Europe that is fueling the MEDIUM TERM risk aversion.

Hi Razor

Thanks for a great reply.

Excellent and clear answers by Aqw3R. Here’s mine. Apologies for rambling a bit but it helps if I put down my thoughts, right or wrong.

Scenario 1: AUDJPY and AUDUSD continue downwards. This is the situation we are in now during risk aversion. But let's assume that the markets move back into risk appetite and that all the other currencies are strengthening against the USD and JPY.

How would we get into a situation like this? What would need to happen in Australia? What would need to happen with China's demand for commodities from Australia?

If all other currencies start showing strength, but not AUD, then I would assume the appetite is not for commodities, but elsewhere (eg. US stocks). I would also infer that until China are happy that their inflation rate reflects steady growth then the demand for Australia’s commodities will not be as great, and therefore investors will be wary of the AUD. This condition is subject to change though so I will keep watching the events in China, and also keep an eye on other economies that are returning to growth, and may soon have commodity demands (eg. The US). I would also be aware of the Australian interest rate as expectations are built in that it will rise later in the year, but if China is not importing, then Australia will have to reconsider.

Scenario 2: AUDUSD and AUDJPY both turn upwards. This can only happen if the markets move into risk appetite, right?

If AUDUSD and AUDJPY both turn up then this must mean there is a demand for the AUD, and this will come from either increased demand for its commodities, or investors wishing to invest in its higher risk asset classes. So yes, I would expect markets to move back to risk appetite before this can happen. Actually, here’s something I don’t quite understand. Australian bonds are guaranteed by the government, and will offer a high rate of interest (if they are derived from the Countrys national interest rate). So therefore, why does money flow out of the AUD in times of Risk Aversion. I would have thought these products would give it some protection.

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

If the US economy grows at a slower rate than expected, and/or China returns to steady growth before the US gets going, then this would lead to AUD strength. I’d also be aware of changes to the carry trade once the US strengthens though.

For instance, would the Australian economy need to expand faster or slower than US? Japan?

Faster, for the reasons above. So expect both AUDJPY and AUDUSD to be strong, until the picture with the carry trade becomes clearer. Then look to be long AUDJPY long-term (if carry trade swaps). But how would the unwinding affect the AUDUSD ? I guess this would be a short-term shorting opportunity ?

Scenario 3: AUDUSD heads up, AUDJPY continues down. Would this be risk appetite or risk aversion? If you said risk appetite then you are correct, AUDUSD can't appreciate in risk aversion.

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

If AUDUSD is heading up (meaning risk appetite) and AUDJPY is heading down then it must mean the JPY economy is stronger than the US. But, if we are in a risk appetite, is it possible for the JPY to remain stronger than the AUD ? I would of thought JPY, being the ‘safest’ currency would be weaker than the AUD in times of risk appetite.

Scenario4: AUDUSD continues down, AUDJPY heads upwards. Would this be risk appetite or risk aversion? If you said risk appetite then you are correct, AUDJPY can't appreciate in risk aversion.

How would the economies in Australia and China need to develop compared to the US? compared to Japan?

Then US compared to Japan?

So we are seeing dollar strength against the AUD, but JPY weakness against the AUD. Well, we can’t be in a time of risk aversion as we’d also expect the JPY to be strong against the AUD. So I think we are probably in a time of risk appetite, the US economy is strengthening, which is leading to the carry trade unwinding, and thus the AUDUSD will go down, while the AUDJPY goes up (thanks to JPY now having the lowest interest rate).

With regards to the carry trade unwinding, how much will the expectation of the US raising interest rates have ? By this I mean - by the time the US has increased its rate higher do you think that the carry trade will already have been unwound.

I feel like I’m obsessing about the carry trade too much.

Most likely outcome.

Well, because of post 107 I’m biased, both AUDUSD and AUDJPY will go up. However, I can see the reasons why this is the most ‘probable’ outcome. Mostly that China’s monetary issues and Europe’s debt issues are medium term, and the US recovery is long-term. Australia’s economy is linked to China, and Japan isn’t going anywhere soon.

Phew ….. Time for a coffee, and then to go find someone else in the house to talk about the carry trade with.

Razor,
I got the books you recommended and I'm slowly starting to read them.
This thread is pretty good, plenty of usefull information. I read it but cannot contribute much yet.

After what happened last week, and granted that I don't have the skills to read the markets I looked for indicators that could predict price changes due to risk of aversion, I found an interesting article:
http://www.banque-france.fr/gb/publi...etud3_1206.pdf
It seems that those indexes help to predict stock crisis, but they didn't test very well for currencies
I think that your experiance in unvaluable and the analysis that you do is the real deal, but do you ever take a look to the RAI (Risk of Aversion Index)?
Thank you

Dear All ,

how we can determine when the turning point
from risk aversion to risk appetite
or when the correction is coming to an end?

for the past one week , I have not seen any major news.

is it based on price action ?

have a nice day

Well done, Astellas! I give you an A-.

You have most of it, just a couple of things that are being overlooked.

If all other currencies start showing strength, but not AUD, then I would assume the appetite is not for commodities, but elsewhere (eg. US stocks). I would also infer that until China are happy that their inflation rate reflects steady growth then the demand for Australia’s commodities will not be as great, and therefore investors will be wary of the AUD. This condition is subject to change though so I will keep watching the events in China, and also keep an eye on other economies that are returning to growth, and may soon have commodity demands (eg. The US). I would also be aware of the Australian interest rate as expectations are built in that it will rise later in the year, but if China is not importing, then Australia will have to reconsider.

Almost, there could be a demand for commodities because currencies like NZD, CAD and the Brazilian Real are also dependent on commodities. If all other currencies other than AUD went up against USD and JPY, then there would be something seriously wrong with the Aussie economy, like out of control sovereign debts or extremely high interest rates strangling the economy.

If AUDUSD and AUDJPY both turn up then this must mean there is a demand for the AUD, and this will come from either increased demand for its commodities, or investors wishing to invest in its higher risk asset classes. So yes, I would expect markets to move back to risk appetite before this can happen.

Yes, exactly. Well done.

Actually, here’s something I don’t quite understand. Australian bonds are guaranteed by the government, and will offer a high rate of interest (if they are derived from the Countrys national interest rate). So therefore, why does money flow out of the AUD in times of Risk Aversion. I would have thought these products would give it some protection.

I'll let you conclude this one with some guidance.

If you BORROW money in a low interest currency to invest in higher risk currencies or assets, you have to make sure that the profits you make from your higher risk investments are enough to cover interest rate payments at the MINIMUM otherwise you will end up losing money. Of course you would want more to make the reward worth the risk you're taking.

So in the above scenario, WHEN will you decide to move your money from the higher risk investment to a safer investment or convert to cash to pay back the loan?

If this doesn't turn on the light bulb, think a bit more about how the carry trade works.

If the US economy grows at a slower rate than expected, and/or China returns to steady growth before the US gets going, then this would lead to AUD strength. I’d also be aware of changes to the carry trade once the US strengthens though.

Just one correction, it would lead to AUD strength AGAINST USD. And the carry trade would shift if the USD strengthens enough to warrant interest rate hikes leading to US interest rates to be HIGHER than JP interest rates.

Faster, for the reasons above. So expect both AUDJPY and AUDUSD to be strong,

Yes.

until the picture with the carry trade becomes clearer. Then look to be long AUDJPY long-term (if carry trade swaps).

Yes.

But how would the unwinding affect the AUDUSD ? I guess this would be a short-term shorting opportunity ?

Are you sure about this?

We are currently in MEDIUM TERM risk aversion. Do you think that the AUDUSD carry trades have or currently are unwinding now?

Again think about when the carry trade is profitable and when it becomes unprofitable, this will help put the pieces in places.

If AUDUSD is heading up (meaning risk appetite) and AUDJPY is heading down then it must mean the JPY economy is stronger than the US.

Yes.

But, if we are in a risk appetite, is it possible for the JPY to remain stronger than the AUD ? I would of thought JPY, being the ‘safest’ currency would be weaker than the AUD in times of risk appetite.

Excellent! Now are you thinking in the right direction!

In times of risk appetite, JPY can be stronger than AUD, but the Aussie economy would have to be in very serious trouble. And in this scenario, the JP economy would have to be accelerating faster than both the Aussie and the US, and the Aussie accelerating faster than the US.

So given the current economic situation how likely is this?

So we are seeing dollar strength against the AUD, but JPY weakness against the AUD. Well, we can’t be in a time of risk aversion as we’d also expect the JPY to be strong against the AUD. So I think we are probably in a time of risk appetite, the US economy is strengthening, which is leading to the carry trade unwinding, and thus the AUDUSD will go down, while the AUDJPY goes up (thanks to JPY now having the lowest interest rate).

Not exactly the AUDUSD carry trade unwinding. Think again. We are in MEDIUM TERM risk aversion, what happened/is happening to the AUDUSD carry trade right now?

But yes, you are correct on the rest.

With regards to the carry trade unwinding, how much will the expectation of the US raising interest rates have ? By this I mean - by the time the US has increased its rate higher do you think that the carry trade will already have been unwound.

Again, I will let you come to the conclusion yourself with some guidance.

At the end of 2009, the markets were in risk appetite, with AUDUSD the preferred carry trade. In order for the Fed to raise rates we would need to see much improved employment and inflation numbers.

Take a look at the AUDUSD and AUDJPY charts when NFP was released on Dec 4th. The numbers were very positive.

How did AUDUSD and AUDJPY react?

Now describe why they reacted the way they did and you will have your answer.

I feel like I’m obsessing about the carry trade too much.

Not at all, I obsess about the carry trade all the time. The carry trade is HUGE. Most retail investors only look at the small profits made from the interest rate differential. That's because they think how much they would make with their own accounts NOT how much is made when 100s of millions are thrown into carry trades.

Combine this with the fact that not only is money made on the interest rate differential but when timed correctly on the invested currency appreciating and you can see why it is a MAJOR market moving economic force in times of risk appetite. And not only have we seen the carry trade in currencies, but also in commodities as well as higher risk assets in emerging markets.

And if you know where, when and why the carry trade is happening not only can you profit by going with the flow of the carry trade, but you can also profit from the carry trade unwinding in times of risk aversion! :nerd:

Well, because of post 107 I’m biased, both AUDUSD and AUDJPY will go up. However, I can see the reasons why this is the most ‘probable’ outcome. Mostly that China’s monetary issues and Europe’s debt issues are medium term, and the US recovery is long-term. Australia’s economy is linked to China, and Japan isn’t going anywhere soon.

The idea isn't for you to just take my word for it, but for you to learn how to do your own analysis so you can come to your own conclusion.

This will help keep you "slightly ahead" of the market and anticipate the turns before they happen.

The best part is that when you get this right, the big boys will move the markets in your favor AFTER you already have your positions in place and make you money!

My personal opinion is that if these indexes were reliable then EVERYONE would be using them.

Unfortunately, each new business cycle bull and bear market are caused by different reasons, so only monitoring certain key stats won't give an accurate assessment of the overall picture.

Having said this, I will occasionally look at yield curves, VIX, COT, etc.

The WORST thing for me would be to base my trades on indicators without doing my own analysis.

It's my analysis that will tell me which way the markets are headed and the indicators are there to only CONFIRM or REFUTE my analysis.

This is going to be individual to each trader.

For me, I would ask myself some questions:

Right now I am shorting everything except CHF, against USD and JPY. Where would prices reach a low enough level to warrant risk taking? Are the prices there yet? Are the causes of the current risk aversion still having an effect? What is the market sentiment? How are the markets reacting to good news? to bad news?

This tells me to either hold my positions or look for areas to unload my current positions and load up on positions going the other way.

What you will notice after some experience is that the markets don't shift from risk aversion to risk appetite and vice versa in just one day, it takes place over a period of time. How long of a time depends on how quickly the fundamentals develop.

Hi Razor

Thanks for your earlier reply on the AUDUSD, AUDJPY scenarios. I am most happy with an A-. I'm going to take a few days to think about and reinforce everything we covered in that post.

In the meantime I have a question related to the above post. I see that AUDUSD and EURUSD are showing some strength. So, in hunting around the news stories in an attempt to find out why I see that FX360 believe this is because of the EU summit meeting scheduled for Thursday, and that speculators/investors believe that the meeting will tackle the mounting fiscal problems in Greece. They also mention that a surprise attendance from the ECB president, Trichet, adds further weight to the seriousness of the meeting and finding a resolution.

So, my questions are:

How much weight will you give to this story ? My view is that the meeting could have a big fundamental impact, providing the members find a way forward.

How will you now manage your trailing stop on AUDUSD ? If it were me I would place it just above 0.88, as this is a round number, is above an area of previous support (now most likely resistance), is above the 61.8% fib of the last 4 hour swing, and also above the descending trendline. I also note that price has bounced off a strong area of previous daily support, 0.86, which is a likely technical place for a reversal if we are going to get one.

I might also be looking for a shorting opportunity after this meeting depending on which way the price action points.

im long AUDJPY, test of support mainly but hoping this AUD and JPY differential creates a carry trade trend which i get in on , going to scale out accordingly

I don't want to tell anyone how to trade, but I think you're stepping in front of a freight train.

IMO, it's way too early to be looking at getting in on the carry trade.

Of course I could be wrong.

You're probably right, it's just im new to using economics in forex . probably need to stop trading (demo anyway ) and learn fundamentals properly then come back

How much weight will you give to this story ? My view is that the meeting could have a big fundamental impact, providing the members find a way forward.

It's good to see that you're learning how to get information.

You need to understand that there will always be short term dips and rallies in the longer (medium and long term) trends

And there will always be reasons behind these short term movements. For instance the bailout rumors.

What you need to do is assess how this will fit into the big picture.

If there is no bailout then no change to the status quo. If there is a bailout, then how will this affect the overall picture.

If Greece gets a bailout, then what will happen with Portugal? Ireland? Spain? Italy? What about China's monetary tightening? Will this trigger risk appetite back into the markets over the MEDIUM TERM?

So IMO, this won't impact the overall picture.

How will you now manage your trailing stop on AUDUSD ? If it were me I would place it just above 0.88, as this is a round number, is above an area of previous support (now most likely resistance), is above the 61.8% fib of the last 4 hour swing, and also above the descending trendline. I also note that price has bounced off a strong area of previous daily support, 0.86, which is a likely technical place for a reversal if we are going to get one.

I think your stops are too close.

I've got my stops at 0.89 just above the last minor rally. And I'll be looking to add to my position at 0.88 right around the downtrend line.

Then if the price goes below the low 0.8575 then I'll move my stops to the high of this current rally, 0.88.

I might also be looking for a shorting opportunity after this meeting depending on which way the price action points.

This is totally up to you. I prefer to play it long term and will look for adding to my overall position.

Of course, I could be completely wrong, but the idea is to trade with the odds in my favor.

hello everyone,

I am trying buy the books mentioned by Razor, but it seems it may take some time to receive them. Is there any way to download it from the web? off course for a fee.